Rawls Group, L.P., Rawls Family, L.P., Rawls Management Corporation, Jerry Rawls and The Jerry S. Rawls Business Trust, Jerry Rawls, Trustee, Partners Other Than the Tax Matters Partner, Petitioners

138 T.C. No. 12 UNITED STATES TAX COURT RAWLS TRADING; L.P., RAWLS MANAGEMENT CORPORATION, TAX MATTERS PARTNER, ET AL.,1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket Nos. 12937-07, 12938-07, 14880-07.

Filed March 26, 2012.

R simultaneously;issued notices of final partnership administrative adjustment (FPAAs) to two lower tier, or "source" partnerships, and one upper tier, or "interim" partnership. The FPAA issued to the interim partnership purþorts to give effect only to the adjustments shown on the FPAAs issued to the source partnerships. Ps petitioned the Court challenging all three FPAAs, and the three partnership proceedings were consolidated. sR súbsequently-asked to stay the proceeding for the interim partnership, conceding that the 1Cases of the following petitioners are consolidated herewith: Rawls Family, L.P., Rawls Management Corporation, Tax Matters Partner, docket No. 12938-07; and Rawls Group, I2P., Rawls Family, LIP., Rawls Management Corporation, Jerry Rawls and the Jerry S. Rawls Business Trust, Jerry Rawls, Tr stee, Partners Other Than the Tax Matters Partner, docket No. 14880-07.

SiWED NAR 262012 underlying FPAA was issued prematurely but asserting that the FPAA is nonetheless valid and properly confers jurisdiction on the Court.

HHeM: Under the analysis and reasoning articulated in GAF Corp. & Subs. v. Commissioner, 114 T.C. 519 (2000), as applied to a tiered partnership structure, the FPAA issued to the interim partnership, which represents only the impact of the adjustments shown on the FPAAs issued to the two source partnerships and which was issued before the completion of the two source partnership proceedings, is invalid and does not confer jurisdiction on the Court Therefore, the Court will, on its own motion, dismiss the interim partnership proceeding for lack ofjurisdiction.

Michael Todd Welty, David E. Colmenero,. and Laura L. Gavioli, for petitioners.

Josh O. Ungerman, fór petitioners in dóckét No. 14880-07.

Elaine H. Harris;David B. Flassing, Julie Ann P. Gasper, and Mark Edward O'Leary, for respondent.

VASQUEZ, Judge: These three consolidated cases are before the Court on respondent s request to stay theýroceeding in one case; The cases òonstitute partnership level proceedings under the unified partnership audit and litigation procedures of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. No. 97 248 sec. 402(a), 96 Stat. at 648 (codified as amended at sections 6221-6233).2 Jni ss therwise indicate li se tio relerences are to tl e Inter al Revenue Code of 1986, a(cid:0)541amended and in,effect for the tax year at issue, 2000, and all Rule referencespre to the Tax Court Rulés of Practice and Pröcedure.

Once each during two discrete periods, the first spanning late March through early April 2000 and the other covering early August through early September 2000, Jerry S. Rawls engaged in the short sale variant of the "Son-of- OSS" tax shelter,3 employing several newly formed entities. These included:

1 awls Family, L.P. (Family), Rawls Group, L.P. (Group), and Rawls Trading, L.P.

(Trading), each of which sought to be characterized as a partnership for tax purposes.⁴ As more fully discussed below, these purported partnerships were arranged in a "tiered" structure, with Family holding ownership interests in Group and Trading.

Group and Trading were the entities in which the "sheltering" transactions, hich allegedly subsequently generated losses, originated. Because Group and Trading were the source of the putative losses, we refer to them as the "source" partnerships. The claimed losses resulted from transactions overstating the bases of partnership interests in the source partnerships. These overstated bases supposedly flowed through to Family, which used them to "fabricate" losses.

These contrived losses eventually inured to Mr. Rawls' tax benefit through other 3See Kligfeld Holdings v. Commissioner, 128 T.C. 192 (2007) (providing a detailed description of the shelter).

4Where applicable, and for narrative convenience only, we adopt some of the terms that Mr. Rawls and others associated with these entities had used to describe the transactions at issue. Such terms include "partner(s)", "partnership", and "L.P." Our use of any of these terms does not constitute, and should not be construed as, a fmding that the legal status or relationship conveyed by that term iii fact existed at the relevant time.

passthrough entities. Because it was interposed between the source partnerships, on the one hand, and Mr. Rawls, on the other, we refer to Fainily as the 'finterim" partnership.

Using this pyramid-like partnership structure, in*which overstated bases purportedly achieved in the source partnerships tiered up through the interim partnership to his benefit, Mr..Rawls claimed tax savinås df approximately $11 million. Respondent, by means of notices of final pärtnership administrative adjustment (FPAAs) issued to.Family, Group; and Trading, disallowed the losses at the respective partnership level and asserted accuracy-related penalties under section 6662(a) and (h).6 The tax matters partners (TMPs) of Family and Trading and a participating partner of Group brought these consolidated actions on behalf of their respective entities.

e After having issued the FPAAs, respondent now contends, in effect, that the FPAA to Familyavas premature Respondent has asked the Court to stay the proceeding with respect to Family until the-partnership-level proceediiigs for This figure represents the taxes that would otherwise have been owing on the long-term capital gains claimed to have been sheltered by the alleged losses. As mentioned inúa Findings of Fact, pt. II. A.,fMrpRawls arranged å sale of shares of common stock that he had held for several years in a company, which wás subsequently publicly listed and traded, at thé interim partnership level. The net 15roceeds of this sale amounted to $61;052,041.70. Becaúse Mr Rawls had a negligible basis in these shares, almost the total net proceeds woulfl have constituted long-term capital gains and been subject to a 20% tax rate. We note that Mr. Rawls' personal income taxes are not at issue in these partnérship-level proceedings..

'On March 17, 2009, the Court granted petitioners' motion to the cases for trial, briefmg, and opinion.

nsolidat Öroup and Trading have been resolved. The issues that we decide here are: (1) whether.the-Family FPAA is valid and properlý confers jurisdiction on usbver the Family case; and (2) if we have jurisdiction, whether we should grant respondent's motion and stay proceedings in the Family case until we have entered our decisions in,the Group and Trading cases and our decisions have becáme "fmal" within the meaning of section 7481(a)(2)(A).

FINDINGS OF FACT

I.

Jerry S. Rawls Mr. Rawls earned a bachelor of science degree in mechanical engineering from Texas Tech University and a master of science degree in industrial ddministration from Purdue University. From 1968 through 1988 he worked for Raycliem Corp., where he began as a sales engineer and eventually rose to general manager of two divisions within the company.

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(cid:16)042Mr:Rawlscofounded the fiber optics company Finisar Corp. (Finisar) in 1989. Upon formation of Finisar, Mr. Rawls received a portion of its on'tstanding shares of common stock. Since'the company's inception, Mr. Rawls has served, variously,ras Finisar's president, chief executive officer, or chairman of the board.

By1999 Finisar had become the nation's leading provider of fiber optic s bsystems and network performance tests. On November 11, 1999, Finisar announcèÈ an initial public offerinÁ ÉlPO) of jts ommoÈstock. On November 17, 1999, Finisar made an IPO of 8,150,000 shares. At the time of the IPO, Mr. Rawls owned 8,470,627 shares of Finisar stock, which represented 20.2% of Finisar's outstanding comníon stock.⁵ However, because ofhis position at the company Mr.-Rawls was subject to a "lock up" that precluded liim from selling his Finisar shares.in the IPO and for a six-month¢eriodithereafter.

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· » a Around the time of the IPO, Mr. Rawls had no personal will or estate plan in place, he had no personal lawyers,;and his Finisar holdings made üp substantiàlly all of his net worth. Between February and March 2000, Mr. Rawls1was búsy traveling the country in advance of an upcóming secondary offering of Finisar's common stock, scheduled for later that sprins. Mr. Rawls intended to sell approximately 600,000 shares of his Finisar commorî stock in this sècondary offering.

IL The Transactions e u On Decëmber.⁸, 1999, Steven J. Lange, a representative from the Heritage Organization, L.L.C. (Heritage)8 made an unsolicited call to Mr. Raùls to discuss Heritage's,services. Accordinÿ, to MreLange's summáry ofthat!call, hè explained to MrnRawls that Heritage does "work in capital gains for-lárge capital gains; actually eliminating the capital gains taxes anda[they] do estate planning, drop ing estate taxes down to 15[%] Mr. Rawls agreed to neetavith a Heritage . Mr. Rawls' stock ownership in Finisar represented approximately 28% of the cómpaný's outstanding cominòn stock before the IPO.

8Héì.itage filed a volùntary petition färYeliefinïdër ch. 11 öf tlie Bankhil tcy Code on May 17, 2004. See In re Heritage Org., L.L.C., 375 B.R. 230, 238-242 (Bankr. N.D. Tex. 2007) (disöussing Heritage's actiirities and itsTélátionship with its clients, às conducted before the filing ofthe bankruptcy petition).

representative in person. Mr. Rawls.met with variousrHeritage representatives several times between December 1999'and early 2000.

. : .

s (cid:16)042 Heritage referred Mr. Rawls to Lewis, Rice, Fingèrlish (Lewis Rice), a law irm to which Heritage had previously referred five clients in the preceding two ears. Mr. Rawls paid Lewis Rice a fee of $150,000 for its services, which i cluded a written tax.opinion for the transactions relating to Trading.⁹ During March and early April 2000, Heritàge and Mr. Rawls discussed s rategies aimed at significantly.reducing capital gains taxes that he would owe on dny future sale of his Finisar stock.

Initially, Heritage and Mr. Rawls .

contemplated a strategy seeking to "inflate", or overstate, the basis-of Mr. Rawls' I inisar stock before its sale.

The strategy,envisaged entering into a short sale bfTfeasury notes and transferring the proceeds of the short sale (along with the obligation to close the s ort sale) to a partnership. The desired tax result was an inflated "outside basis" in the partnershipd° The idea was to "impute" this inflated outside basis to Mr.

91n additiOn, On Or arOund May 5, 2000, Mr. Rawls effectively paid a fee of 4,472,062 to Heritage for its services. The fee was arranged throügh the Jerry S.

Rawls Business Trust (ESBT). -Mr. Rawls was the sole-grantor; trtistee, and eneficiary ofESBT. See infra pt. ILA.

°Outside basis refers to the basis of a partner s partnership interest. See enerally sec. 722 (providing thafthe basis of a partner's partnership!interest acquired by the.contribution of property ôther than money is the basïs of the contributed property; and the basis*of a partner's partnership interest acquired by t e contribution of money is the amount of money'contributed); sec. 752(a) (providing that the basis of a partner's-partnership interest is increàsed to the e tent of the partner's increased share of partnership liabilities); sec. 752(b) (continued...)

Rawls' Finisar stock÷before it was'sbld To achievè this,tMr. Ráwls would have previously arranged for a contribution of lîis Finisar stock to the partnershilï This stock would then.have been redéiVed back in's liquidating distribution ffom the partnership. Presumably, it would haVe been claimed; tinder autho ity of seótion 732(b), that the Finisar stoák vváVbeing received back with a basi(cid:0)541equal to thë inflated outside basis in the partnership:

T However tliis strategy for iriflating the basis of Finisar stock before its sale was subsequently discarded in favor of a more co'mplex strategy involving two partnerships. dt wás envisaged thát the,twö partnerships wòuld eventdallibe arranged in a tiered structure, with öne almost entirely owried by the other. The objective of this stratègy was to "manufacture" a short-term capital'loss in the upper tier partnership Thè loss would then be proclaimed to be aváilabl'e to offset capitaligains that the upper tier partnership woüld realize by selling Firiisar stock previously contribûted to it.

.3 e Engineering the short-term capital loss contemplated, in the first instatice, inflating the outside basis of a partnership--the partnership that woùld become the .

ó tinued (p oviding that the basis of a partner's partnership interest is decreased to the extent of the partner's decreased share of partnekship liabilities); sec. 705 (providing rules for subsequent adjustments to the basis of a partrier's partnership interest, following its.initial determination at the time of original acquisition to reflect the partner(cid:0)541hip'soperatiiig results and the partner's distributive shares of partnership income, gain, loss, deduction and credit); sec. 733 (providing rules for adjustments to the basis of a partner's partnership interest to account for distributions from the partnership to the partner).

lower tier partnership. The notion was to impute this inflated outside basis to the assets of another partnership--the partnership that would become the upper tier partnership. As a consequence of the tiered partnership structure, the erstwhile inflated outside basis in the lower tier partnership would become the overstated ''inside basis" of assets held by the upper tier partnership." These assets would comprise substantially all of the partiiership interests in the lower tier partnership.

The upper tier partnership would subsequently sell these partnership interests, at a price reflecting their true economic value rather than their overstated basis. A short-term capital loss would allegedly be realized as a result of this sale.

As would have been the.casé in the discarded strategy for inflating the basis of Finisar stock, inflating the outside basis in the-lower tier partnership would be achieved by entering into a short sale of Treasury notes. The proceeds of the!short sale (along with the obligation to close the short sale) would be transferred to the lþwer tier partnership. The tiered partnership structure itself would be effected by purported capital contribution of substantially all of the partnership interests in the lower tier partnership to the upper tier partnership. Following this capital "Inside basis refers to the partnership's basis in partnei·ship property. See enerally sec. 723 (providing that the basis of property contributed to a partnership by a partner shall be the adjusted basis of such property to the contributing partner at the time of contribution, increased by the amount of any gain recognized at contribütion) sec. 734 (providing fules for the adjustment of basis in partnership property to account for distributions if the partnership has made an election under sec. 754); sec. 743 (providing rules for the adjustment of basis in partnership property to account for transfers of partnership interest if the partnership has made an election under sec. 754).

contribution, the upper tier partnership+would hold, a(cid:0)541assetsralmost all of the partnership interests-in the lowet tier partnership.. The upper tieripartnership would claim, under authority of section 723, that its basis in these assets is the same as.the inflated outside basis in the lower tier partnership at tlie time of the capital contribution.

As discussed below Mr. Rawls ended up executing the:tiered partnership strategy twice; once during March and April 2000, and then again during August and September 2000. A different,lower tier partnership was involved éach time.

However,-Mr. Rawls used the same upper tier 15artnership on both occasions.

For purposes of resolving,the jurisdictional question at hand:!the proper tax characterization of each step of every transaction at issue is not riecessarily critical., Instead, what matters js,whetlier,theilowef·tier partnerships v7ere indeed the söürce ofthe;asserted overstatement of-their respective outside bases aùd whether the upper tier partnership was merely'a conduit. Consequently; we omit, for now,,many of the exact details of these eitremely elaborate transactions and provide only a:cursory overviewëfinding only such factsøas bear upon the inquiry into whether we have jurisdiction over the interim partnership proceeding.

A.

. The Group Transactions The tiered partnership strategy was f rst in p mented with a eri s of transactiòns that tgok place bòtwéen March 28 and April 10, 20Ò in ughly the order that they áre descril7ed belóiv.

Mr. Rawls formed four entities: the Jerry S. Rawls Management Corp.

(JSRMC); Rawls Management Corp. (RMC); the Jerry S. Rawls Business Trust (ESBT); and the Jerry S..Rawls Family Trust (Family Trust)." Mr. Rawls was the sole shareholder, president, and director of JSRMC and RMC and the grantor, trustee, and beneficiary of ESBT. Mr. Rawls contributed 1,060,000 shares of Finisar stock to ESBT. Mr. Rawls and his brother, Warren Rawls, were the grantor and trustee, respectively, of Family Trust.. Family Trust's beneficiaries are the descendants of Mr. Rawls' parents, with the exception.ofMr. Rawls.

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ESBT and RMC formed Family, which would serve as the upper tier pártnership. Mr. Rawls, as trustee of ESBT, was a 99.99% limited partner in Family, and RMC was a 0.01% general partner, and the sole general partnèr, of Family. Mr. Rawls contributed,his interest in RMC to ESBT. ESBT contributed the 1,060,000 shares of Finisar to Family ESBT, through a brokerage account at Paine Webber, sold short Treasury nótes with a face value of $200 million, receiving $201,326,876 in proceeds.

JSRMC and ESBT formed Group, which would serve as the lower tier partnership.

ESBT received a 99.99% liniited partnership interest in Group in exchange for a JSRMC and RMC each filed a Form 2553, Election by a Small Business Còrporation. Respondent issued notices of acceptance as S corporations to JSRMC and RMC. Mr. Rawls filed an election for ESBT to be a small business trust under sec. 1361(e)(3). Respondent claims that Heritage employed an electing small business trust in its strategies to avoid having a claimed loss appear on an individual customer's tax return. According to respondent, this minimized the likelihood that the claimed loss would be detected and challenged.

contribution of thé proceeds of thé (cid:0)541hortsale, and the oblisation to closÈthe short 12- sal On its Form 1065, U.S. 11eturitáf Pahnèrship Inhome (partnership retur ), for the short ta year bèginning April 2 and ending April 6, 2Ó00, filed February 18, 2001 Groûp accounted for'the short sale þroceeds is ESBT's (cid:0)575aital contribétionPGroup did nôf accoiint for the obligãtion*to cloie fhësiiort sale as a partnershìp liability undei. sectidn!752(a) andì(b)TThu(cid:0)541,ESBT presumably received an inflatéd outside basis in Group. JSRMC fedeived a 0.01% general partnership interest in Group in exchange for a nðininal óontribution and became the sole general partner óf Gröup.

ESBT then contributéd its þartnership intere(cid:0)541tin Groüp tò Family. Faniily, presumably under authority of section 723ï inherited ESBT's inflafed outside basis. The ownership structure at this stage is set forth in the diagram below.

RAWLS

SRMC RMC 99.99% LP 0.01% GP 0.01% GP 99.99% LP JSRMC and Family then sold their respective partnership interests in Group to Family Trust." .Following this sale, all ownership interests in Group were held by Family Trust. Group, now presumably a "single member disregarded entity",14 êontinued to remain liable for the obligation to close the short sale.

On its partnership return for the short tax year beginning March 29 and ending December 31,.2000, filed October 16, 2001, Family claimed a loss of $202,418,954 on the sale of its partnership interest in Group to Family Trust., Almost the entire.amount of this loss was the result of the overstatement of Family's basis in its partnership interest in Group. This overstatement, in turn, arose from Group's failure to account for the obligation to close the short sale.

Family sold 635,297 of the 1,060,000 shares of Finisar stock that had been previously contributed to it in a secondary offering, generating net proceeds of $61,052,041.70 after a 3.9% commission. Family:Trust then closed the short sale of the Treasury notes.

Lewis Rice prepared all the documents in connection with the Group transactions.- However, Lewis Rice refused to issue a "more-likely-than-not"'' dpinion letter for the desired tax consequences. Lewis Rice believed that there as a greater than 50% likelihood that the short-term loss claimed by Family on "Mr. Rawls subsequently sold his interest in JSRMC to Heritage.

14See secs. 301.7701-1(a)(4) (providing that "certain organizations that have a single owner can choose to be recognized or disregarded as entities separate from their owners"), 301.7701-3(b)(1)(ii) (providing that a domestic entity is "[d]isregarded as an entity separate from its owner if it has a single owner."), Proced. & Admin. Regs.

the sale of its;partnership interest in Group would be disallowed uñder section 267. Specifically, the concern appears to have been that-Family and Family Trust would be deemed "related" within:the nieaning of section'267.

After discussions between Mr. Rawls and reßresentatites from Heritage and Lewis Rice; it was decided to undertake a second set oftransactiöns during Augusi and September 2000. These tfánsactions replicated the Group transactions described above in a new lower tier partnership.¹⁵ To avoid section.267 doncerns, it was arranged that the'partnership interests in this new lower tier partnershi woûld be sold to a "bona fide" third partyean4entity organized by Heritag specifically for this purpose.

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B.

The Trading Transactións The transaction with a pew lower tier partnership took place in roughly the order that they are described below. ESBT began bý contribútinf⁵,461,679 shares of Finisar stock, previòusly transferred from Mr. Rawls, to^Family.

ESBT,sthrough.a brokerage account at Donaldson,'Lufkin & Jenrette, sòld short Treasury notes with a faöe value?of $200 million, receiving $200,449,728 in proceeds. ESBT and RMC formed Rawls Trading, L.P:(Trading), which would serve as the new lower tier,partnership ESBT received a 99.99% limited "Álso, RMC was used as dhe 0.01% general jartner of the new lower tier partnership. Mr. Rawls had preyiously sold his interest in JSRMC to Heritage, as part ofthe Group transactions.. See supra note-13 16The number of contributed Finisar shares represented a 3-fon¹ stock split that had taken effect after the Group transactions had been cbmplefed.

þartnership interest in Trading in exchange for a contribution of the þroceeds of the short sale, and the obligation to close the short sale.

On its partnership return for the short tax year beginning August 17 and ending September 7, 2000, filed July 17, 2001, Trading accounted for the short Åale proceeds as ESBT's capital contribution. Trading did not account for the obligation to close the short sale as a partnership liability under section 752(a) and (b); Thus, ESBT presumably received an inflated outside basis in Trading. RMC received a 0.01% general partnership interest in Trading in exchange for a nominal contribution, and became the sole general partner of Trading.

ESBT then contributed its partnership interest in Trading to Family.

Family, presumably under authority of section 723, inherited ESBT's inflated outside basis. The ownership structure at this stage is set forth in the diagram below.

RAWLS

99.99% LP 0.01% GP 's c p 0.01% GP

TRADING

99.99% LP RMC and Family soldvtheir respective.partnershin iiíterests in Ttading to the West Coast Business Trust (West Coast). West Coast's sole trustee was Gary M.

Kornman, a "key" principal ät Heritage, and the individual who osteñsibly controlled Heritage JVest Coast was evidentlyiset up for the sole:purposes of accommodating the sale ofpartnership interests in,Trading. Following this sale, all ownership interests in Trading.were held by West Coast. Trading, now presumably a."single memberidisregarded entity"," continued to reinain.liable for the obligation to close the short sale.

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On its partnership return, Family claimed a loss of $201,951,6Ö3 on the sale of its partnership interest in Trading to West Coast Almost the entire århount of this loss was the result of the overstatement of Family's basis in its partnership interest in Trading. This overstatement, in turn, arose ffom Trading's failure to account for the obligation to close the short salë. West Coast presumably<closed the short sale of the Treasury notes.

It is reádily apparent from the foregoing description of the Group and Trading transactions that Group and Trading were, in fact, the source partnerships in which the overstatement of bases was engineered. By comparison, Family was the partnership that merely transmitted the consequenòes óf these overstated.bases to Mr. Rawls through other passthrough entities, viz, ESBT, RMC and JSRMC.

See supra note 14 (citing the applicable regulations defining a "single member disregarded entity").

As mentioned below, respondent admits as much, and in'so many words. 8 Consequently, each of Group and Trading is properly characterized as a source partnership, while Family is properly designated an interim partnership.

III. Reporting the Transactions On October 16, 2000, Lewis Rice issued a written tax opiñion to Mr. Rawls supporting the short-term capital loss claimed on Family's partnership return on account of the Trading transactions. Mr. Rawls hired Larry Poster, a certified public accountant, to prepare the tax returns for ESBT, Family Trust, Family, Group, and Trading. Mr. Poster was referred to Mr. Rawls by Heritage. Mr.

Poster had previously worked on at least one other transaction with a Heritage client, but had never previously received referral fees from or had a fee (cid:16)042 ' arrangement with Heritage. Mr. Poster characterized the Rawls transaction as involving the "generation of losses to offset other gains".

Mr. Poster reviewed and agreed with the Lewis Rice opinion. He advised Mr. Rawls that the short sale obligation was not a liability for purposeslof section 752. He also advised Mr. Rawls that it was appropriate to report the Group losses on the Family return. Mr. Poster felt it was proper to report the losses from both transactions despite the lack of an-opinion letter for the April transaction. Mr.

Poster charged Mr. Rawls $3,000.to $5,000 per return prepared.

As of the date of trial Mr. Rawls continued to control Family. At that time Family's assets included shares of stock in Finisar and other companies, bonds, 18See infra note 19 and accompanying text.

and private equity, mutual fund, and,hedge fund holdings exceeding $67 million in value, Also, as of the date of trial Mr. Poster*continued tò preparettax returns for Mr. Rawls and entities that he owned.

As mentioned above, the I{amily Group, and Trading partnership returns were filed;on October 16, February 18 and July 17 2001, respectively IV.

, Issuance of the FPAAs .

On March 9(2007, respondent timely mailed to the respective TMPs of Trading, Group,^and Family FPAAs ofthe partnership items of Trading.for the short tax year ending September 7: 2000 (Trading FPAA), Group for the short tax year ending April 6; 2000 (GrouptFPAA), and Family for the tax ýear 2000 (Family FRAA). On June 62200hTrading's;Tl¥IP, RMC, timely filed a þetitión .

for;redetermination of the partnership items of Trading as set forth in thesTrading FPAA. On June 6, 2007, RMC filed a timelygpetition under section 62?6(a) for redetermination of the partnership items of Family as set foith in the Family FPAAi On July 2, 2007, a.petition for redètermination of the partnership ifems of Group;as set forth in.the Group FPAA was filed.

On September 24 2008frpspondent filed a motion toistay the spartner-level proceedings initiated in response;to;the Family FPAA. We denied'respondent s motion without prejudice in an order of January 27, 2009. Respondent now räises the issue for the second time on brief and adopts.the same argumerits contained in his motion .

OPINION

I.

We Are Obliged To Determine Whether We Have Jurisdiction.

Neither party has questioned our jurisdiction over the Family case, or d sputed the validity of the Family FPAA: Respondent(cid:16)042insiststhat the Family FPAA is valid and merely asks us to stay the Family case until the resolution of the Group and Trading cases. See motion to stay 1=2 ("Having issued a valid, but partially premature, FPAA to Family's partners for 2000, respondent requests the case be stayed pending the outcome of the related source partnership proceedings." (Emphasis supplied.)). Petitioners object to a stay and wish for a concurrent resolution of all three consolidated cases.

Regardless of the parties' seeming acquiescence on the validity of the Family FPAA, we are under an affirmative'duty to investigate the extent of our subject matter jurisdiction. See, e.g., Arbaugh v. Y & H Corp., 546 U.S. 500, 514 (2006) (underlining that courts "have an independent obligation to determine whether subject-matter jurisdiction exists, èven in the absence of a challenge from any party"); United States v. Cottoñ, 535 U.S. 625, 630 (2002) (holding that "subject-matter jurisdiction, because it involves a court's power to hear a case, can never be forfeited or waived").

We are a court of limited jurisdictiori, and our jurisdiction is both granted and circumscribed by statute. See sec. 7442 ("The Tax Court arid its divisions shall have such jurisdiction as is conferred on them by this title"); see also Pvo v.

Còmmissioner, 83 T.C. 626, 632 (1984) ("This Court is a court of limited authority and may exercise jurisdiátion only to the extent expressly provided by Congress."). Section;6226(a)*confers jurigdiction on us over a timely filed "petition for a readjustment of the partnership items":that the Commissioner had previously adjusted pursuant to a valid FPAA. Section 6223 re*quires the Commissioner;to 'fmail to each partner whose name and áddress is furnished tô *,*, * [him] notice[s] of%* * the beginning of an administrative proceeding at the partnership level with respect to a partnership item:ànd * * * the final partnership administrative,adjustment resultingvfrom ány such proceeding.

As mentioned·above, respondent had mailed the Family FPAÆon March 9, 2007, and in response RMC had tìmely petitioned the'Court onTune 6, 2007.

Prima facie, we.would appear to have jurisdiction to readjust thê itemsithat respondent had adjusted in the Family FPAA. This presumes, however, that none of the adjustments shown on the Family FPAA constitutes a "coinputational adjustment" within the meaning of sectiorr6231(a)(6).+ If, however,sthe.Family FPAA merely reflects computational adjustments, thein, as we show below, the issuance of this FRAA before the; conclusion-of the partnership-level proceedings for Group and -Trading would render the FPAA ineffective for conferring e jurisdiction upon us.

II.

Adjustments on the Family FPAA Are Computational-Adjustmëhts Section 6231(a)(6).defines computational adjustment as "the change in the tax liability of a partner which properly reflects the treatment * * * of a e partnership.item." It adds thatCAll adjustmentsïreqûired to apply the:results.of a proceeding with respect to a partnership * * * to an indirect partner shall be treated as computational adjustments."

Section 6231(a)(10) def'mes an indirect partner as "a person holding an interest in a partnership tlirough 1 or more pass-thfu pártners " A "pass-thru" partner, in turn, is defined by section 6231(a)(9) as "a partnership * * * or other similaf person through whom other persons hold an iriterest in the partnership with respect to which proceedings under this subchapter are conducted."

Mr. Rawls was an indirect partner in each of Group and Trading because he held interests in both these entities through Family and other "páss-thru partner[s]" within the meaning of section 6231(a)(9). Therefore, to the extent the Family FPAA was merely seeking to apply to Mr. Rawls' individual tax liability the results of the adjustments shovin on the Group FPAA and Trading FPAA, pursuant to section 6231(a)(6), the Family FPAA was only making computational ' ädjustments.

Respondent admits that all adjustnients shown on the Family FPAA reflect the consequences of corresponding adjustments shown on the Group FPAA and Trading FPAA.1° Thus, to the extent the Family FPAA made any adjustments, all such adjustments were computational adjustments within the meaning of section 6231(a)(6).

19The other items shown on the Family FPAA make no change or "adjustment" to Family's return. See motion to stay 11 ("The Family FPAA, but for its prematurity vis-a-vis the source partnership proceedings, is otherwise a v[alid no change FPAA, in that it addresses items reported on the Family return that respondent determined were correctly reported.").

Computational adjustments are not, subje,ct to the full panoply of restrictions on assessments that apply to an "assessment o@a deficienby attributable:to any partnership item",under section 6225. By way,of exarnple,.which is not the case here, under section 6223(g), in the,event of "any computational adjustment required to make the treatment of the items by * * * [a] partner consistent with the treatment of the items onjhe partnership return", the Conìmissioner maÿ dispense with an FPAA and proceed to make a direct assessment of the,computational adjustrnent. If the Commissioner "erroneouslygomputed any [such] computational adjustment", under section 6230(o)(1)(A)(i) the partner is not eligible for a prepayment remedy but instead must pay,the tax and file a claim for refund Another,example,.which also does not apply here, is presented by section 6230(c)(1)(A)(ii) As set forth in that section, iffhe Commissioner "erronèously computed any computational adjustment necessary * * * to apply to the partnei. a settlement, * * [an FPAA], or the decision of a court iri an actioñ" relating to the readjustment of partnershin items, then the partner is restricted to a refund forum and may not litigate irr,deficiency mode.

In otheráords; the partner has to first pay the tax and then file a claim,for refund. See sec-6230(c)(2).

III.

.

Is the Family FPAA Valid?

A.

TEFRA Segregates Partnership and Nonpartnership Items.

TEI!RÄ's de iÉnÍs pfemised on the concepÍuaÍ Èichotomy of partnershi and nonpartner ship items. And TFFRA's procedures require "administrative and judicial resolution of disputes involving partnership items to be separate from and independent of disputes involving non-partnership items." Maxwell v.

Commissioner, 87 T.C. 783, 788 (1986) (citing H. Rept. No. 97-760, at 611 (1982) and section 6226(a) and (f)).

The terms "partnership item" and "nonpartnership item" are defined in section 6231(a)(3) and (4), respectively, as follows:

The term "partnership item" means, with respect to a partnership, any item required to be taken into account for the partnership's taxable year under any provision of subtitle A to.the extent regulations prescribed by the Secretary provide that, for purposes of this subtitle, such item is more appropriately determined at the partnership level than at the partner level.

* * * The term "nonpartnership item" means an item which is (or is treated as) not a partnership item.

.

B.

Computational Adjustments Represent Deficiency Consequences.

By comparison, and as mentioned above, pursuant to section 6231(a)(6), "The term 'computational adjustment' means the change in the tax liability of a partner which properly reflects the treatment under this subchapter of a partnership item." Thus, a computational adjustment is the consequence to the partner of a determination, whether administrative or judicial, regarding "the treatment under this subchapter of a partnership item."

Also instructive in this context is sectioi16230(a)(1), which governs the application of "subchapter B of this chapter * * * to the assessment or collection of any computational adjustment." (Emphasis supplied.) "Subchapter B of this chapter" refers to the deficiency procedures set forth in sections 6211 through 6216. Thus, it is readily apparent from the language of section 6230(a)(1) quoted above that computational adjustménts are viewed as reptêsenting the ''deficiency ifnpact'' of the proper tax treatment-of the underlying; partnership items. This partner-level deficiency consequence may directly flow from an adjüstment of a partnership item. Alternatively; it may arise from an item affected by an adjustment of a partnership item, a so-called affected itein under section 6231(a)(5).

Where the computational adjustment flows from affected items, which themselves require partner-level determinations, then section 6230(a)(2) affords the partner a prepayment forum to challenge the Commissioner's partner-level determinations and his resulting computational adjustment.

In the absence of any affected items requiring partner-level determinations, the partner cannot dispute the Commissioner's computational adjustment in deficiency mode.

Instead, the Commissioner can make a direct assessment, and the partner's remedy is limited to a claim or suit for refund. See sec. 6230(a)(1), (c)(4).

C.

Deficiency Consequences Must Await Completion of Source Partnership Proceedings.

Because a computational adjustment follows an administrative or judicial resolution of the treatment of one or more partnership items, it stands to reason that a computatioñal adjustment itself cannot be the subject of partnership-level proceedings.

In GAF Corp. & Subs. v. Commissioner, 114 T.C. 519, 525 (2000) we had followed Maxwell and its progeny to conclude that we lack jurisdiction to redetermine the effects ofthe Commissioner's partnership-level adjustments "prior to completion of the TEFRA partnership procedures". We had characterized any notice that the Commissioner may issue in the intervening period as "ineffectual" and held it to be invalid. Though GAF Corp. & Subs. and the Maxwell line of· cases dealt with notices of deficiency issued to partner-taxpayers, thèir logic applies with equal force to an FPAA issued to an interim partnership that purports to make only computational adjustments.'

In GAF Corp. & Subs. we had construed section 6225(a) as foreclosing the Commissioner from initiating a partner-level action before the underlying partnership-level proceeding has come to a close. ·We had reasoned that the Commissioner "'has no authority to assess a deficiency attributable to a partnership item until after the close of a pártnership proceeding!"' GAF Corp. & Subs. v. Commissioner, 114 T.C. at 526 (quoting Dubin v. Commissioner, 99 T.C.

325, 328 (1992)).

As mentioned above, we must consider adjustments shown on the Family FPAA as representing the deficiency impact of the adjustments made to the partnership items of the source partnerships. The reasoning advanced in GAF Corp. & Subs. would imply that adjudicating adjustments sho'wn on the Family FPAA must await culmination of the two source partnership-level proceedings.

Not just the intrinsic rationale but also·the explicit holding of GAF Corp. & Subs. precludes respondent from issuing an FPAA to Family; whi'ch shows nothing more than computational adjustments, before the completion of the partnership-level proceedings for the source partnerships. Each item adjusted by the Family FPAA-is àn "affectód item"nvithin the meaning of section 623÷1(a)(5).

As discussed above; adjustments shown on the Family FPAA simøly translate, in tax liability terms,ithe adjustments-made toothe parthershiþ itèms of Group and Trading. Thus, any item adjusted pursuant to the'Family FPAA ''is:affected by a partnership item", viz, the underlying partnership item belonging to éither Group or Trading. This partnership item, in turn, would hàve been adjusted pursuant to the respective source^FPAA We held in GAF Corp. & Subs. V..Commissioner, 1.14 T.C: at 526 (quoting Dubin v Commissioner, 99 T.C. at 328), that "'since'the tax treatnien't of affected items depends on partnership level determinationsraffected items cannot be trièd * * * until the completion of theepartnership level,prodëeding.'" It would follow that the affected items that respondent seeks to adjust by the Family FPAA "cannot be tried * * * until the completion of the [respective source] partnership level proceeding.j' D. We Lack Jurisdiction Over the Famil Casè.

For$he same reasons thatiwe had advanced in GAF Corp. & Subs:, vée hold here that an FPAA issued to;anjinterimspàrtnership showing nothing more than computational adjustments:is invalid and does not confer jurisdiction on us As outlined above, the Commissioner proceeds against a partiier-taxpayer after a TIFRA partnership-leyel proceeding,by first making a computational adjustment. _See secs. 6230, 6231(a)(6) If;the-computational adjustment does not involvé;affected ite,ms requiring partner-level determinations, then the Commissioner may directly assess the amount,0fthe computational adjustmente S sec. 6230(a)(1)r If, however, any partner-level determinations are required, then the Commissioner must issue a,so-called affected items notice of deficiency t the,pprtner-taxpayer. £e_e sec. 6230(a)(2). GAF Corp. & Subs:has interpreted s etion 6225(a) to preclude the Commissioner from issuing this notice before the partnership-level proceeding has come to a close.. And the plainilangüage of séction 6225(a) prohibits,an "assessment of a deficienóycattributable to any partnership item" before a partnership-level decision becomes final.

Thus, whether orjnot partner-level determinations are required, the Commissioner.must wait for thetcompletion ofthe partnershiplevel proceedings bþfore he can commence assessing a computationál adjustù1ent against:the partner- táxpayer.. Any.notice that the Commissioner may issue-before that time that pùrports to make a computational adjustment, whether in.the güise of an FPAA or otherwise; is therefore ineffective for conferring jurisdiction.oiiius. Resßondent acknowledges that the Family.FPAA inakes orily those adjustments that section 6231(a)(6) terms "computationál adjustinent(cid:0)541".nWeconclude'that this FPAA hióh seèks to give éff(cid:0)541ötto the adjustment(cid:0)541shovhi in thé Grofip FPAA and the Trading FPÅA, is invalid because it'was issîie'd%fore the partnership-level p oceedings in the Group case and'thè Trådins case were completed.

I .

Lack of Sùbject Mattef JurisdiótÌon Prevents a Stay.

Resþondent asserts that the.Family FPAA is otherwise alid but merely p emature.: _see'inôtion to'stay 8-9 ("Respondehf reqùessthal the Court stáý tl is case rather than di(cid:0)541missthe determinatiòàs of the.FanfilfAÍfected ItéÈs ÈÁder the holding iñ GAF v. Commissionei.".).- We cannot stäythe procèediÁg in a case ùer which we lack subject matter jufisdictionyAs thö suprême Court éxplained iiî Arbaugh Y & H Corp., 546 ÈS. at 514 ''when'âvfedèral-court cànchides thaf it lacks sùbject matter jurisdiction;îhe òourt imist di(cid:0)541misshé bomplainlìn it(cid:0)541 entirety." Cf. Thompson v5Commissioner, 137sT:C.

; __(2011) (slip op ät 9- 11) (holding "[v]oid [a]b [i]nitio * * * an áffected items nÉtice óf deficiency * * * [issued] in the absence of a need for partner-level determiiiations"R Further, in respóndent's request to staygiráther than dismiss the pròceeding in the Family case, we detect echoes of the dissent's reasoning in GAF Corp. & Subs.-v. Commissioner,114 T:C. at 531 (Halpern, J., dissenting) ("A reasbnable interpretation of the statute does not·require that we dismiss this type of case for lack ofjurisdiction, only that, if necessary, we defer proceeding uñtil considerátion of the affected items is appropriate.")., The dissent's statutory interpretation was not adopted by fhe Court's majority in GAF Còrp & Subs. and stare decisis prevents us from revisiting that argument here.

We are cognizant of respondent's concern that the "no-second-FPAA" rule of section 6223(f) may be deployed as a shield to seek immunity for Family from another round of partnerghip-level proceedings. In particular; respondent worries that if we hold invalid the Family FPAA, then ''the ability to issué a second notice under 6230(a)(2)(C) is not available." .Motion,to,stay 10. Section 6230(a)(2)(C) c9rves out exceptions from tlie "no-second-deficiency notice" rule of section 6212(c), but only for affected items notices of deficiencý issued under 6230(a)(2)(B). v Section 6230(a)(2)(C) says nothing about the Commissioner's ability to issue another FPAA to a partnership if the first FPAA has been held invalid r .

Respondent notes that "Family is itself subject to the TEFRA partnership rules requiring the issuance of a notice of final partnership administrative adjustment to Family's partners under section 6223(f) [sic] rather than a notice of deficiency under section 6212." Mdtiori to stay 10. We assume that, instead of citing section 6223(f), respondent intended to refer to section 6223(a), which requires the Secretary to "mail to each partner whose name and address is furnished to the Secretary notice of * * * the beginning of an admiriistrative proceeding at the partnership level with respect to a partnership item; ànd * * * the final partnership administrative adjustment resultií1g from ariy'such pròceeding [i.e., an FPAA]."

, Respondent argues against applying GAF Corp. & Sübs. arïd inyalidating the Family.FPAA because "section 6223(f) would prohibit respondent from issuing a second FPAA to Family after the completion of the source partnership proceedïngs:"'Motion to stay 10 Respondent depicts'the following "doomsday scenarió" if we were to dismiss the Family case for lack ofjurisdiction:

"Respondent would be forever barred froni hâving an,bppdrtunity to disallow⁴ Family's claimed flow-through losses froni the source partnerships." Id.

4-30- Assume arguendo-that respöndent in his motion tö stay is entirelytacõuráte · in his assertion about the need for:an FPAA to Familý, and complëtëly prophetic injhisipredictioneregarding the impåct of our dismissing the Family case.for lack of jurisdiction. Nevertheless, we still would not be persuaded to exercise jurisdiction ov:er3the Family case.

As noted above, our jurisdiction is.conferred by statute Specifically,-we were established "under article I of the Constitution of the Cnited'States'?±SÉc.

7441. Although an Article I creation;s"the [Tax] [C]ourt exercises a pprtion of the judicial power of the United States". .Freytag v. Commissionef, 501 UfS. 868,i891 (1991) However, we cannot exercise jurisdiction;that Congress hás not explicitly granted,us. See also Commissioner v: Gooch Milling & Elevator Co:, 320 U.(cid:0)540s 418,d422 (1943) ("The InternalxRevenue Codéenot general equitable priñciples; is the mainspring of<the * * * [Tax£ourt's] jurisdiction ").xCompare secQ442 ("The Tax Court and its divisions shall have such jurisdiction ás js:conferred on them by this title") with U.S. Const., article III, sec. 2 ch 1 ("Jurisdiction of [Article III] Courts * * * shall extend to all Cases, iu Law and Equity arising under this Constitution" (emphasis supplied)).

Unlike an Article III court, '?the Tax Court, being a court of limited e jurisdictiong* *;*:[döes] not have equitable power to expand its jurisdiction'.

Buchine v. Commissionern²⁰ F.3d1173r178 (5th Cir. 1994) (citing Cöntinentål EquitiestInc. v. Commissioner,-55142d 74, 79 (5th Cir.1972)). Thus, in:

.

determining the outer limits of the ambit of our subject matter jurisdiction, we cannot consider the consequences, howsoever harsh they may,be, that;our decision inflicts upon one of the parties.

In particular, we,do not "possess[] general equity jurisdiction", Gooch Milling & Elevator Co., 320 U.S. at 421, that could be .

exercised to prevent or undo an inequitable outcome; see also Commissioner v.

McCoy,,484 U.S. 3, 7 (1987) ("The Tax Court is a court of limited jurisdiction and lacks general equitable powers.").

But the inequitable outcome that respondent fears and foretells may not be inevitable. . There are good reasons to believe that respondent is being unduly pessimistic in prognosticating the,effects of our invalidating the Family FPAA.20 The gloom and doom in respondent's motion to stay seèm.to us to be unwarranted.

a r Strictly speaking, it lies beyond the scope of our.inquiry here to consider and opine on whether, following our decision to invalidate the Family FPAA before us and dismiss the Family case for lack ofjurisdiction, respondent may be able.to proceed against Family without issuing another FPAA." We point out, In fact, the Commissioner's thinking on this matter appears to be in 20The motion to stay seems at variance with the Commissioner's other communications addressing the need for an FPAA to proceed against an upper tier partnership. flux. Compare CCA 201020017 (May 21, 2010) (suggesting, for a tiered partnership structure, that "if the [challenged] deduction is an affected item requiring partner level determinations we may have to issue an affected item notice to disallow the deduction as an affected item. Since the partner is itself a v TEFRA partnership, we may have to issue an affected.item FPAA at that level to make this determination" (emphasis supplied)) with CCA 200907033 (Feb.:23, 2009) (declaring that "We don't issue FPAAs to [upper] tier partnerships if the adjustment originates in another 'source' partnership. We only issue an FPAA for the source partnership to all of its partners (including its partnership partners).").

Such an FPAA to Family would presumably represent the "affected items (continued...)

32- höwever, that cruöial tá òuir conclusion that ùe laólêjùfisdiótíòri oker thê*Fámil cáse is'the'provisiori in section 6231(a)(6) that "AllTdjustinents rålùífed toipþly the results of a pröcéeding witiùè(cid:0)541pecttö a partnership * * * toirÚindirect'padner shall!be treated as compûtational'àdju(cid:0)541tments."Whiléthis sentéùce her é(cid:0)541tó^ déprive us ofjuri(cid:0)541dictiónöver the Family cÃse; it riihyélso indicatè a lihth fliat respondent can traverse that does not require another Family FPAA To,the èxtent the first Fámily FPAA,-whiòh vie are invalidátiñg hei·e, represented a coinputationalvadjustment; respóndent should be able fò þföóeed against the indifect partner, Mr Rawls, withôut a:Family FPAA.TIf, äfter:the partnership-level proceedings-in the Group and Trading cases are completed, no partner-level determinatiöns are required, then respondent should be able:tó make a direct assessment of the computational adjustment.

If, òn the other hand, partner-level determinations are required, then respondent (cid:0)541houldbe able to follow the "affected items";deficiency.procedures ofLseótion 6230(a)(2).. Further, the partner-level determinations specified in section 6230(a)(2) may neompass both direct and indirect partners.

· · The definition óf "partrier" in section 6231(a)(2) ináhide(cid:0)541'notjust a."partner in the partnership", but also "any otlier per(cid:0)541oi1whose income tax liàbilitf* * * is deteiinined in whole or part.by-taking into account directly or indirectly partnership iteriis òf the partnership." (Emphasis supplied.) There i(cid:0)541no reason a (..;continued) FPAA" referred to in CCAi0f0Z0017.

e (cid:0)541uprärioie 0.

single "affected items" deficiency proceeding under section 6230(a)(2) should not suffice to make any factual determinations required to give effect to the findings and holdings of the Group and Trading cases.

V.

SourcùPartnership Proceedings Stand Alone.

Finally, we observe that our coiiclusion here is perfectly congruent with our holding in Sente Inv. Club P'ship of Utah v. Commissioner, 95 T.C. 243 (1990), that a proceeding involving a pass-thru interim partner cannot affect the treatment of items originating with lower-tier source partnerships. We held there that the treatment of items in source partnerships must be determined in separate proceedings involving those partnerships.

In doing so, we noted that "the notice provisions [of TEFRA] with respect to indirect partners are calculated to permit them an opportunity to participate in the .o.n_ly proceeding in which adjustments to the return of the partnership in which they hold an indirect interest may be contested." Id. at 249 (emphasis supplied).

It follows that the only proceedings in which adjustments to the return of the source partnerships, in which Mr. Rawls holds an indirect interest, may be contested are the Group and Trading cases. The Family FPAA is invalid, and we lack jurisdiction over the Family case.

The Court has considered all of petitioners' and respondent's contentions, arguments, requests, and statements. To the extent not discussed herein, we conclude that they are meritless, moot, or irrelevant.

HP SMM § To reflect the foregoing, An order of dismissal for lack of jurisdiction will be entered in docket No.

12938-07.

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