So what was left for damage control? Why the appeal? By appealing, the estate hoped to avoid the 40 percent penalty that applies to the portion of a tax underpayment that is "attributable to" a "gross valuation misstatement." § 6662(h). The fulcrum for many bull shit tax shelter transactions when the veneer is stripped away is a gross valuation misstatement. Ambassador Egan's shelter was no exception. But, as is also often the case, there are other bases for denying the claimed tax shelter benefit besides the gross valuation overstatement. Ambassador Egan's also was no exception.
This phenomenon of failing on grounds other than the gross valuation misstatement permitted Ambassador Egan's estate to argue that, well, since more than one ground for disallowance of the claimed tax shelter benefit applied, then it could not be said that the disallowance of the benefit was "attributable to" the "gross valuation misstatement." The circuit courts are split on that issue, although critical mass seems to be in favor of rejecting the argument. The cases are cited in the opinion. The First Circuit rejected the argument as well. [My prediction is that ultimately all courts will resolve to rejecting the argument as well, although it may take the Supreme Court to get there.] So much for the estate's hopes to mitigate the damage from Ambassador Egan's participation in this plainly BS shelter.
At any rate, the First Circuit has some nice sound bites or short pungent analyses that I thought I would deliver up for those not having time to read the full opinion:
In substance, the transaction would provide virtually no opportunity for a net gain but also no risk of a net loss.n1My prior blogs on the district court action in this case are:
n1 Imagine two bets placed on the temperature next Wednesday, such that the wagerer would earn $1 on the first bet but also pay $1 on the second if the temperature was above the date's historic average. If instead the temperature fell below that average, the wagerer would lose $1 on the first bet and win $1 on the second.
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To understand the target of the penalty, a simplified example may help. Basis, in a typical business purchase and sale transaction, equates to the cost (reduced by any depreciation). Thus, a taxpayer might claim that the cost of a widget was $10 -- when its actual cost was $1 -- and report its sale for $1. Overstating the cost of the widget allowed the taxpayer to claim a loss of $9, then used to reduce taxes on other income. So falsely asserting, or increasing, a basis translates into reducing gain or enlarging loss by the amount falsely asserted or increased.
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Fidelity's present appeal is narrow. Apart from a throw-away line or so in its brief, Fidelity does not seriously contest the district court's basis adjustment under the economic substance doctrine. Nor does it appeal the applicability of alternative lower penalties based on the spurious paper losses generated. Instead, its arguments are directed only to the 40 percent penalty. Although Fidelity is the nominal private party, this is effectively a controversy between the Egan estate and the government.
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Congress singled out for stiff penalties a misstated basis or value that improperly reduces taxes; the apparent reason is that the misstated figures directly impair tax collections and prove difficult to resolve (and presumably are easy to fabricate). Here, the figures are misstatements precisely because the transactions lacked any economic purpose for Fidelity other than to generate purported losses to reduce Egan's taxes. Purpose, at least in this case, is an issue of fact quite as much as whether an option was bought or sold.
Relatedly, Fidelity argues that the valuation misstatement penalty only applies in cases where the economic substance doctrine is triggered because basis or value is misstated, and not where the basis for the transaction is reduced to zero after a finding of lack of economic substance. But this is a distinction without a difference; and in any case, the statute by its terms applies the penalty to a misstatement, and given the policy concerns Congress had no reason to care about the nature of the falsity.
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To repeat, the heavy penalty for gross misstatements of value or basis reflects their resulting harm and difficulty in detection. See note 4, above. The misstatements were the vehicle for generating the spurious Fidelity losses carried over to Egan's return to shield his income. That (in this case) alternative grounds with lower or no penalties existed for disallowing the same claimed losses hardly detracts from the need to penalize and discourage the gross value misstatements.
Indeed, one might think that it would be perverse to allow the taxpayer to avoid a penalty otherwise applicable to his conduct on the ground that the taxpayer had also engaged in additional violations that would support disallowance of the claimed losses. Cf. Gilman v. Comm'r, 933 F.2d 143, 150 (2d Cir. 1991), cert. denied, 502 U.S. 1031 (1992). Most circuit courts that have confronted variations on Fidelity's argument in the lack of economic substance context have rejected it.
Update on Fidelity International Advisor Currency Fund A (10/14/10), here.
The Lawyers For the Parties in the Egan Trial (5/21/10), here.
What the Egan Court (Judge Saylor) Said About the Lawyers (5/20/10), here.
Judge Finds Ambassador's Tax Shelter Transactions Bullshit (Actually Worse Than That) (5/19/10), here.