UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW HAMPSHIRE

Richard M . Nault

v. Civil N o . 04-cv-479-PB Opinion N o .

United States of America

MEMORANDUM AND ORDER

Richard Nault brings this action against the United States

to recover income tax refunds for several tax years. Nault’s

claims stem from investments he made in several agriculture-based

limited partnerships (collectively the “AMCOR Partnerships”). In

2001, the tax court entered orders resolving a claim by the

United States that the AMCOR Partnerships were sham transactions

lacking economic substance. The parties agree that Nault’s

entitlement to the refunds he now seeks depends upon the meaning

and legal effect of the tax court orders.

The matter is before me on cross motions for summary

judgment. I. BACKGROUND

This case falls within the purview of the Tax Equity and

Fiscal Responsibility Act of 1982 (“TEFRA”). Accordingly, I

begin by explaining TEFRA’s legal framework. I then describe

Nault’s investments in the AMCOR Partnerships and the tax court

litigation challenging the legitimacy of the partnerships’ tax

returns.

A. The TEFRA Framework1

TEFRA establishes a “single unified procedure for

determining the tax treatment of all partnership items at the

partnership level, rather than separately at the partner level.”

Callaway, 231 F.3d at 108. Whether an item is a partnership item

or a nonpartnership item is the threshold inquiry under TEFRA.

Id. Partnership items are “subject to TEFRA’s centralized audit

procedures,” while “the treatment of nonpartnership items is

determined at the level of the individual partner’s return . . .

.” Id. Under TEFRA, taxpayers are not “permitted to raise

1 In Callaway v . Comm’r, the Second Circuit provided a thorough and enlightening explanation of TEFRA. See

(2d Cir. 2000). I rely heavily on Callaway in explaining TEFRA’s legal framework.

-2- nonpartnership items in the course of a partnership proceeding.”

Correlatively, taxpayers cannot raise partnership items at

partner level proceedings.

TEFRA further mandates that a partner file “an income tax

return that is consistent with the partnership return.”

“The partner’s distributive share of any partnership item must be

reported in the same manner as on the partnership’s information

return (i.e., it must have the same amount, the same

characterization, the same timing).”

(citations

omitted).

“The [Internal Revenue Service (“IRS”)] may adjust

partnership items only at the partnership level and only after

following TEFRA procedures.”

. Specifically, “[t]o

audit a partnership return, the IRS must send notice of the

beginning of an administrative proceeding (‘NBAP’) to the

partners entitled to notice (the ‘notice partners’).”2

2 A notice partner is “a partner entitled to notice under section 6223(a).”

(citing I.R.C. § 6231(a)(8)). “When a partnership has 100 or more partners, a notice partner is generally one who owns at least a one percent interest in the partnership.” Id. (citing I.R.C. § 6223(b)(1)). It is unclear from the record whether Nault was a notice partner in any of the AMCOR Partnerships.

-3- "[A]ny partner has the right to participate in any administrative

proceeding relating to the determination of partnership items at

the partnership level." Id. (citing I.R.C. § 6224(a)). “[I]f

after completing its audit the IRS adjusts the partnership

return, it must send the notice partners a notice of final

partnership administrative adjustment (‘FPAA’).” Id. (citing

I.R.C. § 6223(a)(2), (d)(2)).

“Within 90 days of the date the IRS mails the FPAA notice,

the partnership's ‘tax matters partner’ (TMP) 3 may contest the

FPAA by filing a petition for readjustment in Tax Court, the

Court of Federal Claims or the appropriate federal district

court.” Id. (citing I.R.C. § 6226(a)). “If the TMP does not

file a petition within this period, then any notice partner may

file a petition for readjustment within the next 60 days. Id.

(citing I.R.C. § 6226(b)(1)). “Regardless whether the petition

for judicial readjustment is filed by the TMP or by a notice

partner, all other partners are treated as parties to the suit,

3 The TMP is “the general partner designated in the partnership agreement to handle tax matters.” Id. (citing I.R.C. § 6231(a)(7)).

-4- provided that they have an ongoing interest in the outcome of the

proceedings. Id. (citing I.R.C. § 6226(c), ( d ) ) . “In this

manner TEFRA allows all partners, if they choose, to litigate a

dispute with the IRS in a single proceeding that binds all.” Id.

“After the FPAA adjustments become final (i.e., after they

go unchallenged for 150 days or are judicially resolved in a

section 6226 [tax court, district court, or Court of Federal

Claims proceeding]), the IRS may assess partners with the tax

which properly accounts for their distributive share of the

adjusted partnership items, without notice, as a computational

adjustment.” Id. at 109-10 (citing I.R.C. §§ 6225(a), 6230(a)

( 1 ) , 6231(a)(6)). “In certain cases, where no further factual

determinations are necessary at the partner level, an assessment

attributable to an ‘affected item’ may also be made by

computational adjustment.” Id. at 110. An “affected item” is

“any item to the extent such item is affected by a partnership

item. Id. In the event of an unfavorable court decision, the

TMP, a notice partner, or a 5-percent group make seek appellate

review in the appropriate forum. I.R.C. § 6226(g).

-5- B. Tax Treatment of Nault’s Investments4

Nault invested in the AMCOR Partnerships between 1984 and

1986. Each partnership reported significant losses in its first

year of existence and comparatively smaller amounts of income in

subsequent years. Nault took deductions based on his

distributive share of partnership losses and paid taxes on his

share of partnership income disbursements throughout the course

of his investments.5

In 1987, the IRS examined the AMCOR Partnerships’ tax

returns and issued FPAA notices disallowing deductions claimed by

each partnership. In the FPAA notices, the IRS explained that

the adjustments resulted from, inter alia, an IRS determination

that the AMCOR Partnerships’ activities constituted a series of

sham transactions lacking economic substance.

4 The facts in this section are drawn from the parties’ Joint Statement of Background Facts and Background Discussion of Law Regarding Taxation of Partnership Interests (Doc. N o . 31) and certain exhibits in the summary judgment record. The record is construed in the light most favorable to Nault. 5 Nault’s reported income and loss amounts for the AMCOR Partnerships are represented in a chart appended to the parties’ Joint Statement of Background Facts. A copy of the chart is included with this Memorandum and Order as Appendix A .

-6- Following the issuance of the FPAA notices, certain AMCOR

partners--not including the TMP--filed Petitions for Readjustment

of Partnership Items in the United States Tax Court pursuant to

I.R.C. § 6226. In July 1999, the TMP for each AMCOR Partnership

intervened in each AMCOR tax court proceeding.

In 2001, after years of litigation, the IRS and the TMP

entered into an agreement providing that the IRS would disallow

approximately 72 percent of the AMCOR Partnerships’ losses but

allow the partnerships to retain all of their claimed Investment

Tax Credits. The agreement also provided that the AMCOR partners

would not file amended returns restating any reported income from

the AMCOR Partnerships on which they had already paid income

taxes.

The IRS ultimately filed Motions for Entry of Decision in

the tax court, and the tax court entered decisions with respect

to each AMCOR Partnership reflecting the terms of the settlement

agreement. Each of the tax court decisions contained the

following language:

ORDERED AND DECIDED: . . . [t]hat the foregoing adjustments to partnership income and expenses are attributable to transactions which lacked economic

-7- substance, as described in former I.R.C. § 6621(c)(3)(A)(v), so as to result in a substantial distortion of income and expenses . . . .

After the tax court litigation was resolved, the IRS issued

adjustments to Nault’s 1984, 1985, and 1986 income tax returns

based on the disallowed deductions. Nault then paid the

additional taxes resulting from the adjustments.

While the tax court litigation was ongoing, each of the

AMCOR Partnerships terminated. Nault had no remaining basis in

his partnership interests when the partnerships terminated apart

from any “restored” basis he might be entitled to claim based

upon the tax court’s disallowance of his prior deductions.

In September 2002, Nault sought tax refunds by filing

amended federal income tax returns for 1995, 1996, 1998, 1999,

2000, and 2001. In the amended returns, Nault claimed an

ordinary loss deduction in the year each partnership terminated

as well as carryover adjustments for other years affected by the

termination year losses. Along with his refund claims, Nault

attached statements explaining why he was entitled to the

refunds. Specifically, Nault asserted that the Tax Court’s 2001

disallowance of 72 percent of the AMCOR Partnership deductions--

and derivatively, his share of the deductions--resulted in a

-8- restoration of his basis in those partnerships by corresponding

amounts. As a result of this adjustment to his basis, he argued,

he was entitled to loss deductions in the exact amount of his

previously disallowed deductions because the partnerships became

worthless upon termination.

On December 1 8 , 2002, the IRS denied Nault’s refund claims.

Nault timely filed this action on December 1 7 , 2004.

II. STANDARD OF REVIEW

Summary judgment is appropriate "if the pleadings,

depositions, answers to interrogatories, and admissions on file,

together with the affidavits, if any, show that there is no

genuine issue as to any material fact and that the moving party

is entitled to a judgment as a matter of law." Fed. R. Civ. P.

56(c). "Cross-motions for summary judgment do not alter the

basic Rule 56 standard, but rather simply require [the court] to

determine whether either of the parties deserves judgment as a

matter of law on facts that are not disputed." Adria Int'l

Group, Inc. v . Ferre Dev., Inc.,

(1st Cir.

2001) (citation omitted).

-9- III. ANALYSIS

In claiming a loss deduction, Nault relies upon

(a), which permits individuals to take tax deductions for

losses “not compensated for by insurance or otherwise.” Another

statutory provision--

(c)--adds important

limitations to such deductions. It provides:

In the case of an individual, the deduction under subsection (a) shall be limited to--

(1) losses incurred in a trade or business;

(2) losses incurred in any transaction entered into for profit, though not connected with a trade or business; and

(3) except as provided in subsection ( h ) , losses of property not connected with a trade or business or a transaction entered into for profit, if such losses arise from fire, storm, shipwreck, or other casualty, or from theft.

Nault does not allege that he was involved in a trade or business

in connection with the AMCOR Partnerships. Nor does he allege

that his losses arose from fire, storm, shipwreck, or other

casualty. Thus, Nault’s claimed loss deductions can only be

grounded in § 165(c)(2): “a loss incurred in a transaction

entered into for profit.”

-10- A taxpayer is not entitled to loss deductions pursuant to §

165(c)(2) if his claimed losses stem from transactions that lack

economic substance. See Iles v . C.I.R.,

(6th

Cir. 1992). Moreover, “when a taxpayer claims a deduction, it is

the taxpayer who bears the burden of proving that the transaction

has economic substance.” Coltec Industries, Inc. v . United

States,

(Fed. Cir. 2006). The government

relies on these accepted principles in contending that Nault is

not entitled to the deductions he seeks because, it argues, the

tax court determined that the transactions on which Nault’s

deductions are based lacked economic substance.

Nault recognizes that he is not entitled to take deductions

pursuant to § 165(c)(2) unless he can establish that his claimed

losses are attributable to transactions that had economic

substance. He also agrees that the tax court orders are

determinative on this issue. Thus, this case turns on how the

tax court orders are construed.

The government offers a straightforward interpretation of

the tax court orders. Its position is that the parties to the

tax court proceeding settled their dispute by agreeing to the

entry of court orders recognizing that the losses disallowed

-11- pursuant to the orders were “attributable to transactions which

lacked economic substance.” Because the orders clearly provide

that the transactions on which Nault’s claims are based lacked

economic substance, the government argues, Nault cannot rely on

the disallowed losses to “restore” his basis in his investments.

Nault focuses on the effect of the court orders rather than

their specific terms in arguing that the tax court actually

determined that the AMCOR Partnerships had economic substance.

In making this argument, Nault relies primarily on the basic

principle that “a transaction that lacks economic substance

simply is not recognized for federal taxation purposes, for

better or worse . . . .” ACM P’ships v . Comm’r of Internal

Revenue,

3 1 , 261 (3d Cir. 1998) (citation and internal

quotation marks omitted). He then reasons that if the tax court

acted consistently with this principle, it must have determined

that the AMCOR Partnerships had economic substance because the

court allowed partners to retain their Investment Tax Credits and

a portion of their partnership’s losses and because the

settlement agreement that gave rise to the orders barred partners

from filing amended returns restating any reported income

generated by the partnerships.

-12- I am not convinced that courts are required to apply the

economic substance doctrine in quite so inflexible a manner as

Nault suggests. However, I need not delve into this complex

issue to resolve this case because Nault fails to appreciate the

significance of the fact that the orders on which his claims

depend were issued pursuant to a settlement. The government

argued in the tax court proceeding that the AMCOR Partnerships

were sham transactions that were completely lacking in economic

substance. The TMP disagreed. After extensive litigation, the

parties compromised their claims by settlement and, in so doing,

they agreed to the precise language that was used in the court

orders that resolved the parties’ dispute. That language plainly

provides that the disallowed losses on which Nault’s current

claims are based were attributable to transactions that lacked

economic substance. It is unsurprising and ultimately

insignificant for our purposes that the settlement also

represented something less than a complete victory for either

side. All that matters here is that the settlement resulted in

the issuance of court orders that plainly resolved the issue that

is now before the court.

-13- Accordingly, I hold that the tax court decisions determined

that the disallowed deductions were attributable to transactions

that lacked economic substance. Those decisions are binding on

Nault in this proceeding. Thus, Nault has no claim to loss

deductions resulting from a restored basis because transactions

lacking economic substance cannot give rise to losses under

§ 165(c).

IV. CONCLUSION

For the reasons set forth herein, I grant the government’s

motion for summary judgment (Doc. N o . 34) and deny Nault’s cross-

motion for summary judgment (Doc. N o . 4 3 ) . The clerk is

instructed to enter judgment accordingly.

SO ORDERED.

/s/Paul Barbadoro ___ Paul Barbadoro United States District Judge

February 9, 2007

cc: Robert Lucic, Esq. Courtney H.G. Herz, Esq. Heather Richtarcsik, Esq.

-14-