Tax Court Case Where Party In Interest Invokes the Fifth Amendment (3/19/14)

In Humboldt Shelby Holding Corporation v. Commissioner, T.C. Memo. 2014-47, here, decided yesterday, the Tax Court knocked down a digital options bullshit tax shelter relying on the now uniformly discredited interpretation of Helmer v. Commissioner, T.C. Memo. 1975-160, hawked by bogus tax shelter promoters in the mid-to late 1990s through the early 2000s.  The Court starts the opinion as follows:

James Haber is a tax professional who has promoted tax shelters to third parties through a company called the Diversified Group, Inc. (DGI). This case involves a tax scheme Mr. Haber carried out for his personal benefit. Mr. Haber is petitioner's sole shareholder, and his scheme would have allowed petitioner to avoid approximately $25 million of Federal income tax while incurring costs of only $320,000. 

To carry out the tax scheme at issue, petitioner contributed paired options to a partnership to generate an artificially high basis in property the partnership later distributed. Petitioner recognized large capital losses when it sold the stock and reported those losses on its 2003 return to offset capital gains. Respondent disallowed the capital loss deductions and related section 1621 business deductions and determined that petitioner was liable for a section 6662 accuracy-related penalty. The issues for decision are:

1) whether petitioner improperly claimed short-term capital loss deductions of $74,093,688 for its 2003 taxable year. We hold that it did; 

2) whether petitioner improperly claimed section 162 business deductions of $1,249,925 for professional fees it incurred during its 2003 taxable year. We hold that it did; and 

3) whether petitioner is liable for the accuracy-related penalty under section 6662. We hold that it is.

These holdings are straightforward.

An interesting aspect of the case is the following:

Mr. Haber is petitioner's sole owner and the architect of its tax avoidance plan. Mr. Haber is a witness in criminal proceedings in the Southern District of New York involving a former DGI client. The U. S. attorney for that district denied Mr. Haber's request for immunity. Consequently, Mr. Haber has invoked his Fifth Amendment privilege against self-incrimination and declined to testify in these proceedings. Petitioner moved to stay the case until the criminal prosecution's conclusion. We denied the motion after finding that the interests of justice did not support further delaying the trial. 

OPINION 

I. Burden of Proof 

The taxpayer bears the burden of proving by a preponderance of the evidence that the Commissioner's determinations are incorrect. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Deductions are a matter of legislative grace, and a taxpayer bears the burden of proving entitlement to any claimed deductions. Rule 142(a)(1); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). The term "burden of proof" includes two distinct concepts: (1) the burden of persuasion, "i.e., which party loses if the evidence is closely balanced", and (2) the burden of production, "i.e., which party bears the obligation to come forward with the evidence at different points in the proceeding". Schaffer v. Weast, 546 U.S. 49, 56 (2005). Before trial we considered shifting the burden of proof to respondent in the light of Mr. Haber's decision to invoke his Fifth Amendment privilege and our decision to move forward with the trial in his absence. We ultimately decided against shifting the burden of persuasion because doing so would have effectively sanctioned the Commissioner for the Federal prosecutor's refusal to grant Mr. Haber immunity. We did shift the burden of production to respondent and requested petitioner to provide an offer of proof regarding the testimony Mr. Haber would have provided if he had been granted immunity. 

Immunity is a statutory creation whose administration Congress bestowed on the executive branch. 18 U.S.C. secs. 6002 and 6003 (2012). Congress has given the Attorney General the authority to exchange the protection of immunity for otherwise incriminating testimony when, in his judgment, a witness' testimony may be in the public's interest. United States v. Quinn, 728 F.3d 243 (3d Cir. 2013). "There is * * * overwhelming judicial and legislative authority for the proposition that review on the merits of a Federal prosecutor's decision to grant immunity is barred by statute." United States v. Herman, 589 F.2d 1191, 1201 (3d Cir. 1978). This bar extends to judicial review on the merits of a prosecutor's decision to withhold immunity. Id. 

Rule 142 permits the Court to shift the burden of proof in its discretion under certain circumstances. Given the prosecutor's broad authority to make immunity decisions without judicial interference, we exercised this discretion cautiously here. After careful consideration of Mr. Haber's circumstances, we determined that he could invoke his Fifth Amendment right to avoid testifying, but we declined to shift the burden of persuasion. After trial it is apparent that the burden of persuasion has no bearing on the resolution of this case. The evidence in the record would support our conclusion even if we had shifted the burden and even if Mr. Haber had testified as petitioner claimed in its offer of proof. Considering the significant objective evidence of his intent here, we would have given little weight to his self-serving testimony. See Faulconer v. Commissioner, 748 F.2d 890, 894 (4th Cir. 1984) ("A taxpayer's mere statement of intent is given less weight than objective facts."), rev'g T.C. Memo. 1983-165.

JAT Comments: There are several points about the foregoing that I think are noteworthy.

1.  The USAO SDNY and DOJ Tax have known about Mr. Haber's activities since at least 2005.  Indeed, our understanding was that he was at least a subject and probably a target of the bogus tax shelter investigations by the USAO SDNY leading to the indictments of persons related to KPMG, E&Y, and Jenkens & Gilchrist/BDO Seidman.  Presuming that he did not continue promoting the bogus shelters or attempt to cover them up after hitting that radar screen, I would have thought that his criminal prosecution exposure had long since past.  After all, the criminal statute of limitations is 6 years.  That would mean that his statute of limitations had expired by 10/15/12 (assuming the latest date of a fraudulent return of 10/15/06).  Of course, he could have extended the statute of limitations by consent or done something in the interim to refresh the statute of limitations with respect to his pre-2005 conduct.

2.  The last paragraph indicates that the Court (Judge Goeke) had permitted Mr. Haber to assert his privilege but the Court had refused to shift the burden of persuasion I had previously blogged that, in another case, the Tax Court (Judge Halpern) had granted the petitioner's motion to shift the burden of proof (persuasion) to the IRS because of AUSA SDNY's refusal to grant Mr. Haber immunity.  See Government Refusal to Grant Immunity Shifts Burden of Proof to IRS in Tax Court Case (Federal Tax Crimes Blog 9/24/13), here.  In that blog, I had noted the limits of such shifts in burden of proof in affecting the outcome of real cases -- that where the Court is persuaded one way or the other, the allocation of the burden of proof is irrelevant.  Judge Goeke resolves the potential issue in that way, by making his findings and conclusions based on a preponderance of the evidence and not on a state of equipoise where the burden of proof would control the outcome.  (I should note that Judge Halpern, who shifted the burden of proof in the other case, is very good at the same technique to moot the effect of a shift of burden of proof -- by doing the work to make his findings based on a preponderance of the evidence, so as to avoid the state of equipoise that would make the burden of proof outcome determinative.)

3. One interesting issue that has been addressed in the comments to some recent blogs has been the propriety of a negative inference that a witness or party asserting the Fifth Amendment privilege has committed a crime.  The issue came up with respect to a reader asserting that Ms. Lerner's assertion of the Fifth Amendment before the House Committee investigating alleged political targeting in the IRS enforcement of Section 501(c)(4) permitted a negative inference that she had committed some crime.  The reader analogized to civil cases, where, he asserted, a party asserting the Fifth Amendment can be subject to such a negative inference, at least to defeat the claims that the party was making in the civil case where he or she refuses to testify.  As best I see it, Judge Goeke resolved the case without any reliance on inferences, at least none that he articulated.

4. Finally, the Court's rejection of the reasonable cause defense to the accuracy related penalty is interesting:

Petitioner's underpayment did not result from an honest misunderstanding of the law. Mr. Haber is a sophisticated tax planner who deliberately exploited a perceived loophole in the law. Petitioner did not make a reasonable effort to assess its proper tax liability. Petitioner should have known that reporting $75 million in losses from a transaction that cost $320,000 would result in a significant tax underpayment. 

Petitioner claims that a straightforward interpretation of the Code and caselaw supported its tax position when it filed its return. We disagree. Petitioner's scheme depended on Mr. Haber's unreasonable interpretation of Helmer v. Commissioner, T.C. Memo. 1975-160, and its progeny. In Helmer a partnership granted a development company an option to purchase the partnership's land at a fixed price. The agreement required the development company to make annual payments to the partnership while the option remained unexercised. The annual payments were to count toward the purchase price if the development company exercised the option. The partners argued that the payments increased the partnership's liabilities and thus increased their bases. We disagreed because "no liability arose upon receipt of the option payments". 

Petitioner relied on Helmer for the proposition that a sold option is not a liability, and thus partners should not decrease their bases when they contribute sold options. This interpretation was not reasonable, especially given the abusive result it achieved in this case. The options at issue here did not resemble the option we addressed in Helmer and did not command the same treatment. We find that petitioner has failed to establish reasonable cause and is liable for the accuracy-related penalty.