Monday, October 29, 2007

IRS audit of partnerships – res judicata

Anthony Canterna and Patricia Canterna, Plaintiffs v. United States of America, Department of the Treasury, Internal Revenue Service, Defendants.

U.S. District Court, West. Dist. Pa.; Civ. 03-1783, June 23, 2005.[ Code Sec. 6223]

1. Statutory Scheme

Through the enactment of the Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. No. 97-248, 96 Stat. 324, codified at 26 U.S.C. §§6221-33 ("TEFRA"), Congress established a statutory framework for the administrative and judicial review of partnership returns. Under TEFRA, the Internal Revenue Service may begin a partnership-level audit through a unified proceeding at the partnership level to determine the tax treatment of "partnership items" rather than initiating separate and individualized proceedings for each partner. I.R.C. §6221; see also Slovacek v. United States [ 96-2 USTC ¶50,467], 36 Fed.Cl. 250, 254 (1996) ("the principle purpose of TEFRA is to provide consistency and reduce duplication in the treatment of partnership items by requiring that they be determined in a single unified proceeding at the partnership, rather than the partner, level."). A "partnership item" is any item that must be taken into account for the partnership's tax year, to the extent the regulations provide the item is more appropriately determined at the partnership level than at the partner level. I.R.C. §6231(a)(3). Examples of partnership items are income, gain, loss (such as net operating loss), and deductions or credits, as well as any item that affects the computation of partnership taxable income, such as the method of accounting, the partnership's inventory method, or the characterization of partnership property. Treas. Reg. §301.6231(a)(3)-1(a)(1)(i); Treas. Reg. §301.6231(a)(3)-1(b).Internal Revenue Code Section 6223 gives the notice procedures related to any TEFRA proceedings. I.R.C. §6223. Under these procedures, the IRS must send notice of the beginning of an administrative proceeding ("NBAP") and of the final partnership administrative adjustment ("FPAA") to the tax matters partner ("TMP") and each notice partner. I.R.C. §6223(a). 2 The tax matters partner under TEFRA is charged with representation of the partnership in various ways. Section 6231(a)(7) defines the term as follows:
Tax matters partner. The tax matters partner of any partnership is --

(A) the general partner designated as the tax matters partner as provided in regulations, or

(B) if there is no general partner who has been so designated, the general partner having the largest profits interest in the partnership at the close of the taxable year involved (or, where there is more than 1 such partner, the 1 of such partners whose name would appear first in an alphabetical listing) ....
See Treas. Reg. §301.6231(a)(7)-1. Section 6223(g) provides further that the tax matters partner must "keep each partner informed of all administrative and judicial proceedings for the adjustment at the partnership level of partnership items." Section 6231(a)(8) defines the term notice partner as "a partner who, at the time in question, would be entitled to notice under [26 U.S.C. §6223(a)] (determined without regard to subsections (b)(2) and (e)(1)(B) thereof)."Pursuant to Section 6226 of the Internal Revenue Code, within 90 days of the mailing of an FPAA, the TMP may file a petition for a readjustment of the partnership items for the taxable year with the Tax Court, the appropriate United States District Court, or the Court of Federal Claims. I.R.C. §6226(a). If the TMP fails to file a petition with respect to the FPAA, any notice partner may do so within 60 days after the close of the 90 day period. I.R.C. §6226(b). In addition, the Code provides that partnership partners are considered to be parties to a challenge brought under Section 6226(a) or (b). I.R.C. §6226(c). 3 The partners are therefore bound by any decision rendered by the appropriate court. Further, partners are bound by a settlement agreement entered into between the TMP and the IRS with respect to the determination of partnership items. I.R.C. §6224(c)(1). 4
2. The Doctrine of Res Judicata & I.R.C. §6223
It is well-settled that the doctrine of res judicata applies in the context of income tax cases. United States v. International Bldg. Co. [ 53-1 USTC ¶9366], 345 U.S. 502, 506 (1953); Commissioner of Internal Revenue v. Sunnen [ 48-1 USTC ¶9230], 333 U.S. 591 (1948). 5 The Supreme Court has explained that "if a claim of liability or non-liability relating to a particular tax year is litigated, a judgment on the merits is res judicata as to any subsequent proceeding involving the same claim and the same tax year." Sunnen [ 48-1 USTC ¶9230], 333 U.S. at 598.To establish the doctrine, the following requirements must be present: "(1) a final judgment on the merits in a prior suit involving; (2) the same parties or their privities; and (3) a subsequent suit based on the same cause of action." Tripi v. United States [ 97-1 USTC ¶50,414], 1997 U.S. Dist. LEXIS 4721 *7 (W.D. Pa. 1997), citing Bd. of Tr. of Trucking Emp. Pension Fund v. Centra, 983 F.2d 495, 503 (3d Cir. 1992).However, for a decision of the Tax Court to be res judicata as to a notice partner, notice of the FPAA must have been mailed to that partner. 26 U.S.C. Sec. 6223(a). If the Secretary fails to mail notice to a notice partner, the partner can, pursuant to 26 U.S.C. Sec. 6223(e)(2)(B) elect to have the partnership items treated as non partnership items.Plaintiffs argue that they did not receive notice of the NBAP and the FPAA and did not participate in the partnership proceeding, and therefore they may elect to treat the partnership items as non-partnership items." (Mem. Opp'n at 6, Doc. #22.) Therefore, they argue that the prior proceeding is not res judicata as to their claims. (Mem. Opp'n at 6, Doc. #22.) Section 6223(e)(2) of the Internal Revenue Code entitled "Effect of Secretary's failure to provide notice," provides two options available to a partner to whom the IRS has failed to mail any notice. First, a partner may elect to be bound by an adjustment, decision, or settlement that has become final. I.R.C. §6223(e)(2)(B). Or, if the partner does not make an election, that partner's partnership items for the taxable year in question will be treated as non-partnership items. I.R.C. §6223(e)(2)(B). Section 6223 applies when the IRS has failed to provide notice. Here, Plaintiffs claim that they did not receive notice and therefore they are not bound by the final decision regarding their liability for partnership items.Plaintiffs cite Boyd v. Commissioner [ CCH Dec. 49,365], 101 T.C. 365 (1993) as supporting their argument. In that case, the plaintiffs were notice partners and therefore were entitled to receive notice of an FPAA resulting from a partnership audit under Section 6223(a). It was undisputed that they did not receive timely notice. However, it was also undisputed that the Service did not mail it to them. Id. at 370. When they finally received notice, they challenged the assessment on the basis that it was untimely and barred by res judicata. Meanwhile, the Tax Court had entered a final decision on an action brought on behalf of the partnership. The court explained that in that situation, under Section 6223(e)(2)(B), the plaintiffs may elect to be treated consistently with the decision or chose to have those partnership items treated as non-partnership items. Id. The court explained further that because no election was made, the items in question would be converted to non-partnership items pursuant to Section 6223(e)(2)(B). Id. at 370-71. The court held, inter alia, that the notice of deficiency was issued within one year from the date the items were converted to non-partnership items, and therefore, it was timely under Section 6229(f).As to the Plaintiffs' claim that the assessment was barred by the doctrine of res judicata because the first notice of deficiency was untimely under Section 6501, and therefore, it was invalid, the Court held that the Tax Court's decision based on that deficiency, which was separate and distinct from the partnership proceedings, was also invalid and therefore was not a final decision for purposes of res judicata. Id. at 367, 371-72.In Boyd, the loss was converted to a nonpartnership item because the petitioner had not received timely notice. The notice of deficiency of the nonpartnership item was mailed within the required time. Therefore in Boyd the Court upheld the Commissioner's deficiency determination.The Service has provided the Court with a transcript of Paul Czarnecki's deposition in which he testified that he could not prove that the Plaintiffs received copies of the notices. He could only say that he saw the carbon copy that was shown to him by the U.S. Attorney and based on that he could assume they were mailed. He further testified that although letters are inputted into the system a week to ten days before the date given on the letter, the mailing date was very accurate. Czarnecki Dep. at 26-27, 53, 56-58, Doc. #19, attached thereto.) 6 Mr. Czarnecki testified that the FPAA in Plaintaiff's case, (Ex. C of Ex. 1 to Doc. #19) was a notice generated by a computer. Everything was "pin-fed multi paper carbon kind of thing done on an impact printer." ( Id. at 53.) The printer would have printed multiple carbon copies. ( Id. at 56.) The only way to determine whether or not they had been delivered by the postal service would be if they were returned by the postal service as undeliverable. ( Id. at 57.) When they sent the letter out they would have put the carbon copy in the taxpayer's file ( Id. at 57-58.) Mr. Czarnecki testified that he assumed his counsel, Ms. Oliphant, Esq., had found the carbon copy in the Plaintiff's file. ( Id. at 58.) He agreed with the statement of his counsel that "if we were lucky if they had gotten the return envelope, they would have put that in the file also?"Plaintiffs agree that the copies of those documents which have been provided to the Court reflect their correct mailing address. (Answers to Interrogs. ¶¶7-8, Doc. #19, attached thereto as Ex. 2.)The difficult question in this case would appear to be whether there is an issue of fact as to whether the IRS mailed the notices to Plaintiffs. Have Defendants produced sufficient evidence that the notices were mailed to shift the burden to Plaintiffs to come forward with evidence that the notices were not mailed.The Government's evidence is that Mr. Czarnecki identified a document given to him by his counsel as a carbon copy of the notice that, if the standard procedures were followed, would have been mailed to Plaintiffs. He assumed that his counsel had found the carbon copy in Plaintiff's file. Item 8 of Defendants statement of Material Facts states that "On October 29, 1990, the Service issued a Notice of Final Partnership Administrative Adjustment (FPAA) to the plaintiffs at ... [their correct address]." Doc. # 19. That statement is not under oath or seal and does not state that the FPAA was mailed to Plaintiffs.In Fox v. United States, 1996 U.S. Dist. LEXIS 10480; 96-2 U.S. Tax Cas. [50,]430 (E.D. Cal. 1996) the court made a finding that the IRS had mailed the NBAP to the plaintiff at her correct address. The file contained a certificate of official record from the IRS that a FPAA for that year was sent by certified mail to the plaintiff at her former address and returned to the IRS.

Alvin S. Brown, Esq
Tax Attorney
703 425-1400

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