Route 231, LLC, John D. Carr v. Commissioner of IRS
Filing
PUBLISHED AUTHORED OPINION filed. Originating case number: 013216-10. [999732311]. [14-1983]
Appeal: 14-1983
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PUBLISHED
UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT
No. 14-1983
ROUTE 231, LLC, JOHN D. CARR, TAX MATTERS PARTNER,
Petitioner - Appellant,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent - Appellee.
Appeal from the United States Tax Court.
(Tax Ct. No. 013216-10)
Argued:
October 28, 2015
Before AGEE and
Circuit Judge.
WYNN,
Decided:
Circuit
Judges,
and
January 8, 2016
HAMILTON,
Senior
Affirmed by published opinion. Judge Agee wrote the opinion, in
which Judge Wynn and Senior Judge Hamilton joined.
ARGUED: Timothy Lee Jacobs, HUNTON & WILLIAMS LLP, Washington,
D.C., for Appellant.
Richard Farber, UNITED STATES DEPARTMENT
OF JUSTICE, Washington, D.C., for Appellee.
ON BRIEF: William
L.S. Rowe, Richmond, Virginia, Richard E. May, Hilary B. Lefko,
Matthew S. Paolillo, HUNTON & WILLIAMS LLP, Washington, D.C.,
for Appellant.
Caroline D. Ciraolo, Acting Assistant Attorney
General, Regina S. Moriarty, Tax Division, UNITED STATES
DEPARTMENT OF JUSTICE, Washington, D.C., for Appellee.
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AGEE, Circuit Judge:
Route
231,
LLC,
a
Virginia
limited
liability
company,
(“Route 231”) reported capital contributions of $8,416,000 on
its 2005 federal tax return. 1
This number reflected, in relevant
part, $3,816,000 it received from one of its members, Virginia
Conservation Tax Credit FD LLLP (“Virginia Conservation”).
Upon
audit, the Commissioner of the Internal Revenue Service issued a
Final Partnership Administrative Adjustment (“FPAA”) indicating
that Route 231 should have reported the $3,816,000 received as
gross
income
and
not
a
capital
contribution.
Route
231
challenged the FPAA by petition to the United States Tax Court.
After a trial, the Tax Court determined that the transaction was
a “sale” and reportable as gross income in 2005.
appeals,
asserting
that
the
Tax
Court
erred
Route 231 now
in
finding
the
transfer was not a capital contribution or, alternatively, that
any income was not reportable until 2006.
For the reasons set
forth below, we disagree with Route 231 and affirm the decision
of the Tax Court.
1
The Internal Revenue Code treats limited liability
companies with two or more members as a partnership unless the
company elects otherwise. See 26 C.F.R. §§ 301.7701-1, 7701-2,
7703-3.
Route 231 filed returns consistent with being treated
as a partnership for federal tax purposes.
2
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I.
In May 2005, Raymond Humiston and John Carr formed Route
231, a limited liability company (“LLC”) registered in Virginia.
Humiston and Carr each made initial capital contributions of
$2,300,000 and each received a 50% membership interest in the
LLC.
Route 231’s initial operating agreement stated its purpose
was
“to
property.”
own,
acquire,
(J.A. 225.)
manage
and
operate
[certain]
real
Consistent with that purpose, Route 231
purchased two parcels, known as Castle Hill and Walnut Mountain,
in Albemarle County, Virginia, for approximately $24 million.
Carr and Humiston personally guaranteed the bank loan financing
the purchase.
Carr and Humiston were interested in donating some of Route
231’s
property
for
conservation
purposes
consultant to assist with that process.
and
retained
a
At that time, Virginia
offered state income tax credits “equal to 50 percent of the
fair market value of any land or interest in land located in
Virginia” donated to a public or private agency eligible to hold
such land and interests therein for conservation or preservation
purposes.
Va. Code § 58.1-512 (2005).
Route
discussed
231
the
possibility
Through the consultant,
of
Virginia
Conservation
joining the LLC by contributing money to Route 231 and receiving
a majority of the Virginia tax credits that would be earned as a
result of three proposed conservation donations.
3
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These
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discussions
led
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to
Route
231’s
first
amended
operating agreement, signed December 27, 2005, in which Virginia
Conservation became a member of Route 231 with a 1% membership
interest, with Humiston and Carr’s interests each being reduced
to
49.5%.
Virginia
The
amended
Conservation
operating
agreed
to
agreement
make
an
provided
“initial
that
capital
contribution” of $500 plus an additional sum “in an amount equal
to the product of $0.53 for each $1.00 of [the tax credits]
allocated
to”
it.
operating
agreement
(J.A.
477,
anticipated
§
2.2.)
that
The
Route
first
231
amended
would
earn
Virginia tax credits “in the range of $6,700,000 to 7,700,000”
as
a
result
provided
that
of
the
while
proposed
Carr
conservation
would
receive
donations,
$300,000
Virginia Conservation would receive “the balance.” 2
of
and
it
credits,
(J.A. 479, §
3.6.)
Two days later, on December 29, 2005, Virginia Conservation
paid $3,816,000 into an escrow account pursuant to three escrow
agreements reflecting the three conservation donations Route 231
2
For tax credits earned during the time in question,
taxpayers could claim up to $100,000 of tax credits on their
state income tax returns as a $1 for $1 credit. If the value of
tax credits earned exceeded this cap, taxpayers were permitted
to carry over the tax credits for use up to five years after the
tax credits were earned. See Va. Code § 58.1-512(C)(1) (2005).
4
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intended to make. 3
The escrow agreements provided that the funds
would
to
be
released
Route
231
upon
written
confirmation
by
Virginia Conservation that it had received copies of several
documents verifying the conservation donations and Virginia tax
credits.
One
item
listed
Taxation’s
transaction
was
number
the
for
Virginia
tracking
Department
the
of
conservation
donations and Virginia tax credits.
The next day, December 30, 2005, Route 231 recorded deeds
conveying the following conservation donations of real property:
(1) a deed of gift of an easement on Castle Hill to the Nature
Conservancy, which was valued at $8,849,240; (2) a deed of gift
of an easement on Walnut Mountain to the Albemarle County Public
Recreational
Facilities
Authority,
which
was
valued
at
$5,225,249; and (3) a fee interest in Walnut Mountain (subject
to
the
above
easement)
to
the
Nature
Conservancy,
which
was
valued at $2,072,880.
The final value of these conservation donations – and hence
the amount of Virginia tax credits – was slightly lower than
Route
231’s
consultant
had
anticipated.
Consequently,
Carr
agreed to defer receiving approximately $84,000 of the $300,000
in
tax
credits
he
had
been
promised
3
in
the
first
amended
The escrow agreements contain nearly identical language,
with each agreement corresponding to one of Route 231’s proposed
conservation donations.
5
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operating
receive
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agreement
tax
so
credits
as
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to
allow
equivalent
to
Virginia
the
Conservation
formula
for
Carr,
the
and
to
full
amount of money it had paid into escrow.
On
January
1,
2006,
Humiston,
Virginia
Conservation executed a second amended operating agreement for
Route
231.
The
agreement
described
the
three
specific
conservation donations the LLC had made and set out the Virginia
tax credits Route 231 had earned as a result of those donations.
It indicated that those credits “have been allocated as follows:
(i)
$215,983.00
.
.
Virginia Conservation.
.
to
Carr
and
(ii)
$7,200,000.00”
to
(J.A. 508, § 3.5.)
After execution of the second amended operating agreement,
Route 231 submitted three Virginia Land Preservation Tax Credit
Notification Forms (“Forms LPC”) to the Virginia Department of
Taxation.
Virginia
The
tax
forms
credits
stated
on
that
December
Route
30,
231
2005
had
(the
earned
date
of
its
the
conservation donations), and that it allocated those credits to
Carr and Virginia Conservation in the amounts reflected in the
second amended operating agreement.
In March 2006, the Virginia Department of Taxation provided
Virginia Conservation and Carr with the transaction numbers for
Route 231’s conservation donations and the tax credits.
The
Virginia Department of Taxation’s letter stated that these tax
credits were “effective” in 2005.
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Soon after Virginia Conservation received these tax credit
transaction numbers, the escrow funds were released to Route
231.
In April 2006, Carr – acting as Route 231’s tax matters
partner – filed Route 231’s 2005 federal Return of Partnership
Income
Tax. 4
capital
Schedule
contributions
M-2
of
received
that
in
form
2005
lists
in
total
the
annual
amount
of
$8,416,000, which includes the amounts Humiston and Carr had
provided
as
capital
contributions
as
Virginia Conservation paid into escrow.
well
as
the
$3,816,000
In addition, Schedule
K-1 of Route 231’s tax form lists Virginia Conservation as a
partner that had contributed $3,816,000 in capital “during the
[taxable] year.”
(J.A. 120.)
4
While
there
are
substantive
legal
differences,
particularly for state law purposes, between partnerships and
limited
liability
companies,
they
are
treated
alike
as
partnerships for federal income tax purposes.
See supra n.1.
For
convenience,
we
refer
to
partners
and
partnerships
interchangeably with members and limited liability companies in
our discussion of the federal tax issues in this opinion.
Under the Internal Revenue Code, a partnership is a “passthrough” entity, meaning that although the partnership prepares
a tax return, the partnership does not pay federal income taxes.
Instead, its taxable income and losses pass through to the
individual
partners,
who
in
turn
are
liable
for
their
distributive shares of the partnership’s tax items on their own
individual returns. United States v. Woods, 134 S. Ct. 557, 562
(2013).
7
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The
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Internal
indicating,
in
Revenue
relevant
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Service
part,
that
sent
Route
Route
231
231
had
an
FPAA
improperly
characterized the $3,816,000 received as a capital contribution
rather than as income from the sale of the Virginia tax credits
to
Conservation. 5
Virginia
Route
231
challenged
that
determination in a petition for readjustment in the Tax Court.
In
a
detailed
memorandum
Commissioner’s
Virginia
opinion,
determination
Conservation
and
the
that
Route
Tax
the
231
Court
upheld
transaction
constituted
a
the
between
“disguised
sale” that occurred in 2005, and it adjusted Route 231’s 2005
tax return to reflect the $3,816,000 as gross income.
At the outset of its opinion, the Tax Court described our
decision
in
Commissioner,
Virginia
639
F.3d
Historic
129
Tax
(4th
point” with the case before it.
Credit
Cir.
Fund
2011),
as
2001
LP
v.
“squarely
on
(Cf. J.A. 1518.)
Following
much of the same analysis we applied in Virginia Historic, the
Tax Court first concluded that Route 231’s Virginia tax credits
were “property” so their transfer would fall within the scope of
I.R.C. § 707.
Next, the Tax Court determined that under the
applicable
regulations
tax
of
§
5
707,
the
transaction
was
a
The FPAA made additional adjustments that were resolved by
the parties.
While those adjustments were included in the Tax
Court’s final decision reflecting all of the adjustments to
Route 231’s 2005 tax return, they are not at issue in this
appeal.
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“disguised sale” because the record demonstrated that (1) Route
231
would
Virginia
not
have
transferred
Conservation
“but
the
for”
Virginia
the
fact
tax
credits
that
to
Virginia
Conservation transferred $3,816,000 to it, and (2) Route 231’s
transfer of the Virginia tax credits was not dependent on the
ongoing entrepreneurial risks of Route 231’s operations.
In
examining the totality of the facts and circumstances relevant
to
this
inquiry,
operating
the
agreements
Tax
set
Court
out
the
observed
timing
that
and
the
amount
amended
of
the
exchange with “reasonable certainty”; they established Virginia
Conservation’s
binding
contractual
right
to
the
Virginia
tax
credits; and they secured Virginia Conservation’s rights by an
indemnification clause.
In addition, the Tax Court observed
that Virginia Conservation’s share of the Virginia tax credits
was
disproportionately
large
in
comparison
to
its
membership
interest and that it had no obligation to return the credits to
Route
231.
As
such,
the
Tax
Court
held
that
the
transfer
between Route 231 and Virginia Conservation was a disguised sale
and that the $3,816,000 received was thus gross income.
Lastly, the Tax Court rejected Route 231’s argument that
the transfer occurred for tax purposes in 2006, instead of 2005,
for three separate and independent reasons.
First, for purposes
of federal tax law, the factual circumstances indicate the sale
occurred in 2005; second, because Route 231 used the accrual
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method of accounting, it had to report the transfer as income in
2005
regardless
payment;
and,
of
when
third,
it
Route
received
231’s
Virginia
statements
in
Conservation’s
its
2005
tax
return constituted binding admissions that the transfer of money
(however characterized) occurred in 2005.
Route
231
noted
a
timely
appeal,
and
this
Court
has
jurisdiction pursuant to 26 U.S.C. § 7482(a)(1).
II.
Route
231
reasserts
its
two
arguments
on
appeal.
It
principally contends that the Virginia tax credit transaction
with
Virginia
Conservation
constituted
a
nontaxable
capital
contribution followed by a permissible allocation of partnership
assets to a bona fide partner.
In the alternative, Route 231
asserts that even if Virginia Conservation’s payment was part of
a sale of tax credits, then the sale occurred in 2006 and not
2005.
If that is so, then because 2006 is a closed tax year as
to Route 231, the IRS could not adjust income the LLC received
in that year. 6
6
At the same time it issued the 2005 FPAA, the Commissioner
issued an FPAA with respect to Route 231’s 2006 tax return.
However, Route 231 did not challenge those adjustments before
the U.S. Tax Court. Accordingly, the limitations period for the
IRS to adjust Route 231’s 2006 return expired one year and 151
days after the date of the FPAA, see I.R.C. § 6229(d), or in
August 2011. Therefore, 2006 is now a closed tax year.
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In addressing these arguments, we review the decision of
the Tax Court “on the same basis as [a] decision[] in [a] civil
bench trial[] in United States district court[].”
Comm’r, 179 F.3d 124, 126 (4th Cir. 1999).
Waterman v.
Accordingly, we
review the Tax Court’s legal conclusions de novo and its factual
findings for clear error.
Va. Historic, 639 F.3d at 142.
A.
It
comes
as
no
Disguised Sale
secret
that
taxpayers
often
seek
to
structure transactions creatively in an effort to minimize the
tax
consequences.
Id.
at
138.
In
response,
Congress
has
enacted various statutes that look beyond form to substance in
order to differentiate taxable and nontaxable events.
characterization
with
Virginia
of
the
structure
Conservation
–
a
of
Route
231’s
contribution
to
Id.
The
transaction
partnership
capital or a sale of assets – has significant tax consequences:
“[w]hereas a partnership must report any proceeds received from
the
sale
of
its
assets
as
taxable
income,
partners’
contributions to capital and a partnership’s distributions to
partners are tax-free.”
Id.
Relevant to this case is I.R.C. § 707, which “prevents use
of the partnership provisions to render nontaxable what would in
substance have been a taxable exchange if it had not been ‘run
through’ the partnership.”
Id.
In such a circumstance, the
transaction between the partner and partnership is treated as if
11
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a
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transaction
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between
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third
parties
regardless
of
the
partnership format: “[i]f a partner engages in a transaction
with a partnership other than in his capacity as a member of
such
partnership,
the
transaction
shall,
except
as
otherwise
provided in this section, be considered as occurring between the
partnership
and
one
who
is
not
a
partner.”
I.R.C.
§
707(a)(1)(A).
Particularly
applicable
in
this
case
is
§
707(a)(2)(B),
which provides:
(B) Treatment of certain property transfers. If-(i)
there is a direct or indirect transfer of
money or other property by a partner to a
partnership,
(ii) there is a related direct or indirect
transfer of money or other property by the
partnership to such partner (or another
partner), and
(iii) the transfers described in clauses (i) and
(ii), when viewed together, are properly
characterized as a sale or exchange of
property,
such transfers shall be treated either as a
transaction described in paragraph (1) . . . .
The treasury regulations further explain when such transactions
are “properly characterized as a sale or exchange of property.”
See 26 C.F.R. § 1.707-3. 7
In general, a partner/partnership
7
The regulation describes such “disguised sales” as
transactions in which a partner transfers “property” to the
partnership and the partnership transfers “money or other
consideration to the partner.”
26 C.F.R. § 1.707-3(a)(1).
(Continued)
12
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transaction
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is
a
sale
“if
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based
on
all
the
facts
and
circumstances,” “[t]he transfer of money or other consideration
would not have been made but for the transfer of property” and,
when
the
transfer
transfers
is
not
are
not
dependent
partnership operation.”
simultaneous,
on
the
“the
entrepreneurial
subsequent
risks
of
§ 1.707-3(b)(1).
The regulations additionally provide a non-exclusive list
of ten relevant facts and circumstances “that may tend to prove
the
existence
of
a
sale,”
including
whether
“the
timing
and
amount of a subsequent transfer are determinable with reasonable
certainty at the time of an earlier transfer”; “the transferor
has a legally enforceable right to the subsequent transfer”;
“the partner’s right to receive the transfer of money or other
consideration is secured in any manner”; “the transfer of money
or
other
consideration
disproportionately
general
and
by
large
continuing
the
in
partnership
to
relationship
to
interest
in
the
partnership
the
partner
is
partner’s
profits”;
and
“the partner has no obligation to return or repay the money or
other
consideration
to
the
partnership[.]”
§
1.707-3(b)(2).
The regulations also create a presumption of a sale whenever the
However, we have observed that the regulations specifically
provide that these principles also apply when a partnership
transfers “property” to a partner in exchange for “money or
other consideration.” See Va. Historic, 639 F.3d at 139 (citing
26 C.F.R. § 1.707-6(a)).
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partner/partnership
transfers
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occur
within
a
two-year
period
“unless the facts and circumstances clearly establish that the
transfers do not constitute a sale.”
§ 1.707-3(c)(1).
“This
presumption places a high burden on the partnership to establish
the
validity
of
any
suspect
partnership
transfers.”
Va.
Historic, 639 F.3d at 139.
Route
231
takes
issue
with
the
Tax
Court’s
reliance
on
Virginia Historic in the application of § 707.
Its arguments
largely
with
attempt
Conservation
partnership
to
from
distinguish
what
“reported
a
its
occurred
series
transaction
in
of
that
Virginia
case,
transactions
where
with
a
investor
partners” as capital contributions rather than as income from
“sales” of state historic rehabilitation tax credits.
Id. at
132-33.
sought
The
Virginia
Historic
partnership
actively
investors to contribute “capital” in exchange for a less-thanone-percent
partnership
state tax credits.
interest
and
Id. at 133-35.
an
“allocation”
of
the
The Commissioner asserted
that the investors were not bona fide partners and that “under
the relevant Code provisions and regulations,” “the transactions
between the investors and the [partnership] should nevertheless
be classified as sales for federal tax purposes[.]”
Id. at 137.
We assumed, without deciding, that the investors were bona
fide
partners,
but
found
that
the
classified that series of transactions.
14
Commissioner
Id.
correctly
After rejecting
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the
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partnership’s
contention
constitute
“property”
rules,
concluded
we
presumption
that
Pg: 15 of 35
for
the
purposes
the
the
that
of
partnership
exchange
applicable regulatory factors.
was
tax
credits
the
“disguised
failed
a
did
to
“sale”
sales”
overcome
based
not
on
the
the
Id. at 140-46.
In attempting to distinguish Virginia Historic, Route 231
points
to
whether
its
tax
abstract.
the
“emphas[is]
credits
that
always
[the
Court
constitute
was]
not
‘property’
deciding
in
the
Rather, [the Court was] asked to decide only whether
transfer
of
tax
credits
acquired
by
a
non-developer
partnership to investors in exchange for money constituted ‘a
transfer of property’ for purposes of § 707.”
Route
231
contends
this
language
limited
Id. at 141 n.15.
Virginia
Historic’s
holding to sham partnerships that “ceased to exist as soon as
the credits were transferred” and that the “disguised sale rules
do not apply to a valid partnership with economic substance like
Route 231.”
(Opening Br. 26.)
Furthermore, Route 231 posits
that because Virginia Conservation remains a bona fide partner
in
an
ongoing
partnership,
the
transfer
of
tax
credits
was
“simply an allocation [of partnership assets] among partners,
and
not
a
investors.”
sale
of
property
by
a
sham
entity
to
transitory
(Opening Br. 27.)
Route 231’s argument misses the mark.
We note initially
that Route 231 does not challenge the validity of § 707 or the
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corresponding regulations.
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For the most part, Route 231 also
does not challenge the Tax Court’s application of the § 1.7073(c)
“facts
and
surrounding
circumstances”
its
transaction
test
with
to
the
circumstances
Virginia
Conservation.
Although Route 231 denies doing so, most of its arguments center
on the premise that as Virginia Conservation is a bona fide
partner
in
a
bona
fide
partnership,
its
partner/partnership
transactions are immune from the scope of § 707 and related
provisions.
apply
to
involved
Put another way, Route 231 contends § 707 cannot
the
transaction
at
are
bona
entities
fide
issue
here
in
because
a
genuine
the
entities
contractual
relationship.
The Commissioner does not contest that Route 231 is a valid
entity or that Virginia Conservation is a true partner in it.
Neither did the Tax Court rely on a failure of the bona fides of
the entities in reaching its decision.
There was no need to do
so as Route 231’s argument fails under the plain language of §
707, which expressly applies to transactions between a partner
and
partnership
without
qualification
whenever
a
partner
“engages in a transaction with a partnership other than in his
capacity as a member of such partnership.”
The bona fides of
Virginia Conservation’s status as a member of Route 231, or that
entity’s status as a valid limited liability company (and valid
partnership for tax purposes) do not matter for this inquiry.
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In short, the analysis under § 707 goes to the bona fides of a
particular
transaction,
participants
to
that
not
to
the
transaction.
general
Contrary
status
to
of
Route
the
231’s
repeated assertions, I.R.C. § 707 applies by its plain terms to
designated
transactions
between
otherwise
valid
ongoing
partnerships and their legitimate partners. 8
Relatedly,
in
Virginia
Historic
we
expressly
did
not
analyze whether the partnership itself was legitimate, nor did
we
limit
§
707’s
scope
to
sham
partnerships.
Quite
the
contrary, the Court expressly assumed the existence of a bona
fide partnership and proceeded directly to analyzing whether the
transaction
707.
nonetheless
constituted
a
disguised
Cf. Va. Historic, 639 F.3d at 137.
sale
under
So, too, here:
§
this
case does not turn at all on characteristics of the Route 231
8
To supports its contention that § 707 and the disguised
sale rules apply only when a partnership is illegitimate or a
sham, Route 231 points to Historic Boardwalk Hall, LLC v.
Commissioner, 694 F.3d 425 (3d Cir. 2012).
There, the Third
Circuit observed that some of the same principles applicable to
disguised
sales
also
apply
in
the
separate
context
of
determining whether a bona fide partnership exists. Where those
points overlapped, the court relied in part on our decision in
Virginia Historic.
See id. at 454-55.
Nothing about the
Commissioner’s position or the analysis in Historic Boardwalk
suggests that the two analyses can only take place together, or
that a bona fide partnership cannot engage in a transaction that
§ 707 recognizes as a disguised sale between a partnership and
its partner.
To the extent that its analysis is persuasive
authority, Historic Boardwalk stands for the unremarkable
principle that in certain instances, factors relevant to the one
of these inquiries may overlap with factors relevant to the
other.
17
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entity or its members.
Pg: 18 of 35
Instead, as contemplated by § 707(a),
this case turns on the nature of the transaction at issue: the
exchange of Virginia tax credits for money. 9
Turning
to
Conservation
and
the
Route
specific
231’s
circumstances
transaction,
we
of
Virginia
first
determine
whether the Virginia tax credits constitute “property” within
the scope of I.R.C. § 707 (regulating the “transfer of money or
other property”).
We agree with the Tax Court’s analysis and
its conclusion that the Virginia tax credits are “property” for
purposes of I.R.C. § 707.
is
evidenced
by
their
The tax credits’ status as “property”
value
as
Conservation to join Route 231.
an
inducement
to
Virginia
It bears noting that Virginia
Conservation was paying fifty-three cents on the dollar for a
credit worth a full dollar in tax relief from Virginia state
income tax: a transaction of real economic value.
Moreover,
Route 231’s ownership of the Virginia tax credits gave rise to
such essential proprietary rights as the right to own or use an
item,
to
exclude
others
from
9
ownership,
and
the
right
to
Nor did Virginia Historic limit § 707(a)’s scope to nondeveloper partnerships as Route 231 contends.
To be sure, in
examining the transaction at issue in Virginia Historic, we
pointed out that our holding that the tax credits were property
arose in the factual context of a “non-developer partnership,”
and
that
tax
credits
may
not
categorically
constitute
“property.”
But this language simply recognizes the factual
setting of Virginia Historic and reflects the requisite analysis
of “property” must be made in each case and not taken as a per
se rule.
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transfer them as permitted under state law.
In addition, as we
explained in greater detail in Virginia Historic, treating the
tax credits as “property” is consistent “with Congress’s intent
to widen [§ 707’s] reach” when that statute was amended in 1984.
See 639 F.3d at 142.
Having determined that the Virginia tax credits constitute
“property,” we turn to whether the transfer of this property
from Route 231 to Virginia Conservation constituted a “sale.”
Because the exchange of tax credits for money occurred within a
two-year
period,
the
disguised
sale
arises
presumption
unless
that
the
clearly establish” otherwise.
the
“facts
transaction
and
is
a
circumstances
See 26 C.F.R. § 1.707-3(c)(1).
The regulations provide that transactions of this nature are in
fact sales if, “based on all the facts and circumstances,” (1)
the
transfer
of
money
would
not
have
been
made
without
the
transfer of property, and (2) the subsequent transfer was not
dependent on the entrepreneurial risks of the partnership.
26
C.F.R. § 1.707-3(b)(1).
The analysis of these two considerations is based on the
totality of the “facts and circumstances,” including the ten
potentially
applicable
1.707-3(b)(2).
factors
noted
earlier.
26
C.F.R.
§
As the Tax Court noted, among the items that
“tend to prove the existence of a sale” in this case are:
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• the fixed cash-to-credit ratio for the transaction as
set out in the amended operating agreements, coupled
with Route 231’s agreement to earn those tax credits
by December 31, 2005 (cf. 26 C.F.R. § 1.7073(b)(2)(i); Va. Historic, 639 F.3d at 143);
• Virginia Conservation’s contractual right under the
amended operating agreement to all but Carr’s share
of the tax credits Route 231 earned (cf. 26 C.F.R. §
1.707-3(b)(2)(ii); Va. Historic, 639 F.3d at 143);
• Virginia Conservation’s right to be indemnified by
Route 231, Carr, and Humiston should it not receive
all the tax credits for which it provided Route 231
money (cf. 26 C.F.R. § 1.707-3(b)(2)(iii); Va.
Historic, 639 F.3d at 143-44) 10;
• Carr’s agreement to reduce the amount of tax credits
he would receive so that Route 231 could transfer to
Virginia Conservation the full amount of tax credits
for which it had contracted and paid (cf. 26 C.F.R. §
1.707-3(b)(2)(v));
• That Virginia Conservation received a 1% interest in
the LLC and yet received 97% of Route 231’s state tax
credits for the “contribution” of $3,816,000 while
Carr and Humiston each received a 50% (later reduced
10
We reject Route 231’s argument that the amended operating
agreements’ indemnity clause should not serve as proof that
Virginia Conservation’s right to the tax credits or their value
was secured.
Route 231 contends that the indemnity clause did
not “fully protect [it] from partnership risks” because Route
231, Carr, and Humiston had minimal available assets should any
one of them have been required to pay Virginia Conservation in
satisfaction of the indemnity obligation.
That argument
misunderstands the relevant factor, which is whether “the
partner’s right to receive the transfer of money or other
consideration is secured in any manner[.]”
26 C.F.R. § 1.7073(b)(2)(iii).
The regulation only asks whether the secured
right exists, not whether there is a risk that the secured party
may not in fact be able to collect on a judgment for breach of
contract at some point in time.
Because the indemnity clause
creates a legally enforceable right of indemnity, the Tax Court
appropriately concluded that this factor weighed in favor of a
disguised sale.
20
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to 49.5%) interest in the partnership and yet
received 3% and 0% of Route 231’s conservation tax
credits for their “contributions” of $2,300,000 (cf.
26 C.F.R. § 1.707-3(b)(2)(ix); Va. Historic, 639 F.3d
at 144); and
• That Virginia Conservation had no obligation to return
or repay the tax credits to Route 231, but exercised
full ownership rights in them (cf. 26 C.F.R. § 1.7073(b)(2)(x); Va. Historic, 639 F.3d at 144).
These
facts
and
circumstances
form
the
basis
for
our
conclusion that the Tax Court correctly determined that this
transaction was a sale under 26 C.F.R. § 1.707-3(b)(1).
Viewing
all
and
the
circumstances
surrounding
this
transaction,
in
particular the terms of the amended operating agreements, the
Tax Court did not err in finding that “Route 231 would not have
transferred
$7,200,000
of
Virginia
tax
credits
to
Virginia
Conservation but for the fact that Virginia Conservation had
transferred $3,816,000 to it” and vice versa.
J.A. 1526; cf. 26
C.F.R. § 1.707-3(b)(1)(i).
Moreover, Virginia Conservation’s right to the tax credits
did
not
depend
operations.
on
the
entrepreneurial
risks
Cf. 26 C.F.R. § 1.707-3(b)(1)(ii).
of
Route
231’s
Arguing to the
contrary, Route 231 points to Virginia Conservation’s assuming
certain
entrepreneurial
partnership,
but
whether
later
the
26
risks
C.F.R.
of
the
as
§
partner
in
1.707-3(b)(1)(ii)
two
entrepreneurial risks of Route 231.
21
a
transfers
an
ongoing
focuses
depended
on
on
the
Here, the plain language of
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the amended operating agreements created a fixed cash-to-credit
ratio to determine what each party would exchange.
They also
contained a specific guarantee that Virginia Conservation would
receive all of the tax credits it paid for and that it would be
entitled to reimbursement in cash for any shortfall.
At bottom,
Virginia Conservation’s right to the tax credits depended on
fixed contractual terms, not the entrepreneurial risks of Route
231’s operations.
For these reasons, our review of the record leads us to the
firm belief that Route 231 failed to rebut the presumption that
the transaction between Route 231 and Virginia Conservation was
a sale.
transfers
“unless
Cf. 26 C.F.R. § 1.707-3(c) (creating a presumption that
made
the
within
facts
two
and
years
are
presumed
circumstances
to
clearly
be
a
sale
establish”
otherwise).
Accordingly, we hold that the Tax Court did not err
in
with
agreeing
the
Commissioner
that
the
money
Route
231
received from Virginia Conservation was “income” for federal tax
purposes.
B.
Applicable Tax Year
Route 231 contends that even if the funds it received from
Virginia
Conservation
should
have
been
reported
as
“income,”
that income was reportable in 2006 rather than 2005.
If Route
231 is correct, then the determination that the Virginia tax
credit transfer constituted “income” would have no impact on it
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because the IRS did not seek an adjustment of Route 231’s 2006
tax return on that ground and any change to that tax year is now
barred
by
the
statute
of
limitations.
See
I.R.C.
§
6229
(articulating the limitations period for making assessments).
As we discuss below, we find none of Route 231’s arguments
on the applicable tax year to be meritorious.
The Tax Court
correctly determined that the tax credit sale occurred in 2005
for federal tax purposes. 11
1.
As
an
initial
matter,
Route
231
remains
bound
by
its
affirmative representation on its 2005 federal tax form that it
received $3,816,000 from Virginia Conservation in 2005.
That
factual representation to the Commissioner sets the parameters
of the legal dispute between the Commissioner and Route 231:
given
that
this
transaction
occurred,
how
does
the
Internal
Revenue Code characterize it?
We
have
previously
recognized
with
approval
the
Fifth
Circuit’s decision in Wichita Coca Cola Bottling Co. v. United
States, 152 F.2d 6 (5th Cir. 1945), where the court recognized
that a “duty of consistency in tax accounting” does not require
11
Route
the exhibits
occurred in
supports the
address those
231 also raises evidentiary challenges to some of
the Tax Court relied upon in concluding the sale
2005.
Because other independent evidence fully
Tax Court’s conclusion, it is unnecessary to
arguments. See 28 U.S.C. § 2111.
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a “willful misrepresentation” to be proven, nor does it require
“all the elements of a technical estoppel.
It arises rather
from the duty of disclosure which the law puts on the taxpayer,
along with the duty of handling his accounting so it will fairly
subject his income to taxation.” Id. at 8, relied on favorably
in Interlochen Co. v. Comm’r, 232 F.2d 873, 877-78 (4th Cir.
1956).
Thus,
in
Wichita
Coca
Cola
Bottling
Co.,
the
Fifth
Circuit concluded that if a taxpayer mistakenly “represented a
transaction as to defer taxation on it to a later year he ought
not, when the time for taxation under his view of it comes, to
be allowed to assert the tax ought to have been levied in the
former year if it is then too late so to levy it.”
152 F.2d at
8.
The same basic principle applies here.
Through its 2005
tax return, Route 231 represented to the IRS that the events
constituting the transaction occurred in 2005.
Upon proof that
the reported tax credit transaction is properly characterized as
a disguised sale and thus taxable as income, Route 231 cannot
then
be
allowed
to
assert
the
transaction
occurred
in
a
different year than it represented, given that it is too late to
require Route 231 to report it as income in the later year,
2006.
The bottom-line principle remains constant:
A taxpayer may
be barred from taking one factual position in a tax return and
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then taking an inconsistent position later in a court proceeding
in
an
effort
to
avoid
liability
based
consequences of the original position.
on
the
altered
tax
E.g., Janis v. Comm’r,
461 F.3d 1080, 1085 (9th Cir. 2006) (“‘[T]he duty of consistency
not only reflects basic fairness, but also shows a proper regard
for the administration of justice and the dignity of the law.
The law should not be such a[n] idiot that it cannot prevent a
taxpayer from changing the historical facts from year to year in
order to escape a fair share of the burdens of maintaining our
government.
honesty,
Our tax system depends upon self assessment and
rather
than
upon
hiding
of
the
pea
or
forgetful
[equivocation].’” (quoting Estate of Ashman v. Comm’r, 231 F.3d
541, 544 (9th Cir. 2000))); Alamo Nat’l Bank v. Comm’r, 95 F.2d
622, 623 (5th Cir. 1938) (“It is no more right to allow a party
to blow hot and cold as suits his interests in tax matters than
in other relationships.
Whether it be called estoppel, or a
duty of consistency, or the fixing of a fact by agreement, the
fact
fixed
for
one
year
ought
to
remain
fixed
in
all
its
consequences, unless a more just general settlement is proposed
and can be effected.”).
Accordingly, the Tax Court did not err
in concluding Route 231 remained bound by its original factual
25
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representation
Filed: 01/08/2016
that
the
Pg: 26 of 35
transfer
of
funds
from
Virginia
Conservation occurred in 2005. 12
2.
Quite apart from the equitable consistency consideration,
we
also
conclude
that
the
record
demonstrates
Virginia tax credits in fact occurred in 2005.
the
sale
of
In particular,
the record supports the Tax Court’s determination that Route 231
transferred to Virginia Conservation before January 1, 2006 the
12
Route 231 urges that the duty of consistency should not
apply because, among other things, the IRS could have, and yet
did not, challenge Route 231’s 2006 return in light of its
position with respect to Route 231’s 2005 return.
As such, it
contends the Commissioner is responsible for its inability to
adjust the 2006 return.
In addition, it contends the
Commissioner’s position in this case is inconsistent with its
position in Virginia Historic, where adjustments were proposed
to two years of tax returns based on the argument that the
challenged
transactions
constituted
sales
and
where
the
Commissioner agreed that any adjustments should be made to the
second year’s returns.
This argument overlooks key factual differences between
this case and Virginia Historic. There, the partnership engaged
in multiple transactions with partners that occurred “between
November 2001 and April 2002.”
639 F.3d at 135.
The
Commissioner challenged the partnership’s tax returns for both
2001 and 2002 because the transactions at issue occurred in both
tax years.
Furthermore, the Commissioner stipulated that any
adjustments for all of the transactions should apply to the
partnership’s 2002 tax returns.
Id. at 136.
That stipulation
has no bearing on the Commissioner’s position in this case and
even less on the appropriate analysis.
Here, in contrast, the
Commissioner only challenged one transaction.
The Commissioner
appropriately challenged Route 231’s characterization of that
transaction for the tax year where Route 231 reported the
transaction as having occurred. Far from being inconsistent
positions, the Commissioner has taken its position based on the
facts of the cases before it.
26
Appeal: 14-1983
tax
Doc: 36
credits
Filed: 01/08/2016
that
it
had
Pg: 27 of 35
earned
because
of
the
December
30
conservation donation.
Under
the
then-applicable
Virginia
statute,
Va.
Code
§
58.1-512 (2005), Route 231 earned tax credits as a matter of law
as soon as it made a qualifying conservation donation.
The
statute set out – among other things – the value of the tax
credits (“50% of the fair market value”), what type of donation
qualified, and how the fair market value of the donation was to
be substantiated.
See Va. Code § 58.1-512 (2005).
As the Tax
Court observed, this statutory language was later amended to add
language requiring taxpayers to “apply for a credit” that would
then be “issued” by the Virginia Department of Taxation.
Code § 58.1-512(D)-(E) (2007).
Va.
But that amended language was
not the law of Virginia in 2005.
Based on the applicable Virginia statutory language, Route
231 earned the tax credits by making the statutorily compliant
donation on December 30, 2005.
Notably, Route 231 does not
contend that it had failed to meet any of the Virginia statutory
requirements,
and
Department
of
Taxation
number
earned
of
requirements.
it
tax
only
speculates
might
have
credits
that
decreased
despite
having
the
the
Virginia
anticipated
satisfied
those
The point remains, under the applicable state
27
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statutes, Route 231 earned – and therefore owned – tax credits
as of the time of its donation, which occurred in 2005. 13
The record also shows that Route 231 transferred all but
Carr’s share of those tax credits to Virginia Conservation in
2005.
Under 26 C.F.R. § 1.707-3(a)(2), a
sale is considered to take place on the date that,
under general principles of Federal tax law, the
partnership is considered the owner of the property.
If the transfer . . . from the partnership to the
partner occurs after the transfer . . . . to the
partnership[,] the partner and the partnership are
treated as if, on the date of the sale, the
partnership transferred to the partner an obligation
to transfer to the partner[.]
As
noted
earlier,
a
corollary
principle
applies
when
the
transfer from the partner occurs after the transfer from the
partnership.
See 26 C.F.R. § 1.707-6(a).
Under federal tax law, an entity “owns” property when it
possesses the benefits and burdens of ownership.
The Tax Court
appropriately
to
applied
a
multi-factor
analysis
whether Route 231 owned the tax credits in 2005.
13
determine
The relevant
Route 231’s argument that while it might have been able
to use the tax credits immediately, it could not transfer the
credits
without
registering
them
misreads
the
applicable
Virginia statute.
Va. Code § 58.1-513(C) (2005) allowed the
transfer of “unused but otherwise allowable credit for use by
another taxpayer on Virginia income tax returns” without
reservation.
While that statute required taxpayers to file a
notification of the transfer with the Virginia Department of
Taxation, nothing in the statute required that the notification
occur prior to the transfer of tax credits.
See Va. Code §
58.1-513(C) (2005).
28
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factors in that analysis include: whether legal title passed;
how
the
parties
in
interest
created
treated
property
a
the
present
the
transaction;
was
obligation
acquired;
on
the
whether
whether
seller
an
the
to
equity
contract
execute
and
deliver a deed and a present obligation on the purchaser to make
payments;
whether
the
right
of
possession
was
vested
in
the
purchasers; which party bore the risk of loss or damage to the
property; and which party received profits from the operation
and sale of the property.
Calloway v. Comm’r, 691 F.3d 1315,
1327-28 (11th Cir. 2012); Arevalo v. Comm’r, 469 F.3d 436, 439
(5th Cir. 2006); Crooks v. Comm’r, 453 F.3d 653, 656 (6th Cir.
2006); Upham v. Comm’r, 923 F.2d 1328, 1334 (8th Cir. 1991).
No
one of these factors controls, as the determination of ownership
is based on all the facts and circumstances of a particular
case, and some factors may be “ill-suited or irrelevant” to a
particular case.
Calloway, 691 F.3d at 1327.
Under the totality of the relevant circumstances here, the
Tax Court correctly determined that the sale occurred in 2005.
We
already
discussed
Route
231’s
representation
on
its
2005
federal tax forms, but that is just one of several instances
where Route 231 treated or represented the transfer as occurring
in 2005.
Route 231’s Forms LPC represented to the Virginia
Department of Taxation that the tax credits had been transferred
to Virginia Conservation in December 2005.
29
In addition, the
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first
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amended
Filed: 01/08/2016
operating
Pg: 30 of 35
agreement
(signed
on
December
28)
created a present contractual obligation for Route 231 to convey
to Virginia Conservation all but $300,000 of any tax credits
Route 231 earned from a conservation donation before December
31, 2005.
Thus, as soon as Route 231 earned the tax credits by
recording
the
statutory-compliant
conservation
donation
on
December 30, 2005, Virginia Conservation had the legal right to
those credits.
As further support for our conclusion, the language used in
Route 231’s second amended agreement (signed January 1, 2006)
recited the salient sale events as having occurred in the past,
not as prospective acts.
For example, that agreement refers to
Virginia Conservation as having “made” its contribution, Route
231 as having “duly earned” the tax credits, and those credits
having
“been
respectively.
allocated”
(J.A.
to
504,
Carr
508,
and
517.)
Virginia
Lastly,
Conservation,
in
additional
correspondence between Route 231, Virginia Conservation, and the
escrow agent, Route 231 specifically recognized the potential
tax consequences of the transaction occurring in 2005 versus
2006, and maintained that it occurred in 2005.
Consistent with
that view, when a concern arose as to who bore the risk of loss
and
owned
any
interest
earned
while
the
funds
were
held
in
escrow, Route 231 and Virginia Conservation agreed that Route
231 bore that risk and would also be entitled to any interest
30
Appeal: 14-1983
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earned.
Filed: 01/08/2016
During
those
Pg: 31 of 35
discussions,
Route
231
affirmed
that
Virginia Conservation’s payment of the funds into escrow (in
December
2005)
“satisfied
[its]
contractual
contribute to the capital of Route 231.”
obligation
to
(J.A. 608.)
To recap, Virginia Conservation had legal title, an equity
interest in, and the right to possess the tax credits as soon as
Route 231 earned them in 2005; Route 231, Virginia Conservation,
and
other
parties
transaction
occurred,
to
in
to
the
transaction
all
occur,
and
treated
transaction
2005
throughout
the
the
intended
negotiations
up
for
as
the
having
until
the
Commissioner challenged how Route 231 characterized the transfer
on
its
federal
tax
return;
and
the
first
amended
operating
agreement gave rise to a present obligation on the part of Route
231 to transfer the tax credits earned in 2005, while the second
amended operating agreement documented that this obligation had
been satisfied.
All of these circumstances demonstrate that the
sale occurred in 2005.
Route 231 argues that this analysis ignores the language of
the escrow agreements and the fact that Virginia Conservation
did not authorize release of the funds from escrow until March
2006, after it confirmed receiving various documents related to
the
conservation
donation
transaction numbers.
the
totality
of
and
the
Virginia
tax
credit
To the contrary, the above analysis takes
circumstances
into
31
consideration
rather
than
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focusing on the escrow agreements apart from the whole.
conclusion
also
agreements,
required
finds
which
the
support
provide
escrow
in
that
agent
to
the
language
only
two
return
of
events
the
the
This
escrow
automatically
funds
to
Virginia
Conservation and thus cancelled the sale: failure to record the
charitable donations “on or before December 31, 2005” or failure
to admit Virginia Conservation as a Route 231 partner “on or
before December 31, 2005.”
(J.A. 532, 536, 540.)
Both those
events were known and satisfied before the end of 2005, so the
escrow agreements’ contingency could not have occurred in 2006.
The remaining acts Route 231 points to as showing a sale of
tax credits did not occur in 2005 – that it provide Virginia
Conservation
copies
of
certain
documents
relating
to
the
conservation donation and the tax credits, and that Virginia
Conservation provide written confirmation of receiving them –
are
of
no
substantive.
consequence.
The
escrow
These
acts
agreements
are
only
ministerial,
speak
to
Route
not
231
providing copies of documents and are not directly contingent on
the
outcome
process.
of
the
Virginia
Department
of
Taxation’s
review
Providing copies is a quintessential ministerial task.
See Black’s Law Dictionary 1011 (defining “ministerial” as “[o]f
or relating to an act that involves obedience to instructions or
laws instead of discretion, judgment, or skill”); see also Ray
v. United States, 301 U.S. 158, 163 (1937).
32
In the unlikely
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event
that
Filed: 01/08/2016
the
Virginia
Pg: 33 of 35
Department
of
Taxation
reduced
the
amount of tax credits Virginia Conservation would receive, the
amended
operating
directed
how
agreements
Virginia
(not
the
Conservation
escrow
would
agreements)
be
compensated.
Moreover, it would have no bearing on the fact that Route 231
sold
a
portion
of
Conservation in 2005.
its
earned
tax
credits
to
Virginia
That is to say, it would not impact the
fact of the sale.
Based on the totality of the evidence, the sale of tax
credits for money occurred in 2005, and all that remained in
2006 were ministerial formalities.
3.
Route 231’s argument fails for a third reason:
accrual
method
of
accounting,
and
under
it uses the
the
principles
applicable to the accrual method, the sale occurred in 2005.
Gross
income
must
be
“included
in
the
gross
income
for
the
taxable year in which received by the taxpayer, unless, under
the method of accounting used in computing taxable income, such
amount
is
period.”
to
be
I.R.C.
properly
§
accounted
451(a).
“Under
for
an
as
of
accrual
a
different
method
of
accounting, income is includible in gross income when all the
events have occurred which fix the right to receive such income
and
the
accuracy.”
amount
thereof
can
be
determined
26 C.F.R. § 1.451-1(a).
33
with
reasonable
Generally speaking, this
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Pg: 34 of 35
means that “income . . . is taxable in the year the income is
accrued, or earned, even if it is not received in that year.”
IES Indus., Inc. v. United States, 253 F.3d 350, 357 (8th Cir.
2001).
Although
elaborating
on
we
not
“all
what
do
the
have
any
events”
published
means
for
authority
purposes
of
applying this regulation, the Tax Court adopted a reasonable
interpretation
that
other
cases
have
used:
(1)
the
required
performance takes place, (2) the payment is due, or (3) the
payment is made, whichever comes first.
Johnson v. Comm’r, 108
T.C. 448, 459 (1997), rev’d in part on other grounds, 184 F.3d
786 (8th Cir. 1999).
Here, Route 231 earned Virginia Conservation’s $3,816,000
payment
with
conservation
credits.
reasonable
donations
certainty
that
gave
in
2005
rise
to
when
it
made
the
the
Virginia
tax
Under the terms of the amended operating agreements,
that act was sufficient to obligate Route 231 to transfer all
but Carr’s share of the tax credits to Virginia Conservation.
And,
in
turn,
that
occurrence
was
sufficient
to
obligate
Virginia Conservation to pay Route 231 the pre-determined cashto-credit ratio for the tax credits.
Consequently, by December
31, 2005, “all the events [had] occurred which fix[ed] the right
to
receive
the
amount
thereof c[ould] be determined with reasonable accuracy.”
Cf. 26
C.F.R.
§
[Virginia
1.451-1(a).
Conservation’s
Accordingly,
34
money]
the
Tax
and
Court
correctly
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Pg: 35 of 35
determined that under the accrual method of accounting, Route
231
was
obligated
to
report
the
$3,816,000
in
income
from
Virginia Conservation on its 2005 federal tax forms.
III.
For the reasons set out above, we affirm the Tax Court’s
decision adjusting Route 231’s 2005 Return of Partnership Income
federal
tax
form
to
reflect,
in
relevant
part,
income
of
$3,816,000.
AFFIRMED
35
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