Appeal from the United States District Court for the Northern District of Illinois, Eastern Division.
No. 95 C 1294 Joan B. Gottschall, Judge.
Before Flaum, Easterbrook, and Kanne, Circuit Judges.
Abel and Mary Lou Kaplan had no idea that they owed certain overdue taxes to the Internal Revenue Service (I.R.S.). Abel Kaplan held less than a one-percent interest in the profits of a Utah limited partnership that claimed over nine million dollars of invalid deductions for the 1983 tax year. The Kaplans claimed a distributive share of these deductions on their joint income tax return for 1983. The I.R.S. audited the partnership and disallowed the 1983 deductions on October 21, 1991; it had previously given timely notice of this adjustment to all authorized parties in accordance with the provisions of the Internal Revenue Code. The Kaplans, however, by virtue of their small investment in the partnership, were not one of these authorized parties. Their first hint of a problem came in a 1994 notice of deficiency and demand for payment from the I.R.S. The Kaplans paid these overdue taxes (plus penalties and interest) under protest and, after the I.R.S. did not act on their claim for a refund, they commenced this challenge to force the I.R.S. to refund the disputed funds. The district court dismissed their complaint for want of subject-matter jurisdiction. In addition, the court granted the Government's motion for summary judgment on the Kaplans' claims that the Internal Revenue Code unconstitutionally deprived them of notice of the adjustment to the partnership's 1983 tax return. We affirm.
Partnerships, as such, are not subject to the federal income tax. They must file annual reports of the partners' distributive shares of income, gains, deductions, and credit; the partners are taxed in their individual capacities based on these calculations. I.R.C. sec.sec. 701 & 6031. Congress enacted the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), 26 U.S.C. sec.sec. 6221-33, in response to the special problems posed by the taxation of partnership activities. Through TEFRA, Congress sought to ensure equal treatment of partners by uniformly adjusting partners' tax liabilities and channeling any challenges to these adjustments into a single, unified proceeding. See Staff of the Joint Committee on Taxation, 97th Cong., 2d Sess., General Explanation of the Revenue Provisions of the Tax Equity and Fiscal Responsibility Act of 1982, at 268. This system has the additional advantage of abating the administrative burden that would be wrought by multiple, duplicative audits and lawsuits involving numerous partners in a single partnership.
TEFRA achieves these goals, in part, by establishing procedures for disseminating information regarding the taxation of partnership items. Specifically relevant to this case, the I.R.S. must provide notice to each partner of any adjustments to partnership items. This notice takes the form of a final partnership administrative adjustment (FPAA), which details the I.R.S.'s approval or rejection of the partnership's claims of taxable income and deductions. See I.R.C. sec.sec. 6223(a)(2) & (d)(2). Section 6226(c) binds all partners to the result obtained by a legal challenge brought by one partner, thereby preventing numerous lawsuits concerning the same factual and legal issues; TEFRA prescribes widespread, contemporaneous notification in order to facilitate the coordination of partners' legal challenges to an FPAA and in order to prevent some partners from bringing suit (and binding all other partners) before other partners know of an adjustment.
TEFRA, however, prevents the notification requirements from imposing an unduly onerous burden on the Government. The I.R.S. is required to send notice of an FPAA to each partner that owns at least one percent of the partnership. See id. sec. 6223(a). However, section 6223(b) of the Internal Revenue Code expressly states that the I.R.S. need not send notification to a partner owning less than a one-percent interest in a partnership composed of more than one hundred partners. These small-share partners are not excluded from all notification. Rather, the I.R.S. is required only to send notice of the FPAA to the partnership's "tax matters partner" (TMP), the general partner designated by the partnership to handle tax issues. See I.R.C. sec.sec. 6223(a)-(d). If no TMP is designated, notice may be sent to the partner having the largest interest in the partnership's profits at the end of the relevant tax year; if this proves impracticable, the Secretary of the Treasury may select a TMP. See id. sec. 6231(a)(7). The Code construes notice to the TMP as constructive notice to the small-share partners; the TMP is charged with notifying all of these small-share partners of any adjustments contained in the FPAA. See id. sec. 6223(g).
In 1983, Abel Kaplan was a partner in a Utah limited partnership--Mid-Continent Drilling Associates II (MCDA II)--that was subject to the reporting requirements of TEFRA. On its partnership tax return for 1983, MCDA II claimed over $9 million in deductions; the Kaplans filed a joint income tax return in 1983 in which they claimed their distributive share of these deductions. In 1986, the I.R.S. initiated an audit of the partnership's 1983 tax return. At that time, Oscar Strongin was the tax matters partner for MCDA II in 1986. Strongin signed two agreements with the I.R.S. extending the period for making adjustments to the partnership's 1983 tax deductions; the second of these agreements extended the period for adjusting the partnership's 1983 taxes for an indefinite period of time (subject to conditions stated in the agreement but not relevant here). The partnership dissolved in 1990, but the I.R.S.'s investigation continued until 1991.
The I.R.S. mailed its FPAA to Strongin and the notice partners of MCDA II on October 21, 1991. In the FPAA, the I.R.S. disallowed all of the deductions claimed by MCDA II in its 1983 partnership return (and, consequently, all distributive share deductions claimed by the individual partners on their income tax returns for that year). Kaplan was not a "notice partner" of MCDA II for purposes of TEFRA, see I.R.C. sec. 6223(b)(1), because he owned less than a one-percent interest in a partnership comprised of more than one hundred partners. The I.R.S., therefore, was not obligated by I.R.C. sec. 6223(a) to send him personal notice of an adjustment to MCDA II's taxes. Under the provisions of the Internal Revenue Code, the I.R.S. effectively notified Kaplan of the 1983 adjustment by notifying Strongin, MCDA II's tax matters partner.
This "effective" notice, however, did not translate into actual notice to the Kaplans. For reasons undisclosed in the record, Strongin never notified the Kaplans of the FPAA. The Kaplans were therefore surprised on February 14, 1994, to receive a notice and demand for payment of taxes owed in 1983; this demand also included penalties for negligence and substantial understatement of income tax. The Kaplans paid the amount demanded by the I.R.S. under protest in August 1994 and, after the I.R.S. did not act within six months on their administrative claim for a refund, they commenced this action.
The Kaplans' lawsuit claimed that they were entitled to personal notice of the FPAA under the provisions of the Internal Revenue Code. In the alternative, they argued that denying them personal notice violated their constitutional rights to due process and equal protection of the laws. After the Government filed its answer, the Kaplans moved for summary judgment on these grounds. The Government moved to dismiss the Kaplans' complaint for lack of subject-matter jurisdiction and moved for summary judgment on their ...