Court Opinion

ID: 4483395
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:16:04.773141+00
Date Added: 2024-06-11T15:04:31.274815
License: Public Domain

Goffe, J., concurring: I concur in the result that the trusts should not be recognized as limited partners but I cannot agree with the approach used by the majority. The majority holds that borrowed capital was not a material income-producing factor in the Sonoma limited partnership. There is an attempt to limit such holding to the facts of this case; nevertheless it places a qualification on the concept of “capital as a material income-producing factor” which concept is found in other areas of the tax law; i.e., e.g., definition of earned income from sources without the United States (sec. 911); income subject to the 50-percent maximum rate on personal service income (sec. 1348); earned income for self-employment tax purposes (sec. 1.1402(a)-2(a), Income Tax Regs.); election as to treatment of income subject to foreign community property laws (sec. 981); and the qualification of retirement plans covering self-employed individuals (sec. 1.401-10, Income Tax Regs.). The opinion of the majority is also out of touch with reality. Borrowed capital is almost invariably involved (usually to the maximum extent possible) in real estate developments. Moreover, the rationale adopted by the majority is gratuitous; it was not presented by respondent and, therefore, not argued by the parties in their briefs. The majority emphasizes the unlimited liability of the general partner (petitioner) as distinguished from the limited liability of the limited partners (trusts). Such distinction is meaningless because the degree of liability between general partners and limited partners is not only customary, it is definitional. Indeed, the regulations recognize this truism. Sec. 1.704r-l (e)(3)(ii)(c), Income Tax Regs. All of the members of the Court recognize that the tax avoidance scheme of Arthur Condiotti and his accountant-tax adviser, William P. Barlow, cannot be allowed to stand. It is an obvious attempt, and a somewhat crude attempt, lacking legitimate business purposes, to spread large anticipated sums of ordinary income among several taxpayer trusts to achieve a low rate of tax on such income. The tax-planning technique of splitting anticipated ordinary income among several taxpayers created by the taxpayer who generates the income is a well known method of attempting to minimize the rate of tax on such income; i.e., e.g., multiple corporations, multiple trusts, family partnerships. The only disagreement among the members of the Court is how best to set aside the tax avoidance scheme. I view the majority opinion as a strained approach to the problem and, therefore, reason for an alternative which is less dangerous, supported completely by the regulations and in harmony with the congressional intent of section 704. It would seem to me that the majority should examine the facts in light of the regulations promulgated under section 704(e) as the Court did in Krause v. Commissioner, 57 T.C. 890 (1972), affd. 497 F.2d 1109 (6th Cir. 1974), cert. denied 419 U.S. 1108 (1975). Arthur Condiotti and his tax adviser Barlow owned all of the issued and outstanding stock of petitioner. Condiotti, using his mother as grantor, established five trusts, naming Barlow as trustee of each. The trusts were for the benefit of Condiotti, his wife, and his three children. They were funded by cash contributions of $1,000 each which Condiotti gave to his mother. On the same day that the trust agreements were executed, Barlow, as trustee of the five trusts, acquired limited partnership interests for each of the trusts, using the entire corpus of each trust. The limited partnership consisted of the five trusts and petitioner, the general partner, which contributed only $556 to the capital of the partnership. Under the limited partnership agreement, each limited partner (trust) received an 18-percent share of the profits and assets upon dissolution and the general partner (petitioner) received only a 10-percent share of the profits and assets upon dissolution. The substantial sums of money used by Sonoma to generate its ordinary income came almost exclusively from loans assumed by petitioner or borrowed by petitioner and guaranteed by Condiotti and his wife. The obvious starting point for the examination of the Condiotti-Barlow scheme must be section 704(e),1 entitled “Family Partnership.” The predecessors of section 704(e) were sections 191 and 3797(a)(2) of the Internal Revenue Code of 1939. Those identical sections were added by the Revenue Act of 1951. The committee reports covering the enactment of sections 191 and 3797(a)(2) clearly declare the intent of Congress. H. Rept. 586, 82d Cong., 1st Sess. (1951), 1951-2 C.B. 357,380; S. Rept. 781,82d Cong., 1st Sess. (1951), 1951-2 C.B. 458, 485. After the Supreme Court decided Commissioner v. Tower, 327 U.S. 280 (1946), and Commissioner v. Culbertson, 337 U.S. 733 (1949), numerous cases arose involving transfers of capital among family members in the organization of family partnerships. Such family partnerships were frequently held to be invalid based upon such concepts as “intention,” “business purpose,” “reality,” and “control.” Congress enacted the predecessor of section 704(e) to— harmonize the rules governing interests in the so-called family partnership with those generally applicable to other forms of property or business. Two principles governing attribution of income have long been accepted as basic: (1) income from property is attributable to the owner of the property; (2) income from personal services is attributable to the person rendering the services. There is no reason for applying different principles to partnership income. * * * [H.Rept. 586, supra, 1951-2 C.B. at 380; S. Rept. 781, supra, 1951-2 C.B. at 485.] Section 1.704 — 1(e), Income Tax Regs., reflects the intent of Congress in enacting the predecessor of section 704(e). Petitioner does not challenge the validity of the regulations. The facts of this case should be examined under the tests specified by the various portions of section 1.704 — 1(e), Income Tax Regs., entitled “Family Partnerships.” The income of any partnership must be taxed to the person whose labor and skills earn the income and/or to the person whose own capital is utilized to produce the income. Sec. 1.704-l(e)(l), Income Tax Regs. Under section 752(a) of the Code, the increases in petitioner’s liabilities as a result of being a partner and the liabilities of the partnership assumed by petitioner are deemed to be contributions of money to the partnership, yet the profits of the partnership were allocated among the partners in the ratio of their initial contributions which were nominal in comparison to the tremendous liabilities assumed by petitioner. Even under this broad principle, it is readily apparent that the income of the partnership was not taxed to the partner who provided the capital. In the usual limited partnership, the limited partners contribute substantial sums needed to earn the income and the general partner performs services. In general, a person will be recognized as a partner for income tax purposes if he owns a capital interest in such partnership whether or not such interest is derived by purchase or gift from any other person. Sec. 1.704-l(e)(l)(ii), Income Tax Regs. However, in either the case of a purchase or a gift, the general rule is qualified as follows: A donee or purchaser of a capital interest in a partnership is not recognized as a partner under the principles of section 704(e)(1) unless such interest is acquired in a bona fide transaction, not a mere sham for tax avoidance or evasion purposes, and the donee or purchaser is the real owner of such interest. To be recognized, a transfer must vest dominion and control of the partnership interest in the transferee. The existence of such dominion and control in the donee is to be determined from all the facts and circumstances. A transfer is not recognized if the transferor retains such incidents of ownership that the transferee has not acquired full and complete ownership of the partnership interest. Transactions between members of a family will be closely scrutinized, and the circumstances, not only at the time of the purported transfer but also during the periods preceding and following it, will be taken into consideration in determining the bona fides or lack of bona fides of the purported gift or sale. * * * [Sec. 1.704-l(e)(l)(iii), Income Tax Regs.; Krause v. Commissioner, 57 T.C. 890,897 (1972). Emphasis added.] If all of the facts and circumstances are examined, the limited partnership interests were obviously not acquired in a bona fide transaction but were instead acquired as part of the Condiotti-Barlow scheme to avoid income tax. All of the parties involved were members of one family (that of Arthur Condiotti) except Barlow who was a “good friend and business associate” of Condiotti for approximately 20 years; who was Condiotti’s accountant and tax adviser; who prepared the trust agreements and partnership agreement and was paid for doing so; who advised Condiotti to establish the limited partnership and trusts; who owned enough of the stock of petitioner-general partner (20.5 percent) so that Condiotti did not own 80 percent (control); who was the sole trustee of the five trusts for the benefit of Condiotti, his wife, and three children; who executed, as preparer, many of the income tax returns of Condiotti, of petitioner, of Sonoma partnership, and of the five trusts and whose certified public accounting firm prepared all of such returns; and who was the only person who executed the Sonoma limited partnership agreement on behalf of petitioner-general partner as its assistant secretary and as trustee-limited partner for each of the five trusts for the benefit of Condiotti, his wife, and children. These relationships are more than coincidental; they overwhelmingly demonstrate that Barlow was amenable to the will of Condiotti. Sec. 1.704^1(e)(2)(vii), Income Tax Regs. The circumstances surrounding the creation of the trusts and limited partnership reek with suspicion. Condiotti gave the $5,000 to his mother who, in turn, became the grantor of the five trusts for the benefit of Condiotti, his wife, and his three children. The five trust agreements were executed by Condiotti’s mother as grantor and Barlow as trustee on the same day, but Barlow testified that he never saw Condiotti’s mother and thought she lived in New York although obviously Barlow executed the trust agreements in California. On the same day he executed the trust agreements Barlow executed the limited partnership agreement on behalf of petitioner, the general partner, and as trustee for each of the limited partners. Barlow testified that he intended to invest the $5,000 in the Sonoma limited partnership before the creation of the trusts or creation of the partnership. All of the facts involved amply demonstrate that the acquisitions of the limited partnership interests were nothing more than shams for tax avoidance purposes. The acquisition of each limited partnership interest was cast in terms of a purchase so such acquisitions should first be examined under the provisions of section 1.704-l(e)(4), Income Tax Regs. A purchase of a capital interest in a partnership will be recognized as bona fide if, considering all relevant factors, it has the usual characteristics of an arm’s-length transaction. Sec. 1.704-l(e)(4)(ii) (a) , Income Tax Regs. The purchase in the instant case had none of the characteristics of an arm’s-length transaction. It was between related parties pursuant to an overall plan to avoid taxes. If the purchase is not arm’s-length it can, nevertheless, be recognized if— It can be shown, in the absence of characteristics of an arm’s-length transaction, that the purchase was genuinely intended to promote the success of the business by securing participation of the purchaser in the business or by adding his credit to that of the other participants. [Sec. 1.704r-l(e)(4)(ii)(&), Income Tax Regs.] That test cannot be fulfilled because each of the trusts contributed only “seed money” of $1,000 each and were liable for no more. The trusts did nothing to promote the success of the business; they participated in nothing but profits. The trusts, having failed to satisfy the tests for purchased interests in a family partnership, may be recognized only if they meet the requirements applicable to the acquisition of a partnership interest by gift. Sec. 1.704r-l(e)(4)(i), Income Tax Regs. Indeed, the limited partnership interests were acquired by gifts of cash by Condiotti through his mother to Barlow as trustee for the benefit of himself, his wife, and his three children. Section 1.704H(e)(2)(i) provides: Whether an alleged partner who is a donee of a capital interest in a partnership is the real owner of such capital interest, and whether the donee has dominion and control over such interest, must be ascertained from all the facts and circumstances of the particular case. Isolated facts are not determinative; the reality of the donee’s ownership is to be determined in the light of the transaction as a whole. The execution of legally sufficient and irrevocable deeds or other instruments of gift under state law is a factor to be taken into account but is not determinative of ownership by the donee for the purposes of section 704(e). The reality of the transfer and of the donee’s ownership of the property attributed to him are to be ascertained from the conduct of the parties with res/pect to the alleged gift and not by any mechanical or formal test. Some of the more important factors to be considered in determining whether the donee has acquired ownership of the capital interest in a partnership are indicated in subdivisions (ii) to (x), inclusive, of this subparagraph. [Emphasis added.] The reality of the transaction as a whole, as explained above, clearly shows that the general donee test of ownership cannot be satisfied. Moreover, the scheme fails to satisfy the specific test of section 1.704-l(e)(2)(iii): Controls inconsistent with ownership by the donee may be exercised indirectly as well as directly, for example, through a separate business organization, estate, trust, individual, or other partnership. Where such indirect controls exist, the reality of the donee’s interest will be determined as if such controls were exercisable directly. Here, the donor, Condiotti, and Barlow completely controlled petitioner, which was the sole general partner of Sonoma, which, under the partnership agreement, had the exclusive authority to make decisions of the partnership. In addition to the specific tests of retention of control by the donor, the final “catch-all” provision of section 1.704^1(e)(2)(vi), Income Tax Regs., applies: However, despite formal compliance with the above factors, other circumstances may indicate that the donor has retained substantial ownership of the interest purportedly transferred to the donee. Not by the wildest stretch of the imagination can Barlow satisfy the tests imposed by the regulations on recognition of a trustee as a partner in a family partnership. Trustees as partners. A trustee may be recognized as a partner for income tax purposes under the principles relating to family partnerships generally as applied to the particular facts of the trust-partnership arrangement. A trustee who is unrelated to and independent of the grantor, and who participates as a partner and receives distribution of the income distributable to the trust, will ordinarily be recognized as the legal owner of the partnership interest which he holds in trust unless the grantor has retained controls inconsistent with such ownership. However, if the grantor is the trustee, or if the trustee is amenable to the will of the grantor, the provisions of the trust instrument (particularly as to whether the trustee is subject to the responsibilities of a fiduciary), the provisions of the partnership agreement, and the conduct of the parties must all be taken into account in determining whether the trustee in a fiduciary capacity has become the real owner of the partnership interest. Where the grantor (or person amenable to his will) is the trustee, the trust may be recognized as a partner only if the grantor (or such other person) in his participation in the affairs of the partnership actively represents and protects the interests of the beneficiaries in accordance with the obligations of a fiduciary and does not subordinate such interest to the interests of the grantor. [Sec. 1.704-l(e)(2)(vii), Income Tax Regs. Emphasis added.] Barlow is amenable to the will of Condiotti for numerous business reasons, the most apparent one being that Barlow is the only minority shareholder of petitioner and Condiotti is the only majority shareholder. The close relationship of Condiotti and Barlow spelled out above amply reveals how amenable Barlow is to his client and good friend, Condiotti. The specific provision in the regulations as to limited partners in family partnerships likewise cannot be satisfied here: The recognition of a donee’s interest in a limited partnership will depend, as in the case of other donated interests, on whether the transfer of property is real and on whether the donee has acquired dominion and control over the interest purportedly transferred to him. [Sec. 1.704-l(e)(2)(ix), Income Tax Regs.] The donees of the limited partnership interests are the donor himself, his wife, and his three children. The trustee for the limited partners, Barlow, was subject to the dominion and control of Condiotti, the donor. Petitioner offered no evidence whatever of the independence of Barlow and I suspect there could be no such evidence. Finally, the regulations speak of motive. If the reality of the transfer of interest is satisfactorily established, the motives for the transaction are generally immaterial. However, the presence or absence of a tax-avoidance motive is one of many factors to be considered in determining the reality of the ownership of a capital interest acquired by gift. [Sec. 1.704-l(e)(2Xx), Income Tax Regs. Emphasis added.] This brings us back to the conclusion stated earlier that the creation of the trusts and the limited partnerships was nothing more than a scheme to evade tax. Prior to their creation, Condiotti and his corporations, including petitioner, engaged in the identical business engaged in by the Sonoma limited partnership and Sonoma, in actuality, performed no useful function except the splitting up of income to five more taxpayers. Although the parties here substantially carried out the formal steps in creating the trusts and the partnership, they represent shams. Morton v. Commissioner, 46 T.C. 723 (1966). The parties having flunked all of the tests, I would, therefore, hold that the trusts cannot be recognized as partners and sustain the Commissioner in his determination that all of the income of the Sonoma limited partnership is taxable to petitioner. Scott, Dawson, Irwin, Sterrett, and Wiles, JJ., agree with this concurring opinion.  SEC. 704. PARTNER’S DISTRIBUTIVE SHARE. (e) Family Partnerships.— (1) Recognition of interest created by purchase or gift. — A person shall be recognized as a partner for purposes of this subtitle if he owns a capital interest in a partnership in which capital is a material income-producing factor, whether or not such interest was derived by purchase or gift from any other person. (2) Distributive share of donee includible in gross income. — In the case of any partnership interest created by gift, the distributive share of the donee under the partnership agreement shall be includible in his gross income, except to the extent that such share is determined without allowance of reasonable compensation for services rendered to the partnership by the donor, and except to the extent that the portion of such share attributable to donated capital is proportionately greater than the share of the donor attributable to the donor’s capital. The distributive share of a partner in the earnings of the partnership shall not be diminished because of absence due to military service. (3) Purchase of interest by member of family. — For purposes of this section, an interest purchased by one member of a family from another shall be considered to be created by gift from the seller, and the fair market value of the purchased interest shall be considered to be donated capital. The “family” of any individual shall include only his spouse, ancestors, and lineal descendants, and any trusts for the primary benefit of such persons.