For tax professionals advising clients on entity structuring and partnership contributions, the intersection of the "check-the-box" regulations and Subchapter K can present complex, and sometimes unforgiving, traps. The United States Tax Court recently addressed a novel question in this realm in Continental Grand Limited Partnership v. Commissioner, 166 T.C. No. 3 (2026), evaluating how a retroactive entity classification election impacts the basis of a self-issued promissory note contributed to a partnership.

This article details the factual background, the taxpayer’s arguments, the Tax Court’s technical analysis, and the ultimate conclusions that CPAs and EAs must be aware of when navigating entity classification elections and partnership basis rules.

Factual Background

The case centers on a multi-step transaction involving foreign affiliates of Computer Sciences Corp. (CSC), a U.S. parent company. CSC Computer Sciences GmbH (CSC Germany) was a German holding company that wholly owned another German subsidiary, CSC Financial GmbH (CSC Financial).

On March 26, 2001, CSC Germany issued a promissory note to CSC Financial with a stated issue price and fair market value of $610,220,155. The note, which was guaranteed by the U.S. parent, required CSC Germany to pay over $1.1 billion to the holder in 2009, reflecting the issue price and deferred interest.

Contemporaneous to the note’s issuance, Continental Grand Limited Partnership (the Partnership) was organized under Nevada law, effective March 23, 2001. On March 26, 2001, CSC Financial assigned the promissory note to the Partnership in exchange for a limited partnership interest.

More than a year later, on April 12, 2002, CSC Financial filed an entity classification election under Treasury Regulation Sec. 301.7701-3(c) to be disregarded as an entity separate from CSC Germany. CSC Financial retroactively designated the effective date of this election as March 23, 2001—three days before CSC Germany issued the note and CSC Financial contributed it to the Partnership.

In 2009, CSC Germany prepaid its obligations under the note by transferring over $1.07 billion to the Partnership, and CSC Financial subsequently liquidated its partnership interest for a distribution of over $1.08 billion. Following an examination of the Partnership’s 2009 Form 1065, the Internal Revenue Service (IRS) issued a Notice of Final Partnership Administrative Adjustment (FPAA). The IRS determined that CSC Germany had a zero basis in the promissory note upon contribution, resulting in a zero basis in its partnership interest and a zero basis for the note in the hands of the Partnership.

Taxpayer’s Request for Relief

Century Subsidiary Corporation, acting as the tax matters partner for the Partnership, petitioned the Tax Court to challenge the determinations within the FPAA. The Commissioner filed a Motion for Partial Summary Judgment seeking a ruling that CSC Germany’s adjusted basis in the note, its resulting basis in the partnership interest, and the Partnership’s basis in the note were all zero at the time of the contribution.

The taxpayer objected to the Commissioner’s motion, asking the Court to "look behind the disregarded entity’s elected status" and rule that the promissory note had a substantial basis equal to its fair market value at the time it was contributed. The taxpayer argued that applying the check-the-box regulations in the manner the IRS suggested would "destroy state-created property rights". Furthermore, the taxpayer argued that the note constituted "property" within the meaning of IRC Secs. 722 and 723, and that under the Supreme Court’s precedent in Commissioner v. Tufts, 461 U.S. 300 (1983), the obligation to pay should establish basis.

Court’s Analysis of the Law

The Tax Court first analyzed the mechanics of the check-the-box regulations found in Treasury Regulation Secs. 301.7701-1, -2, and -3. Under these regulations, an eligible foreign entity with a single owner may elect to be disregarded as an entity separate from its owner.

When an entity previously classified as an association elects to be disregarded, Treasury Regulation Sec. 301.7701-3(g)(1)(iii) dictates the deemed treatment: "The association distributes all of its assets and liabilities to its single owner in liquidation of the association". Following this deemed liquidation, Treasury Regulation Sec. 301.7701-2(a) provides that the entity’s "activities are treated in the same manner as a sole proprietorship, branch, or division of the owner".

Next, the Court turned to the basis rules under Subchapter K and Subchapter O. IRC Sec. 722 provides that the basis of a partnership interest acquired by a contribution of property is equal to the amount of money and "the adjusted basis of such property to the contributing partner at the time of the contribution". IRC Sec. 723 establishes the corollary rule for the partnership, stating that the partnership’s basis in contributed property is the adjusted basis of the property in the hands of the contributing partner.

To determine the property’s adjusted basis, the Court looked to IRC Sec. 1012, which states that "[t]he basis of property shall be the cost of such property". Treasury Regulation Sec. 1.1012-1(a) further clarifies that "cost is the amount paid for such property in cash or other property".

Application of the Law to the Facts

Judge Toro methodically applied the entity classification regulations to the timeline of the transactions. Because CSC Financial’s election to be disregarded was retroactively effective to March 23, 2001, it was deemed to have liquidated and distributed all its assets to CSC Germany on that date. Consequently, when CSC Germany issued the note to CSC Financial on March 26, 2001, CSC Financial did not exist as a separate entity for federal tax purposes. The Court ruled that "the issuance of the Note by CSC Germany to CSC Financial on March 26, 2001, must be disregarded for federal tax purposes".

Because CSC Financial’s activities were treated as those of a branch or division of CSC Germany on the date of the contribution, "CSC Germany is viewed as having contributed its own note to the Partnership in exchange for a partnership interest". The Court firmly rejected the taxpayer’s argument that this federal tax treatment destroyed state property rights, quoting the Supreme Court’s mandate that while "[s]tate law creates legal interests and rights," the "federal revenue acts designate [how the] interests or rights, so created, shall be taxed".

Assuming for the sake of argument that the note qualified as "property" under IRC Sec. 722, the Court analyzed its cost basis under IRC Sec. 1012. Applying the regulatory definition of cost, the Court found that "the Note in the hands of its maker had no cost". CSC Germany paid no money or property to create its own note, and therefore, its adjusted basis in the note was zero.

The Court systematically dismantled the taxpayer’s counterarguments:

Reliance on Tufts: The taxpayer argued that under Tufts, an obligation to pay creates basis. The Court distinguished Tufts, noting that Tufts involved a taxpayer borrowing money to acquire real property, where the loan was a cost of acquiring the property. In this case, "CSC Germany did not acquire the Note by incurring its obligation—the Note merely evidences the obligation". Therefore, the obligation was not a cost of making the note.
Reliance on Lessinger and Peracchi: The taxpayer cited Lessinger v. Commissioner, 872 F.2d 519 (2d Cir. 1989), and Peracchi v. Commissioner, 143 F.3d 487 (9th Cir. 1998), where taxpayers generated basis by contributing personal notes to corporations to avoid IRC Sec. 357(c) gain. The Court dismissed these cases because they arose in the corporate context under IRC Sec. 357(c), which looks at the transferee corporation’s basis, whereas IRC Secs. 722 and 723 key directly to the transferor partner’s basis. Furthermore, the Ninth Circuit in Peracchi explicitly stated that its holding "does not extend to the partnership or S Corp context".
Hindsight in Tax Planning: Acknowledging that the taxpayer’s resulting foreign currency translation loss issues may have been unforeseen, the Court maintained that taxpayers are bound by the tax consequences of their structural choices. The Court noted, "Century cannot now attempt to roll back the election simply because it is preferable, with hindsight, for CSC Financial to have been classified another way".

Conclusions

The Tax Court granted the Commissioner’s Motion for Partial Summary Judgment in full. The Court arrived at three specific legal holdings resulting from the retroactive check-the-box election:

First, CSC Germany’s adjusted basis in its own promissory note at the time it was contributed to the Partnership was zero.
Second, pursuant to IRC Sec. 722, CSC Germany’s basis in its partnership interest immediately following the contribution was zero.
Third, pursuant to IRC Sec. 723, the Partnership’s basis in the promissory note immediately following the contribution was zero.

This opinion serves as a critical reminder for tax professionals: while check-the-box regulations offer significant flexibility, retroactive elections carry absolute federal tax consequences. When a disregarded entity contributes a parent’s debt instrument to a partnership, established federal tax principles treat the transaction as the parent contributing its own note, resulting in zero basis for both the partnership interest and the asset itself under Subchapter K.

Prepared with assistance from NotebookLM.