CCA 1052004: Duty of consistency may bar repeated deductions by a related settlement fund

Plain-English summary

Chief Counsel Advice considers whether the Service may prevent a receiver from claiming deductions on a qualified settlement fund's return when the same expenses were previously deducted on a partnership return. The advice concludes that the duty of consistency may apply even though the partnership and settlement fund are separate taxpayers. It relies on the receiver's control over the reporting for both entities, the Service's reliance on the earlier partnership return, and the expiration of the assessment period for that return. The result is that the settlement fund may be barred from deducting the same expenses again.

Ruling snapshot

• Question: May the duty of consistency bar a receiver from claiming on a settlement fund return deductions previously taken on a partnership return?
• Outcome: Advice given
• Key authorities: IRC §§ 6031(a), 761(a), and 1014; Treas. Reg. § 1.468B-2(k)(1); Hollen v. Commissioner, T.C. Memo. 2000-99; Cluck v. Commissioner, 105 T.C. 324 (1995); LeFever v. Commissioner, 103 T.C. 525 (1994); Beltzer v. United States, 495 F.2d 211 (8th Cir. 1974); Hess v. United States, 537 F.2d 457 (Ct. Cl. 1976)

Full text (IRS public release)

       Office of Chief Counsel
       Internal Revenue Service
       Memorandum
       Number: 201052004
       Release Date: 12/30/2010
       CC:PA:06:GTArmstrong
       POSTF-126169-10

UILC: 9111.09-00

date: August 27, 2010

 to:   Yvonne Walker
       Attorney (Seattle)
       (Large & Mid-Size Business)

from: Susan T. Mosley
Senior Technician Reviewer
(Procedure & Administration)

subject: Duty of Consistency as Applied to Form 1120SF

       This Chief Counsel Advice responds to your request for assistance. This advice may
       not be used or cited as precedent.

       LEGEND

       Company A =         ---------------------------------

       Year 1       =      -------

       Year 2       =      -------

       Year 3       =      -------

       Year 4       =      -------

       a            =      ----

       ISSUE

       Whether the Service may assert the doctrine of duty of consistency to preclude a
       receiver from claiming certain deductions on a settlement fund’s return that were

POSTF-126169-10 2

previously taken and allowed on a partnership return for which the period of limitations
on assessment has now expired.

CONCLUSION

Yes. The Service may assert the doctrine of duty of consistency to preclude a receiver
from claiming deductions on a settlement fund’s return that were previously taken and
allowed on a partnership return for which the period of limitations on assessment has
expired.

FACTS

In Year 1, the United States government filed suit against Company A, a partnership for
federal income tax purposes, for its role in an alleged Ponzi scheme. The court hearing
the government’s complaint entered an order appointing a law firm as receiver of the
partnership’s assets. The court ordered the receiver to gather the remaining assets of
the partnership, to conserve them, and to ultimately utilize them to satisfy claims filed by
investors who had filed suit against the partnership. Accordingly, the receiver
established a settlement fund consisting of income generated from the partnership’s
remaining legitimate business activities and interest earned on that income.

As part of its fiduciary duties, the receiver also handled the filing of the partnership’s
income tax returns starting with tax year Year 1. Though not a partner or member of
Company A, the receiver signed the partnership’s returns as the tax matters partner.
On returns filed for Year 1 through Year 2, the receiver caused the partnership to
deduct expenses relating to the partnership’s business operations. The receiver also
caused the partnership to deduct expenses incurred by the receiver in gathering and
conserving the partnership’s assets (the “disputed expenses”). Furthermore, the
receiver determined that the interest accrued by the settlement fund was not includable
on the partnership’s income tax returns. Apparently, the receiver believed that this
interest was more properly reportable on Form 1099’s that the receiver intended to
provide to investors who would receive the settlement payments. The receiver never
issued any Form 1099’s, however, and as a result, the interest that accrued on the
settlement fund was never reported to the Service.

In Year 3, the receiver began making settlement payments to the claimant-investors
who had filed suit against the partnership.

In Year 4, the receiver contacted the Service and confessed to the unreported interest
from the settlement fund account, estimating that over $a -------- had never been
reported on any return filed with the Service. It is our understanding that these interest
amounts should have been included on Forms 1120-SF, U.S. Income Tax Return for
Settlement Funds (the “QSF returns”), which the receiver should have filed for each
year the settlement fund was in existence. Furthermore, had the QSF returns been
timely filed, the receiver could have properly deducted the disputed expenses relating to
its gathering and conservancy duties.
POSTF-126169-10 3

We understand the receiver has agreed that it should have filed the QSF returns in
addition to the partnership returns. Furthermore, the receiver agrees that it should have
reported the interest from the settlement fund on the QSF returns. The receiver now,
however, also seeks to include, as deductions on the QSF returns, the disputed
expenses. The receiver deducted these same expenses on the partnership returns filed
in tax years Year 1-Year 2. The period of limitations on assessment with respect to the
partnership returns has expired. The receiver alleges, however, that it should be
entitled to deduct the disputed expenses regardless of their inclusion on the Year 1-
Year 2 partnership returns. To conclude otherwise, argues the receiver, would penalize
the recipients of the settlement payments because the settlement fund would bear the
burden of the additional income tax (resulting from the disallowed deductions).

LAW AND ANALYSIS

For the reasons set forth below, we conclude that the Service may assert the doctrine of
duty of consistency to preclude the receiver from deducting the disputed expenses on
the QSF returns.

The duty of consistency is an equitable doctrine that Federal courts will employ to
prevent “unfair tax gamesmanship.” Hollen v. Commissioner, T.C. Memo. 2000-99;
Cluck v. Commissioner, 105 T.C. 324 (1995). The doctrine “is based on the theory that
the taxpayer owes the Commissioner the duty to be consistent . . . and will not be
permitted to benefit from the taxpayer’s own prior error or omission.” Cluck, 105 T.C. at

331. The doctrine requires proof of three elements: (1) the taxpayer has made a
     representation in one year; (2) the Service has acquiesced in or relied on that
     representation for that year; and (3) the taxpayer desires to change that representation
     in a later year at a time when the period of limitations bars adjustments to the prior year.
     See id. at 332; LeFever v. Commissioner, 103 T.C. 525, 543 (1994).

As set forth in your request for assistance, it appears that the traditional three-prong test
is met in this case. First, the receiver caused the partnership to take certain deductions
on the partnership’s return relating to expenses incurred by the partnership and by the
receiver. Second, the Service relied upon the partnership’s representations on these
returns. Third, the receiver now seeks to cause the settlement fund to take deductions
for the same expenses (that is, those expenses relating to duties performed by the
receiver) on the QSF returns, which the receiver should have filed, but did not, when it
filed the partnership returns. For the years relevant here, the statute of limitations on
assessing the partnership returns is no longer open. Therefore, under a traditional
analysis, it seems the Service can preclude the receiver from causing the settlement
fund to take deductions on the QSF return for the disputed expenses previously
deducted on the partnership’s return. This fact pattern, however, presents an issue
regarding whether the partnership and the settlement fund can both be considered the
“taxpayer” whose duty it is to be consistent. While we believe these entities to be two
POSTF-126169-10 4

separate taxpayers, we conclude that the representation by one can estop the other in
this case.

First, with respect to the partnership return, the partnership files an information return
(although the partnership itself is not liable for any tax). See I.R.C. § 6031(a) (Every
partnership (as defined in section 761(a)) shall make a return for each taxable year,
stating specifically the items of its gross income and allowable deductions.). With
respect to the QSF return, the settlement fund is the taxpayer and must file an income
tax return (and is ultimately liable for any taxes due). See Treas. Reg. § 1.468B-2(k)(1)
(A qualified settlement fund must file an income tax return with respect to the tax
imposed . . . for the taxable year that the fund is in existence.). With respect to both
returns in this case, however, it is the receiver that is responsible for preparing and filing
the returns, regardless of the identity of the taxpayers. The receiver controls how items
are reported, and therefore, it is the receiver who is charged with the duty to be
consistent in this case.

Indeed, a number of courts have held that, under certain circumstances, a taxpayer may
be estopped by a representation made by or on behalf of a related taxpayer. See, e.g.,
Cluck v. Commissioner, 105 T.C. 324 (1995); Beltzer v. United States, 495 F.2d 211
(8th Cir. 1974); Hess v. United States, 537 F.2d 457 (Ct. Cl. 1976). These courts have
based their findings on the existence of a “sufficiently close relationship between the
party making the representation and the party to be estopped.” Cluck, 105 T.C. at 335.
The sufficiency of the closeness of this relationship will depend upon on the facts and
circumstances. Id.

For example, in Beltzer, the Eighth Circuit Court of Appeals held that a beneficiary was
bound by representations made on the estate’s tax return. On that return, which the
beneficiary son signed as co-executor of his father’s estate, the estate reported certain
stock at its fair market value at the time of the father’s death. The son, after receiving
the stock in a distribution from the estate, sold it for a significant sum and used as his
basis a value much higher than that reported on the estate’s return.1 Because the
period for adjusting the estate’s return had expired, the Service argued that the duty of
consistency doctrine precluded the son from using a different value than that reported
by the estate. The court agreed with the Service and found that the son was bound by
the values reported on the estate’s return.

Similarly, in Hess, the Court of Claims concluded that the duty of consistency precluded
a testamentary trust from claiming a basis in certain stock that was different from the
value of the stock as reported on the estate’s return. Though the court noted that the
estate and trust were “separate legal entities,” it concluded: “The interests of the two
entities being very closely related, and the same individual having acted, we think it only
fair and in accord with the spirit of the law, to require the trust to act in a manner

1
Pursuant to section 1014, the basis of the property acquired from a decedent is generally the fair market
value of the property at the date of the decedent’s death.
POSTF-126169-10 5

consistent with the estate.” Hess, 537 F.2d at 464. The phrase “the same individual
having acted” referred to the fact that the same individual, Mr. Hess, operated as a
trustee of the testamentary trust as well as an administrator of the estate. In those
capacities, Mr. Hess filed returns for both entities in which the stock at issue was
reported at two different values.

Lastly, in Cluck, the Tax Court considered whether the duty of consistency could bind a
petitioner to certain values agreed upon by the petitioner’s husband in a stipulation of
settled issues. Petitioner’s husband entered into the stipulation in an earlier case in
which he and the Service agreed on the value of certain property for purposes of
determining the tax liability of his mother’s estate. After receiving that property in a
distribution from the estate, petitioner’s husband sold the property and recognized
capital gains. Those gains reduced net operating loss (NOL) carryforwards claimed by
the husband and the petitioner on their joint income tax return. The petitioner
challenged the Service’s adjustments to the NOL carryforwards, claiming she was not
bound by the husband’s stipulation and that she had a higher basis in the property. The
Service argued that the duty of consistency applied and the court agreed, finding the
relationship between petitioner and her husband “sufficiently close” to bind the
petitioner. In effect, the husband’s representation in the prior year’s stipulation, upon
which the Service relied, estopped the wife from taking a different position on a later
return.

Similarly, here, the partnership’s representations on its return, upon which the Service
relied, bar the settlement fund from taking deductions for the same expenses on its own
income tax return. Though the partnership and settlement fund are two separate legal
entities, their relationship is “sufficiently close” in this case that the actions of one may
bind the other. In addition, as in Hess, the same entity (the receiver) controls how both
the partnership and the settlement fund report items on their respective returns. The
receiver, similar to the estopped beneficiary in Beltzer, will sign the return of the
settlement fund as administrator and, in the case of the partnership’s return, has signed
the return as the tax matters partner. Because of the sufficiently close relationship of
the two entities and the fact that the receiver controls and signs, or has signed, returns
for both, the partnership’s representations on its returns for the Year 1-Year 2 tax years
should bind the settlement fund.

Were it not for the unique role of the receiver, we would certainly agree that, under a
traditional duty of consistency analysis, the settlement fund would be barred from
deducting the disputed expenses. Your question, however, presents the unique issue
of whether a partnership’s representations can bind a related settlement fund with
respect to the fund’s own income tax return. Here, the receiver caused the partnership,
over which it had control through decree of the court, to file tax returns and claim
deductions for expenses incurred by the receiver in carrying out its fiduciary duties. The
receiver now wishes to cause the related settlement fund to deduct the same expenses
on returns which the receiver neglected to timely file on behalf of the settlement fund.
POSTF-126169-10 6

We conclude that the Service may assert the doctrine of duty of consistency to preclude
the receiver from doing so.

This writing may contain privileged information. Any unauthorized disclosure of this
writing may undermine our ability to protect the privileged information. If disclosure is
determined to be necessary, please contact this office for our views.

Please call (202) 622-7950 if you have any further questions.