                        T.C. Memo. 2005-172



                      UNITED STATES TAX COURT



      WHITMAN & RANSOM, MAGED F. RIAD, TAX MATTERS PARTNER,
                           Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 7916-03.            Filed July 12, 2005.


     Sander B. Ross, for petitioner.

     Robert S. Goodman and Matthew N. Tobias, for participant

Arthur M. Handler.

     Lydia A. Branche, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     HAINES, Judge:   This case is a partnership proceeding

subject to the unified audit and litigation procedures of the Tax

Equity & Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. 97-

248, sec. 402, 96 Stat. 628.   Respondent issued a notice of final
                                 2

partnership administrative adjustment (FPAA) to Maged F. Riad, as

tax matters partner for Whitman & Ransom (W&R), determining

adjustments to W&R’s Form 1065, U.S. Partnership Return of Income

(partnership return) for 1996.   A timely petition for a

readjustment of the partnership items for 1996 was filed pursuant

to section 6226(a).1   The issues for decision are whether W&R may

deduct, as guaranteed payments, adjustments made to eliminate the

negative capital account balances of individual partners who had

withdrawn from W&R, and whether Arthur M. Handler (Handler) was a

partner in W&R during 1996.

                         FINDINGS OF FACT

     The parties submitted this case fully stipulated pursuant to

Rule 122.   The stipulation of facts, the supplemental stipulation

of facts, and the attached exhibits are incorporated herein by

this reference.   We find the stipulated facts accordingly.

     W&R was established in 1919 under the laws of New York as a

general partnership engaged in the practice of law.   From 1993

through 1996, W&R had its principal place of business in New

York, New York.   From 1993 through 1996, Maged F. Riad was the

tax matters partner of W&R.




     1
       All Rule references are to the Tax Court Rules of Practice
and Procedure, and all section references are to the Internal
Revenue Code, as amended. Amounts are rounded to the nearest
dollar.
                                 3

     W&R’s partnership agreement classified partners as either

equity partners, who shared in W&R’s profits and losses on the

basis of their partnership interests, or contract partners, whose

compensation was based upon agreement.   Handler, Donald Parson

(Parson), Richard Tilton (Tilton), and Elliot Hahn (Hahn) were

equity partners.2   James Sargent (Sargent) had been an equity

partner until April 1, 1984.   He continued as a contract partner

until W&R ceased doing business in 1993.

     The partnership agreement was amended as of October 30, 1993

(the amendment), to provide for the liquidation and dissolution

of W&R commencing November 1, 1993.   The amendment provided in

Section 22(k):

     As the affairs of the partnership are wound up and its
     debts paid and other obligations, including obligations
     to partners, discharged or provided for and the
     partners’ capital including voluntary capital and
     interest * * * has been returned to them, any net
     balance remaining in the hands of the liquidating
     partners shall be distributed * * * to the persons who
     are partners on the date of dissolution, pro rata in
     accordance with their “points” in the partnership set
     forth on Schedule A to the Agreement.[3]

     Certain of the former partners of W&R and members of another

law firm, Breed, Abbott & Morgan, formed a new partnership,

Whitman, Breed, Abbott & Morgan (WBAM), effective November 1,


     2
       Michael Allen (Allen) and David Morse (Morse) were
contract partners under the partnership agreement.
     3
       Handler, Parson, Tilton and Hahn are listed on Schedule A
with “points” attributed to them. Sargent is not listed on
Schedule A.
                                 4

1993.   Handler, Parson, Tilton, Hahn, and Sargent did not become

partners in WBAM (the withdrawing partners).

     The amendment to the W&R partnership agreement authorized

the W&R executive committee to negotiate severance agreements

with any partner who did not become a partner in WBAM.   The only

severance agreements stipulated in the record in this case were

those for Parson and Handler.   Sargent’s April 1, 1984, agreement

is also in the record.   There are no severance agreements or

other documentation stipulated into the record for Hahn or

Tilton.

     Parson’s agreement (Parson agreement) dated October 31,

1993, provided, inter alia, that he would have no further

interest in W&R after October 31, 1993, that he was to be repaid

his capital account balance in excess of any capital loans plus

interest, that his capital loans would be paid from the remainder

of his capital contribution, and that, in lieu of all rights to

liquidating distributions for assets, he was to be paid $85,000.

All payments to him were to be completed on or before January 1,

1995.   Parson’s severance agreement also stated in part:

          8. This agreement contains all of the rights and
     obligations of the parties hereto and its execution by
     the said parties shall constitute a full and complete
     release each of the other of any and all claims which
     either party or his legal representatives and assigns
     may now have or in the future might have with respect
     to Parson’s interest in the Firm.
                                5

     Handler withdrew as a partner as of October 31, 1993, and

negotiated a severance agreement.   Handler’s agreement (Handler

agreement) dated April 15, 1994, stated in part:

           1. $31,868.30 (which represents the unpaid
     balance of my contributed Whitman & Ransom capital in
     excess of my $71,602.68 outstanding capital loan due to
     Chemical Bank) plus all accrued and unpaid interest on
     my contributed capital since the date interest was last
     paid to me, will be paid to me on or before May 15,
     1994.

          2. Whitman & Ransom will assume and pay my
     capital loan to Chemical Bank as it comes due and
     Whitman & Ransom hereby indemnifies and holds me
     harmless from any claim of Chemical Bank with regard to
     my capital loan. In addition, on or before May 15,
     1994, Whitman & Ransom will deliver to me an
     unconditional release and discharge by Chemical Bank.

          3. All sums which I have previously drawn from
     Whitman & Ransom, including without limitation, all
     amounts distributed to me in respect of 1993 operations
     of Whitman & Ransom will be retained by me. I will
     have no further claims against Whitman & Ransom in
     respect of 1993 operations, any proceeds of the
     liquidation of Whitman & Ransom or otherwise, and
     Whitman & Ransom will have no claims against me in
     respect of any matters. Simultaneously with the
     delivery of the Whitman & Ransom check and the release
     from Chemical Bank referred to in the first paragraph,
     we will exchange General Releases, excepting only the
     Whitman & Ransom indemnity against any Chemical Bank
     claim set forth in Paragraph 1 of this letter.

Handler did not receive any payments or distributions from W&R

other than those provided in the Handler agreement.   On May 24,

1994, W&R also executed a separate agreement releasing Handler

from any further liabilities.

     W&R sent Handler a Form 1065, Schedule K-1, Partner’s Share

of Income, Credits, Deductions, etc., for 1994 and 1996, but not
                                  6

for 1995.    Handler filed Form 8082, Notice of Inconsistent

Treatment or Amended Return, disputing the allocation for both

years, claiming he was no longer a partner in W&R.

     Sargent, on April 1, 1984, pursuant to a written agreement

(Sargent’s agreement) withdrew as an equity partner, but

continued on as a contract partner.    Sargent was to be repaid his

capital account balance of $72,000 in annual installments of

$5,000 commencing March 31, 1985, and was also to receive income

for life on a graduated scale not tied to profits and a death

benefit.    An appendix attached at the end of this opinion

summarizes the capital accounts as calculated for 1993 and 1994

by W&R for each of the withdrawing partners.    According to the

calculations by W&R, Sargent was paid all sums due to him in

1994.

     The calculations of capital accounts by W&R also establish

that in 1993, Tilton, consistent with Handler, was repaid the

portion of his contributed capital that was in excess of his

capital loans, and his capital loans were paid off from his

remaining contributed capital.    W&R’s calculations also establish

that Hahn had made no capital contributions which would require

repayment.   The calculations by W&R also show that no income was

allocated to any of the withdrawing partners in 1995.

     On the basis of those calculations by W&R, as of December

31, 1994, each withdrawing partner had the following deficit
                                  7

balance in his capital account:

     Partner                   Capital Account Balance

     Parson                           ($30,823)
     Handler                          (186,739)
     Hahn                              (96,351)
     Sargent                           (85,470)
     Tilton                            (46,138)

The total deficit came to $445,521.

     On its 1996 partnership return, W&R elected the cash method

of accounting for tax purposes.   The partnership return’s

Schedule M-2, Analysis of Partners’ Capital Accounts, reported

that each withdrawing partner contributed capital equal to the

amount of the withdrawing partner’s negative capital account

balance resulting in total capital contributed of $445,522.4   The

amount reported as capital contributed in 1996 for each

withdrawing partner zeroed out each withdrawing partner’s

negative capital account balance.

     W&R reported on its 1996 partnership return total income of

$678,711 and claimed a deduction of $456,522 as “Guaranteed

payments to partners”.5   W&R issued to each withdrawing partner a


     4
       The $1 difference between the capital account balances
shown on the chart attached and that claimed on Schedule M-2 will
be attributed to rounding.
     5
       In addition to bringing the negative capital accounts of
the withdrawing partners to zero which made up $445,522, of the
claimed guaranteed payments, W&R actually paid Allen $1,000 for
services rendered and $10,000 to Morse for his services with
regard to the termination and liquidation of W&R’s retirement
plans. The payments to Allen and Morse have been conceded by
                                                   (continued...)
                                 8

1996 Schedule K-1, allocating to each withdrawing partner an

amount classified as a guaranteed payment equal to the deficit

capital account; i.e., Parson was allocated $30,823; Handler

$186,740;6 Sargent $85,470; Tilton $46,138; and Hahn $96,351.

     On March 10, 2003, respondent issued an FPAA for 1996 to

Maged F. Riad as tax matters partner for W&R.   Respondent

disallowed the deduction for guaranteed payments, determining W&R

failed to substantiate that guaranteed payments were incurred or

paid in 1996 or that the amounts were deductible as ordinary and

necessary expenses under section 162.   In the alternative,

respondent determined that Hahn, Handler, Parson, Sargent, and

Tilton received taxable guaranteed payments in 1996 consistent

with the treatment accorded in the partnership return.

     On May 27, 2003, petitioner filed with the Court a Petition

for Readjustment of Partnership Items Under Code Section 6226

praying that the Court:   (1) “determine that petitioner filed a

partnership return for 1996 which correctly and accurately



     5
      (...continued)
respondent to be guaranteed payments.

     6
       The $1 difference between the calculated capital account
and the amount deducted will be attributed to rounding. Handler
reported a $137,074 long-term capital gain on Schedule D, Capital
Gains and Losses, in his 1996 Federal tax return as “liquidation
of p’ship interest” and paid the applicable tax. His calculation
of the deficit in his capital account differed from W&R’s. The
treatment of the transaction by other withdrawing partners is not
in the record.
                                 9

treated the items at issue”; and (2) “allow as deductions from

the partnership taxable income each and every payment allocated

from income to the withdrawing partners as reasonable and

appropriate payment properly allocated from the partnership

income and taxable to these respective partners”.

     A copy of the FPAA in the instant case was sent to Handler.

On May 22, 2003, Handler filed a petition for redetermination

with the Court challenging the FPAA.    On July 18, 2003,

respondent filed a motion to dismiss for lack of jurisdiction on

the ground that respondent did not issue a notice of deficiency

to Handler for 1996.   On September 29, 2003, we issued an order

granting respondent’s motion, but noted that Handler’s remedy was

to file a motion for leave to file a notice of election to

participate and submit a notice of election to participate in the

instant case pursuant to Rule 245.   On November 3, 2003, the

Court granted Handler leave to file his notice of election to

participate, which sets forth Handler’s contention that he was

not a partner in W&R during 1996.

                              OPINION

     This TEFRA proceeding was brought by the tax matters partner

of the law firm.   Congress promulgated the TEFRA partnership

unified audit and litigation provisions of sections 6221 through

6234 intending to simplify and streamline the audit, litigation,

and assessment procedures with respect to partnerships and their
                                10

partners.   These provisions centralized the tax treatment of

partnership items and resulted in equal treatment for partners

through the uniform adjustment of each partner’s tax liability in

a single proceeding.   Chimblo v. Commissioner, 177 F.3d 119, 120-

121 (2d Cir. 1999), affg. T.C. Memo. 1997-535; Harbor Cove Marina

Partners Pship. v. Commissioner, 123 T.C. 64, 78-79 (2004).     Once

an action for readjustment of partnership items is commenced by

either the tax matters partner or a notice partner, any partner

with an interest in the outcome of that action may participate in

it.   Sec. 6226(c) and (d); Rule 245.

      Pursuant to section 6221, the tax treatment of any

partnership item is determined at the partnership level.   A

“partnership item” is any item which must be taken into account

for the partnership’s taxable year to the extent that regulations

prescribe it as an item more appropriately determined at the

partnership level than at the partner level.   Sec. 6231(a)(3).

The regulations provide further that a partnership item not only

includes those items expressly listed in the regulations, but

also includes “the legal and factual determinations that underlie

the determination of the amount, timing, and characterization of

items of income, credit, gain, loss, deduction, etc.”   Sec.

301.6231(a)(3)-1(b), Proced. & Admin. Regs.

      The determination of a guaranteed payment is a partnership

item.   Sec. 301.6231(a)(3)-1(a)(2), Proced. & Admin. Regs.
                                 11

Handler’s claim that he was not a partner in W&R during 1996 is a

partnership item because it could affect the allocation of

partnership items to the other partners.   Blonien v.

Commissioner, 118 T.C. 541, 551 (2002).

     Petitioner bears the burden of establishing that payments in

liquidation of the withdrawing partners’ interest in W&R were

paid or incurred in 1996 which resulted in deductible guaranteed

payments.   See Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115

(1933); I-Tech R&D Ltd. Pship. v. Commissioner, T.C. Memo. 2001-

10, affd. sub nom. Lewin v. Commissioner, 335 F.3d 345 (4th Cir.

2003).7   The burden of proof, or the effect of failure of proof,

does not change because the case is submitted under Rule 122.

See Rule 122(b); Borchers v. Commissioner, 95 T.C. 82, 91 (1990),

affd. 943 F.2d 22 (8th Cir. 1991).

     Petitioner claims the allocation of income to zero out the

negative capital accounts of the withdrawing partners resulted in

guaranteed payments which are deductible by the partnership

pursuant to section 736(a)(2).   Respondent claims that the

allocation of income could not result in guaranteed payments

because there was no proof that payment had been incurred or paid

in 1996, or that, if payments had been incurred or paid, they

were deductible as ordinary or necessary expenses pursuant to



     7
       Petitioner and Handler do not argue that sec. 7491(a)
applies to shift the burden of proof to respondent.
                                 12

section 162(a).    Alternatively, respondent determined that each

of the withdrawing partners received taxable guaranteed payments

in accordance with the partnership return filed by W&R.

     Section 736(a) applies to payments made in liquidation of

the withdrawing partners’ interests.8    The phrase “liquidation of

a partner’s interest” means:

     the termination of a partner’s entire interest in a
     partnership by means of a distribution, or a series of
     distributions, to the partner by the partnership. A
     series of distributions will come within the meaning of
     this term whether they are made in one year or in more
     than one year. Where a partner’s interest is to be
     liquidated by a series of distributions, the interest
     will not be considered as liquidated until the final
     distribution has been made.

Sec. 1.761-1(d), Income Tax Regs.

     The severance agreements signed by Parson in 1993 and by

Handler in 1994 establish that each had withdrawn as members of



     8
         Sec. 736 provides in relevant part:

     SEC. 736.    PAYMENTS TO A RETIRING PARTNER OR A DECEASED
                  PARTNER’S SUCCESSOR IN INTEREST.

          (a) Payments Considered as Distributive Share or
     Guaranteed Payment.--Payments made in liquidation of the
     interest of a retiring partner or a deceased partner shall,
     except as provided in subsection (b), be considered--

                 (1) as a distributive share to the recipient of
            partnership income if the amount thereof is determined
            with regard to the income of the partnership, or

                 (2) as a guaranteed payment described in section
            707(c) if the amount thereof is determined without
            regard to the income of the partnership.
                                 13

W&R by the end of 1994.    Each severance agreement required W&R to

repay to the withdrawing partner the capital contributed by the

withdrawing partner net of capital loans.    The capital loans of

the withdrawing partner were then paid with the balance of the

capital contributed, and in Handler’s case W&R obtained Handler’s

release from the bank that lent Handler the money.    Both

severance agreements contained mutual releases from any further

liabilities and claims for services including a release by the

withdrawing partner of any right to claim assets on liquidation.

Neither withdrawing partner was entitled to income from the

partnership for any year after 1994 because each released W&R

from any further claims.   The accountings prepared by W&R

establish that all moneys due from W&R to Parson and Handler had

been completely paid by the end of 1994.    As a result, no income

was allocated to Parson or Handler in 1995.

     Sargent was not an equity partner but was still owed

$27,000, as of October 31, 1993, for capital he had contributed

to W&R.   According to the capital accounts calculated by W&R, all

moneys due him were paid in 1994.     He had no right to income as a

contract partner and was not listed in the partnership agreement

to share any distributions upon liquidation.

     Tilton’s and Hahn’s severance agreements are not in the

record.   We infer from the stipulations and documents before us

that they were treated in the same manner as Parson’s and
                                 14

Handler’s.    The capital accounts calculated by W&R bear this out.

Tilton was repaid his contributed capital net of capital loans in

1993, his capital loans were paid by the balance of the capital

not distributed to him, and he had no income allocated to him in

1995.    Hahn had made no capital contributions to W&R which would

have had to be repaid and had no income allocated to him in 1995.

     We find:    (1) The withdrawing partners withdrew as members

of W&R by the end of 1994 and were no longer partners; (2) the

withdrawing partners’ partnership interests had been completely

liquidated prior to 1996; (3) the withdrawing partners had

released W&R from any further claims prior to 1996; and (4) W&R

had released the withdrawing partners from any further claims

prior to 1996.    As a consequence there were no payments in 1996

by W&R to the withdrawing partners in liquidation of their

interests.    Further, we find that none of the withdrawing

partners, including Handler, were partners in 1996.    Because we

have found there were no payments in 1996 to the withdrawing

partners in liquidation of their interests pursuant to section

736(a)(2), we hold that no guaranteed payments to the withdrawing

partners were made.9

     We have considered all of the parties’ contentions,

arguments, and requests that are not discussed herein, and we


     9
       Respondent has conceded that the payments of $1,000 to
Allen and $10,000 to Morse were guaranteed payments for services
rendered.
                                 15

conclude that they are without merit or irrelevant.

     To reflect the foregoing,


                                           Decision will be entered

                                      under Rule 155.
                                                     16
                                                APPENDIX

Balance as of 1/1/93        Parson            Handler       Hahn      Sargent     Tilton
Permanent capital1         $128,244          $119,084         ---      $ 27,000    $110,000
Temporary capital2           42,439            50,023       $29,867    (61,657)      21,880

1993
Undistributed              (42,439)          (50,023)      (29,867)      ---          (21,880)
  earnings
Draws3                    (136,275)      (111,150)         (74,250)   (30,000)        (38,089)
Payments for               (14,384)        (7,451)          (2,991)    (8,491)         (4,169)
  partners4
Loan Interest/                 (5,051)       (19,313)         ---        ---            ---
  Principal
Retirement plan                (9,934)         ---            ---      (5,600)           ---
Capital withdrawal               ---           ---            ---        ---          (22,000)

Payment                         ---            3,299          ---        ---             ---
Loan repayment                  ---            ---            ---        ---          (88,000)

1994
Distributions              (93,509)            ---            ---     (27,000)          ---
Draws                     (281,500)            ---            ---        ---            ---
Payments for                  (652)            ---            ---        (838)          ---
  partners
Loan Interest/             (43,074)          (12,429)         ---        ---            ---
  Principal
Retirement plan                (9,934)          ---           ---        ---            ---
Capital repayment                ---         (31,868)         ---        ---            ---
Assumption of loan               ---         (71,603)         ---        ---            ---

1995
Payments for                    ---            (432)          ---        (102)          ---
  partners

K-1 Allocation - 1993          142,542       (37,380)      (20,636)     19,733        (8,005)
K-1 Allocation - 1994          282,769       (17,407)         1,526      1,485          4,045

12/31/94
                           5             6                                        7
Capital account balance     (30,823)      (186,739)        (96,351)   (85,470)     (46,138)


      1
          The partner’s contribution to the capital of the firm.
      2
        This account was credited or charged with the partner’s share of W&R’s profit or
loss. After closing out the nominal accounts, i.e., Draws, Payments for partners, Retirement
plan contributions, the balance was available for withdrawal by the partner.
      3
        Advances to the partners. The agreement characterizes draws as advances against the
current year’s distributable net income.
      4
        Items for a partner’s personal benefit, such as health, life and disability insurance
premiums, personal telephone calls, postage, photocopies, personal travel, professional
subscriptions.
      5
        We note that the stipulated capital account balance of ($30,823) is not the
calculated amount of ($40,758) from the table. We assume this difference of $9,935 is due to
an extra charge to Parson’s retirement plan.
      6
        We note that the stipulated capital account balance of ($186,739) varies from the
actual calculated amount of ($186,650). The parties do not explain this difference.
      7
        We note that the stipulated capital account balance of ($46,138) varies from the
actual calculated amount of ($46,218). The parties do not explain this difference.
