UNITED STATES TAX COURT



IPO II, A PARTNERSHIP, GERALD R. FORSYTHE, TAX MATTERS PARTNER,
                          Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



    Docket No. 14500-02.             Filed April 23, 2004.



         IPO II, an LLC but treated as a partnership for
    Federal income tax purposes, is owned by IO, an S
    corporation, and F, an individual. F owns 100 percent
    of the outstanding stock in IO, 70 percent of the
    outstanding stock of IE, an S corporation, and 63
    percent of the outstanding stock of IP, a C
    corporation. F’s daughters own the remaining 30
    percent of the outstanding stock of IE.

         IPO II purchased an aircraft, and the loan was
    guaranteed by F, IE, and IP, but not IO.

         R determined that the liability incurred in the
    purchase of the aircraft was recourse and fully
    allocable to F. P argues that part of the liability
    should be allocated to IO because it is related to IE,
    a guarantor of the loan.
                               - 2 -

          Held: All of the liability is allocable to F
     because IO cannot be related to F or to IE for purposes
     of determining the allocation of the recourse liability
     pursuant to sec. 1.752-4(b)(2)(iii), Income Tax Regs.



     David J. Duez, Thomas C. Borders, and Ann M. Chavie, for

petitioner.

     Jason W. Anderson, for respondent.



                              OPINION


     HAINES, Judge:   Respondent issued a notice of final

partnership administrative adjustment (FPAA) to Gerald R.

Forsythe, as tax matters partner (TMP) for IPO II, determining

adjustments to IPO II’s Federal tax returns for 1998 and 1999

(years in issue).   For clarification purposes, we shall refer to

Gerald R. Forsythe in his capacity as TMP as petitioner; we shall

refer to Gerald R. Forsythe in his capacity as owner of IPO II

and the other entities described below as Mr. Forsythe.

     After concessions,1 the issue for decision is whether any of

the recourse liability incurred by IPO II with respect to the


     1
        The parties provided the following stipulations: (1)
IPO II is not entitled to claim a deduction for salaries and
wages of $104,000 for each of the years in issue; and (2)
respondent concedes that IPO II correctly reported the principal
business activity as “Chartering Airplane”, the principal product
or service as “Chartering Airplane”, the Business Code number,
and the loss from said activity as an ordinary loss from trade or
business activities. As a result, respondent conceded that IPO
II correctly reported ordinary losses from said activity of
$1,385,457 in 1998 and $752,824 in 1999.
                                 - 3 -

purchase of an aircraft is allocable to Indeck Power Overseas

Ltd. (Indeck Overseas).

                              Background

     The parties submitted this case fully stipulated pursuant to

Rule 122.2    The stipulation of facts and the attached exhibits

are incorporated herein by this reference.

     IPO II is a limited liability company organized in 1996

under the Illinois Limited Liability Company Act.     At the time

the petition was filed, IPO II’s principal place of business was

Wheeling, Illinois.

     IPO II was treated as a partnership for Federal income tax

purposes for the years in issue.     The members of IPO II are Mr.

Forsythe and Indeck Overseas.     Indeck Overseas is an S

corporation in which Mr. Forsythe owned 100 percent of the

outstanding shares during the years in issue.     The members’

interests in the profits and losses of IPO II were allocated

during the years in issue, and are currently allocated, as

follows:     Indeck Overseas, 99 units; Mr. Forsythe, 1 unit.

     IPO II’s operating agreement (operating agreement) provides

the following, in relevant part:




     2
        All Rule references are to the Tax Court Rules of
Practice and Procedure, and all section references are to the
Internal Revenue Code relevant to the years in issue. Amounts
are rounded to the nearest dollar.
                               - 4 -



          2.4 Liability to Third Parties. Except as otherwise
     provided by the Act,[3] the debts, obligations and
     liabilities of the Company, whether arising in contract,
     tort, strict liability or otherwise, shall be solely the
     debts, obligations and liabilities of the Company, and no
     Member or Manager of the Company shall be obligated
     personally for any such debt, obligation or liability of the
     Company solely by reason of being a Member or acting as a
     Manager of the Company.

                *    *    *    *       *   *   *

          5.3 Liability of Members to the Company. A Member
     shall be liable to the Company for capital contributions as
     and to the extent provided by the Act.

                *    *    *    *       *   *   *

          7.1 Allocations of Profits and Losses. All profits
     and losses of the Company (which for all purposes of this
     Agreement shall mean the Company’s net income and net loss
     as determined for federal income tax purposes) for each
     fiscal year (or part thereof) shall be allocated to the
     Members for both financial accounting and income tax
     purposes in proportion to the number of Units held by each
     respective Member. Each item of income, gain, loss,
     deduction, credit or tax preference of the Company entering
     into the computation of such profits or losses, or
     applicable to the period during which any such profits or
     losses were realized, shall be considered allocated between
     the Members in the same proportion as profits and losses are
     allocated to each Member. Profits and losses of the Company
     shall be determined for each fiscal year in accordance with
     the accounting method followed by the Company for federal
     income tax purposes, applied in a consistent manner.


     Mr. Forsythe also owns 70 percent (i.e., 28 of 40 shares) of

the outstanding shares of Indeck Energy Services, Inc. (Indeck

Energy).   Indeck Energy was a C corporation in 1997 but elected


     3
        The operating agreement defines “Act” as “the Illinois
Limited Liability Company Act, effective January 1, 1994, as
amended from time to time.”
                               - 5 -

to be treated as an S corporation for the years in issue.   The

remaining outstanding shares in Indeck Energy (i.e., 12 shares)

are owned equally by Mr. Forsythe’s children:   Michelle Fawcett,

Monica Breslow, Marsha Fournier, and Melissa Forsythe.

      Mr. Forsythe also owned 63 percent of the outstanding shares

of Indeck Power Equipment Co. (Indeck Power), a C corporation,

during the years in issue.

      On December 27, 1996, IPO II purchased a Cessna Citation VII

aircraft for $9,205,800 and two Garrett Allied Signal engines for

$200,375 (collectively, the aircraft) from the Cessna Aircraft

Co.   The total purchase price of the aircraft (i.e., $9,406,175)

was funded by a loan from Nationsbanc Leasing Corp. of North

Carolina (Nationsbanc).   The loan was evidenced by a secured

promissory note dated December 27, 1996, for the total purchase

price, executed by IPO II, as obligor, to the benefit of

Nationsbanc.

      To secure the loan, IPO II and Nationsbanc entered into an

Aircraft Loan and Security Agreement (the loan and security

agreement) on December 27, 1996.   The loan and security agreement

listed the following parties as “Guarantors” of the loan:   Indeck

Energy, Indeck Power, and Mr. Forsythe.   Indeck Overseas was not

listed as a guarantor of the loan.

      In connection with the loan, Mr. Forsythe, Indeck Energy,

and Indeck Power each entered into a guaranty agreement with
                              - 6 -

Nationsbanc (the Forsythe guaranty, the Indeck Energy guaranty,

and the Indeck Power guaranty, respectively).   Each guaranty

provided in relevant part:

          SECTION 1. Guarantee. * * * The Guarantor does
     hereby unconditionally guarantee to the Secured Party and
     its successors, endorsees, transferees and assigns, without
     offset or deduction, the following:

          (a) the prompt payment when due, whether by
          acceleration or otherwise, of all amounts payable by
          the Debtor pursuant to or under the Security Agreement,
          the Note and all related agreements (collectively, the
          “Basic Agreements”); * * *

          (b) the punctual and faithful performance by Debtor of
          each and every duty, agreement, covenant and obligation
          of Debtor under and in accordance with the terms of the
          Basic Agreements and all other obligations of Debtor to
          the Secured Party arising under the Basic Agreements or
          any of the transactions related thereto. The Guarantor
          does hereby agree that in the event Debtor does not or
          is unable to pay or perform in accordance with the
          terms of the Basic Agreements for any reason
          (including, without limitation, the liquidation,
          dissolution, receivership, insolvency, bankruptcy,
          assignment for the benefit of creditors,
          reorganization, arrangement, composition or
          readjustment of, or other similar proceedings affecting
          the status, existence, assets or obligations of Debtor
          or the limitation of damages for the breach, or the
          disaffirmance of, any Basic Agreement in such
          proceeding) it will pay the sums, or amounts equal
          thereto, which Debtor is (or, but for any such reason,
          would be) obligated to pay at the times specified in
          the Basic Agreements, whether by acceleration or
          otherwise (it being the intention hereof that the
          Guarantor shall pay to the Secured Party, as a payment
          obligation directly due from the Guarantor to the
          Secured Party, amounts equal to all amounts which
          Debtor shall fail faithfully and properly to pay when
          due under the Basic Agreements, whether by acceleration
          or otherwise), or otherwise provide for and bring about
          promptly when due such payment and the performance of
          such duties, agreements, covenants and obligations of
          Debtor under the Basic Agreements. The Guarantor
                               - 7 -

          acknowledges that it is fully aware of, and consents to
          the terms and conditions of the Security Agreement, the
          Note and each of the other Basic Agreements. The
          obligations of the Debtor hereby guaranteed are herein
          called the “Obligations”;

               *    *      *   *       *   *     *

          SECTION 3. No Subrogation. * * * The Guarantor
     hereby further irrevocably waives all contractual, common
     law, statutory or other rights of reimbursement,
     contribution, exoneration or indemnity (or any similar
     right) from or against the Debtor or any other party which
     may have arisen in connection with this Guarantee.


     Additionally, as required by the loan and security

agreement, IPO II and Indeck Energy were issued an aircraft

insurance policy with respect to the aircraft.       The promissory

note, loan and security agreement, and guaranties were recorded

and filed in due course.

     In 1997, petitioner was appointed TMP of IPO II, and Indeck

Overseas was appointed manager of IPO II.      Both members continue

to serve in their respective capacities.

     Petitioner filed a Form 1065, U.S. Partnership Return of

Income, on behalf of IPO II for each of the years in issue.         On

July 12, 2002, respondent issued the FPAA to petitioner, as TMP

of IPO II, with respect to the years in issue.       In the FPAA,

respondent determined, inter alia, that 100 percent of the

recourse liability shown on the Schedules K-1, Partner’s Share of

Income, Credits, Deductions, etc., was allocable to Mr. Forsythe,
                                - 8 -

and, therefore, none of the liability was allocable to Indeck

Overseas.4

     On September 11, 2002, petitioner filed a Petition for

Readjustment of Partnership Items Under Code Section 6226 with

the Court for a redetermination of the adjustments set forth in

the FPAA.    Petitioner alleged, inter alia, that respondent erred

in the determination that the liability shown on the respective

Schedules K-1 for the years in issue is fully allocable to Mr.

Forsythe, and in no part to Indeck Overseas.

                             Discussion

I.   Burden of Proof

     As a preliminary matter, petitioner argues that respondent’s

“primary” position, i.e., that the liability reflected on the

Schedules K-1 is nonrecourse, is entitled to the presumption of

correctness, and respondent bears the burden of going forward

with evidence and the burden of persuasion on the “alternative”

position; i.e., that the liability is recourse and fully

allocable to Mr. Forsythe.

     We do not find that the resolution of this case depends on

which party has the burden of proof.      On the basis of evidence in

the record, we hold that the recourse liability is fully


     4
        Respondent initially determined in the FPAA that the
liability listed on the Schedules K-1 from the purchase of the
aircraft was a nonrecourse liability, and alternatively
determined that the liability was recourse and fully allocable to
Mr. Forsythe. Respondent has since conceded that this liability
was recourse.
                               - 9 -

allocable to Mr. Forsythe for the reasons discussed below.

II.   Allocation of Recourse Liability

      A partner’s distributive share of partnership loss is

allowed only to the extent of the adjusted basis of the partner’s

interest in the partnership at the end of the partnership year in

which such loss occurred.   Sec. 704(d).   As relevant here, the

partner’s adjusted basis in the partnership interest is the basis

of such interest determined under section 722, increased or

decreased by the partner’s distributive share of income, loss,

and applicable expenditures.   Sec. 705(a)(1) and (2).   The basis

of an interest in a partnership acquired by a contribution of

property, including money, is the amount of money and the

adjusted basis of such property to the partner at the time of

contribution, increased by the amount of any gain recognized

under section 721(b) at the time.   Sec. 722.   Any increase in a

partner’s share of liabilities of the partnership is considered a

contribution by such partner to the partnership, and,

consequently, increases the basis of the partner’s interest in

the partnership.   Sec. 752(a); sec. 1.752-1(b), Income Tax Regs.;

see HGA Cinema Trust v. Commissioner, 

, 1362 (7th

Cir. 1991), affg. T.C. Memo. 1989-370; Callahan v. Commissioner,

, 280 (1992).

      The regulations guide our allocation of the instant

partnership recourse liability.   See sec. 7805(a); sec. 1.752-
                              - 10 -

5(a), Income Tax Regs.   Section 1.752-1(a)(1), Income Tax Regs.,

defines a partnership liability as a recourse liability “to the

extent that any partner or related person bears the economic risk

of loss for that liability under § 1.752-2.”   Section 1.752-2,

Income Tax Regs., provides the test for determining whether a

partner or related person bears the economic risk of loss.   The

determination to be made is whether, if the partnership were

constructively liquidated, the partner or related person would be

obligated to make a payment when the liability became due and

payable.   Sec. 1.752-2(b)(1), Income Tax Regs.

     In a constructive liquidation, the regulations provide that

the following events are deemed to occur:

          (i) All of the partnership’s liabilities become payable
     in full;

           (ii) With the exception of property contributed to
     secure a partnership liability (see § 1.752-2(h)(2)), all of
     the partnership’s assets, including cash, have a value of
     zero;

          (iii) The partnership disposes of all of its property
     in a fully taxable transaction for no consideration (except
     relief from liabilities for which the creditor’s right to
     repayment is limited solely to one or more assets of the
     partnership);

          (iv) All items of income, gain, loss, or deduction are
     allocated among the partners; and

           (v) The partnership liquidates.

Sec. 1.752-2(b)(1)(i)-(v), Income Tax Regs.

     In a constructive liquidation, the determination of which

partner or related person has an obligation to make a payment is
                                  - 11 -

“based on the facts and circumstances at the time of the

determination.”       Sec. 1.752-2(b)(3), Income Tax Regs.   Such facts

and circumstances take into account all statutory and contractual

obligations relating to the partnership liability, including

contractual obligations outside of the partnership agreement such

as guaranties.     

regulations assume that all

partners and related persons who have obligations actually

perform those obligations, “unless the facts and circumstances

indicate a plan to circumvent or avoid the obligation.”       Sec.

1.752-2(b)(6), Income Tax Regs.

     Initially, we must determine whether Indeck Overseas, as a

member of IPO II, was required by statute, by IPO II’s operating

agreement, or by any other contractual arrangements it entered

into to directly pay the Nationsbanc loan or any other

obligations of IPO II.       The Illinois Limited Liability Company

Act (LLC Act) provides, in relevant part:

     § 10-10.    Liability of members and managers.

     (a) Except as otherwise provided in subsection (d) of this
     Section, the debts, obligations, and liabilities of a
     limited liability company, whether arising in contract,
     tort, or otherwise, are solely the debts, obligations, and
     liabilities of the company. A member or manager is not
     personally liable for a debt, obligation, or liability of
     the company solely by reason of being or acting as a member
     or manager.

                  *      *    *    *    *    *    *

     (d) All or specified members of a limited liability company
     are liable in their capacity as members for all or specified
     debts, obligations, or liabilities of the company if:
                               - 12 -

          (1) a provision to that effect is contained in the
          articles of organization; and

          (2) a member so liable has consented in writing to the
          adoption of the provision or to be bound by the
          provision.

805 Ill. Comp. Stat. Ann. 180/10-10 (West Supp. 2003).    Section

2.4 of the operating agreement, quoted previously, provides that

no member or manager of IPO II is obligated for any debts,

obligations, or liabilities of IPO II.   Moreover, the LLC Act

does not establish a statutory obligation on the part of Indeck

Overseas to contribute to IPO II to meet IPO II’s obligations,

either during its operation or upon its liquidation and

dissolution, unless a promise is otherwise made by Indeck

Overseas to contribute.   See 805 Ill. Comp. Stat. Ann. 180/20-5,

180/25-45 (West Supp. 2003).   The record is devoid of any

evidence of a promise by Indeck Overseas to contribute to IPO II

or to otherwise directly become responsible for IPO II’s debts,

obligations, or liabilities including the Nationsbanc loan.

Indeck Overseas did not guarantee the Nationsbanc loan.

Consequently, there is no evidence that in a constructive

liquidation Indeck Overseas would directly bear the economic risk

of loss for the Nationsbanc loan.

     A finding that Indeck Overseas did not directly bear

economic risk of loss does not end the inquiry.   Economic risk of

loss borne by a “related person” can also establish a recourse

liability for Indeck Overseas.   See sec. 1.752-2(a), Income Tax
                              - 13 -

Regs. The Nationsbanc loan was guaranteed by Mr. Forsythe, Indeck

Energy, and Indeck Power.   Indeck Energy and Indeck Power have no

ownership interests in either Indeck Overseas or IPO II.    Mr.

Forsythe, on the other hand, is at least a majority owner in

Indeck Energy, Indeck Power, and Indeck Overseas.   Even though

Indeck Overseas did not guarantee the Nationsbanc loan, we must

inquire into whether the guaranty by Mr. Forsythe, Indeck Power,

or Indeck Energy can be attributed to Indeck Overseas.

     Petitioner argues that the liability incurred as a result of

the purchase of the aircraft is recourse with respect to each

member:   fully recourse as to Mr. Forsythe as a result of the

Forsythe guaranty, and fully recourse as to Indeck Overseas as a

result of its being related to Indeck Energy, a guarantor,

through Mr. Forsythe’s common ownership.

     Respondent argues that the entire recourse liability

incurred with the purchase of the aircraft should be allocated to

Mr. Forsythe because:   (1) Nationsbanc had no recourse against

Indeck Overseas for the loan; and (2) for purposes of determining

the allocation of the liability, Mr. Forsythe and Indeck Overseas

cannot be related parties, and, therefore, Indeck Overseas and

Indeck Energy cannot be considered related persons through the

common ownership by Mr. Forsythe.

     The regulations define a “related person” as a person having

a relationship to a partner which is specified in section 267(b)
                               - 14 -

or 707(b)(1), subject to certain modifications.    Secs. 1.752-

1(a)(3), 1.752-4(b)(1), Income Tax Regs.    Those modifications

include substituting “80 percent or more” for “more than 50

percent” each place it appears in those sections.    Sec. 1.752-

4(b)(1)(i), Income Tax Regs.

     However, in determining whether a partner bears economic

risk of loss on a partnership liability, the regulations also

provide the following exception:

          (iii) Related partner exception. Notwithstanding
     paragraph (b)(1) of this section (which defines related
     person), persons owning interests directly or indirectly in
     the same partnership are not treated as related persons for
     purposes of determining the economic risk of loss borne by
     each of them for the liabilities of the partnership. This
     paragraph (iii) does not apply when determining a partner’s
     interest under the de minimis rules in § 1.752-2(d) and (e).


Sec. 1.752-4(b)(2)(iii), Income Tax Regs.    Both parties dispute

the effect of this exception (related partner exception) in the

determination of whether Indeck Overseas bore any economic risk

of loss with regard to the liability incurred with the purchase

of the aircraft.

      We interpret the policy behind the related partner

exception as preventing the shifting of basis from a party who

bears actual economic risk of loss to one who does not.    This

means that losses are allowed, to the extent of basis, to the

party who is actually exposed to the risk of economic loss

through the application of statute, organizational documents, or
                              - 15 -

other contractual arrangements.   It also means that, with regard

to recourse liabilities, the shifting of basis cannot occur

without a concomitant shifting of the underlying risk of economic

loss.

     Mr. Forsythe bore the economic risk of loss with regard to

the recourse liability because he personally guaranteed the full

amount of the Nationsbanc loan and had no rights to

“reimbursement, contribution, exoneration or indemnity (or any

similar right)”.   See sec. 1.752-2(b)(3)(i), Income Tax Regs.

Pursuant to the related partner exception, Mr. Forsythe and

Indeck Overseas, as common owners of interests in IPO II, may not

be treated as related persons for purposes of all determinations

of economic risk of loss.   Therefore, Mr. Forsythe’s economic

risk of loss as guarantor cannot be attributed to Indeck

Overseas, as conceded by petitioner.

     Petitioner argues, however, that Indeck Overseas did bear

economic risk of loss for the recourse liability through the

Indeck Energy guaranty.   Petitioner argues that Indeck Overseas

can be related to Indeck Energy through Mr. Forsythe for purposes

of determining economic risk of loss.   We disagree.

     Indeck Overseas is only related to Indeck Energy via its

“relationship” with Mr. Forsythe.   See sec. 267(b)(11); sec.

1.752-4(b)(1), Income Tax Regs.   The related partner exception

begins with the language “Notwithstanding paragraph (b)(1) of
                               - 16 -

this section (which defines related person)”.    The related

partner exception overrides the application of section 267(b)(11)

and section 1.752-4(b)(1), Income Tax Regs.    Pursuant to the

related partner exception, this “relationship” between Indeck

Overseas and Mr. Forsythe is severed for purposes of determining

whether Indeck Overseas bears an economic risk of loss for any of

IPO II’s recourse liability.

     We conclude that Indeck Overseas and Indeck Energy are not

related parties for purposes of determining whether Indeck

Overseas bore any economic risk of loss with regard to IPO II’s

liability for the aircraft because:     (1) Indeck Overseas is not

related to Mr. Forsythe pursuant to the related partner

exception; and (2) Indeck Overseas is related to Indeck Energy

only through Mr. Forsythe, and that relationship is not

recognized for purposes of our determination.    To hold otherwise

would be to allow attribution of economic risk of loss indirectly

even though it cannot be attributed directly.    In the instant

case involving a recourse liability, the shifting of economic

risk of loss to achieve an increased basis cannot be accomplished

through attribution.   Therefore, we hold that none of the

recourse liability incurred by IPO II with respect to the

purchase of the aircraft is allocable to Indeck Overseas.

     We have considered all of the parties’ contentions,

arguments, and requests that are not discussed herein, and we
                             - 17 -

conclude that they are without merit or irrelevant.

     To reflect the foregoing,

                                             Decision will be

                                        entered under Rule 155.