Tigers Eye Trading, LLC v. Comm'r
This text of 2009 T.C. Memo. 121 (Tigers Eye Trading, LLC v. Comm'r) is published on Counsel Stack Legal Research, covering United States Tax Court primary law. Counsel Stack provides free access to over 12 million legal documents including statutes, case law, regulations, and constitutions.
Opinion
The court denied participating partner's motion for partial summary judgment and granting the Commissioner's motion in limine to exclude the expert's report.
In a notice of final partnership administrative adjustment (FPAA) issued to TET regarding a transaction of the type the IRS determined in
zero, that TET's partners' outside bases in their partnership interests were zero, and that accuracy-related penalties determined at the partnership level should be imposed at the partner level.
L and one of the three grantor trusts (PP) L used to engage in the transaction challenge the proposed adjustments in the FPAA and wish in this partnership-level proceeding to raise L's reasonable cause defenses to accuracy-related penalties applicable to any deficiency resulting from the FPAA adjustments to partnership items. L claims that, in reporting losses from the transaction on his return, he relied on the advice of professionals, including two attorneys *119 and a C.P.A., and a written legal opinion of CM to L and the three grantor trusts on the tax consequences of the transaction.
PP has filed a motion for partial summary judgment to declare invalid
R has filed a motion in limine to exclude from evidence PP's expert report prepared by SS that the legal opinion of CM on the tax consequences of the transaction was of such quality and character that PP and L could reasonably rely on the opinion in preparing their income tax returns. R argues that the report should be excluded on the alternative grounds that it relates solely to PP's partner-level defenses and that it expresses legal conclusions. Alternatively, R asserts that portions of the report should be excluded because they constitute advocacy. R is also asserting that CM was a promoter of TET and the transaction, *120 that L and his grantor trusts could not reasonably rely on the opinion of a promoter, and that the status of CM as a promoter should be determined in this partnership-level proceeding.
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The court denied participating partner's motion for partial summary judgment and granting the Commissioner's motion in limine to exclude the expert's report.
In a notice of final partnership administrative adjustment (FPAA) issued to TET regarding a transaction of the type the IRS determined in
zero, that TET's partners' outside bases in their partnership interests were zero, and that accuracy-related penalties determined at the partnership level should be imposed at the partner level.
L and one of the three grantor trusts (PP) L used to engage in the transaction challenge the proposed adjustments in the FPAA and wish in this partnership-level proceeding to raise L's reasonable cause defenses to accuracy-related penalties applicable to any deficiency resulting from the FPAA adjustments to partnership items. L claims that, in reporting losses from the transaction on his return, he relied on the advice of professionals, including two attorneys *119 and a C.P.A., and a written legal opinion of CM to L and the three grantor trusts on the tax consequences of the transaction.
PP has filed a motion for partial summary judgment to declare invalid
R has filed a motion in limine to exclude from evidence PP's expert report prepared by SS that the legal opinion of CM on the tax consequences of the transaction was of such quality and character that PP and L could reasonably rely on the opinion in preparing their income tax returns. R argues that the report should be excluded on the alternative grounds that it relates solely to PP's partner-level defenses and that it expresses legal conclusions. Alternatively, R asserts that portions of the report should be excluded because they constitute advocacy. R is also asserting that CM was a promoter of TET and the transaction, *120 that L and his grantor trusts could not reasonably rely on the opinion of a promoter, and that the status of CM as a promoter should be determined in this partnership-level proceeding.
MEMORANDUM OPINION
BEGHE,
By the partial summary judgment motion, A. Scott Logan (Mr. Logan) as Trustee for A. Scott Logan Grantor Trust I (Logan Trust I or participating partner), a partner other than the tax matters partner, asks us to declare invalid
By the motion in limine respondent asks us to exclude from evidence an expert report and testimony that a legal opinion on the tax consequences of the transactions at issue was of such quality and character that Mr. Logan could reasonably rely on it in preparing his income tax returns. By respondent's response to Mr. Logan's motion, Mr. Logan's reply to that response, Mr. Logan's opposition to respondent's motion, respondent's reply to that opposition, and respondent's supplement to respondent's motion, the parties have joined issue on the subjects of the motions.
Petitioner, Sentinel Advisors, LLC (Sentinel), the tax matters partner of Tigers Eye Trading, LLC (Tigers Eye), has no direct financial interest in the outcome of this case. Thus, Mr. Logan, as trustee of Logan Trust I, is wielding the laboring oar in this proceeding.
In his motion for partial summary judgment Mr. Logan asserts that in preparing his *124 income tax returns he reasonably relied on the opinions of personal advisers -- attorneys and his accountant-as well as an opinion letter and memorandum of the law firm of Curtis, Mallet-Prevost, Colt & Mosle LLP (Curtis Mallet) on the income tax consequences of the transactions at issue. Mr. Logan submitted to the Court a notice of expert witness in which he identified Attorney Stuart A. Smith (Mr. Smith) as a witness who may aid the Court in evaluating whether the Curtis Mallet opinion was of such quality and character that Mr. Logan and Logan Trust I could reasonably rely on it in preparing their income tax returns.
By the motion in limine respondent asks us to exclude from evidence Mr. Smith's expert report and testimony on the alternative grounds that the report: (1) Pertains exclusively to Mr. Logan's partner-level defenses, an issue not properly before the Court, pursuant to the temporary regulation; (2) consists of legal conclusions; and (3) contains advocacy.
Respondent indicated, in respondent's response to Mr. Logan's motion for partial summary judgment, that respondent is asserting in this proceeding that Curtis Mallet was a promoter of the transactions in issue. Respondent *125 asserts that no participating partner of Tigers Eye could reasonably rely on an opinion issued by a promoter and that the status of Curtis Mallet as a promoter of Tigers Eye should be determined in this partnership-level proceeding.
Following
We conclude that whether Curtis Mallet was a promoter of the transactions in issue is to be decided in this partnership-level proceeding. We also conclude that, if we should determine that Curtis Mallet was a promoter of the transactions at issue, reliance on the Curtis Mallet opinion would not be a defense to the penalties. Moreover, Mr. Logan's reliance on the advice of his personal advisers is a partner-level defense that is not assertable *126 in this partnership-level proceeding. See
Since there are unresolved issues whether reliance on and the reliability of the Curtis Mallet opinion are partner-level defenses, respondent's motion in limine cannot be granted on that ground. However, we will grant respondent's motion to exclude Mr. Smith's expert report and testimony because the report consists of legal discussion and argument.
An Afterword notes that TRA 1997, as implemented by the temporary regulation, has created problems of judicial administration in the case at hand and similar pending cases that will not be resolved by recently proposed regulation.
The facts recited in this statement are based on the parties' first and second stipulations of fact and accompanying exhibits and on matters admitted in the pleadings or in the motion papers or set forth in affidavits submitted by the parties or in judicially noticed records of the Court. For the purpose of deciding these motions, *127 we view the facts in the light most favorable to the nonmoving party; the facts recited have not been found to be true after a trial.
The case at hand is one of many Son-of-BOSS cases pending in this Court. 3 It is one of a subset of such cases of transactions promoted by Sentinel that used a limited liability company (treated as a partnership for income tax purposes) to enable an investor (Mr. Logan in the case at hand) to claim losses that substantially offset millions of dollars of long-term capital gain realized on the sale of a business interest.
Mr. Logan was a cofounder of Wood Logan Associates, Inc. (WLA), a wholesale marketing and sales organization that distributed variable annuities. WLA was wholly owned by Manufacturers Life Wood Logan (MLWL), a holding company. Until early 1999 Mr. Logan owned 53,690 shares of MLWL directly and 240,000 shares of MLWL through a family limited partnership (SKL). Mr. Logan, directly and through three grantor trusts, Logan *128 Trust I and two other such trusts (collectively the Logan Trusts), held a more-than-99-percent interest in SKL.
In early 1999 Mr. Logan sold all the MLWL shares he owned, directly and indirectly, to a large Canadian life insurance company for $ 94 per share, resulting in proceeds of $ 22,560,000 to SKL and direct proceeds of $ 5,046,860 to Mr. Logan. The shares of MLWL had an average basis in the hands of SKL and Mr. Logan of approximately $ 1 per share. Mr. Logan reported total long-term capital gain of $ 27,438,537 on his and the Logan Trusts' sales of the MLWL shares.
During the taxable year ended December 31, 1999, Tigers Eye was a limited liability company organized under Delaware law, formed not earlier than September 21, 1999. Sentinel was the tax matters partner of Tigers Eye. Banque Safra, a nominee partner for Brazilian investors, obtained a 7.5-percent capital and profits interest in Tigers Eye for a cash contribution of $ 58,000, and New Vista, an entity owned by Sentinel and its legal adviser, obtained a 0.5-percent profits interest in Tigers Eye for a cash contribution of $ 3,000.
On October 1, 1999, each of the three Logan Trusts bought from and sold to American International *129 Group (AIG) a pair of substantially similar options on the euro -- an option to buy Euro 184,537,700 from AIG (the purchased option) and an option to sell Euro 184,537,700 to AIG (the sold option). The terms of the purchased options were identical to the terms of the sold options with respect to the number of euro, the exercise and expiration date (October 3, 2000), and counterparty (AIG). The exercise prices and premiums of the purchased and sold options differed slightly as shown below:
| Exercise Price | Gross | |||
| Option | Premium | per Euro | Euro | Exercise Price |
| Sold | $ 9,405,027 | $ 1.092 | Euro 184,537,700 | $ 201,515,168.40 |
| Purchased | 9,500,030 | 1.09 | 184,537,700 | 201,330,630.70 |
| Net | 95,003 | 184,537.70 |
The $ 95,003 difference in the premiums payable on each pair of options amounted to 1 percent of the higher premium on the purchased option. The difference in the exercise prices of the purchased and sold options amounted to one-tenth of 1 cent per euro; the $ 184,537.70 gross difference in the exercise prices of the purchased and sold options amounted to .0009155, or less than one-tenth of 1 percent of the higher exercise prices of the sold options.
Because AIG was the counterparty on both options, each of the Logan Trusts *130 did not actually pay $ 9,500,030 of its own funds to AIG for the purchased option, nor did it receive $ 9,405,027 from AIG for the sold option. Instead the Logan Trusts and AIG netted their respective payment obligations with respect to the option premiums, and each Logan Trust paid the net $ 95,003 to AIG with respect to each pair of purchased and sold options. 4
On or about October 9, 1999, in exchange for a partnership interest in Tigers Eye, each of the Logan Trusts contributed its purchased option and assigned its obligations under the sold option to Tigers Eye, along with $ 40,600 cash (a total of $ 121,800 for the three trusts). Tigers Eye recorded that each trust contributed $ 133,743 to capital (total $ 401,229).
On December 15, 1999, about 65 days after the Logan Trusts had contributed and assigned their interests and obligations in the options to Tigers Eye, Tigers Eye distributed to the Logan Trusts in liquidation of their partnership interests euro 5 and 10,419 shares of Xerox Corp., having a combined value of $ 229,992.42. *131 In computing the net amounts the Logan Trusts were entitled to and did receive in liquidation of their interests in Tigers Eye, the obligations of Tigers Eye to deliver euro if AIG should exercise the sold options were netted and offset against the rights of Tigers Eye to demand and receive euro if it should exercise the purchased options. SKL received the 10,419 shares of Xerox Corp. from the Logan Trusts and sold those shares on December 31, 1999, for $ 227,447.36.
The Batts Group LTD (The Batts Group), another partner in Tigers Eye unrelated to Mr. Logan, entered into and carried out transactions in a pair of euro options with AIG and Tigers Eye that were similar to the transactions of the Logan Trusts.
Curtis Mallet issued a 16-page opinion letter (the first letter) and 122-page legal memorandum, both dated March 31, 2000, to Mr Logan individually and as trustee of the Logan Trusts. *132 Curtis Mallet issued a separate 10-page opinion letter, also dated March 31, 2000, on the subject of penalties, to Mr. Logan and the Trusts. By fax, dated April 7, 2000, and letter, dated November 6, 2000, Curtis Mallet revised and supplemented the first letter and the legal memorandum. In Mr. Logan's opposition to respondent's motion in limine, Mr. Logan's counsel asserts that Curtis Mallet provided the same analysis in two opinion letters and a 122-page memorandum to all Tigers Eye partners "who reported basis/'partnership item' and who face the 40 percent penalty".
Mr. Logan and the Logan Trusts claimed an aggregate basis in the Xerox Corp. shares of more than $ 27 million. This resulted in a claimed aggregate loss on the sale of the shares of more than $ 26 million, which Mr. Logan reported on his 1999 Federal income tax return as short-term capital losses offsetting the bulk of the long-term capital gains he reported on his same-year direct and indirect sales of MLWL stock.
Respondent timely sent Tigers Eye the FPAA in issue, comprising (1) Letter 1830, Notice of Final Partnership Administrative Adjustment, (2) Form 870-PT, Agreement for Partnership Items and Partnership Level Determinations *133 as to Penalties, Additions to Tax, and Additional Amounts, including a Schedule of Adjustments, and (3) an exhibit A setting forth respondent's various determinations. The schedule of adjustments adjusted to zero the following five items:
| A. | Capital contributions (Sched. M-2, line 2) | $ 698,595 |
| B. | Distributions of property other than | |
| money Sched. M-2, line 6b) | $ 365,446$ | |
| C. | Outside partnership basis | $ 24,500,059 |
| D. | Other deductions (Sched. K, line 11) | (11,314) |
| E. | Other income (loss) (Sched. K, line 7) | (242,186) |
Unlike items A, B, D, and E, each of which is identified as the adjustment of a line item on the Tigers Eye 1999 Form 1065, U.S. Partnership Return of Income, the item C amount (Outside partnership basis) does not appear on the partnership return, nor can we trace it to any entry on the Schedules K-1, Partner's Share of Income, Credits, Deductions, etc., to the partners, and it does not tie into or relate to any item on the partnership return of which we have been apprised. 6 Items A and B are the sums of the net amounts of property initially contributed and later received as liquidating distributions by The Batts Group and the Logan Trusts. It appears that the option premiums on the purchased *134 (long) options were netted against the option premiums on the sold (short) options in arriving at the gross amounts shown on the 1999 partnership return as having been contributed by and distributed to The Batts Group and the Logan Trusts.
In exhibit A, respondent determined that:
1. Neither Tigers Eye nor its purported partners established its existence as a partnership as a matter of fact;
2. even if Tigers Eye existed as a partnership, it had no business purpose other than tax avoidance, lacked economic substance, and constitutes an economic sham for Federal income tax purposes, so that the partnership and the transactions are disregarded in full and any purported losses resulting from the
transactions are not allowable as deductions and are not allowed for Federal income tax purposes;
3. under
4. the purported partners of Tigers Eye did not enter into the option positions and Tigers Eye did not purchase the foreign currency or stock with a profit motive for purposes of
5. even if the foreign currency options are treated as having been contributed to Tigers Eye, the amount treated as contributed by the partners under
6. the adjusted bases of the purchased options and other property purportedly contributed by the partners to Tigers Eye have not been established under
7. in the case of a sale, exchange, or liquidation of Tigers Eye partners' partnership interests, neither the purported partnership nor its purported partners have established that the bases of the partners' partnership interests were greater than zero for the purpose of determining gain or loss to such partners from the sale, exchange, or liquidation of the partnership interest;
8. accuracy-related penalties are determined at the partnership level and will be imposed at the partner level.
Sentinel, the tax matters partner, filed a petition during the time it was entitled to do so as a notice partner. See
The Court granted Mr. Logan, as trustee of Logan Trust I, leave to file a notice to participate in this proceeding. Banque Safra, as well as Sentinel, has *137 no stake in the outcome of this proceeding. The Batts Group settled its case with the Internal Revenue Service (IRS) arising from the FPAA in the case at hand and also has no stake in the outcome.
Mr. Logan asserts that in reporting losses from the transactions at issue on his return, he relied on the advice of professionals, including two attorneys and a certified public accountant, as well as the Curtis Mallet opinion. He wishes to raise his reliance on that advice as a defense to the application of accuracy-related penalties if we should sustain respondent's determinations in the FPAA that either Tigers Eye or the Logan Trusts' transactions with Tigers Eye should be disregarded so that the accuracy-related penalties would otherwise apply.
Mr. Logan submitted to the Court and served on Sentinel and respondent a notice of expert witness in which he identified Mr. Smith as a witness who may aid the Court in evaluating whether the Curtis Mallet opinion "is of the quality and character upon which the Logan Trust could reasonably rely in preparing its tax returns". A copy of "Petitioner's Expert Report of Stuart A. Smith" (the Smith report) was attached to Mr. Logan's notice. Mr. Logan *138 would have the Smith report entered into evidence to support his claim that his reliance on the Curtis Mallet opinion was reasonable.
On May 20, 2008, the first stipulation of facts, with exhibits, was lodged with the Court. Included among those exhibits were Exhibits 125-J, 126-J, 127-J, 128-J, and 130-J, comprising copies of the Curtis Mallet opinion, as revised and supplemented, and the 122-page legal memorandum.
On September 26, 2008, the second stipulation of facts, with exhibits, was lodged with the Court. Included among those exhibits are copies of communications among representatives of Sentinel and BDO Seidman and attorneys at Curtis Mallet that would indicate that Curtis Mallet played a role in the preparation of the forms of documents used to implement the transactions at issue. Mr. Logan asserts that he did not receive a copy of any such communications included among such exhibits before this litigation commenced.
Neither the first stipulation of facts nor the second stipulation of facts nor any document yet lodged or filed in this proceeding refers to or includes a copy of any retainer agreement between Mr. Logan and Curtis Mallet or to any Curtis Mallet opinion to The Batts *139 Group nor to whether, when, and in what circumstances Tigers Eye disposed of its interests and obligations in the paired options contributed and assigned to Tigers Eye by the Logan Trusts.
The unified partnership audit and litigation procedures set forth in
In a partnership-level proceeding the Court has jurisdiction to determine "all partnership items of the partnership for the partnership taxable year to which the notice of final partnership administrative adjustment relates, the proper allocation of such items among the partners, and the applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to a partnership item."
The term "affected item" means "any item to the extent such item is affected by a partnership item."
Affected items have two essential aspects. The first involves a partnership issue and the second involves a nonpartnership issue; i.e., the partner's personal items. Partners must raise any partnership item that "affects" their personal items at the partnership-level proceeding. See, e.g.,
After the partnership-level proceeding is concluded and the partnership administrative adjustments have become final, the Commissioner makes a "computational adjustment", a change in the tax liability of a partner *142 that properly reflects the treatment of a partnership item. See
Any *143 penalty, addition to tax, or additional amount (collectively penalty) related to adjustments stemming from an adjustment to partnership items has generally been treated as an affected item that often requires a factual determination at the partner level. See
For completeness and to prepare for concluding observations in the Afterword about problems of judicial administration created by TRA 1997 and the temporary regulation, we note two circumstances under
Under
Under
The following comment appears in 1 McKee et al., Federal Taxation of Partners and Partnerships, par. 10.02[4], at 10-16 (4th ed. 2007): Converting partnership items to nonpartnership items may have the salutary effect of freeing the Service and the partnership from the potentially cumbersome procedures of the partnership audit rules in appropriate cases. * * *
On *150 February 12, 2009, the Secretary proposed regulations that would determine that treating items related to listed transactions within the meaning of
We now turn to Mr. Logan's motion for partial summary judgment that
The issue is important. It not only has implications for taxpayer rights; it has practical consequences for judicial administration generally and the conduct of the trial in the case at hand, and also -- as we shall see -- for resolution of respondent's motion in limine.
Mr. Logan's counsel represented the taxpayer in
In
Second, Judge Williams determined that the partnership-level elements for the application of the 40-percent gross *153 valuation misstatement penalty and other accuracy-related penalties had all been satisfied because the transaction was an abusive tax shelter. In the inflated basis [that] the spread transaction in the partnership generated on the * * * [partners'] individual returns * * * * * * it was only the construct of forming the partnership and contributing the spread to the partnership that permitted the tax losses to be realized. Had the * * * [partners] simply done the spread transactions on their own without contributing them to * * * [the partnership] there would have been no substantial losses. As the Court recognized: "
Third, Judge Williams upheld the validity of the temporary regulation. Notwithstanding that a substantial part of the
In
Mr. Logan asserts that he and the Logan Trusts reasonably relied on the Curtis Mallet opinion in taking their return positions that (1) their obligations under the sold options did not reduce the bases of their partnership interests in Tigers Eye and (2) in the liquidation of their partnership interests they received high-basis assets whose sales created capital losses *156 that offset the long-term capital gains Mr. Logan realized earlier in 1999 on the sales of MLWL shares.
Under some circumstances, a taxpayer may avoid liability for the accuracy-related penalty by showing reasonable reliance on a competent professional adviser. *157 See
"In order for reliance on professional tax advice to be reasonable, however, the advice must generally be from a competent and independent advisor unburdened with a conflict of interest and not from promoters of the investment."
Mr. Logan identified Mr. Smith as a witness whose testimony and expert report might aid the Court in evaluating whether the Curtis Mallet opinion "is of the quality and character upon which the Logan Trust could reasonably rely in preparing its tax returns". Respondent filed respondent's motion in limine to exclude the Smith report and filed a supplement to the motion.
Respondent advances two alternative grounds for excluding the Smith report from evidence in its entirety: (1) The Smith report relates solely to Mr. Logan's partner-level defenses that cannot not be raised in this partnership-level proceeding under
Respondent has also taken the position that Curtis Mallet was a promoter of the transactions in issue and that the status of Curtis Mallet as a promoter of Tigers Eye should be determined in this partnership-level proceeding. 17*161 Mr. Logan filed an opposition to respondent's motion in limine, and respondent filed a reply to the opposition by Mr. Logan to respondent's motion in limine as supplemented.
There seems to be incongruity between respondent's position that Mr. Logan's alleged reliance on the Curtis Mallet opinion is a partner-level defense over which we lack jurisdiction in this partnership-level proceeding and respondent's assertion that in this same proceeding we should determine that Curtis Mallet was one of the promoters of the transactions in issue on whose opinion Mr. Logan was not entitled to rely. We therefore consider whether we have jurisdiction in this partnership-level proceeding to decide whether Curtis Mallet was a promoter because it relates to the issue of raising defenses to partnership-item penalties in this proceeding.
C. Status as Promoter of Partnership Determined in Partnership-Level Proceeding
In the FPAA respondent determined, inter alia, that Tigers Eye should be disregarded for Federal income tax purposes because it "had no business purpose other than tax avoidance, lacked economic substance, and constitutes an economic sham for Federal *162 income tax purposes". A "partnership item" includes "the legal and factual determinations that underlie the determination of the amount, timing, and characterization of items of income, credit, gain, loss, deduction, etc."
To prove that Tigers Eye engaged in the transactions at issue for profit, Sentinel and participating partner must show that the activity was undertaken with an actual and honest objective of making a profit. While a reasonable expectation of profit is not required, there must be a bona fide objective of making an economic profit, independent of tax savings.
The analysis of profit objective must be made at the partnership level.
Mr. Logan's counsel states in the opposition to respondent's motion in limine that the universe of partners in Tigers Eye who face the accuracy-related penalties received two opinions and a 122-page memorandum of law from Curtis Mallet and that While it is absolutely true that Mr. Smith states his analysis in terms *165 of whether the Curtis Mallet opinion was of the type on which Mr. Logan could reasonably rely, that reality is true for the universe of those partners who reported the basis/"partnership item" and who face the 40 percent penalty asserted by the FPAA because
It appears to the Court that Curtis Mallet may have provided substantially identical tax opinions to investors in other Sentinel-promoted Son-of-BOSS transactions and that, like Mr. Logan, each investor was required to pay $ 100,000 to obtain a Curtis Mallet opinion. See, e.g.,
Whether Curtis Mallet was a promoter of the transactions at issue such that no investor could reasonably rely on the Curtis Mallet opinion requires factual findings properly determined in a partnership-level proceeding, similar to factual findings necessary to determine that a partner has no basis in his partnership interest because the partnership is a sham or lacks economic substance. See
If, as respondent contends, Curtis Mallet was a promoter of Tigers Eye, our focus in deciding whether Tigers Eye engaged in the activities for profit must include the activities and intent of Curtis Mallet. Whether Curtis Mallet was a promoter is a partnership-level *167 issue to be determined in this proceeding as part of our review of the issues raised by the FPAA concerning the creation and operation of the partnership and the means and manner by which it and participating interests in it were created and sold. Therefore the Curtis Mallet opinion, and the circumstances in which it was arranged and provided for, prepared and produced, and obtained, received, and paid for by Mr. Logan, are properly the subject of evidence in this proceeding. 20
Although respondent *168 has taken the position that Curtis Mallet was a promoter of the transactions at issue, respondent asserts that Mr. Logan's claim that he and the Logan Trusts reasonably relied on the Curtis Mallet opinion is a partner-level defense that cannot be raised in this partnership-level proceeding under the temporary regulation. Respondent asserts that the Smith report relates solely to Mr. Logan's partner-level defenses and asks the Court to exclude the Smith report from evidence in this partnership-level proceeding. We disagree; the analysis that follows shows that the definition of partner-level defense in the temporary regulation does not necessarily encompass Mr. Logan's and the Logan Trusts' reliance on the Curtis Mallet opinion.
The temporary regulation specifically limits partner-level defenses to those defenses "that are personal to the partner or are dependent upon the partner's separate return, and cannot be determined at the partnership level."
A defense based on the reasonable cause exception under
In
Mr. Logan's and the Logan Trusts' reasonable cause defense to partnership-item penalties, their reliance on the Curtis Mallet opinion, is not a partner-level defense if it is personal neither to Mr. Logan nor to the Logan Trusts, does not depend *172 on their separate returns, and can be determined at the partnership level. 1.
The term "personal" is defined as "1: of or relating to a particular person: affecting one individual or each of many individuals: peculiar or proper to private concerns: not public or general * * * 6: exclusively for a given individual". Webster's Third New International Dictionary 1686 (2002). In the context of a partnership, a defense is personal to a partner when it relates exclusively to that partner and requires the Court to consider facts that are unique to that partner.
Partner-level defenses include only those defenses that are personal or unique to a particular partner; i.e., only those defenses that require factual findings that are generally unrelated to the promotion of the transaction or formation of the partnership that would be relevant to all partners -- factual findings unique to the relationship between a particular partner and the adviser on whose advice he claims to rely. Partnership-level defenses are not limited to defenses of the partnership. Rather they include all defenses that require factual findings that are generally relevant to all partners or a class of *173 partners and not unique to any particular partner.
There are situations, as in this case, where the participating partner asserts reasonable reliance on materials and opinions provided to all participating partners (as well as investors in other partnerships promoted by the same persons) by persons who may have been promoters of the transaction. Reliance on such opinions would not be personal to a particular partner.
The determination of whether a taxpayer acted with reasonable cause and in good faith with respect to an underpayment that is related to a partnership item is made on the basis of all pertinent facts and circumstances.
If a partner's defense is reliance on expert or legal advice from an adviser who is unrelated to, and has no interest in, the transaction, that defense requires factual findings unique to the relationship between that partner and that adviser, and the Court has no jurisdiction in a partnership-level proceeding to decide the applicability of the defense. On the other hand, if a partner's defense is reliance on advice from an adviser who participated in structuring the transaction or is otherwise related to, has an interest in, or profits from the transaction, i.e., is considered a "promoter" of the transaction, that defense requires factual findings that would be generally relevant to all similarly situated partners and not unique to that particular partner. A defense that relates to all such partners and is an integral part of the investment program is not personal to a particular partner. The Court has jurisdiction in a partnership-level proceeding to decide the applicability of that defense. 2.
A defense to a partnership-item penalty is a partner-level defense if it depends on the partner's separate return. A defense depends on the partner's separate return if relevant facts can be established only by examination of or reference to the partner's separate return. An example of a defense that depends on the partner's separate return is the adequate disclosure exception to the accuracy-related penalty for a substantial understatement of income tax under
By contrast, deciding whether a particular partner reasonably relied on the advice of a competent tax adviser generally would not require the Court to examine that partner's return. Deciding whether Mr. Logan and the Logan Trusts -- and The Batts Group, if it also received a Curtis Mallet opinion -- were entitled *177 to rely on the Curtis Mallet opinion would not require an examination of their separate returns; the facts necessary to prove they were entitled to rely on the Curtis Mallet opinion and that such reliance was reasonable to support a reasonable cause defense to partnership-item penalties would not depend on their separate returns. 3.
A partner-level defense is a defense that cannot be determined at the partnership level. Defenses that are personal to the partner or depend on the partner's separate return cannot be decided at the partnership level because the Court is unable to decide on the basis of the evidence necessary and relevant to deciding the underlying adjustments in the FPAA whether the defense applies.
The temporary regulation provides examples of partner-level defenses that cannot be raised in the partnership-level proceeding, including, inter alia, whether the partner has satisfied the criteria of the reasonable cause exception under
On the other hand, the nature and character of a partnership's transactions are more appropriately determined at the partnership level than at the partner level. They are within the Court's scope of review in a partnership-level proceeding and the Court has jurisdiction to make findings *179 concerning the character of the partnership's transactions. See
Whether the adviser upon whose opinion the partner claims to have relied is a promoter of the transactions and, if so, whether the adviser's opinion is inherently unreliable can be decided on the basis of the *180 evidence necessary and relevant to deciding the underlying adjustments in the FPAA; they would be more appropriately determined at the partnership level. 4.
We have held that whether Curtis Mallet was a promoter of the transactions at issue is to be decided in this partnership-level proceeding. Curtis Mallet may have provided opinions to The Batts Group substantially similar to its opinions to Mr. Logan and the Logan Trusts. Indeed, respondent may prove that Curtis Mallet provided substantially identical opinions to all, most, many, or some of the other investors who participated in Sentinel-promoted paired-option partnership transactions. In that event, the Curtis Mallet opinion and the circumstances in which it was arranged, provided for, prepared, and produced by Curtis Mallet and obtained, received, and paid for by Mr. Logan, the Logan Trusts, The Batts Group, and other investors who participated in similar Sentinel-promoted paired-option partnership transactions would be proper subjects of evidence in this proceeding. See supra note 20. In considering that evidence, the Court has jurisdiction to decide whether Curtis Mallet was a promoter and whether *181 the circumstances in which the Curtis Mallet opinion was arranged for and provided to investors in the paired-option partnership transactions promoted by Sentinel prove that the opinion is inherently unreliable. If the Court should decide that Curtis Mallet was a promoter of the transactions at issue and that the Curtis Mallet opinion was inherently unreliable, reliance on the opinion would not be a partner-level defense. In that event, the Court would have jurisdiction to decide whether Mr. Logan and the Logan Trusts could reasonably rely on the Curtis Mallet opinion.
By contrast, Mr. Logan might well have partner-level defenses to the partnership-item penalties on the basis of advice he may have received and relied on from other tax, legal, financial, and accounting advisers, defenses that the temporary regulation prevents him from raising in this partnership-level proceeding. 5.
If we should decide in this partnership-level proceeding that Curtis Mallet was not a promoter, deciding whether Mr. Logan and the Logan Trusts reasonably relied on the Curtis Mallet opinion would require an examination of facts personal to Mr. Logan and the trusts, including *182 Mr. Logan's education and business experience and the nature and extent of his relationship with Curtis Mallet. It would be a partner-level defense as defined by the temporary regulation that we would not have jurisdiction to decide in this partnership-level proceeding. 6.
If we should sustain the FPAA determinations that Tigers Eye or Mr. Logan's transactions with Tigers Eye must be disregarded and that the accuracy-related penalties otherwise apply, reliance on the Curtis Mallet opinion by Mr. Logan and the Logan Trusts would be assertable and decided in this partnership-level proceeding only if the Court should decide that Curtis Mallet was a promoter and that the Curtis Mallet opinion was inherently unreliable. If we should hold that Curtis Mallet was not a promoter, Mr. Logan's and the Logan Trusts' reliance on the Curtis Mallet opinion would be a partner-level defense that could not be decided in this partnership-level proceeding. Since reliance on the Curtis Mallet opinion would not be a partner-level defense should we decide that Curtis Mallet was a promoter, at this time we cannot conclude that Mr. Smith's report must be excluded on jurisdictional grounds.
F. Legal *183 Conclusions and Advocacy of Mr. Logan's Position in the Smith Report
Respondent next argues that the Smith report should be excluded because it consists of legal conclusions. We agree. Proceedings in this Court are conducted in accordance with the Federal Rules of Evidence. Pursuant to
In support of the second ground for complete exclusion, respondent's supplement cites Judge Miller's Memorandum Opinion and Order in
In the case at hand the Smith report analyzes how the Curtis Mallet opinion fulfills the requirements of Treasury Department Circular No. 230,
In addition to deciding the issues directly raised by the parties' motions, we have held that we have jurisdiction in this partnership-level proceeding to decide whether the Curtis Mallet firm was a promoter of the transactions in issue. Our decision on the promoter issue will have an impact on whether reliance on the Curtis Mallet opinion by Mr. Logan and the Logan Trusts is a partnership-level defense (over which we have jurisdiction) or a partner-level defense (over which we lack jurisdiction). We have also recognized that Mr. Logan may have other partner-level defenses to the partnership-item penalties on the basis of advice he may have received and reasonably relied on from other tax, legal, financial, and accounting advisers that he could raise only in a refund action. See
Against the background of our holdings and their implications, it bears noting that TRA 1997 has created problems of judicial administration that *191 Congress may not have anticipated. 25 The problem faced by Mr. Logan and other investors who participated in Sentinel-promoted transactions or other Son-of-BOSS transactions is not the temporary regulation (now permanent) -- which gives effect to what would appear to be the legislative intent. Rather, it is TRA 1997, which, for the first time since 1924, denies taxpayers a prepayment forum for the determination of penalties on income tax deficiencies. 26
Although deficiency procedures continue to apply to other affected items, deficiency procedures do not apply to partnership-item penalties regardless of whether further partner-level determinations are required.
As observed
The original purpose of TEFRA was "to promote increased compliance and more efficient administration of the tax laws." H. Conf. Rept. 97-760, at 600 (1982),
Even if a petition challenging the FPAA were filed in a court other than the Tax Court, with the effect that any tax deficiency attributable to the *194 FPAA adjustments could be assessed without further judicial review, penalties attributable to partnership items still required application of the deficiency procedures after completion of partnership-level proceedings.
TRA 1997 represents a partial return to the Revenue Act of 1924, which created the Board of Tax Appeals. Under the Revenue Act of 1924, if the Government prevailed before the Board, the deficiency could be immediately assessed and collected. Although the taxpayer could not directly appeal the Board's decision to a higher court, the taxpayer could file a claim for refund with the predecessor of the IRS and, upon denial of the claim, bring a refund action in a District Court or the Court of Claims. See Dubroff, The United State Tax Court -- An Historical Analysis 77-78 (1979). This approach was promptly repealed by the Revenue Act of 1926, which provided for Court of Appeals review and finality of Board decisions.
TRA 1997 and the regulations promulgated thereunder give *195 the Tax Court the task of determining in a partnership-level challenge to an FPAA whether penalties apply to any deficiency that would result from a decision in favor of the Government on the merits and then provide for the assessment against and collection of both the deficiency and the penalties from each partner. Only thereafter do they allow a partner to assert his individual partner-level reasonable cause defenses to the penalties in a refund action in a District Court or the Court of Federal Claims. TRA 1997 and the regulations thereby result in "splitting a cause of action" with respect to penalties in TEFRA proceedings. As defined in Black's Law Dictionary 1937 (8th ed. 2004), "splitting a cause of action" is: "Separating parts of a demand and pursuing it piecemeal; presenting only a part of a claim in one lawsuit, leaving the rest for a second suit. This practice has long been considered procedurally impermissible."
The prohibition against splitting a cause of action is common law doctrine.
The TRA 1997 rationale to add penalty determinations to partnership-level proceedings and to split them from the partner-level defenses to the penalties was stated as follows: "applying penalties at the partner level through the deficiency procedures following the conclusion of the unified proceeding at the partnership level increases the administrative burden on the IRS and can significantly increase the Tax Court's inventory." *197 H. Rept. 105-148, at 594 (1997),
This rationale obviously applies to "middle class" tax shelter partnerships with scores of partners, such as the Hoyt cattle and sheep-breeding partnerships. See, e.g.,
The TRA 1997 rationale makes less sense in Son-of-BOSS transactions and other tax shelters sold to multimillionaires, where each partnership usually has no more than one or two individuals or family groups as participants. The new procedure under TRA 1997 makes it necessary, in cases in which *199 the partnership-level determinations are sustained, to educate two different courts (or at least two different judges) in the operation of the same complex set of transactions. One court has the task of determining the validity of the FPAA determinations which, if sustained, will lead to deficiency and penalty assessments by way of computational adjustments. Another court, in a refund suit to recover the penalties, must determine the validity of the participating partner's partner-level defenses to those penalties. If the partnership-level adjustments should require an affected items partner-level proceeding to determine the deficiencies and penalties, three proceedings would be required, because the partner-level defenses to the penalties could not be raised in the affected-items deficiency proceeding.
The new procedure also creates complex logistical problems in the conduct of trials by the first court in the FPAA proceeding. Particularly where a participating partner acted as the managing partner or tax matters partner, the new procedure aggravates the problem of deciding whether each item of that partner's proffered testimony relates to partnership-level or partner-level matters *200 and defenses. Cf. Murfam Farms order of Oct. 31, 2008,
It might be objected that a similar splitting of deficiency determinations obtains under the original TEFRA procedures: between the partnership-level proceeding to determine the validity of the FPAA adjustments and the partner-level affected items proceeding that may be needed to determine the deficiencies and the penalties of the individual partners. But at least under the original *201 TEFRA procedure both the legal and factual requirements for the imposition of the accuracy-related penalties and the partner's defenses to those penalties were considered in the same proceeding in one court. It also bears observing that the original TEPRA procedures were the product of a legislative judgment that the benefits of having partnership-level adjustments made by the FPAA apply across the board to multiple partners outweighed the problems that might be encountered in applying these adjustments to the individual partners in multiple affected items proceedings.
The foregoing observations lead to the question whether any technique might be available under which "one-stop shopping" could be made available in partnership cases in which the partnership has no more than a handful of participating partners. "One-stop shopping" in the case at hand would mean that all issues relating to the tax and penalty liabilities of a participating partner or partners could be decided in one court in one proceeding. One example, of course, is where the small partnership exception of
These musings have been cut short by the realization that the Secretary appears to have recently recognized and responded to the observed problems. The Secretary has proposed regulations that would enable the Commissioner to convert partnership items to nonpartnership items in the case of listed transactions and thereby provide for "one-stop shopping" through application of the traditional deficiency procedures to such transactions. See supra Part I.D. It is regrettable that the proposed regulations would not provide relief in the case at hand or the myriad of other pending Son-of-BOSS cases subject to the TEFRA procedures as amended by TRA 1997 and implemented by the regulations currently in effect. 29
On the basis *203 of the rulings in the foregoing discussion,
Footnotes
1. Unless otherwise indicated, all Rule references are to the Tax Court Rules of Practice and Procedure, and all section references are to the Internal Revenue Code in effect for 1999, the year at issue.↩
2. Participating partner also filed a motion for partial summary judgment "regarding confirmation of Code and caselaw as to contingent obligations", seeking a ruling that
Helmer v. Commissioner , T.C. Memo. 1975-160section 752↩ and other federal income tax purposes". By order dated Aug. 5, 2008, we denied the motion for a variety of reasons.3. "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 alsoKligfeld Holdings v. Commissioner , 128 T.C. 192↩ (2007)4. This statement disregards other payments by or on behalf of Mr. Logan to AIG and others to enable the Logan Trusts to participate in the transactions at issue.↩
5. Although the first stipulation of facts that has been lodged does not specify the exact number of euro distributed to the Logan Trusts, it appears that the dollar value of the distributed euro and their proceeds of sale realized on behalf of Mr. Logan before yearend 1999 amounted to less than $ 14,000.↩
6. In a supplement to respondent's response to Mr. Logan's motion, respondent asserts: "All partnership items that feed into the Tigers Eye participants' outside bases in Tigers Eye are properly raised by this line item".↩
7.
Sec. 6231(a)(3) defines "partnership item" as:with respect to a partnership, any item required to be taken into account for the partnership's taxable year under any provision of subtitle A to the extent regulations prescribed by the Secretary provide that, for purposes of this subtitle, such item is more appropriately determined at the partnership level than at the partner level.
8.
Sec. 6231(a)(4)↩ defines the term "nonpartnership item" as "an item which is (or is treated as) not a partnership item."9. With the exception of penalties. See
infra↩ pt. C. immediately following.10. The Taxpayer Relief Act of 1997 (TRA 1997),
Pub. L. 105-34, sec. 1238, 111 Stat. 1026 , amended the partnership procedures regarding penalties by (1) amendingsec. 6221 to require the applicability of any partnership-item penalty to be determined at the partnership level, (2) amendingsec. 6230(a)(2)(A)(i) to exclude partnership-item penalties from the deficiency proceeding, and (3) amendingsec. 6230(c)(4)↩ making conclusive the partnership level determination regarding the applicability of any partnership-item penalty but allowing the partner to assert in a refund claim any "partner-level" defenses.11. In its report underlying the amendments, the House Committee on Ways and Means explained that it had proposed the amendment because:
Many penalties are based upon the conduct of the taxpayer. With respect to partnerships, the relevant conduct often occurs at the partnership level. In addition, applying penalties at the partner level through the deficiency procedures following the conclusion of the unified proceeding at the partnership level increases the administrative burden on the IRS and can significantly increase the Tax Court's inventory. [H. Rept. 105-148, at 594 (1997),
1997-4 C.B. (Vol. 1) 319, 916.] 12. The temporary regulation is consistent with the legislative history. The House committee report explained that the proposed amendment "provides that the partnership-level proceeding is to include a determination of the applicability of penalties at the partnership level. However, the provision allows partners to raise any partner-level defenses in a refund forum." H. Rept. 105-148, at 594 (1997),
1997-4 C.B. (Vol. 1) 319, 916 ↩.13. No such designation has been made by regulation with respect to foreign partnerships.↩
14. In
Evergreen Trading, LLC v. United States , 80 Fed. Cl. 122Jade Trading, LLC v. United States , 80 Fed. Cl. 11 (2007)Evergreen Trading, LLC v. United States , 80 Fed. Cl. 122 (2007)Nussdorf v. Commissioner , 129 T.C. 30↩ (2007)15. See
supra↩ note 2.16. With respect to respondent's argument about advocacy, we observe that Mr. Smith successfully represented the plaintiffs in a partner-level proceeding,
Allison v. United States , 80 Fed. Cl. 568↩ (2008)17. Respondent served notice (in n.7 of respondent's response to Mr. Logan's motion for partial summary judgment to declare the temporary regulation invalid) that respondent asserts that (1) Curtis Mallet was one of the promoters of the transactions in issue, (2) as a matter of law, citing
sec. 6664(d)↩ , a partner cannot reasonably rely on the opinion issued by a promoter, and (3) we should address the status of Curtis Mallet as a promoter in this partnership-level proceeding.18. We also note that par. 4 of exhibit A to the FPAA asserts that the "purported partners of Tigers Eye did not enter into the option positions and Tigers Eye did not purchase the foreign currency or stock with a profit motive for purposes of
section 165(c)(2) ".Notice 2000-44, 2000-2 C.B. 255, 255 , citesFox v. Commissioner , 82 T.C. 1001 (1984)section 165(c)(2)↩ ".19. See also
Carlisle v. Curtis , Mallet-Prevost, Colt & Mosle, LLP, 521 F.3d 597, 599 (6th Cir. 2008)Arthur Andersen LLP v. Carlisle , 556 U.S. ___, 129 S. Ct. 1896, 173 L. Ed. 2d 832↩ (May 4, 2009)20. In this regard, any similar evidence of Curtis Mallet opinions to The Batts Group and to participating partners in other Sentinel-promoted Son-of-BOSS transactions would be relevant to establishing a pattern of activity of Curtis Mallet in concert with Sentinel and any other alleged promoter or promoters that would tend to support respondent's contention that Curtis Mallet acted as a promoter in the case at hand. See, e.g.,
Sochin v. Commissioner , 843 F.2d 351, 355 (9th Cir. 1988)Brown v. Commissioner , 85 T.C. 968↩ (1985)21. Generally, there is a substantial understatement of income tax for any taxable year if the amount of the understatement exceeds the greater of 10 percent of the tax required to be shown on the return for the taxable year or $ 5,000 ($ 10,000 in the case of a corporation other than an S corporation or a personal holding company).
Sec. 6662(d)(1) . In this context, the term "understatement" is defined as the excess of the amount of the tax required to be shown on the return over the amount of the tax imposed which is shown on the return, reduced by any rebate.Sec. 6662(d)(2)(A) . In determining whether an understatement of income tax is substantial, the amount of the understatement is reduced by any portion attributable to an item if there is or was substantial authority for the taxpayer's treatment of the item, or if the relevant facts affecting the item's tax treatment are adequately disclosed in the return or in a statement attached thereto.Sec. 6662(d)(2)(B)↩ .22. In
Stobie Creek Invs., LLC v. United States , 82 Fed. Cl. 636, 703-704 (2008)Id. at 703sec. 301.6221-1T(d) ,Temporary Proced. & Admin. Regs., ).supra↩ 23.
Fed. R. Evid. 702 states:If scientific, technical, or other specialized knowledge will assist the trier of fact to understand the evidence or to determine a fact in issue, a witness qualified as an expert by knowledge, skill, experience, training, or education, may testify thereto in the form of an opinion or otherwise, if (1) the testimony is based upon sufficient facts or data, (2) the
testimony is the product of reliable principles and methods, and (3) the witness has applied the principles and methods reliably to the facts of the case.↩
24. Recently, in an unpublished opinion of the U.S. Court of Federal Claims,
Murfam Farms, LLC v. United States , No. 1:06-cv00245, 2008 U.S. Claims LEXIS 381 (Sept. 19, 2008)Murfam Farms opinion did not address the possibility that the report should be excluded as being proffered in aid of partner-level defenses to penalties that the Court of Federal Claims lacked jurisdiction to consider in the pending proceeding. Soon thereafter, however, on Oct. 31, 2008, Judge Damich issued an order in theMurfam Farms case denying the plaintiffs' motion to confirm jurisdiction to hear their reasonable cause defenses to the accuracy-related penalties determined in the FPAA. The ground of the motion was that each plaintiff was the managing partner of his respective partnership and thus would be mounting a partnership-level defense to the penalties determined against him. Judge Damich was not willing to accept at face value the characterization in the governing agreements that every member partner was a manager; Judge Damich concluded that each partner's involvement in and knowledge of the transactions conducted by the partnerships should be explored at trial. Judge Damich↩ found that there was a genuine issue of material fact as to the identity of the managing member partners and therefore denied plaintiffs' motion.25. See comments in a somewhat similar vein in the concluding paragraphs of
Domulewicz v. Commissioner , 129 T.C. 11, 23-24↩ (2007)26. See Pisem, "What Happened to My Prepayment Forum? The Penalty Problem in TEFRA Partnership Audit Cases", 108 J. Tax. 269 (May 2008).↩
27. Another type of tax shelter antedating TRA 1997 that has spawned numerous affected items proceedings to determine additions to tax have been the jojoba tax shelter TEFRA partnerships. See
Utah Jojoba I Research v. Commissioner , T.C. Memo. 1998-6Altman v. Commissioner , T.C. Memo 2008-290Watson v. Commissioner , T.C. Memo 2008-276Helbig v. Commissioner , T.C. Memo 2008-243Bass v. Commissioner , T.C. Memo 2007-3612009-1 USTC par. 50,332, 103 AFTR 2d 2009-1624, 322 Fed. Appx. 859 (11th Cir. 2009) ;Finazzo v. Commissioner , T.C. Memo 2002-56Welch v. Commissioner , T.C. Memo 2002-39Christensen v. Commissioner , T.C. Memo. 2001-185Serfustini v. Commissioner , T.C. Memo 2001-183Carmena v. Commissioner , T.C. Memo 2001-177Nilsen v. Commissioner , T.C. Memo 2001-163Swanson v. Commissioner , T.C. Memo 2009-31↩28. Notwithstanding that taxpayers have no constitutional right to a prepayment forum, see
Phillips v. Commissioner , 283 U.S. 589, 596-597, 51 S. Ct. 608, 75 L. Ed. 1289, 1931-1 C.B. 264↩ (1931)29. Timely application of the procedures provided by the proposed regulations might also reduce opportunities for gaming the statutes of limitations where multiple passthrough entities have interests in what would otherwise remain a TEFRA partnership. Cf., e.g.,
JT USA, LP. v. Commissioner↩ , 131 T.C. ___ (2008)
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