Summary
In Field v. United States, No. 01 Civ. 3000, 2002 WL 1300249 (S.D.N.Y. June 12, 2002) (" Field I"), this Court declined to reach the merits of plaintiffs' claim, holding that the Court lacked subject matter jurisdiction over the dispute pursuant to 26 U.S.C. § 7422(h) ("[n]o action may be brought for a refund attributable to partnership items (as defined in section 6231(a)(3))...").
Summary of this case from Field v. U.S.Opinion
No. 01 Civ. 3000 (SAS)
June 12, 2002
David A. Field, Esq., New York, New York, for Plaintiffs.
Michael M. Krauss, Assistant United States Attorney, New York, New York, for Defendant.
OPINION AND ORDER
Plaintiffs David and Ellen Field seek a refund of tax-motivated transaction interest in the amount of $87,382, assessed and collected by the Internal Revenue Service ("IRS") under former section 6621(c) of the Internal Revenue Code ("I.R.C.") in connection with their investment in White Rim Oil Gas Associates ("White Rim").
This provision imposed a 120 percent interest rate for underpayments of more than $1,000 attributable to tax-motivated transactions. It was repealed under § 7721(b) of the Omnibus Budget Reconciliation Act of 1989, Pub.L. 101-239, 103 Stat. 2106, which replaced several penalty provisions with a single "accuracy related" penalty. See I.R.C. § 6662.
Defendant United States of America ("the Government") now moves for dismissal pursuant to Federal Rules of Civil Procedure 12(b)(1), for lack of subject matter jurisdiction, and 12(b)(6), for failure to state a claim upon which relief can be granted, or in the alternative, for summary judgment pursuant to Federal Rule of Civil Procedure 56. Plaintiffs cross-move for summary judgment. For the reasons set forth below, defendant's motion to dismiss pursuant to Rule 12(b)(1) is granted.
As a result, I do not address defendant's motion for dismissal under Rule 12(b)(6) or for summary judgment, and plaintiffs' cross-motion for summary judgment.
I. LEGAL STANDARD
"The court properly dismisses a case for lack of subject matter jurisdiction pursuant to Rule 12(b)(1) when the district court lacks the statutory or constitutional power to adjudicate it." Tasini v. New York Times Co., 84 F. Supp.2d 350, 353 (S.D.N.Y. 2002) (quotations, alterations omitted) Plaintiffs bear the burden of proving, by a preponderance of the evidence, that this Court has subject matter jurisdiction over their case. See Makarova v. United States, 201 F.3d 110, 113 (2d Cir. 2000).
"It is well ingrained in the law that subject-matter jurisdiction can be called into question either by challenging the sufficiency of the allegation or by challenging the accuracy of the jurisdictional facts alleged." Gwaltney of Smithfield, Ltd. v. Chesapeake Bay Found., Inc., 484 U.S. 49, 68 (1987). When faced with a Rule 12(b)(1) motion that contains a factual challenge, a court must draw jurisdictional facts from the complaint, affidavits and exhibits submitted by the parties. See Robinson v. Government of Malaysia, 269 F.3d 133, 140 (2d Cir. 2001);Kline v. Kaneko, 685 F. Supp. 386, 389-90 (S.D.N.Y. 1988).
If a defendant challenges only the legal sufficiency of a plaintiff's jurisdictional allegations, a court must take all facts alleged in the complaint as true and draw all reasonable inferences in favor of plaintiff. See Robinson, 269 F.3d at 140; Tasini, 184 F. Supp.2d at 353 (referring to such a challenge as "facial" as distinguished from a "factual attack"); Virtual Countries, Inc. v. Republic of South Africa, 148 F. Supp.2d 256, 262 (S.D.N.Y. 2001). Of course, "where evidence relevant to the jurisdictional question is before the court, the district court may refer to that evidence." Robinson, 269 F.3d at 140 (quotation marks, citation and alterations omitted).
II. FACTUAL BACKGROUND
In or about 1980, plaintiffs purchased one unit of a limited partnership called White Rim Oil Gas Associates. Stipulation of Facts ¶ 1. Plaintiffs' share was less than one percent. Id. ¶ 2. Suspecting that White Rim operated as a tax shelter, the IRS audited the partnership for the tax years 1980 through 1982. Id. ¶ 3. In 1985, the IRS notified plaintiffs of its determination that White Rim was a tax shelter, and that as a result of the disallowance of the tax-sheltered items on plaintiffs' tax returns, they owed additional taxes and tax-motivated transaction interest pursuant to I.R.C. § 6621(c) for those tax years. Id. Plaintiffs paid the principal and interest due. Id. ¶ 4.
In 1985, the IRS notified White Rim's tax matters partner that it was conducting further audits of White Rim for tax year 1983. Id. ¶ 6. The Government maintains that plaintiffs received direct notice of the 1983 audit from the IRS. See Memorandum of Law in Support of the Government's Motion to Dismiss or, in the Alternative, for Summary Judgment ("Def. Mem.") at 3; 11/28/85 IRS Letter to Plaintiff David A. Field, Ex. D to Declaration of Assistant U.S. Attorney ("AUSA") Michael M. Krauss ("Krauss Dec.").
In 1986, White Rim's tax matters partner signed IRS Form 872-0, extending the statute of limitations for the assessment of taxes on White Rim partnership items against all partners for the tax year 1983. Stipulation of Facts ¶ 7; 11/25/86 Special Consent to Extend the Time to Assess Tax Attributable to Items of a Partnership ("Form 872-0"), Ex. C to Plaintiffs' Notice of Motion. The extension provided, in pertinent part, that "the amount of any Federal income tax with respect to any person on any partnership item(s)" could be assessed up to one year "after the date on which the determination of the partnership items become final." Form 872-0 ¶ 1. Plaintiffs contend that this document did not purport to extend the statute of limitations with respect to the penalty interest. Plaintiffs' Memorandum of Law in Opposition to Defendant's Motion to Dismiss or for Summary Judgment ("Pl. Mem.") at 3.
In January 1999, the Tax Court issued a decision in a petition filed by White Rim's tax matters partner for redetermination of partnership items for the tax year 1983 following the IRS's audit and initial determination. See 1/6/99 Order and Decision ("Tax Court Decision"), Ex. A to Supplemental Declaration of AUSA Michael M. Krauss ("Krauss Supp. Dec."). White Rim was among many partnerships that composed a national litigation project called Elektra/Hemisphere. The January 1999 decision was one of a series of decisions issued in accordance with the key opinion, Krause v. Comm'r, 99 T.C. 132 (T.C. 1992), aff'd sub nom., Hildebrand v. Comm'r, 28 F.3d 1024 (10th Cir. 1994), which had served as a test case. See also Marinovich v. Comm'r, T.C.M. 1999-179 (T.C. 1999) (stipulating that White Rim's transactions were essentially identical to those of the partnerships involved in Krause).
In December 1999, pursuant to the Tax Court Decision, the IRS assessed additional taxes against plaintiffs of $17,368 plus penalty interest of $79,724.81 for tax-motivated transactions under I.R.C. § 6621(c). Stipulation of Facts ¶ 8; Second Amended Complaint ("Compl.") ¶ 5. Plaintiffs remitted these sums in July 2000, by which time the interest due had increased to the $87,382 claimed in this suit. Stipulation of Facts ¶ 9; Compl. ¶ 5. Following payment, plaintiffs filed a claim with the IRS for refund of the interest. Stipulation of Facts ¶ 10; 9/11/00 Form 843, Claim for Refund and Request for Abatement, Ex. A to Krauss Dec. The IRS declined to grant the refund, and plaintiffs subsequently brought this action. Compl. ¶¶ 6, 7.
III. DISCUSSION
The Government argues that I.R.C. § 7422(h) deprives this Court of jurisdiction to hear plaintiffs' refund suit. By the terms of the statute, "[n]o action may be brought for a refund attributable to partnership items . . . ." The Government contends that the interest penalty for tax-motivated transactions under I.R.C. § 6221(c), as well as plaintiffs' statute of limitations challenge — the basis of their claim for refund — are attributable to partnership items. As such, the Government argues, plaintiffs' action is time-barred.
A. The Statutory Framework for Partnership Taxation
Partnerships are generally not taxable entities. See I.R.C. §§ 701, 6031. "[T]he income and expenses of the partnership normally `flow through' to the several partners, who remain ultimately responsible for filling their own taxes." Transpac Drilling Venture 1982-12 v. Comm'r, 147 F.3d 221, 223 (2d Cir. 1998). At one time, administrative and judicial proceedings relating to partnership income took place at the individual partner level. See Monti v. United States, 223 F.3d 76, 78 (2d Cir. 2000). These multiple proceedings proved inefficient and often yielded inconsistent outcomes. See id. To address this problem, in 1982 Congress passed the Tax Equity and Fiscal Responsibility Act ("TEFRA"), which, among other things, requires that determinations as to the amount of tax attributable to partnership items take place in a single, partnership-level agency proceeding. See, I.R.C. §§ 6221- 6234; Monti, 223 F.3d at 78-79. Partners still pay their share of the taxes as individual taxpayers. See I.R.C. §§ 6221- 6234; Monti, 223 F.3d at 79.
Under TEFRA, the IRS must notify partners of the beginning of partnership-level administrative proceedings. See I.R.C. § 6223(a). However, in partnerships with more than 100 partners, those partners holding less then one percent interest are not entitled to such individual notice. See I.R.C. § 6223(b). Instead, the designated "tax matters partner" ("TMP"), who acts as the Partnership's liaison to the IRS, receives such notice on their behalf. See I.R.C. §§ 6231(a)(7); 6223(e)(B)(i), (g). Upon issuance of a final partnership administrative adjustment ("FPAA"), the TMP has 90 days within which to contest it by filing a petition for readjustment of partnership items in either the Tax Court, the Court of Federal Claims, or a federal district court. See I.R.C. § 6226(a). If such a suit is brought, all partners are treated as parties to the action. See I.R.C. § 6226(c). They have the right to participate if they wish, but are bound by the resulting decision whether they participate or not. See id. I.R.C. § 7453; Tax Court Rule 251 ("A decision entered by the [Tax] Court in a Partnership action shall be binding on all parties").
A partnership item is "any item required to be taken into account for the partnership's taxable year . . . [that] is more appropriately determined at the partnership level than at the partner level." I.R.C. § 6231(a)(3). These include, inter alia, "items of income, gain, loss, deduction or credit of the partnership." See 26 C.F.R. § 301.6231(a)(3)-1. A second category known as affected items includes any nonpartnership item "to the extent such item is affected by a partnership item." See I.R.C. §§ 6231(a)(4), (5). Unlike partnership items, affected items are determined at the individual partner level. See Chimblo v. Comm'r, 177 F.3d 119, 121 (2d Cir. 1999).
B. Plaintiffs' Suit Is Barred by I.R.C. § 7422(h)
1. The Penalty Interest at Issue Is "Attributable to Partnership Items"
Contrary to plaintiffs' assertions that it is neither a partnership item nor an affected item, interest assessed under I.R.C. § 6621(c) is properly classified as an affected item. See 26 C.F.R. § 301.6231(a)(5)-1; Chimblo, 177 F.3d at 121. Even though the interest is assessed against individual partners after the completion of partnership-level proceedings, I.R.C. § 7422(h) nonetheless will prohibit the action if the penalty is "attributable to partnership items."
The treatment of penalty interest was clarified by the Taxpayer Relief Act of 1997 (which does not reach the tax year in question): ". . . The tax treatment of any partnership item (and the applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to a Partnership item) shall be determined at the partnership level." See I.R.C. § 6221.
The Second Circuit has held that the determining factor in deciding if a refund claim is attributable to partnership items is whether "a decision on that issue depends on facts unique to [the partner] and unconnected with the resolution of partnership-wide issues." Monti, 223 F.3d at 82 (holding that the district court had jurisdiction over non-settling partners' suit for tax treatment consistent with that of other partners who had settled with the IRS because plaintiffs sought only to argue that they had never received the individual notice due them under the relevant statute).
As the court there noted, the words "attributable to partnership items" are vulnerable to overbroad construction, since on some level nearly all refund suits relating to partnership investments may be described as so attributable; it is, after all, the partnership's profits or losses — both partnership items — which trigger the tax liability in the first place. See id. at 82. At the same time, because partners are always individually assessed under the Code, "individual assessment is immaterial to whether or not [plaintiffs'] refund claims are attributable to partnership items. The relevant inquiry is whether the assessments, taxes, and the refund claim flow from or arise out of partnership items."See Anderson v. United States, No. C-91-3523, 1993 WL 204605, at *5 (N.D. Cal. June 3, 1993), aff'd mem., 50 F.3d 13 (9th Cir. 1995). As the Second Circuit explained, ". . . at the partnership-level proceeding, determinations are made as to the tax treatment of partnership items; that treatment is then applied to the partners on a partner-by-partner basis depending on the interest of each in the partnership." Monti, 223 F.3d at 83.
In the case at bar, however, plaintiffs' suit for refund of interest paid under I.R.C. § 6621(c) raises no individualized claims which require partner-level adjudication. Indeed, the assessment of interest under the statute is fairly mechanical. See Barlow v. Comm'r, T.C.M. 2000-339 (T.C. 2000). Once the IRS or, where the TMP has petitioned for readjustment, a court, has determined that a partnership's activities were tax-motivated, any partner whose underpayment for the relevant tax year exceeded $1,000 is liable not only for the underpaid taxes but for the accrued interest at the penalty rate. See supra note 1 (listing the statute's requirements). Plaintiffs do not contest that their underpayment exceeded $1,000. The IRS assessed and collected $17,368 in additional taxes from them for the tax year in question; this suit does not seek a refund of that money.
Moreover, plaintiffs had the right to join in the Tax Court proceeding. See I.R.C. § 6626(c). Whether or not they received individual notice from the IRS which might have prompted them to exercise that right is irrelevant, as the statute does not entitle partners holding a less than one percent share to such notice, and plaintiffs concede that they fell into that category. Thus, absent any partner-level defense to the imposition of the penalty interest, plaintiffs' suit founders on the shoals of the jurisdictional bar of I.R.C. § 7422(h). As discussed below, the statute of limitations defense they assert is a partnership item, and as such cannot invoke the jurisdiction of this court.
In cases in which individual partners have sought to recover both taxes and interest assessed after partnership proceedings, courts have routinely dismissed the claims for lack of subject matter jurisdiction pursuant to I.R.C. § 7422(h), making no exception for the interest even though it is not itself a partnership item. "[Plaintiffs'] argument cannot succeed because the underlying substantive claim concerns the propriety of the adjustments to the partnership's 1983 tax return. If [they] were to succeed in their claim, it would affect the tax liability of all of [the] partners." Kaplan v. United States, 133 F.3d 469, 473 (7th Cir. 1998) (adopted by Chimblo, 177 F.3d at 125). See also Katchis v. United States, No. 98 Civ. 2703, 1999 WL 500147, at *1 (S.D.N.Y. July 15, 1999); Klein v. United States, 86 F. Supp.2d 690 (E.D. Mich. 1999);Barnes v. United States, No. 97-57-Civ-ORL-22, 1997 WL 732594, at *1 (M.D. Fla. July 25, 1997), aff'd, 158 F.3d 587 (11th Cir. 1998); Conway v. United States, 50 Fed. Cl. 273 (Fed.Cl. 2001). That plaintiffs here limited their claim to the interest only should not change the outcome.
2. The Statute of Limitations Challenge is a Partnership-Level Defense
Plaintiffs further argue that Form 872-0, the statute of limitations extension signed by White Rim's TMP, did not cover I.R.C. § 6621(c) interest because the latter is not a partnership item. Pl. Mem. at 3. While the language of the Form may support such a claim, the Second Circuit does not. "Allowing individual taxpayers to raise a statute of limitations defense in multiple partner-level proceedings would undermine TEFRA's dual goals of centralizing the treatment of partnership items and ensuring the equal treatment of partners. Accordingly, we hold that petitioners are barred from raising their statute of limitations defense in this partner-level, affected items proceeding." Chimblo, 177 F.3d at 125. Indeed, the statute setting forth the applicable periods of limitation for IRS assessments applies the same deadlines and extensions to "any tax . . . attributable to any partnership item (or affected item)," an approach consistent with the inclusive reading of Form 872-0.See I.R.C. § 6229(a), (b).
Regardless of whether plaintiffs are correct in asserting that they could not have raised the statute of limitations defense to penalty interest, a nonpartnership item, in the Tax Court proceeding, I.R.C. § 7422(h) still precludes their suit. Pl. Mem. at 3. Plaintiffs essentially seek to relitigate the treatment of partnership items decided in the prior proceeding by casting their argument as a statute of limitations issue. This is not permitted. "Given the relationship between the tax deficiency and the penalty assessments — a deficiency determination being the necessary predicate to a penalty assessment — plaintiff's argument amounts to a collateral attack upon the partnership items determined by the Tax Court." Conway, 50 Fed. Cl. at 278-79.
Plaintiffs' reliance on N.C.F. Energy Partners v. Comm'r, 89 T.C. 741 (T.C. 1987) is misplaced. The Tax Court, holding that I.R.C. § 6621(c) interest is an affected item which can only be determined after the conclusion of the partnership proceeding, noted that penalty interest and other additions to tax "may require findings of fact peculiar to the particular partner." See id. at 745 (emphasis added). Plaintiffs have made no claim that such partner-level findings are required in this case.
As discussed above, courts do not distinguish between taxes and attributable interest sought in refund suits. Instead, the relevant question remains whether the plaintiff's challenge raises partner-level issues of fact or — as is the case in a suit contesting a statute of limitations extension — applies equally to all partners. "[W]hether a statute of limitations applicable to the partnership as a whole was waived . . . is an issue to be decided at the partnership level, since it affects all partners alike (to the extent of their proportional share)." Slovacek v. United States, 36 Fed. Cl. 250, 255 (Fed.Cl. 1996). See also Chimblo, 117 F.3d at 125; Kaplan, 133 F.3d at 473; Crowell v. Comm'r, 102 T.C. 683, 693 (T.C. 1994). Because the statute of limitations is classified as a partnership item, TEFRA requires that any challenge to its extension be raised at the partnership level or not at all. See I.R.C. §§ 6221- 6234.
As an action by individual partners for a refund attributable to partnership items, plaintiffs' suit is barred by I.R.C. § 7422(h). Accordingly, defendant's motion to dismiss pursuant to Rule 12(b)(1) is granted.
IV. CONCLUSION
For the foregoing reasons, defendant's motion to dismiss is granted. The Clerk of the Court is directed to close this case.