CURTIS INVESTMENT COMPANY, LLC, HENRY J. BIRD, A PARTNER OTHER THAN THE TAX MATTERS PARTNER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent GUY R. BAXTER AND LONNIE C. BAXTER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 10181-08, 16835-08
UNITED STATES TAX COURT
August 2, 2017
T.C. Memo. 2017-150
MARVEL, Chief Judge
David D. Aughtry and Hale E. Sheppard, for petitioners. Jason P. Oppenheim, John W. Sheffield, III, and Lawrence Sledz, for respondent.
MARVEL, Chief Judge: These cases have been consolidated for trial, briefing, and opinion. The issues for decision are whether petitioners are:1
- entitled to deduct the losses and fees associated with Custom Adjustable Rate Debt Structure (CARDS) transactions for taxable year 2000 (year at issue) and
- liable for accuracy-related penalties under
section 6662(a) .2
Respondent issued a notice of final partnership administrative adjustment (FPAA) pursuant to
Respondent issued a notice of deficiency to Mr. and Mrs. Baxter on April 8, 2008, that determined a deficiency and accuracy-related penalty under
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The stipulations of fact and facts drawn from stipulated exhibits are incorporated herein by this reference. Mr. and Mrs. Baxter resided in South Carolina at the time of filing their
I. Petitioners
In 1882 Henry Russell Curtis founded Curtis Printing Co., which became a very successful printing company. In 1918 Curtis Printing Co.‘s name was changed to Curtis 1000, and in 1968 Curtis 1000 decided to offer its stock to the public. In order to offer the stock of Curtis 1000 to the public, Curtis 1000 incorporated American Business Products, Inc. (ABP). ABP became the corporate parent of Curtis 1000, and the ABP stock was traded to the public.
Before the public offering, Curtis 1000 was primarily owned by the Curtis family. In 1961 the family formed Curtis Investment, which operated as a holding company for Curtis 1000 stock. After the public offering, Curtis Investment owned approximately 30% of the ABP stock.5 In addition to holding ABP stock, Curtis Investment began diversifying its portfolio. As part of its diversified portfolio, Curtis Investment would borrow funds at a low interest rate to make an investment if it determined that the investment would yield a return greater than the interest cost.
When Mr. Bird became the managing member of Curtis Investment, the company included 34 family members. To centralize management in 1998 Mr. Bird formed an investment committee to assist Curtis Investment with determining what type of assets the company should hold. The investment committee determined that Curtis Investment should diversify its holdings, and therefore as part of that diversification Curtis Investment would sell some of its ABP stock over a 10-year period.
Petitioners knew that the sales of ABP stock would generate substantial tax liabilities, and they began considering ways to shelter the capital gains triggered by the sales. Petitioners considered several different tax shelter transactions but ultimately rejected those proposals. Then in the fall of 2000 they began considering CARDS transactions to minimize their tax liabilities.
II. Petitioners’ Entry Into the CARDS Transactions
CARDS transactions are not new to this Court. See generally Hunter v. Commissioner, T.C. Memo. 2014-132; Crispin v. Commissioner, T.C. Memo. 2012-70, aff‘d, 708 F.3d 507 (3d Cir. 2013); Kerman v. Commissioner, T.C. Memo. 2011-54, aff‘d, 713 F.3d 849 (6th Cir. 2013); Country Pine Fin., LLC v. Commissioner, T.C. Memo. 2009-251. The CARDS transaction, including the
In the fall of 2000 Barbara Coats, an accountant at Windham Brannon, P.C. (Windham Brannon), and an adviser of petitioners, learned about the alleged benefits of CARDS transactions while teaching a class. Ms. Coats was introduced to Mr. Hahn, who recommended CARDS transactions to shelter petitioners’ capital gains that resulted from the ABP stock sale and as a way to obtain long-term funds for investment. Ms. Coats believed the proposal could work for petitioners because of their history with leveraging debt and their desire to shield the gains from the sale of ABP stock.
Ms. Coats and another accountant of Windham Brannon, Matt Levin, presented the CARDS transactions proposal to Mr. Bird. Mr. Bird asked petitioners’ advisers to research the proposal. Petitioners’ advisers included Ms. Coats and Mr. Levin of Windham Brannon; and Thomas H. Rogers III and Ann A. Watkins, lawyers at Rogers & Watkins.8 Mr. Rogers was to review the contracts
During their review of the contracts and tax consequences of the CARDS transactions, petitioners’ advisers received a model legal opinion for a CARDS transaction drafted by the law firm of Brown & Wood. The model opinion letter included several blanks and explanatory brackets where currency amounts, dates, and names were to be entered. Although the model opinion letter did not address petitioners’ specific CARDS transactions,9 the model opinion letter did generally describe a CARDS transaction. The model opinion letter concluded that a CARDS transaction would “more likely than not” have economic substance.10 In
Ms. Coats, Mr. Levin, and Mr. Rogers reviewed the model opinion letter and relied solely on the model opinion letter and materials cited therein to form their opinion of the CARDS transactions. None of petitioners’ advisers provided their own opinion letters. Mr. Bird knew that petitioners’ advisers relied solely on the model opinion letter and the materials cited within the model opinion letter. After reviewing the model opinion letter, petitioners’ advisers concurred with the model opinion letter regarding the tax consequences and did not raise any additional issues.12
Chenery provided petitioners with their respective opinion letters from Brown & Wood that discussed their particular CARDS transactions after petitioners had already entered into their CARDS transactions. As part of
In addition to arranging for a review of the model opinion letter, petitioners hired a private investigator to investigate Chenery and Mr. Hahn. Petitioners’ advisers did research on HVB, the bank providing the loans for the CARDS transactions, and on Brown & Wood, and that research did not generate any concerns.
As described infra pp. 16-18, petitioners, as part of the CARDS transactions, would receive some proceeds that they planned to invest. Mr. Bird assumed the primary responsibility for researching the investment potential of the CARDS transactions and deciding whether petitioners could profit from them. Mr. Bird‘s research led him to conclude that petitioners needed to earn 7.9% to make the CARDS transactions profitable. Mr. Bird calculated that the expected rate of return on investments made with proceeds from the CARDS transactions was 17.2% and that after factoring in costs of 7.9%, petitioners could expect a net return of 9.3% (17.2%-7.9%). Petitioners’ advisers reviewed Mr. Bird‘s calculations and confirmed that the CARDS transactions could be profitable.
Petitioners ultimately decided to participate in the CARDS transactions. Petitioners did not consider any financing options other than the CARDS transactions in the last quarter of 2000.
A CARDS transaction typically has three stages: (1) loan origination; (2) loan assumption; and (3) loan operation. The CARDS transactions at issue in these cases also had three stages, which are described below.
A. Origination
On December 11, 2000, Elizabeth A.D. Sylvester and Michael Sherry,15 residents of the United Kingdom, organized Brondesbury Financial Trading, LLC (Brondesbury), as a Delaware LLC for the sole purpose of facilitating the CARDS transaction with respect to Curtis Investment. Also on December 11, 2000, Ms. Sylvester and Mr. Sherry organized Caledonian Financial Trading, LLC (Caledonian), as a Delaware LLC for the sole purpose of facilitating a CARDS transaction with respect to Mr. and Mrs. Baxter. Ms. Sylvester and Mr. Sherry capitalized the entities solely through the use of promissory notes.
On December 14, 2000, Brondesbury and Caledonian each entered into a credit agreement with HVB, a German-based bank, whereby HVB agreed to lend
Although the credit agreements included a 30-year period, HVB had the unilateral right to call the loan at the end of every year. Interest on the loans accrued annually with the exception of the first and second interest periods, which occurred in the first year of the loan.16 HVB could adjust the interest rate annually.
The agreement governing the loans required different collateralization according to the quality of the collateral. If the collateral consisted of cash, or an acceptable cash equivalent, the borrowers were required to deposit collateral equal to 102% of their obligations to HVB. If the collateral consisted of other assets, the borrowers were required to deposit collateral equal to 108% of the obligations.
HVB deposited 85% of each loan‘s proceeds into a time deposit account established at HVB for each borrower. The time deposits were set to mature in one year.17 HVB disbursed the remaining 15% of each loan‘s proceeds by issuing
Brondesbury and Caledonian pledged their respective time deposits and promissory notes as collateral for the loans.18 As a result of the time deposits and promissory note collateralization, the amounts of the loans were fully collateralized. The entities could not withdraw cash from HVB without substituting collateral, and any substitution of collateral required HVB‘s approval. HVB also had the right to withdraw interest due to HVB from the time deposit account when an interest payment was due.
B. Loan Assumption
On December 27 and 28, 2000, Curtis Investment executed a series of agreements with Brondesbury, and Mrs. Baxter executed similar documents with Caledonian. Both purchased their respective counterparties’ HVB promissory
The full balance of each entity‘s loan was due on December 14, 2030. However, petitioners were also aware that HVB could call the loan on or after December 14, 2001. Petitioners’ attorney, Tom Rogers, had advised Mr. Bird regarding the calling of the loans. Mrs. Baxter was also aware that HVB could call the loans.
Both Brondesbury and Caledonian agreed to make annual interest payments to HVB, but petitioners were required to replace any collateral used to make those interest payments. Both Brondesbury and Caledonian agreed not to request the release or withdrawal of any of the collateral; and as long as the collateral remained (i.e., the time deposits), it would be used to pay off the principal of the loan. Consequently, petitioners did not gain access to the full amounts of the loans.
On December 28, 2000, petitioners redeemed their respective promissory notes. HVB deposited €5.295 million into Curtis Investment‘s HVB account and
C. Operational Phase
Petitioners were subject to the same limitations as Brondesbury and Caledonian in terms of withdrawing the proceeds from the HVB loans. Petitioners could not withdraw the cash without HVB‘s approval. Petitioners purportedly found this unacceptable. Therefore, before entering into the CARDS transactions, petitioners had negotiated a solution with Canadian Imperial Bank of Commerce (CIBC) to facilitate the withdrawal of cash from HVB. Petitioners had a prior relationship with CIBC and held several investment accounts with the bank.
Both Curtis Investment and Mrs. Baxter used the letter of credit as replacement collateral. On December 28, 2000, HVB deemed the letter of credit acceptable as substitute collateral and wired $5,294,520 to one of Curtis Investment‘s CIBC accounts. The funds consisted of $4,892,580 for Curtis Investment and $401,940 for Mrs. Baxter. Petitioners pledged to HVB a first priority lien and security interest in favor of HVB for the letter of credit. As a result of the letter of credit, petitioners’ CARDS loans were fully collateralized.
On December 29, 2000, CIBC credited the $5,294,520 to a Curtis Investment account. Petitioners maintained the proceeds deposited with CIBC in
D. Fees
To set up and facilitate its CARDS transaction Curtis Investment paid $1,938,465 to Chenery. Mrs. Baxter paid Chenery $154,375 to set up and facilitate her CARDS transaction. Therefore, including the $241,200 that petitioners paid CIBC for the letter of credit, petitioners paid $2,334,040 in fees. The upfront fees totaled approximately 45% of the cash petitioners received from HVB.
Mr. Bird was familiar with loans and the lending industry. He was president of a mortgage company called Birdhouse Mortgages. According to Mr. Bird, an origination fee is computed on the amount borrowed and not on the amount owed at the end of the loan. Birdhouse Mortgages did not offer any products with a 44% or more loan origination fee.
IV. Unwinding the CARDS Transactions
On November 13, 2001, petitioners received notice from HVB that HVB intended to call the loans.20 The time deposits in accounts with HVB for the
Petitioners sought replacement financing from CIBC, Bank of North Georgia, Deutsche Bank, and National Bank of South Carolina for the full amounts of the two loans. However, petitioners ultimately did not obtain replacement financing for the entire loan amounts. Petitioners did negotiate a loan of $8.5 million from CIBC and used a portion of the proceeds to satisfy their obligations to HVB.
V. Petitioners’ Income Tax Returns and Notices of Deficiency
Curtis Investment timely filed its Form 1065, U.S. Return of Partnership Income, for the year at issue, reporting a $28,597,759 long-term capital gain from the ABP stock sale. Curtis Investment also reported a $27,724,620 loss as a result of the CARDS transaction. The loss from the CARDS transaction allegedly occurred when Curtis Investment redeemed the promissory note. Curtis
Respondent issued an FPAA to the TMP for Curtis Investment on December 6, 2007. In the FPAA respondent determined that Curtis Investment was not entitled to deductions for capital losses or transaction costs as a result of the CARDS transaction and that Curtis Investment was liable for accuracy-related penalties. Because the TMP did not petition this Court, Mr. Bird, a notice partner and managing member for the year at issue, filed a petition pursuant to
Mr. and Mrs. Baxter timely filed their Form 1040, U.S. Individual Tax Return, for taxable year 2000. On their Form 1040, Mr. and Mrs. Baxter reported a long-term capital gain of $2,444,383 and a short-term capital gain of $18,895 from the sale of ABP stock that Mrs. Baxter owned individually. Mr. and Mrs. Baxter also reported a $2,277,660 capital loss as a result of the CARDS transaction. The loss from the CARDS transaction allegedly occurred when Mrs.
Respondent issued notices of deficiency to Mr. and Mrs. Baxter on April 8, 2008, for taxable years 2000 and 2001. In the notice of deficiency for the 2000 taxable year, respondent determined, inter alia, that Mr. and Mrs. Baxter were not entitled to the capital loss deduction as a result of the CARDS transaction because the transaction lacked economic substance. Additionally, respondent determined that Mr. and Mrs. Baxter were liable for accuracy-related penalties.22 Mr. and Mrs. Baxter timely petitioned this Court.
VI. The Expert Reports
Respondent introduced an expert report by A. Lawrence Kolbe. Dr. Kolbe holds a Ph.D. in economics from the Massachusetts Institute of Technology and has previously testified in or been deposed in Tax Court cases involving CARDS transactions. See, e.g., Hunter v. Commissioner, T.C. Memo. 2014-132; Kipnis v. Commissioner, T.C. Memo. 2012-306; Crispin v. Commissioner, T.C. Memo. 2012-70; Gustashaw v. Commissioner, T.C. Memo. 2011-195, aff‘d, 696 F.3d 1124 (11th Cir. 2012); Kerman v. Commissioner, T.C. Memo. 2011-54; Country Pine Fin., LLC v. Commissioner, T.C. Memo. 2009-251. Dr. Kolbe‘s report focused on the CARDS transactions as financing decisions and therefore analyzed the loans and not what was done with the proceeds. Dr. Kolbe concluded that the CARDS transactions were not economically rational because the expected rate of return on the amount invested did not exceed or even equal the “cost of capital“, i.e., the expected rate of return in capital markets on alternative investments of equivalent risk. On the basis of his analysis, Dr. Kolbe concluded that the net present value of the loans was negative €2.19 million. A typical loan has a net present value of zero. In other words, the loans would reduce petitioners’ wealth by €2.19 million regardless of the returns from the investments.
Dr. Kolbe also considered the fees and interest rate of the CARDS transactions. On the basis of his analysis, Dr. Kolbe concluded that the fees were $1,887,962 more than for a loan that would yield similar proceeds and that the interest rate on the loans was 2.970% higher than market interest rates, without fees. Dr. Kolbe also noted that the longer the loans were maintained, the worse off petitioners were because of the excessive annual costs of the loans after the first year. Dr. Kolbe therefore concluded that the loans were an unprofitable financing
Petitioners introduced the expert report of James A. Walker, a banker with 47 years of experience. Mr. Walker holds an M.B.A. degree from Georgia State University. Mr. Walker‘s report discusses commercial lending practices. He concludes that the credit agreement was a 30-year loan term. His report does not address the profit potential or the business purpose of the CARDS transactions.
Petitioners also introduced the expert report of Conrad S. Ciccotello. Dr. Ciccotello has a Ph.D. in finance from Pennsylvania State University and is a professor at Georgia State University. Dr. Ciccotello‘s report focuses on the investment potential of the CARDS transactions and concludes that petitioners could profit from the CARDS transactions if their investment returns are greater than 9.5%.
OPINION
I. Burden of Proof
Tax deductions are a matter of legislative grace, and the taxpayer has the burden of proving that he is entitled to the deductions claimed.
Although petitioners contend that the burden of proof should shift to respondent, petitioners have failed to produce credible evidence to support a shift in the burden of proof. Therefore, the burden of proof remains with petitioners. Even if petitioners had produced credible evidence, which they did not, to support a shift in the burden of proof, the parties filed a joint statement of issues and did
II. Merits of CARDS Under the Economic Substance Doctrine
Taxpayers have the right to structure their transactions in a manner which decreases the amount of what otherwise would be their taxes. Gregory v. Helvering, 293 U.S. 465, 469 (1935). However, even if a transaction is in formal compliance with the Code, the economic substance of the transaction determines what is and what is not income to a taxpayer. Generally courts use a two-prong test to decide whether a transaction has economic substance. We are mindful, however, that there is a split among the Courts of Appeals as to the proper application of the economic substance doctrine. Absent a stipulation to the contrary appeals in these cases lie with the Court of Appeals for the Eleventh Circuit with respect to Curtis Investment and the Court of Appeals for the Fourth Circuit with respect to Mr. and Mrs. Baxter. Accordingly, we follow the laws of those circuits. See Golsen v. Commissioner, 54 T.C. 742 (1970), aff‘d, 445 F.2d 985 (10th Cir. 1971).
In determining whether a transaction has economic substance the Court of Appeals for the Eleventh Circuit has stated that (1) a transaction ceases to merit tax respect when it has no economic effects other than the creation of tax benefits
To treat a transaction as a sham, the court must find [(1)] that the taxpayer was motivated by no business purpose other than obtaining tax benefits in entering the transaction, and [(2)] that the transaction has no economic substance because no reasonable possibility of a profit exists. * * *
Black & Decker Corp. v. United States, 436 F.3d 431, 441 (4th Cir. 2006); Hines v. United States, 912 F.2d 736, 739 (4th Cir. 1990); Rice‘s Toyota World, Inc. v. Commissioner, 752 F.2d 89, 91 (4th Cir. 1985), aff‘g in part, rev‘g in part, 81 T.C. 184 (1983). Thus the first prong of the test in the Fourth Circuit is subjective while the second is objective. Therefore, for a finding that Mr. and Mrs. Baxter‘s CARDS transaction lacked economic substance the transaction must satisfy both prongs of the test while Curtis Investment‘s CARDS transaction must satisfy only one prong of the test.
This Court has examined other CARDS transactions promoted by Chenery. We have held that the CARDS transaction lacked economic substance on each
A. The Objective Test
The objective test involves a broad examination of whether, from an objective standpoint, the transaction would likely produce economic benefits other than the generation of a tax deduction. Kirchman v. Commissioner, 862 F.2d 1486, 1492-1494 (11th Cir. 1989), aff‘g Glass v. Commissioner, 87 T.C. 1087 (1986). “A reasonable opportunity for profit will ordinarily be found only if there was a legitimate expectation that the nontax benefits would be at least commensurate with the associated transaction costs.” Rovakat, LLC v. Commissioner, T.C. Memo. 2011-225, slip op. at 38, aff‘d, 529 F. App‘x 124 (3d Cir. 2013).
In regard to whether their CARDS transactions lacked economic substance, petitioners contend that the Court must consider its “capital leverage” plan. In other words, petitioners contend that they entered into the CARDS transactions to
Petitioners’ expert reports were not helpful to the Court‘s analysis. Dr. Ciccotello‘s expert report focuses on whether the decisions to enter the CARDS transactions were rational when considering projected returns from investments petitioners would make with proceeds from the CARDS transactions. Because the
Petitioners paid combined fees of $2,092,840 to Chenery to participate in the CARDS transactions. After paying those fees petitioners could not obtain investable proceeds unless they obtained collateral that was satisfactory to HVB.27 As respondent‘s expert notes and we find persuasive, the financing costs were substantially above market rates for comparable financing options. As a result of the substantial financing costs, respondent‘s expert concluded that the costs “would create a very material, and entirely unnecessary, drag on the profitability” of an investment.
B. The Subjective Test
Initially, we note that because the CARDS transaction that Curtis Investment entered into fails the objective test, the subjective motive is irrelevant. See Kirchman v. Commissioner, 862 F.2d at 1492. However, for the Court to determine that the CARDS transaction entered into by Mr. and Mrs. Baxter lacks economic substance, it must also fail the subjective test. See Black & Decker Corp., 436 F.3d at 441. The subjective test reviews the intent or business purpose of the taxpayer. Having a business purpose does not mean the reason for a transaction is free of tax considerations, but the purpose must be one that “figures in a bona fide, profit-seeking business.” United Parcel Serv. of Am., Inc. v. Commissioner, 254 F.3d at 1019. Thus, a transaction that would not have occurred in any form but for tax avoidance reasons does not have a business purpose. Id. at 1020; see also Rice‘s Toyota World, Inc. v. Commissioner, 752 F.2d at 94.
Petitioners contend that their business purpose was to obtain proceeds for investment. Assuming petitioners actually intended to leverage funds for investment purposes, we believe petitioners would have attempted to reduce their costs of borrowing and maximize the amount of funds available for investment. Instead, petitioners paid financing costs of approximately 45% of the proceeds of the loan and organized their CARDS transactions such that the transactions would result in losses close to the amount of taxable gains from the sale of ABP stock. Petitioners did not attempt to obtain any other loan in the last three months of 2000, nor did they attempt to maximize the amount that they could borrow for investment. Petitioners decided to use HVB, a bank with which they had no prior relationship, rather than banks with which they had existing relationships because borrowing money from those banks would not have provided petitioners with the tax losses that CARDS transactions promised. Accordingly, we do not find petitioners’ purported investment motive credible.
Petitioners knew that they had substantial tax liabilities resulting from their sales of their ABP stock and immediately began considering ways to shelter the gains. Petitioners considered other tax shelters before choosing the CARDS transactions and structured their CARDS transactions such that the losses would offset most of the gains and not to maximize investable proceeds. Petitioners rushed to close the CARDS transactions before the end of 2000 because the transactions would shield the gains on their ABP stock, but they waited nearly six weeks before investing the funds. Although petitioners and their advisers testified that the CARDS transactions’ purported business purpose was for investment and would simply defer the tax that would ultimately be paid, we do not find their testimony credible. We find that absent the substantial tax benefits, no rational taxpayer, including petitioners, would have entered into the CARDS transactions. Accordingly, we conclude that petitioners did not have a business purpose for entering into the CARDS transactions.
C. Loan Origination Fees
Respondent also disallowed deductions for loan origination fees with respect to Curtis Investment‘s CARDS transaction. Fees incurred in connection with a transaction that lacks economic substance are generally not deductible. See Winn-Dixie Stores, Inc. v. Commissioner, 113 T.C. 254, 294 (1999), aff‘d, 254 F.3d 1313 (11th Cir. 2001); see also New Phoenix Sunrise Corp. v. Commissioner, 132 T.C. 161, 185-186 (2009), aff‘d, 408 F. App‘x 908 (6th Cir. 2010). However, courts have upheld deductions based on genuine debts where the debts were elements of a transaction lacking economic substance. See Rice‘s Toyota World, Inc v. Commissioner, 752 F.2d at 95-96. The parties did not list the CARDS transaction fees as an issue in their joint statement of issues filed with the Court, and therefore the transaction fees are not at issue. See Our Country Home Enters., Inc. v. Commissioner, 145 T.C. 1, 39 n.18 (2015) (treating an issue not raised in a memorandum of issues to be decided in the case as waived or otherwise abandoned). Even if the fees were at issue, the record confirms on the basis of the CARDS transactions’ structure that Curtis Investment was not genuinely indebted. Consequently, we sustain respondent‘s disallowance of the deductions.
III. Accuracy-Related Penalty
Respondent determined that petitioners are liable for accuracy-related penalties. A taxpayer may be liable for a 20% accuracy-related penalty on the portion of an underpayment of income tax attributable to: (1) negligence or disregard of rules or regulations, (2) a substantial understatement of income tax, or (3) a substantial valuation misstatement.
Respondent determined the 40% accuracy-related penalty applies to any portion of the underpayment related to the disallowed loss deductions as a result of the CARDS transactions.30 Petitioners argue that no accuracy-related penalty applies because they had reasonable cause and acted in good faith. We now address whether petitioners are liable for the 40% accuracy-related penalty.
A. Gross Valuation Misstatement
Respondent determined a 40% accuracy-related penalty for a gross valuation misstatement with respect to the losses reported from the CARDS transactions. The gross valuation misstatement penalty is a 40% penalty that
The Commissioner bears the burden of production with respect to the taxpayer‘s liability for a
Our holding that the CARDS transactions lack economic substance results in the total disallowance of the loss deductions without regard to the value or bases of the property used in the CARDS transactions. See Leema Enters., Inc. v. Commissioner, T.C. Memo. 1999-18, aff‘d sub nom. Keeler v. Commissioner, 243 F.3d 1212 (10th Cir. 2001). The gross valuation penalty applies when an
B. Reasonable Cause and Good Faith
The accuracy-related penalty does not apply with respect to any portion of the underpayment for which the taxpayer shows that there was reasonable cause and that he or she acted in good faith.
Partner-level defenses, including reasonable cause and good faith, may not be asserted in a partnership-level TEFRA proceeding such as the one we have
Petitioners contend that they had reasonable cause and acted in good faith because the CARDS transactions present a novel issue and that they reasonably relied on the advice of tax professionals. We address both below.
1. Novel Issue
This Court has previously found that a taxpayer acted with reasonable cause and good faith when a deficiency is the result of an issue of first impression and the taxpayer‘s position is reasonably debatable. See Williams v. Commissioner, 123 T.C. 144, 153-154 (2004). Likewise this Court has found reasonable cause and good faith when a taxpayer takes a position on an initial interpretation of a statute and the statutory text is unclear. See Bunney v. Commissioner, 114 T.C. 259, 266 (2000). However, regardless of whether the legal issue is novel, the Court considers all of the facts and circumstances in determining whether a
Petitioners contend that the issues raised by the CARDS transactions in these cases are novel issues. Although at the time petitioners filed their returns no CARDS transactions cases had been litigated, the requirement that a transaction have economic substance has been a longstanding principle of tax law. See, e.g., Gregory v. Helvering, 293 U.S. at 468-470; Winn-Dixie Stores, Inc. v. Commissioner, 113 T.C. at 277-280. In fact, Brown & Wood offered an opinion with respect to economic substance of the CARDS transactions that was allegedly based on representations of the parties. Respondent had also already taken a position in Notice 2000-44, 2000-2 C.B. 255, unfavorable to CARDS transactions, and Brown & Wood discussed respondent‘s position in its model opinion letter. Even if petitioners’ CARDS transactions presented novel issues, which they do not, petitioners’ position is not reasonably debatable and petitioners did not prove that they acted with reasonable cause and in good faith.
2. Reliance on Tax Advisers
Petitioners also assert that they acted with reasonable cause and in good faith because they reasonably relied on the advice of their tax advisers. Reliance on the advice of a tax professional may, but does not necessarily, establish
The parties dispute whether petitioners’ tax advisers were competent professionals that had sufficient expertise to justify reliance and whether petitioners relied in good faith on the advisers’ judgment. See Neonatology Assocs., P.A. v. Commissioner, 115 T.C. at 99.
Brown & Wood provided petitioners a model tax opinion before petitioners entered into the CARDS transactions and finalized opinion letters after petitioners had already engaged in the CARDS transactions. The tax opinions were promised as part of petitioners’ entering into the CARDS transactions, and a portion of the
Petitioners contend that even if Brown & Woods had a conflict of interest, they relied on their longtime tax advisers to evaluate the CARDS transactions. Although a taxpayer generally does not reasonably rely on the advice of a tax adviser when the adviser relies on information from a third party that is a promoter of a tax shelter, under some facts and circumstances reliance may be reasonable. See id.;
Petitioners cite CNT as a case analogous to their case. In CNT the taxpayers, Mr. and Mrs. Carroll, owned a chain of successful funeral homes. Mr. Carroll was an aging World War II veteran, held a degree in mortuary science, and had no sophisticated tax or financial knowledge. In fact, the taxpayers had never invested in mutual funds or securities, had no diversified investments, and held
In deciding whether Mr. Carroll‘s tax advisers had sufficient expertise to justify reliance, we noted that the issue is a “close one.” Id. at 227. However, we ultimately held that the taxpayers in CNT had reasonable cause and acted in good faith. Id. at 235. The taxpayers were not sophisticated with respect to tax or financial matters. Mr. Carroll‘s tax advisers had also reviewed materials independent of the tax opinion that was promised as part of the Son-of-BOSS transaction.
Petitioners’ case is distinguishable from CNT. The taxpayers’ advisers in CNT took steps to complete an independent analysis. Although petitioners took
Although the taxpayers’ advisers in CNT reviewed only a few sources other than the opinion letter provided by the promoter, the expertise and sophistication
The Court also notes that petitioners introduced into evidence several documents to prove an investment motive, but the record is devoid of any discussions regarding the tax benefits of the CARDS transactions. However, from the record as a whole, the Court is convinced that the tax benefits of the CARDS transactions were discussed. Petitioners, who were sophisticated in business,
In conclusion, we find, on the basis of all the facts and circumstances, that petitioners failed to establish the reasonable cause and good-faith defense to the accuracy-related penalty. Accordingly we sustain respondent‘s determination that petitioners are liable for the 40% accuracy-related penalty.
We have considered the parties’ remaining arguments, and to the extent not discussed above, conclude those arguments are irrelevant, moot, or without merit.33
To reflect the foregoing,
Appropriate decisions will be entered.