Tax shelter promoters cast a long shadow might be the lesson from last month’s Tax Court decision in the case of Clyde Arashiro. Walter J. Hoyt III died in 2007. His death was reported in the then-nascent tax blogosphere by two of its elder statesmen – Joe Kristan and Paul Caron. Hoyt was serving a long prison term from a 2001 conviction for an “investment scam that defrauded about 4,000 people in 41 states by selling them calves that did not exist.” Among the 4,000 or so was Clyde Arashiro who was recently in Tax Court over penalties assessed on his 1987, 1988, and 1989 returns.
What Are The Stakes?
Actually the stakes did not seem to be that high. And here I have to confess to not wanting to dig as hard as some of you might expect. The penalties are under 6653(a)(1)(A) – $770 – and 6661(a) – $3,854 – for 1987 and 1988 and under 6662(a) – $2,065 – for 1989. My desultory research, which I will not reproduce, makes me think that the penalty from 1989 bears interest, but that the earlier ones don’t. Maybe one of the commenters with more patience than I can give a definitive answer. The whole penalty scheme changed in 1989. According to calculator.com , the $2,065 would turn into $11,325.84 if it were paid as I write this thanks to the miracle of daily compounding.
The History
I have seen decisions concerning even older tax matters (My favorite is Harry Stonehill, whose estate was litigating deficiencies dating back over fifty years), but going on thirty years does seem to be like a bit much. Here is the rough chronology according to the Tax Court decision. The issues involved in Mr. Arashiro’s case relate to his investment Shorthorn Genetic Engineering 1984-A and Durham Shorthorn Breeding Syndicate 1987-D.
In 1988 Mr. Arashiro deducted over $45,000 in losses (nearly four times his cash investment) from the partnerships in spite of an IRS pre-filing warning with respect to at least one of them.
In December 1988 he received a notice from the IRS that his 1987 refund was reduced by $1,554.
On his 1988 and 1989 returns he reported losses of $30,270 and $42,390 respectively resulting in refunds of $3,430 and $4,469. I have to say that it really seems that Mr. Arashiro had more shelter than he really needed.
In 1995 while Tax Court litigation with Shorthorn was pending there was a draft closing agreement (Form 906) between the taxpayer and the IRS that limited his losses to his cash investment and provided for no penalties. In the Tax Court record, there is only an unsigned copy of the closing agreement.
On October 17, 2011 the Tax Court entered an order of dismissal on the Shorthorn case. Generally dismissal means a taxpayer loss, since it is always the taxpayer who comes to the Tax Court.
IRS mailed Mr. Arashiro a notice of deficiency which included the penalties on January 4, 2013.
How About That Gap?
In the order of dismissal, it is noted that Edwin McGifford had been the Tax Matters Partner for Shorthorn and that he had died on September 20, 2010. Nobody wanted to step into the breach. There was not much explanation as to why decades had gone by with the case in suspense.
Good Faith Reliance
One defense against penalties is good faith reliance on tax professionals. In the Tax Court’s view, Mr. Arashiro came up short in that regard.
Although we are mindful that petitioner had limited tax experience at the time he filed his returns, we conclude that his actions in relation to his investment in Shorthorn constituted a lack of due care and a failure to do what a reasonable and ordinarily prudent person would do under the circumstances. Most significantly, petitioner claimed deductions for the substantial losses from Shorthorn on his 1987, 1988, and 1989 returns despite his receipt in 1987 of a prefiling notification letter warning him that the IRS had identified Durham, a similar partnership promoted by the same organization, as an abusive tax shelter. Moreover, petitioner received a second letter from the IRS in late 1988 which reiterated that he could not claim any tax benefits from his investment in Durham. At the least, these letters should have caused petitioner to question the too-good-to-be-true nature of the tax benefits from the Shorthorn losses, which allowed him to claim deductions for losses of $36,324, $30,270, and $42,390 for 1987, 1988, and 1989, respectively, after investing (insofar as the record discloses) a mere $12,374 in Shorthorn during those years.7 Nevertheless, there is no evidence that petitioner made any attempt to independently investigate the propriety of these losses before filing his returns, even after receiving notifications that would have caused a reasonable person, in our view, to investigate further. Instead, he merely filed returns prepared for him by a Hoyt organization affiliate.
What About That Closing Agreement?
Lack of signatures by either the taxpayer or the IRS killed him when it came to the closing agreement.
We reject petitioner’s contention. The only copy of the closing agreement petitioner produced is not signed by either petitioner or a representative of respondent.8 Thus, accepting petitioner’s contention requires us to believe that he signed the closing agreement without making a copy of the signed version and instead–quite implausibly–made a copy of the agreement before signing it and retained that version. We are unpersuaded by petitioner’s self-serving testimony in this regard
Did He Get A Raw Deal?
I think if I had been the judge, I would have told the IRS that it just wasn’t right to penalize this guy after all those years. The purpose of penalties is to encourage compliance not rasie revenue and laying them on over twenty years late just does not do the trick. Of course, there are many reasons why I am not a Tax Court judge and now we have just added another. There are two morals here. One is that having the people who sell you the tax shelter be the ones to prepare your return is probably not a good idea. The other is that not only should you get it in writing. You should also make sure it is signed.
Other Coverage
Lew Taishoff had something titled “Sign On The Dotted Line” – Redivivus focusing on the unsigned closing agreement.
Make three copies, sign all three on the dotted line, keep one, send in the others to IRS, and make sure you get back a fully-signed duplicate original. Keep it in a safe place.
You might say that advice is an illustration of Reilly Fourth Law of Tax Planning – Execution isn’t everything but it’s a lot.