Ninth Circuit Holds Tax Court Erred in Allowing Opt Out Elections
DATED NOV. 14, 2014
JT USA, LP et al. v. Comm.
UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
Tax Ct. No. 5282-05
Appeal from a Decision of the
United States Tax Court
Argued and Submitted
June 2, 2014 -- Pasadena, California
Filed November 14, 2014
Before: Stephen S. Trott and
Consuelo M. Callahan, Circuit Judges, and
Mark W. Bennett, District Judge.*
Opinion by Judge Trott;
Dissent by Judge Callahan
The panel remanded an appeal by the Commissioner of Internal Revenue and held that the tax court erred in concluding that taxpayers could opt out of a partnership administrative proceeding under the Tax Equity and Fiscal Responsibility Act.
The panel held that the meaning of 26 U.S.C. § 6223(e)(3)(B) is clear and unambiguous that unless a partner elects to have all of his or her partnership items treated as nonpartnership items, the partner cannot elect out of proceeding under the Tax Equity and Fiscal Responsibility Act.
Dissenting, Judge Callahan wrote that TEFRA allows one partner to make one election and another partner to make a different election, and that a partner who has both direct and indirect interests should have the same option, at least where the IRS fails to timely notify the taxpayer that a bifurcated election is not allowed.
Joan I. Oppenheimer (argued), Tamara W. Ashford, Deputy Assistant Attorney General, Teresa E. McLaughlin, Tax Division Department of Justice, Washington, D.C., for Respondent-Appellant.
Richard V. Vermazen (argued), Law Office of Richard V. Vermazen, San Diego, California; Ernest S. Ryder and Lauren A. Rinsky, Ernest S. Ryder & Associates, Inc., APLC, San Diego, California, for Petitioners-Appellees.
TROTT, Circuit Judge:
We review de novo the Tax Court's reading and application of a TEFRA statute1 in a convoluted action arising from (1) a partnership's attempted use of a bogus tax shelter to offset capital gains, and (2) the Commissioner of Internal Revenue's subsequent denial of a $32.5 million "loss" claimed by the partnership to eliminate income tax liability on an asset sale resulting in a $28 million capital gain. The Tax Court ruled that a taxpayer holding both direct and indirect interests in a partnership may elect under 26 U.S.C. § 6223(e)(3)(B) not to be bound by the results of a partnership proceeding -- or partnership audit2 -- as to some, but not all, of those interests held during the relevant taxable year. In other words, that § 6223(e)(3)(B) permits taxpayers to opt out of the partnership proceeding with respect to their indirect interests but to leave in that proceeding their alleged remaining direct partnership interests. The Commissioner concedes that "[i]f taxpayers' elections to opt out, but only as indirect partners, are effective, then the assessment of deficiencies flowing from about $36.6 million in adjustments (or on the order of $10 million in tax) is time-barred." Accordingly, it appears that if the IRS prevails, the taxpayers will be liable for additional taxes. Thus, their claim that this case is now moot for the lack of a controversy is groundless.
We have jurisdiction over this timely appeal pursuant to 26 U.S.C. § 7482(a)(1), and we conclude that the Tax Court's reading of the disputed statute was incorrect.3 We also conclude that the IRS's sloppy administrative errors, including mailing the wrong form letter to the taxpayers, were not sufficient either to require a different outcome or to stop the IRS from pursuing this matter and its claims. Thus, because we hold that the taxpayers' disputed elections to opt out were invalid, we remand for further proceedings consistent with this opinion.
The facts and circumstances of this case are available in the Tax Court's decision, JT USA LP v. Comm'r, 131 T.C. 59 (2008), and in our previous opinion in Comm'r v. JT USA, LP, 630 F.3d 1167, 1169-70 (9th Cir. 2011). We attach the Tax Court's opinion as an appendix and repeat the facts only as necessary to illuminate our decision. For the best "explanation of the statutory scheme for dealing with partnership matters," we refer the reader to and incorporate Justice Scalia's opinion in United States v. Woods, 134 S. Ct. 557, 562-63 (2013).
26 U.S.C. § 6223(e)(3)(B)
26 U.S.C. § 6223(e)(3)(B), entitled "Notice to Partners of Proceedings," reads in pertinent part, "In any case to which this subsection applies, if paragraph (2) does not apply, the partner shall be a party to the proceedings unless such partner elects -- . . . (B) to have the partnership items of the partner for the partnership taxable year to which the proceeding relates treated as nonpartnership items."
In Carson Harbor Village, Ltd. v. Unical Corp., 270 F.3d 863, 878 (9th Cir. 2001) (quoting Caminetti v. United States, 242 U.S. 470, 485 (1993)), we said,
It is elementary that the meaning of a statute must, in the first instance, be sought in the language in which the act is framed, and if that is plain, . . . the sole function of the courts is to enforce it according to its terms.
Where the language is plain and admits of no more than one meaning, the duty of interpretation does not arise, and the rules which are to aid doubtful meanings need no discussion.
The statute at the core of this dispute, § 6223(e)(3)(B), provides that a "partner" may elect "to have the partnership items of the partner for the partnership year to which the administrative proceedings relate treated as nonpartnership items." The statute says "the partner," not an indirect partner or any other subset of the term "partner" as defined in 26 U.S.C. § 6231(a)(2). Moreover, § 6223(e)(3)(B) allows the partner to have "the partnership items"(plural) of that partner to be treated as nonpartnership items, not some of that partner's items to be treated as such.
The meaning of this language is clear and unambiguous, and it means -- as the Commissioner argues -- that unless a partner elects to have all of his or her partnership items treated as nonpartnership items, the partner cannot elect out of the TEFRA proceeding. See Exxon Mobil Corp. v. Comm'r, 484 F.3d 731, 734 (5th Cir. 2007) ("Use of the definitive article 'the' in the statute supports a conclusion that there is one overpayment rate for each overpayment situation."). In the vernacular, § 6223(e)(3)(B) is an all- or-nothing rule, and that ends our primary inquiry. The Tax Court's and the taxpayers' excursions into other sections of TEFRA are irrelevant. All the other TEFRA sections to which the taxpayers refer demonstrate that when Congress chose to differentiate between types of partners, they knew how to do so. As the Supreme Court remarked in Loughrin v. United States, ___ U.S. ___ , 134 S. Ct. 2384,2390 (2014), "We have often noted that when 'Congress includes particular language in one section of a statute but omits it in another' -- let alone the very next provision -- this Court 'presume[s]' that Congress intended a different meaning." Indeed, the absence in § 6223(e)(3)(B) of the language the taxpayers would like us to read into it "provides strong affirmative evidence" that Congress did not intend it to be construed or implemented as the taxpayers wish. United States v. Naftalin, 441 U.S. 768, 774-75(1979). Accordingly, a partner in a TEFRA proceeding such as this is limited under § 6223(e)(3)(B) to a single election: either all in, or all out.
Here, the taxpayers tried to have their cake and eat it too. Their multiple simultaneous statements of election were entitled respectively "Statement of Election by Direct Partner Under Section 6223(e)(3)," and "Statement of Election by Indirect Partner Under Section 6223(e)(3)." Each "Indirect" partner's statement of election said that "[t]he undersigned who is an Indirect Partner is also a Direct Partner of the Partnership" and that "[t]his election does not apply to the undersigned as a Direct Partner." The statute does not permit such slight-of-hand, and the taxpayers' current claim that they did not attempt to bifurcate any partnership items in dispute going into the partnership proceeding is impeached by the record. Equally unavailing were their indisputably untimely attempts two years later to have their "elections out" cover both their indirect and direct partnership interests.
Although not necessary to support our conclusion, we note that it is consistent with the official legislative history behind the statute. See Salinas v. United States, 522 U.S. 52, 57-58 (1997). The House Conference Report on § 6223(e) says that "the partner will be a party to the proceeding [under TEFRA] unless he elects . . . to have all partnership items treated as nonpartnership items." H.R. Conf. Rep. No. 97-760, at 602(1982), reprinted in 1982 U.S.C.C.A.N. 1190, 1374 (emphasis added).
Although it dealt with a different TEFRA issue, our reading of § 6223(e)(3)(B) is also consistent with the purpose of TEFRA's partnership provisions recently reiterated by the Supreme Court in United States v. Woods, 134 S. Ct. 557 (2013). These provisions were enacted inter alia to prevent the waste of time, effort, and resources occasioned by a multiply of proceedings such as would occur if the Tax Court's construction of § 6223(e) were to prevail. In a normal case the Tax Court's ruling here would permit "duplicative proceedings and the potential for inconsistent treatment to partners in the same partnership," thus hindering the purpose and policy justifications that produces TEFRA.
Woods, 134 S. Ct. at 563. Citing Kligfeld Holdings, 128 T.C.192, 199-200 (2007), the Tax Court correctly recognized also that "[t]he goal of TEFRA is to have a single point of adjustment for all partnership items at the partnership level, thereby making any adjustments to a particular partnership item consistent among all the various partners." And the Tax Court acknowledged that it's reading of the statute would seem "to be at odds with TEFRA's overall goal to consolidate partnership proceedings and increase consistency." On these points, the Tax Court was correct. Accordingly, we conclude under a proper reading of § 6223(e)(3)(B), that the taxpayers' attempted elections were ineffective.
THE PERTINENT TREASURY REGULATION
Even if we were to agree that § 6223(e)(3)(B)'s meaning is ambiguous, which we do not, we would still be compelled to reach the same conclusion. After the enactment of § 6223(e)(3)(B), the Treasury Department issued Temp. Treas. Reg. § 301.6223(e)-2T(c)(1), 52 Fed. Reg. 6779 (Mar. 5, 1987), which was effective for the year of this controversy. The regulation tracks the language of the House Conference Report, and it provides that "the election shall apply to all partnership items for the partnership taxable year to which the election relates." 52 Fed. Reg. at 6785 (emphasis added). We agree with the government's argument that the regulation -- which uses the words of the House Conference Report -- represents a reasonable reading of the statute and, accordingly, is entitled to Chevron deference. Chevron, U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837(1984); Mayo Found. for Medical Educ. & Research v. United States, 131 S. Ct. 704, 713 (2011) ("The principles underlying our decision in Chevron apply with full force in the tax context.").
The taxpayers' attempt to avoid Chevron deference by simply offering a different interpretation of the statute and the regulation misses the point of Chevron deference. If the agency's reading of a statute is "a permissible construction of the statute," that reading and interpretation stands and is entitled to respect. Alarcon v. Keller Industries, Inc., 27 F.3d 386, 389 (9th Cir. 1994). Such is the case here. Thus, we remand to the tax court for further proceedings consistent with this opinion, and to determine the validity of the adjustments in the "final partnership administrative adjustment," known as the FPAA.
REMANDED for further proceedings.4
* The Honorable Mark W. Bennett, District Judge for the U.S. District Court for the Northern District of Iowa, sitting by designation.
** This summary constitutes no part of the opinion of the court. It has been prepared by court staff for the convenience of the reader.
1 Congress enacted the Tax Treatment of Partnership Items Act of 1982 as Title IV of the Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA"), Pub. L. No. 97-248, §§ 401-406, 96 Stat. 324 (codified as amended at 26 U.S.C. §§ 6221-6232 (2012)).
2 26 U.S.C. §§ 6221, 6231(a)(3); 26 C.F.R. § 301.6221-1.
3 When this controversy first came to us pursuant to 26 U.S.C. § 7482(a)(2)(A) on a failed attempt by the IRS to secure an interlocutory decision on this issue, we said,
If the Tax Court ultimately determines that the Gregorys did not retain a direct interest in JT USA at the relevant time, and therefore do not have tax liability, the IRS will be able to appeal that ruling along with the Tax Court's prior interlocutory order that the Gregorys had authority to bifurcate their election in the TEFRA proceeding.
Comm'r v. JT USA, LP, 630 F.3d 1167, 1173 (9th Cir. 2011) (emphasis added).
4 We find unpersuasive the taxpayers' remaining contention that (1) they are entitled to the benefits of substantial compliance, Baccei v. United States, 632 F.3d 1140, 1145 (9th Cir. 2011), and (2) that the IRS by its delay impliedly ratified their defective elections, Office of Personnel Management v. Richmond, 496 U.S. 414, 419, 422 (1990) (en banc).
END OF FOOTNOTES
* * * * *
DISSENTING OPINION OF JUDGE CALLAHAN
CALLAHAN, Circuit Judge, dissenting:
I respectfully dissent. We are here because the IRS 1) waited too long to give notice to the taxpayers of a TEFRA partnership proceeding, 2) said nothing when the taxpayers attempted to opt out of the TEFRA proceeding with respect to their indirect interests but not with respect to their direct interests,1 and 3) then failed to bring proceedings against the taxpayers outside the TEFRA proceeding within the one-year statute of limitations. Having struck out, in effect, the IRS now seeks a do-over by disallowing the taxpayers' election to opt out of the TEFRA proceeding in order to pull the taxpayers back into the proceeding. Contrary to the majority's contention, the statute does not prohibit such a split election. TEFRA allows one partner to make one election and another partner to make a different election. I think that a partner who has both direct and indirect interests should have the same option, at least where the IRS fails to timely notify the taxpayer that a bifurcated election is not allowed. On the facts of this case, any ambiguity in the statute as to whether a taxpayer can make separate elections based on different ownership interests should be construed in favor of the taxpayer. I would affirm the Tax Court.
This case concerns the IRS's attempts to recover capital gains taxes from Jon Ross Gregory and his wife Rita.2 The Gregorys held both direct and indirect interests in JT USA, LP ("JT USA"), a limited partnership. The IRS issued a notice of final partnership administrative adjustment ("FPAA") to JT USA for the 2000 tax year, initiating a TEFRA proceeding. However, the IRS did not notify the Gregorys of the proceeding, as required by statute under 26 U.S.C. § 6223(d)(1). Because of this error, the Gregorys had the right to opt out of the TEFRA partnership proceeding under 26 U.S.C. § 6223(e)(3)(B). The Gregorys then notified the IRS that they were opting out of the TEFRA proceeding with respect to their indirect interests but that they had elected to participate in the proceeding with respect to their direct interests.3
After the Gregorys' election out of the TEFRA proceeding with respect to their indirect interests in JT USA, the IRS could have brought an action against the Gregorys outside of the TEFRA proceeding. However, the IRS failed to do so within the one-year statute of limitations, see 26 U.S.C. § 6229(f)(1), and the limitations period ran out at the end of 2005. Thus, "by 2006, the IRS had only two options to recover the alleged tax deficiency": either "show that the Gregorys had a direct interest in JT USA at the relevant time during 2000," or "invalidate the Gregorys' election out of the TEFRA proceeding with respect to their indirect interests." JT USA, 630 F.3d at 1170.
The Gregorys filed a petition with the Tax Court in 2006, arguing that they were only indirect partners of JT USA during the period at issue and that they had no tax liability because the IRS had not assessed a tax deficiency before the one-year statute of limitations had run. In response, the IRS argued that taxpayers were not authorized to "bifurcate" their election to participate in TEFRA proceedings, and therefore the Gregorys' election to opt out with respect to their indirect interest in JT USA was invalid. The Tax Court, however, found that the bifurcated election was valid and dismissed the Gregorys as indirect partners from the TEFRA proceeding.
The IRS then filed an interlocutory appeal, which we dismissed for lack of appellate jurisdiction. Id. at 1169. On remand, the Tax Court determined that all of the disputed adjustments related to the Gregorys' interests as indirect partners. As the Tax Court had already ruled that the Gregorys had validly elected out of the partnership proceeding in their capacity as indirect partners, it held that none the adjustments in the final partnership administrative adjustment would pass through to any individual partner's return, and therefore the adjustments were moot. The Commissioner then timely appealed the Tax Court's final judgment.
The statute at issue here, 26 U.S.C. § 6223(e)(3)(B), provides that where the IRS fails to provide proper notice of a TEFRA proceeding to a partner, the partner may elect "to have the partnership items of the partner for the partnership taxable year to which the proceeding relates treated as nonpartnership items." The majority and the IRS claim that this language unambiguously states that a taxpayer may make only one election -- either you opt out completely, or not at all. The majority and the IRS err in their characterization of this statute and the applicable regulations.
The tax code expressly provides that a single individual or entity may have dual capacities as direct and indirect partners and separate rights under each capacity. In other words, an individual may wear different "hats" and exercise its rights differently with respect to each hat. See, e.g., Barbados #6 Ltd. v. Comm'r, 85 T.C. 900, 904-05 (1985)(discussing IRC § 6226(a) and (b)). Thus, the Gregorys were not required to make a single election with respect to their interests as direct and indirect partners. If different partners can make their own separate elections to opt out from a TEFRA proceeding (or to stay in the proceeding) under § 6223, a single individual holding these exact same interests should be treated similarly.
The fact that the statute says "the partner" may elect out of the partnership proceeding does not show that parties with multiple partnership interests have to make a single election. The language just shows that partners may elect out of the TEFRA proceeding, regardless of whether they are direct partners, indirect partners, or otherwise. Thus if a taxpayer wearing his direct partner hat opts out, he opts out with respect to all of his direct interests. However, this need not affect his interests as an indirect partner. If the taxpayer wearing his indirect partner hat opts out, he opts out with respect to all of his interests as an indirect partner, independent of his interests as a direct partner. Such interpretation is not contrary to the statute.4
Nor does the pertinent Treasury regulation decide this issue. The regulation states that "[t]he election shall apply to all partnership items for the partnership taxable year to which the election relates." Miscellaneous Provisions Relating to the Tax Treatment of Partnership Items, 52 Fed. Reg. 6779, 6785 (Mar. 5, 1987). However, this regulation, just like the statute, is susceptible to an interpretation that the election applies to all the partnership items of that particular partner, not all of the individual taxpayer's interests, whether direct or indirect.
Further, as the IRS conceded at oral argument, this issue has never come up before. Thus, the IRS's position in this appeal is only a litigating position which is not entitled to Chevron deference. Accord Price v. Stevedoring Servs. of Am., Inc., 697 F.3d 820, 825-31 (9th Cir. 2012) (en banc)(litigating position of agency director in interpreting statute was not entitled to Chevron deference). Finally, we should interpret the tax code "consistent with the general rule of construction that ambiguous tax statutes are to be construed against the government and in favor of the taxpayer." See Royal Caribbean Cruises, Ltd. v. United States, 108 F.3d 290,294 (11th Cir. 1997) (citations omitted). The majority's interpretation of the statute runs contrary to this general rule.
The majority also errs in holding that TEFRA's general policy mandates reversing the Tax Court. It is true that TEFRA was enacted to avoid duplicative proceedings and inconsistent treatment of partners in the same partnership. See United States v. Woods, 134 S. Ct. 557, 562-63 (2013).However, this general policy does not resolve the question of whether split elections are allowed. When Congress provided for § 6223(e)(3)'s opt-out provision, Congress determined that TEFRA's general policy against multiple proceedings should yield when the IRS does not give proper notice, as happened here. In other words, the opt-out provision is a statutorily-provided exception to the general policy. If the general policy was paramount, Congress never would have enacted § 6223(e)(3) in the first place. Allowing a split election does not thwart TEFRA's general policy any more than the statute's express provision allowing a partner to opt out due to improper notice.
The IRS struck out in this case: one, it failed to give the Gregorys proper notice of the TEFRA proceeding; two, it failed to object to the taxpayers' election out as indirect partners; and three, it failed to bring a proceeding against the Gregorys outside the TEFRA proceeding. Congress specifically allows taxpayers to opt out of the TEFRA proceeding in this context, and the taxpayers did so in their capacities as indirect partners. Moreover, especially in light of the IRS's failures, any ambiguity in the statute should be resolved in favor of the taxpayer. I would therefore affirm the Tax Court.
FOOTNOTES TO DISSENTING OPINION OF JUDGE CALLAHAN
1 For convenience, I refer to the taxpayers' election out with respect to their indirect interests but not with respect to their direct interests as a "split" or "bifurcated" election.
2 This background is taken from our prior decision regarding this dispute, Commissioner v. JT USA, LP, 630 F.3d 1167 (9th Cir. 2011).
3 Once the Gregorys began to suspect that their split election would be disallowed, they sought to opt out of the TEFRA proceeding with respect to both their direct and indirect interests, with no response from the IRS.
4 The conference report's language stated that the statute provided that a partner could opt out of the partnership proceeding with respect to all partnership items. Tax Equity and Fiscal Responsibility Act of 1982, 1982-2 C.B. 600, 602 (Aug. 17, 1982). However, the removal of "all" from the final language of the statute could also suggest that the drafters did not want to prohibit split elections.
END OF FOOTNOTES TO DISSENTING OPINION OF JUDGE CALLAHAN