133 T.C. No. 6
UNITED STATES TAX COURT
3K INVESTMENT PARTNERS, 3K INVESTMENTS LLC, TAX MATTERS PARTNER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 3891-06. Filed September 3, 2009.
In this partnership-level proceeding involving a so- called Son-of-BOSS transaction, P has moved to compel R to produce redacted copies of all tax opinions collected by R that have been issued regarding Son-of-BOSS transactions, as well as a list of the names and addresses of all law firms and accounting firms known to R to have issued tax opinion letters regarding Son-of-BOSS transactions.
Held: Because the materials that P seeks to discover are not relevant and do not appear reasonably calculated to lead to discovery of admissible evidence, and because the materials are nondisclosable “return information” as defined under sec. 6103(b)(2), I.R.C., P’s motions to compel production will be denied. - 2 -
Albert L. Grasso and David B. Shiner, for petitioner.
R. Scott Shieldes, for respondent.
OPINION
THORNTON, Judge: This case is before us on petitioner’s
motions to compel production of documents pursuant to Rules 72
and 104.1 For the reasons described below, we shall deny
petitioner’s motions.
Background
This partnership-level proceeding involves respondent’s
determination that 3K Investment Partners (the partnership) was
formed and availed of to engage in a so-called Son-of-BOSS
transaction.2 Respondent alleges that James Menighan (Mr.
Menighan) purchased a prepackaged tax shelter from the law firm
Jenkens & Gilchrist, P.C. (Jenkens & Gilchrist), whereby through
his limited liability company 3K Investments, LLC, he acquired
and contributed offsetting digital options on foreign currency to
1 Unless otherwise indicated, all Rule references are to Tax Court Rules of Practice and Procedure, and section references are to the Internal Revenue Code, as amended. 2 BOSS is an acronym for “Bond and Option Sales Strategy”, which the Commissioner regards as an abusive tax shelter. See Notice 2000-44, 2000-2 C.B. 255, 256; see also Kligfeld Holdings v. Commissioner, 128 T.C. 192, 194 (2007). - 3 -
the partnership.3 Respondent alleges that the transaction was
designed to inflate artificially Mr. Menighan’s basis in the
partnership. See Klamath Strategic Inv. Fund v. United States,
568 F.3d 537 (5th Cir. 2009); Cemco Investors, LLC v. United
States, 515 F.3d 749 (7th Cir. 2008); Stobie Creek Invs., LLC v.
United States, 82 Fed. Cl. 636 (2008); Jade Trading, LLC v.
United States, 80 Fed. Cl. 11 (2007); see also Kligfeld Holdings
v. Commissioner, 128 T.C. 192 (2007).
In a notice of final partnership administrative adjustment
with respect to the partnership’s tax year ended December 13,
2000, respondent adjusted the items reported on the partnership’s
return. Respondent also determined that pursuant to section
6662(a), accuracy-related penalties apply to all underpayments of
tax attributable to adjustments of the partnership items.4
3 Seemingly implicit in respondent’s allegation that Mr. Menighan purchased a prepackaged tax shelter is the assertion that Jenkens & Gilchrist was the promoter of the shelter, a question properly at issue in this partnership-level proceeding. See Tigers Eye Trading, LLC v. Commissioner, T.C. Memo. 2009-121. In disposing of the motion before us, we need not and do not address any issue as to whether petitioner would be entitled to assert reasonable reliance on the Jenkens & Gilchrist opinions as a defense to the imposition of the penalties. 4 Respondent determined that the accuracy-related penalty should be imposed on these components of underpayments: A 40- percent penalty on the portion of any underpayment attributable to any gross valuation misstatement as provided by sec. 6662(a), (b)(3), (e), and (h); a 20-percent penalty on the portion of any underpayment attributable to negligence or disregard of rules and regulations as provided by sec. 6662(a), (b)(1), and (c); a 20- percent penalty on any underpayment attributable to substantial (continued...) - 4 -
Petitioner timely petitioned the Tax Court. Pursuant to
Rule 72, petitioner served on respondent a request (the first
request) to produce redacted copies of all tax opinions collected
by respondent that have been issued regarding Son-of-BOSS
transactions (the opinion letters). In response to the first
request, respondent produced no documents but noted that he
previously had provided petitioner copies of two opinion letters
that Jenkens & Gilchrist had issued to Mr. Menighan. Respondent
objected to providing any further response on the grounds that
the request was irrelevant, not likely to lead to the discovery
of admissible evidence, and unduly burdensome and impermissibly
sought confidential third-party return information.
Petitioner served on respondent a request (the second
request) to produce a list of the names and addresses of all law
firms and accounting firms known to respondent to have issued tax
opinion letters regarding Son-of-BOSS transactions (the firm
list). In response, respondent identified Jenkens & Gilchrist as
the law firm that issued the two opinion letters to Mr. Menighan
but objected to providing any further response on the grounds
that the request was irrelevant and not likely to lead to the
4 (...continued) understatement of income tax as provided by sec. 6662(a), (b)(2), and (d); or a 20-percent penalty on the portion of any underpayment attributable to any substantial valuation misstatement as provided by sec. 6662(a), (b)(3), and (e). - 5 -
discovery of admissible evidence and impermissibly sought
confidential return information of third-party taxpayers.
Petitioner filed a motion (the first motion) to compel
production of the documents requested in the first request.
After the Court held a hearing on the first motion, petitioner
filed a motion (the second motion) to compel production of the
documents requested in the second request.
Discussion
Respondent objects to petitioner’s motions to compel
production of the opinion letters and the firm list primarily on
the ground of relevance and on the ground that they impermissibly
seek confidential return information of third-party taxpayers.5
Respondent, as the party objecting to discovery, has the burden
of establishing that his objections to the requests for
production should be sustained. Branerton Corp. v. Commissioner,
64 T.C. 191, 193 (1975).
1. Relevance
Rule 70(b)(1), regarding the scope of discovery, provides in
part:
5 At the hearing, although not in his written notice of objection, respondent briefly raised an argument that the opinion letters and the methods employed by the Government in collecting the opinion letters constitute nondiscoverable work product. Because we sustain respondent’s objections to petitioner’s discovery requests on other grounds, we need not and do not address this argument. - 6 -
The information or response sought through discovery may concern any matter not privileged and which is relevant to the subject matter involved in the pending case. It is not ground for objection that the information or response sought will be inadmissible at the trial, if that information or response appears reasonably calculated to lead to discovery of admissible evidence, regardless of the burden of proof involved. * * *
Although the standard of relevancy in a discovery action is
generally liberal, the Court is especially careful to require a
showing of relevancy where, as in this case, the discovery seeks
confidential information relating to third parties. Avedisian v.
Commissioner, T.C. Memo. 1987-176 (citing United States v.
Harrington, 388 F.2d 520 (2d Cir. 1968)).
Petitioner contends that the opinion letters and the firm
list are relevant to its defense against respondent’s
determination of penalties under section 6662. No penalty shall
be imposed under section 6662(a) with respect to any portion of
an underpayment if it is shown that there was reasonable cause
and that the taxpayer acted in good faith. See sec. 6664(c).
Whether a taxpayer acted with good faith depends upon the facts
and circumstances of each case. See sec. 1.6664-4(b)(1), Income
Tax Regs.
In this partnership-level proceeding, the applicability of
any penalty that relates to an adjustment to a partnership item
is determined at the partnership level. See sec. 6221. When
considering the determination of penalties at the partnership - 7 -
level, the Court may consider defenses of the partnership,
including a reasonable cause defense presented on behalf of the
partnership. See Klamath Strategic Inv. Fund v. United States,
supra at 547-548; New Millennium Trading, L.L.C. v. Commissioner,
131 T.C. ___, (2008) (slip op. at 9) ; Whitehouse Hotel Ltd.
Pship. v. Commissioner, 131 T.C. ___, (2008) (slip op. at
90). Respondent does not dispute that petitioner’s requested
discovery pertains to defenses of the partnership that are
properly before the Court.
Petitioner alleges and respondent does not dispute that in
connection with many Son-of-BOSS transactions, one or more law
firms or accounting firms wrote opinion letters to the investors
supporting the claimed tax treatment. Petitioner alleges, and
respondent does not dispute, that respondent has a large number
of these tax opinion letters. Petitioner contends: “The
availability of a large number of law firms and accounting firms
issuing tax opinion letters determining that so-called ‘Son of
Boss’ transactions * * * would produce the tax results as
reported by Petitioner on its subject tax return would bolster
Petitioner’s position that it had reasonable cause and that
Petitioner acted in good faith.” Similarly, at the hearing
petitioner’s counsel argued that “based upon the general
consensus of national law firms across the country that were
issuing tax opinion letters that were taking the same position as - 8 -
the Petitioner in my case was taking, I wanted to show that
reasonable cause does exist to take the position that we took on
the tax return.”
Petitioner’s argument appears to be a variant of the
refrain, familiar to parents of teenagers, that “Everyone’s doing
it.” For the same reason that this does not constitute
reasonable cause for teenagers, it would not constitute
reasonable cause for petitioner. Petitioner must establish the
reasonableness of its position on the basis of the facts and
merits of its own case.6 See Avedisian v. Commissioner, supra
(“each individual must rest on the validity of his own position
under the applicable taxing provisions, independently of
others”). The legal analysis, conclusions, and recommendations
that some tax advisers may have given other taxpayers are
irrelevant to the reasonableness of the positions the partnership
took on its return. See P.T. & L. Constr. Co. v. Commissioner,
63 T.C. 404, 414 (1974).
Petitioner suggests that the requested information is
relevant to the partnership’s defense that it reasonably relied
upon the advice of tax advisers. Reliance on the advice of a
professional tax adviser may demonstrate reasonable cause and
6 We also reject any suggestion that the requested information, which appears to involve only a small subset of tax advisers, shows any “general consensus” of tax advisers regarding Son-of-BOSS transactions. - 9 -
good faith if, taking into account all the facts and
circumstances, the reliance was reasonable and the taxpayer acted
in good faith. Sec. 1.6664-4(b)(1), (c)(1), Income Tax Regs. A
defense of reasonable reliance on the advice of a professional
tax adviser requires the advice to be “provided to (or for the
benefit of) the taxpayer and on which the taxpayer relies,
directly or indirectly, with respect to the imposition of the
section 6662 accuracy-related penalty.” Sec. 1.6664-4(c)(2),
Income Tax Regs. Reliance on a tax adviser may be reasonable and
in good faith if the taxpayer establishes: (1) The adviser was a
competent professional with sufficient expertise to justify
reliance; (2) the taxpayer provided necessary and accurate
information; and (3) the taxpayer actually relied in good faith
on the adviser’s judgment. See Neonatology Associates, P.A. v.
Commissioner, 115 T.C. 43, 99 (2000), affd. 299 F.3d 221 (3d Cir.
2002).
Petitioner does not contend that the advice in the
undisclosed opinion letters was provided directly to the
partnership or for its benefit. Indeed, petitioner’s motions to
compel production are predicated on an alleged lack of access to
these opinion letters and to the identities of their authors.
Petitioner seems to suggest, however, that information in the
opinion letters and the firm list might lead to the discovery of
admissible evidence as to the reasonableness of the partnership’s - 10 -
reliance upon the tax advice contained in opinion letters that
Jenkens & Gilchrist provided to Mr. Menighan with respect to the
transaction at issue. For the reasons described below, we
disagree.
The opinion letters and the firm list have no bearing on
any issue as to whether Jenkens & Gilchrist was provided
necessary and accurate information. Nor do we believe that the
opinion letters and the firm list have any bearing on any issue
as to whether the partnership actually relied in good faith on
the advice of Jenkens & Gilchrist. If, as petitioner’s discovery
motions suggest, the partnership, before it filed its return, did
not have access to the names of any firms (other than Jenkens &
Gilchrist) that issued opinion letters or to the opinion letters
which it now seeks, we do not see how the identity of such firms
and the contents of their opinion letters could tend to establish
that the partnership acted in good faith when it filed its
return.
Finally, petitioner’s requested discovery of the opinion
letters and the firm list does not appear reasonably calculated
to lead to the discovery of admissible evidence with respect to
any issue as to whether Mr. Menighan’s tax advisers at Jenkens &
Gilchrist were competent professionals with sufficient expertise
to justify reliance. At best, petitioner’s discovery requests
might be calculated to lead to discovery of evidence that the - 11 -
advice that Jenkens & Gilchrist provided Mr. Menighan was in some
degree similar to advice that other tax advisers had provided
other taxpayers with respect to transactions that were in some
degree similar. But any relevance of such evidence would be too
remote, we believe, to justify discovery of the requested
materials, especially considering that they relate directly to
confidential information of third parties.7 For similar reasons,
we believe the requested discovery would be unduly burdensome on
respondent, taking into account the needs of the case.8 See Rule
70(b)(2). Moreover, we believe that discovery of evidence of the
professional competence of Mr. Menighan’s tax advisers at Jenkens
& Gilchrist is obtainable from other sources that are more
convenient and less burdensome. See id. Accordingly, we shall
sustain respondent’s relevance objections to petitioner’s motions
to compel production of documents.
Although these are sufficient grounds to deny petitioner’s
discovery motions, for the sake of completeness and because the
parties have argued the issue at length, we shall also briefly
7 Respondent argues persuasively that simply removing the names of taxpayers and other identifying information would not suffice to remove the confidential nature of the opinion letters. 8 Respondent’s counsel presented to the Court, as a representative example, one of the Jenkens & Gilchrist opinion letters to Mr. Menighan that respondent had previously provided petitioner. The opinion letter is nearly 150 pages. Respondent contends, and we agree, especially in the light of the remote relevance of these materials, that it would be unduly burdensome for respondent to review possibly hundreds of such opinion letters page by page to make redactions. - 12 -
address respondent’s contentions that under section 6103 the
opinion letters and the firm list constitute confidential return
information which may not be disclosed.
2. Confidential Return Information Under Section 6103
Section 6103(a) provides that “Returns and return
information shall be confidential” and shall not be disclosed
“except as authorized by this title”. See Church of Scientology
of Cal. v. IRS, 484 U.S. 9, 11-12 (1987). Section 6103(b)(2)(A)
defines “return information” expansively to include, among other
things:
a taxpayer’s identity, the nature, source, or amount of his income, payments, receipts, deductions, exemptions, credits, assets, liabilities, net worth, tax liability, tax withheld, deficiencies, over assessments, or tax payments, whether the taxpayer’s return was, is being, or will be examined or subject to other investigation or processing, or any other data, received by, recorded by, prepared by, furnished to, or collected by the Secretary with respect to a return or with respect to the determination of the existence, or possible existence, of liability (or the amount thereof) of any person under this title for any tax, penalty, interest, fine, forfeiture, or other imposition, or offense * * *
The flush language of section 6103(b)(2) provides that return
information “does not include data in a form which cannot be
associated with, or otherwise identify, directly or indirectly, a
particular taxpayer.”
The purpose and effect of these provisions is to “protect
taxpayers’ private financial information contained within the
files of the Internal Revenue Service * * * and therefore to
encourage the taxpayers’ free and open disclosure to the - 13 -
Service.” Estate of Yaeger v. Commissioner, 92 T.C. 180, 184
(1989). Return information may not be revealed to a third party
except as specifically authorized under section 6103. Id.
We agree with respondent that the opinion letters and the
data requested in the firm list constitute return information
within the meaning of section 6103(b)(2)(A) because they are
“data, received by, * * * or collected by the Secretary with
respect to a return or with respect to the determination of the
existence, or possible existence, of liability (or the amount
thereof) of any person under this title”. Petitioner’s
contention that the opinion letters are not protected from
disclosure under section 6103(a) because they are not tax returns
or attachments thereto ignores the plain terms of the statute,
which makes confidential not only “returns” but also “return
information” as defined expansively in section 6103(b)(2).
Petitioner suggests that if respondent were to redact
taxpayer-specific information from the opinion letters, as
petitioner has requested, they would no longer be protected
“return information”. We disagree. In Church of Scientology of
Cal. v. IRS, supra, the Supreme Court held that correspondence
and memoranda, among other materials, contained within
investigative files of the Internal Revenue Service (IRS) were
nondisclosable return information, even if redacted of
identifying data. The Court stated: “Congress did not intend - 14 -
the statute to allow the disclosure of otherwise confidential
return information merely by the redaction of identifying
details.” Id. at 16.
Petitioner’s reliance on Tax Analysts v. IRS, 117 F.3d 607
(D.C. Cir. 1997), is misplaced. In Tax Analysts, the Court of
Appeals held that legal analyses contained in field service
advice memoranda (FSAs) prepared by attorneys in IRS’s National
Office of the Office of Chief Counsel are not “return
information” under section 6103. The Court of Appeals reasoned
that legal analyses contained in FSAs are not “data” within the
meaning of section 6103(b) because such “non-taxpayer-specific
information” would have “nothing to do with § 6103’s core purpose
of protecting taxpayer privacy.” Id. at 615. In addition, the
Court of Appeals reasoned that section 6103 should be construed
in conjunction with section 6110, which requires that written
determinations of the Secretary be made public. Id.
By contrast, section 6110 has no applicability to the
opinion letters or the firm list. The opinion letters were
written by private law firms or accounting firms rather than the
Commissioner’s Office of Chief Counsel. The opinion letters were
collected from investigated taxpayers or parties potentially
subject to penalties. Moreover, as previously discussed, both
the opinion letters (even if based upon assumed sets of facts as
petitioner suggests) and the data requested in the firm list - 15 -
constitute information specific to other taxpayers that falls
within the core purpose of section 6103 of protecting taxpayer
privacy.
With little elaboration, petitioner contends that even if
the opinion letters are nondisclosable return information under
section 6103, we should nevertheless determine that the firm list
does not constitute return information. It is not apparent to us
that the firm list presently even exists. It is clear, however,
that the information which petitioner seeks to have respondent
provide in the firm list constitutes “data * * * collected by the
Secretary” in determining other taxpayers’ tax liabilities and is
therefore “return information” under section 6103(b)(2). Cf.
Landmark Legal Found. v. IRS, 267 F.3d 1132 (D.C. Cir. 2001)
(identities of tax-exempt organizations, identities of third
parties requesting investigations of tax exempt organizations,
and materials included in the third-party requests were
nondisclosable return information); Solargistic Corp. v. United
States, 921 F.2d 729 (7th Cir. 1991) (the fact of an IRS audit of
a taxpayer was return information).
Petitioner has identified no statutory exception that would
permit disclosure of the return information which it seeks to
discover.9 We conclude and hold that the opinion letters that
9 At the hearing the Court gave the parties the opportunity to brief whether sec. 6103(h)(4), which provides certain exceptions to nondisclosure in the case of judicial and (continued...) - 16 -
respondent has not already provided and the firm list are
confidential return information under section 6103(a) which
respondent may not disclose to petitioner.
In the light of the foregoing,
An order will be issued
denying petitioner’s motions
to compel production of
documents.
9 (...continued) administrative proceedings, has any applicability. Respondent contends it does not. Petitioner filed a legal memorandum but did not address this issue. We deem petitioner to have waived or conceded any argument as to the applicability of sec. 6103(h)(4).