Another Bullshit Tax Shelter Bites the Dust on Appeal Also (9/12/14; 9/20/14)

In Chemtech Royalty Associates v. United States, 766 F.3d 453 (5th Cir. 2014), here, the Fifth Circuit rejected another audit lottery attempt in the guise of a bullshit tax shelter of the smoke and mirrors variety.  For my blog entry on the district court opinion, see Yet Another Bullshit Tax Shelter Bites the Dust (Federal Tax Crimes Blog 2/27/13), here.  This shelter was was hawked to Dow Chemical by the venerable financial wizardry firm of Goldman Sachs, here.  As with bullshit tax shelters generally, it was know by an acronym -- SLIPs for Special Limited Investment Partnerships.  And as with many bullshit tax shelters it needed one or more tax indifferent parties to appear to earn the taxable income that offset of the tax benefits the taxpayer claims.  The tax indifferent parties for many of the bullshit tax shelters are foreign banks some of whom appear more than willing, for a fee, to assist U.S. taxpayers raid the federal fisc.  (I am not sure how these banks can be distinguished from the Swiss banks that the U.S. DOJ has hammered.)  At any rate, the case was about the U.S. taxpayer at the center of this scam -- called by the courts a sham.  The U.S. taxpayer lost.

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?

Another Bullshit Shelter Bites the Dust Even with Variations (5/14/14)

I write today on the defeat of another bullshit tax shelter of the Son-of-Boss ("SOB") variety.  The Markell Company, Inc. v. Commissioner, T.C. Memo. 2014-86, here, decided yesterday.  If it were just another ho-hum SOB, it would be worth noting only in passing.  But, it has a twist -- both the twist and the outcome is projected in the opening two short paragraphs:

This case began when the Commissioner found the remains of a corporation on an Indian reservation in an extremely remote corner of Utah. The tribe claimed not to know how the corporation's stock had ended up in its hands. And there was little or no money or valuable property left inside the corporate shell. 

All signs pointed to the corporation's manager, a sophisticated East Coast moneyman, as the key person of interest. And his method was a series of complex transactions that bore a striking resemblance to Son-of-BOSS deals already examined many times before by this Court -- but with a corporate-partner twist.

The last sentence of the first paragraph resonates with the equally bullshit intermediary transactions.  One of the strategies in shelters is to push tax consequences to an empty shell of a company, so that the IRS is left without anyone to collect tax clearly due.

The Son-of-Boss transactions in their pure bullshit form seemed to promise to the gullible or complicit that the taxable income disappearing from the taxpayer's tax ledger would just go away.  But, every one I know that gave a hard and knowledgeable look knew that, even if the imagined scheme worked to push the income from the original taxpayer (always a doubtful proposition), some taxpayer down the line would be liable for the tax.  Enter the intermediary gambit to make sure that taxpayer down the line had no assets to pay the tax because the taxpayer and the promoters would have sucked all the value out of the company.  Thus, this intermediary was designed to deal with an inherent and blatant flaw in the SOB transactions.  (Of course, SOB transactions had flaws in them before reaching this stage, but the intermediary was a fine artistic touch to put on the bullshit.)

The Merits

Another Bullshit Shelter Bites the Dust (12/19/13)

We have yet another of the genre out of the Tenth Circuit, this time proving Michael Graetz's famous observation that an abusive tax shelter is “[a] deal done by very smart people that, absent tax considerations, would be very stupid.”  The new case is Blum v. Commissioner, 737 F.3d 1303 (10th Cir. 2013), here.

Before discussing the case, I offer this description of tax shelters from my Federal Tax Procedure Book (footnotes omitted):

Abusive tax shelters are many and varied.  Some are outright fraudulent, usually wrapped in a shroud of paper work designed to present the shelter as a real deal.  The more sophisticated are often without substance but do have some at least attenuated, if superficial, claim to legality.  Some of the characteristics that I have observed for tax shelters that the Government might perceive as abusive are that (i) the transaction is outside the mainstream activity of the taxpayer, (ii) the transaction is incredibly complex in its structure and steps so that not many (including specifically IRS auditors) will have the ability, tenacity, time and resources to trace it out to its illogical conclusion (this feature is often included to increase the taxpayer’s odds of winning the audit lottery); (iii) the transaction costs of the arrangement and risks involved, even where large relative to the deal, still have a favorable cost benefit/ratio only because of the tax benefits to be offered by the audit lottery, (iv) the promoters of the adventure make a lot more than even an hourly rate even at the high end for professionals (the so-called value added fee, which is often insurance type compensation to mediate shift potential penalty risks to the tax professional or the netherworld between the taxpayer and the tax professional) and (v) the objective indications as to the taxpayer's purpose for entering the transaction are a tax savings motive rather than any type of purposive business or investment motive.  More succinctly, Michael Graetz, a Yale Law Professor, has described an abusive tax shelter as “[a] deal done by very smart people that, absent tax considerations, would be very stupid.”  Other thoughtful observers vary the theme, e.g. a tax shelter “is a deal done by very smart people who are pretending to be rather stupid themselves for financial gain.”

Blum fits the pattern.

Mr. Blum was a very successful businessman.  He was apparently very capable in assessing risks and rewards of financial ventures.  Mr. Blum retained KPMG who sold him one of its tax shelter products which it marketed in the 1990s and early 2000s.  This particular product was OPIS, a basis enhancement strategy. The abusive basis enhancement strategies claimed to create large amounts of basis without the taxpayer having to incur a cost for the basis.  The taxpayer would then use the artificial basis to offset otherwise taxable gain, thereby artificially reducing the tax liability.  Mr. Blum got into the deal when he had a large gain that would otherwise be taxed.

When KPMG's representative made the pitch, Mr. Blum "claims he saw an investment opportunity; the Commissioner claims Mr. Blum saw a tax evasion opportunity."  (Emphasis supplied.) Mr. Blum bought the pitch and made a representation to KPMG that he was doing the deal for a legitimate nontax business or investment purpose.  (That representation was essential to KPMG's participation in implementing the transaction.)  Bottom-line, the Tax Court concluded and the Tenth Circuit concluded that the representation was false.

Supreme Court Applies 40% Penalty to Bullshit Basis Enhancement Shelters (12/3/13)

In United States v. Woods, ___ U.S. ___, 134 S. Ct. 557 (2013), here, the Court rejected procedural arguments and applied the special 40% accuracy related penalty for valuation and basis overstatements.  §§6662(a), (b)(3), (e)(1)(A), (h).  The unanimous opinion is written  by Justice Scalia, the plain language justice, who not surprisingly concludes:  "The penalty’s plain language makes it applicable here."

I am sure others and even I will have a lot to say about the opinion and its ramifications later. For now, this caught my eye as Justice Scalia jabs at the use of the Blue Book:

Woods contends, however, that a document known as the “Blue Book” compels a different result. See General Explanation of the Economic Recovery Tax Act of 1981 (Pub. L. 97–34), 97 Cong., 1st Sess., 333, and n. 2 (Jt.Comm. Print 1980). Blue Books are prepared by the staff of the Joint Committee on Taxation as commentaries on recently passed tax laws. They are “written after passage of the legislation and therefore d[o] not inform the decisions of the members of Congress who vot[e] in favor of the [law].” Flood v. United States, 33 F. 3d 1174, 1178 (CA9 1994). We have held that such “[p]ost-enactment legislative history (a contradiction in terms) is not a legitimatetool of statutory interpretation.” Bruesewitz v. Wyeth LLC, 562 U. S. ___, ___ (2011) (slip op., at 17–18); accord, Federal Nat. Mortgage Assn. v. United States, 379 F. 3d 1303, 1309 (CA Fed. 2004) (dismissing Blue Book as “a post-enactment explanation”). While we have relied on similar documents in the past, see FPC v. Memphis Light, Gas & Water Div., 411 U. S. 458, 471–472 (1973), our more recent precedents disapprove of that practice. Of course the Blue Book, like a law review article, may be relevant to the extent it is persuasive. But the passage at issue here does not persuade. It concerns a situation quite different from the one we confront: two separate, non­overlapping underpayments, only one of which is attributable to a valuation misstatement. 

Addendum 12/4/13 10:32am:

I have posted the foregoing, along with more discussion on the Blue Book on my Federal Tax Procedure Blog:   Supreme Court Applies 40% Penalty to Bullshit Basis Enhancement Shelters (Federal Tax Procedure Blog 12/3/13), here.

Also, I have extended and updated those comments on the following:  More on the Supreme Court's Opinion in Woods on TEFRA and the 40% Basis Overstatement Penalty (Federal Tax Procedure Blog 12/4/13), here.

Addendum 12/10/13 8:45 am:

For a good crisp discussion of the holdings, see Alan Horowitz, Supreme Court Rules for Government on Both Issues in Woods (Tax Appellate Blog 12/3/13), here.

A Self-Proclaimed "Simple Man," "Utterly Uneducated" in Tax and Finance, but Still a Self-Made Multi-Millionaire Loses his Bullshit Tax Shelter Case (4/13/13)

In Kerman v. Commissioner, ___ F.3d ___, 2013 U.S. App. LEXIS 7032 (6th Cir. 2013), here, the Sixth Circuit rejected the Kerman's claim for tax benefits or, at least, relief from penalties from a bullshit tax shelter, this one of the Cards variety that has met with uniform rejection from the courts.  I just gave you the final result.  But the opinion starts this way (usually you can tell the result from the opening):

A tax shelter can be legitimate — if the reported transaction has economic substance. But the shelter Mark Kerman participated in lacked such substance. The transaction had no purpose other than the creation of an income tax benefit. After Kerman claimed the benefit on his tax return, the IRS disallowed the deduction and imposed a valuation misstatement penalty pursuant to 26 U.S.C. § 6662(e), which was increased to 40 percent of the unpaid tax pursuant to § 6662(h). The tax court affirmed the IRS's decision. Kerman appeals, contending that the shelter was legitimate and that, even if it was not, the penalty should not be imposed. Because the transaction lacked economic substance and Kerman lacked reasonable cause or good faith to believe that it did, we AFFIRM.
I
A
Mark Kerman is a college-educated multi-millionaire.

Toward the end of the opinion another key signal dot is connected as follows:

Finally, Kerman argues, the tax court gave him too much credit. He's just a simple man, "utterly uneducated in the complex tax arena — let alone the more byzantine tax-shelter realm." Appellant's Br. 48. Consequently, he was forced to rely on personal advisors. And, he argues, his reliance was reasonable even if his advisors had conflicts of interest.

So, what should I say about the opinion?  Prudence and respect for my readers time counsels that I should not say anything except the bullet points from the case.  So, I won't.

Supreme Court Will Decide Whether Bullshit Tax Shelters with Basis Overstatements Draw the 40% Penalty (3/25/13)

The Supreme Court has decided to accept cert on the split in the circuits on the issue of whether the 40% valuation / basis overstatement applies to bullshit tax shelters that fail in a number of ways other than just valuation / basis overstatement.  The Supreme Court docket page in the case, United States v. Woods, No. 12-562. is here.  The entry granting cert adds the following TEFRA partnership procedure issue:

In addition to the question presented by the petition, the parties are directed to brief and argue the following question: Whether the district court had jurisdiction in this case under 26 U. S. C. 6226 to consider the substantial valuation misstatement penalty.

I can't get excited about the TEFRA issue.  It is important, to be sure.  But, the principal issue is foisted on the Supreme Court by the Fifth and Ninth Circuits' stubborn insistence to grant relief to bullshit tax shelters with basis overstatements despite their own expressed doubts and the critical mass of circuit court opinions denying that relief. I guess, though, that the TEFRA jurisdictional issue could perhaps give the Court an opportunity to duck the merits issue, thus not resolving the conflict.  (I would think, however, that, if the Supreme Court ducked the issue, the Fifth and Ninth Circuits could still resolve the issue by moving to the majority view in the next cases presenting the issue; alternatively, the Supreme Court might resolve the split in some case that does not present a jurisdictional impediment (such as the case for which petition for certiorari was filed from a majority view case in Alpha I L.P. v. United States, No. 12-550, here.)

For good discussions of the split, see Gustashaw v. Commissioner, 696 F.3d 1124, 1136 (11th Cir. 2012), here; Crispin v. Commissioner, ___ F.3d ___, ___ n. 18 2013 U.S. App. LEXIS 3852 (3d Cir. 2013), here; ; AHG Investments LLC et al. v. Commissioner, 140 T.C. ___, No. 7 (2013), here (adopting this majority rule for the Tax Court in cases where the Circuit Court to which an appeal would be taken has not spoken); and  Jeremiah Coder, Self-Serving Concessions and Penalty Avoidance, 134 Tax Notes 1583 (Mar. 26, 2012).