Estate of Arthur E. Kechijian v. Comm of Internal Revenue

PUBLISHED

UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT

No. 18-2277

ESTATE OF ARTHUR E. KECHIJIAN, DECEASED; SUSAN P. KECHIJIAN,
individually and as co-executor; SCOTT E. HOEHN, co-executor,

Petitioners – Appellants,

v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent – Appellee.

No. 18-2402

LARRY E. AUSTIN; BELINDA AUSTIN,

Petitioners – Appellants,

v.

COMMISSIONER OF INTERNAL REVENUE SERVICE,

Respondent - Appellee.

Appeals from the United States Tax Court. (Tax Ct. Nos. 8967-10; 8966-10)

Submitted: May 8, 2020 Decided: June 23, 2020
Before WILKINSON, NIEMEYER, and KING, Circuit Judges.

Affirmed by published opinion. Judge Wilkinson wrote the opinion, in which Judge
Niemeyer and Judge King joined.

Lynn F. Chandler, Stephanie C. Daniel, Lucas D. Garber, SHUMAKER, LOOP &
KENDRICK, LLP, Charlotte, North Carolina, for Appellants. Richard E. Zuckerman,
Principal Deputy Assistant Attorney General, Richard Farber, Jennifer M. Rubin, Tax
Division, UNITED STATES DEPARTMENT OF JUSTICE, Washington, D.C., for
Appellee.

2
WILKINSON, Circuit Judge:

This case concerns the federal income tax consequences arising from a complex set

of business transactions orchestrated by petitioners Arthur Kechijian and Larry Austin. 1

The IRS Commissioner maintains that petitioners substantially underreported their taxable

income for the 2004 tax year. After a trial, the Tax Court agreed. It held that petitioners

had failed to report approximately $41.2 million of compensation income that they realized

when certain restricted stockholdings that they owned became substantially vested in

January 2004. The Tax Court also upheld the Commissioner’s decision to impose

accuracy-related penalties for negligence and substantial understatement of tax liability,

and it denied petitioners’ post-trial attempt to offset their underreported income with

various net operating loss carrybacks. Petitioners challenge each of these holdings. After

careful review of the record, we find no error in the Tax Court’s rulings and accordingly

affirm its judgment. Petitioners cannot be allowed to proceed on any assumption that the

sheer complexity of their corporate transactions will assist them in the evasion of their

appropriate tax liability.

I.

A.

Petitioners were partners in the distressed debt loan portfolio business for

approximately fifteen years, beginning in 1990. At the most basic level, petitioners’

1
Arthur Kechijian died in 2013; his estate was substituted as a party petitioner on
October 23, 2013. Petitioners’ wives, Belinda Austin and Susan Kechijian, are also parties
to this action by virtue of having filed joint federal income tax returns with their husbands.
3
business entailed raising funds from outside investors to finance the acquisition of

distressed debt from financial institutions and government agencies. Corporate entities

controlled by petitioners would then own and service that debt. Each man brought a

different set of skills to their partnership. Austin performed “front-end work,” such as

acquiring loan portfolios, conducting due diligence on potential acquisitions, formulating

bid strategies, performing cashflow analyses, and maintaining investor relationships. On

the other hand, Kechijian performed “back-end work,” including servicing the loan

portfolios, collection activities, human resources, and other back-office operations.

In 1998, petitioners reorganized their business. Prior to that year, petitioners were

the owners and operators of a group of corporations and limited liability companies

(“LLCs”) known as the “UMLIC entities.” Petitioners decided to consolidate the separate

UMLIC entities into a single holding company known as UMLIC Consolidated, Inc. (the

“UMLIC S-Corp.”). UMLIC S-Corp. was a North Carolina corporation for which

petitioners elected so-called “S corporation status.” The goals of this restructuring were

threefold: (1) allowing assets to be moved more efficiently between the various entities;

(2) reducing the number of tax and financial filings the businesses were required to make;

and (3) achieving substantial tax benefits.

To effectuate the contemplated reorganization, petitioners executed a series of

transactions relevant to the instant case. First, each man transferred the entirety of his

shareholdings in the UMLIC entities, each valued at $142,566, to UMLIC S-Corp. in return

for 47,500 shares of UMLIC S-Corp. common stock. Simultaneously, petitioners executed

two collateral agreements, the Restricted Stock Agreement (“RSA”) and the Employment

4
Agreement (“EA”). Taken together, these agreements provided that either petitioner would

lose at least 50% of the value of his UMLIC S-Corp. stock if he voluntarily terminated his

employment with the company before January 1, 2004. This five-year “earnout” period

was designed to incentivize petitioners to continue working for UMLIC S-Corp. so that the

new company would benefit from their diverse skill sets.

The ownership of UMLIC S-Corp. was further divided over the next few years. In

December 1998, petitioners created an employee stock ownership plan (“ESOP”) for

UMLIC S-Corp. The ESOP purchased 5,000 shares of UMLIC S-Corp. common stock at

a price of $500,000. In August 1999, petitioners each transferred 24,500 shares of their

UMLIC S-Corp. stock to two new, irrevocable trusts established for the benefit of their

families. These shares remained subject to the RSA and EA. Thus, as of August 1999,

petitioners, their trusts, and the ESOP were the only shareholders of UMLIC S-Corp.

As alluded to above, petitioners had an additional, non-business motive for creating

this elaborate corporate shareholding structure, namely the deferral of federal income tax

on the profits of UMLIC S-Corp. Four background principles are necessary to understand

this intricate scheme. First, I.R.C. § 83 applies where property, including stock, is

transferred to a taxpayer “in connection with the performance of services.” At the

taxpayer’s election, he may defer tax inclusion of any gains from such a transfer until the

first taxable year in which his rights in the property “are not subject to a substantial risk of

forfeiture,” 26 U.S.C. § 83(a), i.e., when his rights become “substantially vested,” 26

C.F.R. § 1.83-1. Importantly, such rights “are subject to a substantial risk of forfeiture

if . . . [they] are conditioned upon the future performance of substantial services by any

5
individual.” 26 U.S.C. § 83(c)(1). Second, under the Internal Revenue Code (“IRC”), an

S corporation does not itself pay income taxes; rather, it passes any income or losses it

makes through to its outstanding shareholders who must then report the same on their

individual income tax returns. Third, restricted stock in an S corporation “that is issued in

connection with the performance of services . . . and that is substantially nonvested . . . is

not treated as outstanding stock of the corporation” for tax purposes. 26 C.F.R. § 1.1361-

1(b)(3). As such, profits or losses of an S corporation will not flow through to a holder of

non-vested stock and need not be included on the holder’s individual income tax returns.

Fourth, an ESOP is a tax-exempt entity.

In combination, these principles allowed petitioners to avoid reporting any income

from UMLIC S-Corp. on their federal tax returns from 2000 to 2003, despite the fact that

the company was profitable during that period. The Tax Court aptly summarized the

functioning of this scheme: “[petitioners] took the position that their stock (and that owned

by their grantor trusts) was subject to a ‘substantial risk of forfeiture’ and was thus

‘substantially nonvested’ . . . . Because the 95,000 shares owned by petitioners and their

grantor trusts were deemed to be ‘non-outstanding,’ UMLIC S-Corp. for tax years 2000–

2003 allocated 100% of its income, losses, deductions, and other tax items to the ESOP.

Consistently with the company’s reporting, neither petitioner reported any flow-through

items from UMLIC S-Corp. on the joint return he filed with his spouse for 2000, 2001,

2002, or 2003. And because the ESOP was a tax-exempt entity, it likewise reported no

taxable income from UMLIC S-Corp. for 2000–2003.” Austin v. Comm’r, T.C. Memo.

6
2017-69, at *14–15. In other words, between 2000–2003, no one paid any federal income

tax on UMLIC S-Corp.’s profits.

In late 2003, petitioners again undertook to restructure their business operations.

This second reorganization was undertaken for two purposes. First, petitioners hoped to

attract greater outside investment from hedge funds and private equity firms, which they

felt would be difficult while the business continued to operate as an S corporation. Second,

Congress had amended the tax laws to close the loophole by which petitioners had avoided

reporting taxable income on the earnings of UMLIC S-Corp. As such, the existing

structure would cease to provide tax benefits as of January 1, 2005.

To effectuate this restructuring, petitioners formed UMLIC Holdings, LLC

(“Holdings”), a Delaware limited liability corporation in which petitioners each held a 50%

interest. In November 2003, Holdings purchased all of UMLIC S-Corp.’s operating assets

in exchange for a $190 million interest-bearing promissory note and the assumption of

various liabilities. Though UMLIC S-Corp. realized $174.6 million of capital gain on this

sale, it allocated the entirety of that gain to the tax-exempt ESOP, which, according to

petitioners, was still the only outstanding shareholder of UMLIC S-Corp.

On January 1, 2004, the restrictions imposed by the RSA and EA on petitioners’

UMLIC S-Corp. stock lapsed and their shares became fully vested. At this point, the fair

market value of the shares held by each petitioner and his respective trust was

approximately $45.9 million. But petitioners did not hold these shares for long. On March

30, 2004, petitioners entered into identical “surrender” and “subscription” agreements with

UMLIC S-Corp. (the “Surrender Transactions”). Pursuant to the Surrender Transactions,

7
petitioners purported to (1) return the entirety of their newly vested shares to UMLIC S-

Corp. and (2) simultaneously repurchase 47,500 identical shares from UMLIC S-Corp. in

exchange for a $41.5 million promissory note. On their 2004 income tax returns,

petitioners reported $4.5 million in compensation income from this series of transactions,

which represented the difference between the fair market value of the new UMLIC S-Corp.

shares and the price paid to purchase those shares, i.e., the $41.5 million promissory notes.

On June 22, 2004, UMLIC S-Corp. redeemed the 5,000 shares owned by the ESOP

at a price of approximately $10.4 million. At that point, UMLIC S-Corp. became entirely

owned by petitioners and their trusts. It continued to operate in this manner until the

petitioners’ business failed during the 2008 financial crisis.

B.

The IRS examined petitioners’ income tax returns for the years 2000–2004. In the

course of its investigation, the IRS concluded that petitioners had underreported their tax

liability and significantly underpaid tax over that five-year period. Consequently, on

January 15, 2010, the IRS issued timely notices of deficiency to petitioners. As relevant

here, the IRS asserted that: (1) petitioners’ stock in UMLIC S-Corp. was substantially

vested upon receipt in 1998, such that petitioners were required to report their pro rata

shares of the company’s income each year; and (2) even if the stock did not substantially

vest until the RSA restrictions lapsed in January 2004, petitioners should have reported the

fair market value of that stock as taxable income in 2004, notwithstanding their purported

“surrender” of the shares. The IRS also assessed accuracy-related penalties for negligence

and substantial understatement of tax liability for all five years. Petitioners disputed the

8
IRS’s findings and sought redetermination in the Tax Court. Their case eventually

proceeded to trial in 2015.

The Tax Court resolved the first issue in petitioners’ favor. Specifically, it held that

petitioners’ UMLIC S-Corp. stock remained subject to a substantial risk of forfeiture until

the RSA restrictions lapsed. See Austin, T.C. Memo. 2017-69, at *28. And because

petitioners’ shares were not substantially vested between 2000–2003, they were not

required to report the company’s income on their individual returns during that period.

But petitioners did not get off scot-free. The Tax Court agreed with the IRS that

“[s]ection 83(a)(1) requires that the [fair market value] of stock be treated as compensation

income to the shareholder at the first time the stock becomes substantially vested.” Austin,

T.C. Memo. 2017-69, at *38–39 (internal quotation marks omitted). As such, when

petitioners’ stock vested on January 1, 2004, they each “received taxable compensation in

excess of $45 million at that time” and could not “unring this bell by subsequent actions

with respect to the stock, whether that action consisted of sale to a third party or surrender

to the corporation.” Id. at *39. Likewise, the Tax Court concluded that both the Surrender

Transactions and the promissory notes delivered to UMLIC S-Corp. as part of those

Transactions were “palpably lacking in economic substance” and should be disregarded in

calculating tax liability. Ibid. This because, according to the Tax Court, the Transactions

were undertaken for no purpose other than avoiding tax liability and had no reasonable

possibility of generating an economic profit. Id. at *39–41. Thus, the Tax Court held that

petitioners each were required to include compensation income of approximately $45.7

9
million for tax year 2004, 2 and it upheld the Commissioner’s decision to impose accuracy

penalties for that year. See id. at *44–48.

The Tax Court then ordered the parties to file computations under Tax Court Rule

155 regarding the exact tax liability owed by petitioners. As relevant here, in filing their

computations, petitioners asserted that they had sustained various net operating losses

(“NOLs”) in taxable year 2008 and that they had permissibly carried back those losses to

taxable year 2003. They further maintained that they should now be permitted to carry

those NOLs forward to taxable year 2004 to offset some of the tax liability resulting from

the Tax Court’s decision. The Tax Court rejected this argument on the grounds that “[a]n

NOL carryback or carryforward claim is a new issue that cannot be raised for the first time

in a Rule 155 proceeding.” J.A. 1578.

Finally, on August 28, 2018, the Tax Court issued an order setting the Austins’

deficiency in 2004 income tax due at $1,665,619, J.A. 1641, and the Kechijians’ at

$1,835,130, J.A. 1639. The court also imposed accuracy-related penalties on the Austins

in the amount of $333 thousand, J.A. 1642, and on the Kechijians in the amount of $367

thousand, J.A. 1640. This appeal followed.

2
The Tax Court arrived at this figure by subtracting petitioners’ basis in their
UMLIC S-Corp. shares, which was $142,566, from the fair market value of those shares
on January 1, 2004, which was $45,857,434. Austin, T.C. Memo. 2017-69, at *37.
Because petitioners reported $4.5 million of income on their UMLIC S-Corp. shares in
2004, the total amount of income that they each failed to report was $41,214,868. Id. at
*44.

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 II.

Petitioners challenge two aspects of the Tax Court’s decision: (1) that the court erred

in holding that petitioners each realized and were required to report $45.7 million of taxable

income when their UMLIC S-Corp. stock substantially vested in taxable year 2004 and (2)

that the court erred in upholding the accuracy-related penalties imposed by the

Commissioner.

We review the Tax Court’s decisions “on the same basis as decisions in civil bench

trials in United States district courts,” that is “[q]uestions of law are reviewed de novo, and

findings of fact for clear error.” Baxter v. Comm’r, 910 F.3d 150, 156 (4th Cir. 2018).

A.

Petitioners argue that they were not required to report the $45.7 million in gain that

they realized when their UMLIC S-Corp. shares vested. In reaching its contrary holding,

the Tax Court noted that a taxpayer realizes compensation income “at the first time” that

restricted stock transferred pursuant to I.R.C. § 83 becomes substantially vested, which, in

this case, occurred on January 1, 2004. Austin v. Comm’r, T.C. Memo. 2017-69, at *39–

40 (2017); see also 26 U.S.C. § 83(a)(1). Petitioners do not seriously contest this point.

See Petitioners’ Opening Br. 15 (acknowledging that petitioners “were in constructive

receipt of compensation income on January 1, 2004 when [their shares] became available

to them without substantial restrictions”). Instead, they maintain that the subsequent

Surrender Transactions effectively negated or reversed their receipt of this compensation,

such that they were not required to include it in their gross income. For the reasons that

follow, we disagree.

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 1.

It is a well-settled principle of tax law that compensation is included in the taxable

income of the person who earned it, notwithstanding any assignment or transfer of that

compensation to a third party. See Lucas v. Earl, 281 U.S. 111, 114–15 (1930). Thus, the

mere fact that petitioners purported to return their vested shares back to UMLIC S-Corp.

has no effect on their individual tax liability. Likely aware of this fundamental rule,

petitioners advance a slightly different argument premised on the tax rescission doctrine. 3

Specifically, they maintain that the Surrender Transactions effectuated a complete

rescission of their contractual agreements with UMLIC S-Corp., and because that

rescission occurred in the same year as petitioners’ receipt of compensation income under

those agreements, that income should be disregarded for federal income tax purposes.

We do not see it. The Surrender Transactions did not restore petitioners “to the

relative positions that they would have occupied had no contract been made,” which is a

fundamental requirement for application of the rescission doctrine. Rev. Rul. 80-58, 1980-

1 C.B. 181, 181; Hutcheson v. Comm’r, 71 T.C.M. (CCH) 2425, at *4 (1996) (“For the

rescission to be effective, both buyer and seller must be put back in their original

positions.”); see also Reeves v. United States, 173 F. Supp. 779, 781 (M.D. Ala. 1959). Put

simply, if you can’t restore, you can’t rescind. The contracts at issue here were for personal

services, namely the five years of services performed by petitioners on behalf of UMLIC

3
The parties dispute whether petitioners have waived any argument based on the
rescission doctrine. We need not resolve this question because, as discussed below, we find
that petitioners’ rescission arguments are unavailing even if properly presented.
12
S-Corp. When a personal services contract has actually been performed, it is essentially

impossible for the individual who rendered the services to be “returned” to his position ex

ante. See Jasper L. Cummings, Circular Cash Flows and the Federal Income Tax, 64 Tax

Law. 535, 602 (2011) (noting that “compensation arrangements are not well suited” to

analysis under the tax rescission doctrine “because the employee cannot usually give back

his or her performance”). What is more, as part of the underlying contracts, petitioners

transferred the entirety of their interests in the UMLIC entities to UMLIC S-Corp., but they

did not receive those assets back in the Surrender Transactions. See J.A. 1109–11. As

such, the Surrender Transactions are completely unlike the prototypical instance of

rescission, in which all property that changes hands is returned to its original owner. See

Rev. Rul. 80-58, 1980-1 C.B. 181.

In attempting to fit the square peg of the Surrender Transactions into the round hole

of the rescission doctrine, petitioners point to a line of authorities suggesting that

compensation is not taxable to an employee if returned to his employer in the year it was

received. See, e.g., Russel v. Comm’r, 35 B.T.A. 602 (1937). But those precedents are

inapposite here. As the Tax Court has clarified, they stand only for the limited proposition

that returned compensation may not be taxable income where “the original salary

agreements . . . [were] subject to modification by the taxpayers and their employers and

not absolute.” Jones v. Comm’r, 82 T.C. 586, 591 (1984). There is no indication that

petitioners’ compensation agreements with UMLIC S-Corp. were open-ended in the sense

contemplated by those cases, and petitioners’ belated attempt to modify those agreements

via the Surrender Transactions could not affect their tax liability. See Leicht v. Comm’r,

13
137 F.2d 433, 435 (8th Cir. 1943) (“[I]t is not given to a taxpayer to lift the federal tax-

hand from income, which he has once received in absolute right, by an attempt thereafter

to alter its legal status through modification of the agreement out of which it arose.”).

2.

In any event, even if the Surrender Transactions could somehow be seen as

rescinding petitioners’ employment and compensation agreements with UMLIC S-Corp.,

we agree with the Tax Court’s conclusion that those transactions were totally devoid of

economic substance and must be disregarded for federal income tax purposes.

The economic substance doctrine effectuates the Supreme Court’s command that

the tax effect of a transaction should be based on “the objective economic realities of [the]

transaction rather than . . . the particular form the parties employed.” Frank Lyon Co. v.

United States, 435 U.S. 561, 573 (1978). The doctrine permits the IRS to “ignore for tax

purposes any sham transaction, i.e., a transaction designed to create tax benefits rather than

to serve a legitimate business purpose.” Hines v. United States, 912 F.2d 736, 739 (4th

Cir. 1990). We employ a two-prong test to determine if a given transaction should be

disregarded pursuant to the doctrine. “To treat a transaction as a sham, the court must find

[1] that the taxpayer was motivated by no business purposes other than obtaining tax

benefits in entering the transaction, and [2] that the transaction has no economic substance

because no reasonable possibility of profit exists.” Rice’s Toyota World, Inc. v. Comm’r,

752 F.2d 89, 91 (4th Cir. 1985). The first prong of the test is subjective, and the second is

objective; nevertheless, while we “examine both the subjective motivations of the taxpayer

and the objective reasonableness of the investment, in both instances our inquiry is directed

14
to the same question: whether the transaction contained economic substance aside from the

tax consequences.” Black & Decker Corp. v. United States, 436 F.3d 431, 441 (4th Cir.

2006) (internal quotation marks omitted). Whether a particular transaction was a sham is

a question of fact that we review only for clear error. Rice’s Toyota World, Inc., 752 F.2d

at 92.

Application of the foregoing principles to the instant case reveals that the Surrender

Transactions were indeed nothing more than a sham to avoid tax liability and were rightly

disregarded by the Tax Court.

Petitioners’ own admissions satisfy the first prong of the economic substance test.

At trial, petitioners proffered only one business purpose for the Surrender Transactions—

relieving UMLIC S-Corp. from the burden of withholding and paying payroll and

employment taxes attributable to the $92 million of compensation income realized by

petitioners when their restricted stock vested. See J.A. 1295–96. But as the Tax Court

noted, “[t]hat is in itself a tax-avoidance purpose,” and “by admitting that [they] sought to

avoid payment of employment taxes, [petitioners] in effect admitted that they sought to

avoid payment of income taxes, because the former would not be payable unless the latter

were payable also.” Austin, T.C. Memo. 2017-69, at *40–41.

Surprisingly, petitioners double down on their position in this appeal. They

candidly acknowledge that the only reason they executed the Surrender Transactions was

to enable UMLIC S-Corp. to avoid withholding and remitting approximately $33 million

in state and federal payroll and income taxes. Petitioners maintain that this course of action

was necessary to ensure UMLIC S-Corp.’s continued viability as a going concern. This is

15
because, according to petitioners, UMLIC S-Corp. did not have enough cash on hand to

cover its tax withholding obligations, an assertion that the Tax Court found to be

unsupported by the evidence at trial. See Austin, T.C. Memo. 2017-69, at *40 n.13. But

even if that were true, it does nothing to change the fact that the sole purpose for the

Surrender Transactions was the avoidance of tax obligations, both those of UMLIC S-Corp.

and, by extension, those of petitioners. Under our case law, that is enough to satisfy the

first prong of the economic substance test. See Friedman v. Comm’r, 869 F.2d 785, 792

(4th Cir. 1989) (noting that the first prong “requires a showing that the only purpose for

entering into the transaction was the tax consequences”).

The second prong of the economic substance test is likewise met here. As the Tax

Court found, it is inconceivable that either petitioner “could envision a reasonable

possibility of profit by surrendering, for no consideration, stock worth $45.8 million.”

Austin, T.C. Memo. 2017-69, at *41. The fact that petitioners each gave UMLIC S-Corp.

a $41.5 million promissory note as part of the Surrender Transactions only bolsters this

conclusion, as “no rational person would incur indebtedness of $41.5 million to acquire

stock that he already owned free and clear.” Ibid. On the record before us, we cannot say

that these findings were anything but sound.

Petitioners’ final argument regarding economic substance is based on the

promissory notes that they conveyed in exchange for the newly issued UMLIC S-Corp.

stock. On petitioners’ telling, because those notes constituted recourse debt, they had

independent economic substance such that their value should have been added to

petitioners’ basis in their UMLIC S-Corp. shares. This basis increase would have caused

16
them to realize only $4.2 million in taxable income when those shares vested, rather than

the $45.7 million found by the Tax Court.

Again, we must disagree. For starters, we concur with the Tax Court’s finding that

that the notes lacked economic substance and should be disregarded for tax purposes

because they were issued by petitioners to a company owned and controlled by petitioners.

In other words, petitioners effectively issued the notes to themselves. See Austin, T.C.

Memo. 2017-69, at *41. But there is an additional problem with their argument. As

petitioners themselves point out, the notes were “used to purchase stock in UMLIC.”

Petitioners’ Reply Br. 11 (emphasis added). Thus, even if the notes had economic

substance, their value would be included in petitioners’ basis for the new UMLIC stock

that they purchased in March 2004, not the original UMLIC stock that they acquired in

1998. See 26 U.S.C. § 1012(a) (defining “basis of property” as “the cost of such property”).

Thus, the notes could not possibly offset any of the taxable income petitioners realized

when the original shares vested in January 2004.

B.

Petitioners also take issue with the Tax Court’s decision affirming the

Commissioner’s imposition of accuracy-related penalties.

I.R.C. § 6662 provides for the imposition of a 20% penalty on “any portion of an

underpayment of tax” that is attributable to, inter alia, “[n]egligence or disregard of rules

or regulations” or “[a]ny substantial understatement of income tax.” 26 U.S.C. § 6662(a),

(b)(1), (b)(2). But “[n]o penalty shall be imposed under section 6662 . . . with respect to

any portion of an underpayment if it is shown that there was a reasonable cause for such

17
portion and that the taxpayer acted in good faith with respect to such portion.” 26 U.S.C.

§ 6664(c)(1). In determining whether a taxpayer acted with reasonable cause and good

faith, we consider “all the pertinent facts and circumstances,” but “[g]enerally the most

important factor is the extent of the taxpayer’s effort to assess [his] proper tax liability.”

Treas. Reg. § 1.6664-4(b)(1). Whether a taxpayer acted with reasonable cause and in good

faith is a question of fact, thus we review the Tax Court’s findings on this score only for

clear error. Baxter, 910 F.3d at 165 (citing Antonides v. Comm’r, 893 F.2d 656, 659 (4th

Cir. 1990)).

The Tax Court held that each petitioner’s failure to report $41.2 million of income

on his UMLIC S-Corp. stock was attributable to negligence and amounted to a substantial

understatement of tax. Austin, T.C. Memo. 2017-69, at *45. Petitioners do not contest this

conclusion. Rather, they maintain that they should not have been subject to accuracy-

related penalties because they had reasonable cause for the tax position they took with

respect to the Surrender Transactions, they acted in good faith, and the issues presented in

this case are novel.

We disagree. For starters, as the Tax Court pointed out, petitioners have presented

neither evidence nor legal authority to suggest that they made any effort to accurately

assess their 2004 tax liability. See Austin, T.C. Memo. 2017-69, at *46–47. They did not

obtain or rely on the opinion of a tax professional in adopting their position regarding the

tax effect of the Surrender Transactions. Moreover, petitioners structured the Transactions

with the specific purpose of evading tax liability on the compensation income that even

petitioners admit they realized at the moment their shares substantially vested. And they

18
can point to no legal authority suggesting that the Surrender Transactions were anything

other than a sham designed to avoid taxes that should be disregarded. In sum, we agree

with the Tax Court’s finding that “[p]etitioners’ overall conduct shows that they were fully

aware of the tax consequences of their stock’s becoming substantially vested,” and their

efforts to escape that liability did not rest on an “honest misunderstanding of fact or law

that was reasonable under all the circumstances.” Austin, T.C. Memo. 2017-69, at *47

(internal quotation marks omitted). As such, petitioners have failed to establish a defense

of reasonable cause and good faith.

Petitioners’ argument that the tax law issues in this case are novel does nothing to

change our conclusion. For one thing, we have never recognized novelty as a stand-alone

defense to the imposition of accuracy-related penalties. See Baxter, 910 F.3d at 168. More

importantly, there is nothing novel about the legal issues presented by or doctrines applied

in this case. That the law prohibits a taxpayer from avoiding tax liability by means of a

sham transaction is a rule almost as old as the federal income tax system. See, e.g., Gregory

v. Helvering, 293 U.S. 465, 468–70 (1935); see also Baxter, 910 F.3d at 168 (rejecting a

similar novelty argument on the grounds that “it [is] well-established that transactions

lacking economic substance must be disregarded for tax purposes”). There is no reason

that petitioners, sophisticated businessmen who were clearly cognizant of the tax

consequences of their actions, could have reasonably expected that the Surrender

Transactions would be exempted from this longstanding rule. See Treas. Reg. § 1.6664-

4(b)(1) (noting that “the experience, knowledge, and education of the taxpayer” is relevant

in assessing accuracy-related penalty defenses).

19
 III.

Petitioners further maintain that the Tax Court erred in refusing to consider their

NOL carryback claim during post-trial computation proceedings conducted pursuant to

Tax Court Rule 155. In short, petitioners assert that the Tax Court was affirmatively

required to take account of their NOL claims during this computational phase because, if

those claims were valid, they could have affected petitioners’ tax liability for the taxable

year at issue in this case. That argument is contrary to both the rules and well-settled

precedent of the Tax Court, and we reject it.

Rule 155 authorizes the Tax Court to conduct further proceedings after it “has filed

or stated its opinion or issued a dispositive order determining the issues in a case,” for the

limited purpose of calculating a party’s precise tax liability. T.C. Rule 155(a). In the

course of these proceedings, parties are specifically prohibited from raising “new issues”

that go beyond “computation of the amount to be included in the decision resulting from

the findings and conclusions made by the Court.” Id. 155(c); Vessio v. Comm’r, 60 T.C.M.

(CCH) 1150, 1150 (1990) (“The exclusive purpose of proceedings under Rule 155 . . . is

the computation of the deficiency, liability, or overpayment resulting from the findings and

conclusions made by the Court.”); see also Vento v. Comm’r, 152 T.C. 1, 9 (2019) (noting

that the bar on new issues is “rigorously enforce[d]” by the Tax Court). For purposes of

Rule 155, a new issue is one that “was neither placed in issue by the pleadings, addressed

as an issue at trial, nor discussed by [the Tax] Court in its prior opinion,” or one that “would

necessitate retrial or reconsideration.” Vento, 152 T.C. at 8 (internal quotation marks

omitted). We review the Tax Court’s refusal to consider a new issue in Rule 155

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proceedings for abuse of discretion. See Powell v. Comm’r, 581 F.3d 1267, 1269–70 (10th

Cir. 2009).

Petitioners’ NOL claim was clearly a “new issue” within the meaning of Rule 155.

Quite simply, petitioners’ entitlement to NOL carrybacks from 2008 was not meaningfully

addressed in the Tax Court proceedings on the merits. On the contrary, petitioners did not

include any NOL carryback claims in their original or amended petitions and failed to raise

them in their final pre-trial memorandum and post-trial briefing. The merits of the issue

were not litigated at trial. Consequently, the question of petitioners’ entitlement to NOL

carrybacks formed no part of the “decision resulting from the findings and conclusions

made by the [Tax] Court,” and consideration of that issue would have required the court to

reopen the record. T.C. Rule 155(c); see also Vento, 152 T.C. at 8 (noting that the Tax

Court has found a taxpayer’s “entitlement to a net operating loss carryback” to be a new

issue for the purposes of Rule 155 (citing Vest v. Comm’r, 69 T.C.M. (CCH) 2491, 2493

(1995))). As such, it was no abuse of discretion for the Tax Court to reject petitioners’

attempt to raise this new issue during Rule 155 proceedings.

In an effort to evade the effect of Rule 155, petitioners assert that a provision of the

I.R.C., namely Section 6214(b), required the Tax Court to consider their NOL claim. In

pertinent part, Section 6214(b) provides that “in redetermining a deficiency of income tax

for any taxable year,” the Tax Court “shall consider such facts with relation to the taxes for

other years or calendar quarters as may be necessary correctly to redetermine the amount

of such deficiency.” 26 U.S.C. § 6214(b). On petitioners’ reading, this section

“specifically requires the Tax Court to consider such facts with relation to the taxes for

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other years as may be necessary to correctly redetermine the amount of any tax deficiency.”

Petitioners’ Reply Br. 18. And because, according to petitioners, application of their 2008

NOLs to taxable year 2004 could have reduced their tax liability for that year, the Tax

Court had no discretion to exclude them from its Rule 155 computations.

We cannot accept petitioners’ expansive understanding of Section 6214(b). For

starters, petitioners’ argument proves too much. If adopted, it would effectively vitiate

Rule 155, as the Tax Court would be required to consider every new issue raised during

the computation phase that could conceivably affect the taxpayer’s ultimate liability.

Petitioners have failed to identify any authority supporting such a broad interpretation, and

we have found none. But that is hardly surprising, as petitioners completely misread

Section 6214(b). Rather than an affirmative mandate to the Tax Court, Section 6214(b) is

simply a jurisdictional provision authorizing that court to consider facts from taxable years

not at issue when calculating liability for those years that are at issue. See Estate of

Branson v. Comm’r, 264 F.3d 904, 912–13 (9th Cir. 2001) (characterizing Section 6214(b)

as jurisdictional). It does not limit the Tax Court’s ability to regulate its own proceedings

or insist on the timely presentation of substantive claims prior to the Rule 155

computational phase.

IV.

In conclusion, we affirm the decision of the Tax Court on all issues.

AFFIRMED

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