1 Nichols Patrick CPE, Inc. The Tax Curriculum SM

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1 OCTOBER 5, 2015 Section: 61 No Hardship Exception Exists for Recognition of Cancellation of Debt Income Despite Advice from Bank and IRS Office... 2 Citation: Dunnigan v. Commissioner, TC Memo , 9/28/ Section: 166 Taxpayer Failed to Show in Business of Loaning Money or That Debts Totally Worthless... 3 Citation: Cooper v. Commissioner, TC Memo , 9/28/ Section: 199 Creating Single Doses of Medicine Held to Be Manufacturing, Taxpayer Qualified for 199 Deduction... 4 Citation: Precision Dose v. United States, 116 AFTR 2d , 9/24/ Section: 263A Stamp Taxes Could Not Be Subtracted From Receipts to Determine Qualification for Small Reseller Exception to 263A... 6 Citation: City Line Candy & Tobacco Corp. v. Commissioner, 141 TC No. 13, 11/19/13, affd CA2, 116 AFTR 2d , 9/30/ Section: 280A Keeping House Occupied Due Insurance Requirement Did Not Allow for Deduction of Rental Loss for House Occupied by Daughter Paying Below Market Rent... 7 Citation: Okonkwo v. Commissioner, TC Memo , 9/14/ Section: 3121 Revisions Made to Procedures Agents are to Follow in Payroll Tax Exams... 8 Citation: SBSE , Procedures for Required Filing Checks and Scope of Employment Tax Examinations", 9/14/ Section: 6223 IRS Properly Issue FPAA to Partnership Holding Interest in Partnership That Had Previously Received an FPAA... 9 Citation: American Milling, LP v. Commissioner, TC Memo , 9/28/

2 SECTION: 61 NO HARDSHIP EXCEPTION EXISTS FOR RECOGNITION OF CANCELLATION OF DEBT INCOME DESPITE ADVICE FROM BANK AND IRS OFFICE Citation: Dunnigan v. Commissioner, TC Memo , 9/28/15 Mr. Dunnigan would discover, in the case of Dunnigan v. Commissioner, TC Memo that merely because your bank and an IRS employee told you there wouldn t be tax due on a cancellation of debt, that doesn t mean there actually won t be tax due. Mr. Dunnigan had taken out a $50,000 line of credit for his business in In 2009 Mr. Dunnigan found he was unable to pay off the line of credit, so he negotiated an agreement with the bank where the bank would take $15,628 in full satisfaction of the debt in question. This line of credit wasn t the only debt Mr. Dunnigan had failed to repay in He reported on his Form 1040 for the year cancellation of debt income of $68, for cancellations of debts from three other entities. But the Form 1099-C from the bank with which he had his credit line had box 5 checked, indicating Mr. Dunnigan was not liable for the repayment of the remaining debt. Mr. Dunnigan did not include that amount as taxable on his Form He did include a copy of the Form C with return on which was written the following note: PLEASE NOTE; SWIFT FINANCIAL INDICATED TO ME THAT I AM NOT LIABLE FOR REPAYMENT OF CANCELLED DEBT. I HAD EXPLAINED TO THEM THAT I HAVE A SERIOUS CANCER PROBLEM, AND THAT IM [sic] 76 YEARS OLD. THUS, THEY MARKED BOX 5 'NO'. THE LOCAL IRS OFFICE SUGGESTED I EXPLAIN THE SITUATION AT TIME OF FILING, AND FELT IT WOULD LIKELY COME UNDER 'HARDSHIP' RULES FOR APPROVAL. Mr. Dunnigan clearly believed he was not liable for tax on this amount for two separate reasons: The bank did not require that he repay the balance of the loan (and the Form 1099 noted that) The IRS office had told him that due to his situation (serious cancer problems) he would likely come under hardship rules for approval Unfortunately, neither of those reasons allowed Mr. Dunnigan to leave the cancellation of this debt out of his income for Not being held liable for repaying a debt does not mean there is no cancellation of debt income. As the Court explained: He first argues that Swift did not hold him personally liable for the repayment of the debt and it indicated this result on box 5 of Form 1099-C. Cancellation of debt income, however, may be realized without a taxpayer's personal liability for a debt. See, e.g., Gershkowitz v. Commissioner, 88 T.C. 984, 1006 (1987) (determining that taxpayers realized cancellation of debt income where a creditor discharged their nonrecourse loans in exchange for cash settlements). Moreover, petitioner did not establish that he had no obligation to repay the borrowed funds. Swift's credit agreement with petitioner and Dunnigan Appraisal provided that he was individually and severally liable for repayment of the credit line, in direct opposition to the box 5 indication. The advice from the IRS office and bank regarding hardship relief also did not help Mr. Dunnigan. As the Court noted: Petitioner also alleges that Swift and Internal Revenue Service (IRS) employees told him that "hardship" rules could apply in his case. However, he does not point to any legal authority that addresses a "hardship" exception to the taxability of discharge of indebtedness income. While there are exceptions 2

3 to the recognition of such income, they do not appear to help petitioner's case. See, e.g., sec. 108(a) (excluding discharge of indebtedness from gross income in certain cases involving, inter alia, bankruptcy and insolvency); id. subsec. (e)(2) (same as to lost deductions); id. subsec. (f) (same as to certain student loan discharges);landreth v. Commissioner, 50 T.C. 803 (1968) (creating a judicial exception that a guarantor does not realize discharge of indebtedness income upon the release of a contingent liability). The closest exceptions appear to be bankruptcy or insolvency, but the record does not show that petitioner was either bankrupt or insolvent in But shouldn t he be excused since he relied on that advice from the lender and the IRS office even if it wasn t correct? Unfortunately, that answer is no as the Court pointed out: Petitioner's reliance on alleged statements of Swift and IRS employees is also unpersuasive. A trial before the Court is a proceeding de novo, and our redetermination of a taxpayer's tax liability is based on the merits and not on any matters occurring before the notice of deficiency was sent. Greenberg's Express, Inc. v. Commissioner, 62 T.C. 324, (1974). Additionally, administrative guidance by the IRS is not binding on the Government, nor can it change the plain meaning of tax statutes. See Miller v. Commissioner, 114 T.C. 184, 195 (2000) (addressing specifically IRS publications), aff'd sub nom. Lovejoy v. Commissioner, 293 F.3d 1208 (10th Cir. 2002). In the end the Court agreed that Mr. Dunnigan had suffered hardships (in addition to the cancer, he and his wife had separated during 2009) but that there s no relief from cancellation of debt due to hardship provided for in the Internal Revenue Code. While we can t be sure, it seems most likely that the IRS office was referring more to the possibility that Mr. Dunnigan would be able to get relief from collections due to his hardships. However, as is often true when people who aren t regularly dealing with the tax system get advice, Mr. Dunnigan either did not pick up that nuance that was in the advice, or the IRS employee simply assumed that the taxpayer would understand that it meant the IRS would likely take it easy in collections, not that they would simply allow the income to be treated as nontaxable. SECTION: 166 TAXPAYER FAILED TO SHOW IN BUSINESS OF LOANING MONEY OR THAT DEBTS TOTALLY WORTHLESS Citation: Cooper v. Commissioner, TC Memo , 9/28/15 Fred Cooper lent money to various individuals, including specifically Wolper Construction, Inc. a real estate development business. In the case of Cooper v. Commissioner, TC Memo the Tax Court had to decide if Mr. Cooper could take a deduction for a bad debt in either 2008 or IRC 166 governs the deduction of bad debts for taxpayers. Differing rules apply depending on whether the debt in question is a business bad debt or is not one. Generally business bad debts represent ordinary losses and a deduction can be claimed on a debt that becomes partially worthless. A nonbusiness bad debt is deductible as a short term capital loss and for entities other than corporations per Reg (a)(2), only deductible in the year in which the debt becomes wholly worthless. Mr. Perry lent money to people referred to him by his friends, and those he loaned to included his secretary, his accountant and two business associates, as well as Wolper Construction, Inc. His lending due diligence was a bit informal, as the Court pointed out: Mr. Cooper did almost none of the due diligence that would be customary in a lending business. He did not conduct credit checks or verify collateral through title searches, and he did not collect information through any loan applications before extending loans. He testified that he would "loan to individuals based on their character and whether or not I believe that they have the ability and the willingness to 3

4 repay. I really follow this motto. You can't make an immoral man moral with a contract or the vice vers[a] is also true." Wolper Construction, like many other real estate operations, ran into financial difficulties during the middle of last decade. In April of 2007 when the corporation s $925,000 loan came due Wolper failed to pay, but Mr. Cooper indicated he wasn t terribly concerned at that point, believing the company would eventually pay. Wolper filed for Chapter 11 bankruptcy in June 2008, listing assets of $62,480,203 and liabilities of $34,571,185. A later listing of assets and liabilities showed similarly significant net equity in the business. Mr. Cooper did not file a claim in the bankruptcy proceeding. In 2009 a bank filed a creditor s claim of over $42 million and moved that the proceeding be converted to a Chapter 7 filing, arguing that a mechanic s lien listed as an asset in the bankruptcy was gross overvalued and various liabilities should be added to those listed. The proceeding was converted to a Chapter 7 proceeding and in 2010 the mechanic s lien was sold. While it had initially been valued at over $36,500,000 it was finally sold for $116,000. Mr. Cooper at this point filed an amended return, claiming a bad debt deduction in 2008 as a business loan. In the alternative he argued that if it wasn t deductible in 2008 it was deductible in The Tax Court found initially that the loan did not qualify as a business loan. Mr. Cooper was not found to be in the business of lending. The Court noted that he only made 12 loans over a six-year period from 2005 to 2010, he lent money only to friends and acquaintances, he failed to conduct his lending business in accordance with the normal formalities associated with lending, he did not publicly hold himself out as lending money and he did not keep adequate business records. Thus, if there was a bad debt in any of the years in question it would be a nonbusiness bad debt. But the Court found that Mr. Cooper had failed to show that the debt was completely worthless in either 2008 or One big problem was that Mr. Cooper continued to report the debt as an asset on both a loan application and a personal financial statement he prepared in 2009, valuing the loan to the company at over $1,000,000 in each case. As well, he failed to report the return as worthless on his original 2008 return, prepared in October of He only first acted as if the debt was worthless in 2010 when he filed an amended return. While Wolper filed bankruptcy in 2008, that filing by itself did not show the loan was worthless. In fact, the filings with the bankruptcy showed a positive net worth of tens of millions of dollars. Only when it was established that the mechanic s lien was only worth a small fraction of its listed value did it become clear that the organization was insolvent. Thus the Court found he failed to demonstrate the loan was entirely worthless by the end of either 2008 or SECTION: 199 CREATING SINGLE DOSES OF MEDICINE HELD TO BE MANUFACTURING, TAXPAYER QUALIFIED FOR 199 DEDUCTION Citation: Precision Dose v. United States, 116 AFTR 2d , 9/24/15 In the case of Precision Dose v. United States, 116 AFTR 2d , the United States District Court for the Northern District of Illinois, Western Division looked into whether a company qualified for the domestic production deduction under IRC 199. In this case the company performed the following actions in producing single doses of medication: Plaintiff sells unit doses of medications. A unit dose is a drug in a non-reusable container intended for administration as a single dose to a patient. The specific unit doses plaintiff sells are different liquid, oral drugs sealed in various size cups and syringes. Plaintiff buys, in bulk, certain drugs it deems marketable in unit doses and suitable for sale in unit doses. 4

5 Plaintiff's LR56.1 statement of facts thoroughly describes the process plaintiff undertakes in producing unit doses. The process runs the gamut from deciding what drugs to consider for possible unit doses; testing to determine their suitability and marketability; preparing specifications and documentation for the materials to be used and standard operating procedures for all processes and equipment to be used; developing cups and syringes (and the molds from which they will be made); working with the vendors that will make the containers; buying cups and syringes; contracting with laboratories to conduct stability studies to insure the drug remains within specifications when put into a unit dose and to establish expiration dates; running validation batches; setting up and conducting fill operations; conducting in process testing; conducting post-fill processing; performing release testing to determine if the unit doses are ready for release to customers; and batch record reviews to confirm no anomalies occurred during production. The IRS argued that this represented simply packaging, repackaging, labeling and minor assembly, activities excluded from the definition of manufactured, produced, grown or extracted (MPGE) under Reg (e)(2). In that case, the taxpayer would not qualify for a 199 deduction. The taxpayer argued that they did more than that, claiming to be comparable to the situation in the case of United States v. Dean, 945 F. Supp. 2d 1110 [112 AFTR 2d ] (C.D. Cal. 2013) where a taxpayer who put together gift baskets was found to have engaged in activities beyond merely repackaging goods, and thus qualified for a 199 deduction. The Court found this view compelling, noting that: Here, plaintiff's activities in producing unit doses are analogous to those in Dean. Package is defined as to present (as a product) in such a way as to heighten its appeal to the public and to enclose in a package or covering. (Last visited Sept. 2, 2015). Dean, 945 F. Supp.2d at Repackage is defined as to package again or anew: to put into a more efficient or attractive form., (Last visited Sept. 2, 2015); Dean, 945 F. Supp.2d at While it is certainly true, that packaging or repackaging is a part of what plaintiff does in producing the unit doses, plaintiff's activities include other production activities which render the (e)(2) exception inapplicable. The facts show plaintiff looks for drugs it believes it can successfully process into and sell as unit doses. Drug manufacturers do not seek bids from companies to repackage their drugs into small packages. Plaintiff engages in market research to determine which drugs to buy to turn into unit doses. Plaintiff works with potential customers to identify needs for new unit dose products. Plaintiff acquires sample drugs and tests them for suitability to be processed into unit doses. Plaintiff prepares specifications and works with vendors to develop cups and syringes that are suitable to use for unit doses for each drug that it buys. Sometimes existing cups or syringes are used and sometimes new ones are created through the joint efforts of plaintiff's personnel and vendor personnel. Plaintiff conducts mixing studies to determine the best mixing procedures to use to obtain the proper suspension of the active ingredient in each unit dose and whether the drug can be mixed in such a way that the proper suspension can be obtained at all. It tests plastics to determine compatibility with specific drugs for use in the cups or syringes. The cups, lidding, trays and product inserts are produced by vendors using plaintiff's proprietary design. For cups for which plaintiff owns the designs vendors use molds owned by plaintiff to produce the cups, for trays, which are designed by plaintiff, vendors use molds owned by plaintiff. For lidding which is designed by plaintiff, the vendors use cutting dies owned by plaintiff. This brief recitation of portions of plaintiff's activities in producing the unit doses show, that like in Dean, plaintiff engages in a complex production process that results in a distinct final product. Dean, 945 F. Supp.2d at 1118 n.10. 5

6 The IRS argues that this isn t relevant since it holds the that California District Court came to an improper conclusion in the Dean case. The trial court disagreed with the IRS s view, and held for the taxpayer. Unfortunately this is not necessarily the end of the story. As part of proposed regulations issued just over a month before this decision (REG , 8/27/15) the IRS added an example to proposed regulations to specifically provide that repackaging included what had taken place in Dean, with the preamble noting that the new example was meant to clarify the regulation and reiterating that the IRS believed Dean was erroneously decided anyway. As a practical matter, advisers should expect that agents will continue to assert this position taken in this case and Dean. As well, if the regulations go final without modification, taxpayers taking the positions advanced in this case would likely be forced to show that the IRS s interpretation in the regulations was erroneous not an easy task for the taxpayer to accomplish. SECTION: 263A STAMP TAXES COULD NOT BE SUBTRACTED FROM RECEIPTS TO DETERMINE QUALIFICATION FOR SMALL RESELLER EXCEPTION TO 263A Citation: City Line Candy & Tobacco Corp. v. Commissioner, 141 TC No. 13, 11/19/13, affd CA2, 116 AFTR 2d , 9/30/15 If a taxpayer collects a tax and then passes it on to the consumer, may it exclude that tax from its gross receipts for purposes of the small reseller exemption under IRC 263A s uniform capitalization provisions? That was the issue before the court in the case of City Line Candy & Tobacco Corp. v. Commissioner, 141 TC No. 13, The taxpayer was a wholesaler of cigarettes in New York. Under New York state law the taxpayer purchased tax stamps to affix to the cigarettes it sold. State law required that the taxpayer include the cost of such stamps in the price charged to any consumer after they were affixed to the packs of cigarettes. For financial statement purposes, the corporation reported as gross sales the total amount it charged to the retailers it sold to. However, for income tax purposes the taxpayer reduced the gross receipts by the approximate cost of the stamps and removed any deduction for stamps purchased. With the taxes included in gross revenues, the taxpayer s average gross receipts for the prior three years exceeded $10,000,000. With the taxes removed, the average was well below $10,000,000. This becomes important since a reseller with average gross receipts of less than $10,000,000 for the prior three years qualifies for the small reseller exception to the IRC 263A uniform capitalization rules. The taxpayer argued that state law imposed the tax on the consumer and, as such the amount did not represent gross receipts for the small reseller test. The Tax Court found otherwise. The Court noted that the taxpayer reported the amounts as part of its gross receipts on its financial statements, only netting the amount for tax reporting. As well, the Court found that New York law, while imposing ultimate liability on the consumer, also imposed liability on the reseller based on state case law. Thus the Court found the corporation was not eligible for the small reseller exception and was required to use the uniform capitalization rules found at IRC 263A. 6

7 SECTION: 280A KEEPING HOUSE OCCUPIED DUE INSURANCE REQUIREMENT DID NOT ALLOW FOR DEDUCTION OF RENTAL LOSS FOR HOUSE OCCUPIED BY DAUGHTER PAYING BELOW MARKET RENT Citation: Okonkwo v. Commissioner, TC Memo , 9/14/15 In the case of Okonkwo v. Commissioner, TC Memo , the taxpayer argued that he should be able to claim a loss on the rental of a property to his daughter at a below market rental rate because their homeowner s insurance policy required the property to be occupied. General IRC 280A(a) prohibits a deduction related to a residence used for personal purposes even if otherwise allowed as a rental or business deduction, subject to certain specific exceptions. Personal use is defined later in that at section at IRC 280A(d)(2) which provides: (2) Personal use of unit For purposes of this section, the taxpayer shall be deemed to have used a dwelling unit for personal purposes for a day if, for any part of such day, the unit is used - (A) for personal purposes by the taxpayer or any other person who has an interest in such unit, or by any member of the family (as defined in section 267(c)(4)) of the taxpayer or such other person; (B) by any individual who uses the unit under an arrangement which enables the taxpayer to use some other dwelling unit (whether or not a rental is charged for the use of such other unit); or (C) by any individual (other than an employee with respect to whose use section 119 applies), unless for such day the dwelling unit is rented for a rental which, under the facts and circumstances, is fair rental. As well, the vacation home rules impose a 14 day test on such personal use which will trigger found at IRC 280A(d)(1): (1) In general For purposes of this section, a taxpayer uses a dwelling unit during the taxable year as a residence if he uses such unit (or portion thereof) for personal purposes for a number of days which exceeds the greater of - (A) 14 days, or (B) 10 percent of the number of days during such year for which such unit is rented at a fair rental. For purposes of subparagraph (B), a unit shall not be treated as rented at a fair rental for any day for which it is used for personal purposes. The Tax Court found that these provisions applied regardless of what the taxpayer s insurance policy required. As it noted: Petitioners, however, contend that they are real estate developers and rented the Woodland Hills house to their daughter because their homeowners policy required that the house be occupied. Petitioners, in essence, contend that section 280A is inapplicable. Petitioners' daughter's use of the Woodland Hills house was personal and is attributed to petitioners. See secs. 267(c)(4), 280A(d)(1) and (2)(A). Because their daughter did not pay fair rental, they do not 7

8 qualify for an exception to this [*6] rule. See sec. 280A(d)(2)(C). Accordingly, deductions relating to the Woodland Hills house are limited to the extent of rental income. 3 See sec. 280A(c)(5). The taxpayers did escape being hit with a 20% substantial understatement penalty under IRC 6662(d)(1)(A) because they had been sought and followed the advice of their CPA who had extensive real estate experience. Having provided that person with all relevant information, the taxpayers were found to have reasonably relied in good faith on that advice and thus were excused from being penalized for that position. SECTION: 3121 REVISIONS MADE TO PROCEDURES AGENTS ARE TO FOLLOW IN PAYROLL TAX EXAMS Citation: SBSE , Procedures for Required Filing Checks and Scope of Employment Tax Examinations", 9/14/15 In SBSE on Procedures for Required Filing Checks and Scope of Employment Tax Examinations the IRS outlined revised procedures to be followed by agents conducting payroll tax examinations. The four-page memo contains changes that will be made to the Internal Revenue Manual IRM Agents are instructed to follow the memorandum in the interim until those changes are placed in the manual. In the area of Procedural Changes the memorandum provides the following changes: The agent is to confirm that the taxpayer complied with the following: Filed all required information returns (Forms 1096, 1099, etc.) The taxpayer properly withheld FICA from all reportable payments The taxpayer has filed all other returns, including non-payroll returns In the area of the scope of an examination, the memorandum provides the following: The agent is determine if the exam has been designated as a limited scope examination For limited scope examinations the agent must still do the following: Interview the taxpayer and tour the business Complete the filing and compliance checks noted above Fully develop the limited scope issue(s) Prepare workpapers to support the proposed adjustment If any of these steps reveal a material non-compliance issue, the agent will use his/her discretion with regard as to whether to recommend to his/her manager that the examination should be expanded. For other examinations the agent will use the information obtained during the pre-audit, interview of taxpayer and review of books and records to determine the scope of the examination Under the title of Controlling the Employment Tax Returns the memorandum provides the following: Employment tax returns under exam must generally cover the entire calendar year. Any subsidiary or related employment tax return(s) must be opened for examination as well If less than all four quarters are brought into the exam, the agent must document why not all four quarters are being examined Exams for a year should generally not be started until after January 31 of the following year Examiners also should not examine any quarter of the current year except in unusual circumstances 8

9 Examiners should expand the exam into the prior and subsequent years if the issues being looked at are material and recurring or if there other large, unusual and questionable items (LUQ) items found SECTION: 6223 IRS PROPERLY ISSUE FPAA TO PARTNERSHIP HOLDING INTEREST IN PARTNERSHIP THAT HAD PREVIOUSLY RECEIVED AN FPAA Citation: American Milling, LP v. Commissioner, TC Me mo , 9/28/15 The taxpayer in the case of American Milling, LP v. Commissioner, TC Memo argued that the Tax Court lacked jurisdiction to hear the case where the IRS would ultimately push a tax assessment down to a real taxpayer. The taxpayer in question had taken part in Son of Boss style tax shelter. That shelter can be outlined as follows: Following setting up that structure and closing the short sale (which would generate a minimal gain/loss), the interests in the two single member LLCs that had taken part in the short sale of U.S. Treasury notes were transferred to American Milling, L.P. Since American Milling, LP now held 100% of the interests in American Boat Co., LLC the entity ceased to be a federal tax partnership. American Milling, LP took the position that it had an outside basis in its interest that was $30 million more than the basis of the tugboats it had contributed (and which now were the only assets it was deemed to get back). Following the deemed liquidation of the partnership, American Milling, LP s basis in the partnership would then be fully allocable to the tugboats, thus effectively boosting their basis by $30 million. 9

10 Unfortunately for the taxpayer in this case, the courts have not been kind to these structures. The IRS challenged the arrangement, and issued a final administrative partnership adjustment (FPAA) to American Boat. The IRS contended that American Boat was a sham partnership, the transaction lacked economic substance and the short sale obligations were liabilities under IRC 752 for the partnership. American Milling, as tax matters partner of American Boat challenged the case in U.S. District Court. The District Court found for the IRS that the short sale obligations were liabilities for purposes of 752 (which effectively removed the $30 million basis inflation magic claimed) and that the short sale transaction followed by a contribution to a partnership lacked economic substance. [Am. Boat Co., LLC v. United States, No. 3:06-CV GPM-CJP (S.D. Ill. Nov. 20, 2008), aff'd, 583 F.3d 471 (7th Cir. 2009)]. The IRS did not directly assess tax against Mr. Jump, who was the taxpayer at the base of these transactions. Rather in 2013 the IRS issued an FPAA to American Milling, LP (the entity with the tugboats) that provided, as described by the Court: It states that as a result of the partnership item determinations made in the American Boat FPAA and the District Court case "all contributions, distributions, and any other transactions that American Milling * * * purportedly engaged in with American Boat * * * are disregarded for federal income tax purposes. The results of the [American Boat] partnership item determinations include but are not limited to reducing the basis of assets distributed to American Milling * * * by American Boat * * * by $31,255,986". The explanation of items further states that the Milling FPAA adjusts American Milling's claimed depreciation deductions and capital loss by reducing the bases of the tugboats by $31,255,986. Finally, the explanation of items states that American Milling's deduction of $300,000 for legal fees is disallowed because American Milling "has not established that such expenses were incurred or, if incurred, allowable under any provision of the * * * [Code]". The taxpayer object to this FPAA on two counts. First, the taxpayer claimed the FPAA issued to American Milling, LP is a duplicate FPAA in violation of IRC 6223(f). Second, the taxpayer argued that all of the adjustments in the Milling FPAA are computational adjustments flowing from the American Boat FPAA and there are no affected items requiring factual determinations at the American Milling level, and the IRS did not have authority to issue the Milling FPAA because neither the Code nor the regulations authorize the issuance of an affected items FPAA. For the first item, IRC 6223(f) provides: (f) Only one notice of final partnership administrative adjustment If the Secretary mails a notice of final partnership administrative adjustment for a partnership taxable year with respect to a partner, the Secretary may not mail another such notice to such partner with respect to the same taxable year of the same partnership in the absence of a showing of fraud, malfeasance, or misrepresentation of a material fact. The taxpayer argued the Tax Court s holding in the case of Wise Guys Holdings, LLC v. Commissioner, 140 T.C. 193 (2013) stated that issuing a second FPAA containing adjustments that similar in content dealing with the same issues required the Court to disregard the second FPAA. However, the Tax Court did not agree. It held: We invalidated the second FPAA in Wise Guys because it was issued to the same partnership for the same taxable year and there was no showing of fraud, malfeasance, or misrepresentation of fact. The similarity of the content of the two FPAAs was not essential to our holding in Wise Guys. Instead, it simply aided our finding that the second FPAA was "more [likely] the result of a mistake or a lack of communication on the part of * * * [respondent] than of fraud, malfeasance, or a misrepresentation of a material fact." Wise Guys Holdings, LLC v. Commissioner, 140 T.C. at Here, by contrast, respondent issued the Milling FPAA to the TMP of American Milling--not to the TMP of American Boat- 10

11 -for years distinct from those at issue in the American Boat FPAA. Wise Guys is distinguishable because it involved a second FPAA issued to the same taxpayer for the same tax year. The Court also noted the original District Court case dealt with very different, even if somewhat related, issues, noting Under section 6226(f), the District Court's jurisdiction in American Boat extended only to "all partnership items of * * * [American Boat] for the partnership taxable year to which * * * [the American Boat FPAA] relates, the proper allocation of such items among the partners, and the applicability of any penalty * * * which relates to an adjustment to a partnership item". The District Court did not have jurisdiction to determine the partnership items of American Milling that respondent adjusted in the Milling FPAA, which are adjustments for a different entity and for tax years different from those at issue in American Boat. Moreover, even if the District Court had made affirmative findings regarding American Milling's outside basis in American Boat or American Boat's inside bases in the tugboats for 1998, 16 those determinations would not be conclusive regarding American Milling's bases in the tugboats for 2000 through See infra p. 21. Accordingly, we reject petitioner's contentions that the Milling FPAA [*18] is an improper second FPAA or that it is a duplicate of the American Boat FPAA and therefore invalid under section 6223(f). The Tax Court also did not agree that the adjustments being made to American Milling in the FPAA were merely computation adjustments not subject an FPAA. The Court first notes: Petitioner contends that respondent's description of the adjustments in the Milling FPAA makes clear that the adjustments are merely computational because respondent expressly states that the adjustments to basis, depreciation, and loss are the result of the basis adjustments in the American Boat FPAA. However, respondent's description of the adjustments in the Milling FPAA simply notifies American Milling of the reason for the adjustments. It does not preclude the need [*20] for factual determinations to determine American Milling's correct bases in the tugboats and related depreciation deductions and capital loss amount. The Court noted that more than merely a simple computational adjustment was needed, noting: The usual rule is that an asset distributed by a partnership to one of its partners has a basis equal to the partnership's basis in that asset. Sec. 732(a). But, under section 732(b), the basis of property (other than money) distributed by a partnership to a partner in liquidation of the partner's interest equals the partner's adjusted basis in the partnership, reduced by any money distributed in the same transaction. Accordingly, when American Boat liquidated, American Milling's bases in the tugboats under section 732(b) were determined by reference to its outside basis in American Boat. The District Court did not determine American Milling's outside basis in American Boat as of December 31, 1998, the taxable year at issue in the American Boat proceeding. Moreover, even if the District Court had asserted jurisdiction to determine American Milling's outside basis, such a determination would not conclusively determine American Milling's bases in the tugboats for 2000 through Indeed, determining the legitimate bases of the tugboats and the resulting depreciation deductions and capital losses requires us to make specific factual findings at the American Milling level. For example, American Milling could have incurred capital improvement costs following the liquidating distribution that increased its bases in the tugboats. Determining that American Milling did not incur such costs is also a partnership-level determination. See, e.g., Greenwald v. Commissioner, 142 T.C. 308, 315 (2014); see also Domulewicz v. Commissioner, 129 T.C. 11, 20 (2007) ("Neither the Code nor the regulations thereunder require that partner-level determinations actually result in a substantive change to a [*22] determination made at the partnership level."), aff'd in part, remanded in part sub nom. Desmet v. Commissioner, 581 F.3d 297 (6th Cir. 2009). 11

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