The Economic Substance Doctrine ("ESD")--the Common Law and § 7701(o) (3/31/26; 4/8/26)

In Royalty Management Ins. Co., Ltd. v. Commissioner, T.C. Memo. 2026-26 (T.C. No. 3823-19, here, at #338 and GS here), Judge Lauber smacked down another bullshit tax shelter of the microcaptive insurance genre. This opinion is a follow-through from a prior opinion, Royalty Management Ins. Co. v. Commissioner, T.C. Memo. 2024-87 (GS here). I refer to the prior case as Royalty Mgmt 1 and the current case as Royalty Mgmt 2.

Royalty Mgmt 2 was required because Judge Lauber deferred resolving in Royalty Mgmt 1 the economic substance doctrine (“ESD”) issues (including the codified ESD in § 7701(o) and the accuracy-related penalty for shelters running afoul of the codified ESD in § 6662(b)(6), (i)). In the meantime, the Tax Court had decided Patel v. Commissioner, 165 T.C. ___, No. 10 (11/12/25), GS here, which I discussed Tax Court in Unanimous Reviewed Opinion Interprets and Applies the Accuracy-Related Economic Substance Penalty (11/12/25), here. In material part, Patel held that the codified ESD doctrine in § 7701(o) has a predicate “relevance” requirement. So, Judge Lauber in Royalty Mgmt 2 applied that requirement as a predicate for finding the petitioner liable for the accuracy-related penalty for lack of economic substance. The kerfuffle over whether § 7701(o) has a predicate requirement and precisely what the requirement is and how it may be applied is not relevant to the main body of this blog, so I will defer here and discuss that alleged predicate requirement in my comments below. I do point persons interested in the issue at Royalty Mgmt 2 at pp. 3-4.

Judge Lauber goes through (pp. 5-9) the standard ESD requirements—objective and subjective tests, both of which on the facts found, the petitioner flunked.

Having flunked the ESD test, petitioner drew the increased accuracy-related penalty in § 6662(b)(6), (i). (See pp. 9-11.)

JAT Comments:

Tax Court Rejects Too Good to be True Tax Shelter Defense Based on Tax Opinion Purchased to Support a Reasonable Cause Defense (5/17/25)

In Stevens v. Commissioner, T.C. Memo. 2025-45, TCM here * & GS here, the court rejected the taxpayer’s arguments for the merits of the bullshit, “too good to be true,” tax shelter. Most of the findings of facts and opinion relate to the merits. As usual, the shelter was effected through a shroud of complex financial documents that, in the end, signified nothing that was cognizable for tax purposes. 

* Readers wishing to access the opinion through the docket entries may do so here at docket # 199.]

I find the penalties interesting because the taxpayers recognized that the shelter might be subject to penalties and, for that reason, “purchased” a tax opinion that, they hoped, would protect them against penalties if the IRS saw through the smoke and mirrors in the documents and disallowed the tax benefits of the shelter. Here are some quotes from the opinion (boldface supplied by JAT):

In July 2014 Shannon Stevens [the wife-taxpayer] became concerned with the risk of tax penalties if SLS engaged in the Dermody transaction and claimed interest deductions related to it. Shannon Stevens was the longtime owner and operator of her own accounting firm. She had substantial experience preparing tax returns for individuals and small businesses. She discussed with both Dermody and Witten her concern about tax penalties.

 On July 29, 2014, Dermody sent Shannon Stevens a sample tax opinion letter relating to a transaction of a different type from the Dermody transaction. Dermody recommended that she obtain a tax opinion letter about the Dermody transaction.

 On July 30, 2014, Gopman spoke to Witten and recommended to Witten that petitioners obtain a tax opinion letter from Jeffrey Rubinger, a tax attorney. On July 30, 2014, Witten emailed Shannon Stevens with a copy to Kirk Stevens and Gopman. Witten recommended that petitioners obtain a tax opinion letter for their “protection.” Witten stated that a tax opinion letter could be obtained from Rubinger “for a reasonable price.” In a separate communication with Shannon Stevens, Witten specifically suggested that a tax opinion letter could be obtained from Rubinger for $10,000.

The estimated cost of the opinion letter was too low; the opinion letter ultimately cost $40,000.

Tax Court Rejects Bullshit Syndicated Conservation Easement Shelter for the Usual Reasons (3/31/25)

In Ranch Springs, LLC v. Commissioner, 164 T.C. ___, No. 6 (3/31/25), links below *, the Tax Court rejected another bullshit tax shelter, here of the syndicated conservation easement ilk. The fact pattern for this ilk of bullshit tax shelter may be simply stated: a grossly overvalued property contributed to charity for charitable easement purposes. The holding highly summarized is:

• the real value is determined in an amount grossly less (joining grossly and less may not be good English, but readers will get the concept); and
• the 40% gross valuation misstatement penalty applies because, well, the valuation was grossly misstated.

A more detailed summary is found in the Syllabus and, for those wanting more, in the 66-page opinion (actually 64 excluding the caption and the Syllabus), but that is the guts of the holdings.

These are unexceptional holdings, in my opinion, so I am not sure why the Court designated this a “T.C.” opinion rather than a “T.C. Memo.” opinion. The parts I found interesting (set forth below) are hardly the stuff of which T.C. opinions are usually made. Perhaps the reason is in the third “Held” conclusion in the Syllabus relating to the proffered “before value” found to be erroneous as a matter of law as follows:

Held, further, assuming arguendo that limestone mining was a permissible use, the version of the income method P’s experts used to determine the “before value” of the property is erroneous as a matter of law because it equates the value of raw land with the net present value of a hypothetical limestone business conducted on the land. A knowledgeable willing buyer would not pay, for one of the assets needed to conduct a business, the entire projected value of the business.

. Oh well…..

So, what did I find interesting?

Tax Court Rejects Bullshit Grossly Overvalued Conservation Easement Claim (7/19/24; 11/7/25)

Added 11/7/25: On November 5, 2025, the Sixth Circuit affirmed the Tax Court opinon reported in the blog below. Corning Place Ohio, LLC v. Commissioner, ___ F.4th ___ (6th Cir. 11/5/25), CA 6 here and GS here. Nothing surprising in the affirmance, but the panel did designate the opinion by Judge Sutton for publication.

In Corning Place Ohio, LLC v. Commissioner, T.C. Memo. 2024-72, JAT Google Docs here and GS here, the Court (Judge Lauber) denied a charitable deduction for an alleged conservation easement and imposed accuracy-related penalties. The Court’s opening paragraph tells the story of a bullshit tax shelter, as so often these days, in the guise of a conservation easement (footnote omitted):

          This case presents what might be called the urban version of the conservation easement tidal wave that has deluged this Court. A partnership acquired a historic office building in downtown Cleveland, Ohio, and proceeded to renovate it into luxury [*3] apartments. The renovation was undertaken pursuant to a “rehabilitation plan” approved by the National Park Service (NPS) and the State of Ohio, both of which awarded historic preservation tax credits. The partnership used the tax credits to finance the renovation.

          Gilding the lily, the partnership then granted a conservation easement over the very same property, claiming a $22.6 million charitable contribution deduction on the theory that it had relinquished valuable development rights. The “lost development rights” allegedly consisted of the notional opportunity to add a 34-story vertical addition on top of the historic building. Apart from being structurally implausible and economically unsound, adding 34 floors of steel and concrete atop the building would have required the partnership to forfeit the Federal and Ohio tax credits upon which it relied to finance the renovation. As a condition of receiving those credits, it had pledged that the rehabilitation plan would entail no rooftop improvements “visible from the street.”

          Needless to say, a 34-story addition on top of the building would have been visible from the street. Finding that the 34-story tower was a chimerical concept ginned up solely to support a wildly inflated appraisal, we will sustain the Commissioner’s disallowance of the charitable contribution deduction and his imposition of a 40% penalty under section 6662(h) for a “gross valuation misstatement.”

I include at the end of this blog entry several quotes from the opinion that I thought particularly good to show the perfidy of the actors involved in the drama. First, I will address two tax procedure issues:

Grossly Overvalued Conservation Easement Disallowed in Full and Gross Valuation Misstatement Penalty Applied (2/24/24)

In Oconee Landing Property, LLC v. Commissioner, T.C. Memo. 2024-25 (2/21/24), GS here, the Court (Judge Lauber) denied the charitable contribution deduction because

• the allegedly relied upon appraisers were not “qualified appraisers” because the petitioners knew the property was worth only a fraction of the appraisers’ opined values (Slip Op. 39-48; and
• the property was “ordinary income property” in the hands of the promoters and that character carried over to the partnership, thus limiting the charitable deduction to the promoters basis. Petitioner supplied “no evidence” of that basis. (Slip Op. 48-57.)

Further, the Court held that, although entitled to no deduction, the Court still had to determine the value of the contributed easement to determine whether the valuation misstatement penalties applied. § 6662(a), (b)(3). The penalties are 20% if the valuation is substantial—i.e., 150% or more of the correct value--and 40% if the valuation is gross—200% or more of the correct value. (Slip Op. 74, citing § 6662(h) and § 6662(h)(2)(A)(i), respectively.) The value of the easement claimed on the return was $20.67 million but the value determined “was no greater than $4,972,002, thus the claimed value “exceeded the correct value by 416%.” (Slip Op. 74-75.)

In support of the first holding (not qualified appraisers), the Court said (Slip Op. pp. 45-46):

A person who achieves an advance agreement with an appraiser that property will be overvalued—knowing that it is being overvalued—cannot establish good faith reliance on professional advice that the appraisal is acceptable. n14

But there is more in the indicated footnote, the Court said (Slip Op. 46):

   n14 In its opening post-trial brief petitioner asserted that the regulations governing qualified appraisals and qualified appraisers “did not go through a proper notice-and-comment process and are, therefore, invalid.” That assertion occupied a single sentence; petitioner supplied no argument in support of that assertion, stating that “the Court need not reach that issue in this case.” And in its post-trial Answering Brief petitioner did not mention any challenge to the validity of Treasury Regulation § 1.170A-13(c)(5)(ii), or any other provision of the regulations, based on the Administrative Procedure Act (APA). Under these circumstances, petitioner has not properly presented or preserved an APA challenge to any regulation discussed in this Opinion.