Facts
The petitioners to the case, William and Randal, had a father-son relationship and operated Holdner Farm since 1977. Prior to the formation of the company, William Holdner purchased livestock to start the business. He later purchased property such as the Home place in Oregon, Chapman property for $10,000 and Dutch Caynon property all under his name. The petitioners entered into a verbal agreement for Randal to work in the farm in 1977 though. They shared responsibilities and duties, agreed on financial issues and purchased an insurance policy and property for the farm such as Sattler property in 1984, Ernest property in 1989 and Dike road property in 1989. For the years 2004, 2005 and 2006, the petitioners individually reported one half of the gross income of Holdner Farm. However, they neither filed the Federal Partnership Returns, nor split the expenses on an equal basis. Petitioner William made the most of the deductions of the Holdner farm on his returns for the period. The IRS determined that the farm was either a partnership or a joint venture which would receive similar treatments as a partnership. IRS further established that the petitioners were equal partners and William was held liable for the penalty which was related to the returns. The IRS further made allocations totaling to 100% of the income of the Holdner Farm to the individual petitioners, disallowed for the expenses related to the farm and ascertained the amount of penalties that the petitioners needed to pay. The petitioners sought the review of the determinations made by the respondent.
Issues
The main issue arising from the case was whether the operation of the farm by the Holdners would be considered a partnership or a joint venture for tax purposes for the 2004 to 2006 period. The other issues were whether on determination of the first issue with the Holdner farms as a partnership, the expenses of the partnership would be allocated on an equal basis just as the partnership income. The other issue was whether petitioner William was liable for the penalties.
Analysis
The question regarding the existence of a partnership for tax purposes is based on federal law rather than the local law. Section 7701 (a) (2) provides the definition of a partnership as “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 trust or estate or a corporation.” In considerations of federal law, a partnership is created when people come together with their skills, property or labor to carry out a business, trade or profession with common interests in the profits and losses made. The petitioners contributed capital and labor for the business. William contributed property he had acquired separately prior to the formation of the business for the use in the Holdner Farm, while Randal contributed labor as a service to the farm. Both petitioners further contributed equally to the acquisition of the joint property for the farm. They also shared equally the income from the farm and the rental buildings. Additionally, Randal did not regard the amount of cash share received as wages or salary. Furthermore William did not prepare a wages tax statement showing that the business was formed for profit-making purposes.
The evaluation of the partnership existence was also based on the Luna v. commissioner case. It was stated that: (1) the parties’ agreement and conduct in the execution of terms, of which, the petitioners had agreed on the splitting of the income of the farm which they executed; (2) contributions made by each party to the business of which the petitioners contributed capital and services; (3) control of income and individual right in making of withdrawals, in which, both petitioners had an account for the farm and had unlimited access to withdrawal; (4) mutual obligations and loss sharing for the petitioners was not clear; (5) name of the business; (6) the filling of returns and other representation for which the petitioners did not file partnership income returns but filled their representation to the State of Oregon and to the insurer that the farm operated as a partnership business; (7) the maintenance of separate books of which the petitioners operated a separate bank account for the business while William kept the records of the business and (8) regarding the exercise of mutual control and responsibilities of the business in which both petitioners had equal control.
Regarding the equal allocation of expenses, it was determined that according to section 701, the partners in a partnership business are supposed to be taxed on their individual incomes subject to inclusions of gains, losses and other deductions based on agreement or interest basis. On interest, considerations involve: (1) the contribution to the partnership of which the petitioners were not consistent; (2) the interests of the partners in the profits and losses of the business of which the petitioners had equal interests in incomes but varying interest in expenses; (3) the interests of the partners in the cash flows and other contributions of the business of which the petitioners had equal interests in the cash flows and distributions made and (4) on the interests of the parties on liquidation, of which the petitioners never stipulated the manner of interests upon liquidation or the prior death of Randal, but only considered that of William for which Randal would be entitled to full ownership.
Regarding the penalty on William, the commissioner is authorized by section 6662 (a) and (b) to impose a penalty of up to 20% where income tax is substantially understated. The petitioner failed to make reasonable records pertaining to Holdner Farm and this lowered the income tax. This is attributed to negligence attributed to the experience and professional background of accountancy. The issue of concern is whether or not William did the accounting with the aim of lowering the tax payable and increasing the income of Holdner Farm. Additionally, the issue raises the question of the substantiality of the amount of income tax.
Holding
The tax court held that Holdner Farm was a partnership business. It also held that since the partnership was based on profit-making motives and no substantial evidence on the equality, the petitioners had equal interest in the incomes, expenses and other items of the partnership. The tax court also held that on the matter of the accuracy of penalty, although William is liable for 20% of the penalty due to negligence, further findings have to be established on the substantiality of the understatement.