T.C. Memo. 2000-181
UNITED STATES TAX COURT
PATTY K. COPELAND, A.K.A. PATTY K. WHITE, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
ALVIN C. COPELAND, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 23228-90, 23229-90. Filed June 14, 2000.
J. Grant Coleman, for petitioners.
Elaine Harris Warren and Thomas L. Fenner, for respondent.
MEMORANDUM OPINION
SWIFT, Judge: In these consolidated cases, respondent
determined deficiencies in petitioners’ Federal income taxes and
additions to tax as follows:
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Additions to Tax
Year Deficiency Sec. 6621(c) Sec. 6653(a) Sec. 6653(a)(1) Sec. 6653(a)(2) Sec. 6659
Patty K. and Alvin C. Copeland
1979 $197,476 * $10,054 -- -- --
1980 203,319 * 9,927 -- -- --
1981 164,065 * -- $22,462 ** $80,086
1982 170,990 * –- 24,323 ** 67,608
1983 127,523 -0- -- -0- -0- -0-
Alvin C. Copeland
1985 $ 1,440 -0- -- -0- -0- -0-
* 120 percent of interest accruing after Dec. 31, 1984, on
portion of underpayment attributable to a tax-motivated
transaction.
** 50 percent of interest due on portion of underpayment
attributable to negligence.
This matter is before us on the parties’ cross-motions for
partial summary judgment with regard to the following legal
issues: (1) Whether, in analyzing claimed losses relating only to
the amount of “out-of-pocket” cash invested in limited
partnerships, the profit objective of the investments should be
measured at the partnership level or at the individual partner
level; and (2) whether increased interest under section 6621(c)
applies to petitioners’ tax deficiencies attributable to
petitioners’ limited partnership investments.
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue.
Background
Many of the facts have been stipulated and are so found.
Petitioners resided in Metairie, Louisiana, at the time they
filed their petitions.
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The activities and transactions of the limited partnerships
involved herein, Garfield Oil and Gas Associates, a Utah limited
partnership, and Cardinal Oil Technology Partners, a Pennsylvania
limited partnership (hereinafter referred to as the Garfield and
Cardinal limited partnerships or as the partnerships), are
substantially identical to those of the limited partnerships
involved in our test case opinion in Krause v. Commissioner, 99
T.C. 132, 133-167 (1992), affd. sub nom. Hildebrand v.
Commissioner, 28 F.3d 1024 (10th Cir. 1994).
On their respective Federal income tax returns for the years
in issue, petitioners claimed large losses and interest
deductions relating to their investments as limited partners in
the Garfield and Cardinal limited partnerships. Respondent
disallowed these claimed losses and interest deductions, and
petitioners filed the instant petitions contesting respondent's
adjustments. Petitioners now concede all of the originally
claimed tax benefits relating to their investments in the
partnerships, and petitioners seek a loss deduction only for the
amount of cash they invested in the partnerships.
After a lengthy trial in the Krause test cases, we analyzed
the objectives and activities of the particular partnerships
involved in Krause. We concluded that the partnerships’
activities were not conducted at arm’s length, that they were not
legitimate transactions with economic substance, and that they
lacked a profit objective. We concluded that the licenses and
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leases entered into by the partnerships were not supported by
economic substance, did not conform to industry norms, and
precluded any realistic opportunity for profit. See id. at 169,
175. We sustained respondent's disallowance of the claimed
losses and interest deductions relating to the taxpayers’
investments in the partnerships, and we imposed an increased
interest rate under section 6621(c).
Petitioners herein stipulate that the factual findings made
in the Krause test case opinion with regard to the partnerships
involved therein also apply to the activities of the Garfield and
Cardinal limited partnerships. We treat this stipulation as an
admission that the activities of the Garfield and Cardinal
limited partnerships were not conducted at arm’s length, that
they were not legitimate transactions with economic substance,
and that they lacked a profit objective.
Discussion
As we explained in Vanderschraaf v. Commissioner, T.C. Memo.
1997-306, affd. without published opinion 211 F.3d 1276 (9th Cir.
2000), it is well established that the issue under section 183 as
to whether a partnership investment has associated with it
economic substance and a profit objective is determined at the
partnership level. See Pasternak v. Commissioner, 990 F.2d 893,
900 (6th Cir. 1993), affg. Donahue v. Commissioner, T.C. Memo.
1991-181; Simon v. Commissioner, 830 F.2d 499, 507 (3d Cir.
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1987), affg. T.C. Memo. 1986-156; Krause v. Commissioner, supra
at 168 (and cases cited therein); Drobny v. Commissioner, 86 T.C.
1326, 1341 (1986) (motion to vacate denied at T.C. Memo. 1995-
209, affd. 113 F.3d 670 (7th Cir. 1997)); Brannen v.
Commissioner, 78 T.C. 471, 505 (1982), affd. 722 F.2d 695 (llth
Cir. 1984); Hager v. Commissioner, 76 T.C. 759, 782 n.11 (1981).
In analyzing economic substance and the profit objective
test, courts focus on actions of the partners who manage affairs
of the partnerships and upon the underlying activities of the
partnerships. See Hill v. Commissioner, 204 F.3d 1214 (9th Cir.
2000); Thomas v. United States, 166 F.3d 825, 832-834 (6th Cir.
1999); Drobny v. Commissioner, 86 T.C. at 1341 (citing Brannen v.
Commissioner, 78 T.C. at 504-505); Fox v. Commissioner, 80 T.C.
972, 1007-1008 (1983), affd. without published opinion 742 F.2d
1441 (2d Cir. 1984), affd. sub nom. Barnard v. Commissioner, 731
F.2d 230 (4th Cir. 1984), affd. without published opinions sub
nom. Hook v. Commissioner, Kratsa v. Commissioner, Leffel v.
Commissioner, Rosenblatt v. Commissioner, Zemel v. Commissioner,
734 F.2d 5, 6-7, 9 (3d Cir. 1984).
Under any other approach, different results would accrue to
partners in the same partnerships even though the partners
themselves may have had no control over activities of the
partnerships. See Independent Elec. Supply, Inc. v.
Commissioner, 781 F.2d 724, 729 (9th Cir. 1986), affg. Lahr v.
Commissioner, T.C. Memo. 1984-472; Resnik v. Commissioner, 66
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T.C. 74, 81 (1976), affd. per curiam 555 F.2d 634 (7th Cir.
1977). For these reasons, in analyzing the economic substance
and the profit objective of limited partnership investments, in
particular, individual actions of limited partners are not the
focus of the analysis.
An analysis of the economic substance and the profit
objective element at the partnership level under section 183 is
consistent with and follows the general rule of Federal
partnership taxation that the treatment of partnership income,
loss, deduction, or credit items is to be determined at the
partnership level. See sec. 702(b); Podell v. Commissioner, 55
T.C. 429, 433 (1970) (citing Estate of Freeland v. Commissioner,
393 F.2d 573 (9th Cir. 1968), affg. T.C. Memo. 1966-283); sec.
1.702-1(b), Income Tax Regs.
Section 761(a) defines a partnership for Federal income tax
purposes essentially as a group, joint venture, or other
unincorporated organization through which any business, financial
operation, or venture is carried on. See also section 7701(a)(2)
and section 1.761-1(a), Income Tax Regs., under which the term
“partnership” is defined more broadly than the common-law meaning
of partnership.
We discern no reason to deviate from the above partnership-
level approach merely because petitioners herein have conceded
the originally claimed partnership tax benefits and are now
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seeking a deduction only for their out-of-pocket cash invested in
the partnerships.
The Garfield and Cardinal limited partnerships did not
constitute mere passive coowners of property. These limited
partnerships 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 76l(a) even though the
underlying activities of the partnerships lacked a profit
objective under section 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 issue herein under section 183 as to profit objective is
to be analyzed at the partnership level. 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.
Section 6621(c) Increased Interest
With regard to increased interest under section 6621(c),
among other arguments, petitioners contend that the temporary
regulations under section 6621 that extended increased interest
to transactions lacking a profit objective are invalid and that
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imposition against them of increased interest would violate due
process of law.1 See sec. 301.6621-2T, A-4, Temporary Proced. &
Admin. Regs., 49 Fed. Reg. 50392 (Dec. 28, 1984).
As we explained in Krause v. Commissioner, 99 T.C. at 180,
imposition of increased interest under section 6621(c), and its
predecessor section 6621(d), is largely mechanical. Section
6621(c) provides an increased rate of interest for substantial
underpayments attributable to tax-motivated transactions.
Substantial underpayments are defined as underpayments in excess
of $1,000. By legislative regulation, see sec. 6621(c)(3)(B),
among the types of transactions that are considered to be tax-
motivated transactions within the meaning of section 6621(c) are
those with respect to which related tax deductions are disallowed
under section 183 for lack of profit objective. See Rybak v.
Commissioner, 91 T.C. 524, 568 (1988); sec. 301.6621-2T, A-4(1),
Temporary Proced. & Admin. Regs., 49 Fed. Reg. 50392 (Dec. 28,
1984).
We note that in 1986, in amending section 6621(c) to include
sham transactions among the specified types of transactions that
trigger increased interest, congressional reports expressly
commented with approval on the temporary legislative regulations
under section 6621(c) that included lack of profit motive or
1
As of June 30, 1990, respondent asserts approximately
$250,000 of increased interest under sec. 6621(c) and in excess
of $2 million of regular interest under sec. 6621(a).
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objective as a ground for increased interest. See H. Conf. Rept.
99-841 at II-796 (1986), 1986-3 C.B. (Vol. 4) 796 (Statement of
the Managers).
The validity of the above regulation (and the applicability
of section 6621(c) increased interest) to partnerships
essentially the same as the Garfield and Cardinal partnerships
involved herein was analyzed at length and expressly sustained by
the Court of Appeals for the Ninth Circuit in its recent opinion
in Hill v. Commissioner, 204 F.3d at 1220. Also, imposition of
increased interest under the above regulation in the Krause test
case was sustained by the Court of Appeals for the Tenth Circuit
in its opinion in Hildebrand v. Commissioner, 28 F.3d at 1028.
In a number of cases, the Court of Appeals for the Fifth
Circuit has sustained imposition of increased interest under
section 6621(c). See Durrett v. Commissioner, 71 F.3d 515 (5th
Cir. 1996), affg. in part and revg. in part T.C. Memo. 1994-179;
Chamberlain v. Commissioner, 66 F.3d 729 (5th Cir. 1995), affg.
in part and revg. in part T.C. Memo. 1994-228. In Heasley v.
Commissioner, 902 F.2d 380 (5th Cir. 1990), revg. T.C. Memo.
1988-408, the Court of Appeals for the Fifth Circuit, on the
facts of that particular case, reversed our holding that
increased interest under section 6621(c) applied to the
transactions in question. In none of these cases did the Fifth
Circuit suggest the invalidity of the regulations under section
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6621(c) or any due process problem in the imposition of increased
interest under section 6621(c).
As part of their due process argument, petitioners note that
the accrued interest has, over the years, accumulated against
them to an amount far in excess of the income tax deficiencies.
Respondent counters that the bulk of the accrued interest
consists not of increased interest under section 6621(c) but of
regular interest under section 6621(a).
Petitioners’ reliance on Law v. Commissioner, 84 T.C. 985
(1985), and In re Hardee, 137 F.3d 337 (5th Cir. 1998), is
misplaced. Law v. Commissioner, supra, involved an untimely
attempt by respondent to raise increased interest in an amended
answer. In re Hardee, supra, was a bankruptcy opinion in which
it was held that section 6621(c) increased interest does not
constitute a penalty for purposes of the Bankruptcy Code.
Apart from section 183 and the determination of profit
objective thereunder, petitioners contend that for purposes of
increased interest under section 6621(c) the language of section
6621 imposes its own, separate profit objective test at the
partner-investor level. We disagree. As the Court of Appeals
for the Tenth Circuit stated in Hildebrand v. Commissioner, supra
at 1028, “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.”
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In the Court of Appeals for the Ninth Circuit’s opinion in
Hill v. Commissioner, supra at 1220, the following explanation is
dispositive of petitioners’ arguments:
“We specifically reject Krause’s assertion
that the Tax Court erred in finding Barton
Income Fund liable for an increased rate of
interest because a transaction which is
determined to lack a profit motive does not
equal a tax-motivated transaction under
section 6621. 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.” * * *
[Quoting in part Hildebrand v. Commissioner,
28 F.3d at 1028.]
The reasoning in Hildebrand is sound: the Secretary
has authority to define certain transactions as tax
motivated, the Secretary has defined transactions
lacking a profit motive under section 183 as tax
motivated, the transactions in this case lack a profit
motive under section 183, petitioners’ activities
relating to these transactions are therefore tax
motivated.
A close examination of section 6621(c)
demonstrates that the Secretary is well within the
granted regulatory power to simply equate the violation
of one code section with a violation of section
6621(c).
* * * * * * *
These, and the remaining “tax motivated
transactions” set out in section 6621(c)(3)(A) show a
legislative pattern established by Congress which
treats violations of certain code sections as implicit
violations of section 6621(c). The Secretary simply
followed this pattern pursuant to the regulatory
authority granted in section 6621(c)(3)(B) by
establishing regulations that make a violation of
section 183 a tax motivated transaction.
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Language in Heasley v. Commissioner, supra at 386,
suggesting that profit objective, for purposes of section 6621(c)
increased interest, be evaluated at the individual investor level
is not apropos. Heasley did not involve a partnership
investment.
In light of the lack of profit objective and the lack of
economic substance associated with the activities and investments
of the Garfield and Cardinal limited partnerships, petitioners
are liable for increased interest under section 6621(c). Other
arguments made by petitioners and not addressed specifically
herein have been considered and are rejected.
For the reasons stated, respondent's imposition of increased
interest under section 6621(c) is sustained. We shall grant
respondent’s motion for partial summary judgment and deny
petitioners’ motion for partial summary judgment.
To reflect the foregoing, an
appropriate order will be issued.