T.C. Memo. 2012-16

UNITED STATES TAX COURT

SCOTT A. AND AUDREY R. BLUM, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 2679-06. Filed January 17, 2012.

Ps, through a grantor trust, entered into an

Offshore Portfolio Investment Strategy (OPIS)

transaction through KPMG, an accounting firm. Through

direct and indirect interests in UBS stock, they

created a $45 million loss. Ps claimed the loss for

tax purposes but did not, in fact or substance, incur a

$45 million loss. Ps were pursued by KPMG when KPMG

became aware that Ps would have a substantial capital

gain. KPMG issued an opinion, after the fact, that the

$45 million capital loss would “more likely than not”

be upheld.

1. Held: the OPIS transaction is disregarded

under the economic substance doctrine.

2. Held, further, Ps are liable for accuracyrelated penalties for gross valuation misstatements and

negligence under sec. 6662(a), I.R.C.
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Nancy Louise Iredale, Jeffrey Gabriel Varga, and Stephen J.

Turanchik, for petitioners.

Henry C. Bonney, Jr., Kevin G. Croke, and Elizabeth S.

Martini, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

KROUPA, Judge: Respondent determined deficiencies in and

penalties with respect to petitioners’ Federal income taxes for

1998, 1999 and 2002 (years at issue) as follows:

 Penalties 

Year Deficiency Sec. 6662(b) Sec. 6662(h)

1998 $9,414,861 $1,948 $3,762,048

1999 16,298,672 2,954 6,513,560

2002 18,737 3,747 -0-

The parties have resolved a number of issues in their stipulation

of settled issues. In addition, the Court dismissed for lack of

jurisdiction those portions of the deficiencies and penalties

pertaining to petitioners’ Bond Leveraged Investment Portfolio

Strategy (BLIPS) transaction. Accordingly, the parties will need

to prepare a Rule 1551 computation.

This Court has not previously considered an Offshore

Portfolio Investment Strategy (OPIS) transaction. The question

1All section references are to the Internal Revenue Code

(Code) for the years at issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure, unless otherwise

indicated. All monetary amounts are rounded to the nearest

dollar.
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before us is whether petitioners are entitled to deduct certain

capital losses claimed from their participation in the OPIS

transaction. We hold that they are not because the transaction

lacks economic substance. We must also decide whether

petitioners are liable for gross valuation misstatement penalties

and negligence penalties under section 6662(a). We hold they are

liable for the penalties.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. We

incorporate the stipulation of facts and documents, the second

stipulation of facts and documents, the third stipulation of

documents and the accompanying exhibits by this reference. 

Petitioners resided in Jackson, Wyoming when they filed the

petition.

I. Petitioners’ Background

Scott Blum (Mr. Blum) and Audrey Blum (Mrs. Blum) were

married in the mid-1990s and have twin children. Mr. Blum, the

only adopted child of an engineer and a secretary, was an

entrepreneurial child and prone to selling his toys. After

parking cars for a hotel and selling women’s shoes, he started

his first company when he was 19 years old to sell computer

memory products. He sold that company two years later for over

$2 million. During the same year, at the age of 21, Mr. Blum

started Pinnacle Micro, Inc. (Pinnacle) with his parents. Mr.

Blum and his parents ran Pinnacle for nine years, including when
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it was a public company. Mr. Blum entered into an Internet-based

business after leaving Pinnacle.

Mr. Blum founded Buy.com, an online retailer, in 1997, and

it set a record for being the fastest growing company in United

States history during its first year of operation. In 1998 Mr.

Blum sold a minority interest in Buy.com stock for a total of $45

million. The sales comprised a $5 million stock sale in August

and a $40 million stock sale at the end of September. His basis

in the stock was zero, and in response to the potential gain Mr.

Blum entered into a $45 million OPIS transaction during 1998,

creating a capital loss of approximately $45 million. The OPIS

transaction was created, managed and promoted by Mr. Blum’s

accounting firm.

Mr. Blum, a savvy businessman, has relied on advisers

including accountants, attorneys and investment counselors. He

never prepared his own tax return. We will introduce the

participants in the OPIS transaction and the entities used to set

up the transaction before describing the arrangement.

II. The Participants

A. The Blum Trust

Mr. Blum created the Scott A. Blum Separate Property Trust

(Blum Trust) in 1995 as a grantor trust. A grantor trust is

disregarded as an entity for Federal income tax purposes. The

Blum Trust was established near the time of Mr. Blum’s marriage
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for family financial planning purposes to address the possibility

of a divorce and its effect upon his corporate businesses. The

Blum Trust normally held stock in Mr. Blum’s start-up companies

and has held other investments through stock brokerage firms.

B. KPMG

Petitioners’ accountant, KPMG Peat Marwick LLP (KPMG),2 a

“Big Four” tax and accounting firm, prepared their individual tax

returns. KPMG also represented petitioners in a Federal income

tax audit, and Mr. Blum hired KPMG employees to work for him as

his business employees.

KPMG is a member firm of KPMG International, a Swiss

cooperative, of which all KPMG firms worldwide are members. At

all relevant times, KPMG was one of the largest accounting firms

in the world, providing services to many of the largest

corporations worldwide. KPMG provided tax services to corporate

and individual clients, including preparing tax returns,

providing tax planning and tax advice and representing clients

before the Internal Revenue Service and the U.S. Tax Court.

In 1998 KPMG was promoting a transaction commonly referred

to as OPIS. KPMG’s capital transaction group sought clients with

large capital gains (above a certain dollar threshold) for the

OPIS transaction. Brent Law (Mr. Law) referred petitioners to

2The firm’s name was later reduced by removing “Peat

Marwick.”
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KPMG's capital transaction group. Mr. Law had represented

petitioners in their audit and had prepared their tax returns. 

Mr. Law knew that Mr. Blum had potential capital gains from sales

of Buy.com stock. He therefore suggested to Mr. Blum’s financial

adviser (Mr. Williams) that they contact KPMG’s capital

transaction group to structure Mr. Blum’s stock sales. Days

later, Mr. Blum or Mr. Williams contacted Mr. Law and asked to be

introduced to Carl Hasting (Mr. Hasting) of KPMG’s capital

transaction group.

Mr. Hasting explained the OPIS transaction to Mr. Blum

without providing any written materials. Despite the magnitude

of the investment, Mr. Blum did not personally perform an

economic analysis of the transaction or consult with his

investment advisers about the transaction. He simply inquired

into KPMG’s reputation. On the basis of two hour-long meetings

with Mr. Hasting and without a written prospectus or other

documentation, Mr. Blum decided to participate in the OPIS

transaction.

Mr. Blum, on his own behalf and on behalf of the Blum Trust,

signed an engagement letter in September 1998 (KPMG engagement

letter). Mr. Blum signed the KPMG engagement letter only four

days before he signed a stock purchase agreement to sell $40

million of Buy.com shares. Pursuant to the KPMG engagement

letter, Mr. Blum and the Blum Trust retained KPMG to provide
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advice on the OPIS transaction. KPMG agreed to provide a tax

opinion letter to Mr. Blum for the OPIS transaction, but only if

requested. Upon such request, the opinion letter would rely on

“appropriate” facts and representations, and state that the tax

treatment described in the opinion would “more likely than not”

be upheld. KPMG specified, in the KPMG engagement letter, that

its fees were based on the complexity of its role and the value

of the services provided, rather than time spent. KPMG’s minimum

fee was to be $687,500, with an additional amount to be agreed on

by the parties.

Except for a call from Mr. Hasting to Mr. Blum about a month

into the OPIS transaction, Mr. Blum did not track or monitor the

transaction. He was generally unfamiliar with the entities

involved in his OPIS transaction, other than KPMG and UBS AG

(UBS), and lacked even a generalized knowledge about the assets

involved in the deal.

C. Foreign Special Purpose Entities

Three foreign entities were formed to implement Mr. Blum’s

OPIS transaction, although he was not familiar with them. 

Alfaside Limited (Alfaside) was incorporated in the Isle of Mann

on September 28, 1998. Four days later, Benzinger GP, Inc.

(Benzinger GP) was incorporated as a Cayman Islands exempted
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company.3 The following day, Alfaside acquired 100-percent

ownership of Benzinger GP and formed a Cayman Islands limited

partnership with Benzinger GP called Benzinger Investors, L.P.

(Benzinger LP).4 Petitioners and KPMG intended that Benzinger GP

and Benzinger LP would both be corporations for U.S. Federal

income tax purposes.5 The following diagram illustrates the

ownership structure of the three foreign entities:

3A Cayman Islands exempted company is a common choice for

U.S. practitioners creating a foreign entity. An exempted

company’s operation is conducted mainly outside the Cayman

Islands. A 20-year exemption from taxation in the Cayman Islands

is typically applied for.

4Benzinger LP filed a Form SS-4, Application for Employer

Identification Number. It received a notification of its U.S.

Federal tax identification number on Dec. 22, 1998.

5Petitioners and KPMG took the position that Benzinger GP

defaulted to corporate treatment but also filed a protective

check-the-box election on Form 8832, Entity Classification

Election, electing corporate treatment. See sec.

301.7701–3(b)(2), (c)(1)(i), Proced. & Admin. Regs. Benzinger LP

did not default to corporate treatment, but petitioners and KPMG

took the position that it was eligible to elect its

classification and also filed a Form 8832 electing corporate

treatment for Benzinger LP. See sec. 301.7701–3(a), (b)(2),

(c)(1)(i), Proced. & Admin. Regs. 
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D. QA Investments

A few days later, the Blum Trust retained QA Investments,

LLC (QA) to serve as its investment adviser for the OPIS

transaction.6 Mr. Blum was not familiar with QA and had never

spoken with anyone at QA when his grantor trust retained QA’s

services. Nevertheless, the investment advisory agreement (Blum

Trust advisory agreement) between the Blum Trust and QA gave QA

substantial discretionary authority with respect to specified

funds owned by the Blum Trust, subject to the investment

objectives. The Blum Trust’s investment objectives specified an

6Quadra Capital Management, L.P., d.b.a. QA Investments, was

a financial boutique providing asset management, financial

advice, brokerage activities and tax planning services.
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intent to acquire approximately $2,250,000 of UBS common stock

and the right to instruct QA to purchase or sell put or call

options on UBS common stock. The stated investment objectives

also included an International Swaps and Derivatives Association

(ISDA) swap agreement with respect to UBS and a privately

negotiated call option related to the UBS stock price.7 The Blum

Trust agreed to pay QA a $135,000 fee within 30 days of the

execution of the Blum Trust advisory agreement. The Blum Trust

paid the fee in October 1998.

Benzinger LP also retained QA to serve as its investment

adviser regarding the OPIS transaction pursuant to an investment

advisory agreement (Benzinger LP advisory agreement). The

Benzinger LP advisory agreement gave QA certain discretionary

authority to implement an investment strategy based on certain

expectations about UBS stock. The initial account value to be

invested was $3,015,000 and the strategy contemplated a $45

million notional account value.8 QA was to hedge the notional

7ISDA is a trade organization of participants in the market

for over-the-counter derivatives. ISDA has created a

standardized contract, the ISDA master agreement, which functions

as an umbrella agreement and governs all swaps between the

parties to the ISDA master agreement. See generally K3C Inc. v.

Bank of Am., N.A., 204 Fed. Appx. 455, 459 (5th Cir. 2006).

8In this context, notional account value refers to the total

value of a leveraged position. The investment strategy was to be

initiated through the purchase of UBS securities with a $45

million market value by securing financing or leverage through a

variety of possible means including borrowing, margin,

(continued...)
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account value by writing in-the-money covered call options or

purchasing long significantly out-of-the-money put options.9 QA

billed Benzinger LP $562,500, calculated as a percentage of the

notional account value, in December 1998.

E. UBS

Union Bank of Switzerland merged with Swiss Bank Corporation

(SBC) in mid-1998, a year at issue, to form the entity now known

as UBS. QA first introduced UBS’ Global Equity Derivatives group

to the OPIS transaction. KPMG subsequently provided additional

information about the transaction to UBS. A UBS officer

estimated that UBS’ profit for each OPIS transaction would be 2.5

percent to 3 percent of the notional amount of the transaction. 

The price of UBS stock rose over 48 percent during the

course of petitioners’ OPIS transaction.

8(...continued)

derivatives and other investment techniques.

9Options are often referred to as being “at-the-money,” “inthe-money,” or “out-of-the-money.” An option that is “at-themoney” has its strike price equal to the market price of the

underlying asset. An option is “in-the-money” when the option’s

strike price is less than the current market price of the

underlying asset. If the value of the underlying asset is

greater than the exercise price for a call option or less than

the exercise price for a put option, that option is said to be

“in-the-money.” In this case, it is advantageous to the owner of

the option to exercise his or her right under the option as

opposed to acquiring or selling such assets in the stock market. 

An option is “out-of-the-money” when it would be disadvantageous

to exercise the option, as opposed to acquiring or selling the

assets in the stock market. 
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III. The Transaction

Having introduced the participants, we now delve into the

operation of petitioners’ OPIS transaction. We explain the

different transactions and steps that make up the larger whole.

A. Step 1: The Blum Trust Purchases UBS Stock and GP Call

 Option; Enters into Equity Swap

Mr. Blum wired $2,250,000 to the Blum Trust’s Pali Capital

LLC (Pali) brokerage account (Pali account) on October 2, 1998,

as contemplated in the Blum Trust advisory agreement. The same

day, the Blum Trust used nearly all of those funds to purchase

10,469 shares of UBS stock.

Mr. Blum also wired $3,015,000 to SBC as payment from the

Blum Trust to Alfaside for (1) the first two fixed payments under

an equity swap agreement (equity swap) and (2) the premium under

a call option (GP call option). The equity swap was an agreement

between the Blum Trust and Alfaside. Under the equity swap, the

Blum Trust would pay Alfaside two fixed payments on specified

payment dates. After the termination date, Alfaside was to pay

the Blum Trust an amount in Swiss francs (CHF) to be calculated

based on the price of UBS common stock as of that date. 

Petitioners and KPMG theorized that the parties were not required

to withhold U.S. tax under the equity swap.10

10KPMG opined that the equity swap would most appropriately

be characterized for tax purposes as a notional principal

contract. If that were the case, payments would be sourced by

(continued...)
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The Blum Trust purchased the GP call option from Alfaside

for $112,500. Pursuant to the GP call option, the Blum Trust

could require Alfaside to either (1) sell its half of the stock

of Benzinger GP for $229,500 or (2) pay a cash settlement price

calculated from Benzinger GP’s net asset value. The Blum Trust

had a period of less than two months in which it could exercise

its option.

B. Step 2: Benzinger LP Purchases UBS Stock; Constructs

 Collar

In the second step, Benzinger LP entered into a delayed

settlement agreement with UBS on October 16, 1998 to purchase

163,980 shares of UBS stock for $45 million. Benzinger LP

treated the transaction for tax purposes as a stock purchase as

of that date. It was, however, not required to pay for the stock

and UBS was not required to deliver the stock until November 27,

1998. Benzinger LP’s purported $45 million basis in the 163,980

shares would allegedly shift to the Blum Trust and therefore to

petitioners on November 27 under step 3 below.

Also on October 16, Benzinger LP and UBS used put and call

options to construct a collar on the 163,980 UBS shares.11

10(...continued)

the residence of the taxpayer and therefore exempt from

withholding. See sec. 1441; sec. 1.863-7(b), Income Tax Regs.

11A collar is an option strategy that limits the possible

positive or negative returns on an underlying investment to a

specific range. Generally, in an option collar transaction, an

(continued...)
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Benzinger LP purchased 163,980 put options12 from UBS and sold

147,58213 call options14 to UBS. Pursuant to their terms, the

options could be exercised only on their November 27, 1998

expiration date, and any options that were in-the-money on that

expiration date would be automatically exercised.

The call options had a range option feature that required

UBS to pay Benzinger LP certain amounts if the price of UBS stock

achieved certain levels on specified days (RECAP feature). On

the same day Benzinger LP and UBS entered into the options,

however, the price of the UBS stock closed below the specified

level. The stock’s closing below the specified level eliminated

or terminated the RECAP feature before any payments came due

under it. The share price drop also reset the strike price on

the call options to 90 percent, the same as the strike price on

the put options.

The cost of the UBS call options was almost CHF 3 million

more than the cost of the Benzinger LP put options. Benzinger LP

11(...continued)

investor purchases a put option and sells a call option.

12In industry parlance, these put options are plain-vanilla

90-percent put options.

13These options represent 90 percent of the total number of

options.

14In industry parlance and as partially described below,

these call options could be considered 95-percent call options

with barrier and reset and embedded range options.
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was required to deposit that difference with UBS as part of the

security for the stock purchase. The remainder of the security

posted with UBS consisted of the $3,015,000 that the Blum Trust

paid for the equity swap and the GP call option, converted into

CHF.15

In sum, Benzinger LP purported to purchase $45 million worth

of UBS stock on October 16, 1998, but paid no money, received no

stock and entered into transactions that would cause it to never

receive at least 90 percent of the stock.

QA subsequently sent UBS a document denominated “trade

ticket” that ensured Benzinger LP would not receive the other 10

percent of the stock. The trade ticket ordered UBS to

simultaneously redeem any UBS shares held by Benzinger LP on

November 27, 1998 after the call or put options were exercised.

C. Step 3: UBS Redeems the 163,980 Shares While the Blum

 Trust Purchases 163,980 Call Options

In the third step, UBS redeemed the 163,980 shares that

Benzinger LP had acquired that day pursuant to the delayed

settlement. This was primarily completed through automatic

exercise of the call options, which were in-the-money on November

27, 1998.16

15CHF 6,880,935 was deposited with UBS, composed of CHF

2,913,195 net amount from the put and call options and CHF

3,967,740 (exchanged from $3,015,000).

16The put options were out-of-the money on that date and

(continued...)
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Pursuant to the trade ticket, UBS redeemed the remaining

16,398 shares that were not included in the call options on the

same day. The cumulative result of these transactions was as

follows:

Transaction Information CHF

Step 2 transactions 

 (delayed settlement, 

 collar) and UBS 

 redemption

163,980 shares -4,622,760

Deposit from the Blum 

 Trust

$3,105,000 converted to 

 CHF

3,967,740

Interest on collateral 6,984

Net premium due 

 Benzinger LP on 

 collar

2,913,195

 Total Due to Benzinger LP from 

 UBS

2,265,159

The total due from UBS to Benzinger LP, CHF 2,265,159, was

converted to $1,660,065 and paid on December 8, 1998.

At the same time that UBS redeemed the 163,980 shares, the

Blum Trust purportedly purchased 163,980 out-of-the-money call

options on UBS stock (OTM call options). The OTM call options

were 16.5 percent out-of-the-money. They cost $675,000 and

expired a month later on December 28, 1998.

16(...continued)

therefore expired worthless. See supra note 9 for an explanation

of in-the-money and out-of-the-money options. See infra note 17

for an explanation of expiring worthless.
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D. Step 4: Closing Out

Mr. Blum then closed out the OPIS transaction. The Blum

Trust’s 163,980 call options were left to expire worthless on

December 28, 1998.17 On the same day, the Blum Trust also sold

10,469 shares of UBS stock that had been purchased less than

three months before. In early January 1999 the Blum Trust

purportedly received from Alfaside (1) $368,694 for cash settling

the GP call option and (2) approximately $1.6 million pursuant to

the equity swap.

E. The Net Result

At the conclusion of this convoluted and contrived series of

transactions, the net cost of the OPIS transaction to Mr. Blum

was approximately $1.5 million. For that cost, the OPIS

transaction yielded over $45 million in capital losses to offset

capital gains on tax returns petitioners filed. The following

diagram depicts the cumulative transaction:

17Options have an exercise period or date(s) and an

expiration date, and therefore generally lose value as time

passes. If an option expires out-of-the-money (below the

exercise price for a call option and above the exercise price for

a put option), then the option will be said to expire worthless.
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IV. Tax Returns

KPMG prepared petitioners’ tax returns, on which they

claimed over $45 million in capital losses for 1998 from the OPIS

transaction. Mr. Blum reported these losses on the Blum Trust’s

tax return for 1998, the only tax return the Blum Trust has ever

filed. The Blum Trust’s alleged losses were reported in a chart

that included the following: 
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Item

Date

Acquired Date

Sold

Gross

Sales

Price

Cost or

Other

Basis

Gain / Loss

UBS

stock

10/2/98 12/28/98 $3,257,593 $39,681,91

7

-$36,424,324

UBS 

options

11/27/98 12/27/98 -0- 8,629,508 -8,829,509

Buy.com 7/30/97 10/20/98 500,000 -0- 500,000

Buy.com 7/30/97 10/29/98 20,000,000 -0- 20,000,000

Buy.com 7/30/97 10/30/98 20,000,000 -0- 20,000,000

Buy.com 7/30/97 8/17/98 5,000,000 -0- 5,000,000

The loss of over $36 million was reported on the Blum Trust’s

sale of the 10,469 shares of UBS stock purchased at step 1. The

nearly $9 million loss was reported on the 163,860 call options

purchased at step 3, which expired worthless. The capital gains

from the sales of Buy.com shares were essentially eliminated by

the losses claimed from the OPIS transaction. Petitioners

reported this net difference, as adjusted by a few other

unrelated sales, on the income tax return they filed for 1998. 

Petitioners also claimed a $1,754,670 capital loss from the

equity swap on the income tax return they filed for 1999.

V. Tax Opinion

The KPMG engagement letter stated that KPMG would provide a

tax opinion letter regarding the OPIS transaction, if requested. 

KPMG sent to Mr. Blum a letter, dated after petitioners filed an

income tax return for 1998, asking Mr. Blum to represent certain

information about the OPIS transaction. KPMG agreed to finalize

and issue its tax opinion after receiving the signed
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representation letter. Mr. Blum signed the representation letter

in May 1999. In that letter, Mr. Blum represented that he had

independently reviewed the economics underlying the investment

strategy and believed it had a reasonable opportunity to earn a

reasonable pre-tax profit. He made this representation even

though he had not performed an economic analysis of the

transaction or consulted with his investment advisers about the

transaction.

At some point after mid-May 1999 KPMG executed a tax opinion

letter (tax opinion) dated as of December 31, 1998. The 99-page

tax opinion stated that it relied on representations from Mr.

Blum, Benzinger GP and QA. KPMG opined that it was more likely

than not that (1) Benzinger LP and Benzinger GP would be treated

as corporations for U.S. Federal income tax purposes, (2) the

amount paid by UBS in redemption of Benzinger LP’s UBS shares

would be treated as a dividend, (3) Benzinger LP’s tax basis in

the redeemed UBS shares would be attributed and allocated to the

Blum Trust’s separately purchased UBS shares and potentially to

the Blum Trust’s UBS call options, (4) the Blum Trust would not

be subject to U.S. tax on the dividend received by Benzinger LP

for redeeming its UBS shares and (5) payments made by the Blum

Trust to Alfaside under the swap contract would not be subject to

U.S. withholding tax. The record does not indicate when or if

petitioners received the tax opinion.
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VI. Aftermath

KPMG’s tax-focused transactions, including OPIS, soon became

a topic of governmental and popular interest. 

A. Commissioner’s Position on OPIS

The Commissioner disagreed with the positions taken in

KPMG’s “more likely than not” tax opinion and challenged the

validity of basis-shifting transactions such as OPIS in July

2001, nearly three years after Mr. Blum entered into the OPIS

transaction. The Commissioner rejected the foundations of these

transactions and noted that reasons for disallowance could

include (1) the redemption does not result in a dividend, (2) the

basis shift is improper and (3) there is no stock attribution or

basis shift because the transaction serves no purpose other than

tax avoidance. Notice 2001-45, 2001-2 C.B. 129.

The next year, the Commissioner issued a settlement

initiative for basis-shifting tax shelters, such as OPIS. 

Announcement 2002–97, 2002-2 C.B. 757. The Commissioner

permitted settling taxpayers to claim 20 percent of the claimed

losses and waived penalties in certain cases if the settling

taxpayers conceded 80 percent of the claimed losses. Id. Later

that year, the Commissioner also issued a coordinated issue paper

presenting in greater detail his rejection of OPIS transactions. 

Industry Specialization Program Coordinated Issue Paper, “Basis

Shifting” Tax Shelter, 2002 WL 32351285 (Dec. 3, 2002).
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B. KPMG’s Indictment

Around the same time, KPMG’s legal opinions became the focus

of the United States Senate Permanent Subcommittee on

Investigations’ (committee) inquiry into the development and

marketing of abusive tax shelters. The committee eventually

focused on four transactions designed and promoted by KPMG, one

of which was OPIS. 

Facing the possibility of grand jury indictment, KPMG

entered into a deferred prosecution agreement (DPA) with the

Government in August 2005. KPMG agreed to the filing of a

one-count information charging KPMG with participating in a

conspiracy to defraud the United States, commit tax evasion and

make and subscribe false and fraudulent tax returns. It admitted

and accepted that it helped high-net-worth individuals evade tax

by developing, promoting and implementing unregistered and

fraudulent tax shelters. It further admitted that KPMG tax

partners engaged in unlawful and fraudulent conduct, including

issuing opinions they knew relied on false facts and

representations. KPMG agreed to pay the Government $456 million,

to limit its tax practice to comply with certain guidelines and

to cooperate with any investigation about which KPMG had

knowledge or information.

Later, during 2005, Federal prosecutors obtained numerous

indictments against current and former KPMG employees and
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partners. The indicted individuals were charged with conspiracy

and tax evasion for designing, marketing and implementing tax

shelters, including OPIS.

C. Blum v. KPMG

Despite the DPA, KPMG’s legal battles continued. Mr. Blum

was one of many clients who sued KPMG in the aftermath of its

indictment and the related IRS scrutiny. He filed a complaint

against KPMG in Los Angeles Superior Court at the end of 2009 in

connection with the OPIS transaction.

Mr. Blum refers to OPIS and BLIPS in his lawsuit as the “Tax

Strategies.” Mr. Blum alleges in his suit that KPMG breached its

fiduciary duty to him and induced him to pursue a course of

action that he would not have otherwise pursed. In particular,

Mr. Blum alleges that he was induced to invest millions of

dollars in the Tax Strategies and to conduct his business to

realize taxable income that would be offset by the losses the Tax

Strategies generated. He further claims that, in reliance on

KPMG, he did not adopt other strategies to defer or minimize tax

liability or make different decisions regarding share sales. He

seeks damages of over $100 million.

VII. Deficiency

As previously mentioned, respondent determined deficiencies

in, and penalties regarding, petitioners’ Federal income taxes

for the years at issue. Petitioners timely filed a petition with
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this Court for redetermination of the positions respondent set

forth in the deficiency notice. As previously mentioned, the

parties resolved certain issues in their stipulation of settled

issues and the Court dismissed those portions of the deficiencies

and penalties pertaining to petitioners’ BLIPS transaction.

OPINION

The subject transaction presents a case of first impression

in this Court. We are asked to decide whether petitioners are

entitled to deduct losses from their OPIS transaction. We must

also decide whether petitioners are liable for any accuracyrelated penalties for underpayments resulting from the OPIS

transaction. We begin with the parties’ arguments regarding this

complicated OPIS transaction.

Petitioners argue that their claimed benefits from the OPIS

transaction were taken according to the letter of the tax laws. 

In support of that position, petitioners argue that OPIS yielded

the claimed losses pursuant to the following analysis:

(1) UBS’ exercise of the call options and Benzinger LP’s

sale of the remaining shares to UBS was a redemption of stock

under section 317(b).

(2) To determine whether a redemption qualifies as a sale or

exchange or as a distribution, the stock attribution rules apply. 

Secs. 302(c), 318(a). Petitioners argue that, under the stock

attribution rules, the Blum Trust was treated as owning the
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163,980 shares that are the subject of its call options, in

addition to the 10,469 shares that it directly held. See sec.

318(a)(4). Also under these rules, the Blum Trust was treated as

owning 50 percent of Benzinger GP, and therefore Benzinger LP was

treated as owning the 10,469 shares directly held by the Blum

Trust and the 163,980 shares constructively owned by the Blum

Trust. See sec. 318(a)(3)(C), (4), (5)(A).

(3) Because of Benzinger LP’s constructive ownership of the

Blum Trust’s UBS shares (both direct and constructive), the UBS

redemption of Benzinger LP’s shares did not completely terminate

Benzinger LP’s interest in the corporation. See sec. 302(b)(3). 

Moreover, petitioners argue that it was not a substantially

disproportionate redemption because Benzinger LP was deemed to

own the same number of shares before and after step 3 of the

transaction under the attribution rules. See sec. 302(b)(2). 

Petitioners theorize that the UBS redemption is essentially

equivalent to a dividend. See United States v. Davis, 397 U.S.

301 (1970). Accordingly, petitioners conclude that the

redemption would not be treated as a sale or exchange but would

instead be treated as a distribution of property. See sec.

302(a), (d).

(4) UBS had sufficient earnings and profits in 1998, so the

distribution pursuant to the UBS redemption would be treated as a
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dividend and would not reduce Benzinger LP’s tax basis in the

redeemed UBS shares. See sec. 301(c)(1).

(5) Benzinger LP thus retained its tax basis in the UBS

shares but did not own any shares directly. Petitioners took the

position and argue that Benzinger LP’s basis in the UBS shares

therefore could be allocated to the Blum Trust’s UBS shares and

options because the attribution of shares from the Blum Trust

caused the redemption to be treated as a dividend. See Levin v.

Commissioner, 385 F.2d 521 (2d Cir. 1967), affg. 47 T.C. 258

(1966); sec. 1.302-2(c) and Example (2), Income Tax Regs.18

Petitioners further posit that the OPIS transaction has

economic substance because Mr. Blum entered into it for

investment purposes and had a reasonable possibility of profiting

from the transaction. They also urge the Court that they

reasonably relied on their long-time tax adviser, so they should

not be liable for penalties in case of deficiencies.

Respondent argues petitioners are not entitled to deduct

losses from the OPIS transaction because they incorrectly

reported their Federal income tax treatment of certain steps. 

Specifically, respondent alleges that petitioners’ tax treatment

18Petitioners took the position that UBS’ redemption of

Benzinger LP’s shares was not taxable to the Blum Trust because

(a) the equity swap did not, in substance, transfer to the Blum

Trust an equity interest in Benzinger LP and (b) the GP call

option did not implicate the controlled foreign corporation,

foreign personal holding company and passive foreign investment

company provisions of the Code.
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of the OPIS transaction is incorrect because Benzinger LP never

owned the 163,980 UBS shares for Federal income tax purposes and

therefore did not have a $45 million basis that could be shifted. 

Respondent also takes the position that Benzinger LP could not

shift its alleged basis to the Blum Trust because UBS’ redemption

of Benzinger LP’s UBS stock was a distribution in a sale or

exchange of that stock, and not a dividend. Respondent further

argues that petitioners’ losses are disallowed because the

transaction lacks economic substance.19

We agree with respondent that the OPIS transaction lacked

economic substance. We admit KPMG painstakingly structured an

elaborate transaction with extensive citations to complex Federal

tax provisions. The entire series of steps, however, was a

subterfuge to orchestrate a capital loss. A taxpayer may not

deduct losses resulting from a transaction that lacks economic

substance, even if that transaction complies with the literal

terms of the Code. See Coltec Indus., Inc. v. United States, 454

F.3d 1340, 1352–1355 (Fed. Cir. 2006); Keeler v. Commissioner,

243 F.3d 1212, 1217 (10th Cir. 2001), affg. Leema Enters., Inc.

v. Commissioner, T.C. Memo. 1999-18. Accordingly, we do not

address the parties’ arguments regarding the merits of

19Respondent also argues that petitioners’ losses are

disallowed under sec. 165 because they were not incurred in a

transaction entered into for profit and that they are limited by

the at-risk rules in sec. 465. We need not reach these arguments

because of our other holdings.
-28-

petitioners’ treatment of each step within the OPIS transaction. 

Instead, we begin our analysis with the general principles of the

economic substance doctrine.20

I. Merits of OPIS Under the Economic Substance Doctrine

A court may disregard a transaction for Federal income tax

purposes under the economic substance doctrine if it finds that

the taxpayer failed to enter into the transaction for a valid

business purpose but rather sought to claim tax benefits not

contemplated by a reasonable application of the language and

purpose of the Code or its regulations.21 See, e.g., New Phoenix

Sunrise Corp. & Subs. v. Commissioner, 132 T.C. 161 (2009), affd.

408 Fed. Appx. 908 (6th Cir. 2010); Palm Canyon X Invs., LLC v.

Commissioner, T.C. Memo. 2009-288. There is, however, a split

among the Courts of Appeals as to the application of the economic

20The taxpayer generally bears the burden of proving the

Commissioner’s determinations are erroneous. Rule 142(a). The

burden of proof may shift to the Commissioner if the taxpayer

satisfies certain conditions. Sec. 7491(a). Our resolution is

based on a preponderance of the evidence, not on an allocation of

the burden of proof. Therefore, we need not consider whether

sec. 7491(a) would apply. See Estate of Bongard v. Commissioner,

124 T.C. 95, 111 (2005).

21Congress codified the economic substance doctrine mostly

as articulated by the Court of Appeals for the Third Circuit in

ACM Pship. v. Commissioner, 157 F.3d 231, 247–248 (3d Cir. 1998),

affg. in part and revg. in part on an issue not relevant here

T.C. Memo. 1997–115. See sec. 7701(o), as added to the Code by

the Health Care and Education Reconciliation Act of 2010, Pub. L.

111–152, sec. 1409, 124 Stat. 1067; see also H. Rept. 111–443(I),

at 291–299 (2010). The codified doctrine does not apply here

pursuant to its effective date.
-29-

substance doctrine. An appeal in this case would lie to the

Court of Appeals for the Tenth Circuit absent stipulation to the

contrary and, accordingly, we follow the law of that circuit. 

See Golsen v. Commissioner, 54 T.C. 742 (1970), affd. 445 F.2d

985 (10th Cir. 1971).

The Court of Appeals for the Tenth Circuit applies a socalled unitary analysis in which it considers both the taxpayer’s

subjective business motivation and the objective economic

substance of the transactions. See Sala v. United States, 613

F.3d 1249 (10th Cir. 2010); Jackson v. Commissioner, 966 F.2d

598, 601 (10th Cir. 1992), affg. T.C. Memo. 1991-250. The

presence of some profit potential does not necessitate a finding

that the transaction has economic substance. Keeler v.

Commissioner, supra at 1219. Instead, that Court of Appeals

requires that tax advantages be linked to actual losses. See

Sala v. United States, supra at 1253; Keeler v. Commissioner,

supra at 1218-1219. It has further reasoned that “correlation of

losses to tax needs coupled with a general indifference to, or

absence of, economic profits may reflect a lack of economic

substance.” Keeler v. Commissioner, supra at 1218. Applying

those standards, we hold that petitioners’ OPIS transaction lacks

economic substance and we now discuss our underlying reasoning

and conclusions for our holding.
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A. Prearranged Steps Designed To Generate Loss

Petitioners’ OPIS transaction was a structured deal with

several components, some straight-forward and some complex. The

components of this deal were carefully pieced together to

generate, preserve and shift a substantial tax basis so as to

obviate petitioners’ $45 million capital gain. We conclude,

based on the record and the entirety of the transactions, that

petitioners’ OPIS transaction was designed to create a tax loss

that would offset their capital gains from sales of Buy.com

shares.

KPMG designed OPIS’ prearranged steps to generate a

significant, artificial loss. KPMG sought clients with

substantial capital gains for the OPIS transaction. Investors

were targeted based on their potential capital gains and not

their investment profiles. Indeed, KPMG had a minimum capital

gains requirement for clients participating in the transaction.

Mr. Blum contends that he had no interest in a tax shelter

when he met with Mr. Hasting. The record conflicts, however,

with his contention. Mr. Law suggested that Mr. Blum contact

KPMG’s capital transaction group because he knew that Mr. Blum

had potential capital gains from stock sales. Mr. Blum retained

KPMG for the OPIS transaction just days before selling $40

million of Buy.com shares. Mr. Blum retained KPMG as his tax

adviser, not as his investment adviser. 
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KPMG intended OPIS as a loss-generating transaction. The

OPIS transaction was a prearranged set of steps that, from the

outset, was designed and intended to generate a loss. Those

circumstances are indicative of transactions lacking economic

substance. See Sala v. United States, supra at 1253.

B. Mr. Blum Did Not Approach the Transaction as an Investor

Mr. Blum contends that he did not view the prearranged OPIS

steps as a loss-generating transaction, but that he intended to

make a potentially high-yielding investment. Petitioners’

reliance on this subjective prong of the economic substance

analysis is not supported by the facts. We do not accept Mr.

Blum’s claim that he subjectively believed the OPIS transaction

would be profitable because his actions during or after the

transaction conflict with his contention.

Mr. Blum’s contention concerning his intent on entering into

the transaction conflicts, for example, with the KPMG engagement

letter for tax consultation services that provides for a tax

opinion about losses from the transaction. Mr. Blum’s asserted

focus on investment does not comport with his retention of QA as

an investment adviser when he knew little about and never spoke

to anyone at QA. He hired an investment adviser that he did not

know and he did so through a tax adviser, which suggests that

tax, not investment, was the primary consideration.
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Mr. Blum testified that $5 million was a relatively sizable

amount of money to him. The record indicates that Mr. Blum

essentially entrusted this sizable amount of money to an unknown

investment adviser based on two hour-long presentations from his

tax adviser. Mr. Blum did not perform an economic analysis of

the OPIS transaction, nor did he ask his existing investment

advisers to review it. He had no general knowledge of the

participants (except for KPMG and UBS) and no understanding of

the transaction. Furthermore, Mr. Blum did not track his

investment, except to the extent that he received a call from

KPMG a month into the deal. 

Mr. Blum’s actions belie his testimony. His lack of due

diligence in researching the OPIS transaction indicates that he

knew he was purchasing a tax loss rather than entering into a

legitimate investment. See Pasternak v. Commissioner, 990 F.2d

893, 901 (6th Cir. 1993), affg. Donahue v. Commissioner, T.C.

Memo. 1991-181; Country Pine Fin., LLC v. Commissioner, T.C.

Memo. 2009-251.

Mr. Blum’s statements in his subsequent suit against KPMG

confirm his lack of subjective profit motive. In his suit, Mr.

Blum alleges that he was induced to invest millions of dollars in

a tax strategy and to conduct his business so as to realize

taxable income that would be offset by losses generated by OPIS. 

He further claims that, in reliance on KPMG, he did not adopt
-33-

other strategies to defer or minimize his tax liability or make

different decisions regarding share sales. Mr. Blum’s actions

during and after the OPIS transaction do not indicate a profit

motive.

C. Loss Had No Economic Reality

Petitioners’ significant capital losses from the OPIS

transaction were not only intentional, but they were also

artificial. Indeed, the claimed losses created by the OPIS

transaction were prearranged and intended to be artificial. Mr.

Blum invested approximately $6 million into the OPIS transaction

and lost approximately $1.5 million, yet the transaction

generated over $45 million in capital losses. Petitioners’

disproportionate losses violated the principle that tax

advantages must be linked to actual losses. See Keeler v.

Commissioner, 243 F.3d at 1218.

Benzinger LP was able to create an artificial basis in UBS

shares, which it otherwise would not have, through Benzinger LP’s

delayed settlement stock purchase of UBS shares and the collar on

those shares. Benzinger LP treated the UBS share redemption as a

dividend through its application of the attribution rules and the

rules governing redemptions. This treatment had no tax

consequences to Benzinger LP, but allowed it to retain its

alleged basis in the shares for Federal income tax purposes. 

Retaining this $45 million basis was crucial. As Benzinger LP no
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longer held any interests in UBS shares, its basis allegedly

transferred to petitioners’ UBS shares and options. Petitioners

therefore claimed a substantial capital loss upon selling their

UBS shares and expiration of their options. 

Petitioners’ claimed capital losses far exceeded their

investments in the shares and options. Petitioners’ claimed loss

on their sale of directly-held UBS shares acquired in step 1 of

the transaction is particularly significant to the planned tax

strategy. In reality, the UBS shares appreciated substantially

during this period. Petitioners’ earned approximately $1 million

(before fees) on their direct investment in UBS shares, yet they

claimed a capital loss of over $36 million on the sale.

In other words, petitioners claimed a substantial capital

loss because they received a tax-exempt foreign entity’s

carefully constructed and carefully retained basis in shares that

it never actually received. Petitioners incurred no such

economic loss of the stated magnitude. Indeed, petitioners do

not contest that their loss is fictional. The absence of

economic reality is the hallmark of a transaction lacking

economic substance. Sala v. United States, 613 F.3d at 1254; see

also Coltec Indus., Inc. v. United States, 454 F.3d at 1352;

Keeler v. Commissioner, supra at 1218–1219; K2 Trading Ventures,

LLC v. United States, ___ Fed. Cl. ___, 2011 WL 5998957 (Nov. 30,

2011).
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D. Loss Dwarfs Profit Potential

Petitioners’ artificial $45 million loss has no meaningful

relevance to the minuscule potential for profit from OPIS. 

Petitioners’ expert, Dr. James Hodder (Dr. Hodder), concluded

that petitioners had a 76.3-percent chance of losing money. 

Despite the high risk, Dr. Hodder concluded that OPIS had

potential for high yields that could make the deal an appropriate

investment for the right investor. Dr. Hodder calculated that

OPIS had a 19.1-percent chance of realizing a $600,000 profit. 

He further concluded that petitioners had a 7.6-percent chance of

realizing a $3 million profit. These amounts are de minimis when

compared to petitioners’ capital losses of over $45 million from

OPIS. The expected tax benefit dwarfs any potential gain such

that the economic realities of OPIS are meaningless in relation

to the tax benefits. See Sala v. United States, supra at 1254;

Rogers v. United States, 281 F.3d 1108, 1116 (10th Cir. 2002). 

The mere presence of a profit potential does not automatically

impute substance where a common-sense examination of the

transaction and the record in toto reflects a lack of economic

substance. Sala v. United States, supra at 1254; Keeler v.

Commissioner, supra at 1219.

E. The Numbers Do Not Add Up

Despite the presence of some profit potential in OPIS, we

find that profit was not a primary purpose of the transaction. 
-36-

The expert testimony presented in this case, while not central to

our determination, loosely supports the notion that OPIS was

intended to generate a loss.

Petitioners and respondent both provided the Court with

expert reports that sought to quantify the profitability of

petitioners’ OPIS transaction. Petitioners’ expert, Dr. Hodder,

performed simulations to calculate the expected probability that

the Blum Trust would realize a profit when it entered into the

OPIS transactions. Dr. Hodder concluded that the deal had a

23.7-percent chance of breaking even before taxes, a 19.1-percent

chance of realizing a 10-percent return ($600,000 profit) and a

7.6-percent chance of realizing a 50-percent return ($3 million

profit). The greatest chance for profit was in the Blum Trust’s

direct investment in UBS shares, which was more than twice as

likely as the GP call option and the equity swap to yield a

profit. Dr. Hodder concluded that the OTM call options were the

least likely to yield a profit, with a mere 11.3-percent chance

of breaking even.

Dr. Hodder focused on the high volatility in UBS stock

prices at the time. Based on his volatility estimates, Dr.

Hodder ultimately concluded that OPIS presented a high-risk

opportunity that had potential for high rewards. He stated that

“[i]t is kind of a long shot gamble, but it is a long shot gamble
-37-

with a huge upside, and I don’t think that is unreasonable, but

it is not something that I would have done.”

Dr. Hodder’s calculations are helpful, but his conclusion

that there is some profit potential does not require us to find

that the transaction has economic substance. See Keeler v.

Commissioner, 243 F.3d at 1219; see also K2 Trading Ventures, LLC

v. United States, ___ Fed. Cl. at ___, 2011 WL 5998957 at *19

(“potential for profit does not in and of itself establish

economic substance--especially where the profit potential is

dwarfed by tax benefits”). His calculations assume a transaction

that was not pre-ordained to create a loss intended specifically

to offset a particular gain.

Respondent’s expert witness, Dr. A. Lawrence Kolbe (Dr.

Kolbe), did not address the question of whether petitioners’ OPIS

transaction had profit potential. Instead, Dr. Kolbe looked at

the net present value and the expected rate of return relative to

the cost of capital. He concluded that the OPIS transaction, as

a whole, was extremely unprofitable. Dr. Kolbe determined that

petitioners’ entry into OPIS resulted in an immediate loss of 36

percent of the invested amount because the securities were priced

far above their value.

A bad deal or a mispriced asset need not tarnish a

legitimate deal’s economic substance. A finding of grossly

mispriced assets or negative cashflow can, however, contribute to
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the overall picture of an economic sham. See, e.g., Country Pine

Fin., LLC v. Commissioner, T.C. Memo. 2009-251.

We note that both experts agreed that the equity swap and

the OTM call options were highly overpriced, and neither was able

to replicate the final payment from the GP call option based on

the record. We also note that the price of UBS stock rose over

48 percent during the course of petitioners’ OPIS transaction,

yet petitioners lost hundreds of thousands of dollars from the

transaction (without even considering fees) and then claimed

millions and millions in losses. The numbers do not add up.

In sum, the OPIS transaction lacked economic substance. It

was intended to create a significant capital loss and worked

exactly as intended. Accordingly, the OPIS transaction is

disregarded for tax purposes and petitioners’ claimed losses are

disallowed.22

22Respondent alleges that petitioners failed to report

$35,311 of income in 1999 in connection with the settlement of

the GP call option. Petitioners claim they were entitled to

allocate $35,311 of fees paid to KPMG and QA to the basis of the

GP call option and to recover those amounts when the Blum Trust

settled the GP call option. Because we find that the OPIS

transaction lacked economic substance and related losses are

disallowed without regard to the value or basis of the assets,

this issue is now moot. See Leema Enters., Inc. v. Commissioner,

T.C. Memo. 1999–18, affd. sub nom. Keeler v. Commissioner, 243

F.3d 1212 (10th Cir. 2001).
-39-

II. Accuracy-Related Penalties

We now turn to respondent’s determination that petitioners

are liable for accuracy-related penalties. A taxpayer may be

liable for a 20-percent accuracy-related penalty on the portion

of an underpayment of income tax attributable to, among other

things, negligence or disregard of rules or regulations. Sec.

6662(a) and (b)(1). The penalty increases to a 40–percent rate

to the extent that the underpayment is attributable to a gross

valuation misstatement. Sec. 6662(h)(1). An accuracy-related

penalty under section 6662 does not apply to any portion of an

underpayment of tax for which a taxpayer had reasonable cause and

acted in good faith. Sec. 6664(c)(1).

Respondent determined that the 40-percent accuracy-related

penalty applies to petitioners’ underpayment resulting from the

disallowed losses reported for 1998. Respondent determined that

a 20–percent accuracy-related penalty applies on account of a

disallowed loss and omitted income for 1999. Petitioners deny

that they were negligent with respect to 1999 and assert that

they meet the reasonable cause exception to the accuracy-related

penalties.

A. Gross Valuation Misstatement

Respondent determined an accuracy-related penalty of 40

percent for a gross valuation misstatement with respect to losses

reported from the OPIS transaction for 1998. A taxpayer may be
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liable for a 40–percent penalty on that portion of an

underpayment of tax that is attributable to one or more gross

valuation misstatements. Sec. 6662(h). A gross valuation

misstatement exists if the value or adjusted basis of any

property claimed on a tax return is 400 percent or more of the

amount determined to be the correct amount of such value or

adjusted basis. Sec. 6662(h)(2)(A)(i). The value or adjusted

basis of any property claimed on a tax return that is determined

to have a correct value or adjusted basis of zero is considered

to be 400 percent or more of the correct amount. Sec.

1.6662–5(g), Income Tax Regs. 

Our holding that the OPIS transaction lacks economic

substance results in the total disallowance of the losses at

issue without regard to the value or basis of the property used

in the OPIS transaction. See Leema Enters., Inc. v.

Commissioner, T.C. Memo. 1999-18. We have held that the gross

valuation penalty applies when an underpayment stems from

deductions or credits that are disallowed because of lack of

economic substance. See Petaluma FX Partners, LLC v.

Commissioner, 131 T.C. 84, 104-105 (2008), affd. in pertinent

part, revd. in part and remanded 591 F.3d 649 (D.C. Cir. 2010). 

In the absence of a decision of the Court of Appeals for the

Tenth Circuit squarely on point, we follow our precedent. 

Consequently, a gross valuation misstatement accuracy-related
-41-

penalty applies to petitioners’ underpayment for 1998 absent a

showing of reasonable cause or some other defense. 

B. Negligence

Respondent also determined that petitioners are liable for

the 20-percent accuracy-related penalty because the 1999

underpayment resulting from a disallowed loss and omitted income

was due to negligence. Sec. 6662(a) and (b)(1). Negligence is

defined as a “lack of due care or the failure to do what a

reasonable and ordinarily prudent person would do under the

circumstances.” Viralam v. Commissioner, 136 T.C. 151, 173

(2011). Negligence is strongly indicated where “[a] taxpayer

fails to make a reasonable attempt to ascertain the correctness

of a deduction, credit or exclusion on a return which would seem

to a reasonable and prudent person to be ‘too good to be true’

under the circumstances.” Sec. 1.6662–3(b)(1)(ii), Income Tax

Regs. The deficiency determined by respondent with respect to

petitioners’ tax return for 1999 is linked to OPIS, a “too good

to be true” transaction.

An underpayment is not attributable to negligence, however,

to the extent that the taxpayer shows that the underpayment is

due to the taxpayer’s reasonable cause and good faith. See secs.

1.6662–3(a), 1.6664–4(a), Income Tax Regs. The burden is upon

the taxpayer to prove reasonable cause. See Higbee v.

Commissioner, 116 T.C. 438, 447-449 (2001). We determine whether
-42-

a taxpayer acted with reasonable cause and in good faith by

considering the pertinent facts and circumstances, including the

taxpayer’s efforts to assess his or her proper tax liability, the

taxpayer’s knowledge and experience and the reliance on the

advice of a professional. Sec. 1.6664-4(b)(1), Income Tax Regs. 

Generally, the most important factor is the extent of the

taxpayer’s effort to assess the proper tax liability. Id.

C. Reasonable Cause and Good Faith

Petitioners seek to defend against both accuracy-related

penalties by asserting that they relied on KPMG to prepare the

tax returns and to assure them that the deductions from the OPIS

transaction were claimed legally. The good-faith reliance on the

advice of an independent, competent professional as to the tax

treatment of an item may negate an accuracy-related penalty. See

sec. 1.6664–4(b), Income Tax Regs. A taxpayer may rely on the

advice of any tax adviser, lawyer or accountant. United States

v. Boyle, 469 U.S. 241, 251 (1985); Canal Corp. & Subs. v.

Commissioner, 135 T.C. 199, 218 (2010).

We look to the facts and circumstances of the case and the

law that applies to those facts and circumstances to determine

whether a taxpayer reasonably relied on advice. See sec.

1.6664–4(c)(1)(i), Income Tax Regs. We have used a three-prong

test to guide that review. Namely, the taxpayer must prove by a

preponderance of the evidence that (1) the adviser was a
-43-

competent professional who had sufficient expertise to justify

reliance, (2) the taxpayer provided necessary and accurate

information to the adviser and (3) the taxpayer actually relied

in good faith on the adviser’s judgment. 106 Ltd. v.

Commissioner, 136 T.C. 67, 77 (2011); Neonatology Associates,

P.A. v. Commissioner, 115 T.C. 43, 99 (2000), affd. 299 F.3d 221

(3d Cir. 2002). We review petitioners’ situation in light of

these factors.

First, KPMG was a well-known international “Big Four”

accounting firm. It had not yet faced the legal and public

scrutiny that ultimately resulted from its structured tax

activities. Mr. Law, who had prepared petitioners’ tax returns

and helped them through the audits of four tax years, referred

Mr. Blum to Mr. Hasting. Accordingly, KPMG and its principals

had sufficient relevant expertise and properly appeared competent

to petitioners.

Petitioners failed, however, to satisfy the second factor. 

Initially, we observe that petitioners provided KPMG and its

principals with all the relevant financial data needed to assess

the correct level of income tax. See sec. 1.6664–4(c)(1)(i),

Income Tax Regs. Accordingly, KPMG had the necessary and

accurate information. Nevertheless, petitioners failed to

satisfy the second factor because KPMG’s opinion relied upon

false representations from Mr. Blum. 
-44-

The most crucial of these representations was that Mr. Blum

independently reviewed the economics underlying the investment

strategy and believed it had a reasonable opportunity to earn a

reasonable pretax profit. Mr. Blum knew this representation was

false, or would have known it if he had read it. The record, as

a whole, reflects that the OPIS transaction was structured to

fabricate a loss. This loss creation was KPMG’s reason for

seeking out Mr. Blum and Mr. Blum’s reason for engaging in the

transaction. Mr. Blum’s representations to KPMG are contrary to

this fact and are part of the guise that was used to fabricate

the intended loss. Petitioners thus failed to satisfy the second

factor because Mr. Blum made false representations to KPMG. 

KPMG’s promotion and facilitation of OPIS concerns the last

factor and the heart of the issue. Petitioners certainly relied

on KPMG, and KPMG’s failures toward its client during and after

the years at issue are well-documented. Nevertheless, we do not

find that petitioners actually relied on KPMG in good faith for

purposes of the reasonable cause and good faith defense to

accuracy-related penalties.

Petitioners point to KPMG’s 99-page tax opinion on the OPIS

transaction, but petitioners did not actually rely on this

opinion. The record does not show when the opinion was

finalized, but we know that it was finalized after petitioners

filed the tax return for 1998. As previously mentioned, KPMG’s
-45-

opinion also relied upon false representations from Mr. Blum. 

The opinion on which petitioners allegedly relied was thus

belated and based on a false representation. 

Petitioners also argue that they received oral advice from

KPMG regarding OPIS. KPMG did not, however, describe the tax

opinion to Mr. Blum when he was entering into the transaction.23

Mr. Blum also did not recount any oral advice that would have

supported his argument of reasonable reliance. Petitioners have

failed to satisfy their burden of showing that they reasonably

relied on oral advice. 

Finally, we hold that petitioners could not have reasonably

relied on KPMG because of its role as a promoter. Reliance is

unreasonable if the adviser is a promoter of the transaction or

suffers from an inherent conflict of interest of which the

taxpayer knew or should have known. Neonatology Associates, P.A.

v. Commissioner, supra at 98. We have held that, when the

transaction involved is the same tax shelter offered to numerous

parties, we adopt the following definition of promoter: “‘an

adviser who participated in structuring the transaction or is

23The engagement letter also did not provide a description

of the opinion letter that would be provided upon request. The

engagement letter stated that the opinion letter would rely on

“appropriate” facts and representations and would provide that

the tax treatment described in the opinion would “more likely

than not” be upheld. It provided no details regarding the tax

treatment to be described in the opinion or the facts and

representations that would be required before the opinion could

be issued.
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otherwise related to, has an interest in, or profits from the

transaction.’” 106 Ltd. v. Commissioner, supra at 79-80 (quoting 

Tigers Eye Trading, LLC v. Commissioner, T.C. Memo. 2009–121). 

KPMG sought clients with significant capital gains and structured

the OPIS deal for petitioners and numerous other clients. KPMG

was a promoter of OPIS and its obvious conflict makes

petitioners’ reliance unreasonable. 

Petitioners claimed an artificial loss of over $45 million. 

This is exactly the type of “too good to be true” transaction

that should cause a savvy, experienced businessman to seek

independent advice. See Neonatology Associates, P.A. v.

Commissioner, 299 F.3d at 234 (“When, as here, a taxpayer is

presented with what would appear to be a fabulous opportunity to

avoid tax obligations, he should recognize that he proceeds at

his own peril.”); New Phoenix Sunrise Corp. & Subs. v.

Commissioner, 132 T.C. at 195. Petitioners’ decision to rely

exclusively on KPMG in structuring, facilitating and reporting

their OPIS transaction was therefore not reasonable. Petitioners

did not take their position in good faith and thus lacked

reasonable cause for that position. Accordingly, we sustain

respondent’s determination that petitioners are liable for

accuracy-related penalties for 1998 and 1999.
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We have considered all remaining arguments the parties made

and, to the extent not addressed, we find them to be irrelevant,

moot, or meritless.

To reflect the foregoing and due to the parties’

concessions,

Decision will be entered

under Rule 155.