                                      PETALUMA FX PARTNERS, LLC, RONALD SCOTT VANDERBEEK,
                                         A PARTNER OTHER THAN THE TAX MATTERS PARTNER,
                                              PETITIONER v. COMMISSIONER OF INTERNAL
                                                      REVENUE, RESPONDENT*
                                                        Docket No. 24717–05.                Filed December 15, 2010.

                                                  On remand we are instructed by the Court of Appeals for
                                               the District of Columbia Circuit to determine whether we
                                               have jurisdiction to determine whether a penalty under sec.
                                               6662, I.R.C., is applicable in this partnership-level case.
                                               Petaluma FX Partners, LLC v. Commissioner, 591 F.3d 649
                                               (D.C. Cir. 2010), affg. in part, revg. in part, and vacating in
                                               part 131 T.C. 84 (2008). Held: Applying the instructions set
                                               forth in the Court of Appeals’ opinion, we do not have jurisdic-
                                               tion over any sec. 6662, I.R.C., penalty determination in this
                                               case.

                                           Edward M. Robbins, Jr., for petitioner.
                                           Gerald A. Thorpe and Jason M. Kuratnick, for respondent.

                                                                      SUPPLEMENTAL OPINION

                                        GOEKE, Judge: This matter is before the Court on remand
                                      from the Court of Appeals for the District of Columbia Cir-
                                      cuit for further proceedings consistent with its opinion in
                                      Petaluma FX Partners, LLC v. Commissioner, 591 F.3d 649
                                      (D.C. Cir. 2010), affg. in part, revg. in part, and vacating in
                                      part 131 T.C. 84 (2008). The issue for decision on remand is
                                      whether this Court has jurisdiction over the determination in
                                      respondent’s notice of final partnership administrative
                                      adjustment (FPAA) issued to petitioner and other partners
                                      that all of the underpayments of tax resulting from adjust-
                                      ments of partnership items are attributable to: (1) Gross or
                                      substantial valuation misstatements penalized under section
                                      6662(a), (b)(3), (e), and (h); (2) negligence or disregard of
                                      rules or regulations penalized under section 6662(a), (b)(1),
                                      and (c); or (3) substantial understatements of income tax
                                      penalized under section 6662(a), (b)(2), and (d). 1

                                        * This Opinion supplements our prior Opinion, Petaluma FX Partners, LLC v. Commissioner,
                                      131 T.C. 84 (2008), affd. in part, revd. in part, and vacated in part 591 F.3d 649 (D.C. Cir.
                                      2010).
                                        1 Unless otherwise indicated, all section references are to the Internal Revenue Code in effect

                                      for the year in issue.


                                                                                                                                        581




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                                      582                135 UNITED STATES TAX COURT REPORTS                                      (581)


                                                                               Background
                                         We summarize relevant background from Petaluma FX
                                      Partners, LLC v. Commissioner, 131 T.C. 84 (2008)
                                      (Petaluma I), and set forth additional details for purposes of
                                      deciding the issue on remand.
                                         The dispute in this case relates to an FPAA issued to peti-
                                      tioner and other partners of Petaluma FX Partners, LLC
                                      (Petaluma or the partnership), on July 28, 2005. In the FPAA
                                      respondent made the following adjustments to items reported
                                      on Petaluma’s partnership return for its 2000 tax year and
                                      to outside bases of all the partners, items not reported on the
                                      return:
                                                        Item                              As reported           As corrected
                                             Capital contributions                         $478,800                    -0-
                                             Distributions—property
                                               other than money                              171,806                   -0-
                                             Outside partnership bases                    24,943,505                   -0-
                                             Distributions—money                             206,076                   -0-
                                             Other income                                    107,242                   -0-
                                             Tax-exempt interest income                          547                   -0-
                                             Assets—cash                                     171,939                   -0-
                                             Liabilities and capital—
                                               other current liabilities                      6,158                    -0-
                                             Partners’ capital accounts                     165,781                    -0-

                                      None of the above items result in computational adjustments
                                      (as defined in section 6231(a)(6)) to the partners’ tax liabil-
                                      ities. Petitioner has previously stipulated that substantive
                                      issues over which the Court has jurisdiction will not be con-
                                      tested. Petitioner reserved the penalty for valuation
                                      misstatement from his concession, but the Court of Appeals
                                      has held that we do not have jurisdiction over that penalty.
                                      Petaluma FX Partners, LLC v. Commissioner, 591 F.3d at
                                      655. Form 4605–A, Examination Changes—Partnerships,
                                      Fiduciaries, S Corporations, and Interest Charge Domestic
                                      International Sales Corporations, attached to the FPAA
                                      states: ‘‘I.R.C. Penalty Section 6662 is applicable at the indi-
                                      vidual partner level and may be raised in separate pro-
                                      ceedings at the partner level following the present partner-
                                      ship proceeding.’’
                                         This Court issued Petaluma I on October 23, 2008, holding
                                      that it had jurisdiction to decide: (1) That Petaluma should
                                      be disregarded for tax purposes; (2) that the partners had no




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                                      (581)        PETALUMA FX PARTNERS, LLC v. COMMISSIONER                                           583


                                      bases in their interests in the partnership since the partner-
                                      ship was disregarded; and (3) that a valuation misstatement
                                      penalty under section 6662(b)(3) applied. Petaluma I, 131
                                      T.C. at 100. The Court of Appeals affirmed our determination
                                      that we had jurisdiction to decide whether the partnership
                                      should be disregarded. However, in this partnership-level
                                      case it reversed our determination regarding partners’ out-
                                      side bases, holding that we did not have jurisdiction. The
                                      Court of Appeals remanded the case for a determination of
                                      whether this Court has jurisdiction over any penalties under
                                      section 6662. Petaluma FX Partners, LLC v. Commissioner,
                                      591 F.3d at 656.

                                                                                Discussion
                                         Applying the mandate to reconsider whether we have juris-
                                      diction over any section 6662 penalties, we conclude as
                                      explained herein that this Court lacks jurisdiction over the
                                      penalty issues in this partnership-level proceeding.
                                         After the Court of Appeals issued the mandate, we ordered
                                      the parties to state their respective positions regarding the
                                      issues on remand, and both parties have complied. There
                                      being no need for trial or further hearing, we review the par-
                                      ties’ respective positions in the light of the opinion of the
                                      Court of Appeals.
                                      I. TEFRA in General
                                         Under the Tax Equity and Fiscal Responsibility Act of
                                      1982 (TEFRA), all partnership items are determined in a
                                      single partnership-level proceeding. Sec. 6226; see also
                                      Randell v. United States, 64 F.3d 101, 103 (2d Cir. 1995). In
                                      a partnership-level proceeding, the Court’s jurisdiction is lim-
                                      ited by section 6226(f):
                                         SEC. 6226(f). SCOPE OF JUDICIAL REVIEW.—A court with which a peti-
                                      tion is filed in accordance with this section shall have jurisdiction to deter-
                                      mine all partnership items of the partnership for the partnership taxable
                                      year to which the notice of final partnership administrative adjustment
                                      relates, the proper allocation of such items among the partners, and the
                                      applicability of any penalty, addition to tax, or additional amount which
                                      relates to an adjustment to a partnership item.

                                        Section 6231(a) defines the terms ‘‘partnership item’’, ‘‘non-
                                      partnership item’’, and ‘‘affected item’’:




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                                      584                135 UNITED STATES TAX COURT REPORTS                                      (581)


                                         (3) PARTNERSHIP ITEM.—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 partner-
                                      ship level than at the partner level.
                                         (4) NONPARTNERSHIP ITEM.—The term ‘‘nonpartnership item’’ means an
                                      item which is (or is treated as) not a partnership item.
                                         (5) AFFECTED ITEM.—The term ‘‘affected item’’ means any item to the
                                      extent such item is affected by a partnership item.

                                      An ‘‘affected item’’ is by definition not a ‘‘partnership item’’.
                                      Ginsburg v. Commissioner, 127 T.C. 75, 79 (2006); see also
                                      Dial USA, Inc. v. Commissioner, 95 T.C. 1, 5 (1990). This
                                      distinction is important in the present case as affected items
                                      generally will involve issuance of notices of deficiency to indi-
                                      vidual partners, described as partner-level proceedings.
                                      II. Petitioner’s Position
                                         Petitioner first argues that this Court lacks jurisdiction to
                                      determine the amounts of any penalties in this partnership-
                                      level proceeding because no penalty relates to an adjustment
                                      to a partnership item under section 6226(f). Petitioner main-
                                      tains no underpayment arises as a result of any partnership
                                      item because there is no computational deficiency adjustment
                                      at the partner level as a result of our holding that Petaluma
                                      is to be disregarded for tax purposes. Petitioner contends
                                      that, in the light of the Court of Appeals’ holding that this
                                      Court lacks jurisdiction to determine outside basis, there is
                                      no deficiency or underpayment of tax within the jurisdiction
                                      of this Court in respect of which a penalty can be held to
                                      apply.
                                         Petitioner also argues that because the partnership is a
                                      nullity, no partnership item could create a deficiency or
                                      underpayment to which penalties could apply. Therefore, any
                                      penalty does not relate to an adjustment to a partnership
                                      item, and any penalty is an item which must be determined
                                      with a statutory notice of deficiency.
                                      III. Respondent’s Position
                                        Respondent argues that this Court has jurisdiction to
                                      determine the applicability of the gross valuation
                                      misstatement penalty because sections 6221, 6226(f), and




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                                      (581)        PETALUMA FX PARTNERS, LLC v. COMMISSIONER                                           585


                                      6230(a) give this Court jurisdiction to determine penalties
                                      related to partnership items. Respondent contends the pen-
                                      alty relates to two partnership items—the shamming of the
                                      partnership, which the Court of Appeals affirmed as the
                                      determination of a partnership item, and the amounts of the
                                      purported partners’ contributions to the partnership.
                                      IV. Court of Appeals’ Opinion
                                         The Court of Appeals held that this Court had no jurisdic-
                                      tion to determine that the outside bases of Petaluma’s part-
                                      ners were zero, as outside basis is an affected item, not a
                                      partnership item. The Court of Appeals then held, inasmuch
                                      as this Court lacked jurisdiction over outside basis, that the
                                      Court also lacked jurisdiction to determine that section 6662
                                      penalties apply with respect to outside basis because
                                      those penalties did not relate to a partnership item. With
                                      respect to other section 6662 penalties, the Court of Appeals
                                      vacated our decision and remanded the case to this Court,
                                      stating:
                                      While it may be that some penalties could have been assessed without
                                      partner-level computations, we cannot affirm a decision that has not yet
                                      been made. Therefore, we vacate the opinion of the Tax Court on the pen-
                                      alties imposition and computation. It may be that upon remand, a deter-
                                      mination can be made for some portion of the penalties, but neither party
                                      has briefed that question before us. [Petaluma FX Partners, LLC v.
                                      Commissioner, 591 F.3d at 656.]

                                      We must now decide whether we have jurisdiction to deter-
                                      mine at the partnership level whether any of the section
                                      6662 penalties apply.
                                      V. Section 6662
                                         The penalties about which jurisdiction is in question all
                                      arise under section 6662. The general rule is that if the sec-
                                      tion applies to any portion of an underpayment of tax, 20
                                      percent of that portion will be added as a penalty. In the case
                                      of a gross valuation misstatement under section 6662(h), the
                                      20-percent penalty is increased to 40 percent. Section 6662(b)
                                      describes the circumstances when the section shall apply and
                                      the penalty is triggered. Respondent asserts three of those
                                      circumstances apply in this case and also asserts all three
                                      relate to partnership-level determinations. They are neg-




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                                      586                135 UNITED STATES TAX COURT REPORTS                                      (581)


                                      ligence under section 6662(b)(1) and (c), substantial under-
                                      statement of income tax under section 6662(b)(2) and (d), and
                                      gross or substantial valuation misstatement under section
                                      6662(b)(3), (e), and (h). The Court of Appeals has agreed with
                                      petitioner’s position that this Court lacks jurisdiction over
                                      penalties that apply with respect to outside basis because
                                      those penalties do not relate to partnership item adjust-
                                      ments. There is a question whether ‘‘outside basis’’ is the cor-
                                      rect term because the partnership has been held to be a
                                      sham, but there clearly are adjustments at the partner level
                                      that will relate to the partners’ bases in assets that they
                                      sold. We are directed that such adjustments are beyond our
                                      jurisdiction and the related penalties are also. See Petaluma
                                      FX Partners, LLC v. Commissioner, 591 F.3d at 655
                                      (‘‘Petaluma argues that since the Tax Court lacked jurisdic-
                                      tion to determine outside basis, it also lacks jurisdiction to
                                      determine that penalties apply with respect to outside basis
                                      because those penalties do not relate to an adjustment to a
                                      partnership item. We agree.’’).
                                      VI. Analysis
                                         In this case none of the FPAA adjustments are items that
                                      flow directly to the partner-level deficiency computation as
                                      computational adjustments. Any deficiencies must therefore
                                      be determined against the partners as affected items and
                                      must be resolved in separate partner-level deficiency proce-
                                      dures. The section 6662 penalties are all related to these
                                      adjustments, which have not yet been made by respondent.
                                         The Court of Appeals’ decision addressed the penalty for
                                      substantial valuation misstatement, but on remand
                                      respondent asserts in this partnership-level proceeding that
                                      we have jurisdiction to determine the applicability of the 20-
                                      percent penalty under section 6662(a) and (b)(1) for neg-
                                      ligence on account of our determination that the partnership
                                      is a sham. Respondent does not offer any other issue before
                                      us where a penalty under any subsection of section 6662
                                      could be applied to an adjustment to a specific partnership-
                                      level item. We can find none in the FPAA, the pleadings, or
                                      the stipulation of settled issues.
                                         The determination that the partnership is a sham implies
                                      negligent conduct regarding formation of the partnership, but




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                                      (581)        PETALUMA FX PARTNERS, LLC v. COMMISSIONER                                           587


                                      in this case that determination does not trigger a computa-
                                      tional adjustment to taxable income of the partners. The
                                      Court of Appeals declined to allow the general effect of the
                                      partnership determination of sham to confer jurisdiction of
                                      the penalty relating to valuation because the valuation
                                      related to outside basis, an affected item. The Court of
                                      Appeals instructs that for us to have jurisdiction over a pen-
                                      alty at the partnership level it must ‘‘ ‘[relate] to an adjust-
                                      ment to a partnership item.’ ’’ Petaluma FX Partners, LLC v.
                                      Commissioner, 591 F.3d at 655 (quoting section 6226(f)). It
                                      must also be capable of being ‘‘computed without partner-
                                      level proceedings,’’ id., leading at least potentially to only a
                                      computational adjustment to the partners’ returns. The effect
                                      of the mandate concerning the section 6662 penalty is that
                                      if the penalty does not relate directly to a numerical adjust-
                                      ment to a partnership item, it is beyond our jurisdiction. In
                                      this case there are no such adjustments to which a penalty
                                      can apply. The adjustment is an affected item. The sham
                                      determination in this case only indirectly affects basis at the
                                      partner level. There is no partnership item flowing through
                                      to the partners’ returns as a computational adjustment.
                                         Therefore, in accordance with the opinion of the Court of
                                      Appeals, we conclude that we do not have jurisdiction over
                                      any section 6662 penalty determinations in this partnership-
                                      level case.
                                                                     An appropriate order and decision will
                                                                   be entered.
                                        Reviewed by the Court.
                                        COLVIN, WELLS, THORNTON, WHERRY, KROUPA, and
                                      HOLMES, JJ., agree with this majority opinion.
                                        GUSTAFSON and MORRISON, JJ., did not participate in the
                                      consideration of this opinion.



                                        HALPERN, J., dissenting: In Petaluma FX Partners, LLC v.
                                      Commissioner, 131 T.C. 84, 103 (2008), affd. in part, revd. in
                                      part, and vacated in part 591 F.3d 649 (D.C. Cir. 2010), we
                                      held that, if a partnership is disregarded for tax purposes, we
                                      have jurisdiction to treat the partners’ outside bases as zero.
                                      We added: ‘‘If a property has a basis of zero, any basis




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                                      588                135 UNITED STATES TAX COURT REPORTS                                      (581)


                                      claimed above that will be a valuation overstatement and the
                                      [section 6662 accuracy-related] penalty will apply.’’ Id. While
                                      the Court of Appeals agreed that, in this partnership-level
                                      proceeding, we have jurisdiction to disregard Petaluma as a
                                      partnership, it disagreed that, on account thereof, we can
                                      find that the partners overstated the value of their bases in
                                      Petaluma. Petaluma FX Partners, LLC v. Commissioner, 591
                                      F.3d at 655. It faulted our determination that the partners
                                      overstated their bases (thus possibly attracting a valuation
                                      misstatement penalty) on the ground that outside basis is an
                                      affected item, which we lack jurisdiction to determine in this
                                      partnership-level proceeding. Id. It questioned whether the
                                      accuracy-related penalty ‘‘could have been computed without
                                      partner-level proceedings to determine the affected-items
                                      questions concerning outside bases’’. Id. at 655–656. It specu-
                                      lated whether any penalty ‘‘could * * * [be] assessed without
                                      partner-level computations,’’ and it remanded for us to again
                                      consider the penalty. Id. at 656. The majority concludes ‘‘that
                                      we do not have jurisdiction over any section 6662 penalty
                                      determinations in this partnership-level case.’’ Majority op. p.
                                      587. I disagree.
                                         Section 6226(f) establishes our jurisdiction in a partner-
                                      ship-level proceeding to determine the applicability of pen-
                                      alties that relate to adjustments to partnership items.
                                      Respondent claims that we have adjusted partnership items
                                      in this partnership-level proceeding by disregarding
                                      Petaluma as a partnership and by redetermining the
                                      amounts of the putative partners’ contributions to it. Because
                                      of those adjustments, respondent asks that we sustain his
                                      assertion of the accuracy-related penalty imposed by section
                                      6662. That penalty is an ad valorem addition imposed on the
                                      portion of an underpayment of tax (to which the section
                                      applies) required to be shown on a tax return. See sec.
                                      6662(a). In this case, the relevant tax returns and underpay-
                                      ments are those of Petaluma’s putative partners because,
                                      although it filed a tax return, Petaluma did so as a partner-
                                      ship, which is a passthrough entity that pays no income tax.
                                      See sec. 701. Respondent’s position is that the putative part-
                                      ners underpaid their income taxes because of adjustments to
                                      partnership items made by this Court and that some or all
                                      of those underpayments are attributable to one or more of
                                      three of the circumstances specified in section 6662(b): Neg-




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                                      (581)        PETALUMA FX PARTNERS, LLC v. COMMISSIONER                                           589


                                      ligence or disregard of rules and regulations (without distinc-
                                      tion, negligence), a substantial understatement of income
                                      tax, and a substantial or gross valuation misstatement. See
                                      sec. 6662(b)(1), (2), and (3).
                                         The term ‘‘affected item’’ includes penalties such as the
                                      section 6662 accuracy-related penalty when the penalty is
                                      imposed on a partner with respect to an adjustment to a
                                      partnership item and the penalty is computed with reference
                                      to the portion of an underpayment in tax attributable to the
                                      adjustment. See sec. 301.6231(a)(5)–1T(d), Temporary
                                      Proced. & Admin. Regs., 52 Fed. Reg. 6790 (Mar. 5, 1987)
                                      (currently, section 301.6231(a)(5)–1(e), Proced. & Admin.
                                      Regs.). The penalty may be applicable here. If Petaluma is
                                      disregarded as a partnership or each putative partner’s con-
                                      tribution to Petaluma is deemed to be zero, one or more
                                      items on each putative partner’s return will change, likely
                                      resulting in a net increase in his tax liability and concomi-
                                      tant underpayment of the tax required to be shown on his
                                      return. 1 If in this proceeding we determine that one or more
                                      of the section 6662(b)(1) through (3) circumstances exist with
                                      respect to an adjustment to a partnership item, then we
                                      should sustain respondent’s determination that the penalty
                                      applies; the penalty is an affected item, and each putative
                                      partner’s liability for the penalty is determined by way of a
                                      computational adjustment. See sec. 301.6231(a)(6)–1T(a),
                                      Temporary Proced. & Admin. Regs., 64 Fed. Reg. 3840 (Jan.
                                      26, 1999) (currently, section 301.6231(a)(6)–1(a), Proced. &
                                      Admin. Regs.). Our decision that the penalty applies is nec-
                                      essarily preliminary, however, since we lack jurisdiction in
                                      this partnership-level proceeding to determine any partner’s
                                      tax liability or underpayment of tax.
                                         In Petaluma FX Partners, LLC v. Commissioner, 131 T.C.
                                      at 103, we concluded that the accuracy-related penalty
                                      applied on the ground of a valuation misstatement of outside
                                      basis. We saw no need to address whether the penalty could
                                      be applied on the grounds of negligence or understatement of
                                      income tax. Id. at 108. As stated, the Court of Appeals
                                      reversed our penalty decision on the ground that outside
                                      basis is an affected item over which, in this proceeding, we
                                        1 I conclude the results are ‘‘likely’’ only because I lack information about the particulars of

                                      the putative partners’ returns and tax liabilities.




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                                      590                135 UNITED STATES TAX COURT REPORTS                                      (581)


                                      lack jurisdiction. It questioned whether the accuracy-related
                                      penalty based on a valuation misstatement could be com-
                                      puted ‘‘without partner-level proceedings to determine the
                                      affected-items questions concerning outside bases’’. Petaluma
                                      FX Partners, LLC v. Commissioner, 591 F.3d at 655–656. It
                                      speculated whether any penalty could be assessed without
                                      partner-level computations. Id. at 656.
                                         Respondent answers the specific question posed by the
                                      Court of Appeals in the affirmative, arguing, alternatively,
                                      (1) ‘‘that the overvaluation penalty applies to any under-
                                      payment of tax that results from the determination that the
                                      partnership is a sham’’ and (2) that it applies ‘‘because * * *
                                      [it] relates to adjustments to inside basis in the contributed
                                      options.’’ With respect to his first alternative, respondent
                                      adds: ‘‘The Court can do this [determine the application of
                                      the penalty] without determining each partner’s outside
                                      basis’’. Respondent adds that, as an alternative to imposing
                                      the accuracy-related penalty on the ground of a valuation
                                      misstatement, the Court could impose the penalty on the
                                      ground of negligence or a substantial understatement of
                                      income tax.
                                         The majority believes that it cannot impose any accuracy-
                                      related penalty because any deficiencies in tax resulting from
                                      this proceeding ‘‘must therefore be determined against the
                                      partners as affected items and must be resolved in separate
                                      partner-level deficiency procedures. The section 6662 pen-
                                      alties are all related to these adjustments, which have not
                                      yet been made by respondent.’’ Majority op. p. 586. While it
                                      is true that the accuracy-related penalty is an ad valorem
                                      addition based on an underpayment of tax, which, in the case
                                      of adjustments to partnership items, may be indeterminable
                                      without a partner-level determination, respondent is here
                                      claiming that the proximate cause of any underpayment
                                      resulting from our adjustments to partnership items is either
                                      a partnership-level misstatement of value, partnership-level
                                      negligence, or the adjustments themselves, which will result
                                      in a substantial understatement of income tax. The majority
                                      appears to accept respondent’s claim of proximate cause:
                                      ‘‘The determination that the partnership is a sham implies
                                      negligent conduct regarding formation of the partnership’’.
                                      Majority op. p. 586. Nevertheless, it reads the Court of
                                      Appeals’ questioning of whether a valuation misstatement




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                                      (581)        PETALUMA FX PARTNERS, LLC v. COMMISSIONER                                           591


                                      could be computed without partner-level proceedings to
                                      determine outside basis as establishing a limiting rule: That
                                      for us to have penalty jurisdiction at the partnership level,
                                      not only must the penalty relate to a partnership item (as
                                      plainly required by section 6226(f)), but the penalty also
                                      ‘‘must * * * be capable of being ‘computed without partner-
                                      level proceedings,’ * * * leading at least potentially to only
                                      a computational adjustment to the partners’ returns.’’
                                      Majority op. p. 587. Since the accuracy-related penalty is an
                                      ad valorem addition determinable only at the taxpayer (in
                                      this case, partner) level, what the majority must mean is
                                      that a computational adjustment establishing a partner’s
                                      liability for the penalty must be achievable without the
                                      necessity of any partner-level determination. 2 The majority
                                      adds: ‘‘The effect of the mandate concerning the section 6662
                                      penalty is that if the penalty does not relate directly to a
                                      numerical adjustment to a partnership item, it is beyond our
                                      jurisdiction.’’ Majority op. p. 587. Finding no such adjust-
                                      ments, the majority concludes we have no penalty jurisdic-
                                      tion in this case. Majority op. p. 587.
                                         The Court of Appeals does not mention numerical adjust-
                                      ments, and it speaks about the inability to compute the
                                      accuracy-related penalty without partner-level proceedings
                                      only in the context of our attempt to impose the penalty on
                                      account of a valuation misstatement of an affected item; i.e.,
                                      outside basis. Respondent claims that there are grounds for
                                      the penalty that do not require us to determine an affected
                                      item (other than the penalty itself). While the Court of
                                      Appeals does speculate whether a penalty could have been
                                      assessed without a partner-level computation, both the com-
                                      putational adjustment and assessment of any penalty
                                      liability relating to a partnership item are administrative
                                      steps taken only after the close of the partnership-level pro-
                                      ceeding. See sec. 6225(a); sec. 301.6231(a)(6)–1T(a)(2), Tem-
                                      porary Proced. & Admin. Regs., supra (currently, section
                                      301.6231(a)(6)–1(a)(3), Proced. & Admin. Regs.). Moreover,
                                        2 The term ‘‘partner level determination’’ is used in sec. 301.6231(a)(6)–1T(a), Temporary

                                      Proced. & Admin. Regs., 64 Fed. Reg. 3840 (Jan. 26, 1999) (currently, sec. 301.6231(a)(6)–1(a)(1),
                                      Proced. & Admin. Regs.), to describe an intermediate, partner-level determination that, in some
                                      cases, may be necessary before a change in a partner’s tax liability to reflect the treatment of
                                      a partnership item can be made by way of a computational adjustment. The majority appears
                                      to assume that the penalties here in issue cannot be determined without partner-level deter-
                                      minations.




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                                      592                135 UNITED STATES TAX COURT REPORTS                                      (581)


                                      the regulations are clear that a penalty related to a partner-
                                      ship item may be directly assessed following the partnership-
                                      level proceeding ‘‘based on determinations in that proceeding,
                                      regardless of whether partner level determinations are
                                      required.’’ Sec. 301.6231(a)(6)–1T(a)(2), Temporary Proced. &
                                      Admin. Regs., supra (currently, section 301.6231(a)(6)–
                                      1(a)(3), Proced. & Admin. Regs.). The majority’s attribution
                                      to the Court of Appeals of a rule that a computational adjust-
                                      ment to reflect a penalty must be achievable without the
                                      necessity of any partner-level determination flies directly in
                                      the face of other language in that same regulation, which
                                      distinguishes computational adjustments with respect to pen-
                                      alties from other computational adjustments requiring
                                      partner-level determinations:
                                      However, if a change in a partner’s tax liability cannot be made without
                                      making one or more partner level determinations, that portion of the
                                      change in tax liability attributable to the partner level determinations
                                      shall be made under the provisions of subchapter B of chapter 63 of the
                                      Internal Revenue Code (relating to deficiency procedures), except for any
                                      penalty, addition to tax, or additional amount which relates to an adjust-
                                      ment to a partnership item.

                                      Sec. 301.6231(a)(6)–1T(a), Temporary Proced. & Admin.
                                      Regs., supra (emphasis supplied) (currently, section
                                      301.6231(a)(6)–1(a)(1), Proced. & Admin. Regs.). The Court of
                                      Appeals did not undertake to reorganize the procedural steps
                                      established by Congress and implemented by the Secretary
                                      for determining, computing, assessing, and collecting pen-
                                      alties related to partnership items, nor should we interpret
                                      it as doing so.
                                         We obey the Court of Appeals mandate by reconsidering
                                      the section 6662 penalty on grounds (such as those claimed
                                      by respondent) other than those, such as the putative part-
                                      ners’ outside bases, that depend on our determination of an
                                      affected item. Our task, even if we determine that the pen-
                                      alty applies, is necessarily inconclusive, since the penalty is
                                      an affected item, the amount of which is to be determined by
                                      computational adjustment, which may, as a preceding step,
                                      require one or more partner-level determinations. Our juris-
                                      diction extends to the aspects of the penalty we are author-
                                      ized to determine. Nevertheless, in exercise of that jurisdic-




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                                      (581)        PETALUMA FX PARTNERS, LLC v. COMMISSIONER                                           593


                                      tion, we may have to ask respondent to better explain the
                                      grounds he claims justify the penalty.



                                         MARVEL, J., dissenting: The Court of Appeals for the Dis-
                                      trict of Columbia Circuit remanded this case for consider-
                                      ation of whether in this partnership-level proceeding we have
                                      jurisdiction over ‘‘some portion of the penalties’’. See
                                      Petaluma FX Partners, LLC v. Commissioner, 591 F.3d 649,
                                      656 (D.C. Cir. 2010) (Petaluma II), affg. in part, revg. in part,
                                      vacating in part and remanding 131 T.C. 84 (2008)
                                      (Petaluma I). The majority concludes that we do not.
                                      Majority op. p. 583. Because I believe that the result the
                                      majority reaches is contrary to sections 6221 and 6226(f) as
                                      amended by the Taxpayer Relief Act of 1997 (TRA 1997), Pub.
                                      L. 105–34, sec. 1238, 111 Stat. 1026, I respectfully dissent.
                                      I. The Court of Appeals Opinion
                                         In Petaluma I we held, among other things, that (1) we
                                      had jurisdiction to decide whether the partnership used to
                                      achieve the challenged tax benefits was a sham and/or lacked
                                      economic substance, (2) we also had jurisdiction to decide
                                      that the partners’ outside bases were overstated because the
                                      partners could not have bases in a disregarded or sham part-
                                      nership, (3) we had jurisdiction over the section 6662
                                      accuracy-related penalty because section 6226(f) gave us
                                      jurisdiction to determine ‘‘the applicability of any penalty,
                                      addition to tax, or additional amount which relates to an
                                      adjustment to a partnership item’’, 1 and (4) a 40-percent
                                      accuracy-related penalty attributable to the gross valuation
                                      misstatement of the partners’ outside bases applied. See
                                      Petaluma I, 131 T.C. at 100, 102, 108. In Petaluma II, the
                                      Court of Appeals for the District of Columbia Circuit
                                      affirmed our holding in (1) but reversed our holdings in (2)
                                      and (4), and vacated and remanded ‘‘on the penalties ques-
                                      tion’’. See Petaluma II, 591 F.3d at 656. The Court of
                                      Appeals stated as follows:
                                        1 Although we held we had jurisdiction over the sec. 6662 accuracy-related penalty, we did not

                                      reach the issue of the applicability of any components other than the gross valuation
                                      misstatement component. See Petaluma I, 131 T.C. at 100–102.




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                                      594                135 UNITED STATES TAX COURT REPORTS                                      (581)


                                      As it is not clear from the opinion, the record, or the arguments before this
                                      court that the penalties asserted by the Commissioner and ordered by the
                                      Tax Court could have been computed without partner-level proceedings to
                                      determine the affected-items questions concerning outside bases, we are
                                      unable to uphold the court’s determination of the penalty issues. While it
                                      may be that some penalties could have been assessed without partner-level
                                      computations, we cannot affirm a decision that has not yet been made.
                                      Therefore, we vacate the opinion of the Tax Court on the penalties imposi-
                                      tion and computation. It may be that upon remand, a determination can
                                      be made for some portion of the penalties, but neither party has briefed
                                      that question before us. [Id. at 655–656.]

                                        The Court of Appeals remanded ‘‘on the penalties question’’
                                      because it was not clear ‘‘that the penalties asserted by the
                                      Commissioner and ordered by the Tax Court could have been
                                      computed without partner-level proceedings to determine the
                                      affected-items questions concerning outside bases’’. Id. The
                                      Court of Appeals acknowledged the possibility that on
                                      remand a determination could be made ‘‘for some portion of
                                      the penalties’’. Id. at 656.
                                      II. The Section 6662 Penalty in Petaluma
                                           A. In General
                                        Although respondent’s primary argument under section
                                      6662 is that a 40-percent accuracy-related penalty applies
                                      because of a gross valuation misstatement, he also asserted
                                      in the FPAA a 20-percent accuracy-related penalty attrib-
                                      utable to negligence or to a substantial understatement of
                                      income tax. The application of any of these components of the
                                      accuracy-related penalty involves the juxtaposition of section
                                      6662, the Tax Equity and Fiscal Responsibility Act of 1982
                                      (TEFRA), Pub. L. 97–248, sec. 402, 96 Stat. 648, and amend-
                                      ments to TEFRA by TRA 1997. To better understand the scope
                                      of our jurisdiction over the section 6662 penalty in partner-
                                      ship-level TEFRA cases, an overview of TEFRA and the TRA
                                      1997 amendments is helpful.
                                           B. TEFRA Litigation Structure
                                        Before 1982 partnership tax issues were raised and liti-
                                      gated at the partner level, resulting in bloated caseloads and
                                      duplicative litigation of partnership issues. See Domulewicz
                                      v. Commissioner, 129 T.C. 11, 17 (2007), affd. in part and
                                      remanded in part on other grounds sub nom. Desmet v.




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                                      (581)        PETALUMA FX PARTNERS, LLC v. COMMISSIONER                                           595


                                      Commissioner, 581 F.3d 297 (6th Cir. 2009). In an effort to
                                      eliminate the perceived inefficiencies, the waste of resources,
                                      and the potential for inconsistent results among partners on
                                      the same partnership issues that could result from duplica-
                                      tive litigation at the partner level, Congress, at the Depart-
                                      ment of the Treasury’s request, enacted the unified partner-
                                      ship audit and litigation provisions as part of TEFRA. See id.
                                      The provisions were constructed around a simple premise—
                                      although a partnership is not an entity that is liable for Fed-
                                      eral income tax, partnership tax issues ordinarily must be
                                      resolved in a single proceeding at the partnership level. See
                                      id. at 17–18.
                                         The basic structure of partnership litigation under TEFRA
                                      is easy to understand. Section 6221 provides that the tax
                                      treatment of any partnership item ‘‘shall be determined at
                                      the partnership level.’’ 2 Section 6222(a) provides that a
                                      partner, on the partner’s return, shall treat a partnership
                                      item in a manner consistent with the treatment of the item
                                      on the partnership return. If the Commissioner audits the
                                      partnership return and determines that adjustments to part-
                                      nership items are necessary, he must issue an FPAA to the
                                      partnership (through the tax matters partner) and send a
                                      copy of the FPAA to all partners who are entitled to notice.
                                      See sec. 6223(a)(2).
                                         The tax matters partner or a partner/partners with a large
                                      enough partnership interest may file a petition for judicial
                                      review of the FPAA within certain time limits. Sec. 6226(a)
                                      and (b). A court with which a petition is filed has jurisdiction
                                      ‘‘to determine all partnership items of the partnership for the
                                      partnership taxable year to which the * * * [FPAA] relates
                                      and the proper allocation of such items among the partners.’’
                                      Sec. 6226(f), I.R.C. 1996 (before amendment by TRA 1997).
                                         After the restrictions on assessment and collection under
                                      section 6225 no longer apply, the Commissioner is authorized
                                         2 Partnership items are items required to be taken into account for the partnership’s taxable

                                      year to the extent that those items are more appropriately determined at the partnership level
                                      than at the partner level. See sec. 6231(a)(3). Nonpartnership items that are affected by adjust-
                                      ments to partnership items are called ‘‘affected items’’. Sec. 6231(a)(5). There are two types of
                                      affected items: (1) Items that require factual determinations to be made at the partner level,
                                      and (2) items that require merely a computational adjustment, such as the amount of a medical
                                      expense deduction under sec. 213(a). See N.C.F. Energy Partners v. Commissioner, 89 T.C. 741,
                                      744–745 (1987). The former group, the ‘‘substantive’’ affected items, has not only a computa-
                                      tional element but also a substantive element in that a court must consider evidence and find
                                      facts regarding the affected item in an affected items deficiency proceeding.




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                                      596                135 UNITED STATES TAX COURT REPORTS                                      (581)


                                      to make computational adjustments to the partners’ tax
                                      liabilities to reflect the adjustment of partnership items in
                                      the partnership-level proceeding. Sec. 6231(a)(6) (definition of
                                      computational adjustment); sec. 301.6231(a)(6)–1T(a), Tem-
                                      porary Proced. & Admin. Regs., 64 Fed. Reg. 3840 (Jan. 26,
                                      1999). The deficiency procedures do not apply to the assess-
                                      ment or collection of any computational adjustment unless
                                      the computational adjustment involves a deficiency attrib-
                                      utable to an affected item that requires a partner-level deter-
                                      mination or to items that have become nonpartnership items.
                                      Sec. 6230(a)(1) and (2). If the computational adjustment
                                      involves a deficiency attributable to an affected item that
                                      requires a partner-level determination, the Commissioner
                                      must issue an affected items notice of deficiency to the
                                      partner. Sec. 6230(a)(2). Accordingly, there are two types of
                                      computational adjustments paralleling two types of affected
                                      items: (1) Purely mathematical computational adjustments
                                      that do not require partner-level determinations and may be
                                      directly assessed, 3 see sec. 6230(a)(1); sec. 301.6231(a)(6)–
                                      1T(a)(1), Temporary Proced. & Admin. Regs., supra, and (2)
                                      adjustments that require partner-level determinations and
                                      are therefore subject to deficiency procedures, see sec.
                                      6230(a)(2); sec. 301.6231(a)(6)–1T(a)(2), Temporary Proced. &
                                      Admin. Regs., supra. After the Commissioner issues an
                                      affected items notice of deficiency, generally the partner may
                                      file a Tax Court petition to contest it. See sec. 6213. Alter-
                                      natively, the partner can pay the affected item deficiency, file
                                      a claim for refund, and then bring a refund action. See 28
                                      U.S.C. sec. 1346(a)(1) (2006).
                                         The devil, of course, is in the details, and sections 6221–
                                      6233, as originally enacted, raised many difficult interpretive
                                      issues that occupied this Court and others for years after
                                      TEFRA was enacted. For example, it became apparent in prac-
                                      tice that the litigation procedures as originally enacted did
                                      not adequately address how penalties and additions to tax
                                      that might require partner-level determinations fit into the
                                      partnership litigation regime. 4 Congress took notice and
                                        3 There is no prepayment forum for contesting the accuracy of such adjustments. However, if

                                      an affected item deficiency proceeding is pending, the Tax Court may extend its overpayment
                                      jurisdiction to consider computational adjustments that have been assessed and paid. See, e.g.,
                                      Barton v. Commissioner, 97 T.C. 548 (1991) (overpayment jurisdiction applied).
                                        4 For example, in Maxwell v. Commissioner, 87 T.C. 783, 790, 793 (1986), a reviewed Opinion,

                                      this Court held that additions to tax and investment tax credit carrybacks were ‘‘affected items’’




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                                      (581)        PETALUMA FX PARTNERS, LLC v. COMMISSIONER                                           597


                                      began tweaking the TEFRA provisions to fill gaps in the proce-
                                      dures and make them work better. Two such adjustments
                                      occurred when Congress, as part of the Tax Reform Act of
                                      1986, Pub. L. 99–514, sec. 1875(d), 100 Stat. 2896, enacted
                                      technical corrections to TEFRA that included (1) adding new
                                      section 6229(g), which extended the period of limitations on
                                      assessment with respect to additions to tax affected by
                                      adjustments to partnership items, and (2) amending section
                                      6230(a) to permit the Commissioner to issue an affected
                                      items notice of deficiency. The most relevant adjustments for
                                      purposes of this case, however, occurred in 1997 when Con-
                                      gress enacted TRA 1997.
                                           C. TRA 1997
                                         Before the enactment of TRA 1997, penalties and additions
                                      to tax were classified as affected items and issues regarding
                                      such items were litigated in a partner-level deficiency pro-
                                      ceeding regardless of whether they related to adjustments to
                                      partnership items. See, e.g., N.C.F. Energy Partners v.
                                      Commissioner, 89 T.C. 741, 744–745 (1987). TRA 1997
                                      amended section 6221 to provide that a penalty or addition
                                      to tax ‘‘which relates to an adjustment to a partnership item’’
                                      must be determined at the partnership level. TRA 1997 also
                                      amended section 6226(f) to provide that a court with jurisdic-
                                      tion over a partnership-level proceeding had jurisdiction over
                                      a penalty or addition to tax ‘‘which relates to an adjustment
                                      to a partnership item’’. See sec. 6226(f). Among other impor-
                                      tant changes was the change to section 6230(a)(2)(A)(i),
                                      which was amended to read as follows:
                                      SEC. 6230. ADDITIONAL ADMINISTRATIVE PROVISIONS.
                                           (a) COORDINATION WITH DEFICIENCY PROCEEDINGS.—
                                              (1) IN GENERAL.—Except as provided in paragraph (2) or (3), sub-
                                           chapter B of this chapter[5] shall not apply to the assessment or collec-
                                           tion of any computational adjustment.
                                              (2) DEFICIENCY PROCEEDINGS TO APPLY IN CERTAIN CASES.—
                                                (A) Subchapter B shall apply to any deficiency attributable to—

                                      that must be dismissed from a deficiency proceeding to await the outcome of pending partner-
                                      ship proceedings.
                                        5 Subch. B (secs. 6211 through 6216) contains the provisions authorizing the Commissioner

                                      to issue notices of deficiency and provides the Tax Court with jurisdiction to redetermine those
                                      deficiencies.




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                                      598                135 UNITED STATES TAX COURT REPORTS                                      (581)


                                                 (i) affected items which require partner level determinations
                                               (other than penalties, additions to tax, and additional amounts that
                                               relate to adjustments to partnership items) * * *

                                      Finally, TRA 1997 provided that a partner may file a claim
                                      for refund on the ground that ‘‘the Secretary erroneously
                                      imposed any penalty, addition to tax, or additional amount
                                      which relates to an adjustment to a partnership item.’’ Sec.
                                      6230(c)(1)(C).
                                         As described, under the TEFRA provisions as amended by
                                      TRA 1997, penalties and additions to tax are treated dif-
                                      ferently from other affected items. The net effect of the TRA
                                      1997 changes is that deficiency procedures no longer apply to
                                      penalties and additions to tax related to adjustments to part-
                                      nership items, even if they require factual determinations at
                                      the partner level. Sec. 6230(a)(2)(A)(i); Domulewicz v.
                                      Commissioner, 129 T.C. at 23; Fears v. Commissioner, 129
                                      T.C. 8 (2007). Although the Court has jurisdiction in a part-
                                      nership-level proceeding to consider whether the penalty
                                      attributable to an adjustment to a partnership item applies,
                                      it has no jurisdiction to decide the amount of the penalty or
                                      consider partner-level defenses. Cf. Domulewicz v. Commis-
                                      sioner, supra at 23.
                                           D. The Interaction of Section 6662(a) and TEFRA
                                         In Petaluma, as in most typical Son-of-BOSS cases,
                                      respondent alleged alternative positions with respect to the
                                      section 6662 penalty in the FPAA. Respondent’s primary posi-
                                      tion was that the 40-percent accuracy-related penalty applied
                                      because of a gross valuation misstatement of something, 6
                                        6 Generally, the valuation misstatement penalty applies if there is a misstatement of value

                                      or basis of property on a return. See sec. 6662(e). In the Petaluma FPAA, respondent adjusted
                                      the following items to zero: Capital contributions, distributions of property other than money,
                                      outside partnership basis, and the partners’ capital accounts. All of these items involve a state-
                                      ment of property value or basis, and all of the items, except outside partnership basis, are part-
                                      nership items. In pertinent part, the FPAA stated as follows:
                                      The formation of Petaluma FX Partners, LLC, the acquisition of any interest in the purported
                                      partnership by the purported partner, the purchase of offsetting options, the transfer of offset-
                                      ting options to a partnership in return for a partnership interest, the purchase of assets by the
                                      partnership, and the distribution of those assets to the purported partners in complete liquida-
                                      tion of the partnership interests, and the subsequent sale of those assets to generate a loss, had
                                      no business purpose other than tax avoidance, lacked economic substance, and, in fact and sub-
                                      stance, constitutes (sic) an economic sham for federal income tax purposes. Accordingly, the
                                      partnership and the transaction described above shall be disregarded in full and any purported
                                      losses resulting from these transactions are not allowable as deductions for federal income tax
                                      purposes.




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                                      (581)        PETALUMA FX PARTNERS, LLC v. COMMISSIONER                                           599


                                      and his alternative or additional position was that the 20-
                                      percent accuracy-related penalty attributable to negligence or
                                      substantial understatement of income tax applied.
                                         Generally, section 6662(a) authorizes the imposition in
                                      appropriate cases of an accuracy-related penalty that poten-
                                      tially comprises several components. The penalty applies to
                                      ‘‘any portion of an underpayment of tax required to be shown
                                      on a return’’, sec. 6662(a), if the underpayment or a portion
                                      thereof is attributable to one or more of the following: (1)
                                      Negligence or disregard of rules and regulations, (2) any
                                      substantial understatement of income tax, (3) any substan-
                                      tial valuation misstatement, (4) any substantial overstate-
                                      ment of pension liabilities, and (5) any substantial estate or
                                      gift tax valuation understatement, sec. 6662(b). It is possible
                                      that a portion of an underpayment is attributable to one
                                      component, e.g., negligence, while another portion of the
                                      underpayment is attributable to a different component, e.g.,
                                      gross or substantial valuation misstatement. 7 The section
                                      6662(a) penalty is an ad valorem penalty, and its amount
                                      ultimately depends on the amount of tax underpayment.
                                         The seemingly simple concept of penalty calculations, how-
                                      ever, does not fit well in the context of TEFRA because part-
                                      nerships are accounting mechanisms and are not subject to
                                      Federal income tax. See sec. 701. The section 6662 penalty,
                                      on the other hand, applies to a ‘‘portion of an underpayment’’.
                                      (Emphasis added.) The term ‘‘underpayment’’ is a defined
                                      term 8 and presupposes tax shown on the return or tax pre-
                                      viously assessed or collected. See sec. 6664(a). For this rea-
                                      son, the amount of the penalty cannot be calculated without
                                      reference to the taxpayer’s return, and the relevant return
                                      for purposes of the penalty calculation is the partner’s
                                      return.
                                        7 The alternative components of the sec. 6662 penalty cannot be stacked, and the maximum

                                      accuracy-related penalty imposed on a portion of an underpayment may not exceed 20 percent
                                      of such portion (or 40 percent of the portion attributable to a gross valuation misstatement),
                                      even if such portion is attributable to more than one type of misconduct described in sec.
                                      6662(b). See sec. 1.6662–2(c), Income Tax Regs.
                                        8 Sec. 6664(a) provides:


                                        SEC. 6664(a). UNDERPAYMENT.—For purposes of this part, the term ‘‘underpayment’’ means
                                      the amount by which any tax imposed by this title exceeds the excess of—
                                          (1) the sum of—
                                            (A) the amount shown as the tax by the taxpayer on his return, plus
                                            (B) amounts not so shown previously assessed (or collected without assessment), over
                                          (2) the amount of rebates made.




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                                      600                135 UNITED STATES TAX COURT REPORTS                                      (581)


                                         As follows from the foregoing, the section 6662 partner-
                                      ship-level penalty cannot be calculated and assessed until a
                                      computational adjustment 9 is made to a partner’s tax
                                      liability and the underpayment of tax on the partner’s return
                                      is calculated. Because of the TEFRA partnership litigation
                                      structure, such calculation of the underpayment takes place
                                      after the partnership-level proceeding and/or partner-level
                                      affected items deficiency proceedings are completed.
                                         The sequence of the penalty applicability determination at
                                      the partnership level and the subsequent calculation of the
                                      underpayment and penalty amounts creates further
                                      incongruities when a particular component of the penalty has
                                      a statutory floor. For example, the substantial or gross valu-
                                      ation misstatement component of the penalty applies only if
                                      the portion of the underpayment for the year that is attrib-
                                      utable to substantial or gross valuation misstatements
                                      exceeds $5,000 ($10,000 in the case of a corporation other
                                      than an S corporation). See sec. 6662(e)(2); sec. 1.6662–5(b),
                                      Income Tax Regs. In the case of a return of a partnership or
                                      another pass-through entity, the determination of whether
                                      there is a substantial or gross valuation misstatement is
                                      made at the entity level. See sec. 1.6662–5(h)(1), Income Tax
                                      Regs. However, the dollar limitation ($5,000 or $10,000, as
                                      might be applicable), is applied at the taxpayer level, and the
                                      underpayment is calculated by reference to the partner
                                      return. See id. Accordingly, although it is possible that a
                                      statutory floor will ultimately not be met, the determination
                                      that a penalty applies nevertheless must be made at the
                                      partnership level, see secs. 6221, 6226(f), 6230(a)(2)(A)(i), and
                                      is necessarily conditioned upon a later verification that the
                                      statutory floor is met. That verification flows automatically
                                      from the recalculation of the partner’s tax liability and is
                                      reflected in the resulting computational adjustment that is
                                      made to the partner’s tax liability at the end of the partner-
                                      ship-level proceeding and/or the partner-level affected items
                                      deficiency proceeding. A similar scenario arises with respect
                                      to the substantial understatement component under section
                                      6662(a), (b)(2), and (d).
                                        9 A computational adjustment is the change in the tax liability of a partner which properly

                                      reflects the treatment of a partnership item. See sec. 6231(a)(6).




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                                      (581)        PETALUMA FX PARTNERS, LLC v. COMMISSIONER                                           601


                                         As a consequence and in contrast to what occurs in defi-
                                      ciency cases, a peculiarity of TEFRA cases is that when a
                                      court enters a decision in the partnership-level proceeding
                                      stating that a section 6662(a) penalty applies, neither the
                                      amount of the penalty nor its allocation among partners is
                                      known until after the underpayment is calculated at the
                                      partner level. In fact, even if the court determines that the
                                      penalty applies, the amount of the penalty might be zero if
                                      the statutory floor is not met in the case of the substantial
                                      understatement and valuation misstatement components or
                                      if there is no underpayment by a partnership’s partner. See,
                                      e.g., sec. 1.6662–5(b), Income Tax Regs. Nevertheless, under
                                      TRA 1997 the penalty that ‘‘relates to an adjustment to a
                                      partnership item’’ must be determined at the partnership
                                      level. 10 See sec. 6221.
                                      III. Negligence in This Case
                                         The majority holds that we have no jurisdiction over any
                                      component of the penalty in this case. I believe we have
                                      jurisdiction to determine that the section 6662 penalty attrib-
                                      utable to negligence applies. 11 That penalty rests on the
                                      determination that the Petaluma partnership was a sham
                                      and is not recognized for Federal tax purposes and that all
                                      of the transactions in which it engaged, which were inter-
                                      related and preordained, were the result of negligence at the
                                      entity level. No other factual determinations need be made
                                      at    the    partner    level   to    determine    that    the
                                      mischaracterization of Petaluma as a partnership for Federal
                                      income tax purposes and its claim that it received contribu-
                                      tions of property from its partners and made distributions of
                                        10 The legislative history of TRA 1997 indicates that Congress amended secs. 6221, 6226(f),

                                      and 6230(a)(2)(A)(i) to lessen administrative burdens on the Commissioner and the courts and
                                      to require that culpability for a penalty or addition to tax be litigated at the level on which the
                                      relevant conduct occurs:
                                        Many penalties are based upon the conduct of the taxpayer. With respect to partnerships, the
                                      relevant conduct often occurs at the partnership level. In addition, applying penalties at the
                                      partner level through the deficiency procedures following the conclusion of the unified pro-
                                      ceeding at the partnership level increases the administrative burden on the IRS and can signifi-
                                      cantly increase the Tax Court’s inventory.
                                      H. Rept. 105–148, at 594 (1997), 1997–4 C.B. (Vol. 1) 319, 916.
                                        11 The substantial understatement component of the penalty under sec. 6662(a), (b)(2), and (d)

                                      would also apply if the statutory floor is met. Petitioner does not contend that the partnership
                                      had substantial authority or adequately disclosed the transaction. See sec. 6662(d)(2)(B); sec.
                                      1.6662–4(f)(5), Income Tax Regs. (providing that disclosure in the case of items attributable to
                                      a pass-through entity is made with respect to the entity return).




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                                      602                135 UNITED STATES TAX COURT REPORTS                                      (581)


                                      property to its partners were negligent. Accordingly, what-
                                      ever underpayment results from the nonexistence of the part-
                                      nership and the adjustment to Petaluma’s partnership
                                      status, which is a partnership item, is attributable to neg-
                                      ligence at the partnership level.
                                         As stated above, a penalty must be determined in a part-
                                      nership-level proceeding if (1) it relates (2) to an adjustment
                                      (3) of a partnership item. See secs. 6221, 6226(f). The deter-
                                      minations that the Petaluma partnership was a sham, lacked
                                      economic substance, and should be disregarded for tax pur-
                                      poses are determinations of partnership items, and we have
                                      jurisdiction under section 6226(f) to decide them in a part-
                                      nership-level proceeding. Petaluma II, 591 F.3d at 654. The
                                      determination that the partnership should be disregarded or
                                      that it, or the transactions in which it engaged, had no eco-
                                      nomic substance is an ‘‘adjustment’’ to a partnership item,
                                      and that is confirmed by a review of the FPAA. Consistent
                                      with respondent’s determination that Petaluma was a sham
                                      for Federal tax purposes, the FPAA adjusted all partnership
                                      items, including contributions made by the partners and dis-
                                      tributions made to the partners, claimed on the partnership
                                      return to zero.
                                         The critical interpretive issue under sections 6221, 6226(f),
                                      and 6230(a)(2)(A)(i) is whether the section 6662 penalty
                                      ‘‘relates to’’ an adjustment of a partnership item. The
                                      majority does not interpret the phrase ‘‘relates to’’ but in
                                      effect applies it overly narrowly. Generally, words in revenue
                                      legislation should be interpreted according to their ordinary,
                                      everyday meaning. Fort Howard Corp. & Subs. v. Commis-
                                      sioner, 103 T.C. 345, 351 (1994) (citing Commissioner v.
                                      Soliman, 506 U.S. 168, 174 (1993)). ‘‘Relate’’ means, inter
                                      alia, ‘‘to show or establish logical or causal connection’’.
                                      Merriam Webster’s Collegiate Dictionary 984 (10th ed. 1997).
                                      ‘‘Related’’ means, inter alia, ‘‘being connected; associated.’’
                                      The American Heritage Dictionary of the English Language
                                      1473 (4th ed. 2000). There is a logical and causal relationship
                                      between the determination of sham (a partnership item) and
                                      the computational adjustments such determination produces
                                      at the partner level. Because the negligence component of the
                                      accuracy-related penalty relates to an adjustment to a part-
                                      nership item (shamming of the partnership), we have juris-
                                      diction under section 6226(f) to decide whether the accuracy-




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                                      (581)        PETALUMA FX PARTNERS, LLC v. COMMISSIONER                                           603


                                      related penalty attributable to negligence applies at the part-
                                      nership level, and I would so hold. 12
                                         The majority states: ‘‘The effect of the mandate concerning
                                      the section 6662 penalty is that if the penalty does not relate
                                      directly to a numerical adjustment to a partnership item, it
                                      is beyond our jurisdiction.’’ Majority op. p. 587. The majority
                                      thus requires that (1) a penalty directly relate to an adjust-
                                      ment, and (2) a numerical adjustment to a partnership item
                                      be the only type of partnership item adjustment invoking our
                                      penalty jurisdiction. Neither ‘‘directly’’ nor ‘‘numerical’’
                                      appears in section 6226(f), which gives us jurisdiction to
                                      ‘‘determine * * * the applicability of any penalty, addition to
                                      tax, or additional amount which relates to an adjustment to
                                      a partnership item.’’ Section 6226(f) does not require that the
                                      penalty directly relate to an adjustment, nor does it distin-
                                      guish between numerical and nonnumerical adjustments to a
                                      partnership item. In addition, the Petaluma FPAA contains
                                      both numerical adjustments, which are set forth in a
                                      Schedule of Adjustments, and the narrative Explanation of
                                      Items. The determination that the partnership was a sham
                                      is contained in the Explanation of Items and is reflected at
                                      least in part by the numerical adjustments to specific part-
                                      nership items like partners’ capital contributions and partner
                                      distributions, which are reduced to zero.
                                         The majority also states:
                                        In this case none of the FPAA adjustments are items that flow directly
                                      to the partner-level deficiency computation as computational adjustments.
                                      Any deficiencies must therefore be determined against the partners as
                                      affected items and must be resolved in separate partner-level deficiency
                                      procedures. The section 6662 penalties are all related to these adjust-
                                      ments, which have not yet been made by respondent. [Majority op. p. 586.]
                                        12 Petitioner does not contest or disagree with the finding that the partnership was a sham.

                                      In fact, petitioner has conceded the applicability of the 20-percent accuracy-related penalty for
                                      either negligence or substantial understatement of income tax in the event that the higher 40-
                                      percent accuracy-related penalty for gross valuation misstatement does not apply. Petitioner is
                                      contesting only our jurisdiction to determine the sec. 6662 penalty for negligence. The parties
                                      stipulated:
                                      If the Court determines that it has jurisdiction in this case, petitioner stipulates that he does
                                      not intend to call any witnesses or offer any evidence in this proceeding, or otherwise contest
                                      the determinations made in the FPAA other than the determination that the valuation
                                      misstatement penalty imposed by I.R.C. § 6662(a), (b)(3), (e), and (h) applies to any under-
                                      payment resulting from the adjustments to partnership items.
                                      Although petitioner argues on remand that no component of the accuracy-related penalty ap-
                                      plies, the argument seems to be an opportunistic grab for penalty relief on the basis of Petaluma
                                      II.




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                                      604                135 UNITED STATES TAX COURT REPORTS                                      (581)


                                      I interpret this statement to mean that our jurisdiction over
                                      the section 6662 penalty at the partnership level depends on
                                      whether the adjustment of a partnership item results
                                      in a computational adjustment that is directly assessed. I
                                      disagree with that statement because our jurisdictional grant
                                      under section 6226(f) is not so limited. Section 6226(f)
                                      unequivocally provides that we have jurisdiction to decide
                                      whether a penalty applies if it relates to an adjustment of a
                                      partnership item. In a Son-of-BOSS case like Petaluma, a tax-
                                      payer engages in a set of preordained and interrelated trans-
                                      actions to achieve an artificial and inflated tax loss. The use
                                      of a transient partnership is essential because the partner-
                                      ship enables the taxpayer-partner to ultimately claim the
                                      disputed loss. In the Petaluma version of Son-of-BOSS, the
                                      partners contributed pairs of offsetting options to the part-
                                      nership. See Petaluma II, 591 F.3d at 650. When the part-
                                      ners withdrew from the partnership 2 months later,
                                      Petaluma liquidated their interests in the partnership by dis-
                                      tributing cash and shares of Scient stock. Id. The partners
                                      then sold the distributed Scient stock and claimed
                                      an inflated basis in the stock to calculate the loss. Id. The
                                      inflated basis in the stock was (purportedly) possible only
                                      because of the partnership vehicle. Because of the inter-
                                      relationship of the transactions and the interplay of the basis
                                      rules of subchapter K, the ultimate disallowance of the part-
                                      ner’s loss is related to the adjustments to partnership items
                                      resulting from the partnership-level proceeding. It follows
                                      that we have jurisdiction to decide whether the section 6662
                                      penalty attributable to negligence applies. Sec. 6226(f).
                                         The accuracy-related penalty asserted in the Petaluma
                                      FPAA (other than the substantial valuation component of the
                                      penalty over which the Court of Appeals in Petaluma II held
                                      we had no jurisdiction) relates to the shamming of the part-
                                      nership and to the resulting adjustments to partnership
                                      items such as contributions and distributions. The conduct
                                      that is being sanctioned occurred at the partnership level.
                                      The Petaluma partners could not have achieved the pur-
                                      ported loss without the transient existence of the partner-
                                      ship. The section 6662 penalty with respect to the partner-
                                      ship misconduct must be determined at the partnership level.
                                      Secs. 6221, 6226(f); see also Domulewicz v. Commissioner,
                                      129 T.C. at 20–21.




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                                      (581)        PETALUMA FX PARTNERS, LLC v. COMMISSIONER                                           605


                                         The majority relegates the issue of negligence at the part-
                                      nership level to an affected items deficiency proceeding. That
                                      action is foreclosed by section 6230(a)(2)(A)(i), as amended by
                                      TRA 1997. As discussed above, under section 6230(a)(2)(A)(i),
                                      penalties, additions to tax, and additional amounts that
                                      relate to adjustments to partnership items no longer are sub-
                                      ject to deficiency procedures. Although Congress recognized
                                      that a penalty related to an adjustment to a partnership item
                                      might require partner-level determinations, Congress never-
                                      theless explicitly excepted the determination of such pen-
                                      alties from the deficiency provisions by amending section
                                      6230(a)(2)(A)(i). Temporary regulations under section 6231
                                      take a similar approach. See sec. 301.6231(a)(6)–1T(a)(2),
                                      Temporary Proced. & Admin. Regs., supra (‘‘any penalty,
                                      addition to tax, or additional amount that relates to an
                                      adjustment to a partnership item may be directly assessed
                                      following a partnership proceeding, based on determinations
                                      in that proceeding, regardless of whether partner level deter-
                                      minations are required’’).
                                         For these reasons, I would hold that we have jurisdiction
                                      to decide that the accuracy-related penalty attributable to
                                      negligence applies at the partnership level. 13
                                         COHEN, GALE, and PARIS, JJ., agree with this dissent.

                                                                               f




                                          13 In my opinion, a finding of negligence at the partnership level in a Son-of-BOSS case such

                                      as Petaluma does not preclude a finding of partner-level negligence. That is because of the
                                      unique nature of many Son-of-BOSS transactions, which require partnership level and partner-
                                      level actions to generate the loss. Notably, respondent took the positions in the FPAA that ‘‘Ac-
                                      curacy Penalties under IRC Section 6662 are included as a partnership level determination’’ and
                                      ‘‘I.R.C. Penalty 6662 is applicable at the individual partner level and may be raised in separate
                                      proceedings at the partner level following the present partnership proceeding.’’ I interpret these
                                      seemingly contradictory statements to mean that a sec. 6662 penalty is asserted and may apply
                                      to both partnership-level conduct (such as claiming that a valid partnership existed) and to part-
                                      ner-level conduct (such as claiming an inflated outside basis for the property distributed by the
                                      partnership and sold by the partner).




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