Eleventh Circuit Joins the Consensus that Reckless Conduct Is Subject to the FBAR Civil Willful Penalty (4/24/21)

In United States v. Rum, 995 F.3d 882 (11th Cir. 4/23/21), CA11 here; TN here, the Eleventh Circuit in a per curiam opinion affirmed the district court’s grant of summary judgment for the Government in an FBAR willful civil penalty collection suit.  I wrote on the district court’s grant of summary judgment previously.  District Court Confuses Analysis in Approving Magistrate's R&R Imposing FBAR Willful Penalty (Federal Tax Crimes Blog 9/26/19), here.  

The Eleventh Circuit opinions lists Rum’s arguments:

(A) that the district court applied an incorrect standard of willfulness (by holding that willfulness as used in 31 U.S.C. § 5321(a)(5)(C) includes a reckless disregard of a known or obvious risk); (B) that the district court erred in concluding that there were no genuine issues of material fact as to whether his conduct rose to required level of willfulness/recklessness; (C) that the district court erred in refusing to recognize that 31 C.F.R. § 1010.820(g)(2) limits the amount of a willful violation to $100,000; (D) that the district court erred when it held that the IRS's factfinding procedures were sufficient and therefore applied the arbitrary and capricious rather than a de novo standard of review with respect to the amount of the penalty; (E) that, even assuming the arbitrary and capricious standard applies, the district court erred in failing to conclude that the IRS factfinding procedures were arbitrary and capricious; and finally, (F) that the district court erred in rejecting Rum's challenge to the additions to the base amount (interest and late fees).

I address here only (A) and (D)-(E).

Standard for FBAR Civil Penalty Willfulness

The  Court adopted (Slip Op. 12-16) the consensus holdings that “willfully” as the element of the civil penalty includes recklessness.  I don’t think I need to say more about the holding here because it just rehashes what courts have held before.  The importance of the holding is that it adds to a number of similar holdings, so that it seems that there is no real counterweight to the holding.  It states the consensus.

Rum’s APA Claims

More on Litigation and IRS Raising Civil Fraud New Matter (7/12/19)

I posted this blog entry on my Federal Tax Procedure Blog, here.  I posted the predicate blog entry on both Blogs, so I thought this follow-through should be on both blogs because it deals with the consequences of tax fraud, albeit civil tax fraud which gives rise to a potential civil fraud penalty and an actual unlimited statute of limitations (albeit the IRS may never know about it).  So, here it is:

My last post involved the IRS raising the civil fraud penalty as new matter by amended answer and prevailing. IRS Raises Fraud In Tax Court Amended Answer and Prevails (Federal Tax Crimes Blog 7/9/19), here.  The key point of the blog entry was the danger of unspotted issues after an audit and the risks of petitioning the Tax Court for redetermination.

First, on that issue, I offer the relevant portion of the working draft of my Federal Tax Procedure Book will be published on SSRN in early August 2019 (footnotes omitted):

New Matters [In the Tax Court]. 

The IRS can raise new issues in its answer that seek to increase the amount of the deficiency on a basis not asserted in the notice of deficiency or to justify the deficiency asserted (or part thereof) on some basis not asserted in the notice of deficiency.  Jurisdictionally, the Tax Court case is a case to redetermine the correct amount of tax liability for the year(s) involved, thus permitting it to determine a higher deficiency amount or an overpayment.  § 6214(a) & 6512(b). So the IRS can seek additional taxes and penalties not previously asserted.  The statute of limitations will be open because, to reprise what we learned earlier, the statute is suspended during the period the Tax Court case is pending.  §§ 6213(a) and 6503(a).   This is one of the dangers in proceeding in the Tax Court where the IRS has not previously spotted an issue.  Since the statute of limitations is suspended upon issuance of the notice of deficiency (§ 6503(a)), all new matters may be raised, assuming that the statute of limitations did not bar the notice of deficiency in the first place. 

The IRS's ability to raise new issues after its original answer is, however, limited by rules of fairness.  If the IRS does assert new matters after filing its original answer, it will formally do so by moving to amend the original answer.  The Tax Court rules, like the Federal Rules of Civil Procedure applicable in district courts and the Court of Federal Claims' Rules, permit amended pleadings, usually requiring the approval of the Court which is liberally granted to promote justice on the underlying merits. New issues cannot be inserted too late in the process so as to deny the taxpayer the effective opportunity to respond.  And, as to “new matters,” the IRS bears the burden of persuasion.  (Of course, if the new matter is the civil fraud penalty not asserted in the notice of deficienty, the IRS would have the burden of persuasion anyway to prove civil fraud by clear and convincing evidence, so asserting civil fraud as a new matter has no affect on the burden of persuasion.) 

The IRS is allowed to raise a new theory or ground in support of an issue raised in the notice of deficiency without the theory or ground being a new matter.  Depending upon how much variance the new theory or ground has with the notice of deficiency, the variance might be considered a new matter subject to the foregoing new issues discussion.  Certainly, if it is raised so late that the taxpayer cannot fairly respond with evidence addressing the new issue, the Court should deny the IRS’s attempt to assert the new issue. 

If the IRS asserts an affirmative defense (such as estoppel), it will be deemed denied and the taxpayer need not file a responsive pleading, which is usually called a “reply.”  If, however, the IRS raises “new matter” either in an answer or an amended answer, the taxpayer should file a reply providing the IRS notice as to the taxpayer's position on the new matter.  This is frequently done via a simple denial of the various matters pled with respect to the new matter. 

I think it would be helpful to illustrate the new matter issue.  Recall that § 6662 provides a 20% substantial understatement penalty that is then increased to 40% if the understatement is attributable to a gross valuation misstatement.  If the notice of deficiency asserted the 20% penalty but, in its answer, the IRS asserts the 40% penalty, the IRS will have the burden of proof on the increase in the penalty.  That seems to be the straight-forward reading of the rule shifting the burden of proof to the IRS.  But, let’s focus on one issue raised in this setting.  The taxpayer can avoid the accuracy related penalties if there was reasonable cause for the position on the return.  This is like an affirmative defense to the penalty.  Thus, as to the 20% penalty asserted in the notice and contested in the petition, the taxpayer bears the burden of proving reasonable cause even after the IRS meets its production burden under §7491(c); as to the increased 40% penalty, however, the IRS bears the burden of proof, including establishing absence of reasonable cause. 

Finally, an even worse case for the taxpayer who improvidently petitions for redetermination is that the IRS can raise as new matter a civil fraud penalty.  Say in the above example, the notice of deficiency asserted either the 20% or 40% accuracy related penalty in § 6662 and then in the answer (or amended answer), the IRS asserts the 75% civil fraud penalty in § 6663.  Note in this regard that, if the IRS raises the civil fraud penalty as a new matter, its burden of proof is not affected because, as to civil fraud, the IRS bears the burden of persuasion by clear and convincing evidence anyway, just as it the civil fraud penalty had been asserted in the notice of deficiency.  So,  if the IRS prevails, the taxpayer will be even worse off for having filed a petition for redetermination.  Thus, taxpayers and practitioners should think carefully about unspotted potential issues before filing a petition for redetermination in the Tax Court.

Now let's work this a little more.  This IRS favorable result works because the statute of limitations is still open in Tax Court proceedings.

District Court Holds that Santander's Arguments to Avoid Penalty for Bullshit Tax Shelter (No Substance) Lack Substance (7/24/18)

In Santander Holdings USA, Inc. v. United States (D. Mass. Dkt. 09-11043-GAO Dkt Entry 344 7/17/18), here, Santander previously lost the merits of its bullshit tax shelter on appeal, with the Court of Appeals holding that the shelter lacked economic substance.  Santander Holdings USA, Inc. v. United States, 844 F.3d 15 (1st Cir. 2016), here, cert. denied sub nom. Santander Holdings USA, Inc., & Subsidiaries v. United States, 137 S. Ct. 2295 (2017).  See my discussion of the Court of Appeals decision, First Circuit, Reversing the District Court, Rejects Santander's Bullshit Tax Shelter (Federal Tax Crimes Blog 12/17/16), here.

Santander argued that, although its tax shelter lacked economic substance -- i.e., was bullshit -- it should be able to avoid the accuracy related penalty.  Well, basically, the district court held that that argument too lacked substance -- was bullshit.  The opinion is short and, I think, predictable, so I forego addressing it further.

However, the district court did include a quote from the Court of Appeals' decision that I had included in my prior write up but was in a larger quote so that I had not focused on it.  The district court did focus on it as follows.  This is the quote (cleaned up):

When a transaction is one designed to produce tax gains not real gains—such as when the challenged transaction has no prospect for pre-tax profit—then it is an act of tax evasion that, even if technically compliant, lies outside of the intent of the Tax Code and so lacks economic substance.

The district corut did not quote the whole paragraph from the Court of Appeals which includes "tax evasion" twice, so I offer the whole paragraph (cleaned up):

The economic substance doctrine is centered on discerning whether the challenged transaction objectively lies outside the plain intent of the relevant statutory regime. A transaction fails the economic substance test if, though it actually occurred and technically complied with the tax code, it was merely a device to avoid tax liability. Courts may disregard the form of transactions that have no business purpose or economic substance beyond tax evasion. In other words, when a transaction is one designed to produce tax gains not real gains -- such as when the challenged transaction has no prospect for pre-tax profit -- then it is an act of tax evasion that, even if technically compliant, lies outside of the intent of the Tax Code and so lacks economic substance.

Readers of this blog will recognize the term "tax evasion."  At least in this blog and in other authorities on criminal tax matters, tax evasion is a term of art.  Narrowly, it means the specific tax evasion crime in § 7201, but is often used to cover the panoply of tax crimes where tax was evaded (e.g., the Sentencing Guidelines require that for a tax loss as the first step in the sentencing calculation).  But, the term usually does connote conduct that is criminal.  See e.g., the Wikipedia entry for Tax Evasion, here.

IRS Designates Syndications Exploiting Improper Valuations for Conservation Easement Deductions (1/2/17)

I note at a couple of places in the Federal Tax Procedure Book that some of the most abusive tax shelters do not fail because the legal positions are faulty.  Rather, they fail because the legal positions are all based false facts, often a false valuation of property.  For example, in discussing the substantial and gross valuation misstatement penalties in §§ 6662(e) and (h), here, I state:

Section 6662(e)’s substantial valuation misstatement penalty and § 6662(h)’s gross valuation misstatement penalty are directed to return reporting positions where the law is correctly applied but a critical valuation is grossly erroneous, resulting in the substantial understatement of the tax liability.  In many of the abusive tax shelters over the years, the Achilles heel has been and continues to be inflated valuations.  The legal superstructure had some facial merit, but it was built on a factual house of cards because of gross overvaluation.  A facet of this problem was that, since tax professionals were not valuation experts, they could render their opinions without taking responsibility for the key valuation facts that supported the whole purported tax shelter superstructure.  For example, as to property otherwise qualifying for the old investment tax credit (10 percent of qualifying investment in property), tax shelter promoters would sometimes inflate the value of property to 10 or 20 times its true value and sell it to investment partnerships (where the partners were tax shelter investors) for the inflated value.  Of course, only crazy people would pay the inflated value, so the tax shelter investors paid only a small amount down and “paid” the balance by nonrecourse indebtedness (before the rules related to nonrecourse indebtedness and passive losses).  Assuming that the value was correct, the taxpayers would be entitled to the credit; the problem was in the valuation.  Many, many tax issues, not just tax shelter issues, rely upon valuations.  Thus, for example, estate and gift tax returns rely upon reasonably correct valuations.  The purpose of this penalty is to put some sting in overly aggressive valuations.

I have posted on variations of this theme.  Court Sustains Use of Regular Summons to Appraiser Investigated Even Though Third Party Taxpayers May be Identified (Federal Tax Crimes Blog 1/14/16), here.  See also Prominent and Very Rich Investor Indicted in SDNY (Federal Tax Crimes Blog 5/24/16), here.

Such overvaluations carry risk of criminal prosecution and significant civil penalties.

The IRS strikes again at a valuation shelter in a different package, this one syndications -- promoted "investments" -- offering conservation easement deductions.  Notice 2017-10, 2017-04 IRB, here.  The Notice describes the problem:

The promoters (i) identify a pass-through entity that owns real property, or (ii) form a pass-through entity to acquire real property. Additional tiers of pass-through entities may be formed. The promoters then syndicate ownership interests in the passthrough entity that owns the real property, or in one or more of the tiers of pass-through entities, using promotional materials suggesting to prospective investors that an investor may be entitled to a share of a charitable contribution deduction that equals or exceeds an amount that is two and one-half times the amount of the investor’s investment. The promoters obtain an appraisal that purports to be a qualified appraisal as defined in § 170(f)(11)(E)(i) but that greatly inflates the value of the conservation easement based on unreasonable conclusions about the development potential of the real property. After an investor invests in the pass-through entity, either directly or through one or more tiers of pass-through entities,  the pass-through entity donates a conservation easement encumbering the property to a tax-exempt  entity. Investors who held their direct or indirect interests in the pass-through entity for one year or less may rely on the pass-through entity’s holding period in the underlying real property to treat the donated conservation easement as long-term capital gain property under § 170(e)(1). The promoter receives a fee or other consideration with respect to the promotion, which may be in the form of an interest in the pass-through entity. The IRS intends to challenge the purported tax benefits from this transaction based on the overvaluation of the conservation easement. The IRS may also challenge the purported tax benefits from this transaction based on the partnership anti-abuse rule, economic substance, or other rules or doctrines.

Faulty Tax Shelter Opinions and Appraisals and Resulting Civil Penalties (9/24/16)

Two recent cases highlight the role of the tax professionals' legal opinions in so-called tax shelters.  During the abusive tax shelter proliferation in the late 1990s and early 2000s, the linchpin to abusive tax shelters was tax professionals' opinion letters pronouncing that the tax benefits were "more likely than not" to be sustained if the IRS contested.  Those opinion letters -- being just tax professionals' opinions -- did not affect how courts would resolve the issue of whether the tax shelters worked.  They served solely to give the tax shelter "player" some basis to claim exemption from the penalties that might otherwise apply to aggressive tax reporting positions.  Relying on tax professionals' opinions might permit the taxpayers to claim § 6664(c)'s "reasonable cause" and "good faith" exception to the penalties in § 6664(c), here, or, possibly, a reduction in the penalty base for the substantial understatement penalty in § 6662(d), here (in an earlier iteration).  Many of the tax shelter players did not in the final analysis actually rely upon the promoted tax shelter professionals' opinions, but rather discretely had their own independent counsel advise them on the shelter.  As I understand it, many of these independent advisers gave roughly the following advice:  "No way the shelter will be sustained if contested, but at least the promoted tax professionals' opinions will give the taxpayers a pretty good shot at avoiding the penalty."  (Of course, for this to work, the taxpayer would have to successfully keep from the IRS or ultimately the courts, the substance of the independent adviser's opinion.)

I discussed United States v. Daugerdas, ___ F.3d ___, 2016 U.S. App. LEXIS 17219 (2d Cir. 2016), here, recently, Daugerdas Conviction and Sentencing Affirmed by Second Circuit Court of Appeals (Federal Tax Crimes Blog 9/21/16), here.  I quoted the part of the opinion relevant to today's discussion, but will present the quote again here:

As an essential part of the marketing of all the tax shelters, Daugerdas and his colleagues issued "more-likely-than-not" opinion letters to clients who purchased the shelters. Such letters state that "under current U.S. federal income tax law it is more likely than not that" the transactions comprising the shelters are legal and will have the effect sought by the clients. They protect clients from the IRS's imposition of a financial penalty in the event that the IRS [6]  does not permit the losses generated by the shelter to reduce the client's tax liability. Paralegals or attorneys who worked for Daugerdas generated these letters and Daugerdas often reviewed and signed them himself. The letters stated that the clients had knowledge of the particular transactions underlying the shelter and that the clients were entering into the shelter for non-tax business reasons. Multiple clients testified that they never made representations of knowledge to Daugerdas or his associates and that, in any event, these representations were false because the clients knew little or nothing about the underlying transactions and entered into the shelters only to reduce their tax liability.

Daugerdas' shelters were clearly of the abusive -- aka bullshit -- variety.  In essence, for the tax shelters Daugerdaus and his partners in crime hawked, the play in the shelter gave the taxpayer a shot at the audit lottery and some way potentially to mitigate the penalty damage if he did not win the audit lottery.  But, as it turns out, these shelters were so bad, that they did not really offer much in the way of penalty mitigation except, sometimes, through IRS amnesty programs.  In essence, most of the taxpayers -- certainly the more sophisticated taxpayers who had millions and millions of income to shelter -- got into the shelter on a wink and a nod, hoping for the best with some downside protection.

In Exelon Corp. v. Commissioner, 147 T.C. ___, No. 9 (2016), here, the taxpayer had $1.6 billion in gain that it perceived a need to shelter -- i.e., avoid paying tax on.  The transactions are convoluted (as in the case of many tax shelters where the convolutions masks lack of substance).  (The complexity of the opinion is suggested by the fact that the substantive discussion concludes on p. 161 of the slip opinion.)  The details of the transactions are not important for purposes of this blog, but they are variations on leveraged leases with their own acronym that is familiar to affionados of bullshit tax shelters -- SILOs (to be contrasted from related tax shelters called LILOs).  In the opinion, Judge Laro offers the following "Primer on Leveraged Leases, LILOs, and SILOs:"

Sumner Redstone Owes the Gift Tax from 1972 But Not the Civil Fraud or Negligence Penalties (12/13/15)

In Redstone v. Commissioner, T.C. Memo. 2015-237, here, Sumner Redstone was found liable for "a gift tax deficiency of $737,625 for the calendar quarter ending September 30, 1972."  That's right 1972.  The interest alone on that deficiency will be several, perhaps many times the principal amount of the tax.  (But astute readers will know that Sumner Redstone, a media mogul (see Wikipedia entry here), can pay all of it with little difficulty.)  That was the bad news for Mr. Redstone.  The good news is that the Tax Court relieved him from the civil fraud penalty (then 50%) and the accuracy related penalty (then 5%).  (I am not sure if, for the period in question, these civil penalties drew interest from the due date of the return as they do now.)  The disposition of the penalty issues makes the case interesting, for the determination of the substantive gift tax liability seemed to be relative straight-forward despite the passage of time since 1972.

I will refer to the players involved in the drama by their first names to distinguish them.  The father was Michael "Mickey" Redstone.  I'll call him Mickey, as does the Court.  There were two sons relevant here -- Edward and Sumner.  This opinion does not say a whole lot about Edward's education and experience, but it does say some things about Sumner's because, presumably, that is relevant to what he knew or should have known about the substantive tax liability back in 1972 and hence liability for the penalties.  The Court says cryptically:

Sumner graduated from Harvard College in 1944 and Harvard Law School in 1947. He practiced law for several years, including a stint in the Tax Division of the U.S. Department of Justice, before starting work in 1954 for the family business.

The Wikipedia entry fleshes this out just a bit:

After completing law school, Redstone served as special assistant to U.S. Attorney General Tom C. Clark (who later served as Associate Justice of the Supreme Court of the United States from 1949 to 1967)[3] and then worked for the United States Department of Justice Tax Division in Washington, D.C. and San Francisco, and thereafter entered private practice. 

From just these bare facts, one might surmise that Sumner was familiar with the tax law and the basic tax concepts that the Tax Court applied to determine that, on the facts, Sumner was liable for the gift tax in question.  One of those concepts is surely that transfers of value with a donative intent is a gift, potentially subject to gift reporting and tax.  But, Sumner pleaded ignorance -- certainly lack of intent in avoiding the civil fraud and negligence penalties.  Not only did he not have an intent to evade his tax liability, but he also was not negligent because he relied on this tax advisers and a memorandum from one tax adviser, which Sumner could not produce.

Well, let's get into the fact to set this up.  At some point, after Sumner left the practice of law to join the family business, the three created a corporation in which the three of them were nominal equal shareholders - 100 shares each.  The father contributed to that corporation disproportionately to the two sons, contributing almost 48%, with each son contributing around 26%.  (OK, there might have been a gift at that time from Mickey to the two sons or at least to someone; read on.)

The Economic Rational Actor Model (4/22/15)

I offer today a good, succinct explanation of what is commonly called the standard deterrence model for the economically rational actor for tax obligations.  Kathleen DeLaney Thomas, The Psychic Cost of Tax Evasion, 56 B.C. L. Rev, 618 (2015), here.  I quote her brief explanation (pp. 623-626), omitting all except two footnotes:

A. Standard Deterrence Theory: The Rational Actor Model 

Standard deterrence theory, as applied to tax compliance, assumes that taxpayers are rational actors seeking to maximize their expected utility. Accordingly, a taxpayer who is deciding whether to comply with the tax law will weigh the expected cost of tax evasion against the cost of complying and choose the cheaper option. The cost of complying is simply the amount of tax owed. The cost of evasion, however, is somewhat more complex. If a taxpayer evades and is caught, she will have to pay the tax owed and will also have to pay a penalty, which is usually some fraction of the tax owed (e.g., twenty percent). Together, this penalty added to the tax owed can be thought of as the total fine for evasion (F). There is a chance, however, that the IRS will not detect the taxpayer’s evasion, in which case the taxpayer incurs no cost. Thus, the expected cost of tax evasion is the total fine for evasion discounted by the probability of detection (P): 

Cost of Compliance = Tax Owed
v.
Expected Cost of Evasion = P x F19 

For example, if the probability of detection were one percent (which is the current overall audit rate) and the penalty for evasion were twenty percent of the tax due, the expected cost of evading $100 of tax would be the $100 of tax due plus a $20 penalty (F = $120), discounted by one percent chance of being detected (P). The resulting $1.20 expected cost would be substantially cheaper than the cost of complying (i.e., the $100 of tax owed). In that case, a rational taxpayer would cheat. 

A policymaker seeking to deter a rational taxpayer from evading tax can do so by raising the expected cost of evasion, with the goal of making it more expensive than the cost of compliance. It follows from the model that raising either the probability of detection or the penalty for evasion, or some combination of the two, can increase the expected cost of evasion. In the context of tax compliance, this means higher tax penalties, raising the audit rate, or finding some other method to increase the rate of detection. 

At first glance, raising tax penalties appears to be a simple and potentially cost-effective solution for increasing tax compliance. Current civil tax penalties in the United States range from just twenty percent to seventy-five percent of the tax due, resulting in sub-optimal expected penalties if the risk of detection is small. n22 If Congress increased nominal penalties significantly, it could potentially deter tax evasion without investing more re-sources in ferreting out noncompliant taxpayers.
   n22 In the example in the text above, the expected penalty for evading $100 of tax was just $1.20 when the risk of detection was one percent and the penalty was twenty percent.

More on Bullshit Corporate Tax Shelters (with Some Rantings) (9/12/14)

Today, I posted a blog entry titled Another Bullshit Tax Shelter Bites the Dust on Appeal Also (9/12/14), here, in that article I addressed, perhaps obliquely, the IRS propensity to assert only accuracy related penalties for tax shelters that are nothing more than scams and raids on the fisc by playing the audit lottery.  I said:

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%.

Now, I want to focus on the fraud penalties (with a brush at criminal fraud) and the broader environment.  The background for this blog entry is a recent book on the dynamics that played out as prominent tax professional firms -- accounting and law firms -- became an integral part of the tax shelter scams to raid the fisc.  See Tanina Rostain and Milton C. Regan, Jr., Confidence Games: Lawyers, Accountants and the Tax Shelter Industry (The MIT Press 5/2/14), here on Amazon.  For a good summary of the principal thrust of Confidence Games, I cite readers to Dana A. Remus, Confidence Breach: A Breakdown in Professional Self-Regulation, 92 Texas L. Rev. 1599 (2014), here.

Probably, the best I could do is to just point readers to these sources and stop.  This would be a good blog if I did stop.  But, I won't stop, recognizing that I may not improve on the blog.

Let me add some comments.

1. One of the core insights in the book and the article is that there were institutional and organizational contributors that permitted individuals to push the envelop into inappropriate behavior.

2. The large(r) Accounting firms developed substantial practice groups that, overtime (over time also), became an echo chamber that caused or contributed to individuals doing things that they would not do individually.  (For background, this is a major reason that conspiracy is a separate crime.)  Because individuals in these groups were in a echo chamber, they slowly begin to believe the bull shit of the echo chamber.  Had they not been in the echo chamber, they likely would not have done what they did.  But they were in the echo chamber; conduct become less evil or illegal or morally wrong because all these smart people and honorable people were participating in the venture.  Of course, the views of those at senior and more experienced levels were often substantially influenced by the extravagant money that could be made by participating.

3. Even within the institutions, those who did not participate had a number of warning signals (excess revenue and profits) for these groups shrouded in some secrecy that they chose to ignore because they participated directly or indirectly in the excess revenue and profits.  In the Government's expansive imagination of willful blindness, those in an oversight function in these institutions may have deliberately ignored the criminality inherent in the practices.

4. The shelters that constitute the background for Confidence Games were principally shelters promoted to very wealthy individuals.  However, as Professor Remus notes, there are other shelters that are promoted to corporations (or other analogous entities) where the in-house counsel serve much the same role as law firms in advising the corporate client.  And corporations participated in shelters that were equally as egregious the individual tax shelters. Under the guidance of corporate in-house and out-house counsel, the corporations attempted to exploit those bullshit shelters, seeking in the final analysis to win the audit lottery or, if they lost the audit lottery, at least avoid penalties for tax shelters that were nothing more than shams / scams.  (I could not find that those two words were etymological cognates or otherwise related, but in this context, I am not sure there is an practical difference even if ultimate not traceable to the same Indo-European word.)

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?

Guest Blog - Morris on Inadvertently Running Afoul of the Tax Law (3/6/13)

Inadvertently Running Afoul of the Tax Law

Donald Morris, Professor of Accounting, University of Illinois Springfield

Author of Tax Cheating: Illegal—But Is It Immoral?

The term negligence holds an important place when talking about the work of a professional or a manufacturer or even about driving a car, where expectations for performance are clear and well established. Negligence in those circumstances is the “failure to use such care as a reasonably prudent and careful person would use under similar circumstances.” But what about negligence when applied to a taxpayer?  IRC § 6662 employs a generic meaning for negligence, which includes “any failure to make a reasonable attempt to comply with the provisions of the Code.” But measuring “reasonable” in the context of individual taxpayers is a contentious issue.

In 2011, the IRS audited 1,594,049 individual income tax returns, 1.1 percent of the 143,608,000 returns filed for the previous year. For correspondence audits, the IRS identified errors 79 percent of the times, resulting in corrections, and for field audits, the IRS identified errors 91percent of the time, resulted in IRS changes. Also for 2011, 28,749,882 of the returns filed—or one out of five—was assessed a civil penalty, while 500,472 of the returns audited was assessed an accuracy related (or negligence) penalty—a 31% penalty rate for negligence. If these results can be generalized to the taxpaying population, it is possible that 80 to 90 percent of individual tax returns, if examined by the IRS, would be found wanting, and of those, almost one-third would involve taxpayer negligence.

One question raised by these figures is whether taxpayers are truly that negligent—failing to use such care as a reasonably prudent and careful person would use under similar circumstances—or more likely, that the concept of negligence is out of place when applied to individual taxpayers confronting the notoriously complex tax law. At some point, what is officially seen as taxpayers failing to make a reasonable attempt to comply with the provisions of the Code, must instead be viewed as the congressional failure to provide a code that offers plain and clear guidance so that what a reasonably prudent and careful person would do under similar circumstances can be fairly determined.

A recent case in the U.S. Tax Court illustrates how easily the average taxpayer can cross the line to negligence without even knowing there was a line. In David P. Durden, et ux. v. Comm., TC Memo 2012-140 (05/17/2012), here, the taxpayers contested the IRS’s disallowance of a $25,171 charitable donation to their church. The IRS determined a tax deficiency of $7,552 and an accuracy-related penalty (§ 6662) of $1,510.40 with respect to the taxpayers’ 2007 jointly filed income tax return.