Third Circuit Court Of Appeals Affirm's Tax Court's Decision In Crispin v. Commissioner In Disallowing Losses From CARDS Transaction

Chalk up another economic substance doctrine win for the Service. This one from a three judge panel of the Third Circuit Court of Appeals, in affirming the Tax Court below, in Crispin v. Commissioner, 111 AFTR2d 2013-XXXX (2/25/2013).

The taxpayer in this case , Neal D. Crispin, a businessman-entrepreneur was involved in leasing, structured finance, aircraft acquisition and mortgaged back securities lending. He was a practicing CPA and experienced in tax matters, including tax shelters. He had invested in a "custom adjustable rate debt structure" or CARDS transaction which was designed to generate a substantial artificial ordinary loss deduction. The Service disagreed with the loss claimed an imposed an accuracy-related penalty under Section 6662. The Tax Court disallowed the claimed loss on the grounds that Crispin's CARDS transaction lacked economic substance and held that he could not avoid the penalty based on reasonable cause because he had not relied reasonably or in good faith on the advice of an independent and qualified tax professional. He was therefore saddled with a 40% gross valuation misstatement penalty. The Third Circuit affirmed.

Factual Background

For over 24 years, Crispin purchased and leased commercial aircraft through investment syndicates. The typical deal would involve his company's (S corporation) purchase of used aircraft with a cost between $1M and $10M and then leases the planes for 10 years before reselling them. In 2001, the year in issue, he planned on purchasing 3 aircraft through his S corporation which he owned 50-50 with another investor. Enter the CARDS transaction.

The Third Circuit referred to a CARDS transaction in less than glowing terms, i.e., a tax-avoidance scheme that was widely marketed to wealthy individuals during the 1990's and early 2000's. It purports to generate, through a series of pre-arranged steps, large "paper" losses deductible from ordinary income.

The general structure of a CARDS transaction is thoroughly explained in Gustashaw v. Commissioner, 696 F.3d 1124, 1127 [110 AFTR 2d 2012-6169]-28, 1130-31 (11th Cir. 2012). As a quick summary, first, a tax-indifferent party, such as a foreign entity not subject to United States taxation, borrows foreign currency from a foreign bank (a "CARDS Loan"). Then, a United States taxpayer purchases a small amount, such as 15%, of the borrowed foreign currency by assuming liability for a an equal amount of the CARDS Loan. The taxpayer also agrees to be jointly liable with the foreign borrower for the remainder of the CARDS Loan and so the taxpayer purports to establish a basis equal to the entire borrowed amount. Then, the taxpayer exchanges the foreign currency he purchased for U.S.dollars. That exchange is a taxable event, and the taxpayer claims a loss equal to the full amount of his supposed basis in the CARDS Loan, less the proceeds of the relatively small amount of currency actually exchanged. The taxpayer uses that loss to shelter unrelated income. CARDS marketing materials describe the transaction as providing "financing" to the taxpayer. However, there is no net cash available to the taxpayer, because the foreign bank requires that all of the currency purchased with the proceeds of the CARDS Loan (including the portion purchased by the taxpayer) remain at the bank as collateral for the CARDS Loan. The taxpayer only has access to the proceeds of the CARDS Loan if he delivers to the bank an equal amount of cash, cash equivalents, or other collateral acceptable to the bank.

The IRS, in Notice 2000-44, 2000-2 C.B. 255 (8/13/2000), placed the tax community on notice in 2000, prior to the events occurring in Crispin, supra, about claiming tax deductions sourced from artificial losses generated by inflated bases in certain assets. The Notice containing that warning said that the IRS would not recognize transactions that created an artificially high basis if they...