Fifth Circuit Reverses District Court in Refund Action involving TEFRA Partnerships

(Parker Tax Publishing September 2022)

The Fifth Circuit reversed the ruling of a district court granting summary judgment to a taxpayer in an action for a refund of taxes assessed following a TEFRA partnership-level proceeding in which certain partnership expenses were disallowed. The district court held that the assessment was untimely under Code Sec. 6501 but the Fifth Circuit reversed after finding that the issue of whether the statute of limitations was extended by pre-2018 Code Sec. 6229 was a partnership item and the district court therefore did not have jurisdiction under pre-2018 Code Sec. 7422(h). Baxter v. U.S., 2022 PTC 272 (5th Cir. 2022).

Background

Before being repealed by the Bipartisan Budget Act of 2015, the unified partnership audit rules under the Tax Equity and Fiscal Responsibility Act (TEFRA) provided a two-step framework for addressing partnership-related tax matters. First, a partnership-level proceeding was initiated to audit the partnership's return and make any necessary adjustments to partnership items. If the IRS adjusted any partnership items, it issued a Notice of Final Partnership Administrative Adjustment (FPAA) to the partners. The partnership's tax matters partner could challenge the FPAA in court. If a partnership-level challenge was filed, each partner was deemed a party to the case and was bound by its outcome. Once the adjustments to partnership items became final, the IRS could then initiate partner-level proceedings to make any resulting computational adjustments in the tax liability of the individual partners. The IRS could directly assess most computational adjustments against the partners, and the partners could challenge those assessments in post-payment refund actions.

In the mid-1980s, American Agri-Corp (AMCOR) organized limited partnerships and marketed them to high-income professionals across the country. By 1987, the IRS had begun investigating AMCOR partnerships on suspicion that they were impermissible tax shelters. In 1991, after the investigation concluded, the IRS issued FPAAs to the tax matters partners of each of the partnerships. The IRS determined that the partnerships engaged in a series of sham transactions rather than farming activities and proposed adjustments disallowing several listed farming expenses and other deductions.

Donald Baxter owned limited partnership interests in three AMCOR partnerships: Oasis Date Associates (ODA), Pump Station III Associates (PS3), and Agri-Venture 1985 (AV85). In 2001, after various proceedings and negotiations, the Tax Court entered stipulated decisions relative to many of the AMCOR partnerships, including the three partnerships in which Baxter held interests. In 2002, the IRS assessed additional taxes against Baxter and his wife for tax years 1984 and 1985 that were attributable to the limited partnership interests that Baxter owned in ODA, PS3, and AV85. In 2004, after paying the additional taxes, the Baxters filed a refund action in a district court on the basis that the 2002 assessment was untimely because no preceding notice of deficiency had been issued.

Under Code Sec. 6501, the IRS generally has three years from the filing date of a return to assess taxes. However, when the taxes are attributable to a partnership item or affected item, TEFRA allowed the three-year statute of limitations to be extended under certain circumstances. Pre-2018 Code Sec. 6229(a) provided that taxes that are attributable to any partnership item or affected item must be assessed within three years of the later of the filing date or the due date of the partnership return for the tax year at issue. Pre-2018 Code Sec. 6229(b) allows the three-year statute of limitations to be extended by agreement. Under pre-2018 Code Sec. 6229(d), the statute of limitations is tolled if an FPAA is mailed to the tax matters partner. If, following the FPAA, the tax matters partner or another partner petitions for readjustment at the partnership level, the limitations period is suspended until one year after the conclusion of those partnership-level proceedings. Under pre-2018 Code Sec. 6230(a), a notice of deficiency is not required where a partner is assessed for a computational adjustment. However, under pre-2018 Code Sec. 6230(a)(2)(A)(i), a notice of deficiency is required for a deficiency attributable to affected items requiring a partner-level determination.

Before the district court, the Baxters argued that the 2002 assessment was improper because the 1991 FPAAs were issued more than three years after the filing dates of their joint individual tax returns for tax years 1984 and 1985. They also argued that the IRS was required to issue a notice of deficiency before assessing the taxes because, under pre-2018 Code Sec. 6230(a)(2)(A)(i), their 2002 assessment constituted a deficiency attributable to an affected item requiring a partner-level determination (i.e., the affected item being whether an extension to their Code Sec. 6501 assessment deadline existed). The district court agreed with the Baxters' contentions and granted summary judgment in their favor.

The IRS appealed to the Fifth Circuit. It argued that the district court's ruling conflicted with the Fifth Circuit's decisions in several cases involving AMCOR partners, including Foster v. U.S., 2020 PTC 10 (5th Cir. 2020), and Rodgers v. U.S., 2016 PTC 500 (5th Cir. 2016), in which the Fifth Circuit determined that under pre-2018 Code Sec. 7422(h), district courts did not have subject matter jurisdiction over refund actions brought by AMCOR partners premised on the Code Sec. 6501 time period. The Fifth Circuit reasoned in these cases that the assessment period under pre-2018 Code Sec. 6229 is a partnership item, and thus the timeliness of the assessment cannot be determined without reference to a partnership item. Therefore, partner-level actions premised on Code Sec. 6501 are barred under pre-2018 Code Sec. 7422(h).

The Baxters renewed the arguments they presented to the district court for why the 2002 assessment was improper. They also contended that their discovery of a statement by IRS agent Janis Smith rendered the Fifth Circuit's prior decisions inapplicable. The Baxters pointed to an undated declaration taken from the Foster record, that "part of the preparation of the notice of computational adjustment is to calculate if the statute of limitations for assessment is open for the taxpayer."

Analysis

The Fifth Circuit agreed with the IRS and reversed the district court's ruling and remanded the case to the district court with instructions to dismiss it for lack of jurisdiction.

The Fifth Circuit explained that the analysis in all of its prior decisions involving AMCOR partners' refund claims began with its holding in Weiner v. U.S., 389 F.3d 152 (5th Cir. 2004), that the Code Sec. 6229 assessment period is a "partnership item" for purposes of pre-2018 Code Sec. 7422(h). The court found that where Code Sec. 6501 is asserted to support an individual partner's refund claim, and that issue cannot be determined without reference to the government's asserted basis for extension under pre-2018 Code Sec. 6229 (which is a partnership item), then pre-2018 Code Sec. 7422(h) bars consideration of the refund action.

The Fifth Circuit also disagreed with the district court's conclusion that the IRS's failure to issue deficiency notices to the Baxters for 2002 required a refund of the additional sums paid. The court explained that Code Sec. 6211(a) defines a deficiency as the monetary amount by which the tax imposed exceeds the amounts shown on the taxpayer's return and any amounts previously assessed or collected after accounting for rebates. Thus, the court concluded that, for purposes of pre-2018 Code Sec. 6230(a)(2)(A)(1), a deficiency is not defined as the amount of money, if any, that the taxpayer asserts is owed based on a statute of limitations. Furthermore, the court pointed out that the 2002 deficiency was attributable to the adjustments of partnership items on the relevant partnership returns, not a statute of limitations issue.

Regarding the statement by IRS Agent Janis Smith, the Fifth Circuit found that an IRS agent's practice of confirming that the extended assessment period (provided by pre-2018 Code Sec. 6229) has not expired in preparing a notice of computational adjustment cannot and does not override statutory jurisdictional limitations applicable to refund actions as a matter of law. The court reiterated that under pre-2018 Code Sec. 7422(h), courts do not have jurisdiction to adjudicate the merits of an extension under pre-2018 Code Sec. 6229 of the Code Sec. 6501 limitations period.

For a discussion of the TEFRA 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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