Paul D. and Alicia Garnett v. Commissioner

132 T.C. No. 19
UNITED STATES TAX COURT
PAUL D. GARNETT AND ALICIA GARNETT, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 9898-06. Filed June 30, 2009.
Ps owned interests in L.L.P.s, L.L.C.s, and
tenancies in common. On cross-motions for partial
summary judgment, the parties request a ruling as to
whether Ps’ interests are subject to the rule of sec.
469(h)(2), I.R.C., which treats losses from an
“interest in a limited partnership as a limited
partner” as presumptively passive.
Held: Because Ps did not hold their interests in
the L.L.P.s or L.L.C.s as “limited partners”, these
interests are not subject to the rule of sec.
469(h)(2), I.R.C. Held, further, because Ps’ interests
in the tenancies in common are not interests in limited
partnerships, these interests also are not subject to
the rule of sec. 469(h)(2), I.R.C.
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Jeffrey D. Toberer and Donald P. Dworak, for petitioners.*
J. Anthony Hoefer, for respondent.
OPINION
THORNTON, Judge: This case is before us on the parties’
cross-motions for partial summary judgment. Respondent
determined the following deficiencies in and penalties on
petitioners’ Federal income taxes:
Penalty
Year Deficiency Sec. 6662(a)
2000 $170,268 $34,054
2001 110,300 22,060
2002 80,900 16,180
Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the years at issue, and Rule
references are to the Tax Court Rules of Practice and Procedure.
The deficiencies arise largely from respondent’s
disallowance of losses claimed by petitioners and attributable to
their ownership interests in various limited liability
partnerships, limited liability companies, and other business
ventures. Respondent disallowed the losses under section 469(a)
as passive activity losses on the ground that petitioners did not
materially participate in the activities of the business
entities. The parties seek summary judgment as to whether
*
Brief amicus curiae was filed by Frederick N. Widen of
Ulmer & Berne LLP, Cleveland, Ohio.
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petitioners’ ownership interests in the business entities are
subject to the rule of section 469(h)(2), which places special
restrictions on losses from an “interest in a limited partnership
as a limited partner”.
Summary judgment is appropriate as to this issue because
there is no genuine issue of fact and a decision can be made as a
matter of law. Rule 121(b); Sundstrand Corp. v. Commissioner, 98
T.C. 518, 520 (1992), affd. 17 F.3d 965 (7th Cir. 1994). For
purposes of this disposition, we set forth the following
background drawn from the pleadings and affidavits produced by
the parties with accompanying documents, none of which are in
dispute.
Background
Petitioners resided in Nebraska when they filed their
petition.
During the years at issue petitioners owned interests in
seven limited liability partnerships (L.L.P.s) and two limited
liability companies (L.L.C.s) that were engaged in agribusiness
operations, primarily the production of poultry, eggs, and hogs.1
Petitioners also owned interests in two other business ventures
1
Although it appears from the record that the ownership
interests were held primarily if not entirely by petitioner
husband, in their cross-motions for partial summary judgment and
supporting legal memoranda, the parties generally refer to the
various ownership interests without distinction as belonging to
both petitioners. For clarity and convenience, we do the same in
this Opinion.
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which they characterize as tenancies in common. As explained in
greater detail below, petitioners owned most of these interests
indirectly through one or another of five separate limited
liability companies (the holding L.L.C.s).2
A. The L.L.P.s
Petitioners held an interest in one L.L.P. directly.3 They
held interests in six other L.L.P.s indirectly through one or
another of the holding L.L.C.s.4 The L.L.P.s were all registered
with the State of Iowa. They reported income and expenses on
Forms 1065, U.S. Return of Partnership Income. On Schedule K-1,
Partner’s Share of Income, Credits, Deductions, etc., each L.L.P.
identified the relevant holding L.L.C. or petitioner husband (Mr.
Garnett) as a “limited partner”.
2
The holding L.L.C.s were Garnett Family Farms L.C. (GFF);
Garnett Family Farms I, L.C. (GFF I); Garnett Family Farms II,
L.L.C. (GFF II); Garnett Family Farms III, L.L.C. (GFF III); and
Garnett Family Farms IV, L.L.C. (GFF IV). (Under Iowa law, a
limited liability company may be denoted by either L.C. or L.L.C.
at the end of its name. See Iowa Code Ann. sec. 490A.401(1)
(West 1999).)
3
Petitioners owned directly an 11.11-percent interest in
Quality Poultry & Eggs, L.L.P. (QPE).
4
Petitioners owned interests in L.L.P.s indirectly through
their ownership interests in the holding L.L.C.s as follows: GFF
owned an 11.11-percent interest in Elite Pork Partnership,
L.L.P.; GFF I owned a 12.5-percent interest in Center Fresh Egg
Farm, L.L.P.; GFF II owned a 10-percent interest in Cedar Valley
Egg Farm, L.L.P.; GFF III owned 7.5-percent interests in both
Fremont Farms of Iowa, L.L.P., and Poweshiek County Pullets,
L.L.P.; and GFF IV owned a 10-percent interest in Iowa Quality
Pullets, L.L.P.
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The L.L.P. agreements generally provided that each partner
would actively participate in the control, management, and
direction of the partnership’s business. The L.L.P. agreements
also generally provided that no partner would be liable for the
partnership’s debts or obligations unless otherwise required by
Iowa law.
B. The L.L.C.s
Petitioners held, in addition to their interests in the
holding L.L.C.s, a 16.66-percent interest in one L.L.C. directly
and a 10.12-percent interest in another L.L.C. through one of the
holding L.L.C.s.5 These two L.L.C.s, like the holding L.L.C.s,
were organized and operated under Iowa law. They reported income
and expenses on Forms 1065.6 On Schedule K-1, each L.L.C.
identified the relevant holding L.L.C. or Mr. Garnett as a
“limited liability company member”.
The L.L.C. operating agreements generally provided that
business was to be conducted by a manager with exclusive
authority to act for the company. The manager was to be selected
by majority vote of the L.L.C.’s members and had the
responsibility, among others, to “effectuate * * * the
regulations and decision of the Members”. Petitioners were not
5
Petitioners owned directly an interest in Fremont Farms
L.C. Petitioners owned an interest in Single Poultry Source,
L.L.C., indirectly through GFF IV.
6
The record does not reflect the manner of the holding
L.L.C.s’ tax reporting.
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managing members of the two L.L.C.s that were not holding
L.L.C.s.7
C. Other Business Ventures
Petitioners also owned indirectly, through one of the
holding L.L.C.s, interests in two other business entities, GRD I
and GRD II.8 Petitioners represent, and respondent has not
disputed, that GRD I and GRD II were “de facto” partnerships in
Iowa, “holding title as tenants-in-common among three partners”
(hereinafter the tenancies in common). On their respective Forms
1065 for GRD I and GRD II, the type of entity is listed as
“TENANTS IN COMMON”; the principal business activity is listed
identically as “RENTAL REAL ESTATE”. On Schedules K-1, GFF I is
shown as holding a one-third share in both GRD I and GRD II; GFF
I is identified as a “general partner” of GRD I and as a “limited
partner” of GRD II.
D. Petitioners’ Tax Returns and the Notice of Deficiency
On their joint Federal income tax returns for 2000, 2001,
and 2002, petitioners reported income and losses from their
interests in the L.L.C.s, including the holding L.L.C.s, and the
L.L.P.s. In the notice of deficiency respondent disallowed
7
The record indicates that petitioner husband was the
manager of GFF I and GFF II but does not indicate the manager of
the three other holding L.L.C.s.
8
Petitioners held these interests indirectly through GFF I.
Insofar as the record reveals, GRD I and GRD II are the actual
names rather than mere acronyms.
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certain of these claimed losses on the ground that petitioners
had failed to meet the material participation requirements of
section 469.9
Discussion
A. Passive Activity Losses
1. In General
Section 469(a)(1) limits the deductibility of losses from
certain passive activities of individual taxpayers. Passive
losses disallowed in one year generally may be carried over to
the next year. Sec. 469(b). Generally, a passive activity is a
trade or business in which the taxpayer does not materially
participate. Sec. 469(c)(1). Material participation is defined
generally as regular, continuous, and substantial involvement in
the business operations. Sec. 469(h)(1). The regulations
provide seven exclusive tests for material participation in an
9
Respondent also disallowed some claimed losses on the
additional ground that they were from rental activities
determined to be per se passive activities under sec. 469(c)(2).
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activity.10 Sec. 1.469-5T(a), Temporary Income Tax Regs., 53
10
The regulations provide that an individual generally will
be treated as materially participating in an activity during a
year if and only if:
(1) The individual participates in the activity
for more than 500 hours during such year;
(2) The individual’s participation in the activity
for the taxable year constitutes substantially all of
the participation in such activity of all individuals
(including individuals who are not owners of interests
in the activity) for such year;
(3) The individual participates in the activity for
more than 100 hours during the taxable year, and such
individual’s participation in the activity for the taxable
year is not less than the participation in the activity of
any other individual (including individuals who are not
owners of interests in the activity) for such year;
(4) The activity is a significant participation
activity (within the meaning of paragraph (c) of this
section) for the taxable year, and the individual’s
aggregate participation in all significant participation
activities during such year exceeds 500 hours;
(5) The individual materially participated in the
activity (determined without regard to this paragraph
(a)(5)) for any five taxable years (whether or not
consecutive) during the ten taxable years that immediately
precede the taxable year;
(6) The activity is a personal service activity (within
the meaning of paragraph (d) of this section), and the
individual materially participated in the activity for any
three taxable years (whether or not consecutive) preceding
the taxable year; or
(7) Based on all of the facts and circumstances (taking
into account the rules in paragraph (b) of this section),
the individual participates in the activity on a regular,
continuous, and substantial basis during such year.
[Sec. 1.469-5T(a), Temporary Income Tax Regs., 53 Fed. Reg.
5725-5726 (Feb. 25, 1988).]
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Fed. Reg. 5725-5726 (Feb. 25, 1988).
2. Special Rule for Certain Limited Partnership Interests
The heart of the controversy before us is section 469(h)(2),
which presumptively treats losses from certain limited
partnership interests as passive. Section 469(h)(2) provides:
“Interests in limited partnerships. Except as provided in
regulations, no interest in a limited partnership as a limited
partner shall be treated as an interest with respect to which a
taxpayer materially participates.” Temporary regulations were
promulgated in 1988 but have never been made final.11 The
temporary regulations permit a taxpayer to establish material
participation in a limited partnership but constrain the taxpayer
to only three of the seven regulatory tests that ordinarily are
available.12 Sec. 1.469-5T(e)(1) and (2), Temporary Income Tax
Regs., 53 Fed. Reg. 5726 (Feb. 25, 1988). The temporary
regulations provide:
11
Sec. 7805(e)(2) provides: “Any temporary regulation shall
expire within 3 years after the date of issuance of such
regulation.” This provision, which was enacted in 1988, applies
to any temporary regulation issued after Nov. 20, 1988.
Technical and Miscellaneous Revenue Act of 1988, Pub. L. 100-647,
Sec. 6232(b), 102 Stat. 3735. The temporary regulations involved
herein were issued Feb. 19, 1988, before the effective date of
sec. 7805(e).
12
For the holder of an interest in a limited partnership
subject to sec. 469(h)(2), the exclusive tests for establishing
material participation are the first, fifth, and sixth tests
described supra note 10. See sec. 1.469-5T(e)(2), Temporary
Income Tax Regs., 53 Fed. Reg. 5726 (Feb. 25, 1988).
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(e) Treatment of limited partners--(1) General rule.--
Except as otherwise provided in this paragraph (e), an
individual shall not be treated as materially
participating in any activity of a limited partnership
for purposes of applying section 469 and the
regulations thereunder to--
(i) The individual’s share of any income, gain, loss,
deduction, or credit from such activity that is attributable
to a limited partnership interest in the partnership; and
(ii) Any gain or loss from such activity recognized
upon a sale or exchange of such an interest.
(2) Exceptions.--Paragraph (e)(1) of this section shall
not apply to an individual’s share of income, gain, loss
deduction, and credit for a taxable year from any activity
in which the individual would be treated as materially
participating for the taxable year under paragraph (a)(1),
(5) or (6) of this section if the individual were not a
limited partner for such taxable year.
(3) Limited partnership interest--(i) In general.--
Except as provided in paragraph (e)(3)(ii) of this section,
for purposes of section 469(h)(2) and this paragraph (e), a
partnership interest shall be treated as a limited
partnership interest if--
(A) Such interest is designated a limited partnership
interest in the limited partnership agreement or the
certificate of limited partnership, without regard to
whether the liability of the holder of such interest for
obligations of the partnership is limited under the
applicable State law; or
(B) The liability of the holder of such interest for
obligations of the partnership is limited, under the law of
the State in which the partnership is organized, to a
determinable fixed amount (for example, the sum of the
holder’s capital contributions to the partnership and
contractual obligations to make additional capital
contributions to the partnership).
(ii) Limited partner holding general partner
interest.--A partnership interest of an individual shall not
be treated as a limited partnership interest for the
individual’s taxable year if the individual is a general
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partner in the partnership at all times during the
partnership’s taxable year ending with or within the
individual’s taxable year (or portion of the partnership’s
taxable year during which the individual (directly or
indirectly) owns such limited partnership interest). [Sec.
1.469-5T(e), Temporary Income Tax Regs., 53 Fed. Reg. 5726
(Feb. 25, 1988).]
B. The Issue Presented
The issue presented by the cross-motions for partial summary
judgment is whether petitioners’ interests in the L.L.P.s,
L.L.C.s (other than the holding L.L.C.s), and tenancies in common
(hereinafter collectively “the companies”) should be considered
interests in limited partnerships “as a limited partner” so as to
be treated as presumptively passive under the special rule of
section 469(h)(2).13
C. The Parties’ Contentions
In their motion for partial summary judgment, petitioners
contend that section 469(h)(2) is inapplicable because none of
the companies was a limited partnership and because petitioners
are considered to be general partners rather than limited
partners in the companies. Petitioners rely upon Gregg v. United
13
The parties seek a ruling only with respect to the
companies other than the holding L.L.C.s. Respondent asserts,
and petitioners do not dispute, that for purposes of applying
sec. 469(h)(2) in this case, the intervening interests of the
holding L.L.C.s are to be disregarded. Respondent states: “That
petitioners mostly held their interests indirectly (through
Garnett Family Farm entities) is of no consequence”. In the
light of the parties’ seeming agreement on this point, we need
not and do not consider further the extent to which the nature of
an ownership interest in an intervening entity might be material
in applying sec. 469(h)(2).
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States, 186 F. Supp. 2d 1123 (D. Or. 2000), which held that the
special rule of section 469(h)(2) did not apply to a member of an
L.L.C. formed under Oregon law.
In his cross-motion for partial summary judgment respondent
contends primarily that section 469(h)(2) applies to petitioners’
interests in the companies because they meet the definition of a
“limited partnership interest” set forth in the temporary
regulations. Respondent further contends that petitioners’
interests were not “‘general partner’ interests as that term is
commonly used.” Respondent contends that Gregg v. United States,
supra, was decided incorrectly.
D. The L.L.P.s and L.L.C.s14
We can be certain that when it enacted section 469(h)(2) in
1986, Congress did not have L.L.P.s specifically in mind, since
L.L.P.s did not come into existence until 1991. See 1 Bromberg &
Ribstein, Partnership, sec. 1.01(b)(5) (1998). Similarly, it is
doubtful that Congress had L.L.C.s specifically in mind, since
only one State, Wyoming, had an L.L.C. statute in 1986. Id. sec.
1.01(b)(4). The temporary regulations, promulgated in 1988, make
no explicit reference to L.L.P.s or L.L.C.s. The question is
whether section 469(h)(2) nevertheless applies to them. Because
14
Because the treatment of petitioners’ interests in the
tenancies in common raises special considerations, we consider
them separately infra.
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our analysis is informed by differences among limited
partnerships, L.L.P.s, and L.L.C.s, we start there.
1. Background: Limited Partnerships, L.L.P.s, and L.L.C.s
Limited partnerships have two classes of partners, general
and limited.15 See Iowa Code Ann. sec. 488.102(10), (12) (West
1999); 1 Bromberg & Ribstein, supra sec. 1.01(b)(3). “General
partners typically have management power and personal liability
while limited partners lack management powers and enjoy immunity
from liability for debts of the partnership.” 1 Bromberg &
Ribstein, supra sec. 1.01(b)(3). Limited partners are typically
“passive investors”. Id. A fundamental concept of limited
partnerships is that a limited partner may lose limited liability
by taking part in control of the partnership. See 3 Bromberg &
Ribstein, supra sec. 11.02(c).16
An L.L.P. is a general partnership that by making a filing
or registration has obtained a form of limited liability for its
15
In Iowa, limited partnerships are formed under the Iowa
Uniform Limited Partnership Act or Revised Uniform Limited
Partnership Act. See Iowa Code Ann. sec. 487.101 (West 1999).
Under Iowa law, the term “limited partner” is generally used only
for limited partners in a limited partnership formed under these
statutes. Id.
16
The Iowa Uniform Limited Partnership Act, as enacted in
1916, provided that a limited partner who takes part in control
loses limited liability. 3 Bromberg & Ribstein, Partnership,
sec. 11.02(b) (1998). The Iowa Revised Uniform Limited
Partnership Act, in its 1976 enactment and again in its 1985
amendments, softened this rule by reducing the scope of a limited
partner’s liability for taking part in control. See id. sec.
11.02(c) and (d).
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general partners.17 1 Bromberg & Ribstein, supra sec.
1.01(b)(5). In other respects, an L.L.P. is generally subject to
the provisions of the applicable general partnership statute.
Id.; see Iowa Code Ann. sec. 486A.201 (West 1999) (“A limited
liability partnership continues to be the same entity that
existed before the filing of a statement of qualification”).
Consequently, members of an L.L.P. are not statutorily restricted
from participating in management. See Iowa Code Ann. secs.
486A.101, 486A.1001 (West 1999).
An L.L.C. is “essentially a hybrid of the corporate and
partnership forms of business.” 1 Bromberg & Ribstein, supra
sec. 1.01(b)(4).18 L.L.C. members can participate directly in
management but have limited liability for the company’s debts and
liabilities. See generally Iowa Code Ann. ch. 490A (West 1999);
1 Bromberg & Ribstein, supra sec 1.01(b)(4).
Notwithstanding these differences among limited
partnerships, L.L.P.s, and L.L.C.s, they are all generally
treated for Federal income tax purposes as partnerships. See
sec. 761(a). See generally McNamee v. Dept. of the Treasury, 488
F.3d 100 (2d Cir. 2007); Littriello v. United States, 484 F.3d
372 (6th Cir. 2007); Med. Practice Solutions, LLC v.
17
In Iowa, an L.L.P. is formed under the Iowa Uniform
Partnership Act. See Iowa Code Ann. sec. 486A.101 (West 1999).
18
Iowa Code Ann. sec. 490A.102 (West 1999) defines an
L.L.C. as an “unincorporated association having one or more
members, and organized under or subject to this chapter.”
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Commissioner, 132 T.C. (2009); sec. 1.761-1, Income Tax Regs.;
sec. 301.7701-2(c)(1) Proced. & Admin. Regs. Under the so-called
check-the-box regulations, certain eligible business entities,
including many domestic L.L.C.s and L.L.P.s, can elect to be
treated as corporations. Sec. 301.7701-3(b)(1)(i), Proced. &
Admin. Regs. Such an election is effective for Federal tax
purposes, including application of the rules in sec. 469. Sec.
301.7701-3(a), Proced. & Admin. Regs. Insofar as the record
reveals, none of the companies involved herein elected to be
treated as a corporation pursuant to these regulations.
2. L.L.P. and L.L.C. Interests as “Limited Partnership
Interests” Under the Temporary Regulations
Acknowledging that differences exist among limited
partnerships, L.L.P.s, and L.L.C.s, respondent contends that
under the temporary regulations the differences are “irrelevant”.
Respondent contends that the “sole relevant consideration” is
that petitioners enjoyed limited liability with respect to their
ownership interests. Because of this limited liability,
respondent contends, each L.L.P. and L.L.C. interest in question
is a “limited partnership interest” under the temporary
regulations. See sec. 1.469-5T(e)(3)(i), Temporary Income Tax
Regs., supra. According to respondent, this ends the matter.
Respondent’s contentions, however, overlook the fact that the
operative condition for applying section 469(h)(2) is not simply
that there be an “interest in a limited partnership” but an
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“interest in a limited partnership as a limited partner”. Sec.
469(h)(2) (emphasis added).
The Code and regulations provide no general definition of
“limited partner”.19 Petitioners suggest we should interpret the
term literally to mean nothing more nor less than a limited
partner in an entity that is classified as a limited partnership
under applicable State law. Under such a literal reading, they
suggest, a member of an L.L.P. or an L.L.C. could not be a
“limited partner” because neither an L.L.P. nor an L.L.C. is,
strictly speaking, a limited partnership.
We are not convinced, however, that such a narrow
construction is appropriate. Although not free of ambiguity, the
legislative history suggests that Congress contemplated that the
Secretary would have regulatory authority to treat “substantially
equivalent entities” as limited partnerships for purposes of
section 469(h)(2).20 S. Rept. 99-313, at 732 (1986), 1986-3 C.B.
19
Certain proposed regulations define “limited partner”
“Solely for purposes of section 1402(a)(13)” and the regulations
thereunder, dealing with self-employment tax. Sec. 1.1402(a)-
2(h), Proposed Income Tax Regs., 62 Fed. Reg. 1704 (Jan. 13,
1997). These proposed regulations do not expressly address the
treatment of an L.L.P. or L.L.C. member.
20
As petitioners point out, this quoted Senate report phrase
occurs in explaining the introductory language of sec. 469(h)(2)
(“Except as provided in regulations”) which authorizes regulatory
exceptions to the general rule of sec. 469(h)(2) that treat
certain interests in limited partnerships as presumptively
passive. Petitioners suggest that Congress never intended the
Secretary’s authority to be used to expand the reach of sec.
469(h)(2) to entities other than limited partnerships. The
(continued...)
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(Vol. 3) 1, 732. As a corollary, it would appear that Congress
also contemplated that at least some ownership interests in such
“substantially equivalent entities” might be treated as interests
held by limited partners.
At first glance, it might seem the temporary regulations
accomplish this result with respect to an ownership interest in
an L.L.P. or an L.L.C., insofar as section 1.469-5T(e)(3)(i),
Temporary Income Tax Regs., supra, would appear to treat such an
20
(...continued)
Senate report states in relevant part:
Under the bill, the Secretary of the Treasury is
empowered to provide through regulations that limited
partnership interests in certain circumstances will not
be treated (other than through the application of the
general facts and circumstances test regarding material
participation) as interests in passive activities.
* * *
* * * The exercise of such authority might also be
appropriate where taxpayers sought to avoid limited
partnership status with respect to substantially equivalent
entities.
[S. Rept. 99-313, at 731-732 (1986), 1986-3 C.B. (Vol. 3) 1,
731-732; emphasis added.]
It is unclear whether the Senate report, as drafted, makes
the point for which it was intended. Suspicions are heightened
by the fact that in the General Explanation of the Tax Reform Act
of 1986 at 236 (J. Comm. Print 1987) (published several months
after the enactment of the 1986 Tax Reform Act), the staff of the
Joint Committee on Taxation reproduced the quoted sentences
almost verbatim but changed the words “such authority” to the
arguably less restrictive “regulatory authority”. More
pertinently, the context of the sentences in question, addressing
concerns about abusive efforts to “avoid” limited partnership
status, seems to support a broader reading than petitioners
favor.
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interest as a “limited partnership interest”. If the general
partner exception applies, however, then the ownership interest
“shall not be treated as a limited partnership interest”. Sec.
1.469-5T(e)(3)(ii), Temporary Income Tax Regs., supra (the
general partner exception). The question, then, is whether the
general partner exception applies.
3. The General Partner Exception
As indicated by its caption, “Limited partner holding
general partner interest”, the general partner exception clearly
applies to situations where a partner in a State law limited
partnership possesses dual limited and general partnership
interests. Sec. 1.469-5T(e)(3)(ii), Temporary Income Tax Regs.,
supra. By its terms, however, the general partner exception is
not expressly confined to such a situation, and respondent makes
no argument that it should be so confined.21 In particular,
respondent does not contend that the general partner exception is
21
As a practical matter, it would not appear that the
general partner exception would be of much consequence as applied
to a State law limited partnership in which the general partner
does not also hold a limited partner interest. Because a general
partner interest would appear unlikely to be characterized as a
“limited partnership interest” under sec. 1.469-5T(e)(3)(i),
Temporary Income Tax Regs., 53 Fed. Reg. 5726 (Feb. 25, 1988),
the general partner exception would appear generally unnecessary
if the general partner did not also possess a limited partner
interest. If we seek, however, to apply the temporary
regulations to an entity like an L.L.P. or an L.L.C. which has a
single type of ownership interest that does not correspond
squarely to either a limited partner interest or a general
partner interest but instead reflects aspects of each, the
general partner exception takes on heightened significance.
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categorically unavailable to members of L.L.P.s or L.L.C.s.
Rather, respondent appears to suggest that the availability of
the general partner exception depends upon the extent of
authority and control that the L.L.P. or L.L.C. member enjoys.
The temporary regulations do not define the term “general
partner”. Nor is a general definition of “general partner” found
in the Code or elsewhere in the regulations.22 Citing Giles v.
Vette, 263 U.S. 553, 560 (1924), respondent contends that in
common usage the term general partner means one who has
“authority, actual or apparent, to act for and bind the
copartnership.”23
22
The term “general partner” is used multiple times in the
Code and the regulations but without a general definition. In
certain contexts the term refers specifically to a general
partner in a limited partnership. See, e.g., sec.
2701(b)(2)(B)(ii); sec. 1.280G-1, Q&A-7(e), Example (3), Proposed
Income Tax Regs.; sec. 1.368-2(m)(5), Example (8), Proposed
Income Tax Regs., 69 Fed. Reg. 49840 (Aug. 12, 2004). More
commonly, however, “general partner” seems to refer more broadly
to any partner (whether or not in a limited partnership) other
than a limited partner. See, e.g., secs. 465(c)(7)(D)(ii)(I),
736(b)(3)(B), 988(c)(1)(E)(v), 6231(a)(7); secs. 1.42-2(d)(3)(i),
1.904-4(e)(3)(iv), Example (4), Income Tax Regs.; secs. 1.367(a)-
1T(c)(3)(i)(A), 1.367(a)-2T(c)(2)(ii), Temporary Income Tax
Regs., 51 Fed. Reg. 17940, 17943 (May 15, 1986).
23
We are not persuaded that Giles v. Vette, 263 U.S. 553,
560 (1924), provides the all-purpose definition of “general
partner” which respondent claims to discover there. The holding
in Giles was that would-be limited partners in a failed limited
partnership were not liable as general partners under the Uniform
(General) Partnership Act then in effect in Illinois because the
facts and circumstances indicated they did not intend to become
general partners. The Court in Giles was less concerned with the
definition of a general partner than with the existence of a
partnership. That is not the concern presented here. To the
(continued...)
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Petitioners contend and respondent does not dispute that
under Iowa law they were not precluded from actively
participating in the management and operations of the L.L.P.s and
L.L.C.s. Nor does respondent dispute that petitioners were given
at least some role to play in the management of the L.L.P.s and
L.L.C.s. Respondent contends, however, that these circumstances
do not suffice to classify petitioners as general partners
because: “The partnership agreements here did not give
petitioners the authority to take action on behalf of the
partnerships as a general partner would (nor did petitioners
function like they were general partners).”24
Consequently, in determining the applicability of section
469(h)(2), respondent suggests that we should make threshold
factual inquiries into the nature and extent of petitioners’
authority to act on behalf of the L.L.P.s and the L.L.C.s. These
threshold factual inquiries, however, seem closely akin to
factual inquiries appropriately made under the general tests for
material participation. To import them into the per se rule of
23
(...continued)
contrary, respondent’s arguments for applying sec. 469(h)(2)
presuppose that the L.L.P.s and the L.L.C.s are to be treated as
partnerships and that petitioners are to be treated as partners
for Federal income tax purposes.
24
If we were to agree with respondent’s test for applying
the general partner exception, which we do not, we would conclude
that there are genuine issues of material fact as to the nature
and extent of petitioners’ authority and involvement with the
L.L.P.s and the L.L.C.s.
- 21 -
section 469(h)(2) would tend, we believe, to blur that special
rule and the general rules for material participation in a manner
that is at odds with the statutory framework and legislative
intent.
The legislative history sets forth “special considerations”
that pertained in treating limited partnership interests as
presumptively passive under section 469(h)(2): “since a limited
partner generally is precluded from participating in the
partnership’s business if he is to retain his limited liability
status, the committee believes it should not be necessary to
examine general facts and circumstances regarding material
participation in this context.” S. Rept. 99-313, supra at 720,
1986-3 C.B. (Vol. 3) at 720. Similarly, the legislative history
states: “In general, under relevant State laws, a limited
partnership interest is characterized by limited liability, and
in order to maintain limited liability status, a limited partner,
as such, cannot be active in the partnership’s business.” Id. at
731, 1986-3 C.B. (Vol. 3) at 731.
Thus, while limited liability was one characteristic of
limited partners that Congress considered in the enactment of
section 469(h)(2), it clearly was not, as respondent suggests,
the sole or even determinative consideration. To the contrary,
the more direct and germane consideration was the legislative
belief that statutory constraints on a limited partner’s ability
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to participate in the partnership’s business justified a
presumption that a limited partner generally does not materially
participate and made further factual inquiry into the matter
unnecessary.
We do not believe that this rationale properly extends to
interests in L.L.P.s and L.L.C.s. As previously discussed,
members of L.L.P.s and L.L.C.s, unlike limited partners in State
law limited partnerships, are not barred by State law from
materially participating in the entities’ business. Accordingly,
it cannot be presumed that they do not materially participate.
Rather, it is necessary to examine the facts and circumstances to
ascertain the nature and extent of their participation. That
factual inquiry is appropriately made, we believe, pursuant to
the general tests for material participation under section 469
and the regulations thereunder. We anticipate that this
examination will occur in subsequent phases of this proceeding.
Accordingly, with appropriate regard for the legislative
purpose of section 469(h)(2), we conclude that petitioners held
their ownership interests in the L.L.P.s and the L.L.C.s as
“general partners” within the meaning of the temporary
regulations. In doing so, we recognize that petitioners’ status
in these entities differs significantly from the status of
general partners in State law limited partnerships, but we also
recognize that their status differs significantly from that of
- 23 -
limited partners in State law limited partnerships. The need to
pigeonhole the ownership interests as either general partner
interests or limited partner interests arises in the first
instance from the fiction of treating an L.L.P. or an L.L.C. as a
“limited partnership” under section 1.469-5T(e)(3)(i), Temporary
Income Tax Regs., supra. Inasmuch as classifying an L.L.P. or
L.L.C. interest as a limited partnership interest entails a
departure from conventional concepts of limited partnerships, it
similarly entails, we believe, a departure from conventional
concepts of general partners and limited partners. In the final
analysis, and absent explicit regulatory provision, we conclude
that the legislative purposes of the special rule of section
469(h)(2) are more nearly served by treating L.L.P. and L.L.C.
members as general partners for this purpose. See Gregg v.
United States, 186 F. Supp. 2d 1123 (D. Or. 2000) (holding that
section 469(h)(2) did not apply to Oregon L.L.C. members).
4. Conclusion
We conclude and hold that petitioners’ ownership interests
in the L.L.P.s and the L.L.C.s are excepted from classification
as “limited partnership interests” under the temporary
regulations by operation of the general partner exception.
Accordingly, petitioners’ ownership interests in the L.L.P.s and
the L.L.C.s are not subject to the special rule of section
469(h)(2). In reaching this result, we emphasize that we do not
- 24 -
invalidate the temporary regulations in any respect but simply
decline to fill any gap therein to reflect respondent’s
litigating position in this case. See Gen. Dynamics Corp. &
Subs. v. Commissioner, 108 T.C. 107, 120-121 (1997)
(“Respondent’s litigating position is not afforded any more
deference than that of petitioners. * * * That is especially so
here, where respondent did not publish her position prior to this
controversy.”).
E. The Tenancies in Common
As previously indicated, respondent has not disputed
petitioners’ assertion that GRD I and GRD II were tenancies in
common, as characterized on their Forms 1065. Nor does
respondent expressly argue for any other characterization of
these entities. We treat respondent as having conceded that GRD
I and GRD II were tenancies in common.25
In his cross-motion for partial summary judgment, respondent
makes no express argument (apart from his arguments regarding
L.L.P.s and L.L.C.s) for treating an interest in a tenancy in
common as an interest in a limited partnership pursuant to
25
The parties apparently agree that the tenancies in common
should be recognized as separate business entities. Cf. sec.
301.7701-1(a)(2), Proced. & Admin. Regs. (“mere co-ownership of
property that is maintained, kept in repair, and rented or leased
does not constitute a separate entity for federal tax purposes”;
by contrast, a joint venture may create a separate entity where
the co-owners “carry on a trade, business, financial operation,
or venture and divide the profits therefrom.”)
- 25 -
section 469(h)(2) and the regulations thereunder.26 In
particular, respondent has not asserted and the record does not
suggest that these interests were designated limited partnership
interests, as provided in section 1.469-5T(e)(3)(i)(A), Temporary
Income Tax Regs., supra. Nor has respondent expressly argued
that petitioners’ liability with respect to either of these
interests was limited to a determinable, fixed amount within the
meaning of section 1.469-5T(e)(3)(i)(B), Temporary Income Tax
Regs., supra.27 We conclude and hold that petitioners’ interests
in GRD I and GRD II are not interests in limited partnerships
within the meaning of section 469(h)(2). Perforce it follows
that petitioners did not hold their interests in the joint
tenancies as “limited partners”.
F. Alleged Reporting Inconsistencies
Respondent observes that with one exception, the Schedules
K-1 that the companies issued to petitioners or the relevant
26
In his cross-motion for partial summary judgment,
respondent reserves as an additional basis for disallowing
petitioners’ losses from GRD I and GRD II, and possibly other
entities, that their activities were per se passive rental
activities pursuant to sec. 469(c)(2). With regard to this
issue, there are genuine issues of material fact. This issue is
not within the scope of the parties’ cross-motions for partial
summary judgment, and we do not consider it further herein.
27
Respondent has not argued that petitioners enjoyed limited
liability with respect to their interests in the tenancies in
common by virtue of the fact that they held the interests
indirectly through a holding L.L.C.. To the contrary, as
previously noted, respondent contends that it is of “no
consequence” that petitioners held interests indirectly through
the holding L.L.C.s.
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holding L.L.C. described the interests as something other than
that of a “general partner”.28 In particular, the Schedules K-1
for the subject L.L.P.s and for one of the tenancies in common
(GFF II) described each interest as that of a “limited partner”;
the Schedules K-1 for the two L.L.C.s that were not holding
L.L.C.s described each interest as that of a “limited liability
company member.” Respondent contends that petitioners obtained a
tax benefit by failing to designate their interests as “general
partner” interests, in that they thereby avoided self-employment
tax pursuant to section 1402(a)(13), which excludes from self-
employment earnings certain distributive shares of a “limited
partner”.
Petitioners contend that they or the holding L.L.C.s were
listed as “limited partners” on the L.L.P.s’ Schedules K-1 only
because Schedule K-1 does not list “limited liability partner” as
one of the check-the-box options.29
With respect to the L.L.C.s’ Schedules K-1, we see no
irregularity or inconsistency in the interests’ being listed as
those of a “limited liability company member.” In any event,
respondent concedes that the manner in which the Schedules K-1
28
One of the tenancies in common, GRD I, described the
holding L.L.C.’s (GFF I’s) interest as “general partner”.
29
Petitioners have not expressly offered an explanation as
to why GFF I identified the holding L.L.C.’s interest as “general
partner” while GFF II identified the holding L.L.C.’s interest as
“limited partner”.
- 27 -
described the interests does not conclusively establish that
petitioners held limited partnership interests. Respondent does
not assert that petitioners are collaterally estopped or
constrained by any duty of consistency from asserting in this
proceeding that they did not hold interests as limited partners
for purposes of section 469(h)(2). In neither the notice of
deficiency nor the answer has respondent asserted any deficiency
attributable to underpaid self-employment taxes.
In these circumstances, we are not persuaded that the
alleged inconsistencies in the manner in which petitioners’
interests were listed on the Schedules K-1 are material. Nor has
respondent otherwise set forth specific facts to show that there
is a genuine issue of material fact requiring trial as to the
application of section 469(h)(2). See Rule 121(d).
Accordingly, we shall grant petitioners’ motion for partial
summary judgment and deny respondent’s motion for partial summary
judgment.
An appropriate order
will be issued.