                             T.C. Memo. 2017-150



                       UNITED STATES TAX COURT



  CURTIS INVESTMENT COMPANY, LLC, HENRY J. BIRD, A PARTNER
      OTHER THAN THE TAX MATTERS PARTNER, Petitioner v.
        COMMISSIONER OF INTERNAL REVENUE, Respondent

         GUY R. BAXTER AND LONNIE C. BAXTER, Petitioners v.
         COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket Nos. 10181-08, 16835-08.            Filed August 2, 2017.



      David D. Aughtry and Hale E. Sheppard, for petitioners.

      Jason P. Oppenheim, John W. Sheffield, III, and Lawrence Sledz, for

respondent.
                                        -2-

[*2]        MEMORANDUM FINDINGS OF FACT AND OPINION


       MARVEL, Chief Judge: These cases have been consolidated for trial,

briefing, and opinion. The issues for decision are whether petitioners are:1

(1) entitled to deduct the losses and fees associated with Custom Adjustable Rate

Debt Structure (CARDS) transactions for taxable year 2000 (year at issue) and

(2) liable for accuracy-related penalties under section 6662(a).2

       Respondent issued a notice of final partnership administrative adjustment

(FPAA) pursuant to section 6223 to R. Alan Bird, Jr., the tax matters partner

(TMP) of Curtis Investment Co., LLC (Curtis Investment), a limited liability

company (LLC) organized under the laws of the State of Georgia. In the FPAA

respondent disallowed Curtis Investment’s claimed loss deduction for 2000 that

resulted from a CARDS transaction and the claimed deductions from entering into

the transaction. Respondent also determined accuracy-related penalties under




       1
      We use the term “petitioners” to refer collectively to Curtis Investment and
Mr. and Mrs. Baxter.
       2
       All section references are to the Internal Revenue Code (Code) in effect for
the year at issue, and all Rule references are to the Tax Court Rules of Practice and
Procedure, unless otherwise indicated.
                                          -3-

[*3] section 6662(a) for a gross valuation misstatement.3 Because R. Alan Bird,

Jr., did not petition this Court within 90 days, Henry J. Bird, a notice partner, filed

a petition pursuant to section 6226(b).

      Respondent issued a notice of deficiency to Mr. and Mrs. Baxter on April 8,

2008, that determined a deficiency and accuracy-related penalty under section

6662(a) for a gross valuation misstatement in Mr. and Mrs. Baxter’s Federal

income tax for 2000.4 In the notice of deficiency respondent disallowed a claimed

loss deduction for 2000 as a result of a CARDS transaction similar to Curtis

Investment’s CARDS transaction.

                                FINDINGS OF FACT

      Some of the facts have been stipulated and are so found. The stipulations of

fact and facts drawn from stipulated exhibits are incorporated herein by this

reference. Mr. and Mrs. Baxter resided in South Carolina at the time of filing their



      3
       Alternatively, respondent determined that petitioners are liable for
accuracy-related penalties under sec. 6662(a) for negligence or a substantial
understatement of income tax.
      4
       Respondent also issued a notice of deficiency to Mr. and Mrs. Baxter for
2001 that determined a deficiency in Federal income tax and an accuracy-related
penalty under sec. 6662(a). Respondent’s position with respect to 2001 is an
alternative to respondent’s determination for 2000. Because we hold that Mr. and
Mrs. Baxter’s CARDS transaction lacked economic substance, respondent
concedes the 2001 deficiency and accuracy-related penalty.
                                        -4-

[*4] petition. Curtis Investment’s principal place of business when its petition

was filed was Georgia.

I.     Petitioners

       In 1882 Henry Russell Curtis founded Curtis Printing Co., which became a

very successful printing company. In 1918 Curtis Printing Co.’s name was

changed to Curtis 1000, and in 1968 Curtis 1000 decided to offer its stock to the

public. In order to offer the stock of Curtis 1000 to the public, Curtis 1000

incorporated American Business Products, Inc. (ABP). ABP became the corporate

parent of Curtis 1000, and the ABP stock was traded to the public.

       Before the public offering, Curtis 1000 was primarily owned by the Curtis

family. In 1961 the family formed Curtis Investment, which operated as a holding

company for Curtis 1000 stock. After the public offering, Curtis Investment

owned approximately 30% of the ABP stock.5 In addition to holding ABP stock,

Curtis Investment began diversifying its portfolio. As part of its diversified

portfolio, Curtis Investment would borrow funds at a low interest rate to make an

investment if it determined that the investment would yield a return greater than

the interest cost.


       5
      Members of the Curtis family, including Mrs. Baxter, also individually
owned ABP stock.
                                           -5-

[*5] In 1986 Mrs. Baxter became the managing member of Curtis Investment.6

In 1997 her son, Henry J. Bird (Mr. Bird),7 started to work at Curtis Investment

after previously working at Curtis 1000 for over 15 years. On January 1, 1998,

Mr. Bird became the managing member of Curtis Investment. Mr. Bird holds a

bachelor’s degree in business administration from West Georgia College. He was

also the president of a mortgage company, Birdhouse Mortgages, and as a result he

is familiar with loan origination fees and the lending industry.

      When Mr. Bird became the managing member of Curtis Investment, the

company included 34 family members. To centralize management in 1998 Mr.

Bird formed an investment committee to assist Curtis Investment with determining

what type of assets the company should hold. The investment committee

determined that Curtis Investment should diversify its holdings, and therefore as

part of that diversification Curtis Investment would sell some of its ABP stock

over a 10-year period.




      6
       Mrs. Baxter started working for Curtis Investment in 1978. Mrs. Baxter is
the great-granddaughter of Henry Russell Curtis, the founder of Curtis Printing
Co. The record states that Mrs. Baxter and later her son, Mr. Bird, were the
managing partners of Curtis Investment. Because Curtis Investment was
organized as an LLC, we will refer to them as managing members.
      7
          Mr. Bird is often referred to as Jay Bird throughout the record.
                                        -6-

[*6] In either late 1999 or early 2000, however, ABP received a tender offer for

the purchase of the company. ABP’s board accepted the tender offer, and as a

result of the tender offer, Curtis Investment sold 1,430,499 shares of ABP stock

and 33,800 shares of ABP stock on February 23 and 28, 2000, respectively. These

sales generated a $28,597,759 long-term capital gain. Mrs. Baxter sold 133,190

shares of ABP stock on February 28, 2000, and that sale generated a $2,444,383

long-term capital gain and a $18,895 short-term capital gain. Petitioners were

therefore no longer able to sell their ABP stock over a 10-year period.

      Petitioners knew that the sales of ABP stock would generate substantial tax

liabilities, and they began considering ways to shelter the capital gains triggered

by the sales. Petitioners considered several different tax shelter transactions but

ultimately rejected those proposals. Then in the fall of 2000 they began

considering CARDS transactions to minimize their tax liabilities.

II.   Petitioners’ Entry Into the CARDS Transactions

      CARDS transactions are not new to this Court. See generally Hunter v.

Commissioner, T.C. Memo. 2014-132; Crispin v. Commissioner, T.C. Memo.

2012-70, aff’d, 708 F.3d 507 (3d Cir. 2013); Kerman v. Commissioner, T.C.

Memo. 2011-54, aff’d, 713 F.3d 849 (6th Cir. 2013); Country Pine Fin., LLC v.

Commissioner, T.C. Memo. 2009-251. The CARDS transaction, including the
                                          -7-

[*7] CARDS transactions at issue here, was developed and marketed by Chenery

Associates, Inc. (Chenery). Roy Hahn is Chenery’s founder and worked with

petitioners on their CARDS transactions. The purpose of a CARDS transaction is

to create an artificial substantial capital loss that offsets an unrelated capital gain.

      In the fall of 2000 Barbara Coats, an accountant at Windham Brannon, P.C.

(Windham Brannon), and an adviser of petitioners, learned about the alleged

benefits of CARDS transactions while teaching a class. Ms. Coats was introduced

to Mr. Hahn, who recommended CARDS transactions to shelter petitioners’

capital gains that resulted from the ABP stock sale and as a way to obtain long-

term funds for investment. Ms. Coats believed the proposal could work for

petitioners because of their history with leveraging debt and their desire to shield

the gains from the sale of ABP stock.

      Ms. Coats and another accountant of Windham Brannon, Matt Levin,

presented the CARDS transactions proposal to Mr. Bird. Mr. Bird asked

petitioners’ advisers to research the proposal. Petitioners’ advisers included Ms.

Coats and Mr. Levin of Windham Brannon; and Thomas H. Rogers III and Ann A.

Watkins, lawyers at Rogers & Watkins.8 Mr. Rogers was to review the contracts

      8
      Petitioners had previously retained Stalled Hie as their lawyer. However,
Mr. Hie was no longer their legal counsel by the year at issue. Petitioners also
                                                                       (continued...)
                                       -8-

[*8] and the tax consequences of the CARDS transactions. Windham Brannon also

reviewed tax consequences of the CARDS transactions.

      During their review of the contracts and tax consequences of the CARDS

transactions, petitioners’ advisers received a model legal opinion for a CARDS

transaction drafted by the law firm of Brown & Wood. The model opinion letter

included several blanks and explanatory brackets where currency amounts, dates,

and names were to be entered. Although the model opinion letter did not address

petitioners’ specific CARDS transactions,9 the model opinion letter did generally

describe a CARDS transaction. The model opinion letter concluded that a

CARDS transaction would “more likely than not” have economic substance.10 In




      8
        (...continued)
relied on investment advice from Eric Zimmerman.
      9
       For example, petitioners borrowed from HVB Structured Finance, Inc., a
subsidiary of Bayerische Hypo-Und Vereinsbank, AG (collectively referred to as
HVB) and not Deutsche Bank. The letter also assumed that petitioners were
borrowing the present value of the amount assumed due in 30 years. Petitioners
received only a portion of the amount due in 30 years.
      10
       In 2000 respondent issued Notice 2000-44, 2000-2 C.B. 255, warning
taxpayers of CARDS transactions and Son-of-BOSS transactions. The model
opinion letter from Brown & Wood discusses the notice. Mr. Bird testified that he
reviewed the model opinion letter with Mr. Rogers extensively. We therefore
conclude that Mr. Bird was aware of respondent’s position.
                                        -9-

[*9] reviewing the model opinion letter, petitioners spoke with R. J. Ruble, an

attorney at Brown & Wood.11

      Ms. Coats, Mr. Levin, and Mr. Rogers reviewed the model opinion letter

and relied solely on the model opinion letter and materials cited therein to form

their opinion of the CARDS transactions. None of petitioners’ advisers provided

their own opinion letters. Mr. Bird knew that petitioners’ advisers relied solely on

the model opinion letter and the materials cited within the model opinion letter.

After reviewing the model opinion letter, petitioners’ advisers concurred with the

model opinion letter regarding the tax consequences and did not raise any

additional issues.12

      Chenery provided petitioners with their respective opinion letters from

Brown & Wood that discussed their particular CARDS transactions after

petitioners had already entered into their CARDS transactions. As part of



      11
        Mr. Hahn listed Mr. Ruble as a reference for petitioners to contact
regarding Mr. Hahn’s qualifications.
      12
         Ms. Coats testified that she believed that while the capital loss would
offset the capital gain from the ABP stock, she believed that petitioners would
ultimately pay tax on the gain over time. In other words, the tax would be
deferred. Petitioners also testified to this effect. However, we do not find their
testimony credible. The record is devoid of any documentary evidence to suggest
that petitioners would pay the tax over time, and the model opinion from Brown &
Wood does not include this conclusion.
                                        - 10 -

[*10] petitioners’ CARDS transactions, Chenery had promised the opinion letters.

Chenery told petitioners that the opinion letter would eliminate the risk of tax

penalties. Petitioners did not pay Brown & Wood directly for the opinion letters;

Chenery paid Brown & Wood from fees petitioners paid to Chenery.

      In addition to arranging for a review of the model opinion letter, petitioners

hired a private investigator to investigate Chenery and Mr. Hahn. Petitioners’

advisers did research on HVB, the bank providing the loans for the CARDS

transactions, and on Brown & Wood, and that research did not generate any

concerns.

      As described infra pp. 16-18, petitioners, as part of the CARDS

transactions, would receive some proceeds that they planned to invest. Mr. Bird

assumed the primary responsibility for researching the investment potential of the

CARDS transactions and deciding whether petitioners could profit from them.

Mr. Bird’s research led him to conclude that petitioners needed to earn 7.9% to

make the CARDS transactions profitable. Mr. Bird calculated that the expected

rate of return on investments made with proceeds from the CARDS transactions

was 17.2% and that after factoring in costs of 7.9%, petitioners could expect a net

return of 9.3% (17.2%!7.9%). Petitioners’ advisers reviewed Mr. Bird’s

calculations and confirmed that the CARDS transactions could be profitable.
                                        - 11 -

[*11] On December 16, 2000, Curtis Investment’s investment committee

discussed the CARDS transactions. During the meeting Mr. Bird made a

PowerPoint presentation regarding the CARDS transactions. The presentation

included Mr. Bird’s analysis of the investment potential, which he referred to as a

“capital leverage” plan.13 Although the PowerPoint presentation did not include

any information regarding the tax benefits of the proposal, tax benefits were

discussed.14

      Petitioners ultimately decided to participate in the CARDS transactions.

Petitioners did not consider any financing options other than the CARDS

transactions in the last quarter of 2000.




      13
        The presentation included several errors about the actual CARDS
transactions at issue. For example, the calculations include only 29 years of
accruing interest for a 30-year loan.
      14
         Mr. Bird testified that he did not know whether he would have approved
the CARDS transactions absent the tax benefits. Mrs. Baxter testified that she
would not have engaged in a CARDS transaction if the tax could have been
completely avoided. Another member of the investment committee, Hal Curtis,
testified that the tax benefits were irrelevant to him in his decision that Curtis
Investment should engage in the CARDS transaction. For the reasons discussed
infra pp. 32-34, we do not find petitioners’ testimony credible.
                                       - 12 -

[*12] III.   The CARDS Transactions

      A CARDS transaction typically has three stages: (1) loan origination; (2)

loan assumption; and (3) loan operation. The CARDS transactions at issue in

these cases also had three stages, which are described below.

      A.     Origination

      On December 11, 2000, Elizabeth A.D. Sylvester and Michael Sherry,15

residents of the United Kingdom, organized Brondesbury Financial Trading, LLC

(Brondesbury), as a Delaware LLC for the sole purpose of facilitating the CARDS

transaction with respect to Curtis Investment. Also on December 11, 2000, Ms.

Sylvester and Mr. Sherry organized Caledonian Financial Trading, LLC

(Caledonian), as a Delaware LLC for the sole purpose of facilitating a CARDS

transaction with respect to Mr. and Mrs. Baxter. Ms. Sylvester and Mr. Sherry

capitalized the entities solely through the use of promissory notes.

      On December 14, 2000, Brondesbury and Caledonian each entered into a

credit agreement with HVB, a German-based bank, whereby HVB agreed to lend


      15
        Ms. Sylvester and Mr. Sherry are not strangers to this Court. Each has
participated in other CARDS transactions that have come before us, for example,
in Country Pine Fin., LLC v. Commissioner, T.C. Memo. 2009-251, where they
established another Delaware LLC that acted as the borrower in that matter.
Petitioners did not hire a private investigator to investigate Ms. Sylvester and Mr.
Sherry but did review Ms. Sylvester’s résumé.
                                          - 13 -

[*13] Brondesbury €35.3 million and Caledonian €2.9 million. Both credit

agreements were for a 30-year period. Other than the names of the borrowers and

the amounts borrowed, the two credit agreements were substantially identical.

      Although the credit agreements included a 30-year period, HVB had the

unilateral right to call the loan at the end of every year. Interest on the loans

accrued annually with the exception of the first and second interest periods, which

occurred in the first year of the loan.16 HVB could adjust the interest rate

annually.

      The agreement governing the loans required different collateralization

according to the quality of the collateral. If the collateral consisted of cash, or an

acceptable cash equivalent, the borrowers were required to deposit collateral equal

to 102% of their obligations to HVB. If the collateral consisted of other assets, the

borrowers were required to deposit collateral equal to 108% of the obligations.

      HVB deposited 85% of each loan’s proceeds into a time deposit account

established at HVB for each borrower. The time deposits were set to mature in

one year.17 HVB disbursed the remaining 15% of each loan’s proceeds by issuing


      16
       The interest rate was equal to the 12-month euro LIBOR, plus a spread of
0.5%. Euro LIBOR on December 14, 2000, was 4.885%.
      17
           Mr. Bird testified that he believed that the time deposits would be reset
                                                                          (continued...)
                                        - 14 -

[*14] a one-year promissory note to each borrower. Both the time deposits and the

loan proceeds paid interest at a rate equal to 12-month LIBOR. There was a

difference of 0.5% between the interest owed on the loan and the interest rate paid

on the time deposits and promissory notes.

      Brondesbury and Caledonian pledged their respective time deposits and

promissory notes as collateral for the loans.18 As a result of the time deposits and

promissory note collateralization, the amounts of the loans were fully

collateralized. The entities could not withdraw cash from HVB without

substituting collateral, and any substitution of collateral required HVB’s approval.

HVB also had the right to withdraw interest due to HVB from the time deposit

account when an interest payment was due.

      B.     Loan Assumption

      On December 27 and 28, 2000, Curtis Investment executed a series of

agreements with Brondesbury, and Mrs. Baxter executed similar documents with

Caledonian. Both purchased their respective counterparties’ HVB promissory



      17
       (...continued)
each year. We do not find his testimony credible with respect to the time deposits
because there is no documentary evidence that suggests a reset each year.
      18
        Proceeds from the redemption of the promissory notes were also pledged
as collateral.
                                        - 15 -

[*15] notes that represented 15% of the counterparties’ loan proceeds. In

exchange for the promissory notes, they agreed to assume 100% of their respective

entities’ HVB loans on a joint and several basis. The amounts of the HVB loans

and the amounts of the liabilities assumed by petitioners were calculated to shield

most of the ABP stock gain from taxation.

         The full balance of each entity’s loan was due on December 14, 2030.

However, petitioners were also aware that HVB could call the loan on or after

December 14, 2001. Petitioners’ attorney, Tom Rogers, had advised Mr. Bird

regarding the calling of the loans. Mrs. Baxter was also aware that HVB could

call the loans.

         Both Brondesbury and Caledonian agreed to make annual interest payments

to HVB, but petitioners were required to replace any collateral used to make those

interest payments. Both Brondesbury and Caledonian agreed not to request the

release or withdrawal of any of the collateral; and as long as the collateral

remained (i.e., the time deposits), it would be used to pay off the principal of the

loan. Consequently, petitioners did not gain access to the full amounts of the

loans.

         On December 28, 2000, petitioners redeemed their respective promissory

notes. HVB deposited €5.295 million into Curtis Investment’s HVB account and
                                        - 16 -

[*16] €435,000 into Mrs. Baxter’s HVB Account. On the same day, petitioners

requested that HVB exchange the euro for U.S. dollars at a dollar-to-euro

exchange rate of 0.924. Petitioners also entered into one-year forward contracts19

with HVB. The forward contracts required petitioners to sell U.S. dollars for euro

on December 14, 2001, using a 0.9402 dollar-to-euro exchange rate. As a result of

petitioners’ inflated bases from assuming liability for the full amounts of the loans,

the dollar-to-euro exchange resulted in a $27,724,620 purported loss for Curtis

Investment and $2,277,660 purported loss for Mr. and Mrs. Baxter.

      C.     Operational Phase

      Petitioners were subject to the same limitations as Brondesbury and

Caledonian in terms of withdrawing the proceeds from the HVB loans. Petitioners

could not withdraw the cash without HVB’s approval. Petitioners purportedly

found this unacceptable. Therefore, before entering into the CARDS transactions,

petitioners had negotiated a solution with Canadian Imperial Bank of Commerce

(CIBC) to facilitate the withdrawal of cash from HVB. Petitioners had a prior

relationship with CIBC and held several investment accounts with the bank.


      19
         A forward contract is a contract that allows two parties to buy or sell an
asset at a specified time for a specified amount. In these cases the forward
contract allowed petitioners to convert U.S. dollars back into euro. See Kipnis v.
Commissioner, T.C. Memo. 2012-306, at *15 n.10.
                                         - 17 -

[*17] To facilitate the withdrawal of cash, CIBC issued petitioners one letter of

credit with a value of $6.7 million. HVB would allow the use of the letter of

credit as substitute collateral. CIBC charged petitioners $241,200 for the letter of

credit. The letter of credit had a stated termination date of December 27, 2001. If

petitioners needed the letter of credit for subsequent years, they would have to pay

CIBC $20,000 each year. The assets in petitioners’ CIBC investment accounts

were used to collateralize the letter of credit. To ensure that the letter of credit

was fully collateralized, Curtis Investment was required to maintain at least $6.7

million in its investment accounts at CIBC.

      Both Curtis Investment and Mrs. Baxter used the letter of credit as

replacement collateral. On December 28, 2000, HVB deemed the letter of credit

acceptable as substitute collateral and wired $5,294,520 to one of Curtis

Investment’s CIBC accounts. The funds consisted of $4,892,580 for Curtis

Investment and $401,940 for Mrs. Baxter. Petitioners pledged to HVB a first

priority lien and security interest in favor of HVB for the letter of credit. As a

result of the letter of credit, petitioners’ CARDS loans were fully collateralized.

      On December 29, 2000, CIBC credited the $5,294,520 to a Curtis

Investment account. Petitioners maintained the proceeds deposited with CIBC in
                                        - 18 -

[*18] cash and did not make investments consistent with Mr. Bird’s purported

capital leverage plan until February 15, 2001.

       D.    Fees

       To set up and facilitate its CARDS transaction Curtis Investment paid

$1,938,465 to Chenery. Mrs. Baxter paid Chenery $154,375 to set up and

facilitate her CARDS transaction. Therefore, including the $241,200 that

petitioners paid CIBC for the letter of credit, petitioners paid $2,334,040 in fees.

The upfront fees totaled approximately 45% of the cash petitioners received from

HVB.

       Mr. Bird was familiar with loans and the lending industry. He was president

of a mortgage company called Birdhouse Mortgages. According to Mr. Bird, an

origination fee is computed on the amount borrowed and not on the amount owed

at the end of the loan. Birdhouse Mortgages did not offer any products with a

44% or more loan origination fee.

IV.    Unwinding the CARDS Transactions

       On November 13, 2001, petitioners received notice from HVB that HVB

intended to call the loans.20 The time deposits in accounts with HVB for the

       20
      Petitioners testified that HVB told them as a result of the events on
September 11, 2001, the bank was repositioning its investment focus and had
                                                                      (continued...)
                                       - 19 -

[*19] respective entities were used to repay most of the outstanding loans. As a

result, Curtis Investment had to repay HVB $5,378,764.49, and Mrs. Baxter had to

repay $441,881.50. On or around December 14, 2001, petitioners wired HVB

funds to satisfy the remaining balance of the HVB loans.

      Petitioners sought replacement financing from CIBC, Bank of North

Georgia, Deutsche Bank, and National Bank of South Carolina for the full

amounts of the two loans. However, petitioners ultimately did not obtain

replacement financing for the entire loan amounts. Petitioners did negotiate a loan

of $8.5 million from CIBC and used a portion of the proceeds to satisfy their

obligations to HVB.

V.    Petitioners’ Income Tax Returns and Notices of Deficiency

      Curtis Investment timely filed its Form 1065, U.S. Return of Partnership

Income, for the year at issue, reporting a $28,597,759 long-term capital gain from

the ABP stock sale. Curtis Investment also reported a $27,724,620 loss as a result

of the CARDS transaction. The loss from the CARDS transaction allegedly

occurred when Curtis Investment redeemed the promissory note. Curtis


      20
        (...continued)
decided to call the loan. We do not find petitioners’ testimony credible because
other facts in the record suggest that the CARDS transaction would not last the
entire 30-year term. See infra p. 33.
                                         - 20 -

[*20] Investment redeemed $4,892,580 from the promissory note but claimed a

basis of $32,617,200 as a result of its joint and several liability for the entire HVB

loan of Brondesbury. Curtis Investment also claimed a deduction of $1,400 for

loan origination fees.21

      Respondent issued an FPAA to the TMP for Curtis Investment on December

6, 2007. In the FPAA respondent determined that Curtis Investment was not

entitled to deductions for capital losses or transaction costs as a result of the

CARDS transaction and that Curtis Investment was liable for accuracy-related

penalties. Because the TMP did not petition this Court, Mr. Bird, a notice partner

and managing member for the year at issue, filed a petition pursuant to section

6226(b).

      Mr. and Mrs. Baxter timely filed their Form 1040, U.S. Individual Tax

Return, for taxable year 2000. On their Form 1040, Mr. and Mrs. Baxter reported

a long-term capital gain of $2,444,383 and a short-term capital gain of $18,895

from the sale of ABP stock that Mrs. Baxter owned individually. Mr. and Mrs.

Baxter also reported a $2,277,660 capital loss as a result of the CARDS

transaction. The loss from the CARDS transaction allegedly occurred when Mrs.


      21
       The loan origination fees totaled $1,938,465, but Curtis Investment
amortized the fees and claimed a deduction of $1,400.
                                        - 21 -

[*21] Baxter redeemed her HVB promissory note. Mrs. Baxter redeemed her

promissory note with a value of $401,940 but claimed a basis of $2,679,600 as a

result of her joint and several liability for the entire HVB loan of Caledonian.

      Respondent issued notices of deficiency to Mr. and Mrs. Baxter on April 8,

2008, for taxable years 2000 and 2001. In the notice of deficiency for the 2000

taxable year, respondent determined, inter alia, that Mr. and Mrs. Baxter were not

entitled to the capital loss deduction as a result of the CARDS transaction because

the transaction lacked economic substance. Additionally, respondent determined

that Mr. and Mrs. Baxter were liable for accuracy-related penalties.22 Mr. and

Mrs. Baxter timely petitioned this Court.

VI.   The Expert Reports

      Respondent introduced an expert report by A. Lawrence Kolbe. Dr. Kolbe

holds a Ph.D. in economics from the Massachusetts Institute of Technology and

has previously testified in or been deposed in Tax Court cases involving CARDS

transactions. See, e.g., Hunter v. Commissioner, T.C. Memo. 2014-132; Kipnis v.

Commissioner, T.C. Memo. 2012-306; Crispin v. Commissioner, T.C. Memo.

2012-70; Gustashaw v. Commissioner, T.C. Memo. 2011-195, aff’d, 696 F.3d


      22
        Respondent concedes the 2001 deficiency and penalty if the Court holds
for respondent with respect to 2000.
                                         - 22 -

[*22] 1124 (11th Cir. 2012); Kerman v. Commissioner, T.C. Memo. 2011-54;

Country Pine Fin., LLC v. Commissioner, T.C. Memo. 2009-251. Dr. Kolbe’s

report focused on the CARDS transactions as financing decisions and therefore

analyzed the loans and not what was done with the proceeds. Dr. Kolbe concluded

that the CARDS transactions were not economically rational because the expected

rate of return on the amount invested did not exceed or even equal the “cost of

capital”, i.e., the expected rate of return in capital markets on alternative

investments of equivalent risk. On the basis of his analysis, Dr. Kolbe concluded

that the net present value of the loans was negative €2.19 million. A typical loan

has a net present value of zero. In other words, the loans would reduce

petitioners’ wealth by €2.19 million regardless of the returns from the investments.

      Dr. Kolbe also considered the fees and interest rate of the CARDS

transactions. On the basis of his analysis, Dr. Kolbe concluded that the fees were

$1,887,962 more than for a loan that would yield similar proceeds and that the

interest rate on the loans was 2.970% higher than market interest rates, without

fees. Dr. Kolbe also noted that the longer the loans were maintained, the worse off

petitioners were because of the excessive annual costs of the loans after the first

year. Dr. Kolbe therefore concluded that the loans were an unprofitable financing
                                       - 23 -

[*23] decision and the use of the loan to purchase any investment would create an

unnecessary and material drag on the investment’s profitability.

      Petitioners introduced the expert report of James A. Walker, a banker with

47 years of experience. Mr. Walker holds an M.B.A. degree from Georgia State

University. Mr. Walker’s report discusses commercial lending practices. He

concludes that the credit agreement was a 30-year loan term. His report does not

address the profit potential or the business purpose of the CARDS transactions.

      Petitioners also introduced the expert report of Conrad S. Ciccotello. Dr.

Ciccotello has a Ph.D. in finance from Pennsylvania State University and is a

professor at Georgia State University. Dr. Ciccotello’s report focuses on the

investment potential of the CARDS transactions and concludes that petitioners

could profit from the CARDS transactions if their investment returns are greater

than 9.5%.

                                    OPINION

I.    Burden of Proof

      Tax deductions are a matter of legislative grace, and the taxpayer has the

burden of proving that he is entitled to the deductions claimed. Rule 142(a);

INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co.

v. Helvering, 292 U.S. 435, 440 (1934). However, if a taxpayer produces credible
                                         - 24 -

[*24] evidence23 with respect to any factual issue relevant to ascertaining the

taxpayer’s liability for any tax imposed by subtitle A or B of the Code and satisfies

the requirements of section 7491(a)(2), the burden of proof on any such issue

shifts to the Commissioner. Sec. 7491(a)(1). Section 7491(a)(2) requires a

taxpayer to demonstrate that he or she (1) complied with the requirements under

the Code to substantiate any item, (2) maintained all records required under the

Code, and (3) cooperated with reasonable requests by the Secretary24 for

witnesses, information, documents, meetings, and interviews. See Higbee v.

Commissioner, 116 T.C. 438, 440-441 (2001).

      Although petitioners contend that the burden of proof should shift to

respondent, petitioners have failed to produce credible evidence to support a shift

in the burden of proof. Therefore, the burden of proof remains with petitioners.

Even if petitioners had produced credible evidence, which they did not, to support

a shift in the burden of proof, the parties filed a joint statement of issues and did



      23
        “Credible evidence is the quality of evidence which, after critical analysis,
the court would find sufficient upon which to base a decision on the issue if no
contrary evidence were submitted (without regard to the judicial presumption of
IRS correctness).” Higbee v. Commissioner, 116 T.C. 438, 442 (2001) (quoting
H.R. Conf. Rept. No. 105-599, at 240-241 (1998), 1998-3 C.B. 747, 994-995).
      24
       The term “Secretary” means the Secretary of the Treasury or his delegate.
Sec. 7701(a)(11)(B).
                                       - 25 -

[*25] not list the burden of proof as an issue. Accordingly, the burden of proof is

not at issue.

II.   Merits of CARDS Under the Economic Substance Doctrine

      Taxpayers have the right to structure their transactions in a manner which

decreases the amount of what otherwise would be their taxes. Gregory v.

Helvering, 293 U.S. 465, 469 (1935). However, even if a transaction is in formal

compliance with the Code, the economic substance of the transaction determines

what is and what is not income to a taxpayer. Generally courts use a two-prong

test to decide whether a transaction has economic substance. We are mindful,

however, that there is a split among the Courts of Appeals as to the proper

application of the economic substance doctrine. Absent a stipulation to the

contrary appeals in these cases lie with the Court of Appeals for the Eleventh

Circuit with respect to Curtis Investment and the Court of Appeals for the Fourth

Circuit with respect to Mr. and Mrs. Baxter. Accordingly, we follow the laws of

those circuits. See Golsen v. Commissioner, 54 T.C. 742 (1970), aff’d, 445 F.2d

985 (10th Cir. 1971)

      In determining whether a transaction has economic substance the Court of

Appeals for the Eleventh Circuit has stated that (1) a transaction ceases to merit

tax respect when it has no economic effects other than the creation of tax benefits
                                        - 26 -

[*26] (the objective test) and (2) even if the transaction has economic effects, it

must be disregarded if it has no business purpose and its motive is tax avoidance

(the subjective test). United Parcel Serv. of Am., Inc. v. Commissioner, 254 F.3d

1014, 1018 (11th Cir. 2001), rev’g T.C. Memo. 1999-268; Kipnis v.

Commissioner, at *23-*24. The Court of Appeals for the Fourth Circuit has

stated:

      To treat a transaction as a sham, the court must find [(1)] that the
      taxpayer was motivated by no business purpose other than obtaining
      tax benefits in entering the transaction, and [(2)] that the transaction
      has no economic substance because no reasonable possibility of a
      profit exists. * * *

Black & Decker Corp. v. United States, 436 F.3d 431, 441 (4th Cir. 2006); Hines

v. United States, 912 F.2d 736, 739 (4th Cir. 1990); Rice’s Toyota World, Inc. v.

Commissioner, 752 F.2d 89, 91 (4th Cir. 1985), aff’g in part, rev’g in part, 81 T.C.

184 (1983). Thus the first prong of the test in the Fourth Circuit is subjective

while the second is objective. Therefore, for a finding that Mr. and Mrs. Baxter’s

CARDS transaction lacked economic substance the transaction must satisfy both

prongs of the test while Curtis Investment’s CARDS transaction must satisfy only

one prong of the test.

      This Court has examined other CARDS transactions promoted by Chenery.

We have held that the CARDS transaction lacked economic substance on each
                                       - 27 -

[*27] occasion. See Kipnis v. Commissioner, T.C. Memo. 2012-306; Crispin v.

Commissioner, T.C. Memo. 2012-70; Kerman v. Commissioner, T.C. Memo.

2011-54; Country Pine Fin., LLC v. Commissioner, T.C. Memo. 2009-251. The

other CARDS transactions are essentially the same as the CARDS transactions in

these cases with only immaterial differences. Accordingly, we will look to the

economic substance test as we have in past CARDS transaction cases.

      A.      The Objective Test

      The objective test involves a broad examination of whether, from an

objective standpoint, the transaction would likely produce economic benefits other

than the generation of a tax deduction. Kirchman v. Commissioner, 862 F.2d

1486, 1492-1494 (11th Cir. 1989), aff’g Glass v. Commissioner, 87 T.C. 1087

(1986). “A reasonable opportunity for profit will ordinarily be found only if there

was a legitimate expectation that the nontax benefits would be at least

commensurate with the associated transaction costs.” Rovakat, LLC v.

Commissioner, T.C. Memo. 2011-225, slip op. at 38, aff’d, 529 F. App’x 124 (3d

Cir. 2013).

      In regard to whether their CARDS transactions lacked economic substance,

petitioners contend that the Court must consider its “capital leverage” plan. In

other words, petitioners contend that they entered into the CARDS transactions to
                                        - 28 -

[*28] obtain proceeds for investment and that the Court should consider their

investment purpose in determining whether the CARDS transactions objectively

had economic substance. Other taxpayers have made similar arguments in

CARDS transaction cases, and we have consistently rejected those arguments. See

Kipnis v. Commissioner, at *26-*28; Country Pine Fin., LLC v. Commissioner,

T.C. Memo. 2009-251, slip op. at 35. Although petitioners urge this Court to

consider the profit potential from the investments purchased with proceeds from

the CARDS transactions, we decline the invitation as we have previously and

focus on the transaction “that gave rise to the tax loss”. See Country Pine Fin.,

LLC v. Commissioner, slip op. at 35.25 Because petitioners’ capital leverage plan

is not the transaction that gave rise to the tax loss, we do not consider whether it

had economic substance. We review the CARDS transactions separately from the

transfers of proceeds that petitioners used for their capital leverage plan.




      25
         Petitioners contend that this Court and other courts have erred by
analyzing the financing and investment decisions separately. Petitioners contend
that this Court and other courts have limited the scope of review at the urging of
Dr. Kolbe. We do not find merit in these arguments. This Court and other courts
have not determined the scope of review to include only the transaction that gave
rise to the tax loss solely because of Dr. Kolbe’s opinion. See Am. Elec. Power
Co. v. United States, 326 F.3d 737, 743 (6th Cir. 2003) (“[Courts should not]
evaluate the transaction’s profitability after the challenged deduction has been
allowed. To do so would swallow the sham analysis entirely.”).
                                       - 29 -

[*29] In reviewing the CARDS transactions without reference to the transfer of

the proceeds to petitioners, we find Dr. Kolbe’s report and related testimony

persuasive that the CARDS transactions lacked economic substance.26 Dr.

Kolbe’s report shows that the CARDS transactions lacked profit potential. The

report states that the CARDS transactions reduced petitioners’ wealth by €2.19

million and would have reduced it even more had the CARDS transactions lasted

longer than one year. These losses would exist no matter what investments

petitioners made with the proceeds because the same investments could have been

financed by a more conventional type of loan, and the artificial, unrelated losses

would remain even if we accepted petitioners’ position that we should consider the

transfer of proceeds to them as part of the CARDS transactions. See id.

      Petitioners’ expert reports were not helpful to the Court’s analysis. Dr.

Ciccotello’s expert report focuses on whether the decisions to enter the CARDS

transactions were rational when considering projected returns from investments

petitioners would make with proceeds from the CARDS transactions. Because the

      26
        Petitioners contend on brief that the Court should not admit Dr. Kolbe’s
testimony or reports because Dr. Kolbe has received substantial compensation
from the Commissioner as an expert in previous cases. Pursuant to sec. 7453, we
apply the Federal Rules of Evidence, and Fed. R. Evid. 702 provides requirements
for expert witnesses. Dr. Kolbe has the required education and skills. Petitioners
raised similar arguments at trial, and we overruled their objection. We find that
petitioners’ claims are without merit.
                                        - 30 -

[*30] investment of the proceeds is not part of the transaction “that gave rise to the

tax loss”, see Country Pine Fin., LLC v. Commissioner, slip op. at 35, we do not

find the report helpful or persuasive in evaluating the economic substance of the

CARDS transactions at issue. Additionally, petitioners offered expert testimony

from Mr. Walker. Mr. Walker’s expert report addresses commercial lending

practices and not the question of whether the transactions would objectively yield

a profit. We also do not find Mr. Walker’s report helpful because he does not

address the economic substance of the CARDS transactions at issue.

      Petitioners paid combined fees of $2,092,840 to Chenery to participate in

the CARDS transactions. After paying those fees petitioners could not obtain

investable proceeds unless they obtained collateral that was satisfactory to HVB.27

As respondent’s expert notes and we find persuasive, the financing costs were

substantially above market rates for comparable financing options. As a result of

the substantial financing costs, respondent’s expert concluded that the costs

“would create a very material, and entirely unnecessary, drag on the profitability”

of an investment.




      27
        Petitioners had to pay CIBC $241,200 for a letter of credit so they could
withdraw investable proceeds. In total, petitioners paid $2,334,040 to obtain
investable proceeds of $5,294,520.
                                        - 31 -

[*31] In sum, we find that the CARDS transactions did not objectively provide

petitioners with a reasonable possibility of profit. Petitioners engaged in the

CARDS transactions to create tax losses. Petitioners could have found less

expensive financing options but did not even investigate other options. Before

entering into the CARDS transactions, petitioners knew that the CARDS

transactions would generate a tax loss and this was their motive. There was no

genuine profit motive for these CARDS transactions, and any testimony to the

contrary is simply not credible. Accordingly, petitioners fail to satisfy the

objective test of the economic substance doctrine.

      B.     The Subjective Test

      Initially, we note that because the CARDS transaction that Curtis

Investment entered into fails the objective test, the subjective motive is irrelevant.

See Kirchman v. Commissioner, 862 F.2d at 1492. However, for the Court to

determine that the CARDS transaction entered into by Mr. and Mrs. Baxter lacks

economic substance, it must also fail the subjective test. See Black & Decker

Corp., 436 F.3d at 441. The subjective test reviews the intent or business purpose

of the taxpayer. Having a business purpose does not mean the reason for a

transaction is free of tax considerations, but the purpose must be one that “figures

in a bona fide, profit-seeking business.” United Parcel Serv. of Am., Inc. v.
                                        - 32 -

[*32] Commissioner, 254 F.3d at 1019. Thus, a transaction that would not have

occurred in any form but for tax avoidance reasons does not have a business

purpose. Id. at 1020; see also Rice’s Toyota World, Inc. v. Commissioner, 752

F.2d at 94.

      Petitioners contend that their business purpose was to obtain proceeds for

investment. Assuming petitioners actually intended to leverage funds for

investment purposes, we believe petitioners would have attempted to reduce their

costs of borrowing and maximize the amount of funds available for investment.

Instead, petitioners paid financing costs of approximately 45% of the proceeds of

the loan and organized their CARDS transactions such that the transactions would

result in losses close to the amount of taxable gains from the sale of ABP stock.

Petitioners did not attempt to obtain any other loan in the last three months of

2000, nor did they attempt to maximize the amount that they could borrow for

investment. Petitioners decided to use HVB, a bank with which they had no prior

relationship, rather than banks with which they had existing relationships because

borrowing money from those banks would not have provided petitioners with the

tax losses that CARDS transactions promised. Accordingly, we do not find

petitioners’ purported investment motive credible.
                                        - 33 -

[*33] Petitioners also contend that the proceeds were intended for long-term

investments because the loans were intended to last for 30 years. However,

petitioners knew or should have known that the CARDS transactions would not

last for 30 years. The collateral securing 85% of the outstanding loans was in one-

year time deposits. Petitioners purchased one-year forward contracts, and the

letter of credit from CIBIC would terminate after one year without a renewal.

Further, petitioners knew that HVB could call the loans on a yearly basis.

Although Mr. Walker concluded that the ability to call a loan on a yearly basis is

standard practice, facts in the record, such as the one-year time deposits and the

one-year letter of credit, support an inference that these particular loans would not

remain in place for 30 years.28 We find that petitioners knew or should have

known that the loans would not remain in place for 30 years.29



      28
        We also conclude as a result of these facts that petitioners’ testimony is
not credible with respect to September 11, 2001, as the cause for HVB’s calling
the loans.
      29
         Petitioners did seek replacement financing and ultimately found financing
to satisfy their HVB obligations. In the fall of 2001 when petitioners were notified
that HVB would terminate the loans, petitioners’ investments had decreased and
selling the investments would result in a loss. Therefore, petitioners’ primary
purpose in finding replacement financing was to avoid recognizing the losses. As
Mr. Bird testified: “Well, if everything had been rosy, we’d been--you know, it’d
be one thing, but things were terrible, because now we have to pull money out of
the stock market when it’s down, so it’s going to cost us even more.”
                                        - 34 -

[*34] Petitioners knew that they had substantial tax liabilities resulting from their

sales of their ABP stock and immediately began considering ways to shelter the

gains. Petitioners considered other tax shelters before choosing the CARDS

transactions and structured their CARDS transactions such that the losses would

offset most of the gains and not to maximize investable proceeds. Petitioners

rushed to close the CARDS transactions before the end of 2000 because the

transactions would shield the gains on their ABP stock, but they waited nearly six

weeks before investing the funds. Although petitioners and their advisers testified

that the CARDS transactions’ purported business purpose was for investment and

would simply defer the tax that would ultimately be paid, we do not find their

testimony credible. We find that absent the substantial tax benefits, no rational

taxpayer, including petitioners, would have entered into the CARDS transactions.

Accordingly, we conclude that petitioners did not have a business purpose for

entering into the CARDS transactions.

      C.     Loan Origination Fees

      Respondent also disallowed deductions for loan origination fees with

respect to Curtis Investment’s CARDS transaction. Fees incurred in connection

with a transaction that lacks economic substance are generally not deductible. See

Winn-Dixie Stores, Inc. v. Commissioner, 113 T.C. 254, 294 (1999), aff’d, 254
                                       - 35 -

[*35] F.3d 1313 (11th Cir. 2001); see also New Phoenix Sunrise Corp. v.

Commissioner, 132 T.C. 161, 185-186 (2009), aff’d, 408 F. App’x 908 (6th Cir.

2010). However, courts have upheld deductions based on genuine debts where the

debts were elements of a transaction lacking economic substance. See Rice’s

Toyota World, Inc v. Commissioner, 752 F.2d at 95-96. The parties did not list

the CARDS transaction fees as an issue in their joint statement of issues filed with

the Court, and therefore the transaction fees are not at issue. See Our Country

Home Enters., Inc. v. Commissioner, 145 T.C. 1, 39 n.18 (2015) (treating an issue

not raised in a memorandum of issues to be decided in the case as waived or

otherwise abandoned). Even if the fees were at issue, the record confirms on the

basis of the CARDS transactions’ structure that Curtis Investment was not

genuinely indebted. Consequently, we sustain respondent’s disallowance of the

deductions.

III.   Accuracy-Related Penalty

       Respondent determined that petitioners are liable for accuracy-related

penalties. A taxpayer may be liable for a 20% accuracy-related penalty on the

portion of an underpayment of income tax attributable to: (1) negligence or

disregard of rules or regulations, (2) a substantial understatement of income tax, or

(3) a substantial valuation misstatement. Sec. 6662(a) and (b)(1)-(3). The penalty
                                       - 36 -

[*36] increases to 40% to the extent that the underpayment is attributable to a

gross valuation misstatement. Sec. 6662(h)(1). An accuracy-related penalty under

section 6662 does not apply to any portion of an underpayment of tax for which a

taxpayer had reasonable cause and acted in good faith. Sec. 6664(c)(1).

      Respondent determined the 40% accuracy-related penalty applies to any

portion of the underpayment related to the disallowed loss deductions as a result of

the CARDS transactions.30 Petitioners argue that no accuracy-related penalty

applies because they had reasonable cause and acted in good faith. We now

address whether petitioners are liable for the 40% accuracy-related penalty.

      A.     Gross Valuation Misstatement

      Respondent determined a 40% accuracy-related penalty for a gross

valuation misstatement with respect to the losses reported from the CARDS

transactions. The gross valuation misstatement penalty is a 40% penalty that


      30
        The record is unclear as to whether respondent determined an accuracy-
related penalty with respect to Curtis Investment’s disallowed transaction costs.
Respondent determined that Curtis Investment was liable for an accuracy-related
penalty for a gross valuation misstatement as a result of its promissory note’s
inflated basis. See sec. 6662(h). As an alternative to an accuracy-related penalty
for a gross valuation misstatement, respondent determined that Curtis Investment
was liable for an accuracy-related penalty for negligence or a substantial
understatement of income tax. See sec. 6662(b)(1) and (2). Accordingly, because
we hold that Curtis Investment is liable for an accuracy-related penalty for a gross
valuation misstatement, we do not address respondent’s alternative position.
                                         - 37 -

[*37] applies to any portion of an underpayment of tax required to be shown on a

return that is due to the taxpayer’s overstating the value of, or his adjusted basis in,

property by 400% or more of its true value or adjusted basis (as the case may be).

Sec. 6662(h). When a property’s true basis is zero, the gross valuation

misstatement penalty is automatically triggered if the taxpayer claimed on his tax

return that the property had any basis at all. Sec. 1.6662-5(g), Income Tax Regs.

      The Commissioner bears the burden of production with respect to the

taxpayer’s liability for a section 6662(a) penalty and must produce sufficient

evidence indicating that it is appropriate to impose the penalty. See sec. 7491(c);

Higbee v. Commissioner, 116 T.C. at 446-447. Once the Commissioner meets his

burden of production, the taxpayer must come forward with persuasive evidence

that the Commissioner’s determination is incorrect or that the taxpayer had

reasonable cause or substantial authority for the position. See Higbee v.

Commissioner, 116 T.C. at 446-447.

      Our holding that the CARDS transactions lack economic substance results

in the total disallowance of the loss deductions without regard to the value or

bases of the property used in the CARDS transactions. See Leema Enters., Inc. v.

Commissioner, T.C. Memo. 1999-18, aff’d sub nom. Keeler v. Commissioner, 243

F.3d 1212 (10th Cir. 2001). The gross valuation penalty applies when an
                                        - 38 -

[*38] underpayment stems from deductions or credits that are disallowed because

of lack of economic substance. See United States v. Woods, 571 U.S. ___, 134 S.

Ct. 557 (2013); Gustashaw v. Commissioner, T.C. Memo. 2011-195.

Consequently, respondent has satisfied his burden of production, and the 40%

gross valuation misstatement applies to petitioners’ underpayments absent a

showing of reasonable cause.

      B.     Reasonable Cause and Good Faith

      The accuracy-related penalty does not apply with respect to any portion of

the underpayment for which the taxpayer shows that there was reasonable cause

and that he or she acted in good faith. Sec. 6664(c)(1). The decision as to whether

a taxpayer acted with reasonable cause and in good faith is made on a case-by-case

basis, taking into account all of the pertinent facts and circumstances, including

the experience, knowledge, and education of the taxpayer. See sec. 1.6664-

4(b)(1), Income Tax Regs. “Circumstances that may indicate reasonable cause and

good faith include an honest misunderstanding of fact or law that is reasonable in

light of all of the facts and circumstances, including the experience, knowledge,

and education of the taxpayer.” Id.

      Partner-level defenses, including reasonable cause and good faith, may not

be asserted in a partnership-level TEFRA proceeding such as the one we have
                                       - 39 -

[*39] here. See New Millennium Trading, L.L.C. v. Commissioner, 131 T.C. 275,

288-289 (2008). But when the reasonable cause defense rests on the partnership’s

actions, such as in the cases here, we may entertain the defense at the partnership

level, “taking into account the state of mind of the general partner.” Superior

Trading, LLC v. Commissioner, 137 T.C. 70, 91 (2011), aff’d, 728 F.3d 676 (7th

Cir. 2013).

      Petitioners contend that they had reasonable cause and acted in good faith

because the CARDS transactions present a novel issue and that they reasonably

relied on the advice of tax professionals. We address both below.

              1.   Novel Issue

      This Court has previously found that a taxpayer acted with reasonable cause

and good faith when a deficiency is the result of an issue of first impression and

the taxpayer’s position is reasonably debatable. See Williams v. Commissioner,

123 T.C. 144, 153-154 (2004). Likewise this Court has found reasonable cause

and good faith when a taxpayer takes a position on an initial interpretation of a

statute and the statutory text is unclear. See Bunney v. Commissioner, 114 T.C.

259, 266 (2000). However, regardless of whether the legal issue is novel, the

Court considers all of the facts and circumstances in determining whether a
                                        - 40 -

[*40] taxpayer acted with reasonable cause and in good faith. See sec. 1.6664-

4(b)(1), Income Tax Regs.

      Petitioners contend that the issues raised by the CARDS transactions in

these cases are novel issues. Although at the time petitioners filed their returns no

CARDS transactions cases had been litigated, the requirement that a transaction

have economic substance has been a longstanding principle of tax law. See, e.g.,

Gregory v. Helvering, 293 U.S. at 468-470; Winn-Dixie Stores, Inc. v.

Commissioner, 113 T.C. at 277-280. In fact, Brown & Wood offered an opinion

with respect to economic substance of the CARDS transactions that was allegedly

based on representations of the parties. Respondent had also already taken a

position in Notice 2000-44, 2000-2 C.B. 255, unfavorable to CARDS transactions,

and Brown & Wood discussed respondent’s position in its model opinion letter.

Even if petitioners’ CARDS transactions presented novel issues, which they do

not, petitioners’ position is not reasonably debatable and petitioners did not prove

that they acted with reasonable cause and in good faith.

             2.    Reliance on Tax Advisers

      Petitioners also assert that they acted with reasonable cause and in good

faith because they reasonably relied on the advice of their tax advisers. Reliance

on the advice of a tax professional may, but does not necessarily, establish
                                        - 41 -

[*41] reasonable cause and good faith for the purpose of avoiding a section

6662(a) penalty. United States v. Boyle, 469 U.S. 241, 251 (1985). A taxpayer’s

reliance on a competent tax professional may establish reasonable cause and good

faith when the taxpayer provides necessary and accurate information to the adviser

and the taxpayer reasonably relies in good faith on the adviser’s judgment. See

Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 99 (2000), aff’d, 299

F.3d 221 (3d Cir. 2002). In cases where the tax adviser has an inherent conflict of

interest of which the taxpayer knew or should have known, a taxpayer’s reliance

on the adviser’s opinion is unreasonable. See Canal Corp. v. Commissioner, 135

T.C. 199, 218 (2010); Neonatology Assocs., P.A. v. Commissioner, 115 T.C. at

98-99.

      The parties dispute whether petitioners’ tax advisers were competent

professionals that had sufficient expertise to justify reliance and whether

petitioners relied in good faith on the advisers’ judgment. See Neonatology

Assocs., P.A. v. Commissioner, 115 T.C. at 99.

      Brown & Wood provided petitioners a model tax opinion before petitioners

entered into the CARDS transactions and finalized opinion letters after petitioners

had already engaged in the CARDS transactions. The tax opinions were promised

as part of petitioners’ entering into the CARDS transactions, and a portion of the
                                       - 42 -

[*42] fees that petitioners paid Chenery were used to pay Brown & Wood. The

tax opinion was marketed as a means of eliminating penalty risk. Because

Chenery promised to provide the tax opinion from Brown & Wood as part of

petitioners’ entering into the CARDS transactions, petitioners and their advisers

knew or should have known that Brown & Wood had an inherent conflict of

interest. A taxpayer’s reliance on an adviser with an inherent conflict is not

justified or reasonable. See CNT Inv’rs, LLC v. Commissioner, 144 T.C. 161, 226

(2015).

      Petitioners contend that even if Brown & Woods had a conflict of interest,

they relied on their longtime tax advisers to evaluate the CARDS transactions.

Although a taxpayer generally does not reasonably rely on the advice of a tax

adviser when the adviser relies on information from a third party that is a promoter

of a tax shelter, under some facts and circumstances reliance may be reasonable.

See id.; sec. 1.6664-4(c)(1)(ii), Income Tax Regs.

      Petitioners cite CNT as a case analogous to their case. In CNT the

taxpayers, Mr. and Mrs. Carroll, owned a chain of successful funeral homes. Mr.

Carroll was an aging World War II veteran, held a degree in mortuary science, and

had no sophisticated tax or financial knowledge. In fact, the taxpayers had never

invested in mutual funds or securities, had no diversified investments, and held
                                       - 43 -

[*43] their savings principally in cash. In an attempt to maintain a steady stream

of income during retirement, the taxpayers in CNT decided to sell the funeral

homes but maintain the real property. However, after discussing the proposed

sale, the taxpayers’ longtime advisers determined that transferring the real

property from the funeral home business would create substantial gains as a result

of the taxpayers’ low basis. After various presentations, meetings, and phone

calls, Mr. Carroll’s advisers recommended a Son-of-BOSS transaction. See CNT

Inv’rs, LLC v. Commissioner, 144 T.C. at 169 n.7. As in petitioners’ case, the

promoters of the Son-of-BOSS transaction in CNT provided a tax opinion that the

taxpayers’ advisers reviewed. Id. at 171.

      In deciding whether Mr. Carroll’s tax advisers had sufficient expertise to

justify reliance, we noted that the issue is a “close one.” Id. at 227. However, we

ultimately held that the taxpayers in CNT had reasonable cause and acted in good

faith. Id. at 235. The taxpayers were not sophisticated with respect to tax or

financial matters. Mr. Caroll’s tax advisers had also reviewed materials

independent of the tax opinion that was promised as part of the Son-of-BOSS

transaction.

      Petitioners’ case is distinguishable from CNT. The taxpayers’ advisers in

CNT took steps to complete an independent analysis. Although petitioners took
                                        - 44 -

[*44] steps to independently investigate Chenery and HVB, their advisers relied

solely on the legal analysis within the Brown & Wood model opinion letter in

concluding that petitioners should enter into the CARDS transactions. The

advisers checked some of the materials cited in the model opinion letter but did

not conduct any legal research of their own, and on the basis of this scant review

petitioners’ advisers recommended the CARDS transactions. Mr. Bird knew his

advisers relied solely on the model opinion letter from Brown & Wood in

formulating their opinion.31 Petitioners and their advisers should have known to

conduct an independent legal analysis in the light of the inherent conflict of

interest created by the relationship between Brown & Wood and Chenery.32

      Although the taxpayers’ advisers in CNT reviewed only a few sources other

than the opinion letter provided by the promoter, the expertise and sophistication


      31
         The model opinion letter discusses Notice 2000-44, supra, warning
taxpayers about tax shelters similar to Son-of-BOSS and CARDS. Mr. Bird
testified that he went over this model opinion letter with Mr. Rogers “paragraph by
paragraph”. Consequently, if Mr. Bird’s testimony is truthful, he and his advisers
discussed the notice. While the notice is not dispositive of the issue, we find it
surprising that Mr. Bird did not ask his advisers to conduct a more extensive
review considering respondent’s position. Additionally, the Court in CNT was
unable to conclude whether the taxpayers were aware of this notice. See CNT
Inv’rs, LLC v. Commissioner, 144 T.C. 161, 231 (2015).
      32
        Mr. Hahn listed Mr. Ruble, a lawyer at Brown & Wood, as a reference on
documents he provided to petitioners. Mr. Ruble is the attorney who was
petitioners’ contact at Brown & Wood.
                                        - 45 -

[*45] of the taxpayers in CNT were materially different from petitioners’. Both

Mr. Bird and Mrs. Baxter had sophisticated financial knowledge. Mrs. Baxter was

an assistant manager or manager of Curtis Investment for nearly 20 years. Mr.

Bird had served as manager of Curtis Investment for approximately three years at

the end of 2000. Mr. Bird also had a business degree and was president of

Birdhouse Mortgages. Both had experience working with financing transactions

and financial institutions. Although petitioners were sophisticated with respect to

financial matters, they did not question the costs of the CARDS transactions.

Petitioners did not seek or even investigate other financing options, yet they

contend that the principal purpose of engaging in the CARDS transactions was to

obtain funds to invest. If in fact petitioners intended to obtain funds to leverage, a

businessperson with petitioners’ experience would have investigated alternative

financing arrangements that might have proved less expensive than the CARDS

transactions.

      The Court also notes that petitioners introduced into evidence several

documents to prove an investment motive, but the record is devoid of any

discussions regarding the tax benefits of the CARDS transactions. However, from

the record as a whole, the Court is convinced that the tax benefits of the CARDS

transactions were discussed. Petitioners, who were sophisticated in business,
                                       - 46 -

[*46] should have known that these benefits were too good to be true. We

conclude that petitioners’ reliance was not reasonable or in good faith.

      In conclusion, we find, on the basis of all the facts and circumstances, that

petitioners failed to establish the reasonable cause and good-faith defense to the

accuracy-related penalty. Accordingly we sustain respondent’s determination that

petitioners are liable for the 40% accuracy-related penalty.

      We have considered the parties’ remaining arguments, and to the extent not

discussed above, conclude those arguments are irrelevant, moot, or without

merit.33

      To reflect the foregoing,


                                                      Appropriate decisions will be

                                                entered.




      33
        The parties also asked the Court to decide: (1) whether Mrs. Baxter
pursued the CARDS transaction with an intent to make a profit; (2) whether
petitioners’ liabilities, in excess of the cash received from HVB, constituted
genuine indebtedness; and (3) to what extent Mrs. Baxter was at risk for the
CARDS transaction at the close of the taxable year 2000. However, because we
find that the CARDS transactions lacked economic substance and the loss
deductions are disallowed, we do not need to resolve these issues.
