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Sunday, April 4, 2021

Income and Credit Card Rebates

I am reading a case so unique that I doubt there is much takeaway taxwise, other than someone beat the IRS.

What gets the story started is automobile rebates back in the mid -70s. The economy was limping along, and car manufacturers wanted to sell cars. Buy a car, get money back from the manufacturer.

To a tax geek, receiving a check in the mail raises the question of whether there is income somewhere.

The overall concept behind taxable income is that one has experienced an accession to wealth. That is how discharge of debt can create income, for example. As one’s debt goes down, one’s wealth increases.

What to do with a car rebate?

The IRS did the obvious thing: it saw a car; it saw payment for a car; and it saw a rebate going back to whoever bought the car. There was no increase in wealth here, it decided. The result was that one paid less for the car.

There are countless variations on the theme. What to do with airline miles, for example?

Our case features Konstantin Anikeev (K). K got himself a Blue Cash American Express credit card. The card had a reward program. American Express would send you money for buying (approved) things with the card.

American Express disallowed certain purchases from the program, however, including:

(1)  Interest charges and fees

(2)  Balance transfers

(3)  Cash advances

(4)  Purchase of traveler’s checks

(5)  Purchase or reloading of prepaid cards

(6)   Purchase of any cash equivalent

I get it. American Express did not want someone to walk the transaction through back to cash.

K noticed something: the program did not address gift cards.

A gift card is just a prepaid card, right? Not quite. A gift card is not redeemable in cash or eligible for deposit into your bank account.

I had not really thought about it.

K did think about.

You know what you can do with a gift card?

You can buy a money order, that’s what. You then deposit the money order in the bank.

Sounds like a lot of work for a couple of bucks.

K went to town. Over the course of a year or so, he and his wife generated rebates of over $300 grand.

K knows how to commit.

Interestingly enough, American Express did not seem to care. 

The IRS however did care. They were going to tax K on his $300 grand. K pointed out that the IRS had provided guidance way back by saying that rebates were not income, and all he received were rebates. Granted, there were more bells and whistles here than a 1978 Chrysler Cordoba, but that did not change anything.


The IRS said nay-nay. The guidance they put out back in the 70s involved a product or service. That product or service had a cost, and that cost could then be reduced to absorb the effect of the rebate. There were no goods and services with K’s scheme. There was nothing to “absorb” the rebate.

Off they went to Tax Court.

There is a tax subtlety that we need to point out.

The IRS could have argued that the exchange of the gift card for a money order was a taxable event. Since the cost of the gift card had been adjusted down by the rebate K received (meaning the cost was less than a dollar-on-a-dollar), there would be a gain upon the exchange.

It is a formidable argument.

That is not what the IRS did. They instead argued that K had an income recognition event when he bought the gift card.

Huh? How?

Because he intended to ….

The Court was having none of this argument.

The Court reminded the IRS that gift cards are a product. The card has a uniform product code that the cashier uses to ring up the cost. It is a product, just like a car. The IRS was upset because it got gamed. It did not like the result, but that did not give the IRS leash to arbitrarily look down the road and back-up the tax truck when it did not like the destination. The IRS should tighten its rules.

Here is the Court:

These holdings are based on the unique circumstances of this case. We hope that respondent polices the IRS policy in the future in regulations or in public pronouncements rather than relying on piecemeal litigation.”

K won. He and his wife had tax-free cash.

BTW, K did all this with a card whose credit limit was $35 grand. I am REALLY curious how much time they put into this.

Our case this time was Anikeev v Commissioner, TC Memo 2012-23.

Tuesday, March 23, 2021

When Is Divorce A Tax-Deductible Theft?

 

I am reading a case involving tax consequences from a divorce.

More specifically, the (ex) wife trying to deduct $2.5 million as a theft loss.

That is a little different.

He and she got married in 1987. Husband (Bruno) lifted a successful career in the financial sector, and by 2005 was earning over $2 million annually.

There was an affair.

There was a divorce.

The Court ordered an equitable distribution of marital properties.

That did not seem to impress Bruno, who transferred no marital properties. The court held him in contempt, ordered him to pay interest and yada yada yada.

QUESTION: Can’t a court place someone in jail for contempt?

It appeared that the Court had enough of Bruno, and in 2010 the Court transferred real estate to the (ex) wife, with instructions to sell, keep the first $300 grand and transfer the balance to an escrow account. The property sold for $1.9 million. Th (ex) wife kept all the money, placing nothing in escrow.

Yep, the Court held her in contempt.

By now I am thinking that the contempt of this court is clearly meaningless.

In 2015 our esteemed Bruno filed for bankruptcy. He claimed he was down to his last $2,500.

Which raised the question of where all the money went.

In 2016 the (ex) wife filed suit against Bruno’s new wife and several companies that he, she or both owned.

Methinks we found where the monies went.

She filed a claim against the bankruptcy estate for $3.5 million.

Apparently, there was something to the (ex) wife’s claim, as the bankruptcy trustee filed suit against the new wife, against Bruno’s mother, the Bruno companies previously mentioned and some poor guy Bruno talked to while walking his dog around the neighborhood.

That case was settled in 2019.

Let’s be honest: there is really no likeable character in this story.

The (ex) wife amended her 2015 tax return to report a $2.5 million theft.

That – not surprisingly – created a net operating loss that went springing across tax years like kids at a pre-COVID McDonald’s Playland.

The IRS caught the amended return and said: No way. No theft. No loss. Get outta here.

And that is how we got to the Tax Court.

Establishing the existence of a deductible theft can be tricky in tax law. Yes, one always has the question of what was stolen, how much was it worth and all that. Tax law introduces an additional requirement:

·      One must establish the year in which the loss was sustained.

The blade is in Reg 1.165-1(d):

However, if in the year of discovery there exists a claim for reimbursement to which there is a reasonable prospect of recovery, no portion of the loss with respect to which reimbursement may be received is sustained  .. until the taxable year in which it can be ascertained with reasonable certainty whether or not such reimbursement will be received.”

It is not the “what” that will trip you up; it is the “when.”

There of course some Court guidance over the years, such as:

·      The evaluation should not be made “through the eyes of the ‘incorrigible’ optimist,” or

·      … the “mere possibility or the bare hope of a future development permitting recovery does not bar the deduction of a loss clearly sustained.”

Yep. That is like telling a baseball player to step to the plate against Jacob deGrom and “just swing the bat.”

Thanks for the advice there, pal.

And the Court decided against the (ex) wife.

No one believed Bruno when he filed bankruptcy in 2015 and claimed he was worth only $2,500. The trustee filed suit; the (ex) wife filed suit. Lawsuits were everywhere.

The Court stated that the (ex) wife may well have a theft loss. What she did not have was a theft loss in 2015.

Our case this time for the home gamers was Bruno v Commissioner, T.C. Memo 2020-156.

Sunday, March 14, 2021

Withdrawing A Tax Court Petition

 

We have a case coming up in the Tax Court.

Frankly it should never have gone this far. Much of it was COVID, I suspect. However, some of it was the IRS dropping the ball.

What set this off was someone dying. His employer had a life insurance policy on him. I suspect that this came as a surprise to his employer, who probably thought all along that the employee owned the policy with the employer paying the premiums. This would be a “split dollar” arrangement. The taxation of split dollar plans became trickier in the mid aughts, but these arrangements have been around for a long time. 

The employee died. The company received the proceeds. The company intended for the widow to receive the proceeds. How did the company get the proceeds to the widow?

They botched is what they did.

They tried to correct the botch by amending a Form 1099.

Our client is the widow, and she is being chased by the IRS. I reviewed the history of the transaction, the original and amended 1099, e-mails galore.

I have been trying to contact the IRS on the case. I even reached out to the clerk for Judge Morrison (at the Tax Court) for an assist. She was extremely helpful, but getting a response – or a pulse – from the IRS has been frustrating.

Until this week.

It is amazing how quickly some issues can be resolved if people can just talk.

The IRS understood our argument. They were willing to compromise, except for one thing.

The company never filed the amended 1099 with the IRS.

Explains why the IRS was digging in its heels.

Mind you, we can correct this – now that we know. We could also have corrected this long ago and not involved the Tax Court.

We will never appear before the Court.

Procedure here is important. Both the IRS and we will tell the Court the matter has been settled. The Court will be happy to move on.   

By contrast, what happens if we unilaterally pull out of Tax Court?

Bad things.

The seminal case goes back to 1974.

The IRS came after William Ming. Whatever was going on, the IRS was going after the fraud penalty.

There was back and forth. Mr Ming died. The IRS eventually showed some leeway on the fraud issue.

That caught the estate’s attention.

The estate tried to withdraw its case. They may have wanted a jury, and the Tax Court does not have a jury.

Here is the Court:

It is now settled principle that a taxpayer may not unliterally oust the Tax Court from jurisdiction which, once invoked, remains unimpaired until it decides the controversy.”

There is a Hotel California vibe here: the Tax Court will hold against you should you withdraw. This triggers the legal doctrine of res judicata, and you then cannot relitigate the issue in another court.

You can leave by winning, losing or settling. What you cannot do is walk out.

Our case this time for the at-home tax historians was Estate of Ming 62 T.C. 519.

Friday, March 12, 2021

How Much Paperwork Does the IRS Want?

Sometimes practitioners disagree on how much supporting paperwork – if any – should go with a tax return.

The issue can take on a keener edge when one is working with amended returns or claims for refunds.

COMMENT: For the nerds, an amended return can technically be a claim for refund – if the amended return shows a refund.

It also can vary with the tax issue at play.

I am looking at two cases – the first being the initial hearing and the second the appeal – involving a research tax credit.

The research credit is easier to understand if we think of companies such as Johnson & Johnson or Pfizer. Lab coats, scientific equipment, people wearing safety glasses and so forth. The image screams research.

Mind you, there are accounting and recordkeeping issues that go with this credit.

A routine accounting system would capture functional costs (think payroll, rent, utilities), departmental costs (think auto parts versus auto service at a car dealership) and divisional costs (consumer and industrial, for example). The research credit wants even more detail from the accounting system. It wants detail at the research activity level.

What is a research activity?

You could be an activity. Say that you are an engineer. You work in manufacturing, but a portion of your time is spent on activities that might qualify for the credit. What would be an example? Let’s say improving a product or the process to manufacture that product.  

The accounting system easily captures your payroll as a functional cost.

The system also captures your payroll as a manufacturing cost.

What the system perhaps doesn’t do – at least without upgrades – is break-down your lab time into specific projects, some of which might qualify for the credit and others which might not. Yep, your time sheets going forward are going to be a bear.

Let’s be clear: if you are Pfizer, you likely have tweaked-out your accounting and reporting system to capture 360 degrees of data, including whatever is needed for the research credit. Our discussion here concerns more routine companies.

The Harpers owned a company that specializes in military design build projects. They initially filed returns not claiming a research tax credit.

Now pause and consider what they do.

Chances are that some of what they do has an element of uncertainty: what to, how to do it, what order to do it and so on. Depending upon, that uncertainty might trigger the research credit.

There are four principal requirements to the research credit:

(1)  There must be a reduction in uncertainty about the development or improvement of a product or process.

(2)  That development or improvement in turn involves experimentation – that is, there are different ways to get there from here. The experimentation involves determining which ways work and which ways do not.

(3)  The experimentation must involve hard sciences: engineering, chemistry and so forth. Experimenting with tax law, for example, will not work (sadly).

(4)  The purpose of the activity must be a new or improved product or process: performance, function, quality, reliability, that kind of thing.

The Harpers reviewed what they did and determined that the company had research activities qualifying for the credit. They amended their returns for 2008 and 2010. The credit amount was impressive:

         2008                    $437,632

         2010                    $388,325

The IRS reviewed the amended returns and denied the credit.

Off to Court they went. The first case was in California district court.

The IRS position was both straightforward and cynical:

The claim must set forth in detail each ground upon which a credit or refund is claimed and facts sufficient to apprise the Commissioner of the exact basis thereof.”

Let me rephrase the position: we (the IRS) decide when we have enough facts and in any event the facts you submit are not sufficient to apprise us of anything until we say that they are sufficient.

The district court agreed with the IRS.  The taxpayer was required to establish all facts and details for its refund claim. The IRS said that the taxpayer had not, and the Court said that was all it needed to know.

Wow. Let me think how can this standard can possibly be abused….

The Harpers appealed the case to the 9th Circuit Court of Appeals.

Their argument?

  • The IRS has the right to notice of a claim and its underlying facts so it can make an informed and appropriate determination. This is referred to as the “specificity” requirement.
  • The IRS can always ask one more question. This makes attaching ALL possible paperwork to a claim virtually impossible.
  • In practice, the IRS can review a claim with a taxpayer. One way is to audit the claim, of course. This act is considered a waiver of the specificity requirement.
  • Why would the IRS review a claim and thereby waive anything? Consider the alternative. Tax practitioners would attach so much documentation to the research tax credit that the IRS would have to lease additional storage to house it all.  It is in both parties’ mutual interest to go along and get along.

The Harpers argued that the IRS had waived the specificity requirement.

How did the IRS do this?

By auditing the claim.

The IRS spent four years auditing the amended returns. The Harpers provided over 100,000 pages of supporting documentation. At no point in time did the IRS tell the Harpers that they had not provided ENOUGH documentation.

I am trying to be fair, but I am distressed by the IRS behavior.

It is common professional knowledge that the IRS can always ask for additional information. One can provide it and still get turned down, but the give and take allows the system – the IRS and tax practitioners - to function and not be overwhelmed.

Is that what happened here?

Nope.

The IRS did not go to Court arguing that it had reviewed 100,000 pages of supporting documentation and decided the Harpers did not qualify for the research credit.

The IRS argument was that the Harpers did not meet the specificity requirement – meaning the Harpers did not include enough paperwork.

The Appeals Court called out the IRS. It had waived the specificity requirement by auditing the amended returns.

The Appeals Court sent the case back to the district court. The case should never have been dismissed for the specificity requirement.

The Harpers may win or may lose, but they will have their day in court.

Our case this time for the home gamers was Harper v United States.


Sunday, February 28, 2021

Your 2020 Tax Return and the Stimulus Payments

 

Let’s talk about your 2020 personal tax return and the two stimulus payments that you (may have) received.

The first round of stimulus checks was up to $1,200 for each spouse and $500 for each qualifying child.

The second round was up to $600 for each spouse and qualifying child.

So, if you have two qualifying kids and qualified for the maximum, you would have received $5,800 ($3,400 plus $2,400) between the two rounds.

How do you not qualify for the maximum?

One way is easy: you had too much income.

The second way is nonintuitive: the child was over age 16. A qualifying child means a child under the age of 17. Seems odd to me to exclude a high school senior, but there it is.

Let’s talk about the first non-qualification: income.

Let’s use a married couple with two qualifying children as our example.

The income limit for marrieds is $150,000. Past that point the stimulus check goes away by a nickel on the dollar. The maximum for two spouses is $2,400, so we can calculate this as follows:

                      $2,400 divided by .05 = $ 48,000

                      $150,000 plus 48,000 = $198,000

All right, the stimulus for marrieds burns-out at $198,000, right?

Nope.

Why?

Because of the qualifying children.

Each of the kids adds another $10,000 to the phaseout range.

We have two kids. That means $20,000 added to the $198,000, totaling $218,000 before we burn-out of stimulus altogether.

Are we stilling phasing-out at a nickel on the dollar?

Let’s check.

           $218,000 – 150,000 = $68,000

           $3,400 divided by 68,000 equals $0.05.

Yep, nickel on the dollar.

You received the first stimulus check in April, 2020. Remember that tax returns were automatically extended until July 15, 2020 because of COVID. The odds were extremely good that the IRS was not basing its calculations on your 2019 return, because your 2019 return had not been prepared, much less filed. For most of us, the IRS was looking at our 2018 tax return.

Let’s continue.

You received your second stimulus check very late in December, 2020 or (more likely) January, 2021 – but the income phaseout range was the same.

What did change was the tax year the IRS was looking at. By December, 2020 you would have filed your 2019 tax return (let’s skip paper filings that may not have been processed by then, or we are going to drive ourselves crazy).

If your income went up from 2018 to 2019, you would have climbed the phaseout range. You might have received a first stimulus check, for example, but not qualified for a second one. It could have gone the other way, of course, if your income went down in 2019. 

Now your 2020 tax return lands on my desk and we need to settle-up on the stimulus.

How do we settle-up?

We run through the income phaseout range … again.

Using your 2020 tax return this time.

Did you notice we are doing the calculation three times using income from three different tax years?

Yep, it’s a pain.

Mind you, if you have modest income, I know that you received the maximum stimulus.

Conversely, if you made bank, I know that you received no stimulus.

Fall in between – or have wildly varying income – and I you need to tell me the amount of your stimulus checks.

Let’s go through a quick example, using our married couple with two qualifying children.

Their 2018 adjusted gross income was 201,000.

Here is the first stimulus:

phaseout start

150,000.00

phaseout end

198,000.00

add: 2 children

20,000.00

218,000.00

68,000.00

2018 AGI

201,000.00

51,000.00

First stimulus

2,400.00

1,000.00

3,400.00

times

51,000.00

 =

2,550.00

 

68,000.00

(2,550.00)

850.00

They would have received $850.

Their 2019 adjusted gross income was $320,000.

Way over the income limit. There was no second stimulus.

Their 2020 tax return lands on my desk. Their adjusted gross income is $104,000.

Way below the income limit. Full stimulus.

Two qualifying kids. The maximum over two rounds of stimulus would be $3,400 plus $2,400 = $5,800.

They already received $850 per above.

That means a $4,950 credit on their 2020 individual tax return. I look like a hero.

But why? After all, their 2019 income was over $300 grand – way above the range for receiving any stimulus.

The quirky thing is that the stimulus is based on one’s 2020 tax return. Congress however wanted the money out as fast as possible. The stimulus had an income test, though, so the first option was to do the calculation on one’s 2019 tax return. When that option proved unworkable, the second option was to use 2018. It was messy but quick, and one would settle-up when filing the 2020 tax return.

Congress realized that settling-up could mean repaying some of the stimulus money. Since that somewhat negated the purpose of a stimulus, Congress decided that the gate would only swing one way. If one did not receive enough stimulus, then one could claim the shortfall on the 2020 return. If one was overpaid, well … one got to keep the money. 

It was a win:win.

Not so much for the accountant, though.

Sunday, February 14, 2021

What Does It Mean To File A Return?

 

The IRS generally has three years to examine a return and assess additional taxes after it has been filed.

This can put pressure on whether what was filed is a “return.”

I am looking at a case involving this issue.

Mr Quezada (Q) ran a stonemasonry business. He had a number of people working for him over the years. Like many a contractor, he treated these individuals as subcontractors and not employees.

OK.

He filed Form 1099s.

OK.

Most of these 1099s did not include social security numbers.

Oh oh.

This is a problem. If a payor requests a social security number and an individual refuses to provide it, the tax Code requires the payor to withhold “backup withholding.” The same applies if an individual provides a bogus social security number.

Say that you are supposed to pay someone $1,000 for stone masonry work, but they refuse to provide a social security number.

COMMENT: Let’s be honest: we know what is going on here.

You are required to withhold 24% and send it to the IRS. You should pay the person $860 and send $240 to the IRS.

QUESTION: what are the odds that anyone will ever claim the $240?

FURTHER QUESTION: And how could one, since there is no social security number associated with the $240?

Mr Q was supposed to file the following forms with the IRS:

·      Form 1099

·      Form 1096 (the summary of the 1099s)

·      Form 945 (to remit the $240 in our example)

He filed the first two. He did not file the third as he did not withhold.

Mr Q filed for bankruptcy in 2016. The creditors had a chance to file their claims.

In the spirit of bayoneting the dead, the IRS wanted backup withholding taxes from 2005 onward.

It filed its claim – for over $1.2 million.

QUESTION: how could 2005 (or 2006? or 2007?) still be an open tax year?

The IRS gave its argument:

1.    The liability for backup withholding is reported on Form 945.

2.    Mr Q never filed Form 945.

3.    The statute of limitations never started because Mr Q never filed the return.

The IRS was alluding to the Lane-Wells case.

In Lane-Wells the taxpayer filed one type of corporate tax return rather than another, mostly because it thought that it was the first type and not the other. The distinction meant money to the IRS.

The Supreme Court agreed with the IRS.

The IRS likes to consider Lane-Wells as its trump card in case one does not file a return, unintentionally leaves out a schedule or files the wrong form altogether. The courts have fortunately pushed back on this position.

Mr Q had a problem. He had not filed Form 945. Then again, from his perspective there was no Form 945 to file. He was between a rock and a hard spot.

The Appeals Court hearing Mr Q’s case realized the same thing.

The Court reasoned that the issue was not whether Mr Q filed the “magic” form. Rather, it was whether Mr Q filed a return that:

·      Showed the liability for tax, and

·      Allowed calculation of the amount of tax

Here is the Court:

The IRS could determine that Q[uezada] was liable for backup-withholding taxes by looking at the face of his Forms 1099; if a particular form lacked a TIN, then Q[uezada] was liable for backup withholding taxes applied to the entire amount …”

There is the first test.

For each subcontractor who failed to supply a TIN, the IRS could determine the amount that Q[uezada] should have backup withheld by multiplying the statutory flat rate for backup withholding by the amount Q[uezada] paid the subcontractor.”

There is the second test.

The Court decided that Q had filed returns sufficient to give the IRS a heads-up as to the liability and its amount. The IRS could but did not follow up. Why not? Who knows, but the IRS was time-barred by the statute of limitations.

Our case this time was Quezada v IRS, No 19-51000 (5th Cir. 2020).

Sunday, January 31, 2021

Abandoning A Partnership Interest

I suspect that most taxpayers know that there is a difference between long-term capital gains and ordinary income. Long-term capital gains receive a lower tax rate, incentivizing one to prefer long-terms gains, if at all possible.

Capital losses are not as useful. Capital losses offset capital gains, whether short-term or long-term. If one has net capital losses left over, then one can claim up to $3,000 of such losses to offset non-capital gain income (think your W-2).

That $3,000 number has not changed since I was in school.

And there is an example of a back-door tax increase. Congress has imposed an effective tax increase by not pegging the $3,000 to (at least) the rate of inflation for the last how-many decades. It is the same thing they have done with the threshold amount for the net investment income or the additional Medicare tax. It is an easy way to raise taxes without publicly raising taxes.

I am looking at a case where two brothers owned Edwin Watts Golf. Most of the stores were located on real estate also owned by the brothers, so the brothers owned two things: a golf supply business and the real estate it was housed in.


In 2003 a private equity firm (Wellspring) offered the brothers $93 million for the business. The brothers took the money (so would I), kept the real estate and agreed to certain terms, such as Wellspring having control over any sale of the business. The brothers also received a small partnership position with Wellspring.

Why did they keep the real estate? Because the golf businesses were paying rent, meaning that even more money went their way.

The day eventually came when Wellspring wanted out; that is what private equity does, after all. It was looking at two offers: one was with Dick’s Sporting Goods and the other with Sun Capital.  Dick’s Sporting already had its own stores and would have no need for the existing golf shop locations. The brothers realized that would be catastrophic for the easy-peasy rental income that was coming in, so they threw their weight behind the offer by Sun Capital.

Now, one does not own a private equity firm by being a dummy, so Wellspring wanted something in return for choosing Sun Capital over Dick’s Sporting.

Fine, said the brothers: you can keep our share of the sales proceeds.

The brothers did not run the proposed transaction past their tax advisor. This was unfortunate, as there was a tax trap waiting to spring.  

Generally speaking, the sale or exchange of a partnership interest results in capital gain or loss. The partners received no cash from the sale. Assuming they had basis (that is, money invested) in the partnership, the sale or exchange would have resulted in a capital loss.

Granted, one can use capital losses against capital gains, but that means one needs capital gains.   What if you do not have enough gains? Any gains? We then get back to an obsolete $3,000 per year allowance. Have a big enough loss and one would need the lifespan of a Tolkien elf to use-up the loss.

The brothers’ accountant found out what happened during tax season and well after the fact. He too knew the issue with capital losses. He played a card, in truth the only card he had. Could what happened be reinterpreted as the abandonment of a partnership interest?

There is something you don’t see every day.

Let’s talk about it.

This talk gets us into Code sections, as the reasoning is that one does not have a “sale or exchange” of a partnership interest if one abandons the interest. This gets the tax nerd away from the capital gain/loss requirement of Section 741 and into the more temperate climes of Section 165. One would plan the transaction to get to a more favorable Code section (165) and avoid a less favorable one (741). 

There are hurdles here, though. The first two are generally not a problem, but the third can be brutal.

The first two are as follows:

(1) The taxpayer must show an intent to abandon the interest; and

(2)  The taxpayer must show an affirmative act of abandonment.

This is not particularly hard to do, methinks. I would send a letter to the tax matters or general partner indicating my intent to abandon the interest, and then I would send (to all partners, if possible) a letter that I have in fact abandoned my interest and relinquished all rights and benefits thereunder. This assumes there is no partners’ meeting. If there was a meeting, I would do it there. Heck, I might do both to avoid all doubt.

What is the third hurdle?

There can be no “consideration” on the way out.

Consideration in tax means more than just receiving money. It also includes someone assuming debt you were previously responsible for.

The rule-of-thumb in a general partnership is that the partners are responsible for their allocable share of partnership debt. This is a problem, especially if one is not interested in being liable for any share of any debt. This is how we got to limited partnerships, where the general partner is responsible for the debts and the limited partners are not.

Extrapolating the above, a general partner in a general partnership is going to have issues abandoning a partnership interest if the partnership has debt. The partnership would have to pay-off that debt, refinance the debt from recourse to nonrecourse, or perhaps a partner or group of partners could assume the debt, excluding the partner who wants to abandon.

Yea, the planning can be messy for a general partnership.

It would be less messy for a limited partner in a limited partnership.

Then we have the limited liability companies. (LLCs). Those bad boys have a splash of general partnership, a sprinkling of limited partnership, and they can result in a stew of both rules.

The third plank to the abandonment of a partnership interest can be formidable, depending on how the entity is organized and how the debts are structured. If a partner wants an abandonment, it is more likely than not that pieces on the board have to be moved in order to get there.   

The brothers’ accountant however had no chance to move pieces before Wellspring sold Edwin Watts Golf. He held his breath and prepared tax returns showing the brothers as abandoning their partnership interests. This gave them ordinary losses, meaning that the losses were immediately useful on their tax returns.

The IRS caught it and said “no way.”

There were multiple chapters in the telling of this story, but in the end the Court decided for the IRS.

Why?

Because the brothers had the option of structuring the transaction to obtain the tax result they desired. If they wanted an abandonment, then they should have taken the steps necessary for an abandonment. They did not. There is a long-standing doctrine in the Code that a taxpayer is allowed to structure a transaction anyway he/she wishes, but once structured the taxpayer has to live with the consequences. This doctrine is not tolerant of taxpayer do-overs.

The brothers had a capital and not an ordinary loss. They were limited to capital gains plus $3 grand per year. Yay.

Our case this time for the home gamers was Watts, T.C. Memo 2017-114.