## Facts

- James Mather and members of the Gaines family, and related parties, were partners in Gaines Realty Company and other partnerships that owned three apartment complexes.
- Gaines Properties served as the general partner in four limited partnerships connected to the apartment projects.
- The limited-partnership agreements provided for fixed amounts payable to certain partners (including Gaines Properties) and stated that the amounts “shall constitute guaranteed payments within the meaning of section 707(c)” of the Internal Revenue Code.
- For the 1973 tax year, each limited partnership used the accrual method of accounting and accrued the stated “guaranteed payments,” claiming deductions for them on the partnerships’ 1973 returns.
- Gaines Properties used the cash method of accounting, never received the accrued payments, and did not report the amounts as income.
- The individual partners and their spouses filed joint 1973 returns and did not report income reflecting the Commissioner’s later adjustments.
- The Commissioner asserted that Gaines Properties (and, through partnership reporting, the individual partners) should be taxed currently on the accrued “guaranteed payments.”
- At the same time, the Commissioner determined that part of the partnerships’ claimed deductions for those payments was not currently deductible because the amounts were capital in nature, and issued deficiency notices to the partners and their spouses.
- The taxpayers petitioned the U.S. Tax Court to redetermine the deficiencies.

## Issues

1. Whether amounts labeled as § 707(c) guaranteed payments and accrued by accrual-method partnerships for 1973 were currently includible in the partners’ income when the payee (Gaines Properties) was on the cash method and did not receive payment.
2. Whether, notwithstanding the § 707(c) label, some portion of the accrued amounts had to be treated as capital expenditures (and therefore not currently deductible by the partnerships in 1973).
3. Whether the Commissioner could both (a) deny current partnership deductions by capitalizing part of the amounts and (b) still include the full accrued amounts in the partners’ 1973 taxable income.

## Decision

- The court looked to the substance of the accrued amounts and held that the § 707(c) label in the partnership agreements did not control deductibility.
- The court agreed that portions of the amounts accrued as “guaranteed payments” were capital expenditures and therefore were not currently deductible by the limited partnerships in 1973.
- The court rejected the Commissioner’s attempt to tax the partners currently on the full accrued “guaranteed payment” amounts while also denying current deductions for part of those same amounts as capital expenditures.
- The partners’ 1973 taxable income was to be recomputed consistently with the court’s determinations on which amounts were properly deductible as guaranteed payments in 1973 and which amounts had to be capitalized.

## Legal Principles

- Amounts described in an agreement as “guaranteed payments” under I.R.C. § 707(c) are not automatically currently deductible; deductibility still depends on general tax rules distinguishing current expenses (e.g., § 162) from capital expenditures (e.g., § 263).
- If an amount is capital in nature, it must be capitalized even if the parties call it a guaranteed payment.
- The tax treatment of a payment as a § 707(c) guaranteed payment depends on its proper characterization and timing at the partnership level; partner-level income consequences should be computed consistently with the partnership-level determination.
- The Commissioner may not create a timing result that treats an amount as currently taxable guaranteed-payment income to partners while simultaneously treating the same amount as nondeductible capital expenditure at the partnership level for that year.

## Conclusion

Gaines v. Commissioner held that partnership agreements’ § 707(c) wording did not control where the accrued “guaranteed payments” were, in substance, capital expenditures, requiring capitalization and preventing current deductions in 1973; the court also refused to allow the Commissioner to tax the partners currently on the full accrued amounts while denying current partnership deductions for the capital portions, requiring consistent recomputation of the partners’ 1973 income.


Gaines v. Commissioner, 45 T.C.M. (CCH) 363 (1982)