In Uncategorized on 04/03/2012 at 18:22

Or, The Case of the Vanishing Note

What is genuine becomes bogus in Roy Zeluck, 2012 T.C. Mem. 98, filed 4/3/12. Roy goes into an oil and gas deal at the urging of his brother Kevin’s old buddy, mass-tortist trial lawyer Weitz. Roy has his accountants suss out the deal, and they say it appears okay.

So Roy ponies up $110K, signs a note to the partnership for $200K, putting up his partnership interest and his rights to distributions as collateral. The note is payable at stated times with stated interest and stated maturity. The partnership agrees to withhold interest and deduct from any liquidating distributions to Roy to pay whatever is due on the note, and Roy is personally liable.

The note is then hocked to a turnkey driller owned by the promoter of the deal, and for one year all the required payments are withheld.

The partnership is supposedly managed by Weitz’s brother-in-law, a CPA with zero oil drilling experience.

In year two, the promoter dissolves the partnership without telling his partners. But distributions keep getting paid, at first with token withholding against the sums due on the note but nowhere near what should be withheld, and then for years without withholding.

IRS blows up the deal and hits Roy with a SNOD, claiming Section 465(e) at-risk requires Roy to recognize the whole $200K as income, as he was no longer at risk from year two onward. IRS doesn’t raise cancellation of debt income, interestingly.

Roy says if I’m not at risk because there is no debt, I never was at risk from day one, so IRS should assert I got the $200K in year one. But everyone agrees that’s a closed year and no fraud asserted, so good night, IRS.

No, says IRS, and Judge Goeke agrees. The note was a genuine debt obligation in year one. Let’s review what is a debt:  written evidence of indebtedness (note duly signed); interest charged and collected per note during year one; fixed and stated dates of repayment; collateral given to secure repayment (partnership interest and right to receive distributions); whether payments were made (and they were in year one, although in years two and beyond payments were minimal); and had borrower (Roy) a reasonable prospect of repaying the loan (Roy testified at trial he didn’t have $200K, but he did have $110K in 2003, and if proper withholding had been taken from his distributions he would have paid 80% of the interest due).

Of course the turnkey driller, to whom the note was hocked, did nothing to collect, even though Roy was getting distributions and was personally liable. Most of the partners never even found out the partnership had been dissolved years before until they got SNODs.

No one demanded payment when the note matured. The contract driller never notified Roy or anyone else that it held the note, or demanded full payment of interest for years. Roy testified at trial he didn’t know who held the note, but no one asked him for money. The note evidenced a genuine debt in year one, but by year two it was a dead letter.

So Roy owes tax on $200K from 2003 onward.

Roy could not have relied on Weitz because Weitz was in the deal himself, was a crony of the promoter, and his brother-in-law supposedly ran the partnership. Besides, Weitz may have been a mass-tortist of high degree, but what he knew about taxation is nowhere stated (yet lawyers can practice in Tax Court with even less knowledge than that).

Roy could not rely on his accountants, although he had given them all the dope when he entered the deal, because he didn’t tell them anything in the year the debt went south, not even that he got a big check from the partnership that year. Moreover, Roy never asked what was going on or tried to find out anything about the deal.

20% accuracy penalty for Roy.


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