Opinion ID: 503838
Heading Depth: 2
Heading Rank: 1

Heading: The Proper Legal Standard for the Sham Determination

Text: 8 Taxpayers argue that the tax court failed to apply the correct legal standard to determine whether the investments were shams. The tax court's conclusion that the transactions were shams is a finding of fact that is reviewed under the clearly erroneous standard. Bail Bonds by Marvin Nelson, Inc. v. Commissioner, 820 F.2d 1543, 1548 (9th Cir.1987). However, the legal standard applied by the tax court in making the sham determination is reviewed de novo. 6 Id.A. The Proper Test 9 We noted in Bail Bonds that courts typically focus on the related factors of whether the taxpayer has shown 1) a non-tax business purpose (a subjective analysis), and 2) that the transaction had economic substance beyond the generation of tax benefits (an objective analysis). 820 F.2d at 1549. However, we did not intend our decision in Bail Bonds to outline a rigid two-step analysis. Instead, the consideration of business purpose and economic substance are simply more precise factors to consider in the application of this court's traditional sham analysis; that is, whether the transaction had any practical economic effects other than the creation of income tax losses. See, e.g., Neely v. United States, 775 F.2d 1092, 1094 (9th Cir.1985); Thompson v. Commissioner, 631 F.2d 642, 646 (9th Cir.1980), cert. denied, 452 U.S. 961, 101 S.Ct. 3110, 69 L.Ed.2d 972 (1981). Thus, the tax court's failure to specifically delineate a two-prong test and the factual findings that support each prong is not itself fatal. B. The Tax Court's Legal Standard 10 The tax court's analysis indicates that it considered the proper factors and applied the correct legal standard to reach its conclusion. After noting that the loss must result from a bona fide transaction, the court held that Taxpayers failed to establish that the entire program ... did not exist solely to provide tax benefits for its investors. Brown, 85 T.C. at 988. Further, the court likened the transactions to those in Julien v. Commissioner, 82 T.C. 492 (1984), in which the disallowance was based on a finding that the transaction served no economic function other than the generation of tax deductions. 85 T.C. at 999. Finally, in discussing the imposition of damages, the court held that [Taxpayers] were sufficiently knowledgeable and sophisticated with respect to business and tax matters to have known, and actually did know, ... that the transactions were too good to be real and therefore were shams. Id. at 1001. 11 In short, the tax court reviewed the transactions for economic effects other than the creation of income tax losses, and in doing so considered both economic substance and business purpose. The court thus applied the proper legal standard. 12