Gustashaw v. Comm'r of Irs

• Decision Date: 28 September 2012
• Docket Number: No. 11–15406.,11–15406.
• Citation: 696 F.3d 1124
• Parties: William E. GUSTASHAW, Jr., Nancy D. Gustashaw, Petitioners–Appellants, v. COMMISSIONER OF IRS, Respondent–Appellee.
• Court: U.S. Court of Appeals — Eleventh Circuit

696 F.3d 1124

23 Fla. L. Weekly Fed. C 1600

William E. GUSTASHAW, Jr., Nancy D. Gustashaw, Petitioners–Appellants,

v.COMMISSIONER OF IRS, Respondent–Appellee.

No. 11–15406.

United States Court of Appeals, Eleventh Circuit.

Sept. 28, 2012.

Harris LaRue Bonnette, Jr., Fisher, Tousey, Leas & Ball, PA, Jacksonville, FL, William P. Gregory, Francis R. Lakel, Tampa, FL, for Petitioners–Appellants.

Ellen Page DelSole, Joan I. Oppenheimer, Tamara W. Ashford, Richard Farber, U.S. Dept. of Justice, Tax Div., App. Section, Robert R. Di Trolio, U.S. Tax Court, Washington, DC, Robert Walter Dillard, Stephen Rickio Takeuchi, Chief Counsel—IRS, Jacksonville, FL, for Respondent–Appellee.

Petition for Review of a Decision of the U.S. Tax Court.

Before HULL, MARCUS and HILL, Circuit Judges.

HULL, Circuit Judge:

Although a tax shelter can be legitimate, Petitioner William Gustashaw, Jr.,¹ participated in one that was not. Gustashaw claimed substantial tax benefits from the shelter on four consecutive tax returns. The IRS later disallowed Gustashaw's claim and determined deficiencies in tax and accuracy-related penalties, including gross valuation misstatement penalties and a negligence penalty. Gustashaw conceded the deficiencies in tax, but contested the penalties. The Tax Court affirmed the IRS's imposition of the penalties. After review and oral argument, we affirm.

I. BACKGROUND

A. Gustashaw's Education and Business Background

Petitioner Gustashaw is a college-educated, successful businessman. Gustashaw, who married his wife Nancy in college, graduated from Gannon University in 1973 with a bachelor of science degree in industrial management. While in college, Gustashaw took business-related courses, including managerial cost accounting and the principles of accounting.

Following graduation, Gustashaw embarked on a nearly thirty-year business career. From 1973 to 1993, Gustashaw held management positions with various companies in the food and beverage industry. Then, in 1994, Gustashaw became vice-president of operations at Merck Medco Managed Care (“Merck Medco”) in Tampa, Florida. As vice-president of operations, Gustashaw was responsible for large-scale prescription processing in a mail-order pharmacy. Subsequently, Merck Medco promoted Gustashaw to vice-president and general manager, which expanded his responsibilities to all operations of two mail-order pharmacies. Merck Medco also provided Gustashaw with generous stock options.

B. Gustashaw's Early Retirement Plan

In 1995, Gustashaw, who was then 45 years old, began planning for an early retirement. Gustashaw had a conservative investment history and handled nearly all of his and his wife's investment decisions himself. In addition, Gustashaw had filed all of the couple's joint federal income tax returns. However, to assist with his retirement plan, Gustashaw decided to hire a financial planner.

To that end, Gustashaw hired Ralph Maulorico, a financial planner at New England Financial who represented wealthy individuals. Gustashaw wanted to exercise his Merck Medco stock options by 2000, and sought Maulorico's advice on whether the stock option exercise would generate enough income to fund the Gustashaws' retirement. Maulorico recommended the stock option exercise. Thus, in 1996, Gustashaw sold some of the acquired stock and invested the proceeds in mutual funds.

The next year, 1997, Gustashaw decided to hire a tax accountant to review the Gustashaws' tax returns, which Gustashaw would continue to prepare until 2000. On Maulorico's recommendation, Gustashaw hired William Gable, Maulorico's college friend. Gable, who owns an accounting practice in Florida, is an enrolled agent and accountant, but not a certified public accountant. Gable received both an undergraduate and a master's degree in accounting, with the master's degree specializing in taxation, at LaCrosse University. Gable reviewed the Gustashaws' self-prepared joint returns for 1997 through 1999, before they were filed.

In 1999, Merck Medco underwent a reorganization and offered Gustashaw an option to retire early. Gustashaw accepted and retired that same year. The following year, 2000, Gustashaw exercised his remaining Merck Medco stock options and sold the stock, generating $8,077,376 in income. For that year, Gable prepared the tax return, at Gustashaw's request. The 2000 return claimed tax benefits through a complicated financial transaction known as “CARDS,” as explained in the next section.

C. The CARDS Tax Shelter

In early 2000, Maulorico learned from a colleague about the Custom Adjustable Rate Debt Structure (“CARDS”) transaction and its use as a tax shelter. The colleague learned of the CARDS transaction through Roy Hahn, a certified public accountant and founder of Chenery Associates, Inc. (“Chenery”). Chenery developed and promoted the CARDS shelter. At the time, Maulorico, who had experience in tax shelters, believed the transaction offered both profit potential and a tax shelter for the income from Gustashaw's stock option exercise. Thus, Maulorico suggested the CARDS transaction to Gustashaw, who became interested in it.

During the 1990s and early 2000s, the CARDS transaction was promoted to high net worth individuals both as an investment-financing mechanism and a tax shelter. In the CARDS transaction, a U.S. taxpayer, facilitated by a newly created company, uses a bank loan to create a tax loss based on an artificially high basis (or cost) in assets, which then allows the taxpayer to generate a tax benefit by offsetting real, taxable income.

There are three steps to create the CARDS tax shelter.² First, in the loan origination step, a foreign bank loans currency to the borrower, a Delaware limited liability company owned 100% by nonresident alien individuals. Importantly, the foreign ownership of the borrower ensures the borrower is not subject to U.S. taxation. The loan is for a 30–year term with annual interest payments due, but not principal payments. The bank deposits the loan proceeds directly into the borrower's account at the bank. However, to use the loan proceeds, the borrower must meet collateralization requirements by acquiring valuable, stable assets such as government bonds.

Second, in the loan assumption step, a U.S. taxpayer and the borrower enter into an agreement whereby the U.S. taxpayer assumes joint and several liability for the borrower's entire loan. In exchange, the U.S. taxpayer receives only a small percentage of the loan proceeds from the borrower, e.g., 15% for our purposes. The borrower agrees to retain all interest obligations, and the U.S. taxpayer agrees to repay the unpaid principal amount. The U.S. taxpayer then could, in theory, use the assumed loan proceeds to make an investment, but the bank maintains discretion on whether to release any funds. To access the loan proceeds, the U.S. taxpayer must deposit equivalent, substitute collateral with the bank.

And third, in the currency exchange step, the U.S. taxpayer exchanges his 15% portion of the foreign-currency loan for U.S. dollars. This currency exchange is a taxable event generating tax benefits. To achieve the benefits, the U.S. taxpayer claims that his basis in the exchanged currency is the entire amount of the loan, not the 15% of the loan that the taxpayer actually received from the tax-exempt borrower. This discrepancy creates a permanent tax loss of 85% of the original loan amount, which permits the U.S. taxpayer to shelter other unrelated, taxable income.

In August 2000, the Internal Revenue Service (“IRS”) issued a notice warning taxpayers against claiming tax benefits through tax shelters similar to the CARDS shelter, because such benefits would be subject to penalties. SeeI.R.S. Notice 2000–44, 2000–2 C.B. 255. In March 2002, the IRS issued another, similar notice that was targeted specifically at the CARDS shelter. SeeI.R.S. Notice 2002–21, 2002–1 C.B. 730. The 2002 notice also advised taxpayers who had used the shelter to file amended returns. Id. Then, in 2005, the IRS offered a settlement initiative whereby taxpayers could pay a reduced penalty by conceding the claimed tax benefits. SeeI.R.S. Announcement 2005–80, 2005–2 C.B. 967.

D. Gustashaw's Investigation of the CARDS Transaction

After Maulorico suggested the CARDS transaction, Gustashaw began to investigate it. Maulorico arranged for Gustashaw to speak with Hahn, and most of Gustashaw's understanding of the transaction was from oral discussions with Maulorico, Gable, and Hahn. According to Gustashaw, the CARDS shelter appeared attractive because it provided both tax advantages and investment opportunities. These opportunities included (1) elimination of his year 2000 tax liability by creating a tax loss, (2) access to investment funds over 30 years, and (3) leverage of the euro against the dollar by drawing down a euro-denominated loan and repaying it in dollars.

Over several months, Gustashaw, Maulorico, and Gable had multiple conversations about the CARDS transaction with Hahn, the transaction's promoter. Hahn explained how the CARDS transaction worked, including that the transaction would generate a permanent tax loss of approximately 85% of the original loan amount. Chenery, Hahn's firm, would set up the transaction, and Hahn stated that Gustashaw's only out-of-pocket expense would be Chenery's investment banking fee.

In June 2000, Gustashaw met with Maulorico and Gable to discuss both the CARDS transaction and an executive summary about CARDS that Hahn had prepared. After the meeting, Maulorico opined that Gustashaw could make a 16% return on his investment in the CARDS transaction, based on Maulorico's “anecdotal[ ]” review of the transaction's economics and past Standard & Poor's compound annual returns. Maulorico did not provide a written analysis. Ultimately, Gustashaw and Maulorico concluded that Gustashaw would benefit from the CARDS transaction and the tax benefits it would generate for his 2000 tax return.

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