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Highpoint Tower Technology Inc. v. Commissioner of Internal Revenue

United States Court of Appeals, Eleventh Circuit

July 24, 2019

HIGHPOINT TOWER TECHNOLOGY INC., Petitioner - Appellant,
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent - Appellee.

          Petition for Review of a Decision of the U.S. Tax Court Agency No. 2828-16

          Before ED CARNES, Chief Judge, ANDERSON and JULIE CARNES, Circuit Judges.

          ANDERSON, CIRCUIT JUDGE

         This is 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.[1] The issue in this case is whether, under the Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA"), [2] 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.

         I. BACKGROUND

         A. Factual Background

         This 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. 255.

         In 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.

         B. Procedural Background

         Before 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.

         1. Overview of statutory scheme

         "A 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 tax matters:

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 concerning Arbitrage.

         2. Partnership-level proceedings

         In 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 misstatement."

         I.R.C. § 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 [400] 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 percent.

26 C.F.R. § 1.6662-5(g); see also Gustashaw, 696 F.3d at 1135.

         In 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 timeframe.

         3. Partner-level proceedings

         In 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 2016.[3]

         A few 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. § 6230(a).

         On July 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).

         In August 2017, Highpoint filed a Motion for Reconsideration of the Tax Court's July 17 order. In support of ...


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