Whack a Mole - Fifth Circuit Confirms that the Stench of a Bullshit Shelter Does Not Smell Better with Time (5/18/16)

In Chemtech Royalty Associates, L.P. as Tax Matters Ptnr v. United States, ___ F.3d ___, 2016 U.S. App. LEXIS 9037 (5th Cir. 5/17/16), here, the Fifth Circuit rejected odorific (Urban Dictionary here) arguments in support of the bona fides of the partnership's investment bullshit tax shelter.  The Fifth Circuit had previously called the shelter itself foul indeed.  See Chemtech Royalty Assocs., L.P. v. United States, 766 F.3d 453 (5th Cir. 2014); see my blog on the prior Fifth Circuit opinion in Another Bullshit Tax Shelter Bites the Dust on Appeal Also (Federal Tax Crimes Blog 9/12/14; 9/20/14), here.  This time on appeal the issue was whether the partnership could avoid a penalty after the Fifth Circuit had previously called the shelter foul indeed.

In the first appeal, the district court had rejected the merits of the shelter (a holding affirmed on appeal) and held that two 20% accuracy related penalties applied -- the negligence and the substantial understatement.  Each of those penalties could apply, although only one 20% accuracy related penalty would apply (2 reasons for the one penalty).  The taxpayer appealed.  In the first opinion calling the merits of the shelter foul indeed, the Fifth Circuit vacated the penalties to remand for the district court to determine whether the penalties remained applicable in light of the Fifth Circuit opinion on the merits and the Supreme Court's opinion in United States v. Woods, 134 S. Ct. 557 (2013) (which actually involved the substantial and gross valuation misstatement penalties but which effectively, according to the Fifth Circuit, overruled two Fifth Circuit precedents).  On the remand, the district court re-affirmed the application of the negligence and substantial understatement penalties, and the partnership again appealed.

In this iteration, the Fifth Circuit held the negligence penalty applicable but deferred opining on the substantial understatement penalty.  It seems to me that the Court's opinion is a bit confusing (at least to me), so I will try to summarize my understanding of how the Court got there.

1.  The substantial understatement penalty.  Because the transaction in question was a tax shelter, the substantial understatement penalty applied unless, under the law applicable at the time, the taxpayer established that it reasonably believed that the tax benefits were more likely than not to prevail.  The Court essentially ducked that issue for now, by holding that the defense based on reasonable belief did not have to be litigated in the partnership proceeding, thus perhaps deferring it to another day when the taxpayer might pursue it.

2. The negligence penalty.  After rejecting the Government's procedural arguments to consideration of the taxpayer's defense to the negligence penalty, the Court rejected the partnership's claim that it had substantial authority, a traditional defense to the negligence penalty.  Basically, there was no substantial authority that the a taxpayer can hide a lending arrangement as a partnership.

Readers of this blog will recall that the Second Circuit said basically the same thing in GE's tax shelter misadventure in TIFD-III-E Inc. v. United States, 604 Fed. Appx. 69 (2d Cir. 2015), which, like the instant case, bounced from trial court to appellate court with the only difference that there was an obstinate trial judge in TIFD trying to help GE; the Second Circuit had to call the matter to a halt in a way that did not appear favorable to either GE or the trial judge; in the instant case, of course, the trial judge got it right and was affirmed by the Fifth Circuit.  See on the TIFD saga, my discussion of the final Second Circuit holding GE Gets Slapped Down Again for its BullShit Tax Shelter (Federal Tax Crimes Blog 5/20/15), here.