T.C. Memo. 2018-59
UNITED STATES TAX COURT
DERRINGER TRADING, LLC, JETSTREAM BUSINESS LIMITED, TAX MATTERS PARTNER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
MARLIN TRADING, LLC, JETSTREAM BUSINESS LIMITED, TAX MATTERS PARTNER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 20872-07, 6268-08.1 Filed May 3, 2018.
John E. Rogers, for petitioner Jetstream Business Limited in docket Nos.
20872-07 and 6268-08.
Michael D. Hartigan (an officer), as an affected participating individual for
participating partner Leila Verde Fund, LLC, in docket No. 20872-07 and for
participating partner Monticello Shrub Fund, LLC, in docket No. 6268-08.
1 These cases were consolidated by order issued February 1, 2016, for purposes of trial, briefing, and opinion. -2-
[*2] David A. Lee, Elizabeth Y. Ireland, and Daniel M. Trevino, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
GOEKE, Judge:2 These cases concern two petitions for adjustment of
partnership items under section 6226.3 They involve two partnerships, their
partners, and investors in essentially “cookie cutter” distressed asset debt (DAD)
tax shelter investments similar to those addressed in Superior Trading, LLC v.
Commissioner, 137 T.C. 70 (2011), supplemented by T.C. Memo. 2012-110, aff’d,
728 F.3d 676 (7th Cir. 2013), and Kenna Trading, LLC v. Commissioner, 143 T.C.
322 (2014). The Internal Revenue Service (IRS) issued a notice of final
partnership administrative adjustment (FPAA) to Jetstream Business Ltd.
(Jetstream), as tax matters partner of Derringer Trading, LLC (Derringer), on July
25, 2007, for 2003 and 2004 and to Jetstream, as tax matters partner of Marlin
2 These cases were assigned to Judge Robert A. Wherry, Jr., who retired from judicial service on January 1, 2018. With the parties’ agreement, the cases were reassigned to Judge Joseph R. Goeke for the purpose of rendering an opinion. 3 Unless otherwise indicated all section references are to the Internal Revenue Code of 1986 as amended and in effect for the tax years at issue, and all Rule references unless otherwise stated are to the Tax Court Rule of Practice and Procedure. -3-
[*3] Trading, LLC (Marlin), on March 7, 2008, for 2004. Petitioner filed timely
petitions in both cases with this Court. Each partnership’s principal place of
business was in Illinois when the petitions were filed.
On December 28, 2016, the Court filed respondent’s motion for summary
judgment in both of these cases. After considering these motions and petitioner’s
responses in opposition to the motions, the Court in Derringer at docket No.
20872-07 granted summary judgment on all issues, except the section 6662
penalty issues and the amortization and deduction issues discussed below, by
order entered July 26, 2017.4 Respondent’s motion for summary
4 Petitioner’s first supplement to opposition to motion for summary judgment filed on May 20, 2017, belatedly asserted that the Court shammed Warwick Trading, LLC, and Sugarloaf Fund, LLC, in previous opinions. Therefore, when addressing the same years at issue and almost identical transactions, the sham partnerships here, according to petitioner, established “a simple agency relationship among the members. Subchapter K does not apply to mere agency relationships. Sec. 761(a). Since the partnership[s] never existed the disguised sale rules do not apply. Each trading company and main trust takes its own basis from [Lojas] Arapua[, S.A.] or Globex [Utilidades, S.A.] by carryover under Section 721 [sic 723] or Section 1015.” The Court disagrees with petitioner that the partnerships may now recharacterize their transactions for Federal income tax purposes as mere agent-principal transactions to reflect the substance rather than the form of the transactions. See Commissioner v. Nat’l Alfalfa Dehydrating & Milling Co., 417 U.S. 134, 149 (1974).
Even if the partnerships could change the chosen form of their transactions, they have failed to establish a tax basis for Federal income tax purposes in the charged-off consumer receivables and which receivables were charged off. Tigers (continued...) -4-
[*4] judgment with respect to the section 6662 penalties was denied because
4 (...continued) Eye Trading, LLC, v. Commissioner, 138 T.C. 67, 148 (2012), aff’d in part, rev’d in part on other grounds sub nom. Logan Trust v. Commissioner, 616 F. App’x 426 (D.C. Cir. 2015), confirms that an agency “is not an entity (i.e., it has no legal identity apart from the separate identities of its participants).” However, it goes on to state:
[B]ecause Tigers Eye filed a partnership return * * *, that return must be treated as if it were filed by an entity. See sec. 301.6233-1T(c), Temporary Proced. & Admin. Regs. * * *; see also sec. 301.6233-1(b), Proced. & Admin. Regs. * * * [W]e could ask what were the entity items of Tigers Eye, as agent. It would seem to make no difference whether we address the agency as a hypothetical entity, acting through Tigers Eye, or address Tigers Eye as an entity in its own right, acting as agent for the trusts. * * * [W]e shall proceed as if Tigers Eye, in its own right, is the relevant entity.
* * * * * * *
[B]ecause it purchased the property as agent of the trusts, it--rather than the trusts--had the information necessary to determine what property it had purchased for each trust and how much of each trust’s money it had expended on those purchases. Those were determinations that Tigers Eye had to make for purposes of its books and records in order to furnish information to the trusts. If we consider Tigers Eye the trusts’ agent obligated to make those determinations, Tigers Eye’s determination of the costs of the property it purchased for the trusts would be an entity item by analogy to section 301.6231(a)(3)-1(c)(3)(iii), Proced. & Admin. Regs. (adjusted basis to the partnership of distributed property is a partnership item). Because we have jurisdiction to determine entity items, see sec. 6226(f), we have jurisdiction to determine the costs of the currency and the shares, which * * * establishes the trusts’ bases in those properties.
Id. at 148-149. -5-
[*5] respondent had, at that time, not yet conclusively established that the IRS had
complied fully with the requirements of section 6751(b)(1). That section generally
requires the personal approval “(in writing) by the immediate supervisor of the
individual making such determination or such higher level official as the Secretary
may designate” before a penalty shall be assessed. See Chai v. Commissioner, 851
F.3d 190 (2d Cir. 2017), vacating, remanding, aff’g in part, rev’g in part T.C.
Memo. 2015-42; Graev v. Commissioner, 149 T.C. __ (Dec. 20, 2017),
supplementing 147 T.C. 460 (2016).
Respondent’s motion for summary judgment in Marlin at docket No.
6268-08 was held in abeyance and then denied. The Court took these actions
because of the apparent presence of some different DAD transactions not
considered in Superior Trading, and to afford the primary investor in Marlin,
Mashud Sarshar Sars,5 the maximum opportunity to elect to participate in the
litigation, which has been conducted by the promoters of the DAD transactions.
Consequently, remaining for resolution are the following three issues: (1) whether
Marlin may deduct, pursuant to section 166, allegedly bad debts arising from
Brazilian consumer receivables of $4,850,000 for 2004; (2) whether Derringer
5 Mr. Sars’ ownership of Marlin was a result of his apparent ownership of all, or almost all, of three other passthrough Federal tax entities, two limited liability companies, and a subchapter S corporation. -6-
[*6] may amortize expenses of $14 and $400 for 2003 and 2004, respectively, and
deduct other costs of $348 stemming from its DAD transactions for 2004, and
similarly whether Marlin may amortize expenses of $174 and deduct collection
expenses of $150 stemming from its DAD transactions for 2004; and (3) whether
Derringer and/or Marlin is subject to the imposition of accuracy-related penalties
pursuant to section 6662, for Derringer’s 2003 and/or 2004 taxable year(s) and for
Marlin’s 2004 taxable year because of an underpayment attributable to a
substantial understatement of income tax, a gross valuation misstatement and/or
negligence, or disregard of rules and regulations.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The stipulation of
facts and the supplemental stipulations of facts, with the accompanying exhibits,
are incorporated herein.
I. Objections to Stipulations and Referenced Attached Exhibits
Petitioner has made various objections to stipulation paragraphs. These
objections are overruled except as to paragraph 12 of the first stipulation of facts
and paragraphs 66, 71, 82, and 108 of the joint fourth supplemental stipulation of
facts. The objections to these paragraphs and the specifically referenced exhibits
are sustained, and those stipulations and referenced exhibits are hereby struck. -7-
[*7] Jetstream’s objections are mostly hearsay and relevancy objections. Those
of Marlin made by Monticello Shrub Fund, LLC (Monticello), and Leila Verde are
generally hearsay, best evidence, self-serving, and “assertion (question) calls for a
conclusion.” The relevancy bar of rule 401 of the Federal Rules of Evidence is a
low one, requiring that the evidence only increase the likelihood that a fact of
consequence is true or false. This is particularly true where, as in these cases, the
focus of our inquiry goes to intent, substance versus form, and the question of
sham. Other than the few exceptions noted above, which in some cases indicated
a true dispute as to the stated fact, we find the objections unjustified, and we
overrule them. Petitioner has not objected, pursuant to rule 403 of the Federal
Rules of Evidence, on grounds that the danger of unfair prejudice, confusions of
issues, or accumulative evidence substantially exceeds the probative value of any
stipulation, and petitioner’s relevancy objections are not sound.
Rule 91(a) requires the parties to comprehensively stipulate “all facts, all
documents and papers or contents or aspects thereof, and all evidence which fairly
should not be in dispute”, subject to any noted objections for relevancy.
Petitioner’s objections to the admission of the evidence, pursuant to rule 1002 of
the Federal Rules of Evidence, are unjustified here. Documents referred to in
these stipulations and included in the attached exhibits were not read out loud in -8-
[*8] open court, there was no jury, and the documents are photocopies of the
originals. Rule 1003 of the Federal Rules of Evidence permits the use of
photocopies, and the parties have acknowledged in the stipulations that the
documents in the exhibits to the stipulations are “duplicates to the originals as
defined in Rule 1001(4) Fed. R. Evid.” Such “documents described * * * and
attached * * * as exhibits [to the stipulations] are considered authentic
documents.” We further note that respondent has challenged many of the
transactions at issue here as shams and does not seek to introduce a number of the
documents objected to for the truth of what they assert. Rather, respondent seeks
to show that the purported transactions did not in fact occur nor were they
intended to be implemented as represented. Rule 801(a) through (c) of the Federal
Rules of Evidence defines hearsay as an out of court statement offered to prove the
truth of the matter asserted. Consequently, those documents are not hearsay.
Participating partner Leila Verde’s “self-serving and the assertion (question)
calls for a conclusion” objections do not reference any specific rule of the Federal
Rules of Evidence and are ambiguous and confusing in this context. If they relate
to rules 602 and 701 through 704, they are without merit. The stipulated
statements are admitted to be true, and the exhibits are accurate copies of
documents in and/or related to the transactions at issue. The Court has found them -9-
[*9] to be helpful in determining the facts when considered in the context of all the
other evidence in these cases. Rules concerning opinion testimony under rules
701 through 704 of the Federal Rules of Evidence and this Court’s Rule 143 have
not been abused here.
We further address participating partner Leila Verde’s objections for
relevancy or materiality against the admission of any “post 2003 exhibits”. As
noted above, the relevancy and materiality bar of rule 401 of the Federal Rules of
Evidence is a low one, and this Court has allowed the admission of evidence
relating to years after those before the Court on many occasions. See, e.g., Estate
of Gilford v. Commissioner, 88 T.C. 38, 53-54 (1987) (holding that
post-valuation-date documents were admissible as evidence in support of a higher
valuation of a taxpayer’s stock); Polidori v. Commissioner, T.C. Memo. 1996-514
(holding that when determining whether the taxpayer fraudulently underreported
his income, the taxpayer’s conviction for filing a false individual income tax
return for one year after those before the court was admissible because the
taxpayer’s tax evasion scheme continued in succeeding years); Jessup v.
Commissioner, T.C. Memo. 1977-289, 36 T.C.M. (CCH) 1145, 1146 n.1 (holding
that in determining whether a taxpayer was in an extensive and continuous trade or - 10 -
[*10] business, his financial documents relating to years after those before the
Court were admissible).
Accordingly, Leila Verde’s objections for relevancy with respect to the
admission of all post-2003 documents are meritless. Again, there is a failure to
show that the probative value is substantially outweighed by the dangers of unfair
prejudice, confusing the issues, wasting time, or needless presentation of
cumulative evidence as required by rule 403 of the Federal Rules of Evidence, to
exclude otherwise relevant evidence.
II. Prior Cases
As previously noted, in Superior Trading, LLC v. Commissioner, 137 T.C.
at 73-79, and Kenna Trading, LLC v. Commissioner, 143 T.C. at 327-350, some of
the issues decided were identical or extremely similar to the facts or the law being
litigated in the current proceedings. See Reyn’s Pasta Bella, LLC v. Visa USA,
Inc., 442 F.3d 741, 746 n.6 (9th Cir. 2006); Estate of Reis v. Commissioner, 87
T.C. 1016, 1027 (1986). We note that our decision in Superior Trading is now
final within the meaning of section 7481. - 11 -
[*11] III. Specific Facts Similar or Identical to Those in the Superior Trading and/or Kenna Trading Cases
We found the following facts in Superior Trading to be relevant, and on the
basis of the testimony, pleadings, filings, stipulations, and attached exhibits in the
instant cases, we find the same or similar facts to have existed in the instant cases.
We briefly summarize them here for context. Warwick Trading, LLC (Warwick),
was a limited liability company organized on December 17, 2001, under the laws
of the State of Illinois by John E. Rogers. On May 7, 2003, Warwick entered into
a so-called contribution agreement with Lojas Arapua, S.A. (Arapua), a Brazilian
retailer, under which Arapua transferred certain Brazilian consumer receivables
(Arapua receivables) to Warwick in exchange for a 99% interest in Warwick. Cf.
Superior Trading, LLC v. Commissioner, 137 T.C. at 73. Shortly after transferring
its receivables, Arapua was redeemed out of its partnership interest in Warwick.
Id. at 77.
At different times during the latter half of 2003 and the first three quarters
of 2004, Warwick, in turn, claimed to have contributed varying portions of the
Arapua receivables it acquired in exchange for a 99% membership interest in
different limited liability companies (trading companies). These trading
companies included Derringer and Marlin in addition to those which were parties - 12 -
[*12] in Superior Trading. Id. at 73-74. Individual U.S. investors acquired
membership interests in these trading companies through yet another set of Illinois
limited liability companies (holding companies), including Leila Verde and
Monticello. Id. at 74. To accomplish this, Warwick contributed virtually all of its
membership interests in each given trading company to the corresponding holding
company. Id. These trading companies then sold, exchanged, or otherwise
liquidated the Arapua receivables for the receivables’ fair market value, which was
a small fraction of their face value. Id. at 78.
Asserting that they had inherited a carryover tax basis in the Arapua
receivables under section 723, the trading companies then claimed deductions in
the amount of the excess of their asserted tax bases over the receivables’ fair
market value. Id. As a result, during 2003 and 2004 each of the trading
companies wrote off almost the entire claimed tax basis in its share of the Arapua
receivables and claimed the resulting deductions. Id. at 74.
Respondent issued FPAAs to Warwick and the trading companies,
disallowing the trading companies’ deductions for both 2003 and 2004. Id. In
Superior Trading we consolidated and decided the partnership-level cases of 14 of
these trading companies, along with Warwick. Id. at 70 n.1. During the years at
issue there, Jetstream, a company originally formed under the laws of the British - 13 -
[*13] Virgin Islands, was the managing member of Warwick, each of the 14
trading companies, and the various holding companies. Id. at 74. Mr. Rogers was
Jetstream’s sole owner and, with John J. Gabel, was one of its two directors. Id. at
92.
It appears that before Marlin was organized and funded,6 all or almost all of
the Arapua receivables may have already been contributed to other trading
companies by Warwick. Thus, to cover any dollar amount shortage of allegedly
contributed Arapua receivables, Warwick substituted consumer receivables
allegedly contributed to Warwick or Sugarloaf Fund, LLC (Sugarloaf), a new
entity, by Globex Utilidades, S.A. (Globex), in July 2004.7 Cf. Kenna Trading,
6 Marlin was organized in 2003 as a limited liability company and was funded pursuant to a contribution agreement with Warwick as of December 19, 2003. Pursuant to the contribution agreement, Marlin was funded with a “Portfolio of Receivables” described on the Exhibit A to the contribution agreement. Exhibit A is a blank page. Importantly, as of December 31, 2003, Warwick held only Arapua receivables. It was not until July 2004 that Warwick’s subsequent substitute entity, Sugarloaf, acquired Globex consumer receivables. 7 During this period Warwick and/or Sugarloaf was experiencing book- keeping problems with the amount of their Brazilian receivables records, which may have led to some transactional discrepancies necessitating the substitution of Globex consumer receivables for Arapua consumer receivables, if in fact the correct real amount of consumer receivables was ever transferred. The Marlin petition implies at paragraphs 5, kk, bbb, ccc, ddd, and eee, that the allegedly contributed receivables to Warwick were from Arapua, but respondent has acknowledged receiving documents (including collection records) (continued...) - 14 -
[*14] LLC v. Commissioner, 143 T.C. at 328. If true, it is as yet unexplained by
petitioner how Warwick acquired the Globex receivables. The apparent presence
of Globex consumer receivables also requires us to reference our Opinion in
Kenna Trading, LLC v. Commissioner, 143 T.C. at 330-338, as Globex consumer
receivables were not involved in Superior Trading. While Globex may not have
been completely redeemed out of Warwick or its subsequent substitute entity
Sugarloaf, a Delaware limited liability company, within two years of the claimed
consumer receivable contributions (treatment as a sale rather than a contribution),
the result would be the same on the basis of all of the facts and evidence even
without a sale presumption in the instant cases. Id. at 329, 351-353. We reach the
same conclusion in the Marlin case.
OPINION
I. Deductions Relating to the Arapua Receivables
In Superior Trading and Kenna Trading we held that neither Arapua nor
Globex ever formed a bona fide partnership with Jetstream, Warwick, or
Sugarloaf, nor did Arapua ever make a bona fide contribution of the Arapua
receivables to Warwick, nor did Globex ever make a bona fide contribution of the
7 (...continued) indicating at least some of the contributed consumer receivables came from Globex. See Respondent’s pretrial memorandum at 4 n.4, dated August 2, 2017. - 15 -
[*15] Globex receivables to Warwick and/or Sugarloaf. Superior Trading, LLC v.
Commissioner, 137 T.C. at 81-83; Kenna Trading, LLC v. Commissioner, 143
T.C. at 351-353. We found that Jetstream and Arapua did not intend to join
together as partners in the conduct of a business. Instead Jetstream, Warwick, and
Sugarloaf looked to the Arapua and Globex receivables for their built-in losses,
while Arapua and Globex wanted to dispose of them in order to more quickly
derive cash from them. See Superior Trading, LLC v. Commissioner, 137 T.C. at
81-83; Kenna Trading, LLC v. Commissioner, 143 T.C. at 351-353. In short, the
so-called partnerships formed between Arapua and Jetstream, and/or Globex and
Jetstream, were not bona fide partnerships for Federal income tax purposes as they
lacked a common intent to collectively pursue a joint business. See Commissioner
v. Culbertson, 337 U.S. 733, 741-742 (1949); Superior Trading, LLC v.
Commissioner, 728 F.3d at 680; Kenna Trading, LLC v. Commissioner, 143 T.C.
at 351-353.
Both of the present cases, while involving trading companies different from
the 15 trading companies at issue in Superior Trading and the many more at issue
in Kenna Trading, involve transactions among Arapua, and/or Globex, Jetstream,
and Warwick similar to those we analyzed in Superior Trading and Kenna
Trading. Petitioner has not adduced any credible evidence challenging our - 16 -
[*16] conclusions in Superior Trading and Kenna Trading that neither Arapua
and/or Globex formed a bona fide business partnership with Jetstream nor made a
bona fide contribution of receivables to Warwick and/or Sugarloaf. Accordingly,
we reiterate those conclusions here.
Mr. Rogers asserted again, as he had in both of the former cases, that he and
Warwick intended to make a profit from anticipated currency exchange rates
resulting from a falling U.S. dollar and an appreciating Brazilian currency (real) as
well as from consumer receivable collections. He acknowledges, however, that no
investor has ever received any money back from these investments. He has
attributed this, without persuasive credible evidence, to theft and bad management
by the investment entities’ collection agents, Multicred Investments Limited
and/or MultiCred Investimentos Limitada.
No doubt any incidental profit from the exchange rate and/or consumer
receivables collections would have been welcomed as fortuitous “icing on the
cake”. But the primary objective and the driving purpose for these transactions, as
in Superior Trading and Kenna Trading, were achieving Federal income tax loss
deductions. See Superior Trading, LLC v. Commissioner, 728 F.3d at 680. Even
as losses mounted Mr. Rogers continued to sell interests in trading companies and,
after 2004, in trusts to investors, and the entities continued to write off the - 17 -
[*17] consumer receivables claiming the resulting manufactured built-in section
166 bad debts. These resulted in claimed passthrough losses for the investors.
As an alternative holding in Superior Trading and Kenna Trading we
concluded that because Arapua received cash for its interest in Warwick within a
year after entering into the contribution agreement, the contribution may be
recharacterized as a disguised sale under section 707(a)(2)(B). See Superior
Trading, LLC v. Commissioner, 137 T.C. at 83; Kenna Trading, LLC v.
Commissioner, 143 T.C. at 353-355. Under section 1.707-3(c)(1), Income Tax
Regs., if a partner transfers property to a partnership and within two years
thereafter the partnership transfers money or other consideration to that partner,
the partner’s transfer is presumed to be a sale of the property to the partnership.
We held in Superior Trading and Kenna Trading that because no evidence was
provided to rebut that presumption, the transactions between Arapua and/or
Globex and Warwick constituted sales under section 707(a)(2)(B). See Superior
Trading, LLC v. Commissioner, 137 T.C. at 83; Kenna Trading, LLC v.
Commissioner, 143 T.C. at 353-355.
In the instant cases the evidence and record indicate the same results.
Petitioner has adduced insufficient credible evidence and presented no persuasive
arguments to justify reconsidering the conclusions we reached in Superior Trading - 18 -
[*18] and Kenna Trading. Therefore, we reiterate as an alternative holding that
the transactions between Arapua and/or Globex and Warwick constituted sales
rather than contributions.
Additionally as a further holding in Superior Trading and Kenna Trading,
we invoked the step transaction doctrine and collapsed the many steps in the series
of transactions between Arapua and/or Globex, Jetstream, and Warwick and/or
Sugarloaf. See Superior Trading, LLC v. Commissioner, 137 T.C. at 87-91;
Kenna Trading, LLC v. Commissioner, 143 T.C. at 355-357. We determined that
the transactions between Arapua and Warwick could certainly meet the “end result
test”, which focuses on the parties’ subjective intent at the time of structuring the
transaction. Superior Trading, LLC v. Commissioner, 137 T.C. at 89-90; Kenna
Trading, LLC v. Commissioner, 143 T.C. at 356-357. The Court arrived at this
conclusion by pointing out that tax benefits were the primary inducement for
individual U.S. investors to participate in the scheme, and obtaining those tax
benefits “required the carefully choreographed entry and exit of Arapua” and
Globex from the outset. Superior Trading, LLC v. Commissioner, 137 T.C. at 90.
We concluded therefore that there must have been a prearranged plan to reap those
tax benefits. Id. at 89-90; Kenna Trading, LLC v. Commissioner, 143 T.C. at 356-
357. - 19 -
[*19] Moreover, we held in Superior Trading and Kenna Trading that the
transactions between Arapua and/or Globex and Warwick and/or Sugarloaf could
also pass the interdependence test for invoking the step transaction doctrine. See
Superior Trading, LLC v. Commissioner, 137 T.C. at 90; Kenna Trading, LLC v.
Commissioner, 143 T.C. at 356-358. This test focuses on whether the intervening
steps are so interdependent that the legal relationships created by one step would
have been fruitless without completion of the later series of steps. See Penrod v.
Commissioner, 88 T.C. 1415, 1428-1430 (1987).
The Court concluded from the facts in Superior Trading and Kenna Trading
that an outright sale of the Arapua and/or Globex receivables, rather than a
contribution of the Arapua and/or Globex receivables, would have been just as
effective in transferring title and facilitating their subsequent servicing. Superior
Trading, LLC v. Commissioner, 137 T.C. at 90; Kenna Trading, LLC v.
Commissioner, 143 T.C. at 357. We ultimately held that Arapua’s entry to and
exit from Warwick and Globex’s entry to and ultimate exit from Warwick and/or
Sugarloaf served no economic or business purpose other than obtaining tax
benefits. Superior Trading, LLC v. Commissioner, 137 T.C. at 89-90; Kenna
Trading, LLC v. Commissioner, 143 T.C. at 356-358. - 20 -
[*20] Because both tests were satisfied, either of which could suffice
independently to invoke the step transaction doctrine, we collapsed the series of
transactions into just one: the sale of the Arapua and/or Globex receivables to
Warwick and/or Sugarloaf. Superior Trading, LLC v. Commissioner, 137 T.C. at
90-91; Kenna Trading, LLC v. Commissioner, 143 T.C. at 357-358.
A similar analysis and conclusion apply here. Petitioner produced
insufficient, if any, credible and/or new evidence regarding the transactions
between Arapua and/or Globex and Warwick that would cause us to reconsider
our decision to invoke the step transaction doctrine as we did in Superior Trading
and Kenna Trading.
In sum, we concluded in Superior Trading and Kenna Trading that three
independent reasons, viz, no bona fide partnership and contribution, a disguised
sale, and the step transaction doctrine, lead us to the same result: Warwick’s
and/or Sugarloaf’s basis in the Arapua and/or Globex receivables should be a cost
basis rather than a carryover basis. Superior Trading, LLC v. Commissioner, 137
T.C. at 91; Kenna Trading, LLC v. Commissioner, 143 T.C. at 357. Neither
Warwick nor any of the trading companies whose cases we decided in Superior
Trading or Kenna Trading were able to credibly substantiate the amounts of
payments Warwick made to Arapua and/or Globex for the purchased consumer - 21 -
[*21] receivables. Superior Trading, LLC v. Commissioner, 137 T.C. at 91;
Kenna Trading, LLC v. Commissioner, 143 T.C. at 357-358.
We imputed a zero cost basis to those receivables in the hands of Warwick
and/or Sugarloaf, and consequently, a zero cost basis for each of the trading
companies at issue there. Superior Trading, LLC v. Commissioner, 137 T.C. at
91; Kenna Trading, LLC v. Commissioner, 143 T.C. at 358.
In the instant cases petitioner also failed to adduce adequate evidence to
substantiate the amount of Warwick’s and/or Sugarloaf’s payments for the Arapua
and/or Globex consumer receivables. Therefore, the partnerships’ tax bases in the
Arapua and/or Globex receivables should be zero as well. With a zero cost basis,
the consumer receivables at issue here cannot generate any of Marlin’s claimed
$4,850,000 section 166 bad debt DAD deduction; that deduction is hereby
disallowed.
The Court notes also that the Court of Appeals for the Seventh Circuit in
Superior Trading considered 15 transactions similar to the partnership cases at
issue here. It held that “[t]here is not even a colorable basis for the tax shelter that
* * * [Mr. Rogers] created and the * * * [petitioner parties] implemented.”
Superior Trading, LLC v. Commissioner, 728 F.3d at 680-682. This Court in
Kenna Trading similarly held, as did the Court of Appeals for the Seventh Circuit, - 22 -
[*22] that Warwick and Sugarloaf, respectively, were sham partnerships not
entitled to the benefits of Federal income tax law. Kenna Trading, LLC v.
Commissioner, 143 T.C. at 353-359. We conclude this holding is also apropos to
Derringer and Marlin for purposes of these cases.
II. Expense Deductions
Marlin deducted, on its 2004 Form 1065, U.S. Return of Partnership
Income, collection expenses of $150 in connection with its DAD transactions and
consumer receivables collection efforts. It also deducted $174 of amortization
expenses resulting from DAD-related activities for 2004. We addressed similar
issues in Kenna Trading. Id. at 365. We noted there that deductions are “a matter
of legislative grace” and that taxpayers have the responsibility to identify,
substantiate, and establish that they are entitled to each and every claimed
deduction. Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84
(1992); Welch v. Helvering, 290 U.S. 111, 115 (1933); Roberts v. Commissioner,
62 T.C. 834, 836-837 (1974).
Section 162 permits taxpayers to deduct all ordinary and necessary
partnership business expenses paid or incurred in connection with a trade or
business. Sections 195(b) and 709(b) permit taxpayers to elect to amortize certain
startup and partnership organizational expenses. But these sections do not include - 23 -
[*23] abusive tax shelter expenditures or sham partnerships’ startup and
organizational expenses which are not legitimate ordinary or necessary business
expenses. Hewlett-Packard Co. v. Commissioner, 875 F.3d 494, 500 (9th Cir.
2017), aff’g T.C. Memo. 2012-135; Wells Fargo & Co. v. United States, 641 F.3d
1319, 1330 (Fed. Cir. 2011); Gerdau Macsteel, Inc. v. Commissioner, 139 T.C. 67,
182 (2012). Marlin’s and Derringer’s activities during 2003 and/or 2004 consist
only of abusive DAD tax-shelter-related efforts and expenditures; hence they
created no allowable deductions for the partnerships. See Southgate Master Fund,
LLC, ex rel. Montgomery Capital Advisors, LLC v. United States, 659 F.3d 466,
483 n.53 (5th Cir. 2011); sec. 301.7701-1(a)(1), Proced. & Admin. Regs.
Petitioner also failed to satisfactorily carry its burden of identifying,
substantiating, and establishing that Derringer and/or Marlin incurred and paid the
claimed expenses and/or were entitled to deduct the $14, $400, and $174,
respectively, of amortization expenses, for ordinary or necessary business
purposes. For these reasons, we conclude that respondent appropriately
disallowed Derringer’s claimed $14, $400, and $348 deductions for 2003 and
2004, respectively, and Marlin’s claimed $150 and $174 deductions for 2004. - 24 -
[*24] III. Accuracy-Related Penalties
Respondent determined section 6662 accuracy-related penalties against both
partnerships, including a section 6662(a) 20% accuracy-related penalty and the
section 6662(h) 40% gross valuation misstatement penalty. A gross valuation
misstatement arises if the adjusted basis of any property claimed on any return of
tax imposed is 400% or more of the amount determined to be correct. Sec.
6662(h)(2)(A)(i). Whereas here we determined that the adjusted bases of the
consumer receivables were zero, the amounts claimed as bad debt deductions
result in gross valuation misstatements. See sec. 1.6662-5(g), Income Tax Regs.
Consequently, there are gross valuation misstatements on Derringer’s 2003 and
2004 income tax returns and Marlin’s 2004 income tax return. Section 6751(b)(1)
requires, as a prerequisite for the assessment of an accuracy-related penalty, the
personal written approval of the immediate supervisor of the individual who had
made “the initial determination of such assessment”. Chai v. Commissioner, 851
F.3d at 216; see also Graev v. Commissioner, 149 T.C. __ (Dec. 20, 2017).
As to Marlin, respondent’s counsel and Mr. Rogers, at the trial, orally
represented to the Court that respondent had established that section 6751(b)(1)
had been complied with in all material respects and was no longer an issue in the
Marlin case. As to Derringer, respondent introduced evidence at the trial showing - 25 -
[*25] that the requirement of section 6751(b)(1) has been met. Petitioner has not
presented any evidence indicating the requirements of section 6751(b)(1) were not
met and fully fulfilled in these cases. Consequently, we conclude that respondent
met all requirements imposed upon him by section 6751(b)(1) to impose the
applicable section 6662 penalties. See Higbee v. Commissioner, 116 T.C. 438,
446-447 (2001).
We also conclude that the 20% section 6662(a) accuracy-related penalty
applies to the portion of the underpayment attributable to Marlin’s disallowed
$150 collection expense and $174 amortization expense deductions for 2004. The
section 6662(a) penalty applies to the portion of an underpayment due to
negligence or disregard of rules or regulations. Marlin did not keep all records
required by section 6001 and negligently claimed abusive tax-shelter expenses.
See sec. 1.6001-1(a), Income Tax Regs. Similarly, the section 6662 accuracy-
related penalty is 20% for Derringer’s portion of the deficiencies attributable to
the $14 and $400 of claimed amortization expenses for 2003 and 2004,
respectively, and the $348 other costs deduction for 2004. Respondent has met
any statutory burden imposed by section 7491(c);8 consequently, the accuracy-
8 We note that it is not yet settled whether sec. 7491(c) imposes the initial burden of production on the Commissioner where a case is commenced by the (continued...) - 26 -
[*26] related penalty is 40% as to the portion of the deficiencies resulted from the
$3,395,000 and $4,850,000 bad debt deductions, respectively, in both Derringer
and Marlin.
With respondent’s threshold showing, the burdens shift to petitioner who,
for the partnerships to avoid penalties, must establish that they acted with
reasonable cause and in good faith as to the claimed valuation and expense
deductions. See Higbee v. Commissioner, 116 T.C. at 446. If we were to find that
Derringer and Marlin acted with reasonable cause and in good faith, we would not
sustain the accuracy-related penalties. See sec. 6664(c)(1). We make this
determination at the partnership level, taking into account the state of mind of the
general partner. See New Millennium Trading, LLC v. Commissioner, 131 T.C.
275 (2008). Mr. Rogers, the relevant person here, as the controlling person and
managing member of Jetstream, was a well-educated, sophisticated, and tax-savvy
individual and attorney. See Superior Trading, LLC v. Commissioner, 137 T.C. at
75, where we also noted the same. Therefore, Mr. Rogers’ subjective intent is the
focus here since he was the sole owner and a director of Jetstream and the tax
8 (...continued) filing of a petition under sec. 6226. Green Gas Del. Statutory Tr. v. Commissioner, 147 T.C. 1, 74 (2016). Sec. 7491(c) provides that the Secretary shall have the burden of production with respect to the liability of any individual for a penalty or addition to tax. - 27 -
[*27] matters partner of Warwick, Sugarloaf, Derringer, and Marlin during 2003
and 2004. Superior Trading, LLC v. Commissioner, 137 T.C. at 92; Kenna
Trading, LLC v. Commissioner, 143 T.C. at 329. In Superior Trading, LLC v.
Commissioner, 137 T.C. at 92, we found that “[t]here ha[d] been no showing of
reasonable cause or good faith on [Mr.] Rogers’ part in conceptualizing,
designing, and executing the transactions.” In these cases too, petitioner has not
adduced sufficient, if any, credible evidence of reasonable cause or good faith by
Mr. Rogers.
Petitioner has not demonstrated that the partnerships qualify for the
exception to the penalty provided by section 6664(c) for reasonable cause. See
United States v. Woods, 571 U.S. 31, 40 (2013); Superior Trading, LLC v.
Commissioner, 728 F.3d at 682; Neonatology Assocs., P.A. v. Commissioner, 115
T.C. 43, 99 (2000) (setting forth a three-prong test to determine whether a
taxpayer’s reliance on tax professionals may be reasonable cause), aff’d, 299 F.3d
221 (3d Cir. 2002).
The Court has considered all of the parties’ arguments and, to the extent not
discussed above, concludes that those arguments are irrelevant, moot, or without
merit. - 28 -
[*28] To reflect the foregoing,
Decisions will be entered for
respondent.