Tax Court Calls Out Yet Another Bullshit Tax Shelter and Imposes 40% Gross Valuation Misstatement Penalty (2/24/26)

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 [to come], 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):

• applied the 40% Substantial Valuation Misstatement and Gross Valuation Misstatement Penalties in § 6662(e)(1)(A) and I.R.C. § 6662(h) because the overstated basis well exceeded 200%
• did not apply the other § 6662 penalties because it found that the taxpayer qualified for the reasonable cause exception. 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 substantial authority statement surprised me since, as I read the facts as found and the law as held by the court, the opinions do not make sense. I would infer that the authors of the opinion (see particularly the Miscellanea observation #1 below) knew they were blessing (at least to the level of substantial authority) the creation of basis and deductions from nothing. And, of course, the taxpayer had to know that at some level they were claiming deductions they never paid for which might suggest that their reliance was more wink and nod than real reliance. But Judge Weiler reads the tea leaves (and life experience) differently than I do.

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. The opinion clearly states in the body (Slip 42):

          Since the adjusted basis of OPLLC originally claimed on the return was $744 million—which is well in excess of 200% of the amount determined here by this Court—we find that the adjusted basis reported by OPLP is a “gross valuation misstatement.” This finding triggers application of the 40% gross valuation misstatement penalty under section 6662(e)(1)(A) and (h) to those portions of the 2012  underpayment in excess of 200% of the adjusted basis amount, as permitted by respondent.

But in the Conclusion (Slip Op. 46), it says (bold-face supplied by JAT): 

       Principally, having determined that OPLP incorrectly determined its basis adjustment under section 743(b), we will sustain respondent’s disallowance of its Basis Deduction. We will further sustain respondent’s disallowance of its Basis Deduction having also determined, in the alternative, that the transactions at issue should be disregarded as shams lacking economic substance. However, on the basis of its established reasonable cause defense, we will overrule respondent’s imposition of penalties in this case.

The bold-face statement is not accurate because the Court did sustain the “gross valuation misstatement” penalty In any event, this will certainly be flushed out in the Rule 155 calculations where the parties by agreement or the Court reconciles the numbers to the opinion for entry of the decision.

4. 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.