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Good-faith Reliance on Attorney Absolves Retiree of Sham Transaction Tax Penalties.

(Parker Tax Publishing March 30, 2015)

The Tax Court held that a retired mortician had reasonably relied on the advice of his long-time attorney in participating in a Son-of-BOSS transaction to divest his funeral home business of its real property holdings. Although the court determined the transaction was a sham, it declined to impose gross valuation misstatement penalties due to the unsophisticated taxpayer's reliance on his trusted attorney's advice. CNT Investors, LLC et al. v. Comm'r, 144 T.C. No. 11 (2015).

Background

Charles Carroll began operating a funeral home in 1954 through a corporation owned with his family, Charles Carroll Funeral Home, Inc. (CCFH), which held the titles to the mortuary buildings and the underlying real property. In early 1999, Carroll began contemplating retirement and decided to sell the business, but wanted to retain ownership of the underlying real estate in order to lease it so the family could maintain a periodic stream of income.

Carroll's attorney, J. Roger Myers, initially struggled to identify a way of transferring the real estate out of CCFH without triggering recognition of substantial built-in gain due to the property's low basis. In time, Myers encountered a colleague who suggested using the now-infamous Son-of-BOSS transaction. Initially skeptical, Myers met with his colleague and numerous other tax advisors who explained the transaction in detail. On the basis of the information he received, including a memorandum from a large accounting firm, Myers believed the transaction was a legitimate way to resolve CCFH's low basis dilemma. He presented the strategy to Carroll who agreed to go ahead with the transaction.

The series of transactions divested CCFH of its real estate holdings and concluded with Carroll and his two daughters owning the mortuary properties through a newly formed partnership, purportedly generating only $623,284 of taxable long-term capital gain in the process. Absent the Son-of-BOSS transaction, the amount would have been $3,496,623 due to the low basis of the real property. The accounting firm charged $116,000 for its services and also delivered opinion letters describing the transactions and attesting to their probable tax consequences.

The considerably less favorable actual consequences arrived in 2008 when the IRS issued a Final Partnership Administrative Adjustment (FPAA) disregarding the transaction as a sham and assessing a gross valuation misstatement penalty.

Analysis

A gross-valuation misstatement exists if the value or adjusted basis of any property claimed on the partnership return is 400 percent or more of the correct amount (Code Sec. 6662(e)(1)(A)). Any underpayment of tax attributable to a gross-valuation misstatement is subject to a 40 percent penalty (Code Sec. 6662(h)(1)). A taxpayer can avoid the penalty by showing there was a reasonable cause for the misstatement and the taxpayer acted in good faith (Code Sec. 6664(c)). Taxpayers may argue that he or she had reasonable cause and showed good faith by relying on professional advice (Reg. Sec. 1.6664-4(c)).

After collapsing the steps involved, the Tax Court determined the transaction was a sham and consequently the partnerships misstated the correct value of the property by 400 percent or more. As such, the court determined the Code Sec. 6662 penalty could apply to the underpayments of tax. Carroll argued, however, that while the transaction may have been a sham, the penalty was inapplicable as he had reasonable cause and acted in good faith with respect to the underpayments, as he had relied on the advice of Myers, his trusted attorney of over twenty years.

The court noted there were three factors for this defense established by prior case law:

(1) Was the adviser a competent professional who had sufficient expertise to justify reliance?

(2) Did the taxpayer provide necessary and accurate information to the adviser?

(3) Did the taxpayer actually rely in good faith on the adviser's judgment?

The court found the first requirement was met, as Myers possessed sufficient expertise to justify reliance by Carroll. As of 1999, Myers had represented Carroll for almost 20 years, and Carroll had relied on his advice in growing his business and he had previously advised Carroll on general tax law principles.

The IRS argued that Carroll could not satisfy the second requirement, as he failed to inform Myers of the fee the accounting firm would charge for the transaction. The court disagreed, finding that given Carroll's lack of sophistication, he would not have recognized the fee amount's relevance to Myers' evaluation of the proposed transaction.

The IRS also claimed that Carroll could not have relied on Myer's advice in good faith, as Carroll himself ignored IRS warnings about Son-of-BOSS transactions and had performed no independent research on the transaction. However, the tax court disagreed, noting that while Carroll was an intelligent businessman, he had no tax or investment expertise and would not have been aware of IRS warnings about such transactions. The court also concluded Carroll was under no obligation to personally verify the validity and accuracy of the transactions and returns, as he had retained and relied on counsel exactly for that purpose.

As the Tax Court found that Carroll satisfied all three of the necessary prongs to establish reasonable cause and good faith within the meaning of Code Sec. 6664(c), the court declined to impose the Code Sec. 6662 accuracy related penalty.

OBSERVATION: The Tax Court recently decided a similar case involving a Son-of-BOSS transaction in which the taxpayer also argued reasonable reliance on professional advice to avoid penalties (436, Ltd. v. Comm'r, T.C. Memo. 2015-28). In that case, the professional was a tax promoter who not only participated in structuring the transaction, but was responsible for arranging the entire deal and sold similar transactions to other clients. Because of the professional's promoter status, the court did not believe the taxpayer could have relied on his advice in good faith. By contrast, Myers was working only for Carroll, billed him monthly for work on the transaction at his regular hourly rate, and received no other compensation or incentive for recommending the transaction.

For a discussion of tax penalties, see Parker Tax ¶262,100.(Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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