Opinion
Civil Action No. 03-1783, Re: Doc. #18.
May 27, 2005
MAGISTRATE JUDGE'S REPORT AND RECOMMENDATION
I. RECOMMENDATION
It is recommended that Defendants' Motion for Summary Judgment be denied.
II. REPORT
This is an action against the United States for a refund of income tax and interest paid for the year ending in 1986. Plaintiffs Anthony and Patricia Canterna ("Plaintiffs") commenced this action on November 20, 2003 to recover a refund of income tax and interest they paid as a result of a disallowance of losses claimed in 1986 by Quartet Films Associates, a partnership in which they had an interest.
On May 8, 2003, Defendants filed a Motion for Summary Judgment on three separate grounds. First, Defendants contend that Plaintiffs' action is barred by the doctrine of res judicata; second, that Plaintiffs received the Notice of Beginning of an Administrative Proceeding ("NBAP"), and the Notice of Final Partnership Administrative Adjustment ("FPAA") contrary to their argument that they did not receive them; third, that 26 U.S.C. § 7422(h) prohibits the adjudication of cases involving the separate tax liability of partners in a partnership.
In response, Plaintiffs argue that, as greater than 1% interest holders in Quartet Films Associates, they were entitled to notice. They argue further that there is a material question of fact as to whether the Service's notices were actually mailed. Additionally, they argue that the doctrine of res judicata does not apply to the prior proceeding because they may elect to treat their partnership share as non-partnership items. Based on that election, they also argue that their suit is not barred by sovereign immunity.
The parties did not file a joint statement of material facts which are not in dispute. Accordingly, the facts stated herein are culled from the pleadings, answers to interrogatories, and exhibits.
In 1986, Plaintiffs Anthony and Patricia Canterna invested in a partnership known as Quartet Films Associates. (Answers to Interrogs. ¶ 3, Doc. #19, attached thereto as Ex. 2.) At the end of that year, they received a K-1 indicating the amount of profit and loss generated by their investment. (Answers to Interrogs. ¶ 6, Doc. #19, attached thereto as Ex. 2.) The K-1 was correctly addressed to them at RD #3 Box 32K, Washington, PA 15301. (Answers to Interrogs. ¶ 6, Doc. #19, attached thereto as Ex. 2.) Plaintiffs incorporated the information in the K-1 in their federal tax return. (Compl. ¶ 4.)
On November 28, 1989, the Internal Revenue Service ("Service" or "IRS") generated a Notice of Beginning of an Administrative Proceeding ("NBAP") for the 1986 tax year. ( See Notice dated November 28, 1989, Doc. #19, attached thereto as Ex. B of Ex. 1.) The Notice concerned Quartet Films Associates Partnership and it was correctly addressed to Plaintiff Anthony Canterna at RD #3 Box 32K, Washington, PA 15301. ( See Notice dated November 28, 1989, Doc. #19, attached thereto as Ex. B of Ex. 1; Answers to Interrogs. ¶ 7, Doc. #19, attached thereto as Ex. 2.) Plaintiffs deny they received this Notice. (Answers to Interrogs. ¶ 7, Doc. #19, attached thereto as Ex. 2.)
On October 29, 1990, the Service generated a Notice of Final Partnership Administrative Adjustment ("FPAA") for the 1986 tax year. ( See Notice dated October 29, 1990, Doc #19, attached thereto as Ex. C of Ex. 1.) The Notice concerned Quartet Films Associates Partnership and it was correctly addressed to Plaintiffs Anthony and Patricia Canterna at RD #3 Box 32K, Washington, PA 15301-9803. (Answers to Interrogs. ¶ 8, Doc. #19, attached thereto as Ex. 2.) Plaintiffs deny they received this Notice as well. (Answers to Interrogs. ¶ 8, Doc. #19, attached thereto as Ex. 2.)
Through its tax matters partner ("TMP"), Quartet Films Associates challenged the FPAA. (Compl. ¶ 11; Answer ¶ 11.) On September 22, 1999, the Tax Court entered a decision, pursuant to a settlement reached by the Partnership and the Service, in which 50% of the losses claimed by Quartet Films Associates for the 1986 tax year were disallowed. (Compl. ¶ 11; Answer ¶ 11.)
On September 20, 2000, the Service notified Plaintiffs that certain losses taken for 1986 pertaining to the Partnership were disallowed and demanded payment of $76,780.00 in tax. (Compl. ¶ 5.) On October 23, 2000, the Service notified Plaintiffs of an additional $179,154.00 due in interest. (Compl. ¶ 5.)
On February 7, 2001, Plaintiffs paid the outstanding balance of tax and interest due. (Compl. ¶ 7; Answer ¶ 7.) Plaintiffs filed the instant action on November 20, 2003 to recover a refund of the tax and interest paid as a result of the disallowance.
B. Rule 56(c) Summary Judgment Standard
Summary judgment is appropriate if, resolving all inferences and doubts in favor of the non-movant, "the pleadings, depositions, answers to interrogatories and admissions on file, together with the affidavits, if any, show that there is no genuine issue of material fact and the movant is entitled to judgment as a matter of law." Fed.R.Civ.P. 56(c). Summary judgment may be granted against a party who fails to adduce facts sufficient to establish the existence of any element essential to that party's case, and for which that party will bear the burden of proof at trial. Celotex Corp. v. Catrett, 477 U.S. 317, 322 (1986). The moving party bears the initial burden of identifying evidence which demonstrates the absence of a genuine issue of material fact. An issue is genuine only if the evidence is such that a reasonable jury could return a verdict for the nonmoving party. Anderson v. Liberty-Lobby, Inc., 477 U.S. 242, 248 (1986).
Once that burden has been met, the nonmoving party must set forth "specific facts showing that there is a genuine issue for trial" or the factual record will be taken as presented by the moving party and judgment will be entered as a matter of law.Matsushita Elec. Indus. Corp. v. Zenith Radio Corp., 475 U.S. 574, 587 (1986).
C. Discussion
Defendant bases its Motion for Summary Judgment on three separate grounds. First, it argues that the instant case is barred by the final judgment entered by the Tax Court under the doctrine of res judicata. Second, it argues that 26 U.S.C. § 6223 requires only that the Service send notice of a partnership proceeding, and Plaintiffs' claim that they did receive it is irrelevant. Third, it argues that 26 U.S.C. § 7422(h) prohibits the adjudication of cases involving separate tax liability of partners in a partnership. The statutory framework and Defendant's arguments will be discussed in turn below.
1. Statutory Scheme
Through the enactment of the Tax Equity and Fiscal Responsibility Act of 1982, Pub.L. No. 97-248, 96 Stat. 324, codified at 26 U.S.C. §§ 6221- 33 ("TEFRA"), Congress established a statutory framework for the administrative and judicial review of partnership returns. Under TEFRA, the Internal Revenue Service may begin a partnership-level audit through a unified proceeding at the partnership level to determine the tax treatment of "partnership items" rather than initiating separate and individualized proceedings for each partner. I.R.C. § 6221; see also Slovacek v. United States, 36 Fed. Cl. 250, 254 (1996) ("the principle purpose of TEFRA is to provide consistency and reduce duplication in the treatment of partnership items by requiring that they be determined in a single unified proceeding at the partnership, rather than the partner, level."). A "partnership item" is any item that must be taken into account for the partnership's tax year, to the extent the regulations provide the item is more appropriately determined at the partnership level than at the partner level. I.R.C. § 6231(a) (3). Examples of partnership items are income, gain, loss (such as net operating loss), and deductions or credits, as well as any item that affects the computation of partnership taxable income, such as the method of accounting, the partnership's inventory method, or the characterization of partnership property. Treas. Reg. § 301.6231(a) (3)-1(a) (1) (i); Treas. Reg. § 301.6231(a)(3)-1(b).
Internal Revenue Code Section 6223 gives the notice procedures related to any TEFRA proceedings. I.R.C. § 6223. Under these procedures, the IRS must send notice of the beginning of an administrative proceeding ("NBAP") and of the final partnership administrative adjustment ("FPAA") to the tax matters partner ("TMP") and each notice partner. I.R.C. § 6223(a). The tax matters partner under TEFRA is charged with representation of the partnership in various ways. Section 6231(a) (7) defines the term as follows:
A partner provides identification information to the IRS via the partnership tax return, as well as by direct submissions to the IRS. Treas. Reg. § 301.6223(c)-1.
Tax matters partner. The tax matters partner of any partnership is —
(A) the general partner designated as the tax matters partner as provided in regulations, or
(B) if there is no general partner who has been so designated, the general partner having the largest profits interest in the partnership at the close of the taxable year involved (or, where there is more than 1 such partner, the 1 of such partners whose name would appear first in an alphabetical listing). . . .See Treas. Reg. § 301.6231(a) (7)-1. Section 6223(g) provides further that the tax matters partner must "keep each partner informed of all administrative and judicial proceedings for the adjustment at the partnership level of partnership items." Section 6231(a) (8) defines the term notice partner as "a partner who, at the time in question, would be entitled to notice under [ 26 U.S.C. § 6223(a)] (determined without regard to subsections (b) (2) and (e) (1) (B) thereof)."
Pursuant to Section 6226 of the Internal Revenue Code, within 90 days of the mailing of an FPAA, the TMP may file a petition for a readjustment of the partnership items for the taxable year with the Tax Court, the appropriate United States District Court, or the Court of Federal Claims. I.R.C. § 6226(a). If the TMP fails to file a petition with respect to the FPAA, any notice partner may do so within 60 days after the close of the 90 day period. I.R.C. § 6226(b). In addition, the Code provides that partnership partners are considered to be parties to a challenge brought under Section 6226(a) or (b). I.R.C. § 6226(c). The partners are therefore bound by any decision rendered by the appropriate court. Further, partners are bound by a settlement agreement entered into between the TMP and the IRS with respect to the determination of partnership items. I.R.C. § 6224(c) (1). 2. The Doctrine of Res Judicata I.R.C. § 6223
26 U.S.C. § 6226(c) provides:
Partners treated as parties. If an action is brought under subsection (a) or (b) with respect to a partnership for any partnership taxable year —
(1) each person who was a partner in such partnership at any time during such year shall be treated as a party to such action, and
(2) the court having jurisdiction of such action shall allow each such person to participate in the action.
26 U.S.C. § 6224(c) (1) provides in pertinent part:
Settlement agreement. In the absence of a showing of fraud, malfeasance, or misrepresentation of fact —
(1) Binds all parties. A settlement agreement between the Secretary or the Attorney General (or his delegate) and 1 or more partners in a partnership with respect to the determination of partnership items for any partnership taxable year shall (except as otherwise provided in such agreement) be binding on all parties to such agreement with respect to the determination of partnership items for such partnership taxable year.
It is well-settled that the doctrine of res judicata applies in the context of income tax cases. United States v. International Bldg. Co., 345 U.S. 502, 506 (1953); Commissioner of Internal Revenue v. Sunnen, 333 U.S. 591 (1948). The Supreme Court has explained that "if a claim of liability or non-liability relating to a particular tax year is litigated, a judgment on the merits is res judicata as to any subsequent proceeding involving the same claim and the same tax year."Sunnen, 333 U.S. at 598.
"Claim preclusion refers to the effect of a judgment in foreclosing litigation of a matter that never has been litigated, because of a determination that it should have been advanced in an earlier suit." Migra v. Warren City Sch. Dist. Bd. of Educ., 465 U.S. 75, 77 n. 1 (1984); see also 18 C. Wright, A. Miller, E. Cooper, Federal Practice and Procedure: Jurisdiction 2d § 4402 (2002). On the other hand, "[i]ssue preclusion refers to the effect of a judgment in foreclosing relitigation of a matter that has been litigated and decided." Migra, 465 U.S. at 77 n. 1.
To establish the doctrine, the following requirements must be present: "(1) a final judgment on the merits in a prior suit involving; (2) the same parties or their privities; and (3) a subsequent suit based on the same cause of action." Tripi v. United States, 1997 U.S. Dist. LEXIS 4721 *7 (W.D. Pa. 1997), citing Bd. of Tr. of Trucking Emp. Pension Fund v. Centra, 983 F.2d 495, 503 (3d Cir. 1992).
However, for a decision of the Tax Court to be res judicata as to a notice partner, notice of the FPAA must have been mailed to that partner. 26 U.S.C. Sec. 6223(a). If the Secretary fails to mail notice to a notice partner, the partner can, pursuant to 26 U.S.C. Sec. 6223(e) (2) (B) elect to have the partnership items treated as non partnership items.
Plaintiffs argue that they did not receive notice of the NBAP and the FPAA and did not participate in the partnership proceeding, and therefore they may elect to treat the partnership items as non-partnership items." (Mem. Opp'n at 6, Doc. #22.) Therefore, they argue that the prior proceeding is not res judicata as to their claims. (Mem. Opp'n at 6, Doc. #22.) Section 6223(e) (2) of the Internal Revenue Code entitled "Effect of Secretary's failure to provide notice," provides two options available to a partner to whom the IRS has failed to mail any notice. First, a partner may elect to be bound by an adjustment, decision, or settlement that has become final. I.R.C. § 6223(e) (2) (B). Or, if the partner does not make an election, that partner's partnership items for the taxable year in question will be treated as non-partnership items. I.R.C. § 6223(e) (2) (B). Section 6223 applies when the IRS has failed to provide notice. Here, Plaintiffs claim that they did not receive notice and therefore they are not bound by the final decision regarding their liability for partnership items.
Plaintiffs cite Boyd v. Commissioner, 101 T.C. 365 (1993) as supporting their argument. In that case, the plaintiffs were notice partners and therefore were entitled to receive notice of an FPAA resulting from a partnership audit under Section 6223(a). It was undisputed that they did not receive timely notice. However, it was also undisputed that the Service did not mail it to them. Id. at 370. When they finally received notice, they challenged the assessment on the basis that it was untimely and barred by res judicata. Meanwhile, the Tax Court had entered a final decision on an action brought on behalf of the partnership. The court explained that in that situation, under Section 6223(e) (2) (B), the plaintiffs may elect to be treated consistently with the decision or chose to have those partnership items treated as non-partnership items. Id. The court explained further that because no election was made, the items in question would be converted to non-partnership items pursuant to Section 6223(e) (2) (B). Id. at 370-71. The court held, inter alia, that the notice of deficiency was issued within one year from the date the items were converted to nonpartnership items, and therefore, it was timely under Section 6229 (f).
As to the Plaintiffs' claim that the assessment was barred by the doctrine of res judicata because the first notice of deficiency was untimely under Section 6501, and therefore, it was invalid, the Court held that the Tax Court's decision based on that deficiency, which was separate and distinct from the partnership proceedings, was also invalid and therefore was not a final decision for purposes of res judicata. Id. at 367, 371-72.
In Boyd, the loss was converted to a nonpartnership item because the petitioner had not received timely notice. The notice of deficiency of the nonpartnership item was mailed within the required time. Therefore in Boyd the Court upheld the Commissioner's deficiency determination.
The Service has provided the Court with a transcript of Paul Czarnecki's deposition in which he testified that he could not prove that the Plaintiffs received copies of the notices. He could only say that he saw the carbon copy that was shown to him by the U.S. Attorney and based on that he could assume they were mailed. He further testified that although letters are inputted into the system a week to ten days before the date given on the letter, the mailing date was very accurate. Czarnecki Dep. at 26-27, 53, 56-58, Doc. #19, attached thereto.)
Paul L. Czarnecki is the accounting control and services operations manager in the Philadelphia campus. His job entails overseeing the accounting operation "which includes various aspects of the pipeline and total reconciliation of the general ledger for the director." (Czarnecki Dep. at 4-5, Doc. #19, attached thereto.)
Mr. Czarnecki testified that the FPAA in Plaintaiff's case, (Ex. C of Ex. 1 to Doc. #19) was a notice generated by a computer. Everything was "pin-fed multi paper carbon kind of thing done on an impact printer." (Id. at 53.) The printer would have printed multiple carbon copies. (Id. at 56.) The only way to determine whether or not they had been delivered by the postal service would be if they were returned by the postal service as undeliverable. (Id. at 57.) When they sent the letter out they would have put the carbon copy in the taxpayer's file (Id. at 57-58.) Mr. Czarnecki testified that he assumed his counsel, Ms. Oliphant, Esq., had found the carbon copy in the Plaintiff's file. (Id. at 58.) He agreed with the statement of his counsel that "if we were lucky if they had gotten the return envelope, they would have put that in the file also?"
Plaintiffs agree that the copies of those documents which have been provided to the Court reflect their correct mailing address. (Answers to Interrogs. ¶¶ 7-8, Doc. #19, attached thereto as Ex. 2.)
The difficult question in this case would appear to be whether there is an issue of fact as to whether the IRS mailed the notices to Plaintiffs. Have Defendants produced sufficient evidence that the notices were mailed to shift the burden to Plaintiffs to come forward with evidence that the notices were not mailed.
The Government's evidence is that Mr. Czarnecki identified a document given to him by his counsel as a carbon copy of the notice that, if the standard procedures were followed, would have been mailed to Plaintiffs. He assumed that his counsel had found the carbon copy in Plaintiff's file. Item 8 of Defendants statement of Material Facts states that "On October 29, 1990, the Service issued a Notice of Final Partnership Administrative Adjustment (FPAA) to the plaintiffs at . . . [their correct address]." Doc. # 19. That statement is not under oath or seal and does not state that the FPAA was mailed to Plaintiffs.
In Fox v. United States, 1996 U.S. Dist. LEXIS 10480; 96-2 U.S. Tax Cas. 430 (E.D. Cal. 1996) the court made a finding that the IRS had mailed the NBAP to the plaintiff at her correct address. The file contained a certificate of official record from the IRS that a FPAA for that year was sent by certified mail to the plaintiff at her former address and returned to the IRS.
The record also contained a disclosure letter stating that "`a review of the file indicates that statutory notices were mailed out of the service center' and that the mailing log would be available from the IRS office in Fresno." When the plaintiff's attorney made a request for the mailing log under the Freedom of Information Act it could not be found.
The court found that the IRS did mail the NBAP to the plaintiff at his former address and added that that finding was "supported, if not compelled, by the presumption of official regularity. Under this presumption, courts presume that officials have properly discharged their official duties, unless there is clear evidence to the contrary." The court found that the presence of the letter in the plaintiff's file created a presumption that the letter was in fact mailed.
Defendants here have not produced sufficient evidence that the notices were mailed to create a presumption that they were mailed. In this case there are too many missing links. First, there is no evidence that Exhibit B and Exhibit C of Defendants' Memorandum, Doc. # 19, the NBAP and the FPAA were found in Plaintiff's file. During his deposition Mr. Czarnecki merely answered that he assumed his counsel, Ms. Oliphant, Esq., had found the carbon copy in the plaintiff's file. Defendants have not offered any affidavit or admissible evidence as to where it was found or by whom.
In addition, in Fox, there were two important items of evidence. First, the IRS administrative file contained "a certificate of official record from the IRS that a Final Partnership Administrative Adjustment (FPAA) for the tax year was sent by certified mail to Plaintiff at her Long Beach address on March 23, 1987 and returned to the IRS on May 15, 1987."
Second, the record also contained "an April 1994 IRS disclosure letter stating that `a review of the file indicates that statutory notices were mailed out of the service center.'"
Defendants have produced no evidence which is equivalent to either of these two items of evidence and therefore there is no basis for a presumption that the letter was in fact mailed, as was established in Fox.
Further, although Plaintiffs' affidavits that they did not receive the notices would not effectively contradict actual evidence that the notices were mailed, in light of Defendants' failure to produce adequate evidence that the notices were mailed to establish the presumption, they could support a theory that because they were not received because they were not mailed.
Since Defendants have not provided evidence that the notices were mailed to Plaintiffs they have not established that Plaintiffs' complaint is barred by res judicata. 3. 26 U.S.C. § 7422 (h) (Sovereign Immunity)
Defendant also argues that the instant action is barred by Section 7422(h) which provides that "[n]o action may be brought for a refund attributable to partnership items (as defined in section 6231(a) (3) [ 26 USCS § 6231(a) (3)]) except as provided in section 6228(b) [ 26 USCS § 6228(b)] or section 6230(c) [ 26 USCS § 6230 (c)]." Therefore, Plaintiffs' suit can only survive summary judgment if their claims fall into one of the exceptions or if the items in question have been converted to non-partnership items.
Plaintiffs argue that Section 7422(h) does not apply to them because Defendants' failure to send them notice of the FPAA authorizes them to elect to treat partnership items as nonpartnership items under Section 6223(e) (2). Defendants have not established that a copy of the FPAA was mailed to Plaintiffs. That appears to be a genuine issue of material fact. Accordingly, Defendants have not shown that Section 7422(h) operates as a bar to Plaintiffs' action.
III. CONCLUSION
For the foregoing reasons, it is recommended that Defendants' Motion for Summary Judgment be denied.
In accordance with the Magistrates Act, 28 U.S.C. § 636(b) (1) (B) and (C), and Rule 72.1.4(B) of the Local Rules for Magistrates, the parties are allowed ten (10) days from the date of service to file objections to this report and recommendation. Any party opposing the objections shall have seven (7) days from the date of service of objections to respond thereto. Failure to file timely objections may constitute a waiver of any appellate rights.