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"
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."
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.
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.
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.
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.