Mr. Meruelo owns a partnership interest in Intervest Financial, LLC via Meruelo Capital Management, LLC (a single-member limited liability company) (hereafter “MCM”). Mr. Meruelo’s portion of Intervest’s 1999 loss was $4,538,844; the losses stemmed from foreign currency transactions. On his 1999 tax return, he claimed the entire loss as a deduction. The return was filed in October 2000. The IRS has not: audited Intervest’s 1999 partnership tax return, notified Intervest of a pending audit of its 1999 partnership tax return, issued a final partnership administrative adjustment (FPAA) to Intervest for 1999.
On October 10, 2003, just before the three-year statute of limitations expired, the IRS issued a Notice-of-Deficiency (NOD) to the Meruelo’s. The NOD indicated that the IRS disallowed their Intervest loss because of sections 465 and 704(d). Section 465 limits losses to amounts at-risk. Section 704(d) limits partnership losses to a partner’s basis. But these sections are not at issue here.
The Meruelos motion the Court to dismiss this case for lack of jurisdiction on two grounds. First, they argue that the NOD is invalid because the deficiency is related to an affected item of Intervest. As such, the IRS is required to either issue a notice of FPAA or accept Intervest’s 1999 as filed, neither of which had been done. Second, the Meruelos argue in the alternative that the items in the NOD are not in fact affected items.
Limited Jurisdiction and Affected Item
The Tax Court “is a court of limited jurisdiction. Whether [the Court] has jurisdiction over the subject matter of a dispute is an issue that either party may raise at any time. Here… jurisdiction rests on finding that the NOD issues to [the Meruelos] was valid and that [their] petition to this Court was timely.”
Fortunately, the Court defines “affected item” before moving on to its analysis. There is no sense paraphrasing the Court here.
The term “partnership items” includes any item of income, gain, loss, deduction, or credit that the Secretary has determined is more appropriately determined at the partnership level than at the partner level. See sec. 6231(a)(3); sec. 301.6231(a)(3)-1(a), Proced. & Admin. Regs. The term does not include an “affected item”, defined by statute as any item to the extent the item is affected by a partnership item. See sec. 6231(a)(5); Adkison v. Commissioner, 129 T.C. 97, 102 (2007).
Affected items are of two types. The first type is a computational adjustment made to a partner’s tax liability to reflect adjustments to partnership items. See sec. 6231(a)(6). When partnership-level proceedings are complete, the Commissioner may assess computational adjustments against a partner without issuing a notice of deficiency. See secs. 6225(a), 6230(a)(1); N.C.F. Energy Partners v. Commissioner, 89 T.C. 741, 743-744 (1987).
The second type of affected item requires a partner-level determination; it is an adjustment to a partner’s tax liability (other than to reflect a penalty, addition to tax, or additional amount relating to an adjustment to a partnership item) to reflect the proper treatment of a partnership item that is dependent upon factual determinations to be made at the partner level. See sec. 6230(a)(2)(A)(i); Domulewicz v. Commissioner, supra at 22-24.
The normal deficiency procedures apply to affected items that require partner-level determinations (other than penalties, additions to tax, and additional amounts that relate to adjustments to partnership items). See sec. 6230(a)(2)(A)(i). These procedures require the timely issuance of an NOD as a precondition to the Commissioner’s assessment of a deficiency or accuracy-related penalty related to affected items. A valid NOD requires that any partnership-level proceeding involving the related partnership be complete. See sec. 6225(a); GAF Corp. v. Commissioner, supra at 528; Maxwell v. Commissioner, supra at 788.
When an FPAA is issued to the partnership and a partnership-level proceeding as to the FPAA is properly brought in this Court, the partnership-level proceeding is complete when our decision becomes final. See sec. 6225(a)(2). When the Commissioner opts not to begin a partnership-level proceeding or issue an FPAA within the normal period of limitations, the partnership-level proceeding is considered complete when the Commissioner accepts the partnership’s return as filed. See Roberts v. Commissioner, 94 T.C. 853, 860-861 (1990). Whether the Commissioner has accepted a partnership return as filed is a question of fact that turns in part on a finding of whether the Commissioner opted to allow the normal period of limitations to expire without beginning a partnership-level proceeding. See id.
Tax Court’s Analysis
The Tax Court dismisses the Meruelo’s motion. In addressing their first argument, the Court points out that the IRS concedes it may no longer adjust Intervest’s partnership items because the normal statute of limitations has expired. Accordingly, the restriction to complete partnership-level proceedings under section 6225(a) prior to issuing an NOD is lifted. As such, the NOD is valid.
The Meruelos argued in the alternative that their items were not affected items. Of course they were. A partner’s basis and amounts at risk are necessarily partner-level determinations; the second type of affected items. Therefore, their alternative argument also fails.
The Court takes note that while the NOD was issued to MCM, Mr. Mereulo placed no weight on this fact in his argument; he attacked only the IRS’s proceedings, or lack thereof, with Intervest. I am not sure what, if any, difference this would make.
Lastly, Mr. Mereulo’s alternative argument is just silly (silly is a term of art in Tax Law). Perhaps they did not understand “affected items.”