Attorney-at-Law

A Piece of the Action

In Uncategorized on 01/09/2011 at 01:09

Old-time “Star Trek” fans will remember Bela Oxmyx, the outer-space gangster who was looking for a piece of the action. But Circular 230 personnel would be well-advised to forswear a piece of the action, especially after reading Stobie Creek LLC v. US , 82 Fed.Cl. 636 (2008), affd, 608 F.3d 1366 (Fed. Cir. 2010). This Court of Claims decision, affirmed in June, 2010, shows again the perils of tax advisors being compensated with “a piece of the action”.

This case presents yet another variation on the sham foreign currency deal. Taxpayer was an LLC taxed as a partnership. Taxpayer’s partners were selling the family business. As usual, it was a corporation because Daddy made it so. Also as usual, the family’s basis in their shares was pennies and the gain multi-millions. So the family put their stock in a partnership and threw in a foreign currency options deal that would have a 99% chance of yielding nothing economically, but which, after the foreign currency deal yielded the expected zero result, would allow the partners to distribute the partnership assets with a greatly stepped-up basis.

I’m less concerned with the details here, but Judge Christine Cook Odell Miller was willing to wade through the wheeling-and-dealing for 128 pages. If Digital Option Trading is your thing, read them all. For me, there are two takeaways: first, don’t take a piece of the action, and second, woodshed your experts good. For now, I’ll only discuss taking a piece of the action.

Taxpayer’s key advisors were the family lawyers, who had represented Daddy when he first bought the lumberyard that was the cradle of the family fortune, and the ill-fated Dallas-based Jenkens & Gilchrist, P.C., law firm, which later came massively unglued for promoting phony tax shelters.

Leaving aside the want of economic substance that permeated the transaction, and the taxpayer’s blatant tax-avoidance motivation, once the Court found for the IRS’s imposition of tax, taxpayer sought relief from 6662 penalties by claiming good-faith reliance on experts.

Though the Court extensively canvassed the substantial authority and reasonable basis arguments, the Court found that the conflict-of-interest arising out of the manner of compensation of the two parties relied upon by taxpayer, put taxpayer out of court. Both the family lawyers and Jenkens & Gilchrist, P.C., were paid a flat fee based on a percentage of the tax savings their gambit was intended to generate. And the Court stated that the family lawyers who introduced taxpayer to Jenkens & Gilchrist, P.C., were little more than brokers, selling a tax dodge on commission.

Though taxpayer’s controlling person was an ex-Wall Streeter who claimed to be immune to sticker shock from legal fees in big deals, the Court was obviously troubled by anyone relying upon experts who were being paid what amounted to an upfront contingency fee on a tax saving.

The Court never mentions Circular 230 (the current version of which was not in effect when the Stobie Creek deal went down), but the fees provision thereof very much speaks to the point. See Circular 230 §10.27(b). Contingency fees are prohibited except in certain instances–and this case isn’t one of them.

Recall once more Canal Corporation and Subsidiaries v. Commissioner, 135 T.C. 9 (8/5/10), which cites Stobie Creek for the proposition that taxpayers cannot rely on advice furnished by the very persons who are promoting the deal. There the advisor was paid a very large, upfront fee; the advisor had a huge stake in taxpayer’s buying into the deal.

Penalties sustained.

There are certain pressures against which the better angels of our nature often strive in vain: high on that list is the pecuniary interest of the pressured one.

In short, tax professional: don’t do it.

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