Government Loses Son of Boss Tax Shelter Case

By Alistair M. Nevius, J.D.

In a rare tax shelter loss for the IRS, a federal district court has allowed a taxpayer to offset income with losses from a “son of boss” transaction (Sala, No. 05-cv-00636-LTB (D.C. Colo. 4/22/08)).

The taxpayer in the case had over $60 million in income in 2000 but claimed losses on various long and short options on foreign currencies that virtually eliminated his tax liability. The Service sought to characterize these transactions as fraudulent but lost on that issue in an earlier round of litigation (Sala, No. 05-cv-00636-LTB-PAC (D.C. Colo. 5/1/07)). The IRS then sought to use the Sec. 752 regulations to portray the transactions as lacking in business purpose and having no profit potential.

The Service focused on one portion of the investments in one year (2000) to argue that the taxpayer entered into the transactions purely as a tax dodge. However, the court disagreed. The court looked at all the taxpayer’s transactions over a five-year period—including transactions that had no tax benefit—and held that the taxpayer had a “reasonable possibility of profits beyond the tax benefits” and had a “business purpose other than tax avoidance.”

Furthermore, the court held that the government could not retroactively apply the Sec. 752 regulations to the taxpayer’s case (the regulations were finalized in 2003). Under Sec. 7805, regulations may be applied retroactively only in very specific situations. Instead, the court found the Sec. 752 regulations to be “overly broad” and not to be legislative regulations requiring deference under Chevron U.S.A., Inc. v. Natural Resource Defense Council, Inc., 467 US 837 (1984). The court characterized the Sec. 752 regulations as “Treasury’s attempt to legislate” and “an attempt to bootstrap the government’s litigating position with respect to ‘Son of Boss’ cases.” The court therefore held Regs. Sec. 1.752-6 to be unlawful and set it aside. (However, the regulations had earlier been upheld by the Seventh Circuit in Cemco Investors LLC, No. 07-2220 (7th Cir. 2/7/08).)

Not surprisingly, IRS Chief Counsel Donald Korb has announced that the Sala case will not affect the Service’s (generally successful) litigation strategy in tax shelter cases (2008 TNT 80-1, Doc. 2008-9063). 

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