Income from Partnership Is Self-Employment Income Where Taxpayer Chose Not to Be a Partner

The Eleventh Circuit Court of Appeals held that payments a taxpayer received from a nursing home business were taxable self-employment income despite the taxpayer’s convoluted attempts to characterize them as partnership distributions (Plotkin, No. 12-10620 (11th Cir. 11/27/12), aff’g T.C. Memo. 2011-260).

The taxpayer operated nursing homes through various partnerships and corporations. He was convicted in 1999 of three counts of willfully making and subscribing false tax returns under Sec. 7206(1) for 1991 through 1993 because he had treated the funds from the nursing homes as his personal income but had not reported them as such. Most of the entities were owned by the taxpayer’s friends and family members, not by the taxpayer himself, but he treated the entities as his personal bank account, paying many of his personal expenses through them, and did not have a bank account of his own.

When he was convicted, the court called one of the entities, a partnership called Autumn Years, a sham. Autumn Years was ostensibly owned by the taxpayer’s three children (75%), the taxpayer’s ex-girlfriend (20%), and his ex-wife (4%), with the remaining 1% split between various entities. The children and ex-wife did not know they were partners, no partnership returns were filed, and no other partnership formalities were observed. Autumn Years supposedly held a 99% limited partnership interest in Rolla Health Care Associates LP (RHCA), which operated the nursing homes.

In 2008, the IRS issued a notice of deficiency for the same years covered in the criminal proceedings and for 1994 and 1995 as well. The notice of deficiency reported Schedule C income from self-employment—for the amounts the taxpayer had received from the nursing home businesses over the years and not reported—of $302,319 for 1991; $172,081 for 1992; $138,490 for 1993; $135,611 for 1994; and $805,246 for 1995. The adjustment for 1995 included $217,246 from the sale of a nursing home that one entity had paid to a bank in satisfaction of a loan the taxpayer had taken out to build a house. The taxpayer filed a petition with the Tax Court challenging the deficiencies, but the Tax Court upheld them.

The taxpayer appealed the Tax Court’s decision to the Eleventh Circuit, where he argued that because the court in the criminal case had found that Autumn Years was a sham, the 99% partnership interest Autumn Years held in RHCA should be imputed to him. Under this theory, the money that the taxpayer received from RHCA’s payments to Autumn Years and another entity was not Schedule C income, but was instead partnership distributions, which were then taxable only to the extent they exceeded his basis in RHCA.

The appeals court reasoned that, even though Autumn Years may have been a sham partnership, that in itself was not sufficient to support the taxpayer’s claim that he should be considered the owner of Autumn Years’s 99% interest in RHCA because he could have made himself a partner in RHCA but chose not to. In addition, the court explained, even if he was considered a partner in RHCA, the money he received would not automatically be treated as partnership distributions. If a partner performs services for a partnership, other than in his capacity as a member of the partnership, those services are treated as if they were provided by a nonpartner, not as partnership distributions.

Also, because a partner’s distributive share is determined by the partnership agreement, the taxpayer must establish that the payments were distributions made under the terms of a partnership agreement. The taxpayer could not and did not allege that his work was performed pursuant to a partnership agreement. Therefore, the Tax Court’s determination of the taxpayer’s deficiencies for 1991 through 1995 was upheld.