Klein v. U.S.

• Decision Date: 13 April 1999
• Docket Number: No. 98-72344.,98-72344.
• Parties: Emery I. KLEIN and Diane Klein, Plaintiffs, v. UNITED STATES of America, Defendants.
• Court: U.S. District Court — Eastern District of Michigan

86 F.Supp.2d 690

Emery I. KLEIN and Diane Klein, Plaintiffs, v. UNITED STATES of America, Defendants.

No. 98-72344.

United States District Court, E.D. Michigan, Southern Division.

April 13, 1999.

Lawrence S. Jackier, Jackier, Gould, Bloomfield Hills, MI, for Emery I. Klein, plaintiff.

John A. Lindquist, III, U.S. Department of Justice, Tax Division, Washington, DC, for United States of America, defendant.

OPINION AND ORDER GRANTING PARTIAL MOTION TO DISMISS

ROBERTS, District Judge.

I. Background

This tax related matter is before the Court on Defendant United States of America's Motion to Dismiss [document 19-1].¹ The Court grants Defendant's Motion.

A.

The unfortunate circumstances of this case arose from Plaintiff Emery Klein's $25,000 investment in a limited partnership, Masters Recycling Associates (hereinafter, "Masters"), in 1982. Masters purportedly leased Sentinel expanded polystyrene ("EPS") recyclers. As a result of his participation in the limited partnership, Plaintiffs Emery and Diane Klein claimed on their 1982 tax return deductions for advance rentals in the amount of $13,104, an investment tax credit of $12,833 and a business energy credit of $12,833. These deductions and credits reduced Plaintiffs' tax burden by $32,218 for 1982. For 1983 and 1984, Plaintiffs claimed deductions in connection with the limited partnership that reduced their liability by $332 and $128 respectively.

By August 1984, the Internal Revenue Service began suspecting that various recycling partnerships, including Masters, were abusive tax shelters. One such recycling limited partnership—Clearwater Group—was held to be a sham in Provizer v. Commissioner of Internal Revenue, 63 T.C.M. (CCH) 2531 (1992), aff'd 996 F.2d 1216 (6th Cir.1993) (unpublished).² Shortly thereafter, the putative tax matters partner (hereinafter, "TMP") of Masters, Sam Winer, entered into a settlement agreement with the Commissioner of Internal Revenue to adjust partnership items of Masters for the taxable years of 1982 through 1985 (Exhibit 5).³ Pursuant to the terms of the settlement, the United States Tax Court entered a Decision on February 23, 1994. As a result of that settlement and Decision, the Internal Revenue Service (hereinafter, "IRS") assessed Plaintiffs $32,678—the total of the Masters' related deductions and credits claimed for years 1982 through 1984—plus interest. They were also assessed penalties of $27,846.60. In compliance with the assessments, Plaintiffs paid the IRS $141,392.85 in 1995.

Plaintiffs then filed timely claims with the IRS for refund of the $141,392.82, which the IRS denied. This action followed. In their Complaint, Plaintiffs request judgment in their favor of $141,392.85, interest, costs and attorneys' fees. Defendant now moves to dismiss all of Plaintiffs' claims except their request for refund of the assessed negligence penalty.

B.

In large measure, Plaintiffs' claims for refund are premised upon their theory that they are not bound by the 1994 Tax Court Decision. Plaintiffs' argue that Winer acted without TMP authority when he (1) extended the deadline for the IRS to file its final partnership administrative adjustment (FPAA) (the document that detailed the IRS's rejection of Masters' taxable income and deductions); (2) filed a Petition for Readjustment of Partnership Items Under Code Section 6226 on behalf of Masters on July 30, 1989; and (3) agreed to the settlement that led to the February 1994 Tax Court Decision.

Although Plaintiffs challenge the propriety of Winer acting as TMP, they do not dispute that, ordinarily, a TMP is authorized to extend deadlines for the IRS to file the FPAA, file petitions for readjustment and agree to settlements that bind the limited partners. Such authority was bestowed when Congress enacted the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), 26 U.S.C. § 6221 et. seq. TEFRA established that the tax treatment of partnership items is determined at the partnership level⁴.

Prior to TEFRA, the IRS was required to determine partnership related tax issues on an individual partner basis.

For income tax purposes, partnerships are not taxable entities. Instead, a partnership is a conduit, in which the items of partnership income, deduction, and credit are allocated among the partners for inclusion in their respective income tax returns.

....

Since a partnership is a conduit rather than a taxable entity, adjustments in tax liability may not be made at the partnership level. Rather, adjustments are made to each partner's income tax return at the time that return is audited. A settlement agreed to by one partner with the internal revenue service is not binding on any other partner or on the service in dealing with other partners. Similarly, a judicial determination of an issue relating to a partnership item generally is conclusive only as to those partners who are parties to the proceeding.

H.R.Conf.Rep. 97-760, Pt. II, 97th Cong., 2d Sess. 467, 599. The House Conference Report further noted that the IRS was required to obtain a consent from each individual partner for which it sought to extend the three year period of limitation to assess a tax. Any consent obtained by the IRS bound only the consenting partner. Id.

TEFRA was an effort by Congress to alleviate the inequities in treatment and administrative burden that resulted from determining partnerships related tax issues at the individual partner level.

Through TEFRA, Congress sought to ensure equal treatment of partners by uniformly adjusting partners' tax liabilities and channeling any challenges to these adjustments into a single, unified proceeding. This system has the additional advantage of abating the administrative burden that would be wrought by multiple, duplicative audits and lawsuits involving numerous partners in a single partnership.

Kaplan v. U.S., 133 F.3d 469, 471 (7th Cir.1998) (citation omitted).

Under TEFRA, the IRS mails the FPAA to the TMP and to all partners who are entitled to notice. 26 U.S.C. § 6223.⁵ "[T]he function of the FPAA is to give adequate notice to affected taxpayers that [the IRS] has made a final partnership administrative adjustment for the tax years involved." Seneca, Ltd. v. Commissioner, 92 T.C. 363, 368, 1989 WL 11484 (1989). For 90 days following the mailing of the FPAA, the TMP has the exclusive right to file a petition with the Tax Court, United States District Court or Federal Court of Claims. 26 U.S.C. § 6226(a).⁶ Although the TMP has the exclusive right to file a petition with a federal court within that 90 day period, each partner during the taxable year(s) at issue is considered a party and is allowed to participate in the action. Section 6226(c). Since each partner is considered a party, each partner is bound by the result of the action. Kaplan at 471. TEFRA "thereby prevent[s] numerous lawsuits concerning the same factual and legal issues." Id.

In addition to having the authority to file a petition on behalf of the partnership, the TMP is authorized to consent to an extension of the statute of limitations for the IRS to file an assessment. The TMP's consent binds all partners. 26 U.S.C. § 6229(b)(1)(B).

In this case, Plaintiffs challenge Winer's authority to act as a TMP for Masters and to bind them to the result of the February 23, 1994 Decision.

C.

The basis of Plaintiffs' challenge to Winer's authority to act on behalf of Masters is a February 18, 1986 permanent injunction entered into against Winer that required him to resign as TMP of Masters. The history of the injunction at issue is outlined in Davenport Recycling Associates v. Commissioner, 76 T.C.M. (CCH) 562 (1998).

The Davenport opinion reveals that Winer was the general partner of seven substantially identical limited partnerships, including Masters, that leased Sentinel EPS recyclers. Id. at 563-564. In 1984, Winer came under suspicion for promoting or selling partnerships that included gross valuation overpayments. Id. at 565. The Commissioner of Internal Revenue, thus, authorized the U.S. Department of Justice ("DOJ") to seek injunctions against Winer. Id. Pursuant to an agreement ultimately reached between the DOJ and Winer, the United State District Court for the Middle District of Florida entered a permanent injunction on February 18, 1986 which ordered Winer to resign as TMP of the partnerships and to send a letter to all partners notifying them of his resignation. Id. at 567. The letter was also required to provide the name and address of a new TMP. Id.

According to Plaintiffs, the successor TMP for Masters was E.B.A. Investment Co. ("E.B.A."). Plaintiffs further allege that E.B.A. was not consulted before it was appointed TMP and that the government was solely responsible for selecting E.B.A. The Davenport Court found that Winer and his attorney, not the government, selected the successor TMPs. Id. at 568. At any rate, it is undisputed that E.B.A. refused to act as TMP for Masters. Id. and Complaint at ¶ 20. As a result, according to Plaintiffs, the government realized that it lacked a functioning TMP and sought to have Winer reinstated as TMP for the government's own administrative purposes. Thus, on August 11, 1986, the government and Winer filed a Joint Motion for Relief from Final Judgment of Permanent Injunction, which was granted on September 17, 1986. Id. at 570-571. According to Davenport, the September 17 Order authorized Winer to "act as tax matters partner for the purpose of providing administrative services to the *** partnerships."⁷ Id. at 571.

Plaintiffs allege that because Winer resigned as TMP on February 18 and because the September 17 Order limited Winer's TMP authority to providing administrative services, he was not authorized to sign Internal Revenue Service consent forms, Forms 872-P, extending the statute of limitations within which the IRS could issue the FPAA. Nonetheless, Winer signed Forms 872-P on behalf of Masters (Complaint at ¶¶ 24-27). Plain...