UNITED STATES TAX COURT

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T.C. Memo. 2003-209

UNITED STATES TAX COURT

CURTIS R. AND LYNN BITKER, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

JERRY D. AND COLEEN A. BITKER, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 7321-00, 7334-00.

Filed July 15, 2003.

Jon J. Jensen and Alexander F. Reichert, for petitioners.

Blaine Holiday, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

JACOBS,

Judge:

Respondent

determined

deficiencies

petitioners’ Federal income taxes and accuracy-related penalties

under section 6662(a) for 1996 and 1997 as follows:1

Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect at all relevant times, and Rule

(continued...)

- 2 -

Docket No./Year

Deficiency

Penalty

Sec. 6662(a)

Docket No. 7321-00

1996

1997

$186,324

53,547

$37,264.80

10,709.40

Docket No. 7334-00

1996

1997

235,290

59,632

47,058.00

11,926.40

The issues to be decided2 are:

1. Whether payments by Ray Bitker & Sons partnership (the

Bitker partnership) on petitioners’ debts should be characterized

(for tax purposes) as rental expenses of the Bitker partnership or

constructive partnership distributions to petitioners;

2. whether petitioners received distributions from the Bitker

partnership in 1996 and 1997 that exceeded their bases in the

Bitker partnership; and

whether

petitioners

are

liable

for

accuracy-related

penalties under section 6662(a) for the years at issue.

(...continued)

references are to the Tax Court Rules of Practice and Procedure.

Other adjustments that respondent made to petitioners’

1996 and 1997 returns are computational; the resolution with

respect to these adjustments depends on our determination of the

issues for decision.

- 3 FINDINGS OF FACT

Some of the facts have been stipulated and are so found.

stipulation

facts

and

the

exhibits

attached

thereto

The

are

incorporated herein by this reference.

Petitioners and the Bitker Partnership

Curtis Bitker and Lynn Bitker are husband and wife.

Bitker and Coleen Bitker are husband and wife.

Jerry

Curtis Bitker and

Jerry Bitker (petitioner husbands) are brothers.

All petitioners

resided in Minnesota when the petitions in these cases were filed.

Petitioner husbands were raised on a farm in Norman County,

Minnesota, owned by their father, Ray Bitker.

Petitioner husbands

and their father formed the Bitker partnership on January 1, 1979.

Each owned a one-third interest in the Bitker partnership.

The

Bitker partnership’s principal business is farming; however, it

does not own any of the land that is farmed.

In 1989, petitioner husbands acquired their father’s interest

in the Bitker partnership at no cost; each then held a one-half

interest in the partnership.

Although their father was no longer

a partner in the Bitker partnership, the partnership continued to

farm his land and pay him rent for the use thereof.

In 1991, Lynn Bitker and Coleen Bitker (petitioner wives) each

obtained a 20-percent interest in the Bitker partnership at no

cost.

Since 1991, each petitioner husband has held a 30-percent

- 4 interest in the Bitker partnership, and each petitioner wife has

held a 20-percent interest.

During the years at issue, petitioner husbands conducted all

of their farming activity through the Bitker partnership.

Jerry

Bitker is responsible for the day-to-day bookkeeping of the Bitker

partnership’s income and expenses.

Some of the farm crops were processed and sold through several

cooperatives.

(and

thus

Only active farm operators could purchase shares

become

members)

these

cooperatives.

most

instances, shares of stock in the cooperatives were issued to

petitioner

husbands

Nonetheless,

(as

petitioners

opposed

accounted

the

for

Bitker

their

partnership).

the

cooperatives’ income through the Bitker partnership.

The Bitker Partnership’s Forms 1065

Earl Mostoller, a certified public accountant, is a member of

Drees, Riskey

Vallager,

Ltd.,

accounting

firm

that

has

prepared the Bitker partnership tax returns since its formation.

Mr. Mostoller has prepared petitioners’ Forms 1040, U.S. Individual

Income Tax Return, and the Bitker partnership’s Forms 1065, U.S.

Partnership Return of Income, since 1985.

Jerry Bitker provided

Mr. Mostoller with information as to the Bitker partnership’s

income and expenses, as well as loan records from the Farm Credit

Service.

Loans

petitioners’

made

names

for

rather

partnership

than

purposes

the

name

were

the

made

Bitker

- 5 partnership.

All four petitioners are personally liable for the

Bitker partnership’s debts.

Mr. Mostoller prepared and maintained a depreciation schedule

showing the historical cost of equipment, less depreciation taken

each year.

He verified loan balances by calling the Farm Credit

Service. Mr. Mostoller calculated the Bitker partnership’s capital

by subtracting the loan balances from the total adjusted cost bases

partnership

Mostoller

assets

determined

(cost

the

basis

partners’

less

depreciation).

capital

contributions

Mr.

and

distributions by taking each partner’s beginning capital account,

adding

thereto

(or

subtracting

therefrom)

the

partner’s

distributive share of the Bitker partnership’s net income (or net

loss) for the year, and subtracting the partner’s ending capital

account--the difference being the amount of the distribution to, or

the amount of the contribution by, the partner to the Bitker

partnership for the particular year.

On Schedules K-1 attached to Forms 1065 filed by the Bitker

partnership for years prior to 1991, the amounts for “Partner’s

share of liabilities” and “Analysis of partner’s capital account”

were left blank.

Schedules K-1 attached to the Forms 1065 filed by

the Bitker partnership for years 1991-97 (the 1991-97 Schedules K1) reflect that each petitioner husband owned 30 percent of its

capital and that each was entitled to 30 percent of its profits and

losses.

The 1991-97 Schedules K-1 reflect that each petitioner

- 6 wife owned 20 percent of the capital of the Bitker partnership and

that each was entitled to 20 percent of its profits and losses.

The 1991-97 Schedules K-1 also reflect each “Partner’s share of

liabilities” and “Analysis of partner’s capital account” as follows

(discrepancies attributable to rounding):

- 7 -

1991

Partner’s share of liabilities

Analysis of partner’s capital account:

Capital account at beginning of year

Capital contributed during year

Partner’s share of net book income (loss)

Withdrawals and distributions

Capital account at end of year

1992

Partner’s share of liabilities

Analysis of partner’s capital account:

Capital account at beginning of year

Capital contributed during year

Partner’s share of net book income (loss)

Withdrawals and distributions

Capital account at end of year

1993

Partner’s share of liabilities

Analysis of partner’s capital account:

Capital account at beginning of year

Capital contributed during year

Partner’s share of net book income (loss)

Withdrawals and distributions

Capital account at end of year

1994

Partner’s share of liabilities

Analysis of partner’s capital account:

Capital account at beginning of year

Capital contributed during year

Curtis

Jerry

Lynn

Coleen

Total

$557,991

$371,994

$1,859,970

(519,852)

117,284

19,149

-0(383,418)

(519,852)

117,284

19,149

-0(383,418)

-0-012,766

(268,377)

(255,611)

-0-012,766

(268,377)

(255,611)

(1,039,704)

234,568

63,830

(536,754)

(1,278,058)

629,863

419,909

2,099,544

(383,417)

-011,246

(67,126)

(439,297)

(383,417)

-011,246

(67,126)

(439,297)

(255,612)

-07,497

(44,751)

(292,866)

(255,612)

-07,497

(44,751)

(292,866)

(1,278,058)

-037,486

(223,754)

(1,464,326)

457,122

304,749

1,523,742

(439,296)

88,159

24,201

-0(326,936)

(439,296)

88,159

24,201

-0(326,936)

(292,866)

58,773

16,134

-0(217,959)

(292,866)

58,773

16,134

-0(217,959)

(1,464,324)

293,864

80,670

-0(1,089,790)

691,441

691,442

460,961

2,304,805

(326,296)

-0-

(326,936)

-0-

(217,959)

-0-

(217,960)

-0-

(1,089,151)

-0-

- 8 Partner’s share of net book income (loss)

69,265

46,177

230,884

Withdrawals and distributions

(255,431)

(170,287)

(851,436)

Capital account at end of year

(512,462)

(513,106)

(342,070)

(342,071) (1,709,709)

1995

Partner’s share of liabilities1

593,699

593,698

395,799

1,978,995

Analysis of partner’s capital account:

Capital account at beginning of year

(513,102)

(342,070)

(342,071) (1,710,345)

Capital contributed during year

20,240

13,494

67,468

Partner’s share of net book income (loss)

(75,354)

(75,355)

(50,236)

(251,181)

Withdrawals and distributions

-0-0-0-0-0Capital account at end of year

(568,216)

(568,217)

(378,812)

(378,813) (1,894,058)

1996

Partner’s share of liabilities1

554,358

554,357

369,571

1,847,857

Analysis of partner’s capital account:

Capital account at beginning of year

(568,216)

(568,217)

(378,812)

(378,813) (1,894,058)

Capital contributed during year

-0-0-0-0-0Partner’s share of net book income (loss)

58,559

39,039

195,196

Withdrawals and distributions

(209,266)

(139,511)

(139,510)

(697,553)

Capital account at end of year

(718,923)

(718,924)

(479,284)

(479,284) (2,396,415)

1997

Partner’s share of liabilities1

551,278

367,518

1,837,592

Analysis of partner’s capital account:

Capital account at beginning of year

(718,923)

(718,924)

(479,284)

(479,284) (2,396,415)

Capital contributed during year

-0-0-0-0-0Partner’s share of net book income (loss)

45,089

45,087

30,059

150,294

Withdrawals and distributions

(4,673)

(3,116)

(15,578)

Capital account at end of year

(678,507)

(678,510)

(452,341)

(452,341) (2,261,699)

The partners’ shares of liabilities reflect only shares of long-term debt as shown on the

balance sheets on the Bitker partnership’s returns.

- 9 None of the Bitker partnership’s Forms 1065 for years before

1992 showed balance sheets.

The balance sheets reported on the

1992-97 Forms 1065 show assets, liabilities, and partners’ capital

at yearend for 1991-97 as follows (discrepancies attributable to

rounding):

- 10 -

Assets:

Cash

Other current assets

Buildings & other depreciable assets

Less accumulated depreciation

Total assets

Liabilities & capital:

Short-term mortgages, notes, bonds

Long-term mortgages, notes, bonds

Partners’ capital accounts

Total liabilities & capital

Assets:

Cash

Other current assets

Buildings & other depreciable assets

Less accumulated depreciation

Total assets

Liabilities & capital:

Short-term mortgages, notes, bonds

Long-term mortgages, notes, bonds

Partners’ capital accounts

Total liabilities & capital

1991

1992

1993

1994

$70,073

154,635

1,389,587

(1,032,382)

581,913

$23,230

99,990

1,625,901

(1,113,910)

635,220

$22,089

57,730

1,466,600

(1,112,469)

433,950

$4,000

144,000

1,678,611

(1,232,151)

594,460

1,859,971

-0(1,278,058)

581,913

2,099,544

-0(1,464,324)

635,220

1,523,741

-0(1,089,791)

433,950

692,861

1,611,944

(1,710,345)

594,460

1995

1996

1997

128,593

533,485

1,661,845

(1,299,147)

1,024,776

85,057

137,815

1,635,270

(1,367,442)

490,700

29,964

102,530

1,930,251

(1,453,207)

609,538

939,839

1,978,995

(1,894,058)

1,024,776

1,039,258

1,847,857

(2,396,415)

490,700

1,033,645

1,837,592

(2,261,699)

609,538

- 11 Of the $939,839 of short-term debt and $1,978,995 of long-term

debt reported on the 1995 Form 1065, $205,263 of short-term debt

and $756,759 of long-term debt were owed by petitioners in their

individual capacities.

the

1996

Form

1065,

the

Bitker

partnership

reported

ordinary income of $132,754 that was attributable to its farming

activity.

Bitker

On the 1996 Schedule F, Profit or Loss From Farming, the

partnership

$1,983,752

reported

expenses.

$2,116,506

The

expenses

gross

included,

income

inter

and

alia,

$236,390 for rent or lease of land, animals, etc., $92,811 for

depreciation, and $223,411 for interest.

the

1997

Form

1065,

the

Bitker

partnership

reported

ordinary income of $150,255 that was attributable to its farming

activity.

On the 1997 Schedule F, the Bitker partnership reported

$2,223,960 of gross income and $2,073,705 total expenses, which

expenses included, inter alia, $141,072 for rent or lease of land,

animals, etc., $85,267 for depreciation, and $211,622 for interest.

Each year on their Forms 1040, petitioners reported the income

reflected on their Schedules K-1 from the Bitker partnership.

their 1996 Forms 1040, in addition to the income from the Bitker

partnership, petitioners reported other income from rental real

estate on Schedules E.

On their 1996 Form 1040, Curtis and Lynn

Bitker reported $80,000 of rental income from farmland in Polk

County, Minnesota.

On their 1996 Form 1040, Jerry and Coleen

- 12 Bitker reported $80,000 of rental income from two parcels of

farmland in Norman County, Minnesota.

Petitioners did not report

any income from rental real estate on their 1997 Forms 1040.

The Notices of Deficiency

In September 1998, an agent of respondent began an examination

the

Bitker

partnership’s

1996

and

petitioners’ 1996 and 1997 Forms 1040.

1997

Forms

1065

and

Mr. Mostoller represented

both the Bitker partnership and petitioners during the examination.

The agent requested that petitioners extend the period for

assessment of tax for 1996 and 1997.

They declined to do so.

a consequence, petitioners did not have an opportunity to have the

proposed changes for 1996 and 1997 reviewed by the Appeals Office

of the Internal Revenue Service.

The agent calculated that, as of December 31, 1995, the

partners had negative capital accounts totaling $1,144,343 and the

Bitker partnership had short-term debt of $734,576 and long-term

debt of $1,222,236.

The agent determined that (1) for 1996 the

Bitker partnership had a profit of $334,263, interest income of

$12, and a short-term capital gain of $50,234 and (2) for 1997 it

had a profit of $260,411 and interest income of $39.

The agent

also determined that the following amounts constituted personal

expenses of petitioners and that the Bitker partnership’s payment

of the expenses constituted distributions by the partnership to the

partners (discrepancies attributable to rounding):

- 13 -

1996

Payments on land

Repairs

Supplies

Depreciation

Utilities

Medical insurance

Total

1997

Payments on land

Repairs

Supplies

Depreciation

Utilities

Medical insurance

Total

Curtis

Jerry

Lynn

Coleen

Total

$121,347

2,723

102

296

734

1,780

126,982

$121,347

2,723

102

296

734

1,780

126,982

-0$1,816

197

490

1,187

3,758

-0$1,816

197

490

1,187

3,758

$242,694

9,078

340

986

2,448

5,934

261,480

64,494

212

407

277

708

1,304

67,402

64,494

212

407

277

708

1,304

67,402

-0141

271

184

472

870

1,938

-0141

271

184

472

870

1,938

128,988

706

1,356

922

2,360

4,348

138,680

The agent reclassified the depreciation, as well as the

interest paid by the Bitker partnership on petitioners’ personal

mortgages on their farmland (the mortgages are on land that the

partnership farms), as rental expenses on petitioners’ Schedules E.

Respondent issued notices of deficiency to petitioners for

1996 and 1997.

The statements of changes attached to the notices

reflect the following adjustments:

Curtis & Lynn Bitker

Capital gain or loss

Exemptions

Itemized deductions

K-1 Ray Bitker & Sons (C)

K-1 Ray Bitker & Sons (L)

Schedule E rental expense

Schedule F Curtis

Schedule F Lynn

SE AGI adjustment

Self-employ health

Total adjustments

12/31/96

12/31/97

$473,015

14,076

-60,453

40,302

(101,453)

(947)

(2,645)

221

(1,762)

481,260

$89,312

1,590

2,171

33,046

22,031

(25,000)

45,387

-(5,332)

(1,619)

161,586

- 14 Jerry & Coleen Bitker

Capital gain or loss

Exemptions

Itemized deductions

K-1 Ray Bitker & Sons (C)

K-1 Ray Bitker & Sons (J)

Schedule E rental

Schedule F Coleen

Schedule F Jerry

SE AGI adjustment

Self-employ health

Standard deduction

Total adjustments

12/31/96

$473,015

5,100

6,770

40,302

60,453

(101,597)

(1,032)

36,545

(2,542)

(2,241)

(6,700)

508,073

12/31/97

$89,312

1,060

2,535

22,031

33,047

(25,000)

–

33,770

(4,511)

(1,953)

–

150,291

The explanations attached to the notices of deficiency state

that the income from the Bitker partnership should be increased

and

“We

have

adjusted

partnership

return,

adjustments

deducted on

Schedule

activity.

These

your

which

Schedules

accordance

has

also

were

explained

that

expenses

return

were

are

been

the

examined.”3

The

were

attributable

allowed

with

“Expenses

Schedule

the

E.”

rental

The

adjustments to the Schedule E rental expenses were determined to be

“Rental expenses, which you deducted elsewhere, are allowed as

rental expenses.

Losses are limited due to passive loss rules.”

The explanations attached to the notices of deficiency state

that adjustments were made with respect to capital gain or loss

because “Amounts distributed by partnership, which are in excess of

The examination report showing adjustments resulting from

the examination of the Bitker partnership returns was not attached

to the notices of deficiency. The notices of deficiency do not

otherwise show or explain the adjustments made to the partnership

returns.

- 15 the partners’ bases, have resulted in a capital gain.

3 to show you how we figured the gain.”

See Exhibit

Exhibit 3 computes the

gain as follows:

12/31/96

12/31/97

Curtis & Lynn Bitker

Short-term capital gain or loss

Short-term capital loss carryover

Net short-term capital gain or

$506,139

-0506,139

$87,801

-087,801

Long-term capital gain or loss

Long-term capital loss carryover

Net long-term gain or loss

7,378

-07,378

6,238

-06,238

Net capital gain or loss

Capital loss limitation

Capital gain or loss as corrected

Capital gain or loss per return

Adjustment to income

513,517

-0513,517

40,501

473,015

94,039

-094,039

4,727

89,312

Jerry & Coleen Bitker

Short-term capital gain or loss

Short-term capital loss carryover

Net short-term capital gain or

504,634

-0504,634

89,312

-089,312

Long-term capital gain or loss

Long-term capital loss carryover

Net long-term gain or loss

9,634

-09,634

10,521

-010,521

Net capital gain or loss

Capital loss limitation

Capital gain or loss as corrected

Capital gain or loss per return

Adjustment to income

514,268

-0514,268

41,253

473,015

99,833

-099,833

10,521

89,312

- 16 OPINION

Burden of Proof: Rule 142(a); Sections 7522 and 7491

As a general rule, the Commissioner’s determinations in a

notice of deficiency are presumed correct, and the burden is on the

taxpayer to prove otherwise.

U.S. 111, 115 (1933).

Rule 142(a); Welch v. Helvering, 290

However, this rule does not apply for new

matters raised by the Commissioner after the issuance of the notice

deficiency.

Rule

142(a).

circumstances,

the

Commissioner.

See secs. 7522, 7491.4

burden

proof

addition,

under

production

certain

the

Section 7522

Section 7522 requires a notice of deficiency to “describe the

basis” for the tax deficiency.

In some situations, this Court has

held that failure to describe the basis for the tax deficiency in

the notice of deficiency is analogous to the raising of a new

matter under Rule 142(a).

Shea v. Commissioner, 112 T.C. 183, 197

(1999); Wayne Bolt & Nut Co. v. Commissioner, 93 T.C. 500, 507

(1989); Estate of Ballantyne v. Commissioner, T.C. Memo. 2002-160.

In this regard, we stated that a new matter is raised when the

basis or theory upon which the Commissioner relies is not stated or

Sec. 7491 applies to court proceedings arising in

connection with examinations beginning after July 22, 1998.

Internal Revenue Service Restructuring and Reform Act of 1998, Pub.

L. 105-206, sec. 3001(a), 112 Stat. 726.

In this case, the

examination of petitioners’ returns began after July 22, 1998.

Accordingly, sec. 7491 is applicable to this case.

- 17 described in the notice of deficiency and the new theory or basis

requires the presentation of different evidence. Wayne Bolt & Nut

Co. v. Commissioner, supra at 507.

In such a situation, the burden

of proof is placed on the Commissioner with respect to that issue.

Id.

The adjustments to petitioners’ income were made primarily on

the

basis

adjustments

the

income

partnership tax returns for 1996 and 1997.

reported

Bitker

Knowledge of the

specific adjustments to the income of Bitker partnership for the

years

issue

necessary

resolve

the

correctness

respondent’s determinations.

Petitioners assert that, because the notices of deficiency did

not include a copy of the examination report for the Bitker

partnership or otherwise specify the adjustments to its income,

respondent did not adequately describe the basis for, or explain,

the

adjustments

the

notices

deficiency.

Petitioners

conclude, therefore, that the burden is on respondent pursuant to

section 7522 and Rule 142(a).

We agree that it would have been helpful if respondent either

had

attached

copy

the

examination

report

showing

the

adjustments to partnership income to the notices of deficiency or

had included the computations and adjustments from the Bitker

partnership in the explanations of the adjustments.

See, e.g.,

Brodsky v. Commissioner, T.C. Memo. 2001-240 (each notice of

- 18 deficiency included schedules that listed for each of the years at

issue the Commissioner’s position regarding the sources of the

deposits into the taxpayer’s accounts during each year and the

total amount of the deposits during each year from each source).

But we do not find respondent’s failure to do so in this case

constitutes the raising of new matter.

The purpose of section 7522 is to give the taxpayer notice of

the Commissioner’s basis for determining a deficiency.

Commissioner, supra at 196.

Shea v.

In the situation before us, Mr.

Mostoller represented petitioners during the examination of their

returns, as well as the examination of the Bitker partnership

returns, and he had a copy of the examination report related to the

partnership returns.

The notices of deficiency, in conjunction

with the partnership examination report to which petitioners had

access through Mr. Mostoller, gave petitioners sufficient notice of

respondent’s basis for determining the deficiencies.

Under these

circumstances, we are satisfied that the notices of deficiency

sufficiently described the basis of the deficiencies within the

meaning of section 7522.

Section 7491

Penalties

Under section 7491(c), the Commissioner has the burden of

production with respect to an individual’s liability for any

penalty.

Respondent acknowledges having the burden of production

- 19 with

respect

the

accuracy-related

penalties

under

section

6662(a).

Factual Issues

Pursuant to the general rule of section 7491(a)(1), if the

taxpayer introduces credible evidence with respect to any factual

issue relevant to ascertaining the taxpayer’s liability for income

tax, the Commissioner bears the burden of proof with respect to

that issue.

The preceding rule applies, however, only if the

taxpayer has: (1) Complied with requirements under the Internal

Revenue Code to substantiate any item; (2) maintained all records

required by the Internal Revenue Code; and (3) cooperated with

reasonable requests by the Secretary for information, documents,

and meetings.

proving

that

Sec. 7491(a)(2).

these

requirements

Taxpayers bear the burden of

have

been

met.

Snyder

Commissioner, T.C. Memo. 2001-255 (citing H. Conf. Rept. 105-599,

at 240-241 (1998), 1998-3 C.B. 747, 994-995).

Respondent contends that the burden of proof remains on

petitioners with respect to all factual issues in this case because

petitioners failed to comply with the substantiation requirements,

failed to maintain all records required by the Internal Revenue

Code,

and

failed

cooperate

with

reasonable

requests

for

information and documents.

In this case, there are multiple factual issues relevant to

determining petitioners’ tax liabilities. We will define those

- 20 factual issues

and apply section 7491(a) to each on the basis of

the circumstances involved.

II.

Factual Issues in This Case

Respondent determined deficiencies in petitioners’ Federal

income

taxes

and

self-employment

taxes.

The

adjustments

petitioners’ income resulted from adjustments made to the income of

the Bitker partnership as reported on its tax returns for 1996 and

1997 and from a determination that it made distributions to the

partners.

For purposes of Federal income tax liability, a partnership is

not

taxed

the

entity

level.

Sec.

701.

Instead,

the

partnership’s income is passed through to its partners, and each

partner is individually taxed on his/her distributive share of

partnership income.

individual’s

Secs. 701-704, 761(a).

self-employment

income

subject

self-employment tax in addition to Federal income tax.

Sec. 1401.

Subject to exclusions not relevant to this case, self-employment

income means net earnings from self-employment. Sec. 1402(b). Net

earnings from self-employment include, inter alia, an individual’s

distributive share, whether or not distributed, of income or loss

(as described in section 702(a)(8)) from any trade or business

carried on by a partnership in which the individual is a partner.

Sec. 1402(a).

- 21 A.

Whether Payments Made by the Bitker Partnership on

Indebtedness Owed by Petitioners Are Rental Expenses of

the Bitker Partnership or Constructive Distributions to

Petitioners From the Bitker Partnership

The Bitker partnership claimed a deduction for interest it

paid

mortgages

against

petitioners’

farmland.

Respondent

disallowed the deduction. That disallowance resulted in increases

in petitioners’ distributive shares of partnership farming income,

which is reported on Schedule F.

Respondent determined that the interest on the mortgages

represented

petitioners’

individual

partnership expenses) reportable as

expenses

(as

opposed

rental expenses on Schedule E

of petitioners’ returns and that the deductibility of that interest

subject

the

passive

adjustments resulted in

loss

rules

section

469.

Those

increases in petitioners’ self-employment

tax. The parties agree that the interest payments totaled $242,964

in 1996 and $128,988 in 1997 and that petitioner husbands each

constructively received half of each year’s payment.

Moreover,

petitioners concede the reclassification of the claimed Schedule F

interest expenses on the Bitker partnership’s returns as Schedule

rental

expenses

petitioners’

returns;

further,

they

acknowledge that the losses from their rental real estate activity

are subject

the

passive

loss

limitations

section

469.

Petitioners contend, however, that the principal and interest paid

by the Bitker partnership should be treated as payments by it for

use of petitioners’ land.

In effect, petitioners are asserting

- 22 that

the

payments

are

rental

income

petitioners

and

additional rental expense of the Bitker partnership.

Payments a partner receives from a partnership generally fall

into one of three categories.

First, a partner may receive

payments representing distributions of his/her distributive share

of partnership income.

See sec. 731.

Second, a partner may

receive payments in circumstances where he/she is not treated as a

partner.

Sec.

707(a).

And

third,

partner

may

receive

guaranteed payments for services or use of capital that do not

represent distributions of partnership income.

Sec. 707(c).

Payments made to a partner either in his capacity other than

as a partner under section 707(a) or as guaranteed payments under

section 707(c) must satisfy the requirements of section 162(a)

before such payments may be deducted by the partnership.

Cagle v.

Commissioner, 63 T.C. 86, 91, 95 (1974) (no deduction is allowed if

the payment by the partnership to a partner constitutes a capital

expenditure), affd. 539 F.2d 409 (5th Cir. 1976).

Section 1.707-1(a), Income Tax Regs., provides in part:

Where a partner retains the ownership of property but

allows the partnership to use such separately owned

property for partnership purposes (for example, to obtain

credit or to secure firm creditors by guaranty, pledge,

or other agreement), the transaction is treated as one

between partnership and a partner not acting in his

capacity as a partner.

Here, petitioners retained ownership of their farmland but

allowed the Bitker partnership to use the land in connection with

- 23 its farming activity.

Pursuant to section 707(a), this type of

transaction is treated as one between the Bitker partnership and

petitioners acting other than in their capacity as partners.

Consequently,

payments

made

petitioners

partnership for use of the farmland could constitute

the

Bitker

ordinary and

necessary rental expenses incurred in the conduct of its trade or

business that are deductible under section 162.

Petitioners maintain that the Bitker partnership’s payments of

principal and interest on petitioners’ land mortgages should be

treated as payments of land rent.

Petitioners, however, have

offered no evidence, testimonial or otherwise, that (a) the Bitker

partnership made the payments as rent for such use or (b) the

payments represented fair rental value.

Moreover, the record is

silent as to the number of acres used by the Bitker partnership.

Simply stated, petitioners have failed to provide any information

or substantiation that would permit us to estimate the allowable

deductions as permitted under Cohan v. Commissioner, 39 F.2d 540,

543-544 (2d Cir. 1930).

742-743 (1985).

See Vanicek v. Commissioner, 85 T.C. 731,

Since petitioners have failed to provide evidence

on the factual issue as to the amount of rent, if any, paid by the

Bitker partnership for use of the land, section 7491(a) does not

place the burden of proof on respondent with respect to this issue.

Accordingly, in computing petitioners’ tax liabilities, (1)

petitioners’ shares of income from the Bitker partnership will not

- 24 be reduced for rent of the farmland, (2) petitioners’ income from

their rental real estate activity will not be increased for such

rent,

and

(3)

petitioners’

distributions

from

the

Bitker

partnership will include the partnership’s payments of petitioners’

personal debt.

Whether Distributions Petitioners Received From the

Bitker Partnership in 1996 and 1997 Exceeded Their Bases

in Their Partnership Interests

Section 731(a) sets forth the circumstances under which a

partner recognizes gain or loss from partnership distributions. In

the case of a distribution by a partnership to a partner, gain is

recognized only to the extent that the money (including marketable

securities) distributed exceeds the adjusted basis of a partner’s

interest in the partnership immediately before the distribution.

Sec. 731(a)(1); Jacobson v. Commissioner, 96 T.C. 577, 584 (1991),

affd. 963 F.2d 218 (8th Cir. 1992).

Any gain recognized under

section 731(a) is considered gain from the sale or exchange of the

partnership interest of the distributee partner.

Sec. 731(a);

P.D.B. Sports, Ltd. v. Commissioner, 109 T.C. 423, 441 (1997).

the case of a sale or exchange of an interest in a partnership,

gain recognized to the transferor partner is generally treated as

gain from the sale or exchange of a capital asset.

Sec. 741;

Colonnade Condo., Inc. v. Commissioner, 91 T.C. 793, 814 (1988).

Section 705(a) states a general rule for determining the

adjusted basis of a partner’s interest.

In relevant part, section

- 25 705(a) provides that the adjusted basis of a partner’s interest in

partnership

(relating

the

basis

contributions

determined

under

partnership)

section

7225

section

7426

(relating to transfers of partnership interests) (1) increased by

the partner’s distributive share of partnership income for the

current and prior years and (2) decreased (but not below zero) by

the amount of distributions from the partnership under section 7337

and by the partner’s distributive share of partnership losses for

the current and prior years.

Sec. 722 provides that the basis of a partnership

interest acquired by contribution of property, including money, is

“the amount of such money and the adjusted basis of such property

to the contributing partner at the time of the contribution”. For

purposes of sec. 722, a contribution of money includes: “Any

increase in a partner’s share of the liabilities of a partnership,

or any increase in a partner’s individual liabilities by reason of

the assumption by such partner of partnership liabilities”. Sec.

752(a).

Sec. 742 provides: “The basis of an interest in a

partnership acquired other than by contribution shall be determined

under part II of subchapter O (sec. 1011 and following).”

general, the basis of property acquired by gift is the same as it

was in the hands of the donor.

Sec. 1015.

For purposes of

determining loss, however, if that basis is greater than the fair

market value of the property at the time of the gift, then the

basis is the fair market value at the time of the gift. Id.

In the case of a distribution by a partnership to a

partner other than in liquidation of a partner’s interest, the

adjusted basis of the partner is reduced by the amount of money

distributed to that partner. Sec. 733. Additionally, any decrease

in a partner’s share of the liabilities of a partnership is

considered a distribution of money to the partner by the

partnership. Sec. 752(b).

- 26 Section 705(b) grants the Secretary the authority to prescribe

regulations under which the adjusted basis of a partner’s interest

in a partnership may be determined by reference to the partner’s

proportionate share of the adjusted basis of partnership property

upon a termination of the partnership. The regulations promulgated

to implement this section (found in section 1.705-1(b), Income Tax

Regs.) provide that an alternative method (the alternative rule)

may be used in circumstances where (a) a partner cannot practicably

apply the general rule set forth in section 705(a) and section

1.705-1(a), Income Tax Regs., or (b) from a consideration of all

the facts, the Commissioner reasonably concludes that the result

will not vary substantially from the result obtainable under the

general rule.

Sec. 1.705-1(b), Income Tax Regs.

Where the

alternative rule is used, certain adjustments may be necessary to

reflect discrepancies arising as a result of contributed property,

transfers of partnership interests, or distributions of property to

the partners.

Id. Petitioners maintain that their bases should be

determined under the alternative rule.

Respondent asserts that petitioner wives’ bases in their

partnership interests can be determined under the general rule of

section 705(a) from their Schedules K-1 for 1991-97.

On the other

hand, petitioners maintain that petitioner wives’ bases should be

determined under the alternative rule.

Respondent posits that,

since

their

petitioner

wives

neither

paid

husbands

for

the

- 27 interests nor contributed any property to the Bitker partnership,

the bases

their

partnership

interests

respective shares of partnership debt.

are

equal

their

We disagree.

The 20-percent interests that petitioner wives acquired in

1991 included 20-percent interests in the Bitker partnership’s

existing capital--property interests that had been owned by their

husbands at the time the wives became partners.

Under Minnesota

law, a presumption exists that money or property transferred by a

husband to his wife (or a parent to his/her child) is a gift.

State v. One Oldsmobile Two-Door Sedan, 35 N.W.2d 525 (Minn. 1948);

Stahn v. Stahn, 256 N.W. 137 (Minn. 1934); Jenning v. Rohde, 109

N.W. 597 (Minn. 1906); Kiecker v. Estate of Kiecker, 404 N.W.2d 881

(Minn. Ct. App. 1987); see also Matarese v. Commissioner, T.C.

Memo. 1975-184.

Here, the facts show that petitioner wives paid nothing for

their respective 20-percent interests in the Bitker partnership.

conclude,

therefore,

that

petitioner

wives

acquired

their

interests in the Bitker partnership as gifts from their husbands.

Consequently,

pursuant

section

1015(a),

for

purposes

determining gain, the basis of each wife’s 20-percent interest was

two-fifths of her husband’s basis in his partnership interest.

This conclusion is supported by the fact that the Schedules K-1 for

1991 reflect that petitioner wives each held a 20-percent interest

for the entire year and that petitioner wives were each treated as

- 28 partners of the Bitker partnership for the entire year.

Moreover,

petitioner wives each reported (on their respective individual

income tax returns) 20 percent of the partnership income and

deductions for 1991.

The 1991 Schedules K-1 do not accurately

reflect the partners’ capital accounts--the beginning year negative

capital

accounts

shown

petitioner

husbands’

Schedules

K-1

reflect their 50-percent interests before gifts to their wives, not

their 30-percent interests following the gifts.

Moreover, the

reported contributions from petitioner husbands to the Bitker

partnership, as well as the distributions to petitioner wives were

erroneous--the numbers used were “plugged in” in by Mr. Mostoller

to account for the changes in ownership.

Mr. Mostoller’s approach

to reporting the partners’ capital accounts, contributions, and

distributions for 1991 was not correct.

The partners’ capital

accounts for 1991 are more accurately reflected as follows:

- 29 Curtis

1991

Analysis of partner’s capital account

Capital account at beginning of year

($311,911)

Capital contributed during year

Partner’s share of net book income (loss)

19,149

Distributions

(90,656)

Capital account at end of year

(383,418)

Partner’s share of liabilities

557,991

Jerry

Lynn

Coleen

Total

($311,911)

($207,941)

($207,941) ($1,039,704)

19,149

(90,656)

(383,418)

557,991

12,766

(60,436)

(255,611)

371,994

12,766

(60,436)

(255,611)

371,994

63,830

(302,184)

(1,278,058)

1,859,970

- 30 Respondent argues on brief that, pursuant to the principle

known as duty of consistency, petitioners are bound as to the

amounts of the capital accounts and distributions reported on the

1991 return.

We disagree.

A taxpayer is under a duty of consistency when:

(1) the taxpayer has made a representation or reported an

item for tax purposes in one year,

(2) the Commissioner has acquiesced in or relied on that fact

for that year, and

(3) the taxpayer desires to change the representation,

previously made, in a later year after the statute of

limitations on assessments bars adjustments for the initial

tax year. * * * [Beltzer v. United States, 495 F.2d 211, 212

(8th Cir. 1974).]

The duty of consistency is an affirmative defense that should be

raised in pleadings before trial.

Sec. 7453; Rule 39; LeFever v.

Commissioner, 100 F.3d 778 (10th Cir. 1996), affg. 103 T.C. 525

(1994).

In the instant case, respondent’s answer contained no

affirmative defenses or any allegation that respondent has relied

upon the capital accounts and distributions reported on the 1991

Schedules K-1. Consequently, because the duty of consistency is an

affirmative defense and was not pleaded by respondent, nor tried by

consent of the parties, it is deemed waived.

Rule 39; Monahan v.

Commissioner, 109 T.C. 235, 250 (1997); Green v. Commissioner, T.C.

Memo. 1998-274

(collateral

estoppel),

affd.

without

published

opinion 201 F.3d 447 (10th Cir. 1999); see also Gustafson v.

Commissioner, 97 T.C. 85, 89-92 (1991) (if an affirmative defense

- 31 is not pleaded, it is deemed waived).

We conclude therefore that

petitioners are not bound by the duty of consistency to the capital

accounts and distributions reported on the 1991 tax return.

The Bitker partnership was formed in 1979. The records of the

partnership do not show the amounts of cash contributions or the

bases in property contributed by petitioner husbands and their

father,

Ray

Bitker,

the

partnership

when

was

formed.

Moreover, a calculation of the distributions made to each partner

each year since its formation cannot be made.

The partnership tax

returns in the record cover only the years 1984-97.

Only the tax

returns

Under

for

1992-97

show

balance

sheets.

these

circumstances, it is appropriate to apply the alternative rule set

forth

establish

section

1.705-1(b),

petitioners’

Income

adjusted

Tax

bases

Regs.,

their

order

partnership

interests.

Regardless

where

the

burden

proof

may

lie,

the

preponderance of the evidence establishes that the distributions

petitioners received in 1996 and 1997 did not exceed their bases in

their partnership interests.

The

parties

agree

that

the

Bitker

partnership had the

following assets and liabilities as of December 31, 1995-97:

- 32 -

Assets:

Cash

Adjusted basis of buildings and

other depreciable assets

Basis of other assets

Farm Services stock

Unit Retains

USWP stock

Total assets

Liabilities:

Short-term debt

Long-term debt

Total liabilities

the

basis

the

12/31/95

12/31/96

12/31/97

$128,593

$85,057

$29,964

362,698

267,828

477,044

134,345

186,834

-812,470

137,815

172,934

-663,634

102,530

151,696

68,333

829,567

734,576

1,222,236

1,956,812

988,477

1,069,820

2,058,297

1,189,635

1,232,633

2,422,268

Bitker

partnership’s

assets

and

liabilities as of the beginning and end of each year at issue (as

agreed to by respondent) and its income (as adjusted during the

examination of the partnership return), the cash distribution to

petitioners (including the deemed distribution for payment of

petitioners’ personal expenses) is $634,830 for 1996 and $458,488

for 1997.

The amounts of the distributions to petitioners are

computed as follows:

Assets:

Cash

Adjusted basis of buildings and

other depreciable assets

Basis of other assets

Farm Services stock

Unit Retains

USWP stock

Total assets

Liabilities:

Short-term debt

Long-term debt

Total liabilities

12/31/95

12/31/96

12/31/97

$128,593

$85,057

$29,964

362,698

267,828

477,044

134,345

186,834

-812,470

137,815

172,934

-663,634

102,530

151,696

68,333

829,567

734,576

1,222,236

1,956,812

988,477

1,069,820

2,058,297

1,189,635

1,232,633

2,422,268

- 33 Partners’ capital

Analysis of partners’ capital:

Net income per books

Distributions

Balance at year end

Beginning year balance

(1,144,342)

(1,394,663)

(1,592,701)

384,509

260,450

(634,830)

(458,488)

(1,394,663) (1,592,701)

(1,144,342) (1,394,663)

In order for the distributions to have exceeded $634,830 for 1996

and $458,488 for 1997, the Bitker partnership would have had to

have depleted its assets, incurred additional debt, or earned more

income.

Under the alternative computation, a partner’s basis is equal

to the partner’s proportionate share of the adjusted basis of

partnership property upon a termination of the partnership.8

That

basis may equal his/her negative capital account plus his/her share

of partnership liabilities.

Long v. Commissioner, 77 T.C. 1045,

1084 (1981) (basis equaled negative capital account plus taxpayer’s

Section 705(a) sets forth the general rule for

determining a partner’s basis in his partnership interest. Any

increase or decrease in a partner’s share of partnership

liabilities is deemed either a cash contribution by the partner to

the partnership or a distribution to the partner by the

partnership. Sec. 752(a) and (b). The partner’s basis in his/her

partnership interest is increased by the amount of the deemed

contribution or reduced by the deemed distribution.

This is not true as to the partner’s capital account, however.

The capital account generally reflects a partner’s equity

investment in the partnership and is not increased by his/her share

of partnership liabilities. Tapper v. Commissioner, T.C. Memo.

1986-597. Thus, it is possible for partners, like petitioners in

this case, to have negative capital accounts while maintaining

positive tax bases in their partnership interest.

Unlike a partner’s basis, which can never be less than zero,

a partner’s capital account will be negative if the sum of the

capital contributions credited to him on the partnership’s books

and his share of “book” profits is less than the sum of the amounts

distributed to him and his share of “book” losses.

- 34 share of partnership liabilities); see also Tapper v. Commissioner,

T.C. Memo. 1986-597; cf. Coleman v. Commissioner, T.C. Memo.

1974-78 (Court refused to apply alternative computation because

taxpayer failed to provide proof of partnership’s asset basis),

affd. 540 F.2d 427 (9th Cir. 1976).

The computation may require

adjustments to reflect “any significant discrepancies arising as a

result of contributed property, transfers of partnership interest,

or distributions of property to partners.” Sec. 1.705-1(b), Income

Tax Regs.

The record contains no evidence that any contributions were

entered on the Bitker partnership’s books at other than their tax

bases.

Nor does the record reflect any differences between the

financial and tax accounting treatment of partnership income or

expense items or partnership losses (before the year in issue) that

were not previously deductible by reason of section 704(d). Nor is

an adjustment required for Ray Bitker’s transfer of his interest in

the Bitker partnership to petitioner husbands in 1989 or for

petitioner husbands’ transfers to petitioner wives in 1991 because

all of those transfers were gifts.

petitioners

are

determined

using

(The respective bases of

transferred

bases

for

the

interests received by gifts. Secs. 742, 1015(a); cf. Tapper v.

Commissioner, supra (adjustment required to reflect retirement of

former partner’s interest in prior year).)

- 35 On

the

basis

the

Bitker

partnership’s

assets

and

liabilities as of the beginning and end of each year at issue as

agreed

respondent,

its

income

adjusted

during

the

examination of the partnership return, and the cash distributions

to petitioners of $634,830 for 1996 and $458,488 for 1997, which

necessarily

included

the

deemed

distribution

for

payment

petitioners’ personal expenses, we conclude that the distributions

did not exceed petitioners’ bases in their partnership interests.

The computations we have used in reaching this conclusion

follows:

are as

- 36 1996

Assets at beginning of year:

Cash

Adjusted basis of buildings and

other depreciable assets

Basis of other assets:

Farm Services stock

Unit Retains

USWP stock

Total assets

Liabilities at beginning of year:

Short-term debt

Long-term debt

Total liabilities

Partners’ capital at beginning of year

Change in liabilities:

Liabilities at beginning of year

Liabilities at year end

Increase (decrease)

Partners’ bases at beginning of year

1996 Income (as adjusted)

Contributions:

Cash/property

Deemed by increase in liabilities

Partners’ bases before distributions

Distributions:

Cash

Deemed by reduction in liabilities

Partners’ bases after distributions

Differences due to rounding.

Total1

Curtis (30%)

Jerry (30%)

Lynn (20%)

Coleen (20%)

$128,593

$38,578

$25,719

362,698

108,809

72,540

134,345

186,834

-812,470

40,304

56,050

-243,741

40,304

56,050

–243,741

26,869

37,367

–162,495

26,869

37,367

-162,495

734,576

1,222,236

1,956,812

(1,144,342)

220,373

366,671

587,044

(343,303)

220,373

366,671

587,044

(343,303)

146,915

244,447

391,362

(228,867)

146,915

244,447

391,362

(228,867)

1,956,812

2,058,297

101,485

812,470

384,509

587,044

617,489

30,445

243,741

115,353

587,044

617,489

30,445

243,741

115,353

391,362

411,659

20,297

162,495

76,902

391,362

411,659

20,297

162,495

76,902

-0101,485

1,298,464

-030,445

389,539

-030,445

389,539

-020,297

259,694

-020,297

259,694

(634,830)

-0663,634

(190,449)

-0199,090

(190,449)

-0199,090

(126,966)

-0132,728

(126,966)

-0132,728

- 37 1997

Assets at beginning year:

Cash

Adjusted basis of buildings and

other depreciable assets

Basis of other assets:

Farm Services stock

Unit Retains

USWP stock

Total assets

Liabilities:

Short-term debt

Long-term debt

Total liabilities

Partners’ capital at beginning of year

Change in liabilities:

Liabilities at beginning of year

Liabilities at year end

Increase (decrease)

Partners’ bases at beginning of year

1997 Income (as adjusted)

Contributions:

Cash/property

Deemed by increase in liabilities

Partners’ bases before distributions

Distributions:

Cash

Deemed by reduction in liabilities

Partners’ bases after distributions

Differences due to rounding.

Total1

Curtis (30%)

Jerry (30%)

Lynn (20%)

Coleen (20%)

$85,057

$25,517

$17,011

267,828

80,348

53,566

137,815

172,934

-663,634

41,345

51,880

-199,090

41,345

51,880

-199,090

27,563

34,587

-132,727

27,563

34,587

-132,727

988,477

1,069,820

2,058,297

(1,394,663)

296,543

320,946

617,489

(418,399)

296,543

320,946

617,489

(418,399)

197,695

213,964

411,659

(278,933)

197,695

213,964

411,659

(278,933)

2,058,297

2,422,268

363,971

663,634

260,450

617,489

726,680

109,191

199,090

78,135

617,489

726,680

109,191

199,090

78,135

411,659

484,454

72,795

132,728

52,090

411,659

484,454

72,795

132,728

52,090

-0363,971

1,288,058

-0109,191

386,416

-0109,191

386,416

-072,795

257,613

-072,795

257,613

(458,488)

-0829,570

(137,546)

-0248,870

(137,546)

-0248,870

(91,698)

-0165,915

(91,698)

-0165,915

- 38 Respondent argues that because petitioners erroneously treated

$962,022 of personal debt as the Bitker partnership’s liabilities,

the adjustment that was made to remove the $962,022 of liabilities

from the

partnership’s

balance

sheet

distribution under section 752(b).

When

partnership

should

treated

as a

We disagree.

assumes

individual

partner’s

liabilities, the assumption of those liabilities results in a

deemed distribution to the partner of the amount assumed by the

partners.

Sec. 752(b).

Conversely, when a partner assumes the

partnership’s liabilities, the assumption of such liability results

in a deemed contribution by the partner to the partnership of the

amount assumed.

Sec. 752(a).

Additionally, any increase or

decrease in a partner’s share of partnership liabilities is deemed

either a cash contribution by the partner to the partnership or a

distribution to the partner by the partnership.

(b).

Sec. 752(a) and

The partner’s basis in his/her partnership interest is

increased by the amount of the deemed contribution or reduced by

the

deemed

distribution.

Secs.

705,

722,

733;

Barron

Commissioner, T.C. Memo. 1992-598; Moore v. Commissioner, T.C.

Memo. 1987-499.

Section 1.752-1(f), Income Tax Regs., provides:

(f) Netting of increases and decreases in liabilities

resulting from same transaction. If, as a result of a

single transaction, a partner incurs both an increase in

the partner’s share of the partnership liabilities (or

the partner’s individual liabilities) and a decrease in

the partner’s share of the partnership liabilities (or

- 39 the partner’s individual liabilities), only the net

decrease is treated as a distribution from the

partnership and only the net increase is treated as a

contribution of money to the partnership.

Section

1.752-1(g),

Income

Tax

Regs.,

provides

the

following

example of the effect of netting:

Example 1. Property contributed subject to a liability;

netting of increase and decrease in partner’s share of

liability. B contributes property with an adjusted basis

of $1,000 to a general partnership in exchange for a

one-third interest in the partnership. At the time of

the contribution, the partnership does not have any

liabilities outstanding and the property is subject to a

recourse debt of $150 and has a fair market value in

excess of $150.

After the contribution, B remains

personally liable to the creditor and none of the other

partners bears any of the economic risk of loss for the

liability under state law or otherwise. Under paragraph

(e) of this section, the partnership is treated as having

assumed the $150 liability. As a result, B’s individual

liabilities decrease by $150. At the same time, however,

B’s share of liabilities of the partnership increases by

$150. Only the net increase or decrease in B’s share of

the liabilities of the partnership and B’s individual

liabilities is taken into account in applying section

752. Because there is no net change, B is not treated as

having contributed money to the partnership or as having

received a distribution of money from the partnership

under paragraph (b) or (c) of this section. Therefore

B’s basis for B’s partnership interest is $1,000 (B’s

basis for the contributed property).

Petitioners were at all times personally liable for the debts

erroneously included as partnership liabilities.

Netting results

in a complete offset (i.e., no change) for the deemed contributions

and

distributions

when

petitioners’

personal

liabilities

are

assumed by the Bitker partnership and when the liabilities are

removed from the partnership.

In essence, the total distributions

- 40 to petitioners in 1996 are unaffected by the adjustment to the

amount of partnership liabilities.

Since we conclude that petitioners had sufficient bases taking

into account only the assets and liabilities agreed to by the

parties, we need not decide other arguments made by petitioners

regarding this issue.

Whether Petitioners Are Liable for The Accuracy-Related

Penalties Under Section 6662(a) for The Years at Issue.

Respondent

contends

that

petitioners

are

liable

for

accuracy-related penalty under section 6662(a). Respondent has the

burden of production under section 7491(c) and must come forward

with evidence sufficient for us to sustain the section 6662(a)

penalty. See Higbee v. Commissioner, 116 T.C. 438, 446-447 (2001);

Emerson v. Commissioner, T.C. Memo. 2003-82.

penalty

pertinent

the

here,

portion

section

6662(a)

underpayment

imposes

20-percent

attributable

negligence or disregard of rules or regulations, sec. 6662(b)(1),

substantial

understatement

tax,

sec.

6662(b)(2).

Negligence includes any failure to make a reasonable attempt to

comply with the provisions of the Internal Revenue Code, including

any failure to keep adequate books and records or to substantiate

items properly.

Regs.

Sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax

An “understatement” is the excess of the amount of tax

required to be shown in the tax return over the amount of tax shown

- 41 in the tax return, sec. 6662(d)(2)(A), and is “substantial” in the

case of an individual if the understatement exceeds the greater of

10 percent of the tax required to be shown or $5,000, sec.

6662(d)(1)(A).

The penalty under section 6662(a) does not apply to any

portion of an understatement of tax if it is shown that there was

reasonable cause for the taxpayer’s position and that the taxpayer

acted in good faith with respect to that portion. Sec. 6664(c)(1).

The determination of whether a taxpayer acted with reasonable cause

and in good faith is made on a case-by-case basis, taking into

account

all

the

pertinent

facts

1.6664-4(b)(1), Income Tax Regs.

and

circumstances.

Sec.

The most important factor is the

extent of the taxpayer’s effort to assess his/her proper tax

liability for the year.

Id.

Reasonable cause requires that the taxpayer exercise ordinary

business care and prudence as to the disputed item.

United States

v. Boyle, 469 U.S. 241 (1985); see also Neonatology Associates,

P.A. v. Commissioner, 115 T.C. 43, 98 (2000), affd. 299 F.3d 221

(3d Cir. 2002).

The good faith reliance on the advice of an

independent, competent professional as to the tax treatment of an

item may meet this requirement.

United States v. Boyle, supra;

sec. 1.6664-4(b), Income Tax Regs.

Whether a taxpayer reasonably

relies on advice of a professional depends on the facts and

circumstances of the case and the law applicable thereto.

Sec.

- 42 1.6664-4(c)(1)(i), Income Tax Regs.

The taxpayer must prove that:

(1) The adviser was a competent professional who had sufficient

expertise to justify reliance, (2) the taxpayer provided necessary

and accurate information to the adviser, and (3) the taxpayer

actually relied in good faith on the adviser's judgment.

Ellwest

Stereo Theatres, Inc. v. Commissioner, T.C. Memo. 1995-610; see

also Rule 142(a)(1).

To show good faith reliance, the taxpayer

must show that the return preparer was supplied with all the

necessary information and the incorrect return was a result of the

preparer’s mistakes.

Pessin v. Commissioner, 59 T.C. 473, 489

(1972); sec. 1.6664-4(c)(1)(i), Income Tax Regs.

In this case, the understatement of tax is attributable to the

disallowance of the Bitker partnership’s deduction of interest on

petitioners’ individual debt on the farmland they owned. We do not

believe that petitioners reasonably relied on Mr. Mostoller with

respect to this disallowance.

The farmland was not shown as an

asset of the Bitker partnership on the partnership return prepared

by Mr. Mostoller. Consequently, we believe Mr. Mostoller knew that

the Bitker partnership did not own any farmland.

Mr. Mostoller verified loan balances by calling Farm Credit

Services. Petitioners have failed to establish, however, that they

furnished Mr. Mostoller with necessary and relevant information to

identify any of the loans as mortgages on their individually owned

farmland.

Moreover, petitioners have failed to show that the

- 43 incorrect treatment of the interest paid on those mortgages was due

to Mr. Mostoller’s mistakes. Accordingly, we hold that petitioners

are liable for the section 6662(a) accuracy-related penalty with

regard to the increases in income tax and self-employment tax

resulting from the disallowance of the deduction claimed by the

Bitker partnership for interest on petitioners’ debt.

To reflect the foregoing and concessions by the parties,

Decisions will be entered

under Rule 155.

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.