Free Memorandum - District Court of Federal Claims - federal

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No. 05-1223 T (Judge Allegra)

IN THE UNITED STATES COURT OF FEDERAL CLAIMS

CLEARMEADOW INVESTMENTS, LLC, CLEARMEADOW CAPITAL CORP., Tax Matters Partner, Plaintiff, v.

THE UNITED STATES, Defendant.

BRIEF IN SUPPORT OF PLAINTIFF'S CROSS-MOTION FOR SUMMARY JUDGMENT

THOMAS C. PLISKE Stientjes & Pliske, LLC 1120 Olivette Executive Parkway Suite 220 St. Louis, MO 63132 Tel: (314) 872 -3988 Fax: (314) 872-7374 Attorney for Plaintiff

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TABLE OF CONTENTS Page Questions Presented .......................................................................................................1 Statement of the Case.....................................................................................................3 A. Hutton reasonably believed that the MLD investment was a high risk/high reward transaction. Hutton was not promised any tax benefits as alleged by Defendant. .........................................................6 Hutton, upon learning of the MLD investment took all actions one could reasonably be expected to take. ............................................7

B.

Jurisdiction.....................................................................................................................8 Argument .......................................................................................................................9 I. For purposes of this cross-motion for summary judgment, the plaintiff concedes, six years after Defendant invested in the MLD investment, that the investment lacked economic substance. ......................................................9 The Court has jurisdiction to determine if partnership and partner level defenses apply to penalties asserted in the FPAA. ...........................................9 The plaintiffs assert that the penalties stated in the FPAA do not apply in this matter. ......................................................................................................12 A. The plaintiffs assert that the Gross Valuation Misstatement / Substantial Valuation Misstatement penalty stated in the FPAA do not apply in this matter. . .....................................................................13 The plaintiffs assert that the Substantial Understatement of Income Tax penalty stated in the FPAA does not apply in this matter. ...........16 The plaintiffs assert that the Negligence or Disregard of Rules or Regulations penalty stated in the FPAA does not apply in this matter. .................................................................................................19

II.

III.

B.

C.

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[Table of Contents, continued]

Page

IV.

Both the partnership and the partner have a common defense against the penalty as there is reasonable reliance under Section 6664 with respect to the reliance on: (i) the advice of Cantley & Sedacca, (ii) the advice and representation of CPA Scott Hewitt, and (iii) on the advice and position of investment advisor Bryan Hanning. ................................................................20

Conclusion ...................................................................................................................23

Appendix A Internal Revenue Code of 1986 (26 U.S.C.)....................................................25 Treasury Regulations (26 C.F.R.) ....................................................................50 Miscellaneous: 28 U.S.C. § 1346(e) .........................................................................................97 Notice 2000-44, 2000-2 CB 255 (August, 2000).............................................98 Notice of Election to Participate in Announcement 2004-46 ........................101 Treasury Decision, TD 9207, May 24, 2005 .................................................105 Appendix B, Vol. 1 (Separately Bound): Declaration of Thomas C. Pliske in Support of Plaintiff's Cross Motion for Summary Judgment ...........................................................................................1 Exhibit 1: Complete Condensed Deposition Transcript and Exhibits of Mark E. Hutton taken on May 8, 2007. .............................................................3 Exhibit 2: Complete Condensed Deposition Transcript and Exhibits of Bryan S. Hanning taken on May 8, 2007.........................................................54 Exhibit 3: Complete Condensed Deposition Transcript and Exhibits of Scott R. Hewitt taken on May 8, 2007.............................................................73 Exhibit 4: Notice of Final Partnership Administrative Adjustment for Clearmeadow LLC.........................................................................................128 Exhibit 5: January 22, 2002 Opinion Letter from Cantley & Sedacca ..........141

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TABLE OF AUTHORITIES Cases: Page

Crystal Beach Development of Destin Ltd. v. Commissioner, 79 T.C.M. (CCH) 2068 (2000)......................................................................................................10 Denver & Rio Grande Western Railroad Co. v. United States, 505 F.2d 1266 (Ct. Cl. 1974) ..........................................................................................................18 Heasley v. Commissioner, 902 F.2d 380, 383 (5th Cir. 1990) ..............................15, 19 Lemery v. Commissioner, 52 T.C. 367 (1969), aff'd 451 F.2d 173 (9th Cir. 1971)....19 Long v. Commissioner, 660 F.2d 416 (10th Cir. 1981), aff'g 71 T.C. 1 (1979)..........19 Long Term Capital Holdings, Ltd. v. U.S., 330 F.Supp. 2d 122, 205 (D. Conn. 2004) (citing H.R. Conf. Rep. 105-599 at 241) ...............................................21 Montgomery v. Commissioner, 127 T.C. 43, 66 (2006)..............................................21 Neonatology Associates v. Commissioner, 299 F.3d 221, 234 (3rd Cir. 2002) .... 21-22 Santa Monica Pictures v. Commissioner, 89 T.C.M. (CCH) 1157 (2005) ..................11 Swayze v. Commissioner, 785 F.2d 715, 719 (9th Cir. 1986).....................................21 Weiner v. U.S., 389 F.3d 152, 161-62 (5th Cir. 2004) ................................................15 Statutes: Internal Revenue Code of 1986: § 752 ..............................................................................................14, 18 § 6221.....................................................................................................9 § 6226(e)(1) .........................................................................................10 § 6226(f)...........................................................................................9, 10 § 6230(c)(4) .........................................................................................12 § 6231(a)(3) .........................................................................................10 § 6231(a)(5) ...........................................................................................9 § 6662.....................................................................................................9 § 6662 (2001).......................................................................................13 § 6662(b)(1). ........................................................................................13 § 6662(b)(2) and (d).............................................................................13 § 6662(b)(3) and (e) .............................................................................13 § 6662(b)(3) and (h).............................................................................13 § 6662(c) ..............................................................................................19 § 6662(d)(2)(B)(i) ................................................................................17 § 6662(d)..............................................................................................17 § 6662(d)(2)(C)....................................................................................17 § 6662(e)(1)(A) (2001) ........................................................................14 § 6662(h)(1) .......................................................................................13 § 6662(h)(2) .........................................................................................13 § 6664.........................................................................................2, 12, 20 § 6664(c) ........................................................................................21, 23

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[Table of Authorities, continued] Treasury Regulations (26 C.F.R.):

Page

Temporary Treas. Reg. § 1.752-6T..................................................................19 § 1.752-1 ...................................................................................................18, 19 § 1.752-6 .........................................................................................................19 § 1.6662-4(d)(2).........................................................................................17, 20 § 301.6221-1(d)................................................................................................11 § 1.6662-3(b)(1).........................................................................................19, 20 § 1.6662-3(b)(1)(ii) ..........................................................................................20 § 1.6662-3(b)(3)...............................................................................................20 § 1.6662-4(d)(3)(i) ...........................................................................................17 § 1.6662-4(d)(3)(iii)...................................................................................18, 20 § 1.6664-4(b)....................................................................................................21 § 1.6664-4(c)....................................................................................................22

Miscellaneous: 28 U.S.C. § 1346(e) ...................................................................................10, 12 Pub. L. 108-357, Title VIII, § 812(f), Oct. 22, 2004, 118 Stat. 1580 ..............17 Notice of Election to Participate in Announcement 2004-46 ............................8 The Taxpayer Relief Act of 1997 ....................................................................10 Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA"), I.R.C. §§ 6221-6233 ....................................................................................................9, 10

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IN THE UNITED STATES COURT OF FEDERAL CLAIM ____________ No. 05-1223 T (Judge Allegra) CLEARMEADOW INVESTMENTS, LLC, CLEARMEADOW CAPITAL CORP., Tax Matters Partner, Plaintiff, v. THE UNITED STATES, Defendant. ____________ BRIEF IN SUPPORT OF PLAINTIFF'S CROSS-MOTION FOR SUMMARY JUDGMENT ____________ The plaintiff, Clearmeadow Investments, LLC, Clearmeadow Capital Corp., Tax Matters Partner, presents the following brief in support of its cross-motion for summary judgment. All relevant statutes, regulations and other non-case authorities are set out in Appendix A, infra. All exhibits are set forth in the Declaration of Thomas C. Pliske in support of Plaintiff's Cross Motion for Summary Judgment, separately bound as Appendix B. QUESTIONS PRESENTED 1. For purposes of this cross-motion for summary judgment, does the MLD

investment lack economic substance?

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2.

Do the penalties stated in the Notice of Final Partnership Administrative

Adjustment (hereinafter referred to as "FPAA") apply to the Plaintiff and the related parties in this matter? 3. Does this court have jurisdiction to determine if partnership and partner

level defenses apply to penalties asserted in the FPAA? 4. Does the common defense of reasonable reliance under Section 6664 of

the partnership and the partner against the penalty of with respect to the reliance on: (i) the advice of Cantley & Sedacca, (ii) the advice and representation of CPA Scott Hewitt, and (iii) on the advice and position of investment advisor Bryan Hanning?

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STATEMENT OF THE CASE In 2001, the taxpayer, Mark Hutton (hereinafter "Hutton"), made an investment in a complex transaction for which it was represented to him there was an opportunity to make a large return on his investment. In addition, he was advised, like in every other investment transaction, there were tax consequences (benefits/detriments) that could flow from this investment. The MLD transaction is a very complex investment transaction. The tax benefits that flowed from the transactions are pursuant to the black letter of the law, i.e. the Internal Revenue Code as it existed at the time the transaction took place and at the time the tax return was filed. The Internal Revenue Service, recognizing that certain investors were obtaining tax benefits in an MLD type investment, issued Notice 2000-44, putting taxpayers on notice that it would challenge this type of investment based upon lack of economic substance. The Internal Revenue Service, like a taxpayer, has the power to interpret the law and the facts associated with certain transactions, but does not have the power to write the law or determine whether an investment is a viable investment or not. Only Congress and the Courts have such power. The Notice issued by the Service simply informed the public that it would challenge the viability of the transaction. In 2001, Hutton was initially approached by his long time investment advisor, Bryan Hanning (hereinafter referred to as "Hanning"), informing him of an opportunity to invest in a complicated transaction which has been referred to as a Market Linked Deposit (hereinafter referred to as "MLD") Investment. (Plaintiff's Proposed Uncontroverted Facts (hereinafter referred to as "PFUF") No. 7 ) Hanning has been an investment advisor for Hutton from 1992 through today. (PFUF No. 3 ) Hanning has

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brought to Hutton's attention different investments that he believes will be beneficial to Hutton. (PFUF No. 4) Hutton trusts Hanning because his background in selling life insurance and investment products and because of their long term relationship. (PFUF No. 5) Hanning is a representative member and agent of AGH Wealth Advisors and employed with Massachusetts Mutual Life. (PFUF No. 6 ) In the past, Hanning has brought Plaintiffs investment ideas and investment opportunities such as split dollar life insurance, key-person insurance policies and 401(k) plans. (PFUF No. 4) In all cases, Hanning receives compensation if Hutton takes advantages of the investment opportunity being offered. (PFUF No. 6 ) Hanning approached Hutton in 2001 with respect to the MLD investment opportunity because Hutton was interested in different investment opportunities. (PFUF No. 7 ) Scott Hewitt (hereinafter referred to as "Hewitt") has been Hutton's certified public accountant since 1993. (PFUF No. 24) Hutton considers Hewitt to be a financial advisor who had sufficient knowledge and experience in financial and business matters to evaluate the MLD transaction. (PFUF No. 24) Hewitt prepared and continues to prepare Hutton's personal and business tax returns from 1994 though 2006. (PFUF No. 25) Hewitt is an independent and trusted advisor. (PFUF No. 25) Hewitt assisted Hutton in making his business successful through the years. (PFUF No. 26) Hewitt never gave

Hutton any reason to think that he did not have the financial and business knowledge needed to evaluate the merits of trading options on foreign currencies. (PFUF No. 26) Because of the complexity of this MLD investment, Hutton requested that Hanning and Hewitt participate in a conference call with Cantley & Sedacca, the law firm with intricate knowledge of the MLD investment. (PFUF No. 9) During this initial call,

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Mr. Sedacca (hereinafter referred to as "Sedacca"), from Cantley & Sedacca, explained the mechanics of the MLD investment opportunity, the risks involved, and the reward scenarios. (PFUF No. 9) Following Mr. Sedacca's presentation, Hutton posed questions regarding the transaction, followed by Hanning's and Hutton's questions. (PFUF No. 9) A subsequent teleconference was held with Hutton, Hanning, Hewitt, Sedacca, and Mark Kaplan (hereinafter referred to as "Kaplan"). (PFUF No.10) During this second call, Hanning also had another CPA that he works with, Kaplan, accompany him to explain the partnership aspects of the MLD investment transaction to Hutton. (PFUF No. 10) The second call was to clarify the information Hutton, Hanning and Hewitt received in the first call from Sedacca (PFUF No. 10) Typically, Hutton sought Hewitt's advice regarding various business and tax related transactions. (PFUF No. 27) Hutton relied, and Hewitt understood, that if he did not approve of the transaction, he would advise Hutton, that it would not be in his best interest to pursue such an investment. (PFUF No. 28) Hewitt, after review of the MLD investment material, participating in telephone conferences with Cantley and Sedacca, and performing independent research never advised Hutton that the MLD transaction would not be in his best interest. (PFUF No. 9, 26, and 27 ) Following the telephone calls, Hewitt went back to his office to do research before advising Hutton that the investment looked good. (PFUF No. 26) Because of the nature of Hutton's and Hewitt's relationship, if Hewitt had a concern or a comment about the MLD transaction, Hewitt would have expressed his concerns or comments. (PFUF No. 28) Hewitt never made

any comment or expressed his concerns regarding the MLD transaction. (PFUF No. 28) Because of Hewitt's silence, Hutton took Hewitt's silence on the subject as a statement

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that the MLD transaction actually did provide a reasonable opportunity for profit and with respect to the represented tax consequences. (PFUF No. 28) A. Hutton reasonably believed that the MLD investment was a high risk/high reward transaction. Hutton was not promised any tax benefits as alleged by Defendant.

Hutton, as investor and managing member partner, was advised of the nature of the risk of the MLD investment. (PFUF No. 9) He understood that it was a high risk investment that had a high possible reward. (PFUF No. 23) Hutton has invested in oil wells and other high risks investments and has obtained tax benefits from such investments as intangible drilling costs. (PFUF No. 2) His trusted advisors, Hanning, an investment advisor, presented Hutton with investment opportunities in the past and Hutton's personal and business certified public accountant (CPA) Hewitt were involved in the review and analysis of those transactions, as well as the MLD investment. (PFUF No. 7, 11, 37) Neither of these trusted advisors ever advised Hutton that the MLD transaction was not a good investment or that the represented tax consequences, good or bad, were being improperly represented. (PFUF No. 28, 34) Both of these individuals are experienced financial advisors and have worked with Hutton many years prior to 2001 and are still working with him through today. (PFUF No. 4, 5, 24, 27, 28) They continue to provide him with both financial and tax advice as might be applicable with respect to certain investments. (PFUF No. 4, 27) They participated in the initial conferences with the law firm that introduced the MLD transaction to Hanning, they participated in subsequent follow up conferences with Cantley and Sedacca and they did their own independent research. (PFUF No. 9, 10, 26) To the extent that Defendant concludes in its statement of facts for Defendant's Motion for Summary Judgment, Hutton or his

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financial advisors possessed knowledge and experience in financial and business matters sufficient to ensure his (or his financial advisor's) capability to evaluate the merits and risks of the MLD transaction was false, is absolutely wrong. (DFUF No. 21, 28) Hutton had every reason to believe, based on the facts that his financial advisors properly evaluated the merits and risks of the MLD transactions. (PFUF No. 28, 34) The mere fact that Hanning brought the MLD investment to Hutton, led Hutton to believe it had merit. Hanning never brought an investment to Hutton that did not have merit. (PFUF No.4, 34) Same with Hewitt, in that he was involved in all conferences with Hutton and did his own independent research. (PFUF No. 9, 26, 30) He never told Hutton that that the investment did not have merit and their working relationship was such that if the investment did not have merit, or if he was unable to properly analyze the investment, he would have told Hutton such. (PFUF No. 28) B. Hutton, upon learning of the MLD investment took all actions one could reasonably be expected to take.

Hutton, as stated above, relied on his own independent CPA and tax advisor, Scott Hewitt, to evaluate the investment transaction. (PFUF No. 33) Hewitt participated in telephone conferences with the law firm Cantley and Sedacca, the experts in foreign currency transactions, and satisfied himself at the time that he understood the transaction. (PFUF No. 9) Hewitt did his own independent research with respect to any tax consequences that might result from the MLD investment. (PFUF No. 30) Hutton ultimately obtained the signed written opinion from a law firm, Cantley and Sedacca, stating the legal basis for all representations that had been made to him and his advisors since their initial contact. (PFUF No. 40)

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Hutton, in 2005, after being contacted by the IRS and learning that this transaction was being challenged, hired an attorney, Anthony S. Gasaway, and filed amended tax returns. (PFUF No. 40) Prior to being contacted by the IRS, neither Hutton nor Hewitt, were ever aware that the MLD investment, was what might be considered a listed transaction by the IRS, or that such investment might be included in Notice 200044 that was issued by the IRS. (PFUF No. 41) In addition to amending the 2001 tax returns and adjusting for any tax benefits that might have flowed from the MLD investment, Hutton paid any additional tax liability that was due. (PFUF No. 42) In addition, he took advantage of the Settlement Initiative being offered by the IRS with respect to investors in the MLD type investments. (PFUF No.42) He completed Form 13582, Notice of Election to Participate in Announcement 2004-46 Settlement Initiative, for his attorney, Gasaway, which was subsequently filed with the Service. (PFUF No. 43) Upon the IRS seeking follow up information, Hutton provided such information to his attorney. (PFUF No. 44) Today, the Service states that it never received a response for Hutton with respect to their follow up questions and that is the reason it did not enter a settlement with Hutton. (PFUF No. 45) However, Hutton did not hesitate to provide any information requested by the Defendant as part of this Court case. Clearly, Hutton has done everything possible to comply with the law and the payment of tax that could be reasonably expected of any taxpayer. JURISDICTION This Court has Jurisdiction to determine if partnership and partner level defenses apply to penalties asserted in the FPAA. For a discussion of this Court's Jurisdiction see below in Section II of Plaintiff's Argument.

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ARGUMENT

I.

For purposes of this cross-motion for summary judgment, the plaintiff concedes, six years after Defendant invested in the MLD investment, that the investment lacked economic substance.

For purposes of the Cross Motion for Summary Judgment, it can be assumed that the MLD investment, upon the suggestion and advice of legal counsel and with the approval of his independent CPA and tax advisor, lacked economic substance or business purpose. Although the transaction, the MLD investment, followed the black letter of the law as it was written during the time the transaction was entered and at the time the 2001 tax return was prepared and filed with the Internal Revenue Service, the plaintiff will concede for this motion that the underlying transaction lacked economic substance as stated within the FPAA as issued by the Internal Revenue Service. II. This Court has jurisdiction to determine if partnership and partner level penalties apply, as asserted in the FPAA.

This case is governed by the Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA"), IRC §§ 6221-6233. Under TEFRA, "the tax treatment of any partnership item (and the applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to a partnership item) shall be determined at the partnership level." IRC § 6221. A "partnership item" generally includes items that are "more appropriately determined at the partnership level at the partner level." IRC § 6231(a)(3). A "partnership item" can be distinguished from an "affected item," which is defined as any item affected by a "partnership item." IRC § 6231(a)(5). The scope of judicial review in a TEFRA proceeding is set forth in IRC § 6226(f): A court with which a petition is filed in accordance with this section shall have jurisdiction to determine all

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partnership items of the partnership for the partnership taxable year to which the notice of final partnership administrative adjustment relates, the proper allocation of such items among the partners, and the applicability of any penalty, addition to tax, or additional amount with relates to an adjustment to a partnership item. (emphasis added). Prior to filing the petition in this Court, and in accordance with IRC § 6226(e)(1), Hutton deposited with the Internal Revenue Service the amount by which his tax liability would be increased if the partnership items on the tax returns were made consistent with the treatment of partnership items on the partnership return, as adjusted by the final partnership administrative adjustment. (PFUF No. 46) Accordingly, pursuant to 28 U.S.C. § 1346(e) and IRC § 6226(f), this Court has jurisdiction to determine all partnership items and the applicability of any penalty "which relates to an adjustment to a partnership item." Prior to The Taxpayer Relief Act of 1997, penalties were not "partnership items" and could not be considered until the completion of partnership-level proceedings; Crystal Beach Development of Destin Ltd. v. Commissioner, 79 T.C.M. (CCH) 2068 (2000). It might be argued that the reasonable cause defense is a "partner level defense," and TEFRA provides that the exclusive forum for asserting such defenses is through a refund proceeding. However, the TEFRA refund provision (§ 6230(c)(4)) is permissive, rather than mandatory. In fact, the IRS position, as stated in the FPAA, is based upon the transactions entered by the partners. As a result, the partnership items to be determined in this case are the proper tax base of Plaintiff, and the proper allocation to the respective partners. Therefore, the Court has jurisdiction to determine the applicability of any penalties related to any adjustment to these partnership items, it may consider whether the

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reasonable cause exception applies to the activities of the Plaintiff, Clearmeadow Capital, and Hutton in this matter. Although unclear, the regulations provide that "[p]artner-level defenses are limited to those that are personal to the partner or dependent on the partner's separate return and cannot be determined at the partnership level." Treas. Reg. § 301.6221-1(d). Examples of partner-level defenses include the applicable threshold underpayment of tax with respect to a partner or whether a partner has met the criteria under the reasonable cause exception. Id., Treas. Reg. § 301.6221-1(d). The regulation suggests that the reasonable cause exception is a "partner-level defense." However, the case law, does not read the statute and regulation so narrow. In the circumstances of a given case, the reasonable cause exception maybe considered at the partnership-level if it involves actions, as in this case, by the managing member partner. See Santa Monica Pictures v. Commissioner, 89 T.C.M. (CCH) 1157 (2005). In Santa Monica Pictures, Santa Monica Pictures ("SMP") through its tax matters partner, contested adjustments made by the IRS to SMP's tax returns. Id., 89 T.C.M. 1157. In evaluating the applicability of defenses to accuracy-related penalties, such as the reasonable cause exception, the tax court considered the experience of its tax matters partner and the opinions he relied upon as the tax matters partner. Id., 89 T.C.M. 1157. Similarly, this case involves Hutton's, Plaintiff's managing member partner's, reliance on Cantley and Sedacca and CPA Scott Hewitt with respect to his investment in the MLD transaction. (PFUF No. 33) The FPAA was based, in part, on the agreements between Mark Hutton, the plaintiff and Clearmeadow. (PFUF No. 46) The determination of the partners' proper basis in the partnership is affected by this Court's decision.

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However, assuming for purposes of this cross-motion for summary judgment, this Court believes that the parties improperly computed the partner's basis, it could determine that the parties reasonably relied on Cantley and Sedacca, Scott Hewitt and Bryan Hanning in their representations to the plaintiff. It would serve no purpose and would amount to judicial inefficiency to determine that penalties apply to the plaintiff, wait for them to be assessed by the IRS, subsequently paid by the partners of plaintiff, only to allow them to come back to this Court and argue reasonable reliance pursuant to IRC § 6664. III. The Plaintiff asserts that the penalties stated in the FPAA do not apply in this matter.

First of all, it is the position of the plaintiff that it has complied with the literal provisions of the Internal Revenue Code and the regulations thereunder as of the time that the MLD investment was made and at the time the 2001 tax returns were filed. Subsequent to plaintiff's investment, the IRS issued regulations and applied them retroactively that would question the viability of the MLD investment by the Plaintiff had such regulations existed at the time the investment was made and the tax return been filed. Pursuant to 28 U.S.C. § 1346(e) and IRC § 6226(f), this court has jurisdiction to determine the applicability of any penalty which relates to an adjustment to a partnership issue. Whether the penalty applies to the partnership or to the individual partner, is one and the same, as the same individual, Mark Hutton, took all the actions and followed all the advice of the professionals with respect to the MLD transaction. It is impossible to bifurcate the applicability of the penalties at the partnership level or the partner level. In the FPAA issued by the Internal Revenue Service, the Service asserted the following four accuracy-related penalties in this case:

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1) a 40% penalty for gross valuation misstatement. IRC § 6662(b)(3) and (h); 2) a 20% penalty for substantial valuation misstatement. IRC § 6662(b)(3) and (e); 3) a 20% penalty for substantial understatement of income tax. IRC § 6662(b)(2) and (d); and 4) a 20% penalty for negligence or disregard of rules and regulations. IRC § 6662(b)(1). (PFUF No. 46) The penalties, proposed in the alternative, as stated in the FPAA, would be imposed at the partnership level and the partner level. Although unclear in the FPAA, penalties may arguably be imposed/not be imposed based upon the actions of Plaintiff, Hutton, in his role as the managing partner acting on behalf of the partnership (i.e. president of Clearmeadow Capital) and on himself as a partner. A. The Plaintiff asserts that the Gross Valuation Misstatement / Substantial Valuation Misstatement penalty stated in the FPAA do not apply in this matter.

The IRS may impose a 40% penalty "to the extent that a portion of the underpayment to which IRC § 6662 applies is attributable to one or more gross valuation misstatements." IRC § 6662(h)(1) A gross valuation misstatement occurs if the value of any property (or the adjusted basis of any property) claimed on any return is 400 percent or more of the amount determined to be the correct amount of such valuation or adjusted basis. IRC § 6662(h)(2). Additionally, The IRS may impose a 20% penalty to the extent that the portion of any underpayment which is attributable to any substantial valuation misstatement. I.R.C. § 6662 (2001). A substantial valuation misstatement occurs when "the value of any

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property (or the adjusted basis of any property) claimed on any return of tax imposed by chapter l is 200 percent or more of the amount determined to be the correct amount of such valuation or adjusted basis (as the case may be)." I.R.C. § 6662(e)(1)(A) (2001). In the FPAA issued by the Internal Revenue Service, the Service's position is that the 400 percent threshold is met because the partnership incorrectly assumed Clearmeadow Capital's basis in the liability of $2,769,200 on the short MLD position. (PFUF No. 48) Therefore, the IRS' position is that the understatement of basis satisfies the 400 percent ratio and the IRS properly asserted the penalty in the FPAA. (PFUF No. 48) Alternatively, the IRS has raised the position that the understatement of basis satisfies the 200 percent ratio for the substantial understatement valuation penalty and the IRS properly asserted the penalty in the FPAA. (PFUF No. 46) The plaintiff's position is simply that its tax return at the time that it filed its 2001 tax return, reflected that it properly applied I.R.C. § 752 in determining their basis in the partnership, and, therefore, any underpayment would not be attributable to an overstatement of basis. The plaintiff relies on the law and regulations as they existed at the time it engaged in the MLD investment and at the time it filed its tax return for 2001. Also, the IRS position, as stated in the FPAA, is that the MLD investment and the related loan transactions lacked economic substance. As stated in this Cross Motion for Summary Judgment, and solely for the purpose of the Cross Motion for Summary Judgment, the Plaintiff will concede for the moment that the IRS is correct, then the underpayment of tax is not "attributable to" any gross valuation misstatement or substantial valuation misstatement. Instead, the underpayment would be attributable to the disregard of the transactions.

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In addition, as a matter of law, an overvaluation penalty cannot apply when the IRS totally disallows a deduction or credit, and this case is similar to the situation in which the IRS totally disallows a deduction or credit. Heasley v. Commissioner, 902 F.2d 380, 383 (5th Cir. 1990); Weiner v. U.S., 389 F.3d 152, 161-62 (5th Cir. 2004). In Heasley, the taxpayers took an investment tax credit based on a valuation of some equipment they purchased. Id., 902 F.2d at 381-82. The IRS totally disallowed the credit. Id. at 382. The IRS also applied a valuation overstatement penalty because the taxpayers overvalued the basis of the equipment. Id., 902 F.2d at 382. The taxpayers did not dispute the disallowance, but challenged the imposition of penalties. Id., 902 F.2d at 382. The court concluded that the valuation overstatement penalty did not apply. Id., 902 F.2d at 383. The court reasoned that the underpayment of tax was attributable to an improper deduction or credit, not the valuation overstatement. Id., 902 F.2d at 383. Specifically, the court stated "[w]henever the I.R.S. totally disallows a deduction or credit, the I.R.S. may not penalize the taxpayer for a valuation overstatement included in that deduction or credit." Id., 902 F.2d at 383. Heasley is controlling in this case. Accordingly, a penalty for a gross valuation misstatement or substantial valuation misstatement cannot apply when the IRS totally disregards a transaction as lacking economic substance. The defendant in this matter may argue that the "Investor Representation" letter received by Hutton along with the tax opinion letter received on January 23, 2002, stating that "the opinion letter may not be relied upon unless and until we have received the ... Investor Representations fully executed by you, the LLC and the Corp...." Despite the fact that by the time that Hutton signed the letter on March 11, 2002, the facts had changed such that he was no longer investing in the MLD transactions in such a way that

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he was going to receive a reasonable economic return on his investment, he, and his advisors, Hanning and Hewitt, did rely on the opinions and representations of Cantley and Sedacca from the beginning of the investigatory stage of this investment. The defendant is likely to simply argue that the point in time to determine whether the plaintiff relied on the advice and representation of Cantley and Sedacca is at the end, when the representation letter was signed, rather than at the time the initial contact was made and all subsequent phone contacts were made. It would be silly to allow Cantley and Sedacca to control for their liability purpose when in fact a client, and their advisors, can rely on the advice that they have given. However, it cannot be ignored, that Hutton did not act alone. In his capacity as both an investor and partner, he immediately sought the advice and counsel of his CPA, Scott Hewitt. (PFUF No. 9, 10, 23) Well versed in tax law with years of experience, Hewitt, participated in telephone conversations with Cantley and Sedacca asking questions in an effort to understand the transactions and potential tax consequences associated with the transaction. (PFUF No. 9) Hewitt testified that he did his own independent research and saw nothing adverse with the MLD investment to advise his client, Hutton, not to invest in the MLD transaction. (PFUF No. 30) In fact at the time or preparing the tax return, Hewitt, independently completed the tax return, making only one small adjustment when confirming with Cantley and Sedacca, how such tax consequences were to be reflected on the tax return. (PFUF No. 38) B. The Plaintiff asserts that the Substantial Understatement of Income Tax penalty stated in the FPAA does not apply in this matter.

The third penalty proposed in the FPAA is for the substantial understatement of income tax. The IRS may impose a 20% penalty for a substantial understatement of

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income tax. A "substantial understatement of income tax" occurs if the amount of understatement exceeds the greater of 1) 10 percent of the tax required to be shown on the return, or 2) $5,000. IRC § 6662(d). Notwithstanding the mathematical test, the statute provides an exception to the penalty. "The amount of the understatement ... shall be reduced by that portion of the understatement which is attributable to . . . the tax treatment of any item by the taxpayer if there is or was substantial authority for such treatment." IRC § 6662(d)(2)(B)(i). There was "substantial authority" for the treatment of the plaintiff's tax position at the time plaintiff filed their 2001 tax return. The substantial authority standard is an objective standard involving an analysis of the law and application of the law to relevant facts. The substantial authority standard is less stringent than the more likely than not standard (the standard that is met when there is a greater than 50-percent likelihood of the position being upheld), but more stringent than the reasonable basis standard." Treas. Reg. § 1.6662-4(d)(2). It should be noted that in 2004, the law was changed that eliminated the substantial authority exception altogether in cases that have been determined to be tax shelters. IRC § 6662(d)(2)(C). The amendment, however, is not effective for the tax year at issue. See Pub. L. 108-357, Title VIII, § 812(f), Oct. 22, 2004, 118 Stat. 1580. For substantial authority to exist, "the weight of the authorities supporting the treatment is substantial in relation to the weight of authorities supporting contrary treatment." Treas. Reg. § 1.6662-4(d)(3)(i). Although the plaintiff received opinions, written and oral, from attorneys (Cantley & Sedacca) and his own trusted and independent CPA (Scott Hewitt), the opinions rendered by tax professionals are not

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authority. Treas. Reg. § 1.6662-4(d)(3)(iii). However, the authorities underlying such opinions, if applicable to the facts of a particular case, may give rise to substantial authority for the tax treatment of an item. Id. Substantial authority does in fact exist in this case for a number of reasons. First, the plaintiffs obtained a comprehensive opinion of counsel, Cantley and Sedacca, before they filed their returns. (PFUF No. 39) This opinion letter relied on the relevant authority at the time the MLD investment was made by the plaintiff and prior to the filing of the plaintiffs' 2001 tax return. (PFUF No. 40) The plaintiff also relied on his CPA, Hewitt, who did independent research with respect to the tax issues. (PFUF No. 30) In addition, in the independent preparation of the plaintiff's 2001 tax return, Hewitt contacted Cantley and Sedacca law firm to question them on their position prior to finalizing of the plaintiff's 2001 tax return, and in fact, completed the tax return in a manner for which he believed was proper and correct prior to questioning Cantley & Sedacca. (PFUF No. 39) In 2001, I.R.C. § 752 did not require Clearmeadow LLC to adjust the basis of Clearmeadow Capital's partnership interest for Clearmeadow LLC's alleged assumption of contingent liabilities. Treas. Reg. § 1.752-1, in defining liabilities did not include "contingent liabilities" and does not define "obligation." Because contingent liabilities were not included in the definition of liability or obligation, caselaw is controlling on whether contingent liabilities reduce the basis of the partner's partnership basis. The prior caselaw holds that courts have been reluctant to include contingent liabilities in basis adjustments because of their speculative nature. See generally, Denver & Rio Grande Western Railroad Co. v. United States, 505 F.2d 1266 (Ct. Cl. 1974); Lemery v.

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Commissioner, 52 T.C. 367 (1969), aff'd 451 F.2d 173 (9th Cir. 1971); and Long v. Commissioner, 660 F.2d 416 (10th Cir. 1981), aff'g 71 T.C. 1 (1979). However, subsequent Congressional action, Treasury Department Decisions and Proposed Treasury Regulations have retroactively changed Treas. Reg. § 1.752-1 to include the definition of contingent liability in defining liabilities through: (1) Temporary Treas. Reg. § 1.752-6T in June 24, 2003, for liabilities from October 18, 1999 to June 24, 2003 to include contingent liabilities under I.R.C § 358(h)(3); (2) Treas. Reg. § 1.752-6 in May 23, 2005, finalizing Treas. Reg. § 1.752-6T; and (3) amending Treas. Reg. & 1.752-1 on May 23, 2005, to include contingent liabilities in its definition of liabilities and obligations for transaction entered on or after June 24, 2003. In this case, the subsequent changes were not in place in 2001 when Mark Hutton, Clearmeadow LLC, or Clearmeadow Capital Corp. entered into the MLD transaction and filed the 2001 tax returns. The plaintiff, Mark Hutton, is neither an attorney nor an accountant. He relied, as he always does, on the professionals, their research, and the advice that was provided to him as well as the law and the regulations that existed at the time. (PFUF No. 33) C. The Plaintiff asserts that the Negligence or Disregard of Rules or Regulations penalty stated in the FPAA do not apply in this matter.

In the FPAA that was issued to the Plaintiff in this matter, the IRS imposed, in the alternative, a fourth penalty-for negligence or disregard of rules or regulations. Negligence includes any failure to make a reasonable attempt to comply with the provisions of the Code, to exercise ordinary and reasonable care in the preparation of a tax return, to keep adequate books and records, or to substantiate items properly. IRC § 6662(c); Treas. Reg. § 1.6662-3(b)(1). It also includes the failure to do what a reasonable and ordinarily, prudent person would do under the circumstances. Heasley, 902 F.2d at

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383. Negligence is strongly indicated if a taxpayer fails to make a reasonable attempt to ascertain the correctness of a deduction or credit which would seem "too good to be true" to a reasonable and prudent person. Treas. Reg. § 1.6662-3(b)(1)(ii). In this case, the taxpayer, immediately upon learning of the MLD investment sought out the advice of his independent CPA that has provided him with guidance in tax and investment matters since 1993. (PFUF No. 24, 26-28) CPA Scott Hewitt continues to provide the plaintiff both personal and business tax advice. (PFUF No. 25, 26) There can be no finding of negligence if there was a reasonable basis for a return position. Treas. Reg. § 1.6662-3(b)(1). Reasonable basis is a significantly higher standard than not frivolous or not patently improper; it cannot be merely arguable or a merely colorable claim. Treas. Reg. § 1.6662-3(b)(3). Reasonable basis requires reliance on legal authorities and not on opinions rendered by tax professionals. Id.; Treas. Reg. § 1.6662-4(d)(3)(iii). The Court may, however, examine the authorities relied upon in a tax opinion to determine if a reasonable basis exists. Treas. Reg. § 1.6662-4(d)(3)(iii). The "reasonable basis" standard for reliance on opinions is lower than the "substantial authority" standard. Treas. Reg. § 1.6662-4(d)(2). As discussed in the previous section, there was "substantial authority" to rely on the Cantley and Sedacca opinion along with the opinion of CPA Scott Hewitt, and, therefore, the "reasonable basis" standard has been met. Accordingly, a penalty for negligence is not applicable in this case. IV. Both the partnership and the partners have a common defense against the penalty as there is reasonable reliance under Section 6664 with respect to the reliance on (i) the advice of Cantley & Sedacca, (ii) the advice and representation of CPA Scott Hewitt, and (iii) on the advice and position of investment advisor Bryan Hanning.

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A taxpayer may defeat the imposition of any of those penalties if he demonstrates reasonable cause. The defense, found in IRC § 6664(c), provides: "No penalty shall be imposed under this part with respect to any portion of an underpayment if it is shown that there was a reasonable cause for such portion and that the taxpayer acted in good faith with respect to such portion." The plaintiffs bear the burden of production and proof on their reasonable cause defenses. Long Term Capital Holdings, Ltd. v. U.S., 330 F.Supp. 2d 122, 205 (D. Conn. 2004) (citing H.R. Conf. Rep. 105-599 at 241); Montgomery v. Commissioner, 127 T.C. 43, 66 (2006). The most important factor is the extent of the taxpayer's effort to assess his proper tax liability in light of all the circumstances. Treas. Reg. § 1.6664-4(b). Reliance on the advice of a professional tax advisor does not necessarily demonstrate reasonable cause and good faith. Id., Treas. Reg. § 1.6664-4(b). However, a taxpayer is not required to challenge the advisor's conclusions, seek a second opinion, or check the advice himself. U.S. v. Boyle, 469 U.S. 241, 250-51 (1985). The validity of the reliance turns on "the quality and objectivity of the professional advice obtained." Swayze v. Commissioner, 785 F.2d 715, 719 (9th Cir. 1986). Although it might be argued that there was a conflict of interest by Cantley and Sedacca in providing the legal advice and in promoting the MLD investment, any such perceived conflict would have been unknown to the Plaintiffs at the time the investment was made or at the time the 2001 tax return was filed. The plaintiffs simply paid for legal advice as they might in every other situation involving a complex investment involving tax consequences. Reliance is also unreasonable if the taxpayer failed to supply the professional with all the necessary information to assess the tax matter. Neonatology Associates v.

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Commissioner, 299 F.3d 221, 234 (3rd Cir. 2002); Treas. Reg. § 1.6664-4(c); Boyle, 469 U.S. at 250-51. Hutton provided all the advice provided to him from Cantley & Sedacca to Scott Hewitt. Hutton completed the Cantley & Sedacca client intake form with the help of his business advisor. He participated in numerous teleconferences providing the necessary information requested and asked numerous questions regarding the transaction. Cantley & Sedacca are well aware of all transactions undertaken by Clearmeadow LLC, Clearmeadow Capital, as they formed these entities on behalf of Hutton and assisted in the transaction involving the MLD investment. The plaintiffs may not have completely understood the complexity of the tax consequences that would result from the MLD investment, but he was certainly aware and willing to embrace the risk in order to obtain the potential reward from the MLD investment. (PFUF No. 23) The written opinion that was ultimately issued on January

23, 2002 and was issued after the fact, but reflected the facts as they existed at or near the time that plaintiff entered into the transaction. (PFUF No. 39, 47) However, in addition to the Cantley and Sedacca written opinion, the plaintiff, through Hutton, sought out the assistance and advice of his CPA, Scott Hewitt, to evaluate the MLD investment. (PFUF No. 23) Hewitt was involved in telephone conversations, examined promotional materials, asked questions, and sought the advice of the law firm Cantley and Sedacca at the time of the preparation of the firm. (PFUF No. 9, 10) In fact, Hewitt, based upon his own research and understanding of the Internal Revenue Code in the preparation of the tax return, independent of the advice of Cantley and Sedacca in the preparation of the return. (PFUF No. 30) He made one small modification to the return after the advice was sought. (PFUF No. 38) What more could

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Plaintiff do than follow the advice of his CPA, who was sought out to give a second opinion as to the MLD investment. Furthermore, Hewitt reviewed the promotional material and legal opinion and concluded that the plaintiffs could reasonably rely on them for purposes of both an investment vehicle and for purposes of the tax consequences that may flow from such an investment. (PFUF No. 27) As was the practice between Hutton and Hewitt, if Hewitt was suspicious of the transaction as an investment or of the discussed tax consequences he would have advised Hutton of such. (PFUF No. 28) The fact that Hewitt did not discourage Hutton from the investment was in fact the approval Hutton needed to go forward with the transaction. (PFUF No. 28) The detailed opinions of Cantley and Sedacca certainly provide a reasonable interpretation of the law as of the time the opinion was issued. The IRS has since issued new regulations and applied such regulations retroactively as to the plaintiffs' investment in the MLD investment and the tax benefits that flowed from such investment. But at the time, the opinion and advice provided to the plaintiff was reasonable. Therefore, the plaintiffs relied in good faith on the advice of qualified tax accountants and tax lawyers. Accordingly, they have fulfilled the criteria under the reasonable cause exception of IRC § 6664(c) and no accuracy-related penalties are to be imposed. CONCLUSION For the reasons given, the plaintiff asks the Court to grant Plaintiff's Cross Motion for Summary Judgment and make the following determinations: 1) that it has jurisdiction to determine if the penalties, as set out in the FPAA, apply to the plaintiff, 2) that the penalties do not apply to the plaintiff, that if the penalties apply to the plaintiffs

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or to partner Hutton, 3) that it has the jurisdiction to consider if any of the defenses apply, and 4) that if this Court determines that penalties are applicable to the partnership/partner, that it determines that it has jurisdiction to consider all defenses, and 5) that upon considering the defenses, that the penalties do not apply. The plaintiff believes that the determinations as set out above resolve the case completely. Respectfully Submitted,

/s/ THOMAS C. PLISKE THOMAS C. PLISKE Stientjes & Pliske, LLC 1120 Olivette Executive Parkway Suite 220 St. Louis, MO 63132 Tel: (314) 872 -3988 Fax: (314) 872-7374 Attorney for Plaintiff

Date : October 24, 2007

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APPENDIX A Internal Revenue Code of 1986 (26 U.S.C. ):

§ 162. Trade or business expenses
(a) In general There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including-- ....

§ 351. Transfer to corporation controlled by transferor
(a) General rule No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation and immediately after the exchange such person or persons are in control (as defined in section 368(c)) of the corporation. (b) Receipt of property If subsection (a) would apply to an exchange but for the fact that there is received, in addition to the stock permitted to be received under subsection (a), other property or money, then-- (1) gain (if any) to such recipient shall be recognized, but not in excess of-- (A) the amount of money received, plus (B) the fair market value of such other property received; and (2) no loss to such recipient shall be recognized. (c) Special rules where distribution to shareholders (1) In general In determining control for purposes of this section, the fact that any corporate transferor distributes part or all of the stock in the corporation which it receives in the exchange to its shareholders shall not be taken into account. (2) Special rule for section 355 If the requirements of section 355 (or so much of section 356 as relates to section 355) are met with respect to a distribution described in paragraph (1), then, solely for purposes of determining the tax treatment of the transfers of property to the controlled corporation by the distributing corporation, the fact that the shareholders of the distributing corporation dispose of part or all of the distributed stock, or the fact that the corporation whose stock was distributed issues additional stock, shall not be taken into account in determining control for purposes of this section. (d) Services, certain indebtedness, and accrued interest not treated as property For purposes of this section, stock issued for-- (1) services, (2) indebtedness of the transferee corporation which is not evidenced by a security, or

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(3) interest on indebtedness of the transferee corporation which accrued on or after the beginning of the transferor's holding period for the debt, shall not be considered as issued in return for property. (e) Exceptions This section shall not apply to-- (1) Transfer of property to an investment company A transfer of property to an investment company. For purposes of the preceding sentence, the determination of whether a company is an investment company shall be made-- (A) by taking into account all stock and securities held by the company, and (B) by treating as stock and securities-- (i) money, (ii) stocks and other equity interests in a corporation, evidences of indebtedness, options, forward or futures contracts, notional principal contracts and derivatives, (iii) any foreign currency, (iv) any interest in a real estate investment trust, a common trust fund, a regulated investment company, a publicly-traded partnership (as defined in section 7704 (b)) or any other equity interest (other than in a corporation) which pursuant to its terms or any other arrangement is readily convertible into, or exchangeable for, any asset described in any preceding clause, this clause or clause (v) or (viii), (v) except to the extent provided in regulations prescribed by the Secretary, any interest in a precious metal, unless such metal is used or held in the active conduct of a trade or business after the contribution, (vi) except as otherwise provided in regulations prescribed by the Secretary, interests in any entity if substantially all of the assets of such entity consist (directly or indirectly) of any assets described in any preceding clause or clause (viii), (vii) to the extent provided in regulations prescribed by the Secretary, any interest in any entity not described in clause (vi), but only to the extent of the value of such interest that is attributable to assets listed in clauses (i) through (v) or clause (viii), or (viii) any other asset specified in regulations prescribed by the Secretary. The Secretary may prescribe regulations that, under appropriate circumstances, treat any asset described in clauses (i) through (v) as not so listed. (2) Title 11 or similar case A transfer of property of a debtor pursuant to a plan while the debtor is under the jurisdiction of a court in a title 11 or similar case (within the meaning of section 368 (a)(3)(A)), to the extent that the stock received in the exchange is used to satisfy the indebtedness of such debtor. (f) Treatment of controlled corporation If-- (1) property is transferred to a corporation (hereinafter in this subsection referred to as the "controlled corporation") in an exchange with respect to which gain or loss is not recognized (in whole or in part) to the transferor under this section, and (2) such exchange is not in pursuance of a plan of reorganization, section 311 shall apply to any transfer in such exchange by the controlled corporation in the same manner as if such transfer were a distribution to which subpart A of part I applies. (g) Nonqualified preferred stock not treated as stock

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(1) In general In the case of a person who transfers property to a corporation and receives nonqualified preferred stock-- (A) subsection (a) shall not apply to such transferor, and (B) if (and only if) the transferor receives stock other than nonqualified preferred stock-- (i) subsection (b) shall apply to such transferor; and (ii) such nonqualified preferred stock shall be treated as other property for purposes of applying subsection (b). (2) Nonqualified preferred stock For purposes of paragraph (1)-- (A) In general The term "nonqualified preferred stock" means preferred stock if-- (i) the holder of such stock has the right to require the issuer or a related person to redeem or purchase the stock, (ii) the issuer or a related person is required to redeem or purchase such stock, (iii) the issuer or a related person has the right to redeem or purchase the stock and, as of the issue date, it is more likely than not that such right will be exercised, or (iv) the dividend rate on such stock varies in whole or in part (directly or indirectly) with reference to interest rates, commodity prices, or other similar indices. (B) Limitations Clauses (i), (ii), and (iii) of subparagraph (A) shall apply only if the right or obligation referred to therein may be exercised within the 20-year period beginning on the issue date of such stock and such right or obligation is not subject to a contingency which, as of the issue date, makes remote the likelihood of the redemption or purchase. (C) Exceptions for certain rights or obligations (i) In general A right or obligation shall not be treated as described in clause (i), (ii), or (iii) of subparagraph (A) if-- (I) it may be exercised only upon the death, disability, or mental incompetency of the holder, or (II) in the case of a right or obligation to redeem or purchase stock transferred in connection with the performance of services for the issuer or a related person (and which represents reasonable compensation), it may be exercised only upon the holder's separation from service from the issuer or a related person. (ii) Exception Clause (i)(I) shall not apply if the stock relinquished in the exchange, or the stock acquired in the exchange is in-- (I) a corporation if any class of stock in such corporation or a related party is readily tradable on an established securities market or otherwise, or (II) any other corporation if such exchange is part of a transaction or series of transactions in which such corporation is to become a corporation described in subclause (I). (3) Definitions For purposes of this subsection-- (A) Preferred stock The term "preferred stock" means stock which is limited and preferred as to dividends and does not participate in corporate growth to any significant extent. Stock shall not be treated as participating in corporate growth to any significant extent unless there is a real

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and meaningful likelihood of the shareholder actually participating in the earnings and growth of the corporation. If there is not a real and meaningful likelihood that dividends beyond any limitation or preference will actually be paid, the possibility of such payments will be disregarded in determining whether stock is limited and preferred as to dividends. (B) Related person A person shall be treated as related to another person if they bear a relationship to such other person described in section 267 (b) or 707 (b). (4) Regulations The Secretary may prescribe such regulations as may be necessary or appropriate to carry out the purposes of this subsection and sections 354 (a)(2)(C), 355 (a)(3)(D), and 356 (e). The Secretary may also prescribe regulations, consistent with the treatment under this subsection and such sections, for the treatment of nonqualified preferred stock under other provisions of this title. (h) Cross references (1) For special rule where another party to the exchange assumes a liability, see section 357. (2) For the basis of stock or property received in an exchange to which this section applies, see sections 358 and 362. (3) For special rule in the case of an exchange described in this section but which results in a gift, see section 2501 and following. (4) For special rule in the case of an exchange described in this section but which has the effect of the payment of compensation by the corporation or by a transferor, see section 61 (a)(1). (5) For coordination of this section with section 304, see section 304 (b)(3).

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§ 358. Basis to distributees
(a) General rule In the case of an exchange to which section 351, 354, 355, 356, or 361 applies-- (1) Nonrecognition property The basis of the property permitted to be received under such section without the recognition of gain or loss shall be the same as that of the property exchanged-- (A) decreased by-- (i) the fair market value of any other property (except money) received by the taxpayer, (ii) the amount of any money received by the taxpayer, and (iii) the amount of loss to the taxpayer which was recognized on such exchange, and (B) increased by-- (i) the amount which was treated as a dividend, and (ii) the amount of gain to the taxpayer which was recognized on such exchange (not including any portion of such gain which was treated as a dividend). (2) Other property The basis of any other property (except money) received by the taxpayer shall be its fair market value. (b) Allocation of basis (1) In general Under regulations prescribed by the Secretary, the basis determined under subsection