In VisionMonitor Software, LLC v. CIR, T.C. Memo 2014-182, the Tax Court faced another taxpayer’s attempt to create basis in a partnership interest through the contribution of a promissory note. Unfortunately for the taxpayer, VisionMonitor follows pretty well established law that a partner’s contribution of his own promissory note to his partnership does not create basis in the partner’s partnership interest. The partner has a zero basis in his note and the partner’s argument that the contribution of the note put him at more financial risk was rejected. To have additional basis, the partner would have had to actually assume entity level debt, not just contribute his note to capital. While interesting, this is really not new. What is interesting (maybe to a Tax Wonk) is how the Tax Court looked at whether the basis is a partnership level determination or a partner level determination.
In the court’s analysis, Judge Holmes concludes that this is clearly a partnership level issue and that the applicability of penalties that relate to the adjustment of a partnership item must be litigated at the partnership level proceeding. Judge Holmes also notes that while a partnership is not a taxpayer, the court can determine the applicability of the understatement, negligence or intentional disregard penalty at the partnership level because it is related to what the partnership is doing (with “related” meaning “logical and causal relationship”).
He compares the jurisdictional issue for partnership items and partner level items as follows: “Partnership-penalty law gets even more complicated when one looks at defenses because jurisdiction over them can exist at both the partnership and partner levels. The partnership itself may have a defense to a penalty that would shield all its partners; one partner may have a defense to the penalty that’s all his own. Our Court has jurisdiction to rule on any partnership-level defense, but partners have to take their partner-level defenses to a refund forum.”
He then analyzed the taxpayer’s defense against the proposed negligence penalty of relying on professional advice, being fairly generous in its holding for the taxpayer. While clearly finding that the tax advisor was competent, Judge Holmes focused on whether the taxpayer had provided all the information necessary to allow the advisor to properly analyze the basis issue. While noting some sloppiness, errors and discrepancies, the Court found that the taxpayer had provided the advisor all the information needed.
This interesting case may be helpful where one is attempting to avoid penalties based the on the reliance on professional advice. While cases of this nature are very fact specific, Judge Holmes’ common sense approach to determining reasonable reliance on the professional advisor is refreshing.