TEFRA Jurisdiction and Sham Partnerships — Again?

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Today’s guest post is written by Professor Andy Grewal, of the University of Iowa College of Law. In this post, Professor Grewal returns us to TEFRA and issues spinning out of IRS efforts to combat partnership-housed shelters. We have previously discussed some of the TEFRA issues stemming from the Supreme Court’s US v Woods case (most recently last month here). Professor Grewal is a creative scholar whose interests include the intersection of tax law, administrative law, statutory interpretation theory, and tax shelters. Recent articles include a take on the economic substance doctrine and an introduction to an important symposium dedicated to the intersection of administrative law and tax (his articles can be downloaded for free here). In addition, he is in the small club of academics digging into the rabbit hole that is TEFRA, with the Supreme Court citing his amicus brief in Woods. In this post, Professor Grewal discusses a fascinating issue that the taxpayers have raised in Petaluma FX Partners v US, a case before the DC Circuit Court of Appeals, namely whether IRS/Treasury’s use of 13 year old temporary regulations deprives the court of jurisdiction. This argument was based on Professor Grewal’s scholarship, and has relevance beyond TEFRA as it tackles the problem of IRS/Treasury issuing regulations that are inconsistent with the norms of other agencies, the Internal Revenue Code and Administrative Procedure Act. Les

The ongoing disputes regarding TEFRA and sham partnerships took an interesting turn this week, when the taxpayer in Petaluma FX Partners v. United States submitted a brief in the D.C. Circuit arguing that the Tax Court lacked jurisdiction to hear its case. The taxpayer’s arguments might sound surprising to those familiar with United States v. Woods. In that case, the Supreme Court held that Section 6226(f) establishes TEFRA jurisdiction to consider the applicability of the valuation misstatement penalty when a partnership is disregarded as sham.

Petaluma argues that the Tax Court not only lacked jurisdiction to consider the valuation misstatement penalty, but that TEFRA did not reach any aspect of its proceedings. Those arguments are borrowed from an article written by yours truly soon after Woods came down. In that short article, which I had hoped would be the last thing I ever wrote about TEFRA, I explained that in focusing on Section 6226(f), the parties missed a threshold jurisdictional question: Did TEFRA apply at all to sham partnerships for the tax years at issue?

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In Woods, as in Petaluma, TEFRA jurisdiction ultimately rested on temporary regulations issued under Section 6233(b) of the code. Under that section, Congress conditioned the extension of TEFRA to sham partnerships on the issuance of regulations.   But, as Petaluma points out, the regulations that purportedly established jurisdiction over its sham partnership were procedurally defective. Those regulations were first issued in proposed form and received comments, but the Treasury declined to address those comments. Instead, in 1987, the regulations were re-issued (without change) in “temporary” form, along with a promise that the Treasury would soon issue final regulations that incorporated those comments. But the Treasury never made good on its promise, and the temporary regulations sat on the shelf for 14 years, when final regulations were issued for tax years starting after October 3, 2001.

Petaluma consequently argues that during its tax year at issue (2000), no final regulations extended TEFRA to sham partnerships. And the application of the 13-year old temporary regulations would be the poster child for improper administrative overreach — the Treasury proposed regulations, received comments, issued temporary regulations that ignored those comments, and then, more than a decade later, adversely invoked those regulations against the taxpayer.

The taxpayer’s presentation of this argument should make this case worth following, even for those who do not take an interest in TEFRA matters. The Tax Court will frequently apply a decades-old temporary regulation in a tax case, but circuit courts have wondered why “why such a ‘temporary regulation,’ issued in 1987 shortly after enactment of the Tax Reform Act of 1986, should remain ‘temporary’ well over a decade later.” Tedori v. United States, 211 F.3d 488, 491 n.9 (9th Cir. 2000). But no circuit court has squarely considered the government’s argument that Section 7805(e)(2) blesses decades-old temporary regulations, and the D.C. Circuit may be the first.

Regarding that argument, the government essentially takes the position that because Section 7805(e)(2) sets a 3-year expiration period for temporary regulations issued after November 20, 1988, any temporary regulations issued before that date — even ones going back as far as the 1970s — remain valid indefinitely. I’ve previously argued that the APA’s express-statement rule clearly refutes the government’s position (see pages 1051-1058 of this article). But whatever way the D.C. Circuit comes out on this, taxpayers will benefit from some clear guidance on the status of decades-old temporary regulations.

There’s also a broader question about how the D.C. Circuit will generally react to the taxpayer’s arguments. Although parties enjoy wide latitude to bring jurisdictional arguments at any stage of a proceeding, the taxpayer’s argument might come across as a bit of a curveball — parties in TEFRA cases have thus far ignored the procedural irregularities associated with the Section 6233(b) regulations.

However, there are some indications that the D.C. Circuit remains intensely interested in TEFRA matters. After Woods was decided, the government in Petaluma moved for summary reversal of the Tax Court’s holding in favor of the taxpayer, and Petaluma essentially acquiesced to the government’s motion. But the D.C. Circuit, on its own, ordered full re-briefing of the case, stating that the court did not think that the issues were as clear-cut as the parties made them out to be. And, it’s not every day that a court, or anyone else, for that matter, asks for more TEFRA analysis. So, the taxpayer may be in luck — the D.C. Circuit seems poised to thoughtfully consider the relevant issues, even if they are being raised for the first time this late in the game. This makes Petaluma a case well worth watching.

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