CNT Investors, LLC, Charles C. Carroll, Tax Matters Partner v. Commissioner , 144 T.C. 161 ( 2015 )

CNT INVESTORS, LLC, CHARLES C. CARROLL, TAX MATTERS
PARTNER, PETITIONER v. COMMISSIONER OF INTERNAL
REVENUE, RESPONDENT
Docket No. 27539–08. Filed March 23, 2015.
C and his wife and related individuals owned appreciated
real estate through an S corporation (S). C and the related
individuals engaged in a Son-of-BOSS transaction to create
outside basis in a purported partnership to which S contrib-
uted the appreciated real estate. A series of further trans-
actions left C and the related individuals holding the real
estate through the partnership. No party reported recognizing
any of the real estate’s built-in gain. For 1999 R determined
that the partnership was a sham and adjusted to zero the
partnership’s reported losses, deductions, distributions, capital
contributions, and outside basis. R also determined a penalty
under I.R.C. sec. 6662 on multiple grounds. In this TEFRA
partnership-level proceeding, C, as TMP, conceded that the
partnership and the Son-of-BOSS transaction were shams
161
162 144 UNITED STATES TAX COURT REPORTS (161)
having no business purpose but challenged the FPAA’s timeli-
ness and the penalty. Held: The step transaction doctrine
applies to the transactions at issue. Collapsing the steps, S
distributed the appreciated real estate to its shareholders and
should have recognized gain under I.R.C. sec. 311(b). The par-
ties’ stipulation that the partnership and the Son-of-BOSS
transaction were shams does not compel us to disregard the
real estate’s transfer or the gain it generated because this
transfer was the object and end result, not a mere component,
of the subject series of transactions. Held, further, under
Rhone-Poulenc Surfactants & Specialties, L.P. v. Commis-
sioner, 114 T.C. 533, 540–543 (2000), for each partner in a
TEFRA partnership, the limitations period for the assessment
of tax attributable to partnership items or affected items is
the longer of the period specified in I.R.C. sec. 6229 or that
prescribed by I.R.C. sec. 6501. C and the related individuals
entirely omitted from their respective tax returns passthrough
I.R.C. sec. 311(b) gain. Consequently, R contends the six-year
limitations period of I.R.C. sec. 6501(e)(1)(A) applies. Under
United States v. Home Concrete Supply, LLC, 566 U.S. ll,
132 S. Ct. 1836 (2012), for purposes of determining whether
I.R.C. sec. 6501(e)(1)(A) applies to any taxpayer, we must dis-
regard any omitted gain that is attributable solely to the basis
overstatement resulting from the Son-of-BOSS transaction.
Held, further, for each partner, a portion of the omitted gain
was not attributable to the basis overstatement. With respect
to C and his wife (W), that portion constitutes a substantial
omission from income under I.R.C. sec. 6501(e)(1)(A). With
respect to the other partners, it does not. Therefore, the FPAA
was timely issued with respect to C and W only, and C and
W, but not the other individual partners, are proper parties
to the action under I.R.C. sec. 6226(d)(1)(B). Held, further, the
adjustments in the FPAA are sustained. Held, further, no
I.R.C. sec. 6662 penalty applies because C, as the partner-
ship’s TMP, relied reasonably and in good faith on inde-
pendent professional advice.
Steven R. Mather and Lydia B. Turanchik, for petitioner.
John W. Stevens and Richard J. Hassebrock, for
respondent.
CONTENTS
FINDINGS OF FACT ............................................................................. 164
I. Introducing the Carroll Family .................................................... 165
II. Solving the Low Basis Dilemma .................................................. 168
III. Selling the Son-of-BOSS Strategy ............................................... 171
IV. Achieving the Basis Boost ............................................................ 173
(161) CNT INVESTORS, LLC v. COMMISSIONER 163
A. Son-of-BOSS ........................................................................... 174
B. Basis Boost .............................................................................. 176
C. Real Estate Extraction ........................................................... 177
V. Reporting the Transactions .......................................................... 179
A. CNT’s 1999 Returns ............................................................... 179
B. CCFH’s 1999 Return .............................................................. 180
C. Individuals’ 1999 Returns ...................................................... 181
VI. Challenging the Transactions ...................................................... 181
OPINION ................................................................................................. 182
I. Preliminary Matters ..................................................................... 182
A. When Appellate Venue Matters ............................................ 182
B. Why Appellate Venue Does Not Matter Here ...................... 183
II. Timeliness of the FPAA ................................................................ 186
A. Timeliness Under TEFRA ..................................................... 186
B. Theory of Omission ................................................................ 188
C. Omission by Bootstrapping .................................................... 188
D. Scope of Sham ........................................................................ 191
1. Gregory Revisited ............................................................ 194
2. Sham Transaction Doctrine ............................................ 199
3. Step Transaction Doctrine .............................................. 202
4. Blending the Doctrines ................................................... 204
5. Conclusion ........................................................................ 208
E. Definition of Omission ........................................................... 208
1. Mr. Carroll ....................................................................... 210
2. Ms. Cadman ..................................................................... 211
3. Ms. Craig ......................................................................... 212
F. Adequacy of Disclosure .......................................................... 213
1. Legal Standard ................................................................ 213
2. Petitioner’s Proof ............................................................. 215
3. Returns’ Revelations ....................................................... 215
G. Conclusion ............................................................................... 219
III. Consequences of the Sham Stipulation ........................................ 219
IV. Liability for the Accuracy-Related Penalty ................................. 220
A. Penalties’ Applicability .......................................................... 221
B. Petitioner’s Defense ................................................................ 222
1. Sufficient Expertise? ....................................................... 223
2. Necessary Information? .................................................. 227
3. Good-Faith Reliance? ...................................................... 229
V. Conclusion ...................................................................................... 234
WHERRY, Judge: This case constitutes a partnership-level
proceeding under the unified partnership audit and litigation
procedures of the Tax Equity and Fiscal Responsibility Act
of 1982 (TEFRA), Pub. L. No. 97–248, sec. 402(a), 96 Stat.
164 144 UNITED STATES TAX COURT REPORTS (161)
at 648 (codified as amended at sections 6221–6234). 1 On
August 25, 2008, respondent mailed a notice of final partner-
ship administrative adjustment (FPAA) to CNT Investors,
LLC (CNT), for its taxable period ending December 1, 1999.
Pursuant to section 6226, petitioner, Charles C. Carroll,
CNT’s tax matters partner (hereinafter referred to as Mr.
Carroll or petitioner), timely petitioned this Court on
November 12, 2008, for readjustment of CNT’s partnership
items determined in the FPAA. After concessions by peti-
tioner, which we discuss below, the issues remaining for deci-
sion are:
(1) whether the six-year limitations period of section
6501(e)(1)(A) applies to CNT’s partners for their 1999 taxable
years, such that the FPAA was timely;
(2) whether the adjustments in the FPAA should be sus-
tained; and
(3) whether a section 6662 valuation misstatement or
accuracy-related penalty applies to any underpayment attrib-
utable to the partnership-level determinations made in the
FPAA, to the extent sustained herein.
FINDINGS OF FACT
Petitioner lived in California when he filed CNT’s petition.
CNT, the limited liability company to which the FPAA was
directed, was, as agreed to by the parties, a sham entity with
no business purpose. CNT did, however, file Federal income
tax returns annually from 1999 through at least 2010. On its
1999, 2000, and 2001 returns CNT provided a California
address and reported ownership of real property. As of
January 22, 2015, online grantor/grantee records of the Ven-
tura County, California, Recorder reflected that CNT held
legal title to interests in four parcels of real property situated
within that county. 2 Those records also reflected that CNT
1 Unless otherwise indicated, all section references are to the Internal
Revenue Code of 1986, as amended and in effect for the year at issue,
1999, and all Rule references are to the Tax Court Rules of Practice and
Procedure.
2 A court may take judicial notice of appropriate adjudicative facts at any
stage in a proceeding whether or not the parties request it. See Fed. R.
Evid. 201(c), (f ). In general, the court may take notice of facts that are ca-
pable of accurate and ready determination by resort to sources whose accu-
racy cannot reasonably be questioned. Id. subdiv. (b).
(161) CNT INVESTORS, LLC v. COMMISSIONER 165
leased some portion of its real property interests to ‘‘SCI
California Funeral Services, Inc.’’, in 2004. The lease agree-
ment(s) had a 15-year term and included an option to pur-
chase.
I. Introducing the Carroll Family
After serving in the United States Marine Corps at the
time of World War II, Mr. Carroll attended mortuary science
college. He also became a licensed embalmer. Mr. Carroll
began operating Charles Carroll Funeral Home (funeral
home) in 1954. The funeral home was an archetypal family
business. Mr. Carroll and his wife, Garnet, lived for many
years and raised their twin daughters, Teri Craig and Nancy
Cadman, at various times in homes above, behind, and next
door to their mortuaries. 3 Mr. and Mrs. Carroll both worked
As we do here, a court may take judicial notice of public records not sub-
ject to reasonable dispute, such as county real property title records. See,
e.g., Velazquez v. GMAC Mortg. Corp., 605 F. Supp. 2d 1049, 1057–1058
(C.D. Cal. 2008) (taking judicial notice of two deeds of trust and a full re-
conveyance recorded in the Official Records of the Los Angeles County,
California, Recorder); Haye v. United States, 461 F. Supp. 1168, 1174 (C.D.
Cal. 1978) (taking judicial notice of deeds recorded with the Los Angeles
County Index). Ample precedent exists for our reliance on electronic
versions of public records. See, e.g., Marshek v. Eichenlaub, 266 Fed. Appx.
392, 392–393 (6th Cir. 2008) (holding that court could take judicial notice
of information on the Inmate Locator, which enables the public to track
the location of Federal inmates, is maintained by the Federal Bureau of
Prisons, and is accessed through the agency’s Web site, to discover that ap-
pellant had been released since the filing of his appeal and conclude that
there remained no actual injury which the court could redress with a fa-
vorable decision and, thus, dismiss the appeal as moot); Denius v. Dunlap,
330 F.3d 919, 926–927 (7th Cir. 2003) (holding that District Court erred
when it refused to take judicial notice of information on official Web site
of Federal agency that maintained medical records on retired military per-
sonnel, the fact of which was appropriate for judicial notice because it is
not subject to reasonable dispute); Sears v. Magnolia Plumbing, Inc., 778
F. Supp. 2d 80, 84 n.6 (D.D.C. 2011) (taking judicial notice of corporate
resolutions available through the Maryland Department of Assessments
and Taxation’s Web site); Lengerich v. Columbia Coll., 633 F. Supp. 2d
599, 607 n.2 (N.D. Ill. 2009) (taking judicial notice of a corporation filing
for Columbia College Chicago on the Illinois secretary of state’s Web site).
3 We refer to Mr. and Mrs. Carroll, Ms. Craig, and Ms. Cadman collec-
tively as the Carroll family, and to Mr. Carroll, Ms. Craig, and Ms.
Cadman (i.e., the Carroll family, less Mrs. Carroll) collectively as the
Carrolls.
166 144 UNITED STATES TAX COURT REPORTS (161)
for the funeral home from 1954 until the business was sold
in 2004, and their daughters and Ms. Craig’s two sons also
worked for the funeral home during various periods.
Although Mr. Carroll was an astute and successful
businessman, he understood only basic tax principles and
lacked sophistication in various stock and bond type financial
matters. Hence he sought counsel and assistance from profes-
sional advisers on legal and accounting issues relating to the
funeral home. Attorney J. Roger Myers began working with
Mr. Carroll in the late 1970s or early 1980s, when he
assisted Mr. Carroll in acquiring two additional mortuaries.
Mr. Myers thereafter became the funeral home’s de facto
general counsel, providing general business consultation,
maintaining records, and advising on employment and regu-
latory issues. The Carroll family regularly consulted Mr.
Myers on legal issues arising in connection with the funeral
home, and Mr. and Mrs. Carroll also engaged Mr. Myers to
prepare their estate plan, which included an inter vivos
giving program.
As of 1999 Mr. Myers had practiced law for almost 30
years, most of them spent in a business-oriented private
practice involving some civil litigation. Although he did not
hold himself out as a tax lawyer and typically referred clients
to specialists for complicated income tax advice, Mr. Myers
had taken basic Federal income and estate tax courses in law
school, had previously prepared estate tax returns, and had
advised Mr. Carroll on general tax law principles.
Certified Public Accountant (C.P.A.) Frank Crowley also
began working with Mr. Carroll in the early 1980s, and Mr.
Carroll followed him when Mr. Crowley changed accounting
firms. Mr. Crowley provided general bookkeeping and
monthly payroll services for the funeral home, and he pre-
pared its financial statements and Federal income tax
returns. In the late 1990s Mr. Crowley conferred with Mr.
Carroll monthly concerning the funeral home’s financial
statements. He interacted more frequently with Ms. Cadman
and Ms. Craig, who performed in-house bookkeeping duties
for the funeral home. Mr. Carroll relied on Mr. Crowley for
routine income tax advice although the funeral home’s oper-
ations rarely gave rise to complex tax issues.
In addition to his C.P.A. credential, Mr. Crowley held
bachelor’s and master’s degrees in accounting and was a cer-
(161) CNT INVESTORS, LLC v. COMMISSIONER 167
tified financial planner. He had taken classes in individual
and corporate income tax and partnership and estate tax
during his degree programs. Before meeting Mr. Carroll, Mr.
Crowley had worked as a cost accountant at a publicly held
company and practiced at multiple private accounting firms.
His work entailed advising clients on accounting and income
and estate tax issues, and as of 1999, financial matters.
By the mid-1990s, the funeral home’s operations had
expanded to five mortuaries. The Carrolls owned the funeral
home through a corporation, Charles Carroll Funeral Home,
Inc. (CCFH), which also held title directly or indirectly to the
mortuary buildings and underlying real property. 4 Mr. Car-
roll was the funeral home’s original owner and CCFH’s only
shareholder until he implemented the giving program
through which he transferred annual tranches of shares to
his daughters. 5 As of 1999 Mr. Carroll held 94.4512% of
4 Some evidence in the record suggests that, before November 1999, Mr.
and Mrs. Carroll held legal title to one of the five real properties as trust-
ees of the Carroll Family Trust. The record also suggests, however, that
for all practical purposes, the Carroll family treated this fifth property as
if it, too, were owned by CCFH. Ms. Cadman testified that CCFH owned
all five properties. Ms. Craig initially confirmed her sister’s statement.
After prompting from counsel, however, she stated that she did recall
something but was not an expert, then agreed when counsel asked her to
confirm her recollection that one property was owned by a trust. She em-
phasized that, operationally, the distinction did not matter. Mr. Crowley,
who had for many years prepared the Carroll family’s individual tax re-
turns and those for CCFH and who also assisted Ms. Craig with book-
keeping for the business, apparently believed that CCFH owned all five
properties. In a facsimile message sent in August 1999 to the promoter of
the tax shelter that led to this case, Mr. Crowley listed all five properties
as assets of the corporation, breaking out the book values of the land and
buildings on each parcel. When asked by respondent’s counsel whether the
promoter needed this information in order to calculate the amount of gain
that the shelter transaction would need to offset, Mr. Crowley answered
that he believed so. We found Mr. Crowley credible as a witness and con-
clude that he would not have sent the promoter information inconsistent
with the Carroll family’s and CCFH’s past tax reporting. Accordingly, we
find that, for tax purposes, CCFH owned all five properties, even if one
was titled in what amounted to a nominee’s name.
5 Some evidence in the record suggests that Mr. and Mrs. Carroll origi-
nally held CCFH’s shares through a form of joint ownership, and that Mr.
and Mrs. Carroll jointly held a partnership interest in CNT. Other evi-
dence is to the contrary. In their supplemental stipulation of fact the par-
Continued
168 144 UNITED STATES TAX COURT REPORTS (161)
CCFH’s outstanding shares, and Ms. Cadman and Ms. Craig
each held 2.7744%. CCFH had initially operated as a C cor-
poration but elected S corporation status at some time before
1999.
II. Solving the Low Basis Dilemma
Mr. Carroll was 73, going on 74, in early 1999. He and his
family had begun to contemplate his retirement and the
funeral home’s sale. Mr. Carroll intended to sell the funeral
home business but retain ownership of the real property,
which would be leased to the buyer(s). SCI, a mortuary com-
pany that had recently begun operating in the area, had fol-
lowed this model for acquisitions of other local mortuaries,
and SCI had contacted the Carrolls about purchasing the
funeral home.
Mr. Carroll believed that, if a national mortuary chain pur-
chased the funeral home, it would not want to purchase the
real property. Retaining and leasing the real estate would
also provide the family with a periodic income stream during
retirement. Mr. Carroll was financially conservative, and he
had no extensive investment experience. Before 1999 he had
never invested in United States Treasury notes (T-notes),
traded stocks, bonds, or other securities on margin, or
participated in a short sale transaction. In 1999 Mr. Carroll’s
interests in the funeral home and five mortuary properties
represented almost 100% of his net worth, and his only other
holdings consisted of certificates of deposit and cash.
To facilitate sale of the business without the real estate,
Messrs. Myers and Crowley determined that the two needed
to be separated. They initially concluded that the preferred
mechanism for achieving this separation would be for CCFH
to divest itself of the mortuary properties, leaving it holding
only the funeral home’s business operations. They could not,
however, identify a way of transferring the real estate out of
CCFH without triggering recognition of substantial built-in
gain, caused largely by inflation in real estate prices. 6 As of
ties have simplified matters matters by referring to Mr. Carroll as holding
his interests in CCFH and CNT and as participating in the transactions
at issue independently from his wife. We follow the parties’ lead and refer
herein only to Mr. Carroll given that, in any event, Mr. and Mrs. Carroll
filed joint Federal income tax returns for 1999 and 2000.
6 Depending on when CCFH filed its S election, some or all of the recog-
(161) CNT INVESTORS, LLC v. COMMISSIONER 169
November 1999, in the aggregate CCFH’s real estate
holdings had an adjusted tax basis of $523,377 and a fair
market value of $4,020,000.
By late 1999 Mr. Crowley considered the real estate’s pro-
posed transfer from CCFH a ‘‘dead issue’’ because, after a
few years of analysis and brainstorming with Mr. Myers and
other attorneys, he had identified no way for the Carrolls to
accomplish the transfer without incurring significant tax
liability. Nevertheless, while sale of CCFH’s stock (after
divestiture of the real estate) appeared a nonstarter, sale of
its business assets remained a possibility. In that case, how-
ever, CCFH could lose its S election and become subject to
dual-level income taxation within three years after the asset
sale because of the passive income limitation of section
1362(d)(3). Either way, retention of the real estate would
have income tax implications.
In 1999 Mr. Myers encountered a potential solution. Over
lunch with a longtime acquaintance, local financial adviser
Ross Hoffman, Mr. Myers described Mr. Carroll’s problem in
general terms, explaining that he had a client who needed to
transfer appreciated assets out of a corporation for estate
planning purposes. Mr. Hoffman advised Mr. Myers that he
knew of a strategy that might work.
Earlier in the year Mr. Hoffman had attended a Las Vegas
conference sponsored by Fortress Financial, a New York-
based tax planning firm. Erwin Mayer, an attorney with the
law firm Jenkens & Gilchrist, gave a seminar at the con-
ference on a strategy he called a ‘‘basis boost’’ that could
allegedly increase the tax basis of low-basis assets. The basis
boost strategy Mr. Mayer presented was, in substance, a Son-
of-BOSS transaction. 7
nized gain could have been subject to two levels of income tax because of
sec. 1374(a).
7 Throughout this Opinion, for brevity and ease of reference, we charac-
terize the T-note short sales and purported partnership capital contribu-
tions made by Mr. Carroll and his daughters as a Son-of-BOSS trans-
action. We recognize, however, that the overall series of transactions did
not entirely align with the definition we have previously provided for a
Son-of-BOSS transaction:
Son-of-BOSS is a variation of a slightly older alleged tax shelter known
as BOSS, an acronym for ‘‘bond and options sales strategy.’’ There are
Continued
170 144 UNITED STATES TAX COURT REPORTS (161)
Mr. Hoffman was not a tax professional and did not hold
himself out as one. In 1999 he was a certified financial
planner and regularly advised clients on liquidity, life insur-
ance, asset allocation, and investment planning, with a focus
on estate planning. He offered clients ‘‘industry designed’’
tax-advantaged products, such as limited partnerships,
municipal bonds, and annuities. Mr. Hoffman attended the
Las Vegas conference to learn about strategies and ideas that
he could sell to clients or to their attorneys or C.P.A.’s.
Before attending the conference, Mr. Hoffman was unfamiliar
with Mr. Mayer and with Jenkens & Gilchrist and had never
traded stocks or conducted any T-note or short sale trans-
actions for clients. Mr. Hoffman never fully understood the
Son-of-BOSS transaction that Mr. Mayer pitched at the con-
ference, but he nevertheless described it to Mr. Myers at the
luncheon as a possible solution for Mr. Myers’ client.
Mr. Myers wanted to understand the Son-of-BOSS trans-
action better before presenting it to Mr. Carroll, so Messrs.
Hoffman and Myers met again, this time for a conference call
with Mr. Mayer. Bill Fairfield, another Ventura, California,
attorney who had clients situated similarly to the Carrolls,
also participated in the call. After speaking with Mr. Mayer,
Mr. Myers understood that the proposed transaction would
involve a short sale and would conclude with the real estate’s
being transferred out of CCFH with a new basis. At Mr.
a number of different types of Son-of-BOSS transactions, but what they
all have in common is the transfer of assets encumbered by significant
liabilities to a partnership, with the goal of increasing basis in that part-
nership. The liabilities are usually obligations to buy securities and typi-
cally are not completely fixed at the time of transfer. This may let the
partnership treat the liabilities as uncertain, which may let the partner-
ship ignore them in computing basis. If so, the result is that the part-
ners will have a basis in the partnership so great as to provide for
large—but not out-of-pocket—losses on their individual tax returns.
Enormous losses are attractive to a select group of taxpayers—those
with enormous gains. [Kligfeld Holdings v. Commissioner, 128 T.C. 192,
194 (2007).]
Here, as explained below, rather than use the Son-of-BOSS to offset unre-
lated, recognized gains, the Carrolls used the Son-of-BOSS to eliminate
gain prospectively. We note that in Kligfeld Holdings, the taxpayer like-
wise executed the Son-of-BOSS transaction to boost the tax basis of an ap-
preciated asset (in Mr. Kligfeld’s case, stock) to forestall gain recognition
upon its disposition. See id. at 194–197.
(161) CNT INVESTORS, LLC v. COMMISSIONER 171
Myers’ request, Mr. Mayer sent him a memorandum pre-
pared by Jenkens & Gilchrist describing and analyzing the
transaction. Mr. Myers reviewed the memorandum and con-
sulted some of the legal authorities cited therein, albeit not
in extreme detail.
Thereafter, on two occasions Messrs. Myers and Hoffman
met with the Carrolls and Mr. Crowley at Mr. Myers’ office
to discuss the proposed transaction. Using visual aids, Mr.
Hoffman described in broad strokes how Mr. Carroll could,
through a short sale of securities, create basis in a new
entity, and he mentioned that Ted Turner had engaged in a
similar transaction and, in a subsequent case concerning it,
prevailed. Ms. Cadman found the Ted Turner story persua-
sive, reasoning that, if someone who could afford the very
best legal and tax advice had engaged in this kind of trans-
action, it must be effective. 8 After the second meeting with
Mr. Hoffman, the Carrolls decided to proceed with the Son-
of-BOSS transaction.
III. Selling the Son-of-BOSS Strategy
Mr. Hoffman pitched the Son-of-BOSS transaction to the
Carrolls, but the Carrolls never became his clients or paid
him any compensation. He never provided any tax advice to
Mr. Carroll, gave a written opinion as to the transaction, or
expressly represented that the transaction would achieve Mr.
Carroll’s desired result. He did, however, answer Mr.
Carroll’s and his advisers’ questions, parroting what he had
heard from Mr. Mayer and consulting with Mr. Mayer when
he needed more information. Messrs. Myers and Crowley and
Ms. Cadman all perceived, after meeting with him, that Mr.
Hoffman supported and recommended the transaction. Once
Mr. Carroll decided to go forward with the transaction, Mr.
Hoffman assisted ministerially with finalizing paperwork. He
expected to receive a ‘‘finder’s fee’’ in the form of a percent-
8 By agreement between the parties’ counsel, and despite respondent’s
subpoenas, which respondent did not seek to enforce, neither Mr. nor Mrs.
Carroll testified at trial, in both cases for health reasons. Petitioner’s coun-
sel represented, and letters from Mr. and Mrs. Carroll’s attending physi-
cian lodged with the Court confirm, that neither Mr. Carroll nor Mrs. Car-
roll would be able to testify to any meaningful recollection of the relevant
events.
172 144 UNITED STATES TAX COURT REPORTS (161)
age of Fortress Financial’s fee if Mr. Carroll proceeded with
the transaction.
After the various presentations, meetings, and phone calls,
Mr. Myers believed that he had a good grasp of how the Son-
of-BOSS transaction would work and of the legal theories
behind it. He had met with fellow Ventura attorney Bill Fair-
field and had researched Jenkens & Gilchrist in Martindale
Hubbell and on the Internet, learning that the firm had
offices throughout the United States, including in Chicago,
where Mr. Mayer worked. He had spoken by telephone with
Mr. Mayer about the transaction. He had reviewed Mr.
Mayer’s memorandum and the supporting legal authorities.
And he had been present for Mr. Hoffman’s presentation. Mr.
Myers believed the transaction was feasible and that the
Carrolls should seriously consider it. He advised Mr. Carroll
that the transaction looked like a viable way to resolve
CCFH’s low basis dilemma.
Mr. Myers’ opinion did not change as the transaction pro-
ceeded. During the implementation phase, he spoke by tele-
phone with Mr. Mayer on multiple occasions. Mr. Myers did
not know all of the details of the transaction. He did not
know, for instance, how much money was actually at risk in
the Son-of-BOSS component of the transaction, had no finan-
cial information about the short sale, and was unaware that
the short sale would almost certainly generate no profit. He
did not know how much Jenkens & Gilchrist would charge
Mr. Carroll to implement the transaction. On the basis of
what he did know, however, Mr. Myers formed the opinion
that the transaction was legitimate and proper, and he
shared this opinion with Mr. Carroll. Mr. Myers was working
only for Mr. Carroll, billed Mr. Carroll monthly for work on
the transaction at his regular hourly rate, and received no
other compensation or incentive for recommending it.
Like Mr. Myers, Mr. Crowley did not know how much
money was actually at risk in the Son-of-BOSS transaction,
had no financial information about the short sale, and was
unaware that the short sale would almost certainly generate
no profit. Also like Mr. Myers, Mr. Crowley was working only
for Mr. Carroll and received no unusual compensation for his
counsel to the Carroll family. However, his advice was more
ambivalent than Mr. Myers’: Mr. Crowley did not conceal his
lack of complete understanding of the transaction, and rather
(161) CNT INVESTORS, LLC v. COMMISSIONER 173
than affirmatively endorse it, he told Mr. Carroll that he
would ‘‘go along with’’ it. He was willing to do so because the
transaction had been developed by what he thought was a
knowledgeable national law firm that was sufficiently con-
fident to promise, in writing, that it would defend the trans-
action if it were challenged. As a C.P.A. in a small, two-
partner firm, Mr. Crowley felt intimidated by the Jenkens &
Gilchrist brand and essentially ‘‘acquiesced’’. Notwith-
standing Mr. Crowley’s uncertainty, Ms. Cadman testified
that the family believed he and their other advisers rec-
ommended proceeding with the Son-of-BOSS transaction.
According to Ms. Cadman, had Mr. Crowley advised against
it, the Carrolls would not have moved forward.
IV. Achieving the Basis Boost
Once the ‘‘go’’ decision had been made, Mr. Mayer formed
four limited liability companies (LLCs): (1) CNT, which
elected to be treated as a partnership for income tax pur-
poses, 9 (2) Teloma Investments, LLC (Teloma), of which Mr.
Carroll was the sole member, (3) Santa Paula Investments,
LLC (Santa Paula), of which Ms. Craig was the sole member,
and (4) S. Mountain Investments, LLC (S. Mountain), of
which Ms. Cadman was the sole member. 10 Each of the
LLCs was formed under Delaware law. 11 Each was a sham
entity with no business purpose.
9 The parties have stipulated that CNT was a sham entity with no busi-
ness purpose. Respondent further contends that CNT was not a partner-
ship as a matter of fact, and that its partners should not be treated as
such. We use the terms ‘‘partnership’’ and ‘‘partner’’ and related terms for
convenience only.
10 Teloma, Santa Paula, and S. Mountain would ordinarily be dis-
regarded as entities separate from their respective sole owners. See secs.
301.7701–2(c)(2), 301.7701–3(a), (b)(1)(ii), Proced. & Admin. Regs. None of
these three entities ever filed a Federal income tax return, and CNT iden-
tified the entities’ individual owners, not the entities themselves, as part-
ners even though the individuals made their capital contributions through
their respective LLCs.
11 Online records of the Delaware Division of Corporations reflect that
CNT Investors, LLC, was formed in Delaware on August 26, 1999. Those
records do not reflect whether CNT remains in good standing, but it evi-
dently has not been dissolved. Online records of the California secretary
of state reflect that a ‘‘CNT Investors, LLC’’ was formed in California on
June 26, 2009. Those records list Ms. Cadman as that entity’s agent for
Continued
174 144 UNITED STATES TAX COURT REPORTS (161)
Pursuant to directions from and with the active control of
Mr. Mayer and his colleagues at Jenkens & Gilchrist, the fol-
lowing sequence of transactions occurred. 12
A. Son-of-BOSS
On November 18, 1999, the five real properties were trans-
ferred by deed to CNT. The book value of the transferred real
estate was credited to CCFH’s capital account. See supra
note 4. At that time, the five properties’ aggregate adjusted
tax basis, and hence CCFH’s initial outside basis in CNT,
was $523,377. 13
On November 24, 1999, Mr. Carroll, Ms. Craig, and Ms.
Cadman, via their respective LLCs, engaged in short sales of
T-notes. 14 Once the proceeds had settled, on November 26,
service of process and list the entity’s address as that provided on CNT’s
1999, 2000, and 2001 Federal income tax returns. We take judicial notice
of these adjudicative facts pursuant to Fed. R. Evid. 201(b). See Sears, 778
F. Supp. 2d at 84 n.6 (taking judicial notice of corporate resolutions avail-
able through the Maryland Department of Assessments and Taxation’s
Web site); Grant v. Aurora Loan Servs., Inc., 736 F. Supp. 2d 1257, 1265
(C.D. Cal. 2010) (taking judicial notice of, inter alia, Delaware secretary
of state’s certificate of authentication for a certificate of incorporation and
a certificate of conversion from a corporation to an LLC); Lengerich, 633
F. Supp. 2d at 607 n.2 (taking judicial notice of a corporation filing for Co-
lumbia College Chicago on the Illinois secretary of state’s Web site); supra
note 2.
12 We explain the intended tax consequences of each transaction merely
to illustrate how the shelter was designed to work. We expressly do not
find that any of these consequences actually ensued.
13 Under sec. 722, ‘‘[t]he basis of an interest in a partnership acquired
by a contribution of property * * * to the partnership shall be the * * *
adjusted basis of such property to the contributing partner at the time of
the contribution’’—that is, an exchanged basis. Hence, as no taxable gain
was recognized at that time, CCFH’s tax basis in its partnership interest
would equal its tax basis in the contributed real estate. The Schedule
K–1, Partner’s Share of Income, Credits, Deductions, etc., CNT issued to
CCFH for CNT’s tax year ending December 1, 1999, reports the amount
of CCFH’s capital contributions during the tax year as $523,377.
14 In a short sale, the investor borrows securities and incurs an obliga-
tion to return identical securities within a specified period. The investor
then sells the borrowed securities for cash, planning to purchase replace-
ment securities later for return to the lender. If the securities’ market
price declines in the meantime, the investor will make a profit. If the secu-
rities’ market price increases, the investor will incur a loss. When an in-
vestor conducts such a transaction through a broker, the broker may re-
quire that the investor post the sale proceeds as security and/or deposit
(161) CNT INVESTORS, LLC v. COMMISSIONER 175
1999, the Carrolls transferred a total of $2,877,343 in cash
proceeds from the short sales, together with the related
obligations and a nominal amount of cash, apparently
$10,800, to CNT. These transfers were sham transactions
having no business purpose. The transferred proceeds and
cash, totaling $2,877,343, were credited to Mr. Carroll, Ms.
Cadman, and Ms. Craig’s capital accounts and established
their respective initial outside bases in CNT as $2,716,609,
$80,367, and $80,367. See supra note 13. On the premise
that the transferred obligations were not liabilities for pur-
poses of determining the purported partners’ capital con-
tributions, their capital accounts and outside bases were not
reduced to reflect the partnership’s assumption of these
partner obligations. 15
CNT immediately used the transferred proceeds and cash
to purchase T-notes having a principal amount slightly
greater than the amount the Carrolls had sold short. It did
so under an agreement with Deutsche Bank whereby Deut-
sche Bank agreed to repurchase the T-notes (repo). Through
this offsetting repo transaction, CNT reduced to near zero its
risk of incurring a loss on the short sale.
On November 29, 1999, CNT closed the repo transaction
and used the proceeds to satisfy the obligations that had
funds into a ‘‘margin account’’ so that, if the market price has increased
and the short sale proceeds are insufficient to fund the purchase of re-
placement securities, the broker can apply the funds in the margin account
to the deficit. See generally Farr v. Commissioner, 33 B.T.A. 557, 559
(1935) (explaining a short sale conducted on the New York Stock Exchange
through a broker).
In opening the short sale transaction and in later contributing the open
positions and obligations to CNT, the Carrolls acted through their respec-
tive wholly owned LLCs. Because we disregard these three LLCs as enti-
ties separate from their owners, see supra note 10, and for brevity, we
refer to the individuals directly.
15 Under sec. 752(b), ‘‘[a]ny decrease in a partner’s * * * individual li-
abilities by reason of the assumption by the partnership of such individual
liabilities, shall be considered as a distribution of money to the partner by
the partnership.’’ The partner’s outside basis decreases by the amount of
the deemed distribution. Sec. 733(1). The partner’s capital account also
decreases by the amount of the deemed distribution. Sec. 1.704–
1(b)(2)(iv)(b)(4), Income Tax Regs. Of course, if a partnership were to as-
sume a partner’s obligation that did not qualify as a ‘‘liability’’ for purposes
of sec. 752, as was intended here, then the downward adjustments of out-
side basis and capital would not occur.
176 144 UNITED STATES TAX COURT REPORTS (161)
been transferred to it, repurchasing the same number of
T-notes that Mr. Carroll, Ms. Craig, and Ms. Cadman had
previously sold short and closing the short sale positions.
This transaction, which generated a nominal $2,268 loss to
CNT, had an estimated less than 1% probability of gener-
ating a gain or loss greater than the additional $10,800
margin that Deutsche Bank had required the Carrolls to post
in connection with the transaction. The transaction did, how-
ever, leave CNT allegedly holding only the real estate with
an adjusted tax basis, or inside basis, of $523,377. 16 By
comparison, its partners’ aggregate adjusted basis in their
partnership interests, or outside basis, was $3,400,718.
B. Basis Boost
On December 1, 1999, Mr. Carroll, Ms. Cadman, and Ms.
Craig, who were CCFH’s only shareholders, purported to
transfer their respective partnership interests in CNT to
CCFH. As a result of these transfers, CCFH became CNT’s
sole owner.
The transfers triggered the termination of CNT as a part-
nership. 17 For tax purposes, the following events were
deemed to occur: CNT liquidated, transferring all of its
assets to its partners in proportion to their interests, and the
three individual partners then contributed the assets
received in the liquidation to CCFH, leaving CCFH holding
all of the real estate. 18 Each of CNT’s partners took a tax
basis in the assets received in the deemed liquidation equal
to that partner’s outside basis. 19 With that step, the real
16 Under sec. 723, a partnership’s basis in contributed property is ‘‘the
adjusted basis of such property to the contributing partner at the time of
the contribution’’—that is, a transferred basis—so CNT would have taken
CCFH’s tax basis in the real estate since neither one recognized any gain
that could have added to that basis.
17 Sec. 708(b)(1)(B) provides that a partnership is considered terminated
if ‘‘within a 12-month period there is a sale or exchange of 50 percent or
more of the total interest in partnership capital and profits.’’ Here, 84.6%
of CNT changed hands.
18 See Rev. Rul. 99–6, 1999–1 C.B. 432.
19 Under sec. 732(b), ‘‘[t]he basis of property * * * distributed by a part-
nership to a partner in liquidation of the partner’s interest shall be an
amount equal to the adjusted basis of such partner’s interest in the part-
nership’’. Here, the partners’ initial aggregate outside basis, $3,400,718,
would have been reduced pursuant to sec. 705(a)(2) for the $2,268 short-
(161) CNT INVESTORS, LLC v. COMMISSIONER 177
estate’s aggregate adjusted tax basis rose from $523,377 to
$3,396,716, ostensibly without any taxable event’s having
occurred.
Upon the deemed contribution of CNT’s assets to CCFH,
the real estate’s newly boosted basis transferred to CCFH,
and the Carrolls’ aggregate basis in their CCFH stock
increased by the same amount. 20 Inside and outside bases
were once again allegedly aligned. All that remained to be
done was to transfer the real estate out of CCFH.
C. Real Estate Extraction
On December 31, 1999, CCFH distributed percentage
interests in CNT (totaling 100%) to its three shareholders in
proportion to their respective interests in CCFH. The deemed
liquidation and contribution occurring on December 1
resulted in ownership of the real estate’s shifting, for tax
purposes, from CNT to the Carrolls, and then from them to
CCFH. But title to the real estate did not change; CNT
continued to hold title to the property. For tax purposes, the
distribution of CNT interests on December 31 resulted in (1)
a deemed distribution of the real estate to CCFH’s share-
holders, followed by (2) their deemed contribution of the real
estate to a new partnership, New CNT. 21
Upon the deemed distribution of the real estate, CCFH rec-
ognized gain equal to the difference between its aggregate
adjusted tax basis in the real estate, $3,396,716, and the real
estate’s then-current fair market value, $4,020,000—that is,
term capital loss and $1,734 of interest expense incurred by CNT in con-
nection with the short sale.
20 Under sec. 351(a), persons transferring property to a corporation rec-
ognize no gain or loss if the transfer is made ‘‘solely in exchange for stock
in such corporation and immediately after the exchange’’ such persons hold
stock representing 80% of the corporation’s combined voting power and
80% of the other shares of the corporation. In this case, the Carrolls held
100% of CCFH’s outstanding shares both before and after the transaction
and so would have recognized neither gain nor loss. Their basis in their
CCFH stock would have increased pursuant to sec. 358(a) by the amount
of their basis in their partnership interests adjusted pursuant to sec.
705(a)(2), see supra note 19, or $2,873,955. Under sec. 362(a), CCFH would
have taken a transferred basis of $2,873,955 in the 84.6% of CNT that it
received in the exchange, giving it a total basis in CNT of $3,396,716.
21 See Rev. Rul. 99–5, 1999–1 C.B. 434.
178 144 UNITED STATES TAX COURT REPORTS (161)
$623,284. 22 Because CCFH was an S corporation, that
$623,284 gain passed through and was taxable to CCFH’s
shareholders. 23 The passthrough gain increased each share-
holder’s outside basis in CCFH, possibly giving each a suffi-
cient basis to absorb the distribution without further gain
recognition. 24 The shareholders’ aggregate basis in the
distributed real estate, and the amount of the distribution,
was its fair market value, $4,020,000. 25 That fair market
value basis transferred to New CNT upon the deemed con-
tribution. 26 The deemed contribution also revived CNT as a
partnership in the form of New CNT.
This series of transactions divested CCFH of its real estate
holdings and concluded with Mr. Carroll, Ms. Cadman, and
Ms. Craig owning the five mortuary properties through New
CNT, purportedly generating only $623,284 of taxable, long-
term capital gain in the process. Absent the basis boost to
the real estate from the Son-of-BOSS transaction, the
amount would have been $3,496,623. 27 Jenkens & Gilchrist
22 Sec. 311(b) provides, generally, that if a corporation distributes to a
shareholder property, the fair market value of which exceeds its adjusted
tax basis, the corporation must recognize gain ‘‘as if such property were
sold to the distributee at its fair market value.’’
23 Under sec. 1366(a)(1) and (c), an S corporation shareholder’s gross in-
come for any tax year includes the shareholder’s pro rata share of the S
corporation’s ‘‘items of income’’ for the S corporation’s tax year ending with
or within the shareholder’s tax year.
24 Sec. 1367(a)(1) provides that an S corporation shareholder’s basis in
his stock shall be increased by the sum of income items of the S corpora-
tion passed through to the shareholder under sec. 1366(a)(1). Under sec.
1368(b) and (c), a distribution to an S corporation shareholder is non-
taxable to the extent of either the shareholder’s basis (if the S corporation
has no earnings and profits), or the net amount of passthrough income and
loss from the S corporation reported by the shareholder, less prior distribu-
tions (if the S corporation has earnings and profits).
25 Under sec. 301(b), the amount of a distribution is its fair market
value. Under sec. 301(d), a corporate shareholder takes a fair market value
basis in property distributed by a corporation.
26 Under sec. 723, a partnership takes a transferred basis in property
contributed by a partner in exchange for a partnership interest.
27 Because sec. 311(b) requires a corporation to recognize gain on the dis-
tribution of appreciated property as if it had sold that property for fair
market value, we calculate gain absent the basis boost as the difference
between CCFH’s amount realized, the property’s fair market value of
$4,020,000, and CCFH’s original tax basis, $523,377. Respondent agrees
with these figures for the real estate’s fair market value and adjusted tax
(161) CNT INVESTORS, LLC v. COMMISSIONER 179
charged $116,000 for its services in arranging, executing, and
assisting with reporting of the series of transactions. The
firm also delivered to Mr. Carroll, Ms. Cadman, and Ms.
Craig similar opinion letters describing the transactions and
attesting to their probable tax consequences.
V. Reporting the Transactions
Mr. Crowley prepared all relevant Federal income tax
returns for the transactions. When asked to prepare returns
for tax year 1999, Mr. Crowley sought further explanation
about the transactions from Mr. Mayer. Jenkens & Gilchrist
later reviewed Mr. Crowley’s first drafts of CCFH and CNT’s
1999 tax returns at his request and recommended some
changes.
A. CNT’s 1999 Returns
Because of its mid-year termination and subsequent
revival, CNT filed two Forms 1065, U.S. Partnership Return
of Income, for tax year 1999: one for the taxable period Sep-
tember 15 through December 1, 1999 (December 1 return),
and one for a one-day taxable period, December 31, 1999
(December 31 return).
On the December 1 return, CNT reported interest expense
of $1,734 and, on Schedule D, Capital Gains and Losses, a
$2,268 short-term capital loss incurred on November 29,
1999, on a short sale of T-notes. On the appended Schedules
K–1 CNT reported capital interests, capital contributions,
distributive shares of short-term capital loss and interest
expense, distributions, and yearend capital accounts as fol-
lows:
basis but calculates the amount of gain that would have been recognized
by CCFH (and passed through to its shareholders) absent the Son-of-BOSS
transaction as $3,497,239. Respondent does not explain why his computa-
tion exceeds the difference between basis and the amount realized by $616,
but this amount does equal CCFH’s distributive share of CNT’s net loss
reported on its December 1 return. Because whether CCFH’s shareholders
may ultimately be required to recognize $616 of gain as a result of this
loss’s disallowance is a legal question, we describe here only the gain rec-
ognition compelled by secs. 311(b) and 1366(a).
180 144 UNITED STATES TAX COURT REPORTS (161)
Charles and
Garnet Nancy Teri
Item Carroll Cadman Craig CCFH Total
Capital interest 79.88% 2.36% 2.36% 15.40% 100%
Capital
contributions $2,716,607 $80,367 $80,367 $523,377 $3,400,718
Short-term
capital loss (1,811) (54) (54) (349) (2,268)
Interest expense (1,385) (41) (41) (267) (1,734)
Distributions (2,713,409) (80,273) (80,273) (522,761) (3,396,716)
Yearend
capital account -0- -0- -0- -0- -0-
On the December 31 return, New CNT reported no income,
deductions, gains, or losses. On the appended Schedules
K–1, New CNT reported capital interests, capital contribu-
tions, distributions, and yearend capital accounts as follows:
Capital Capital Yearend capital
Partner interest (%) contributions Distributions account
Charles and
Garnet Carroll 94.4512 $3,164,116 --- $3,164,116
Nancy Cadman 2.7744 92,942 --- 92,942
Teri Craig 2.7744 92,942 --- 92,942
Total 100 3,350,000 --- 3,350,000
B. CCFH’s 1999 Return
CCFH filed a single Federal income tax return for 1999 on
Form 1120S, U.S. Income Tax Return for an S Corporation.
On the appended Schedules K–1, Shareholder’s Share of
Income, Credits, Deductions, Etc., CCFH identified its share-
holders and their ownership percentages as: Charles Carroll,
94.4512%; Nancy Cadman, 2.7744%; and Teri Craig,
2.7744%. CCFH’s shareholders and their ownership percent-
ages remained unchanged from the beginning of the tax year.
On a Treasury ‘‘Reg. Sec. 1.351–3(b) Statement’’ (351 state-
ment) appended to its return, CCFH reported receiving, as a
contribution to capital, an 84.6% interest in CNT having a
basis in the transferor’s hands of $2,873,955 as of December
1, 1999. Jenkens & Gilchrist provided the 351 statement to
Mr. Crowley for attachment to CCFH’s 1999 return, and Mr.
Mayer told him that it was a ‘‘necessary disclosure’’.
With regard to CCFH’s distribution to shareholders of CNT
interests, Mr. Mayer explained that disclosure was unneces-
sary because there had been a ‘‘simultaneous transaction’’.
On the basis of this guidance, Mr. Crowley did not report the
transaction as a deemed asset sale on Schedule D, Capital
(161) CNT INVESTORS, LLC v. COMMISSIONER 181
Gains and Losses and Built-In Gains, which he believed
would ordinarily be required. Mr. Crowley did not under-
stand Mr. Mayer’s explanation but nonetheless followed his
instructions. CCFH did not report any short- or long-term
capital gain or loss for 1999 and did not file Schedule D that
year. It reported total nondividend distributions to share-
holders during the year of $245,470.
C. Individuals’ 1999 Returns
On their respective 1999 Forms 1040, U.S. Individual
Income Tax Return, Mr. and Mrs. Carroll, Ms. Cadman and
her husband (Cadmans), and Ms. Craig and her husband
(Craigs), each couple filing jointly, reported only passthrough
ordinary income from CCFH. None of them reported any
passthrough capital gain from CCFH, and none of them
reported any otherwise taxable distribution from CCFH.
Mr. and Mrs. Carroll filed their 1999 return on October 15,
2000. The Cadmans and the Craigs filed their 1999 returns
on October 18, 2000. Respondent received from Mr. and Mrs.
Carroll and the Cadmans on September 5, 2006, and from
the Craigs on September 8, 2006, signed Forms 872–I, Con-
sent to Extend the Time to Assess Tax As Well As Tax
Attributable to Items of a Partnership, extending the period
for assessment as to their 1999 tax years to October 15,
2007. On June 28, 2007, respondent received from each
couple a second signed Form 872–I extending the limitations
period to December 31, 2008.
VI. Challenging the Transactions
On August 5, 2008, respondent mailed an FPAA with
respect to CNT’s December 1 return. In the FPAA,
respondent adjusted to zero CNT’s reported losses, deduc-
tions, distributions, capital contributions, and outside basis
for the applicable tax period. The FPAA cites myriad bases
for these adjustments, including that CNT was not, as a fac-
tual matter, a partnership, lacked economic substance, and
was formed or availed of solely for tax avoidance purposes;
and that both the Son-of-BOSS transaction and the indi-
vidual partners’ subsequent contribution of their interests to
CCFH were sham transactions undertaken solely for tax
avoidance purposes. Respondent also determined an
182 144 UNITED STATES TAX COURT REPORTS (161)
accuracy-related penalty under section 6662 of 20% or 40%
of any underpayment attributable to a gross or substantial
valuation misstatement, negligence or disregard of rules and
regulations, and/or a substantial understatement of income
tax.
CNT, through its tax matters partner, Mr. Carroll, timely
petitioned this Court on November 12, 2008, for readjust-
ment of partnership items under section 6226, challenging
each of respondent’s adjustments and all alleged bases for
the determined penalty.
OPINION
I. Preliminary Matters
We have listed above only three issues for decision in this
case, but the parties have, between them, raised several
others. Before proceeding to the issues we will decide, we
explain why we do not decide two others: (1) whether the
venue for appeal in this case is in the U.S. Court of Appeals
for the Ninth Circuit (Ninth Circuit) or the U.S. Court of
Appeals for the District of Columbia Circuit (D.C. Circuit);
and (2) whether this Court has jurisdiction over the
accuracy-related penalty determined in the FPAA. We need
not answer the second question because the U.S. Supreme
Court has already done so—in the affirmative—in United
States v. Woods, 571 U.S. ll , ll, 134 S. Ct. 557, 564
(2013). We need not resolve the first question because, after
Woods, the answer will not affect our analysis of the sub-
stantive issues in this case.
A. When Appellate Venue Matters
Section 7482(b) governs the venue for appeal from a deci-
sion of this Court. Where our decision readjusts partnership
items pursuant to a petition under section 6226, the appel-
late venue is the U.S. Court of Appeals for the circuit in
which the partnership’s principal place of business is located.
Sec. 7482(b)(1)(E). If, however, the subject partnership has
no principal place of business when the petition is filed, the
appellate venue will be the D.C. Circuit. Sec. 7482(b)(1)
(flush language); see also AHG Invs., LLC v. Commissioner,
140 T.C. 73, 82 (2013) (where it was not established whether
a partnership had a principal place of business at the time
(161) CNT INVESTORS, LLC v. COMMISSIONER 183
the petition was filed, concluding that the case would be
appealable in the D.C. Circuit). Respondent contends that
CNT had no principal place of business when the petition
was filed, and that the D.C. Circuit is the proper venue for
appeal. Petitioner, however, insists that the venue for appeal
in this case is the Ninth Circuit. 28
As a trial court, we do not ordinarily opine on the venue
for appeal of our decisions. See Peat Oil & Gas Assocs. v.
Commissioner, T.C. Memo. 1993–130, 65 T.C.M. (CCH) 2259,
2264 (1993). However, this Court ‘‘follow[s] a Court of
Appeals decision which is squarely in point where appeal
from our decision lies to that Court of Appeals and to that
court alone.’’ Golsen v. Commissioner, 54 T.C. 742, 757
(1970), aff ’d, 445 F.2d 985 (10th Cir. 1971). Where the
proper venue for appeal determines how we should apply the
law, ‘‘[w]e believe it appropriate * * * to consider the issue
of venue’’. Brewin v. Commissioner, 72 T.C. 1055, 1059
(1979), rev’d and remanded on other grounds, 639 F.2d 805(D.C. Cir. 1981).
B. Why Appellate Venue Does Not Matter Here
In their briefs, the parties invoke the Golsen rule with
respect to two related issues. First, the substantial and gross
valuation misstatement penalties apply with respect to any
understatement of tax ‘‘attributable to’’ the misstatement.
Sec. 6662(b)(3), (h). If the venue for appeal is the Ninth Cir-
28 Respondent argues that he issued the FPAA with respect to CNT’s De-
cember 1 return, and under sec. 708(b), the partnership for which that re-
turn was filed terminated on December 1, 1999, and could therefore have
had no principal place of business when the petition was filed nearly seven
years later. Moreover, the parties have stipulated that CNT was a sham
entity, and respondent contends that a sham entity cannot have a prin-
cipal place of business. Either way, respondent reasons, the appellate
venue is in the D.C. Circuit.
CNT contends that whether a partnership has terminated or is a sham
for tax purposes does not affect its legal or factual existence as a legally
existing business entity. As evidence of a principal place of business in
California, it points to CNT’s purported ownership of California real estate
and its filing of income tax returns reflecting such ownership and stating
a California address. Petitioner alleges that CNT filed such returns ‘‘for
many years after the sham transfers of property occurred’’; that, as a lim-
ited liability company, it remains in good standing; and that it has con-
tinuously held four of the five mortuary properties since 1999.
184 144 UNITED STATES TAX COURT REPORTS (161)
cuit, petitioner contends we would be bound to follow that
court’s decisions in Keller v. Commissioner, 556 F.3d 1056(9th Cir. 2009), aff ’g in part, rev’g in part T.C. Memo. 2006–
131, and Gainer v. Commissioner, 893 F.2d 225 (9th Cir.
1990), aff ’g T.C. Memo. 1988–416, interpreting the phrase
‘‘attributable to’’.
In Gainer v. Commissioner, 893 F.2d at 226, the taxpayer
purchased an interest in a shipping container at an inflated
value, paying most of the purchase price with a promissory
note, then claimed an investment tax credit and deducted
depreciation on the basis of the inflated value. The Commis-
sioner disallowed the deduction because the container was
not placed in service in the tax year at issue, 1981, and also
determined a valuation misstatement penalty. Id. Affirming
this Court, the Ninth Circuit held that the taxpayer’s under-
statement of income tax was not ‘‘attributable to’’ his over-
statement of the container’s value. Id. at 228. Rather, the
understatement was attributable to the container’s not
having been placed in service, a fact that precluded the tax-
payer from deducting any depreciation. See id. In Keller v.
Commissioner, 556 F.3d at 1060–1061, the Ninth Circuit
extended Gainer’s reasoning to disallow a gross valuation
misstatement penalty where the taxpayer engaged in a sham
transaction and then claimed deductions for and reported
basis in assets that he never actually acquired. On peti-
tioner’s reading, these precedents compel us to disallow any
valuation misstatement penalty here because any under-
statement of tax results from CNT’s sham status, not from
a valuation misstatement.
In making this argument, petitioner did not have the ben-
efit of the Supreme Court’s subsequently released decision in
Woods. Specifically citing Keller, the Supreme Court rejected
the premise on which the Ninth Circuit’s rule rests—that is,
that a transaction’s lack of economic substance and an over-
statement of basis are necessarily independent possible
causes for an understatement of tax. Woods, 571 U.S. at
ll, 134 S. Ct. at 567. Where ‘‘partners underpa[y] their
taxes because they overstate[ ] their outside basis * * *
because the partnership[ ] * * * [is a] sham[ ]’’, the Court
had ‘‘no difficulty concluding that’’ any resulting under-
payment was attributable to the misstatement of outside
basis. Id. at ll, 134 S. Ct. at 568. Woods governs the valu-
(161) CNT INVESTORS, LLC v. COMMISSIONER 185
ation misstatement penalty’s applicability here, regardless of
the appellate venue.
Second, under section 6221 we may consider the applica-
bility of a penalty only to the extent that it ‘‘relates to an
adjustment to a partnership item’’. If the venue for appeal is
the D.C. Circuit, petitioner contends we would be bound to
follow that court’s decision in Petaluma FX Partners, LLC v.
Commissioner, 591 F.3d 649 (D.C. Cir. 2010), aff ’g in part,
rev’g in part, vacating and remanding in part 131 T.C. 84(2008). There, the D.C. Circuit strongly hinted that, where
the Commissioner determines that a penalty applies to an
understatement of income tax, and that understatement is
attributable to an adjustment of outside basis, this Court
lacks jurisdiction over the penalty in a partnership-level pro-
ceeding because outside basis is an affected item ‘‘to be
resolved at the partner level’’. See id. at 655–656.
This Court has twice before examined the scope and import
of the D.C. Circuit’s holding. See Tigers Eye Trading, LLC v.
Commissioner, 138 T.C. 67, 136–138 (2012); Petaluma FX
Partners, LLC v. Commissioner, 135 T.C. 581, 586–587
(2010). We need not revisit the question here because, in the
interim, the Supreme Court has had the final word. In
Woods, 571 U.S. at ll, 134 S. Ct. at 564, where the alleg-
edly misstated item was outside basis in a sham partnership,
the Supreme Court concluded that a trial court in a partner-
ship-level proceeding has jurisdiction to determine whether
the partnership’s lack of economic substance can ‘‘justify
imposing a valuation-misstatement penalty on the partners.’’
Regardless of the appellate venue, Woods confirms that we
have jurisdiction to consider the valuation misstatement pen-
alty.
We need not invoke the Golsen rule for either reason
raised by the parties. We will apply the same legal principles
to the issues in this case whether the venue for appeal is the
D.C. Circuit or the Ninth Circuit. For us to undertake to
resolve the correct appellate venue, inasmuch as it would not
affect the disposition of this case, ‘‘would, at best, amount to
rendering an advisory opinion. This we decline to do.’’ See
Greene-Thapedi v. Commissioner, 126 T.C. 1, 13 (2006).
186 144 UNITED STATES TAX COURT REPORTS (161)
II. Timeliness of the FPAA
The parties have stipulated that CNT and the Son-of-
BOSS transaction were shams. One might view this stipula-
tion as a concession by petitioner of the entire case. It is not.
Petitioner offers a defense to the penalties determined in the
FPAA, and more importantly, vigorously contests the FPAA’s
validity in the first instance, claiming that its issuance was
untimely.
A. Timeliness Under TEFRA
In the context of an FPAA issued under TEFRA proce-
dures, timeliness for statute of limitations purposes is deriva-
tive:
The Internal Revenue Code prescribes no period during which TEFRA
partnership-level proceedings, which begin with the mailing of the * * *
[FPAA], must be commenced. However, if partnership-level proceedings
are commenced after the time for assessing tax against the partners has
expired, the proceedings will be of no avail because the expiration of the
period for assessing tax against the partners, if properly raised, will bar
any assessments attributable to partnership items.
Generally, in order to be a party to a partnership action, a partner
must have an interest in the outcome. If the statute of limitations
applicable to a partner bars the assessment of tax attributable to the
partnership items in issue, that partner would generally not have an
interest in the outcome. See sec. 6226(c) and (d). However, * * * a
partner may participate in such action for the purpose of asserting that
the period of limitations for assessing any tax attributable to partner-
ship items has expired and that we have jurisdiction to decide whether
that assertion is correct. * * *
[Rhone-Poulenc Surfactants & Specialties, L.P. v. Commissioner, 114
T.C. 533, 534–535 (2000); fn. refs. omitted.]
Section 6229(a) prescribes a three-year limitations period,
commencing on the later of the date on which the partner-
ship return is filed or the last day for filing such return with-
out regard to extensions, for the assessment of tax attrib-
utable to any partnership item or affected item. However, we
have held that ‘‘[s]ection 6229 provides a[n] [alternative]
minimum period of time for the assessment of any tax attrib-
utable to partnership items (or affected items)’’ that can
extend, but not reduce, the limitations period otherwise pre-
scribed by section 6501. Rhone-Poulenc Surfactants &
Specialties, L.P. v. Commissioner, 114 T.C. at 540–543.
(161) CNT INVESTORS, LLC v. COMMISSIONER 187
Respondent issued the FPAA with respect to CNT’s
December 1 return, which covered the taxable period Sep-
tember 15 through December 1, 1999. That taxable period
ended within the partners’ common 1999 taxable year, so we
must ascertain whether the period for assessment for the
1999 tax year had expired as to any or all of CNT’s partners
when respondent issued the FPAA on August 25, 2008. See
sec. 706(a) (partner must include partnership items in
income in the partner’s tax year within or with which the
partnership’s tax year ends).
It is undisputed that the alternative three-year limitations
periods in sections 6501(a) and 6229(a) had both lapsed with
respect to all partners’ 1999 tax years when respondent
issued the FPAA. Instead, respondent hangs his hat on sec-
tion 6501(e)(1)(A), which extends the limitations period to six
years where a taxpayer ‘‘omits from gross income an amount
properly includible therein which is in excess of 25 percent
of the amount of gross income stated in the return’’.
In that case, the time for assessment would have expired
on October 15, 2006, as to Mr. and Mrs. Carroll, and three
days later as to the Cadmans and the Craigs. 29 Before their
respective expiration dates under section 6501(e)(1)(A), but
after their respective expiration dates under sections 6501(a)
and 6229(a), Mr. and Mrs. Carroll, the Cadmans, and the
Craigs all agreed to extend the periods for assessment for
their 1999 tax years, including with respect to tax items
attributable to CNT, to October 15, 2007. See sec. 6501(c)(4).
Before that date, each couple agreed to further extend the
limitations period to December 31, 2008. Respondent issued
the FPAA before that later date. The FPAA’s timeliness
therefore turns on whether section 6501(e)(1)(A) applies. 30
29 CCFH, the fourth partner identified on CNT’s December 1 return, was
a passthrough entity wholly owned by the named individuals, so we do not
consider it separately in our analysis of the applicable limitations periods.
30 If the FPAA was timely, then it tolled the statute of limitations as to
CNT’s partners for the duration of this proceeding, until one year after our
decision in this case becomes final. See sec. 6229(d); Rhone-Poulenc
Surfactants & Specialties, L.P. v. Commissioner, 114 T.C. 533, 551–557
(2000).
188 144 UNITED STATES TAX COURT REPORTS (161)
B. Theory of Omission
The statute of limitations is an affirmative defense to be
pleaded and ultimately proven by petitioner; but because
respondent asserts that the six-year statute of limitations in
section 6501(e)(1)(A) applies, respondent bears the burden of
going forward with the evidence regarding the alleged omis-
sion of income. See Hoffman v. Commissioner, 119 T.C. 140,
146–147 (2002). If respondent satisfies that burden, then
petitioner must introduce evidence of his own to rebut
respondent’s showing. See id. at 146.
Relying on stipulated facts and the tax returns in the
record, respondent offers the following: Pursuant to the par-
ties’ stipulations, CNT, Teloma, Santa Paula, and S. Moun-
tain are all disregarded as shams, and the transfer of short
sale proceeds and related obligations to CNT is also dis-
regarded as a sham. Therefore, CCFH in fact distributed its
interest in the highly appreciated assets of CNT (the five
mortuary properties) to its shareholders, the Carrolls.
Under section 311(b), if a corporation distributes appre-
ciated property to a shareholder, the corporation must recog-
nize gain as if it had sold the property for fair market value.
Where the corporation is an S corporation, that gain passes
through and is taxable to the corporation’s shareholders
pursuant to section 1366(a)(1). Yet neither CCFH nor its
shareholders reported any of this gain. Hence, an item of
gross income was omitted from CCFH’s 1999 Form 1120S
and from its three shareholders’ 1999 Forms 1040. By
respondent’s computations, because this omission amounted
to more than 25% of gross income for each partner, section
6501(e)(1)(A) applies.
We conclude that respondent has met his burden of going
forward with evidence as to the longer, six-year period of
limitations. We turn now to petitioner’s response. Petitioner
offers four alternative reasons section 6501(e)(1)(A) will not
avail respondent here. We examine each of these arguments
in turn.
C. Omission by Bootstrapping
First, petitioner charges respondent with attempting to
‘‘bootstrap’’ an alleged omission by a different taxpayer, using
a transaction occurring outside the tax period covered by the
(161) CNT INVESTORS, LLC v. COMMISSIONER 189
return that is the subject of the FPAA (the December 1
return), to hold open the period of limitations with respect to
items reported on that return. Petitioner contends this
approach stretches our caselaw too far.
We view petitioner’s ‘‘bootstrapping’’ critique as aimed at
two mismatches: between CNT and the taxpayers from
whose returns the income item was allegedly omitted, and
between the tax period covered by the December 1 return
and the tax period in which the event giving rise to the
income item occurred. Neither of these incongruities is
unprecedented.
In Rhone-Poulenc Surfactants & Specialties, L.P. v.
Commissioner, 114 T.C. at 536, the taxpayer corporation had
purportedly transferred property to a partnership in
exchange for an interest therein. The Commissioner, dis-
cerning a sale disguised as a capital contribution, issued an
FPAA adjusting items relating to the purported contribution.
Id. Before this Court, the Commissioner claimed that while
no income had been omitted from the partnership’s return, if
the FPAA adjustments were sustained, the taxpayer corpora-
tion would have failed to report a substantial gain on its own
return. Id. at 538. Because of this omission by a partner, the
six-year limitations period of section 6501(e)(1)(A) would
apply with respect to that partner. See id. We agreed with
the Commissioner’s analysis. See id. at 551.
Petitioner contends that respondent stretches Rhone-
Poulenc beyond its moorings by relying on an omission by a
third-party entity. But as we have elucidated above, if the
FPAA’s adjustments are sustained, then it will necessarily
follow that Mr. Carroll, Ms. Cadman, and Ms. Craig will
each have omitted income from his or her own return—that
is, passthrough section 311(b) gain, includible under section
1366(a)(1). It is this omission, not CCFH’s omission of the
section 311(b) gain from its 1999 Form 1120S, that would
trigger section 6501(e)(1)(A) as to the Carrolls. Granted, the
omitted item does not flow through to the individual partners
directly from CNT but instead from another source, CCFH.
Yet in Rhone-Poulenc Surfactants & Specialties, L.P. v.
Commissioner, 114 T.C. at 536, likewise, the omitted item
did not flow through to the taxpayer corporation from the
partnership but instead arose under section 1001. And here,
as in Rhone-Poulenc, there will have been an omission only
190 144 UNITED STATES TAX COURT REPORTS (161)
if the adjustments in the FPAA are sustained. Id. at 551.
Given these essential similarities, we think that Rhone-
Poulenc squarely applies to the facts before us. 31
Petitioner further cites as unprecedented respondent’s reli-
ance on an omission arising from a transaction that occurred
outside the partnership tax period covered by the subject
return. Yet in Kligfeld Holdings v. Commissioner, 128 T.C.
192 (2007), we addressed a highly similar situation. There,
in 1999, an individual taxpayer engaged in a Son-of-BOSS
tax shelter transaction and contributed the proceeds and
related obligations to a partnership along with highly appre-
ciated Inktomi stock. Id. at 194–195. The partnership sold
most of the stock in 1999 but distributed the proceeds and
the remaining stock to its partners—the taxpayer and his
wholly owned S corporation—in 2000. Id. at 197. In 2004 the
Commissioner issued to the partnership an FPAA based
upon its 1999 Form 1065. Id. at 198. The partnership’s tax
matters partner petitioned this Court and raised a statute of
limitations defense. Id. at 199.
The Commissioner asserted that the FPAA was timely
because the limitations period with respect to the individual
taxpayer’s 2000 tax year had not expired when the FPAA
was mailed, and the adjustments in the FPAA would, if sus-
tained, affect items reported on that taxpayer’s 2000 tax
return, namely, the distributed proceeds from the stock sale.
See id. at 199. Scrutinizing TEFRA, we discerned that ‘‘Con-
gress anticipated that the taxable year in which an assess-
ment is made would not always be the same as the taxable
year in which the adjustments are made.’’ Id. at 205. Specifi-
cally rejecting the tax matters partner’s timing mismatch
arguments, we held that the FPAA was timely when issued
because the limitations period had not yet run as to the tax-
able year in which an assessment triggered by the FPAA’s
adjustments would be made. Id. at 202, 206–207.
Kligfeld Holdings more than justifies respondent’s position
here. There, no overlap existed between the taxable period
covered by the FPAA and the taxable period for which, if its
adjustments were sustained, an assessment would be made.
Here, given that the alleged omission arose from a trans-
31 Here the alleged omission results from sustaining the partnership-
level adjustments, not from a wholly independent source.
(161) CNT INVESTORS, LLC v. COMMISSIONER 191
action occurring on December 31, 1999, any assessment as to
CNT’s partners would be made for their 1999 tax year.
CNT’s December 1 return covers a period entirely within
that same tax year.
Moreover, contrary to petitioner’s assertion, there was a
third-party entity in play in Kligfeld Holdings. As here, the
only other partner in the purported partnership created by
the individual taxpayer in Kligfeld Holdings v. Commis-
sioner, 128 T.C. at 194–195, was his wholly owned S corpora-
tion, to which (as occurred here) he contributed a sufficiently
large interest in the partnership to trigger a technical termi-
nation under section 708(b)(1). And while in Kligfeld
Holdings the FPAA’s adjustments would have flowed through
directly to the individual taxpayer’s return, sustaining those
adjustments would also have resulted in additional pass-
through income to the taxpayer under section 1366(a)(1). See
id. at 199 (explaining Commissioner’s position that S cor-
poration should have reported capital gain on the partner-
ship’s distribution of cash proceeds from the stock sale).
Between them, Rhone-Poulenc and Kligfeld Holdings pro-
vide ample support for respondent’s theory and decisively
answer petitioner’s ‘‘boot-strapping’’ argument. We therefore
proceed to petitioner’s second argument.
D. Scope of Sham
Petitioner insists that—pursuant to the parties’ stipulation
and on the basis of the entire record—every step in the series
of transactions the Carrolls undertook should be disregarded.
Petitioner contends that transfer of the real estate was part
of an integrated series sham of transactions, that the entire
series should be disregarded, and that CCFH should be
treated as the real properties’ continuous tax owner. 32
32 At trial, petitioner introduced a chart comparing the amount of depre-
ciation that could have been taken on the real estate had the transactions
at issue not occurred with the depreciation possible after the basis boost
for tax years 2002–10. Petitioner’s counsel explained that the chart aimed
to show the Carrolls’ ‘‘net tax benefit’’ from the transactions. We admitted
the chart as Exhibit 116. Petitioner also sought to introduce a second chart
marked as petitioner’s Exhibit 117 which purported to depict the amounts
by which New CNT’s net income and the flowthrough income of its
partners would have increased if the real estate’s basis had remained
Continued
192 144 UNITED STATES TAX COURT REPORTS (161)
Accordingly, petitioner concludes, the transaction generating
the allegedly omitted income never occurred, so no income
could have been omitted.
Respondent, naturally, demurs. In his view only the Son-
of-Boss transaction was a sham because it was entered into
solely to artificially eliminate the built-in gain in the real
estate, while the remaining steps were cognizable for tax
purposes. The parties’ arguments implicate three closely
related and frequently conflated legal doctrines: the economic
substance doctrine, the sham transaction doctrine, and the
step transaction doctrine.
Although these doctrines’ distinct names might suggest
corresponding substantive distinctions, the lines between and
among them blur upon examination. Congress reduced
prospective confusion as to the economic substance doctrine’s
unchanged throughout the transaction. Respondent objected to the figures
as a hypothetical scenario representing expert opinion, and respondent fur-
ther disputed the figures themselves. After ascertaining that the numbers
in the exhibit had been drawn from proposed amended returns submitted
to, but not accepted by, respondent, the Court reserved decision on the ex-
hibit’s admission.
With regard to respondent’s expert testimony objection, although the ex-
hibit represents a hypothetical, we think it one to which Mr. Crowley could
testify as a lay witness under Fed. R. Evid. 701. Mr. Crowley prepared the
tax returns that were actually filed. The exhibit reflects how he would
have prepared those returns differently pursuant to Internal Revenue
Code and Internal Revenue Service (IRS) requirements had the trans-
actions at issue not occurred—in which case, there would have been no sec.
311(b) gain to recognize. No special expertise is needed for a witness to
opine on how that witness would have applied undisputed rules differently
under hypothetical, alternative circumstances. See, e.g., United States v.
Cuti, 720 F.3d 453, 457–458 (2d Cir. 2013) (where accountants who had
not been qualified as experts testified to how accounts they prepared under
undisputed accounting rules would have differed had they been aware of
certain facts, finding testimony admissible as lay opinion). We further find
Exhibit 117 relevant to petitioner’s argument that the events detailed here
represent a single, integrated sham transaction and that the parties there-
fore remain in their pretransaction tax positions. The exhibit reflects peti-
tioner’s view of the Carrolls’ tax liabilities if his argument prevails. Al-
though Exhibit 117 omits any gain from the transactions at issue, Fed. R.
Evid. 401 sets a low bar for relevancy. We will therefore admit the exhibit
as relevant to petitioner’s aforementioned argument, and for the limited
purpose of proving how Mr. Crowley would have prepared the Carrolls’
post-1999 returns had the transactions at issue not taken place. We give
it weight commensurate with its probative value.
(161) CNT INVESTORS, LLC v. COMMISSIONER 193
tenets when it codified that doctrine in March 2010. See
Health Care and Education Reconciliation Act of 2010, Pub.
L. No. 111–152, sec. 1409, 124 Stat. at 1067–1070 (codified
at section 7701(o)). Yet the flurry of commentary that fol-
lowed the issuance by the IRS of Notice 2014–58, 2014–44
I.R.B. 746, interpreting the codified provision amply dem-
onstrates the degree of remaining uncertainty as to the
scope, contours, and sources of economic substance and the
other, noncodified judicial doctrines. See, e.g., Jasper L.
Cummings, Jr., ‘‘The Sham Transaction Doctrine’’, 145 Tax
Notes 1239 (2014); Amy S. Elliott, ‘‘Economic Substance
Notice’s Sham Treatment Prompts Criticism’’, 145 Tax Notes
377 (2014); Susan Simmonds, ‘‘Economic Substance Cases
Still Reflect a Vague Doctrine’’, 146 Tax Notes 32 (2015).
If one looks to the caselaw, the economic substance, sham
transaction, and substance over form doctrines resemble a
Venn diagram. In a statutorily mandated 1999 study the
Joint Committee on Taxation attempted to define and distin-
guish these three doctrines as well as the business purpose
and step transaction doctrines. See Staff of J. Comm. on Tax-
ation, Study of Present-Law Penalty and Interest Provisions
as Required by Section 3801 of the Internal Revenue Service
Restructuring Act of 1998 (Including Provisions Relating to
Corporate Tax Shelters) (Vol. I), at 186–198 (J. Comm. Print
1999). The study candidly acknowledges that ‘‘[t]hese doc-
trines are not entirely distinguishable, and their application
to a given set of facts is often blurred by the courts and the
IRS. There is considerable overlap among the doctrines, and
typically more than one doctrine is likely to apply to a trans-
action.’’ Id. at 186.
The doctrines’ substantive similarities would not, alone,
generate uncertainty for taxpayers (or tenure opportunities
for tax academics) if courts applying the doctrines did so
using consistent terminology. We have not. 33
33 We have described the step transaction doctrine, for example, as sim-
ply an extension or application of the ‘‘substance over form’’ doctrine. See,
e.g., Holman v. Commissioner, 130 T.C. 170, 187 (2008) (‘‘ ‘The step trans-
action doctrine embodies substance over form principles[.]’ ’’ (quoting Santa
Monica Pictures, L.L.C. v. Commissioner, T.C. Memo. 2005–104)), aff ’d,
601 F.3d 763 (8th Cir. 2010). Similarly, courts have used the term ‘‘sham’’
to characterize transactions lacking economic substance, see, e.g., United
Continued
194 144 UNITED STATES TAX COURT REPORTS (161)
Despite their lexical imprecision, prior opinions of this
Court and other courts form a substantial body of precedent
for the application of judicial doctrines to disallow tax results
in transactions that, on their face, technically strictly con-
form to the letter of the Code and the regulations. 34 In
identifying the source of those doctrines, courts typically
point to Gregory v. Helvering, 293 U.S. 465 (1935). Gregory
has come to stand for so many principles that, in order to
define our premises before applying them to the facts of this
case, what the Supreme Court actually said and what it was
doing in that case bear reexamination.
1. Gregory Revisited
Gregory and subsequent Supreme Court opinions relying
upon it contain the seeds of each of the doctrines attributed
to it. 35 Mrs. Gregory had conducted a series of transactions
States v. Woods, 571 U.S. ll, ll, 134 S. Ct. 557, 567 (2013), or charac-
terized the economic substance and sham transaction doctrines as equiva-
lents, see, e.g., UnionBanCal Corp. v. United States, 113 Fed. Cl. 117, 129
n.29 (2013).
34 Some may quibble with the notion that widely accepted legal doctrines
can develop within so short a span as 30 or even 80 years. See, e.g., Jasper
L. Cummings, Jr., ‘‘ The Sham Transaction Doctrine’’, 145 Tax Notes 1239,
1241 (2014). The common law’s development has been described as a
‘‘gradual [process], building on past decisions, drawing on new experience,
and responding to changing conditions.’’ See Ohio v. Roberts, 448 U.S. 56,
64 (1980), abrogated on other grounds by Crawford v. Washington, 541
U.S. 36 (2004). For better or worse, the pace at which those ‘‘conditions’’
change has inexorably quickened in recent decades. Social, technological,
economic, and political changes all occur far more rapidly now than in the
days of Blackstone or even Holmes. We do not find it implausible that com-
mon law principles should coalesce more swiftly in this environment. Nor,
it seems, does Congress, which recognized economic substance as a com-
mon law doctrine in 2010. See Health Care and Education Reconciliation
Act of 2010, Pub. L. No. 111–152, sec. 1409, 124 Stat. at 1067–1070 (codi-
fied at sec. 7701(o)).
35 Courts and commentators have variously characterized Gregory v.
Helvering, 293 U.S. 465 (1935), as: (1) interpolating a business purpose re-
quirement into the predecessor statute of sec. 368, see, e.g., Bazley v. Com-
missioner, 4 T.C. 897, 901–902 (1945), aff ’d, 155 F.2d 237 (3d Cir. 1946),
aff ’d, 331 U.S. 737 (1947); Cummings, supra, at 1246–1247; (2) reading a
business purpose requirement into the Code more generally, see, e.g.,
Weller v. Commissioner, 270 F.2d 294, 297 (3d Cir. 1959), aff ’g 31 T.C. 33(1958), and aff ’g Emmons v. Commissioner, 31 T.C. 26 (1958); (3) identi-
fying and disregarding a sham transaction, see, e.g., Helvering v. Minn.
(161) CNT INVESTORS, LLC v. COMMISSIONER 195
that, she asserted, satisfied all requirements for a reorga-
nization under then-applicable law, such that her wholly
owned corporation’s transfer to her of highly appreciated
stock, ensconced within a transient corporate shell, was non-
taxable. See Gregory v. Helvering, 293 U.S. at 467–468. In its
opinion the Supreme Court asked ‘‘whether what was done,
apart from the tax motive, was the thing which the statute
intended.’’ Id. at 469. The Court’s answer to that question
implicates two rationales. First, the Court read the statute to
apply only to transfers made in pursuit of a ‘‘business or cor-
porate purpose’’. See id. Second, the Court emphasized its
focus on the substance, rather than the form, of what had
transpired, characterizing the transaction as ‘‘a mere device
which put on the form of a corporate reorganization as a dis-
guise for concealing its real character’’. See id.Less than one year later, the Court echoed these two
themes in Helvering v. Minn. Tea Co., 296 U.S. 378, 385
(1935), another reorganization case. The Court distinguished
the case before it from Gregory as involving a ‘‘bona fide busi-
ness move’’ (i.e., business purpose). Id. Further, the Court
explained that Gregory had ‘‘revealed a sham[,] * * * a mere
device intended to obscure the character of the transaction’’,
but confirmed that Gregory had ‘‘disregarded the mask and
dealt with realities.’’ Id. The Court thus used the word
‘‘sham’’ to describe a transaction, the true ‘‘character’’ of
which did not align with its form, and thereby tethered the
term ‘‘sham’’ to substance over form principles. See id.Tea Co., 296 U.S. 378, 385 (1935); Rice’s Toyota World, Inc. v. Commis-
sioner, 752 F.2d 89, 95 (4th Cir. 1985), aff ’g in part, rev’g in part 81 T.C.
184 (1983); (4) enunciating a broad substance over form principle, see, e.g.,
Gilbert v. Commissioner, 248 F.2d 399, 403 (2d Cir. 1957), remanding T.C.
Memo. 1956–137; Alvin C. Warren, Jr., ‘‘The Requirement of Economic
Profit in Tax Motivated Transactions’’, 59 Taxes 985, 986 (1981); and (5)
applying the step transaction principle, see, e.g., Assoc. Wholesale Grocers,
Inc. v. United States, 927 F.2d 1517, 1522 (10th Cir. 1991). Courts also
routinely cite Gregory in applying the economic substance doctrine. See,
e.g., ACM P’ship v. Commissioner, 157 F.3d 231, 246 (3d Cir. 1998), aff ’g
in part, rev’g in part T.C. Memo. 1997–115. But cf. David P. Hariton, ‘‘Sort-
ing Out the Tangle of Economic Substance’’, 52 Tax Law. 235, 241–245
(1999) (crediting Judge Learned Hand’s opinion for the Court of Appeals
for the Second Circuit in Gregory as the doctrine’s source).
196 144 UNITED STATES TAX COURT REPORTS (161)
Hence, the sham transaction doctrine originated as an
extension of Gregory’s substance over form principle. 36 We
have described that doctrine as having two strands: (1) a fac-
tual sham is a transaction that did not, in fact, take place,
and (2) a legal or economic sham, also known as a sham in
substance, is a transaction that did take place but that had
no independent economic significance aside from its tax
implications. See Krumhorn v. Commissioner, 103 T.C. 29,
38, 46 (1994). The latter strand can be traced to Gregory. In
a transaction that is a sham in substance, papers may have
been signed and money moved around, but in concrete, eco-
nomic terms, the transaction is a nullity. Afterward, the par-
ties’ beneficial interests remain essentially unchanged.
Courts typically apply the substance over form principle to
recharacterize a transaction to make its form (on the basis
of which it will be taxed) consistent with the economic,
nontax substance of what occurred. When the transaction is
an economic sham, such that nothing of substance in fact
occurred (or could have occurred as the transaction was
structured), we disregard it altogether, just as we would do
with a factual sham. 37
36 We have previously characterized the sham transaction doctrine as
founded on or related to substance over form principles. See, e.g., Klaas v.
Commissioner, T.C. Memo. 2009–90, 97 T.C.M. (CCH) 1467, 1472 (2009),
aff ’d, 624 F.3d 1271 (10th Cir. 2010); Andantech L.L.C. v. Commissioner,
T.C. Memo. 2002–97, 83 T.C.M. (CCH) 1476, 1501 (2002), aff ’d in part and
remanded on other grounds, 331 F.3d 972 (D.C. Cir. 2003); Gaw v. Com-
missioner, T.C. Memo. 1995–531, 70 T.C.M. (CCH) 1196, 1226 (1995), aff ’d
without published opinion, 111 F.3d 962 (D.C. Cir. 1997).
37 Knetsch v. United States, 364 U.S. 361, 365–366 (1960), the first tax
case in which the Supreme Court used the phrase ‘‘sham transaction’’, il-
lustrates this rationale. Mr. Knetsch purchased from an insurance com-
pany an annuity contract ‘‘with a so-called guaranteed cash value at matu-
rity * * * which would produce * * * substantial life insurance proceeds
in the event of his death before maturity.’’ Pursuant to the contract, how-
ever, he also borrowed repeatedly and regularly against the annuity’s cash
value, such that ‘‘the net cash value, on which any annuity or insurance
payments would depend,’’ remained negligible. Id. at 366. He claimed a de-
duction for interest paid on the loans under sec. 163. Id. at 363–364.
Quoting Gregory, the Court asked ‘‘ ‘whether what was done, apart from
the tax motive, was the thing which the statute intended’ ’’ and concluded
the answer was no. Id. at 365 (quoting Gregory v. Helvering, 293 U.S. at
469). The alleged premium and interest payments simply offset the alleged
loans and ‘‘did ‘not appreciably affect * * * [the taxpayer’s] beneficial in-
terest except to reduce his tax’ ’’. See id. at 365–366 (quoting Gilbert v.
(161) CNT INVESTORS, LLC v. COMMISSIONER 197
Only five years later, in Higgins v. Smith, 308 U.S. 473,
476 (1940), the Court deemed substance over form a ‘‘broad
and unchallenged principle’’. The taxpayer in that case had
claimed an ordinary loss deduction in connection with a sale
of securities to his wholly owned corporation, which he had
created solely to achieve income and estate tax savings. See
id. at 474–475. Because substance over form ‘‘furnishe[d]
only a general direction’’, the Court looked to Gregory’s busi-
ness purpose theme and extrapolated from it: ‘‘[If] the
Gregory case is viewed as a precedent for the disregard of a
transfer of assets without a business purpose but solely to
reduce tax liability, it gives support to the natural conclusion
that transactions, which do not vary control or change the
flow of economic benefits, are to be dismissed from consider-
ation.’’ Id. at 476. Gregory, the Court implied, supports the
twin propositions that any property transfer must have a
nontax purpose and that transactions without nontax, eco-
nomic consequences may be disregarded for tax purposes. See
id. These propositions now make up the two prongs of the
codified economic substance doctrine. 38
Gregory, as interpreted by the Court in its subsequent
opinions, spawned the economic substance, sham transaction,
business purpose, and substance over form doctrines. 39 We
Commissioner, 248 F.2d 399, 411 (2d Cir. 1957) (Learned Hand, J., dis-
senting)). ‘‘What he was ostensibly ‘ lent’ back was in reality only the re-
bate of a substantial part of’’ his interest payments. Id. at 366. In sum,
‘‘there was nothing of substance to be realized by Knetsch from this trans-
action beyond a tax deduction.’’ Id. (emphasis added). Hence, it was a
‘‘sham.’’ Id.
38 Congress has mandated that, in applying ‘‘the common law doctrine
under which tax benefits * * * with respect to a transaction are not allow-
able if the transaction does not have economic substance or lacks a busi-
ness purpose’’ to any transaction to which it is ‘‘relevant’’, the Federal
courts use a conjunctive test. Sec. 7701(o)(1), (5)(A). Of course, the trans-
actions at issue occurred before codification, so if we were to apply the eco-
nomic substance doctrine in this Opinion, we would do so on the basis of
relevant caselaw rather than in accordance with the later-enacted statute.
We will not apply the doctrine, however, because the Government has not
invoked the doctrine and because, in any event, the case may be resolved
through the application of other principles.
39 As an extension of the substance over form principle, see supra note
33, the step transaction doctrine likewise finds its roots in Gregory. When
a group of transactions is so ‘‘integrated’’, ‘‘interdependent’’, and ‘‘focused
Continued
198 144 UNITED STATES TAX COURT REPORTS (161)
do not trace these doctrines back to Gregory in order to add
to the extensive literature parsing Gregory and related
caselaw, or in order to propose a discrete doctrinal taxonomy.
We source the judicial doctrines to Gregory to draw attention
not to what the Court said, but to what it was doing, in that
case and subsequent cases.
Gregory, like much of the caselaw using the economic sub-
stance, sham transaction, and other judicial doctrines in
interpreting and applying tax statutes, represents an effort
to reconcile two competing policy goals. On one hand, having
clear, concrete rules embodied in a written Code and regula-
tions that exclusively define a taxpayer’s obligations (1)
facilitates smooth operation of our voluntary compliance
system, (2) helps to render that system transparent and
administrable, and (3) furthers the free market economy by
permitting taxpayers to know in advance the tax con-
sequences of their transactions. On the other side of the
scales, the Code’s and the regulations’ fiendish complexity
necessarily creates space for attempts to achieve tax results
that Congress and the Treasury plainly never contemplated,
while nevertheless complying strictly with the letter of the
rules, at the expense of the fisc (and other taxpayers).
In Gregory, the Court confronted such an extreme result
and, on the basis of equitable principles, interpreted and
applied the relevant statute so as to subject Mrs. Gregory’s
transaction to tax. Likewise, the various other judicial doc-
trines applied in tax cases all represent efforts to rein in
activity that, while within the technical letter of the rules,
deeply offends their spirit. 40 Attempts to parse and define
the doctrines merely intellectualize what is, ultimately, an
equitable exercise. Those who favor transparency might
on a particular end result’’ that evaluating the tax consequences independ-
ently will not ‘‘reflect[ ] the actual overall result’’, we disregard the trans-
actions’ formal separateness and treat them, in substance, as one. See Gor-
don v. Commissioner, 85 T.C. 309, 324 (1985); see also Superior Trading,
LLC v. Commissioner, 137 T.C. 70, 88–90 (2011), aff ’d, 728 F.3d 676 (7th
Cir. 2013).
40 Such efforts lie squarely within the courts’ role in interpreting the law
in ways consistent with congressional intent. ‘‘[C]ourts in the interpreta-
tion of a statute have some scope for adopting a restricted rather than a
literal or usual meaning of its words where acceptance of that meaning
would lead to absurd results, * * * or would thwart the obvious purpose
of the statute’’. Helvering v. Hammel, 311 U.S. 504, 510–511 (1941).
(161) CNT INVESTORS, LLC v. COMMISSIONER 199
prefer a strictly circumscribed taxonomy of judicial doctrines,
to include exclusive definitions of the circumstances in which
they should be applied. Those who favor administrability,
protection of the fisc, and respect for congressional purpose
might prefer that courts exercise carte blanche in disallowing
results of transactions perceived as abusive. Gregory and its
progeny represent an ongoing effort to reconcile these
opposing principles and methodologies. Litigants and courts
employ specialized terminology to make this effort appear
more rigorous, but candidly, underneath, we are simply
engaged in the difficult, commonsense task of judging.
We attempt to apply Gregory’s teachings to the trans-
actions at issue.
2. Sham Transaction Doctrine
The parties have stipulated numerous exhibits—including
real estate deeds, account agreements, trade confirmations,
and account statements—demonstrating that the trans-
actions at issue actually occurred, so we consequently focus
on the economic sham strand of the sham transaction doc-
trine. See Krumhorn v. Commissioner, 103 T.C. at 38, 46
(distinguishing factual shams from shams in substance). We
ask whether any of these transactions had ‘‘nontax sub-
stance’’ or affected the parties’ beneficial interests other than
by reducing their tax obligations. See Knetsch v. United
States, 364 U.S. 361, 366 (1960).
The parties have stipulated that CNT, Teloma, Santa
Paula, and S. Mountain were sham entities with no business
purpose. They have likewise stipulated that the Carrolls’
purported contribution of short sale proceeds and related
obligations (along with a nominal amount of cash) to CNT in
exchange for partnership interests in CNT was a sham trans-
action with no business purpose. They have not, however,
stipulated that any of the other transactions at issue, nor the
entire series of transactions, constitutes a sham. On the
basis of our factual findings and review of the record, we
identify six separate actions undertaken here: (1) CCFH
contributed the five mortuary properties to CNT; (2) the
Carrolls opened short sale positions; (3) the Carrolls contrib-
uted those short sale positions to CNT; (4) CNT closed the
short sale positions; (5) the Carrolls contributed their CNT
interests to CCFH; and (6) CCFH distributed New CNT
200 144 UNITED STATES TAX COURT REPORTS (161)
interests to its shareholders. Following Knetsch, we must
determine whether these transactions had ‘‘nontax sub-
stance’’ and were thus what they purported to be—that is,
not economic shams.
Examining each step independently (before determining
whether and to what extent the step transaction doctrine
should apply), we find that steps (1), (3), and (5) were all
sham transactions, principally because CNT was a sham
entity. The parties have stipulated, and the record reflects,
that CNT lacked any legitimate business purpose. Rather, it
was formed solely as a vehicle for effecting the Son-of-BOSS
transaction and artificially ‘‘boosting’’ the real estate’s aggre-
gate adjusted tax basis. Hence, consistent with the parties’
stipulation, it was a sham partnership. See Commissioner v.
Culbertson, 337 U.S. 733, 742 (1949) (explaining that, to form
a valid partnership under Federal law, ‘‘the parties in good
faith and acting with a business purpose [must] intend[ ] to
join together in the present conduct of the enterprise’’). We
therefore disregard its existence. See, e.g., Sparkman v.
Commissioner, 509 F.3d 1149, 1156 n.6 (9th Cir. 2007), aff ’g
T.C. Memo. 2005–136; Andantech L.L.C. v. Commissioner,
331 F.3d 972, 980 (D.C. Cir. 2003), aff ’g and remanding T.C.
Memo. 2002–97, 83 T.C.M. (CCH) 1476 (2002); see also
Moline Props., Inc. v. Commissioner, 319 U.S. 436, 439 (1943)
(explaining, in a tax case, that ‘‘the corporate form may be
disregarded when it is a sham or unreal’’).
We likewise disregard as shams the purported contribu-
tions of property to, and contributions of interests in, the
sham partnership that occurred at steps (1), (3), and (5).
Although deeds were signed and funds moved among
accounts, economically, the parties’ positions did not change.
CCFH and the Carrolls could not have contributed property
in exchange for interests in a nonexistent partnership. They
acquired nothing of substance and relinquished nothing of
substance. A transaction undertaken with a sham entity is,
a fortiori, a sham.
We further conclude that steps (2) and (4), together, con-
stituted a sham transaction. The Carrolls opened the short
sale positions, and—disregarding the positions’ purported
contribution to the sham partnership, CNT—closed them
mere days later pursuant to a prearranged plan. Pursuant to
that same plan, during the brief period for which the short
(161) CNT INVESTORS, LLC v. COMMISSIONER 201
sale positions remained open, the short sale proceeds were
invested in the same T-notes sold short, in an almost iden-
tical amount, thereby reducing to near zero the risk of a loss
on the short sale. Conversely, respondent’s expert concluded,
and petitioner does not specifically dispute, that the short
sale as structured had virtually no chance of generating a
profit. As designed, the short sale could have had no lasting
economic consequence and would alter only the individuals’
tax positions, through the creation of basis in a purported
partnership. 41 Hence, like the offsetting premium payments
and loans in Knetsch, which ‘‘did ‘not appreciably affect * * *
[the taxpayer’s] beneficial interest except to reduce his tax’ ’’,
steps (2) and (4) constitute an economic sham. See Knetsch,
364 U.S. at 365–366 (quoting Gilbert v. Commissioner, 248
F.2d 399, 411 (2d Cir. 1957) (Learned Hand, J., dissenting));
see also, e.g., Horn v. Commissioner, 968 F.2d 1229, 1236
(D.C. Cir. 1992) (describing an economic sham as a trans-
action structured ‘‘in such a way as to create the tax
benefits while completely avoiding economic risk’’), rev’g Fox
v. Commissioner, T.C. Memo. 1988–570, and rev’g Kazi v.
Commissioner, T.C. Memo. 1991–37; Neely v. United States,
775 F.2d 1092, 1094 (9th Cir. 1985) (defining a sham trans-
action as ‘‘one having no economic effect other than to create
income tax losses’’).
Step (6), however, was different. If, for the reasons
explained above, we disregard the preceding steps as shams
and look through New CNT to its then partners, at this step
CCFH transferred the five mortuary properties to the
Carrolls. This transfer materially changed the Carrolls’ and
CCFH’s economic positions, entirely aside from tax consider-
ations. CCFH was a passthrough entity for tax purposes, but
for other legal purposes it was a legal entity distinct from its
owners. The parties have not stipulated, and the record does
not reflect, that CCFH was a sham entity. On the contrary,
CCFH was a going concern that had operated a viable busi-
ness and held the real properties for several years, not an
41 Although as explained supra note 38, we do not herein apply the eco-
nomic substance doctrine, the facts suggest that the T-note short sale also
ran afoul of that doctrine. The parties have stipulated that Mr. Carroll had
never before engaged in a short sale or any remotely similar financial
transaction. Petitioner has offered, and we can discern, no nontax purpose
for the T-note short sale.
202 144 UNITED STATES TAX COURT REPORTS (161)
ephemeral shell created solely for this series of transactions.
In distributing the real estate to its shareholders, it reduced
its balance sheet and lost the right to control and dispose of
a valuable asset. Its shareholders, meanwhile, acquired the
‘‘bundle of rights’’ associated with ownership of real property.
In particular, the Carrolls acquired the right to lease and
receive rental income from the properties, as they had con-
templated doing. All obligations connected with ownership of
land likewise passed from CCFH to the Carrolls.
Moreover, as petitioner essentially acknowledges, a
substantial, nontax purpose motivated the transfer, and
attainment of that purpose altered the parties’ economic posi-
tions in a meaningful way. The Carroll family wanted to
retire from the mortuary business and hoped to sell the
funeral home, retaining the real estate as a source of ongoing
income. Their advisers had concluded that the best means of
achieving this goal would be to separate the real estate from
the operating assets by transferring the real estate out of
CCFH. In sharp contrast to the annuity arrangement in
Knetsch, this transaction’s participants did realize something
of substance beyond a tax deduction: They implemented the
business disposition and rental income retirement plan rec-
ommended by their advisers.
For the foregoing reasons, we conclude that step (6) had
nontax substance, and we will not disregard CCFH’s transfer
of the real estate as a sham transaction.
Petitioner, however, repeatedly emphasizes that the
Carrolls and their advisers refrained from causing CCFH to
transfer the real estate until they had identified an osten-
sible means of accomplishing it without tax consequences. He
contends that, but for the Son-of-BOSS transaction, the real
estate would never have been transferred at all. This conten-
tion essentially invokes the step transaction doctrine. Even
if, on its own, step (6) had nontax substance, must we never-
theless disregard it because it was part and parcel of an
integrated sham transaction?
3. Step Transaction Doctrine
It is axiomatic that ‘‘a transaction’s true substance rather
than its nominal form governs its Federal tax treatment.’’
Superior Trading, LLC v. Commissioner, 137 T.C. 70, 88
(2011), aff ’d, 728 F.3d 676 (7th Cir. 2013); see also Commis-
(161) CNT INVESTORS, LLC v. COMMISSIONER 203
sioner v. Court Holding Co., 324 U.S. 331, 334 (1945) (‘‘The
incidence of taxation depends upon the substance of a trans-
action.’’). Before recharacterizing a transaction’s form to align
with its substance, we conduct ‘‘a searching analysis of the
facts to see whether the true substance of the transaction is
different from its form or whether the form reflects what
actually happened.’’ Harris v. Commissioner, 61 T.C. 770, 783
(1974); see also Gordon v. Commissioner, 85 T.C. 309, 324
(1985) (‘‘[F]ormally separate steps in an integrated and inter-
dependent series that is focused on a particular end result
will not be afforded independent significance in situations in
which an isolated examination of the steps will not lead to
a determination reflecting the actual overall result of the
series of steps.’’).
Three alternative tests of varying degrees of permissive-
ness exist for determining whether to invoke the step trans-
action doctrine: the binding commitment test, the end result
test, and the interdependence test. Superior Trading, LLC v.
Commissioner, 137 T.C. at 88. ‘‘[A] transaction need only sat-
isfy one of the tests to allow for the step transaction doctrine
to be invoked.’’ Id. at 90.
Under the binding commitment test, we ask whether, at
the time of the first step to occur, there was a binding
commitment to undertake the subsequent steps. See Commis-
sioner v. Gordon, 391 U.S. 83, 96 (1968). Courts have seldom
used this test, and we have typically applied it only where
‘‘ ‘a substantial period of time has passed between the steps
that are subject to scrutiny.’ ’’ Superior Trading, LLC v.
Commissioner, 137 T.C. at 89 (quoting Andantech LLC v.
Commissioner, 83 T.C.M. (CCH) at 1504). Because all steps
here occurred within little over one month, the binding
commitment test is likely inappropriate to these cir-
cumstances. See id.; see also Assoc. Wholesale Grocers, Inc. v.
United States, 927 F.2d 1517, 1522 n.6 (10th Cir. 1991)
(declining to apply binding commitment test where case did
not involve series of transactions over multiple years). 42
Under the end result test, we examine ‘‘whether the for-
mally separate steps are prearranged components of a com-
posite transaction intended from the outset to arrive at a
42 Were we to apply the test regardless, it would not alter our ultimate
conclusion because the transactions at issue satisfy the other two tests.
204 144 UNITED STATES TAX COURT REPORTS (161)
specific end result.’’ Superior Trading, LLC v. Commissioner,
137 T.C. at 89; see also True v. United States, 190 F.3d 1165,
1175 (10th Cir. 1999) (observing that what matters is
whether the parties ‘‘intended to reach a particular result by
structuring a series of transactions in a certain way’’). The
interdependence test similarly asks whether the various
steps are so interdependent that each alone accomplishes no
independent business purpose and ‘‘would have been fruitless
without completion of the later series of steps.’’ Superior
Trading, LLC v. Commissioner, 137 T.C. at 90. Petitioner
readily admits that the series of transactions undertaken by
the Carrolls and their wholly owned entities were orches-
trated solely to achieve a particular goal, established at the
outset, of removing the real estate from CCFH and that each
step in the series would not have occurred but for the others.
Under either the end result test or the interdependence test,
then, the step transaction doctrine plainly applies.
We thus collapse the series of transactions into one, dis-
regarding CNT, Teloma, Santa Paula, and S. Mountain as
sham entities pursuant to the parties’ stipulation. Before the
series of transactions began, CCFH owned the five mortuary
properties. When the dust settled, Mr. Carroll, Ms. Cadman,
and Ms. Craig owned the properties. Accordingly, the
‘‘stepped’’ transaction is a transfer of the five properties by
CCFH to the three individuals, and for the reasons discussed
above, that transaction had nontax substance. It was not, as
petitioner would have it, a nonevent. ‘‘[I]n cases where a tax-
payer seeks to get from point A to point D and does so stop-
ping in between at points B and C’’, we apply the step trans-
action doctrine to ignore the interim stops, Smith v. Commis-
sioner, 78 T.C. 350, 389 (1982), not to return the taxpayer to
point A.
The foregoing conclusion is decidedly not the one petitioner
seeks. Rather than simply stop there, we must consider a
strand of authority he raises on brief that, in effect, blends
the sham and step transaction doctrines.
4. Blending the Doctrines
Where a sham transaction consists of multiple steps, we
have recognized that ‘‘there is authority [for the proposition]
that a sham transaction may contain elements whose form
reflects economic substance and whose normal tax con-
(161) CNT INVESTORS, LLC v. COMMISSIONER 205
sequences therefore may not be disregarded.’’ Alessandra v.
Commissioner, T.C. Memo. 1995–238, 69 T.C.M. (CCH) 2768,
2770, 2773 (1995) (requiring inclusion of income generated by
T-bills purchased and interest-bearing account opened in
connection with a sham transaction), aff ’d without published
opinion, 111 F.3d 137 (9th Cir. 1997).
In most such cases, courts determined that interest paid
on bona fide indebtedness could be deducted even when the
indebtedness had been incurred in connection with or in
anticipation of a sham transaction. See, e.g., Jacobson v.
Commissioner, 915 F.2d 832, 840 (2d Cir. 1990) (con-
cluding that interest and loan commitment fees were deduct-
ible), aff ’g in part, rev’g in part on other grounds T.C. Memo.
1988–341; Bail Bonds by Marvin Nelson, Inc. v. Commis-
sioner, 820 F.2d 1543, 1549 (9th Cir. 1987) (finding that a
loan was a sham, but implying that if it were bona fide,
interest would be deductible), aff ’g T.C. Memo. 1986–23;
Rice’s Toyota World, Inc. v. Commissioner, 752 F.2d 89, 96
(4th Cir. 1985) (in a sham sale-leaseback transaction
financed with notes, holding that taxpayer could deduct
interest paid on a recourse note because it represented a gen-
uine obligation), aff ’g in part, rev’g in part 81 T.C. 184(1983); Rose v. Commissioner, 88 T.C. 386, 423–424 (1987)
(allowing deduction of interest payments ‘‘attributable to the
forbearance of amounts due on genuine indebtedness’’ in
connection with a transaction lacking economic substance),
aff ’d, 868 F.2d 851 (6th Cir. 1989).
On the other hand, we have declined to sever interest pay-
ments from a multistep sham transaction where the interest
payments were ‘‘an integral part of the tax-motivated
sham.’’ 43 Alessandra v. Commissioner, 69 T.C.M. (CCH) at
2772; see, e.g., Sheldon v. Commissioner, 94 T.C. 738, 762
(1990) (disallowing deductions for interest owed to securities
repo counterparties where the repo transactions ‘‘lacked tax-
independent purpose’’); Seykota v. Commissioner, T.C. Memo.
1991–541, 62 T.C.M. (CCH) 1116, 1117, 1119 (1991) (dis-
43 In such cases we disregard both the income and the deductions gen-
erated by the sham transaction. See Sheldon v. Commissioner, 94 T.C. 738,
762 (1990); see also Arrowhead Mountain Getaway Ltd. v. Commissioner,
T.C. Memo. 1995–54, 69 T.C.M. (CCH) 1805, 1821–1822 (1995), aff ’d with-
out published opinion, 119 F.3d 5 (9th Cir. 1997); Seykota v. Commissioner,
T.C. Memo. 1991–541, 62 T.C.M. (CCH) 1116, 1118 (1991).
206 144 UNITED STATES TAX COURT REPORTS (161)
allowing current-year deductions for interest paid to a
commercial lender where the taxpayer borrowed the funds to
purchase capital assets that would be sold in the following
tax year, thereby both deferring recognition of income and
converting ordinary income to capital gain); see also Gold-
stein v. Commissioner, 364 F.2d 734, 740 (2d Cir. 1966)
(affirming disallowance of interest deductions where debt
was incurred solely for its anticipated tax consequences),
aff ’g 44 T.C. 284 (1965).
Petitioner argues that the latter strand of caselaw governs
here because CCFH’s transfer of the real estate was
‘‘integral’’ to the sham Son-of-BOSS transaction and would
not have occurred but for that transaction. Thus, petitioner
asks us to disregard the tax consequences flowing from the
transfer and to hold, for tax purposes, that CCFH still owns
the real estate.
Petitioner’s characterization of the real estate’s transfer as
a mere component of a sham transaction represents a cat-
egory mistake. 44 Transferring the real estate was the reason
for and objective of the series of transactions at issue, not
simply one of the transactions. Taxpayers have most com-
monly used Son-of-BOSS transactions retrospectively, to
offset recognized gains from unrelated, completed trans-
actions. See supra note 7. Here, the Carrolls used the Son-
of-BOSS transaction prospectively, to avoid recognizing gains
on a planned transaction—to wit, separation of the real
estate from the funeral home business. We think this a
distinction without a difference. A Son-of-BOSS transaction
is a tax shelter undertaken, as its moniker implies, to offset,
or ‘‘shelter’’, income that would otherwise be subject to tax.
Neither the sham transaction doctrine nor the step trans-
action doctrine nor the two combined requires us to disregard
the income-producing event along with the shelter trans-
action designed to offset it. Such an interpretation would
render the doctrines toothless and yield absurd results.
None of the cases petitioner cites as supporting his position
persuades us otherwise. In Sheldon v. Commissioner, 94 T.C.
44 ‘‘[A]
category mistake treats a concept ‘as if [it] belonged to one logical
type or category * * * when [it] actually belong[s] to another’ ’’. Planned
Parenthood of Idaho, Inc. v. Wasden, 376 F.3d 908, 930 n.21 (9th Cir.
2004) (quoting Gilbert Ryle, The Concept of Mind 15 (1949)).
(161) CNT INVESTORS, LLC v. COMMISSIONER 207
at 762, where we disallowed interest deductions generated by
sham repo transactions, we held that the taxpayers need not
recognize the ‘‘relatively small amounts of interest income’’
generated by the transactions; we did not discuss, much less
disregard as shams, the transactions that had produced the
ordinary income the taxpayers presumably hoped to shelter
with the interest deductions. Accord Arrowhead Mountain
Getaway Ltd. v. Commissioner, T.C. Memo. 1995–54, 69
T.C.M. (CCH) 1805 (1995), aff ’d without published opinion,
119 F.3d 5 (9th Cir. 1997); Seykota v. Commissioner, T.C.
Memo. 1991–541.
In United States v. Wexler, 31 F.3d 117, 126 (3d Cir. 1994),
a criminal tax fraud case, the Court of Appeals for the Third
Circuit found clear error in a jury instruction that would
have recognized as valid interest deductions ‘‘constituting the
tax benefits of the entire [sham] transaction.’’ The ‘‘profits
from other transactions’’ that had been offset by these deduc-
tions were not at issue. See id. at 120. And in Goldstein,
where we disallowed deductions of interest paid on loans that
were shams, we did not hold that the taxpayer need not rec-
ognize the sweepstakes income that her son had engineered
the loans to offset. Goldstein v. Commissioner, 44 T.C. at
286–287, 296, 300 (likewise disallowing interest on loans
incurred solely to obtain a deduction, without concurrently
disregarding sweepstakes income).
We would no more disregard the transfer of the real estate
here than we would Mrs. Goldstein’s sweepstakes win. Here,
the gain-producing transaction and the shelter transaction
occurred pursuant to a plan, and the shelter trans-
action arguably preceded realization of the gains it was
designed to shield. But if we were to disregard the gain-pro-
ducing transaction along with the shelter transaction, we
would encourage taxpayers to hedge against the audit lottery
by structuring their tax shelter transactions to precede and
intertwine with their income-producing activities. We will not
do so. ‘‘[W]hile a taxpayer is free to organize his affairs as
he chooses, nevertheless, once having done so, he must
accept the tax consequences of his choice, whether con-
templated or not’’. Commissioner v. Nat’l Alfalfa Dehydrating
& Milling Co., 417 U.S. 134, 149 (1974).
208 144 UNITED STATES TAX COURT REPORTS (161)
5. Conclusion
In sum, we hold that the step transaction doctrine applies
to the transactions undertaken by the Carrolls; that applica-
tion of that doctrine collapses the various transactions to a
transfer of the real estate from CCFH to the Carrolls; and
that this transfer was not simply part and parcel of a larger
sham transaction. We will not disregard the transfer or the
gain it generated.
E. Definition of Omission
Although we will not disregard CCFH’s transfer of the real
estate as petitioner urges, he has another arrow in his
quiver. He contends that, under the Supreme Court’s deci-
sion in United States v. Home Concrete Supply, LLC, 566
U.S. ll, 132 S. Ct. 1836 (2012), the allegedly omitted
item—gain recognized on CCFH’s distribution of appreciated
property to its shareholders—does not constitute an omission
within the meaning of section 6501(e)(1)(A) because it derives
entirely from an overstatement of outside basis.
In Home Concrete, 566 U.S. at ll, 132 S. Ct. at 1841, the
Supreme Court held that its interpretation in Colony, Inc. v.
Commissioner, 357 U.S. 28, 36 (1958), of a prior version of
section 6501(e)(1)(A) applies with equal force to the current
statute: To ‘‘omit’’ an amount properly includible in gross
income is to leave something out entirely. When a taxpayer
‘‘overstates his basis in property that he has sold, thereby
understating the gain that he received from its sale’’, section
6501(e)(1)(A) does not apply. Home Concrete, 566 U.S. at
ll, 132 S. Ct. at 1839. In such a case, the taxpayer has
reported, not omitted, the item of gain, albeit in an incorrect
amount.
As we have explained, respondent’s theory here is that, in
purporting to distribute interests in New CNT to its share-
holders, CCFH in fact distributed the appreciated real estate.
Both CCFH (under section 311(b)) and its shareholders
(under section 1366(a)(1)) should have reported gain as if the
property had been sold for its fair market value. Neither
CCFH, nor Mr. Carroll, nor Ms. Cadman, nor Ms. Craig
reported this gain. Hence, respondent concludes, CNT’s part-
ners each entirely left out an income item from its, his, or
her return, so Home Concrete’s rule is inapposite.
(161) CNT INVESTORS, LLC v. COMMISSIONER 209
If one considers the supposed omission from a different
angle, however, Home Concrete appears far more relevant.
The amount of gain that the partners were obliged but failed
to report was the difference between the real estate’s aggre-
gate fair market value and its adjusted tax basis. See secs.
311(b), 1001(a), 1366(a)(1). If that difference was zero
because CCFH had overstated its basis in the real estate as
equal to the real estate’s fair market value, then Home Con-
crete would apply squarely to the alleged omission. The Son-
of-BOSS transaction in which the Carrolls engaged was
designed to inflate the real estate’s tax basis so as to elimi-
nate or minimize the tax consequences when CCFH trans-
ferred the property. Basis overstatement was the essence of
the transaction. Hence, we must determine whether the
allegedly omitted gain derives entirely from a basis over-
statement, and if so, whether the correction of that overstate-
ment by respondent is barred by the statute of limitations.
We have concluded that for tax purposes CCFH trans-
ferred the property directly to the Carrolls. In our findings,
we found that this transfer would have resulted in recogni-
tion of $3,496,623 of gain under section 311(b), and we also
described the tax treatment the Carrolls intended their
transactions to receive. Even affording the transactions and
entities involved the Carrolls’ desired tax treatment and
accepting all overstatements of basis as accurate, CCFH
should have recognized and reported $623,284 of gain under
section 311(b) on its distribution of CNT interests to its
shareholders. CCFH did not report any gain. Hence, of
CCFH’s omitted section 311(b) gain, $623,284 of the omitted
amount cannot be explained by the basis overstatement
resulting from the Son-of-BOSS transaction. Therefore, under
section 1366(a)(1), even accepting all overstatements of basis
as accurate, CCFH’s shareholders should have included a
total of $623,284 of gain in their income, allocated among
them in the following amounts:
Shareholder Amount
Mr. Carroll ............................................................... $588,699.22
Ms. Cadman ............................................................. 17,292.39
Ms. Craig .................................................................. 17,292.39
Total .................................................................... 623,284.00
210 144 UNITED STATES TAX COURT REPORTS (161)
None did so. Because these omissions cannot be attributed to
a basis overstatement, Home Concrete does not necessarily
bar the application of section 6501(e)(1)(A).
To determine whether these omissions exceeded 25% of
‘‘the amount of gross income stated in the return’’, sec.
6501(e)(1)(A), for Mr. Carroll, Ms. Cadman, and/or Ms. Craig,
we must first compute the amounts of gross income stated in
their respective 1999 Federal income tax returns, each of
which was filed jointly with a spouse. For this purpose
‘‘ ‘gross income’ means those items listed in section 61(a),
which includes, among other things, gains derived from
dealings in property.’’ Insulglass Corp. v. Commissioner, 84
T.C. 203, 210 (1985) (quoting section 6501(e)(1)(A)). Gross
income does not, however, include losses derived from
dealings in property, as section 62, not section 61, provides
for the deduction of such losses. Schneider v. Commissioner,
T.C. Memo. 1985–139, 49 T.C.M. (CCH) 1032, 1034 (1985);
see also Barkett v. Commissioner, 143 T.C. 149, 152–156
(2014) (reaffirming Insulglass and Schneider and holding
that, outside the context of sales of goods or services, gross
income is calculated under the general statutory definition,
such that gain from the sale of investment property, not
amount realized, is includible).
Section 6501(e)(1)(A)(i) provides a corollary to the general
rule that gross income comprises only those items identified
in section 61: ‘‘In the case of a trade or business, the term
‘gross income’ means the total of the amounts received or
accrued from the sale of goods or services * * * prior to
diminution by the cost of such sales or services’’. Thus ‘‘[i]n
the case of a trade or business, ‘gross income’ is equated with
gross receipts.’’ Insulglass Corp. v. Commissioner, 84 T.C. at
210. We apply these principles to Mr. Carroll, Ms. Cadman,
and Ms. Craig, in turn.
1. Mr. Carroll
Beginning with Mr. Carroll, he and Mrs. Carroll reported
the following items of income on their 1999 Form 1040:
$36,000 of wages, salaries, and/or tips, $33,220 of taxable
interest, $963 of taxable refunds, credits, or offsets of State
and local income tax, and $23,028 of taxable Social Security
benefits. These amounts all constitute income within the
meaning of section 61 and thus are all includible in Mr.
(161) CNT INVESTORS, LLC v. COMMISSIONER 211
Carroll’s stated gross income. See sec. 61(a); Insulglass Corp.
v. Commissioner, 84 T.C. at 210. Mr. and Mrs. Carroll also
reported $1,811 of capital loss, which represented their
distributive share of the short-term capital loss CNT
reported on its December 1 return, but we will not reduce
Mr. Carroll’s stated gross income by the amount of this loss.
See Schneider v. Commissioner, 49 T.C.M. (CCH) at 1034. In
sum, Mr. Carroll reported $93,211 of nonbusiness gross
income.
Mr. and Mrs. Carroll also reported income on Schedule E,
Supplemental Income and Loss, from three business activi-
ties: (1) CNT, 45 (2) CCFH, and (3) ‘‘Business Interest
Charles Carroll’’, an S corporation. CNT reported no gross
receipts for either of its short tax years in 1999. CCFH
reported gross receipts of $1,841,144 for 1999, of which Mr.
and Mrs. Carroll’s 94.4512% share was $1,738,982.60. The
record contains no evidence of gross receipts to associate with
‘‘Business Interest Charles Carroll’’, nor any other evidence
regarding that activity. Hence, on the record before us, Mr.
Carroll reported a total of $1,738,982.60 of business gross
income.
For purposes of applying section 6501(e)(1)(A), Mr.
Carroll’s 1999 stated gross income equals the sum of his non-
business income and his share of the three business activi-
ties’ gross receipts—that is, $1,832,193.60, 25% of which is
$458,048.40; $588,699.22 exceeds that amount. Hence, Mr.
Carroll’s omission exceeded 25% of his stated gross income.
2. Ms. Cadman
Turning to Ms. Cadman, for 1999 she and her husband
reported $98,528 of wages, salaries, and/or tips, $6 of taxable
interest, $16 of ordinary dividends, $915 of taxable refunds,
credits, or offsets of State and local income tax, and $61,321
of taxable pension and annuity distributions. These amounts
all constitute income within the meaning of section 61 and
thus are all includible in Ms. Cadman’s stated gross income.
See sec. 61(a); Insulglass Corp. v. Commissioner, 84. T.C. at
45 As the parties have stipulated, and as we have found, CNT was a
sham entity with no business purpose. However, we will treat CNT as a
business within the context of this analysis because we consider here the
omissions that would exist even if we were to afford the Carrolls and their
business entities their desired tax treatment.
212 144 UNITED STATES TAX COURT REPORTS (161)
210. The Cadmans also reported $143 of capital loss. This
amount represented the sum of Ms. Cadman’s $54 distribu-
tive share of the net short-term capital loss CNT reported on
its December 1 return and her $89 distributive share of the
net long-term capital loss reported for the 1999 tax year by
an unrelated partnership in which she was a partner. As
with Mr. Carroll, we will not reduce Ms. Cadman’s stated
gross income by the amounts of these capital losses. See
Schneider v. Commissioner, 49 T.C.M. (CCH) at 1034. In
sum, Ms. Cadman reported $160,786 of nonbusiness gross
income.
Like Mr. and Mrs. Carroll, the Cadmans did not file
Schedule C, Profit or Loss from Business. Also like Mr. and
Mrs. Carroll, they listed three activities on Schedule E: CNT,
CCFH, and the unrelated partnership. As noted above, CNT
reported no gross receipts for either of its short 1999 tax
years. Ms. Cadman’s 2.7744% share of CCFH’s 1999 gross
receipts was $51,080.70. Like CNT, the unrelated partner-
ship reported no gross receipts on its 1999 Form 1065.
Hence, Ms. Cadman reported a total of $51,080.70 of busi-
ness gross income.
For purposes of applying section 6501(e)(1)(A), Ms.
Cadman’s 1999 stated gross income equals the sum of her
nonbusiness income and her share of the three business
activities’ gross receipts—that is, $211,866.70, 25% of which
is $52,966.68; $17,292.39 does not exceed that amount.
Hence, Ms. Cadman’s omission did not exceed 25% of her
stated gross income.
3. Ms. Craig
Ms. Craig and her husband reported $51,129 of wages,
salaries, and/or tips, $1,486 of taxable interest, and $16 of
ordinary dividends. These amounts all constitute income
within the meaning of section 61 and consequently are all
includible in Ms. Craig’s stated gross income. See sec. 61(a);
Insulglass Corp. v. Commissioner, 84 T.C. at 210. The Craigs
also reported $144 of capital loss. This amount represented
the sum of Ms. Craig’s $54 distributive share of the net
short-term capital loss CNT reported on its December 1
return and her $89 distributive share of the net long-term
capital loss reported for the 1999 tax year by the same unre-
lated partnership in which Ms. Cadman was a partner. We
(161) CNT INVESTORS, LLC v. COMMISSIONER 213
will not reduce Ms. Craig’s stated gross income by the
amounts of these capital losses. See Schneider v. Commis-
sioner, 49 T.C.M. (CCH) at 1034. In sum, Ms. Craig reported
$52,631 of nonbusiness gross income.
On Schedule C Ms. Craig and her husband reported gross
receipts of $112,138 from ‘‘Mark Craig Productions’’, a music
production activity. On Schedule E they reported interests in
the unrelated partnership, CNT, and CCFH. As noted above,
both the unrelated partnership and CNT reported no gross
receipts for 1999. Ms. Craig’s 2.7744% share of CCFH’s 1999
gross receipts was $51,080.70. Hence, Ms. Craig reported a
total of $163,218.70 of business gross income.
For purposes of applying section 6501(e)(1)(A), Ms. Craig’s
1999 stated gross income equals the sum of her nonbusiness
income and her share of her business activities’ gross
receipts—that is, $215,849.70, 25% of which is $53,962.43;
$17,292.39 does not exceed that amount. Hence, Ms. Craig’s
omission did not exceed 25% of her stated gross income.
In sum, for Mr. and Mrs. Carroll, the omitted amount
exceeded 25% of reported gross income for tax year 1999; for
Ms. Cadman and Ms. Craig, it did not. Accordingly, Home
Concrete prohibits application of the six-year statute of
limitations in section 6501(e)(1)(A) to Ms. Cadman and Ms.
Craig, but not to Mr. and Mrs. Carroll. Because the limita-
tions period remained open as to at least one of CNT’s
partners, its expiration as to two of the other partners did
not render the FPAA meaningless. See Rhone-Poulenc
Surfactants & Specialties, L.P. v. Commissioner, 114 T.C. at
534–535.
F. Adequacy of Disclosure
Finally, petitioner contends that the six-year limitations
period cannot apply because the allegedly omitted item was
adequately disclosed in the relevant returns.
1. Legal Standard
Section 6501(e)(1)(A)(ii) provides that ‘‘[i]n determining the
amount omitted from gross income, there shall not be taken
into account any amount which is omitted from gross income
stated in the return if such amount is disclosed in the return,
or in a statement attached to the return, in a manner ade-
quate to apprise the Secretary of the nature and amount of
214 144 UNITED STATES TAX COURT REPORTS (161)
such item.’’ In short, adequate disclosure in the return will
insulate a taxpayer from application of the six-year limita-
tions period of section 6501(e)(1)(A). For purposes of section
6501(e), the ‘‘return’’ in question consists of a taxpayer’s own
return, and if the taxpayer is a partner in a partnership or
a shareholder in an S corporation, the partnership or S cor-
poration’s information return as well. See Harlan v. Commis-
sioner, 116 T.C. 31, 53 (2001).
In evaluating an alleged disclosure, we ask whether a
reasonable person would discern the fact of the omitted gross
income from the face of the return. Univ. Country Club, Inc.
v. Commissioner, 64 T.C. 460, 471 (1975). Whether a return
adequately discloses omitted income is a question of fact.
Rutland v. Commissioner, 89 T.C. 1137, 1152 (1987). In
addressing that question, we bear in mind that in enacting
the predecessor statute of section 6501(e)(1)(A)(ii), ‘‘Congress
manifested no broader purpose than to give the Commis-
sioner * * * [additional time] to investigate tax returns in
cases where, because of a taxpayer’s omission to report some
taxable item, the Commissioner is at a special disadvantage
in detecting errors. In such instances the return on its face
provides no clue to the existence of the omitted item.’’
Colony, Inc. v. Commissioner, 357 U.S. at 36.
Given this relatively narrow congressional purpose, we
have held that for an alleged disclosure to qualify as ade-
quate, the return need not recite every underlying fact but
must provide a clue more substantial than one that would
intrigue the likes of Sherlock Holmes. See Highwood Part-
ners v. Commissioner, 133 T.C. 1, 21 (2009) (citing Quick
Trust v. Commissioner, 54 T.C. 1336, 1347 (1970), aff ’d, 444
F.2d 90 (8th Cir. 1971)). A disclosure need only be ‘‘suffi-
ciently detailed to alert the Commissioner and his agents as
to the nature of the transaction so that the decision as to
whether to select the return for audit may be a reasonably
informed one.’’ Estate of Fry v. Commissioner, 88 T.C. 1020,
1023 (1987). We have also cautioned, however, that an
alleged disclosure will not qualify as adequate if the Commis-
sioner must thoroughly scrutinize the return to ascertain
whether gross income was omitted, Highwood Partners v.
Commissioner, 133 T.C. at 22, or the disclosure is mis-
leading, Estate of Fry v. Commissioner, 88 T.C. at 1023.
(161) CNT INVESTORS, LLC v. COMMISSIONER 215
2. Petitioner’s Proof
To demonstrate adequate disclosure, petitioner invites the
Court’s attention to various aspects of CCFH’s, CNT’s, and
the individuals’ 1999 tax returns. First, petitioner points to
the December 1 return as disclosing CNT’s formation and the
contributions of the short sale proceeds and positions and the
real estate. Second, he contends that the December 1 return
also disclosed the short positions’ closure. Third, petitioner
cites the 351 statement as disclosing the Carrolls’ contribu-
tion of their interests in CNT to CCFH. And fourth, he
asserts that the December 31 return disclosed CCFH’s dis-
tribution of CNT to its shareholders because it did not iden-
tify CCFH as a partner. In rebuttal, respondent narrows the
aperture to CCFH’s 1999 return, arguing that the Schedules
K–1 do not reflect the appreciated real estate’s distribution
in any manner and that the 351 statement provides no clue
as to the omitted income.
Petitioner frames the inquiry as whether the transaction
was adequately disclosed, but to find that the Carrolls
qualify for the statutory safe harbor, we need not conclude
that the returns reasonably disclose each transactional step
that they undertook. Rather, the statute requires disclosure
‘‘of the nature and amount’’ of the omitted item. See sec.
6501(e)(1)(A)(ii). This distinction matters. We conclude below
that the returns adequately disclose the Carrolls’ trans-
actions—specifically, that CCFH distributed the real estate
to its shareholders. But the returns do not reveal the one
additional fact they must disclose for CNT’s partners to
qualify for the safe harbor: that the real estate’s fair market
value exceeded its adjusted basis, such that CCFH, and
hence its shareholders, should have recognized some amount
of gain in connection with the distribution—in short, that the
real estate had appreciated.
3. Returns’ Revelations
CCFH’s 1999 return lies at the heart of our inquiry, and
we begin there. Schedule L, Balance Sheet per Books, reflects
that when 1999 began, CCFH owned land, buildings and
other depreciable assets with a combined depreciated book
value of $735,765. Schedule L further reflects that, at year-
end, CCFH held buildings and other depreciable assets with
216 144 UNITED STATES TAX COURT REPORTS (161)
a combined, depreciated book value of $99,853, but no land.
Plainly, CCFH engaged in a transaction involving its real
estate at some point during the year.
CCFH’s return does not readily disclose the form or nature
of that transaction. As is most relevant here, the 1999
instructions to Schedule D (Form 1120S), Capital Gains and
Losses and Built-In Gains, directed S corporations to use this
schedule to report, inter alia, ‘‘[g]ains on distributions to
shareholders of appreciated capital assets.’’ Yet for 1999
CCFH did not file Schedule D. Moreover, although the 1999
instructions to Form 1120S directed that ‘‘[n]oncash distribu-
tions of appreciated property * * * valued at fair market
value’’ be reported on line 20 of Schedule K, Shareholders’
Shares of Income, Credits, Deductions, etc., CCFH reported
on that line only $245,470—an amount less than the
decrease in book value of CCFH’s real estate and other
depreciable assets, and far less than the distributed real
estate’s aggregate fair market value. Consequently, CCFH
did not properly report the distribution, and it reported no
other transaction that could account for the change in book
value of its real estate and other depreciable assets. For
example, CCFH did not file Form 4797, Sales of Business
Property, on which it would have reported the sale or
exchange of noncapital or business assets. Nor did it report
having engaged in a like-kind exchange or other nontaxable
transaction for which reporting is required.
Where, then, did the real estate go? CNT’s December 1
return provides a plausible answer. That return reports that
CCFH transferred $523,377 of property to CNT in exchange
for a 15.4% interest in CNT, and that CNT terminated on
December 1, 1999, after distributing $522,761, a near-equal
amount of property, to CCFH. Looking again to CCFH’s 1999
tax return, the attached 351 statement discloses that one or
more existing CCFH shareholders transferred an 84.6%
interest in CNT to CCFH on or after December 1, 1999.
From these two returns one can reasonably discern that
CNT’s December 1 termination occurred pursuant to section
708(b)(1)(B); that CNT made only deemed, not actual, dis-
tributions to CCFH and its other interest holders; that CNT
continued to hold the assets CCFH contributed to it; and that
it became a disregarded entity wholly owned by CCFH when
CCFH’s shareholders contributed their CNT interests to
(161) CNT INVESTORS, LLC v. COMMISSIONER 217
CCFH. All of the foregoing suggests that CCFH contributed
the real estate to CNT, thereby converting its real estate
assets to a non-real-estate asset without a taxable event.
New CNT’s December 31 return completes the picture. The
December 1 return coupled with the 351 statement revealed
that CCFH became CNT’s sole owner on December 1, 1999.
On the appended Schedules K–1, the December 31 return
identifies as New CNT’s partners the same individuals
identified as CCFH’s shareholders on the Schedules K–1
appended to CCFH’s 1999 return. The individuals’ percent-
age interests in the two entities are identical. These details
indicate that CCFH must have distributed interests in CNT,
and indirectly its former real estate holdings, to its share-
holders on December 31, 1999. Hence, CCFH and CNT’s
returns, which constitute part of Mr. Carroll’s return for
present purposes, provided a sufficient clue that an S cor-
poration had distributed real estate to its shareholders.
But one crucial piece of the puzzle remains missing. Sec-
tion 311(b) requires that a corporation recognize gain on a
distribution of appreciated property to its shareholders as if
it had instead sold the property for fair market value; if the
property has not appreciated, no gain is recognized. The par-
ties have stipulated that the aggregate fair market value of
the five mortuary properties as of December 1999 was
$4,020,000. That number appears nowhere in the various tax
returns. Indeed, the returns nowhere disclose a fair market
value for the real estate that would enable a reasonable rev-
enue agent to discern that the real estate had appreciated,
such that section 311(b) gain should have been reported.
CCFH’s return reports only the real estate’s book value
together with that of other depreciable assets, not its fair
market value. Schedule L of CNT’s December 1 return lists
no book values for the assets purportedly contributed to CNT
(which would include the short positions and offsetting
obligations purportedly contributed by the Carrolls in addi-
tion to the real estate), or for any other assets. Schedule
M–2, Analysis of Partners’ Capital Accounts, identifies the
contributed property’s book value, which would ordinarily
equal its fair market value on the date of contribution, see
sec. 1.704–1(b)(2)(iv)(d)(1), Income Tax Regs., as $3,400,718.
New CNT’s December 31 return lists buildings and other
depreciable assets (but no land) with a book value of
218 144 UNITED STATES TAX COURT REPORTS (161)
$3,350,000 and capital contributions with an equal book
value.
The returns making up Mr. Carroll’s return for section
6501(e)(1)(A)(ii) purposes contain no clue that the fair
market value of the property CCFH distributed to its share-
holders was $4,020,000, or in any event, some amount
greater than its tax basis. The returns disclose no shred of
information that would alert the occupant of 221B Baker
Street, let alone a reasonable revenue agent, to the facts
that—basis overstatement notwithstanding—CCFH had
omitted section 311(b) gain from its return and its share-
holders had omitted section 1366(a)(1) passthrough gain from
theirs.
Our caselaw is consistent with this conclusion. In Estate of
Fry v. Commissioner, 88 T.C. at 1023, for example, we found
a corporation’s disclosure on its tax return of a $150,000 pay-
ment to be inadequate for purposes of section 6501(e)(1)(A)(ii)
because the return ‘‘failed to show that the transaction was
a redemption; i.e., a payment to a shareholder or that the
payment was in fact a transfer of real property valued at
$150,000’’. The returns under scrutiny here present the con-
verse problem: They disclose that a transfer of real property
occurred, but not the real property’s value.
In Univ. Country Club, Inc. v. Commissioner, 64 T.C. at
470, we found adequate disclosure where the taxpayer fully
reported a transaction consistently with the taxpayer’s
desired tax characterization, but the Commissioner later re-
characterized the transaction. Here, in contrast, the Carrolls
and their business entities did not fully report their trans-
actions consistently with their desired tax characterization
because, as we have explained, their transactions as reported
should have resulted in $623,284 of recognized gain. Finally,
in Quick Trust v. Commissioner, 54 T.C. at 1347, the Com-
missioner determined additional gross receipts for a partner-
ship and argued that a partner had omitted them from
income. We found adequate disclosure of the omitted income
in the partnership’s reporting of distributions to the partner
far greater than the amount reported on the partner’s return.
Id. Here, however, no amount reported on any of the various
tax returns hints at the source of the omitted item, the
discrepancy between the real estate’s tax basis and its fair
market value.
(161) CNT INVESTORS, LLC v. COMMISSIONER 219
For the foregoing reasons, Mr. and Mrs. Carroll may not
claim the safe harbor of section 6501(e)(1)(A)(ii).
G. Conclusion
We hold that the period for assessment for the 1999 tax
year had expired with respect to Ms. Cadman and Ms. Craig
before respondent issued the FPAA. They are not parties to
this proceeding and will not be affected or bound by any
readjustments determined herein. See secs. 6226(c), (d)(1)(B),
6228(a)(4)(B). We further hold that the six-year limitations
period of section 6501(e)(1)(A) applies to Mr. and Mrs. Car-
roll for the 1999 tax year, and that this limitations period
remained open when respondent issued the FPAA.
III. Consequences of the Sham Stipulation
Because petitioner’s statute of limitations arguments
obliged us to consider the merits of some of respondent’s
determinations in the FPAA, we need only briefly discuss the
second issue before us, whether the adjustments in the FPAA
should be sustained. Petitioner conceded respondent’s sham
entity theory for determining the adjustments in the FPAA.
At trial the parties essentially ignored the merits issues, con-
centrating instead on the statute of limitations and penalties,
but on brief, respondent asserts that petitioner should be
deemed to have conceded all theories raised in the FPAA
because respondent’s determinations enjoy a presumption of
correctness. Petitioner claims that his concession mooted
respondent’s other theories and rendered litigation of them
unnecessary.
Petitioner’s concession and our holdings herein more than
suffice to sustain the FPAA adjustments, and we decline to
analyze respondent’s other theories unnecessarily. We con-
clude that the FPAA adjustments to CNT’s December 1
return should be sustained considering the parties’ stipula-
tion that CNT was a sham and our conclusions above con-
cerning the sham and step transaction doctrines’ applica-
bility. 46
46 In the FPAA respondent reduced to zero CNT’s reported capital con-
tributions, distributions, and outside partnership basis. We sustain these
adjustments principally on the basis of the parties’ stipulation that CNT
Continued
220 144 UNITED STATES TAX COURT REPORTS (161)
IV. Liability for the Accuracy-Related Penalty
In the FPAA respondent determined that all underpay-
ments of tax resulting from his adjustments of CNT’s part-
nership items were attributable, in the alternative, to (1)
gross (or if not gross, substantial) valuation misstatement(s),
(2) substantial understatements of income tax, or (3) neg-
ligence or disregard of rules and regulations. Hence,
respondent determined that either a 40% penalty or a 20%
penalty would apply to any underpayment. See sec. 6662(a),
(b)(1)–(3), (c)–(e), (h).
The Commissioner bears the burden of production and
‘‘must come forward with sufficient evidence indicating that
it is appropriate to impose the relevant penalty.’’ Sec.
7491(c); see Higbee v. Commissioner, 116 T.C. 438, 446
(2001). Once the Commissioner has met his burden of
production, the burden shifts to the taxpayer to prove an
affirmative defense or that he or she is otherwise not liable
was a sham partnership. Because CNT was not, for tax purposes, a part-
nership, it could neither receive contributions nor make distributions for
purposes of subch. K of the Code, and its partners’ having outside bases
greater than zero was a ‘‘legal impossibility’’. See Woods, 571 U.S. at ll,
134 S. Ct. at 565 n.2.
Respondent also disallowed CNT’s reported $2,268 of short-term capital
loss and $1,734 of interest expense, both of which were incurred in connec-
tion with the Son-of-BOSS transaction. We sustain these adjustments be-
cause the short sale transaction was structured to assure it would have
few or no economic consequences. It was, as we concluded above, an eco-
nomic sham, so its direct tax consequences—the short-term capital loss
and the interest expense—are properly disregarded. Disallowance of deduc-
tions for these passthrough items would ordinarily affect the Carrolls’ bot-
tom-line income in two ways: (1) directly, through elimination of their dis-
tributive share of CNT’s reported interest expense ($1,385) and short-term
capital loss ($1,811), and (2) indirectly, through elimination of their dis-
tributive share of CCFH’s distributive share of CNT’s reported interest ex-
pense ($267) and short-term capital loss ($349). However, although CNT
issued a Schedule K–1 to CCFH that reflected its distributive shares of
these passthrough items, CCFH did not report the items on its 1999 re-
turn, and the Schedules K–1 CCFH issued to its shareholders reflect no
interest expense or short-term capital loss. Because CCFH apparently did
not reduce its income by the amount of its $616 passthrough loss from
CNT attributable to the short-term capital loss and the interest expense,
disallowance of these underlying tax items will have no indirect effect via
CCFH on the Carrolls’ income.
(161) CNT INVESTORS, LLC v. COMMISSIONER 221
for the penalty. Higbee v. Commissioner, 116 T.C. at 446–
447.
A. Penalties’ Applicability
Section 6662(a) and (b)(3) provides for imposition of a 20%
penalty on the portion of an underpayment of tax required
to be shown on a return that is attributable to a substantial
valuation misstatement. For returns filed on or before
August 16, 2006, as is relevant here, a substantial valuation
misstatement occurs when ‘‘the value of any property (or the
adjusted basis of any property) claimed on any return of tax
imposed by chapter 1 is 200 percent or more of the amount
determined to be the correct amount of such valuation or
adjusted basis (as the case may be)’’. Sec. 6662(e)(1)(A). Sec-
tion 6662(h) increases this penalty to 40% if the value or
adjusted basis claimed on the return is 400% or more of the
actual value or adjusted basis. A regulation clarifies that
when the actual value or basis is zero, any claimed value is
considered 400% or more of the correct amount. Sec. 1.6662–
5(g), Income Tax Regs. 47
In the FPAA respondent adjusted to zero several items on
CNT’s December 1 return, including partnership outside
basis. We have sustained those adjustments in their
entirety. 48 Consequently, for each of these items, the
reported value exceeded the correct value by 400% or more.
Respondent has satisfied his burden of production with
respect to the gross and substantial valuation misstatement
penalties, and petitioner does not question respondent’s com-
putations. Because we find the 40% gross valuation
misstatement penalty applicable to any underpayment
resulting from respondent’s adjustments, we need not
address the substantial understatement and negligence pen-
47 Petitioner objects to the application of this regulation as inconsistent
with precedent of the Ninth Circuit, to which he maintains this case is ap-
pealable. As we have explained, however, the Supreme Court’s decision in
Woods abrogates that precedent.
48 Because the parties have stipulated that CNT is a sham entity, we
disregard even CCFH’s purported contribution of the real estate to CNT,
so the value of CCFH’s capital contribution and its outside basis in its
CNT interest are both properly zero. CCFH simply retained its original
basis in the real estate until it distributed that real estate to its share-
holders on December 31, 1999.
222 144 UNITED STATES TAX COURT REPORTS (161)
alties. See sec. 1.6662–2(c), Income Tax Regs. (explaining
that if a portion of an underpayment of tax is attributable to
more than one type of misconduct described in section 6662,
the applicable penalty is the highest percentage penalty trig-
gered by the relevant types of misconduct).
B. Petitioner’s Defense
A section 6662 penalty will not apply to any portion of an
underpayment resulting from positions taken on the tax-
payer’s return for which the taxpayer had reasonable cause
and with respect to which the taxpayer acted in good faith.
See sec. 6664(c). Petitioner claims reasonable cause and good
faith on the basis of his reasonable reliance on the advice of
Messrs. Myers and Crowley.
Partner-level defenses, including reasonable cause and
good faith, may not be asserted in a partnership-level
TEFRA proceeding such as this one. See New Millennium
Trading, LLC v. Commissioner, 131 T.C. 275, 288–289 (2008)
(upholding temporary regulation as ‘‘a valid interpretation of
the statutory scheme’’); sec. 301.6221–1T(d), Temporary
Proced. & Admin. Regs., 64 Fed. Reg. 3838 (Jan. 26, 1999).
But when the reasonable cause defense rests on the partner-
ship’s actions, we may entertain the defense at the partner-
ship level, ‘‘taking into account the state of mind of the gen-
eral partner,’’ Superior Trading, LLC v. Commissioner, 137
T.C. at 91 (citing New Millennium Trading, LLC v. Commis-
sioner, 131 T.C. 275), in this case, Mr. Carroll. 49
We determine ‘‘whether a taxpayer acted with reasonable
cause and in good faith * * * on a case-by-case basis, taking
into account all pertinent facts and circumstances’’, sec.
1.6664–4(b)(1), Income Tax Regs., including ‘‘[t]he taxpayer’s
mental and physical condition, as well as sophistication with
respect to the tax laws, at the time the return was filed’’,
Kees v. Commissioner, T.C. Memo. 1999–41, 77 T.C.M. (CCH)
1374, 1378 (1999); accord Ruckman v. Commissioner, T.C.
49 Mr. Carroll did not testify at trial; Ms. Craig and Ms. Cadman did.
We decline petitioner’s implicit invitation, on brief, to consider the Carrolls’
collective good faith and reliance in determining whether he has satisfied
his burden of proof as to the sec. 6664(c) defense. We will instead give Ms.
Cadman’s and Ms. Craig’s testimony its proper weight and consider it,
along with other testimony and evidence in the record, to the extent it con-
stitutes circumstantial evidence of Mr. Carroll’s state of mind.
(161) CNT INVESTORS, LLC v. COMMISSIONER 223
Memo. 1998–83, 75 T.C.M. (CCH) 1880, 1886 (1998); Escrow
Connection, Inc. v. Commissioner, T.C. Memo. 1997–17, 73
T.C.M. (CCH) 1705, 1714 (1997). Reliance on professional
advice will absolve the taxpayer if such reliance was reason-
able and the taxpayer acted in good faith. Sec. 1.6664–
4(b)(1), Income Tax Regs. In such a case ‘‘the taxpayer must
prove by a preponderance of the evidence that the taxpayer
meets each requirement of the following three-prong test: (1)
The adviser was a competent professional who had sufficient
expertise to justify reliance, (2) the taxpayer provided nec-
essary and accurate information to the adviser, and (3) the
taxpayer actually relied in good faith on the adviser’s judg-
ment.’’ Neonatology Assocs., P.A. v. Commissioner, 115 T.C.
43, 99 (2000), aff ’d, 299 F.3d 221 (3d Cir. 2002).
We examine below whether petitioner’s professed reliance
upon Mr. Myers satisfied each of these three requirements.
Petitioner also contends that he relied on Mr. Crowley’s
advice, but this claim plainly fails. Ms. Cadman, who joined
Mr. Carroll at the various meetings described herein,
credibly testified that she believed Mr. Crowley endorsed the
transaction. But Mr. Crowley testified, and Ms. Cadman con-
firmed, that Mr. Crowley had openly acknowledged that he
did not fully understand the transaction. Even if, contrary to
his testimony, Mr. Crowley endorsed the transaction and did
not just tepidly agree to ‘‘go along with’’ it, petitioner’s reli-
ance on that endorsement could not have been reasonable
and in good faith given Mr. Crowley’s admitted confusion.
Whatever constitutes ‘‘sufficient expertise to justify reliance,’’
see id., we think the adviser must, at the very least, hold
himself out as possessing sufficient expertise to understand
the transaction at issue. Mr. Crowley made no such pretense
here—quite the opposite, in fact—so to the extent Mr. Carroll
relied on his advice, that reliance was unjustified and
unreasonable.
1. Sufficient Expertise?
The sufficiency of Mr. Myers’ expertise poses a more dif-
ficult question. Rather than set a specific standard, the regu-
lations under section 6664(c) outline certain baseline com-
petency requirements. First, rather than mandate that the
adviser possess knowledge of relevant aspects of Federal tax
law, the regulations stipulate only that ‘‘reliance may not be
224 144 UNITED STATES TAX COURT REPORTS (161)
reasonable or in good faith if the taxpayer knew, or reason-
ably should have known, that the advisor lacked’’ such
knowledge. Sec. 1.6664–4(c)(1), Income Tax Regs. Second, the
adviser must base his or her advice on ‘‘all pertinent facts
and circumstances and the law as it relates’’ to them. Id.subpara. (1)(i). Third, the adviser must not himself or herself
‘‘unreasonably rely on the representations, statements,
findings, or agreements of the taxpayer or any other person.’’
Id. subpara. (1)(ii) (emphasis added).
In applying these general guidelines, this Court has not
articulated a uniform standard of competence that an adviser
must satisfy but has instead demanded expertise commensu-
rate with the factual circumstances of each case. See, e.g.,
106 Ltd. v. Commissioner, 136 T.C. 67, 77 (2011) (the tax-
payer’s longtime attorney and accounting firm, who ‘‘would
have appeared competent to a layman’’, and especially so to
the taxpayer, had adequate expertise to advise on a Son-of-
BOSS-type transaction), aff ’d, 684 F.3d 84 (D.C. Cir. 2012);
Neonatology Assocs., P.A. v. Commissioner, 115 T.C. at 99 (an
insurance agent who was not a tax professional lacked suffi-
cient expertise to advise on tax implications of a complex,
group whole/term-hybrid life insurance plan); Thousand Oaks
Residential Care Home I, Inc. v. Commissioner, T.C. Memo.
2013–10, at *13, *41 (the taxpayers’ longtime accountant, an
enrolled agent with a master’s degree in business adminis-
tration, was a competent professional with sufficient exper-
tise to advise on employment plan contributions); Kirman v.
Commissioner, T.C. Memo. 2011–128, 101 T.C.M. (CCH)
1625, 1633 (2011) (taxpayer failed to establish that part-time
tax return preparer who held an accounting degree was a
competent professional with sufficient expertise to advise on
business expense and charitable contribution deductions).
Under the circumstances of this case, we think that Mr.
Myers possessed sufficient expertise to justify reliance by Mr.
Carroll. As of 1999 Mr. Myers had practiced law for 30 years
and had represented Mr. Carroll for almost 20 of them. Mr.
Carroll had relied on Mr. Myers’ advice in growing his busi-
ness through acquisitions, properly maintaining his corpora-
tion, complying with regulations, managing his employees,
and formulating his estate plan. Although Mr. Myers did not
hold himself out as a tax specialist and tended to refer cli-
ents out for complicated tax matters, he had studied tax in
(161) CNT INVESTORS, LLC v. COMMISSIONER 225
law school and prepared estate tax returns, and he had pre-
viously advised Mr. Carroll on general tax law principles.
The record reflects that Mr. Myers was Mr. Carroll’s go-to
attorney and trusted counselor.
The record also reflects that Mr. Carroll, while a successful
businessman, was not a financial sophisticate. Although Mr.
Carroll did hold a post-high-school degree in mortuary
science, he had obtained it approximately 50 years earlier,
and the record does not reflect that he obtained any further
education. To the extent that his mortuary science college
curriculum incorporated any finance, tax, or economics mate-
rial, that material would have been sorely out of date by
1999. Indeed, Mr. Myers credibly testified that Mr. Carroll
understood only basic tax principles. According to Mr.
Crowley, Mr. Carroll had never before invested in even gar-
den-variety mutual funds or securities, let alone participated
in a short sale transaction involving T-notes. When presented
with the exotic financial engineering proposed by Mr. Hoff-
man, Mr. Carroll naturally relied on Mr. Myers, to whom he
had turned in the past for all forms of legal advice, including
with regard to more general tax matters.
Mr. Myers performed due diligence. After Mr. Hoffman
pitched the Son-of-BOSS transaction to him, in an effort to
better understand the proposal Mr. Myers held a conference
call with Mr. Mayer. This conversation left Mr. Myers
unsatisfied with his grasp of how the transaction would
work, so he requested, and Mr. Mayer sent, a memorandum
and an article from a tax publication describing and ana-
lyzing the transaction and citing various legal authorities.
Mr. Myers reviewed Mr. Mayer’s memorandum and con-
sulted some of the legal authorities cited therein, albeit not
in extreme detail. He also researched Jenkens & Gilchrist.
During the implementation phase, he spoke by telephone
with Mr. Mayer several times.
Mr. Myers believed that he had a good grasp of how the
Son-of-BOSS transaction would work and of the legal theo-
ries behind it. Although Mr. Myers did not know all of the
details of the transaction, the record does not indicate that
he shared this fact with Mr. Carroll. Rather, Mr. Myers
formed the opinion that the transaction was ‘‘legitimate [and]
proper’’, and he did share this opinion with Mr. Carroll. He
226 144 UNITED STATES TAX COURT REPORTS (161)
advised Mr. Carroll that the transaction looked like a viable
way to resolve CCFH’s low basis dilemma.
We find that Mr. Carroll could justifiably rely upon that
advice. To Mr. Carroll, a tax and financial layperson, Mr.
Myers would have appeared ideal, not simply competent, to
advise him on the feasibility and implications of the basis
boost transaction. See 106 Ltd. v. Commissioner, 136 T.C. at
77.
Respondent offers two counterarguments. First, he empha-
sizes that Mr. Myers was not a ‘‘tax professional’’. What con-
stitutes a ‘‘tax professional’’ is debatable. Mr. Myers, for
example, did provide some general tax advice to clients and
also prepared estate tax returns, although he did not prepare
other income tax returns (most attorneys do not) or specialize
in dispensing tax advice. More to the point, the regulations
under section 6664(c) define ‘‘advice’’ as including, but not as
consisting solely of, communications of a ‘‘professional tax
advisor’’. Our caselaw has never restricted the reasonable
reliance defense to advice from persons bearing this moniker
or any other. That caselaw prompts us to examine the sub-
stance of Mr. Myers’ expertise under the particular factual
circumstances of this case, which we have done.
Second, respondent suggests that Mr. Myers unreasonably
and impermissibly relied, himself, on representations of Mr.
Mayer. The regulations prohibit such reliance on a third
party, see sec. 1.6664–4(c)(1)(ii), Income Tax Regs., and
where, as here, the third party is a promoter, reliance is
doubly forbidden, see Canal Corp. v. Commissioner, 135 T.C.
199, 218 (2010) (‘‘Courts have repeatedly held that it is
unreasonable for a taxpayer to rely on a tax adviser actively
involved in planning the transaction and tainted by an
inherent conflict of interest.’’); Swanson v. Commissioner,
T.C. Memo. 2009–31, 97 T.C.M. (CCH) 1127, 1129 (2009)
(holding that relied-upon advice must ‘‘be from competent
and independent parties, not from the promoters of the
investment’’). But see Bruce v. Commissioner, T.C. Memo.
2014–178, at *56 & n.30 (finding that where a taxpayer
retained his ‘‘longtime tax adviser’’ to meet with tax shelter
promoters and advise him on the proposed transaction, the
taxpayer reasonably relied upon the adviser rather than the
promoters). Where the record establishes that the adviser
(161) CNT INVESTORS, LLC v. COMMISSIONER 227
himself relied solely upon the promoters’ opinions, the tax-
payer’s reliance might not be reasonable.
We acknowledge this issue is a close one. Mr. Myers did
testify to having repeated conversations with Mr. Mayer in
an effort to clarify his understanding of the proposed trans-
action. Yet taken as a whole, his testimony confirms that he
did not rely on Mr. Mayer with respect to the facts or the law
in forming his opinion in favor of the transaction. With
regard to the facts, unlike Mr. Mayer, Mr. Myers possessed
intimate knowledge of Mr. Carroll’s personal and business
legal arrangements, and his advice could thus take into
account ‘‘all pertinent facts and circumstances’’ including
‘‘the taxpayer’s purposes * * * for entering into a transaction
and for structuring a transaction in a particular manner.’’
Sec. 1.6664–4(c)(1)(i), Income Tax Regs. With regard to the
law, Mr. Myers credibly testified that he directly reviewed
some of the legal authorities cited in Mr. Mayer’s memo-
randum and, crucially, that he believed he understood the
legal theories behind the proposed transaction. Taking into
account the entire record, we find that Mr. Myers did not
simply rely upon assurances and representations by Mr.
Mayer as to the transaction’s tax implications but instead
evaluated it for himself and formed an independent opinion.
Mr. Myers possessed sufficient expertise to justify reliance
by a reasonable person of Mr. Carroll’s education, sophistica-
tion, and business experience. Accordingly, Neonatology’s
first prong is satisfied.
2. Necessary Information?
A taxpayer must affirmatively provide ‘‘necessary and
accurate information to the adviser’’ on whose advice the tax-
payer claims reliance. Neonatology Assocs., P.A. v. Commis-
sioner, 115 T.C. at 99. The regulations under section 6664(c)
similarly caution that the taxpayer must not ‘‘fail[ ] to dis-
close a fact that it knows, or reasonably should know, to be
relevant to the proper tax treatment of an item.’’ Sec.
1.6664–4(c)(1)(i), Income Tax Regs. At the same time, how-
ever, those regulations provide that the reasonableness of a
taxpayer’s reliance must be determined ‘‘on a case-by-case
basis, taking into account all pertinent facts and cir-
cumstances’’, including personal characteristics of the tax-
payer. Id. para. (b)(1); see also id. para. (c)(1). The two fore-
228 144 UNITED STATES TAX COURT REPORTS (161)
going regulatory provisions, considered together, capture
what should be an obvious corollary to Neonatology’s second
prong: The taxpayer’s obligation to provide the adviser with
accurate information necessary to a competent analysis is
coextensive with the taxpayer’s knowledge. Stated dif-
ferently, the taxpayer is not obliged to share details that the
reasonably prudent taxpayer does not know, or that the tax-
payer neither knows nor reasonably should know are rel-
evant.
The parties dispute whether Mr. Carroll provided Mr.
Myers with the information necessary for Mr. Myers to prop-
erly evaluate the proposed transaction. Respondent specifi-
cally points to two omitted nuggets of information: (1) the
amount of Jenkens & Gilchrist’s fee and (2) the fact that the
short sale would almost certainly generate no profit. With
regard to the short sale’s profit potential, the evidence in the
record makes clear that T-note short sales would have been
wholly unfamiliar to Mr. Carroll, and we are not convinced
that he understood the concept well enough to appreciate
whether it was likely to yield a profit. With regard to Jen-
kens & Gilchrist’s fee, the amount of that fee appears in the
record only on an invoice dated March 23, 2000, months after
the transactions at issue had concluded.
While we think it likely that Mr. Carroll, an astute
businessman, would have inquired about price before
plunging ahead, the record is silent as to when and under
what circumstances that price was disclosed to him. There is
no evidence that the fee was contingent or computed as a
percentage of any alleged tax savings. Considering Mr.
Carroll’s education, experience, and sophistication, we find
that he would not have recognized the fee amount’s relevance
to Mr. Myers’ evaluation of the proposed transaction. Indeed,
Mr. Myers testified that he did not find the fee amount
unusual and that it would not necessarily have changed his
assessment.
Respondent argues that Mr. Carroll’s ability to profit from
the Son-of-BOSS transaction, taking into account Jenkens &
Gilchrist’s fee, provided the transaction’s only ostensible
nontax substance. That may well be true, but as we have
observed, Mr. Carroll had no prior experience with or knowl-
edge of short sale transactions or margin trading and lacked
an appreciation for the Son-of-BOSS transaction’s profit
(161) CNT INVESTORS, LLC v. COMMISSIONER 229
potential. He had been told—by Mr. Hoffman, to whom he
had been introduced by his trusted counselor, Mr. Myers—
that Ted Turner had prevailed in a legal case involving
essentially the same transaction. Under the circumstances, a
layperson like Mr. Carroll could reasonably have believed
that his transaction would follow the Ted Turner model and
that it, too, would pass muster; he could not reasonably have
contemplated that the fees paid to a service provider to
implement that model would make or break the transaction.
In sum, we conclude that Mr. Carroll has satisfied his bur-
den of proof as to Neonatology’s second prong. While
respondent has identified two items of information that Mr.
Carroll failed to provide Mr. Myers, we decline to hold Mr.
Carroll to an unreasonable standard exceeding his knowledge
and capabilities. See sec. 1.6664–4(b)(1), (c)(1), Income Tax
Regs.
3. Good-Faith Reliance?
As a further prerequisite to a reasonable reliance defense,
a taxpayer must have actually received advice and relied
upon it in good faith. See Neonatology Assocs., P.A. v.
Commissioner, 115 T.C. at 99. Advice need not ‘‘be in any
particular form’’ but rather embraces ‘‘any communication
* * * setting forth the analysis or conclusion of a person,
other than the taxpayer, provided to * * * the taxpayer and
on which the taxpayer relies, directly or indirectly’’. Sec.
1.6664–4(c)(2), Income Tax Regs. Mr. Myers credibly testified
that he advised Mr. Carroll that the series of proposed trans-
actions, including the Son-of-BOSS, looked like a viable way
to resolve CCFH’s low basis dilemma and that he believed it
would be ‘‘legitimate [and] proper’’. We find equally credible
Mr. Carroll’s reliance upon that advice given Mr. Myers’
longstanding role as Mr. Carroll’s principal adviser in both
business and personal legal matters.
Respondent, however, contends that any reliance by Mr.
Carroll on Mr. Myers’ advice could not have been in good
faith because: (1) given his business savvy and intelligence,
Mr. Carroll should have recognized the proposed solution to
his low basis dilemma was too good to be true; (2) Mr. Car-
roll ignored warnings from the IRS about engaging in a Son-
of-BOSS transaction; (3) Mr. Carroll’s sole purpose for
engaging in the transaction was to avoid Federal income tax;
230 144 UNITED STATES TAX COURT REPORTS (161)
and (4) Mr. Carroll failed to attempt to personally determine
the Son-of-BOSS transaction’s validity and the related tax
returns’ accuracy. 50 We consider each argument in turn.
First, respondent asserts that Mr. Carroll was highly intel-
ligent, had no trouble understanding tax concepts, and
understood, at the very least, the tax implications of
transferring the real estate out of CCFH. In short,
respondent argues, Mr. Carroll was smart enough to know
that the result Messrs. Hoffman and Mayer pitched to him
was too good to be true. For mental health reasons, Mr. Car-
roll, now in his mideighties, did not testify or even appear at
trial, so the Court had no opportunity to observe him first-
hand or to assess his credibility. Instead, we must weigh the
other witnesses’ expressed opinions of him and the factual
information they provided about his education and experi-
ence.
The parties point to snippets of testimony by Messrs.
Myers and Crowley in which they opine, mostly in response
to leading questions, concerning Mr. Carroll’s abilities. From
their testimony as a whole, we conclude that, while Mr.
Carroll’s confidants respected his success as a businessman
and believed him fairly intelligent, they also considered his
knowledge of tax and financial matters rudimentary. More-
over, although the subjective opinions of trusted advisers are
not unpersuasive, objective facts carry more weight. Mr. Car-
roll attended college, presumably on the ‘‘G.I. Bill’’ after
World War II, but the college was a specialized one for morti-
cians. He built a local chain of funeral homes from the
ground up, but that business accounted for nearly 100% of
his net worth. He made no diversifying investments and held
his savings principally in cash. His business, operating
funeral homes, demanded hard work, compassion, and some
degree of numeracy; it did not require him to engage in com-
plex problem-solving, legal research, or sophisticated finan-
cial transactions. On the record before us, we decline to find
that Mr. Carroll knew or should have known that the prom-
ised results of the Son-of-BOSS transaction were too good to
50 Respondent also argues that petitioner lacked good faith because he
participated in a tax shelter, but the substance of this argument, including
the authorities cited to support it, relates only to the substantial authority
defense described in sec. 6662(d)(2)(B). Petitioner has not raised this de-
fense, so we need not analyze respondent’s argument against it.
(161) CNT INVESTORS, LLC v. COMMISSIONER 231
be true. 51 Cf. Rawls Trading, L.P. v. Commissioner, T.C.
Memo. 2012–340, at *38–*39 (holding that an ‘‘accomplished
engineer’’ who ‘‘ha[d] cofounded a very successful fiber optics
company’’ but was ‘‘not a sophisticated investor’’ or ‘‘familiar
with tax law * * * did not have the background or experi-
ence necessary’’ to recognize that Son-of-BOSS transactions
were ‘‘too good to be true’’).
Second, citing Rev. Rul. 95–26, 1995–1 C.B. 131, and
Notice 2000–44, 2000–2 C.B. 255, respondent contends that
Mr. Carroll ignored warnings from the IRS about engaging
in a Son-of-BOSS transaction and therefore lacked good
faith. Whether a taxpayer’s reliance is reasonable under
Neonatology’s first prong is an objective inquiry, but whether
the taxpayer acted in good faith is a subjective one. Jenkens
& Gilchrist’s opinion letter discusses Rev. Rul. 95–26, supra,
so we presume that Mr. Carroll was aware of it. Yet a rev-
enue ruling reflects the IRS’ position on an issue; it is not
binding precedent. E.g., Taproot Admin. Servs., Inc. v.
Commissioner, 133 T.C. 202, 209 n.16 (2009), aff ’d, 679 F.3d
1109 (9th Cir. 2012); Hosp. Corp. of Am. v. Commissioner,
109 T.C. 21, 65 n.47 (1997). And Jenkens & Gilchrist’s
opinion letter also describes a host of contrary authorities
and concludes that these precedents would govern if the IRS
were to challenge the transaction. We accordingly cannot
conclude that Mr. Carroll’s presumed knowledge of Rev. Rul.
95–26, supra, negates his good faith.
With regard to Notice 2000–44, supra, we have no reason
to suspect that Mr. Carroll was aware of the notice, and we
will not impute to a taxpayer claiming reliance on a profes-
sional adviser knowledge of all policy statements published
by the IRS to date. See, e.g., Am. Boat Co., LLC v. United
51 Respondent cites Mr. Crowley’s alleged refusal to endorse the proposed
transaction and the amount of Jenkens & Gilchrist’s fee as ‘‘red flags’’ to
which Mr. Carroll was willfully blind. First, the record reflects that Mr.
Crowley acquiesced in the transaction, not that he affirmatively refused to
endorse it. And second, respondent’s comparison of the fee to the ‘‘millions
of dollars in tax liabilities’’ avoided is hyperbole. The roughly $3.5 million
of sec. 311(b) gain that went unreported could not, mathematically, gen-
erate multiple millions of dollars in tax liability at the individual tax rates
then in effect. Moreover, Mr. Myers, at least, did not consider the fee
amount obviously excessive given Jenkens & Gilchrist’s size, stature, and
metropolitan base.
232 144 UNITED STATES TAX COURT REPORTS (161)
States, 583 F.3d 471, 483–486 (7th Cir. 2009) (affirming Dis-
trict Court’s holding that tax matters partner reasonably
relied on Mr. Mayer with regard to a Son-of-BOSS trans-
action from which the partnership began claiming substan-
tial tax benefits in 1999); Klamath Strategic Inv. Fund, LLC
v. United States, 472 F. Supp. 2d 885, 902, 904–905 (E.D.
Tex. 2007) (holding that tax matters partner reasonably
relied on professional advice with regard to a transaction cov-
ered by Notice 2000–44), remanded on other grounds, 568
F.3d 537 (5th Cir. 2009); see also Sun Microsystems, Inc. v.
Commissioner, T.C. Memo. 1995–69, 69 T.C.M. (CCH) 1884,
1887 (1995) (notices, like revenue rulings, are mere state-
ments of the IRS’ position). Mr. Carroll, even if he knew
about it, did not necessarily demonstrate a lack of good faith
in failing to follow IRS administrative guidance.
Third, respondent insists that Mr. Carroll’s sole purpose
for engaging in the transaction was to avoid Federal income
tax and that this fact belies his claim of good faith. As we
have explained, however, Mr. Carroll had an independent,
nontax purpose for engaging in the series of transactions
that included the Son-of-BOSS: He sought to rearrange his
assets in the manner his longtime advisers, Messrs. Myers
and Crowley, deemed best to facilitate sale of the funeral
home business and retirement income for the Carrolls. Cf.
Gerdau Macsteel, Inc. v. Commissioner, 139 T.C. 67, 196
(2012) (finding that taxpayers could not have relied on a
legal opinion in good faith when they ‘‘knew that the only
purpose of the transactions was to achieve a tax loss’’
(emphasis added)).
Granted, he sought to do it in a manner that would mini-
mize his tax liability, and he had in fact contemplated this
rearrangement of assets for some time but postponed it
because of the anticipated tax implications. His motives were
thus mixed. See Gregory v. Helvering, 293 U.S. at 468–469
(explaining that a taxpayer’s ‘‘motive * * * to escape pay-
ment of a tax’’ will not invalidate an otherwise lawful trans-
action but finding the instant transaction invalid because it
lacked any nontax purpose). But that Mr. Carroll had two
goals in mind does not imply that he did not rely in good
faith upon Mr. Myers’ advice that, after years of analyzing
and rejecting various alternatives, a group of transactions
had finally been conceived through which Mr. Carroll could
(161) CNT INVESTORS, LLC v. COMMISSIONER 233
achieve his two historical objectives simultaneously. See
Helvering v. Gregory, 69 F.2d 809, 810 (2d Cir. 1934) (‘‘Any
one may so arrange his affairs that his taxes shall be as low
as possible; he is not bound to choose that pattern which will
best pay the Treasury; there is not even a patriotic duty to
increase one’s taxes.’’).
Finally, respondent argues that Mr. Carroll’s failure to
attempt to personally determine the Son-of-BOSS trans-
action’s validity and the related tax returns’ accuracy dem-
onstrates he lacked good faith. The regulations under section
6664(c) emphasize that ‘‘[g]enerally, the most important
factor’’ in determining whether a taxpayer acted with reason-
able cause and good faith ‘‘is the extent of the taxpayer’s
effort to assess the taxpayer’s proper tax liability.’’ Sec.
1.6664–4(b)(1), Income Tax Regs. The regulations do not,
however, require that the taxpayer personally analyze his or
her liability. On the contrary, the regulations expressly
permit a taxpayer to establish reasonable cause through
reasonable reliance on professional advice. As the Supreme
Court explained in United States v. Boyle, 469 U.S. 241, 251
(1985):
When an accountant or attorney advises a taxpayer on a matter of tax
law, such as whether a liability exists, it is reasonable for the taxpayer
to rely on that advice. Most taxpayers are not competent to discern error
in the substantive advice of an accountant or attorney. To require the
taxpayer to challenge the attorney, to seek a ‘‘second opinion,’’ or to try
to monitor counsel on the provisions of the Code himself would nullify
the very purpose of seeking the advice of a presumed expert in the first
place. * * *
Nevertheless, we have stated that ‘‘blind reliance on a
professional does not establish reasonable cause.’’ Estate of
Goldman v. Commissioner, T.C. Memo. 1996–29, 71 T.C.M.
(CCH) 1896, 1903 (1996). 52 As respondent points out, Mr.
52 Like the coexecutrices in Estate of Goldman v. Commissioner, T.C.
Memo. 1996–29, 71 T.C.M. (CCH) 1896 (1996), when Mr. Crowley pre-
sented him with CNT’s 1999 tax returns, Mr. Carroll asked no questions
and, to Mr. Crowley’s knowledge, did not review the returns before signing
them. Yet in Estate of Goldman, the coexecutrices faced other obstacles to
establishing good faith. One coexecutrix wrote 16 $10,000 checks from the
hospitalized decedent’s accounts, apparently to deplete them before her
death, and claimed that the decedent intended to make gifts. Id., 71
T.C.M. (CCH) at 1898, 1900. She also wrote $25,000 checks to herself and
Continued
234 144 UNITED STATES TAX COURT REPORTS (161)
Carroll asked no questions and has not established that he
reviewed CNT’s 1999 tax returns when Mr. Crowley pre-
sented them to him for signature; he simply signed them.
Mr. Carroll’s apparent possible failure to scrutinize CNT’s
returns is troubling, but not fatal. We cannot characterize his
reliance on Mr. Crowley as ‘‘blind’’ given the depth and dura-
tion of their professional relationship. In any event, the fact
that the reliance at issue here is Mr. Carroll’s reliance on
Mr. Myers makes respondent’s argument regarding Mr.
Carroll’s failure to review the returns a red herring. The
returns’ inaccuracy stemmed not from a computational or
other return preparation error by Mr. Crowley, but rather
from Messrs. Mayer’s, Hoffman’s, and Myers’ failure to
appreciate that CNT was a sham partnership. Had Mr. Car-
roll reviewed the returns, he would have seen nothing incon-
sistent with the theories that Mr. Myers had assured him
were sound.
We find that Mr. Carroll relied on Mr. Myers in good faith,
thereby satisfying Neonatology’s third prong. Hence, he has
demonstrated reasonable cause and good faith within the
meaning of section 6664(c), and no penalty shall be imposed
with respect to any portion of any underpayment resulting
from the FPAA adjustments.
V. Conclusion
We conclude that the period of assessment remained open
as to Mr. and Mrs. Carroll’s 1999 tax year when respondent
issued the FPAA and that the FPAA was consequently timely
as to them. We further conclude that neither Ms. Cadman
nor Ms. Craig is a proper party to this action under section
her coexecutrix from the estate’s accounts, purportedly for expense reim-
bursement; the estate could not substantiate any of the expenses, and nei-
ther executrix could recall whether she actually spent $25,000. Id. at 1902.
Bagur v. Commissioner, 66 T.C. 817 (1976), remanded on other grounds,
603 F.2d 491 (5th Cir. 1979), and Georgiou v. Commissioner, T.C. Memo.
1995–546, 70 T.C.M. (CCH) 1341 (1995), on which Estate of Goldman re-
lies, are likewise inapposite. In Bagur v. Commissioner, 66 T.C. at 823–
824, the taxpayer did not rely on a professional but rather assumed, with-
out ever discussing it with him, that her husband had filed joint returns
and signed her name. In Georgiou v. Commissioner, 70 T.C.M. (CCH) at
1353, the record established that the taxpayers conspired with their tax re-
turn preparers to present false accounting information and instructed the
preparers rather than relied on them.
(161) CNT INVESTORS, LLC v. COMMISSIONER 235
6226(d)(1)(B). We sustain respondent’s adjustments to CNT’s
partnership items determined in the FPAA and hold that
while the gross valuation misstatement penalty would other-
wise apply here, petitioner has demonstrated reasonable
cause and good faith, so no penalty is applicable.
The Court has considered all of petitioner’s and respond-
ent’s contentions, arguments, requests, and statements. To
the extent not discussed herein, we conclude that they are
meritless, moot, or irrelevant.
To reflect the foregoing,
An appropriate order and decision will be
entered.
f