Opinion ID: 163637
Heading Depth: 2
Heading Rank: 2

Heading: Tax Court Approach

Text: 39 The Commissioner also attempts to defend the Tax Court's ruling, which he paraphrases to say: [T]he manner in which the distributive share of a partner in bankruptcy is allocated between the partner and the bankruptcy estate of that partner is not a `partnership item' under IRC § 6231(a)(3), and need not be made at the partnership level. Aple. Br. at 30. He acknowledges that the total amount of partnership losses for the year is determined at the partnership level, and the manner in which those losses are divided among the partners of each partnership is also a partnership item. Id. But he states that [t]he regulation promulgated by the Secretary to define partnership items, Treas. Reg. § 301.6231(a)(3)-1, does not address the possibility that one partner will file a bankruptcy petition during the taxable year. Id. at 31. According to the Commissioner, not only is there no indication in the Regulation that the allocation of a debtor-partner's loss between the debtor-partner and the bankruptcy estate is a partnership item, id., but neither does general tax law require partnerships to take into account on the partnership return the fact that one partner has become a debtor in bankruptcy, and his partnership interest has become property of a bankruptcy estate, id. at 31-32. 40 Although the premises of the Commissioner's argument may well be true, his conclusion does not follow. First, the absence of a reference to bankruptcy in the regulation defining partnership items does not imply that there must be some sort of exception in that context. On the contrary, it indicates the general applicability of the regulation to bankrupt partners. Moreover, the Secretary's promulgation of a regulation (the Bankruptcy Regulation) specifically to provide for an exception to the general rule when a bankruptcy is involved strongly suggests that the existence of a bankruptcy would otherwise not be a reason to treat as a nonpartnership item what would be a partnership item under the general regulation. 41 Second, the rule regarding allocation of losses between the debtor-partner and the bankruptcy estate is a red herring. What is important is that the debtor was a partner during part of the partnership year, so the partnership returns must set forth the debtor's share of income, loss, etc. It may be that the partnership can report all such items as the debtor's, and need not prepare a K-1 for the bankruptcy estate. And perhaps the proper tax treatment of the debtor's share of income and losses is to allocate all items to the bankruptcy estate. Nevertheless, the Commissioner has not challenged the proposition that the partnership return must contain an assignment of income and loss to a partner who has declared bankruptcy, whether the figures be $1 million or $0, and that these figures are partnership items unless excluded by a regulation. If a figure is wrong, it can be challenged only in a partnership-level proceeding. 42 To say that the allocation is not a partnership item is to confuse the process with the result. The statute requires partnership-level proceedings if a partnership item is being challenged. The partnership item is, of course, the result of the allocation of the partnership's income, losses, etc; but the allocation process itself is not a partnership item. The requirement of a partnership-level proceeding is triggered regardless of how the partnership item was calculated. There may be sound policy reasons for not requiring a full-blown partnership-level proceeding when an alleged error in one partner's return affects only one other taxpayer rather than all the partners. But for now the law is otherwise. 43 We DISMISS the appeal in Case No. 01-9010. In Case No. 01-9009 and Case No. 01-9011, we REVERSE the decision of the Tax Court and REMAND for proceedings consistent with this opinion. We express our appreciation to counsel for the fine appellate briefs.