Tax Court Calls Out Yet Another Bullshit Tax Shelter But Relieves Taxpayer of 6662 Penalties (2/24/26 as corrected; 2/27/26)

Major Correction: I made an error in the original blog post, by misreading the court's application of the 40% Substantial Valuation Misstatement and Gross Valuation Misstatement Penalties in § 6662(e)(1)(A) and I.R.C. § 6662(h) but not picking up that the reasonable cause defense it sustained effectively wiped out all 6662 penalties.

Yesterday, the Tax Court (Judge Weiler) decided Otay Project LP v. Commissioner, T.C. Memo. 2026-21, TC Dkt here at # 349, TN here, and GS here, tanking another bullshit tax shelter. There is no indication that this is a syndicated shelter creating basis and thus deductions out of thin air in complex structures taxed as partnership; as presented it seems like “one-off” imagined by creative minds and blessed by firms that have played prominently in tax sheltering—E&Y and McKee Nelson LLP; moreover, I suspect (suspicion only) that variations on the shelter were promoted on and opined upon on other occasions.

I find it a bit odd that, although Judge Weiler says he read the those firms’ opinions (Slip Op. 45), but he does not identify the persons signing the opinions. Oh well, let’s move on to the main points for tax procedure enthusiasts.

On the Merits of the Complex Machinations:

The actual bottom-line tax costs of the shelter failing must await the Rule 155 computation, but the Court concludes on the merits (other than penalties) (Slip Op. 31):

In sum, we determine petitioner has not met its burden here and has failed to correctly establish the Basis Deduction under section 743(b), as claimed on OPLP’s 2012 Form 1065. Accordingly, we will sustain respondent’s disallowance of $713,759,615 of a more than $743 million claimed Basis Deduction reported on OPLP’s 2012 Form 1065 for the 2012 tax period. 

I believe it would not be helpful to most tax procedure enthusiasts to wade into the complex facts and partnership tax law discussed in the opinion. Although this appeared not to be one of the abusive shelters of the late 1990s and early 2000s (e.g., BLIPS or variants used by different accounting and law firms), I suspect that some of the fanciful notions asserted in those earlier versions were deployed here in a more complex and “engineered” (Slip Op. 30-32) journey through esoteric partnership tax provisions.

Suffice it to say that the Court rejected that “engineered” journey on the merits of the partnership tax law and also based on economic substance doctrine. In this regard, because it preceded the effective date, the transaction was not subject to the codified economic substance doctrine in § 7771(o) or the penalty in § 6662(b)(6). (See Slip Op 2 n. 2.)

 The Penalties:

 After denying the gambit on its merits, the Court then addressed  penalties as follows (Slip Op. 42-46):

• found the 40% Substantial Valuation Misstatement and Gross Valuation Misstatement Penalties in § 6662(e)(1)(A) and I.R.C. § 6662(h) to apply because the overstated basis well exceeded 200%
• but relieved the taxpayer of all potentially applicable § 6662 penalties based on the reasonable cause defense in § 6664(c). The Court noted in this regard the taxpayer reliance on the E&Y  and McKee Nelson opinions which, the Court said (Slip Op. 45), (i) “contains substantial authority for each and every conclusion reached therein.” And (ii) “the opinions reached a confidence level of substantial authority on each material issue relating to the transactions at issue.”

The Court's acceptance of the reasonable cause defense surprised me since, as I read the facts as found and the law as held by the court, the legal opinions blessed, at least to the level of alleged substantial authority, basis and resulting deductions created by legal hocus pocus, essentially out of thin air by multiple complex entities and strained readings of the partnership tax sections. Yet the Court found that the taxpayer had reasonable cause and acted in good faith. I have not read the opinions, so I cannot say for sure that they lacked substantial authority (whatever exactly that is). Great job by the taxpayer's counsel. 

The Court does note that the IRS assertion that the two underlying taxpayers (brothers) involved in the commotion withheld information from McKee Nelson (Slip Op. 44 n. 39): 

39 Respondent only points us to Al’s and Jim’s alleged misrepresentation to McKee Nelson that, at the time of the transactions at issue, there was no plan or intention to liquidate OPLP. We do not find this representation (at the time it was made) to be materially false, as alleged by respondent.

Does that mean that the representation (i) was not false or (ii) even if false, was not material to the McKee Nelson opinion? As it is written, it would appear to be the latter (but that is not certain since the Court earlier said it was an alleged misrepresentation but then seems to treat the representation as having been made). The Court does not explain why any such false representation, if made, would not have been material to the opinion.

I am reminded of perhaps similar false representations required in the earlier round of shelters that the taxpayer did the transaction creating the magical deductions with a profit motive rather than a tax motive. That representation was not truthful (at least in most cases I observed), but the taxpayers knew the opinions would not issue without the representation. Was that false representation material? (As I say, I have not read the opinions in Otay, so I am not sure that is a good analogy.)

Miscellanea

1. McKee & Nelson in the firm name are authors of what I think is still the principal authority on partnership taxation: Federal Taxation of Partnerships and Partners, here, listing five authors, the last two of which are McKee and Nelson; but during most of my practising career, the two named authors were McKee and Nelson; I generally found the text outstanding (although as always I checked it out)).

2. The opinion shorthands Ernst & Young to “EY” but, in the same paragraph, refers to EY and E&Y (the latter being the sole reference to E&Y). I use E&Y in this blog.

3. From the docket entries, here, it appears that the trial lasted 8 days in the period from 10/15/24 through 10/28/24. The opinion, dated 2/23/26, was # 349 on the docket entries. So, I infer the machinations in court were as complex as the machinations to cobble together this abusive scheme.

4. (added 2/25/26 7:45pm): Today, my Charlottesville NonFiction Book Club discussed Charles Freeman,’s The Closing of the Western Mind, Amazon here. Perhaps Freeman’s main theme is that, in the previously proclaimed dark ages, the western mind directed by bishops and priests (usually as puppets of political leaders such as Constantine) turned to mystery and magic rather than applying Artistotelan-inspired reason (see Wikipedia here). That is a simplistic statement of Freeman’s historical argument, but, based somewhat on that simplism, I could not help but think that somehow the tax community may operate the same way. The E&Y and McKee Nelson legal opinions spun a fantastic story of mystery and magical deductions used to, in the story told by the tax returns filed based on the legal opinions, make fantastical claims that only the privileged few (such as the persons rendering the opinions, like religious and political authorities in the supposed dark ages) could discern and impose on the others without powers of discernment. Reason (exemplified by the Otay merits discussion) burst the bubble of that spinning, but Reason still bowed the spinning of mystery and magic in the penalties discussion.

5.  (added 2/27/26 1pm): Today, I reflected on 2/27 as National Asshole Day, here, which led me to this philosophical, perhaps same as tongue-in-cheek (a more appropriate body metaphor), discussion. Aaron James, The Meaning of “Asshole” (The Philosophers' Magazine), here. James cites the iconic Frankfurt On Bullshit, a magnificent tome on the subject, appearing in both book format, Princeton Press here, and an earlier essay format, here (Wikipedia here).

Considering the philosophical implications of bullshit, I decided to reconsider or at least further explain my use of the bullshit metaphor for abusive tax shelters that are “beyond the pale,” which Merriam-Webster Online says means “offensive or unacceptable.” That works in the context that I use bullshit to describe abusive tax shelters. Frankfurt says that the critical distinction between the bullshitter and the liar is that the liar knows something is not true and lies about it, whereas the bullshitter is indifferent to whether something is true. For example, Trump is a bullshitter for many of his claims; Trump does not know the relevant facts or history (to the extent the two categories may be different) and does not care, permitting him to make claims that are factually and historically not true without really lying (he does not know the truth, sort of a Cheekian type of knowing). In cases of this genre, the bullshitter perceives some benefit to the bullshitter in making the bullshit claim.

In the case of bullshit tax shelters, the benefits are (i) outsized tax benefits for the taxpayer and (ii) usually outsized financial reward for the promoters (among whom I include enabling tax professionals plying their trade with tax opinion magical incantations). Essentially, the promoters get between the taxpayers raiding the fisc and the fisc they raid and rake off some portion of the taxpayers’ tax benefit.

Bullshitter may thus describe promoters and taxpayers of little tax truth. The point I address in the post above is whether this category of bullshitters should be able to access the audit lottery without risk of penalty—i.e., as to the taxpayers, only pay the tax the taxpayers owe anyway? In Otay, the Court blessed that “get-out-of-penalty-free opportunity for the taxpayer.

Bullshit is a form of magical thinking untethered by truth (here tax truth). I am not saying, necessarily, that the taxpayer and the promoters knew that the claimed raids on the Treasury were affirmatively false in the Cheek willfulness sense (or in Frankfurt's liar sense); I am suggesting that promoters and taxpayers were motivated to promote and claim bullshit positions on the tax returns without serious consideration of the tax-truth of the claims. Maybe they believed that the claims were “respectable” enough to avoid Cheek willfulness, so that in their motivated minds, the claims were significant authority. But in the final analysis, on the merits, that’s bullshit and the promulgators are bullshitters in the Frankfurtian sense.

Indeed, the Court’s analysis of the merits suggests that the return claims were bullshit, little more than motivated magical tax analysis (Slip Op. 28-31, footnote omitted and bold-face supplied by JAT): 

          After considering section 743(b) and Treasury Regulation § 1.743-1(d), we find respondent’s arguments made in his briefing to be compelling. In this case the foregoing calculation resulting in the section 743(b) basis adjustment to OPLLC is illogical. The balance sheet of OPLP, which was used to make these calculations, reflects assets of only $28 million, liabilities of $71 million, and a total negative capital of $848 million. More specifically, OPLLC—the 99.9% partner in OPLP—reflects negative capital of $911,595,423 ($912 million). Petitioner provided no explanation as to these figures other than rejecting respondent’s proposed changes to how the section 743(b) adjustment was made.

          We find respondent’s arguments compelling, since the contortion of this balance sheet was the result of prior distributions made by OPLP. OPLLC’s negative capital balance is the result of the distribution of tax-deferred profits along with the distribution of OPLP’s interest in the Finco entities. These prior distributions of cash (or cash equivalents) were ignored by petitioner when it calculated OPLLC’s section 743(b) basis adjustment.

          A partnership generally selects its method of accounting and taxable year, see I.R.C. §§ 703(b), 706(b); it may choose a method of accounting different from the method used by its partners, see Treas. Reg. § 1.703-1(b)(1). In this case petitioner seeks to gain a tax benefit through these differences in accounting methods. On the one hand OPLP benefited from deferred taxable gains of some $921 million based on its use of CCM, while on the other hand OPLP claims to have made distributions of previously taxed capital of approximately $912 million to its 99.9% partner, OPLLC. This disparity cannot be the case and must ultimately be reconciled. Petitioner claims a hypothetical liquidation would result in OPLLC’s receiving only $106,608,746 in cash; however, in reality it has been allocated an additional $912 million in cash based on OPLLC’s capital account, which has been booked against its capital accounts as a liability or negative figure.

          A primary feature of the Treasury regulations relating to section 704(b) and a partner’s distributive share are the allocations of items of income, loss, etc. among partners and whether these allocations made under any partnership agreement 31 satisfy the “substantial economic effect” test. See Treas. Reg. § 1.704-1(b)(2). An allocation made to any partner will not be considered to have “economic effect” unless it comports with the underlying arrangements of the partners, and only if it ensures that a partner who receives an economic benefit equally bears an economic burden relating to the partnership for tax purposes. See id. subdiv. (ii)(a). In other words, any tax items allocated to a partner for tax purposes should have an equivalent impact on the amount of cash that the partner would be entitled to receive upon liquidation of the partnership. See id. subdiv. (ii)(b). Furthermore, if the partner has a deficit balance in his capital account upon liquidation, after adjustments are made for the partnership year, that partner is unconditionally obligated to restore the amount of that deficit balance to the partnership. See id. subdiv. (ii)(b)(3). The regulations also address when a partner’s obligation to restore a deficit capital account will be respected and consistent with guidance related to section 752 including when a partner’s obligation is not legally enforceable, or the facts and circumstances otherwise indicate a plan to circumvent or avoid the obligation. See Treas. Reg. § 1.704-1(b)(2)(ii)(c)(2).

          As mentioned above, and at the time of OPLP’s section 743(b) adjustment, OPLLC reflected negative capital of $912 million. This negative figure is difficult to accept for a number of reasons. First, while a partner’s capital account can go negative, here it defies logic that OPLLC’s negative capital can realistically go beyond OPLP’s entire balance sheet, which reflects total assets of $28 million and liabilities of $71 million. OPLLC’s negative capital flies in the face of reality and proper tax accounting.

          Second, this negative capital is fundamentally impossible from a cash perspective, meaning it is ordinarily impossible for any partner to withdraw nearly a billion dollars in capital in excess of the amount of capital that the partner previously contributed to the partnership. It is apparent this discrepancy can only be attributed to the $921 million in deferred profits listed on the CCM Schedules. In other words, for cash (or book) accounting purposes OPLP has distributed deferred gains to its partners, principally to OPLLC. However, for tax reporting purposes no gain has been recognized since OPLP retains its Construction Obligations under CCM. We refuse to accept (or otherwise recognize) this otherwise illogical disparity reflected on OPLP’s balance sheet, because doing so would defy tax accounting principles and would result in a partnership with an overall negative value of $848 million. Lastly, and importantly, to achieve a negative capital account of nearly $912 million while maintaining substantial economic effect (as required under the partnership agreement), OPLLC must (1) have an equal unconditional obligation to restore the amount of its deficit capital balance to the partnership and (2) bear an economic burden equal to its previously received economic benefit relating to the partnership for tax purposes. See Treas. Reg. § 1.704-1(b)(2)(ii)(a), (b)(3). Upon liquidation of a partnership or a partner’s interest in a partnership, liquidating distributions will be made in accordance with properly maintained positive capital account balances. See id. subdiv. (ii)(b). Considering the foregoing, since OPLP has treated the prior distributions of excess capital to OPLLC of $912 million as having substantial economic effect, OPLLC holds an unconditional obligation to restore its negative capital account. Accordingly, the Basis Deduction calculation must account for OPLLC’s negative capital, for the prior partnership distributions to maintain economic effect. See id.

          Petitioner’s engineered section 743(b) adjustment, absent the deferred gain found on OPLP’s CCM Schedule and OPLLC’s liability found in its negative capital account, is an incomplete calculation and contrary to the partnership agreement. Thus, the Basis Deduction calculation cannot be respected here. A correct section 743(b) adjustment must account for OPLLC’s negative capital of $912 million and its unconditional obligation to restore this negative balance through a contribution of additional cash upon liquidation or recognition as a liability. See I.R.C. § 752; Treas. Reg. §§ 1.743-1(d)(1)(i), 1.704-1(b)(2)(ii)(b)(3).

          In sum, we determine petitioner has not met its burden here and has failed to correctly establish the Basis Deduction under section 743(b), as claimed on OPLP’s 2012 Form 1065. Accordingly, we will sustain respondent’s disallowance of $713,759,615 of a more than $743 million claimed Basis Deduction reported on OPLP’s 2012 Form 1065 for the 2012 tax period.

Immediately after posting this, I read this blog: Marcy Wheeler, The Bullshit about John Roberts’ Tolerance for Bullshit (Emptywheel 2/27/26), here. The context is not the same, but the use of the term bullshit is the same. (JAT opinion: Emptywheel is a great blog.)