Another Bullshit Shelter Bites the Dust Even with Variations (5/15/14)

I write today on the defeat of another bullshit tax shelter of the Son-of-Boss ("SOB") variety.  The Markell Company, Inc. v. Commissioner, T.C. Memo. 2014-86, here, decided yesterday.  If it were just another ho-hum SOB, it would be worth noting only in passing.  But, it has a twist -- both the twist and the outcome is projected in the opening two short paragraphs:

This case began when the Commissioner found the remains of a corporation on an Indian reservation in an extremely remote corner of Utah. The tribe claimed not to know how the corporation's stock had ended up in its hands. And there was little or no money or valuable property left inside the corporate shell. 

All signs pointed to the corporation's manager, a sophisticated East Coast moneyman, as the key person of interest. And his method was a series of complex transactions that bore a striking resemblance to Son-of-BOSS deals already examined many times before by this Court -- but with a corporate-partner twist.

The last sentence of the first paragraph resonates with the equally bullshit intermediary transactions.  One of the strategies in shelters is to push tax consequences to an empty shell of a company, so that the IRS is left without anyone to collect tax clearly due.

The Son-of-Boss transactions in their pure bullshit form seemed to promise to the gullible or complicit that the taxable income disappearing from the taxpayer's tax ledger would just go away.  But, every one I know that gave a hard and knowledgeable look knew that, even if the imagined scheme worked to push the income from the original taxpayer (always a doubtful proposition), some taxpayer down the line would be liable for the tax.  Enter the intermediary gambit to make sure that taxpayer down the line had no assets to pay the tax because the taxpayer and the promoters would have sucked all the value out of the company.  Thus, this intermediary was designed to deal with an inherent and blatant flaw in the SOB transactions.  (Of course, SOB transactions had flaws in them before reaching this stage, but the intermediary was a fine artistic touch to put on the bullshit.)

The Merits

The Chevron Two-Step (5/6/14)

Tax Procedure enthusiasts know -- or should know -- that Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984), here, empowered the administrative state whereby agencies' interpretations of statutes entrusted by Congress to their administration are given deference.  The Chevron analysis involves two key steps, explained as follows from my Federal Tax Procedure book (footnotes omitted):

The Court established a “two-step” inquiry.  The First Step inquires whether the meaning of the statute is plain and unambiguous?  An alternative way to say this is whether the meaning of the statute is “clear” and needs no interpretation either by the courts or the agency.  If so, the regulation is irrelevant because the plain or clear meaning of the statute itself pre-empts the interpretive field.  A regulation inconsistent with the clear (or plain or unambiguous) meaning is invalid.  The Second Step, reached only if the text is determined to be not clear (or not plain or not unambiguous) in the First Step, is whether the agency interpretation is unreasonable? Under this Second Step, the agency’s interpretation in the regulations is given deference so long as it is not arbitrary, capricious or manifestly contrary to the statute it seeks to interpret (I generally just truncate this litany to “unreasonable”). This gives the IRS authority to interpret and determine the law where in the conceptual space between clear statutory text and an interpretation that is unreasonable under the statutory text.  This two-step inquiry is very important; students, practitioners and scholars must know the steps instinctively; I encourage readers of this text to commit them to memory – at least the formulation of the steps.

With that introduction, here are creative NYU Law students demonstrating the Chevron two-step.

Hat tip to the Tax Prof Blog for bringing the video to my attention.

Role and Culpability of Taxpayers Participating in Bullshit Tax Shelters (4/4/14)

I write today to collect and update some thoughts I have expressed before on this blog.  The background is the bullshit tax shelters on which I have written and even fulminated, if not eloquently, at least often.  I start with my own definition from my Tax Procedure Book (footnotes omitted).

  Abusive tax shelters are many and varied.  Some are outright fraudulent, usually wrapped in a shroud of paper work designed to present the shelter as a real deal.  The more sophisticated are often without substance but do have some at least attenuated, if superficial, claim to legality.  Some of the characteristics that I have observed for tax shelters that the Government might perceive as abusive are that (i) the transaction is outside the mainstream activity of the taxpayer, (i) the transaction is incredibly complex in its structure and steps so that not many (including specifically IRS auditors) will have the ability, tenacity, time and resources to trace it out to its illogical conclusion (this feature is often included to increase the taxpayer’s odds of winning the audit lottery); (iii) the transaction costs of the arrangement and risks involved, even where large relative to the deal, still have a favorable cost benefit/ratio only because of the tax benefits to be offered by the audit lottery, (iv) the promoters of the adventure make a lot more than even an hourly rate even at the high end for professionals (the so-called value added fee, which is often insurance type compensation to mediate shift potential penalty risks to the tax professional or the netherworld between the taxpayer and the tax professional) and (v) the objective indications as to the taxpayer's purpose for entering the transaction are a tax savings motive rather than any type of purposive business or investment motive.  More succinctly, Michael Graetz, a Yale Law Professor, has described an abusive tax shelter as “[a] deal done by very smart people that, absent tax considerations, would be very stupid.”  Other thoughtful observers vary the theme, e.g. a tax shelter “is a deal done by very smart people who are pretending to be rather stupid themselves for financial gain.”

The bullshit tax shelter with which I am most familiar is the Son-of-Boss shelter.  That shelter purported to generate offsets to taxable income.  The offsets were wrapped in commotion but ultimately simply created from thin air -- very thin, indeed a perfect vacuum.  Bullshit shelters appear in many guises other than Son-of-Boss.  The commotion they are wrapped in serve two purposes:  (i) creating the illusion of some basis for the magical tax benefits and (ii) hiding the fact that the illusion is an illusion.  Bottom-line, several courts have characterized the imagined benefits as "too good to be true" and indeed recognizably "too good to be true."

As readers of this blog know, many bullshit tax shelter promoters have been convicted for their participation in the bullshit tax shelters.  Taxpayers themselves have not been prosecuted or convicted.  I do understand that some taxpayers have been named targets or subjects of grand jury investigations for their participation but those investigations ended in only promoter prosecutions.

Discovery from IRS Files and Employees About Fair Notice of Liability and Treatment of Other Taxpayers (5/2/14)

In NetJets Large Aircraft, Inc. v. United States, 2014 U.S. Dist. LEXIS 58677 (SD OH 2014), here, Magistrate Judge Terence P. Kemp, here, resolved discovery disputes in this tax refund and abatement action relating to transportation tax under Section 4261, here.  Magistrate Judge Kemp does a very good job addressing discovery issues related to the IRS's alleged inconsistent application of the Section 4261 tax.  I am not sure the opinion will survive unscathed on appeal to the district judge, but it is a good opinion.  So I offer it to readers of this blog.

The taxpayers "provide aircraft management and aviation support services to aircraft owners and leaseholders (with whole and/or fractional interests in the aircrafts)."  I think the question in terms of the substantive application of the law is whether the taxpayers' role in providing ownership or leasing and all related services to fractional owners/leaseholders is serving in an analogous role to airline companies who must collect the tax from their customers (who, after all, can viewed as leasing the space on the plane for the time of the trip).

In a prior case, Executive Jet Aviation, Inc. v. United States, 125 F.3d 1463 (Fed. Cir. 1998), here, the Court held "the occupied hourly fees that fractional management companies received from fractional owners were subject to the tax imposed by section 4261(a)."  The taxpayers in NetJets apparently try to differentiate that case on the basis that the Executive Jet decision was premised on the arrangement not being "a bona fide economic arrangement."

Subsequently, the IRS promulgated regulations that, according to the taxpayers, make such arrangements bona fide when agreements of the type that the taxpayers used with their customers.

Notwithstanding the alleged distinction of the Executive Jet Aviation decision, the IRS asserted the tax against the taxpayers.

The litigation and the discovery disputes ensued.

The basic rule of discovery is that it be relevant to a legitimate dispute in the case.  To determine that, the Court reviewed the relief the taxpayers sought as follows:

(1) Plaintiffs do not provide "taxable transportation" under 26 U.S.C. §4261, and thus the payments Plaintiffs receive from aircraft owners are not subject to the section 4261 excise tax;
(2) The IRS failed to provide clear guidance to Plaintiffs that they were required to collect and remit the section 4261 excise tax on the monthly management and fuel variable surcharge fees they received from aircraft owners;
(3) The IRS violated its duty to treat similar taxpayers in a consistent manner because it has assessed the section 4261 excise tax against certain of the fees that Plaintiffs charge fractional aircraft owners while not assessing the tax against those same fees with respect to certain of Plaintiffs' competitors; and
(4) The IRS is legally bound by a Technical Advice Memorandum ("TAM") it issued to Plaintiffs' predecessor, Executive Jet Aviation, in 1992, which provides that only the occupied hourly fees paid by fractional aircraft owners, and not monthly management or fuel variable surcharge fees, constitute payments for "taxable transportation" under 26 U.S.C. §4261. Under applicable Treasury regulations, as well as the IRS's own internal guidelines, the IRS is bound by the 1992 TAM until such time as the IRS issues Plaintiffs another TAM modifying or replacing the one from 1992. The IRS has never issued such a subsequent TAM, and thus its assessment of the section 4261 tax against Plaintiffs' monthly management and fuel variable surcharge fees, in violation of Treasury regulations and IRS guidelines, was unlawful.

What Does Shall Mean? Herein of Slippery Mandatory Language and Summons Enforcement (5/1/14)

In Jewell v. United States, 2014 U.S. App. LEXIS 7899 (10th Cir. 2014), here, the Court held that shall means shall.  So stated, not a surprising holding.  The context -- ah yes, context is important -- was the statutory textual requirement in Section 7609(a)(1), here, that the taxpayer being investigated "shall be given" notice of the summons "within 3 days of the day on which such service is made, but no later than the 23rd day before the day fixed in the summons as the day upon which such records are to be examined."  Now for further background.

The summons authority is in Section 7602, here.  Section 7609 is titled "Special procedures for third-party summonses."  The critical "shall" is in Section 7609(a)(1).

Summonses generally must meet the four part Powell test established in United States v. Powell, 379 U.S. 48 (1964), here (brackets added to highlight the four parts]:

[i] that the investigation will be conducted pursuant to a legitimate purpose, [ii] that the inquiry may be relevant to the purpose, [iii] that the information sought is not already within the Commissioner's possession, and [iv] that the administrative steps required by the Code have been followed * * * .

The issue in Jewell was whether, given the command of the Section 7609(a)(1) that notice "shall be given," the IRS's failure to give Jewell notice in the time period required prevents the IRS from having issued a valid summons and therefore prevents the IRS from petitioning the district court to enforce the summons.

Essentially, the Court held that shall means shall and denied enforcement of the petition.  And, to complete the reasoning, the Court said that the giving of timely notice was an administrative step required by Powell.

The Court engages in a lawyerly discussion over the meaning of shall.  When is the use of shall mandatory or simply precatory, a guide but not a straightjacket?  The court discusses the contrary authority in other circuits where a no harm no foul approach was adopted -- i.e., the summons would be enforced unless the taxpayer shows prejudice (or perhaps the IRS shows lack of prejudice), so that the requirement was merely a technicality that can be dispensed with or ignored.  Not so, says the Court.  The use of shall, properly and plainly interpreted, established an administrative step that Powell requires to be met.

Consider the implications.  One that comes readily to mind is the use of shall in statutory requirements for a notice of deficiency.  For example, uncodified Section 3463 of the Internal Revenue Restructuring and Reform Act of 1998 ("Act") states that the IRS "shall include on each notice of deficiency . . . the date determined by [the IRS] as the last day on which the taxpayer may file a petition with the Tax Court." Courts have not invalidate the notice of deficiency for failure to meet this "shall" requirement. A number of cases have so held, and the Tax Court made this holding less than a year ago.  John C. Hom & Assocs. v. Comm'r, 2013 U.S. Tax Ct. LEXIS 12 (T.C. 2013), here. Here is the Tax Court's reasoning: