                        T.C. Memo. 2000-181



                      UNITED STATES TAX COURT



     PATTY K. COPELAND, A.K.A. PATTY K. WHITE, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent

                ALVIN C. COPELAND, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 23228-90, 23229-90.      Filed June 14, 2000.



     J. Grant Coleman, for petitioners.

     Elaine Harris Warren and Thomas L. Fenner, for respondent.



                        MEMORANDUM OPINION


     SWIFT, Judge:   In these consolidated cases, respondent

determined deficiencies in petitioners’ Federal income taxes and

additions to tax as follows:
                                                   - 2 -
                                                             Additions to Tax
Year          Deficiency      Sec. 6621(c)   Sec. 6653(a)   Sec. 6653(a)(1)   Sec. 6653(a)(2)   Sec. 6659

Patty K. and Alvin C. Copeland

1979           $197,476              *         $10,054            --                --              --
1980            203,319              *           9,927            --                --              --
1981            164,065              *            --           $22,462              **          $80,086
1982            170,990              *            –-            24,323              **           67,608
1983            127,523             -0-           --             -0-                -0-            -0-

Alvin C. Copeland

1985           $    1,440           -0-           --              -0-               -0-           -0-


                     * 120 percent of interest accruing after Dec. 31, 1984, on
                       portion of underpayment attributable to a tax-motivated
                       transaction.

                    ** 50 percent of interest due on portion of underpayment
                       attributable to negligence.



            This matter is before us on the parties’ cross-motions for

       partial summary judgment with regard to the following legal

       issues: (1) Whether, in analyzing claimed losses relating only to

       the amount of “out-of-pocket” cash invested in limited

       partnerships, the profit objective of the investments should be

       measured at the partnership level or at the individual partner

       level; and (2) whether increased interest under section 6621(c)

       applies to petitioners’ tax deficiencies attributable to

       petitioners’ limited partnership investments.

            Unless otherwise indicated, all section references are to

       the Internal Revenue Code in effect for the years in issue.


                                               Background

            Many of the facts have been stipulated and are so found.

            Petitioners resided in Metairie, Louisiana, at the time they

       filed their petitions.
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     The activities and transactions of the limited partnerships

involved herein, Garfield Oil and Gas Associates, a Utah limited

partnership, and Cardinal Oil Technology Partners, a Pennsylvania

limited partnership (hereinafter referred to as the Garfield and

Cardinal limited partnerships or as the partnerships), are

substantially identical to those of the limited partnerships

involved in our test case opinion in Krause v. Commissioner, 99

T.C. 132, 133-167 (1992), affd. sub nom. Hildebrand v.

Commissioner, 28 F.3d 1024 (10th Cir. 1994).

     On their respective Federal income tax returns for the years

in issue, petitioners claimed large losses and interest

deductions relating to their investments as limited partners in

the Garfield and Cardinal limited partnerships.   Respondent

disallowed these claimed losses and interest deductions, and

petitioners filed the instant petitions contesting respondent's

adjustments.   Petitioners now concede all of the originally

claimed tax benefits relating to their investments in the

partnerships, and petitioners seek a loss deduction only for the

amount of cash they invested in the partnerships.

     After a lengthy trial in the Krause test cases, we analyzed

the objectives and activities of the particular partnerships

involved in Krause.   We concluded that the partnerships’

activities were not conducted at arm’s length, that they were not

legitimate transactions with economic substance, and that they

lacked a profit objective.   We concluded that the licenses and
                                 - 4 -

leases entered into by the partnerships were not supported by

economic substance, did not conform to industry norms, and

precluded any realistic opportunity for profit.    See id. at 169,

175.    We sustained respondent's disallowance of the claimed

losses and interest deductions relating to the taxpayers’

investments in the partnerships, and we imposed an increased

interest rate under section 6621(c).

       Petitioners herein stipulate that the factual findings made

in the Krause test case opinion with regard to the partnerships

involved therein also apply to the activities of the Garfield and

Cardinal limited partnerships.    We treat this stipulation as an

admission that the activities of the Garfield and Cardinal

limited partnerships were not conducted at arm’s length, that

they were not legitimate transactions with economic substance,

and that they lacked a profit objective.


                             Discussion

       As we explained in Vanderschraaf v. Commissioner, T.C. Memo.

1997-306, affd. without published opinion 211 F.3d 1276 (9th Cir.

2000), it is well established that the issue under section 183 as

to whether a partnership investment has associated with it

economic substance and a profit objective is determined at the

partnership level.    See Pasternak v. Commissioner, 990 F.2d 893,

900 (6th Cir. 1993), affg. Donahue v. Commissioner, T.C. Memo.

1991-181; Simon v. Commissioner, 830 F.2d 499, 507 (3d Cir.
                               - 5 -

1987), affg. T.C. Memo. 1986-156; Krause v. Commissioner, supra

at 168 (and cases cited therein); Drobny v. Commissioner, 86 T.C.

1326, 1341 (1986) (motion to vacate denied at T.C. Memo. 1995-

209, affd. 113 F.3d 670 (7th Cir. 1997)); Brannen v.

Commissioner, 78 T.C. 471, 505 (1982), affd. 722 F.2d 695 (llth

Cir. 1984); Hager v. Commissioner, 76 T.C. 759, 782 n.11 (1981).

     In analyzing economic substance and the profit objective

test, courts focus on actions of the partners who manage affairs

of the partnerships and upon the underlying activities of the

partnerships.   See Hill v. Commissioner, 204 F.3d 1214 (9th Cir.

2000); Thomas v. United States, 166 F.3d 825, 832-834 (6th Cir.

1999); Drobny v. Commissioner, 86 T.C. at 1341 (citing Brannen v.

Commissioner, 78 T.C. at 504-505); Fox v. Commissioner, 80 T.C.

972, 1007-1008 (1983), affd. without published opinion 742 F.2d

1441 (2d Cir. 1984), affd. sub nom. Barnard v. Commissioner, 731

F.2d 230 (4th Cir. 1984), affd. without published opinions sub

nom. Hook v. Commissioner, Kratsa v. Commissioner, Leffel v.

Commissioner, Rosenblatt v. Commissioner, Zemel v. Commissioner,

734 F.2d 5, 6-7, 9 (3d Cir. 1984).

     Under any other approach, different results would accrue to

partners in the same partnerships even though the partners

themselves may have had no control over activities of the

partnerships.   See Independent Elec. Supply, Inc. v.

Commissioner, 781 F.2d 724, 729 (9th Cir. 1986), affg. Lahr v.

Commissioner, T.C. Memo. 1984-472; Resnik v. Commissioner, 66
                               - 6 -

T.C. 74, 81 (1976), affd. per curiam 555 F.2d 634 (7th Cir.

1977).   For these reasons, in analyzing the economic substance

and the profit objective of limited partnership investments, in

particular, individual actions of limited partners are not the

focus of the analysis.

     An analysis of the economic substance and the profit

objective element at the partnership level under section 183 is

consistent with and follows the general rule of Federal

partnership taxation that the treatment of partnership income,

loss, deduction, or credit items is to be determined at the

partnership level.   See sec. 702(b); Podell v. Commissioner, 55

T.C. 429, 433 (1970) (citing Estate of Freeland v. Commissioner,

393 F.2d 573 (9th Cir. 1968), affg. T.C. Memo. 1966-283); sec.

1.702-1(b), Income Tax Regs.

     Section 761(a) defines a partnership for Federal income tax

purposes essentially as a group, joint venture, or other

unincorporated organization through which any business, financial

operation, or venture is carried on.   See also section 7701(a)(2)

and section 1.761-1(a), Income Tax Regs., under which the term

“partnership” is defined more broadly than the common-law meaning

of partnership.

     We discern no reason to deviate from the above partnership-

level approach merely because petitioners herein have conceded

the originally claimed partnership tax benefits and are now
                               - 7 -

seeking a deduction only for their out-of-pocket cash invested in

the partnerships.

     The Garfield and Cardinal limited partnerships did not

constitute mere passive coowners of property.   These limited

partnerships entered into transactions, formed joint ventures,

operated gas wells, and engaged in various other activities.

They carried on a financial operation or venture.   They are to be

treated as partnerships under section 76l(a) even though the

underlying activities of the partnerships lacked a profit

objective under section 183.   The Garfield and Cardinal limited

partnerships each had the formal indicia of partnership status

and conducted themselves generally as partnerships.   They are to

be treated as partnerships.

     The issue herein under section 183 as to profit objective is

to be analyzed at the partnership level.   The parties’

stipulation that activities and transactions of the Garfield and

Cardinal limited partnerships were not entered into with a profit

objective does not affect the status of the partnerships as

partnerships for Federal income tax purposes.


Section 6621(c) Increased Interest

     With regard to increased interest under section 6621(c),

among other arguments, petitioners contend that the temporary

regulations under section 6621 that extended increased interest

to transactions lacking a profit objective are invalid and that
                               - 8 -

imposition against them of increased interest would violate due

process of law.1   See sec. 301.6621-2T, A-4, Temporary Proced. &

Admin. Regs., 49 Fed. Reg. 50392 (Dec. 28, 1984).

     As we explained in Krause v. Commissioner, 99 T.C. at 180,

imposition of increased interest under section 6621(c), and its

predecessor section 6621(d), is largely mechanical.   Section

6621(c) provides an increased rate of interest for substantial

underpayments attributable to tax-motivated transactions.

Substantial underpayments are defined as underpayments in excess

of $1,000.   By legislative regulation, see sec. 6621(c)(3)(B),

among the types of transactions that are considered to be tax-

motivated transactions within the meaning of section 6621(c) are

those with respect to which related tax deductions are disallowed

under section 183 for lack of profit objective.   See Rybak v.

Commissioner, 91 T.C. 524, 568 (1988); sec. 301.6621-2T, A-4(1),

Temporary Proced. & Admin. Regs., 49 Fed. Reg. 50392 (Dec. 28,

1984).

     We note that in 1986, in amending section 6621(c) to include

sham transactions among the specified types of transactions that

trigger increased interest, congressional reports expressly

commented with approval on the temporary legislative regulations

under section 6621(c) that included lack of profit motive or


1
     As of June 30, 1990, respondent asserts approximately
$250,000 of increased interest under sec. 6621(c) and in excess
of $2 million of regular interest under sec. 6621(a).
                               - 9 -

objective as a ground for increased interest.    See H. Conf. Rept.

99-841 at II-796 (1986), 1986-3 C.B. (Vol. 4) 796 (Statement of

the Managers).

     The validity of the above regulation (and the applicability

of section 6621(c) increased interest) to partnerships

essentially the same as the Garfield and Cardinal partnerships

involved herein was analyzed at length and expressly sustained by

the Court of Appeals for the Ninth Circuit in its recent opinion

in Hill v. Commissioner, 204 F.3d at 1220.   Also, imposition of

increased interest under the above regulation in the Krause test

case was sustained by the Court of Appeals for the Tenth Circuit

in its opinion in Hildebrand v. Commissioner, 28 F.3d at 1028.

     In a number of cases, the Court of Appeals for the Fifth

Circuit has sustained imposition of increased interest under

section 6621(c).   See Durrett v. Commissioner, 71 F.3d 515 (5th

Cir. 1996), affg. in part and revg. in part T.C. Memo. 1994-179;

Chamberlain v. Commissioner, 66 F.3d 729 (5th Cir. 1995), affg.

in part and revg. in part T.C. Memo. 1994-228.   In Heasley v.

Commissioner, 902 F.2d 380 (5th Cir. 1990), revg. T.C. Memo.

1988-408, the Court of Appeals for the Fifth Circuit, on the

facts of that particular case, reversed our holding that

increased interest under section 6621(c) applied to the

transactions in question.   In none of these cases did the Fifth

Circuit suggest the invalidity of the regulations under section
                                - 10 -

6621(c) or any due process problem in the imposition of increased

interest under section 6621(c).

     As part of their due process argument, petitioners note that

the accrued interest has, over the years, accumulated against

them to an amount far in excess of the income tax deficiencies.

Respondent counters that the bulk of the accrued interest

consists not of increased interest under section 6621(c) but of

regular interest under section 6621(a).

     Petitioners’ reliance on Law v. Commissioner, 84 T.C. 985

(1985), and In re Hardee, 137 F.3d 337 (5th Cir. 1998), is

misplaced.     Law v. Commissioner, supra, involved an untimely

attempt by respondent to raise increased interest in an amended

answer.   In re Hardee, supra, was a bankruptcy opinion in which

it was held that section 6621(c) increased interest does not

constitute a penalty for purposes of the Bankruptcy Code.

     Apart from section 183 and the determination of profit

objective thereunder, petitioners contend that for purposes of

increased interest under section 6621(c) the language of section

6621 imposes its own, separate profit objective test at the

partner-investor level.    We disagree.   As the Court of Appeals

for the Tenth Circuit stated in Hildebrand v. Commissioner, supra

at 1028, “Section 6621(c)(1) imposes an increased rate of

interest on ‘any substantial underpayment attributable to tax

motivated transactions,’ which include activities not engaged in

for profit.”
                             - 11 -

     In the Court of Appeals for the Ninth Circuit’s opinion in

Hill v. Commissioner, supra at 1220, the following explanation is

dispositive of petitioners’ arguments:


          “We specifically reject Krause’s assertion
          that the Tax Court erred in finding Barton
          Income Fund liable for an increased rate of
          interest because a transaction which is
          determined to lack a profit motive does not
          equal a tax-motivated transaction under
          section 6621. Section 6621(c)(1) imposes an
          increased rate of interest on ‘any
          substantial underpayment attributable to tax
          motivated transactions,’ which include
          activities not engaged in for profit.” * * *
          [Quoting in part Hildebrand v. Commissioner,
          28 F.3d at 1028.]

     The reasoning in Hildebrand is sound: the Secretary
     has authority to define certain transactions as tax
     motivated, the Secretary has defined transactions
     lacking a profit motive under section 183 as tax
     motivated, the transactions in this case lack a profit
     motive under section 183, petitioners’ activities
     relating to these transactions are therefore tax
     motivated.

          A close examination of section 6621(c)
     demonstrates that the Secretary is well within the
     granted regulatory power to simply equate the violation
     of one code section with a violation of section
     6621(c).

     *       *       *       *        *      *       *

          These, and the remaining “tax motivated
     transactions” set out in section 6621(c)(3)(A) show a
     legislative pattern established by Congress which
     treats violations of certain code sections as implicit
     violations of section 6621(c). The Secretary simply
     followed this pattern pursuant to the regulatory
     authority granted in section 6621(c)(3)(B) by
     establishing regulations that make a violation of
     section 183 a tax motivated transaction.
                              - 12 -

     Language in Heasley v. Commissioner, supra at 386,

suggesting that profit objective, for purposes of section 6621(c)

increased interest, be evaluated at the individual investor level

is not apropos.   Heasley did not involve a partnership

investment.

     In light of the lack of profit objective and the lack of

economic substance associated with the activities and investments

of the Garfield and Cardinal limited partnerships, petitioners

are liable for increased interest under section 6621(c).    Other

arguments made by petitioners and not addressed specifically

herein have been considered and are rejected.

     For the reasons stated, respondent's imposition of increased

interest under section 6621(c) is sustained.    We shall grant

respondent’s motion for partial summary judgment and deny

petitioners’ motion for partial summary judgment.


                               To reflect the foregoing, an

                          appropriate order will be issued.
