4th CIRCUIT HOLDS 6 YEAR SOL NOT APPLICABLE TO PARTNERSHIP BASIS ISSUES

No sooner had the ink dried on the 7th Circuit's decision in Beard, that the Fourth Circuit Court of Appeals in Home Concrete & Supply et. al. v. United States (No. 09-2353, February 7, 2011) held that it will follow Colony, Inc. v. Commissioner, 357 U.S. 28 (1958) and will not defer to Treasury Reg. 301.6501(e)-1(e) even after the recent Supreme Court's decision in Mayo Foundation for Medical Education and Research v. United States, 562 U.S. __, No. 09-837, slip op. at 6-7 (Jan. 11, 2011).  Colony held that an overstatement of basis in assets resulting in an understatement of reported gain and gross income does not constitute an "omission" from gross income in extending the three (3) year statute of limitations to six (6) years under section 6501(e)(1)(A) of the Internal Revenue Code.  Consequently, there is now a significant split of authority among the Circuit Courts as to whether the retroactively promulgated Reg. 301.6501(e)-1(e) will have legal effect in the IRS's war on tax shelters, and in particular with respect to adjusted basis cases arising from partnership "liquidating" distributions of assets with overstated basis due to sham treatment or partnership lack of business purpose or economic substance.  Numerous cases involving this issue are pending in other Circuit Courts of Appeal and more is sure to come.

SEVENTH CIRCUIT OVERTURNS TAX COURT ON 6 YEAR STATUTE

On January 26th, the Seventh Circuit Court of Appeals overturned the U.S. Tax Court's prior rulings, and held that the IRS is entitled to apply a six (6) year statute of limitations to basis overstatements on income tax returns.  The Seventh Circuit found that the Supreme Court's decision in Colony Inc. v. Commissioner, 357 U.S. 28 (1958) was distinguishable and not controlling.  The Seventh Circuit's decision, entitled Beard v. Commissioner, ___ F.7th ___, No. 09-3741, 2011 WL 222249 (Jan. 26, 2011), is the IRS's first victory on the SOL issue in the Federal Circuit Courts of Appeal.  This issue is pending in several other Circuits so it is not likely to be the last word on the issue.  But the ruling effectively provides the IRS with a powerful argument for more time to challenge basis issues in its war on tax shelters, such as Son of Boss and other partnership basis strips.  For a copy of the case, direct your request to wce@ceclaw.com.

PETALUMA AFFIRMED ON REMAND

The U.S. Tax Court recently decided on remand whether the Court had jurisdiction under TEFRA over individual partner penalty determinations under Section 6662.  In Petaluma v. Commissioner, 135 T.C., No 29 (December 15, 2010), the Tax Court held that the 6662 penalty was not a partnership level computational adjustment item that would meet section 6226(f)'s requirement that it relate to a partnership item.  Instead, the Tax Court held that since it was an ad valorem penalty determination at the partner level resulting from an outside basis adjustment to assets received from a partnership, no jurisdiction could exist because partner level outside basis adjustments and their related penalties, do not related to partnership item adjustments. 

The Tax Court's decision is consistent with the rulings issued in the earlier related case decided by the D.C. Circuit Court of Appeals in Petaluma FX Partners, LLC v. Commissioner, 591 F.3d 649 (D.C. Cir. 2010), affg. in part, revg.in part, and vacating in part 131 T.C. 84 (2008).  The outside partnership interest basis jurisdictional issue is an item the IRS may need to take to Congress for further help in these cases.

CANAL CASE SPARKING DEBATE

Practitioners are debating the implications of the recent Tax Court decision in Canal Corporation and Subsidiary, et. al., v. Commisioner of Internal Revenue, 135 T.C. No. 9 (8-5-10), which involved an LLC contribution of a corporate subsidiary's balance sheet to a new LLC in exchange for a small residual interest, and the LLC's subsequent distribution of financing proceeds that were distributed to the contributing member under an arrangement whereby the member had agreed to indemnify the other member and the LLC for the distribution indebtedness.  The Tax Court found the member had insufficient assets to support the indemnity obligation and the indemnity covenant could not be relied upon to allocate the LLC debt to the contributing member, and that the disguised sale rules under IRC Section 707(a)(2)(B) applied.  The Tax Court also imposed a substantial understatement penalty, holding that no reliance could be placed upon the tax opinion issued by the taxpayer's advisor due to bias resulting from the opinion writer having participated in the structuring of the transaction and therefore lacking sufficient objectivity to provide a basis of reliance.  See the link below for a copy of the case.

[Click for Link: https://docs.google.com/fileview?id=0B0wpOGVGFkgYODI0M2I1MGItZjYxYi00NmNhLTgyMWQtNWFkYmE0YWQxNjM0&hl=en&authkey=CP-3jZ0G ]

FAMILY LLC TRANSER RESTRICTIONS INVALID UNDER SECTION 2703

On September 1, 2010 in Fisher v. United States, No. 1:08-cv-00908, the United States District Court for the Southern District of Indiana held that family LLC transfer restrictions must be ignored under IRC Section 2703 in the valuation of gifts of family LLC units by the taxpayers to their children.  The basis for the ruling was that the LLC was not a bona fide business because the lake front lot that was it's principal asset was not a business.  The District Court relied on the decision in Holman v. Commissioner, 601 F.3d 763 (8th Cir. 2010) which held that a family LLC passively holding publicly traded stock served no bona fide business purpose for purposes of respecting transfer restrictions under IRC Section 2703.  The determination did not eliminate the application of valuation discounts for lack of control or marketability, but it did require that any gift valuation discounts not take the LLC's operating agreement transfer restrictions into account.  This case reflects the Service's ongoing challenge to family LLC estate and gift transfer valuations, particularly in cases where the family LLC holds nothing but passive investment assets without any specific investment criteria or focus.

U.S. District Court Rules on Discovery Privileges In Tax Shelter Case Regarding Emails

A recent U.S. District Court case, Green v. Beer, et. al., No. 1: 06-cv-4156 (Southern District of New York) addressed attorney-client privilege issues in connection with emails, and ruled legal advice concerning certain aspects of the shelter were protected, while emails shared with the legal clients' financial advisors resulted in waivers of the privilege with respect to those emails.  This case should provide helpful guidance to tax counsel providing tax advice in connection with a transaction as to the do's and don'ts of privilege protections. 

Our Firm will be glad to furnish a copy of the case upon request.

Whitehouse Valuation Case Remanded

The Fifth Circuit Court of Appeals just remanded Whitehouse to the Tax Court. The case involves the valuation of a facade easement and one of the interesting issues in the case is the determination of highest and best use. See Whitehouse Hotel Limited Partnership v. Commissioner, Case No. 09-60085 (5th Cir., 8/10/10).