A truism is a saying that is so commonly accepted as true that it needs no further explanation. For example: "never get involved in a land war in Asia.” Today’s lesson shows us a tax truism: never take tax advice from the person selling you the deal. In RB-1 Investment Partners, Eric Reinhart, Tax Matters Partner v. Commissioner, T.C. Memo. 2018-64 (May 14, 2018), the taxpayer received millions of dollars from the sale of a business and invested in a complex transaction that the promoter promised would magically wipe away the gain with no actual economic loss (except fees). When the taxpayer got caught, it conceded the merits, but attempted to avoid imposition of a 40% penalty under §6662 by arguing reasonable reliance on an opinion letter from the law firm promoting the scheme. I explain below the fold the taxpayer’s argument, why it failed, and what we can learn.
RB-1 Investment Partners (RB-1) was a tax-shelter partnership created by the brothers Doug and Eric Reinhart in 2000. That was the year they and their sister sold their family concrete business for millions of dollars of gain (Doug reported a gain of over $7 million and Eric reported a gain of about $6.7 million). Eric’s long-time financial advisor, Randy Smith, told them about a “big-boy deal” that the law firm of Jenkins & Gilchrist had worked out with Deutsche Bank to shelter large capital gains for a modest fee of $400,000 (the quote comes from testimony recited in Judge Holmes’ opinion). Smith introduced them to the people in those firms, who then sold the brothers on the idea of what became known as a son-of-BOSS tax shelter,
The sister appears to have been mature enough to realize that the scheme was too good to be true, but the boys forged ahead. On their 2000 return they claimed losses of over $10 million from a scheme about which they were clueless, but for which they held clutched in their hand a 135 page opinion letter from Jenkins & Gilchrist that said the scheme complied with the tax laws.
The IRS audited the RB-1 partnership return and disallowed the claimed losses. The parties put the case on hold while the folks from Jenkins & Gilchrist (J&G) and from Deutsche Bank---the ones who had created and marketed the scheme---were criminally prosecuted. Some pled guilty, others were convicted, and one was acquitted. In Tax Court the brothers eventually conceded the case on the merits and sought only to avoid the §6662 40% penalty for the portion of their understatement of tax attributable to the gross valuation misstatement stemming from the son-of-BOSS.
There are lots of ways to screw up returns. If the mistake is minor, there is no penalty. However, if the error is too big or is caused by being too careless, §6662(a) imposes a 20% penalty for the inaccuracy. The penalty gets bumped up to 40% when the inaccuracy is really big. That’s what RB-1 was facing. Even there, however, taxpayers can escape the penalty if they can show there was a reasonable cause for the error causing the inaccuracy, and the taxpayer acted in good faith with respect to that error. §6665(c)(1).
RB-1 argued that it (via Eric, it’s Tax Matters Partner) that the reasonable cause for the error was the J&G opinion letter and that Eric acted in good faith in relying on J&G. At first blush, that seems like a good argument. J&G was (at that time) well regarded as a competent professional tax firm. The advice the firm gave to Eric and Doug was the cause of the error and Eric’s reliance on J&G to navigate the complexities of the tax laws was in good faith because if you cannot trust your attorneys to keep you legal, who can you trust?
Judge Holmes’ opinion does a super job in de-constructing the argument. He begins by reciting facts showing how Eric “knew how to get professional advice when he thought he needed it.” He then contrasts that behavior with Eric’s all-in approach to the son-of-BOSS transaction, a transaction Eric admitted he did not really understand. Judge Holmes points out that Eric knew J&G were selling this idea to lots of others. And J&G required him to sign a confidentiality agreement to actively prevent him from sharing the information with other folks who might give him a different perspective on the proposal. So, lured by the promise of eliminating most of his tax liability, Eric threw caution to the winds. That’s not acting in good faith. That’s rolling the dice, squeezing and hoping, wishing and praying.
The lesson here is now a tax truism. As Judge Holmes so nicely puts it: “reliance on a promoter takes the good faith out of good-faith reliance.” This opinion is just the latest in a long series of similar cases coming to similar conclusions. The D.C. Circuit recently applied this same tax truism in Palm Canyon X Investments, LLC, AH Investment Holdings, LLC, Tax Matters Partner v. Commissioner, (DC Cir. Feb. 16, 2018) and Keith Fogg has a nice blog post about it over at Procedurally Taxing.
Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law.