IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT
_______________________________
No. 01-60068
_______________________________
ALVIN C. COPELAND,
Petitioner-Appellant,
versus
COMMISSIONER OF INTERNAL REVENUE
Respondent-Appellee,
_______________________________
No. 01-60069
_______________________________
PATTY K. COPELAND, also known as Patty K. White,
Petitioner-Appellant,
versus
COMMISSIONER OF INTERNAL REVENUE
Respondent-Appellee,
_________________________________________________
Appeals from the Decision
of the United States Tax Court
_________________________________________________
May 13, 2002
Before JONES, WIENER, and PARKER, Circuit Judges.
WIENER, Circuit Judge:
Petitioners-Appellants Alvin C. Copeland and Patty K.
Copeland, also known as Patty K. White (collectively, “Taxpayers”)
appeal the Tax Court’s grant of partial summary judgment to the
Commissioner of Internal Revenue (“Commissioner”) and the Tax
Court’s denial of their motion for summary judgment. We conclude
that the Tax Court properly denied the Taxpayers’ deduction under
26 U.S.C. § 165 (“I.R.C. § 165") for their initial investments in
the partnerships, and therefore affirm that ruling. The Tax Court
erred, however, in sustaining the Commissioner’s imposition of the
increased interest rate under 26 U.S.C.§ 6621(c) (“I.R.C. §
6621(c)”). Because no deduction was disallowed under 26 U.S.C. §
183 (“I.R.C. § 183"), and because the Commissioner proffered no
alternative basis for imposing the I.R.C. § 6621(c) interest rate,
the Commissioner may not impose that rate. Accordingly, we reverse
the Tax Court’s ruling on the I.R.C. § 6621(c) interest rate, and
remand for imposition of a judgment consistent with these rulings
I. Facts and Proceedings
The disputed tax items and interest charges derive from the
following transactions: In 1979, Taxpayers invested $100,000 in
Garfield Oil and Gas Associates (“Garfield”), a state-law
partnership, and in 1981 they invested $75,000 in Capricorn Company
(“Capricorn”), also a state-law partnership. Capricorn invested in
another state-law partnership, Cardinal Oil Technology Partners
(“Cardinal”), after which Garfield and Cardinal together invested
in enhanced oil recovery technology projects. From 1979 to 1982,
Garfield and Cardinal reported partnership tax items relating to
the investments in the enhanced oil recovery technology projects,
and allocated the tax items to the partners, including Taxpayers.
Taxpayers filed joint tax returns for the tax years 1979 through
1982, which returns included deductions allocated to the Taxpayers
from the Garfield and Capricorn partnerships.
In 1990, the Commissioner issued notices of deficiency to
2
Taxpayers, based on the Commissioner’s disallowance of the
partnership deductions on Taxpayers’ returns. The notice of
deficiency also imposed interest at 120% of the usual rate on the
Taxpayers’ underpayment of tax attributable to the disallowed
deductions, employing the Secretary’s temporary regulations1 issued
pursuant to the then-applicable version of I.R.C. § 6621(c).
Taxpayers petitioned the Tax Court for a redetermination of the
deficiency that year, but, aside from two flurries of activity in
which the parties entered their pleadings, stipulated issues, and
made appearances in the Tax Court, there was no further action
taken in the Tax Court until 1999.
In the interim, the Tax Court decided Krause v. Commissioner
of Internal Revenue,2 a case involving various enhanced oil
recovery technology partnerships which had engaged in activities
and transactions substantially identical to those in which Garfield
and Cardinal were involved.3 Following the Tax Court’s decision in
Krause, Taxpayers paid the principal amount of the tax deficiency,
but were allegedly unable to afford to pay the interest that had
1
Temporary Treasury Reg. § 301.6621-2T.
2
99 T.C. 132 (1992), aff’d sub nom. Hildebrand v.
Commissioner of Internal Revenue, 28 F.3d 1024 (10th Cir. 1994),
cert. denied, 513 U.S. 1079 (1995).
3
As the Commissioner explains, the Garfield and Cardinal
limited partnerships were members of a group of limited
partnerships known as the “Elektra/Hemisphere” partnerships. The
activities and transactions of Garfield and Cardinal were
substantially identical to those of the Elektra/Hemisphere
partnerships that were the subject of Krause.
3
accumulated by that time. When the Tax Court activities in this
case resumed in 1999, the court issued an order requiring the
parties to show cause “why a decision in this case should not be
entered in accordance with the Court’s disposition of the issues in
[Krause].” That issue was not actually addressed at the show-cause
hearing, however. Instead, when the Tax Court learned that
Taxpayers were willing to settle the case by paying the standard
interest (not the I.R.C. § 6621(c) increased interest) on the
deficiency in a lump-sum payment, the court adjourned the hearing
with instructions to the Taxpayers to make the settlement offer
within 12 days, and to the Commissioner to file a status report
with the court regarding settlement discussions within 30 days.
The Tax Court further instructed that (1) if the parties should
fail to reach a settlement, they should file a stipulation of
facts; (2) the Commissioner should file a motion for summary
judgment within 60 days after the status report was due; and (3)
Taxpayers should file a response to the Commissioner’s motion
within one month thereafter.
The parties did not reach a settlement agreement. In
accordance with the Tax Court’s instructions, they filed a
stipulation of facts, which included an affirmation that the
factual findings and legal conclusions made in Krause were
incorporated by reference, “except for the conclusion that I.R.C.
§ 6621(c) applies and [except for] any implication that the
[Krause] partnerships are partnerships for federal income tax
4
purposes, notwithstanding that they lack profit objective within
the meaning of I.R.C. § 183.” In particular, the parties agreed
that the Krause decision “control[led] the tax treatment of the
Partnership Tax Items, as well as the additions to tax asserted in
these cases.”
The Commissioner then filed a motion for partial4 summary
judgment, arguing that the increased rate of interest under I.R.C.
§ 6621(c) was properly applied to Taxpayers’ underpayment of tax,
and that Taxpayers were not entitled to deductions under I.R.C. §
165 for their initial cash investments in the Garfield and Cardinal
partnerships. Taxpayers filed their own motion for partial summary
judgment, directly opposing both of the Commissioner’s contentions.
In a Memorandum Opinion,5 the Tax Court granted the
Commissioner’s motion and denied Taxpayers’ counter-motion,
sustaining the imposition of the I.R.C. § 6621(c) interest rate on
Taxpayers’ underpayment of tax, and disallowing the I.R.C. § 165
deduction for their initial cash investments in the partnerships.
The court entered a Decision reflecting this ruling in October
4
In the Stipulation of Facts submitted by the parties
jointly, they agreed that “[a]fter resolution of the I.R.C. §§
6621 (c) and 165 issues, the only disputed issues will be (A) the
petitioner Patty K. Copeland’s entitlement to innocent spouse
relief, (B) the reclassification of interest on petitioner Alvin
C. Copeland’s 1985 returns and the effect, if any, of such
reclassification on the Joint Returns, and (C) the determination
and allocation of certain carrybacks to the Joint Returns between
petitioners for purposes of determining the amount of their
respective deficiencies.”
5
Copeland v. Commissioner, 79 T.C.M. (CCH) 2127 (2000).
5
2000, from which Taxpayers timely appealed.
II. Discussion
A. Standard of Review
“The Tax Court’s determinations of law —— for example,
interpretations of statutory language —— are reviewed de novo,
while its factual findings are reviewed for clear error.”6
B. Analysis
1. I.R.C. § 165 Deduction for Initial Investment
As the Tax Court observed in its Memorandum Opinion, after the
Krause case was decided, Taxpayers “concede[d] all of the
originally claimed tax benefits relating to their investments in
the partnerships, and...[sought] a loss deduction only for the
amount of cash they invested in the partnerships.” In support of
this deduction, they framed their argument to the Tax Court as
follows:
Unless there is a finding of fact that
[Taxpayers’] investment in the Partnerships
lacked sufficient profit motive under IRC §
183, [Taxpayers] are entitled to their out-of-
pocket investment under IRC § 165. [Taxpayers]
have conceded that if the Partnerships were
partnerships for federal income tax purposes,
then [Taxpayers] are not entitled to out-of-
pocket deductions, however, [Taxpayers] argue
that the Partnerships are not partnerships for
federal income tax purposes.” [Emphasis
added.]
Although Taxpayers have not made the above concession so clear in
6
Stanford v. Commissioner of Internal Revenue, 152 F.3d
450, 455 (5th Cir. 1998) (citing G.M. Trading Corp. v.
Commissioner, 121 F.3d 977, 980 (5th Cir. 1997)).
6
their appellate briefs and oral arguments to us, they have premised
their argument in favor of the deduction solely on the assertion
that “Garfield and Cardinal are not partnerships for federal income
tax purposes.” “If an enterprise, such as Garfield and Cardinal,
is formed without any profit motive,” their reasoning runs, “it
cannot be a partnership for federal income tax purposes and the
activities of the partnership cannot be imputed to the investors
for purposes of determining the applicability of 26 U.S.C. § 183 to
the investors. In such cases, a determination of profit motive
must be made at the individual investor level.” Although this
argument is certainly creative, it is without merit.
Section 761(a) defines what a “partnership” is for federal
income tax purposes:
(a) Partnership. For purposes of this
subtitle, the term “partnership” includes a
syndicate, group, pool, joint venture, or
other unincorporated organization through or
by means of which any business, financial
operation, or venture is carried on, and which
is not, within the meaning of this title, a
corporation or a trust or estate.7
In keeping with this definition, the Tax Court observed that the
Garfield and Cardinal 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
761(a) even though the underlying activities
of the partnerships lacked a profit objective
under section 183. The Garfield and Cardinal
7
26 U.S.C. § 761(a).
7
limited partnerships each had the formal
indicia of partnership status and conducted
themselves generally as partnerships. They
are to be treated as partnerships.
...
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.8
We agree with the distinction presented by the Tax Court on this
issue: “[A] court decision that a partnership activity...lacks a
profit objective...is not equivalent to[] a holding that the
investors intended to create an entity other than a partnership.”9
Even though the Krause court determined that the activities engaged
in by the partnerships lacked a profit objective, none can
seriously contend that those who created these business entities
did not intend to create entities “by means of which [a] business,
financial operation, or venture [would be] carried on.” We reject
Taxpayers’ argument that is premised on the proposition that the
determination that the partnership activities lacked profit
objective stripped the partnerships themselves of partnership
status for federal income tax purposes. Accordingly, we affirm the
Tax Court’s determination that the Commissioner properly denied the
Taxpayers’ deductions for their initial investments in the
partnerships.
8
Copeland, 79 T.C.M. (CCH), at 2130 (emphasis added).
9
Vanderschraaf v. Commissioner of Internal Revenue, 74
T.C.M. (CCH) 7, 11 (1997) (emphasis in original).
8
2. I.R.C. § 6621(c) Interest
In 1984, Congress amended I.R.C. § 6621 to provide for an
increased rate of interest on substantial underpayments of tax
attributable to tax-motivated transactions.10 As amended by the Tax
Reform Act of 1986, I.R.C. § 6621(c), which is applicable for the
tax years here in question, provided:
(c) Interest on substantial underpayments attributable to
tax motivated transactions.
(1) In general. In the case of interest payable under
section 6601 with respect to any substantial underpayment
attributable to tax motivated transactions, the rate of
interest established under this section shall be 120
percent of the underpayment rate established under this
section.
(2) Substantial underpayment attributable to tax
motivated transactions. For purposes of this subsection,
the term “substantial underpayment attributable to tax
motivated transactions” means any underpayment of taxes
imposed by subtitle A for any taxable year which is
attributable to 1 or more tax motivated transactions if
the amount of the underpayment for such year so
attributable exceeds $1,000.
(3) Tax motivated transactions.
(A) In general. For purposes of this subsection, the
10
Upon enactment in 1984, this provision was codified as
I.R.C. § 6621(d). It was amended and redesignated as I.R.C. §
6621(c) by the Tax Reform Act of 1986, Pub. L. No. 99-514, 100
Stat. 2744, § 1511(c)(1)(A)-(C). I.R.C. § 6621(c) applies to
interest accruing after December 31, 1984, even if the
transaction was entered into before the date of its enactment.
Tax Reform Act of 1984, § 144(c), Pub. L. No. 98-369, Div. A,
July 18, 1984, 98 Stat. 494. Section 6621(c) was among several
penalty provisions replaced with a single “accuracy-related”
penalty by the 1989 Act. See H.R. Rep. No. 101-247, at 1388,
1394 (1989), reprinted in 1989 U.S.C.C.A.N. 1906, 2858-59, 2864.
Despite its repeal, I.R.C. § 6621(c) still applies to tax years
prior to 1989.
9
term “tax motivated transaction” means ——
(i) any valuation overstatement (within the
meaning of section 6659(c)),
(ii) any loss disallowed by reason of section
465(a) and any credit disallowed under
section 46(c)(8),
(iii) any straddle (as defined in section 1092(c)
without regard to subsections (d) and (e) of
section 1092),
(iv) any use of an accounting method specified
in regulations prescribed by the
Secretary as a use which may result in a
substantial distortion of income for any
period, and
(v) any sham or fraudulent transaction.
(B) Regulatory authority. The Secretary may by
regulations specify other types of transactions which
will be treated as tax motivated for purposes of this
subsection and may by regulations provide that specified
transactions being treated as tax motivated will no
longer be so treated.... [Emphasis added.]
The Secretary exercised the authority granted in I.R.C. §
6621(c)(3)(B), and enacted Temporary Regulation § 301.6621-2T (“TTR
§ 301.6621-2T”), which provides, in relevant part:
Q-2. What is a tax motivated underpayment?
A-2. A tax motivated underpayment is the portion of a
deficiency (as defined in section 6211) of tax imposed by
subtitle A (income taxes) that is attributable to any of the
following tax motivated transactions:
(1) ... a valuation overstatement within the meaning of
section 6659(c)(1)[];
...
(6) Any deduction disallowed with respect to any other
tax motivated transactions (see A-4 of this section).
...
Q-4. Are any transactions other than those specified in A-2 of
this section and those involving the use of accounting methods
under circumstances specified in A-3 of this section
considered tax motivated transactions under A-2(6) of this
section?
A-4. Yes. Deductions disallowed under the following
provisions are considered to be attributable to tax motivated
transactions:
(1) Any deduction disallowed for any period under
section 183, relating to an activity engaged in by
10
an individual or an S corporation that is not
engaged in for profit....11
To summarize the foregoing, I.R.C. § 6621(c) authorized the
imposition of 120% of the usual interest rate on underpayments of
tax in excess of $1,000, but only if they were attributable to tax
motivated transactions as defined either in I.R.C. § 6621(c)(3)(A)
or in the regulations enacted by the Secretary pursuant to I.R.C.
§ 6621(c)(3)(B). Exercising this authority, the Secretary added
a sixth category of tax motivated transactions to the five
specified by the Congress in I.R.C. § 6621(c)(3)(A) by promulgating
TTR § 301.6621-2T: “Any deduction disallowed for any period under
section 183, relating to an activity engaged in by an individual or
an S corporation that is not engaged in for profit.”
As a threshold matter, Taxpayers argue that the Commissioner
abused his discretion by imposing the tax from the date the payment
was due, instead of giving them the opportunity “to resolve this
matter without payment of interest at the penalty increased rate.”
At oral argument, they asked specifically that we reverse the Tax
Court’s decision and render judgment in their favor as to the
interest that accrued between the due date of the relevant tax
returns and the 1990 notice of deficiency. In support of this
request, they argue that the legislative history of I.R.C. §
6621(c) shows that the section was intended to serve as a tool for
managing the Tax Court’s docket, by providing incentive for
11
26 C.F.R. § 301.6621-2T (emphasis added).
11
taxpayers to concede to the Commissioner’s assessment of tax
deficiencies without resorting to litigation. Instead of
furthering the legislative intent, Taxpayers argue, the
Commissioner’s imposition of the I.R.C. § 6621(c) rate, of which
they learned only when they received the notice of deficiency,
amounted to a penalty. As noted above,12 I.R.C. § 6621(c) expressly
applies to interest accruing after December 31, 1984, even if the
offending transaction was entered into before the date of its
enactment. According to Taxpayers, the Commissioner’s “penalizing”
imposition of I.R.C. § 6621(c) interest is therefore particularly
unfair on these facts, because their investment in the
partnerships, which is the only transaction for which this penalty
could serve any deterrent purpose, pre-dated the enactment of
I.R.C. § 6621(c).
We are not persuaded by Taxpayers’ arguments on this point.
If I.R.C. § 6621(c) is applicable at all to Taxpayers’
underpayment, it is applicable from the due date of the tax that
they have been determined to owe. The initial language of I.R.C.
§ 6621(c) references “interest payable under section 6601.” I.R.C.
§ 6601, in turn, states:
§ 6601. Interest on underpayment, nonpayment, or
extensions of time for payment, of tax.
(a) General rule. If any amount of tax imposed by this
title (whether required to be shown on a return, or to be
paid by stamp or by some other method) is not paid on or
before the last date prescribed for payment, interest on
12
See supra note 9.
12
such amount at the underpayment rate established under
section 6621 shall be paid for the period from such last
date to the date paid.13
The application of this provision is mechanical, and we find no
abuse of discretion by the Commissioner in calculating the interest
from the date that Taxpayers’ tax deficiency was due.
Neither are we persuaded by Taxpayers’ invocation of the
legislative intent of I.R.C. § 6621(c). In combination, I.R.C. §§
6621(c) and 6601 are unambiguous, requiring the imposition of
interest starting from “the last such date” of “the period” for
which the unpaid tax was due. As the Commissioner emphasizes, in
the absence of ambiguity, we are not to look beyond the plain
wording of the statute or regulation to divine legislative intent.14
The larger question presented here is the propriety of
imposing the I.R.C. § 6621(c) interest rate on Taxpayers’
underpayment at all. In contesting the imposition of that rate,
Taxpayers argue that the Tax Court erred in failing to analyze
whether they, the Taxpayers, had a profit motive when they invested
in the subject partnerships. Our close analysis of this argument
leads us to conclude that indeed it was error, on these facts, to
impose the I.R.C. § 6621(c) interest rate at all, irrespective of
13
26 U.S.C. § 6601(a) (emphasis added).
14
See, e.g., Guilzon v. Commissioner of Internal Revenue,
985 F.2d 819, 823-24 n.11 (5th Cir. 1993) (citing Swearingen v.
Owens-Corning Fiberglas Corp., 968 F.2d 559, 562 (5th Cir.1992))
(“Fifth Circuit law is crystal clear that when, as here, the
language of a statute is unambiguous, this Court has no need to
and will not defer to extrinsic aids or legislative history.”).
13
the individual partners’ profit motive, because there was no
deduction disallowed under § 183, as TTR § 301.6621-2T pellucidly
requires. We therefore reverse the Tax Court’s ruling and hold
that the I.R.C. § 6621(c) interest rate is inapplicable to
Taxpayers’ underpayment of tax.15
To repeat, I.R.C. § 6621(c) interest may be imposed only when
there is a “substantial” underpayment of tax that is attributable
to a tax motivated transaction as defined either in I.R.C. §
6621(c)(3)(A) or in the regulations enacted by the Secretary
pursuant to I.R.C. § 6621(c)(3)(B). As any underpayment of $1,000
or more is deemed “substantial,” that element of the section is not
at issue. And, the Commissioner does not contend that any of the
definitional categories of “tax motivated transaction” listed under
I.R.C. § 6621(c)(3)(A) apply. Rather, the only kind of tax
motivated transaction that is proffered by the Commissioner is the
one found in TTR § 301.6621-2T, A4:
Deductions disallowed under the following provisions are
considered to be attributable to tax motivated
transactions:
(1) Any deduction disallowed for any period under
[I.R.C.] section 183, relating to an activity
engaged in by an individual or an S corporation
that is not engaged in for profit. [Emphasis
added.]
15
Taxpayers also argue that it was an abuse of discretion
for the Commissioner to refuse their settlement offer of a lump-
sum payment equal to the amount of interest, calculated at the
regular rate, that had accrued. As we conclude that the I.R.C. §
6621(c) interest rate should not be imposed at all, we need not
address their argument premised on the settlement offer.
14
The Commissioner maintains that because the Tax Court determined
that the partnerships in which Taxpayers invested lacked a profit
motive under I.R.C. § 183, the requirements of TTR § 301.6621-2T
were met, and it was proper to impose the I.R.C. § 6621(c) interest
rate. This application of TTR § 301.6621-2T, which was adopted by
the Tax Court and blessed by the Ninth and Tenth Circuits,
impermissibly broadens the reach of this penalty.
Examination of the plain language of TTR § 301.6621-2T
establishes that the essential elements of the type of tax
motivated transaction defined by that regulation are as follows:
There must be (1) a deduction (2) that is disallowed under I.R.C.
§ 183, (3) that is related to an activity engaged in by an
individual or an S corporation, and (4) that is not engaged in for
profit. Despite this clear and unambiguous regulatory mandate,
however, the Commissioner’s appellate brief asserts that,
“[p]ursuant to [the Secretary’s] statutory grant of authority, the
Treasury Regulations under I.R.C. § 6621(c) adopt the profit motive
test of § 183 as a litmus test for ‘tax motivated transactions.’”
Similarly, the Tax Court, in its Memorandum Opinion, quoted
Hildebrand v. Commissioner of Internal Revenue,16 as it insisted:
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.17
16
28 F.3d 1024 (10th Cir. 1994).
17
Copeland, 79 T.C.M (CCH), at 2131 (quoting Hildebrand, 28
F.3d at 1028).
15
These statements are both imprecise and flatly incorrect. The TTR
§ 301.6621-2T definition indisputably requires that a deduction be
disallowed under I.R.C. § 183 before the increased penalty may be
imposed, not that an activity be determined to lack profit motive
under the factors of I.R.C. § 183. Being disallowed under I.R.C.
§ 183 is not congruent with being tested —— and found wanting ——
under the factors set forth in I.R.C. § 183. Indeed, the
Taxpayers’ deductions were not “disallowed under” I.R.C. § 183 but
were, as the Commissioner notes, purportedly found to be lacking in
profit motive under the factors set forth in the regulations that
accompany I.R.C. § 183. More importantly, even if the Commissioner
had wanted to disallow the Taxpayers’ deductions under I.R.C. § 183
for purposes of TTR § 301.6621-2T, he could not have done so!
I.R.C. § 183 states:
§ 183. Activities not engaged in for profit.
(a) General rule. In the case of an activity engaged in
by an individual or an S corporation, if such activity is
not engaged in for profit, no deduction attributable to
such activity shall be allowed under this chapter except
as provided in this section.18
The plain language of the statute thus explicitly cabins its
applicability to activities engaged in by individuals or S
corporations —— and, by virtue of the traditional maxim of statutory
construction, expressio unis est exclusio alterius (the expression
of one thing is the exclusion of others), precludes the section’s
applicability to partnerships. Yet the only parties that engaged
18
26 U.S.C. § 183(a) (emphasis added).
16
in an activity for other than profit were the two partnerships: No
individual and no S corporation engaged in any activity here, with
or without a profit motive.
The Commissioner nevertheless relies on the fact that the Tax
Court in Krause sustained the Commissioner’s disallowance of
deductions “under section 183.” The deduction having been
disallowed “under section 183,” argues the Commissioner, leads
inexorably to the conclusion that the I.R.C. § 6621(c) increased
interest rate applies. We disagree with the Commissioner’s basic
premise that these deductions were disallowed “under § 183.”
In Krause, the Tax Court engaged in an analysis of whether the
deductions at issue met the requirements of I.R.C. §§ 162 and 174.19
Those two I.R.C. sections provide, in relevant part:
§ 162. Trade or business expenses.
(a) In general. There shall be allowed as a deduction
all the ordinary and necessary expenses paid or incurred
during the taxable year in carrying on any trade or
business....20
and
§ 174. Research and experimental expenditures.
(a) Treatment as expenses. (1) In general. A taxpayer
may treat research or experimental expenditures which are
paid or incurred by him during the taxable year in
connection with his trade or business as expenses which
are not chargeable to capital account. The expenditures
so treated shall be allowed as a deduction.21
Both statutes require that the expense be paid or incurred in
19
Krause, 99 T.C. 132, 168 (1992).
20
26 U.S.C. § 162(a) (emphasis added).
21
26 U.S.C. § 174(a) (emphasis added).
17
connection with a “trade or business” before the deduction is
allowed. It is well-established that the determination whether an
undertaking qualifies as a trade or business involves an inquiry
into profit motive:
Congress allows deductions under 26 U.S.C. §
162 for expenses of carrying on activities that
constitute a taxpayer’s trade or business, [or]
under 26 U.S.C. § 174 for research and
development expenses in connection with a trade
or business....Expenditures may only be
deducted under sections 162 [and] 174...if the
facts and circumstances indicate that the
taxpayer made them primarily in furtherance of
a bona fide profit objective independent of tax
consequences.22
It is equally accepted that in the partnership context, the profit
motive inquiry focuses on the partnership, not the individual
partners,23 and that the factors in the Treasury Regulations to
I.R.C. § 183 (for determining whether an “activity is...engaged in
for profit”) may be employed to determine the profit motive required
by sections 162 and 174 exists.24 It bears emphasizing, however,
22
Agro Science Co. v. Commissioner of Internal Revenue, 934
F.2d 573, 576 (5th Cir. 1991) (citing 26 C.F.R. § 1.183-2(a)
(1990); Mayrath v. Commissioner, 357 F.2d 209, 214 (5th Cir.
1966); Drobny v. Commissioner, 86 T.C. 1326, 1340 (1986)).
23
See, e.g., Tallal v. Commissioner of Internal Revenue,
778 F.2d 275, 276 (5th Cir. 1985) (“When the taxpayer is a member
of a partnership, we have interpreted 26 U.S.C. § 702(b) to
require that business purpose must be assessed at the partnership
level.”).
24
Id. (approving the use of the “criteria identified in
Treasury Regulation § 1.183-2" for guidance in determining
whether a partnership “lacked a bona fide profit objective”).
See also Krause, 99 T.C. at 168 (“The factors set out in the
Treasury regulations under section 183 generally are utilized in
determining whether the requisite profit objectives are present
18
that the factors from I.R.C. § 183 are only tools for determining
the requisite profit objective under I.R.C. §§ 162 and 174;
deductions for partnership expenses are not allowed or disallowed
directly under I.R.C. § 183 itself.
Despite this truism, however, the Tax Court in Krause, after
employing the factors from the Regulations under I.R.C. § 183 in its
analysis of the deductions claimed under I.R.C. §§ 162 and 174,
concluded:
In summary, presented to us in this case
is a chain or multilayered series of
obligations, stacked or multiplied on top of
each other via the numerous partnerships to
produce debt obligations in staggering dollar
amounts, using a largely undeveloped and
untested product, in a highly risky, very
speculative, and non-arm’s-length manner in an
attempt to generate significant tax deductions
for investors. The transactions did not, and
do not, constitute legitimate for-profit
business transactions.
Losses of the partnerships are disallowed
under section 183....25
The Tax Court’s wording to the contrary notwithstanding, however,
the deductions were not actually disallowed under I.R.C. § 183, but
under I.R.C. §§ 162 and 174, neither of which are limited —— as is
§ 183 —— to activities engaged in by individuals and S corporations,
to the exclusion of partnerships.26 I.R.C. § 183 provided the
under section 162 [and] section 174.”).
25
Krause, 99 T.C. at 175-76 (emphasis added).
26
Even the Commissioner recognizes this limitation in his
appellate brief when he states (emphasis ours): “The regulations
under § 183 list a number of factors relevant to the
determination of profit motive, and those factors have frequently
19
Krause court with only the factors for analysis, not statutory
authority to allow or disallow deductions themselves. To say that
the deductions are disallowed “under section 183" impermissibly
conflates the I.R.C. sections in question and thereby glosses over
this crucial distinction.
The Tax Court again endorsed this gloss, however, when it
considered the instant case. Adopting the rationale offered by the
Ninth Circuit,27 the Tax Court stated,
[T]he 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.28
That, of course, is not what TTR § 301.6621-2T states. Again, that
regulation designates as “tax motivated” “[a]ny deduction disallowed
for any period under section 183, relating to an activity engaged
in by an individual or an S corporation that is not engaged in for
profit”; and, again, the deductions disallowed in Krause (which
ruling was stipulated to apply here) were disallowed under § 162 and
been applied by the courts in determining whether a profit motive
exists for all sorts of entities, including partnerships and
corporations, to which the limitations on deductibility of § 183
do not apply.”
27
See Hill v. Commissioner of Internal Revenue, 204 F.3d
1214, 1220 (9th Cir. 2000). The Hill court was, in turn, relying
on the Tenth Circuit’s reasoning in Hildebrand v. Commissioner,
28 F.3d 1024 (10th Cir. 1994).
28
Copeland, 79 T.C.M. (CCH), at 2131 (emphasis added).
20
§ 174, employing only the profit objective factors in the Treasury
Regulations accompanying § 183. The Ninth Circuit’s and Tax Court’s
pronouncements that “transactions lacking a profit motive under
section 183" constitute tax motivated transactions under I.R.C. §
6621(c) impermissibly broadens the reach of this punitive interest
provision. The definition of a tax motivated transaction found in
TTR § 301.6621-2T ineluctably requires that the underpayment of tax
be attributable to deduction disallowed under I.R.C. § 183, and such
a disallowance simply did not take place in the instant case —— nor
could it have.
As the foregoing makes clear, we respectfully differ with our
fellow circuits regarding the application of I.R.C. § 6621(c) via
TTR § 301.6621-2T.29 We are, of course, mindful of the admonition
of the Ninth Circuit that “[u]niformity among Circuits is especially
important in tax cases to ensure equal and certain administration
of the tax system.”30 Nevertheless, the plain language of TTR §
301.6621-2T leaves us no choice, for it compels our conclusion. It
is certainly conceivable that the Secretary meant to classify as tax
motivated any deduction that was determined to lack a profit motive,
as the Commissioner and Tax Court contend. Indeed, TTR § 301.6621-
29
See, e.g., Hill v. Commissioner of Internal Revenue, 204
F.3d 1214 (9th Cir. 2000); Hildebrand v. Commissioner of Internal
Revenue, 28 F.3d 1024 (10th Cir. 1994).
30
Hill, 204 F.3d at 1217 (quoting Pacific First Fed. Sav.
Bank v. Commissioner, 961 F.2d 800, 803 (9th Cir. 1992) (quoting
First Charter Financial Corp. v. United States, 669 F.2d 1342,
1345 (9th Cir. 1982))).
21
2T could have been drafted to do just that: apply when partnership
transactions tested for profit motive using the factors from I.R.C.
§ 183 were found to lack such a profit motive. TTR § 301.6621-2T,
however, unambiguously directs a different analysis. As the
Commissioner insisted when arguing that the rules for the starting-
date of the interest rate accrual should be mechanically applied,31
when the statutory (or regulatory) language is clear, we must look
no further.
Neither do our earlier rulings applying I.R.C. § 6621(c) compel
a different conclusion. In Heasley v. Commissioner of Internal
Revenue,32 we considered a non-partnership case in which the
Commissioner sought to impose the I.R.C. § 6621(c) interest rate by
means of the statutory definition relating to a valuation
overstatement, or, alternatively, employing TTR § 301.6621-2T.
Having determined earlier in the Heasley opinion that the
underpayment of tax was not attributable to a valuation
overstatement, we considered the alternative basis for the increased
interest rate, TTR § 301.6621-2T, and rejected that, as well.
Accepting for the purposes of that inquiry the simplified
articulation of the test in TTR § 301.6621-2T (“The I.R.S. defines
transactions ‘not engaged in for profit’ as tax-motivated”33), we
advanced to the next step of the analysis and determined that the
31
See supra note 12 and accompanying text.
32
902 F.2d 380 (5th Cir. 1990).
33
Heasley, 902 F.2d at 385.
22
Tax Court erred in failing to consider the individual taxpayers’
profit motive, and, further, that if the Tax Court had conducted the
proper inquiry it would have found the requisite profit motive.34
The net result, therefore, was the same as in the instant case,
albeit for slightly different reasons: disapproval of the
Commissioner’s attempt to impose the I.R.C. § 6621(c) interest rate
using TTR § 301.6621-2T.
In Heasley, we reached that result by implicitly granting the
Commissioner’s interpretation of TTR § 301.6621-2T for the sake of
argument, yet finding that the taxpayers had a profit motive. Here,
we never reach the question whether profit motive is to be tested at
the individual or partnership level, because we begin (and end) with
an examination of that which the Heasley court assumed arguendo ——
the Commissioner’s interpretation and application of TTR § 301.6621-
2T.
Our three subsequent encounters with I.R.C. § 6621(c) are
likewise distinguishable, for none of them implicates TTR §
301.6621-2T. In those three partnership cases, Lukens v.
Commissioner of Internal Revenue,35 Chamberlain v. Commissioner of
Internal Revenue,36 and Durrett v. Commissioner of Internal Revenue,37
the Commissioner sought to impose the increased interest rate by
34
Heasley, 902 F.2d at 386.
35
945 F.2d 92 (5th Cir. 1991).
36
66 F.3d 729 (5th Cir. 1995).
37
71 F.3d 515 (5th Cir. 1996).
23
means of I.R.C. § 6621(c)(3)(A)(v), the statutory category of tax
motivated transactions implicating sham or fraudulent transactions.
Sham, though, is not the category chosen by the Commissioner in the
instant case; rather, the TTR § 301.6621-2T category of disallowance
under I.R.C. § 183 is the thrust here. We note in passing that in
all three sham cases, we rested our affirmance of the imposition of
the I.R.C. § 6621(c) interest rate at least in part on the
recognition of the Tax Court’s factual finding that the individual
Taxpayers lacked a profit motive. But again, as explained above, we
decline in the instant case even to reach the question of whose
profit motive to analyze, because the requisite disallowance of a
deduction under I.R.C. § 183 simply did not take place.
To summarize, then, TTR § 301.6621-2T defines a tax motivated
transaction, for purposes of I.R.C. § 6621(c), as “[a]ny deduction
disallowed for any period under section 183, relating to an activity
engaged in by an individual or an S corporation that is not engaged
in for profit.” The unambiguous plain language of TTR § 301.6621-2T
thus expressly limits its applicability to instances in which a
deduction has been disallowed under I.R.C. § 183; and that section
is itself limited in application to activities of individuals and S
corporations. The only role I.R.C. § 183 played in the instant case
was to provide analytical tools —— the factors found in the Treasury
Regulations —— for assessing the partnership’s profit objective, for
purposes of sections 162 and 174. To repeat for emphasis, in
promulgating TTR § 301.6621-2T, the Secretary could have defined a
24
tax motivated transaction as one for which a profit motive, as
analyzed under the factors of § 183, was found lacking, but the
Secretary did not. Instead, TTR § 301.6621-2T defines a tax
motivated transaction as a deduction that has been disallowed under
§ 183, and no such disallowance has been or could have been made in
this case. It was therefore error for the Tax Court to adopt
unquestioningly the Ninth Circuit’s assumption that a finding of a
lack of profit motive using the factors of I.R.C. § 183 could,
without more, support the imposition of I.R.C. § 6621(c) interest
via TTR § 301.6621-2T. Accordingly, we reverse the Tax Court’s
ruling and hold that the I.R.C. § 6621(c) interest rate cannot be
applied to the Taxpayers’ underpayment of tax. We therefore remand
this action to the Tax Court for entry of an appropriate judgment
consistent herewith.
AFFIRMED in part; and REVERSED in part and REMANDED for entry of
judgment.
25
Copeland v. Commissioner
Court: Court of Appeals for the Fifth Circuit
Date filed: 2002-05-13
Citations: 290 F.3d 326
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