DocketNumber: Docket No. 7632-12
Citation Numbers: 108 T.C.M. 256, 108 Tax Ct. Mem. Dec. (CCH) 256, 2014 Tax Ct. Memo LEXIS 180, 2014 T.C. Memo. 182
Judges: HOLMES
Filed Date: 9/3/2014
Status: Non-Precedential
Modified Date: 11/20/2020
Decision will be entered under
HOLMES,
Mantor and Smith argue that the notes increased their bases in VisionMonitor, which would let them claim greater passthrough losses from those years on their individual returns. The Commissioner says that VisionMonitor's basis in each note was zero because the partners' bases in the notes were zero. The partners reply that the notes put them at substantial*181 financial risk and that should be enough.
Mantor received his bachelor's degree in business in Norway in 1979, and an MBA from the University of Wisconsin in 1980. He took a job in Houston working as a financial analyst for a company called Norse Services Houston, Inc. Norse was eventually bought by the American Metallurgical Coal Company (AMC), an investment company focused on the energy industry. Mantor rose to become president of AMC and worked there until 2000. As AMC wound down most of its Norse investments, Mantor decided to start VisionMonitor. In 2002, he *184 made an initial capital contribution of more than $300,000 and with Alan Smith and AMC founded the VisionMonitor partnership.1*182
VisionMonitor burned money for the next four years, and AMC refused to shovel in any more unless Mantor and Smith put some additional "skin in the game." This was a problem--Mantor and Smith didn't have the liquidity to contribute cash. So they called their longtime attorney, Rick Sympson, to discuss some ideas. Smith asked Sympson about the tax implications of contributing promissory notes to a partnership. Sympson did some cursory research to make sure that the notes "would get him basis," but testified that he relied mainly on the fact that Mantor and Smith were required by the other investors to contribute something more to the company. He knew the notes were enforceable, and that the partnership would put them down as assets on its balance sheet. So he told Mantor and Smith that the notes were appropriate capital contributions and "would create partnership basis." But he never issued a written legal opinion, and didn't *185 review any company documents before giving his oral advice. This was still good enough for Mantor and Smith, and Mantor and Smith agreed at the start of 2007 to a*183 "Resolution of the Managing Members" of VisionMonitor. They agreed to freeze their salaries, to provide personal credit to the "Company vendors * * * to ensure continued uninterrupted operations," and to "indebt themselves through notes payable to the Company to improve the Company's financial position." The resolution was the formal authorization for the issuance of the promissory notes from Mantor and Smith to VisionMonitor. This was also not their first time--Smith had already made contributions of promissory notes in 2004, 2005, and 2006, as had Mantor in 2005.
Their 2007 notes were for $50,000 and $95,000; and their 2008 notes were for $25,000 and $43,000. This was enough for AMC--satisfied that Mantor and Smith were all in, AMC provided VisionMonitor an additional $900,000 to sustain operations--and received in exchange $450,000 in equity and $450,000 in convertible debt.
The execution of this transaction was not perfect. Smith's notes are signed and notarized, but contain incorrect dates and incorrect values as to the amounts payable. His 2007 note for $95,000 states a written nominal amount of "One Hundred Thousand Dollars" with a parenthetical next to it reading *186 "($104,451.07)"*184 and the date June 30, 2008. His 2008 note for $43,000 similarly contains a nominal amount of "One Hundred Thousand Dollars" with a parenthetical figure stating "($58,718.27)" and the date July 31, 2009. The amount of the parenthetical figure following the nominal amount of each note seems to include accrued but unpaid interest that Smith owed on his previously contributed notes. And the nominal amount seems to be a carryover from a prior draft of the note that sloppy proofreading didn't catch, but the amounts that the partners now claim as the face values of the notes are the values actually reported in VisionMonitor's books, although neither the nominal amount nor the amount in the parentheses matches the amount that is identified on the VisionMonitor return as Smith's 2007 and 2008 contributions.
Mantor's notes were never notarized, but the dates on the unsigned acknowledgment certificates are March 31, 2007 and April 30, 2008. The nominal value of the 2007 note is stated as "Fifty Thousand Dollars ($50,000.00)" and that of the 2008 note is stated as "Twenty Five Thousand Dollars ($25,000.00)" which is just what VisionMonitor reported as Mantor's capital contributions. Unlike the*185 interest on Smith's notes, the interest that Mantor promised to pay is not included in the parenthetical figure following the nominal amount of each note.
*187 All four were 7-year balloon notes with 6-percent interest rates. All four notes were unsecured, and in none of them did either Mantor or Smith assume any partnership debt. The notes also state the payee as "VisionMonitor Investors, LLC," which was not actually the name of the company. (This was to have been the name of a holding company for VisionMonitor Software, but everyone involved treated the notes as for the benefit of the actually existing company, and they were consistently recorded as assets on that company's books.) Strapped for cash, Mantor and Smith couldn't make the interest payments and instead had VisionMonitor report unpaid accrued interest on the unpaid promissory notes.2*186
AMC's money did its work, though, and VisionMonitor became profitable in 2012 and continued to grow in 2013. But this case is about VisionMonitor's loss years. The Commissioner audited both Mantor's and VisionMonitor's returns for 2007 and 2008, and then he issued both a notice of deficiency to the Mantors and a notice of final partnership administrative adjustment (FPAA) to Mantor as *188 tax matters partner of VisionMonitor.3*187 We consolidated the cases and tried them in Texas, where Mantor continues to reside and where VisionMonitor was organized and has its principal office.
Partnerships don't pay income tax, but they do file information returns, and partners are supposed to use the numbers from those returns on their own individual returns.
TEFRA limits our jurisdiction at the partnership level to
So what are partnership items? [t]he term "partnership item" means,
*190 Once we spot a partnership item we have jurisdiction to redetermine it regardless of whether the Commissioner adjusted it in the FPAA.
The value of what a partner contributes to his partnership can be tricky when he contributes something other than cash--like the notes at issue here. VisionMonitor argues that the contribution of the promissory notes increased Mantor's and Smith's outside bases in amounts equivalent to their face value. But a partnership's basis in property contributed by a partner is the adjusted basis of that property in the hands of the contributing partner at the time of the contribution.
VisionMonitor relies on
VisionMonitor's reliance on this case is misplaced. In
This means these cases are more like
All that is left is the penalties that the Commissioner argues are applicable at the partnership level.
Partnership-penalty law gets even more complicated when one looks at defenses because jurisdiction over them can exist at both the partnership and partner levels. The partnership itself may have a defense to a penalty that would shield all its partners; one partner may have a defense to the penalty that's all his own. Our Court has jurisdiction to rule on any partnership-level defense, but *196 partners have to take their partner-level defenses to a refund forum.7*195
With this background out of the way, we now turn to the applicability of any penalty and the merits of any partnership-level defenses. The Commissioner argues that the 20-percent
We have little doubt that these grounds make the
Applicability of penalties that relate to the adjustment of a partnership item must be litigated in the partnership-level proceeding. We know that a partner's basis in contributed property, like the notes in this case, is definitely a partnership item,
VisionMonitor's only defense is that it relied on professional advice. • Was the adviser a competent professional who had sufficient expertise to justify reliance? • Did the taxpayer provide necessary and accurate information to the adviser? • Did the taxpayer actually rely in good faith on the adviser's judgment?
The key figure here is Rick Sympson. Sympson was the longtime attorney and tax preparer for VisionMonitor and the Mantors. He knew the ins-and-outs of the business and had established himself as an experienced tax professional. He's a certified tax specialist and has more than 20 years of experience. We take no issue with his competence.
*199 Whether VisionMonitor provided accurate information to Sympson is a closer question. The promissory notes themselves are riddled with errors and*198 inconsistencies. Smith's notes have discrepancies between their nominal amounts and parenthetical figures, and though signed, those notes aren't dated. The notary statement attached to each (dated June 30, 2008, and July 31, 2009) is well after VisionMonitor's prior tax year had closed, but the partnership returns credit each note as a capital contribution for the preceding tax year. Mantor's notes have the right amounts and a dated notary statement--but are unsigned. We also could not figure out why notes dated two months apart (the Mantor note dated April 30, 2008, and the Smith note dated June 30, 2008) are accounted for in two different years.
These problems may push
We have little problem in finding that VisionMonitor actually relied on Sympson's advice--his conclusion that the notes were additions to VisionMonitor's capital (and the capital accounts of Smith and Mantor) was set out on the company's returns. And we have little trouble in finding that this reliance was in good faith. In a case like this one--where VisionMonitor secured Smith and Mantor's promises to increase their personal risk alongside their promise to extend their personal credit to the firm's vendors--advice from a longtime tax adviser that this increased Smith's and Mantor's bases would seem reasonable to Mantor. Even though we can't agree that*200 the contribution of the *201 notes increased their bases, we cannot find Mantor's (and through Mantor, VisionMonitor's) reliance on Sympson's reading of the subtleties in the caselaw in bad faith.
That makes this a split result, which means that
1. An LLC is a hybrid form of business entity that shares some of the characteristics of a partnership and some of the characteristics of a corporation. It has "members" rather than shareholders, and an LLC with more than one member is by default classified as a partnership for tax purposes.
2. Not only were the notes a bit off, but so were VisionMonitor's Schedules K-1. VisionMonitor reported Mantor's ending shares of profit, loss, and capital in 2007 as 43.78%, 43.78%, and 32.3594%, respectively, but his beginning shares for 2008 as 61.6648%, 14.4197%, and 31.24%. The same inconsistency is present on VisionMonitor's 2008 K-1 to Mantor, 2007 K-1 to Smith, and 2007 K-1 to AMC. There are no tax consequences from these mistakes.
3. Under the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA),
4. A "nonpartnership item" is "an item which is (or is treated as) not a partnership item."
5.
6. VisionMonitor argues that the notes should be included in outside basis because Mantor and Smith were "at risk" under
7. Well, maybe. If the Commissioner assesses a tax, and then tries to collect any unpaid portion of it by filing notices of liens against, or levying on, a taxpayer's property, the Code grants taxpayers a collection due process hearing.
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Nussdorf v. Comm'r , 129 T.C. 30 ( 2007 )