Nominal Qualified Offers and TEFRA

We welcome guest blogger Ted Afield. Professor Afield directs the low income taxpayer clinic at Georgia State. The Georgia State tax clinic serves more clients that almost any clinic in the country and provides them with high quality service. The tax clinic at the Legal Services Center at Harvard and the Georgia State tax clinic have partnered on several amicus briefs and it’s always a pleasure to work with their clinic. The case discussed by Professor Afield provides important precedent for successful litigants seeking to recover fees after making a qualified offer. Paying attorney’s fees to a partnership that engaged in an abusive tax shelter promotion makes for a tough pill for the government to swallow which, I believe, caused it to argue the issues discussed here so vigorously. Even though I do not support the underlying tax position taken by the partnership, it had the winning issue on the statute of limitations and that formed the basis for successful litigation on the attorney’s fees issue. Perhaps the benefit of this opinion for parties seeking fees will outweigh the loss to a tax shelter promoter. Keith

The United States Court of Appeals for the Federal Circuit recently issued an opinion in BASR Partnership, William F. Pettinati, Sr., Tax Matters Partner v. United States, in which the court determined whether a partnership was entitled to recover its reasonable litigation costs from the government when it submitted a nominal $1 qualified offer to the government in tax controversy litigation and subsequently prevailed at summary judgment.   This case was a Son of Boss case in which the IRS waited a decade before issuing a Final Partnership Administrative Adjustment (FPAA) disallowing BASR Partnership’s tax benefits.  Accordingly, the tax matters partner, William Pettinati, Sr., challenged the FPAA as untimely pursuant to the three year statute of limitations in IRC § 6501(a).  Given the confidence that the BASR partners had in their statute of limitations argument, they submitted a $1.00 qualified offer to the government, which the government rejected.  As it turns out, the BASR partners’ confidence was indeed justified, and they prevailed on summary judgment and then moved for an award of litigation costs under IRC § 7430(c)(4)(E), which the trial court granted. 

On appeal, the government raised five arguments for why the court should not have awarded litigation costs, three of which being of particular interest in that they explore the relationship between TEFRA and qualified offers as well as whether nominal offers are in fact permissible.  The government’s first argument was that BASR was not a “party” in the litigation because of TEFRA and therefore could not be a “prevailing party” as required under the qualified offer statute.  The government’s second and third arguments were that, even if BASR was a “party,” the tax liability was not “in issue” and BASR did not incur any litigation costs during the underlying TEFRA proceeding.  The government’s remaining arguments were that, even if IRC § 7430(a)’s eligibility requirements were satisfied, the trial court did not apply the real-party-in-interest doctrine and abused its discretion in granting the award.  These arguments presented an opportunity for the Federal Circuit to examine how the TEFRA and qualified offer rules interact with each other and, of particular interest to me and Keith, presented an opportunity for the court to determine whether nominal qualified offers, which are often utilized by low-income taxpayer clinics, would be considered per se unreasonable. 

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The Underlying Partnership is a Prevailing Party 

 The court rejected the government’s argument that only individual partners, rather than the partnership itself, can be parties in a TEFRA proceeding and that, accordingly, BASR Partnership could not be a “prevailing party.”  The court noted that the language in IRC § 6226 that permits individual partners to participate in the proceeding should be read inclusively rather than exclusively (i.e., just because the statute specifically indicates that partners can be parties, that does not mean that it prevents the partnership itself from also being a party).  The court noted that the cost-shifting language of IRC § 7430(c)(4)(A)(ii) supported this interpretation of IRC § 6226 because it specifically contemplated “any partnership” as being included in the definition of “prevailing party.” 

Tax Liability is “In Issue” in a TEFRA Proceeding 

 After determining that BASR Partnership could indeed be a prevailing party, the court next had to consider whether the tax liability was “in issue” in a TEFRA proceeding.  The government contended that the liability was not “in issue” because the tax liability is determined at the partner level rather than at the partnership level in such proceedings.  The Court rejected this narrow reading of the phrase “in issue”, however, and held that actual liability would not have to be determined at the partnership level for it to be “in issue”—rather, it was sufficient that the partnership determination would impact the partners’ individual tax liability. 

The partnership incurred litigation costs despite the fact that the costs were incurred in the partner’s name, and the partnership was the “real party in interest” 

Because the resolution turned more on an issue of contract and state partnership law than an issue of tax procedure, I will not overly dwell on the government’s argument that the partnership did not incur any litigation costs because the costs were incurred by the managing partner individually and the argument that the “real party in interest” doctrine prevented a recovery of costs because the real parties in interest were the partners, whose net worth would have made them ineligible to recover costs under IRC § 7430.  Suffice to say that the court rejected these arguments because the managing partner had brought an action in his capacity as tax matters partner under IRC § 6226, and the partnership agreement and the relevant state partnership law (in this case, it was Texas) obligated the partners to reimburse him for litigation costs.  It is worth noting, however, that the “real party in interest” issue is the one that provoked a dissenting opinion arguing that the fact that the partners were entitled to have their litigation costs reimbursed by the partnership made them the true beneficiaries of the award and thus the real parties in interest. 

Awarding litigation costs was not an abuse of discretion (i.e., the issue causing low-income taxpayer clinics to weigh in) 

The government’s final argument was that awarding litigation costs constituted an abuse of discretion because the taxpayer’s nominal $1.00 qualified offer “was not made in a good-faith attempt to produce a settlement.”  This was the argument that got Keith’s and my attention, because it seemed to us that the government was attempting to argue that nominal qualified offers were per se invalid.  If successful, this argument could have severely hindered a common litigation strategy that low-income taxpayers employ in frozen refund litigation.   

 Accordingly, our clinics (the Philip C. Cook Low-Income Taxpayer Clinic of Georgia State University College of Law and the Harvard Federal Tax Clinic) filed a joint amicus brief in this case solely on the issue of whether taxpayers should be denied reasonable litigation and administrative costs based on the dollar value of a qualified offer.  The clinics argued that none of the requirements of IRC § 7430 state that an offer must be of a minimum amount or of a minimum percentage of the taxpayer’s possible liability in order to be valid.  The clinics were particularly concerned with the potential impact that a rule requiring a minimum qualified offer amount would have on low-income taxpayers, which motived them to submit the brief. Low-income taxpayers who have had their refunds frozen often submit $1 qualified offers when they believe that they will prevail in a tax court case in order to shorten the time it takes for them to resolve their case and receive their frozen refund.  Obtaining these frozen refunds is of critical importance to these vulnerable taxpayers because they often need the tax refunds generated by the earned income tax credit to meet their basic living expenses.  Submitting a qualified offer puts pressure on the government to consider the low-income taxpayer’s case more quickly than it otherwise would because of the risk that the government would have to pay fees and costs if the taxpayer prevails.   

 In looking at this issue, the court agreed that a nominal $1 qualified offer can be reasonable and that awarding litigation fees was not an abuse of discretion.  While the court did not discuss the impacts to low-income taxpayers directly in its opinion, the clinics are pleased that the court reached this result and that nominal qualified offers will remain a viable litigation tool for low-income taxpayers who rely on them to obtain improperly frozen refunds as quickly as possible.