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Federal Circuit Affirms Award of Litigation Costs to Partnership in TEFRA Proceeding

(Parker Tax Publishing March 2019)

The Federal Circuit affirmed a decision of the Court of Federal Claims awarding a partnership litigation costs it incurred in connection with a proceeding under the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA). The Federal Circuit rejected the government's argument that the partnership was not entitled to litigation costs under Code Sec. 7430 because it was not a party to the partnership-level TEFRA proceeding. BASR Partnership, et al v. U.S., 2019 PTC 50 (Fed. Cir. 2019).


The Pettinati family owned a commercial printing company, Page Printing, from 1982 until they sold it in 1999. Before completing the sale, the Pettinatis hired a law firm to advise them on an investment strategy that potentially provided tax benefits arising from the sale of their business. The strategy called for the Pettinatis to form BASR, a general partnership. BASR assumed certain U.S. Treasury note obligations, which increased its cost basis. Each partner of BASR - William Pettinati, Sr., his wife, Virginia, and gift trusts belonging to their two sons, William and Andrew - contributed all of their shares in Page Printing to BASR in June 1999. Two months later, BASR sold all of its stock in Page Printing to Nationwide Graphics, Inc. for approximately $6.8 million. When offset against the overstated cost basis, BASR realized a gain of only around $263,900. By creating the BASR partnership, the Pettinatis greatly reduced the tax liability arising from the sale of their business.

A decade later, in January 2010, the IRS issued a final partnership administrative adjustment (FPAA) disallowing the tax benefits generated from BASR's 1999 tax filing. As the tax matters partner, William Pettinati, Sr. filed a petition and summary judgment motion in the Court of Federal Claims challenging the FPAA as untimely under Code Sec. 6501(a), which provides a three-year statute of limitations. At that time, BASR had zero assets, and had filed its last partnership return in 1999.

While BASR's filings were pending, the BASR partners offered the government $1 to settle all of the adjustments that the government made in the FPAA. The government rejected the offer. In September 2013, the Court of Federal Claims granted summary judgment for BASR, holding that the FPAA was untimely issued. In March 2016, BASR, by and through Pettinati, moved for litigation costs under Code Sec. 7430(c)(4)(E). The Court of Federal Claims granted BASR's motion in part and awarded BASR approximately $314,700 in litigation costs. The government appealed the award to the Federal Circuit.


Under Code Sec. 7430, the "prevailing party" may be awarded reasonable litigation costs incurred in connection with a court proceeding brought against the United States in connection with the determination, collection, or refund of any tax, interest, or penalty under the Internal Revenue Code. Generally, a party must "substantially prevail" with respect to the amount in controversy or the issues presented under Code Sec. 7430(c)(4)(A). However, special rules apply when a taxpayer makes a monetary offer to settle the tax dispute and the government rejects the offer. In that case, if the taxpayer's liability under the court's judgment turns out to be less than or equal to the taxpayer's settlement offer, the taxpayer is treated as a prevailing party as long as it is also a party to the court proceeding. This "qualified offer rule" does not apply, however, if the amount of tax liability is not "in issue" during the court proceeding. Code Sec. 7430(c)(4)(E) partially incorporates the "real-party-in-interest rule" in 28 U.S.C. Sec. 2412(d)(2)(B), which prohibits an individual whose net worth exceeds $2 million, and a partnership whose net worth exceeds $7 million, from being awarded litigation costs under Code Sec. 7430.

TEFRA enables the IRS to correct errors on a partnership's tax return in a single, unified partnership proceeding. Under TEFRA, the IRS first initiates proceedings at the partnership level to adjust partnership items. Once the tax treatment of the partnership items at the partnership level becomes final, the IRS next initiates a partner level proceeding to make any resulting computational adjustments to the individual partners' tax liability.

Observation: Congress repealed he TEFRA partnership audit rules for tax years beginning after 2017 and replaced them with a single set of rules for auditing partnerships, generally effective for tax years beginning after 2017.

The Government's Arguments

The government argued that as a partnership, BASR was not a party to the TEFRA partnership-level proceedings and therefore could not be a "prevailing party" under Code Sec. 7430(c)(4)(A). The government also argued that even if BASR were a party, it still could not receive litigation costs because there was no amount of tax liability "in issue" under Code Sec. 7430(c)(4)(E)(ii)(II).

The government further argued that BASR was ineligible for an award Sec. 7430 because it did not pay or incur any litigation costs; the government pointed out that the engagement letters and invoices related to the TEFRA partnership-level hearing were all addressed to the Pettinatis, not to BASR, and that the Pettinatis paid the invoices from their own funds.

Finally, the government argued that the Pettinatis, not BASR, were the real parties in interest because they would be liable for the litigation costs if an award was denied and would ultimately recover their litigation costs - either as a consequence of the partnership agreement or due to the inherent passthrough nature of partnerships - if an award was granted. And because the Pettinatis' net worth exceeded $2 million, they were ineligible to receive litigation costs.

The Federal Circuit's Analysis

The Federal Circuit rejected all of the government's arguments and affirmed the order granting litigation costs to BASR. The court found that under Code Sec. 6226, which concerns judicial review of FPAAs under TEFRA, a partner is treated as a party to the TEFRA partnership-level proceeding, but it does not disqualify the partnership entity from also being a party. The Federal Circuit noted that, in at least one Tax Court decision, the partners, not the partnership, were held to be the parties in a TEFRA proceeding. However, the courtt found that the Tax Court's interpretation improperly converted an inconclusive statutory provision into an exclusive one. Moreover, the Federal Circuit noted language in the Tax Court's opinion that the partners, not the partnership, were the "essential" parties in a partnership audit, leaving open the possibility that a partnership could be a nonessential party.

The Federal Circuit also found that under Code Sec. 7430(c)(4)(A)(ii), a prevailing party must meet the requirements of 28 U.S.C. Sec. 2412, which includes "any partnership" in the definition of a party. In the court's view, the fact that Code Sec. 7430 incorporates a provision that sets specific requirements for partnerships suggested that Congress intended for partnerships to be eligible for costs. The court rejected the government's position that the qualified offer rule could never result in a costs award in partnership-level cases, finding that Code Sec. 7430 applies in any proceeding "in connection with the determination, collection, or refund of any tax."

The Federal Circuit also found the definition of "in issue" in under Code Sec. 7430(c)(4)(E)(ii)(II) was broader that the government asserted and required neither a calculation nor determination of tax liability amount. The court also did not agree that BASR incurred no litigation costs; rather, BASR was obligated under the partnership to reimburse the partners for legal fees arising from the TEFRA partnership-level proceeding.

The Federal Circuit agreed with the Court of Federal Claims that BASR was the real party in interest with respect to litigation costs because BASR was liable for the costs under the partnership agreement and Texas state law. The court reasoned that if it were to deny an award in this case, BASR would be liable for the costs that the partners advanced on its behalf, even though BASR presumably would be unable to reimburse its partners. However, the court noted that if it were to grant an award, the government would be liable for the costs. In light of the foregoing and the fact that Code Sec. 7430 and 28 U.S.C. Sec. 2412 did not explicitly prohibit an insolvent party from obtaining an award, the court concluded that BASR would be the beneficiary of the award. Accordingly, the real party in interest doctrine did not prevent BASR from obtaining an award under Code Sec. 7430, the Federal Circuit concluded.

Observation: In a dissenting opinion, one judge expressed the view that the Pettinatis, not BASR, were the real parties in interest with regard to litigation costs and attorney fees because they were liable for the financial obligations resulting from the IRS's untimely issuance of the FPAA.

For a discussion of recovering litigation or administrative costs, see Parker Tax ¶263,540. For a discussion of TEFRA audit procedures, see Parker Tax ¶28,505.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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