MEMORANDUM FINDINGS OF FACT AND OPINION
Respondent issued a notice of final partnership administrative adjustment (FPAA) with respect to New Millennium Trading, LLC (NMT), for NMT's 1999 tax year. In the FPAA respondent determined, among other things,
The case at hand is one of many involving a particular tax shelter variant promoted by Sentinel Advisors, LLC (Sentinel),
FINDINGS OF FACT
In 1987 Mr. Filipowski founded Platinum Technology, Inc. (Platinum), a computer software company in Chicago, Illinois. Platinum developed, marketed, and supported software products for enterprise systems management, data warehousing, and database management. As of February 1999 Mr. Filipowski was Platinum's president and chief executive officer and owned 4,652,068 voting shares.
By May 1999 Platinum had reached $1 billion in revenue and had become the eighth-largest computer software company in the world. Platinum was acquired by Computer Associates International, Inc., in March 1999 for approximately $3.5 billion (Platinum sale). Mr. Filipowski expected to receive combined capital gains and ordinary income of $110 million from the Platinum sale.
Creation of the Spread Transaction
Sentinel, formed by Ari Bergmann and Abraham Pfeiffer in 1997, was a hedge fund manager in New York. The Ari Bergmann Revocable Trust was the managing member of Sentinel. Mr. Bergmann was the trustee of the Ari Bergmann Revocable Trust. Mr. Bergmann managed Sentinel. Sentinel owned and controlled New Vista, LLC (New Vista), and Shomrim, LLC (Shomrim), and owned 75% of and controlled Shakti Advisors, LLC (Shakti).
Mr. Bergmann graduated from Towson State University with a major in accounting, and he is a certified public accountant (C.P.A.). Before managing Sentinel, he worked at Price Waterhouse, Drexel Burnham Lambert Trading, and Bankers Trust. Mr. Bergmann began work at Bankers Trust in 1989 at the U.S. Interest Rate Derivatives trading desk and managed this unit in 1992 and 1993. During this time he was active in arbitrage and in the development of structured notes, index-amortizing swaps, times swaps, binary options, and other derivative products. From 1993 to 1997 he headed the Transaction Development Group (TDG), a unit that he founded within Bankers Trust. TDG was active in the application of derivative techniques in the privatization of a number of European state-owned companies. TDG also advised clients on mergers and acquisitions, tax transactions, and hedge fund structures. Mr. Bergmann formed Sentinel after leaving his position as senior managing director at Bankers Trust.
BDO Seidman, LLP (BDO), is an accounting firm. During 1999 BDO's management encouraged its employees to sell tax shelters to wealthy individuals and established a bonus program for its employees who sold these tax shelters. During 1999 BDO had a practice group called "Tax Solutions Group" (TSG), consisting of 20 to 40 BDO partners. TSG was responsible for designing, selling, and implementing tax shelters.
One such tax shelter was the "spread transaction". BDO and Sentinel co-developed the spread transaction and structured it to create an ordinary loss, a capital loss, or both. Between May and December 1999 BDO and Sentinel marketed the spread transaction to clients who had income of at least $15 million. The spread transaction consisted of the following steps: (1) creation of an option
Fees payed by clients to engage in the spread transaction were split among Sentinel, BDO, and AIG International, Inc. (AIG), a foreign currency dealer. Sentinel generally collected its share and BDO's share of the fees via consulting agreements between clients and New Vista or Shomrim. Sentinel generally paid BDO 40% of the fees received through the consulting agreements and kept the remaining 60%. AIG directly received a fee for serving as the counterparty to the spread transaction.
Search for a Tax Strategy
Soon after the Platinum sale, several law and accounting firms selling tax strategies approached Mr. Filipowski and other Platinum executives. In March 1999 Mr. Filipowski called Katten Muchin & Zavis (Katten) regarding KPMG and Ernst & Young (E&Y) tax strategies. In April 1999 another Platinum executive sent a request to Alex. Brown and Jenkens & Gilchrist (Jenkens) to present their respective tax strategies.
Mr. Filipowski engaged Katten, which had represented Mr. Filipowski and Platinum for years, to review and advise him on which tax strategy to choose. Katten assigned Arnold Harrison,
On May 27, 1999, Mr. Filipowski and Mr. Harrison met with Paul Daugerdas, a Jenkens attorney, at the Jenkens office in Chicago to discuss a tax strategy. Later that day Mr. Filipowski and Mr. Harrison went to Robert Greisman's office at BDO to discuss the spread transaction (May meeting). Mr. Greisman was a BDO tax partner and TSG member. Mr. Greisman became aware of the Platinum sale and asked a friend to introduce him to Mr. Filipowski. Mr. Greisman arranged for the May meeting among himself, Mr. Filipowski, Mr. Harrison, and Mr. Bergmann. The four men spoke for the first time at the May meeting, with Mr. Bergmann participating via telephone. During the May meeting Mr. Bergmann gave an overview of the spread transaction.
On May 28, 1999, BDO sent Mr. Filipowski and Mr. Harrison a sample marketing opinion that BDO had prepared for potential investors in the spread transaction. The marketing opinion laid out the steps of the spread transaction and went into detail about its tax consequences. The marketing opinion summarized the Federal income tax consequences of the spread transaction as more likely than not that—
2. Your basis for the Partnership interest should be equal to your basis in the Purchased Call Option, reduced by the amount of liabilities assumed by the Partnership. The sold call option should not be considered a liability for purposes of section 752.
3. Your share of any loss incurred by the Partnership should be deductible by you, and should not be subject to the passive activity loss rules.
4. You should not recognize gain or loss on the receipt of foreign currency from the Partnership in exchange for your Partnership interest.
5. The basis of the foreign currency received in liquidation of your Partnership interest should equal your basis for the Partnership interest.
6. The gain or loss recognized on your sale of the foreign currency should be treated as ordinary income or loss.
On June 9, 1999, a meeting (June meeting) was held at Platinum's offices among Messrs. Greisman, Bergmann, Filipowski, Harrison, a partner at Katten, Vincent Aquilino, and four other Platinum executives, Michael Cullinane, Paul Tatro, Paul Humenansky, and Larry Freedman (Platinum executives). At the June meeting, Mr. Bergmann gave a more detailed presentation of the spread transaction using PowerPoint software (Sentinel presentation). The Sentinel presentation laid out the steps of the spread transaction.
The Sentinel presentation included an example of a spread transaction in which a participant transferred an option spread costing $350,000
In August 1999 Mr. Filipowski decided to execute the spread transaction. The spread transaction Mr. Filipowski executed (NMT spread transaction) followed the steps listed in the Sentinel presentation.
Messrs. Filipowski, Greisman, and Harrison all understood that the NMT spread transaction had to be completed in 1999 to offset Mr. Filipowski's income from the Platinum sale.
Setup of Entities
In May 1999 William Doyle, an attorney at Katten, formed the AJF-1999 Trust (trust). Mr. Doyle named himself and Mr. Filipowski cotrustees, and named Mr. Filipowski as the grantor and sole beneficiary of the trust. The trust was set up to be used in connection with the tax strategy.
Mr. Harrison organized AJF-1 on July 1, 1999, as an Illinois limited liability company. The sole member of AJF-1, which was disregarded for tax purposes, was the trust. Mr. Harrison served as AJF-1's registered agent.
Fees for the NMT Spread Transaction
Mr. Filipowski negotiated the fees for the NMT spread transaction with Mr. Bergmann. During negotiations, Mr. Filipowski and Mr. Harrison informed Mr. Bergmann and Mr. Greisman that Mr. Filipowski was looking at competing tax strategies. Mr. Filipowski and Mr. Bergman negotiated the fees (fixed fees) for the NMT spread transaction as a percentage of the amount of tax Mr. Filipowski wanted to shelter. Mr. Harrison suggested to Mr. Filipowski that he increase the size of his tax strategy from $110 million, the amount that Mr. Filipowski expected to receive from the Platinum sale, to $120 million. Mr. Filipowski decided the size of his tax strategy would be $120 million. It was agreed that the fixed fees for the spread transaction would be 3.5% of $120 million, i.e., $4.2 million.
The $4.2 million in fixed fees consisted of the following:
The fixed fees remained the same whether or not Mr. Filipowski did any activity with Shomrim outside of the NMT spread transaction. Sentinel and BDO agreed to split the Shomrim consulting fee and the BDO tax opinion fee 60/40, respectively.
On August 15, 1999, Mr. Filipowski and Shomrim executed an investment advisory and consulting agreement (Shomrim agreement). The Shomrim agreement specified that Mr. Bergmann, through Shomrim, would advise Mr. Filipowski, AJF-1, and the trust. The $3,570,000 fixed fee due under the Shomrim agreement was payable as follows: $70,000 in August 1999 and $100,000 each subsequent month for the next 35 months. The Shomrim agreement also provided Shomrim with authority to invest assets Mr. Filipowski placed in a discretionary account. The Shomrim agreement charged management and incentive fees
On the same day Mr. Filipowski obtained a termination agreement (termination agreement) signed by Mr. Bergmann. The termination agreement allowed Mr. Filipowski to terminate the Shomrim agreement if Shomrim were unable to transfer the option spread to a partnership while the sold option position was out of the money.
On August 3, 1999, AJF-1 and AIG entered into a letter agreement (AIG agreement), which governed AJF-1's transactions with AIG. Under the AIG agreement, with AIG's approval AJF-1 could assign transactions to a different counterparty. Provision 11.1 of the AIG agreement states in part:
The AIG agreement had no provision with respect to any fee related to opening a trading account or trading in foreign currency options. AJF-1, however, paid AIG a $600,000 account opening fee.
On August 19, 1999, at Shomrim's direction, AJF-1 entered into an option spread with AIG as the counterparty. The option spread comprises a purchased European-style
The option spread had three possible outcomes depending on the EUR/USD spot rate at the time of expiration. First, if the spot rate were below 1.0880 at expiration, the option spread would expire worthless and AJF-1's loss would have been the net premium paid. Second, if the spot rate were at or above 1.0890, the spread option would have been worth a net payoff of $2,300,591, or net profit of $1,100,591.
The option spread could be restruck provided that AIG was protected from credit risk and consented to restriking. For the purchased option and the sold option to be separated, AIG would have to provide approval and AJF-1 or NMT would have to post the margin between the option spread premiums. Neither AJF-1 nor NMT could acquire or hold the purchased option or the sold option by itself, as each lacked the required funds.
AIG sent Mr. Filipowski two separate confirmations for AJF-1's respective purchased option and sold option (original confirmations). The confirmations were subsequently amended and resent on or around September 23, 1999 (amended confirmations). The original confirmations and the amended confirmations were identical except for the following provision. The original confirmations stated:
The amended confirmations read:
With the amended confirmations, the maximum net profit from the option spread, before fees, was approximately $1.1 million.
On August 6, 1999, NMT, was formed as a Delaware limited liability company. NMT's original members were Banque Safra-Luxembourg, S.A. (Banque Safra), Fidulex Management, Inc. (Fidulex), and Shakti. Banque Safra contributed $300,000 and signed an NMT subscription agreement on September 17, 1999. Fidulex contributed $150,000 and signed an NMT subscription agreement on October 18, 1999. Shakti contributed $20,000 and was the managing member of NMT.
NMT's partnership agreement provided that Shakti, as managing member, received three types of fees (NMT variable fees) from the other members: (1) a management fee of 2% annually on the value of their capital accounts, (2) an incentive fee of 20% of any increase in the value of their capital accounts, which was not subject to any hurdle, and (3) a 5% early withdrawal fee if a they withdrew from NMT within 12 months.
AJF-1 Joins NMT
On September 15, 1999, Mr. Filipowski, on behalf of AJF-1, signed a subscription agreement for NMT (NMT subscription). The following day AJF-1 transferred $600,000 to NMT. AJF-1 initially attempted to transfer the option spread to NMT on September 16, 1999, by signing an assignment and assumption agreement (assignment agreement) but was unable to do so, presumably because of the discrepancy between the original confirmations and the amended confirmations. Once the amended confirmations were subsequently prepared and sent to AJF-1, AJF-1 assigned the option spread to NMT. AIG consented to the assignment of the option spread to NMT.
Sometime between November 15 and 19, 1999, Mr. Filipowski signed new copies of the NMT subscription and assignment agreement and backdated the new assignment agreement as of September 30, 1999. NMT assigned the option spread a value of $1,172,417 as of September 30, 1999, and credited AJF-1's capital account by that amount. At the time AJF-1 transferred the option spread to NMT, it was out of the money. NMT determined AJF-1's initial capital account to be $1,772,417, consisting of the option spread and the $600,000 transferred on September 16, 1999.
After AJF-1 joined NMT, the members' interests were as follows: AJF-1 had 79.04%, Shakti had .89%, Fidulex had 6.69%, and Banque Safra had 13.38%.
NMT Trading Activity
NMT entered into a variety of transactions in financial markets on behalf of its members. On average the positions were short term, unprofitable, and small relative to the option spread entered into and contributed by AJF-1. Most of the transactions were opened and closed out on the same day or the following day.
The only transaction of significance was a reverse knockout option NMT purchased from AIG on October 6, 1999, for a premium of $189,642, when the USD/EUR spot rate was 1.0724. The reverse knockout option had an expiration date of October 13, 2000, and a notional value of 20ac114.4 million. It had a strike price of 1.0685 USD/EUR and a knockout price of 1.122 USD/EUR. This means that if the spot rate reached or exceeded 1.122 USD/EUR at any time before expiration of the reverse knockout option, it would immediately lose all value. If the exchange rate went very close to 1.122 USD/EUR without ever exceeding that level, the reverse knockout option could pay off several million dollars.
Respondent's expert, Dr. Brown, opined that the most likely outcome for the reverse knockout option is that it would expire worthless. It was sold back to AIG on December 10, 1999, for $147,000, a loss of $42,642.
On December 2, 1999, AJF-1 requested to withdraw and redeem its interest in NMT. On December 15, 1999, AJF-1 officially withdrew from NMT. Sentinel communicated to AJF-1 that its interest in NMT, less a 5% withdrawal fee, would be sent to AJF-1 in currency and equity securities by December 22, 1999.
On December 22, 1999, NMT transferred to AJF-1 €617,664 and 21,454 shares of Xerox stock valued at $623,223 and $445,171, respectively. AJF-1's withdrawal distribution was $56,231 less than AJF-1's NMT capital account on December 15, 1999, because of the 5% withdrawal fee.
On December 17, 1999, NMT closed out the option spread. NMT remained in existence until October 2000. Banque Safra and Fidulex withdrew in October 2000 and received cash in exchange for their NMT interests. NMT terminated operations as of December 31, 2000, and filed a certificate of cancellation in 2001. Accordingly, NMT did not have a principal place of business when the petition was filed.
AJF-1 Disposes of Property
On December 22, 1999, AJF-1 sent a fax to Salomon Smith Barney and AIG requesting to sell all of its Xerox stock and 20ac530,000 of the 20ac617,664, respectively. The next day Salomon sold AJF-1's 21,454 shares of Xerox stock for $464,191. On or about December 29, 1999, AIG sold 20ac530,000 of AJF-1's for $537,420. The 20ac87,664 AJF-1 retained had a value of $88,891 as of December 22, 1999.
Total Fees Paid for the NMT Spread Transaction
In 1999 and 2000 Mr. Filipowski paid $570,000 and $1,100,000, respectively, under the Shomrim agreement. In 2000 Mr. Filipowski paid BDO $30,000. In 2001 Mr. Filipowski paid $991,403 to terminate the Shomrim agreement. Mr. Filipowski's total fees paid with respect to the NMT spread transaction were $3,479,822, calculated as follows:
BDO initially referred Mr. Filipowski and Mr. Harrison to the law firm Curtis Mallet with the expectation that that firm would provide Mr. Filipowski with a tax opinion. Mr. Harrison could not work with Curtis Mallet on the opinion that it was going to issue to Mr. Filipowski. Mr. Greisman and Larry Cohen, a BDO and TSG member, discussed whether BDO could issue an opinion to Mr. Filipowski incorporating the changes Mr. Harrison sought on a draft Curtis Mallet opinion. On March 20, 2000, BDO ultimately issued a formal tax opinion (BDO tax opinion) to Mr. Filipowski which reflected Mr. Harrison's input and changes. Mr. Filipowski paid $30,000 for the BDO tax opinion.
Other NMT Members
Sentinel, through Shomrim, expected to receive a fixed fee of $2,142,000
NMT is one of a number of LLCs managed by Sentinel, or an affiliate of Sentinel, to which certain members contributed or transferred foreign currency options as part of a spread strategy in 1999 and/or 2000. In 1999 Shomrim and New Vista passed through to Sentinel over $17 million and the 26 limited liability companies (Sentinel LLCs) listed on Sentinel's 1999 return passed through a total net loss of $43,929, with no single Sentinel LLC passing through a gain or loss greater than $16,000. Banque Safra participated as a nominee in 32 of the 33 Sentinel LLCs and Fidulex, or its parent company, participated in 4.
Banque Safra and Fidulex did not participate in NMT on their own behalf. The record does not reveal the persons (nominee participants) on whose behalf Banque Safra and Fidulex transferred cash to NMT. The record does not show whether the nominee participants had any income from the United States or had any U.S. tax issues.
The trust's Form 1041, U.S. Income Tax Return for Estates and Trusts (trust 1999 return), reported a $59,827,262 ordinary loss on the sale of the 20ac530,000 and a $49,786,580 capital loss on the sale of 21,454 shares of Xerox stock.
BDO prepared Mr. Filipowski's 1999 tax returns. Mr. Filipowski, on his 1999 Form 1040, U.S. Individual Income Tax Return (Filipowski 1999 return), offset Platinum wage income of $62,099,865 with $59,827,262 in claimed losses from the sale of euro and offset his long-term capital gains of $53,989,700 from the Platinum sale with $49,786,580 in claimed losses from the Xerox stock. The Filipowski 1999 return claimed a $633,571 passthrough loss from the trust, which originated with NMT. The Filipowski 1999 return reported a tax liability of $6,726,497.
Mr. Filipowski filed a Form 1040X, Amended U.S. Individual Income Tax Return, for his 2000 tax year that claimed a $9,905,079 loss deduction on the 20ac87,664 AJF-1 disposed of in 2000.
NMT retained Untracht & Associates (Untracht) to prepare and file the NMT 1999 return. On the NMT 1999 return NMT reported that AJF-1 was a partner in NMT, made a contribution of $1,772,417, and received a partnership withdrawal distribution of $1,124,620. The NMT 1999 return reported total contributed capital of $2,242,417, ending capital of $406,044, and a net loss of $711,753.
On March 10, 2001, NMT filed its year 2000 Form 1065 marked "Final", reporting no assets and liabilities and all participants having withdrawn. In 2001 a certificate of cancellation was filed for NMT.
On September 21, 2005, respondent issued the FPAA to NMT. The FPAA made a number of adjustments: (1) disallowing NMT's claimed operating loss deduction of $669,206 and other deductions of $18,712 and (2) decreasing to zero the capital contributions and distributions of property other than money accounts. The FPAA indicated these changes in chart form. Each adjustment was shown in a chart with an "adjustment", "as reported", and "corrected" box accompanying each individual adjustment. The chart included figures for each of the above adjustments but showed asterisks instead of figures as to outside partnership basis.
Respondent determined, among other things, that NMT was a sham and that penalties under section 6662 are applicable.
On September 21, 2005, respondent timely mailed a copy of the FPAA to Shakti, which at the time was NMT's tax matters partner (TMP). AJF-1, a notice partner withing the meaning of section 6231(a)(8), timely filed the petition upon which this case is based. On the date the petition was filed, NMT did not exist. By order dated June 13, 2007, AJF-1 was appointed TMP for NMT.
NMT's case was tried at a special trial session in Atlanta, Georgia, in February 2015. The record consists of the pleadings, stipulations of facts with attached exhibits,
Jurisdiction Under TEFRA
Under the unified partnership audit and litigation procedures of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. No. 97-248, sec. 402(a), 96 Stat. at 648, the tax treatment of any partnership item, except as otherwise provided in subchapter C, must be determined at the partnership level. Sec. 6221. Section 6226(a) authorizes a TMP to file a petition for readjustment of partnership items within 90 days after the date on which an FPAA is mailed to the TMP. In a partnership-level proceeding filed pursuant to section 6226(a), this Court has jurisdiction to readjust all partnership items for the partnership year to which the FPAA relates and to readjust the allocation of such items among the partners. Sec. 6226(f). A "partnership item", in substance, is an item "required to be taken into account" by the partnership for tax purposes, to the extent those items are more appropriately determined at the partnership level than at the partner level. Sec. 6231(a)(3). This Court has jurisdiction to determine whether a partnership is a sham, lacks economic substance, or otherwise should be disregarded for tax purposes.
A nonpartnership item is an item that is not a partnership item and whose tax treatment is determined at the partner level. Sec. 6231(a)(3) and (4). An affected item is any item to the extent it is affected by a partnership item, the tax treatment of which is determined in a partner-level proceeding after the underlying partnership item(s) is determined at the partnership level.
Burden of Proof
Petitioner bears the burden of proof to overcome respondent's determinations.
Validity of NMT for Federal Income Tax Purposes
The essential question in determining whether an entity is recognized for Federal income tax purposes is whether the parties intended to join together for the present conduct of the enterprise.
Petitioner argues that NMT meets the test for partnership recognition under
Respondent argues that NMT should be disregarded as a partnership under the
We have made findings consistent with respondent's averments, and we are not persuaded by petitioner's arguments to the contrary. The evidence is overwhelming that NMT was created exclusively for tax avoidance purposes.
AJF-1 participated in NMT for a brief time, withdrawing three months after it executed the subscription agreement for the first time. All of the other NMT participants withdrew in just over a year after NMT was formed. NMT was created in August 1999 and terminated operation in October 2000. Mr. Filipowski's interactions with NMT were preplanned and followed the spread transaction steps outlined in the Sentinel presentation. Mr. Filipowski set up two single-purpose entities, the trust and AJF-1, to engage in the NMT spread transaction.
Nothing in the record suggests that consideration was given to conducting NMT's activity through anything other than a partnership, because a partnership was necessary to claim the tax benefits. The transactions undertaken by AJF-1 could have been undertaken outside of NMT at a lower cost. AJF-1 could have directly engaged in the same type of activity that NMT engaged in without contracting to pay $4.2 million in fixed fees. By keeping the option spread under the Shomrim agreement, AJF-1 could have invested under Mr. Bergmann's management at a lower cost without using NMT. The Shomrim variable fees were less than the NMT variable fees, and Mr. Bergmann managed both NMT and the activity under the Shomrim agreement.
The structure of the NMT spread transaction is not novel, and we have consistently disregarded entities that attempt to generate artificial losses by exploiting the partnership tax rules.
As an alternative argument, petitioner contends that NMT must be respected as a partnership because at least two of its members, Banque Safra and Fidulex, invested in NMT to earn profits from a rise in the euro. Large guaranteed tax benefits combined with the possibility of making a relatively small profit, however, do not create a valid business purpose.
NMT was created solely for tax avoidance purposes, and, for that reason, we do not recognize it as an entity for Federal tax purposes. Since it is not a tax-recognized entity, it is ineligible to be classified as a partnership for Federal tax purposes.
Consequences of Disregarding NMT
The FPAA adjusted NMT's reported loss of $669,206, other deductions of $18,712, capital contributions of $2,242,417, and distributions of $1,124,620 all to zero. The loss, other deductions, capital contributions, and distributions are partnership items that are appropriately decided at the partnership level. Sec. 301.6231(a)(3)-1(a)(1)(i), (4), Proced. & Admin. Regs.;
When a partnership is disregarded for tax purposes, the rules of subchapter K of chapter 1 of the Code no longer apply, and the partnership's activities will be deemed to have been engaged by one or more of its purported partners.
We have determined that NMT is not recognized as an entity for Federal tax purposes and, thus, cannot elect to be taxed as a partnership. As discussed
Section 6662 Accuracy-Related Penalty
In the FPAA respondent determined that any underpayment of tax resulting from his adjustments of NMT's partnership items was attributable, in the alternative, to (1) gross (or if not gross, substantial) valuation misstatement(s), (2) a substantial understatement of income tax, or (3) negligence or disregard of rules or regulations. Hence, respondent determined that either a 40% penalty or a 20% penalty applies to any underpayment.
Jurisdiction Over Penalties
Section 6226(f) grants this Court jurisdiction to determine the applicability of any penalty that could result from an adjustment to a partnership item, "even if imposing the penalty would also require determining affected or non-partnership items".
Applicability of the Penalty
Section 6662(a) and (b)(1), (2), and (3) imposes an accuracy-related penalty if any part of an underpayment of tax required to be shown on a return is due to, among other things, negligence or disregard of rules or regulations, a substantial understatement of income tax, or a substantial valuation misstatement. The penalty is 20% of the portion of the underpayment of tax to which the section applies. Sec. 6662(a). In the case of a gross valuation misstatement, 20% is increased to 40%. Sec. 6662(h)(1). The gross valuation misstatement penalty is a 40% penalty that applies to any portion of tax that a partner underpaid because he overstated the value of or his basis in property by 400% or more of its true value. Sec. 6662(e)(1), (h)(2). Only one accuracy-related penalty may be applied with respect to any given portion of an underpayment, even if that portion is subject to the penalty on more than one of the grounds set out in section 6662(b). Sec. 1.6662-2(c), Income Tax Regs.
The NMT spread transaction was used to generate tax losses by enabling petitioner to claim an artificially high outside basis in NMT. The FPAA deemed NMT to no longer exist, and accordingly, no partner could legitimately claim an outside basis greater than zero.
We have determined that NMT was a sham partnership, and we have sustained respondent's adjustments to the return, triggering the gross valuation penalty. Because we find the 40% gross valuation misstatement penalty applicable to any underpayment resulting from respondent's adjustments, we need not address the substantial understatement and negligence penalties.
A section 6662 penalty will not apply to any portion of an underpayment resulting from positions taken on the taxpayer's return for which the taxpayer had reasonable cause and with respect to which the taxpayer acted in good faith.
Partner-level defenses to any penalty, addition to tax, or additional amount that relates to an adjustment to a partnership item may not be asserted in the partnership-level proceeding. Sec. 301.6221-1T(c) and (d), Temporary Proced. & Admin. Regs., 64 Fed. Reg. 3838 (Jan. 26, 1999);
Petitioner claims reasonable cause and good faith on the basis of its and NMT's reasonable reliance on Untracht's advice. Petitioner's argument that we should take into consideration AJF-1's reasonable cause and good faith defense is misplaced. In
Reasonable cause exists where a taxpayer relies in good faith on the advice of a qualified tax adviser where the following three elements are present: "(1) [t]he adviser was a competent professional who had sufficient expertise to justify reliance, (2) the taxpayer provided necessary and accurate information to the adviser, and (3) the taxpayer actually relied in good faith on the adviser's judgment."
Additionally, petitioner argues that NMT had a reasonable basis for treating itself as a partnership. In assessing whether NMT had reasonable cause, we examine Shakti's role as NMT's managing partner and TMP. Specifically, we focus on Mr. Bergmann's conduct, as he controlled Shakti.
Mr. Bergmann is a highly sophisticated C.P.A. with significant tax experience. Mr. Bergmann, through Shakti, was involved in executing the NMT spread transaction and managing NMT. The option spread contributed to NMT was structured to yield and did yield tax benefits which Mr. Bergmann should have recognized as "too good to be true". Petitioner spent $1.2 million to purchase the option spread and reaped approximately $120 million in taxable losses. A reasonably prudent person, with Mr. Bergmann's C.P.A. background and tax experience, would not have conducted himself as Mr. Bergmann did in promoting and facilitating the tax losses arising out of the NMT spread transaction. Mr. Bergmann, through Shakti, did not act with reasonable cause and good faith in filing the NMT 1999 return, and therefore the gross valuation penalty applies.
We sustain respondent's adjustments to NMT's 1999 return. We find that NMT is a disregarded entity for Federal tax purposes. We further sustain respondent's determination as to the section 6662 accuracy-related penalty at the entity level to the extent determinable.
We have considered all other arguments, and to the extent not discussed above, we conclude those arguments are irrelevant, moot, or without merit.
To reflect the foregoing,