Alpha I, L.P. Ex Rel. Sands v. United States , 682 F.3d 1009 ( 2012 )

United States Court of Appeals
for the Federal Circuit
__________________________
ALPHA I, L.P, (BY AND THROUGH ROBERT SANDS, A
NOTICE PARTNER), BETA PARTNERS, L.L.C., (BY AND
THROUGH ROBERT SANDS, A NOTICE PARTNER), R, R, M
& C PARTNERS, L.L.C., (BY AND THROUGH R, R, M & C
GROUP, L.P., A NOTICE PARTNER), R, R, M & C GROUP
L.P., (BY AND THROUGH ROBERT SANDS CHARITABLE
REMAINDER UNITRUST – 2001, A NOTICE PARTNER),
CWC PARTNERSHIP I, (BY AND THROUGH TRUST FBO
ZACHARY STERN U/A FIFTH G. ANDREW STERN AND
MARILYN SANDS, TRUSTEES, A NOTICE PARTNER),
MICKEY MANAGEMENT, L.P., (BY AND THROUGH
MARILYN SANDS, A NOTICE PARTNER), M, L, R & R, (BY
AND THROUGH RICHARD E. SANDS, TAX MATTERS
PARTNER),
Plaintiffs-Cross Appellants,
v.
UNITED STATES,
Defendant-Appellant.
__________________________
2011-5024, -5030
__________________________
Appeals from the United States Court of Federal
Claims in consolidated case nos. 06-CV-407, 06-CV-408,
06-CV-409, 06-CV-410, 06-CV-411, 06-CV-810, and 06-
CV-811, Chief Judge Emily C. Hewitt.
___________________________
ALPHA I v. US 2
Decided: June 15, 2012
___________________________
THOMAS A. CULLINAN, Sutherland Asbill & Brennan
LLP, of Atlanta, Georgia, argued for plaintiffs-cross
appellants. With him on the brief were N. JEROLD COHEN
and JOSEPH M. DEPEW; and KENT L. JONES, of Washing-
ton, DC.
FRANCESCA U. TAMAMI Attorney, Tax Division, United
States Department of Justice, of Washington, DC, argued
for defendant-appellant. With her on the brief were
GILBERT S. ROTHENBERG, Acting Deputy Assistant Attor-
ney General, and Kenneth L. Greene, Attorney.
__________________________
Before RADER, Chief Judge, NEWMAN, and O’MALLEY,
Circuit Judges.
O’MALLEY, Circuit Judge.
The U.S. Court of Federal Claims dismissed the In-
ternal Revenue Service’s determination that certain
taxpayers’ transfers of their partnership interests to
trusts were shams because the court believed it lacked
jurisdiction to address the IRS’s determination at the
partnership level. The United States appeals that ruling
in Case No. 2011-5024. We reverse the Court of Federal
Claims’s dismissal. The identity of the true partners in
the partnership at issue appropriately is determined at
the partnership level because, on the particular facts of
this case, partnership identity could affect the distributive
shares reported to the partners.
After this action commenced, the taxpayers conceded
certain capital gain and loss adjustments imposed by the
IRS and moved for summary judgment on the valuation
3 ALPHA I v. US
misstatement penalties that the IRS sought as a result of
those adjustments. The taxpayers argued that their
concession of the IRS’s adjustments rendered the valua-
tion misstatement penalties moot. The Court of Federal
Claims agreed, granted summary judgment to the tax-
payers, and declined to impose the valuation misstate-
ment penalties. The United States appeals that ruling in
Case No. 2011-5024. We vacate that judgment because
the Court of Federal Claims failed to determine whether
the taxpayers’ underpayment of tax was attributable to
the alleged valuation misstatement.
Finally, the Court of Federal Claims granted the gov-
ernment’s motion for summary judgment with respect to
additional penalties for negligence, substantial under-
statement, and failure to act reasonably and in good faith,
and imposed a twenty-percent penalty on the taxpayers.
The taxpayers appeal that ruling in Case No. 2011-5030.
We dismiss the taxpayers’ appeal as premature. If the
Court of Federal Claims concludes on remand that the
forty-percent valuation misstatement penalty applies,
that valuation misstatement penalty could render moot
the propriety of the twenty-percent penalty that is the
subject of the taxpayers’ cross appeal.
I
This case arises from two so-called “Son-of-BOSS”
transactions, as well as a transaction involving charitable
remainder unitrusts (“CRUTs”), conducted by the heirs of
the late Marvin Sands, the founder of Constellation
Brands, Inc. In a Son-of-BOSS transaction, a taxpayer
attempts to realize tax benefits by transferring assets
encumbered by significant liabilities to a partnership in
an attempt to increase the partner’s basis in the partner-
ship. See Stobie Creek Invs. LLC v. United States, 608
F.3d 1366, 1368-71 (Fed. Cir. 2010); Korman & Assocs. v.
ALPHA I v. US 4
United States, 527 F.3d 443, 446 n.2 (5th Cir. 2008).
Normally, when a partner contributes property to a
partnership, the partner’s basis in the partnership in-
creases, and when the partnership assumes a partner’s
liability, the partner’s basis decreases. See I.R.C. §§ 722,
733, 752, 754. A Son-of-BOSS transaction recognizes a
partnership’s acquisition of a partner’s asset (here, short-
sale proceeds), and disregards the partnership’s acquisi-
tion of an essentially offsetting liability (here, the obliga-
tion to close out the short-sale position). See Stobie Creek
Invs., 608 F.3d at 1368-69; Korman & Assocs., 527 F.3d at446 n.2. By employing this strategy, the taxpayer at-
tempts to generate a tax loss or reduce the gain that
would otherwise result from the sale of an asset. Id.In this case, Marvin Sands’s heirs owned stock in
Constellation. In the first Son-of-BOSS transaction, they
used several partnerships to convert approximately $66
million in taxable gain that they anticipated receiving
from the sale of their stock into large capital losses. The
heirs also prearranged for their partnership interests to
be held temporarily by tax-exempt CRUTs at the time of
the sale so that, as the government alleges, any gain that
might be recognized from the sale would escape taxation.
The CRUTs were terminated shortly after they were
formed, and the assets of the CRUTs, including the sale
proceeds, were distributed to the heirs, purportedly tax
free. In the second Son-of-BOSS transaction, the heirs
sought to generate significant capital losses to offset other
income, again through the use of various partnerships.
In notices of final partnership administrative adjust-
ment (“FPAAs”) issued to the partnerships involved in the
Son-of-BOSS transactions, the IRS determined that the
transactions should be disregarded and that the transfers
of the partnership interests to the CRUTs were shams.
The IRS also asserted various basis and capital gain and
5 ALPHA I v. US
loss adjustments, as well as several alternative penalties,
including a forty-percent penalty for gross valuation
misstatement, a twenty-percent penalty for substantial
understatement of tax, and a twenty-percent penalty for
negligence. The IRS also asserted that the transactions
did not increase the partners’ amounts at risk under
I.R.C. § 465.
The partnerships involved in the Son-of-BOSS trans-
actions initially challenged the IRS’s adjustments to the
basis, capital gain, and capital loss calculations. In an
amended complaint, however, the partnerships conceded
the capital gain and loss adjustments on the purported
basis of I.R.C. § 465. The Court of Federal Claims later
agreed with the partnerships that, because the adjust-
ments had been conceded on the basis of I.R.C. § 465, the
forty-percent gross valuation misstatement penalty
sought by the IRS because of the adjustments was inap-
plicable. The Court of Federal Claims also held that the
identity of a partnership’s partners is a non-partnership
item that cannot be addressed in a partnership proceed-
ing, such that it could not consider whether the transfers
of the partnership interests to the CRUTs were shams.
Finally, the Court of Federal Claims determined that the
twenty-percent penalties for substantial understatement
of tax and negligence applied and imposed such a penalty
on the taxpayers.
A
During 2001 and 2002, the years at issue, Constella-
tion was a leading producer and marketer of alcoholic
beverages in North America and the United Kingdom,
with gross sales exceeding $3 billion in fiscal year 2001.
Constellation was founded and owned by the late Marvin
Sands. After his death, the following family members
held a controlling interest in Constellation through stock
ALPHA I v. US 6
ownership: Marvin’s sons, Robert and Richard Sands; his
wife, Marilyn Sands; and two trusts established for the
benefit of his grandchildren, Abigail Stern and Zachary
Stern (the “Children’s Trusts”). The government claims
that, in 2001, the heirs’ stock was worth more than $75
million and had a tax basis of approximately $9 million.
1
The heirs received tax advice from The Heritage Or-
ganization, LLC, which designed and directed the imple-
mentation of the two Son-of-BOSS transactions. The
heirs implemented the first Son-of-BOSS transaction as
follows. Between August 21 and 23, 2001, they estab-
lished brokerage accounts with Paine Webber. Through
those accounts, they collectively sold short approximately
$85.6 million of U.S. Treasury Notes. 1 On August 27,
2001, the Children’s Trusts assigned their portion of the
short-sale proceeds and the obligation to close out the
short sale to CWC Partnership I (“CWC”), a preexisting
family investment partnership. On August 28, 2001, the
heirs and CWC contributed (i) the proceeds from the short
sale, (ii) the obligation to close out the short sale, and (iii)
a total of 2,000,000 shares of Constellation stock to R,R,M
& C Group, L.P. (“RRMC Group”), a new partnership
created at the direction of Heritage. The general partner
of RRMC Group was R,R,M & C Management Corporation
(“RRMC Corp.”), an entity created by Richard and Robert
on August 23, 2001. For its claimed 0.1% interest in
1 A short sale is a sale of securities that are not
owned by the seller. Securities are borrowed, usually
from a brokerage house, and then sold on the open mar-
ket. The seller holds the proceeds from the sale but is
required to replace the borrowed property in kind—
referred to as “closing out” the short sale—at some future
date. See Zlotnick v. Tie Commc’ns, 836 F.2d 818, 820 (3d
Cir. 1988).
7 ALPHA I v. US
RRMC Group, RRMC Corp. contributed 2,002 shares of
Constellation stock to the partnership.
On August 31, 2001, RRMC Group, in turn, contrib-
uted the Constellation stock, the short-sale proceeds, and
the obligation to close out the short sale to R,R,M & C
Partners, L.L.C. (“RRMC Partners”), another new entity
established at the direction of Heritage. RRMC Group
held a 99.7163% interest in RRMC Partners. The remain-
ing interest was held by Gloria Robinson, the mother of
the heirs’ accountant.
On September 6, 2001, RRMC Partners closed out the
short-sale position at a net loss of $425,565. On Septem-
ber 10, 2001, RRMC Group purchased Robinson’s interest
in RRMC Partners, thereby effecting a termination of
RRMC Partners. The government alleges that, as a result
of this transaction, RRMC Group claimed that its basis in
the Constellation stock increased by approximately $85.6
million, from $9 million to $94.7 million.
2
In connection with the first Son-of-BOSS transaction,
the heirs prearranged to channel the sale of the Constel-
lation stock through tax-exempt CRUTs. A CRUT is a
charitable trust that provides an income beneficiary, often
the grantor, annual payments for a fixed term. At the end
of the fixed term, a charity receives the remainder inter-
est. See I.R.C. § 664. A CRUT generally is exempt from
tax, but the income of a CRUT is taxable to its income
beneficiaries upon distribution. I.R.C. § 664(b), (c)(1).
On September 21, 2001—eleven days after RRMC
Partners had terminated and distributed the Constella-
tion stock back to RRMC Group with the increased ba-
sis—Richard, Robert, Marilyn, and CWC each created a
CRUT with a twenty-year term. Richard and Robert were
ALPHA I v. US 8
designated the trustees of the CRUTs, and the heirs and
CWC were named as the income beneficiaries. On the
same day, Richard, Robert, Marilyn, and CWC trans-
ferred their respective interests in RRMC Group, which
held the Constellation stock, to the CRUTs. At that time,
appraisals were obtained valuing each partnership inter-
est at $5,198,897. Based on these appraisals, each of the
four transferors claimed a $519,935 charitable contribu-
tion deduction with respect to the remainder interests
purportedly transferred.
On October 1, 2001, RRMC Group sold the Constella-
tion stock for approximately $75 million. The government
claims that the actual basis of the stock was approxi-
mately $9 million and that RRMC Group should have
realized a $66 million gain. As the government further
claims, however, RRMC Group claimed a $20 million loss
because the heirs inflated the basis through the Son-of-
BOSS transaction.
On January 28, 2002, the Sands Supporting Founda-
tion was designated as the charitable beneficiary of the
CRUTs. On February 22, 2002, that charity designation
was revoked, and the Educational and Health Support
Fund, an entity created by Robert and Richard on the
same day, was named as the charitable beneficiary.
Updated appraisals valued each CRUT’s partnership
interest at $5,482,334. Based upon the updated apprais-
als, on February 27, 2002, Richard, Robert, Marilyn, and
CWC purchased from the Educational and Health Sup-
port Fund the remainder interests in the CRUTs for
$550,000 each. This had the effect of terminating each
CRUT (because the income and remainder interests were
merged), and the partnership interests in RRMC Group,
which held the $75 million from the sale of the Constella-
tion stock, were distributed back to the heirs and CWC.
9 ALPHA I v. US
The heirs and CWC claimed that these distributions were
tax-free distributions of the CRUTs’ assets.
3
In the second Son-of-BOSS transaction, on December
3, 2001, the heirs and CWC formed Alpha I, L.P. (“Al-
pha”), a limited partnership in which they held a cumula-
tive 99.9% interest. The remaining 0.1% interest was
held by RRMC Corp. as general partner. By agreement
dated December 10, 2001, Alpha and Gloria Robinson,
who was involved in the first Son-of-BOSS transaction,
formed Beta Partners L.L.C. (“Beta”), with Alpha holding
a 99.0043% interest and Robinson holding the remaining
0.9957% interest. On December 12, 2001, the heirs and
CWC collectively transferred approximately $1.1 million
to their respective Paine Webber accounts. On the same
day, the heirs and CWC sold short approximately $44
million of U.S. Treasury Notes. On December 13, 2001,
the heirs and CWC contributed the short-sale proceeds,
the short-sale obligations, and $1.24 million to Alpha.
Shortly thereafter, RRMC Corp. contributed $2,582 to
Alpha.
On December 17, 2001, Alpha purchased 67,525
shares of Corning, Inc., common stock for $595,570.50 and
33,400 shares of Yahoo, Inc., common stock for $599,530.
On December 20, 2001, Alpha contributed its assets,
including the short-sale proceeds, the short-sale obliga-
tions, and the Corning and Yahoo stock, to Beta. On
December 27, 2001, Beta closed out the short-sale posi-
tion, realizing a net gain of $90,018. On the same date,
Alpha purchased Robinson’s 0.9957% interest in Beta,
causing the termination of Beta. As a result of these
transactions, Alpha claimed it had a basis in the Corning
stock of $23,230,361 and a basis in the Yahoo stock of
$22,262,094.
ALPHA I v. US 10
Alpha distributed most of the Corning and Yahoo
stock to the heirs and CWC, who, in February 2002,
transferred the stock to two other family partnerships:
Mickey Management L.P. and M,L,R & R. Each time the
stock was transferred, the transferee claimed a carryover
basis in the stock equal to Alpha’s allegedly inflated basis.
In December 2002, Alpha, Mickey Management, and
M,L,R & R each sold a portion of its Corning and Yahoo
stock, claiming losses of approximately $9 million total
due to the allegedly inflated basis of the stock.
B
The IRS audited the partnerships’ 2001 and 2002
partnership returns. In 2005 and 2006, the agency issued
FPAAs denying the losses from the transactions. With
respect to the first Son-of-BOSS transaction, the IRS
adjusted the basis of the Constellation stock and deter-
mined that the sale of the stock resulted in capital gains
rather than capital losses. The IRS listed several alterna-
tive theories supporting the adjustments, including I.R.C.
§ 752 and related regulations, the sham-partnership
doctrine, and the economic-substance doctrine. The IRS
issued similar FPAAs to the partnerships involved in the
second Son-of-BOSS transaction, adjusting the basis of
the Corning and Yahoo stock and eliminating the loss
claimed on the sales of that stock. The IRS also asserted
in each FPAA a forty-percent penalty for gross valuation
misstatement, or, alternatively, a twenty-percent penalty
for substantial valuation misstatement; a twenty-percent
penalty for substantial understatement of tax; and a
twenty-percent penalty for negligence.
In a section titled “I.R.C. § 465 At Risk Rules,” the
IRS further stated in each FPAA that “[i]t is determined
that none of the transactions of the Partnership increases
the amount considered at-risk for an activity under I.R.C.
11 ALPHA I v. US
§ 465(b)(1),” such that “the amount for which a partner is
considered to be at risk for an activity is not increased by
any transactions with the Partnership.”
Finally, in the FPAAs issued to the partnerships in-
volved in the first Son-of-BOSS/CRUTs transaction, the
IRS also asserted that the transfers of the RRMC Group
partnership interests to the CRUTs should be disregarded
as shams. Consequently, the IRS asserted, the proceeds
from RRMC Group’s sale of the Constellation stock should
not flow through to the CRUTs, but instead should flow
through to the heirs and CWC as partners in RRMC
Group.
C
In their complaints, the partnerships challenged each
of the determinations contained in the FPAAs. The
partnerships engaged in the first Son-of-BOSS/CRUTs
transaction filed a motion to dismiss the determination
that the transfers to the CRUTs were shams. They
argued that the identity of RRMC Group’s partners is not
a “partnership item,” such that the court lacked jurisdic-
tion under I.R.C. § 6226(f) to decide whether the transfers
should be disregarded. The Court of Federal Claims
granted the motion to dismiss, holding that the identity of
RRMC Group’s partners is not a partnership item and
that, as a result, it did not possess jurisdiction to consider
the issue.
The partnerships involved in both Son-of-BOSS
transactions challenged the forty-percent gross valuation
misstatement penalty. With respect to the FPAAs’ I.R.C.
§ 465 determination, the partnerships asserted that the
at-risk amounts were properly computed, and they argued
that, even if incorrectly computed, the “at-risk” rules of
I.R.C. § 465 could be used only to disallow the claimed
ALPHA I v. US 12
losses and would not require a partnership or its partners
to recognize any gain.
The partnerships, however, later filed a motion to
amend their complaints in which they conceded the
capital gain and loss adjustments on the purported basis
of I.R.C. § 465. They stated that “[p]laintiffs have deter-
mined that it would be more economical to narrow the
issues before the Court by conceding the defendant's
capital gains adjustments on one of the several alterna-
tive grounds asserted by defendants. Plaintiffs believe
that such concession also eliminates the possibility of
incurring a 40 percent penalty.” They conceded that
“none of the transactions of the partnerships increases the
amount considered at-risk for an activity under I.R.C.
§ 465(b)(1) and that the at-risk rules would disallow
losses and require the partnerships and their partners to
recognize gain on the transactions as described in the
adjustments set forth in [the FPAAs].” The partnerships
further stated that “[p]laintiffs do not concede defendant’s
capital gains and losses adjustments on any other ground,
nor do they concede any other determination set forth in
the FPAAs issued to them. However, plaintiffs’ conces-
sion of the § 465(b)(1) issue and defendant’s capital gain
adjustments eliminates the need for the Court to decide
whether defendant’s alternative grounds for such capital
gain adjustments . . . support the adjustments.” The
Court of Federal Claims granted the partnerships’ motion
to amend their complaints.
The partnerships then moved for summary judgment
on the valuation misstatement penalty. The Court of
Federal Claims granted the motion, holding that the
partnerships’ concession of the capital gain and loss
adjustments on the basis of I.R.C. § 465 obviated the need
to make any valuation determinations and, therefore,
rendered the valuation misstatement penalty inapplica-
13 ALPHA I v. US
ble. The government filed a motion for reconsideration,
which the court denied, concluding that the government
failed to identify error in the court’s summary judgment
opinion.
The parties also filed cross-motions for summary
judgment on the government’s remaining penalty claims:
the twenty-percent negligence penalty and the twenty-
percent substantial-understatement-of-tax penalty. The
Court of Federal Claims held that both penalties applied.
The court found that the partnerships had engaged in a
tax shelter based on “the transfer of short sale proceeds to
RRMC Group without the transfer of the related contin-
gent obligations . . . .” 2
On September 16, 2010, the Court of Federal Claims
entered final judgment consistent with its various opin-
ions.
II
The Court of Federal Claims erred when it dismissed
the IRS’s determination that the transfers of the partners’
interests in RRMC Group to the CRUTs were shams. The
court’s ruling was on a question of law, which we review
de novo. Keener v. United States, 551 F.3d 1358, 1361
(Fed. Cir. 2009) (“The Court of Federal Claims’ decision to
grant [a] . . . motion to dismiss for lack of jurisdiction is a
matter of law, which this court reviews de novo.”).
In determining whether the transfers were shams, the
Court of Federal Claims was asked to determine the
2 The taxpayers dispute the trial court’s finding
that they engaged in a tax shelter. Cross Appellants’ Br.
59-61. Because they dispute that finding in the cross-
appeal that we dismiss as premature, we express no
opinion on the tax shelter finding. For that reason, we
refer to the taxpayers’ activities as “transactions” rather
than “tax shelters.”
ALPHA I v. US 14
identity of the true partners of RRMC Group. The Court
of Federal Claims erred in finding that it lacked jurisdic-
tion to determine partner identity because it incorrectly
found that the determination of the identity of the part-
ners in RRMC Group would not affect the allocation of the
partnership items among the partners. On the facts of
this case, partner identity could, in fact, affect allocation
of the partnership items. As such, partner identity is
properly resolved at the partnership level in this proceed-
ing.
A
Whether the Court of Federal Claims may exercise ju-
risdiction to determine the identities of the partners in
RRMC Group turns on whether partner identity must be
determined at the partnership or partner level. The
statutory framework governing partnership- and partner-
level determinations provides the foundation on which
that issue must be resolved.
Partnerships are pass-through entities, meaning they
do not pay federal income tax. Rather, all income, deduc-
tions, and credits are allocated among the individual
partners. I.R.C. §§ 701, 702; Keener, 551 F.3d at 1361.
While partnerships are not taxpayers, they are required
to file annual information returns reporting the partners’
distributive shares of income, gain, deductions, or credits.
I.R.C. § 6031. The individual partners then report their
distributive shares on their federal income tax returns.
I.R.C. §§ 701-04.
In the past, the differing tax treatment of partner-
ships and their partners resulted in duplicative audits
and litigation, and, often, inconsistent treatment of part-
ners in the same partnership. See Anisa Afshar, The
Statute of Limitations for the TEFRA Partnership Pro-
ceedings: The Interplay Between Section 6229 and Section
15 ALPHA I v. US
6501, 64 Tax Law. 701 (2011). In 1982, Congress enacted
legislation with the goal of establishing coordinated
procedures for determining the proper treatment of “part-
nership items” at the partnership level in a single, unified
audit and judicial proceeding. See id.; Tax Equity and
Fiscal Responsibility Act of 1982 (“TEFRA”), Pub. L. No.
97-248, § 402 et seq., 96 Stat. 648; and Keener, 551 F.3d at
1361. These procedures are commonly referred to as
“TEFRA” procedures. “Whether a tax item is a ‘partner-
ship item’ governs how the TEFRA procedures apply.”
Keener, 551 F. 3d at 1361.
When the IRS disagrees with a partnership’s report-
ing of any partnership item, it must issue an FPAA before
making any assessments attributable to that item against
the partners. I.R.C. §§ 6223(a)(2), (d)(2), 6225(a). The
tax-matters partner has ninety days from the date of the
FPAA to file a petition contesting the adjustments in the
FPAA in the Tax Court, a federal district court, or the
Court of Federal Claims. I.R.C. § 6226(a). If no such
petition is filed, any other partner entitled to notice of
partnership proceedings may file a petition within the
following sixty days. I.R.C. § 6226(b)(1).
If a petition contesting the FPAA is filed, the review-
ing court’s jurisdiction at the partnership-level proceeding
is limited to certain categories. I.R.C. § 6226(f). In this
action, the parties dispute whether the identity of RRMC
Group’s partners may be categorized as a reviewable
item.
B
I.R.C. § 6226(f) specifies the categories that fall within
a reviewing court’s jurisdiction as follows:
A court with which a petition is filed in accor-
dance with this section shall have jurisdiction to
ALPHA I v. US 16
determine all partnership items of the partnership
for the partnership taxable year to which the notice
of final partnership administrative adjustment re-
lates, the proper allocation of such items among
the partners, and the applicability of any penalty,
addition to tax, or additional amount which re-
lates to an adjustment to a partnership item.
I.R.C. § 6226(f) (emphasis added). As relevant to this
action, the Court of Federal Claims may exercise jurisdic-
tion to determine the identity of RRMC Group’s partners
if partnership identity is a partnership item for the rele-
vant partnership tax year, and may then determine the
proper allocation of such items among the partners. Id.
The statute defines a partnership item, in relevant part,
as follows:
[A]ny item required to be taken into account for
the partnership’s taxable year under any provi-
sion of subtitle A [of the tax code] 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.
I.R.C. § 6231(a)(3). The statutory definition has two
prongs: (1) a requirement that the item is one which must
be “taken into account for the partnership’s taxable year
under any provision of subtitle A”; and (2) a requirement
that the Secretary has concluded that the item is “more
appropriately determined at the partnership level than at
the partner level.” Id. We must look to IRS implement-
ing regulations for guidance regarding both prongs of this
inquiry. This is so for two reasons: one governed by our
case law and the other governed by the statutory text.
First, we concluded in Keener that the reference in
Section 6231(a)(3) to Subtitle A of the tax code is ambigu-
17 ALPHA I v. US
ous, requiring that we give deference to any reasonable
agency interpretation of that phrase. 551 F.3d at 1363
(citing Chevron U.S.A., Inc. v. Natural Res. Def. Council,
Inc., 467 U.S. 837, 843 (1984)). 3 Next, the statute ex-
pressly requires that a “partnership item” be designated
by the Secretary via its regulatory authority as more
appropriately determined at the partnership level than at
the partner level. I.R.C. § 6231(a)(3).
Thus, because the statute expressly refers to the regu-
lations with respect to the second prong, and our prece-
dent requires Chevron deference to those regulations
governing the first, we look to the regulations as the
primary source for the definition of a “partnership item.”
Treasury Regulation § 301.6231(a)(3)-1(a) implements
the statutory definition of “partnership item.” Subsection
(a) of that provision defines a partnership item, in rele-
vant part, as “[t]he partnership aggregate and each
3 In Keener, the parties debated whether the refer-
ence to “Subtitle A” in Section 6231(a)(3) modifies “any
item required to be taken into account”—which would
restrict the meaning of “partnership item” to only those
items appearing in Subtitle A—or modifies “the partner-
ship’s taxable year”—thereby encompassing anything that
affects, or is “required to be taken into account for,” the
partnership’s taxable year, including items outside Subti-
tle A. 551 F.3d at 1363. Because courts had been incon-
sistent in their construction of the phrase, we concluded
that the phrase was ambiguous, requiring deference to
agency regulations defining the term “partnership item,”
when those regulations are reasonable. Id. While we did
not undertake an independent grammatical analysis of
the statutory text in Keener, the conclusion that we must
give Chevron deference to regulations interpreting the
interplay between the term “partnership item” and the
reference to Subtitle A of the tax code in Section
6231(a)(3) is unmistakable and, thus, controlling.
ALPHA I v. US 18
partner’s share of . . . [i]tems of income, gain, loss, deduc-
tion, or credit of the partnership[.]” 26 C.F.R.
§ 301.6231(a)(3)-1(a), (a)(1), (a)(1)(i). 4 The U.S. Tax Court
determines whether partner identity would affect the
“partnership aggregate” or “each partner’s share of . . .
income, gain, loss, deductions, or credits of the partner-
ship” by examining the particular facts of the case before
it. Grigoraci v. Comm’r, 84 T.C.M. (CCH) 186 (2002),
2002 Tax Ct. Memo LEXIS 207, at *17-18. If partner
identity would affect the distributive shares reported to
the partners, it is a partnership item for purposes of that
case. Id. at *13. If, under the particular facts of the case,
partner identity would affect the distributive shares of the
partnership, the item must be determined at the partner-
ship level. See, e.g., Blonien v. Comm’r, 118 T.C. 541(2002), 2002 U.S. Tax Ct. LEXIS 33, at *20 n.6.
The statutory requirement that a partnership file an
information return establishes a close relationship be-
tween allocation and partner identity. See I.R.C.
§ 6031(a). That requirement mandates that a partner-
ship’s information return identify “the individuals who
would be entitled to share in the taxable income if dis-
tributed and the amount of the distributive share of each
individual.” Id. Here, the parties dispute which partners
4 In Keener, the court did not specifically address
whether Treasury Regulation § 301.6231(a)(3)-1(a) is
entitled to Chevron deference. The court held only that
Treasury Regulation § 301.6231(a)(3)-1(b) was reasonable,
and, thus, was entitled to deference. The parties here do
not dispute whether Treasury Regulation
§ 301.6231(a)(3)-1(a) is entitled to Chevron deference,
however. All parties, in fact, rely on Keener and urge
deference to governing regulations. For purposes of this
appeal, therefore, we assume, but do not decide, that
Treasury Regulation § 301.6231(a)(3)-1(a) is entitled to
Chevron deference.
19 ALPHA I v. US
are entitled to share in the taxable income and the dis-
tributive share of each party. The Court of Federal
Claims cannot determine the parties who would be enti-
tled to share in the taxable income and the distributive
share of each party unless it properly identifies the true
partners of the partnership.
One regional circuit that has considered this issue
and the Tax Court have come to the same conclusion. In
Katz v. Commissioner, the Tenth Circuit recognized the
relationship between allocation and partner identity. 335
F.3d 1121, 1128-29 (10th Cir. 2003). There, the taxpayer
declared bankruptcy and attempted to allocate his share
of losses incurred by partnerships in which he was a
partner between his bankruptcy estate and himself. Id.
at 1123. The IRS determined that the losses should have
been allocated entirely to the bankruptcy estate and
attempted to challenge the allocation in a partner-level
deficiency proceeding. Id. at 1124-25. The Tenth Circuit
rejected the partner-level challenge. The court observed
that the partnership was required to specify a partner’s
income and losses on its partnership return. Id. at 1128-
29. That task could not be accomplished unless allocation
were conducted at the partnership level, the court ob-
served. “What is important is that the debtor was a
partner during part of the partnership year, so the part-
nership returns must set forth the debtor’s share of in-
come, loss, etc.” Id. at 1128.
The Tax Court, similarly, has found that partner
identity can be necessary to properly allocate the partner-
ship items. In Blonien, the Tax Court found that partner
identity was more appropriately determined at the part-
nership level because it could affect allocation of partner-
ship items among the partners in that action. 2002 U.S.
Tax Ct. LEXIS 33, at *20 n.6. Blonien was a partner-level
proceeding. The government argued that the court lacked
ALPHA I v. US 20
jurisdiction to revisit a determination made in a prior,
partnership-level proceeding that the taxpayer, Blonien,
was a partner in the partnership. Id. at *18. The Tax
Court agreed with the government because, if Blonien
successfully argued that he was not a partner, “the share
of [the partnership’s] COD income wrongly allocated to
Mr. Blonien would have to be reallocated among the other
partners.” Id. at *20 n.6. The Tax Court recognized that
the determination of partner identity could be a partner-
level determination “where resolution of the issue would
not affect the allocation of partnership items to the other
partners,” but found that resolution of that issue in Blo-
nien’s case would affect allocation. Id.
This case is similar to Blonien and Katz. Here, it is
possible that the distributive shares reported to the
partners of RRMC Group would change if one or more of
the CRUTs were disregarded. During the 2001 tax year,
four heirs, four CRUTs, and RRMC Management Corp.
were listed as the partners of record on RRMC Group’s
partnership return. If the Court of Federal Claims were
to determine that some of the heirs’ transfers to the
CRUTs were shams, each remaining partner’s share of
the partnership items could change. If the court were to
disregard one, two, or three of the CRUTs, for example,
the distributive shares would be different than if the court
were to disregard all of the CRUTs. In such a scenario,
the court would be required to decide who should report
the disregarded CRUT’s share. Thus, while the validity of
the CRUTs would not impact the partnership’s aggregate
income, it could affect the remaining parties’ individual
shares of that income.
Even in cases in which the Tax Court determined that
partner identity was not a partnership-level determina-
tion, it recognized that the inquiry turns on the facts of
the particular case and the effect that partner identity
21 ALPHA I v. US
would have on the distributive shares. In Grigoraci, the
IRS asserted in its FPAAs that certain corporate partners
were shams and sought to reallocate shares to certain
individuals. 2002 Tax Ct. Memo LEXIS 207, at *3-4. The
taxpayers challenged the FPAAs in a partnership-level
proceeding in the Tax Court. Id. at *1-4. The government
moved to dismiss on the ground that the identity of the
partners was a partner-level issue over which the Tax
Court lacked jurisdiction in the partnership-level proceed-
ing. Id. at *2-3. The Tax Court began its analysis by
stating that “the hallmark of a partnership item is that it
affects the distributive shares reported to the other part-
ners.” Id. at *13. To that end, the Tax Court inquired
whether identifying individuals rather than corporations
as the true partners would affect the distributive shares.
Id. at *15.
The Tax Court noted that no dispute existed concern-
ing the aggregate income, gain, loss, deductions, and
credits of the partnership. Id. at *16. It further noted
that, even if the income were reallocated to the individual
partners, “there [would be] no dispute about the amount
of the allocations made to the partners . . . .” Id. at *16-
17. Because the allocations would have no effect on
“either the partnership’s aggregate or each partner’s
share of income, gain, loss, deductions, or credits of the
partnership,” the court concluded that partnership iden-
tity was not a partnership item on the facts of that case.
Id. at *18. While the Tax Court found that the partner
identification question at issue before it was a partner-
level determination, the court made clear that it made
that determination based on the particular facts of that
case: “Under the circumstances of this case, we hold that a
determination that the partners of record were not the
true and actual partners is not a ‘partnership item . . . .’”
Id. at *21 (emphasis added).
ALPHA I v. US 22
The facts of this case are distinct from those in
Grigoraci. RRMC Group was required to report its gain
or loss from the sale of the Constellation stock on its
partnership return. RRMC Group also was required to
assign that gain or loss to its partners. The IRS’s FPAAs
challenged both the losses claimed by RRMC Group and
its assignment of certain of those losses to the CRUTs. As
discussed above, whether those losses were properly
assigned to the CRUTs could affect the distributive shares
reported to the remaining partners. This is an exercise
that must be conducted at the partnership level.
The Court of Federal Claims relied on Grigoraci and
another Tax Court case, Hang v. Commissioner, 95 T.C.
74 (1990), to conclude that RRMC Group’s partners’
identities cannot be determined at the partnership level.
Specifically, relying on Grigoraci, the Court of Federal
Claims concluded that identification of the partners in
this case would not affect the distributive shares. The
court stated that, “[w]here ‘[t]here is . . . no dispute about
the amount of the allocations made to the partners[,]’ . . .
as is the case before the court[,] . . . ‘[a]n item with ‘no
effect on either the partnership’s aggregate
or each partner’s share of income, gain, loss, deductions,
or credits of the partnership’ is not a partnership item.’”
Alpha I, L.P. v. United States, No. 06-cv-407 (Fed. Cl. Oct.
9, 2008) (opinion and order at 19) (quoting Grigoraci, 2002
Tax Ct. Memo LEXIS 207, at *17-18, and Russian Recov-
ery Fund Ltd. v. United States, 81 Fed. Cl. 793,
800 (2008)). While the trial court was correct to rely on
the general rule set forth in Grigoraci, for the reasons
noted above, its application of the facts at issue here to
that rule was erroneous.
The Court of Federal Claims’s reliance on Hang also
is misplaced. In Hang, the Tax Court held that the iden-
tity of shareholders in an S corporation was more appro-
23 ALPHA I v. US
priately determined at the shareholder level, but based
that conclusion on somewhat different reasoning than it
employed in Grigoraci. In Hang, the IRS attempted to
reallocate an S corporation’s income from the two owners
of record, who were minor children, to the children’s
father, who was not an owner of record. 95 T.C. at 75.
The statute and regulations defining “S corporation
items” in Hang are analogous to the TEFRA provisions at
issue here. See id. at 78. Like the implementing regula-
tion defining a partnership item, the regulation at issue
in Hang defined a “Subchapter S” item, in relevant part,
as “[t]he S corporation aggregate and each shareholder’s
share of, and any factor necessary to determine . . . items
of income, gain, loss, deduction, or credit of the corpora-
tion.” Id. at 79 (quoting 26 C.F.R. § 301.6245-1T).
Because the father was not a shareholder of record,
the Tax Court found that the IRS’s proposed reallocation
could not expressly fall within the scope of “the S corpora-
tion aggregate,” “each shareholder’s share of,” or “any
factor necessary to determine” the “income, gain, loss,
deduction, or credit of the corporation.” Id. at 80. While
the government argued that the Tax Court should find
that the regulation nevertheless encompassed the pro-
posed reallocation because the father was allegedly the
beneficial owner of the corporation’s stock and could
therefore qualify as a shareholder for purposes of the
regulation, the Tax Court declined to adopt that argu-
ment. Id. The court found that insufficient information
existed at the corporate level to determine beneficial
ownership: “[a]s a practical matter, there is no way for a
corporation to determine who the beneficial owners of its
stock are because the information necessary to make the
determination would not be available at the corporate
level where the beneficial owner of stock is not a share-
holder of record.” Id.
ALPHA I v. US 24
Here, the Court of Federal Claims equated the rela-
tionship of the heirs to the CRUTs to that of the sons to
the father in Hang. It concluded that “the [RRMC] Group
partnership is not in a position to go behind the transac-
tions between a partner and its successor of record. Both
are questions of succession to interests that appear to the
court to require determination at the individual taxpayer
level.” That analysis was incorrect, however. In Hang,
the scenario expressly fell outside the scope of the regula-
tory definition of an S corporation item because the father
was not a shareholder of record. The Tax Court was
required, consequently, to address the IRS’s alternative
theory of beneficial ownership by inquiring whether all
information was available at the partnership level to
determine whether the father was the beneficial share-
holder. Here, however, the scenario expressly falls within
the regulation’s definition of a partnership item because
all parties who could be identified as true partners—the
heirs, the CRUTs, and RRMC Corp.—are listed as part-
ners of record on the partnership’s 2001 information
return, and the determination of the true partners in the
partnership could affect the distributive shares attributed
to one or more of those named partners. 5 The fact that
the distributive shares could be affected by the determi-
nation of the partners’ identity is sufficient to sweep the
5 The taxpayers argue that the Sands ceased being
partners of record, and that the taxable year closed with
respect to them as a matter of law, when they transferred
their partnership interests to the CRUTs. See I.R.C.
§ 706(c)(2)(A) (providing that the taxable year of a part-
nership closes with respect to a partner whose entire
interest in the partnership terminates). That argument is
circular. The trial court has yet to determine whether the
Sands’ partnership interests terminated because it has
yet to determine whether their transfers to the CRUTs
were valid.
25 ALPHA I v. US
issue within the definition of a partnership item, because
the effect on the distributive shares is the “hallmark” of a
partnership item. Grigoraci, 2002 Tax Ct. Memo LEXIS
207, at *13.
Because partner identity in this case falls within the
regulation’s definition of a partnership item, the Court of
Federal Claims erred in adding an additional layer to the
analysis by requiring that “all information” necessary to
determine the identity of RRMC Group’s partners be
available at the commencement of the partnership-level
proceedings. The taxpayers defend the trial court’s
analysis, arguing that a court cannot make findings in a
partnership-level proceeding on the intentions of the
individual Sands family members and the trustees of
their charitable funds when they engaged in the CRUT
transactions. The taxpayers are wrong. The Court of
Federal Claims can allow discovery and hear testimony in
a partnership-level proceeding as long as the inquiry
regards a partnership-level item, which we hold it does on
these facts. Indeed, adjudicating this issue in a partner-
ship-level proceeding is consistent with the congressional
policy favoring that such issues be resolved in unified
judicial proceedings. See Afshar, 64 Tax Law. 701;
TEFRA, Pub. L. No. 97-248, § 402 et seq., 96 Stat. 648;
and Keener, 551 F.3d at 1361.
C
The taxpayers next argue that the allocation among
them will not change regardless of the identity of RRMC
Group’s true partners. They point out that the IRS pro-
posed disregarding the four CRUTs and reallocating the
items reported by RRMC Group among the four heirs in
the same proportion they were allocated among the
CRUTs. Each heir, in other words, would merely stand in
the shoes of its CRUT and be allocated the same share
ALPHA I v. US 26
that its CRUT would have been allocated. The taxpayers
claim that, because the partnership items would be allo-
cated in the same manner among either four CRUTs or
four heirs, the distributive shares would not change.
While the IRS did propose such an allocation, its pro-
posal does not deprive the Court of Federal Claims of
jurisdiction. The Court of Federal Claims exercises de
novo review of an FPAA and is not bound to follow the
IRS’s proposal. See Jade Trading, LLC v. United States,
80 Fed. Cl. 11, 43 (2007). The Court of Federal Claims
dismissed the portion of the FPAA at issue before it
considered the FPAA’s merits. At this stage, we cannot
conclude with certainty that the trial court would accept
the IRS’s proposal if this matter were to proceed to trial. 6
Tellingly, while the taxpayers argue that the alloca-
tion would not change under the IRS’s proposal, they
remain silent as to whether they agree with the IRS’s
proposal. They claim that “the government has not
pointed to anything that suggests . . . [RRMC] Group’s
partnership items would be allocated to anyone other
than the Sands family member who made the transfer to
the CRUT,” but they do not reveal whether they would
stipulate to such an allocation if the trial court were to
consider the merits of it. Thus, the record leaves open a
live issue concerning allocation, which the Court of Fed-
6 We disagree with the taxpayers that the govern-
ment waived this argument. The Court of Federal Claims
ruled on the issue of whether partner identity affects
allocation when it stated that “the question of whether
the partnership interests in [RRMC] Group were validly
transferred does not affect the allocation of income, gain,
or losses among other partners.” On appeal, the govern-
ment is merely developing its argument on that same
issue, namely, whether a live issue concerning allocation
exists.
27 ALPHA I v. US
eral Claims must address on the merits. The IRS’s pro-
posal, therefore, does not control the jurisdictional issue.
The taxpayers also caution that the conclusion we
reach here is tantamount to placing a continuing burden
on partnerships to ascertain the identity of their partners.
The taxpayers point out that many partnerships have
hundreds or even thousands of partners whose partner-
ship interests may be actively traded, and that Congress
never intended to burden partnerships with the responsi-
bility of ascertaining their “true” partners.
The taxpayers are correct—at least in the abstract. It
is true, for example, that, after partners exchange their
partnership interests, a partnership is not required to
note such an exchange on its return until it is notified of
the exchange. I.R.C. § 6050K(c). The taxpayers also
observe, and the government does not dispute, that the
IRS does not require partnerships to do anything more
than rely on their known partners of record to satisfy
their obligation to file a return identifying the individuals
who would be entitled to the partnership’s distributive
shares under I.R.C. § 6031(a). Thus, the taxpayers cor-
rectly observe that partnerships are entitled to take their
partners of record at face value.
The taxpayers are incorrect, however, in arguing that
our holding, which is limited to the particular facts of this
case, places a new and additional burden on all partner-
ships to ascertain the identity of their true partners.
Congress created TEFRA proceedings such as this one to
provide a vehicle for determining partner identity when
partner identity is challenged by the IRS; sometimes that
is appropriate at the partnership level and sometimes it is
appropriate at the partner level, depending upon the
circumstances. Partnerships do not bear the burden of
identifying their true partners in all filings; rather, the
ALPHA I v. US 28
IRS bears the burden of establishing that the partners are
other than those identified as known partners in a part-
nership’s tax filings. Where, as here, that challenge, if
successful, would directly impact the number of distribu-
tive shares attributable to other members of the partner-
ship, resolution of that question at the partnership level is
appropriate.
For the foregoing reasons, the identity of the partners
in RRMC Group is appropriately determined at the part-
nership level. 7
III
With respect to the forty-percent gross valuation mis-
statement penalty, the Court of Federal Claims erred
when it granted the taxpayers summary judgment on that
penalty. The Court of Federal Claims was wrong to
conclude that it was not obligated to determine whether
the taxpayers’ underpayments are attributable to a valua-
7 While the government also attempts to argue that
partner identity falls within the scope of Treasury Regu-
lation § 301.6231(a)(3)-1(b), we find that argument unper-
suasive. Treasury Regulation § 301.6231(a)(3)-1(b)
provides, in relevant part, that a “‘partnership item’
includes . . . the legal and factual determinations that
underlie the determination of the amount, timing, and
characterization of items of income, credit, gain, loss,
deduction, etc.” 26 C.F.R. § 301.6231(a)(3)-1(b). The
government proffers arguments as to why partnership
identity, in the abstract, underlies the determination of
items such as the amount, timing, and characterization of
items of income, credit, gain, loss, deduction. Appellant’s
Br. 43-45. The government, however, fails to explain why
partner identity would be necessary to determine those
items on the facts of this particular case. As explained
above, whether a particular item qualifies as a partner-
ship item turns on the specific facts of the case. The
government’s abstract argument, therefore, is insufficient.
29 ALPHA I v. US
tion misstatement merely because the taxpayers conceded
the gain and loss adjustments in the FPAAs. The cases
on which the trial court relied for this conclusion misap-
ply the valuation misstatement penalty, and, thus, do not
properly characterize the law in this circuit. We review
the Court of Federal Claims’s ruling de novo. Merino v.
Comm’r, 196 F.3d 147, 155 n.12 (3d Cir. 1999) (“[T]he
question of whether the valuation overstatement statute
applies to a particular taxpayer’s situation is a question of
law that we subject to plenary review.” (citing Gainer v.
Comm’r, 893 F.2d 225, 226 (9th Cir. 1990))). Upon doing
so, we vacate that ruling and remand for further penalty
proceedings.
The tax code provides that a penalty “shall be added”
“to any portion of an underpayment of tax required to be
shown on a return . . . which is attributable to . . . [a]ny
substantial valuation misstatement.” I.R.C. § 6662(a) &
(b)(3). A penalty may apply for both a substantial valua-
tion misstatement and a gross valuation misstatement.
The substantial valuation misstatement penalty applies
when the value of any property or the adjusted basis of
any property is 200% or more of the amount the IRS
determines to be the correct amount; the gross valuation
misstatement penalty applies when the claimed value or
basis is 400% or more of the correct amount. I.R.C.
§ 6662(e)(1)(B)(i), (h)(2)(A)(ii)(I). Here, the IRS sought to
impose a forty-percent gross-valuation misstatement
penalty based on its determination that the partnerships
inflated the cost basis of the Constellation stock by more
than 900%, the cost basis of the Yahoo stock by more than
3,700%, and the cost basis of the Corning stock by more
than 3,900%.
The statute requires that any underpayment of tax on
which a valuation misstatement penalty is based be
“attributable to” the valuation misstatement. I.R.C.
ALPHA I v. US 30
§ 6662(b)(3). The taxpayers conceded the IRS’s capital
gain and loss adjustments in the FPAAs solely on the
ground of I.R.C. § 465. They then argued that the under-
payment of tax they conceded was not “attributable to” a
valuation misstatement because I.R.C. § 465 does not
address a valuation misstatement. That I.R.C. § 465 does
not address a valuation misstatement, however, does not
absolve the partnerships from liability for the penalty.
I.R.C. § 465 does not address the valuation of any
claimed gain or loss. It provides that an individual’s
deduction of certain losses must be limited to the amount
considered “at risk.” I.R.C. § 465(a)(1). The provision
does not disallow the existence of a loss; it limits the
deduction of that loss. See id. Because the deduction of a
loss is typically at issue only with respect to an individual
partner’s income tax return, the Tax Court has held that
any question concerning whether an taxpayer meets the
“at-risk” requirement of I.R.C. § 465 must be addressed in
a partner-level, rather than partnership-level, proceeding.
Hambrose Leasing 1984-5 LP v. Comm’r, 99 T.C. 298, 310
(1992) (“[T]he application of section 465 is not a determi-
nation ‘required to be taken into account for the partner-
ship’s taxable year.’” (quoting I.R.C. § 6231(a)(3))).
Thus, the partnerships’ alleged failure to report the
alleged gains in this action is conceptually distinct from
the issue presented in the context of I.R.C. § 465. First,
I.R.C. § 465 addresses the deduction of losses. The IRS,
however, did not take issue in the FPAAs with the
amount of loss deduction that the partnerships claimed.
Rather, the IRS took issue with the partnership’s failures
to report their gains. I.R.C. § 465 does not apply to gains.
See I.R.C. § 465(a)(1). Second, the “at-risk” provision of
I.R.C. § 465, is generally a partner-level item. Hambrose
Leasing, 99 T.C. at 310. The IRS, therefore, could not rely
on I.R.C. § 465, a provision that limits the deduction of a
31 ALPHA I v. US
loss in a partner-level proceeding, to penalize the partner-
ships for undervaluing gains in partnership-level proceed-
ing. For the same reason, the partnerships could not rely
on I.R.C. § 465 to concede the adjustments underlying the
penalty that the IRS sought. 8
The Court of Federal Claims appeared to acknowledge
that I.R.C. § 465 does not provide a valid basis for the
partnerships’ concession. Rather than confront this
reality, however, the trial court concluded it was not
required to address at all whether the partnerships relied
on a valid basis for the concession or to look behind that
concession to determine the real cause of the tax under-
payment. The trial court stated that it was not required
to “endorse the validity of the ground on which plaintiffs
made their concession,” as long as the “[p]laintiffs did not
concede the adjustments on grounds relating to valuation
that could cause the penalties to be applied.” Alpha I,
L.P. v. United States, No. 06-cv-407 (Fed. Cl. Nov. 25,
2008) (opinion at 19 n.6) (“Penalty Op.”). The trial court
missed the point, however. The taxpayers could not
revise the grounds upon which their underpayment of
taxes actually is attributable by choosing to concede that
underpayment on some other, invalid theory.
The Court of Federal Claims cited several cases to
support its decision to defer to the terms of the partner-
8 The IRS did cite I.R.C. § 465 in the FPAAs and
assert that the transactions did not increase the partners’
amounts at risk. While the Court of Federal Claims
placed substantive significance on the citation to I.R.C.
§ 465, remarking that “the § 465 adjustment was listed
right along with the defendant’s other theories for adjust-
ing plaintiffs’ basis and gain,” the IRS’s decision to cite
I.R.C. § 465 does not convert the section into one that
applies to loss deductions in the face of its plain language
to the contrary.
ALPHA I v. US 32
ships’ concession without further scrutiny, two of which it
found particularly persuasive: Todd v. Commissioner, 862
F.2d 540 (5th Cir. 1988), and Gainer v. Commissioner, 893
F.2d 225 (9th Cir. 1990). Not only do we find those cases
factually distinguishable from this one, we disagree with
the legal analysis employed in Todd and Gainer, finding it
flawed in material respects.
In Todd, the Fifth Circuit affirmed the Tax Court’s
ruling that penalties sought for valuation overstatements
did not apply because the taxpayers’ underpayments were
not attributable to the valuation overstatements. 862
F.2d at 543. There, the IRS disallowed certain deprecia-
tion deductions and credits because the property in ques-
tion had not been placed in service during the tax years in
issue. Id. The IRS separately imposed the penalty for
valuation overstatement. Id. The tax liability after
adjusting for the failure to place the property in service
did not differ from the tax liability after adjusting for the
valuation overstatements. Id. Any alleged valuation
overstatement, moreover, was irrelevant, because the
property that was the subject of the alleged overvaluation
misstatement was never placed in service during the
relevant tax year. Id. The Fifth Circuit, therefore, held
that the tax underpayment could not be attributed to the
valuation overstatement. Id.Gainer involved the same fact pattern as Todd. 893
F.2d at 226. Like the Fifth Circuit, the Ninth Circuit
declined to impose valuation overstatement penalties
where the IRS separately disallowed depreciation deduc-
tions and credits because the property at issue was not
placed in service during the relevant tax year. Id. at 228.
Because a valid, independent basis for disallowing the
deductions and credits existed, the court concluded that
33 ALPHA I v. US
“[plaintiff’s] overvaluation bec[ame] irrelevant to the
determination of any tax due.” Id. 9
The Court of Federal Claims concluded that this case
is analogous to those in the Todd and Gainer category
because, in its view, the “adjustments were made on
grounds unrelated to valuation . . . .” Penalty Op. at 15.
The trial court disregarded that a valid, independent
basis for the adjustments existed in those cases. The only
grounds on which the partnerships conceded the adjust-
ments in this case was the inapplicable I.R.C. § 465
adjustment. The trial court, accordingly, analogized this
case to cases in which a valid, independent basis existed
for the adjustment, even though no such basis existed
9 The other cases the trial court cited to support its
conclusion also involved fact patterns where an alterna-
tive basis for the IRS’s adjustments existed. See Derby v.
Comm’r, 95 T.C.M. (CCH) 1177, 2008 Tax Ct. Memo
LEXIS 46, at *90-91 (Tax Ct. Feb. 28, 2008) (“[B]ecause
there is a separate, independent ground for disallowing
[the] deductions, the overvaluation penalty may not be
imposed against the petitioners.”); McCrary v. Comm’r, 92
T.C. 827, 851-55 (1989) (holding that valuation over-
statement penalties did not apply where the taxpayers
“conceded that they were not entitled to [an] investment
tax credit because the agreement was a license and not a
lease,” which were grounds unrelated to valuation);
Rogers v. Comm’r, 60 T.C.M. (CCH) 1386, 1990 Tax Ct.
Memo LEXIS 695, at *47-49 (Tax Ct. Dec. 10, 1990)
(holding that overvaluation penalty did not apply where
the taxpayers conceded other grounds of adjustment in
the notice of deficiency, including that they lacked a profit
objective, that the property at issue was not qualifying
property, and that the property was not placed in service);
and Weiner v. United States, 389 F.3d 152, 153 & 162-63
(5th Cir. 2004) (declining to impose a valuation penalty
where the taxpayers conceded an FPAA listing several
independent grounds for the adjustments, including the
sham and economic substance doctrines).
ALPHA I v. US 34
here. The analogy is inapt. Thus, assuming we were
persuaded by the legal theory employed in Todd and
Gainer, we would find that theory inapplicable to the facts
before us.
Even if factually identical to this case, moreover, we
are not persuaded that Todd, Gainer, and their progeny
accurately apply the valuation misstatement penalty.
Indeed, the flaws in the analysis employed in Todd and
Gainer are so apparent that subsequent panels of the
circuit courts deciding those cases have questioned their
holdings.
In Todd, the Fifth Circuit looked to guidance from the
“Blue Book,” a post-enactment summary of the legislation
prepared by the staff of the Joint Committee on Taxation,
to determine whether the tax underpayment at issue was
attributable to a valuation misstatement. 862 F.2d at
542-43 (interpreting Staff of the Joint Committee on
Taxation, General Explanation of the Economic Recovery
Tax Act of 1981, at 333 (Comm. Print 1981) (“Blue
Book”)). The Blue Book proposed applying the following
analytical rule: “The portion of a tax underpayment that
is attributable to a valuation overstatement will be de-
termined after taking into account any other proper
adjustments to tax liability . . . .” Id. (quoting Blue Book
at 333). The Blue Book then proposed a formula for
applying that rule: The tax underpayment attributable to
the valuation overstatement equals the difference be-
tween (i) “‘actual tax liability (i.e., the tax liability that
results from a proper valuation and which takes into
account any other proper adjustments’”; and (ii) “‘actual
tax liability as reduced by taking into account the valua-
tion overstatement.’” Id. (quoting Blue Book at 333). The
Blue Book then provided an example of the application of
that rule: If an improper $20,000 deduction “was claimed
by the taxpayer as a result of a valuation misstatement,”
35 ALPHA I v. US
and “another deduction of $20,000 is disallowed totally for
reasons apart from the valuation overstatement,” then
the overvaluation penalty should apply only to the former
valuation-related deduction, not to the latter unrelated
deduction. Id. at 543 (quoting Blue Book at 333 n.2).
Thus, if the taxpayer’s filing reflected a taxable income of
$40,000, but the actual taxable income after adjusting for
each improper deduction was $80,000, then the tax un-
derpayment attributable to the valuation overstatement
is $80,000(r) minus $60,000(r), where r is the tax rate.
See id.The Blue Book, in sum, offers the unremarkable
proposition that, when the IRS disallows two different
deductions, but only one disallowance is based on a valua-
tion misstatement, the valuation misstatement penalty
should apply only to the deduction taken on the valuation
misstatement, not the other deduction, which is unrelated
to valuation misstatement.
The court in Todd mistakenly applied that simple rule
to a situation in which the same deduction is disallowed
based on both valuation misstatement- and non-
valuation-misstatement theories. There, the IRS disal-
lowed the claimed deduction because the property was not
placed in service during the relevant tax year and was
overvalued. Id. at 543. Because placing the property in
service was a prerequisite for taking the deduction, the
court believed that any alleged overvaluation of the same
property was irrelevant where the property never met the
prerequisite in the first instance. Id.The Blue Book does not describe or apply to the sce-
nario presented in Todd, however. The Fifth Circuit
recognized this flaw in a recent case in a concurring
opinion joined by the entire panel. See Bemont Invs., LLC
v. United States, No. 10-41132, slip op. at 20 (5th Cir.
ALPHA I v. US 36
April 26, 2012) (Prado, J., concurring, joined by Reavley
and Davis, JJ.) While the panel in Bemont Investments
was obligated to affirm a district court decision denying a
valuation misstatement penalty on the basis of Todd, it
wrote separately to express its disagreement with Todd’s
reasoning. As the concurrence correctly observed:
The Blue Book only covers the case of two unre-
lated deductions, one of which is caused by over-
valuation. Accordingly, the Blue Book does not
suggest that the overvaluation penalty should not
apply if overvaluation is one of two possible
grounds for denying the same deduction and the
ground explicitly chosen is not overvaluation.
Id. at 22. The court in Bemont Investments further ob-
served that every circuit court to have addressed the
issue, except the Ninth Circuit in Gainer, has rejected
Todd’s reasoning. Id. at 24-25 (citing Fid. Int’l Currency
Advisor A Fund, LLC v. United States, 661 F.3d 667, 673-
74 (1st Cir. 2011); Merino, 196 F.3d at 158; Zfass v.
Comm’r, 118 F.3d 184, 191 (4th Cir. 1997); Illes v.
Comm’r, 982 F.2d 163, 167 (6th Cir. 1992); Gilman v.
Comm’r, 933 F.2d 143, 151 (2d Cir. 1991); Massengill v.
Comm’r, 876 F.2d 616, 619-20 (8th Cir. 1989). Even the
Ninth Circuit has recognized that Gainer might have been
incorrectly decided. Keller v. Comm’r, 556 F.3d 1056,
1060-61 (9th Cir. 2009) (holding that the Ninth Circuit is
“constrained by” Gainer, which “rested in large part” on
Todd, but recognizing the “sensible method” of “many
other circuits”). We, too, part with the Todd and Gainer
panels.
We agree that an underpayment of tax may be attrib-
utable to a valuation misstatement for purposes of the
statute even when the IRS asserts both a valuation-
misstatement ground and a non-valuation-misstatement
37 ALPHA I v. US
ground for the same adjustment. When considering
whether such a “dual-cause” scenario falls within a stat-
ute’s reach, courts consider the context and policy under-
lying the statute. Fid. Int’l, 661 F.3d at 673 (citing W.
Page Keeton et al., Prosser and Keeton on Torts §§ 41-42
(5th ed. 1984)). There is little doubt that Congress in-
tended to prevent abuse of the tax code when it enacted
the valuation misstatement penalty. See, e.g., id. at 673
(“One might think that it would be perverse to allow the
taxpayer to avoid a penalty otherwise applicable to his
conduct on the ground that the taxpayer had also engaged
in additional violations that would support disallowance
of the claimed losses.”); Gilman, 933 F.2d at 152 (holding
that a transaction disregarded for lack of economic sub-
stance—a non-valuation-related ground—nevertheless
may be subject to a valuation misstatement penalty
because “[a] transaction that lacks economic substance
generally reflects an arrangement in which the basis of
the property was misvalued in the context of the transac-
tion” and that Congress “intended to penalize” such
transactions); Merino, 196 F.3d at 158-59 (agreeing with
Gilman); and Clearmeadow Invs. LLC v. United States, 87
Fed. Cl. 509, 534 (2009) (“[I]t is particularly dubious that
Congress intended to confer . . . largesse upon partici-
pants in tax shelters, whose intricate plans for tax avoid-
ance often run afoul of the economic substance doctrine.”).
An interpretation of the statute that allows imposition of
a valuation misstatement penalty even when other
grounds are asserted furthers the congressional policy of
deterring abusive tax avoidance practices.
The Court of Federal Claims erred both by adopting
the legal analysis applied in Todd and Gainer and by
expanding that flawed analysis even beyond the facts
presented there. On remand, the trial court must deter-
mine whether the taxpayers’ underpayments are attrib-
ALPHA I v. US 38
utable to a valuation misstatement. That determination
is a fact-driven one, focusing on the role that any valua-
tion misstatements played in attaining any improper tax
benefits. The trial court, for example, may examine the
features of the transactions at issue and consider whether
any valuation misstatements were “the vehicle for gener-
ating” inappropriate basis calculations or losses, Fid. Int’l,
661 F.3d at 673; whether a transaction “reflects” an
improper valuation, Gilman, 933 F.2d at 152; and
whether any improper valuation of the property in ques-
tion “is an essential component of the tax avoidance
scheme,” Merino, 196 F.3d at 158. This assessment must
be made despite, and independent of, the “concession” of
capital gain and loss adjustments that the partnerships
offered. We leave it to the trial court to make its deter-
mination in the first instance.
IV
Finally, the taxpayers appeal the Court of Federal
Claims’s grant of summary judgment to the government
on the twenty-percent penalty for negligence, substantial
understatement, and failure to act reasonably and in good
faith. The taxpayers’ appeal is premature. If the Court of
Federal Claims concludes on remand that the forty-
percent gross valuation misstatement penalty applies, the
taxpayers’ cross appeal of the twenty-percent penalty
potentially will be moot. Even if the trial court were to
find that both penalties apply, it would be permitted to
impose only the highest of those because the gross valua-
tion misstatement penalty and accuracy-related penalty
may not be stacked. See 26 C.F.R. § 1.6662-2(c).
If the Court of Federal Claims were to impose the
forty-percent penalty, and this court were to affirm that
penalty, arguments regarding the propriety of the twenty-
percent penalty would be moot. This court would not be
39 ALPHA I v. US
required to address the twenty-percent penalty to affirm
the trial court’s judgment in those circumstances. It is
possible that this court will still be required to address
the twenty-percent penalty—if, for example, this court
were to reverse the trial court’s imposition of the forty-
percent penalty, or the trial court were to decline to
impose the forty-percent penalty in the first instance and
the twenty-percent penalty were the only issue presented
on appeal. Unless and until such an appeal is filed,
however, we find it premature to address a penalty that
may not be determinative in resolving this case.
V
We reverse the Court of Federal Claims’s holding that
it lacked jurisdiction to determine the identity of RRMC
Group’s partners. We also vacate its holding that the
gross valuation penalty is inapplicable. Finally, we
dismiss the taxpayers’ appeal of the negligence penalty as
premature, without prejudice to reassertion of the argu-
ments relating to that appeal if and when appropriate.
This action is remanded to the trial court for further
proceedings consistent with this opinion.
REVERSED IN PART, DISMISSED IN PART, and
REMANDED