Court Opinion

ID: 9403247
Source: CourtListenerOpinion
Date Created: 2023-06-20 19:02:45.687421+00
Date Added: 2024-06-11T17:20:05.804757
License: Public Domain

United States Tax Court

                                  T.C. Memo. 2023-74

                          ANTHONY J.A. BRYAN, JR.,
                                Petitioner

                                            v.

               COMMISSIONER OF INTERNAL REVENUE,
                           Respondent

                                       —————

Docket No. 16797-16.                                             Filed June 20, 2023.

                                       —————

Anthony J.A. Bryan, Jr., pro se.

S. Penina Shadrooz and Sarah A. Herson, for respondent.

                           MEMORANDUM OPINION

      KERRIGAN, Chief Judge: Respondent determined the following
income tax deficiencies, additions to tax, and accuracy-related
penalties: 1

    Year             Deficiency                     Additions to Tax/Penalties
                                                 § 6651(a)(1)              § 6662(a)
    2010              $46,539                      $11,635                  $9,308
    2011                41,128                       5,511                   8,226
    2012              150,237                       35,425                  30,047

      The determinations for 2010 and 2011 were made in a deficiency
notice issued to petitioner (Anthony J.A. Bryan, Jr., a.k.a. Anthony

        1 Unless otherwise indicated, statutory references are to the Internal Revenue

Code (Code), Title 26 U.S.C., in effect at all relevant times, regulation references are
to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all relevant times,
and Rule references are to the Tax Court Rules of Practice and Procedure. All
monetary amounts are rounded to the nearest dollar.

                                   Served 06/20/23
                                            2

[*2] Bryan, Jr., John A. Bryan, or John Bryan, Jr.) and his wife (Ms.
Bryan) and stem from their joint federal income tax returns for those
years. The determinations for 2012 were made in a deficiency notice
issued to petitioner only and stem from his separate federal income tax
return for that year. Petitioner petitioned the Court to redetermine the
determinations for all three years (subject years). Ms. Bryan did not
join in his Petition for 2010 and 2011.

       Following concessions, we are left to consider two issues for each
subject year. 2 First, we decide whether petitioner may deduct the net
operating loss (NOL) carryover that was claimed on his tax return. We
hold he may not. Second, we decide whether petitioner is liable for the
section 6651(a)(1) addition to tax that respondent determined. We hold
he is.

                                     Background

I.      Background

       This case is before the Court fully stipulated under Rule 122. The
stipulated facts and facts drawn from the stipulated exhibits are
incorporated herein by this reference. Petitioner resided in California
when he timely filed his Petition.

       Petitioner and Ms. Bryan were married throughout the subject
years, and they filed joint federal income tax returns for 2010 and 2011. 3

        2  Petitioner in his Amended Opening Brief also addresses a third issue:
whether the Court should sustain the section 6662(a) accuracy-related penalties. The
parties have stipulated that “[p]etitioner is liable for the accuracy-related penalty
under I.R.C. § 6662 for 2010 and 2011 only as to the portion of the deficiency arising
from the disallowed Schedule A home mortgage interest deductions,” that “[p]etitioner
is not liable for the accuracy-related penalty under I.R.C. § 6662 as to the remaining
issues for 2010 and 2011,” and that “[p]etitioner is not liable for the accuracy-related
penalty under I.R.C. § 6662 for 2012.” Those stipulations resolve any dispute that the
parties may have had as to the applicability of the section 6662 accuracy-related
penalties and are binding on the parties unless we conclude that justice requires
otherwise. See Rule 91(e); Bail Bonds by Marvin Nelson, Inc. v. Commissioner, 820
F.2d 1543, 1547 (9th Cir. 1987), aff’g T.C. Memo. 1986-23. We do not conclude that
justice requires otherwise and will apply those stipulations without further discussion.
        3 Ms. Bryan was granted innocent spouse relief pursuant to section 6015 for

the deficiencies, penalties, and additions to tax in the notice of deficiency for 2010 and
2011.
                                           3

[*3] Petitioner filed a separate federal income tax return for 2012, using
the filing status of married filing separately.

II.     Watley Group, LLC

      The Watley Group, LLC (Watley), is a California limited liability
company formed on February 27, 1996. From January 1, 2007, through
December 31, 2012, petitioner owned a 99% membership interest in
Watley, and Ms. Bryan owned the remaining 1% interest. 4 Watley’s
operating agreement does not state that its members are liable for
Watley’s debts, and it does not provide for mandatory cash calls by or to
its managers or members. Watley’s operating agreement does not
provide for a capital deficit restoration obligation.

       Watley’s operating agreement does not require its members to
contribute additional capital to Watley in excess of the “Maximum
Capital Contribution” listed in the operating agreement. Watley
members must make their maximum capital contribution upon receipt
of a notice of request from a “majority in interest” of Watley’s members.
Petitioner owned a “majority in interest” in Watley from January 1,
2007, through December 31, 2012. Maximum Capital Contribution
amounts, when requested by the “majority in interest,” are paid in
installments “determined exclusively by the Managers, in their
reasonable discretion as needed for [Watley’s] business.” The operating
agreement lists petitioner’s Maximum Capital Contribution as
$166,667. The record does not show whether he has ever made that
contribution.

      Petitioner gave Watley a purported promissory note (petitioner’s
$2.7 million note), dated September 30, 2007, stating that he would pay
$2.7 million to Watley on or before December 31, 2030, with interest
accruing at an annual rate of 4.75%. The note is neither secured nor

        4 Neither party contends that any of Watley’s taxable years herein is subject to

the audit procedures of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA).
See §§ 6221–6234 (as in effect for years before 2018). Watley qualified for small
partnership status under section 6231(a)(1)(B) for each of those years and checked a
box on its 2008 through 2011 partnership returns indicating that it was not electing to
have the TEFRA provisions apply. Therefore, Watley is not subject to the TEFRA
provisions, and we proceed accordingly.
                                         4

[*4] collateralized. 5 The note does not include a repayment schedule but
does allow repayment to be extended without notice.

       Watley filed Forms 1065, U.S. Return of Partnership Income, for
2008, 2009, 2010, and 2011. 6 Watley did not report petitioner’s $2.7
million note on Schedules L, Balance Sheets per Books, of any of those
returns. Watley conducted business activities in 2012 but did not file a
partnership return for that year.

III.   Pool Boy the Movie, LLC

        Pool Boy the Movie, LLC (Pool Boy), is a Louisiana limited
liability company formed on August 24, 2006, to produce the movie
American Summer. New Moon Pictures, LLC (New Moon), and three
individuals who are not relevant to this Opinion executed the initial Pool
Boy operating agreement dated August 24, 2006. The operating
agreement was amended as of September 30, 2007, to add Watley as a
Pool Boy member. From September 30, 2007, through December 31,
2012, Watley owned a 20% membership interest in Pool Boy.

       As part of the amendment to the operating agreement, Watley
gave Pool Boy a promissory note of $2.7 million (Watley $2.7 million
note), payable with interest at 4.75% per annum, in return for its
interest in Pool Boy. The Watley $2.7 million note is dated September
30, 2007, and has the same terms as petitioner’s $2.7 million note.
Watley also received a $300,000 credit in its member’s account for prior
services that it had provided to Pool Boy. Neither Watley nor either of
the Bryans made any payment on the Watley $2.7 million note.

      Pool Boy’s operating agreement states that its members are not
personally liable for any judgment, decree, or court order against Pool
Boy or for the debts, obligations, liabilities, or contracts of the company.
The amendment to Pool Boy’s operating agreement does not alter the
personal liability protections provided in the original operating
agreement.

      Watley was not required to make any capital contribution to Pool
Boy in addition to the Watley $2.7 million note. Pool Boy’s operating

       5Although   the note is dated September 30, 2007, we cannot find in the record
the specific day on which the note was executed.
         6 The record does not include any partnership return that Watley may have

filed for 2007.
                                     5

[*5] agreement requires that the managing member make additional
capital contributions as needed to produce the movie. New Moon was
the managing member of Pool Boy from Pool Boy’s formation through
December 31, 2012. Watley was not a managing member of Pool Boy at
any time through December 31, 2012.

      Pool Boy’s operating agreement provides that members may not
make voluntary capital contributions to Pool Boy. It does not provide
for mandatory cash calls to its members (other than the managing
member). It does provide that its members have no capital deficit
restoration obligation.

       Pool Boy filed a Form 1065 and an amended Form 1065 for 2007.
The amended return was filed on January 19, 2010, and stated that it
was filed to report correctly notes receivable of $6,600,000, among other
things. Pool Boy filed Forms 1065 for 2008 through 2012. The 2008
through 2012 returns report notes receivable of $6,600,000 as
Schedule L assets.

IV.   NOTD Investments, LLC

     NOTD Investments, LLC (NOTD), is a Louisiana limited liability
company formed on May 22, 2008, to produce the movie Night of the
Demons. New Moon executed NOTD’s operating agreement, dated as of
May 22, 2008. At the time New Moon was the sole member.

       A second amendment to NOTD’s operating agreement was
executed, effective August 31, 2009, adding as NOTD members
petitioner, Peter M. Hoffman, and others not relevant to this Opinion.
Petitioner executed a promissory note of $1 million (payable with
interest at 2.75%) in exchange for his interest in NOTD. Neither of the
Bryans made any principal payment on that note.

        NOTD’s operating agreement states that its members are not
personally liable for any judgment, decree, or court order against NOTD
or for the debts, obligations, liabilities, or contracts of the company. The
second amendment to NOTD’s operating agreement does not alter the
personal liability protections provided in the original operating
agreement.

     NOTD’s operating agreement states that the managing member
must make capital contributions as needed to produce the movie. New
Moon was the managing member of NOTD from NOTD’s formation
                                   6

[*6] through December 31, 2012. Petitioner was not the managing
member of NOTD at any time through December 31, 2012.

      NOTD’s operating agreement provides that members may not
make voluntary capital contributions to NOTD. It does not provide for
mandatory cash calls to its members (other than the managing
member). It does provide (with limited exceptions not relevant to this
Opinion) that its members have no capital deficit restoration obligation.

       NOTD filed a Form 1065 for each year 2008 through 2012. NOTD
did not issue petitioner a 2008 Schedule K–1, Partner’s Share of Income,
Deductions, Credits, etc. NOTD’s Forms 1065 for 2009 through 2012 all
report yearend notes receivable of $4,280,000 as Schedule L assets.

V.     Autopsy LLC

       Autopsy, LLC (Autopsy), is a Louisiana limited liability company
formed on August 24, 2006. Autopsy’s members were New Moon and
three individuals who are not relevant to this Opinion.

VI.    New Moon

       New Moon’s sole member from August 24 through December 19,
2006, was Seven Arts Pictures, Inc. (SAP Inc.), an entity wholly owned
by Mr. Hoffman. New Moon added additional members thereafter. The
identity of those additional members is not relevant to this Opinion.

VII.   Seven Arts Pictures, PLC

       Seven Arts Pictures, PLC (SAP PLC), was a publicly traded
company in the United Kingdom and the United States, of which
Mr. Hoffman was the chairman, the chief executive officer, and a
director. SAP PLC was formed in 2001 and owned interests in 27
completed motion pictures as of 2007. As of March 30, 2007, SAP Inc.
owned 8,095,000 ordinary shares of SAP PLC, and public shareholders
owned 21,659,000 ordinary shares.

VIII. Palm Finance Loan

       Palm Finance Corp. (Palm Finance), New Moon, Pool Boy, and
Autopsy executed a loan agreement, effective May 7, 2007, wherein
Palm Finance agreed to lend New Moon, Pool Boy, and Autopsy
(collectively, Palm Finance loan borrowers) up to $5,500,000 (Palm
Finance loan). The Palm Finance loan was guaranteed by SAP Inc. and
                                    7

[*7] SAP PLC and an affiliate of theirs. Mr. Hoffman conducted
negotiations for the Palm Finance loan on behalf of the Palm Finance
loan borrowers and the guarantors. The following amounts were
disbursed pursuant to the Palm Finance loan to or on behalf of Pool Boy:

                       Date                Amount
                   May 9, 2007             $750,000
                   May 14, 2007             650,000
                   May 23, 2007             550,000
                   May 30, 2007             550,000
                   June 8, 2007             550,000
                   July 3, 2007             150,000
                   July 20, 2007            117,000
                   July 31, 2007               196
                   July 31, 2007             17,000
                   Aug 22, 2007              50,601
                   Aug. 22, 2007             49,399
                   Sept. 5, 2007             60,000
                   Sept. 17, 2007            45,000
                   Oct. 2, 2007              70,000
                   Feb. 19, 2007            150,000
                   Mar. 1, 2008                420
                   May 1, 2008                2,276
                   July 31, 2008               180
                   Aug. 24, 2012               702
                   Total                 $3,762,774

       The Palm Finance loan borrowers were jointly and severally
liable for the Palm Finance loan. Any payment on the Palm Finance
loan was credited to the loan as a whole and not allocated among the
Palm Finance loan borrowers. Neither Watley nor either of the Bryans
was personally liable for the Palm Finance loan. Neither Pool Boy,
Watley, nor either of the Bryans made any payment on the Palm
Finance loan.

      In the event of a default on the Palm Finance loan, collection was
not limited to the collateral specified in the loan agreement. Palm
Finance, however, was not entitled to directly collect on the loan against
Watley’s or either of the Bryans’ assets. Neither Watley nor either of
the Bryans pledged any of their assets as collateral or security for the
Palm Finance loan, and neither Watley nor either of the Bryans was a
                                    8

[*8] guarantor of the Palm Finance loan. Neither the Watley $2.7
million note nor petitioner’s $2.7 million note was ever pledged as
collateral or security for the Palm Finance loan. Nor was either of those
notes mentioned in any of the Palm Finance loan documents.

       On or about February 15, 2008, Palm Finance agreed to lend the
Palm Finance loan borrowers an additional $150,000 to complete the
production of movies. Approximately 3½ years later, Palm Finance
agreed to lend New Moon, Pool Boy, and Autopsy an additional $250,000
to repay the distributor for the advances in connection with the release
of a movie. Neither Watley nor either of the Bryans pledged any
collateral or made any payment to Palm Finance as to those additional
loans.

      The Palm Finance loan was still outstanding as of March 31,
2018. Collection letters on the Palm Finance loan were addressed to
Mr. Hoffman.

IX.   Cold Fusion Media Group, LLC Loan

       NOTD, New Moon, SAP Inc., SAP PLC, and an affiliate of the
latter two entities (collectively, Cold Fusion loan borrowers) executed a
loan agreement with Cold Fusion Media Group, LLC (Cold Fusion), in
or around February 2009 wherein Cold Fusion agreed to lend the Cold
Fusion loan borrowers an amount not to exceed $750,000 (Cold Fusion
loan). Cold Fusion agreed to lend the funds “in accordance with the cash
flow schedule approved by [Cold Fusion] and attached [to the Cold
Fusion loan agreement] as Exhibit ‘D’ (the “Cash Flow Schedule”) and
the Budget.” Exhibit D states that it includes a “1) CASH FLOW
SCHEDULE; 2) APPROVED BUDGET; AND 3) APPROVED
SCREENPLAY” but does not actually include any cashflow schedule or
approved budget.

        The Cold Fusion loan was executed by Mr. Hoffman on behalf of
each Cold Fusion loan borrower. Neither of the Bryans was personally
liable for the Cold Fusion loan. In the event of default, Cold Fusion was
not entitled to directly collect on the Cold Fusion loan against either of
the Bryans’ assets. Neither of the Bryans pledged any property as
collateral or security for the Cold Fusion loan, and neither of them was
a guarantor of the Cold Fusion loan. The $1 million note petitioner gave
to NOTD in exchange for his interest in NOTD was not pledged as
collateral or security for the Cold Fusion loan. Nor is that note
mentioned in the Cold Fusion loan documents.
                                    9

[*9] Neither Watley nor either of the Bryans made any payment on
the Cold Fusion loan. Payments were made by SAP Inc., SAP PLC, and
the aforementioned affiliate of those two entities.

X.    Petitioner’s Tax Returns

      A.     Background

        On his respective tax returns for the subject years, petitioner
claimed deductions for NOL carryovers of $3,501,337, $3,389,314, and
$3,240,711. The NOLs result from passthrough losses that petitioner
deducted on his 2007, 2008, and 2009 returns, the excesses of which
were carried forward as NOLs.             Respondent disallowed those
deductions, determining in the notices of deficiency that petitioner
(1) failed to substantiate the existence or amounts of the claimed NOLs;
(2) failed to substantiate he had a sufficient basis to deduct the claimed
NOLs; (3) did not substantiate he was at risk so as to be allowed to
deduct the claimed NOLs; and (4) did not substantiate that he
materially participated in the activity or activities generating the losses
so as to be allowed to deduct the claimed NOLs. Respondent has since
conceded that petitioner materially participated in the activity or
activities generating the NOLs disallowed as deductions for 2010, 2011,
and 2012.

      B.     2007

       Watley issued petitioner a 2007 Schedule K–1 reporting an
ordinary loss of $2,620,290. Watley issued Ms. Bryan a 2007 Schedule
K–1 reporting an ordinary loss of $26,468. The Bryans reported those
losses on their 2007 Schedule E, Supplemental Income and Loss.

       Watley included a nonpassive ordinary loss of $3 million
attributable to Pool Boy in computing net profit/loss for 2007. The
Bryans’ Schedule E loss for 2007, to the extent it exceeded their income
for that year, resulted in an NOL that the Bryans carried forward to
2008.

      C.     2008

       The Bryans’ 2008 Schedule E reported a loss of $1 million from
NOTD. To the extent that this loss exceeded the Bryans’ income for that
year, the Bryans added that excess to the NOL that they carried forward
from 2007 and carried forward to 2009 the resulting sum.
                                   10

[*10] D.     2009

       For 2009 the Bryans recognized wage income of $1,500, taxable
interest income of $165,042, and capital gains income of $1,593, and
they claimed a Schedule E loss of $755,226 and an “NOL CARRYOVER
TO 2009” of $2,719,784. The taxable interest was from passthrough
entities in which one or both Bryans was a member. The Bryans’ 2009
Schedule E reported a loss of $1 million from NOTD. To the extent that
the reported NOTD loss exceeded the Bryans’ income for 2009, the
Bryans added that excess to the NOL that they carried forward from
2008 and carried forward to 2010 the resulting sum.

      E.     2010

       For 2010 the Bryans recognized wage income of $73,250, taxable
interest income of $223,355, and Schedule E income of $130,466, and
they claimed an “NOL CARRYOVER TO 2010” of $3,501,337. The
taxable interest was from passthrough entities in which one or both
Bryans was a member.

      Petitioner’s 2010 tax return was due on October 15, 2011,
pursuant to an extension to file. The IRS received petitioner’s return on
January 2, 2013.

      F.     2011

       For 2011 the Bryans recognized wage income of $146,000, taxable
interest income of $223,250, and Schedule E income of $28,773, and they
claimed an “NOL CARRYOVER TO 2011” of $3,389,314. The taxable
interest was from passthrough entities in which one or both Bryans was
a member.

      Petitioner’s 2011 tax return was due on October 15, 2012,
pursuant to an extension to file. That return was received by the IRS
on January 7, 2013.

      G.     2012

       For 2012 petitioner recognized wage income of $130,000, taxable
interest income of $221,968, and Schedule E income of $338,024, and he
claimed a “Prior Year NOL” of $3,240,711. The taxable interest was
from passthrough entities in which petitioner was a member.
                                   11

[*11] Petitioner’s 2012 tax return was due on October 15, 2013,
pursuant to an extension to file. That return was received by the IRS
on June 16, 2014.

                               Discussion

I.    Overview

      Section 172(a) allows a taxpayer to deduct NOLs for a taxable
year. The amount of the NOL deduction equals the aggregate of the
NOL carryovers and NOL carrybacks to the taxable year. See id.
Section 172(c) defines an NOL as the excess of deductions over gross
income, computed with certain modifications specified in section 172(d).

       An unused NOL is “carried to the earliest of the taxable years to
which . . . such loss may be carried.” § 172(b)(2). Any excess NOL that
is not applied in one year is carried to the next earlier year. See id.
Absent an election under section 172(b)(3), an NOL for any taxable year
first must be carried back two years and then carried forward over 20
years. See § 172(b)(1)(A), (2), (3). A taxpayer who claims an NOL
deduction bears the burden of establishing both the existence of the NOL
and the amount that may be carried over to the year involved. See Keith
v. Commissioner, 115 T.C. 605, 621 (2000).

       The NOLs correlate to (1) a $3 million loss from Pool Boy for 2007,
(2) a $1 million loss from NOTD for 2008, and (3) a $1 million loss from
NOTD for 2009. The parties agree that Pool Boy and NOTD realized
those losses but dispute whether petitioner may claim any deduction for
the subject years with respect to them.

      Watley was a member of Pool Boy in 2007, and Pool Boy
apportioned the $3 million loss to Watley as its distributive share of a
Pool Boy loss. Watley then apportioned its loss (which included in its
computation the $3 million Pool Boy loss) to the Bryans, its only
members, who reported the Watley loss on their 2007 tax return.

       In 2009 petitioner became a member of NOTD, which apportioned
to him a $1 million loss for that year. The Bryans reported this loss on
their 2009 tax return. Neither of the Bryans was a member of NOTD in
2008.

      Petitioner deducted the NOL carryforwards stemming from the
above-described losses, on his tax returns for the subject years.
Respondent disallowed these deductions. Petitioner has the burden to
                                    12

[*12] show disallowance of the loss deductions was wrong. See Rule
142(a); Welch v. Helvering, 290 U.S. 111, 115 (1993). Petitioner does not
contend that the burden of proof shifts to respondent under section
7491(a) as to any issue of fact.

II.   2007 Loss from Pool Boy

       Petitioner must prove three points to overcome respondent’s
disallowance of the deductions with respect to the Pool Boy loss. First,
petitioner must prove that Watley had a sufficient outside basis in Pool
Boy to deduct the $3 million loss. See § 704(d). Second, he must prove
that he had a sufficient outside basis in Watley to deduct the losses that
Watley apportioned to him and Ms. Bryan. See id. Third, he must prove
that he was at risk with respect to Pool Boy’s activities. See § 465. We
will sustain respondent’s determination if petitioner fails to establish
any of those three points. See, e.g., Furey v. Commissioner, T.C. Memo.
2009-35.

      A.     Outside Basis

             1.     Overview

       A partner’s distributive share of a partnership loss is allowed only
to the extent of the adjusted basis of the partner’s interest in the
partnership at the end of the partnership year in which the loss
occurred. See § 704(d). A partner’s basis in a partnership interest,
referred to as outside basis, is determined by looking at (1) any property
that the partner contributed to the partnership, (2) any increase or
decrease based on the partnership’s income, loss, deductions, or credits,
(3) any partnership distribution, and (4) the partner’s share of
partnership liabilities. See §§ 705, 722, 733, 752; see also Rawls
Trading, L.P. v. Commissioner, 138 T.C. 271, 275 n.10 (2012). A
partner’s contribution of a promissory note to a partnership in which he
is a partner does not increase the partner’s outside basis. See
VisionMonitor Software, LLC v. Commissioner, T.C. Memo. 2014-182,
at *10 (and cases cited thereat).

        The amount of a partnership liability that is included in a
partner’s basis depends on whether the liability is recourse or
nonrecourse. See Treas. Reg. §§ 1.752-2(a), 1.752-3(a). Treasury
regulations under section 752 provide for the characterization of a
liability as recourse or nonrecourse. See Treas. Reg. § 1.752-1(a)
(defining recourse and nonrecourse liabilities); see also IPO II
v. Commissioner, 122 T.C. 295, 300 (2004). State law characterization
                                     13

[*13] of the liability, as well as the characterization of the liability by
the parties thereto, is not conclusive.

       Treasury Regulation § 1.752-1(a)(1) defines recourse liability as a
partnership liability to the extent that a partner or related person bears
the economic risk of loss as to the liability. Economic risk of loss (or lack
thereof) can result from statutes, the partnership’s governing
documents, or outside contracts. See Treas. Reg. § 1.752-2(b)(3). A
partner bears economic risk of loss

      to the extent that, if the partnership constructively
      liquidated, the partner or related person would be
      obligated to make a payment to any person (or a
      contribution to the partnership) because that liability
      becomes due and payable and the partner or related person
      would not be entitled to reimbursement from another
      partner or person that is a related person to another
      partner.

Id. subpara. (1).

        For purposes of the constructive liquidation, the regulations deem
the following events to occur simultaneously: (1) all partnership
liabilities become payable in full, (2) all partnership assets that do not
secure a partnership liability have a value of zero, (3) all partnership
property is disposed of in a fully taxable transaction for no consideration,
(4) the partnership’s income, gain, loss, and deductions are apportioned
among the partners, and (5) the partnership liquidates. Id. A partner’s
share of a recourse liability equals the portion of that liability for which
the partner or a related party bears the economic risk of loss. See id.
para. (a).

             2.     Watley’s Outside Basis in Pool Boy

       In 2007 New Moon, Pool Boy, and Autopsy borrowed money from
Palm Finance to finance making movies. Petitioner must prove that the
Palm Finance loan gave Watley a sufficient basis in Pool Boy for Watley
to deduct the Pool Boy loss. The parties agree that there was no other
capital contribution, transaction, or activity that would provide Watley
with an outside basis in Pool Boy.

        Pursuant to the Treasury regulations, the Palm Finance loan is a
recourse liability of Pool Boy since New Moon would bear the economic
risk of loss as to that liability. Because Pool Boy was a Louisiana limited
                                          14

[*14] liability company, its members would generally not be liable for
the company’s debts and would have no obligation to pay the Palm
Finance loan should Pool Boy’s assets be insufficient to satisfy the
liability. See La. Stat. Ann. § 12:1320 (2023). Pool Boy’s operating
agreement reiterates the members’ protected status. The operating
agreement states: “No Member, by virtue of his or its status as a
Member, shall be bound by or be personally liable . . . for the debts,
obligations, liabilities or contracts of the Company.” The operating
agreement provides that with the exception of the managing member,
“[n]o Member shall be required to contribute any additional capital to
the Company” and that “[e]xcept to the extent of its share of minimum
gain or non-recourse debt minimum gain [neither of which is applicable
here] . . . no Member shall have a Deficit Restoration Obligation.” These
provisions of the operating agreement are consistent with Treasury
Regulation § 1.752-2(b)(3)(ii).

       In contrast to the other members, New Moon would have an
obligation to pay the Palm Finance loan in the event of Pool Boy’s
constructive liquidation. New Moon was a borrower on the Palm
Finance loan, jointly and severally liable for the full amount of debt
pursuant to the loan agreement. In the event of a constructive
liquidation, when all Pool Boy’s liabilities became payable, its assets had
no value, and all its property was disposed of for no consideration, New
Moon alone would be responsible for payment of the Palm Finance loan.
New Moon would not be eligible for reimbursement from any of the other
partners. 7 Additionally, as Pool Boy’s managing member, New Moon
could be obligated to contribute additional capital.

       We conclude that Watley acquired no basis in Pool Boy on account
of the Palm Finance loan. Accordingly, Watley had no outside basis in
Pool Boy throughout the subject years.

                3.      The Bryans’ Outside Basis in Watley

       We conclude likewise that neither of the Bryans had any outside
basis in Watley throughout the subject years. The parties agree that
petitioner’s claim to any basis in Watley must stem from petitioner’s

        7 Under California law, New Moon may be eligible for reimbursement from its

co-borrowers if it pays more than its proportionate share of the Pool Boy loan. See Cal.
Civ. Code § 1432 (West 2023). However, we do not find in the record that any of the
co-borrowers are related to Pool Boy’s partners under Treasury Regulation § 1.752-
4(b). New Moon’s right of reimbursement from these entities is therefore irrelevant
for purposes of the economic risk of loss analysis, for reasons we previously discussed.
                                           15

[*15] $2.7 million note, the Watley $2.7 million note, and/or the Palm
Finance loan. In cases of tiered partnerships with recourse liabilities,
the liabilities of a lower-tier partnership allocated to the upper-tier
partnership (the lower-tier partnership’s member) equal the amount of
economic risk of loss the upper-tier partnership bears with respect to the
liabilities and any other liabilities for which the partners of the upper-
tier partnership bear the economic risk of loss. Treas. Reg. § 1.752-2(i).

       We conclude that Watley (the upper-tier partnership), does not
bear any economic risk of loss as to a Pool Boy liability, nor does either
of the Bryans bear any economic risk of loss as to a Pool Boy liability. 8
Neither of the Bryans acquired any outside basis in Watley from the
Palm Finance loan. Neither do petitioner’s $2.7 million note and the
Watley $2.7 million note provide either of them with any basis. See
VisionMonitor Software, T.C. Memo. 2014-182, at *10. Accordingly,
neither of the Bryans had any outside basis in Watley during the subject
years.

        B.      At Risk

       Even if we found sufficient outside basis to deduct the
passthrough loss from either Pool Boy or Watley, petitioner would still
have to establish he met the section 465 at risk requirement with respect
to Pool Boy’s movie-making activity to deduct the Watley losses. See
§ 465(a)(1). An individual taxpayer’s loss deduction from certain
activities is limited to the aggregate amount for which he is at risk for
that activity at the close of that year. Id. A taxpayer is at risk with
respect to a particular activity to the extent of (1) money and adjusted
basis of property he contributed to the activity and (2) amounts
borrowed with respect to the activity for which the taxpayer is
personally liable for repayment or has pledged property (other than
property used in the activity) as security for the loan. § 465(b)(1) and (2).

         8 Even if Watley would have been liable for Pool Boy’s debts, petitioner would

be shielded from paying those liabilities under California law because of Watley’s
status as a limited liability company. Similar to Louisiana law, California law provides
that “no member of a limited liability company shall be personally liable . . . for any
debt, obligation, or liability of the limited liability company, whether that liability or
obligation arises in contract, tort, or otherwise, solely by reason of being a member of
the limited liability company.” Cal. Corp. Code § 17101(a) (repealed 2013) (current
version at Cal. Corp. Code § 17703.04 (West 2023)). Watley’s operating agreement
does not alter the protections provided by California law; it states that “the rights and
liabilities of the parties . . . shall be determined in accordance with the provisions of
the laws of the State of California.”
                                   16

[*16] Borrowed amounts are generally not taken into account for at-
risk purposes if they are borrowed from someone who has an interest in
the activity or from a person related to someone having an interest in
the activity (other than the taxpayer). § 465(b)(3)(A). Property pledged
as security is not taken into account if the property is directly or
indirectly financed by indebtedness secured by the property that was
contributed. See § 465(b)(2). A taxpayer is not at risk with respect to
amounts for which he is protected against loss through nonrecourse
financing, guarantees, stop loss agreements, or similar arrangements.
§ 465(b)(4).

       In determining whether a taxpayer is personally liable for
repayment of borrowed money under section 465(b)(2), the Court of
Appeals for the Ninth Circuit, to which an appeal of this case would
normally lie, asks whether the taxpayer would be the obligor of last
resort. See Pritchett v. Commissioner, 827 F.2d 644, 647 (9th Cir. 1987)
(citing Melvin v. Commissioner, 88 T.C. 63, 75 (1987), aff’d, 894 F.2d
1072 (9th Cir. 1990)), rev’g and remanding 85 T.C. 580 (1985). Neither
Watley nor either of the Bryans contributed any money used in Pool
Boy’s movie-making activity. Nor were any of those three personally
liable for any amount borrowed for use in Pool Boy’s activities.

       Additionally, because Watley’s operating agreement does not
require additional capital contributions, petitioner could potentially be
at risk for Pool Boy’s activities. Cf. id. (finding limited partners had
ultimate liability because cash calls were mandatory and economic
reality would cause them to be made). While Watley’s operating
agreement provides for “maximum capital contributions” from its
members, if petitioner has already made the maximum capital
contribution which that agreement requires of him, he cannot be
required to make any further contribution. If on the other hand he has
not made his maximum contribution, the contribution would be required
only upon his receipt of a notice of a request from a majority in interest
of members. Petitioner owned a majority in interest in Watley
throughout the relevant timeframe. We find it unlikely that petitioner
would make a demand upon himself (or Ms. Bryan) to contribute funds
that would be earmarked for the payment of a liability for which neither
Watley nor either of the Bryans was personally liable. Cf. id.

      Petitioner relies on Melvin, 88 T.C. 63, to support his view that
he was at risk with respect to Pool Boy’s movie-making activity. In
Melvin the taxpayer’s wholly owned general partnership, Medici Film
Partners (Medici), was a limited partner in ACG Motion Picture
                                    17

[*17] Investment Fund (ACG), a California limited partnership. See id.
at 64. Medici acquired its interest in ACG in exchange for a $35,000
cash payment and a $70,000 recourse note in which Medici committed
to making capital contributions of $14,000 per year plus interest for five
years. See id. at 65. ACG acquired a $3.5 million recourse loan from a
bank. See id. at 66.

       As collateral for the loan, ACG pledged most of its assets,
including Medici’s $70,000 note and the other recourse notes it received
from its limited partners for deferred capital contributions. See id. The
bank loan agreement required that the partners’ notes “be physically
transferred to the bank in order to protect the bank’s security interest
in the notes.” See id. We held that the taxpayer could deduct his pro
rata share of the $3.5 million loan and cash payment. See id. at 79. We
concluded that the taxpayer was at risk for the amounts borrowed by
ACG because he was personally liable for the borrowed money. See id.
at 72–79.

       Respondent contends that Melvin can be distinguished on the
ground that petitioner’s $2.7 million note was not given to the lender or
specifically pledged as collateral. We do not need to decide whether
Melvin is distinguishable on that ground because we conclude that
Melvin is otherwise inapplicable as to the Pool Boy loss because we are
not persuaded that petitioner’s $2.7 million note was a bona fide debt.

         The Ninth Circuit has defined a loan in the context of taxation as
“‘an agreement, either express or implied, whereby one person advances
money to the other and the other agrees to repay it upon such terms as
to time and rate of interest, or without interest, as the parties may
agree.’ The conventional test is to ask whether, when the funds were
advanced, the parties actually intended repayment.”                    Welch
v. Commissioner, 204 F.3d 1228, 1230 (9th Cir. 2000) (quoting
Commissioner v. Valley Morris Plan, 305 F.2d 610, 618 (9th Cir. 1962),
rev’g in part 33 T.C. 572 (1959), and rev’g in part Morris Plan Co. of Cal.
v. Commissioner, 33 T.C. 720 (1960)), aff’g T.C. Memo. 1998-121. The
Ninth Circuit has looked to a transaction as a whole to evaluate whether
it is in fact a loan and has referenced the following factors, none of which
is dispositive in and of itself: (1) whether the promise to repay is
evidenced by a note or other instrument; (2) whether interest was
charged; (3) whether a fixed schedule for repayments was established;
(4) whether collateral was given to secure repayment; (5) whether
repayment was made; (6) whether the borrower had a reasonable
prospect of repaying the loan and whether the lender had sufficient
                                       18

[*18] funds to advance the loan; and (7) whether the parties conducted
themselves as if the transaction were a loan. Id.

       We have considered the factors, concluding that close scrutiny is
appropriate for a transaction between related parties. See Brown v.
United States, 329 F.3d 664, 673 (9th Cir. 2003); Advance Int’l, Inc. v.
Commissioner, 91 T.C. 445, 455 (1988). We are not persuaded that the
parties to petitioner’s $2.7 million note intended that the note be paid.
While petitioner through the note promised to pay Watley $2.7 million
with interest at 4.75% per year, he did so without setting a payment
schedule other than that the note had to be fully paid almost a quarter
of a century after the date that the note states that it was made.
Payment of the debt also is unsecured and uncollateralized. We do not
find in the record that any amount was ever paid on the note or that
petitioner had the ability to pay any significant portion of the note.

       Petitioner has not established that petitioner’s $2.7 million note
was executed on or about September 30, 2007, the date on the document,
or that either party to the note considered it to represent debt. While
Watley’s 2007 tax return is not in the record, subsequent returns fail to
reflect a $2.7 million promissory note as an asset on Schedule L, and no
interest income relating to the note is reported on petitioner’s tax
returns. 9 Conversely, the Watley $2.7 million note executed in 2007
does appear to be accounted for on Schedule L. In addition while the
two notes are essentially identical, unlike the Watley $2.7 million note
that was used to procure Watley’s ownership in Pool Boy, petitioner has
shown no business reason for execution of petitioner’s $2.7 million note.
We conclude that petitioner’s $2.7 million note was created at an
undetermined time and intended to be used solely to support petitioner’s
position that he was at risk with respect to Pool Boy’s activities.

      We conclude that petitioner has failed to establish that he was at
risk with respect to Pool Boy’s movie-making activity.

III.   NOTD Losses

       A.     2008 Loss

       Petitioner reported a $1 million passthrough loss from NOTD for
2008. He first became a member of NOTD in 2009. Petitioner is not
entitled to deduct a passthrough loss from NOTD for a year before he

        9 According to the attached return schedules, the interest income reported

flows almost entirely from Pool Boy.
                                            19

[*19] became a member of NOTD. See Richardson v. Commissioner, 76
T.C. 512, 525 (1981), aff’d, 693 F.2d 1189 (5th Cir. 1982). Accordingly,
we sustain respondent’s disallowance.

        B.      2009 Loss

       Petitioner relies on the Cold Fusion loan to contend that he has a
basis in NOTD for 2009. Petitioner, however, has not established the
amount of any Cold Fusion liability. While the Cold Fusion loan
agreement allows for borrowings of up to $750,000 in accordance with
certain documents, those documents are not in the record. We do not
know the amount (if any) advanced by Cold Fusion to the Cold Fusion
loan borrowers under the loan agreement.

       Petitioner also has failed to prove that the Cold Fusion loan
agreement grants a security interest in all of NOTD’s assets (one asset
of which was his $1 million note payable to NOTD). We conclude that
petitioner cannot establish his outside basis in NOTD. 10 See Hargis
v. Commissioner, T.C. Memo. 2016-232, at *29–30, aff’d sub nom. Hargis
v. Koskinen, 893 F.3d 540 (8th Cir. 2018). Therefore, petitioner had no
outside basis in NOTD. Accordingly, he is not entitled to deduct the
2009 loss that NOTD passed through to him.

IV.     Additional Argument of Petitioner

      Petitioner contends that the Watley loss and the NOTD loss
passed through to the Bryans or to him alone. The argument relies on
the premise that the three notes—petitioner’s $2.7 million note, the
Watley $2.7 million note, and the $1 million note payable to NOTD—are
assets of the respective entities and therefore collateral for the Palm
Finance and Cold Fusion loans pursuant to the loan agreements.
Treasury Regulation § 1.752-2(h) addresses the consequences of
pledging property, and specifically promissory notes, as security for a
partnership liability.

          10 Under Louisiana law, limited liability company members are not liable for

the company’s debts. See La. Stat. Ann. § 12:1320(B) (2023). NOTD’s operating
agreement confirms this in the setting at hand, stating that “[n]o member by virtue of
his or its status as a Member, shall be bound by or be personally liable . . . for the debts,
obligations, liabilities or contracts of the Company.” That agreement adds that, with
the exception of the managing member, “[n]o member shall be required to contribute
any additional capital to the Company,” and “[e]xcept to the extent of its share of
minimum gain or non-recourse debt minimum gain [neither if which is applicable here]
. . . no Member shall have a Deficit Restoration Obligation.”
                                    20

[*20] Treasury Regulation § 1.752-2(h)(1) and (2) provides that a
partner bears the economic risk of loss for a partnership liability to the
extent of property he pledges as security for the liability (i.e., direct
pledge) or property he contributes to the partnership “solely for the
purpose of securing a partnership liability” (i.e., indirect pledge). The
regulations specify, however, that a promissory note contributed to a
partnership by a partner or related person for the purpose of securing a
partnership liability is not taken into consideration for this purpose
unless the note is readily tradable on an established securities market.
Id. subpara. (4).

       Petitioner and Watley did not personally provide any property as
security for the Palm Finance or Cold Fusion loans. And the notes in
question were contributed to the entities, not given to the lenders, and
were not specifically designated as collateral in the loan agreements.
Palm Finance and Cold Fusion were possibly not aware of these notes
at the time of the loan agreements. The notes are not a direct pledge of
property as security for a partnership liability within the context of
Treasury Regulation § 1.752-2.

       We also conclude that the notes do not fall within the indirect
pledge provisions of those regulations. To constitute an indirect pledge
of property as security for Pool Boy’s and NOTD’s liabilities, petitioner
must establish that the Watley $2.7 million note, petitioner’s $2.7
million note, and petitioner’s $1 million note to NOTD were “readily
tradeable on an established securities market.” See id. para. (h)(4).
Petitioner and the record do not support such a conclusion. Because the
notes do not constitute security for the Palm Finance and Cold Fusion
loans as either direct or indirect pledges of property, they do not support
petitioner’s claim of a basis.

V.    Additions to Tax

       A taxpayer who fails to file a tax return timely is liable for an
addition of 5% for each month or fraction of a month that the return is
not filed, up to a maximum of 25%, unless the failure to file timely was
due to reasonable cause and not to willful neglect. See § 6651(a)(1).
Respondent has a burden of production which requires that he produce
evidence showing that imposition of the section 6651(a)(1) additions to
tax is appropriate. See § 7491(c); Higbee v. Commissioner, 116 T.C. 438,
446–47 (2001). Because the record shows that petitioner’s returns for
2010, 2011, and 2012 were not filed timely, respondent has met the
burden of production.
                                    21

[*21] The burden shifts to petitioner to establish that his failure to file
his returns timely was due to reasonable cause and not to willful neglect.
See § 6651(a)(1); Higbee, 116 T.C. at 447. Petitioner contends that he
had reasonable cause because he relied on tax professionals to prepare
his tax returns in a timely manner. He contends that his principal tax
professional had personal and health issues that resulted in delays in
following up with the preparer.

       Petitioner’s assertions are not supported by the record. A
taxpayer’s duty to file a timely tax return is nondelegable. See United
States v. Boyle, 469 U.S. 241, 249–50 (1985). Accordingly, petitioner is
liable for the late filing additions to tax.

       We have considered all arguments, and to the extent not
discussed above, we find them to be irrelevant or without merit. To
reflect the foregoing,

      Decision will be entered under Rule 155.