Seaview Trading, LLC v. Comm'r of Internal Revenue

• Court: U.S. Court of Appeals — Ninth Circuit
• Writing for the Court: M. SMITH, Circuit Judge
• Citation: Seaview Trading, LLC v. Comm'r of Internal Revenue, 858 F.3d 1281 (9th Cir. 2017)
• Decision Date: 07 June 2017
• Docket Number: No. 15-71330,15-71330
• Parties: SEAVIEW TRADING, LLC and Robert Kotick, Petitioners–Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent–Appellee.

858 F.3d 1281

SEAVIEW TRADING, LLC and Robert Kotick, Petitioners–Appellants,

v.COMMISSIONER OF INTERNAL REVENUE, Respondent–Appellee.

No. 15-71330

United States Court of Appeals, Ninth Circuit.

Argued and Submitted April 7, 2017, Pasadena, California

Filed June 7, 2017

Daniel Benjamin Levin (argued), Jessica Barclay–Strobel, and Ronald L. Olson, Munger Tolles & Olson LLP, Los Angeles, California; David W. Foster and Armando Gomez, Skadden Arps Slate Meagher & Flom LLP, Washington, D.C.; for Petitioners–Appellants.

Andrew Weiner (argued) and Richard Farber, Attorneys; Tax Division, United States Department of Justice, Washington, D.C.; for Respondent–Appellee.

Before: MILAN D. SMITH, JR. and N. RANDY SMITH, Circuit Judges, and GARY FEINERMAN, District Judge.^*

OPINION

M. SMITH, Circuit Judge:

This appeal presents the question of whether entities that are disregarded for federal tax purposes may nevertheless constitute pass-thru partners under 26 U.S.C. § 6231(a)(9) such that their partnership is not eligible for the small-partnership exception contained in § 6231. For the reasons stated in this opinion, we hold that an entity's disregarded status does not preclude its classification as a pass-thru partner.

FACTUAL AND PROCEDURAL BACKGROUND

In 2001, Robert Kotick (Kotick) and his father Charles Kotick (C. Kotick) formed a Delaware limited liability company (LLC), Seaview Trading, LLC (Seaview). Federal tax regulations treat Seaview as a partnership. See Treas. Reg. § 301.7701–3(b)(1)(i). The Koticks each held their respective interests in Seaview through Delaware LLCs: AGK Investments LLC (AGK), owned wholly by Kotick, and KMC Investments LLC (KMC), owned wholly by C. Kotick.

Seaview acquired an interest in a common trust fund, which in 2001 reported a loss that was allocated to its investors—including Seaview. Kotick reported the loss arising from Seaview's interest in the trust fund on his 2001 Form 1040. In 2004, the Internal Revenue Service (IRS) audited Kotick's 2001 Form 1040, at which time it became aware of Kotick's claimed loss resulting from Seaview's investment. At the conclusion of the audit, the IRS disallowed certain transaction expenses relating to Seaview, and assessed additional taxes. It did not, however, disallow the loss that Kotick had reported on his individual tax return as a result of Seaview's trust investment. The statute of limitations for Kotick's 2001 Form 1040 expired in July 2005. 26 U.S.C. § 6501(a).

The IRS began an audit of Seaview in October 2005. Five years later, in October 2010, the IRS issued a final partnership administrative adjustment (FPAA) notice disallowing the loss from Seaview's trust investment and imposing penalties. Kotick filed a petition in tax court on behalf of Seaview challenging the IRS's notice in regard to Seaview's 2001 taxes. Kotick argued that the IRS's notice was invalid because Seaview was exempt from the otherwise-applicable partnership audit pursuant to the small-partnership exception set forth at 26 U.S.C. § 6231(a)(1)(B)(i). AGK filed a separate petition seeking the same relief.

The IRS moved to dismiss Kotick's petition for lack of jurisdiction, arguing that (1) Seaview did not fall within the § 6231 small-partnership exception, and (2) Kotick lacked standing to file the petition on behalf of Seaview because he was not Seaview's tax matters partner. In March 2015, the tax court granted the IRS's motion. Kotick then filed this appeal.

JURISDICTION AND STANDARD OF REVIEW

On March 11, 2015, the tax court issued an order dismissing Kotick's petition for lack of jurisdiction. That order constituted a final judgment as to all claims and all parties. Kotick timely noticed his appeal on April 30, 2015. 26 U.S.C. § 7483 ; Fed. R. App. P. 13(a). We have jurisdiction pursuant to 26 U.S.C. § 7482(a). We review de novo the tax court's dismissal of a petition for lack of jurisdiction. Gorospe v. Comm'r , 451 F.3d 966, 968 (9th Cir. 2006).

ANALYSIS

I. Disregarded Entities and the Tax Equity and Fiscal Responsibility Act of 1982

Under Treasury Regulation § 301.7701–3, "an eligible entity with a single owner can elect to be classified as an association or to be disregarded as an entity separate from its owner." Subsection (b)(1)(ii) of the regulation provides that a domestic eligible entity with a single owner will be "[d]isregarded as an entity separate from its owner" by default, unless the entity chooses otherwise. The activities of a disregarded entity "are treated in the same manner as a sole proprietorship, branch, or division of the owner," except in regard to the application of certain special employment and excise tax rules. Treas. Reg. § 301.7701–2(a).

The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. No. 97–248, § 1(a), 96. Stat. 324, sets forth unified audit and litigation procedures applicable to partnerships. See 26 U.S.C. §§ 6221 –6234. In a partnership-level proceeding, a tax court has jurisdiction to determine

all partnership items of the partnership for the partnership taxable year to which the notice of final partnership administrative adjustment relates, the proper allocation of such items among the partners, and the applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to a partnership item.

Id. at § 6226(f). Under the exception provided by § 6231(a)(1)(B)(i), an entity will not be considered a "partnership" for the purposes of TEFRA's audit procedures if the entity has "10 or fewer partners each of whom is an individual ..., a C corporation, or an estate of a deceased partner."

Treasury Regulations provide a caveat to the exception contained in § 6231 : The small-partnership exception in § 6231(a)(1)(B)(i)"does not apply to a partnership for a taxable year if any partner in the partnership during that taxable year is a pass-thru partner as defined in section 6231(a)(9)." Treas. Reg. § 301.6231(a)(1)–1(a)(2). TEFRA defines a pass-thru partner as any "partnership, estate, trust, S corporation, nominee, or other similar person through whom other persons hold an interest in the partnership." 26 U.S.C. § 6231(a)(9).

II. Disregarded Single–Member LLCs Constitute Pass–Thru Partners

Appellants argue that under § 301.7701–3, the so-called "check-the-box" regulation, AGK and KMC were disregarded entities treated as sole proprietorships of their respective individual owners, and that consequently they could not constitute pass-thru partners within the meaning of Treasury Regulation § 301.6231(a)(1)–1. Seaview is correct in regard to its first contention—AGK and KMC were disregarded entities—but their disregarded status for the purpose of federal taxes does not preclude their classification as pass-thru partners under § 301.6231(a)(1)–1. To the contrary, every source cited by the parties has found that single-member LLCs qualify as pass-thru partners, regardless of their elected classification under § 301.7701–3. Seaview has provided no compelling reason for us to diverge from this consensus.

The IRS directly addressed the question of whether a disregarded entity may constitute a pass-thru partner in Revenue Ruling 2004–88, 2004–2 C.B. 165.¹ We have previously applied Skidmore deference to revenue rulings. See Omohundro v. United States , 300 F.3d 1065, 1068 (9th Cir. 2002) (per curiam).² Under Skidmore v. Swift & Co. , 323 U.S. 134, 65 S.Ct. 161, 89 L.Ed. 124 (1944), and the Supreme Court's decision in United States v. Mead Corp. , 533 U.S. 218, 121 S.Ct. 2164, 150 L.Ed.2d 292 (2001), an agency's ruling "is eligible to claim respect according to its persuasiveness." 533 U.S. at 221, 121 S.Ct. 2164 (citing generally Skidmore , 323 U.S. 134, 65 S.Ct. 161, 89 L.Ed. 124 ). We consider multiple factors when exercising Skidmore review of agency action, including "the thoroughness and validity of the agency's reasoning, the consistency of the agency's interpretation, the formality of the agency's action, and all those factors that give it the power to persuade, if lacking the power to control." Tualatin Valley Builders Supply, Inc. v. United States , 522 F.3d 937, 942 (9th Cir. 2008) ; see also Tablada v. Thomas , 533 F.3d 800, 806–08 (9th Cir. 2008) (finding Skidmore deference warranted in light of the "rational validity" and consistent application of an agency's position, despite the existence of reasonable alternative interpretations).

Applying Skidmore 's framework for reviewing agency rulings, Revenue Ruling 2004–88 carries persuasive, if not decisive, force, and therefore warrants judicial deference. Ruling 2004–88 concededly does not contain extensive discussion of its analysis; but the concise nature of its reasoning does not undercut its basic logic. Ruling 2004–88 starts by emphasizing that the definition of a "pass-thru" partner contained in § 6231(a)(9) includes "partnership[s], estate[s], trust[s], S corporation[s], nominee[s] or [an]other similar person through whom other persons hold an interest in the partnership ." Rev. Rul. 2004–88 (quoting § 6231(a)(9) ). In other words, the definition expressly contemplates its application beyond the specific enumerated forms. Single-member LLCs are indisputably entities "through whom other persons hold an interest in [a] partnership." The question, therefore, is whether a single-member LLC constitutes a "similar person" in respect to the enumerated entities. Ruling 2004–88 holds that the requisite similarity exists when "legal title to a partnership interest is held in the name of a person other than the ultimate owner." Id . In support of this holding, Ruling 2004–88 cites White v. Commissioner , 62 T.C.M. (CCH) 1181 (1991), in which the custodian for minor children was not a pass-thru partner because it did not hold legal title to the children's partnership interests. Ruling 2004–88 contrasts that result with the outcome in Primco Management Co. v. Commissioner , 74 T.C.M. (CCH) 177 (1997), in which a grantor trust holding legal title to an interest in an...