                              T.C. Memo. 2018-191



                         UNITED STATES TAX COURT



ESTATE OF JAMES P. KEETER, DECEASED, GARRY L. HOLTON, JR., AND
    THOMAS W. SCHAEFER, CO-EXECUTORS, AND JULIE KEETER,
                          Petitioners v.
        COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 6771-16.                           Filed November 15, 2018.



      N. Jerold Cohen and Rebecca M. Stork, for petitioners.

      Gerald A. Thorpe, for respondent.



                           MEMORANDUM OPINION


      GOEKE, Judge: Pending before the Court is petitioners’ motion to restrain

the assessment or the collection of tax or to order the refund of the amount
                                         -2-

[*2] collected.1 This case is based on affected item notices of deficiency issued to

James and Julie Keeter following the completion of a partnership-level proceeding

under the unified audit and litigation partnership procedures (TEFRA). Petitioners

argue that the notices of deficiency are invalid and the Court lacks jurisdiction.2

Respondent argues that the notices are valid and acquiesces to petitioners’ motion

to restrain the assessment and the collection of tax if the Court determines that the

notices are valid. We find the notices are valid, and we will grant petitioners’

motion to restrain the assessment and collection of tax.

      The validity of the notices of deficiency depends on whether a partner-level

determination is required following the decision in the TEFRA case. Petitioners

argue that no partner-level determination is required because the partnership was a

sham, and a partner’s outside basis in a sham partnership cannot exceed zero.

Respondent agrees that a partner’s outside basis in a sham partnership is zero.

However, he contends that a partner-level determination is required where the



      1
       Unless otherwise indicated, all section references are to the Internal
Revenue Code (Code) in effect for the years at issue. All amounts are rounded to
the nearest dollar.
      2
        Petitioners argue that if we find the notices invalid, we nevertheless have
jurisdiction to enjoin the assessment and the collection of tax. Respondent argues
that we lack jurisdiction if the notices are invalid. As we find the notices valid, we
do not address petitioners’ argument.
                                          -3-

[*3] partners have claimed loss deductions on the sale of assets received in a

liquidating distribution from the sham partnership as petitioners have in this case.

Accordingly, he argues that the deficiency procedures apply, the notices of

deficiency are valid, and we have jurisdiction over the deficiencies and the

authority to enjoin the assessment and the collection of tax. We hold that the

notices are valid and we have jurisdiction over this case.

                                      Background

      The background facts are based on the pleadings and attached exhibits, the

parties’ filings with respect to petitioners’ motion, including respondent’s

objection, the parties’ supporting memoranda and attached exhibits, and other

material in the Court’s record. The parties’ written statements of fact to the Court

have not been disputed.

      Petitioners are a widow and her deceased husband’s estate. Julie Keeter

resided in Florida at the time of the petition’s filing. The estate had a mailing

address in Georgia. The record does not indicate either executor’s State of

residence. In the petition, petitioners state that the estate’s legal residence is in

Georgia.

      James and Julie Keeter filed joint tax returns for 1999 through 2003.

During 1999 the Keeters engaged in a tax shelter transaction referred to as the
                                         -4-

[*4] Bond Linked Issue Premium Structure (BLIPS) through Sanford Strategic

Investment Fund, LLC (Sanford), a partnership for Federal tax purposes. The

objective of the tax shelter was to inflate the tax shelter investor’s outside basis in

a partnership to generate a tax loss on the partner’s subsequent sale of property

received in a liquidating distribution from the partnership.

      Under the BLIPS tax shelter the investor would organize a single-member

limited liability company (LLC) that would obtain a premium loan consisting of a

principal amount and a substantial additional premium with an above-market

interest rate. Shasta Strategic Inv. Fund, LLC v. United States (Shasta Strategic),

No. C-04-04264-RS, 2014 WL 3852416, at *2 (N.D. Cal. July 31, 2014). The

premium amount of the loan was set to equal the investor’s desired tax loss. Id.

The investor also made a capital contribution to the LLC of approximately 7% of

the premium. Id. The LLC would contribute all the funds to an investment fund,

also organized as an LLC (second LLC), and the second LLC would assume the

liability to repay the loan. Id. at *3. For purposes of calculating the investor’s

outside basis in the second LLC, the investor would treat the obligation to repay

the premium portion of the loan as contingent and not as a liability assumed by the

LLC under section 752. Id. As a result the investor calculated his outside basis as

equal to the premium plus his capital contribution, resulting in an inflated outside
                                         -5-

[*5] basis. Id.; see secs. 722 (providing that a partner’s outside basis in a partner

interest acquired by a contribution of property equals the contributing partner’s

adjusted basis in the property plus any gain recognized to the contributing partner

under section 721(b)), 733 (providing that a partner’s outside basis increases for

capital contributions to the partnership and decreases for the partner’s liabilities

assumed by the partnership). The second LLC would purchase foreign currency

assets. After a brief time, typically 60 days, the investor would exit the BLIPS tax

shelter. For the investors to obtain the tax shelter benefits, the LLC would

terminate; it would sell certain assets, repay the loan, and distribute a small

amount of foreign currency and stock to the investor. The investor would claim

inflated bases in the distributed assets on the basis of his inflated basis in the LLC,

generating tax losses on the investor’s sales of the distributed assets.

      As part of the tax shelter the Keeters received a liquidating distribution of

marketable securities (stock) and foreign currency during 1999 from Sanford. The

Keeters treated the distributed assets as having adjusted bases in their hands equal

to their outside basis in Sanford pursuant to section 732(b). That same year they

sold the stock and a portion of the foreign currency. They sold the remainder of

the currency during 2000 through 2002. For 1999 the Keeters claimed a capital

loss deduction on the sale of the stock and an ordinary loss deduction on the sale
                                          -6-

[*6] of the foreign currency; for 2000 through 2002 they claimed ordinary loss

deductions on the sales of the currency. The losses were generated upon the sales

of the distributed assets as a result of the Keeters’ inflated outside basis in

Sanford.3

      On July 23, 2004, respondent issued a notice of deficiency for 1999 through

2001 to the Keeters (2004 notice) for tax deficiencies arising from the tax shelter.

In response to the 2004 notice the Keeters made payments to the Internal Revenue

Service (IRS) for 1999 and 2000 in excess of $16 million. The IRS also applied

an overpayment from 2006 of approximately $3.2 million for 2001. Subsequently,

respondent determined that he had issued the 2004 notice in error because the

TEFRA partnership-level proceeding had not been resolved and notified the

Keeters of the error in November 2007. In February 2008 the Keeters filed a

refund claim for the payments and credit. The IRS denied the refund claim on the

basis that the amounts were advance payments and not overpayments of tax.

      On July 19, 2004, respondent issued a notice of final partnership

administrative adjustment (FPAA) for Sanford’s December 22, 1999, tax period.

In the FPAA he determined that Sanford was a sham and disregarded for tax

purposes, the BLIPS transaction lacked economic substance, and the Keeters

      3
          The Keeters are partners in Sanford as defined in sec. 6231(a)(2)(B).
                                         -7-

[*7] engaged in the transaction for tax-avoidance purposes. The tax matters

partner filed a complaint in the District Court for the Northern District of

California seeking a readjustment of the partnership items in the FPAA. Sanford

Strategic Inv. Fund, LLC v. United States, No. C-04-04398-RS (N.D. Cal. filed

Oct. 18, 2004). The case was consolidated for trial with other cases involving

BLIPS tax shelters. The District Court granted summary judgment for the

Government. Shasta Strategic, 2014 WL 3852416, at *1. The District Court

examined the economic substance of the BLIPS transactions and held that they

lacked economic substance and should be disregarded for Federal tax purposes.

Id. at *5-*9. The District Court did not specifically address whether the LLCs

were shams. On January 20, 2015, the District Court entered its final judgment for

the Government with respect to all adjustments to partnership items in the FPAA

except for one issue not relevant here. Sanford Strategic Inv. Fund, LLC, No. C-

04-04398-RS (N.D. Cal. Jan. 20, 2015).

      On December 18, 2015, respondent issued a notice of deficiency to James

and Julie Keeter for each year from 1999 through 2003 relating to affected items

attributable to the TEFRA partnership proceeding. He disallowed the capital and

ordinary loss deductions that the Keeters claimed arising from the sales of the

stock and currency, respectively, and determined that the Keeters realized capital
                                         -8-

[*8] gain and ordinary income on the sales, respectively. He also made

adjustments to other items, including itemized deductions and exemptions, on the

basis of the increase in the Keeters’ adjusted gross income resulting from the

disallowance of the loss deductions. In the notices respondent determined that the

Keeters had adjusted bases in the stock and the foreign currency greater than zero.

      On that same date respondent issued notices of computational adjustment

for 1999 and 2000 for adjustments attributable to the TEFRA proceeding that

respondent determined did not require partner-level determinations. The

adjustments in the notices of computational adjustment are separate from the

adjustments determined in the notices of deficiency for 1999 and 2000 and relate

to adjustments of the Keeters’ distributive share of the income, loss, or deduction

from Sanford. On March 17, 2016, respondent assessed the deficiencies asserted

in the affected item notices as a protective measure. In their petition, petitioners

raised an issue relating to the application of the Keeters’ advance payments and

the 2006 overpayment to their tax liabilities.

      The issue for consideration is whether the adjustments in the notices of

deficiency attributable to the TEFRA decision require a partner-level

determination and thus give us jurisdiction over this case. We hold that they do
                                        -9-

[*9] and that we have jurisdiction. Accordingly, we have jurisdiction to enjoin the

assessment and the collection of tax, and we grant petitioners’ motion.

                                     Discussion

      Section 6213(a) provides that the Commissioner is generally prohibited

from assessing and collecting tax without first issuing a notice of deficiency. The

prohibition on assessment extends during the time a petition may be filed in this

Court, during the pendency of any proceeding actually brought, and until the

decision of the Court becomes final. Sec. 6213(a). The Court has jurisdiction to

enjoin the assessment and the collection of a tax deficiency that the Court has

jurisdiction to redetermine. Sec. 6213(a); see Meyer v. Commissioner, 97 T.C.

555, 560-561 (1991). We have jurisdiction to redetermine a deficiency if the

Commissioner issues a valid notice of deficiency and the taxpayer files a timely

petition. Sec. 6214(a); GAF Corp. & Subs. v. Commissioner, 114 T.C. 519, 521

(2000). We must first determine whether the notices of deficiency are valid and

we have jurisdiction over the tax deficiencies before we can enjoin the assessment

or the collection of tax.

      As a general rule, partnerships do not pay tax, and items of partnership

income, loss, deduction, and credit are reflected on the partners’ individual tax

returns. See sec. 701. The TEFRA audit and litigation procedures under sections
                                        - 10 -

[*10] 6221 through 6234 apply to partnership items. Adjustments to partnership

items from a TEFRA partnership-level proceeding may result in adjustments to the

tax liability of the individual partners. Once the partnership items become final,

the Commissioner generally must initiate further action at the partner level to

adjust an individual partner’s tax liability. An affected item is “any item to the

extent such item is affected by a partnership item.” Sec. 6231(a)(5).

      There are two types of affected items: one that does not require a partner-

level determination and one that does. Where the adjustment to the affected item

does not require a partner-level determination (computational adjustment), the

adjustment is not subject to the deficiency procedures under sections 6211 through

6216. A “computational adjustment” is the change in the partner’s tax liability to

properly reflect the treatment of a partnership item under TEFRA. Sec.

6231(a)(6). The Commissioner may immediately assess the resulting tax

deficiency from the computational adjustment against the partner without issuing a

notice of deficiency. Sec. 6230(a)(1) and (2)(A)(i); sec. 301.6231(a)(5)-1(b),

Proced. & Admin. Regs. In such case the partner does not have access to a

prepayment forum to challenge the computational adjustment and must file a

refund claim. See sec. 6230(a)(1), (c)(4). For an adjustment that does not require

a partner-level determination, a notice of deficiency would be invalid to the extent
                                        - 11 -

[*11] it pertains to that adjustment. Conversely, an adjustment to an affected item

that requires a partner-level determination is subject to the deficiency procedures,

and the Commissioner must issue a notice of deficiency to the partner before

assessing the tax. Sec. 6230(a); sec. 301.6231(a)(6)-1(a)(3), Proced. & Admin.

Regs. When an adjustment to an affected item requires a partner-level

determination, the partner has a prepayment forum to challenge the

Commissioner’s determination. Sec. 6230(a)(2)(A).

      A notice of deficiency is valid if a partner-level determination is required

before the Commissioner may assess the resulting tax deficiency. Sec.

6230(a)(2)(A)(i). Both parties agree that the TEFRA partnership-level case

effectively determined that Sanford was a sham and disregarded for Federal tax

purposes.4 Petitioners argue that no partner-level determination is required to

adjust a purported partner’s outside basis to zero in a sham partnership because a

taxpayer cannot have a basis in an asset that does not exist for tax purposes, citing

Woods v. United States, 571 U.S. 31 (2013). According to petitioners’ argument

the adjustment of outside basis to zero at the partner level following a partnership-

      4
        We do not address the parties’ position that the partnership-level case
effectively determined that the partnership was a sham. We do not need to
determine for purposes of petitioners’ motion whether the case so held as we hold
that even if the partnership was a sham, a partner-level determination is required
relating to the assets that Sanford formally distributed to the Keeters.
                                        - 12 -

[*12] level proceeding that finds the partnership to be a sham does not require a

partner-level determination or the issuance of a notice of deficiency before

assessment of the resulting tax. Accordingly, petitioners argue that the notices of

deficiency are invalid and we lack jurisdiction. Respondent contends that even if

outside basis is always zero for a sham partnership, partner-level determinations

are required in this case. He contends that partner-level determinations are

required relating to the assets distributed to the Keeters from Sanford. He argues

that the notices of deficiency are valid and we have jurisdiction. We agree with

respondent.

      The notices of deficiency adjusted loss deductions claimed by the Keeters

on the sales of the stock and currency they received in a liquidating distribution

from Sanford. In general, when a partnership distributes an asset (other than

money) to a partner other than in liquidation, the partner’s basis in the asset equals

the partnership’s adjusted basis in the asset. Sec. 732(a). When a partnership

interest is liquidated, the partner’s basis in property (other than money) received in

a liquidating distribution from the partnership generally equals the partner’s

outside basis in the partnership. Sec. 732(b). The Keeters’ outside bases in the

stock and the foreign currency received in the liquidating distribution from

Sanford would equal their (inflated) outside basis in Sanford. See sec. 732(b). As
                                        - 13 -

[*13] Sanford was a sham, petitioners argue the Keeters’ outside basis must be

zero and there is no need for a partner-level determination.

      When a partnership is a sham and disregarded for Federal tax purposes, the

activities of the partnership are deemed to be engaged in directly by the purported

partners. A disregarded partnership has no identity separate from its partners. See

6611, Ltd. v. Commissioner, T.C. Memo. 2013-49, at *61. Accordingly, there can

be no capital contributions to the purported partnership or distributions from the

purported partnership. See id. The purported partner would hold the purported

partnership’s assets directly, and his adjusted bases in the assets would be

determined under section 1012(a). See sec. 1012(a) (providing the basis of

property is generally its cost). The putative partner would not have an adjusted

basis in an asset received in a liquidating distribution that carries over from his

outside basis under section 732(b). The District Court in the partnership-level

TEFRA case held that the BLIPS transactions, including the loans and capital

contributions, lacked economic substance and were disregarded for Federal tax

purposes. Shasta Strategic, 2014 WL 3852416, at *9. Moreover, a partner’s

outside basis in his partnership interest is generally an affected item that must be

adjusted at the partner level. Sec. 6231(a)(1); see Woods, 571 U.S. at 42;

Thompson v. Commissioner, 729 F.3d 869, 873 (8th Cir. 2013), rev’g and
                                        - 14 -

[*14] remanding 137 T.C. 220 (2011); Petaluma FX Partners, LLC v.

Commissioner, 591 F.3d 649, 654-655 (D.C. Cir. 2010), aff’g in part, rev’g and

remanding in part 131 T.C. 84 (2008).

      We hold that the adjustments to the loss deductions on the sales of the stock

and the foreign currency are affected items that require partner-level

determinations. Partner-level determinations are required to adjust the loss

deductions including partner-level determinations relating to the Keeters’ holding

periods of the stock and currency, the character of the gain or loss, and whether

the stock sold by the Keeters in 1999 and the foreign currency sold in 1999

through 2003 were the stock and currency distributed by Sanford.5 See Napoliello

v. Commissioner, 655 F.3d 1060 (9th Cir. 2011), aff’g T.C. Memo. 2009-104;

Domulewicz v. Commissioner, 129 T.C. 11, 20 (2007), aff’d in relevant part,

remanded in part sub nom. Desmet v. Commissioner, 581 F.3d 297 (6th Cir.

2009). Petitioners argue that in the notices of deficiency respondent did not in fact


      5
        In the notices of deficiency respondent also determined affected item
adjustments for itemized deductions and exemptions. Although these adjustments
are mathematical computations based on applicable statutory limitations, they are
affected items that require partner-level determinations because they are
attributable to the increase in the Keeters’ adjusted gross income from the
disallowance of the loss deductions on the sales of the stock and the foreign
currency that requires partner-level determinations. See sec. 301.6231(a)(5)-1(a),
Proced. & Admin. Regs.
                                        - 15 -

[*15] make any determinations at the partner level. However, the deficiency

procedures apply even though the resulting partner-level determinations may not

alter the result. “Neither the Code nor the regulations * * * require that partner-

level determinations actually result in a substantive change to a determination

made at the partnership level.” Domulewicz v. Commissioner, 129 T.C. at 20.

Moreover, in the notices of deficiency respondent did not determine that the

distributed assets had adjusted bases of zero. Rather, he determined that the assets

had adjusted bases greater than zero.

      As we have found that the adjustments require partner-level determinations,

the deficiency procedures apply. The notices of deficiency are valid, and we have

jurisdiction over this case. Likewise, the deficiency procedures apply to the other

affected items adjusted in the notices of deficiency, including certain adjustments

to itemized deductions based on the applicable statutory limitations period for

adjusted gross income as a result of the increases to the Keeters’ adjusted gross

income from the disallowance of the loss deductions. See sec. 301.6231(a)(5)-

1(a), Proced. & Admin. Regs.

      We will grant petitioners’ motion to enjoin the assessment and the

collection of tax. We will deny as untimely that part of petitioners’ motion that

seeks a refund. We have jurisdiction to order a refund of overpayments
                                        - 16 -

[*16] determined by this Court. Sec. 6512(b); Estate of Quick v. Commissioner,

110 T.C. 440, 443 (1998); see sec. 6402(a) (granting the Secretary authority to

credit an overpayment to any tax liability). As we have not determined whether

there is an overpayment, we do not have authority to order a refund.

         In reaching our holding, we have considered all arguments made, and, to the

extent not mentioned above, we conclude that they are moot, irrelevant, or without

merit.


                                                 An appropriate order will be

                                        issued.
