## Facts

- Robert and Phyllis Johnston filed a 1982 federal income tax return.
- In September 1982, Robert Johnston organized Maple Village, a limited partnership formed to purchase, own, and operate a shopping center.
- Maple Village initially had nominal capital ($100), with Johnston contributing most of it and an original limited partner contributing the balance.
- Maple Village planned to raise capital by selling 40 limited partnership units for $200,000 per unit to outside investors.
- Under the offering terms, Johnston would serve as general partner and receive (i) a $30,000 organizing fee and (ii) a 1% interest in the partnership’s capital, profits, and losses without making an additional capital contribution.
- The offering closed in December 1982; limited partners invested and the partnership became fully funded.
- On audit, the Commissioner determined a 1982 deficiency, asserting Johnston received taxable income equal to the fair market value of the 1% partnership capital interest transferred to him for services, valued at or around the closing when the partnership was fully capitalized.
- Johnston petitioned the Tax Court, disputing both current inclusion and the Commissioner’s valuation timing and method.

## Issues

1. Whether a partnership capital interest transferred to a service provider as compensation is includible in gross income in the year received.
2. If includible, what valuation date and method properly determine the fair market value of the transferred capital interest.

## Decision

- The Tax Court held that Johnston’s 1% capital interest constituted taxable compensation includible in gross income for 1982.
- The court accepted valuing the interest when it became economically meaningful and effectively vested, tied to the partnership’s capitalization after the closing of the limited partner offering.
- The court sustained the deficiency to the extent based on the fair market value of the 1% capital interest (subject to any valuation adjustments supported by the evidentiary record).

## Legal Principles

- Gross income includes compensation for services, including property transferred in exchange for services, measured by the property’s fair market value when transferred and vested.
- A partnership “capital interest” (an interest that would yield value upon immediate liquidation) is treated as property with ascertainable value and is generally taxable upon receipt when granted for services.
- Valuation of a compensatory partnership capital interest may properly reflect the partnership’s funded capital structure at the time the interest is transferred and becomes noncontingent, rather than at formation when capitalization is nominal.

## Conclusion

The Tax Court treated a service-related grant of a partnership capital interest as taxable compensation in the year received and valued the interest based on the partnership’s capital at the point the grant became vested and economically measurable after the investor offering closed.


Johnston v. Commissioner, T.C. Memo. 1995-140 (1995)