106 LTD., David Palmlund, Tax Matters Partner, Appellant v. COMMISSIONER OF INTERNAL REVENUE SERVICE, Appellee.
No. 11-1242.
United States Court of Appeals, District of Columbia Circuit.
Argued April 24, 2012. Decided June 22, 2012.
684 F.3d 84
Patrick J. Urda, Attorney, United States Department of Justice, argued the cause for the appellee. Tamara W. Ashford, Deputy Assistant Attorney General, and Kenneth L. Greene, Attorney, were on brief.
Before: SENTELLE, Chief Judge, HENDERSON and GARLAND, Circuit Judges.
Opinion for the Court filed by Circuit Judge HENDERSON.
106 Ltd. (Partnership), a limited partnership, appearing through its tax matters partner David Palmlund (Palmlund), appeals a decision of the United States Tax Court (Tax Court) upholding the imposition of a forty per cent accuracy-related penalty by the Internal Revenue Service (IRS). See 106 Ltd. v. Comm‘r, 136 T.C. 67 (2011). The IRS determined that the Partnership had utilized a so-called “Son of BOSS” tax shelter to overstate its basis in Partnership interests by approximately $3 million and to thereby reduce Palmlund‘s individual federal income tax liability by nearly $400,000. The sole issue before us is whether the Tax Court erred in determining that the Partnership failed to establish a reasonable cause defense to the accuracy-related penalty pursuant to
I.
A “Son of BOSS” tax shelter “employs a series of transactions to create artificial financial losses that are used to offset real financial gains, thereby reducing tax liability.” Petaluma FX Partners, LLC v. Comm‘r, 591 F.3d 649, 650 (D.C.Cir.2010).1 In 2000, the IRS identified the Son of BOSS tax shelter as an abusive transaction if used to generate artificial (i.e., non-economic) losses for tax purposes. Tax Avoidance Using Artificially High Basis, Notice 2000-44, 2000-36 I.R.B. 255 (Sept. 5, 2000). The IRS also indicated that “purported losses from these transactions (and from any similar arrangements designed to produce noneconomic tax losses by artificially overstating basis in partnership interests) are not allowable as deductions for federal income tax purposes.” Id. at 255.
Palmlund is an executive recruiter and business consultant in Dallas, Texas.2 He has previously held executive positions at several companies, including American Home Shield, Eastman Kodak and Merrill Lynch Realty. Palmlund also operated a real estate investment partnership, formed a family limited partnership called Palmlund Ltd. with the stated purpose of “investments” and actively managed several personal bank and brokerage accounts. 106 Ltd., 136 T.C. at 69. For the 2001 tax year, he reported nearly $2 million in income. Since the early 1990s, Palmlund has used Joe Garza as his personal lawyer, including for legal work related to wills and trusts. He has used Turner, Stone & Company, LLP (Turner & Stone), an accounting firm, to prepare his tax returns for more than ten years. According to the Tax Court‘s findings, Palmlund was an active client who reviewed carefully every return Turner & Stone prepared.
In early 2001, Garza approached Palmlund about a foreign currency investment opportunity that was a variation of a Son of BOSS shelter. Although initially uninterested, Palmlund later warmed up to the idea. After Garza explained the mechanics of the shelter and its tax advantages, Palmlund told Garza that he wanted to
Using the Tax Court‘s unchallenged description, we provide a brief summary of the shelter‘s details. In November 2001, Palmlund executed documents forming three entities, all of which he controlled: (1) the Partnership, (2) 32, LLC and (3) 7612, LLC. 7612, LLC bought offsetting long and short foreign currency digital options with premiums of $3 million and $2.97 million, respectively, from Deutsche Bank.3 The actual cost of the options, however, was only $30,000-the difference in the premiums. 7612, LLC transferred both digital options to the Partnership. Next, 7612, LLC bought $4,000 worth of Canadian currency that it then transferred to the Partnership. Finally, on December 26, 2001, the Partnership distributed thirty-five per cent of the Canadian currency-with a value of $1,400-to Palmlund Ltd., the family limited partnership previously formed by Palmlund. Meanwhile, at Palmlund‘s request, the Partnership terminated the digital options on December 4 for a profit of $10,000, excluding fees owed to Garza for implementing the shelter (which fees totaled either $72,000 or $95,000).
On the Partnership‘s 2001 tax return prepared by Turner & Stone, it reported a basis in the distributed Canadian currency of $2,974,000. On Palmlund‘s individual tax return-also prepared by Turner & Stone-he claimed a flow-through loss of $1,030,491 from the distribution of the Canadian currency. In effect, Palmlund used the Son of BOSS tax shelter to reduce his total income by over $1 million and thereby reduce his tax liability by nearly $400,000.4 Turner & Stone initially understated Palmlund‘s loss attributable to the distribution of the Canadian currency because it assumed a distribution of only thirty-three per cent to Palmlund Ltd. Palmlund noticed the error and instructed Turner & Stone to increase the loss to reflect the thirty-five per cent distribution. Trial Tr. at 383.5 Turner & Stone charged Palmlund $8,000 for preparing the 2001 tax returns for the Partnership, for 32, LLC, for 7612, LLC and for Palmlund individually. In previous years, it had charged Palmlund $1,500 for tax return preparation services, notwithstanding the fact that Palmlund‘s tax returns before 2001-given his wealth and investments-were complex.
Part of Garza‘s $72,000 or $95,000 fee was for the preparation of a tax opinion
In May 2004, the IRS first communicated with Palmlund by sending him a copy of IRS announcement 2004-46 which outlined the IRS‘s proposed terms of settlement for any taxpayer utilizing a Son of BOSS tax shelter. After meeting with Garza and with Turner & Stone to discuss his response, Palmlund decided to amend his individual tax return. He removed the $1,030,491 loss attributable to the distribution of the Canadian currency and paid an additional $394,329 in taxes. Palmlund did not amend the Partnership‘s tax return.
After initiating an administrative proceeding in February 2005 regarding the Partnership‘s asserted basis in the distributed Canadian currency, the IRS issued a final partnership administrative adjustment (FPAA) to the Partnership on May 5, 2005. The FPAA adjusted the Partnership‘s basis from $2,974,000 to $0 and, pursuant to
After a trial, the Tax Court concluded that the Partnership had not established the reasonable cause defense because Palmlund, acting on behalf of the Partnership, did not establish his “actual good-faith reliance on Garza‘s, and Turner & Stone‘s, professional advice” in overstating the Partnership‘s basis in the Canadian currency. 106 Ltd., 136 T.C. at 78. According to the Tax Court, Palmlund “could not rely on their advice in good faith” because Garza and Turner & Stone were promoters of the shelter, Garza‘s opinion letter contained obvious inaccuracies, Palmlund should have known the transaction was improper given his business experience and Palmlund entered into the
II.
As noted earlier, the only question before us is whether the Tax Court erred in deciding that the Partnership, acting through Palmlund, failed to establish the reasonable cause defense for using a $2,974,000 basis in the distributed Canadian currency.10 “Whether a taxpayer had reasonable cause [under section 6664(c)(1)] is a question of fact decided on a case-by-case basis” and “[w]e review this determination and the findings underlying it for clear error.” Stobie Creek Invs. LLC v. United States, 608 F.3d 1366, 1381 (Fed. Cir.2010); see Am. Boat Co. v. United States, 583 F.3d 471, 483 (7th Cir.2009) (“Whether reasonable cause existed-and the findings underlying this determination-are questions of fact, which we review for clear error.“); see also United States v. Boyle, 469 U.S. 241, 249 n. 8 (1985) (“Whether the elements that constitute ‘reasonable cause’ are present in a given situation is a question of fact, but what elements must be present to constitute ‘reasonable cause’ is a question of law.” (emphases in original)).
A.
One way in which a taxpayer can establish the reasonable cause defense “is to show reliance on the advice of a competent and independent professional advisor.” Am. Boat Co., 583 F.3d at 481; see also Boyle, 469 U.S. at 251 (“When an accountant or attorney advises a taxpayer on a matter of tax law, such as whether a liability exists, it is reasonable for the taxpayer to rely on that advice.” (emphasis in original)). By itself, however, “[r]eliance on ... the advice of a professional tax advisor ... does not necessarily demonstrate reasonable cause and good faith.”
To be reasonable, reliance on professional tax advice must meet several requirements. First, “[t]he advice must be based upon all pertinent facts and circumstances and the law as it relates to those facts and circumstances.”
B.
We find no error-let alone clear error-in the Tax Court‘s determination that the Partnership failed to establish the reasonable cause defense because Palmlund unreasonably relied on both Garza‘s and Turner & Stone‘s advice. To begin with, the role of Garza “in promoting, implementing, and receiving fees from the [Son of BOSS] strategy” is more than sufficient to support the Tax Court‘s finding that he was a promoter and therefore possessed
With respect to Turner & Stone, it too implemented and profited from the transaction. Its tax return preparation services were essential to the execution of the transactions and it had worked with Garza previously to implement Son of BOSS tax shelters for other clients. Moreover, the $8,000 it charged Palmlund for tax return preparation far exceeded its normal charge of $1,500 and included research costs related to Son of BOSS transactions that it conducted for a different client. As the Tax Court found, the inflated fee represented Turner & Stone‘s “cut for helping to make the deal happen.” 106 Ltd., 136 T.C. at 81.
Furthermore, Palmlund knew or should have known that Garza and Turner & Stone were promoters of the tax shelter. Garza “recommended” the Son of BOSS shelter to Palmlund, Trial Tr. at 299, and told Palmlund that he would “do everything” to implement it, id. at 55; see Stobie Creek Invs., 608 F.3d at 1382 (unreasonable to rely on professional advisor if his “role as a promoter of the [Son of BOSS] strategy was evident“). One of Palmlund‘s accountants also testified that the Son of BOSS shelter “was referred-or brought to [Palmlund‘s] attention by Joe Garza.” Trial Tr. at 314. Garza‘s fee statement included Garza‘s work in the “Formation of LLC Disregarded Entity[,] Formation of Limited Partnership[,] Negotiations with investment bank and review of transactions[,] Legal Opinion Letter [and] Tax return preparation and review.” Statement for Services Rendered (Nov. 7, 2001) (Fee Statement). Palmlund also testified that he went through with the deal despite knowing that “[Garza] was not a licensed broker.” Trial Tr. at 120. Finally, Palmlund knew Garza was performing similar transactions for other clients. Palmlund testified that he knew Garza had “done this type of [transaction]” in the past, id. at 50, and that Garza told him he was “developing a financial organization” to handle similar transactions, id. at 120.
Palmlund also knew or should have known that Turner & Stone was working with Garza to structure and implement the tax shelter. See Van Scoten v. Comm‘r, 439 F.3d 1243, 1253 (10th Cir.2006) (unreasonable for taxpayer to rely on professional advisor “directly affiliated with the promoter“). Garza encouraged Palmlund to seek out Turner & Stone‘s advice regarding the Son of BOSS shelter because Garza “[had] been doing transactions with them,” Trial Tr. at 50, and Garza informed Palmlund that “the accountants on [the
Notwithstanding Palmlund‘s earlier bona fide dealings with Garza and with Turner & Stone, we believe the Tax Court record establishes that Palmlund unreasonably relied on Garza and on Turner & Stone in this instance because he knew or should have known that his “advisors” were not providing independent advice and that they were in fact promoters of the tax shelter who possessed an inherent conflict of interest. See Stobie Creek Invs., 608 F.3d at 1383 (if taxpayer knew advisors were promoting Son of BOSS shelter, taxpayer‘s reliance was “not objectively reasonable ... regardless of [his] longstanding relationship with ... or the reputations of [the advisors]“). Accordingly, the Tax Court did not err in concluding that the Partnership failed to establish the reasonable cause defense to the forty per cent accuracy-related penalty. See id. at 1382-83; see also Am. Boat Co., 583 F.3d at 482 (“[C]ourts have upheld the imposition of penalties on taxpayers who relied on advisors involved in implementing [Son of BOSS tax shelters]....“).
In addition, the Tax Court did not clearly err in concluding that Palmlund unreasonably relied on Garza‘s opinion letter as a matter of law because it was “based upon [] representation[s] or assumption[s] which [Palmlund] kn[ew], or ha[d] reason to know, [were] unlikely to be true.”
The letter contained other inaccuracies as well. It stated that Palmlund received the distributed Canadian currency “as [a] Partnership liquidating distribution[],” Op. Letter at 3, but the December 2001 distribution did not liquidate Palmlund‘s partnership interest because it distributed only thirty-five per cent of the Canadian currency. Importantly, Palmlund demonstrated his awareness of this fact by directing Turner & Stone to amend his individual tax return to reflect the distribution of thirty-five per cent of the Canadian currency. The opinion letter also claimed that the Partnership “do[es] not even now know if [it] will be called upon to satisfy [its] obligations under the [digital op-
Finally, even if Palmlund did not know about Garza‘s and Turner & Stone‘s conflicts of interest, we find no error in the Tax Court‘s determination that Palmlund‘s motive for entering into the tax shelter and his business experience “demonstrate[] [his] lack of good-faith reliance.” 106 Ltd., 136 T.C. at 81. As noted earlier, the Tax Court credited Denson‘s testimony that Palmlund‘s “intent was to lose money” on the tax shelter, id. at 73, and found that Palmlund participated in the shelter because of the “alluring tax benefit,” id. at 70. Although Palmlund testified that he made investments only “to make money” and that he decided to enter into the Son of BOSS transaction based on a tip from a business partner‘s daughter, Trial Tr. at 54, 44, the Tax Court “was not required to credit [Palmlund‘s] self-serving explanation of his motives.” United States v. Bolla, 346 F.3d 1148, 1153-54 (D.C.Cir.2003). Moreover, the improbable tax advantages offered by the tax shelter-a $1 million dollar loss from a transaction that earned Palmlund $10,000 (less Garza‘s fees)-should have alerted a person with Palmlund‘s business experience and sophistication to the shelter‘s illegitimacy. See Stobie Creek Invs., 608 F.3d at 1383 (no reasonable reliance if taxpayer had “sufficient knowledge and experience to know when a taxplanning strategy was likely ‘too good to be true’ ” and selected strategy “because of a desire to avoid taxes that would otherwise be owed“); see also Pasternak, 990 F.2d at 903 (when tax deduction exceeded amount invested by fifty per cent, “a reasonably prudent person would have asked a tax advisor if th[e] windfall were not ‘too good to be true’ “).
For the foregoing reasons, we affirm the judgment of the Tax Court.
So ordered.