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Acute Care Specialists Ii, Ltd., Gregory W. Jackson and Nora A. v. United States of America

December 14, 2011


The opinion of the court was delivered by: Matthew F. Kennelly, District Judge:


Acute Care Specialists II, Ltd. (Acute Care) and eight other taxpayers have sued the United States seeking refunds of income tax and interest. Plaintiffs claim that the Internal Revenue Service (IRS) improperly assessed taxes and interest against them after the statutory period for doing so had expired and/or under an improper theory of liability. The government has moved to dismiss all of plaintiffs' claims. For the reasons stated below, the Court grants the motion.


The following facts are taken from the plaintiffs' complaint, documents referred to in the complaint, and the parties' memoranda of law. The Court construes all facts in the complaint favorably to the plaintiff when considering a motion to dismiss. Graczyk v. West Pub. Co., 660 F.3d 275, 279 (7th Cir. 2011). The Court may take judicial notice of the contents of public court documents without converting a motion to dismiss into a motion for summary judgment. Henson v. CSC Credit Servs., 29 F.3d 280, 284 (7th Cir. 1994). The Court may also take judicial notice of "proceedings in other courts, both within and outside of the federal judicial system, if the proceedings have a direct relation to matters at issue." Green v. Warden, 699 F.2d 364, 369 (7th Cir. 1983).


Although partnerships are required to file informational tax returns, they are not themselves liable for income tax. "Instead, a partnership is treated as a conduit through which income passes to its partners, who are responsible for reporting their pro rata share of tax on their individual income tax returns." Duffie v. United States, 600 F.3d 362, 365 (5th Cir. 2010). Congress enacted the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) in order to "achieve consistent treatment of all partners in a partnership and to alleviate the administrative burden of determining partnership related tax issues at the individual partner level." Matthews v. United States, No. 00 C 4131, 2010 WL 2305750, at *1 (S.D. Tex. June 8, 2010).

TEFRA was designed to streamline the process that takes place when the IRS reviews a partnership return and disputes some aspect of it. . . . Rather than undertake an arduous series of partner-by-partner audits, as had previously been required, TEFRA allows for a single, unified audit to determine the treatment of "partnership items" for all the partners. These are items whose treatment affects the entire partnership, and so analyzing them at the partnership level makes more sense than doing so partner-by-partner. Under TEFRA, the IRS performs its audit of the partnership return and then transmits a notice of any required adjustments to each of the partners.

Bush v. United States, 655 F.3d 1323, 1324-25 (Fed Cir. 2011) (internal citations omitted). TEFRA allows the IRS to adjust partnership items "at a singular proceeding, and then subsequently assess all of the partners based on the adjustment to that particular item," rather than conducting "individual 'partner level' proceedings for each member of a partnership." Prati v. United States, 81 Fed. Cl. 422, 427 (Fed. Cl. 2008).

The"partnership items" that the IRS may determine at the partnership level are defined as "any item required to be taken into account for the partnership's taxable year under any provision of Subtitle A to the extent regulations prescribed by the Secretary provide that, for purposes of [Subtitle F], such item is more appropriately determined at the partnership level than at the partner level."*fn1 26 U.S.C. § 6231(a)(3). Treasury regulations provide that these items include gains, losses, deductions, and credits of a partnership, as well as the "legal and factual determinations that underlie the determination of the amount, timing, and characterization of items of income, credit, gain, loss, deduction, etc." 26 C.F.R. § 301.6231(a)(3)-1.

TEFRA also defines a "nonpartnership item" as "an item which is (or is treated as) not a partnership item." 26 U.S.C. § 6231(a)(3). The tax treatment of these items requires "partner-specific determinations that must be made at the individual partner level." Duffie, 600 F.3d at 366. Finally,

TEFRA also includes a hybrid category of "affected items." An "affected item" is "any item to the extent such item is affected by a partnership item." 26 U.S.C. § 6231(a)(5). For example, a taxpayer-partner's medical expense deduction under 26 U.S.C. § 213(a) is an "affected item." Because a taxpayer can only deduct medical expenses to the extent those expenses exceed 7.5% of adjusted gross income, a change in the partnership's income affects the amount of the partner's deduction. Affected items can have both partnership-item and nonpartnership-item components. For example, determining a limited partner's "amount at risk" for purposes of 26 U.S.C. § 465 may require a partnership-item determination of the amount of partnership debt and a nonpartnership-item determination of the amount of that debt assumed by the limited partner. Id.

After examining the partnership's tax return to determine whether all partnership items are properly categorized and accounted for, the IRS may adjust those items it finds to be invalid.

If the IRS decides to adjust any partnership items on a partnership's informational income tax return, it must notify the individual partners of the adjustment by issuing a Notice of Final Partnership Administrative Adjustment ("FPAA"). A Notice of FPAA sets out the proposed adjustments, e.g. disallowing all or part of the partnership's deductions, and lists the grounds for the adjustments. For ninety days after a notice of FPAA issues, the Tax Matters Partner [("TMP")] has the exclusive right to challenge the proposed adjustments in Tax Court, the Court of Federal Claims, or a United States District Court. 26 U.S.C. § 6226(a). If the TMP does not file suit challenging the proposed adjustments within this period, other partners have sixty days to file a petition for readjustment. Id. § 6226(b)(1). If a partnership level challenge is filed, each partner in the partnership is deemed a party to the case. 26 U.S.C. § 6226(c)(1). Id. at 366-67 (internal citations omitted). "A tax matters partner is the partner designated to act as a liaison between the partnership and the IRS in administrative proceedings and as the representative of the partnership in judicial proceedings." Id. at 366 n.1.

Under a statutory provision formerly codified at 26 U.S.C. § 6621(c), the IRS imposed additional interest when making an adjustment based on "substantial underpayments attributable to tax motivated transactions." The statutorily defined tax motivated transactions (TMTs) included "any sham or fraudulent transaction." Id. at 6621(c)(3)(A)(v). Section 6621(c) was repealed in 1989, but plaintiffs do not dispute that it was in effect during the years for which the IRS applied it to them.

B. Facts

In the early 1980s, [American Agri-Corp (AMCOR)] organized a number of limited partnerships for which it acted as general partner. These partnerships had as stated goals acquiring agricultural land, investing in agricultural ventures, and growing crops. AMCOR solicited investments from high-income professionals across the country. Each partner in an AMCOR partnership would receive a projected tax loss from crops planted in the first year of roughly twice that partner's investment. Investors paid the farming expenses up front and deducted the amount invested on their tax returns. The next year, when the crops were harvested, the amount of loss in excess of the amount invested would be subject to taxes. However, the farming expenses typically exceeded any income realized from the farming activities. In 1987, the IRS began an investigation and audit into the AMCOR partnerships to determine whether they were impermissible tax shelters.

Duffie, 600 F.3d at 367. "In Crop Associates--1986 v. Comm'r of Internal Revenue, T.C. Memo 2000--216, 2000 WL 976792 (U.S. Tax Court 2000), the court found that from its inception in 1981 until 1986, AMCOR was engaged in the business of promoting tax shelter partnerships." Id. at 367 n.3.

Plaintiffs Acute Care, Gregory Jackson, Alan Kaplan, Anthony Raccuglia, and Joseph Shanahan were each limited partners in one or more of four AMCOR partnerships: Agri-Cal Venture Associates (ACVA), Agri-Venture II (AV2), Agri-Venture-85 (AV85), and Western Agri-Venture Associates (WAVA).*fn2 For the tax years 1984 through 1986, each of these partnerships timely filed one or more IRS Form 1065 partnership tax returns that was later the subject of an IRS audit. All of the plaintiffs timely filed income tax returns reflecting their limited partner status for the years during which they were involved with the partnership(s).

In the course of investigating the AMCOR partnerships, the IRS issued FPAAs for ACVA and WAVA in 1990 and for AV2 and AV85 in 1991, disallowing several listed farming expenses for 1984 and/or 1985 as well as other deductions. Each FPAA stated that the partnership's activities constituted "a series of sham transactions" or "a series of sham transactions lacking economic substance," in addition to other grounds for adjustment.

Various partners filed suit in Tax Court pursuant to section 6226(b), challenging the proposed adjustments set forth in the FPAAs. The ACVA case was consolidated with six other Tax Court cases and designated as the "Test Case Group," while AV2, AV85, and WAVA were consolidated with seventy-six other cases. Fred Behrens, an AMCOR officer and general partner, intervened as the TMP for these four partnerships and most of the others. Behrens and the IRS eventually agreed to a trial for the Test Case Group, during which the judge would decide, among other things, the question of whether the IRS had assessed liability after the statute of limitations had expired. In preparation for this trial, on December 6, 1999, parties to each of the cases, including the four partnerships involving plaintiffs, filed documents entitled "Stipulation to Be Bound." These documents include the following statement:

The parties stipulate and agree that the outcome of the statute of limitations issues [for the specified year or years] presented in this Partnership Case will be determined in a manner consistent with the Court's findings of fact and law on the statute of limitations issues present in the Test Case Group ...

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