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Tax Court Sinks Riverboat Pilot's Tax Avoidance Scheme.

(Parker Tax Publishing March 5, 2015)

The Tax Court held that a taxpayer's reliance on the self-interested advice of a tax shelter promoter defeated his reasonable cause and good faith reliance defense against gross-valuation misstatement penalties stemming from his involvement in a variant on the Son-of-BOSS tax scheme. 436, Ltd. v. Comm'r, T.C. Memo. 2015-28.


Robert Heitmeier left college after only one semester to work as a deckhand on a tugboat. After dropping out, he went on to become a captain, a riverboat pilot, and a successful businessman in Louisiana.

In 1991, Louisiana approved fifteen new riverboat casinos in New Orleans. Heitmeier seized the opportunity and set up a business to provide maritime crews to the new casinos. Heitmeier incorporated that business as Riverboat Services, Inc. in 1995 and was its sole shareholder. In 2001, a large casino company bought the Showboat Casino, one of Riverboat Services' clients. The company wanted to take its piloting in-house and approached Heitmeier to buy out Riverboat Services' contract with Showboat, and the former deckhand sold his contract for a $4 million payday. Heitmeier's happiness over his windfall quickly turned to anxiety about the potential tax bill. He was especially worried that the tax due would be at ordinary rates and contacted his tax adviser, who put Heitmeier in contact with Joe Garza, a dealer in variants of the notorious "Son-of-BOSS" tax shelters.

Garza's scheme involved a partnership to which his clients would transfer assets and liabilities. As a matter of economics, the liabilities would offset the value of the assets, but those liabilities wouldn't be completely fixed at the time of transfer, and the partners would ignore them in calculating their outside bases in that partnership. The partnership would also ignore the liabilities in computing its inside bases in the contributed property. Ignoring the liabilities in calculating basis created an inflated basis. When the partners liquidated their partnership interests, they would get a distribution of property to which they would attach this high basis in the partnership. And then when they sold that property, it would produce large tax, but not out-of-pocket, losses. The scheme pitched to Heitmeier included a complicated series of transactions involving multiple entities, purchasing Canadian dollars, and almost perfectly offsetting long and short options on Japanese yen.

Ellis Roussel (one of his regular tax advisors) and two other attorneys brought on to advise Heitmeier, Vince Giardina and Brian Leftwich, were all concerned about the deal's lack of profit motive and flimsy economic substance. Roussel, who had originally put Heitmeier in contact with Garza, refused to make any recommendation regarding whether Heitmeier should participate in the transaction. Giardina also refused to bless the arrangement and alerted Heitmeier that he might be exposed to an audit if he chose to proceed with the scheme. Leftwich ultimately decided that he didn't feel comfortable giving an opinion either way. Despite these warning signs, in late October 2001, Heitmeier decided to go forward with Garza's transaction.

Garza set up three entities, 8252 LLC, 94 LLC, and 436 Ltd. to facilitate the transactions. The 436 Ltd. partnership was the key to the operation, as the inflated basis from the currency transactions were reported as partnership items on the partnership's return, and the liquidation of 436 Ltd. purportedly passed through losses to offset the $4 million gain Heitmeier had from the sale of his riverboat contract.

The IRS audited the partnership's return under TEFRA and issued a notice of final partnership administrative adjustment (FPAA) to 436 Ltd. in September 2005. The FPAA adjusted the partnership's capital contributions and distributions to zero, effectively ruining the scheme, and assessed a gross-valuation misstatement penalty under Code Sec. 6662.


A gross-valuation misstatement exists if the value or adjusted basis of any property claimed on the partnership return is 400 percent or more of the correct amount (Code Sec. 6662(e)(1)(A)). Any underpayment of tax attributable to that gross-valuation misstatement is subject to a 40 percent penalty (Code Sec. 6662(h)(1)). A taxpayer can avoid this penalty if it is shown that there was a reasonable cause for the misstatement and that the taxpayer acted in good faith (Code Sec. 6664(c)). Taxpayers may argue that he or she had reasonable cause and showed good faith by relying on professional advice (Reg. Sec. 1.6664-4(c)).

The Tax Court noted that imposing a gross-valuation penalty on Heitmeier and 436 Ltd. was appropriate, as the transaction reported an artificially inflated basis in the foreign currency options in excess of 10,000 percent of the correct amount, which the court said was simply the $40,000 paid for the options.

The only issue left in dispute was whether Heitmeier had a Code Sec. 6664 reasonable cause and good faith defense for the gross-valuation misstatement penalty. Heitmeier claimed he had reasonably relied on the professional opinions of Jones, Roussel, Giardina, and Garza. The court noted the three factors for this defense established by prior caselaw:

(1) Was the adviser a competent professional who had sufficient expertise to justify reliance?

(2) Did the taxpayer provide necessary and accurate information to the adviser?

(3) Did the taxpayer actually rely in good faith on the adviser's judgment?

The court noted that Garza satisfied the first two factors as he was licensed and would have appeared competent, at least to non-tax lawyers, at the time the partnerships prepared their returns, and because the partnerships provided Garza with all the relevant financial data needed to assess the correct level of income tax.

However, the court noted that Heitmeier could not rely on Garza if he was a promoter of tax strategies because the advice of such promoters is necessarily self-interested. In another case involving a Garza tax scheme, the Tax Court defined a promoter as "an adviser who participated in structuring the transaction or is otherwise related to, has an interest in, or profits from the transaction."

The court found that Garza not only participated in structuring the transaction, but was responsible for arranging the entire deal. Garza had set up the LLCs and coordinated the deal from start to finish, and he testified that he profited from selling similar transactions to numerous other clients, not just Heitmeier. The court noted Garza wasn't being paid to evaluate the deal or tweak a real business deal to increase its tax advantages; he was being paid to make it happen. That made him a promoter, meaning Heitmeier could not have reasonably relied on his opinion.

Heitmeier's lack of good faith and reasonable reliance was even more apparent when the court considered the other professionals involved, each of whom refused to endorse the proposed transaction or provide any encouragement to Heitmeier other than advising him how to report it on his tax returns.

Because Heitmeier did not reasonably rely on professional advice to enter into Garza's transaction, the Tax Court upheld the IRS's assessment of a gross-valuation misstatement penalty.

For a discussion of tax penalties, see Parker Tax ¶262,100. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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