T.C. Mem o. 2 01 5- 28

UNITED STAT ES TAX COURT

43 6, LTD., ROBERT HEITMEIER, TAX MATTERS PARTNER, Peti ti on er v . COMM ISSI ONER OF INTERNAL REVENUE, Resp on de nt

Doc ke t No . 23 52 5- 05
. Fi le d F eb ru ary 18 , 20 15
. Ky le R. Co le m an , forpe ti ti on er. Ri ch ardJ. Has se br oc k, Nan cy B. Herb ert , andGary

R. Shul er, J r., fo r res po nd en t.

MEMORANDUM FINDINGS OF FACT AND OPINION HOLMES, Ju dg e: Thi s ca se co m es to us fro m a ri ve rb oa t ca si no on th e lo wer Mi ss is si pp i. In19 91 Ro be rt He it m ei er s aw a lu crat iv e o pp ortuni ty in the
ne wly le ga li zedriv erb oa t-g am bl in g i ndus try of New Orl ean s. He st art edsev eral- 2 -

[* 2] bu si ne ss es to pro vi de crews an d c on su lt in g s erv ic es to th es e n ew cas in os , and in 20 01 Heit m ei er h itth e jack po t wh enHarrah ’s pu rch as edhi s p il ot in g c on tra ct with t he Sh owb oa t Ca si no for$4 m il li on . He rep orte d a n a dd it io na l $ 14 2,0 00 of
or di na ry in co m e fro m

hi s co ns ul ti ng servi ces , and$2 32 ,00 0 o f or di nary in co m e fro m hi s s erv ic es inpro vi di ng crews . He to oka ch an ce t o t ry to lo wer h is tax bi ll with aco m

pl ic at edser ie s o f tr an sa ct io ns in vo lv in g m ul ti pl e en ti ti es an d a lm os t pe rfec tl y off se tt in g b et s o n J ap an es e y en . The Co m m is si on er ai m s t o s in k h is sh el te r.

FINDINGS OF FACT I. The DeckhandTurn edMi ll io na ire Ro be rt “ Bo bb y ” Hei tm ei er l eftco ll eg e aft er o nl y on e se m es te r to workas a de ckhandon a tu gb oa t. He ro se to be co m e a capt ai n a ndth ena ri ve rb oa t p il ot . Ri ve rb oa t p il ot s an d c ap ta in s o ug htno t t o b e co nf us ed . A capt ai n i s al m os t al way s i n c omm an d o f th e sh ip , exc ep t wh enitgo es in to a lo cksyste m or a dry do ck
. Cap ta in in g i s g oo d wo rk , bu t p il ot in g- -ah , “ a p il ot , inth os e d ay s, was th e o nl y un fet te redan d e nt ire ly ind ep en de nthu m anbe in g t ha t l iv edinth e earth .” 1
MarkTwain , Life o n t he Mi ss is si pp i 1 05 (Harp er & B ro s. Publ ’g 19 01 ) 1 (1 88 3) , ava il ab le at ht tp ://b oo ks .go og le .co m

/b oo ks ? id =5 IRaAAAAMAAJ &p rin ts ec= fro nt co ve r&s our ce= gb s_ ge _s umm ary_r&ca d= 0# v= on ep ag e&q &f= fal se .- 3 -

[* 3] Pi lo ts gu id e sh ip s thr ou gh co ng es te d h arb or s an d p orts us in g t he ir i nt en se ly lo cal kn owl ed ge of m ari ti m e co nd it io ns . This co m es at apri ce, an d e ve n i n an te be ll um

Am eri ca p il ot s ea rn eda “pr in cel y sal ary. ” See i d. at34 . Nowad ay s a pi lo t d oe sn ’t eve n h av e to tak e th e whe el --tho ug h h is job rem ai ns to di rectth e sh ip
an d m on it orth e co ur se of h is sh ip an d o th ers aro un d i t. Mo de rnna vi ga ti on al te ch no lo gy has no t re li ev edsh ip pe rs of the ne edforpi lo ts inm an y pl aces , in cl ud in g t he lo wer Mi ss is si pp i, wh ere s ta te law re qu ire s the ir u se an d d oe s n ot al lo w op enen try int o t he fie ld
. Heit m ei er i s s av vy andsu cces sf ul ly nav ig at edhi s 2
co ur se to a pi lo ti ng li cen se fro m Lou is ianain19 89 . In 2 00 1 h e was als o l ic en se d
as a ri ve r pi lo t b y

th e U.S. Co as t Gu ard
.

The Lo ui si an a Co de ha s a t it le de vo te d t o n av ig at io n a ndsh ip pi ng , and 2 withi n t ha t t it le , a se ct io n d ed ic at edto pi lo ts . La. Rev. St at . Ann . sec s. 3 4: 94 1 et se q. (20 11 ). All sec ti on refe ren ces are t o t he Int ern al Rev enue Co de ineffe ctfor th e y ear i n i ss ue , un le ss ot he rwis e in di cat ed . Thes e st atut es requi re tha t al l se ag oi ng ve ss el s m ov in g b etweenNew Orlea ns an d o th er p orts be na vi ga te d ex cl us iv el y

by pil ot s wh o a re St at e o ffi cers . Thes e p il ot s ar e so -cal le d ri ve r po rt pi lo ts an d c anga in cert ifi cat io n b y th e St at e Bo ardof R iv er Pi lo t Co m mis si on ers -- al so pi lo ts --o nl y

aft er p erfo rm in g a n o bl ig at ory si x- m on th ap pr en ti ces hi p wi th an in cu m be ntpi lo t. Ob ta in in g an app ren ti ces hi p i s n o e as y tas k. In cu m

be ntpi lo ts ha ve alm os t u nf

et te reddi sc ret io n u nd er the law t o s el ectpro sp ect iv e ap pr en ti ces –a ndpi lo ti ng is on e o f th e v ery few job s i n wh ic h s ta te -s an ct io ne d ne po ti sm ha s s urvi ve d c on st itut io na l ch al le ng e. See Ko tc h v . Boa rdof R iv er Po rt Pi lo t Co m

m ’rs, 33 0 U.S. 5 52 , 55 5 (1 94 7) (ne po ti sm inpi lo t s el ect io n d oe s n ot vi ol at e Equ al Pro te ct io n C laus e).- 4 -

[* 4] The Cit y

of Ne w Orlea ns ha s b eena m ajorworl d p ort fo r ne arl y th ree cen tu rie s. Th e Lou is ianaleg is la tu re h as co nt ro ll edth e act iv it ie s an d app oi nt m en t of pi lo ts si nc e b efo re the territ ory was a dm it te d a s a s ta te . In 1 99 1 t he st at e ap pr ov edfif

te enne w riv erb oa t ca si no s. Hei tm ei er s hr ewd ly saw th atas abu si ne ss op po rtu ni ty--gam

bl in g p eo pl e kne w Vega s, b utth ey weren ’t “ go in g t o kno w an yth in g abo uta bo at ”--s o h e se t up abu si ne ss to pro vi de m ari ti m e cre ws t o t he
ne w cas in os . Each ri ve rb oa t n eed edab ou t s ix ty of Hei tm ei er’s em pl oyees, ro ug hl y fou r cre ws p er s hi p, wh o c ou ldwork12 -h ou r-l on g, 7 -d ay -o n, 7 -d ay -o ff sh ift s. Th is workso on be cam e le ss th anarduo us , as the bo at s qui ck ly sto pp ed actua ll y cru is in g o n t he riv er an d b ecame atta ch edas f irmly as b arn acl es to th e do ck s. (Th ou gh so m et im es th ey do ck edon a di tc h fi ll edwith ri ve r- 5 -

[* 5] wate r--“ bo at s i n m oa ts ” as th ey are ca ll ed .) Heit m ei er i nc or po rat edth at 3 bu si ne ss as R iv erb oa t Se rv ic es , Inc ., in19 95 an d was it s s ol e sh areh ol de r. Heit m ei er al so form edtwo ot he r bu si ne ss es aro un d t he same tim e fo r hi s riv erb oa t-r el at edact iv it ie s- -Westb an k R iv erb oa t Se rv ic es , Inc ., andBRK Co ns ul ti ng , LLC. Heitm ei er u se d Westba nkto supp ly w orke rs to th e ri ve rb oa t
cas in os , anddi d h is ownco ns ul ti ng workth ro ug h B RK Co ns ul ti ng . Heitm ei er rep orte d m or e th an$2 30 ,00 0 o f in co m e fro m W es tb an k fo r 20 01 . He sh ared
Thi s p ract ic e o f m an ni ng a fu ll crew o n b oa ts th atne ve r le av e th e sh or e is 3 th e res ul t o f st at e-l aw te ch ni cal it ie s re st ric ti ng ga m bl in g (apa rt f

ro m Am eri can In di ancas in os an d o ne lan d- ba se d c as in o) to “ riv erb oa ts .” Lou is iana ’s st atut e sa y s tha t “ th e d iv is io n m ay is su e up t o fi fte enli cen se s t o c on du ctga m in g a ct iv it ie s on a ri ver bo at , inacco rd an ce wi th th e p ro vi si on s o f th is Ch ap te r.” Lou is iana Ri ve rb oa t Eco no m ic Deve lo pm en t an d Gam in g C on tro l Act , La. Rev . Sta t. An n. se c. 27 :6 5 (e m

ph as is ad de d) . The s ta tu te de fin es a ri ve rb oa t, i n p art , as ave ss el th at“ [c]arri es a va li d C ert ifi cat e o f In sp ect io n (C OI) fro m th e Uni te d S tate s C oa st Gua rdforth e carria ge of am in im um of s ix hu nd redpa ss en ge rs an d c rew.” Id
. se c. 27 :4 4( 23 )(b ). Thu s, wh il e Lou is ianaan d o th er s ta te s o n t he Mi ss is si pp i tha t al lo w riv erb oa t g am

bl in g h av e el im in at edth e requi rem en t tha t the bo at s ac tu al ly m ov e, se e, e.g ., id . sec . 27 :6 5( B)(1 )(c) , cas in o b oa ts m us t m eetCo as t Gu ard requi rem en ts to rece iv e a COI. Th e Co as t Gu ardsp eci fie s i n t he COI th e m in im um crew re qu ire m en ts fora bo at , anditba se s thi s d et erm in at io n o n fa ct or s su chas the si ze o f th e b oa t, the nu m be r of pa ss en ge rs , andit s i nt en de d u se . 46 C.F.R. s ec. 1 5.5 01 . The d et erm in at io n i s fa ctsp eci fic foreach bo at , bu t Co as t Gua rdgu id el in es su gg es t tha t Hei tm ei er’s s ta ffi ng de ci si on s wer e n otou t o f th e or di na ry . See, e.g ., The U.S. Co as t Gu ard , Mari ne Safe ty Manu al Vol . III: Mari ne In du stry Pers on ne l, B2 -7 (20 14 ), av ai la bl e a t ht tp ://www.u sc g.m il /d ire ct iv es /c im /1 60 00 -1 69 99 /C IM_ 16 00 0_ 8B .pd f. Thi s h as st ru ckso m e o bs erv ers as abs ur d, b utitcrea te d alu crat iv e o pp ortu ni ty for tho se sh rewden ou gh to tak e advant ag e o f it
.- 6 -

[* 6] own ers hi p o f BRK wi thhi s wi fe, an d t he y each rep orte d m or e th an$7 0,0 00 of in co m e fro m

itfor 20 01 . By

Octo be r 20 01 he ha d abo ut$1 m il li on in ve st edin
va rio us Merr il l Ly

nc h a cco un ts . In20 01 Harrah ’s bo ug htth e Sh owb oa t Ca si no , on e o f Ri ve rb oa t Se rv ic es ’ cl ie nt s. Harr ah ’s want edto tak e it s p il ot in g i n- ho us e an d app ro ach edHeit m ei er t o bu y ou t Ri ve rb oa t Se rv ic es ’ co nt ractwith S ho wbo at . Heit m ei er re pr es en te d hi m se lf a nddi ck eredwith Harrah ’s ov er the pri ce fo r a wh il e b efo re ca ll in g i n KPMG t o s et tl e th in gs with ava lu at io n. KPM G cam e up wi th a va lu e, an d t he fo rm er d eckha ndso ldhi s co nt ractfora $4 m il li onpa y da y . II. Ent er Mr . Garza Jo e Garzais anatt orne y

fro m Dall as , Texa s, wh o h ada lo ng -es tabl is he d pr act ic e inin su ran ce d efen se , ERISA, an d b on d fi na nc in g b efo re h e m ov edin to ta x p lann in g- -s om et im es qu it e ag gr es si ve tax pl an ni ng . See 6 61 1 Lt d. v
. Co m m is si on er, T.C. Mem o. 2 01 3- 49 ; Gar ci a v . Commis si on er, T.C. Mem o. 2 01 1- 85 , 20 11 W L 14 04 91 9; Est at e o f Hur fo rdv. Co m m is si on er, T.C. Mem o. 2 00 8- 27 8, 2 00 8 WL 52 03 65 2; 70 50 , Ltd . v. Co m m is si on er, T.C. Mem o. 2 00 8- 11 2, 2 00 8 W L 18 19 92 0. Itwas Gar za wh o s ol d Hei tm ei er o n s om ethi ng he ha dn ’t heardof- 7 -

[* 7] be fo re-- a v ari an t o f th e n ow n ot or io us So n- of -BOSS de al us in g d ig it al op ti on s an d J ap an es e y en . See Kl ig fel d Ho ld in gs v. Co m m is si on er, 1 28 T.C. 19 2, 4 19 4 (2 00 7)
. A. The App ro ach Aro un d 1 99 9 Gar za fi rs t b ecame aware o f So n- of -BOSS tra ns act io ns --a l aw firm na m edJen ke ns & Gil ch ris t was do in g alo t o f th em , andsev eral of h is cli en ts
wan te d t o d o t he m

to o. Garz a co nc lu de d t ha t h e co ul d e ithe r refe r hi s i nt eres te d cl ie nt s t o J en ke ns & Gil ch ris t o r do th e d eal s h im se lf. He d eci de d t o l earn ho w to do th e d eal s h im se lf. Fi rs t h e co ns ul te d wi thCrai g B ruba ke r--an e x- Arth urAnd ers enem pl oyee an d a t the ti m e a d ire ct orat Deu ts ch e Ban k Al ex Bro wn. Bruba ke r ha d b een worki ng on a lo t o f th es e d eal s fo r Je nk en s & Gil ch ris t, an d Gar za was co nf id en t of Bruba ke r’s kn owl ed ge an d abi li ti es . Bruba ke r gave Garza s om e in fo rm at io n o n ho w th es e d eal s wo rk edan d h ow m uc h Deu ts ch e Ban k c ha rg edforth em .
Garza was n’t re al ly urg in g asp ecu la ti ve for ay infor ei gncurren cy --h e was 4 pr om ot in g atype o f So n- of -BOSS tax sh el te r (wh ic h i s a v ari an t o f th e Bo ndan d Opt io ns Sal es Str at eg y

(BOSS) sh el te r) tha t u se s Euro pe andi gi ta l o pt io ns on fo rei gncurren cy . Unl ik e an“ Am eri can ” o pt io n, wh ic h c anbe ex erci se d a t an y ti m e b efo re i t ex pi res , a “ Euro pe an ” o pt io n c anbe ex erci se d o nl y at apa rti cu lar da te an d t im e. An o pt io n i s “ di gi ta l” if i t h as th e sa m e p ay ou t n o m at te r ho w far i n th e m on ey

itis . Dig it al op ti on s ar e al so kn own as “ al l-o r-n ot hi ng ” o pt io ns . See Marke ll Co . v. Co m

m is si on er, T.C. Mem o. 2 01 4- 86 , at * 4 n .5.- 8 -

[* 8] Bruba ke r al so su gg es te d t ha t Gar za s pe akwith a no th er l awy er ru m or edto ha ve do ne a $1 00 mil li on trans act io n fo r a l oc al bi ll io na ire who “ se em edto kn ow wha t h e was do in g,” to lea rnm or e. Garza f ol lo wedBruba ke r’s reco m m en da ti on an d p ai d t he lawyer $5 0,0 00 fora da rk -s id e CLE on th e fi ne r po in ts of t he de al
. In cl ud edinth e b arg ai n was a tu rn ke y op in io n l et te r--o ne th atGarza c ou ldus e in hi s o wn p ract ic e. Partof Garza’s p ro m ot io na l p it chwas tha t i f a t ax pa y er h ada

“ go od ” ta x o pi ni on let te r, he wou ldno t h av e to pa y an y pe na lt ie s ev enif the tax be ne fit s wer e d is al lo wed
. Onc e Garzaha d h is tu rn ke y op in io n l et te r an d kne w th e tr an sa ct io n wel l
en ou gh , he b eg anpi tc hi ng . The p ur po se of a ll So n- of

-BOSS tax sh el te rs is to
crea te “ art ifi ci al tax lo ss es de si gn edto off se t i nc om e fro m

ot he r tr an sa ct io ns .” Kornm an& Ass oc s., In c. v. Un it edSta te s, 5 27 F.3d44 3, 4 46 n.2 (5t h C ir. 2 00 8)
. Garza ’s sch em e in vo lv eda partn ers hi p t o wh ic h h is cli en ts wou ldtra ns fer a ss et s an d l iabi li ti es . As a m at te r of eco no m ic s, the li ab il it ie s wo ul d o ffs etth e v al ue of th e as se ts , bu t tho se li ab il it ie s wo ul dn ’t be c om pl et el y fix edat t he ti m e o f tr an sf er, an d t he pu rp orte d p artne rs wou ldig no re the m incal cu la ti ng th ei r ou ts id e b as es in th atpa rtn ers hi p. Th e p artne rs hi p wo ul d a ls o i gn or e th e li ab il it ie s i n c om pu ti ng it s- 9 -

[* 9] in si de ba se s i n t he co nt rib ut edpro pe rty. Ign or in g t he li ab il it ie s i n 5 cal cu la ti ng ba si s cr eat es anin fla te d b as is . Whe n the pu rp orte d p artne rs li qu id at ed th ei r pa rtn ers hi p i nt eres ts , th ey wou ldge t a d is tri bu ti on of p ro pe rty to wh ic h t he y wou ldatt ach th is hi gh ba si s i n t he pa rtn ers hi p. An d t he n wh enth ey so ldth at pr op erty , itwou ldpro du ce l arg e ta x- -b utno t o ut -o f-p oc ke t-- lo ss es . See, e.g ., Marke ll Co . v. Co m

m is si on er, T.C. Mem o. 2 01 4- 86 , at * 12 , *3 1 n .17
. Garzaus eda si x- st ep de al :

• bu y

a fo rei gn -cu rren cy

cal l o pt io n (a ndsel l an off se tt in g fo rei gn -cu rren cy cal l o pt io n i n t he same curre nc y to th e sa m e co un te rp arty ) an d a ls o 6 Can ad ian d ol lars th ro ug h asi ng le -m em be r LLC;

• fo rm

a pa rtn ers hi p wi th a th irdpa rty or wh ol ly owne d LLC;

• co nt rib ut e th e fo rei gn -cu rren cy op ti on s an d C an ad ian d ol lars to th e pa rtn ers hi p;
Ins id e b as is is th e b as is a pa rtn ers hi p h as init s o wn as se ts , sec . 72 3; 5 ou ts id e b as is is th e b as is a pa rtn er h as inhi s p artne rs hi p i nt eres t, s ec. 7 22 ; s ec. 1.7 22 -1 , Exam

pl e (1 ), In co m e Tax Reg s. W e ref er el se whe re i n t hi s o pi ni on to su chop ti on s as “ lo ng op ti on s” an d 6 “ sh ort o pt io ns .” “ Lon g” canm eansev eral th in gs infin an ce-s pe ak ; h ere, i t s im pl y m ean s t o b uy andho lda po si ti on . “ Sh ort” li ke wis e h as m ul ti pl e m ean in gs : Here , itm ean s t o s el l a p os it io n. Be cau se th e lo ng an d s ho rt l eg s i n t he op ti on tra ns act io ns in vo lv edth e sam e p art ie s, the same peri od s, an d the same co un te rp art ie s, the y

eco no m ic al ly zeroe d e ach ot he r ou t ex cep t fo r th e n arro w sp readbe twee n t he two strik e p ric es : On e p arty co ul d b uy the y enat $ X fro m th e se co ndpa rty, andth e se co ndparty cou ldtu rnaro un d andbu y th e y enat $ X m in us th e sp readfro m

th e fi rs t p arty .- 10 -

[* 10 ] • reco gn iz e a g ai n o r lo ss by the pa rtn ers hi p wh enth e o pt io ns ex pi red

orwere ex erci se d;

• te rm in at e an d l iqui da te th e p artne rs hi p; an d

• se ll th e Can ad ian d ol lars th atth e si ng le -m em be r LLC rece iv edfro m

th e pa rtn ers hi p’s l iqui da ti on . Garzacred ib ly test ifi edto ha vi ng so ldov er a d oz enof t he se types of t ran sa ct io ns to di ffer en t t ax pa y ers . Garzasays h e wou ldalwa y s h av e h is cli en ts ch oo se whi chcurren cy to us e bu t wo ul d m ak e st ro ng reco m m en da ti on s. He wo ul d a ls o i ns is t tha t ea chof h is cl ie nt s t al k wi th Brubake r. Bruba ke r wou ldex pl ai n wh attra de s wo ul d b e m ad e, an swe r ot he r qu es ti on s, an d h el p t he cli en t s etup Deut sc he Ban k a cco un ts . If th e cl ie ntask edGarza wh athe th ou gh t, h e wou ldsay so m ethi ng en co ur ag in g l ik e “ I th in k t he y enis go in g d own hi ll ” an d p ro ceedfro m th ere. We als o n ot e es pe ci al ly th atGarza n ev er n eg ot ia te d a ny of th e in ve st m en t d et ai ls forhi s cl ie nt s. He l et Brubake r an d Deu ts ch e Ban k v al ue th e o pt io ns . B. GarzaSp read s t o New Orl ean s Heit m ei er was happ y

ab ou t h is win df

al l, b utworr ie d abo utth e p os si bl e ta x bi ll . He was es pe ci al ly w orrie d t ha t the tax du e wou ldbe at “ reg ul ar” ( i.e.,
or di na ry ) rat es , so he cal le d h is tax advi se r, W al te r Jo ne s. Hei tm ei er an d J on es wen t way back --Hei tm ei er’s l on gt im e CPA, Han k LeVi erre , was J on es ’ fo rm er- 11 -

[* 11 ] bu si ne ss pa rtn er, an d Hei tm ei er an d J on es ha d g ro wn up t og ethe r, th ei r fathe rs ha d g ro wn up t og ethe r, an d Hei tm ei er’s b ro th er h adev enda te d J on es ’ si st er. Whe n LeVi erre ret ire d, J on es to okov er Hei tm ei er’s acc ount in g a nd pr ep aredth e returns for

Heit m ei er’s thr ee b us in es se s. J on es wasn ’t in vo lv edin th e d ay -to -d ay

op erat io ns , bu t a wee k a fte r Hei tm ei er t ol d h im ab ou t the sal e pr oc eed s, J on es pro po se d h e m eetwith aco ll eag ue , Elli s R ou ss el , to di sc us s

“ so m ethi ng di ffer en t, s om ethi ng go in g o n ri gh t n ow.” Ro us se l wo rk edforth e firm LeGlu e & Co m

pa ny CPAs, wh ic h h adit s o ffi ces inth e sa m e b ui ld in g a s Jo ne s’ inNew Orlea ns , andJo ne s o fte n h an de d o ff b ig ge r job s t o the m . Ro us se l fi rs t l earn edab ou t the So n- of -BOSS de al inSep te m

be r 20 01 fro m on e EdwardTurn er, a Tex as CPA who di d p eer r ev ie ws o f LeGlu e & Co m pa ny’ s work. Turn er d idn’t g o i nt o g reatde ta il with R ou ss el at t ha t p oi nt , bu t ju stga ve

7 Ro us se l a b rie f de sc rip ti onof t he de al an d s ai d h e’d d on e itwith g oo d re su lt s i n
To b e a m em

be r of th e Am eri canIns ti tu te of C PAs ( AICPA), p ub li c 7 acco un ti ng firm s m

us t b e en ro ll edina pr act ic e-m on it or in g (o r “pe er re vi ew”) pr og ram . The AICP A requi res acco un ti ng firm s t o h av e anin de pe nd en t ev al ua to r rev ie w th ei r acc ou nt in g andau di ti ng pra ct ic es ge ne ral ly every thr ee years. See Am eri canIns ti tu te of C ert ifi edPubl ic Acco un tant s, In c., 20 13 PeerRev ie w Pro gr am Man ua l: AICPA St an da rd s fo r Perf orm in g a ndRep orti ng on Peer Rev ie ws s ec. 1 00 0( .01 )-(.0 3) (20 13 ), av ai labl e at ht tp ://www.ai cp a.o rg /R es earc h/ St an da rd s/ Peer Rev ie w/Do wnl oa dabl eDo cum en ts /2 01 3M arPe erRe vi ewSt an da rd s.p df- 12 -

[* 12 ] th e p as t. On ce J on es go t wi ndof t he de al , andto ldRo us se l h e h adso m eo ne who m ig htbe in te res te d, Hei tm ei er m etwith t he two of t he m to di sc us s the op po rtu ni ty. Duri ng th e m eet in g, Hei tm ei er d idn’t u nd ers tandth e d et ai ls of t he
co nt em pl at edtra ns act io n, b uthe was c ert ai nl y in tri gu edby the po te nt ia l fo r ta x be ne fit s. He l at er co nt act edRo us se l t o s ay he want edto m ov e fo rward
. C. Heit m ei er Me et s Gar za At s om e p oi ntRo us se l co nt act edTurn er ag ai n, an d Tu rn er s en t h im an op in io n l et te r writ te n b y

Jen ke ns & Gil ch ris t fo r an ot he r cl ie ntwho ha d d on e a So n- of -BOSS de al an d t he n p uthi m into uc h wi thGarza. Hei tm ei er fi rs t s po ke with Gar za i n aco nf

eren ce ca ll with R ou ss el an d Gar za. Dur in g t he cal l Gar za de sc rib edeach st ep of t he de al . A few weeks lat er h e cam e to New Orlea ns to eat ét ou ffée an d p it chHeit m ei er atth e LeGlu e o ffi ces . At th is m eet in g, Gar za pr ov id edHeit m ei er wi th writ te n m at eri al s tha t o ut li ne d t he de al . Garza “ [s ]pok e a lo t i n g en eral it ie s, [a nd ] wen t thr ou gh so m e it em s p ret ty fast .” Ro us se l was ge tt in g m or e co m fo rtabl e wit h t he de al ’s m ech an ic s b utst il l “ cert ai nl y di dn ’t hav e a to ta l g ras p o n i t.” Bu t Hei tm ei er’s b ig tak eaway from th is m eet in g was th atth e tra ns act io n m ig htdo ub le hi s i ni ti al ou tl ay of $ 40 ,00 0 i f th e Japane se y enm ov ed
on e way , andinan y

ev en t wo ul d g ai n fo r hi m a “ si gn ifi can t wri te -o ff” fo r ta x pu rp os es .- 13 -

[* 13 ] Aro un d t he same tim e h e was lea rn in g abo utth e d eal fro m Garza, R ou ss el al so pu ll edinot he r pe op le to do so m e in de pe nd en t re se arch . Vin ce Gi ard in a, an ot he r LeGlu e p artne r, res earc he d t he tax asp ect s o f th e d eal . Rou ss el als o c al le d Bri anLeftwi ch , a New Orlea ns tax att orne y who oft enact edas c ouns el for LeGlu e. The m or e th ey

lea rn ed , th e m or e th ey

fret te d. Ro us se l, Gi ard in a, an d Leftwichwere al l co nc ern edab ou t the de al ’s lac k o f pr of itm ot iv e an d g os sa m er eco no m ic subs tanc e. Ro us se l re fu se d t o m ak e an y reco m m en da ti on reg ard in g whe th er Hei tm ei er s ho ul d p art ic ip at e in th e tr an sa ct io n, an d t ol d Hei tm ei er,

“ Lis te n, we ca n’t g iv e y ouanop in io n t ha t you c ando it ; we ca n’t-- * * * the re’s
so m e in di cat io ns , y oukn ow, tha t m ay rai se so m e que st io ns .” Giar di naals o refu se d t o b le ss th e arr an ge m en t an d a le rte d Hei tm ei er tha t h e m ig htbe ex po se d t o anau di t i f he ch os e to pro ceed . AndLeftwi chul ti m at el y de ci de d tha t h e d idn’t feel co m fo rtabl e g iv in g a n o pi ni on eit he r way --h e was n’t wel l-v ers edinfor ei gn cu rren cy op ti on s. Des pi te th es e warn in g s ig ns , inlat e Oct ob er 2 00 1, Hei tm ei er de ci de d t o fo ll ow Gar za an d g o fo rwardwith t he So n- of -BOSS trans act io n. D. The Deal ThatW as Don e Garzach arg edHeit m ei er a fl atfee o f $1 35 ,00 0 fo r hi s s erv ic es . The b il l th atGarza s en t t o Hei tm ei er was en ti tl ed“ St at em en t fo r Serv ic es Ren de red ,” an d- 14 -

[* 14 ] sai d i t co ve red“ al l s erv ic es to be ren de redinco nn ect io n wi th y ou r di gi ta l op ti on tra ns act io n a ndth e rel at edleg al op in io n,” in cl ud in g:

• fo rm at io n o f LLC di sr eg ard eden ti ty;

• fo rm at io n o f li m it edpa rtn ers hi p;

• ne go ti at io ns with i nv es tm en t b an k a ndrev ie w of tran sa ct io ns ;

• le ga l o pi ni on let te r; a nd

• ta x re tu rnpre pa rat io n a ndrev ie w. 8 It a ls o s ai d tha t the $1 35 ,00 0 wo ul d c ov er “ an y an d a ll servi ces ne ces sa ry in th e ev en t tha t ei th er y ouor t he ab ov e en ti ti es are s el ect edforanau di t b y th e IRS in th e fu tu re.” Th is m ean t tha t Gar za wo ul d c ov er the ir l eg al fees if the tra ns act io n b le w up . Garzarequi redHeit m ei er t o p ay th e fi rs t i ns ta ll m en t o f $6 7,5 00 up on rece ip t o f hi s “ St at em en t fo r Serv ic es Ren de red ,” an d t he rem ai ni ng $6 7,5 00 when he de li ve redhi s l eg al op in io n. Hei tm ei er p ai d t he fir stin st al lm en t o n Oct ob er 3 0, 20 01 fro m

a Hib ern iaBan k a cco un t o pe ne d i n t he na m e o f Ri ve rb oa t Se rv ic es , In c. Heit m ei er kne w th atth e en ti ti es were cr eat edto cap tu re the tax be ne fit s o f th e d ig it al op ti on /J ap an es e y entra ns act io n, an d t ha t the tra ns act io n h adto be Garza wo ul d o ccas io na ll y rev ie w returns , bu t h e d idno t p rep are t he m . 8- 15 -

[* 15 ] co m

pl et edby 200 1 fo r hi m

to cap tu re the tax be ne fit s. He rel ie d e nt ire ly on Garzato pre pa re the pape rwo rkan d fi le th e n eces sa ry do cu m en ts with t he di ffer en t s ta te au th or it ie s, an d d idn’t b ot he r to ob ta in an y in ve st m en t o r fi na nc ia l advi ce ab ou t the tra ns act io n fr om hi s i nv es tm en t b ro ke r atth e ti m e. Garza m ov ed qu ic kl y . He setup inCo lo rad o a ndGeor gi a b ecau se th os e st at es pro ces se d fi li ng s qu ic kl y an d c he ap ly. He na m edth e en ti ti es with n um be rs be cau se he want edto
av oi d a ny sna gs th atm ig htha ve sl owe d t he de al if s om eo ne els e h adanLLC or pa rtn ers hi p wi thth e sam e n am e. AndGarza d idn’t draftan y of t he en ti ty ag reem en ts fro m

scr at ch , bu t ad ap te d t he m fro m th e sam pl e h e al read y

ha d. Th e do cu m en ts Heit m ei er ac tu al ly sig ne d, h e si gn edwitho utread in g. Othe r do cu m en ts were s ig ne d o n h is be ha lf a s R ob ertHeitm ei er PA, ev enth ou gh Heit m ei er h adno t d es ig na te d o r au th or iz edan y on e to acton hi s b eh al f. Garzalau nc he d t he Heit m ei er tran sa ct io n o n Oct ob er 2 9, 2 00 1 a ndth in gs to okoff :

! Fro m

Octo be r 29 to 30 , 20 01 , Garza h el pe d Hei tm ei er fo rm th ree en ti ti es : 8 25 2, LLC, 9 4 LLC, an d 4 36 , Ltd
.- 16 -

[* 16 ] " 82 52 is a di sr eg ard eden ti ty for fed eral tax purp os es , was

fo rm edun de r Geo rg ialaw, an d Hei tm ei er i s l is te d a s i ts so le m em be r. 9
" 94 was fo rm edas aCo lo rad o l im it edli ab il ity co m pany, Heit m ei er was it s s ol e m em be r, an d i t n ev er m ad e anele ct io n on Fo rm 88 32 to be cla ss ifi edas a n a ss oc ia ti on forfed eral tax pu rp os es . " 43 6 was form edas aCo lo rad o l im it edpa rtn ers hi p, an d o n i ts 20 01 return i t l is te d Hei tm ei er as a 99 % li m it edpa rtn er, an d 9 4 as a ge ne ral pa rtn er wi th a 1% l im it ed -p artne rs hi p i nt eres t. ! On Oct ob er 2 9, 2 00 1, Hei tm ei er s etup th ree a cco un ts with Deu ts ch e Ban k- -o ne forRiv erb oa t Se rv ic es , on e fo r 82 52 , andon e fo r 43 6. ! On Oct ob er 3 0, 2 00 1, Hei tm ei er h adRiv erb oa t Se rv ic es sen d $ 45 ,00 0 to 82 52 ’s Deut sc he Ban k a cco un t. Thi s was th e o nl y cap it al co nt rib ut io n m ad e to 82 52
. ! On Oct ob er 3 0, 2 00 1, Hei tm ei er al so ha d R iv erb oa t Se rv ic es sen d $6 7,5 00 to Garza’s ac co un t atBan k On e--h al f hi s t ot al fee. ! On No ve m

be r 1, 2 00 1, 8 25 2 b ou gh t an d s ol d o ffs et ti ng lo ng an d sh ort fo rei gn -cu rren cy

op ti on s o n J ap an es e y enfro m Deut sc he Ban k fo r a $ 40 ,00 0 n etpre m iu m . Bot h o pt io ns ex pi redon Decem be r 12 , 1 0 20 01
. A U.S. bu si ne ss en ti ty w ith o nl y on e m em be r is eit he r a co rp or at io n o r a 9 “ di sr eg ard eden ti ty.” (Whe n a n e nt ity is “ di sr eg ard ed ”, itm ean s tha t i ts own er i s tre at edun de r th e Co de as aso le pro pr ie to r. Sec. 3 01 .77 01 -2 (a), Pr oc ed . & Adm in
. Reg s.) If itdo es n’t wan t t o b e d is reg ard ed , Form 88 32 , Ent ity

Cla ss ifi cat io n Elec ti on , all ows th e en ti ty to el ectto be tax edas aco rp or at io n. Se c. 30 1.7 70 1- 3( b) (1 )(i i), (c )(1 )(i ), Pro ced . & Adm in . Reg s. The p rem iu m s o n t he lo ng an d s ho rt p os it io ns were $ 4 m il li on an d 1 0 $3 ,96 0,0 00 , res pe ct iv el y .- 17 -

[* 17 ] ! On Dec em

be r 3, 2 00 1, 8 25 2 t ran sf

erre d b ot h t he lo ng an d s ho rt op ti on s t o 4 36 inex ch an ge for$1 0 “ an d o th er g oo d a ndva lu ab le co ns id erat io n.” ! On Dec em

be r 4, 2 00 1, 8 25 2 p ai d $ 4,0 00 to bu y Can$6 ,20 7.2 0. ! On Dec em

be r 10 , 20 01 , th e o pt io ns were i n the m on ey with o nl y

two da y s l eftbe fo re the ir e xp ira ti on . Heit m ei er ac cep te d Deu ts ch e Ban k’s o fferto cas h h im

ou t fo r $5 0,0 00 , whi chhe de po si te d i nt o t he Deu ts ch e Ban k a cco un t fo r 43 6. ! On o r ab ou t Dec em be r 24 , 20 01 , 82 52 tra ns ferr edth e Can$6 ,20 7.2 0 to 43 6. ! On Dec em

be r 19 , 20 01 , Heit m ei er as ke d Deu ts ch e Ban k t o t ran sf er $5 0,0 00 fro m

43 6’s ac co un t t o a n a cco un t fo r Garza& St ap le s- -th e se co ndha lf o f Garza ’s leg al fees . Garza as ke d t ha t the rem ai ni ng $1 7,5 00 be wire d t o t he acco un t o f Garza& St ap le s wi th Ban k On e, Tex as . ! On Dec em

be r 26 , 20 01 , Heit m ei er as si gn edth e Can ad ian d ol lars he ld by 43 6 t o 8 25 2. Acco rd in g t o 4 36 ’s and82 52 ’s Deut sc he Ban k acco un t s ta te m en ts , ho wev er, tha t as si gn m en t was ne ve r co ns umm at ed
. ! On J anua ry

4, 2 00 2, 4 36 tra ns ferr edth e sa m e Can $6 ,20 7.8 2 t o Ri ve rb oa t Se rv ic es . ! On Dec em

be r 31 , 20 01 , Riv erb oa t Se rv ic es so ldCan$6 ,20 7.8 2 fo r $3 ,84 8.4 0, wh ic h was de po si te d i nt o R iv erb oa t Se rv ic es ’ Deu ts ch e Ban k a cco un t. ! On Dec em

be r 31 , 20 01 , a Can cel la ti on of Do m es ti c Certi fic at e o f Lim it edPartne rs hi p was fil edinCo lo rad o fo r 43 6.- 18 -

[* 18 ] The pa rti es st ip ul at edth at82 52 , 94 , and43 6 d idn’t co nduc t an y act iv it ie s ot he r th anth es e fo rei gn -curren cy tra de s. Fo r bo th 94 an d 4 36 , Heitm ei er p ro vi de d a b us in es s ad dr es s i n C ol or ad o S pr in gs , Col or ad o, ev enth ou ghhe ha d n o co nn ect io n wi th Co lo rad o. Th e p artne rs hi p a gr eem en t fo r 43 6 was a pr o f orma ag reem en t tha t Gar za u se d. Garz a te st ifi edth atitco nt ai ne d s ev eral in co rrec t st at em en ts , su chas arefe ren ce t o apri orpa rtn ers hi p a gr eem en t, an arb itrary te rm in at io n d at e, an d a ct iv it ie s tha t the pa rtn ers hi p wo ul d e ng ag e in (e.g ., farm in g an d ra nc hi ng , bu y in g a ndlea si ng oi l, an d p ur ch as in g a ndsel li ng m ach in ery). As we’ve alr eady

no te d, Hei tm ei er h adby thi s t im e am as se d asi zab le Merril l Lync h b ro ke rag e acc ount --ab ou t $ 1 m il li on . Butbe fo re No ve m be r 20 01 Heit m ei er h adne ve r in ve st edinfor ei gn curren cy . His i nv es tm en t advi se r, Lanc e Giam be ll uc a, cred ib ly saidth atHeit m ei er h adin ve st edm os tl y intec h s to ck s an d be enburn edby the st oc k m ark etcras h o f ear ly 200 0. Hei tm ei er h adat o ne ti m e di sc us se d a no th er d eri va ti ve s p ro du ctcal le d a“ co ve redcal l” with Gi am be ll uc a, bu t h e n ev er b ou gh t i n. III. Rep orti ng th e Tran sa ct io ns A. Garza ’s Opi ni on Garzasen t anop in io n l ette r to Heit m ei er d at edDecem be r 30 , 20 01 . The le tt er h adab ou t fo urpa ge s o f fac ts supp os ed ly des cri bi ng th e tr an sa ct io n a ndov er- 19 -

[* 19 ] 80 pa ge s o f bo il erp late lan gu ag e o n t ax -la w do ctrin es --ru nn in g t he ga m ut fro m pa rtn ers hi p- ba si s ru le s t o t reat m en t o f fo rei gn -curren cy co nt ract s, the st ep tra ns act io n d oc tri ne , eco no mic subs tanc e, di sg ui se d- sa le pro vi si on s, an d pa rtn ers hi p a nt i-abu se reg ul at io ns . The l et te r al so co nc lu de d t ha t the tax tre atm en t Garzapro po se d wo ul d “ m or e li ke ly than n ot ” wit hs tandIRS s cru ti ny. Garza , ho wev er, rel ie d o n c ert ai n “ fact s” to reac h h is “ m or e li ke ly than n ot ”
co nc lu si on , andth es e “ fact s” were jus t p la in wron g. Here are s om e o f th e k ey m is ta ke s h e m ad e in th e fac tu al reci tati onsec ti on --the fir stfou r pa ge s o f eac h op in io n:

• The op in io n s ta te s tha t Hei tm ei er’s tran sa ct io n i nv ol ve d o pt io ns on Can ad ian d ol lars , eve n t ho ug h t he op ti on s wer e o n J ap an es e y en .

• The op in io n s ta te s tha t Hei tm ei er m ad e th e li st edrep res en ta ti on s, b ut he di dn ’t. Garza m ad e up the rep res en ta ti on s o n h is own .

• The op in io n l et te r st at es th atHeit m ei er “be li ev edth ere was [a] reas on ab le op po rtu ni ty to ea rna reas on ab le pre -ta x p ro fitfro m th e tra ns act io ns * * * (n otin cl ud in g a ny tax be ne fit s tha t m ay oc cur), in ex ces s o f al l the ass oc ia te d fe es an d c os ts .” Bu t Gar za’s $ 13 5,0 00 fee was ig no redinreac hi ng th atco nc lu si on . The o pi ni on do es n’t m en ti on Garza’s fe e atall
. Andhe re ar e so m e o f th e k ey factua l m is ta ke s m ad e in th e o pi ni on let te r’s di sc us si on sec ti on , onwhi chGarza b as edke y leg al co nc lu si on s:

• The pu rch as ed(lo ng ) an d s ol d (s ho rt) op ti on s h adth ei r own co nf irmatio ns .- 20 -

[* 20 ] • The lo ng an d s ho rt o pt io ns were the subjec t o f th e sa m e

co nf irmatio n.

• The pa rtn ers hi p h adto de li ve r fo rei gn curren cy if the sh ort o pt io n was ex erci se d.

• The pa rtn ers hi p h adno ob li ga ti on to de li ve r fo rei gn curren cy .

• As o f th e d at e o f th e o pi ni on , th e o pt io ns ha d n oty etex pi red --s o i t was un cert ai n wh ethe r th e p artne rs hi p wo ul d h av e to sat is fy it s ob li ga ti on reg ard in g t he sh ort o pt io n.

• Whe n Gar za s en t o utth e o pi ni onlet te rs , th e o bl ig at io ns un de r th e o pt io n c on tra ct s wer e b y th atti m e certa in
.

• Non e o f th e p artne rs hi ps ’ (i.e ., 43 6’s, 9 4’s, an d 8 25 2’s) partn ers were rel at ed
.

• The pa rtn ers of e ach pa rtn ers hi p wer e rel at ed --Hei tm ei er was th e 9 9% l im it edpa rtn er, an d h is who ll y own edan d c on tro ll ed 94 was the 1% g en eral pa rtn er.

• The ass et s co nt rib ut edby a part ne r (Hei tm ei er) wo ul d n otbe th e sa m e as se ts di st rib ut edto th atpa rtn er.

• The Can ad ian d ol lars di st rib ut edwere the same on es co nt rib ut edby the pa rtn er. If Garz a was m ak in g up fa ct s fo r hi s o pi ni onlet te r, Heitm ei er wo ul dn ’t hav e no ti cedbe cau se he ne ve r rev ie wedth e fac ts inth e o pi ni onforaccu racy, or ev en as ke d fo r any

cla rif ic at io n. Garz a cre di bl y

tes ti fie d t ha t h e h adsev eral
co nv ers at io ns with Hei tm ei er an d R ou ss el bu t tha t the y ne ve r br ou gh t up- -le t al on e as ke d h im

to co rrec t-- an y

m is take s i n t he op in io n. Th e le tt er, fo r al l i ts- 21 -

[* 21 ] len gt h, al so lac ks ev ena m en ti on of o ne ve ry im po rta ntdo cu m en t-- Not ic e 20 00 -4 4, Tax Avo id an ce Us in g Art ifi ci al ly H ig h B as is , 20 00 -2 C.B. 2 55 , whi ch th e Co m m is si on er p ub li sh edon Sep te m be r 5, 2 00 0- -ev enth ou gh Garza kne w ab ou t i t wh enhe pro vi de d t he leg al op in io n t o Hei tm ei er. B. Wha t Was Re po rte d Jo ne s p rep aredth e 2 00 1 re tu rnforRiv erb oa t Se rv ic es , Inc ., an S
co rp or at io n, by fili ng Fo rm 11 20 S, U.S. Inc om e Tax Return fo r anS 1 1 Co rp or at io n. Ri ve rb oa t Se rv ic es cla im eda “ se ct io n 9 88 Curren cy Los s” of n earl y $4 m il li on . The cl ai m edlo ss th enpa ss edth ro ug h t o t he Heit m ei ers ’ 20 01 joi nt return, wh ic h J on es als o p rep ared , andsubs tant ia ll y off se t the $4 .7 m il li on in in co m e p as se d t hr ou gh fro m Riv erb oa t Se rv ic es to th e Hei tm ei ers . Giar di napre pa red43 6’s p artne rs hi p re tu rnforHeit m ei er t o s ig n. Th e pa rtn ers hi p re po rte d n o i nc om e o r lo ss for20 01 . On it s p artne rs hi p re turnforth e y ear 4 36 rep orte d p artne r cap it al co nt rib ut io ns of $ 4,1 87 ,59 3, co ns is ti ng of t he $4
m il li on no ti on al am ou ntof t he lo ng op ti on ; p lu s $ 3,9 90 for th e p ur ch as e o f th e Can ad ian d ol lars ; $ 50 ,00 0 c ap it al co nt rib ut io n; $8 5,0 00 inatt orne y ’s fees ; an d ab ou t $ 49 ,00 0 i n a cco un ti ng fees . Whi le 43 6 t reat edth e n ot io na l am ou ntof the An S co rp or at io n i s a c or po rat io n g ov ern edun de r th e la ws o f subc hapt er 1 1 S o f th e In te rn al Rev enue Co de . C cor po rat io ns are g ov ern edby sub ch ap te r C, an d p artne rs hi ps by sub ch ap te r K.- 22 -

[* 22 ] $4 m il li onlo ng -o pt io n p rem iu m as acap it al co nt rib ut io n, i t d idno t re po rt th e li ab il ity

in he ren t i n t he no ti on al $3 ,96 0,0 00 sh ort-o pt io n p rem iu m . The pa rtn ers hi p re tu rnals o re po rte d o ffs et ti ng pa rtn ers hi p d is tri bu ti on s o f pr op erty ot he r th anm on ey

of $ 4,1 87 ,59 3, wh ic h re su lt edfro m tre at in g t he no ti on al am ou nt of th e $ 4 m il li on lo ng -o pt io n p rem iu m as aco ntrib ut io n t ha t wo ul d b e d is tri bu te d up on th e li qu id at io n o f 43 6. Itdi d n ot , ho wev er, t ak e in to co ns id erat io n t he li ab il ity in he ren t i n t he $3 ,96 0,0 00 sh ort-o pt io n p rem iu m . Bot h t he cap it al
co nt rib ut io ns an d p artne rs hi p d is tri bu ti on s wer e al lo cat ed$4 ,14 5,7 17 to Heitm ei er an d $ 41 ,87 6 t o 9 4 LLC o n t he Sch edul es K-1. Bu t re m em

be r th atby thi s t im e th e o pt io ns ha d l on g s in ce b eencas he d o ut , so th e supp os edba si s i n t he lo ng op ti on canth eo ret ic al ly be atta ch edto th e o nl y no nc as h (i .e., no n- Am eri cancas h) ass et43 6 h adlef t-- th e Can$6 ,20 7.8 2. By rep orti ng th is $4 ,18 7,5 93 as a“ di st rib ut io n o f pr op erty ,” Giar di nawas e ffec ti ve ly rep orti ng itas 4 36 ’s bas is inth atpro pe rty. IV. Prel ud e The Co m m is si on er au di te d 4 36 ’s return u nd er TEFRA an d i ss ue d ano ti ce of fin al pa rtn ers hi p a dm in is tra ti ve ad jus tm en t (F PAA) to 43 6 i n S ep te m be r 20 05
. 1 2 TEFRA is th e Tax Equ ity an d F is cal Res po ns ib il ity Act o f 19 82 1 2 (TEFRA), Pub. L. No. 9 7- 24 8, 9 6 S ta t. 3 24 , on e p artof wh ic h g ov ern s the tax (co nt in ue d...)- 23 -

[* 23 ] The FP AA adju st ed43 6’s capi ta l co nt rib ut io ns an d d is tri bu ti on s t o z ero an d de te rm in edaccu racy-rela te d p en al ti es un de r se ct io n 6 66 2. The FPAA Sch edul e o f Adju st m en ts di d n ot ad ju st Heit m ei er’s o r 94 ’s
ou ts id e b as es , bu t i n the “ Exh ib itA-Exp lana ti on of I te m s” sen t t o 4 36 , th e Co m m is si on er d idm ak e de te rmi na ti on s ab ou t o ut si de ba si s, i nc lu di ng th e de te rm in at io n t ha t the pa rtn ers ha ve no t “ es tabl is he d t ha t the ba se s o f th e p artne rs ’ pa rtn ers hi p i nt eres ts were g reat er tha n z ero .” Thi s m ay or m ay no t h av e b een su ffi ci en t t o p utou ts id e b as is at i ss ue he re, cf. Cl ov is I v. Co m m is si on er, 8 8 T.C. 98 0, 9 82 (19 87 ), bu t the Co m m is si on er l at er co nc ed edth atth e FPAA d idno t ad jus t o ut si de ba si s. Un li ke a co nc es si on on a po in t o f law reg ard in g wh ethe r we (...co nt in ue d) 1 2 tre atm en t an d aud itpro cedur es form os t p artne rs hi ps . See TEFRA s ecs . 40 1- 40 6, 96 Sta t. at64 8- 67 0. TEFRA p artne rs hi ps are s ub ject t o s pe ci al tax an d aud itrul es . See s ecs . 62 21 -6 23 4. Each TEFRA partn ers hi p, fo r ex am pl e, is supp os edto de si gn at e a t ax m at te rs pa rtn er (TMP ), to ha nd le th e p artne rs hi p's admin is tra ti ve is su es with t he IRS an d any resu lt in g l it ig at io n. TEFRA requi res th e uni fo rm tre atm en t o f al l “pa rtn ers hi p i te m s” --a t erm de fin edby sect io n 6 23 1( a)(3 ) an d (4 )-- an d i ts ge ne ral go al is to ha ve a si ng le po in t o f ad jus tm en t fo r th e IRS rathe r th an ha vi ng itm ak e se pa rat e p artne rs hi p i te m ad jus tm en ts on each pa rtn er’s i nd iv idua l return. Se e H. Con f. Rep t. 9 7- 76 0, at59 9- 60 1 (1 98 2) , 19 82 -2 C.B. 6 00 , 66 2- 63
. If the IRS d eci de s t o a dju stan y pa rtn ers hi p i te m s o n apa rtn ers hi p re tu rn , itm us t no ti fy th e in di vi du al pa rtn ers of t he ad jus tm en t b y

is su in g a n F PAA. Sec. 6 22 3( a). An FP AA gen eral ly inc lu de s: (1) a no ti ce o f fi na l p artne rs hi p a dm in is tra ti ve ad jus tm en t, (2 ) Fo rm

87 0- PT, Agre em en t fo r Part ne rs hi p It em s an d P artne rs hi p Lev el Dete rm in at io ns as t o P en al ti es , Add it io ns to Tax, an d Ad di ti on al Am ou nt s, in cl ud in g aSch edul e o f Adju st m en ts , and(3) an“ Exh ib itA--Exp lana ti on of Ite m s,” l is ti ng th e Co m

m is si on er’s o th er ad

jus tm en ts or d et erm in at io ns .- 24 -

[* 24 ] ha ve juri sd ic ti on ov er o ut si de ba si s atth e p artne rs hi p l ev el , see Tig ers Ey e Trad in g LLC v . Comm is si on er, 1 38 T.C. 67 , 74 (20 12 ), ap pe al fil ed(D.C. Cir
. Mar . 9, 2 01 2) , th e Co m

mis si on er’s co nc es si on he re s im pl y no te s tha t the se pa rti cu lar FPAAs were n otad jus ti ng ou ts id e b as is an d t ha t h e was n’t s eek in g a de te rm in at io n o f ou ts id e b as is inth is pa rtn ers hi p- le ve l p ro ceed in g. Whil e we are al way s re qu ire d t o s at is fy ours el ve s tha t we h av e juri sd ic ti on be fo re en te rin g a de ci si on , see Gray

v. Co m m is si on er, 1 38 T.C. 29 5, 2 97 (20 12 ), we do n’t h av e to
reac h o utan d p utin to pl ay is su es th e p art ie s d on ’t see k t o a dju di cat e. InTig ers Ey e Trad in g we h adto de te rm in e whe th er we h adjuri sd ic ti on be cau se th e ta xp ay er ar gu edth atwe lac ke d i t. Bu t we ag ree wi thth e Co m m is si on er tha t
ou ts id e b as is is n’t atis su e h ere. In st ead , li ke 66 11 , th is cas e is ab ou t anin si de -b as is So n- of -BOSS de al --the in fla te d b as is was a tt ach edto anass etth atth e p artne rs hi p h el d a ndth en di st rib ut edto a pa rtn er wh o s ol d i t fo r a s up po se d l os s. As in ot he r Garza
1 3 The u su al rul e is th atanass etdi strib ut edby a partne rs hi p t o o ne of i ts 1 3 pa rtn ers ha s a b as is equa l t o the pa rtne rs hi p ’s bas is inth atve ry

ass et
. Sec. 7 32 (a). In si de -b as is So n- of

-BOSS de al s cl ai m

to be ab le to tra ns fer b as is withi n t he pa rtn ers hi p fr om

on e as se t t o a no th er v iasec ti on73 2( b) . See 7 05 0, Lt d., T.C. Mem o. 2 00 8- 11 2. Un de r se ct io n 7 32 (b ), a p artne r ta ke s a t ran sf erre d b as is inth e di st rib ut edpro pe rty the same as h is ou ts id e b as is inth e p ut at iv e p artne rs hi p in te res t (m in us an y

cas h re cei ve d) . The p art ie s h ere a gr ee tha t the cla im edtax be ne fit s co m e fro m

th e d is po si ti on of a n a ss etform erl y he ldby a pu ta ti ve

(co nt in ue d...)- 25 -

[* 25 ] in sp ire d t ran sa ct io ns , see , e.g., 1 06 Ltd . v. Co m m is si on er, 1 36 T.C. 67 , 73 (2 01 1) , aff’d, 6 84 F.3d84 (D.C. Cir . 20 12 ); 6 61 1, Lt d v . Commis si on er, T.C. Mem o. 2 01 3- 49 ; 7 05 0, Lt d. v . Comm is si on er, T.C. Mem o. 2 00 8- 11 2, the in fla te d ba si s l ay infor ei gn curren cy

(in th os e cas es , Can ad ian d ol lars ) an d the aim is to try to h av e th os e b as is -b lo at edCan ad ian d ol lars di st rib ut edto a pa rtn er wh o c an th entre atth em

as ares erv oi r of

ord in ary lo ss , di pp edin to as n eces sa ry by sell in g th em fora m as si ve tax lo ss . One di st in ct io n b etweenin si de -b as is an d o ut si de -b as is So n- of -BOSS de al s is th atth ere i s a c on fli ctam on g c ou rts ab ou t wh ethe r ou ts id e b as is is a pa rtn ers hi p it em . See Pet al um a FX Partn ers , LLC v. Co m m is si on er, 5 91 F.3d64 9, 6 54 (D.C. Ci r. 20 10 ), aff’g i n p art , rev ’g inpa rt, v acat in g a ndrem an di ng on pe na lty is su es 13 1 T.C. 8 4 (2 00 8) ; Ti ge rs Ey e Trad in g, 1 38 T.C. at 1 15 -2 8. Th e Co m m is si on er us ua ll y want s a p en al ty in b ot h t y pe s o f cas es , so whet he r anit em is a “pa rtn ers hi p it em ” th enaffe ct s wh ethe r a p en al ty “ ‘relat es to anad jus tm en t t o apa rtn ers hi p it em .’ ” See Un it edSta te s v . W oo ds , 57 1 U.S. _ _, _ _, 1 34 S. Ct. 5 57 , 56 3- 64 (2 01 3) (qu ot in g s ect io n 6 22 6( f)); Tig ers Ey e Trad in g, 1 38 T.C. at 1 39 -4 2.

(...co nt in ue d) 1 3 pa rtn ers hi p, n otth e d is po si ti on of apa rtn er’s i nt eres t i n tha t p artne rs hi p.- 26 -

[* 26 ] W e h ap pi ly avo idth os e d is pu te s h ere. Th e Co m m is si on er d oe s wan t pe na lt ie s i n t hi s ca se , andth e FPAA Exp lana ti on of I te m s d et erm in edth at [A]ll o f th e und erp aym en ts of t ax res ul ti ng fro m [th e] ad ju stmen ts of pa rtne rs hi

p i te ms are at tri bu tabl e to , at a m in im um , (1) subs tant ia l un de rs ta te m en ts of i nc om e ta x, (2 ) gr os s v al ua ti on m is st at em en t(s ), or(3) ne gl ig en ce o r di sr eg ard edrul es or r eg ul at io ns . * * * Itis th eref or e d et erm in edth at , at a m in im um , th e acc ur acy-rela te d p en al ty un de r Sec ti on 66 62 (a) o f th e In te rn al Rev enue Co de ap pl ie s t o a ll un de rp aym en ts of t ax attrib ut ab le to ad ju stmen ts of

pa rtne rs hi

p i te ms of 43 6, LTD. [Em

ph as is ad de d.] The Exp lana ti on of I te m s wen t o n t o d et erm in e a 4 0% g ro ss -v al ua ti on m is st at em en t p en al ty or, barri ng th at , a 20 % subs tant ia l-v al ua ti on -m is st at em en t pe na lty . In the alt ern at iv e, itass ert edeit he r a 2 0% p en al ty for n eg li ge nc e, di sr eg ardof rul es an d re gu la ti on s, o r subs tant ia l u nd ers ta te m en t o f in co m e ta x. In
res po ns e 4 36 rai se s o nl y

th e d efen se th atitha d re as on ab le cau se an d a ct edin go od -fai th rel ianc e o n p ro fes si on al advi ce. The Co m m is si on er h as rei te rat edth at 1 4 he do es no t s eeka pe na lty rel at edto Heit m ei er’s o ut si de ba si s i n t he pa rtn ers hi p; he see ks itrel at edto th e in fla te d c on tri bu ti on s t o, an d d is tri bu ti on s fr om , th e pa rtn ers hi p- -a p artne rs hi p’s b as is inanass etis us ua ll y it s b as is inth e h an ds of t he pa rtn er wh o’s co nt rib ut in g t ha t as se t, s ec. 7 23 , andth e b as is of a n a ss etot he r th an They cou ldha ve , bu t h av e n ot , arg ue d tha t the im po si ti on of p en al ti es was 1 4 so m eh ow o th erwi se de fect iv e. Whi le we m us t s at is fy

ou rs el ve s ab ou t o urown juri sd ic ti on , we dee m

43 6 t o h av e wai ve d a ny oth er co un te rarg um en t re ga rd in g th e im po si ti on of p en al ti es ap artfro m reas on ab le cau se an d g oo d fa ith.- 27 -

[* 27 ] m on ey

(an d t ha t m ean s Am eri canm on ey ) di st rib ut edto a pa rtn er i s u su al ly th e p artne rs hi p’s b as is inth atass et , see sec . 73 2( a). The re were pl en ty of ot he r is su es , andHeit m ei er, i n h is rol e as tax m at te rs pa rtn er fo r 43 6, fi le d ati m el y pe ti ti on . W e tr ie d the cas e p art ly in Dal la s, an d t he n trie d t o t ak e te st im on y fro m 1 5
on e wit ne ss vi a v id eo up li nk
. 1 6 OPINION I. Ju ris di ct io n Part ne rs hi ps do no t p ay

in co m e ta x, b utth ey

do fil e in fo rm at io n re tu rn s, an d pa rtn ers are s up po se d t o u se th e num be rs fro m th os e returns on th ei r own in di vi du al returns . See s ecs . 70 1, 6 03 1, 6 22 2( a). Whi le 43 6 was a pa rtn ers hi p subjec t t o aud itun de r TEFRA, ou r juri sd ic ti on at t he pa rtn ers hi p l ev el is li m it ed
un de r TEFRA to pa rtne rs hi

p i te ms o f the pa rtne rs hi

p f or th e p ar tn er

sh ip taxa bl e yea r to wh ic h the no ti ce o

f f in al pa rtne rs hi

p a dmi nistra ti ve a dj us tmen t re la tes , th e p ro pe r al lo cat io n o f su chit em s among th e p artne rs , and th e ap pl ic ab il ity

of a ny pen al ty, ad di ti on to tax , or a dd it io na l am ou nt whi chrel at es to anad

jus tm en t t o apa rtn ers hi p i te m .
43 6 was a de func t TEFRA p artne rs hi p wh enth e p et it io ns were fi le d, s o 1 5 an y ap pe al wou ldli ke ly headto th e D.C. Ci rcu it . See s ec. 7 48 2( b) (1 ). The a tt em

ptto co nt in ue th e tr ia l b y vi de o d idn’t wo rkou t, an d t he pa rti es 1 6 st ip ul at edwhathapp en eddurin g t hi s p artof t he tri al
.- 28 -

[* 28 ] Sec. 6 22 6( f) (em

ph as is ad de d)
. So whatare p artne rs hi p i te m s? Sect io n 6 23 1( a)(3 ) sa y s tha t [t]he term “pa rtn ers hi p i te m ” m ean s, wi th res pe ct to a p ar tn er

sh ip , an y it em re qu ir ed

to be ta ken in to ac co un t f or th e p ar tn er

sh ip ’s taxa bl e yea r

un de r an y

pro vi si on of s ub ti tl e A to th e ex te nt reg ul at io ns pre sc rib edby the Secr et ary pr ov id e th at , forpu rp os es of th is subt it le , su chit em

is m or e ap pr op ria te ly det erm in edat t he pa rtn ers hi p l ev el th anat t he pa rtn er l ev el . [Em ph as is ad de d.] The Secr et ary ha s t ol d u s wh athe ’s det erm in edto be pa rtn ers hi p i te m s i n s ect io n 30 1.6 23 1( a)(3 )-1 , Pro ced . & Adm in . Reg s. Co urts st il l d is ag ree o ve r wha t i s a

“pa rtn ers hi p i te m ”--ave ry bi g p ro bl em

gi ve n TEFRA’s s tru ctur al fram ewo rk , whi chm ak es th e d is ti nc ti on be twee n p artne rs hi p a ndno np artne rs hi p i te m s im po rta ntto our juri sd ic ti on . Bu t o nc e we h ol d a n i te m is a pa rtn ers hi p i te m

we ha ve juri sd ic ti on to de te rm in e th atpa rtn ers hi p i te m reg ard le ss of wh ethe r th e Co m m is si on er ad

jus te d itinth e FPAA. See, e.g ., Tige rs Ey e Trad in g, 1 38 T.C. at 9 5. We als o h av e juri sd ic ti on to de te rm in e “ th e p ro pe r al lo cat io n o f [the se ] * * * i te m s among th e pa rtn ers an d t he ap pl ic ab il ity of a ny pen al ty, ad di ti on to tax , or a dd it io na l am ou nt th atrel at es to anad

jus tm en t t o apa rtn ers hi p i te m .” Id . This lat te r juri sd ic ti on is n’t unl im it ed , ho wev er, an d we h av e rec en tl y go ne to gre atpa in s t o d et erm in e it s- 29 -

[* 29 ] bo un da rie s. See , e.g., i d. at95 -1 43 ; Pe ta lu m a FX Partn ers , LLC v. Co m m is si on er, T.C. Mem o. 2 01 2- 14 2, 2 01 2 WL 17 58 71 2. A “ no np artne rs hi p i te m ” is “ anit em whi chis (or

is tre at edas) no t a pa rtn ers hi p i te m .” Sec. 6 23 1( a)(4 ). Andan“ affe ct edit em ” is a no np artne rs hi p it em th atis affe ct edby the de te rm in at io n o f a p artne rs hi p i te m . See s ec. 62 31 (a)( 5) ; Gi ns bu rg v. Co m m is si on er, 1 27 T.C. 75 , 79 (20 06 ). As i t d oe s fo r ot he r no np artne rs hi p i te m s, the Co de tel ls us th atwe cande te rm in e aff ect edit em s (wit h the ex cep ti onof c ert ai n p en al ti es ) on ly at th e in di vi du al lev el an d n otina pa rtn ers hi p- le ve l p ro ceed in g. Be cau se th is cas e is ap pe al ab le to th e D.C. Ci rcu it , we m us t fo ll ow tha t co urt’s p rece de nt . See, e.g ., Gol se n v . Comm is si on er, 5 4 T.C. 74 2, 7 57 (19 70 ), aff’d, 4 45 F.2d98 5 (1 0t h C ir. 1 97 1)
. II. Part ne rs hi p- Ite m

Dete rm in at io ns an d Ad

jus tm en ts 1 7 A. Vali di ty of th e Partn ers hi ps 1. Unc he ck edBo xe s One of t he m os t i m

po rta nt“pa rtn ers hi p i te m s” is whet he r a p artne rs hi p i s actua ll y a pa rtn ers hi p at al l. The Co m m is si on er s ay s tha t 4 36 is n’t a pa rtn ers hi p–th atwe sh ou lddi sr eg arditbe cau se itwasn ’t an e nt ity sep arat e fro m W e are de ci di ng th is cas e o n t he pre po nd eran ce o f th e ev id en ce, s o we d o 1 7 no t h av e to de ci de whi chpa rty has th e b ur de n o f pr oo f. See, e.g ., Esta te of Tu rn er v. Co m m is si on er, 1 38 T.C. 30 6, 3 09 (20 12 ).- 30 -

[* 30 ] Heit m ei er an d fa il edto sat is fy th e reg ul at ory

requi rem en ts to be tre at edas a pa rtn ers hi p. Un de r th e ch eck -th e-b ox reg ul at io ns , if i t d oe sn ’t m ak e anele ct io n ot he rwis e, anen ti ty w ith o nl y on e o wne r is di sr eg ard edfortax pu rp os es , andif the si ng le own er i s an in di vi du al , th e reg ul at io ns tel l the Co m m is si on er t o treatth e en ti ty as a s ol e p ro pr ie to rs hi p. Se e supr a n ot e 9 ; s ee al so Pie rre v . Commis si on er, 13 3 T.C. 2 4, 4 2- 43 (20 09 ) (“ A so le pro pr ie to rs hi p i s g en eral ly und ers to odto ha ve no leg al id en ti ty apartfro m th e p ro pr ie to r”). Anen ti ty w ith o nl y on e o wne r is th us in el ig ib le fortax tre atm en t as a pa rtn ers hi p. Bu t 4 36 ’s 20 01 pa rtn ers hi p re tu rnli st s m or e th anon e o wne r: Hei tm ei er i s th e 9 9% l im it edpa rtn er an d 9 4 i s the 1% g en eral pa rtn er. The Co m m is si on er s ay s th is do es n’t m atte r an d a rg ue s tha t b ecau se 94 di d n otpro pe rly elec t t o b e tr eat ed
as a co rp or at io n, i t i s a d is reg ard eden ti ty. See s ec. 3 01 .77 01 -3 (b )(1 )(i i), Pr oc ed
. & Admin . Reg s. Si nc e th e p art ie s s ti pu la te d tha t 9 4 n ev er el ect edon Fo rm 88 32 to be cla ss ifi edas aco rp or at io n, we ag ree. Thatm ean s tha t Hei tm ei er, as th e 1 8
so le m em be r of 94 , wil l b e tr eat edas o wni ng all of 4 36 . Andwe di sr eg arda
Whi le in di vi du al s an d e nt it ie s m ay ap pl y foranem

pl oyer id en ti fic at io n 1 8 nu m be r (EIN) u si ng Fo rm

SS-4 , App li cat io n fo r Em pl oyer Ide nt ifi cat io n Nu m be r, th is form alo ne do es n’t m ak e a v al idele ct io n t o b e ta xe d a s a s pe ci fic type o f en ti ty. Fo r pa rtn ers hi ps , on ly Form 88 32 m ay

be us edto m ak e anele ct io n. Se e se c. 30 1.7 70 1- 3( c)(1 ), Pro ced . & Adm in . Reg s.; see als o F orm SS-4 , at 3 (Rev
. Apr . 20 00 ) (“ Cau ti on : Th is is no t an ele ct io n fo r a t ax cla ss ifi cat io n o f anen ti ty”).- 31 -

[* 31 ] si ng le -o wne r en ti ty for t ax pu rp os es un de r se ct io ns 30 1.7 70 1- 2( a) an d 30 1.7 70 1- 3( b) (1 )(i i), Pr oc ed . & Adm in . Reg s., u nl es s i t el ect s t o b e ta xe d a s a co rp or at io n. Tho ug h t he se fact s l arg el y m im ic th os e in 66 11 , th ey di fferinon e k ey

way th atsav es us a di sc us si on of wh ethe r a p artne rs hi p e xi st ed . Heit m ei er h as no t arg ue d t ha t h is wife was the sec on d o wne r of 94 an d 4 36 be cau se Lou is ianais a co m m un ity -p ro pe rty sta te . Thi s m ean s we d on ’t nee d t o t ru dg e th ro ug h 1 9 Lou is iana ’s Civ il Co de to de te rm in e whe th er Mr s. Hei tm ei er wo ul d h av e b een co ns id ereda se co ndpu ta ti ve pa rtn er. Bu t we d o n ot e itm ig htha ve m ad e a di ffer en ce i n t he an al y si s o f on e o f th e m an y fact or s we g en eral ly con si de r to de te rm in e whe th er two i nd iv idua ls in te nd edto joi n t og ethe r as pa rtn ers inth e co nduc t o f a b us in es s. See Lunav. Co m m is si on er, 4 2 T.C. 1 06 7, 1 07 7 (1 96 4) 2 0 Altho ug h t he reg ul at io n’s d efau ltrul e fo r en ti ti es own edby an in di vi du al 1 9 is to tre atth em

as s ol e p ro pr ie to rs hi ps , it s d efau ltrul e fo r en ti ti es own edby mor e th anon e in di vi du al is to tre atth em as p artne rs hi ps . See s ec. 3 01 .77 01 -3 (a) and (b )(1 )(i ), Pro ced . & Adm in . Reg s. In 6 61 1, we wal ke d t hr ou gh th e Lun a fac to rs to de te rm in e whe th er the 2 0 ta xp ay ers ’ wiv es wou ldha ve be enco ns id eredsec on d p artne rs inth e p artne rs hi p. Lun a v . Comm is si on er, 4 2 T.C. 1 06 7, 1 07 7- 78 (19 64 ). Every fact orex cep t o ne cl earl y po in te d t he same way . The s ol e fac to r th atrequi redfurth er an al y si s was “ The Part ie s’ Con tro l Ov er In co m e an d C ap it al .” In66 11 , Texa s’s co m m un ity pr op erty laws supp orte d apro po si ti on th at“ a sp ou se * * * [r et ai ns ] so le m an ag em en t, co ntro l, an d d is po si ti on of t he co m m un ity pro pe rty tha t the sp ou se

(co nt in ue d...)- 32 -

[* 32 ] (ci ti ng Co m

m is si on er v . Cul be rts on , 33 7 U.S. 7 33 (19 49 )); see als o Hi st or ic Bo ardwalkHall , LLC v. Co m m is si on er, 6 94 F.3d42 5 (3 d C ir. 2 01 2) , rev ’g an d
rem an di ng 13 6 T.C. 1 (20 11 ); S ou th ga te Mas te r Fu nd , L.L. C. ex rel . Mo nt go m ery Cap it al Adv is or s v . Uni te d S ta te s, 6 59 F.3d46 6 (5 th Cir . 20 11 ).

2. Tax -Mo ti va te d B us in es s Pu rp os e The re i s a s eco ndan d s ep arat e o bs ta cl e to an y fin di ng th at43 6 was a pa rtn ers hi p: A part ne rs hi p d oe s n otco m e in to ex is te nc e fo r ta x p ur po se s unt il it be gi ns it s b us in es s ac ti vi ti es . See To rres v. Co m m is si on er, 8 8 T.C. 7 02 , 73 7 (1 98 7) ; M ark el l Co . at * 22 . The ca se law is cle ar, h owe ve r, th atth e p ur su itof (...co nt in ue d) 2 0 wou ldha ve own edif s in gl e,” s ee Tex . Fam . Cod e Ann . sec . 3.1 02 (a) (West20 06 ), an d t ha t the rig htas aform al pa rtn er t o m an ag e an d c on tro l a p artne rs hi p was no t it se lf c omm

un ity pro pe rty, see Tex . Bus . Orgs . Cod e Ann . sec . 15 2.2 03 (a) (West 20 12 ). Qui te th e o pp os it e is tru e h ere. Lo ui si an a h as a ve ry stro ng pre su m

pt io n i n fav orof c omm

un ity pro pe rty, see La. Ci v. Co de Ann ., andco nt ai ns no st atut es an al og ou s t o Tex as ’. Lou is iana ’s Civ il Co de art . 23 38 (20 12 ) pr ov id es th at co m m un ity pro pe rty inc lu de s p ro pe rty acqu ire d dur in g t he m arri ag e th ro ug h t he effo rt, s ki ll , or i ndus try of ei th er s po us e an d t he “ na tural an d c iv il fru it s” of co m m un ity pro pe rty. T he re i s l aw on th e b oo ks to supp ort the in te rp ret at io n t ha t art ic le s 2 33 8 a nd23 40 in cl ud e in te res ts injoi ntve ntur es an d p artne rs hi ps as co m m un ity pro pe rty. Brass et t v . Bras se tt(Inre Bra ss et t), 3 32 B.R. 7 48 (Ban kr
. M.D. La. 20 05 ). Co nc ei vabl y th en , Mrs . Heit m ei er co ul d h av e h ada co m m un ity pr op erty in te res t i n M r. Heitm ei er’s p artne rs hi p s ha res an d arig htto a sh are o f an y di st rib ut io n o f 43 6’s s ur

pl us pro fit s o r pr op erty . See al so La. Civ . Cod e Ann . art . 23 46 (20 12 ) (ex pl ai ni ng th ateachsp ou se act in g a lo ne m ay m an ag e an d c on tro l co m m un ity pro pe rty). Howev er, s he wou ldha ve fai le d e ve ry ot he r fac to r in th e Lun a te st .- 33 -

[* 33 ] bu si ne ss act iv ity

infurth eran ce o f ta x a vo id an ce “ is no m or e a b us in es s pu rp os e th anactua ll y

en ga gi ng intax av oi da nc e.” ASA In ve st eri ng s P’sh ip v. Co m m is si on er, 2 01 F.3d50 5, 5 13 n.6 (D.C. Cir . 20 00 ), aff’g T.C. Me m o. 1 99 8- 30 5. Th e “ ab se nc e o f a n on ta x b us in es s p ur po se is fat al .” Id . at 5 12 ; s ee al so Bo ca In ve st eri ng s P’sh ip v. Un it edSta te s, 3 14 F.3d62 5, 6 32 (D.C. Cir . 20 03 ). W e th eref

or e m us t as k s pe ci fic al ly if th e “parti es in te nd edto joi n t og ethe r as pa rtn ers to co nduc t b us in es s ac ti vi ty fo r a pu rp os e o th er th an tax a vo id

an ce .” ASA Inv es te rin gs , 20 1 F .3dat 5 13 (em ph as is ad de d)
. The 43 6 p artne rs hi p a gr eem en t s ay s tha t i ts pri m ary pu rp os e is “ to m ak e a [p ]rofi t, i nc reas e weal th , andpro vi de a m ean s fo r eac h [p ]artn er’s [f]am il y to be co m e kno wled ge ab le of, m an ag e, an d p res erv e [f]amil y [a]ss et s.” Ev enif we be li ev e wha t the pa rtn ers hi p a gr eem en t s ay s (wh ic h we d on ’t), cou rts ha ve be en rel uc tantto fin d t ha t m an ag in g andpre se rv in g fa m il y ass et s i s a l eg it im at e an d si gn ifi can t n on ta x re as on for est ab li sh in g apa rtn ers hi p wh ere t he pro pe rty do es n’t requi re ac ti ve m an ag em en t. See , e.g., Est at e o f Bi ge lo w v. Co m m is si on er, 5 03 F.3 d 9 55 , 97 2- 73 (9t h C ir. 2 00 7) (pr op erty co nt rib ut edco ns is te d o f a h ou se th at
was ren te d t o aten an t), a ff’g T.C. Mem o. 2 00 5- 65 ; Es ta te of R os env. Co m m is si on er, T.C. Mem o. 2 00 6- 11 5, 2 00 6 WL 15 17 61 8, at*7 (as se ts
co nt rib ut edco ns is te d p rimaril y of s to ck s, b on ds , andcas h, co nduc te d n o b us in es s- 34 -

[* 34 ] act iv ity

an d h adno bu si ne ss pu rp os e fo r it s ex is te nc e). Man ag in g fam il y as se ts jus t d oe sn ’t just ify the ex is te nc e o f any en ti ty tha t d oe sn ’t act iv el y m an ag e an y pro pe rty or carry

on an y bu si ne ss . As i n M ark el l, the reco rdhe re s ho ws ex act ly why 43 6 was form ed . It was
crea te d s ho rtl y

be fo re Hei tm ei er p ur ch as edan d c on tri bu te d t he op ti on s o n yen an d Can ad ian d ol lars to 43 6. Th e p artne rs hi p d idn’t h ol d tho se ass et s fo r lo ng --l es s th ana m on th --b efo re i t l iqui da te d a nddi st rib ut edall of t he rem ai ni ng pro pe rty to Heit m ei er. Garza ’s pl anpre de te rm in edth e m ay fly-li ke li fe o f 43 6 fr om it s ha tc hi ng to it s d is pa tc hi ng . Andwe als o fi ndth ere was n’t a n on ta x n eedto form th e p artne rs hi ps to tak e adva nt ag e o f an y pu rp orte d p ot en ti al pro fit s o f in ve st in g in di gi ta l o pt io ns an d C an ad ian d ol lars . There fo re, we fi ndth atth e o nl y pu rp os e fo r 43 6 was to carry

ou t a t ax -av oi da nc e sc he m e. Andwe fin d Hei tm ei er n ev er in te nd edto run bu si ne ss es un de r th e u m br el laof 4 36 . W e d is reg ard43 6 fo r ta x pu rp os es forth is reas on to o.

3. Co ns eque nc es of Di sr eg ard in g 4 36 Whe n we d is reg arda pa rtn ers hi p fo r ta x p ur po se s, we ar e h ol di ng th atth e ru le s o f subc hapt er K o f ch ap te r 1 o f th e Co de (th e subs tant iv e la w go ve rn in g t he in co m e ta xa ti on of p artne rs ) no lo ng er ap pl y , andth atwe wil l d eem th e pa rtn ers hi p’s ac ti vi ti es to be en ga ge d i n b y on e o r m or e o f it s p ur

po rte d p artne rs .- 35 -

[* 35 ] See i d. at*3 4- *3 5. A d is reg ard edpa rtn ers hi p h as no id en ti ty sep arat e fro m it s o wne rs , andwe tre atitas ju stanag en t o r no m in ee. See , e.g., Tig ers Ey e Trad in g, 1 38 T.C. at 9 4, 9 6 n .32 , 99 . Butdi sr eg ard in g t he partn ers hi p d oe sn ’t
ne ces sa ril y

m eanth atth e ta xp ay er’s i nv es tm en t an d a ll it em s re po rte d b y th e di sr eg ard edpa rtn ers hi p a re p erm an en tl y reduc edto zero . Alth ou gh we do n’t
res pe ctth e fo rm , we st il l n eedto de al with the subs tanc e o f th e tr an sa ct io ns to th e ex te ntwe ha ve juri sd ic ti on . See, e.g ., ACM P’sh ip v. Co m m is si on er, 1 57 F.3d 23 1, 2 62 -6 3 (3 d C ir. 1 99 8) (al lo win g d educ ti on s fo r se curit ie s tha t h ad“ ob jecti ve eco no m ic co ns eque nc es ap artfro m tax be ne fit s * * * ev enwhen in cu rredinth e co nt ex t o f a b ro ad er tran sa ct io n t ha t co ns ti tu te [d ] aneco no m ic sh am ” (ci ta ti on s om itte d) ), aff’g i n p art , rev ’g inpa rt T.C. M em o. 1 99 7- 11 5; Tig ers Ey e Trad in g, 13 8 T.C. at10 8- 09 (st at in g we h av e juri sd ic ti on un de r TEFRA to de te rm in e b as is of pro pe rty all eg ed ly con tri bu te d t o apu rp orte d p artne rs hi p, ev enif the pa rtn ers hi p n ev er ex is te d)
. The Co de tel ls us th atTEFRA pro cedur es wil l s ti ll ap pl y inth es e cas es as lo ng as t he pu rp orte d p artne rs hi p fi le d apa rtn ers hi p re tu rn --wh ic h 4 36 di d fo r 20 01
. See s ecs . 62 31 (g ), 62 33 ; s ee al so sec . 30 1.6 23 3- 1( b) , Pro ced . & Adm in
. 2 1 TEFRA app li es ge ne ral ly to an y partn ers hi p, b utth ere i s an ex cep ti on for 2 1 “ sm al l p artne rs hi ps ”--m ean in g t ho se ha vi ng 10 or f ewer p artne rs . Sec.

(co nt in ue d...)- 36 -

[* 36 ] Reg s. Th is m ean s tha t we h av e to de te rm in e an y it em s tha t wo ul d h av e b een

“pa rtn ers hi p i te m s,” a s d efi ne d i n s ect io n 6 23 1( a)(3 ), an d s ect io n 3 01 .62 31 (a)( 3)
- 1, Pr oc ed . & Adm in . Reg s., h ad43 6 b eena va li d p artne rs hi p fo r ta x p ur po se s. Tig ers Ey e Trad in g, 1 38 T.C. at 9 7. Th is is th e “ hypo th et ic al en ti ty” app ro ach
. See i d. at14 8- 49 (Hal pe rn , J., co nc urrin g) . W e n ow turn t o t he FPAA an d t he pl ead in gs to de ci de whi chit em s ar e st il l i n p lay forus to de ci de
. B. Cap it al Co nt rib ut io ns an d Di st rib ut io ns of P ro pe rty The Co m m is si on er ad

jus te d 4 36 ’s rep orte d c ap it al co nt rib ut io ns an d di st rib ut io ns of p ro pe rty. G iv enth atsubc hapt er K d oe sn ’t app ly to a s im pl e ag en cy rel at io ns hi p, the re can b e n o c on tri bu ti on s t o o r di st rib ut io ns fro m a pa rtn ers hi p t ha t d oe s n otex is t. See id . at 1 07 . The p ro pe rty is e ffec ti ve ly treat ed
as if i t h adn’t b eenco nt rib ut edto or d is tri bu te d fr om th e p ur po rte d p artne rs hi p, an d s etti ng “ Cap it al Co nt rib ut io ns ” an d “ Dis tri bu ti on s o f Pro pe rty oth er tha n Mo ne y ” to zero is ap pr op ria te . Butth atdo es n’t m eanth e und erl y in g p ro pe rty has
no subs tant iv e v al ue . Sin ce the ba si s ( i.e. in si de ba si s) of t he all eg ed ly con tri bu te d (...co nt in ue d) 2 1 62 31 (a)( 1) (B). Th is ex cep ti on do es n’t ap pl y if any partne r is a “pa ss -th ro ug h pa rtn er.” Se c. 30 1.6 23 1( a)(1 )-1 (a)( 2) , Pro ced . & Adm in . Reg s. A “pa ss -th ro ug h pa rtn er” i nc lu de s a “ pa rtn ers hi p, es ta te , tru st , S co rp or at io n, n om in ee, o r ot he r si mil ar p ers on .” Sec. 6 23 1( a)(9 ). The C omm is si on er h as de te rm in edth is in cl ud es di sr eg ard eden ti ti es , see Rev . Rul . 20 04 -8 8, 2 00 4- 2 C .B. 16 5, an d we a gr ee. Si nc e 43 6 h ada si ng le -m em

be r LLC as a pa rtn er, TEFRA p ro cedur es ap pl y he re.- 37 -

[* 37 ] op ti on co nt ract s an d C an ad ian m on ey wou ldbo th ha ve be enpa rtn ers hi p it em s i f th e p artne rs hi p was res pe ct ed , we hav e juri sd ic ti on to de te rm in e th em in th is pa rtn ers hi p- le ve l p ro ceed in g. W ith re ga rdto th e o pt io n c on tra ct s, we ec ho ou r ho ld in g i n M ark el l: Heit m ei er s ho ul d h av e tr eat edth e fo rei gn -cu rren cy op ti on s as a si ng le op ti on sp read --m ean in g t he lo ng an d s ho rt p os it io ns were p artof o ne co nt ractan d
co ul dn ’t hav e b eensep arat edas am atte r of factan d l aw. See Mark el l, T.C.M.

2 2 The o pt io n l eg s wer e acqui redon th e sa m e d at e, ex ecu te d wi th th e sa m e 2 2 co un te rp arty , inth e sa m e fo rei gn curren cy , con ti ng en t o n i de nt ic al fact s, l is te d o n a si ng le tra ns act io n c on firm at io n, an d e xe rci sabl e o n t he same dat e. The p art ie s si m pl y pl acedbe ts on on e fac t: th e p ric e m ov em en t o f th e y enov er a s ta te d p ric e. Heit m ei er p ai d asi ng le ne t p rem iu m of $ 40 ,00 0 fo r th e sp read --the di ffer en ce be twee n the lo ng an d s ho rt p os it io ns . Andth e ex pe rts inth es e cas es cred ib ly te st ifi edth atDeut sc he Ban k wo ul d n otha ve en te redin to th e o pt io ns un le ss th ey were treat edas l in ke d. If t he op ti on s wer e se pa rab le , Deut sc he Ban k’s ri skwou ld be to o g reat : Hei tm ei er l ack edth e fi na nc ia l capa ci ty to p ay th e p rem iu m

on th e lo ng op ti on , andlac ke d the fin an ci al cap aci ty to p ay th e b an k the m il li on s o f do ll ars th atwou ldha ve be endu e if th e sh ort o pt io n, s tand in g a lo ne , exp ire d i n t he m on ey . InHelm er v . Comm is si on er, T.C. Mem o. 1 97 5- 16 0, 1 97 5 WL 27 87 , th e ta xp ay ers be ne fic ia ll y

own edreal pro pe rty tha t was subjec t t o a n o pt io n. Tit le to th e o pt io ne d p ro pe rty was h el d b y anesc ro w age nt , andth e p artne rs hi p wh ic h gr an te d t he op ti onrece iv edy earl y op ti onpre m iu m

pa ym en ts fro m

th e o pt io n ho ld er, an d l is te d t ho se am ou nt s as di st rib ut io ns to th e ta xp ay ers on th e pa rtn ers hi p’s b oo ks an d t ax returns . The t ax pa y ers arg ue d t ha t the op ti on pa ym en ts were fo r a co nt in ge ntli ab il ity be cau se th e o pt io n was st il l o ut st an di ng . Bu t we h el d t ha t the re was no co nt in ge ntli ab il ity be cau se th e tr an sa ct io n un de rlyin g t he op ti on was s ti ll op en , andth e o pt io n p rem iu m s wer e n otsubjec t t o (co nt in ue d...)- 38 -

[* 38 ] 20 14 -8 6 a t * 35 ; cf

. sec . 10 92 (“ st rad dl e” ru le s) . The l on g o pt io n t ha t 8 25 2 pu rch as edas He it m ei er’s n om in ee en ti tl ed82 52 to rece iv e $ 8 m il li on fro m Deu ts ch e Ban k i f th e lo ng op ti onwas i n t he m on ey when itex pi red . Butit
wou ld ’ve b eenrequi redto pa y analm os t equa l am ountto Deut sc he Ban k i f th e sh ort o pt io n was als o i n t he m on ey on th atday --$ 7,9 20 ,00 0. The ap pr op ria te ba si s i n t he op ti on pa ir i s s im pl y what82 52 pa idforit . See
se c. 10 12 (a). Th at ’s $4 0,0 00 . The ap pr op ria te ba si s i n t he Can ad ian m on ey is li ke wis e jus t wh at82 52 pa idforitas He it m ei er’s n om in ee an d a ge nt --$ 4,0 00
. III. Pen al ti es All th atis lef

t i s the pe na lt ie s. We hav e juri sd ic ti on ov er p en al ti es at t he pa rtn ers hi p l ev el be cau se th ey “rel at e to ” p artne rs hi p- le ve l ad jus tm en ts : We can ad jus t the am ou nt s o f pa rtn ers hi p c on tri bu ti on s an d d is tri bu ti on s i n l ig htof o ur de te rm in at io n t ha t the pa rtn ers hi p d oe sn ’t exi st . See Wood s, 5 71 U.S. __ , 13 4 S
. Ct . at 5 64 (di sc us si ng th e “ in he ren tl y pro vi si on al ” juri sd ic ti on of d is tri ctco urts in de te rm in in g p en al ti es ). The Co m m is si on er m eet s an y

bu rd enof p ro du ct io n h e m ay have on th e pe na lty with s im pl e ari th m et ic . See, e.g ., Palm er Ra nc h Ho ld in gs Ltd . v. (...co nt in ue d) 2 2 fo rfei tu re. Unl ik e th e ta xp ay ers inHelm er, Hei tm ei er l ack edth e fi na nc ia l capa ci ty to clo se th e o pt io n t ran sa ct io ns , whi chm ak es Helm er re ad il y di st in gu is habl e.- 39 -

[* 39 ] Co m

m is si on er, T.C. Mem o. 2 01 4- 79 at * 43 -* 44 . A gro ss -v al ua ti on m is st at em en t ex is ts if the va lu e o r ad jus te d b as is of a ny pro pe rty clai m edon th e pa rtn ers hi p re tu rnis 40 0% o r m or e o f th e co rrec t am ou nt . See s ec. 6 66 2( e)(1 )(A), (h )(2 )(A). The ad

jus te d b as is or v al ue 43 6 re po rte d fo r Can ad ian d ol lars (d es cri be d o pa qu el y

as adi strib ut io n o f pr op erty ) was well ov er 1 0,0 00 % of t he
co rrec t v al ue . Any

un de rp aym en t o f ta x a ttrib ut ab le to th atgro ss -v al ua ti on m is st at em en t i s s ub

ject t o a40 % pe na lty . See s ec. 6 66 2( h) (1 ). The on ly iss ue lef

t i n d is pu te is whet he r 43 6 h adsec ti on 66 64
reas on ab le -cau se -an d- go od -fai th de fen se s fo r th e g ro ss -v al ua ti on m is st at em en t pe na lty . W e h av e h el d t ha t a p artne rs hi p c anrai se th is de fen se to th atpe na lty at th e p artne rs hi p l ev el , see 10 6 Lt d., 1 36 T.C. at 7 6- 77 , and43 6 d oe s h ere. The gro ss -v al ua ti on -m is st at em en t p en al ty can b e reb ut te d b y a sh owi ng of
reas on ab le cau se an d g oo d fa ith, s ec. 6 66 4( c), an d atax pa y er wi ll oft enarg ue th at he ha d re as on ab le cau se an d s ho wedgo odfai th by rely in g o n p ro fes si on al advi ce. The reg ul at io n s om ewh atun he lp fu ll y st at es th atrel ianc e o n p ro fes si on al advi ce i s

“ reas on ab le cau se an d g oo d fa ith i f, un de r al l the cir cu m st an ces , su chrel ianc e was reas on ab le an d t he tax pa y er ac te d i n g oo d fa ith.” Sec. 1 .66 64 -4 (b )(1 ), In co m e Tax Reg s. Th e cas el aw li st s thr ee fa ct or s. Neo na to lo gy Asso cs ., P.A. v. Co m m is si on er, 1 15 T.C. 43 , 99 (20 00 ), aff’d, 2 99 F.3d22 1 (3 d C ir. 2 00 2)
.- 40 -

[* 40 ] • Fi rs t, was th e advi se r a co m pe te ntpro fes si on al who ha d s uf fic ie nt ex pe rti se to jus ti fy

rel ianc e?

• Seco nd , di d t he tax pa y er p ro vi de ne ces sary an d a ccurat e in fo rm at io n to th e advi se r?

• Thi rd , di d t he tax pa y er ac tu al ly rely ingo odfai th on th e advi se r’s jud gm en t? Heit m ei er-- act in g i n h is cap aci ty as TMP an d g en eral m an ag er o f hi s pa rtn ers hi p- -cl ai m s re as on ab le rel ianc e o n t he pro fes si on al op in io ns of J on es , Ro us se l, Gi ard in a, an d Gar za. A. Garza ’s Exp ert is e Garzawas l ic en se d a ndwou ldha ve ap pe aredco m pe te ntev ento a la wy er at th e ti m e th e p artne rs hi ps pre pa redth ei r returns --atlea stto lawyers n otve rs edin ta x l aw. B. Pro vi si on of Ne ces sa ry an d Acc ur at e In fo rm at io n W e al so fin d tha t the partn ers hi p p ro vi de d Gar za wi thall th e rel ev an t fin an ci al da tane ed edto ass es s the co rrec t l ev el of i nc om e ta x. Se e se c. 1.6 66 4- 4( c)(1 )(i ), In co m e Tax Reg s. Garz a in factge ne rat edm os t o f th at in fo rm at io n a ndcert ai nl y ha d i t al l av ai labl e.- 41 -

[* 41 ] C. Actu al Rel ianc e in Goo d F ai th It’s the th irdpo in t-- th e is su e o f Hei tm ei er’s actua l g oo d- fai th rel ianc e o n Garza ’s pro fes si on al advi ce-- th at ’s th e m ajorweakne ss inth e p artne rs hi p’s de fen se s: The p artne rs hi p c an ’t rely onGarza i f he was apro m ot er b ecau se pr om ot ers tak e th e g oo d- fai th ou t o f go od -fai th rel ianc e. See, e.g ., 10 6 Lt d., 6 84 F.3 d a t 9 0- 91 ; Neo na to lo gy Asso cs ., 11 5 T.C. at98 . In 1 06 Ltd . (an ot he r Garza
cas e), we d efi ne d apro m ot er as “ ‘an advi se r who pa rti ci pa te d i n s tru ctur in g t he tra ns act io n o r is ot he rwis e rel at edto , has anin te res t i n, o r pr of it s fr om th e tra ns act io n.’” 10 6, Lt d., 1 36 T.C. at 7 9 (quo ti ng Tig ers Ey e Trad in g, LLC v
. Co m m is si on er, T.C. Mem o. 2 00 9- 12 1, 2 00 9 WL 14 75 15 9, at*1 9)
. W e al so de ci de d i n 1 06 Ltd . th atwe wou ldap pl y th is de fin it io n “ whe n t he tra ns act io n i nv ol ve d i s the same tax sh el te r of fere d t o n um ero us pa rti es .” See i d. at80 . Bas edon th e rec or ds inall th es e cas es , we fin d a ga in , as we d idin10 6 Lt d., th atGarza n oton ly part ic ip at edinstru ctur in g t he tra ns act io n b utals o a rran ge d t he
en ti re d eal . It was he who setup th e LLCs, p ro vi de d aco py of th e o pi ni on let te r, an d c oo rd in at edth e d eal fro m st artto fin is h. An d h e test if ie d th athe pro fit edfro m se ll in g t he tra ns act io n t o n um ero us cli en ts --n otjus t Hei tm ei er, b utov er a d oz en ot he rs as we ll . Heit m ei er kne w th is . Garza ch arg edhi m a fl atfee fo r im pl em en ti ng itan d wo ul dn ’t hav e b eenco m pe ns at edat a ll if h e h adde ci de d n ot- 42 -

[* 42 ] to go th ro ug h wi thit . He wasn ’t bei ng pa idto ev al ua te th e d eal or t weaka real bu si ne ss de al to in crea se it s t ax adva nt ag es ; h e was be in g p ai d t o m ak e it happ en . Thi s m ak es hi m

a pr om ot er. AndHeit m ei er co ul d n otha ve reas on ab ly rel ie d o n h is op in io n. Heit m ei er’s l ackof g oo d fa ith a ndreas on ab le rel ianc e is ev enm or e o bv io us whe n we turn t o t he ot he r th ree p ro fes si on al s i nv ol ve d: Jo ne s, Ro us se l, an d Giar di na . All thr ee re fu se d t o e nd or se th e p ro po se d Gar za tran sa ct io n o r pr ov id e an y en co ur ag em en t t o Hei tm ei er o th er than a dv is in g h im ho w to rep ort i t o n h is ta x re turn s. J on es m ad e cl ear a t the ou ts etth atth e So n- of -BOSS tra ns act io n was

“ ou t o f hi s re al m ” an d t ha t h e h adno in te res t i n e ve n t ry in g t o u nd ers tandit
. Ro us se l an d Gi ard in a sp en t m on th s try in g t o d eci de if the y co ul d e nd or se th e tra ns act io n, an d u lt im at el y th ey di dn ’t. Heitmeier co ul d n otha ve reas on ab ly reli ed
on Ro us se l’s o r Giard in a’s op in io ns inm ov in g fo rwardwith t he tra ns act io n, be cau se th e o nl y

op in io ns Ro us se l an d Gi ard in a p ro vi de d wer e warn in gs th atth is
was th e type o f tr an sa ct io n t he IRS wo ul d l ik el y go aft er. Andth ei r cl earl y- 43 -

[* 43 ] ex pr es se d re lu ct an ce t o e nd or se th e d eal to th ei r lo ng ti m e cl ie nton ly blo ws an ot he r ho le inHeit m ei er’s s up po se d g oo d fa ith i n re lying on Garza. An ap pr op ria te de ci si on wil l b e en te red
.