Tax Court: No section 6662 penalty in sham transaction case

No section 6662 penalty in "sham transaction" case

The U.S. Tax Court today issued an opinion finding, in part, that no section 6662 penalty applied because the individual tax matters partner had relied “reasonably and in good faith” on independent professional advice.

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The case is: CNT Investors, LLC v. Commissioner, 144 T.C. No. 11 (March 23, 2015). Read the Tax Court’s 119-page opinion [PDF 416 KB]


Individual taxpayers owned appreciated real estate (funeral homes) through an S corporation and, in 1999, engaged in “Son-of-BOSS transactions” in an attempt to create outside basis in a purposed partnership to which the S corporation contributed appreciated real estate. After a series of transactions, the individuals were left holding the real estate through the partnership, with no one reporting recognition of the real estate’s built-in gain.

The IRS determined that the partnership was a sham, and made corresponding adjustments. The IRS also determined a penalty applied under section 6662.

In this proceeding, the taxpayer / tax matters partner conceded that the partnership and transaction were shams, having no business purpose. The taxpayer, however, challenged the timeliness of the FPAA and the penalty assessment.

Tax Court

The Tax Court today found that the period of assessment was open for the individual taxpayers when the IRS issued the FPAA.

The Tax Court further concluded that while the gross valuation misstatement penalty would otherwise apply in this case, the individual tax matters partner had demonstrated reasonable cause and good faith in relying on professional advice of an attorney (who had represented the business for over 30 years) and an accountant, neither of whom held himself out as having sufficient expertise to understand the transaction at issue. Specifically, the Tax Court set out the elements for reasonable reliance and good faith:

  • The adviser was a competent professional who had sufficient expertise to justify reliance.
  • The taxpayer provided necessary and accurate information to the adviser.
  • The taxpayer actually relied in good faith on the adviser’s judgment.

Finding that all three elements were satisfied in this case, the court did not uphold the penalty assessment.

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