# UNITED STATES TAX COURT

> Briefs, arguments, decisions, and more.

URL: https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3A8015dd89d9be80de

## Record

- **Collection:** Agency decision
- **Document type:** Agency decision

## Text

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

in

petitioners’ Federal income taxes and accuracy-related penalties
under section 6662(a) for 1996 and 1997 as follows:1

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
3.

whether

petitioners

are

liable

for

accuracy-related

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

1

(...continued)
references are to the Tax Court Rules of Practice and Procedure.
2

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

of

facts

and

the

exhibits

attached

thereto

The
are

incorporated herein by this reference.
A.

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)

of

these

cooperatives.

In

most

instances, shares of stock in the cooperatives were issued to
petitioner

husbands

Nonetheless,

(as

petitioners

opposed

to

accounted

the
for

Bitker
their

partnership).

shares

of

the

cooperatives’ income through the Bitker partnership.
B.

The Bitker Partnership’s Forms 1065
Earl Mostoller, a certified public accountant, is a member of

Drees, Riskey

&

Vallager,

Ltd.,

an

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

in

purposes

the

name

were
of

the

made

in

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
of

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

$557,991

$371,994

$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

629,863

419,909

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

457,122

304,749

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

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
69,265
46,177
46,177
230,884
Withdrawals and distributions
(255,431)
(255,431)
(170,287)
(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
395,799
1,978,995
Analysis of partner’s capital account:
Capital account at beginning of year
(513,102)
(513,102)
(342,070)
(342,071) (1,710,345)
Capital contributed during year
20,240
20,240
13,494
13,494
67,468
Partner’s share of net book income (loss)
(75,354)
(75,355)
(50,236)
(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
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
58,559
39,039
39,039
195,196
Withdrawals and distributions
(209,266)
(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
551,278
367,518
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
30,059
150,294
Withdrawals and distributions
(4,673)
(4,673)
(3,116)
(3,116)
(15,578)
Capital account at end of year
(678,507)
(678,510)
(452,341)
(452,341) (2,261,699)
1
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.
On

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

of

reported

expenses.

$2,116,506

The

expenses

of

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.
On

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.

On

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.
C.

The Notices of Deficiency
In September 1998, an agent of respondent began an examination

of

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.

As

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
68
197
490
1,187
3,758

-0$1,816
68
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

to

deducted on

Schedule

activity.

These

your

which

Schedules
F

in

accordance

has

also

were

explained

F
that

expenses

return

were

are

been

on

the

examined.”3

The

as

were

attributable

allowed

with

“Expenses
to

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

3

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
I.

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
of

deficiency.

Rule

142(a).

circumstances,

the

Commissioner.

See secs. 7522, 7491.4

A.

burden

of

In
proof

addition,
or

under

production

is

certain
on

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

4

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

of

adjustments

to

the

income

partnership tax returns for 1996 and 1997.

reported

on

Bitker

Knowledge of the

specific adjustments to the income of Bitker partnership for the
years

at

issue

is

necessary

to

resolve

the

correctness

of

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

in

the

notices

of

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

a

copy

of

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.
B.

Section 7491
1.

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

to

the

accuracy-related

penalties

under

section

6662(a).
2.

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

v.

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

to

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

to

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

at

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.
An

individual’s

Secs. 701-704, 761(a).
self-employment

income

is

subject

self-employment tax in addition to Federal income tax.

to

a

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

on

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

to

rental expenses on Schedule E

of petitioners’ returns and that the deductibility of that interest
is

subject

to

the

passive

adjustments resulted in

loss

rules

of

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
E

rental

expenses

on

petitioners’

returns;

further,

they

acknowledge that the losses from their rental real estate activity
are subject

to

the

passive

loss

limitations

of

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

to

petitioners

and

an

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,

a

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

to

petitioners

by

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.
B.

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).

In

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
a

partnership

(relating

to

is

the

basis

contributions

as
to

determined
a

under

partnership)

or

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.

5

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).
6

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).”
In
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.
7

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

of

their

partnership

interests

respective shares of partnership debt.

are

equal

to

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.
We

conclude,

therefore,

that

petitioner

wives

acquired

their

interests in the Bitker partnership as gifts from their husbands.
Consequently,

pursuant

to

section

1015(a),

for

purposes

of

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

on

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,

to

the

partnership

when

it

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

in

establish

section

1.705-1(b),

petitioners’

Income

adjusted

Tax

bases

Regs.,

in

in

their

order

to

partnership

interests.
Regardless

of

where

the

burden

of

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

On

the

basis

of

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
8

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

of

the

Bitker

partnership’s

assets

and

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

to

by

respondent,

its

income

as

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

of

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
1
Differences due to rounding.

Total1

Curtis (30%)

Jerry (30%)

Lynn (20%)

Coleen (20%)

$128,593

$38,578

$38,578

$25,719

$25,719

362,698

108,809

108,809

72,540

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
1
Differences due to rounding.

Total1

Curtis (30%)

Jerry (30%)

Lynn (20%)

Coleen (20%)

$85,057

$25,517

$25,517

$17,011

$17,011

267,828

80,348

80,348

53,566

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

a

partnership

should

be

treated

as a

We disagree.

assumes

an

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

v.

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.
C.

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

an

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.
As
penalty

pertinent
on

the

here,
portion

section

6662(a)

of

underpayment

an

imposes

a

20-percent

attributable

to

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

a

substantial

understatement

of

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.

---

Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3A8015dd89d9be80de. Public record. Not legal advice.