Petition for Review of a Decision of the U.S. Tax Court
Agency No. 2828-16
ED CARNES, Chief Judge, ANDERSON and JULIE CARNES, Circuit
ANDERSON, CIRCUIT JUDGE
an appeal by Highpoint Tower Technology, Inc.
("Highpoint") of the Tax Court's denial of its
Motion to Restrain Collection of the gross
valuation-misstatement penalty, I.R.C. § 6662(h)(1),
which was determined to be applicable during relevant
partnership proceedings. The issue in this case is whether,
under the Tax Equity and Fiscal Responsibility Act of 1982
("TEFRA"),  a Tax Court presiding over partner-level
deficiency proceedings has jurisdiction over a gross
valuation-misstatement penalty previously determined to be
applicable at the partnership level where the partnership was
determined to be a "sham" and "lacking
economic substance." The Internal Revenue Code, as in
effect during the relevant time, applicable regulations, and
Supreme Court precedent make clear that the
valuation-misstatement penalty at issue here relates to an
adjustment to a partnership item and, consequently, is
explicitly excluded from the Tax Court's deficiency
jurisdiction. We hold that a Tax Court presiding over
partner-level deficiency proceedings does not have
jurisdiction over gross valuation-misstatement penalties
imposed against a partnership previously determined to be a
"sham" and "lacking economic substance."
We accordingly affirm the Tax Court's order denying
taxpayer's Motion to Restrain Collection to the extent it
related to the gross valuation-misstatement penalty.
case involves a tax shelter known as "Son-of-BOSS."
"Like many of its kin, this tax shelter employs a series
of transactions to create artificial financial losses that
are used to offset real financial gains, thereby reducing tax
liability." Petaluma FX Partners, LLC v.
Comm'r, 591 F.3d 649, 650 (D.C. Cir. 2010),
abrogated on other grounds by United States v.
Woods, 571 U.S. 31, 134 S.Ct. 557 (2013).
There are a number of different types of Son-of-BOSS
transactions, but what they all have in common is the
transfer of assets encumbered by significant liabilities to a
partnership, with the goal of increasing basis in that
partnership. The liabilities are usually obligations to buy
securities, and typically are not completely fixed at the
time of transfer. This may let the partnership treat the
liabilities as uncertain, which may let the partnership
ignore them in computing basis. If so, the result is that the
partners will have a basis in the partnership so great as to
provide for large-but not out-of-pocket-losses on their
individual tax returns. Enormous losses are attractive to a
select group of taxpayers-those with enormous gains.
Kligfeld Holdings v. Comm'r, 128 T.C. 192, 194
(2007); see also I.R.S. Notice 2000-44, 2000-2 C.B.
1999, Highpoint joined Arbitrage Trading, LLC
("Arbitrage") as a partner. In exchange for a
membership interest in Arbitrage, Highpoint contributed $62,
500 in cash and a pair of Euro options that it had purchased
from AIG International, Inc. By disregarding the potential
obligations under the Euro options as a potential liability,
Highpoint reported its outside basis as $13, 295, 980. A few
months after entering the partnership, Highpoint withdrew in
exchange for a liquidated distribution of the Euros. It then
sold the Euros and reported a related capital loss of $13,
111, 783 on its 1999 federal income tax return.
outlining the legal proceedings that ensued after Highpoint
filed its 1999 income tax return reflecting artificial losses
generated by its participation in this tax shelter, we first
pause to outline the statutory framework governing taxation
of partnerships at the time in question. After this overview,
we outline the partnership-level proceedings concerning
Arbitrage and the partner-level proceedings concerning
Highpoint that have spanned the twenty years or so since
Highpoint filed its income tax return reporting the losses at
issue, which ultimately resulted in this appeal.
Overview of statutory scheme
partnership does not pay federal income taxes; instead, its
taxable income and losses pass through to the partners."
United States v. Woods, 571 U.S. 31, 38, 134 S.Ct.
557, 562 (2013) (citing I.R.C. § 701). Partnerships file
informational returns, § 6031(a), and individual
partners report their shares of the partnership's income
or losses on their respective income tax returns, § 702.
Prior to TEFRA
the IRS had no way of correcting errors on a
partnership's return in a single, unified proceeding.
Instead, tax matters pertaining to all the members of a
partnership were dealt with just like tax matters pertaining
only to a single taxpayer: through deficiency proceedings at
the individual-taxpayer level. See generally
§§ 6211-6216 (2006 ed. and Supp. V). Deficiency
proceedings require the IRS to issue a separate notice of
deficiency to each taxpayer, § 6212(a) (2006 ed.), who
can file a petition in the Tax Court disputing the alleged
deficiency before paying it, § 6213(a). Having to use
deficiency proceedings for partnership-related tax matters
led to duplicative proceedings and the potential for
inconsistent treatment of partners in the same partnership.
Congress addressed those difficulties by enacting [TEFRA]. 96
Stat. 648 (codified as amended at 26 U.S.C. §§
6221-6232 (2006 ed. and Supp. V)).
Woods, 571 U.S. at 38, 134 S.Ct. at 562-63. TEFRA
created a two-step process for addressing partnership-related
First, the IRS must initiate proceedings at the partnership
level to adjust "partnership items," those relevant
to the partnership as a whole. §§ 6221, 6231(a)(3).
It must issue [a Final Partnership Administrative Adjustment]
notifying the partners of any adjustments to partnership
items, § 6223(a)(2), and the partners may seek judicial
review of those adjustments, § 6226(a)-(b). Once the
adjustments to partnership items have become final, the IRS
may undertake further proceedings at the partner level to
make any resulting "computational adjustments" in
the tax liability of the individual partners. §
6231(a)(6). Most computational adjustments may be directly
assessed against the partners, bypassing deficiency
proceedings and permitting the partners to challenge the
assessments only in post-payment refund actions. §
6230(a)(1), (c). Deficiency proceedings are still required,
however, for certain computational adjustments that are
attributable to "affected items," that is, items
that are affected by (but are not themselves) partnership
items. §§ 6230(a)(2)(A) (i), 6231(a)(5).
Id. at 39, 134 S.Ct. at 563. With this framework in
mind, we next outline the partnership-level proceedings
October 2005, the IRS issued a Notice of Final Partnership
Administrative Adjustment ("FPAA") to Arbitrage,
proposing adjustments to partnership items for the 1999 tax
year. The FPAA reported that the IRS had determined that
Arbitrage "was formed and availed of solely for the
purposes of tax avoidance by artificially overstating basis
in the partnership interests of its purported partners."
The IRS had determined that Arbitrage "was a sham"
and "lacked economic substance." Accordingly, the
IRS had determined that (a) Arbitrage would be disregarded
and all transactions engaged in by the purported partnership
would be treated as engaged in directly by its purported
partners; (b) the foreign currency options would be treated
as if never contributed to Arbitrage; (c) the purported
partners would not be treated as partners of Arbitrage; and
(d) contributions to Arbitrage would be adjusted to reflect
the partnership's or purported partner's income.
Purported partners were determined to have "not
established adjusted bases in their respective partnership
interests in an amount greater than zero." The IRS
further determined, among other things, that "a 40
percent penalty shall be imposed on the portion of any
underpayment attributable to the gross valuation
§ 6662(a) imposes a 20% accuracy-related penalty to the
portion of underpaid tax attributable to, among other things,
negligence, any substantial understatement of income tax, or
any substantial valuation misstatement. § 6662(a),
(b)(1)-(3). The penalty increases to 40% if there is a gross
valuation misstatement. § 6662(h)(1). "A gross
valuation misstatement exists if 'the value of any
property (or the adjusted basis of any property) claimed on
any return of tax . . . is  percent or more of the
amount determined to be the correct amount of such valuation
or adjusted basis (as the case may be).'"
Gustashaw v. C.I.R., 696 F.3d 1124, 1135 (11th Cir.
2012) (citing § 6662(e)(1)(A), (h)(2)(A)(i)). A treasury
regulation relatedly provides:
The value or adjusted basis claimed on a return of any
property with a correct value or adjusted basis of zero is
considered to be 400 percent or more of the correct amount.
There is a gross valuation misstatement with respect to such
property, therefore, and the applicable penalty rate is 40
26 C.F.R. § 1.6662-5(g); see also Gustashaw,
696 F.3d at 1135.
March 2006, Arbitrage sought judicial review of the FPAA
pursuant to § 6226(a). In October 2014, the Court of
Federal Claims issued an amended judgment sustaining all
adjustments of partnership items contained in the FPAA and
stating that the explanations offered in the FPAA are
"conceded to be correct." It sustained all
penalties contained in the FPAA but noted that "partners
of Arbitrage, LLC reserve their right to pursue partner-level
defenses to these penalties." This concluded the
partnership-level proceedings involving Arbitrage. We next
outline the partner-level proceedings initiated by Highpoint
as well as other interactions between the parties during that
November 2015, the IRS issued a Notice of Deficiency to
Highpoint. This notice reflected a deficiency of $5, 222,
675, based upon the following adjustments: (1) a $13, 191,
937 increase in capital gains income representing the
disallowed short-term capital loss for the sale of the Euro
option distributed from Arbitrage when Highpoint left the
partnership, (2) a disallowance of $1, 573, 727 in claimed
professional fee deductions relating to these transactions,
and (3) an increase of $72, 053 in "other income"
representing a disallowed loss from the partnership. The
notice also reflected a 40% gross valuation-misstatement
penalty pursuant to I.R.C. § 6662(h) amounting to $2,
089, 070. Highpoint filed a petition in the Tax Court for
redetermination of its deficiency in February
days later, the IRS issued a Notice of Tax Due reflecting the
same amount contained in the Notice of Deficiency as well as
$12, 755, 355.16 in interest, resulting in a total of $20,
067, 100.16 due. In June 2016, the IRS notified Highpoint
that it intended to levy Highpoint's property and apply
the proceeds to the $20, 067, 100.16 owed. A few days after
that, Highpoint filed a Motion to Restrain Collection in the
United States Tax Court. In July 2016, the IRS objected to
Highpoint's Motion to Restrain Collection. The IRS
asserted that, while the Tax Court had jurisdiction over
adjustments relating to capital gains income and the
professional fee deductions, it did not have jurisdiction
over the valuation-misstatement penalty and the adjustment to
"other income." In September 2016, the IRS moved to
dismiss the portions of the case before the Tax Court
relating to the adjustment to other income and the
valuation-misstatement penalty, asserting that neither were
subject to deficiency proceedings under I.R.C. §
17, 2017, the Tax Court ordered further briefing on the
adjustment to other income issue and denied Highpoint's
Motion to Restrain Collection to the extent that it related
to the penalty. As to the valuation-misstatement penalty, the
Tax Court stated:
In United States v. Woods, 134 S.Ct. 557, 565-566
(2013), the Supreme Court stated that where the partnership
is a sham, no partner-level determinations are needed to
determine outside basis because "once the partnerships
were deemed not to exist for tax purposes, no partner could
legitimately claim an outside basis greater than zero."
See also Greenwald v. Commissioner, 142 T.C. 308,
315 (2014). It is not possible for petitioner to have an
outside basis greater than zero in Arbitrage, a partnership
that does not exist for tax purposes. The final decision in
the partnership-level proceeding applied the section 6662
penalty. It is well settled that the penalty may be directly
assessed as a computational adjustment that we lack
jurisdiction over, notwithstanding the need for partner-level
determinations. See sec. 6230(a)(2), (c)(4);
Woods, 571 S.Ct. at 565, n.2; Thompson v.
Commissioner, T.C. Memo. 2014-154 at *8; Logan
Tr., 616 Fed.Appx. 426 (D.C. Cir. 2015).
August 2017, Highpoint filed a Motion for Reconsideration of
the Tax Court's July 17 order. In support of ...