Attorney-at-Law

A SOUR NOTE

In Uncategorized on 09/03/2014 at 20:43

Torgeir Mantor and his business partner Alan Smith needed a cash transfusion into their start-up LLC, as the venture capitalists were threatening to pull the plug on Visionmonitor Software, LLC, Torgeir Mantor, Tax Matters Partner, the subject of 2014 T. C. Memo. 182, filed 9/3/14.

Unable themselves to pump the cash, Tor and Al signed various sloppy, unnotarized, internally-contradictory and otherwise potentially defective promissory notes in favor of the foundering LLC, claiming thereby to have guaranteed payment and performance of the obligations of same to the vendors and other creditors thereof.

The VC types (venture capital, not Viet Cong, although in these times, who knows?), satisfied that Tor and Al have placed their anatomies on the table, fund the LLC, so that it actually makes money, eventually.

But Tor and Al want to take losses personally for the lean years. For that, as the LLC is box-checked as a partnership, they need basis in their membership interests, and claim the promissory notes give them that.

IRS claims they had zero basis in the notes, because the notes weren’t guarantees of the LLC’s debts, such as would have given Tor and Al basis.

This is a FPAA, so these are partnership-level issues post-Woods, as are the 20% chops for understated tax.

And who better to explicate the truth that promissory notes to the partnership butter no basis, than The Great Dissenter, a/k/a The Judge Who Writes Like A Human Being, s/a/k/a The Relentless, Implacable Foe of the Partitive Genitive, Judge Mark V. Holmes?

Setting the stage: “The value of what a partner contributes to his partnership can be tricky when he contributes something other than cash–like the notes at issue here. VisionMonitor argues that the contribution of the promissory notes increased Mantor’s and Smith’s outside bases in amounts equivalent to their face value. But a partnership’s basis in property contributed by a partner is the adjusted basis of that property in the hands of the contributing partner at the time of the contribution. Sec. 723. The Commissioner argues that the company’s basis in the notes is zero because Mantor’s and Smith’s bases in them were each zero.” 2014 T. C. Memo. 182, at p. 10.

And the Commissioner wins. There’s much caselaw to back up the Commish, and Tor and Al’s one case has to do with a direct guarantee by the partner. The partner has to step up to the creditors directly, placing the aforementioned anatomy on the creditor’s table, not the partnership’s.

And the “at-risk” rules aren’t relevant here. Judge Holmes blows them off in a footnote.

“VisionMonitor argues that the notes should be included in outside basis because Mantor and Smith were ‘at risk’ under section 465. It argues that the substance of the transaction made Mantor and Smith ultimately responsible for a fixed and definite obligation, that nothing in the Code or caselaw makes any explicit preclusion of partnership debts made to the partners themselves, and that the promissory notes constituted ‘genuine indebtedness.’ The Commissioner retorts that the ‘at risk’ limitation isn’t a partnership-level determination, and isn’t something we can determine here. It’s also an issue that we don’t have to decide because the relevant question isn’t whether the notes were a debt owed by the partners to VisionMonitor but whether the partners had basis in the notes.” 2014 T. C. Memo.182, at p. 13, footnote 6.

But while the applicability of the Section 6662 accuracy penalties can be decided at partnership-level (with a tip of the hat to Judge Marvel, and although the partners may individually have a shot at fighting them in a CDP, which is another story), Tor and Al dodge the bullet, relying on their trusty tax lawyer, who, although he did a dodgy job here, still impresses with his credentials and the guys’ transparent good faith. They let it all hang out, and their expert had credentials.

Good stuff here, guys. Read and heed.

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