PAA Management, Ltd. v. U.S.

• Citation: 962 F.2d 212
• Decision Date: 27 April 1992
• Docket Number: D,No. 982,No. 91-6275,982,91-6275
• Parties: -1166, 92-1 USTC P 50,261 PAA MANAGEMENT, LTD., Petitioner-Appellee, v. UNITED STATES of America, Respondent-Appellant. ocket
• Court: United States Courts of Appeals. United States Court of Appeals (2nd Circuit)

Page 212

962 F.2d 212

69 A.F.T.R.2d 92-1166, 92-1 USTC P 50,261

PAA MANAGEMENT, LTD., Petitioner-Appellee, v. UNITED STATES of America, Respondent-Appellant.

No. 982, Docket No. 91-6275.

United States Court of Appeals Second Circuit.

Argued Feb. 13, 1992.

Decided April 27, 1992.

Randall A. Hack, Chicago, Ill. (Barbara M. Angus, Kirkland & Ellis, of counsel), for petitioner-appellee.

David E. Sipiora, Asst. U.S. Atty., New York City (Otto G. Obermaier, U.S. Atty., Gabriel W. Gorenstein, Asst. U.S. Atty., of counsel), for respondent-appellant.

Before: FEINBERG and MINER, Circuit Judges, and HAIGHT, District Judge. ^*

MINER, Circuit Judge:

Respondent-appellant United States of America appeals from an order of the United States District Court for the Southern District of New York (Knapp, J.). The order quashed administrative summonses, issued by the Internal Revenue Service ("IRS") pursuant to section 7602 of the Internal Revenue Code of 1986, 26 U.S.C. §§ 1 et seq. ("I.R.C." or "Code"), to petitioner-appellee PAA Management, Ltd. ("PAAM"), and to Arthur Andersen & Co., Spear, Leeds & Kellogg, Wagner Stott Clearing Corp., and Merrill Lynch, Pierce, Fenner & Smith. PAAM is the general partner, and "tax matters partner" under the Code, see I.R.C. § 6231(a)(7), of Professional Arbitrage Associates ("PAA"), a partnership organized under the laws of Bermuda. The other entities to which summonses were issued are "third-party recordkeepers" under the Code with respect to PAA, see I.R.C. § 7609(a)(3). The summonses required production of certain documents, in the possession of the summonsed parties and relating to transactions undertaken by PAA, in connection with an IRS administrative investigation of PAA and its partners for the 1983-85 tax years. The return dates of the summonses fell on or after the date on which a final partnership administrative adjustment ("FPAA") was sent by the IRS to each of PAA's partners for each of the 1983-85 tax years. An FPAA is somewhat analogous to a tax deficiency notice for an individual. See I.R.C. § 6223(a).

In quashing the summonses, the district court emphasized the timing of the return dates, and relied primarily on section 6223(f) of the Code, which provides that only one FPAA may be sent to each partner for each tax year in question. Judge Knapp apparently construed section 6223(f) to mean that the IRS's determination of partner tax liability set forth in the FPAA is not subject to subsequent revision, and that the issuance of an FPAA necessarily brings to an end the investigative role of the IRS. It further appears that the district court concluded, for these reasons, that the summonses issued in this case could serve no legitimate purpose and/or sought irrelevant information, and that section 6223(f) constitutes an express limitation on the summons authority of the IRS under circumstances such as those revealed here. Judge Knapp also attached importance to a collateral Tax Court proceeding commenced by PAAM challenging the FPAAs, and the ability of the IRS in that proceeding to discover the information sought by the summonses.

For the reasons that follow, we disagree with the district court's view of the effects on this case of section 6223(f) and the collateral Tax Court proceeding. Accordingly, the order of the district court quashing the summonses is reversed, and the case is remanded for further proceedings consistent with this opinion.

BACKGROUND

Partnerships such as PAA, unlike individuals and corporations, are not taxable entities under the Code and do not pay taxes as such. See I.R.C. § 701. Instead, each partner pays taxes only as an individual, based on the portion of partnership income allocable to him (as well as on such other income as may be earned by the partner from non-partnership activities). See id. However, income derived from the partnership, called "partnership item[s]" by the Code, see I.R.C. § 6231(a)(3), generally must be determined at the partnership level as if the partnership were a taxable entity, see I.R.C. § 6221, and in that connection, partnerships are required to file informational tax returns, see I.R.C. § 6031. Each partner's individual tax return must be consistent, as to partnership items, with the partnership's return. See I.R.C. § 6222(a).

Administrative and judicial proceedings relating to the determination of partnership items are separate under the Code from those relating to the determination of individual income. See I.R.C. §§ 6221-6233 (Subchapter C of Chapter 63 of Subtitle F, relating to partnership items, and added to the Code by the Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA")); I.R.C. §§ 6211-6216 (Subchapter B of Chapter 63 of Subtitle F, relating to individual deficiencies). While the Code does not specifically define the FPAA, it is evident from the context, structure and purpose of the applicable Code provisions that an FPAA gives notice of the amount of partnership income properly allocable, in the view of the IRS, to each partner for individual tax purposes. See also Clovis I v. Commissioner, 88 T.C. 980 (1987) (FPAA is notice that IRS has made final administrative determination for partnership items for particular tax years, as individual deficiency notice is notice of final administrative determination of individual tax liability). In general, an FPAA must be sent to each partner. See I.R.C. § 6223(a). The tax matters partner of the partnership, being the one designated to handle all tax matters of the partnership, may then petition for judicial review of the partnership items of income as determined in the FPAA. See I.R.C. § 6226(a). Such partnership level proceedings, the subject of Subchapter C, must be completed before an individual tax deficiency attributable to any partnership item may be determined under Subchapter B. See I.R.C. § 6225. Likewise, proceedings relating to individual taxpayers involve a notice of deficiency sent by the IRS to the taxpayer, setting forth the amount of tax owing, see I.R.C. §§ 6211, 6212, which the taxpayer may then challenge by petition to the Tax Court, see I.R.C. § 6213.

The IRS is authorized by the Code to make administrative "inquiries, determinations, and assessments" relating to all internal revenue taxes owing but unpaid. See I.R.C. § 6201. The IRS further is authorized, "[f]or the purpose of ascertaining the correctness of any return ... [or] determining the liability of any person for any internal revenue tax" to "examine any books, papers, records, or other data which may be relevant or material." I.R.C. § 7602(a)(1). In connection with its investigative authority, the IRS is empowered to issue administrative summonses to "any person having possession, custody, or care of books of account containing entries relating to the business of the [taxpayer or other entity being investigated]." I.R.C. § 7602(a)(2). A summons may direct production by the summonsed party of "such books, papers, records, or other data ... as may be relevant or material." Id. Summonses issued to third-parties are subject to some additional procedural requirements added by the TEFRA. See I.R.C. § 7609.

Against this statutory backdrop, the IRS began in the spring of 1986 what became a long examination of PAA and its more than 200 partners, focusing on the 1983-1985 tax years. PAA is engaged in the business of arbitrage and other forms of securities trading. Accordingly, the IRS particularly scrutinized the gains and losses attributable to PAA's trading of stocks, stock options and other securities, as well as certain interest expenses claimed by PAA in connection with the financing of its securities transactions. PAA provided numerous requested documents to the IRS, including analyses that PAA was required to create on its own. Over the years, and as permitted by the Code, PAA also agreed to extend the statute of limitations period applicable to each partner for assessment of individual deficiencies. See I.R.C. § 6229(b). However, on October 24, 1990, PAA refused in writing to extend the limitations period beyond December 31, 1990, the expiration date then in effect.

Between December 18 and December 28, 1990, the IRS issued summonses for additional documents to PAAM, as well as third-party summonses to the third-party recordkeepers, all of whom possessed documents relating to PAA securities transactions. The return date of the PAAM summons was December 28, 1990, and the return dates of the third-party summonses fell in January 1991. On December 28, 1990, the IRS issued an FPAA to each PAA partner, relating to the 1983-85 tax years.

Neither PAAM nor any of the third-party recordkeepers complied with the summonses. Instead, PAAM moved in the district court, on January 10, 1991, for an order quashing the summonses, and the government cross-moved for enforcement. On March 5, 1991, PAAM, as tax matters partner, petitioned the Tax Court for review of the FPAAs. In a brief Memorandum and Order entered on July 29, 1991, the district court granted PAAM's motion to quash the summonses (although it did not expressly deny the government's cross-motion for enforcement). The district court denied the government's motion for reargument on August 30, 1991, and this appeal followed. The Tax Court proceedings presently are continuing in the regular course.

DISCUSSION

In order to make a prima facie case for enforcement of a summons under section 7602 of the Code, the government must show that (i) a legitimate purpose exists for the investigation, (ii) the summons may be relevant to that purpose, (iii) the information sought is not already in the possession of the government, and (iv) the procedural and administrative steps required by the Code for serving a summons have been followed. See United States v. Powell, 379 U.S. 48, 57-58, 85 S.Ct. 248, 254-55, 13 L.Ed.2d 112 (1964). The burden then shifts to the taxpayer or other entity challenging the summons to object to the summons " 'on...