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“Cargo Cult” Tax Opinions Won’t Stop IRS Push for
International Penalties
(October 28, 2004)
A “cargo cult” is a belief that if one goes through the
proper rituals – building a runway and control tower on
a remote South Sea island, for instance – that the
results one wants (e.g., planes full of cargo) are
destined to occur. Some taxpayers have followed their
own cargo cult, believing that a taxpayer could shield
itself from IRS penalties merely by getting a tax
opinion from a law or accounting firm.
In a devastating district court decision (Long Term
Capital Holdings v. United States), two opinions from
established law firms were excoriated as empty rituals
designed to make an otherwise ridiculous tax shelter
look respectable. The opinions blessed a transaction
that resulted in a partnership receiving contributions
of preferred stock with a tax basis about 100 times fair
market value. The partnership later sold the contributed
stock and purported to realize losses in excess of $100
million.
The court’s opinion reads like a do and don’t list:
- Don’t rely on an informal, cursory or oral opinion
before entering into a transaction or reporting it on
your tax return.
- Don’t play privilege games. An opinion that asserts
work-product doctrine protection will not be viewed as
objective.
- Don’t try to hide the transaction by reporting it on a
questionable line or schedule of the return.
- Don’t accept a conclusory opinion at face value.
Insist on seeing the full legal analysis and how it
applies to your facts.
- Most importantly, don’t ask your adviser to rely on
unrealistic assumptions, and don’t rely on an adviser
who is willing to swallow (or invent) them.
The IRS has tightened its rules for negotiating
settlements of transactions similar to Long Term Capital
Holdings, demanding that the taxpayer concede 100% of
the tax benefit and 50% of the penalties. In the
transfer pricing area, revenue agents are now required
to explain why the taxpayer’s documentation is
sufficient to avoid a penalty. Taxpayers should expect
that the Service will extend this skeptical attitude to
other international issues, particularly where treaty
abuse is evident.
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