Bankruptcy Court Properly Determined Strategy Was Not Investment; No Registration Required (In re Canada, Jr., DC Tex.)

CCH Tax Day Report

An attorney’s bankruptcy estate was not liable for a tax shelter promoter penalty for the attorney’s failure to register as tax shelters certain financial arrangements he marketed and sold as the employee of an insurance-based estate-planning strategies promoter. The strategies were not “tax shelters” under Code Sec. 6111 because they were not “investments.” Therefore, the individual could not be penalized for failing to register them. Alternatively, even if the arrangements were tax shelters, the individual fell within the statutory safe harbor provision because he had reasonable cause for the failure to register.

In order to be classified as a tax shelter under Code Sec. 6111, a transaction must be an “investment.” However, the strategy sold by the organization did not fit within any commonly understood definition of the word investment. The organization did not offer for sale to, or purchase on behalf of its clients any share or interest in any corporation, entity or stock in the traditional sense. What it sold, and what its clients purchased, was a strategy, composed of a series of prescribed steps or transactions, to reduce capital gains taxes. Although it was not clear to what extent the organization oversaw or facilitated implementation of the strategy, it was clear that any purchases and sales were accomplished through independent, national brokerage houses. Further, the few passages of legislative history relied upon by the IRS fell short of the clear expression of congressional intent required to overcome the language of the statute. Therefore, the strategy was not an investment for purposes of Code Sec. 6111.

Additionally, the IRS’s argument that the bankruptcy court erred by narrowly construing Code Sec. 6111 because it is Code Sec. 6707, that actually imposes the penalty was a nonstarter. The two provisions clearly function in tandem: Code Sec. 6111 imposes the registration requirement and Code Sec. 6707 imposes the penalty for failing to comply with the registration requirement. Any distinction between which is “penal” and which is “regulatory” was a distinction without a difference.

Moreover, even if the strategy was a tax shelter subject to the registration requirements, the attorney established reasonable cause for his failure to do so. There were no cases interpreting the applicable provisions of Code Secs. 6111 and 6707 for the attorney to consult; the only guidance available was Code Sec. 6111 and Temporary Reg. §301.6111-1T, both of which the attorney reviewed. However, reasonable cause is not defined in the statute and the regulation stated only that reasonable cause is a question of fact and that a seller must make a “reasonable inquiry” to determine whether the tax shelter is registered and register it as soon as practicable after the seller first knows or has reason to know that the tax shelter has not been timely registered.

The IRS’s argument that the attorney could not rely on his own independent analysis of the registration requirement because he had a financial interest in the strategy was rejected. Reliance on the advice of a tax professional is not the same as an attorney’s reliance on his own investigation of his registration responsibilities. In addition, although the individual was not a tax attorney, he was still a trained lawyer with over 15 years of commercial litigation experience and several years working in insurance-based estate-planning products. He read the only authority in existence at the time, the statute and its corresponding regulation and determined that they did not apply. While the IRS contended that the attorney should have consulted other authorities, he consulted the only authorities that were available at the time. Moreover, nothing in his duties as an employee, which included reading tax publications and interacting with clients’ personal financial advisors, convinced him that he was required to register the strategy. Thus, it would be unfair to penalize the attorney for what appears to have been an honest mistake of law based on his reasonable, good faith effort to comply.

Affirming a BC-DC Tex. decision 2016-1 ustc ¶50,314

In re W.R. Canada Jr., DC Tex., 2017-1 ustc ¶50,227

Other References:

Code Sec. 6111

CCH Reference – 2017FED ¶37,002.1789

Code Sec. 6707

CCH Reference – 2017FED ¶40,090.20

Tax Research Consultant

CCH Reference – TRC FILEBUS: 9,402

AUTHOR

CCHTaxGroup

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