DocketNumber： Tax Ct. Dkt. No. 21525-94
Citation Numbers： 74 T.C.M. 1157, 1997 Tax Ct. Memo LEXIS 593, 1997 T.C. Memo. 507
Judges： JACOBS
Filed Date： 11/12/1997
Status： Non-Precedential
Modified Date： 4/18/2021
*593 Decision will be entered under Rule 155.
Marshall R. Jones, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION*594
JACOBS, JUDGE: Respondent determined a $73,055 deficiency in petitioner's 1991 Federal income tax, a $12,313 addition to tax for failure to timely file a 1991 Federal income tax return pursuant to section 6651(a)(1), and a $14,611 accuracy-related penalty for substantial understatement of tax pursuant to section 6662. The deficiency primarily relates to Sam E. Scott's (petitioner) withdrawal from his law firm partnership.*595
*596 After concessions, the following issues remain for decision: (1) Whether petitioner was entitled to a $121,500 loss deduction due to his withdrawal from his law firm partnership; (2) whether petitioner received an $85,455 taxable distribution from his law firm's 401(k) plan; (3) whether petitioner is entitled to a $33,943 interest expense deduction; (4) whether petitioner is liable for an addition to tax for failure to timely file his 1991 Federal income tax return pursuant to section 6651(a)(1); and (5) whether petitioner is liable*597 for an accuracy-related penalty for the substantial understatement of tax pursuant to section 6662.
All section references are to the Internal Revenue Code as in effect for the year in issue, unless otherwise indicated. All Rule references are to the Tax Court Rules of Practice and Procedure.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The stipulation of facts and the attached exhibits are incorporated herein by this reference.
Petitioner resided in Hazlehurst, Mississippi, at the time he filed his petition.*598
HEIDELBERG & WOODLIFF LAW PARTNERSHIP
In 1963, petitioner joined the law firm of Heidelberg, Woodliff & Franks (which later became Heidelberg & Woodliff), a general partnership in Jackson, Mississippi, as an associate attorney. Petitioner's practice primarily was confined to general civil litigation.
In 1968, petitioner became a partner in Heidelberg, Woodliff & Franks (hereinafter referred to as the firm, law firm, or the partnership). Upon becoming a partner, petitioner purchased his interest in the law firm by making monthly payments to the three named partners. During his tenure there, petitioner was active in the firm's management, serving as*599 managing partner for a time.
In 1983, Messrs. Woodliff and Franks sold their interests (totaling 46 percent) in the partnership for approximately $500,000 to seven junior partners. (Junior partners received a percentage of the law firm profits to the extent they exceeded a certain amount, plus a salary, but did not own an interest in the partnership.) Four of the junior partners who bought Messrs. Woodliff's and Franks' interests left the firm in 1985 and refused to pay the balance due. Thereafter, the remaining partners at the firm (including petitioner) assumed the obligation owed to Messrs. Woodliff and Franks.
Sometime during the late 1980's, the firm adopted a new partnership agreement that granted partners only income interests in the firm rather than specific interests in the firm's assets. Partners under the old partnership agreement were bought out by the partnership. Thus, under the new partnership agreement, partners did not make capital contributions when they entered the partnership, and received no liquidating distributions when they left. The income interests were based on an annual evaluation of each partner through a point system used by the firm's compensation*600 committee. In 1990, petitioner had an 8.86-percent interest in the partnership.
On January 2, 1991, petitioner gave notice of his termination from the firm, effective retroactively to December 31, 1990. Petitioner then left Heidelberg & Woodliff, and together with several other individuals who had earlier left the firm, started a new law firm. At the time petitioner left Heidelberg & Woodliff, he was the firm's largest producer.
Petitioner's 1990 Schedule K-l on Form 1065 (Partner's Share of Income, Credits, Deductions, Etc.) from Heidelberg & Woodliff reported petitioner's capital account adjustments as follows:
| (a) Capital account at | $ (21,369) |
| beginning of year | |
| (b) Capital contributed | -- |
| during year | |
| (c) Income (loss) from | 223,264 |
| * * * below | |
| (d)Incomenotincluded647 | |
| incolumn(c)plus | |
| nontaxableincome | |
| (e)Lossesnotincluded | (19,672) |
| incolumn(c),plus | |
| unallowabledeductions | |
| (f)Withdrawalsand | (182,870) |
| distributions | |
| (g)Capitalaccountatendof | -- |
| year(combinecolumns | |
| (a)through(f)) |
The Schedule K-1 reflected that petitioner had a capital account balance of zero at the end of 1990. *601 Petitioner did not receive any payments from Heidelberg & Woodliff with respect to the termination of his interest in the law firm. Heidelberg & Woodliff continued to exist following petitioner's departure.
Petitioner did not receive a Schedule K-1 for 1991. The only distribution petitioner received in 1991 from Heidelberg & Woodliff was from the firm's 401(k) plan.
SALARY REDUCTION PLAN DISTRIBUTION
Petitioner participated in Heidelberg & Woodliff's 401(k) salary reduction plan (the plan) which was administered by a firm committee. The plan's funds were held in trust at Deposit Guaranty National Bank (Deposit Guaranty).
In July 1989, petitioner borrowed $36,510.38 from the plan and executed a promissory note to the plan. Later that month, petitioner borrowed an additional $12,521.04 from the plan, for a total of $49,031.42, and executed a new note to the plan. The note provided for quarterly repayments of the borrowed funds at 12-percent interest, with the final installment due on July 5, 1994. The note further provided:
It is agreed that in case of default in any payment of interest, or termination of the employment of maker, or the death of maker, the entire debt*602 shall immediately become due and payable at the option of the holder hereof.
Petitioner never made any repayments of the borrowed funds to the plan.
At the end of 1990, Jessie Homan, an account administrator for Deposit Guaranty, contacted Jerard Pitts, the business manager at Heidelberg & Woodliff, to discuss petitioner's delinquent payments on his loan. Ms. Homan inquired whether the loan should be declared in default and charged off. Mr. Pitts informed Ms. Homan that petitioner was leaving the firm; they decided to charge off the loan in January 1991 in accordance with the terms of the note.
On February 7, 1991, Deposit Guaranty issued a check for $36,424.07 payable to petitioner. The check represented petitioner's balance in the plan, $85,455.49, less the amount of unrepaid funds borrowed from the plan, $49,031.42. The check was mailed to Mr. Pitts and was negotiated by petitioner in 1991. Petitioner failed to roll over any of the distributed funds into another qualified tax-deferred account within 60 days.
A Form 1099-R (Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRA's, Insurance Contracts, etc.) was issued to petitioner for 1991*603 reporting a taxable distribution of $85,455.49. The address on the Form 1099 was the same as that on petitioner's notice of termination submitted by Heidelberg & Woodliff to Deposit Guaranty. At no time did Deposit Guaranty personally notify petitioner that his loan was charged off or that the bank deemed the loan repaid.
1991 FEDERAL TAX RETURN
On his 1991 Federal tax return, petitioner reported adjusted gross income of $69,424. On his Schedule E (Supplemental Income and Loss) under income or loss from partnerships and S corporations, petitioner reported a $121,500 loss from Heidelberg & Woodliff. Petitioner calculated the loss based on his 8.86-percent interest in the firm's accounts receivable, work in progress, cash on hand, and furniture and equipment that he never received upon his departure from the firm.
NOTICE OF DEFICIENCY
In the notice of deficiency, respondent disallowed petitioner's $121,500 loss claim from Heidelberg & Woodliff because he could not establish his basis in the partnership. Respondent determined that petitioner received an $85,455 taxable distribution*605 from Heidelberg & Woodliff's salary reduction plan and accordingly increased petitioner's taxable income by $40,355. Moreover, respondent disallowed all but $211 of petitioner's $33,943 investment interest expense deductions on the basis that petitioner's offsetting investment income was only $211. Respondent also determined that petitioner had only substantiated $29,443 of the interest expenses.
Respondent also determined (1) a 25-percent addition to tax for failure to timely file the 1991 tax return pursuant to section 6651(a)(1) on the basis that the estimated total tax liability reported on Form 4868 was unreasonable, and thus the automatic 4-month extension for filing the tax return was void, and (2) an accuracy-related penalty for substantial understatement of tax pursuant to section 6662.
OPINION
ISSUE 1. LOSS FROM LAW FIRM PARTNERSHIP
The first issue for decision is whether petitioner was entitled to a $121,500 loss deduction due to his withdrawal from the Heidelberg & Woodliff law firm partnership. Petitioner asserts that the $121,500 loss represents the value of accounts receivable and work in progress, along with other assets, he "left*606 on the table" when he departed the law firm. Respondent disagrees, contending that (1) petitioner left the law firm in 1990, and thus there was no event in 1991 (the year in issue) upon which petitioner could recognize a loss, and (2) assuming arguendo that petitioner left the law firm in 1991, petitioner failed to prove his basis in the partnership. For the reasons set forth below, we sustain respondent's determination with respect to this issue.
In order to prevail and recognize a loss, petitioner must show that upon withdrawing from the law firm his basis in the firm exceeded the amount he received. Sec. 731. See
A partner's initial basis in a partnership is determined by the amount of money contributed and the adjusted basis of any other type of property contributed. Sec. 722. The partner's basis in the partnership is then adjusted upward for the partner's distributive share of *607 separately stated income items, and downward by distributions of money (including the relinquishment of liabilities) or the adjusted basis of other property distributed, and the partner's distributive share of losses and nondeductible expenses. Sec. 705;
Petitioner claims a $121,500 basis A partner's basis for his interest in a partnership depends on how he acquired it. It may consist of the amount of cash he contributed to the property sic, it may consist of PROPERTY contributed to the partnership on the amount paid to a retiring partner for his interest. *608 The testimony and exhibits show that Petitioner purchased an interest in 1968 and paid a portion of debt due to retiring partners after the 1985 consumption of 4/7 of the former junior partners' debt to the named partners who had sold their interests. The contribution to the partnership by the Petitioner of work in process and accounts receivable are contributions of property. This is recognized by Petitioner's reasoning is flawed. Petitioner is not entitled to a deduction for failure to realize anticipated income. To the extent that petitioner may have had other sources which affected his basis in the partnership (such as capital contributions), he has failed to prove such basis. Rule 142(a); *610 Thus, we hold that petitioner is not entitled to a $121,500 loss deduction due to his withdrawal from the Heidelberg and Woodliff partnership because he failed to prove that he had any basis in the partnership. However, assuming arguendo that petitioner did have basis in the Heidelberg & Woodliff partnership when he left the law firm, petitioner*611 has not shown that he is entitled to a loss deduction in 1991. A partner retires when he ceases to be a partner under local law. However, for purposes of subchapter K, chapter 1 of the Code, a retired partner or a deceased partner's successor will be treated as a partner until his interest in the partnership has been completely liquidated. A retiring partner's entire interest in a partnership is terminated through the liquidation of the partner's interest by means of a distribution or series of distributions to the partner by the partnership. Secs. 736(b), 761(d); Here, the parties stipulated that petitioner left the firm at the end of 1990; indeed, petitioner testified that he was not a partner after December 31, 1990. Petitioner introduced no evidence that under Mississippi law he was a partner after December 31, 1990. *612 Petitioner claims that he was entitled to a liquidating distribution in 1990 which he never received and which could not have been discovered from the firm's financial records until their completion in 1991. Thus, he asserts he is entitled to recognize a tax loss in 1991. Petitioner's argument must fail. Although petitioner may have believed he was entitled to a liquidating distribution in exchange for his partnership interest, the fact is he never received one in 1991 *613 Because petitioner received no liquidating distributions in 1991, petitioner's gain or loss in the partnership must be calculated as of the time he withdrew from the partnership on December 31, 1990. See ISSUE 2. SALARY REDUCTION PLAN DISTRIBUTION The second issue for decision is whether petitioner must include $85,455 in income as a taxable distribution from the Heidelberg & Woodliff salary reduction plan upon his termination from the law firm. Petitioner contends that he was not properly notified of the cancellation of the note and that equity requires leniency. Respondent asserts that under the terms of the plan and the note, there were three separate grounds for requiring immediate repayment of petitioner's note and treating it as having been repaid and satisfied in 1991: (1) Petitioner failed to make the required quarterly payments, and thus, was in default of payment; (2) petitioner's employment with Heidelberg & Woodliff had terminated; and (3) because petitioner's plan balance was to be distributed*614 to him in 1991, the plan's terms required that the note be paid first. We agree with respondent's assertions. The amount of any distribution to a taxpayer from a qualified pension plan described in section 401(a) generally is includable in gross income in the year of distribution. Sec. 402(a)(1). Such distribution includes the outstanding balance of any loan at the time of the beneficiary's separation from service or default on the note. If the taxpayer fails to roll over distributed funds within 60 days, and the distribution is made before the date the taxpayer attains the age of 59-1/2, and none of the other exceptions in section 72(t)(2) applies, the tax on the distribution is increased by an amount equal to 10 percent*615 of the portion includable in gross income. Sec. 72(t). Petitioner was 54 years old at the time he received his distribution from Heidelberg & Woodliff's salary reduction plan; he did not roll over such funds into another qualified plan. See To conclude, the entire $85,455.49 is includable in petitioner's 1991 gross income as a taxable distribution from Heidelberg & Woodliff's salary reduction plan, and petitioner, having failed to show that any of the exceptions in section 72(t)(2) apply, is liable for the additional 10-percent tax for early distributions imposed by section 72(t). ISSUE 3. INTEREST EXPENSE DEDUCTION The third*616 issue for decision is whether petitioner is entitled to deduct $33,943 for interest expenses. Petitioner argues that such amount, to the extent substantiated, *617 and with respect to which the taxpayer did not materially participate. Sec. 163(d)(5)(A)(ii). Net investment income means investment income (gross income from property held for investment and net gain from the disposition of property held for investment) over investment expenses. Sec. 163(d)(4)(A) and (B). On his 1991 Federal tax return, petitioner reported that the interest expenses incurred were investment interest. In his petition and on brief, petitioner described the interest as incurred from business loans. At trial, petitioner described the interest as incurred on loans borrowed to support his interest in an automobile dealership. Petitioner offered no evidence of his involvement in the automobile dealership and thus failed to sustain his burden with respect to the nature of the interest paid. Rule 142(a); The fourth issue for decision is whether petitioner is liable for an addition to tax for failure to timely file his 1991 Federal tax return. Petitioner claims that he timely filed the return following two extensions granted by the IRS. Respondent contends that any extensions granted were invalid because petitioner failed to make a bona fide and reasonable attempt to estimate his proper tax liability. Section 6651(a)(1) imposes an addition to tax of 5 percent of the amount of tax due per month for each month that a tax return is not timely filed, not to exceed 25 percent. An exception is made for reasonable cause not due to willful neglect. Petitioner's 1991 Federal tax return was due on April 15, 1992, but petitioner received an automatic 4-month extension through his filing of Form 4868. In August 1992, petitioner sought and received an additional 2-month extension to October 15, 1992. Petitioner subsequently filed his return on October 15, 1992. Petitioner reported a total 1991 estimated tax liability of $25,000 on Form 4868, which was approximately one-third of the final tax liability of $75,354 determined by respondent. Respondent*619 argues that petitioner failed to estimate properly his tax liability on Form 4868 when he filed for the automatic extension, and thus such extension is invalid. One of the requirements for the automatic extension of time to file an individual tax return is the proper estimation of the final tax liability for the taxable year. To establish a proper estimate of the tax liability for purposes of the automatic extension, the taxpayer must make "a bona fide and reasonable estimate of his tax liability based on the information available to him at the time he makes his request for extension." Petitioner testified that he acted reasonably in estimating his tax liability and utilized the information he had available to him. According to petitioner's request for a second extension of time to file his 1991 return, he was waiting for records from Heidelberg & Woodliff that were necessary to prepare the return. The failure to obtain the necessary information when filing Form 4868, however, does not lead to the conclusion that petitioner properly estimated his tax liability. See Petitioner knew that he terminated his interest in Heidelberg & Woodliff as of the end of 1990; he also knew that he did not receive a Schedule K-1 for 1991 from the firm. Moreover, he was a partner in the firm when the partnership agreement was amended to eliminate partner capital contributions upon admission and liquidating distributions upon retirement. And he should have been aware that no deduction is allowable for leaving his share of the law firm's*621 anticipated but not realized income (i.e., the firm's accounts receivable and work in progress) on the table. See As to the tax consequences of the distribution from the Heidelberg & Woodliff salary reduction plan, petitioner claims that he never received the Form 1099 issued to him reflecting such distribution. Yet, petitioner never inquired as to why he did not receive a Form 1099, nor did he inquire as to the status of the note executed in favor of the plan for the loan proceeds he borrowed. Even a cursory review of the note would have alerted petitioner to the fact that his termination from the firm would cause an acceleration of the debt; moreover, he knew that he was in default on the note. Additionally, the notice of termination from Heidelberg & Woodliff states that petitioner is to receive 100 percent of his vested interest in the partnership's salary reduction plan, which should have indicated to him that the distribution was not limited to the proceeds from the check he received and negotiated. Petitioner failed to make a bona fide and reasonable estimate of his tax liability when he filed Form 4868. See Because petitioner's reliance on the filing extensions constituted his sole defense to the section 6651(a)(1) addition to tax, petitioner has not shown that his failure to timely file his 1991 tax return was due to reasonable cause and not willful neglect. See ISSUE 5. ACCURACY-RELATED PENALTY The final issue for decision is whether petitioner is liable for the accuracy-related penalty for the substantial understatement of tax pursuant to section 6662. Petitioner asserts that he had reasonable cause for the understatement of tax. Section 6662 imposes an accuracy-related penalty equal to 20 percent of any portion of an understatement attributable to a substantial understatement. A substantial understatement means an understatement which exceeds the greater of 10 percent of the tax required to be shown on the return or $5,000. Sec. 6662(d)(1). The understatement is reduced by that portion of the understatement for which the taxpayer had substantial authority or for which the taxpayer adequately disclosed the relevant facts in the return. Sec. 6662(d)(2)(B). Additionally, no penalty is imposed with respect to any portion of an understatement as to which the taxpayer acted with reasonable cause and in good faith. Sec. 6664(c)(1). Petitioner provided no disclosures in his return and supplied this Court with no substantial authority*624 for his positions. See To reflect the foregoing and the concessions of the parties, Decision will be entered under Rule 155.
1. The distributions were actually from the Heidelberg & Woodliff 401(k) salary reduction plan, not from any individual retirement accounts.↩
2. At trial, petitioner calculated his basis in his partnership interest by adding the amount of accounts receivable and costs associated with petitioner's clients ($93,744.68) with current work in progress ($65,485.20), for a total of $159,229.88. Petitioner then applied a collection rate which reduced the total figure to $121,500.↩
3. Petitioner conceded that neither he nor the firm received or reported any income from accounts receivable and work in progress during 1990.↩
4. Mississippi law provides that retiring partners may seek an accounting of their interests in their former partnerships.
5. Heidelberg & Woodliff's Schedule K-1 issued to petitioner indicates that petitioner's share of partnership liabilities at the end of 1990 was $69,756. Luther Thompson, a partner at Heidelberg & Woodliff, testified that he could not vouch for the accuracy of that figure because it was handwritten and not typewritten like the remainder of the schedule. To the extent petitioner was relieved of partnership liabilities, such would constitute a distribution of money to petitioner by the partnership and hence a deemed liquidating distribution at the end of 1990. Sec. 752(b); see
6. Respondent determined in the notice of deficiency that petitioner had substantiated $29,443 of the interest expenses.↩
7. In the notice of deficiency, respondent allowed $211 of investment interest expenses. This figure was based on $157 of unreported dividend income, $36 of reported interest income, and $18 of unreported interest income. Due to respondent's concession regarding the $157 of dividend income, however, the amount of net investment income must be reduced to $54.↩
Raich v. Commissioner , 46 T.C. 604 ( 1966 )
La Rue v. Commissioner , 90 T.C. 465 ( 1988 )
Wilford E. Thatcher v. Commissioner of Internal Revenue , 533 F.2d 1114 ( 1976 )
francis-e-holman-and-eloise-f-holman-his-wife-v-commissioner-of , 564 F.2d 283 ( 1977 )
Clark v. Comm'r , 101 T.C. 215 ( 1993 )
Rodoni v. Commissioner , 105 T.C. 29 ( 1995 )
Hort v. Commissioner , 61 S. Ct. 757 ( 1941 )
Welch v. Helvering , 54 S. Ct. 8 ( 1933 )