J. Krause, et al v. USA

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UNPUBLISHED OPINION FILED. [10-50312 Affirmed ] Judge: EGJ , Judge: EMG , Judge: CES Mandate pull date is 12/03/2010 [10-50312]

J. Krause, et al v. USA

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Case: 10-50312

Document: 00511260192

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Date Filed: 10/12/2010

IN THE UNITED STATES COURT OF APPEALS United States Court of Appeals FOR THE FIFTH CIRCUIT Fifth Circuit FILED
October 12, 2010 N o . 10-50312 S u m m a r y Calendar Lyle W. Cayce Clerk

J . WINSTON KRAUSE; SHERI S. KRAUSE, P la in t iffs - Appellants, v. U N IT E D STATES OF AMERICA, D e fe n d a n t - Appellee

A p p e a l from the United States District Court for the Western District of Texas U S D C No. 1:08-CV-865

B e fo r e JOLLY, GARZA, and STEWART, Circuit Judges. P E R CURIAM:* I n this tax refund case, Plaintiffs-Appellants J. Winston and Sheri S. K r a u s e ("Krause") appeal the district court's grant of summary judgment to D e fe n d a n t -A p p e lle e the United States. The Krauses argue that the district c o u r t erred when it concluded that, under the Tax Equity and Fiscal R e s p o n s ib ilit y Act ("TEFRA"), the court could not consider the couple's tax

Pursuant to 5TH CIR. R. 47.5, the court has determined that this opinion should not be published and is not precedent except under the limited circumstances set forth in 5TH CIR. R. 47.5.4.

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Date Filed: 10/12/2010

No. 10-50312 r e fu n d claims. For the reasons discussed herein, we AFFIRM the district court's g r a n t of summary judgment. A tax attorney and certified public accountant, J. Winston Krause 1 formed t h e partnership Krause & Associates Advanced Strategies ("KAAS") in 2001. KAAS had one general partner, Krause Holdings, Inc., which was controlled and o w n e d by Krause. KAAS's limited partner was Krause & Associates, LP,

K r a u s e 's law firm, of which he was the sole member. I n 2002, Krause created a Son of BOSS (Bond and Option Sale Strategy) t a x shelter,2 which made it appear as though KAAS had suffered a multi-million d o lla r loss. Due to the partnership's tax status, this loss passed through to the p a r tn e r s h ip 's limited partner, Krause & Associates which Krause controlled. U lt im a t e ly , the loss appeared on the Krauses's joint federal income tax returns in 2002 and 2003. I n 2006, the IRS issued a Final Partnership Administrative Adjustment (" F P A A " ) to KAAS's general partner, Krause Holdings. The FPAA determined t h a t KAAS was a hoax and existed for the sole purpose of tax avoidance. It also s t a t e d that the adjustments of partnership items for KAAS, which resulted in t h e underpayment of taxes, were due to: "(1) substantial understatements of in c o m e tax, (2) gross valuation misstatement(s), or (3) negligence or disregarded r u le s or regulations." The IRS then issued a Notice of Deficiency, which In

in d ic a te d Krause owed additional taxes due to the FPAA adjustments.

Named in the Complaint, Sheri S. Krause is a party only because she filed joint tax returns with her husband for the years in question. J. Winston Krause is responsible for the acts contested by the IRS. A Son of BOSS tax shelter takes advantage of the way in which a partnership treats assets and contingent liabilities for tax purposes. This treatment allows a taxpayer to generate an artificial loss that can be used to offset income from other transactions. See Kornman & Assocs. Inc. v. United States, 527 F.3d 443, 446 n.2 (5th Cir. 2008). The Internal Revenue Service ("IRS") considers these tax shelters an abusive tax practice. I.R.S. Notice 2000-44, 2000-2 C.B. 255.
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No. 10-50312 a d d it io n , the Notice of Deficiency stated that Krause owed $112,466 in penalties a n d interest for the gross valuation misstatements. Krause did not contest the FPAA or the Notice of Deficiency. Krause paid t h e additional tax, penalties, and interest, and then filed a refund claim for the p e n a lt ie s and interest paid. The IRS did not respond and Krause sued. In his pleadings, Krause asserted that under I.R.C. § 6662(h), the IRS c o u ld not impose an accuracy-related penalty because his understatement of tax w a s attributable to the disallowance of a deduction, not a valuation m is s t a te m e n t as the IRS had alleged. The IRS responded by filing a motion for s u m m a r y judgment,3 which argued that Krause's lawsuit was barred under T E F R A , I.R.C. §§ 6221-6232, because his refund claim related to penalties, a p a r tn e r s h ip -le v e l item that should have been contested by the partnership, not a partner. The district court granted the IRS's summary judgment motion. The court c o n c lu d e d that it lacked the jurisdiction to consider the case because under § 6 2 3 0 (c )(4 ), the dispute related to partnership-level items, which could not be c o n t e s t e d once the IRS finalized the FPAA. The court also determined it could n o t consider the case because Krause did not raise any partner-level defenses t h a t would allow the suit to proceed. K r a u s e appealed. He now argues that the district court mis-characterized t h e refund claim and erroneously concluded that TEFRA barred the lawsuit. We review a district court's grant of summary judgment de novo, applying t h e same standard as the district court. Kornman, 527 F.3d at 450. Summary ju d g m e n t is appropriate when pleadings, depositions, discovery answers, and a ffid a v it s reveal no genuine issue of material fact and show that the movant is

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Krause filed a cross-motion for summary judgment, which the district court denied.

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No. 10-50312 e n t i t l e d to judgment as a matter of law. Anderson v. Liberty Lobby, Inc., 477 U .S . 242, 247-48 (1986). F o r tax purposes, partnerships are considered pass-through entities that file informational returns, but do not pay federal income tax. I.R.C. § 6031. This m e a n s that all income, gain, losses, deductions, taxes, and penalties are a llo c a t e d among, or assessed against, individual partners, who report the items o n their personal income tax returns. Id. §§ 701-04. To avoid duplicative litigation stemming from the tax treatment of p a r tn e r s h ip s , Congress enacted TEFRA, which creates a unified procedure for d e t e r m in in g the treatment of partnership tax transactions. TEFRA requires

t h e differentiation between the tax treatment of partnership-level and partnerle v e l items. Id. § 6221. Partnership items include all items of "income, gain, lo s s , deduction, or credit of the partnership," along with "optional adjustments t o the basis of partnership property pursuant to an election under section 754," a n d "the accounting practices and the legal and factual determinations that u n d e r lie the determination of. . . items of income, credit, gain, loss, deduction, e t c ." Treas. Reg. §§ 301.6231(a)(3)-1(a)(1)(i), (a)(3), (b); see also Weiner v. United S ta te s , 389 F.3d 152, 154 (5th Cir. 2004). If the IRS seeks to adjust any partnership items, it issues an FPAA to the p a r tn e r s reflecting adjustments and penalties. I.R.C.§§ 6223, 6225. Although p e n a lt ie s are determined at the partnership level because of a partnership's p a s s -t h r o u g h tax status, they are assessed against the individual partners, who u lt im a te ly are responsible for payment. Treas. Reg. § 1.6662-5(h). W h e n the partnership fails to contest the FPAA within a certain time p e r io d , adjustments and penalties become final. I.R.C. §§ 6225, 6230; see also R a n d e ll v. United States 64 F.3d 101, 108 (2d Cir. 1995). After the FPAA b e c o m e s final, a partner is barred from further litigating the adjustment or p e n a lt y because "TEFRA requires the treatment of all partnership items to be 4

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No. 10-50312 d e t e r m in e d at the partnership level." Weiner, 389 F. 3d at 154. A partner may, h o w e v e r , sue for a refund if they assert a reasonable cause defense or argue that t h e IRS made a computational error in applying a partnership adjustment. I.R.C. § 6230(c); Klamath Strategic Inv. Fund v. United States, 568 F.3d 537, 547 (5 t h Cir. 2009). H e r e , Krause asserts that the district court erred in finding that TEFRA b a r r e d the present lawsuit because the penalties were not attributable to p a r tn e r s h ip -le v e l items. We disagree. The penalties assessed under the FPAA were directly attributable to the fr a u d u le n t $2.79 million loss KAAS alleged it incurred when it sold its Canadian c u r r e n c y . This loss, which passed through to Krause Holdings and then to K r a u s e , occurred because of the overstated basis KAAS had claimed in the C a n a d ia n currency due to an earlier basis election. Thus, the penalty related to b a s is , basis adjustments, and losses, all of which are considered partnership it e m s under § 6231. See also Treas. Reg. §§ 301.6231(a)(3)-1(a)(1)(i), (a)(3), (b); S to b ie Creek Invs. LLC v. United States, 608 F.3d 1366, 1380-81 (Fed. Cir. 2010) (h o ld in g that court could consider case because partnership had contested a d ju s tm e n t of partnership-level items prior to finalization of FPAA.) F u r t h e r , the refund sought by Krause relates to penalties and penaltyr e la t e d interest that are associated with partnership-level items, both of which a r e in and of themselves considered partnership-level items. I.R.C. §§ 6221, 6 2 3 0 ( c ) (4 ). In this regard, the Code is clear: these are items that must be c o n t e s t e d before the IRS finalizes an FPAA. The district court did not err by c o n c lu d in g that it could not consider Krause's refund claims. T o bolster his argument that a gross valuation penalty may not be imposed in circumstances such as this case, Krause relies upon Heasley v. Comm'r, 902 F .2 d 380, 381-84 (5th Cir. 1990) and Todd v. Comm'r, 862 F.2d 540, 542 (5th Cir. 1 9 8 8 ) . He urges us to find that the district court's ruling misinterpreted the 5

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No. 10-50312 h o ld in g s of Heasley and Todd. These cases, like this matter, involved questions a b o u t tax-related penalties. Their holdings are inapplicable, however, because t h e s e cases did not involve questions about partnerships, partnership t r a n s a c t io n s , or more importantly, TEFRA. K r a u s e also argues that the IRS erroneously enacted the penalty because t h e alleged misvaluation relates to a foreign currency option that Krause did not c o n t r ib u t e to the partnership. Therefore, Krause asserts, the misvaluation in q u e s t io n was not a partnership-level item. To fully address this argument we m u s t first ignore the fact that this argument directly relates to the penalties im p o s e d by an FPAA, which TEFRA specifically considers as partnership-level it e m s that cannot be contested at the partner-level. These facts aside, Krause's c o n t e n t io n is still incorrect. Although Krause did not contribute the foreign currency option in question t o the partnership, it played a significant role in Krause's tax chicanery. The r e c o r d is clear­ Krause's tax-treatment of this option was entwined with his taxt r e a t m e n t of the foreign currency option that he contributed to KAAS. In

a d d it io n , the FPAA specifically stated that options were "in substance a single in t e g r a t e d financial transaction." And, because of that, the FPAA disallowed the p u r p o r t e d loss. Thus, what lies at the core of Krause's argument is the FPAA's c h a r a c t e r iz a t io n and treatment of purported losses and gains. And, as we stated e a r lie r , gains, losses, and penalties are all partnership-level items, which must b e contested before the FPAA is finalized. F o r the foregoing reasons, we find the district court did not err and we A F F IR M the district court's grant of summary judgment to the United States.

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