Tax Court in Unanimous Reviewed Opinion Interprets and Applies the Accuracy-Related Economic Substance Penalty (11/12/25)

In Patel v. Commissioner, 165 T.C. ___, No. 10 (11/12/25) (unanimous reviewed opinion), the Tax Court (Judge Jones) applied the interpreted the requirements of the accuracy-related penalty for transactions that lack economic substance, § 6662(b)(6), which applies the economic substance doctrine as codified under I.R.C. § 7701(o). The Opinion (for which there is yet no Tax Court permalink, may be reviewed in the Tax Court docket entries for the lead case, here at # 421, dated 11/12/25, on my Google Drive here, on TN here, and on GS here. The transaction at issue was yet another captive insurance case, but addressed for the first time the economic substance accuracy-related penalty.

The Tax Court earlier had shot down the particular captive insurance on the substantive tax merits in Patel v. Commissioner (Patel I), T.C. Memo. 2020-133, here, and Patel v. Commissioner (Patel II), T.C. Memo. 2024-34, here. The new Patel opinion addresses penalty issues not resolved in the prior opinions.

The new Patel opinion offers a relatively straightforward application of the statutory text to a transaction that, in my opinion from the prior Patel opinions, lacked economic substance and was the type of transaction to which the penalty should apply. Indeed, I think the Court’s application of the principles of statutory interpretation, although I think wooden, are what the current judicial environment requires (including a bow to legislative history “For those who consider legislative history relevant.” (Slip Op. 18-19); as phrased, it is not clear whether Judge Jones for the Court felt legislative history was relevant).

Readers of this blog entry are directed to the opinion for the Court’s reasoning and steps.

JAT Comments/Musings:

I offer just the following comments that caught my specific attention as I wandered through the Opinion (in order as they arise in the opinion and not necessarily in order of importance):

1. A host of amici briefs were filed; they are identified at Slip Op. 2 n. 2. The Opinion identifies the amici briefs in the footnote but otherwise does not refer to them. The footnote does add: 

At respondent’s request, we ordered the parties to file briefs in response to the amicus briefs. At the parties’ request, we held oral argument on the issues raised by the briefs.

I have not seen the amici briefs but, since the Court does not refer otherwise to them, I am not going to speculate what effect amici briefs had to the outcome. I will say that I have known the Patels’ lead counsel for some time, he is a very good tax litigator, and assume that he covered the bases in the briefs on which his name appears.

2. The Opinion says (Slip Op. 3 n. 5): “We understand the interaction of section 6662(a) and (b)(6) to impose a single penalty. Because the Commissioner determined that penalty for multiple years (each of the tax years at issue), we will refer to it in the plural (penalties).” Think about that unexplained comment.

3. The Opinion says (Slip Op. p. 4): “After reading books on asset management and captive insurance, Dr. Patel decided to form a captive insurance company.” I think that sets up the further discussion  (and smackdown) of Dr. Patel’s reasonable cause/good faith defense. In my practice, I generally found that often doctors had an inflated opinion of their ability to determine tax law better than tax lawyers.

4. The Opinion says (Slip Op. 5.) that 

Dr. Patel retained Mr. Coomes—a tax attorney who has focused his practice on captive insurance, as well as business and estate planning—to help form a captive. Id. at *8–9. Mr. Coomes does not have formal training in captive insurance or writing insurance policies. Id. at *9. Rather, he learned to write insurance policies by self-study, including reviewing commercial insurance policies, reading articles, and studying books. Id.

Coomes’ web site is here.

5. Mr. Coomes prepared a business plan that described as follows (Slip Op. 6.):

The record establishes that the business plan was created to serve as justification to form a captive—after the decision had already been made—not to analyze whether a captive was necessary. See id. at *11. No person associated with Magellan completed a feasibility study to determine the costs and merits of a captive arrangement for Dr. Patel’s businesses. Id. Moreover, neither Dr. Patel nor his advisers explored the cost and availability of the same policies on the commercial market. Id.

 6. The opinion says (Slip Op. 8.):

          In an effort to legitimize the microcaptives he formed, Mr. Coomes formed Capstone Reinsurance Co., Ltd. (Capstone). Id. at *9. Microcaptives—including Magellan and Plymouth—participated in a purported risk pool through Capstone via two written agreements: (1) a Reinsurance Agreement and (2) an accompanying Quota Share  Retrocession Agreement. Id. at *22. These agreements created a circular flow of funds whereby participants paid 51% of their premiums into the pooling arrangement as part of the reinsurance agreement. Id. at *23. And in less than a year, they received a significant percentage of funds back as part of the quota share agreement. Id.

          Magellan and Plymouth were no different. The money they paid under the Capstone agreements created a circular flow of funds such that OST, ICR, and SCR paid funds to Magellan (or Plymouth), those funds were paid to Capstone, and the money then flowed back to Magellan (or Plymouth). See id. at *39.

 7, The Opinion says (Slip Op. 8-9):

          Premium pricing for Magellan and Plymouth was developed to facilitate favorable income tax treatment for the Patels, not for business purposes. Although Mr. Rosenbach was retained to provide actuarially determined premium pricing, he did not do so. Id. at *9–10, *30. Instead, he was flexible in determining premium pricing, changing the premium amounts when requested to do so. Id. at *30.

          And although the Patels claimed that Mr. Rosenbach developed premium pricing for the captives, the record reveals that Dr. Patel provided target premiums he wanted to pay. Id. at *32. For example, in December 2012 Ms. Guerrero inquired via email: “Dr. Patel wanted to know what the max is that we can pay into the captive.” Id. at *32–33.

 * * **

          The foregoing facts demonstrate that the purpose of issuing policies through the microcaptives was to drive up premium prices to take advantage of the deductibility of premiums paid to the microcaptives. See §§ 162(a), 831(b). The record does not support a finding that the purpose of these transactions was to provide legitimate insurance coverage needs.

 8. The Opinion section starts with the usual discussion of burden of proof. (Slip Op. 11-13.) But the Opinion notes (p. 13 n. 12): “Regardless of who bears the burden of proof, there is ample support in the record demonstrating that the purported microcaptive arrangements lacked economic substance. See infra Opinion Part II.D.”

9. The Opinion gives a Brief History of the Economic Substance Doctrine. (Slip Op,. 13-15.) Nothing necessarily new or even particularly interesting there except the Court distinguishes “Frank Lyon Co. v. United States, 435 U.S. 561, 583–84 (1978) (allowing a transaction because it was a “genuine multiple-party transaction with economic substance which is compelled or encouraged by business or regulatory realities, is imbued with tax-independent considerations, and is not shaped solely by tax-avoidance features that have meaningless labels attached”)”

10. The Opinion makes much of the holding that § 7701(o)(5) has a “relevancy” requirement. (Slip Op. 17-19.) I am not sure what that is all about and think that § 7701(o)(5) would have applied even without that holding that relevance is required by the text.

11. The Opinion discusses The Patels’ "Argument That They Were “Congressionally Induced.” (Slip Op. 22-23.) I just ask whether that was an argument like the devil made me do it. I suppose the notion is that, if Congress “induced” the Patel conduct, it is OK or at least accuracy-related penalties should not apply.

12. The Opinion has the following cryptic statement (Slip Op. 27 n. 19): “The parties do not dispute—so we assume without deciding—that the deductions claimed for payments of purported policy premiums and other expenses on the Patels’ tax returns constitute “claimed tax benefits” within the meaning of section 6662(b)(6).” Why is not that holding required for the bottom-line?

13. The Opinion has the following in a footnote (Slip Op. 30 n. 21):

For the first time, in a footnote in a sur-reply, the Patels attempt to argue that “[t]he Notice 2016-66 invalidation and Forms 1120-PC negate Section 6662(i).” The Patels’ argument is not fully developed, and burying arguments in footnotes is seldom appropriate. See Nat’l Oilseed Processors Ass’n v. OSHA, 769 F.3d 1173, 1184 (D.C. Cir. 2014) (observing that courts generally decline “to consider an argument if a party buries it in a footnote and raises it in only a conclusory fashion”); Estate of Saunders v. Commissioner, 745 F.3d 953, 962 n.8 (9th Cir. 2014) (“Arguments raised only in footnotes, or only on reply, are generally deemed waived.”), aff’g 136 T.C. 406 (2011). Moreover, arguments made for the first time in a reply brief are deemed waived. See Considine v. Commissioner, 74 T.C. 955, 969–70 (1980) (characterizing as “untimely” and thus declining to consider an argument advanced for the first time in a reply brief); Ashkouri v. Commissioner, T.C. Memo. 2019-95, at *24 n.9 (“Having conceded an issue by failing to advance a meaningful argument on that issue in their opening brief, [the taxpayers] could not withdraw that concession by belatedly including a cognizable argument in their reply brief.”); see also United States v. Smith, 609 F. App’x 180, 185 (5th Cir. 2015).

 Whew!