May 13, 2011
The en banc Federal Circuit heard oral argument in the Bush TEFRA case on Wednesday the 10th of May. For those still interested after reading this, you can listen to the argument here. As we indicated in our prior analysis, we think the resolution of this case is simple. Unfortunately, although the parties and the court almost escaped the weeds several times, with one of the judges asking a question very close to the mark, it was a dissatisfying oral argument (from our perspective). The point that needed to be made is that an agreement to “no change” a partnership item is “treatment” of a partnership item in and of itself — you have just treated it the same as it was originally treated. Thus, a change in tax liability that “reflects” a partnership no change is a computational adjustment.
To put some more meat on that, section 6221 illustrates the purpose of TEFRA to require “the tax treatment of any partnership item [to be] determined at the partnership level.” Section 6230(a) coordinates the Code’s deficiency proceedings with TEFRA and mandates that, aside from converted items, notices of deficiency are required only for “affected items which require partner level determinations.” Claims arising out of erroneous “computational adjustments” can be litigated but the underlying treatment of partnership items resolved in a TEFRA proceeding cannot be re-litigated. Section 6230(c). Section 6231(a)(6) defines a “computational adjustment” as a “change in the tax liability of a partner which properly reflects the treatment … of a partnership item.”
Where you have a change in tax liability of a partner that “reflects” the “treatment” (not the “change” in treatment, just the treatment) of a partnership item and no partner-level determinations are necessary, then no notice of deficiency is required. In Bush, the partners settled the “treatment” of the partnership items as a no change and agreed to all of the necessary partner level determinations so there was no need for a partner-level determination to determine tax consequences. Accordingly, no notice of deficiency was necessary. Contrary to the taxpayers’ position at oral argument (and in the briefs), the fact that there could be other (non-partnership) items contested in a notice of deficiency is irrelevant. Likewise, it is irrelevant that the partnership items or treatment of those items never changed. You don’t need a change in a partnership item or a change in the treatment of that item to have a computational adjustment. Instead, you need a change in tax liability that reflects the treatment of partnership items. Any TEFRA-based adjustment does that even if the partnership items stay as they are on the original return because their treatment is reflected in that tax liability. That is the whole point of TEFRA: partnership item treatment is relegated to TEFRA proceedings and everything flows out of that treatment. So a change in tax liability driven by a change in allowed partnership losses based on a change in a partner’s at-risk amount reflects the treatment of a partnership item (the losses, which are no-changed, which is a form of “treatment”) and thus is a computational adjustment.
Although the court asked several questions on the period of limitations and assessment issues and asked other questions to determine the scope of the problem, the rest of the taxpayers’ arguments are a sideshow. It is always tough to tell how a case will be decided based on the arguments, but, even though it was less than satisfying, the court’s questioning indicates to us that the government will prevail and the court will find its way out of this part of the TEFRA forest.