Copeland v. CommissionerCopeland v. Commissioner
Petitioners-Appellants Alvin C. Copeland and Patty K. Copeland, also known as Patty K. White (collectively, “Taxpayers”) appeal the Tax Court’s grant of partial summary judgment to the Commissioner of Internal Revenue (“Commissioner”) and the Tax Court’s denial of their motion for summary judgment. We conclude that the Tax Court properly denied the Taxpayers’ deduction under
I. Facts and Proceedings
The disputed tax items and interest charges derive from the , following transactions: In 1979, Taxpayers invested $100,000 in Garfield Oil and Gas Associates (“Garfield”), a state-law partnership, and in 1981 they invested $75,000 in Capricorn Company (“Capricorn”), also a state-law partnership. Capricorn invested in another- state-law partnership, Cardinal Oil Technology Partners (“Cardinal”), after which Garfield and Cardinal together invested in enhanced oil recovery technology projects. From 1979 to 1982, Garfield and Cardinal reported partnership tax items relating to the investments in the enhanced oil recovery technology projects, and allocated the tax items to the partners, including Taxpayers. Taxpayers filed joint tax returns for the tax years 1979 through 1982, which returns included deductions allocated to the Taxpayers from the Garfield and Capricorn partnerships.
In 1990, the Commissioner' issued notices of deficiency to Taxpayers, based on the Commissioner’s disallowance of the partnership deductions on Taxpayers’ returns. The notice of deficiency also imposed interest at 120% of the usual rate on the Taxpayers’ underpayment of tax attributable to the disallowed deductions, employing the Secretary’s temporary regulations
1
issued pursuant to the then-applicable version of
In the interim, the Tax Court decided
Krause v. Commissioner of Internal Revenue,
2
a case involving various enhanced oil recovery technology partnerships which had engaged in activities and transactions substantially identical to those in which Garfield and Cardinal were involved.
3
Following the Tax Court’s decision in
Krause,
Taxpayers paid the principal amount of the tax deficiency, but were allegedly unable to afford to pay the interest that had accumulated by that time. When the Tax Court activities in this case resumed in 1999, the court issued an order requiring the parties to show cause “why a decision in this case should not be entered in accordance with the Court’s disposition of the issues in
[Krause
].” That issue was not actually addressed at the show-cause hearing, however. Instead, when the Tax Court learned that Taxpayers were willing to settle the case by paying the standard interest (not the
The parties did not reach a settlement agreement. In accordance with the Tax Court’s instructions, they filed a stipulation of facts, which included an affirmation that the factual findings and legal conclusions made in
Krause
were incorporated by reference, “except for the conclusion that
The Commissioner then filed a motion for partial
4
summary judgment, arguing that the increased rate of interest under
In a Memorandum Opinion,
5
the Tax Court granted the Commissioner’s motion and denied Taxpayers’ counter-motion, sustaining the imposition of the
II. Discussion
A. Standard of Review
“The Tax Court’s determinations of law—for example, interpretations of statutory language—are reviewed de novo, while its factual findings are reviewed for clear error.” 6
B. Analysis
1.
As the Tax Court observed in its Memorandum Opinion, after the Krause case was decided, Taxpayers “eoncede[d] all of the originally claimed tax benefits relating to their investments in the partnerships, and ... [sought] a loss deduction only for the amount of cash they invested in the partnerships.” In support of this deduction, they framed their argument to the Tax Court as follows:
“Unless there is a finding of fact that [Taxpayers’] investment in the Partnerships lacked sufficient profit motive under IRC§ 183 , [Taxpayers] are entitled to their out-of-pocket investment under IRC§ 165 . [Taxpayers] have conceded that if the Partnerships were partnerships for federal income tax purposes, then [Taxpayers] are not entitled to out-of-pocket deductions, however, [Taxpayers] argue that the Partnerships are not partnerships for federal income tax purposes.” [Emphasis added.]
Although Taxpayers have not made the above concession so clear in their appellate briefs and oral arguments to us, they have premised their argument in favor of the deduction
solely
on the assertion that “Garfield and Cardinal are not partnerships for federal income tax purposes.” “If an enterprise, such as Garfield and Cardinal, is formed without any profit motive,” their reasoning runs, “it cannot be a partnership for federal income tax purposes and the activities of the partnership cannot be imputed to the investors for purposes of determining the applicability of
Section 761(a) defines what a “partnership” is for federal income tax purposes:
(a) Partnership. For purposes of this subtitle, the term “partnership” includes a syndicate, group, pool, joint venture, or other unincorporated organization through or by means of which any business, financial operation, or venture is carried on, and which is not, within the meaning of this title, a corporation or a trust or estate. 7
entered into transactions, formed joint ventures, operated gas wells, and engaged in various other activities. They carried on a financial operation or venture. They are to be treated as partnerships under section 761(a) even though the underlying activities of the partnerships lacked a profit objective undersection 183 . The Garfield and Cardinal limited partnerships each had the formal indicia of partnership status and conducted themselves generally as partnerships. They are to be treated as partnerships.
The parties’ stipulation that activities and transactions of the Garfield and Cardinal limited partnerships were not entered into with a profit objective does not affect the status of the partnerships as partnerships for Federal income tax purposes. 8
We agree with the distinction presented by the Tax Court on this issue: “[A] court decision that a partnership activity ... lacks a profit objective ... is not equivalent to[] a holding that the investors intended to create an entity other than a partnership.” 9 Even though the Krause court determined that the activities engaged in by the partnerships lacked a profit objective, none can seriously contend that those who created these business entities did not intend to create entities “by means of which [a] business, financial operation, or venture [would be] carried on.” We reject Taxpayers’ argument that is premised on the proposition that the determination that the partnership activities lacked profit objective stripped the partnerships themselves of partnership status for federal income tax purposes. Accordingly, we affirm the Tax Court’s determination that the Commissioner properly denied the Taxpayers’ deductions for their initial investments in the partnerships.
2.
In 1984, Congress amended
(c) Interest on substantial underpayments attributable to tax motivated transactions.
(1) In general. In the case of interest payable under section 6601 with respect to any substantial underpayment attributable to tax motivated transactions, the rate of interest established under this section shall be 120 percent of the underpayment rate established under this section.
(2) Substantial underpayment attributable to tax motivated transactions. For purposes of this subsection, the term “substantial underpayment attributable to tax motivated transactions” means any underpayment of taxes imposed by subtitle A for any taxable year which is attributable to 1 or more tax motivated transactions if the amount of the underpayment for such year so attributable exceeds $1,000.
(3) Tax motivated transactions.
(A) In general. For purposes of this subsection, the term “tax motivated transaction” means—
(i) any valuation overstatement (within the meaning of section 6659(c)),
(ii) any loss disallowed by reason of section 465(a) and any credit disallowed under section 46(c)(8),
(iii) any straddle (as defined in section 1092(c) without regard to subsections (d) and (e) of section 1092),
(iv) any use of an accounting method specified in regulations prescribed by the Secretary as a use which may result in a substantial distortion of income for any period, and
(v) any sham or fraudulent transaction.
(B) Regulatory authority. The Secretary may by regulations specify other types of transactions which will be treated as tax motivated for purposes of this subsection and may by regulations provide that specified transactions being treated as tax motivated will no longer be so treated.... [Emphasis added.]
The Secretary exercised the authority granted in
Q-2. What is a tax motivated underpayment?
A-2. A tax motivated underpayment is the portion of a deficiency (as defined in section 6211) of tax imposed by subtitle A (income taxes) that is attributable to any of the following tax motivated transactions:
(1) ... a valuation overstatement within the meaning of section 6659(c)(l)[ ];
(6) Any deduction disallowed with respect to any other tax motivated transactions (see A-k of this section).
Q-4. Are any transactions other than those specified in A-2 of this section and those involving the use of accounting methods under circumstances specified in A-3 of this section considered tax motivated transactions under A-2(6) of this section?
A-4. Yes. Deductions disallowed under the following provisions are considered to be attributable to tax motivated transactions:
(1) Any deduction disallowed for any period undersection 183 , relating to an activity engaged in by an individual or an S corporation that is not engaged in for profit.... 11
To summarize the foregoing,
As a threshold matter, Taxpayers argue that the Commissioner abused his discretion by imposing the tax from the date the payment was due, instead of giving them the opportunity “to resolve this matter without payment of interest at the penalty increased rate.” At oral argument, they asked specifically that we reverse the Tax Court’s decision and render judgment in their favor as to the interest that accrued between the due date of the relevant tax returns and the 1990 notice of deficiency. In support of this request, they argue that the legislative history of
We are not persuaded by Taxpayers’ arguments on this point. If
§ 6601 . Interest on underpayment, nonpayment, or extensions of time for payment, of tax.
(a) General rule. If any amount of tax imposed by this title (whether required to be shown on a return, or to be paid by stamp or by some other method) is not paid on or before the last date prescribed for payment, interest on such amount at the underpayment rate established undersection 6621 shall be paid for the period from such last date to the date paid. 13
The application of this provision is mechanical, and we find no abuse of discretion by the Commissioner in calculating the interest from the date that Taxpayers’ tax deficiency was due.
Neither are we persuaded by Taxpayers’ invocation of the legislative intent of
The larger question presented here is the propriety of imposing the
To repeat,
Deductions disallowed under the following provisions are considered to be attributable to tax motivated transactions:
(1) Any deduction disallowed for any period under [I.R.C.] section 18S, relating to an activity engaged in by an individual or an S corporation that is not engaged in for profit. [Emphasis added.]
The Commissioner maintains that because the Tax Court determined that the partnerships in which Taxpayers invested lacked a profit motive under
Examination of the plain language of TTR § 301.6621-2T establishes that the essential elements of the type of tax motivated transaction
defined by that regulation
are as follows: There must be (1) a deduction (2) that is disallowed under
Section 6621(c)(1) imposes an increased rate of interest on “any substantial underpayment attributable to tax motivated transactions,” which include activities not engaged in for profit, 17
These statements are both imprecise and flatly incorrect. The TTR § 301.6621-2T definition indisputably requires that a
deduction be disallowed under
§ 188. Activities not engaged in for profit.
(a) General rule. In the case of an activity engaged in by an individual or an S corporation, if such activity is not engaged in for profit, no deduction attributable to such activity shall be allowed under this chapter except as provided in this section. 18
The plain language of the statute thus explicitly cabins its applicability to activities engaged in by individuals or S corporations — and, by virtue of the traditional maxim of statutory construction, expressio unis est exclusio alterius (the expression of one thing is the exclusion of others), precludes the section’s applicability to partnerships. Yet the only parties that engaged in an activity for other than profit were the two partnerships: No individual and no S corporation engaged in any activity here, with or without a profit motive.
The Commissioner nevertheless relies on the fact that the Tax Court in
Krause
sustained the Commissioner’s disallowance of deductions “under
In
Krause,
the Tax Court engaged in an analysis of whether the deductions at issue met the requirements of
§ 162 . Trade or business expenses.
(a) In general. There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.... 20
and
§ 171. Research and experimental expenditures.
(a) Treatment as expenses. (1) In general. A taxpayer may treat research or experimental expenditures which are paid or incurred by him during the taxable year in connection with his trade or business as expenses which are not chargeable to capital account. The expenditures so treated shall be allowed as a deduction. 21
Both statutes require that the expense be paid or incurred in connection with a “trade or business” before the deduction is allowed. It is well-established that the determination whether an undertaking qualifies as a trade or business involves an inquiry into profit motive:
Congress allows deductions under26 U.S.C. § 162 for expenses of carrying on activities that constitute a taxpayer’s trade or business, [or] under26 U.S.C. § 174 for research and development expenses in connection with a trade or business.... Expenditures may only be deducted undersections 162 [and] 174 ... if the facts and circumstances indicate that the taxpayer made them primarily in furtherance of a bona fide profit objective independent of tax consequences. 22
It is equally accepted that in the partnership context, the profit motive inquiry focuses on the partnership, not the individual partners,
23
and that the factors in the Treasury Regulations to
Despite this truism, however, the Tax Court in
Krause,
after employing the factors from the Regulations under
In summary, presented to us in this case is a chain or multilayered series of obligations, stacked or multiplied on top of each other via the numerous partnerships to produce debt obligations in staggering dollar amounts, using a largely undeveloped and untested product, in a highly risky, very speculative, and non-arm’s-length manner in an attempt to generate significant tax deductions for investors. The transactions did not, and do not, constitute legitimate for-profit business transactions.
Losses of the partnerships are disallowed undersection 183 .... 25
The Tax Court again endorsed this gloss, however, when it considered the instant case. Adopting the rationale offered by the Ninth Circuit, 27 the Tax Court stated,
[T]he Secretary has authority to define certain transactions as tax motivated, the Secretary has defined transactions lacking a profit motive undersection 183 as tax motivated, the transactions in this case lack a profit motive undersection 183 , petitioners’ activities relating to these transactions are therefore tax motivated. 28
That, of course, is
not
what TTR § 301.6621-2T states. Again, that regulation designates as “tax motivated” “[a]ny
deduction disallowed
for any period
under
As the foregoing makes clear, we respectfully differ with our fellow circuits regarding the application of
Neither do our earlier rulings applying
In Heasley, we reached that result by implicitly granting the Commissioner’s interpretation of TTR § 301.6621-2T for the sake of argument, yet finding that the taxpayers had a profit motive. Here, we never reach the question whether profit motive is to be tested at the individual or partnership level, because we begin (and end) with an examination of that which the Heasley court assumed arguendo — the Commissioner’s interpretation and application of TTR § 301.6621-2T.
Our three subsequent encounters with
To summarize, then, TTR § 301.6621-2T defines a tax motivated transaction, for purposes of
AFFIRMED in part; and REVERSED in part and REMANDED for entry of judgment.
Notes
. Temporary Treasury Reg. § 301.6621-2T.
.
. As the Commissioner explains, the Garfield and Cardinal limited partnerships were members of a group of limited partnerships known as the "Elektra/Hemisphere” partnerships. The activities and transactions of Garfield and Cardinal were substantially identical to those of the Elektra/Hemisphere partnerships that were the subject of Krause.
.In the Stipulation of Facts submitted by the parties jointly, they agreed that "[ajfter resolution of the
.
Copeland v. Commissioner,
.
Stanford v. Commissioner of Internal Revenue,
.
.
Copeland,
.
Vanderschraaf
v.
Commissioner of Internal Revenue,
. Upon enactment in 1984, this provision was codified as
.
. See supra note 9.
.
.
See, e.g., Guilzon v. Commissioner of Internal Revenue,
. Taxpayers also argue that it was an abuse of discretion for the Commissioner to refuse their settlement offer of a lump-sum payment equal to the amount of interest, calculated at the regular rate, that had accrued. As we conclude that the
.
. Copeland, 79 T.C.M (CCH), at 2131 (quoting Hildebrand, 28 F.3d at 1028).
.
.
Krause,
.
.
.
Agro Science Co. v. Commissioner of Internal Revenue,
.
See, e.g., Tallal v. Commissioner of Internal Revenue,
.
Id.
(approving the use of the "criteria identified in Treasury Regulation
. Krause, 99 T.C. at 175-76 (emphasis added).
. Even the Commissioner recognizes this limitation in his appellate brief when he states (emphasis ours): "The regulations under
.
See Hitt v. Commissioner of Internal Revenue,
.
Copeland,
.
See, e.g., Hill v. Commissioner of Internal Revenue,
.
Hitt,
. See supra note 12 and accompanying text.
.
.
Heasley,
.
Heasley,
.
.
.