Son of Boss Abusive Tax Shelter

IRS DOCUMENTS

Son of Boss - IRS Press Release - August 11, 2000

IRS Notice 2000-44 - August 11, 2000

Treasury Guidance - September 23, 2003

Son of Boss Settlement Initiative - July 1, 2004

Son of Boss - Final Settlement Totals - March 24, 2005

1. TREASURY SHUTS DOWN "SON OF BOSS" ABUSIVE TAX SHELTER

August 11, 2000 LS-831

The Treasury Department and the Internal Revenue Service on Friday issued a notice to shut down another abusive tax shelter that is being marketed and sold. This new scheme is similar in design to the so-called Bond and Option Sales Strategy, or BOSS tax shelter, which the Treasury and IRS shut down last December with Notice 99-59.

"Despite these steps, the use of abusive tax schemes will continue to unfairly raise the tax burden on the American people," Treasury Secretary Lawrence H. Summers said. "Until we have an overall legislative solution in place, we are sure to see further generations of this and other abusive tax shelters."

As in the BOSS shelter, this new scheme uses a series of contrived steps (in this case involving interests in a partnership) to generate artificial tax losses designed to offset income from other transactions. Notice 2000-44 issued today would deny taxpayers the purported losses resulting from this shelter transaction because they do not represent bona fide losses reflecting actual economic consequences as required under the tax law. The notice informs taxpayers and promoters that appropriate penalties may be imposed on participants in these transactions. The notice also warns that taxpayers and promoters who participate in these transactions and willfully conceal their efforts on tax returns may be subject to criminal penalties.

Background

In one variant of this transaction, a taxpayer purchases a call option and simultaneously writes a similar offsetting call option. The offsetting option positions are then transferred to a partnership. Under the position advanced by the promoters of this arrangement, the taxpayer purports to have a positive basis in the partnership interest equal to the cost of the purchased call options, even though the taxpayer's net economic outlay to acquire the partnership interest and the value of the partnership interest are nominal or zero. This is because they claim that the taxpayer's basis in the partnership interest is not reduced for the partnership's assumption of the taxpayer's obligation with respect to the written call options. This artificially high tax basis in the partnership is then used to claim deductible losses (that can be used to shelter other income) by immediately selling the taxpayer's partnership interest, even though the taxpayer has incurred no corresponding economic loss.

2. IRS NOTICE 2000-44 (Son of Boss)

Author's Note: Notice 2000-44 was directly aimed at the Son of Boss Tax Shelter Transaction. See the press release Treasury Shuts Down "Son Of Boss" Abusive Tax Shelter issued on the same day.

Cumulative Bulletin Notice 2000-44, , 2000-2 CB 255, August 11, 2000.

In Notice 99-59 , 1999-52 I.R.B. 761, the Internal Revenue Service and the Treasury Department described certain transactions that were being marketed to taxpayers for the purpose of generating artificial tax losses. This notice concerns other similar transactions that purport to generate tax losses for taxpayers.

As stated in Notice 99-59 , a loss is allowable as a deduction for federal income tax purposes only if it is bona fide and reflects actual economic consequences. An artificial loss lacking economic substance is not allowable. See ACM Partnership v. Commissioner, 157 F.3d 231, 252 (3d Cir. 1998), cert. denied, 526 U.S. 1017 (1999) ("Tax losses such as these ... which do not correspond to any actual economic losses, do not constitute the type of 'bona fide' losses that are deductible under the Internal Revenue Code and regulations."); Scully v. United States, 840 F.2d 478, 486 (7th Cir. 1988) (to be deductible, a loss must be a "genuine economic loss"); Shoenberg v. Commissioner, 77 F.2d 446, 448 (8th Cir. 1935) (to be deductible, a loss must be "actual and real"); §1.165-1(b) of the Income Tax Regulations ("Only a bona fide loss is allowable. Substance and not mere form shall govern in determining a deductible loss.").

Notice 99-59 describes an arrangement that purported to give rise to deductible losses on disposition of stock by applying the rules relating to distributions of encumbered property to shareholders in order to create artificially high basis in the stock. The Service and the Treasury have become aware of similar arrangements that have been designed to produce noneconomic tax losses on the disposition of partnership interests. These arrangements purport to give taxpayers artificially high basis in partnership interests and thereby give rise to deductible losses on disposition of those partnership interests.

One variation involves a taxpayer's borrowing at a premium and a partnership's subsequent assumption of that indebtedness. As an example of this variation, a taxpayer may receive $3,000X in cash from a lender under a loan agreement that provides for an inflated stated rate of interest and a stated principal amount of only $2,000X. The taxpayer contributes the $3,000X to a partnership, and the partnership assumes the indebtedness. The partnership thereafter engages in investment activities. At a later time, the taxpayer sells the partnership interest.

Under the position advanced by the promoters of this arrangement, the taxpayer claims that only the stated principal amount of the indebtedness, $2,000X in this example, is considered a liability assumed by the partnership that is treated as a distribution of money to the taxpayer that reduces the basis of the taxpayer's partnership interest under §752 of the Internal Revenue Code . Therefore, disregarding any additional amounts the taxpayer may contribute to the partnership, transaction costs, and any income realized or expenses incurred at the partnership level, the taxpayer purports to have a basis in the partnership interest equal to the excess of the cash contributed over the stated principal amount of the indebtedness, even though the taxpayer's net economic outlay to acquire the partnership interest and the value of the partnership interest are nominal or zero. In this example, the taxpayer purports to have a basis in the partnership interest of $1,000X (the excess of the cash contributed ($3,000X) over the stated principal amount of the indebtedness ($2,000X)). On disposition of the partnership interest, the taxpayer claims a tax loss with respect to that basis amount, even though the taxpayer has incurred no corresponding economic loss.

In another variation, a taxpayer purchases and writes options and purports to create substantial positive basis in a partnership interest by transferring those option positions to a partnership. For example, a taxpayer might purchase call options for a cost of $1,000X and simultaneously write offsetting call options, with a slightly higher strike price but the same expiration date, for a premium of slightly less than $1,000X. Those option positions are then transferred to a partnership which, using additional amounts contributed to the partnership, may engage in investment activities.

Under the position advanced by the promoters of this arrangement, the taxpayer claims that the basis in the taxpayer's partnership interest is increased by the cost of the purchased call options but is not reduced under §752 as a result of the partnership's assumption of the taxpayer's obligation with respect to the written call options. Therefore, disregarding additional amounts contributed to the partnership, transaction costs, and any income realized and expenses incurred at the partnership level, the taxpayer purports to have a basis in the partnership interest equal to the cost of the purchased call options ($1,000X in this example), even though the taxpayer's net economic outlay to acquire the partnership interest and the value of the partnership interest are nominal or zero. On the disposition of the partnership interest, the taxpayer claims a tax loss ($1,000X in this example), even though the taxpayer has incurred no corresponding economic loss.

The purported losses resulting from the transactions described above do not represent bona fide losses reflecting actual economic consequences as required for purposes of §165 . The purported losses from these transactions (and from any similar arrangements designed to produce noneconomic tax losses by artificially overstating basis in partnership interests) are not allowable as deductions for federal income tax purposes. The purported tax benefits from these transactions may also be subject to disallowance under other provisions of the Code and regulations. In particular, the transactions may be subject to challenge under §752 , or under §1.701-2 or other anti-abuse rules. In addition, in the case of individuals, these transactions may be subject to challenge under §165(c)(2) . See Fox v. Commissioner, 82 T.C. 1001 (1984). Furthermore, tax losses from similar transactions designed to produce noneconomic tax losses by artificially overstating basis in corporate stock or other property are not allowable as deductions for federal income tax purposes.

Appropriate penalties may be imposed on participants in these transactions or, as applicable, on persons who participate in the promotion or reporting of these transactions, including the accuracy-related penalty under §6662 , the return preparer penalty under §6694 , the promoter penalty under §6700 , and the aiding and abetting penalty under §6701 .

Transactions that are the same as or substantially similar to the transactions described in this Notice 2000-44 are identified as "listed transactions" for the purposes of §1.6011-4T(b)(2) of the Temporary Income Tax Regulations and §301.6111-2T(b)(2) of the Temporary Procedure and Administration Regulations. See also §301.6112-1T , A-4. It should be noted that, independent of their classification as "listed transactions" for purposes of §§1.6011-4T(b)(2) and 301.6111 -2T(b)(2) , the transactions described in this Notice 2000-44 may already be subject to the tax shelter registration and list maintenance requirements of §§6111 and 6112 under the regulations issued in February 2000 (§§301.6111-2T and 301.6112 -1T , A-4), as well as the regulations issued in 1984 and amended in 1986 (§§301.6111-1T and 301.6112 -1T , A-3). Persons required to register these tax shelters who have failed to register the shelters may be subject to the penalty under §6707(a) and to the penalty under §6708(a) if the requirements of §6112 are not satisfied.

In addition, the Service and the Treasury have learned that certain persons who have promoted participation in transactions described in this notice have encouraged individual taxpayers to participate in such transactions in a manner designed to avoid the reporting of large capital gains from unrelated transactions on their individual income tax returns (Form 1040). Certain promoters have recommended that taxpayers participate in these transactions through grantor trusts and use the same grantor trusts as vehicles to realize the capital gains. Further, although each separate capital gain and loss attributable to a portion of a trust that is treated as owned by a grantor under the grantor trust provisions of the Code (§671 and following) is properly reported as a separate item on the grantor's individual income tax return (see §1.671-2(c) and the Instructions to Form 1041, U.S. Income Tax Return for Estates and Trusts), the Service and the Treasury understand that these promoters have advised that the capital gains and losses from these transactions may be netted, so that only a small net capital gain or loss is reported on the taxpayer's individual income tax return. In addition to other penalties, any person who willfully conceals the amount of capital gains and losses in this manner, or who willfully counsels or advises such concealment, may be guilty of a criminal offense under §§7201 , 7203 , 7206 , or 7212(a) or other provisions of federal law.

The principal authors of this notice are David A. Shulman of the Office of Associate Chief Counsel (Passthroughs and Special Industries) and Victoria S. Balacek of the Office of Associate Chief Counsel (Financial Instruments and Products). For further information regarding this notice, contact Mr. Shulman at (202) 622-3080 or Ms. Balacek at (202) 622-3930 (not toll free calls).

3. TREASURY ISSUES GUIDANCE ON PARTNERSHIP ABUSES - Son of Boss Transactions

June 23, 2003 JS-493

Today the Treasury Department and the Internal Revenue Service issued regulations dealing with a tax shelter commonly known as "Son of Boss." The regulations address the tax treatment of the assumption of certain obligations by a partnership from a partner. The regulations ensure that temporary or permanent non-economic tax losses cannot be created by transferring these obligations to partnerships.

"These regulations are part of our increased efforts to shut down abusive tax shelter transactions," stated Treasury Assistant Secretary for Tax Policy Pam Olson. "In Notice 2000-44, we warned that these Son of Boss transactions didn't work. Nevertheless, we understand that some promoters have continued to pitch them. The regulations will remove any question that the transactions do not produce the results claimed by the promoters of the transactions."

In one variation of a 'Son of Boss' transaction, a taxpayer purchases and writes economically offsetting options and then purports to create substantial positive basis by transferring those option positions to a partnership. On the disposition of the partnership interest, the liquidation of the partnership, or the taxpayer's sale or depreciation of distributed partnership assets, the taxpayer claims a tax loss, even though the taxpayer has incurred no corresponding economic loss.

For example, assume that taxpayer A issues and purchases options to acquire stock in Corporation X. A pays $100 for the option to acquire X stock and receives $100 on the issuance of the option to acquire X stock. A then contributes to a partnership the $100 A received on the sale of the option, and the partnership assumes A's obligation to satisfy the option that A has issued. The value of A's interest in the partnership is $0. However, some taxpayers have argued that A's basis in the partnership is $100, because A's basis in the partnership interest is not reduced by the amount of the option obligation assumed by the partnership. A then sells his partnership interest for $0 and claims a $100 loss.

The regulations address this transaction by requiring A to reduce his basis in the partnership by the amount of the assumed option obligation. In accordance with legislation granting Treasury authority to issue these regulations, the regulations apply to assumptions by partnerships occurring on or after October 19, 1999.

The temporary and proposed regulations are attached.

4. STRONG RESPONSE TO "SON OF BOSS" SETTLEMENT INITIATIVE

IR-2004-87, July 1, 2004

WASHINGTON - The Internal Revenue Service announced today a strong turnout by taxpayers to settle a tax shelter commonly known as "Son of Boss." More than 1,500 taxpayers filed Notices of Election by the June 21 deadline.

"By any measure, this is a strong response from taxpayers entangled in Son of Boss transactions," said IRS Commissioner Mark W. Everson. "Those who elected to settle did the right thing. We have already begun to contact the taxpayers who didn't take us up on the offer and expect to begin enforcement action soon." The IRS announced the Son of Boss settlement initiative on May 5 to encourage people to settle before IRS enforcement action. The IRS is aware of transactions involving estimated understatements of tax in excess of $6 billion, not including interest and penalties.

Under the terms of the settlement, taxpayers must concede all the claimed tax losses, must pay all applicable interest and must pay a penalty unless they previously disclosed their participation in the transaction. Participating taxpayers will be allowed to deduct as a loss their out-of-pocket transaction costs, typically promoter and professional fees. Taxpayers not participating in the settlement will soon receive a statutory notice of deficiency (90-day letter) disallowing all losses and out-of-pocket costs and will be assessed maximum applicable penalties, up to 40 percent.

The IRS continues to identify new Son of Boss and other abusive transaction participants through investor lists obtained in IRS promoter investigations and successful summons enforcement actions by the Department of Justice. This year, the IRS has uncovered at least 500 previously undisclosed Son of Boss transactions. "We will vigorously pursue all those who participated in Son of Boss deals but did not take advantage of the settlement initiative," Everson said. Highlights of an initial review of the applications show:

* About 85 percent of the taxpayers known to the IRS filed elections to settle.

* Many of those taxpayers had transactions generating tax losses of between $10 million and $50 million. In several cases, the tax losses claimed were greater than $500 million. About two-thirds of those electing face either a 10 or 20 percent penalty - depending on whether they had been involved in other abusive shelters.

* More than 300 taxpayers who were previously unknown have come forward. The IRS believes these elections will help lead to additional promoters and investors in Son of Boss-type shelters and additional taxpayers that participated in these and other abusive transactions.

For taxpayers who filed elections to settle, a variety of steps will unfold during the next several months. Following information exchanges, the taxpayers must sign the formal settlement documents and pay all monies due. The IRS will not know the total amount of tax, interest and penalties involved until after investors have provided relevant information that will be reviewed during the next several months.

"For those who haven't come forward and intend to take the IRS to court, we plan an aggressive litigation strategy," said IRS Chief Counsel Don Korb. "The word is getting out that there won't be a better deal waiting if people take these cases to court."

Son of Boss was aggressively marketed in the late 1990s and 2000 to companies and wealthy individuals by a network of law firms, accounting firms and investment banks. In August 2000, the IRS issued Notice 2000-44 declaring the transactions abusive and requiring promoters to maintain a list of investors.

5. IRS COLLECTS $3.2 BILLION FROM SON OF BOSS - Final Figure Should Top $3.5 Billion

IR-2005-37, March 24, 2005

WASHINGTON - The Internal Revenue Service announced today that taxpayers participating in the Son of Boss tax shelter settlement have so far paid in more than $3.2 billion, a figure that should top $3.5 billion when the project concludes in coming months.

Son of Boss was an abusive transaction aggressively marketed in the late 1990s and 2000 primarily to wealthy individuals. The settlement initiative required taxpayers to concede 100 percent of the claimed tax losses and pay a penalty of either 10 percent or 20 percent unless they previously disclosed the transactions to the IRS.

"This was a particularly bad shelter, and we're glad so many chose to get right with the government," said IRS Commissioner Mark W. Everson. "Despite the tough terms we offered, two-thirds of Son of Boss participants have come forward and paid up." So far, $3.2 billion in taxes, interest and penalties have been collected from the 1,165 taxpayers who are participating in the settlement initiative. The typical taxpayer payment was almost $1 million, with 18 taxpayers paying more than $20 million each and one paying over $100 million. Processing of individual settlements continues.

Based on disclosures the IRS has received from promoter investigations and from investor lists from Justice Department litigation, the agency has determined that just over 1,800 people participated in Son of Boss. "For those who didn't come forward, we know who they are," Everson said. "We are going after them." Participants not taking part in the settlement initiative have or will shortly receive a deficiency notice from the IRS disallowing all claimed tax losses and transaction costs. They will also be assessed the maximum applicable penalty -- 40 percent. Their choice now will be either to settle with the IRS by paying the higher amounts or litigate their cases in court. "The IRS's legal position on this abusive transaction is strong," IRS Chief Counsel Don Korb said. "It's our belief that taxpayers who did not participate in the settlement will rue the day they made that decision."

The Son of Boss initiative is part of a broader enforcement effort at the IRS, including eradicating abusive tax shelter deals and cracking down on those who promoted them. This effort includes increased audit activity of taxpayers and promoters; expanded criminal investigations; a new focus on professional ethics and responsibility through the IRS Office of Professional Responsibility; designating appropriate tax cases for litigation; and offering targeted settlement initiatives.

Following the Son of Boss initiative, a new settlement program involving an abusive transaction of stock option transfers by executives to family controlled entities was announced last month. Taxpayers have until May 23 to come forward to participate in that initiative.

Key congressional committees have worked with the IRS on the continuing efforts to combat abusive tax shelters, particularly the Senate Finance Committee and the Senate Governmental Affairs Permanent Subcommittee on Investigations."We appreciate the continued support from Congress on our tax shelter efforts," Everson said. "In particular, I want to thank Chairman Grassley and Sen. Baucus as well as Sen. Levin and Sen. Coleman for championing shelter initiatives."

States Benefit from Son of Boss initiative

States will also benefit from the Son of Boss initiative, part of a larger partnership between the IRS and the states. Many taxpayers who filed Son of Boss elections also are amending their state tax returns. Arizona, Illinois, Maine, Maryland, Michigan, New York, Ohio, Utah and Virginia are among the states initially benefiting from the initiative and have collected more than $23.5 million from voluntary state tax return amendments.

In addition, the IRS information shared with the states has, to date, resulted in $161 million in disallowed losses claimed and assessments of nearly $16 million in taxes, interest and penalties for Colorado, Connecticut, Maine, Maryland, Missouri, North Dakota, Pennsylvania, Utah and Virginia combined. More states are expected to show significant benefits as the initiative progresses.

On a separate track, some states have been pursuing Son of Boss participants through their own programs. "IRS efforts to share information on their Son of Boss initiative with the states is just one more example of the reinvigorated effort of IRS and the states to work together to combat abusive tax transactions," said Harley T. Duncan, executive director of the Federation of Tax Administrators, an association representing tax administration agencies in the 50 states, the District of Columbia and New York City. "We're excited by the results, and these efforts send a very clear message that engaging in abusive transactions has consequences at the federal, state and local levels."

[End of IRS Articles]

For additional information, check out:

Treasury Issues Guidance on Partnership Abuses

Son of Boss Scheme

Government Wins First Son of BOSS Case to be Tried

U.S. Loses Son of Boss Tax Case