Unless Your Partner Isn’t Your Partner

Judge Wherry can’t shake John E. Rogers, tax whiz and DADs promoter; see my most recent blogpost “There Goes The Neighborhood”, 9/3/13, where Judge Posner of Seventh Circuit decries Judge Wherry’s whimsy but slugs Mr. Rogers nevertheless. I’ve discussed Mr. Rogers’ multifarious and nefarious doings numerous times.

But today Mr Rogers is playing second fiddle to Mr. Timothy J. Elmes in Sugarloaf Fund LLC, Jetstream Business Limited, Tax Matters Partner, 141 T. C. 4, filed 9/5/13. Tim’s main trust and sub-trust were loaded up with bits and pieces of Mr. Rogers’ Brazilian IOUs, courtesy of Mr Rogers’ creation Sugarloaf, LLC.

Clear? Thought not.

Howbeit, Tim claims a Section 166 bad debt deduction based on the Brazilian paper, which IRS claims is worthless and always was, tosses the deduction and hands Tim a SNOD, which Tim doesn’t petition, so Tim tries to cut in on the Sugarloaf FPAA, claiming he’s an indirect partner of Sugarloaf.

Judge Wherry is very un-whimsical: “This Court has for some time, even predating Mr. Elmes’ attempt to intervene in this case, been concerned as to whether ‘individual U.S. investors who claimed to have purchased ownership interests in the Holding Companies as well as those who acquired beneficial interests in the Sub-Trusts’ had ‘the right to participate in these partnership-level proceedings’. This Court’s order dated April 17, 2012, discussed these issues in some detail and directed the parties to file briefs addressing these issues. Both petitioner and respondent have, in response to the Court’s order, filed briefs addressing these issues. After careful consideration, we have concluded that Mr. Elmes is not a direct or an indirect partner in Sugarloaf within the meaning of section 6226(c) or 6231(a)(2). Consequently, he may not participate in this case, and we will deny his outstanding motions as moot….” 141 T. C. 4, at pp. 3-4.

For more about the April 17, 2012 Order above-cited, see my blogpost “Mr. Rogers Tries Again”, 4/17/12.

So what’s the story with Tim? He’s not a partner, direct or indirect, at least for the year at issue.

Tim has K-1s for the two years subsequent, but can’t produce one for the year at issue. “Nor does Mr. Elmes contend he or his trusts banded together with the Brazilian retailers, Warwick, and Jetstream to jointly conduct, through the Sugarloaf partnership, a common undertaking. Therefore, Mr. Elmes has not demonstrated that either he or the Elmes Sub-Trust was a direct partner of Sugarloaf for 2005. Thus, in order for Mr. Elmes to participate in this case, he must be a ‘person whose income tax liability… * * * is determined in whole or in part by taking into account directly or indirectly partnership items of the partnership.’ Sec. 6231(a)(2)(B).” 141 T. C. 4 at p. 9 (Citations and footnote omitted).

While some are partners for TEFRA purposes, like spouses or common parent of a consolidated group where one subsidiary is a partner, and some are “pass-thru” partners, Tim is none of the above, as he had no interest in Sugarloaf in the year at issue.

Tim’s beef is that his deficiency depends on the value of the Brazilian junk he got from Sugarloaf, so he’s a partner in Sugarloaf.

No, says Judge Wherry, “…if the argument were correct, then any trust to which a partnership transferred assets would be a member of that partnership. We do not believe that a trust is necessarily a partner of a partnership merely because the trust received assets from that partnership, and we do not accept Mr. Elmes’ expansive interpretation of section 6231(a)(2)(B).” 141 T. C. 4, at p. 13.

Tim got assets, not a partnership interest, directly or indirectly. And while it might be nice if the value of the Brazilian junk was determined once for all and for everyone, the IRS need not be consistent unless the statute requires it, and here it doesn’t. Anyway, Tim has no standing in the Sugarloaf FPAA. He should have petitioned the SNOD.

Had enough about non-partners? There’s more. Judge Morrison has something to say in Philip D. Long A.K.A Phil Long, Docket No. 26552-10, filed 9/5/13.

Phil was building a condominium, but hit a snag and sued the counterparty to his contract. He promised a third party, with the fetching name “Steelervest”, $875K from the earlier to occur of winning or settling the lawsuit or building and selling the condominium units.

Phil got $5.75 million for what Judge Morrison calls the “sale” of the lawsuit; how you sell a lawsuit is also interesting, but let’s assume he meant “settlement”. Phil paid Steelervest $800K, and Steelervest released Phil from his promise.

Phil claims he and Steelervest had a joint venture as regards the condo, so the $5.75 million he got out of the lawsuit belongs in part at least to Steelervest.

IRS says no, it’s all yours Phil. And Phil and IRS go to trial.

The interesting part is that, post-trial, IRS moves to amend their pleadings to conform to the proof that, since Phil promised Steelervest $875K but only gave them $800K, Phil was relieved of indebtedness to the tune of $75K.

No, says Judge Morrison. “Under Rule 41(b)(1), the Court may allow such amendment of the pleadings as may be necessary to cause them to conform to the evidence when an issue not raised by the pleadings are tried by express or implied consent of the parties. Undue prejudice to the other party, because the party had insufficient notice of the issue to be raised, is a key factor in deciding whether to allow an amendment to the pleadings under Rule 41(b)(1).

“Long was not notified of the cancelled-debt theory until the IRS made its motion at the end of trial. Evaluating the merits of the cancelled-debt theory conceivably requires evidence other than the evidence relevant to the other issues at trial, such as the existence or nonexistence of a joint venture with Steelervest. Therefore, Long was unduly prejudiced by the IRS’s failure to plead the cancelled debt theory.” Order, at p. 2-3. (Citations and footnote omitted).

And here’s the omitted footnote: “If Long’s relationship with Steelervest was not a joint venture, this does not necessarily mean that Steelervest was a creditor of Long. See Ewing v. Commissioner, 20 T.C. 216 (1953) (finding a joint venture did not exist and disallowing a deduction for worthless debt where repayment would be made out of operating profits).” Order, at p. 3, footnote 2.

Honor your partner, indeed.