SUGARLOAF FUND LLC, JETSTREAM BUSINESS LIMITED, TAX
MATTERS PARTNER, PETITIONER v. COMMISSIONER OF
INTERNAL REVENUE, RESPONDENT
Docket No. 671–10. Filed September 5, 2013.
In 2005, S, a purported partnership, set up Illinois common
law business trusts Main Trust and Sub-Trust. S then trans-
ferred distressed Brazilian consumer receivables to Main
Trust. S, Main Trust, and the trustee in turn allocated the
receivables to Sub-Trust. E transferred cash to Main Trust in
exchange for the entire beneficial interest in Sub-Trust. E
wrote off most of the value of the receivables as an I.R.C. sec.
166 bad debt deduction, claiming a carryover basis in the
receivables equal to S’ basis. R issued a notice of final part-
nership administrative adjustment regarding S’ 2004 and
2005 taxable years. R made adjustments to S’ income on a
number of theories. One theory is that S’ basis in the receiv-
ables was zero. An extension of this theory is that E’s basis
in the receivables is a carryover basis and would also be zero.
R made such a determination and issued E a statutory notice
of deficiency denying the deduction. E did not petition this
Court for review of his individual income tax liability. E now
alleges he, as the beneficiary and grantor of Sub-Trust, is a
partner of S such that he may intervene and participate as a
party in this TEFRA proceeding on the grounds that Sub-
Trust’s basis in the receivables is a partnership item of S.
Held: E is not a direct or indirect partner in S.
214
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(214) SUGARLOAF FUND LLC v. COMMISSIONER 215
John E. Rogers (an officer), for petitioner.
Joseph A. DiRuzzo III, for participating partner Timothy J.
Elmes.
Ronald S. Collins, Jr., for respondent.
OPINION
WHERRY, Judge: The petition in this case was filed by Jet-
stream Business Limited (Jetstream) as tax matters partner
for Sugarloaf Fund, LLC (Sugarloaf), on January 8, 2010. On
July 12, 2012, Timothy J. Elmes filed an election to partici-
pate in this case pursuant to section 6226(c). 1 On July 19,
2012, Mr. Elmes filed a motion requesting that the Court
stay consolidation of this case with other transactionally
related cases. On July 30, 2012, Mr. Elmes filed a motion
requesting a determination that he is a partner of Sugarloaf.
The Court invited petitioner and respondent to file responses
to Mr. Elmes’ motions. Respondent on April 11, 2013, filed a
response contending that Mr. Elmes is not a partner of
Sugarloaf. Petitioner did not file a response. On April 17,
2013, we denied Mr. Elmes’ motions to stay consolidation and
to set the partner determination issue for oral argument and
set a briefing schedule. We also denied without prejudice Mr.
Elmes’ motion for a partner determination, believing resolu-
tion of the issue was unnecessary at the time. On May 16,
2013, Mr. Elmes filed a motion to compel discovery from peti-
tioner. We directed petitioner to file a response, which it did
not do. Mr. Elmes then moved on June 12, 2013, for an order
to show cause why the Court should not hold petitioner in
contempt for its failure to file a response.
This Court has for some time, even predating Mr. Elmes’
attempt to intervene in this case, been concerned as to
whether ‘‘individual U.S. investors who claimed to have pur-
chased ownership interests in the Holding Companies as well
as those who acquired beneficial interests in the Sub-Trusts’’
had ‘‘the right to participate in these partnership-level pro-
ceedings’’. This Court’s order dated April 17, 2012, discussed
these issues in some detail and directed the parties to file
briefs addressing these issues. Both petitioner and
respondent have, in response to the Court’s order, filed briefs
1 Unless otherwise indicated, all section references are to the Internal
Revenue Code of 1986, as amended and in effect for the tax years at issue.
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216 141 UNITED STATES TAX COURT REPORTS (214)
addressing these issues. After careful consideration, we have
concluded that Mr. Elmes is not a direct or an indirect
partner in Sugarloaf within the meaning of section 6226(c) or
6231(a)(2). Consequently, he may not participate in this case,
and we will deny his outstanding motions as moot for the
reasons discussed below.
Background
For the sole purpose of deciding this issue, we draw the fol-
lowing background information from the agreed-upon allega-
tions in the pleadings and from the uncontroverted state-
ments in the motions and in the accompanying memoranda,
including exhibits thereto.
This case is a partnership-level proceeding under the uni-
fied audit and litigation provisions of the Tax Equity and
Fiscal Responsibility Act of 1982, Pub. L. No. 97–248, sec.
402(a), 96 Stat. at 648, commonly referred to as TEFRA and
currently codified at sections 6221 through 6234. Sugarloaf is
an Illinois limited liability company and has filed tax returns
as a partnership under the default classification rules. See
sec. 301.7701–3(a) and (b)(1)(i), Proced. & Admin. Regs. One
or more Brazilian companies allegedly contributed uncol-
lected and overdue consumer receivables to Sugarloaf in
exchange for a 98% interest in Sugarloaf. Warwick Trading,
LLC (Warwick), and Jetstream owned the remaining 2%
interest in Sugarloaf.
Sugarloaf claims to have contributed some of the Brazilian
consumer receivables to ‘‘Illinois common law business
trusts’’ (main trusts). Then, these main trusts purportedly
formed sub-trusts and assigned a portion of the receivables
to these sub-trusts, which, according to petitioner, operated
to hold, preserve, and delegate collections of the receivables.
Investors would contribute cash to a main trust in exchange
for an interest in that main trust and the entire beneficial
interest in a specified sub-trust. Mr. Elmes was apparently
one of these investors. The investors in these sub-trusts
reported on their individual tax returns section 166 bad debt
deductions relating to the consumer receivables. The
Commissioner has denied the claimed deductions and deter-
mined income tax deficiencies and penalties against many of
the investors.
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(214) SUGARLOAF FUND LLC v. COMMISSIONER 217
Sugarloaf formed the Elmes 2005 Trust (Elmes Main
Trust) and the Elmes 2005–A Sub-Trust (Elmes Sub-Trust)
and was the initial grantor and beneficiary. Sugarloaf then
purportedly transferred receivables to Elmes Main Trust,
which then purportedly allocated those receivables to Elmes
Sub-Trust. John Rogers, the strategist behind these trans-
actions, was the trustee of both trusts. Mr. Elmes contrib-
uted $75,000 to Elmes Main Trust in exchange for an
interest in Elmes Main Trust and the entire beneficial
interest in Elmes Sub-Trust and claimed to be the grantor of
Elmes Sub-Trust. Sugarloaf, Mr. Elmes, and the trusts
treated the Brazilian receivables as having a carryover basis.
Elmes Sub-Trust reported a business bad debt deduction of
$1,455,000 on account of the partial worthlessness of the
Brazilian receivables. Mr. Elmes, as a purported grantor of
Elmes Sub-Trust, claimed this deduction on his 2005 tax
return.
Respondent disallowed the loss deduction on a number of
grounds and determined an income tax deficiency and a pen-
alty against Mr. Elmes for which a statutory notice of defi-
ciency was issued. According to respondent and to this
Court’s records, Mr. Elmes did not petition this Court for
review of that statutory notice of deficiency, and respondent
assessed the deficiency. 2 Mr. Elmes is now seeking to litigate
his deficiency indirectly by participating in this case.
To support this belated attempt, Mr. Elmes relies on lan-
guage used in the previously mentioned order dated April 17,
2012, that we issued both in this case and a number of
transactionally related cases. In that order we requested
briefs on whether the beneficial owners of trusts similar to
the Elmes Main Trust and the Elmes Sub-Trust should be
considered partners of Sugarloaf. Both respondent and peti-
tioner in this case responded in the negative, as did the peti-
tioners in a number of transactionally related cases. Mr.
Elmes, however, filed a protective election to participate in
this case, although he has no separate case of his own, and
further filed a motion contending that he should be treated
2 As a general matter, while Congress has sought to afford taxpayers a
prepayment forum to dispute the Commissioner’s determined Federal in-
come tax deficiencies, it has also indicated that this opportunity should be
afforded only once as to any determined income tax deficiency for any spec-
ified taxable year. See generally secs. 6320(c), 6330(c)(2)(B).
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218 141 UNITED STATES TAX COURT REPORTS (214)
as a partner of Sugarloaf, which, if true, would justify his
participation.
Our April 17, 2012, order hypothesized that if Sugarloaf ’s
basis in the receivables was a partnership item of Sugarloaf
and the main trust’s and sub-trust’s basis in the receivables
was a carryover basis, then the sub-trust’s basis in the
receivables would likely be controlled by our finding as to
Sugarloaf ’s basis in the receivables. As we stated in that
order: ‘‘Consequently, an individual U.S. investor who
claimed a beneficial interest in a Sub-trust would seem to
have his Federal income tax liability ‘determined in whole or
[in] part by taking into account directly or indirectly
[Sugarloaf ’s basis in these partnership assets, which are]
partnership items of the partnership.’ Sec. 6231(a)(2).’’
Discussion
Generally when the tax matters partner or other partner
petitions this Court for readjustment of items in a notice of
final partnership administrative adjustment (FPAA), each
partner who was a partner during the partnership taxable
year at issue may participate in the proceeding. Sec. 6226(c).
A partner seeking to participate under section 6226(c) must
have an interest in the outcome. Sec. 6226(d). Thus, for Mr.
Elmes to participate in this proceeding, he must have been
a partner in Sugarloaf at some time during the 2005 taxable
year of Sugarloaf, which is at issue in this case. See sec.
6226(c)(1).
Section 6231(a)(2) defines a partner for TEFRA purposes
not just as a ‘‘partner in the partnership’’ but also as ‘‘any
other person whose income tax liability * * * is determined
in whole or in part by taking into account directly or
indirectly partnership items of the partnership.’’ A partner-
ship item is ‘‘any item required to be taken into account for
the partnership’s taxable year under any provision of subtitle
A to the extent regulations prescribed by the Secretary pro-
vide that, for purposes of this subtitle, such item is more
appropriately determined at the partnership level than at the
partner level.’’ Sec. 6231(a)(3). The regulations include as
partnership items ‘‘amounts determinable at the partnership
level with respect to partnership assets’’. Sec. 301.6231(a)(3)–
1(a)(1)(vi), Proced. & Admin. Regs.
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(214) SUGARLOAF FUND LLC v. COMMISSIONER 219
The records of Sugarloaf for 2005 do not indicate that Mr.
Elmes was a direct partner in Sugarloaf under section
6231(a)(2)(A). Nevertheless, in support of his position that he
was a partner in Sugarloaf in 2005, Mr. Elmes submitted
Schedules K–1, Partner’s Share of Income, Deductions,
Credits, etc., for the 2007 and 2008 tax years. These docu-
ments suggest that as the result of the alleged dissolution of
at least some of the trading companies and liquidation of the
trusts, both of which petitioner alleges have occurred, Mr.
Elmes may have become a partner or indirect partner in
Sugarloaf in 2007 and 2008. Without deciding the authen-
ticity or significance of these Schedules K–1, we note that
Mr. Elmes has not provided a similar document for the 2005
tax year, which is the year at issue in this case. Nor does Mr.
Elmes contend he or his trusts banded together with the Bra-
zilian retailers, Warwick, and Jetstream to jointly conduct,
through the Sugarloaf partnership, a common undertaking. 3
See Commissioner v. Culbertson, 337 U.S. 733 (1949). There-
fore, Mr. Elmes has not demonstrated that either he or the
Elmes Sub-Trust was a direct partner of Sugarloaf for 2005.
Thus, in order for Mr. Elmes to participate in this case, he
must be a ‘‘person whose income tax liability [for 2005] * * *
is determined in whole or in part by taking into account
directly or indirectly partnership items of the partnership.’’
Sec. 6231(a)(2)(B).
Section 6231(a)(2)(B) brings within the definition of
partner certain persons who are liable or jointly and sever-
ally liable for a tax liability attributable to partnership
items. For example, a spouse may be a deemed partner if the
other spouse is a partner and they file jointly or if the
spouse, by operation of State law, has a joint interest in the
partnership interest. See Callaway v. Commissioner, 231
F.3d 106, 111 (2d Cir. 2000), rev’g T.C. Memo. 1998–99. In
addition, a common parent corporation of a consolidated
3 We
also acknowledge that the so-called check-the-box regulation, sec.
301.7701–3(a), Proced. & Admin. Regs., permits ‘‘[a]n eligible entity with
at least two members * * * [to] elect to be classified as * * * a partner-
ship’’. But neither Mr. Elmes nor the Elmes Sub-Trust ever came together
with Sugarloaf or any of its partners to constitute an entity for this pur-
pose. See generally Superior Trading, LLC v. Commissioner, T.C. Memo.
2012–110, slip. op. at 11–15, supplementing 137 T.C. 70 (2011), aff ’d, 728
F.3d 676 (7th Cir. 2013).
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220 141 UNITED STATES TAX COURT REPORTS (214)
group may be a partner when a subsidiary member of the
group is a partner in the partnership, because the common
parent and each subsidiary member of the common group is
severally liable for tax computed under section 1502. Rev.
Rul. 2006–11, 2006–1 C.B. 635. 4 Indirect partners under sec-
tion 6231(a)(10), which are ‘‘person[s] holding an interest in
a partnership through 1 or more pass-thru partners’’, are
also deemed partners under section 6231(a)(2)(B). PCMG
Trading Partners XX, L.P. v. Commissioner, 131 T.C. 206,
209–210 (2008). While the definition of a ‘‘pass-thru partner’’
includes a trust through which ‘‘other persons hold an
interest in the partnership’’, sec. 6231(a)(9), neither Elmes
Main Trust nor Elmes Sub-Trust had such an interest in
Sugarloaf. 5
Mr. Elmes contends, however, that he is a partner in
Sugarloaf by virtue of his status as grantor of Elmes Sub-
Trust. Specifically, he contends:
In Dionne v. Commissioner, T.C. Memo. 1993–117, the Court held that
the petitioner fell within the ambit of Section 6231(a)(2) because he was
a shareholder of a S–Corporation, a pass-through entity. The S–Corpora-
tion was a partner in a TEFRA partnership, and the Court concluded
that the ‘‘petitioner’s income tax liability as stockholder in the S–Cor-
poration [was] clearly determined by taking into account, indirectly,
partnership items of the partnership...’’ Id. Thus, under Section
6231(a)(2)(B), the petitioner was deemed a partner of the partnership.
Id. Like the petitioner’s ownership in the S–Corporation in Dionne,
Elmes is the grantor of 2005 Elmes Subtrust, a passthrough entity.
* * * The 2005 Elmes Subtrust, in turn, has a partnership interest in
4 The mere fact that the subsidiary member is a partner in a partnership
does not make the common parent a partner in the partnership. Rev. Rul.
2006–11, 2006–1 C.B. 635. Rather, it is the several liability that requires
the common parent to be treated as a partner in the partnership for
TEFRA partnership proceedings, but only to the extent that the liability
stems from a partnership item. Id.
5 It is not clear that Elmes Sub-Trust would fall within the definition of
a ‘‘pass-thru’’ partner because, as a grantor trust, it may be treated as a
disregarded entity for Federal income tax purposes. Secs. 671–679; cf.
Samueli v. Commissioner, 132 T.C. 37, 39 n.3 (2009) (discussing a grantor
trust as a disregarded entity such that the grantor is treated as the owner
of what the trust owns), aff ’d in part and remanded on another issue, 661
F.3d 399 (9th Cir. 2011). If this were the case, Mr. Elmes would own what-
ever Elmes Sub-Trust owned for Federal income tax purposes, including
any partnership interest in Sugarloaf. But because Elmes Sub-Trust did
not own a partnership interest in Sugarloaf in 2005, this avenue is also
a dead end for Mr. Elmes.
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(214) SUGARLOAF FUND LLC v. COMMISSIONER 221
SUGARLOAF. As a result, under Section 6231(a)(2)(B), Elmes is consid-
ered a deemed partner of SUGARLOAF. [Fn. ref. omitted.]
The problem with this argument is that in Dionne, the S cor-
poration had an interest in the partnership, whereas here,
Elmes Sub-Trust has no such interest.
We have discussed above some of the circumstances under
which a taxpayer is deemed a partner under section
6231(a)(2)(B). Mr. Elmes, however, takes a different tack and
claims that he is a partner of Sugarloaf under section
6231(a)(2)(B) because his income tax liability depends in part
on the trust’s basis in the receivables, which he contends
depends on Sugarloaf ’s basis in those same receivables. Mr.
Elmes is correct that the basis of the receivables is a partner-
ship item of Sugarloaf. See Superior Trading, LLC v.
Commissioner, 137 T.C. 70, 91 n.20 (2011) (involving a tiered
partnership structure that was allegedly set up for servicing
Brazilian receivables, holding that ‘‘[e]ach partnership’s basis
in the receivables is part of that partnership’s inside basis
and is therefore a ‘partnership item’ within the meaning of
sec. 6231(a)(3) and sec. 301.6231(a)(3)–1, Income Tax Regs.’’),
supplemented by T.C. Memo. 2012–110, aff ’d, 728 F.3d 676
(7th Cir. 2013).
The gist of Mr. Elmes’ argument appears to be that any
adjustment to Sugarloaf ’s basis in the receivables deter-
mined by respondent or this Court would necessarily affect
the amount of the bad debt deduction to which Mr. Elmes is
entitled on his individual income tax return. This would
occur because under section 1015(b) the basis of the receiv-
ables in the hands of the transferee trust must be the same
as the basis of those receivables in the hands of transferor
Sugarloaf.
This argument depends on the fact that the receivables
were transferred from Sugarloaf to Elmes Main Trust and
then allocated to Elmes Sub-Trust, but does not depend on
any legal relationship among Mr. Elmes, the trusts, and the
partnership Sugarloaf for purposes of income taxation. We
also note that if the argument were correct, then any trust
to which a partnership transferred assets would be a member
of that partnership. We do not believe that a trust is nec-
essarily a partner of a partnership merely because the trust
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222 141 UNITED STATES TAX COURT REPORTS (214)
received assets from that partnership, and we do not accept
Mr. Elmes’ expansive interpretation of section 6231(a)(2)(B).
In support of his position that he should be considered a
partner of Sugarloaf, Mr. Elmes cites our Supplemental
Memorandum Opinion, Superior Trading, LLC v. Commis-
sioner, T.C. Memo. 2012–110. In Superior Trading, the tax-
payers contended that a Brazilian retailer contributed dis-
tressed consumer receivables to Warwick, which then
contributed the receivables to a series of trading companies.
Warwick then contributed most of its interest in those
trading companies to various holding companies. Warwick
then sold a supermajority interest in the holding companies
to investors, who claimed substantial bad debt deductions.
Respondent issued FPAAs to both Warwick and the trading
companies. In those FPAAs respondent took several alter-
native positions, including that the receivables had no value
even before they were transferred to Warwick.
Warwick and most of the trading companies filed petitions
with this Court. Warwick’s petition was consolidated with
some, but not all, of the trading companies’ petitions. After
trial of those consolidated cases, we found for respondent on
each of his alternative theories, including the theory that the
receivables had no value.
In our Supplemental Memorandum Opinion on petitioners’
motion for reconsideration, before addressing again each of
respondent’s alternative theories, we discussed the investors
who had acquired ownership interests in the holding compa-
nies. After quoting section 6231(a)(2)(B), we stated that ‘‘to
the extent their income tax liability is affected by the basis
of the * * * [distressed consumer] receivables, a partnership
item in these partnership-level proceedings, these investors
are partners for purposes of these proceedings. Consequently,
pursuant to section 6226(c)(1), each such investor ‘shall be
treated as a party to such action’.’’ Id., slip op. at 9.
Superior Trading did involve a Sugarloaf-type entity (War-
wick), but Warwick’s proceeding had been consolidated for
trial and opinion with the trading companies’ TEFRA pro-
ceedings. Our holding in the consolidated cases that the
receivables’ basis was zero was a factual and legal deter-
mination of a partnership item not just for Warwick, but also
for the trading companies that were also involved in the case.
Unlike Mr. Elmes, the investors, each of whom owned an
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(214) SUGARLOAF FUND LLC v. COMMISSIONER 223
interest in a trading company through one or more pass-
through partners, were indirect partners of the trading
companies under section 6231(a)(10) and therefore were
bound by our decision as to partnership items of the trading
companies, particularly the basis of the receivables owned by
their particular trading company. 6 Our conclusion that the
investors were partners for purposes of the consolidated
Superior Trading proceeding was correct on the basis of the
legal relationship between the investors and the trading
companies, rather than on the transferor/transferee relation-
ship between Warwick and the trading companies. Mr.
Elmes’ reliance on the language in Superior Trading as sup-
port for his contention that he is a partner of Sugarloaf is
misplaced.
Mr. Elmes does not cite caselaw, other than Superior
Trading and Dionne, discussed supra, to support his
expanded definition of partner for a TEFRA proceeding. But,
the Court of Appeals for the Seventh Circuit, to which this
case appears to be appealable absent stipulation to the con-
trary, has provided some guidance in this realm, and it is
contrary to Mr. Elmes’ position. Cemco Investors, LLC v.
United States, 515 F.3d 749 (7th Cir. 2008). Cemco Investors
involved three entities: a trust, a partnership, and the tax-
payer (Cemco), a limited liability company treated as a part-
nership for Federal income tax purposes. Id. at 750. The
trust entered into two-week-long offsetting short and long
option contracts with a bank and then contributed those
options to the partnership. Id. The partnership purchased
euro and terminated the option contracts the next day. Id.
The partnership then liquidated, transferring its assets, both
dollars and euro, to the trust. Id. The trust turned around
and contributed the euro to Cemco, which then sold them. Id.
Cemco claimed a loss on this sale on the grounds that it took
a carryover basis from the trust, which allegedly had an
increased basis in the euro equal to the full amount of the
long option. Id. at 750–751.
One of Cemco’s arguments in its challenge to the FPAA
was that the Commissioner should have first issued an FPAA
6 Our decision regarding basis did not necessarily bind those trading
company partnerships (and their partners) whose cases had not been con-
solidated.
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224 141 UNITED STATES TAX COURT REPORTS (214)
to the partnership because the adjustment to Cemco’s basis
in the euro depended on the partnership’s basis in the euro.
Id. at 752–753. The Court of Appeals rejected this argument:
‘‘Cemco has never been a partner of the Partnership or the
Trust. These sections of the Code [sections 6221 through
6234] therefore do not link the tax treatment of the euros in
Cemco’s hands to their tax treatment in anyone else’s.’’ Id.
at 753.
By analogy, Mr. Elmes has never been a partner in
Sugarloaf. The TEFRA provisions do not require that the tax
treatment of the receivables in Mr. Elmes’ hands match their
treatment in Sugarloaf ’s hands. While consistency of treat-
ment in the two parties’ hands would be ideal, and many
related cases are consolidated with this one in part for that
purpose, nothing in the TEFRA provisions requires this. See
id. (‘‘[T]he IRS need not ensure consistent tax treatment
unless a statute so requires. Sections 6221 to 6234 don’t
require this because Cemco is not an investor in the Partner-
ship.’’). Because Mr. Elmes is not a partner, direct or
indirect, in Sugarloaf, he has no standing to participate in
this TEFRA proceeding.
We have considered all of Mr. Elmes’ contentions, argu-
ments, requests, and statements. To the extent not discussed
herein, we conclude that they are meritless, moot, or irrele-
vant. To reflect the foregoing,
An appropriate order will be issued.
f
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