There have been several criminal tax shelter cases in the news lately.
One of the most frequently employed and egregious shelters has been The Sales Option Bond Strategy, or Son of BOSS.
I call it S.O.B.
Here’s how S.O.B works:
Purpose of Son of Boss
Generally, capital losses can only be deducted to the extent of capital gains.
S.O.B. is a tax shelter that attempts to create capital losses that can be used by a taxpayer to offset capital gains.
Now why would anyone want to create a loss?
No one does. At least not a real loss.
But a phony one?
You betcha.
The only purpose of the S.O.B. tax shelter is to create artificial losses that are then used to offset a taxpayers’ taxable gains.
Son of Boss sales pitch and setup
Shelly Turr is the promoter of an S.O.B. scheme.
He incorporates two separate and distinct entities. We’ll call them Soprano Company and Gotti Company.
Now let’s say a taxpayer named Sammy the Bull sold a capital asset in 2008 that generated a capital gain of $2,000,000.
Absent any capital losses, Mr. Bull will have to pay taxes on the capital gain at a 15% rate.
Shelly Turr approaches The Bull and tells him that for a small fee of $30,000,00 he will save him the $300,000.
Happy as a gangster at a shakedown party. Mr. Bull says “sure, why not?”
He doesn’t care how Mr. Turr is going to save him $300k.
And to be sure, Mr. Turr will make the transaction appear so complicated that even if Mr. Bull desired to understand its intricacies, he would not be able to.
Basic scheme of Son of Boss (and similar stepped-up basis shelters)
Shelly Turr goes back to his office and gets to work.
Here’s what he does:
- He has Soprano Company acquire a fixed asset, say a $5,000 computer system (any capital asset will do);
- He has Mr. Bull purchase the computer system from Soprano for, say, $5,000 cash plus a 20 year Promissory Note payable to Soprano in the amount of $2,005,000; and
- He has Mr. Bull sell his computer system to Gotti Company for $5,000.00
Mr. Bull sold an asset for $5,000 that he had “purchased” for $2,005,000. Thus, he has a created a loss sufficient to offset his $2,000,000.00 capital gain and at a cost of $5,000 for the computer system and $30,000 for Shelly Turr’s fee.
Not a bad return on investment I’m sure you’ld agree.
Shelly Turr, through the implementation of a Son of Boss tax shelter has just created a $2,000,000 capital loss for Mr. Bull
Mr. Bull is very happy and probably won’t whack Turr . . . at least not until he gets his audit notice.
This is, of course, an exaggeratedly simplified version of the S.O.B. scheme.
The typical S.O.B. shelter involves the use of offsetting stock or currency options and the artificial step-up in basis is achieved by exploiting a since closed loophole in the tax code involving contingent partnership liabilities.
For a more complete explanation of the workings of these kinds of tax shelters I recommend you read The Son of Boss Shelter, by Robert L. Sommers.
Why Son of Boss is illegal
There is a basic doctrine in tax law that says the tax code applies only to transactions that have real economic substance i.e. transactions that are not artificially created for the sole purpose of reducing a taxpayer’s tax liability.
It’s called the Econmic Substance Doctrine and it permits the IRS to disregard transactions that lack economic substance.
14 responses so far ↓
1 Mary // Jun 25, 2009 at 9:37 am
So, what happens in 20 years when the promissory note for $2 million comes due? How can Mr. Bull trust that a company like Soprano won’t try to collect on that debt?
2 Peter // Jun 25, 2009 at 9:40 am
Mary,
Thanks for stopping by.
You lie down with dogs, you wake up with fleas.
The other issue, of course, is if Mr. Bull doesn’t repay the Promissory Note doesn’t he have forgiveness of debt income?
That’s why the example I used is extremely simplified.
The actual S.O.B. transactions are more complex and, I assume, deal with the debt collection and debt forgiveness problems.
3 whistlewhat // Jun 25, 2009 at 9:49 am
uh, you are wrong, that is not how it works and what if profit was possible from the transaction, does that change your analysis? not all sob are the same economically.
4 Peter // Jun 25, 2009 at 10:22 am
whistlewhat,
Uh, if you think I am wrong, it might be helpful to my readers if you regaled them with the correct interpretation of the workings of a Son of Boss tax shelter.
That might be more convincing than simply declaring, “uh, you are wrong.”
Don’t get me wrong, I do appreciate the sarcasm of the “uh” utterance. A very nice touch, indeed.
I will stand by my post until I hear your detailed critique of why and how it is incorrect.
With baited breath, I am . . .
Respectfully yours.
5 whistlewhat // Jun 25, 2009 at 10:51 am
dude, the whole premise of sob is using “contingent liabilities” which are not treated as liabilities for tax purposes, like option premiums or loan premiums (or short bond sales), all amounts are always paid back. The purported issue is was profit possible from the transaction, like from the option trades, was it possible to make profit or in the sob to which you directly refer, was profit possible from the investments in forward currency contracts or interest rate movements. Check out Klamath, Jade and Sala. The taxpayer actually won in the Sala sob and obtained a $60 million tax deduction.
kudos, for at least printing my response. P.S., in 1999 the IRS gave Ted Turner a $75 million sob deduction in Fulcrum Financial Partners via settlement for a transaction the DOJ and IRS alleged in court filings had absolutely no economic substance and were shams.
6 Peter // Jun 25, 2009 at 12:40 pm
whistlewhat,
I guess “dude” is a step up from “uh.”
Thank you for your politeness.
I agree the S.O.B is about contingent liabilities. That’s why I wrote this:
7 Peter // Jun 25, 2009 at 12:48 pm
whistlewhat,
I forgot to add that if the S.O.B. has economic substance it ain’t a tax shelter.
Ted Turner’s transaction obviously did have economic substance.
And that should answer your question about a reasonable prospect of recieving a return on investment (i.e. profit).
8 whistlewhat // Jun 25, 2009 at 1:43 pm
Dude, Sommers article is incomplete and most certainly does not discuss many of the favorable cases like Boca, Smith, Compaq, IES, Sala, Gitlitz and even the dicta of ACM. In any event, the example you used bares no correlation to SOB as it implies value for value was not exchanged, i.e. a $2 million dollar deduction based on the value of a $5000 computer. I hate to say it but you are wrong about Fulcrum, both the IRS and DOJ held the transaction had no economic substance yet gave Ted a $75 million deduction which was only part of the $135 million deduction he claimed. Further, the Fulcrum transaction lasted a mere 30 days (at most, actually 3 days for Turner), involved a repo of a $140 million treasury bond with exactly offsetting positions, same principle amount, same interest rate and same expiration date, according to Sommers that would be tax fraud.
Regards
9 Peter // Jun 25, 2009 at 2:26 pm
whistlewhat,
We are making progress.
First I was “uh,” then I was “dude,” now I’m “Dude” with a capital “D.”
By the time I’m finished with you, you’ll be calling me “Your Lordship.”
Summer’s article is incomplete and so is my blog post. It would take a 3 volume treatise to explore and explain all of the various incarnations of Son of BOSS.
I will check out the Fulcrum case. I find it hard to believe that a court actually found there was no economic substance and still allowed the loss.
Keep coming back, Sir Whistlewhat.
You’ll keep me on my toes.
10 Peter // Jun 25, 2009 at 2:48 pm
whistlewhat,
I didn’t publish your last email because of the extremely vuglar and slanderous comments you made in it.
I suggest counseling.
It has to be tough going through life that miserable.
Good luck and God speed.
11 Charles C. // Jun 25, 2009 at 11:00 pm
Thanks for going through the S.O.B. fundamentals. I’ve often hear of it but never really understood it. Too bad that ‘dude’ lost his composure, for a while it was good supplemental analysis. It would be nice if you would kick the example up a notch sometime, now that we have a foundation. I looked at Sommers explaination, but would appreciate a Cliff Notes version. Thanks.
(for the unique site too!).
12 Charles C. // Jun 25, 2009 at 11:16 pm
ok, I apologize. I reread the Sommers paper and it actually is Cliff Notes. Very well written.
13 Peter // Jun 26, 2009 at 12:05 am
Charles C.,
Thanks for the comments.
I will do another Son of BOSS post soon. I was suprised at how much interest there is in this topic.
The next one will be more detailed . . . for the true tax geeks.
Glad you enjoy the blog and I hope you come back.
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