T.C. Memo. 2021-5
UNITED STATES TAX COURT
MICHAEL HOHL AND JENNIFER PARKER HOHL, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
BRADEN B. BLAKE AND KRISTEN S. BLAKE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 4489-16, 4493-16. Filed January 13, 2021.
Paul W. Jones, for petitioners.
Rebekah A. Myers, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
BUCH, Judge: Michael Hohl, Braden Blake, and James Bowles were
partners in a partnership from which they reported guaranteed payments. A fourth
partner, Eduardo Rodriguez, regularly infused money into the partnership, which
Served 01/13/21 -2-
[*2] the partnership and the partners generally treated as loans. For 2012, the year
the partnership ceased operation, the partners treated Mr. Rodriguez’ loans as
contributions, and the partners were not called on to repay their respective shares
of the loans. The Commissioner issued notices of deficiency to the partners
determining cancellation of indebtedness income for 2012. Because the funds
provided by Mr. Rodriguez were loans to the partnership, and the partnership’s
liability was allocated among the partners, the cancellation of those loans resulted
in income to the partners.
FINDINGS OF FACT
I. The Parties and the Formation of Echo
The Hohls lived in Utah and the Blakes lived in Washington State when
they filed their petitions.
In 2009, Mr. Hohl and Mr. Blake, along with Mr. Bowles1 and Mr.
Rodriguez, formed Echo Mobile Marketing Solutions, LLC (Echo). Echo was in
the business of text message advertising. Mr. Hohl, Mr. Blake, and Mr. Bowles
conceived of the business, and Mr. Rodriguez provided capital. Mr. Hohl handled
1 Mr. Bowles also has a case before this Court at docket No. 4494-16 involving the same partnership underlying these consolidated cases. Mr. Bowles’ case was previously consolidated with these cases. On April 15, 2019, Mr. Bowles agreed to be bound by the outcome of these cases as to the issue of cancellation of indebtedness. The Court severed his case that same day. -3-
[*3] sales, marketing, bookkeeping, and product development. Mr. Blake handled
web and other development work. Mr. Bowles provided sales and marketing
services.
Echo’s partners entered into an operating agreement that set forth their
capital contributions and percentage partnership interests. That agreement stated
that Messrs. Hohl, Blake, and Bowles each contributed no money and owned a
30% interest in Echo, and that Mr. Rodriguez contributed $265,000 in exchange
for a 10% interest.2 It provided that the partners’ capital accounts would be
established and maintained in accordance with section 1.704-1(b)(2)(iv), Income
Tax Regs. And it provided a formula for allocating the profits and losses of the
business among the partners on the basis of their capital accounts. The agreement
also provided for nondilution rights in the event additional capital was needed. If
the partnership needed capital, it was required to notify all partners in writing to
give them equal opportunity to contribute. The partners considered the
arrangement to be a 30-30-30-10 split. At trial, Mr. Hohl, Mr. Blake, and Mr.
Bowles each testified that they understood themselves to each own 30% interests
and Mr. Rodriguez to own a 10% interest. The partners shared annual losses
according to these percentage interests.
2 All monetary amounts are rounded to the nearest dollar. -4-
[*4] Over the life of the partnership, 2009 through 2012, Mr. Rodriguez
repeatedly provided funds to the partnership. Mr. Hohl, who did the bookkeeping
for Echo, recorded a total of $653,506 received from Mr. Rodriguez as loans to
Echo. The partners intended to repay those amounts to Mr. Rodriguez.
II. Tax Reporting
A. 2009
Echo filed a Form 1065, U.S. Return of Partnership Income, for 2009. It
reported gross receipts of $1,214 and deductions of $46,549 resulting in a net loss
of $45,335. The deductions consisted primarily of guaranteed payments to the
partners. Echo’s balance sheet showed a liability under the line item “Other
liabilities” of $345,366, which it described on the required attachment as “NOTE
PAYABLE--MEMBER.” This liability matches the entire amount provided by
Mr. Rodriguez in 2009, including the $265,000 listed in the operating agreement
as a capital contribution.
On the accompanying Schedules K-1, Partner’s Share of Income,
Deductions, Credits, etc., the loss and the liability (which was reported as a
recourse liability) were allocated 30% to Mr. Hohl, 30% to Mr. Blake, 30% to Mr.
Bowles, and 10% to Mr. Rodriguez. None of the partners’ Schedules K-1,
including Mr. Rodriguez’, reported any initial capital account balances. Each -5-
[*5] partner reduced his capital account by his share of Echo’s loss for the year,
resulting in negative capital accounts.
Mr. Hohl and his spouse filed a joint Form 1040, U.S. Individual Income
Tax Return, for 2009. On Schedule E, Supplemental Income and Loss, the Hohls
reported the $13,600 loss that Echo allocated to Mr. Hohl and the $15,061
guaranteed payment Echo made to him. They reported net partnership income of
$1,461.
The Blakes also filed a joint Form 1040 for 2009.3 On Schedule E, the
Blakes reported the $13,600 loss that Echo allocated to Mr. Blake and the $14,800
guaranteed payment Echo made to him. They reported net partnership income of
$1,200.
B. 2010
Echo reported a loss again for 2010. A loss of $379,739 arose largely from
Echo’s deduction of $297,120 of guaranteed payments made to its partners.
Echo’s balance sheet showed an increase in liabilities, bringing the total note
payable--member amount to $564,322. The increase in the liability reflected an
additional $218,956 infusion from Mr. Rodriguez in 2010.
3 They later filed an amended return to claim itemized deductions. -6-
[*6] The allocation of Echo’s items as reported on the 2010 Schedules K-1
differed slightly but significantly from that of 2009. Echo allocated the loss in the
same percentages for the previous year. However, Echo allocated the liability
100% to Mr. Rodriguez. Each partner’s capital account balance again decreased
by the partner’s allocation of loss.
The Hohls and the Blakes each filed joint Forms 1040 for 2010. They
reported their guaranteed payments ($113,020 and $70,735, respectively) and their
30% shares of Echo’s loss ($113,922 each), resulting in their reporting of net
partnership losses of $902 and $43,187, respectively. They each checked “No” in
box 27 on their Schedules E, indicating that they were not reporting any losses
disallowed for previous years because of, for example, basis limitations.
C. 2011
In 2011, Echo reported a $168,960 loss, $155,922 of which arose from the
guaranteed payments. The liability representing Mr. Rodriguez’ loans increased
by $75,000 to a total of $639,322.
The Schedules K-1 for 2011 closely followed those from 2010. Consistent
with those Schedules K-1, the Hohls and the Blakes reported their guaranteed
payments ($57,320 and $39,985, respectively) and their 30% shares of Echo’s loss
($50,688 each). Neither of them reported a share of the liability, and each of them -7-
[*7] decreased his capital account by his allocation of Echo’s loss. The
partnership allocated to Mr. Rodriguez his 10% share of the loss and 100% of the
recourse liability.
D. 2012
Echo’s 2012 Form 1065 was marked as its final return. Echo reported no
income, deductions, losses, or guaranteed payments. Echo’s liability increased by
$14,184, to $653,506, but unlike past years’ liabilities the amount was recorded as
“Loans from partners”, not as “Other liabilities.”
The Schedules K-1 for 2012 reflected Echo’s limited operations that year.
Echo did not allocate any income, losses, deductions, or guaranteed payments to
Mr. Hohl, Mr. Blake, or Mr. Bowles. Their Schedules K-1 each reported negative
capital account balances, unchanged from 2011, of $178,210. Mr. Rodriguez’
Schedule K-1 reported a negative capital account balance of $59,404, but no
longer reported any share of partnership liabilities.
Both Mr. Blake and Mr. Hohl filed joint Forms 1040 for 2012; however
neither reported any income or loss from Echo.
In summary, Echo’s 2012 return showed a liability remaining on its balance
sheet of $653,506, but no partner reported an allocation of any share of that
liability. The partnership did not report any income, such as income from the -8-
[*8] discharge of indebtedness, nor did Echo allocate to any partner any share of
any such income. Mr. Hohl and Mr. Blake reported no partnership income for
2012.
III. Examination and Petition
The Internal Revenue Service (IRS) examined the Hohls’ and the Blakes’
2012 returns. On November 23, 2015, the IRS mailed the Hohls and the Blakes
notices of deficiency determining deficiencies and accuracy-related penalties for
2012. The Commissioner has since conceded the penalties. In each notice the
Commissioner adjusted the taxpayer’s Schedule E income upward by $178,210,
the amount of the partner’s negative capital account balances, representing the
partner’s share of cancellation of indebtedness income. The explanation of the
adjustment stated: “It is determined that your share of income from the
partnership known as Echo Mobile Marketing for taxable year 2012 is
$178,210.00 instead of $0.00 as reported on your return. Therefore, taxable
income is increased $178,210.00 for tax year ended December 31, 2012.” Each
couple timely filed a petition with our Court. -9-
[*9] OPINION
I. Jurisdiction and Burden of Proof
We have jurisdiction to redetermine the Commissioner’s determinations, as
set forth in a notice of deficiency, when a taxpayer files a timely petition
challenging those determinations.4 Generally, the Commissioner’s determinations
in a notice of deficiency are presumed correct and the taxpayer bears the burden of
proving otherwise.5 Which party bears the burden of proof is relevant only in the
event of an evidentiary tie or a failure of proof.6
Although our jurisdiction to redetermine a deficiency is limited to the year
set forth in the notice of deficiency, we may “consider such facts with relation to
the taxes for other years * * * as may be necessary correctly to redetermine the
amount of such deficiency.”7 The Hohls and the Blakes timely filed petitions
challenging the deficiencies determined by the Commissioner for 2012. We have
4 Sec. 6213(a). Echo had four partners, all of whom are individuals, and accordingly is subject to deficiency procedures. See sec. 6231(a)(1)(B)(i). All section references are to the Internal Revenue Code (Code) in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated. 5 Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). 6 Vandenbosch v. Commissioner, T.C. Memo. 2016-29, at *11. 7 Sec. 6214(b). - 10 -
[*10] jurisdiction to determine the correct amount of any tax deficiencies for 2012,
but we may consider relevant facts from other years.
II. Mr. Rodriguez’ Deposits
Before we decide whether the partnership recognized cancellation of
indebtedness income, we must decide whether Mr. Rodriguez provided Echo loans
or capital contributions. The Hohls and the Blakes argue that Mr. Rodriguez
provided capital contributions. For this contention, they cite the operating
agreement, the lack of any written agreements between Mr. Rodriguez and Echo,
and the lack of any repayment or collection activity. The Commissioner argues
that the deposits were loans, as reported on all of the partnership returns other than
the final return.
Whether we treat amounts put into a partnership by a partner as capital
contributions or loans “is not a new question.”8 Rather, this “question is one of
fact.”9 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
8 Schnitzer v. Commissioner, 13 T.C. 43, 60 (1949), aff’d, 183 F.2d 70 (9th Cir. 1950). 9 Schnitzer v. Commissioner, 13 T.C. at 60. - 11 -
[*11] the parties; and (3) the likelihood of obtaining similar loans from
disinterested investors.”10
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.
Echo’s partners’ actions suggest that they considered Mr. Rodriguez’ cash
infusions to be loans. Echo reported the amounts as liabilities each year it
operated. The Schedules K-1 Echo sent to its partners reported the amounts as
liabilities every year and allocated a share of those liabilities to each partner in
2009. 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 2009, 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, Echo had to notify all partners in writing and give them an equal
10 Greenberg v. Commissioner, T.C. Memo 1992-292, 63 T.C.M. (CCH) 3042, 3043 (1992). - 12 -
[*12] 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.
As for the third factor, the record includes no evidence that Echo could not
have obtained loans from third parties.
The amounts Echo received from Mr. Rodriguez were loans.
III. The Discharge of Debt
Gross income generally includes income from the discharge of
indebtedness.11 The rationale for this inclusion is that the cancellation of
indebtedness provides the debtor with an economic benefit that is equivalent to
other forms of income.12 The Supreme Court has previously explained:
When a taxpayer receives a loan, he incurs an obligation to repay that loan at some future date. Because of this obligation, the loan proceeds do not qualify as income to the taxpayer. * * *
Because of the obligation to repay, the taxpayer is entitled to include the amount of the loan in computing his basis in the property * * *
* * * * * * *
11 Sec. 61(a)(12). 12 See United States v. Kirby Lumber Co., 284 U.S. 1 (1931). - 13 -
[*13] When the obligation is canceled, the * * * [debtor] is relieved of his responsibility to repay the sum he originally received * * *
We therefore hold that a taxpayer must account for the proceeds of obligations he has received tax-free and included in basis. * * * [13]
When Echo’s loans were canceled, section 61(a)(12) required Echo to include the
entire canceled amount in the partnership’s income for the year of cancellation.14
When a taxpayer realizes income from cancellation of indebtedness is a
question of fact.15 Discharge of a debt occurs when it becomes clear that the debt
will never be repaid.16 We look for “[a]ny ‘identifiable event’ which fixes the loss
with certainty.”17
13 Commissioner v. Tufts, 461 U.S. 300, 307, 312-313 (1983). 14 While partnerships usually do not pay income tax, sec. 701, the partnership’s taxable income is generally computed at the partnership level, sec. 703, and then reported as distributive shares by its partners, sec. 702. 15 See Policy Holders Agency, Inc. v. Commissioner, 41 T.C. 44, 47 (1963). 16 Cozzi v. Commissioner, 88 T.C. 435, 445 (1987). 17 Cozzi v. Commissioner, 88 T.C. at 445 (citing United States v. S.S. White Dental Mfg. Co., 274 U.S. 398 (1927)); see also sec. 1.6050P-1(b)(2)(i), (iv), Income Tax Regs. (providing an exclusive list of eight “identifiable events” under which debt is discharged for information reporting purposes, including the expiration of a 36-month nonpayment testing period). - 14 -
[*14] It became certain in 2012 that Echo would not repay its debt to Mr.
Rodriguez, and thus Echo had income from the discharge of debt for that year.
The partners testified that Echo would pay Mr. Rodriguez when the venture
became profitable. When Echo ceased operations, it became clear it would never
be profitable. Echo ceased operations when it filed its final return in 2012.
Echo’s termination in 2012 is when the debt became uncollectible.
The Hohls and the Blakes argue that Echo ceased operations in 2011. But
the partnership had ongoing activity in 2012, evidenced by Mr. Rodriguez’
lending the partnership an additional $14,184 in that year. Echo therefore did not
terminate in 2011.
IV. Allocating the Cancellation of Debt Income
Partners must recognize as ordinary income their distributive shares of
partnership discharge of indebtedness income.18 Except as otherwise required by
the Code, a partner’s distributive share of income is determined by the partnership
agreement.19 If the partnership agreement does not provide for the partner’s share,
or if the allocation made by the agreement does not have substantial economic
effect, the partner’s distributive share of income is determined “in accordance with
18 Gershkowitz v. Commissioner, 88 T.C. 984, 1006-1008 (1987). 19 Sec. 704(a). - 15 -
[*15] the partner’s interest in the partnership (determined by taking into account
all facts and circumstances).”20
Echo’s operating agreement allocates distributive shares of income to its
partners according to a formula based on the partner’s capital accounts. If those
allocations have substantial economic effect, the income from the discharge of the
indebtedness is allocated in the manner provided by the operating agreement.
To have substantial economic effect, allocations must be consistent with the
underlying economic arrangement of the partners.21 The allocations made by
Echo’s operating agreement (based on capital accounts) do not have substantial
economic effect. In all other respects, the partnership and its partners shared items
30-30-30-10, instead of following the formula provided by the operating
agreement. This course of conduct makes clear that Echo did not adhere to the
allocations in the operating agreement and instead allocated losses on the basis of
the partners’ 30%, 30%, 30%, and 10% ownership interests. The partners also did
not follow the operating agreement’s provisions for contributing capital or
maintaining capital accounts.
20 Sec. 704(b). 21 Sec. 1.704-1(b)(2)(ii)(a), Income Tax Regs. - 16 -
[*16] Because the allocations provided by the operating agreement do not have
substantial economic effect, the partners’ distributive shares of income are
determined according to their interests in the partnership.22 A partner’s interest in
the partnership depends on the facts and circumstances.23 In these cases, during all
four years Echo operated, it allocated losses according to the stated 30%, 30%,
30%, and 10% ownership interests. Allocation of the income in 2012 should
follow the allocation of losses for each other year of the partnership’s existence.
Mr. Hohl and Mr. Blake should each have included a 30% share of the income
from the discharge of indebtedness in their income for 2012.
The Hohls and the Blakes argue that if Echo recognized income from the
discharge of indebtedness all of that income should be allocated to Mr. Rodriguez.
They argue that the loans were nonrecourse loans and therefore the lending partner
bears the economic risk of loss so it is treated as a recourse liability allocated to
that partner. They conclude:
Thus, a nonrecourse loan from a partner is, in effect, treated as a recourse liability allocated solely to the lending partner. * * * [See sec. 1.704-2(b)(4), Income Tax Regs.] Its allocation is covered by the nonrecourse deduction regulations. See Treas. Reg. sec. 1.704-2(i). In other words, a partner cannot make a nonrecourse loan to a
22 Sec. 704(b). 23 Sec. 704(b); sec. 1.704-1(b)(3)(i), Income Tax Regs. - 17 -
[*17] partnership that gives other partners basis. Treas. Reg. sec. 1.752- 2(c).
Their argument is incorrect for several reasons.
The partners chose to treat the liability as a recourse liability and to allocate
it according to the partners’ 30%, 30%, 30%, and 10% interests in the partnership.
Additionally, the partners claimed, and took the tax benefit from, the additional
basis arising from their shares of the loans. They were not required to structure
their economic relationship that way but chose to reflect their economic
arrangement as a recourse loan shared by all partners.
Further, the section 704 regulations petitioners cite govern allocations
attributable to nonrecourse liabilities, not the allocation of the liabilities
themselves, which are governed by the regulations under section 752. Under the
section 752 regulations, a partnership liability is recourse to the extent a partner
bears the economic risk of loss and nonrecourse to the extent no partner bears the
economic risk of loss.24 When the lender is also a partner, that partner bears the
economic risk of loss to the extent that the partner makes a nonrecourse loan to the
partnership and no other partner bears the economic risk of loss.25 The regulations
24 Sec. 1.752-1(a)(1) and (2), Income Tax Regs. 25 Sec. 1.752-2(c)(1), Income Tax Regs. - 18 -
[*18] contemplate a partner other than the lending partner bearing the economic
risk of loss for, and receiving the corresponding allocation of, a loan made by
another partner.
Finally, the item at issue is income, not a liability. Echo failed to include
the income from the discharge of a debt, specifically the loans from Mr.
Rodriguez. Once the loans were discharged, they ceased to be a partnership
liability and instead became partnership income.
V. Outside Bases
Ultimately, the Commissioner argues that Mr. Hohl’s and Mr. Blake’s
distributive shares of income should include income from the discharge of
indebtedness of $196,081 each (30% of the total discharged debt) but that they are
each entitled to a capital loss deduction of $17,841 on the liquidation of their
partnership interests. Determining the amount of income to be recognized requires
a calculation of Mr. Hohl’s and Mr. Blake’s outside bases.
The parties disagree on how to calculate Mr. Hohl’s and Mr. Blake’s bases
in their partnership interests in Echo. The Hohls and the Blakes argue that the
guaranteed payments they received increased their outside bases. The
Commissioner disagrees. The parties do not dispute the characterization of the - 19 -
[*19] payments as guaranteed payments, and we accept their characterization of
them as such.
Outside basis is a partner’s adjusted basis in the partnership interest.26
Partnerships generally do not report partners’ outside bases.27 But partners must
track their outside bases to determine the tax consequences of any nonliquidating
distribution, the tax consequences upon liquidation of their partnership interests,
and whether they may deduct partnership losses.28
Mr. Hohl and Mr. Blake had bases of zero in their interests in Echo at
formation. They received their interests in exchange for services.29 The receipt of
a capital interest in exchange for services is treated as the receipt of property in
exchange for services and is taxable compensation under section 61.30 At the time
of formation Echo had a value of zero, so the property Mr. Hohl and Mr. Blake
26 William S. McKee et al., Federal Taxation of Partnership and Partners, para. 6.01 (4th ed. 2007). 27 See Greenwald v. Commissioner, 142 T.C. 308, 314 (2014). 28 McKee et al., supra, para. 5.01. 29 They did not purchase their interests or contribute property for their interests. We note that the record includes some evidence that they contributed intellectual property but do not find any value of such a contribution anywhere in the record whereas the operating agreement and tax returns show their contributions to have been zero. 30 McKee et al., supra, para. 14.03[1]. - 20 -
[*20] received for their services was zero. Therefore, they had initial outside
bases of zero.
At the close of 2009, Mr. Hohl and Mr. Blake adjusted their outside bases to
take into account the partnership’s activities for the year. A distributive share of a
loss decreases a partner’s outside basis but not below zero.31 When a partner
assumes liability for a share of a partnership debt, the assumption is treated as a
contribution of money to the partnership.32 A contribution of money to a
partnership increases the partner’s outside basis.33 For 2009, Echo reported a
$45,335 loss. The partnership allocated Mr. Hohl and Mr. Blake each 30% shares
of this loss, equal to $13,600 apiece. That year, they were each also allocated 30%
shares of the $345,366 partnership liability. Therefore, at the end of 2009, Mr.
Hohl and Mr. Blake each had outside bases of $117,201, representing their shares
of the liability less their shares of the loss. This process repeats through each year
the partnership is in operation.
The Hohls and the Blakes argue that the loans were solely allocated to Mr.
Rodriguez and that the guaranteed payments each partner received increased his
31 Sec. 705(a)(2)(A). 32 Sec. 752(a). 33 Sec. 722. - 21 -
[*21] basis. They argue that the proper calculation of their outside bases is their
guaranteed payments less their 30% shares of the loss.
Guaranteed payments do not increase outside bases. A guaranteed payment
is a “payment[] to a partner for services” that is “determined without regard to the
income of the partnership.”34 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.35 Like a salary, guaranteed payments are ordinary income to
the partners and deductible to the partnership under section 162 or 263, as
appropriate.36
The Hohls and the Blakes argue that because guaranteed payments are not
considered part of a partner’s distributive share only for purposes of section 61(a)
and section 162(a), they are considered as “distributive shares of partnership
income” for all other purposes. They further argue that they may include their
guaranteed payments in their outside bases under section 705(a) because the
34 Sec. 707(c). 35 McKee et al., supra, para. 14.03[1]. 36 Sec. 707(c); Cagle v. Commissioner, 63 T.C. 86, 92 (1974), aff’d, 539 F.2d 409 (5th Cir. 1976). - 22 -
[*22] payments are part of their distributive shares of income. The flaw in this
argument is that the guaranteed payments, while income to the partners receiving
the payments, are an expense at the partnership level. And Echo deducted them as
a partnership expense.
We agree with the Commissioner’s formula for calculating petitioners’
outside bases. Mr. Hohl’s and Mr. Blake’s outside bases are their shares of Echo’s
recourse liability minus their shares of Echo’s losses.37 Therefore, for 2012,
before considering the discharge of indebtedness, each had an outside basis of his
share of the partnership’s liability, less his previously allocated losses.
When the debt was discharged in 2012, the partnership had to recognize
income in the amount of the discharged liability and each partner had to recognize
his share in proportion to his interest in the partnership. This recognition of
income increased their outside bases.38 Because the liability no longer existed,
each partner’s share of partnership liabilities decreased, a decrease that is treated
37 Contrary to the reporting on the Schedules K-1, it does not appear that Mr. Hohl, Mr. Blake, or Mr. Bowles was relieved of his share of the partnership liability between 2009 and 2010. A decrease in their shares of the partnership liability in 2010 would have caused a deemed distribution to them under section 752(b). The record does not explain the shift in reporting. Rather, consistent with their interests in the partnership, Mr. Hohl, Mr. Blake, and Mr. Bowles should have continued to receive 30% allocations of the partnership’s liability. 38 See sec. 705(a)(1)(A). - 23 -
[*23] as a distribution of money to the partner by the partnership.39 This
distribution would decrease their outside bases.40 The Hohls and the Blakes may
treat their remaining outside bases as losses on the liquidation of their partnership
interests.41
VI. Mr. Hohl’s Insolvency
At trial, Mr. Hohl argued that he was insolvent in 2012. Mr. Hohl argues
that even if Echo realizes income from the discharge of indebtedness and he is
allocated a share of that income, he does not include the allocation in his income
because he was insolvent in 2012. Mr. Hohl bears the burden of proof on this
issue.42
Section 108(a)(1)(B) provides that gross income does not include income
from the discharge of indebtedness if the discharge occurs when the taxpayer is
insolvent. While income from the discharge of indebtedness is included at the
partnership level, this exception for insolvency is applied at the partner level.43
39 See sec. 752(b). 40 See secs. 705(a)(2), 733. 41 See sec. 731(a)(2). 42 See Rule 142(a). 43 See 2925 Briarpark, Ltd. v. Commissioner, 163 F.3d 313, 316 n.1 (5th Cir. (continued...) - 24 -
[*24] A taxpayer is insolvent if the amount of his or her liabilities exceeds the fair
market value of his or her assets, determined immediately before the discharge of
indebtedness.44 In the case of a taxpayer who qualifies for the insolvency
exclusion, the excluded amount cannot exceed the amount by which the taxpayer
is insolvent.45
Mr. Hohl has not established that he was insolvent at the close of 2012. At
trial, he produced an insolvency worksheet showing liabilities in excess of assets
by $351, but the amounts shown as liabilities in that worksheet are not adequately
supported by the record; he did not provide sufficient documents to substantiate
the expenses he reported on his insolvency worksheet.
VII. Conclusion
Mr. Hohl and Mr. Blake received income from the discharge of Echo’s
indebtedness in 2012. They are not liable for the accuracy-related penalties
because the Commissioner has conceded those penalties.
43 (...continued) 1999), aff’g T.C. Memo 1997-298; Gershkowitz v. Commissioner, 88 T.C. at 1009. 44 Sec. 108(d)(3). 45 Sec. 108(a)(3). - 25 -
[*25] To reflect the foregoing,
Decisions will be entered for
petitioners as to the penalties and for
respondent as to all other issues.