141 T.C. No. 4
UNITED STATES TAX COURT
SUGARLOAF FUND LLC, JETSTREAM BUSINESS LIMITED, TAX MATTERS PARTNER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 671-10. Filed September 5, 2013.
In 2005, S, a purported partnership, set up Illinois common law business trusts Main Trust and Sub-Trust. S then transferred distressed Brazilian consumer receivables to Main Trust. S, Main Trust, and the trustee in turn allocated the receivables to Sub-Trust. E transferred cash to Main Trust in exchange for the entire beneficial interest in Sub-Trust. E wrote off most of the value of the receivables as an I.R.C. sec. 166 bad debt deduction, claiming a carryover basis in the receivables equal to S’ basis. R issued a notice of final partnership administrative adjustment regarding S’ 2004 and 2005 taxable years. R made adjustments to S’ income on a number of theories. One theory is that S’ basis in the receivables was zero. An extension of this theory is that E’s basis in the receivables is a carryover basis and would also be zero. R made such a determination and issued E a statutory notice of deficiency denying the deduction. E did not petition this Court for review of his individual income tax liability. E now alleges he, as the beneficiary and grantor of Sub- Trust, is a partner of S such that he may intervene and participate as a -2-
party in this TEFRA proceeding on the grounds that Sub-Trust’s basis in the receivables is a partnership item of S.
Held: E is not a direct or indirect partner in S.
John E. Rogers (an officer), for petitioner.
Joseph A. DiRuzzo III, for participating partner Timothy J. Elmes.
Ronald S. Collins, Jr., for respondent.
OPINION
WHERRY, Judge: The petition in this case was filed by Jetstream Business
Limited (Jetstream) as tax matters partner for Sugarloaf Fund, LLC (Sugarloaf), on
January 8, 2010. On July 12, 2012, Timothy J. Elmes filed an election to
participate in this case pursuant to section 6226(c).1 On July 19, 2012, Mr. Elmes
filed a motion requesting that the Court stay consolidation of this case with other
transactionally related cases. On July 30, 2012, Mr. Elmes filed a motion
requesting a determination that he is a partner of Sugarloaf. The Court invited
petitioner and respondent to file responses to Mr. Elmes’ motions. Respondent on
1 Unless otherwise indicated, all section references are to the Internal Revenue Code of 1986, as amended and in effect for the tax years at issue. -3-
April 11, 2013, filed a response contending that Mr. Elmes is not a partner of
Sugarloaf. Petitioner did not file a response. On April 17, 2013, we denied Mr.
Elmes’ motions to stay consolidation and to set the partner determination issue for
oral argument and set a briefing schedule. We also denied without prejudice Mr.
Elmes’ motion for a partner determination, believing resolution of the issue was
unnecessary at the time. On May 16, 2013, Mr. Elmes filed a motion to compel
discovery from petitioner. We directed petitioner to file a response, which it did
not do. Mr. Elmes then moved on June 12, 2013, for an order to show cause why
the Court should not hold petitioner in contempt for its failure to file a response.
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 -4-
may not participate in this case, and we will deny his outstanding motions as moot
for the reasons discussed below.
Background
For the sole purpose of deciding this issue, we draw the following
background information from the agreed-upon allegations in the pleadings and
from the uncontroverted statements in the motions and in the accompanying
memoranda, including exhibits thereto.
This case is a partnership-level proceeding under the unified audit and
litigation provisions of the Tax Equity and Fiscal Responsibility Act of 1982, Pub.
L. No. 97-248, sec. 402(a), 96 Stat. at 648, commonly referred to as TEFRA and
currently codified at sections 6221 through 6234. Sugarloaf is an Illinois limited
liability company and has filed tax returns as a partnership under the default
classification rules. See sec. 301.7701-3(a) and (b)(1)(i), Proced. & Admin. Regs.
One or more Brazilian companies allegedly contributed uncollected and overdue
consumer receivables to Sugarloaf in exchange for a 98% interest in Sugarloaf.
Warwick Trading, LLC (Warwick), and Jetstream owned the remaining 2%
interest in Sugarloaf.
Sugarloaf claims to have contributed some of the Brazilian consumer
receivables to “Illinois common law business trusts” (main trusts). Then, these -5-
main trusts purportedly formed sub-trusts and assigned a portion of the receivables
to these sub-trusts, which, according to petitioner, operated to hold, preserve, and
delegate collections of the receivables. Investors would contribute cash to a main
trust in exchange for an interest in that main trust and the entire beneficial interest
in a specified sub-trust. Mr. Elmes was apparently one of these investors. The
investors in these sub-trusts reported on their individual tax returns section 166
bad debt deductions relating to the consumer receivables. The Commissioner has
denied the claimed deductions and determined income tax deficiencies and
penalties against many of the investors.
Sugarloaf formed the Elmes 2005 Trust (Elmes Main Trust) and the Elmes
2005-A Sub-Trust (Elmes Sub-Trust) and was the initial grantor and beneficiary.
Sugarloaf then purportedly transferred receivables to Elmes Main Trust, which
then purportedly allocated those receivables to Elmes Sub-Trust. John Rogers, the
strategist behind these transactions, was the trustee of both trusts. Mr. Elmes
contributed $75,000 to Elmes Main Trust in exchange for an interest in Elmes
Main Trust and the entire beneficial interest in Elmes Sub-Trust and claimed to be
the grantor of Elmes Sub-Trust. Sugarloaf, Mr. Elmes, and the trusts treated the
Brazilian receivables as having a carryover basis. Elmes Sub-Trust reported a
business bad debt deduction of $1,455,000 on account of the partial worthlessness -6-
of the Brazilian receivables. Mr. Elmes, as a purported grantor of Elmes Sub-
Trust, claimed this deduction on his 2005 tax return.
Respondent disallowed the loss deduction on a number of grounds and
determined an income tax deficiency and a penalty against Mr. Elmes for which a
statutory notice of deficiency was issued. According to respondent and to this
Court’s records, Mr. Elmes did not petition this Court for review of that statutory
notice of deficiency, and respondent assessed the deficiency.2 Mr. Elmes is now
seeking to litigate his deficiency indirectly by participating in this case.
To support this belated attempt, Mr. Elmes relies on language used in the
previously mentioned order dated April 17, 2012, that we issued both in this case
and a number of transactionally related cases. In that order we requested briefs on
whether the beneficial owners of trusts similar to the Elmes Main Trust and the
Elmes Sub-Trust should be considered partners of Sugarloaf. Both respondent and
petitioner in this case responded in the negative, as did the petitioners in a number
of transactionally related cases. Mr. Elmes, however, filed a protective election to
participate in this case, although he has no separate case of his own, and further
2 As a general matter, while Congress has sought to afford taxpayers a prepayment forum to dispute the Commissioner’s determined Federal income tax deficiencies, it has also indicated that this opportunity should be afforded only once as to any determined income tax deficiency for any specified taxable year. See generally secs. 6320(c), 6330(c)(2)(B). -7-
filed a motion contending that he should be treated as a partner of Sugarloaf,
which, if true, would justify his participation.
Our April 17, 2012, order hypothesized that if Sugarloaf’s basis in the
receivables was a partnership item of Sugarloaf and the main trust’s and sub-
trust’s basis in the receivables was a carryover basis, then the sub-trust’s basis in
the receivables would likely be controlled by our finding as to Sugarloaf’s basis in
the receivables. As we stated in that order: “Consequently, an individual U.S.
investor who claimed a beneficial interest in a Sub-trust would seem to have his
Federal income tax liability ‘determined in whole or [in] part by taking into
account directly or indirectly [Sugarloaf’s basis in these partnership assets, which
are] partnership items of the partnership.’ Sec. 6231(a)(2).”
Discussion
Generally when the tax matters partner or other partner petitions this Court
for readjustment of items in a notice of final partnership administrative adjustment
(FPAA), each partner who was a partner during the partnership taxable year at
issue may participate in the proceeding. Sec. 6226(c). A partner seeking to
participate under section 6226(c) must have an interest in the outcome. Sec.
6226(d). Thus, for Mr. Elmes to participate in this proceeding, he must have been -8-
a partner in Sugarloaf at some time during the 2005 taxable year of Sugarloaf,
which is at issue in this case. See sec. 6226(c)(1).
Section 6231(a)(2) defines a partner for TEFRA purposes not just as a
“partner in the partnership” but also as “any other person whose income tax
liability * * * is determined in whole or in part by taking into account directly or
indirectly partnership items of the partnership.” A partnership item is “any item
required to be taken into account for the partnership’s taxable year under any
provision of subtitle A to the extent regulations prescribed by the Secretary
provide that, for purposes of this subtitle, such item is more appropriately
determined at the partnership level than at the partner level.” Sec. 6231(a)(3).
The regulations include as partnership items “amounts determinable at the
partnership level with respect to partnership assets”. Sec. 301.6231(a)(3)-
1(a)(1)(vi), Proced. & Admin. Regs.
The records of Sugarloaf for 2005 do not indicate that Mr. Elmes was a
direct partner in Sugarloaf under section 6231(a)(2)(A). Nevertheless, in support
of his position that he was a partner in Sugarloaf in 2005, Mr. Elmes submitted
Schedules K-1, Partner’s Share of Income, Deductions, Credits, etc., for the 2007
and 2008 tax years. These documents suggest that as the result of the alleged
dissolution of at least some of the trading companies and liquidation of the trusts, -9-
both of which petitioner alleges have occurred, Mr. Elmes may have become a
partner or indirect partner in Sugarloaf in 2007 and 2008. Without deciding the
authenticity or significance of these Schedules K-1, we note that Mr. Elmes has
not provided a similar document for the 2005 tax year, which is the year at issue in
this case. 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.3 See Commissioner v. Culbertson,
337 U.S. 733 (1949). 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 [for 2005] * * * is determined in whole or in part by taking into account
directly or indirectly partnership items of the partnership.” Sec. 6231(a)(2)(B).
Section 6231(a)(2)(B) brings within the definition of partner certain persons
who are liable or jointly and severally liable for a tax liability attributable to
3 We also acknowledge that the so-called check-the-box regulation, sec. 301.7701-3(a), Proced. & Admin. Regs., permits “[a]n eligible entity with at least two members * * * [to] elect to be classified as * * * a partnership”. But neither Mr. Elmes nor the Elmes Sub-Trust ever came together with Sugarloaf or any of its partners to constitute an entity for this purpose. See generally Superior Trading, LLC v. Commissioner, T.C. Memo. 2012-110, slip. op. at 11-15, supplementing 137 T.C. 70 (2011), aff’d, ___ F.3d ___, 2013 WL 4505155 (7th Cir. Aug. 26, 2013). -10-
partnership items. For example, a spouse may be a deemed partner if the other
spouse is a partner and they file jointly or if the spouse, by operation of State law,
has a joint interest in the partnership interest. See Callaway v. Commissioner, 231
F.3d 106, 111 (2d Cir. 2000), rev’g T.C. Memo. 1998-99. In addition, a common
parent corporation of a consolidated group may be a partner when a subsidiary
member of the group is a partner in the partnership, because the common parent
and each subsidiary member of the common group is severally liable for tax
computed under section 1502. Rev. Rul. 2006-11, 2006-1 C.B. 635.4 Indirect
partners under section 6231(a)(10), which are “person[s] holding an interest in a
partnership through 1 or more pass-thru partners”, are also deemed partners under
section 6231(a)(2)(B). PCMG Trading Partners XX, L.P. v. Commissioner, 131
T.C. 206, 209-210 (2008). While the definition of a “pass-thru partner” includes a
trust through which “other persons hold an interest in the partnership”, sec.
4 The mere fact that the subsidiary member is a partner in a partnership does not make the common parent a partner in the partnership. Rev. Rul. 2006-11, 2006-1 C.B. 635. Rather, it is the several liability that requires the common parent to be treated as a partner in the partnership for TEFRA partnership proceedings, but only to the extent that the liability stems from a partnership item. Id. -11-
6231(a)(9), neither Elmes Main Trust nor Elmes Sub-Trust had such an interest in
Sugarloaf.5
Mr. Elmes contends, however, that he is a partner in Sugarloaf by virtue of
his status as grantor of Elmes Sub-Trust. Specifically, he contends:
In Dionne v. Commissioner, T.C. Memo. 1993-117, the Court held that the petitioner fell within the ambit of Section 6231(a)(2) because he was a shareholder of a S-Corporation, a pass-through entity. The S-Corporation was a partner in a TEFRA partnership, and the Court concluded that the “petitioner’s income tax liability as stockholder in the S-Corporation [was] clearly determined by taking into account, indirectly, partnership items of the partnership...” Id. Thus, under Section 6231(a)(2)(B), the petitioner was deemed a partner of the partnership. Id. Like the petitioner’s ownership in the S-Corporation in Dionne, Elmes is the grantor of 2005 Elmes Subtrust, a passthrough entity. * * * The 2005 Elmes Subtrust, in turn, has a partnership interest in SUGARLOAF. As a result, under Section 6231(a)(2)(B), Elmes is considered a deemed partner of SUGARLOAF. [Fn. ref. omitted.]
The problem with this argument is that in Dionne, the S corporation had an
interest in the partnership, whereas here, Elmes Sub-Trust has no such interest.
5 It is not clear that Elmes Sub-Trust would fall within the definition of a “pass-thru” partner because, as a grantor trust, it may be treated as a disregarded entity for Federal income tax purposes. Secs. 671-679; cf. Samueli v. Commissioner, 132 T.C. 37, 39 n.3 (2009) (discussing a grantor trust as a disregarded entity such that the grantor is treated as the owner of what the trust owns), aff’d in part and remanded on another issue, 661 F.3d 399 (9th Cir. 2011). If this were the case, Mr. Elmes would own whatever Elmes Sub-Trust owned for Federal income tax purposes, including any partnership interest in Sugarloaf. But because Elmes Sub-Trust did not own a partnership interest in Sugarloaf in 2005, this avenue is also a dead end for Mr. Elmes. -12-
We have discussed above some of the circumstances under which a taxpayer
is deemed a partner under section 6231(a)(2)(B). Mr. Elmes, however, takes a
different tack and claims that he is a partner of Sugarloaf under section
6231(a)(2)(B) because his income tax liability depends in part on the trust’s basis
in the receivables, which he contends depends on Sugarloaf’s basis in those same
receivables. Mr. Elmes is correct that the basis of the receivables is a partnership
item of Sugarloaf. See Superior Trading, LLC v. Commissioner, 137 T.C. 70, 91
n.20 (2011) (involving a tiered partnership structure that was allegedly set up for
servicing Brazilian receivables, holding that “[e]ach partnership’s basis in the
receivables is part of that partnership’s inside basis and is therefore a ‘partnership
item’ within the meaning of sec. 6231(a)(3) and sec. 301.6231(a)(3)-1, Income
Tax Regs.”), supplemented by T.C. Memo. 2012-110, aff’d, ___ F.3d ___, 2013
WL 4505155 (7th Cir. Aug. 26, 2013).
The gist of Mr. Elmes’ argument appears to be that any adjustment to
Sugarloaf’s basis in the receivables determined by respondent or this Court would
necessarily affect the amount of the bad debt deduction to which Mr. Elmes is
entitled on his individual income tax return. This would occur because under
section 1015(b) the basis of the receivables in the hands of the transferee trust -13-
must be the same as the basis of those receivables in the hands of transferor
Sugarloaf.
This argument depends on the fact that the receivables were transferred
from Sugarloaf to Elmes Main Trust and then allocated to Elmes Sub-Trust, but
does not depend on any legal relationship among Mr. Elmes, the trusts, and the
partnership Sugarloaf for purposes of income taxation. We also note that 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).
In support of his position that he should be considered a partner of
Sugarloaf, Mr. Elmes cites our Supplemental Memorandum Opinion in Superior
Trading, LLC v. Commissioner, T.C. Memo. 2012-110. In Superior Trading, the
taxpayers contended that a Brazilian retailer contributed distressed consumer
receivables to Warwick, which then contributed the receivables to a series of
trading companies. Warwick then contributed most of its interest in those trading
companies to various holding companies. Warwick then sold a supermajority
interest in the holding companies to investors, who claimed substantial bad debt -14-
deductions. Respondent issued FPAAs to both Warwick and the trading
companies. In those FPAAs respondent took several alternative positions,
including that the receivables had no value even before they were transferred to
Warwick.
Warwick and most of the trading companies filed petitions with this Court.
Warwick’s petition was consolidated with some, but not all, of the trading
companies’ petitions. After trial of those consolidated cases, we found for
respondent on each of his alternative theories, including the theory that the
receivables had no value.
In our Supplemental Memorandum Opinion on petitioners’ motion for
reconsideration, before addressing again each of respondent’s alternative theories,
we discussed the investors who had acquired ownership interests in the holding
companies. After quoting section 6231(a)(2)(B), we stated that “to the extent their
income tax liability is affected by the basis of the * * * [distressed consumer]
receivables, a partnership item in these partnership-level proceedings, these
investors are partners for purposes of these proceedings. Consequently, pursuant
to section 6226(c)(1), each such investor ‘shall be treated as a party to such
action’.” Id., slip op. at 9. -15-
Superior Trading did involve a Sugarloaf-type entity (Warwick), but
Warwick’s proceeding had been consolidated for trial and opinion with the trading
companies’ TEFRA proceedings. Our holding in the consolidated cases that the
receivables’ basis was zero was a factual and legal determination of a partnership
item not just for Warwick, but also for the trading companies that were also
involved in the case. Unlike Mr. Elmes, the investors, each of whom owned an
interest in a trading company through one or more passthrough partners, were
indirect partners of the trading companies under section 6231(a)(10) and therefore
were bound by our decision as to partnership items of the trading companies,
particularly the basis of the receivables owned by their particular trading
company.6 Our conclusion that the investors were partners for purposes of the
consolidated Superior Trading proceeding was correct on the basis of the legal
relationship between the investors and the trading companies, rather than on the
transferor/transferee relationship between Warwick and the trading companies.
Mr. Elmes’ reliance on the language in Superior Trading as support for his
contention that he is a partner of Sugarloaf is misplaced.
6 Our decision regarding basis did not necessarily bind those trading company partnerships (and their partners) whose cases had not been consolidated. -16-
Mr. Elmes does not cite caselaw, other than Superior Trading and Dionne,
discussed supra, to support his expanded definition of partner for a TEFRA
proceeding. But, the Court of Appeals for the Seventh Circuit, to which this case
appears to be appealable absent stipulation to the contrary, has provided some
guidance in this realm, and it is contrary to Mr. Elmes’ position. Cemco Investors,
LLC v. United States, 515 F.3d 749 (7th Cir. 2008). Cemco Investors involved
three entities: a trust, a partnership, and the taxpayer (Cemco), a limited liability
company treated as a partnership for Federal income tax purposes. Id. at 750. The
trust entered into two-week-long offsetting short and long option contracts with a
bank and then contributed those options to the partnership. Id. The partnership
purchased euro and terminated the option contracts the next day. Id. The
partnership then liquidated, transferring its assets, both dollars and euro, to the
trust. Id. The trust turned around and contributed the euro to Cemco, which then
sold them. Id. Cemco claimed a loss on this sale on the grounds that it took a
carryover basis from the trust, which allegedly had an increased basis in the euro
equal to the full amount of the long option. Id. at 750-751.
One of Cemco’s arguments in its challenge to the FPAA was that the
Commissioner should have first issued an FPAA to the partnership because the
adjustment to Cemco’s basis in the euro depended on the partnership’s basis in the -17-
euro. Id. at 752-753. The Court of Appeals rejected this argument: “Cemco has
never been a partner of the Partnership or the Trust. These sections of the Code
[sections 6221 through 6234] therefore do not link the tax treatment of the euros in
Cemco’s hands to their tax treatment in anyone else’s.” Id. at 753.
By analogy, Mr. Elmes has never been a partner in Sugarloaf. The TEFRA
provisions do not require that the tax treatment of the receivables in Mr. Elmes’
hands match their treatment in Sugarloaf’s hands. While consistency of treatment
in the two parties’ hands would be ideal, and many related cases are consolidated
with this one in part for that purpose, nothing in the TEFRA provisions requires
this. See id. (“[T]he IRS need not ensure consistent tax treatment unless a statute
so requires. Sections 6221 to 6234 don’t require this because Cemco is not an
investor in the Partnership.”). Because Mr. Elmes is not a partner, direct or
indirect, in Sugarloaf, he has no standing to participate in this TEFRA proceeding.
We have considered all of Mr. Elmes’ contentions, arguments, requests, and
statements. To the extent not discussed herein, we conclude that they are
meritless, moot, or irrelevant. To reflect the foregoing,
An appropriate order
will be issued.