A taxpayer is liable for an accuracy-related penalty on any
part of an underpayment attributable to, among other things, a substantial
understatement of income tax. Sec. 6662(b)(2). There is a substantial
understatement of income tax if the amount of the understatement exceeds the
greater of either 10% of the tax required to be shown on the return or $5,000.
Sec. 6662(a), (b)(2), (d)(1)(A); sec. 1.6662-4(a), Income Tax Regs.; see Jarman
v. Commissioner, T.C. Memo. 2010-285 [TC Memo 2010-285]. See Higbee v. Commissioner, 116 T.C. at 446;
Jarman v. Commissioner, T.C. Memo. 2010-285 [TC Memo 2010-285]. A taxpayer is
not liable for an accuracy-related penalty, however, if the taxpayer acted with
reasonable cause and in good faith with respect to any portion of the
underpayment. Sec. 6664(c)(1); sec. 1.6664-4(a), Income Tax Regs.
We have considered all arguments made in reaching our
decision and, to the extent not mentioned, we conclude that they are moot,
irrelevant or without merit.
Stephan F. Brennan, et ux., et al. v. Commissioner, TC Memo
2012-209 , Code Sec(s) 702; 706; 736; 761; 6651; 6662; 7491.
STEPHAN F. BRENNAN AND BETH A. BRENNAN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent MELVIN W. ASHLAND AND BROOKE C.
ASHLAND, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
Case Information:
Code Sec(s):
702; 706; 736; 761; 6651; 6662; 7491
Docket: Dkt.
No. 25117-08, 25306-08. 1
Date Issued:
07/23/2012.
Judge: Opinion by
Kroupa, J.
Tax Year(s):
Disposition:
HEADNOTE
1.
Reference(s): Code Sec. 702; Code Sec. 706; Code Sec. 736;
Code Sec. 761; Code Sec. 6651; Code Sec. 6662; Code Sec. 7491
Syllabus
Official Tax Court Syllabus
Counsel
William Edward Taggart, Jr., for petitioners in Docket No.
25117-08.
Arthur V. Pearson and Jason J. Galek, for petitioners in
Docket No. 25306-08.
Lori Katrine H. Shelton, Elizabeth Wickstrom, and Matthew
Williams, for respondent.
KROUPA, Judge
Respondent determined the following deficiencies,
accuracy-related penalties under section 6662(a) 2 and additions to tax under
section 6651(a):
Petitioners Stephan Brennan and Beth Brennan Addition to tax
Deficiency Sec. 6651(a)(1) Year 2002
$1,783,909 $438,655 2003 91,652 ---2004 68,296 ---
Petitioners Melvin Ashland and Brooke Ashland Penalty and
addition to tax Year Deficiency Sec.
6662(a) Sec. 6651(a)(1) 1997 $248,896
$49,779 ---1998 380,718 76,144 ---1999 407,185 81,437 ---2000 135,079 27,016
$3,183 2002 439,876 87,975 ---2004 135,011 27,002 ---2005 123,095 24,619 ---
There are three issues for decision. 3 The first issue is to
what extent (if any) the Brennans and the Ashlands must recognize capital gains
income for 2003 and 2004 from the sale of certain assets by Cutler &
Company LLC 4 (Cutler), a partnership for Federal tax purposes. We hold that
they each must recognize their distributive shares of the capital gains income
for 2003 and 2004. The second issue is whether the Ashlands are liable for an
addition to tax under section 6651(a)(1) for late filing of a Federal tax
return for 2000. We hold they are liable. The final issue is whether the
Ashlands are liable for the accuracy-related penalty under section 6662(a) for
each year at issue. We hold they are liable.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The
stipulation of facts, the first, second and third supplemental stipulation of
facts and the accompanying exhibits are incorporated by this reference.
The Ashlands resided in Oregon and the Brennans resided in
Nevada when each filed a petition.
I. Background Ms. Ashland and Mr. Brennan were members of
Cutler. Cutler managed asset portfolios for wealthy individuals and
institutional investors, charging management fees for its services. Cutler
decided to restructure its business in 2002 after turmoil resulted among its
members. To that end, Cutler, Ms. Ashland and Mr. Brennan, among others,
entered into an Agreement Regarding Restructuring of Cutler & Co.
(restructuring agreement) in June 2002. Cutler agreed to sell certain
institutional accounts, i.e., a customer list, under the restructuring agreement.
Cutler was to use the sale proceeds first to satisfy certain
Cutler liabilities and obligations. Any remaining proceeds (net IA sale
proceeds) were to be distributed to the members, including Ms. Ashland and Mr.
Brennan, who were each to receive 44.985% of the net IA sale proceeds under the
restructuring agreement. Mr. Brennan was to hold an economic interest in Cutler
rather than a membership interest upon the sale of the institutional accounts.
The economic interest conferred on Mr. Brennan the right to share in the
income, gains, losses, deductions, credits or similar Cutler items and was to
serve as collateral for Cutler's obligation with respect to the net IA sale
proceeds. Ms. Ashland was to remain a Cutler member after the sale of the
institutional accounts.
Cutler sold the institutional accounts to Fox Asset
Management LLC (Fox) on October 31, 2002 (IA sale). Fox made certain payments
to Cutler for the institutional accounts in 2003 and 2004, with the last
payment being made in April 2004. Cutler did not distribute cash or any
property to Mr. Brennan in 2003 or 2004.
Cutler filed for bankruptcy in April 2004. Ms. Ashland was
the last remaining Cutler member as of September 2004.
II. Tax Returns Cutler filed Forms 1065, U.S. Return of
Partnership Income, for 2003 and 2004. Cutler reported $1,228,244 and $947,675
of long-term capital gains income from the IA sale for 2003 and 2004,
respectively.
The Ashlands filed joint Federal income tax returns for 2003
and 2004. The Ashlands reported a portion of the capital gains income Cutler
reported from the IA sale for 2003. They did not report any capital gains
income for 2004.
The Brennans filed joint Federal income tax returns for 2003
and 2004. The Brennans did not report any of the capital gains income for 2003
or 2004 that Cutler reported from the IA sale.
III. Deficiency Litigation Respondent issued the Ashlands
and the Brennans separate deficiency notices determining that both failed to
report capital gains income from the IA sale for 2003 and 2004. Respondent took
inconsistent positions in the deficiency notices with respect to the capital
gains income reported on Cutler's Forms 1065 for 2003 and 2004 to avoid being
in a “whipsaw” 5 position. More specifically, respondent determined that the
Ashlands were required to report all of the capital gains income from the IA
sale for 2003 and 2004 while also determining that the Brennans were required
to report a portion of the same capital gains income for those years. The
Ashlands and the Brennans each filed petitions with this Court for
redetermination.
OPINION
We are asked to decide to what extent (if any) the Brennans
and the Ashlands must recognize capital gains income from the IA sale for 2003
and 2004. We also must decide whether the Ashlands are liable for a late-filing
addition to tax under section 6651(a) for 2000 and whether the Ashlands are
liable for an accuracy-related penalty under section 6662(a) for each year at
issue. 6 We address each issue in turn.
I. Capital Gains Income We first turn to whether the
Brennans must recognize capital gains income from the IA sale for 2003 and
2004. Cutler was a partnership for tax purposes when the relevant capital gains
income was realized from the IA sale. A partnership is not subject to Federal
income tax under subchapter K. Secs. 701, 6031. The partners, rather, are
liable for tax in their separate or individual capacities. Sec. 701. Each
partner is required to take into account his or her distributive share of the
partnership's income, gain, loss, deductions and credits. Sec. 702(a).
Moreover, a partner must take into account his or her distributive share
regardless of whether any actual distribution of cash or other property is
made. United States v. Basye, 410 U.S. 441 [31 AFTR 2d 73-802] (1973); sec.
1.702-1(a), Income Tax Regs. A partner's distributive share is determined by
the governing partnership agreement. Sec. 704(a). 7 A partner's distributive
share is includible in the partner's income in the taxable year of the
partnership ending within or with the taxable year of the partner. Sec. 706(a).
A partnership's taxable year shall close with respect to a partner who sells or
exchanges his entire interest in a partnership and with respect to a partner
whose entire interest is liquidated.Sec. 1.706-1(c)(2)(i), Income Tax Regs.
The Brennans argue that Mr. Brennan's status as a partner of
Cutler for tax purposes terminated in 2002 and therefore Mr. Brennan did not
realize any capital gains income from the IA sale in 2003 or 2004. Respondent
counters that Mr. Brennan was a Cutler partner for tax purposes for 2003 and
2004 and therefore must take into account his distributive share of the capital
gains income from the IA sale. We agree with respondent. A partner that retires
8 or otherwise withdraws from a partnership remains a partner for tax purposes
until his or her interest in the partnership has been completely liquidated.
Scott v. Commissioner, T.C. Memo. 1997-507 [1997 RIA TC Memo ¶97,507], aff'd
without published opinion, 182 F.3d 915 [84 AFTR 2d 99-5029] (5th Cir. 1999);
sec. 1.736-1(a)(1)(ii), Income Tax Regs. A retiring partner's interest in a
partnership is completely liquidated when the entire partnership interest is
terminated through a distribution or series of distributions to the partner by
the partnership. Secs. 736(b), 761(d); sec. 1.761- 1(d), Income Tax Regs. The
partnership interest liquidates upon the final distribution to the partner
where the interest is to be liquidated through a series of distributions. Sec.
1.761-1(d), Income Tax Regs.
Here, Mr. Brennan was entitled to receive 44.985% of the net
IA sale proceeds in complete liquidation of his partnership interest 9 in
Cutler after the IA sale. Cutler received proceeds from the IA sale in 2003 and
2004, yet never distributed any amount of the net IA sale proceeds to Mr.
Brennan. Nor did Cutler make any other distribution of cash or property in
complete liquidation of Mr. Brennan's partnership interest in Cutler before the
end of 2004. Accordingly, Mr. Brennan remained a Cutler partner for tax
purposes for 2003 and 2004. Consequently, Mr. Brennan must take into account
his distributive shares of the capital gains income from the IA sale for 2003
and 2004 as set forth in the restructuring agreement, along with various other
partnership items as required under section 702(a).
We now address what portion of the capital gains income from
the IA sale for 2003 and 2004 the Ashlands must recognize. The Ashlands do not
dispute that Ms. Ashland was a Cutler partner for tax purposes during 2003 or
2004. Therefore, Ms. Ashland must take into account her distributive shares of
the capital gains income from the IA sale for 2003 and 2004 as set forth in the
restructuring agreement, along with various other partnership items as required
under section 702(a).
II. Addition to Tax We next turn to whether the Ashlands are
liable for the late-filing addition to tax under section 6651(a)(1) for 2000.
The late-filing addition to tax is imposed for failure to file a tax return on
or before the specified filing date unless it is shown that such failure is due
to reasonable cause and not due to willful neglect. Sec. 6651(a)(1); United
States v. Boyle, 469 U.S. 241, 245 [55 AFTR 2d 85-1535] (1985). The
Commissioner has the burden of production with respect to additions to tax.
Sec. 7491(c);Higbee v. Commissioner, 116 T.C. 438, 446 (2001). To meet this
burden, the Commissioner must produce sufficient evidence establishing that it
is appropriate to impose the additions to tax. See Higbee v. Commissioner, 116
T.C. at 446-447. If the Commissioner meets his burden, then the taxpayer bears
the burden of proving that the late filing or nonfiling was due to reasonable
cause and not willful neglect. Id. at 446.
Respondent satisfied his burden of production by showing
that the Ashlands did not timely file their income tax return for 2000. In
contrast, the Ashlands have not demonstrated nor argued that they timely filed
a joint income tax return for 2000. Moreover, the Ashlands have not established
nor argued that their failure to file is due to reasonable cause and not due to
willful neglect. Accordingly, we sustain respondent's determination that the
Ashlands are liable for the late-filing addition to tax for 2000.
III. Accuracy-Related Penalties We last address respondent's
determination that the Ashlands are liable for an accuracy-related penalty
under section 6662(a) for each year at issue. The Commissioner has the burden
of production, and the taxpayer has the burden as to reasonable cause. Sec.
7491(c); Rule 142(a); see Higbee v. Commissioner, 116 T.C. at 446-447.
To reflect the foregoing, and due to the parties'
concessions,
Decisions will be entered under Rule 155.
1
These cases have
been consolidated for trial, briefing and opinion. Joseph Furey and Katherine
Furey were petitioners in a consolidated case at Docket No. 25772-08. The
Fureys have since entered into a stipulated decision with respondent, and their
case has been severed from these consolidated cases.
2
All section
references are to the Internal Revenue Code for the years at issue, and all
Rule references are to the Tax Court Rules of Practice and Procedure, unless
otherwise indicated. All monetary amounts are rounded to the nearest dollar.
3
Respondent has
conceded on brief his determination that Mr. Brennan failed to report a
“guaranteed payment” of $4,300,616 (or any other amount) for 2002. The Brennans
have conceded that for 2002 they failed to report certain dividend income and a
certain retirement distribution. These concessions resolve the Brennans'
deficiency for 2002. The Brennans have also conceded the addition to tax under
sec. 6651(a)(1) that respondent determined for 2002. Additionally, the Brennans
have conceded that they failed to report certain dividend income for 2003 and
2004 and certain gambling income for 2004.
The Ashlands have conceded that they were not entitled to a
$4,785,616 flow-through loss deduction from Airport Plaza Partnership for 2002
from purported “guaranteed payments” Airport Plaza made. In addition, our
decision inBrennan v. Commissioner, T.C. Memo. 2012-187 [TC Memo 2012-187],
bars the Ashlands from claiming that Cutler made certain “guaranteed payments”
in 2002 entitling them to a $4,785,616 flow-through loss deduction from Cutler.
The flow-through loss deduction concession with respect to Airport Plaza and
our decision resolve the Ashlands' deficiency for 2002.
The Ashlands' deficiencies for 1997, 1998, 1999, 2000, 2004
and 2005 are based on the disallowance of net operating loss carrybacks and
carryforwards stemming from the claimed flow-through loss deduction from
Airport Plaza for 2002. Accordingly, these deficiencies too are resolved by the
Ashlands' concession and our decision in Brennan.
All other issues either have been conceded or need not be
decided because they follow from our holdings or are computational.
4
Cutler changed its
name to Table Rock Asset Management in 2003. We refer to Table Rock Asset
Management as Cutler for convenience and clarity.
5
The term “whipsaw”
refers to a situation when different taxpayers treat the same transaction
involving the same items inconsistently, thus creating the possibility that
income could go untaxed or two unrelated parties could deduct the same expenses
on their separate returns.
6
The taxpayer
generally bears the burden of proving the Commissioner's determinations are
erroneous. Rule 142(a). The burden of proof may shift to the Commissioner if
the taxpayer satisfies certain conditions. Sec. 7491(a). We resolve the issues
here on a preponderance of the evidence, not on an allocation of the burden of
proof. Therefore, we need not consider whether sec. 7491(a) would apply. See
Estate of Black v. Commissioner, 133 T.C. 340, 359 (2009).
7
The partnership agreement
includes all understandings and agreements among the partners, or between one
or more partners and the partnership, concerning affairs of the partnership and
responsibilities of partners, whether oral or written, and whether or not
embodied in a document referred to by the partners as the partnership
agreement. Sec. 1.704-1(b)(2)(ii)(h), Income Tax Regs. Therefore, the
allocation of the capital gains income from the IA sale to Mr. Brennan and Ms.
Ashland set forth in the restructuring agreement overrides any different
allocation set forth in a prior Cutler partnership agreement or other document.
8
A partner retires
when he or she ceases to be a partner under local law. Sec. 1.736-1(a)(1)(ii),
Income Tax Regs.
9
Because Cutler is a
partnership for tax purposes and for convenience and clarity, we refer to Mr.
Brennan's membership interest in Cutler as a partnership interest.
www.irstaxattorney.com (212) 588-1113 ab@irstaxattorney.com
No comments:
Post a Comment