William E. Gustashaw, Jr. v. Commissioner of IRS ( 2012 )

Case: 11-15406 Date Filed: 09/28/2012 Page: 1 of 41
[PUBLISH]
IN THE UNITED STATES COURT OF APPEALS
FOR THE ELEVENTH CIRCUIT
________________________
No. 11-15406
________________________
Agency No. 19668-06
WILLIAM E. GUSTASHAW, JR.,
NANCY D. GUSTASHAW,
lllllllllllllllllllllllllllllllllllllll l Petitioners-Appellants,
versus
COMMISSIONER OF IRS,
llllllllllllllllllllllllllllllllllllllll Respondent-Appellee.
________________________
Petition for Review of a Decision of the
U.S. Tax Court
________________________
(September 28, 2012)
Before HULL, MARCUS and HILL, Circuit Judges.
HULL, Circuit Judge:
Case: 11-15406 Date Filed: 09/28/2012 Page: 2 of 41
Although a tax shelter can be legitimate, Petitioner William Gustashaw, Jr.,1
participated in one that was not. Gustashaw claimed substantial tax benefits from
the shelter on four consecutive tax returns. The IRS later disallowed Gustashaw’s
claim and determined deficiencies in tax and accuracy-related penalties, including
gross valuation misstatement penalties and a negligence penalty. Gustashaw
conceded the deficiencies in tax, but contested the penalties. The Tax Court
affirmed the IRS’s imposition of the penalties. After review and oral argument,
we affirm.
I. BACKGROUND
A. Gustashaw’s Education and Business Background
Petitioner Gustashaw is a college-educated, successful businessman.
Gustashaw, who married his wife Nancy in college, graduated from Gannon
University in 1973 with a bachelor of science degree in industrial management.
While in college, Gustashaw took business-related courses, including managerial
cost accounting and the principles of accounting.
Following graduation, Gustashaw embarked on a nearly thirty-year business
1
For purposes of this appeal, we refer to William Gustashaw, Jr., alone as “petitioner.”
His wife Nancy Gustashaw is a party solely because the Gustashaws filed joint returns, but
Nancy Gustashaw relied on her husband to prepare their taxes and took no part in the
investigation and reporting of the transactions at issue.
2
Case: 11-15406 Date Filed: 09/28/2012 Page: 3 of 41
career. From 1973 to 1993, Gustashaw held management positions with various
companies in the food and beverage industry. Then, in 1994, Gustashaw became
vice-president of operations at Merck Medco Managed Care (“Merck Medco”) in
Tampa, Florida. As vice-president of operations, Gustashaw was responsible for
large-scale prescription processing in a mail-order pharmacy. Subsequently,
Merck Medco promoted Gustashaw to vice-president and general manager, which
expanded his responsibilities to all operations of two mail-order pharmacies.
Merck Medco also provided Gustashaw with generous stock options.
B. Gustashaw’s Early Retirement Plan
In 1995, Gustashaw, who was then 45 years old, began planning for an early
retirement. Gustashaw had a conservative investment history and handled nearly
all of his and his wife’s investment decisions himself. In addition, Gustashaw had
filed all of the couple’s joint federal income tax returns. However, to assist with
his retirement plan, Gustashaw decided to hire a financial planner.
To that end, Gustashaw hired Ralph Maulorico, a financial planner at New
England Financial who represented wealthy individuals. Gustashaw wanted to
exercise his Merck Medco stock options by 2000, and sought Maulorico’s advice
on whether the stock option exercise would generate enough income to fund the
Gustashaws’ retirement. Maulorico recommended the stock option exercise.
3
Case: 11-15406 Date Filed: 09/28/2012 Page: 4 of 41
Thus, in 1996, Gustashaw sold some of the acquired stock and invested the
proceeds in mutual funds.
The next year, 1997, Gustashaw decided to hire a tax accountant to review
the Gustashaws’ tax returns, which Gustashaw would continue to prepare until
2000. On Maulorico’s recommendation, Gustashaw hired William Gable,
Maulorico’s college friend. Gable, who owns an accounting practice in Florida, is
an enrolled agent and accountant, but not a certified public accountant. Gable
received both an undergraduate and a master’s degree in accounting, with the
master’s degree specializing in taxation, at LaCrosse University. Gable reviewed
the Gustashaws’ self-prepared joint returns for 1997 through 1999, before they
were filed.
In 1999, Merck Medco underwent a reorganization and offered Gustashaw
an option to retire early. Gustashaw accepted and retired that same year. The
following year, 2000, Gustashaw exercised his remaining Merck Medco stock
options and sold the stock, generating $8,077,376 in income. For that year, Gable
prepared the tax return, at Gustashaw’s request. The 2000 return claimed tax
benefits through a complicated financial transaction known as “CARDS,” as
explained in the next section.
C. The CARDS Tax Shelter
4
Case: 11-15406 Date Filed: 09/28/2012 Page: 5 of 41
In early 2000, Maulorico learned from a colleague about the Custom
Adjustable Rate Debt Structure (“CARDS”) transaction and its use as a tax shelter.
The colleague learned of the CARDS transaction through Roy Hahn, a certified
public accountant and founder of Chenery Associates, Inc. (“Chenery”). Chenery
developed and promoted the CARDS shelter. At the time, Maulorico, who had
experience in tax shelters, believed the transaction offered both profit potential
and a tax shelter for the income from Gustashaw’s stock option exercise. Thus,
Maulorico suggested the CARDS transaction to Gustashaw, who became
interested in it.
During the 1990s and early 2000s, the CARDS transaction was promoted to
high net worth individuals both as an investment-financing mechanism and a tax
shelter. In the CARDS transaction, a U.S. taxpayer, facilitated by a newly created
company, uses a bank loan to create a tax loss based on an artificially high basis
(or cost) in assets, which then allows the taxpayer to generate a tax benefit by
offsetting real, taxable income.
There are three steps to create the CARDS tax shelter.2 First, in the loan
origination step, a foreign bank loans currency to the borrower, a Delaware limited
2
For a fuller discussion of the CARDS transaction, see Kerman v. Comm’r, 2011 WL
839768 (T.C. 2011), appeal pending, No. 11-1822 (6th Cir.).
5
Case: 11-15406 Date Filed: 09/28/2012 Page: 6 of 41
liability company owned 100% by nonresident alien individuals. Importantly, the
foreign ownership of the borrower ensures the borrower is not subject to U.S.
taxation. The loan is for a 30-year term with annual interest payments due, but not
principal payments. The bank deposits the loan proceeds directly into the
borrower’s account at the bank. However, to use the loan proceeds, the borrower
must meet collateralization requirements by acquiring valuable, stable assets such
as government bonds.
Second, in the loan assumption step, a U.S. taxpayer and the borrower enter
into an agreement whereby the U.S. taxpayer assumes joint and several liability for
the borrower’s entire loan. In exchange, the U.S. taxpayer receives only a small
percentage of the loan proceeds from the borrower, e.g., 15% for our purposes.
The borrower agrees to retain all interest obligations, and the U.S. taxpayer agrees
to repay the unpaid principal amount. The U.S. taxpayer then could, in theory, use
the assumed loan proceeds to make an investment, but the bank maintains
discretion on whether to release any funds. To access the loan proceeds, the U.S.
taxpayer must deposit equivalent, substitute collateral with the bank.
And third, in the currency exchange step, the U.S. taxpayer exchanges his
15% portion of the foreign-currency loan for U.S. dollars. This currency exchange
is a taxable event generating tax benefits. To achieve the benefits, the U.S.
6
Case: 11-15406 Date Filed: 09/28/2012 Page: 7 of 41
taxpayer claims that his basis in the exchanged currency is the entire amount of the
loan, not the 15% of the loan that the taxpayer actually received from the tax-
exempt borrower. This discrepancy creates a permanent tax loss of 85% of the
original loan amount, which permits the U.S. taxpayer to shelter other unrelated,
taxable income.
In August 2000, the Internal Revenue Service (“IRS”) issued a notice
warning taxpayers against claiming tax benefits through tax shelters similar to the
CARDS shelter, because such benefits would be subject to penalties. See I.R.S.
Notice 2000-44, 2000-2 C.B. 255. In March 2002, the IRS issued another, similar
notice that was targeted specifically at the CARDS shelter. See I.R.S. Notice
2002-21, 2002-1 C.B. 730. The 2002 notice also advised taxpayers who had used
the shelter to file amended returns. Id. Then, in 2005, the IRS offered a
settlement initiative whereby taxpayers could pay a reduced penalty by conceding
the claimed tax benefits. See I.R.S. Announcement 2005-80, 2005-2 C.B. 967.
D. Gustashaw’s Investigation of the CARDS Transaction
After Maulorico suggested the CARDS transaction, Gustashaw began to
investigate it. Maulorico arranged for Gustashaw to speak with Hahn, and most of
Gustashaw’s understanding of the transaction was from oral discussions with
Maulorico, Gable, and Hahn. According to Gustashaw, the CARDS shelter
7
Case: 11-15406 Date Filed: 09/28/2012 Page: 8 of 41
appeared attractive because it provided both tax advantages and investment
opportunities. These opportunities included (1) elimination of his year 2000 tax
liability by creating a tax loss, (2) access to investment funds over 30 years, and
(3) leverage of the euro against the dollar by drawing down a euro-denominated
loan and repaying it in dollars.
Over several months, Gustashaw, Maulorico, and Gable had multiple
conversations about the CARDS transaction with Hahn, the transaction’s
promoter. Hahn explained how the CARDS transaction worked, including that the
transaction would generate a permanent tax loss of approximately 85% of the
original loan amount. Chenery, Hahn’s firm, would set up the transaction, and
Hahn stated that Gustashaw’s only out-of-pocket expense would be Chenery’s
investment banking fee.
In June 2000, Gustashaw met with Maulorico and Gable to discuss both the
CARDS transaction and an executive summary about CARDS that Hahn had
prepared. After the meeting, Maulorico opined that Gustashaw could make a 16%
return on his investment in the CARDS transaction, based on Maulorico’s
“anecdotal[]” review of the transaction’s economics and past Standard & Poor’s
compound annual returns. Maulorico did not provide a written analysis.
Ultimately, Gustashaw and Maulorico concluded that Gustashaw would benefit
8
Case: 11-15406 Date Filed: 09/28/2012 Page: 9 of 41
from the CARDS transaction and the tax benefits it would generate for his 2000
tax return.
Gable, however, refused to prepare Gustashaw’s 2000 tax return without a
tax opinion letter affirming the legitimacy of the CARDS transaction and the
resultant permanent tax loss. Gable was unfamiliar with the Internal Revenue
Code (“Code”) provisions implicated by the transaction and was reluctant to opine
on the transaction’s tax ramifications. Accordingly, Gable asked Hahn, the
promoter of the CARDS transaction, to obtain a tax opinion letter on the
transaction’s federal income tax consequences.
Hahn offered to provide a model opinion letter prepared by the law firm of
Brown & Wood LLP. When Chenery, Hahn’s firm, began developing the CARDS
transaction in 1999, it retained Brown & Wood to write a model opinion letter on
the transaction’s tax consequences. Brown & Wood then maintained and updated
this model opinion letter, which it either sent directly to persons interested in the
CARDS transaction or permitted Chenery to distribute it. Hahn also knew that
Brown & Wood “stood available” to write individual, formal tax opinion letters
for CARDS participants.
Gable relayed Hahn’s offer to Gustashaw and explained that because the
model opinion letter was written by a major and reputable law firm, it would more
9
Case: 11-15406 Date Filed: 09/28/2012 Page: 10 of 41
likely than not protect Gustashaw from substantial tax penalties if the IRS
ultimately disregarded the CARDS transaction for federal tax purposes.
Gustashaw asked to see the model opinion letter.
The model opinion letter explained that the CARDS transaction was a tax
shelter and that the CARDS transaction “has not been before a court of law
addressing the issues addressed herein.” Nonetheless, the letter concluded that,
based on authority in analogous contexts, a taxpayer, “more likely than not,” could
claim the permanent tax loss promised by Chenery. The letter further opined that:
(1) the transaction—the transfer of the euro-denominated deposit proceeds to the
U.S. taxpayer in exchange for his assumption of the borrower’s obligations to the
bank—would constitute a sale of the foreign currency by the borrower to the
taxpayer; (2) the taxpayer’s tax basis in the foreign currency would equal the
principal amount of the loan, plus the amount of cash and the fair market value of
other consideration paid by the taxpayer to the borrower; (3) any gain or loss
resulting from the foreign currency’s disposition would be characterized as
ordinary income or loss under I.R.C. § 988; and (4) the taxpayer would recognize
no income upon the borrower’s payment of the loan to the bank.
Gustashaw met with Maulorico and Gable to review the model opinion
letter’s conclusions. Although Chenery, the CARDS transaction’s promoter, had
10
Case: 11-15406 Date Filed: 09/28/2012 Page: 11 of 41
retained and paid Brown & Wood to provide the model opinion letter, Gable
viewed the letter as an “honest opinion of the viability of [the CARDS]
transaction” because Brown & Wood was a major, reputable law firm. Gable then
insisted Gustashaw obtain a formal tax opinion letter from Brown & Wood.
However, Gable did not recommend obtaining an opinion from a different attorney
or law firm, as he believed it was an unnecessary expense. Gustashaw, relying
partly on Gable’s assurance that Brown & Wood had expertise in foreign
transactions, had Chenery obtain an opinion letter only from Brown & Wood.
Chenery paid for the formal opinion letter out of its fee agreement with
Gustashaw, but Gustashaw did not know how much Chenery paid. Gustashaw
never had any individualized discussions or conversations with anyone at Brown
& Wood.
In July 2000, Gustashaw asked Gable to determine his estimated year 2000
tax liability and to make projections about his potential tax savings as a result of
the CARDS shelter. To make the report, completed in August 2000, Gable relied
on information provided by Hahn, the CARDS transaction’s promoter. Gable’s
report included projections on the necessary CARDS investment schedule needed
to create a loss sufficient to offset Gustashaw’s 1998, 1999, and 2000 tax
liabilities, and projections for the potential costs of the transaction, using
11
Case: 11-15406 Date Filed: 09/28/2012 Page: 12 of 41
reasonable rates of return if the IRS disallowed the generated deductions. The
report assumed that the CARDS transaction would terminate, prompting the loan’s
repayment, on April 30, 2004. That date was chosen because it was outside the
period of limitations of assessing additional tax for the 2000 tax return.
Following the conclusion of his investigation, Gustashaw decided to enter
into a CARDS transaction. Gustashaw never investigated whether he could obtain
a similar credit arrangement from other sources. Gustashaw also did not seek a
ruling from the IRS on the CARDS transaction’s tax consequences, or any
independent opinion regarding the transaction’s legality. Rather, according to
Gustashaw, he believed Maulorico’s and Gable’s assurances about the
transaction’s legitimacy, even though Gable and Maulorico themselves relied on
Hahn’s representations about the transaction. Gable and Maulorico were
impressed that a major law firm and a major bank would be involved, thinking
neither would engage in illegitimate transactions.
E. The CARDS Transaction for Gustashaw
Hahn and Chenery agreed to arrange the CARDS transaction for Gustashaw
for an $800,000 fee. Gustashaw paid Chenery $10,000 up front, with the balance
to be paid upon the loan’s termination.
The CARDS transaction for Gustashaw worked as follows. Bayerische
12
Case: 11-15406 Date Filed: 09/28/2012 Page: 13 of 41
Hypo- und Vereinsbank AG (“HVB”), a large German bank, served as the lender.
A newly formed Delaware L.L.C., Osterley Financial Trading L.L.C. (“Osterley”),
served as the borrower. Osterley was wholly owned by two nonresident alien
individuals.
On December 5, 2000, the bank HVB entered into an agreement with
Osterley to lend €12,900,000 to Osterley for a 30-year term with interest payments
(but not principal payments) due annually. HVB deposited the loan proceeds
directly into Osterley’s account at HVB, with 85% invested in government bonds,
and 15% on short-term deposit. All of these funds served as collateral for the
loan, and no funds ever left the bank. To withdraw the loan proceeds, Osterley
was required to deposit substitute collateral.
Next, the bank HVB sent Gustashaw a letter, dated December 21, 2000,
confirming his interest in assuming joint and several liability for the euro-
denominated loan to Osterley. The letter stated that HVB made no guarantee or
representation about any aspect of the CARDS transaction, including its tax
ramifications. Further, the letter stated that Gustashaw represented that his own,
independent legal counsel had advised him and that he would comply with U.S.
tax laws.
On December 21, 2000, Gustashaw executed the documents to participate in
13
Case: 11-15406 Date Filed: 09/28/2012 Page: 14 of 41
the CARDS transaction. Gustashaw read the documents before signing them, but
he admitted that he did not fully understand them. Gustashaw assumed most of
the language was boilerplate and formalized his discussions with Hahn. Thus,
Gustashaw did not have Gable, Maulorico, or an attorney review the CARDS
transaction documents.
The CARDS transaction documents executed by Gustashaw provided that
Osterley agreed to transfer 15% of the loan proceeds on short-term deposit to
Gustashaw. In exchange, Gustashaw agreed to assume joint and several liability
for Osterley’s obligations to the bank HVB, including repayment of the entire
loan. Osterley and Gustashaw also agreed that, as between them, Gustashaw
would repay the unpaid principal amount of the loan at maturity and Osterley
would retain all interest obligations. There was no provision for a euro-dollar
conversion opportunity in the first year.
After Gustashaw executed the agreement, the bank HVB transferred the
15% portion of the loan to an HVB account in Gustashaw’s name and converted it
to dollars. HVB maintained discretion on whether Gustashaw could access those
funds. If Gustashaw desired to access the funds, HVB required him to deposit
substitute collateral with the bank that was at least equivalent to the amount of
funds withdrawn. In other words, the entire amount of the loan would remain
14
Case: 11-15406 Date Filed: 09/28/2012 Page: 15 of 41
fully collateralized at all times. At each annual interest date, HVB at its discretion
could permit Gustashaw to purchase more of the loan proceeds, up to the full
principal amount of the loan, by his providing additional collateral. HVB had
discretion to call the loan.
Sometime after Gustashaw executed the agreement, he received Brown &
Wood’s formal tax opinion letter, dated December 31, 2000. This letter set out the
details of Gustashaw’s CARDS transaction, including the roles played by
Chenery, HVB, and Osterley, as well as the amount borrowed. The tax analysis
contained in the letter, however, was identical to that contained in the Brown &
Wood model opinion letter that Chenery used to promote the CARDS transaction,
and was not particularized to Gustashaw’s CARDS transaction. Accordingly,
Gustashaw’s letter from Brown & Wood reached the same “more likely than not”
conclusions as the firm’s model opinion letter. Gable also reviewed the letter and
read the cited Code sections, but performed no independent analysis. Gable
assumed the letter was correct.
F. The Termination of the CARDS Transaction
Gustashaw did not attempt to access the funds for several months. Then, on
April 2, 2001, he pledged substitute collateral with a value of $2,550,850. The
bank HVB wired $1,008,465 to Gustashaw’s HVB account, and $735,000 to
15
Case: 11-15406 Date Filed: 09/28/2012 Page: 16 of 41
Chenery for fees associated with the CARDS transaction.
On November 13, 2001, HVB issued a mandatory prepayment election
notice to Gustashaw. The notice stated that the entire outstanding principal
amount of the loan, including any interest accrued, would be due and payable as of
December 5, 2001. Maulorico asked Chenery’s Hahn whether another bank would
provide the same credit arrangement, but all other banks declined. On December
17, 2001, Gustashaw’s CARDS transaction terminated, with all debts satisfied.
G. Gustashaw’s Tax Returns and the Notice of Deficiency
On his 2000 tax return, Gustashaw reported the CARDS transaction as a
foreign currency transaction, pursuant to I.R.C. § 988. The return stated that
Gustashaw had acquired property in a foreign currency transaction with an alleged
basis of $11,739,258 on December 5, 2000, and sold it on December 21, 2000, at
an alleged sales price of $1,800,934. That generated an ordinary loss of
$9,938,324. Gable, who prepared Gustashaw’s 2000 return, relied on Hahn to
calculate the amounts reported.
The claimed ordinary loss offset all of Gustashaw’s reported income for
2000, resulting in $1,784,462 of negative adjusted gross income. Gustashaw then
claimed net operating loss carryforward deductions related to the CARDS
transaction of $1,231,106, $785,986, and $498,860 on his 2001, 2002, and 2003
16
Case: 11-15406 Date Filed: 09/28/2012 Page: 17 of 41
returns, respectively.
On June 29, 2006, the IRS issued a notice of deficiency to Gustashaw,
assessing deficiencies in tax and accuracy-related penalties under I.R.C. § 6662(a)
for his 2000, 2001, 2002, and 2003 tax returns. The IRS assessed a 40% gross
valuation misstatement penalty for 2000 through 2002, and a 20% negligence
penalty for 2003. Specifically, the penalties were: $1,275,290 for 2000; $63,910
for 2001; $34,260 for 2002; and $898 for 2003.3
The IRS disallowed the $9,938,324 loss claimed on the 2000 tax return on
the ground that, inter alia, Gustashaw failed to establish the claimed $11,739,258
basis and that the CARDS transaction lacked economic substance. Further, the
IRS stated that the transaction “was entered into for the primary purpose of tax
avoidance, and/or was prearranged and predetermined.” The IRS also disallowed
the 2001, 2002, and 2003 claimed net operating loss carryforward deductions
because of the adjustments to the 2000 tax return.
H. HVB’s Admission of Fraudulent Behavior
On February 13, 2006, the bank HVB entered into a deferred prosecution
3
In the original notice of deficiency, the IRS assessed 20% negligence penalties against
Gustashaw for the years 2001 and 2002, in the amounts of $31,955 and $17,130, respectively.
After proceedings commenced in the Tax Court, the IRS filed an “Amendment to Answer to
Amended Petition” in which it asserted that Gustashaw was liable for 40% gross valuation
misstatement penalties for both years, rather than just the 20% negligence penalties. The
increased 40% penalty amounts were $63,910 for 2001 and $34,260 for 2002.
17
Case: 11-15406 Date Filed: 09/28/2012 Page: 18 of 41
agreement with the United States in which it admitted that it participated in several
tax shelter transactions, including CARDS, between 1996 and 2002. HVB
admitted that loans entered in connection with the CARDS shelter purported to
involve 30-year loans, when all parties, including the borrowers, knew that the
transactions would be unwound in approximately one year so as to generate false
tax benefits for the participants. HVB acknowledged that the transactions had no
purpose other than to generate tax benefits for the participants. HVB further
admitted that it engaged in activities with others, including Brown & Wood,
“related to the CARDS tax shelter with the intention of defrauding the United
States.”
I. Tax Court Trial and Opinion
In light of HVB’s admissions of fraudulent behavior, Gustashaw conceded
the deficiencies in income tax for all four years in issue. Gustashaw challenged
only the penalties in the Tax Court. The case proceeded to trial in the Tax Court.
At trial, Gustashaw admitted that he did not suffer a $9,938,324 economic
loss associated with the $9,938,324 tax loss claimed on the 2000 tax return.
Gustashaw continued to contend that he was not liable for the penalties, in part
because he had “reasonable cause,” pursuant to I.R.C. § 6664, to believe the
CARDS transaction was legitimate. Gustashaw also argued that because the IRS
18
Case: 11-15406 Date Filed: 09/28/2012 Page: 19 of 41
disregarded the transaction on economic-substance grounds, the valuation
misstatement penalty should not apply as a matter of law, pursuant to a minority
rule interpretation of I.R.C. § 6662.
After a trial, the Tax Court upheld the 40% gross valuation misstatement
penalties for 2000 through 2002 and the 20% negligence penalty for 2003. The
Tax Court applied the majority rule interpretation of I.R.C. § 6662 and rejected
Gustashaw’s reasonable-cause defense.
1. Valuation Misstatement Penalties
The Tax Court first addressed the valuation misstatement penalties.
It explained that I.R.C. § 6662(a) and (b)(3) impose a penalty of 20% of the
portion of the underpayment of tax that is attributable to a substantial valuation
misstatement.4 Such a misstatement exists if the taxpayer claims that the value or
adjusted basis of any property is 200% or more of the amount determined to be the
correct amount of such valuation or adjusted basis. I.R.C. § 6662(e)(1)(A). If the
misstatement is 400% or more of the correct amount, a gross valuation
misstatement exists and the penalty increases to 40%. Id. § 6662(h). The Tax
4
As indicated by the Tax Court, “[u]nless otherwise stated, section references are to the
Internal Revenue Code in effect for the years in issue.” Likewise, in their briefs the parties refer
and cite to the version of the Code that was in effect during the relevant years. Accordingly,
unless otherwise stated, we do the same herein.
19
Case: 11-15406 Date Filed: 09/28/2012 Page: 20 of 41
Court explained that Treasury Regulation § 1.6662-5(g) provides that the “value
or adjusted basis claimed on a return of any property with a correct value or
adjusted basis of zero is considered to be 400 percent or more of the correct
amount.”
The Tax Court found that Gustashaw was liable for the 40% gross valuation
misstatement penalty for 2000 through 2002, concluding that his underpayments
in tax for those years resulted from his claiming a basis in foreign currency on his
2000 return of $11,739,258, rather than a basis of zero, which is the correct
amount when a transaction lacks economic substance. In the notice of deficiency,
the Commissioner determined that the correct basis for the asset was zero, and the
Tax Court found that Gustashaw “effectively accepted” that determination “as
accurate in conceding all of the deficiencies in tax.” It further noted that a line of
cases from the Fifth and Ninth Circuits supported Gustashaw’s argument that a
valuation misstatement penalty is not applicable when the entire transaction is
disregarded on lack-of-economic-substance grounds, but pointed out that those
cases represented the minority rule and declined to follow them. Because the
proper basis was zero, the Tax Court concluded that the basis claimed on
Gustashaw’s 2000 return exceeded the correct basis by 400% or more.
Additionally, because that grossly inflated basis gave rise to losses that Gustashaw
20
Case: 11-15406 Date Filed: 09/28/2012 Page: 21 of 41
carried forward to his 2001 and 2002 years, the Tax Court concluded that the
underpayments in tax for those years were also attributable to a gross valuation
misstatement.
2. Negligence Penalty
For 2003, in which Gustashaw’s carryover loss was too small for a gross
valuation misstatement penalty to apply, the Tax Court upheld the 20% negligence
penalty. It reasoned that “[n]egligence is strongly indicated where ‘[a] taxpayer
fails to make a reasonable attempt to ascertain the correctness of a deduction,
credit or exclusion on a return which would seem to a reasonable and prudent
person to be “too good to be true.’”” The Tax Court explained that a return
position is not negligent if it is reasonably based on certain enumerated
authorities, but that conclusions reached in opinion letters written by tax
professionals are not considered authority. The Tax Court further explained that a
reasonable and ordinarily prudent person would have considered carryforward
deductions from the CARDS transaction “too good to be true” when he did not
suffer an associated economic loss and invested only $800,000 in the transaction.
As such, he would have conducted a thorough investigation before claiming the
deduction on his tax return. The Tax Court found that Gustashaw, despite his
education and experience, did not attempt to understand the mechanics of the
21
Case: 11-15406 Date Filed: 09/28/2012 Page: 22 of 41
CARDS transaction, executed transaction documents without an attorney’s review,
and, although aware of the transaction’s untested tax ramifications, declined to
seek a ruling from the IRS. The Tax Court concluded that, presented with such a
“too good to be true” situation, Gustashaw was negligent in failing to more closely
scrutinize the CARDS transaction.
3. The Reasonable Cause and Good Faith Defense
The Tax Court further concluded that Gustashaw had failed to show that
there was reasonable cause for his underpayment or that he acted in good faith, as
required for him to avoid penalties under I.R.C. § 6664(c). It rejected
Gustashaw’s arguments that he reasonably relied on Gable or Maulorico because
neither actually opined on the tax issues involved. It concluded that the only tax
advice Gustashaw sought concerning the CARDS transaction was from Brown &
Wood, as neither Gable nor Maulorico proffered an opinion on the tax issues
involved, and Gustashaw’s reliance on Brown & Wood’s advice was unreasonable
because he should have known about the firm’s inherent conflict of interest. The
Tax Court noted that Chenery referred Gustashaw to Brown & Wood and supplied
him with the firm’s model opinion letter, which described a CARDS transaction
that was not unique to Gustashaw’s situation. Gustashaw also proffered no
evidence that he had an engagement letter with Brown & Wood, spoke to any
22
Case: 11-15406 Date Filed: 09/28/2012 Page: 23 of 41
attorney at the firm, or compensated Brown & Wood for either opinion letter. On
these facts, the Tax Court held that Gustashaw could not have reasonably believed
that Brown & Wood was an independent adviser.
Based on this decision, the Tax Court entered a judgment in favor of the
Commissioner, upholding the penalties for the years 2000 through 2003 imposed
against Gustashaw under § 6662. Gustashaw now appeals.
II. STANDARD OF REVIEW
We review the Tax Court’s legal conclusions de novo, and its factual
findings for clear error. See Campbell v. Comm’r, 658 F.3d 1255, 1258 (11th Cir.
2011). Whether a taxpayer acted with reasonable cause and in good faith with
regard to an underpayment of tax is a question of fact that we review for clear
error. Id.III. DISCUSSION
A. Gross Valuation Misstatement Penalty in I.R.C. § 6662
Gustashaw argues that the Tax Court erred in upholding the IRS’s
imposition of the 40% gross valuation misstatement penalties for 2000 through
2002. See I.R.C. § 6662(a)–(h). Specifically, Gustashaw contends that because
the CARDS transaction lacked economic substance, there was no value or basis to
misstate as to trigger the valuation misstatement penalties, and the penalties
23
Case: 11-15406 Date Filed: 09/28/2012 Page: 24 of 41
should not apply as a matter of law. Gustashaw also argues that Congress has
penalized lack-of-economic-substance transactions by enacting I.R.C. §§ 6662A
and 6663, and therefore, he should not be subject to gross valuation misstatement
penalties under § 6662.5
The Internal Revenue Code establishes penalties for underpayment of tax.
Section 6662(a) of the Code imposes an accuracy-related penalty of 20% of the
portion of an underpayment of tax “attributable to,” inter alia, negligence, any
substantial understatement of income tax, or any substantial valuation
misstatement. I.R.C. § 6662(a), (b)(1)–(3). Under the applicable regulations, only
one penalty may apply to a particular underpayment of tax, even if the IRS
determines accuracy-related penalties on multiple grounds. Treas. Reg. § 1.6662-
2(c).
The 20% penalty increases to 40% if there is a gross valuation misstatement.
I.R.C. § 6662(h)(1). A gross valuation misstatement exists if “the value of any
5
Gustashaw additionally argues that his general concession of his underpayment of tax
immunizes him from the imposition of gross valuation misstatement penalties. He argues that
when the IRS disallows a transaction on several alternative bases, not all of which involve a
valuation misstatement, and the taxpayer makes a general concession of underpayment, the
underpayment is not “attributable to” a gross valuation misstatement within the meaning of
I.R.C. § 6662. Gustashaw did not raise this argument before the Tax Court, and we therefore
decline to consider it for the first time on appeal. Access Now, Inc. v. Sw. Airlines Co., 385 F.3d
1324, 1331 (11th Cir. 2004). Even if we were to consider this argument, it is substantially
intertwined with and relies on a minority line of cases whose reasoning we reject infra.
24
Case: 11-15406 Date Filed: 09/28/2012 Page: 25 of 41
property (or the adjusted basis of any property) claimed on any return of tax . . . is
[400] percent or more of the amount determined to be the correct amount of such
valuation or adjusted basis (as the case may be).” I.R.C. § 6662(e)(1)(A),
(h)(2)(A)(i). By contrast, a “substantial valuation misstatement,” which receives
only the 20% penalty, occurs when the “value of any property (or the adjusted
basis of any property) claimed on any return of tax . . . is 200 percent or more of
the amount determined to be the correct amount of such valuation or adjusted
basis (as the case may be).” Id. § 6662(e)(1)(A). Treasury Regulations further
provide that a gross valuation misstatement exists when the correct or adjusted
basis of property is zero. Treas. Reg. § 1.6662-5(g). However, unless the portion
of the underpayment attributable to the valuation misstatement exceeds $5,000, no
substantial valuation misstatement penalty may be imposed. I.R.C. § 6662(e)(2).
The Internal Revenue Code provides a narrow exception to the imposition
of accuracy-related penalties for an underpayment if the taxpayer shows that he
acted with reasonable cause and in good faith. I.R.C. § 6664(c)(1). This
exception is detailed in section E, below.
B. Majority Rule: The Penalty Applies When the Deduction is Totally
Disallowed for Lack of Economic Substance
There is no question that the CARDS transaction lacked economic
25
Case: 11-15406 Date Filed: 09/28/2012 Page: 26 of 41
substance. Indeed, Gustashaw admitted as much at trial, and concedes this on
appeal. The correct basis of the foreign currency, then, was not $11,739,258, as
Gustashaw reported on his 2000 tax return, but zero. This reduction of basis to
zero in turn eliminated the $9,938,324 loss that Gustashaw had claimed on his
2000 return. With the loss eliminated, the IRS properly determined Gustashaw’s
underpayments in tax, and Gustashaw conceded the deficiencies.
The question we now confront, for the first time in this Circuit, is whether
Gustashaw is liable for the assessed gross valuation misstatement penalties when
the IRS disregarded the CARDS transaction in its entirety because it lacked
economic substance. It seems the obvious and sensible conclusion is that
Gustashaw’s tax underpayments were “attributable to” a gross valuation
misstatement within the meaning of § 6662. That is, the underpayments resulted
from Gustashaw’s reporting an artificially inflated basis in currency, which was
not $11,739,258, but zero. And, pursuant to the regulations, the basis claimed by
Gustashaw ($11,739,258) was 400% more than the correct basis of the property
(zero), making Gustashaw liable for the 40% gross valuation misstatement
penalty. See Treas. Reg. § 1.6662-5(g).
The statute speaks in mandatory terms—the valuation misstatement penalty
“shall be added” “to any portion of an underpayment of tax required to be shown
26
Case: 11-15406 Date Filed: 09/28/2012 Page: 27 of 41
on a return . . . which is attributable to . . . [a]ny substantial valuation
misstatement” or “gross valuation misstatement.” I.R.C. § 6662(a), (b)(3), (h)(1).
We can discern no exception for when the valuation or basis misstatements are so
egregious that the entire tax benefit is disallowed, and no suggestion that the
penalty should not apply when the correct basis or value is determined to be zero
because the transaction is completely lacking in economic substance.
Our interpretation is in accord with the majority of circuits to have
considered the question. See, e.g., Alpha I, L.P., ex rel. Sands v. United States,
682 F.3d 1009, 1026–31 (Fed. Cir. 2012); Fidelity Int’l Currency Advisor A Fund,
LLC, ex rel. Tax Matters Partner v. United States, 661 F.3d 667, 671–75 (1st Cir.
2011); Merino v. Comm’r, 196 F.3d 147, 155, 157–59 (3d Cir. 1999); Zfass v.
Comm’r, 118 F.3d 184, 190–91 (4th Cir. 1997); Illes v. Comm’r, 982 F.2d 163,
167 (6th Cir. 1992); Gilman v. Comm’r, 933 F.2d 143, 149, 151 (2d Cir. 1991);
Massengill v. Comm’r, 876 F.2d 616, 619–20 (8th Cir. 1989). Only two circuits,
the Fifth and the Ninth, have gone the other way. See Gainer v. Comm’r, 893 F.2d
225 (9th Cir. 1990); Todd v. Comm’r, 862 F.2d 540 (5th Cir. 1988). Notably,
both circuits have since questioned the soundness of their interpretation. See
Bemont Invs., L.L.C. ex rel. Tax Matters Partner v. United States, 679 F.3d 339,
351 (5th Cir. 2012) (panel specially concurring); Keller v. Comm’r, 556 F.3d
27Case: 11-15406 Date Filed: 09/28/2012 Page: 28 of 41
1056, 1061 (9th Cir. 2009).
Here, we find the majority rule to be the better interpretation and will apply
it in this case. That rule holds that the penalty applies even if the deduction is
totally disallowed because the underlying transaction, which is intertwined with
the overvaluation misstatement, lacked economic substance. See, e.g., Fidelity,
661 F.3d at 673–74. This rule rests upon the fact that the abusive tax shelter is
built upon the basis misstatement, and the transaction’s lack of economic
substance is directly attributable to that misstatement. As Judge Boudin stated in
Fidelity, that “alternative grounds with lower or no penalties existed for
disallowing the same claimed losses hardly detracts from the need to penalize and
discourage the gross value misstatements.” Id. at 673.
C. Minority Rule
As for the minority rule, we think it important to note that the Fifth and the
Ninth Circuits have questioned the wisdom of their positions. The Fifth Circuit
has stated that, under its rule,
by crafting a more extreme scheme and generating a deduction that is
improper not only due to a basis misstatement, but also for some other
reason (e.g., a lack of economic substance), the taxpayer increases his
chance of avoiding the valuation-misstatement penalty—because, per
the Todd/Heasley hierarchy whereby the overvaluation penalty is
subordinated to any other proper adjustment, disallowing the deduction
on the other ground could block the penalty. Amplifying the
28
Case: 11-15406 Date Filed: 09/28/2012 Page: 29 of 41
egregiousness of the scheme—to the point where the transaction is an
utter sham—could thus, perversely, shield the taxpayer from liability for
overvaluation. . . . By creating this perverse incentive structure, the
Todd/Heasley rule frustrates the purpose of the valuation-misstatement
penalty, which is to deter taxpayers from inflating values and bases to
generate large, improper tax benefits. . . .
Bemont, 679 F.3d at 355 (panel specially concurring) (citing Heasley v. Comm’r,
902 F.2d 380, 383 (5th Cir. 1990); Todd, 862 F.2d at 542–45). The Ninth Circuit
also has recognized that its decision in Gainer, which rested in large part on the
Fifth Circuit’s reasoning in Todd, leads to the same anomalous result, and thus
encourages a taxpayer to engage “in behavior one might suppose would implicate
more tax penalties, not fewer.” Keller, 556 F.3d at 1061.
The Fifth Circuit has further questioned the soundness of its reasoning in
Todd, insofar as the reasoning was based on a misinterpretation of the legislative
history surrounding I.R.C. § 6659 (repealed 1989), the predecessor to § 6662. See
Bemont, 679 F.3d at 351–53 (panel specially concurring); see also Alpha I, 682
F.3d at 1028–30 (discussing this issue and declining to adopt the Fifth Circuit’s
approach); Fidelity, 661 F.3d at 673–74 (same). The concurring panel in Bemont
noted that the Todd Court had relied on and interpreted the 1981 “Blue Book,” a
post-enactment summary of tax legislation prepared by the staff of the Joint
Committee on Taxation, in analyzing § 6659’s penalties assessed against tax
29
Case: 11-15406 Date Filed: 09/28/2012 Page: 30 of 41
underpayments that were “attributable to” a valuation misstatement. Bemont, 679
F.3d at 351 (citing Todd, 862 F.2d at 542–43; Staff of the Joint Comm. on
Taxation, 97th Cong., General Explanation of the Economic Recovery Tax Act of
1981 333 (Comm. Print 1981) (“Blue Book”)). In relevant part, the Blue Book
states that
[t]he portion of a tax underpayment that is attributable to a valuation
overstatement will be determined after taking into account any other
proper adjustments to tax liability. Thus, the underpayment resulting
from a valuation overstatement will be determined by comparing the
taxpayer’s (1) actual tax liability (i.e., the tax liability that results from
a proper valuation and which takes into account any other proper
adjustments) with (2) actual tax liability as reduced by taking into
account the valuation overstatement. The difference between these two
amounts will be the underpayment that is attributable to the valuation
overstatement.
Fidelity, 661 F.3d at 673–74 (quoting Blue Book at 333). Through the use of
further examples, the Blue Book concludes that when the IRS disallows two
different deductions, but only one disallowance is based on a valuation
misstatement, the valuation misstatement penalty should apply only to the
deduction taken on the valuation misstatement, and not to the other deduction that
is unrelated to valuation misstatement. See Bemont, 679 F.3d at 351–52 (panel
specially concurring) (quoting Blue Book at 333 & n.2).
In Todd, however, the Fifth Circuit misapplied this guidance to a situation
30
Case: 11-15406 Date Filed: 09/28/2012 Page: 31 of 41
in which the IRS disallowed a single deduction on several grounds, only one of
which related to a valuation misstatement. Todd, 862 F.2d at 543–44. The
Bemont Court correctly recognized that the reasoning contained in the Blue Book
does not extend to a scenario in which “overvaluation is one of two possible
grounds for denying the same deduction and the ground explicitly chosen is not
overvaluation,” but that it was nevertheless bound to follow Todd as the rule of
decision. Bemont, 679 F.3d at 352, 355 (panel specially concurring). As other
courts have noted in addressing this situation, the Blue Book’s guidance is
designed to avoid attributing to a basis or value misstatement an upward
adjustment of taxes that is unrelated to the overstatement, and is instead due solely
to some other, independent tax reporting error. See Alpha I, 682 F.3d at 1029–30;
Fidelity, 661 F.3d at 674. This is entirely different from excusing an
overstatement because it is one of two independent, rather than the sole, cause of
the same underpayment error. We therefore agree with the majority of the other
Circuits that have addressed this issue, and decline to adopt the reasoning of the
Fifth and Ninth Circuits with regard to the application of valuation misstatement
penalties in the present case.
D. Penalties Under I.R.C. §§ 6662A and 6663
We also find no merit in Gustashaw’s suggestion that Congress intended to
31
Case: 11-15406 Date Filed: 09/28/2012 Page: 32 of 41
penalize taxpayers who engage in transactions devoid of economic substance
solely through I.R.C. §§ 6662A and 6663, rather than through the penalties in
§ 6662. Congress added § 6662A to the Code in 2004, and this provision imposes
a penalty only on certain understatements made regarding reportable transactions.
See American Jobs Creation Act of 2004, Pub. L. No. 108-357, Title VIII,
§ 812(a), 118 Stat. 1577 (codified at I.R.C. § 6662A). This penalty provision does
not apply to instances of gross valuation misstatements, which are still determined
under § 6662(h). See I.R.C. § 6662A(e)(2)(B), cross-referencing id. § 6662(h).
By virtue of both its date of enactment and its terms, therefore, § 6662A is
irrelevant to the present case. Additionally, § 6663 penalizes underpayments
attributable to fraud, and is likewise irrelevant to Gustashaw’s situation.
E. The Reasonable Cause and Good Faith Defense in I.R.C. § 6664(c)
As to all the penalties, Gustashaw argues that he reasonably relied on
Gable’s and Maulorico’s advice and the Brown & Wood opinion letters regarding
the legitimacy of the CARDS transaction.6
The Code contains an exception to otherwise-applicable penalties under
I.R.C. § 6662. See I.R.C. § 6664(c)(1). Section 6664(c)(1) provides that “[n]o
6
Gustashaw makes no argument on the negligence penalty for 2003 aside from his
reasonable-reliance argument. Thus, Gustashaw has waived any other argument on the
applicability of the negligence penalty. See Access Now, 385 F.3d at 1330.
32
Case: 11-15406 Date Filed: 09/28/2012 Page: 33 of 41
penalty shall be imposed under [section 6662] . . . with respect to any portion of an
underpayment if it is shown that there was a reasonable cause for such portion and
that the taxpayer acted in good faith with respect to such portion.” Id. The
taxpayer bears the burden of establishing that he acted with reasonable cause and
in good faith. Calloway v. Comm’r , — F.3d —, No. 11-10395, 2012 WL
3599606 (11th Cir. Aug. 23, 2012).
Under the regulations, the determination of whether the taxpayer has
established reasonable cause is made based on all the pertinent facts and
circumstances. Treas. Reg. § 1.6664-4(b)(1). The most important factor in this
determination is the “extent of the taxpayer’s effort to assess [his] proper tax
liability.” Id. A taxpayer may meet his burden by showing that he reasonably
relied in good faith on the advice of an independent professional, such as a tax
advisor, lawyer, or accountant, as to the transaction’s tax treatment. United States
v. Boyle, 469 U.S. 241, 251, 105 S. Ct. 687, 692–93 (1985); Treas. Reg.
§ 1.6664-4(c). The taxpayer’s education and business experience are relevant to
the determination of whether the taxpayer’s reliance on professional advice was
reasonable and done in good faith. Treas. Reg. § 1.6664-4(c)(1).
The professional’s advice must meet several requirements. First, the
taxpayer must show that the advice was based on “all pertinent facts and
33
Case: 11-15406 Date Filed: 09/28/2012 Page: 34 of 41
circumstances and the law as it relates to those facts and circumstances.” Id.§ 1.6664-4(c)(1)(i). Second, the advice relied upon must not be based on any
“unreasonable factual or legal assumptions,” and must not “unreasonably rely on
the representations, statements, findings, or agreements of the taxpayer or any
other person.” Id. § 1.6664-4(c)(1)(ii). Third, the reasonableness of any reliance
turns on the quality of the advice and whether, under the circumstances, it was
objectively reasonable for the taxpayer to rely on that advice. See 106 Ltd. v.
Comm’r, 684 F.3d 84, 90 (D.C. Cir. 2012); Klamath Strategic Inv. Fund ex rel. St.
Croix Ventures v. United States, 568 F.3d 537, 548 (5th Cir. 2009).
Reliance is not reasonable if the adviser was a promoter of the transaction or
otherwise had a conflict of interest about which the taxpayer knew or should have
known. Stobie Creek Invs. LLC v. United States, 608 F.3d 1366, 1381–82 (Fed.
Cir. 2010); Chamberlain v. Comm’r, 66 F.3d 729, 732–33 (5th Cir. 1995) (noting
that, to establish good faith reliance on professional advice, “taxpayers may not
rely on someone with an inherent conflict of interest, or someone with no
knowledge concerning that matter upon which the advice is given” (footnotes
omitted)). Reliance on professional advice is likewise unreasonable when the
“taxpayer knew or should have known that the transaction was ‘too good to be
true’” in light of all the circumstances, including the taxpayer’s education,
34
Case: 11-15406 Date Filed: 09/28/2012 Page: 35 of 41
sophistication, and reasons for entering into the transaction. Stobie Creek, 608
F.3d at 1382; cf. Barlow v. Comm’r, 301 F.3d 714, 723 (6th Cir. 2002) (noting
“that courts have found that a taxpayer is negligent if he puts his faith in a scheme
that, on its face, offers improbably high tax advantages, without obtaining an
objective, independent opinion on its validity”). In addition, reliance may not be
reasonable or in good faith if the taxpayer knew or reasonably should have known
that the advisor lacked knowledge in the relevant aspects of federal tax law.
Treas. Reg. § 1.6664-4(c)(1). A tax professional’s independence is only one factor
in determining whether a taxpayer acted with reasonable cause and in good faith.
Id.; Stobie Creek, 608 F.3d at 1381–82.
F. No Clear Error in the Tax Court’s Findings
We find no clear error in the Tax Court’s findings that Gustashaw failed to
establish that he acted with reasonable cause and in good faith regarding his
underpayment of tax. With regard to Maulorico’s advice concerning the CARDS
transaction, although Maulorico became familiar with the transaction through a
colleague, and originally introduced the transaction to Gustashaw as an investment
opportunity, he was not qualified to offer an opinion on the CARDS transaction’s
tax consequences and expressly declined to do so. Maulorico was not a tax
professional and lacked sufficient knowledge in the relevant aspects of federal tax
35
Case: 11-15406 Date Filed: 09/28/2012 Page: 36 of 41
law. To show that he acted with reasonable cause, Gustashaw cannot rely on the
general financial planning advice provided by Maulorico when that advice failed
to encompass the tax consequences of the CARDS transaction and did not analyze
the relevant law as it related to Gustashaw’s particular circumstances. Treas. Reg.
§ 1.6664-4(c)(1).
Nor do we find persuasive Gustashaw’s arguments that he was entitled to
rely on the advice provided by Gable, and that such reliance was reasonable
because Gable was an independent tax professional whom Gustashaw paid to
render an opinion. As for tax advice, Gable testified that he did not even
understand the particular details of the CARDS transaction and that he did not
have any expertise in the tax law involved. Just as with Maulorico, Gable
expressly declined to offer an independent opinion on the validity of the CARDS
transaction’s tax benefits.
Instead, Gable recommended that Gustashaw obtain a legal opinion
regarding the CARDS transaction’s validity from Brown & Wood, whom both
Gable and Gustashaw knew were Chenery and Hahn’s attorneys. Gable even
solicited the Brown & Wood opinion letters through Hahn, the promoter of the
CARDS transaction. Gable did not pay Brown & Wood, and knew that
Gustashaw did not pay, for either the model opinion letter or the formal opinion
36
Case: 11-15406 Date Filed: 09/28/2012 Page: 37 of 41
letter which, in conjunction with Gable’s requests to Brown & Wood being routed
through the promoter, Hahn, demonstrate that Gable should have been aware that
Brown & Wood was not providing objective, disinterested tax advice.
Ultimately, the only advice that Gable provided was his opinion that
Gustashaw could rely on the Brown & Wood opinion letter because it came from a
major, reputable law firm, and that obtaining a second opinion would be an
unnecessary expense. Yet, as noted above, Gable offered this advice knowing that
Brown & Wood had been retained and paid by Chenery, and that Brown & Wood
had written a model opinion letter for Chenery and Hahn to use in promoting the
CARDS transaction. Further, even to the extent that Gable’s statements
concerning Brown & Wood’s reputation qualify as advice in the traditional sense,
they do not constitute tax advice on which Gustashaw was entitled to rely. In sum,
the fact that Gable was an independent, paid advisor cannot outweigh the fact that
he lacked the requisite knowledge to provide competent advice on the tax
consequences of the CARDS transaction. See Treas. Reg. § 1.6664-4(c)(1).
Gustashaw argues that by finding that he was not entitled to rely in good
faith on Gable’s advice, the Tax Court effectively required him to second guess
the tax professional whom he paid to provide him with tax advice. Had Gable
been equipped with the relevant tax expertise and rendered his own opinion as to
37
Case: 11-15406 Date Filed: 09/28/2012 Page: 38 of 41
the CARDS transaction’s tax consequences, this argument would be more
persuasive. However, in this case, Gable was unprepared to render an independent
opinion, informed Gustashaw of this fact, and went on to obtain the opinion letter
through Hahn, the CARDS transaction’s promoter, from Brown & Wood. See
Chamberlain, 66 F.3d at 732 (holding that a taxpayer cannot rely on someone with
no knowledge of the relevant tax matters to establish good faith reliance on
professional advice). Where, as here, Gable did not have the expertise necessary
to provide an independent opinion regarding the tax consequences of the CARDS
transaction, the Tax Court did not clearly err in determining that Gustashaw could
not reasonably rely in good faith on Gable’s opinion.
Finally, we find no clear error in the Tax Court’s conclusion that
Gustashaw’s reliance on the Brown & Wood opinion letter fails to demonstrate
that he acted with reasonable cause and in good faith regarding his underpayments
of tax. Despite Gable’s advice that Brown & Wood was a reputable firm and that
obtaining a second opinion was an unnecessary expense, Brown & Wood was not
an independent advisor to Gustashaw, and the opinion letter that the firm sent to
Gustashaw was not tailored to Gustashaw or the CARDS transaction in which he
sought to participate. Although the opinion letter did summarize Gustashaw’s
CARDS transaction and the amounts being loaned and distributed, the legal and
38
Case: 11-15406 Date Filed: 09/28/2012 Page: 39 of 41
tax analysis contained in the opinion letter was materially identical to the model
opinion letter and did not contain any particularized legal or tax analysis for
Gustashaw.
The Tax Court determined that Gustashaw should have known about Brown
& Wood’s inherent conflict of interest caused by its affiliation with Chenery
because Gable’s inquiries regarding obtaining a tax opinion letter were routed
through Chenery’s Hahn, and Brown & Wood had been retained by Chenery to
provide a model opinion letter as well as opinion letters to Chenery’s individual
clients, if needed. Gustashaw did not retain Brown & Wood on his behalf, and
Gustashaw never met with a representative of Brown & Wood individually or
otherwise verified that Brown & Wood was acting as his agent or was fully
apprised of his personal circumstances. Cf. Van Scoten v. Comm’r, 439 F.3d
1243, 1253 (10th Cir. 2006) (holding that it was unreasonable for taxpayers to rely
on tax professionals with whom they did not personally consult and who were
agents of the promoter of the transaction at issue). In addition, Brown & Wood
was paid out of Gustashaw’s fee arrangement with Chenery, and Gustashaw did
not know how much of the $800,000 fee he paid to Chenery was sent to Brown &
Wood in exchange for the firm’s writing of his opinion letter.
These facts indicate that Gustashaw, if he was not actually aware of it,
39
Case: 11-15406 Date Filed: 09/28/2012 Page: 40 of 41
should have known that Brown & Wood labored under a conflict of interest and
that any advice provided by Brown & Wood would not necessarily be objective.
See Klamath, 568 F.3d at 548. This does not mean that Gustashaw was required
to understand the merits of the legal reasoning contained in the opinion letter, but
rather, only shows that Gustashaw could not have relied in good faith on the
opinion of Brown & Wood, an interested party, when he had reason to know about
Brown & Wood’s conflict of interest.
Furthermore, in light of Gustashaw’s education (which included courses in
accounting), nearly thirty years of business experience, and history of handling his
own finances and preparing his own tax returns, all of which are relevant to the
reasonable cause determination, his reliance on the Brown & Wood opinion letter
becomes less reasonable. Treas. Reg. § 1.6664-4(c)(1). These factors, which
show Gustashaw’s level of tax-related sophistication, are particularly relevant
because Gustashaw was presented with the incredible opportunity, for a fee of
only $800,000, to claim a loss of $9,938,324, which offset the entirety of the tax
liability generated by his exercise in 2000 of his remaining Merck Medco stock
options. See 106 Ltd., 684 F.3d at 93 (concluding that “the improbable tax
advantages offered by the tax shelter” should have alerted a taxpayer, who had
significant business experience, to the shelter’s illegitimacy). As the Tax Court
40
Case: 11-15406 Date Filed: 09/28/2012 Page: 41 of 41
concluded, such a scenario, especially in light of Gustashaw’s personal financial
history and business sophistication, was plainly “too good to be true.”
Taking (1) Gustashaw’s personal experience and characteristics, (2) the
failure of either Maulorico or Gable to offer independent advice on the CARDS
transaction’s tax consequences, (3) Brown & Wood’s conflict of interest, and
(4) the unbelievable benefits offered by the CARDS transaction into account, the
Tax Court did not clearly err in finding that, under this particular combination of
factual circumstances, Gustashaw did not have reasonable cause for his
underpayment of tax or act in good faith with respect to it.
IV. CONCLUSION
The Tax Court correctly concluded that Gustashaw was liable for the 40%
gross valuation misstatement penalties from 2000 through 2002. In addition, we
find no clear error in the Tax Court’s determination that Gustashaw failed to
establish that he acted with reasonable cause and in good faith with respect to his
underpayment of tax. Accordingly, the judgment of the Tax Court is affirmed.
AFFIRMED.
41