Duffie v. United States

Case: 08-20708 Document: 00511046900 Page: 1 Date Filed: 03/10/2010

IN THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT United States Court of Appeals

Fifth Circuit

FILED

March 10, 2010

No. 08-20708 Charles R. Fulbruge III

Clerk

JOHN C DUFFIE; MELISSA DUFFIE

Plaintiffs - Appellants

v.

UNITED STATES OF AMERICA

Defendant - Appellee

Appeal from the United States District Court

for the Southern District of Texas

Before KING, JOLLY and STEWART, Circuit Judges.

CARL E. STEWART, Circuit Judge:

John and Melissa Duffie appeal the district court’s grant of summary

judgment in their tax refund suit. We affirm.

A district court’s grant of summary judgment is reviewed de novo,

applying the same standard as the district court. Kornman & Assocs. v. United

States, 527 F.3d 443, 450 (5th Cir. 2008). This court reviews findings of fact for

clear error and legal issues de novo. Houston Exploration Co. v. Halliburton

Energy Servs., Inc., 359 F.3d 777, 779 (5th Cir. 2004). Specifically, a district

court’s characterization of a transaction for tax purposes is a question of law

subject to de novo review, but the particular facts from which that

characterization is made are reviewed for clear error. See Compaq Computer

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Corp. v. Comm’r, 277 F.3d 778, 780 (5th Cir. 2001) (citing Frank Lyon Co. v.

United States, 435 U.S. 561, 581 n.16 (1978)).

We have reviewed the applicable law, the appellate briefs of the parties,

the record on appeal, and the district court’s opinion. We have further considered

the contentions of the parties presented at oral argument. We are convinced that

the district court correctly decided the issues in this appeal in its thorough and

thoughtful opinion, which we attach hereto and adopt as the opinion of this

court. See Keener v. United States, 551 F.3d 1358 (Fed. Cir.), cert. denied, 130 S.

Ct. 153 (2009). The judgment of the district court is therefore AFFIRMED.

APPENDIX

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IN THE UNITED STATES DISTRICT COURT

FOR THE SOUTHERN DISTRICT OF TEXAS

HOUSTON DIVISION

JOHN C. and MELISSA DUFFIE, §

§

Plaintiffs, §

§

VS. § CIVIL ACTION NO. H-06-2870

§

UNITED STATES OF AMERICA, §

§

Defendant. §

MEMORANDUM AND OPINION

In this tax refund suit, the plaintiffs, John Duffie and Melissa Duffie, allege that the

Internal Revenue Service improperly assessed enhanced or penalty interest against them

under 26 U.S.C. § 6621(c). That statute, which was effective for only a few years, provides

for interest at 120% of the statutory interest rate when there is a substantial underpayment

of taxes attributable to a tax-motivated transaction.

John Duffie became a limited partner in American Agri-Corp, Inc. (“AMCOR”) in

1984. His proportionate share of the partnership’s income loss was reported on the Duffies’

1984 joint income tax return. The IRS subsequently disallowed AMCOR expense deductions

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for tax year 1984, reducing the partnership’s loss. As a result, partners, including the

Duffies, had underpaid their income tax liability for 1984. The IRS assessed enhanced

interest against the Duffies under Section 6621(c) for the underpayment. The Duffies seek

a refund.

The parties have filed cross-motions for summary judgment. The Duffies seek

summary judgment that as a matter of law, imposing the Section 6621(c) enhanced or penalty

rate of interest was erroneous because it is based on a Tax Court judgment entered after a

settlement of partnership-level items that did not decide partner-level issues critical to

assessing the interest. The government asserts that the Duffies’ claims are barred by res

judicata and that this court lacks subject-matter jurisdiction over the refund claim because

it would require the court to reexamine the partnership items resolved in the Tax Court.

Based on a careful review of the motions, the pleadings, the record, and the applicable

law, this court denies the Duffies’ motion for summary judgment and grants the

government’s cross-motion. Final judgment dismissing this case is entered by separate order.

The reasons for this ruling are set forth in detail below.

I. Background

A. The Tax Equity and Fiscal Responsibility Act of 1982

Partnerships file informational tax returns, but partnerships are not subject to federal

income taxes. 26 U.S.C. § 701. Instead, a partnership is treated as a conduit through which

income passes to its partners, who are responsible for reporting their pro rata share of tax on

their individual income tax returns. Id.

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Before 1982, examining a partnership for federal tax purposes was a tedious process.

A partnership filed an informational tax return on a Form 1065, which reflected the

distributive shares of partnership income, gains, deductions, and credits attributable to the

partners. If the IRS sought to adjust an item on a partnership return, the IRS had to examine

each partner’s individual return. As a result, the IRS could not ensure consistent adjustments

of partnership items among partners. In response, Congress enacted the Tax Equity and

Fiscal Responsibility Act of 1982, Pub. L. No. 97-248, 96 Stat. 324, 648-671 (“TEFRA”).

TEFRA consolidated the partnership-level audit and adjustment procedures by

requiring that “the tax treatment of any partnership item shall be determined at the

partnership level.” 26 U.S.C. § 6221. TEFRA “created a single unified procedure for

determining the tax treatment of all partnership items at the partnership level, rather than

separately at the partner level.” In re Crowell, 305 F.3d 474, 478 (6th Cir. 2002). After

TEFRA, the IRS could adjust partnership items “at a singular proceeding, and then

subsequently assess all of the partners based upon the adjustment to that particular item. The

IRS would not have to conduct individual ‘partner level’ proceedings for each member of a

partnership.” Prati v. United States, 81 Fed. Cl. 422, 427 (Fed. Cl. 2008).

TEFRA defines a “partnership item” as “any item required to be taken into account

for the partnership’s taxable year under any provision of Subtitle A to the extent regulations

prescribed by the Secretary provide that, for purposes of [subtitle F], such item is more

appropriately determined at the partnership level than at the partner level.” 26 U.S.C. §

6231(a)(3). The regulations provide that items “more appropriately determined at the

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partnership level” include the gains, losses, deductions, and credits of a partnership. 26

C.F.R. § 301.6231(a)(3)-1. The term “partnership item” also “includes the accounting

practices and the legal and factual determinations that underlie the determination of the

amount, timing, and characterization of items of income, credit, gain, loss, deduction, etc.”

26 C.F.R. § 301.6231(a)(3)-1(b).

A “nonpartnership item” is “an item which is (or is treated as) not a partnership item.”

26 U.S.C. § 6231(a)(4). The tax treatment of nonpartnership items requires partner-specific

determinations that must be made at the individual partner level. See Crnkovich v. United

States, 202 F.3d 1325, 1328-29 (Fed. Cir. 2000).

TEFRA also includes a hybrid category of “affected items.” An “affected item” is

“any item to the extent such item is affected by a partnership item.” 26 U.S.C. § 6231(a)(5).

For example, a taxpayer-partner’s medical expense deduction under 26 U.S.C. § 213(a) is an

“affected item.” Because a taxpayer can only deduct medical expenses to the extent those

expenses exceed 7.5% of adjusted gross income, a change in the partnership’s income affects

the amount of the partner’s deduction. Affected items can have both partnership-item and

nonpartnership-item components. For example, determining a limited partner’s “amount at

risk” for purposes of 26 U.S.C. § 465 may require a partnership-item determination of the

amount of partnership debt and a nonpartnership-item determination of the amount of that

debt assumed by the limited partner.

There are two different types of affected items. “The first type of affected items

requires only a computational adjustment at the partner level, which can only be made at the

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conclusion of the partnership level proceeding.” Woody v. Comm’r of Internal Revenue, 95

T.C. 193, 201-02 (1990) (citing N.C.F. Energy Partners v. Comm’r of Internal Revenue, 89

T.C. 741, 744, 1987 WL 45298 (1987)). “The term ‘computational adjustment’ means the

change in the tax liability of a partner which properly reflects the treatment under this

subchapter of a partnership item.” 26 U.S.C. § 6231(a)(6). “A computational adjustment

may include a change in tax liability that reflects a change in an affected item where that

change is necessary to properly reflect the treatment of a partnership item.” 26 C.F.R. §

301.6231(a)(6)-1T(a). Such a “computational affected item” may be applied to the individual

partner without any factual determination at the partner level. “The other type of affected

item is one that is dependent upon factual determinations (other than a computation) relating

to an adjustment made at the partner level.” Woody, 95 T.C. at 202; N.C.F. Energy Partners,

89 T.C. at 744-75. These affected items require fact-finding particular to the individual

partner.

If the IRS decides to adjust any partnership items on a partnership’s informational

income tax return, it must notify the individual partners of the adjustment by issuing a Notice

of Final Partnership Administrative Adjustment (“FPAA”). 26 U.S.C. § 6223; see also

Kaplan v. United States, 133 F.3d 469, 471 (7th Cir. 1998). A Notice of FPAA sets out the

proposed adjustments, e.g. disallowing all or part of partnership’s deductions, and lists the

grounds for the adjustments. Id. For ninety days after a Notice of FPAA issues, the Tax

Matters Partner1 has the exclusive right to challenge the proposed adjustments in Tax Court,

1

A tax matters partner is the partner designated to act as a liaison between the

partnership and the IRS in administrative proceedings and as the representative of the

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the Court of Federal Claims, or a United States District Court. 26 U.S.C. § 6226(a). If the

TMP does not file suit challenging the proposed adjustments within this period, other

partners have sixty days to file a petition for readjustment. Id. § 6226(b)(1). If a partnership

level challenge is filed, each partner in the partnership is deemed a party to the case. 26

U.S.C. § 6226(c)(1).

If a partner settles his tax liability with the IRS, the partner will not be able to

participate in the partnership-level suit and will be bound by the settlement agreement terms.

Id. § 6228(a)(4), § 6226(c)(1). If the IRS enters into a settlement agreement with any partner

with respect to partnership items, other partners are entitled to a consistent settlement as to

those partnership items. 26 U.S. C. § 6224(c)(2). The TMP may bind “non-notice” partners

to a settlement agreement resolving partnership items if the TMP expressly states in the

agreement that it “shall bind the other partners.” 26 U.S.C. § 6224(c)(3)(A). A non-notice

partner is a partner with less than a 1% interest in a partnership that has more than 100

partners. See 26 U.S.C. §§ 6231(a)(8), 6223(b)(1).

In a partnership-level proceeding, the Tax Court has jurisdiction to determine all

partnership items for the tax year to which the FPAA relates. The Tax Court also has

jurisdiction to determinate the proper allocation of the partnership items among the partners.

26 U.S.C. § 6226(f). For tax years before1997, the Tax Court does not have jurisdiction over

nonpartnership items or over affected items.2 Id. The TMP and the IRS may reach an agreed

partnership in judicial proceedings.

2

Congress amended Section 6226(f) in 1997 to grant the Tax Court jurisdiction over

“the applicability of any penalty, addition to tax, or additional amount which related to an

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decision in the Tax Court as to partnership items. T AX C OURT R. 248(b). In a partner-level

refund action, courts do not have jurisdiction over partnership items. 26 U.S.C. § 7422(h).

But a court does have jurisdiction in a partner-level refund action over partnership items that

were converted to nonpartnership items through a settlement with the IRS. Id. §

6231(b)(1)(C).

B. Factual Background

In the early 1980s, AMCOR organized a number of limited partnerships for which it

acted as general partner. These partnerships had as stated goals acquiring agricultural land,

investing in agricultural ventures, and growing crops.3 AMCOR solicited investments from

high-income professionals across the country. Each partner in an AMCOR partnership

would receive a projected tax loss from crops planted in the first year of roughly twice that

partner’s investment. Investors paid the farming expenses up front and deducted the amount

invested on their tax returns. The next year, when the crops were harvested, the amount of

loss in excess of the amount invested would be subject to taxes. However, the farming

expenses typically exceeded any income realized from the farming activities. In 1987, the

IRS began an investigation and audit into the AMCOR partnerships to determine whether

they were impermissible tax shelters.

adjustment to a partnership item.” The amendment was limited to tax years ending after

August 5, 1997.

3

In Crop Associates-1986 v. Comm’r of Internal Revenue, T.C. Memo 2000-216, 2000 WL 976792

(U.S. Tax Court 2000), the court found that from its inception in 1981 until 1986, AMCOR was engaged in

the business of promoting tax shelter partnerships.

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In 1984, John Duffie invested as a limited partner in one of the AMCOR partnerships,

Texas Farm Venturers, a Texas limited partnership.4 The general partners in Texas Farm

Venturers in 1984 included AMCOR and Robert A. Wright. John Duffie held a 0.5966%

interest in Texas Farm Venturers. On March 25, 1985, Texas Farm Venturers timely filed

its partnership return for tax year 1984. (Docket Entry No. 29, Appendix at 9). The return

states that Texas Farm Venturers had one hundred partners.5 The partnership reported an

ordinary income loss of $9,698,031.00 for 1984. (Id.). The Duffies timely filed their 1984

income tax return on June 18, 1985. (Docket Entry No. 30, Ex. 2). The Duffies’ joint return

reported John Duffie’s share of the Texas Farm Venturers loss as $57,859.00. (Docket Entry

No. 30, Ex. 1).

After investigating the AMCOR partnerships, the IRS issued a Notice of FPAA to the

TMPs of a number of the AMCOR partnerships in 1990 and 1991. The notices proposed to

adjust the partnership items of these AMCOR partnerships for tax years 1984, 1985, and

1986, as applicable. Wright, the TMP of Texas Farm Venturers, received a Notice of FPAA

on April 10, 1991. (Docket Entry No. 30, Ex. 3). The FPAA listed several reasons for

disallowing part of the Texas Farm Venturer farming expenses. The reasons included that

4

Although Melissa Duffie was not a partner in Texas Farm Venturers, she is a party

to this lawsuit because she filed joint tax returns with her husband, John Duffie. See 26 U.S.C.

§ 6013(d)(3).

5

Although the Duffies’ summary judgment motion states that John Duffie was a

non-notice partner (Docket Entry No. 30 at 17), the record, including the partnership return,

shows that John Duffie was a notice partner because Texas Farm Venturers did not have more

than one hundred partners.

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the IRS had determined that the partnership’s activities were a series of sham transactions

and that the activities lacked economic substance. (Id.).

On July 10, 1991, limited partners in Texas Farm Venturers other than the TMP filed

a petition in United States Tax Court contesting the FPAA for the partnership. (Docket Entry

No. 29, Appendix at 16-49). The case was assigned case number 15058-91. (Id. at 16.). The

Duffies became parties to the Tax Court case under 26 U.S.C. § 6226(c), which treats non-

participating partners as parties to a case in which a partner challenges the FPAA. The Tax

Court consolidated case number 15058-91 with six other cases involving AMCOR

partnerships. Wright subsequently intervened as the Texas Farm Venturers TMP.

In 1997, while the Tax Court cases were pending, several limited partners in AMCOR

partnerships settled their income tax liability with the IRS by executing Forms 870-P(AD).

The IRS imposed enhanced interest under 26 U.S.C. § 6621(c) against these partners for

underpayment of taxes. Morris Weiner, a limited partner in several AMCOR partnerships,

challenged the imposition of enhanced interest. In Weiner v. United States, 389 F.3d 152

(5th Cir. 2004), cert. denied, 544 U.S. 1050 (2005), the appellate court concluded that the

IRS improperly assessed enhanced interest against Weiner under Section 6621(c). Because

the FPAA listed multiple independent reasons for disallowing the partnership’s deductions,

there was “no way to determine, without additional superfluous litigation, whether the

taxpayer’s underpayment is ‘attributable to’ a reason that also qualifies as a tax-motivated

transaction (such as a sham).” Id. at 162.

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The Duffies did not settle with the IRS. The Duffies remained parties to the Texas

Farm Venturers Tax Court case. On April 16, 2001, the IRS moved under Tax Court Rule

248(b) for entry of decisions in the AMCOR cases. (Docket Entry No. 29, Appendix at 50).

The Motion for Entry of Decisions stated that the IRS and the TMPs for the AMCOR

partnerships had reached “contingent agreements with respect to all of the disputed

partnership items at issue in the FPAA Cases.” (Id. at 52, ¶ 8). The agreements were

contingent on the Tax Court’s entry of the Decision submitted with the IRS motion. The IRS

Motion for Entry of Decisions stated that all partners “in each partnership whose partnership

items are to be determined in the FPAA Cases and who meet the interest requirements of

I.R.C. § 6226(d) are deemed parties to the partnership proceedings,” would be bound by the

determination of the partnership items in the applicable Decision, and would be “assessed

any additional tax resulting from the adjustments contained in the Decision documents

pursuant to . . . I.R.C. § 6225, 6230(a) and 6231(a)(6). . . .” (Id., ¶ 9). The Motion also

stated that the IRS had made “preliminary determinations as to certain affected items,

including the liability of the liability of the limited partners for additions to tax pursuant to

I.R.C. § 6653 and 6661, and for the assessment of interest on the deficiencies in the partners’

income tax at the increased rate prescribed by former I.R.C. § 6621(c); which determinations

the tax matters partner and other partners are expected to dispute.” (Id., ¶ 16). The Motion

stated that “[o]nce the Decisions . . . are entered by the Court and become final, respondent

will assess any deficiency in income tax due from each partner by way of computational

adjustment, under I.R.C. § 6231(a)(6) based upon the adjustment contained in the Decisions,

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. . . and based upon the determination made in the Decisions, respondent will assess interest

which has accrued thereon under former I.R.C. § 6621(c). . . .” (Id., ¶ 20).

On June 14, 2001, the Duffies moved in the Tax Court for leave to file a notice of

election to participate out of time. (Docket Entry No. 29, Appendix at 67-69). The motion

for leave stated that the Duffies did not object to entry of the proposed decision. Because

entry of the agreed decisions in the Tax Court could be halted by one objecting partner from

any of the partnerships, the Duffies sought to preserve their right to a consistent settlement

with the IRS under Section 6224(c)(2). The right to a consistent settlement was only

preserved for sixty days after issuance of the Notice of FPAA. The Tax Court denied the

Duffies’ motion on July 19, 2001.

The Tax Court entered its decision in the Texas Farm Venturers case on July 19, 2001.

(Docket Entry No. 30, Ex. 6). The decision stated that the partnerships’ claimed farming

expenses would be reduced by $4,154,659.00. (Id.). The Tax Court’s decision also stated:

[t]hat the adjustments to partnership income and expense for the

taxable year 1984 are attributable to transactions which lacked

economic substance, as described in former I.R.C. §

6621(c)(3)(A)(v), so as to result in a substantial distortion of

income and expense, as described in I.R.C. § 6621(c)(3)(A)(iv),

when computed under the partnership’s cash receipts and

disbursements method of accounting.

(Id.). The contingent agreement stated that all parties’ right to appeal was waived. The

Duffies did not appeal the Tax Court’s decision.

The adjustment to the Texas Farm Venturers partnership items – specifically, the

$4,154,659.00 reduction in farming expenses – resulted in a reduction of John Duffie’s share

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of the partnership loss. This increased the Duffies’ taxable income for 1984 by $27,787.000,

resulting in $8,540.00 in unpaid income tax liability. On December 19, 2001, the Duffies

paid the IRS an advance remittance of $44,000.00. On July 19, 2002, the IRS sent the

Duffies a letter with an enclosed form, Form 4549A, that showed the adjustments to the

Duffies’ 1984 income tax liability as a result of the Tax Court’s decision. (Docket Entry No.

30, Ex. 10). On August 12, 2002, the IRS assessed $8,540.00 in income tax liability and

$43,991.34 in interest against the Duffies for tax year 1984. (Docket Entry No. 29, Appendix

at 6). This included interest at the penalty rate under Section 6621(c). The interest amount

was corrected that same day to add $416.31 in interest previously allowed. (Docket Entry

No. 29, Appendix at 72, 85). The Duffies’ $44,000.00 advance was applied to the

assessment. The IRS sent the Duffies a bill for the remaining balance of $8,947.65. The

Duffies paid the IRS $8,947.65 on September 9, 2002. (Id.).

On August 11, 2004, the Duffies filed an amended income tax return for 1984,

claiming a tax refund of $8,540.00. (Docket Entry No. 29, Appendix at 75-85). On the same

day, the Duffies also filed a refund claim, IRS Form 843, for tax year 1984, requesting a

refund of $43,991.34 in interest. (Id. at 86-95). Each document had a letter attached

asserting why the Duffies were entitled to a refund. The Duffies claimed that the statute of

limitations on tax year 1984 had expired before the taxes were assessed; that Section 6621(c)

interest was improperly assessed; that Avon Products, Inc. v. United States, 588 F.2d 342 (2d

Cir. 1978), restricted the amount of interest that could be assessed; that interest should be

abated under 26 U.S.C. § 6404(e); and that a refund should be issued for the amount the

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Duffies would have received had the IRS not refused to compromise the Duffies’ tax

liability. (Docket Entry No. 29, Appendix at 79-81, 89-91). The IRS denied the Duffies’

refund claims on September 8, 2004. (Id. at 96). The Duffies filed this lawsuit on September

8, 2006. (Docket Entry No. 1).

C. The Summary Judgment Evidence

The relevant summary judgment evidence in the record includes the Duffies’ original

1984 Income Tax Return Form 1040 6 ; John Duffie’s Schedule K-1 form stating his

proportionate share of the Texas Farm Venturers credits and deductions 7 ; the Texas Farm

Venturers 1984 Form 1065 8 ; the Notice of FPAA sent by the IRS to the Texas Farm

Venturers TMP 9 ; the Tax Court petition filed by partners of Texas Farm Venturers other than

the TMP challenging the adjustments in the FPAA 10 ; the IRS’s Motion for Entry of Decisions

in the Tax Court11 ; the Duffies’ motion in the Tax Court for leave to file notice of election

to participate out of time 12 ; the Tax Court’s decision 13 ; the Form 4549-A that the IRS sent to

6

(Docket Entry No. 30, Ex. 2).

7

(Id., Ex. 1).

8

(Docket Entry No. 29, Appendix at 9-13).

9

(Docket Entry No. 30, Ex. 3).

10

(Docket Entry No. 29, Appendix at 16-31).

11

(Id., Appendix at 50-66).

12

(Id., Appendix at 67-69).

13

(Docket Entry No. 30, Ex. 6).

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the Duffies to notify them of adjustments to their income tax liability for 1984 14 ; the Duffies’

amended 1984 Income Tax Return Form 1040X 15 ; the Duffies’ refund claim form and

attached explanatory letter 16 ; and the IRS letter denying the Duffies’ refund claim.17

II. Summary Judgment

Summary judgment is appropriate if no genuine issue of material fact exists and the

moving party is entitled to judgment as a matter of law. F ED.R.C IV.P. 56(c). “The movant

bears the burden of identifying those portions of the record it believes demonstrate the

absence of a genuine issue of material fact.” Lincoln Gen. Ins. Co. v. Reyna, 401 F.3d 347,

349 (5th Cir. 2005) (citing Celotex Corp. v. Catrett, 477 U.S. 317, 322–25 (1986)).

If the burden of proof at trial lies with the nonmoving party, the movant may satisfy

its initial burden by “‘showing’ – that is, pointing out to the district court – that there is an

absence of evidence to support the nonmoving party’s case.” See Celotex, 477 U.S. at 325.

While the party moving for summary judgment must demonstrate the absence of a genuine

issue of material fact, it does not need to negate the elements of the nonmovant’s case.

Boudreaux v. Swift Transp. Co., 402 F.3d 536, 540 (5th Cir. 2005) (citation omitted). “‘An

issue is material if its resolution could affect the outcome of the action.’” DIRECTV, Inc. v.

Robson, 420 F.3d 532, 536 (5th Cir. 2005) (quoting Weeks Marine, Inc. v. Fireman’s Fund

14

(Id., Ex. 10).

15

(Docket Entry No. 29, Appendix at 75-76).

16

(Id., Appendix at 86-91).

17

(Id., Appendix at 74).

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Ins. Co., 340 F.3d 233, 235 (5th Cir. 2003)). “If the moving party fails to meet its initial

burden, the motion for summary judgment must be denied, regardless of the nonmovant’s

response.” Quorum Health Res., L.L.C. v. Maverick County Hosp. Dist., 308 F.3d 451, 471

(5th Cir. 2002) (citing Little v. Liquid Air Corp., 37 F.3d 1069, 1075 (5th Cir. 1994) (en

banc)).

When the moving party has met its Rule 56(c) burden, the nonmoving party cannot

survive a summary judgment motion by resting on the mere allegations of its pleadings.

“[T]he nonmovant must identify specific evidence in the record and articulate the manner in

which that evidence supports that party’s claim.” Johnson v. Deep E. Tex. Reg’l Narcotics

Trafficking Task Force, 379 F.3d 293, 301 (5th Cir. 2004) (citation omitted). “This burden

is not satisfied with ‘some metaphysical doubt as to the material facts,’ by ‘conclusory

allegations,’ by ‘unsubstantiated assertions,’ or by ‘only a ‘scintilla’ of evidence.’” Little,

37 F.3d at 1075 (internal citations omitted). In deciding a summary judgment motion, the

court draws all reasonable inferences in the light most favorable to the nonmoving party.

Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 255 (1986) (citation omitted).

III. Analysis

A. Voluntary Dismissal of the Duffies’ Claims Based on the Statute of

Limitations and Interest Abatement

The Duffies’ complaint alleged that the IRS assessed tax and interest after the statute

of limitations expired, entitling them to a refund of amounts paid under 26 U.S.C. § 6401.

(Docket Entry No. 1). The complaint also alleged that the IRS erroneously failed to abate

interest under 26 U.S.C. § 6404(e). (Id.). In its cross-motion for summary judgment, the

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government correctly noted that district courts lack jurisdiction over both of these claims. In

Weiner, 389 F.3d at 153, the Fifth Circuit held that district courts do not have jurisdiction in

a partner-level refund suit over a claim that tax and interest were assessed after the statute

of limitations expired. Id. In Hinck v. United States, 2007-47 I.R.B. 1032, 127 S. Ct. 2011,

167 L.Ed. 888 (2007), the Supreme Court held that district courts lack jurisdiction to hear

claims regarding the IRS’s refusal to abate interest under Section 6404(e). In their response

to the cross-motion for summary judgment and reply to the response in opposition to their

motion for summary judgment, the Duffies moved for voluntary dismissal of both the claims

based on the statute of limitations and the claims based on interest abatement. (Docket Entry

No. 35 at 1). Under F ED R. C IV. P. 41(a)(2), this court grants the Duffies’ motion for

voluntary dismissal of both claims.

B. Claim Preclusion

The government argues that the Duffies’ claim that the IRS improperly assessed

enhanced interest under Section 6621(c) is barred by claim preclusion, or res judicata. The

Duffies do not dispute the preclusive effect of the Tax Court’s agreed decision on partnership

items. Interest, including interest under Section 6621(c), is an “affected item” that has both

partnership and nonpartnership components. The Duffies dispute the res judicata effect of

the Tax Court’s decision on the assessment of enhanced interest under 26 U.S.C. § 6621(c).

Claim preclusion “bars the litigation of claims that either have been litigated or should

have been raised in an earlier suit.” Test Masters Educ. Servs., Inc. v. Singh, 428 F.3d 559,

571 (5th Cir. 2005), cert. denied, 547 U.S. 1055, 126 S.Ct. 1662, 164 L.Ed.2d 397 (2006),

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citing Petro-Hunt, L.L.C. v. United States, 365 F.3d 385, 395 (5th Cir. 2004). The test for

claim preclusion has four elements: (1) the parties in the subsequent action are identical to,

or in privity with, the parties in the prior action; (2) the judgment in the prior case was

rendered by a court of competent jurisdiction; (3) there has been a final judgment on the

merits; and (4) the same claim or cause of action is involved in both suits. Id.; see also Ellis

v. Amex Life Ins. Co., 211 F.3d 935, 937 (5th Cir. 2000). If a party can only win the suit by

convincing the court that the prior judgment was in error, the second suit is barred. Test

Masters, 428 F.3d at 571 (internal citations omitted). When all four elements are present,

claim preclusion prohibits a litigant from asserting “any claim or defense in the later action

that was or could have been raised in support of or in opposition to the cause of action

asserted in the prior action.” United States v. Shanbaum, 10 F.3d 305, 310 (5th Cir. 1994).

1. Identical Parties in Both Actions

The first element of claim preclusion is met here because the parties in this action are

identical to the parties in the Tax Court case. Under 26 U.S.C. § 6226(c)(1), John Duffie was

treated as a party to the Texas Farm Venturers Tax Court Case, in which the IRS was the

opposing party.

2. Judgment Rendered by a Court of Competent Jurisdiction

The Duffies argue that the Tax Court was not a “court of competent jurisdiction” with

respect to imposing enhanced interest under Section 6621(c) on partners of the partnership.

In a partnership-level proceeding, the Tax Court’s jurisdiction is limited to determining

partnership items and the proper allocation of those partnership items among the partners.

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26 U.S.C. § 6226(f). Section 6621(c), an affected item, imposes interest at 120% of the

statutory rate for substantial underpayment of tax. A tax underpayment is substantial when

it exceeds $1,000 for the tax year in question. 26 U.S.C. § 6621(c)(2). The IRS may not

assess interest under Section 6621(c) unless the substantial underpayment is attributable to

one of the tax-motivated transactions defined by statute. Tax-motivated transactions include

“any sham or fraudulent transaction,” 26 U.S.C. § 6621(c)(3)(A)(v), and any use of an

accounting method that may result in a substantial distortion of income, 26 U.S.C. §

6621(c)(3)(A)(iv). In the Texas Farm Venturers case, the Tax Court stated: “That the

adjustments to partnership income and expense for the taxable year 1984 are attributable to

transactions which lacked economic substance, as described in former I.R.C. §

6621(c)(3)(A)(v) [sham transaction], so as to result in a substantial distortion of income and

expense, as described in I.R.C. § 6621(c)(3)(A)(iv) [accounting method] when computed

under the partnership’s cash receipts and disbursements method of accounting; . . .” (Docket

Entry No. 30, Ex. 6).

The Duffies argue that the Tax Court’s determination that the partnership transactions

that resulted in the adjustments “lacked economic substance, as described in former I.R.C.

§ 6652(c)(3)(A)(v)” is not a finding of tax-motivated transactions. (Docket Entry No. 30,

at 30). In other AMCOR partnership cases, courts have examined the language from the Tax

Court’s agreed decision in the consolidated cases and found that it clearly stated that the

partnership’s transactions were tax-motivated, allowing the IRS to impose interest under

Section 6621(c). See Nault v. United States, 517 F.3d 2, 5 (1st Cir. 2008); Kimball v.

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Comm’r of Internal Revenue, T.C. 2008-78, 2008 WL 862339 (U.S. Tax Court 2008)

(because the partnership’s transactions lacked economic substance, they constituted tax-

motivated transactions). In Nault, the court stated:

The reference to [Section 6621(c)(3)(A)(v)], which helps to

define tax-motivated transactions, confirms that the transactions

were “sham[s] or fraudulent transaction[s]” and therefore lacked

economic substance. The phrase “so as to result in a substantial

distortion of income and expense” simply tracks the language of

the former 26 U.S.C. § 6621(c)(3)(A)(iv), which likewise helps

to define tax-motivated transactions. Thus, each phrase

independently establishes that the adjustments were attributable

to the partnerships’ tax-motivated activities.

517 F.3d at 5 (internal citations omitted).

The government asserts that the Tax Court has already determined that the

transactions that resulted in the adjustments to the partnership items were tax-motivated

transactions; this determination is binding on the Duffies; and this determination meets the

requirements for imposing enhanced tax under Section 6621(c), leaving open only issues that

were not and could not have been addressed in the Tax Court. The open issues do not

include any examination into the character of the underlying transactions. The Duffies assert

that even if the Tax Court finding at the partnership level that the adjustments resulted from

transactions that lacked economic substance means that they were “sham” tax-motivated

transactions, this determination leaves unresolved issues requiring partner-level

determinations, including the individual partner’s personal profit motive. These issues were

not and could not be made at the partnership level because the Tax Court does not have

subject-matter jurisdiction to determine them. As a result, according to the Duffies, the Tax

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Court decision did not resolve their liability for the enhanced interest and they are free to

challenge the assessment.

a. The Tests for Determining Sham Transaction

The Tax Court’s jurisdiction depends on whether the test for determining a sham

transaction under Section 6621(c) requires substantive partner-level factual determinations.

The genesis of the sham-transaction doctrine is the Supreme Court’s decision in Frank Lyon

Co. v. United States, 435 U.S. 561 (1978). The Court stated that a transaction will be

accorded tax recognition only if it has “economic substance which is compelled or

encouraged by business or regulatory realities, is imbued with tax-independent

considerations, and is not shaped solely by tax-avoidance features that have meaningless

labels attached.” Id. at 583-84.

Subsequent case law developed two predominant tests for identifying a sham

transaction. In Rice’s Toyota World, Inc. v. Commissioner, 752 F.2d 89 (4th Cir. 1985), the

Fourth Circuit adopted a two-prong standard, stating that “[t]o treat a transaction as a sham,

the court must find that the taxpayer was motivated by no business purposes other than

obtaining tax benefits in entering the transaction, and that the transaction has no economic

substance because no reasonable possibility of a profit exists.” Id. at 91. The business-

purpose prong inquires into the taxpayer’s subjective motive for entering the transaction. Id.

at 92. The economic-substance prong “requires an objective determination of whether a

reasonable possibility of profit from the transaction existed apart from the tax benefits.” Id.

at 94.

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The other test, adopted by a majority of the circuits, states that “the[] distinct aspects

of the economic sham theory inquiry do not constitute discrete prongs of a rigid two-step

analysis, but rather represent related factors both of which inform the analysis of whether the

transaction had sufficient substance, apart fromits tax consequences, to be respected for tax

purposes.” ACM P’ship v. Comm’r of Internal Revenue, 157 F.3d 231, 247 (3d Cir. 1998),

cert. denied, 526 U.S. 1017 (1999); see alsoSochin v. Comm’r of Internal Revenue, 843 F.2d

351, 354 (9th Cir. 1988), cert. denied, 488 U.S. 824 (1988); Rose v. Comm’r of Internal

Revenue, 868 F.2d 851, 854 (6th Cir. 1989); James v. Comm’r of Internal Revenue, 899 F.2d

905, 908-09 (10th Cir. 1990); Winn-Dixie Stores, Inc. v. Comm’r of Internal Revenue, 254

F.3d 1313, 1316 (11th Cir. 2001). “The sham transaction doctrine has few bright lines, but

‘[i]t is clear that transactions whose sole function is to produce tax deductions are substantive

shams.’” Winn-Dixie Stores, 254 F.3d at 1316 (quoting Kirchman v. Comm’r of Internal

Revenue, 862 F.2d 1486, 1492 (11th Cir. 1989).

Courts of appeals following the approach followed in most of the jurisdictions to

consider the issue have held that while a taxpayer’s subjective business purpose or profit

motive may be relevant to the sham transaction inquiry, the lack of a subjective profit motive

is not required to assess interest at the enhanced rate under Section 6621(c). See Thomas v.

United States of America, 166 F.3d 825, 833 (6th Cir. 1999) (“by its plain language I.R.C.

§ 6621(c) imposes no inquiry into the taxpayer’s investment motive when the transaction is

found to be a sham); Chakales v. Comm’r of Internal Revenue, 79 F.3d 726, 728 (8th Cir.

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1996) (no basis for reading a separate state of mind requirement into the sham transaction

test for purposes of Section 6621(c)(3)(A)(v)); Estate of Carberry v. Comm’r of Internal

Revenue, 933 F.2d 1124, 1129-30 (2d Cir. 1991) (upholding enhanced interest under Section

6621(c) without considering the taxpayer’s motive); Karr v. Comm’r of Internal Revenue,

924 F.2d 1018, 1026 (11th Cir. 1991) (upholding enhanced interest assessment without

inquiring into taxpayer’s motive because Tax Court found partnership activity lacked

economic substance); Jackson v. Comm’r of Internal Revenue, 966 F.2d 598, 601 (10th Cir.

1992) (the mere presence of a profit motive does not prevent a transaction from being a

sham).

The Fifth Circuit has recognized, but not resolved, the disagreement between those

circuits that apply the two-prong test for finding a sham transaction and those that collapse

the prongs into a “factors” test. The Fifth Circuit has declined opportunities to determine

what test should apply. In Compaq Computer Corp. & Subsidiaries v. Comm’r of Internal

Revenue, 277 F.3d 778, 781-82 (5th Cir. 2001), the court found it unnecessary to determine

the appropriate standard for determining a sham transaction because in that case, the taxpayer

met its burden on both prongs. See id. at 781-82.18 Because Compaq did not involve a

partnership, “the question of how a partner’s individual profit motive fits into the sham

inquiry was not at issue in that case.” Weinerv. United States, 255 F.Supp.2d 624, 679 (S.D.

Tex. 2002). In Copeland v. Commissioner, 290 F.3d 326 (5th Cir. 2002), a partnership case

18

See also IES Industries, Inc. v. United States, 253 F.3d 350, 353-54 (8th Cir. 2001) (the

court expressly declined to decide whether the two-prong test was required because the transactions at issue

had both economic substance and business purpose).

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involving a sham transaction, the Fifth Circuit did not “reach the question whether profit

motive is to be tested at the individual or partnership level.” Id. at 337. Answering this

question was unnecessary in Copeland because the IRS relied on 26 U.S.C. § 183 for

disallowing the partnership’s deductions, a section not applicable to partnerships. Id. at 337.

b. Jurisdiction to Determine a Sham Transaction

The Tax Court has held that it does not have jurisdiction in a partnership-level

proceeding to determine “whether the adjustments made on [a FPAA] are attributable to a

tax motivated transaction pursuant to section 6621(c).” Affiliated Equip. Leasing II v.

Comm’r of Internal Revenue, 97 T.C. 575, 576-78, 1991 WL 241149 (1991) (citing White

v. Comm’r of Internal Revenue, 95 T.C. 209, 212, 1990 WL 125093 (1990)); see also N.C.F.

Energy Partners, 89 T.C. 741 at 744. This is because “section 6621(c) interest is not a

‘partnership item’ and is not within the Court’s scope of review in a partnership level

proceeding,” but is rather “an affected item which requires a partner-level determination.”

White, 95 T.C. at 212 (citing N.C.F. Energy Partners, 89 T.C. at 745). The Second and

Fourth Circuits agree that interest assessed against a partner under Section 6621(c) is not a

partnership item. Field v. United States, 328 F.3d 58, 60 (2d Cir. 2003); Zfass v. Comm’r of

Internal Revenue, 118 F.3d 184, 192 (4th Cir. 1997). In Field, the Second Circuit stated that

enhanced interest under Section 6621(c) is an affected item that turns on factual

determinations made at the partner level. 328 F.3d at 60; see also McGann v. United States,

76 Fed. Cl. 745, 757 (Fed. Cl. 2007) (assessment of enhanced interest for “tax motivated

transactions” is not a partnership item, but an affected item).

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In recent cases, courts have held that the Tax Court does have jurisdiction to “make

factual findings concerning whether the partnership’s transactions were designed merely to

secure tax benefits.” River City Ranches #1 Ltd. v. Comm’r of Internal Revenue, 401 F.3d

1136, 1143 (9th Cir. 2005); see also Keener v. United States, 76 Fed. Cl. 455, 469 (2007);

Prati, 81 Fed. Cl. at 439. The Ninth Circuit in River City Ranches did not characterize

Section 6621(c) interest as a partnership item or an affected item. The court held that “the

nature of the partnership’s transactions (i.e., whether the transactions were tax-motivated)

is a ‘partnership item.’” 401 F.3d at 1143. The Tax Code defines partnership item as “any

item required to be taken into account for the partnership’s taxable year under any provision

of subtitle A to the extent regulations prescribed by the Secretary provide that, for purposes

of [subtitle F], such item is more appropriately determined at the partnership level than at the

partner level.” 26 U.S.C. § 6231(a)(3). The court in River City Ranches reasoned:

The character of the partnership’s transactions does relate back

to subtitle A, because it determines the individual partners’

personal income taxes–a subtitle A matter. A partnership’s tax

items affect not the (non-existent) income tax of the

partnerships, but the income tax of the partners. A

partnership’s tax items, which determine the partner’s taxes,

are litigated in partnership proceedings–not in the individual

partner’s cases.

Id. at 1144 (internal citations omitted). These cases recognize that a determination of sham

transaction, properly made at the partnership level, affects the individual partner’s income

tax liability at the partner level.

In Keener, the court concluded that Section 6621(c) interest is an affected item with

a partnership-item component and a nonpartnership-item component. 76 Fed. Cl. at 469.

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The nature of a partnership’s transactions – whether they are a sham – is the partnership item

component of assessing Section 6621(c) interest. Id. Whether a transaction “was a sham

must be resolved first in a partnership-level proceeding, before any consideration can be

given in a refund action to whether the interest should have been imposed on the individual

partner.” Id.

Section 6621(c) applies to tax-motivated transactions other than sham transactions,

including “any loss disallowed by reason of Section 465(a).” 26 U.S.C. § 6621(c)(3)(ii).

Section 465 was added to the Tax Code to combat tax shelters caused by nonrecourse

financing and other situations in which taxpayers were effectively immunized from loss. See

Comm’r of Internal Revenue v. Tufts, 461 U.S. 300, 309 n.7 (1983). Under Section 465(a),

any loss from an activity covered by the section “shall be allowed only to the extent . . . the

taxpayer is at risk.” 26 U.S.C. § 465(a)(1). A taxpayer is considered to be at risk for the

amount of cash contributed and for certain amounts borrowed for the activity. Id. § 465(b).

A taxpayer is generally not at risk for “amounts protected against loss through nonrecourse

financing, guarantees, stop loss agreements, or other similar arrangements.” Id. § 465(b)(4).

The Keener court drew a parallel between a sham transaction and Section 465(a).

Application of the at-risk provisions of Section 465(a) is an affected item. See Ginsburg v.

Comm’r of Internal Revenue, 127 T.C. 75 (2006); Greenberg Bros P’ship #4 v. Comm’r of

Internal Revenue, 111 T.C. 98, 202 (1998). Issues concerning items such as the nonrecourse

character of partnership notes “are to be resolved in a partnership-level proceeding, with

those determinations then being binding on the partners in any refund litigation that would

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ensue.” Keener, 76 Fed. Cl. at 467 (citing Greenberg Bros P’ship, 111 T.C. at 202). The

sham-transaction determination is appropriately made at the partnership level, in a unified

proceeding, and not at the individual-partner level.

In Keener and River City Ranches, the courts distinguished between the actual

assessment of interest under Section 6621(c) by the IRS, which requires that the partner’s tax

underpayment was greater than $1,000, and the factual determination of whether a

partnership was engaged in sham transactions. The decisions characterizing Section 6621(c)

interest as an “affected item” that must be resolved at the partner level did not consider

whether Section 6621(c) has a partnership-item component that requires findings at the

partnership level. The court in Keener stated that these cases “go astray . . . in assuming that

because interest is not itself a partnership item, a court is not required to resolve issues

concerning the nature of the partnership’s transactions in a unified partnership proceeding.”

Id.

In Ertz v. Comm’r of Internal Revenue, 2007 WL 174133 (U.S. Tax Court Jan. 24,

2007), the Tax Court applied River City Ranches to hold that it lacked jurisdiction in a

partner-level proceeding to determine whether a transaction was tax-motivated under Section

6621(c). The taxpayer-partner in Ertz resided in Idaho and the appeal from the Tax Court’s

decision was to the Ninth Circuit. The Tax Court followed the rule that it is bound “to follow

a Court of Appeals decision which is squarely [on] point where appeal from [the] decision

lies to that Court of Appeals and that court alone.” Golsen v. Comm’r of Internal Revenue,

54 T.C. 742, 756, 1970 WL 2191 (1970), aff’d 445 F.2d 985 (10th Cir. 1971), cert. denied,

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404 U.S. 940 (1971). Under the Ninth Circuit precedent, the Tax Court held that jurisdiction

to determine whether a transaction was tax-motivated under Section 6621(c) was only present

in a partnership-level proceeding.

The River City Ranches rule regarding Tax Court jurisdiction is consistent with the

Ninth Circuit’s approach to sham transaction in the partnership context. “The determination

of an existing profit motive is made at the partnership level and does not address the

subjective intent of the particular partner in question.” Hill v. Commissioner, 204 F.3d 1214,

1218 (9th Cir. 2000). Upon finding that a partnership transaction was a sham, as long as the

partner’s underpayment was $1,000 or greater, the IRS may impose interest under Section

6621(c) irrespective of the taxpayer-partner’s subjective intent. See id. at 1220.

The Duffies argue that in the Fifth Circuit, a sham-transaction determination requires

a finding that the individual partner lacked a profit motive. In partnership cases decided

before Compaq and Copeland, the Fifth Circuit affirmed Tax Court decisions that the IRS

properly imposed interest at the Section 6621(c) enhanced rate. See Chamberlain v. Comm’r

of Internal Revenue, 66 F.3d 729, 732 (5th Cir. 1995); Lukens v. Comm’r of Internal

Revenue, 945 F.2d 92 (5th Cir. 1991); Durrett v. Comm’r of Internal Revenue, 71 F.3d 515

(5th Cir. 1996). In these cases, the Tax Court had found that the individual partner lacked

a profit motive, despite testimony to the contrary. Chamberlain, 66 F.3d at 732; Lukens, 945

F.2d at 99-100; Durrett, 71 F.3d at 517. The Fifth Circuit affirmed the imposition of interest

at the Section 6621(c) rate in these cases because the Tax Court’s factual finding that the

individual partners lacked a profit motive was not clearly erroneous.

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The Fifth Circuit has not decided which of the two tests followed in the circuit courts

is the appropriate test for sham transaction. Copeland, 290 F.3d at 337-38. In Transcapital

Leasing Associates 1990-II LP v. United States, 246 Fed. Appx. 266 (5th Cir. 2007), the

court stated it was “unnecessary to adopt either variant of the sham transaction doctrine”

“because the transaction lacked a genuine business purpose and was economically

insubstantial.” The court also expressed “no opinion on whether the [profit motive] analysis

of an alleged sham transaction . . . focuses on the subjective motivation of the taxpayer

partner or the flow-through partnership entity.” Id. In Chamberlain, Lukens, and Durrett, the

Fifth Circuit merely affirmed the result reached in the Tax Court, based in part on the fact

that the Tax Court’s finding that the individuals lacked a profit motive was not clearly

erroneous.

Contrary to the Duffies’ assertion, the Fifth Circuit does not require a finding that an

individual partner lacked a profit motive to impose interest at the enhanced rate under

Section 6621(c). While the individual taxpayer’s subjective business purpose or profit

motive may be relevant to the sham-transaction inquiry, lack of profit motive is not required

to impose interest at the enhanced rate. See Thomas, 166 F.3d at 833; Karr, 924 F.2d at

1026; see alsoCherin v. Commissioner, 89 T.C. 986, 993 (1987) (the Tax Court has “never

held that the mere presence of an individual's profit objective will require [it] to recognize

for tax purposes a transaction which lacks economic substance); Bohrer v. Commissioner,

945 F.2d 344, 348 n. 5 (10th Cir.1991) (noting that either lack of profit motive or lack of

economic substance can render a transaction a sham). In weighing the relevant factors to

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determine whether a partnership transaction is a sham – economic substance and business

purpose – a court is not required to determine whether the individual partner lacked a profit

motive in deciding that enhanced interest applies.

The Duffies concede that under Tax Court Rule 248(b) and the language of the IRS’s

Motion for Entry of Decisions, they are bound by the Tax Court’s determination of

partnership items. In its Motion for Entry of Decisions, the IRS took the position that

enhanced interest under Section 6621(c) was an affected item, not a partnership item, which

is a judicial admission binding on the IRS. See Martinez v. Bally’s La., Inc., 244 F.3d 474,

476 (5th Cir. 2001) (holding “[a] judicial admission is a formal concession in the pleadings

or stipulations by a party or counsel that is binding on the party making them.”).

Although enhanced interest under Section 6621(c) is an affected item, it has a

partnershipitem component and a nonpartnership-item component. Keener, 76 Fed. Cl at

469. The nonpartnership-item component of Section 6621(c) interest is whether the

taxpayer’s underpayment was substantial – $1,000 or greater – and whether it was

attributable to a transaction previously determined at the partnership level to be

tax-motivated. The Tax Court does not have jurisdiction to make this nonpartnership

determination in a partnership-level proceeding. The Tax Court did not determine whether

any underpayment by the Duffies was substantial or whether such underpayment was

attributable to Texas Farm Venturers’s disallowed farming expenses. The Tax Court did

determine – and had jurisdiction to do so – that the partnership’s transactions resulting in the

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adjustments were a sham. This determination of the partnership-item component of Section

6621(c) interest is properly made at the partnership level.

Making the sham-transaction determination at the partner level could lead to

inconsistent results. TEFRA was intended to channel partnership items into a unified

procedure for resolution; determining whether the partnership’s activities were sham

transactions in a partnership-level proceeding is consistent with that purpose. The Tax Court

had jurisdiction to determine whether the Texas Farm Venturers transactions were sham

transactions.

3. Final Judgment on the Merits

Section 6226(g) states that a determination by a court on the FPAA “shall have the

force and effect of a decision of the Tax Court.” 26 U.S.C. § 6226(g). The Duffies assert

that because the Tax Court decision was an agreed decision, drafted by the IRS, it should not

be given preclusive effect. The Fifth Circuit has held that an agreed decision in the Tax

Court may be given res judicata effect. Shanbaum, 10 F.3d at 313-14. The court in

Shanbaum stated that “[s]imply because the Tax Court decisions were reached by agreement

does not mean that [the taxpayer’s] income tax and transferee liabilities were not resolved

by a [sic] final judgments on the merits for the purposes of res judicata.” Id.

Because an agreed decision is contractual in nature, the “preclusive effects should be

measured by the intent of the parties.” 18A W RIGHT, M ILLER & C OOPER, F EDERAL

P RACTICE AND P ROCEDURE:JURISDICTION 2 D § 4443. Preclusion should be denied as to

claims the parties intended to leave open for further litigation. See id. The Duffies argue that

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the parties did not intend the Tax Court proceedings and decision to determine whether the

assessment of Section 6621(c) interest at the partner level was appropriate. The Duffies

argue that they are not bound by the agreement in Attachment C to the IRS’s Motion for

Entry of Decisions, which stated that the limited partners would be estopped from

challenging the assessment of interest under Section 6621(c). (Docket Entry No. 29,

Appendix at 63).

Once a partnership-level suit is filed in the Tax Court, the TMP may enter into a

settlement agreement with the IRS that is binding on all the other partners, notice and non

notice, with respect to the determination of the partnership items in dispute. T AX C OURT 4.

248(b)(1)(B), 251. The agreement between the IRS and the TMP concerning Section 6621(c)

interest, Attachment C, stated in relevant part:

Effective upon entry of the Decision and in consideration of

the reduced adjustments set forth therein, the partners

expressly consent to the assessment of interest on the

deficiencies in income tax, if any, which are attributable to the

adjustments to the partnership items of the partnership at the

increased rate specified in former I.R.C. § 6621(c).

....

Absent a timely objection to the entry of decisions . . . the

parties to the proceedings shall be presumed to have consented

to all of the terms of the agreement described above and shall

be estopped from challenging the adjustments to the

partnership items determined in the decision and from

challenging the assessment of interest accruing on any

deficiencies in income tax attributable thereto at the increased

rate prescribed by former I.R.C. § 6621(c).

(Id. at 59-63).19 The IRS’s Motion for Entry of Decisions stated:

19

Attachment C also stated that the general partners of Texas Farm Venturers

consented to the assessment of an addition to tax under 26 U.S.C. § 6661 at the rate of 10%

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[The IRS has made] preliminary determinations as to certain

affected items, including the . . . assessment of interest on the

deficiencies in the partners’ income tax at the increased rate

prescribed by the former I.R.C. § 6621(c); which

determinations the tax matters partner and other partners are

expected to dispute.

(Docket Entry No. 29, Appendix at 54, ¶ 16).

The agreement and decision are binding and preclude relitigation of partnership items.

This includes the partnership-item component of Section 6621(c), whether the partnership’s

transaction resulting in the adjustments was a sham transaction. Although the IRS’s Motion

for Entry of Decisions states that the assessment of Section 6621(c) interest would not be

subject to challenge by partners, the Motion also states that the IRS expected the partners to

dispute the IRS’s preliminary determinations as to the liability of the limited partners for

additions to tax under Sections 6653 and 6661 and for the assessment of interest on the

deficiencies in the partners’ income tax at the rate set under Section 6621(c). (Docket Entry

No. 29, Appendix at 54, ¶ 16). Taken together, these two sections of the Motion, the

of any additional tax deficiency resulting from the adjustments to partnership items in the Tax

Court decision. The time period for making this assessment began on the date the separate

“Closing Agreement” between the IRS and the general partners of AMCOR partnerships

became effective. The Closing Agreement between the IRS and the general partners of Texas

Farm Venturers, Robert A. Wright and Frederick Behrens, repeats the general partners’

consent to assessment of an addition to tax under Section 6661 as stated in Attachment C.

(Docket Entry No. 30, Ex. 8). The Closing Agreement also stated that Wright and Behrens

individually consented to the assessment of interest at the rate prescribed by Section 6621(c)

for Wright’s and Behren’s tax underpayments.

In assessing interest against the Duffies under Section 6621(c), the IRS did not rely on the

Closing Agreement, which only binds the general partners of Texas Farm Venturers, but

rather on Attachment C, which binds the partners to the determination of partnership items

in the Tax Court. Because the Tax Court’s determination that Texas Farm Venturers’s

activities were sham transactions is a partnership item, the Duffies’ argument that they are

not bound by the Closing Agreement is irrelevant.

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agreement, and the decision allow a partner-level challenge of the nonpartnership-item

component of Section 6621(c) interest: whether the partner’s underpayment was greater than

$1,000 and whether it was attributable to the transaction previously determined at the

partnership level to be tax-motivated.

Section 6621(c), Section 6653, and Section 6661(a), under which the IRS made

determinations it expected the partners to dispute, all impose additional tax or interest for tax

underpayment. Section 6653 imposes an addition to tax of “50 percent of the interest payable

under Section 6601" for an underpayment “which is attributable to . . . negligence or

intentional disregard” of rules or regulations. 26 U.S.C. § 6653(a)(2). Section 6661(a), in

effect during tax years 1983 and 1984 20 , provided that if there were a “substantial

understatement” of income tax for a taxable year, a penalty of twenty-five percent of the

amount of the underpayment attributable to the understatement would be imposed. An

understatement was deemed substantial if it exceeded the greater of ten percent of the tax

required to be shown on the return or $5,000. 26 U.S.C. § 6661(b).

It is instructive to look at the difference between Section 6621(c), on the one hand,

and Sections 6653 and 6661, on the other, regarding the necessary factual findings at the

partner level. Section 6653 requires a finding of the individual partner’s negligence. N.C.F.

Energy Partners, 89 T.C. at 744. If the transaction is a tax shelter, Section 6661 requires a

partner-level factual finding concerning the taxpayer’s reasonable beliefs about litigation

risks. Id. In contrast, if the partnership-level proceeding results in adjustments attributable

20

This provision was repealed in 1989. See Omnibus Budge Reconciliation Act of 1989, Pub.

L. No. 101-239, § 7721(c)(2), 103 Stat. 2399.

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to a tax-motivated transaction, the factual finding at the partner level for Section 6621(c) is

computational. The Tax Court has held that “Section 6621(c)’s applicability . . . turns on the

amount of the taxpayer’s underpayment attributable to a taxmotivated transaction.” N.C.F.

Energy Partners, 89 T.C. at 746. Determining the amount of a partner’s underpayment

resulting from the partnership-level adjustment resulting from a tax-motivated transaction

is a computational task of deciding whether the underpayment amount was greater than

$1,000. Although some federal district courts in the Fifth Circuit have concluded that sham

transaction requires an inquiry into the individual partner’s profit motive 21 , the Fifth Circuit

has not adopted this requirement. When a sham transaction is found at the partnership level,

the factual finding required at the individual partner level is computational: whether the

resulting underpayment was greater than $1,000.

The agreement in Attachment C states that “in consideration of the parties’ consent

to the assessment of interest at the rate prescribed by former I.R.C. § 6621(c), [the IRS]

expressly waives all claims against the limited partners for any additions to tax that might be

due under I.R.C. §§ 6653 and 6661.” (Docket Entry No. 29, Appendix at 62). However, the

“general partners . . . consent[ed] to the assessment of an addition to tax pursuant to I.R.C.

§ 6661, at the rate of 10% of any additional tax deficiency which results from the adjustments

to partnership items contained in the Decisions.” (Id.). The IRS waived its claims against

the general partners for the assessment of additional tax under Section 6653. (Id. at 63).

21

See Weiner, 255 F.Supp.2d at 656-57; Kraemer v. United States, 2002 WL 575791 (S.D. Tex.

Feb. 13, 2002); Mellina v. United States, 518 F.Supp.2d 825 (N.D. Tex. 2007); Bartimmo v. United States,

525 F.Supp.2d 879 (S.D. Tex. 2007).

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When the IRS stated that it expected the partners to dispute its determinations under Sections

6653, 6661, and 6621(c), it expected that the general partners would dispute their reasonable

belief about litigation risks under Section 6661 and that the limited partners would dispute

the determination that their underpayments were greater than $1,000 under Section 6621(c)

and whether that partner’s underpayment resulted from the transaction previously determined

at the partnership level to be tax-motivated. But nothing in the Motion or agreement allows

a partner to relitigate the Tax Court’s decision on the partnership-item components of Section

6621(c) interest. A partner may not relitigate the Tax Court’s determination that the

partnership transactions resulting in the adjustments were factual or economic shams, that

is, tax-motivated transactions as defined in Section 6621(c).

An agreed decision in the Tax Court is generally treated as a final judgment on the

merits, but its preclusive effect is limited to the items the parties agreed would be determined

as a final matter, not subject to later dispute. Claim and issue preclusion cannot be applied

against a party that did not have the opportunity to litigate the matters as to which preclusion

is sought. Kremer v. Chemical Constr. Corp., 456 U.S. 461, 480-81 n.22 (1982). Under the

IRS’s Motion for Entry of Decisions, the parties did not intend to determine all aspects of the

assessment of interest under Section 6621(c) as to an individual partner. The interest

assessment is subject to later dispute at the partner level, but only as to the

nonpartnership-item components of that assessment. The parties did intend the agreed

decision to be a final judgment on the merits as to all partnership items, including the

determination that the Texas Farm Venturers transactions that resulted in the adjustments

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were sham transactions. The Duffies may not dispute or relitigate the determinations made

in the Tax Court as to the partnership-item components of the Section 6621(c) interest

assessment. The Duffies may dispute and litigate in a partner-level proceeding the

nonpartnership-item components of Section 6621(c) interest: whether their underpayment

was substantial and whether it was attributable to the transaction previously determined to

be tax motivated. The Duffies are free to challenge at the partner level the IRS’s

computation that their underpayment resulting from the adjustments to Texas Farm

Venturers’s farming expenses was greater than $1,000.

4. Same Claim or Cause of Action Involved in Both Suits

The fourth element of res judicata is met because “one’s total income tax liability for

each taxable year constitutes a single, unified cause of action, regardless of the variety of

contested issues and points that may bear on the final computation.” Finley v. United States,

612 F.2d 166, 170 (5th Cir. 1980).

C. Jurisdiction

The government claims that this court lacks subject-matter jurisdiction over the

Duffies’ refund claim because “[n]o action may be brought for a refund attributable to

partnership items.” 26 U.S.C. § 7422(h). The Duffies argue that Section 7422(h) does not

defeat this court’s subject-matter jurisdiction because the assessment of interest under

Section 6621(c) is an affected item, not a partnership item. The government concedes that

Section 6621(c) interest is an affected item but asserts that to decide the Duffies’ claim, this

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court would have to revisit the Tax Court’s determination of the character of the

partnership-item adjustments, which is the partnership prong of Section 6621(c).

The government also argues that this court lacks subject-matter jurisdiction over the

Duffies’ claim because they failed to file a refund claim with the IRS within the six-month

TEFRA limitations period. The Duffies assert that the six-month filing requirement does not

apply to this refund claim.

1. Section 7422(h) is a Bar to Jurisdiction

The government argues that this court lacks jurisdiction, under Section 7422(h), to

consider the Duffies’ claim that the IRS erred in assessing Section 6621(c) interest against

them. The government asserts that there are two parts to the determination that Section

6621(c) interest applies: 1) the adjustments to the partnership’s income, losses, deductions,

or credits must cause the partners’ underpayment to exceed $1,000; and (2) the adjustments

must be attributable to a tax-motivated transaction. 26 U.S.C. § 6621(c)(2). The government

argues that determining the Duffies’ claim would require this court to examine partnership

items, such as the adjustments to the partnerships expenses, over which this court lacks

subject-matter jurisdiction.

The Duffies do not challenge the adjustments to the partnership’s farming expenses

that are part of the Tax Court agreed judgment. The Duffies agree that this court cannot

redetermine whether the Texas Farm Venturers farming expenses lacked economic

substance. The Duffies challenge the Tax Court’s determination that Texas Farm Venturer’s

transactions were tax-motivated sham transactions.

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The government cites Keener, 76 Fed. Cl. at 469, in which the plaintiff was a limited

partner in an AMCOR partnership who sued for a refund of interest assessed under Section

6621(c). The court held that it lacked jurisdiction to consider the plaintiff’s refund claim

because that would require the court to decide whether it was proper to adjust partnership

items, including income and expenses. Determining whether the plaintiff, a limited partner,

was entitled to an interest refund would require the court to determine whether the interest

was on adjustments “attributable to” the partnership-item component of Section 6621(c). The

court concluded that it lacked jurisdiction to do so. Id.

The Duffies assert that Section 7422(h) is no bar to subject-matter jurisdiction because

the IRS’s interest assessment under Section 6621(c) is an affected item, not a partnership

item. In Field, the court held that Section 7422(h) does not bar a district court from

reviewing the plaintiff’s claim for refund of interest assessed under Section 6621(c) because

the refund claim was not “attributable to a partnership item.” 329 F.3d at 59. The court

stated that to be attributable to a partnership item, the refund claim must be based on the

assessment of a partnership item, and the assessment of interest on a partner under Section

6621(c) is an affected item, not a partnership item. Id. The court’s holding was based in part

on the statutory definition of “partnership item,” which refers to the regulations for examples

of partnership items. See 26 C.F.R. § 301.6231(a)(3)-1. Because Section 6621(c) interest

is not found in the regulation, the court held that the assessment of Section 6621(c) is not a

partnership item, but an affected item. Id.; see also Mellina v. United States, 518 F.Supp.2d

825, 828-29 (N.D. Tex. 2007); McGann, 76 Fed. Cl. at 757.

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The Duffies’ refund claim is attributable to the Tax Court’s determination that the

Texas Farm Venturers activities were sham transactions. The Duffies’ claim is that the Tax

Court’s determination of sham transaction was insufficient because there was no finding that

John Duffie lacked a profit motive. Because the nature of a partnership’s activities – whether

they are sham transactions – is the partnership-item component of an affected item, the

Duffies’ refund claim is based on the determination of a partnership item. Section 7422(h)

deprives this court of subject-matter jurisdiction to consider the Duffies’ claim that the Tax

Court erred in determining that the Texas Farm Venturers activities were taxmotivated sham

transactions.

The Duffies also argue that Section 7422(h) does not bar jurisdiction because the

partnership items at issue converted to nonpartnership items under the settlement agreement

with the IRS. When a partner enters into a settlement agreement with the IRS concerning

partnership items, these items are converted to nonpartnership items. 26 U.S.C. §

6231(b)(1)(C). A partner who has settled with the IRS no longer has an interest in the

partnership-level proceeding. 26 U.S.C. § 6226(d)(1)(A). Any determination made at the

partnership level will not apply to the settling partner. The conversion from partnership

items to nonpartnership items lifts the jurisdictional bar of Section 7422(h). Alexander v.

United States, 44 F.3d 328, 331 (5th Cir. 1995).

The Duffies’ position is unpersuasive. The agreement on which the Tax Court

decision was based expressly states that it “does not act to convert partnership items to

nonpartnership items, but rather, sets forth how the Decisions will be entered by the Tax

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Court which will be binding on the non-participating partners who are parties to these

proceedings.” (Docket Entry No. 30, Appendix at 55). The Duffies’ argument also ignores

the statutory purpose and structure. TEFRA’s goal of uniformity is accomplished by

channeling challenges to the adjustment of partnership items into a single, unified

proceeding. This goal would be undermined if a partner who participated in such a

proceeding was able subsequently to challenge the partnership-level adjustments made in that

proceeding in an individual refund action based on a “conversion.” The rule of conversion

applies only to settlement agreements entered into before the partnership-level proceedings

occur, not a contingent agreement that served as the basis for an agreed decision in a

partnership-level proceeding in the Tax Court.

2. The Duffies’ Failure to Timely File a Refund Claim Deprives this

Court of Jurisdiction

“The United States, as sovereign, is immune from suit save it consents to be sued

. . . and the terms of its consent to be sued in any court define that court’s jurisdiction to

entertain the suit.” United States v. Sherwood, 312 U.S. 584, 586 (1941). Under Section

1346(a)(1), district courts have original jurisdiction over:

[a]ny civil action against the United States for the recovery of

any internal-revenue tax alleged to have been erroneously or

illegally assessed or collected, or any penalty claimed to have

been collected without authority or any sum alleged to have

been excessive or in any manner wrongfully collected under

the internal-revenue laws. . . .

28 U.S.C. § 1346(a)(1). “Because tax refund suits are actions in which the sovereign has

waived its immunity and consented to be sued, statutory provisions governing such suits

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are strictly construed.” Alexander v. United States, 829 F.Supp. 199, 200-01 (N.D. Tex.

1993). One condition to suit against the United States is compliance with the time period

within which a claim must be filed. Under 26 U.S.C. § 7422(a):

No suit or proceeding shall be maintained in any court for the

recovery of any internal revenue tax alleged to have been

erroneously or illegally assessed or collected ... until a claim

for refund or credit has been duly filed with the Secretary,

according to the provisions of law in that regard, and the

regulations of the Secretary established in pursuance thereof.

(emphasis added). To overcome sovereign immunity in a tax refund action, a taxpayer must

file a refund claim with the IRS within the time limits established by the Internal Revenue

Code. United States v. Dalm, 494 U.S. 596, 602 (1990). A taxpayer’s failure to file a timely

refund claim with the IRS deprives the district court of subject-matter jurisdiction. Gustin v.

United States, 876 F.2d 485, 488 (5th Cir. 1989).

The general limitations periods for filing refund claims with the IRS are prescribed

by subchapter B of Chapter 66 of the Internal Revenue Code, set forth at 26 U.S.C. § 6511

et seq. (the “regular refund procedures”). Under Section 6511(a), a refund claim must be

filed within the later of two years from the time the tax was paid or three years from the time

the tax return was filed. Under TEFRA, the regular refund procedures and the two or three

year statutes of limitations do not apply to credit or refund of an overpayment “attributable

to a partnership item (or an affected item ).” 26 U.S.C. § 6230(d)(6).22

22

Section 6230(d)(6) was subsequently amended to remove the language “(or an

affected item).” Taxpayer Relief Act of 1997, Pub. L. No. 105-34, § 1239(c)(1), 111 Stat. 788,

1028 (1997). The amendment was effective only as to taxable years after August 5, 1997. Id.

at § 1239(f).

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The two types of affected items, computational and substantive, each have different

procedural requirements. For computational affected items, the IRS need not issue a

statutory notice of deficiency, and the TEFRA time requirements apply. Woody, 95 T.C. at

201-02. Under TEFRA, if the IRS erroneously computes the adjustment, the taxpayer must

file a refund claim within six months after the IRS mails a notice of computational

adjustment to the partner. 26 U.S.C. § 6230(c)(2)(A). The IRS is required to follow the

non-TEFRA deficiency procedures when making an adjustment relating to a

noncomputational or “substantive” affected item. 26 U.S.C. § 6230(a)(2)(A)(I); 26 C.F.R.

§ 301.6231(a)(6)-1T(a); Woody, 95 T.C. at 202; N.C.F. Energy Partners, 89 T.C. at 745. The

TEFRA time requirements do not apply to such substantive affected items. Instead, refund

claims based on substantive affected items are governed by the limitations period in Section

6511(a). Brookstone Corp. v. United States, 1994 WL 621576 (S.D. Tex. May 23, 1994).

The government argues that the enhanced interest assessed against the Duffies under

Section 6621(c) is a computational affected item. In support, the government cites Barlow

v. Commissioner, 78 T.C.M. (RIA) ¶ 2000-339, 2000 WL 1649506 (T.C. 2000), which states

that Section 6621(c) interest “is an affected item because the determination of a taxpayer’s

liability for such interest may require findings of fact peculiar to the particular taxpayer,

namely the amount of the taxpayer’s underpayment that is attributable to a taxmotivated

transaction.” (emphasis added). According to the government, the fact that Section 6621(c)

may require individual partner-level findings does not mean such findings are always

required. The Barlow court noted that once it decides “that there is a taxmotivated

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transaction . . ., the determination of the additional interest is largely mechanical.” Id. at

2000-1945. Because the Tax Court judgment found that the adjustments at the partnership

level resulted from transactions lacking in economic substance, the government argues that

the determination of the Duffies’ additional interest was similarly mechanical. The

government asserts that substantive affected items “are more accurately described as affected

items that depend on ‘non-computational’ partner level factual determinations.” Olson v.

United States, 37 Fed. Cl. 727, 732 n.7 (1997). The factual determination at the partner

level, according to the government, must be more than just computational or mechanical to

be a substantive affected item. There are no noncomputational facts, the government

maintains, that must be determined at the partner level to determine whether Section 6621(c)

interest was properly applied to the Duffies.

In response, the Duffies assert that the assessment of Section 6621(c) interest is a

substantive affected item, requiring factual determinations at the partner level. The Duffies

cite Mellina, 518 F.Supp.2d at 829-30, and Bartimmo, 525 F.Supp.2d at 884. In both Mellina

and Bartimmo, the courts stated that Section 6621(c) interest is an affected item that turns

on issues specific to the individual partners. However, neither court analyzed or discussed

what partner-specific issues had to be determined at the partner level. The Mellina court

relied on the Second Circuit’s opinion in Field, 328 F.3d at 59, as holding that Section

6621(c) interest is always substantive affected item and not a computational adjustment. The

question before the Field court was whether Section 6621(c) is a partnership item, not

whether it is a substantive or computational affected item. The statement in Field that

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Section 6621(c) interest is a substantive affected item comes from a parenthetical in which

the court summarized the holding of Barlow, 78 T.C.M. at 2000339. Barlow clarified that

the partner-specific issues with respect to Section 6621(c) interest are “the amount of the

taxpayer’s underpayment that is attributable to a taxmotivated transaction.” Id. at 2000-1944.

In the Texas Farm Venturers case, the Tax Court determined that the adjustments

to partnership expenses were attributable to tax-motivated transactions. The only issue in this

partner-level refund action is whether the Duffies’ tax underpayment resulting from the

partnership transactions previously found to be tax-motivated was substantial, $1,000 or

greater, clearly a computational rather than a substantive issue. In this case, the IRS’s

assessment of interest under Section 6621(c) is a computational affected item. Because the

interest assessment under Section 6621(c) is a computational affected item in this case, the

general limitations period of Section 6511(a) does not apply. Rather, the TEFRA sixmonth

statute of limitations applies to the Duffies’ refund claim.

The Duffies have the burden of showing compliance with the applicable limitations

period. See Makaraova v. United States, 201 F.3d 110, 113 (2d Cir. 2000). The undisputed

facts in the record show that the IRS notified the Duffies of the adjustments to their income

tax liability on July 19, 2002 and assessed additional tax liability and interest on August 12,

2002. The Duffies paid the full balance of tax and interest on September 9, 2002. It is

undisputed that the Duffies filed a refund claim on August 11, 2004. The Duffies failed to

timely file their refund claim with the IRS within the applicable six-month limitations period.

IV. Conclusion

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The Tax Court’s decision is res judicata with respect to partnership items, including

the determination that the Texas Farm Venturers transactions that resulted in the partnership

adjustments were sham transactions. This court does not have subject-matter jurisdiction to

review substantive issues relating to the interest assessment under Section 6621(c) because

the interest assessment is attributable to a partnership item. The partnership item, the

character of the transactions that resulted in the adjustments, was resolved by the Tax Court’s

determination that the Texas Farm Venturers transactions were sham transactions. This court

also lacks subject-matter jurisdiction because the Duffies failed to timely file their refund

claim with the IRS. This court denies the Duffies’ motion for summary judgment and grants

the government’s cross-motion for summary judgment. Final judgment is entered by separate

order.

SIGNED on September 30, 2008, at Houston, Texas.

______________________________________

Lee H. Rosenthal United States District Judge

47