I mean written ones. Among businesspeople. They never follow them. They never even read them, until it’s time to sue or be sued. Or maybe be audited. Just ask Michael Hohl and Jennifer Parker Hohl, 2021 T. C. Memo. 5, filed 1/13/21. Or you could also ask Braden B. Blake and Kristen S. Blake, conjoined as partners with Mike and Jen.

You could ask Ed Rodriguez, who bankrolled Mike and Brad in their text message advertising business that went bust. But Ed never showed for the trial.

The business suffered because Mike and Brad and another partner, also a no-show at trial, got guaranteed payments. I’ll let Judge Buch man-‘splain.

“A guaranteed payment is a ‘payment[] to a partner for services’ that is ‘determined without regard to the income of the partnership.’  Guaranteed payments from a partnership to a partner are comparable to a salary paid by an employer to an employee. Unlike a payment representing a return of capital, the payments are not tied to the financial success of the partnership. Like a salary, guaranteed payments are ordinary income to the partners and deductible to the partnership under section 162 or 263, as appropriate.” 2021 T. C. Memo. 5, at p. 21.

OK, so the partners had that income. But did they have any other? Well, what were the cash infusions from Ed Rodriguez, capital contributions or loans? The 1065s treated them as loans; the operating agreement (partnership agreement or box-checked LLC) said that capital contributions required formal overcall notices and other stuff, none of which the partners followed. Mike and Brad claimed they were capital contributions from Ed Rodriguez. I won’t keep you in suspense; spoiler alert: IRS said they were loans, and when the partnership cratered and Ed Rodriguez didn’t collect, Mike and Brad had passthrough cancellation of indebtedness income.

Judge Buch: “We focus on the substance of the transaction, not the form. Among the factors we consider are: ‘(1) The presence of a written agreement; (2) the intent of the parties; and (3) the likelihood of obtaining similar loans from disinterested investors.’” 2021 T.C. Memo. 5, at pp. 10-11. (Citation omitted).

But Judge Buch don’t need no factors.

“We do not find credible petitioners’ argument that Mr. Rodriguez made capital contributions. While the absence of a written loan document might support petitioners as to the first factor, the partners clearly intended to treat, and did treat, the amounts received from Mr. Rodriguez as loans.” 2021 T. C. Memo. 5, at p. 11.

In proof of my assertions at the head hereof, see the following.

“[Partnership’s] partners’ actions suggest that they considered Mr. Rodriguez’ cash infusions to be loans. [Partnership] reported the amounts as liabilities each year it operated. The Schedules K-1 [Partnership] sent to its partners reported the amounts as liabilities every year and allocated a share of those liabilities to each partner…. Mr. Hohl and Mr. Blake each filed individual returns accepting and benefiting from their characterization of these amounts as debt. If Mr. Rodriguez had made a capital contribution of $265,000 in [Year X}, paragraph 4.4 of the operating agreement would have required Mr. Rodriguez to include that contribution in his initial capital account balance. He did not do so. And according to the agreement, if the partnership needed additional capital contributions, [Partnership] had to notify all partners in writing and give them an equal opportunity to contribute. We have no evidence of any such notices. The record also does not include any explanation as to why Mr. Rodriguez’ ownership percentage did not change as a result of his supposed additional capital contributions. Mr. Rodriguez did not testify.” 2021 T. C. Memo. 5, at pp. 11-12.

Judge Buch does throw in a make-weight: “As for the third factor, the record includes no evidence that [Partnership] could not have obtained loans from third parties.” 2021 T. C. 5, at p. 12. Judge, after reading your description I make so bold as to doubt that third parties would lend.

The identifiable event that marks the end of the enterprise was the year at issue, when the last of Ed Rodriguez’s loans was made. And while Mike claims the Section 108(a)(1)(B) insolvency out, his numbers showed he was under water by $351; and his liabilities were inadequately established.