                              T.C. Memo. 2015-28



                        UNITED STATES TAX COURT



 436, LTD., ROBERT HEITMEIER, TAX MATTERS PARTNER, Petitioner v.
         COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 23525-05.                        Filed February 18, 2015.



      Kyle R. Coleman, for petitioner.

      Richard J. Hassebrock, Nancy B. Herbert, and Gary R. Shuler, Jr.,

for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      HOLMES, Judge: This case comes to us from a riverboat casino on the

lower Mississippi. In 1991 Robert Heitmeier saw a lucrative opportunity in the

newly legalized riverboat-gambling industry of New Orleans. He started several
                                        -2-

[*2] businesses to provide crews and consulting services to these new casinos, and

in 2001 Heitmeier hit the jackpot when Harrah’s purchased his piloting contract

with the Showboat Casino for $4 million. He reported an additional $142,000 of

ordinary income from his consulting services, and $232,000 of ordinary income

from his services in providing crews. He took a chance to try to lower his tax bill

with a complicated series of transactions involving multiple entities and almost

perfectly offsetting bets on Japanese yen.

      The Commissioner aims to sink his shelter.

                              FINDINGS OF FACT

I.    The Deckhand Turned Millionaire

      Robert “Bobby” Heitmeier left college after only one semester to work as a

deckhand on a tugboat. He rose to become a captain and then a riverboat pilot.

Riverboat pilots and captains ought not to be confused. A captain is almost

always in command of the ship, except when it goes into a lock system or a

drydock. Captaining is good work, but piloting--ah, “a pilot, in those days, was

the only unfettered and entirely independent human being that lived in the earth.”1


      1
        Mark Twain, Life on the Mississippi 105 (Harper & Bros. Publ’g 1901)
(1883), available at
http://books.google.com/books?id=5IRaAAAAMAAJ&printsec=frontcover&sour
ce=gbs_ge_summary_r&cad=0#v=onepage&q&f=false.
                                        -3-

[*3] Pilots guide ships through congested harbors and ports using their intensely

local knowledge of maritime conditions. This comes at a price, and even in

antebellum America pilots earned a “princely salary.” See id. at 34. Nowadays a

pilot doesn’t even have to take the wheel--though his job remains to direct the ship

and monitor the course of his ship and others around it. Modern navigational

technology has not relieved shippers of the need for pilots in many places,

including the lower Mississippi, where state law requires their use and does not

allow open entry into the field.2 Heitmeier is savvy and successfully navigated his

course to a piloting license from Louisiana in 1989. In 2001 he was also licensed

as a river pilot by the U.S. Coast Guard.




      2
        The Louisiana Code has a title devoted to navigation and shipping, and
within that title, a section dedicated to pilots. La. Rev. Stat. Ann. secs. 34:941et
seq. (2011). All section references are to the Internal Revenue Code in effect for
the year in issue, unless otherwise indicated. These statutes require that all
seagoing vessels moving between New Orleans and other ports be navigated
exclusively by pilots who are State officers. These pilots are so-called river port
pilots and can gain certification by the State Board of River Pilot Commissioners--
also pilots--only after performing an obligatory six-month apprenticeship with an
incumbent pilot. Obtaining an apprenticeship is no easy task. Incumbent pilots
have almost unfettered discretion under the law to select prospective
apprentices–and piloting is one of the very few jobs in which state-sanctioned
nepotism has survived constitutional challenge. See Kotch v. Board of River Port
Pilot Comm’rs, 330 U.S. 552, 555 (1947) (nepotism in pilot selection does not
violate Equal Protection Clause).
                                         -4-

[*4] The City of New Orleans has been a major world port for nearly three

centuries. The Louisiana legislature has controlled the activities and appointment

of pilots since before the territory was admitted as a state. In 1991 the state

approved fifteen new riverboat casinos. Heitmeier shrewdly saw that as a business

opportunity--gambling people knew Vegas, but they weren’t “going to know

anything about a boat”--so he set up a business to provide maritime crews to the

new casinos. Each riverboat needed about sixty of Heitmeier’s employees,

roughly four crews per ship, who could work 12-hour-long, 7-day-on, 7-day-off

shifts. This work soon became less than arduous, as the boats quickly stopped

actually cruising on the river and became attached as firmly as barnacles to the

docks. (Though sometimes they docked on a ditch filled with river
                                        -5-

[*5] water--“boats in moats” as they are called.)3 Heitmeier incorporated that

business as Riverboat Services, Inc., in 1995 and was its sole shareholder.

      Heitmeier also formed two other businesses around the same time for his

riverboat-related activities--Westbank Riverboat Services, Inc., and BRK

Consulting, LLC. Heitmeier used Westbank to supply workers to the riverboat

casinos, and did his own consulting work through BRK Consulting. Heitmeier

reported more than $230,000 of income from Westbank for 2001. He shared


      3
        This practice of manning a full crew on boats that never leave the shore is
the result of state-law technicalities restricting gambling (apart from American
Indian casinos and one land-based casino) to “riverboats.” Louisiana’s statute
says that “the division may issue up to fifteen licenses to conduct gaming activities
on a riverboat, in accordance with the provisions of this Chapter.” Louisiana
Riverboat Economic Development and Gaming Control Act, La. Rev. Stat. Ann.
sec. 27:65 (emphasis added). The statute defines a riverboat, in part, as a vessel
that “[c]arries a valid Certificate of Inspection (COI) from the United States Coast
Guard for the carriage of a minimum of six hundred passengers and crew.” Id.
sec. 27:44(23)(b). Thus, while Louisiana and other states on the Mississippi that
allow riverboat gambling have eliminated the requirement that the boats actually
move, see, e.g., id. sec. 27:65(B)(1)(c), casino boats must meet Coast Guard
requirements to receive a COI. The Coast Guard specifies in the COI the
minimum crew requirements for a boat, and it bases this determination on factors
such as the size of the boat, the number of passengers, and its intended use. 46
C.F.R. sec. 15.501. The determination is fact specific for each boat, but Coast
Guard guidelines suggest that Heitmeier’s staffing decisions were not out of the
ordinary. See, e.g., The U.S. Coast Guard, Marine Safety Manual Vol. III: Marine
Industry Personnel, B2-7 (2014), available at
http://www.uscg.mil/directives/cim/16000-16999/CIM_16000_8B.pdf. This has
struck some observers as absurd, but it created a lucrative opportunity for those
shrewd enough to take advantage of it.
                                       -6-

[*6] ownership of BRK with his wife, and they each reported more than $70,000

of income from it for 2001. By October 2001 he had about $1 million invested in

various Merrill Lynch accounts.

      In 2001 Harrah’s bought the Showboat Casino, one of Riverboat Services’

clients. Harrah’s wanted to take its piloting in-house and approached Heitmeier to

buy out Riverboat Services’ contract with Showboat. Heitmeier represented

himself and dickered with Harrah’s over the price for a while before calling in

KPMG to settle things with a valuation. KPMG came up with a value, and the

former deckhand sold his contract for a $4 million payday.

II.   Enter Mr. Garza

      Joe Garza is an attorney from Dallas, Texas, who had a long-established

practice in insurance defense, ERISA, and bond financing before he moved into

tax planning--sometimes quite aggressive tax planning. See 6611 Ltd. v.

Commissioner, T.C. Memo. 2013-49; Garcia v. Commissioner, T.C. Memo. 2011-

85, 2011 WL 1404919; Estate of Hurford v. Commissioner, T.C. Memo. 2008-

278, 2008 WL 5203652; 7050, Ltd. v. Commissioner, T.C. Memo. 2008-112, 2008

WL 1819920. It was Garza who sold Heitmeier on something he hadn’t heard of
                                        -7-

[*7] before--a variant of the now notorious Son-of-BOSS deal using digital

options and Japanese yen.4 See Kligfeld Holdings v. Commissioner, 128 T.C. 192,

194 (2007).

      A.      The Approach

      Around 1999 Garza first became aware of Son-of-BOSS transactions--a law

firm named Jenkens & Gilchrist was doing a lot of them, and several of his clients

wanted to do them too. Garza concluded that he could either refer his interested

clients to Jenkens & Gilchrist or do the deals himself. He decided to learn how to

do the deals himself.

      First he consulted with Craig Brubaker--an ex-Arthur Andersen employee

and at the time a director at Deutsche Bank Alex Brown. Brubaker had been

working on a lot of these deals for Jenkens & Gilchrist, and Garza was confident

of Brubaker’s knowledge and abilities. Brubaker gave Garza some information on

how these deals worked and how much Deutsche Bank charged for them.


      4
        Garza wasn’t really urging a speculative foray in foreign currency--he was
promoting a type of Son-of-BOSS tax shelter (which is a variant of the Bond and
Options Sales Strategy (BOSS) shelter) that uses European digital options on
foreign currency. Unlike an “American” option, which can be exercised at any
time before it expires, a “European” option can be exercised only at a particular
date and time. An option is “digital” if it has the same payout no matter how far in
the money it is. Digital options are also known as “all-or-nothing” options. See
Markell Co. v. Commissioner, T.C. Memo. 2014-86, at *4 n.5.
                                         -8-

[*8] Brubaker also suggested that Garza speak with another lawyer rumored to

have done a $100 million transaction for a local billionaire who “seemed to know

what he was doing,” to learn more. Garza followed Brubaker’s recommendation

and paid the lawyer $50,000 for a dark-side CLE on the finer points of the deal.

Included in the bargain was a turnkey opinion letter--one that Garza could use in

his own practice. Part of Garza’s promotional pitch was that if a taxpayer had a

“good” tax opinion letter, he would not have to pay any penalties even if the tax

benefits were disallowed.

      Once Garza had his turnkey opinion letter and knew the transaction well

enough, he began pitching. The purpose of all Son-of-BOSS tax shelters is to

create “artificial tax losses designed to offset income from other transactions.”

Kornman & Assocs., Inc. v. United States, 527 F.3d 443, 446 n.2 (5th Cir. 2008).

Garza’s scheme involved a partnership to which his clients would transfer assets

and liabilities. As a matter of economics, the liabilities would offset the value of

the assets, but those liabilities wouldn’t be completely fixed at the time of transfer,

and the purported partners would ignore them in calculating their outside bases in

that partnership. The partnership would also ignore the liabilities in computing its
                                          -9-

[*9] inside bases in the contributed property.5 Ignoring the liabilities in

calculating basis creates an inflated basis. When the purported partners liquidated

their partnership interests, they would get a distribution of property to which they

would attach this high basis in the partnership. And then when they sold that

property, it would produce large tax--but not out-of-pocket--losses. See, e.g.,

Markell Co. v. Commissioner, T.C. Memo. 2014-86, at *12, *31 n.17.

      Garza used a six-step deal:

•     buy a foreign-currency call option (and sell an offsetting foreign-currency
      call option in the same currency to the same counterparty)6 and also
      Canadian dollars through a single-member LLC;

•     form a partnership with a third party or wholly owned LLC;

•     contribute the foreign-currency options and Canadian dollars to the
      partnership;



      5
        Inside basis is the basis a partnership has in its own assets, sec. 723;
outside basis is the basis a partner has in his partnership interest, sec. 722; sec.
1.722-1, Example (1), Income Tax Regs.
      6
        We refer elsewhere in this opinion to such options as “long options” and
“short options.” “Long” can mean several things in finance-speak; here, it simply
means to buy and hold a position. “Short” likewise has multiple meanings: Here,
it means to sell a position. Because the long and short legs in the option
transactions involved the same parties, the same periods, and the same
counterparties, they economically zeroed each other out except for the narrow
spread between the two strike prices: One party could buy the yen at $X from the
second party, and the second party could turn around and buy the yen at $X minus
the spread from the first party.
                                       - 10 -

[*10] •      recognize a gain or loss by the partnership when the options expired
             or were exercised;

•     terminate and liquidate the partnership; and

•     sell the Canadian dollars that the single-member LLC received from the
      partnership’s liquidation.

Garza credibly testified to having sold over a dozen of these types of transactions

to different taxpayers.

      Garza says he would always have his clients choose which currency to use

but would make strong recommendations. He would also insist that each of his

clients talk with Brubaker. Brubaker would explain what trades would be made,

answer other questions, and help the client set up Deutsche Bank accounts. If the

client asked Garza what he thought, he would say something encouraging like “I

think the yen is going downhill” and proceed from there. We also note especially

that Garza never negotiated any of the investment details for his clients. He let

Brubaker and Deutsche Bank value the options.

      B.     Garza Spreads to New Orleans

      Heitmeier was happy about his windfall, but worried about the possible tax

bill. He was especially worried that the tax due would be at “regular” (i.e.,

ordinary) rates, so he called his tax adviser, Walter Jones. Heitmeier and Jones

went way back--Heitmeier’s longtime CPA, Hank LeVierre, was Jones’ former
                                       - 11 -

[*11] business partner, and Heitmeier and Jones had grown up together, their

fathers had grown up together, and Heitmeier’s brother had even dated Jones’

sister. When LeVierre retired, Jones took over Heitmeier’s accounting and

prepared the returns for Heitmeier’s three businesses. Jones wasn’t involved in

the day-to-day operations, but a week after Heitmeier told him about the sale

proceeds, Jones proposed he meet with a colleague, Ellis Roussel, to discuss

“something different, something going on right now.” Roussel worked for the

firm LeGlue & Company CPAs, which had its offices in the same building as

Jones’ in New Orleans, and Jones often handed off bigger jobs to them.

      Roussel first learned about the Son-of-BOSS deal in September 2001 from

one Edward Turner, a Texas CPA who did peer reviews of LeGlue & Company’s

work.7 Turner didn’t go into great detail with Roussel at that point, but just gave

Roussel a brief description of the deal and said he’d done it with good results in


      7
        To be a member of the American Institute of CPAs (AICPA), public
accounting firms must be enrolled in a practice-monitoring (or “peer review”)
program. The AICPA requires accounting firms to have an independent evaluator
review their accounting and auditing practices generally every three years. See
American Institute of Certified Public Accountants, Inc., 2013 Peer Review
Program Manual: AICPA Standards for Performing and Reporting on Peer
Reviews sec. 1000(.01)-(.03) (2013), available at
http://www.aicpa.org/Research/Standards/PeerReview/DownloadableDocuments/2
013MarPeerReviewStandards.pdf
                                       - 12 -

[*12] the past. Once Jones got wind of the deal, and told Roussel he had someone

who might be interested, Heitmeier met with the two of them to discuss the

opportunity. During the meeting, Heitmeier didn’t understand the details of the

contemplated transaction, but he was certainly intrigued by the potential for tax

benefits. He later contacted Roussel to say he wanted to move forward.

      C. Heitmeier Meets Garza

      At some point Roussel contacted Turner again, and Turner sent him an

opinion letter written by Jenkens & Gilchrist for another client who had done a

Son-of-BOSS deal and then put him in touch with Garza. Heitmeier first spoke

with Garza in a conference call with Roussel and Garza. During the call Garza

described each step of the deal. A few weeks later he came to New Orleans to eat

étouffée and pitch Heitmeier at the LeGlue offices. At this meeting, Garza

provided Heitmeier with written materials that outlined the deal. Garza “[s]poke a

lot in generalities, [and] went through some items pretty fast.” Roussel was

getting more comfortable with the deal’s mechanics but still “certainly didn’t have

a total grasp on it.” But Heitmeier’s big takeaway from this meeting was that the

transaction might double his initial outlay of $40,000 if the Japanese yen moved

one way, and in any event would gain for him a “significant write-off” for tax

purposes.
                                       - 13 -

[*13] Around the same time he was learning about the deal from Garza, Roussel

also pulled in other people to do some independent research. Vince Giardina,

another LeGlue partner, researched the tax aspects of the deal. Roussel also called

Brian Leftwich, a New Orleans tax attorney who often acted as counsel for

LeGlue. The more they learned, the more they fretted. Roussel, Giardina, and

Leftwich were all concerned about the deal’s lack of profit motive and gossamer

economic substance. Roussel refused to make any recommendation regarding

whether Heitmeier should participate in the transaction, and told Heitmeier,

“Listen, we can’t give you an opinion that you can do it; we can’t--* * * there’s

some indications, you know, that may raise some questions.” Giardina also

refused to bless the arrangement and alerted Heitmeier that he might be exposed to

an audit if he chose to proceed. And Leftwich ultimately decided that he didn’t

feel comfortable giving an opinion either way--he wasn’t well-versed in foreign-

currency options. Despite these warning signs, in late October 2001, Heitmeier

decided to follow Garza and go forward with the Son-of-BOSS transaction.

      D.     The Deal That Was Done

      Garza charged Heitmeier a flat fee of $135,000 for his services. The bill

that Garza sent to Heitmeier was entitled “Statement for Services Rendered,” and
                                           - 14 -

[*14] said it covered “all services to be rendered in connection with your digital

option transaction and the related legal opinion,” including:

       •       formation of LLC disregarded entity;

       •       formation of limited partnership;

       •       negotiations with investment bank and review of transactions;

       •       legal opinion letter; and

       •       tax return preparation and review.8

       It also said that the $135,000 would cover “any and all services necessary in

the event that either you or the above entities are selected for an audit by the IRS

in the future.” This meant that Garza would cover their legal fees if the

transaction blew up.

       Garza required Heitmeier to pay the first installment of $67,500 upon

receipt of his “Statement for Services Rendered,” and the remaining $67,500 when

he delivered his legal opinion. Heitmeier paid the first installment on October 30,

2001 from a Hibernia Bank account opened in the name of Riverboat Services,

Inc.

       Heitmeier knew that the entities were created to capture the tax benefits of

the digital option/Japanese yen transaction, and that the transaction had to be

       8
           Garza would occasionally review returns, but he did not prepare them.
                                        - 15 -

[*15] completed by 2001 for him to capture the tax benefits. He relied entirely on

Garza to prepare the paperwork and file the necessary documents with the

different state authorities, and didn’t bother to obtain any investment or financial

advice about the transaction from his investment broker at the time. Garza moved

quickly. He set up in Colorado and Georgia because those states processed filings

quickly and cheaply. He named the entities with numbers because he wanted to

avoid any snags that might have slowed the deal if someone else had an LLC or

partnership with the same name. And Garza didn’t draft any of the entity

agreements from scratch, but adapted them from the sample he already had. The

documents Heitmeier actually signed, he signed without reading. Other

documents were signed on his behalf as Robert Heitmeier PA, even though

Heitmeier had not designated or authorized anyone to act on his behalf.

      Garza launched the Heitmeier transaction on October 29, 2001 and things

took off:


      !      From October 29 to 30, 2001, Garza helped Heitmeier form three
             entities: 8252, LLC, 94 LLC, and 436, Ltd.
                                      - 16 -

[*16]        "     8252 is a disregarded entity for federal tax purposes, was
                   formed under Georgia law, and Heitmeier is listed as its sole
                   member.9

             "     94 was formed as a Colorado limited liability company,
                   Heitmeier was its sole member, and it never made an election
                   on Form 8832 to be classified as an association for federal tax
                   purposes.

             "     436 was formed as a Colorado limited partnership, and on its
                   2001 return it listed Heitmeier as a 99% limited partner, and 94
                   as a general partner with a 1% limited-partnership interest.

        !    On October 29, 2001, Heitmeier set up three accounts with Deutsche
             Bank--one for Riverboat Services, one for 8252, and one for 436.

        !    On October 30, 2001, Heitmeier had Riverboat Services send $45,000
             to 8252’s Deutsche Bank account. This was the only capital
             contribution made to 8252.

        !    On October 30, 2001, Heitmeier also had Riverboat Services send
             $67,500 to Garza’s account at Bank One--half his total fee.

        !    On November 1, 2001, 8252 bought and sold offsetting long and
             short foreign-currency options on Japanese yen from Deutsche Bank
             for a $40,000 net premium.10 Both options expired on December 12,
             2001.


        9
        A U.S. business entity with only one member is either a corporation or a
“disregarded entity.” (When an entity is “disregarded”, it means that its owner is
treated under the Code as a sole proprietor. Sec. 301.7701-2(a), Proced. & Admin.
Regs.) If it doesn’t want to be disregarded, Form 8832, Entity Classification
Election, allows the entity to elect to be taxed as a corporation. Sec. 301.7701-
3(b)(1)(ii), (c)(1)(i), Proced. & Admin. Regs.
        10
        The premiums on the long and short positions were $4 million and
$3,960,000, respectively.
                                   - 17 -

[*17] !   On December 3, 2001, 8252 transferred both the long and short
          options to 436 in exchange for $10 “and other good and valuable
          consideration.”

     !    On December 4, 2001, 8252 paid $4,000 to buy Can $6,207.20.

     !    On December 10, 2001, the options were in the money with only two
          days left before their expiration. Heitmeier accepted Deutsche
          Bank’s offer to cash him out for $50,000, which he deposited into the
          Deutsche Bank account for 436.

     !    On or about December 24, 2001, 8252 transferred the Can $6,207.20
          to 436.

     !    On December 19, 2001, Heitmeier asked Deutsche Bank to transfer
          $50,000 from 436’s account to an account for Garza & Staples--the
          second half of Garza’s legal fees. Garza asked that the remaining
          $17,500 be wired to the account of Garza & Staples with Bank One,
          Texas.

     !    On December 26, 2001, Heitmeier assigned the Canadian dollars held
          by 436 to 8252. According to 436’s and 8252’s Deutsche Bank
          account statements, however, that assignment was never
          consummated.

     !    On January 4, 2002, 436 transferred the same Can $6,207.82 to
          Riverboat Services.

     !    On December 31, 2001, Riverboat Services sold Can $6,207.82 for
          $3,848.40, which was deposited into Riverboat Services’ Deutsche
          Bank account.

     !    On December 31, 2001, a Cancellation of Domestic Certificate of
          Limited Partnership was filed in Colorado for 436.
                                       - 18 -

[*18] The parties stipulated that 8252, 94, and 436 didn’t conduct any activities

other than these foreign-currency trades. For both 94 and 436, Heitmeier provided

a business address in Colorado Springs, Colorado, even though he had no

connection with Colorado. The partnership agreement for 436 was a pro forma

agreement that Garza used. Garza testified that it contained several incorrect

statements, such as a reference to a prior partnership agreement, an arbitrary

termination date, and activities that the partnership would engage in (e.g., farming

and ranching, buying and leasing oil, and purchasing and selling machinery).

       As we’ve already noted, Heitmeier had by this time amassed a sizable

Merrill Lynch brokerage account--about $1 million. But before November 2001

Heitmeier had never invested in foreign currency. His investment adviser, Lance

Giambelluca, credibly said that Heitmeier had invested mostly in tech stocks and

been burned by the stock market crash of early 2000. Heitmeier had at one time

discussed another derivatives product called a “covered call” with Giambelluca,

but he never bought in.

III.   Reporting the Transactions

       A.    Garza’s Opinion

       Garza sent an opinion letter to Heitmeier dated December 30, 2001. The

letter had about four pages of facts supposedly describing the transaction and over
                                        - 19 -

[*19] 80 pages of boilerplate language on tax-law doctrines--running the gamut

from partnership-basis rules to treatment of foreign-currency contracts, the step-

transaction doctrine, economic substance, disguised-sale provisions, and

partnership anti-abuse regulations. The letter also concluded that the tax treatment

Garza proposed would “more likely than not” withstand IRS scrutiny.

      Garza, however, relied on certain “facts” to reach his “more likely than not”

conclusion, and these “facts” were just plain wrong. Here are some of the key

mistakes he made in the factual recitation section--the first four pages of each

opinion:

      •      The opinion states that Heitmeier’s transaction involved options on
             Canadian dollars, even though the options were on Japanese yen.

      •      The opinion states that Heitmeier made the listed representations, but
             he didn’t. Garza made up the representations on his own.

      •      The opinion letter states that Heitmeier “believed there was [a]
             reasonable opportunity to earn a reasonable pre-tax profit from the
             transactions * * * (not including any tax benefits that may occur), in
             excess of all the associated fees and costs.” But Garza’s $135,000 fee
             was ignored in reaching that conclusion. The opinion doesn’t
             mention Garza’s fee at all.

      And here are some of the key factual mistakes made in the opinion letter’s

discussion section, on which Garza based key legal conclusions:

      •      The purchased (long) and sold (short) options had their own
             confirmations.
                                        - 20 -

[*20]         •     The long and short options were the subject of the same
                    confirmation.

        •     The partnership had to deliver foreign currency if the short option
              was exercised.

              •     The partnership had no obligation to deliver foreign currency.

        •     As of the date of the opinion, the options had not yet expired--so it
              was uncertain whether the partnership would have to satisfy its
              obligation regarding the short option.

              •     When Garza sent out the opinion letters, the obligations under
                    the option contracts were by that time certain.

        •     None of the partnerships’ (i.e., 436’s, 94’s, and 8252’s) partners were
              related.

              •     The partners of each partnership were related--Heitmeier was
                    the 99% limited partner, and his wholly owned and controlled
                    94 was the 1% general partner.

        •     The assets contributed by a partner (Heitmeier) would not be the same
              assets distributed to that partner.

              •     The Canadian dollars distributed were the same ones
                    contributed by the partner.

        If Garza was making up facts for his opinion letter, Heitmeier wouldn’t have

noticed because he never reviewed the facts in the opinion for accuracy, or even

asked for any clarification. Garza credibly testified that he had several

conversations with Heitmeier and Roussel but that they never brought up--let

alone asked him to correct--any mistakes in the opinion. The letter, for all its
                                       - 21 -

[*21] length, also lacks even a mention of one very important document--Notice

2000-44, Tax Avoidance Using Artificially High Basis, 2000-2 C.B. 255, which

the Commissioner published on September 5, 2000--even though Garza knew

about it when he provided the legal opinion to Heitmeier.

      B.     What Was Reported

      Jones prepared the 2001 return for Riverboat Services, Inc., an S

corporation,11 by filing Form 1120S, U.S. Income Tax Return for an S

Corporation. Riverboat Services claimed a “section 988 Currency Loss” of nearly

$4 million. The claimed loss then passed through to the Heitmeiers’ 2001 joint

return, which Jones also prepared, and substantially offset the $4.7 million in

income passed through from Riverboat Services to the Heitmeiers.

      Giardina prepared 436’s partnership return for Heitmeier to sign. The

partnership reported no income or loss for 2001. On its partnership return for the

year 436 reported partner capital contributions of $4,187,593, consisting of the $4

million notional amount of the long option; plus $3,990 for the purchase of the

Canadian dollars; $50,000 capital contribution; $85,000 in attorney’s fees; and

about $49,000 in accounting fees. While 436 treated the notional amount of the

      11
         An S corporation is a corporation governed under the laws of subchapter
S of the Internal Revenue Code. C corporations are governed by subchapter C,
and partnerships by subchapter K.
                                         - 22 -

[*22] $4 million long-option premium as a capital contribution, it did not report

the liability inherent in the notional $3,960,000 short-option premium. The

partnership return also reported offsetting partnership distributions of property

other than money of $4,187,593, which resulted from treating the notional amount

of the $4 million long-option premium as a contribution that would be distributed

upon the liquidation of 436. It did not, however, take into consideration the

liability inherent in the $3,960,000 short-option premium. Both the capital

contributions and partnership distributions were allocated $4,145,717 to Heitmeier

and $41,876 to 94 LLC on the Schedules K-1.

      But remember that by this time the options had long since been cashed out,

so the supposed basis in the long option can theoretically be attached to the only

noncash (i.e., non-American cash) asset 436 had left--the Can $6,207.82. By

reporting this $4,187,593 as a “distribution of property,” Giardina was effectively

reporting it as 436’s basis in that property.

IV.   Prelude

      The Commissioner audited 436’s return under TEFRA and issued a notice

of final partnership administrative adjustment (FPAA) to 436 in September 2005.12

      12
      TEFRA is the Tax Equity and Fiscal Responsibility Act of 1982
(TEFRA), Pub. L. No. 97-248, 96 Stat. 324, one part of which governs the tax
                                                                   (continued...)
                                        - 23 -

[*23] The FPAA adjusted 436’s capital contributions and distributions to zero and

determined accuracy-related penalties under section 6662.

      The FPAA Schedule of Adjustments did not adjust Heitmeier’s or 94’s

outside bases, but in the “Exhibit A-Explanation of Items” sent to 436, the

Commissioner did make determinations about outside basis, including the

determination that the partners have not “established that the bases of the partners’

partnership interests were greater than zero.” This may or may not have been

sufficient to put outside basis at issue here, cf. Clovis I v. Commissioner, 88 T.C.

980, 982 (1987), but the Commissioner later conceded that the FPAA did not

adjust outside basis. Unlike a concession on a point of law regarding whether we

      12
         (...continued)
treatment and audit procedures for most partnerships. See TEFRA secs. 401-406,
96 Stat. at 648-670. TEFRA partnerships are subject to special tax and audit rules.
See secs. 6221-6234. Each TEFRA partnership, for example, is supposed to
designate a tax matters partner (TMP), to handle the partnership's administrative
issues with the IRS and any resulting litigation. TEFRA requires the uniform
treatment of all “partnership items”--a term defined by section 6231(a)(3) and (4)--
and its general goal is to have a single point of adjustment for the IRS rather than
having it make separate partnership item adjustments on each partner’s individual
return. See H. Conf. Rept. 97-760, at 599-601 (1982), 1982-2 C.B. 600, 662-63.
If the IRS decides to adjust any partnership items on a partnership return, it must
notify the individual partners of the adjustment by issuing an FPAA. Sec. 6223(a).
An FPAA generally includes: (1) a notice of final partnership administrative
adjustment, (2) Form 870-PT, Agreement for Partnership Items and Partnership
Level Determinations as to Penalties, Additions to Tax, and Additional Amounts,
including a Schedule of Adjustments, and (3) an “Exhibit A--Explanation of
Items,” listing the Commissioner’s other adjustments or determinations.
                                         - 24 -

[*24] have jurisdiction over outside basis at the partnership level, see Tigers Eye

Trading LLC v. Commissioner, 138 T.C. 67, 74 (2012), appeal filed (D.C. Cir.

Mar. 9, 2012), the Commissioner’s concession here simply notes that these

particular FPAAs were not adjusting outside basis and that he wasn’t seeking a

determination of outside basis in this partnership-level proceeding. While we are

always required to satisfy ourselves that we have jurisdiction before entering a

decision, see Gray v. Commissioner, 138 T.C. 295, 297 (2012), we don’t have to

reach out and put into play issues the parties don’t seek to adjudicate. In Tigers

Eye Trading we had to determine whether we had jurisdiction because the

taxpayer argued that we lacked it. But we agree with the Commissioner that

outside basis isn’t at issue here.

      Instead, like 6611, this case is about an inside-basis Son-of-BOSS deal--the

inflated basis was attached to an asset that the partnership held and then

distributed to a partner who sold it for a supposed loss.13 As in other Garza-

      13
          The usual rule is that an asset distributed by a partnership to one of its
partners has a basis equal to the partnership’s basis in that very asset. Sec. 732(a).
Inside-basis Son-of-BOSS deals claim to be able to transfer basis within the
partnership from one asset to another via section 732(b). See 7050, Ltd., T.C.
Memo. 2008-112. Under section 732(b), a partner takes a transferred basis in the
distributed property the same as his outside basis in the putative partnership
interest (minus any cash received). The parties here agree that the claimed tax
benefits come from the disposition of an asset formerly held by a putative
                                                                          (continued...)
                                         - 25 -

[*25] inspired transactions, see, e.g., 106 Ltd. v. Commissioner, 136 T.C. 67, 73

(2011), aff’d, 684 F.3d 84 (D.C. Cir. 2012); 6611, Ltd v. Commissioner, T.C.

Memo. 2013-49; 7050, Ltd. v. Commissioner, T.C. Memo. 2008-112, the inflated

basis lay in foreign currency (in those cases, Canadian dollars) and the aim is to

try to have those basis-bloated Canadian dollars distributed to a partner who can

then treat them as a reservoir of ordinary loss, dipped into as necessary by selling

them for a massive tax loss.

      One distinction between inside-basis and outside-basis Son-of-BOSS deals

is that there is a conflict among courts about whether outside basis is a partnership

item. See Petaluma FX Partners, LLC v. Commissioner, 591 F.3d 649, 654 (D.C.

Cir. 2010), aff’g in part, rev’g in part, vacating and remanding on penalty issues

131 T.C. 84 (2008); Tigers Eye Trading, 138 T.C. at 115-28. The Commissioner

usually wants a penalty in both types of cases, so whether an item is a “partnership

item” then affects whether a penalty “‘relates to an adjustment to a partnership

item.’” See United States v. Woods, 571 U.S. __, __, 134 S. Ct. 557, 563-64

(2013) (quoting section 6226(f)); Tigers Eye Trading, 138 T.C. at 139-42.




      13
        (...continued)
partnership, not the disposition of a partner’s interest in that partnership.
                                         - 26 -

[*26] We happily avoid those disputes here. The Commissioner does want

penalties in this case, and the FPAA Explanation of Items determined that

      [A]ll of the underpayments of tax resulting from [the] adjustments of
      partnership items are attributable to, at a minimum, (1) substantial
      understatements of income tax, (2) gross valuation misstatement(s),
      or (3) negligence or disregarded rules or regulations. * * * It is
      therefore determined that, at a minimum, the accuracy-related penalty
      under Section 6662(a) of the Internal Revenue Code applies to all
      underpayments of tax attributable to adjustments of partnership items
      of 436, LTD. [Emphasis added.]

The Explanation of Items went on to determine a 40% gross-valuation-

misstatement penalty or, barring that, a 20% substantial-valuation-misstatement

penalty. In the alternative, it asserted either a 20% penalty for negligence,

disregard of rules and regulations, or substantial understatement of income tax. In

response 436 raises only the defense that it had reasonable cause and acted in

good-faith reliance on professional advice.14 The Commissioner has reiterated that

he does not seek a penalty related to Heitmeier’s outside basis in the partnership;

he seeks it related to the inflated contributions to, and distributions from, the

partnership--a partnership’s basis in an asset is usually its basis in the hands of the

partner who’s contributing that asset, sec. 723, and the basis of an asset other than

      14
         They could have, but have not, argued that the imposition of penalties was
somehow otherwise defective. While we must satisfy ourselves about our own
jurisdiction, we deem 436 to have waived any other counterargument regarding
the imposition of penalties apart from reasonable cause and good faith.
                                        - 27 -

[*27] money (and that means American money) distributed to a partner is usually

the partnership’s basis in that asset, see sec. 732(a). There were plenty of other

issues, and Heitmeier, in his role as tax matters partner for 436, filed a timely

petition.15 We tried the case partly in Dallas, and then tried to take testimony from

one witness via video uplink.16

                                      OPINION

I.    Jurisdiction

      Partnerships do not pay income tax, but they do file information returns, and

partners are supposed to use the numbers from those returns on their own

individual returns. See secs. 701, 6031, 6222(a). While 436 was a partnership

subject to audit under TEFRA, our jurisdiction at the partnership level is limited

under TEFRA to

      partnership items of the partnership for the partnership taxable year
      to which the notice of final partnership administrative adjustment
      relates, the proper allocation of such items among the partners, and
      the applicability of any penalty, addition to tax, or additional amount
      which relates to an adjustment to a partnership item.



      15
        436 was a defunct TEFRA partnership when the petitions were filed, so
any appeal would likely head to the D.C. Circuit. See sec. 7482(b)(1).
      16
         The attempt to continue the trial by video didn’t work out, and the parties
stipulated what happened during this part of the trial.
                                        - 28 -

[*28] Sec. 6226(f) (emphasis added).

      So what are partnership items? Section 6231(a)(3) says that

      [t]he term “partnership item” means, with respect to a partnership,
      any item required to be taken into account for the partnership’s
      taxable year under any provision of subtitle A to the extent
      regulations prescribed by the Secretary provide that, for purposes of
      this subtitle, such item is more appropriately determined at the
      partnership level than at the partner level. [Emphasis added.]

The Secretary has told us what he’s determined to be partnership items in section

301.6231(a)(3)-1, Proced. & Admin. Regs. Courts still disagree over what is a

“partnership item”--a very big problem given TEFRA’s structural framework,

which makes the distinction between partnership and nonpartnership items

important to our jurisdiction.

      But once we hold an item is a partnership item we have jurisdiction to

determine that partnership item regardless of whether the Commissioner adjusted

it in the FPAA. See, e.g., Tigers Eye Trading, 138 T.C. at 95. We also have

jurisdiction to determine “the proper allocation of [these] * * * items among the

partners and the applicability of any penalty, addition to tax, or additional amount

that relates to an adjustment to a partnership item.” Id. This latter jurisdiction

isn’t unlimited, however, and we have recently gone to great pains to determine its
                                        - 29 -

[*29] boundaries. See, e.g., id. at 95-143; Petaluma FX Partners, LLC v.

Commissioner, T.C. Memo. 2012-142, 2012 WL 1758712.

      A “nonpartnership item” is “an item which is (or is treated as) not a

partnership item.” Sec. 6231(a)(4). And an “affected item” is a nonpartnership

item that is affected by the determination of a partnership item. See sec.

6231(a)(5); Ginsburg v. Commissioner, 127 T.C. 75, 79 (2006). As it does for

other nonpartnership items, the Code tells us that we can determine affected items

(with the exception of certain penalties) only at the individual level and not in a

partnership-level proceeding. Because this case is appealable to the D.C. Circuit,

we must follow that court’s precedent. See, e.g., Golsen v. Commissioner, 54 T.C.

742, 757 (1970), aff’d, 445 F.2d 985 (10th Cir. 1971).

II.   Partnership-Item Determinations and Adjustments17

      A.     Validity of the Partnerships

             1.    Unchecked Boxes

      One of the most important “partnership items” is whether a partnership is

actually a partnership at all. The Commissioner says that 436 isn’t a

partnership–that we should disregard it because it wasn’t an entity separate from

      17
        We are deciding this case on the preponderance of the evidence, so we do
not have to decide which party has the burden of proof. See, e.g., Estate of Turner
v. Commissioner, 138 T.C. 306, 309 (2012).
                                        - 30 -

[*30] Heitmeier and failed to satisfy the regulatory requirements to be treated as a

partnership. Under the check-the-box regulations, if it doesn’t make an election

otherwise, an entity with only one owner is disregarded for tax purposes, and if the

single owner is an individual, the regulations tell the Commissioner to treat the

entity as a sole proprietorship. See supra note 9; see also Pierre v. Commissioner,

133 T.C. 24, 42-43 (2009) (“A sole proprietorship is generally understood to have

no legal identity apart from the proprietor”). An entity with only one owner is

thus ineligible for tax treatment as a partnership.

      But 436’s 2001 partnership return lists more than one owner: Heitmeier is

the 99% limited partner and 94 is the 1% general partner. The Commissioner says

this doesn’t matter and argues that because 94 did not properly elect to be treated

as a corporation, it is a disregarded entity. See sec. 301.7701-3(b)(1)(ii), Proced.

& Admin. Regs. Since the parties stipulated that 94 never elected on Form 8832

to be classified as a corporation, we agree.18 That means that Heitmeier, as the

sole member of 94, will be treated as owning all of 436. And we disregard a


      18
         While individuals and entities may apply for an employer identification
number (EIN) using Form SS-4, Application for Employer Identification Number,
this form alone doesn’t make a valid election to be taxed as a specific type of
entity. For partnerships, only Form 8832 may be used to make an election. See
sec. 301.7701-3(c)(1), Proced. & Admin. Regs.; see also Form SS-4, at 3 (Rev.
Apr. 2000) (“Caution: This is not an election for a tax classification of an entity”).
                                        - 31 -

[*31] single-owner entity for tax purposes under sections 301.7701-2(a) and

301.7701-3(b)(1)(ii), Proced. & Admin. Regs., unless it elects to be taxed as a

corporation.

      Though these facts largely mimic those in 6611, they differ in one key way

that saves us a discussion of whether a partnership existed. Heitmeier has not

argued that his wife was the second owner of 94 and 436 because Louisiana is a

community-property state.19 This means we don’t need to trudge through

Louisiana’s Civil Code to determine whether Mrs. Heitmeier would have been

considered a second putative partner. But we do note it might have made a

difference in the analysis of one of the many factors we generally consider to

determine whether two individuals intended to join together as partners in the

conduct of a business.20 See Luna v. Commissioner, 42 T.C. 1067, 1077 (1964)


      19
          Although the regulation’s default rule for entities owned by an individual
is to treat them as sole proprietorships, its default rule for entities owned by more
than one individual is to treat them as partnerships. See sec. 301.7701-3(a) and
(b)(1)(i), Proced. & Admin. Regs.
      20
         In 6611, we walked through the Luna factors to determine whether the
taxpayers’ wives would have been considered second partners in the partnership.
Luna v. Commissioner, 42 T.C. 1067, 1077-78 (1964). Every factor except one
clearly pointed the same way. The sole factor that required further analysis was
“The Parties’ Control Over Income and Capital.” In 6611, Texas’s community-
property laws supported a proposition that “a spouse * * * [retains] sole
management, control, and disposition of the community property that the spouse
                                                                       (continued...)
                                       - 32 -

[*32] (citing Commissioner v. Culbertson, 337 U.S. 733 (1949)); see also Historic

Boardwalk Hall, LLC v. Commissioner, 694 F.3d 425 (3d Cir. 2012), rev’g and

remanding 136 T.C. 1 (2011); Southgate Master Fund, L.L.C. ex rel. Montgomery

Capital Advisors v. United States, 659 F.3d 466 (5th Cir. 2011).

             2.    Tax-Motivated Business Purpose

      There is a second and separate obstacle to any finding that 436 was a

partnership: A partnership does not come into existence for tax purposes until it

begins its business activities. See Torres v. Commissioner, 88 T.C. 702, 737

(1987); Markell Co. at *22. The caselaw is clear, however, that the pursuit of


      20
         (...continued)
would have owned if single,” see Tex. Fam. Code Ann. sec. 3.102(a) (West 2006),
and that the right as a formal partner to manage and control a partnership was not
itself community property, see Tex. Bus. Orgs. Code Ann. sec. 152.203(a) (West
2012). Quite the opposite is true here. Louisiana has a very strong presumption in
favor of community property, see La. Civ. Code Ann., and contains no statutes
analogous to Texas’. Louisiana’s Civil Code art. 2338 (2012) provides that
community property includes property acquired during the marriage through the
effort, skill, or industry of either spouse and the “natural and civil fruits” of
community property. There is law on the books to support the interpretation that
articles 2338 and 2340 include interests in joint ventures and partnerships as
community property. Brassett v. Brassett (In re Brassett), 332 B.R. 748 (Bankr.
M.D. La. 2005). Conceivably then, Mrs. Heitmeier could have had a community-
property interest in Mr. Heitmeier’s partnership shares and a right to a share of any
distribution of 436’s surplus profits or property. See also La. Civ. Code Ann. art.
2346 (2012) (explaining that each spouse acting alone may manage and control
community property). However, she would have failed every other factor in the
Luna test.
                                        - 33 -

[*33] business activity in furtherance of tax avoidance “is no more a business

purpose than actually engaging in tax avoidance.” ASA Investerings P’ship v.

Commissioner, 201 F.3d 505, 513 n.6 (D.C. Cir. 2000), aff’g T.C. Memo. 1998-

305. The “absence of a nontax business purpose is fatal.” Id. at 512; see also

Boca Investerings P’ship v. United States, 314 F.3d 625, 632 (D.C. Cir. 2003).

We therefore must ask specifically if the “parties intended to join together as

partners to conduct business activity for a purpose other than tax avoidance.”

ASA Investerings, 201 F.3d at 513 (emphasis added).

      The 436 partnership agreement says that its primary purpose is “to make a

[p]rofit, increase wealth, and provide a means for each [p]artner’s [f]amily to

become knowledgeable of, manage, and preserve [f]amily [a]ssets.” Even if we

believe what the partnership agreement says (which we don’t), courts have been

reluctant to find that managing and preserving family assets is a legitimate and

significant nontax reason for establishing a partnership where the property doesn’t

require active management. See, e.g., Estate of Bigelow v. Commissioner, 503

F.3d 955, 972-73 (9th Cir. 2007) (property contributed consisted of a house that

was rented to a tenant), aff’g T.C. Memo. 2005-65; Estate of Rosen v.

Commissioner, T.C. Memo. 2006-115, 2006 WL 1517618, at *7 (assets

contributed consisted primarily of stocks, bonds, and cash, conducted no business
                                         - 34 -

[*34] activity and had no business purpose for its existence). Managing family

assets just doesn’t justify the existence of any entity that doesn’t actively manage

any property or carry on any business.

      As in Markell, the record here shows exactly why 436 was formed. It was

created shortly before Heitmeier purchased and contributed the options on yen and

Canadian dollars to 436. The partnership didn’t hold those assets for long--less

than a month--before it liquidated and distributed all of the remaining property to

Heitmeier. Garza’s plan predetermined the mayfly-like life of 436 from its

hatching to its dispatching. And we also find there wasn’t a nontax need to form

the partnerships to take advantage of any purported potential profits of investing

in digital options and Canadian dollars. Therefore, we find that the only purpose

for 436 was to carry out a tax-avoidance scheme. And we find Heitmeier never

intended to run businesses under the umbrella of 436. We disregard 436 for tax

purposes for this reason too.

             3.    Consequences of Disregarding 436

      When we disregard a partnership for tax purposes, we are holding that the

rules of subchapter K of chapter 1 of the Code (the substantive law governing the

income taxation of partners) no longer apply, and that we will deem the

partnership’s activities to be engaged in by one or more of its purported partners.
                                        - 35 -

[*35] See id. at *34-*35. A disregarded partnership has no identity separate from

its owners, and we treat it as just an agent or nominee. See, e.g., Tigers Eye

Trading, 138 T.C. at 94, 96 n.32, 99. But disregarding the partnership doesn’t

necessarily mean that the taxpayer’s investment and all items reported by the

disregarded partnership are permanently reduced to zero. Although we don’t

respect the form, we still need to deal with the substance of the transactions to the

extent we have jurisdiction. See, e.g., ACM P’ship v. Commissioner, 157 F.3d

231, 262-63 (3d Cir. 1998) (allowing deductions for securities that had “objective

economic consequences apart from tax benefits * * * even when incurred in the

context of a broader transaction that constitute[d] an economic sham” (citations

omitted)), aff’g in part, rev’g in part T.C. Memo. 1997-115; Tigers Eye Trading,

138 T.C. at 108-09 (stating we have jurisdiction under TEFRA to determine basis

of property allegedly contributed to a purported partnership, even if the

partnership never existed).

      The Code tells us that TEFRA procedures will still apply in these cases as

long as the purported partnership filed a partnership return--which 436 did for

2001.21 See secs. 6231(g), 6233; see also sec. 301.6233-1(b), Proced. & Admin.

      21
        TEFRA applies generally to any partnership, but there is an exception for
“small partnerships”--meaning those having 10 or fewer partners. Sec.
                                                                     (continued...)
                                        - 36 -

[*36] Regs. This means that we have to determine any items that would have been

“partnership items,” as defined in section 6231(a)(3), and section 301.6231(a)(3)-

1, Proced. & Admin. Regs., had 436 been a valid partnership for tax purposes.

Tigers Eye Trading, 138 T.C. at 97. This is the “hypothetical entity” approach.

See id. at 148-49 (Halpern, J., concurring). We now turn to the FPAA and the

pleadings to decide which items are still in play for us to decide.

      B.     Capital Contributions and Distributions of Property

      The Commissioner adjusted 436’s reported capital contributions and

distributions of property. Given that subchapter K doesn’t apply to a simple

agency relationship, there can be no contributions to or distributions from a

partnership that does not exist. See id. at 107. The property is effectively treated

as if it hadn’t been contributed to or distributed from the purported partnership,

and setting “Capital Contributions” and “Distributions of Property other than

Money” to zero is appropriate. But that doesn’t mean the underlying property has

no substantive value. Since the basis (i.e. inside basis) of the allegedly contributed

      21
        (...continued)
6231(a)(1)(B). This exception doesn’t apply if any partner is a “pass-through
partner.” Sec. 301.6231(a)(1)-1(a)(2), Proced. & Admin. Regs. A “pass-through
partner” includes a “partnership, estate, trust, S corporation, nominee, or other
similar person.” Sec. 6231(a)(9). The Commissioner has determined this includes
disregarded entities, see Rev. Rul. 2004-88, 2004-2 C.B. 165, and we agree. Since
436 had a single-member LLC as a partner, TEFRA procedures apply here.
                                       - 37 -

[*37] option contracts and Canadian money would both have been partnership

items if the partnership was respected, we have jurisdiction to determine them in

this partnership-level proceeding.

      With regard to the option contracts, we echo our holding in Markell:

Heitmeier should have treated the foreign-currency options as a single option

spread--meaning the long and short positions were part of one contract and

couldn’t have been separated as a matter of fact and law.22 See Markell, T.C.M.

      22
          The option legs were acquired on the same date, executed with the same
counterparty, in the same foreign currency, contingent on identical facts, listed on
a single transaction confirmation, and exercisable on the same date. The parties
simply placed bets on one fact: the price movement of the yen over a stated price.
Heitmeier paid a single net premium of $40,000 for the spread--the difference
between the long and short positions. And the experts in these cases credibly
testified that Deutsche Bank would not have entered into the options unless they
were treated as linked. If the options were separable, Deutsche Bank’s risk would
be too great: Heitmeier lacked the financial capacity to pay the premium on the
long option, and lacked the financial capacity to pay the bank the millions of
dollars that would have been due if the short option, standing alone, expired in the
money.

      In Helmer v. Commissioner, T.C. Memo. 1975-160, 1975 WL 2787, the
taxpayers beneficially owned real property that was subject to an option. Title to
the optioned property was held by an escrow agent, and the partnership which
granted the option received yearly option premium payments from the option
holder, and listed those amounts as distributions to the taxpayers on the
partnership’s books and tax returns. The taxpayers argued that the option
payments were for a contingent liability because the option was still outstanding.
But we held that there was no contingent liability because the transaction
underlying the option was still open, and the option premiums were not subject to
                                                                       (continued...)
                                         - 38 -

[*38] 2014-86 at *35; cf. sec. 1092 (“straddle” rules). The long option that 8252

purchased as Heitmeier’s nominee entitled 8252 to receive $8 million from

Deutsche Bank if the long option was in the money when it expired. But it

would’ve been required to pay an almost equal amount to Deutsche Bank if the

short option was also in the money on that day--$7,920,000.

       The appropriate basis in the option pair is simply what 8252 paid for it. See

sec. 1012(a). That’s $40,000. The appropriate basis in the Canadian money is

likewise just what 8252 paid for it as Heitmeier’s nominee and agent--$4,000.

III.   Penalties

       All that is left is the penalties. We have jurisdiction over penalties at the

partnership level because they “relate to” partnership-level adjustments: We can

adjust the amounts of partnership contributions and distributions in light of our

determination that the partnership doesn’t exist. See Woods, 571 U.S. __, 134 S.

Ct. at 564 (discussing the “inherently provisional” jurisdiction of district courts in

determining penalties).

       The Commissioner meets any burden of production he may have on the

penalty with simple arithmetic. See, e.g., Palmer Ranch Holdings Ltd. v.

       22
        (...continued)
forfeiture. Unlike the taxpayers in Helmer, Heitmeier lacked the financial capacity
to close the option transactions, which makes Helmer readily distinguishable.
                                       - 39 -

[*39] Commissioner, T.C. Memo. 2014-79 at *43-*44. A gross-valuation

misstatement exists if the value or adjusted basis of any property claimed on the

partnership return is 400% or more of the correct amount. See sec. 6662(e)(1)(A),

(h)(2)(A). The adjusted basis or value 436 reported for Canadian dollars

(described opaquely as a distribution of property) was well over 10,000% of the

correct value. Any underpayment of tax attributable to that gross-valuation

misstatement is subject to a 40% penalty. See sec. 6662(h)(1).

      The only issue left in dispute is whether 436 had section 6664

reasonable-cause-and-good-faith defenses for the gross-valuation misstatement

penalty. We have held that a partnership can raise this defense to that penalty at

the partnership level, see 106 Ltd., 136 T.C. at 76-77, and 436 does here.

      The gross-valuation-misstatement penalty can be rebutted by a showing of

reasonable cause and good faith, sec. 6664(c), and a taxpayer will often argue that

he had reasonable cause and showed good faith by relying on professional advice.

The regulation somewhat unhelpfully states that reliance on professional advice is

“reasonable cause and good faith if, under all the circumstances, such reliance was

reasonable and the taxpayer acted in good faith.” Sec. 1.6664-4(b)(1), Income Tax

Regs. The caselaw lists three factors. Neonatology Assocs., P.A. v.

Commissioner, 115 T.C. 43, 99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002).
                                        - 40 -

[*40] •      First, was the adviser a competent professional who had sufficient
             expertise to justify reliance?

      •      Second, did the taxpayer provide necessary and accurate information
             to the adviser?

      •      Third, did the taxpayer actually rely in good faith on the adviser’s
             judgment?

      Heitmeier--acting in his capacity as TMP and general manager of his

partnership--claims reasonable reliance on the professional opinions of Jones,

Roussel, Giardina, and Garza.

      A.     Garza’s Expertise

      Garza was licensed and would have appeared competent even to a lawyer at

the time the partnerships prepared their returns--at least to lawyers not versed in

tax law.

      B.     Provision of Necessary and Accurate Information

      We also find that the partnership provided Garza with all the relevant

financial data needed to assess the correct level of income tax. See sec.

1.6664-4(c)(1)(i), Income Tax Regs. Garza in fact generated most of that

information and certainly had it all available.
                                         - 41 -

[*41] C.     Actual Reliance in Good Faith

      It’s the third point--the issue of Heitmeier’s actual good-faith reliance on

Garza’s professional advice--that’s the major weakness in the partnership’s

defenses: The partnership can’t rely on Garza if he was a promoter because

promoters take the good-faith out of good-faith reliance. See, e.g., 106 Ltd., 684

F.3d at 90-91; Neonatology Assocs., 115 T.C. at 98. In 106 Ltd. (another Garza

case), we defined a promoter as “‘an adviser who participated in structuring the

transaction or is otherwise related to, has an interest in, or profits from the

transaction.’” 106, Ltd., 136 T.C. at 79 (quoting Tigers Eye Trading, LLC v.

Commissioner, T.C. Memo. 2009-121, 2009 WL 1475159, at *19).

      We also decided in 106 Ltd. that we would apply this definition “when the

transaction involved is the same tax shelter offered to numerous parties.” See id.

at 80. Based on the records in all these cases, we find again, as we did in 106 Ltd.,

that Garza not only participated in structuring the transaction but also arranged the

entire deal. It was he who set up the LLCs, provided a copy of the opinion letter,

and coordinated the deal from start to finish. And he testified that he profited from

selling the transaction to numerous clients--not just Heitmeier, but over a dozen

others as well. Heitmeier knew this. Garza charged him a flat fee for

implementing it and wouldn’t have been compensated at all if he had decided not
                                        - 42 -

[*42] to go through with it. He wasn’t being paid to evaluate the deal or tweak a

real business deal to increase its tax advantages; he was being paid to make it

happen.

      This makes him a promoter. And Heitmeier could not have reasonably

relied on his opinion.

      Heitmeier’s lack of good faith and reasonable reliance is even more obvious

when we turn to the other three professionals involved: Jones, Roussel, and

Giardina. All three refused to endorse the proposed Garza transaction or provide

any encouragement to Heitmeier other than advising him how to report it on his

tax returns. Jones made clear at the outset that the Son-of-BOSS transaction was

“out of his realm” and that he had no interest in even trying to understand it.

Roussel and Giardina spent months trying to decide if they could endorse the

transaction, and ultimately they didn’t. Heitmeier could not have reasonably relied

on Roussel’s or Giardina’s opinions in moving forward with the transaction,

because the only opinions Roussel and Giardina provided were warnings that this

was the type of transaction the IRS would likely go after. And their clearly
                                       - 43 -

[*43] expressed reluctance to endorse the deal to their longtime client only blows

another hole in Heitmeier’s supposed good faith in relying on Garza.


                                                An appropriate decision will be

                                      entered.
