United States Court of Appeals, District of Columbia Circuit
February 5, 2018
Appeal from the Decision of the United States Tax Court
M. Shah argued the cause for appellant. With him on the
briefs was Thomas A. Cullinan.
Richard Farber, Attorney, U.S. Department of Justice, argued
the cause for appellee. With him on the brief were Thomas J.
Clark and Richard Caldarone, Attorneys. Ellen Page DelSole,
Attorney, entered an appearance.
Before: Wilkins, Circuit Judge, and Edwards and Silberman,
Senior Circuit Judges.
Edwards, Senior Circuit Judge:
Partners ("Mellow"), a general partnership formed
by and between two single-member LLCs, appeals the Tax
Court's decisions holding that it had jurisdiction over
partnership-related determinations concerning Mellow's
partnership return for the 1999 tax year and imposing
penalties for the underpayment of taxes. The Internal Revenue
Service ("IRS") determined that Mellow was
"formed and availed of solely for purposes of tax
avoidance" and "constitute[d] an economic
sham." Final Partnership Administrative Adjustment
Letter, Tax Year Ended: December 31, 1999, reprinted
in Joint Appendix ("J.A.") 64. On the basis of
this determination, IRS commenced partnership-level
proceedings under the Tax Equity and Fiscal Responsibility
Act of 1982 ("TEFRA"), 26 U.S.C. §§
6221-6234 (2012), to adjust the partnership items in
Mellow's 1999 partnership return. On March 24, 2005, IRS
issued to Mellow a Notice of Final Partnership Administrative
Adjustment ("FPAA") setting forth adjustments to
the partnership items, disallowing losses from unlawful
transactions, and assessing penalties.
filed a petition with the Tax Court challenging the FPAA. It
then moved to dismiss the case for lack of jurisdiction,
arguing that the FPAA was invalid because Mellow was a
"small partnership" exempt from TEFRA's audit
and litigation proceedings under 26 U.S.C. §
6231(a)(1)(B). The Tax Court denied the motion. The court
held that, as set forth in Treasury Regulation §
301.6231(a)(1)-1(a)(2) and other authorities, a partnership
does not qualify for the small-partnership exception if any
of its partners is a "pass-thru partner" within the
meaning of 26 U.S.C. § 6231(a)(9), and that disregarded
single-member LLCs are such pass-thru partners. The Tax Court
subsequently entered a decision upholding most of IRS's
adjustments to Mellow's partnership return and imposing
appeal, Mellow asserts that the Tax Court erred in rejecting
its contention that it qualified for the small-partnership
exception to TEFRA. It contends that, pursuant to certain
tax-classification regulations, the single-member LLCs'
individual owners rather than the LLCs themselves were
Mellow's partners for TEFRA purposes and, therefore,
Mellow constituted a "small partnership" within the
plain meaning of § 6231(a)(1)(B). Mellow also asserts
that the Tax Court erred in imposing penalties because IRS
failed to obtain the requisite written approval for such
penalties, as required by 26 U.S.C. § 6751(b)(1) (2012).
affirm the Tax Court's holding that Mellow was subject to
the TEFRA partnership proceedings. The record makes clear
that Mellow's partners were the single-member LLCs, not
their individual owners. Moreover, we defer to IRS's
reasonable interpretation of its own regulation that a
partnership with pass-thru partners is ineligible for the
small-partnership exception and that single-member LLCs
constitute pass-thru partners. We further hold that we lack
jurisdiction over Mellow's challenge to the penalties
because Mellow failed to raise its claim below and waived its
claim by consenting to a decision applying penalties.
Statutory and Regulatory Background
Internal Revenue Code ("Code") "recognizes a
variety of business entities-including corporations,
companies, associations, partnerships, sole proprietorships,
and groups- and, based on the classifications, treats the
entities in various ways for income tax purposes."
McNamee v. Dep't of Treasury, 488 F.3d 100, 103
(2d Cir. 2007). Pursuant to its authority to "prescribe
all needful rules and regulations for the enforcement of
[Title 26, the Internal Revenue Code], " 26 U.S.C.
§ 7805(a) (2012), the Treasury Department has
promulgated regulations governing, inter alia,
business entities with only one owner, see Treas.
Reg. §§ 301.7701-1 to -3. These regulations, which
are often referred to as "check-the-box"
regulations, permit "an eligible entity with a single
owner [to] elect to be classified as an association or to be
disregarded as an entity separate from its owner" for
federal tax purposes. Id. § 301.7701-3(a);
see also Pierre v. Comm'r, 133 T.C. 24, 24
(2009), supplemented, 99 T.C.M. (CCH) 1436 (2010).
If the entity is "disregarded as an entity separate from
its owner, " its activities "are treated in the
same manner as a sole proprietorship, branch, or division of
the owner." Treas. Reg. § 301.7701-2(a).
contrast, "[a] business entity with two or more members
is classified for federal tax purposes as either a
corporation or a partnership." Id. Partnerships
do not pay federal income taxes. 26 U.S.C. § 701 (2012).
"A partnership's taxable income and losses instead
pass through to the partners, who report their shares of
partnership income or losses on their individual federal
income tax returns." Petaluma FX Partners, LLC v.
Comm'r, 792 F.3d 72, 75 (D.C. Cir. 2015) (citing
§ 701). Partnerships are nevertheless required to submit
annual informational returns to IRS reporting income, gains,
losses, and deductions. See 26 U.S.C. § 6031(a)
(2012); Treas. Reg. § 301.6231(a)(3)-1(a)(1)(i).
established a framework for reviewing partnership tax matters
in TEFRA. In 2015, Congress amended the TEFRA provisions.
See Bipartisan Budget Act of 2015, Pub. L. No.
114-74, § 1101, 129 Stat. 584, 625-38 (2015). However,
because the amendments apply to partnership returns filed for
partnership taxable years beginning after December 31, 2017,
id. at 638, we proceed with our analysis using the
statutory provisions in force at the time of the events under
consideration in this appeal.
the applicable TEFRA framework, "if the IRS disagrees
with a partnership's information return, it can bring a
partnership-level proceeding in which it may adjust
'partnership items, ' defined as items 'more
appropriately determined at the partnership level,
'" by issuing a FPAA to the partnership's
partners. Petaluma FX Partners, 792 F.3d at 75
(quoting §§ 6221 and 6231(a)(3)). The partners can
challenge the FPAA by filing a petition for readjustment with
the United States Tax Court, a federal district court, or the
Court of Federal Claims. 26 U.S.C. § 6226(a) (2012). The
reviewing court will have jurisdiction over the case so long
as IRS has provided a valid FPAA and the taxpayer has
"proper[ly] fil[ed] a petition for readjustment of
partnership items for the year or years to which the FPAA
pertains." Wise Guys Holdings, LLC v.
Comm'r, 140 T.C. 193, 196 (2013). In particular, the
court will have jurisdiction to "determine all
partnership items of the partnership for the partnership
taxable year to which the [FPAA] relates, the proper
allocation of such items among the partners, and the
applicability of any penalty, addition to tax, or additional
amount which relates to an adjustment to a partnership
item." 26 U.S.C. § 6226(f) (2012).
general rule, the TEFRA procedures apply to all business
entities that are required to file a partnership return.
Bedrosian v. Comm'r, 143 T.C. 83, 104 (2014)
(citing 26 U.S.C. § 6231(a)(1)(A)). However, there is a
limited exception for "small partnerships, " which
are defined as having "10 or fewer partners each of whom
is an individual . . ., a C corporation, or an estate of a
deceased partner." 26 U.S.C. § 6231(a)(1)(B)
(2012). In 1987, the Treasury Department promulgated
temporary regulations setting forth rules governing the
small-partnership exception. See Miscellaneous
Provisions Relating to the Tax Treatment of Partnership
Items, 52 Fed. Reg. 6, 779, 6, 789 (Mar. 5, 1987). As
relevant here, one of the temporary regulations provided
that, "[t]he [small-partnership] exception provided in
section 6231(a)(1)(B) does not apply to a partnership for a
taxable year if any partner in the partnership during that
taxable year is a pass-thru partner." Id. In
2001, the Treasury Department issued a final regulation,
which stated, inter alia, that the small-partnership
exception "does not apply to a partnership for a taxable
year if any partner in the partnership during that taxable
year is a pass-thru partner as defined in section
6231(a)(9)." Unified Partnership Audit Procedures, 66
Fed. Reg. 50, 541, 50, 556 (Oct. 4, 2001) (codified at Treas.
Reg. § 301.6231(a)(1)-1(a)(2)); see id. at 50,
544 (stating that the final regulations apply to partnership
proceedings concerning partnership taxable years beginning on
or after October 4, 2001). The Code, in turn, defines
"partner" as "a partner in the
partnership" and "any other person whose income tax
liability . . . is determined in whole or in part by
taking" partnership items "directly or
indirectly" into account, 26 U.S.C. § 6231(a)(2)
(2012), and "pass-thru partner" as "a
partnership, estate, trust, S corporation, nominee, or other
similar person through whom other persons hold an interest in
the partnership, " id. § 6231(a)(9)
the 2001 Treasury Department regulations at issue here apply
prospectively, the parties do not dispute that the temporary
regulations were in effect when Mellow filed its 1999
partnership return and that the temporary regulations applied
to Mellow's return. The parties also agree that the
material terms in the temporary and final regulations are the
same. The only difference is that the 2001 regulation added
the language, "as defined in section 6231(a)(9)."
However, the parties agree that under both the temporary and
final regulations, a pass-thru partner is as defined in
§ 6231(a)(9). Therefore, like the parties, we base our
analysis on the language set forth in the final regulation,
Treasury Regulation § 301.6231(a)(1)-1(a)(2).
Factual and Procedural Background
Partners was formed on November 12, 1999 and dissolved in
December 1999. Mellow's partnership agreement states that
the purpose of the partnership was to invest partnership
assets in "securities, businesses, real estate interests
and other investment opportunities, " including
"stocks, bonds, options, foreign currencies, foreign
exchange and over the counter derivatives, and other
financial instruments." J.A. 68. The partnership
agreement also states that the partnership was formed
"by and between" MB 68th Street Investments LLC
("68th Street") and WNM Hunters Crest Investments
LLC ("Hunters Crest") (collectively, "the
single-member LLCs" or "the LLCs").
Id. Mr. Myer Berlow, the sole member of 68th Street,
and Mr. William Melton, the sole member of Hunters Crest,
signed the partnership agreement on behalf of their
respective LLCs. The single-member LLCs did not elect to be
treated as associations under the check-the-box