Monday, October 18, 2010

Debit by the Window - Credit out the Window

KRAUSE v. U.S., Cite as 106 AFTR 2d 2010-5382, 10/12/2010

There is an old joke about a CPA who used to come to work everyday, open his desk drawer and look at a slip of paper.  After he retired someone found the slip of paper and saw written on it "Debits by the Window - Credits by the Door".  If he went to law school and started doing Son of BOSS deals, he would have had to change it to something more in line with the title of this post.
My readers, who may well number in the scores, vary in their degree of tax geekiness.  Those of you who come here out of friendship or because I have grovelled may want to just click on a few ads and move on, because this is one of those points that is a stretch for me.  I feel I must comment on this synchronicity.  My last two posts have been about Fidelity International Currency.  The rather long decision was issued in May.  It disallowed two partnerships which had been used by EMC founder Richard Egan to shelter capital gains from the sale of stock and ordinary income from the exercise of non-qualified options.

The decision was amended on October 6 to indicate that penalties would apply.  Talk about waiting for the other shoe to drop. The Egans had already put up the 60 million or so in tax.  Somehow I doubt they had been counting on the refund they were suing for to do their Christmas shopping.  So the October 6 amendment might be what they were really sweating out.  If the judge had wanted to make life even more difficult he would have waited until January.  Mr. Egan died in August 2009 making the extended due date of his estate tax return fairly imminent.  Presumably the penalty will go in as a debt of the estate.

In my post I indicated that since this was a partnership case, I was leaving it to the tax litigators as to whether that really was the venue for deciding individual penalties.  Next time I take a break from October 15 returns and start crawling through decisions I find the case of J. Winston Krause.  Mr. Krause was a tax attorney and CPA who built his own Son of BOSS shelter.  I have to wonder if he has two sides to his personality. Right now the CPA side is yelling "Language of 752, language of 752 - I knew it couldn't work.  The entry didn't balance.  You can't get all that basis without crediting something."  The tax attorney side has answers. I can show you an example of a CPA making beautifully balanced entries that make no impression on judges, who are lawyers.

Mr. Krause's partnership did not fight the disallowance of the Son of BOSS losses.  He paid the assessed tax, penalty and interest and then sued for refund of the penalties.  Mr. Krause, not being a high tech billionaire. "only" has about $112,000 in penalties. (I have a rule that the word "only" should not be used in connection with sums of money greater than four dollars, but I'm relaxing it in light of the Egan's 20 million plus penalty).  In arriving at its ruling he court goes into a discussion on the partnership provisions of TEFRA. (Tax Equity and Fiscal Responsibility Act of 1982).  The partnership provisions of TEFRA are a more subtle part of the war against tax shelters than passive activity loss rules of the Tax Reform Act of 1986.  Without them each parter in a partnership could litigate the same transactions in tax court.

To avoid duplicative litigation stemming from the tax treatment of partnerships, Congress enacted TEFRA, which creates a unified procedure for determining the treatment of partnership tax transactions. TEFRA requires the differentiation between the tax treatment of partnership-level and partner-level items.Id . § 6221. Partnership items include all items of “income, gain, loss, deduction, or credit of the partnership,” along with “optional adjustments to the basis of partnership property pursuant to an election under section 754,” and “the accounting practices and the legal and factual determinations that underlie the determination of... items of income, credit, gain, loss, deduction, etc.”

The penalties assessed under the FPAA were directly attributable to the fraudulent $2.79 million loss KAAS alleged it incurred when it sold its Canadian currency. This loss, which passed through to Krause Holdings and then to Krause, occurred because of the overstated basis KAAS had claimed in the Canadian currency due to an earlier basis election. Thus, the penalty related to basis, basis adjustments, and losses, all of which are considered partnership items under § 6231

 Further, the refund sought by Krause relates to penalties and penalty-related interest that are associated with partnership-level items, both of which are in and of themselves considered partnership-level items. I.R.C. §§ 6221, 6230(c)(4). In this regard, the Code is clear: these are items that must be contested before the IRS finalizes an FPAA. The district court did not err by concluding that it could not consider Krause's refund claims.

So if this decision holds, the Egan family might be able to appeal the Fidelity decision, but they won't get to have a fresh hearing on the penalties when they are assessed against the individual returns.

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