Tax Court Finds Taxpayer Cannot Claim a $78.5 Million Tax Shelter Loss

In Blum v. Commissioner, TC Memo 2025-18, the Tax Court addressed a dispute concerning the disallowance of a $78.5 million tax shelter loss, penalties, and the validity of notices issued by the IRS. The central issues revolved around the petitioners’ participation in a Bond Linked Issue Premium Structure (BLIPS) tax shelter, the IRS’s notification procedures, and various legal arguments raised by the Blums.

Facts of the Case

During 1999, Scott Blum engaged in the BLIPS tax shelter through Democrat Strategic Investment Fund, LLC (DSIF), which was a TEFRA partnership. Blum held his interest in DSIF through Bogan Ventures, LLC (Bogan), a single-member LLC and a disregarded entity for tax purposes, making Blum an indirect partner in DSIF. The tax shelter’s strategy involved inflating Bogan’s outside basis in DSIF, which then liquidated and distributed its assets to Bogan. Blum then sold these assets at prices lower than their inflated bases, generating a $78.5 million artificial tax loss, which the Blums deducted on their 1999 personal income tax return to offset gains from the sale of an unrelated asset.

The IRS initiated an audit of the Blums’ 1998 return in October 2001, expanding it to include their 1999 and 2000 returns, and DSIF’s 1999 return. In early 2002, the Blums moved to Wyoming. The IRS mailed a notice of beginning of partnership administrative proceeding (NBAP) for DSIF’s 1999 taxable year to its TMP. In May 2004, Mr. Blum informed the RA of their Wyoming address.

In late 2004, DSIF’s Tax Matters Partner (TMP) declined to extend the limitations period for 1999. Subsequently, the IRS issued a Notice of Final Partnership Administrative Adjustment (FPAA) for DSIF’s 1999 taxable year. In March 2005, DSIF’s TMP filed a petition for review of the FPAA adjustments in the District Court for the Northern District of California.

The IRS issued a Notice of Deficiency to the Blums for 1998, 1999, and 2002 in November 2005, disallowing the $78.5 million BLIPS tax shelter loss for 1999. The Blums filed a petition with the Tax Court, arguing the notice was invalid regarding the BLIPS adjustments because they were partnership or affected items. The Tax Court dismissed the BLIPS adjustments for lack of jurisdiction because the adjustments were partnership or affected items and were at issue in the ongoing district court case.

In July 2014, the district court held that the BLIPS transactions lacked economic substance and were disregarded for federal tax purposes. As a result, in December 2015, the IRS issued affected items Notices of Deficiency to the Blums for 1999, 2007, and 2010.

Taxpayers’ Arguments for Relief

The Blums contested the affected items Notices of Deficiency based on several arguments:

  • Improper Mailing of FPAA: The Blums argued that the IRS failed to mail a notice partner FPAA to Mr. Blum at his correct address, invalidating the subsequent affected items Notices of Deficiency. They contended that Mr. Blum, as an indirect partner, should have received the notice directly.
  • Statute of Limitations: The Blums asserted that the statute of limitations had expired before the IRS issued the DSIF FPAA and the affected items Notices of Deficiency, challenging the validity of both partnership and individual consents to extend the limitations period.
  • Settlement in Prior Tax Court Case: The Blums claimed that their tax liability related to the BLIPS tax shelter loss was resolved in a prior Tax Court case (Blum I) and incorporated in a Rule 155 computation, thus precluding the IRS from reassessing the issue.
  • Improper Basis Adjustment: The Blums argued that the IRS improperly adjusted their bases in the DSIF assets in the affected items case, as such an adjustment required a determination that DSIF was a sham, which the district court had not made.
  • Estoppel: The Blums argued that judicial estoppel should prevent the IRS from arguing that the district court’s decision was controlling. The Blums also asserted that collateral estoppel prevented the IRS from adjusting Mr. Blum’s bases in the DSIF assets because the assets’ bases were allegedly litigated in Blum I.

Tax Court’s Analysis of Law and Authorities

The Tax Court addressed each of the Blums’ arguments by analyzing the relevant legal authorities and applying them to the facts:

  • Mailing of Notice Partner FPAA: The court emphasized that under TEFRA, the IRS is required to mail the notice partner FPAA to the names and addresses of the partners as shown on the partnership return or as furnished to the IRS in accordance with Treasury regulations. The court found that Mr. Blum’s identity as an indirect partner was not properly furnished to the IRS, as DSIF’s partnership return did not indicate that Bogan was a single-member LLC or that Mr. Blum was its sole member or DSIF’s indirect partner. The court referenced § 6223(a), (c)(1) and (2) which requires the IRS to mail the notice partner FPAA to the names and addresses of the partners that are shown on the partnership return for the taxable year at issue or the names and addresses that are furnished to the IRS by the TMP or any other person in accordance with the Treasury regulations.
    • The court also cited Wind Energy Tech. Assocs. III v. Commissioner, 94 T.C. 787 (1990) and Wayne Caldwell Escrow P’ship v. Commissioner, T.C. Memo. 1996-401, noting that when the IRS fails to mail an FPAA to a notice partner, section 6223(e) is the exclusive remedy for the notice partner which allows the affected notice partner to elect to convert the partnership items into nonpartnership items.
  • Statute of Limitations: The court noted that partners cannot challenge the validity of TMP consents in a partner-level case, as the timeliness of an FPAA is a partnership item that must be raised during the TEFRA case. Citing § 6221, the court stated that partnership items must be determined at the partnership level. The court also found that the individual consents were valid and, in any event, immaterial because the limitations period was still open under § 6229.
    • The court referenced Kaplan v. United States, 133 F.3d 469, 473 (7th Cir. 1998), noting that a challenge to the validity of a TMP consent “is precisely the type of challenge prohibited by TEFRA in light of Congress’s decision that such suits are better addressed in one fell swoop at the ’partnership level’ than in countless suits by individual partners."
  • Settlement in Prior Tax Court Case: The court dismissed the Blums’ argument that the prior Tax Court case (Blum I) resolved the BLIPS tax shelter loss, emphasizing that Blum I specifically excluded adjustments subject to TEFRA partnership provisions. The court also noted that the deficiency determined in Blum I was related to an OPIS tax shelter, not the BLIPS tax shelter.
    • The court cited Bedrosian, 143 T.C. at 108–09, stating that it is common practice for the Commissioner to issue both an FPAA to a partnership and a Notice of Deficiency to a partner determining the same adjustments.
  • Improper Basis Adjustment: The court held that it was unnecessary for the district court to deem DSIF a sham for the IRS to adjust Mr. Blum’s bases in the DSIF assets. The court stated that the district court’s determination that the BLIPS transactions lacked economic substance was sufficient for the IRS to adjust Bogan’s outside basis in DSIF to zero.
    • Referencing Woods, 571 U.S. at 42, the court stated that a partner’s outside basis in his partnership interest is an affected item.
  • Estoppel: The court found no grounds to apply judicial estoppel against the IRS, as the Blums were parties to the 63 SIFs case. It also rejected the Blums’ collateral estoppel argument, reiterating that Mr. Blum’s bases in the distributed DSIF assets are affected items.
    • The court cited New Hampshire v. Maine, 532 U.S. 742, 750–51 (2001), stating that generally, three nonexhaustive factors guide our analysis when we are asked to invoke this doctrine: whether (1) the party’s later position is clearly inconsistent with its earlier position, (2) the party persuaded a court to accept its earlier position, and (3) the party seeking to assert an inconsistent position would derive an unfair advantage.

Ultimate Findings

The Tax Court sided with the IRS on nearly all counts:

  • The court upheld the validity of the affected items Notices of Deficiency, finding that the IRS properly mailed the notice partner FPAA to Bogan at the Schedule K–1 address and that the Blums had actual notice of the FPAA.
  • The court held that the affected items Notices of Deficiency were timely issued.
  • The court rejected the Blums’ argument that their tax liability related to the BLIPS tax shelter loss was resolved in a prior case or through a closing agreement.
  • The court sustained the IRS’s adjustment of the Blums’ bases in the DSIF assets.
  • The court found the Blums liable for the section 6651(a)(1) addition to tax for the untimely filing of their 2007 return.
  • The court dismissed the section 6662(h) penalties for lack of jurisdiction, as penalties related to adjustments of partnership items are not subject to deficiency procedures.

In conclusion, the Tax Court’s decision in Blum v. Commissioner affirmed the IRS’s disallowance of the $78.5 million tax shelter loss and upheld the agency’s procedures in handling the TEFRA partnership adjustments and related notices.

Prepared with assistance from Notebook LM.