Filed: Jul. 03, 2018
Latest Update: Nov. 14, 2018
Summary: T.C. Memo. 2018-101 UNITED STATES TAX COURT GREGORY RAIFMAN AND SUSAN RAIFMAN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 3897-14. Filed July 3, 2018. Brian G. Isaacson, for petitioners. Aimee R. Lobo-Berg and Catherine J. Caballero, for respondent. MEMORANDUM FINDINGS OF FACT AND OPINION NEGA, Judge: By notice of deficiency dated November 21, 2013, respondent determined deficiencies in the Federal income tax of petitioners, -2- [*2] Gregory and Susan Raifman, for t
Summary: T.C. Memo. 2018-101 UNITED STATES TAX COURT GREGORY RAIFMAN AND SUSAN RAIFMAN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 3897-14. Filed July 3, 2018. Brian G. Isaacson, for petitioners. Aimee R. Lobo-Berg and Catherine J. Caballero, for respondent. MEMORANDUM FINDINGS OF FACT AND OPINION NEGA, Judge: By notice of deficiency dated November 21, 2013, respondent determined deficiencies in the Federal income tax of petitioners, -2- [*2] Gregory and Susan Raifman, for ta..
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T.C. Memo. 2018-101
UNITED STATES TAX COURT
GREGORY RAIFMAN AND SUSAN RAIFMAN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 3897-14. Filed July 3, 2018.
Brian G. Isaacson, for petitioners.
Aimee R. Lobo-Berg and Catherine J. Caballero, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
NEGA, Judge: By notice of deficiency dated November 21, 2013,
respondent determined deficiencies in the Federal income tax of petitioners,
-2-
[*2] Gregory and Susan Raifman, for taxable years 2004, 2005, 2006, and 2008
(years at issue) and accuracy-related penalties under section 6662 as follows:1
Penalty
Year Deficiency sec. 6662(a)
2004 $849,029 $169,806
2005 184,489 36,898
2006 221,279 44,256
2008 16,509 3,301
The Raifmans timely petitioned this Court for redetermination.2
1
Unless otherwise indicated, all section references are to the Internal
Revenue Code (Code) in effect for the years at issue. All Rule references are to
the Tax Court Rules of Practice and Procedure. All monetary amounts are
rounded to the nearest dollar.
2
The Raifmans have a related case before this Court: Raifman v.
Commissioner, docket No. 12144-11L (CDP case). The CDP case results from
respondent’s attempt to collect the Raifmans’ unpaid tax for 2003. There the
Raifmans claimed entitlement to theft loss deductions for 2006 that, if sustained,
they intend to carry back to 2003 to eliminate their unpaid tax balance. See, e.g.,
sec. 172(a), (b)(1)(E), (d)(4).
On September 20, 2011, respondent filed a motion for summary judgment
(motion) in that case, arguing, as relevant here, that the Raifmans’ sale of stock
did not result in a deductible theft loss. On August 7, 2012, this Court released
Raifman v. Commissioner, T.C. Memo. 2012-228, wherein we declined to grant
respondent’s motion and held that disputed issues of material fact necessitated
trial.
On April 29, 2016, the parties filed a joint stipulation to be bound with
respect to the CDP case. In the stipulation to be bound the parties agreed that the
outcome of the present case will resolve all issues presented in the CDP case.
(continued...)
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[*3] After concessions and stipulations,3 the issues remaining for decision are
2
(...continued)
Accordingly, on June 20, 2016, upon due consideration of the parties’ stipulations,
we ordered that the CDP case be held in abeyance pending the entry of decision in
the present case.
3
The Raifmans have stipulated or did not address--at trial or on brief--a
number of adjustments determined in the notice of deficiency. Accordingly, the
Raifmans have, or are deemed to have, conceded the following issues and
adjustments. See Rule 34(b)(4); Mendes v. Commissioner, 121 T.C. 308, 312-313
(2003); Leahy v. Commissioner,
87 T.C. 56, 73-74 (1986).
For 2004: a $4,970,743 increase in capital gains; a $35,034 reduction in a
deduction for mortgage interest claimed on Schedule A, Itemized Deductions; a
$305,631 reduction in a claimed deduction for investment interest claimed on
Schedule A; and the denial of a deduction of $3,005 claimed on Schedule F, Profit
or Loss From Farming.
For 2005: a $51,749 reduction in a claimed mortgage interest deduction and
a $593,784 reduction in a claimed investment interest deduction.
For 2006: a $664,384 reduction in a claimed investment interest deduction
and a $79,411 increase to income to reflect the unreported receipt of a State tax
refund.
For 2008: various computational adjustments.
The Raifmans, however, did not concede their dispute with respect to the
statutory interest determined in the notice of deficiency. We observe that this
Court’s jurisdiction to redetermine a tax deficiency does not permit the Court to
review or abate statutory interest absent the taxpayer first exhausting his or her
otherwise available administrative remedies. Sec. 6404(h); Rule 280; Bourekis v.
Commissioner, 110 T.C. 20, 26 (1998); cf. Bennett v. Commissioner, T.C. Memo.
2017-243, at *6-*9. The Raifmans neither alleged receipt of, nor entered into evi-
dence, any final determination wherein respondent rejects their request for abate-
ment of interest. Similarly, the Raifmans neither alleged nor entered into evidence
any proof that they have even filed for or otherwise formally requested from
respondent an abatement of interest. Accordingly, we hold that this Court lacks
jurisdiction to hear the Raifmans’ attempt to seek a redetermination of interest
under sec. 6404(h). See Carter v. Commissioner, T.C. Memo. 2014-142, at *5.
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[*4] whether the Raifmans are: (1) entitled to deduct theft losses totaling
$10,798,061 for their 2008 tax year;4 (2) entitled to a long-term capital loss
deduction of $400,000 for their 20085 tax year; and (3) liable for the section
6662(a) accuracy-related penalty for each of the years at issue.
4
The notice of deficiency disallowed a $15,160,607 theft loss deduction for
for the Raifmans’ tax year 2008.
In their petition the Raifmans revised their claimed theft losses to reflect the
amount above. This amount remaining at issue comprises a $3,750,000 loss
arising from their participation in the Derivium program; a $2,475,000 loss arising
from their participation in the ClassicStar program; a $1,934,084 loss arising from
their investment in the Real Return Fund; and a loss of $2,638,977 arising from
their investment in the Secured Lending Fund.
5
The Raifmans initially claimed this $400,000 loss deduction as a
component of their $15,160,607 theft loss deduction claimed for tax year 2008. In
the notice of deficiency, respondent disallowed any deduction for the full amount
of that theft loss. The Raifmans now argue this $400,000 amount was a properly
deductible capital loss for their tax year 2009. The Raifmans’ 2009 tax year,
however, is not before the Court. Additionally, we find the record lacks facts
sufficient to enable us to consider the implications of the Raifmans’ 2009 tax year
with respect to our redetermination of the deficiencies properly before this Court.
See Hill v. Commissioner, 95 T.C. 437, 439-440 (1990). Accordingly, our
jurisdiction over this loss extends only to reach the claim made on the Raifmans’
2008 tax return.
We observe that the Raifmans have also claimed this loss deduction in a
parallel refund suit brought before the U.S. Court of Federal Claims, with respect
to their tax year 2009. On May 15, 2014, the U.S. Court of Federal Claims stayed
all proceedings in that case until this Court renders a decision in the present
matter.
-5-
[*5] FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The stipulation of
facts and the attached exhibits are incorporated herein by this reference. The
Raifmans6 were married and resided in California at all times relevant to this case.
I. The Beginning
A. Background
Mr. Raifman is a graduate of the University of Michigan and the
Georgetown University Law Center, where he earned a bachelor of arts degree in
economics and history and a juris doctorate, respectively. Mr. Raifman began his
professional career as a judicial law clerk serving the U.S. District Court for the
Southern District of Georgia. Following his clerkship, Mr. Raifman took
successive positions at the law firms of Latham and Watkins, and Skadden, Arps,
Meagher and Flom. At those firms Mr. Raifman gained significant exposure to,
and practiced in, the fields of high-yield debt financing, “hostile takeovers”, and
corporate mergers and acquisitions. Mr. Raifman developed skills in these fields,
6
The Raifmans engaged in the transactions discussed herein both personally
and by way of wholly owned pass-through entities, notably Helicon Ltd.
(Helicon), their entity organized in the Cayman Islands, and the Gekko Group,
LLC, or Gekko Holdings, LLC (Gekko). For clarity we distinguish the individual
Raifmans, Gekko, and Helicon only where necessary. We otherwise refer to all as
the Raifmans.
-6-
[*6] and in due time he pivoted his legal career to focus his work therein: first by
taking a position as counsel at Montgomery Securities, where he specialized in
facilitating initial and secondary public offerings for his clients, and later by
founding his own law firm and numerous venture capital investment and advisory
firms primarily dedicated to investing in computing and information technologies
and the legal issues arising therefrom.
It was Mr. Raifman’s work in the capital markets and the technology field
that led him to found Mediaplex, Inc. (Mediaplex). Mr. Raifman served as
president, CEO, and outside legal counsel of Mediaplex, and in each role he was
compensated by way of stock and options.
Mrs. Raifman graduated from Barnard College, where she received a
bachelor of arts degree in English. She subsequently earned master’s degrees in
both business administration and urban planning from the University of California,
Los Angeles. Mrs. Raifman, like her husband, experienced success in the
corporate world, where she was an executive in marketing and promotions for a
number of public companies before later taking a similar role at Mediaplex.
In the fourth quarter of 1999 Mr. Raifman guided Mediaplex’s initial public
offering. Mediaplex shares debuted to significant market demand and were at one
point valued as high as $104 per share. At that time the Raifmans owned roughly
-7-
[*7] 46.5% of Mediaplex, and as a result of the market’s valuation of Mediaplex,
the couple’s wealth was significantly bolstered during that initial offering period.
The Raifmans, however, were unable to immediately capitalize on Mediaplex’s
success as their holdings were restricted and not readily marketable. Shortly after
Mediaplex went public, the internet and technology markets tumbled, and as a
result the per-share value of Mediaplex stock dropped below a dollar.
In October 2001 Valueclick, Inc., a competing internet advertising firm,
purchased Mediaplex. As a result of that purchase, approximately 2 million of the
Raifmans’ Mediaplex shares were converted to interests in Valueclick. Valueclick
retained Mr. Raifman’s services as a member of the Valueclick board of directors
and, as part of his compensation for performing in this role, provided him over
600,000 nonqualified options for the purchase of Valueclick stock.
By 2003 the couple’s personal and professional lives began to evolve: Mrs.
Raifman had left the workforce, and Mr. Raifman had resigned from his position
on the Valueclick board. In tendering his resignation Mr. Raifman exercised his
nonqualified stock options, purchasing 668,363 shares of Valueclick stock at
$1.22 per share. As the market price at that time was roughly $3.43 per share, the
Raifmans realized ordinary income of $2.21 per share, or $1,476,480 total.
-8-
[*8] Mr. Raifman did not consult with any professional advisers or tax
professionals before exercising his nonqualified options.
B. Objectives
Following the exercise of the Valueclick options, the Raifmans wished to
manage their wealth in a sustainable manner that would generate an income stream
sufficient to sustain their then-current lifestyle for the remainder of their lives. To
this end, the Raifmans envisioned the assembly of a portfolio that would function
as their personal “endowment”, providing them annual disposable income of
approximately $400,000 net of all expenses and taxes and generating 10% annual
growth. The Raifmans were aware, however, of the fact that nearly all of their
wealth was concentrated in Valueclick stock. Informed by their earlier experience
with Mediaplex, the Raifmans knew that a portfolio composed of positions
concentrated in a single company posed a hazard to one’s wealth and that to
manage their wealth in a manner sufficient to meet their objectives their
investment portfolio required diversity.
The Raifmans began to seek help in developing their course of action.
Initially they turned to family friend and neighbor Steve Glaser. Mr. Glaser was a
former auditor who was operating a catering company while moonlighting as a
financial consultant. Mr. Glaser informed the Raifmans that they would need to
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[*9] initially fund their “endowment” with, at minimum, $10 million. Mr. Glaser
possessed neither the means nor wherewithal to deliver them the substance of their
objectives, but believed he knew someone that did possess such ability and means:
Joe Ramos.
Both Mr. Glaser and Mr. Ramos had previously worked for Arthur
Andersen, where Mr. Glaser had supervised Mr. Ramos’ work as an auditor. Mr.
Ramos was a licensed certified public accountant (C.P.A.) during his employment
at Arthur Andersen, but by summer 2003 his career trajectory had turned toward
the securities brokerage and financial planning industries. Although Mr. Ramos
had allowed his C.P.A. licence to lapse, he was a certified financial planner and
operated his own investment advising firm: Ramos Financial d.b.a. Private
Capital Management (Ramos Financial). Mr. Glaser knew that Mr. Ramos’
financial planning practice catered to high net worth individuals and used unique
means and methods for meeting client objectives. For these reasons Mr. Glasser
recommended that the Raifmans meet with Mr. Ramos.
While Mr. Ramos independently owned and operated Ramos Financial, he
was also a “managing director”--an affiliate or, functionally, a franchisee--of the
Private Consulting Group (PCG). PCG was an investment advisory and securities
brokerage firm founded by Robert Keys in the late nineties. Robert Keys designed
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[*10] PCG to cater to the interests of high net worth individuals and did so by
offering, in addition to standard brokerage and advising services, access to
designer opportunities for the empowerment of one’s “true wealth”. Notably,
PCG provided its clients access to numerous opportunities that enabled clients to
“reduce, defer, and in some cases avoid” tax and to transform these tax efficiencies
into additional sources of income, wealth, and equity.7
7
To this end, PCG offered a variety of tax efficiency strategies each tailored
to address the spectrum of issues that PCG had found to routinely cause client
concern. For the client interested in liquidating appreciated stock, PCG offered
tax-efficient methods of asset monetization that could convert the client’s “paper
profits” to currency. For the client concerned with retirement, PCG offered access
to a “tax-to-equity conversion” plan designed to recover the client’s income tax
paid for prior years and place that recovered tax into “exclusive vehicles” to fund
the client’s retirement. For the client concerned about estate tax and asset
protection, PCG offered access to leaders in the field of establishing offshore
“tax-advantaged” vehicles designed to protect an individual’s wealth from
“unscrupulous creditors and frivolous lawsuits” and minimize if not eliminate tax.
Should these strategies appear suspect to skeptical potential clients, PCG
offered comfort, noting that “many” of its true wealth strategies had received a
“should” or “more likely than not” tax opinion from a “major” accounting firm or
law firm. Additionally, PCG boasted that the “wealth design” professionals in its
affiliated network--advisers, lawyers, and accountants--were intimately familiar
with successfully implementing PCG’s true wealth strategies, and would be at the
immediate disposal of PCG, its franchisees, and their clients as necessary.
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[*11] C. Mr. Ramos and His Plans
1. The Derivium Program
Before meeting the Raifmans, Mr. Ramos had been briefed by Mr. Glaser
with respect to the Raifmans’ objectives. Accordingly, Mr. Ramos prepared a
customized presentation identifying the strategies he believed best suited to
provide the desired results. In July 2003 Mr. Ramos, armed with this presentation
and his PCG-affiliate marketing materials, met with the Raifmans and pitched to
them a variety of proposals and investing strategies that ranged from the
conservative to the nontraditional. Mr. Ramos reviewed each proposal in detail
with Mr. Raifman and Mr. Glaser, and the three collaborated in weighing the risks
and rewards of each proposed strategy. Of these Ramos proposals, Mr. Raifman
was particularly intrigued by a nontraditional “loan”-based strategy proposed by
Mr. Ramos: the 90% stock “loan” program (Derivium8 program).
Mr. Ramos was introduced to the Derivium program through his affiliation
with PCG. Derivium was one of PCG’s strategic alliance partners, and
8
Derivium Capital, LLC, Derivium USA, Bancroft Ventures, Witco
Services, Ltd., and Optech, Ltd., were entities directly related to Charles Cathcart
and were the brand names under which Mr. Cathcart peddled the 90% stock loan
program. See Grayson Consulting, Inc. v. Wachovia Sec., LLC (In re Derivium
Capital, LLC), 716 F.3d 355, 359 (4th Cir. 2013); General Holding, Inc. v.
Cathcart,
2009 U.S. Dist. LEXIS 130777, at *12-*14 (D.S.C. July 29, 2009). For
clarity we refer to all as Derivium.
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[*12] implementing the Derivium program’s asset monetization strategy was
integral to effecting a tax-efficient, true wealth optimization plan for PCG’s
clients.
The Derivium program was tailored toward individuals, such as the
Raifmans, who held concentrated positions in a single marketable stock and
wished to generate liquidity without triggering a taxable event. The Derivium
program facilitated this monetization of stock by “lending” program participants
up to 90% of their stock’s fair market value. In return participants would
surrender to Derivium the ostensibly leveraged stock as “collateral” and would
accrue interest on the loan principal over the life of the loan.9 Participants were
prohibited from making any payments before loan maturity and, similarly,
Derivium was prohibited from calling the loan before maturity. Most importantly,
the loans were nonrecourse to the participant.
Because a Derivium loan was nonrecourse, a participant had no personal
liability for principal or interest and could instead choose--for example, should the
9
Accordingly, the terms of the program agreement provided Derivium the
unfettered right and power to “assign, transfer, pledge, repledge, hypothecate,
rehypothecate, lend, encumber, short sell, and/or sell outright some or all of” the
collateral during the loan term.
To the extent relevant, the record before us establishes that Derivium’s
hedging strategy consisted of investing in startups founded or run by individuals
related to the principals of Derivium. These startups eventually failed.
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[*13] value of the participant’s stock drop over the agreement’s term--to default
and cede the collateral to Derivium. Alternatively, upon maturity of the loan,
participants could pay their balance due and request return of their collateral, or
renew and refinance the loan for an additional term in order to monetize any
appreciation of the collateral that occurred during the initial loan term. (We will
refer collectively to these three choices as the alternatives to payment.)
Mr. Raifman and Mr. Glaser recognized that the Derivium program featured
an inherent risk, specifically, the sustainability of its operations and its ability to
perform on its potential obligations related to the Raifmans’ alternatives to
payment. Mr. Ramos explained that he, too, was initially skeptical with respect to
Derivium’s proprietary hedging “strategy” and readily admitted he was not privy
to any specific details or mechanics of Derivium’s proprietary hedging strategy,
but he noted that, all sustainability risks considered, the present value of the tax
savings and rate arbitrage10 promised by the Derivium program functionally
eliminated the Raifmans’ exposure to risk.
10
That is, these presumably tax-free loan proceeds would enable the
Raifmans to currently monetize 90 cents on the fair market value dollar of their
Valueclick stock, far better than the estimated 75 cents of the same resulting from
a market sale.
- 14 -
[*14] Although the Raifmans chose to implement a diverse set of strategies to
achieve their objectives, they ultimately also chose to participate in a series of
Derivium transactions in order to jump-start their planning.
Before engaging in their first Derivium transaction, the Raifmans directed
Mr. Ramos and Mr. Glaser to meet an estate planning attorney and C.P.A. with
whom the Raifmans had previously worked, to solicit his opinion with respect to
the claimed tax benefits of the Derivium program.11 The attorney declined to
provide them with his approval of the Derivium transaction’s purported tax
characterization but skeptically recommended that, should the Raifmans choose to
participate in the Derivium program, they limit the extent of their participation and
execute these transactions in a piecemeal fashion.
The Raifmans sought no further legal or tax advice with respect to the
Derivium program and never met or otherwise engaged with any agent,
representative, or other employee of Derivium.
In August 2003, roughly a month after first meeting Mr. Ramos and hearing
his initial pitch, the Raifmans decided to go forward with their first Derivium
11
The record appears to indicate that this attorney was Arnold Zippel, whom
the Raifmans had previously engaged in order to establish a trust. The record
contains no further facts with respect to the Raifmans’ relationship with Mr.
Zippel.
- 15 -
[*15] transaction and transferred 159,000 shares of Valueclick in exchange for
$1,260,336, an amount representing 90% of that stock’s fair market value.
On September 4, 2003, the Raifmans formally retained Mr. Ramos as their
investment adviser. Later that month the Raifmans engaged in their second
Derivium transaction, this time exchanging 161,000 shares of Valueclick for
$1,362,804, an amount representing 90% of the stock’s fair market value.
In July 2004 the Raifmans entered into a third Derivium transaction by
transferring 300,000 shares of Valueclick in exchange for $2,810,476, an amount
representing 86% of that stock’s fair market value.12
In November 2004 the Raifmans engaged in their final Derivium
transaction, this time exchanging 200,000 shares of Valueclick for $2,160,267.
12
The Raifmans executed this Derivium transaction through their wholly
owned Cayman Islands entity, Helicon. This Derivium transaction was part of an
offshore tax-advantaged asset protection plan arranged through Mr. Ramos by Tim
Scrantom, a PCG-affiliated wealth-design professional and attorney.
The Raifmans organized Helicon and contributed to that entity 300,000
shares of Valueclick stock. The Raifmans then caused Helicon to engage in a
Derivium transaction and route the proceeds of that transaction to a domestic
entity, Khronos Capital, Inc. (Khronos). Khronos then lent the Raifmans
$2,795,000; in exchange, to secure this loan, the Raifmans provided Khronos a
deed of trust over their home. The Raifmans subsequently routed this money back
to Helicon, along with the proceeds of a more conventional home equity loan
provided by Wells Fargo.
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[*16] 2. The ClassicStar Program
During his initial July meetings with the Raifmans, Mr. Ramos undertook a
review of the Raifmans’ 2003 tax items and the income tax returns they had filed
for years past. From this review Mr. Ramos ascertained that the exercise of Mr.
Raifman’s nonqualified Valueclick options exposed the Raifmans to a potential
$405,670 income tax liability for the 2003 tax year. His discovery of this potential
liability led Mr. Ramos to propose that the Raifmans explore potential
“tax-to-equity” strategies that might enable them to defer recognition of this
ordinary income and allow them to recapture income tax paid for years past.
Mr. Ramos began to introduce the Raifmans to a series of his favored tax-
to-equity strategies, notably the ClassicStar mare leasing program. The
ClassicStar program offered individuals an opportunity to enter the thoroughbred
horse breeding and racing businesses by enabling them to lease the reproductive
capacity of ClassicStar’s mares for the duration of a thoroughbred breeding
season. During the term of the lease ClassicStar would mate these leased mares,
and any resulting foals would become the property of the participating lessee.
Although ClassicStar disclaimed the notion that past results were indicative
or a guaranty of future performance, its promotional materials boasted that the sale
of any resulting foal typically yielded participants a significant return on their
- 17 -
[*17] investment. But more important than those returns were the ostensible tax
benefits ClassicStar claimed would result from participation in its program.
Notably, ClassicStar promoted its lease fees as a fully deductible farm business
expense that could shield current-year income from taxation and, should that
deduction exceed the participant’s current-year income, could be carried back to
recover tax paid for prior years. ClassicStar noted that this shielding of ordinary
income in the current year provided a future tax benefit to participants upon the
sale of any resulting foals, as those gains realized would be taxed only at the
preferential capital gains rate. As an alternative, ClassicStar also offered
participants the opportunity to perpetually defer tax by way of like-kind
exchanges.
ClassicStar participants were given a “Due Diligence” booklet that provided
them with guidance for drafting business plans and participation logs and
contained a DVD and a set of tax opinions from accounting firm Karren, Hendrix
& Associates, P.C. (Karren), and law firm Handler, Thayer & Duggan, LLC
(Handler), each explaining the tax benefits of the program. However, both
ClassicStar’s marketing materials and the due diligence booklet encouraged all
participants to seek independent tax advice with respect to the benefits that might
arise from participation in the ClassicStar program.
- 18 -
[*18] Mr. Ramos calculated that if the Raifmans purchased $3.4 million of mare
leases, then they could completely offset the entire tax liability arising from Mr.
Raifman’s option exercise and also recapture approximately $700,000 of income
tax they had paid for prior years. Mr. Ramos explained to the Raifmans his belief
that the only risk posed, in this respect, was in establishing that the Raifmans’
participation in the program constituted a bona fide business venture.13 Mr.
Ramos provided the Raifmans a copy of the due diligence booklet for their review.
The Raifmans reviewed these materials and decided to participate in the
ClassicStar program.
On November 24, 2003, the Raifmans executed a letter of understanding
with ClassicStar. In the weeks that followed they paid ClassicStar $3.4 million to
participate in the program.14 On January 2, 2004, ClassicStar provided the
13
Mr. Ramos received a commission from ClassicStar for placing clients
with the program. Mr. Raifman was aware of this fact. Mr. Raifman discussed the
possibility of referring potential clients to Mr. Ramos for the purpose of placing
them with ClassicStar and splitting any commissions arising therefrom.
14
From December 15-19, roughly three weeks after signing the letter of
understanding formalizing their participation in the ClassicStar program, Mrs.
Raifman attended a ClassicStar seminar in St. Croix where the topic of discussion
was primarily the tax implications of having a horse breeding business. Mrs.
Raifman’s contemporaneous notes from these seminars suggest the seminar’s
predominant topic was how to generate material participation in order to ensure
the preservation of a tax deduction for the current year.
(continued...)
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[*19] Raifmans with their mare leasing agreements and a breeding schedule, all
backdated to reflect execution on December 31, 2003. The Raifmans’ leases
began retroactive to December 1, 2003, and would expire July 1, 2004, and
projected that any resulting foals would be delivered in spring 2005. The
Raifmans’ leases explicitly warned that the lessees (i.e., the Raifmans) bore all
economic risk of loss should their leases fail to result in a foal and that by entering
into this leasing agreement the lessees represented that they had evaluated and
fully acknowledge the substantial financial risk inherent to participation in the
mare leasing program. Before engaging in the program the Raifmans never met,
or otherwise discussed the program with, any ClassicStar employee, agent, or
other representative, nor did they seek legal or tax counsel with respect to their
participation therein.
During the first quarter of 2004 Mr. Ramos urged the Raifmans to secure a
personalized tax opinion with respect to their participation in ClassicStar, and the
14
(...continued)
Upon her return, the Raifmans assembled their participation log for 2003. It
reported that they engaged in 139 hours of activity with respect to their
participation in the ClassicStar program. A total of 62 hours was attributed to pre-
participation diligence work (e.g., visiting local California farms and reviewing
the due diligence booklet). A total of 24 hours was attributed to reading “Blood
Horse” magazine. A total of 39 hours was attributed to Mrs. Raifman’s attendence
at the St. Croix seminar. A total of 14 hours was attributed to the couple’s view-
ing of six online horse breeding presentations on December 30 and 31, 2003.
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[*20] Raifmans directed Mr. Ramos to do so. Mr. Ramos did so by contacting
Handler, the law firm that had provided the generic tax opinion included in the
ClassicStar due diligence binder. On March 24, 2004, Handler provided the
Raifmans with a generic tax opinion, nearly identical to the one in the ClassicStar
due diligence binder. This tax opinion opened with an engagement letter
disclosing to the Raifmans Handler’s conflicts of interest, notably that Handler
served as general counsel to ClassicStar and that ClassicStar had paid for the
production of this “personalized” tax opinion.
By July 2004 only two of the Raifmans’ leased mares had become pregnant,
and their leasehold on their remaining mares had expired.15
In January 2005 representatives of ClassicStar contacted Mr. Raifman to
propose a trade: The Raifmans would exchange their claim to the two in utero
15
In November 2004, months after the Raifmans’ mare leases had expired,
ClassicStar issued the Raifmans a revised schedule of their mare breeding pairs.
The revised schedule reduced the number of leases that the Raifmans had
purportedly held and revised the identities of the breeding pairs associated with
the Raifmans’ failed mare leases. The revised schedule also adjusted the lease and
breeding costs for the Raifmans’ two pregnant mares. The revised schedule did
not extend any leasing periods.
The record does not adequately reveal what precipitated this revision.
Neither does it explain how this revised schedule might have otherwise altered the
Raifmans’ rights as lessees as, again, at the time of modification the Raifmans’
leases had expired. We observe that this revision occurred, roughly, at the same
time the Raifmans finalized and filed their 2003 tax return in November 2004.
- 21 -
[*21] foals, as well as their other expired, unfruitful leases, for the rights to 25
quarter horse pairs to be bred in spring 2005, with resulting foal delivery projected
for spring 2006. Additionally, ClassicStar offered to make incentive payments to
the Raifmans and provide them an option to “put” all resulting foals to ClassicStar
at a guaranteed price of $4,080,000. (We will refer collectively to this transaction
as the quarter horse swap.)
Mr. Raifman directed ClassicStar to contact Mr. Ramos, and ClassicStar did
so. On January 4, 2005, Mr. Ramos contacted the Raifmans and expressed
enthusiasm for the swap and noted that, in order to ensure that the tax advantages
of the swap would be honored, the Raifmans ought to keep up their “active”
participation.16
On January 7, 2005, the Raifmans’ executed the quarter horse swap
agreement.17
3. The Ramos Investments
The Raifmans turned over the proceeds from their various Derivium
transactions to Mr. Ramos, who they then entrusted with managing that money in
16
The parties considered this a like-kind exchange.
17
The record indicates, however, that the Raifmans did not provide
ClassicStar with this executed agreement until sometime after February 22, 2005.
- 22 -
[*22] a manner sufficient to meet their objectives. The Raifmans were Mr.
Ramos’ largest clients, and he afforded them the attention such a status deserved,
meeting with them regularly to discuss potential investments and to review the
performance of their portfolio.
a. The Secured Lending Fund
Mr. Ramos recommended that the Raifmans invest in the Secured Lending
Fund (SLF). SLF was a fund organized by Robert Keys, the CEO of PCG,18 and
Lee Brower, a PCG affiliate. SLF was in the business of making “hard money” or
“bridge” loans to real estate developers who had exhausted, or otherwise could not
secure, financing from traditional lenders. Through a related company, SLF
would vet potential borrowers and the associated underlying property. However,
SLF typically eschewed formal appraisals of the underlying property and would
instead look only to past appraisals or rely on informal representations made by
real estate professionals familiar with the property and the surrounding area.
SLF did not lend directly but instead facilitated its lending operations
through a series of limited liability companies (sub-SLFs). Each sub-SLF would
18
By late 2003, although he retained ownership and his position as PCG’s
CEO, Robert Keys’ primary focus was on his personal book of clients and
investment opportunities; he had delegated most of the company’s day-to-day
operations to other PCG executives.
- 23 -
[*23] provide its borrower any requested funding in exchange for a security
interest in the borrower’s underlying real estate development. Generally, each
sub-SLF was funded by selling its debt to third parties (sub-SLF investors). Sub-
SLF investors would receive a note promising above-market yields and purporting
to make a “collateral assignment” of the sub-SLF’s security interest in the
underlying real estate development. Notwithstanding the nomenclature, this
collateral assignment did not convey, nor entitle sub-SLF investors to receipt of or
the right to record, any security instrument; the collateral assignment did not
purport to convey to any sub-SLF investors a deed of trust, mortgage, or any other
recognizable security interest. Instead, the intended function of this purported
collateral assignment was to establish that each loan made by a sub-SLF was itself
secured and to represent to sub-SLF investors that, if necessary, the sub-SLF could
foreclose on and sell the underlying real estate development in order to repay its
investors.
Mr. Ramos erroneously believed this meant that each note holder’s
investment was a “secured” interest in the underlying real estate development.
Mr. Ramos represented his erroneous belief when selling Mr. Raifman on
investing with SLF. Mr. Ramos presented Mr. Raifman with the private
- 24 -
[*24] placement memorandum (PPM) describing the SLF operation.19 The
Raifmans invested approximately $1.5 million in sub-SLF notes, which they left
under the management of Mr. Ramos.20
19
The SLF PPM described the purported “collateral assignment” as security
for the sub-SLF notes, as follows:
Although the Notes will be limited recourse obligations of * * *
[SLF, and each sub-SLF], each Note will also be secured by one or
more collateral assignments made by * * * [SLF and each sub-SLF].
Each collateral assignment will assign to * * * [investors] on a pari
passu and pro rated basis, all of the collateral that * * * [SLF and
each sub-SLF] receive[] from * * * [their borrowers].
Each sub-SLF borrower
will pledge real estate in addition to other acceptable collateral to
secure Bridge Loans made by * * * [SLF and each sub-SLF]. * * *
[SLF and each sub-SLF] will collaterally assign all of the collateral
that * * * [SLF and each sub-SLF] receive[] from * * * [their
borrowers].
The PPM, with respect to the purpose and intent of the collateral
assignment, is equally abstruse, providing that the collateral assignment “is
intended to make * * * [investors] secured creditors of * * * [SLF and each sub-
SLF] in the unlikely event of a * * * [SLF or sub-SLF] bankruptcy.”
20
Mr. Ramos established the Real Return Fund in late 2005 as a limited
partnership. Generally, Mr. Ramos would request that his clients contribute those
assets under his management into the fund because this would benefit all his
clients as the collectivization of risk reduced the exposure of each individual
client. Upon contribution, each of his clients would become a partner in the
partnership. The Raifmans agreed to this collectivization of risk and put
approximately $2.16 million of their Ramos-managed investments and other assets
(continued...)
- 25 -
[*25] Ultimately, because of the high-risk nature of the loans made and a
downturn in the real estate market, the sub-SLFs were forced to foreclose on
almost all of the real estate developments to which they had extended loans.
These foreclosures, however, were often mired in dispute and rarely resulted in
investor repayment.
b. A Stroke of Genius: Prints and Advertising Debt
Mr. Ramos also presented the Raifmans with an opportunity to invest in
debt issued for the print and advertising campaign (P&A) of a feature-length
motion picture, Bobby Jones: A Stroke of Genius. Although he lacked any
familiarity with motion picture financing and understood that this debt was
unsecured and risky, Mr. Ramos felt this investment was a “can’t miss”
opportunity as the debt carried a 12% interest rate and featured a back-end
“sweetener” that promised P&A investors an equity stake in the film should it
succeed at the box office.21 Mr. Ramos informed the Raifmans that both he and
Mr. Glaser had personally invested in the P&A debt. Mr. Ramos provided Mr.
20
(...continued)
into the Real Return Fund. For convenience, we distinguish between SLF
investments and the Real Return Fund only where necessary.
21
Ideally, Mr. Ramos noted, the film only needed to gross $10 million in
order to ensure that investors received the desired results.
- 26 -
[*26] Raifman with the private placement offering materials for the P&A debt. In
March 2004 the Raifmans agreed to purchase $400,000 of notes issued by P&A.
The film underperformed at the box office. On January 6, 2006, Mr. Ramos
wrote to his clients to inform them that he considered the P&A debt worthless and
to acknowledge errors in his judgment. Accordingly, Mr. Ramos refunded to his
clients all management fees he had collected with respect to the P&A debt and
recommended that his clients write off their entire investment.
II. The Raifmans’ 2003 Return and Subsequent Audit
A. Shopping for an Adviser
In early 2004 the Raifmans directed Mr. Ramos to meet with Tim Jorstad,
their longtime C.P.A., to discuss the tax effects of their participation in the
ClassicStar program. Following that meeting the Raifmans informed Mr. Ramos
that they had dismissed Mr. Jorstad, and they requested that Mr. Ramos refer them
to another C.P.A to begin preparing their 2003 tax return. Mr. Ramos referred the
Raifmans to, and the Raifmans subsequently engaged, Don Shaw, a licensed
C.P.A. and the father-in-law of one of Mr. Ramos’ employees.22
22
The Raifmans hired Mr. Shaw approximately four months after they had
engaged in the ClassicStar program. Mr. Shaw’s contract with the Raifmans
specifically limits the scope of his duties and responsibilities as their return
preparer.
- 27 -
[*27] Following a conversation with Mr. Ramos and agents of ClassicStar,23 Mr.
Shaw accepted the representation that the Raifmans were engaged in a bona fide
horse breeding trade or business, despite lacking any particular belief that the
Raifmans had any business purpose for participating in the ClassicStar program
beyond capturing the program’s tax benefits. Accordingly, Mr. Shaw reported the
Raifmans ClassicStar buy-in as a deductible $3.4 million agribusiness expense for
tax year 2003.
Relying on Mr. Ramos’ representation that the Derivium transactions
constituted bona fide loans, Mr. Shaw did not report as income any of the proceeds
received therefrom, and for the same reason he did not review any of the related
contracts or other relevant materials. Mr. Shaw proceeded in a similar fashion
with respect to deducting Derivium interest expenses on the Raifmans’ tax returns
for the years at issue.
On November 16, 2004, Mr. Shaw completed the Raifmans’ return for tax
year 2003, and Mr. Ramos informed the Raifmans that they should expect a
prompt Federal income tax refund of half a million dollars.
23
Mr. Shaw testified that he principally and directly dealt with Mr. Ramos--
“probably 90 percent” of the time--with respect to any matters related to the
Raifmans’ returns.
- 28 -
[*28] Mr. Shaw remained the Raifmans’ return preparer through tax year 2014.
Mr. Shaw used the same approach to coordinating and completing those returns as
he had with the 2003 return.
B. Auditing the Raifmans’ 2003 Tax Return
In 2005 the Internal Revenue Service (IRS) began an examination of the
Raifmans’ tax return for 2003. The IRS initially selected the Raifmans’ return for
examination because Mr. Shaw failed to report any tax consequence associated
with the exercise of Mr. Raifman’s nonqualified Valueclick options; once the
examination began, however, the IRS soon expanded its scope to include review
of the Raifmans’ participation in the Derivium and ClassicStar programs.
Mr. Shaw initially represented the Raifmans during this examination and
closely coordinated his representation with Mr. Ramos. As the examination
progressed, Mr. Shaw and Mr. Ramos became increasingly concerned with
preserving the treatment of the Raifmans’ participation in the ClassicStar program
and their associated multiyear refund claim. Accordingly, Mr. Shaw began to
coordinate directly with ClassicStar representatives. Specifically, as the
examination continued, the IRS began to question Mr. Shaw with respect to the
Raifmans’ quarter horse swap. Earlier, ClassicStar had directed Mr. Shaw to
refrain from providing the auditor any documentation or information with respect
- 29 -
[*29] to the quarter horse swap, in the hope of preserving its treatment as a like-
kind exchange. Sensing that the auditor’s interest in this issue could further
complicate the examination, Mr. Shaw contacted ClassicStar to develop a
coordinated response to the IRS’ now-expanding inquiry. The ClassicStar
solution, however, led to Mr. Shaw’s routinely presenting the IRS examiner with
fabricated and otherwise uncorroborated reports with respect to the Raifmans’
purported horse breeding business.
Subsequently, at the recommendation and, initially,24 the expense of
ClassicStar, the Raifmans engaged a law firm to represent them before the IRS
examiner. The examination of the Raifmans’ 2003 tax return closed when the
Raifmans entered into a closing agreement25 wherein they conceded liability for a
$1,025,640 deficiency in tax and agreed that their participation in the ClassicStar
program was a nondeductible expense.
The examination of their returns for the years at issue, continued, however.
On November 21, 2013, respondent issued a notice of deficiency determining the
24
ClassicStar ceased to pay for the Raifmans’ legal representation sometime
in mid-August 2006. At that time the Raifmans independently retained the same
firm to continue to represent them before the IRS.
25
The Raifmans’ failure to pay the tax assessed pursuant to this closing
agreement gave rise to their associated CDP case, discussed supra note 2.
- 30 -
[*30] Raifmans had income tax deficiencies for the years at issue. The
deficiencies reflected, as relevant here, respondent’s disallowance of interest
expense deductions related to Derivium transactions for tax years 2004-06,
deductions for additional ClassicStar expenses for tax year 2004, a theft loss
deduction exceeding $15 million for tax year 2008, and a determination that the
Raifmans had underreported their capital gain income for tax year 2004 from their
participation in the Derivium program.
III. Collapse and Aftermath
A. Derivium
As the examination of the Raifmans’ 2003 return continued, their first
Derivium transaction neared “maturity”. Derivium contacted the Raifmans to
notify them of this approaching maturity date and to remind them of their possible
alternatives to repayment. At that time, September 2006, Valueclick had
appreciated significantly, to the extent that the Raifmans realized that the value of
the shares they had originally transferred now exceeded the “principal” and
“interest” due on their “loan”. Accordingly, the Raifmans directed Mr. Ramos to
pursue their available alternatives to payment, specifically to request that
Derivium return to them an amount of Valueclick shares equivalent to the excess
of appreciation of the “collateralized” Valueclick stock over their balance due.
- 31 -
[*31] Derivium, however, failed to honor this request. Derivium also failed to
honor the Raifmans’ secondary request: to extend the term of the agreement, to
“refinance” in exchange for cash proceeds equal to the as-yet uncaptured
appreciation of the “collateralized” Valueclick stock. The Derivium-related
entities were regularly collapsing or dissolving.26
On March 5, 2010, Mr. Cathcart, the principal of the Derivium program,
was permanently enjoined from promoting it, as it constituted an abusive tax
shelter.
Following the complete collapse of Derivium and all associated entities, the
Raifmans, joined by a number of other former Derivium participants, attempted to
sue Wachovia for its role in facilitating the transfer of participants’ shares to
Derivium. On March 31, 2014, the U.S. District Court for the Northern District of
California dismissed the participants’ claims. In May of 2016, the Court of
Appeals for the Ninth Circuit affirmed the judgment of the District Court.
26
A year earlier, in September 2005, Derivium had filed a voluntary petition
for chapter 11 bankruptcy protection. On October 10, 2005, Noel Murphy, Don
Shaw’s son-in-law, brought to Mr. Ramos’ attention a Forbes article detailing the
collapse-in-progress of Derivium and its related entities.
- 32 -
[*32] B. ClassicStar
In February 2006 Government agents raided the offices of ClassicStar on
the suspicion that ClassicStar was in the business of operating abusive tax
shelters.27
Meanwhile, the IRS examination of the Raifmans’ participation in the
ClassicStar program was expanding. Mr. Raifman began pressing Mr. Ramos to
pursue the incentive payments promised in the quarter horse swap and to further
pressure ClassicStar to provide the Raifmans a refund of their original $3.4 million
participation fee. On June 20, 2006, ClassicStar wired the Raifmans $70,000 as
part of the incentives payments arising from the quarter horse swap. Aware that
the Raifmans’ IRS examiner was beginning to expand her inquiry to include
review of the quarter horse swap, Mr. Ramos also began demanding that
ClassicStar provide documentation, specifically proof of birth and registration,
with respect to the horses associated with the swap. ClassicStar failed to produce
27
The record suggests that the Raifmans discovered that ClassicStar was
under investigation only when they were contacted by the Department of Justice
(DOJ) in August of 2006. Pursuant to that initial contact, the Raifmans were
offered immunity from prosecution for any Federal crime, on the basis of
statements they provided pursuant to an immunity agreement, including but not
limited to violations of secs. 7201 and 7206, criminal tax evasion, and criminal
false statements to the taxing authorities, respectively.
The Raifmans accepted these offers of immunity roughly a year later, in
September 2007.
- 33 -
[*33] this information. ClassicStar and its attorneys did, however, continue to
work with both Mr. Ramos and the Raifmans to arrive at an acceptable settlement
to compensate the Raifmans for ClassicStar’s failures.
A number of the principals of the ClassicStar program were indicted for,
and pleaded guilty to, conspiracy to defraud the U.S. Government through their
operation and promotion of the ClassicStar program.
In a related civil lawsuit, the Raifmans and numerous other ClassicStar
participants were collectively awarded damages in excess of $50 million, resulting
from ClassicStar’s fraud. See West Hills Farms, LLC v. ClasicStar Farms, Inc. (In
re ClassicStar Mare Lease Litig.), 727 F.3d 473 (6th Cir. 2013). Pursuant to that
disposition the Raifmans, between 2008 and 2012, settled a number of associated
claims against other parties who had directly facilitated or aided in the ClassicStar
program’s fraud, receiving settlements of $50,000 from Handler in 2008, $20,754
from Karen Hendrix in 2009, and $918,975, collectively, from GasStar,
ClassicStar’s parent company, and associated individuals.
C. Mr. Ramos and Mr. Keys
As the examination of their returns continued into July 2007, the Raifmans
dismissed Mr. Ramos, generally, from his investment advisory duties. However,
they did not completely remove their assets from his management, believing there
- 34 -
[*34] was still value in allowing their investments in SLF to mature; accordingly,
they retained Mr. Ramos to continue managing such until 2008, when Mr. Ramos
resigned. At the time of his resignation Mr. Ramos informed the Raifmans that it
might take as long as five years to unwind and liquidate their remaining
investments because of issues with particular assets, but most notably because of
tax concerns arising from the Raifmans’ offshore investment vehicles.
In September 2007 the Raifmans entered arbitration with Mr. Ramos, PCG
and Mr. Keys, alleging, among other things, numerous breaches of fiduciary duty,
including self-dealing and nondisclosure; breach of contract; negligence; fraud;
and misrepresentation. After 18 days of hearings, the arbitrator determined that
Mr. Ramos had failed to adequately disclose referral fees and commissions he had
received from the operators and promoters of many of the investments and
programs that he had sold the Raifmans and the fee sharing aspects of his
relationship with PCG. The arbitrator also determined that Robert Keys, in his
role as CEO of PCG, had a conflict of interest in that he encouraged PCG and its
affiliates to promote investment vehicles he had founded or which would result in
the largest commissions to him personally.28
28
The arbitrator also laid out the deficiencies in Mr. Ramos’ comprehension
of the nature of the SLF notes in which he had encouraged the Raifmans to invest,
(continued...)
- 35 -
[*35] Accordingly, on September 23, 2009, the arbitrator ruled that Mr. Ramos
and PCG were liable for, among other things, breaching their fiduciary duties to
the Raifmans. The arbitrator did not, however, hold that Mr. Ramos and Mr. Keys
had committed common law fraud. Instead, owing to their breaches of duty and
care, the arbitrator held that they were liable for having worked a constructive
fraud on the Raifmans, as the arbitrator specifically found that neither Mr. Keys
nor Mr. Ramos acted with any intent to deceive or defraud the Raifmans.
Accordingly, the arbitrator generally awarded the Raifmans damages arising from,
among other things, their participation in the ClassicStar ($5 million) and
Derivium ($7,500,000) programs and their investments in the P&A and SLF notes
($500,000 and $2,500,000, respectively). Mr. Ramos, Ramos Financial, Mr. Keys,
and PCG were held jointly and severally liable for those damages.
Shortly after the arbitrator delivered his decision, Mr. Ramos filed for
bankrupcy protection. The Raifmans intervened and secured a settlement
agreement with Mr. Ramos, wherein he promised to pay them $900,000 pursuant
28
(...continued)
and the deficiencies in SLF’s borrower vetting and loan issuance procedures. At
the time of the arbitration proceedings SLF had begun to foreclose on nearly all of
the properties for which it had extended loans. The record at arbitration revealed
that SLF had regularly failed to adequately evaluate the properties itself and had
insufficient capital to ensure it could adequately seize the troubled properties.
- 36 -
[*36] to the arbitration and agreed to testify on their behalf in any further actions
brought against Mr. Keys or in any further proceedings with the taxing authorities.
On November 19, 2009, the Raifmans filed a suit in the Superior Court of
California, County of San Francisco, naming as defendants, among others, Mr.
Keys, SLF, and related sub-SLF entities. The Raifmans alleged the defendants
had, among other things, perpetrated securities fraud and actual fraud. The
Raifmans moved to voluntarily dismiss this action on December 17, 2010.
On May 11, 2010, Mr. Keys filed for chapter 7 bankruptcy protection. Mr.
Keys subsequently pleaded guilty to wire fraud and money laundering offenses
with respect to a $1.1 million loan he brokered between a longtime client and a
recent business associate, and bankruptcy fraud.
OPINION
I. The Theft Losses
A. The Nature of the Parties’ Contentions
The Raifmans do not dispute respondent’s determinations as set forth in the
notice of deficiency with respect to their participation in the Derivium and
ClassicStar programs. Instead, they argue that the facts and circumstances
surrounding their participation in those programs, as well as their investment in
- 37 -
[*37] the SLF notes, ought to entitle them to deduct theft losses for tax year
2008.29 The Raifmans argue a unique theory with respect to each loss. These
theories are as follows.
With respect to their Derivium transactions, the Raifmans argue that each
transaction was two separate transactions: the sale of their stock to Derivium, and
their purchase of an “option” to reacquire from Derivium an identical amount of
stock at maturity for a strike price equal to their balance due.30 In this respect, the
Raifmans allege that Derivium’s failure to honor these “options” at the maturity of
their first agreement, and Derivium’s subsequent collapse before the maturity of
their second and third agreements, constitute the theft of those options by false
pretenses. The Raifmans appear to specifically allege that they were intentionally
defrauded by Derivium’s principal, Mr. Cathcart.
29
Although in their original 2008 return the Raifmans claimed a $15,160,607
theft loss, they now appear to claim only a $10,798,061 theft loss. This loss
comprises individual losses of $2,475,000 related to their participation in the
ClassicStar program, $3,750,000 related to their direct transactions with the
Derivium program, $2,638,977 related to their Derivium transaction routed
through Helicon, and $1,934,084 with respect to their investments in SLF notes
and as associated with the Real Return Fund.
30
The Raifmans’ argument appears to rely on Calloway v. Commissioner,
135 T.C. 26 (2010), aff’d,
691 F.3d 1315 (11th Cir. 2012). There, this Court
characterized the alternatives to payment as being “at best” an “option” to
purchase from Derivium an equivalent amount of stock for a price equal to the
principal and accrued interest on the purported loan. Id. at 35-37.
- 38 -
[*38] With respect to ClassicStar, noting that respondent has conceded that an
actual theft occurred, the Raifmans allege that the ClassicStar program constituted
a “ponzi” scheme and seek to avail themselves of the safe harbor provisions
provided by Rev. Proc. 2009-20, 2009-14 I.R.B. 749.
With respect to their investments in SLF notes, the Raifmans allege that Mr.
Keys and other principals of SLF defrauded them by misrepresenting the nature of
their investment in SLF, notably that the notes did not convey to the Raifmans any
security interest in any underlying properties.31
With respect to Derivium and SLF, respondent alleges that the Raifmans
failed to establish that an actual theft occurred, notably because the Raifmans have
failed to establish the criminal intent of Mr. Cathcart or Mr. Keys. With respect to
their participation in the ClassicStar program, respondent argues that the Raifmans
have failed to establish the appropriate amount of their theft loss and the
appropriate year of its deduction. Respondent additionally contends that the
Raifmans are ineligible for safe-harbor treatment under Rev. Proc. 2009-20, supra,
31
The Raifmans do not allege privity with Mr. Keys or any other agent or
principal of SLF; rather they allege that the misrepresentations made by those
individuals to Mr. Ramos and subsequently communicated to the Raifmans by Mr.
Ramos, resulted in a theft by false pretenses.
- 39 -
[*39] because they do not constitute “qualified investors” and the ClassicStar
program does not constitute a “specified fraudulent arrangement”, as defined.
B. Theft Loss Analysis
Section 165 generally permits taxpayers to deduct against their ordinary
income the amount of any uncompensated loss resulting from theft for the year in
which the taxpayer sustains that loss. See sec. 165(a), (c), (e). To qualify for a
theft loss deduction, taxpayers must prove: (1) the occurrence of a theft, (2) the
amount of the theft loss, and (3) the year in which the taxpayers discover the theft
loss. Id. The taxpayer bears the burden of proving entitlement to a theft loss
deduction. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).
In order to ascertain whether theft has occurred, this Court applies the law
of the State where the loss was sustained. Bellis v. Commissioner, 540 F.2d 448,
449 (9th Cir. 1976), aff’g
61 T.C. 354 (1973). Because the alleged theft took
place in California, we apply California law. Under California Penal Code section
484, any person who shall “feloniously steal, take, carry, lead, or drive away the
personal property of another, * * * or who shall knowingly and designedly, by any
false or fraudulent representation or pretense, defraud any other person of money
* * * or real or personal property” will be held accountable for theft. Cal. Penal
Code sec. 484(a) (Deering 2000). While this statute endeavors to consolidate all
- 40 -
[*40] theft offenses within its terms, the State of California still recognizes that the
individual elements of each permutation of theft--such as larceny, false pretenses,
embezzlement--have remained unchanged. People v. Gonzales, 392 P.3d 437,
441-445 (Cal. 2017); People v. Ashley,
267 P.2d 271, 279 (Cal. 1954).
Insofar as the Raifmans allege theft through fraudulent misrepresentations,
they allege theft by false pretenses. Theft by false pretenses consists of three
conjunctive elements: (1) the perpetrator must, knowingly and with the specific
intent to defraud the property owner, (2) have made a false representation or
pretense which (3) materially influenced the owner to part with his or her property
in reliance on those representations. People v. Williams, 305 P.3d 1241, 1248
(Cal. 2013). Implicit in these elements is a relationship of privity between the
perpetrator and his or her victim. Crowell v. Commissioner, T.C. Memo. 1986-
314.32
32
In certain narrow circumstances a theft loss deduction has been allowed
where the taxpayer lacks privity with the alleged thief. See Boothe v.
Commissioner, 768 F.2d 1140 (9th Cir. 1985), rev’g
82 T.C. 804 (1984). The
Raifmans do not allege privity with Mr. Cathcart, Mr. Keys, or any other agent or
principal of Derivium or SLF. Instead, the Raifmans argue that our analysis ought
to look beyond privity and to apply a “feeder” theory to our theft loss analysis, as
suggested in Paine v. Commissioner,
63 T.C. 736 (1975), aff’d without published
opinion,
523 F.2d 1053 (5th Cir. 1975), and Jensen v. Commissioner, T.C. Memo.
1993-393, aff’d without published opinion,
72 F.3d 135 (9th Cir. 1995). As we
reach our holding on the question of intent, however, we need not and do not
(continued...)
- 41 -
[*41] Intent to defraud is a question of fact to be determined from all the
circumstances of the case and usually must be proven circumstantially. People v.
Fujita, 117 Cal. Rptr. 757, 765-766 (Ct. App. 1974). Courts must examine the
evidence to determine whether an alleged thief behaved in a manner consonant
with an intent to defraud; a record establishing a mere ordinary breach of contract
or fiduciary duty will be insufficient to support a finding of a party’s intent to
defraud. See Ashley, 267 P.2d at 265.
C. Derivium
The Raifmans argue they are entitled to a theft loss deduction arising from
their participation in the Derivium program. As the Raifmans see it, the alleged
theft relates to Derivium’s failure to honor the “options” arising from the
agreements’ alternatives to payment. To establish the requisite criminal intent
with respect to this theft claim, the Raifmans rely nearly exclusively on a
permanent injunction enjoining Mr. Cathcart, the Derivium principal, from
continuing to promote and operate that program. The District Court for the
Northern District of California entered this permanent injunction against Mr.
Cathcart pursuant to section 7408.
32
(...continued)
address the Raifmans’ “feeder” theory or otherwise analyze any issue pertaining to
matters of privity.
- 42 -
[*42] Section 7408 authorizes the Federal District Courts to enjoin individuals
who have engaged, as relevant here, in the promotion of abusive tax shelters when
it is shown that an individual organized or sold, or participated in the organization
or sale of, an arrangement, and made or caused to be made false statements
concerning the tax benefits to be derived from that arrangement while knowing, or
having reason to know, the falsity and materiality of those false statements. See,
e.g., United States v. Estate Pres. Servs., 202 F.3d 1093, 1098 (9th Cir. 2000).
We do not find this injunction, and the associated materials, to be
dispositive with respect to the Raifmans’ theft claim. While the injunction may be
highly probative with respect to Mr. Cathcart’s intent to develop and market an
abusive tax shelter, it does not follow that Mr. Cathcart conceived and
implemented the program “options”, the alternatives to payment, with the specific
intent to defraud the Raifmans, or any other participant of his tax shelter, of their
property.33
33
The Government was granted summary judgment with respect to the
falsity of the Derivium program’s purported tax benefits. Trial was to be held in
order to resolve, primarily, the disputed factual question of whether Mr. Cathcart
knowingly misrepresented those tax benefits. At trial he declined to contest this
remaining factual allegation. Accordingly, he was enjoined from promoting the
Derivium program or any other program similar thereto.
- 43 -
[*43] Rather the injunction gives rise to a strong inference that Mr. Cathcart’s
intent was to develop and market a tax shelter that might disguise sales as a
lending arrangement.34 In order to ensure that the sales would be honored as the
nonrecourse loans they purported to be, the transaction necessitated pro forma
documentation that would suggest the existence of bona fide indebtedness.
Accordingly, Mr. Cathcart developed the “loan” agreements, specifically the
alternatives to payment at issue here, in a manner that he believed would provide
his program the veneer necessary to help it survive scrutiny and deliver his clients
the tax benefits he promised. The agreement and its terms, the alternatives to
payment, were part and parcel of the Derivium transaction’s nature as a disguised
sale.
To the extent we find the injunction and the other Derivium-related
materials indicative of any intent, we find only that Mr. Cathcart intended to
market a tax shelter and to aid and abet in the defrauding of the U.S. Treasury. On
the record before us, we do not find evidence sufficient to establish that he
intended to defraud any individual Derivium participant through a failure to
34
The contracts clearly indicated to the participants that in turning over their
property to Derivium, they were transferring thereto all the benefits and burdens
of, and complete dominion over, the stock. The loan was nonrecourse to the
participant and could not be called before maturity. Similarly, the participants
were prohibited from prepaying any interest or principal.
- 44 -
[*44] perform on the program’s ill-conceived “options”, the alternatives to
payment. Accordingly, the Raifmans have failed to establish the requisite intent
necessary to sustain their Derivium-related theft claim.35
D. Secured Lending Fund
The Raifmans argue they are entitled to a theft loss deduction arising from
their investment in SLF. The Raifmans allege that Mr. Keys misrepresented, and
caused others to intentionally misrepresent, the nature of the “collateral
assignment” integral to the sub-SLF notes and that Mr. Keys did so with the intent
of depriving investors of their money. To establish the requisite intent of Mr.
Keys, the Raifmans rely on the testimony of Mr. Ramos and an expert report.
Mr. Ramos repeatedly testified that Mr. Keys lied to him with respect to the
nature of SLF and the associated collateral assignment. The weight of the entire
record, however, establishes that Mr. Keys had little contact with Mr. Ramos and
35
The Raifmans have entered into the record an expert report purporting to
provide a valuation of these theoretical “options”, to establish the fair market
value thereof. Additionally, the Raifmans argue that they are entitled to a step-up
in basis because the Derivium transaction did not constitute a literal sale but rather
a “constructive sale” under sec. 1058. Because we decide the issue of theft on the
existence of intent, we decline to explore these aspects of the Raifmans’ claim.
We observe, however, that respondent’s initial determination with respect to the
proper tax treatment of the Derivium transaction appears to have already
accounted for the 10% of the market value of their ValueClick stock which was
not monetized in the Derivium sale. See Calloway v. Commissioner, 135 T.C. at
53 (Halpern, J., concurring).
- 45 -
[*45] does not establish that, in their limited communications, Mr. Keys ever
willfully communicated any material misrepresentation with respect to SLF and its
purported collateral assignment with an intent to defraud Mr. Ramos or his
clients.36 We observe that the PPM details the nature and operation of the
collateral assignment and that the terms it employs in doing so are arguably
ambiguous. The record before us does not, however, establish that Mr. Ramos,
Mr. Keys, or any other individuals associated with SLF were at odds with respect
to how they interpreted the term “collateral assignment” and how such a collateral
assignment was to operate. The record establishes that the principals of SLF
understood that they were obligated to “collaterally assign” any “collateral
received” from their borrowers to SLF investors. The principals of SLF
understood this to mean that SLF investors would be entitled to repayment of their
“limited recourse” notes from the proceeds of foreclosure. The record similarly
establishes that Mr. Ramos, having read the PPM and done the due diligence
required of him, arrived at a similar understanding. That Mr. Ramos and others
then began describing the notes issued by SLF as “secured” appears to belie their
36
As respondent notes, in California the misrepresentation or omission of a
material fact in the offering or selling of a security may be unlawful. Cal. Corp.
Code sec. 25401 (Deering 2014). Such a misrepresentation, however, will be
considered criminal only when it is made wilfully (i.e., intentionally). Id. sec.
25540(b); People v. Salas, 127 P.3d 40, 49 (Cal. 2006).
- 46 -
[*46] comprehension as to the actual meaning, function and operation of a security
interest. But it certainly does not give rise to an inference of willful
misrepresentation with the intent to defraud investors. Accordingly, we find that
the testimony of Mr. Ramos lacked credibility and reliability and failed to
establish that Mr. Keys, or any other SLF principal, exhibited the intent necessary
to sustain the Raifmans’ allegations of theft.37
The expert report offered by the Raifmans re-interprets the factual findings
and holdings of the Raifmans’ arbitration with Mr. Ramos and Mr. Keys in order
to arrive at the determination that the actions of Mr. Keys were “categorically
fraudulent” and that the “entirety of the Raifman’s [sic] experience” with Mr.
Keys, and associated entities, was based on fraud. The report purports to arrive at
this conclusion through an application of the industry standards of care for
investment advisers.
To the extent the expert report is meant to support a conclusion that Mr.
Keys defrauded the Raifmans, it is unhelpful. The report does not invite our
attention to any particular indicia of the willful intent of Mr. Keys to defraud the
37
We observe that the Raifmans have entered into the record numerous
documents related to guilty pleas entered by Mr. Keys with respect to unrelated
crimes. To the extent the Raifmans invite us to infer, by way of propensity
evidence, that Mr. Keys intended to defraud them, we decline to do so.
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[*47] Raifmans, or any other SLF investor. Moreover, the report primarily
summarizes the arbitration opinion and, in doing so, appears to conflate breaches
of fiduciary duties and industry standards of care with the relevant California law
germane to our analysis under section 165.38 We recognize that fraud may take
many forms, but the defects and redundancy of this report lead us to accord it very
little weight with respect to establishing that Mr. Keys, or any other party related
to the SLF investments, acted with an intent to defraud the Raifmans.
E. ClassicStar
1. Concession, Positions, and the Remaining Elements
In a response to a motion for summary judgment filed by the Raifmans,
respondent conceded that the Raifmans suffered a theft pursuant to their
participation in the ClassicStar program. Recognizing respondent’s concession,
our analysis turns to the remaining two elements of a theft loss: (1) the correct
year of a deduction and (2) the correct amount of the deduction.
The Raifmans, however, argue that the ClassicStar program constituted a
ponzi scheme and rely exclusively on Rev. Proc. 2009-20, supra, in inviting this
Court to hold the same in accordance with Rev. Rul. 2009-9, 2009-14 I.R.B. 735.
38
This is, perhaps, to prevent the report from appearing to offer an
impermissible legal conclusion. See Nationwide Transp. Fin. v. Cass Info. Sys.,
Inc., 523 F.3d 1051, 1058 (9th Cir. 2008).
- 48 -
[*48] Accordingly, the Raifmans argue that they are entitled to a theft loss
deduction of $2,475,000.39 The Raifmans do not, however, allege a specific
context for the theft here conceded, and they do not identify the nature of the
property stolen. Similarly, they do not attempt to establish the fair market value
of, or their basis in, the unidentified stolen property.
2. The Provisions of Rev. Proc. 2009-20
The Raifmans allege the ClassicStar program constituted a ponzi scheme
and ask this Court to apply Rev. Proc. 2009-20, supra, to afford them a theft loss
deduction in accordance with the Commissioner’s disposition in that revenue
procedure. We observe that revenue procedures and revenue rulings are not
necessarily binding on this Court, see Estate of Lang v. Commissioner, 613 F.2d
770 (9th Cir. 1980), aff’g in part, rev’g in part
64 T.C. 404, 406-407 (1975), and
note that to the extent this Court might apply this revenue procedure, we would
not hold that the Raifmans qualify for beneficial treatment thereunder.
As pertinent here, Rev. Proc. 2009-20, supra, provides a safe harbor for a
taxpayer who is a “qualified investor” that unwittingly experienced losses by way
of participation in certain specified fraudulent arrangements. This procedure
39
This amount appears to represent the Raifmans’ initial ClassicStar
participation fee, reduced in acknowledgment of their receipt of various incentive
and settlement payments.
- 49 -
[*49] generally relaxes the showing required of a taxpayer with respect to the
timing and amount of a theft loss. When a taxpayer qualifies for the safe harbor
treatment, the Commissioner will not challenge that taxpayer’s theft loss
deduction of the full amount of the taxpayer’s investment, for the tax year in
which the theft was “discovered”.
A qualified investor is a taxpayer who did not have actual knowledge of the
fraudulent nature of the arrangement before its becoming known to the general
public; additionally, the arrangement must not constitute a tax shelter, as defined
in section 6662(d)(2)(C)(ii). As relevant here, section 6662(d)(2)(C)(ii) defines a
tax shelter as any investment plan or other arrangement whose significant purpose
is the avoidance or evasion of Federal income tax. An investment plan or other
arrangement will be considered principally, significantly, motivated to avoid
taxation if that purpose exceeds any other purpose. Sec. 1.6662-4(g)(2), Income
Tax Regs. The existence of an economic motivator will not, itself, establish that a
transaction’s principal purpose is not the sheltering of income from taxation if
objective evidence indicates otherwise. Id.
Mr. Ramos introduced the Raifmans to the ClassicStar program principally
because Mr. Ramos believed it could offset the Raifmans’ “phantom” tax liability
arising from their exercise of Mr. Raifman’s nonqualified Valueclick options. Mr.
- 50 -
[*50] Ramos determined, with exactitude, the amount of money that the Raifmans’
would need to buy into the ClassicStar program in order to offset that liability, and
provide them a net operating loss large enough to secure a refund of their Federal
income tax paid for prior years.40 Moreover, the record is replete with depositions
and testimony wherein Mr. Ramos, Mr. Shaw, and Mrs. Raifman stated that the
Raifmans’ principal purpose for participating in the ClassicStar program was to
avoid income tax for 2003 and recover income tax paid for previous years.
The weight of the evidence before us fails to establish that the Raifmans
participated in the ClassicStar program for any significant purpose other than the
avoidance of Federal income tax. We find that the Raifmans do not constitute
qualified investors and, accordingly, they could not qualify for the safe harbor
provisions of Rev. Proc. 2009-20, supra.
3. The Amount of the ClassicStar Theft Losses
The amount of a theft loss is limited to the lesser of (1) the fair market value
of the property immediately before the theft or (2) the adjusted basis of the stolen
40
We also observe that, in this manner, the ClassicStar program was
designed to operate as an “artful device” that enabled its participants to shelter
ordinary income from taxation for a current year and to convert ordinary income
into capital gain income a short time later. See, e.g., Commissioner v. P.G. Lake,
Inc., 356 U.S. 260, 265 (1958) (citing Corn Prods. Ref. Co. v. Commissioner,
350
U.S. 46, 52 (1955)).
- 51 -
[*51] property. Sec. 165(b); secs. 1.165-7(b)(1), 1.165-8(c), Income Tax Regs. A
taxpayer may not, however, deduct a theft loss to the extent he or she has
recovered or been compensated for that loss. Sec. 165(a); see Doud v.
Commissioner, T.C. Memo. 1982-158.
To the extent established by the record before us, we find that the Raifmans
were victims of a theft arising exclusively in the context of the material
misrepresentations made by ClassicStar to induce their acceptance of the quarter
horse swap agreement. Similarly, we find that the property the Raifmans
conveyed in reliance on those misrepresentations was their interests in the two
unborn foals and any rights arising from their unfruitful mare leases that had
previously expired on July 1, 2004. The record establishes bases41 for these two in
utero foals of $281,865 and $480,700.
41
With respect to the amount of their theft loss the Raifmans relied
exclusively on Rev. Proc. 2009-20, 2009-14 I.R.B. 749, as discussed above.
Accordingly, they declined to offer any data or calculations indicative of the fair
market value of the rights arising from their expired leases, did not invite our
attention to any data or calculation with respect to any collateral expenses incurred
pursuant to their attempts to recover their property, and have advanced no
associated argument with respect thereto. See Ander v. Commissioner, 47 T.C.
592, 595 (1967)
- 52 -
[*52] 4. The Year of Loss
Generally, taxpayers may deduct a loss only for the year such loss is
sustained. Sec. 165(a). With respect to theft losses, however, taxpayers are
permitted to treat the theft loss as being sustained during the taxable year in which
the taxpayer discovers the theft. Sec. 165(e). Taxpayers may not, however, claim
a theft loss deduction for a year in which he or she may still have a claim for
reimbursement, with respect to which there is a reasonable prospect of recovery.
Sec. 1.165-1(d)(2) and (3), Income Tax Regs. A reasonable prospect of recovery
will postpone the theft loss deduction until such time as that prospect no longer
exists. Sec. 1.165-1(d)(3), Income Tax Regs.
The Raifmans, among other investors, concluded litigation against
ClassicStar and its parent corporations in 2013 and have been routinely recovering
from related parties since initiating litigation with ClassicStar in 2008.
Accordingly, we reject the Raifmans’ claim that 2008 is the proper year for them
to recognize their theft loss associated with their participation in the ClassicStar
program.
II. The Investment in P&A Notes as a Worthless Security Capital Loss
The Raifmans argue that they ought to be allowed to deduct a long-term
capital loss for tax year 2008 with respect to their investment in the P&A notes. If
- 53 -
[*53] a security which is a capital asset becomes worthless during the taxable year,
section 165(g) allows a taxpayer to deduct the loss resulting therefrom as a capital
loss. A security, for these purposes, constitutes a bond, a note, or other evidence
of indebtedness, issued by a corporation. Sec. 165(g)(2). Individuals may deduct
capital losses to the extent of capital gains plus $3,000 of ordinary income. Sec.
1211(b).
A taxpayer seeking a deduction for a worthless security must, among other
things, prove the actual worthlessness of the security. A taxpayer may claim such
a deduction only for the first year in which there is no reasonable chance of
recovery. Sec. 1.165-4(a), Income Tax Regs.; see Vincentini v. Commissioner,
T.C. Memo. 2008-271, slip op. at 17-19, aff’d, 429 F. App’x 560 (6th Cir. 2011);
Favia v. Commissioner, T.C. Memo. 2002-154. If, in the year of discovery, there
exists a claim for reimbursement with respect to which there is a reasonable
prospect of recovery, no portion of the loss for which reimbursement may be
received may be deducted until the taxable year in which it can be ascertained with
reasonable certainty whether or not the reimbursement will be received, for
example, by a settlement, adjudication, or abandonment of the claim. Secs.
1.165-1(d), 1.165-5, 1.165-8(a)(2), Income Tax Regs. As with theft losses,
- 54 -
[*54] taxpayers may deduct a worthless security loss only to the extent not
compensated. Sec. 165(a).
The record establishes that the Raifmans invested $400,000 in the P&A
notes. These notes are a security within the meaning of section 165(g). The
money owed the Raifmans on those notes is unlikely to ever be paid. In
September 2009 the Raifmans were awarded $500,000 with respect to this
investment, pursuant to their arbitration involving Mr. Ramos, Mr. Keys, and
PCG. Accordingly, the proper year of loss is not 2008, as the Raifmans claim, but
a later year that the record does not establish.
III. Section 6662 Accuracy-Related Penalties
Respondent determined that for all years at issue the Raifmans were liable
for accuracy-related penalties under section 6662(a) and (b)(1) and (2) for
negligence, disregard of rules or regulations, or substantial understatements of
income tax. The Raifmans contest the imposition of these penalties.
A taxpayer is liable for a section 6662(a) accuracy-related penalty with
respect to any portion of an underpayment attributable to negligence or disregard
of rules and regulations, or a substantial understatement of income tax. Sec.
6662(a) and (b)(1) and (2). Negligence occurs when the taxpayer fails to make a
reasonable attempt to comply with the provisions of the Code while disregard of
- 55 -
[*55] rules and regulations means any careless, reckless, or intentional disregard
thereof. Sec. 6662(c); sec. 1.6662-3(b)(1)(ii), Income Tax Regs. (stating that a
taxpayer exhibits negligence when he or she “fails to make a reasonable attempt to
ascertain the correctness of a deduction, credit or exclusion which would seem to a
reasonable and prudent person to be ‘too good to be true’ under the
circumstances”). A substantial understatement of income tax exists when the
amount of the understatement exceeds the greater of 10% of the tax required to be
shown on the return for the taxable year or $5,000. Sec. 6662(d)(1)(A).
The Commissioner bears the burden of production with respect to the
accuracy-related penalty under section 6662. Sec. 7491(c); Higbee v.
Commissioner, 116 T.C. 438, 446 (2001).
A. Graev Implications
This case was tried during the Court’s October 25, 2016, trial session in San
Francisco, California. The record remained open until June 1, 2017. Before the
court closed the record in this case, neither party attempted to introduce evidence
with respect to the written supervisory approval requirement of section 6751(b)(1).
Briefing was completed on December 1, 2017.42
42
Shortly after the conclusion of trial, this Court released Graev v.
Commissioner (Graev II), 147 T.C. 460 (2016), supplemented and overruled in
(continued...)
- 56 -
[*56] On December 20, 2017, this Court released Graev v. Commissioner (Graev
III), 149 T.C. __ (Dec. 20, 2017), supplementing and overruling in part 147 T.C.
460 (2016). In Graev III, 149 T.C. at __ (slip op. at 14), as pertinent here, this
Court held for the first time that as part of his burden of production the
Commissioner must offer into the record evidence of his compliance with the
written supervisory approval requirement of section 6751(b)(1). On January 23,
2018, we ordered the parties to address the effect of Graev III on this case and to
file any associated motions by February 15, 2018.43
On February 9, 2018, respondent filed a motion to reopen the record and the
declaration of Theresa Alvarez in support of that motion (collectively,
respondent’s motion). Revenue Agent Theresa Alvarez (RA Alvarez) was tasked
with examining the Raifmans’ returns for the years at issue. Respondent’s motion
42
(...continued)
part by Graev v. Commissioner (Graev III), 149 T.C. __ (Dec. 20, 2017), where
we held that the Commissioner was only required to comply with the written
supervisory approval requirement of sec. 6751(b)(1) before the actual assessment
of applicable penalties. At the close of the record, and through the completion of
briefing, Graev II was controlling in this case.
43
On January 29, 2018, respondent filed a response to our order dated
January 23, 2018, notifying the Court that he had informed the Raifmans about the
penalty approval form on January 23, 2018, and informing the Court and the
Raifmans of his intent to file a motion to reopen the record. See Fed. R. Evid.
902(11).
- 57 -
[*57] seeks to reopen the record to add documentary evidence that might establish
his compliance with the written supervisory approval requirement of section
6751(b)(1).
Respondent’s motion includes a “Penalty Approval Form” and “Negligence
or Disregard of the Rules or Regulations Lead Sheet 6662(c)” (collectively,
penalty approval form). The penalty approval form indicates that it was prepared
by RA Alvarez with respect to her examination of the Raifmans’ returns for the
years at issue. A signature dated March 18, 2013, appears on the penalty approval
form in the space provided for “Group Manager Approval to Assess Penalties
Identified Above”. In her declaration RA Alvarez states that this signature is that
of her then-immediate supervisor, Robert Gee, and that she is already familiar with
the signature of Mr. Gee, who regularly signed documents she had prepared during
his tenure as her immediate supervisor. RA Alvarez additionally states that this
penalty approval form was drafted contemporaneously with her examination of the
Raifmans’ returns for the years at issue and that these forms are of the type that
employees of the IRS regularly create and keep in the course of ordinary business.
On February 15, 2018, the Raifmans filed a competing motion to reopen the
record (Raifmans’ motion). The Raifmans’ motion objects to respondent’s motion
only insofar as the Raifmans request that any reopening of the record also afford
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[*58] them the opportunity to cross-examine Mr. Gee and to again cross-examine
RA Alvarez. To this extent, the Raifmans’ motion argues that the penalty
approval form fails to establish that RA Alvarez and Mr. Gee adequately
considered their reasonable cause defense to the accuracy-related penalties under
section 6662 for the years at issue.
On February 23, 2018, we ordered the parties to respond to these competing
motions to reopen the record, and the parties complied.
The decision to reopen the record to admit additional evidence is a matter
within the discretion of the trial court. Zenith Radio Corp. v. Hazeltine Research,
Inc., 401 U.S. 321, 331 (1971); see also Nor-Cal Adjusters v. Commissioner,
503
F.2d 359, 363 (9th Cir. 1974), aff’g T.C. Memo. 1971-200. This Court, however,
will not exercise such discretion unless the evidence that a party seeks to admit to
the record is material and will aid the Court in determining the outcome of the
case; the record will not be reopened to admit evidence that is merely cumulative
or impeaching. Butler v. Commissioner,
114 T.C. 276, 287 (2000), abrogated on
other grounds, Porter v. Commissioner,
132 T.C. 203 (2009); see SEC v. Rogers,
790 F.2d 1450, 1460 (9th Cir. 1986). Similarly, this Court will weigh the
diligence of, and any prejudice to, the parties when disposing of motions to reopen
the record. See Estate of Freedman v. Commissioner, T.C. Memo. 2007-61, slip
- 59 -
[*59] op. at 26-28; see also Purex Corp. v. Procter & Gamble Co., 664 F.2d 1105,
1109 (9th Cir. 1981) (citing Skehan v. Bd. of Trustees,
590 F.2d 470, 478 (3d Cir.
1978)).
The Raifmans’ motion challenged neither the authenticity or admissibility of
the penalty approval form as a business record nor the associated declaration of
RA Alvarez.44 Additionally, the Raifmans do not argue that the grant of
respondent’s motion would be improper in that the penalty approval form is
immaterial, cumulative, or impeaching.45 Instead, the Raifmans appear to argue
that they would be prejudiced if we admitted the penalty approval form without
giving them an opportunity to cross-examine RA Alvarez and Mr. Gee. To this
extent, the Raifmans argue the penalty approval form is insufficient to establish
44
As a preliminary matter, we hold that the penalty approval form is
admissible in that the form is an admissible business record under Fed. R. Evid.
803(6). See Fed. R. Evid. 902(11); see also Clough v. Commissioner, 119 T.C.
183, 190-191 (2002). By the same measure, we hold that RA Alvarez sufficiently
identified and established her familiarity with the signature of Mr. Gee. See Fed.
R. Evid. 901(b)(2).
45
On the basis of this Court’s holdings in Graev II and Graev III, see supra
note 42, the record before us lacks any evidence upon which we may ascertain
whether the Commissioner complied with the written supervisory approval
requirement of sec. 6751(b)(1). Accordingly, the penalty approval form is by its
nature material and manifestly not cumulative, as admission of the penalty
approval form into evidence would stand to influence this case’s outcome by being
the only record in evidence that might establish whether the Commissioner
actually complied with the requirement of sec. 6751(b)(1).
- 60 -
[*60] whether RA Alvarez or Mr. Gee adequately considered the applicability of
any reasonable cause penalty defense available to the Raifmans and that the only
means of establishing such is through cross-examination.
Section 6751(b)(1) requires only that “the initial determination * * * [of the
accuracy-related penalty be] personally approved (in writing) by the immediate
supervisor” of the individual who determined that the penalty is applicable. We
are not persuaded by the Raifmans’ argument that additional cross-examination is
necessary to avoid prejudice.
First, the penalty approval form, as documentary evidence offered as part of
respondent’s motion, will indicate that respondent either did or did not comply
with the written supervisory approval requirement of section 6751(b)(1). We
again note that the Raifmans’ motion and subsequent response failed to challenge
the penalty approval form or its attached declaration in any respect, evidentiary or
otherwise. Absent such a prima facie challenge we are left with the conviction
that admission of the penalty form would not prejudice the Raifmans, and that
further cross-examination is unnecessary.
Second, to the extent the Raifmans request the opportunity to cross-examine
RA Alvarez and Mr. Gee with respect to whether they adequately contemplated
the Raifmans’ reasonable cause defense, we determine that such a line of
- 61 -
[*61] questioning would be immaterial and wholly irrelevant to ascertaining
whether respondent complied with the written supervisory approval requirement
of section 6751(b)(1) or the merits of the Raifmans’ reasonable cause defense to
accuracy-related penalties under section 6662 for the years at issue. The written
supervisory approval requirement of section 6751(b)(1) requires just that: written
supervisory approval. We decline to read into section 6751(b)(1) the subtextual
requirement advocated by the Raifmans in their request for additional cross-
examination. Similarly, we believe it would be imprudent for this Court to now
begin examining the propriety of the Commissioner’s administrative policy or
procedure underlying his penalty determinations. See Greenberg’s Express, Inc. v.
Commissioner, 62 T.C. 324, 328-329 (1974).46 Thus, we cannot conclude that the
Raifmans would be prejudiced.
Accordingly, respondent’s motion will be granted and the penalty approval
form is received into evidence. The Raifmans’ motion will be denied.
Recognizing the parties concessions, and in the light of our holdings above and
46
The rule stated by this Court in Greenberg’s Express, Inc. v.
Commissioner, 62 T.C. 324 (1974), predates the addition of the written
supervisory approval requirement of sec. 6751(b)(1) to the Code. Congress
understood the longstanding rule of Greenberg’s Express when it enacted sec.
6751(b)(1) and at that time did not deem it necessary to expand our jurisdiction or
overturn our precedent, as the Raifmans advocate here. See Lorillard v. Pons,
434
U.S. 575, 580 (1978).
- 62 -
[*62] our discussion below, we hold that respondent has satisfied his burden of
production.
B. Reasonable Cause, Justified Reliance
Once the Commissioner meets his burden, the burden of proof is on the
taxpayer to prove that the application of the penalty is inappropriate. See Higbee
v. Commissioner, 116 T.C. at 446-447. The Raifmans argue that the accuracy-
related penalties are inappropriate, as they acted with reasonable cause and in
good faith in relying on the tax advice of Mr. Ramos and Mr. Shaw.
The accuracy-related penalty will not apply to any portion of the
underpayment for which a taxpayer establishes that he or she had reasonable cause
and acted in good faith. Sec. 6664(c)(1). The determination of whether a taxpayer
acted with reasonable cause and in good faith is made on a case-by-case basis,
taking into account all the pertinent facts and circumstances, including his or her
efforts to assess the proper tax liability, the knowledge and experience of the
taxpayer, and the extent to which he or she relied on the advice of a tax
professional. See sec. 1.6664-4(b)(1), Income Tax Regs.
A taxpayer acts with reasonable cause when he or she exercises ordinary
business care and prudence with respect to a disputed tax item. Neonatology
Assocs., P.A. v. Commissioner, 115 T.C. 43, 98 (2000), aff’d,
299 F.3d 221 (3d
- 63 -
[*63] Cir. 2002). Good-faith reliance on the advice of an independent, competent
professional as to the tax treatment of an item may meet this requirement. See sec.
1.6664-4(b)(1), Income Tax Regs. A taxpayer acts in good faith when he or she
acts upon honest belief and with intent to perform all lawful obligations. See
Rutter v. Commissioner, T.C. Memo. 2017-174, at *45.
A taxpayer alleging reasonable, good-faith reliance on the advice of an
independent, competent professional must prove that (1) the adviser was a
competent professional who had sufficient expertise to justify reliance, (2) the
taxpayer provided necessary and accurate information to the adviser, and (3) the
taxpayer actually relied in good faith on the adviser’s judgment. Neonatology
Assocs, P.A. v. Commissioner, 115 T.C. at 99. A taxpayer’s unconditional
reliance on an otherwise qualified professional does not constitute reasonable
reliance in good faith for purposes of section 6664(c)(1). See Stough v.
Commissioner, 144 T.C. 306, 323 (2015). A taxpayer asserting reasonable
reliance must show that the opinion of a qualified adviser took into account all
facts and circumstances and was not based on unreasonable facts or legal
assumptions. Sec. 1.6664-4(c)(1), Income Tax Regs. Similarly, a taxpayer cannot
reasonably rely on the professional advice of an individual the taxpayer knows, or
should know, to be an insider or a promoter of a particular tax scheme, or to have
- 64 -
[*64] an inherent conflict of interest. New Phoenix Sunrise Corp. v.
Commissioner, 132 T.C. 161, 193-195 (2009), aff’d, 408 F. App’x 908 (6th Cir.
2010); Marine v. Commissioner,
92 T.C. 958, 992-993 (1989), aff’d without
published opinion,
921 F.2d 280 (9th Cir. 1991).
First, we observe that the Raifmans jettisoned their former C.P.A. after
electing to engage in the ClassicStar and Derivium programs and shortly after Mr.
Ramos had presented that C.P.A. with materials regarding the Raifmans’
participation in the ClassicStar program. Following this parting of ways the
Raifmans turned to Mr. Ramos for referral to a return preparer. Mr. Ramos, the
individual who sold the Raifmans on the transactions at issue, had a professional
interest in delivering the Raifmans a return preparer who would respect those
transactions, particularly as they had not sought or secured any legal or tax advice
before engaging in them. Accordingly, Mr. Ramos referred the Raifmans to Mr.
Shaw, who they hired sight unseen.
Second, as Mr. Shaw’s testimony and the remainder of the record illustrate,
Mr. Shaw did not provide the Raifmans with any actual independent and objective
tax advice. Mr. Shaw did not examine the substance of any of the transactions
which the Raifmans had hired him to report on. Indeed, Mr. Shaw’s engagement
with the Raifmans expressly limited the scope of his responsibilities. Any
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[*65] independent advice that Mr. Shaw may have rendered was not based on his
own review of all pertinent facts and circumstances. Mr. Shaw, instead, closely
coordinated with Mr. Ramos, and other promoters, in his preparation and defense
of the Raifmans’ returns for the years at issue and assumed the veracity of the
factual and legal representations of those individuals.47
Additionally, we observe that the Raifmans are sophisticated individuals
whose experience and savvy ought to have clued them in, early on, to the reality
that the tax benefits touted by the Derivium and ClassicStar programs were too
good to be true. With respect to the Derivium transaction, the Raifmans directed
Mr. Ramos to review the program with an outside adviser, a licensed C.P.A. and
attorney, an attorney who declined to engage in any such review. Undaunted, the
Raifmans sought no further expertise, consulted no other professionals, and
engaged in a series of Derivium transactions despite their own misgivings. More
egregiously, the Raifmans sought no outside counsel, with respect to the tax
benefits of the ClassicStar program before choosing to participate in the program.
47
With respect to the Raifmans’ originally claimed deduction for a $15
million theft loss for tax year 2008, Mr. Shaw testified, without elaboration, that
he determined this deduction would be proper pursuant to the arbitration decision.
We observe that Mr. Shaw’s determination in this regard similarly relies on
unreasonable assumptions with respect to the deduction claimed or completely
disregards rules and regulations which proscribe deductions for theft losses until
no reasonable prospect of recovery exists.
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[*66] To this extent, the Raifmans’ assertion of reliance on the advice of Mr. Shaw
is again unreasonable, as their actions reveal a lack of reasonable business care
and prudence on their part. See Neonatology Associates, P.A. v. Commissioner,
299 F.3d at 234 (“When, as here, a taxpayer is presented with what would appear
to be a fabulous opportunity to avoid tax obligations, he should recognize that he
proceeds at his own peril.”); New Phoenix Sunrise Corp. v. Commissioner, 132
T.C. at 195.
On the record before us, any objective and independent advice the Raifmans
may have received did not come from Mr. Shaw. The Raifmans engaged Mr.
Shaw as a strictly prophylactic measure. To the extent Mr. Shaw rendered any
advice, the Raifmans either knew, or should have known, that such advice was
moored to the representations of Mr. Ramos and others riddled with conflicts
stemming from their roles as promoters and insiders of the transactions at issue.
Thus, any reliance on Mr. Shaw is objectively unreasonable. Accordingly, we
sustain respondent’s determination that petitioners are liable for accuracy-related
penalties for the years at issue, consistent with our holdings above.
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[*67] To reflect the foregoing,
An appropriate order will be
issued, and decision will be entered
under Rule 155.
