Boynton v. C.I.R.

• Decision Date: 09 July 1981
• Docket Number: No. 80-5069,80-5069
• Citation: 649 F.2d 1168
• Parties: 81-2 USTC P 9560 Joe T. BOYNTON and Helen J. Boynton, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. . Unit B
• Court: U.S. Court of Appeals — Fifth Circuit

Page 1168

649 F.2d 1168

81-2 USTC P 9560

Joe T. BOYNTON and Helen J. Boynton, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 80-5069.

United States Court of Appeals, Fifth Circuit.

Unit B

July 9, 1981.

Rogers & Meisel, Robert O. Rogers, David S. Meisel, Palm Beach, Fla., for petitioners-appellants.

M. Carr Ferguson, Asst. Atty. Gen., Gilbert E. Andrews, Acting Chief, Appellate Sect., Richard W. Perkins, Daniel F. Ross, Attys., Tax Div., U. S. Dept. of Justice, N. Jerold Cohen, Chief Counsel, Internal Revenue Service, Washington, D. C., for respondent-appellee.

Appeal From the Tax Court of the United States.

Before HILL, and FRANK M. JOHNSON, Jr., Circuit Judges, and SCOTT ^*, District Judge.

FRANK M. JOHNSON, Jr., Circuit Judge:

Joe T. Boynton ¹ petitioned the United States Tax Court for a redetermination of federal income tax deficiencies totalling $203,487 assessed against him by the Commissioner of Internal Revenue (Commissioner) for calendar years 1971 through 1974. ² The Tax Court, 72 T.C. 1147, found for the Commissioner and we consider Boynton's appeal under 26 U.S.C.A. § 7482. This appeal and that of Holladay v. Commissioner, 649 F.2d 1176 (5th Cir. 1981) (consolidated for oral argument and decided the same day) both involve the propriety of allocating all of the losses sustained by a partnership to one partner. Because we conclude that these allocations lacked substantial economic effect, we affirm.

I. Facts

The facts are substantially undisputed. In February 1974, Boynton formed the Palm Beach Ranch Groves partnership in order to purchase and operate a citrus grove. Plimpton, who was to operate the grove, had a pre-existing agreement to purchase the 1,922.37-acre citrus grove located in Palm Beach County, Florida, at $1,600 an acre for a total price of approximately $3,075,635; he also agreed to reimburse the seller for expenses, pay for the fruit on the trees and pay a brokerage commission. However, Plimpton was unable to obtain institutional financing for this project without the participation of a financially strong individual such as Boynton who also had an agricultural background. Plimpton's contract for the purchase of the grove was assigned to the partnership. They agreed that the partnership would borrow the purchase money and initial working capital and thereafter each partner would equally contribute any additional funds that might be required to operate the grove.

They were able to borrow $3,000,000 from the John Hancock Mutual Life Insurance Company (John Hancock) and $500,000 from the First National Bank & Trust Company of Lake Worth (First National). As security Boynton, Plimpton and their wives had to submit personal financial statements and agree to be jointly and severally liable for the repayment of the loans; ³ additionally Boynton also submitted a personal note worth approximately $725,000 as security for the First National loan. When the purchase was closed, the partnership had paid $3,075,632 for the land, $40,000 for the fruit on the trees, $85,500 for reimbursement of maintenance expenses, and $116,000 for the broker's commission with the balance of the $3,500,000 being used for working capital. This working capital was soon exhausted and the partners, utilizing one of Boynton's contacts, borrowed an additional $150,000 from the Production Credit Association. These funds were also quickly exhausted and Plimpton informed Boynton that more funds were needed to meet the grove's operating expenses. Boynton began making contributions to the partnership on the assumption that Plimpton would make matching contributions.

It became clear during June and July 1974 that the grove was not operating as profitably as projected mainly because the yield and the quality of the lemon crop were much poorer than expected. ⁴ Moreover Boynton became concerned with Plimpton's failure to contribute his share of the capital as required by the partnership agreement. Plimpton claimed he could not make his contributions within the near future because he had no financial resources to draw upon. Apparently one of Plimpton's businesses had been shut down by an Environmental Protection Agency order and one of his commercial properties worth approximately $370,000 was being foreclosed. The partnership needed at least $135,000 in order to meet the October interest payment to John Hancock.

Boynton discussed the situation with their accountant, Everett Nowlen, who concluded that Plimpton's inability to carry his financial obligation was of a permanent or continuing nature; the accountant advised Boynton that the partnership agreement should be modified to reflect the fact that Boynton would be the sole supporter of the partnership for a period of time. On October 30, 1974, the partnership agreement was amended as follows: (1) whenever a partner made a greater contribution than the other, the amount of excess advances would be treated as a loan to the partnership (with a priority right of repayment from subsequent cash distributions); (2) only one partner at a time could have a credit balance in his loan account; (3) all of the federal tax losses of the partnership would be allocated to the partner with the credit balance in his loan account regardless of the actual amount in the credit balance; (4) the allocation of losses only affected the method of reporting losses (but not profits) for income tax purposes since for purposes other than federal income taxes, the prior provisions that required an equal division of profits and losses remained in effect; ⁵ and (5) after all of the excess advances were repaid with interest, the original agreement was again in effect. See Appendix, Amended Partnership Agreement. Nowlen did not recommend and Boynton did not request a change in the allocation of overall economic profits or losses to give Boynton a greater economic share of the partnership to reflect his additional contributions as Boynton did not want to surrender his right of recoupment against Plimpton for the unmatched contributions should his economic situation turn around.

Both partners were satisfied that the modifications to the partnership agreement were fair under the circumstances. Boynton was aware of the tax benefits that the new loss allocation provision would provide him and he actively sought this tax advantage. Boynton would have continued to make monetary contributions to the partnership even without the tax incentive of the new loss allocation because of his personal liability for the partnership's obligations. During 1974, Boynton's capital contributions, which exceeded Plimpton's by $123,474.81, were reclassified as loans thus giving Boynton a credit balance in his loan account. Because of this credit balance, all of the partnership's taxable losses of $730,592 were allocated to Boynton. On his 1974 return Boynton deducted $732,592 as his distributive share of the partnership's net losses; the Commissioner disagreed that Boynton could claim 100% of the partnership's losses and allowed Boynton only 50% of the partnership's losses or $366,296 as his distributive share. Boynton had also claimed that $59,366.02 was the net operating loss for 1974 and carried that loss back to 1971 and 1972 for tentative refunds of $32,917 and $1,567. But because the redetermination of Boynton's distributive share eliminated the net operating loss for 1974, these tentative refunds had to be recaptured by the IRS. The Commissioner assessed deficiencies of $32,917 (1971), $1,567 (1972), $505 (1973) and $168,498 (1974) for a total of $203,487.

Boynton tried to sell the grove as early as the fall of 1974 but a bona fide offer of $3,570,000 for the grove (excluding the fruit) was not received until 1977. The fruit on the trees was put in a citrus pool for sale. Plimpton agreed to continue managing the grove for $1,900 per month but only if he received as additional compensation 100% of the profits from the citrus pool. The profits from the citrus pool were estimated at $15,000 to $30,000 but were much larger than expected. After the partnership liabilities were satisfied, excluding the money owed to Boynton, $85,000 to $90,000 remained from the citrus pool sale, which money was equally divided between Boynton and Plimpton. These funds were the only funds ever recovered by Boynton from the partnership. When the partnership was eventually terminated in 1978, Boynton's economic and tax losses were identical. ⁶

II. Interpretation of Boynton's Loss Allocation Under IRC § 704(a)

The sole issue before the Tax Court was whether the partnership's amended loss allocation provision under which Boynton claimed 100% of the partnership's 1974 taxable losses was a bona fide allocation of losses within the meaning of Section 704 of the Internal Revenue Code of 1954 (IRC), as amended, 26 U.S.C.A. § 704. ⁷ The Tax Court ruled against Boynton by finding that, since the 1974 amendment to the partnership provision did not in fact increase his "distributive share" of the partnership's profits and losses, the loss allocation was ineffective and Boynton could claim on his tax return only 50% of the partnership's losses. IRC § 704(a) provides that the formula selected by the partners for actually dividing the profits and losses will determine their distributive shares. ⁸ The Tax Court concluded that the amended partnership agreement lacked economic substance since it had no effect on the original agreement's overall distribution of profits and losses and had effect only for federal tax purposes. ⁹

On appeal Boynton argues that the loss allocation had economic justification since without his funds the partnership could not have continued operations. In other words, the economic circumstance necessary to justify the allocation of all of the taxable losses to Boynton was the reasonably high probability that he would bear the economic detriment of any losses in light of Plimpton's...