Vaughn v. U.S. Internal Revenue Serv. (In re Vaughn)

• Decision Date: 26 August 2014
• Docket Number: No. 13–1189.,13–1189.
• Parties: In re James Charles VAUGHN, Debtor. James Charles Vaughn, Appellant, v. United States of America Internal Revenue Service, Appellee.
• Court: U.S. Court of Appeals — Tenth Circuit

765 F.3d 1174

In re James Charles VAUGHN, Debtor.

James Charles Vaughn, Appellant,

v.United States of America Internal Revenue Service, Appellee.

No. 13–1189.

United States Court of Appeals,Tenth Circuit.

Aug. 26, 2014.

Joseph J. Mellon of The Mellon Law Firm, Denver, CO, for Appellant.

Rachel I. Wollitzer, Attorney, Tax Division (John F. Walsh, United States Attorney, of Counsel; Kathryn Keneally, Assistant Attorney General; and Bruce R. Ellisen, Attorney, Tax Division, with her on the brief), Department of Justice, Washington, D.C., for Appellee.

Before TYMKOVICH, McKAY, and MATHESON, Circuit Judges.

McKAY, Circuit Judge.

This appeal arises from an adversary proceeding initiated by Appellant James Charles Vaughn seeking a declaration that his taxes assessed for the years 1999 and 2000 are dischargeable under his Chapter 11 bankruptcy petition. After a trial, the bankruptcy court determined the taxes were not dischargeable under 11 U.S.C. § 523(a)(1)(C) because Appellant had filed a fraudulent tax return and sought to evade those taxes. The bankruptcy court's decision was affirmed by the federal district court on appeal. Appellant now appeals the district court's order affirming the bankruptcy court's decision.

I.

The following material facts were among those presented to the bankruptcy court at trial. In the mid-nineties, Appellant was Chief Executive Officer of a cable television acquisition company, FrontierVision Partners, LP. Though Appellant had little formal education beyond high school, he had significant practical business experience. In the decade-and-a-half prior to becoming CEO of FrontierVision, Appellant served in senior executive positions at a number of cable and communication companies. Appellant was so effective in these positions he was described by one of his colleagues, the Chief Financial Officer at FrontierVision, Jack Koo, as having “as much business acumen as anyone that [Mr. Koo had] known in [his] career.” (Supplemental App. at 591.)

Between the years 1995 and 1999, Appellant shepherded FrontierVision as it grew from a start-up venture into a multi-billion dollar company. In 1999, FrontierVision was sold to another company for roughly $2.1 billion. Appellant received approximately $20 million in cash and $11 million in the purchasing company's stock from this sale.

Appellant testified that around the time of the FrontierVision sale, he realized he “was going to come into a lot of money,” and he “needed to do some kind of tax planning, whatever it turned out to be.” (Supplemental App. at 532–533.) In June 1999, a partner of the international accounting firm KPMG LLP introduced Appellant to a tax strategy known as Bond Linked Issue Premium Structure (“BLIPS”), which was a product offered by a company called Presidio Advisory Services LLC and marketed by KPMG. FrontierVision had an established relationship with KPMG, which had handled a number of acquisition, tax, and accounting matters for FrontierVision since 1995.

Through a series of communications with representatives of KPMG and Presidio, BLIPS was presented to Appellant in detail. BLIPS was described as a structured, multi-stage program that involved investment in foreign currencies. BLIPS's use as a tax strategy resulted from the manner in which the program combined a participant's relatively small cash contribution to an investment fund (made through a limited liability company), with a nonrecourse loan and a loan premium, ultimately facilitating a high tax loss for the participant without a corresponding economic loss. Through BLIPS, a desired tax loss could be tailored to offset a participant's actual economic gain, and thereby shelter that gain from tax. The BLIPS program was structured so the basis for a desired tax loss would be achieved by closing out the investment fund after sixty days. In fact, Appellant testified he understood that the ultimate amount he would contribute to his BLIPS investment fund was based on the tax loss he wished to generate to offset his capital gain from the sale of FrontierVision. He also testified that when he entered the BLIPS program in October 1999, he did so knowing he would withdraw by the end of the year—after roughly sixty days—essentially guaranteeing his BLIPS transaction would generate a tax loss covering his capital gains.

KPMG advised Appellant that BLIPS was accompanied by the risks of an IRS audit and the possibility of owing additional taxes. KPMG advised Appellant that in order for a BLIPS transaction to withstand a challenge by the IRS, a participant needed to have a legitimate profit motive in the BLIPS investment. Appellant appreciated the risks associated with BLIPS, stating he understood the BLIPS program “as a choice between paying $9 million of taxes currently or claiming the benefits of [the BLIPS] losses and paying $3 million currently with some risk of paying more taxes later.” (Appellant's App. at 1189.) Appellant memorialized his appreciation of these risks when he signed an engagement letter in September 1999 which stated he “acknowledge[d] that [BLIPS] is aggressive in nature and that the [IRS] might challenge the intended results of [BLIPS] and could prevail under any of various tax authorities.” (Supplemental App. at 124.) The letter further stated Appellant “acknowledge [d] that any tax opinion issued by KPMG would not guarantee tax results, but would provide that with respect to the tax consequences described in the opinion, there is a greater than 50 percent likelihood (i.e., it is ‘more likely than not’) that those consequences will be upheld if challenged by the [IRS].” ( Id. at 123.) The engagement letter also set forth the $506,000 fee Appellant was to pay KPMG for its role in advising Appellant regarding BLIPS.

The sale of FrontierVision closed on October 1, 1999. Shortly thereafter, between the months of October and December, Appellant participated in a BLIPS transaction. As a result of Appellant's artificially high basis in his BLIPS LLC, his $2.8 million contribution to a BLIPS investment fund, when combined with a loan and loan premium issued to his BLIPS LLC, generated a purported tax loss of roughly $42 million upon Appellant's withdrawal from the BLIPS investment and the disposition of the BLIPS LLC's assets.

On April 11, 2000, Appellant reviewed and signed his 1999 tax return. Appellant reported a long-term capital gain of approximately $30.6 million as a result of the sale of FrontierVision. However, he also reported a short-term capital loss of roughly $32.3 million as a consequence of his BLIPS transaction. He further reported an ordinary loss of roughly $3.3 million based on his BLIPS participation. These claimed losses were sufficient to offset Appellant's capital gains from the sale of FrontierVision. Appellant admitted at his deposition—and denied at trial—that he had been instructed by one of the partners of KPMG not to claim the full amount of his BLIPS capital loss on his return in order to avoid arousing suspicion. (Supplemental App. at 473–74.) Furthermore, Appellant testified that when he signed the 1999 return, he knew he had not suffered an economic loss corresponding to his claimed tax loss.

In September 2000, the IRS issued Internal Revenue Bulletin Notice 2000–44, in which the IRS discussed “arrangements [that] purport to give taxpayers artificially high basis in partnership interests and thereby give rise to deductible losses on disposition of those partnership interests,” including schemes “involv[ing] a taxpayer's borrowing at a premium and a partnership's subsequent assumption of that indebtedness.” (Appellant's App. at 1146.) While BLIPS was not specifically mentioned in the notice, the type of transactional scheme described in the notice perfectly described BLIPS. The IRS stated that purported losses resulting from such transactions “are not allowable as deductions for federal income tax purposes” because they “do not represent bona fide losses reflecting actual economic consequences as required for purposes of § 165” of the Internal Revenue Code. ( Id.) In the wake of this bulletin, KPMG issued a directive requiring BLIPS clients to be notified of Notice 2000–44. Appellant was informed of Notice 2000–44 by KMPG and provided with a copy of the bulletin by February 2001. ( Id. at 801.)

In March 2001, Appellant separated from his then wife, Cindy Vaughn, and purchased a townhome for $1.4 million. In September, the couple divorced. Pursuant to a separation agreement, Ms. Vaughn received the couple's marital residence—valued at $2.5 million—and five luxury and collector vehicles—valued collectively at roughly $260,000—while Appellant received the recently purchased townhome and a Mercedes SUV. The couple's Morgan Stanley investment accounts—valued at $18 million—were divided equally. The couple's divorce decree was entered on September 13, 2001.

Shortly after separating from Ms. Vaughn, Appellant entered a relationship with another woman, Kathy St. Onge. In April 2001, Appellant purchased Ms. St. Onge a new BMW. In mid-September 2001, Appellant became engaged to Ms. St. Onge. Around this time, Appellant purchased a $1.73 million home with his own funds, with the home titled in Ms. St. Onge's name only. Appellant married Ms. St. Onge in October 2001.

Meanwhile, in June 2001, Mr. Koo, who had also participated in BLIPS, was notified he was to be audited in relation to his BLIPS participation. In a proof of claim related to a subsequent lawsuit against KPMG, Appellant indicated that Mr. Koo contacted Appellant about the audit shortly after June 2001.¹ In February 2002, KPMG representatives met with Appellant and informed him that because they were being examined by the IRS in connection with BLIPS, it was likely that Appellant would be identified by the IRS as a BLIPS participant and his 1999 tax return would be subject to audit. Therefore, the representativessuggested that Appellant participate in an IRS...