Shirley v. United States

Decision Date08 February 2013
Docket NumberCIVIL ACTION NO. 3:11-CV-323-DW
CourtU.S. District Court — Western District of Kentucky

This tax refund lawsuit raises novel and complex jurisdictional issues under the Tax Equity and Financial Security Act of 1982 (TEFRA), Pub.L. No. 97-248, 96 Stat. 324, See 26 U.S.C. §§6221-6231. The suit also arises in what can only be described as a singularly unique set of factual circumstances. Upon consideration of the parties' well-drafted briefs and oral argument, the Court concludes that it lacks subject matter jurisdiction under TEFRA to consider the Plaintiffs' refund lawsuit given the requirements of 26 U.S.C. §7422(h).1 Fundamental to this conclusion is the view of the Court that the Plaintiffs cannot prove under the existing case law of the Sixth Circuit that Fountain Holding, LLC, filed the amended partnership tax return for the 2004 tax year that contains the net operating loss that the Plaintiffs now seek to carry back to their 2002 tax year return.

The Material Facts.

The Plaintiffs are a married couple, Jerry G. Shirley and his wife, Nina R. Shirley. The Shirleys are residents of Scott County, Kentucky. Their lawsuit is an effort to recover an additional federal tax refund of $244,844 for the 2002 tax year. They allege that this claimedrefund arises from the carry back of a 2004 net operating loss (NOL) incurred by a limited liability company, Fountain Holding, LLC, which is treated as a partnership for federal tax purposes.

Fountain Holding itself is comprised of four business trusts. Each of the trusts is apparently named for a member of the Shirley family with the Steve Shirley Business Trust holding the largest ownership interest and designation as "tax matters partner" under 26 U.S.C. §6231(a)(7).2 In December of 2001, Jerry Shirley became the trustee, grantor and sole beneficiary of the Jerry Shirley Business Trust (Trust), then organized as a complex trust. The Trust filed its first federal trust return, IRS Form 1041, in December of 2002, which resulted in a $39,023 overpayment that was applied to the Trust's 2003 estimated federal income tax.

The Shirleys filed their joint federal tax return for the 2002 tax year, IRS Form 1040, on March 14, 2003, and obtained an initial tax refund of $225,968 based on an overpayment of $256,024 of which $30,056 was applied to their own 2003 estimated federal income tax. The following year, on Feb. 14, 2004, the Trust filed an amended IRS Form 1041Xtax return to reflect its change from a complex trust to a grantor trust. By this amended return the Trust requested that $95,600 in previously made payments on its original 2002 trust return be applied to Jerry Shirley as the beneficiary of the Trust.

The following month, on March 24, 2004, Jerry and Nina Shirley filed a first amended joint individual tax return, IRS form 1040X, for the 2002 tax year to reflect the changes that occurred when the Trust changed from a complex to a grantor trust. On this first amended 2002 Form 1040X return, the Shirleys reflected an overpayment of $40,031 which they requested be applied to their 2003 estimated federal income tax. On Aug. 11, 2005, the couple filed their joint individual federal income tax returns for the 2004 tax year showing a total overpayment of $254,137 to be refunded to them.

At this point, the tax history of the Shirleys and Fountain Holding, LLC, becomes more convoluted. According to the Shirleys, on Jan. 9, 2006, Fountain Holding allegedly filed an amended 2004 partnership tax return, IRS Form 1065X, to claim a substantial net operating loss to be passed on to the four business trusts. This 2004 amended partnership return, according to the Shirleys, was prepared by their CPA, the same individual who prepared their personal tax returns and the returns for the four trusts. The Shirleys have provided the Government and the Court with a copy of the 2004 amended partnership return for Fountain Holding.

Unfortunately, the IRS has no record of ever having received this critical 2004 amended partnership tax return. As the Government explained at oral argument, nowhere in the standard computer records of the IRS is there any indication that this particular amended partnership return was ever filed with the Service. Yet, as noted by the Shirleys' counsel, as late as 2009, the Shirleys' accountant continued to send correspondence to the IRS to inquire aboutthe status of the Shirleys' NOL carry back refund claim and the amended partnership return.

No dispute exists that on Jan. 11, 2006, the Shirleys filed an amended joint individual federal income tax return, IRS Form 1040X, for the 2004 tax year to reflect additional losses reported to the Trust on the Trust's amended 2004 trust return. The amended 2004 individual tax return filed by the Shirleys identified a NOL of $668,625 for the 2004 tax year (the "2004 NOL carry back"). Two days later, on Jan. 13, 2006, the Shirleys filed a second, amended joint individual federal income tax return, IRS Form 1040X, for the 2002 tax year to reflect changes to income related to the 2004 NOL carry back. These changes reflect an additional overpayment by the Shirleys for the 2002 tax year of $244,844, the refund which the Shirleys now seek to obtain by their present lawsuit.

The following month on Feb. 26, 2006, the Trust filed an amended IRS Form 1041X for the 2004 tax year after it received an amended Schedule K-1 from Fountain Holding for the 2004 tax year. This amended K-1 reported the additional losses mentioned above. Five months later on July 31, 2006, the tax representative for the couple mailed to the IRS a copy of the amended 2004 trust return as shown by a copy of the certified mail receipt and return receipt. No certified mail receipt or return receipt exists for the amended 2004 partnership tax return of Fountain Holding claiming the NOL that is the ultimate basis for the Shirleys' $244,844 refund claim.

While the above events were occurring in 2006, the IRS began an audit of the amended 2002 individual tax return of the tax matters partner (TMP) for Fountain Holding, Steve Shirley. The audit resulted in a tax court proceeding. During the course of that proceeding, the IRS and Steve Shirley apparently came to a resolution of the dispute, which thePlaintiffs maintain included a refund to Steve Shirley based on his proportional share of the 2004 net operating loss of Fountain Holding, which the Plaintiffs claim in their own proportionate share as the basis for their carry back on their 2002 tax year.

As fate would have it, little is known about what occurred during the tax court proceedings that involve Steve Shirley and the 2004 NOL of Fountain Holding. At most, it was suggested at oral argument that possibly, as part of a global settlement, the representatives of the IRS involved agreed to approve Steve Shirley's NOL carry back refund claim, perhaps based upon their examination of the apparently unfiled, amended 2004 partnership return for Fountain Holding. Such suggestion is only that - - a suggestion - - as the IRS is unable to locate the audit file for the Steve Shirley tax audit. Given the present posture of the case, which is before the Court on a motion to dismiss for lack of subject matter jurisdiction under Rule 12(b)(1) of the Federal Rules of Civil Procedure, the Court shall assume all presented facts in a fashion most favorable to the nonmoving party, the Plaintiffs.3

Legal Analysis

Under the doctrine of sovereign immunity, lawsuits may not be brought againstthe United States unless it has waived immunity. United States v. Testan, 424, U.S. 392, 399 (1976). In the ordinary, nonpartnership tax refund case, the Government by statute has broadly waived its immunity via 28 U.S.C. §1346(a)(1).4 See United States v. Forma, 42 F.3d 759, 763 (2nd Cir. 1994). The broadly-worded language of §1346(a)(1), however, "must be read in conformity with other statutory provisions that qualify a taxpayer's right to bring a refund suit upon compliance with certain conditions." United States v. Dalm, 494 U.S. 596, 601 (1990). One specific statutory provision which qualifies the right of a taxpayer to bring a refund suit is the previously cited 26 U.S.C. §7422(h), which states that "no action may be brought for a refund attributable to partnership items, except as provided for in section 6228(b)5 or section6230(c)."6


The upshot of the quoted language is that unless the Shirleys can carry their burden to prove that their present tax refund suit falls within either of the two statutory exceptions of §§6228(b) or 6230(c), or otherwise falls entirely outside of TEFRA and §7422(h), their refund claim will be held to be barred by the doctrine of sovereign immunity so that the Court will lack subject matter jurisdiction. See Greer v. United States, Case No. 93-CV-194, 2004 WL 1192525 at *4 (E.D. Ky. Apr. 15, 2004) (citing Williams v. United States, 1997 WL 375209 (E.D. Ky. 1997), affirmed, 162 F.3d 30, 1998 WL 537579 (6th Cir. 1998)).

To better understand the nature of the sovereign immunity challenge presented to the Shirleys, one must first understand the tax treatment of partnerships both before and after 1982, the year in which TEFRA became law. This task, as least insofar as it relates to the provisions of TEFRA, is perhaps no easy goal, given the apt description of TEFRA as a "statutory labyrinth." See Prati v. United States, 81 Fed. Cl. 422, 427 (2008) (Block, J.). Nonetheless, such an explanation of the pre- and post-TEFRA treatment of partnership taxation is important to the proper outcome of this case.

Perhaps the most fundamental principle in this area of taxation is that a partnership itself is not liable at the entity level for the payment of federal income taxes. See 26 U.S.C. §701. See Desmet v. C.I.R., 581 F.3d 297, 301 (6th Cir. 2009)(explaining partnership taxation fundamentals under...

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