Bassing v. United States

United States Court of Appeals for the Federal Circuit
2008-5107

CHARLES W. BASSING, III,

Plaintiff-Appellant,

v.

UNITED STATES,

Defendant-Appellee.

Patrick G. Dooher, Buchanan, Ingersoll & Rooney, PC, of Washington, DC, argued
for plaintiff-appellant.

Carol Barthel, Attorney, Appellate Section, Tax Division, United States Department
of Justice, of Washington, DC, argued for defendant-appellee. With her on the brief were
Nathan J. Hochman, Assistant Attorney General, and Michael J. Haungs, Attorney.

Appealed from: United States Court of Federal Claims

Judge Thomas C. Wheeler
 United States Court of Appeals for the Federal Circuit

2008-5107

CHARLES W. BASSING, III,

Plaintiff-Appellant,

v.

UNITED STATES,

Defendant-Appellee.

Appeal from the United States Court of Federal Claims
in 06-CV-712, Judge Thomas C. Wheeler.

__________________________

DECIDED: April 16, 2009
___________________________

Before BRYSON, LINN, and MOORE, Circuit Judges.

BRYSON, Circuit Judge.

The question presented in this income tax refund case is whether the release of

one partner’s obligation to restore a capital account deficit is a “partnership item,” as

that term is used in the Tax Equity and Fiscal Responsibility Act of 1982 (“TEFRA”),

Pub. L. 97-248, 96 Stat. 324. The Court of Federal Claims held that the release at issue

in this case is most appropriately treated as a partnership item. We agree, and we

therefore affirm.
 I

The 1110 Bonifant Limited Partnership was organized in 1985 under Maryland

law for the purpose of developing an office building in Silver Spring, Maryland, to be

held as an investment property. The partnership agreement named Richard S. Cohen

and appellant Charles W. Bassing, III, as the two general partners. The two of them

were also limited partners along with several other individuals and entities, including

three family limited partnerships. The partnership maintained a capital account balance

for each partner, which reflected each partner’s contributions to the partnership, his

allocation of the partnership’s income, and his share of the partnership’s expenditures

and losses. The partnership agreement, as amended in 1988, provided that in the

event of the partnership’s liquidation, any partner with a negative capital account was

obligated to restore the amount of the deficiency to the partnership.

In the late 1980’s, the partnership became unable to satisfy its obligations. It

subsequently entered into a settlement agreement with its principal creditor on February

1, 1991, and was treated as having liquidated as of that date. At that time, Mr. Bassing

had a total negative capital account balance of $882,871 that he was obligated to

restore to the partnership. Mr. Bassing was insolvent, however. As a consequence,

when the partners entered into the settlement agreement with the partnership’s creditor,

they also entered into a separate agreement releasing Mr. Bassing from his obligations

to the partnership. In that agreement, Mr. Bassing waived certain rights he had under

the partnership agreement, as amended.

On April 15, 1992, Mr. Bassing filed his income tax return for the 1991 tax year.

In that return, he treated the release from his deficit restoration obligation as a deemed

2008-5107 2
sale of his interests in the partnership, and he reported a long-term capital gain of

$882,871 from that transaction. He reported tax due of $68,695 with respect to that

return, but he did not pay any portion of that sum at that time.

Through the accumulation of interest and penalties, Mr. Bassing’s tax obligation

for 1991 rose to $152,539 by 2002. He paid that amount on April 8, 2002. Later that

year, Mr. Bassing filed an amended return for 1991. In his amended return, he claimed

that the release of his deficit restoration obligation should have been characterized as

income from the cancellation of a debt rather than as income from a deemed sale, and

that in light of his insolvency, most of the gain from that transaction should have been

excluded from his gross income for 1991. The Internal Revenue Service denied his

claim.

Mr. Bassing then filed this action in the Court of Federal Claims seeking a refund

of his 2002 payment. The government responded that his action was barred by the

operation of 26 U.S.C. § 7422(h), which prohibits refund actions attributable to

“partnership items,” as that term is defined by 26 U.S.C. § 6231(a)(3), except in limited

circumstances not present in this case. Mr. Bassing replied that the release was not a

“partnership item” under 26 U.S.C. § 6231(a)(3), but was an item that should be treated

at the partner level, and that the bar of section 7422(h) therefore did not apply. The

Court of Federal Claims agreed with the government that the release was a partnership

item and that Mr. Bassing’s claim was therefore barred. The court noted that the

release “was signed by eight partners” and “was a comprehensive document that

defined the partners’ obligations to each other.” The court concluded that it is “difficult

to imagine an item more appropriate for treatment at the partnership level than the

2008-5107 3
release of one of the partner’s financial obligations to the partnership,” and it therefore

granted the government’s motion for summary judgment.

II

On the merits of the underlying tax question, Mr. Bassing contends that the

obligation to restore his capital account deficit should be treated as a debt, and the

release of that obligation should be treated as a cancellation of debt rather than as a

deemed sale. If the capital account deficit is treated as a debt, Mr. Bassing contends

that most of the income he realized from the cancellation of that debt would be subject

to 26 U.S.C. § 108(a)(1)(B), which provides that a discharge of indebtedness is not

includible in gross income if the discharge occurs when, and to the extent that, the

taxpayer is insolvent. See Halle v. Comm’r, 83 F.3d 649 (4th Cir. 1996).

Before we can reach the merits of the underlying tax issue, we must first

determine whether the trial court properly characterized the release of Mr. Bassing’s

capital account restoration obligation as a partnership item and therefore correctly held

that his refund action is barred by 26 U.S.C. § 7422(h). Mr. Bassing admits that his

negative capital account balance was a partnership item. However, he contends that

the treatment of his negative account balance for tax purposes is an item that should be

determined at the partner level and that he is therefore free to recharacterize that

obligation as a personal debt. The government argues that the characterization of the

restoration obligation and the release of that obligation should both be regarded as

partnership items, and that Mr. Bassing’s argument that the restoration obligation and

the release of that obligation should be regarded as partner-level items is contrary to the

legislative framework for partnership taxation established by TEFRA.

2008-5107 4
 Before TEFRA, the Internal Revenue Code treated partnership items such as the

partnership’s income, gain, loss, or credit at the individual partner level. The piecemeal

nature of the individual partner level determinations frequently resulted in inconsistent

treatment of the same items by different partners. See Monti v. United States, 223 F.3d

76, 78 (2d Cir. 2000). In TEFRA, Congress responded to that problem by creating a

system in which items “more appropriately determined at the partnership level than at

the partner level” would have their tax treatment established by the partnership rather

than separately by individual partners. 26 U.S.C. § 6231(a)(3); see H.R. Conf. Rep. No.

97-760, at 599-600 (1982); see also Transpac Drilling Venture 1983-63 v. United

States, 16 F.3d 383, 387 (Fed. Cir. 1994). TEFRA was enacted “in order that one

proceeding would determine how partnership items would be reported on all partners’

individual returns. TEFRA thus requires partners, on their individual tax returns, to treat

partnership items consistently with the item’s treatment on the partnership information

return.” Olson v. United States, 172 F.3d 1311, 1316 (Fed. Cir. 1999); see 26 U.S.C.

§ 6222(a); Treas. Reg. § 301.6222(a)-1(a).

Mr. Bassing’s negative capital account balance of $882,871 was a partnership

item because it represented an amount determined by the partnership under its capital

account maintenance rules, which constituted an accounting practice adopted by the

partnership and applicable to all the partners. See Treas. Reg. § 301.6231(a)(3)-1(b)

(defining the term “partnership item” to include “the accounting practices and the legal

and factual determinations that underlie the determination of the amount, timing, and

characterization of items of income, credit, gain, loss, deduction, etc.”). The release of

that obligation was also a partnership item because it was necessary to determine

2008-5107 5
whether, under the partnership’s capital account maintenance rules, the capital account

deficit would be treated as an enforceable obligation, so that the release of that

obligation would qualify as a cancellation of debt for the partnership. See Treas. Reg.

§ 301.6231(a)(3)-1(a)(1) (defining “partnership items” to include the “partnership

aggregate and each partner’s share of . . . [i]tems of income, gain, loss, deduction, or

credit of the partnership”). 1 Mr. Bassing’s refund claim ultimately depended on the

capital account deficit being characterized as a debt. Because, with exceptions

inapplicable here, TEFRA provides that “the tax treatment of any partnership item . . .

shall be determined at the partnership level,” 26 U.S.C. § 6221, Mr. Bassing’s refund

claim was “attributable to partnership items” and his refund action was accordingly

barred under 26 U.S.C. § 7422(h).

Mr. Bassing’s argument that the release of his capital deficit restoration obligation

is not a partnership item is premised on the assumption that treating his capital account

deficit as a debt would either have no effect on the remaining partners or would have a

readily ascertainable effect so that it is possible to determine the effects at the partner,

rather than the partnership, level. According to Mr. Bassing’s explanation, treating his

capital account deficit as a debt “would have allowed Mr. Cohen, his co-general partner,

to claim an $882,871 worthless debt deduction under § 166 because Mr. Cohen was the

1
Absent an enforceable restoration obligation, it is likely that a partner’s capital
account deficit would not qualify as a debt. See Buckley v. Comm’r, 69 T.C.M. (CCH)
1747 (1995) (finding that balance in capital account was “capital” and not “debt”);
Curran v. Comm’r, 47 T.C.M. (CCH) 1160 (1984) (finding that capital account deficit did
not create a “bona fide debt” because partners did not contemplate “a specific
unconditional written or oral promise to repay the amount”); Turner v. Comm’r, 19
T.C.M. (CCH) 1163 (1960) (finding that capital account deficit did not give rise to a
debtor-creditor relationship).

2008-5107 6
Partnership’s sole creditor . . . and would have received the entire $882,871 payable by

Mr. Bassing in the absence of the 1991 Release Agreement.”

In describing the effect of the treatment of his capital account deficit as a debt,

Mr. Bassing appears to suggest that Mr. Cohen’s worthless debt deduction would arise

based on Mr. Cohen’s status as a creditor rather than on his status as a partner. In fact,

however, Mr. Bassing’s obligation to restore the capital account deficit was an obligation

to the partnership, not to Mr. Cohen personally, and thus was required by TEFRA to be

treated as a partnership item. See Treas. Reg. § 301.6231(a)(3)-1(a)(1)(i) (defining, as

partnership items, “Items of income, gain, loss, deduction, or credit of the partnership”).

Mr. Bassing contends that while TEFRA requires similarly situated partners to

treat particular items in the same way, that requirement does not apply here because he

and Mr. Cohen are on different sides of the transaction: Mr. Cohen is in the role of a

creditor and Mr. Bassing is in the role of a debtor, and as such they would necessarily

treat the debt cancellation differently. For that reason, Mr. Bassing argues, the release

is not the type of transaction that the partnership was required to accord a single

characterization. Mr. Bassing contends that “the Government fails to present any

convincing reason as to why the Partnership’s presumed realization of a loss . . .

dictates the treatment of the income realized by Mr. Bassing.” Mr. Bassing suggests

that whether the debt release is treated as a private transaction between Mr. Cohen and

Mr. Bassing or instead as a transaction involving the partnership, the ultimate effect is

the same. The consistent theme in his arguments is that the change in characterization

from a deemed sale to a cancellation of debt affects only him and is therefore properly

treated at the partner level.

2008-5107 7
 TEFRA’s mandate that partners treat the same items consistently applies not

only to similarly situated partners, but also to differently situated partners. While Mr.

Bassing and Mr. Cohen were in different positions with respect to the capital account

transaction, TEFRA requires and ensures that the item will be treated consistently by all

partners who are affected by it. 26 U.S.C. § 6222(a). Because a decision about

whether to characterize a transaction as the cancellation of debt or as a deemed sale

can have tax implications for all of the partners in a partnership, it is “more appropriately

determined at the partnership level than at the partner level.” 26 U.S.C. § 6231(a)(3). 2

While allowing Mr. Cohen and Mr. Bassing to characterize the same transaction

differently might not have any tax consequences on the facts of this case, Congress

clearly wanted to avoid the risk of such disparate treatment when it enacted TEFRA.

The TEFRA regulations explicitly deal with this problem by providing that both the

amount of a capital account and the “character of an amount” of a capital account are

partnership items. Treas. Reg. § 301.6231(a)(3)-1(a)(4). Under that regulation, in order

for Mr. Bassing to prevail on his claim that the release in this case should be treated as

a cancellation of debt rather than as a deemed sale of his partnership interest, he would

have to show that the item should have been treated as a cancellation of debt at the

partnership level. However, any attempt to make that showing in the present refund

action is foreclosed by 26 U.S.C. § 7422(h), which prohibits an action from being

2
In this case, the partnership made no determination as to the character of the
release, but left that matter to the individual partners. The requirements of TEFRA
cannot be so easily avoided, however; the TEFRA regulations state that “failure by the
partnership to make a determination [as to a partnership item] does not prevent an item
from being a partnership item.” Treas. Reg. § 301.6231(a)(3)-1(c)(1).

2008-5107 8
brought “for a refund attributable to partnership items.” The Court of Federal Claims

therefore properly dismissed Mr. Bassing’s refund action for lack of jurisdiction.

AFFIRMED.

2008-5107 9