American Boat Co., LLC v. U.S.

• Decision Date: 01 October 2009
• Docket Number: No. 09-1109.,09-1109.
• Citation: 583 F.3d 471
• Parties: AMERICAN BOAT COMPANY, LLC, and American Milling, LP, its tax matters partner, Plaintiffs-Appellees, v. UNITED STATES of America, Defendant-Appellant.
• Court: U.S. Court of Appeals — Seventh Circuit

583 F.3d 471

AMERICAN BOAT COMPANY, LLC, and American Milling, LP, its tax matters partner, Plaintiffs-Appellees, v. UNITED STATES of America, Defendant-Appellant.

No. 09-1109.

United States Court of Appeals, Seventh Circuit.

Argued May 28, 2009.

Decided October 1, 2009.

Anthony J. Rollins (argued), Wagner, Johnston & Rosenthal, P.C., Atlanta, GA, for Plaintiffs-Appellees.

Judith A. Hagley, Wendy J. Kisch, Department of Justice Tax Division, Richard Farber (argued), Department of Justice Civil Division, Immigration Litigation, Washington, DC, for Defendant-Appellant.

Before BAUER, FLAUM, and KANNE, Circuit Judges.

KANNE, Circuit Judge.

This is a tax case involving another example of the now infamous Son of BOSS tax shelter. The Internal Revenue Service (IRS) determined that American Boat, LLC implemented an illegal tax shelter and misstated certain information on its tax documents, resulting in significant tax underpayment by its owners. On July 18, 2006, the IRS issued American Boat a Notice of Final Partnership Administrative Adjustment (FPAA). American Boat, through its tax matters partner American Milling, LP, sued the United States seeking judicial review of the FPAA. The district court agreed with the IRS that American Boat's transactions were invalid and that the related tax benefits were improper—conclusions American Boat does not appeal. The government, however, appeals the district court's determination that American Boat and its members are not subject to accuracy-related penalties. Although we see merit in some of the government's arguments, we find no reversible error below.

I. BACKGROUND

This case arose from a series of transactions constituting an example of what is now known as a "Son of BOSS" tax shelter. The shelter, which was aggressively marketed by law and accounting firms in the late 1990s and early 2000s, is a younger version of its parent—the equally illegal BOSS (bond and options sales strategy) shelter. See Kligfeld Holdings v. Comm'r, 128 T.C. 192, 194, 2007 WL 1556083 (2007) (providing a description of the Son of BOSS tax shelter). A Son of BOSS shelter may take many forms, but common to them all is the transfer to a partnership of assets laden with significant liabilities. Id. The liabilities are typically obligations to purchase securities, meaning they are not fixed at the time of the transaction. The transfer therefore permits a partner to inflate his basis¹ in the partnership by the value of the contributed asset, while ignoring the corresponding liability. Id.; see also Clearmeadow, 87 Fed.Cl. at 514. The goal of the shelter is to eventually create a large, but not out-of-pocket, loss on a partner's individual tax return. This may occur when the partnership dissolves or sells an over-inflated asset. In turn, this artificial loss may offset actual— and otherwise taxable—gains, thereby sheltering them from Uncle Sam.

In this case, American Boat does not challenge the district court's determination that the particular transactions and tax structure violated tax law. Fortunately for those of us less mathematically inclined, we need not dwell on the finer details of American Boat's transactions. The IRS will receive its delinquent taxes. The real question in this case is whether American Boat, managed by David Jump, had reasonable cause for its underpayment. If it did, then no accuracy-related penalty applies; if it did not, American Boat's owners will be liable for forty percent of the underpayment of $1,260,544. See 26 U.S.C. § 6662(h).

Jump is a St. Louis businessman who has developed a large grain and commodities business in central Illinois. He has owned a variety of business interests, including a fleet of towboats operating on the Mississippi River. In 1996, as Jump's wealth continued to grow, his Chicago banker advised him to consider planning his estate. At his banker's recommendation, Jump contacted Erwin Mayer, an attorney at the Chicago law firm of Altheimer & Gray.

Mayer developed an estate plan that reorganized Jump's operating entities into a number of limited partnerships. Mayer also established the Jump Family Trust, which eventually owned more than ninety-eight percent of Jump's many business assets. As part of the reorganization, Mayer recommended that Jump engage in a short-sale version of the Son of BOSS tax shelter. The shelter permitted one of Jump's entities to report a large loss, thereby allowing Jump to offset gains earned from the dissolution of another of his entities. Altheimer & Gray provided a written opinion regarding the validity of the transaction, upon which Jump's accountants relied in preparing subsequent income tax returns. Although Jump's 1996 transactions were likely an invalid Son of BOSS tax shelter, the IRS did not discover them until after the statute of limitations had expired.

Jump's next encounter with the Son of BOSS shelter came in 1998, purportedly as an indirect result of a near-disaster of titanic proportions. One of Jump's towboats, with multiple loaded barges in tow, struck a bridge near downtown St. Louis. Some of the barges broke free from the towboat, floated down river, and crashed into the Admiral, a floating casino in the St. Louis harbor.

The 2,000 passengers aboard were in grave danger as the Admiral's moorings began to break. With no means of navigation, the steamboat-turned-casino would be left to the currents of a flood-stage Mississippi River. The ship was too tall to fit under the next bridge, meaning that the inevitable collision would either capsize the boat or tear it to pieces. Either outcome could have resulted in one of the worst maritime disasters in United States history. But, fortunately, one of the Admiral's moorings held; the towboat released its remaining barges and pinned the casino against the riverbank until assistance arrived.

The wayward towboat was owned by American Milling, LP, which at that time was the overarching entity that owned most of Jump's businesses. American Milling's potential liability from an accident such as the one that nearly occurred would have easily exceeded the company's insurance coverage. As a result, Jump was advised that he should readjust the ownership structure of his companies to limit potential liability.

In addition to his admiralty attorneys, Jump contacted Mayer again, who was still at Altheimer & Gray. Mayer, familiar with Jump's various businesses, advised Jump that he isolate the towboats from his companies' remaining assets. As a result, American Boat Company, LLC was born. It eventually came to own and operate Jump's Mississippi River towboats.

Mayer's reorganization advice, however, was not what attracted the IRS's attention. In addition to restructuring, Mayer advised Jump to conduct another short-sale version of the Son of BOSS tax shelter. To do so, Mayer created two other companies for Jump in late 1998: Gateway Grain, LLC, and Omaha Pump, LLC. Sometime thereafter, Jump transferred his eighteen towboats, which were owned by various entities, to American Boat.²

On December 15, 1998, Gateway Grain and Omaha Pump engaged in short sales of short-term United States Treasury Notes,³ resulting in proceeds totaling approximately $30 million. Both companies also entered into repurchase agreements with Morgan Stanley, their broker, using the proceeds as collateral until the Notes were replaced.

The next day, Gateway Grain and Omaha Pump transferred their brokerage accounts—now fat with more than $30 million—to American Boat. Along with the short-sale proceeds, however, came the obligation to close the short-sale transactions. On December 18, American Boat used the $30 million proceeds to close the short sales, resulting in an overall economic loss of just $15,213.86.

The next steps were a series of complex transactions that are largely irrelevant to the issues in this case.⁴ Suffice it to say that Jump was able to increase the basis of the eighteen towboats owned by American Boat to match the partners' newly inflated outside basis. The basis in the towboats increased from what American Milling had originally claimed was $3,280,783 to a combined total of $31,594,334.

American Boat accomplished this feat by claiming that the contribution of the short-sale proceeds increased the partners' basis by $30 million, but that American Boat's assumption of the corresponding $30 million obligation to close the short sales was not a "liability" that reduced the partners' basis under § 752 of the Internal Revenue Code. See 26 U.S.C. § 752. The result was a drastic artificial increase in the basis that permitted Jump and his entities to claim much higher deductions for the depreciation of the towboats and to offset taxable gains earned by later sales of some of the boats. Based on the structure of the various entities, the consequences of these tax benefits flowed through to Jump's individual tax return.

In addition to the reorganization, Mayer, who had since moved his practice to the law firm of Jenkens & Gilchrist, provided Jump with an opinion letter regarding the validity of the above-described transactions. Among other things, Mayer opined that the increased partnership basis was permissible because the obligation to close the short sales was not a "liability" under § 752. The opinion further stated that the taxpayer had a business purpose for the transferring the short-sale positions to American Boat and that it likewise had a reasonable expectation of making a profit—premises that the government claims were shams.

Beginning in the taxable year 1999, American Milling and Jump claimed substantial tax benefits on their respective returns as a result of the Son of BOSS shelter. In doing so, Jump provided Mayer's opinion letter to his accountants at Deloitte and Touche. Although Deloitte was not asked to opine on the validity of American Boat's short-sale transactions in 1996 or 1998, the accountants informed Jump that they considered the legal...