Partner IOUs fail to increase basis. Just like S corporation shareholders, partners in a partnership can only deduct their share of the entity’s losses to the extent they have basis. Like S corporation owners, partner basis starts with the basis of property and the amount of cash contributed to the partnership; it is increased by the owner’s share of taxable and tax-exempt income, and is reduced by expenses and distributions.
In a Tax Court case yesterday, partners”contributed” IOU from themselves to the partnership, VisionMonitor Software LLC.; the partners then used the amounts of the IOUs as basis for deducting losses.
Unfortunately for the partners, that doesn’t work. Judge Holmes explains (minor editing by me):
VisionMonitor argues that the notes in this case, like the assumption of debt in Gefen, were necessary to persuade a third party to kick in more funding to a cash-strapped partnership. But unlike the partner in Gefen, neither Mantor nor Smith were guaranteeing a preexisting partnership debt to a third party. And they did not directly assume any of VisionMonitor’s outside liabilities — these notes are their liability to VisionMonitor, not an assumption or guaranty of VisionMonitor’s debt to a third party… And there’s also no evidence that Mantor or Smith were personally obliged under the VisionMonitor partnership agreement to contribute a fixed amount for a specific, preexisting partnership liability.
Unlike S corporation shareholders, partners can get basis for debt owed by a partnership to third parties — for example, by providing a guarantee to a third-party lender (watch out for the “at-risk” rules). But the court held that writing an IOU, by itself, doesn’t rise to the level of creating debt basis for the partner:
Here… the partners each have no adjusted basis in the notes, and until they are paid, the notes are only a contractual obligation to their partnership. Mantor made a payment under his notes only in 2010, and the record has no evidence that Smith ever did. We therefore find that Mantor’s and Smith’s bases in their promissory notes during the 2007 and 2008 tax years were zero and, accordingly, that VisionMonitor’s basis in the contributed notes was also zero.
As it always does, the IRS tried to stick the partners with a 20% “accuracy-related” penalty. Judge Holmes wisely declined, holding that they relied reasonably on oral advice from their tax man, a Mr. Sympson:
We have little problem in finding that VisionMonitor actually relied on Sympson’s advice — his conclusion that the notes were additions to VisionMonitor’s capital (and the capital accounts of Smith and Mantor) was set out on the company’s returns. And we have little trouble in finding that this reliance was in good faith. In a case like this one — where VisionMonitor secured Smith and Mantor’s promises to increase their personal risk alongside their promise to extend their personal credit to the firm’s vendors — advice from a longtime tax adviser that this increased Smith’s and Mantor’s bases would seem reasonable to Mantor.
This is the sort of standard that the Tax Court should apply. Taxes are hard — that’s why people hire out their tax work. If they are open with their tax advisor, and they don’t have reason to think the tax advisor is incompetent, they shouldn’t get hammered with penalties just because the advisor makes a mistake. After all, the IRS makes mistakes too.
The Moral: If you want to get basis in your partnership without putting in cash, you need to get third party debt allocated to you in a way that makes you at-risk. And: when things get complicated, if you are open with your preparer and follow the advice given, IRS penalties are not automatic.
TANSTAAFL. (There Aint) No Such Thing As A Free Lunch: IRS Mulls Tax On Employee Meals. (TaxGrrrl) Just because you can make a theoretical argument that something is taxable doesn’t mean you should tax it.
So you think regulation of preparers by IRS will stop fraud? IRS Employee Accused Of Tax Fraud. If they can’t keep themselves honest, they aren’t likely to prevent preparer cheating. Of course, preparer regulation isn’t about stopping fraud or improving tax compliance. It’s about grabbing power and helping well-placed friends. Russ Fox has more.
Jana Luttenegger, Tax Court Ruling on Frequent Flyer Miles as Income (Davis Brown Tax Law Blog)
Kay Bell, Tax differences between home repairs & home improvements. It can make a big difference when you sell.
Robert D. Flach tells you WHAT TO ASK A TAX PRO
Jack Townsend, Proof Beyond a Reasonable Doubt – Ramblings
David Brunori, Business Pays a Lot of State and Local Taxes (Tax Analysts Blog):
COST recently released its 12th edition of the report. And it continues to influence the state tax debate as much today as it did in 2002. The new report says that businesses paid $671 billion in state and local taxes in 2013, up about 4 percent over the previous year. But business taxes accounted for 45 percent of all state and local taxes.
I note that the amount of tax paid by “business” is deceptive. Businesses do not pay taxes; people pay taxes. And every dime of the $671 billion was paid by some combination of shareholder, owner, employee, customer, or supplier. Those on the left desperately want the burden to fall on shareholders. But there is growing evidence that in a global economy, the burden falls on employees.
And if it does fall on shareholders, remember that pension funds are also shareholders.
Lyman Stone, Governor Rick Scott Offers Mixed Bag of Tax Proposals for Florida (Tax Policy Blog). “Governor Scott’s tax proposals offer meaningful improvements in some areas like cell phone and corporate income taxes. But on other issues like the property tax cap, it’s not clear whether or how the plan will work; on sales tax holidays, the proposed “tax cut” would actually make the tax code more complicated and distortionary, while creating little or no economic growth.”
Yes. Next Question? Is It Time to Repeal The Corporate Income Tax? (Howard Gleckman, TaxVox) “This view acknowledges that roughly 10 million businesses already have engaged in self-help tax reform by organizing themselves as pass-through firms (where owners at taxed as individuals but bypass the corporate tax entirely).”
TaxProf, The IRS Scandal, Day 483
News from the Profession. Ladies Still Need Entire Panels Made Up of Dudes to Talk About Ladies in the Profession (Adrienne Gonzalez, Going Concern) “Don’t worry, ladies, the guys are ON IT.”