An issue ever present when taxpayers do such scams is the penalty exposure. As readers of this blog know, when such sophisticated taxpayers enter such scams, they look to minimize their penalty exposure with tax opinions from tax professionals upon which they claim to have "relied." If they can convince a court that they relied, then the cost of playing the audit lottery via the scam is just paying the taxes they owed anyway, interest during the period they used the fisc's money, and the exorbitant fees they paid to implement the scam. So, as is typical,. this taxpayer got an opinion letter from a prominent law firm, Andrews & Kurth, here, which had helped Goldman Sachs conceptualize the scam. By the time of trial, for some unexplained reason, the taxpayer did not rely upon the opinion for penalty relief. The district court in its opinion (fn. 4) said: "Dow does not rely on the opinion of Andrews & Kurth in this case, and the Court does not take it into consideration in this opinion."
So, after rejecting the scam, the Fifth Circuit turned to the issue of whether the taxpayer could avoid the penalties that come along with bullshit tax shelters. Excepting civil fraud penalties that perhaps ought to come along with such scams, the penalties at play in these well-papered and well-lawyered scams are the accuracy related penalties of 20% or in particularly egregious cases 40%. The district court imposed the 20% penalty for (i) negligence and (ii) substantial understatement. The district court declined to assert the gross valuation misstatement penalty based upon outlier Fifth Circuit authority that suggested that, when the shelter was so stinky as a matter of law that it had no substance whatever, any gross misvaluation or basis overstatement can be ignored so the grosss valuation misstatement did not apply. After the district court so held, the Supreme Court decided United States v. Woods, ___ U.S. ___, 134 S. Ct. 557 (2013), here, which rejected that notion. For my blog entry on Woods, see Supreme Court Applies 40% Penalty to Bullshit Basis Enhancement Shelters (Federal Tax Crimes Blog 12/3/13), here. Accordingly, the Fifth Circuit remanded to the district court to reconsider its penalty conclusions in light of Woods.
Addendum 9/20/14 3:00 pm:
As in many bullshit tax shelters, the phantom income that is the consequence of phantom tax benefits need to be deflected, otherwise if that income were left with the taxpayer playing the game, the benefits would be reversed. So, as is typical, the hunt is on in these deals for a tax indifferent party who can "suffer" the phantom income with no tax cost. Foreign banks are real accommodating in that respect. They were ubiquitous in the tax shelter shenanigans of the 1990s and early 2000s, both the individual mass (somewhat) marked individual shelters and the corporate shelters that I have discussed in this blog. Needless to say they were prominent in Chemtech. From the Fifth Circuit opinion:
This appeal concerns the tax consequences of two transactions undertaken by Dow Chemical Company ("Dow") and a number of foreign banks n1 from 1993 through 2006. During those years, Dow and the foreign banks purported to operate two partnerships that generated over one billion dollars in tax deductions for Dow. * * * *
n1 Bank of Brussels Lambert, Dresdner Bank A.G., Kredietbank N.V., National West-minster Bank plc, and Rabo Mercent Bank N.V. (collectively, "the foreign banks").
Third, the corporation had to entice foreign entities to participate in the transaction. The tax benefits generated by the partnership could be attained only if the partnership's income could be assigned to a tax-indifferent party.The foreign banks were the tax indifferent parties. Hence, they entered fake transactions to assist the taxpayer in raiding the fisc. Shame on them. Why not more consequences than shame? At least in the individual tax shelter cases, major penalties were imposed on some of the banks for facilitating the bullshit tax shelters other than the taxpayers suffered any costs for enabling the bullshit tax shelters, except perhaps reputational when called out by name in cases such as Chemtech. And the corporate tax shelter taxpayers only paid the tax, often a 20% penalty and sometimes a 40% penalty, and interest on the tax and penalty, costs hardly sufficient on a cost benefit basis to really discourage the benefits of winning the audit lottery. How many of these deals and at what cost to the fisc that were never discovered or if discovered to complex to understand in the blizzard of contrivances in which they were packaged?