Tag Archives: Tax Shelter

4th Circuit: District Court Abused Discretion by Allowing Evidence of CPA’s Personal Tax Situation in Tax Shelter Promoter Case

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The Fourth Circuit Court of Appeals vacated portions of a jury’s findings, including imposition of a $2.6 million penalty, because the District Court allowed the introduction of evidence of the defendant CPA’s personal tax situation (he didn’t file returns) during the penalty phase of the trial.

The Fourth Circuit held that the District Court abused its discretion by permitting the evidence into the record over the defendant’s objection. The Court of Appeals further held that the personal tax information was not relevant to the tax shelter promotion penalty in question and the effect of allowing it into evidence was highly prejudicial. The lower court’s error was not harmless.

The appellate court concluded that the evidence “bears all the indicia of garden-variety “bad acts” evidence with no other purpose than to emotionally inflame the jury against the defendant.”

Read the opinion here:
Nagy v. U.S., No. 10-2072 (4th Cir. Mar. 29, 2013)

Tax Court: No Penalties for Son of Boss Participants

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In a memorandum opinion related to a division opinion we reported earlier this year, the Tax Court has found that underpayment and accuracy-related penalties asserted against investors in a “Son of Boss” tax shelter, did not apply to the participant taxpayers because they established reasonable cause under IRC § 6664(c)(1). However, the Court did sustain the government’s determination, which apparently was uncontested by the taxpayers, that they had underreported tax because of their involvement with the Son of Boss transactions.

The opinion offers a thorough discussion of the taxpayers’ conduct and the applicable standards for reasonable cause. The language and findings may provide useful guidance for taxpayers, and their counsel, seeking to avoid penalties by establishing reliance upon their advisors.

Read the entire opinion here:
Rawls v. Commissioner, T.C. Memo. 2012-340

4th Circuit: Denial of Transferee Liability for Intermediary Transaction Tax Shelter Affirmed

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The Fourth Circuit Court of Appeals affirmed the Tax Court’s decision in favor of four taxpayers who were alleged to have participated in what the IRS describes as an Intermediary Transaction tax shelter. The majority opinion, authored by Circuit Judge Davis, held that the Tax Court properly identified and applied the controlling legal principles and did not commit clear error in its factual findings.

At issue was the application of IRC § 6901 which provides for collection of liabilities from transferees in certain transactions. The transaction that prompted the allegedly transferred tax liability was the sale of a closely held C corporation. The IRS characterized the sale as substantially similar to an abusive tax shelter as described in Notice 2001-16, later modified by Notice 2008-111 (Intermediary Transaction).

The IRS attacked this transaction by asserting transferee liabilities under IRC § 6901 against the four former shareholders of the dissolved corporation. As noted by the Tax Court, section 6901 does not independently impose a tax liability but rather is a procedural device by which the IRS may collect unpaid tax owned by the transferor of an asset to a transferee. Thus, the transferee liability argument was pursued only as a basis for attaching the tax liability of the corporation to the former individual shareholders. The primary tax argument advanced by the IRS was that the sale of the company resulted in a direct distribution of proceeds (and corresponding tax liabilities) to the taxpayers.

In a 33-page memorandum decision, the Tax Court denied the government’s attempt to assert transferee liability against the former shareholders. The Tax Court followed the U.S. Supreme Court’s guidance in Commissioner v. Stern, 357 U.S. 39 (1958), which defined the application of the predecessor section to section 6901, and found that the former shareholders were not liable for the transferred assets under laws of the state of North Carolina.

The appellate tribunal examined Stern closely noting that the Supreme Court had interpreted section 6901 as requiring a two-part analysis. The first was a procedural finding that section 6901 applied as a matter of federal law. The second analytical step was to determine if the transferee was liable for the transferor’s debts under state law. The Court of Appeals agreed with the Tax Court and found that section 6901 applied as a matter of procedural law but that the government had failed to prove that the former shareholders were liable for the transferee’s debts under state law. Since the governing state law did not establish a liability for the former shareholders, the IRS could not use section 6901 to collect the alleged tax liability.

Read the entire opinion here:
Starnes v. Commissioner, Nos. 11-1636 et. al. (4th Cir. May 31, 2012)

Tax Court: Premature FPAA on Computational Items Invalid, Jurisdiction Denied

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There are few areas of the tax code as complex and potentially confusing as the rules for TEFRA partnership proceedings. Even the most steely-eyed tax pros wince at the details. Nonetheless, TEFRA is at the heart of many of the transactions that the IRS has challenged over the course last decade and the courts are still sifting through the details.

In Rawls Trading, LP v. Commissioner the government sought a stay of proceedings on a Final Partnership Administrative Adjustment (FPAA) issued to one of three partnerships involved in a single tax-advantaged transaction. Respondent argued that the FPAA was issued prematurely and that the court should stay its proceedings until determinations were made on FPAAs issued to the two related partnerships which were party to the transaction. Petitioners argued for a consolidated hearing on all three FPAAs. The Tax Court chose a third path and raised the question of jurisdiction.

The FPAA for the upper tier partnership, which the government wanted stayed, contained only computational adjustments.  All of the adjusted items were held in the lower tier partnerships and the upper tier partnership FPAA only noted the consequences those adjustments on a pass-through basis.  The Court reasoned that if the adjustments on the upper tier partnership were only computational and the FPAA did not contain items that were subject to the Court’s determination in a deficiency proceeding then there was nothing for the court to determine in a deficiency proceeding. The Court made exactly such a finding and determined that the FPAA was invalid as filed. The Court dismissed the FPAA for lack of jurisdiction noting that it could not stay proceedings on an FPAA that did not confer jurisdiction on its own merits.

Yes, there is a little more to it than that, but Judge Vasquez does a better job of navigating the labyrinth of TEFRA to reach that conclusion in his opinion than I can in this short column. Nonetheless, this is an important decision in the field of TEFRA procedure and adds yet another layer of complexity to this already challenging area of the law.

Read the full opinion here:
Rawls, LP v. Commissioner, 138 T.C. No. 12 (2012)

Department of Justice Trumpets Victories

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The U.S. Department of Justice released a press release announcing victories in three tax cases on the same day. The press release characterizes all three cases as tax shelters. We will add all three cases, Southgate Master Fund LLC v. United States (5th Circuit), Pritired 1 LLC v. United States (S.D. Iowa), and WFC Holdings Corporation v. United States (D. Minn.) to the blog later this week.

Read the Department of Justice Press release here.

Tax Court: Tax Motivated Distressed Asset Transaction Disallowed

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Superior Trading LLC v. Commissioner, which consolidated several pending petitions, represented the Tax Court’s first consideration of the Distressed Asset Debt/Distressed Asset Trust (“DAD”/”DAT”) transaction cases.  The Superior Trading transaction, a DAD transaction, operated through the contribution of significantly distressed, but not yet worthless, foreign assets to a partnership owned by the taxpayer seeking the tax loss. Under prior law, no election under section 754 was made at the time of the contribution which allowed the high basis, or purported face value, of the distressed assets to carry over to the partnership following the contribution. The contributed partnership interest was then redeemed, triggering recognition of the contributed built in loss which then passed through to the taxpayer.

The Court characterized the transaction as tax motivated on the first page of the opinion, comparing it to the widely litigated Son-of-Boss transactions. On the substantive issues, the Court found that the taxpayer failed to show that the distressed foreign assets had a tax basis prior to their contribution to the partnership. The Court then applied the step transaction doctrine to collapse the contribution of the debt to the partnership, and the redemption of that interest, into a single transaction. It characterized that transaction as a sale of the assets and further held that the taxpayers failed to prove the amount paid for the asset, thus again denying the recognition of any tax basis in the assets. The Court also rejected the taxpayer’s good faith and reasonable cause defenses and upheld the imposition of accuracy-related penalties.

Read the opinion here:
Superior Trading LLC v. Commissioner, 137 T.C. No. 6 (2011)

Tax Court: OTC Foreign Currency Options are not Section 1256 Contracts

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On a motion for summary judgment, the Tax Court rules that over the counter foreign currency options are not “foreign currency contracts” under Sec. 1256.

In some instances, and in this case, offsetting foreign currency options are used as part of a strategy to reduce federal income tax known as a major/minor transaction. Though not part of the court’s opinion here, the IRS might argue (and indeed may have argued) that this transaction is substantially similar to a “Son of Boss” transaction which it deems to be an abusive tax shelter. The effect of the court’s ruling in this case effectively denies the taxpayer the federal tax benefit realized by the transaction.

Read the opinion here:
Garcia v. Commissioner, TC Memo. 2011-85

Fifth Circuit: Overstated Basis is Not Omitted Income for the 6-Year Statute of Limitations

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The hits keep on coming. The Fifth Circuit joins the growing chorus from the Courts of Appeals holding that an overstatement of basis does not equal an omission of income and the 6 year statute of limitations does not apply.

Read the opinion here:
Burks v. United States, No. 09-11061 (5th Cir. Feb. 9, 2011)