How to write a tax memorandum

how to write a tax memorandum

Tax File Memorandum

This tax file memorandum was a final project in my Tax Research class. My professor made up a set of facts and we were to create a file memorandum containing our conclusions and our research findings for support. This was my conclusion.

Jessica Spillner

San Luis Obispo, CA 93401

September 11, 2009

Relevant Facts

There is an already formed partnership named AB Partnership where “A” and “B” are partners. A new partner joins “A” and “B” in AB Partnership, “C”. “C” is considered a service providing partner gaining an interest in the partnership by providing past services. There is a §1231 asset used by the partnership which is a dual espresso and knife sharpening machine. The applicable values for the machine are as follows: fair market value is $250,000; cost basis is $150,000; and adjusted basis is $100,000. This all happens in Tax Year 1 and now the tax year has closed. All taxpayers are on the calendar year system.

Specific Issues

Will the partnership recognize a gain or loss on the transfer of interest to the service providing partner if it is holding an appreciated or depreciated asset?

If the partnership decides to not recognize the gain or loss of the transfer of interest, will it be subjected to the I.R.C. § 6672 substantial understatement interest? Will the tax return preparer be subject to the I.R.C. § 6694 preparer penalty?


AB Partnership should opt for nonrecognition of a gain or loss because with little substantial authority on the issue of recognition when a service providing partner is involved, we can interpret the silence of the courts on the issue to be in our favor. In terms of the penalties, we can expect not to be subjected to neither the substantial understatement penalty nor the preparer penalty because there is little authority governing the recognition of gain or loss, we will not be willfully evading payment of tax liability or knowingly reporting and understating tax liability on a return.


I.R.C. §721(a) states a gain or loss shall not be recognized if a partner contributes property in exchange for an interest in the partnership. The section mentions the recognition of property in an exchange of interest, but services are not considered property. Also, this section does not address the issue of rendering services in exchange for an interest in the partnership. Prop. Treas. Reg. § 1.721-1 does address the issue of transferring interest for services. Under Prop. Treas. Reg. § 1.721-1(b)(2) there shall be no recognition of gains or losses for a partnership when the transfer of an interest is exchanged for services.

Prop. Treas. Reg. § 1.83-6(b) provides a transferor should recognize a gain to the extent that the transfer amount exceeds the transferor’s basis in the property. The partnership transferred a one – third interest to the service providing partner, which gave him a $66,000 basis in the partnership. The interest that was transferred to the service providing partner does not exceed the partnership’s basis in the property.

Under I.R.C. § 83(h) the partnership is allowed to deduct the interest in the partnership that was transferred to the service providing partner.

McDougal v. Commissioner, 62 T.C. 720 (1974) covers tax issues involving the formation of a joint venture and gain recognition. We will distinguish from McDougal for many reasons. First, McDougal v. Commissioner involves a joint venture, not a partnership. Secondly, McDougal took place outside of our district where there may be many differences in how tax liability issues are resolved. According to judicial practices, courts that are located in different districts may have differing opinions on how some tax liability issues should be resolved. It is not the responsibility of one court to follow the ruling of another court in a differing district, but for a court for following the rulings of its District Court of Appeals or the Supreme Court. Thirdly, there are no other court cases following McDougal which have reaffirmed the findings of the court. There have been references made to McDougal to varying degrees, but there have been no court rulings reaffirming recognition of gains or losses need to transpire when a service providing partner is first transferred an interest in the partnership. Fourthly, McDougal addresses the issue of forming a partnership; AB Partnership was an already formed partnership when “C” gained a 1/3 interest. Lastly, and most importantly, McDougal ruled for recognition for the partners, not the partnership. Since our concern is for the partnership then we will depart from the court’s ruling.

In the case of Mark IV Pictures, Inc, et al. v. Commissioner, TC Memo 1990-571 (1990) the court ruled that the partner had to recognize a gain for an interest in a partnership transferred in exchange for services. The court remained silent on the issue of whether the partnership should recognize the gain in the transfer of interest. We interpret the courts silence in our favor for nonrecognition,

I.R.C. § 6672(a) states, “Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in such manner to evade or defeat any such tax or the payment thereof…” By examining the language used in this section the taxpayer will not be exposed to the understatement penalty because we are truthfully accounting for the tax and are not willfully attempting to evade or defeat any tax payments. We will be truthfully reporting all income and deductions on the proper forms to be filed and therefore we are not willfully evading tax payments.

Under I.R.C § 6694(a), “If a tax return preparer prepares any return or claim of refund with respect to which any part of an understatement of liability…and, knew (or reasonably should have known) of the position, such tax return preparer shall pay a penalty with respect to each return or claim…”   Since there is no substantial authority addressing the issue of whether a partnership should recognize a gain or loss on a transfer of interest to a service providing partner, we are not knowingly preparing a return that contains an understatement of liability. With this lack of supporting evidence we will not be subjected to the preparer penalty.


Meet with the client to determine a final position.


Category: Taxes

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