A district court in the Ninth Circuit has followed several of its peers in finding that a Son of BOSS tax shelter lacks economic substance. A forty-percent penalty was imposed under section 6662 for a gross valuation misstatement. See Download Maguire Partners.DCt CA.020409, No. CV 06-0774-JFW (RZx).
The shelter was undertaken by two real estate investors, Edward Fox and James Thomas, who were partners in trusts and partnerships with highly leveraged interests in properties in California, Texas and Pennsylvania, including the Wells Fargo Center in Los Angeles. In 2001, certain entities entered into BOSS transactions designed by Arthur Andersen involving a sale of a short option, purchase of a long option, purchase of a promissory note from AIG, and a pledge of the proceeds of the long option and promissory note to secure the short option. (Isn't it interesting, in light of the US taxpayer bailout of AIG in 2008, that AIG was a counterparty in the transactions?) The taxpayers claimed that the transactions were entered into as legitimate hedges against potential losses. In each transaction, the long option and promissory note was contributed to a partnership, and the partnership assumed the short option (all with the approval of AIG). The partnership did not take account of the short option in its Form 1065 or the partners' K-1s.
As a result, the partners were treated as having higher capital contributions (and higher outside bases). By engaging in these transactions, "a taxpayer would be able to create a basis in an amount substantially greater than the amount of money actually paid for the call-option spread by taking the position that the transaction created a 'contingent' liability for purposes of I.R.C. section 752. " Maquire Partners, slip opinion at 14. This was just "one of many tax-avoidance techniques marketed by Arthur Andersen." Id. "The partnership contributions were always viewed by [the participants] as integral to the entire transaction." Id. at 17.
The court determined that the transaction did not have economic substance, asking "whether the transaction had any practical economic effect other than the creation of tax benefits" and examining both objective substance and subjective motivation, not as "discrete prongs" but as ways of determining whether the transaction was a sham. Id. at 18. A de minimis economic effect is not sufficient to lend the transaction economic substance. Id. at 19. Subjective motivation may be revealed by whether a taxpayer acts like a "prudent economic actor" or "contrary to rational business interests." Id. at 20. The court also noted that a taxpayer's sophistication was relevant to the taxpayer's tax avoidance motivation--one of the taxpayers, Thomas, was a former IRS trial attorney. Furthermore, one of the people who was integral to selling the options transaction to the taxpayers, Mandel, was a tax expert rather than an options expert, and "there was no credible evidence that the transactions performed as a hedge." Id. at 24.
The battle of the experts in the case was easily lost by the taxpayers. Experts showed that the taxpayers "paid approximately 2700 and 2600 times the value of the transactions they purchased." Id. at 24.
The court found that "the transactions at issue do not have economic substance because Thomas and Fox received no economic benefit, other than the increase in basis, from the transactions. In addition, the Court finds that the evidence demonstrates that Thomas and Fox were motivated by this increased basis and not by any purported 'hedging' benefit." Id at 21. Ultimately, the transactions were shams because"tax benefits shaped the structure of the investment in order to achieve the goal of tax avoidance." Id. at 28.
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