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Supervisory Approval Issue Must be Raised during Partnership-Level Proceedings

(Parker Tax Publishing November 2021)

The Eleventh Circuit affirmed a district court and held that, in partnership tax cases controlled by the Tax Equity and Fiscal Responsibility Act of 1982, the Code Sec. 6751 supervisory approval issue must be exhausted with the IRS before a partner files a refund lawsuit and it must be raised during the partnership-level proceedings. As a result, the taxpayer, a partner in a partnership, was liable for a 40 percent penalty for a gross valuation misstatement made on the partnership's tax return. Ginsburg v. U.S., 2021 PTC 346 (11th Cir. 2021).


In 2001, Alan Ginsburg, Alpha Consultants LLC, Samuel Mahoney, and Helios Trading LLC formed AHG Investments LLC. On its 2001 partnership tax return, AHG Investments reported a $25,618 total loss. But on Ginsburg's 2001 tax return, he reported a $10,069,505 loss from AHG Investments. Ginsburg used the reported $10,069,505 loss from AHG Investments to offset his $22,826,616 in income and decrease his tax liability by $3,583,873.

In 2008, the IRS sent Ginsburg a notice that it was proposing adjustments to the partnership items on AHG Investments' 2001 and 2002 tax returns. The IRS alleged that AHG Investments and its partners had not established that AHG Investments was a partnership as a matter of fact. Instead, the IRS said, it was formed solely for purposes of tax avoidance. According to the IRS, AHG Investments was a sham and lacked economic substance, and its principal purpose was to reduce substantially the present value of its partners' aggregate federal tax liability. Thus, the IRS said, it would disregard the partnership, the "purported" partners of AHG Investments would not be treated as partners, and "any purported losses" would not be allowable as deductions. For Ginsburg, the IRS disallowed the $10,069,505 loss from AHG Investments on his 2001 tax return. And the IRS said it would impose a 40 percent penalty for "gross valuation misstatement." Any of the partners could contest the IRS's adjustments in the Tax Court, the Court of Federal Claims, or the district court in the district of the partnership's principal place of business.

At the partnership-level proceeding, Ginsburg petitioned the Tax Court to contest the part of the IRS's adjustment notice imposing the 40 percent penalty for grossly misstating AHG Investments' value. Ginsburg agreed that he was not entitled to deduct AHG Investments' losses because he was not at risk and the partnership's transactions did not have substantial economic effect. But Ginsburg contested the 40 percent gross valuation misstatement penalty. Based on Ginsburg's concessions, the Tax Court found that AHG Investments was a sham, lacked economic substance, and was formed for tax avoidance purposes. The Tax Court concluded that AHG Investments must be disregarded for federal income tax purposes, and adjusted AHG Investments' 2001 tax return, consistent with the IRS's notice, to show no losses. The Tax Court also rejected Ginsburg's petition and concluded that the 40 percent penalty applied to any underpayment of tax attributable to any gross valuation misstatement, subject to any partner-level defenses.

Based on the Tax Court's decision, the IRS sent Ginsburg a notice of computational adjustment disallowing the $10,069,505 loss from Ginsburg's 2001 tax return, which resulted in a $2,458,964 tax deficiency. The IRS also calculated the 40 percent penalty as $983,586. The notice told Ginsburg that if he wanted to dispute the computational adjustment made to his return, or if he wanted to assert partner-level defenses to any penalty imposed in the notice, he had to pay the adjusted tax in full and then file a claim for refund with the IRS. If the IRS disallowed his refund claim, the notice said that Ginsburg could file a refund suit as provided by law.

Ginsburg paid the $2,458,964 tax deficiency, the $983,586 penalty, and $3,208,674 in interest on the tax deficiency and penalty and filed a claim for refund with the IRS. Ginsburg asked the IRS to refund his $983,586 penalty and $876,198 of interest paid on the penalty. Ginsburg explained that he was entitled to a refund because he reasonably relied in good faith on accounting advice, a tax opinion, legal advice, tax return services, and financial advice from reputable firms and professionals. The IRS denied Ginsburg's refund claim. Ginsburg filed suit in a district court, arguing that he was not liable for the penalty and the interest on the penalty because he acted reasonably and in good faith with respect to the underlying tax issues. The government argued that Ginsburg could not and did not reasonably rely on the advice of his accountants, tax experts, lawyers, and financial advisors to avoid the penalty. Ginsburg contended that he was entitled to summary judgment because the government did not get written approval of the penalty by an immediate supervisor, as required by Code Sec. 6751(b)(1). Without approval, Ginsburg asserted, the penalty is void. The government had the burden to show that the IRS complied with Code Sec. 6751(b)(1), Ginsburg argued, and there was no dispute that it didn't meet that burden here.

The district court granted the government's summary judgment motion and denied Ginsburg's motion. The district court concluded that Ginsburg could not have reasonably relied on the advice of his tax, legal, and financial advisors. And the district court determined that it couldn't consider Ginsburg's Code Sec. 6751(b) supervisory approval argument because he didn't exhaust it in his claim for refund with the IRS. Ginsburg appealed to the Eleventh Circuit.


The question in this case, the Eleventh Circuit noted, is when must a partner in a limited liability company or a partnership raise the Code Sec. 6751(b)(1) supervisory approval issue: Before or after the partner files a refund lawsuit or during the partnership-level proceedings or the partner-level proceedings? The Eleventh Circuit held that, in partnership tax cases controlled by the Tax Equity and Fiscal Responsibility Act of 1982, the supervisory approval issue must be exhausted with the IRS before a partner files a refund lawsuit and it must be raised during the partnership-level proceedings. Because Ginsburg did not exhaust the Code Sec. 6751(b)(1) supervisory approval issue before he filed his refund lawsuit, and because he didn't raise the issue during the partnership-level proceedings, the Eleventh Circuit affirmed the summary judgment for the government.

Ginsburg, the court said, had to raise the Code Sec. 6751(b)(1) issue in the partnership-level proceedings before the Tax Court. And he had to exhaust it with the IRS in his claim for refund. Because he did neither, the Eleventh Circuit found that the district court rightly refused to consider Ginsburg's argument and correctly granted summary judgment for the government on Ginsburg's refund lawsuit.

For a discussion of the Code Sec. 6751(b)(1) supervisory approval issue, see Parker Tax ¶262,195.

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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