T.C. Memo. 2003-308
UNITED STATES TAX COURT
RODNEY J. BLONIEN AND NOREEN E. BLONIEN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent*
Docket No. 2660-00. Filed November 7, 2003.
R. Todd Luoma, for petitioners.
Kathryn K. Vetter and Neal O. Abreu, for respondent.
SUPPLEMENTAL MEMORANDUM OPINION
BEGHE, Judge: This case has remained before us because
petitioners have objected to respondent’s computations for
________________
*
This Supplemental Opinion supplements Blonien v.
Commissioner, 118 T.C. 541 (2002).
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entry of decision under Rule 1551 pursuant to our opinion in
Blonien v. Commissioner, 118 T.C. 541 (2002). In that opinion,
we sustained respondent’s determination that petitioners had a
deficiency in 1992 Federal income tax as a result of the
allocation to Mr. Blonien (petitioner), in a partnership-level
proceeding under TEFRA,2 of a distributive share of cancellation
of debt (COD) income of the bankrupt law firm of Finley, Kumble,
Wagner, Heine, Underberg, Manley, Myerson & Casey (Finley
Kumble).
The remaining issues are: (1) Whether respondent used the
proper method to allocate COD income of Finley Kumble to
petitioner, and (2) whether proper adjustments to reduce
petitioner’s taxable income were omitted from respondent’s Rule
155 computations. We shall enter decision in accordance with
respondent’s computations.
Background
In Blonien v. Commissioner, supra, petitioners argued that
petitioner never became a partner of Finley Kumble, that the
period of limitations under section 6229 to assess a deficiency
1
Unless otherwise indicated, all Rule references are to the
Tax Court Rules of Practice and Procedure, and all section
references are to the Internal Revenue Code in effect for the
year at issue.
2
See the partnership unified audit and litigation procedures
enacted by the Tax Equity & Fiscal Responsibility Act of 1982
(TEFRA), Pub. L. 97-248, sec. 402(a), 96 Stat. 648, codified at
secs. 6221 through 6233.
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relating to partnership items did not apply to him, and that the
statutory period of limitations on assessing nonpartnership items
had expired.
We held the Court lacks jurisdiction to determine whether
petitioner was not a partner because the Commissioner’s
determination of partnership items can be challenged under TEFRA
only in a partnership-level proceeding.3 We held petitioner
lacks standing to challenge on due process grounds the
partnership-level determination that he was a partner in Finley
Kumble. This was particularly true for at least two reasons:
First, on prior years’ returns, petitioner had claimed he was a
partner and the tax benefits derived therefrom; and, second, for
1992, the tax year in issue, he had received a Schedule K-1 (Form
1065), Partner’s Share of Income, Credits, Deductions, Etc., that
he failed to take issue with by notifying respondent that he was
not a partner by filing Form 8082, Notice of Inconsistent
Treatment or Administrative Adjustment Request. See Blonien v.
Commissioner, supra at 552-557. Therefore, the period of
limitations under section 6229 for the IRS to assess the
3
One might wonder how this case ever came to the Court,
inasmuch as all the issues have been resolved on the ground of
lack of jurisdiction. In our opinion in Blonien v. Commissioner,
supra at 550 n.4, we speculated that respondent might have used
the “affected items” procedure to enable petitioner (and other
Finley Kumble partners) to claim that he need not recognize his
share of Finley Kumble’s COD income to the extent of his own
insolvency. See sec. 108(a)(1)(B). We observed that petitioner
did not claim in his petition that he was insolvent.
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deficiency did not expire before the affected item deficiency
notice was issued. Id. at 557. We concluded that a Rule 155
computation was needed to consider whether a $2,000 credit
petitioners are entitled to for their inclusion of $2,000 of COD
income reported on their 1992 income tax return (the $2,000
credit) and other items reported on petitioner’s 1992 Schedule K-
1 received from Finley Kumble had properly been given effect in
computing the deficiency. Id. at 558-559, 564.
As part of respondent’s Rule 155 computation, Form 5278,
Statement-Income Tax Change, states petitioner’s “Adjustment to
Income” for partnership items of Finley Kumble as “Finley Other
Income” of $34,332. Respondent’s Form 4549-CG, Income Tax
Examination Changes, attached to the statutory notice of
deficiency, recited “Finley Other Income $36,332.” Respondent’s
computation has given proper effect to the $2,000 of COD income
reported on petitioners’ 1992 return.
The first page of Finley Kumble’s 1992 Form 1065, U.S.
Partnership Return of Income, at line 7, Other income (loss),
referenced “SEE STATEMENT 1”, which was a Form 8275, Disclosure
Statement, containing an Item 2 “CANCELLATION OF INDEBTEDNESS
$55,777,452”. Petitioner’s 1992 Schedule K-1 indicated he had a
0.0170-percent interest in Finley Kumble’s profits and losses,
and a 0.0345-percent interest in capital. The Schedule K-1 also
indicated that petitioner had a yearend negative capital account.
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Petitioners’ Federal income tax return for 1987, the only year
petitioner did legal work for Finley Kumble clients, reported a
distributive share of partnership income that was substantially
exceeded by the partnership draws he actually received from
Finley Kumble during that year. Finley Kumble announced its
dissolution late in 1987 and was declared bankrupt early the next
year without petitioner’s having made any capital contribution to
the firm.
Respondent has explained that under the closing agreement
between the IRS and the Finley Kumble bankruptcy trustee that
concluded the Finley Kumble partnership-level TEFRA proceeding,
COD income was allocated to petitioner and all other partners
using a two-step process. After taking into account the capital
contribution of $15,000 that petitioner was required to make in
the Finley Kumble bankruptcy proceeding, over 10 years, with
interest at 10 percent, including the present value of the future
interest payments on the deferred installments thereof,
petitioner still had a negative capital account of $26,099. In
the first step of the COD income allocation, petitioner was
allocated $26,099 of COD income to reduce his negative capital
account to zero. Finley Kumble’s remaining COD income, after
accounting for step-one COD income allocations to petitioner and
other partners with negative capital accounts, was $26,580,484.
In the second step, Finley Kumble allocated the remaining COD
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income among the partners in proportion to their contributions to
the partnership under the bankruptcy plan. The total
contribution by all partners was $38,962,594. Petitioner’s
second COD income allocation of $10,233 was calculated by
dividing his $15,000 contribution by the total of all partner
contributions, $38,962,594, and then multiplying the result by
the remaining COD income, $26,580,484 (15,000/38,962,594 = .03849
percent x $26,580,484).4
In order to explain fully the two-step process, respondent
attached to his response to petitioners’ objection to his
computation a spreadsheet titled “IRS Closing Agreement” that
reflects the computation of the COD income allocation to
petitioner using the two-step process described above. Neither
party introduced the closing agreement or the spreadsheet into
evidence during the trial of the case.
The following adjustments (the adjustment items) to
petitioners’ income listed on respondent’s Form 4549A-CG, Income
Tax Examination Changes, reduce petitioners’ taxable income by
$1,199: (1) Capital loss of $18, (2) Finley Kumble interest
4
The computation shows the second allocation amount is
$10,231, which is $2 less than the $10,233 allocation claimed by
respondent. The discrepancy could be caused by mistakes in
amounts recited in respondent’s response. This computational
discrepancy is minimal and harmless and does not change our
decision.
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income of $127, (3) Finley Kumble ordinary loss of $1,251, and
(4) itemized deductions of $57.
Discussion
Petitioners and respondent provide the following alternative
computations of petitioners’ additional taxable income:
Petitioners’ Computation Respondent’s Computation
Additional Taxable Income Additional Taxable Income
COD income $9,482.17 $36,332
$2,000 credit (2,000.00) (2,000)
Finley Kumble
interest income 127.00 Already accounted for
Capital loss (18.00) Already accounted for
Finley Kumble
ordinary loss (1,251.00) Already accounted for
Itemized deductions (57.00) Already accounted for
Total: 6,283.17 34,332
Petitioners argue the two-step process described above was
not the proper method to compute and allocate COD income to
petitioner. They complain that the two-step process resulted in
an allocation of COD income to petitioner that substantially
exceeds his percentage interest in profits and losses as shown by
his Schedule K-1 for 1992, the taxable year in issue.
Petitioners also argue respondent’s Rule 155 computation did not
take the adjustment items into account.
Issue 1. Whether the Proper Method Was Used To Compute
and Allocate Finley Kumble COD Income to Petitioner
Petitioners argue that, in accordance with Finley Kumble’s
1992 Form 1065 and Schedule K-1, petitioner’s increased
distributive share of Finley Kumble’s COD income should be
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$7,482.17 (Finley Kumble’s total COD income of $55,777,452,
multiplied by petitioner’s 0.0170-percent interest in Finley
Kumble’s profits and losses, minus the $2,000 credit for the COD
income actually reported by petitioners on their return).
Respondent argues the Court lacks jurisdiction to review
the allocation of COD income to petitioner because such
allocation is a partnership item that could only have been raised
in the prior TEFRA proceeding. Respondent also argues
petitioners are raising new issues in the Rule 155 computation.
We hold, pursuant to our opinion in Blonien v. Commissioner,
118 T.C. 541 (2002), that the Court does not have jurisdiction to
consider the proper methodology to allocate Finley Kumble COD
income to petitioner because such allocation is a partnership-
level item that was determined in the partnership-level TEFRA
proceeding. Moreover, petitioners’ objection to respondent’s
computation is an attempt to raise a new issue we would not
address at this stage of the proceedings even if we did have
jurisdiction.
a. Jurisdiction To Review Method Used To Compute
and Allocate COD Income
We agree with respondent that we have no jurisdiction to
consider the allocation of COD income to petitioner because such
allocation is a partnership item. We have no jurisdiction to
consider partnership items in a partnership-level deficiency
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proceeding. Id. at 550-552; GAF Corp. v. Commissioner, 114 T.C.
519 (2000); Maxwell v. Commissioner, 87 T.C. 783 (1986).
Items determined at the partnership level include the amount
of, and each partner’s distributive share of, partnership items
of income. Dakotah Hills Offices Ltd. Pship. v. Commissioner,
T.C. Memo. 1996-35; sec. 301.6231(a)(3)-1(a)(1), (4), Proced. &
Admin. Regs.
The amount of Finley Kumble’s COD income and each partner’s
share of such COD income are partnership items. See sec.
301.6231(a)(3)-1(a)(1), Proced. & Admin. Regs. The first and
second steps of respondent’s allocations to petitioner of his
distributive share of COD income are items determined at the
partnership level.
The decision on the method of allocating partnership income
is a partnership-level determination. The allocation and
computation of COD income to petitioner under the two-step
process must be and was determined at the partnership level
because it affects the allocation of the remaining COD income to
all the other partners.
We do not have jurisdiction to review the method used to
compute and allocate Finley Kumble COD income to petitioner.
b. New Issue in a Rule 155 Proceeding
Generally, new issues may not be raised in a Rule 155
proceeding. Rule 155(c); Harris v. Commissioner, 99 T.C. 121,
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123 (1992); Gladstone v. Commissioner, T.C. Memo. 1992-10. That
is because, as relevant here, the record would have to be
reopened in order to permit petitioners to introduce the
spreadsheet into evidence to establish a discrepancy between
petitioners’ and respondent’s computations of petitioner’s Finley
Kumble COD income. See Harris v. Commissioner, supra at 124;
Cloes v. Commissioner, 79 T.C. 933, 937 (1982). Issues
considered in a Rule 155 proceeding are limited to “purely
mathematically generated computational items”. The Home Group,
Inc. v. Commissioner, 91 T.C. 265, 269 (1988), affd. on another
issue 875 F.2d 377 (2d Cir. 1989). Petitioners do not claim
there is a mathematical error or that the formula resulting from
application of the two-step process was improperly applied;
rather they argue the two-step process was not the proper method
to allocate COD income.
The notice of deficiency, notice of final partnership
administrative adjustment, and petitioner’s Schedule K-1 gave
petitioners notice of the amount of COD income allocated to
petitioner. Petitioners did not provide any reasons why they
failed to raise this issue prior to the Rule 155 computation. We
did not find or hold in our prior opinion that petitioner’s
.0170-percent profits or capital interest should or did determine
the amount of COD income that should be allocated to petitioner.
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Because the resolution of the issue of the proper method
used to allocate COD income is a matter that would require the
Court to consider new evidence, i.e., the terms of the closing
agreement and spreadsheet, not presented at the original
proceeding, we would not consider the issue at the Rule 155
proceeding. See Bankers Pocahontas Coal Co. v. Burnet, 287 U.S.
308, 313 (1932) (prohibiting taxpayer from raising new issue in
postdecision tax deficiency proceeding: “It is not shown that
the evidence tendered was not available to the petitioner in
ample time to present it before the Board had made and filed its
findings of fact and opinion.”); Paccar, Inc. v. Commissioner,
849 F.2d 393, 400 (9th Cir. 1988) (“a further trial is exactly
what is not permitted under Rule 155”), affg. 85 T.C. 754 (1985);
Cloes v. Commissioner, supra at 937.
Issue 2. Whether Downward Adjustments to Petitioners’ Income
Listed in Respondent’s Form 4549A-CG Were Omitted From
Respondent’s Rule 155 Computation
Petitioners argue the adjustment items were not reflected in
respondent’s Rule 155 computation.
Respondent took the adjustment items into consideration in
his Rule 155 computation. In issuing the notice of deficiency,
respondent reduced petitioners’ taxable income by $1,199 from
$254,590 reported on petitioners’ 1992 return to $253,391 to take
the adjustments items into account.
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Having sustained respondent’s determinations and
computations without having reached the merits of petitioners’
arguments and objections, we make some final observations. We
make these observations to allay any impression--which
petitioners have tried to create, in arguing their case and in
contesting respondent’s Rule 155 computations--that petitioner
has been treated unfairly in the TEFRA proceeding and in this
proceeding.
In making these observations, we do not intend to belittle
the economic insecurity and resulting aggravation and anxiety
that petitioner experienced in having been induced to join a law
firm that was about to go under. But these are matters for which
the tax law provides no redress; we still would have sustained
respondent’s determination and adopted respondent’s computations,
even if we had been able to rule on the merits of petitioner’s
arguments and objections.
In 1987, the year Finley Kumble announced its dissolution,
petitioner received cash distributions, in the form of
partnership draws, that substantially exceeded his share of
partnership profits. As a result, petitioner had a negative
capital account at the end of 1987 that could only go more
negative in the intervening years until 1992, the taxable year in
issue. In that year, petitioner agreed with the Finley Kumble
bankruptcy trustee to make a $15,000 capital contribution with
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interest over 10 years, which still left him with a negative
capital account.
As a general rule, absent an agreement to the contrary, a
partner will be liable to a partnership to the extent of such
partner’s negative capital account balance upon dissolution of
the partnership. See sec. 1.704-1(b)(2)(ii)(b)(3), (c), Income
Tax Regs.
For tax and accounting purposes, Finley Kumble first
allocated COD income to petitioner and other partners to reduce
their negative capital accounts and then allocated the remaining
COD income to petitioner and all other partners in proportion to
their contributions to the partnership under the bankruptcy plan.
The restoration of the balance of petitioner’s negative capital
account was accomplished by the first-step allocation of the
partnership’s COD income resulting from the discharge of its
debts in the bankruptcy proceeding; the second-step allocation
allocated the remaining COD income to petitioner and the other
partners in proportion to their capital contributions.
All in all, the partnership-level TEFRA proceeding seems to
have led to a sensible tax result insofar as petitioner is
concerned. In 1987, petitioner realized tax benefits from Finley
Kumble in the form of losses that reduced his distributive share
of partnership income to less than his actual distributions
received, which was a contributing factor in causing his capital
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account to go negative. The determinations in the partnership-
level TEFRA proceeding--to which we are bound to give effect--
have resulted in the recapture of those tax benefits and also
take into account the current economic benefit petitioner
realized as a partner in 1992 from the discharge of his share of
the remaining liability to the firm’s creditors. What goes
around comes around.
To reflect the foregoing,
Decision will be entered
in accordance with respondent’s
computations.