Note: The following is an excerpt from the introduction to the article as published in The Tax Lawyer. Author citations have been omitted for brevity. Tax Section members may read the article in its entirety in Adobe Acrobat format.
Beating the Dead Horse: Revisiting McDougal in Search of Substantial Authority
Rodney P. Mock*
Over thirty-five years have passed (including a certain racehorse named “Iron Card”) since the famous U.S. Tax Court case of McDougal v. Commissioner, yet to this day taxpayers in partnerships, tax practitioners, and academics wrestle with the mystery of the precedential application of the recognition event described in that decision. A fierce academic debate continues over whether an existing partnership with appreciated or depreciated assets recognizes gains or losses when it transfers a capital interest (as opposed to a profits-only interest) in the partnership in exchange for services. A “profits-only” interest is a distinctly different type of interest, and not the focus of discussion in this Article, as most of the issues surrounding the receipt of a profits-only interest by a service partner were resolved with the issuance of Revenue Procedure 1993-27, which generally treats receipt of such as a nontaxable event.
All that being said, the Treasury’s failure to finalize Proposed Regulations sections 1.721-1 (2005) and 1.83-6 (2005) may have been the magical silver bullet of finality putting to rest the already weakened “cash-out-cash-in” academic theory supporting nonrecognition. This Article analyzes whether or not there is any life remaining in the cash-out-cash-in theory, as a “reasonable basis” position if disclosed, and, if undisclosed, whether such is supported by “substantial authority,” for the purposes of the preparer penalty and the substantial understatement of income tax penalty under sections 6694(a)(2) and 6662(d)(2)(B), respectively.
*Rodney P. Mock, J.D., LL.M., Assistant Professor, California Polytechnic State University.