internal_revenue_service number release date index number --------------------------- ----------------------------------- ------------------------------------------------------------ -------- --------------------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact ---------------- id no ------------------ telephone number -------------------- refer reply to cc psi b01 plr-137040-16 date march legend x ------------------------------------------- ----------------------------- y -------------------------------------------- -------------------------------------------- trust1 -------------------------------------------------------------------------------------------------- ------------------------------------------------------------------------------------------------------------------- ------------------------ -------------------------- trust2 -------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------- -------------------------- trust3 -------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --- ------------------------------------------------------------------- -------------------------------------------- date ------------------------ date --------------------------- date ---------------------- plr-137040-16 date ------------------------ date --------------------------- date ---------------------- state --------------- dear ----------------- this responds to a letter dated date submitted on behalf of x requesting relief under sec_1362 of the internal_revenue_code the code for an inadvertent termination of its s_corporation_election facts according to the information submitted and representations within x was formed and made a valid s_corporation_election on date under the laws of state y was formed and made a valid s_corporation_election on date under the laws of state on date x acquired all of the stock in y x made a valid qualified_subchapter_s_subsidiary qsub election for y effective date at the time of x’s s_corporation_election trust1 a grantor_trust was the sole shareholder of x on date trust1 transferred x shares to trust2 trust2 made a valid electing_small_business_trust esbt election effective date on date the assets of trust2 were transferred to trust3 trust3 was not a valid s_corporation shareholder thereby causing x’s s_corporation_election to terminate effective date x represents that trust3 was eligible to make an electing_small_business_trust esbt election as of date however the trustee of trust5 inadvertently failed to file an esbt election x represents that trust3 has been treated as if a valid esbt election had been made on date and has at all times since date met the requirements of an esbt under sec_1361 x further represents that trust3 has filed its income_tax returns consistent with being an esbt x represents that the circumstances resulting in the failure to make the esbt election was inadvertent and not motivated by tax_avoidance or retroactive tax planning x further represents that x has filed its income_tax returns consistent with having a valid s election in effect for all taxable years since x elected to be an s_corporation x represents that other than the failure to make a valid esbt election on date x has qualified as a small_business_corporation at all times since its election on date lastly x and its shareholders agree to make any adjustments required as a condition of obtaining relief under sec_1362 that may be required by the secretary plr-137040-16 law and analysis sec_1361 provides that an s_corporation is a small_business_corporation for which an election under sec_1362 is in effect sec_1361 provides that the terms small_business_corporation means a domestic_corporation which is not an ineligible_corporation and which does not a have more than shareholders b have as a shareholder a person other than an estate a_trust described in sec_1361 or an organization described in sec_1361 who is not an individual c have a nonresident_alien as a shareholder and d have more than class of stock sec_1361 generally provides that a qsub shall not be treated as a separate corporation and all assets liabilities and items of income deduction and credit of a qsub shall be treated as assets liabilities and such items as the case may be of the s_corporation sec_1361 defines a qsub as a domestic_corporation which is not an ineligible_corporation if percent of the stock of the corporation is owned by the s_corporation and the s_corporation elects to treat the corporation as a qualified_subchapter_s_subsidiary sec_1362 provides that an election under sec_1362 shall be terminated whenever at any time on or after the 1st day of the 1st taxable_year for which the corporation is an s_corporation such corporation ceases to be a small_business_corporation sec_1361 of the code provides that for purposes of sec_1361 a_trust all of which is treated under subpart e of part i of subchapter_j of this chapter as owned by an individual who is a citizen or resident_of_the_united_states may be an s_corporation shareholder sec_1361 provides that for purposes of sec_1361 an esbt is a permissible shareholder sec_1361 provides that an election under sec_1361 e shall be made by the trustee any such election shall apply to the taxable_year of the trust for which made and all subsequent taxable years of such trust unless revoked with the consent of the secretary sec_1_1361-1 provides that the trustee of an esbt must make the esbt election by signing and filing with the service_center where the s_corporation files its income_tax return a statement that meets the requirements of sec_1_1361-1 plr-137040-16 sec_1_1361-1 provides that the trustee of an esbt must file the esbt election within the time requirements prescribed in sec_1_1361-1 for filing a qsst election generally within the 16-day-and-2-month period beginning on the day that the stock is transferred to the trust sec_1_1361-3 prescribes the time and manner for making an election to be classified as a qsub sec_1362 provides that an election under sec_1362 shall be terminated whenever at any time on or after the 1st day of the 1st taxable_year for which the corporation is an s_corporation such corporation ceases to be a small_business_corporation sec_1362 provides in relevant part that if an election under sec_1362 by any corporation was not effective for the taxable_year for which made determined without regard to sec_1362 by reason of a failure to meet the requirements of sec_1361 the secretary determines that the circumstances resulting in such ineffectiveness or termination were inadvertent no later than a reasonable period of time after discovery of the circumstances resulting in such ineffectiveness or termination steps were taken so that the corporation for which the termination occurred is a small_business_corporation and the corporation for which the termination occurred and each person who was a shareholder in such corporation at any time during the period specified pursuant to sec_1362 agrees to make the adjustments consistent with the treatment of such corporation as an s_corporation as may be required by the secretary with respect to such period then notwithstanding the circumstances resulting in such ineffectiveness or termination such corporation shall be treated as an s_corporation during the period specified by the secretary conclusion based solely on the facts submitted and the representations made we conclude that the failure of trust3 to make an esbt election effective date caused an inadvertent termination of x’s s_corporation_election within the meaning of sec_1362 on date pursuant to the provisions of sec_1362 x will be treated as continuing to be an s_corporation beginning on and after date and y will continue to be a qsub of x effective date unless x's s_corporation_election is otherwise terminated under sec_1362 this letter_ruling is subject_to the condition that within days from the date of this letter an election to treat the trust3 as an esbt effective date must be made with the appropriate service_center a copy of this letter should be attached to the esbt election if this condition is not met then this ruling is null and void furthermore if this condition is not met x must send notification that its s election has terminated to the service_center with which x’s s election was filed plr-137040-16 except as specifically ruled upon above we express or imply no opinion concerning the federal tax consequences of the facts of this case under any other provision of the code specifically we express or imply no opinion regarding x’s eligibility to be an s_corporation this ruling is directed only to the taxpayer who requested it according to sec_6110 this ruling may not be used or cited as precedent pursuant to the power_of_attorney on file with this office we are sending a copy of this letter to your authorized representatives sincerely david r haglund david r haglund branch chief branch office of the associate chief_counsel passthroughs special industries enclosures copy of this letter copy of this letter for sec_6110 purposes


department of the treasury internal_revenue_service washington d c date cc te_ge eoeg et2 cor-115310-00 o f f ic e o f c h ief c o u n sel number info release date dear this responds to your request for general information on the issue of whether lodging provided by groundskeeping duties at a rural field station owned by the university is excludable from that individual’s gross_income under sec_119 of the internal_revenue_code the code to an individual who performs as a general matter apart from the procedure for issuing a formal opinion as described in revproc_2000_1 2000_1_irb_4 the internal_revenue_service is not able to provide binding legal advice applicable to particular taxpayers we have enclosed a copy of revproc_2000_1 for your reference in the event that you decide to request formal guidance such as a private_letter_ruling you should follow the procedures set forth in revproc_2000_1 in the absence of a request for formal guidance we are only able to provide general information accordingly in response to your request we have reviewed the facts provided to us and set forth below general information which we hope will be helpful to you according to the information you provided the university has an agreement with an individual to perform groundskeeping duties at a rural field station owned by the university the groundskeeper is required to live on the premises located at the field station the agreement specifies that in return for providing groundskeeping services the groundskeeper is provided housing and utilities valued at dollar_figure per month and is permitted to use a barn and pasture valued at dollar_figure per month the groundskeeper receives no other remuneration for the services provided sec_61 of the internal_revenue_code the code provides that except as otherwise provided gross_income means all income from whatever source derived including fringe_benefits such as employer-provided housing cor-115310-00 sec_1_61-2 of the income_tax regulations the regulations provides that the value of living quarters that an employee receives in addition to the employee’s salary constitutes gross_income unless it is furnished for the convenience_of_the_employer and meets the conditions specified in sec_119 of the code and the regulations thereunder sec_1_61-21 of the regulations provides that to the extent a particular fringe benefit is specifically excluded from gross_income pursuant to another section of subtitle a of the code that section shall govern the treatment of the fringe benefit examples of excludable fringe_benefits include meals or lodging furnished to an employee for the convenience_of_the_employer under code sec_119 sec_119 of the code provides that there shall be excluded from the gross_income of an employee the value of any lodging furnished to the employee the employee’s spouse or any of the employee’s dependents by or on behalf of the employer for the convenience_of_the_employer but only if the employee is required to accept such lodging on the business_premises of the employer as a condition_of_employment sec_1_119-1 of the regulations provides that the value of lodging furnished to an employee by the employer is excludable from the employee’s gross_income if three tests are met the lodging is furnished on the business_premises of the employer the lodging is furnished for the convenience_of_the_employer and the employee is required to accept such lodging as a condition_of_employment with respect to the convenience_of_the_employer and the condition_of_employment tests the courts have held that they are essentially the same see eg bob jones university v united_states f 2d pincite ct_cl 71_tc_216 aff’d per curiam 614_f2d_398 5th cir these tests are satisfied if the employee is required to accept the lodging in order to enable him properly to perform the duties of his employment lodging will be regarded as provided to enable the employee properly to perform the duties of his employment when for example the lodging is furnished because the employee is required to be available for duty at all times or because the employee could not perform the services required of him unless he is furnished such lodging lodging provided in order to ensure that the employee is available for duty at all times and or because it is cor-115310-00 necessary to enable the employee to perform the services required of him will also be regarded as provided for a substantial noncompensatory business reason see eg revrul_68_354 1968_2_cb_60 if the three tests above are not met code sec_119 provides another alternative for exclusion_from_gross_income of the value of qualified_campus_lodging furnished to an employee of an educational_institution pursuant to sec_119 the term qualified_campus_lodging means lodging to which subsection a of sec_119 does not apply ie lodging which does not meet the three tests above which is located on or in the proximity of a campus of the educational_institution and which is furnished to the employee his spouse and any of his dependents by or on behalf of such institution for use_as_a_residence pursuant to sec_119 the fair_market_value of the qualified_campus_lodging provided to an employee of an educational_institution will not be treated as income to the employee provided that the employee pays rent for such lodging in an amount that equals or exceeds five percent of the fair_market_value of the lodging if the employee does not pay rent of at least five percent of the appraised value he or she receives taxable_income in the amount of the difference between the rent paid and the lesser_of five percent of the fair_market_value of the lodging or the average rental paid_by individuals not affiliated with the institution for lodging provided by the institution that is comparable to that provided the employee the attorney assigned to this matter is lynne camillo badge she can be reached at sincerely jerry e holmes chief employment_tax branch office of the associate chief_counsel tax exempt and government entities


internal_revenue_service number release date index numbers -------------------------- ----------------------------------- ------------------------------------------------ ----------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact ---------------------- id no ----------------- telephone number -------------------- refer reply to cc psi b03 plr-106414-11 date may x --------------------------------------- legend country --------------------- date ---------------------- dear ---------------- this letter responds to your letter dated date and subsequent correspondence submitted on behalf of x by x’s authorized representative requesting an extension of time under sec_301_9100-3 of the procedure and administration regulations to file an election to treat x as a partnership for federal tax purposes under sec_301_7701-3 facts according to the information submitted x was formed under country law on date as a limited_liability partnership x intended to be treated as a partnership for federal tax purposes effective date however x inadvertently failed to timely file a form_8832 entity classification election law and analysis sec_301_7701-3 provides that a business_entity that is not classified as a corporation under sec_301_7701-2 or an eligible_entity can elect its classification for federal tax purposes as provided in sec_301_7701-3 an eligible plr-106414-11 entity with at least two members can elect to be classified as an association and thus a corporation under sec_301_7701-2 or a partnership sec_301_7701-3 provides that unless it elects otherwise a foreign eligible_entity is a a partnership if it has two or more members and at least one member does not have limited_liability b an association if all members have limited_liability or c disregarded as an entity separate from its owner if it has a single owner that does not have limited_liability sec_301_7701-3 provides that for purposes of sec_301_7701-3 a member of a foreign eligible_entity has limited_liability if the member has no personal liability for the debts of or claims against the entity by reason of being a member sec_301_7701-3 provides in part that an eligible_entity may elect to be classified other than as provided under sec_301_7701-3 or to change its classification by filing form_8832 with the service_center designated on form_8832 sec_301_7701-3 provides that an election made under sec_301 c i will be effective on the date specified by the entity on form_8832 or on the date filed if no date is specified on the election form the effective date specified on form_8832 can not be more than days prior to the date on which the election is filed and can not be more than months after the date on which the election is filed if an election specifies an effective date more than days prior to the date on which the election is filed it will be effective days prior to the date it was filed sec_301_9100-1 provides that the commissioner has discretion to grant a reasonable extension of time under the rules set forth in sec_301_9100-2 and sec_301_9100-3 to make a regulatory election or a statutory election but no more than six months except in the case of a taxpayer who is abroad under all subtitles of the code except subtitles e g h and i sec_301_9100-1 defines a regulatory election to include an election whose due_date is prescribed by a regulation published in the federal_register sec_301_9100-2 provides automatic extensions of time for making certain elections sec_301_9100-3 provides extensions of time for making elections that do not meet the requirements of sec_301_9100-2 sec_301_9100-3 provides that requests for relief subject_to sec_301_9100-3 will be granted when the taxpayer provides the evidence including affidavits described in sec_301_9100-3 to establish to the satisfaction of the commissioner that the taxpayer acted reasonably and in good_faith and the grant of relief will not prejudice the interests of the government plr-106414-11 conclusion based solely on the information submitted and the representations made we conclude that the requirements of sec_301_9100-3 have been satisfied as a result x is granted an extension of time of days from the date of this letter to make an election to be treated as a partnership for federal tax purposes effective date x should make the election by filing a properly executed form_8832 with the appropriate service_center a copy of this letter should be attached to the form_8832 a copy is enclosed for that purpose except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent in accordance with a power_of_attorney on file with this office we are sending a copy of this letter to your authorized representative the ruling contained in this letter is based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the ruling_request it is subject_to verification on examination sincerely associate chief_counsel passthroughs special industries by ________________________________________ james a quinn senior counsel branch office of associate chief_counsel passthroughs special industries enclosures copy of this letter copy for sec_6110 purposes cc


t c memo united_states tax_court bcp trading and investments llc william t esrey trading partners lp a partner other than the tax matters commissioner of internal revenue respondent partner petitioner v docket nos filed date robert h albaral david g glickman george m clarke iii and mireille r oldak for petitioner george m gerachis michael l charlson david c cole and juliana d hunter for intervenor kalkhoven pettit trading partners lp tax_matters_partner robert e mckenzie and kathleen m lach for pcmg trading partners vi lp a partner other than the tax_matters_partner these attorneys also represent pcmg trading partners xii lp and kalkhoven pettit trading partners lp roy wulf ewan d purkiss mary e wynne kevin g croke l katrine shelton and henry c bonney jr for respondent memorandum findings_of_fact and opinion holmes judge these cases are about a purported partnership that used almost perfectly offsetting bets on foreign_currency to pass over dollar_figure billion of tax losses through to its partners--partners who contributed only dollar_figure million these massive losses were passed through to some very wealthy corporate executives who used them to eliminate millions of dollars in tax the commissioner thinks this is just another son-of-boss deal the partners’ first defense is that we lack jurisdiction they then argue that if we do have jurisdiction the commissioner caught them too late and if this statute-of-limitations argument fails they say son-of-boss is a variation of a slightly older alleged tax_shelter known as boss an acronym for bond and options sales strategy there are a number of different types of son-of-boss transactions but what they all have in common is the transfer of assets encumbered by significant liabilities to a partnership with the goal of increasing basis in that partnership the liabilities are usually obligations to buy securities and typically are not completely fixed at the time of transfer this may let the partnership treat the liabilities as uncertain which may let the partnership ignore them in computing basis if so the result is that the partners will have a basis in the partnership so great as to provide for large--but not out-of-pocket--losses on their individual tax returns this complex transaction was really just about diversification and that’s a perfectly permissible business_purpose findings_of_fact a the player sec_1 kalkhoven and pettit son-of-boss deals are usually complex--intentionally so according to the irs and this particular web was spun by a group of especially sophisticated and wealthy corporate executives partners and partnerships we begin unraveling it by looking first at two corporate executives who owned multiple partnerships in these cases--kevin kalkhoven and danny pettit after high school kalkhoven went straight to work for ibm as a programmer and was later promoted to system analyst other companies took notice of his abilities and he was hired as the marketing director of a computer time-sharing company the company soon promoted him to coo and made him responsible for reshaping the company it didn’t take long for other companies to try to poach kalkhoven--including jds uniphase corporation jds --which brought him in as its ceo and tasked him with the job of turning it around too in and he had worked his way up to become the cochairman and ceo of jds pettit also had a very successful career he earned his undergraduate degree in minnesota and an mba from pepperdine after pepperdine pettit worked his way up the corporate ranks through various positions and found his niche as an artist of the turnaround later pettit accepted a position as cfo at jds and remained in that position until when jds re-purposed him jds grew quickly during kalkhoven and pettit’s tenure and there soon was a need for someone to run its european operations jds thought pettit was just the man for the job so it made him president of european operations he moved back to the states in early and worked on a special project--finding a new direction for the corporation--until he retired in date as executives at jds kalkhoven and pettit were extremely well compensated and part of their compensation was lucrative stock_options they partially exercised these options in and on their and tax returns kalkhoven and pettit reported income of year type of income income from salary capital_gain sec_2001 income from salary capital_gains kalkhoven dollar_figure big_number big_number big_number pettit dollar_figure big_number big_number big_number esrey and lemay william esrey and ronald lemay are the other two corporate executives in these cases both were longtime executives at the telecommunication giant sprint corporation sprint esrey came to sprint as an executive vice president of corporate planning but was promoted to cfo and in promoted again to ceo lemay began his career as a mere lawyer and earned his law degree from the university of arkansas in he went to work as a lawyer for southwestern bell and became that baby bell’s chief legal counsel in arkansas but his aptitude for management--and indeed what turned out to be entrepreneurial talents--stretched out against the confines of a jd and he decided in to leave law for a management position at southwestern bell it was the perfect time-- at t was about to be split into the seven baby bell companies and the telecommunications revolution was about to be unleashed he moved to at t and became its vice president in he moved again to what would become sprint and in became sprint’s coo and with the expectation that he would succeed esrey as ceo as coo he was involved in every significant strategic decision and by the time he left sprint it had grown from a local phone company to a giant in the industry raking in dollar_figure billion in revenue with offices in countries it all crashed for esrey and lemay in when they were fired for using questionable tax strategies--including the one at issue here like kalkhoven and pettit esrey and lemay were well compensated during their time at sprint each held over dollar_figure million in sprint stock_options and on their and tax returns they reported income of year type of income income from salary capital_gain sec_2001 income from salary capital_gains esrey dollar_figure big_number big_number big_number lemay dollar_figure big_number big_number big_number needless to say all four executives were sitting on enormous amounts of taxable_income in and in those years successful businessmen like these executives accountants and other tax sharpies viewed such large taxable incomes as neither good fortune nor great reward but as a big problem that called for an expensive solution enter ernst young e y and its complex solution ernst young llp e y had an all-too-good-to-be-true way to avoid the monstrous tax bills that usually follow the receipt of enormous amounts of taxable income in e y hatched a group called value ideas produce extraordinary results--viper through viper e y designed and marketed very high-fee tax strategies that very high-net-worth clients could use to very nearly eliminate or at least defer their tax bills viper at first aimed only at clients with at least dollar_figure million to shelter but that number later grew to dollar_figure million viper measured its success not by the revenue it generated for clients but by the amount of tax losses it sold one particularly lucrative strategy it used was called the contingent deferred swap cds the goal of a cds was to generate tax losses and within e y it was referred to as the loss generator cds was not viper’s own serpent’s egg--the idea for it seems to have slithered to them from something called the private capital management group pcmg a group that seems to have multiplied into many partnerships even before these cases began robert coplan an e y executive described how cds was supposed to work the client enters into a trading partnership which invests in swap transactions with the economic results being partly contingent on movements in either the s p index or currencies in addition the partnership engages in a large volume of short term trading activities accrued payments on the swaps are deducted as ordinary business_expenses in year one if the swap is prematurely terminated after viper later shed its skin and renamed itself the less acronymically deft strategic individual solutions group sisg months in the following year the gain produced is long-term_capital_gain between and kalkhoven pettit esrey and lemay--and almost other rich e y clients--used cds which generated more than dollar_figure million in fees for e y cds was complex to implement and paper and e y used pcmg and a firm called bolton capital planning to implement it in pcmg stopped working with e y and bolton capital took over completely bolton capital was owned and run by the next character in our story one charles bolton bolton was instrumental in implementing cds and later cds plus it was a very lucrative setup for bolton and he made millions in just a few years viper was by this time bruising the heel of the irs and the enmity put between tax collector and tax- shelter promoter made it only a matter of time before the irs turned to bruising its head in bolton was indicted for conspiracy to defraud the irs and for making false statements and obstructing the administration of the internal revenue laws all for his role in promoting cds and the tag-on to cds that’s at issue in these cases cds plus the indictment also charged bolton with making millions on the transactions and using them to lower his own tax bills he pleaded guilty in coplan was convicted of conspiracy to commit tax_evasion and making false statements to the irs in connection with cds plus see 703_f3d_46 2d cir there’s one final key player in our story belle six started off working in viper but moved to pcmg in to be its liaison with e y when pcmg transferred its part of the cds business to bolton capital six became the liaison between bolton capital and e y like coplan and bolton six didn’t escape legal trouble in she too was indicted and pleaded guilty to charges of conspiracy to defraud the united_states in connection with her role in marketing and promoting the tax_shelters offered by e y pcmg and bolton capital see united_states v six no cr s d n y she testified against coplan at his trial b bcp cds plus cds only converted ordinary_income into capital_gains and kicked the collection date down the road a year e y clients who bought the deal would still have to pay some tax eventually e y put together cds plus to solve this problem and it’s cds plus that’s at issue in these cases since kalkhoven pettit esrey and lemay had all already used cds it wasn’t hard for e y to get them to tack on cds plus with enormous tax bills looming the record and stipulations show none of them bothered to ask any real questions about what they were dumping their money into everyone was focused on the tax benefits cds plus promised esrey and lemay even stipulated that they just participated in cds plus to lower their tax bills from exercising their sprint stock_options and unwinding their cds transactions there was no realistic possibility of profit esrey didn’t ask whether cds plus could generate any pretax profits and no one at e y brought up the topic even though he entrusted a good portion of his money to cds plus lemay doesn’t remember discussing profit potential with anyone at e y either at trial esrey admitted that cds plus was bogus and lemay said it was a fraud kalkhoven and pettit stipulated that e y described the tax advantages of buying into cds plus but e y didn’t mention anything about making an actual profit kalkhoven and pettit didn’t think to ask either e y made sure everyone signed nondisclosure agreements so they couldn’t discuss cds plus with anyone outside e y forming bcp to work cds plus needed a central partnership that everyone could use to artificially inflate his basis and generate tax losses in date bolton capital formed bcp trading and investments inc bcp officially bcp’s business purpose was to trade on margins bcp had members including bolton capital itself the other client members--all either limited_liability companies or limited partnerships--were e y clients and almost all of them had already used cds transactions bolton capital was the managing member the bcp operating_agreement was between bolton capital and the other client members bolton signed the agreement for bolton capital but he also was the managing director or general_partner for all the client members so he signed the operating_agreement for them too the operating_agreement gave bolton capital all powers and rights necessary proper convenient or advisable to effectuate and carry out the purposes business and objectives of the company the other client members weren’t permitted to take part in the management or control of the business or affairs of the company including without limitation voting to remove the managing member and they didn’t have any voice in the management or operation of any company property the four client members that did not engage in cds aren’t relevant to these cases kalkhoven pettit esrey and lemay all owned a number of the bcp client members which they used to put cds plus into action kalkhoven and pettit jointly owned kalkhoven pettit trading partners kp1 kalkhoven pettit trading partners kp2 and pcmg trading partners xii pcmg xii esrey owned william t esrey trading partners lp wtetp and private capital management group v pcmg v and lemay owned ronald t lemay trading partners lp rtltp and private capital management group vi pcmg vi bolton bought into the action too in he bought a interest in pcmg xii and in interests in both kp1 and kp2 to summarize kalkhoven pettit and bolton’s interests in bcp looked like this esrey and lemay’s interests in bcp looked like this how it worked to implement cds plus e y had the client members buy nearly offsetting contingent assets and liabilities and contribute them to bcp each client member took a basis in bcp equal to the contingent assets it contributed without reducing its basis by the contingent liabilities after the contingency period for the assets and liabilities ended--usually with no economic consequence--a client member would terminate its interest in bcp and receive a distribution with a basis equal to the contingent assets the client member originally contributed the idea was to create property with a very high basis relative to its actual value a digital options the contingent assets and liabilities here were the sort of digital options familiar to connoisseurs of son-of-boss deals see eg ltd v commissioner tcmemo_2013_49 between july and date pcmg vi pcmg xii wtetp kp1 and kp2 and the other client members entered into european-style digital-option spread trades in foreign_currencies with the code says that a partner’s basis in a partnership must equal the basis of the property the partner contributed to the partnership minus any liabilities the partner contributed sec_722 sec_752 all section references are to the internal_revenue_code and all rule references are to the tax_court rules_of_practice and procedure unless otherwise indicated refco capital markets ltd refco and contributed them to bcp the options were paired--long options bought by the client members and short options sold to refco by the client members the long options were bought at the same time and for the same currency as the short options but had very small differences in the strike_price this created a one pip spread there were option pairs each client member was required to pay refco for the long options and to be paid_by refco for the short options but the payments from refco were always less and the payments were netted refco just reduced each premium it was entitled to receive by the corresponding premium it had to pay client members paid a total premium premiums_paid by the client members less the premiums refco owed of dollar_figure million for cds plus there are two basic types of options--american and european a european option can be exercised only at maturity an american option can be exercised anytime during the life of the option a digital option has only two possible outcomes at expiration some fixed payoff amount or nothing digital options are typically also european-style options which means that they can be exercised only on the option's expiration date markell co v commissioner tcmemo_2014_86 ltd at n one long option and the corresponding short option made up an option pair a pip stands for percentage in point and is the smallest pricing increment used in foreign exchange markets for a u s dollars japanese yen trade a pip is if the japanese yen is trading at dollar_figure yen dollar and weakens by one pip the new price will be all the options were digital options that means that a client member would receive a predetermined payoff on his long option if the currency’s spot_rate was at or above the option’s strike_price but the option would expire worthless if the spot_rate was less than the strike_price on his short option however a client member would have to pay refco a predetermined payoff if the currency’s spot_rate was at or above the option’s strike_price refco was on the opposite side of these options it would have to pay on the client’s call option if the currency’s spot_rate was at or above the option’s strike_price but it would get paid on the client’s put option if the spot_rate was at or above the option’s strike_price remember that the clients’ long options were always a little more in nominal terms than the short options and that the strike prices of the two options were very close this made the two most likely outcomes that both the client’s call and refco’s put option would be in the a call option gives the buyer the right to purchase a security eg stock or foreign_currency at a particular price some point in the future option buyers pay a premium for that right if the actual price turns out to be higher than the price where the option was struck strike_price then the option buyer makes money if the actual price is lower than the strike_price the call option expires worthless a put option is the opposite it gives the owner the right to sell at a particular strike_price a taxpayer would buy a put option if they think the price of a particular currency will go down when buying a call option it’s common to say you are going long and when buying a put option it’s common to say you are going short money--if so the client would make some money on the difference or that both would expire out of the money--if so refco got to keep the spread refco was also effectively in charge of the deal--it got to determine the spot price on the expiration date all by itself albeit in good_faith and in a commercially reasonable manner for option pairs the short-option payout was of the long-option payout the options were the only assets the client members contributed to bcp and on the date they contributed them each option was out of the money meaning that if the prices of the currencies didn’t change the options would expire worthless b creating tax losses the last stage is where using a partnership and the tax rules for partnerships became critical to the scheme and how enormous tax losses magically appeared the client members all claimed their bases in bcp equaled the values of long option premiums they contributed but without any reduction for the value of the short-option liabilities the partnership assumed on their behalf e y told clients to liquidate their interests in bcp the year they wanted to recognize their tax lossesdollar_figure in exchange for the withdrawing client member’s interest bcp the bcp operating_agreement allowed each client member to withdraw from bcp by submitting a written withdrawal request each withdrawing client continued distributed japanese yen and set its basis equal to the basis the client member originally claimed in bcp in client members--including pcmg vi and pcmg xii--withdrew from bcp and received japanese yen in liquidating distributions the next year wtetp kp1 kp2 and the remaining client members withdrew and received japanese yen that left bcp without any assets or liabilities and it went out of existence shortly afterwards in date after they received the yen client members turned around and sold them at their real value the long-option premiums that the client members contributed totaled over dollar_figure billion but the total premium they paid refco was only dollar_figure million the dollar_figure billion was the whole point of cds plus the client members used that dollar_figure billion--after converting it into japanese yen--to claim enormous losses these losses flowed through to the wealthy e y clients who actually owned the client members--including kalkhoven pettit esrey and lemay--who claimed them on their individual tax returns this was all done to significantly reduce their tax_liabilities kalkhoven earned over dollar_figure million in but paid only dollar_figure million in tax because of his continued member was to be paid an amount equal to its book capital_account losses from pcmg xii kp1 and kp2 in he earned almost dollar_figure million but paid only around dollar_figure million in taxes pettit fared pretty well too in and he took home almost dollar_figure million but paid only dollar_figure million in tax because of the losses he claimed from pcmg xii kp1 and kp2 esrey made almost dollar_figure million in and but thanks to more than dollar_figure million in losses from pcmg v and wtetp he received tax refunds of almost dollar_figure million not to be outdone lemay reported earnings_of over dollar_figure million in and but got refunds of around dollar_figure million fees and lack of profit potential the client members all paid a steep price for these complicated maneuvers they paid e y and bolton capital more than dollar_figure million to participate in cds plus--more than they realistically could have made the most all the client members could have collected if every one of the long and short options expired in the money was around dollar_figure million--excluding the very small possibility that a long option would expire in the money while its short option expired out of the money or in the sweet spot coplan told others at e y that the transaction fees would be more than any payoff the client members could receive from cds plus six and bolton also both admitted later that cds plus couldn’t make money e y based its fees on the amount of losses a client wanted to generate according to its engagement letter e y charged client members a fee of of whatever loss cds plus generated kalkhoven and pettit’s client members-- kp1 kp2 and pcmg xii--paid almost dollar_figure million in fees to e y and bolton capital to get in on cds plus pettit testified that he wasn’t concerned about these fees though he just wanted e y to take care of everything esrey’s two client members paid over dollar_figure million and lemay’s two paid over dollar_figure million to e y and bolton capital client members also paid the net premium to refco and dollar_figure for an opinion letter c investigation of e y promoter audit it didn’t take long for the commissioner to begin looking into e y in date the irs began a promoter audit of e y for failing to provide information and keep a list of advisees for reportable_transactions in date the irs expanded the promoter audit to include promoting abusive tax sheltersdollar_figure the irs sent e y summonses and deposed people during the audit the expansion also included an audit of e y under sec_6694 understatement of taxpayer’s liability by tax_return_preparer penalties for aiding_and_abetting understatement_of_tax liability action to enjoin tax_return_preparers and actions to enjoin specified_conduct related to tax_shelters and reportable_transactions including coplan the record doesn’t contain a great deal of information about the promoter audit and there’s some evidence to suggest that at least some records were destroyed--pursuant to irs recordkeeping policy--by the time these cases came to trial we don’t have the final closing_agreement between the irs and e y either what we do know is that pursuant to summonses e y provided lists of its tax-shelter clients and their transactions to the irs e y was concerned about using the word penalty in the closing_agreement and it seems that the settlement price was increased so there would be no mention of penalty by the time the irs and e y reached a settlement in date criminal and senate investigation while the irs was conducting its civil investigation the new york times published a scathing article in date titled big accounting firm’s e y tax plans help the wealthy conceal income that predicted e y’s tax_shelters wouldn’t stand up to an audit it didn’t take long for the article to draw the eye of the u s attorney’s office in manhattan and a few days later it called e y’s general counsel and requested that it keep any documents relevant to the tax_shelters in the new york times article e y quickly hired a criminal attorney but between date and date there wasn’t any contact between the u s attorney and e y in date the senate got in on the action too the senate permanent subcommittee on investigations told e y to give it everything e y had on its tax-sheltering activities in october of that year an e y client who participated in another tax_shelter testified before the senate committee on finance and the next month the subcommittee heard testimony from representatives of major accounting firms--including e y the subcommittee later produced a report called the role of professional firms in the u s tax_shelter industry in date the u s attorney for the southern district of new york sdny opened a grand-jury investigation into e y’s sale of tax_shelters that june sdny met with e y’s attorney to discuss the investigation four former e y partners ultimately were indicted including coplan bolton was added to the list the next year it was as a result of this criminal investigation that bolton six and coplan were all either convicted or pleaded guilty for their roles in promoting cds plus the prosecutors asked e y to voluntarily provide information to help in the investigation but in july the grand jury issued its first subpoena to e y that same month e y wrote to kalkhoven pettit esrey and lemay told them about the criminal investigation and moved their representation to fulbright jaworski e y itself was never indicted and finally wrapped up the problem when it signed a nonprosecution agreement but that was just the u s attorney’s office--not the irs in date the irs told e y that it had not made a criminal_referral the next day sdny told the attorney representing e y in the criminal case that the irs had decided not to open an investigation into criminal charges but in may and date the irs civil team working on the promoter audit met several times with the irs criminal_investigation_division cid the civil-audit team learned then that cid was investigating several e y partners for selling tax_shelters but those partners were never actually indicted in date the irs told e y’s attorney that cid still wasn’t investigating e y although there’s some evidence suggesting that the civil team and cid shared information in date cid issued a summons to coplan but that was something of a red herring--cid was looking into another e y partner who was selling another type of tax shelter--not cds or cds plus cds and bcp investigation within this swirl of investigations we have to focus on the one that aimed at bcp the parties agree that by e y was aware that the irs was auditing cds e y formed an internal task force to deal with the audit but hired skadden arps to help out in date the parties stipulated that no one on the irs cds audit team knew anything about a potential criminal investigation until date and no one on the team knew that the criminal investigation implicated any e y partners involved in cds or cds plus until indictments were announced in date even before then in the irs made a global_settlement offer for cds transactions extending the statute_of_limitations all these investigations took a long time and the irs wanted to keep the statute_of_limitations open for bcp’s and tax years so the irs asked bolton capital to extend the statute bcp and its client members were willing to do so in november and date six told kalkhoven pettit esrey and lemay that bolton capital planned to extend the statute_of_limitations at the partnership level unless she heard otherwise from them and that e y itself recommended bolton capital sign the extensions when no one objected bolton signed the extensionsdollar_figure the extensions were on forms 872-p consent to extend bolton signed the extension in his capacity as managing direct of bolton capital_tax matters partner of kp1 which was the tax_matters_partner for bcp under the tax equity and fiscal responsibility act of tefra pub_l_no sec_402 stat pincite any partnership including all the partnerships that brought these cases must designate one of its partners as the tax_matters_partner tmp to handle its administrative issues with the commissioner and manage any resulting litigation sec_6231 the time to assess tax attributable to partnership items this extended the period the irs could assess any federal_income_tax attributable to the partnership items of bcp against any partner of the partnership pcmg vi pcmg xii wtetp kp1 and kp2 were all partners of the partnership over the next several years bolton signed a number of extensions for bcp’s tax_year he signed extensions on date extension signed by bolton date date date date date date extension signed by irs date date date date date date extension expired date date date date date and for bcp’ sec_2001 tax years bolton signed forms 872-p on date extension signed by bolton date date date date date extension signed by irs date date date date date extension expired date date date date these extensions ultimately kept the statute_of_limitations open for bcp and its client members through date for the both the and tax years bolton and six knew about their own potential liability as promoters of cds plus and other e y tax_shelters when they signed these extensions the parties stipulated that by at least date both bolton and six knew about the investigation of e y’s tax_shelters although it wasn’t until may or july of after bolton signed all but two pairs of extensions--that bolton and six became concerned about their personal liability and hired counsel bolton wasn’t the only one who signed extensions though kalkhoven pettit esrey and lemay all signed a different version of form_872 numbered 872-i consent to extend the time to assess tax as well as tax attributable to items of a partnership these forms 872-i extended the time for assessing tax on any return s made by or for kalkhoven pettit esrey and lemay it also extended the time for assessing any_tax attributable to any partnership items affected items computational adjustments and partnership items converted to nonpartnership_items beginning in date kalkhoven and pettit each signed nine pairs of extensions to keep their tax years open through the end of they signed the last extensions in date tax years covered date extension signed by kalkhoven pettit date extension signed by irs date extension expired november date may date january date date date february november date date date date date february date date date date date date date date date date february august date date date date lemay signed five forms 872-i tax years covered date extension signed by ledate date date date date date expired date extension date extension signed by irs date date date date date date date date date days after consent revoked esrey signed the most extensions and kept his tax years open through date tax years covered date extension signed by esrey date date date july date date date date date date date date expired date extension date extension signed by irs date date date date date date date date date date date date date date date date date date june date date date date date kalkhoven and pettit weren’t ignorant of the e y investigations when they signed their extensions even when they signed the first extensions in date and they were still represented before the irs by e y they knew something was wrong with their e y tax strategies back in e y told them it was turning over documents to the irs pursuant to summonses related to certain transactions in which you were involved e y also told them to contact mckee nelson llp the outside law firm e y engaged to assist it in the matter if either of them had any questions there was also the new york times article published in date by date kalkhoven and pettit hired fulbright jaworski and vinson elkins to represent them before the irs kalkhoven and pettit continued to sign extensions for years while they were represented by fulbright jaworski and vinson elkins esrey and lemay also had reason to question e y and its tax strategies when they started signing extensions in the fall of esrey and lemay brought in king spalding to look at cds and cds plus king spalding raised concerns about whether the transactions were valid in date esrey and lemay sent a letter to e y telling it king spalding would be looking over e y’s shoulder and would be providing independent legal advice about an irs audit of pcmg vi as well as any future audits they wanted king spalding to be their liaison with e ydollar_figure they also told e y to give king spalding all relevant documents and to consult with king spalding about strategic matters regarding audits and possible litigation e y was told to hold update meetings at least quarterly with king spalding as well in date they told e y they expected it to continue to handle these audits on a day-to-day basis though in july and date esrey and lemay each signed powers of attorney for e y to represent them before the irs esrey hired baker mckenzie and lemay hired arnstein lehr to represent them before the irs lemay knew that e y was under investigation no later than the summer of when a new york times reporter called him with questions about the e y investigation d fpaas in date the commissioner finished his audit of bcp under tefra and issued notices of final_partnership_administrative_adjustment fpaas for and dollar_figure he determined in those fpaas that bcp was a sham formed part of tefra governs the tax treatment and audit procedures for most partnerships see tefra pub_l_no secs stat pincite tefra partnerships are subject_to special tax and audit rules see secs tefra requires the uniform treatment of all partnership_item s --a term defined by sec_6231 and and its general goal is to have a single point of adjustment for the irs rather than having it make separate partnership-item adjustments on each partner’s individual return see h_r conf rept no pincite 1982_2_cb_600 if the irs decides to adjust any partnership items on a partnership return it must notify the individual partners of the adjustment by issuing an fpaa sec_6223 an fpaa generally includes a notice of final_partnership_administrative_adjustment form 870-pt agreement for partnership items and partnership level determinations as to penalties additions to tax and additional_amounts including a schedule of adjustments and an exhibit a--explanation of items listing the commissioner’s other adjustments or determinations bolton capital didn’t make a capital_contribution and didn’t have a profits interest in bcp it couldn’t be the tmp see sec_301_6231_a_7_-1 proced admin regs so kp1 replaced bolton capital as the tmp on date and the commissioner mailed the fpaas to kp1 because it was bcp’s tax_matters_partner at the time solely for purposes of tax_avoidance by artificially overstating basis in the partnership_interest of its purported partners and that it didn’t have a profit_motive he therefore determined to disregard bcp for tax purposes and eliminate the dollar_figure loss bcp claimed for and the dollar_figure loss it claimed for dollar_figure wtetp one of the notice partners filed two petitions in tax_court one for each yeardollar_figure kp1 intervened as the tmp pcmg vi kp2 and pcmg xii all joined as participantsdollar_figure there are three remaining issues that we must decide we will address them in the following order our jurisdiction the validity of the statute-of-limitations extensions and the commissioner initially imposed accuracy-related_penalties but he decided later that the penalties don’t apply because the client members in these cases disclosed their participation in cds plus sec_6231 generally defines a notice_partner as a partner who is entitled to notice of an administrative_proceeding under sec_6223 which includes any partner in a partnership with or fewer partners the partners are divided into two camps the first camp is kalkhoven and pettit through their client members kp1 kp2 and pcmg xii and the second is esrey and lemay through their client members wtetp and pcmg vi these cases are appealable to the d c circuit because bcp didn’t exist when the petition was filed and the parties haven’t stipulated otherwise see sec_7482 flush language whether bcp was a sham_partnership opinion i jurisdiction partnerships do not pay income_tax but they do file informational returns that their partners then use to calculate their own individual tax_liability see sec_701 sec_6031 sec_6222 tefra deals with partnership tax matters in two stages united_states v woods u s __ __ 134_sct_557 in the first the commissioner tries to adjust partnership items at the partnership level id see sec_6221 sec_6231 after the partnership adjustments are final the commissioner then may start proceedings at the partner level to make computational adjustments to the individual partner’s tax_liability sec_6231 woods u s at __ s ct pincite bcp was subject_to audit under tefra so our jurisdiction at the partnership level is limited to partnership items of the partnership for the partnership taxable_year to which the notice of final_partnership_administrative_adjustment relates the proper allocation of such items among the partners and the applicability of any penalty addition_to_tax or additional_amount which relates to an adjustment to a partnership_item sec_6226 emphasis added so what are partnership items sec_6231 says that t he term partnership_item means with respect to a partnership any item required to be taken into account for the partnership’s taxable_year under any provision of subtitle a to the extent regulations prescribed by the secretary provide that for purposes of this subtitle such item is more appropriately determined at the partnership level than at the partner level the secretary has told us what he’s determined to be partnership items in sec_301_6231_a_3_-1 proced admin regs once a petition is filed we have jurisdiction to determine partnership items see eg 138_tc_67 aff’d in part rev’d in part and remanded sub nom 616_fedappx_426 d c cir we also have jurisdiction to determine the proper allocation of these items among the partners and the applicability of any penalty addition_to_tax or additional_amount that relates to an adjustment to a partnership_item id see also woods u s at __ s ct pincite this latter jurisdiction isn’t unlimited however and we have gone to great pains to determine its boundaries see eg tigers eye t c pincite petaluma fx partners llc v commissioner tcmemo_2012_142 rev’d and remanded 792_f3d_72 d c cir a nonpartnership item is an item which is or is treated as not a partnership_item sec_6231 and an affected_item is a nonpartnership item that is affected by the determination of a partnership_item see sec_6231 127_tc_75 as it does for other nonpartnership_items the code tells us that we can determine affected items with the exception of certain penalties only at the individual level and not in a partnership-level proceeding the supreme court has told us that determining a partner’s outside_basis is a nonpartnership item woods u s at __ s ct pincite see 591_f3d_649 d c cir aff’g in part rev’g in part vacating and remanding in part 131_tc_84 because these cases are appealable in the d c circuit we must follow that court’s precedent see eg 54_tc_742 aff’d 445_f2d_985 10th cir kalkhoven and pettit make several jurisdictional arguments that we must address they first claim that we don’t have jurisdiction to sham bcp because our jurisdiction to do so would be under sec_301_6233-1t c proced admin regs fed reg date which is they allege procedurally invalid because it didn’t go through notice and comment that’s simply not true the validity of a partnership is a partnership_item under woods see woods u s at __ s ct pincite tigers eye t c pincite see also petaluma fx partners f 3d pincite this partnership-level determination is what the partner-level computational adjustments are based on in later proceedings tigers eye t c pincite the question is just like any other determination of a partnership item’s amount or characterization woods u s at __ s ct pincite petaluma fx partners f 3d pincite if we find that an entity that filed a partnership return is a sham there can’t be any partnership income gain_or_loss because these items cannot properly be characterized as belonging to a partnership tigers eye t c pincite kalkhoven and pettit try to severely narrow what we can look at when we determine whether bcp was a sham they claim we don’t have jurisdiction to look at anything that happened above bcp ie that we can’t look at what the client members did under their argument we can’t look at the client members’ purchase of the option pairs whether there was profit_motive or whether the client members acted in concert these are all key pieces to the commissioner’s argument that bcp was a sham and we note that esrey and lemay don’t bother to make these arguments we don’t have to turn a blind eye to any fact that isn’t strictly a partnership_item we have consistently evaluated whether parties had a profit_motive and looked at their actions in cases like this see eg ltd v commissioner tcmemo_2015_28 markell co v commissioner tcmemo_2014_86 see also woods u s at __ s ct pincite we may consider the facts in the record when we make partnership-level determinations see petaluma fx partners f 3d pincite sec_301_6231_a_3_-1 and b proced admin regs kalkhoven and pettit’s last jurisdictional argument is that we aren’t allowed to determine outside_basis they’re right originally the commissioner disallowed the outside_basis each of the client members claimed in bcp but the commissioner now correctly concedes we don’t have jurisdiction over partners’ outside bases under woods ii statute_of_limitations we now turn to the statute-of-limitations issue a partnership is required to file a return by the fifteenth day of the fourth month generally april after the end of the taxable_year of the partnership sec_6031 sec_1_6031_a_-1 income_tax regs the commissioner then has three years to assess income_tax attributable to partnership items sec a the clock starts either on the date the partnership return is filed or the last day for filing the return again usually april whichever is later id bcp filed its tax_return in date and it sec_2001 tax_return in date that means that under the general rules the commissioner had to issue the fpaa by date and the fpaa by april dollar_figure id the fpaas weren’t issued until date but there are two ways to extend the three-year window the first is for the commissioner to get permission from the partner whose return would be affected id subsec b a or if the commissioner wants to deal with a question that affects the partnership itself he may ask the tmp to sign an agreement extending the period for all the partners id subpara b 147_f3d_221 2d cir rev’g tcmemo_1994_ both types of agreements must be signed before the original three-year statute_of_limitations runs out sec b the statute_of_limitations is an affirmative defense so taxpayers start with the burden_of_proof rule a 95_tc_227 85_tc_535 a bcp extensions the commissioner got extensions from the tmp through bolton and from kalkhoven pettit esrey and lemay the forms 872-p that bolton signed bcp filed its return early the time for assessing income_tax for bcp’s tax_return didn’t expire until date see sec marcy v commissioner tcmemo_2008_166 wl at noting that date was a sunday and that the filing_date and period of limitation was pushed back by one day sec_1_6031_a_-1 income_tax regs extended the statute_of_limitations for assess ing any federal_income_tax attributable to the partnership items of bcp against any partner of the partnership that means that pcmg vi pcmg xii wtetp kp1 and kp2 are on the hook for bcp if the extensions were valid and the commissioner would win bolton signed the first extension on date but that extension kept the period open only for the tax_year over the next several years however bolton signed eight more forms 872-p and ultimately kept the statute_of_limitations open until date so the commissioner wasn’t barred from issuing the fpaas in date unless the extensions weren’t valid all the partners here now claim that the first form 872-p for tax_year that bolton signed back in date wasn’t valid they argue bolton signed it at the direction of e y which was under a disabling conflict of interest because it was being investigated by the irs and the usaodollar_figure they also argue that e y obtained consent through misrepresentation and undue influence and they claim bolton signed these consents in his capacity as the managing director of bolton capital which was the tmp for kp1 the tmp for bcp the partners do not address the validity of the many other extensions bolton signed--other than to argue that they were signed after the statute_of_limitations had closed because the first extension bolton signed in their view was invalid--so we deem those conceded see rule e 92_tc_661 tufft v commissioner tcmemo_2009_59 wl at that e y controlled bolton by embedding six--a former e y employee-- inside bolton capital where she got bolton to defer to her and e y’s instructions when he signed the initial consent the partners finish by saying the commissioner knew of the disabling conflict when he got e y to get consent essentially the partners try to conflate the roles played by e y and bolton they build their argument on 147_f3d_221 in transpac the commissioner first tried to get consents from the partners to extend the statute_of_limitations but most of them said no id pincite knowing the partners didn’t want to extend the statute_of_limitations the commissioner turned to the tmps whom he knew were under criminal investigation the tmps were unsurprisingly more receptive to the commissioner’s request id they had a powerful incentive to ingratiate themselves to the government and worked with the irs in a criminal prosecution of the transpac promoter because their immunity or suspended sentence depended on it id pincite the tmps signed the extensions right about the time they were especially trying to coax the government into granting them immunity or agreeing to lighter sentences id pincite the second circuit held that the commissioner couldn’t use these consents to bind the partners because he knew the tmps had a strong incentive to cooperate with the government and had conflicting interests with the partners id pincite the court was particularly concerned that the commissioner knew that the partners didn’t want to extend the statute_of_limitations but got the extensions from the tmps anyway id this issue is very fact dependent 295_f3d_280 2d cir aff’g tcmemo_2001_85 and transpac is distinguishable from these cases in several ways unlike in transpac the commissioner here was not originally turned down by the client members or by kalkhoven pettit esrey and lemay before he turned to bolton kalkhoven pettit esrey and lemay in fact all signed many extensions themselves six told kalkhoven pettit esrey and lemay that bcp planned to extend the statute_of_limitations unless she heard otherwise from them no one objected the second circuit’s primary concern in transpac was that the commissioner knew the individual partners didn’t want extensions but got them anyway from the tmps isn’t present here the tmps in transpac were also already under criminal investigation and they knew it here the parties agree that bolton didn’t become concerned about personal criminal liability until sometime in the summer of 2006--after he signed all but two of the extensions even then bolton didn’t cooperate with the government by testifying in coplan’s case and he didn’t get immunity or a suspended sentence like the tmps in transpac--he was indicted and pleaded guilty in we find that e y which was cooperating with the government did not bind bcp it was bolton who did bcp tries to link the two by arguing that e y embedded six in bcp but six testified in another case that she left e y for messy personal reasons we will not allow the partners to now claim the extensions are not valid when they were given ample opportunity to object in the first place but chose not to see eg 114_tc_115 existence of criminal investigation alone doesn’t undermine a tmp’s judgment aff’d 272_f3d_1172 9th cir madison recycling assocs v commissioner tcmemo_2001_85 aff’d 295_f3d_208 2d cir transpac is also distinguishable because it dealt with a situation where the taxpayers themselves didn’t sign consents in contrast all four taxpayers here signed separate consents see eg 859_f3d_684 9th cir we turn next to the argument that the extensions were a result of e y’s misrepresentation and undue influence and that e y breached its fiduciary duty to disclose these disabling conflicts of interest the partners base these arguments on the idea that statute extensions should be treated like contracts but an agreement to extend the statute_of_limitations for collecting taxes is not a contract it’s the waiver of a defense 282_us_270 80_tc_1035 77_tc_1291 contract principles are important though to determine whether the waiver is valid see 93_tc_623 piarulle t c pincite but using the partners’ contractual analysis doesn’t invalidate these extensions undue influence is unfair persuasion by a person who dominates a party or when because of their relationship a party justifiably assumes the person won’t do anything against his welfare chai v commissioner t c memo wl at see also restatement contract sec_2d sec_177 the problem with this argument is that e y wasn’t kalkhoven pettit esrey or lemay’s only adviser and they all had ample reason to question e y long before in 2000--long before bolton signed the extension--esrey and lemay hired king spalding to look into cds plus it was then that king spalding questioned whether cds plus could get through an audit in esrey and lemay informed e y that king spalding would be looking over e y’s shoulder and providing its own legal advice they told e y to give king spalding any relevant documents and consult it about any strategic matters regarding the audits lemay even received a call from a reporter at the new york times asking him about the e y investigation in given their close relationship we find it more_likely_than_not that he told esrey about the call in date esrey hired baker mckenzie and lemay hired arnstein lehr to represent them before the irs these facts lead us to find that esrey and lemay understood far more than they let on and undercut their claim that they blindly relied on e y as for kalkhoven and pettit e y told them in date that it was giving the irs documents related to certain transactions in which you were involved e y told them to speak with mckee nelson if they had concerns kalkhoven and pettit hired fulbright jaworski and vinson elkins in date to represent them before the irs with these law firms representing them kalkhoven and pettit didn’t object to bolton’s continuing to sign extensions through date given these facts we cannot believe that e y manipulated bolton into signing the form 872-p and hid its intent from kalkhoven pettit esrey and lemay as they claim b individual partner extensions this all would be enough for us to find that the statute_of_limitations was still open when the commissioner sent the fpaas in but we will also address the extensions that kalkhoven pettit esrey and lemay signed we’ll start with esrey and lemay they repeat their arguments for why the partnership- level extension wasn’t valid--the irs knew e y had a conflict and e y induced them to sign through undue influence and misrepresentation but they make this argument only for the extension esrey signed in date and the one lemay signed in date this argument doesn’t work for the same reason it didn’t work for the partnership-level extension we’ve already said undue influence requires unfair persuasion by a person who dominates a party or when because of their relationship a party justifiably assumes the person won’t do anything against his welfare see chai v commissioner wl at e y didn’t control esrey and lemay they had e y report to king spalding and king spalding provide them with independent legal advice both knew that prosecutors were investigating e y because e y told them so both were also sophisticated businessmen who were represented by sophisticated law firms and yet they continued to sign extensions while being represented by baker mckenzie and arnstein lehr that leaves kalkhoven and pettit they also argue that e y failed to disclose all the facts before they signed their extensions they focus their argument on the extensions each signed in date and date the commissioner responds that the date extensions are valid but irrelevant because kalkhoven and pettit didn’t file their tax_return until date that means the three-year period hadn’t expired when they signed the second set of extensions in date it’s these extensions that the commissioner focuses on kalkhoven and pettit stipulated that they were represented before the irs by fulbright jaworski and vinson elkins by date when they signed the extensions kalkhoven and pettit knew about e y’s conflicts-- that’s why e y had shuffled them over to fulbright jaworski and e y had already told kalkhoven and pettit back in date that it was subject_to a promoter audit for cds it told them--as it had esrey and lemay--to contact mckee nelson if they had any questions again we can’t find that kalkhoven and pettit were misled by e y under these circumstances and as kalkhoven pettit esrey and lemay don’t argue that the remaining extensions are invalid we deem them valid as well see rule e petzoldt t c pincite tufft tcmemo_2009_59 iii son-of-boss deal after working through these jurisdictional and statute-of-limitations arguments we arrive at the now-familiar scene of a son-of-boss tax_shelter esrey and lemay don’t argue with the commissioner that bcp was a sham or that this deal doesn’t work but kalkhoven and pettit insist that bcp’s status as a partnership must be respected while there are different varieties of son-of-boss deals what they have in common is the transfer of assets encumbered by significant liabilities to a partnership with the goal of inflating basis in that partnership see 128_tc_192 the liabilities are usually obligations to buy securities and they always include at least one that seems contingent at the time of transfer taxpayers who engage in these deals claim that this allows the partner to ignore those liabilities in computing basis which allows the partnership to ignore them in computing basis the result is that the partners will have bases in the partnership high enough to provide for large noneconomic losses on their individual tax returns in these cases bcp was at the center of everything bolton capital formed it and sent over to it client members who contributed more than dollar_figure billion in long options when the client members contributed the options they claimed to have bought partnership interests and calculated their bases in bcp without taking into account the contingent liabilities they also contributed see sec_752 this step is of extreme importance in son-of-boss deals--a partner who gets his partnership to assume a liability has to reduce his basis in the partnership by the amount of that liability see id subsec b doing so would however defeat the goal of inflating basis to create a giant artificial loss so when kalkhoven and pettit did this through their client members they were setting up their argument that their client members’ outside bases in bcp were only their bases in the long options bcp then bought japanese yen and distributed them to the client members in liquidation of their partnership interests under sec_732 the client members’ supposed outside bases became bases in the distributed yen which they then sold but rather than calculate their gain_or_loss by subtracting the actual purchase_price of the options from the actual sale price they claimed that they could subtract the pretend bases for those options from the actual sale price thus at the end of the paper shuffle kalkhoven and pettit claimed losses just shy of dollar_figure billion in and from the sale of the yen--an amount sufficient to almost offset their enormous incomes from those years a bcp as a partnership for this deal to work it’s essential that bcp have been a valid partnership because it is only partnership-basis rules that seem to lend themselves to this kind of chicanery we begin our analysis as we usually do federal_law controls the classification of an entity for federal tax purposes 42_tc_1067 so we must first determine whether bcp--organized as an llc--was in fact a bona_fide partnership under the code see markell at the term partnership is defined as a syndicate group pool joint_venture or other unincorporated organization through or by means of which any business financial operation or venture is carried on sec_761 sec_7701 mere co-ownership is not by itself enough see sec_301_7701-1 proced admin regs instead we look to several factors the contributions if any which each party has made to the venture the agreement of the parties and their conduct in executing its terms whether business was conducted in the joint names of the parties whether each party was a principal and coproprietor sharing a mutual proprietary interest in the net profits and having an obligation to share losses or whether one party was the agent or employee of the other receiving for his services contingent_compensation in the form of a percentage of income not a relevant distinction in these cases whether the parties exercised mutual control_over and assumed mutual responsibilities for the enterprise the parties’ control_over income and capital and the right of each to make withdrawals whether separate books of account were maintained for the venture and whether the parties filed federal partnership returns or otherwise represented to respondent or to persons with whom they dealt that they were joint venturers luna t c pincite see 459_f3d_220 2d cir as with any such prongified area of law these factors make sense only if they help us answer a common underlying question that question here is whether the parties intended to and did in fact join together for the present conduct of an undertaking or enterprise 337_us_733 327_us_280 694_f3d_425 3d cir rev’g and remanding 136_tc_1 659_f3d_466 5th cir tifd f 3d pincite jimastowlo oil llc v commissioner t c memo 2013-dollar_figure we will examine each of the applicable factors as we noted in markell at n this type of entity-focused and continued parties’ contribution to the venture bcp was established on date and between july and date the client members contributed the paired-option bundles to bcp as their capital contributions this factor weighs in favor of finding a partnership parties’ agreement and whether business was conducted in a joint name there was a formal operating_agreement but all the actual activity was shunted through a single conduit bolton the managing director of bolton capital the only business that bcp conducted was the sale of the option pairs used to buy dollar_figure worth of japanese yen from refco which it quickly distributed to the client members in liquidation of their partnership interests--generating enormous tax losses for the client members to pass up to their owners under any definition business means a course of activities engaged in for profit 799_f2d_833 n 2d cir aff’g tcmemo_1985_462 and tcmemo_1985_614 339_f2d_377 2d cir quoting mertens law of federal income_taxation sec dollar_figure the phrase course of activities implies more than a single transaction it implies routine or a series of transactions here there wa sec_21 continued intent-seeking approach to determining the existence of a partnership applies broadly--not just to partnerships engaged in dubious digital-option deals no business to conduct just a single transaction and even it wasn’t in joint name these factors weigh very heavily against finding a partnership principal v employee and lack of mutual control kp1 kp2 and pcmg xii may have had interests in bcp but it was bolton through bolton capital who exercised all the power under the operating_agreement the agreement is clear bolton capital had all powers and rights necessary proper convenient or advisable to effectuate and carry out the purposes business and objectives of the company none of the client members could have operated the alleged partnership the client members were not permitted to take part in the management or control of the business or affairs of the company including without limitation voting to remove the managing member or have any voice in the management or operation of any company property on top of all this bolton was the managing director for all the client members and he was the one who signed the operating_agreement on behalf of each client member it’s bolton’s--and only bolton’s--signature that is on the operating_agreement almost forty times there was no mutual control there was only one-man control this weighs against finding a partnership parties’ control_over income and capital and right to withdraw the parties didn’t have control_over income--there wasn’t any real profit the operating_agreement did allow the client members to withdraw by submitting a written request but e y told the client members when to withdraw they did get an amount equal to their book capital_account when they withdrew at best these factors are neutral whether business was conducted in joint name bcp’s books do seem to have been kept separate from other ventures and bcp did file partnership forms u s return of partnership income for its and tax years both were prepared by e y bcp also issued schedules k-1 partner’s share of income deductions credits etc to the client members the returns show that bcp held itself out as a federally recognized partnership this factor does weigh in favor of finding a partnership but this entire multifactor test turns on the fair and objective characterization of all the circumstances what we find is a scrupulous adherence to the formal requirements of making bcp look like a partnership but a complete absence in its operating_agreement and actual operations of any objective indication of a mutual combination for the present conduct of an ongoing enterprise we therefore find that the client members did not intend to join together to undertake business under bcp and that they were not partners in this purported partnership b the business of tax savings there is a second and separate hurdle to any finding that bcp was a partnership a partnership must conduct some kind of business activity see culbertson u s pincite 88_tc_702 markell at the caselaw clearly says that tax_avoidance is no more a business_purpose than actually engaging in tax_avoidance 201_f3d_505 n d c cir aff’g tcmemo_1998_305 see also 314_f3d_625 d c cir the business_purpose doctrine applied in asa investerings establishes that while taxpayers are allowed to structure their business transactions in such a way as to minimize their tax these transactions must have a legitimate non-tax avoidance business_purpose to be recognized as legitimate for tax purposes we must decide whether the parties intended to join together as partners to conduct business activity for a purpose other than tax_avoidance asa investerings f 3d pincite kalkhoven and pettit argue that the client members contributed the option pairs to bcp to diversify their risk and that bcp must be respected if it provided an objective nontax benefit or it had a subjective business_purpose but the commissioner retorts that any diversification here was merely pretext rather than a real business_purpose and that adding bcp into the mix only complicated everything a relatively minor business_purpose will not validate a transaction if it’s no more than a facade id pincite and bcp hasn’t demonstrated that diversification was anything more than a facade to hide bcp’s true purpose-- generation of dollar_figure billion in non-economic lossesdollar_figure paired options the paired options in these cases consisted of short and long european digital options similar to those we have seen in other iterations on this son-of-boss transaction see eg markell tcmemo_2014_86 essentially all of the bcp options had substantial similarities the ratio of the cash payout if the paired options were in-the-money to the cash outlay was just over the short option payout was of the long option payout the cash outlay was just under of the long premium all had between a and chance of being in the money at maturity all options were between and away from the spot rates at the time of the trade and all options had maturity dates between october and date bcp contends that bolton pooled the option pairs as part of cds plus to diversify their investors’ assets kalkhoven and pettit testified that they invested with bolton as part of a broad diversification plan and that they saw cds plus as part of that plan we find this testimony--to the extent it relates to the contribution of the option pairs to bcp--not credible and inconsistent with the objective facts before us the terms of the option spread were also unusual the strike prices were only one pip apart and very far out-of-the-money the strike prices were so close together that from a risk-management perspective they were indistinguishable refco as both the calculating and settlement agent had the choice of any price that was printed pincite a m on the date of expiration the key fact is that the short option could not have been disposed of without the long option we specifically find that refco would never have allowed bcp which had only dollar_figure million in its refco account to collect dollar_figure billion on the short leg or even dispose_of it separately given the credit risk and here the credit risk to refco would be the inability to collect from bcp if the short leg was in-the-money at expiration refco in its own economic self-interest would never choose a spot_rate that fell in the sweet spot profit_motive the commissioner determined that bcp lacked a genuine profit_motive when it purchased the japanese yen and acquired the option pairs when e y promoted cds plus it carefully explained the tax implications but kalkhoven and pettit can’t quite remember ever discussing whether cds plus could actually make a profit outside of tax saving they didn’t independently look at whether cds plus could make nontax profits eitherdollar_figure cds plus was a tax strategy e y promoted specifically to offset the capital_gains from cds--another strategy e y promoted to lower its wealthy clients’ tax_liabilities and known as the loss generator cds was designed to use an ordinary_loss to offset ordinary_income and generate capital_gains the next year cds plus was supposed to get rid of the resulting capital_gains everything about cds plus was strictly focused on tax savings it was offered only to wealthy clients with at least dollar_figure million to shelter e y told clients to withdraw from bcp the year they wanted to generate losses the high transaction fees were all based on the amount of the desired loss kalkhoven and pettit’s client members paid almost dollar_figure million in fees to e y and bolton capital for cds plus that’s not including the premiums the client members had to pay refco and the dollar_figure for an opinion letter pettit even testified that he didn’t care about these fees--he as we’ve said esrey and lemay don’t try to claim that bcp was anything other than a sham so it’s worth noting what they said about the transaction since they are in similar positions to kalkhoven and pettit esrey and lemay stipulated that they participated in cds plus simply to lower their tax bills when they exercised their sprint options and unwound their cds transactions they didn’t care about the possibility of actual profit neither discussed the topic with e y or six esrey said in court that cds plus was bogus and lemay said it was fraudulent just wanted e y to take care of everything coplan admitted that any payout would be less than the transaction fees and six and bolton admitted cds plus couldn’t make money coplan said that the e y slides explaining cds plus were strictly for internal use and he was concerned that cds plus would lose all of its ‘business purpose’ if it is reduced to steps in a powerpoint slide the slides were not even supposed to be shown to clients this all adds up to an obvious conclusion--the business_purpose was tax savings and that’s not a real business_purpose we also have to note that the facts here fall squarely within other cases disallowing deductions in son-of-boss deals in ltd tcmemo_2013_49 the taxpayers scored gigantic paydays in contingency fees a promoter approached the taxpayers with an aggressive tax planning strategy involving digital options and canadian dollars the scheme began with the purchase of foreign-currency short and long options as well as canadian dollars through a single-member llc the formation of a partnership with a third party and the contribution of the options and the canadian dollars to that partnership the options would then expire worthless creating huge tax losses at the partnership level that could be unlocked when the single-member llc sold the canadian dollars it received when the partnership liquidated there the commissioner argued the llcs were single-member llcs and should be disregarded for tax purposes the taxpayers countered that because theirs was a community-property state their wives were the second owners of the llcs making the llc a partnership by default under the regulations see sec_301_7701-3 and b i proced admin regs we disagreed with the taxpayers because not a single luna factor weighed in favor of finding a partnership entity and several weighed heavily against it in historic boardwalk f 3d pincite the third circuit concluded that a partner who avoids any meaningful downside risk in the partnership while enjoying a dearth of meaningful upside potential was not a bona_fide partner at all following the second circuit the court held that to be a bona_fide partner for tax purposes a party must have a meaningful stake in the success or failure of the enterprise id pincite the second circuit itself had disregarded two foreign banks as possible partners because the prevailing character of their interest resembled debt rather than equity tifd f 3d pincite finding the purported interests were overwhelmingly in the nature of a secured lender’s interest which would neither be harmed by poor performance of the partnership nor significantly enhanced by extraordinary profits the seventh circuit in 728_f3d_676 7th cir aff’g 137_tc_70 and tcmemo_2012_110 disregarded a supposed partnership where it lacked a valid business_purpose aside from tax motivation in that case the partners created an llc and contributed to it uncollectible accounts_receivable from a defunct brazilian company the partners then sold their interests to outsiders who could take advantage of the losses on the sales of the worthless receivables--all because of a since-closed loophole in the code see american_jobs_creation_act_of_2004 pub_l_no sec_833 sec_118 stat pincite amending sec_704 and sec_743 the court found that the sole purpose of creating the llc was to transfer the losses of the bankrupt brazilian retailer to u s taxpayers who could then deduct the losses from their taxable_income the court also found that a bona_fide partnership requires a joint business goal by the partners superior trading f 3d pincite finding no joint business goal where one partner aimed to extract value from a worthless asset and the other aimed to make the loss from that asset a tax bonanza we’ll not step off this well-marked trail today we find that bcp was created to carry out a tax-avoidance scheme and we find that the client members never intended to run a business through bcp we find that the client members had no intention to join bcp to share in profits and losses from business activities--they all left in just over a year we also find that cds plus was done through bcp only to further a tax-avoidance scheme and we find that the character of the resulting tax loss and not any potential for profit was the primary consideration in buying and then distributing the option pairsdollar_figure we therefore will disregard bcp iv consequences of disregarding bcp when we disregard a partnership for tax purposes we are holding that the rules of subchapter_k of chapter of the code the substantive law governing the income_taxation of partners no longer apply and that we will treat the partnership’s activities as engaged in directly by the purported partners see ltd tcmemo_2015_28 at a disregarded partnership has no identity separate from its owners and we treat it as just an agent or nominee see eg tigers eye t c pincite n but disregarding the partnership doesn’t necessarily mean that all the items reported by the disregarded partnership are reduced to zero--we still need to deal with the substance of the transactions to the extent we have jurisdiction see eg acm p’ship v commissioner 157_f3d_24 we will grant the partners’ joint motion to substitute exhibits 84-j 86-j and 92-j we will deny the partners’ other motions as moot 3d cir allowing deductions for securities that had objective economic consequences apart from tax benefits even when incurred in the context of a broader transaction that constitute d an economic sham citations omitted aff’g in part rev’g in part tcmemo_1997_115 tigers eye t c pincite holding we have jurisdiction under tefra to determine the basis_of_property allegedly contributed to a purported partnership even if it never existed the code tells us that tefra procedures will still apply in these cases as long as the purported partnership filed a partnership return--which bcp did see sec_6231 sec_6233 see also sec_301_6233-1 proced admin regs this means that we have to determine any items that would have been partnership items as defined in sec_6231 and sec_301_6231_a_3_-1 proced admin regs had bcp been a valid partnership for tax purposes tigers eye t c pincite this is the hypothetical entity approach see id pincite halpern j concurring in these cases that means we treat everything as being owned directly by the client members--and this includes the option pairs we also treat the option pairs as never being contributed to bcp and any gain_or_loss supposedly realized by bcp as having been realized by the client members the client members are not treated as partners since there is no partnership with regard to the option contracts specifically we incorporate our analysis in markell and adopt its holding again here markell at with regard to the option contracts the client members should have treated the foreign-currency options as single-option spreads--meaning the long and short positions were part of one contract and couldn’t have been separated as a matter of fact and law see id cf sec_1092 straddle rules we sustain the commissioner’s disallowance of the losses the client members claimed so each of the client member’s basis must be adjusted as follows client member wtetp kp1 kp2 pcmg vi pcmg xii basis_adjustment dollar_figure big_number big_number big_number big_number bcp did have basis in the yen that basis then passed on to the client members who got small losses or gains their appropriate bases in the yen are like the option contracts just what the client members paid for the yen see sec_1012 see eg markell at bcp used the proceeds from the sales of the options to buy dollar_figure in yen from refco since we have disregarded bcp we treat the client members as having bought and sold the yen directly and recognizing any gain_or_loss accordingly we will leave these computations for later and appropriate decisions will be entered