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MELLOW PARTNERS CASE--GENERAL PARTNERSHIP OF 2 SINGLE-MEMBER LLCs IS SUBJECT TO TEFRA

06 / 30 / 2018

Mellow Partners v. IRS, 890 F.3d 1070 (D.C. Cir. 5-22-2018)

Mellow Partners, a general partnership comprised of 2 single-member LLCs, appealed a Tax Court holding that the Tax Court had jurisdiction over the partnership-level determinations concerning the Mellow Partners' 1999 partnership tax return and imposing penalties for underpayment of taxes.  

The IRS had determined by way of a FPAA that Mellow Partners was formed and availed of solely to avoid taxes and was an economic sham.  The IRS commenced TEFRA audit, and issues a FPAA to adjust partnership items and disallow losses, and assesses penalties. 

Mellow Partners files a petition in Tax Court to contest the FPAA, moving to dismiss the case for lack of jurisdiction, arguing that the FPAA was invalid because Mellow Partners was a "small partnership" exempt from TEFRA, and arguing that even though the LLCs were listed on the K-1s, the individual owners of these single-members LLCs were the true partners.  The Tax Court denied that motion, rulling that Mellow Partners was not a "small partnership" under TEFRA because its partners were "pass-thru partners" within the meaning of Section 6231(a)(9), in the form of disregarded single member LLCs.  The court affirms the Tax Court on this important point, rejecting efforts by Mellow Partners to point out that on the face of the Form 1065, they had checked "no" on the box, as to whether TEFRA applied.  

"The check-the-box regulations do not determine the tax consequences of a separate, higher-level partnership comprised of two or more disregarded entities, not do they specify who holds a partnership interest for TEFRA purposes."  Therefore, the court of appeals rejected Mellow Partners claim that the single-member LLCs classification as disregarded entities under the check-the-box regulations means that the LLCs' individual owners, rather than the LLCs, were "partners" of Mellow Partners for TEFRA purposes.  When Mellow Partners then argued that the Tax Court erred in finding that these single-member LLCs were "pass-thru partners" as that term is defined under Section 6231(a)(9)(i.e., that a partnership with pass-thru partners is ineligible for the small-partnership exception), the DC Circuit noted that the regulation on point was valid, and rejected that the pass-thru provisions do not apply to DRE's.  The court then gives "Auer" deference to Revenue Ruling 2004-88 and the litigation position of the IRS as a reasonable construction of Regulation 301.6231(a)(1)-1(a)(2), and Mellow Partners did not provide a "compelling reason" to contravene the consistent stance of the IRS and the Tax Courts that have uniformly treated DRE single-member LLCs as pass-thru partners.  The DC Circuit therefore affirmed the Tax Court.