Losses and Fees Associated with CARDS Transactions Not Deductible (Curtis Investment Company, LLC, TCM)

A partnership and its partners were not allowed to deduct the losses and fees associated with Custom Adjustable Rate Debt Structure (CARDS) transactions. The taxpayers had a substantial capital gain when they sold their privately held printing business and entered into the CARDS transactions to create a substantial artificial loss to offset that gain. However, the CARDS transactions lacked economic substance because they had: (1) no economic effects other than the creation of tax benefits; and (2) no business purpose and the motive for entering into the transactions was tax avoidance. Thus, the CARDS transactions lacked economic substance because they failed both the objective and subjective tests.

In addition, the substantial financing costs incurred created a very material and unnecessary drag on the profitability of any investment made with the borrowed money. Assuming the taxpayers actually intended to leverage the borrowed funds for investment purposes, they would have tried to reduce their costs of borrowing to maximize the funds available for investment. Instead, the taxpayers paid financing costs of approximately 45 percent of the loan proceeds and organized the CARDS transactions so they would result in a loss almost equal to the gain from the stock sale. The taxpayers did not even investigate other, less expensive financing options. Thus, the CARDS transactions did not objectively provide the taxpayers with a reasonable possibility of profit.

Moreover, the taxpayers knew that the CARDS transactions would generate a tax loss before entering into the transactions. Additionally, there was no genuine profit motive for the CARDS transactions and any testimony to the contrary was not credible. Absent the substantial tax benefits, no rational taxpayer would have entered into the CARDS transactions. Accordingly, the taxpayers did not have a business purpose for entering into the CARDS transactions.

In addition, the partnership was not genuinely indebted based on the structure of the CARDS transactions. Consequently, the IRS properly disallowed the taxpayers’ fees deductions.

The taxpayers were liable for accuracy-related penalties because the taxpayers did not have reasonable cause or act in good faith. The IRS had already taken an unfavorable position about CARDS transactions in Notice 2000-44, 2002-2 CB 255. Thus, the CARDS transactions did not present a novel issue and the taxpayers did not reasonably rely on the advice of tax professionals. The taxpayers’ position was not reasonably debatable and their reliance on a law firm with an inherent conflict of interest was not justified or reasonable.

Curtis Investment Company, LLC, TC Memo. 2017-150, Dec. 60,980(M)

Other References:

Code Sec. 165

CCH Reference – 2017FED ¶9900.151

Code Sec. 6662

CCH Reference – 2017FED ¶39,651G.17

Tax Research Consultant

CCH Reference – TRC BUSEXP: 30,168

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