Amici Argue Lack of Notice to Tax Matters Partner Nullifies Executed Agreements

The amici are a group of taxpayers who are partners in numerous partnerships organized and managed by Walter J. Hoyt III. In this respect they are similarly situated to the appellants Richard and Marilyn Phillips. Not only are amici partners in a number of the Hoyt partnerships, they are also parties to the Hoyt partnership cases pending before the Tax Court.

As tax matters partner, Hoyt served as the partnerships' representative for purposes of the TEFRA audits and case processes. Hoyt, acting in his fiduciary capacity as tax matters partner, also executed statute of limitations extensions extending the time for the IRS to assess taxes against the Phillipses and others, including amici. In one of their own cases before the Tax Court, amici filed a motion for summary judgment, arguing that under reg. section 1.6231(c)-5T, Walter Hoyt as tax matters partner lacked the legal capacity to bind them to agreements with the IRS because he was under criminal investigation or otherwise suffered from a debilitating conflict of interest. The Tax Court denied the motion based on Phillips v. Commissioner, 114 T.C. 115 (2000) and the finding that genuine issues of fact exist. Amici state that the outcome of the Phillips case will affect their pending cases, even though they have proffered different legal arguments than the Phillips. (For a summary of that opinion, see Tax Notes, Mar. 6, 2000, p. 1391; for the full text, see Doc 2000-6047 (32 original pages) or 2000 TNT 41-18 .)

The amicus brief states that the amici now want to present a legal argument in the Phillips case that has not been made by either of the parties. Their argument is that under section 6231 the IRS is required to notify a tax matters partner under criminal investigation that his partnership items are to be treated as nonpartnership items. The brief maintains that reg. section 6231(c)-5-T mandates this notice to the tax matters partner be made within a reasonable period of time under due process considerations. The amicus brief further argues that the government's violation of this reg renders agreements entered into by Walter Hoyt a legal nullity and the IRS is estopped from binding partners to any such agreements.

II. ISSUE PRESENTED

III. STATEMENT OF FACTS NOT PRESENTED BY PETITIONERS

VI. [sic] ARGUMENT

A. The Unified Partnership Audit Rules Require that the TMP Be Capable of Operating as the Partnership's Fiduciary

B. Interpreting The Special Enforcement Regulation As Requiring Notice Converting Partnership Items of TMP Under Criminal Investigation is Consistent With Congressional Intent and Due Process

1. Temp. Treas. Reg. section 6231(c)-5-T Mandates Notice to

V. CONCLUSION

TABLE OF AUTHORITIES

[2] Like Appellants, Amici have been subject to and effected by the actions of Jay Hoyt as TMP in the processing of their partnership's tax cases before the I.R.S., including personal tax assessments against Amici that were predicated on agreements made by the TMP with the I.R.S. In the Tax Court proceedings Amici have raised similar legal issues to Appellants around the legal capacity of Jay Hoyt as TMP to bind Amici to agreements with the I.R.S. by reason of the operation of Treas. Reg. 1.6231(c)-5T when he is under criminal investigation or otherwise suffers from a debilitating conflict of interest. The Tax Court denied Amici's Motion for Summary Judgment based on Phillips v. Commissioner, 114 T.C. 115 (2000), as well as a finding that genuine issues of fact exist. As illustrated by the Tax Court's order, the outcome of this captioned case will effect Amici's pending cases, even though Amici have proffered different legal arguments than Appellants and respondent/Appellees ("respondent") in this case. Amici desire to present a legal argument that has not been made by either Appellants or respondent.

II. ISSUE PRESENTED

[3] Whether Internal Revenue Code section 6231(c) and Temporary Regulation 301.6231(c)-5T REQUIRES the Commissioner of Internal Revenue Service ("I.R.S.') to notify a Tax Matters Partner ("TMP") under criminal investigation that his partnership items are to be treated as nonpartnership items.

III. STATEMENT OF FACTS NOT PRESENTED BY PETITIONERS

[4] Amici generally concur with Appellants' summary of the facts as presented in their Tax Court case. However, Appellants did not directly address the Tax Court's holding that Hoyt did not have, as a matter of fact (not law), a conflict of interest. In their Motion for Summary Judgment, Amici have proffered additional evidence pertaining to Jay Hoyt's conflict of interest which may not have been offered, or available to offer, by Appellants in the captioned case. While Amici understand that this additional evidence is unavailable for this Court's consideration in the captioned case, Amici desire to make this court aware that other evidence to establish Jay Hoyt's debilitating conflicts of interest exists for the same partnerships at issue in this captioned case. This is important, because the Second Circuit has held that a TMP is rendered legally incapable of operating as the TMP if he has a conflict of interest, regardless of the operation of Temporary Regulation 301.6231(c)-5T. Transpac Drilling Venture 1982-12 v. Commissioner, 147 F.3d 221 (2d Cir. 1998). Amici continue to pursue this argument in their pending cases. Also important is the fact that the I.R.S. is now arguing that the Tax Court's finding in Phillips v. Commissioner (that no conflict of interest in fact existed in this case) binds Amici in their pending case. Since Amici's pending cases, which include additional evidence of Hoyt's conflict of interest, are appealable to this Court, Amici urge this Court, should it affirm the Tax Court that the criminal investigation of Jay Hoyt is insufficient factual evidence of a conflict of interest, to limit such affirmance to the evidence before it and not broadly rule that the criminal investigation of a TMP does not cause a conflict of interest.

IV. ARGUMENT

A. THE UNIFIED PARTNERSHIP AUDIT RULES REQUIRE THAT THE TMP BE CAPABLE OF OPERATING AS THE PARTNERSHIP'S FIDUCIARY.

[5] In 1982, Congress enacted the Partnership Audit Rules which provide that the tax treatment of partnership items of income, gain, loss, deduction and credit would be determined in a unified partnership proceeding, rather than separate proceedings for each partner thereof. ² To that end, the audit rules provide that each partnership will designate a general partner to serve as Tax Matters Partner ("TMP") through whom the I.R.S. will give notice and process of the partnership audit. 26 U.S.C. section 6231(a)(7). The I.R.S. issues a Final Partnership Administrative Adjustment ("FPAA") which sets forth its determination of proposed tax adjustments to the partnership and only the TMP (and certain other qualifying partners of which there were none in the instant case) may petition a court for review of the determinations. 26 U.S.C. sections 6223 and 6226. The treatment of the partnership items under the FPAA, settlement agreement or court decision is conclusive and binding on the partners, and not subject to substantive review. 26 U.S.C. sections 6224(c)(3), 6226(c), 6230(c)(4) and 6231(a)(6).

[6] The TMP has a pivotal role in assuring the partners are accorded their opportunity for substantive review of partnership items. The TMP's role was amplified by the Tax court in Computer Programs Lambda v. Commissioner, 89 T.C. 198 (1987), where the court advised:

The tax matters partner is the central figure of

[7] Thus, the TMP acts like a class-action representative and, as such, his interests must not be at odds with the partners he represents. Computer Programs Lambda, 90 T.C. 1124, 1127 (1988). Accordingly, Congress and the I.R.S. have identified certain circumstances where the actions personally affecting the TMP will interfere with the fair, effective and efficient audit of the partnerships.

B. INTERPRETING THE SPECIAL ENFORCEMENT REGULATION AS REQUIRING NOTICE CONVERTING PARTNERSHIP ITEMS OF TMP UNDER CRIMINAL INVESTIGATION IS CONSISTENT WITH CONGRESSIONAL INTENT AND DUE PROCESS.

1. TEMP. TREAS. REG. SECTION 6231(c)-5-T MANDATES NOTICE TO

(1) Applicability of subsection. This subsection

[9] The statute provides that with respect to criminal investigations (among other special enforcement areas), once the Secretary determines by regulation that criminal investigations of partners "will interfere" with the effective and efficient enforcement of TEFRA, then that partner's partnership items "shall be treated as nonpartnership items." 26 U.S.C. 6231(c)(2). This direction is mandatory. Many courts, including the Supreme Court, have found that the word "shall" is unmistakably mandatory. See, Hewitt v. Helms, 459 U.S. 460, 471-472 (1083); Johnson v. Burnley, 887 F.2d 471, 476 (4th Cir. 1989); Estate of La Sala v. Commissioner, 71 T.C. 752, 763-764 (1979).

[10] Under this statutory authority, the I.R.S. authored the following regulation:

The treatment of items as partnership items with respect to a

[11] The regulation unequivocally states that criminal investigations of a partner WILL interfere with the enforcement of the internal revenue laws. The regulation does not provide any exceptions to the stated rule. Having found that the criminal investigation "will interfere," and in following the statute at 26 U.S.C. section 6231(c)(2), the regulation states the partnership items SHALL be converted to nonpartnership items

[12] Rules of statutory construction apply to regulations. Idaho First National Bank, et al. v. Commissioner, 997 F.2d 1285 (9th Cir. 1993); "Whelan v. United States, 529 F.2d 1000 (Ct. Cl. 1976). The regulation must be interpreted in the same manner and consistent with the governing statute. Commissioner v. Netcher, 143 F.2d 484, 487 (7th Cir. 1944); cert. den., 323 U.S. 759 (1944) (court must not give a regulation as [sic] construction which would violate or contradict the language of the statute). Thus, the only permissible construction is one that effectuates the mandate that the partnership items be converted when it is concluded that treating them as partnership items interferes with the TEFRA audit.

[13] The Secretary had the discretion to determine if criminal investigations of partners would interfere with the TEFRA audit. But, once the Secretary made that determination (which it did in the regulation), the STATUTE REQUIRES that the partnership items "shall" be converted and does not allow any discretion whether or not the partner should receive notice converting his partnership items. It simply states that a criminal investigation will interfere and then describes the notification process. To interpret the regulation as providing some discretion whether to send the notice sets the statutory scheme and purpose on its head.

[14] The regulation and statute must be construed to give effect to the intent of Congress. Cramer v. Commissioner, 101 T.C. 225, 247 (1993), affd, 64 F.3d 1406 (9th Cir. 1995). The intent of Congress was to ensure a fair, efficient, and consistent administration of partnership actions in the event a TMP is nonexistent, terminated or unable to discharge his fiduciary duties. I.R.C. sections 6221-6231; Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. 97-248, Sec. 402 (at 96 Stat. 324, 628). Respondent "has a public duty to assure the fairness of the partnership's administrative proceedings." Seneca, Ltd. v. Commissioner, 92 T.C. 363 (1989). This public duty is necessarily abrogated if Temp. Treas. Reg. section 6231(c)-5T is interpreted to mean respondent has discretion to rectify a situation where they have concluded that it is impossible to achieve the fair and efficient administration of a partnership audit. Yet, this is precisely the result of the Tax Court's ruling.

[15] It would be clearly anomalous to construe the regulation as providing for a possibility that the respondent send no notice at all, since the respondent determined a condition exists that interferes with an effective and efficient TEFRA audit. This construction of the statute is impermissible, because it renders the mandatory instruction (if Secretary says it interferes, then it does) superfluous and inoperative. Duke v. University of Texas, 663 F.2d 522, 526 (5th Cir. 1981). Where the rights of individuals are affected, it is incumbent upon agencies to follow their own procedures.

2. THE REGULATION MANDATES NOTICE TO THE TMP BY REASON OF

[17] The Second Circuit recently held that the TMP's consent to extend the statute of limitations was void by reason of his conflict of interest, notwithstanding the operation of the special enforcement regulation at 301.6131(c)-5T. Transpac Drilling Venture 1982-12 v. Commissioner, 147 F.3d 221 (2nd Cir. 1998). The Transpac case arose from the Commissioner's TEFRA audit of numerous limited partnerships promoted by persons who also served as TMPs. Like the present case, the Commissioner was investigating the TMPs for criminal tax fraud while the civil audits of the partnerships were ongoing. When the statutes of limitations were about to expire on the civil audit, the Commissioner in Transpac sought extensions from individual partners. When the individuals refused, he obtained agreements from the TMPs to extend the statutes. The partners later argued that the FPAAs were untimely because the statute extensions executed by the TMPs were not valid.

[18] The Court in Transpac Drilling stated:

We cannot lightly impute to Congress the intent to vest sole

[19] The Commissioner asserted in Transpac that the TMP's responsibilities continue, in spite of the conflict of interest, until such time as the Commissioner decides to terminate his role by sending a notice to the partners of such termination under Temp. Treas. Reg. section 6231(c)-5T. Transpac Drilling, 147 F.3d at 225. However, as the Transpac court noted, it is anomalous and contrary to any law of due process for the Commissioner to place himself in the single and exclusive capacity to decide whether the investor partner is receiving due process through his fiduciary, particularly when the Commissioner stands in the position to gain from the TMP's conflict of interest. Transpac Drilling, 147 F.3d at 227-228, citing, Sriram v. Preferred Income Fund III Ltd. Partnership, 22 F.3d 498 (2d Cir. 1994).

[20] Accordingly, the statutory and regulatory authority do not permit the I.R.S. to place itself in such an untenable situation. The I.R.S. has no discretion to send the notice converting the TMP's partnership items.

3. NOTICE OF THE CONVERSION MUST BE ISSUED WITHIN A

[22] The more harmonious interpretation of the notice provisions of the regulation is that the I.R.S. has the nondiscretionary duty to notify the TMP that his partnership items have been converted within a reasonable period of time. What is a reasonable period of time? The I.R.S. suggests an automatic conversion upon the inception of a criminal investigation is unworkable and unreasonable. Amici do not agree, but that is not what Amici suggest nevertheless. Amici argue that the triggering event for sending notice can be upon the inception of the criminal investigation as argued by Appellants, or at the latest, from the time the I.R.S. notifies the partner he is under criminal investigation. ⁴ Amici suggest that respondent has 30 days from the triggering event to send notice converting the partner's partnership items.

[23] There is instruction from related statutes in TEFRA to ascertain a reasonable period of time for the notice converting partnership items. For instance, 26 U.S.C. section 6231(a)(7) presents an analogous situation where there is no effective TMP. There the I.R.S. has the power to appoint a TMP if necessary to ensure fair administration of case and notice of such appointment must be made within 30 days. A reasonable time requirement such as 30 days is implicit in order to give meaning to the statute and regulation read as a whole. Pearce v. Director, Office of Worker's Compensation Programs, et al., 647 F.2d 716 (7th Cir. 1981).

C. RESPONDENT'S VIOLATION OF TREAS. REG. SECTION 6231(c)-5T RENDERS AGREEMENTS BY JAY HOYT A LEGAL NULLITY.

[24] Where the rights of individuals are affected, it is incumbent upon agencies to follow their own procedures. Morton v. Ruiz, 415 U.S. 199, 235. (1974). The I.R.S.' failure to provide notice results in the agreement between the I.R.S. and the disabled TMP being a legal nullity. Anderson v. U.S., 72 AFTR 2d 5249 (N.D. Cal 1993) (action taken by a TMP whose partnership items were converted due to his personal bankruptcy is a legal nullity. [sic] Had Jay Hoyt's partnership items been converted as required, he would not have had the authority to enter into agreements on behalf of the partnerships. The respondent's violation of his regulation cannot serve to validate the actions of the TMP.

[25] In that regard, respondent is essentially estopped from binding the partners to Jay Hoyt's agreement, because the respondent knew Jay Hoyt was under criminal investigation and knew that their failure to send notice converting Jay Hoyt's partnership items would result in unwitting partners detrimental reliance on the misleading silence of the I.R.S.. Fredericks v. Commissioner, 126 F.3d 433 (3rd Cir. 1997). The I.R.S. knew facts, unknown to the partners, i.e., that their TMP was under criminal investigation. The I.R.S. intended that the partners rely on conduct of the I.R.S. (their silence) to confirm that their TMP had the legal capacity to execute agreements which were in their best interests. The partners relied to their detriment on the conduct. Accordingly, the respondent is estopped from gaining the benefit of agreements that could not have been gained but for respondent's violation of their own regulation. Time Oil Co. v. Commissioner, 258 F.2d 237 (9th Cir. 1958) (I.R.S. estopped from recouping tax advantages obtained by employer where default was in part triggered by Commissioner).

V. CONCLUSION

[26] When a TMP is under criminal investigation for violation of internal revenue laws, the statute and regulation require the I.R.S. to notify the TMP, within a reasonable period of time, that his partnership items have become nonpartnership items. The I.R.S. has no discretion to notify the TMP. The I.R.S.' failure to issue such notice renders any agreements executed by said TMP, after the reasonable time period for notice, a legal nullity and the I.R.S. is otherwise estopped from binding partners to such agreements.

Dated: October 30, 2000

[27] This is to certify that service of this motion has been made on counsel for the appellee and counsel for the appellant by mailing two (2) copies thereof on 31 October, 2000 in postage paid wrappers addressed as follows:

     JOHN A. DUDECK, Jr. (As Lead Counsel)

² See, H.R. Conf. Rept. No. 97-760, at 599; The Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA"), Pub. L. No. 97-248, 96 Stat. 324.

³ The I.R.S. similarly determined that the individual bankruptcy of a TMP, and the determination of a TMP's taxable income by the indirect proof method would interfere with the audit of a partnership. Temp. Treas. Regs. sections 301.6231(c)-6T and 301.6231(c)-7T.

⁴ Respondent does not dispute Jay Hoyt was notified he was under criminal investigation. That fact alone sets the In Re Miller case apart from the instant case, because the court therein had no evidence that Jay Hoyt knew about the criminal investigation and it was concerned that no party would know when to terminate the TMP status. 174 B.R. 791, 796, 74 A.F.T.R. 2d (RIA) 7320 (9th Cir. BAP 1994).