Stobie Creek Investments LLC v. United States , 93 Fed. Cl. 1366 ( 2010 )


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  •   United States Court of Appeals
    for the Federal Circuit
    __________________________
    STOBIE CREEK INVESTMENTS LLC,
    JFW ENTERPRISES, INC.,
    TAX MATTERS AND NOTICE PARTNERS; AND
    STOBIE CREEK INVESTMENTS LLC,
    BY AND THROUGH
    JFW INVESTMENTS, LLC,
    TAX MATTERS AND NOTICE PARTNER,
    Plaintiffs-Appellants,
    v.
    UNITED STATES,
    Defendant-Appellee.
    __________________________
    2008-5190
    __________________________
    Appeal from the United States Court of Federal
    Claims in 05-CV-748 and 07-CV-520, Judge Christine
    O.C. Miller.
    __________________________
    Decided: June 11, 2010
    __________________________
    ROBERT E. KOLEK, Schiff Hardin LLP, of Chicago, Illi-
    nois, argued for plaintiffs-appellants. With him on the
    brief were NEIL LLOYD and THOMAS R. WECHTER. Of
    counsel was COLLEEN FEENEY ROMERO.
    STOBIE CREEK INVESTMENTS   v. US                        2
    JUDITH A. HAGLEY, Attorney, Appellate Section, Tax
    Division, United States Department of Justice, of Wash-
    ington, DC, argued for defendant-appellee. With her on
    the brief were JOHN A. DICICCO, Acting Assistant Attorney
    General, GILBERT S. ROTHENBERG, Acting Deputy Assis-
    tant Attorney General, and RICHARD FARBER, Attorney.
    __________________________
    Before BRYSON, PROST, and MOORE, Circuit Judges.
    PROST, Circuit Judge.
    This tax refund suit concerns a series of transactions
    exemplifying the Son of BOSS 1 tax shelter, marketed here
    as the Jenkens & Gilchrist (“J & G”) strategy. The shel-
    ter took advantage of the fact that assets and contingent
    liabilities were treated differently for tax purposes when
    contributed to a partnership, thus enabling the taxpayer
    to generate an artificial loss. See 
    26 U.S.C. §§ 722
    , 733,
    752, 754; see also IRS Notice No. 2000-44, 2000-
    2 C.B. 255
    , 
    2000 WL 1138430
    . This artificial loss is then used to
    offset income from other transactions.
    In this case, the taxpayers used the J & G strategy to
    inflate the basis of their stock in the Therma-Tru family
    business, thereby eliminating more than $200 million in
    capital gains (and avoiding $4 million in taxes) resulting
    from the sale of that stock. The Internal Revenue Service
    (“IRS”) subsequently determined that the partnership
    used to implement the J & G strategy, Stobie Creek
    Investments LLC (“Stobie Creek”), was a sham. Based on
    1    “BOSS” is an acronym for “Bond and Option Sales
    Strategy.” Son of BOSS is a variation on the BOSS tax
    shelter. Kornman & Assocs. v. United States, 
    527 F.3d 443
    , 446 n.2 (5th Cir. 2008).
    3                          STOBIE CREEK INVESTMENTS   v. US
    this determination, the IRS disallowed the partnership’s
    stated basis in the stock, increased the partnership’s
    capital gain from the sale of that stock, and assessed
    additional taxes.
    Stobie Creek, JFW Enterprises, Inc., and JFW In-
    vestments, LLC (collectively, “plaintiffs”) then filed this
    refund suit in the United States Court of Federal Claims,
    contesting the Notices of Final Partnership Administra-
    tive Adjustment (“FPAAs”) in which these determinations
    were made. Following a bench trial, the Court of Federal
    Claims upheld the FPAAs and associated penalties,
    concluding that the basis-inflating transactions were
    properly disregarded under the economic substance
    doctrine. Stobie Creek Invs., LLC v. United States, 
    82 Fed. Cl. 636
    , 701-02, 721 (2008). Plaintiffs now appeal
    the application of the economic substance doctrine, accu-
    racy-related penalties, and an evidentiary ruling made
    during trial. We affirm.
    This case turns on whether a series of transactions
    was properly disregarded under the economic substance
    doctrine, despite complying with the literal terms of the
    tax code. We conclude that the answer is yes. The trial
    court properly disregarded the transactions as lacking an
    objective economic reality; the taxpayers failed to show
    that the transactions were undertaken for any business
    purpose beyond obtaining a tax benefit. Accordingly,
    Stobie Creek, acting through Jeffrey Welles, was properly
    subject to accuracy-related penalties pursuant to 
    26 U.S.C. § 6662
    . Because it was not reasonable for Stobie
    Creek to rely on advice of professionals involved in pro-
    moting and implementing the tax shelter, the narrow
    reasonable-cause defense in 
    26 U.S.C. § 6664
    (c)(1) does
    not apply.
    STOBIE CREEK INVESTMENTS   v. US                        4
    BACKGROUND
    The taxpayers in this case are six members of the
    Welles family and the Welles trust (collectively the
    “Welleses”). This case arises out of a series of events
    beginning in 1999, when the Welles family agreed to sell a
    controlling interest in the family business, Therma-Tru
    Corporation (“Therma-Tru”) to Kenner and Company
    (“Kenner”). Stobie Creek, 82 Fed. Cl. at 642. Patriarch
    and taxpayer David Welles Sr. (“David Welles”) started
    what became Therma-Tru in 1962, when attorneys from
    the law firm of Shumaker, Loop & Kendrick, LLP (“SLK”)
    helped him purchase a lumberyard. Therma-Tru subse-
    quently grew into one of the leading manufacturers and
    sellers of residential entry doors. Id. at 641.
    Over the years, the Welles family retained SLK for a
    variety of legal matters, including the Therma-Tru deal
    with Kenner. David Waterman (“Waterman”) was the
    principal SLK attorney representing the Welleses in the
    transaction. The deal called for Kenner to infuse Therma-
    Tru with cash equal to a 50% equity position. At the
    same time, Therma-Tru shareholders would redeem 50%
    of their stock for cash. Because the deal involved Kenner
    paying cash for stock, the Therma-Tru shareholders
    would be taxed on their redemption of stock for cash. The
    Welles family planned to redeem 50% of their stock for
    approximately $215 million in cash. Because of their low
    basis in the stock, the redemption was expected to pro-
    duce more than $200 million in capital gains.
    Before the sale to Kenner was finalized, Jeffrey
    Welles asked Waterman whether there were any strate-
    gies for reducing the taxes the Welles family would oth-
    erwise owe on the planned sale. Id. at 643. Jeffery
    Welles is the son of Therma-Tru founder David Welles
    5                          STOBIE CREEK INVESTMENTS   v. US
    and the primary investment adviser to Therma-Tru and
    the Welles family. Prior to assuming this role, Jeffrey
    Welles worked in investment banking with Goldman
    Sachs and Lazard Freres. Id. at 641. In response to
    Jeffrey Welles’s request, SLK contacted the law firm
    Jenkens & Gilchrist, P.C. (“J & G”). Waterman had
    previously referred other SLK clients with similar re-
    quests to J & G. In those cases, as here, Waterman and
    SLK then helped the clients implement a strategy 2 devel-
    oped and marketed by J & G.
    To learn the details of the J & G strategy, the Welles
    family signed confidentiality agreements prepared by
    Donna Guerin, a partner at J & G. Id. at 643. In Janu-
    ary 2000, the Welles family met in Vero Beach, Florida, to
    discuss various matters related to the pending Therma-
    Tru deal with Kenner (the “Vero Beach meeting”). During
    the two-day meeting, Waterman gave a presentation on
    the J & G strategy. Id. at 645. Among the materials
    Waterman distributed and discussed was an executive
    summary prepared by J & G, which gave a detailed
    overview of the J & G strategy. When asked whether he
    would engage in the J & G strategy if he were in the
    Welleses’ situation, Waterman said he would. Id. at 646.
    The goal of the J & G strategy was to reduce the capi-
    tal gain resulting from the sale of assets. The strategy
    reduced a taxpayer’s capital gain by increasing, or “step-
    ping up,” the basis in the asset the taxpayer wanted to
    sell. Because a partnership does not pay taxes, the result-
    ing stepped-up basis passes through to the partners,
    2  J & G called its strategy the “Basis Enhancing
    Derivatives Structure,” or BEDS. 82 Fed. Cl. at 643 n.6.
    We refer to it simply as the “J & G strategy.”
    STOBIE CREEK INVESTMENTS   v. US                          6
    thereby reducing the partner’s capital gain and attendant
    capital gains tax when the asset is sold. Id. at 645.
    To create a stepped-up basis in the asset, the J & G
    strategy called for contributions to a partnership, followed
    by distribution of the partnership’s assets to the taxpay-
    ers. This goal was accomplished through a sequence of
    six steps, carried out in a particular order to ensure the
    taxpayers received the desired tax benefit: (1) investment
    in foreign currency options through a single-member LLC;
    (2) formation of a partnership with a third party or
    wholly-owned S corporation; (3) contribution of the foreign
    currency options to the partnership; (4) recognition of an
    economic gain or loss by the partnership when the options
    expired or were exercised; (5) termination and liquidation
    of the partnership through contribution of the taxpayer’s
    partnership interest to an S corporation; (6) sale of the
    partnership’s assets by the S corporation or taxpayer. Id.
    Because of their importance to this appeal, steps 1, 3,
    and 5 warrant additional discussion here. Step 1 of the J
    & G strategy called for a particular type of investment in
    foreign currency: option spreads. To create an option
    spread, or “collar,” the taxpayer sells a short option and
    purchases a long option on the same currency.
    When the options are contributed to the partnership
    (here, Stobie Creek) during step 3, the taxpayer’s basis in
    his partnership interest is increased by the cost of the
    long option, but not decreased by the short option obliga-
    tion. Under the J & G strategy, the short option’s contri-
    bution has no effect on the taxpayer’s basis because it is
    not treated as a “liability” under 
    26 U.S.C. § 752
     when
    calculating the taxpayer’s basis in his partnership inter-
    est. When the partnership is liquidated during step 5, the
    tax basis in the partnership’s assets is “stepped up” to
    7                          STOBIE CREEK INVESTMENTS   v. US
    match the partner’s outside basis. This stepped-up basis
    allows the taxpayer to recognize less capital gain when
    the asset is sold during step 6.
    The Welles family decided to pursue the J & G strat-
    egy. To obtain help implementing the strategy, the
    Welleses agreed to pay a fixed fee to J & G and SLK.
    J & G received a fee equal to 2% of the total gain to be
    sheltered, or $4,091,500. SLK’s fee was 1% of the total
    gain to be sheltered, or $2,045,750. 
    Id. at 651
    .
    On March 3, 2000, the Stobie Creek partnership was
    formed.     Single-member limited liability companies
    (“LLCs”) were also formed for each family member, as
    well as the David Welles Qualified Annuity Trust (“Welles
    Trust”). To allow the LLCs to join Stobie Creek as part-
    ners, SLK attorneys prepared the corresponding paper-
    work, originally dated March 3, 2000. SLK asked Jeffrey
    Welles to review drafts of various documents, including
    the Stobie Creek company agreement and authorization
    for Stobie Creek to receive all cash proceeds from the
    Therma-Tru sale.
    Three days later, Waterman sent a letter to each of
    the Welleses. The letter “confirm[ed] and correct[ed]
    certain information [SLK] provided to” the Welleses at the
    Vero Beach meeting. Waterman stated that J & G would
    be issuing a tax opinion for the Welleses similar to the
    one attached to the letter, which would opine that it was
    “more likely than not” that the transactions would be
    respected for federal income tax purposes. 
    Id. at 647
    .
    Waterman also opined that recently issued federal regula-
    tions “did not appear to apply” to the Welles family, since
    the J & G strategy reduced only individual income tax
    liability, not corporate tax liability.
    STOBIE CREEK INVESTMENTS   v. US                         8
    Contrary to his prior recommendation, Waterman’s
    letter made a point of not recommending the J & G strat-
    egy: “I believe we [SLK] have been clear that we are not
    recommending that you pursue [J & G’s] proposal. In
    fact, we have advised you that our knowledge of J & G’s
    proposal was obtained in confidence under a confidential-
    ity agreement . . . [and] we are therefore unable to issue
    the opinion being offered by J & G.” While noting that
    the letter tried to distance Waterman and SLK from their
    prior promotion of the J & G strategy, the trial court
    nonetheless found that the legal advice of Waterman or
    SLK was tainted by self-interest. 
    Id. at 648
    . The trial
    court concluded that SLK was a broker for J & G’s strat-
    egy. 
    Id.
    Two weeks later, on March 20, 2000, SLK sent an
    email to J & G. Per the email’s request, J & G instructed
    Deutsche Bank to open accounts for each of the Welleses’
    single-member LLCs. SLK provided J & G and Deutsche
    Bank with a list showing the amount of capital gain each
    of the Welleses expected to realize upon redemption of
    their Therma-Tru stock. 
    Id. at 648
    . Deutsche Bank used
    this list to determine the stated premiums for the options
    the Welleses would be purchasing as part of the J & G
    strategy.     Deutsche Bank subsequently sent Jeffrey
    Welles sample confirmations for the type of digital options
    the Welleses were planning to acquire.
    On March 28, 2000, $2,045,750 was wired from the
    Welles trust to Deutsche Bank. Jeffrey Welles authorized
    the transfer, which paid for the options the LLCs were to
    acquire through step 1 of the J & G strategy. The amount
    corresponded to the difference between the stated premi-
    ums on the long and short options. Three days later, on
    March 31, each of the LLCs entered into two pairs of
    option contracts (collectively, the Foreign Exchange
    9                           STOBIE CREEK INVESTMENTS   v. US
    Digital Options Transactions or “FXDOTS”). The first
    pair was an option collar on the value of the Swiss franc
    (“CHF”) versus the United States dollar. The second pair
    was an option collar on the value of the United States
    dollar versus the euro. Both pairs of options were to close
    on April 17, 2000. Each option was digital, meaning the
    payoff was a fixed amount if the option expired “in the
    money” or nothing at all if the option expired “out of the
    money.” A long (call) option expires “out of the money” if
    the asset’s price is lower at the option’s expiration than
    the price of exercising the option to buy the asset. A short
    (put) option expires “out of the money” if the asset’s price
    is higher at the option’s expiration than the price of
    exercising the option to sell the asset. 
    Id.
     at 649 & n.9.
    On April 3, 2000, the LLCs transferred their option
    contracts to the Stobie Creek partnership.
    The option collar on the euro consisted of a purchased
    long option with a strike price of $0.9912 per euro and a
    sold short option with a strike price of $0.9914 per euro.
    The two-pip (two-thousands of a unit) spread between the
    two options, $0.9912 - $0.9914 per euro, was referred to as
    that option collar’s “sweet spot.” Using the LLC belonging
    to Jeffrey Welles as an example, if the euro traded at less
    than $0.9912 per euro on the option’s close date, the LLC
    (Jeffrey Welles) would lose $96,625. If the euro traded at
    more than $0.9914 per euro, he would gain $96,625. If
    the euro traded in the collar’s sweet spot (above $0.9912
    but below $0.9914), Jeffrey Welles would gain
    $19,228,357.
    Analogously, the option collar on the Swiss franc con-
    sisted of a purchased long option with a strike price of
    CHF 1.7027 per dollar and a sold short option with a
    strike price of CHF 1.7029 per dollar. The sweet spot for
    STOBIE CREEK INVESTMENTS   v. US                        10
    the Swiss franc option collar was again a two-pip spread,
    CHF 1.7027 – CHF 1.7029 per dollar. 3
    As shown in the table below, there were nine possible
    outcomes for Stobie Creek’s investments in the euro and
    Swiss franc digital options. The returns from these
    possible outcomes varied from a gain of $407 million
    (hitting both collars’ sweet spots) to a loss of $2 million
    (all options finishing out of the money).
    As the table shows, six of the nine possible outcomes yield
    a positive return. However, as the experts explained at
    trial, the outcomes were not all equally likely to occur.
    3    Again taking the LLC belonging to Jeffrey Welles
    as an example, if the Swiss franc traded at less than CHF
    1.7027 per dollar, the LLC (Jeffrey Welles) would lose
    $96,625. If the Swiss franc traded at more than CHF
    1.7029 per dollar, he would gain $96,625. If the euro
    traded in the collar’s sweet spot (above CHF 1.7027 but
    below CHF 1.7029), Jeffrey Welles would gain $19,228,357.
    11                          STOBIE CREEK INVESTMENTS   v. US
    On April 17, 2000, all of the options expired out of the
    money. Stobie Creek consequently lost its entire invest-
    ment of $2,045,750. On May 9, 2000, the Therma-Tru
    deal with Keener closed. 
    Id. at 650
    .
    After the close of the Therma-Tru deal (and long after
    the options expired), a series of emails and faxes passed
    among the Welleses, SLK, and J & G regarding the
    proper dates for documents related to the formation and
    transfer of partnership interests among the different
    corporate entities. SLK was responsible for preparing
    undated versions of some forms, which it then sent to J &
    G for review. At trial, the government introduced several
    copies of the assignment and joinder agreements transfer-
    ring the Stobie Creek partnership interests from the
    LLCs to the S corporations. Some were signed, others
    were not; some were undated, others bore various (con-
    flicting) dates. Upon learning that the Therma-Tru stock
    certificates had to be dated April 14, 2000, an attorney at
    SLK asked Guerin at J & G whether this posed a “timing
    issue,” though he believed the April 14th date “pose[d] no
    threat.” 
    Id.
     The trial court found that the “threat” re-
    ferred to the proper ordering of the transactions, which
    was necessary to achieve the strategy’s beneficial tax
    treatment. The “threat” was ultimately addressed by
    replacing the March 24, 2000 documents assigning each
    LLC’s interest in the Therma-Tru stock with documents
    dated April 14, 2000. Another series of emails between
    SLK and J & G concerned the date on which to “docu-
    ment” the shift of the partnership interests from the LLCs
    to the S corporations. SLK and J & G ultimately settled
    on April 30, 2000 because it enabled them to file a tax
    return for a short year. Other emails and faxes between
    SLK and J & G show that confusion (and re-dating) of
    documents continued through December 2000. 
    Id. at 651
    .
    STOBIE CREEK INVESTMENTS   v. US                         12
    In February 2001, Stobie Creek filed its federal in-
    come tax return for the tax period beginning on Stobie
    Creek’s formation date, March 3, 2000, and ending on
    April 30, 2000, the date when the partnership interests
    were documented as passing from the LLCs to the S
    corporations (the “2000 tax year”). 
    Id. at 657
    . In Febru-
    ary 2002, Stobie Creek filed its return for the tax period
    beginning May 1, 2000 and ending December 31, 2000
    (the “2000 stub year”).
    The IRS issued a FPAA for Stobie Creek’s 2000 tax
    year in March 2005. The IRS issued a FPAA for Stobie
    Creek’s 2000 stub year in February 2007. The FPAAs
    disregarded Stobie Creek for tax purposes as a sham and
    disallowed the partnership’s stated basis in the Therma-
    Tru stock, finding it attributable to transactions entered
    into for the purpose of tax avoidance. As a result, the
    FPAAs increased Stobie Creek’s capital gain income from
    the sale of the Therma-Tru stock and assessed over $4.2
    million in additional taxes. The FPAAs also imposed
    accuracy-related penalties pursuant to 
    26 U.S.C. § 6662
    .
    
    Id. at 702
    .
    Stobie Creek and the other plaintiffs filed this action
    in the Court of Federal Claims in July 2005. 
    Id. at 657
    .
    The complaint sought readjustment of partnership items
    for the 2000 tax year and 2000 stub year, as well as a tax
    refund of the $4.2 million assessed in the FPAAs.
    During a two week bench trial, the Court of Federal
    Claims heard testimony from several fact witnesses,
    including Waterman and Jeffrey Welles. Plaintiffs also
    presented three expert witnesses, Dr. Robert Kolb, Dr.
    Richard Levich, and Dr. Jeffrey Frankel. The government
    offered the testimony of one expert witness, Dr. David
    DeRosa. 
    Id.
     at 639-40 n.3. The trial court found that
    13                          STOBIE CREEK INVESTMENTS    v. US
    Stobie Creek’s basis calculations complied with the literal
    requirements of the tax code. 
    Id. at 670-71
    . In so finding,
    the trial court declined to apply Treasury Regulation §
    1.752-6 retroactively. 4 The trial court nonetheless disre-
    garded the transactions implementing the J & G strategy
    under the economic substance, step transaction, and end
    result doctrines. Id. at 671-702. In doing so, the court
    found that the plaintiffs failed to show the FXDOTs had a
    business purpose beyond creating a tax advantage. Id. at
    696. This finding was largely based on the nature of the
    investments: the trial court found that for the FXDOTs to
    make any profit, two historically correlated currencies—
    the Swiss franc and the euro—had to decouple and move
    in opposite directions. If the currencies moved in the
    same direction relative to the dollar, the most favorable
    outcome the Welleses could hope for was breaking even,
    or zero profit. Id. at 690.
    The trial court further found that Stobie Creek, acting
    through Jeffrey Welles, the manager of the tax matters
    partner for Stobie Creek, was liable for accuracy-related
    penalties under 
    26 U.S.C. § 6662
    . In so holding, the trial
    court rejected plaintiffs’ argument that the reasonable
    cause defense in 
    26 U.S.C. § 6664
    (c)(1) applied. The trial
    4    Had the trial court applied Treasury Regulation
    § 1.752-6 retroactively, plaintiff’s refund action would fail
    under the literal application of the tax code and treasury
    regulations because the short options would constitute
    liabilities for the purpose of 
    26 U.S.C. § 752
    , reducing the
    LLCs’ basis in their partnership interests.
    The government has not appealed the trial court’s
    holding on the retroactivity of Treasury Regulation §
    1.752-6. Accordingly, we do not decide whether Treasury
    Regulation § 1.752-6 applies retroactively because, even if
    it does not, the J & G strategy was properly disregarded
    under the economic substance doctrine.
    STOBIE CREEK INVESTMENTS   v. US                       14
    court found that Jeffrey Welles’s reliance on the profes-
    sional advice of J & G and SLK was not reasonable or in
    good faith, given that both firms had a clear conflict of
    interest and Jeffrey Welles’s own investment experience
    meant he would have recognized that the J & G strategy
    was “too good to be true.” Id. at 707-21.
    The plaintiffs now appeal. We have jurisdiction under
    
    28 U.S.C. § 1295
    (a)(3).
    ANALYSIS
    This case is governed by certain provisions of the Tax
    Equity and Fiscal Responsibility Act of 1982 (“TEFRA”),
    
    26 U.S.C. §§ 6221-6234
    . TEFRA created a unified part-
    nership-level procedure for auditing and litigating “part-
    nership items,” thus addressing concerns about
    inconsistent treatment of the same partnership items
    across partners. See Schell v. United States, 
    589 F.3d 1378
    , 1381 (Fed. Cir. 2009). Penalties related to adjust-
    ments of partnership items are also determined during
    the partnership-level proceeding. 
    26 U.S.C. §§ 6221
    ,
    6226(f).
    I. Economic Substance Doctrine
    The primary question before this court is whether the
    transactions implementing the J & G strategy were
    properly disregarded under the economic substance
    doctrine. We conclude that they were.
    How a transaction is characterized is a question of
    law we review de novo. Accordingly, we review the trial
    court’s application of the economic substance doctrine
    without deference. Coltec, 454 F.3d at 1357. The trial
    court’s underlying factual findings are reviewed for clear
    15                          STOBIE CREEK INVESTMENTS   v. US
    error. Jade Trading, LLC ex rel. Ervin v. United States,
    
    598 F.3d 1372
    , 1376 (Fed. Cir. 2010). Because deductions
    are a matter of legislative grace, the taxpayer has the
    burden of proving that a transaction had economic sub-
    stance by a preponderance of evidence. 
    Id.
    The economic substance doctrine seeks to distinguish
    between structuring a real transaction in a particular way
    to obtain a tax benefit, which is legitimate, and creating a
    transaction to generate a tax benefit, which is illegiti-
    mate. Coltec, 454 F.3d at 1357; see also Klamath Strate-
    gic Invest. Fund ex. rel St. Croix v. United States, 
    568 F.3d 537
    , 543-44 (5th Cir. 2009). Under this doctrine, we
    disregard the tax consequences of transactions that
    comply with the literal terms of the tax code, but nonethe-
    less lack “economic reality.” Coltec, 454 F.3d at 1355-56;
    see also Frank Lyon Co. v. United States, 
    435 U.S. 561
    ,
    583-84 (1978); Klamath, 
    568 F.3d at 544
    ; United Parcel
    Serv. of Am., Inc. v. Comm’r, 
    254 F.3d 1014
    , 1018 (11th
    Cir. 2001); ACM P’ship v. Comm’r, 
    157 F.3d 231
    , 247 (3d
    Cir. 1998); James v. Comm’r, 
    899 F.2d 905
    , 908-09 (10th
    Cir. 1990). Such transactions include those that have no
    business purpose beyond reducing or avoiding taxes,
    regardless of whether the taxpayer’s subjective motiva-
    tion was tax avoidance. Coltec, 454 F.3d at 1355 (citing
    Higgins v. Smith, 
    308 U.S. 473
    , 476 (1940)); Ballagh v.
    United States, 
    331 F.2d 874
    , 877-78 (Ct. Cl. 1964); see also
    Frank Lyon, 
    435 U.S. at 583-84
    ; Klamath, 
    568 F.3d at 544
    . We also disregard transactions shaped solely by tax-
    avoidance features. Frank Lyon, 
    435 U.S. at 583-84
    ; see
    also Coltec, 454 F.3d at 1355; Gregory v. Helvering, 
    293 U.S. 465
    , 469-70 (1935); Klamath, 
    568 F.3d at 544
    .
    Whether a transaction lacks “economic reality,” has no
    bona fide “business purpose” or was shaped solely by tax-
    avoidance features is an objective inquiry, evaluated
    prospectively. Coltec, 454 F.3d at 1356. In other words,
    STOBIE CREEK INVESTMENTS   v. US                          16
    the transaction is evaluated based on the information
    available to a prudent investor at the time the taxpayer
    entered into the transaction, not what may (or may not)
    have happened later.
    As they did at trial, the parties on appeal primarily
    focus on whether the FXDOTs should be disregarded
    under the economic substance doctrine. The plaintiffs
    argue that the FXDOTs should not be disregarded be-
    cause they were entered into with a bona fide business
    purpose: namely, profit from investing in foreign curren-
    cies.
    In a careful, well-reasoned opinion, the Court of Fed-
    eral Claims rejected plaintiffs’ argument. It then disre-
    garded the FXDOTs as lacking economic substance. In
    doing so, the trial court properly gave greater weight to
    the testimony of government expert Dr. DeRosa. The
    trial court did not clearly err in finding that Dr. DeRosa’s
    testimony provided the more convincing and complete
    methodology for determining how a “reasonable investor”
    would judge the profit potential of the FXDOTs. This
    analysis examined the probability of each outcome, the
    expected rate of return, and the price of the options,
    which are all factors a prudent investor might consider
    when deciding whether to invest. Stobie Creek, 82 Fed.
    Cl. at 685-89. The factors Dr. DeRosa considered were
    thus highly relevant to evaluating the central question
    about the FXDOTs: whether a prudent investor would
    have had a reasonable expectation of earning a profit
    from the transaction. See Coltec, 454 F.3d at 1357.
    Similarly, the trial court did not clearly err in finding
    that the selective and incomplete analysis of the plaintiffs’
    experts undermined their opinions that the FXDOTs had
    a “very substantial profit potential” (Dr. Kolb) or at least
    17                          STOBIE CREEK INVESTMENTS    v. US
    a modest profit potential (Dr. Levich). Stobie Creek, 82
    Fed. Cl. at 677-80. For example, although plaintiffs’
    expert Dr. Kolb testified that the nine possible outcomes
    were not equally probable, he did not calculate the prob-
    abilities of the different outcomes—even though these
    probabilities were essential to evaluating whether a profit
    potential existed. As the trial court correctly observed, no
    reasonable person would make an investment, no matter
    what the stated return, if the probability of achieving that
    return were zero. Id. at 691. The analysis of plaintiffs’
    second expert, Dr. Levich, was similarly incomplete. Dr.
    Levich estimated that the probability of obtaining a 2-to-1
    payoff on the FXDOTS was 9-21% on the dollar/euro
    options and 15-27% on the Swiss franc/dollar options; as
    for either or both options hitting the sweet spot (5 of the 9
    outcomes), Dr. Levich simply stated it would be a “rela-
    tively rare occurrence.” Id. at 680. The trial court prop-
    erly accorded Dr. Levich’s testimony little weight for two
    reasons. First, the trial court found Dr. Levich’s opinion
    was based on estimates of high volatility in the exchange
    rate, which the market data did not support. Second, the
    trial court found Dr. Levich’s opinion was undermined by
    the nature of the trades themselves: to return any profit-
    able outcome, the FXDOTs required two historically
    correlated currencies to decouple and move in opposite
    directions. So long as the currencies moved in the same
    direction (as they had historically), the most the Welleses
    could hope for was breaking even, or zero profit. 82 Fed.
    Cl. at 690. In light of the record, neither of these findings
    is clearly erroneous.
    Based on its evaluation of the expert testimony and
    supporting documentation, the trial court disregarded the
    FXDOTs under the economic substance doctrine. It
    concluded that the transactions did not reflect economic
    STOBIE CREEK INVESTMENTS   v. US                         18
    reality, nor were they motivated by a business purpose.
    Id. at 672-98, 701-02.
    We reach the same conclusion. Measured either by
    their economic reality or their purported business pur-
    pose, the FXDOTs were properly disregarded under the
    economic substance doctrine.
    A. Economic Reality
    A transaction lacks “economic reality” when the tax
    result (gain or loss) is “purely fictional.” See, e.g., Jade
    Trading, 
    598 F.3d at 1377
    . This inquiry often focuses on
    whether there was a reasonable possibility of making a
    profit from the transaction. See, e.g., Coltec, 454 F.3d at
    1356 (quoting Black & Decker Corp. v. United States, 
    436 F.3d 431
    , 441 (4th Cir. 2006)); see also Gilman v. Comm’r,
    
    933 F.2d 143
    , 146-47 (2d Cir. 1991) (asking whether a
    prudent investor would have found that a “realistic poten-
    tial for economic profit” existed). Thus, in Jade Trading,
    we held that the taxpayers were not entitled to a basis of
    over $15 million in their Jade partnership interests (and
    an attendant tax loss of $14.9 million) because they had
    not contributed $15 million to the partnership, nor had
    they lost $14.9 million on exiting the partnership. 
    598 F.3d at 1377
    . In so holding, we explained that the “[op-
    tion] transaction's fictional loss, inability to realize a
    profit, lack of investment character, meaningless inclu-
    sion in a partnership, and disproportionate tax advantage
    as compared to the amount invested and potential return,
    compel a conclusion that the spread transaction objec-
    tively lacked economic substance.” 
    Id.
    In this case, the FXDOTs lacked economic reality for
    at least two reasons: (1) the tax result flowing from the
    FXDOTs was purely fictional; and (2) there was no rea-
    19                         STOBIE CREEK INVESTMENTS   v. US
    sonable possibility that the FXDOTs would return a
    profit. We discuss each of these reasons in turn.
    First, as in Jade Trading, the $204,575,000 stepped-
    up basis in the Therma-Tru stock 5 was purely fictional:
    although the taxpayers only paid (and lost) about $2
    million for the FXDOTs, they claimed a basis of over $200
    million in their partnership interests, based on the con-
    tribution of those FXDOTs to Stobie Creek. See 
    598 F.3d at 1377
    . It is true that the taxpayers did purchase and
    contribute long options with a stated premium of
    $204,575,000 to Stobie Creek. However, they also sold
    and contributed short options with a stated premium of
    $202,529,250. Even though a literal application of the tax
    code at that time 6 may have permitted the taxpayers to
    treat these transactions separately, what matters under
    the economic substance doctrine is whether the tax
    treatment accords with economic reality.
    In our analysis, the FXDOTs are properly treated as a
    single, unified transaction. Such treatment is more
    consistent with what was actually paid for the FXDOTs
    and how Deutsche Bank, the broker for the options,
    treated the transaction. Because Deutsche Bank is a
    third party and the one that stood to lose if the invest-
    ments were not properly hedged, Deutsche Bank’s treat-
    ment is particularly probative. The evidence shows that
    Deutsche Bank netted the premiums of the long and short
    5  When the partnership interests were transferred
    from the LLCs to the S corporations, the basis in the
    Therma-Tru stock was stepped up to match the taxpayers’
    outside basis in the partnership, $204,575,000.
    6  The applicable regulations have since been
    amended. See 
    Treas. Reg. §§ 1.752-6
    , 1.752-7 (2009).
    STOBIE CREEK INVESTMENTS   v. US                       20
    options against each other, rather than require full pay-
    ment of the option premiums and deposits against the
    margin, as is typically required when such options are
    entered into separately. The netting of the premiums and
    absence of a margin requirement are strong evidence
    Deutsche Bank did not view the long and short options as
    separate (or separable) transactions. Indeed, because
    Deutsche Bank treated the FXDOTs as one transaction,
    the taxpayers only paid the difference between the pre-
    miums, $2,045,750, rather than the long option’s stated
    premium of $204,575,000. Thus, when the FXDOTs
    expired out of the money, the taxpayers lost only
    $2,045,750, not $204,575,000.
    Because the economic reality is that the long and
    short options were not separate, under the economic
    substance doctrine they similarly should not be separate
    for the purpose of calculating the taxpayers’ basis in
    Stobie Creek. Accordingly, the taxpayers’ claimed basis of
    $204,575,000 is properly disregarded as lacking economic
    reality; it does not reflect what the taxpayers paid
    Deutsche Bank for the FXDOTs ($2,045,757), or what
    they lost when the FXDOTs expired out of the money.
    The FXDOTs also lack economic reality because there
    was no reasonable possibility the FXDOTs would return a
    profit, due to a combination of factors. These factors
    included the nature of the market (i.e., the high positive
    correlation between the movement of the euro and Swiss
    franc), the overpricing of the option premiums, and the
    structure of the investment (i.e., the necessity of the
    currencies decoupling, the effectively nonexistent “sweet
    spot,” and the narrow range of the strike price). Cf.
    Klamath, 
    568 F.3d at 545
     (noting that the taxpayers
    designed the transactions and investment strategy “so
    there was no reasonable possibility of a profit”).
    21                          STOBIE CREEK INVESTMENTS   v. US
    The evidence presented at trial shows that for the
    FXDOTs to have made any profit, the historically corre-
    lated euro and Swiss franc would have had to decouple
    and move in opposite directions. Stobie Creek, 82 Fed. Cl.
    at 690. Taking probabilities into account reveals that five
    of the nine possible outcomes would never occur, because
    the sweet spots would never be hit. Government expert
    Dr. DeRosa explained that the sweet spots could never be
    hit because of the strike price’s narrow range (two pips)
    and Deutsche Bank’s wide latitude in deciding whether
    the FXDOTs were “in the money.” Id. at 686. In deciding
    whether a sweet spot had hit, Deutsche Bank could
    choose a quote’s bid price, ask price, or something in
    between. Nor was Deutsche Bank limited to a specific
    bank’s quote; it could solicit quotes from as many banks
    as it wanted and could choose among them. Further, the
    quotes Deutsche Bank received were three pips wide, and
    thus always greater than the two-pip spreads for the
    FXDOTs’ sweet spots. The unattainable nature of the
    sweet spots is supported by the way Deutsche Bank
    internally hedged the FXDOTs. The evidence shows
    Deutsche Bank manually changed the short component’s
    strike price for each option pair, eliminating the need for
    Deutsche Bank to internally hedge against the risk of
    hitting the sweet spot. Because there was effectively no
    sweet spot, the probability of any positive return was only
    11.43% for the dollar/euro options and 19.95% for the
    Swiss franc/dollar options. Id. at 688.
    The expected rates-of-return similarly show there was
    no reasonable possibility the FXDOTs would earn a profit.
    Expected rates of return are revealing, particularly if they
    account for costs and fees associated with implementing
    the transaction; a reasonable investor would consider
    such expenses when evaluating an investment’s likely
    profitability. Dr. DeRosa testified that the expected rate
    STOBIE CREEK INVESTMENTS   v. US                          22
    of return was -77.14% for the dollar/euro options and -
    60.10% for the Swiss franc/dollar options. Id. at 688.
    With J & G’s and SLK’s fees for implementing the trans-
    action included in the analysis, these rates were even
    more negative.
    Finally, the price the Welleses paid for FXDOTs
    strongly suggests the transaction lacked economic reality.
    The trial court sensibly reasoned that a prudent investor
    would not want to overpay for an investment, and would
    thus avoid a transaction in which the premiums were
    greater than the investment’s expected value. By this
    rubric, the FXDOTs were precisely the type of transaction
    a reasonable investor would seek to avoid: Although the
    theoretical value of the euro/dollar long options was only
    about $23.3 million, the premiums valued the options at
    $102.3 million, more than four times that amount. The
    Swiss franc/dollar options were similarly overpriced; the
    stated premiums valued the options at more than three
    times the options’ theoretical value. This disparity is far
    greater than the marginal variation Dr. DeRosa testified
    could occur, and there is no evidence of a market-related
    reason for the significant pricing difference.
    B. Business Purpose
    Asking whether a transaction has a bona fide busi-
    ness purpose is another way to differentiate between real
    transactions, structured in a particular way to obtain a
    tax benefit (legitimate), and transactions created to gen-
    erate a tax benefit (illegitimate). Coltec, 454 F.3d at 1357.
    We conclude that the FXDOTs fall in the category of
    “illegitimate” transactions identified in Coltec. See id.
    The evidence shows that the FXDOTs were part of a
    prepackaged strategy marketed to shelter taxable gain.
    23                         STOBIE CREEK INVESTMENTS   v. US
    Stobie Creek, 82 Fed. Cl. at 693-94. The Welleses sought
    out the J & G strategy not because they wanted to profit
    from investments in foreign currency (a legitimate pur-
    pose), but only because they wanted to lower their tax
    liability on the Therma-Tru deal, an unrelated transac-
    tion (an illegitimate purpose). Here the tax-avoidance
    motive preceded the “investment” strategy and any
    evaluation of profit potential; the FXDOTs (and the J & G
    strategy more generally) were simply a means to the
    desired end of creating a tax benefit.
    It is true that the Welleses implemented the J & G
    strategy for the purpose of minimizing the tax conse-
    quences of the Therma-Tru deal, a real transaction with
    economic substance. That connection in itself, however,
    does not legitimize the FXDOTs or the J & G strategy.
    Although the Welleses were unquestionably free to struc-
    ture the Therma-Tru deal to minimize their tax liability,
    the J & G strategy was not a way of structuring the
    Therma-Tru deal. Cf. Coltec, 454 F.3d at 1357. Rather,
    the J & G strategy was a separate, independent set of
    transactions that had no purpose besides creating a tax
    benefit. Id.; cf. Ballagh, 
    331 F.2d at 878
    .
    The Welleses’ claim of a profit motive behind the
    FXDOTs is belied by ample evidence that the tax advan-
    tages could not have been achieved had the transaction
    taken another form and that, absent the tax advantages,
    the transaction never would have occurred. See Frank
    Lyon, 
    435 U.S. at
    583 n.18; Gregory, 
    293 U.S. at 469-70
    .
    This court’s decision in Jade Trading held that the
    “meaningless inclusion in the partnership” of options was
    evidence the transaction lacked economic substance. Cf.
    
    598 F.3d at 1377
    . In this case, the Welleses similarly
    used unnecessary corporate entities to invest in the
    FXDOTs. Although the LLCs, S corporations, and part-
    STOBIE CREEK INVESTMENTS   v. US                        24
    nership (Stobie Creek) were not necessary to the transac-
    tion and did not enhance its potential profitability, the
    taxpayers nevertheless went to great lengths to create
    these entities and transfer the FXDOTs among them. See
    id.; cf. Gregory, 
    293 U.S. at 469-70
    .
    Taxpayers’ focus on generating tax benefits, rather
    than pursuing a legitimate business purpose, is also
    evidenced by the backdating of different transactions,
    including the FXDOTs, to conform to the J & G strategy.
    Stobie Creek, 82 Fed. Cl. at 695. The trial court found
    this backdating did nothing to enhance the transactions’
    investment potential, but was absolutely critical to
    achieving the desired basis enhancement and associated
    tax benefits. Id. at 695-96. Indeed, the FXDOTs could
    have been, and in fact were, carried out in a different
    order than J & G’s prescribed strategy. We agree with
    the trial court that the redating of different transactions
    reveals an emphasis on generating tax benefits; conform-
    ing to the J & G strategy mattered only if the purpose was
    tax avoidance, not economic profit from the FXDOTs. Cf.
    Neonatology Assocs. v. Comm’r, 
    299 F.3d 221
    , 230 n.12 (3d
    Cir. 2002); Rogers v. United States, 
    281 F.3d 1108
    , 1114-
    15 (10th Cir. 2002).
    Finally, the fee structure undermines plaintiffs’ con-
    tention that the J & G strategy had a business purpose
    (besides generating tax benefits, which does not count).
    See Coltec, 454 F.3d at 1358-59. The fees paid to SLK, J
    & G, and Deutsche Bank were all computed based on the
    amount of gain to be sheltered by the J & G strategy,
    without reference to typical economic considerations, such
    as the amount of risk on the investment. Stobie Creek, 82
    Fed. Cl. at 693-94. Plaintiffs have offered no explanation
    for why the taxpayers paid such high fees, particularly to
    Deutsche Bank. Deutsche Bank’s fee exceeded not only
    25                         STOBIE CREEK INVESTMENTS   v. US
    the normal fees for foreign currency options, but the value
    of the FXDOTs themselves.
    Thus, because the FXDOTs lacked economic reality
    and had no business purpose, they were properly disre-
    garded under the economic substance doctrine.
    II. Penalties
    A. Jurisdiction
    A threshold question is whether we have jurisdiction
    to review the accuracy-related penalties imposed under 
    26 U.S.C. § 6662
    . See Special Devices, Inc. v. OEA, Inc., 
    269 F.3d 1340
    , 1342-43 (Fed. Cir. 2001). Because plaintiffs
    challenge the “applicability of a[] penalty . . . which re-
    lates to an adjustment to a partnership item” and do not
    raise a partner-level defense, we conclude that the answer
    is yes. 
    26 U.S.C. §§ 6226
    (f), 6230.
    The penalties challenged on appeal relate to Stobie
    Creek’s misstatement of its inside basis in Therma-Tru
    stock, as well as to adjustments of its basis in that stock
    pursuant to 
    26 U.S.C. § 754
    . The partnership’s basis in
    contributed property is a partnership item. 
    Treas. Reg. § 301.6231
    (a)(3)-1(a)(vi), (c)(2); see also Am. Boat Co. v.
    United States, 
    583 F.3d 471
     (7th Cir. 2009). Adjustments
    made pursuant to a § 754 election are also partnership
    items. 
    Treas. Reg. § 301.6231
    (a)(3)-1(a)(3). Accordingly,
    the penalties “relate[] to an adjustment to a partnership
    item,” i.e., Stobie Creek’s basis in the Therma-Tru stock.
    
    26 U.S.C. § 6226
    (f).
    Further, the defense at issue on appeal is a partner-
    ship-level defense, not a partner-level defense. In a
    partnership-level proceeding such as this, we lack juris-
    STOBIE CREEK INVESTMENTS   v. US                        26
    diction to consider partner-level defenses. See 
    26 U.S.C. §§ 7422
    (h), 6230(c); Schell, 
    589 F.3d at 1382
    ; Am. Boat,
    
    583 F.3d at 478-79
    . Stobie Creek argues it had reason-
    able cause for stepping up the basis in the Therma-Tru
    stock.    A reasonable-cause defense under 
    26 U.S.C. § 6664
    (c) may be a partner- or partnership-level defense,
    depending on who is asserting it. See Temp. 
    Treas. Reg. § 301.6221
    -1T(d); Klamath, 
    568 F.3d at 548
    ; Whitehouse
    Hotel Ltd. v. Comm’r, 
    131 T.C. 112
    , 173 (2008). We have
    jurisdiction because here the partnership (Stobie Creek)
    is claiming it had reasonable cause based on the actions of
    its managing partner, Jeffrey Welles. 7 See Am. Boat, 
    583 F.3d at 479-80
    .
    B. Reasonable-Cause Defense
    On the merits, the only question is whether Stobie
    Creek, acting through Jeffrey Welles, had reasonable
    cause for its tax position. Stobie Creek argues reasonable
    cause and good faith are demonstrated by Jeffrey Welles’s
    reliance on advice from SLK and J & G. Stobie Creek, 82
    Fed. Cl. at 718. The answer turns on whether such
    reliance was reasonable under the circumstances. We
    conclude that it was not.
    Mandatory, accuracy-related penalties apply to cer-
    tain underpayments of tax that meet the statutory re-
    quirements. 
    26 U.S.C. § 6662
    (a), (h). Section 6664(c)(1)
    provides a narrow defense to § 6662 penalties if the
    taxpayer proves it had (1) reasonable cause for the under-
    payment and (2) acted in good faith. See also 
    Treas. Reg. § 1.6664-4
    (c)(1). The taxpayer bears the burden of show-
    7   Jeffrey Welles was the manager of North Chan-
    nel, the tax-matters partner of Stobie Creek.
    27                          STOBIE CREEK INVESTMENTS    v. US
    ing this exception applies. See Conway v. United States,
    
    326 F.3d 1268
    , 1278 (Fed. Cir. 2003). Whether a taxpayer
    had reasonable cause is a question of fact decided on a
    case-by-case basis. Id.; 
    Treas. Reg. § 1.6664-4
    (b)(1). We
    review this determination and the findings underlying it
    for clear error. See Am. Boat, 
    583 F.3d at 483
    ; Barrett v.
    United States, 
    561 F.3d 1140
    , 1148 (10th Cir. 2009). In
    doing so, we take into account all the pertinent facts and
    circumstances. 
    Treas. Reg. § 1.6664-4
    (b)(1). The most
    important of these factors is “the extent of the taxpayer’s
    effort to assess the taxpayer’s proper tax liability,” judged
    in light of the taxpayer’s “experience, knowledge, and
    education.” 
    Treas. Reg. § 1.6664-4
    (b)(1).
    One way to show reasonable cause is to show reason-
    able reliance on the advice of a competent and independ-
    ent professional adviser. 
    Treas. Reg. § 1.6664-4
    (b)(1);
    United States v. Boyle, 
    469 U.S. 241
    , 251 (1985). This
    advice must meet several requirements. First, the tax-
    payer must show that the advice was based on “all perti-
    nent facts and circumstances and the law as it relates to
    those facts and circumstances.” 
    Treas. Reg. § 1.6664
    -
    4(c)(1)(i). Second, the advice relied upon must not be
    based on any “unreasonable factual or legal assumptions,”
    and must not “unreasonably rely on the representations,
    statements, findings, or agreements of the taxpayer or
    any other person.” 
    Id.
     § 1.6664-4(c)(1)(ii). Third, the
    taxpayer’s reliance on the advice must itself be objectively
    reasonable. The reasonableness of any reliance turns on
    the quality and objectivity of the advice. See Klamath,
    
    568 F.3d at 548
    ; Chamberlain v. Comm’r, 
    66 F.3d 729
     (5th
    Cir. 1995); Swayze v. United States, 
    785 F.2d 715
    , 719
    (9th Cir. 1986). Reliance is not reasonable, for example, if
    the adviser has an inherent conflict of interest about
    which the taxpayer knew or should have known. 
    Treas. Reg. § 1.6664-4
    (c); Am. Boat, 
    583 F.3d at 481-82
    ; Hansen
    STOBIE CREEK INVESTMENTS   v. US                         28
    v. Comm’r, 
    471 F.3d 1021
    , 1031-32 (9th Cir. 2006); Neona-
    tology, 
    299 F.3d at 234
    ; Pasternak v. Comm’r, 
    990 F.2d 893
    , 903 (6th Cir. 1993). Nor is it reasonable if the tax-
    payer knew or should have known that the transaction
    was “too good to be true,” based on all the circumstances,
    including the taxpayer’s education, sophistication, busi-
    ness experience, and purposes for entering into the trans-
    action. 
    Treas. Reg. § 1.6664-4
    (c); Hansen, 
    471 F.3d at 1032
    .
    The trial court concluded that Stobie Creek was not
    entitled to the reasonable-cause defense because it was
    not reasonable for Jeffrey Welles to rely on the advice of
    SLK or J & G. Stobie Creek, 82 Fed. Cl. at 720-21. The
    court found that both firms had an inherent conflict of
    interest, which Jeffrey Welles knew or should have known
    about. This conflict of interest arose from the role of SLK
    and J & G in promoting, implementing, and receiving fees
    from the J & G strategy. Accordingly, the trial court
    found that the firms could hardly qualify as independent
    professionals, since neither was disinterested in the
    outcome of the strategy they were evaluating.
    We agree that the reasonable-cause defense does not
    apply to Stobie Creek. The trial court did not clearly err
    in finding it objectively unreasonable for Jeffrey Welles to
    rely on the advice of J & G and SLK because J & G was a
    promoter of the shelter and SLK was an agent of the
    promoter, making them anything but independent. Cf.
    Pasternak, 
    990 F.2d at 903
    . Advice hardly qualifies as
    disinterested or objective if it comes from parties who
    actively promote or implement the transactions in ques-
    tion. See, e.g., id.; Mortensen v. Comm’r, 
    440 F.3d 375
    (6th Cir. 2006); Van Scoten v. Comm’r, 
    439 F.3d 1243
    ,
    1253 (10th Cir. 2006); Goldman v. Comm’r, 
    39 F.3d 402
    ,
    408 (2d Cir. 1994).
    29                         STOBIE CREEK INVESTMENTS   v. US
    Further, the trial court did not clearly err in finding
    that Jeffrey Welles knew or should have known about this
    conflict of interest. At trial, the government presented
    extensive circumstantial evidence that Jeffrey Welles
    authorized, reviewed, or at minimum received updates on
    the strategy’s progress, and thus knew about both firms’
    roles.
    For example, J & G’s role as a promoter of the strat-
    egy was evident from the initial confidentiality agree-
    ment, which stated that the “proprietary” strategy had
    been “developed by J & G.” This role was again apparent
    in J & G’s fee agreement, which tied the firm’s compensa-
    tion to the gain sheltered by the strategy. Jeffrey Welles
    received, reviewed, and signed these documents. J & G’s
    role was similarly evidenced by its efforts to implement
    the shelter. For example, J & G helped set up the
    FXDOTs, draft the formation and transfer agreements for
    Stobie Creek, and assure that the transactions adhered to
    the strategy’s chronology.
    Similarly, the evidence supports the trial court’s con-
    clusion that Jeffrey Welles knew or should have known
    that SLK was an agent of J & G, and thus could not
    reasonably rely on SLK’s advice. SLK’s agency relation-
    ship was apparent from the beginning. Waterman re-
    ferred the Welleses to J & G, presented the strategy at
    the Vero Beach meeting, and recommended the strategy.
    As was true for J & G, SLK’s fee agreement made clear
    that SLK had a financial stake in the outcome, again
    tying compensation to the sheltered gain. SLK also
    helped implement the strategy by drafting and backdat-
    ing documents for the different corporate entities. In-
    deed, SLK openly acknowledged its role in a letter to the
    Welleses. The letter stated that the lower taxable gain
    that would be reported on Stobie Creek’s return was
    STOBIE CREEK INVESTMENTS   v. US                          30
    “produced by the tax strategy that was developed by [J &
    G] and implemented with our [SLK’s] help earlier this
    year.” The trial court found that Jeffrey Welles received
    this letter. Based on that and other evidence presented at
    trial, it was reasonable for the trial court to infer that
    Jeffrey Welles (and thus Stobie Creek) knew or should
    have known about the conflicts of interest for J & G and
    SLK. It was not objectively reasonable for Jeffrey Welles
    to ignore evidence of these conflicts and continue to rely
    on the advice, regardless of the Welleses’ longstanding
    relationship with SLK or the reputations of both firms.
    Even if Jeffrey Welles had not known about the con-
    flicts of interest, his reliance on the advice of SLK and J &
    G was still unreasonable. Based on Jeffrey Welles’s
    education and experience, as well as the reason the
    Welleses pursued the J & G strategy, the trial court found
    that Jeffrey Welles should have known that the J & G
    strategy was “too good to be true.” Cf. Neonatology, 
    299 F.3d at 234
    . This determination is not clearly erroneous.
    Jeffrey Welles was a highly educated professional with
    extensive experience in finance, having worked as an
    investment banker and as the manager of his family’s
    complex finances. Stobie Creek, 82 Fed. Cl. at 715. In
    that managerial role, he had helped implement a number
    of sophisticated tax-planning strategies, giving him
    sufficient knowledge and experience to know when a tax-
    planning strategy was likely “too good to be true.” Jeffrey
    Welles knew that the J & G strategy was marketed as a
    “Basis Enhancing Derivatives Structure” and that the
    purpose of the strategy was to boost the basis in capital
    assets, “generating a reduced gain for tax purposes.”
    Moreover, Jeffrey Welles sought out and selected the J &
    G strategy because of a desire to avoid taxes that would
    otherwise be owed on the Therma-Tru deal, not because
    he wanted to structure the deal itself to minimize taxes.
    31                          STOBIE CREEK INVESTMENTS   v. US
    Accordingly, Stobie Creek had no reasonable-cause
    defense for its tax position.
    III. Evidentiary Ruling
    Plaintiffs argue that they are entitled to a new trial
    because the trial court erroneously excluded the testi-
    mony of their expert, Stuart Smith. We disagree.
    A trial court’s evidentiary rulings are reviewed for
    abuse of discretion. Pac. Gas & Elec. Co. v. United States,
    
    536 F.3d 1282
    , 1285 (Fed. Cir. 2008). In this case, Smith
    sought to testify about the tax laws “as they existed in
    2000” and whether the J & G tax opinion letter complied
    with the standards set out in Treasury Circular 230. The
    trial court excluded Smith’s expert report and testimony
    under Federal Rule of Evidence 702, concluding that
    Smith’s opinion would not “assist” the court because the
    opinion concerned a question of law, not fact. Stobie
    Creek Invs., LLC v. United States, 
    81 Fed. Cl. 358
    , 359-61
    (2008).
    Plaintiffs are not entitled to a new trial because the
    trial court properly excluded Smith’s expert testimony.
    Under Rule 702, expert testimony must “assist the trier of
    fact to understand the evidence or to determine a fact in
    issue.” Fed. R. Evid. 702 (emphases added). Because
    proper interpretation of the tax laws and Treasury Circu-
    lar 230 are issues of law, it was not an abuse of discretion
    to exclude expert testimony related to those questions.
    See Mola Dev. Corp. v. United States, 
    516 F.3d 1370
    , 1379
    n.6 (Fed. Cir. 2008). To the extent Smith sought to testify
    about whether the J & G tax opinion letter met the stan-
    dards of Treasury Circular 230, that opinion similarly
    would not have “assist[ed]” the trial court because Smith’s
    proposed testimony consisted of a lengthy legal analysis of
    STOBIE CREEK INVESTMENTS   v. US                       32
    past precedent and assumed key factual representations
    underlying the J & G opinion were accurate, when in
    actuality they were false (and known to be so by the
    Welleses). Stobie Creek, 81 Fed. Cl. at 362; see Stobie
    Creek, 82 Fed. Cl. at 706-07, 720-21. Excluding Smith’s
    report and testimony was thus within the trial court’s
    discretion.
    CONCLUSION
    We affirm the application of the economic substance
    doctrine to the J & G strategy and accuracy-related
    penalties imposed on Stobie Creek. Stobie Creek was not
    entitled to a reasonable-cause defense under § 6664(c)(1)
    and the testimony of plaintiff’s expert Smith was properly
    excluded under Federal Rule of Evidence 702.
    AFFIRMED
    

Document Info

Docket Number: 2008-5190

Citation Numbers: 93 Fed. Cl. 1366

Judges: Bryson, Moore, Prost

Filed Date: 6/11/2010

Precedential Status: Precedential

Modified Date: 8/3/2023

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