2014 T.C. Memo. 182
T.C.2014Background
- Torgeir Mantor and Alan Smith were managing members of VisionMonitor Software, LLC (a partnership for tax purposes); they contributed personal promissory notes to the partnership in 2007 and 2008 when the firm needed additional capital.
- Notes: Mantor’s notes of $50,000 (2007) and $25,000 (2008); Smith’s notes of $95,000 (2007) and $43,000 (2008). All were unsecured 7-year balloon notes at 6% interest; neither partner made required interest payments for those years.
- VisionMonitor recorded the notes as capital contributions on its books and reported increased partner bases on its returns; Mantor and Smith claimed larger passthrough losses on their individual returns as a result.
- The IRS audited and issued an FPAA and notice of deficiency; consolidated proceedings addressed whether the partners obtained outside basis from contributing their own promissory notes and whether partnership-level penalties applied.
- Trial evidence showed sloppy and inconsistent note documentation and K-1s; the partners’ long-time attorney, Rick Sympson, advised orally that the notes would create basis and prepared the returns.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether a partner’s contribution of his own promissory note increases his outside basis | Mantor/Smith: the notes increased their bases (treated as contributed property/capital) | Commissioner: partners had zero adjusted basis in their own notes, so partnership basis in the notes is zero | Contribution of a partner’s own promissory note did not increase outside basis; partners’ bases in the notes were zero, so partnership basis was zero |
| Whether the notes constituted "at-risk" capital under Sec. 465 sufficient to create basis | VisionMonitor: partners were at substantial financial risk; notes were genuine indebtedness and should be treated as at-risk | Commissioner: at-risk status is not a partnership-level determination and irrelevant to partnership-basis question here | Court did not decide at-risk issue (not necessary); focused on partners’ basis in the notes and found it was zero |
| Applicability of accuracy-related penalties (Sec. 6662) at partnership level | Commissioner: VisionMonitor’s reporting of nonzero basis was negligent/substantial understatement, so penalty applies | VisionMonitor: reasonable reliance on competent tax advice (Sympson)—defense to penalty | Court found penalty applicable (the issue relates to partnership item) but partnership proved reasonable, good-faith reliance on adviser for defense; split result to be resolved under Rule 155 |
| Whether reliance-on-advice defense succeeded for partnership-level penalty | VisionMonitor: relied in good faith on longtime competent adviser who had access to records | Commissioner: notes and K-1 discrepancies show inadequate/incorrect information and sloppy documentation undermining reliance | Court held adviser was competent, partner provided information Sympson had access to, and VisionMonitor actually and in good faith relied on advice; defense established at partnership level |
Key Cases Cited
- Nussdorf v. Commissioner, 129 T.C. 30 (2007) (partner’s basis in contributed property is a partnership item)
- Gefen v. Commissioner, 87 T.C. 1471 (1986) (partner’s guaranty/assumption of partnership recourse debt increased outside basis)
- United States v. Woods, 134 S. Ct. 557 (2013) (TEFRA allows courts in partnership-level proceedings to determine applicability of penalties relating to partnership-item adjustments)
- Petaluma FX Partners, LLC v. Commissioner, 591 F.3d 649 (D.C. Cir. 2010) (discussing TEFRA jurisdiction and penalty applicability)