Mr. Rossman was recently in bankruptcy court.  It is hard to get tax debts discharged in bankurptcy.  They can’t be too recent and even if they are old, the IRS will sometimes argue that you were dodging the taxes and you won’t get a discharge.  Mr. Rossman’s troubles really trace back to one, in retrospect, bad decision in 1986.  He bought into the logic of pre-1987 tax shelters.  If you could find an investment that provided twice as much in deductions as your cash outlay, the investment was, in effect, free.  You could pay a balance due on your tax return and get nothing in return – other than the satisfaction of being a good citizen – or you could pay the same amount to a tax shelter promoter and get  ….  Well there were all sorts of things you might get.  An interest in an affordable housing project, an oil well, some cattle and enough grain to feed them for a year.  Sometimes the thing that you got only existed in the mind of the tax shelter promoter.

You didn’t have to look very hard to find deals like that.  As a matter of fact, if you had a really good income, the deals had a way of finding you.  I spent a lot of time on affordable housing shelters, because the firm that I worked for had a lot of dentists as clients.  That apparently ridiculous sentence made perfect sense in the environment of the early eighties.  The nice thing about affordable housing deals was that they actually worked.  The deals may have made some contribution to promoting affordable housing, although I sometimes suspected that their primary function was to serve as a white collar jobs program.

Mr. Rossman was a plaintiff’s attorney.  That business can have elements of feast or famine about it.  In 1985, his ship finally came in:

In 1985, one year before the onset of the investments which precipitated the current dispute with the IRS, Rossman recovered a $5 million dollar judgment in a case which rested on proof that fire engines were defectively designed and presented an unreasonable hazard to the firefighters who used them. According to the Debtor, the case resulted in a change to the design of fire engines. In conjunction with the action, Rossman received a substantial fee of approximately $900,000, a sum which dwarfed his previous, typical income of approximately $100,000 per year.

Mr. Rossman was sharing office space with a financial planner, so a way of sheltering his big score was quick to find him.  The promoters had some slick marketing material:

The marketing materials set forth significant tax benefits for investments in the partnerships, namely a 220% write-off in 1986 for a minimum 30-unit subscription for Rancho Madera Partners, and a 200% writeoff in 1986 for a 35-unit subscription for Vista Ag-Realty Partners. Prior to making any investments in the partnerships, Rossman consulted with his accountant, Paul Johnson (“Johnson”), a certified public accountant. Following his discussions with Robillard and Johnson, Rossman, in 1986, invested $200,000 in Rancho Madera Partners and $100,000 in Vista Ag-Realty Partners.

Here is what Mr. Rossman understood the investment to be:

The plan was that the land was being used – essentially it was being held and it was being used to raise crops and specifically grapes and other crops and with the idea that the land ultimately would be developed for shopping centers or shopping malls or sold to a developer who would use it for some other purpose and that there would be a large profit at the end.

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he write off was meaningless to me because I had – – the net effect on my taxes was $300,000. So I would either have paid the $300,000 – – had I not made the investment, I would have paid $300,000 more in taxes. I would have written the check; I had the money. I made this investment with the same $300,000 that I would have paid had I not made the investment.

That’s pretty much the way it worked, when it did work.  Instead of paying taxes you bought into something that deferred the taxes.  The expectation or hope was that the investment would provide the money to pay the taxes that had been deferred.  Apparently the deals that Mr. Rossman got in were problematical.  Like maybe there were not any actual grape vines anywhere.  At the end of the day, it was kind of a one for one write-off rather than a two for one write-off.

The Tax Court entered decisions in the Rancho Madera Partners and Vista Ag-Realty Partners cases on July 19, 2001, adjusting certain partnership items, resulting in the disallowance of approximately half of the losses reported on the partnership returns.

This is where Albert Einstein enters the case.  Note that the Tax Court decision was some fifteen years after the investment.  After the decision it took a little while for the IRS to sort out exactly what they thought Mr. Rossman owed.  The additional tax for 1986 was $157,132 which is roughly in line with his $300,000 being deductible at one for one rather than two for one.  Then there is the Albert Einstein piece – $658,607.89 in interest.  Actually it is likely that Albert Eintstein did not really say that compound interest is the most powerful force in the universe. I don’t care.  He should have said it.  Interest rates were a lot higher back then than they are now and because there was a tax shelter involved the Government gets bonus interest.

Mr.  Rossman did not have the odd eight hundred grand laying around in 2002 so another battle with the IRS commenced.  That didn’t work out so well either.  The details of the bankruptcy decision end up being an examination of Mr. Rossman’s life for the last couple of decades to determine whether he is a tax dodger or a big spender who was living high on the hog while not paying his tax bills.  You have a link to the case if you really want to know things like how much he spent on his daughter’s wedding.  (I’ve been encouraging my daughter to elope, when the time comes.)  Overall the Court seemed to think that Mr. Rossman was pretty much a mensch.

The Court finds that Rossman was a hardworking attorney and lobster fisherman. His commendable legal career involved representation of firefighters and police officers. His work experience demonstrated service to both his country and community. Moreover, his spending was both consistent with a middle or upper middle class lifestyle and his occupation and status in the community. The Court credits his testimony that his spending was motivated by the need and desire to take care of his family, which included a physically disabled son and a son with learning disabilities, as well as his wife’s elderly mother.

The IRS cannot sustain its burden by suggesting that taking care of one’s children, particularly those who are handicapped and disadvantaged by learning disabilities, expressed by a desire to provide them with the best possible education and other advantages (like mobility for a handicapped son via an appropriate vehicle) evidences willful evasion of taxes.

There was a problem, though.  Mr. Rossman had very high income in 2004 and 2005.  The Court concluded that he could have paid something towards the deficiency in those years. The Court ended up splitting the decision between him and the IRS.

In view of the foregoing, the Court shall enter judgment in favor of the IRS and against Rossman with respect to the 1986 underpayment of tax and any interest which is not the subject of the Tax Court case of Rossman v. Comm’r. With respect to the interest and TMT interest which Rossman has challenged or for which he has sought abatements, the Court finds that the IRS failed to satisfy its burden of establishing a willful attempt to evade or defeat those tax liabilities. Thus, The Court shall enter judgment in favor of Rossman and against the IRS with respect to those amounts.

The Third Circuit had a case with some similarities about a year ago.  The numbers were much more dramatic.  The taxpayer owed over $19,000,000 and he had been much more complicit not just using the shelters himself but also profiting from having sold them.  He was denied discharge largely on the ground that he could have paid something.  I’ll bet these cases are not the last of the hangover from pre-1987 tax shelters.  The most useful policy point is probaby that we don’t want marginal rates to creep much higher than they have and, if possible, it might be good if they were carved back.  From a practice viewpoint, they illustrate one of my fundamental laws of tax planning.  Sometimes it is better to just pay the taxes.