1984 Tax Ct. Memo LEXIS 336 | Tax Ct. | 1984
MEMORANDUM FINDINGS OF FACT AND OPINION
HAMBLEM,
All of the facts have been stipulated, and are found accordingly. The stipulation of facts and attached exhibits are incorporated herein by this reference.
Petitioners James Miller ("James") and Yvonne Miller ("Yvonne") resided in Geneva, Ohio, when they filed their petition in this case and resided in Madison, Ohio, when they filed their 1976 and 1977 joint Federal income tax returns with the1984 Tax Ct. Memo LEXIS 336">*338 Internal Revenue Service Center at Cincinnati, Ohio.
On December 26, 1975, petitioners and another couple, William and Margie Blauman, formed a partnership entitled Northeast Realty and Investment, Limited. The capital contributions were divided in the partnership agreement as follows:
Capital | Ownership | |
Partner | Contribution | Interest |
James Miller | $45,000.00 | 45 percent |
Yvonne Miller | 5,000.00 | 5 percent |
William Blauman | 45,000.00 | 45 percent |
Margie Blauman | 5,000.00 | 5 percent |
The partnership agreement allocated all depreciation to James for the years 1976 through 1980. The income of the partnership was divided equally among the partners in an amount based on their individual percentage of ownership interest. The agreement provided that upon dissolution of the partnership, distributions would be made to the partners in accordance with their individual percentages of ownership interest.
In an amendment to the partnership agreement, dated June 1976, all income, gain, loss, deduction or credit attributable to the partnership's contemplated investment in Tele Media Company of Key West, Limited ("Tele Media"), was allocated to James. The1984 Tax Ct. Memo LEXIS 336">*339 amendment indicates that the funds for the investment, if made, would be provided by James and that:
[T]he partners recognize among themselves that any allocation from Tele Media Company of Key West, Limited among the partners of this Limited Partnership of ordinary income or of loss, gain, deduction, or credit, or any part of such items, would be disproportionate to their interest in this Partnership, accordingly, we do recognize that the allocation to the one partner, JAMES E. MILLER, would have a substantial economic effect on him alone * * *.
On their 1976 and 1977 income tax returns, petitioners claimed $36,308.00 and $22,565.00, respectively, as deductions from the partnership. Respondent reallocated the partnership loss in the statutory notice of deficiency, allocating petitioners' 50 percent of the loss, which was equal to their combined partnership ownership percentage. The losses claimed by petitioners were disallowed in the amount of $23,101.00 for 1976 and $10,983.00 for 1977.
(2) the allocation to a partner under the agreement of income, gain, loss, deduction, or credit (or item thereof) does not have substantial economic effect.
The test for substantial economic effect examines whether the partner to whom an item is specially allocated for tax purposes also bears the economic burdens and benefits of that specially allocated item. 2
1984 Tax Ct. Memo LEXIS 336">*341
1984 Tax Ct. Memo LEXIS 336">*342
The validity of an allocation to a partner is discovered by examining the effect of the allocation upon the capital accounts of the partners at liquidation.
In
In the instant case, James was allocated all depreciation deductions of the partnership. Additionally, he was allocated all items from the partnership's purported investment in Tele Media. Applying the capital accounts analysis to the facts of the instant case, it is apparent that the special allocations lack substantial economic effect. See
Petitioners argue that the special allocations from the partnership's investment in Tele Media should be upheld, since James planned to provide the capital for the investment in Tele Media and because of the short duration of the allocations. Petitioners placed no evidence in the record to show either that James in fact provided all funds for investment, or that he ceased to claim all allocations from Tele Media after 1977. Even if we assume that James did provide the capital, and did cease to claim the allocations, the special allocations to him do not affect the dollar amounts of the partners' share of the total partnership income or loss independent of the tax consequences. 1984 Tax Ct. Memo LEXIS 336">*345 The ritualistic incantation of the phrase "substantial economic effect" in the amendment to the partnership agreement does not serve to create the required effect. The business purpose behind the allocations is not determinative, since James' interest in the partnership was not reduced by the special allocations made during the years in issue. See
We have considered petitioners' other arguments and find them unpersuasive. Therefore, since the special allocations from the partnership to James lack substantial economic effect, petitioners are entitled to deduct only their share of partnership losses reflecting their 50 percent ownership interest under
To reflect the foregoing,
Footnotes
1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended and in effect during the taxable years in issue.↩
2.
Sec. 704 was amended by sec. 213(d), Tax Reform Act of 1976, Pub. L. 94-455, 90 Stat. 1525, 1548, replacing the tax avoidance or evasion test insec. 704(b)(2)↩ with the substantial economic effect test for taxable years beginning after Dec. 31, 1975.3. See
; see also McKee, Nelson and Whitmire, Federal Taxation of Partnerships and Partners, par. 10.02 (1977); Willis, Pennell and Postlewaite, Partnership Taxation, sec. 82.08 (3d Ed. 1981).Magaziner v. Commissioner, T.C. Memo. 1978-205↩4. The regulation provides the following tests:
"Whether the partnership or a partner individually has a business purpose for the allocation; whether the allocation has 'substantial economic effect', that is, whether the allocation may actually affect the dollar amount of the partners' shares of the total partnership income or loss independently of tax consequences; whether related items of income, gain, loss, deduction, or credit from the same source are subject to the same allocation; whether the allocation was made without recognition of normal business factors and only after the amount of the specially allocated item could reasonably be estimated; the duration of the allocation; and the overall tax consequences of the allocation. * * *"↩
5. See also
;Hirsch v. Commissioner, T.C. Memo 1984-52">T.C. Memo. 1984-52Magaziner v. Commissioner, supra.↩