Kerman v. Commissioner
2013 U.S. App. LEXIS 7032
6th Cir.2013Background
- Kerman sold 27% of Kenmark Optical to an ESOP in May 2000, realizing a taxable gain and seeking shelter for it.
- Kerman participated in a CARDS transaction promoted to generate a large tax loss from a high-basis, low-value foreign currency loan.
- The CARDS structure used a foreign bank loan (collateral held by the bank) and a purchase/assumption arrangement to assign a large purported basis to the currency.
- Kerman claimed a $4.25 million ordinary loss on a $5 million loan by treating the full loan as his basis, while the loan produced virtually no economic profit.
- IRS Notice 2000-44 warned such transactions produce noneconomic losses and are not deductible; Ruble prepared a sample opinion endorsing CARDS.
- Kenmark’s funds were wired into HVB, Colindale was formed in Delaware, and Kerman guaranteed the loan, exchanging euros for dollars and unwinding the loan a year later.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Economic substance of CARDS | Kerman argues CARDS had economic substance as a legitimate financing tool. | Government contends CARDS lacked economic substance and was a sham. | CARDS lacked economic substance; deduction disallowed. |
| Proper penalties for misstatement | Kerman argues substantial understatement should apply, not valuation misstatement. | Government contends valuation misstatement (and its enhanced form) applies. | Court applied §6662(e)/(h) valuation misstatement penalties. |
| Reasonable cause and good faith | Kerman asserts reliance on advisors could show reasonable cause/good faith. | Government argues reliance was misplaced and not reasonable in light of facts. | No reasonable cause or good faith; penalties upheld. |
| Admissibility of Kolbe's expert | Kerman contends Daubert gatekeeping was bypassed for Kolbe's report. | Government contends admissibility was properly exercised. | Kolbe's expert properly admitted; report considered for economic substance. |
| Reliance on Ruble opinion and non-independent advisors | Kerman relied on non-independent opinions as reasonable advice. | Government argues such reliance was unreasonable given conflicts and misstatements. | Reasonable reliance not established; advisors' conflicts undermined reliance. |
Key Cases Cited
- Illes v. Comm’r, 982 F.2d 163 (6th Cir. 1992) (economic substance governs deductions; two-part Mahoney test)
- Rose v. Comm’r, 868 F.2d 851 (6th Cir. 1989) (economic substance and profit motive in shelters)
- Mahoney v. Comm’r, 808 F.2d 1219 (6th Cir. 1987) (two-part test for deductions lacking substance)
- Dow Chem. Co. v. United States, 435 F.3d 594 (6th Cir. 2006) (sham transactions and economic reality standard)
- American Elec. Power Co. v. United States, 326 F.3d 737 (6th Cir. 2003) (economic substance and taxpayer intent considerations)
- Daubert v. Merrell Dow Pharms., Inc., 509 U.S. 579 (Supreme Court 1993) (gateway for admissibility of expert testimony)
- Estate of Kluener v. Comm’r, 154 F.3d 630 (6th Cir. 1998) (standards for reviewing tax court conclusions)
- Gustashaw v. Comm’r, 696 F.3d 1124 (11th Cir. 2012) (split on whether §6662 applies to lack of economic substance)