                  T.C. Summary Opinion 2006-102



                     UNITED STATES TAX COURT



               TERRY NATHAN NORMAN, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 24688-04S.              Filed July 10, 2006.


     Terry Nathan Norman, pro se.

     Gavin L. Greene, for respondent.



     PANUTHOS, Chief Special Trial Judge:    This case was heard

pursuant to the provisions of section 7463 of the Internal

Revenue Code in effect at the time the petition was filed.     The

decision to be entered is not reviewable by any other court, and

this opinion should not be cited as authority.    Unless otherwise

indicated, subsequent section references are to the Internal

Revenue Code in effect for the year in issue, and all Rule

references are to the Tax Court Rules of Practice and Procedure.
                               - 2 -

     Respondent determined a $3,674 deficiency in petitioner’s

2002 Federal income tax.   After a concession by respondent,1 the

issues for decision are:   (1) Whether petitioner was a partner in

Physical Therapist Search International, Ltd. Limited Partnership

(PTSI or the partnership); (2) if he was a partner in PTSI,

whether petitioner must report a distributive share of PTSI’s

income; (3) whether petitioner is entitled to a theft loss

deduction under section 165(e) relating to certain actions taken

by PTSI’s general partner; and (4) whether respondent is estopped

from asserting a deficiency against petitioner.

     Some of the facts have been stipulated, and they are so

found.   The stipulation of facts and attached exhibits are

incorporated herein by this reference.   Petitioner resided in

Playa Del Rey, California, when his petition was filed.   For

convenience, we combine our findings and discussion herein.

Burden of Proof

     Pursuant to section 7491(a), the burden of proof as to

factual matters shifts to respondent under certain circumstances.

See also Rule 142.   Petitioner has neither alleged that section

7491(a) applies nor established his compliance with the

requirements of section 7491(a)(2)(A) and (B) to substantiate


     1
       Respondent concedes that petitioner is not liable for
self-employment tax of $1,194. The adjustments in respondent’s
notice of deficiency not addressed in this opinion are
computational.
                               - 3 -

items, maintain records, and cooperate fully with respondent’s

reasonable requests.   Petitioner therefore bears the burden of

proof.

Issue 1.   Whether Petitioner Was a Partner in PTSI

     In 1990, petitioner entered into an agreement titled

“Limited Partnership Agreement of Physical Therapist Search

International, Ltd. Limited Partnership” (the agreement).    The

other party to the agreement was an Illinois corporation called

PT Search International Ltd. (the corporation).    The agreement

provides that petitioner and the corporation “hereby enter into a

limited partnership” for the purpose of placing physical

therapists in hospitals and healthcare facilities.    The agreement

lists petitioner as a limited partner and the corporation as the

general partner and tax matters partner.

     The agreement provides that petitioner “shall make an

Initial Capital Contribution in the amount of $100,000 and shall

receive a four percent (4%) Participating Percentage” in PTSI.

The agreement provides that the corporation shall contribute

$50,000 and receive the remaining 96-percent participating

percentage.   “Participating Percentage” is defined as the

interest of each partner in the partnership.    Petitioner invested

$100,000 as specified in the agreement.    The parties did not

address whether the corporation invested $50,000 in PTSI, though

we have no reason to believe it did not do so.
                                - 4 -

     The agreement provides that petitioner shall receive

distributions from PTSI in proportion to his participation

percentage.    Petitioner also is entitled to a “Preferred Return”,

which the agreement defines as “an amount equal to 10% annually,

cumulative and non-compounded, on each Partner’s Adjusted Capital

Account”.   As is relevant here, the term “Adjusted Capital

Account” means a partner’s contributions to PTSI less any amounts

distributed to him.    Petitioner reviewed the agreement with his

attorney before he signed it.

     A partnership “includes a syndicate, group, pool, joint

venture, or other unincorporated organization through or by means

of which any business, financial operation, or venture is carried

on, and which is not * * * a corporation or a trust or estate.”

Sec. 761(a).   To determine whether a partnership exists, we

consider whether, in light of all the facts, the parties in good

faith and acting with a business purpose intended to join

together in the present conduct of an enterprise.    Commissioner

v. Culbertson, 337 U.S. 733, 742 (1949); Allum v. Commissioner,

T.C. Memo. 2005-177.

     The agreement indicates that petitioner and the corporation

intended to form a partnership, and that petitioner’s $100,000

investment was a contribution of capital in exchange for a

partnership interest.   Petitioner, however, believes that the

agreement created a creditor-debtor relationship and that the
                               - 5 -

$100,000 was a loan to PTSI.   He argues that the preferred return

is similar to a loan repayment schedule because it entitles him

to receive a return of principal along with a specified rate of

interest.   Petitioner contends the 4-percent participation

percentage he received was collateral for the purported loan.

     Where a taxpayer seeks to vary the form in which a

transaction is cast pursuant to an arm’s-length bargain, we

require strong proof that the form of the transaction does not

reflect its substance.   Miami Purchasing Serv. Corp. v.

Commissioner, 76 T.C. 818, 830 (1981); Major v. Commissioner, 76

T.C. 239, 246 (1981); see also Schulz v. Commissioner, 294 F.2d

52 (9th Cir. 1961), affg. 34 T.C. 235 (1960).

     Petitioner challenges the form of the transaction based

solely on the allegedly debtlike characteristics of the preferred

return.   In the context of partnership agreements, however,

arrangements such as the preferred return are not unusual:

     Many partnership agreements provide partners who
     contribute capital with some sort of distribution
     preference. Frequently, the preference is expressed as
     an annual percentage return on invested capital. In
     this respect, if in no other, a distribution preference
     may resemble a form of “interest” on capital. This
     superficial resemblance is likely to be misleading,
     however. Distribution preferences rarely have either
     the economic or the tax attributes of true interest
     payments to partners. [Whitmire et al., Structuring &
     Drafting Partnership Agreements: Including LLC
     Agreements, par. 5.03 (3d ed. 2006).]

See also Jacobson v. Commissioner, 96 T.C. 577, 591 (1991)

(describing as “usual and customary” arrangements whereby “the
                               - 6 -

partner who put up a greater share of the capital than his share

of the partnership profits is to receive preferential

distributions to equalize capital accounts.”) (citing Otey v.

Commissioner, 70 T.C. 312, 321 (1978), affd. 634 F.2d 1046 (6th

Cir. 1980)), affd. 963 F.2d 218 (8th Cir. 1992).

     Petitioner has not provided the strong proof necessary to

vary the form in which his transaction with the corporation was

cast.    See Major v. Commissioner, supra.   We therefore hold that

petitioner and the corporation formed a partnership.2

Issue 2. Whether Petitioner’s Gross Income Includes a
Distributive Share of PTSI’s Income

     For its taxable year 2002, PTSI filed a Form 1065, U.S.

Return of Partnership Income, reporting income of $168,957.    PTSI

prepared a Schedule K-1, Partner’s Share of Income, Credits,

Deductions, etc., reporting petitioner’s distributive share of

this income as $8,448.   Petitioner did not report that amount on

his 2002 Federal income tax return.    Respondent determined that




     2
       Secs. 6221 to 6234 were added by the Tax Equity and Fiscal
Responsibility Act (TEFRA) of 1982, Pub. L. 97-248, sec. 402(a)
96 Stat. 648, and provide for the determination of partnership
items at the partnership, rather than at the individual partner,
level. See Fargo v. Commissioner, T.C. Memo. 2004-13 n.1, affd.
447 F.3d 706 (9th Cir. 2006). In general, the TEFRA provisions
do not apply to partnerships having 10 or fewer members unless
the partnership otherwise elects. Sec. 6231(a)(1)(B). Because
the partnership in question had fewer than 10 members and there
is no indication it made such an election, the TEFRA provisions
do not apply.
                                 - 7 -

the $8,448 was includable in petitioner’s gross income and issued

petitioner a notice of deficiency.

     A partnership is generally not subject to income tax.

Persons carrying on the business as partners are liable for

income tax in their separate or individual capacities.       Sec. 701.

In general, a partner must take into account separately his

distributive share, whether or not distributed, of each class or

item of partnership income, gain, loss, deduction, or credit.

Sec. 1.702-1(a), Income Tax Regs.     A partner’s distributive share

of income, gain, loss, deduction, or credit generally is

determined by the partnership agreement.     Sec. 704(a).

     Petitioner does not dispute the amount of PTSI’s income in

2002.     Nor does he directly challenge the amount of his

distributive share that PTSI reported.     Instead, he believes he

should not be taxed on the $8,448 because the corporation, as

general partner of PTSI, allegedly committed various wrongful

acts.     Petitioner asserts the corporation refused to provide him

with PTSI’s financial information, refused to make distributions

to him, and embezzled partnership funds.

        Although we address the merits of petitioner’s allegations

infra, we do not do so here.     That is because even if

petitioner’s assertions are true, petitioner must report his

distributive share of PTSI’s income in 2002.     See Burke v.

Commissioner, T.C. Memo. 2005-297 (taxpayer’s distributive share
                               - 8 -

of partnership income was taxable to him even though his partner

had stolen partnership funds, taxpayer had not received any

portion of the stolen funds, and taxpayer and his partner

disputed the amount of their respective distributive shares of

partnership income), on appeal (1st Cir., May 23, 2006); see also

Stoumen v. Commissioner, 208 F.2d 903 (3d Cir. 1953), affg. a

Memorandum Opinion of this Court; Gold v. Commissioner, T.C.

Memo. 1983-711.   We therefore hold that petitioner must report

his distributive share of PTSI’s income.

Issue 3. Whether Petitioner Is Entitled to a Theft Loss
Deduction Under Section 165(e)

     Petitioner argues that any income he earned from PTSI in

2002 was “offset” by moneys owed to him by the partnership.

Petitioner believes the preferred return provided for in the

agreement entitled him to receive at least $10,000 per year from

PTSI.3   Petitioner argues he was not paid those amounts because

the corporation embezzled or absconded with partnership funds.

We interpret petitioner’s argument as a claim for a theft loss

deduction under section 165(e).




     3
       This figure represents the 10-percent preferred return on
petitioner’s initial $100,000 contribution. In his pretrial
memorandum, however, petitioner asserts that his preferred return
has increased to $20,000 per year. Based on our resolution of
the third issue for decision infra, we need not decide whether
petitioner’s assertion is correct, and we do not address this
issue further.
                                - 9 -

     Section 165(a) allows a deduction for “any loss sustained

during the taxable year and not compensated for by insurance or

otherwise.”   Concerning theft losses, section 165(a) is

applicable for the year “in which the taxpayer discovers such

loss.”   Sec. 165(e).   For purposes of section 165(e), theft

includes embezzlement.    Sec. 1.165-8(d), Income Tax Regs.    If in

the year of discovery there is a claim for reimbursement that has

a reasonable prospect for recovery, a loss is not considered

sustained until the tax year in which it can be ascertained with

reasonable certainty.    Secs. 1.165-1(d)(3), 1.165-8(a)(2), Income

Tax Regs.

     Petitioner bears the burden of proving a deductible loss,

and he must establish the extent and amount of the loss.       Citron

v. Commissioner, 97 T.C. 200, 207 (1991).    We apply the law of

the jurisdiction where the loss was sustained to determine

whether a theft or embezzlement has occurred.    Bellis v.

Commissioner, 540 F.2d 448, 449 (9th Cir. 1976), affg. 61 T.C.

354 (1973); Luman v. Commissioner, 79 T.C. 846, 860 (1982).

     It is unclear where petitioner resided in 2002.    As a

result, it is also unclear where petitioner may have sustained

his claimed theft loss.    The record indicates that petitioner

formerly resided in Illinois and currently resides in California.

We set forth each State’s theft statute.
                                   - 10 -

     Section 16-1 of the Illinois Criminal Code, in pertinent

part, defines “theft” as follows:

     Sec. 16-1.   Theft. (a)       A person commits theft when he
     knowingly:

          (1) Obtains or exerts unauthorized control over
     property of the owner; or

          (2) Obtains by deception control over property of
     the owner; * * *

                  *    *       *      *     *    *    *

          and
                 (A) Intends to deprive the owner
          permanently of the use or benefit of the
          property; or

                 (B) Knowingly uses, conceals or abandons
          the property in such manner as to deprive the
          owner permanently of such use or benefit; or

                 (C) Uses, conceals, or abandons the
          property knowing such use, concealment or
          abandonment probably will deprive the owner
          permanently of such use or benefit. [720 Ill.
          Comp. Ann. 5/16-1 (LexisNexis 2006).]


In Illinois, the crime of theft includes theft by embezzlement.

See People v. McCarty, 445 N.E.2d 298, 301-302 (Ill. 1983)

(discussing the Committee Comments to Illinois’s Criminal Code);

In re Trovato, 145 Bankr. 575, 580 (Bankr. N.D. Ill. 1991).

     Section 484(a) of the California Penal Code, in pertinent

part, defines “theft” as follows:

     Every person who shall feloniously steal, take, carry,
     lead, or drive away the personal property of another,
     or who shall fraudulently appropriate property which
     has been entrusted to him or her, or who shall
     knowingly and designedly, by any false or fraudulent
                              - 11 -

     representation or pretense, defraud any other person of
     money, labor or real or personal property * * * is
     guilty of theft. [Cal. Penal Code sec. 484(a) (West
     2001).]

In California, the crime of theft also includes theft by

embezzlement.   People v. Creath, 37 Cal. Rptr. 2d 336, 339 (Ct.

App. 1995); People v. Krupnick, 332 P.2d 720, 722 (Cal. Ct. App.

1958).

     A. The Corporation’s Alleged Refusal To Communicate With
Petitioner and Its Alleged Disappearance in 1993

     Petitioner contends that from the inception of the

partnership, the corporation refused to provide him with PTSI’s

financial information.   He also contends that sometime in or

about 1993, PTSI and the corporation “disappeared for over 10

years”, during which time he was unable to locate either company.

     In August 1999, petitioner attempted to contact PTSI by

letter.   The agreement lists PTSI’s principal place of business

as an address in Glenview, Illinois (the Glenview address), “or

such other place or places as the General Partner may designate.”

Petitioner sent a certified letter to the Glenview address, but

the letter was returned to petitioner and marked “Unable to

forward”.   The record does not describe the content of the

letter.   Nor does the record indicate whether petitioner made

additional attempts to contact PTSI or the corporation before the

notice of deficiency was issued in November 2004.
                               - 12 -

     In July 2005, respondent’s Appeals officer sent a letter to

the corporation as PTSI’s tax matters partner asking for

information about petitioner and the partnership (the Appeals

officer’s letter).   The Appeals officer’s letter was sent to an

address in Grayslake, Illinois (the Grayslake address).     Paul

Stern, who appears to have been an officer and/or director of the

corporation,4 responded to the Appeals officer in an undated

letter (Mr. Stern’s letter).   Mr. Stern’s letter states:    (1)

PTSI experienced several years of financial difficulty beginning

in the mid-1990s; (2) as a result, PTSI was unable to make

distributions to petitioner and ultimately ceased operations in

2004;5 (3) PTSI did not have an updated mailing address for

petitioner and had been sending his Forms K-1 to an address in

Chicago, Illinois, which was the address PTSI had on file for

him; (4) the Forms K-1 that PTSI sent had not been returned as

undeliverable; (5) PTSI had changed its principal place of

business to the Grayslake address at an unspecified date and

remained there until April 2004; and (6) the Grayslake address

was no longer used to conduct business.   Mr. Stern’s letter

concludes by listing a contact address in Oak Creek, Wisconsin



     4
       Mr. Stern signed the agreement on behalf of the
corporation.
     5
       Neither Mr. Stern’s letter nor the remainder of the record
indicates what happened to PTSI’s assets after the partnership
ceased operations.
                                - 13 -

(the Oak Creek address).   Enclosed with the letter were copies of

Forms K-1 that PTSI had prepared for petitioner for the taxable

years 2000 through 2004.

     Petitioner testified that he also sent a letter to Mr. Stern

at the Grayslake address in 2005 (petitioner’s 2005 letter).6

The record does not establish precisely when petitioner sent the

2005 letter, although attachments to his pretrial memorandum

indicate it was in November 2005.    Petitioner claims that his

2005 letter also was returned to him and marked “Unable to

forward”.   Petitioner believes the return of his 1999 and 2005

letters demonstrates that Mr. Stern “refused to accept any

correspondence” from petitioner.

     We are skeptical of petitioner’s contentions regarding

PTSI’s alleged disappearance.    First, PTSI remained an active

business in the Chicago metropolitan area7 until 2004, which

petitioner acknowledged at trial.    Such ongoing operations are

inconsistent with the theory that PTSI was attempting to conceal

itself from petitioner.    Even if PTSI had been trying to conceal

itself, it is difficult to believe that petitioner could not have

located PTSI had he made reasonable efforts to do so.


     6
       It is not clear why petitioner mailed this letter to the
Grayslake address rather than the Oak Creek address listed in Mr.
Stern’s letter. We assume that petitioner sent his 2005 letter
before receiving a copy of Mr. Stern’s letter from respondent.
     7
       Both Glenview, Ill. and Grayslake, Ill. are located north
of Chicago.
                              - 14 -

     Second, although petitioner claims he diligently searched

for PTSI after 1993, the only evidence of specific attempts to

contact PTSI are the letters petitioner sent in 1999 and 2005.

Petitioner did not describe what additional efforts, if any, he

made to find PTSI, the corporation, or Mr. Stern.    Furthermore,

while petitioner emphasizes that his 1999 and 2005 letters were

returned to him, it appears that both letters were sent to

outdated addresses.   Petitioner sent his 1999 letter to the

Glenview address listed in the agreement.    It is not clear when

PTSI stopped using this address; however, the 1999 letter was

returned and marked “Unable to forward”.    Had the letter been

marked “Refused”, it might have supported petitioner’s contention

that Mr. Stern was unwilling to accept petitioner’s

correspondence.   As it stands, the returned letter suggests only

that PTSI had moved before the 1999 letter was sent and was no

longer receiving forwarded mail from the Glenview address.

     With respect to petitioner’s 2005 letter, Mr. Stern’s letter

indicates PTSI stopped using the Grayslake address in April 2004.

The record does not explain why the Appeals officer’s letter was

forwarded to the corporation while petitioner’s letter was not;

however, this seeming anomaly does not establish that the

corporation or Mr. Stern was attempting to avoid contact with

petitioner.
                               - 15 -

     Finally, as for petitioner’s claims that PTSI withheld

information, Mr. Stern’s letter indicates that PTSI prepared and

mailed Forms K-1 to petitioner at the address PTSI had on file

for him.   Petitioner did not deny that he changed his mailing

address, nor did he contend that he provided PTSI with updated

information.   In sum, while petitioner claims that PTSI

“disappeared”, petitioner appears to have made little effort to

stay in contact with the partnership.

     B.    PTSI’s Alleged Failure To Make Partnership Distributions

     Petitioner contends that PTSI did not make distributions to

him at any time.    Even if petitioner is correct, the agreement

provides that no cash shall be distributed to the partners unless

PTSI “has acquired a cash reserve of at least $350,000”.    As

discussed supra, the agreement called for petitioner to

contribute $100,000 and the corporation to contribute $50,000,

for a total of $150,000.    There is no indication PTSI accumulated

the additional cash necessary to fund the cash reserve and enable

the partnership to make distributions.    To the contrary, the

financial difficulties mentioned in Mr. Stern’s letter indicate

that PTSI was, in fact, losing money for most of its existence.

Petitioner introduced no credible evidence to contradict the

statements in Mr. Stern’s letter.
                                - 16 -

     C.    The Corporation’s Alleged Embezzlement of Partnership
Funds

     Petitioner contends that the corporation embezzled or

“laundered” partnership funds.     Petitioner also makes vague

allegations of fraud against PTSI, the corporation, Mr. Stern,

and other individuals.     As evidence of the alleged wrongdoing,

petitioner offers PTSI’s Form 1065 for the taxable year 2002,

including the Form K-1 prepared for the corporation, which

indicates the corporation received a distribution of $185,793 in

2002.     As we understand his argument, petitioner contends that

PTSI improperly made distributions to the corporation while

refusing to make distributions to petitioner.

     The agreement provides that “Available Funds shall be

distributed to the Partners pro rata in accordance with their

Participating Percentages”.     This language indicates that if one

partner receives a distribution, the other partners should also

receive pro rata distributions.     The parties agree that

petitioner did not receive a cash distribution from PTSI in 2002.

Thus, petitioner argues, the corporation violated the agreement

and embezzled funds.     We disagree.

     More than 10 years elapsed between the formation of the

partnership and the distribution to the corporation.     There may

be a number of reasons why petitioner did not receive a cash

distribution in 2002.     However, we do not speculate as to those

reasons.     Petitioner did not introduce the testimony of Paul
                                - 17 -

Stern or anyone else involved with the corporation or PTSI.      Nor

did he produce other credible evidence establishing that a theft

loss occurred.     Accordingly, petitioner has not met his burden of

proof and, therefore, is not allowed a deduction under section

165(e).

Issue 4. Whether Respondent Is Estopped From Asserting a
Deficiency Against Petitioner

     Respondent issued petitioner a notice of deficiency on

November 1, 2004.     On December 27, 2004, respondent sent

petitioner a “closing notice”, which states: “we were able to

clear up the differences between your records and your payers’

records.   * * *    If you have already received a notice of

deficiency, you may disregard it.     You won’t need to file a

petition with the United States Tax Court”.

     Respondent’s change in position raises the issue of

equitable estoppel against respondent.     “Equitable estoppel is a

judicial doctrine that ‘precludes a party from denying his own

acts or representations which induced another to act to his

detriment.’”     Hofstetter v. Commissioner, 98 T.C. 695, 700 (1992)

(quoting Graff v. Commissioner, 74 T.C. 743, 761 (1980), affd.

673 F.2d 784 (5th Cir. 1982)).     To apply equitable estoppel

against the Government, however, we must find, inter alia, that

the claimant relied on the Government’s representations and

suffered a detriment because of that reliance.     See Norfolk S.

Corp. v. Commissioner, 104 T.C. 13, 60 (1995), affd. 140 F.3d 240
                               - 18 -

(4th Cir. 1998); Estate of Emerson v. Commissioner, 67 T.C. 612,

617-618 (1977).    In addition, the Court of Appeals for the Ninth

Circuit requires the party seeking to apply the doctrine against

the Government to prove affirmative misconduct.     Miller v.

Commissioner, T.C. Memo. 2001-55.

     Respondent has not explained why the closing notice was sent

to petitioner.    Nevertheless, we cannot apply equitable estoppel

against respondent because petitioner timely petitioned the Tax

Court.    Thus, he did not rely to his detriment on the closing

notice.    Even if petitioner had relied to his detriment, there is

no evidence of affirmative misconduct by respondent.    Finally, we

note that section 6212(d) provides the Secretary with the

authority to rescind a notice of deficiency with the consent of

the taxpayer.    Where that has not occurred, we have stated that

only a closing agreement or decision by the Court binds the

parties.    Miller v. Commissioner, supra.   Respondent did not

rescind the notice of deficiency.    Because there was no closing

agreement or decision of the Court, the parties are not bound by

the closing notice.

     Petitioner also notes that he received a closing notice for

his taxable year 2001.    Petitioner appears to argue that the

favorable result reflected in the closing notice for that year

should also apply to his taxable year 2002.    We disagree.     Each

taxable year stands on its own, and the Commissioner may
                                - 19 -

challenge in a succeeding year what was overlooked or condoned in

previous years.    See, e.g., Rose v. Commissioner, 55 T.C. 28,

31-32 (1970).     The closing notice that petitioner received in

2001 does not affect the outcome of this case.

     Respondent’s determination is sustained.     In reaching our

holding, we have considered all arguments made, and, to the

extent not mentioned, we conclude that they are moot, irrelevant,

or without merit.

     Reviewed and adopted as the report of the Small Tax Case

Division.

     To reflect the foregoing,

                                           Decision will be entered

                                      under Rule 155.
