CNT INVESTORS, LLC, CHARLES C. CARROLL, TAX MATTERS PARTNER, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Docket No. 27539-08
United States Tax Court
Filed March 23, 2015
144 T.C. 161
Conclusion
The Bedrosians ask us to grant leave for them to file an untimely motion for reconsideration. That motion for reconsideration would have us reconsider our opinion in which we held that we have jurisdiction over the deductibility of professional fees that the Bedrosians reported as deductions on their personal income tax return. Because the deductibility of those fees is a factual affected item, we have jurisdiction to determine the deductibility of those fees in this proceeding. In doing so, we are bound by prior partnership-level determinations, such as the determination that the partnership is a sham. Because the motion for reconsideration would not yield a different result, we will deny the motion for leave.
An appropriate order will be issued.
John W. Stevens and Richard J. Hassebrock, for respondent.
CONTENTS
| FINDINGS OF FACT | 164 |
| I. Introducing the Carroll Family | 165 |
| II. Solving the Low Basis Dilemma | 168 |
| III. Selling the Son-of-BOSS Strategy | 171 |
| IV. Achieving the Basis Boost | 173 |
| A. Son-of-BOSS | 174 |
| B. Basis Boost | 176 |
| C. Real Estate Extraction | 177 |
| V. Reporting the Transactions | 179 |
| A. CNT‘s 1999 Returns | 179 |
| B. CCFH‘s 1999 Return | 180 |
| C. Individuals’ 1999 Returns | 181 |
| VI. Challenging the Transactions | 181 |
| OPINION | 182 |
| I. Preliminary Matters | 182 |
| A. When Appellate Venue Matters | 182 |
| B. Why Appellate Venue Does Not Matter Here | 183 |
| II. Timeliness of the FPAA | 186 |
| A. Timeliness Under TEFRA | 186 |
| B. Theory of Omission | 188 |
| C. Omission by Bootstrapping | 188 |
| D. Scope of Sham | 191 |
| 1. Gregory Revisited | 194 |
| 2. Sham Transaction Doctrine | 199 |
| 3. Step Transaction Doctrine | 202 |
| 4. Blending the Doctrines | 204 |
| 5. Conclusion | 208 |
| E. Definition of Omission | 208 |
| 1. Mr. Carroll | 210 |
| 2. Ms. Cadman | 211 |
| 3. Ms. Craig | 212 |
| F. Adequacy of Disclosure | 213 |
| 1. Legal Standard | 213 |
| 2. Petitioner‘s Proof | 215 |
| 3. Returns’ Revelations | 215 |
| G. Conclusion | 219 |
| III. Consequences of the Sham Stipulation | 219 |
| IV. Liability for the Accuracy-Related Penalty | 220 |
| A. Penalties’ Applicability | 221 |
| B. Petitioner‘s Defense | 222 |
| 1. Sufficient Expertise? | 223 |
| 2. Necessary Information? | 227 |
| 3. Good-Faith Reliance? | 229 |
| V. Conclusion | 234 |
WHERRY, Judge: This case constitutes a partnership-level proceeding under the unified partnership audit and litigation procedures of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA),
(1) whether the six-year limitations period of
(2) whether the adjustments in the FPAA should be sustained; and
(3) whether a
FINDINGS OF FACT
Petitioner lived in California when he filed CNT‘s petition. CNT, the limited liability company to which the FPAA was directed, was, as agreed to by the parties, a sham entity with no business purpose. CNT did, however, file Federal income tax returns annually from 1999 through at least 2010. On its 1999, 2000, and 2001 returns CNT provided a California address and reported ownership of real property. As of January 22, 2015, online grantor/grantee records of the Ventura County, California, Recorder reflected that CNT held legal title to interests in four parcels of real property situated within that county.2 Those records also reflected that CNT
I. Introducing the Carroll Family
After serving in the United States Marine Corps at the time of World War II, Mr. Carroll attended mortuary science college. He also became a licensed embalmer. Mr. Carroll began operating Charles Carroll Funeral Home (funeral home) in 1954. The funeral home was an archetypal family business. Mr. Carroll and his wife, Garnet, lived for many years and raised their twin daughters, Teri Craig and Nancy Cadman, at various times in homes above, behind, and next door to their mortuaries.3 Mr. and Mrs. Carroll both worked
Although Mr. Carroll was an astute and successful businessman, he understood only basic tax principles and lacked sophistication in various stock and bond type financial matters. Hence he sought counsel and assistance from professional advisers on legal and accounting issues relating to the funeral home. Attorney J. Roger Myers began working with Mr. Carroll in the late 1970s or early 1980s, when he assisted Mr. Carroll in acquiring two additional mortuaries. Mr. Myers thereafter became the funeral home‘s de facto general counsel, providing general business consultation, maintaining records, and advising on employment and regulatory issues. The Carroll family regularly consulted Mr. Myers on legal issues arising in connection with the funeral home, and Mr. and Mrs. Carroll also engaged Mr. Myers to prepare their estate plan, which included an inter vivos giving program.
As of 1999 Mr. Myers had practiced law for almost 30 years, most of them spent in a business-oriented private practice involving some civil litigation. Although he did not hold himself out as a tax lawyer and typically referred clients to specialists for complicated income tax advice, Mr. Myers had taken basic Federal income and estate tax courses in law school, had previously prepared estate tax returns, and had advised Mr. Carroll on general tax law principles.
Certified Public Accountant (C.P.A.) Frank Crowley also began working with Mr. Carroll in the early 1980s, and Mr. Carroll followed him when Mr. Crowley changed accounting firms. Mr. Crowley provided general bookkeeping and monthly payroll services for the funeral home, and he prepared its financial statements and Federal income tax returns. In the late 1990s Mr. Crowley conferred with Mr. Carroll monthly concerning the funeral home‘s financial statements. He interacted more frequently with Ms. Cadman and Ms. Craig, who performed in-house bookkeeping duties for the funeral home. Mr. Carroll relied on Mr. Crowley for routine income tax advice although the funeral home‘s operations rarely gave rise to complex tax issues.
In addition to his C.P.A. credential, Mr. Crowley held bachelor‘s and master‘s degrees in accounting and was a cer-
By the mid-1990s, the funeral home‘s operations had expanded to five mortuaries. The Carrolls owned the funeral home through a corporation, Charles Carroll Funeral Home, Inc. (CCFH), which also held title directly or indirectly to the mortuary buildings and underlying real property.4 Mr. Carroll was the funeral home‘s original owner and CCFH‘s only shareholder until he implemented the giving program through which he transferred annual tranches of shares to his daughters.5 As of 1999 Mr. Carroll held 94.4512% of
II. Solving the Low Basis Dilemma
Mr. Carroll was 73, going on 74, in early 1999. He and his family had begun to contemplate his retirement and the funeral home‘s sale. Mr. Carroll intended to sell the funeral home business but retain ownership of the real property, which would be leased to the buyer(s). SCI, a mortuary company that had recently begun operating in the area, had followed this model for acquisitions of other local mortuaries, and SCI had contacted the Carrolls about purchasing the funeral home.
Mr. Carroll believed that, if a national mortuary chain purchased the funeral home, it would not want to purchase the real property. Retaining and leasing the real estate would also provide the family with a periodic income stream during retirement. Mr. Carroll was financially conservative, and he had no extensive investment experience. Before 1999 he had never invested in United States Treasury notes (T-notes), traded stocks, bonds, or other securities on margin, or participated in a short sale transaction. In 1999 Mr. Carroll‘s interests in the funeral home and five mortuary properties represented almost 100% of his net worth, and his only other holdings consisted of certificates of deposit and cash.
To facilitate sale of the business without the real estate, Messrs. Myers and Crowley determined that the two needed to be separated. They initially concluded that the preferred mechanism for achieving this separation would be for CCFH to divest itself of the mortuary properties, leaving it holding only the funeral home‘s business operations. They could not, however, identify a way of transferring the real estate out of CCFH without triggering recognition of substantial built-in gain, caused largely by inflation in real estate prices.6 As of
By late 1999 Mr. Crowley considered the real estate‘s proposed transfer from CCFH a “dead issue” because, after a few years of analysis and brainstorming with Mr. Myers and other attorneys, he had identified no way for the Carrolls to accomplish the transfer without incurring significant tax liability. Nevertheless, while sale of CCFH‘s stock (after divestiture of the real estate) appeared a nonstarter, sale of its business assets remained a possibility. In that case, however, CCFH could lose its S election and become subject to dual-level income taxation within three years after the asset sale because of the passive income limitation of
In 1999 Mr. Myers encountered a potential solution. Over lunch with a longtime acquaintance, local financial adviser Ross Hoffman, Mr. Myers described Mr. Carroll‘s problem in general terms, explaining that he had a client who needed to transfer appreciated assets out of a corporation for estate planning purposes. Mr. Hoffman advised Mr. Myers that he knew of a strategy that might work.
Earlier in the year Mr. Hoffman had attended a Las Vegas conference sponsored by Fortress Financial, a New York-based tax planning firm. Erwin Mayer, an attorney with the law firm Jenkens & Gilchrist, gave a seminar at the conference on a strategy he called a “basis boost” that could allegedly increase the tax basis of low-basis assets. The basis boost strategy Mr. Mayer presented was, in substance, a Son-of-BOSS transaction.7
Mr. Myers wanted to understand the Son-of-BOSS transaction better before presenting it to Mr. Carroll, so Messrs. Hoffman and Myers met again, this time for a conference call with Mr. Mayer. Bill Fairfield, another Ventura, California, attorney who had clients situated similarly to the Carrolls, also participated in the call. After speaking with Mr. Mayer, Mr. Myers understood that the proposed transaction would involve a short sale and would conclude with the real estate‘s being transferred out of CCFH with a new basis. At Mr.
Thereafter, on two occasions Messrs. Myers and Hoffman met with the Carrolls and Mr. Crowley at Mr. Myers’ office to discuss the proposed transaction. Using visual aids, Mr. Hoffman described in broad strokes how Mr. Carroll could, through a short sale of securities, create basis in a new entity, and he mentioned that Ted Turner had engaged in a similar transaction and, in a subsequent case concerning it, prevailed. Ms. Cadman found the Ted Turner story persuasive, reasoning that, if someone who could afford the very best legal and tax advice had engaged in this kind of transaction, it must be effective.8 After the second meeting with Mr. Hoffman, the Carrolls decided to proceed with the Son-of-BOSS transaction.
III. Selling the Son-of-BOSS Strategy
Mr. Hoffman pitched the Son-of-BOSS transaction to the Carrolls, but the Carrolls never became his clients or paid him any compensation. He never provided any tax advice to Mr. Carroll, gave a written opinion as to the transaction, or expressly represented that the transaction would achieve Mr. Carroll‘s desired result. He did, however, answer Mr. Carroll‘s and his advisers’ questions, parroting what he had heard from Mr. Mayer and consulting with Mr. Mayer when he needed more information. Messrs. Myers and Crowley and Ms. Cadman all perceived, after meeting with him, that Mr. Hoffman supported and recommended the transaction. Once Mr. Carroll decided to go forward with the transaction, Mr. Hoffman assisted ministerially with finalizing paperwork. He expected to receive a “finder‘s fee” in the form of a percent-
After the various presentations, meetings, and phone calls, Mr. Myers believed that he had a good grasp of how the Son-of-BOSS transaction would work and of the legal theories behind it. He had met with fellow Ventura attorney Bill Fairfield and had researched Jenkens & Gilchrist in Martindale Hubbell and on the Internet, learning that the firm had offices throughout the United States, including in Chicago, where Mr. Mayer worked. He had spoken by telephone with Mr. Mayer about the transaction. He had reviewed Mr. Mayer‘s memorandum and the supporting legal authorities. And he had been present for Mr. Hoffman‘s presentation. Mr. Myers believed the transaction was feasible and that the Carrolls should seriously consider it. He advised Mr. Carroll that the transaction looked like a viable way to resolve CCFH‘s low basis dilemma.
Mr. Myers’ opinion did not change as the transaction proceeded. During the implementation phase, he spoke by telephone with Mr. Mayer on multiple occasions. Mr. Myers did not know all of the details of the transaction. He did not know, for instance, how much money was actually at risk in the Son-of-BOSS component of the transaction, had no financial information about the short sale, and was unaware that the short sale would almost certainly generate no profit. He did not know how much Jenkens & Gilchrist would charge Mr. Carroll to implement the transaction. On the basis of what he did know, however, Mr. Myers formed the opinion that the transaction was legitimate and proper, and he shared this opinion with Mr. Carroll. Mr. Myers was working only for Mr. Carroll, billed Mr. Carroll monthly for work on the transaction at his regular hourly rate, and received no other compensation or incentive for recommending it.
Like Mr. Myers, Mr. Crowley did not know how much money was actually at risk in the Son-of-BOSS transaction, had no financial information about the short sale, and was unaware that the short sale would almost certainly generate no profit. Also like Mr. Myers, Mr. Crowley was working only for Mr. Carroll and received no unusual compensation for his counsel to the Carroll family. However, his advice was more ambivalent than Mr. Myers‘: Mr. Crowley did not conceal his lack of complete understanding of the transaction, and rather
IV. Achieving the Basis Boost
Once the “go” decision had been made, Mr. Mayer formed four limited liability companies (LLCs): (1) CNT, which elected to be treated as a partnership for income tax purposes,9 (2) Teloma Investments, LLC (Teloma), of which Mr. Carroll was the sole member, (3) Santa Paula Investments, LLC (Santa Paula), of which Ms. Craig was the sole member, and (4) S. Mountain Investments, LLC (S. Mountain), of which Ms. Cadman was the sole member.10 Each of the LLCs was formed under Delaware law.11 Each was a sham entity with no business purpose.
Pursuant to directions from and with the active control of Mr. Mayer and his colleagues at Jenkens & Gilchrist, the following sequence of transactions occurred.12
A. Son-of-BOSS
On November 18, 1999, the five real properties were transferred by deed to CNT. The book value of the transferred real estate was credited to CCFH‘s capital account. See supra note 4. At that time, the five properties’ aggregate adjusted tax basis, and hence CCFH‘s initial outside basis in CNT, was $523,377.13
On November 24, 1999, Mr. Carroll, Ms. Craig, and Ms. Cadman, via their respective LLCs, engaged in short sales of T-notes.14 Once the proceeds had settled, on November 26,
1999, the Carrolls transferred a total of $2,877,343 in cash proceeds from the short sales, together with the related obligations and a nominal amount of cash, apparently $10,800, to CNT. These transfers were sham transactions having no business purpose. The transferred proceeds and cash, totaling $2,877,343, were credited to Mr. Carroll, Ms. Cadman, and Ms. Craig‘s capital accounts and established their respective initial outside bases in CNT as $2,716,609, $80,367, and $80,367. See supra note 13. On the premise that the transferred obligations were not liabilities for purposes of determining the purported partners’ capital contributions, their capital accounts and outside bases were not reduced to reflect the partnership‘s assumption of these partner obligations.15
CNT immediately used the transferred proceeds and cash to purchase T-notes having a principal amount slightly greater than the amount the Carrolls had sold short. It did so under an agreement with Deutsche Bank whereby Deutsche Bank agreed to repurchase the T-notes (repo). Through this offsetting repo transaction, CNT reduced to near zero its risk of incurring a loss on the short sale.
On November 29, 1999, CNT closed the repo transaction and used the proceeds to satisfy the obligations that had
B. Basis Boost
On December 1, 1999, Mr. Carroll, Ms. Cadman, and Ms. Craig, who were CCFH‘s only shareholders, purported to transfer their respective partnership interests in CNT to CCFH. As a result of these transfers, CCFH became CNT‘s sole owner.
The transfers triggered the termination of CNT as a partnership.17 For tax purposes, the following events were deemed to occur: CNT liquidated, transferring all of its assets to its partners in proportion to their interests, and the three individual partners then contributed the assets received in the liquidation to CCFH, leaving CCFH holding all of the real estate.18 Each of CNT‘s partners took a tax basis in the assets received in the deemed liquidation equal to that partner‘s outside basis.19 With that step, the real
Upon the deemed contribution of CNT‘s assets to CCFH, the real estate‘s newly boosted basis transferred to CCFH, and the Carrolls’ aggregate basis in their CCFH stock increased by the same amount.20 Inside and outside bases were once again allegedly aligned. All that remained to be done was to transfer the real estate out of CCFH.
C. Real Estate Extraction
On December 31, 1999, CCFH distributed percentage interests in CNT (totaling 100%) to its three shareholders in proportion to their respective interests in CCFH. The deemed liquidation and contribution occurring on December 1 resulted in ownership of the real estate‘s shifting, for tax purposes, from CNT to the Carrolls, and then from them to CCFH. But title to the real estate did not change; CNT continued to hold title to the property. For tax purposes, the distribution of CNT interests on December 31 resulted in (1) a deemed distribution of the real estate to CCFH‘s shareholders, followed by (2) their deemed contribution of the real estate to a new partnership, New CNT.21
Upon the deemed distribution of the real estate, CCFH recognized gain equal to the difference between its aggregate adjusted tax basis in the real estate, $3,396,716, and the real estate‘s then-current fair market value, $4,020,000—that is,
This series of transactions divested CCFH of its real estate holdings and concluded with Mr. Carroll, Ms. Cadman, and Ms. Craig owning the five mortuary properties through New CNT, purportedly generating only $623,284 of taxable, long-term capital gain in the process. Absent the basis boost to the real estate from the Son-of-BOSS transaction, the amount would have been $3,496,623.27 Jenkens & Gilchrist
V. Reporting the Transactions
Mr. Crowley prepared all relevant Federal income tax returns for the transactions. When asked to prepare returns for tax year 1999, Mr. Crowley sought further explanation about the transactions from Mr. Mayer. Jenkens & Gilchrist later reviewed Mr. Crowley‘s first drafts of CCFH and CNT‘s 1999 tax returns at his request and recommended some changes.
A. CNT‘s 1999 Returns
Because of its mid-year termination and subsequent revival, CNT filed two Forms 1065, U.S. Partnership Return of Income, for tax year 1999: one for the taxable period September 15 through December 1, 1999 (December 1 return), and one for a one-day taxable period, December 31, 1999 (December 31 return).
On the December 1 return, CNT reported interest expense of $1,734 and, on Schedule D, Capital Gains and Losses, a $2,268 short-term capital loss incurred on November 29, 1999, on a short sale of T-notes. On the appended Schedules K-1 CNT reported capital interests, capital contributions, distributive shares of short-term capital loss and interest expense, distributions, and yearend capital accounts as follows:
| Item | Charles and Garnet Carroll | Nancy Cadman | Teri Craig | CCFH | Total |
|---|---|---|---|---|---|
| Capital interest | 79.88% | 2.36% | 2.36% | 15.40% | 100% |
| Capital contributions | $2,716,607 | $80,367 | $80,367 | $523,377 | $3,400,718 |
| Short-term capital loss | (1,811) | (54) | (54) | (349) | (2,268) |
| Interest expense | (1,385) | (41) | (41) | (267) | (1,734) |
| Distributions | (2,713,409) | (80,273) | (80,273) | (522,761) | (3,396,716) |
| Yearend capital account | -0- | -0- | -0- | -0- | -0- |
On the December 31 return, New CNT reported no income, deductions, gains, or losses. On the appended Schedules K-1, New CNT reported capital interests, capital contributions, distributions, and yearend capital accounts as follows:
| Partner | Capital interest (%) | Capital contributions | Distributions | Yearend capital account |
|---|---|---|---|---|
| Charles and Garnet Carroll | 94.4512 | $3,164,116 | --- | $3,164,116 |
| Nancy Cadman | 2.7744 | 92,942 | --- | 92,942 |
| Teri Craig | 2.7744 | 92,942 | --- | 92,942 |
| Total | 100 | 3,350,000 | --- | 3,350,000 |
B. CCFH‘s 1999 Return
CCFH filed a single Federal income tax return for 1999 on Form 1120S, U.S. Income Tax Return for an S Corporation. On the appended Schedules K-1, Shareholder‘s Share of Income, Credits, Deductions, Etc., CCFH identified its shareholders and their ownership percentages as: Charles Carroll, 94.4512%; Nancy Cadman, 2.7744%; and Teri Craig, 2.7744%. CCFH‘s shareholders and their ownership percentages remained unchanged from the beginning of the tax year.
On a Treasury “Reg. Sec. 1.351–3(b) Statement” (351 statement) appended to its return, CCFH reported receiving, as a contribution to capital, an 84.6% interest in CNT having a basis in the transferor‘s hands of $2,873,955 as of December 1, 1999. Jenkens & Gilchrist provided the 351 statement to Mr. Crowley for attachment to CCFH‘s 1999 return, and Mr. Mayer told him that it was a “necessary disclosure“.
With regard to CCFH‘s distribution to shareholders of CNT interests, Mr. Mayer explained that disclosure was unnecessary because there had been a “simultaneous transaction“. On the basis of this guidance, Mr. Crowley did not report the transaction as a deemed asset sale on Schedule D, Capital
C. Individuals’ 1999 Returns
On their respective 1999 Forms 1040, U.S. Individual Income Tax Return, Mr. and Mrs. Carroll, Ms. Cadman and her husband (Cadmans), and Ms. Craig and her husband (Craigs), each couple filing jointly, reported only passthrough ordinary income from CCFH. None of them reported any passthrough capital gain from CCFH, and none of them reported any otherwise taxable distribution from CCFH.
Mr. and Mrs. Carroll filed their 1999 return on October 15, 2000. The Cadmans and the Craigs filed their 1999 returns on October 18, 2000. Respondent received from Mr. and Mrs. Carroll and the Cadmans on September 5, 2006, and from the Craigs on September 8, 2006, signed Forms 872-I, Consent to Extend the Time to Assess Tax As Well As Tax Attributable to Items of a Partnership, extending the period for assessment as to their 1999 tax years to October 15, 2007. On June 28, 2007, respondent received from each couple a second signed Form 872-I extending the limitations period to December 31, 2008.
VI. Challenging the Transactions
On August 5, 2008, respondent mailed an FPAA with respect to CNT‘s December 1 return. In the FPAA, respondent adjusted to zero CNT‘s reported losses, deductions, distributions, capital contributions, and outside basis for the applicable tax period. The FPAA cites myriad bases for these adjustments, including that CNT was not, as a factual matter, a partnership, lacked economic substance, and was formed or availed of solely for tax avoidance purposes; and that both the Son-of-BOSS transaction and the individual partners’ subsequent contribution of their interests to CCFH were sham transactions undertaken solely for tax avoidance purposes. Respondent also determined an
CNT, through its tax matters partner, Mr. Carroll, timely petitioned this Court on November 12, 2008, for readjustment of partnership items under section 6226, challenging each of respondent‘s adjustments and all alleged bases for the determined penalty.
OPINION
I. Preliminary Matters
We have listed above only three issues for decision in this case, but the parties have, between them, raised several others. Before proceeding to the issues we will decide, we explain why we do not decide two others: (1) whether the venue for appeal in this case is in the U.S. Court of Appeals for the Ninth Circuit (Ninth Circuit) or the U.S. Court of Appeals for the District of Columbia Circuit (D.C. Circuit); and (2) whether this Court has jurisdiction over the accuracy-related penalty determined in the FPAA. We need not answer the second question because the U.S. Supreme Court has already done so in the affirmative in United States v. Woods, 571 U.S. ___, ___, 134 S. Ct. 557, 564 (2013). We need not resolve the first question because, after Woods, the answer will not affect our analysis of the substantive issues in this case.
A. When Appellate Venue Matters
As a trial court, we do not ordinarily opine on the venue for appeal of our decisions. See Peat Oil & Gas Assocs. v. Commissioner, T.C. Memo. 1993-130, 65 T.C.M. (CCH) 2259, 2264 (1993). However, this Court “follow[s] a Court of Appeals decision which is squarely in point where appeal from our decision lies to that Court of Appeals and to that court alone.” Golsen v. Commissioner, 54 T.C. 742, 757 (1970), aff‘d, 445 F.2d 985 (10th Cir. 1971). Where the proper venue for appeal determines how we should apply the law, “[w]e believe it appropriate * * * to consider the issue of venue“. Brewin v. Commissioner, 72 T.C. 1055, 1059 (1979), rev‘d and remanded on other grounds, 639 F.2d 805 (D.C. Cir. 1981).
B. Why Appellate Venue Does Not Matter Here
In their briefs, the parties invoke the Golsen rule with respect to two related issues. First, the substantial and gross valuation misstatement penalties apply with respect to any understatement of tax “attributable to” the misstatement.
In Gainer v. Commissioner, 893 F.2d at 226, the taxpayer purchased an interest in a shipping container at an inflated value, paying most of the purchase price with a promissory note, then claimed an investment tax credit and deducted depreciation on the basis of the inflated value. The Commissioner disallowed the deduction because the container was not placed in service in the tax year at issue, 1981, and also determined a valuation misstatement penalty. Id. Affirming this Court, the Ninth Circuit held that the taxpayer‘s understatement of income tax was not “attributable to” his overstatement of the container‘s value. Id. at 228. Rather, the understatement was attributable to the container‘s not having been placed in service, a fact that precluded the taxpayer from deducting any depreciation. See id. In Keller v. Commissioner, 556 F.3d at 1060-1061, the Ninth Circuit extended Gainer‘s reasoning to disallow a gross valuation misstatement penalty where the taxpayer engaged in a sham transaction and then claimed deductions for and reported basis in assets that he never actually acquired. On petitioner‘s reading, these precedents compel us to disallow any valuation misstatement penalty here because any understatement of tax results from CNT‘s sham status, not from a valuation misstatement.
In making this argument, petitioner did not have the benefit of the Supreme Court‘s subsequently released decision in Woods. Specifically citing Keller, the Supreme Court rejected the premise on which the Ninth Circuit‘s rule rests—that is, that a transaction‘s lack of economic substance and an overstatement of basis are necessarily independent possible causes for an understatement of tax. Woods, 571 U.S. at ___, 134 S. Ct. at 567. Where “partners underpa[y] their taxes because they overstate[] their outside basis * * * because the partnership[] * * * [is a] sham[]“, the Court had “no difficulty concluding that” any resulting underpayment was attributable to the misstatement of outside basis. Id. at ___, 134 S. Ct. at 568. Woods governs the valu-
Second, under section 6221 we may consider the applicability of a penalty only to the extent that it “relates to an adjustment to a partnership item“. If the venue for appeal is the D.C. Circuit, petitioner contends we would be bound to follow that court‘s decision in Petaluma FX Partners, LLC v. Commissioner, 591 F.3d 649 (D.C. Cir. 2010), aff‘g in part, rev‘g in part, vacating and remanding in part 131 T.C. 84 (2008). There, the D.C. Circuit strongly hinted that, where the Commissioner determines that a penalty applies to an understatement of income tax, and that understatement is attributable to an adjustment of outside basis, this Court lacks jurisdiction over the penalty in a partnership-level proceeding because outside basis is an affected item “to be resolved at the partner level“. See id. at 655-656.
This Court has twice before examined the scope and import of the D.C. Circuit‘s holding. See Tigers Eye Trading, LLC v. Commissioner, 138 T.C. 67, 136-138 (2012); Petaluma FX Partners, LLC v. Commissioner, 135 T.C. 581, 586-587 (2010). We need not revisit the question here because, in the interim, the Supreme Court has had the final word. In Woods, 571 U.S. at ___, 134 S. Ct. at 564, where the allegedly misstated item was outside basis in a sham partnership, the Supreme Court concluded that a trial court in a partnership-level proceeding has jurisdiction to determine whether the partnership‘s lack of economic substance can “justify imposing a valuation-misstatement penalty on the partners.” Regardless of the appellate venue, Woods confirms that we have jurisdiction to consider the valuation misstatement penalty.
We need not invoke the Golsen rule for either reason raised by the parties. We will apply the same legal principles to the issues in this case whether the venue for appeal is the D.C. Circuit or the Ninth Circuit. For us to undertake to resolve the correct appellate venue, inasmuch as it would not affect the disposition of this case, “would, at best, amount to rendering an advisory opinion. This we decline to do.” See Greene-Thapedi v. Commissioner, 126 T.C. 1, 13 (2006).
The parties have stipulated that CNT and the Son-of-BOSS transaction were shams. One might view this stipulation as a concession by petitioner of the entire case. It is not. Petitioner offers a defense to the penalties determined in the FPAA, and more importantly, vigorously contests the FPAA‘s validity in the first instance, claiming that its issuance was untimely.
A. Timeliness Under TEFRA
In the context of an FPAA issued under TEFRA procedures, timeliness for statute of limitations purposes is derivative:
The Internal Revenue Code prescribes no period during which TEFRA partnership-level proceedings, which begin with the mailing of the * * * [FPAA], must be commenced. However, if partnership-level proceedings are commenced after the time for assessing tax against the partners has expired, the proceedings will be of no avail because the expiration of the period for assessing tax against the partners, if properly raised, will bar any assessments attributable to partnership items.
Generally, in order to be a party to a partnership action, a partner must have an interest in the outcome. If the statute of limitations applicable to a partner bars the assessment of tax attributable to the partnership items in issue, that partner would generally not have an interest in the outcome. See
sec. 6226(c) and (d). However, * * * a partner may participate in such action for the purpose of asserting that the period of limitations for assessing any tax attributable to partnership items has expired and that we have jurisdiction to decide whether that assertion is correct. * * *
[Rhone-Poulenc Surfactants & Specialties, L.P. v. Commissioner, 114 T.C. 533, 534-535 (2000); fn. refs. omitted.]
It is undisputed that the alternative three-year limitations periods in sections 6501(a) and 6229(a) had both lapsed with respect to all partners’ 1999 tax years when respondent issued the FPAA. Instead, respondent hangs his hat on section 6501(e)(1)(A), which extends the limitations period to six years where a taxpayer “omits from gross income an amount properly includible therein which is in excess of 25 percent of the amount of gross income stated in the return“.
In that case, the time for assessment would have expired on October 15, 2006, as to Mr. and Mrs. Carroll, and three days later as to the Cadmans and the Craigs.29 Before their respective expiration dates under section 6501(e)(1)(A), but after their respective expiration dates under sections 6501(a) and 6229(a), Mr. and Mrs. Carroll, the Cadmans, and the Craigs all agreed to extend the periods for assessment for their 1999 tax years, including with respect to tax items attributable to CNT, to October 15, 2007. See
The statute of limitations is an affirmative defense to be pleaded and ultimately proven by petitioner; but because respondent asserts that the six-year statute of limitations in section 6501(e)(1)(A) applies, respondent bears the burden of going forward with the evidence regarding the alleged omission of income. See Hoffman v. Commissioner, 119 T.C. 140, 146-147 (2002). If respondent satisfies that burden, then petitioner must introduce evidence of his own to rebut respondent‘s showing. See id. at 146.
Relying on stipulated facts and the tax returns in the record, respondent offers the following: Pursuant to the parties’ stipulations, CNT, Teloma, Santa Paula, and S. Mountain are all disregarded as shams, and the transfer of short sale proceeds and related obligations to CNT is also disregarded as a sham. Therefore, CCFH in fact distributed its interest in the highly appreciated assets of CNT (the five mortuary properties) to its shareholders, the Carrolls.
Under section 311(b), if a corporation distributes appreciated property to a shareholder, the corporation must recognize gain as if it had sold the property for fair market value. Where the corporation is an S corporation, that gain passes through and is taxable to the corporation‘s shareholders pursuant to
We conclude that respondent has met his burden of going forward with evidence as to the longer, six-year period of limitations. We turn now to petitioner‘s response. Petitioner offers four alternative reasons section 6501(e)(1)(A) will not avail respondent here. We examine each of these arguments in turn.
C. Omission by Bootstrapping
First, petitioner charges respondent with attempting to “bootstrap” an alleged omission by a different taxpayer, using a transaction occurring outside the tax period covered by the
We view petitioner‘s “bootstrapping” critique as aimed at two mismatches: between CNT and the taxpayers from whose returns the income item was allegedly omitted, and between the tax period covered by the December 1 return and the tax period in which the event giving rise to the income item occurred. Neither of these incongruities is unprecedented.
In Rhone-Poulenc Surfactants & Specialties, L.P. v. Commissioner, 114 T.C. at 536, the taxpayer corporation had purportedly transferred property to a partnership in exchange for an interest therein. The Commissioner, discerning a sale disguised as a capital contribution, issued an FPAA adjusting items relating to the purported contribution. Id. Before this Court, the Commissioner claimed that while no income had been omitted from the partnership‘s return, if the FPAA adjustments were sustained, the taxpayer corporation would have failed to report a substantial gain on its own return. Id. at 538. Because of this omission by a partner, the six-year limitations period of section 6501(e)(1)(A) would apply with respect to that partner. See id. We agreed with the Commissioner‘s analysis. See id. at 551.
Petitioner contends that respondent stretches Rhone-Poulenc beyond its moorings by relying on an omission by a third-party entity. But as we have elucidated above, if the FPAA‘s adjustments are sustained, then it will necessarily follow that Mr. Carroll, Ms. Cadman, and Ms. Craig will each have omitted income from his or her own return—that is, passthrough section 311(b) gain, includible under section 1366(a)(1). It is this omission, not CCFH‘s omission of the section 311(b) gain from its 1999 Form 1120S, that would trigger section 6501(e)(1)(A) as to the Carrolls. Granted, the omitted item does not flow through to the individual partners directly from CNT but instead from another source, CCFH. Yet in Rhone-Poulenc Surfactants & Specialties, L.P. v. Commissioner, 114 T.C. at 536, likewise, the omitted item did not flow through to the taxpayer corporation from the partnership but instead arose under section 1001. And here, as in Rhone-Poulenc, there will have been an omission only
Petitioner further cites as unprecedented respondent‘s reliance on an omission arising from a transaction that occurred outside the partnership tax period covered by the subject return. Yet in Kligfeld Holdings v. Commissioner, 128 T.C. 192 (2007), we addressed a highly similar situation. There, in 1999, an individual taxpayer engaged in a Son-of-BOSS tax shelter transaction and contributed the proceeds and related obligations to a partnership along with highly appreciated Inktomi stock. Id. at 194-195. The partnership sold most of the stock in 1999 but distributed the proceeds and the remaining stock to its partners—the taxpayer and his wholly owned S corporation—in 2000. Id. at 197. In 2004 the Commissioner issued to the partnership an FPAA based upon its 1999 Form 1065. Id. at 198. The partnership‘s tax matters partner petitioned this Court and raised a statute of limitations defense. Id. at 199.
The Commissioner asserted that the FPAA was timely because the limitations period with respect to the individual taxpayer‘s 2000 tax year had not expired when the FPAA was mailed, and the adjustments in the FPAA would, if sustained, affect items reported on that taxpayer‘s 2000 tax return, namely, the distributed proceeds from the stock sale. See id. at 199. Scrutinizing TEFRA, we discerned that “Congress anticipated that the taxable year in which an assessment is made would not always be the same as the taxable year in which the adjustments are made.” Id. at 205. Specifically rejecting the tax matters partner‘s timing mismatch arguments, we held that the FPAA was timely when issued because the limitations period had not yet run as to the taxable year in which an assessment triggered by the FPAA‘s adjustments would be made. Id. at 202, 206-207.
Kligfeld Holdings more than justifies respondent‘s position here. There, no overlap existed between the taxable period covered by the FPAA and the taxable period for which, if its adjustments were sustained, an assessment would be made. Here, given that the alleged omission arose from a trans-
Moreover, contrary to petitioner‘s assertion, there was a third-party entity in play in Kligfeld Holdings. As here, the only other partner in the purported partnership created by the individual taxpayer in Kligfeld Holdings v. Commissioner, 128 T.C. at 194-195, was his wholly owned S corporation, to which (as occurred here) he contributed a sufficiently large interest in the partnership to trigger a technical termination under section 708(b)(1). And while in Kligfeld Holdings the FPAA‘s adjustments would have flowed through directly to the individual taxpayer‘s return, sustaining those adjustments would also have resulted in additional passthrough income to the taxpayer under section 1366(a)(1). See id. at 199 (explaining Commissioner‘s position that S corporation should have reported capital gain on the partnership‘s distribution of cash proceeds from the stock sale).
Between them, Rhone-Poulenc and Kligfeld Holdings provide ample support for respondent‘s theory and decisively answer petitioner‘s “bootstrapping” argument. We therefore proceed to petitioner‘s second argument.
D. Scope of Sham
Petitioner insists that—pursuant to the parties’ stipulation and on the basis of the entire record—every step in the series of transactions the Carrolls undertook should be disregarded. Petitioner contends that transfer of the real estate was part of an integrated series sham of transactions, that the entire series should be disregarded, and that CCFH should be treated as the real properties’ continuous tax owner.32
Accordingly, petitioner concludes, the transaction generating the allegedly omitted income never occurred, so no income could have been omitted.
Respondent, naturally, demurs. In his view only the Son-of-BOSS transaction was a sham because it was entered into solely to artificially eliminate the built-in gain in the real estate, while the remaining steps were cognizable for tax purposes. The parties’ arguments implicate three closely related and frequently conflated legal doctrines: the economic substance doctrine, the sham transaction doctrine, and the step transaction doctrine.
Although these doctrines’ distinct names might suggest corresponding substantive distinctions, the lines between and among them blur upon examination. Congress reduced prospective confusion as to the economic substance doctrine‘s
If one looks to the caselaw, the economic substance, sham transaction, and substance over form doctrines resemble a Venn diagram. In a statutorily mandated 1999 study the Joint Committee on Taxation attempted to define and distinguish these three doctrines as well as the business purpose and step transaction doctrines. See Staff of J. Comm. on Taxation, Study of Present-Law Penalty and Interest Provisions as Required by Section 3801 of the Internal Revenue Service Restructuring Act of 1998 (Including Provisions Relating to Corporate Tax Shelters) (Vol. I), at 186-198 (J. Comm. Print 1999). The study candidly acknowledges that “[t]hese doctrines are not entirely distinguishable, and their application to a given set of facts is often blurred by the courts and the IRS. There is considerable overlap among the doctrines, and typically more than one doctrine is likely to apply to a transaction.” Id. at 186.
The doctrines’ substantive similarities would not, alone, generate uncertainty for taxpayers (or tenure opportunities for tax academics) if courts applying the doctrines did so using consistent terminology. We have not.33
Despite their lexical imprecision, prior opinions of this Court and other courts form a substantial body of precedent for the application of judicial doctrines to disallow tax results in transactions that, on their face, technically strictly conform to the letter of the Code and the regulations.34 In identifying the source of those doctrines, courts typically point to Gregory v. Helvering, 293 U.S. 465 (1935). Gregory has come to stand for so many principles that, in order to define our premises before applying them to the facts of this case, what the Supreme Court actually said and what it was doing in that case bear reexamination.
1. Gregory Revisited
Gregory and subsequent Supreme Court opinions relying upon it contain the seeds of each of the doctrines attributed to it.35 Mrs. Gregory had conducted a series of transactions
that, she asserted, satisfied all requirements for a reorganization under then-applicable law, such that her wholly owned corporation‘s transfer to her of highly appreciated stock, ensconced within a transient corporate shell, was nontaxable. See Gregory v. Helvering, 293 U.S. at 467-468. In its opinion the Supreme Court asked “whether what was done, apart from the tax motive, was the thing which the statute intended.” Id. at 469. The Court‘s answer to that question implicates two rationales. First, the Court read the statute to apply only to transfers made in pursuit of a “business or corporate purpose“. See id. Second, the Court emphasized its focus on the substance, rather than the form, of what had transpired, characterizing the transaction as “a mere device which put on the form of a corporate reorganization as a disguise for concealing its real character“. See id.
Less than one year later, the Court echoed these two themes in Helvering v. Minn. Tea Co., 296 U.S. 378, 385 (1935), another reorganization case. The Court distinguished the case before it from Gregory as involving a “bona fide business move” (i.e., business purpose). Id. Further, the Court explained that Gregory had “revealed a sham[,] * * * a mere device intended to obscure the character of the transaction“, but confirmed that Gregory had “disregarded the mask and dealt with realities.” Id. The Court thus used the word “sham” to describe a transaction, the true “character” of which did not align with its form, and thereby tethered the term “sham” to substance over form principles. See id.
Courts typically apply the substance over form principle to recharacterize a transaction to make its form (on the basis of which it will be taxed) consistent with the economic, nontax substance of what occurred. When the transaction is an economic sham, such that nothing of substance in fact occurred (or could have occurred as the transaction was structured), we disregard it altogether, just as we would do with a factual sham.37
Only five years later, in Higgins v. Smith, 308 U.S. 473, 476 (1940), the Court deemed substance over form a “broad and unchallenged principle“. The taxpayer in that case had claimed an ordinary loss deduction in connection with a sale of securities to his wholly owned corporation, which he had created solely to achieve income and estate tax savings. See id. at 474-475. Because substance over form “furnishe[d] only a general direction“, the Court looked to Gregory‘s business purpose theme and extrapolated from it: “[If] the Gregory case is viewed as a precedent for the disregard of a transfer of assets without a business purpose but solely to reduce tax liability, it gives support to the natural conclusion that transactions, which do not vary control or change the flow of economic benefits, are to be dismissed from consideration.” Id. at 476. Gregory, the Court implied, supports the twin propositions that any property transfer must have a nontax purpose and that transactions without nontax, economic consequences may be disregarded for tax purposes. See id. These propositions now make up the two prongs of the codified economic substance doctrine.38
Gregory, as interpreted by the Court in its subsequent opinions, spawned the economic substance, sham transaction, business purpose, and substance over form doctrines.39 We
do not trace these doctrines back to Gregory in order to add to the extensive literature parsing Gregory and related caselaw, or in order to propose a discrete doctrinal taxonomy. We source the judicial doctrines to Gregory to draw attention not to what the Court said, but to what it was doing, in that case and subsequent cases.
Gregory, like much of the caselaw using the economic substance, sham transaction, and other judicial doctrines in interpreting and applying tax statutes, represents an effort to reconcile two competing policy goals. On one hand, having clear, concrete rules embodied in a written Code and regulations that exclusively define a taxpayer‘s obligations (1) facilitates smooth operation of our voluntary compliance system, (2) helps to render that system transparent and administrable, and (3) furthers the free market economy by permitting taxpayers to know in advance the tax consequences of their transactions. On the other side of the scales, the Code‘s and the regulations’ fiendish complexity necessarily creates space for attempts to achieve tax results that Congress and the Treasury plainly never contemplated, while nevertheless complying strictly with the letter of the rules, at the expense of the fisc (and other taxpayers).
In Gregory, the Court confronted such an extreme result and, on the basis of equitable principles, interpreted and applied the relevant statute so as to subject Mrs. Gregory‘s transaction to tax. Likewise, the various other judicial doctrines applied in tax cases all represent efforts to rein in activity that, while within the technical letter of the rules, deeply offends their spirit.40 Attempts to parse and define the doctrines merely intellectualize what is, ultimately, an equitable exercise. Those who favor transparency might
We attempt to apply Gregory‘s teachings to the transactions at issue.
2. Sham Transaction Doctrine
The parties have stipulated numerous exhibits—including real estate deeds, account agreements, trade confirmations, and account statements—demonstrating that the transactions at issue actually occurred, so we consequently focus on the economic sham strand of the sham transaction doctrine. See Krumhorn v. Commissioner, 103 T.C. at 38, 46 (distinguishing factual shams from shams in substance). We ask whether any of these transactions had “nontax substance” or affected the parties’ beneficial interests other than by reducing their tax obligations. See Knetsch v. United States, 364 U.S. 361, 366 (1960).
The parties have stipulated that CNT, Teloma, Santa Paula, and S. Mountain were sham entities with no business purpose. They have likewise stipulated that the Carrolls’ purported contribution of short sale proceeds and related obligations (along with a nominal amount of cash) to CNT in exchange for partnership interests in CNT was a sham transaction with no business purpose. They have not, however, stipulated that any of the other transactions at issue, nor the entire series of transactions, constitutes a sham. On the basis of our factual findings and review of the record, we identify six separate actions undertaken here: (1) CCFH contributed the five mortuary properties to CNT; (2) the Carrolls opened short sale positions; (3) the Carrolls contributed those short sale positions to CNT; (4) CNT closed the short sale positions; (5) the Carrolls contributed their CNT interests to CCFH; and (6) CCFH distributed New CNT
Examining each step independently (before determining whether and to what extent the step transaction doctrine should apply), we find that steps (1), (3), and (5) were all sham transactions, principally because CNT was a sham entity. The parties have stipulated, and the record reflects, that CNT lacked any legitimate business purpose. Rather, it was formed solely as a vehicle for effecting the Son-of-BOSS transaction and artificially “boosting” the real estate‘s aggregate adjusted tax basis. Hence, consistent with the parties’ stipulation, it was a sham partnership. See Commissioner v. Culbertson, 337 U.S. 733, 742 (1949) (explaining that, to form a valid partnership under Federal law, “the parties in good faith and acting with a business purpose [must] intend[] to join together in the present conduct of the enterprise“). We therefore disregard its existence. See, e.g., Sparkman v. Commissioner, 509 F.3d 1149, 1156 n.6 (9th Cir. 2007), aff‘g T.C. Memo. 2005-136; Andantech L.L.C. v. Commissioner, 331 F.3d 972, 980 (D.C. Cir. 2003), aff‘g and remanding T.C. Memo. 2002-97, 83 T.C.M. (CCH) 1476 (2002); see also Moline Props., Inc. v. Commissioner, 319 U.S. 436, 439 (1943) (explaining, in a tax case, that “the corporate form may be disregarded when it is a sham or unreal“).
We likewise disregard as shams the purported contributions of property to, and contributions of interests in, the sham partnership that occurred at steps (1), (3), and (5). Although deeds were signed and funds moved among accounts, economically, the parties’ positions did not change. CCFH and the Carrolls could not have contributed property in exchange for interests in a nonexistent partnership. They acquired nothing of substance and relinquished nothing of substance. A transaction undertaken with a sham entity is, a fortiori, a sham.
We further conclude that steps (2) and (4), together, constituted a sham transaction. The Carrolls opened the short sale positions, and—disregarding the positions’ purported contribution to the sham partnership, CNT—closed them mere days later pursuant to a prearranged plan. Pursuant to that same plan, during the brief period for which the short
Step (6), however, was different. If, for the reasons explained above, we disregard the preceding steps as shams and look through New CNT to its then partners, at this step CCFH transferred the five mortuary properties to the Carrolls. This transfer materially changed the Carrolls’ and CCFH‘s economic positions, entirely aside from tax considerations. CCFH was a passthrough entity for tax purposes, but for other legal purposes it was a legal entity distinct from its owners. The parties have not stipulated, and the record does not reflect, that CCFH was a sham entity. On the contrary, CCFH was a going concern that had operated a viable business and held the real properties for several years, not an
Moreover, as petitioner essentially acknowledges, a substantial, nontax purpose motivated the transfer, and attainment of that purpose altered the parties’ economic positions in a meaningful way. The Carroll family wanted to retire from the mortuary business and hoped to sell the funeral home, retaining the real estate as a source of ongoing income. Their advisers had concluded that the best means of achieving this goal would be to separate the real estate from the operating assets by transferring the real estate out of CCFH. In sharp contrast to the annuity arrangement in Knetsch, this transaction‘s participants did realize something of substance beyond a tax deduction: They implemented the business disposition and rental income retirement plan recommended by their advisers.
For the foregoing reasons, we conclude that step (6) had nontax substance, and we will not disregard CCFH‘s transfer of the real estate as a sham transaction.
Petitioner, however, repeatedly emphasizes that the Carrolls and their advisers refrained from causing CCFH to transfer the real estate until they had identified an ostensible means of accomplishing it without tax consequences. He contends that, but for the Son-of-BOSS transaction, the real estate would never have been transferred at all. This contention essentially invokes the step transaction doctrine. Even if, on its own, step (6) had nontax substance, must we nevertheless disregard it because it was part and parcel of an integrated sham transaction?
3. Step Transaction Doctrine
It is axiomatic that “a transaction‘s true substance rather than its nominal form governs its Federal tax treatment.” Superior Trading, LLC v. Commissioner, 137 T.C. 70, 88 (2011), aff‘d, 728 F.3d 676 (7th Cir. 2013); see also Commis-sioner v. Court Holding Co., 324 U.S. 331, 334 (1945) (“The incidence of taxation depends upon the substance of a transaction.“). Before recharacterizing a transaction‘s form to align with its substance, we conduct “a searching analysis of the facts to see whether the true substance of the transaction is different from its form or whether the form reflects what actually happened.” Harris v. Commissioner, 61 T.C. 770, 783 (1974); see also Gordon v. Commissioner, 85 T.C. 309, 324 (1985) (“[F]ormally separate steps in an integrated and interdependent series that is focused on a particular end result will not be afforded independent significance in situations in which an isolated examination of the steps will not lead to a determination reflecting the actual overall result of the series of steps.“).
Three alternative tests of varying degrees of permissiveness exist for determining whether to invoke the step transaction doctrine: the binding commitment test, the end result test, and the interdependence test. Superior Trading, LLC v. Commissioner, 137 T.C. at 88. “[A] transaction need only satisfy one of the tests to allow for the step transaction doctrine to be invoked.” Id. at 90.
Under the binding commitment test, we ask whether, at the time of the first step to occur, there was a binding commitment to undertake the subsequent steps. See Commissioner v. Gordon, 391 U.S. 83, 96 (1968). Courts have seldom used this test, and we have typically applied it only where “‘a substantial period of time has passed between the steps that are subject to scrutiny.‘” Superior Trading, LLC v. Commissioner, 137 T.C. at 89 (quoting Andantech LLC v. Commissioner, 83 T.C.M. (CCH) at 1504). Because all steps here occurred within little over one month, the binding commitment test is likely inappropriate to these circumstances. See id.; see also Assoc. Wholesale Grocers, Inc. v. United States, 927 F.2d 1517, 1522 n.6 (10th Cir. 1991) (declining to apply binding commitment test where case did not involve series of transactions over multiple years).42
Under the end result test, we examine “whether the formally separate steps are prearranged components of a composite transaction intended from the outset to arrive at a
We thus collapse the series of transactions into one, disregarding CNT, Teloma, Santa Paula, and S. Mountain as sham entities pursuant to the parties’ stipulation. Before the series of transactions began, CCFH owned the five mortuary properties. When the dust settled, Mr. Carroll, Ms. Cadman, and Ms. Craig owned the properties. Accordingly, the “stepped” transaction is a transfer of the five properties by CCFH to the three individuals, and for the reasons discussed above, that transaction had nontax substance. It was not, as petitioner would have it, a nonevent. “[I]n cases where a taxpayer seeks to get from point A to point D and does so stopping in between at points B and C“, we apply the step transaction doctrine to ignore the interim stops, Smith v. Commissioner, 78 T.C. 350, 389 (1982), not to return the taxpayer to point A.
The foregoing conclusion is decidedly not the one petitioner seeks. Rather than simply stop there, we must consider a strand of authority he raises on brief that, in effect, blends the sham and step transaction doctrines.
4. Blending the Doctrines
Where a sham transaction consists of multiple steps, we have recognized that “there is authority [for the proposition] that a sham transaction may contain elements whose form reflects economic substance and whose normal tax con-
In most such cases, courts determined that interest paid on bona fide indebtedness could be deducted even when the indebtedness had been incurred in connection with or in anticipation of a sham transaction. See, e.g., Jacobson v. Commissioner, 915 F.2d 832, 840 (2d Cir. 1990) (concluding that interest and loan commitment fees were deductible), aff‘g in part, rev‘g in part on other grounds T.C. Memo. 1988-341; Bail Bonds by Marvin Nelson, Inc. v. Commissioner, 820 F.2d 1543, 1549 (9th Cir. 1987) (finding that a loan was a sham, but implying that if it were bona fide, interest would be deductible), aff‘g T.C. Memo. 1986-23; Rice‘s Toyota World, Inc. v. Commissioner, 752 F.2d 89, 96 (4th Cir. 1985) (in a sham sale-leaseback transaction financed with notes, holding that taxpayer could deduct interest paid on a recourse note because it represented a genuine obligation), aff‘g in part, rev‘g in part 81 T.C. 184 (1983); Rose v. Commissioner, 88 T.C. 386, 423-424 (1987) (allowing deduction of interest payments “attributable to the forbearance of amounts due on genuine indebtedness” in connection with a transaction lacking economic substance), aff‘d, 868 F.2d 851 (6th Cir. 1989).
On the other hand, we have declined to sever interest payments from a multistep sham transaction where the interest payments were “an integral part of the tax-motivated sham.”43 Alessandra v. Commissioner, 69 T.C.M. (CCH) at 2772; see, e.g., Sheldon v. Commissioner, 94 T.C. 738, 762 (1990) (disallowing deductions for interest owed to securities repo counterparties where the repo transactions “lacked tax-independent purpose“); Seykota v. Commissioner, T.C. Memo. 1991-541, 62 T.C.M. (CCH) 1116, 1117, 1119 (1991) (dis-
Petitioner argues that the latter strand of caselaw governs here because CCFH‘s transfer of the real estate was “integral” to the sham Son-of-BOSS transaction and would not have occurred but for that transaction. Thus, petitioner asks us to disregard the tax consequences flowing from the transfer and to hold, for tax purposes, that CCFH still owns the real estate.
Petitioner‘s characterization of the real estate‘s transfer as a mere component of a sham transaction represents a category mistake.44 Transferring the real estate was the reason for and objective of the series of transactions at issue, not simply one of the transactions. Taxpayers have most commonly used Son-of-BOSS transactions retrospectively, to offset recognized gains from unrelated, completed transactions. See supra note 7. Here, the Carrolls used the Son-of-BOSS transaction prospectively, to avoid recognizing gains on a planned transaction—to wit, separation of the real estate from the funeral home business. We think this a distinction without a difference. A Son-of-BOSS transaction is a tax shelter undertaken, as its moniker implies, to offset, or “shelter“, income that would otherwise be subject to tax. Neither the sham transaction doctrine nor the step transaction doctrine nor the two combined requires us to disregard the income-producing event along with the shelter transaction designed to offset it. Such an interpretation would render the doctrines toothless and yield absurd results.
None of the cases petitioner cites as supporting his position persuades us otherwise. In Sheldon v. Commissioner, 94 T.C.
In United States v. Wexler, 31 F.3d 117, 126 (3d Cir. 1994), a criminal tax fraud case, the Court of Appeals for the Third Circuit found clear error in a jury instruction that would have recognized as valid interest deductions “constituting the tax benefits of the entire [sham] transaction.” The “profits from other transactions” that had been offset by these deductions were not at issue. See id. at 120. And in Goldstein, where we disallowed deductions of interest paid on loans that were shams, we did not hold that the taxpayer need not recognize the sweepstakes income that her son had engineered the loans to offset. Goldstein v. Commissioner, 44 T.C. at 286-287, 296, 300 (likewise disallowing interest on loans incurred solely to obtain a deduction, without concurrently disregarding sweepstakes income).
We would no more disregard the transfer of the real estate here than we would Mrs. Goldstein‘s sweepstakes win. Here, the gain-producing transaction and the shelter transaction occurred pursuant to a plan, and the shelter transaction arguably preceded realization of the gains it was designed to shield. But if we were to disregard the gain-producing transaction along with the shelter transaction, we would encourage taxpayers to hedge against the audit lottery by structuring their tax shelter transactions to precede and intertwine with their income-producing activities. We will not do so. “[W]hile a taxpayer is free to organize his affairs as he chooses, nevertheless, once having done so, he must accept the tax consequences of his choice, whether contemplated or not“. Commissioner v. Nat‘l Alfalfa Dehydrating & Milling Co., 417 U.S. 134, 149 (1974).
In sum, we hold that the step transaction doctrine applies to the transactions undertaken by the Carrolls; that application of that doctrine collapses the various transactions to a transfer of the real estate from CCFH to the Carrolls; and that this transfer was not simply part and parcel of a larger sham transaction. We will not disregard the transfer or the gain it generated.
E. Definition of Omission
Although we will not disregard CCFH‘s transfer of the real estate as petitioner urges, he has another arrow in his quiver. He contends that, under the Supreme Court‘s decision in United States v. Home Concrete Supply, LLC, 566 U.S. 478, 132 S. Ct. 1836 (2012), the allegedly omitted item—gain recognized on CCFH‘s distribution of appreciated property to its shareholders—does not constitute an omission within the meaning of
In Home Concrete, 566 U.S. at 487, 132 S. Ct. at 1841, the Supreme Court held that its interpretation in Colony, Inc. v. Commissioner, 357 U.S. 28, 36 (1958), of a prior version of
As we have explained, respondent‘s theory here is that, in purporting to distribute interests in New CNT to its shareholders, CCFH in fact distributed the appreciated real estate. Both CCFH (under
We have concluded that for tax purposes CCFH transferred the property directly to the Carrolls. In our findings, we found that this transfer would have resulted in recognition of $3,496,623 of gain under
| Shareholder | Amount |
|---|---|
| Mr. Carroll | $588,699.22 |
| Ms. Cadman | 17,292.39 |
| Ms. Craig | 17,292.39 |
| Total | 623,284.00 |
To determine whether these omissions exceeded 25% of “the amount of gross income stated in the return“,
1. Mr. Carroll
Beginning with Mr. Carroll, he and Mrs. Carroll reported the following items of income on their 1999 Form 1040: $36,000 of wages, salaries, and/or tips, $33,220 of taxable interest, $963 of taxable refunds, credits, or offsets of State and local income tax, and $23,028 of taxable Social Security benefits. These amounts all constitute income within the meaning of
Mr. and Mrs. Carroll also reported income on Schedule E, Supplemental Income and Loss, from three business activities: (1) CNT,45 (2) CCFH, and (3) “Business Interest Charles Carroll“, an S corporation. CNT reported no gross receipts for either of its short tax years in 1999. CCFH reported gross receipts of $1,841,144 for 1999, of which Mr. and Mrs. Carroll‘s 94.4512% share was $1,738,982.60. The record contains no evidence of gross receipts to associate with “Business Interest Charles Carroll“, nor any other evidence regarding that activity. Hence, on the record before us, Mr. Carroll reported a total of $1,738,982.60 of business gross income.
For purposes of applying
2. Ms. Cadman
Turning to Ms. Cadman, for 1999 she and her husband reported $98,528 of wages, salaries, and/or tips, $6 of taxable interest, $16 of ordinary dividends, $915 of taxable refunds, credits, or offsets of State and local income tax, and $61,321 of taxable pension and annuity distributions. These amounts all constitute income within the meaning of
Like Mr. and Mrs. Carroll, the Cadmans did not file Schedule C, Profit or Loss from Business. Also like Mr. and Mrs. Carroll, they listed three activities on Schedule E: CNT, CCFH, and the unrelated partnership. As noted above, CNT reported no gross receipts for either of its short 1999 tax years. Ms. Cadman‘s 2.7744% share of CCFH‘s 1999 gross receipts was $51,080.70. Like CNT, the unrelated partnership reported no gross receipts on its 1999 Form 1065. Hence, Ms. Cadman reported a total of $51,080.70 of business gross income.
For purposes of applying
3. Ms. Craig
Ms. Craig and her husband reported $51,129 of wages, salaries, and/or tips, $1,486 of taxable interest, and $16 of ordinary dividends. These amounts all constitute income within the meaning of
On Schedule C Ms. Craig and her husband reported gross receipts of $112,138 from “Mark Craig Productions“, a music production activity. On Schedule E they reported interests in the unrelated partnership, CNT, and CCFH. As noted above, both the unrelated partnership and CNT reported no gross receipts for 1999. Ms. Craig‘s 2.7744% share of CCFH‘s 1999 gross receipts was $51,080.70. Hence, Ms. Craig reported a total of $163,218.70 of business gross income.
For purposes of applying
In sum, for Mr. and Mrs. Carroll, the omitted amount exceeded 25% of reported gross income for tax year 1999; for Ms. Cadman and Ms. Craig, it did not. Accordingly, Home Concrete prohibits application of the six-year statute of limitations in
F. Adequacy of Disclosure
Finally, petitioner contends that the six-year limitations period cannot apply because the allegedly omitted item was adequately disclosed in the relevant returns.
1. Legal Standard
In evaluating an alleged disclosure, we ask whether a reasonable person would discern the fact of the omitted gross income from the face of the return. Univ. Country Club, Inc. v. Commissioner, 64 T.C. 460, 471 (1975). Whether a return adequately discloses omitted income is a question of fact. Rutland v. Commissioner, 89 T.C. 1137, 1152 (1987). In addressing that question, we bear in mind that in enacting the predecessor statute of
Given this relatively narrow congressional purpose, we have held that for an alleged disclosure to qualify as adequate, the return need not recite every underlying fact but must provide a clue more substantial than one that would intrigue the likes of Sherlock Holmes. See Highwood Partners v. Commissioner, 133 T.C. 1, 21 (2009) (citing Quick Trust v. Commissioner, 54 T.C. 1336, 1347 (1970), aff‘d, 444 F.2d 90 (8th Cir. 1971)). A disclosure need only be “sufficiently detailed to alert the Commissioner and his agents as to the nature of the transaction so that the decision as to whether to select the return for audit may be a reasonably informed one.” Estate of Fry v. Commissioner, 88 T.C. 1020, 1023 (1987). We have also cautioned, however, that an alleged disclosure will not qualify as adequate if the Commissioner must thoroughly scrutinize the return to ascertain whether gross income was omitted, Highwood Partners v. Commissioner, 133 T.C. at 22, or the disclosure is misleading, Estate of Fry v. Commissioner, 88 T.C. at 1023.
To demonstrate adequate disclosure, petitioner invites the Court‘s attention to various aspects of CCFH‘s, CNT‘s, and the individuals’ 1999 tax returns. First, petitioner points to the December 1 return as disclosing CNT‘s formation and the contributions of the short sale proceeds and positions and the real estate. Second, he contends that the December 1 return also disclosed the short positions’ closure. Third, petitioner cites the 351 statement as disclosing the Carrolls’ contribution of their interests in CNT to CCFH. And fourth, he asserts that the December 31 return disclosed CCFH‘s distribution of CNT to its shareholders because it did not identify CCFH as a partner. In rebuttal, respondent narrows the aperture to CCFH‘s 1999 return, arguing that the Schedules K-1 do not reflect the appreciated real estate‘s distribution in any manner and that the 351 statement provides no clue as to the omitted income.
Petitioner frames the inquiry as whether the transaction was adequately disclosed, but to find that the Carrolls qualify for the statutory safe harbor, we need not conclude that the returns reasonably disclose each transactional step that they undertook. Rather, the statute requires disclosure “of the nature and amount” of the omitted item. See
3. Returns’ Revelations
CCFH‘s 1999 return lies at the heart of our inquiry, and we begin there. Schedule L, Balance Sheet per Books, reflects that when 1999 began, CCFH owned land, buildings and other depreciable assets with a combined depreciated book value of $735,765. Schedule L further reflects that, at year-end, CCFH held buildings and other depreciable assets with
CCFH‘s return does not readily disclose the form or nature of that transaction. As is most relevant here, the 1999 instructions to Schedule D (Form 1120S), Capital Gains and Losses and Built-In Gains, directed S corporations to use this schedule to report, inter alia, “[g]ains on distributions to shareholders of appreciated capital assets.” Yet for 1999 CCFH did not file Schedule D. Moreover, although the 1999 instructions to Form 1120S directed that “[n]oncash distributions of appreciated property * * * valued at fair market value” be reported on line 20 of Schedule K, Shareholders’ Shares of Income, Credits, Deductions, etc., CCFH reported on that line only $245,470—an amount less than the decrease in book value of CCFH‘s real estate and other depreciable assets, and far less than the distributed real estate‘s aggregate fair market value. Consequently, CCFH did not properly report the distribution, and it reported no other transaction that could account for the change in book value of its real estate and other depreciable assets. For example, CCFH did not file Form 4797, Sales of Business Property, on which it would have reported the sale or exchange of noncapital or business assets. Nor did it report having engaged in a like-kind exchange or other nontaxable transaction for which reporting is required.
Where, then, did the real estate go? CNT‘s December 1 return provides a plausible answer. That return reports that CCFH transferred $523,377 of property to CNT in exchange for a 15.4% interest in CNT, and that CNT terminated on December 1, 1999, after distributing $522,761, a near-equal amount of property, to CCFH. Looking again to CCFH‘s 1999 tax return, the attached 351 statement discloses that one or more existing CCFH shareholders transferred an 84.6% interest in CNT to CCFH on or after December 1, 1999. From these two returns one can reasonably discern that CNT‘s December 1 termination occurred pursuant to
New CNT‘s December 31 return completes the picture. The December 1 return coupled with the 351 statement revealed that CCFH became CNT‘s sole owner on December 1, 1999. On the appended Schedules K-1, the December 31 return identifies as New CNT‘s partners the same individuals identified as CCFH‘s shareholders on the Schedules K-1 appended to CCFH‘s 1999 return. The individuals’ percentage interests in the two entities are identical. These details indicate that CCFH must have distributed interests in CNT, and indirectly its former real estate holdings, to its shareholders on December 31, 1999. Hence, CCFH and CNT‘s returns, which constitute part of Mr. Carroll‘s return for present purposes, provided a sufficient clue that an S corporation had distributed real estate to its shareholders.
But one crucial piece of the puzzle remains missing.
CCFH‘s return reports only the real estate‘s book value together with that of other depreciable assets, not its fair market value. Schedule L of CNT‘s December 1 return lists no book values for the assets purportedly contributed to CNT (which would include the short positions and offsetting obligations purportedly contributed by the Carrolls in addition to the real estate), or for any other assets. Schedule M-2, Analysis of Partners’ Capital Accounts, identifies the contributed property‘s book value, which would ordinarily equal its fair market value on the date of contribution, see
The returns making up Mr. Carroll‘s return for
Our caselaw is consistent with this conclusion. In Estate of Fry v. Commissioner, 88 T.C. at 1023, for example, we found a corporation‘s disclosure on its tax return of a $150,000 payment to be inadequate for purposes of
In Univ. Country Club, Inc. v. Commissioner, 64 T.C. at 470, we found adequate disclosure where the taxpayer fully reported a transaction consistently with the taxpayer‘s desired tax characterization, but the Commissioner later recharacterized the transaction. Here, in contrast, the Carrolls and their business entities did not fully report their transactions consistently with their desired tax characterization because, as we have explained, their transactions as reported should have resulted in $623,284 of recognized gain. Finally, in Quick Trust v. Commissioner, 54 T.C. at 1347, the Commissioner determined additional gross receipts for a partnership and argued that a partner had omitted them from income. We found adequate disclosure of the omitted income in the partnership‘s reporting of distributions to the partner far greater than the amount reported on the partner‘s return. Id. Here, however, no amount reported on any of the various tax returns hints at the source of the omitted item, the discrepancy between the real estate‘s tax basis and its fair market value.
G. Conclusion
We hold that the period for assessment for the 1999 tax year had expired with respect to Ms. Cadman and Ms. Craig before respondent issued the FPAA. They are not parties to this proceeding and will not be affected or bound by any readjustments determined herein. See
III. Consequences of the Sham Stipulation
Because petitioner‘s statute of limitations arguments obliged us to consider the merits of some of respondent‘s determinations in the FPAA, we need only briefly discuss the second issue before us, whether the adjustments in the FPAA should be sustained. Petitioner conceded respondent‘s sham entity theory for determining the adjustments in the FPAA. At trial the parties essentially ignored the merits issues, concentrating instead on the statute of limitations and penalties, but on brief, respondent asserts that petitioner should be deemed to have conceded all theories raised in the FPAA because respondent‘s determinations enjoy a presumption of correctness. Petitioner claims that his concession mooted respondent‘s other theories and rendered litigation of them unnecessary.
Petitioner‘s concession and our holdings herein more than suffice to sustain the FPAA adjustments, and we decline to analyze respondent‘s other theories unnecessarily. We conclude that the FPAA adjustments to CNT‘s December 1 return should be sustained considering the parties’ stipulation that CNT was a sham and our conclusions above concerning the sham and step transaction doctrines’ applicability.46
IV. Liability for the Accuracy-Related Penalty
In the FPAA respondent determined that all underpayments of tax resulting from his adjustments of CNT‘s partnership items were attributable, in the alternative, to (1) gross (or if not gross, substantial) valuation misstatement(s), (2) substantial understatements of income tax, or (3) negligence or disregard of rules and regulations. Hence, respondent determined that either a 40% penalty or a 20% penalty would apply to any underpayment. See
The Commissioner bears the burden of production and “must come forward with sufficient evidence indicating that it is appropriate to impose the relevant penalty.”
A. Penalties’ Applicability
In the FPAA respondent adjusted to zero several items on CNT‘s December 1 return, including partnership outside basis. We have sustained those adjustments in their entirety.48 Consequently, for each of these items, the reported value exceeded the correct value by 400% or more. Respondent has satisfied his burden of production with respect to the gross and substantial valuation misstatement penalties, and petitioner does not question respondent‘s computations. Because we find the 40% gross valuation misstatement penalty applicable to any underpayment resulting from respondent‘s adjustments, we need not address the substantial understatement and negligence pen
B. Petitioner‘s Defense
A
Partner-level defenses, including reasonable cause and good faith, may not be asserted in a partnership-level TEFRA proceeding such as this one. See New Millennium Trading, LLC v. Commissioner, 131 T.C. 275, 288-289 (2008) (upholding temporary regulation as “a valid interpretation of the statutory scheme“);
We determine “whether a taxpayer acted with reasonable cause and in good faith * * * on a case-by-case basis, taking into account all pertinent facts and circumstances“,
We examine below whether petitioner‘s professed reliance upon Mr. Myers satisfied each of these three requirements. Petitioner also contends that he relied on Mr. Crowley‘s advice, but this claim plainly fails. Ms. Cadman, who joined Mr. Carroll at the various meetings described herein, credibly testified that she believed Mr. Crowley endorsed the transaction. But Mr. Crowley testified, and Ms. Cadman confirmed, that Mr. Crowley had openly acknowledged that he did not fully understand the transaction. Even if, contrary to his testimony, Mr. Crowley endorsed the transaction and did not just tepidly agree to “go along with” it, petitioner‘s reliance on that endorsement could not have been reasonable and in good faith given Mr. Crowley‘s admitted confusion. Whatever constitutes “sufficient expertise to justify reliance,” see id., we think the adviser must, at the very least, hold himself out as possessing sufficient expertise to understand the transaction at issue. Mr. Crowley made no such pretense here—quite the opposite, in fact—so to the extent Mr. Carroll relied on his advice, that reliance was unjustified and unreasonable.
1. Sufficient Expertise?
The sufficiency of Mr. Myers’ expertise poses a more difficult question. Rather than set a specific standard, the regulations under
In applying these general guidelines, this Court has not articulated a uniform standard of competence that an adviser must satisfy but has instead demanded expertise commensurate with the factual circumstances of each case. See, e.g., 106 Ltd. v. Commissioner, 136 T.C. 67, 77 (2011) (the taxpayer‘s longtime attorney and accounting firm, who “would have appeared competent to a layman“, and especially so to the taxpayer, had adequate expertise to advise on a Son-of-BOSS-type transaction), aff‘d, 684 F.3d 84 (D.C. Cir. 2012); Neonatology Assocs., 115 T.C. at 99 (an insurance agent who was not a tax professional lacked sufficient expertise to advise on tax implications of a complex, group whole/term-hybrid life insurance plan); Thousand Oaks Residential Care Home I, Inc. v. Commissioner, T.C. Memo. 2013-10, at *13, *41 (the taxpayers’ longtime accountant, an enrolled agent with a master‘s degree in business administration, was a competent professional with sufficient expertise to advise on employment plan contributions); Kirman v. Commissioner, T.C. Memo. 2011-128, 101 T.C.M. (CCH) 1625, 1633 (2011) (taxpayer failed to establish that part-time tax return preparer who held an accounting degree was a competent professional with sufficient expertise to advise on business expense and charitable contribution deductions).
Under the circumstances of this case, we think that Mr. Myers possessed sufficient expertise to justify reliance by Mr. Carroll. As of 1999 Mr. Myers had practiced law for 30 years and had represented Mr. Carroll for almost 20 of them. Mr. Carroll had relied on Mr. Myers’ advice in growing his business through acquisitions, properly maintaining his corporation, complying with regulations, managing his employees, and formulating his estate plan. Although Mr. Myers did not hold himself out as a tax specialist and tended to refer clients out for complicated tax matters, he had studied tax in
The record also reflects that Mr. Carroll, while a successful businessman, was not a financial sophisticate. Although Mr. Carroll did hold a post-high-school degree in mortuary science, he had obtained it approximately 50 years earlier, and the record does not reflect that he obtained any further education. To the extent that his mortuary science college curriculum incorporated any finance, tax, or economics material, that material would have been sorely out of date by 1999. Indeed, Mr. Myers credibly testified that Mr. Carroll understood only basic tax principles. According to Mr. Crowley, Mr. Carroll had never before invested in even garden-variety mutual funds or securities, let alone participated in a short sale transaction involving T-notes. When presented with the exotic financial engineering proposed by Mr. Hoffman, Mr. Carroll naturally relied on Mr. Myers, to whom he had turned in the past for all forms of legal advice, including with regard to more general tax matters.
Mr. Myers performed due diligence. After Mr. Hoffman pitched the Son-of-BOSS transaction to him, in an effort to better understand the proposal Mr. Myers held a conference call with Mr. Mayer. This conversation left Mr. Myers unsatisfied with his grasp of how the transaction would work, so he requested, and Mr. Mayer sent, a memorandum and an article from a tax publication describing and analyzing the transaction and citing various legal authorities. Mr. Myers reviewed Mr. Mayer‘s memorandum and consulted some of the legal authorities cited therein, albeit not in extreme detail. He also researched Jenkens & Gilchrist. During the implementation phase, he spoke by telephone with Mr. Mayer several times.
Mr. Myers believed that he had a good grasp of how the Son-of-BOSS transaction would work and of the legal theories behind it. Although Mr. Myers did not know all of the details of the transaction, the record does not indicate that he shared this fact with Mr. Carroll. Rather, Mr. Myers formed the opinion that the transaction was “legitimate [and] proper“, and he did share this opinion with Mr. Carroll. He
We find that Mr. Carroll could justifiably rely upon that advice. To Mr. Carroll, a tax and financial layperson, Mr. Myers would have appeared ideal, not simply competent, to advise him on the feasibility and implications of the basis boost transaction. See 106 Ltd. v. Commissioner, 136 T.C. at 77.
Respondent offers two counterarguments. First, he emphasizes that Mr. Myers was not a “tax professional“. What constitutes a “tax professional” is debatable. Mr. Myers, for example, did provide some general tax advice to clients and also prepared estate tax returns, although he did not prepare other income tax returns (most attorneys do not) or specialize in dispensing tax advice. More to the point, the regulations under
Second, respondent suggests that Mr. Myers unreasonably and impermissibly relied, himself, on representations of Mr. Mayer. The regulations prohibit such reliance on a third party, see
We acknowledge this issue is a close one. Mr. Myers did testify to having repeated conversations with Mr. Mayer in an effort to clarify his understanding of the proposed transaction. Yet taken as a whole, his testimony confirms that he did not rely on Mr. Mayer with respect to the facts or the law in forming his opinion in favor of the transaction. With regard to the facts, unlike Mr. Mayer, Mr. Myers possessed intimate knowledge of Mr. Carroll‘s personal and business legal arrangements, and his advice could thus take into account “all pertinent facts and circumstances” including “the taxpayer‘s purposes * * * for entering into a transaction and for structuring a transaction in a particular manner.”
Mr. Myers possessed sufficient expertise to justify reliance by a reasonable person of Mr. Carroll‘s education, sophistication, and business experience. Accordingly, Neonatology‘s first prong is satisfied.
2. Necessary Information?
A taxpayer must affirmatively provide “necessary and accurate information to the adviser” on whose advice the taxpayer claims reliance. Neonatology Assocs., P.A. v. Commissioner, 115 T.C. at 99. The regulations under
The parties dispute whether Mr. Carroll provided Mr. Myers with the information necessary for Mr. Myers to properly evaluate the proposed transaction. Respondent specifically points to two omitted nuggets of information: (1) the amount of Jenkens & Gilchrist‘s fee and (2) the fact that the short sale would almost certainly generate no profit. With regard to the short sale‘s profit potential, the evidence in the record makes clear that T-note short sales would have been wholly unfamiliar to Mr. Carroll, and we are not convinced that he understood the concept well enough to appreciate whether it was likely to yield a profit. With regard to Jenkens & Gilchrist‘s fee, the amount of that fee appears in the record only on an invoice dated March 23, 2000, months after the transactions at issue had concluded.
While we think it likely that Mr. Carroll, an astute businessman, would have inquired about price before plunging ahead, the record is silent as to when and under what circumstances that price was disclosed to him. There is no evidence that the fee was contingent or computed as a percentage of any alleged tax savings. Considering Mr. Carroll‘s education, experience, and sophistication, we find that he would not have recognized the fee amount‘s relevance to Mr. Myers’ evaluation of the proposed transaction. Indeed, Mr. Myers testified that he did not find the fee amount unusual and that it would not necessarily have changed his assessment.
Respondent argues that Mr. Carroll‘s ability to profit from the Son-of-BOSS transaction, taking into account Jenkens & Gilchrist‘s fee, provided the transaction‘s only ostensible nontax substance. That may well be true, but as we have observed, Mr. Carroll had no prior experience with or knowledge of short sale transactions or margin trading and lacked an appreciation for the Son-of-BOSS transaction‘s profit
In sum, we conclude that Mr. Carroll has satisfied his burden of proof as to Neonatology‘s second prong. While respondent has identified two items of information that Mr. Carroll failed to provide Mr. Myers, we decline to hold Mr. Carroll to an unreasonable standard exceeding his knowledge and capabilities. See
3. Good-Faith Reliance?
As a further prerequisite to a reasonable reliance defense, a taxpayer must have actually received advice and relied upon it in good faith. See Neonatology Assocs., P.A. v. Commissioner, 115 T.C. at 99. Advice need not “be in any particular form” but rather embraces “any communication * * * setting forth the analysis or conclusion of a person, other than the taxpayer, provided to * * * the taxpayer and on which the taxpayer relies, directly or indirectly“.
Respondent, however, contends that any reliance by Mr. Carroll on Mr. Myers’ advice could not have been in good faith because: (1) given his business savvy and intelligence, Mr. Carroll should have recognized the proposed solution to his low basis dilemma was too good to be true; (2) Mr. Carroll ignored warnings from the IRS about engaging in a Son-of-BOSS transaction; (3) Mr. Carroll‘s sole purpose for engaging in the transaction was to avoid Federal income tax;
First, respondent asserts that Mr. Carroll was highly intelligent, had no trouble understanding tax concepts, and understood, at the very least, the tax implications of transferring the real estate out of CCFH. In short, respondent argues, Mr. Carroll was smart enough to know that the result Messrs. Hoffman and Mayer pitched to him was too good to be true. For mental health reasons, Mr. Carroll, now in his mideighties, did not testify or even appear at trial, so the Court had no opportunity to observe him firsthand or to assess his credibility. Instead, we must weigh the other witnesses’ expressed opinions of him and the factual information they provided about his education and experience.
The parties point to snippets of testimony by Messrs. Myers and Crowley in which they opine, mostly in response to leading questions, concerning Mr. Carroll‘s abilities. From their testimony as a whole, we conclude that, while Mr. Carroll‘s confidants respected his success as a businessman and believed him fairly intelligent, they also considered his knowledge of tax and financial matters rudimentary. Moreover, although the subjective opinions of trusted advisers are not unpersuasive, objective facts carry more weight. Mr. Carroll attended college, presumably on the “G.I. Bill” after World War II, but the college was a specialized one for morticians. He built a local chain of funeral homes from the ground up, but that business accounted for nearly 100% of his net worth. He made no diversifying investments and held his savings principally in cash. His business, operating funeral homes, demanded hard work, compassion, and some degree of numeracy; it did not require him to engage in complex problem-solving, legal research, or sophisticated financial transactions. On the record before us, we decline to find that Mr. Carroll knew or should have known that the promised results of the Son-of-BOSS transaction were too good to
Second, citing
With regard to
Third, respondent insists that Mr. Carroll‘s sole purpose for engaging in the transaction was to avoid Federal income tax and that this fact belies his claim of good faith. As we have explained, however, Mr. Carroll had an independent, nontax purpose for engaging in the series of transactions that included the Son-of-BOSS: He sought to rearrange his assets in the manner his longtime advisers, Messrs. Myers and Crowley, deemed best to facilitate sale of the funeral home business and retirement income for the Carrolls. Cf. Gerdau Macsteel, Inc. v. Commissioner, 139 T.C. 67, 196 (2012) (finding that taxpayers could not have relied on a legal opinion in good faith when they “knew that the only purpose of the transactions was to achieve a tax loss” (emphasis added)).
Granted, he sought to do it in a manner that would minimize his tax liability, and he had in fact contemplated this rearrangement of assets for some time but postponed it because of the anticipated tax implications. His motives were thus mixed. See Gregory v. Helvering, 293 U.S. at 468-469 (explaining that a taxpayer‘s “motive * * * to escape payment of a tax” will not invalidate an otherwise lawful transaction but finding the instant transaction invalid because it lacked any nontax purpose). But that Mr. Carroll had two goals in mind does not imply that he did not rely in good faith upon Mr. Myers’ advice that, after years of analyzing and rejecting various alternatives, a group of transactions had finally been conceived through which Mr. Carroll could
Finally, respondent argues that Mr. Carroll‘s failure to attempt to personally determine the Son-of-BOSS transaction‘s validity and the related tax returns’ accuracy demonstrates he lacked good faith. The regulations under
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. Most taxpayers are not competent to discern error in the substantive advice of an accountant or attorney. To require the taxpayer to challenge the attorney, to seek a “second opinion,” or to try to monitor counsel on the provisions of the Code himself would nullify the very purpose of seeking the advice of a presumed expert in the first place. * * *
Nevertheless, we have stated that “blind reliance on a professional does not establish reasonable cause.” Estate of Goldman v. Commissioner, T.C. Memo. 1996-29, 71 T.C.M. (CCH) 1896, 1903 (1996).52 As respondent points out, Mr.
Carroll asked no questions and has not established that he reviewed CNT‘s 1999 tax returns when Mr. Crowley presented them to him for signature; he simply signed them. Mr. Carroll‘s apparent possible failure to scrutinize CNT‘s returns is troubling, but not fatal. We cannot characterize his reliance on Mr. Crowley as “blind” given the depth and duration of their professional relationship. In any event, the fact that the reliance at issue here is Mr. Carroll‘s reliance on Mr. Myers makes respondent‘s argument regarding Mr. Carroll‘s failure to review the returns a red herring. The returns’ inaccuracy stemmed not from a computational or other return preparation error by Mr. Crowley, but rather from Messrs. Mayer‘s, Hoffman‘s, and Myers’ failure to appreciate that CNT was a sham partnership. Had Mr. Carroll reviewed the returns, he would have seen nothing inconsistent with the theories that Mr. Myers had assured him were sound.
We find that Mr. Carroll relied on Mr. Myers in good faith, thereby satisfying Neonatology‘s third prong. Hence, he has demonstrated reasonable cause and good faith within the meaning of
V. Conclusion
We conclude that the period of assessment remained open as to Mr. and Mrs. Carroll‘s 1999 tax year when respondent issued the FPAA and that the FPAA was consequently timely as to them. We further conclude that neither Ms. Cadman nor Ms. Craig is a proper party to this action under section
The Court has considered all of petitioner‘s and respondent‘s contentions, arguments, requests, and statements. To the extent not discussed herein, we conclude that they are meritless, moot, or irrelevant.
To reflect the foregoing,
An appropriate order and decision will be entered.
WILLIAM SCOTT STUART, JR., TRANSFEREE, ET AL.,1 PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Docket Nos. 1685-11, 1686-11, 1687-11, 1688-11.
Filed April 1, 2015.