                        T.C. Memo. 2016-229



                  UNITED STATES TAX COURT



WALTER S. MACK, JR. AND CONSUELO C. MACK, Petitioners v.
  COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 7186-14.                           Filed December 19, 2016.



       In 2011 P-H was a partner of a New York partnership, which
reported P-H’s distributive share of partnership income as $479,743.
On their timely filed 2011 tax return, Ps reported only $75,000 of the
income from P-H’s partnership. Ps contend that P-H’s fiduciary
duties under State law required him to use the remainder to pay
partnership expenses to keep the firm from failing.

      Held: Ps are liable for income tax on P-H’s full distributive
share of partnership income for 2011. Any payment of partnership
expenses by P-H was a contribution to capital, and he can deduct his
share of the partnership’s expenses.

      Held, further, Ps are liable for an accuracy-related penalty for
an underpayment attributable to a substantial understatement of
income tax for their failure to report partnership income.
                                         -2-

[*2] Walter S. Mack, Jr., and Consuelo C. Mack, for themselves.

      Shawna A. Early, for respondent.



                          MEMORANDUM OPINION


      GUSTAFSON, Judge: Pursuant to section 6212(a)(1),1 on December 23,

2013, the Internal Revenue Service (“IRS”) issued to petitioners Walter S. Mack,

Jr., and Consuela C. Mack a notice of deficiency, which determined for 2011 a

deficiency in tax of $140,302 and an accuracy-related penalty of $28,060 under

section 6662(a). The Macks filed a timely petition under section 6213(a) for

redetermination of the deficiency and the penalty.

      The case is before the Court on a motion for summary judgment filed by

respondent, the Commissioner of the IRS, which the Macks have opposed. The

sole issue raised by the petition2 is whether, as the Macks contend, Mr. Mack’s


      1
       Unless otherwise indicated, all section references are to the Internal
Revenue Code (26 U.S.C.), as amended and in effect for the year in issue, and all
Rule references are to the Tax Court Rules of Practice and Procedure.
      2
       The Macks’ opposition to the motion for summary judgment, signed only
by Mr. Mack, states: “I have the authority and permission to represent my
co-petitioner spouse, Consuelo C. Mack. * * * All decisions and acts that the
Respondent complains of are entirely my responsibility, and I ask whatever the
consequences of my actions or omissions that such be visited upon me and me
                                                                     (continued...)
                                         -3-

[*3] otherwise taxable income from his partnership is reduced by his alleged

obligation to make expenditures on behalf of the partnership. We hold that it is

not, and we will grant the Commissioner’s motion.

                                    Background

      For purposes of the Commissioner’s motion for summary judgment under

Rule 121, we assume correct the facts asserted by the Macks, as well as facts

demonstrated by the Commissioner that the Macks did not dispute.3


      2
        (...continued)
alone.” If this is an attempt to assert for Mrs. Mack a claim for “innocent spouse”
relief under section 6015--a claim not hinted at in the petition (and not otherwise
articulated or supported in the opposition)--then we decline to entertain it. See
Rule 34(b) (“The petition in a deficiency or liability action shall contain * * *
[c]lear and concise assignments of each and every error which the petitioner
alleges to have been committed by the Commissioner in the determination of the
deficiency or liability. * * * Any issue not raised in the assignments of error shall
be deemed to be conceded”). Thus, any “innocent spouse” claim that Mrs. Mack
may have is “not an issue in * * * [this] proceeding.” See sec. 6015(g)(2).
      3
        A motion for summary judgment under Rule 121will be granted only if it is
shown that there is no genuine dispute as to any material fact and that a decision
may be rendered as a matter of law. See Rule 121(b). In deciding whether to
grant summary judgment, we construe factual materials and inferences drawn from
them in the light most favorable to the nonmoving party. Sundstrand Corp. v.
Commissioner, 98 T.C. 518, 520 (1992), aff’d, 17 F.3d 965 (7th Cir. 1994). It is at
best only debatable that the Macks made a factual showing of the critical fact (that
Mr. Mack’s share of DRKM’s income was not paid to him but was used instead to
pay firm expenses) that would be adequate even under the permissive standard of
Rule 121, since they relied not on affidavits but only on very general statements in
brief, and the only financial data they submitted did not pertain to the relevant
                                                                        (continued...)
                                         -4-

[*4] Income from DRKM

      Mr. Mack is an attorney admitted to practice law in the State of New York,

and he is a partner in the firm of Doar, Rieck, Kaley and Mack (“DRKM”). The

notice of deficiency reflects, and the Macks do not dispute, that in 2011 two

DRKM entities4 issued Schedules K-1, “Partner’s Share of Income, Deductions,

Credits, etc.”, that reported Mr. Mack’s share of partnership income (i.e.,

partnership revenue over expenses) as $18,357 and $461,386, totaling $479,743.

It was then incumbent on Mr. Mack to reflect that on his tax return.

DRKM’s “negative capital”

      However, Mr. Mack alleges that, in the wake of the 2008 recession, other

partners at DRKM could not cover their shares of the firm’s expenses and that, as

a result, the firm had gone into “significant negative capital”. Mr. Mack felt that it

was his fiduciary obligation under New York partnership law5 to cover other


      3
          (...continued)
period.
      4
       Both the notice of deficiency and the tax return reflect Schedules K-1 for
two DRKM entities. The distinction between these two entities is not explained in
our record.
      5
       Mr. Mack states that New York State “Partnership Law, Article 4”
provided the basis for his belief that he had a fiduciary duty to devote a portion of
his share of the partnership income to pay firm expenses. This article of New
                                                                        (continued...)
                                        -5-

[*5] partners’ partnership expenses. Mr. Mack claims that his DRKM “capital

account bore no relationship to the financial condition of the partnership, and what

little money was available to * * * [Mr. Mack] was used to absorb expense [sic]

that normally would have been expenses of the firm.” Mr. Mack does not allege

that any partnership expenses were omitted from the partnership’s returns and

Schedules K-1.

Advice from tax professionals

      Because the available money had allegedly not been paid out to Mr. Mack

but had been used to pay firm expenses, Mr. Mack evidently felt it should not be

treated as income to him. But according to Mr. Mack,

      When I sought the advice of the firms’ accountants and tax preparers,
      I was in essence told that the tax law was unfair and unjust under
      these circumstances, and my options were to dissolve the firm, take
      all the capital in the firm to pay my taxes and move on, and let my
      partners fend for themselves, and the employees go on
      unemployment. When I discussed [m]y obligations under New York
      State Partnership Law to act as a fiduciary to my partners, I was told
      to be prepared to face the consequence of that decision as I am now,

      5
        (...continued)
York’s partnership statute, N.Y. P’ship Law art. 4 (McKinney 2015), does include
fiduciary obligations that partners owe each other, but it is not clear what section
in particular gave Mr. Mack the impression that he was obligated to pay other
partners’ shares of entity expenses. In any event, whether Mr. Mack had an
obligation under State law to reinvest some of his income in the partnership is not
relevant to the amount of DRKM’s income properly attributable to him for Federal
income tax purposes.
                                         -6-

[*6] that the Respondent would likely be deaf to the financial realities of
     the firm and not respect the state law fiduciary partnership duties.

That is, the tax professionals told Mr. Mack that the law unfairly required him to

report the income, but he decided not to follow the advice of the tax professionals

and instead to “face the consequence”.

Non-reporting on Form 1040

      The Macks prepared their own Form 1040, “U.S. Individual Income Tax

Return”, for 2011 and filed it on October 22, 2012. On the attached Schedule E,

“Supplemental income and loss”, line 28(j) (“Nonpassive income from

Schedule K-1”), they reported that their income from the two DRKM entities was

$25,000 and $50,000, totaling $75,000, rather than the actual DRKM total of

$479,743.

Notice of deficiency

      On December 23, 2013, the IRS issued a notice of deficiency to the Macks

relating to taxable year 2011. The IRS determined that the Macks had failed to

report partnership income from DRKM in the amount of $454,743.6 The IRS also

      6
        The return reported on Schedule E the two DRKM amounts totaling
$75,000 and a loss of $5,552 from an entity called “Macktrack, Inc.” (a loss for
which a deduction was not disallowed in the notice of deficiency), yielding total
partnership income of $69,448 on line 32. The notice of deficiency stated that the
total income from DRKM shown on the return was only $25,000 (not $75,000)
                                                                      (continued...)
                                         -7-

[*7] determined an accuracy-related penalty of $28,060 under section 6662(a) for

an underpayment attributable to a substantial understatement of income tax.

Tax Court proceedings

      On March 21, 2014, the Macks timely mailed their petition to this Court. In

the petition, they contend that: (1) New York partnership law imposed a fiduciary

duty upon Mr. Mack not to compel DRKM to fail; and (2) the expenditure of

DRKM funds to pay partnership expenses left the firm with no money to pay

Mr. Mack his share of income and left him with no money to pay his Federal

income tax liability.

      On May 27, 2015, the Commissioner filed a motion for summary judgment

under Rule 122.

      As to their underlying Federal tax liability, the Macks’ response to the

Commissioner’s motion essentially advances the same two arguments that are in

their petition (i.e., they received no actual income in 2011, and they were therefore

unable to pay their income tax).




      6
       (...continued)
and calculated the unreported partnership income as $454,743 (rather than
$404,743, as we would calculate it). This $50,000 discrepancy can be corrected or
explained under our Rule 155 procedures.
                                         -8-

[*8] As to the accuracy-related penalty, the Macks oppose its imposition upon

them, arguing that it would be inappropriate to impose the penalty in light of

Mr. Mack’s good-faith payment of partnership expenses.

                                     Discussion

      The issues for decision are whether the Macks received and failed to report

taxable income from DRKM for taxable year 2011, and whether they are liable for

the accuracy-related penalty under section 6662(a) and (b)(2) for an underpayment

attributable to a substantial understatement of income tax. As to both questions,

we hold in favor of respondent.

I.    Partnership taxation principles

      Section 701 provides: “A partnership * * * shall not be subject to the

income tax imposed by this chapter. Persons carrying on business as partners shall

be liable for income tax only in their separate or individual capacities.” In

determining his individual income tax, each partner must separately include his

distributive share of the entity’s taxable income or loss. Sec. 702(a).

      Even assuming the Macks’ factual assertions, DRKM’s income is taxable to

Mr. Mack as a partner to the extent of his distributive share. See sec. 702(c). This

is so whether Mr. Mack received distributions or not, “[f]or it is axiomatic that

each partner must pay taxes on his distributive share of the partnership’s income
                                         -9-

[*9] without regard to whether that amount is actually distributed to him.” United

States v. Basye, 410 U.S. 441, 453 (1973).

      The Macks have not provided evidence to challenge effectively the IRS’s

determinations for 2011. They do not dispute that DRKM had income (revenue

greater than expenses) in 2011 nor that Mr. Mack’s share was $479,743. Rather,

they simply assert that the firm did not distribute to him his share of the 2011

income (a fact that would not affect the attribution of that income to him) and that

the firm used its available money to pay firm expenses (a fact that could generate

partnership deductions, reducing the firm’s income, and Mr. Mack’s share of it).

      If Mr. Mack did in effect plow his share of the 2011 income back into the

firm (because he thought that State law required him to do so), then that amount

presumably constituted a contribution to the firm’s capital and would increase his

own capital account at the firm, see 26 C.F.R. sec. 1.704-1(b)(2)(iv)(b) and (c),

Income Tax Regs., but such a capital contribution is not deductible, see sec. 721

(providing nonrecognition treatment for contributions to partnerships by partners);

Lopo v. Commissioner, T.C. Memo. 1961-126, 20 T.C.M. (CCH) 620, 624 (1961)

(holding that capital contributions to joint ventures are not deductible business

expenses).
                                         -10-

[*10] As a partner in DRKM, Mr. Mack was obliged to report his share of the

firm’s income, whether or not it was distributed to him, and whether or not that

money was thereafter used to pay firm expenses.

II.   Ability to pay

      The Macks do not advance an argument based on partnership taxation

principles. Rather, their argument is that Mr. Mack could not reasonably be

expected to pay tax on money that was never paid to him. This argument may

reflect a misunderstanding of the nature of this case and the jurisdiction that this

Court has been given.

      The Tax Court is a court of limited jurisdiction. We therefore exercise

jurisdiction only to the extent expressly provided by statute. Breman v.

Commissioner, 66 T.C. 61, 66 (1976). In a case such as this one, brought pursuant

to section 6213(a), the Tax Court has jurisdiction to redetermine a “deficiency” of

tax; a “deficiency” of income tax does not consist of the portion of the liability

that has not been paid but instead consists of the portion of the liability that was

not reported. See sec. 6211(a).

      A taxpayer’s assertion that he has no money to pay an income tax liability

might be relevant in a “collection due process” (“CDP”) case brought pursuant to

section 6330(d); and in a deficiency case the assertion might be relevant to an
                                         -11-

[*11] argument that he should not be held liable for an addition to tax for failure to

timely pay, pursuant to section 6651(a)(2) (which the IRS did not determine in this

case). But where, as here, the issue is the unreported amount of the liability, the

Macks’ argument misses the mark.

       A taxpayer’s ability to pay the tax he owes has no bearing on the amount of

his or her tax liability. The Macks may in the future raise issues of collectibility at

a CDP hearing before IRS Appeals under section 6320 or 6330, and the judicial

appeal of an IRS determination in such a hearing would lie in this Court.

However, in the instant case, a deficiency case arising under section 6213(a), the

Macks’ argument about their inability to pay is not relevant to our ultimate issue--

the amount of their tax liability.

       We therefore uphold the IRS’s determinations regarding the taxability of

Mr. Mack’s distributive share of partnership income from DRKM.

III.   Accuracy-related penalty

       We now consider whether the Macks are liable for the accuracy-related

penalty. See sec. 6662(a). A taxpayer is liable for an accuracy-related penalty as

to any portion of an underpayment attributable to, among other things, a

substantial understatement of income tax or negligence. Sec. 6662(a) and (b)(1)

and (2). There is a substantial understatement of income tax if the amount of the
                                        -12-

[*12] understatement exceeds the greater of 10% of the tax required to be shown

on the return or $5,000. Sec. 6662(d)(1)(A); 26 C.F.R. sec. 1.6662-4(a), Income

Tax Regs.

      The Commissioner has the burden of production and must present sufficient

evidence that it is appropriate to impose the penalty. See sec. 7491(c); Higbee v.

Commissioner, 116 T.C. 438, 446-447 (2001). Once the Commissioner satisfies

his burden of production, the taxpayers must present evidence sufficient to

persuade the Court that they should not be held liable for the penalty. Higbee v.

Commissioner, 116 T.C. at 447.

      Although the Macks’ understatement of income tax may be recomputed

under Rule 155, see supra note 6, it is clear that the understatement greatly

exceeds both $5,000 and 10% of the tax required to be shown on the return. Thus,

the Commissioner has met his burden of production regarding the existence of a

substantial understatement of income tax for 2011. (Because we conclude that

there is a substantial understatement of income tax, we need not address

negligence.)

      Once the Commissioner has met the burden of production, the taxpayer

must come forward with persuasive evidence that the substantial understatement

penalty is inappropriate. Higbee v. Commissioner, 116 T.C. at 446. A taxpayer
                                         -13-

[*13] who is otherwise liable for the accuracy-related penalty may avoid the

liability if he successfully invokes one of three other provisions: Section

6662(d)(2)(B) provides that an understatement may be reduced, first, where the

taxpayer had substantial authority for his treatment of any item giving rise to the

understatement or, second, where the relevant facts affecting the item’s treatment

are adequately disclosed and the taxpayer had a reasonable basis for his treatment

of that item. Mr. Mack made no showing that would implicate either of these two

provisions.

      The third provision available to a taxpayer who resists the accuracy-related

penalty is section 6664(c)(1), which provides that no penalty “shall be imposed

under section 6662 or 6663 with respect to any portion of an underpayment if it is

shown that there was a reasonable cause for such portion and that the taxpayer

acted in good faith with respect to such portion.” The decision as to whether a

taxpayer acted with reasonable cause and in good faith is made on a case-by-case

basis, taking into account all pertinent facts and circumstances. See sec. 1.6664-

4(b)(1), Income Tax Regs. Generally, the most important factor is the extent of

the taxpayer’s effort to assess her or his proper tax liability. Id.; see Halby v.

Commissioner, T.C. Memo. 2009-204.
                                        -14-

[*14] Taxpayers often invoke this “reasonable cause” defense by showing reliance

on the advice of a tax professional. E.g., Woodsum v. Commissioner, 136 T.C.

585, 591 (2011). Such a contention requires the taxpayer to show three things by

a preponderance of the evidence: “(1) The adviser was a competent professional

who had sufficient expertise to justify reliance, (2) the taxpayer provided

necessary and accurate information to the adviser, and (3) the taxpayer actually

relied in good faith on the adviser’s judgment.” Neonatology Assocs., P.A. v.

Commissioner, 115 T.C. 43, 99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002).

      If the Macks contend that their failure to include the proper amounts was for

reasonable cause or in good faith, then the contention fails. Mr. Mack admits that

tax professionals explained to him that the tax law required him (albeit

“unfair[ly]”, they said) to report his share of the partnership income (and advised

him to dissolve the firm in order to stay in compliance with his own tax

obligations), and that he disregarded their advice and affirmatively decided not to

do so but instead to “face the consequence”. The accuracy-related penalty is now

part of that consequence.
                                  -15-

[*15] To reflect the foregoing,


                                               An appropriate order will be

                                         issued granting respondent’s motion,

                                         and decision will be entered under

                                         Rule 155.
