Items of Deficiency and Accuracy-Related Penalties

Items of Deficiency and Accuracy-Related Penalties

What constitutes proper notice of a final partnership administrative adjustment?

Estate of Albert Simon, et al. v. Commissioner, T.C. Memo. 2013-174 (July 29, 2013) is an instance in which petitioners (a decedent’s estate and his wife) didn’t fare too well.  In fact, the Tax Court denied the petitioners’ motion in full, holding that the Internal Revenue Service gave proper notice to the petitioners for a deficiency of $1,293,264 and granting the IRS’ motion to dismiss the case on the grounds that the court lacked jurisdiction to decide the penalty issues. 


The Charlevoix Partnership

The decedent, Albert Simon, wholly owned a limited liability company ASCS Investments, LLC (AIL) and an S corporation, ASCS Investments, Inc. (AII).  AIL and one other individual were the sole general partners of Charlevoix Investment Partners (Charlevoix), formed by Albert on Oct. 26, 2000.  AIL owned a 99 percent interest in Charlevoix’s profit, loss and capital; the individual held a 1 percent remaining interest.   

Charlevoix’s partners contributed essentially offsetting digital options to the partnership.  In November 2000, the partners went long on some of the options (for a total cost of $5.7 million) and went short on the remaining options (for a total selling price of $5.653 million).  On Dec. 4, 2000, the options terminated, and on Dec. 5, Charlevoix bought publicly traded stock.  About one week later, AIL contributed its interest in Charlevoix to AII, and Charlevoix terminated and distributed its assets to AII.  AII then sold the assets and realized non-economic capital losses on the sale, attributable to the assets’ inflated bases.  The losses passed through to Albert as AII’s shareholder.

For the tax year consisting of Oct. 26, 2000 to Dec. 14, 2000, Charlevoix filed a Form 1065, Return of Partnership Income.  Charlevoix didn’t designate a “tax matters partner” on the return.  On Sept. 15, 2001, Albert signed Form 1065 for the partnership and designated an address in Petoskey, Mich. as the partnership address.  A Schedule K-1 similarly listed the same Petoskey, Mich. address as AIL’s address.  The Petoskey, Mich. address was also Albert’s residential address and Charlevoix’s principal place of business.

After Dec. 14, 2000, Charlevoix, ALL and AII ceased operating.  In January 2001, Albert and his family moved to Equestrian Way in Charlevoix, Mich.  They resided at Equestrian Way until 2010. 


It’s in the Mail

The IRS audited Charlevoix’s 2000 return and in March 2004, an IRS agent out of Boston mailed (by certified mail) to the Petoskey, Mich. address a “notice of beginning of administrative proceeding” (NBAP), dated March 1, 2004.  After the Postal Service unsuccessfully attempted to deliver the NBAP three times, it returned the NBAP to the IRS.  The IRS also mailed to the Petoskey, Mich. address a letter dated March 1, 2004, addressed to Charlevoix in care of Albert as a “Member.”  The IRS also mailed to the Petoskey, Mich. address another copy of the NBAP, dated March 2, 2004, addressed to AIL and “Attn: Mr. Albert Simon, Single Owner.”  The IRS additionally mailed a copy of the NBAP dated March 2, 2004 to Equestrian Way and addressed it to “Albert & Ellen S Simon.”

The next month, the IRS mailed to Equestrian Way an NBAP dated April 2, 2004 for Charlevoix’s taxable year ending Dec. 14, 2000, addressed to Charlevoix’s tax matters partner in care of Albert as “Member.”  Around that same time, the IRS also mailed two other letters to Equestrian Way—one addressed to Charlevoix’s tax matters partner in care of Albert as “Member” and the other addressed to Charlevoix’s tax matters partner.

In April 2004, Albert and his wife signed a Form 872-I, Consent to Extend Time to Assess Tax as Well as Tax Attributable to Items of a Partnership.  Albert listed Equestrian Way as his present address and listed a former address in Naples, Fla. as a prior address.  From Feb. 8, 2005 through Dec. 1, 2008, Albert and his wife signed six consents, each of which listed Equestrian Way as their current address.  The final consent extended the assessment period through June 30, 2010.


Notice of FPAA

In May 2010, an IRS agent out of St. Paul mailed to the Petoskey address copies of the final partnership administrative adjustment (FPAA) for Charlevoix’s taxable year ending Dec. 14, 2000.  The copies were addressed to Charlevoix’s tax matters partner and to AIL.  The IRS didn’t mail copies of the FPAA to Albert as either an indirect partner or individually. 

The FPAA, among other things, adjusted to zero the partnership items of other deductions and also determined that Charlevoix was to be disregarded for federal income tax purposes; reduced the outside basis to zero; applied a 40 percent penalty to the part of underpayment attributable to a valuation/basis mistake; and applied a 20 percent penalty to the part of the underpayment attributable to negligence.  The Postal Service returned the FPAA to the IRS as “Not deliverable As Addressed—Unable to Forward.”

Albert and his wife never timely challenged the FPAA and defaulted on it on Oct. 11, 2010.  The IRS assessed penalties of $484,133 and an addition to tax of $117,577.   On Oct. 6, 2011, the IRS issued a deficiency notice.  All of the issues underlying the deficiency relate to adjustments to Charlevoix’s partnership items. 


Motion to Dismiss: Granted

The IRS moved to dismiss the case with regard to penalties, arguing that an assessment of penalties wasn’t part of typical deficiency procedures under Internal Revenue Code Sections 6211 through Sections 6216.  The IRS asserted that the applicability of penalties was a partnership-level determination and thus outside of the court’s jurisdiction.  Albert’s estate argued that the penalties weren’t partnership items that should be determined at the partnership level because the IRS never gave proper notice of the FPAA.  The estate argued that the IRS knew the Petoskey address wasn’t valid; rather, the Equestrian Way address was the valid address. 

The court found the estate’s arguments unpersuasive.  Although the Tax Court has jurisdiction over items underlying a deficiency, it doesn’t have jurisdiction over penalties:  deficiency procedures don’t apply to the assessment of penalties determined at the partnership level, regardless of whether partner-level determinations must be made to assess the penalty. (Section 6230(a)(2(A)(i)).  “Penalties . . . are a different story,” said the court.


What’s Proper Notice?

The Tax Court further rejected the estate’s argument that the items in the deficiency notice were no longer partnership items because the IRS failed to give proper notice of the FPAA.  The court stated that under IRC Section 6223(c)(1), the IRS must “use the names, addresses, and profit interests shown on the partnership return” to ascertain where to send the notice.  Moreover, the IRS’ duty to give a direct or indirect partner notice arises to the extent the IRS is provided with available information containing the name, address and profits interest of the partner.  This information can be provided in two ways: by the tax return of the partnership under audit or through a written statement that meets the requirements of Section 301.622(c)-1T(b)(1), Temporary Procedures & Administrative Regulations (March 5, 1987).  The IRS has no duty to search its records to get information not provided to it under either of these two methods. 

Albert’s estate, however, claimed that beginning April 2004, the IRS used the Equestrian Way address for both Albert and his wife individually and for Charlevoix and its tax matters partner.  Accordingly, the estate argued, the IRS should have sent the FPAA to the Equestrian Way address instead of or in addition to the address on the 2000 return. 

The Tax Court disagreed, stating that the IRS had no duty to send the FPAA to an address other than that on the partnership return under audit or on a statement that met the requirements of Section 301.622(c)-1T(b)(1), Temporary Procedures & Administrative Regulations.  The court further distinguished the facts in this case from the cases cited by Albert’s estate, including Stone Canyon Partners, T.C. Memo. 2007-377, aff’d sub nom. Bedrosian v. Comm’r, 358 Fed. App. 868 (9th Cir. 2009).  Refusing to readStone Canyon Partners as broadly as Albert’s estate did, the Tax Court disagreed with the petitioners that “good faith” meant the IRS should have mailed a copy of the FPAA to every address at which the IRS knew an affected partner may be contacted.  Rather, stated the Tax Court, due process requires that notice be “reasonably calculated, under all circumstances, to apprise interested parties of the pendency of the action and afford them an opportunity to present their objections” (Mullane v. Cent. Hanover Bank & Trust Co., 339 US. 306, 314 (1950)).  The Tax Court thus concluded that the IRS followed proper procedure by mailing separate copies of the FPAA to the Petoskey address addressed to Charlevoix’s tax matters partner and to AIL—the only partner (other than the 1 percent individual) of whom the 2000 tax return identified and provided an address. 

The Tax Court also questioned why Albert and his wife didn’t send in a statement to change their address.  Albert and his wife were responsible for updating their contact information, but they failed to do so.  “The fact that an FPAA was not mailed to the Equestrian Way address is due to their own inaction,” stated the Tax Court.  


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