TaxProf Blog

Tuesday, April 27, 2004

Joni Larson (Thomas Cooley) has posted Tax Evidence II: A Primer on the Federal Rules of Evidence as Applied by the Tax Court on SSRN. Here is the abstract:

The United States Tax Court applies the Federal Rules of Evidence (the “Rules”) during its proceedings. These rules establish the guidelines the judge will use to determine what testimony and documents will be admissible in evidence.

We follow the Federal Rules of Evidence in our proceedings. This provides all parties with ground rules for presenting their cases. To depart from these rules not only would contradict our mandated authority but also would prejudice the parties by removing the certainty of what the Court may consider in finding facts. A party could not adequately prepare or defend a case if it were uncertain what standards would be applied to judge the admissibility of evidence. While it is generally accepted that a relaxed application of the rules of evidence during a bench trial results in less prejudice to the fact finder because of a judge’s legal training and experience, the uncertainty of what will be used to find facts is highly prejudicial to a party whether the fact finder is a judge or a jury. Incompetent evidence should not be admitted to proof. We, therefore, believe that adhering to the Federal Rules of Evidence is a sound way to protect the integrity of our proceedings.

In order to present the best case possible, it is imperative for a party litigating in the Tax Court to understand the Rules and how they have been interpreted and applied by the Tax Court.

This Article surveys the Tax Court’s interpretation and application of the Rules. It updates and expands an earlier version of this Article. The Article does not discuss the application of the Rules by federal district courts, the Court of Federal Claims, or the federal circuit courts of appeal, except to the extent there is a split of authority in the circuit courts. Appendix A identifies those Rules that have not been addressed or interpreted by the Tax Court in its opinions. Appendix B provides a tabular summary of the Rules most commonly used in the Tax Court and their various foundational requirements.

Monday, April 26, 2004

Susan Kalinka (LSU) has posted Individuals and Passthrough Entities – Fifth Circuit’s Opinion in St. David’s Raises More Questions than it Answers on SSRN. Here is the abstract:

On November 7, 2003, the United States Court of Appeals for the Fifth Circuit published its opinion in St. David’s Health Care System, Inc., reversing a grant of summary judgment in favor of the plaintiff, a nonprofit hospital, by the District Court for the Western District of Texas. The issue in St. David’s concerned whether the IRS had abused its discretion in revoking the tax-exempt status of the nonprofit hospital when it entered into a limited partnership with a for-profit hospital. This article discusses the opinions of both the district court and the Fifth Circuit in St. David’s and the standards that the Fifth Circuit set forth for purposes of determining whether forming a partnership or other entity classified as a partnership with a for-profit organization will cause a nonprofit organization to lose its tax-exempt status.

Monday, April 26, 2004

Howard Abrams (Emory) has posted The Section 734(b) Basis Adjustment Needs Repair on SSRN. Here is the abstract:

The partnership tax provisions – Subchapter K of the Internal Revenue Code – work pretty well. Those provisions have a difficult job of providing a reasonable mechanism for taxing arrangements between parties that can be far from off-the-rack. It should not be difficult to figure out how to tax two individuals who contribute equal amounts of cash to start a joint business in which each will own a one-half interest. It quickly becomes problematic, however, when one of the two partners wants a greater share of early receipts in exchange for a lower share of back-end gains. If the amounts the partners contribute are unequal, they will have some arrangement to account for that difference which the taxing structure must digest. A partnership is the most flexible form of business organization, and the rules of Subchapter K capture that flexibility surprisingly well.

The basic paradigm upon which Subchapter K is best described is tax transparency; that is, that a partnership should be all but invisible to the taxing system. In particular, transactions between a partner and the partnership should be tax-free as much as possible, with the taxable events being dealings between the partnership (or the partners) and third parties. Thus, most contributions and distributions are tax-free, but transfers of partnership assets or interests to non-partners generally are taxable.

A corollary of tax transparency is the general equality of aggregate inside and outside bases. “Inside basis” is the partnership’s adjusted basis in its assets, while outside basis is a partner’s adjusted basis in his partnership interest. Because aggregate inside basis and aggregate outside basis each represent the after-tax (and debt-financed) investment in partnership assets, they should equal each other. They start equal by reason of the basis rules applicable to contributions of property (including the debt allocation rules of section 752), and will in general remain equal throughout the life of the partnership. The examples presented in this Article do not consider the case of partnership indebtedness, although adding debt to the transaction should not create any change to the analysis.

When inside and outside basis are not equal, astute taxpayers can exploit the difference. Suppose, for example, that aggregate outside basis is higher than aggregate inside basis. A sale of all the partnership interests would transfer the partnership’s assets just as would a direct asset sale, but by selling the higher-basis interests, aggregate gain is reduced. Conversely, if inside basis were higher, the assets rather than the interests would be sold.

Nonetheless, there are transactions that can break the equality of aggregate inside and aggregate outside basis. An election is provided by section 754 which ensures, by adjusting inside basis, that this equality is in fact always maintained so long as the election is made early enough. Indeed, the basis adjustments provided by the section 754 election are so well designed – and the equality between aggregate inside and aggregate outside basis so important – that commentators have called for making these basis adjustments mandatory rather than optional.

When an election under section 754 is made, the electing partnership becomes subject to two basis adjustment provisions: (1) section 734(b), providing for certain inside basis adjustments upon the occurrence of specified triggering distributions of cash or property from the partnership; and (2) section 743(b), providing for certain inside basis adjustments upon the sale or exchange of a partnership interest. The regulations specifying the manner of making these adjustments have recently undergone major revisions, with the greatest attention focused on the section 743(b) adjustments. Now, despite the lack of any real statutory support, an incoming partner will in effect take a share of inside basis in each of the partnership’s assets equal to that partner’s share of each asset’s fair market value, an outcome so reasonable that one could only have wished Congress rather than the Treasury had seen fit to specify it.

Unfortunately, the regulations applicable to section 734(b) adjustments were not much changed, and that is indeed unfortunate. While the amount of the section 734(b) adjustment is computed properly, the allocation of that adjustment is not right. Absent a correction, the statute as written offers significant tax reduction strategies.