Monahan v. Commissioner
| Decision Date | 05 May 1994 |
| Docket Number | Docket No. 14677-91. |
| Parties | John M. Monahan and Rita K. Monahan v. Commissioner. |
| Court | U.S. Tax Court |
F. Michael Kovach, 710 Cherry St., Seattle, Wash., for the petitioners. Christopher D. Hatfield, for the respondent.
Memorandum Findings of Fact and Opinion
Respondent determined deficiencies in petitioners' Federal income tax and additions to tax as follows:
Additions to Tax Additional Interest
Year Deficiency Sec. 6653(a)(1) Sec. 6653(a)(2) Sec. 6661 Sec. 6621(c)
1984 $201,640 $10,082 50% of the $50,410 Int. apr. 120%
interest due of IRC 6621(a)
on $201,640 rate on $201,640
1985 74,082 3,704 50% of the 18,521 Int. apr. 120%
interest due of IRC 6621(a)
on $74,082 rate on $74,082
Additions to Tax Additional Interest
Sec
Year Deficiency 6653(a)(1)(A) Sec. 6653(a)(1)(B) Sec. 6661 Sec. 6621(c)
1986 $ 10,964 $ 548 50% of the $ 2,741 Int. apr. 120%
interest due of IRC 6621(a)
on $10,964 rate on $10,964
1987 12,673 634 50% of the 3,168 Int. apr. 120%
interest due of IRC 6621(a)
on $12,673 rate on $12,673
Additions to Tax Additional Interest
Year Deficiency Sec. 6653(a)(1) Sec. 6653(A)(1)(B) Sec. 6661 Sec. 6621(c)
1988 $ 1,834 $ 92 N/A N/A Int. apr. 120%
of IRC 6621(a)
rate on $1,834
The issues for decision are: (1) Whether the notice of deficiency was timely regarding taxable year 1984; (2) whether and when petitioners realized income due to the termination of an interest in a partnership held by John M. Monahan (hereinafter petitioner); (3) whether petitioners were entitled to losses for payments to the former partnership in 1984 and 1985; (4) whether petitioners failed to report interest income earned during 1985 on certificates of deposit; (5) whether payments made to certain entities in 1987 and 1988 were deductible as interest; (6) whether petitioners are liable for additions to tax as determined by respondent and (7) whether petitioners are entitled to use income averaging in determining their income for 1986.1
Some of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by this reference. Petitioners resided in Seattle, Washington, when they filed their petition.
For purposes of convenience, our findings of fact and opinion for each issue are combined. The major issues revolve around Span Services Co. (Span Services), an Anguillan general partnership cofounded by petitioner on September 1, 1981. The other partners in Span Services were: (1) Edwards Interests, Ltd. (Edwards Interests), a Washington corporation holding a 51-percent partnership interest and wholly owned by Robert T. Edwards, a Canadian citizen; and (2) Span Corp., Ltd. (Span Corp.), an Anguillan corporation holding a 4-percent partnership interest and wholly owned by Lynwood S. Bell, a Canadian citizen residing in Anguilla. The Span Services partnership agreement allocated 100 percent of partnership gross income to Span Corp. Petitioner was allocated 45 percent of partnership losses and deductions.
Petitioner is a lawyer specializing in corporate and international trade law with emphasis in tax planning and complex corporate transactions.2 Most of the entities involved herein were directly or indirectly owned—either jointly or separately—by petitioner and Mr. Bell, who had a close business relationship. Both Mr. Bell and petitioner had financial and business reasons for continuing their close relationship. Petitioner recommended Mr. Bell to his clients for business dealings and introduced clients to Mr. Bell. Some of petitioner's clients paid management fees to entities owned by Mr. Bell. From 1981 through 1988, petitioner acted as tax counsel for Span Corp.
Section 6501(a)3 generally provides that the amount of any tax imposed by the Internal Revenue Code shall be assessed within 3 years after the return is filed. Section 6501(e)(1)(A) extends the time to assess tax:
In the case of any tax imposed by subtitle A—
If the taxpayer omits from gross income an amount properly includible therein which is in excess of 25 percent of the amount of gross income stated in the return, the tax may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at any time within 6 years after the return was filed. * * *
Thus, when the circumstances mentioned in section 6501(e)(1)(A) are present, it creates a 6-year period of limitations during which the Commissioner may assess tax. See Thoburn v. Commissioner [Dec. 46,799], 95 T.C. 132, 146 (1990). Following the mandate of the Supreme Court, we must construe statutes of limitation strictly "in favor of the Government." Badaracco v. Commissioner [84-1 USTC ¶ 9150], 464 U.S. 386, 391-392 (1984); Thoburn v. Commissioner, supra at 146-147.
The notice of deficiency in this case was dated April 5, 1991. Petitioners' 1984 return was signed on April 14, 1985. It is therefore deemed filed no earlier than April 15, 1985, Thoburn v. Commissioner, supra at 146, which is within 6 years of the date the notice of deficiency was issued.
The additional 1984 income determined by respondent exceeds $400,000. It is undisputed that this is clearly greater than 25 percent of the amount of gross income reported on petitioners' 1984 return. See sec. 6501(e)(1)(A). Thus, if we find that petitioners omitted the income in question and that the omission was from petitioners' 1984 gross income, then the 6-year period of limitations will apply to petitioners' 1984 taxable year. Sec. 6501(e)(1)(A). Respondent bears the burden of proving that petitioners omitted the income in question in 1984. Estate of Dillingham v. Commissioner [90-1 USTC ¶ 60,021], 903 F.2d 760, 765 (10th Cir. 1990), affg. [Dec. 44,003] 88 T.C. 1569 (1987).
Respondent contends that petitioner terminated his interest in Span Services during 1984 and that petitioner realized $400,074 in income from that transaction. Petitioners argue that petitioner terminated his interest in 1983.
Span Services did not carry on a trade or business in the United States, nor did it have United States sourced income during the taxable years 1981 through 1984.4 On December 31, 1983, Span Services had liabilities of $2,210,043, petitioner's allocable share of partnership liabilities totaled $994,519, and his capital account was in deficit by $400,074.
Because of his potential liability for partnership debts and because of disagreements between the partners, petitioner began to consider terminating his interest in Span Services. Upon hearing of petitioner's intention to terminate his interest in Span Services, petitioner's accountant, Michael J. Maloney, advised him to terminate his interest at the end of a taxable year to minimize accounting difficulties. Mr. Maloney could not recall at trial when that discussion took place.
Sometime after October 12, 1984, petitioner executed an undated "Termination and Transfer Agreement" by which he agreed to sell his interest in Span Services to Edwards Holdings, Ltd. (Edwards Holdings), an Anguilla corporation, in return for the agreement of Edwards Holdings to assume petitioner's allocable share of Span Services' liabilities. The agreement stated, in pertinent part:
1. Effective as of January 1, 1984, Edwards Holdings Limited agrees to buy, and John M. Monahan agrees to sell, * * * [his] 45 percent capital and profits interest in Span Services Co. in consideration of Edwards Holdings Limited assuming John M. Monahan's pro rata share of the liabilities of Span Services Co.
* * *
3. Pursuant to paragraph 6.3 of the Partnership Agreement, John M. Monahan agrees to restore his negative capital account arising due to the operations of Span Services Co. in the amount of $400,074.00. It is agreed by the parties that this amount will fully restore such amount to the partnership as is necessary to result in his capital account equalling zero.
4. John M. Monahan further agrees to pay the delinquent management fee owing to Span Corp Limited in the amount of $170,000.00. It is agreed by the parties that this expense is to be borne individually by John M. Monahan, but that should such expense be attributed to the partnership, that it shall be specially allocated to John M. Monahan, and that this expense is required to be paid to complete the termination of his interest in the partnership.
5. Attached to this Termination and Transfer Agreement, and hereby incorporated by reference, are financial statements for Span Services Co., and the Schedule K-1, as filed by the partnership for John M. Monahan showing the amount of his negative capital account.
6. By the terms of this Agreement, John M. Monahan hereby assigns his interest in the partnership in favor of Edwards Holdings Limited effective as of January 1, 1984, and, accordingly, agrees that any...
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