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Stevens v. Commissioner (T.C. Memo. 2020-118)

On August 6, 2020, the Tax Court issued a Memorandum Opinion in the case of Stevens v. Commissioner (T.C. Memo. 2020-118). The primary issue before the court in Stevens was whether (and to the what extent) the Tax Court can uphold the IRS’s deficiencies in the face of the petitioners’ claimed partnership loss deductions. The decision of this broad issue hinges on three primary sub-issues, which are whether (1) three partnerships were “small partnerships” under TEFRA; (2) whether the “oversheltered return” rules of IRC § 6234 apply; and (3) whether the petitioners provided sufficient “grounds” for challenging the IRS’s determination and disallowance of deductions.

History of (Non)Filings

The petitioners and their partnerships were dilatory at best with respect to their tax return filings. If a return was filed, it was nowhere near timely (2-3 years late was about average). If no return had been filed, the petitioners were in the habit of making an “amended” one appear when Appeals asked for it. The petitioners were playing around with big money, too, on their 2009 Form 1040 alone, the petitioners listed their AGI as a -$10m (due in part to a large NOL carryover).

All told, the petitioners did not file timely returns for any of their taxable years from 2006 through 2012. For two of those years, 2007 and 2012, petitioners did not file returns at all. The 2008, 2008, 2009, and 2010 returns were (very) late, and the 2011 return was filed after the petitioners filed their petition.

The Oversheltered Return Rules

TEFRA’s unified partnership audit and litigation rules require that the tax treatment of partnership items be determined in partnership-level proceedings that are generally binding on all partners. If a partner claims a large enough loss from a partnership subject to the TEFRA rules, that loss might not only “shelter” the income reported by the partner on his individual return but also absorb the effect of any adjustments the IRS seeks to make to the partner’s non-partnership items, thereby preventing the IRS from determining a deficiency.

Congress enacted the “oversheltered return” rules of IRC § 6234 to address that prospect. Essentially, the rules of IRC § 6234 apply when the effects of adjustments to non-partnership items are absorbed by the taxpayer’s reported net partnership loss so that the adjustments do not produce a deficiency.

Four conditions must be met for IRC § 6234 to apply. First, the taxpayer must file an “oversheltered return” for a taxable year, meaning that the return shows no taxable income and a net loss from partnership items. IRC § 6234(a)(1) (rule); IRC § 6234(b) (definition of oversheltered return). Second, the IRS must make a determination with respect to the treatment of the taxpayer’s non-partnership items. IRC § 6234(a)(2). Third, the IRS’s adjustments must not give rise to a deficiency. IRC § 6234(a)(3). Fourth, the adjustments would have given rise to a deficiency but for the loss from partnership items. Id.

Instead of a notice of deficiency, in the case of an oversheltered return, the IRS must issue a “notice of adjustment,” though, if the IRS issues a notice of deficiency in error, it will be treated as a notice of adjustment for purposes of any petition filed in response. IRC § 6234(a) (notice of adjustment); IRC § 6234(h)(2) (treatment of notice of deficiency as notice of adjustment). The Tax Court has the jurisdiction to make a declaration with respect to all items (other than items that require partner level determinations under IRC § 6230(a)(2)(A)(i) for the taxable year to which the notice of adjustment relates. IRC § 6234(c).

The Dees Test for Proving Jurisdiction

The Tax Court has long held that the party invoking this Court’s jurisdiction bears the burden of demonstrating that it exists. Dees v. Commissioner, 148 T.C. 1, 23 (2017). Although the burden usually falls on the petitioner, who (you guessed it) filed the petition, the IRS can (and in Stevens did) invoke jurisdictional concerns as well. Thus, for example, in response to a taxpayer’s motion to dismiss, the Tax Court noted that it may be appropriate to place on the IRS the burden of proving the facts that establish the Court’s jurisdiction. See, e.g., Pietanza v. Commissioner, 92 T.C. 729, 736-737 (1989).

Indeed, the Tax Court has even found that the IRS has the burden of proving facts to establish the Tax Court’s jurisdiction to disallow deductions without a prior TEFRA proceeding. Jimastowlo Oil, LLC v. Commissioner, T.C. Memo. 2013-195, *6. When however the party shifts to the IRS, and the Tax Court observes that the IRS has no evidence to meet their burden only because the petitioners have refused to provide any, then the Tax Court will not shift the burden (at least in partnership proceedings). See Harrell v. Commissioner, 91 T.C. 242, 247 (1988). This is so, because of the risk of a whipsaw to the IRS by putting it in a position of learning, only after having initiated partnership proceedings, that it was correct to have addressed the deductions in issue at the partner level after all, but is now estopped from doing so.

No Deficiency Today Does Not Preclude Deficiency Tomorrow

With regard to the petitioners’ taxable years 2007 and 2009 through 2012, the Tax Court was faced with a choice between concluding that it lacked jurisdiction or instead accepting jurisdiction under IRC § 6214(a) and concluding that the petitioners had no deficiency for any of those years. That choice turned on the validity of the notices of deficiency the IRS issued for the affected years.

The Tax Court saw no grounds on which to invalidate the notices of deficiency for the petitioners’ taxable years 2007 and 2009 through 2012, even though the adjustments reflected in those notices would not result in deficiencies after taking into account the claimed partnership losses. Therefore, the Tax Court concluded that petitioners had no deficiencies for any of those years.

Victory for the petitioners, right? Not so fast, Skippy.

A little more than halfway through the 87-page opinion, the Tax Court makes an incredibly important statement in dicta with regard to the IRS’s deficiency for the petitioners’ 2007 return. Having held that the petitioners have no deficiency in 2007, the Tax Court pats the IRS on the administrative shoulder and says, “Chin up, old sport; this isn’t the end of the road.” If and when the IRS decides to audit the partnership returns of the petitioners’ partnerships, and makes adjustments to partnership-level items, including the substantial losses reported on the petitioners’ individual returns, the IRS will be able to computationally assess tax on the petitioners’ non-partnership items.

Even in 2007, where the petitioners filed no return and, therefore, computational adjustments are improper, the IRS may pursue additional deficiency proceedings against the petitioners based on the partnership-level determinations. See IRC § 6231(e)(1). In essence, the Tax Court politely told to the petitioners to enjoy their victory today, because when the IRS gets around to auditing the partnerships and adjusts the partnership losses, the results will not be ever in their favor.

(T.C. Memo. 2020-118) Stevens v. Comissioner

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