Opinion ID: 578652
Heading Depth: 2
Heading Rank: 2

Heading: Application of Statutory and Regulatory Scheme to the Case

Text: 30 Mr. Goulding challenges the validity of Treasury Regulation § 301.7701-15(b)(3), in accordance with which he was deemed the preparer of the partners' returns and penalized for the understatements in them. As the sole preparer of the partnership return, Mr. Goulding provided copies of the partnership K-1 forms to the individual partners, who then entered (or whose own return preparers then entered) a single number (a deduction) on their own tax returns. Mr. Goulding argues that he cannot have prepared returns he never saw or touched, that he did not give advice to partners he never met or spoke with, and that in any case, he cannot be considered as having prepared a substantial portion of returns on which he is responsible for a single entry. Mr. Goulding also argues that he was not compensated by the partners, as required by the statutory definition of preparer. 31 Mr. Goulding contends that in deeming him the preparer of the partners' returns, the regulation is contrary to the statutory definition of preparer, to the Commissioner's own regulation defining substantial portion, and to the intent of Congress as revealed in the legislative history. Under the statutory definition of preparer, Mr. Goulding cannot be the preparer of these returns unless he prepared a substantial portion of the returns. According to Mr. Goulding, the single entry on the partnership returns cannot constitute a substantial portion. He argues that in promulgating a regulation which transforms a single entry into a substantial portion, the Commissioner has exceeded his authority. In this regard, Mr. Goulding relies primarily on a passage from the legislative history which explains the intent behind the substantial portion language of the statute: 32 Whether or not a portion of a return constitutes a substantial portion is to be determined by examining both the length and complexity of that particular portion of the return and the amount of tax liability involved. In a normal case, the filling out of a single schedule of a tax return would not be considered a substantial portion of that return unless that particular schedule was the dominant portion of the entire tax return. 33 H.R.Rep. No. 658, 94th Cong., 2d Sess. 275, reprinted in 1976 U.S.C.C.A.N. 3171. As noted above, the regulation defining substantial preparation also directs that length and complexity be taken into consideration. Mr. Goulding maintains that the single entry on a partner's return which reflects information from the partnership return cannot be considered a substantial portion of the partner's return under the length and complexity standard. 34 Mr. Goulding also points to the House Report's statement that an individual who gives advice on particular issues of law or IRS policy relating to particular deductions or items of income will not have prepared a return with respect to those issues if the advice does not directly relate to any specific amounts which are to be placed on the return of the taxpayer. Id. Because issues, deductions, items, and amounts are plural, Mr. Goulding argues that Congress did not intend that giving advice relating to a single amount or deduction result in preparer status. Moreover, Mr. Goulding argues that, in providing copies of the K-1 forms to the partners, he did not give advice to them; in most cases he never spoke with them or even met them. 35 Finally, Mr. Goulding suggests that the regulation is in conflict with other provisions of the Internal Revenue Code. He argues that the other provisions regarding preparers cannot possibly apply to him. For example, he could not be required to sign the partners' returns or retain copies of them. A consistent construction of the definition of preparer, he argues, would exclude him from liability under section 6694 as well. 5 36 The government argues that the legislative history makes clear that a person who supplies substantive information and advice relating to specific entries on a return may be treated as a preparer of that return even though someone else fills it out. See H.R.Rep. No. 658, 94th Cong., 2d Sess. 275, reprinted in 1976 U.S.C.C.A.N. 3171. The Regulations apply that principle to a person in appellant's position, treating the preparer of a partnership return as the preparer of a partner's return if the information on the partnership return is directly reflected on, and constitutes a substantial portion of, the partner's return. Appellee's Br. at 20. The objective of the statutory scheme is to impose the penalty on the person who is responsible as a substantive matter for the way in which a return is prepared. Because the partnership pays no taxes itself, the purpose of the partnership tax return and the Schedules K-1 is to figure out the deductions or income that each partner may state on his return. Therefore, argues the IRS, appellant is directly responsible as a substantive matter for the partners' returns. Moreover, the IRS points out, there would be very little deterrent effect in penalizing the preparer of the partnership return for that return alone. Therefore, the regulations are a reasonable method of carrying out the intent of Congress to deter improper preparation.
37 In evaluating these contentions, we believe that one point must be central to our analysis. In drafting and in enforcing the regulation, the Commissioner has a duty to apply the intent of the Congress to a myriad of financial relationships and transactions. See Muffler Dealers Ass'n v. United States, 440 U.S. 472, 477, 99 S.Ct. 1304, 1307, 59 L.Ed.2d 519 (1979). In each instance, the relationship of the preparer and the taxpayer necessarily will differ. But the policy objective remains the same: to deter negligent conduct on the part of a person who prepares an analysis of financial data upon which the taxpayer will rely in stating a substantial part of his tax liability. 38 Here the government's position reflects both the congressional intent and the realities of the limited partnership relationship. Partnerships are hybrids--for some purposes they are entities separate from the partners, for other purposes they are aggregates of the individual partners. See generally 1 W. McKee, W. Nelson & R. Whitmire, Federal Taxation of Partnerships and Partners, p 1.02 (2d ed. 1990). Under the Internal Revenue Code, partnerships are not taxpayers or taxable entities. When a partnership receives income, the partners record their share of that income on their individual returns and are taxed on it, whether or not that income is actually distributed to them. Partners also deduct partnership losses on their individual returns. Partnerships are entities for purposes of calculating and filing informational returns; otherwise they are conduits through which the taxpaying obligation passes to the individual partners in accord with their distributive shares. United States v. Basye, 410 U.S. 441, 448, 93 S.Ct. 1080, 1085, 35 L.Ed.2d 412 (1973). This arrangement means that the calculation of income at the partnership level is nothing more than 'a method of centralizing a host of decisions that must be made uniformly for all partners, such as whether particular items received by the partnership constitute income or the return of capital, whether expenditures qualify as ordinary or necessary expenses of conducting the firm's business, and so on.'  Estate of Newman v. C.I.R., 934 F.2d 426, 432-33 (2d Cir.1991) (quoting 3 B. Bittker & L. Lokken, Federal Taxation of Income, Estates and Gifts, p 86.1.1 (2d ed. 1991)). 39 As the partnership is both entity and aggregate, the tax preparer's relationship to the partnership is necessarily dual--he is dealing with the partnership both as entity and as aggregate of partners. Appellant was retained to analyze the partnership operation; however, the analysis of the partnership operation was a making of decisions and calculations for all the individual partners, to whom the tax liability or deductions would flow through the partnership. These decisions and calculations were directly reflected on the returns of the partners; all the individual partners depended upon Mr. Goulding's analysis. Thus while appellant was retained by the partnership and compensated by the partnership, 6 in reality his work was for all the partners. 40 True, Mr. Goulding's work boiled down to one entry on each partner's return, but it represented a far more complicated analysis of partnership earnings--an analysis upon which the limited partners necessarily relied. Thus, Mr. Goulding's comparison of the Schedules K-1 to other informational forms is unconvincing. As appellee points out, normally it is just a question of fact how much a taxpayer has earned from wages or interest; a bookkeeper can prepare a Form W-2 or 1099 and the taxpayer who receives the form can check it against his own records. Appellee's Br. at 31. This is not true of Schedules K-1; because of the often complicated nature of a partnership return and partnership transactions, a partner cannot readily verify the information and calculations on the partnership return. Moreover, the Internal Revenue Code requires, as a general rule, that tax treatment of partnership items be determined at the partnership level, see 26 U.S.C. § 6221, and that an individual partner, on his own return, treat a partnership item in a manner which is consistent with the treatment of the item on the partnership return. See 26 U.S.C. § 6222. 41 Because appellant's analysis of the partnership's financial operations was in essence an analysis of income directly taxable to the partners and losses directly deductible by them, the regulation making him the preparer of their returns reflects the real relationship between Mr. Goulding and the partners. The compensation Mr. Goulding received for his legal service to the partnership is, given the relationship of the partners to the partnership, really from the partners. His relationship to the partnership and its members was very much the one Congress had in mind in its regulation of income tax return preparers. 42 We note, moreover, that under the regulation, only a preparer of a return--a person who meets the statutory definition of preparer with respect to a return--may be deemed to be the preparer of another return. If Mr. Goulding were the employee of the partnership, or had not received compensation for the partnership return, or had merely furnished mechanical assistance in the preparation of the partnership return, see 26 U.S.C. § 7701(a)(36), he could not, under the regulation, be deemed the preparer of the partners' return. The regulation thus preserves the congressional intention to distinguish between professional or commercial preparers on the one hand and employees, friends or relatives on the other. 43 Finally, we cannot accept Mr. Goulding's contention that, by deeming him the preparer of the partners' returns, the regulation is inconsistent with other uses of the term income tax return preparer in the Internal Revenue Code. None of the other statutory provisions governing the conduct of income tax return preparers applies in blanket fashion to all preparers. Rather, in each case application is expressly limited to those specified in regulations prescribed by the Secretary. See 26 U.S.C. § 6107(c); § 6109(a); § 6695(a), (b), (c), & (d). Thus, the statutory scheme reflects recognition of the fact that more than one person may be a preparer in respect to one return, and that not all provisions imposing duties on preparers will apply to all preparers. 44 In short, we conclude that the regulation harmonizes with the plain language of the statute, its origin, and its purpose. National Muffler Dealers Ass'n v. United States, 440 U.S. 472, 477, 99 S.Ct. 1304, 1307, 59 L.Ed.2d 519 (1979). It was well within the Commissioner's authority to promulgate the regulation in question, and under the terms of that regulation, Mr. Goulding is properly considered the preparer of the limited partners' returns.