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ALLISON v. UNITED STATES

UNITED STATES DISTRICT COURT FOR THE MIDDLE DISTRICT OF PENNSYLVANIA


June 18, 1974

Herbert L. Allison and Lois J. Allison (now Warfield), Plaintiffs
v.
United States of America, Defendant

Sheridan, District Judge.

The opinion of the court was delivered by: SHERIDAN

Memorandum

SHERIDAN, District Judge:

 This is a civil action for the refund of $8,315.93 in income taxes, together with interest, which the taxpayer claims were erroneously and illegally assessed by the defendant for the calendar year 1962. The case was submitted on a stipulation of facts.

 On March 1, 1959, the plaintiff, *fn1" Herbert L. Allison, received as a gift from his father, Herbert F. Allison, a portion of his father's capital account in a partnership, the Lycoming Equipment Company. On that same date plaintiff entered into a partnership agreement and became a partner in the Lycoming Equipment Company. Plaintiff's contribution to capital was the $200,000 interest from the capital account of his father which plaintiff had received by a deed of gift. The partnership agreement provided that plaintiff's father had the right during his lifetime to repurchase the interest of the plaintiff at book value, and that in the event of the death of plaintiff's father, the plaintiff had the primary right to purchase his father's remaining interest in the partnership at book value.

 Plaintiff's father died on January 3, 1961. On March 2, 1961, the plaintiff exercised his primary right to purchase his father's remaining interest in the partnership. At that time the father's capital account in the partnership was overdrawn in the amount of $9,181; thus, by the exercise of his option, plaintiff assumed this liability. On the original federal estate tax return, the father's remaining interest in the partnership was valued at zero since there was a deficit of $9,181 in his capital account. On the federal estate tax return the estate also indicated informationally the father's earlier transfer by deed of gift of part of his capital interest in the partnership to plaintiff.

 Following the filing of a petition in the Tax Court of the United States, the estate and the Internal Revenue Service agreed to a settlement under which the estate would value the father's retained partnership interest at $53,550 and the gift interest at $53,550. This settlement was incorporated in an order of the Tax Court on February 9, 1967. The estate tax determination substantially increased the assumed basis for plaintiff's partnership interest, the settlement having in effect increased the basis for the partnership assets acquired by plaintiff as a result of his father's death. Therefore, within a year after the estate tax determination, the partnership filed an election under Section 754 of the Internal Revenue Code of 1954, 26 U.S.C.A. § 754, to make adjustments to the basis of partnership property provided for in Section 743 of the 1954 Code, 26 U.S.C.A. § 743, for the partnership fiscal year beginning March 1, 1961, the first fiscal year after the death of plaintiff's father. Simultaneously, with the filing of the election by the partnership, plaintiffs filed a claim for refund for the calendar year 1962 based on the adjustments to basis of partnership property under Section 743. Plaintiff argues in the alternative that he is entitled to relief under the mitigation provisions of the Internal Revenue Code, specifically under Section 1312(7) of the 1954 Code, 26 U.S.C.A. § 1312(7), reasoning that there was a determination of the basis of property subsequent to an erroneous treatment of a prior transaction. The parties agree that the plaintiff is entitled to a tax refund due to the adjustment to basis of partnership property provided for in Section 743 if the partnership election under Section 754 was timely. Since the court has decided that the election under Section 754 was timely, it does not reach the issue of mitigation under Section 1312(7).

 Thus, the issue is whether, in order for a partner to avail himself of the optional adjustment to the basis of partnership property, the partnership must file the written statement, containing the declaration that the partnership elects under Section 754 to apply the provisions of Section 743, with the partnership return for the first taxable year to which the election applies.

 Although a partnership is not a taxable entity, each partnership must file an annual information return showing items of gross income and allowable deductions, and such other information as the Secretary or his delegate may require to carry out the provisions of the law relating to the taxation of incomes from partnerships. The partnership information return must include the names and addresses of individuals entitled to share in the taxable income if distributed, and the amount of the distributive share of each individual. 26 U.S.C.A. § 6031.

 The basis of partnership property as a general rule is not to be affected by the sale or exchange of a partnership interest, by the death of a partner, or by a distribution of partnership property. 26 U.S.C.A. §§ 734(a) and 743(a). However, Sections 734(b) and 743(b) permit an adjustment if the partnership makes an election under Section 754. The adjustment to the basis of the partnership's assets is for the benefit of the transferee partner only, and the basis adjustment is measured by the difference between the transferee's basis for his partnership interest and his proportionate share of the partnership's basis for its assets at the time of the transfer.

 The treasury regulations provide that the Section 754 election "shall be made in a written statement filed with the partnership's return for the first taxable year to which the election applies." 26 C.F.R. § 1.754-1. The statute has no such time requirement and the court holds that such a requirement cannot be validly imposed by the Commissioner, at least not under the facts of this case.

 Though treasury regulations are entitled to consideration and respect and may often be persuasive in resolving ambiguities, it is clear that a regulation is invalid if it is inconsistent with the statute upon which it is based or if it is unreasonable. United States v. Whitney Land Co., 8 Cir. 1963, 324 F.2d 33; Abbott v. Commissioner of Internal Revenue, 3 Cir. 1958, 258 F.2d 537; Commonwealth Development Association of Pennsylvania v. United States, M.D. Pa. 1973, 365 F. Supp. 792. The power of an administrative officer or agency to administer a federal statute and to prescribe rules and regulations to that end is not the power to make law -- for no such power can be delegated by Congress -- but the power to adopt regulations to carry into effect the will of Congress as expressed by the statute. A regulation which does not do this, but operates to create a rule out of harmony with the statute is a mere nullity. Thus, a regulation to be valid must not only be consistent with the statute but also must be reasonable. Manhattan General Equipment Co. v. Commissioner of Internal Revenue, 1936, 297 U.S. 129, 56 S. Ct. 397, 80 L. Ed. 528; United States v. Whitney Land Co., 8 Cir. 1963, 324 F.2d 33. This principle is no more than a reflection of the fact that Congress, not the Commissioner, prescribes the tax laws. Dixon v. United States, 1965, 381 U.S. 68, 73, 14 L. Ed. 2d 223, 85 S. Ct. 1301.

 In Neel v. United States, N.D. Ga. 1966, 266 F. Supp. 7, the court declared regulation 1.754-1(b) void holding that the time limitation with respect to making a Section 754 election was unreasonable and could not be validly imposed by the Commissioner. The court allowed a partnership to file an election under Section 754 on April 1, 1962, to be applied retroactively to the partnership fiscal year which ended June 30, 1959, the year in which the transfer of a partnership interest due to the death of a partner occurred. Thus, the court permitted the transferee partner taxpayer to avail himself of the adjustment to the basis of partnership property provided for in Section 743. The court held that the limitation on the time in which the partnership may exercise its right of election, imposed only by the Commissioner's regulation, § 1.754-1, and not by the statute, had the effect of imposing a penalty and was unreasonable.

 In Estate of Dupree v. United States, 5 Cir. 1968, 391 F.2d 753, the court decided that an attempt to make a Section 754 election was too late. As a result of a sale in August 1960 of a motel owned by the partnership, the partnership filed a Section 754 election with respect to a transfer of a partnership interest that had occurred in 1957. The election was filed in an amended partnership return in September 1963 which sought to amend the partnership return for its fiscal year ending on March 31, 1961, which had reported the motel sale of August 1960. The partnership in filing its original return on July 15, 1961, did not make the Section 754 election. Likewise, the election had not been made in the return for 1957, the year of transfer of the partnership interest. The court held that the election could not be by an amendment filed over two years after the original return for 1960 was due. The court stated:

 

". . . Cases involving elections under other sections of the Internal Revenue Code have permitted an election to be validly exercised only in an original return or in a timely amendment, with 'timely amendment ' meaning if filed within the period provided by the statute for filing the original return. J.E. Riley Investment Company v. Commissioner of Internal Revenue, 311 U.S. 55, 61 S. Ct. 95, 85 L. Ed. 36 (1940); Scaife & Sons Co. v. Commissioner of Internal Revenue, 314 U.S. 459, 62 S. Ct. 338, 86 L. Ed. 339 (1941). We conclude that for a valid election to have been made for the taxable year 1960, it should have been timely made in the original return or by an amended return filed within the statutory time for filing the original return." 391 F.2d at 758-59.

 The court did not reach the issue decided in Neel :

 

"In view of our conclusion that the election was made too late to be valid, it is unnecessary to consider and decide the second defense of the government that an election could be made for the first time only in the year of the transfer -- 1957. We note that a recent district court case, Neel v. United States, 266 F. Supp. 7 (N.D. Ga., 1966), decided that issue adversely to the government but we express no opinion here as to that case or issue, declining instead to consider it because of it being unnecessary to do so in order to decide the case before us." 391 F.2d at 759.

 It should be noted that while it would be unreasonable to have expected the partnership in the instant case to have filed a Section 754 election any sooner than it did, in Dupree there would appear to be no legitimate reason for the partnership not having made the election earlier.

 The time limitation imposed in Commissioner's regulation 1.754-1 is patently unreasonable, at least with respect to cases involving the transfer of a partnership interest due to the death of a partner, in that in many instances the value of the partnership interest is not finally determined, as here, in the same year the transfer due to death occurred. Until the value of the partnership interest is finally determined, an intelligent decision whether to elect under Section 754 is impossible. In the instant case, plaintiff filed his Section 754 election shortly after the federal estate tax settlement of the deceased partner, incorporated in the order of the Tax Court, which had the effect of greatly increasing the basis of plaintiff's partnership interest. To require a partnership to file a Section 754 election before the basis of a transferred interest has been finally determined simply is not rational. Congress imposed no time limitation in the statute with respect to making an election under Section 754, and although a more narrowly drawn regulation with respect to the timing of an election might be valid, one that proscribes an election under the facts of this case and similar cases involving transfers of partnership interests due to the death of partners is untenable and void. Since the regulation goes a long way toward negating the relief which Congress intended should be available to a transferee partner, the regulation is a nullity.

 The court holds that the Section 754 election filed in the instant case is timely under the statute and hence is valid. The taxpayer therefore is entitled to a refund.


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