In DJB Holding Corp. the 9^th Circuit concluded that a purported related-party partnership was not a bona fide partnership for tax purposes and taxable income was redirected to the taxable C corporation performing the underlying profitable services. The ultimate taxable services were performed by the C corporation but a partnership agreement between that C corporation and an upper-tier pass-through entity directed 70% of the income to the upper-tier pass-through entity for the stated consideration that the pass-through entity (and its owners) provided a needed financial guarantee as shown in this simplified diagram. The 9^th Circuit affirmed the Tax Court conclusion that this was not a bona fide partnership under the historical Culbertson and Luna authorities.

The underlying Tax Court decision essentially disregarded the upper-tier guarantor’s nominal ownership in the partnership, noting that the totality of the circumstances did not support partner status. First, as an factual matter, the partners did not respect their own documentation and the actual income sharing between the partners was substantially different than the documented sharing and the accountant did not file partnership tax returns. Second, the court did not find the guarantee to be of significant value and noted that the other related parties that joined in the guarantee did not also receive partnership interest. Third, the court noted that the unilateral control exercised by the taxable C corporation supported the lack of partnership status. The primary issue on appeal was whether the guarantee had any significant value. The 9^th circuit court found that the record supported that there were no value to such guarantee, asserting that the 100% owned taxable C corporation would have been entitled to the guarantees of the ultimate individual owners through their existing obligations to the C corporation.