As a part of the continuing TEFRA partnership audit proceeding litigation saga, the Eighth Circuit in Thompson v. Comm’r, (No. 12-1725) (Sept. 9, 2013), weighed in on the question of whether outside basis can be decided at the partnership level, or whether it is an affected item that must be determined subsequently at the partner level. In Thompson, after partnership-level proceedings involving a SON-of-BOSS transaction were decided in favor of the government, the IRS issued a notice of deficiency to the partners explaining several adjustments made to their individual returns and imposing a 40% accuracy-related penalty. When the taxpayers filed a petition in Tax Court to challenge the notice of deficiency, the IRS moved to dismiss for lack of jurisdiction and argued that the notice was issued in error and that the deficiency procedures of I.R.C. § 6230(a)(1) were inapplicable. The Tax Court agreed with the IRS and dismissed the partners’ petition. Writing for the majority, Judge Wherry held that computing the partners’ deficiency arising from the adjustments finalized in the partnership-proceeding did not require any partner-level determinations since the partnership activities “constituted an economic sham” that “foreclosed [the partners] from claiming any loss on liquidating a partnership interest in a disregarded partnership.” On appeal, the Eighth Circuit reversed, holding that the Tax Court erred in determining that it lacked jurisdiction over the petition.
The Eighth Circuit’s focus, interestingly, was on whether the Tax Court actually made a determination of the partners’ outside basis in the partnership-level proceeding. The Eighth Circuit held that because the Tax Court did not determine the partners’ outside basis in the partnership, the notice deficiency procedures were applicable and the Tax Court had jurisdiction to consider the taxpayers’ petition. But, as Judge Gruender noted in his concurring opinion, the question is not whether the Tax Court made the determination; Judge Gruender argued that the Tax Court did in fact make a determination that the partners’ outside basis in the partnership was zero, but that this determination must be “determined at the partner level.”
In holding the Tax Court had jurisdiction, the Eighth Circuit agreed with other circuits to have addressed the question, citing Jade Trading, LLC v. United States, 598 F.3d 1372 (Fed. Cir. 2010) and Petaluma FX Partners, LLC v. Comm’r, 591 F.3d 649 (D.C. Cir. 2010).
The United States Supreme Court may rule on this issue in United States v. Woods, 471 Fed. Appx. 320 (5th Cir. 2012), cert. granted, 133 S. Ct. 1632 (Mar. 25, 2013) (No. 12-562), where, on its own initiative, the Court directed the parties to brief and argue whether the district court had jurisdiction to consider the substantial misstatement penalty for an underpayment “attributable to” an overstatement of basis.