Partnership Tax Question

[wserra]

Yes, I know, I'm a lawyer. But to this non-tax practitioner, the answer is not obvious. In fact, it's pretty obscure, even after research.

Begin with a law practice LLP. The practice does business in multiple states. The practice's home state (NY) has a personal income tax, as do a couple of the other states in which it does business.

The earnings of a certain non-equity partner are fixed by written agreement as a percentage of what he brings in. He draws no salary. This lawyer is admitted only in NY, and all of his business is in NY state and federal courts. (He is admitted in federal courts outside of NY, but for the year in question had no business in them.) In other words, every dime of his income is directly traceable to NY sources, and only to NY sources.

This lawyer just got a K-1 showing CA and NJ income, and therefore income tax owing to those states. The firm in fact does business in CA and NJ. Are there any circumstances under which this is correct?

Many thanks. Understood not legal advice, etc.

[Arthur Rubin]

Yes, I know, I'm a lawyer. But to this non-tax practitioner, the answer is not obvious. In fact, it's pretty obscure, even after research.

Begin with a law practice LLP. The practice does business in multiple states. The practice's home state (NY) has a personal income tax, as do a couple of the other states in which it does business.

The earnings of a certain non-equity partner are fixed by written agreement as a percentage of what he brings in. He draws no salary. This lawyer is admitted only in NY, and all of his business is in NY state and federal courts. (He is admitted in federal courts outside of NY, but for the year in question had no business in them.) In other words, every dime of his income is directly traceable to NY sources, and only to NY sources.

This lawyer just got a K-1 showing CA and NJ income, and therefore income tax owing to those states. The firm in fact does business in CA and NJ. Are there any circumstances under which this is correct?

Many thanks. Understood not legal advice, etc.

Quite possible. If the LLP is taxed as a partnership, but any income the partnership earns, not directly attributed (by the partnership agreement) to a specific partner, is taxed to all partners in the percentages specified in the partnership agreement. With some exceptions, (especially in CA), the partnership, itself, pays no income tax.

[wserra]

The LLP is taxed as a partnership. But I am a non-equity partner - that is, I don't "share in profits and losses" (language of NY Partnership Law). I don't even have a partnership agreement in the usual sense, just an agreement fixing my compensation as above.

Thanks, Arthur.

[Dark Optimist]

If the person is receiving a guaranteed payment (line 4 of the K-1), I do not think that would be apportioned - I would have to check the states. It would be comparable to receiving a W-2. It sounds like they are receiving a share of the entity's ordinary income (line 1 on the K-1), which is apportioned to the states where the company does business, which is why there is income being apportioned to CA and NJ.

[Jeffrey]

If we’re answering tax questions. If you did a job but didn’t get paid for it do you have to report the money you didn’t get paid?

[Chaos]

If we’re answering tax questions. If you did a job but didn’t get paid for it do you have to report the money you didn’t get paid?

I do in nj

[AndyK]

If we’re answering tax questions. If you did a job but didn’t get paid for it do you have to report the money you didn’t get paid?

Not paid like how? Stiffed, barter, earned subject to future payments, work in progress with payment on completion, etc

And what is your accounting scheme? Cash, accrual, other?

All of these matter.

[Jeffrey]

It's been over a year now so let’s say stiffed. Maybe 20% chance I get paid eventually. Moot anyways, didn’t report it.

[wserra]

If the person is receiving a guaranteed payment (line 4 of the K-1), I do not think that would be apportioned - I would have to check the states. It would be comparable to receiving a W-2. It sounds like they are receiving a share of the entity's ordinary income (line 1 on the K-1), which is apportioned to the states where the company does business, which is why there is income being apportioned to CA and NJ.

Bingo. In fact, it is reported as a guaranteed payment (line 4 of K-1), as it should be, since it does not depend on partnership income/loss. Since source is entirely NY, as you say, should not be apportioned.

Thank you, DO. Thank you, everyone.

[Dark Optimist]

I'm glad to be of help - but I still put out the caveat that state laws may still require apportionment of guaranteed payments. This is a specific question that would need to be researched further. I have not seen a lot of K-1's reporting guaranteed payments for a multi-state business, so I don't remember if the guaranteed payments were apportioned or allocated.

[wserra]

I ran a Lexis search for 26 USC 707(c) (the "guaranteed payments" statute). CA: nada. NY: one cite, nothing to do with apportionment.

[AndyK]

It's been over a year now so let’s say stiffed. Maybe 20% chance I get paid eventually. Moot anyways, didn’t report it.

Depending on your personal/business organization and accounting structure, you might be able to take all your costs as a tax loss. COSTS (out of pocket expenses) NOT -- NOT value of your time or labor.

[jcolvin2]

The following FTB Notice looks good, but later caselaw (which I will put in a following post) involving a lawyer at Baker Hostetler does not look as helpful:

1989 WL 201229 (Cal.Fran.Tax.Bd.)
Franchise Tax Board
State of California
FTB Notice
89-493
September 5, 1989

*1 Re: Partnerships—Guaranteed Payments

Nonresident Partners' California Source Portion, Payroll Factor Computation

Advice has been requested as to the proper allocation of guaranteed payments to nonresident partners as income from California sources and the proper amount to be included in the payroll factor of a partnership engaged in business within and without California.

Holdings

1. Guaranteed payments should be treated as a distributive share of partnership income. Under 18 Cal. Code Regs. § 17951-4(f), the individual partner will treat 60% of both the distributive share [if any] and guaranteed payment as salary, to be sourced wherever the services to the partnership are rendered.

The remaining 40% of distributive share and guaranteed payment will be apportionable in accordance with the apportionment factors of the partnership.

2. Guaranteed payments should be treated for payroll factor purposes as distributive shares and included as provided in 18 Cal. Code Regs. § 17954-4(f). In the case of a nonresident partner who renders services to the partnership, 60% of that partner's distributive share, including any guaranteed payments, is included in the payroll factor denominator. The “deemed salary” portion of the nonresident partner will be included in the California numerator only to the extent that the partner performs services in California.

Analysis

General Discussion

18 Cal. Code Regs. § 17951-4(f) recognizes that the income generated by a professional partnership is partially attributable to the personal efforts of the partners and partially attributable to other factors such as partners' capital contributions and the activities of nonpartner employees.

Logically, the portion of the income produced by the individual efforts of the partners should be treated, both to the partnership and to the individual partner, as compensation for services. It should be included in the payroll factor denominator and in the numerator of the state where the services were rendered, and it should be treated as income sourced in the state where the services were performed.

The remaining portion of each partner's income, attributable to partnership capital and the efforts of nonpartner employees, should logically be treated as a share of the profits from the partnership's business activities generally. This portion should therefore be apportioned according to the partnership's property, payroll and sales (revenue) factors.
Although guaranteed payments have some characteristics of salary, notably that they are deductible by the partnership and must be taken into income by the partner when paid, they are regarded as a partner's distributive share of ordinary income for most purposes (see Treas. Reg. § 1.707(c).) This recognizes the fact that the amount paid as a guaranteed payment often reflects more than the market value of services rendered to the partnership by that individual partner.

Issue 1—Sourcing of Guaranteed Payments

*2 Revenue and Taxation Code § 17854, which provides that guaranteed payments to a nonresident partner shall be gross income from sources within this state, must be read in conjunction with Revenue and Taxation Code § 17041(b), which imposes a tax on income of nonresidents which is derived from California sources, and Revenue and Taxation Code § 17951, which limits the gross income of nonresidents to California source income.

18 Cal. Code Regs. § 17951-1(b) explains that the gross income of nonresidents who are members of partnerships includes the [partner's] distributive share of partnership income [only] to the extent that the [partner's] distributive share is derived from California sources, including amounts received by a nonresident partner as payments for services or use of capital (i.e. guaranteed payments.)

Therefore, that portion of a guaranteed payment which is treated either as compensation for services performed in California or as the apportioned California share of partnership income will be treated as California source income to a nonresident partner.

18 Cal.Code Regs. § 17951-4(f) establishes a bright-line test for nonresidents engaged in the practice of a profession (such as the practice of law), treating 60% of the income as compensation for services rendered, and 40% as income derived from other partnership activities. In the case of a partner who does not render professional services to the partnership, 100% is treated as income derived from other partnership activities.

The second part of the Example in 18 Cal.Code Regs. § 17951-4(f) shows the proper computation of a nonresident partner's income from California sources.

Issue 2—Treatment of Guaranteed Payments in Payroll Factor

As explained above, for payroll factor purposes, guaranteed payments should be treated as distributive shares and included in the payroll factor as shown in 18 Cal. Code Regs. § 17951-4(f). This treatment recognizes that a portion (40% under the bright-line test) of the guaranteed payment may be attributable either to partnership capital, in which case it should not be included in the factor at all, or to the activities of nonpartner employees, in which case it would be reflected by the inclusion of the salaries of those employees in the appropriate numerator.

DRAFTING INFORMATION

The principal author of this notice is Bruce R. Langston, Senior Staff Counsel, Franchise Tax Board Legal Division. For further information regarding this notice, contact Mr. Langston at P.O. Box 1468, Sacramento CA, 95812-1468.
1989 WL 201229 (Cal.Fran.Tax.Bd.)

[jcolvin2]

2017 WL 6759169 (Cal.St.Bd.Eq.)
State Board of Equalization
State of California
IN THE MATTER OF THE APPEAL OF: EDWARD L. RIPLEY
Not to be Cited as Precedent
Case No. 611701
October 24, 2017
*1 Franchise and Income Tax Appeal
Representing the Parties:
For Appellant:
Edward L. Ripley
For Respondent:
Maria Brosterhous
Tax Counsel
Counsel for the Board of Equalization:
Linda Frenklak
Tax Counsel III1

SUMMARY DECISION

This appeal is made pursuant to section 19324 of the Revenue and Taxation Code (R&TC) from the Franchise Tax Board's (FTB or respondent) action of denying a refund claim in the amount of $1,383.702 for tax year 2007. The issue presented in this appeal is whether respondent properly denied appellant's claim for refund.

FINDINGS AND DISCUSSION

Background

Appellant failed to file a timely 2007 California return. Respondent received information from the law firm, Baker & Hostetler, LLP (the firm), indicating that appellant received allocated income during 2007 in an amount that required the filing of a California return. On March 9, 2009, respondent issued a Request For Tax Return (request letter) to appellant that required him to file a 2007 California return or explain why no return was required by no later than April 8, 2009. After appellant failed to respond to the request letter, respondent issued appellant a Notice of Proposed Assessment (NPA) dated June 2, 2009. The NPA estimates appellant's income as $15,718 based on the Schedule K-1 that the firm issued to appellant for 2007.3 The NPA proposed a tax liability of $760.14, and imposed a late filing penalty of $190.03 plus interest.4
After appellant failed to remit payment or respond to the NPA, respondent issued an Order to Withhold Personal Income Tax dated March 27, 2012, to Wells Fargo Bank for appellant's unpaid tax liability of $1,383.70 for 2007. In a letter dated April 11, 2012, appellant protested the assessed tax liability. On April 15, 2012, Wells Fargo remitted the requested amount of $1,383.70 to respondent, which satisfied appellant's 2007 balance due. In a letter May 23, 2012, appellant claimed a refund. In a letter to appellant dated October 4, 2012, respondent informed appellant that it was denying his claim for refund.

This timely appeal followed.

Request for Additional Briefing

In order to further develop the issues, the Appeals Division requested additional briefing by letter dated September 3, 2014. Respondent was requested to submit a copy of the Schedule K-1 that was the basis for the additional assessed tax liability or provide other documentary evidence that supports the additional assessed tax liability. Appellant was provided an opportunity to file a reply brief. The parties submitted responsive additional briefs that are discussed below.

Appellant's Contentions

Appellant contends that respondent erroneously assessed a tax liability for 2007 based on his designation as a non-equity or income partner at the firm. He describes the firm as a limited liability partnership (LLP) that had offices in Texas, New York, Ohio, Colorado, Florida, Washington, D.C., and California during 2007. Appellant states that from 2001 through October 2007, he worked at the firm as an “income partner”, but he was never an equity partner of the firm. Appellant states, “For employment and professional purposes I had the title ‘partner.”’

*2 Appellant asserts that since 1985, he has continuously lived and worked in Houston, Texas, and he was never based in the firm's California office. He also asserts that he never lived or worked in California, and he never owned any assets or property or had interests of any kind in any business in California. Appellant states that he attached to the appeal letter copies of applicable portions of his 2007 federal return, which show that he lacked any connection with California. In his appeal letter, appellant states, “Presumably, both the Franchise Tax Board and the State Board of Equalization [[have] access to Baker & Hostetler's partnership returns that should have identified me as a general partner and reported my compensation as guaranteed.”

Appellant describes his compensation arrangement at the firm as follows:

Under the terms of my employment with Baker Hostetler as an Income Partner, I received a guaranteed base compensation. I was budgeted to bill a minimum of hours per year. If I exceed[ed] that minimum by a specified amount, then I would have been eligible to receive certain bonus amounts depending upon how many additional hours I billed. These potential bonus amounts were solely based on my work and fixed salary. None of my compensation for the year 2007 (or any other year) was based upon or impacted, in any way, by the income or financial performance of Baker's California office.

Appellant asserts that as an income partner, he was not responsible for the firm's debts or obligations, he was not entitled to share in the firm's earnings and profits, he was not obligated to make and never made any capital contributions to the firm, he “had no voice in the management of the firm, and he had no voting rights in election of firm management or any firm decisions.” He asserts that the 2007 Schedule K-1 that the firm issued to him should have reported that he did not have any profit sharing, loss sharing, capital ownership, or any share of the firm's liabilities. According to appellant, respondent and this Board have access to this 2007 Schedule K-1. Appellant asserts that “law firms and other professional service firms have abandoned the traditional associate/employee vs. owner/partner organization to allow for a number of other status levels within a firm, such as designating persons as “permanent associate', ‘special partner’ or ‘non-equity partner’.'D' Appellant states that each of these designations “reflects a status beyond traditional associate, but not a true co-owner of the firm.”

In his reply brief, appellant states that respondent asserts that appellant did not provide a copy of the partnership agreement but appellant asserts that “these passing references” do not “raise or create any legitimate fact issue about [his] employment or position at Baker Hostetler.” According to appellant, respondent has never indicated that it disputed his position as a non-equity income partner at the firm. Appellant asserts that he stated in a telephone conversation with respondent that he did not have a copy of the partnership agreement, he has not been employed at the firm for six years, he would not have been permitted to retain a copy of the partnership agreement when he left the firm, even if he ever had a copy of it, and “any professional firm's partnership agreement is highly confidential.” Appellant states that respondent did not appear to have a problem with his response and that respondent could have contacted the human resources department at the firm's Houston office to verify his employment or appellant “could have provided a letter to that effect.”

*3 Citing Luna v. Comm'r (1964) 42 T.C. 1067, 1077-78, appellant contends that it is a question of fact whether an individual is a partner for tax purposes based on all of the circumstances. Appellant asserts that in Comm'r v. Culbertson (1949) 337 U.S. 733, 742-743(Culbertson), the United States Supreme Court held that factors to be considered in determining whether a person is a partner for tax purposes include the agreement between the parties, their respective abilities and capital contributions, and the actual control of income and the purpose for which it is used.

Appellant argues that the facts in this appeal are similar to the facts in Kelly v. Comm'r, T.C. Memo 1970-250, in which the Tax Court held that the taxpayer's relation to the accounting firm after October 1, 1960, was not that of a partner because he “had no mutual interest in the capital of the partnership, no control of its general business, no proprietary interest in its interest in its profits, and no ultimate liability for its losses.” Appellant states that his salary was fixed and was not dependent on the firm's profits or losses, particularly any profit or loss of the firm's California offices. Appellant contends that he was not a partner of the firm for tax purposes and the income the firm reported as a guaranteed payment to a partner under Internal Revenue Code (IRC) section 707(c) constitutes “income from personal services rendered to the firm.” As a result, appellant contends that the income is sourced to Houston, Texas where the services were performed. For this reason, appellant argues that he had no California source income and, as a nonresident, he had no California filing requirement or tax liability for 2007 or any other tax year.

Citing this Board's summary decisions in the Appeal of John V. Jansonius, adopted on February 2, 1999, the Appeal of Charles C. Frederiksen, adopted on January 7, 1999, and the Appeal of Bruce F. Howell, adopted on April 7, 1998,5 appellant asserts that this Board previously decided at least three appeals “with essentially identical facts where a non-equity partner was found not to be a partner for purposes of California tax law.” (Emphasis in original.) According to appellant, each of these appeals involved Texas attorneys who were designated as “special partners' with a national law firm with offices located in California. Appellant asserts that the Board found in those cases that “the attorneys did not share in the profits, did not make capital contributions and did not have a voice in management of the firm” and concluded that “they were not considered partners for tax purposes and were not required to file a California tax return.” Appellant asserts that respondent's “position and its briefing completely failed to acknowledge or discuss the SBOE's prior - exactly on-point precedent[s.]” Appellant attached copies of these three unpublished Board decisions to the appeal letter and indicates that they were previously submitted to respondent.

*4 Appellant asserts that he filed California returns based on erroneous information for tax years 2003, 2004, and 2005 and paid California taxes for these tax years. He also asserts that respondent subsequently represented to him that he was not required to file a California return and refunded the entire amounts of taxes he erroneously paid for tax years 2003, 2004, and 2005. Appellant provided copies of three checks in the amounts of $951.20, $1,038.74, and $996.72 for refunds for tax years 2003, 2004, and 2005, respectively, that respondent issued within a one-week period from October 26, 2006, to November 6, 2006.

Appellant asserts that other income partners based at the firm's Houston office “took the same action and also received complete refunds.” He states that respondent never requested that he file a California return for tax year 2006 and questions why he was issued refunds for prior year's erroneous tax payments but was assessed tax for 2007. He states that he did not file a California return for tax year 2006 or 2007 “based on the FTB's prior position and conduct.”

Appellant argues that “[b]ased on the clear precedent, uncontested fact and prior actions,” he owes no California income tax for 2007 or any other year arising from his employment at the law firm. He asserts that respondent's decision to assess him a tax liability for 2007 and deny his claim for refund was apparently based solely on his title as “partner”, which, if true, means that respondent's “decision is completely arbitrary and without any factual foundation and instead ignores the actual facts and economic substance of my employment while at Baker as well as applicable legal authority.” Appellant states that any issues about the firm's treatment of income partners, like himself, for tax purposes should be addressed directly to the firm. He asserts that the law firm presumably still characterizes income partners in the same manner that it characterized him several years ago but he states that he was unaware and did not participate in the firm's decisions about treatment of guaranteed salary employees for tax purposes. He also contends that respondent collected the assessed tax liability at issue by improperly garnishing his son's college fund account.

In a reply brief, appellant contends that respondent cites no legal authority in support of its position and fails to address the “totality-of-the-circumstances” test set forth in Culbertson, supra, 337 U.S. at pp. 742-743. Citing TIFD III-E, Inc. v. United States (2nd Cir. 2012) 666 F.3d 836, appellant contends that Culbertson and other cases he cites in his appeal letter were ignored by respondent and “continue to be cited with approval and applied in cases dealing with whether a person or entity is considered a true ““partner” or co-owner for tax purposes.” Appellant asserts that in TIFD III-E, Inc. v. United States, the Second Circuit Court of Appeals held that Culbertson was controlling and held “that foreign banks were not partners for tax purposes even though they were titled as such in a written partnership agreement.” Appellant argues that respondent's reliance on his title as ““partner” disregards “facts and economic substance.” Appellant also contends that respondent ignores Kelly v. Comm'r, supra, T.C. Memo 1970-250, “where the totality of circumstances factors were applied including lack of any capital contribution by cash or services, lack of control and lack of any share in the profits (or losses).” Appellant states, “Each factor weighs strongly in Appellant's favor and when combined, clearly evidences that the FTB's decision (however it was derived) is completely erroneous and arbitrary.”

*5 Appellant argues that there is no merit to respondent's citation of Blalock v. Allen (M.D. Ga 1951) 100 F. Supp. 869, as holding that the performance of services in a non-capital intensive venture such as a law firm “is the far more essential factor in establishing a person as a partner.” According to appellant, this case involved “a taxpayer (and then decedent) [[who] had been an admitted partner in a number of family ventures and for which he made extensive capital contributions” and “long time services were also factored into that person's partnership capital accounts.” Appellant contends that respondent takes the position that the law firm is not capital intensive, which “evidences a real lack of understanding about basic economic realities.” Appellant contends that an equity partner at Baker Hostetler would have made a substantial capital contribution or buy-in.” Appellant asserts that he “never made such a contribution by cash or services.”

In his additional brief, appellant contends that there is no “credible dispute” that his income from the firm was a set, guaranteed amount, completely unrelated to and unaffected by income from the firm's California office and that respondent has not provided any contrary evidence. In response to the Appeals Division's request for a copy of his 2007 Schedule K-1, appellant states that respondent subsequently submitted 2007 income information that shows that he received a guaranteed salary from the firm for the portion of the year he was employed there. Appellant contends, however, that respondent erroneously asserts that the firm's Schedule K-1 references that his guaranteed salary was “‘sourced’ or ‘treated as a distributive share of the firm's California income.”’

Appellant also states that respondent erroneously asserts in its additional brief that he stated that the firm's partnership returns indicate that he is “a general partner.” He contends that he was never an equity partner at the firm and has never used the term “general partner” to describe his position at the firm. Appellant asserts that he was not aware that anyone at the firm was described as a general partner. According to appellant, the firm, like many professional service firms, had two types of partners: a non-equity income partner and an equity partner. Appellant asserts that the income partner receives “a set base salary, [which is] not contingent or affected by the firm's profits or losses, [and has] no vote in management, no contributions to capital accounts, and no ownership interest,” whereas the equity partner “includes votes on management decisions, requires capital contributions and compensation is not fixed, but changes, annually, determined by the firm's actual, annual profit and loss and that equity partner's points or percentage of ownership.” He asserts that an equity partner “would fit the test of being a partner for tax purposes attributing or ‘sourcing’ the firm's California based income[,] even if that partner did not live in or [have an] office in California.”

Respondent's Contentions

*6 In its opening brief, respondent contends that it properly sourced to California a portion of the income that the firm paid to appellant during 2007. Respondent asserts that pursuant to R&TC section 17951, appellant's gross income includes income from sources within California and that pursuant to R&TC section 17854, “a partner's guaranteed payments must be included as gross income from sources within California in the same manner as if the payments were a distributive share of the partnership.” According to respondent, there is no dispute that the firm conducted business within California and derived income from that business and thus “derived income from sources within California.”

Respondent states that that appellant concedes that he received guaranteed payments from the firm and that the firm issued appellant “a Schedule K-1, which reported the guaranteed payments (treated as a distributive share of the firm's California source income) to him.” Respondent further asserts that under California Code of Regulations, title 18, section (Regulation) 17951-4(d), “a portion of the guaranteed payment received by appellant and reported on his Schedule K-1 by a unitary law firm doing business in California was properly sourced to California.”

Respondent contends that appellant's status as a nonresident income partner at the firm does not prevent him from being subject to California income tax on the California-sourced portion of the guaranteed payment he received in 2007. Respondent states, “By appellant's own admission in his opening brief, and by the former law firm's issuance of the Schedule K-1 to appellant, it is clear that the former law firm was in fact a partnership and elected to be taxed as such.” Respondent also states that under R&TC section 17008, the law firm is classified as a partnership because it was an unincorporated organization through which business was carried on and that appellant was a partner of the law firm because he was a member of this unincorporated organization.

Respondent contends that there is no merit to appellant's argument that “his designation as an income partner is insufficient to deem him a partner for tax purposes.” According to respondent, there is strong evidence that the firm conducted its business as a partnership and appellant was a partner of the firm. Respondent asserts that the firm filed a partnership income tax return and issued to appellant a Schedule K-1. Citing 2007 Form 1065 and 2007 Schedule K-1 (Form 1065) instructions, respondent states, “Only partnerships file partnership income tax returns, and only partners receive Schedules K-1.”

Citing IRC section 707(a)(1) and (c), respondent also asserts that guaranteed payments “are solely features of partnership tax law and only a partner is eligible to receive guaranteed payment, which must be earned by recipients in their capacities as partners.” In addition, respondent states that “appellant freely admits to being a member of a partnership, stating on pages 2 and 3 of his opening brief that the firm's returns should report him as a general partner entitled to received guaranteed payments.” Lastly, respondent states that appellant could have been classified as an employee, an independent contractor, or a partner but that there is no category of income or equity partner. Respondent asserts that if appellant was an employee, the firm would have issued a Form W-2 or if he was an independent contractor, it would have issued a Form 1099-MISC. Instead, respondent states that the firm issued appellant a Schedule K-1, which signifies that he was a partner and appellant never objected to the Schedule K-1.

*7 Respondent asserts that appellant relies on a number of unpublished summary decisions by this Board, which are “not citable as precedent for any purposes” under R&TC section 40, subdivision (d), and this Board's Rules for Tax Appeals, Regulation 5551. Respondent also contends that these unpublished summary decisions “rely heavily upon the factors outlined in Commissioner v. Culbertson, which have been greatly de-emphasized since the enactment of the check-the-box regulations.” Respondent states that “[i]t is questionable whether the factors outlined in Culbertson have any continuing vitality at all” since the check-the-box regulations were enacted.

Respondent asserts that appellant relies on the following three factors set forth in Culbertson: 1) the parties' agreement; 2) their respective abilities and capital contributions; and 3) the actual control of income and the purpose for which it is used. Respondent states that these factors are no longer relevant to this determination and contends that appellant has failed to provide a copy of the partnership agreement that purportedly designates him as an “income partner.” Citing the Appeal of Oscar D. and Agatha Seltzer, 80-SBE-154, decided on November 18, 1980,6 respondent states that its determinations must be upheld in the absence of uncontradicted, credible, competent and relevant evidence showing that its determinations are incorrect.

Respondent contends that the firm elected to designate itself as a partnership under Treasury Regulations section 301.7701-2(a), which means that “all members, regardless of classification, are to be treated as partners for tax purposes, regardless of the rights, privileges, and obligations granted or required under the partnership agreement.” Respondent asserts that, “[a]s an owner of an interest in the partnership, appellant is a partner.”

Respondent contends that appellant was a partner of the firm even if he did not have a capital interest in the partnership. Citing Pogetto v. United States (9th Cir. 1962) 306 F.2d 76, 79, respondent argues that “the extent of appellant's capital interest or lack thereof in a service partnership like a law firm is not a relevant inquiry.” Citing Blalock v. Allen, supra, 100 F. Supp. 869 and Pucci v. Comm'r (1951) 10 T.C.M. (CCH) 529, respondent states that “in a non-capital intensive venture, such as a law firm, the performance of services in connection with the law firm's business is [a] far more essential factor in establishing a person as a partner” than “the extent of appellant's capital interest or lack thereof[.]”

Respondent contends that there is no merit to appellant's argument that he did not share in the firm's profits because it is not relevant how the firm chose to allocate its profits. Respondent asserts that under the check-the-box regulations, Treasury Regulations section 301.7701-1(a)(2), a partnership is created for federal tax purposes if the participants “carry on a trade, business, financial operation, or venture and divide the profits therefrom.” Respondent states that “the division of profits for these purposes does not require sharing of the risks and rewards of entrepreneurial participation.” Respondent asserts that “profits are considered divided if they are derived from the same business and are not derived in some third-party capacity, such as an employee or lender.” Respondent states, “Although appellant argues he did not share in the law firm's California profits, his law firm owned its Texas profits, as well as the profits from the other states and district in which it did business (including profits derived from California).” Citing R&TC section 25101 et seq., respondent asserts that California's unitary tax rules control for tax purposes.

*8 Respondent contends that there is no merit to appellant's argument that he did not share in the firm's losses because none of the partners was personally liable for the firm's losses pursuant to Ohio law. Respondent asserts that the Ohio Secretary of State Office and Florida Department of State Division of Corporations' records show that the firm was an Ohio LLP and that Ohio Revised Code section 1776.36 provides that a partner of an LLP is not personally liable for the partnership's obligations solely by reason of being or acting as a partner. Moreover, respondent contends that, assuming it was relevant whether appellant had a voice in the management of the law firm, appellant “has failed to provide respondent with a copy of the partnership agreement or any other corroborating evidence in support of this assertion.”
In its additional brief, respondent asserts that it is attaching appellant's 2007 federal wage and income transcript, which includes the relevant Schedule K-1 from the firm showing that during 2007, appellant received guaranteed payments totaling $185,278. Respondent asserts that in his opening brief and reply brief, appellant stated that the partnership returns should indicate him to be a “general partner” receiving guaranteed compensation. Attached to respondent's additional brief is a copy of appellant's 2007 federal wage and income transcript, including a Schedule K-1 1065 from the firm showing guaranteed payments of $185,278.

Discussion

Burden of Proof

In an appeal based on a denial of a claim for refund, the appellant must prove that respondent's determination of his tax liability is erroneous and the correct amount of tax that he or she owes. (Appeal of Omer W. Ross Deceased, 86-SBE-120, June 10, 1986; Appeal of Edward Durley, 82-SBE-154, July 26, 1982 (citing Griffin v. United States (5th Cir. 1979) 588 F.2d 521).) An appellant's unsupported assertions are not sufficient to satisfy his or her burden of proof; further, an appellant's failure to produce evidence that is within his or her control gives rise to a presumption that such evidence is unfavorable to their appeal. (Appeal of James C. and Monablanche A. Walshe, 75-SBE-073, Oct. 20, 1975; Appeal of Don A. Cookston, 83-SBE-048, Jan. 3, 1983.)

Partnership for Income Tax Purposes

IRC section 761(b) defines a partner for federal tax purposes as a member of a partnership. (See also Int.Rev. Code, § 6231(a)(2)(A).) Federal partnership tax law (i.e., IRC sections 701-761) is generally incorporated into California law at R&TC section 17851. Federal partnership tax regulations are generally incorporated into California law at R&TC section 17024.5, subd. (d).) Whether a partnership exists for tax purposes is a matter of the Internal Revenue Code and/or the Revenue &Taxation Code, rather than local law. (Treas. Reg., § 301.7701-1(a)(1); Rev. & Tax. Code, § 23038, subds. (b)(2)(B)(ii) & (iii); Cal. Code of Regs., tit. 18, § 23038, subd. (b)-1.

*9 As relevant to this appeal, Ohio partnership law allows a partnership to file as an LLP. (ORC Ann. 1775.61(A) (as in effect in 2007).)7 An Ohio LLP will generally protect the partners from liability from the partnership's obligations. (Ohio Rev. Code Ann. § 1776.36(C).) (“An obligation of a partnership incurred while the partnership is a limited liability partnership, whether arising in contract, tort, or otherwise, is solely the obligation of the partnership.”)

In Culbertson, supra, 337 U.S. at pp. 741-743, the Supreme Court held that in determining whether a partnership will be respected for tax purposes, the inquiry is whether “the parties in good faith and acting with a business purpose intended to join together in the present conduct of the enterprise.” The Supreme Court also held that the parties' intention should be evaluated based on all of the facts, such as “the agreement, the conduct of the parties in execution of its provisions, their statements, the testimony of disinterested persons, the relationship of the parties, their respective abilities and capital contributions, the actual control of income and the purposes for which it is used, and any other facts throwing light on their true intent[.]” (See also Comm'r v. Tower (1946) 327 U.S. 280.)

Similarly, the Tax Court in Luna v. Comm'r, supra, 42 T.C. at pp. 1077-1078, held that the issue of whether an unincorporated association qualifies as a partnership may be determined based on various factors, including the agreement and the parties' conduct in executing its terms, any contributions made by the parties, the parties' control over income and capital, whether each party is a principal and co-proprietor or whether one party was an agent or employee and whether the parties filed partnership returns or otherwise represented that they were joint venturers and whether the parties exercises mutual control over the enterprise.

Effective January 1, 1997, the so-called “check-the-box regulation,” Treasury Regulations section 301.7701-3(a), allows an eligible entity with at least two members to elect to be classified as a partnership. A business entity that is not a per se corporation is an “eligible entity,” entitled to elect its tax classification. (Treas. Regs., § 301.7701-3(a).) An eligible entity uses IRS Form 8832 to elect how it will be classified for federal tax purposes, as a corporation, a partnership, or an entity disregarded as separate from its owner. “[T]he purpose of the “check-the-box regulations” is “merely to determine whether the default tax treatment of the entity shall be under the corporate or the partnership provisions of federal tax law[.]” (Superior Trading, LLC v. Comm'r (7th Cir. 2013) 728 F.3d 676, 681, aff'g (2011) 137 T.C. 70. See also Markell Co. v. Comm'r, T.C. Memo 2014-86; Jimastowlo Oil, LLC v. Comm'r, T.C. Memo 2013-195.)

*10 Under the “check-the-box regulations,” a partnership with two or more members will be classified by default as a partnership for tax purposes unless it files IRS Form 8832 to elect a classification or change its current classification. (Treas. Regs., § 301.7701-3(b)(1).) California tax law conforms to the federal entity classification election system. (Rev. & Tax. Code, § 23038(b)(2)(B)(ii) & (iii); Cal. Code Regs., tit. 18, § 23038(b)-3(c); FTB Legal Ruling 2014-01.)8

Guaranteed Payments

As incorporated by R&TC section 17851, IRC sections 701 to 777 (Subchapter K) govern the taxation of partners in partnerships, except as otherwise provided. Payments that a partnership makes to a partner generally fall into one of the following three categories: 1) payments representing distributions of the partner's distributive share of partnership income (See Int.Rev. Code, § 731); 2) payments in circumstances in which the partner is not treated as a partner. (Int.Rev. Code, § 707(a); and 3) guaranteed payments (Int.Rev. Code, § 707(c)). (Seismic Support Services, LLC v. Comm'r, T.C. Memo. 2014-78, fn. 9 (citing Cahill v. Comm'r, T.C. Memo 2013-220.)
A guaranteed payment is a payment to a partner from a partnership in consideration for services or use of capital that does not represent a distribution and it is determined without regard to the income of the partnership. (Int.Rev. Code, § 707(c); Treas. Regs., § 1.707-1(c).

) Guaranteed payments by a partnership to a partner are includible in the gross income of the partner receiving guaranteed payments and are deductible as a business expense by the partnership. (Id.) A guaranteed payment is includable in the partner's ordinary income. (Treas. Regs., § 1.707-1(c).) A partner receiving guaranteed payments is not treated “as an employee of the partnership for the purposes of withholding of tax at source, deferred compensation plans, etc.” (Id.) “The legislative history of [IRC] section 707(c) reveals that it was specifically intended to require ordinary income treatment to the partner receiving guaranteed salary payments and to give a deduction at the partnership level.” (Falconer v. Comm'r (1963) 40 T.C. 1011, 1015. See also Kampel v. Comm'r (1979) 72 T.C. 827, 833-34, affd. (2d Cir. 1980) 634 F.2d 708.)
A partnership issues a Schedule K-1 to a partner who received guaranteed payments. (See IRS Publication, “Partner's Instructions for Schedule K-1 (Form 1065-B) (2007) Partner's Share of Income, Deductions, Credits, etc. (For Partner's Use Only).”9 A partnership issues a Schedule K-1 to partners; it is not issued to an employee or an independent contractor. (Id.) A partner reports guaranteed payments for personal services on his Schedule E (Form 1040), line 28, column J. (Id.)
California imposes a tax upon the California-source income of nonresidents. (Rev. & Tax. Code, § 17041, subd. (b).) For purposes of computing California taxable income, R&TC section 17951 and Regulation section 17951-1, subdivision (a), limits the gross income of nonresidents to income from sources within California. Regulation 17951-1, subdivision (b), provides that the gross income of a nonresident member of a partnership includes his or her distributive share of the partnership's taxable income to the extent that his or her distributive share is derived from sources within California.
*11 In the case of a nonresident partner, R&TC section 17854 provides that guaranteed payments by a partnership to a nonresident partner shall be treated as a part of the partner's distributive share of the partnership's profits for purposes of computing the partner's gross income from California sources. R&TC section 17854 states:

For purpose of computing “taxable income of a nonresident or part-year resident” under paragraph (1) of subdivision (i) of Section 17041, in the case of a nonresident partner, guaranteed payments, as defined by Section 707(c) of the Internal Revenue Code, shall be included in that computation as gross income from sources within this state in the same manner as if those payments were a distributive share of that partnership.

There is no dispute that during 2007, the firm paid appellant, a nonresident of California, income for personal services that the firm reported as guaranteed payments to a partner under IRC section 707(c). Appellant argues that R&TC section 17854 does not apply to the guaranteed payments he received from the firm during 2007 because he was a non-equity partner. Under IRC section 707(c), which is referenced in R&TC section 17854,, guaranteed payments are expressly paid to partners. There is no statutory exception under IRC section 707(c) or Treasury Regulations section 1.707-1(c) for any type of partner, such as a non-equity or income partner. Rather, the provisions of IRC section 707(c) and Treasury Regulations section 1.707-1(c) apply to all partners.

R&TC section 17854 provides that the guaranteed payments of a nonresident partner shall be included as taxable income from sources within California “in the same manner as if those payments were a distributive share of that partnership.” There is no statutory exception under R&TC section 17854 for any type of partner, such as a non-equity or income partner. Rather, the provisions of R&TC section 17854 apply to all partners and this Board lacks the authority to carve out an exception to the plain language of the statute.

“The plain meaning of legislation should be conclusive, except in the ‘rare cases [in which] the literal application of a statute will produce a result demonstrably at odds with the intentions of its drafters.”’ (United States v. Ron Pair Enterprises, Inc. (1989) 489 U.S. 235, 242 (quoting Griffin v. Oceanic Contractors, Inc. (1982) 458 U.S. 564, 571).) Pursuant to the plain meaning of R&TC section 17854, there is no exclusion for the guaranteed payments received by a nonresident individual who is a non-equity partner. This Board has determined that a taxpayer's disagreement with the law should be directed to the Legislature, which is charged with formulating the law, rather than to those who are charged with enforcing the law as it is written. (Appeal of Thomas C. and Donna G. Albertson, 84-SBE-002, Jan. 17, 1984; Appeal of Chester A. Rowland, 75-SBE-071, Oct. 21, 1975; Appeal of Samuel R. and Eleanor H. Walker, 73-SBE-020, Mar. 27, 1973.) Appellant has not met his burden of proving that R&TC section 17854 does not apply this appeal.

*12 As relevant to this appeal, Douglas R. Richmond concludes in his law review article, The Partnership Paradigm and Law Firm Non-equity Partners, 58 U. Kan. L. Rev. 507 (2010), that non-equity partners in law firms generally are true partners as a matter of partnership law and other law despite differences between them and equity partners.” Mr. Richmond states:
“Partnership” is an imprecise term. It refers to a contractual relationship that may vary widely in form and substance. Partners do not even have to appreciate that they are partners for a partnership to exist. Viewing partnership in this light, and considering the factors discussed previously, it is apparent that non-equity law firm partners are generally “partners” in the full legal meaning and context of the term. On the facts most crucial to courts charged with evaluating alleged partnership relations-profit sharing, loss-sharing, and joint control or equal participation in management-equity and non-equity partners are closely aligned. Also important to courts evaluating whether partnerships exist is whether law firms clearly hold out their non-equity partners as partners. This they generally do. The differences between equity and non-equity partners-e.g., equity partners receive a greater share of firm profits because their income is not fixed, equity partners vote on admitting lawyers to equity partnership while non-equity partners do not vote-do not foreclose the conclusion that non-equity partners are partners for purposes of partnership law.

Appellant argues that under the “totality-of-the-circumstances” test, as articulated in Culbertson, supra, 337 U.S. at pp. 741-745, he was not a partner of the firm for purposes of R&TC section 17854, because he was a non-equity partner. Culbertson and its progeny look to the facts and circumstances surrounding the partnership to determine whether a partnership existed. These cases do not support appellant's position because the issue in these cases was whether the parties formed a valid partnership and there is no dispute here that Baker Hostetler was a valid partnership under the laws of Ohio.

The firm issued appellant a 2007 Schedule K-1, which specifically listed guaranteed payments of $185,278. According to appellant, this amount represents compensation paid by the firm to him for personal services he rendered to the firm during 2007. The issuance of a Schedule K-1 is strong evidence of the existence of a partnership between appellant and the firm. A Schedule K-1 is only issued to partners; it is not issued to an employee or an independent contractor. (See IRS Publication, “Partner's Instructions for Schedule K-1 (Form 1065-B) (2007) Partner's Share of Income, Deductions, Credits, etc. (For Partner's Use Only).”10 Appellant reported the guaranteed payments of $185,278 on his 2007 Schedule E (Form 1040), line 28, column J, which is consistent with the IRS instructions for 2007 for a partner's reporting of guaranteed payments for personal services. (Id.)

*13 We find no merit in appellant's contention that he was not a partner of the firm for tax purposes because the guaranteed payments for personal services were paid to him without regard to the profitability of the firm overall or any particular geographic office of the firm or “compensation by profits per partner or by partnership points.” In Miller v. Comm'r (1969) 52 T.C. 752, 760, the Tax Court held that a law firm's payments to one of its partners without regard to the firm's income or the partner's share of the partnership profits in consideration of the partner's services in managing the firm's office in Paris, France were guaranteed payments within the meaning of IRC section 707(c).

Although appellant contends that the 2007 Schedule K-1 that the firm issued to him should have reported that he did not have any share of the firm's liabilities, the Ohio LLP statute, Ohio Rev. Code Ann. § 1776.36(C), effectively eliminated partners' vicarious liability from the partnership's obligations. This provision states in part, “An obligation of a partnership incurred while the partnership is a limited liability partnership, whether arising in contract, tort, or otherwise, is solely the obligation of the partnership.” In addition, appellant does not dispute that he signed a partnership agreement with the firm. The Ohio LLP statute, Ohio Rev. Code Ann. § 1776.01(N), defines a partnership agreement as “the agreement among the partners concerning the partnership, whether written, oral, or implied.”

Appellant provides no legal authority for the proposition that he was not a partner in the firm because he made no cash capital contributions and the services he performed were not credited to any capital account. Capital is not usually a material income-producing factor of a partnership, such as a law firm, “where the income of the business consists principally of fees, commissions, or other compensation for personal services performed by members or employees of the partnership.” (Treas. Regs., § 1.704-1(e)(1)(iv). See also Ketter v. Comm'r, supra, 70 T.C. at p. 645; Miller v. Comm'r, supra, 52 T.C. 752, 760.)

Lastly, we are not persuaded that respondent is barred from assessing appellant a tax liability for 2007 because respondent reportedly issued him refunds for the self-assessed taxes he paid when he filed California returns for 2003, 2004, and 2005. Each tax year stands on its own and must be examined separately. (Burnett v. Sanford & Brooks Co. (1931) 282 U.S. 359, 365-366.)

CONCLUSION

Respondent's action in denying appellant's claim for refund is sustained.
Footnotes
1
Ms. Frenklak, an employee of the California Department of Tax and Fee Administration, provided counsel to the Board of Equalization in this appeal.
2
According to respondent, this is the amount of the denied refund claim consisting of additional tax of $760.14, a late filing penalty of $190.03 plus interest. In a letter dated January 15, 2013, this Board's Board Proceedings Division acknowledged appellant's appeal in the amount of $1,483.70, which appears to include $1,383.70 plus an additional amount of $100.00 that Wells Fargo Bank charged appellant for the processing of respondent's collection order. Appellant does not contest the imposition of the late filing penalty or the accrued interest.
3
The firm issued appellant a 2007 Schedule K-1, listing guaranteed payments of $185,278. Appellant reported the guaranteed payments of $185,278 on his 2007 Schedule E (Form 1040) 2007, line 28, column J.
4
Because appellant failed to timely protest the NPA within 60 days of the mailing of the NPA, by August 3, 2009, the NPA became final and could not be appealed to this Board. (Rev. & Tax. Code, §§ 19041, 19042.)
5
This Board adopted unpublished summary decisions for these appeals that appellant obtained from LexisNexis.com and attached to the appeal letter. They are not available on this Board's website. Unpublished summary decisions may not be cited as precedent and are not controlling. (Cal. Code Regs., tit 18, § 5451, subd. (d).)
6
State Board of Equalization cases (designated “SBE”) can be viewed on this Board's website (www.boe.ca.gov).
7
In 2008, the Ohio legislature enacted a new Chapter 1776 that is substantially identical to the Revised Uniform Partnership Act of 1997. Chapter 1776 replaces Chapter 1775, which was based on the Uniform Partnership Act of 1914. (Jeanne M. Rickert, Ohio's New Partnership Law,” 57 Clev, St. L. Rev. 783, 783 (2009).)
8
There is no dispute that in 2007, the firm was an Ohio LLP engaged in the practice of law in multiple states, including California, and that it filed a 2007 partnership income tax return. Appellant received from the firm guaranteed payments totaling $185,278, as reflected in the 2007 Schedule K-1 that the firm issued him.


For purposes of this appeal, there is no need to discuss business entity law as it applies to the firm, an Ohio LLP (see Treas. Regs., § 301.7701-2) or the California apportionment formula for guaranteed payments (see Regulation 17951-4(d) & (g)).
9
This IRS publication can be found on its website at http://www.irs.gov/pub/irs-prior/i1065sk1--2007.pdf.
10
This IRS publication can be found on its website at http://www.irs.gov/pub/irs-prior/i1065sk1--2007.pdf.