Nadler v. Commissioner

• Decision Date: 08 July 1992
• Docket Number: Docket No. 16783-90.
• Citation: 64 T.C.M. 70
• Parties: David Nadler v. Commissioner.
• Court: U.S. Tax Court

64 T.C.M. 70

T.C. Memo. 1992-383.

David Nadler v. Commissioner.

Docket No. 16783-90.

United States Tax Court.

Filed July 8, 1992.

Norman R. Berkowitz and Jay D. Fischer, 1450 Broadway, New York, N.Y., for the petitioner. Paul N. Schneiderman, for the respondent.

Memorandum Findings of Fact and Opinion

BEGHE, Judge:

Respondent determined deficiencies in petitioner's Federal income tax and an addition to tax as follows:

                Addition to tax
                Year                  Deficiency   Sec. 6651(a)(1)
                1979 ..............    $18,435           --
                1980 ..............      7,970        $1,195.50
                

After concessions, the sole issue for decision is whether a closing agreement between petitioner and respondent regarding the tax treatment of a limited partnership investment precluded respondent from disallowing certain loss deductions claimed by petitioner on his 1979 and 1980 income tax returns.

Findings of Fact

David Nadler (petitioner) was a resident of New York, New York, at the time he filed his petition. Petitioner is an attorney specializing in real estate law. Petitioner has been licensed to practice law in New York State since 1966.

In 1977, petitioner acquired 4.44 units of a limited partnership interest in Milton Cable Associates for $40,000 in cash. The Milton partnership agreement purportedly made each limited partner personally liable on an "equipment note" to the extent of $17,678.57 per unit. The maximum amount of petitioner's liability under this clause was approximately $78,500.

Petitioner claimed the following investment tax credits and deductions for his distributive share of losses incurred by Milton:

                Year                    Deduction     Credit
                1977 ................    $15,600    $1,131.00
                1978 ................     43,282       198.00
                1979 ................     31,312       344.20
                1980 ................      8,483       309.40
                

Respondent subsequently examined petitioner's entitlement to these deductions and credits. In June 1985,¹ petitioner and respondent entered into a closing agreement regarding the Milton partnership that dealt conclusively with certain tax issues related to the partnership. In the discussions between petitioner and respondent's representatives that led to respondent's preparation of the agreement, petitioner expressed concerns about "phantom income". Respondent's appeals officer prepared the agreement on Form 906. The operative part of the agreement reads in its entirety:

NOW IT IS HEREBY DETERMINED AND AGREED for Federal income tax purposes:

(1) That the taxpayer is entitled to ordinary deduction from taxable income in the amount of $15,600.00 for the taxable year ended December 31, 1977 and an ordinary deduction from taxable income in the amount of $24,400.00 for the taxable year ended December 31, 1978, said deduction being the equal [sic] to the cash paid by the taxpayer.

(2) That taxpayer is not entitled to investment credit with respect to his interest in Milton Cable Associates partnership for any taxable year.

(3) That taxpayer has an adjusted basis of zero as of December 31, 1978 for his partnership interest in Milton Cable Associates.

(4) That taxpayer is not entitled to any increase in the basis of his partnership interest as a result of any nonrecourse obligation until such time and only to the extent that the nonrecourse obligation is paid by making cash payments on the nonrecourse obligation.

(5) That the discharge, forgiveness or any disposition of the partnership nonrecourse obligation in any tax year subsequent to December 31, 1978 will not result in gross income to the taxpayer(s), except that losses deducted by the taxpayer(s) in excess of the cash paid by the taxpayer(s) and which were not disallowed by the Internal Revenue Service are to be includable as ordinary income by the taxpayer(s) in the year in which the nonrecourse obligation is cancelled, forgiven or otherwise disposed of.

When petitioner signed the agreement, he did not understand paragraph 3. He did not ask respondent's appeals officer what it meant. Prior to signing the agreement, he did not consult with anyone knowledgeable in tax law or procedure. At the time he signed the agreement, petitioner had the impression that paragraph 5 addressed his concerns about phantom income.

Following execution and delivery of the closing agreement, respondent issued several notices of proposed deficiency ("30-day letters") to petitioner, proposing to disallow the deductions petitioner had claimed for 1979 and 1980 with respect to petitioner's interest in the partnership. Petitioner wrote respondent letters in October 1986, November 1986, December 1986, and April 1987. Petitioner wrote these letters himself, apparently without the help of a tax adviser. In each letter, petitioner asserted that paragraph 5 of the closing agreement prohibited the disallowance of deductions in 1979 and 1980. Respondent's replies were the two statutory notices of deficiency in this case, issued in May 1990.

Opinion

Closing agreements are statutory agreements, authorized by section 7121.² They are employed to define conclusively the tax treatment of an item or a taxpayer's liability for specific tax years. Saltzman, IRS Practice and Procedure, par. 9.09[2], at 9-66 (2d ed. 1991). Agreements utilizing Form 906 define conclusively the tax treatment of an item, see Estate of Magarian v. Commissioner [Dec. 47,436], 97 T.C. 1, 5 (1991); Zaentz v. Commissioner [Dec. 44,714], 90 T.C. 753, 760-761 (1988), such as the basis of an investment as of a specified date in the past. Saltzman, IRS Practice and Procedure, par. 9.09[2], at 9-65, 9-66. Both the taxpayer and the Service are bound by the terms of the closing agreement, absent a showing of fraud, malfeasance, or misrepresentation of a material fact. Sec. 7121(b). A court may not disregard or modify the agreement without such a showing. Sec. 7121(b)(2). Petitioner does not contend that any of the conditions of section 7121(b) that would permit the closing agreement to be disregarded have been satisfied.

Petitioner agreed under paragraph 3 of the closing agreement that he had an adjusted basis of zero in his partnership interest in Milton as of the end of 1978. Partners are not allowed deductions for their distributive shares of partnership losses in any amount greater than their basis. Sec. 704(d). Therefore, in order to be entitled to the deductions claimed on the 1979 and 1980 returns, petitioner must show that something caused his adjusted basis in his partnership interest to become greater than zero after December 31, 1978. Petitioner has the burden of proof on this issue. Rule 142(a). Petitioner offered no proof that anything happened during 1979 or 1980 to increase the adjusted basis of his interest in the partnership. Therefore, petitioner is not entitled to the claimed deductions.

Petitioner asserts that the basis of his partnership interest was greater than zero because of the equipment note. He claims that his liability on the equipment note was recourse and that he was at risk for the entire $78,500, thus entitling him to deduct the loss pass-throughs.

Petitioner's interpretation of the effect of the note is inconsistent with the terms of the closing agreement. Petitioner agreed in the closing agreement that he had a zero adjusted basis in his' Milton investment as of December 31, 1978. We therefore do not see how an obligation he had incurred in 1977, prior to the execution of the closing agreement, could have entitled him to a positive basis in 1979 and 1980. Whatever petitioner's original basis in the partnership might have been, taking account of the equipment note, the closing agreement wiped out any and all such basis; he cannot now resurrect it. Estate of Johnson v. Commissioner [Dec. 43,675], 88 T.C. 225, 232-233 (1987), affd. without publish opinion 838 F.2d 1202 (2d Cir. 1987).

We need not consider whether the equipment note was recourse or nonrecourse.³ In either case and in any event, petitioner was not entitled to include any part of the principal amount of the note in the basis of his partnership interest at the end of 1978. He therefore had no basis in his partnership interest in 1979 and 1980 that would support a loss pass-through from the partnership.

Petitioner argues that paragraph 5 of the closing agreement guaranteed that he would be able to deduct the 1979 and 1980 losses. Petitioner claims that the paragraph "clearly looks to losses which were not specifically addressed in the Closing Agreement." Petitioner's interpretation of paragraph 5 is that petitioner was entitled to deduct the 1979 and 1980 losses, but would be required to include the amount of the losses as "phantom income"⁴ in the "burnout" year, i.e., the year that the equipment note will be forgiven or canceled.

Petitioner focuses on the word "were" in the exception clause to paragraph 5. The clause talks about deductions that "were not disallowed". The 1979 and 1980 deductions were not disallowed by the closing agreement. Petitioner's interpretation is that if the deductions were not disallowed as of the time of the signing of the agreement, they were allowed by the agreement, subject to their inclusion in income when burnout should occur. To the extent that the closing agreement is ambiguous on the point, petitioner urges us to interpret the agreement in his favor under general principles of contract law that resolve ambiguities against the drafter of an agreement.

We disagree with petitioner's analysis. Even allowing for the ambiguity petitioner claims, the agreement falls short of allowing the 1979 and 1980 deductions. The proper focus is on the phrase "not disallowed". In tax parlance, "not disallowed" does not mean "allowed". "Allowed", when it appears in a closing agreement, means that no action may ever be taken to disallow the deductions. It has the same meaning as "entitled to" in paragraph 1 of the closing agreement. "Not disallowed" means no action has yet been taken to...