Taxes/June 2004

But I Don’t Sell Tax Shelters! The Expanding Reach of the Code Sec. 6700 Promoter Penalty

Brian Lynn discusses the expanding reach of Code Sec. By 6700 promoter penalty. Brian R. Lynn “I say to the hucksters, it’s time to at every level, the IRS is expand- fi nd an honest living.” ing its use of the Code Sec. 6700 —Senator Charles Grassley (Promoting Abusive Tax Shelters, (R-Iowa)1 Etc.) penalty beyond its usual suspects—the telemarketer and tax- “Tax shelters are not fair to the protester crowd—into the realm of corporations and taxpayers who transactional tax lawyers who issue strive to comply with the law. We opinions on what the IRS considers need to work on restoring faith in to be aggressive tax transactions. our tax system. Every day we fail to Two recent IRS developments address abusive tax shelter practices, illustrate this trend. First, the IRS honest taxpayers pay the bill.” announced last October that it —Senator Max Baucus successfully settled its fi rst Code (D-Montana)2 Sec. 67003 penalty case against a bond lawyer in connection with Tax-shelter bashing is a popular an opinion that he rendered on sport in Washington, D.C. these the tax-exempt status of inter- days. It is no secret that both Con- est on a new issue of municipal gress and the IRS have been hunting bonds. Second, the IRS issued a for anything that smells like a tax chief counsel advice this January shelter over the last few years. addressing several Code Sec. 6700 The IRS has created the Office issues in connection with the sale of Tax Shelter Analysis, launched of what appeared to be a basis- disclosure initiatives and stiffened shifting tax shelter. shelter-reporting and list-mainte- Whether courts will uphold nance obligations. Congressional Code Sec. 6700 penalties against leaders have been less successful at lawyers who render opinions in instituting reform, but they con- the recent wave of aggressive tax tinue to huff and puff about tax shelters; and they vow to pass ad- ditional shelter-penalty legislation. Brian R. Lynn is a Tax Associate at Caplin ©2004 B.R. Lynn In an effort to combat shelters & Drysdale, Chartered in Washington, D.C.

47 The Code Sec. 6700 Promoter Penalty

transactions is an open question. penalty, its view of Code Sec. 6700 the Code Sec. 6694 penalty base In general, however, the courts appears to be changing. The IRS is was the the ultimate taxpayer’s have interpreted Code Sec. 6700 dusting off Code Sec. 6700 in its understatement of tax as a result to apply to legal opinions. In in- new “war” on tax shelters. of employing the tax shelter on terpreting the “false or fraudulent” his return, which could take years statement requirement of Code Background to determine. Second, these penal- Sec. 6700, courts have rejected The tax-shelter industry’s fi rst hey- ties could only be imposed against the “opinion can’t be false” de- day was the 1970s and early 1980s. return preparers or those advising fense and held that, like factual Marginal rates were high, tax cred- on return positions, so if a pro- statements, tax opinions that are its abounded, and taxpayers could moter merely sold shelter interests erroneous can be false statements. generally use passive losses to offset and distanced himself from the And in applying the “knowledge active income. Most of these shel- return-preparation function, he or reason to know” requirement ters were structured as partnerships, could escape liability. of Code Sec. 6700, most courts which made enforcement diffi cult Code Sec. 6700 is intentionally have not required the govern- because the IRS had to audit each much broader. It punishes any ment to prove that the author of partner separately. The IRS grew person who: the opinion actually had “scien- tired of this chase and encouraged organizes (or assists in the or- ter,” or knowledge that his views Congress to help. Congress re- ganization of) or participates were erroneous when made; if the sponded by passing TEFRA, which, in the sale of any interest in author’s background and involve- among other things, consolidated an entity, plan or arrangement ment in the transaction, as well partnership audits. (a “tax shelter”); and as the surrounding facts, indicate TEFRA also introduced the in connection, makes or fur- that he “should have known” of Code Sec. 6700 shelter-promoter nishes: the falsity of his statement, Code penalty. Congress viewed this new 1. a statement (addressing Sec. 6700 may apply. To date, how- penalty as a way to cut shelters off tax-benefit availability ever, the courts’ consideration of at the knees: from participating in the these Code Sec. 6700 issues has tax shelter) which the been limited to fact situations Congress concluded that ... promoter knows or has involving egregious tax-shelter abusive tax shelters must be reason to know is false or transactions in which the attor- attacked at their source: the fraudulent as to any mate- ney rendering the opinion played organizer and salesman. ... rial matter, or a dual role as both the organizer [P]revention of abusive shelter 2. a “gross valuation over- of the shelter and the author of promotions will require less statement.9 the tax opinion. manpower than enforcement A striking aspect of Code Sec. actions against numerous in- 6700 is that it uses this shotgun vestor-taxpayers.6 approach to defi ne the type of I. Structure and transactions that are potentially Recent Guidance To this end, Congress gave the within its coverage. Virtually every IRS the power to assess a monetary tax planning project undoubtedly Congress introduced the Code penalty against promoters under involves some type of “entity, Sec. 6700 promoter penalty 22 Code Sec. 6700 and to enjoin them plan or arrangement.” Certainly, years ago in the Tax Equity and from further shelter-promotion traditional tax-shelter investments Fiscal Responsibility Act of 1982 activities under Code Sec. 7408.7 (such as limited-partnership in- (TEFRA)4 to stop abusive tax shel- terests) fit this definition. The ters by penalizing what appeared Statutory Structure committee reports also point out to be the real problem in the Prior to TEFRA, the IRS’s only that clubs distributing tax-protest- shelter industry: the promoters.5 tools to go after promoters were er materials qualify as an “entity, It drafted the statute to cast a wide the Code Sec. 6694(a) return-pre- plan or arrangement,”10 and the net for what was perceived to be a parer penalty and the Code Sec. courts have agreed.11 As a result, growing tax compliance problem. 7602 criminal aiding-a-false-return the Code Sec. 6700 cases usually And while the IRS historically has penalty.8 These penalties were in- boil down to disagreements over been very selective in invoking this adequate for two reasons. First, (1) whether the person made a

48 Taxes/June 2004 false statement, and (2) whether 2. It defines the statutory terms with an organization promoting a that person “knew or had reason “organizes” and “participates tax shelter is potentially liable for to know” the statement was false. in the sale of ” broadly for pur- the penalty. It defi nes “organiz- Penalty Amounts. Congress also poses of determining the type ing” activities by reference to the divorced the penalty amount from of activities that are subject to Code Sec. 6111 shelter-registration the tax liability of the ultimate tax- Code Sec. 6700. regulations, which require anyone payer (thus eliminating the delay). Duplicative Penalties. CCA involved in discovering, creating, Under Code Sec. 6700, a promoter 200402008 first concludes that initiating or executing the transac- must pay the lesser of $1,000 or the the $1,000 penalty can be applied tion to register.19 It defi nes “sale” promoter’s collected fees, with re- separately against individuals as- participation activities to reach spect to each plan or arrangement sociated with the entity selling the anyone directly or indirectly in- activity. Initially, a confl ict emerged shelter (e.g., employees, LLC mem- volved in contacting or advising in the courts over what constituted bers, partners, etc.) as well as the prospective purchasers, even if that an “activity,”12 but in 1989, Congress entity itself. For example, if Jones person’s communication is relayed clarifi ed that each individual sale of & Smith LLP sells only one shelter to the purchaser by a third party. one interest is a separately punish- to one client, the IRS can assess This includes telemarketers and ad- able activity.13 Thus, if a promoter three separate Code Sec. 6700 penal- vertising agents (e.g., direct mail), sells 10 limited-partner interests in ties: one each against Jones, Smith among others. It also includes one partnership, his maximum and Jones & Smith LLP (assuming those persons who merely instruct penalty is $10,000 ($1,000 for each both Jones and Smith partici- or advise salespeople. Thus, for ex- sale), not $1,000.14 pated). That’s $3,000 for one sale. ample, an accounting fi rm partner Projecting this out, the potential who gives selling tips to his col- Recent IRS Guidance penalties multiply quickly. A fi rm league—and has no other contact The IRS hasn’t released much selling fi ve investment units in a with the shelter—may be subject to guidance on Code Sec. 6700 in particular shelter to 20 investors Code Sec. 6700 if he should have that provision’s 22 years of life. It each, with fi ve employees involved known his colleague would make has never promulgated any regula- in each sale, for instance, creates false statements about the product. tions, nor issued any signifi cant $500,000 (5 x 20 x 5 x $1,000) in Similarly, a lawyer giving oral ad- administrative guidance clearing potential Code Sec. 6700 penal- vice to a sales person on the tax up the statute’s ambiguities. That ties.16 This conclusion is based on consequences of the transaction is changed this past January, how- the statute’s use of the term “any potentially liable for the penalty. ever, with Chief Counsel Advice person,” which the IRS interprets In short, when Congress was (CCA) 200402008, which broadly broadly to mean that every person targeting early 1980s tax shelters, interprets several aspects of Code who, directly or indirectly, partici- it drafted a broad Code Sec. 6700 Sec. 6700.15 pates in the organization or sale of statute that potentially reaches in- Specifi cally, CCA 200402008 ad- the shelter is potentially liable for dividuals involved in today’s tax dresses a scenario where an LLC the penalty.17 shelter activities. And if the IRS promotes tax shelters by making Two district courts have con- has its way, Code Sec. 6700 will be cold calls to individuals with large sidered this issue, and reached applied to almost anyone associ- capital gains and offering to sell confl icting decisions. One court ated, directly or indirectly, with them a capital-loss-generating concluded that it was an unauthor- promoting or selling the shelter. product. The CCA makes two ized double penalty, and the other main interpretive points: court found that the statute per- 1. It defines the scope of the mits multiple assessments.18 CCA II. False Statement $1,000 maximum penalty on 200402008 didn’t add to the dis- Requirement a per-person as well as a per- cussion. It simply sided with the sale basis, so that if several latter decision. A False Opinion persons are involved in the Potential Targets. The CCA also sale of one shelter unit, or addresses the type of activities that One of the first interpretive one person is involved in the may subject individuals to Code questions under Code Sec. 6700 sale of several units, multiple Sec. 6700 liability. According to the considered by the courts was the penalties might apply. CCA, virtually anyone associated scope of the term “false” in the

49 The Code Sec. 6700 Promoter Penalty

context of legal opinions. Can an The Campbell court dismissed fraudulent—since Code Sec. 6700’s erroneous legal opinion on the this argument and held that arrival in 1982. And like the Fifth likely tax consequences of a trans- opinions can indeed be false. Circuit, the IRS believes that opin- action constitute a false statement? Their reasoning: Congress said ions can be false simply because For example, is it a false statement so. “Congress determined that Congress said so; it never challeng- if I predict that the New York Yan- statements concerning availability es this self-fulfi lling prophesy. In kees are going to win the World of tax benefi ts could be reduced CCA 200402008, for example, the Series this year, and they don’t? to questions of fact and thereby IRS assumes opinion letters can be What if I thoroughly researched adjudged false by enacting Code false, stating matter-of-factly that the Yankees and interviewed a Sec. 6700(a)(2)(A) and proscribing “statements directly addressing the number of baseball experts, who such statements.”22 Mr. Campbell availability of tax benefi ts” can be all agree that the Yankees were a deserved better; a Congress-said-so false statements.23 virtual certainty to win the World response places tax practitioners Series? Does that make my predic- in an impossible position when Promoter and Protester Cases tion that the Yankees will win the rendering opinions. It certainly Judging from the reported cases, World Series “true”? Such is the is not self-evident that an incor- the IRS generally has invoked world of Code Sec. 6700. rect opinion is a “false” opinion, the Code Sec. 6700 penalty in a Both the IRS and the courts particularly when one considers restrained manner. It has pursued have easily concluded that an in- the juxtaposition of “false” and low-hanging fruit, prosecuting correct opinion regarding the tax “fraudulent” in Code Sec. 6700. egregious cases involving either consequences of a transaction is a Perhaps in recognition of this, shelter promoters or tax pro- false statement. the IRS initially only assessed testers. And this makes sense. A.F. Campbell20 is a signifi cant Code Sec. 6700 penalties against Congress enacted Code Sec. 6700 case on this issue. In that case, tax practitioners giving clearly to deter tax shelter activity, not to Allen Campbell, an attorney who fraudulent advice. The IRS gen- penalize transactional tax lawyers also functioned as the organizer erally didn’t pursue lawyers for being wrong on an opinion.24 and marketer of the limited part- giving opinions on questionable Promoters. The fi rst promoter nership tax shelter, advised his real-world business transactions. cases involved exactly this target, client/investors that they could Instead, most of the early reported plainly abusive leasing tax shel- treat as part of their tax basis in cases involve either tax protesters ters. In these cases, determining their partnership interests (and or tax-shelter promoters selling the falsity of the promoter’s state- deduct in the year of purchase) shelters with vastly overvalued ments was usually quite simple, the face amount of long-term assets. The tax opinions given because the opinions addressed purchase-money notes. These in these instances often were so the tax benefi ts associated with notes were denominated in the blatantly wrong that no one even substantially overvalued assets. rapidly depreciating Brazilian worried about the “false opinion” These shelters typically involved currency. In the face of evidence problem. The IRS simply didn’t limited partnerships leasing either that, without an exchange-rate- target practitioners writing opin- nonexistent or overvalued assets correction mechanism the ion letters covering arguably open and taking large tax credits and de- notes were virtually worthless, questions of tax law. This trend ductions in the lease’s early years. the Fifth Circuit agreed with might be changing, however, as They didn’t depend on technical the district court’s finding that the IRS increasingly targets tax- loopholes like today’s shelters; Mr. Campbell’s tax opinion oriented transactions that are instead, they relied on the asset’s constituted a false statement.21 not clearly fraudulent, but that it overvaluation to generate infl ated Mr. Campbell argued that his deems abusive. credits and deductions.25 statement was not false because And in most of these cases, it was merely an opinion—as it IRS Guidance the false-statement issue is less turned out, an incorrect predic- The IRS hasn’t published any pronounced because the IRS tion of future events—and the meaningful guidance on what didn’t need it. The IRS could rely IRS or a court could have agreed the term “false or fraudulent state- on the overvaluation provision with him on the tax consequenc- ment” means—with the exception (the other Code Sec. 6700(a)(2) es of the transaction. of saying it doesn’t really mean prong) to impose the penalty.

50 Taxes/June 2004

The cases often technically hold testers’ in the latter, are just part The district court determined that the promoter made a false of the larger scams. The promoters that Mr. Campbell made two statement in advising clients, but and protesters might technically be separate false statements in sell- the false opinion is based on an giving tax advice, but most would ing Coral interests. First, it found underlying factual misstatement agree that the issues do not involve that his statement that Coral’s (the asset overvaluation), rather debatable positions. “center of gravity” was in Brazil than a faulty tax analysis. In was wrong.30 Second, the district other words, the promoters were False Opinion Cases court held that his statement that not penalized for inaccurately On a few occasions, the IRS has investors would receive the prom- analyzing the facts presented to asserted that substantive tax opin- ised tax benefi ts was false because them, but rather for falsifying ions constitute false statements, the transaction was “devoid of eco- the facts, and then giving an albeit in somewhat egregious situ- nomic substance.”31 This aspect of incorrect tax opinion based on ations. Nonetheless, this marks a the Campbell opinion shows that these false facts. departure from earlier cases and the “false” statement requirement Music Masters26 is a good exam- shows that Code Sec. 6700 can ap- of Code Sec. 6700 can be satisfi ed ple. It involved a leasing tax shelter ply to incorrect tax opinions. by incorrect tax advice rendered where investors purchased lease- Campbell best illustrates a false on a complex transaction. hold units in master recordings tax opinion. Mr. Campbell was H.F.K. Kersting32 also demonstrates and took substantial deductions an attorney who was also the that the IRS may go after economic- and credits. The genesis of the tax organizer and promoter of the substance opinions under Code Sec. benefi ts, however, was the master alleged tax shelter. Mr. Campbell 6700. Mr. Kersting created and sold recordings’ infl ated valuation. The established a Brazilian company, numerous tax shelters to clients IRS assessed a Code Sec. 6700 pen- Coral Sociedade Brasileira de Peq- throughout the 1970s and 1980s. In alty against the promoter on the uisas e Desenvolvemento Limitada the typical transaction, an investor grounds that (1) he made a false (“Coral”), in 1982 with a “stated would borrow money at 18-percent statement about the tax benefi ts, purpose” of testing artifi cial an- interest to buy stock in a new cor- and (2) he overvalued the master tibodies, produced entirely by a poration. The investor would then recordings.27 The court found that related company in the United take out a second, nine-percent loan the promoter made a false state- Kingdom, to be used in medical to pay the interest on the fi rst loan. ment, but his error did not involve research. The enterprise showed At year-end, the corporation would a murky area of the tax law. negligible commercial promise. issue a “nontaxable dividend” to Protesters. The IRS’s other early Nevertheless, Mr. Campbell sold the investor to pay off the face Code Sec. 6700 targets were tax pro- interests in Coral to various U.S. value of the second loan, and the testers, or more specifi cally, leaders investors for $600,000. Each of investor would deduct the interest of the tax-protester movement. the investors paid $75,000 in U.S. on both loans.33 The IRS found In these cases, undercover IRS dollars and issued a long-term this transaction to be a sham that agents usually attend tax-protest- $525,000 promissory note that lacked economic substance, and er meetings and collect materials was to be repaid not in dollars, the courts agreed, finding that published by the group’s leaders. but in the equivalent Brazilian Mr. Kersting’s opinions were false The materials invariably contain currency. Mr. Campbell advised under Code Sec. 6700.34 proclamations that you don’t have investors that they could deduct Estate Preservation Services35 is to pay income taxes for frivolous the entire $600,000 in the fi rst similar to Campbell and Kersting reasons (e.g., wages aren’t income).28 year. The hook for this tax shelter in that the false statement was The IRS and the courts could then was that the notes would not cost made with respect to substantive easily characterize the opinions the investors $525,000 to repay if tax issues. In Estate Preservation, a expressed in these promotional the Brazilian currency declined (it CPA named Robert Henkell sold materials as false statements. was in a free fall at the time). The so-called Estate Preservation Trusts As with the early shelter cases, notes bore 10-percent interest, but (EPTs). Mr. Henkell advised pur- the false-statement issue is almost they had no monetary-correction chasers that they could contribute an afterthought in these protester factor—i.e., infl ation was substan- their personal residences to their decisions. The promoters’ opinions tially reducing the investors’ true EPT and deduct the associated in the fi rst instance, and the pro- economic liability.29 costs, such as depreciation and

51 The Code Sec. 6700 Promoter Penalty

utilities.36 Mr. Henkell also advised factual elements of Code Sec. the statement was false?” If the taxpayers that they could contrib- 6700, the IRS has the burden of answer is yes, the author may ute depreciated assets to the trust proof on this issue.39 be liable under Code Sec. 6700, tax-free and receive a stepped-up The “reason to know” even if he can establish that basis in such assets.37 The Ninth language was added by the Con- he didn’t “deliberately” mis- Circuit concluded that these state- ference Committee to the Senate state the tax consequences of ments regarding EPT’s tax benefi ts version of Code Sec. 6700, to the transaction. were false and imposed the Code “clarif[y] that the Secretary Campbell illustrates this point. Sec. 6700 penalty.38 This is obvi- may rely on objective evidence The lower court in Campbell did ously bad tax advice. Deducting of the knowledge of a promoter not find that Mr. Campbell personal expenses violates Code or salesperson (for example) to actually knew the transaction Sec. 162, and stepping up your prove that he deliberately fur- would not be respected on basis in gifted assets directly con- nished a false or fraudulent economic substance grounds. It tradicts Code Sec. 1015. In this statement.” The Committee only determined that he knew or sense, Estate Preservation didn’t ad- report goes on to provide an should have known the transac- vance the false-statement ball. But example of the application tion he was selling and opining it does further evidence that Code of this standard: “A salesman on was invalid “because it was Sec. 6700 penalties may be imposed would ordinarily be deemed totally devoid of economic on substantive tax opinions. to have knowledge of the facts substance.”41 On appeal, Mr. revealed in the sales materials Campbell argued that he wasn’t which are furnished to him liable for the penalty since he III. Intent by the promoter.” The report didn’t actually know the transac- Requirement cautions that “[t]he ‘reason to tion lacked economic substance. know standard’ is not, however, The Fifth Circuit rejected this The second and more diffi cult intended by the conferees to be argument, holding that the (from the IRS’s standpoint) used to impute knowledge to a lower court’s “knew or should evidentiary hurdle of Code Sec. person beyond the level of com- have known” fi nding was suf- 6700 is the requirement that the prehension required by his role fi cient to sustain the penalty.42 promoter “knew or had reason in the transaction. Thus, this In essence, the Fifth Circuit ap- to know” that the statement was standard does not carry with it plied an objective test and asked false. To assess a Code Sec. 6700 a duty of inquiry concerning whether a tax practitioner with penalty against a tax practitio- the transaction.” 40 Mr. Campbell’s background ner opining on a transaction, Case Law. The courts have and heavy involvement in the the IRS must not only show that considered the “reason to know” transaction (in a planning and the opinion was wrong (e.g., the standard in several cases, once marketing capacity) would have transaction did not generate the again involving egregious tax reasonably known of the trans- promised capital loss), but that shelter transactions in which the action’s defi ciencies. the lawyer knew or had reason to lawyer rendering the tax opinion The Ninth Circuit also ad- know it was wrong. While most was also heavily involved in the opted this standard in upholding of the courts have interpreted the creation and marketing of the a Code Sec. 6700 penalty against “knowledge requirement” not to arrangement. However, giving Mr. Henkell in Estate Preservation. require the IRS to prove that the credence to the old adage that Mr. Henkell sold taxpayers trusts author of the opinion actually bad cases make bad law, the that allegedly allowed them to had “scienter,” or knowledge opinions in these cases employ deduct personal living expenses, that the statement was false when broad language, which arguably among other things. The lower made—so long as the lawyer’s goes beyond the conference court found that someone with background and involvement committee’s original intent. Mr. Henkell’s experience and in the transaction establish that Specifically, the cases tend to education would have reason he should have known that the characterize the “reason to know” to know that these trusts would statement was false—one court standard as simply “should some- fail to provide the promised tax has imposed the stricter “sci- one with this person’s education benefi ts.43 The Ninth Circuit af- enter” requirement. As with all and experience have known that fi rmed application of the penalty

52 Taxes/June 2004 in Mr. Henkell’s case based on “requires, inter alia, a specific of an abusive tax shelter? As a this fi nding, and it summarized fraudulent intent as an essential few recent court decisions have the reason-to-know standard as element for the assessment of the shown us, some transactions “what a reasonable person in the penalty.”49 Weir did state that while that the IRS calls abusive are [defendant’s] ... subjective position the shelter appeared too good to perfectly legitimate.51 would have discovered.”44 Specifi - be true, it had a “semi-logical basis These and other questions of cally, the court looked at three in the tax laws,”50 so maybe the interpretation will likely have to factors to determine whether Mr. reason-to-know analysis employed await the development of actual Henkell should have known of the by the other courts would not court cases by the IRS. false statement: have produced a different result. 1. The extent of his reliance on But on balance, it’s hard to square knowledgeable professionals Weir with the other cases on this IV. Conclusion 2. His sophistication and educa- intent issue. Code Sec. 6700 appears to be en- tion level The $64 questions remain tering a new era. The IRS might 3. His familiarity with tax mat- unanswered. Consider the follow- try to move well beyond Campbell, ters45 ing situations where a reputable, Kersting and Estate Preservation in Generally, the shelter-promot- mainstream law fi rm renders a the next few years. It is under a er cases employ this objective tax opinion that turns out to be signifi cant amount of pressure standard to determine whether incorrect. Assume that neither to crack down on abusive tax a person had reason to know the opinion writer nor the law shelters, and Congress hasn’t the questioned statement was fi rm was involved in organizing really given it any new tools to false. The protester cases, on the or marketing the arrangement to use. The IRS is fi ghting today’s other hand, often skip this point which the opinion relates, and war with yesterday’s weapons, because the statements are so bla- that there are different views in and one of yesterday’s weapons tantly false that the government the legal community regarding is the Code Sec. 6700 promoter can prove actual knowledge. In the soundness of the opinion. penalty. The IRS evidently likes Savoie, for example, the court While the opinion may very well Code Sec. 6700 because it alters a held that Mr. Savoie knew his be “false,” did the “author have tax professional’s calculus when protester schemes were false reason to know” it was false if: deciding to issue an opinion and didn’t need to use any 1. there was “substantial” legal and thus might deter a lawyer objective measures: “Savoie was authority for the opinion? or accountant from blessing a unquestionably aware of the 2. the factual underpinnings of questionable transaction. fraudulence of his advice about the opinion known to the au- The IRS has turned to Code Sec. the allowability of deductions thor at the time were adequate, 6700 in its recent efforts to stop under his Schedule C and W-4 but further inquiry would potentially abusive shelters from plans, because it consisted exclu- have called certain material making it to the marketplace by sively of half truths.”46 facts into question? threatening penalties against the In contrast, in D.J. Weir,47 the 3. the author innocently missed tax lawyers and accountants in- district court held that the gov- a key legal authority that volved in these transactions. The ernment must prove a specific would have caused him to interesting question is whether it fraudulent intent to assess a Code reduce his level of confidence will ultimately succeed in penal- Sec. 6700 penalty. The court found from “more likely than not” izing such practitioners under this that Mr. Weir furnished a false to “reasonable basis”? provision. The IRS has certainly statement with respect to a tax shel- Does the “reason-to-know” had success in pursuing these ter he was selling, but it declined to standard require the IRS to penalties in the past, but the enforce the Code Sec. 6700 penalty establish negligence, gross targets were easier. With modern because he did not deliberately de- negligence, recklessness or de- shelters, the IRS is going to have fraud his customers when he sold liberateness on the part of tax to prove that incorrect opinions the shelters. “He lacked the ‘intent’ counsel to impose a Code Sec. can be false statements and that to misstate the tax consequences.”48 6700 penalty? Does the penalty the practitioner had reason to The court held that the false-state- apply every time tax counsel know it was false when he signed ment prong of Code Sec. 6700(a)(2) comes out on the wrong side it. That might be easy where the

53 The Code Sec. 6700 Promoter Penalty

transaction violates clear statutory that appear to produce favorable arguably confl icting or ambiguous provisions or relies on false facts tax consequences and only fail be- legal authorities, the IRS may be or valuations. But in transactions cause of technical foot faults or facing an uphill battle. ENDNOTES

1 Senators Scrutinize “Peddlers” of Abusive N.Y., 91-1 USTC ¶50,183, 766 FSupp ¶50,456, 269 FSupp2d 1262 (similar Tax Shelters, 101 TAX NOTES 418 (Oct. 1248, 1257, aff’d in part and rev’d in part, claims in taxpayer’s book THE FEDERAL 27, 2003). CA-2, 93-1 USTC ¶50,173, 989 F2d 1290 MAFIA); Savoie, supra note 11 (similar). 2 Baucus Introduces Bill to End Abusive Tax Shel- (concluding that the IRS could not impose 29 Campbell, supra note 20, 897 F2d, at ters, 2003 TNT 227-28 (Nov. 24, 2003). a Code Sec. 6700 penalty against both a 1318–19. 3 All Code Sec. references are to the partnership and its partners for the same 30 Id., at 1320. 31 Internal Revenue Code of 1986, as conduct), with Bailey Vaught Robertson & Campbell, DC Tex., 88-2 USTC ¶9525, amended, unless otherwise noted. Co., DC Tex., 828 FSupp 442 (1993) (al- 704 FSupp 715, 724. 4 32 Act Sec. 320(a) of the Tax Equity and lowing a Code Sec. 6700 penalty against H.F.K. Kersting, CA-9, 2000-1 USTC Fiscal Responsibility Act of 1982 (P.L. a partnership and each partner engaging ¶50,287, 206 F3d 817. 33 97-248). in the prohibited conduct). Kersting, DC Hawaii, 93-2 USTC ¶50,606, 5 Staff of Joint Comm. on Tax’n, 97th Cong. 19 Temporary Reg. §§301.6111-1T: A-27 at 4–6. 2d Sess., General Explanation of the Rev- and A-28. 34 Kersting, supra note 32, 206 F3d, at 20 enue Provisions of the Tax Equity and Fiscal A.F. Campbell, CA-5, 90-1 USTC 819–20. Responsibility Act of 1982 (“Bluebook”), ¶50,215, 897 F2d 1317. 35 Estate Preservation Services, CA-9, 21 at 210–12 (Comm. Print 1982). Id., 897 F2d, at 1322. 2000-1 USTC ¶50,203, 202 F3d 1093. 6 Bluebook, at 210. 22 Id., at 1321. 36 Id., 202 F3d, at 1101. 7 Id., at 212–14. 23 Presumably, the opinion’s confi dence 37 Id., at 1099–1100. 8 Id., at 210. level impacts this false-statement de- 38 Id., at 1103. 9 Code Sec. 6700(a); Code Sec. 6700(b) termination. Perhaps an opinion stating 39 Code Sec. 6703(a). defines “gross valuation overstate- a transaction “should” generate certain 40 Bluebook, at 210–11. ment.” tax benefi ts will be false, but could an 41 Campbell, supra note 31, 704 FSupp, at 10 Bluebook, at 211. opinion stating that the same benefi ts 724. Interestingly, the Fifth Circuit noted 11 See, e.g., Savoie, DC La., 594 FSupp are “more likely than not” available be that no similar foreign-currency obliga- 678 (1984); D. Kaun, CA-7, 87-2 USTC true? tions had been disallowed—effectively ¶9487, 827 F2d 1144. 24 Bluebook, at 210–11. admitting this was a case of fi rst impres- 12 25 See, e.g., I. Bond, CA-9, 89-1 USTC See, e.g., Savoie, supra note 11; G.S. sion on that issue. Campbell, supra note ¶9271, 872 F2d 898, 899–901 (hold- Buttorf, CA-5, 85-1 USTC ¶9435, 761 20, 897 F2d, at 1321. ing that Code Sec. 6700’s $1,000 F2d 1056. 42 Campbell, supra note 20, 897 F2d, at 26 minimum penalty is a yearly minimum, Music Masters, DC N.C., 85-2 USTC 1321. not a per-transaction minimum). ¶9839, 621 FSupp 1046, aff’d, CA-4 43 Estate Preservation Services, DC Calif., 13 H.R. REPT. NO. 247, 101st Cong., 1st (unpublished opinion), 816 F2d 674 2000-1 USTC ¶50,202, 38 FSupp2d Sess. (hereinafter, “1989 Act House (1987). 846, 854. Report”), at 1397. 27 Id., 621 FSupp, at 1055–56. 44 Estate Preservation, supra note 35, 202 14 Also, prior to the 1989 change, the pen- 28 See also R.R. Raymond, CA-7, 2000-2 F3d, at 1103 (quoting Campbell, supra alty amount was the greater of $1,000 USTC ¶50,750, 228 F3d 804 (2000) note 20, 897 F2d, at 1321–22). or 20 percent of the promoter’s income (statements by U.S. Taxpayer’s Party 45 Id. from the activity. members disputing government’s abil- 46 Savoie, supra note 11, at 681. 15 47 See also FSA 200129001 (Mar. 20, ity to tax citizens); Buttorf, supra note 25 D.J. Weir, DC Ala., 89-2 USTC ¶9431, 2001) (addressing Code Sec. 6700 (discussing phony “Constitutional Pure 716 FSupp 574. application issues with respect to tax- Equity Trust” scheme); Kaun, supra note 48 Id., 716 FSupp, at 580. 49 exempt bond counsel). 11, aff’g, DC Wisc., 86-1, USTC ¶9454, Id., at 577. 16 Note that Code Sec. 6700 penalties are 633 FSupp 406 (describing “spurious 50 Id., at 580. essentially capped at collected fees—but or patently frivolous” statements that 51 See, e.g., Compaq Computer Corp., CA-5, such fees are often quite high. wages are not income, return fi ling is not 2002-1 USTC ¶50,144, 277 F3d 778; United 17 Code Sec. 6700(a). required by law, individuals can revoke Parcel Service of America, Inc., CA-11, 18 Compare In re Tax Refund Litigation, DC SSNs, etc.); Schiff, DC Nev., 2003-2 USTC 2001-2 USTC ¶50,475, 254 F3d 1014.

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