                              T.C. Memo. 2014-78



                        UNITED STATES TAX COURT



     SEISMIC SUPPORT SERVICES, LLC, SCOTT A. WHITTINGTON,
               TAX MATTERS PARTNER, Petitioner v.
         COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket Nos. 20458-11, 9936-12.             Filed May 5, 2014.



      Scott A. Whittington, pro se.

      Lisa M. Oshiro, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      KROUPA, Judge: These consolidated cases arise from notices of final

partnership administrative adjustment (FPAAs) issued to tax matters partner Scott

A. Whittington (petitioner) regarding Seismic Support Services, LLC (Seismic),

for 2007, 2008 and 2009 (years at issue). We must decide two issues. The first
                                        -2-

[*2] issue is whether the amounts Seismic paid petitioner were guaranteed

payments for services under section 707(c).1 We hold that they were. The second

issue is whether respondent correctly determined accuracy-related penalties under

section 6662. We hold that he did.

                               FINDINGS OF FACT

      Some of the facts have been deemed stipulated pursuant to Rule 91(f) and

are so found. The stipulation of facts and the accompanying exhibits are

incorporated by this reference. Petitioner resided in Washington when he filed the

petition.

      Petitioner was employed as a seismic design consultant. He formulated a

scheme to alter his status as an employee to reduce his tax obligations. He first

requested that his employer treat him as an independent contractor. His employer

refused, so he resigned that position. Petitioner decided to form an LLC through

which he could provide services as a subcontractor. To that end, he organized




      1
       All section references are to the Internal Revenue Code (Code) in effect for
the years at issue, and all Rule references are to the Tax Court Rules of Practice
and Procedure, unless otherwise indicated.
                                         -3-

[*3] Seismic under Delaware law. Petitioner owned 95% of Seismic, and

Management Partners, LLC,2 owned the rest.

      Seismic provided consultation services as a subcontractor during the years

at issue. Petitioner performed all services on Seismic’s behalf. Seismic received

all compensation for those services. Seismic paid petitioner $131,690 in 2007,

$168,300 in 2008 and $142,600 in 2009 (payments).3 Seismic labeled the

payments “distributions” on each bank draft.4

      Seismic filed Forms 1065, U.S. Return of Partnership Income, for the years

at issue. Seismic reported gross income of $157,267 for 2007, $178,302 for 2008

and $166,592 for 2009. Seismic claimed management fee deductions of $141,400

for 2007, $161,800 for 2008 and $150,000 for 2009. Seismic did not have any

employees or file employment tax returns for the periods during the years at issue.

      Respondent issued the FPAAs determining that the payments were

guaranteed payments under section 707(c). According to the FPAAs, the

payments are still fully deductible by Seismic, but by recharacterizing the


      2
          The record does not establish who owned this entity.
      3
      Seismic also paid petitioner additional amounts purportedly for mileage
expenses. Those amounts are not in dispute.
      4
        The record does not establish how petitioner reported the distributions on
his individual return.
                                          -4-

[*4] payments as guaranteed payments, respondent will be able to assert, in a

subsequent partner-level proceeding, that petitioner is personally liable for self-

employment tax.5 Respondent disallowed the corresponding management fee

deductions and determined the accuracy-related penalties. Petitioner timely filed

petitions as the tax matters partner.

                                        OPINION

      These cases involve an ill-fated attempt by an individual to avoid his tax

obligations. Petitioner first asked his employer to misrepresent his employment

status. His employer refused, so he resigned his position and developed an

alternative scheme to provide services through a partnership6 subject to the Tax

Equity and Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. No. 97-248, sec.

402(a), 96 Stat. at 648, that he established. Petitioner hoped that this would shield




      5
        The payments must first be recharacterized at the partnership level because
respondent determined that they are guaranteed payments. Guaranteed payments
are a partnership item that must first be determined at the partnership level. Secs.
301.6231(a)(2)-1, 301.6221-1, Proced. & Admin. Regs. Once the partnership item
is determined at the partnership level, each partner’s distributive share can be
challenged in a subsequent partner-level proceeding.
      6
       The parties do not dispute that Seismic is a TEFRA partnership. The
record establishes that Seismic filed Forms 1065, for the 2007, 2008 and 2009 tax
years.
                                        -5-

[*5] his income from Federal tax. This scheme, however, still involved petitioner

receiving compensation for services he performed.

      We must decide in this partnership-level proceeding whether the payments

were guaranteed payments for services under section 707(c). Petitioner contends

that the payments were capital expenditures. Respondent asserts that the payments

were for services. We agree with respondent.

I. Jurisdiction

      We begin our analysis with a discussion of the Court’s jurisdiction over a

TEFRA proceeding. The Court is a court of limited jurisdiction, and we may

exercise our jurisdiction only to the extent provided by Congress. See sec. 7442;

GAF Corp. & Subs. v. Commissioner, 114 T.C. 519, 521 (2000). The Court has

authority in a TEFRA partnership-level proceeding to determine all partnership

items for a partnership taxable year to which the FPAA relates, the proper

allocation of partnership items among the partnership’s partners, and the

application of any penalty, addition to tax or additional amount that relates to an

adjustment to a partnership item. Sec. 6226(f). A guaranteed payment is a

partnership item appropriately determined in a partnership-level proceeding. See

sec. 6221; sec. 301.6231(a)(3)-1(a)(2), Proced. & Admin. Regs.; see also Brennan

v. Commissioner, T.C. Memo. 2012-187.
                                        -6-

[*6] The Court’s jurisdiction over a TEFRA partnership-level proceeding is

invoked upon the Commissioner’s issuance of a valid FPAA and the proper filing

of a petition for readjustment of partnership items for the year or years to which

the FPAA pertains. See Harbor Cove Marina Partners P’ship v. Commissioner,

123 T.C. 64, 78 (2004). Petitioner timely filed petitions challenging the

adjustments in the FPAAs. We therefore have jurisdiction to determine whether

the payments were guaranteed payments for services and whether the accuracy-

related penalty applies.7

II. Burden of Proof

      We now consider whether the burden of proof shifts to respondent under

section 7491(a). The Commissioner’s adjustments in an FPAA are generally

presumed correct, and a party challenging an FPAA has the burden of proving that

the Commissioner’s adjustments are in error. Rule 142(a); Welch v. Helvering,

290 U.S. 111, 115 (1933); Republic Plaza Props. P’ship v. Commissioner, 107


      7
       We note that petitioner contends that respondent exceeded his authority in
adjusting the partnership item. This argument is without merit. Congress has
granted the Commissioner authority to examine books to ascertain the correctness
of any return. Sec. 7602(a). The Commissioner may determine the tax treatment
of any partnership item at the partnership level. Sec. 6221. Seismic claimed a
deduction for management fees. Respondent examined the partnership return,
determined that the deduction was mischaracterized and determined that the
payments instead were deductible as guaranteed payments.
                                        -7-

[*7] T.C. 94 (1996). The burden shifts to the Commissioner if the taxpayer

introduces credible evidence with respect to the issue and meets other

requirements. Sec. 7491(a)(2)(A) and (B). If each party produces credible

evidence, then we decide using the burden of persuasion. The burden of

persuasion, however, is immaterial because we decide this matter based on the

preponderance of the evidence. See Kaufman v. Commissioner, T.C. Memo.

2014-52. Petitioner has not presented credible evidence salient to the disputed

factual issues to shift the burden to respondent. See sec. 7491(a). Petitioner

therefore has the burden.

III. Determination of Partnership Items

      A. Guaranteed Payments

      We now turn to the payments. Respondent contends the payments were

guaranteed payments for services petitioner performed. Petitioner contends that

the payments were for the use of capital rather than services.8 We agree with

respondent.

      A guaranteed payment is a payment from a partnership to a partner for

services or use of capital that does not represent a distribution and is determined

      8
        Seismic labeled the payments distributions and then claimed deductions for
them as management fees. Petitioner no longer contends that the payments were
distributions or management fees. We are perplexed by petitioner’s action.
                                        -8-

[*8] without regard to the partnership’s income.9 Sec. 707(c); Durkin v.

Commissioner, 87 T.C. 1329, 1388-1389 (1986), aff’d, 872 F.2d 1271 (7th Cir.

1989); DeSantis v. Commissioner, T.C. Memo. 1997-141; sec. 1.707-1(c), Income

Tax Regs. The substance of the transaction governs as opposed to the form.

Falconer v. Commissioner, 40 T.C. 1011, 1015 (1963); sec. 1.707-1(a), Income

Tax Regs. A guaranteed payment is includable in the recipient’s ordinary income.

Sec. 1.707-1(c), Income Tax Regs.

      We conclude that Seismic made payments to petitioner for services that

were determined without regard to Seismic’s income. Petitioner performed all

services on behalf of Seismic. There is no basis in the record to conclude the

payments were for the use of capital.10 We agree that the payments were

guaranteed payments for services.




      9
       Payments from a partnership to a partner generally fall into one of three
categories. See Cahill v. Commissioner, T.C. Memo. 2013-220. First, a partner
may receive payments representing distributions of his or her distributive share of
partnership income. See sec. 731. Second, a partner may receive payments in
circumstances where he or she is not treated as a partner. Sec. 707(a). And third,
a partner may receive guaranteed payments. Sec. 707(c).
      10
        We note that petitioner contends that the payments were “capital
expenditures” without further explanation or factual support. We interpret
petitioner’s argument to be that the payments were for the use of capital.
                                         -9-

[*9] B. Accuracy-Related Penalty

      We now consider the accuracy-related penalties under section 6662(a). A

taxpayer is liable for an accuracy-related penalty on any part of an underpayment

attributable to, among other things, negligence or disregard of rules or regulations.

Sec. 6662(b)(1). The Commissioner has the burden of production with regard to

penalties and must come forward with sufficient evidence indicating that it is

appropriate to impose penalties.11 Sec. 7491(c); see Higbee v. Commissioner, 116

T.C. 438, 446-447 (2001). The taxpayer bears the burden of proof as to any

defense to the accuracy-related penalty. Sec. 7491(c); Rule 142(a); Higbee v.

Commissioner, 116 T.C. at 446.

      Respondent contends that the accuracy-related penalty for negligence

applies here. Negligence is defined as any failure to make a reasonable attempt to


      11
         We note that on its face, sec. 7491(c) refers to liability of any “individual”
for penalties. Several opinions of this Court have held that this section is
inapplicable where the taxpayer is not an “individual.” See NT, Inc. v.
Commissioner, 126 T.C. 191, 194-195 (2006) (holding sec. 7491(c) inapplicable
to corporate taxpayer); Santa Monica Pictures, LLC v. Commissioner, T.C. Memo.
2005-104 (questioning applicability of sec. 7491(c) to corporate entity and
whether Commissioner has any burden of production but nonetheless holding that
if statute applied, Commissioner satisfied his burden). Nonetheless, several other
opinions of this Court have applied sec. 7491(c) in cases of taxpayers who are not
individuals. See D & R Fin. Servs. Inc. v. Commissioner, T.C. Memo. 2011-252;
McGehee Family Clinic, P.A. v. Commissioner, T.C. Memo. 2010-202; Maint.,
Painting & Constr., Inc. v. Commissioner, T.C. Memo. 2003-270.
                                       - 10 -

[*10] comply with the provisions of the Code or to exercise ordinary and

reasonable care in the preparation of a tax return. Sec. 6662(c); sec.

1.6662-3(b)(1), Income Tax Regs. Negligence is strongly indicated where a

taxpayer fails to make a reasonable attempt to ascertain the correctness of a

deduction, credit or exclusion on a return that would seem to a reasonable and

prudent person “too good to be true” under the circumstances. Higbee v.

Commissioner, 116 T.C. at 446; sec. 1.6662-3(b)(1)(ii), Income Tax Regs.

      Because partnerships do not pay taxes, penalties for tax underpayments are

imposed at the partner level. Sec. 701. Notwithstanding this, TEFRA requires

that the applicability of some penalties must be determined in the partnership-level

proceeding. See sec. 6226(f); United States v. Woods, 571 U.S. __, __, 134 S. Ct.

557, 564 (2013). This Court has jurisdiction to consider the applicability of the

accuracy-related penalty related to adjustments to partnership-level items. See

Woods, 571 U.S. at __, 134 S. Ct. at 564; 6611, Ltd. v. Commissioner, T.C.

Memo. 2013-49. Guaranteed payments are partnership-level items. Sec.

301.6231(a)(3)-1(a)(2), Income Tax Regs. Thus, the applicability of the penalty

for the negligent reporting of the guaranteed payments is determined in the

partnership-level proceeding, while the imposition of the penalty occurs at the

partner-level proceeding. Woods, 571 U.S. at __, 134 S. Ct. at 564. The statute
                                        - 11 -

[*11] provides that although a partnership-level determination12 is conclusive in a

subsequent refund action, it does not prevent individual partners from asserting

any partner-level defenses that may apply in the partner-level proceedings. Id.

(citing section 6230(c)(4)).

      Respondent has met any burden of production he may have. Seismic

initially described the payments as distributions but then claimed deductions for

them as management fees. The record demonstrates that the payments were

guaranteed payments. There is no indication in the record that petitioner made a

reasonable attempt to ascertain the correctness of the characterization of his

deductions. Seismic knew the payments were made for services petitioner

provided, yet it mischaracterized them as management fees. Thus, Seismic was

negligent in its reporting of the payments as management fees. The record reflects

that Seismic mischaracterized the payments to enable petitioner to avoid partner-

level self-employment taxes. Indeed, petitioner admitted that he was trying to

avoid paying taxes. We determine that the accuracy-related penalties are

applicable.




      12
        Concerning the applicability of any penalty that relates to the adjustment
of a partnership item.
                                        - 12 -

[*12] A taxpayer is not liable for an accuracy-related penalty, however, if the

taxpayer acted with reasonable cause and in good faith with respect to any portion

of the underpayment. Sec. 6664(c)(1); sec. 1.6664-4(a), Income Tax Regs. The

determination of whether a taxpayer acted with reasonable cause and in good faith

depends on the pertinent facts and circumstances, including the taxpayer’s efforts

to assess his or her proper tax liability, the knowledge, experience and education

of the taxpayer, and the taxpayer’s reliance on the advice of a professional. Sec.

1.6664-4(b)(1), Income Tax Regs. We inquire into a taxpayer’s reasonable cause

and good faith, or lack thereof, at the partnership level, taking into account the

state of mind of the general partner. New Millennium Trading, LLC v.

Commissioner, 131 T.C. 275, 279-280 (2008).

       Petitioner did not advance any arguments or articulate any reasons as to why

the accuracy-related penalties are not warranted. Thus, we sustain respondent’s

penalty determinations. See Zapara v. Commissioner, 124 T.C. 223 (2005), aff’d,

652 F.3d 1042 (9th Cir. 2011); see also Higbee v. Commissioner, 116 T.C. at 446-

447.

       In reaching these holdings, we have considered all of the parties’ arguments,

and, to the extent not addressed, we conclude that they are moot, irrelevant or

without merit.
                                  - 13 -

[*13] To reflect the foregoing,


                                                 Decisions will be entered

                                           for respondent.
