Page 2 - Can the Code Sec. 6700 Tax Shelter Promoter Penalty Apply to Everyday Tax Advice?

Most practitioners believe that the penalty under Code Sec. 6700 is designed for abusive tax shelters that are marketed by unscrupulous tax shelter promoters.
PENALTIES
income from such activity. The penalty for participation and sale of interests in the plan or arrangement is 50 per- cent of the gross income derived (or to be derived) from such activity. For purposes of calculating the amount of the penalty, the organization of the tax shelter is treated as a separate activity from the participation and sale of interests in the shelter, meaning that the promoter can be liable for both activities. There is no statute of limitations for assertion of a Code Sec. 6700 penalty.2
Code Sec. 6700 cases typically involve an individual, or individuals working through an entity, who understand the way in which the “tax shelter” operates and the tax consequences of the transaction at issue. For example, the alleged promoter in Stover3 was an attorney and an accoun- tant with a MBA whose “sole motivation in promoting [the schemes] was to defer recognition of income,” and he “advised one client to form a Parallel C structure solely in order to reduce taxes.” Similarly, A.F. Campbell 4 involved
tax benefits by reason of participating in the investment, plan or arrangement; (iii) knowledge or reason to know that the statement was false; and (iv) that the false state- ments pertain to a material matter.7 To understand the full scope of Code Sec. 6700, it is helpful to analyze each of these elements separately.
A. Is the Transaction at Issue an “investment plan or other arrangement”?
To be subject to penalties under 6700, an alleged pro- moter must make a tax statement in connection with an “investment plan or arrangement.” Unfortunately, Code Sec. 6700 does not define an “investment plan or other arrangement” and the term has been construed quite broadly by courts.8 Nevertheless, both courts and the IRS itself have referred to the Internal Revenue Code provi- sions and regulations defining “tax shelters” in interpreting the meaning of relevant portions of Code Sec. 6700, including what constitutes an “investment plan or other arrangement.”9 Tax shelters have been defined to include only plans or arrangements that have a significant purpose of avoiding or evading federal tax.10 While the IRS could argue that other kinds of transactions fit into the broad definition of an investment plan or arrangement in Code Sec. 6700, there is a strong argument that the penalty ap- plies only to transactions that have a significant purpose of tax avoidance or evasion.
B. Did the Alleged Promoter
Make Statements Regarding
the Allowability of Tax Benefits by Reason of Participation in
the Transaction?
Two types of statements fall within the ambit of Code Sec. 6700: (i) statements directly addressing the allowability of tax benefits and (ii) statements concerning factual matters relevant to the allowability of tax benefits.11 Thus, a factual statement that does not specifically address taxes can provide a basis for a Code Sec. 6700 penalty. For example, in Campbell,12 a promoter created a Brazilian company that purported to provide certain research services and sold interests in that entity. The Court held that the false statement that the service provider was located in Brazil, when it actually was in another country, was key to the investors’
an attorney with a MBA who marketed the subject invest- ments as a way to reduce taxes such that the main issue in the case was whether he knew or had reason to know that some of his statements were false. In Gleason,5 the alleged promoter was an experienced tax return preparer who was marketing the “Tax Toolbox,” a pre-packaged plan that “aggressively promoted tax savings through home-based businesses.” Many cases refer to the alleged promoter’s familiarity with tax matters in determining whether the person had reason to know that their statement was false, indicating that the statement must necessarily be about tax consequences to trigger penalties under Code Sec. 6700.6
As these cases illustrate, the typical Code Sec. 6700 case involves a transaction that is designed and marketed to taxpayers to reduce taxes. Nevertheless, the language of Code Sec. 6700 is sufficiently broad that an IRS agent could attempt to shoehorn a transaction that did not have a principal or even significant purposes of tax avoidance into the requirements of the statute. Courts have identified four elements that the IRS must prove to impose a Code Sec. 6700 penalty: (i) the organization or participation in the sale of an investment, plan or arrangement; (ii) a state- ment by the alleged promoter regarding the allowability of
22 JOURNAL OF TAX PRACTICE & PROCEDURE
OCTOBER–NOVEMBER 2016