ES NPA Holding, LLC, Joseph NPA Investment, LLC, Tax Matters Partner

T.C. Memo. 2021-68UNITED STATES TAX COURT
ES NPA HOLDING, LLC, JOSEPH NPA INVESTMENT, LLC, TAX
MATTERS PARTNER, Petitioner v. COMMISSIONER OF INTERNAL
REVENUE, Respondent
Docket No. 13471-17. Filed June 3, 2021.
Jason A. Reschly, Derek T. Teeter, and Ashley N. Minton, for petitioner.
Randall L. Eager and Robert C. Teutsch, for respondent.
MEMORANDUM OPINION
WEILER, Judge: This matter is before the Court on petitioner’s motion for
summary judgment and respondent’s cross-motion for partial summary judgment. 1
1
Each party has filed an objection to the other’s motion, and respondent
replied to petitioner’s objection. We refer to the motions, objections, and the reply,
collectively, as the motion papers.
Served 06/03/21
-2-
[*2] For the reasons outlined below we will deny the motion for summary
judgment filed by Joseph NPA Investment, LLC (petitioner), and grant in part and
deny in part the cross-motion for partial summary judgment filed by the
Commissioner of Internal Revenue (respondent).
Respondent issued a notice of final partnership administrative adjustment
(FPAA) for the 2011 taxable year of ES NPA Holding, LLC (ES NPA). The
FPAA was mailed to ES NPA’s members, including its tax matters partner,
petitioner. The FPAA increased ES NPA’s ordinary income and determined that
section 6662 accuracy-related penalties applied to the members of ES NPA. 2
Petitioner timely petitioned this Court challenging the adjustment to ES NPA’s
2011 income and the penalties.
In its motion for summary judgment petitioner argues that respondent’s
adjustment to ES NPA’s 2011 ordinary income originates at the level of another
limited liability company (LLC) named Integrated Development Solutions, LLC
(IDS), in which ES NPA held an interest. In other words petitioner contends that
the adjustment is a partnership item of IDS and not a partnership item of ES NPA.
2
Unless otherwise indicated, all section references are to the Internal
Revenue Code in effect for the relevant year, and all Rule references are to the Tax
Court Rules of Practice and Procedure. All monetary amounts are rounded to the
nearest dollar.
-3-
[*3] Respondent opposed petitioner’s motion for summary judgment and filed his
own cross-motion for partial summary judgment, contending that the unreported
income is a partnership item of ES NPA, and not a partnership item of IDS. In his
cross-motion for partial summary judgment respondent also seeks judgment as a
matter of law that ES NPA is not entitled to a flowthrough compensation deduction
equal to the value of a membership interest it received in exchange for services
provided (or to be provided).
Background
The background of this case is drawn from the first and supplemental
stipulations of facts, the exhibits submitted therewith, and the undisputed portions
of the exhibits attached to the parties’ motion papers. We refer to those
documents, from which we draw factual inferences, as the record.
ES NPA and Its Tax Matters Partner
ES NPA was formed on September 12, 2011. The tax matters partner for
ES NPA is petitioner, and SBV-NPA holds the remaining membership interest in
ES NPA.3 When the petition in this case was filed, petitioner was a Delaware
LLC, formed on September 22, 2011.
According to respondent, the entity holding the remaining interest in ES
3
NPA was “SVP-NPA”. Our conclusions herein would remain the same whether
-4-
[*4] When the petition in this case was filed and at all other relevant times, ES
NPA was a Delaware LLC, classified as a partnership for Federal income tax
purposes. For 2011 ES NPA’s tax year was the calendar year. On April 15, 2012,
ES NPA timely filed its 2011 Form 1065, U.S. Return of Partnership Income.
ES NPA’s FPAA
On March 20, 2017, respondent issued an FPAA to the members of ES
NPA. In the FPAA respondent determined that ES NPA failed to report income of
$16,106,250 and that section 6662 penalties applied to the members of ES NPA.
The FPAA did not provide a specific reason for the income adjustment; however,
the parties stipulated that according to the FPAA respondent determined that the
unreported income was attributable to ES NPA’s receipt of a 50% direct capital
interest in IDS; or in the alternative, ES NPA’s receipt of a 30% indirect capital
interest (held through IDS) in National Performance Agency, LLC (NPA, LLC).
Sale of the Consumer Loan Business
In 2011 Joshus Landy owned all the shares in NPA, Inc., an S corporation.
Mr. Landy also owned 100% of the shares in three other S corporations. Mr.
Landy used these four S corporations to operate a consumer loan business. In 2011
the owner is SBV-NPA or SVP-NPA. Both parties agree that this entity is a
passthrough entity.
-5-
[*5] Mr. Landy wanted to sell a portion of the loan business. Monu Joseph and
Amit Raizada contacted Mr. Landy about the potential sale. Mr. Joseph and Mr.
Raizada would later own membership interests in the LLCs that were members of
ES NPA.
The sale of this portion of the business was arranged through the following
transactions taking place on September 27, October 13, and October 14, 2011. On
September 27, 2011, NPA, Inc., formed two LLCs: IDS and NPA, LLC. IDS had
two classes of membership units (units): class B and class C. NPA, LLC had three
classes of units: class A, class B, and class C. The class B and C units in IDS
tracked the class B and C units in NPA, LLC, respectively, in that the owner of
IDS class B units was entitled to 100% of the payments received by IDS because
of its ownership of NPA, LLC class B units and the owner of IDS class C units
was entitled to 100% of the payments received by IDS because of its ownership of
NPA, LLC class C units.
On October 13, 2011, NPA, Inc., contributed substantially all of its business
assets to NPA, LLC in exchange for all three classes of units (classes A, B, and C)
in NPA, LLC. NPA, Inc., then contributed all three classes of units (classes A, B,
and C) in NPA, LLC to IDS as a capital contribution to IDS. At the end of the day
-6-
[*6] on October 13, 2011, the relevant aspects of the entity ownership structure
were as follows:
On October 14, 2011, NPA, LLC entered into revenue-sharing agreements
with the other three S corporations that conducted the consumer loan business. An
entity named NPA Investors, LP (NPA Investors), purchased from IDS all NPA,
LLC class A units for $14,502,436. In addition, NPA Investors contributed
$6,483,073 to NPA, LLC. On October 14, 2011, ES NPA exercised a call option
granted by NPA, Inc., and pursuant thereto acquired all of the IDS class C units.
Under the terms of that call option agreement ES NPA agreed to provide services
-7-
[*7] to NPA, Inc., in exchange for the option to pay $100,000 to NPA, Inc., to
acquire all of the IDS class C units. The services consisted of rendering “strategic
advice for the purpose of enhancing the performance of * * * [NPA, Inc.’s]
business and to assemble an investor group that would purchase 40 percent of * * *
[NPA, Inc.’s] business for approximately $21 million”.
At the end of the day on October 14, 2011, the relevant aspects of the entity
ownership structure were as follows:
-8-
[*8]
Similarly to ES NPA, IDS and NPA, LLC were also LLCs under State law,
both were classified as partnerships for Federal income tax purposes, and each
filed a Form 1065 for its 2011 tax year.
-9-
[*9] Discussion
I. Legal Concepts
A. Summary Judgment
A party may move for summary judgment regarding all or any part of the
legal issues in controversy. See Rule 121(a); Wachter v. Commissioner, 142 T.C.
140, 145 (2014). We may grant summary judgment if the pleadings, stipulations
and exhibits, and any other acceptable materials show that there is no genuine
dispute as to any material fact and that a decision may be rendered as a matter of
law. See Rule 121(a) and (b); see also CGG Americas, Inc. v. Commissioner, 147
T.C. 78, 82 (2016); Elec. Arts, Inc. & Subs. v. Commissioner, 118 T.C. 226, 238
(2002). We construe the facts and draw all inferences in the light most favorable
to the nonmoving party to decide whether summary judgment is appropriate.
Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), aff’d, 17 F.3d 965(7th Cir. 1994). The moving party has the burden of proving that there is no
genuine issue of material fact. Naftel v. Commissioner, 85 T.C. 527, 529 (1985).
However, the nonmoving party may not rest upon the mere allegations or denials
in its pleadings but instead must “set forth specific facts showing that there is a
genuine dispute for trial.” Rule 121(d); see also Sundstrand Corp. v.
Commissioner, 98 T.C. at 520.
-10-
[*10] B. TEFRA Rules
The unified audit and litigation procedures of TEFRA 4 applied to ES NPA
during the relevant period.5
C. Disregarded Entities
Upon formation and until October 14, 2011, IDS and NPA, LLC were
single-member LLCs. Thus, during that period, IDS and NPA, LLC were both
classified as “disregarded entities” for Federal income tax purposes under section
301.7701-3(b)(1)(ii), Proced. & Admin. Regs.
D. Our Jurisdiction
Section 6226 provides for judicial review of FPAAs. In general, section
6226(f) gives this Court jurisdiction to determine all partnership items of the
partnership for the partnership’s taxable year to which the FPAA relates. However,
this Court’s jurisdiction does not extend to determining the partnership items of
lower tier partnerships. See Sente Inv. Club P’ship of Utah v. Commissioner, 95
T.C. 243, 247-248 (1990). That means that we may determine only the partnership
4
Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. No. 97-248, tit.
IV, 96 Stat. 648-671, repealed by Bipartisan Budget Act of 2015, Pub. L. No. 114-
74, sec. 1101(a), (c)(1), (g), 129 Stat. at 625, 638.
5
ES NPA had flowthrough entities as its partners, so the small partnership
exception in sec. 6231(a)(1)(B)(i) did not apply.
-11-
[*11] items of the partnership to which the FPAA relates. Id. If the partnership
items of a lower tier partnership are included in the FPAA of the partnership before
us, we are without jurisdiction to determine those lower tier partnership items. See
Rawls Trading, L.P. v. Commissioner, 138 T.C. 271, 288-289 (2012); Sente Inv.
Club P’ship of Utah v. Commissioner, 95 T.C. at 247-248.
Generally, the Commissioner’s determinations in an FPAA are presumed
correct, and the party challenging the FPAA bears the burden of proving those
determinations are erroneous. See Rule 142(a)(1); Crescent Holdings, LLC v.
Commissioner, 141 T.C. 477, 485 (2013); Republic Plaza Props. P’ship v.
Commissioner, 107 T.C. 94, 104 (1996). However, the party alleging our
jurisdiction to determine partnership items bears the burden of proving the facts
establishing our jurisdiction. Jimastowlo Oil, LLC v. Commissioner, T.C. Memo.
2013-195, at *6; see also McNutt v. Gen. Motors Acceptance Corp. of Ind., 298
U.S. 178, 189 (1936); Pietanza v. Commissioner, 92 T.C. 729, 736-737 (1989),
aff’d without published opinion, 935 F.2d 1282 (3d Cir. 1991).
Section 6231(a)(3) defines a partnership item as
any item required to be taken into account for the partnership’s
taxable year under any provision of subtitle A to the extent
regulations prescribed by the Secretary provide that, for purposes of
this subtitle, such item is more appropriately determined at the
partnership level than at the partner level.
-12-
[*12] In general, the “partnership’s aggregate and each partner’s share of * * *
[i]tems of income, gain, loss, deduction, or credit of the partnership” are
partnership items. Sec. 301.6231(a)(3)-1(a)(1)(i), Proced. & Admin. Regs.;
see also sec. 703(a) (“[T]axable income of a partnership shall be computed in the
same manner as in the case of an individual.”). The tax treatment of any
partnership item generally must be determined at the partnership level. Sec. 6221.
E. Receipt of a Partnership Interest in Exchange for Services
Section 721(a) provides that “[n]o gain or loss shall be recognized to a * * *
partner[] in the case of a contribution of property to the partnership in exchange for
an interest in the partnership.” (Emphasis added.) For the same reason the
Commissioner has ruled that partners generally do not recognize gain or loss upon
the conversion of a disregarded entity to a partnership. See Rev. Rul. 99-5, 1999-1
C.B. 434. 6
By contrast, where a person receives a partnership interest in exchange for a
contribution of services, nonrecognition is not always guaranteed. See sec. 1.721-
1(b)(1), Income Tax Regs. Under section 1.721-1(b)(1), Income Tax Regs., the
6
Rev. Rul. 99-5, 1999-1 C.B. 434, concludes that when an LLC, classified
for tax purposes as a “disregarded entity”, converts to a partnership by adding a
second unrelated member, the LLC members are deemed for tax purposes as
having made tax-free contributions to a new partnership in exchange for receipt of
partnership interests.
-13-
[*13] “receipt of a partnership capital interest in exchange for services is taxable to
the service provider.” Crescent Holdings, LLC v. Commissioner, 141 T.C. at 488
(emphasis added); see also sec. 83(a) (generally dictating the recipient’s tax
treatment of property received in connection with services performed); sec. 1.61-
2(d), Income Tax Regs. (stating property received as compensation must be
included in income). After section 1.721-1(b)(1), Income Tax Regs., went into
effect, there was confusion about how receipt of a partnership profits interest
would be treated. See Rev. Proc. 93-27, sec. 3, 1993-2 C.B. 343, 343. In 1993 the
Commissioner issued Rev. Proc. 93-27, which addresses the issue and states that
if a person receives a profits interest for the provision of services to
or for the benefit of a partnership in a partner capacity or in
anticipation of being a partner, the Internal Revenue Service will not
treat the receipt of such an interest as a taxable event for the partner
or the partnership.
Rev. Proc. 93-27, sec. 4.01, 1993-2 C.B. at 344 (emphasis added). But see id. sec.
4.02 (providing exceptions to the rule articulated in section 4.01). Therefore,
under present guidance from the Commissioner, whether the receipt of a
partnership interest in exchange for services provided to or for the benefit of the
-14-
[*14] issuing partnership is a taxable event turns on whether the partnership
interest is a capital interest or a profits interest. See Rev. Proc. 93-27, sec. 4.01.7
F. Deduction for Compensation Paid in the Form of a Partnership
Interest
Section 83(h) allows a deduction under section 162 to “the person for whom
were performed the services in connection with which * * * property was
transferred”. Property includes a partnership interest in or held by the service
recipient. 8 Secs. 1.83-3(e), 1.721-1(b), Income Tax Regs.; see also McDougal v.
Commissioner, 62 T.C. 720, 728 (1974). The service recipient may deduct an
amount equal to the payment that the service provider included in gross income
under section 83(a), (b), or (d)(2), to the extent the amount meets the requirements
of section 162 and the regulations interpreting it. 9 Sec. 83(h); sec. 1.83-6(a)(1),
Income Tax Regs.; see Venture Funding, Ltd. v. Commissioner, 110 T.C. 2367
The Tax Court is not bound by revenue rulings; rather, under Skidmore v.
Swift & Co., 323 U.S. 134, 140 (1944), the weight afforded to revenue rulings
depends upon their persuasiveness and the consistency of the Internal Revenue
Service’s position over time. See Webber v. Commissioner, 144 T.C. 324, 352-
353 (2015).
Sec. 83(e)(3) excludes from the reach of sec. 83 “the transfer of an option
8
without a readily ascertainable fair market value”.
9
The service recipient may claim that deduction for the taxable year for
which the service provider includes the amount in gross income. See sec. 83(h).
-15-
[*15] (1998) (holding that the deduction under section 83 is limited to the amount
included, as opposed to includible, in gross income, subject to certain exceptions),
aff’d without published opinion, 198 F.3d 248 (6th Cir. 1999).
Section 162(a) allows a deduction for the “ordinary and necessary expenses
paid or incurred during the taxable year in carrying on any trade or business”.
See also sec. 162(a)(1) (allowing deduction for “reasonable allowance for salaries
or other compensation for personal services actually rendered”).
II. Our Analysis
A. The Court’s Jurisdiction
Petitioner argues that respondent’s proposed adjustment to ES NPA’s
income constitutes a partnership item of IDS, which the Court could only
adjudicate in a proceeding under TEFRA involving IDS. Specifically, petitioner
contends that if income was realized with respect to the NPA, LLC class C units on
October 14, 2011, then IDS was the source of that income because it held the class
C units in NPA, LLC. Accordingly, as petitioner argues, the income represents a
partnership item of IDS and not ES NPA.
Respondent counters petitioner’s argument and directs us to the call option
agreement as the most relevant transactional document, which provides that ES
NPA received IDS class C units, for the sum of $100,000 and for services provided
-16-
[*16] (or to be provided) by ES NPA. In respondent’s view, the IDS class C units
were worth more than the $100,000 paid, and consequently ES NPA received
income that it was required to recognize on its 2011 partnership income tax return.
Petitioner argues that this Court’s Opinion in Sente compels a decision in its
favor. In that case the Court granted the Commissioner’s motion to dismiss for
lack of jurisdiction. Sente Inv. Club P’ship of Utah v. Commissioner, 95 T.C.
at 249-250. The Court agreed with the Commissioner that it did not have
jurisdiction to determine certain flowthrough partnership items from two
partnerships in which the Sente Investment Club held limited partnership interests.
Id. at 247-249. The relevant flowthrough items were losses and a credit. Id.
at 246-247. The losses and credit were incurred by the two lower tier partnerships,
and Sente Investment Club reported a distributive share of these items. Id. We
concluded that allowing the partners of Sente Investment Club to contest
adjustments to the partnership items of the lower tier partnerships would defeat the
purpose of the TEFRA framework, which provided for a single proceeding with
respect to any one partnership. Id. at 249.
Petitioner’s reliance on Sente is misplaced. The adjustment at issue resulted
when ES NPA obtained an interest in IDS; it is not a distributive share of IDS’
income like the Sente Investment Club’s distributive share of the losses and credit
-17-
[*17] of the lower tier partnerships. See id. at 246-247. Though the interest that
ES NPA received--the IDS class C units--tracks the NPA, LLC class C units held
by IDS, that does not alter the analysis. The record does not show that respondent
based his adjustment on underlying payments from NPA, LLC to IDS under the
terms of IDS class C units in NPA, LLC. 10 On the record before us, we hold that
the adjustment to the 2011 gross income made in the FPAA is properly classified
as a partnership item of ES NPA. 11
B. Capital or Profits Interest
Relatively late in the game--namely, in its objection to respondent’s cross-
motion for partial summary judgment--petitioner advances the argument that the
IDS class C units (and corresponding NPA, LLC units) received by ES NPA are
mere profits interests, and thus no income is recognized because of the
Commissioner’s published guidance in Rev. Proc. 93-27, supra. In the motion
papers, the parties have disputed at length the nature of this transaction.
10
Furthermore, petitioner has not argued and the record does not show that
IDS (rather than ES NPA) was the service provider.
11
We do not decide herein whether respondent’s adjustment at issue is
proper, but only that the adjustment to 2011 gross income made in the FPAA is
properly classified as a partnership item of ES NPA, and not IDS.
-18-
[*18] If we were to adopt respondent’s views of the receipt of the class C units
entirely on the basis of the call option agreement between NPA, Inc., and ES NPA,
one would question whether section 721 and its underlying regulations have any
relevance to this case since under the call option agreement ES NPA did not
transfer anything to IDS in exchange for the interest received in IDS. Instead, ES
NPA acquired its interest in IDS from NPA, Inc., for $100,000 and the promise of
services provided (or to be provided).
However, if we were to adopt petitioner’s more expansive view of the
receipt of the class C units and assume that section 721 would apply, respondent
has nevertheless convincingly demonstrated a genuine dispute of material fact in
the record regarding whether ES NPA held a capital interest rather than a profits
interest. Thus, summary judgment is inappropriate with respect to this issue.
C. Deductibility of the Value of the Class C Units Received
Finally, in the motion papers, the parties also dispute whether ES NPA is
entitled to a deduction equal to the value of the class C units received.
Petitioner’s only plausible argument is that it is entitled to a compensation
deduction for the value of the interest it received, which would plainly dictate the
deduction to be a flowthrough item from IDS and/or NPA, LLC. However, as
discussed in our analysis in supra Section II, Part A, we lack jurisdiction in this
-19-
[*19] proceeding to decide flowthrough items from a lower tier partnership.
Equally, we decline to determine as a matter of law that ES NPA is not entitled to a
deduction on these grounds as respondent argues.
Accordingly, we decline to grant respondent’s cross-motion for partial
summary judgment on this issue.
We have considered all of the arguments that the parties made and to the
extent they are not addressed herein, we consider them to be moot, irrelevant, or
without merit.
To reflect the foregoing,
An appropriate order will be issued
denying petitioner’s motion for summary
judgment and granting in part, and denying
in part, respondent’s cross-motion for partial
summary judgment.