Sala v. U.S., Civil No. 05-cv-00636-LTB.

CourtUnited States District Courts. 10th Circuit. United States District Court of Colorado
Writing for the CourtBabcock
Citation552 F.Supp.2d 1167
Docket NumberCivil No. 05-cv-00636-LTB.
Decision Date22 April 2008
PartiesCarlos E. SALA, and Tina ZanoliniSala, Plaintiffs, v. UNITED STATES of America, Defendant.
552 F.Supp.2d 1167
Carlos E. SALA, and Tina ZanoliniSala, Plaintiffs,
v.
UNITED STATES of America, Defendant.
Civil No. 05-cv-00636-LTB.
United States District Court, D. Colorado.
April 22, 2008.

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Cori E. Flanders-Palmer, Darrell Delmar Hallett, John Mark Colvin, Robert J. Chicoine, Chicoine & Hallett, Inc., P.S., Seattle, WA, for Plaintiffs.

David Neil Geier, Amy T. Matchison, Joseph Andrew Sergi, U.S. Department of Justice, Washington, DC, for Defendant.

FINDINGS OF FACT, CONCLUSIONS OF LAW, AND ORDER

BABCOCK, District Judge.


This action concerns a claim by Plaintiffs Carlos E. Sala and Tina Zanolini Sala (referred to herein as "Sala," since Tina Zanolini-Sala is a named plaintiff only because the Salas filed a joint tax return) for a refund on Sala's 2000 federal taxes. Sala timely filed his 2000 federal tax return on or before April 15, 2001. Although Sala had income in 2000 of more than $60 million, he claimed a tax loss that essentially nullified his tax burden. Sala achieved the alleged loss through his involvement in a foreign currency options investment transaction known as Deerhurst. Sala filed an amended return on November 18, 2003, eliminating the loss claimed on his original 2000 return and paying over $26 million in taxes, plus penalties and interest. Sala later filed another amended return reclaiming the tax loss and seeking a refund of the taxes, interest, and penalties. The Government contends Sala is not entitled to claim the tax loss because Deerhurst was an improper tax shelter. Sala disagrees, and brought suit against the Government to obtain a refund of the taxes, interest, and penalties he paid to the Government.

An eight day trial to the Court in this matter was held commencing March 10, 2008, and concluding March 19, 2008. The two claims at issue were Sala's entitlement to a refund of the taxes, penalties, and interest he paid on his 2000 income and — to the extent any refund was due Sala on putatively "excess" interest—the Government's entitlement to an accuracy-related penalty owed, but not assessed. After a review of all the evidence presented both at trial and by deposition, I find in favor of Carlos Sala and Tina Zanolini-Sala and against the Government on all claims and counterclaims.

I. BACKGROUND FACTS

The following facts are not disputed. In 1997, Sala became employed as CFO, Secretary, and Treasurer of Abacus Direct, Inc. Sala's compensation included cash and stock options. In June 1999, Abacus was acquired by DoubleClick, Inc. In connection with the acquisition, Sala received DoubleClick stock options. Sala sold his DoubleClick options in February or March of 2000. Largely as a result of the sale of these options, Sala realized more than $60 million in income in 2000.

Sala invested most of this income into municipal bonds and other fixed income financial products. Approximately $9 million, however, was invested in a foreign currency investment program, which is collectively referred to herein as the "Deerhurst Program." As part of the Deerhurst Program, Sala deposited $500,000 on October 23, 2000, into a personal account at Refco Capital Markets ("Refco") that was managed by Deerhurst Management Company, Inc. ("Deerhurst Management"). Deerhurst Management was principally owned and managed by Andrew Krieger, a renowned foreign currency trader.

On November 21, 2000, Sala deposited an additional $8,425,000 into his personal

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account at Refco. Between November 20 and November 27, 2000, Deerhurst Management acquired 24 foreign currency options on Sala's behalf. The options consisted of both long and short options in various foreign currencies with a net cost to Sala of approximately $728,297.85.

On November 8, 2000, Sala formed Solid Currencies, Inc. ("Solid" or "Solid Currencies")—a Delaware S Corporation in which he was the sole shareholder. On November 28, 2000, Sala transferred the 24 options, plus approximately $8 million in cash, to Solid and then from Solid to Deerhurst Investors, GP, ("Deerhurst GP") in exchange for a partnership interest. Deerhurst GP was liquidated prior to December 31, 2000. Upon liquidation of Deerhurst GP, Solid received a share of, the proceeds. Solid transferred its share of the Deerhurst GP proceeds to Deerhurst Trading LLC. Krieger continued to manage these funds on behalf of Sala in various entities through 2004.

On or before April 15, 2001, Sala filed a corporate income tax return for Solid for the 2000 tax year. The return was prepared and signed by David Schwartz, the brother of Michael Schwartz—the person who introduced Sala to the Deerhurst Program. The return reported an ordinary loss from a trade or business of $60,449,984.

The approximately $60 million loss claimed was allegedly achieved by a series of predetermined steps, orchestrated under a then-existing tax rule that disregarded short options as liabilities for purposes of establishing partnership basis. Under this rule, established in Helmer v. Commissioner of Internal Revenue, T.C. Memo.1975-160 (1975), liabilities created by short options were considered too contingent to affect a partner's basis in the partnership. Upon transfer of the 24 foreign currency options from Sala to Solid and then to Deerhurst GP, Solid's basis in Deerhurst GP was increased by the value of the long options, $60,987,866.79, but was not offset by the $60,259,568.94 cost of the short options. Accordingly, Solid's claimed basis in Deerhurst GP was approximately $69 million—the value of the cash plus the long options.

Upon liquidation of Deerhurst GP, Solid received a portion of Deerhurst GP's liquidated assets equal to the proportionate size of Solid's basis. Solid claimed to have received approximately $8 million in cash and two foreign currency contracts. Under the Tax Code, the foreign currency contracts were considered to be "property" at transfer. The value of the foreign exchange contracts distributed to Solid, therefore, was claimed to be approximately $61 million—$69 million (Solid's original basis in Deerhurst GP) less the $8 million in cash. When Solid sold the foreign currency contracts, its loss was equal to the $61 million dollar value of the contracts, offset by any profit received from their sale. According to Solid's 2000 tax return, the combined loss on the foreign currency contracts was approximately $60,250,065.94. When combined with Solid's other expenses and losses, Solid's 2000 loss was reported as $60,449,984.

On or before April 15, 2001, Sala filed a personal federal income tax return for the 2000 year ("2000 return"). The 2000 return reported wages of $51,748,681; taxable interest income of $1,837,561; dividend income of $410,300; taxable refunds, credits, or offsets of state and local income taxes of $7,846; a capital gain of $6,472,000; and other income of ($23). The 2000 return reported on line 17 (rental real estate, royalties, partnerships, S corporations, trusts, etc.) the $60,449,984 loss attributed to a non-passive loss from Solid Currencies. The 2000 return reported adjusted gross income of $26,381. Sala reported owing no federal taxes.

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In November 2003, Sala filed a form 1040X amending his 2000 return. The amended return reported the same income amounts as the original return, but did not report the $60,449,984 loss previously attributed to Solid Currencies. Sala paid the resulting approximately $26 million in taxes, interest, and penalties. On or about June 18, 2004, the IRS issued a Notice of Deficiency to Sala, asserting he owed additional taxes in the amount of $22,204 due to the disallowance of $56,071 of losses Sala reported as attributable to Solid Currencies. The Notice of Deficiency also asserted an accuracy-related penalty in the amount of $4,400.80 for tax year 2000.

In September 2004, Sala filed another form 1040X for the 2000 tax year reclaiming the loss attributable to Solid Currencies and claiming a refund due of $23,727,630.

In the Amended Pretrial Order [Docket # 195], the parties stipulated to the following additional relevant facts. In late 1999, Sala was introduced to KPMG partner Tracie Henderson through Sala's friend Tim Gillis—also a KPMG partner. KPMG prepared Sala's federal and state tax returns for the years 2000, 2001, 2002, and 2003. Prior to 2000, Sala's tax returns were prepared by PricewaterhouseCoopers.

On August 13, 2000, IRS Notice 2000-44 was released electronically; on September 18, 2000, it was published.

On or about April 15, 2001, Sala paid R.J. Ruble $75,000 for a tax opinion letter involving the tax benefits of the Deerhurst Program.

II. ISSUES PRESENTED AT TRIAL

Five distinct issues were presented at trial: (1) whether the transactions creating Sala's 2000 tax loss constituted sham transactions; (2) whether Sala entered into the transactions creating his 2000 tax loss for profit; (3) whether the transactions creating Sala's 2000 tax loss, as executed, allowed the tax loss; (4) whether any allowable tax loss was rendered retroactively disallowed by 26 C.F.R. § 1.752-6; and (5) whether the Government is entitled to an offset of any excess interest payments made by Sala with an accuracy-related penalty. The second issue is an issue of fact. See Hildebrand v. Comm'r of Internal Revenue, 28 F.3d 1024, 1026 (10th Cir.1994). The fourth issue is a question of law. The remaining issues are mixed questions of law and fact.

Before addressing these issues, however, it is necessary to define the appropriate burden of proof in this case and define the scope of the loss-generating transaction.

III. BURDEN OF PROOF

The allocation of burdens as to each specific factual issue will be addressed where appropriate throughout this...

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9 practice notes
  • Barrie v. U.S. Dept. of Labor, Case No. 07-cv-01751-LTB.
    • United States
    • United States District Courts. 10th Circuit. United States District Court of Colorado
    • January 29, 2009
    ...this regulation depends on whether the authority to make the rule is considered legislative or interpretive. See Sala v. United States, 552 F.Supp.2d 1167, 1198 (D.Colo. 2008). "If Congress has explicitly or implicitly delegated authority to an agency to issue a certain regulation, the regu......
  • The Tax Matters Partner v. USA, Civil Action No. 3:06cv379-HTW-MTP.
    • United States
    • United States District Courts. 5th Circuit. Southern District of Mississippi
    • April 30, 2010
    ...IRS on October 12, 2001, as well as to a February, 2002 notification that the investigation would be expanded. See also Sala v. U.S., 552 F.Supp.2d 1167, 1204 (D.Colo.2008), reconfirming the October and February dates KPMG was given notice of the IRS investigation of its role regarding the ......
  • Gonzalez v. U.S.A, Case No: C 08-3189 SBA
    • United States
    • United States District Courts. 9th Circuit. United States District Courts. 9th Circuit. Northern District of California
    • March 4, 2011
    ...is met by the taxpayer if he can show any business purpose for structuring his transactions other than tax avoidance." Sala v. U.S., 552 F.Supp.2d 1167, 1186 (D. Colo. 2008) (citing Friedman v. C.I.R., 869 F.2d 785, 792 (4th Cir. 1989)). At bottom, Plaintiff has failed to offer any authorit......
  • Palm Canyon X Investments, LLC v. Commissioner of Internal Revenue, T.C. Memo. 2009-288 (U.S.T.C. 12/15/2009), No. 5610-06.
    • United States
    • U.S. Tax Court
    • December 15, 2009
    ...Stobie Creek Invs., LLC v. United States, 82 Fed. Cl. at 667-671 (regulation cannot be applied retroactively); Sala v. United States, 552 F. Supp. 2d 1167 (D. Colo. 2008) (regulation unlawful and cannot be applied retroactively); Klamath Strategic Inv. Fund, LLC v. United States, 440 F. Sup......
  • Request a trial to view additional results
9 cases
  • Barrie v. U.S. Dept. of Labor, Case No. 07-cv-01751-LTB.
    • United States
    • United States District Courts. 10th Circuit. United States District Court of Colorado
    • January 29, 2009
    ...this regulation depends on whether the authority to make the rule is considered legislative or interpretive. See Sala v. United States, 552 F.Supp.2d 1167, 1198 (D.Colo. 2008). "If Congress has explicitly or implicitly delegated authority to an agency to issue a certain regulation, the......
  • The Tax Matters Partner v. USA, Civil Action No. 3:06cv379-HTW-MTP.
    • United States
    • United States District Courts. 5th Circuit. Southern District of Mississippi
    • April 30, 2010
    ...IRS on October 12, 2001, as well as to a February, 2002 notification that the investigation would be expanded. See also Sala v. U.S., 552 F.Supp.2d 1167, 1204 (D.Colo.2008), reconfirming the October and February dates KPMG was given notice of the IRS investigation of its role regarding the ......
  • Gonzalez v. U.S.A, Case No: C 08-3189 SBA
    • United States
    • United States District Courts. 9th Circuit. United States District Courts. 9th Circuit. Northern District of California
    • March 4, 2011
    ...met by the taxpayer if he can show any business purpose for structuring his transactions other than tax avoidance." Sala v. U.S., 552 F.Supp.2d 1167, 1186 (D. Colo. 2008) (citing Friedman v. C.I.R., 869 F.2d 785, 792 (4th Cir. 1989)). At bottom, Plaintiff has failed to offer any author......
  • Palm Canyon X Investments, LLC v. Commissioner of Internal Revenue, T.C. Memo. 2009-288 (U.S.T.C. 12/15/2009), No. 5610-06.
    • United States
    • U.S. Tax Court
    • December 15, 2009
    ...Stobie Creek Invs., LLC v. United States, 82 Fed. Cl. at 667-671 (regulation cannot be applied retroactively); Sala v. United States, 552 F. Supp. 2d 1167 (D. Colo. 2008) (regulation unlawful and cannot be applied retroactively); Klamath Strategic Inv. Fund, LLC v. United States, 440 F. Sup......
  • Request a trial to view additional results

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