Tax Court Rules In Favor Of Service In TEFRA Entity Level Audit Case In Kearney Partners Fund, LLC, By And Through Lincoln Partners Fund, LLC, TMP v. United States

The plaintiffs challenged a set of tax adjustments and related penalty determinations made by the Internal Revenue Service to nine partnership returns subject to the TEFRA entity audit rules that were introduced under the Tax Equity and Fiscal Responsibility Act of 1982 . Kearney Partners Fund, LLC ("Kearney Partners"), Nebraska Partners, and Lincoln Partners were formed as limited liability companies that were taxable as partnerships. On December 4, 2001, a Mr. Sarma acquired a direct partnership interest in Nebraska Partners and indirect partnership interests in Lincoln Partners and Kearney Partners based on Nebraska Partners' 99% ownership interest in Lincoln Partners and Lincoln Partners' 99% ownership interest in Kearney Partners. This three-tiered partnership structure is referred to by the acronym "FOCus".

During 2002, the IRS started an investigation of FOCus and its use of a multi-tiered partnership structure, which it claimed was a "tax shelter" through which Sarma derived substantial tax benefits.

Under TEFRA rules, when the IRS initiates an audit of a partnership return, and believes that the positions taken on the return are not all correct, it is required to mail each partner a Notice of Beginning of Administrative Proceeding ("NBAP") "no later than 120 days before" the issuance of the Final Partnership Administrative Adjustment ("FPAA"). 26 U.S.C. §§ 6223(a) & (d). The IRS' failure to do so entitles the partner the option to opt-out of the partnership examination or judicial proceedings. § 6226(e).

On June 6, 2003, the IRS issued Plaintiffs, but not Sarma, the NBAP. On December 9, 10, and 11 2009, the IRS sent Plaintiffs and Sarma the FPAAs with a cover letter advising Sarma that the IRS had failed to mail him the NBAPs within the required time and informing him of his right to opt-out of the partnership examination. On January 23, 2010, Sarma elected to opt out. However, on February 25, 2010, the IRS sent a letter to Sarma's counsel acknowledging that it had erred in informing Sarma of his right to opt-out because he was not entitled to directly receive the NBAPs and thus could not elect to not be bound by the partnership examination. The plaintiffs filed a motion for summary judgment arguing that Sarma properly opted out of this proceeding which divests this Court of subject matter and personal jurisdiction.

A motion to dismiss for want of subject matter jurisdiction as to one member, Sarma, was made. The Federal District Court for the Middle District of Florida noted that, at its discretion, it may rule on a motion to dismiss on the basis of affidavits alone, may choose to permit discovery in aid of the motion, or may conduct an evidentiary hearing on the merits of the motion. See, e.g., Internet Solutions Corp. v. Marshall, 557 F.3d 1293, 1295 (11th Cir. 2009); Eaton v. Dorchester Dev., Inc., 692 F.2d 727, 730-31 (11th Cir. 1982) (recognizing a qualified right to jurisdictional discovery in the Eleventh Circuit).

TEFRA Entity Level Audit Rules

TEFRA, under Section 6223, sets forth procedures designed to notify certain partners of the beginning and end of an administrative proceeding or audit. When the IRS audits a partnership with fewer than 100 partners, such as FOCus, TEFRA requires the Service to issue a notice of an administration...