Free Reply to Response to Motion - District Court of Federal Claims - federal

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IN THE UNITED STATES COURT OF FEDERAL CLAIMS No. 06-407 T (into which have been consolidated Nos. 06-408 T, 06-409 T, 06-410 T, 06-411 T, 06-810 T, 06-811 T) Judge Emily C. Hewitt (E-Filed: September 14, 2007) ____________________________________________ ) ALPHA I, L.P., BY AND THROUGH ROBERT ) SANDS, A NOTICE PARTNER ) ) Plaintiff, ) ) v. ) 06-407 T ) THE UNITED STATES, ) ) Defendant. ) ____________________________________________) ) BETA PARTNERS, L.L.C., BY AND THROUGH ) ROBERT SANDS, A NOTICE PARTNER ) ) Plaintiff, ) ) v. ) 06-408 T ) THE UNITED STATES, ) ) Defendant. ) ____________________________________________) ) R, R, M & C PARTNERS, L.L.C., BY AND ) THROUGH R, R, M & C GROUP, L.P., A ) NOTICE PARTNER, ) ) Plaintiff, ) ) v. ) 06-409 T ) THE UNITED STATES, ) ) Defendant. ) ____________________________________________)

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____________________________________________ ) ) ) ) Plaintiff, ) ) v. ) ) THE UNITED STATES, ) ) Defendant. ) ____________________________________________) ) CWC PARTNERSHIP I, BY AND THROUGH ) TRUST FBO ZACHARY STERN U/A FIFTH G. ) ANDREW STERN AND MARILYN SANDS, ) TRUSTEES, A NOTICE PARTNER, ) ) Plaintiff, ) ) v. ) ) THE UNITED STATES, ) ) Defendant. ) ____________________________________________) ) MICKEY MANAGEMENT, L.P., BY AND ) THROUGH MARILYN SANDS, A NOTICE ) PARTNER, ) ) Plaintiff, ) ) v. ) ) THE UNITED STATES, ) ) Defendant. ) ____________________________________________) R, R, M & C GROUP, L.P., BY AND THROUGH ROBERT SANDS, A NOTICE PARTNER

06-410 T

06-411 T

06-810 T

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____________________________________________ ) ) ) ) Plaintiff, ) ) v. ) ) THE UNITED STATES, ) ) Defendant. ) ____________________________________________) M, L, R & R, BY AND THROUGH RICHARD E. SANDS, TAX MATTERS PARTNER,

06-811 T

PLAINTIFFS' RESPONSE AND REPLY TO UNITED STATES' RESPONSE TO PLAINTIFFS' CROSS MOTION FOR SUMMARY JUDGMENT AND TO PLAINTIFFS' REPLY TO UNITED STATES' MOTION FOR SUMMARY JUDGMENT

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TABLE OF CONTENTS PAGE(S) INTRODUCTION ...............................................................................................................1 ISSUES PRESENTED.........................................................................................................3 ARGUMENT.......................................................................................................................4 I. THE OBLIGATION TO COVER A SHORT SALE IS NOT A LIABILTY FOR PURPOSES OF SECTION 752. .....................................................................4 A. B. C. D. Defendant does not dispute the long-settled legal principle that contingent obligations are not liabilities for purposes of section 752. ........4 There is no longer any dispute that the partners' cost to cover their short sale obligations was contingent. .........................................................5 Defendant has acknowledged that Colm Producer, Inc. was incorrectly decided. ........................................................................................................7 An obligation to return property where the cost of acquiring that property is contingent, is not, and never has been, a "liability" for purposes of section 752..............................................................................10 Defendant's assertion that the IRS' position has consistently been that an obligation is a "liability" under section 752 whenever it creates or increases the basis of any of the obligors' assets is misleading.................15 The Tax Court's Memorandum Decision In Salina...................................17 Rev. Rul. 95-26 is not entitled to any deference........................................18

E.

F. G. II.

THE RETROACTIVE REGULATION IS INVALID. .........................................22 A. The Treasury Department did not have authority to promulgate the Retroactive Regulation...............................................................................24 1. 2. B. Standard of Review........................................................................26 Act section 309(c) did not give the Treasury Department authority to promulgate the Retroactive Regulation......................26

The Treasury Department failed to comply with the requirements of the Administrative Procedure Act when promulgating the Retroactive Regulation. .................................................................................................32

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C.

The Retroactive Regulation violates due process and fundamental notions of fair government and is an abuse of the Commissioner's discretion....................................................................................................35 Klamath Strategic Investment Fund, LLC v. United States.......................37

D. III.

NO PENALTIES ARE APPLICABLE OR WARRANTED. ...............................38 A. B. C. D. Plaintiffs had substantial authority for their tax positions. ........................38 Plaintiffs were not negligent. .....................................................................40 There was no valuation misstatement. .......................................................44 Plaintiffs had reasonable cause and good faith for taking the tax positions at issue. .......................................................................................45 1. 2. The Court has jurisdiction over plaintiffs' penalty defenses. ........45 Plaintiffs have demonstrated their reasonable cause and good faith. ...............................................................................................50

CONCLUSION..................................................................................................................50

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TABLE OF AUTHORITIES CASES PAGE(S)

Albany Car Wheel Co. v. Comm'r, 40 T.C. 831 (1963), aff'd, 333 F.2d 653 (2d Cir. 1964).....4, 39 Alcaraz v. Block, 746 F.2d 593 (9th Cir. 1984) .............................................................................33 American Fed'n of Gov't Employees v. Block, 655 F.2d 1153 (D.C. Cir. 1981) ...........................33 American Iron & Steel Inst. v. Envtl. Prot. Agency, 568 F.2d 284 (3d Cir. 1977) ........................34 B.F. Goodrich Co. v. United States, 94 F.3d 1545 (Fed. Cir. 1996) .............................................18 Beneficial Corp. v. United States, 814 F.2d 1570 (Fed. Cir. 1987)...............................................26 Bowen v. Georgetown Univ. Hosp., 488 U.S. 204 (1988) .................................................26, 35, 37 Brountas v. Comm'r, 692 F.2d 152 (1st Cir. 1982), cert. denied, 462 U.S. 1106 (1983) ..........4, 39 Chock Full O'Nuts Corp. v. United States, 453 F.2d 300 (2d Cir.1971) .................................35, 37 The Coalition for Common Sense in Gov't Procurement v. Sec'y of Veteran Affairs, 464 F.3d 1306 (Fed. Cir. 2006).................................................................................................32 Colm Producer, Inc. v. United States, 460 F. Supp. 2d 713 (N.D. Tex. 2006)................................................................................1, 2, 7, 8, 9, 10, 18, 40 Compaq Computer Corp. v. Comm'r, 277 F.3d 778 (5th Cir. 2001) .............................................44 Deputy v. du Pont, 308 U.S. 488 (1940)............................................................................13, 14, 39 Farmar v. United States, 689 F.2d 1017 (Ct. Cl. 1982), rev'd on other grounds, 464 U.S. 206 (1984)....................................................................................................................18, 19 Gibson Prods. Co. v. United States, 637 F.2d 1041 (5th Cir. 1981) .....................................5, 8, 38 Glass City Bank v. United States, 326 U.S. 265 (1945).................................................................32 Gregory v. Helvering, 293 U.S. 465 (1935) ..................................................................................44 Helmer v. Comm'r, 34 T.C.M. (CCH) 727 (1975).................................4, 8, , 15, 16, 17, 21, 22, 38 Henry v. Comm'r, 170 F.3d 1217 (9th Cir. 1999)..........................................................................40 IES Indus. v. United States, 253 F.3d 350 (2001)..........................................................................44

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Klamath Strategic Inv. Fund, LLC v. United States, 440 F. Supp. 2d 608 (E.D. Tex. 2006) ....................................................................................3, 14, 17, 21, 22, 35, 37, 40, 48 Klamath Strategic Inv. Fund, LLC v. United States, 472 F. Supp. 2d 885 (E.D. Tex. 2007) ..................................................................................................................................48 La Rue v. Comm'r, 90 T.C. 465, 1988 WL 23562 (1988) .............................................8, 10, 11, 38 Lemery v. Comm'r, 52 T.C. 367 (1969), aff'd on other grounds, 451 F.2d 173 (9th Cir. 1971) ..............................................................................................................................4, 39 Long v. Comm'r, 71 T.C. 1, 1978 WL 3318 (1978).........................................................4, 8, 16, 38 Long Term Capital Holdings v. United States, 330 F. Supp. 2d 122 (D. Conn. 2004) .................48 Ludwig v. Comm'r, 68 T.C. 979 (1977) .........................................................................................37 Mobil Oil Corp. v. Dep't of Energy, 610 F.2d 796 (Temp. Emer. Ct. App. 1979) ........................33 National Fed'n of Fed. Employees v. Devine, 671 F.2d 607 (D.C. Cir. 1982) ..............................33 New Jersey, Dep't of Envtl. Prot. v. United States Envtl. Prot. Agency, 626 F.2d 1038 (D.C. Cir. 1980) .................................................................................................................33 Rice's Toyota World, Inc. v. Comm'r, 81 T.C. 184 (1983), affd. on this issue, 752 F.2d 89 (4th Cir. 1985)....................................................................................................................44 Rite Aid Corp. v. United States, 255 F.3d 1357 (Fed. Cir. 2001) ............................................25, 26 Salina Partnership v. Comm'r, 80 T.C.M. 686 (2000) ................................................15, 17, 18, 39 Santa Monica Pictures, LLC v. Comm'r, 89 T.C.M. (CCH) 1157 (2005).....................................48 Schlumberger Tech. Corp. v. United States, 55 Fed. Cl. 203 (2003) ................................18, 20, 44 Texas Food Indus. Assoc. v. United States Dep't of Agric., 842 F. Supp. 254 (W.D. Tex. 1993) ..................................................................................................................................34 Trainer v. United States, 800 F.2d 1086 (Fed. Cir. 1986) .............................................................20 United States v. Carlton, 512 U.S. 26 (1994) .........................................................................35, 36 United States v. Garner, 767 F.2d 104 (5th Cir. 1985) .................................................................33 United States v. Mead Corp., 533 U.S. 218 (2001) .......................................................................19 United States v. Rainbow Family, 695 F. Supp. 294 (E.D. Tex. 1988) ...................................33, 34

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Vinson v. Comm'r, 38 T.C.M. (CCH) 740 (1979)..........................................................................37 Xerox Corp. v. United States, 41 F.3d 647 (Fed. Cir. 1995)..........................................................20 Zhang v. Slattery, 55 F.3d 732 (2d Cir. 1995) ...............................................................................33 STATUTES 5 U.S.C. §§ 553(b) .........................................................................................................................32 5 U.S.C. § 553(b)(B)......................................................................................................................32 26 U.S.C. § 358(h)(1) ....................................................................................................................29 26 U.S.C. § 358(h)(2) ....................................................................................................................30 26 U.S.C. § 358(h)(3) ....................................................................................................................29 26 U.S.C. § 6664............................................................................................................................47 Community Renewal Tax Relief Act of 2000, Pub. L. No. 106-554, 114 Stat. 2763 (2000).................................................................................................................................24 RULES AND REGULATIONS Treas. Reg. § 1.1233-1(a)(1)..........................................................................................................38 Treas. Reg. § 1.358-7.........................................................................................................28, 29, 30 Treas. Reg. §1.6662-3....................................................................................................................40 Treas. Reg. § 1.662-3(b) ................................................................................................................44 Treas. Reg. § 1.752-1(a)(4)(i) ........................................................................................................23 Treas. Reg. § 1.752-1(a)(4)(ii).......................................................................................................22 Treas. Reg. § 1.752-6(a) ..........................................................................................................22, 23 Treas. Reg. § 1.752-6(b)(2)............................................................................................................30 Treas. Reg. § 1.752-6(d) ................................................................................................................35 Treas. Reg. § 1.752-7...............................................................................................................24, 31 Treas. Reg. § 1.752-7(b)(3)............................................................................................................22 Treas. Reg. § 1.752-6.......................................................................................................2, 3, 22, 23 v

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Rev. Rul. 73-301, 1973-2 C.B. 215 .........................................................................................15, 21 Rev. Rul. 88-77, 1988-2 C.B. 129 ...........................................................................................16, 18 Rev. Rul. 95-26, 1995-1 C.B. 131 ...............................................................................18, 19, 20, 39 MISCELLANEOUS 1997 FSA (Nov. 21, 1997) at 1997 W.L. 33313960......................................................5, 11, 16, 39 Assumption of Partner Liabilities, 68 Fed. Reg. 37,414, 37,416 (June 24, 2003)...............................................................................17, 22, 24, 31, 32, 34, 36 Chief Counsel Notice 2003-020 (June 25, 2003), 2003 WL 24016805 ........................................37 David F. Shores, Deferential Review of Tax Court Decisions: Dobson Revisted, 49 Tax Law 629 (1996)..................................................................................................................49 H.R. Rep. No. 105-148 at 594 (1997)............................................................................................46 Industry Specialization Program Coordinated Issue, "Basis Shifting" Tax Shelter, 2002 WL 32351285 (Dec. 3, 2002) ............................................................................................47 Industry Specialization Program Coordinated Issue, Notional Principal Contracts, 2005 WL 43711 (Jan. 6, 2005) ...................................................................................................47 I.R.S. Notice 2000-44 ..............................................................................................................39, 40 I.R.S. Notice 2001-17 ....................................................................................................................27 John F. Coverdale, Court Review of Tax Regulations and Revenue Rulings in the Chevron Era, 64 Geo. Wash. L. Rev. 35, 87 (1995) .............................................18, 19, 20 Letter from the American Institute of Certified Public Accounts to Commissioner Mark Everson, AICPA Comments on Proposed and Temporary Regulations on Assumption of Partner Liabilities Under I.R.C. Section 752, 83 DTR G-7 (April 30, 2004) ............................................................................................................................24 Letter from Fred Goldberg, Jr. (former IRS Chief Counsel, Commissioner of IRS, and Assistant Secretary of the Treasury for Tax Policy) to IRS, Goldberg Suggests Son of Boss Regs Will Diminish Settlement Prospects, 2003 Tax Notes Today 219-47 (Nov. 13, 2003)......................................................................................................24 Letter from New York State Society of Certified Public Accountants to Mr. Horace Howells at IRS, CPAs Comment On Proposed Definition of Partnership Liabilities, 2003 Tax Notes Today 195-16 (Sept. 15, 2003) .............................................24

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Robert Bird & Alan Tucker, Tax Sham or Prudent Investment: Deconstructing the Government's Pyrrhic Victory in Salina Partnership v. Commissioner, 22 Va. Tax Rev. 231, (2002) ................................................................................................................17 STAFF OF JT. COMM. ON TAX'N, 105TH CONG., GENERAL EXPLANATION OF TAX LEGISLATION ENACTED IN 1997 377 (Jt. Comm. Print 1997) ("1997 Blue Book")...........46 WEBSTER'S THIRD NEW INT'L DICTIONARY 1798 (3d ed. 1968). ..................................................33

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INTRODUCTION The central legal issue raised in the parties' cross motions for summary judgment is whether the obligation to cover a short sale is a "liability" for purposes of section 752. While defendant goes to great lengths to cloud the issue, there is no dispute that the answer to this question depends on whether the obligation to cover the short sale with replacement securities is contingent or, instead, is fixed and determinable. If the obligation is contingent it is not a liability for purposes of section 752. Conversely, if the obligation is fixed and determinable, then it is a liability for purposes of section 752.1 There have been several important developments since the parties filed their opening briefs. First, the parties deposed Mr. Fritz Luedke, the broker at UBS Paine Webber who facilitated the short sale trades at issue in this case. Mr. Luedke testified that the obligation to cover a short sale is contingent because the cost to acquire covering securities cannot be known until the covering securities are actually acquired and the short sale is closed. Mr. Luedke's testimony is undisputed, and it reflects the accepted understanding of a short sale both in the investment community and in existing legal authority. Second, defendant has now retreated from the decision of the district court in Colm Producer, Inc. v. United States, 460 F. Supp. 2d 713 (N.D. Tex. 2006), which defendant asked this Court to follow in defendant's opening brief. In Colm, the district court held, precisely contrary to the government's position here, that the obligation to cover a short sale position is a contingent obligation. However, the district court in Colm also held that the obligation in that case became fixed and determinable and, therefore, a "liability" for purposes of section 752, when the partners in the partnership (which held the short sale position) sold their partnership
1

Unless otherwise noted, all references to "section" or "Code" are to the Internal Revenue Code of 1986, as amended.

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interests to a third party (because at that time the amount of the obligation could then be calculated for purposes of computing the partners' bases in the partnership). Defendant has now conceded that the district court erred in this latter conclusion, leaving only the district court's initial determination that the obligation to cover a short sale position is a contingent obligation. Mr. Luedke's testimony and defendant's retreat from Colm has left defendant in an untenable position. The law is clear that contingent obligations do not constitute liabilities for purposes of section 752, and the evidence is clear that the obligation to cover a short sale is contingent in amount. In response, defendant makes a contrived argument: that the obligation to close the short sale is fixed and determinable (and therefore a "liability" for purposes of section 752) in the sense that the borrower knows at the outset what type and how many securities will have to be delivered to the lender to close the short sale, even though the borrower cannot know in advance how much it will cost to acquire those covering securities. As plaintiffs explain herein, defendant's effort to create a new framework of tax law that would determine basis by reference to abstract property rights and obligations, instead of cost, must be rejected. Evidently recognizing that its interpretation of section 752 is deeply flawed, defendant now seeks to raise an entirely new ground in support of its motion for summary judgment. Defendant now argues that even if the obligation to cover a short sale is not a liability for purposes of section 752, then it must be treated as a liability under the alternative framework of Treas. Reg. § 1.752-6. That regulation (hereinafter sometimes referred to as the "Retroactive Regulation"), which was promulgated in 2003, purports to retroactively change the definition of a "liability" for purposes of section 752 to include the very contingent obligations that defendant has historically and consistently argued are not liabilities for purposes of section 752. The Retroactive Regulation is nothing more than an effort by defendant to buttress its litigating position in current cases, and has properly been held invalid by the only court to have considered

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it. Klamath Strategic Inv. Fund, LLC v. United States, 440 F. Supp. 2d 608, 621-22 (E.D. Tex. 2006). Finally, on July 31, 2007, the day that discovery was initially scheduled to expire in this case, defendant produced to plaintiffs a number of inaccurate and incomplete documents that defendant had in its possession since at least December of 2006. These documents contained what purport to be transcripts of conversations between employees of The Heritage Organization "Heritage" and members of the Sands family. Defendant relied on these purported transcripts in its response brief to assert that it has properly asserted penalties against plaintiffs. However, defendant did not submit these transcripts under the affidavit of any witness with personal knowledge of their content. The parties have since deposed several participants to these conversations, and none of these witnesses could authenticate the transcripts, establish them as business records, or establish a chain of custody. Plaintiffs have filed contemporaneously with this brief a motion to strike these purported transcripts from defendant's response. Regardless, defendant makes too much of these purported transcripts: the Sands have never disputed the fact that taxes were an important part of their decision-making process. However, the undisputed evidence clearly establishes that the Sands considered several important non-tax purposes when they decided to engage in these transactions and that tax savings was not their "sole motivation" as defendant now claims. ISSUES PRESENTED In addition to the issues presented in plaintiffs' opening brief, defendant's response raises the following additional issue: Whether Treas. Reg. § 1.752-6 applies to reduce the partners' basis in Alpha and Alpha to reduce its basis in Beta by the "amount" of the contingent obligation to close the short sale?

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ARGUMENT I. THE OBLIGATION TO COVER A SHORT SALE IS NOT A LIABILTY FOR PURPOSES OF SECTION 752. A. Defendant does not dispute the long-settled legal principle that contingent obligations are not liabilities for purposes of section 752.

In their opening brief, plaintiffs discussed several of the many cases and authorities which universally hold that contingent obligations are not treated as "liabilities" for purposes of section 752. (Pls.' Resp. and Cross-Mot. Summ. J. 14-21.) Defendant has never disputed the validity of this legal principle. To the contrary, defendant has consistently advocated this very position, as it has historically worked to its benefit, and has been instrumental in creating this body of law. To put the issue beyond any doubt, plaintiffs direct the Court's attention to many other cases, aside from the trilogy of Helmer, Long and LaRue, all of which cases have consistently held that contingent obligations do not constitute liabilities for purposes of section 752. In Lemery v. Comm'r, 52 T.C. 367, 377-378 (1969), aff'd on other grounds, 451 F.2d 173 (9th Cir. 1971), the Tax Court held that a purchaser's obligation to pay the seller $200,000 out of the purchaser's "net profits" for a covenant not to compete was too contingent and indefinite to be included in the purchaser's cost basis. In Albany Car Wheel Co. v. Comm'r, 40 T.C. 831 (1963), aff'd, 333 F.2d 653 (2d Cir. 1964), the Tax Court held that the purchaser's obligation under a union contract which was in effect prior to the purchase of the assets and which required the purchaser to give written notice or severance pay to employees with one and five years' service was too speculative to be included in the basis of the purchased assets. In Brountas v. Comm'r, 692 F.2d 152 (1st Cir. 1982), cert. denied, 462 U.S. 1106 (1983), the First Circuit Court of Appeals held that a partner's obligation under nonrecourse notes, which would be paid out of oil and gas production or not at all, were too contingent or speculative to be included in the partner's

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basis for purposes of section 752. In Gibson Prods. Co. v. United States, 637 F.2d 1041 (5th Cir. 1981), the Fifth Circuit Court of Appeals held that a partnership's liability under nonrecourse notes which would be paid out of possible future oil and gas production was too contingent to be treated as a liability for purposes of section 752. The IRS analyzed these same cases in 1997 and concluded that "contingent liabilities which are too contingent to value are generally not added to basis until they become fixed." 1997 FSA (Nov. 21, 1997) at 1997 WL 33313960 (Pls. Ex. 8, App. A at p. 2).2 It is therefore undisputed that the partners' obligations to cover the short sale positions at issue in this case are not to be treated as "liabilities" for purposes of section 752, as we submit, these obligations were contingent in nature or amount. B. There is no longer any dispute that the partners' cost to cover their short sale obligations was contingent.

On December 11, 2001, each of the Alpha limited partners executed short sales of Treasury Notes through brokerage accounts at UBS PaineWebber. To effectuate the short sales, each of the limited partners borrowed Treasury Notes from UBS PaineWebber and sold them on the open market for cash. Specifically, the limited partners borrowed an aggregate face amount of $30,800,000 U.S. Treasury notes bearing coupon interest of 2.75% due 9/30/03 and an aggregate face amount of $13,200,000 U.S. Treasury notes bearing coupon interest of 4.625% due 5/15/06, and they sold all of those Treasury Notes for cash. As is true in any short sale, the limited partners as the borrowers were obligated to return to UBS PaineWebber as the lender the property that they had borrowed. Thus, the limited partners were obligated to return to UBS PaineWebber an aggregate face amount of $30,800,000

2

In fact, plaintiffs' description of these cases in this brief is taken almost verbatim from the IRS description of them in the 1997 Field Service Advisory.

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U.S. Treasury notes bearing coupon interest of 2.75% due 9/30/03 and an aggregate face amount of $13,200,000 U.S. Treasury notes bearing coupon interest of 4.625% due 5/15/06. However, the limited partners had discretion as to when they would close the short sale as there was no fixed timetable for settlement. Pls. Ex. 69, App. B at p. 142. The partners would earn a profit on these short sales if the price of these Treasury Notes declined by the time that the replacement notes were acquired and delivered back to UBS PaineWebber. (Pls.' Resp. and Cross-Mot. Summ. J. 8-9); Pls. Ex. 69, App. B at pp. 136-38. The parties deposed Mr. Fritz Luedke, a Senior Vice President at UBS PaineWebber on July 17, 2007. Mr. Luedke obtained his MBA from the Wharton School of Business in 1979, and after working for Solomon Brothers and Merrill Lynch for several years, has been working at UBS PaineWebber since the late 1980's. Mr. Luedke specializes in fixed income securities, such as Treasury Notes. Pls. Ex. 69, App. B at pp. 132-35. Mr. Luedke's testimony is highly instructive on the contingency point: Q. When a customer executes a short sale of Treasury notes for example, can you tell

them how much it will cost to close short sale? A. Q. A. Q. A. Heavens no. Why not? To close it out? Uh-huh. It is ­ it's unforseeable [sic]. There's no way on earth you could. If interest rates

go up, they'll make money, if interest rates go down, they'll lose money. You're making an interest call. .... Q. But when the customer executes the short sale of Treasury notes, they don't know

then what it's going to cost to cover the short sale? MR. BERRY: To close?

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A.

To close the transaction? Absolutely not. Of course, not ­ let me think. When

you buy a stock, you know what it's going to be in a week? No. And it's similar to that. You don't know. That's the market. Q. A. Q. A. Q. A. .... Q. A. So the cost to cover is going to be contingent on what the market does? Exactly. When do you know what it will cost? When they close the transaction, when they cover their short. How is the price of Treasury notes determined; do you know? No. If I knew that... I've been pondering that for 28 years. Do you know any of the factors that relate? What moves the markets.

Pls. Ex. 69, App. B. at pp. 139-41, 143. Mr. Luedke's testimony is undisputed. Thus, there is no longer any question in this case that the limited partners' cost to acquire notes to close their short sale positions was contingent and could not be determined when they executed the short sales. The only remaining dispute on the section 752 issue is defendant's new found position that the obligations to cover the short sales ­ while contingent in amount ­ are fixed and determinable (and purportedly therefore liabilities for purposes of section 752) in the sense that the borrower is required to return specific property to the lender. Plaintiffs address this contention below, but believe it is instructive to set the stage by revisiting the Colm case which defendant relied on in its opening brief. C. Defendant has acknowledged that Colm Producer, Inc. was incorrectly decided.

In its opening brief defendant directed this Court's attention to Colm Producer, Inc. v. United States, 460 F. Supp. 2d 713 (N.D. Tex. 2006), and argued that this Court should follow the Colm decision. (Def.'s Mot. Summ. J. 15-16, 19.) However, defendant has since

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acknowledged that the district court wrongly decided Colm, and what is left of the Colm decision now directly supports plaintiffs' position in this case. As in this case, the partners in the Colm partnership executed short sales and then contributed those brokerage accounts to the partnership. Unlike in this case, the partners in the Colm partnership then sold their interests in the partnership (which had not yet closed the short sales) to an unrelated buyer. The issue in Colm was otherwise the same as that here: whether the obligation to close the short sale positions should be treated as a liability for purposes of calculating the partners' bases in their partnership interest under section 752. The district court concluded as follows: Although COLM correctly states that "liability" within the meaning of section 752 does not encompass contingent obligations, COLM erroneously concludes that the obligation to replace the borrowed T-Notes constitutes a contingent obligation. The cases on which COLM relies stand for the proposition that liabilities that are contingent as to the obligation itself or as to the amount of the obligation do not qualify as "liabilities" for purposes of section 752. [FN1] However, the obligation to close a short sale by replacing the borrowed TNotes is not contingent in this way. First, the existence of the obligation to replace the borrowed T-Notes was not itself contingent; the obligation existed as a legally enforceable obligation when GMK sold Valiant to Czerwinski. Second, the amount of the obligation became fixed at the moment GMK sold Valiant because at that time GMK could determine its gain or loss on the short sale transaction according to the current market rates for T-Notes; any future fluctuations in the interest rates affected the gain or loss of the short sale transaction only as to Czerwinski, not GMK. FN1. See La Rue v. Comm'r 90 T.C. 465, 479, 1988 WL 23562 (1988) (clarifying that a fixed and definite contractual liability does not amount to a "liability" under section 752 until the cost of that obligation becomes fixed in amount); Long v. Comm'r, 71 T.C. 1, 7, 1978 WL 3318 (1978) (stating that "although [the claims at issue] may be considered 'liabilities' in the generic sense of the term, contingent or contested liabilities are not 'liabilities' for [section 752 purposes] at least until they become fixed or liquidated"); Helmer v. Comm'r, 34 T.C.M. (CCH) 727 (1975) (holding that partnership's receipt of option payments from a third party under an option agreement for purchase of property did not give rise to a section 752 liability because the partnership's obligation to credit the payments against the purchase price was contingent upon the third party's exercise of the option); see also Gibson Prods. Co. v. U.S., 637 F.2d 1041 (5th Cir. 1981) (finding that promissory note did not constitute a liability for purposes of section

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752 when the partnership's liability on the note depended upon future oil and gas production under the oil and gas lease). 460 F.Supp. 2d at 716 (emphasis added). Neither party in this case disputes the district court's conclusion in Colm that a "'liability' within the meaning of section 752 does not encompass contingent obligations". Indeed, this principle is now so well-established in the case law that it is beyond dispute. And the district court plainly and correctly concluded that the obligations to cover the short sale positions were contingent in amount when the short sales were executed. This is the very issue facing this Court, and the district court in Colm plainly decided it in plaintiffs' favor. The district court in Colm then determined that the amount of the obligation to cover the short sale became fixed and determinable when the partners in the partnership holding the short sale positions sold their partnership interests, such that the amount of the obligation could then be calculated. However, as plaintiffs explained in their opening brief, the fact that the obligation may have become fixed and determinable after it was assumed by the partnership would not result in any adjustment to the partners' basis under section 752. (Pls.' Resp. and Cross-Mot. Summ. J. 31-32.) Defendant now understands this. In its brief on the appeal of Colm to the Fifth Circuit defendant disavowed the conclusion reached by the district court: We agree with appellants that the District Court erred in using, sua sponte, the date of sale of a partnership interest to determine whether a partnership obligation is fixed or contingent. The proper time for determining whether an obligation is fixed is the date the obligation becomes a partnership obligation. Pls. Ex. 9, App. A. at p. 5. It is curious that much of defendant's response brief in this case is quoted verbatim from its brief to the Fifth Circuit, but defendant neglected to inform this Court of the concession it has made in the Fifth Circuit. It is disingenuous for defendant to ask this Court to follow Colm while at the same time distancing itself from that decision in the Fifth Circuit.

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In the Colm appeal, defendant is now making the same desperate and novel argument that it is making in this case: that the obligation to cover a short sale is fixed and determinable when the short sale is first executed because the borrower knows how much and what type of property must be returned to the lender, even though the borrower cannot anticipate what it will ultimately cost to acquire that property. As plaintiffs discuss next, defendant's effort (here and on appeal in Colm) to salvage its position under section 752 is misguided and wrong. D. An obligation to return property where the cost of acquiring that property is contingent, is not, and never has been, a "liability" for purposes of section 752.

Defendant's argument ­ that an obligation to return specific property is a liability for purposes of section 752 even though the cost of acquiring that property is unknown ­ is almost comical because this is precisely the argument that was made by the taxpayer and disputed by defendant and rejected by the Tax Court in La Rue v. Comm'r, 90 T.C. 465 (1988). In La Rue, the taxpayer was a general partner in Goodbody & Co., which at the time was one of the largest stock brokerage firms in the country. Unfortunately, Goodbody "encountered logistical problems due to a failure of their record keeping technology to keep up with trading volume," which were known as back office problems. Some of these problems resulted in Goodbody owing money to its customers, but many of the failures left Goodbody liable for missing or overbought securities. The Service argued, and the Tax Court agreed, that while Goodbody's obligations to replace missing securities was fixed in the sense that the taxpayer was under an obligation to replace those securities for its customers, that obligation did not constitute a liability for purposes of section 752 because the cost of acquiring those securities was contingent on the market. The Tax Court wrote: Once the `back office' failures occurred, Goodbody incurred an obligation. The partnership was contractually obligated to its customers under the NYSE rules. Goodbody was under an obligation to replace any missing securities or money. . . . All of petitioners' witnesses testified that these were transactions 10

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for which the partnership was liable. There was, however, a contingency or speculative quality concerning the amount of Goodbody's liability. Until any missing securities were purchased or excess securities sold, at market price, there was no way of determining the amount of loss, or in some circumstances, gain. Petitioners have not shown that these amounts were determinable with reasonable accuracy. . . . [T]he exact amount of loss or gain was not determinable until actual purchase or sale. Valuation of the claims may be a purely ministerial matter because of the ready market for securities, but is not readily determinable until purchase or sale occurs. The additional reserves reflected potential liabilities of the partnership, valued by reference to listed stock prices but before actual sale or purchase and, accordingly, represented estimates. Accrual accounting requires that the amount be determinable with `reasonable accuracy.' A loss is not determinable until the securities are actually purchased or sold, and the transaction closed. We accordingly hold that because the reserves were not a fixed obligation of the partnership sufficiently determinable in amount in 1970, they cannot be included in the partners' bases in that year. LaRue, 90 T.C. at 479-80 (footnotes omitted). The obligation at issue in LaRue ­ to replace identified missing securities ­ is indistinguishable from the obligation of the Alpha partners to cover their short sales of Treasury notes. In LaRue, the Tax Court clearly held that, despite the existence of a ready market from which the securities could be obtained or priced, the amount of the obligation remained contingent and speculative and such an obligation therefore could not represent a "liability" under section 752. La Rue has been followed and positively discussed in several dozen cases, IRS pronouncements, and scholarly articles. And, the IRS conducted a careful analysis of La Rue and the other contingent liability cases discussed in this brief and concluded ­ in stark contrast to defendant's position here ­ that "contingent liabilities which are too contingent to value are generally not added to basis until they become fixed." 1997 FSA (Nov. 21, 1997) (emphasis added) (Pls. Ex. 8, App. A at p.2). The conclusion reached by the Tax Court in La

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Rue should control in this case, and the government has offered no explanation for its selfinterested abandonment of its victory in La Rue.3 In any event, defendant's position here is simply wrong for a number of reasons. To begin with, defendant's theory is nothing more than an effort to distinguish obligations to deliver property from obligations to deliver cash. However, an obligation to deliver an unknown amount of cash and an obligation to deliver property, where the cost of acquiring the property is unknown, are contingent in precisely the same manner. In either case, the obligor simply does not know how much it will cost to satisfy the obligation. Indeed, defendant's theory fails to account for the possibility that the borrower and lender in a short sale may agree to "cash settle" the transaction. Defendant's position in this case is also directly contrary to how defendant requires taxpayers to calculate gain or loss on short sales under section 1233. As explained by plaintiffs in their opening brief, the law is clear that taxpayers are precluded from recognizing gain or loss on a short sale precisely because the amount it will cost the taxpayer to acquire covering securities is contingent. (Pls.' Resp. and Cross-Mot. Summ. J. 8-13.) Neither the courts nor defendant have ever accepted the position for purposes of section 1233 that defendant advocates here: that the obligation to cover a short sale should be considered "fixed and determinable" because the borrower is obligated to deliver replacement securities at some point in the future. Defendant's brief wholly fails to explain how the same exact obligation can be "contingent" for purposes of section 1233 but "fixed and determinable" for purposes of section 752.

3

On the bottom of page 6 of its response brief, defendant asserted that "plaintiffs have cited no authority holding that an unconditional obligation to replace borrowed property borrowed from a third party is a contingent liability." La Rue is such an authority.

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Indeed, defendant fails to offer any support (aside from its own Revenue Ruling) as to how the amount of the liability should be quantified. Defendant now argues that the amount of the "liability" in a short sale equals the amount received on the sale of the borrowed securities. But everyone agrees that such amount will almost certainly not be accurate, which is why the "open transaction doctrine" and section 1233 defer the recognition of gain or loss. Defendant does not explain how taxpayers should account for changes in the "amount" of the "liability" as what would be the cost to close the position changes from day-to-day. Defendant's theory would also open up a Pandora's Box. If the obligation to return specific property is a liability for purposes of section 752, then partners in partnerships will be able to shift basis at will. Assume a partnership has two equal partners, each with a $1,000 basis in their partnership interests. Partner A wants to "shift" $500 of his basis to Partner B. Under defendant's theory, Partner A can simply borrow a piece of property worth $1,000 and contribute it to the partnership. If the obligation to return the property is a "liability," as defendant argues here, then Partner A has his basis reduced by the $1,000 obligation assumed by the partnership, see section 752(b), but both partners then have their bases increased by their equal shares of the new partnership liability under section 752(a). Defendant is asking the Court to set a very dangerous precedent. Defendant's position is also directly contrary to Deputy v. du Pont, 308 U.S. 488 (1940). In du Pont, the taxpayer borrowed stock and agreed to return it within ten years, and also agreed in the interim to pay the lender all dividends that he received on the borrowed shares. The taxpayer then sold the stock to nine du Pont executives (i.e., he sold it short). In 1931, the taxpayer paid the lender $567,648 in dividends that had been paid on the stock, and he deducted that amount as "interest paid or accrued . . . on indebtedness" under former section 23(b) (the predecessor to current section 163). The Service contended that an obligation to cover a short

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sale was not "indebtedness" and disallowed the deduction. The Supreme Court decided the issue under a plain meaning approach. It determined that "indebtedness" meant "borrowed money" and "interest on indebtedness" meant "compensation for the use or forbearance of money." The Court held that while the requirement to cover the short sale was an "obligation," it was not "borrowed money," and could not therefore be "indebtedness." Id. at 497-98. Obviously, defendant's argument here ­ that the obligation to return a fixed amount of property is a "liability" ­ is directly contrary to the decision of the Supreme Court that the obligation to return property does not constitute "indebtedness." To recap, defendant's position is that: (1) taxpayers are not entitled to deduct losses on short sales until the short sale is closed because the amount of the obligation is contingent; (2) taxpayers are not allowed to deduct as interest amounts paid to borrow securities in a short sale, because the obligation to return property is not "indebtedness"; but (3) taxpayers must, to their detriment, account for any obligation to cover a short sale position as a liability for purposes of section 752 because the obligation to return property is fixed and determinable, even though the amount of that obligation is contingent. Plaintiffs respectfully submit that the only common policy evident in these inconsistent positions is a beaurocratic desire to maximize revenue for the Treasury at any cost to the statutory scheme. The district court in Klamath made this very point: The only difference between the 752 Cases regarding liability and this case is that the taxpayer is receiving the benefit rather than the IRS. It is clear from the record that the government has often and consistently relied on the principle that a "liability" under Section 752 does not include an obligation that is contingent. The government has applied this principle when it works to its benefit (to increase taxes owed). This Court will consistently apply these same principles even if they sometimes work to the benefit of taxpayers (to decrease taxes owed). This Court's analysis of "liability" under Section 752 will not vary in meaning simply based on whose ox is being gored. 440 F. Supp. 2d at 619.

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E.

Defendant's assertion that the IRS' position has consistently been that an obligation is a "liability" under section 752 whenever it creates or increases the basis of any of the obligors' assets is misleading.

Defendant devotes an entire section of its brief to arguing that the IRS has "consistently maintained that when, as here, an obligation creates or increases the basis of the obligor's assets, that obligation is a liability under § 752." (Def.'s Resp. to Pls.' Cross-Mot. Summ. J. 9-11.) That has only been true ­ if it is true at all ­ when the "obligation" is fixed and determinable. On the other hand, when the obligation is contingent ­ as is the case here ­ the IRS' position (until Salina) has unfailingly been that the obligation is NOT a liability for purposes of section 752, regardless of whether the obligation results in the creation of, or increase in, the basis of any property owned by the obligor. Defendant conveniently forgets that the obligations at issue in several of the cases and IRS pronouncements discussed in plaintiffs' opening brief gave rise to "the creation of, or an increase in, the basis of any property owned by the obligor (including cash attributable to borrowings)," which is the test quoted by defendant in its brief. For example, in Helmer the partnership received cash for giving the development corporation an option to acquire property. If the IRS policy was to treat obligations as liabilities whenever the obligation (e.g., the option in Helmer) results in the creation of cash or basis, as defendant alleges, then the IRS should have allowed the Helmer brothers to increase their bases in their partnership interest. But the IRS did not allow the brothers to increase their bases. Helmer v. Comm'r, 34 T.C.M. (CCH) 727, 730-31 (1975).4 The IRS took the same inconsistent position in Rev. Rul. 73-301, 1973-2 C.B. 215

4

Although defendant tries to distinguish Helmer later in its brief (at page 15) by arguing that the partnership in that case was not obligated to return that cash, that is clearly wrong ­ for the partnership was obligated to apply the amount received against the purchase price for the property if the development corporation exercised its option (i.e., it was a contingent obligation).

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(ruling that progress payments received by a partnership are not liabilities even though they gave rise to basis inside the partnership). Defendant's citation to Rev. Rul. 88-77, 1988-2 C.B . 129 to support its suggestion that the IRS is not being inconsistent in this case is shocking, because in that Ruling the IRS determined that unpaid expenses and accounts payable of a cash basis partnership, although binding obligations, did NOT constitute liabilities for purposes of section 752. In fact, the IRS has described Rev. Rul. 88-77 as holding that "a liability that is too contingent to give rise to an immediate deduction is not a partnership liability." 1997 FSA (Nov. 21, 1997) (Pls. Ex. 8, App. A at p. 2). Perhaps the best evidence of the inconsistency in defendant's position is its practical application. In Helmer, Long, La Rue, and the other cases cited by plaintiffs earlier in this brief, defendant argued that partners in various partnerships could not increase their bases in these partnerships by their share of contingent partnership obligations. In each of those cases, the partnerships had incurred obligations that were contingent in some sense. In each case, the partners desired to increase their bases in their partnership interests, and the partners argued those contingent obligations should constitute liabilities for purposes of section 752, such that the partners' were entitled to increase their bases in their partnership interests by their share of these partnership liabilities pursuant to section 752(a). Defendant's position that a short sale obligation is a liability under section 752 defies all of those cases. Under defendant's new position, taxpayers can increase their bases in their partnership interests at will. A partner only needs to have the partnership enter into a short sale. If, as defendant proposes, the obligation to cover the short sale position is a liability for purposes of section 752, then such a partner will increase his basis under section 752(a) by his share of the new partnership liability.

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The truth is that defendant did not consider contingent obligations to be liabilities until 2003, when it first issued temporary Treasury regulations that purport to change the definition of the term "liability" for purposes of section 752 to now include contingent obligations. Unlike the brief filed by defendant in this case, the preamble to these new regulations concisely recognizes that this new concept of a "liability" set out in these regulations does NOT follow the result that the Service advocated, and obtained, in Helmer and related cases. See Assumption of Partner Liabilities, 68 Fed. Reg. 37,434, 37,436 (June 24, 2003). Defendant's brief is itself internally inconsistent on this point, for it cannot reconcile the fact that the new regulations purport to change the definition of the term "liability" with its argument here that it is not taking a position inconsistent with prior law. When the government made this same contrived argument to the district court in Klamath, that court rightfully and squarely rejected it: Further, if there was not a change in law, as the government posits, there would have been no need to promulgate the Regulation. Indeed, from this Court's view, the promulgation ­ and the statements made in conjunction with the promulgation ­ is compelling evidence that the IRS knew it was seeking to change settled law to bar, retroactively, the transactions engaged in by the Plaintiffs. 440 F. Supp. 2d at 620. F. The Tax Court's Memorandum Decision In Salina

Plaintiffs explained in their opening brief the many shortcomings in the Tax Court's memorandum decision in Salina Partnership v. Comm'r, 80 T.C.M. 686 (2000). Defendant did not directly respond to any of these arguments, other than to assert that the Salina case received critical approval by Robert Bird & Alan Tucker, Tax Sham or Prudent Investment: Deconstructing the Government's Pyrrhic Victory in Salina Partnership v. Commissioner, 22 Va. Tax Rev. 231, 252 (2002). (Def.'s Resp. to Pls.' Cross-Mot. Summ. J. 10-11.) Plaintiffs offer two brief points in response to this "critical approval." First, Dr. Tucker is an economist (not a tax lawyer or tax scholar) who served as an expert witness for the government in the 17

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Salina case. Id. at n.aa1. It is therefore hardly surprising that he would write an article in support of the court's conclusion. Second, Dr. Tucker argued in his article that the Tax Court correctly decided that the short sale obligation was not contingent because of his opinion that the cost to cover the obligation, while variable, could be determined by obtaining prices on the open market at any point while the short sale was open (i.e., he appeared to contemplate a type of mark-to-market approach). However, this is the exact position that the government has now conceded is wrong in its brief to the Fifth Circuit in the Colm case. The government's new position is that the obligation is fixed and determinable at the time the short sale is executed and that the cost to close the position can be reasonably calculated by assuming it will equal the proceeds received on the sale of the borrowed securities. Given that Dr. Tucker wrote that the cost to cover would vary over time, it seems unlikely that he would concur with the government's new position. G. Rev. Rul. 95-26 is not entitled to any deference.

In the end, defendant has nothing left to argue in this case except the assertion that the position espoused in Rev. Rul. 95-26, 1995-1 C.B. 131, should be offered Chevron deference. (Def.'s Resp. to Pls.' Cross-Mot. Summ. J. 11-15, 17-19.)5 However, this Court and the Federal Circuit do not grant Chevron deference to revenue rulings. B.F. Goodrich Co. v. United States, 94 F.3d 1545, 1550 (Fed. Cir. 1996) ("We recognize, however, that IRS Revenue Rulings have no binding effect on this court."); Schlumberger Tech. Corp. v. United States, 55 Fed. Cl. 203, 212 (2003) (determining that revenue rulings are not entitled to Chevron deference but only have the power to persuade); Farmar v. United States 689 F.2d 1017, 1024 n.12 (Ct. Cl. 1982)

5

Defendant also argues that Rev. Rul. 88-77 is entitled to deference. However, as discussed above, that ruling offers no support to defendant in this case, as it only applies to obligations that are fixed and determinable, which begs the question at issue.

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("Revenue rulings are not binding on this court. They are not accorded a presumption of correctness but must be analyzed for consistency with the statute.") (citations omitted), rev'd on other grounds, 464 U.S. 206 (1984). Defendant's brief cites United States v. Mead Corp., 533 U.S. 218 (2001) in support of its argument that revenue rulings, in general, should be entitled to Chevron deference and should be followed unless their interpretation of a statute is arbitrary, capricious, or manifestly contrary to the statute. (Def.'s Resp. to Pls.' Cross-Mot. Summ. J. 11.) Defendant argues that although revenue rulings are not formed through notice-and-comment rulemaking or formal adjudication, they should still be given Chevron deference so long as it appears that Congress intended to grant the agency power to make binding rules. Defendant's interpretation of Mead, though novel, has no support in the case law. Defendant's argument ignores the standard set forth in Mead for determining the deference (if any) due an agency's interpretation of a statute contained in an informal rulemaking. The deference required under Mead for informal rulemaking (that is not based on notice-and-comment rulemaking or formal adjudication) is determined based on the "thoroughness evident in its consideration, the validity of its reasoning, its consistency with earlier and later pronouncements, and all those factors which give it the power to persuade." 533 U.S. at 228. The poorly reasoned, single page statement of the IRS's litigating position set out in Rev. Rul. 95-26 cannot receive significant deference under this standard, for it lacks thorough consideration of the issues, is not consistent with earlier IRS positions, and has no power to persuade. Defendant further states that "[t]he only material distinction between the Commissioner's interpretive regulations and his revenue rulings is that the latter are not issued pursuant to noticeand-comment procedures." (Def.'s Resp. to Pls.' Cross-Mot. Summ. J. 12.) This "material

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distinction" requires materially different treatment. Practically, Courts do not grant Chevron deference to informally promulgated rules because: Application of Chevron to Revenue Rulings would upset the balance between the values of participation and administrative expediency. Close judicial scrutiny of Revenue Rulings serves as an offset to the absence of notice-and-comment rulemaking in the promulgation of Revenue Rulings. Chevron deference to Revenue Rulings would give the Treasury excessive discretion without the counterweight of public participation. This would be especially lamentable with regard to tax because of the enormous impact of the tax system on large numbers of citizens and the importance, in a system of voluntary compliance, of assuring citizens that the tax collector does not have the last word on the application of the tax laws. John F. Coverdale, Court Review of Tax Regulations and Revenue Rulings in the Chevron Era, 64 GEO. WASH. L. REV. 35, 87 (1995). Contrary to Defendant's argument, revenue rulings are not given the same deference as Treasury regulations that are promulgated by notice-and-comment procedures. Xerox Corp. v. United States, 41 F.3d 647, 657 (Fed. Cir. 1995) (noting that, although revenue rulings are entitled to some weight when they reflect the Commissioner's interpretation of a regulation, they do not have the same force as a regulation); Trainer v. United States, 800 F.2d 1086, 1090 (Fed. Cir. 1986) ("In any event, Rev. Rul. 78-61 is not binding on this court; and, although Treasury Regulations are of greater force and effect than Revenue Rulings, 26 C.F.R. § 1.901-2 was not issued until after the years involved here.") This Court has determined that revenue rulings do not have the force of law because they have not been subject to notice and comment procedures. Schlumberger, 55 Fed. Cl. at 212.6 Plaintiffs explained in their opening brief why Rev. Rul. 95-26 is deeply flawed and should accordingly be given no deference. (Pls.' Resp. and Cross-Mot. Summ. J. 22-26.)
6

Defendant also argues that Rev. Rul. 95-26 is entitled to Chevron deference even if it represents a change in agency position. (Def.'s Resp. to Pls.' Cross-Mot. Summ. J. 17-19.) Since this Court and the Federal Circuit have repeatedly held that Revenue Rulings are not entitled to Chevron deference regardless of whether they represent a change in agency position, plaintiffs will not otherwise respond to this argument.

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Defendant does not respond to plaintiffs' explanation, but instead offers two reasons to support the revenue rulings, both of which are also flawed. First, defendant self-servingly states that "[i]t makes perfect sense to require a partner who has included an asset in his outside basis to reduce his basis by the obligation that created this asset because the legally enforceable obligation diminishes the value of his partnership interest," and to do otherwise would lead to an obvious distortion between inside and outside basis. (Def.'s Resp. to Pls.' Cross-Mot. Summ. J. 13-14.) But if that is true, then the converse should also be true: a taxpayer should be allowed to increase his outside basis by the amount of any partnership obligation (whether contingent or not) that gave rise to an asset. Yet, as discussed above, the IRS argued precisely the opposite in Helmer and Rev. Rul. 73-301. It is clear that defendant only points to this "policy" when it serves to maximize taxes owed, and it should be rejected for that reason. See Klamath, 440 F. Supp. 2d at 619 (rejecting the same argument made by defendant in that case because "[t]he positions the government took in the 752 Cases resulted in the same disparity between inside and outside basis that it protests will occur here under Plaintiffs' position."). Second, defendant argues that, as an economic matter, the borrower in a short sale is prohibited from transferring the proceeds. Plaintiffs do not understand what relevance defendant believes this point may hold. It appears that defendant may be trying to argue that the obligation is effectively collateralized by the margin account. Yet the fact that the taxpayer in La Rue had set up reserves for the contingent obligations in that case did not alter the conclusion reached by defendant and the Tax Court that the obligations were not liabilities for purposes of section 752 because they were contingent in amount. In any event, whatever point defendant may be trying to make is moot because defendant's premise is incorrect. Defendant has already admitted that the Alpha partners transferred their brokerage accounts (including the proceeds from the short

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sale) to Alpha, and then Alpha transferred them aga