                          T.C. Memo. 2010-231



                      UNITED STATES TAX COURT



                  DENNIS MALSOM, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 24084-07.                Filed October 21, 2010.



     Terri A. Merriam, Marlyn P. Chu, Jaret R. Coles, and Adam J.

Blake,1 for petitioner.

     Nhi T. Luu, for respondent.



                            MEMORANDUM OPINION


     KROUPA, Judge:   This case is one of seven pending affected

item proceedings involving separate allocation of section 6662

accuracy-related penalties under section 6015(c) (separate


     1
      Marlyn P. Chu, Jaret R. Coles, and Adam J. Blake filed
motions to withdraw as petitioner’s counsel. We granted all
three motions.
                                 -2-

liability allocation).2    The taxpayers in each of the pending

cases were investors in Hoyt cattle partnerships subject to the

provisions of the Tax Equity and Fiscal Responsibility Act of

1982 (TEFRA), Pub. L. 97-248, sec. 402, 96 Stat. 648.

     The parties in each of the pending cases have agreed that

this case and Andrews v. Commissioner, T.C. Memo. 2010-230, also

filed today, will be used to present the penalty allocation issue

to the Court.   The parties chose Andrews and Malsom because they

represent two distinct scenarios.      The requesting spouse in this

case is the spouse who earned the higher income during the years

at issue while the requesting spouse in Andrews earned the lower

income.   Nevertheless, the parties agree that the same

computational methodology should be used in all cases for

consistency.    We will therefore apply the methodology established

in Andrews to this case.

     The parties filed a Stipulation of Settled Issues at trial

that resolved all issues except the computation of petitioner’s

separate liability allocation.    The parties agree that Dennis

Malsom (petitioner) and his late spouse (Mrs. Malsom) are liable

for the accuracy-related penalties for taxable years 1989 through

1996 (the years at issue), and they agree that petitioner is

entitled to the separate liability allocation for each year.

They also agree that the computational methodology established in


     2
      All section references are to the Internal Revenue Code.
                                 -3-

Estate of Capehart v. Commissioner, 125 T.C. 211 (2005) (Capehart

Estate methodology), should be applied to determine petitioner’s

separate liability allocation.   There is no dispute as to the

liability for each year at issue.      The parties disagree, however,

on how the liabilities and the penalties should be allocated when

there are multiple sets of computational adjustments to

petitioner’s liability for each year.      There are two sets of

computational adjustments for each year because petitioner and

his late spouse were partners in multiple TEFRA partnerships, the

Tier 1 and Tier 2 partnerships, during the years at issue.3        The

Tier 2 partnerships were also partners in the Tier 1 partnership.

Petitioners reported partnership losses from both the Tier 1 and

Tier 2 partnerships on the joint returns for the years at issue.

     The parties’ disagreement focuses on the timing of the

computations.   We dealt with this same issue in Andrews.

Respondent’s proposed computations make the Tier 1 and Tier 2

computational adjustments for each year in two separate steps.

In contrast, petitioner’s proposed computations make the Tier 1

and Tier 2 computational adjustments in one step.     Applying the


     3
      Petitioner and his late spouse were partners in two
partnerships, Timeshare Breeding Services 1987 and Durham Farms
#2 (Tier 2 partnerships), during the years at issue. The Tier 2
partnerships were also partners in upper tier Hoyt partnerships
(Tier 1 partnerships). Tier 1 partnership losses flowed through
the Tier 2 partnerships to petitioner and Mrs. Malsom.
Petitioner and Mrs. Malsom reported partnership losses from both
the Tier 1 and Tier 2 partnerships on the joint returns for the
years at issue.
                                  -4-

computations in one step as petitioner proposes results in one

deficiency and one penalty for each of the years at issue.

Applying the computations in two steps as respondent proposes

results in two separate sets of deficiencies and penalties for

each year.     The allocated amounts are also different when the

computations are made in two steps rather than together in one

step.    We agree with respondent that the computations for each

TEFRA partnership must be made separately before the liabilities

and penalties are allocated under the Capehart Estate

methodology.

I.   Separate Liability Allocation and Capehart Estate Methodology

      We begin with an overview of separate liability allocation.

Generally, taxpayers filing joint Federal income tax returns are

jointly and severally liable for all taxes due.      See sec.

6013(d)(3).     A spouse (requesting spouse) may elect to have the

liability limited to his or her proportionate share of the

liability, however, if the spouses are divorced, legally

separated, or living apart for the 12 months preceding the

election.     Sec. 6015(c)(1), (3)(A)(i).   The separate liability

allocation must be made no later than two years after the

Secretary has begun collection activities with respect to the

electing spouse.     Sec. 6015(c)(3)(B).

        Liability allocation is based on the items that gave rise to

the deficiency (erroneous items).       Erroneous items are allocated
                                  -5-

to each spouse as though each had filed a separate return for the

taxable year, subject to some exceptions.    Sec. 6015(d)(3)(A).

Erroneous items are reallocated under the tax benefit exception

to the extent one spouse received a tax benefit on the joint

return and the other spouse did not.    Sec. 6015(d)(3)(B).   The

requesting spouse’s proportionate share of the deficiency is

based on his or her proportionate share of the erroneous items.

See sec. 6015(d)(1), (3)(A); sec. 1.6015-3(d)(4)(i)(A), Income

Tax Regs.

      The requesting spouse’s allocable share of the accuracy-

related penalty is based on his or her allocable share of the

underpayment.   Sec. 1.6015-3(d)(4)(iv)(B), Income Tax Regs.    The

underpayment is reduced, however, by the requesting spouse’s

share of excess withholding credits, estimated tax payments, and

other payments that were frozen by the Commissioner instead of

being refunded to the taxpayer.    See sec. 6664(a); sec. 1.6664-

2(a), (d), Income Tax Regs.   The requesting spouse’s share of the

underpayment is then multiplied by 20 percent to determine his or

her allocable share of the accuracy-related penalty.    Capehart

Estate, supra at 225-226.

II.   Applying the Computational Adjustments

      We now turn to the parties’ proposed computations of

petitioner’s separate liability allocation.    Petitioner claims

that the amount of the liability should be the same regardless of
                                -6-

whether the computational adjustments are made in one step or

multiple steps.   He analogizes the assessment of computational

adjustments in TEFRA proceedings to the computation of tax

deficiencies to support his claim.    We note, however, that normal

deficiency procedures do not apply to computational adjustments.

Sec. 6230(a)(1); see sec. 6230(a)(2)(A).   We do not find

petitioner’s analogy helpful.

     Petitioner’s proposed computations also ignore the

partnership procedures set forth in TEFRA.   See secs. 6221

through 6231.   The TEFRA rules provide for separate proceedings

at the partner and partnership levels.    See GAF Corp. & Subs. v.

Commissioner, 114 T.C. 519, 524 (2000).    The computational

adjustments at issue stem from separate partner and partnership

level proceedings.   The Tier 1 computational adjustments are

partnership-level adjustments and the Tier 2 computational

adjustments are partner-level adjustments of Tier 1 partnership

items.   Accordingly, the TEFRA rules require that the Tier 1

partnership-level computational adjustments be made separate from

the Tier 2 partner-level computational adjustments.

     Petitioner’s proposed computations also ignore the 1-year

limitation on making computational adjustments.    See sec. 6229

(a), (d).   Decisions were finalized in the Tier 1 partnership

proceedings in 2005, or almost a year before the decisions were

finalized in the Tier 2 partnership proceedings.    The Tier 1
                                 -7-

computational adjustments must therefore be made before the Tier

2 computational adjustments to comply with the Tier 1 limitations

period.

III.    Applying the Capehart Estate Methodology

       We now turn to the application of the Capehart Estate

methodology to make the separate liability allocation.       We have

already determined that the Tier 1 and Tier 2 computations for

each taxable year should be made separately and the Tier 1

computations should be made first.     The Capehart Estate

methodology should also be applied separately to each set of

computations.    This means that the tax benefit exception should

be applied twice.    The tax benefit exception should be applied

once at the Tier 1 partnership level and again at the Tier 2

partnership level.

       Petitioner’s proposed computations, however, apply the tax

benefit exception only to the Tier 1 erroneous items and ignore

the tax benefits petitioner received from the Tier 2 Hoyt income

and partnership losses.    We find that respondent’s proposed

computations properly apply the tax benefit exception separately

to the Tier 1 and Tier 2 erroneous items.

IV.    Allocation of the Penalties

       We now turn to the allocation of the penalties.   We find

that the accuracy-related penalties, which are based on the Tier

1 and Tier 2 underpayments, must also be separately allocated for
                                -8-

each set of computations.   We further find that respondent’s

computations properly account for frozen refunds before

separately allocating the Tier 1 and Tier 2 penalties.

     In reaching our holding, we have considered all arguments

made, and, to the extent not mentioned, we conclude that they are

moot, irrelevant, or without merit.


                                           An appropriate order will

                                      be issued.
