UNITED STATES TAX COURT

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138 T.C. No. 6

UNITED STATES TAX COURT

TIGERS EYE TRADING, LLC, SENTINEL ADVISORS, LLC,

TAX MATTERS PARTNER, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 14510-05.

Filed February 13, 2012.

The stipulated decision in this Son of BOSS TEFRA

partnership-level case, entered by the Court Dec. 1, 2009, was agreed

to by R and the tax matters partner (TMP) of Tigers Eye Trading, LLC

(Tigers Eye), with concurrence of participating partner (P), a partner

other than TMP. The first decision paragraph specifies that the

partnership items of ordinary loss, other deductions, distributions of

property, and capital contributions were reduced to zero as determined

in the notice of final partnership administrative adjustment (FPAA)

issued to Tigers,Eye. The second decision paragraph, determining that

the FPAA is correct, includes the determinations that Tigers Eye is

disregarded for Federal income. tax purposes, outside basis is reduced

to zero, and a 40% penalty applies to any gross valuation/basis

SERVED Feb 13 2012

-2misstatement. The third and fourth decision paragraphs respectively

determine that the 40% gross valuation misstatement penalty under

I.R.C. sec. 6662(b)(3), (e), and (h) applies to any underpayment of tax

attributable to overstating the capital contributions claimed to have

been made to the purported partnership and a 20% penalty for

negligence or substantial underpayment under I.R.C. sec. 6662 applies

to any additional underpayment of tax attributable to the partnership

item adjustments other than the claimed capital contributions.

On Jan. 12, 2010, the Court of Appeals for the D.C. Circuit, to

which this case would be appealable, issued Petaluma FX Partners,

LLC v. Commissioner, 591 F.3d 649 (D.C. Cir. 2010) (Petaluma II),

aff'g in part, rev'g in part and remanding 131 T.C. 84 (2009)

(Petaluma I). In Petaluma II the Court of Appeals for the D.C. Circuit

held that outside basis is not a partnership item that the Tax Court had

jurisdiction to determine in the partnership-level proceeding and

remanded the case on the applicability of penalties.

On Jan. 19, 2010, P filed a motion for leave to file a motion to

revise the stipulated decision and lodged the motion to revise. On Dec.

30, 2010, the Court granted the motion for leave nunc pro tunc as of

Jan. 19, 2010, and as of that date filed the motion to revise. In the

motion to revise P asks the Court to revise the stipulated decision to

conform to the jurisdictional limits on the authority of the Tax Court

established in Petaluma II.

On Dec. 15, 2010, this Court issued Petaluma FX Partners, LLC

v. Commissioner, 135 T.C. 581 (2010) (Petaluma III), on appeal.(D.C.

Cir. Mar. 8, 2011), holding that for this Court to have jurisdiction over

a penalty at the partnership level, Petaluma II requires that the penalty

be computable without partner-level proceedings to determine affected

items, leading at least potentially to only a computational adjustment to

the partners' returns. Id. at 586-587.

After Petaluma II and Petaluma III were issued, the Supreme

Court issued Mayo Found. for Med. Educ. & Research v. United

-3States, 562 U.S. __, 131 S. Ct. 704 (2011). In Mayo Found., the

Supreme Court made clear that courts must defer to regulations that

interpret the Internal Revenue Code unless they fail to meet the two-

step standard of Chevron, U.S.A., Inc. v. Natural Res. Def. Council,

Inc., 467 U.S. 837, 842-843 (1984). In the recently issued opinion in

Intermountain Ins. Serv. of Vail, LLC v. Commissioner, 650 F.3d 691

(D.C. Cir. 2011), rev'g and remanding 134 T.C. 211 (2010),

supplementing T.C. Memo. 2009-195, the Court of Appeals for the

D.C. Circuit held that, prior caselaw to the contrary notwithstanding,

the Tax Court must defer to a regulation unless it holds the regulation

invalid under Chevron.

Held: The motion to revise the stipulated decision will be

denied; the jurisdictional limitations established in Petaluma II were

based on a concession by the Government that does not apply in the

case at hand; the applicability of the accuracy-related penalties

determined by the stipulated decision in the case at hand is sustained

by the decision's adoption of adjustments to partnership items that are

related to said penalties.

Held, further, because Tigers Eye filed a partnership return for

1999, the TEFRA procedures apply with respect to 1999 to Tigers Eye

and its items and to TMP, P, and other persons holding an interest in

Tigers Eye, and the Tax Court has jurisdiction to determine that Tigers

Eye does not exist and is not a partnership for Federal income tax

purposes. See I.R.C. sec. 6233; sec. 301.6233-1T(a), (c), Temporary

Proced. & Admin. Regs., 52 Fed. Reg. 6779, 6795 (Mar. 5, 1987).

Held, further, because Tigers Eye does not exist and is not a

partnership for Federal income tax purposes, the Court has jurisdiction

to make determinations with respect to all items of Tigers Eye that

would be partnership items, as defined in I.R.C. sec. 6231(a)(3) and

sec. 301.6231(a)(3)-1, Proced. & Admin. Regs., if Tigers Eye had been

a partnership, including the nature and character of those items. See

I.R.C. sec. 6233; sec. 301.6233-1T(a), (c), Temporary Proced. &

Admin. Regs., supra.

-4Held, further, because Tigers Eye is disregarded for Federal

income tax purposes, it acted as a nominee and agent for P and others

who participated in the transactions at issue and Tigers Eye's items are

of that nature and character.

Held, further, the determination that Tigers Eye is disregarded as

a partnership for Federal income tax purposes serves as a basis for a

computational adjustment reflecting the disallowance of any loss or

credit claimed by P or any other purported partner with respect to

Tigers Eye, and the Court has jurisdiction to determine that all items of

Tigers Eye that purported to be partnership items are adjusted to zero.

See I.R.C. sec. 6233; sec. 301.6233-lT(a), Temporary Proced. &

Admin. Regs., supra.

Held, further, items of Tigers Eye that are necessary for

maintaining its books and records as nominee-agent acting on behalf of

the purported partners and providing information to them are

entity/partnership items that the Court has jurisdiction to decide in this

partnership/entity-level proceeding. See sec. 301.6231(a)(3)1(a)(4), Proced. & Admin. Regs.

Held, further, because Tigers Eye conducted the transactions as

nominee-agent for P, P's basis in the distributed property is Tigers

Eye's cost basis in the property, which P concedes is the amount of the

distributions shown on the Schedule K-1, Partner's Share of Income,

Credits, Deductions, etc., Tigers Eye issued to P; Tigers Eye's cost

basis in the distributed property is an entity/partnership item that this

Court has jurisdiction to decide in this proceeding. See sec.

301.6231(a)(3)-1(a)(4), (c)(3)(iii), Proced. & Admin. Regs.

Held, further, in accordance with Mayo Found. and

Intermountain, we must apply the TEFRA regulations that satisfy the

Chevron standard and are not bound to follow a contrary holding of

Petaluma II to the extent those regulations were not specifically

considered and applied by the Court of Appeals in deciding the issue.

-5Held, further, Petaluma II notwithstanding, outside basis is an

entity/partnership item related to contributions and distributions that

Tigers Eye needed to determine for purposes of maintaining its books

and records and providing information to its purported partners that the

Court has jurisdiction to decide in the partnership/entity-level

proceeding. See sec. 301.6231(a)(3)-1(a)(4), Proced. & Admin. Regs.

Held, further, sec. 301.6231(a)(3)-1(a)(4), Proced. & Admin.

Regs., is valid under the two-step Chevron standard.

Held, further, the ordinary loss and other deductions reduced to

zero by the first decision paragraph flowed directly through to the

purported partners' returns, and R may compute and assess the

deficiencies related to the adjustments of those partnership items to

zero without issuing a statutory notice of deficiency; under Petaluma II,

this Court has jurisdiction in this partnership-level proceeding to

determine applicability of penalties to the underpayments of tax

resulting from the adjustments to zero of the ordinary loss and other

deductions that flowed directly through to the purported partners'

individual returns.

Held, further, the adjustment of the ordinary loss to zero is

attributable to overstating the capital contributions claimed to have

been made to the purported partnership; pursuant to the stipulated

decision the 40% gross valuation misstatement penalty and the 20%

negligence penalty apply respectively to the underpayments of tax

resulting from the adjustments of the loss and other deductions to zero.

Held, further, the overstatement of the purported partners' bases

in the distributed property is attributable to claiming that capital

contributions were made to the purported partnership; the

underpayment of tax resulting from the overstatement of basis in the

distributed property (distributed property loss deficiency) is attributable

to the reduction to zero of capital contributions claimed to have been

made to the purported partnership that is disregarded for Federal

income tax purposes; this Court has jurisdiction in this partnership-

-6level proceeding to determine in the stipulated decision that the 40%

gross basis misstatement penalty applies to the distributed property loss

deficiency.

Held, further, there will be a gross misstatement of basis in the

distributed property if the misstatement exceeds four times the amount

of the distributions shown on the Schedule K-1 issued to the purported

partner; the 40% penalty will apply to any underpayment of tax

attributable to claiming basis in the property that is more than four

times the amount of the distributions shown on the Schedule K-1 issued

to the purported partner.

Felix B. Laughlin and Mark D. Allison, for petitioner.

David D. Aughtry, Hale E. Sheppard, and William E. Buchanan, for

participating partner.

James E. Gray, for respondent.

CONTENTS

Page

Background.. . : . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

Discussion.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36

Introduction: Coniplexity of Income Tax Treatment of Partners and

Partnerships.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36

. Overview of Subchapter K. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36

TEFRA... ......... .......... ..... .. . .. ....... ........ 37

In General. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37

TEFRA Penalty Litigation Structure Before TRA 1997. . . . . . 38

-73.

TEFRA Penalty Litigation Structure After TRA 1997. . . . . . . 39

Attempted Exploitation by Tax Shelter Promoters of Complex

Interactions and Disconnects of Subchapter K Substantive Rules

and TEFRA Procedural Rules. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42

II.

Jurisdiction Under TEFRA When Entity Filing Partnership Return Is

Not a Partnership or Does Not Exist. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47

TEFRA Procedures.Apply When Entity That Filed Partnership

Return Is Not a Partnership or Does Not Exist: Sections 6226(f)

and 6233..............................................47

III.

Jurisdiction To Determine Items of Disregarded Entity: Section

301.6233-1T(a) and (c), Temporary Proced. & Admin. Regs., 52

Fed. Reg. 6779, 6795 (Mar. 5, 1987). . . . . . . . . . . . . . . . . . . . . . . . 51

Jurisdiction To Determine Applicability of Any Penalty That

Relates to Adjustment of Entity Item: Section 6226(f). . . . . . . . . . . 56

Jurisdiction To Enter Stipulated Decision as Written With Respect to

Partnership Items.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56

Provisions of the Stipulated Decision.. . . . . . . . . . . . . . . . . . . . . . . . 56

Disregard of Tigers Eye.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58

Items of Tigers Eye. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59

First Decision Paragraph. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60

Partnership Loss and Deductions.. . . . . . . . . . . . . . . . . . . . . . 62

Contributions and Distributions. . . . . . . . . . . . . . . . . . . . . . . . 62

Items Related to Contributions. . . . . . . . . . . . . . . . . . . 63

Items Related to Distributions. . . . . . . . . . . . . . . . . . . . 65

Adjustment of Items to Zero. . . . . . . . . . . . . . . . . . . . . . . . . . 67

Second Decision Paragraph.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68

Basis in Property Distributed by Disregarded Entity. . . . . . . . 69

Outside Basis... . . . . . . ... . . . . . . . . . . . . . . . . . . . . . . . . . . . 71

Petaluma Superseded by Mayo Found. and

Intermountain: TEFRA Regulations Must Be

Applied. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72

Determination of Outside Basis: General Rule

Under Section 705(a). . . . . . . . . . . . . . . . . . . . . . . . . . 76

-8c.

Determination of Outside Basis: Alternative Rule

Under Section 705(b). . . . . . . . . . . . . . . . . . . . . . . . . . 79

Outside Basis Is a Partnership Item. . . . . . . . . . . . . . . . 80

Required To Be Taken Into Account Under

Subtitle A. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80

ii.

More Appropriately Determined at the

iii.

Partnership Level: Outside Basis

Determined Under the General Rule. . . . . . . . . . 81

More Appropriately Determined at the

Partnership Level: Outside Basis

Determined Under Alternative Rule.. . . . . . . . . . 85

iv.

More Appropriately Determined at the

Partnership Level: Outside Basis When the

Partnership Is Disregarded.. . . . . . . . . . . . . . . . . 86

Misapplication of Dial USA, Inc. v. Commissioner. . . . 88

Validity of the Regulation Under the Chevron Two-

Step Standard. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94

Outside Bases of Tigers Eye's Purported Partners

Are Partnership Items. . . . . . . . . . . . . . . . . . . . . . . . . . 99

IV.

Jurisdiction To Enter Stipulated Decision as Written With Respect to

Application of Penalties.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101

Items Adjusted in the Stipulated Decision and the Application of

Accuracy-Related Penalties Thereto Within the Jurisdictional

Limitations of Petaluma II. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105

40% Gross Basis Misstatement Penalty.. . . . . . . . . . . . . . . . 107

20% Negligence Penalty. . . . . . . . . . . . . . . . . . . . . . . . . . . . 110

. Conclusion. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111

Petaluma II Notwithstanding, Jurisdiction To Determine the 40%

Penalty Applies to the Overstatement of the Basis of the

Distributed Property. . . .,: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . I11

Applicability of 40% Penalty to the Overstatement of the

Basis of the Distributed Property.. . . . . . . . . . . . . . . . . . . . . 111

Petaluma III: The Court Was Bound by the Law of the

Case and the Rule of Mandate To Follow Petaluma II

Dicta on Lack of Jurisdiction Over Outside Basis. . . . . . . . . 115

TRA 1997: The Tax Court Has Jurisdiction To

Determine Applicability of Penalties That Relate to

Adjustment of Partnership Items. . . . . . . . . . . . . . . . . . . . . . 119

Conclusion. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 126

OPINION

BEGHE, Judge: Following entry of a stipulated decision on December 1,

2009, this Son of BOSS' case remains before this Court on a motion to revise the

decision. The motion was filed by participating partner A. Scott Logan Grantor

Retained Annuity Trust I, A. Scott Logan, Trustee, a partner other than the tax

matters partner. We refer to the trustee in his individual capacity as Mr. Logan and

to the trust as Logan Trust I or participating partner.

Participating partner argues that the stipulated decision upholds adjustments

in the final partnership administrative adjustment (FPAA) and applies accuracyiThe Son of BOSS tax shelter was described by the Internal Revenue Service

(IRS) as a "listed transaction" in Notice 2000-44, 2000-2 C.B. 255, 256. In

Announcement 2004-46, 2004-1 C.B. 964, the IRS announced a settlement initiative

for taxpayers to resolve transactions described in Notice 2000-44, supra, and similar

Son of BOSS transactions, with penalties topping out at 20% of the deficiencies.

Within a year thereafter, the IRS announced that the settlement initiative had

resulted in the collection of more than $3.2 billion of Federal income taxes and

reduced penalties from more than 1,000 taxpayers.. See "Son of BOSS Settlement

Initiative Reaps $3.2 Billion, With More Expected, IRS Says", TM Weekly Report

(BNA), 24 TMWR 467 (Mar. 28, 2005) (Tax Shelters).

-10related penalties that exceed this Court's jurisdiction under section 6226(f),2 thereby

overstepping the jurisdictional limits under the TEFRA3 statute and regulations,4 as

established by the Court of Appeals for the D.C. Circuit in Petaluma FX Partners,

LLC v. Commissioner,5 591 F.3d 649 (D.C. Cir. 2010) (Petaluma II), aff'g in part,

rev'g in part and remanding on penalty issues 131 T.C. 84 (2008) (Petaluma I). On

December 15, 2010, this Court responded to the remand on penalty issues with its

reviewed Opinion (7-5, with 2 dissenting opinions), Petaluma FX Partners, LLC v.

Commissioner, 135 T.C. 581 (2010) (Petaluma III), and on March 8, 2011, the

2Unless otherwise stated, all section references are to the Internal Revenue

Code (Code) in effect for 1999, the year at issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure.

3Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. No. 97248, sec. 402, 96 Stat. at 648, as amended by the Taxpayer Relief Act of 1997

(TRA 1997), Pub. L. No. 105-34, sec. 1238, 111 Stat. at 1026.

4Sec. 301.6231(a)(6)-lT(a), Temporary Proced. & Admin. Regs., 64 Fed.

Reg. 3840 (Jan. 26, 1999); see also sec. 301.6231(a)(6)-1(a)(1), Proced. & Admin.

Regs.

5In most Son of BOSS cases--as in the case at hand and in Petaluma FX

Partners, LLC v. Commissioner, 135 T.C. 581 (2010) (Petaluma III), on remand

from Petaluma FX Partners, LLC v. Commissioner, 591 F.3d 649 (D.C. Cir. 2010)

(Petaluma II), aff'g in part, rev'g in part and remanding on penalty issues 131 T.C.

84 (2008) (Petaluma I)--the taxpayers contributed money and offsetting long and

short foreign currency options to a partnership and reported multimillion-dollar

losses on the sale of property that they claimed was distributed to them in

liquidation of their partnership interests.

-11Commissioner filed a notice of appeal.6 Participating partner argues that under the

Golsen7 rule the Court's jurisdiction to decide the issues in dispute in this

partnership-level proceeding is controlled by Petaluma II, so that the Court must

vacate and revise the stipulated decision to conform to the jurisdictional limits

imposed by Petaluma II.8

We observe that the limiting holdings in Petaluma II were the result of a

concession by the Government that the Court of Appeals accepted without any

discussion of the applicable regulations. In an opinion issued after Petaluma II

6Appeal docketed, No. 024717-05 (D.C. Cir. Mar. 8, 2011). We note that

Petaluma II has already been followed by the Court of Appeals for the Federal

Circuit in Jade Trading, LLC, v. United States, 598 F.3d 1372, 1379-1380 (Fed.

Cir. 2010) (Jade Trading II), aff'g in part, rev'g in part and remanding on penalty

issues 80 Fed. Cl. 11 (2007) (Jade Trading I), remanded to 98 Fed. Cl. 453 (2011)

(Jade Trading III), aff'd, ___ Fed. Appx. __ (Fed. Cir. Jan. 12, 2012), and by the

unpublished summary order of another panel of the Court of Appeals for the D.C.

Circuit in LKF X Invs., LLC, v. Commissioner, 106 A.F.T.R. 2d (RIA) 2010-5003,

2010-1 U.S. Tax Cas. (CCH) para. 50, 488 (D.C. Cir. 2011), aff'g in part, rev'g in

part and remanding on penalty issues T.C. Memo. 2009-192.

7Golsen v. Commissioner, 54 T.C. 742 (1970), aff'd, 445 F.2d 985 (10th Cir.

1971).

8Tigers Eye Trading, LLC, was dissolved before the petition was filed;

pursuant to sec. 7482(b) the proper venue for an appeal would be the Court of

Appeals for the D.C. Circuit. When the tax matters partner filed the petition (in its

capacity as a notice partner, see Barbados #6 Ltd. v. Commissioner, 85 T.C. 900,

903-905 (1985)), Mr. Logan was a resident of Florida and the place of business of

the tax matters partner was in New York. .The business address of Tigers Eye

Trading, LLC, before its dissolution was in New York.

-12-

was filed, Mayo Found. for Med. Educ. & Research v. United States, 562 U.S. ___,

131 S. Ct. 704 (2011), the Supreme Court emphatically reminded lower courts that

they must defer to regulations that satisfy the two-step Chevron' standard. More

recently, in Intermountain Ins. Serv. of Vail, LLC v. Commissioner, 650 F.3d 691

(D.C. Cir. 2011), rev'g and remanding 134 T.C. 211 (2010), supplementing T.C.

Memo. 2009-195, the Court of Appeals for the D.C. Circuit held that the deference

given to regulations under Mayo Found. required the Court to apply the definitions

of statutory terms provided in valid TEFRA regulations rather than follow earlier

caselaw. In accordance with Mayo Found. and Intermountain, this Court must

apply the TEFRA regulations, unless we hold them to be invalid, rather than follow

the holding in Petaluma II in which the Court of Appeals did not specifically

consider and apply the regulations.

Under the assumption that this Court was bound by the holdings of the Court

of Appeals in Petaluma II, in respondent's response to participating partner's motion

to vacate and revise the decision, respondent made the same concession as the

Government made in Petaluma II.

9Chevron, U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837, 842843 (1984).

-13Subject-matter jurisdiction relates to a court's statutory or constitutional

power to hear a given type of case. United States v. Cotton, 535 U.S. 625, 630

(2002); United States v. Morton, 467 U.S. 822, 828 (1984); Alikhani v. United

States, 200 F.3d 732, 734 (1 lth Cir. 2000). The Supreme Court has held that

"subject-matter jurisdiction, because it involves a court's power to hear a case, can

never be forfeited or waived." Cotton, 535 U.S. at 630. "[S]ubject matter

jurisdiction is an unwaivable sine qua non for the exercise of federal judicial

power". Curley v. Brignoli, Curley & Roberts, Assocs., 915 F.2d 81, 83 (2d Cir.

1990). Moreover, courts have an independent obligation to determine whether

subject matter jurisdiction exists, even in the absence of a challenge from any party.

Ruhrgas AG v. Marathon Oil Co., 526 U.S. 574, 583 (1999).

Whether a court has subject matter jurisdiction to adjudicate the merits of a

controversy is a question of law. Taylor v. Vo 541s,

271 U.S. 176, 186 (1926) ("a

petition for revision will lie to bring up for review the question of law whether the

court of bankruptcy has jurisdiction to.adjudicate the merits of such controversy in a

summary proceeding"); Adkison v. Commissioner, 592 F.3d 1050, 1052 (9th Cir.

2010) ("Whether the Tax Court has subject matter jurisdiction is a question of law

and thus reviewed de novo"), aff'g 129 T.C. 97 (2007); United States v. Moore,

443 F.3d 790, 793 (1lth Cir. 2006). The meaning of a statutory term is

-14also a question of law. Crane v. Commissioner, 331 U.S. 1, 15 (1947) (Tax Court's

determinations of statutory terms "announced rules of general applicability on

clear-cut questions of law").

Neither the Supreme Court nor an appellate court is bound to accept the

Government's concession that the court below erred on a question of law. Orloff v.

Willoughby 345 U.S. 83, 88 (1953). Similarly, the Tax Court need not accept a

party's concession on a question of law, particularly when to do so would strip the

Court of its jurisdiction. See Charlotte's Office Boutique, Inc. v. Commissioner,

121 T.C. 89, 102 (2003), aff'd, 425 F.3d 1203 (9th Cir. 2005).

The Golsen rule does not apply where the precedent from the Court of

Appeals constitutes dicta or contains distinguishable facts or law. See, e.g., Hefti v.

Commissioner, 97 T.C. 180, 187 (1991) (dictum not controlling), a_fLd, 983 F.2d

868 (8th Cir.1993); Metzger Trust v. Commissioner, 76 T.C. 42, 72-74 (1981)

(factual distinctions render Golsen rule not squarely on point), aff'd, 693 F.2d 459

(5th Cir.1982); Kueneman v. Commissioner, 68 T.C. 609, 612 n.4 (1977) (distinct

legal question not governed by the Golsen rule), a_ff£d, 628 F.2d 1196 (9th Cir.

1980). As we stated in Lardas v. Commissioner, 99 T.C. 490, 493-495 (1992), the

Golsen rule applies only where the "clearly established" position of a Court of

Appeals signals "inevitable" reversal upon appeal.

-15In Petaluma II the Government conceded that outside basis was an affected

item but argued that the Tax Court had jurisdiction to decide an affected item where

its elements consisted entirely of partnership items. The Court of Appeals agreed

that outside basis was an affected item but rejected the Government's elements

argument. The Court of Appeals did not decide (1) whether under section

301.6231(a)(3)-1(a)(4) and (c)(3)(iii), Proced. & Admin. Regs., outside basis is a

partnership.item because it is an item related to contributions and distributions

necessary for maintaining its books and records and providing information to the

purported partners; (2) whether outside basis was an entity item under section

301.6233-1T(a) and (c), Temporary Proced. & Admin. Regs., 52 Fed. Reg. 6779,

6795 (Mar. 5, 1987); (3) whether the basis in the property distributed by an entity

that is disregarded as a partnership for Federal income tax purposes is an entity item

under section 301.6233-1T(a) and (c), Temporary Proced. & Admin. Regs., supra;

or (4) whether section 301.6231(a)(3)-1(a)(4) and (c)(3)(iii), Proced. & Admin.

Regs., and section 301.6233-1T(a) and (c), Temporary Proced. & Admin. Regs.,

supra, are valid.

The Court of Appeals for the D.C. Circuit recognizes its "obligation to

explore any promising avenue to * * * [the inferior court's] jurisdiction, whether or

not suggested by the parties". Ass'n of Am. Med. Colleges v. Califano, 569

-16-

F.2d 101, 111 (D.C. Cir. 1977); see also Da Silva v. Kinsho Int'l Corp., 229 F.3d

358, 361 (2d Cir. 2000) ("the issue of subject matter jurisdiction is one we are

required to consider, even if the parties have ignored it or, as here, have switched

sides on the issue"). Because the Court of Appeals did not consider the precise

issue we decide herein, Golsen does not apply. See Read v. Commissioner, 114

T.C. 14 (2000), aff'd without published opinion sub nom. Mulberry Motor Parts,

Inc. v. Commissioner, 273 F.3d 1120 (11th Cir. 2001); Estate of Branson v.

Commissioner, 113 T.C. 6, 34 (1999), aff'd, 264 F.3d 904 (9th Cir. 2001).

Accordingly, we reject respondent's concession and apply the applicable

regulations, authorized by sections 6231(a)(3) and 6233, and hold that this Court

has jurisdiction to enter the stipulated decision as written, even to the extent it

adjusts outside basis to zero and applies the 40% gross basis misstatement penalty

under section 6662(h) to the deficiency that results from the overstatement of the

purported partners' bases in distributed property. Therefore we shall deny

participating partner's motion to vacate and revise the decision.

Background

Entry of the stipulated decision in this 1999 taxable year Son of BOSS case

was preceded by our opinion in Tigers Eye Trading, LLC v. Commissioner, T.C.

-17Memo. 2009-121 (Tigers Eye I).'°. Tigers Eye I was preceded by extensive

1°In Tigers Eye I we denied, on the authority of New Millennium Trading,

LLC, v. Commissioner, 131 T.C. 275 (2008), participating partner's partial

summary judgment motion to invalidate sec. 301.6221-lT(c) and (d), Temporary

Proced. & Admin. Regs., 64 Fed. Reg. 3838 (Jan. 26, 1999). We thereby denied

Mr. Logan and Logan Trust I the right in this partnership-level proceeding to

interpose their partner-level good faith/reasonable cause defenses under sec.

6664(c) to the accuracy-related penalties. We also granted respondent's motion in

limine to exclude participating partner's expert witness report on the reliability of a

tax opinion on which Mr. Logan, Logan Trust I, and Mr. Logan's two other grantor

trusts (collectively, Logan Trusts) claim to have relied in preparing their 1999

Federal income tax returns.

In Tigers Eye I respondent also contended that Curtis Mallet Prevost Curt &

Mosle (Curtis Mallet)--the law firm that issued the tax opinion on which Mr. Logan

and participating partner claim to have relied in taking their 1999 Federal income

tax return positions--was a promoter of the transaction. In Tigers Eye I we also

expressed the view that this promoter contention raised a partnership-level issue that

the Court could address at the trial; we also set forth our views on the legal standard

for determining promoter status. In 106 Ltd. v. Commissioner, 136 T.C. 67, 77-81

(2011), the Court, notwithstanding that in Tigers Eye I we had expressed those

views in dicta, adopted and applied those views in holding that the law firm that had

issued the tax opinion in the Son of BOSS transaction in that case was a promoter of

the transaction whose opinion could not be reasonably relied upon in good faith by

the partnership or the taxpayer.

Tigers Eye I concluded with an Afterword that deplored the inefficiency and

waste ofjudicial and party resources caused by the apparent splitting of the

accuracy-related penalty cause of action under TEFRA as amended by TRA 1997.

That inefficiency and waste are exemplified by the motions we have had to deal

with in Tigers Eye I and by the continuing controversies in Petaluma, the case at

hand, and other Son of BOSS cases over whether the accuracy-related penalties

must or can be determined at the partnership level or the partner (individual

taxpayer) level.

(continued...)

-18discovery and motion practice," the lodging of expert reports on the actual and

expected financial consequences of the transaction, and the lodging and later filing

of two extensive stipulations of fact." The undisputed factual material thereby

(...continued)

We noted in Tigers Eye I that the IRS has initiated a response to the observed

problems, relying on its authority under sec. 6231(c) to promulgate regulations with

respect to special enforcement areas if it determines that treating certain items as

partnership items under TEFRA will interfere with the effective and efficient

enforcement of the revenue laws. The IRS has proposed regulations, Notice of

proposed rulemaking, sec. 301.6231(c)-9(c), Proposed Proced. & Admin. Regs., 74

Fed. Reg. 7205 (Feb. 13, 2009)), which, when and if promulgated, would enable the

Commissioner to convert partnership items to nonpartnership items in partnership

cases involving listed transactions; invoking this procedure would have the salutary

effect of providing for "one-stop shopping" through application of the traditional

deficiency procedures to both deficiencies and accuracy-related penalties in such

transactions. See 1 William S. McKee et al., Federal Taxation of Partners and

Partnerships, par. 10.02[4], at 10-16 (4th ed. 2007). We also noted that the

proposed regulations would not provide relief in the case at hand or the myriad other

pending Son of BOSS cases. The proposed regulations have not been finalized.

"Including participating partner's motion for partial summary judgment

"regarding confirmation of Code and caselaw as to contingent obligations".

Participating partner sought a ruling that Helmer v. Commissioner, T.C. Memo.

1975-160, requires a holding that "a contingent obligation such as the Sold Euro

Option each of the Logan Trusts sold to AIG falls short of a fixed 'liability' for

section 752 and other federal income tax purposes". By order dated August 5,

2008, we denied the motion for a variety of reasons.

"On December 1, 2010, the day the stipulated decision was entered, the

Court deemed moot and discharged its order to show cause in response to

respondent's Rule 91(f) motion to show cause why proposed facts in evidence

(embodied in a proposed third stipulation of facts and Exhibits 145-J through

(continued...)

-19made available enables us to describe the operative facts of the transaction. The

extensive and detailed facts set forth in Tigers Eye I are incorporated herein by this

reference. In addressing the pending motion, we take account of additional

indisputable facts and repeat only the most pertinent facts set forth in Tigers Eye I.

The subject transaction was one of a number of such transactions promoted

by Sentinel Advisors, LLC (Sentinel)," the tax matters partner, using a limited

"(...continued)

155-J) should not be accepted as established.

"Among the cases of Sentinel-promoted Son of BOSS transactions that have

been filed in the Court of Federal Claims are Jade Trading I; Evergreen Trading,

LLC, v. United States, 80 Fed. Cl. 122 (2007), to which Nussdorf v. Commissioner,

129 T.C. 30 (2007), is related; and K2 Trading Ventures, LLC v. United States, _

Fed. Cl. _ (Nov. 30, 2011), to which Asuma Trading Ventures, LLC v.

Commissioner, infra, is related. Other cases of Sentinel-promoted transactions filed

in this Court include Sterling Trading Opportunities, LLC v. Commissioner, No.

12361-05, and Topaz Trading LLC v. Commissioner, No. 12629-05 (stip. decs.

entered June 24, 2008); New Millennium Trading, LLC v. Commissioner, No.

3439-06 (filed Feb. 16, 2006); Asuma Trading Ventures, LLC v. Commissioner,

No. 26772-06 (filed Dec. 27, 2006); Sapphire Traders, LLC v. Commissioner, No.

19067-09 (filed Aug. 10, 2009); Eagle Trading Opportunities, LLC v.

Commissioner, No. 9733-05 (stip. dec. entered Jan. 23, 2009); Pinnacle Trading

Opportunities, LLC v. Commissioner, No. 19291-05 (filed Oct. 14, 2005); and Oak

Leaf Trading, LLC v. Commissioner, No. 1896-06 (stip. dec. entered July 29,

2008). Stipulated decisions in Sterling and Topaz are virtually identical to each

other and to the decision in the case at hand in adjusting to zero the same four items,

in not expressly making an outside basis adjustment (which was expressly made in

the FPAA), in providing that the 40% penalty applies to underpayments of tax

attributable to overstating capital contributions, and in providing that 20%

negligence or substantial understatement penalties apply to any additional

(continued...)

-20liability company--Tigers Eye Trading, LLC (Tigers Eye), in the case at

hand--treated as a partnership for income tax purposes, as the vehicle needed to

create the claimed basis step-ups that were the transaction's reason for being.'4

During 1999 Mr. Logan realized a multimillion-dollar long-term capital gain

on his sale to a large Canadian f'mancial services holding company of his stock

interest in a corporation he had cofounded to act as a distributor of variable

annuities.

Tigers Eye was a Delaware limited liability company formed in late

September 1999, ostensibly to engage in foreign currency trading but in reality to

generate paper losses to offset taxpayers' otherwise taxable capital gains. On

October 1, 1999, the Logan Trusts each acquired a pair of offsetting long and short

foreign currency options through AIG, which they then contributed along with

"(...continued)

underpayments. See also Diebold v. Commissioner, T.C. Memo. 2010-238, in

which Sentinel appears to have played a facilitating role in creating artificial losses

claimed on the sale of corporate assets, resulting in a deficiency in Federal

corporation income tax and accuracy-related penalties not contested by the selling

corporation.

14Although the parties have stipulated the correctness of the determinations in

the FPAA, including that the existence of Tigers Eye was not established as a fact

and that the transactions in which it claimed to have participated should be

disregarded in full, we use the terms "partnership", "partner", and related terms for

convemence.

-21cash to become partners in Tigers Eye on October 9, 1999. The Logan Trusts

inflated their adjusted bases in Tigers Eye to reflect their contributions of the long

options without reducing those bases to reflect Tigers Eye's assumption of their

obligations under the short options. The basis inflation is premised on (1) treating

each purchased option separately from each sold option, (2) each purchased

option's having a basis equal to the gross premium in the hands of both the Logan

Trusts and Tigers Eye, (3) treating the assignment to and assumption by Tigers Eye

of the contingent obligation to satisfy the sold option separately from the purchased

option for purposes of section 752, and (4) disregarding the contingent obligation to

satisfy the sold option in determining outside basis in the partnership under the

authority of Helmer v. Commissioner, T.C. Memo. 1975-160.

An unrelated entity, the Batts Group, also acquired interests in offsetting

foreign currency options through AIG that were transferred to Tigers Eye and also

received other property in liquidation of its interest in Tigers Eye.'5 We refer to

participants in offsetting options transactions with partnerships such as the offsetting

option transactions of the Logan Trusts and the Batts Group with Tigers Eye as '

option partners. In addition to Sentinel, the tax matters partner, which

'5The Batts Group settled its case with the IRS without any court proceeding.

In the following description and discussion we will for the most part ignore the role

of the Batts Group.

-22contributed $3,000 cash, Tigers Eye also had as a partner a foreign entity, Banque

Safra-Luxembourg (Banque Safra), which contributed $58,000 cash. Neither

Sentinel nor Banque Safra had any financial interest in the option transactions, and

neither has a stake in the outcome of this proceeding.

During December 1999 Sentinel caused Tigers Eye to unwind or terminate

the paired options at a net loss.16 Sentinel through Tigers Eye used the remaining

cash contributions to purchase foreign currency (euro) and shares of listed stock

(Xerox Corp.) that were purportedly distributed to the Logan Trusts in liquidation of

their purported partnership interests. The Logan Trusts claimed that they had

hugely inflated bases in Tigers Eye that attached to the foreign currency and stock

Tigers Eye transferred to them (sometimes referred to herein as the distributed

property). They sold the currency and stock before yearend 1999 and claimed

16Ignoring the various fees paid by the Logan Trusts and Mr. Logan to

participate in the transaction, the total outlay of the Logan Trusts to purchase their

interests in the options and to make their cash contributions was approximately

$400,000. What is important for the claimed basis inflation in the case at hand was

that the premium on each option exceeded $9 million and the exercise price of each

option exceeded $200 million. However, the net premium the Logan Trusts paid for

each purchased option was only $95,003 more than the premium received or

receivable for the offsetting sold option. The net premium that Tigers Eye received

from AIG on the unwinding of each pair of options was $40,044.68, resulting in a

total loss of $164,875 to the Logan Trusts on the unwinding of the options

(($95,003 x 3 = $285,009) - ($40,044.68 x 3 = $120,134.04) = $164,874.96).

-23huge losses that flowed through to Mr. Logan's 1999 Federal income tax return.

Mr. Logan used the claimed losses on the sales of the foreign currency to offset his

ordinary income, and he used the claimed short-term losses on the sales of the

Xerox Corp. stock to offset most of the multimillion-dollar long-term capital gain he

realized on the sale of his stock interest in the annuity distribution business."

On April 14, 2000, Tigers Eye filed a Form 1065, U.S. Partnership Return of

Income, for its 1999 taxable year. On March 7, 2005, respondent issued an FPAA

to the Tigers Eye partners.

The FPAA comprises (1) Letter 1830, Notice of Final Partnership

Administrative Adjustment, (2) Form 870-PT, Agreement for Partnership Items and

Partnership Level Determinations as to Penalties, Additions to Tax, and Additional

Amounts, including a Schedule of Adjustments, and (3) an "Exhibit

A--Explanation of Items", setting forth respondent's other adjustments or

determinations.

As compared with their total $400,000 outlay to acquire their interests in the

paired options and make their cash capital contributions, see supra note 16, the

Logan Trusts received foreign currency and shares of Xerox Corp. having combined

cost and value of approximately $230,000, of which approximately $14,000 was

attributable to the foreign currency. The Logan Trusts claimed an ordinary loss that

they flowed through to Mr. Logan of approximately $1.7 million on the sale of the

foreign currency; Mr. Logan and the Logan Trusts claimed an aggregate basis of

more than $27 million in the Xerox Corp. shares, resulting in claimed losses of more

than $26 million on their sales.

-24The Schedule of Adjustments adjusted to zero the following five items:

A. Capital Contributions (Sched. M-2, line 2)

$698,595

B. Distributions of Property other than Money

(Sched. M-2, line 6b)

365,446

C. Outside Partnership Basis

24,500,059

D. Other Deductions (Sched. K, line 11)

11,314

E. Ordinary Income, Other Income (Loss)

(Sched. K, line 7)

(242,186)

Items A, B, D, and E are each identified as the adjustment of a line item on the

Tigers Eye 1999 Form 1065. Item C (Outside Partnership Basis) is not such an item

and does not correspond to any line item on the partnership return. Unlike the item

A, B, D, and E amounts, each of which is identified as the adjustment of a line item

on the Tigers Eye 1999 Form 1065, the item C amount does not appear on the

partnership return or on the Schedules K-1, Partner's Share of Income, Credits,

Deductions, etc., of the partnership return and sent to the partners.

Only two of the foregoing adjustments were to items appearing on the

partnership return that directly flowed through to the returns of the Logan Trusts and

thence to Mr. Logan's individual return. These two adjustments change to zero two

items that appeared on Schedule K of the partnership return: "Other

-25Deductions" of $11,314 (appearing on line 11, Schedule K, page 3, of the

partnership return) and the negative amount "($242,186)" reported for "Ordinary

Income, Other Income (Loss)" (on line 7, Schedule K, Partners' Shares_of Income,

Credits, Deductions, etc., page 3, of the partnership return). These line items were

described in greater detail in Statements 1 and 2 of the return, reproduced below.18

Statement 1, which attributes the negative figure -257,857 to "ORDINARY LOSS

18Statements 1 and 2 reported as follows:

SCHEDULE K

OTHER INCOME (LOSS)

DESCRIPTION

STATEMENT 1

AMOUNT

NONPORTFOLIO SHORT-TERM CAPITAL GAIN (LOSS)

INTEREST INCOME

WITHDRAWAL FEES

ORDINARY LOSS FROM SEC. 988 TRANSACTIONS

5,354

1,617

8,700

-257,857

TOTAL TO SCHEDULE K, LINE 7

-242,186

SCHEDULE K

OTHER DEDUCTIONS

DESCRIPTION

STATEMENT 2

AMOUNT

OPERATING EXPENSES

11,314

TOTAL TO SCHEDULE K, LINE 11

11,314

-26FROM SEC. 988 TRANSACTIONS", thereby indicates that this negative figure

included the net loss claimed by Tigers Eye on the termination or unwinding of the

contributed paired options, as well as the results of other foreign currency

transactions.''

The partnership return Schedules K-1 for the Logan Trusts show that their

respective shares of the entries on lines 7 and 11 of Schedule K were a loss of

$52,583 and other deductions of $2,136, respectively, for a total loss of $157,749

and total other deductions of $6,408 that flowed from the partnership return through

the returns of the Logan Trusts to Mr. Logan's 1999 Federal income tax return.20

Indeed, the Form 1041, U.S. Income Tax Return for Estates and Trusts,

19Respondent's proposed third stipulation of facts and Exhibits 145-J through

155-J, the subjects of respondent's Rule 91(f) motion, see supra note 12, would

have conclusively established that the option spreads were terminated at a net loss

during December 1999 and that the loss was included in the "ORDINARY LOSS

FROM SEC. 988 TRANSACTIONS" that was claimed on the partnership return.

Our conclusion that the contributed paired options were terminated or unwound

during December 1999 is supported by the fact that Tigers Eye's final return for the

year 2000, which showed Sentinel and Banque Safra to be the only partners, also

showed relatively small amounts of remaining assets (much less than the aggregate

capital contributions of the Logan Trusts and the Batts Group), liabilities, and

capital at the beginning of the year, and relatively small losses and income from

dispositions of assets and winding-up operations.

20The differences between these figures and the gross amounts shown on

Statements 1 and 2, see supra note 18, that were adjusted to zero by the FPAA were

attributable to the Batts Group's participation in Tigers Eye.

-27for each of the Logan Trusts reports a $55,278 nonpassive loss from partnerships,

which is within $600 of the $54,719 sum of the items allocated to each Logan Trust

on lines 7 and 11. Mr. Logan's 1999 individual Federal income tax return, in three

separate schedules entitled "1999 income from passthroughs", shows a loss of

$55,278 from "SCHEDULE E ACTIVITY INCOME (LOSS)" for each of the

Logan Trusts ($55,279 loss for Logan Trust II) for total "SCHEDULE E INCOME

OR (LOSS) FROM ESTATES OR TRUSTS STATEMENT 21 NONPASSIVE

LOSS OF" $165,835.

Statement 6 on the partnership return, "PARTNERS' CAPITAL ACCOUNT

SUMMARY", shows "Capital Contributed" and "Withdrawals" (the latter is

identical to "Distributions of Property Other Than Money") totaling $698,595 and

$365,446, respectively, that were also adjusted to zero by the FPAA.

The "Capital Contributions" of $698,595 shown by the partnership return and

zeroed out by the FPAA (and the stipulated decision) was the sum of the cash

contributed by all the partners plus the net value of the paired options that the Logan

Trusts and the Batts Group had ostensibly contributed to the partnership; this net

value was arrived at by netting the premiums on the long and short options. This

partnership return reporting differed from the inflated bases claimed

-28by the Logan Trusts through the tax shelter2i in that the option partners claimed

bases in their partnership interests that included the premiums on the long options

(amounting to more than $27 million, see supra note 17) without reduction or offset

for the liabilities represented by the premiums on the short options.

The "Withdrawals" ("Distributions of Property Other Than Money") of

$365,446 zeroed out by the FPAA was the book value (the aggregate purchase

price/cost) of the foreign currency and corporate shares purchased by Sentinel

through Tigers Eye on behalf of the Logan Trusts and the Batts Group for

distribution to them.22 The Logan Trusts' share of this cost amounted to

2iCapital contributions are to be reported by a partnership at fair market value

rather than the cost or adjusted basis of the contributed property to the contributing

partners, which is the "inside basis" of such property to the partnership under sec.

723. Secs. 1.704-1(b)(2)(iv)(b), 1.705-1(a)(1), Income Tax Regs.; see also

Interhotel Co. v. Commissioner, T.C. Memo. 2001-151; Mitchell v. Commissioner,

T.C. Memo. 1997-382 n.5. Because of the short time (less than 1 month) between

the option partners' purchases of the option spreads and their contribution to Tigers

Eye, it seems likely that there was little difference between the purchase prices of

the option spreads and their fair market values when contributed to Tigers Eye. In

any event, the determination that Tigers Eye is not a partnership for Federal income

tax purposes and the adjustment of capital contributions to zero by both the FPAA

and the stipulated decision has had the effects of denying the purported partnership

any bases in the paired options and of disallowing any partnership loss claimed by

Tigers Eye for 1999 on the termination or unwinding of the paired options and on

any other foreign currency transactions.

22Under sec. 732(a)(1) the basis of property (other than money) distributed

(continued...)

-29approximately $230,000. See supra note 17. .The aggregate inflated "outside"

bases claimed by the Logan Trusts on the sales of foreign currency and Xerox Corp.

stock were more than 118 times greater than (11,800% of) the

withdrawals/distribution amounts reported on the partnership return.

The "EXHIBIT A--Explanation of Items" made the following additional

adjustments or determinations: (1) Tigers Eye's existence as a partnership had not

been established as a fact; (2) Tigers Eye had no business purpose other than tax

avoidance, lacked economic substance, and was an economic sham so that Tigers

Eye and the transactions in which it claimed to have participated should be

disregarded in full; and (3) Tigers Eye had been formed or availed of, within the

meaning of section 1.701-2, Income Tax Regs., for a principal purpose of

improperly reducing the partners' Federal income tax liabilities.

The Explanation of Items went on to make alternative adjustments or

determinations premised on regarding Tigers Eye as a partnership that had

22(...continued)

to a partner in a nonliquidating distribution is its cost to the partnership or its "inside

basis", whereas, under sec. 732(b), the basis of such property distributed to a

partner in liquidation is an amount equal to the distributee partner's interest in the

partnership; i.e., its "outside basis". Under sec. 988 and preexisting law, s_ee_Nat'l-

Standard Co. v. Commissioner, 80 T.C. 551, 558 (1983), aff'd, 749 F.2d 369 (6th

Cir. 1984), foreign currency is generally considered property other than money for

Federal income tax purposes.

-30received the paired foreign currency options as contributions and assignments from

the option partners (the Logan Trusts and the Batts Group) and thereafter distributed

foreign currency and listed shares of stock to them in liquidation of their partnership

interests. In that regard, the Explanation of Items determined that (1) the partners

"have not established [under section 723] adjusted bases in their respective

partnership interests in amounts greater than zero"; (2) "the purported partners of

Tigers Eye did not enter into the option positions and Tigers Eye did not purchase

the foreign currency or [listed] stock with a profit motive for purposes of section

165(c)(2)"; and (3) the obligations under the sold options should be netted against

the purchased options so that "any * * * claimed increases in the outside bases in

Tigers Eye resulting from the contributions of the sold [sic "purchased"] options

should be disallowed". The alternative adjustments described in this paragraph

have been rendered inapplicable by the stipulated decision's adoption of the primary

adjustments disregarding the partnership described in the immediately proceeding

paragraph.

Finally, the Explanation of Items determined at the partnership level that

accuracy-related penalties to be imposed at the individual taxpayer level apply "to

all underpayments of tax attributable to adjustments of partnership items of Tigers

Eye Trading, LLC". The Explanation of Items went on to state:

-31The penalty shall be imposed on the components of

underpayment as follows:

A. a 40 percent penalty shall be imposed on the portion of any

underpayment attributable to the gross valuation misstatement as

provided by Sections 6662 (a), 6662(b)(3),.6662(e), and 6662(h) of the

Internal Revenue Code.

B. a 20 percent penalty shall be imposed on the portion of the

underpayment attributable to negligence or disregard of rules and

- regulation as provided by Sections 6662(a), 6662(b)(1), 6662(c) of the

Internal Revenue Code.

C. a 20 percent penalty shall be imposed on the underpayment

attributable to the substantial understatement of income tax as provided

by sections 6662(a), 6662(b)(2), and 6662(d) of the Internal Revenue

Code.

D. a 20 percent penalty shall be imposed on the underpayment

attributable to the substantial valuation misstatement as provided by

Sections 6662(a), 6662(b)(3), and 6662(e) of the Internal Revenue

Code.

Sentinel, the tax matters partner, filed the petition in this case but claims to

have no direct financial interest in its outcome. Mr. Logan, as trustee of Logan

Trust I," sought and was granted leave to participate in this proceeding as

"Participating partner had originally filed a refund suit (to recover a deposit

of $18,898.93) in the Court of Federal Claims, Tigers Eye Trading, LLC v. United

States, No. 05-00864-LAS (filed Aug. 4, 2005), contemporaneously with

petitioner's filing of the petition in the case at hand. After the United States filed a

motion to dismiss for lack ofjurisdiction by reason of the pendency of the case at

hand, see sec. 6226(b)(2), participating partner began proceedings to participate in

the case at hand. This Court granted leave and recognized Logan Trust I's status

(continued...)

-32participating partner. Mr. Logan, through his counsel, has wielded the laboring oar

and called the shots for the taxpayer interests in this proceeding.24

"(...continued)

as participating partner, see this Court's order of Mar. 9, 2007, and the case in the

Court of Federal Claims was dismissed per order (Mar. 20, 2007). We would

observe that Mr. Logan's deposit in the Court of Federal Claims case was an

admission that the FPAA adjusted partnership items on the Tigers Eye 1999

partnership return such that Mr. Logan's Federal income tax liability was increased

thereby. See sec. 301.6226(e)-1T (a)(1), Temporary Proced. & Admin. Regs., 52

Fed. Reg. 6788 (Mar. 5, 1987); see also sec. 301.6226(e)-1(a)(1), Proced. &

Admin. Regs.

240n Oct. 6, 2009, after the filing of Tigers Eye I, participating partner filed a

motion and supporting memorandum for partial summary judgment regarding

inapplicability of sec. 6662(h). In the motion and supporting memorandum,

participating partner conceded that the loss on the sale of the distributed stock and

foreign currency was not allowed under sec. 465(b)(4) because it exceeded the

amount at risk. The motion and memorandmn and subsequent filings made clear

that by conceding the at-risk issue participating partner intended to take the sec.

6662(h) 40% gross basis misstatement penalty out of play at both the partnership

and partner/individual levels. In attempting so to do, participating partner cited and

relied on the opinion of the Court of Federal Claims in Alpha I, L.P. v. United

States, 84 Fed. Cl. 622, 634 (2008). In orders dated November 6 and 18, 2009,

respectively, we denied the motion for partial summary judgment and explained our

view, citing Hambrose Leasing 1984-5 Ltd. P'ship v. Commissioner, 99 T.C. 298

(1992), and Russian Recovery Fund, Ltd. v. United States, 81 Fed. Cl. 793 (2008),

that at risk under sec. 465 is a partner-level issue on which the Court lacks

jurisdiction to accept a concession in a partnership-level proceeding such as the case

at hand.

The importance of the 40% penalty to both the IRS and taxpayers in Son of

BOSS cases is shown by the repeated attempts by taxpayers to use concessions to

take the penalty out of play. See, e.g., Bergmann v. Commissioner, 137 T.C. 136

(2011), and Chief Counsel Notice CC-2012-001 (Oct. 5, 2011), opposing the

(continued...)

-33Within a week before the scheduled trial,25 the Court was gratified to receive

the stipulated decision document signed by respondent's counsel, by Sentinel,

through Ari Bergmann, trustee of the Bergmann Revocable Trust, tax matters

partner of Sentinel, tax matters partner of Tigers Eye, and by Sentinel's counsel.

Participating partner through counsel indicated no objection to entry of the decision.

The decision provides as follows:

"(...continued)

allowance of concessions to avoid imposition of valuation misstatement penalties.

See 199 Daily Tax Rept. (BNA) K-6 (Oct. 14, 2011). In a status report filed

November 13, 2009, in the case at hand respondent provided a list, with docket

numbers, of more than 40 Son of BOSS cases pending in the Tax Court in which

respondent was asserting both sec. 465 at risk (as an alternative position) and the

40% gross basis misstatement penalty. In a previous filing, respondent had asserted

that the aggregate amount of the 40% penalties being asserted in such cases

amounted to approximately $130 million, ofswhich the 40% penalties in five stillpending Sentinel-promoted Son of BOSS cases amounted to approximately $41

million.

25Participating partner's counsel informed the Court,.in filings of October 26

and November 2, 2009, and in a recorded telephone conference of November 5,

2009, that participating partner would not participate in the trial that had been set for

a special session scheduled to commence on November 30, 2010, in Washington,

D.C. Participating partner's counsel stated that it would be futile and prohibitively

expensive to have a trial in the partnership-level proceeding. Instead, participating

partner had decided to "pursue reasonable cause in the refund action consistent with

this Court's ruling that it lacks jurisdiction over that reasonable cause". In the

preamble of our order of November 18, 2009, we urged participating partner to

reconsider not participating in the trial; we ordered participating partner and

petitioner to file a status report by November 29, 2009, "informing the Court

whether they intend to participate in the trial of this case".

-34ORDERED AND DECIDED: That the following statement

shows the adjustments to the partnership items of Tigers Eye Trading,

LLC, for the taxable year 1999:

Partnership Item

As Reported

As Determined

Ordinary Income,

Other Income (Loss)

($242,186)

$ -0-

Other Deductions

$11,314

$ -0-

Distributions of

$365,446

$ -0-

$698,595

$ -0-

Deductions,

Property other than

Money

Capital Contributions

It is determined that the notice of final partnership administrative

adjustment dated March 7, 2005, which is the subject matter of this

case, is correct.

It is determined that a 40 percent gross valuation misstatement

penalty under I.R.C. § 6662(a); (b)(3), (e) and (h) applies to any

underpayment of tax attributable to overstating the capital contributions

claimed to have been made to the purported partnership.

It is determined that a 20 percent penalty applies to any

additional underpayment of tax attributable to the foregoing partnership

item adjustments other than the capital contributions claimed to have

been made to the purported partnership, as such underpayment is

attributable to negligence or disregard of rules or regulations under

I.R.C. § 6662(a), (b)(1) and (c) or a substantial understatement of

income tax under I.R.C. § 6662(a), (b)(2) and (d).

-35On November 25, 2009, the Court issued an order striking the case from the

November 30, 2009, Washington, D.C., special trial session. On December 1,

2009, the Court entered the stipulated decision.

The Court's gratification from receipt and entry of the stipulated decision was

short lived. On January 12, 2010, the Court of Appeals for the D.C. Circuit issued

Petaluma II. One week later, on January 19, 2010, participating partner filed the

motion for leave to file a motion to revise the stipulated decision and lodged the

motion to revise decision. On November 30, 2010, the Court granted leave and the

motion to revise decision was filed.26 Participating partner asserts that the Court

must vacate and revise the stipulated decision because it exceeds the jurisdictional

limitations imposed by Petaluma II.

26By October 2010 respondent became concerned that if the stipulated

decision were not vacated, it would have already become final (on March 1, 2010)

and the one-year period of limitations under sec. 6229(d) for making computational

adjustments and assessing any resulting deficiency and accuracy-related penalties

and/or issuing an affected items notice of deficiency would expire on March 1,

2011. On November 30, 2010, we granted the motion for leave nunc pro tunc as of

the date it had been filed, January 19, 2010, and ordered the lodged motion to revise

decision to be filed as of that date. As a result, the 90-day period for appeal of the

stipulated decision under Fed. R. App. P. 13 does not commence to run until the

motion to revise is granted or denied and the one-year period of limitations under

sec. 6229(d) is thereby extended. See Nordvik v. Commissioner, 67 F.3d 1489,

1492 (9th Cir. 1995),<a_fff'g T.C. Memo. 1992-731; Simon v. Commissioner, 176

F.2d 230 (2d Cir. 1949); Stewart v. Commissioner, 127 T.C. 109, 117.(2006.).

-36Discussion

Introduction: Complexity of Income Tax Treatment of Partners and

Partnerships

Overview of Subchapter K

A partnership is not taxed as an entity, and its items of income and loss flow

through to its partners. Sec. 701. Partnerships are required to file annual

information returns reporting the partners' distributive shares of income, deductions,

and other partnership items. Sec. 6031. The individual partners report their

distributive shares of the partnership items on their Federal income tax returns.

Secs.701-704.

The substantive law governing the income taxation of partners is in

subchapter K of chapter 1 of the Code (subchapter K). Subchapter K creates a

detailed and complex system of rules for characterizing transactions between the

partnership and the partners, computing and/or characterizing partnership income,

assets, and liabilities, allocating those items among the partners, and determining

and making adjustments to a partner's basis (cost for tax purposes under section

1012 except as otherwise provided in subchapter K) in the partnership for his share

of those items. The purpose of subchapter K is "to permit taxpayers to conduct

joint business (including investment) activities through a flexible

-37economic arrangement without incurring an entity-level tax." Sec. 1.701-2(a),

Income Tax Regs.

TEFRA

1. In General

The unified audit and litigation procedural rules applicable to partnerships and

their partners were enacted by Congress in the Tax Equity and Fiscal Responsibility

Act of 1982 (TEFRA), Pub. L. No. 97-248, sec. 402, 96 Stat. at 648, and amended

by Congress in the Taxpayer Relief Act of 1997 (TRA 1997), Pub. L. No. 105-34,

sec. 1238, 111 Stat. at 1026? The TEFRA procedures are set forth in subchapter C

of chapter 63 of the Code. Under the TEFRA procedures all partnership items, the

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

"TEFRA as amended by TRA 1997 is an egregious example of "hyperlexis",

s_ee Bayless Manning, "Hyperlexis: Our National Disease, 71 Nw. U. L. Rev. 767

(1977), and is discussed in the tax context in Bayless Manning, "Hyperlexis and the

Law of Conservation of Ambiguity", 36 Tax Law. 9 (1982), and Gordon D.

Henderson, Controlling Hyperlexis--The Most Important "Law and * * *", 43 Tax

Law. 177 (1989). See also Richard M. Lipton, "We Have Met the Enemy and He is

Us: More Thoughts on Hyperlexis", 47 Tax Law. 1 (1993); Walter D.

Schwidetzky, "Hyperlexis and the Loophole", 49 Okla. L. Rev. 403 (1996). We

would suggest that TEFRA as amended by TRA 1997 has gone beyond the

conservation of ambiguity described by Henderson, supra, at 184-186, to its

exponential augmentation. See generally Sidney I. Roberts, et al., "A Report on

Complexity And the Income Tax", 27 Tax L. Rev. 325 (1972), on the operation of

"Gresham's Law of Tax Practice", describing the role of tax practitioners who

disregard professional standards of care, exemplified more recently by those who

acted as promoters of Son of BOSS transactions.

-38applicability of any penalty, addition to tax, or additional amount that relates to an

adjustment to a partnership item are determined in a single partnership-level

proceeding. Sec. 6226. The determinations of partnership items in partnershiplevel proceedings are binding on the partners and may not be challenged in

subsequent partner-level proceedings. See secs. 6230(c)(4), 7422(h).

TEFRA Penalty Litigation Structure Before TRA 1997

Before Congress enacted TRA 1997, any penalty, addition to tax, or

additional amount (collectively, penalty) related to adjustment of a partnership item

or items in a TEFRA proceeding at the partnership level was generally treated as an

affected item that required a factual determination in a subsequent proceeding at the

partner level. See N.C.F. Energy Partners v. Commissioner, 89 T.C. 741, 744

(1987); sec. 301.6231(a)(5)-lT(d), Temporary Proced. & Admin. Regs., 52 Fed.

Reg. 6790 (Mar. 5 1987). Before Congress enacted TRA 1997, the Tax Court

lacked jurisdiction in a partnership-level proceeding to decide the applicability of

partnership-item penalties. See N.C.F. Energy Partners v. Commissioner, 89 T.C. at

744. Rather, partnership-item penalties were determined at the partner level as

affected items in a deficiency proceeding after the related partnership-level

proceeding had been completed. Procedurally, this made sense, inasmuch

-39as the ultimate liability of each individual partner depended, almost invariably, upon

his ability to sustain his individual reasonable cause/good faith defenses under

section 6664(c), irrespective of whether the application of the penalty originated

from misconduct or failure of care at the partnership or individual level.

TEFRA Penalty Litigation Structure After TRA 1997

TRA 1997 sec. 1238 made a comprehensive set of procedural amendments to

the regime for the determination of penalties under TEFRA:

(1) By amending section 6221, TEFRA's introductory jurisdictional

provision, to require the applicability of any partnership-item penalty to be

determined at the partnership level ("Except as otherwise provided in this

subchapter, the tax treatment of any partnership item (and the applicability of any

penalty * * * which relates to an adjustment to a partnership item) shall be

determined at the partnership level" (emphasis added));

(2) by amending and expanding section 6226(f), on the scope ofjudicial

review by the Tax Court, the Court of Federal Claims, or Federal District Courts

with which a petition to review an FPAA is filed, i.e., in a partnership-level

proceeding, to provide that such court "shall have jurisdiction to determine" not

only all partnership items and their allocations among partners but also "the

-40applicability of any penalty * * * which relates to an adjustment to a partnership

item" (emphasis added);

(3) by amending section 6230(a)(2)(A)(i) to deprive the Tax Court of

jurisdiction to determine partnership-item penalties in a partner-level deficiency

proceeding ("(A) Subchapter B [sections 6211-6216 titled "Deficiency Procedures

in the Case of Income, Estate, Gift and Certain Excise Taxes"] shall apply to any

deficiency attributable to--(i) affected items which require partner-level

determinations (other than penalties * * * that relate to adjustments to partnership

items)");

(4) by adding section 6230(c)(1)(C), which allows a partner to file a claim for

refund on the ground that "the Secretary erroneously imposed any penalty, addition

to tax, or additional amount which relates to an adjustment to a partnership item";

and

(5) by amending section 6230(c)(4) to make conclusive the partnership-level

determination regarding the applicability of any partnership-item penalty, but

allowing the partner to assert any "partner-level" defenses in the refund claim. This

amendment was added to and continued the provision of section 6230(c)(4) that

makes conclusive partnership-level adjustments of partnership items that

-41result in computational adjustments without the need for an affected items notice of

deficiency, but also allows those adjustments to be challenged in a refund suit.

In its report underlying the amendments, the House Committee on Ways and

Means provided the following.explanation:

Present Law

Partnership items include only items that are required to be taken

into account under the income tax subtitle. Penalties are not

partnership items since they are contained in the procedure and

administration subtitle. As a result, penalties may only be asserted

against a partner through the application of the deficiency procedures

following the completion of the partnership-level proceeding.

Reasons for Change

Many penalties are based upon the conduct of the taxpayer. With

respect to partnerships, the relevant conduct often occurs at the partnership

level. In addition, applying penalties at the partner level through the

deficiency procedures following the conclusion of the unified proceeding at

the partnership level increases the administrative burden on the IRS and can

significantly increase the Tax Court's inventory.

Explanation of Provision

The bill provides that the partnership-level proceeding is to

include a determination of the applicability of penalties at the

partnership level. However, the provision allows partners to raise any

partner-level defenses in a refund forum.

[H. R. Rept. 105-148, at 594 (1997), 1997-4 C.B. (Vol. 1) 319, 915- 916i]

The foregoing recitation of these TRA 1997 amendments to TEFRA and their

legislative history displays the common theme~that unites them. The

-42recitation makes clear that the applicability of the accuracy-related penalty or

penalties that relate to the adjustment of partnership items would henceforth be

determined in the partnership-level proceeding to determine the validity of the

adjustments to partnership items by the FPAA. No longer would application of

accuracy-related penalties be determined at the partner level by the resolution of a

partner-level affected-items deficiency proceeding. Nevertheless, for all the reasons

discussed in the Afterword to Tigers Eye I, see supra two concluding paragraphs of

note 10, the TRA 1997 changes have spawned many controversies concerning

proper application of the TEFRA procedural rules, particularly in Son of BOSS

cases, including the case at hand.

Attempted Exploitation by Tax Shelter Promoters of Complex

Interactions and Disconnects of Subchapter K Substantive Rules and

TEFRA Procedural Rules

The substantive and procedural rules applicable to the income taxation of

partners and partnerships are "distressingly complex and confusing".28 Rhone-

Poulenc Surfactants and Specialties, L.P. v. Commissioner, 114 T.C. 533, 539-540 .

28Ä partnership is simultaneously considered to be an aggregation of

individual partners (the "aggregate theory") and a separate entity (the "entity

theory"). The mixing of the aggregate and entity theories by the substantive and

procedural laws applicable to the income taxation of partners and partnerships is a

primary source of uncertainty in the application of those laws. Rhone-Poulenc

Surfactants and Specialties, L.P. v. Commissioner, 114 T.C. 533, 539-540 (2000).

-43(2000) (citing Foxman v. Commissioner, 41 T..C. 535, 551 n.9 (1964), a_f_f d, 352

F.2d 466 (3d Cir. 1965)). That complexity has proven to be easily exploited, and

consequently, entities classified as partnerships have become the vehicles of choice

in creating and operating abusive tax shelters. The difficulty of applying the TEFRA

partnership provisions in tax shelter cases is evidenced--in addition to Petaluma and

the case at hand--by the opinions of the various trial courts and the Courts of

Appeals to which the cases were appealed. See, e.g., Jade Trading, LLC, v. United

States, 598 F.3d 1372, 1379-1380 (Fed. Cir. 2010) (Jade Trading II), aff g in part,

rev'g in part and remanding on penalty issues 80 Fed. Cl. 11

(2007) (Jade

Trading I), remanded to 98 Fed. Cl. 453 (2011) (Jade Trading III), afff d_, ___ Fed.

Appx. __ (Fed. Cir. Jan. 12, 2012); LKF X Invs. LLC, v. Commissioner, 106

A.F.T.R. 2d (RIA) 2010-5003, 2010-1 U.S. Tax Cas. (CCH) para. 50,488 (D.C.

Cir. 2010), aff g in part, rev'g and remanding on penalty issues T.C. Memo. 2009-

192; RJT Invs. X v. Commissioner, 491 F.3d 732 (8th Cir. 2007); Desmet v.

Commissioner, 581 F.3d 297 (6th Cir. 2009), aff g in part and remanding

Domulewicz v. Commissioner, 129 T.C. 11, 22 (2007), remanded to T.C. Memo.

2010-177; New Millennium Trading, LLC v. Commissioner, 131 T.C. 275, 279

(2008); Hambrose Leasing 1984-5 Ltd. P'ship v. Commissioner, 99 T.C.

-44298 (1992); Alpha I, L.P. v. United States, 93 Fed. Cl. 280, 326 (2010); Russian

Recovery Fund, Ltd. v. United States, 81 Fed. Cl. 793 (2008).

Abusive tax shelters are complex financial artifices which

exploit two fundamental weaknesses in the federal tax system: (1) the

complexity of the internal revenue laws and (2) the government's

inability by conventional means to identify quickly and challenge

abusive tax schemes. By exploiting these weaknesses, tax shelter

promoters precipitated a proliferation of abusive tax shelters and huge

revenue losses to the federal government.

* * * Congress could not draft provisions that anticipated every

colorable interpretation for fabricating a tax shelter. New tax shelter

techniques continued to develop unhindered by legislative efforts at

containment.

[D. French Slaughter, "The Empire Strikes Back: Injunctions of

Abusive Tax Shelters After TEFRA", 3 Va. Tax Rev. 1, 6 (Summer 1983);

fn. refs., citations, and quotation marks omitted.]

The above quotation was not only an accurate description of past and present ills as

of the time it was published--1983--but also a forecast of future developments, as

exemplified by the Son of BOSS transactions that are central to the formation of the

limited liability companies of Tigers.Eye in the case at hand and Petaluma in the

Petaluma case; they are a variation of the "bond and options sales strategy", which

the Commissioner regards as an abusive.tax shelter, see Notice 2000-44, 2000-2

C.B. 255, 256; supra note 1, and this Court has repeatedly so held, see, e.g.,

Carpenter Family Invs., LLC, v. Commissioner, 136 T.C. 373, 375 (2011);

-453K Invs. Partners v. Commissioner, 133 T.C. 112, 113 n.2 (2009); see also Kligfeld

Holdings v. Commissioner, 128 T.C. 192, 194 (2007).

Taxpayers attempted to exploit the complexity of partnership substantive tax

law by using Son of BOSS transactions to inflate artificially the basis of

property

ostensibly distributed by a partnership to the purported partners in liquidation of

their partnership interests. Those attempts exploited the complexity of the TEFRA

partnership procedural rules to impede the Government's ability to identify quickly

and challenge abusive Son of BOSS transactions and to avoid the proper imposition

of the accuracy-related penalties.29 As a result of those attempts, a disproportionate

number of cases under TEFRA have been devoted to procedural,

29TEFRA, particularly as revised by TRA 1997, is fiendishly complicated.

Significant procedural problems arise from the complexity introduced by two levels

of proceedings under TEFRA as amended by TRA 1997--the partnership level and

the partner level. There are situations in which the two levels fail to fit perfectly

together or the Commissioner's auditing agents are unable to discern which

positions are properly raised at the partnership level in the FPAA or during the

partnership-level court proceeding rather than at the partner level in a "freestanding" notice of deficiency (issued without regard to any FPAA), an affected

items notice of deficiency, or during the attendant court proceedings, and vice versa.

These situations have allowed or created the potential for taxpayers to escape

liabilities for tax deficiencies and penalties that would have been due if the

Commissioner had asserted the correct arguments and positions at the correct level.

See, e.g., Domulewicz v. Commissioner, 129 T.C. 11 (2007), aff'd sub nom.

Desmet v. Commissioner, 581 F.3d 297 (6th Cir. 2009), remanded to T.C. Memo.

2010-177.

-46jurisdictional, and statute of limitations questions.3° The diversion of resources from

the determination and collection of liabilities for taxes, penalties, and interest has

been substantial. See supra note 1.

Application of the TEFRA provisions is the most "distressingly complex and

confusing" in tax shelter cases such the case at hand and Petaluma where the

Commissioner takes and sustains the primary position in the FPAA (and the parties

agree or the taxpayer concedes) that an entity purporting to be a partnership is to be

disregarded on grounds of sham or lack of economic substance. In such cases the

entity is not a partnership for Federal income tax purposes, the persons holding

interests in the entity are not partners, their interests in the entity are not interests in

a partnership, and the transactions between the entity and the interest holders are not

transactions between a partnership and its partners. Consequently, the substantive

provisions of subchapter K simply do not apply to the entity, the persons holding

interests in the entity, or their transactions with the entity and among themselves.

However, pursuant to section 6233(a) and (b), the TEFRA procedural provisions

applicable to partnerships do apply "to the extent provided by regulations" to an

entity that has filed a partnership return and to the persons holding

30See, e.g., cases cited infra note 37 on proper application of the six-year

statute of limitations under·secs. 6229(c)(2) and 6501(e)(1)(A) to substantial

omissions from gross income.

-47an interest in the entity even if it is not a partnership for Federal income tax

purposes or even "if it is determined that there is no such entity". Sec. 301.62331T(c), Temporary Proced. & Admin. Regs., 52 Fed. Reg. 6795 (Mar. 5, 1987).

The complexity of the TEFRA provisions in a case where an entity purporting

to be a partnership is disregarded as such begins with sections 6226(f) and 6233,

which govern the Tax Court's jurisdiction in partnership-level proceedings. Our

jurisdiction to enter the stipulated decision as written also begins with those

statutory provisions.

II.

Jurisdiction Under TEFRA When Entity Filing Partnership Return Is.Not a

Partnership or Does Not Exist

TEFRA Procedures Apply When Entity That Filed Partnership Return

Is Not a Partnership or Does Not Exist: Sections 6226(f) and 6233

Generally, in partnership-level proceedings we have jurisdiction under section

6226(f) to determine all partnership items of the partnership for the partnership

taxable year to which the FPAA relates, and we are not limited to the partnership

items adjusted in the FPAA. Sec. 301.6226(f)-lT, Temporary Proced. & Admin.

Regs., 52 Fed. Reg. 6788 (Mar. 5, 1987). We also have jurisdiction to determine

the proper allocation of those partnership items among the partners and

-48the applicability of any penalty, addition to tax, or additional amount that relates to

an adjustment to a partnership item. Sec. 6226(f).

The TEFRA procedures and our jurisdiction in TEFRA proceedings are not

limited to partnership items of valid business entities recognized as partnerships for

Federal tax purposes. Pursuant to section 6233 and the regulations promulgated

thereunder, if an entity that has filed a partnership return is determined not to be a

partnership or not to exist, the TEFRA partnership procedures (statutory and

regulatory) will apply to the entity, its items, and persons holding an interest in the

entity. Sec. 301.6233-1T(a), (c), Temporary Proced. & Admin. Regs., supra. In

such a case, the Court has jurisdiction to make the determinations that the entity is

not a partnership and/or that it does not exist as well as determinations with respect

to all items of the entity that would be partnership items, as defined in section

6231(a)(3) and section 301.6231(a)(3)-1, Proced. & Admin. Regs., if the entity had

been a partnership. Sec. 301.6233-1T(a), (c), Temporary Proced. & Admin. Regs.,

supra.

Generally, a valid business entity.having two or more owners is taxed either

as a corporation or a partnership. However, an entity that merely acts as nominee

and agent for its owners may be disregarded as a separate business entity. Cf.

Commissioner v. Bollinger, 485 U.S. 340, 344-345 (1988). In such a case, the

-49Court may determine that the entity does not exist and is neither a corporation nor a

partnership, but the TEFRA procedures will still apply in accordance with section

6233(b) and section 301.6233-lT(c), Temporary Proced. & Admin. Regs., supra.

When Congress enacted the TEFRA procedures and the Secretary first

promulgated the temporary regulations, there were frequent controversies over

whether an unincorporated business entity with two or more owners (often a limited

partnership) was properly classified as a corporation or a partnership for Federal tax

purposes under section 301.7701-2, Proced. & Admin. Regs., in effect at that time.

Section 301.6233-1T(a), Temporary Proced. & Admin. Regs., supra, focuses on the

resolution of such controversies and, if the entity is properly taxable as a

corporation, gives the Court jurisdiction in the TEFRA proceeding to determine the

taxable income of the corporation, which will also "serve as a basis for a

computational adjustment reflecting the disallowance of any loss of credit claimed

by a purported partner with respect to that entity."31 However, the

Controversies involving the proper classification of a multimember business

entity were virtually eliminated in 1996 when the Secretary issued new classification

regulations, sec. 301.7701-3, Proced. & Adinin. Regs., commonly referred to as the

"check-the-box" regulations. Under the "check-the-box" regulations a business

entity with two or more members is classified as a partnership for Federal income

tax purposes, absent an election to be treated as a corporation.

(continued...)

-50procedures under section 6233 are not limited to controversies regarding the proper

classification of an entity as a corporation or as a partnership. Section 6233(b) and

section 301.6233-lT(c), Temporary Proced. & Admin. Regs.] supra, gives the Court

jurisdiction in the partnership-level proceeding to determine that an entity that filed

a partnership return does not exist." If the Court determines that the entity does not

exist or is deemed not to exist, the nonexistent or disregarded entity will be treated

as an entity that filed a partnership return, and section 301.6233-1T(a), Temporary

Proced. & Admin. Regs., supra, will apply. The Court must then determine whether

the entity is nonetheless a partnership for Federal income tax purposes." If the

Court determines that it is not, the Court has jurisdiction to make determinations

with respect to all items of the entity that would be partnership

"(...continued)

Sec. 301.7701-3(a) and (b), Proced. &.Admin. Regs.

"That situation might arise, for example, where an entity purporting to be a

legal entity under State law, such as a limited liability company or a limited

partnership, was never formed under State law. It could also arise where, as in

Petaluma and the case at hand, the entity, although legally formed under State law,

is deemed not to exist for Federal income tax purposes because it is a sham, has no

real business purpose, and merely acts as nominee and agent for its owners. Cl

g.., Commissioner v. Bollinger, 485 U.S. 340, 344-345 (1988).

"For example, a limited partnership or limited liability company that does not

legally exist because it was not properly formed under State law might nonetheless

be deemed to be a general partnership because the partners or members have

conducted transactions as general partners of the purported entity.

-51-

items, as defined in section 6231(a)(3) and section 301.6231(a)(3)-1, Proced. &

Admin. Regs., if the entity had been a partnership.

Jurisdiction To Determine Items of Disregarded Entity: Section

301.6233-1T(a) and (c), Temporary Proced. & Admin. Regs., 52 Fed.

Reg. 6779, 6795 (Mar. 5, 1987)

Section 6233 provides that if a partnership return is filed for a taxable year

but it is determined that no partnership exists, the TEFRA procedures still apply to

the entity, its items, and persons holding an interest in the entity, to the extent

provided in the regulations. In such a case, the TEFRA temporary regulations

applicable to Tigers.Eye's 1999 taxable year provide that the Court may make

determinations with respect to all items of the entity (entity items) that "would be

partnership items, as defined in section 6231(a)(3) and the regulations thereunder

[section 301.6231(a)(3)-1, Proced. & Admin. Regs.], if * * * [it].had been a

partnership". Sec. 301.6233-1T(a), Temporary Proced. & Admin. Regs., supra.

Further, the TEFRA temporary regulations provide:

Paragraph (a) of this section shall apply where a partnership return is filed for

a taxable year but it is determined that there is no entity for such taxable year.

For purposes of applying paragraph (a) of this section, the partnership return

shall be treated as if is was filed by an entity.

-52Sec. 301.6233-1T(c), Temporary Proced. & Admin. Reg., supra; see also sec.

301.6233-1(a), (d), Proced. & Admin. Regs., supra (applicable for taxable years

beginning on or after October 4, 2001).

A partnership item is an item that is (1) required to be taken into account

under any provision of subtitle A, governing income taxes, and (2) identified by the

Secretary in the regulations as "more appropriately determined at the partnership

level". Sec. 6231(a)(3).34 In section 301.6231(a)(3)-1, Proced. & Admin. Regs.,

the Secretary identified the items that are "more appropriately determined at the

partnership level than at the partner level and, therefore, are partnership items".

Section 301.6231(a)(3)-1(a)(1)(i), Proced. & Admin. Regs., provides that

partnership items include the partnership aggregate and each partner's share of

items of income, gain, loss, deduction, or credit of the partnership. Partnership

34Sec. 6231(a)(3) defines the term "partnership item" as follows:

(3) Partnership item.--The term "partnership item" means, with

respect to a partnership, 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 this subtitle, such item is more appropriately determined at

the partnership level than at the partner level.

-53items also include "the legal and factual determinations that underlie the

determination of the amount, timing, and characterization of items of income,

credit, gain, loss, deduction, etc." Sec. 301.6231(a)(3)-1(b), Proced. & Admin.

Regs.

042

The existence of a valid partnership is a partnership item. First, it must be

taken into account in computing a purported partner's income taxes. "'When filling

out individual tax returns, the very process of calculating an outside basis, reporting

a sales price, and claiming a capital loss following a partnership liquidation

presupposes that the partnership was valid.'" Petaluma II, 591 F.3d at 653 (quoting

RJT Invs. X v. Commissioner, 491 F.3d at 736). Second, the existence of a valid

partnership "is a sine qua non for determining the amount and characterization of all

other partnership items." IÅ The legal and factual determinations underlying the

Court's determination that the entity is not a partnership and/or does not exist will

determine the character of the items of income, credit, gain, loss, and deduction of

the entity.· Thus the legal or factual determination that establishes the existence or

nonexistence of a partnership is an item that the Secretary has identified as being

more appropriately decided at the partnership level than at the partner level. Id.

-54The determination that an entity is not a partnership because it is an

association taxable as a corporation or because it was merely the nominee or agent

for its owners is such a legal or factual determination and is a "partnership item"

that the Court has jurisdiction to decide in the partnership-level proceeding. The

classification of the entity as a corporation or as a nominee-agent will determine the

character of the items of income, credit, gain, loss, and deduction of the entity.

Thus, if the Court determines that the entity that filed a partnership return is not a

partnership but is an association taxable as a corporation, entity items would include

amounts taxable to the entity as a corporation. Sec. 301.6233-1T(a), Temporary

Proced. & Admin. Regs., supra. If the Court determines that an entity is a nomineeagent for the purported partners, the items of the entity will be directly attributable

to them.

"[D]etermining whether there is a valid partnership necessarily controls

whether there can be partnership income, partnership gain, partnership losses, and

so forth." Petaluma II, 591 F.3d at 653. If the Court has determined that an entity

that filed a partnership return is not a partnership and/or does not exist, there is no

partnership income, partnership gain, or partnership loss. The items of the entity are

not properly characterized as those of a partnership. The regulations provide that

the Court's determination that an entity that filed a partnership return is not a

-55partnership and is taxable as a corporation "will serve as a basis for a computational

adjustment reflecting the disallowance of any loss or credit claimed by a purported

partner with respect to that entity". Sec. 301.6233-lT(a), Temporary Proced. &

Admin. Regs., supra. Because that section of the temporary regulation also applies

to entities that do not exist, the determination that the entity is deemed not to exist

and is not a partnership for Federal tax purposes will also serve as a basis for a

computational adjustment reflecting the disallowance of any loss or credit claimed

by a purported partner with respect to that entity. Notably, the regulation does not

limit the computational adjustment to the disallowance of the purported partner's

share of "partnership loss or credit" that flowed through to his return from the

partnership return; the regulation extends the permissible computational adjustment

to the disallowance of "a_n_y loss or credit claimed by a purported partner with

respect to that entity". (Emphasis added.) Such a loss or credit, because it would

be "with respect to that entity", would include a loss claimed on the sale or

liquidation of the partner's purported partnership interest in the entity or on his sale

of property purportedly distributed to him in liquidation of his partnership interest in

the entity. Thus the Court has jurisdiction in the partnership-level proceeding to

determine that items of the entity that purport to be partnership items do not exist

and to adjust all such items to zero so that a computational adjustment

-56can be made to reflect the disallowance of any loss or credit claimed by a purported

partner with respect to the entity.

Jurisdiction To Determine Applicability of Any Penalty That Relates to

Adjustment of Entity Item: Section 6226(f)

If the Court determines that an entity that filed a partnership return is not a

partnership, the TEFRA provisions, including section 6226(f), apply. Sec.

301.6233-lT(a), Temporary Proced. & Admin. Regs., supra. Pursuant to section

6226(f) the Court has jurisdiction to determine the applicability of any penalty that

relates to an adjustment to a partnership item.

III.

Jurisdiction To Enter Stipulated Decision as Written With Respect to

Partnership Items

Provisions of the Stipulated Decision

The first decision paragraph in the stipulated decision gives specific effect to

four of the five scheduled adjustments made by the FPAA: Loss, Other Deductions,

Distributions of Property Other Than Money, and Capital Contributions, omitting

any reference to "Outside Partnership Basis". The $242,186 loss and the $11,314

of other deductions flowed directly through to the purported partners' returns. The

deficiencies resulting from those adjustments do not require any facts to be

determined in a partner-level proceeding. Therefore respondent

-57may assess those deficiencies and the penalties applicable thereto without sending a

statutory notice of deficiency.

The third and fourth decision paragraphs apply accuracy-related penalties to

any underpayment of tax attributable to the specified adjustments of partnership

items made by the first decision paragraph. The third decision paragraph applies the

40% gross valuation (basis) misstatement penalty to the portion of any

underpayment attributable to the gross valuation misstatement, as provided by

section 6662(a), (b)(3), (e), and (h), attributable to overstating the capital

contributions claimed to have been made to the purported partnership. The fourth

decision paragraph provides that any additional underpayment of tax that may be

attributable to the adjustments to zero of the loss, other deductions, and distributions

is attributable to negligence or disregard of rules or regulations under section

6662(a), (b)(1), and (c) or a substantial understatement of.incóme tax under section

6662(a), (b)(2), and (d) and applies the 20% penalty to that underpayment.

By the second decision paragraph stating that the FPAA is correct the parties

adopt and incorporate all determinations made in the FPAA, including the initial

FPAA determination that Tigers Eye is disregarded for Federal income tax purposes.

Notwithstanding that the first and third decision paragraphs omit any

-58reference to "Outside Partnership Basis", the parties agree that the second decision

S paragraph, in determining that the FPAA is correct, implicitly upholds the FPAA's

adjustment of outside partnership basis to zero and the application of the 40%

penalty to the portion of any underpayment attributable to the gross valuation

misstatement as provided by section 6662 (a), (b)(3), (e), and (h). Consequently,

the 40% penalty will apply to the portion of the underpayment attributable to the

gross misstatement of basis in the distributed property (the basis participating

partner claimed was its outside basis in its partnership interest in Tigers Eye)."

Disregard of Tigers Eye

By the second decision paragraph of the stipulated decision, the parties have

agreed and the Court has decided that the FPAA that is the subject matter of this

case is correct. The decision upholds the initial FPAA determination that the

partnership is a sham, lacks economic substance, and is disregarded for Federal

income tax purposes. Thus, the stipulated decision reflects the parties' agreement

that for Federal income tax purposes Tigers Eye does not exist and is not a

"This interpretation of the stipulated decision, agreed to by the parties before

the Court of Appeals for the D.C. Circuit issued Petaluma II, is consistent with the

holding of Petaluma I that the Court has jurisdiction in the partnership-level

proceeding to determine outside basis and the applicability of penalties thereto, and

the positions taken by the parties in addressing participating partner's motion to

revise the stipulated decision.

-59partnership. Pursuant to section 6233 and.the regulations thereunder, we have

jurisdiction to make those determinations as well as determinations-with respect to

all items of Tigers Eye that would be partnership items, as defined in section

6231(a)(3) and section 301.6231(a)(3)-1, Proced. & Admin. Regs., if it had been a

partnership. Pursuant to section 301.6233-1T(a) and (c), Temporary Proced. &

Admin. Regs., supra, the TEFRA procedures apply to Tigers Eye, its items, and all

persons holding interests in Tigers Eye, and the Court has jurisdiction under section

6226(f) to determine the applicability of any penalty that relates to an adjustment to

an item of Tigers Eye. That conclusion is consistent with the holding of the Court of

Appeals in the Petaluma case. Petaluma II, 591 F.3d at 652-654; Petaluma I, 131

T.C. at 92-97.

C. .

Items of Tigers Eye

The Court has jurisdiction to make determinations with respect to all of

Tigers Eye's items, including the legal and factual determinations that underlie the

determination of the amount, timing, and characterization of items of income, credit,

gain, loss, and deduction related to the transactions conducted by Tigers Eye. See

sec. 301.6233-lT(a), (c), Temporary Proced. & Admin. Regs., supra; sec.

301.6231(a)(3)-1(b), Proced. & Admin. Regs. The determination that Tigers Eye is

a sham and lacks economic substance is a factual determination that

-60underlies the characterization of items of income, gain, and loss related to its

transactions. Because Tigers Eye is a sham and had no'real business purpose, it

merely acted as nominee and agent for the option partners and the items related to

the transactions involving the option spreads and purchases and distribution of stock

and foreign currency are charaöterized as such. Cf. Commissioner v. Bollinger, 485

U.S. at 344-345. We have jurisdiction to make those factual and legal

determinations in this partnership (entity)-level proceeding and to determine the

items of Tigers Eye that resulted from its acting as nominee or agent for the option

partners.

We also have jurisdiction to determine that items that purport to be

partnership items do not exist and to adjust all such items to zero so that a

computational adjustment can be made to reflect the disallowance of any loss or

credit claimed by a purported partner with respect to the nonexistent Tigers Eye

partnership. The items reported on the partnership return that were adjusted to zero

in the first decision paragraph are such items.

First Decision Paragraph

By the first decision paragraph, the loss, deductions, capital contributions,

and distributions reported by Tigers Eye on the partnership return are items adjusted

to zero. Tigers Eye's purported partners claimed their proportionate

042

-61-

shares of the loss and deductions on their returns. The option partners also claimed

huge losses on the sale of the distributed property, which they characterized as

property distributed to them in liquidation of their interests in a partnership

purportedly acquired by contributing property to the purported partnership. The

parties' agreement to the Court's determination that Tigers Eye is not a partnership

for Federal income tax purposes "will serve as a basis for a computational

adjustment reflecting the disallowance of any loss claimed by a purported partner

with respect to that entity" (emphasis added), i.e., Tigers Eye, including the loss

claimed on the sale of property purported to have been distributed to a purported

partner on liquidation of a nonexistent partnership interest in Tigers Eye. See sec.

301.6233-1T(a), Temporary Proced. & Admin. Regs., supra. Pursuant to section

6233 and its implementing regulation, we have jurisdiction to determine that all

items of Tigers Eye purported to be partnership items are adjusted to zero. The

loss, other deductions, capital contributions, and distributions are identified in

section 301.6231(a)(3)-1(a)(1)(i), (4), Proced. & Admin. Regs., as

partnership/entity items that the Secretary determined are more appropriately

decided at the partnership level than at the partner level.

-621.

Partnership Loss and Deductions

The Secretary determined in section 301.6231(a)(3)-1(a)(1)(i), Proced. &

Admin. Regs., that the partnership aggregate and each partner's share of items of

income, gain, loss, deduction, or credit of the partnership are partnership items more

appropriately determined at the entity level. The $242,186 partnership loss and the

$11,314 partnership other deductions are partnership items. We have jurisdiction to

determine that, because Tigers Eye is not a partnership, Tigers Eye did not have any

partnership loss or partnership deductions. See sec. 301.6233-1T(a), Temporary

Proced. & Admin. Regs., supra. Thus, we have jurisdiction to adjust to zero the

$242,186 loss and the $11,314 deduction, as provided in the first decision paragraph

of the stipulated decision.

Contributions and Distributions

In section 301.6231(a)(3)-1(a)(4), Proced. & Admin. Regs., the Secretary

decided that items relating to contributions to the partnership and distributions from

the partnership are partnership items

to the extent that a determination of such items can be made from

determinations that the partnership is required to make with respect to

an amount, the character of an amount, or the percentage interest of a

partner in the partnership, for purposes of the partnership books and

records or for purposes of furnishing information to a partner * * *

-63Thus, the Secretary decided that items related to contributions to the partnership and

distributions from the partnership that the partnership is required to determine for its

books and records or for providing information to its partners are partnership items.

Items Related to Contributions

In section 301.6231(a)(3)-1(c)(2), Proced. & Admin. Regs., the Secretary

provided the following illustrations of additional determinations the partnership is

required to make for purposes of its books and records or for purposes of furnishing

information to a partner that relate to contributions:

(2) Contributions.--For purposes of its books and records, or for

purposes of furnishing information to a partner, the partnership needs

to determine:

(i) The character of the amount received from a partner (for

example, whether it is a contribution, a loan, or a repayment of a loan);

(ii) The amount of money contributed by a partner;

(iii) The applicability of the investment company rules of section

721(b) with respect to a contribution;.and

(iv) The basis to the partnership of contributed property

(including necessary preliminary determinations, such as the partner's

basis in the contributed property).

To the extent that a determination of an item relating to a contribution

can be made from these and similar determinations that the

-64partnership is required to make, therefore, that item is a partnership

item. To the extent that the determination requires other information,

however, that item is not a partnership item. * * *

Under the regulation, for purposes of keeping its books and records and

providing information to the option partners as a purported partnership, Tigers Eye

was required to determine (1) the amount of money and (2) the character and basis

of the paired options received from the purported partners. Tigers Eye needed to

determine its basis in the paired options in order to compute the losses realized on

the unwinding of the option spreads, which were part of the loss claimed on the

partnership return. In determining the basis of the paired options, Tigers Eye

needed to determine each partner's basis in the contributed property, including the

amount of the liabilities to which the property was subject. Partnership items

include the partnership aggregate and each partner's share of partnership liabilities,

including determinations as to the amounts of the liabilities, whether the liabilities

are nonrecourse, and increases or decreases during the taxable year. Sec.

301.6231(a)(3)-1(a)(1)(v), Proced. & Admin. Regs.

Tigers Eye was also required to determine the contributions for purposes of

determining the partners' percentage interests in the purported partnership, the

partners' shares of the partnership loss and deductions, and the amounts to which

the purported partners were entitled on the purported liquidation of their interests.

-65Tigers Eye was required to make the same determinations for purposes of its

books and records and providing information to the option partners with respect to

the money and property it received in conducting the transactions as nominee or

agent for the option partners. Tigers Eye needed to account for expenses it incurred

on behalf of the option partners, the amounts received and expended on the

unwinding of the paired options, and the costs of the foreign currency and stock

purchased on behalf of the option partners. Tigers Eye needed to provide that

information to the option partners so that they could report their gain or loss on the

unwinding of the paired options and determine their bases in the foreign currency

and stock purchased on their behalves.

Items Related to Distributions

In section 301.6231(a)(3)-1(c)(3), Proced. & Admin. Regs., the Secretary

provided the following illustrations of additional determinations the partnership is

required to make for purposes of its books and records, or for purposes of furnishing

information to a partner that relate to distributions:

(3) Distributions.--For purposes of its books and records, or for

purposes of furnishing information to a partner, the partnership needs

to determine:

(i) The character of the amount transferred to a partner (for

example, whether it is a distribution, a loan, or a repayment of a

loan);

-66(ii) The amount of money distributed to a partner;

(iii) The adjusted basis to the partnership of distributed

property; and

(iv) The character of partnership property (for example,

whether an item is inventory or a capital asset).

To the extent that a determination of an item relating to a distribution

can be made from these and similar determinations that the partnership

is required to make, therefore, that item is a partnership item. To the

extent that the determination requires other information, however, that

item is not a partnership item. Such other information would include

those factors used in determining the partner's basis for the partnership

interest that are not themselves partnership items, such as the amount

that the partner paid to acquire the partnership interest from a

transferor partner if that transfer was not covered by an election under

section 754.

Under the regulation, for purposes of keeping its books and records and providing

information to the option partners as a purported partnership, Tigers Eye needed to

determine the character of the amount distributed to an option partner; i.e., that it

was a distribution in liquidation of the partner's interest in the purported partnership.

Having made that determination, Tigers Eye needed to determine the amounts to be

distributed to the purported partners on liquidation of their interests. Tigers Eye

needed to select the property to be distributed, determine its basis in the property,

and remove it as an asset on its books. Tigers Eye needed to provide

-67that information to the option partners so that they could properly determine their

bases in the distributed property.

Tigers Eye was required to make the same determinations for purposes of its

books and records and providing information to the option partners with respect to

the property it distributed to them in conducting the transactions as nommee or

agent on their behalves. Tigers Eye was required to determine the character of

property distributed to an option partner; i.e., that it was a distribution of the

property Tigers Eye purchased as nominee or agent of the option partners. Having

made that determination, Tigers Eye needed to identify the property to be

distributed, determine its basis in the property, and account for it on its books.

Tigers Eye needed to provide that information to the option partners so that they

could properly determine their bases in the distributed property.

Adjustment of Items to Zero

Because Tigers Eye is not a partnership for Federal income tax purposes, it

had no partnership items, there was no partnership loss, and there were no

partnership deductions, no contributions to the purported partnership, and no

distributions from a partnership to its purported partners. Adjustment of those items

to zero is appropriate. The loss, deductions, capital contributions, and distributions

that are adjusted to zero pursuant to the first decision paragraph are

-68partnership items that this Court has jurisdiction decide under section 6233 and

section 301.6233-1T(a), Temporary Proced. & Admin. Regs., supra.

Second Decision Paragraph

By the second decision paragraph the parties adopt and incorporate all

determinations made in the FPAA, including the disregard of Tigers Eye, the

adjustment of outside basis to zero, and the application of the 40% penalty to the

underpayment attributable to gross valuation/basis misstatement. Participating

partner asserts that under Petaluma II the Court does not have jurisdiction to decide

outside basis or the applicability of the 40% penalty to an underpayment of tax

attributable to an overstatement of the basis in the distributed property, which

participating partner attributed to its outside basis in the partnership. Participating

partner concludes, therefore, that the Court must revise the second decision

paragraph accordingly. However, for the reasons set forth below, we conclude that

the option partners' bases in the distributed property as well as their outside bases

(or lack thereof) in their purported partnership interests are partnership/entity items

of Tigers Eye that we have jurisdiction under sections 6233 and 6231(a)(3) and their

regulations to decide in this partnership/entity-level proceeding.

-691.

Basis in Property Distributed by Disregarded Entity

Pursuant to section 6233 and its regulation, we have jurisdiction to determine

the items of Tigers Eye acting as nominee for the option partners. Tigers Eye was

required to make determinations for purposes of its books and records and for

providing information to the option partners with respect to the transactions it

conducted as nominee or agent on their behalves.

An option partner is required to take his basis in the distributed property into

account in computing his gain or loss on the sale of the property and computing his

income tax taking into account that gain or loss. The Secretary has determined in

section 301.6231(a)(3)-1(a)(4), Proced. & Admin. Regs., that items relating to

distributions that the partnership is required to make for purposes of its books and

records or for providing information to a partner are "more appropriately determined

at the partnership level" and are partnership items. The regulation specifically

provides that, for purposes of its books.and records and providing information to a

partner, the partnership needs to determine "[t]he adjusted basis to the partnership

of distributed property". Sec. 301.6231(a)(3)-1(c)(3)(iii), Proced. & Admin. Regs.

Tigers Eye needed to account for the money it received from the option

partners, the expenses it incurred on behalf of the option partners, the amounts

-70received and spent on the receipt and unwinding of the paired options, and t e cost

of the foreign currency and stock purchased on behalf of the option partners. Tigers

Eye needed to provide that information to~the option partners so that they could

properly report their gain or loss on the unwinding of the paired options and

determine their bases in the foreign currency and stock purchased on their behalves.

Tigers Eye was required to determine the character of property distributed to an

option partner; i.e., that it was a distribution of the property Tigers Eye purcliased as

nominee or agent on behalf of the option partners. Tigers Eye needed to ider tify the

property to be distributed, determine its basis in the property (which, in view of its

nominee-agent status, is participating partner's basis in the property) and acc unt

for the property on its books. Because Tigers Eye did not separately accour t for

the transactions on behalf of the various option partners, the items are entity items

(partnership items) that we have jurisdiction to decide in this entity/partnersh p-level

proceeding.

Although the FPAA Schedule of Adjustments adjusted partnership

distributions to zero, it did not mention or make any specific adjustment to the bases

of the foreign currency and stock received by the option partners. However,

pursuant to section 6226(f), regardless of whether the Commissioner specifically

made adjustments in the FPAA, the Court has jurisdiction to determine "all

-71partnership items of the partnership for the partnership taxable year to which the

notice of FPAA relates, the proper allocation of such items among the partners, and

the applicability of any penalty, addition to tax, or additional amount which relates

to an adjustment to a partnership item". Tigers Eye's basis in the foreign currency

and stock (which is participating partner's basis) is a partnership/entity item we

have jurisdiction to decide in this case. See sec. 301.6231(a)(3)-1(c)(3)(iii), Proced.

& Admin. Regs. Participating partner acknowledges that the distributions reported

on the partnership return filed by Tigers Eye is Tigers Eye's cost basis in the

distributed property. Thus, the distributions shown on the Schedule K-1 issued to

each option partner is Tigers Eye's cost basis in the property distributed to such

partner.

Outside Basis

Participating partner and petitioner agree that the second decision paragraph,

in determining that the FPAA is correct, upholds the FPAA's adjustment of outside

partnership basis to zero. Participating partner asserts that the stipulated decision

must be revised because under Petaluma II this Court lacks jurisdiction to make

adjustments to outside basis. However, for the reasons set forth below, we do not

believe the holding of the Court of Appeals on that issue in Petaluma II serves as

binding precedent under the intervening opinion of the Supreme Court

-72in Mayo Found. for Med. Educ. & Research v. United States, 562 U.S. ___, 131 S.

Ct. 704 (2011), and the recently filed opinion of the Court of Appeals for the D.C.

Circuit, Intermountain Ins. Serv. of Vail, LLC v. Commissioner, 650 F.3d 691 (D.C.

Cir. 2011).

Petaluma Superseded by Mayo Found. and

Intermountain: TEFRA Regulations Must Be

Applied

The adjustments made in the Tigers Eye FPAA are similar to those made in

the Petaluma FPAA.36 In Petaluma I the Tax Court held that (1) the partnership was

a sham and was disregarded for Federal tax purposes; (2) the purported partners had

no bases in their interests in the disregarded partnership; and (3) a valuation

misstatement penalty under section 6662(b)(3) applied to underpayments related to

the gross misstatement of the partners' outside bases. In deciding the second issue,

the Court held that although in some cases a partner's outside basis may be an

36The FPAA in Petaluma, although more detailed in some respects, is

substantially similar to the FPAA in the case at hand, both with respect to the

adjustments, including outside basis, capital contributions, and distributions of

property other than money, and the Exhibit A--Explanation of Items. However, the

adjustments in Petaluma do not include any other partnership items that would

directly flow through from the partnership return to the returns of the partners to

create any deficiency. Unlike the case at hand, the FPAA adjustments in Petaluma

do not include the zeroing out of an overall loss; it is a small amount of net income

that is zeroed out. Nor do the adjustments in Petaluma zero out or even refer to an

"Other Deductions" item.

-73affected item, under the regulations defining partnership items the outside basis of

the Petaluma partners was a partnership item the Court had jurisdiction in the

partnership-level proceeding to decide.

In Petaluma II, the Court of Appeals affirmed the Petaluma I holding that the

determination that the partnership is a sham and is disregarded for Federal tax

purposes is a partnership item the Tax Court has jurisdiction to decide in the

partnership-level proceeding. In so doing, the Court of Appeals held that the Tax

Court's jurisdiction in the case was governed by section 6233. The Court of

Appeals then meticulously applied section 6231(a)(3) and the regulations thereunder

to decide that the existence or nonexistence of a partnership is a partnership item.

Next, contrary to the Tax Court's holding in Petaluma I that under the

regulations outside basis was a partnership item, the Government conceded that

outside basis was not a partnership item. The Court of Appeals accepted the

Government's concession without any discussion of section 6233 or 6231 or the ,

regulations under section 6231 upon which the Tax Court had relied. The

Government argued that the Tax Court had jurisdiction in the partnership proceeding

to determine the partners' outside bases as affected items whose elements are

determined mainly from partnership items. The Court of Appeals

-74rejected that argument and held that the Tax Court did not have jurisdiction it the

partnership proceeding to determine the partners' outside bases, an affected i em,

despite the disregard of the partnership. Consequently, the Court of Appeals agreed

with Petaluma that "since the Tax Court lacked jurisdiction to determine outside

basis, it also lacks jurisdiction to determine that penalties apply with respect to

outside basis because those penalties do not relate to an adjustment to a partnership

item". Petaluma II, 591 F.3d at 655.

After Petaluma II was issued, the Supreme Court in Mayo Found., 562 U.S.

_, 131 S. Ct. 704, made it clear that Federal courts must defer to regulatior s

interpreting the Code that satisfy the two-step Chevron standard. See Chevrcn,

U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837, 842-843 (1984).

More recently, in Intermountain Ins. Serv. of Vail, LLC v. Commissioner, 650 F.3d

at 691, the Court of Appeals for the D.C. Circuit held that the deference give 1 to

regulations under Mayo Found. requires the Court to apply the definitions of

statutory terms provided in valid TEFRA regulations rather than follow earlier

caselaw.

The jurisdictional holdings of Petaluma II on outside basis and accuracyrelated penalties have their genesis in the Government's concession that outside

basis was not a partnership item. The Court of Appeals summarily accepted that

-75concession without any reference to section 301.6233-1T, Temporary Proced. &

Admin. Regs., supra, or section 301.6231(a)(3)-1, Proced. & Admin. Regs. In

contrast, the Court of Appeals discussed and applied sections 6233 and 6231(a)(3),

section 301.6233-lT(a), Temporary Proced. & Admin. Regs., supra, and section

301.6231(a)(3)-1, Proced. & Admin. Regs., in affirming our holding in Petaluma I

that disregard of the partnership is a partnership item.

Because the Court of Appeals did not consider the regulation in concluding in

Petaluma II that outside basis is an affected item, we believe that its decision on the

outside basis issue in Petaluma II has been superseded by the intervening opinions

of the Supreme Court in Mayo Found. and the Court of Appeals in Intermountain.

Intermountain requires us to apply the TEFRA regulations rather than follow any

contrary holding in Petaluma II, unless we hold the regulation to be invalid under the

two-step Chevron standard as mandated by the Supreme Court in Mayo Found.

If, under the applicable regulations, outside basis can be a partnership item,

as we believe it to be generally, and more particularly when the entity is disregarded

for Federal income tax purposes, acceptance of the Government's concession

effectively invalidates the regulation. Consequently, we will follow the Supreme

Court's command in Mayo Found. and apply the TEFRA regulations

-76rather than hold them invalid or inapplicable. In determining the validity of a

regulation, we are not bound to follow Petaluma II where the Court of Appeals did

not specifically consider the applicability of the regulation in deciding the issue. See

Intermountain Ins. Serv. of Vail, LLC v. Commissioner, 650 F.3d at 702. We begin

by identifying the factors that determine outside basis in a valid partnership, so as to

set the stage for the corresponding analysis that applies when the partnership is

disregarded.

Determination of Outside Basis: General Rule Under

Section 705(a)

Section 705(a) states the general rule for determining the adjusted basis of a

partner's interest in a partnership. In relevant part, section 705(a) provides that the

adjusted basis of a partner's interest in a partnership is his original basis as

determined under section 722 (relating to contributions to a partnership) or section

742 (relating to transfers of partnership interests) increased by (1) the amount of

money and his basis in property subsequently contributed to the partnership and (2)

his distributable share of the income of the partnership and decreased (but not below

zero) by (1) the amount of money and the partnership's adjusted basis in property

distributed to the partner in a nonliquidating distribution to the partner and (2) his

distributable shares of partnership losses and expenditures. Secs.

-77705(a), 722, 732(a). The original outside basis of a partner who obtains an interest

in a partnership by contribution to the partnership is equal to the amount of money

contributed plus his adjusted basis in any property contributed. Sec. 722; sec.

1.722-1, Income Tax Regs. The original outside basis of a partner who obtains his

interest in the partnership by purchase is his cost basis equal to the purchase price.

Sec. 742; sec. 1.742-1, Income Tax Regs.

The partnership's assumption of a partner's liability and a reduction of a

partner's share of the liabilities of the partnership are treated as distributions of

money. Sec. 752(b). The partner's assumption of a liability of the partnership and

an increase in a partner's share of the liabilities of the partnership are treated as

contributions of money. E If, as a result of a single transaction, a partner incurs

both an increase and a decrease in his share of partnership liabilities, only the net

increase is treated as a contribution or the net decrease is treated as a distribution.

Sec. 1.752-1(f), Income Tax Regs. Thus, if property contributed to the partnership

is subject to indebtedness or if liabilities of the partner are assumed by the

partnership, the increase and decrease in the partner's basis from the deemed

contributions and distributions of money are netted and the contributing partner's

outside basis is reduced by the portion of the indebtedness allocated to the other

partners. Sec. 1.722-1, Income Tax Regs.

-78The provisions governing the determination of outside basis are intended to

equate the aggregate of the partnership's inside bases in its assets with the aggregate

of its partners' outside bases in their partnership interests. Salina P'ship LP v.

Commissioner, T.C. Memo. 2000-352 (citing 1 William S. McKee et al., Federal

Taxation of Partnerships and Partners, par. 6.01, at 6-3 (3d ed. 1997)). The

carryover-basis rule in section 722 generally results in a matching of inside and

outside bases upon the formation of a partnership. See Coloman v. Commissioner,

540 F.2d 427, 429 (9th Cir. 1976), a_ff g T.C. Memo. 1974-78. The adjustments to

basis to account for income and expenses from partnership operations under section

705(a) generally preserve the equivalence of inside and outside bases. I_dl. Finally,

the practical impact of the basis adjustment prescribed in section 752(a) to reflect

increases and decreases in a partner's share of partnership liabilities has been

described as follows:

If a partnership borrows money, the basis of its assets increases by the

amount of cash received, even though the receipt of the borrowed

funds is not income. By treating the partners as contributing cash in an

amount equal to their shares of the debt, inside/outside basis equality is

preserved and distortions are avoided. If a liability for borrowed

money were not added to the partners' bases, they could be taxed on a

distribution of the borrowed cash even though there is no gain inherent

in the partnership's assets. A similar result could occur if a partnership

incurs a purchase money liability to acquire property, since the liability

is added to the partnership's basis in the property.

-791 McKee, supra, par. 7.0l[1], at 7-2; see Laney v. Commissioner, 674 F.2d 342,

345-346 (5th Cir. 1982), aff'g in part, rev'g in part on another ground T.C. Memo.

1979-491. The preamble to section 1.752-lT, Temporary Income Tax Regs., 53

Fed. Reg. 53143 (Dec. 30, 1988), states in pertinent part:

The allocation of partnership liabilities among the partners

serves to equalize the partnership's basis in its assets ("inside basis")

with the partners' bases in their partnership interests ("outside basis").

The provision of additional basis to a partner for the partner's

partnership interest will permit the partner to receive distributions of

the proceeds of partnership liabilities without recognizing gain under

section 731, and to take deductions attributable to partnership liabilities

without limitation under section 704(d) (which limits the losses that a

partner may claim to the basis of the partner's interest in the

partnership). By equalizing inside and outside basis, section 752

simulates the tax consequences that the partners would realize if they

owned undivided interests in the partnership's assets, thereby treating

the partnership as an aggregate of its partners.

The determination of the partners' shares of partnership liabilities under section 752

is also complex, requiring a determination of each partner's liability for recourse

debt and the proper allocation of nonrecourse debt. See secs. 1.752-1 through

1.752-5, Income Tax Regs.

Determination of Outside. Basis: Alternative Rule Under

Section 705(b)

Section 705(b) authorizes the Secretary to prescribe regulations under which

the adjusted basis of a partner's interest in a partnership may be determined by

-80reference to the partner's proportionate share of the adjusted basis of partnership

property that would be distributable upon a termination of the partnership. The

regulations promulgated to implement this section, see sec. 1.705-1(b), Income Tax

Regs., provide that an alternative method (alternative rule) may be used in

circumstances where (a) a partner cannot practicably apply the general rule set forth

in section 705(a) and section 1.705-1(a), Income Tax Regs., or (b) from a

consideration of all the facts, the Commissioner reasonably concludes that the result

will not vary substantially from the result obtainable under the general rule.

Outside Basis Is a Partnership Item

Under section 6231(a)(3), a partnership item must be (1) required to be taken

into account for the partnership's taxable year under any provision of subtitle A,

governing income taxes, and (2) identified by regulation as "more appropriately

determined at the partnership level".

Required To Be Taken Into Account Under

Subtitle A

"A partner is required to determine the adjusted basis of his interest in a

partnership only when necessary for the determination of his tax liability or that of

any other person." Sec. 1.705-1(a)(1), Income Tax Regs. The regulation provides

that it is necessary to determine a partner's outside basis (1) at end of a taxable

-81year to determine the extent to which the partner may deduct his share of

partnership loss or deductions and (2) on the date of sale or liquidation of his

interest in the partnership. Id.

As the Court of Appeals stated in deciding that the validity of a partnership is

a partnership item in Petaluma II, 591 F.3d at 653:

We have little difficulty concluding that application of the income tax

provisions of Subtitle A to the tax liability of a taxpayer who receives

income from a purported partnership entails a determination of the

validity of that partnership. As the Eighth Circuit has stated, "When

filling out individual tax returns, the very process of calculating an

outside basis, reporting a sales price, and claiming a capital loss

following a partnership liquidation presupposes that the partnership

was valid." RJT Investments X v. Comm'r, 491 F.3d 732, 736 (8th

Cir. 2007). Thus the first requirement of the test is met. [Emphasis

added.]

Outside basis is required to be taken into account in computing the income tax

liability from the sale of property purportedly received by the taxpayer from a

partnership in liquidation of his interest in the purported partnership. Thus the first

requirement of section 6231 is satisfied.

More Appropriately Determined at the Partnership

Level: Outside Basis Determined Under the

General Rule

Under statutory authority, the Secretary has decided that items related to

contributions to the partnership and distributions from the partnership that the

-82. partnership is required to determine for its books and records or for providing

information to its partners are partnership items. Sec. 301.6231(a)(3)-1(a)(4),

Proced. & Admin. Regs. The Secretary has also decided that, to the extent that a

determination of an item relating to contributions and distributions can be made

from the determination of contributions, distributions, and similar determinations

that the partnership is required to make, that item is a partnership item. Sec.

301.6231(a)(3)-1(c)(2) and (3), Proced. & Admin. Regs.. Conversely, to the extent

that the determination of such an item requires other information, that item is not a

partnership item.

The regulation recognizes that a partner's basis in his partnership interest is

an item relating to distributions and, in many instances, that the determination of that

outside basis under the general rule of section 705(a) may be made solely from the

determination of contributions, distributions, and similar determinations that the

partnership is required to make--the partner's share of items of partnership income,

credit, loss, deduction, and liabilities. If the partner has contributed property to the

partnership that is subject to indebtedness, the contributing partner's outside basis is

reduced by the portion of the indebtedness allocated to the other partners. Sec.

1.722-1, Income Tax Regs. Determination of the amounts and nature of those

liabilities, whether they are nonrecourse or contingent, and each partner's

-83-

share of each liability is a partnership item. Sec. 301.6231(a)(3)- 1(a)(v), Proced. &

Admin. Regs. A partner's share of partnership liabilities is determined under the

complex regulations promulgated under section 752. Section 1.752-4(d), Income

Tax Regs.,.requires a partner's share of liabilities to be calculated only when

necessary to determine the tax liability of the partner, such as at the end of the

partnership taxable year or when a partner sells or liquidates his partnership interest.

The partnership is required to inform the partners of their shares of partnership

liabilities so the partners can determine the extent to which they may deduct their

shares of partnership loss or deductions and determine the amounts of deemed

distributions or contributions of money from any increase or decrease in their shares

of the partnership liabilities. In those circumstances, outside basis is a partnership

iten1.

Under the regulation, a partner's outside basis is not a partnership item (i.e., it

is an affected item) onk when and to the extent the determination requires other

information. Sec. 301.6231(a)(3)-1(c)(3), Proced. & Admin. Regs. "Such other

information would include those factors used in determining the partner's basis for

the partnership interest that are not themselves partnership items." IA (emphasis

added). Examples of such factors would include the amount the partner paid to

acquire his partnership interest from a transferor partner and that the transfer was

-84-

not covered by an election under section 754. Sec. 301.6231(a)(3)-1(c)(2) and (3),

Proced. & Admin. Regs.

When a partner acquires an interest in the partnership by purchase, the

partnership may make optional adjustments to the basis of partnership property if an

election is made under section 754. Under section 301.6231(a)(3)-1(a), Proced. &

Admin. Regs., the optional adjustment, including the determination of the partner's

initial cost basis in the partnership, is a partnership item, and the determination of

the partner's adjusted outside basis can be made from the determination of

distributions, contributions, and similar determinations, including the partner's initial

cost basis, that the partnership is required to make. In that case, the partner's

adjusted outside basis.is a partnership item under the regulation.

If no

election is made under section 754, the determination of the partner's initial basis is

not one that the partnership is required to make. Pursuant to section

301.6231(a)(3)-1(a), Proced. & Admin. Regs., to the extent the determination of the

partner's adjusted basis requires information regarding the amount paid for the

interest, it is not a partnership item. To that extent, it is an affected item. See sec.

301.6231(a)(5)-1T(b), Temporary Proced. & Admin. Regs., 52 Fed. Reg. 6790

(Mar. 5, 1987). '

-85iii.

More Appropriately Determined at the Partnership

Level: Outside Basis Determined Under

Alternative Rule

When a partner's outside basis is determined under the alternative rule of

section 705(b), his basis is equal to his share of the adjusted basis of partnership

property that would be distributable to him upon termination of the partnership. If

the partnership makes a distribution to a partner in liquidation of the partner's

interest in the partnership, the partnership's basis in the distributed property is a

partnership item. Sec. 301.6231(a)(3)-1(c)(3), Proced. & Admin. Regs. The

determination of outside basis under the alternative rule of section 705(b) may be

made solely from the determination of distributions that the partnership is required

to make when property is distributed in liquidation of a partner's interest in the

partnership. in determining the amount of the distribution, the partnership must

determine the partner's interest in the partnership and identify the property to be

distributed and its basis in the property for purposes of its books and records and for

providing information to the partner. Thus, when outside basis is determined under

the alternative rule, it is a partnership item.

-86iv.

More Appropriately Determined at the Partnership

Level: Outside Basis When the Partnership Is

Disregarded

Section 301.6231(a)(3)-1(c)(1), Proced. & Admin. Regs., explicitly states

that the illustrations therein are not exhaustive; there may be additional

determinations of items relating to contributions and distributions that the

partnership is required to make for purposes of its books and records or providing

information to its partners. The partnership's existence for Federal income tax

purposes is a determination the partnership is required to make that also relates to

the proper tax treatment of contributions and distributions. If, as here, the parties

agree and the Court determines on grounds of sham or lack of economic substance

that the entity is not a partnership, then the purported partners are not partners and

never acquired any interests in a partnership and the transactions between the entity

and the purported partners are not treated as transactions between a partnership and

its partners. If the partnership does not exist for Federal tax purposes, it follows that

there were no contributions from a partner to a partnership, no distributions from a

partnership to a partner, no items of partnership income, partnership deduction, or

partnership loss, no partnership liabilities or partnership property, nor any adjusted

basis in partnership property. Solely from these determinations, it can be

determined with absolute certainty that there can be no outside basis in the

-87nonexistent partnership interest. No additional facts are required to determine the

absence of an outside basis, and no additional facts could possibly alter that

conclusion. That being the case, the above regulation makes outside basis (or the

lack thereof) a partnership item if the partnership is disregarded. Indeed, in holding

that the determination of the existence of a valid partnership is a partnership item,

the Court of Appeals for the D.C. Circuit observed in Petaluma II that "'the very

process of calculating an outside basis, reporting a sales price, and claiming a

capital loss following a partnership liquidation presupposes that the partnership-was

valid.'" Petaluma II, 591 F.3d at 653 (quoting RJT Invs. X v. Commissioner, 491

F.3d at 736 (emphasis added)).

Moreover, pursuant to section 301.6233-1T(a), Temporary Proced. & Admin.

Regs., supra, the determination that the entity is not a partnership serves as a basis

for a computational adjustment reflecting the disallowance of any loss or credit

claimed by a purported partner with respect to that entity, including the losses

reported by the option partners on their sales of property purported to have been

distributed to them in liquidation of their purported partnership interests. We have

jurisdiction under section 6233 and its regulations to make all adjustments of .

-88items necessary to make that computational adjustment, including taking account of

the absence of outside basis by adjusting it to zero.

Misapplication of Dial USA, Inc. v. Commissioner

Citing Dial USA, Inc. v. Commissioner, 95 T.C. 1, 4-6 (1990), and section

301.6231(a)(5)-1T(b), Temporary Proced. & Admin. Regs., supra, this Court has

held in some cases that a partner's basis in his partnership interest is an affected

item. See, e.g., Meruelo v. Commissioner, 132 T.C. 355, 367 (2009); Gustin v.

Commissioner, T.C. Memo. 2002-64. However, the cited regulation does not define

partnership item; it defines affected items and provides that "A partner's basis in his

interest in the partnership is an affected item to the extent it is not a partnership

item." Sec. 301.6231(a)(5)-1T(b), Temporary Proced. & Admin. Regs. (emphasis

added). None of the immediately above-cited cases examined the antecedent

regulation defining "partnership item'' to determine the extent to which or the

circumstance in which a partner's basis in his partnership interest is a partnership

item.

Moreover, Dial involved the Court's jurisdiction to determine subchapter S

items at the corporate level under the unified subchapter S audit and litigation

provisions of the Subchapter S Revision Act of 1982 (SSRA), Pub. L. No. 97-354,

sec. 4(a), 96 Stat. at 1691. The SSRA provisions, enacted shortly after TEFRA

-89and set forth at former sections 6241 through 6245, have since been repealed by the

Small Business Job Protection Act of 1996, Pub. L. No. 104-188, sec. 1307(c)(1),

110 Stat. at 1781, applicable to tax years beginning after December 31, 1996.

Under SSRA, the TEFRA provisions that relate to partnership items and the judicial

determination of partnership items were made applicable to subchapter S items

except to the extent modified or made inapplicable by regulations. Sec. 6244.

Subchapter S items were defined in section 6245 as "any item of an S corporation to

the extent regulations prescribed by the Secretary provide that, for purposes of this

subtitle such item is more appropriately determined at the corporate level than the

shareholder level." The Secretary identified subchapter S items in section

301.6245-1T, Temporary Proced. & Admin. Regs., 52 Fed. Reg. 3003 (Jan. 30,

1987). The subchapter S items in that regulation are very similar to the partnership

items identified in section 301.6231(a)(3)-lT, Temporary Proced. & Admin. Regs.,

supra, and they include items relating to contributions and distributions to the extent

they can be made from those determinations and similar determinations that the

corporation is required to make. The respective regulations, however, are markedly

different from each other with respect to a shareholder's basis in the S corporation

and a partner's basis in his partnership interest.. The flush language of section

-90301.6245-1T(c)(3), Temporary Proced. & Admin. Regs., 52 Fed. Reg. 3004 (Jan.

30, 1987), provides:

To the extent that the determination requires other information,

however, that item is not a subchapter S item. Such other information

would include the.determination of a shareholder's.basis in the

shareholder's stock or in the indebtedness of the S corporation to the

shareholder. [Emphasis added.]

By contrast, the flush language of section 301.6231(a)(3)-1(c)(3), Proced. & Admin.

Regs., provides:

To the extent that that determination requires other information,

however, that item is not a partnership item. Such other information

would include those factors used in determining the partner's basis for

the partnership interest that are not themselves partnership items, such

as the amount that the partner paid to acquire the partnership interest

from a transferor partner if that transfer was not covered by an election

under section 754. [Emphasis added.]

Thus,.the SSRA regulations defining subchapter S items modified the TEFRA

regulations that relate to partnership items, making the determination of outside

basis a partnership item under certain circumstances inapplicable to subchapter S

items. The shareholder's basis in the S corporation stock was solely an affected

item. By contrast, a partner's basis in the partnership is an affected item only "to

the extent it is not a partnership item." Sec. 301.6231(a)(5)-1T(b), Temporary

Proced. & Admin. Regs., supra. Section 6244 made the TEFRA provisions that

relate to partnership items and the judicial determination of partnership items

-91applicable to subchapter S items.. There is no statute or regulation that makes the S

corporation provisions applicable to partnerships. Consequently, the holding in D_ia.1

that the shareholder's basis in the stock of the corporation is not a subchapter S item

is inapplicable to the issue of the extent to which or circumstance in which a

partner's outside basis is or may be a partnership item.

An S corporation, like a partnership, is a passthrough entity, and pursuant to

section 1366(a)(1) a shareholder must take into account his or her pro rata share of

the S corporation's items of income, loss, deduction, or credit. However, an S

corporation is not considered an aggregate of its shareholders-it is merely a small

corporation that has elected to have its_income taxed to its shareholders rather than

at the corporate level. For that reason the provisions governing the determination of

a shareholder's basis are not intended to equate the aggregate of the corporation's

bases in its assets with the aggregate of its shareholders' bases in their stock in the

corporation. Shareholders in S corporations have no bases in their stock attributable

to any liabilities of the S corporation. However, a shareholder in an S corporation

has a separate tax basis in loans the shareholder makes to the S corporation equal to

the amount of the loans. Secs. 1012, 1366(d)(1)(B). Generally, under section 1367

a shareholder's tax basis in the stock in, and in the loans to, an S corporation are

adjusted to reflect the shareholder's share of income, losses, deductions, and credits

-92of the S corporation as calculated under section 1366(a)(1). If a shareholder's tax

basis in his stock in an S corporation is reduced to zero by his share of the losses of

the S corporation, any further share of the S corporation's losses decreases, but not

below zero, the shareholder's tax basis in outstanding loans the shareholder has

made to the S corporation. Sec. 1367(b)(2)(A); sec. 1.1367-2(b)(1), Income Tax

Regs.

The computation of a shareholder's pro rata share of the S corporation's

items of income is mucli simpler than the determination of a partner's distributable

share of partnership items. A shareholder's pro rata share of the S corporation items

is determined by assigning an equal amount to each share of outstanding stock. By

contrast, a partner's distributive share of partnership items of income, loss, etc., is

determined by the partnership agreement, provided the allocation has substantial

economic effect. Sec. 704(a). Otherwise the partner's distributive share is

determined in accordance with the partner's interest in the partnership, taking into

account all the facts and circumstances. Sec. 704(b). That determination would

require an analysis or determination of, inter alia, the partnership agreement, capital

accounts maintained under general accounting practices, capital accounts maintained

for tax purposes in cases where there is a difference, historical allocation of income

and deduction items, implications of negative capital account balances, partners'

-93liability for partnership debt, whether partnership debt is recourse or nonrecourse,

partners' shares of profit and loss, and partners' shares of partnership assets upon

liquidation of the partnership.

Determination of the partners' outside bases in their interests in a partnership

that is recognized for Federal income tax purposes requires complex determinations

of not only the amounts of partnership items that are elements of outside basis but

also the partners' shares of those amounts, which are also partnership items. Those

complex determinations must be made in the partnership proceeding, and most often

there are no other factors to be determined at the partner level. As the argument in

Helmer v. Commissioner, T.C. Memo. 1975-160, raised in Son of BOSS cases

such as this case demonstrates, the effect of partnership liabilities on the partners'

outside bases exacerbates the complexity of computing outside basis.

Determination of the partners' shares of partnership liabilities and any changes in

those shares are usually unrelated to adjustments of any partnership items of

income, loss, deduction, or credit. The determination of one partner's share of any

partnership item affects every other partner's share of that item. The complexity of

determining a partner's basis in his partnership interest justifies the Secretary's

determination that outside basis is a partnership item to be determined at the

-94partnership level to the extent it requires no additional information that must be

determined at the partner level.

By comparison, the determination of a shareholder's basis in his stock in an S

corporation is relatively simple once the S corporation items of income, loss,

deduction, and/or credit are determined at the corporate level (either as reported on

the S corporation return and accepted by the Commissioner or as a result of a

corporate-level proceeding). A shareholder's share of those S corporation items can

be determined at the shareholder level on the basis of the number of shares in the S

corporation without affecting any other shareholder's pro rata share. His basis in

any property contributed to the S corporation can also be determined by his records.

The relative simplicity of computing a shareholder's basis in the stock of an S

corporation justified the Secretary's determination that stock basis was an affected

item to be determined at the shareholder level.

Validity of the Regulation Under the Chevron Two-Step

Standard

We must follow the regulation, unless we hold it to be invalid under the

principles of Chevron, U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837

(1984). Under Chevron, we ask first whether Congress has addressed the precise

question at issue. Id. at 842. Where the statutory text is ambiguous, we

-95ask whether the agency's chosen interpretation is a "reasonable interpretation" of

the enacted text. Idiat 844. We may not disturb the regulation unless it is

"arbitrary or capricious in substance, or manifestly contrary to the statute." Mayo

Found., 562 U.S. at

, 131 S. Ct. at 711 (quoting Household Credit Servs., Inc.

v. Pfennig, 541 U.S. 232, 242 (2004)) (internal quotation marks omitted).

First, we ask whether the statute is "silent or ambiguous" on the issue in

question such that the agency has room to interpret. Chevron, 467 U.S. at 843. In

doing so, we use "traditional tools of statutory construction, including the statutory

language and legislative history." Anderson v. DOL, 422 F.3d 1155, 11·80 (10th

Cir. 2005) (citing Chevron, 467 U.S. at 843 n.9). Thus we ask whether Congress'

intent is clear with respect to whether the term "partnership item" in section

6231(a)(3) includes the. partners' outside bases in the partnership. Section

6231(a)(3) defines the term "partnership item" as any item with respect to a

partnership that is required to be taken into account for the partnership's taxable

year under the provisions governing income taxes to the extent regulations

prescribed by the Secretary provide that, for purposes of subtitle A, such item is

more appropriately determined at the partnership level than at the partner level. A

partner's basis in his partnership interest is an item that is required to be taken into

account when the partner is determining the extent to which he may deduct

-96partnership losses and expenses each year or the amount of income he may realize

when he receives a distribution from the partnership. Therefore Congress has not

excluded the partners' outside bases from the definition of partnership item.

We proceed to the second step and ask whether the regulation is "based on a

permissible construction of the statute." Chevron, 467 U.S. at 843. If the

Secretary's construction is reasonable, Chevron requires the Court to accept that

construction, even if the Secretary's "reading differs from what the court believes is

the best statutory'interpretation." Nat'l Cable & Telecomms. Ass'n v. Brand X,

545 U.S. 967, 980 (2005).

Nothing in section 6231(a)(3) unambiguously forecloses the Secretary from

interpreting "partnership items" as including items relating to contributions to the

partnership and distributions from the partnership to the extent that the items can be

ascertained from determinations that the partnership is required to make with

respect to an amount, the character of an amount, or the percentage interest of a

partner in the partnership, for purposes of the partnership books and records or for

purposes of furnishing information to a partner. They are items the partners are

required to take into account in determining their income taxes for the partnership's

taxable year. It is not arbitrary for the Secretary to decide that items that can be

determined solely by contributions, distributions, and other similar

-97items that the partnership is required to keep records of for purposes of its books

and records or for providing information to its partners are more appropriately

determined at the partnership level. They are items that can be determined only

from other items that must be determined at the partnership level, and the

determination with respect to one partner necessarily affects the other partners, e.g.,

determination of the basis in property distributed to one partner reduces the

partnership basis in its remaining assets for purposes of its books and records.

Determining the nature and amounts of liabilities assumed by the partnership as the

result of one partner's contribution of property to the partnership affects the other

partners' shares of those liabilities and their deemed contributions of money related

to the increase in the partnership liabilities allocated to them.

The regulatory scheme under section 6231(a)(3) is technical and complex.

We find that the Secretary considered the treatment of partnership items in a

detailed and reasoned fashion before making a final decision. The regulations were

promulgated pursuant to notice and comment procedures, "'a "significant" sign that

a rule merits Chevron deference.'" Mayo Found., 562 U.S. at __, 131 S. Ct. at

714 (quoting United States v. Mead Corp., 533 U.S. 218, 230 (2001)). We note

that the regulations in question are longstanding, antedating TRA 1997 by 10 years

or so. See United States v. Cleveland Indians Baseball Co., 532 U.S.

-98200, 204 (2001) (according "due respect to the [Internal Revenue] Service's

reasonable, longstanding construction of the governing statutes and its own

regulations"); United States v. Correll, 389 U.S. 299, 307 (1967) (the Supreme

Court will defer to longstanding interpretations of the Code and regulations that

reasonably "implement the congressional mandate"). We also note that the

regulations in question are legislative rather than interpretive, having been

promulgated pursuant to congressional direction. See Square D Co. v.

Commissioner, 438 F.3d 739 (7th Cir. 2006), aff'g 118 T.C. 299, 307 (2002);

Carlos v. Commissioner, 123 T.C. 275, 280 (2004). We hold that the regulation is

valid.37 Applying the regulation, we hold further that where a determination of a

partner's basis in his interest in the partnership can be made solely from the

"We also observe that the règulations in question are not so controversial as

the regulations currently under consideration in the cases concerning the

applicability of the six-year period of limitations under secs. 6229 (c)(2) and

6501(2)(1)(A) in Son of BOSS cases. Accord Grapevine Imports Ltd. v. United

States, 636 F.3d 1368 (Fed. Cir. 2011), rev'g 77 Fed. Cl. 505 (2008); see, e.g.,

Beard v. Commissioner, 633 F.3d 616 (7th Cir. 2011) (three-year period of

limitation for assessing tax was applicable rather than six-year period under secs.

6229(c)(2) and 6501(e)(1)(A)), rev'g T.C. Memo. 2009-184; Contra Home

Concrete & Supply, LLC v. United States, 634 F.3d 249 (4th Cir. 2011), cert.

granted, 132 S. Ct. 71 (2011); Burks v. United States, 633 F.3d 347 (5th Cir.

2011); Carpenter Family Invs., LLC v. Commissioner, 136 T.C. 373 (2011);

Intermountain Ins. Serv. of Vail, LLC v. Commissioner, 650 F.3d 691 (D.C. Cir.

2011), rev'g and remanding 134 T.C. 211 (2010), supplementing T.C. Memo. 2009195.

-99determination of contributions, distributions, and similar determinations that the

partnership is required to make and requires no other information, that item is a

partnership item.

Outside Bases of Tigers Eye's Purported Partners Are

Partnership Items

In the case at hand, the option partners obtained their interests in the

purported Tigers Eye partnership by contribution and not by purchase from a

transferor partner. Under the regular rule of section 705(a), their outside bases

would be determined solely by their purported contributions to the partnership and

their shares of the loss and deductions Tigers Eye reported on the partnership return;

1.e., determinations that a partnership is required to make. Participating partner

premised his claimed inflated basis on (1) treating each purchased option separately

from each sold option, (2) treating each purchased option as having a basis equal to

the gross premium in the hands of both the Logan Trusts and Tigers Eye, (3) treating

the assignment to and assumption by Tigers Eye of the contingent obligation of the

sold option separately from the purchased option for purposes of section 752, and

(4) disregarding the contingent obligation to satisfy the sold option in determining

outside basis in the partnership under the authority of/Helmer v. Commissioner, T.C.

Memo. 1975-160.

-100Assuming without deciding that Helmer would apply if Tigers Eye had been

recognized as a partnership for Federal tax purposes, the fact that the obligation to

satisfy the sold option might have been contingent does not mean there would have

been no deemed distribution to the option partners as a result of the

partnership's

assumption of the liability. At best, it means the deemed distribution could not be

determined until the option was exercised or lapsed and the liability became fixed.

Because the option partner could not practicably apply the general rule set forth in

section 705(a) and section 1.705-1(a), Income Tax Regs., his basis would have to

be determined under the alternative rule by reference to his proportionate share of

the adjusted basis of partnership property that would be distributable upon a

termination of the partnership. . See sec. 1.705-1(b), Income Tax Regs. The

property distributed to each option partner was his share of partnership property

distributed in liquidation of his interest in the partnership. Thus, had Tigers Eye

been recognized as a partnership for Federal income tax purposes, the distribution

reported on the Schedule K-1 issued to each option partner would have been the

partnership's adjusted basis in the distributed property and would have been the

option partner's outside basis in the partnership under the alternative rule.

-101Pursuant to the second decision paragraph, Tigers Eye is a sham and is not

treated as a partnership for Federal income tax purposes. Consequently the option

partners were not partners and did not acquire interests in a partnership, they made

no contributions to a partnership and received no distributions from a partnership,

and there were no items of partnership income, partnership deduction, or partnership

loss. Consequently it follows with absolute certainty that there was no outside basis

in the partnership. No additional facts are required to determine a zero outside

basis, and no additional facts could possibly alter that conclusion.

Therefore, pursuant to section 301.6231(a)(3)-1(c)(3), Proced. & Admin.

Regs., the lack of outside basis is a partnership item that we have jurisdiction to

decide in the partnership/entity-level proceeding, and we need not revise the

stipulated decision.

IV.

Jurisdiction To Enter Stipulated Decision as Written With Respect to

Application of Penalties

We have jurisdiction in this proceeding to determine the applicability of any

penalty "which relates to an adjustment to a partnership item". Sec. 6226(f); sec.

301.6233-lT(a), Temporary Proced. & Admin. Regs., supra. Therefore, the

stipulated decision will exceed our jurisdiction under section 6226(f) if it decides

that a penalty applies to an adjustment that does not relate to a partnership item.

-102In Petaluma II, the Court of Appeals succinctly disposed of the penalties in

two paragraphs. First, having accepted the Government's concession that outside

basis was not a partnership item, the Court of Appeals reversed the Tax Court's

holding that the 40% penalty for gross valuation misstatement applied to the

partners' outside bases. The Court of Appeals agreed with Petaluma that "since the

Tax Court lacked jurisdiction to determine outside basis, it also lacks jurisdiction to

determine that penalties apply with respect to outside basis because those penalties

do not relate to an adjustment to a partnership item."

In the second paragraph, the Court of Appeals vacated the Tax Court's

Opinion and decision in Petaluma I upholding other accuracy-related penalties38 and

remanded the case for further proceedings on that issue. The Court of Appeals

could not determine from the Ta

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