Fifth Circuit reverses District Court and holds that taxpayer did not disclose listed transaction which extended the statute of limitations on assessment

May 10, 2012   
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On April 26, 2012, the United States Court of Appeals for the Fifth Circuit issued its opinion in  Bemont Investments, LLC et al. v. United States of America, case # 10-41132. 

The facts are as follows:

On October 13, 2006, the IRS issued Final Partnership Administrative Adjustments (“FPAAs”) to Bemont and BPB (the “taxpayers” or “partnerships”) for tax years 2001 and 2002. An FPAA is the partnership equivalent of a statutory notice of deficiency to an individual or nonpartnership entity. The FPAAs disallowed losses from a foreign currency hedging transaction claimed on Bemonts 2001 partnership return and BPBs 2002 return. Both FPAAs also imposed four, alternative, non-cumulative penalties: (1) a 40% penalty for underpayment attributable to a gross valuation misstatement, (2) a 20% penalty for underpayment attributable to negligence, (3) a 20% penalty for underpayment attributable to a substantial understatement of income tax, and (4) a 20% penalty for underpayment attributable to a substantial valuation misstatement, all under 26 U.S.C. § 6662, available here.

The partnerships timely commenced actions for readjustment of partnership items by filing petitions in the district court.

Before trial, the court granted the partnerships motion for partial summary judgment, under Federal Rule of Civil Procedure 56, available here, holding that the government was foreclosed from imposing the valuation misstatement penalties (items (1) and (4) above). The remainder of the case proceeded to trial. After a bench trial, the court determined that the FPAA issued to Bemont for 2001 was time-barred, precluding the tax assessment and penalties related to that tax year. The court upheld the disallowance of losses reported by the partnerships and the imposition of penalties against them (items (2) and (3) above) for 2002. Both sides appealed.

The transaction underlying this dispute is described by the IRS as a “Son of BOSS” tax shelter; see our prior blog entries on this issue here. This type of shelter creates tax benefits in the form of deductible losses or reduced gains by creating an artificially high basis in partnership interests.  The IRS classified such schemes as abusive tax shelters; see Notice 2000-44, 2000-2 C.B. 255, available here. The notice designated such shelters as “listed transactions” for purposes of Treasury Regulation §§ 1.6011-4T(b)(2) and 301.6111-2T(b)(2). A listed transaction is one the IRS has determined to be a tax avoidance transaction. Treas. Reg. § 1.6011-4T.  In general, the taxpayer must file a disclosure statement with any tax return that includes gains or losses from a listed transaction. 26 U.S.C. § 6011, available here.

To address the problem of taxpayers and promoters who fail to comply with the disclosure requirements, Congress extended the usual three-year statute of limitations for the issuance of a deficiency notice or FPAA in cases involving undisclosed listed transactions until one year after the taxpayer or his tax shelter advisor has complied with the notice requirements; see 26 U.S.C. § 6501(c)(10), available here.

In this case, the partnerships filed the disclosure statements required by Notice 2000-44 and 26 U.S.C. § 6011 with their tax returns affected by participation in the transactions.  In April 2005, the IRS audited one of the partnerships indirect partners 2002 tax return and inquired about a $46 million loss allocated from one of the partnerships. The accountant who had prepared the indirect partners income tax return gave the IRS agent a copy of the agreement assigning the direct partners rights under the swaps to Bemont. The agreement listed all four swaps – two long and two short. The accountant also provided copies of the confirmation letters for the long swaps but did not provide further detail on the short swaps. No adjustments were made by the IRS to the indirect partners return for that year.

On October 13, 2006, after the ordinary three-year statute of limitations for examining the partnerships 2001 returns had expired, the IRS issued FPAAs to the partnerships. The FPAA issued by IRS to Bemont covered the 2001 tax year, disallowing the losses from the swaps and determining that Bemonts partners had no basis in the partnership. The FPAA issued by IRS to BPB dealt with the 2002 tax year, and disallowed the losses from the swaps and determined that the BPB partners had no basis.

The district court found that subpart (A) of § 6501(c)(10) did not apply because neither the partnerships nor Beal provided the required disclosure with their respective returns and because the accountant did not furnish complete information about the swaps during the audit of the indirect partners 2002 tax return. The accountant provided full disclosure regarding the long swaps, but did not disclose the offsetting short swaps.  The district court also found that an IRS summons to Deutsche Bank (a material advisor to the partnerships) revealed information to the IRS no later than July 2005 which identified Bemont and BPB as participating in a Son of Boss shelter and that the information provided substantially complied with the statute and applicable regulations issued by the IRS as set forth in 26 C.F.R. § 301.6112-1T. More specifically, the district court found that by July 2005, the IRS had information that identified BPB and Bemont, and as to these entities, the account number for the buy and sell, the foreign exchange amount, the foreign exchange rate, the amount of U.S. dollars involved, the trade and sell dates, and the percentage sold. Based on these findings, the district court held that the FPAA issued to Bemont in October 2006 was too late and the IRS was time barred from assessing additional taxes or related penalties for the 2001 tax year.

On appeal, the Fifth Circuit reversed the district court ruling that the disclosures made by Deutsche Bank were sufficient as a matter of law to meet the disclosure requirements of 26 U.S.C. section 6011, and as a result the statute of limitations was extended pursuant to 26 U.S.C. section 6501(c)(10.  The Fifth Circuit based its conclusion on the fact that the disclosure was (i) not provided by the partnerships, and (ii) was not in a form that enabled the IRS to indentify the information related to the listed transaction “without undue delay or difficulty.”  The Deutsche Bank disclosures included 226 CDs that captured 2.2 million pages of documents.  In essence, the 5th Circuit held that the disclosure was tantamount to providing the information to the IRS that forced the IRS to identify a “needle in a haystack.”

The full opinion can be viewed here.

The attorneys at Fuerst Ittleman, PL have extensive experience litigating tax shelter cases at both the trial level and the appellate level.  You can contact us by email at or by calling us at 305.350.5690.