NEVADA PARTNERS FUND, L.L.C., by and through SAPPHIRE II, INCORPORATED, Tax Matters Partner v. UNITED STATES of America, by and through its agent, the INTERNAL REVENUE SERVICE
No. 10-60559
United States Court of Appeals, Fifth Circuit
June 24, 2013
Because the statement in the PSR did not specify whether the victim sustained any injury, and because—like in Guerrero—a significant injury does not invariably follow from the type of conduct at issue, we conclude that the district court‘s factual finding of bodily injury to support the
III.
For the foregoing reasons, we conclude that it was not error for the district court to impose the management enhancement, but the bodily-injury enhancement is VA
David Decoursey Aughtry, Esq., Chamberlain, Hrdlicka, White, Williams & Aughtry, Charles E. Hodges, II, Esq., Attorney, Kilpatrick, Townsend & Stockton, L.L.P., Atlanta, GA, Alveno N. Castilla, Kaytie Michelle Pickett, Esq., Walter Whitaker Rayner, Esq., Jones Walker LLP, Jackson, MS, for Plaintiff-Appellant Cross-Appellees.
Arthur Thomas Catterall, Tamara W. Ashford, Esq., Deputy Assistant Attorney, Kenneth L. Greene, Esq., Supervisory Attorney, Gilbert Steven Rothenberg, Esq., Deputy Assistant Attorney, Michael N. Wilcove, U.S. Department of Justice, Washington, DC, for Defendant-Appellee Cross-Appellant.
JAMES L. DENNIS, Circuit Judge:
This appeal arises from eleven notices of final partnership administrative adjustment (FPAAs) issued by the IRS with respect to three Limited Liability Companies (LLCs) treated as partnerships for tax purposes:1 Nevada Partners Fund,
I.
A. The FOCus Program2
[1] James Kelley Williams, an experienced and highly successful Mississippi businessman, expected to realize a large capital gain in the 2001 tax year—$18 million from the cancellation of Williams’ liability on a loan he had guaranteed.3 Because of this expected gain, Williams conferred with his accountant and tax advisor, KPMG, LLP, and his attorneys at Baker Donelson, PC. At a meeting with them on October 2, 2001, KPMG agents gave a PowerPoint presentation to Williams and his attorneys that described a long-term investment program offered by Bricolage Capital, LLC (“Bricolage“), called the Family Office Customized or “FOCus” program. According to the PowerPoint presentation, the FOCus program had a “structure [that] may result in favorable income tax consequences [] to the investor” and explained that the program was expected to yield a tax benefit with zero net capital gains and losses.4 The PowerPoint indicated that the favorable income tax consequences would be approved in a “‘more likely than not’ tax opinion from Arnold & Porter LLP.” In an internal memorandum, KPMG referred to this program as an “investment vehicle with a tax loss-generator possibility for th[at] year.”
The history of the FOCus program can be traced to earlier in 2001. Bricolage formulated the program for its clients who wished to obtain favorable tax treatment of certain assets. Bricolage enlisted Credit Suisse-First Boston (“Credit Suisse“) as the bank that would be essential to the program, which would involve using LLCs or partnerships in “execut[ing] foreign ex
Clients of Bricolage will invest in an investment partnership that has embedded losses that have not yet been realized for tax purposes. The clients will guarantee liabilities of the investment partnership to create sufficient tax basis to recognize such losses without any limit, and the losses will be triggered and allocated to the clients. The Transaction results in the allocation of an ordinary tax loss to an investor that economically did not suffer the loss.
As described to Williams in the KPMG PowerPoint, Bricolage‘s FOCus program entailed a three-tiered investment strategy that would produce the desired deductible tax loss. The first tier of this strategy involved the investment manager establishing an LLC with a transitory partner to act as a holding company for other funds (known as a “fund of funds“). The first-tier LLC would own 99% of a second LLC, which in turn would own 99% of a third LLC. Initially, the transitory partner would own a 99% interest in the first-tier LLC, with 1% interest in each LLC held by Bricolage. The two lower-tiered LLCs would engage in the transactions that would produce the desired tax loss. The third-tier LLC would enter into sets of currency forward contracts, or “straddle” trades, that would produce offsetting gains and losses. In the “gain” legs of the straddle trades, the gains would be realized and reported as income by the 99% transitory partner; while the losses in the other legs would be suspended in the books of the third-tier LLC. At that point, the investor-client would purchase the transitory partner‘s interest in the LLCs. The second-tier LLC would then obtain a Credit Suisse loan guaranteed by the investor that would be used to engage in a limited-risk foreign currency trade. The investor‘s guarantee of the loan would give him enough basis6 in the LLCs to take advantage of the embedded loss they had generated.7 Finally, after the investor had offset the large tax gain with the embedded loss, the FOCus program called for the investor to conduct more traditional investments with Bricolage. In addition to the foregoing benefits, Bricolage would furnish a legal opinion letter from the law firm of Arnold & Porter, LLP, approving of the tax treatment of this investment structure.8
Following Williams’ October 2, 2001, meeting, Bricolage began to carry out the FOCus strategy described in the PowerPoint presentation. Bricolage utilized three LLCs in which it already owned interests, Nevada Partners, Carson Partners, and Reno Partners. They became, respectively, the first-, second-, and third-tier LLCs in the FOCus Program. The initial transitory 99% owner of Nevada was Pensacola PFI Corp. (“Pensacola“), an S-corporation whose directors were two Bricolage principals, Andrew Beer and Samyak Veera. The two shareholders of Pensacola were two LLCs wholly owned, respectively, by Andrew Ahn and Jason Chai, two investors with connections to Bricolage. Bricolage Capital Management Company retained a 1% ownership interest in Nevada and Carson, and the 1% owner of Reno was Delta Currency Management Co., another Bricolage-affiliated company owned by Beer and Veera.9
Pursuant to the FOCus plan, between October and December of 2001, Reno engaged in foreign currency straddle transactions, which resulted in approximately eighty closely offsetting loss and gain “legs,” as described in the FOCus program documents. These trades were conducted through Credit Suisse and resulted in approximately $18 million in gains and $18 million in losses.10 In order to begin the process of separating the corresponding gains and losses, Pensacola distributed its 99% ownership interest in Nevada to the two LLCs owned by Ahn and Chai. As more than fifty percent of the interest in Nevada was sold or exchanged in this transaction, it resulted in the “technical termination” of Nevada and the lower-tier LLCs for that tax year,11 meaning that Reno closed its books for tax purposes and reopened them the next day. Because Reno‘s tax year had closed, it was required to declare, or “mark to market,” certain of the gains and losses on its straddle trades.12 Reno did so, and the gains flowed up the partnership chain to Ahn and Chai‘s LLCs. Ahn and Chai ultimately reported the gains on their respective tax returns for 2001. However, because the parties involved in the transaction were “related parties,” they could only claim the gains from the straddle trades, and could not yet claim the losses.13 Accordingly,
Between October 2, 2001, and December 4, 2001, Williams, through his attorneys at Baker Donelson, kept in close contact with the Bricolage principals and KPMG. During that time, he was kept apprised of the LLCs’ progress in implementing the FOCus steps; he, his son, and his attorney negotiated the terms of the partnership operating agreement with Bricolage and the fees to be paid to Bricolage, KPMG, and Arnold & Porter; and he informed Bricolage that he would need to claim approximately $18 million in losses, including $17 million in capital losses and $1 million in ordinary losses on his 2001 personal income tax return.
On December 4, 2001, Williams made his initial investment called for by the FOCus program. Acting on behalf of the JKW 1991 Revocable Trust (“the Williams Trust“), which held most of Williams’ substantial wealth, Williams purchased a 99% interest in Nevada Partners from Ahn and Chai‘s holding companies for approximately $883,000. Bricolage retained the remaining 1% interest. Bricolage was named the “Administrative Member,” giving it the power and duty to approve any purchase of the Nevada partnerships. Then, on December 12, 2001, the Williams Trust purchased Nevada‘s 99% interest in Carson Partners for approximately $523,0000, with Bricolage again retaining a 1% interest. Williams became the “Controlling Member” of Carson and retained decision-making authority. Following this purchase, the Williams Trust increased its basis in Carson by transferring equity interests and approximately $1.1 million in cash into Carson. This transaction gave Williams a tax basis in Carson valued at approximately $9.7 million, slightly more than half of the basis needed for Williams to take advantage of Carson‘s anticipated $18 million embedded loss.15
In mid-December of 2001, Reno settled five remaining open loss legs, producing approximately $1 million in ordinary losses. The losses flowed up the partnership chain to Williams, who reported them as ordinary losses on his 2001 tax return. On December 21, 2001, Carson sold its 99% interest in Reno to another corporation owned by Bricolage principals for its fair market value of just under $168,000. This sale triggered a $17 million capital loss for Carson due to Reno‘s embedded loss, which Carson later reported.16 At that
Thus, the next step was to increase Williams’ basis in Carson so that he could take advantage of the loss for tax purposes. Consistent with the plan, on December 20, 2001, Williams signed a personal guarantee of a $9 million loan from Credit Suisse to Carson for the purpose of engaging in a deep-in-the-money foreign exchange transaction involving Japanese Yen (JPY).17 This transaction, known as a “carry trade,” utilized the spread in value between the Japanese Yen and the U.S. Dollar. During the three-month term of the loan, Carson and Credit Suisse limited their exposure to exchange-rate fluctuations by means of a narrow risk “collar,” which ensured that, regardless of the Dollar-Yen exchange rate on the maturation date, Carson stood to gain at most $77,000 or to lose at most $90,000. Carson ultimately gained $51,000 on the transactions.
As Dr. Timothy M. Weithers, the government‘s expert, explained in his testimony and report, investment in the Yen at that time in theory made good economic sense because the Japanese economy was weak and the Yen was expected to decline. However, as Weithers stated in his report, instead of fully taking advantage of profits in this economic situation, Carson took an “unorthodox” approach by imposing the collar, essentially the equivalent of buying “insurance against a depreciation of the USD (the exact opposite of what this strategy requires).” Weithers concluded that, without the collar on the Yen trade, the potential profits would have been many times greater than the $51,000 earned. Moreover, according to the testimony of Gary Gluck of Credit Suisse, Williams’ personal guarantee of the loan was not required by the bank as a condition of the loan because the Carson foreign exchange trade had a very limited risk exposure (to a maximum of $90,000) due to the collar, and Carson deposited as collateral an amount sufficient to cover that small risk.18 Nevertheless, Williams, acting on Bricolage‘s advice, provided his personal guarantee anyway so as to increase his basis in Carson by another $9 million.
Williams paid Bricolage a fee of $845,000, a figure that the record suggests was derived from a negotiated 7% of the $18 million desired loss, less the fees for Arnold & Porter, KPMG, and funds to be used as collateral for the Yen carry trades.19 The fee was negotiated between
From March 2002 forward and in following years, on Bricolage‘s recommendation, Williams made more traditional and straightforward investments through Carson for profit in hedge funds, foreign exchange, and private equities. These transactions were not designed to create losses or to tightly rein in gains, and, consequently, they were very profitable. During this time, Williams took full advantage of the Dollar-Yen spread, which ultimately earned him $8 million. From 2002 through 2007, he earned $23 million from investments in various hedge funds and energy equity funds with Bricolage. Williams reported and paid the taxes due on those earnings. As the district court found, “[t]his investment activity was carried on independently of the 2001 FOCus steps.”20
B. IRS Tax Shelter Notices and Investigation of FOCus Program
In September of 2000, the IRS issued a notice alerting taxpayers that it intended to regulate certain abusive tax shelters, see IRS Notice 2000-44, that were similar in several respects to the FOCus program. The IRS identified certain arrangements of tiered partnerships to be abusive tax shelter arrangements because such arrangements are designed to generate artificial tax losses from foreign currency options transactions.21 IRS Notice 2000-44, entitled “Tax Avoidance Using Artificially High Basis,” alerted taxpayers that the so-called “Son of BOSS scheme” had been “‘listed’ as an abusive tax shelter.”22 “Although there are several variants of the Son of BOSS tax shelter[,] ... they all rely on the same common principles. ‘Son of BOSS’ uses a series of contrived steps in a partnership interest to generate artificial tax losses designed to offset income from other transactions.”23
As this Court recently explained, the “classic Son of BOSS shelter[s] ... create[] tax benefits in the form of deductible losses or reduced gains by creating an
On April 21, 2002, the IRS compelled KPMG to disclose all information about and all persons participating in FOCus programs. Then, on June 27, 2002, the IRS issued Notice 2002-50, entitled “Partnership Straddle Tax Shelter.” The notice “advise[d] taxpayers and their representatives that the described transaction, which uses a straddle, a tiered partnership, a transitory partner and the absence of a section 754 election to obtain a permanent non-economic loss, is subject to challenge by the Service on several grounds. The notice holds that the described transaction is now a ‘listed transaction’ and warns of the potential penalties that may be imposed if taxpayers claim losses from such a transaction,” and that the transactions will be disregarded if they lack “economic substance.” Notice 2002-50, 2002-28 I.R.B. 98, 2002-2 C.B. 98.
On October 11, 2002, several months after Notice 2002-50 was issued, Arnold & Porter sent Carson and Williams the “more likely than not” legal opinion letters as stipulated in the KPMG PowerPoint presentation promoting the FOCus program and investment package.26 The letter addressed to Williams stated that, in the firm‘s “opinion, it is more likely than not that the series of transactions analyzed in this opinion are the same as, or substantially similar to, the listed transaction described in Notice 2002-50.” Nonetheless, the Arnold & Porter tax opinions do not attempt to distinguish the FOCus transactions from those described by Notice 2002-50 or to address how the Notice could affect a court‘s analysis of the transactions. The letter simply recommended that the transactions described in the letter “more likely than not” had economic substance. The partnerships filed their eleven Form 1065 partnership information returns between March and October of 2002 reporting the embedded loss from the sale of Reno.27 On October 15, 2002, Williams filed his individual tax return claiming the deduction for the embedded loss.28
Nevada Partners Fund, LLC ... was formed and availed of solely for purposes of tax avoidance and, in furtherance of such purpose, engaged in a prearranged transaction, designed and executed through a series of meaningless steps, using a straddle, a tiered partnership structure, a transitory partner, and the absence of a Section 754 election to allow a tax shelter investor to claim a permanent non-economic loss.... [T]he series of steps comprising the Transaction, including the creation of [Nevada, Carson, and Reno,] ... and the purchase and sale of foreign currency contracts and positions was a sham, lacked economic substance, and was not engaged in for a legitimate business purpose.
Accordingly, the FPAAs disallowed the losses claimed by the partnerships and, in turn, by Williams, under the economic substance doctrine, which, in short, “allows courts to enforce the legislative purpose of the [Internal Revenue] Code by preventing taxpayers from reaping tax benefits from transactions lacking in economic reality.”30
In the alternative, the IRS asserted that under Treasury Regulation
C. District Court Proceedings
The plaintiffs filed eleven actions in the United States District Court for the Southern District of Mississippi challenging each FPAA and penalty. The cases were consolidated and tried in a bench trial. The district court heard testimony from numerous witnesses over several weeks, and in a seventy eight-page memorandum opinion and order dated April 30, 2010, the district court upheld the adjustments and two of the three penalties asserted in the FPAAs. The court concluded that the multi-step FOCus program lacked economic substance and was intended only to provide Williams with a tax shelter. The court also upheld the IRS‘s reliance on Treasury Regulation
The plaintiffs moved to amend the district court‘s judgment to reflect a dismissal of their claims as to only eight of the eleven FPAAs. They argued that the judgment, as entered, effectively imposed a double tax because eight of the FPAAs disallowed the losses as lacking in economic substance, while the remaining three FPAAs would have held Williams responsible for the gains. The plaintiffs argued that judgment in the actions challenging the three “gain” FPAAs should be rendered in their favor because they were premised on the IRS‘s alternative argument—namely, that, if the transactions did have economic substance, then the partnerships’ gains on the transactions should be reallocated to Williams and taxed even though they fell outside the period in which he had an ownership interest in the partnerships, pursuant to the Treasury Regulations’ “anti-abuse rule.”32 The government opposed the motion on procedural grounds but conceded that in substance it did not seek to collect taxes from the partnerships on both its principal theory (lack of economic substance) and its alternative theory (Treasury Regulation
II.
A. Economic Substance Doctrine35
Our economic substance analysis begins with Gregory v. Helvering, 293 U.S. 465, 55 S.Ct. 266, 79 L.Ed. 596 (1935), “the Supreme Court‘s foundational exposition of economic substance principles under the Internal Revenue Code.” ACM P‘ship v. Comm‘r, 157 F.3d 231, 246 (3d Cir.1998). In Gregory, the taxpayer engaged in a series of transactions which were technically consistent with the Internal Revenue Code but which lacked any real economic substance and defeated the purpose of the Code provisions. 293 U.S. at 467-70, 55 S.Ct. 266. The taxpayer attempted to avoid paying taxable dividends on stock transfers from her wholly-owned corporation by first creating a new corporation to which she transferred the stock, and then liquidating the new corporation and trans
The Supreme Court has explained that a “natural conclusion” of its holding in Gregory was that transactions that “do not vary control or change the flow of economic benefits[] are to be dismissed from consideration.” Higgins v. Smith, 308 U.S. 473, 476, 60 S.Ct. 355, 84 L.Ed. 406 (1940); accord Coltec Indus., Inc. v. United States, 454 F.3d 1340, 1355 (Fed.Cir.2006). This Court, the Federal Circuit, and other Courts of Appeals have followed a similar approach. See Klamath, 568 F.3d at 543.36 In Klamath, we observed that a split existed among other circuits regarding when a transaction should be disregarded as lacking economic reality. See id. We did not follow the Fourth Circuit‘s “rigid two-prong test, where a transaction will only be invalidated if it lacks economic substance and the taxpayer‘s sole motive is tax avoidance.” Id. at 544 (citing Rice‘s Toyota World, Inc. v. Comm‘r, 752 F.2d 89, 91-92 (4th Cir.1985)) (emphasis added). Instead, we adopted the majority view, which “is that a lack of economic substance is sufficient to invalidate the transaction regardless of whether the taxpayer has motives other than tax avoidance.” Id. (citations omitted). We concluded that the majority view more accurately interprets the Supreme Court‘s prescript in Frank Lyon Co. v. United States, 435 U.S. 561, 98 S.Ct. 1291, 55 L.Ed.2d 550 (1978), which addressed the factors courts should consider when assessing whether a transaction lacks economic substance. Klamath, 568 F.3d at 544.
We derived from Frank Lyon a “multi-factor test for when a transaction must be honored as legitimate for tax purposes,” including whether the transaction: “(1) has economic substance compelled by business or regulatory realities, (2) is imbued with tax-independent considerations, and (3) is not shaped totally by tax-avoid
“[W]hen applying the economic substance doctrine, the proper focus is on the particular transaction that gives rise to the tax benefit, not collateral transactions that do not produce tax benefits.” Klamath, 568 F.3d at 545. “As to the first Klamath factor, transactions lack objective economic reality if they ‘do not vary, control, or change the flow of economic benefits.‘” Southgate, 659 F.3d at 481 (citation and alteration omitted). “The objective economic substance inquiry asks whether the transaction affected the taxpayer‘s financial position in any way.” Id. at 481 n. 41 (citation, quotation marks, and alterations omitted). “This is an objective inquiry into whether the transaction either caused real dollars to meaningfully change hands or created a realistic possibility that they would do so[,]” meaning “‘a reasonable possibility of profit from the transaction existed apart from tax benefits.‘” Id. at 481 & n. 43 (citation and other footnote omitted). “That inquiry must be ‘conducted from the vantage point of the taxpayer at the time the transactions occurred, rather than with the benefit of hindsight.‘” Id. at 481 (citation omitted).
When considering whether a transaction lacks economic substance and thus should be disregarded for tax purposes, courts have given close scrutiny to arrangements with subsidiaries that do not affect the economic interest of independent third parties. See Southgate, 659 F.3d at 481 n. 42 (“A circular flow of funds among related entities does not indicate a substantive economic transaction for tax purposes.“) (citation, quotation marks, and alteration omitted); see also, e.g., Frank Lyon, 435 U.S. at 575, 583, 98 S.Ct. 1291 (holding that a “genuine multiple-party transaction” had economic substance, and distinguishing more “familial” arrangements involving only two parties); Gregory, 293 U.S. at 469, 55 S.Ct. 266 (concluding that the transfer of stock from a wholly owned corporation to a newly created corporation, and then directly to the taxpayer, lacked economic substance because the “sole object and accomplishment of [the transfer] was the consummation of a preconceived plan, not to reorganize a business ... but to transfer a parcel of corporate shares to the petitioner“); Coltec, 454 F.3d at 1360 (“[T]he transaction here could only affect relations among Coltec and its own subsidiaries—it has absolutely no [e]ffect on third party ... claimants.“); United Parcel Serv. of Am., 254 F.3d at 1018-19 (concluding that a transaction had economic substance because it created “genuine obligations enforceable by an unrelated party” that was not under the taxpayer‘s control).
B. Economic Substance Vel Non of the FOCus Transactions
The district court‘s ultimate conclusion as to whether a transaction has economic substance is a question of law we review de novo, but we review the particular facts from which that characterization is made for clear error. Southgate, 659 F.3d at 480; Klamath, 568 F.3d at 543. Measured by these standards, we see no error of law or clear error of fact in the district court‘s decision.
Applying the foregoing economic substance doctrine principles, we conclude that the district court did not err legally or factually in determining that the partnerships failed to meet their burden of proving that the transactions giving rise to the $18 million tax loss in question had economic substance. The district court correctly held that the multi-step FOCus strategy carried out in conjunction with the three-tiered partnership structure of Nevada, Carson, and Reno between October and December of 2001 lacked economic substance and served no other purpose than to provide the structure through which Williams could enjoy the reduction of his tax burden for that year. Accordingly, the district court correctly concluded that the FOCus transactions must be disregarded for tax purposes, and that in their absence the $18 million embedded loss in Reno and Carson was correctly disallowed by the IRS. The district court in making these determinations correctly analyzed the FOCus transactions that gave rise to the tax benefit at issue and correctly rejected the partnerships’ argument that the court should consider the FOCus transactions as part of Williams’ subsequent, highly profitable investments with Bricolage from mid-2002 through 2007.
The record shows that the 2001 Reno foreign currency straddles, the pre-March 2002 Carson Yen carry trades, and Williams’ personal guarantee of the Credit Suisse loan to Carson, viewed objectively, were not designed to make a profit, but were used to create an $18 million loss; to separate the gains from that loss by allocating the gains to the transitory owners of Carson, to embed the loss on Carson‘s books; to allow Williams to acquire Carson along with its embedded $18 million loss; and ultimately to allow him to acquire, by his loan guarantee, the rest of his $18 million basis in Carson that he needed to claim the loss as a deduction against his unrelated $18 million personal capital gain.37 Altogether, those were the transactions that enabled Williams with some
Further, the key FOCus transactions were conducted among several related entities and even the trades with third persons were engineered to avoid producing any meaningful profits or losses apart from the artificial loss embedded in Reno and Carson that gave rise to Williams’ tax benefit. See, e.g., Southgate, 659 F.3d at 481 n. 42 (“A circular flow of funds among related entities does not indicate a substantive economic transaction for tax purposes.“) (citation, quotation marks, and alteration omitted); Frank Lyon, 435 U.S. at 575, 98 S.Ct. 1291 (suggesting that “familial” arrangements, in contrast with “genuine multiple-party transaction[s],” are more likely to lack economic substance); Coltec, 454 F.3d at 1360 (concluding transaction that had “absolutely no [e]ffect on third party ... claimants” lacked economic substance).
We agree with the district court‘s assessment, based in part on the persuasive testimony of the government‘s expert, Dr. Timothy Weithers, that the 2001 Reno straddle trades had no objective possibility of making a meaningful overall profit or of appreciably affecting the beneficial interest—aside from tax avoidance—of either Williams or the partnerships. The straddles produced almost precisely offsetting gains and losses; as Weithers explained, those trades “involved little or no real market exposure, with virtually no likelihood of generating significant positive or negative returns.” Reno and Credit Suisse followed a plan calculated to ensure those closely offsetting results by invariably unwinding each straddle within one or two business days, and with the same exchange rate exposure, to lock in the virtually offsetting gains and losses that typically result from exchange rate fluctuations within such short periods.
The partnerships argue that straddle trades are often used to make a profit, citing the report and testimony of their expert witness. The partnerships contend that an investor could reasonably profit after having bought both an option to purchase (a “call“) and an option to sell (a “put“) in the same commodity or currency by exercising whichever of the two would generate a higher net gain. Indeed, both parties’ experts recognized that straddle trades are a relatively common investment strategy and can in theory generate a profit.38 However, the Reno straddle
Likewise, Williams’ personal guarantee of Credit Suisse‘s $9 million loan to Carson had no economic substance. The personal guarantee was not required by the bank as a condition of the loan and did not further any non-tax related business objective of Williams or the partnerships. It was essentially gratuitous and designed only to increase Williams’ tax basis in Carson so that he could claim Carson‘s embedded loss as a deduction. In sum, the transactions that created Carson‘s $18 million embedded loss had no economic substance and Williams obtained the benefit of an $18 million deduction on his 2001 personal income tax return without suffering any real economic loss.
The partnerships also argue that the Carson Yen carry trade maturing in March of 2002 had economic substance because it ended with a slight credit balance of approximately $51,000. This argument is without merit for several reasons. First, the tax benefit claimed by Williams stemmed from the Reno straddle trades, not from the Carson Yen carry trade. See Klamath, 568 F.3d at 545 (“[W]hen applying the economic substance doctrine, the proper focus is on the particular transaction that gives rise to the tax benefit, not collateral transactions that do not produce tax benefits.“) The particular transactions that gave rise to the tax loss benefit were generated by the Reno straddle trades, not the Carson Yen carry trade. Because the straddle transactions lacked economic substance, the $18 million artificial loss must be disregarded for tax purposes regardless of whether Carson‘s March 2002 Yen carry trade was entered into for profit.
Moreover, the record supports the district court‘s conclusion that the Carson Yen trade was by design not entered into for profit, either. In the Yen transaction, Carson limited its exposure to exchange-rate fluctuations by means of a narrow risk “collar,” which ensured that Carson stood to gain at most $77,000 or to lose at most $90,000—by design a relatively insignifi
Finally, the partnerships contend that the transactions had economic substance because the FOCus program represented the preliminary stage of an integrated long-term investment program by Williams with Bricolage that ultimately earned Williams $8 million from Yen carry trades from March 2002 forward, and $23 million from other types of investments from mid 2002 to 2007. As the district court reasonably found, however, the transactions giving rise to the tax loss benefit, the 2001 Reno straddle trades, were distinct from the subsequent profitable investments from March 2002 forward. Correspondingly, the highly profitable investments by the Williams family with Bricolage from mid 2002 to 2007 did not give rise to the 2001 tax loss at issue in this case. Thus, the district court did not err in finding that the FOCus artificial loss-creation plan simply was not “interrelated with” the subsequent for-profit investment activity; instead, they were “separate events, not dependent upon each other, and neither requiring the other to proceed.” Nevada Partners, 714 F.Supp.2d at 633; see Sala v. United States, 613 F.3d 1249, 1250, 1252-54 (10th Cir.2010) (holding that the IRS properly disallowed deductions due to their lack of economic substance where the taxpayer participated in “an investment program that included an initial phase designed primarily to generate a tax loss so as to offset” otherwise taxable income and the transactions giving rise to the tax benefit were separable from the follow-on investment plan), cert. denied, U.S. —, 132 S.Ct. 91, 181 L.Ed.2d 21 (2011).
The record as a whole supports the district court‘s factual findings, and the plaintiffs do not present a cogent reason why we should be left with a firm and definite conviction that a mistake has been made. See Anderson v. City of Bessemer City, 470 U.S. 564, 573-74, 105 S.Ct. 1504, 84 L.Ed.2d 518 (1985).
III.
Finally, having decided that the FOCus transactions must be disregarded for federal income tax purposes, we have jurisdiction to review the district court‘s determinations regarding the penalties assessed against the partnerships by the IRS. See Klamath, 568 F.3d at 547-48;
Section 6662 of the Internal Revenue Code in effect in 2001 authorizes the IRS to levy a penalty equal to 20% of the portion of any underpayment of tax attributable to, inter alia, the following: (i) negligence or disregard of rules or regulations; (ii) substantial understatement of income tax; and (iii) substantial valuation misstatement.41 The IRS assessed a penalty against the partnerships under each of these three provisions. However, because penalties under
The district court reversed the penalty for substantial valuation misstatement in accord with our decisions in Todd v. Commissioner, 862 F.2d 540 (5th Cir.1988) and Heasley v. Commissioner, 902 F.2d 380 (5th Cir.1990), holding that a valuation misstatement penalty is not applicable where an entire transaction is disregarded under the economic substance doctrine. Because this panel, like the district court, is bound by our circuit precedents in Todd and Heasley,42 we will affirm the district court‘s judgment in this respect without added discussion here. For the reasons hereinafter assigned, we conclude that the negligence penalty was correctly assessed and affirmed by the district court. Because but one 20% penalty may stand, we will affirm the district court‘s approval of the negligence penalty and vacate its approval of the substantial understatement of income tax penalty without needless discussion of that alternate basis for the penalty.
We review a lower court‘s “findings of negligence under the clearly erroneous rule.” Streber v. Comm‘r, 138 F.3d 216, 219 (5th Cir.1998); accord, e.g., Masat v. Comm‘r, 784 F.2d 573, 577 (5th Cir.1986). “Clear error exists when this court is left with the definite and firm conviction that a mistake has been made.” Streber, 138 F.3d at 219. “The taxpayer bears the burden of establishing the absence of negligence.” Reser v. Comm‘r, 112 F.3d 1258, 1271 (5th Cir.1997); accord, e.g., Zmuda v. Comm‘r, 731 F.2d 1417, 1422 (9th Cir.1984) (“The taxpayer has the burden of establishing that the penalty was erroneous.“); see also, e.g., INDOPCO, Inc., 503 U.S. at 84, 112 S.Ct. 1039 (“[T]he burden of clearly showing the right to the claimed deduction is on the taxpayer.“); Arevalo, 469 F.3d at 440 (“Taxpayers bear the burden of proving their entitlement to deductions.“).
Section 6662 of the Internal Revenue Code imposes the 20% penalty attributable to “[n]egligence or disregard of rules or regulations.”
On the basis of the record, the district court was justified in concluding as a matter of fact that the partnerships were negligent and exposed themselves to liability for the
Further, the persons involved in promoting and setting up the partnerships’ 2001 FOCus transactions were experienced investors who proceeded with their plans to create an artificial tax loss for the benefit of Williams or other Bricolage clients, despite clear warning against “Partnership Straddle Tax Shelter[s]” by IRS Notice 2002-50, 2002-28 I.R.B. 98.44 The plaintiffs were negligent for failing “to make a reasonable attempt to comply with the provisions of this title[,]”
B. The Reasonable Cause and Good Faith Defense
Section 6664(c)(1) provides a narrow defense to
First, the partnerships contend that in, making the 2001 FOCus transactions, they were entitled to reasonably rely on what they claim to be relevant authority, viz., Compaq Computer Corp. & Subsidiaries v. Commissioner, 277 F.3d 778, 786 (5th Cir. 2001), UPS of America, Inc. v. Commissioner, 254 F.3d 1014, 1018 (11th Cir.2001), and IES Industries, Inc. v. United States, 253 F.3d 350, 354 (8th Cir.2001). We disagree. These cases are not apposite here. In each of them, the court concluded that the transaction challenged by the IRS had economic substance because it involved a reasonable possibility of significant profit or loss. See Compaq, 277 F.3d at 786 (“Compaq‘s U.S. tax on that net pre-tax profit was roughly $644,000. Subtracting $644,000 from the $1.894 million results in an after-tax profit of about $1.25 million. The transaction had economic substance.“); IES, 253 F.3d at 354 (“The foreign corporation‘s withholding and payment of the tax on IES‘s behalf is no
Next, the partnerships argue that their negligence should have been excused because Williams, who ultimately became their “controlling member,” acted for them in relying on the advice of professionals. While it is true that actual reliance on the tax advice of an independent, competent professional may negate a finding of negligence, see, e.g., United States v. Boyle, 469 U.S. 241, 250, 105 S.Ct. 687, 83 L.Ed.2d 622 (1985), the reliance itself must be objectively reasonable in that the taxpayer supplied the professional with all the necessary information to assess the tax matter and that the professional himself does not suffer from a conflict of interest or lack of expertise that the taxpayer knew of or should have known about, see
Thus, a taxpayer‘s reliance on the advice of a professional may constitute reasonable cause and good faith where the taxpayer proves by a preponderance of the evidence that: (1) the taxpayer reasonably believed that the professional upon whom the reliance was placed was an independent, competent adviser, without a conflict of interest, and with sufficient expertise to justify reliance; (2) the taxpayer provided all necessary and accurate information to the adviser; and (3) the taxpayer actually relied in good faith on the adviser‘s judgment. See SAS Inv. P‘s v. Comm‘r, 103 T.C.M. (CCH) 1845 (T.C.2012) (citing Neonatology Assocs., P.A. v. Comm‘r, 115 T.C. 43, 98-99 (T.C.2000), aff‘d, 299 F.3d 221 (3d Cir.2002);
The partnerships’ argument that they are entitled to complete exculpation of
Moreover, assuming without deciding that Williams, as “controlling member,” acted within the scope of his authority to act for the partnerships in obtaining and relying on the tax opinions pertaining to the FOCus program from Arnold & Porter,46 and assuming that Arnold & Porter was not only a competent adviser, but was also independent and conflict-free,47 we conclude that the partnerships could not reasonably rely on Arnold & Porter‘s tax opinions in good faith because Williams and the partnerships failed to prove by a preponderance of the evidence that they supplied the professional with all pertinent information necessary to assess the purpose and elements of the transactions at issue as they were actually effectuated.
The advice upon which the taxpayer claims reliance “must be based upon all pertinent facts and circumstances and the law as it relates to those facts and circumstances.”
The partnerships contend that, independently of Arnold & Porter, they relied on the advice of Williams’ counsel at Baker Donelson. However, the evidence supports the district court‘s finding that the attorneys at Baker Donelson relied on the Arnold & Porter opinions in rendering their advice, Nevada Partners, 714 F.Supp.2d at 633, and, because the partnerships and Williams were aware of this, they could not reasonably rely on the advice of Baker Donelson independently of Arnold & Porter. The district court concluded that Williams and the partnerships were “superbly educated, experienced and sophisticated investors,” and that they did not reasonably rely in good faith on this advice under the circumstances. Id. at 640. Consequently, the district court did not clearly err in finding that the partnerships failed to carry their burden of proving the defense of reasonable reliance in good faith so as to excuse them for their negligence and disregard of tax laws, rules and regulations.
CONCLUSION
For the foregoing reasons, we AFFIRM the district court‘s determinations that: (1) the FOCus transactions lacked economic substance and must be disregarded for tax purposes; (2) the negligence penalty is applicable and the partnerships are not entitled to the reasonable cause defense; and (3) the valuation misstatement penalty is inapplicable. As to the remaining actions addressing the FPAAs premised on the government‘s alternative theory under Treasury Regulation