It's always a disappointment to me when something I get excited about turns out to be old news. Such was the case with Fidelity International Currency which was the topic of Wednesday's post. The decision, issued October 6 was an amendment of a decision issued in May. I must admit that I have not done a word for word comparison. but skipping to the end I found that in the section headed "The Court does not reach the following issues":
(4.) Whether specific accuracy-related penalties should be assessed against any member or partner of Fidelity High Tech or Fidelity International
was dropped in the amended finding.
In the conclusion section we find added
(6.) The following accuracy-related penalties are applicable to any understatement of the income tax liability of Richard Egan arising from the treatment of the Fidelity High Tech and Fidelity International transactions on the tax returns of those entities for the years 2001 and 2002.
(a.) a 40% penalty for gross valuation misstatement pursuant to § 6662(a), (b)(3), and (h);
(b.) a 20% penalty for substantial valuation misstatement pursuant to § 6662(a) and (b)(3);
(c.) a 20% penalty for substantial understatement of income tax pursuant to § 6662(a), (b)(2), and (d)(2)(A); and
(d.) a 20% penalty for negligence or disregard of rules and regulations pursuant to § 6662(a) and (b)(1).
The penalties are alternatively, and not cumulatively, applied
There are some complex court jurisdiction issues in this case, which don't interest me an awful lot. The Egans put up the estimated amount of tax that would be assessed if the partnership determination was upheld rather than go to Tax Court. The penalties discussed above are not the partnership's penalties. So I suppose there is some question as to whether the court is supposed to be ruling on them, particularly since they are not yet assessed. Whether Mr. Egan's executors can go to tax court over the penalties is a question for the tax litigators.
The two primary emotions I experience in my wanderings through the ever expanding body of primary source tax documents are compassion and schadenfreude (Curious that you have to go to German for that term.) Mr. Egan certainly doesn't need my compassion, but I do think it is sad that he was vilified in the media as a tax cheat in the final year of a life of high achievement. I think it would be tasteless and unprofessional to express schadenfreude with respect to any of the professionals involved in this debacle. I will, however, single out one for a special type of compassion. It is the "There, but for the grace of God, go I" variety of compassion. You see there is not very far distant alternate reality in which the Egans upset with their maltreatment by KPMG decide that leaving the warm embrace of a well established regional firm like O'Connon and Drew was a mistake. Maybe there are some other firms in their region of similar size to O'Connor and Drew with somebody who knows about partnerships and tax shelters. In that dystopia, the odds that this nightmare could have ended up on my desk are far from remote. Thankfully, the Egans decided to stay national. So my sympathy goes to Ron Wainwright of RSM McGladrey who got to sign the returns that KPMG wouldn't sign without disclosures that the tax attorneys said were not required.
In my previous post on this issue I analogized the people in the national firms who believed tax shelters still worked to isolated detachments of Japanese soldiers who were probably more prevalent in TV sitcoms than in real life in the fifties and sixties. Implicit in this analogy is analogizing the Tax Reform Act of 1986 to the atomic bomb. This may seem irreverent, but what can I say it's a metaphor. And it is a pretty good one because tax shelters had already been dealt very heavy blows and might have went down anyway. So in this elaborate metaphor Section 465, the at-risk rules, plays the role of ComSubPac, which sunk all the Japanese merchant ships.
At any rate to explain my own role in the world of tax shelters in similar terms it is necessary to switch sides. In this metaphor the Tax Reform Act of 1986 is the blitzkrieg. My part of the tax shelter world, low income housing, was like Vichy France. Our deals that were still in their pay in period were granted transitional relief. Somebody told me that the fiscal trade-off for that was fiscal years for S corporations. Not a good trade from my viewpoint. We got a whole new credit, which meant all the new deals had to be redesigned and kept on trucking. People capitalizing low income housing without much upside beyond the tax benefits was the way thing's were supposed to be. This particular metaphor really sucks because it makes the national guys the Maquis and me, well never mind its a metaphor. Basically we had to learn all the aggravating stuff in the 704(b) regulations and whatever other collateral damage the war against tax shelters did to Subchapter K, but we didn't have to hide in the woods while we were preparing returns.
I experienced this difference in world views in the mid-nineties when I was on the AICPA Tax Division's Partnership committee. (Hey it really impressed somebody on our peer review team once). When discussing some particularly arcane regulation a couple of the national guys indicated that they would be just as pleased if it stayed unclear. I must say that was exceptional. Generally the committee was striving for clearer regulations. I also remember that the anti- abuse regulations (1.701-2) were more or less hot off the presses at the time of our meeting. There were a lot of bent out of shape people. I, on the other hand, just looked at example 6 Special allocations; nonrecourse financing; low-income housing credit; use of partnership consistent with the intent of subchapter K and decided that there was nothing to worry about.
The Fidelity opinion got into the real nitty gritty of return preparation. The transaction I explained in my previous post was executed by a partnership called Fidelity High Tech. There were three partnership returns covering two years. The reason for the extra return was that the plan required a "technical termination" meaning that a change in ownership created a new partnership for income tax purposes. The "new partnership" was able to apply basis created by what a simple minded accountant like myself would see as an unbalanced entry to EMC stock the Egans had contributed to the partnership. In a nice bit of presentation work, they got Mellon Bank to present a capital gain (loss) schedule which incorporated the new basis. That can be a real challenge. The court mentions that they didn't file form 8275, but they had an opinion that there transaction was somehow different. What I see as the real "gotcha" is this:
Because Fidelity High Tech did not use cash cost to compute the stepped-up basis, it was required to attach an explanation to Schedule D. No such explanation was attached. An adequate explanation, as required by the instructions, would have included disclosure of the underlying transaction that resulted in the purported stepped-up tax basis used by Fidelity High Tech.
Back in the good old days, when we did returns by hand, my favorite review note was. RTFI - Read The Instructions. I really think that if I had been sweating this return out, I would have caught that. There would have been some sort of explanation. Likely it would not have been sufficient, but if you look at the revenue procedures on adequate disclosure (e.g. Rev Proc 2010-15), sometimes thoroughly filling out the form is what does the trick.