Another Bullshit Tax Shelter Goes Down; On Frank Lyon (4/17/25)

Judge Lauber nails another bullshit tax shelter in GWA, LLC v. Commissioner, T.C. Memo. 2025-34, TC here at Dkt # 357, GS here [to come] and TN here. Suffice it to say that Judge Lauber was not confused by the smoke and mirrors the taxpayer threw up on the proverbial wall. The key issue is whether the financial contract was an option contract or an ownership contract. For the tax benefits, the taxpayer wanted to treat it as an option contract, the form in which it appeared; the taxpayer argued it was an option contract that permitted deferral and ultimate favorable tax treatment; the IRS asserted it was an ownership contract not allowing such treatment. Other issues were (i) whether the treatment as an ownership contract was, under the facts, a change of accounting requiring a § 481 adjustment (it did) and (ii) whether the taxpayer was subject to penalties (it is).

I write to discuss the role of Frank Lyon Co. v. United States, 435 U.S. 561, 573 (1978) in the opinion. Frank Lyon was a disaster of an opinion, and my principal poster child as to why tax cases are too important to have the Supreme Court decide them. (That is hyperbole, of course, but not much.) In Frank Lyon, the Court, while nominally honoring the venerable tax concept of substance over form, entered a fact-intensive multi-element inquiry to bless the form of a sale-leaseback transaction with tax ownership benefits (depreciation) going to the nominal lessor (Frank Lyon). I think that most careful observers of Frank Lyon believe that Frank Lyon was incorrectly decided. E.g., Charles I. Kingson, How Tax Thinks, 27 Suffolk U. L. Rev. 1031, 1034-35 (2004). “few [tax] shelters are shoddier than those approved by the Court in Lyon and Brown [Commissioner v. Clay B. Brown, 380 U.S. 563 (1965)]”; and Bernard Wolfman, The Supreme Court in the Lyon's Den: A Failure of Judicial Process, 66 Cornell L. Rev. 1075, 1098 (1981). Still, perhaps saving the day, courts generally find enough in Frank Lyon to reject bullshit tax shelters, as Judge Lauber did in GWA, LLC v. Commissioner.

I won’t get into a back story on Frank Lyon in which I was peripherally involved at DOJ Tax. Perhaps I will write on it sometime, in order to explain why, in my judgment, the Court imprudently granted the petition for certiorari in the first place and then wrote the opinion the way it did (in my view imprudently, rather than DIG the case). Nevertheless, that should not detract from the opinion on its four corners. Since Frank Lyon, most of the bullshit tax shelter legal opinions cite and claim to rely on Frank Lyon. Most judicial opinions cite Frank Lyon in shooting down bullshit tax shelters.

In GWA, LLC v. Commissioner, Judge Lauber deploys Frank Lyon to shoot down the bullshit tax shelter. See particularly Slip Op. pp. 45-46, 70, 72, 88-92 (discussing Frank Lyon’s “more than 20 factors” bearing on substance over form, 132-133.) The Court addressed Frank Lyon in the penalty discussion as follows (p. 132-133):

Finally, petitioner contends that Frank Lyon supplies authority for GWA’s return positions. But the Supreme Court in that case addressed a sale-and-leaseback transaction, not a putative call option. And the analysis the Court conducted—considering the application of 20+ factors bearing on “the substance and economic realities of the transaction”—does not remotely support characterizing the Barrier Contracts as genuine call options. See supra pp. 45–92. Because the Barrier Contracts displayed none of the essential economic and legal characteristics of true options, their substance could not possibly be viewed as matching their form.62
   n62 The parties disagree over whether the “reasonable basis” standard is a subjective or an objective one, i.e., whether petitioner must establish GWA’s actual reliance on the authorities that allegedly supported GWA’s return positions. See Wells Fargo & Co. v. United States, 957 F.3d 840, 852 (8th Cir. 2020) (finding that the standard is subjective); TIFD III–E Inc. v. United States, 8 F. Supp. 3d 142, 151 (D. Conn. 2014) (finding it objective), rev’d on other grounds, 604 F. App’x 69 (2d Cir. 2015). We need not resolve that disagreement here because none of the authorities cited by petitioner plausibly supports the positions GWA took on its returns, regardless of whether Mr. Gendreau or another GWA member actually relied on them.

Another interesting aspect of that discussion appears in footnote 29 on p. 92:

   n29 Petitioner contends that, under Frank Lyon as applied in the Second Circuit, the presence of some business purpose underlying a transaction precludes application of the substance-over-form doctrine. In advancing this contention, petitioner seems to confuse the substance-over-form inquiry with the “economic substance” doctrine, which the Second Circuit and this Court recognize as distinct. See supra p. 46 & note 15. In any event, we reject petitioner’s view. What the Supreme  Court and the Second Circuit require is a fact-intensive analysis into “the objective economic realities of [the] transaction.” Altria Grp., 658 F.3d at 284 (quoting Frank Lyon, 435 U.S. at 573). Our multifactor analysis shows that the Barrier Contracts lacked the essential legal and economic characteristics of true options.

Early when I entered private practice in Houston, I was consulted on a proposed sale-leaseback to obtain the Frank Lyon results. I recommended that they clone every feature of the Frank Lyon transaction and, if possible, change the names of the parties to Frank Lyon Co., and Worthen Bank. That was hyperbole, but not much.

Finally, I suggest to readers that, if you see Frank Lyon cited in a legal opinion appearing to support a transaction with a “too good to be true” tax benefit, be suspicious.