Tax Court Has Jurisdiction over Penalty Relating to Inconsistent Partnership Reporting

(Parker Tax Publishing May 2017)

The Tax Court rejected arguments by a partner in a partnership that it lacked jurisdiction over a penalty relating to the partner's inconsistent reporting of partnership items and thus deficiency procedures did not apply. According to the court, since there were no adjustments to partnership items, deficiency procedures applied to the penalties asserted by the IRS. Malone v. Comm'r, 146 T.C. No. 16 (2017).

Bernard Malone was a partner of MBJ Mortgage Services America, Ltd (MBJ), a partnership that is subject to the unified audit and litigation procedures of Code Sec. 6220 through Code Sec. 6234 (i.e., TEFRA provisions). On its 2005 Form 1065, U.S. Return of Partnership Income, MBJ reported installment sales of partnership assets and reported as Mr. Malone's distributive share from those sales $3,200,748 of ordinary income and $3,547,326 of net long-term capital gain.

On their joint 2005 Form 1040, Malone and his wife failed to report Mr. Malone's distributive share from those sales but reported $4,526,897 of long-term capital gain from the sale of Mr. Malone's partnership interest in MBJ. With respect to Mr. Malone's distributive share, the Malones did not file a Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request, or otherwise notify the IRS that they were taking a position inconsistent with that reported by MBJ. The Malones also claimed repairs and maintenance and bad debt deductions, both of which are unrelated to MBJ.

In the notice of deficiency, the IRS adjusted the Malones' return to include the partnership items reported by MBJ but omitted by the Malones, disallowed the reported net long-term capital gain because Mr. Malone did not sell his partnership interest in 2005, and disallowed the claimed repairs and maintenance and bad debt deductions. The IRS asserted a negligence penalty under Code Sec. 6662 relating to the Malones failure to report partnership items. The Malones disagreed with the IRS's assessment and took their case to the Tax Court.

Before the Tax Court, the Malones moved to dismiss the penalty from the case, asserting that the Tax Court lacked jurisdiction over a penalty relating to their inconsistent reporting of partnership items. Under Code Sec. 6230(a)(2)(A)(i), deficiency procedures do not apply to penalties, additions to tax, and additional amounts that relate to adjustments to partnership items.

The Malones argued that the inconsistently reported partnership items on their 2005 Form 1040 were "adjusted" within the meaning of Code Sec. 6230(a)(2)(A)(i). The Tax Court had to determine whether the deficiency procedures apply to a Code Sec. 6662 accuracy-related penalty for negligence imposed solely because of a partner's inconsistent reporting of partnership items.

The Tax Court held that, regardless of whether the Code Sec. 6662(a) and Code Sec. 6662(b)(1) negligence penalty is a nonpartnership item or a factual affected item unrelated to an adjustment to a partnership item, deficiency procedures apply to the determination of the penalty because there were no adjustments to partnership items. Accordingly, the Tax Court denied the Malones' motion to dismiss for lack of jurisdiction.

For a discussion of partnership audit procedures, see Parker Tax ¶28,505.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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