Filed: Dec. 02, 2013
Latest Update: Nov. 14, 2018
Summary: CRESCENT HOLDINGS, LLC, ARTHUR W. FIELDS AND JOLEEN H. FIELDS, A PARTNER OTHER THAN THE TAX MATTERS PARTNER, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT Docket Nos. 23756–11, 23757–11. Filed December 2, 2013. Holdings was a limited liability company formed on Sept. 7, 2006, and classified as a partnership for Federal income tax purposes. Resources was a limited liability company whose ownership was transferred to Holdings on Sept. 7, 2006. On Sept. 7, 2006, Resources entered into
Summary: CRESCENT HOLDINGS, LLC, ARTHUR W. FIELDS AND JOLEEN H. FIELDS, A PARTNER OTHER THAN THE TAX MATTERS PARTNER, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT Docket Nos. 23756–11, 23757–11. Filed December 2, 2013. Holdings was a limited liability company formed on Sept. 7, 2006, and classified as a partnership for Federal income tax purposes. Resources was a limited liability company whose ownership was transferred to Holdings on Sept. 7, 2006. On Sept. 7, 2006, Resources entered into ..
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CRESCENT HOLDINGS, LLC, ARTHUR W. FIELDS AND
JOLEEN H. FIELDS, A PARTNER OTHER THAN THE
TAX MATTERS PARTNER, PETITIONERS v.
COMMISSIONER OF INTERNAL
REVENUE, RESPONDENT
Docket Nos. 23756–11, 23757–11. Filed December 2, 2013.
Holdings was a limited liability company formed on Sept. 7,
2006, and classified as a partnership for Federal income tax
purposes. Resources was a limited liability company whose
ownership was transferred to Holdings on Sept. 7, 2006. On
Sept. 7, 2006, Resources entered into an employment agree-
ment with P to have Holdings transfer a 2% interest in
Holdings to P if P served as chief executive officer (CEO) of
Resources for a period of three years ending on Sept. 7, 2009.
The 2% interest was subject to a substantial risk of forfeiture
and was not transferable. Holdings allocated partnership
profits and losses attributable to the 2% interest to P for the
taxable years 2006 and 2007 (years at issue). Ps included
these amounts in their gross income for the years at issue. P
resigned as CEO and forfeited his right to the 2% interest
before it vested. The issue is whether P or the other partners
should recognize the undistributed partnership income alloca-
tions attributable to the 2% interest for the years at issue.
Held: The 2% interest is a partnership capital interest, not a
partnership profits interest. Rev. Proc. 93–27, 1993–2 C.B.
343, and Rev. Proc. 2001–43, 2001–2 C.B.191, are inapplicable
because they apply only to partnership profits interests. Held,
further, I.R.C. sec. 83 applies to a nonvested partnership cap-
ital interest transferred in exchange for the performance of
services. Held, further, under sec. 1.83–1(a)(1), Income Tax
Regs., the undistributed partnership income allocations attrib-
utable to the nonvested 2% partnership capital interest are to
be recognized in the income of the transferor. Held, further,
Holdings was the transferor of the 2% partnership capital
interest. The undistributed partnership allocations attrib-
utable to the 2% capital interest are allocable to the partners
holding the remaining interest in Holdings.
James R. Kelley and William T. Ramsey, for petitioners.
Jasper G. Taylor III, Richard L. Hunn, and Michelle A.
Spiegel, for intervenor.
477
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478 141 UNITED STATES TAX COURT REPORTS (477)
W. Benjamin McClendon and Kirk Chaberski, for
respondent.
RUWE, Judge: Respondent issued a notice of final partner-
ship administrative adjustment (FPAA) for the taxable year
2006 and an FPAA for the taxable year 2007 to Crescent
Holdings, LLC (Crescent Holdings). Arthur Fields (peti-
tioner), a partner other than the tax matters partner, filed
petitions for readjustment of partnership items under section
6226. 1 The cases were consolidated for trial, briefing, and
opinion.
The issues for decision are: (1) whether petitioner should
be treated as a partner owning a 2% interest in Crescent
Holdings for purposes of allocating its profits and losses for
the taxable years 2006 and 2007 (years at issue); and (2) if
not, how the profits and losses attributable to the 2% interest
should be allocated to the other partners.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts and the attached exhibits are incor-
porated herein by this reference.
At the time the petitions were filed, Crescent Holdings’
principal place of business was in North Carolina.
Crescent Resources, LLC (Crescent Resources), was a
Georgia limited liability company. Crescent Resources devel-
oped and managed commercial, residential, and multifamily
real estate projects primarily in the Southeastern and South-
western United States. Before September 7, 2006, Crescent
Resources was wholly owned by Duke Ventures, LLC (Duke
Ventures), a Nevada limited liability company. Duke Ven-
tures was an indirect wholly owned subsidiary of Duke
Energy Corp. (Duke Energy), a publicly traded company.
Petitioner joined Crescent Resources in 1987 as the vice
president of real estate development. Petitioner signed an
employment agreement with Crescent Resources on
December 3, 1987, which was subsequently amended in 1994
and 1998. At some point in the 1990s petitioner became
president of Crescent Resources and a member of the Duke
1 All section references are to the Internal Revenue Code (Code) in effect
for the years at issue, and all Rule references are to the Tax Court Rules
of Practice and Procedure, unless otherwise directed.
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(477) CRESCENT HOLDINGS, LLC v. COMMISSIONER 479
Energy executive team. As a result of his position on the
executive team, petitioner was allowed to participate in Duke
Energy’s nonqualified executive retirement plan.
In 2005 Duke Energy hired Morgan Stanley as a consult-
ant to explore options to monetize the value of Crescent
Resources. One of the proposed options was for Duke Energy
to sell all or a part of its interest in Crescent Resources.
Morgan Stanley informed Duke Energy that its hedge funds
would be interested in purchasing a partial interest in Cres-
cent Resources. Duke Energy agreed to sell a partial interest
in Crescent Resources.
Sale of Crescent Resources
On September 7, 2006, Duke Ventures and Crescent
Resources entered into a formation and sale agreement
(Formation Agreement) with Morgan Stanley Real Estate
Fund V U.S., L.P., Morgan Stanley Real Estate Fund V Spe-
cial U.S., L.P., Morgan Stanley Real Estate Investors V U.S.,
L.P., MSP Real Estate Fund V, L.P., and Morgan Stanley
Strategic Investments, Inc. (Initial MS Members). Pursuant
to the Formation Agreement, Crescent Holdings, a Delaware
limited liability company, was formed on September 7, 2006.
Crescent Holdings is classified as a partnership for Federal
income tax purposes. 2
Pursuant to section 2.2(a) of the Formation Agreement
Duke Ventures contributed 100% of its interest in Crescent
Resources to Crescent Holdings in exchange for 100% of the
member interest in Crescent Holdings. In accordance with
section 2.2(b) Crescent Holdings issued additional member
interests to petitioner such that the Crescent Holdings
member interests were held 98% by Duke Ventures and 2%
by petitioner. Section 2.2(c) required that, simultaneously
with the transactions in section 2.2(a) and (b), Crescent
Resources would enter into a credit agreement and borrow
$1,225,000,000, of which $1,187,000,000 would be distributed
to Crescent Holdings, which would distribute that amount to
Duke Ventures. In accordance with section 2.2(d), Duke Ven-
2 Since
Crescent Holdings is treated as a partnership for tax purposes,
in our discussion the term ‘‘partner’’ refers to petitioner’s status as a mem-
ber of Crescent Holdings, and the term ‘‘partnership’’ refers to Crescent
Holdings.
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480 141 UNITED STATES TAX COURT REPORTS (477)
tures sold 49% of the member interest in Crescent Holdings
to the Initial MS Members. Pursuant to the Formation
Agreement the Initial MS Members purchased from Duke
Ventures a 49% member interest in Crescent Holdings for
approximately $415 million.
Concurrent with the Formation Agreement, on September
7, 2006, petitioner entered into a new employment agreement
with Crescent Resources. Petitioner agreed to remain the
president and chief executive officer of Crescent Resources
for three years. On that date petitioner also entered into an
agreement and acknowledgment (Fields Agreement) with
Crescent Resources and Duke Energy. As an inducement for
petitioner to forgo his rights from his previous employment
agreement, the Fields Agreement provided that: (1) Duke
Energy would credit petitioner with $37,796,000 to an
unfunded bookkeeping account to be administered as if main-
tained under Duke Energy’s nonqualified executive retire-
ment plan; and (2) Crescent Holdings would grant petitioner
a 2% restricted membership interest in Crescent Holdings
subject to section 83 of the Code and in accordance with the
terms stated in Exhibit A to the Fields Agreement. 3 Exhibit
A stated that petitioner’s membership interests in Crescent
Holdings would be forfeited if he terminated his employment
with Crescent Resources before the third anniversary of the
formation of Crescent Holdings. 4 Exhibit A also stated that
petitioner’s ‘‘[i]nterests are nontransferable unless and until
forfeiture restrictions shall have lapsed’’. Exhibit A required
petitioner to pay Crescent Resources an amount sufficient to
satisfy all withholding for employment taxes and other
applicable taxes before the forfeiture restrictions would lapse.
Exhibit A provided that petitioner is entitled to the same dis-
tributions as other holders of member interests and that any
distributions he received are not subject to forfeiture.
3 The
Fields Agreement states in regard to the 2% interest: ‘‘Holdings is
granting Employee a 2% restricted equity interest in Holdings subject to
Section 83 of the United States Internal Revenue Code of 1986, amended
(the ‘Code’), substantially in accordance with the provisions of Exhibit A
hereto (the ‘Equity Grant’)’’.
4 The third anniversary was September 7, 2009.
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(477) CRESCENT HOLDINGS, LLC v. COMMISSIONER 481
Petitioner did not make an election under section 83(b) to
treat his restricted interest in Crescent Holdings as substan-
tially vested.
On September 7, 2006, Duke Ventures, the Initial MS
Members, and petitioner executed an amended and restated
limited liability company agreement of Crescent Holdings,
LLC (Holdings Agreement). No priority capital contributions
were made by the members on or before September
7, 2006. The Holdings Agreement was amended by the first
amendment to amended and restated limited liability com-
pany agreement, dated effective as of September 29,
2006, and the second amendment to amended and
restated limited liability company agreement, dated
effective as of October 11, 2006. The amendments
admitted MSREF V U.S. CIP–II Co-Investment Partner-
ship-F, L.P., MSREF V U.S. CIP–II Co-Investment
Partnership-C, L.P., and MSREF V U.S. CIP–II Co-
Investment Partnership-B, L.P. as additional members to
Crescent Holdings. 5 The additional members received their
interests out of the 49% interest that the Initial MS Mem-
bers owned.
Tax Filings of Crescent Holdings
On April 17, 2007, Crescent Holdings filed Form 1065, U.S.
Return of Partnership Income, for the taxable year ended
December 31, 2006. Crescent Holdings designated Duke Ven-
tures as the tax matters partner on Form 1065. 6 Crescent
Holdings issued a Schedule K–1, Partner’s Share of Income,
Deductions, Credits, etc., to petitioner that allocated him
$423,611 of ordinary business income. Petitioner did not
receive any distributions from Crescent Holdings in 2006.
The income allocated to petitioner was calculated to rep-
resent his distributive share of Crescent Holdings’ income in
accordance with section 704.
Petitioner was surprised he received a Schedule K–1 that
allocated income to him because he believed he was not a
partner since his interest had not yet vested. Petitioner
5 We
will refer to the member group that consists of these additional
members and the Initial MS Members as MSREF.
6 Duke Ventures was also designated as the tax matters partner on Cres-
cent Holdings’ Form 1065 for the taxable year ended December 31, 2007.
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482 141 UNITED STATES TAX COURT REPORTS (477)
spoke with Wayne McGee, who was then the chief financial
officer of Crescent Resources. Wayne McGee told petitioner
that he was not a partner but noted that Crescent Holdings
had already filed Schedules K–1 and Morgan Stanley did not
want to have to file amended Schedules K–1 for all of the
partner investors in MSREF. Petitioner was told that the
matter would be corrected for the next tax year. As a result,
petitioner reported the Schedule K–1 items on his 2006 Fed-
eral income tax return, believing that the matter would be
taken care of for the next year.
On April 15, 2008, Crescent Holdings filed Form 1065 for
the 2007 tax year. Crescent Holdings issued a Schedule
K–1 to petitioner that allocated $3,608,218 of ordinary busi-
ness income to him. Petitioner did not receive any distribu-
tions from Crescent Holdings in 2007. Petitioner was shocked
to receive another Schedule K–1 because he believed that
Wayne McGee had indicated he would not receive a Schedule
K–1 for 2007. Petitioner spoke with Kevin Lambert, who was
then the chief financial officer of Crescent Resources. Kevin
Lambert then spoke with the accounting firm that had pre-
pared the Form 1065 and Schedules K–1 for Crescent
Holdings. Kevin Lambert told petitioner that the accounting
firm believed the economic substance of the transaction
indicated that petitioner was a partner. Petitioner was upset
but wanted to avoid tax penalties for not properly reporting
his income, so he reported the Schedule K–1 items on his
2007 Federal income tax return.
The income allocated to petitioner for the taxable years
2006 and 2007 was calculated to represent his distributive
shares under section 702. As a result, petitioner had to pay
the tax associated with the income allocations out of his own
pocket. Petitioner was unhappy with these substantial out-of-
pocket expenses and spoke with the management of Duke
Ventures and the board of Crescent Holdings. An agreement
was reached whereby Crescent Resources paid $1,900,040 to
petitioner on July 16, 2008, to cover the tax he paid on the
income allocations for the 2006 and 2007 taxable years. On
January 13, 2009, Crescent Resources paid $524,500 to peti-
tioner to cover his estimated tax for the 2008 taxable year. 7
7 These payments to cover petitioner’s tax were not treated by Crescent
Holdings as a partnership distribution to petitioner.
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(477) CRESCENT HOLDINGS, LLC v. COMMISSIONER 483
Bankruptcy
The financial condition of Crescent Resources began to
deteriorate in 2009 and bankruptcy was imminent. Petitioner
resigned from Crescent Resources pursuant to a letter dated
May 29, 2009, which was delivered on or before June 1, 2009,
to Kevin Lambert. Since petitioner resigned before his three-
year anniversary on September 7, 2009, his interest in Cres-
cent Holdings was forfeited. 8 In a letter addressed to the
holders of member interests in Crescent Holdings dated June
9, 2009, petitioner abandoned whatever interest he had in
Crescent Holdings. On June 10, 2009, Crescent Holdings and
Crescent Resources filed a petition under chapter 11 of the
Bankruptcy Code with the U.S. Bankruptcy Court for the
Western District of Texas (bankruptcy court).
By letter dated March 9, 2010, Crescent Holdings, through
their counsel in the chapter 11 proceeding, demanded that
petitioner repay the $2,424,540 paid to him to cover his 2006,
2007, and 2008 income tax liabilities resulting from the
allocation of his distributive shares of income. The letter
stated: ‘‘As a result of your departure, you forfeited the
potential interest upon which the Tax Advance payments
were based, along with any right to retain such payments or
have them applied to your tax liability.’’ On June 9, 2010,
Crescent Holdings and Crescent Resources filed an adversary
complaint in the bankruptcy court against petitioner to
recover the $2,424,540 of tax advance payments. The
adversary complaint stated: ‘‘Before the interest vested, how-
ever, Fields chose to terminate his employment, forfeiting
any interest in Crescent Holdings, and negating his income
tax liability arising out of the forfeited interest.’’ The credi-
tors of Crescent Holdings intervened in the bankruptcy pro-
ceeding and claimed that any repayment of the $2.4 million
was owed to them. Petitioner entered into an agreement with
the creditors whereby he agreed to: (1) immediately pay the
creditors $600,000; (2) file amended Federal income tax
returns; and (3) repay the creditors the balance of the tax
advance payments when he received refunds from his
amended returns.
8 Appendix E of the Holdings Agreement provides that if petitioner ter-
minated his employment prior to September 7, 2009, the 2% interest would
be forfeited to Crescent Holdings.
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484 141 UNITED STATES TAX COURT REPORTS (477)
Procedural History
Respondent issued an FPAA to Duke Ventures, the tax
matters partner for Crescent Holdings, for the 2006 taxable
year (2006 FPAA) and an FPAA for the 2007 taxable year
(2007 FPAA). The 2006 FPAA increased Crescent Holdings’
ordinary income by $11,177,727. The 2007 FPAA decreased
Crescent Holdings’ ordinary income by $5,999,968. 9 The
2006 and 2007 FPAAs determined that petitioner should be
treated as a partner of Crescent Holdings for purposes of
allocating partnership items. The 2006 and 2007 FPAAs were
also issued to petitioner.
Petitioners timely filed petitions disputing the determina-
tions in the 2006 and 2007 FPAAs. Duke Ventures (inter-
venor) as the tax matters partner filed a notice of election to
intervene.
OPINION
Jurisdiction
Crescent Holdings is a limited liability company with two
or more members; therefore, it is treated as a partnership
unless it elects to be treated as a corporation. See sec.
301.7701–3(b)(1)(i), Proced. & Admin. Regs. Crescent
Holdings did not elect to be treated as a corporation and thus
is treated as a partnership for Federal income tax purposes.
The substantive law with respect to the income taxation of
partners and partnerships is found in subchapter K, chapter
1, subtitle A of the Code (subchapter K). The unified audit
and litigation procedural rules applicable to partnerships and
their partners were enacted by Congress in the Tax Equity
and Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. No.
97–248, sec. 402(a), 96 Stat. at 648, and amended by Con-
gress in the Taxpayer Relief Act of 1997 (TRA 1997), Pub. L.
No. 105–34, sec. 1238, 111 Stat. at 1026. The determinations
of partnership items in partnership-level proceedings are
binding on the partners and may not be challenged in subse-
quent partner-level proceedings. See secs. 6230(c)(4), 7422(h).
Section 6226 provides for the judicial review of FPAAs.
Generally, under section 6226(f) we have jurisdiction to
9 The net effect of the 2006 and 2007 FPAAs adjustments to Crescent
Holdings’ ordinary income was an increase of $5,177,759.
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(477) CRESCENT HOLDINGS, LLC v. COMMISSIONER 485
determine all partnership items of the partnership for the
partnership taxable year to which the FPAA relates and the
proper allocation of those partnership items among the part-
ners. Our jurisdiction is not limited to the partnership items
adjusted in the FPAA. See Tigers Eye Trading, LLC v.
Commissioner, 138 T.C. 67, 95 (2012); sec. 301.6226(f)–1(a),
Proced. & Admin. Regs. Section 6231(a)(3) defines partner-
ship items as ‘‘any item required to be taken into account for
the partnership’s taxable year under any provision of subtitle
A to the extent regulations prescribed by the Secretary pro-
vide that, for purposes of this subtitle, such item is more
appropriately determined at the partnership level than at the
partner level.’’ Whether a taxpayer is a partner is a partner-
ship item if the taxpayer’s claim that he was not a partner
would affect the distributive shares of the other partners. See
Blonien v. Commissioner, 118 T.C. 541, 551–552 (2002). Sec-
tion 301.6231(a)(3)–1(a)(1)(i), Proced. & Admin. Regs., pro-
vides that a partner’s share of income and loss is more
appropriately determined at the partnership level.
The 2006 and 2007 FPAAs determined that petitioner was
a partner of Crescent Holdings for purposes of allocating
profits and losses. Petitioner claims that he was not a
partner. The allocation of profits and losses of Crescent
Holdings to petitioner, Duke Ventures, and MSREF is a part-
nership item. See sec. 6231(a)(3); sec. 301.6231(a)(3)–
1(a)(1)(i), Proced. & Admin. Regs. Accordingly, we have juris-
diction to determine whether petitioner was a partner of
Crescent Holdings and the allocation of the profits and losses
associated with the 2% interest in Crescent Holdings.
Burden of Proof
The Commissioner’s determinations in an FPAA are gen-
erally presumed correct, and a party challenging an FPAA
has the burden of proving that the Commissioner’s deter-
minations are in error. See Rule 142(a); Welch v. Helvering,
290 U.S. 111, 115 (1933); Republic Plaza Props. P’ship v.
Commissioner, 107 T.C. 94, 104 (1996). Intervenor argues
that the burden of proof is on either petitioner or respondent.
Our conclusions, however, are based on a preponderance of
the evidence, and thus the allocation of the burden of proof
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486 141 UNITED STATES TAX COURT REPORTS (477)
is immaterial. See Kimberlin v. Commissioner, 128 T.C. 163,
171 n.4 (2007).
Arguments
Petitioner’s right to the 2% interest in Crescent Holdings
never vested. Nevertheless, between the date the 2% interest
was granted to him and the date petitioner forfeited the
interest, Crescent Holdings allocated a significant amount of
income to this interest.
Petitioners argue that section 83 applies to the nonvested
2% interest in Crescent Holdings. Because petitioner’s right
to the 2% interest never vested, he was not the owner of the
interest under section 1.83–1(a)(1), Income Tax Regs. As a
result, petitioners argue that petitioner should not be allo-
cated any partnership profits or losses attributable to the
interest for the years at issue.
Intervenor argues that section 83 does not apply to the 2%
interest. Intervenor contends that petitioner’s interest was a
partnership profits interest; therefore, under Rev. Proc. 93–
27, 1993–2 C.B. 343, petitioner was liable for tax on his
share of the undistributed profits of Crescent Holdings for
the years at issue. 10
Respondent argues that Rev. Proc. 93–27 and Rev. Proc.
2001–43, 2001–2 C.B. 191, apply only to partnership profits
interests and are inapplicable to a partnership capital
interest and that petitioner’s interest in Crescent Holdings
was a capital interest. 11 Respondent argues that petitioner’s
partnership capital interest is subject to section 83 and that
since petitioner was not the owner of the interest under sec-
tion 1.83–1(a)(1), Income Tax Regs., no profit or loss should
have been allocated to him for the years at issue. 12
10 We note that intervenor does not argue that petitioner was a partner
of Crescent Holdings under sec. 761(b) and, therefore, should be allocated
partnership profits or losses.
11 Respondent does not argue that Rev. Proc. 93–27, 1993–2 C.B. 343,
and Rev. Proc. 2001–43, 2001–2 C.B. 191, are invalid. Respondent specifi-
cally limits his rationale to arguing that petitioner’s interest was a part-
nership capital interest, and thus sec. 83 applies.
12 In his answers respondent requested the Court to approve the deter-
minations made in the FPAAs. However, in his pretrial memorandum and
posttrial brief, respondent argued that petitioner is not the owner of the
2% interest in Crescent Holdings.
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(477) CRESCENT HOLDINGS, LLC v. COMMISSIONER 487
For good measure intervenor also argues that if Rev. Proc.
93–27 does not apply, then section 1.721–1(b)(1), Income Tax
Regs., and not section 83, controls; thus petitioner was the
owner of the interest.
Subchapter K and Rev. Procs. 93–27 and 2001–43
Section 721(a) provides that ‘‘[n]o gain or loss shall be rec-
ognized to a partnership or to any of its partners in the case
of a contribution of property to the partnership in exchange
for an interest in the partnership.’’ (Emphasis added.) Sec-
tion 721 applies to contributions of property; it does not
apply to contributions of services. The treatment of a part-
nership interest received in exchange for services is provided
for in section 1.721–1(b)(1), Income Tax Regs.
§ 1.721–1. Nonrecognition of gain or loss on contribution.—
* * * * * * *
(b)(1) * * * To the extent that any of the partners gives up any part
of his right to be repaid his contributions (as distinguished from a share
in partnership profits) in favor of another partner as compensation for
services * * * section 721 does not apply. The value of an interest in
such partnership capital so transferred to a partner as compensation for
services constitutes income to the partner under section 61. The amount
of such income is the fair market value of the interest in capital so
transferred, either at the time the transfer is made for past services, or
at the time the services have been rendered where the transfer is condi-
tioned on the completion of the transferee’s future services. The time
when such income is realized depends on all the facts and circumstances,
including any substantial restrictions or conditions on the compensated
partner’s right to withdraw or otherwise dispose of such interest. * * *
Section 1.721–1(b)(1), Income Tax Regs., provides that if a
partner contributes services in exchange for a capital interest
in the partnership then the nonrecognition treatment of sec-
tion 721 is not applicable. As a result, the partner must rec-
ognize the fair market value of his partnership interest in
income. ‘‘The time when such income is realized depends on
all the facts and circumstances, including any substantial
restrictions or conditions on the compensated partner’s right
to withdraw or otherwise dispose of such interest.’’ Sec.
1.721–1(b)(1), Income Tax Regs. The regulation operates as a
deferral provision in that the recognition of income may be
deferred if there are substantial restrictions on a partner’s
right to dispose of the interest. However, the regulation dif-
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488 141 UNITED STATES TAX COURT REPORTS (477)
fers from section 83 in that section 1.83–1(a)(1), Income Tax
Regs., explicitly states that the transferor of the property is
regarded as the owner of the property until the property
becomes substantially vested. Section 1.721–1(b)(1), Income
Tax Regs., is silent as to who is the owner of the property
if there are substantial restrictions on a partner’s right to
dispose of the interest.
Section 1.721–1(b)(1), Income Tax Regs., provides that the
receipt of a partnership capital interest in exchange for serv-
ices is taxable to the service provider. However, courts had
been divided over whether the receipt of a partnership profits
interest in exchange for services is taxable. See Rev. Proc.
93–27, sec. 3, 1993–2 C.B. at 343.
In July 1993 the Commissioner issued Rev. Proc. 93–27,
which stated that if a person receives a partnership profits
interest in exchange for services provided to a partnership
the Commissioner would not treat the receipt of such an
interest as a taxable event. Id. sec. 4.01, 1993–2 C.B. at 344.
Rev. Proc. 93–27 defines a profits interest as ‘‘a partnership
interest other than a capital interest.’’ Id. sec. 2.02, 1993–2
C.B. at 343. A capital interest is defined as ‘‘an interest that
would give the holder a share of the proceeds if the partner-
ship’s assets were sold at fair market value and then the pro-
ceeds were distributed in a complete liquidation of the part-
nership.’’ 13 Id. sec. 2.01.
On August 20, 2001, the Commissioner issued Rev. Proc.
2001–43. Rev. Proc. 2001–43 first clarified Rev. Proc. 93–27
by providing that the determination as to whether a partner-
ship interest is a capital interest or a profits interest is made
‘‘at the time the interest is granted, even if, at that time, the
interest is substantially nonvested (within the meaning
of § 1.83–3(b) of the Income Tax Regulations).’’ Rev. Proc.
13 The test used in Rev. Proc. 93–27 to determine whether an interest
is a capital interest is similar to the test that had been used by this Court.
See Mark IV Pictures, Inc. v. Commissioner, T.C. Memo. 1990–571, 1990
Tax Ct. Memo LEXIS 643, at *20 (‘‘Deciding whether a partner’s interest
in a partnership is a capital interest, rather than a mere profits interest,
turns on whether that partner has the ‘right to receive’ a share of the part-
nership’s assets upon a hypothetical winding up and liquidation imme-
diately following acquisition of the interest, rather than the mere right to
share in future partnership earnings or profits.’’), aff ’d, 969 F.2d 669 (8th
Cir. 1992).
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(477) CRESCENT HOLDINGS, LLC v. COMMISSIONER 489
2001–43, sec. 3, 2001–2 C.B. at 191. As pertinent to peti-
tioner and intervenor, Rev. Proc. 2001–43, sec. 4, 2001–2
C.B. at 192, states:
This revenue procedure clarifies that, for purposes of Rev. Proc. 93–
27, where a partnership grants an interest in the partnership that is
substantially nonvested to a service provider, the service provider will be
treated as receiving the interest on the date of its grant, provided that:
.01 The partnership and the service provider treat the service provider
as the owner of the partnership interest from the date of its grant and
the service provider takes into account the distributive share of partner-
ship income, gain, loss, deduction, and credit associated with that
interest in computing the service provider’s income tax liability for the
entire period during which the service provider has the interest;
.02 Upon the grant of the interest or at the time that the interest
becomes substantially vested, neither the partnership nor any of the
partners deducts any amount (as wages, compensation, or otherwise) for
the fair market value of the interest; and
.03 All other conditions of Rev. Proc. 93–27 are satisfied.
One of the conditions of Rev. Proc. 93–27 is that the partner-
ship interest must be a profits interest as opposed to a cap-
ital interest. Rev. Proc. 93–27, sec. 4.01.
Treatises have noted that Rev. Proc. 2001–43 seems to
assume that a service provider who receives a nonvested
partnership profits interest can be recognized as a partner
from the time he receives the interest. See 1 William S.
McKee et al., Federal Taxation of Partnerships and Partners,
para. 5.03, at 5–47 (4th ed. 2007). Intervenor relies on this
assumption.
Capital Interest or Profits Interest
Intervenor and respondent each argue that classifying peti-
tioner’s interest as either a partnership profits interest or a
partnership capital interest determines whether petitioner
was the owner of the interest. As a result, the first question
we must answer is whether petitioner’s interest in Crescent
Holdings was a capital interest or a profits interest for pur-
poses of applying Rev. Proc. 93–27 and Rev. Proc. 2001–43.
Rev. Proc. 93–27, sec. 2.01, provides that a ‘‘capital interest
is an interest that would give the holder a share of the pro-
ceeds if the partnership’s assets were sold at fair market
value and then the proceeds were distributed in a complete
liquidation of the partnership.’’ Rev. Proc. 93–27, sec. 2.02,
defines a profits interest as ‘‘a partnership interest other
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490 141 UNITED STATES TAX COURT REPORTS (477)
than a capital interest.’’ The determination of whether a
partnership interest is a capital interest or a profits interest
is made ‘‘at the time the interest is granted, even if, at that
time, the interest is substantially nonvested (within the
meaning of § 1.83–3(b)’’. Rev. Proc. 2001–43, sec. 3, 2001–2
C.B. at 191. Petitioner was granted his interest on Sep-
tember 7, 2006.
Respondent argues that petitioner received a capital
interest in Crescent Holdings. Intervenor argues that peti-
tioner received a profits interest. Both intervenor and
respondent point to the Holdings Agreement to support their
respective positions. We look to the Holdings Agreement to
determine if petitioner would have received a share of the
proceeds in a hypothetical liquidation of Crescent Holdings
on September 7, 2006. See Mark IV Pictures, Inc. v. Commis-
sioner, T.C. Memo. 1990–571, 1990 Tax Ct. Memo LEXIS
643, at *20-*21 (reviewing the articles of limited partnership
to determine if the taxpayer had a capital interest), aff ’d,
969 F.2d 669 (8th Cir. 1992).
Section 9 of Appendix E to the Holdings Agreement states
that petitioner’s interest in Crescent Holdings shall be sub-
ject to all the terms and conditions of the Holdings Agree-
ment. Section 4 of Appendix E states ‘‘Arthur W. Fields shall
be entitled to participate, from time to time, in distributions
from the Company to its Members in proportion to his
Percentage Interest’’. Appendix A defines percentage interest
as ‘‘the percentage set forth on Exhibit A’’. Exhibit A states
that petitioner has an initial percentage interest of 2%.
Exhibit A of the Fields Agreement states that petitioner’s
entitlement to distributions is the ‘‘[s]ame as all other
holders of the issued and outstanding membership interests’’.
Section 4 of Appendix E to the Holdings Agreement provides
that distributions petitioner receives are not subject to for-
feiture.
Section 12.02 of the Holdings Agreement provides rules for
the dissolution of Crescent Holdings. Section 12.02(c)(i) pro-
vides that the proceeds of the sale of Crescent Holdings and
its assets shall be distributed in the following order of pri-
ority: (1) the satisfaction of the debts and liabilities of Cres-
cent Holdings; (2) the satisfaction of the expenses of liquida-
tion; and (3) the setting up of a reserve for contingent liabil-
ities. Section 12.02(c)(ii) provides that if there is a balance
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(477) CRESCENT HOLDINGS, LLC v. COMMISSIONER 491
remaining after distributions to satisfy section 12.02(c)(i),
then the balance shall be distributed to the members in
accordance with section 6.03.
Section 6.03 of the Holdings Agreement is entitled ‘‘Dis-
tributions in Liquidation.’’ Section 6.03 provides that upon
the dissolution of Crescent Holdings ‘‘the proceeds of sale and
other assets of the Company distributable to the Members
under section 12.02(c)(ii) shall be distributed * * * to the
Members in accordance with Section 6.02.’’
Section 6.02 of the Holdings Agreement is entitled ‘‘Dis-
tributions.’’ Section 6.02(a) states ‘‘[e]xcept as provided in
Section 6.03 and subject to * * * the provisions of section
6.02(c) * * * the Executive Committee shall have the sole
authority to approve the making of distributions to the Mem-
bers’’. Section 6.02(a) states ‘‘[a]ll distributions made in
accordance with the terms of this Section 6.02 shall be made
in the following order of priority:’’ (1) each member shall
receive a distribution in the amount of its priority capital
contributions and a 20% cumulative annual preferred return
thereon; and (2) ‘‘[t]hereafter, any remaining amount shall be
distributed to the Members in proportion to their then cur-
rent Percentage Interests at the time of such distribution.’’
Appendix A of the Holdings Agreement defines priority
capital contributions as any capital contribution made by a
member pursuant to section 4.02. Section 4.02 provides that
the members of Crescent Holdings may be requested to make
additional capital contributions. In his opening brief
respondent requested as a proposed fact that no priority cap-
ital contributions were made to Crescent Holdings on or
before September 7, 2006. Intervenor did not object to this
proposed fact; and nothing in the record indicates that a pri-
ority capital contribution was made on or before September
7, 2006. Therefore, we find that no priority capital contribu-
tions were made on or before September 7, 2006.
Section 6.02(a) of the Holdings Agreement indicates that,
absent priority capital contributions, the members are enti-
tled to receive a liquidation distribution equal to their
percentage interest. At the time of formation, petitioner had
an initial percentage interest of 2%. Therefore, respondent
argues that petitioner would have received 2% of the dis-
tributions from the proceeds of a hypothetical liquidation on
September 7, 2006. Respondent in his opening brief describes
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492 141 UNITED STATES TAX COURT REPORTS (477)
the above-mentioned sections of the Holdings Agreement and
concludes that since petitioner would have received a dis-
tribution from a hypothetical liquidation on September 7,
2006, then petitioner’s interest was a capital interest as
defined by Rev. Proc. 93–27.
Intervenor disagrees. Intervenor notes that petitioner did
not contribute any money to receive his interest and he was
not credited with a beginning capital account balance. Inter-
venor summarily argues that if Crescent Holdings had liq-
uidated on September 7, 2006, petitioner would not have had
a balance in his capital account and, therefore, would not
have received a distribution under section 6.02(c) of the
Holdings Agreement.
Section 6.02(c) of the Holdings Agreement states: ‘‘The
Members acknowledge and agree that, unless the Executive
Committee determines otherwise and except as otherwise
provided in Section 6.8(d) of the Formation Agreement, the
Company shall make annual distributions’’. 14 Section 6.02(c)
then provides that the amount of the annual distributions
will be the lesser of: (1) the maximum amount permitted
under the Delaware Limited Liability Company Act and
under loan and other credit agreements; and (2) an amount
that is based on the unreturned capital of Crescent Holdings
and priority capital contributions. 15 Intervenor does not
elaborate or explain why it believes section 6.02(c) would pre-
vent petitioner from receiving a distribution in a hypothetical
liquidation on September 7, 2006.
Intervenor’s reliance on section 6.02(c) is inapposite. Sec-
tion 6.02(c) determines only the amount of the total distribu-
tion to all members. Section 6.02(c)(v) states ‘‘the Executive
Committee shall authorize for distribution to the Members in
accordance with Section 6.02(a) an aggregate amount ’’. 16
(Emphasis added.) Section 6.02(a) determines to whom the
distribution is made from this aggregate amount. Section
6.02(a) clearly states that after an amount is distributed for
14 Sec. 6.02(c) provides that the annual distribution is made every fiscal
year as soon as practicable following the end of the fiscal year.
15 There were no priority capital contributions on or before September 7,
2006. Therefore, a hypothetical liquidation distribution would be based on
the unreturned capital.
16 Sec. 6.02 indicates that the aggregate amount is the total amount that
is available as an annual distribution to the members.
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(477) CRESCENT HOLDINGS, LLC v. COMMISSIONER 493
the return of priority capital contributions, ‘‘the remaining
amount shall be distributed to the Members in proportion to
their current Percentage Interests at the time of such dis-
tribution.’’ Section 6.02(a) does not limit the remaining
amount of the distribution to members that have contributed
capital to Crescent Holdings. In fact, section 4 of Appendix
E specifically provides that petitioner is entitled to distribu-
tions from Crescent Holdings in proportion to his percentage
interest and that any distributions he receives are not sub-
ject to forfeiture. Furthermore, Exhibit A to the Fields Agree-
ment also provides that petitioner’s entitlement to distribu-
tions is the same as other members. Intervenor’s argument
that section 6.02(c) prevents petitioner from receiving a dis-
tribution is contradicted by section 6.02(a) of the Holdings
Agreement, Section 4 of Appendix E, and Exhibit A to the
Fields Agreement.
Intervenor’s argument also fails because Appendix A of the
Holdings Agreement defines unreturned capital in terms of
the unreturned capital of Crescent Holdings, not in terms of
the individual members. Section 6.02(c) determines the
amount of the distribution, which is, in part, based on
unreturned capital. However, Appendix A clearly defines
unreturned capital in terms of the unreturned capital of
Crescent Holdings. This amount is then distributed to the
members in accordance with section 6.02(a). Therefore, inter-
venor’s reliance on the term ‘‘unreturned capital’’ in deter-
mining the amount of the distribution to an individual
member is misplaced.
The Holdings Agreement indicates that if Crescent
Holdings had liquidated on September 7, 2006, petitioner
would have received a share of the proceeds. 17 Accordingly,
we hold that petitioner’s interest in Crescent Holdings would
have entitled him to receive a distribution if Crescent
Holdings had liquidated on September 7, 2006. As a result,
17 Appendix
E of the Holdings Agreement provides that if petitioner died,
became disabled, was terminated, or there was a certain change in control
of Crescent Holdings, then he would immediately vest in the 2% interest.
We note that allowing petitioner to receive a distribution if Crescent Hold-
ings liquidated is consistent with Appendix E, which essentially provides
that if, through no initiative of his own, petitioner could not fulfill his ten-
ure as chief executive officer, he would immediately vest in the 2% inter-
est.
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494 141 UNITED STATES TAX COURT REPORTS (477)
petitioner’s interest in Crescent Holdings is a capital interest
as defined by Rev. Proc. 93–27. 18 Therefore, we hold that
Rev. Proc. 2001–43 and Rev. Proc. 93–27 are not applicable
to our analysis in determining whether petitioner should rec-
ognize in income the partnership profits and losses allocated
to the 2% interest.
Provisions Governing a Nonvested Partnership Capital
Interest
Petitioners and respondent argue that section 1.83–1(a)(1),
Income Tax Regs., provides that petitioner was not the owner
of the interest for purposes of income recognition. Intervenor
argues that section 1.721–1(b)(1), Income Tax Regs., provides
that petitioner was the owner. We must first decide whether
section 83 applies to the transfer of a partnership capital
interest in exchange for services.
Section 83
Section 83(a) generally provides that where property is
transferred to a taxpayer in connection with the performance
of services, the fair market value of the property, less the
amount paid for the property, shall be included in the tax-
payer’s gross income in the first taxable year in which the
taxpayer’s rights in the property are ‘‘transferable or are not
subject to a substantial risk of forfeiture’’. Section 83(a) is a
deferral provision that allows a taxpayer to defer recognition
of income to the taxable year in which his interest in the
property is transferable or no longer subject to a substantial
risk of forfeiture. 19
Section 1.83–1(a)(1), Income Tax Regs., provides that
‘‘[u]ntil such property becomes substantially vested, the
18 Since we find that petitioner’s interest is a capital interest, we need
not decide whether sec. 83 applies to partnership profit interests.
19 Sec. 83(a) deferral treatment is not mandatory. Sec. 83(b) allows a tax-
payer to elect out of the sec. 83(a) deferral and recognize the fair market
value of the property, less any amount paid for the property, as gross in-
come in the taxable year the property is transferred. The taxpayer must
elect this treatment by filing an election with the Commissioner no later
than 30 days after the date of the transfer. Sec. 83(b)(2). If an election is
not made under sec. 83(b), then a taxpayer will recognize the income under
sec. 83(a). Petitioner did not file a sec. 83(b) election. Therefore, the 2%
interest will be subject to sec. 83(a) treatment if sec. 83 is applicable to
the 2% interest.
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(477) CRESCENT HOLDINGS, LLC v. COMMISSIONER 495
transferor shall be regarded as the owner of such property’’.
Section 1.83–3(b), Income Tax Regs., provides that
‘‘[p]roperty is substantially vested for such purposes when it
is either transferable or not subject to a substantial risk of
forfeiture.’’ As a result, for income recognition purposes the
transferor of the property is regarded as the owner of the
property until the property becomes substantially vested.
This Court has held that a partnership capital interest is
property for purposes of section 83. See, e.g., Larson v.
Commissioner, T.C. Memo. 1988–387, 1988 Tax Ct. Memo
LEXIS 418, at *7 (‘‘Under section 83, a compensatory
transfer of a partnership capital interest results in taxable
income to the transferee to the extent that the fair market
value of the interest exceeds the amount paid for the
interest, in the year that the rights to the interest are
transferable or not subject to a substantial risk of for-
feiture.’’). 20 These cases did not discuss who owned the part-
nership capital interest prior to it becoming substantially
vested, however, in these cases the Court applied section 83
to determine the taxable year in which the transferee would
recognize income.
In Hensel Phelps Constr. Co. v. Commissioner, 74 T.C. 939
(1980), aff ’d, 703 F.2d 485 (10th Cir. 1983), the taxpayer
agreed to construct an office building in exchange for a 50%
capital interest in a partnership. Id. at 947–948. The primary
issue in Hensel Phelps was whether the taxpayer received its
partnership interest in 1973 or 1974. Id. at 947. The Court
stated that the performance of services in exchange for a
partnership capital interest was a taxable event under sec-
tion 61, citing section 1.721–1(b)(1), Income Tax Regs., for
support. Id. The Court found as a fact that the taxpayer
received its partnership interest in 1974 and held that under
section 1.721–1(b)(1), Income Tax Regs., the taxpayer
realized taxable income in 1974. Id. at 948. However, the
Court noted that even if the taxpayer had received its part-
nership interest in 1973, at that time the interest would
have been ‘‘nontransferable within the meaning of section
83(c)(2).’’ Id. at 953. It was not until 1974 that the taxpayer’s
interest was transferable or not subject to a substantial risk
20 We have also held that sec. 83 applies to options to purchase partner-
ship units. See Schulman v. Commissioner, 93 T.C. 623, 631–635 (1989).
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496 141 UNITED STATES TAX COURT REPORTS (477)
of forfeiture within the meaning of section 83(c). Id. ‘‘Con-
sequently, pursuant to section 83, the taxable event occurred
during * * * 1974’’. Id.
In Mark IV Pictures, Inc. v. Commissioner, 1990 Tax Ct.
Memo LEXIS 643, at *21, the taxpayers received capital
interests in limited partnerships in exchange for services.
The Court noted that section 1.721–1(b)(1), Income Tax
Regs., provides for the amount of the income to be recognized
under section 61. Id. at *21-*22. The taxpayers argued that
their capital interests were subject to a substantial risk of
forfeiture and thus section 83 precluded the recognition of
income for the years at issue. The Court analyzed the capital
interests under section 83 and determined that the ‘‘interests
were freely transferable and not subject to substantial risk of
forfeiture.’’ Id. at *24.
Hensel Phelps Constr. Co. and Mark IV Pictures, Inc. held
that section 1.721–1(b)(1), Income Tax Regs., requires income
to be realized under section 61 when a partnership capital
interest is received in exchange for services. However, these
cases provide that section 83 governs the timing of when to
recognize income from the receipt of a partnership capital
interest subject to a substantial risk of forfeiture.
In Campbell v. Commissioner, T.C. Memo. 1990–162, 1990
Tax Ct. Memo LEXIS 144, at *52-*53, aff ’d in part, rev’d in
part, 943 F.2d 815 (8th Cir. 1991), the taxpayer received
partnership profit interests in exchange for services. The
Court noted that under State law and the Uniform Limited
Partnership Act any partnership interest is personal prop-
erty. Id. at *64. The Court held that partnership capital
interests and profit interests are personal property and ‘‘are
literally within the terms of section 83.’’ Id. at *65. As a
result, the Court concluded that the taxpayer’s partnership
profit interests were property within the meaning of section
83 and should have been included in income under section
83. Id. at *64-*67, *78.
On appeal the Court of Appeals for the Eighth Circuit
noted that ‘‘some question exists as to the applicability of
section 83 to a service partner’s receipt of a profits interest.
* * * Arguably, the section 1.721–1(b)(1) distinction between
capital and profits interests and the regulations under sec-
tion 83 create the implication that a profits interest is not
property subject to section 83.’’ Campbell v. Commissioner,
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(477) CRESCENT HOLDINGS, LLC v. COMMISSIONER 497
943 F.2d at 821 n.7. 21 As pertinent to this case, the court
then stated that a partnership capital interest was an
interest in intangible personal property; therefore, ‘‘the
receipt of a capital interest appears to be taxable under the
authority of section 83 of the Internal Revenue Code.’’ Id. at
820. The Court of Appeals reversed the Tax Court’s decision
because it found that the taxpayer’s partnership profits
interests did not have a fair market value at the time he
received them; therefore, the taxpayer did not have income.
Id. at 823.
In these opinions the Tax Court and the Court of Appeals
for the Eighth Circuit have indicated that section 83 applies
to partnership capital interests. Respondent cited the above-
mentioned opinions, except for Campbell, in his opening
brief. Intervenor did not discuss these cases nor cite any case
where the Court held that section 83 was not applicable to
a partnership capital interest.
Instead, intervenor argues that sections 1.83–1(a)(1) and
1.721–1(b)(1), Income Tax Regs., are in conflict. Intervenor
notes that section 1.83–1(a)(1), Income Tax Regs., includes
the statement ‘‘[u]ntil such property becomes substantially
vested, the transferor shall be regarded as the owner of such
property,’’ whereas section 1.721–1(b)(1), Income Tax Regs.,
does not include any statement regarding who is to be
regarded as the owner of the property before it becomes
substantially vested. Intervenor argues the absence of this
language in section 1.721–1(b)(1), Income Tax Regs.,
indicates that the transferee should be considered the owner
of the partnership interest before it becomes substantially
vested. Intervenor argues that the Court should apply section
1.721–1(b)(1), Income Tax Regs., because it specifically
applies to the transfer of an interest in partnership capital
as compensation for services whereas section 83 and section
1.83–1(a)(1), Income Tax Regs., are general provisions that
do not even mention partnerships.
Intervenor cites no cases to support this argument. As we
have previously noted, this Court has held that a partnership
capital interest is property for purposes of section 83. See
21 We have found that petitioner’s interest in Crescent Holdings was a
capital interest. Therefore, we do not need to decide whether sec. 83 ap-
plies to a partnership profits interest.
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498 141 UNITED STATES TAX COURT REPORTS (477)
Larson v. Commissioner, 1988 Tax Ct. Memo LEXIS 418, at
*7.
Intervenor argues that section 83 does not apply to a
transfer of partnership capital interests in exchange for serv-
ices because section 83 and its legislative history do not state
that section 83 applies to partnerships or even mention part-
nerships. It is true that section 83 and its legislative history
do not mention partnerships. However, a statement that sec-
tion 83 applies to partnerships is not necessary because sec-
tion 83(a) explicitly states: ‘‘If, in connection with the
performance of services, property is transferred to any per-
son’’. (Emphasis added.) Section 83 uses the term ‘‘property’’,
which is broad. Section 1.83–3(e), Income Tax Regs., provides
that ‘‘[f]or purposes of section 83 and the regulations there-
under, the term ‘property’ includes real and personal prop-
erty other than either money or an unfunded and unsecured
promise to pay money or property in the future.’’ 22 Crescent
Holdings is a Delaware limited liability company. Del. Code
Ann. tit. 6, sec. 18–701 (2005) states that a ‘‘limited liability
company interest is personal property.’’ 23 The Delaware
statute classifying petitioner’s interest in Crescent Holdings
as personal property means petitioner’s interest is ‘‘literally
within the terms of section 83.’’ Campbell v. Commissioner,
1990 Tax Ct. Memo LEXIS 144, at *64-*65 (noting that
under State law a partnership capital interest was personal
property and was therefore property for purposes of section
83).
Intervenor argues that the discussion of restricted stock
plans in H.R. Rept. No. 91–413, at 86 (1969), 1969–3 C.B.
(Part 1) 200, 254, indicates that Congress did not intend sec-
tion 83 to apply to partnerships. However, further review of
the legislative history to section 83 shows that H.R. Conf.
Rept. No. 91–782, at 303 (1969), 1969–3 C.B. 644, 659, states
‘‘[t]he House bill provides that a person who receives com-
pensation in the form of property, such as stock’’. (Emphasis
22 We note that proposed regulations issued on May 24, 2005, ‘‘provide
that a partnership interest is property within the meaning of section 83,
and that the transfer of a partnership interest in connection with the per-
formance of services is subject to section 83.’’ 70 Fed. Reg. 29676 (May 24,
2005).
23 In fact, sec. 5.03 of the Holdings Agreement also provides that the ‘‘in-
terests of all Members in the Company are personal property.’’
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(477) CRESCENT HOLDINGS, LLC v. COMMISSIONER 499
added.) The use of the phrase ‘‘property, such as stock’’ in
H.R. Conf. Rept. No. 91–782 indicates that Congress
intended that stock is merely one of the types of property
section 83 applies to, not the only type of property subject to
section 83. See also Montelepre Systemed, Inc. v. Commis-
sioner, T.C. Memo. 1991–46, 1991 Tax Ct. Memo LEXIS 65,
at *11 (‘‘It is clear, however, that Congress intended section
83 to apply to all restricted ‘property,’ not just stock.’’), aff ’d,
956 F.2d 496 (5th Cir. 1992). This is further evidenced by the
fact that the discussions of section 83 in H.R. Rept. No. 91–
413 and H.R. Conf. Rept. No. 91–782 are both subtitled
‘‘Restricted Property’’, not restricted stock. 24
Regardless of Congress’ intention that intervenor attempts
to glean from the legislative history, the language of section
83, enacted by Congress, is clear: section 83 applies to prop-
erty. ‘‘Indeed, if Congress intended section 83(a) to apply
solely to restricted stock used to compensate employees, it
could have used much narrower language. Instead, Congress
made section 83(a) applicable to all restricted ‘property,’ not
just stock; to property transferred to ‘any person,’ not just
employees’’. Alves v. Commissioner, 734 F.2d 478, 481–482
(9th Cir. 1984), aff ’g 79 T.C. 864 (1982). Intervenor’s search
through the legislative history to find what Congress did and
did not intend section 83 to apply to is misdirected. Limita-
tions to the applicability of section 83 are found in section
83(e). 25 None of the limitations found in section 83(e) apply
24 Further
support is found in a comment made in the Senate Finance
Committee’s report concerning the enactment of sec. 707(a)(2): ‘‘if a part-
ner received an interest in a partnership in exchange for services, he may
recognize income upon that receipt. See sections 61 and 83’’. S. Comm. on
Finance, Deficit Reduction Act of 1984, Explanation of Provisions Approved
by the Committee on March 21, 1984, S. Prt. 98–169 (Vol. 1), at 226 n.4
(S. Comm. Print 1984).
25 SEC. 83(e). APPLICABILITY OF SECTION.—This section shall not apply
to—
(1) a transaction to which section 421 applies,
(2) a transfer to or from a trust described in section 401(a) or a
transfer under an annuity plan which meets the requirements of
section 404(a)(2),
(3) the transfer of an option without a readily ascertainable fair
market value,
(4) the transfer of property pursuant to the exercise of an option
with a readily ascertainable fair market value at the date of grant,
Continued
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500 141 UNITED STATES TAX COURT REPORTS (477)
to the instant case. ‘‘We have held that section 83 should be
given broad application so as to cover transfers not specifi-
cally excepted.’’ Montelepre Systemed, Inc. v. Commissioner,
1991 Tax Ct. Memo LEXIS 65, at *17.
Section 83 governs the timing of income recognition when
property is transferred in exchange for services. Section 721
provides that the contribution of property to a partnership in
exchange for an interest in the partnership is a nonrecogni-
tion event for the partner and partnership. Section 83 does
not conflict with section 721.
We have previously applied section 83 to partnership cap-
ital interests. See Larson v. Commissioner, 1988 Tax Ct.
Memo LEXIS 418, at *7; see also Schulman v. Commissioner,
93 T.C. 623, 631–635 (1989) (section 83 applies to options to
purchase partnership units). Nothing in the language of sec-
tion 83 or its legislative history indicates that Congress did
not intend for section 83 to apply to partnerships. Accord-
ingly, we hold that section 83 applies to the transfer of a
partnership capital interest in exchange for the performance
of services.
Allocation of Undistributed Partnership Income
Section 1.83–1(a)(1), Income Tax Regs., states that ‘‘any
income from such property received by the employee or inde-
pendent contractor (or beneficiary thereof) or the right to the
use of such property by the employee or independent con-
tractor constitutes additional compensation and shall be
included in the gross income of such employee or inde-
pendent contractor for the taxable year in which such income
is received or such use is made available.’’ As a result, if the
transferee receives an actual distribution of income from the
property before his right is substantially vested, then this
income is treated as additional compensation and the trans-
feree must include it in his gross income in the year
received. 26 Section 1.83–1(a)(1), Income Tax Regs., creates a
dichotomy for ownership between the property and income
actually received from the property: it treats income the
or
(5) group-term life insurance to which section 79 applies.
26 We
note that petitioner did not receive any actual distributions with
regard to the 2% interest in Crescent Holdings.
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(477) CRESCENT HOLDINGS, LLC v. COMMISSIONER 501
transferee actually received from the property as owned by
the transferee and treats property that is not substantially
vested as owned by the transferor.
In addition to the dichotomy created by section 1.83–
1(a)(1), Income Tax Regs., between property and income
received by the transferee, there exists another stream of
potential income recognition—income attributable to property
(such as a partnership interest) but not actually distributed.
Section 83 does not specifically address whether recognition
of undistributed income attributable to the property is also
deferred. Similarly, section 1.83–1(a)(1), Income Tax Regs.,
does not address whether income attributable to the prop-
erty, but not actually received by the transferee, is included
in the gross income of the transferee or the transferor. Par-
ticular to this case, section 1.83–1(a)(1), Income Tax Regs., is
silent as to whether the distributive share of partnership
income attributable to the nonvested 2% partnership interest
is included in the income of the transferor or the transferee
(petitioner).
Petitioners and respondent argue that section 1.83–1(a)(1),
Income Tax Regs., provides that petitioner was not the owner
of the 2% interest for purposes of income recognition. There-
fore, they argue that petitioner should not have been allo-
cated any of the partnership profits or losses attributable to
the 2% interest. In its opening brief intervenor notes that if
this regulation applies to the 2% interest, then petitioner
would not be treated as the owner of the interest for income
recognition purposes until the interest is substantially
vested. However, intervenor argues that section 1.83–
1(a)(1), Income Tax Regs., is in conflict with section
1.721–1(b)(1), Income Tax Regs. Intervenor argues that sec-
tion 1.721–1(b)(1), Income Tax Regs., applies to the 2%
interest; therefore, petitioner should be allocated the partner-
ship profits and losses attributable to the 2% interest. This
appears to be an issue of first impression as no case has
specifically decided whether the transferor or the transferee
of a nonvested partnership capital interest must include in
gross income the undistributed partnership profit or loss
allocations attributable to the partnership capital interest.
Section 1.83–1(a)(1), Income Tax Regs., states ‘‘[u]ntil such
property becomes substantially vested, the transferor shall
be regarded as the owner of such property’’. The regulation
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502 141 UNITED STATES TAX COURT REPORTS (477)
also provides that any income actually received by the trans-
feree from the property constitutes additional compensation
and is included in the gross income of the transferee. How-
ever, the regulation does not address whether income attrib-
utable to the property, but not actually received by the trans-
feree, is included in the gross income of the transferee or the
transferor. Although neither section 83 nor section 1.83–
1(a)(1), Income Tax Regs., specifically addresses this issue,
for the reasons below we hold that the transferor of a part-
nership capital interest must recognize in income the undis-
tributed partnership profit or loss allocations attributable to
a nonvested capital interest.
(1) The Purpose of Section 83 Is To Defer Recognition of
Income When Property Is Subject to a Substantial Risk
of Forfeiture.
Section 83 is a deferral provision that delays the recogni-
tion of income to the taxable year in which the transferee’s
interest in the property is either transferable or not subject
to a substantial risk of forfeiture. The policy underpinning
section 83 is that it would be unfair to require a taxpayer to
recognize the fair market value of property in income if the
taxpayer may never own the property.
‘‘The rights of a person in property are subject to a
substantial risk of forfeiture if such person’s rights to full
enjoyment of such property are conditioned upon the future
performance of substantial services by any individual.’’ Sec.
83(c)(1); see also sec. 1.83–3(c), Income Tax Regs. When Cres-
cent Holdings was formed, petitioner was the president and
chief executive officer of Crescent Resources. Crescent
Resources was to become the primary asset of Crescent
Holdings. Exhibit A to the Fields Agreement stated that the
2% interest would be forfeited if petitioner terminated his
employment with Crescent Resources before September 7,
2009. Therefore, the 2% interest was conditioned upon peti-
tioner’s future performance of substantial services. As a
result, the 2% interest was subject to a substantial risk of
forfeiture. See sec. 83(c)(1); sec. 1.83–3(c)(1), Income Tax
Regs.
‘‘[T]he rights of a person in property are transferable if
such person can transfer any interest in the property to any
person other than the transferor of the property, but only if
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(477) CRESCENT HOLDINGS, LLC v. COMMISSIONER 503
the rights in such property of such transferee are not subject
to a substantial risk of forfeiture.’’ Sec. 1.83–3(d), Income Tax
Regs. Exhibit A to the Fields Agreement states that peti-
tioner’s ‘‘[i]nterests are nontransferable unless and until for-
feiture restrictions shall have lapsed’’. Petitioner resigned
from his position at Crescent Resources before the forfeiture
restrictions lapsed. As a result, the 2% interest never became
transferable under section 1.83–3(d), Income Tax Regs.
Under section 83(a) petitioner did not recognize the fair
market value of the 2% interest as income because this
interest never vested.
Petitioner’s right to receive the undistributed income
allocations attributable to the 2% interest was subject to the
same substantial risk of forfeiture as his right to the 2%
interest. If petitioner forfeited his right to the 2% interest,
then he would also forfeit his right to receive any benefit
from the undistributed income allocations. In other words,
petitioner’s right to eventually receive any benefit from the
undistributed income allocations was entirely dependent on
whether his right vested in the 2% interest. When petitioner
resigned from his position with Crescent Resources, he for-
feited his right to the 2% interest, which resulted in him
losing any rights he would have had to the undistributed
income attributable to the 2% interest. Therefore, we find
that the undistributed income allocations were subject to the
same substantial risk of forfeiture as the 2% interest in Cres-
cent Holdings. The 2% interest was not recognized in peti-
tioner’s income because it was subject to a substantial risk
of forfeiture. Consistency requires that the undistributed
partnership income allocations attributable to the 2%
interest, which were subject to the same risk of forfeiture,
should also not be recognized in petitioner’s income.
If petitioner had continued his employment with Crescent
Resources until September 7, 2009, then his interest would
have vested. If this had occurred, then under section 83(a)
petitioner would have recognized the fair market value of his
partnership interest in gross income in the 2009 taxable
year. The fair market value of the interest is measured at
the time the property becomes substantially vested, which
would have been on September 7, 2009. See sec. 83(a); sec.
1.83–1(a)(1), Income Tax Regs. The fair market value of peti-
tioner’s interest on September 7, 2009, would have been
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504 141 UNITED STATES TAX COURT REPORTS (477)
enhanced by income allocable to his interest for which no dis-
tributions had yet been paid.
Since petitioner forfeited his right to the 2% interest before
it substantially vested, he never owned the interest. Peti-
tioner never received any of the economic benefits from the
undistributed partnership income allocations to the 2%
interest. Requiring petitioner to recognize the partnership
allocations in his income is inconsistent with the fact that he
received no economic benefit from the allocations. 27 When
petitioner’s interest was forfeited to Crescent Holdings, his
right to the 2% interest and to receive any benefit from the
partnership income allocations reverted to Crescent
Holdings. 28 As a result, Crescent Holdings became equally
owned by Duke Ventures and MSREF. The remaining part-
ners, Duke Ventures and MSREF, received any economic
benefits attributable to the undistributed income allocations.
(2) Section 1.83–1(a)(1), Income Tax Regs., Does Not Con-
flict With Section 1.721–1(b)(1), Income Tax Regs.
Intervenor argues that section 1.83–1(a)(1), Income Tax
Regs., conflicts with section 1.721–1(b)(1), Income Tax Regs.,
and since section 1.721–1(b)(1), Income Tax Regs., specifi-
cally applies to partnerships we should apply that regulation
to determine who should be allocated the partnership profits
and losses attributable to the 2% interest.
Section 721(a) provides that ‘‘[n]o gain or loss shall be rec-
ognized to a partnership or to any of its partners in the case
of a contribution of property to the partnership in exchange
for an interest in the partnership.’’ (Emphasis added.) Sec-
27 We note that Crescent Holdings filed an adversary complaint in the
bankruptcy court against petitioner, which stated ‘‘Fields chose to termi-
nate his employment, forfeiting any interest in Crescent Holdings, and ne-
gating his income tax liability arising out of the forfeited interest.’’ The ad-
versary complaint eventually resulted in petitioner paying $600,000 to the
creditors of Crescent Holdings and promising to pay the remainder when
he received refunds from the filing of amended returns for the years at
issue. It is inconsistent for intervenor to have argued to the bankruptcy
court that petitioner’s tax liability for the allocations to his forfeited inter-
est was negated and then argue to this Court that petitioner should be lia-
ble to pay tax on the income allocated to his forfeited interest.
28 Appendix E of the Holdings Agreement provides that if petitioner ter-
minates his employment prior to September 7, 2009, his interest would be
forfeited to Crescent Holdings.
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(477) CRESCENT HOLDINGS, LLC v. COMMISSIONER 505
tion 721 applies to contributions of property; it does not
apply to contributions of services. Section 1.721–1(b)(1),
Income Tax Regs., provides that the nonrecognition treat-
ment for contributions of property to a partnership provided
by section 721 does not apply to contributions of services. In
other words, the regulation requires the service provider to
recognize as income the fair market value of his partnership
capital interest. Section 1.721–1(b)(1), Income Tax Regs., also
states that the ‘‘time when such income is realized depends
on all the facts and circumstances, including any substantial
restrictions or conditions on the compensated partner’s right
to withdraw or otherwise dispose of such interest.’’ This regu-
lation provides no statements regarding who is treated as the
owner of the partnership capital interest prior to the capital
interest becoming substantially vested. As a result, the provi-
sion in section 1.83–1(a)(1), Income Tax Regs., providing that
the transferor of the property is treated as the owner of the
property until it becomes substantially vested, does not con-
flict with section 1.721–1(b)(1), Income Tax Regs., or with
section 721.
We hold that under section 1.83–1(a)(1), Income Tax Regs.,
undistributed partnership allocations attributable to a non-
vested partnership capital interest are to be recognized in
the gross income of the transferor. 29
Identity of the Transferor
Section 1.83–1(a)(1), Income Tax Regs., provides that the
transferor of petitioner’s interest in Crescent Holdings will be
treated as the owner of petitioner’s interest. We must first
determine who the transferor was in order to determine who
is allocated the profits and losses associated with petitioner’s
2% interest for the years at issue.
Respondent argues that Duke Ventures was the transferor
and thus petitioner’s 2% interest in Crescent Holdings should
29 Petitioner
also argues that Crescent Holdings and intervenor should
be judicially estopped from asserting that petitioner should be allocated
the undistributed partnership profits or losses because in the adversary
complaint filed in the bankruptcy court Crescent Holdings argued that be-
cause petitioner forfeited his interest his income tax liability arising out
of the forfeited interest was negated. Since we hold that petitioner should
not be allocated any of the undistributed partnership profits and losses at-
tributable to the 2% interest, we need not address this argument.
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506 141 UNITED STATES TAX COURT REPORTS (477)
be allocated solely to Duke Ventures. In the alternative,
respondent argues that if we find that Crescent Holdings was
the transferor then petitioner’s 2% interest should be allo-
cated proportionally between Duke Ventures and MSREF.
Intervenor argues that Crescent Holdings was the transferor,
therefore, petitioner’s interest should be allocated on a pro
rata basis to Duke Ventures and MSREF. Petitioner takes no
position as to how the 2% interest should be allocated.
Pursuant to section 2.2(a) of the Formation Agreement
Duke Ventures contributed 100% of its interest in Crescent
Resources to Crescent Holdings in exchange for 100% of the
member interest in Crescent Holdings. In accordance with
section 2.2(b) Crescent Holdings issued additional member
interests to petitioner such that the Crescent Holdings
member interests were held 98% by Duke Ventures and 2%
by petitioner. Pursuant to section 2.2(d), Duke Ventures sold
49% of the member interest in Crescent Holdings to the Ini-
tial MS Members.
Section 2.2 of the Formation Agreement clearly provides
that Crescent Holdings was the transferor of petitioner’s 2%
interest in Crescent Holdings. Both respondent and inter-
venor agree that if Crescent Holdings was the transferor of
petitioner’s 2% interest, then the partnership profits and
losses associated with the 2% interest for the years at issue
should be allocated on a pro rata basis to Duke Ventures and
MSREF. Furthermore, the 2% interest was forfeited to Cres-
cent Holdings, which in turn was owned by Duke Ventures
and MSREF. Therefore, Duke Ventures and MSREF will
both receive any of the economic benefits attributable to the
2% interest. We hold that the partnership items, profits and
losses and the FPAA income adjustments associated with the
2% interest in Crescent Holdings for the years at issue
should be allocated on a pro rata basis to Duke Ventures and
MSREF.
Conclusion
Petitioner should not be regarded as the owner of the 2%
interest in Crescent Holdings for the years at issue. As a
result, petitioner should not have been allocated any partner-
ship profits or losses for the years at issue. Instead, the part-
nership profits or losses associated with the 2% interest
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(477) CRESCENT HOLDINGS, LLC v. COMMISSIONER 507
should be allocated on a pro rata basis to Duke Ventures and
MSREF.
In reaching our decision, we have considered all arguments
made by the parties, and to the extent not mentioned or
addressed, they are irrelevant or without merit.
To reflect the foregoing,
Decisions will be entered under Rule 155.
f
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