Celebration time at the IRS!

Did you hear that champagne cork pop from Washington, D.C.? I think we all did as this past week the Supreme Court denied certiorari in Coltec Industries, Inc. v. United States, 454 F.3d 1340 (Fed. Cir. 2006). The obvious question becomes - Now What?

Well first the obvious – The opinion as to Jade Trading should be coming out shortly and it should be in the favor of the government. This is not a difficult conclusion to make after all the Court of Claims is bound by the Federal Circuit and the parties had agreed to postpone the Court’s ruling until Coltec’s appeal. It appears that the Court just wanted to see the appeal run its course. Thus, for all those pending cases in the Court of Claims the outcome is pretty well settled and the only remaining question will be one of penalties.

The interesting question is what will the IRS do with it new toy? Well with the Son of Boss cases pending in the United States Tax Court, we can and should expect the IRS to seek to have the Coltec standard applied in these cases. That is, the worst kept secret is that the IRS was disappointed with the result in Salina v. Commissioner, T.C. Memo 2000-352. Yes, the the IRS did win its section 752 argument but Judge Jacob’s refused to accept the Coltec argument as submitted by the IRS. Rather, Judge Jacobs looked at the entire transaction for purposes of applying the economic substance doctrine. As stated in the opinion:

"Contrary to respondent's position, we decline to analyze the economic substance of the disputed transaction by focusing solely on events occurring during the period December 28 through 31, 1992. Segregating FPL's investment in Salina into two parts, as respondent suggests, would violate the principle that the economic substance of a transaction turns on a review of the entire transaction. See Kirchman v. Commissioner, supra at 1493-1494; Winn-Dixie Stores, Inc. v. Commissioner, supra at 280. Although we agree with respondent that Goldman Sachs structured FPL's purchase of the Salina partnership interest to provide FPL with a perceived tax benefit, this factor, standing alone, is insufficient to render the transaction a sham in substance. "

With Coltec out there, one should expect the IRS to try again and persuade the United States Tax Court to reconsider its position. Personally, I hope the entire Court visits the economic substance doctrine.  Even though I question various aspects of the Tax Court’s opinion in Estate of Bongard v. Commissioner, 124 T.C. 95 (2005), Bongard gave tax litigators and planners an opportunity to examine/reexamine the merits of family limited partnerships. I believe most tax litigators/tax planners would likewise want to hear the full court's views on economic substance.  Stated bluntly, the Court is a national forum and there is too much intellectual and judicial talent to have it spent on due process hearing cases and I want to hear, for better or for worse, what the full Court has to say on this important judical doctrine.

But if I were the IRS I would be very careful as to which cases I would seek to apply the Coltec standard. After all not all tax deferral mechanisms are tax shelters. For example, the IRS might be emboldened to bring out the Coltec standard in a LILO case. Yes, I am familiar with the case in North Carolina but that LILO case was the exception not the general rule. Most LILO cases involve legitimate factual issues. The IRS’s pointing to interest earning financial instruments while interest deductions are being claimed may not be sufficient - After all can we say UPS.

In United Parcel Service of America v. Commissioner, 254 F. 3d 1014 (11th Cir. 2001), the Eleventh Circuit in an eight page opinion disposed of the one hundred plus page opinion of the Tax Court. In the Eleventh Circuit’s opinion at page 1019, the Court stated:

“A “business purpose” does not mean a reason for a transaction that is free of tax considerations. Rather, a transaction has a “business purpose,” when we are talking about a going concern like UPS, as long as it figures in a bona fide, profit-seeking business. See ACM P'ship v. Comm'r, 157 F.3d 231, 251 (3d Cir.1998). This concept of “business purpose” is a necessary corollary to the venerable axiom that tax-planning is permissible. See Gregory v. Helvering, 293 U.S. 465, 469, 55 S.Ct. 266, 267, 79 L.Ed. 596 (1935) (“The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted.”).”

Thus, I would humbly submit that not even the Coltec standard could withstand the UPS standard if the facts involved an aggressive but legitimate LILO. As they say we shall see.

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