Hubert Enterprises, Incorporated v. Commissioner of Internal Revenue, T.C. Memo. 2008-46 (U.S.T.C. 2/28/2008)
| Decision Date | 28 February 2008 |
| Docket Number | No. 16798-03.,16798-03. |
| Parties | HUBERT ENTERPRISES, INCORPORATED, SUCCESSOR BY MERGER TO HUBERT HOLDING COMPANY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent.<SMALL><SUP>*</SUP></SMALL> |
| Court | U.S. Tax Court |
L is a limited liability company that purchased equipment and partially financed its purchases using recourse debt. L reports its operations for Federal income tax purposes on the basis of a taxable year ending July 31. On Mar. 28, 2001, L's two members amended L's operating agreement to add a provision on deficit capital account restoration. Under the provision, stated as effective Jan. 1, 2000, any L member with a deficit capital account following the liquidation of its interest in L had to contribute to L by the end of the taxable year, or if later within 90 days after the date of the liquidation, funds equal to the amount of the deficit for payment to L's creditors or for distribution to the members of L with positive capital accounts. Pursuant to the provision, H, a member of L with a 99-percent interest therein, took into account its proportionate share of L's recourse debt in computing its at-risk amounts under sec. 465(b)(2)(A), I.R.C., for H's taxable years ended in July 2000 and 2001.
Held: For Federal income tax purposes, the provision is inapplicable to H's taxable year ended in 2000 because the amendment was made too late under sec. 761(c), I.R.C., and other provisions, to be included in L's operating agreement for that year.
Held, further, H may not take into account L's recourse debt for H's taxable year ended in 2001 because H was not personally liable for the repayment of that debt under sec. 465(b)(2)(A), I.R.C.
William F. Russo and R. Daniel Fales, for petitioner.
Gary R. Shuler, Jr., for respondent.
SUPPLEMENTAL MEMORANDUM FINDINGS OF FACT AND OPINION
This case is before the Court on remand from the Court of Appeals for the Sixth Circuit. We filed our initial report as Hubert Enters., Inc. & Subs. v. Commissioner, 125 T.C. 72 (2005) (Hubert I). Hubert I was a consolidation of three cases, and the Court of Appeals for the Sixth Circuit affirmed our decisions in two of those cases. See Hubert Enters., Inc. v. Commissioner, 230 Fed. Appx. 526 (6th Cir. 2007), affg. in part, vacating in part and remanding 125 T.C. 72 (2005). The Court of Appeals for the Sixth Circuit vacated the remaining decision and remanded the case to this Court to decide, after allowing the parties to develop the record more fully, whether the deficit capital account restoration obligation (DRO) included in the amended and restated operating agreement of Leasing Co., L.L.C. (LCL), a limited liability company, rendered LCL's members payors of last resort under the law applicable in the Sixth Circuit. Id. at 531. The relevant years for LCL are its taxable years ended July 31, 2000 and 2001, and LCL's members added the DRO to LCL's operating agreement on March 28, 2001, stated as effective January 1, 2000. LCL's members are HBW, Inc. (HBW), a wholly owned subsidiary of Hubert Holding Co. (HHC), and Hubert Commerce Center (HCC). The subject years are HHC's taxable years ended in July 2000 and 2001.1
On remand, we ordered the parties to state the proper course of action to be taken in light of the remand. Neither party requested any further trial, stating that the mandate of the Court of Appeals for the Sixth Circuit was best followed through their filing of seriatim briefs. Accordingly, we decide the relevant issue on the basis of the record underlying Hubert I, with the assistance of additional briefing by the parties. We incorporate herein our facts as set forth in Hubert I and repeat those facts only as necessary for a comprehensive analysis of the relevant issue. We hold that the DRO did not render HBW a payor of last resort under the applicable law.2 Unless otherwise noted, section references are to the applicable versions of the Internal Revenue Code.
LCL was formed as a Wyoming limited liability company on April 30, 1998, and was treated as a partnership for Federal income tax purposes. LCL operated on the basis of a fiscal year ended July 31, and it filed Forms 1065, U.S. Return of Partnership Income, to report its operations for Federal income tax purposes. During the relevant years, LCL engaged in equipment leasing activities and purchased equipment subject to a lease. LCL partially financed its purchases of that equipment using promissory notes. Some portions of the notes were recourse; the remaining portions were nonrecourse.
LCL's members were HBW and HCC. HBW owned 99 of LCL's 100 membership units, and HCC owned the remaining unit. During the subject years, HBW was a wholly owned subsidiary of HHC and a member of its affiliated group. HCC also was connected with that group.
In 1998, LCL purchased some equipment from Capital Resources Group, Inc. (CRG). In connection with this purchase, LCL signed four promissory notes. Two of the notes were nonrecourse; the other two notes were partially recourse. Neither LCL member signed any of these notes or otherwise guaranteed repayment of the notes.
In 2000, LCL purchased other equipment from CRG. In connection with this purchase, LCL signed two promissory notes.
Both notes were partially recourse. Neither LCL member signed either of these notes or otherwise guaranteed repayment of the notes.
Section 4.2 of LCL's initial operating agreement (initial operating agreement) states that "No Member shall be liable as such for the liabilities of the Company". On March 28, 2001, LCL's two members amended and restated the initial operating agreement in its entirety (revised operating agreement) and stated in the revised operating agreement that it was effective as of January 1, 2000. The revised operating agreement is construed under Wyoming law, and only the parties that signed the revised operating agreement (and their successors in interest) have any rights or remedies under that agreement. The revised operating agreement states that the life of LCL is 30 years from the date of the filing of its articles of organization with the Wyoming secretary of state.3 The revised operating agreement states that neither LCL member is required to make any additional capital contribution to LCL.
Section 7.7 of the revised operating agreement contains the DRO.4 That provision states as follows:
Deficit Capital Account Restoration. If any Partner has a deficit Capital Account following the liquidation of his, her or its interest in the partnership, then he, she or it shall restore the amount of such deficit balance to the Partnership by the end of such taxable year or, if later, within 90 days after the date of such liquidation, for payment to creditors or distribution to Partners with positive capital account balances.
The revised operating agreement contains a provision concerning potential third-party beneficiaries. As stated in section 20.9 of that agreement:
Nothing express or implied in this Agreement is intended or shall be construed to confer upon or to give any person or entity, other than the parties or their successors-in-interest in accordance with the provision of this Agreement, any rights or remedies hereunder or by reason hereof.
For its taxable years ended in July 2000 and 2001, HBW took into account its proportionate share of LCL's recourse debt in computing its at-risk amounts under section 465(b). Respondent determined that HBW was not entitled to increase its at-risk amounts on account of that debt. Accordingly, respondent determined, HBW was not entitled to deduct losses that it claimed with respect to LCL's leasing activities because those losses exceeded the amounts for which HBW was at risk with respect to those activities.
OPINIONPetitioner argues that the DRO rendered HBW a payor of last resort as to LCL's recourse debt for purposes of applying the at-risk rules of section 465(b).5 Respondent argues that HBW was not a payor of last resort as to LCL's recourse debt because the DRO did not render HBW personally liable as to that debt. We agree with respondent.
As to the first subject year, the DRO was included in the revised operating agreement which resulted from an amendment made on March 28, 2001. Although the amendment was written retroactively as effective January 1, 2000, the agreement had no such retroactive effect for Federal income tax purposes. LCL's partnership return for its taxable year ended July 31, 2000, was required (absent an extension) to be filed by November 15, 2000, see sec. 1.6031(a)-1(e)(2), Income Tax Regs., and for Federal income tax purposes a partnership agreement may include as to a taxable year only those provisions included with the agreement on or before the unextended due date of the partnership return for that year, see sec. 761(c); Fahey v. Commissioner, T.C. Memo. 1979-20; see also Long v. Commissioner, 77 T.C. 1045, 1078 n.17 (1981). In addition, in the context of section 465, section 465(a)(1) requires that the amount for which a taxpayer is at risk with respect to an activity for a taxable year be determined as of the close of that year. See also Callahan v. Commissioner, 98 T.C. 276, 281 (1992); Melvin v. Commissioner, 88 T.C. 63, 73 (1987), affd. 894 F.2d 1072 (9th Cir. 1990). The amendment's purported retroactive effect to the earlier year also does not comport with the annual accounting system of Federal income taxation. Under that system, the amount of income tax payable for a taxable year is generally determined on the basis of those events happening or circumstances present during that year. See Hillsboro Natl. Bank v. Commissioner, 460 U.S. 370, 377 (1983); Burnet v. Sanford & Brooks Co., 282 U.S. 359 (1931); Hayutin v Commissioner, 508 F.2d 462, 474 (10th Cir. 1974), affg. T.C. Memo....
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