21 - CA 10 Clarifies TEFRA Partnership Audit SOL and Trial Court Jurisdiction. Omega Forex Group LC et al., (CA 10 10/22/2018) 122 AFTR 2d

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1 21 - CA 10 Clarifies TEFRA Partnership Audit SOL and Trial Court Jurisdiction Omega Forex Group LC et al., (CA 10 10/22/2018) 122 AFTR 2d The Court of Appeals for the Tenth Circuit, affirming a district court opinion, has rejected all of the arguments of a partnership and one of its notice partners, including arguments that the statute of limitations (SOL) barred IRS's Final Partnership Administrative Adjustment (FPAA) and that the district court's determination of a fraud penalty was improper because the fraud penalty is not a partnership item. Background TEFRA audit rules, generally. Under the Tax Equity and Fiscal Responsibility Act of '82 (TEFRA) partnership audit rules (former Section 6221 through former Section 6234), the tax treatment of any partnership item, and the applicability of any penalty that relates to an adjustment to a partnership item, generally was determined at the partnership level. A partnership item was any item required to be taken into account for the partnership's tax year under any provision of subtitle A to the extent [the] regs...provide that, for purposes of this subtitle, such item is more appropriately determined at the partnership level than at the partner level. (Former Section 6231(a)(3)) To initiate adjustments to partnership items, TEFRA required IRS to conduct a unitary audit of the partnership. When IRS sought to adjust partnership items as a result of such an audit, it had to give notice to certain partners, of the beginning of an administrative proceeding at the partnership level with respect to a partnership item, and issue an FPAA at the end of the proceeding. (Former Section 6223(a)) Under the TEFRA rules, partners with a 1% or greater interest in the partnership were classified as "notice partners." (Former Section 6223(b)) Under certain circumstances, a notice partner could file a suit contesting an FPAA. (Former Section 6226(a), former Section 6226(b)) The court hearing such a suit had jurisdiction to adjudicate an assertion by any partner participating in such a suit that the limitations period for assessing partnership-related taxes against him has expired. (Former Section 6226(d)(1)) After the FPAA became final, IRS could assess tax to the individual partners whose tax returns for the year or years in question remain open under the SOL, for those partners' distributive shares of the adjusted partnership items. 67

2 Generally effective for tax years beginning after Dec. 31, 2017, the Bipartisan Budget Act of 2015 (BBA) repealed the TEFRA partnership procedures, replacing them with a new regime. Background SOL on assessments. Code Sec. 6501(a) provides the general rule that any tax deficiency must be assessed within three years after the return was filed. However, if a return is false and fraudulent, with the intent to evade tax, the tax may be assessed at any time. (Code Sec. 6501(c)(1)) Under the TEFRA rules, subject to exceptions, the period for assessing tax attributable to a partnership item (or affected item) for a partnership tax year "shall not expire" before the date that is three years after the later of: (1) the date the partnership return was filed, or (2) the last day for filing the return for that year (without regard to extensions). (Former Section 6229(a)) Under former Section 6229(c)(1), if a partner signed with the intent to evade tax, or directly or indirectly participated in the preparation of, a partnership return with a false or fraudulent item, the period is extended indefinitely for the signing or participating partner and is six years for all other partners. Background avoiding penalty by relying on professional advice. A taxpayer claiming reliance on a tax professional as a defense against imposition of a penalty must prove that: (1) the adviser was a competent professional who had sufficient expertise to justify reliance; (2) the taxpayer provided necessary and accurate information to the adviser; and (3) the taxpayer actually relied in good faith on the adviser's judgment. (Neonatology Associates, (2000) 115 TC 43, affd (CA ) 90 AFTR 2d ) Facts. The taxpayer, Robert Flath, a dentist, got involved with a currency trading partnership, Omega, via a financial advisor, Dennis Evanson. Flath allegedly became a partner in Omega by contributing $200,000 to Omega in '98. However there was no evidence that Flath ever paid this amount to Omega. He did contribute $165,000 in stocks to Omega; however that amount, less a fee paid to Evanson, ended up in an account of another Evanson-related company in the Cayman Islands. Flath had control of that $165,000 in the Cayman Islands company; he used monies from that account for his personal purposes. Evanson also had Flath's dental practice make monthly payments of $8,000 to another Evanson-controlled entity for the ostensible purpose of purchasing dental malpractice insurance. Flath's dental practice took deductions for these payments. These amounts were also allocated to Flath's account in this other Evanson-controlled entity and could be used for Flath's personal purposes. Omega sent Flath a K-1 tax form for '98 stating that he had contributed capital during '98 totaling $200,000. Omega's form 1065 for '98 also showed that 68

3 amount as a contribution by Flath. The K-1 showed that Flath's share of Omega's loss was $150,000. After receiving his K-l for '98, Flath consulted with Gail Anger, a certified public accountant, to assist him in filing his '98 return. Flath falsely assured Ms. Anger that he had contributed at least $150,000 to Omega during '98. Anger was apprehensive about the loss deduction and didn't think IRS would allow it, and stated in a letter to Flath that the return was prepared in reliance on Flath's assurance that he had at least the amount of the loss deduction at risk. Flath didn't tell Anger about the Cayman account. On Aug. 11, 2014, IRS issued two FPAAs. The '98 FPAA indicated that IRS was eliminating entirely Omega's alleged $4,698,325 loss for tax year '98 due to fraud at the partnership level. Similarly, the '99 FPAA indicated that IRS was eliminating entirely Omega's alleged $3,058,405 loss for tax year '99 due to fraud at the partnership level. Flath, a notice partner, filed a petition for readjustment. Taxpayer loses SOL argument. The Court rejected Flath's argument that, because the FPAA was issued after six years from the date the partnership return was timely filed, it was barred by the statute of limitations. Flath argued that, reading Code Sec and former Section 6229 together, the computation of a partner's statute of limitations with respect to a partnership item (such as the currency trading losses here) starts with the general 3-year assessment period and is extended beyond that solely according to former Section He said that former Section 6229(c) sets two different limitations periods related to partnership items depending on the partner's involvement in an allegedly fraudulent partnership: culpable partners who help prepare the partnership return are subject to an indefinite limitations period; all other partners are subject to a 6-year period. Flath argued that here, because IRS did not show (nor did the district court find) that Flath fell into the group of culpable partners, he was in the "other" category and, consequently, the statute of limitations (normally three years) was only extended to six years and expired before the FPAAs were issued. But the Court, citing several cases including Curr-Spec Partners, L.P., (CA ) 104 AFTR 2d , said that former Section 6229 provides a minimum period of time for the assessment of any tax attributable to partnership items (or affected items) notwithstanding the period provided for in Code Sec Based on the plain text of the statute, former Section 6229(a) does not create an independent statute of limitations. The "shall not expire" language of former Section 6229, together with the broad application of Code Sec. 6501, work in conjunction to provide for a potential extension of the Code Sec period, not an independent SOL for partnership items. 69

4 District court could determine Flath's outside basis. The Court rejected Flath's argument that the district court "exceed[ed] its jurisdiction by evaluating and determining Flath's outside tax basis which is not a partnership item properly considered in a TEFRA partnership level proceeding." A partnership's basis in its assets is referred to as its "inside basis," and a partner's basis in his partnership interest is called his or "outside basis." The Court said that former Section 6226(d) provided the district court with jurisdiction to adjudicate Flath's assertion that the limitations period for assessing Omega's partnership-related taxes against him had expired. That grant of jurisdiction necessarily allowed the district court to examine any and all items on Flath's personal returns for purposes of determining whether Flath had fraudulent intent in filing those returns. In doing so, the district court properly considered the entirety of Flath's relationship with Omega, including the value and timing of the assets he actually contributed to Omega (i.e., his outside tax basis in Omega), versus the amounts that Omega reported in its records and that Flath reported on his personal tax returns. The district court also properly considered Flath's transactions with the other Evanson-controlled entities because those matters were relevant to the issue whether Flath committed fraud on his individual returns. Taxpayer's reliance on his accountant wasn't relevant. The Court also rejected Flath's assertion that the district court applied the wrong legal standard in evaluating whether his reliance on expert advice negated any fraudulent intent with respect to his personal returns. Flath argued that his reliance on Anger's advice showed he lacked fraudulent intent as to his personal returns. Flath argued, "no matter whether the advice was good or reasonable, [he] did not procure it fraudulently, and no facts were introduced at trial or found by the District Court to support such a finding." Flath argued that if Anger needed additional information from Flath, it was Anger's obligation to request it. "It certainly cannot be considered fraud," Flath argued, "to fail to affirmatively provide that which is not requested." Flath's arguments, the Court said, ignored a key point of law, as well as the evidence presented at trial. Taxpayer reliance on expert advice hinges, in part, on the taxpayer making "a full disclosure to the expert preparing" his tax return. Here, however, the evidence presented by the government at trial established, and the district court expressly found, that Flath actively concealed information from Anger that was relevant to preparation of Flath's personal tax returns. For example, the evidence indicated that Anger expressly told Flath that Anger was claiming the $150,00 Omega loss on Flath's '98 personal tax return based on Flath's statement that he had contributed at least that much to Omega. The evidence, however, clearly established that Flath had not made the requisite capital contribution to Omega, but nevertheless failed to disclose this information to Anger. The evidence also clearly established that Flath failed to inform Anger 70

5 that he suffered no loss at all, and that the capital contribution Flath eventually made to Omega ended up in an account available for Flath's use. District court could assert fraud penalty. And, the Court rejected Flath's argument that, because a fraud penalty is not a partnership item, the district court exceeded its jurisdiction by upholding IRS's assessment of the fraud penalty at the partnership level. The court looked to former Section 6226(f), which held that a court with a petition to hear a TEFRA partnership audit has jurisdiction with respect to the applicability of any penalty which relates to an adjustment to a partnership item. It also cited the Supreme Court in Woods, (S Ct 2013) 112 AFTR 2d , which provided that notwithstanding that every penalty must be imposed in partner-level proceedings after partner-level determinations, TEFRA provides that the applicability of some penalties must be determined at the partnership level. "Barring partnership-level courts from considering the applicability of penalties that cannot be imposed without partner-level inquiries would render TEFRA's authorization to consider some penalties at the partnership level meaningless." 71