In Harbor Cove Marina Partners Partnership v. Commissioner, the Tax Court held that in some situations, a partnership that has been dissolved under state law is not necessarily terminated for federal taxation purposes. The underlying issue was the proper taxable year in which a minority partner was required to report certain partnership items. Specifically, the court addressed circumstances in which a partner of a partnership files a lawsuit alleging that the controlling partner wound up the business affairs of the partnership by using procedures contrary to those stated in the partnership agreement. The court ruled that when the outcome of that lawsuit could reasonably lead to significant income, credit, gain, loss, or deduction for the partnership in a subsequent year, the partnership is not terminated for federal tax purposes. In Harbor Cove, the Tax Court reversed the Service’s determination under section 708 of the Code that the partnership had terminated under these circumstances. The Service contended that the partnership had terminated because the controlling partner subjectively believed that he had dissolved the partnership, the partnership and the other partners filed tax returns reflecting that belief, and the state courts had determined that the partnership had dissolved. While the Tax Court agreed that section 708(b)(1)(A) was applicable to determine whether the partnership had terminated for federal tax purposes, it disagreed with the Service’s use of subjective evidence and state law. Instead, the court pointed to the Service’s previously “liberal” methods of finding a nexus sufficient to prevent the termination of a partnership. It held that the “broad authority to negotiate the terms of [the] business relationship” given to partners in a partnership means that the partnership can only be terminated according to the terms of the partnership agreement.
This Note argues that the Tax Court’s decision was not only correct, but was perfectly tailored to the situation. Partnerships have long been attractive to entrepreneurs and businesspeople because they allow investors with limited funds to be influential in larger business ventures. The Tax Court perpetuated Congress’s long-standing policy of keeping partnerships flexible and equitable, but avoided giving minority partners so much control over the termination of the partnership as to lead to a disincentive for larger investors or a possible vessel for improper tax avoidance. Part I of this Note describes the factual background of Harbor Cove and Part II details the Tax Court’s analysis. Part III argues that the Tax Court’s decision addressed concerns of both fairness to the taxpayer and larger policy implications. Finally, Part IV highlights the Tax Court’s wisdom in narrowly approaching the issues in Harbor Cove so as to protect the viability of the partnership vehicle.