Thursday, May 31, 2018

You And Your Shadow Do Not A Partnership Make

This post was originally published on Forbes Feb 23, 2015

Judge Holmes might have started his opinion on 436, LTD with a Casablanca reference - "Round up the usual suspects"

It was a Son-of- Boss deal and we have mentions in it of Jenkens & Gilchrist, KPMG and Deutsche Bank - certainly the usual suspects when Son-of-Boss shows up.

Judge Holmes, who is well known for his literary bent, had another angle.  The tax matters partner and principal of 436, LTD, Robert Heitmeier is an honest to goodness Mississippi river boat pilot, allowing Judge Holmes to freely quote from Mark Twain's Life On The Mississippi - "a pilot, in those days, was the only unfettered and entirely independent independent human being that lived in the earth".  If you haven't read Life on The Mississippi, well, what are you doing reading a tax blog?  Go read Life on the Mississippi and if, God forbid, you haven't read Roughing It, read that too.  You don't want to chance having a heart attack or something while reading another of my posts on Son-of-Boss deals and die without having read those two.

Riverboat Gamblers

As happens so often with Tax Court cases, the story behind the story is probably the more interesting part.  Robert Heitmeirer, as noted was a riverboat pilot.  In 1991, the state of Louisiana approved fifteen new riverboat casinos.  Captain Heitmeirer saw an opportunity reasoning that the Las Vegas casino operators probably did not know all that much about boats, what with Las Vegas being in a desert and all.  He established a business to provide maritime crews to the casinos.  Each riverboat need about sixty of Heitmeier's employees - four crews to give coverage 168 hours a week. Even when they figured out they could save on fuel by just leaving the boat at the dock, licensed crews were still required.  Eventually an operator that wanted to bring piloting services in-house bought Hetemeiers company for $4 million.  That payday is what sparked the interest in Son of Boss.

Peer Review Gone Bad

The mastermind behind this particular deal was Texas attorney Joe Garza.  The manner in which he connected to Heitemeirer is just a little disturbing and might want us to rethink the way the quality of public accounting firms is maintained.  Heitemeirer was of course concerned about the tax he would have to pay on the ship that had come in, thinking it might be ordinary income.  He spoke to his long time CPA, Walter Jones.  Jones had heard about something new that was going around and referred his client and friend to another CPA Ellis Roussel who worked for LeGlue & Co.  Roussel knew about the Son-of-Boss deal, but not in detail. He referred Captain Hetemeirer to Edward Turner, a Texas CPA who made the final hand-off to attorney Garza.

  Here is the disturbing part.  Turner knew Roussel because he had been on the peer review team for LeGlue & Co.  So here we have LeGlue & Co hiring somebody to come and torture them about their audit and financial statement quality (CPAs feel the same way about peer reviewers as the detectives on NYPD Blue felt about internal affairs - the rat squad) and he spends his time spreading tax mishegas.

Unrepresentative Representations

Some of the flaws that the Judge Holmes noted were flaws in execution that are indicative of the way these deals had become routinized.  That of course was their attraction to the professionals involve.  Big fees for little work.
Garza sent an opinion letter to Heitmeier dated December 30, 2001. The letter had about four pages of facts supposedly describing the transaction and over  80 pages of boilerplate language on tax-law doctrines--running the gamut from partnership-basis rules to treatment of foreign-currency contracts, the step-transaction doctrine, economic substance, disguised-sale provisions, and partnership anti-abuse regulations. The letter also concluded that the tax treatment Garza proposed would "more likely than not" withstand IRS scrutiny.
Garza, however, relied on certain "facts" to reach his "more likely than not" conclusion, and these "facts" were just plain wrong. Here are some of the key mistakes he made in the factual recitation section--the first four pages of each opinion: The opinion states that Heitmeier's transaction involved options on Canadian dollars, even though the options were on Japanese yen. The opinion states that Heitmeier made the listed representations, but he didn't. Garza made up the representations on his own. The opinion letter states that Heitmeier "believed there was [a] reasonable opportunity to earn a reasonable pre-tax profit from the transactions *** (not including any tax benefits that may occur), in excess of all the associated fees and costs."
Me And My Shadow

Here is the part that I found most interesting, arguably another flaw in execution.
One of the most important "partnership items" is whether a partnership is actually a partnership at all. The Commissioner says that 436 isn't a partnershipthat we should disregard it because it wasn't an entity separate from  Heitmeier and failed to satisfy the regulatory requirements to be treated as a partnership. Under the check-the-box regulations, if it doesn't make an election otherwise, an entity with only one owner is disregarded for tax purposes, and if the single owner is an individual, the regulations tell the Commissioner to treat the entity as a sole proprietorship. See supra note 9; see also Pierre v. Commissioner, 133 T.C. 24, 42-43 (2009) ("A sole proprietorship is generally understood to have no legal identity apart from the proprietor"). An entity with only one owner is thus ineligible for tax treatment as a partnership.
But 436's 2001 partnership return lists more than one owner: Heitmeier is the 99% limited partner and 94 is the 1% general partner. The Commissioner says this doesn't matter and argues that because 94 did not properly elect to be treated as a corporation, it is a disregarded entity. See sec. 301.7701-3(b)(1)(ii), Proced. & Admin. Regs. Since the parties stipulated that 94 never elected on Form 8832 to be classified as a corporation, we agree. 18 That means that Heitmeier, as the sole member of 94, will be treated as owning all of 436. And we disregard a  single-owner entity for tax purposes under sections 301.7701-2(a) and301.7701-3(b)(1)(ii), Proced. & Admin. Regs., unless it elects to be taxed as a corporation.
The key to Son-of-Boss was a paired currency option.  When you contribute the paired option to the partnership you don't treat your obligation to perform on one side as a liability, but you claim corresponding basis on the other side anyway.  Essentially you have an unbalance entry, which is why normal accountants have such a hard time understanding the deals.  Anyway without a partnership, you can't even pretend that the whole things work.

I don't think it is news that you can't create a partnership with yourself and a disregarded entity, but it is a point that bears repeating.  You can see it  happening in the family limited partnership space.  I haven't thought through whether that would be fatal to discounts, but the notion makes me very uncomfortable.

Sometimes It Is Better To Just Pay The Taxes

Heitmeier had no luck getting out of the penalties.  Garza's opinion was no good, since he was a promoter and his other advisers did not pretend to understand the deal.
Heitmeier's lack of good faith and reasonable reliance is even more obvious when we turn to the other three professionals involved: Jones, Roussel, and Giardina. All three refused to endorse the proposed Garza transaction or provide any encouragement to Heitmeier other than advising him how to report it on his tax returns. Jones made clear at the outset that the Son-of-BOSS transaction was "out of his realm" and that he had no interest in even trying to understand it. Roussel and Giardina spent months trying to decide if they could endorse the transaction, and ultimately they didn't. Heitmeier could not have reasonably relied on Roussel's or Giardina's opinions in moving forward with the transaction, because the only opinions Roussel and Giardina provided were warnings that this was the type of transaction the IRS would likely go after. And their clearly  expressed reluctance to endorse the deal to their longtime client only blows another hole in Heitmeier's supposed good faith in relying on Garza.
Other Coverage

Michael Doyle also noted Judge Holmes's fine writing.
With a light touch, some refreshing clarity and a fond citation to Mark Twain, Tax Court Judge Mark Holmes in a decision Wednesday demonstrates once more his mastery of the art of judicial writing.
Lew Taishoff was intrigued by the introduction, but lost interest when he noted it was a Son-of- BOSS case.
But alas, it’s just another son-of-BOSS phony foreign exchange dodge, the only twist being that outside basis isn’t brought into play in this TEFRA case. Nonetheless, Pilot Bob’s tax dodge gets blown up, with heavy-duty substantial undervaluation penalties.

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