dissenting: I respectfully dissent. For the reasons indicated herein, I disagree with the Court’s analysis of the profit-motive issue and for that reason with the conclusion reached by the Court. In addition, although of relatively little importance in this case, I believe that the Court’s analysis of section 183, and its application of section 183(b) and section 1.183-2(b), Income Tax Regs., to tax shelter partnerships is incorrect, unnecessary, and, by clear implication, creates an unfortunate discrimination against corporate partners.
I. The Facts as Found Relevant to the Profit-Motive Issue Support the Conclusion that the Britton Properties Partnership Should Be Recognized for Federal Tax Purposes
In the partnership context, the profit intent must be tested as of the time the partnership was organized and commenced business. The question becomes material at a later time only in response to a contention that the original business or nonbusiness intent has changed. Commissioner v. Culbertson, 337 U.S. 733 (1949). Here, the intent must be first tested as of sometime during the first half of 1974, although the tax year 1975 is before the Court, since no one contends that the intent was any different in the second year. Determination of intent in limited partnership circumstances presents a particularly difficult question, especially where, as here, a promoter, with only a minimal partnership interest, is the sole general partner.
Limited partners clearly cede to the general partners both the establishment of business policy and its implementation. Estate of Freeland v. Commissioner, 393 F.2d 573 (9th Cir. 1968). However, as this Court has held, that intent cannot be derived from the "separate activities of the partners.” Madison Gas & Electric Co. v. Commissioner, 72 T.C. 521 (1979). The majority appears to look principally to the activities and to the knowledge (express or implied) of the sole general partner. I cannot believe that determination of this issue should depend on such a limited and subjective focus. My disagreement in this case is not with the majority’s findings of fact but rather with the relevance to the determination of profit motive of certain of the facts upon which the majority seems principally to rest its decision.
Respondent’s contention appears to be that investment in Britton Properties was presented to the potential limited partners as a mechanism designed to produce solely tax deductions. In apparent support of this contention but without a finding to this effect, the majority concludes that: "When all of these facts are considered, it is clear that from the outset, the general partner [Michael Stern] had effectively destroyed whatever small chance the partnership had of making a profit and insured that it would be an economic failure.” There is no finding, however, that the limited partners at the time of their respective investments knew or should have known that the general partner intended to operate the partnership so as to preclude a profit. Both the record and the Court’s findings amply support the conclusion that investment in this limited partnership was presented as a highly speculative venture but one intended to make a profit. While the petitioner in this case, Dr. Brannen, by careful investigation might have determined that the likelihood of profit was too remote to warrant the investment for that purpose, I do not believe that his arguably insufficient investigation is a sufficient cause, either by itself or in conjunction with other facts and circumstances, to support the majority’s conclusion. Whether or not Michael Stern knew or should have known that the venture could not produce a profit is not entirely clear, but there is no indication in the record or in the Court’s findings that he or any of his business associates communicated to the limited partners facts indicating impossibility of a profit.
The majority’s conclusion that the possibility of deriving any profit was precluded by the actions of the general partner in agreeing to the purchase price and the other contracts is grounded on the Court’s determination that the film had only a minimal value. However, in order to impute knowledge of this fact to Britton Properties partnership, one must conclude that the failure of the investors to demand a valuation under the circumstances in itself demonstrates that they collectively had a total disinterest in a profit objective or actually knew the facts. I cannot reach that conclusion on the record, and the majority has not so found.
The majority’s analysis is essentially in terms of actions and knowledge of the general partner both as to Britton Properties as well as 19 unrelated but similar limited partnerships formed by Mr. Stern or by some of his business associates. Unless, in making this profit motive determination, the Court is constrained to consider only the actions and knowledge of the sole general partner and of his business associates, the decision is not supportable. The Court has not found, as respondent contends, that the partnership was "presented to the potential investors as a venture designed solely to produce tax deductions,” or that reasonable investors would or should have reached that understanding. In the absence of such findings about the investors’ motives and knowledge, I conclude that the Britton Properties partnership, the aggregate of all participants, had a business purpose and a profit motive. This is not a case where, as in Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C. 1221, 1244 (1981), the Court has found that the petitioner "appeared completely indifferent to the success or failure of the venture.”
Tax shelters present a difficult problem not only for the Commissioner but also for the courts. In a typical case, of which this is an example, the limited partnership is established and sold to potential investors essentially in the same manner as any other speculative investment. The entity is given all of the trappings of an investment for profit. Unscrupulous promoters, if well rehearsed, can more often than not persuade the unsophisticated investor to part with his money. The judiciary, itself, has fashioned two potent weapons to use against tax investors who are found to be too gullible or too greedy. Deductions relative to the nonrecourse debt may be disallowed when, as in this case, it is determined, with the benefit of hindsight, that the value of the note grossly exceeded the value of the property securing it. In the egregious case, the partnership may fail of recognition or deductions in excess of income may be disallowed.
Loss of the nonrecourse debt benefits in this case is amply supported. I am not, however, persuaded that we should further penalize the investor limited partners where on the facts known and presented to them it is reasonable to conclude that the partnership was established as an investment vehicle with a profit motive. It is unreasonable, I submit, to reach the opposite conclusion when to do so one must attach controlling importance to facts and actions unknown to the partnership as a whole. The Court goes too far in grounding its decision on its hindsight as to values, on presumptive uncommunicated knowledge of the sole general partner, on the apparent overreaching or deceptive conduct by one or more of the general partner’s nonpartnership business associates, and on the pattern of lack of financial success of some 19 other limited partnerships. The 19 were unconnected to Britton Properties although all 20 were spawned under the direction of a single puppeteer (Richard Friedberg) whose manipulations were certainly unsuspected by petitioner and, presumptively, the other investors. In fact, Mr. Friedberg’s activities may not have been fully comprehended by his own business associates, including this partnership’s general partner.
II. The Existence Vel Non of a Profit Motive Will Determine Whether or Not the Britton Properties Partnership Should Be Recognized for Federal Income Tax Purposes
For almost 40 years, it has been accepted that a partnership for Federal tax purposes is created "when persons join together their money, goods, labor, or skill for the purpose of carrying on a trade, profession, or business and when there is community of interest in the profits and losses.” Commissioner v. Tower, 327 U.S. 280, 286 (1946). (Emphasis supplied.) The Supreme Court in Tower further stated that the question to be decided is:
whether the partners really and truly intended to join together for the purpose of carrying on business and sharing in the profits or losses or both. And their intention in this respect is a question of fact, to be determined from testimony disclosed by their "agreement, considered as a whole, and by their conduct in execution of its provisions.” * * * [327 U.S. at 287. Emphasis supplied.]
Commissioner v. Culbertson, supra, strongly reaffirms this tax definition of a partnership, and in a series of cases, this Court has stated that one of the essential principles of a partnership is the agreement to share profits. See, for example, S. & M. Plumbing Co. v. Commissioner, 55 T.C. 702 (1971); Podell v. Commissioner, 55 T.C. 429 (1970).
The majority in note 14 calls attention to the fact that neither petitioner nor respondent contended that the lack of profit motive would cause the partnership to fail recognition for Federal tax purposes. I think the Court in this footnote misreads prior decisional law. I do not read either of the cases cited in the footnote—Madison Gas & Electric Co. v. Commissioner, supra, or Luna v. Commissioner, 42 T.C. 1067 (1964)—as standing squarely for the proposition that there can be a valid partnership when profit motive is lacking. Therefore, I believe that the majority is not only departing from the Supreme Court’s definition of a partnership, but substantially from our own cases.
In Madison Gas & Electric Co. v. Commissioner, supra, we said, but without citation of authority:
First, the statute [sec. 761 or sec. 7701] does not require a profit motive; rather it merely requires "an unincorporated organization, through or by means of which any business, financial operation, or venture is carried on.” The business activity or profit motive test is important in distinguishing partnerships from the mere coownership of property. However, this test is not the only test for what constitutes a partnership for Federal tax purposes. * * *[72 T.C. at 561-562.]
That statement was unnecessary for that decision, however, since we also found that the requisite profit motive was present.
In Luna v. Commissioner, 42 T.C. at 1077-1078, we made the general statement that several factors, none of which are exclusive, bear on the determination of whether a partnership exists. Because one of the stated factors was the sharing of a mutual proprietary interest in the net profits and having an obligation to share losses, this case might be seen as supporting the majority’s position here. However, there was no contention in Luna that, overall, profit motive was lacking so the Court’s inclusion of the sharing of profits and losses as only one of the several factors, rather than as a factor whose presence is absolutely crucial to the existence of a partnership for tax purposes, should be seen as mere dictum.
A. Willis, Partnership Taxation, sec. 184.02 (3d ed. 1981), makes the flat statement: "If there is no joint profit motivation, a partnership does not exist, either under the ULPA or for income tax purposes.” W. McKee, W. Nelson & R. Whitmire, Federal Taxation of Partnerships and Partners, par. 3.03[3] (1977), is to the same effect. I know of no case where a partnership without a direct or indirect profit motive was recognized for tax purposes.
I recognize that the profit-motive test under section 162 is the same as in the partnership context. In each case, the underlying issue is the presence of a trade or business purpose, which necessarily implies an intention to make a profit. However, the consequences of disallowing business deductions under section 162 are not necessarily the same as the nonrecognition of the partnership, itself. At any rate, since I find in this case adequate proof of the existence of a profit motive, the result, as I see it, would be the same whether we are applying the profit-motive test under section 162 or under sections 761 and 7701.
III. Section 183 Should Not Be Extended to Tax Shelter Partnerships
In relying upon section 183(b) to allow deductions to offset the $679 of partnership income allocated to petitioners in 1975, the majority implies that deductions up to the amount of gross income would not have been allowed absent section 183(b)(2).
I believe, however, that this is an incorrect principle. Based on the overall scheme of taxation, established practice, and available analogy, the Court should accept, as a general principle, that gross income can always be offset by expense deductions regardless of whether section 183(b)(2) applies.
Neither section 162 nor section 212 explicitly requires that the taxpayer have a profit motive. All that section 162 requires is that the expenses be "ordinary” and "necessary” and incurred in a "trade or business.” Section 212(1) and (2) requires the expenses to relate to the "production of income.” A long series of cases under these sections have read into these general requirements the specific requirement that the activity be engaged in for profit. Because the requirement of a profit motive is a judicial gloss on sections 162 and 212, not an ironclad requirement of the Code, itself, the courts have a duty to reasonably interpret this requirement, keeping in mind the overall scheme of taxation and the particular purposes for the deductions involved.
The primary reason for requiring deductions claimed under sections 162 and 212 to satisfy a profit-motive requirement is to prevent taxpayers from deducting, as business expenses, expenses that are personal in nature because they relate not to the earning of income but to a hobby, recreational activity, or other activity in which the possibility of producing income is not a significant motivating factor. With respect to expenses not exceeding gross income, there is no reason for imposing a profit-motive requirement. To the extent the activity actually produces income, it is not entirely a personal, nonbusiness activity but has a hybrid character. To account for this hybrid nature, deductions not in excess of the amount of gross income should be viewed as expenses incurred by the taxpayer in the process of earning income, rather than as nondeductible personal expenses, and deductions should be allowed for these expenses.
The practice of the Commissioner has been not to inquire whether a profit motive exists unless claimed deductions exceed gross income. When the deductions exceed gross income, a profit-motive inquiry may be undertaken but the lack of a profit motive will cause disallowance of only the difference between the amount of deductions and the gross income from the activity. See Imbesi v. Commissioner, 361 F.2d 640 (3d Cir. 1966), revg. on other grounds a Memorandum Opinion of this Court. Because the Government has consistently recognized that the profit-motive requirement applies only to expenses in excess of gross income, and has therefore never attacked deductions up to the amount of gross income from an activity, no court has issued an opinion on whether the lack of an overall profit motive should cause deductions, not in excess of gross income, not to be allowed under sections 162 and 212.1 believe it was an accepted principle, even before the enactment of section 183, that profit motive need not be shown to deduct under section 162 or 212 expenses not exceeding gross income from the activity to which the expenses are attributable. The enactment of section 183 was not meant to alter this rule.
Not only does the established practice of the Commissioner support this view but it is also supported by the overall design of chapter 1 of the Code to impose a tax on net income only. Courts should avoid interpreting chapter 1 as a tax on gross receipts instead of net income unless Congress has expressed a specific desire to disallow a deduction of a particular type of expense. See Commissioner v. Sullivan, 356 U.S. 27 (1958), in which the Supreme Court, in allowing deductions for rent and wages to a taxpayer conducting an illegal gambling operation, noted that to disallow these deductions would come close to making gambling businesses taxable on gross receipts while all other businesses would be taxable on the basis of net income, and if that choice were to be made, Congress — not the courts or the Commissioner — should make it. See also Comeaux v. Commissioner, 10 T.C. 201, 207 (1948), in which this Court allowed a gambling enterprise to deduct salaries and other expenses and stressed that expenditures made in the actual production of income should be allowed because the "income tax law is not a tax on gross income.”
I believe the same approach must be applied in interpreting the "trade or business” or the "production of income” language of sections 162 and 212. There is no congressional indication whatsoever that engaging in an activity without a profit motive should be burdened with a tax on gross receipts from the activity, while taxpayers engaged in profit-oriented activities are entitled to be taxed on net income only. Thus, without reference to section 183, there is no basis for denying petitioners here a deduction for expenses up to the amount of gross income allocated to them by the partnership.
Additionally, I note that recognition of a general rule allowing deductions up to the amount of gross income regardless of the applicability of section 183 is warranted because of the anomalous result that would be reached were such a general rule not to exist. Because section 183 is not applicable to corporations (other than subchapter S corporations), if no such general rule existed, corporations would not be able to deduct expenses up to the amount of income if the expenses were incurred in an activity not engaged in for profit, even though individuals who also lacked profit motive could deduct this type of expense under section 183(b)(2). Furthermore, because the Court indicates that section 183(b)(2) applies to any partnership in which individuals, trusts, estates, or subchapter S corporations are partners, and because it finds that the application of section 183(b) reduces the partnership’s income to zero so that it has no profit and no loss, a corporate partner would be allocated no income. Were we not to recognize a general principle of allowing deductions up to the amount of income, a corporation engaging in the same activity directly rather than through a partnership would be treated differently because it would be taxed on gross income from the activity but not allowed any offsetting deductions. To avoid these anomalous results, we should specifically recognize the general principle.
In short, rather than rely on section 183(b)(2) to allow the deduction of expenses up to the amount of income received by petitioners in 1975, I believe the Court should simply state that the deductions are allowed because of the general principle of allowing deductions up to the amount of gross income. By so doing, the Court would avoid any implication that the deductions would not have been allowed if section 183(b)(2) were inapplicable.
This approach has the further advantage of avoiding the awkward bifurcation of section 183 which the Court adopts in this case when it grafts section 183(b) onto section 162. Clearly, section 183 was enacted to assist the Commissioner and individual taxpayers in resolving the ambiguous circumstances attendant on recreational and hobby-type activities which usually generate expenses in excess of receipts. There is no need to extend it to partnership activities at all, but its framework is particularly inept when the Government seeks to use it, or misuse it, as a weapon with which to wage the tax shelter battle.