Free Cross Motion - District Court of Federal Claims - federal

Case 1:05-cv-00231-EJD

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IN TI UND STATES DISTRCl COURT

FOR TH SOUT DISlRCT OF INIAA
INIAAPLIS DMSION
IN RE COBRA TAX SHELTER LITIGATION,
§

§
§ §

TIS DOUMNT RELATES TO:
1 :06-CV -8000 1 :06-CV -8002

§ §
§

i :05-ml-09727-JDT- WI

§ § §

CASE MAAGEMENT PLA
I. Parties aDd ReDresentatives.
A. Petitioners - Carmel Partners Case No. 1:06-v-8002.

Carel Parers
HNC Ditch Investments LLC Henry N. Camferdam, Jr.

JM Sedgemoor Investments LLC
Jeffey M. Adams 1M Walnut Investments LLC Jay S. Michener CT Oak Tree Investments LLC

Carol A. Bockelman-Trigilo
B. Petitioners' Counsel- Carmel Case No. 1:06--8000.

Jackie M. Bennett, Jr.
F. Anthony Paganell

SOMMR BARNAR PC
One Indiana Squar
Suite 3500

Indianapolis, IN 46204 (317) 713-3444 Telephone
(3 i 7) 713-3699 Facsimile

jbenne~sommerbamard.com
paganelli~sommerbamard.com

= GOVERNMENT

t c _ EXIBI

I.
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C. Petitioners Tesro Cae No. i :06--8000.
Gary Woods, as Tax Mattrs Parer of

SA Tesoro Invesent Parers
Gar Woods, as Tax Matrs Parer of

Tesoro Drive Parers
D. Petitioners' CouDsel- Tesoro Case No. 1:06--8000.

Joel N. Crouch M. Todd Welty . Michael E. McCue Anthony P. Daddino MEADOWS, OWENS, COLLIER, REED COUSINS & BLAU, LLP

901 Mai Street
Suite 3700

Dallas, TX 75202 (214) 744-3700 Telephone
(214) 747-3732 Facsimile

jcrouch~meadowsowens.com twelty~meadowsowens.com

mmccue~eadowsowens.com adaddino~eadowsowens.com
E. Respondent.

United States of America
F. Respondent's Counsel- Carmel Case No.l:06-v-8002

- Tesoro Case No. 1:06-8000
Dennis M. Donohue John A. Lindquist David M. Steiner U.S. DEPARTMT OF JUSTICE - TAX DIVISION

555 4th Stret NW
Room 71 04 Washington, DC 20001

(202) 307-6492 Telephone
(202) 307-2504 Facsimile

dennis.donohue~usdoj.gov john.a.lindquis~usdoj.gov david.m.steiner§usdoj.gov
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Joseph A. Pitzinger, II

Jonathan L. Blacker

U.S. DEPARTM OF JUSTICE-TAX DIVISION 717 N. Harood, Suite 400 Dallas, Texa 75201 (214) 880-9728 Telephone
(214) 880-9742 Facsimile
Joseh.A.Pitinger~sdoj .gov

Jonathan.blacker2~sdoj.gov
Jeffy L. Hunter

. Assistt U.S. Attorey
U.S. Depaent of Justice
1 0 West Market Street
Suite 2100

Indianapolis, IN 46204
(317)226-6333 Telephone

(317)226-6 I 25 Facsimile

jeff.hunter~usdoj.gov
Counsel shall promptly file a notice with the Clerk if there is any change in this
information.
II. Svnoosb of Case.

A. Petioner Carmel Parters' Statement.

Petitioners bring this case under 26 U.S.C. § 6226 for redetermination of
partership items. On July 16, 2004, the Commissioner of Internal Revenue (the
"Commissioner) issued a Notice of

Final Parership Administive Adjustment (the "FPAA")

against Carmel Parrs for ta year ending Dember 23, 1999, disallowing all ta benefits . arising from cein transactions and applying negligence and accuracy-related penalties under
26 V.S.C. § 6662. Petitioners believe these adjustents are improper and that the

Court should

reverse the adjustents in the FPAA and refund Petitioners' deposits.

The two primar factual and legal issues in this case are: (1) whether Henr N.
Camferdam, Jeffey M. Adams, Jay S. Michener, and Carol A. Bockelman- Trigilo (collectively

"Taxpayer") corrtly reported the ta consequence of cerin trsactions (the "TraIsactions")
on their federal income ta returns, and (2) whether the Taxpayers should be penalized under 26

V.S.e. § 6662 for engaging in the Transactions. Ths Cour has jurisdiction to entertin this
controversy under 26 U.S.C. §§ 6226(a), (c) and 28 U.S.C. § 1346(e).
1. Transaction Details.

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On November 16, 1999, the Taxpayers, through their wholly-owned limited liabilty companies, entered into certin over-the-counter, non-publicly traded Europeancurrency option poitions on the Euro and Yen (collectively the "Options'') with style foreign Deutsche Bank AG New York Branch (the "Bank"). Eàeh Taxayer bought an option and sold a second option.
On November 17, 1999, the Taxpayer each contributed their Options to

Carel Parers as contrbutions to capitaL. On Deember 15, 1999, Carel Parers' option positions were terminated puruant to a terination ågreement for a profit in excess of the net amounts paid to the Bank for such positions. On the sae day, Camferdam and Adams contrbuted bonds they had held for investment for more than one year (the "Bonds") to Carel

Parers.
On December 23, 1999, the Taxpayers each contribute their intere in

Carmel Parners to BAMC, Inc., a Delaware corporation. As a result of those contributions, Carel Parers was dissolved and liquidated. Upon liquidation, all of the Bonds were
distributed to BAMC, Inc., who sold the Bonds on December 28, 1999.
2. Tax Treatment or

Transactions.
its investment

Various tax professionals opined that BAMC, Ine.'s sale of

in the Bonds triggered a loss that was reported on BAMC, Inc.'s IRS Form i 120S and the
corresponding Schedules K-l for the 1999 tax year. This aggegate loss was in the amount of

$68,734,215. Generally speaing, this loss arose from the opinions that the options sold were
not trated as liabilties under 26 V.S.C. § 752, and consequently, did not reduce the Taxpayers'

basis in the parerhip interests.
Carel Parers and BAMC, Inc. timely fied their federal income ta returns. The Taxpayers also timely fied their respective federal income ta returns for the 1999
tax yea, which included their respective shar of income, losses, and deductions from BAMC,

with the opinions received from various ta professionals and the returns Inc. In accordance prepared by ta professionals at Ernst & Young, LLP, in reliance theron, the loss generated by
BAMC Inc.' s sale of the Bonds was allocated to the Taxpayers for the 1999 ta yea as follows:
(a) $48,825,463 was allocated to Camferdam; (b) $11,713,479 was allocate to Adas;

(c) $6,829,165 was allocate to Michener; and (d) $1,366,108 was allocated to Trigilo.
3. IR Adjustments Are Improper aDd Should be Revers.

The Commissioner disallowed all the ta benefits asociated with the

Transactions described above and applied penalties against the Taxayers on a number of
theories when it issued the FP AA. Each of thes theories is erroneous and cannot form the basis of the adjustments proposed.
4. PeDaIties Should Not Apolv.

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Taxpayers should not be penaliz beause they relied on th advice, counsel, and guidance of competent ta professionals, including, but not limite to, professionals at Jenkens & Gilchrist P.C., Brown & Wood LLP, and Ern & Young, LLP in detrmining the

federal income ta consequences and proper reportg obligations relative to the Trasacions
described above.
The Taxpayers each obtained a sepate written legal opinion frm

Jenkens & Gilchrist P.C. dated Januar 3 I, 2000. Jenens & Gilchrist P.C. provided an opinion

on a more likely than not basis regarding the federal ta consequences of the Trasactions. Brown & Wood LLP also issed opinions which provided lega anlysis and conclusions consistent with those of Jenens & Gilchrst P.C. Oter ta professionas confinned this advice
to the Taxpayer, including Ernst & Young, LLP, who preared and fied the varous entity returns and two of the four Taxpayers' returs. The concluions se fort in the legal opinions, as raified and confinned by the other professionals, provided reaonable bass for the maner in which the Transactions were reported for federal ta purps. Conseuently, Petitioners have a complete defense to the application of penalties.

B. Petitioner SA Tesoro Investment Partners aDd Tesro Drive Partners'

Statement.

Petitioner, SA Tesoro Investment Parers ("SA TI Parters") and Tesoro Drive
Parters (''T Parersn) bring this cae under 26 V.S.C. § 6226 for redetrmination of parership items. On December 27, 2004, the Commissioner of Inteal Revenue (the
"Commissioner) issued a Notice of Final Parership Administrtive Adjusent (the "FPAAn) against SATI Parers for ta year ending December 31. 1999, disallowing .all ta benefrts

arising from certin transactions and applying negligence and accuracy-related penalties under

26 U.S.C. § 6662. On December 21, 2004, the Commissioner issued a Notice of Final
Parership Adjustment against ID Parers for the ta year ended December 31, 1999,

disallowing all ta benefits arising from certin transations and apply negligence and accuracyrelated penalties under 26 U.S.C. § 6662. Petitioners SAT! Parers and ID Parers believe these adjustments are improper and that the Court should reverse the adjustents in the FP AAs
and refud Petitioners' deposits.

The th primar factual and legal issues in these cases ar: (1) whether Gar V. Woos and Bily J. McCombs (collectively "Taxpayers") correctly reported the ta" consequences of certin trsactions (the "Transations") on their federal income ta returns, (2) whether the Taxpayers should be penalized under 26 U.S.C. § 6662 for engaging in the
Transactions, and (3) whether the Government properly promulgated Treas. Reg. §§ 1.752-6 and i .752-6T retroactively changing the definition of"liabiltyn for the purposes ofIRC § 752.
1. SA TI Partners Transaction.

On November 18, 1999, the Taxpayers, through their wholly-owned limited liabilty companies, entered into certin over-the-counter, non-publicly tred European-

style foreign currncy option positions on the Japanese Yen, Swiss Franc and Australian Dollar
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(collectively the "Options'') with Deutsche Ban AG New York Branch (the "Ban"). The
Taxpayers bought options and sold options.

On November 19, 1999, the Taxpayers contributd each contrbutd their Options to SATI as contributions to capita. On December 17,1999, SATI option positions wer termnated puruant to a termination agrment for a profit in excess of the net amounts paid to the Bank for such positions. On December 3, 1999. SA Tesoro Investent Parers puhaed
shares of Sun Micrsystems Inc., ("Shar") as an investent.

On December 27, 1999, the Taxpayers contrbute their interests in SATI to a Delawar corpration, SA Tesoro Invesors, Inc. As a reslt of those contrbutions. Tesoro
Investment Parers was dissolved and liquidated. Upon liquidation, all of the Shars were
distributed to .SA Tesoro Investors, Inc., "which sold the Shars on Dember 29~ 1999.
2. TD Partners TraDsaction.

On Novembe 18, 1999, the Taxpayers, though their wholly-owned limited liabilty companies, entered into cerin over-the-counter, non-publicly trded Europe-

style foreign currency option positions on the German Deutschmark and Swiss Frac
(collectively the "Options") with Deutshe Bank AG New York Branch (the "Bank''). The Taxpayers bought options and sold options.

On November 19, 1999, the Taxpayers each contributed their Options to Tn Partners as contributions to capitaL. On Decembe 17, 1999, m Parers' option positions
terminated. The date of termination was esblished after carful monitoring of the applicable exchange rates in order to maximize the overall retu on investent. On December 22, 1999,
TO Parters purchased Canadian Dollar ("Foreign Currency") as an investment.

On December 27, 1999, the Taxpayers contributed their interests in 1D
Partners to a Delaware corpration, Tesoro Dnve Investors, Inc. As a result of those

contributions. TD Parers was dissolved and liquidated. Upori liquidation. all of the Foreign

Currency was distributed to Tesoro Drive Invesrs, Inc., which sold the Foreign Currency on
Deccmber 29, 1999.
3. Tax Treatment or

Transactions.

Various ta professionals opined that SA Tesoro Investors Inc.'s sale of its
investment in the Shares trggered a loss that was reported on SA Tesoro Investment Inc.'s IRS
Form 1 120S and the corresponding Schedules K-l for the 1999 ta yea. This aggregate loss
was in the amount of

$32,297,786. This loss arose frm the opinions that the options sold were

not treated as liabilties under 26 U.S.C. § 752, and consequently, did not reduce the Taxpayers'
basis in the parership interests.

Various ta professionals opined that Tesoro Drive Investors Inc.'s sale of
its investent in the Foreign Currency triggered a loss that was reported on Tesoro Drive

Investors, Inc.'s IRS Fonn 1120S and the corresponding Schedules K-I for the 1999 ta year.
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This aggregate Joss was in the amount of $13,353,162. This loss arose

from the opinions that

options sold were not treated as liabilties under 26 U.S.C. § 752, and consequently did not
reduce the Taxpayers' basis in the parership interests.

SAT! Parers SA Tesro Investors, Inc. and TD Parers and Tesoro
Drive Investors, Inc. timely filed their federal income. ta returs. The Taxpayers also tiìnely
fied their respective federal income ta retu for the 1999 ta yea, which include their

respetive share of income, losses, and deductions frm SAT! Parers, SA Tesro Invesors, Inc., TO Parers and Tesoro Drve Invesors, Inc. In accordance with the opinions reived
from varous ta professionals and the retus prepard by ta professionals at Erst & Young,
LLP, in reliance thereon, the loss generated by SA Tesoro Invesors Inc.'s sale of

the Shars was

allocated to the Taxpayers for the 1999 ta year as follows: (a) $3,229,779 was allocated to

Gar Woods and; (b) $29,068,077 was allocated to Bily 1. McCombs.
Likewise, in accordance with the opinions obtined from ta profesionals

and the retrns prepared by Erst & Young, LLP, in reliance thereon, the loss generated by Tesoro Drive Investors, Inc.'s sae of the Foreign Currency was allocat to the Taxayers for the 1999 ta year as follows: (a) $8,217,536 was allocated to Gar Woods; and (b) $5,135,626 was allocted to Bily J. McCombs.
4. IR Adjustments Are ImDroDer and Should be Reversed.

The Commissioner disallowed all the ta benefits associated with the Trasactions described above and applied penaltes against the Taxpayers on a number of
theories when it issued the FP AA. Each of these theories is eroneous and cannot form the basis
of

the adjustents proposed.

5. Penalties Should Not Applv.

Taxpayers should not be penalized because they relied on the advice, counsel, and guidance of competent ta professionals, including, but not limited to, professionals at Jenkens & Gilchrist P.C., Brown & Wood LLP, and Ernst & Young, LLP in detrmining the
federal income ta consequences and proper reporting obligations relative to the Trasactions described above.

The Taxpayers each obtained a sepate written legal opinion from
Jenkens & Gilchrist P.c. dated Januar 3 I, 2000. Jenkens & Gilchrist P.C. provided an opinion

on a more likely than not basis regarding the federal ta consequences of the Tranactions. Brown & Wood LLP also issued opinions which provided legal analysis and conclusions
consistent with those of Jenkens & Gilchrist P.C. Other ta professionals confirmed this advice to the Taxpayers, including Ernst & Young, LLP, who prepared and fied the various entity returns and two of the fòur Taxpayers' retrns. The conclusions set fort in the legal opinions,
as ratified and confirmed by the other professionals, provided reaonable bases for the maner in

which the Trasactons were report for federal ta purposes. Conseuently, Petitioners have a
complete defense to the application of pealties.
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6. MiellaDeous Matter.

In its sttement below, Repondent makes repeted references to
Camferda, et al. v. Ernt & Young et al., Case No. 02 Civ. 10100 (USDCSDNY, and implies
that the Tesoro petioners ar paies in that case. The Tesoro petitioners ar not and have never

been parties in that ca.
C. Resondent's Statement.
This cae arses out of a complex abusive ta shelt strtegy developed in the

mid 1990's by the Chicago law firm of lenkens & Gilchrst, a Professional Corpration ("J&G")
and others. The purpse of this generc tax shelter pruct was to eliminat gains realized by the
tapayers from the recnt sale of

their bùsiness and other income. The strtegy was essentially

baed on the purchase by weathy taayers of what were charriz as option contrcts, but
which in reality were nothing more than private wagering argements. The contracts were not

sold on any exchange. Nor was there any re possibilty of foreign curncy ever exchanging
hands on the trsactons. The strategy called for the purchase of purprt offsetting currcy

positions, but which had no reasnable possibilty of a profit in excess of the enormous fees on the trnsactions.
The fees for these trsactions were a fixed percentage of the taxpayers' desired

ta loss. The only question for the tapayers was how much of the gains to eliminate. The

scheme, sometimes with minor variations, was marketed under various names, including the . version refined by Ern and Young, LLP ("E&Y"), which was marketed to its wealthy clients

under the acronym of "COBRA, or Currency Options Bring Reward Alternatives. The
DeutscheBank A.G. ("DB") was recruited to serve as the financial counter par to the private

wagering contracts. J&G was recruite to assist in the development and implementation of the strategy. There were a total of 16 COBRA transactions through which taxpayers attempted to
generae nearly $1 bilion worth of

artificial losses.

1. Summary of

Facts as to The Marketne: of

the Strate2V.

According to allegations in a class action suit against

the promoters of

this

strategy, as discussed infr E& Y presented the ta strategy to petitioners by the use of power
point displays and represented that it devised the ta strtegy, when in fact it was merly the
marketing agent of J&G. At the beginning of

the presetation, potential investors were required

to sign confidentiality agreements with both J&G and E&Y. Under these confidentiality
agreements, which expressly disclosed I&G's role as a promoter, paricipats agree that they

would not disclose any of the mareting materials used by E&Y to explain the steps of the
transaction.

After agreeing to the marketing terms, participants then met with E& Y for
a document signing ceremony at which they pre-signed documents necessar to effectate the

COBRA trnsaction. The Carel paricipants have testified that they did not in fact read the
documents they signed. It is unclear at this time where and when in November the documents were signed in Tesoro. E&Y appers to have recommended that paricipants eliminate only par
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their gains, so as to avoid flagging the tron to the IRS. J&G and E&Y also appea to have decided that the fee paid to J&G should not be claimed by paricipats as itmized
of

deductions, again to avoid flagging the trsaon to the IRS.

. E& Y apparntly repreted to paricipants that the IRS would never be able to find the trsaction on the multple tax.rerns used to report the trsation. J&G and anoter law firm Brown & Wood, ("B&W" furnished "caed" and ''prefabricated'' .legal
opinion to paricipats in an attempt to insulate the COBRA transactions from pealties, should they ever be discovered by the IR. However, both of these law firms were copromoters of
COBRA.
The fees to purchas the COBRA product were pre-set by the promoters as
a fixe perctage of

the investors' desired ta loss. Tota trsaction costs and fes wer set at 9

.1/2 % of thé desir loss. E&Y allegedly recommended that pacipants not eliminate their entire income, so as to avoid flagging the trsation to th IRS. E& Y thereaftr "picked" the
loss petitioners needed to generate and the paicipants signed the form documents which were
then generated to efftute the trsaction. The investors' parerships were created as an
integral pa of

this trsaction for puroses of generating the losses that had been "picked."

These tax shelte trsactions are but one of a host of abusive ta shelter transactions recently uneaed by the Internal Revenue Serice which were marketed to wealthy

individuals. Apa frm E&Y and J&G, at leas three other professional firms were also
involved in the. design, marketing, and implementation of COBRA. These firms were the DeutscheBan ("DB"), and the law firms of Brown & Wood ("B&W") and Scheef & Stone
("S&S"). J&G and B&W prepard the boilerplate opinions to "bless" the transactions.
Counsel for the Tesoro peitioners have filed one other case involving the

same COBRA ta strategy that was purchased by petitioners in the Federal Court of Claims. JZ Buckingham v. United States, No. 05-231 T (Fed. C1.). JZ Buckingham also involves that same five third paries that are involved in this MOL litigation. Tesoro counsel has represented that they are also about to fie three more cases involving the COBRA tax strategy in the Court of Federal Claims. According to Tesoro counsel, these three new cases also involve E&Y and DB and a new law firm, Proskuer & Rose, which prepared the legal opinions for the paricipants in
these caes. Thes new cases wil therefore involve much of the sae third par discovery.
Accordingly, while 28 USC § 1407 does not cover cases before the Federal Court of

Claims, we wil seek, by stpulation or court order, to allow the third par discovery taken in the MOL litigation to apply to the Court of Federal Claims cass. Coordinating identical third par discovery wil be beneficial to all paries, as well as the court in these different case, since it
wil obviate the need for duplicative discovery.

It is anticipated by the United States that the scope of its third part discovery wil be substtiaL. The United States anticipates that it will require at least 100
depositions in these three MDL cases and the one Court of Federal Claims cas and 150

interrogatories in each case, and has fied a motion to enlarge discovery limits. The need for such discovery is amply ilustrated by petitioners' own allegations in their class action against
these same third paries in which they have alleged that E&Y, DB, J&G, B&W conspired:
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. . . to devise the scheme and agred to provide a veneer of legitimacy to each

other's opinion as to the lawflness and ta conseuences of the COBRA
tranaction by ageeing to the represtations tht would be made

and to issue

allegedly "independent" opinions before potential clients were solicited. These "independent" opinions were prefaricated and caed opinions use for each and
every client across the United States with basic factu information inserted

depending upon the client.

Second Amended Complaint, 1181, Camrda, et ai. v. Ernt & Young, et a/., Case No. 02 Civ.
Second Amended Complaint," 59, Caerdam, et aL. v. Ernst &

10 i 00 (USDC SDNY. The underlying options transacions were allegely also rigged. See, Young, et ai., Cas No. 02 Civ.

i 0 i 00 (USDC SDNY. A preliminar order ceifying the class, dat May 14, 200, reflects
that discover. agains J&G was stayed. during seement negotiatons. J&G setted the claims

agains it for about $85 milion. Under the term of this selement, J&G prouced to class
counsel over 200,000 pages of documents and allowed extensive interviews of its key witnesses, including Paul Daugerdas, Edwin Mayer, Donna Guerin and Patrck O'DanieL. Class counsel have represented that they spent 18,799 hours of attorney and paalegal time. Petitioners' remaining claims against E&Y, DB and B&W are stil pending. B&W also has settled many of the paricipants' claims against it with respect to these transactions.
The Offce of the United States Attorney for the Southern District of

New

York has a pending criminal investigation with respect to these trctions. That offce has

asked that it be kept apprised Qf any discovery in this action in order to ensure that this action does not adversely effect its pending criminal investigations. In the event that it does, the United
States anticipates that it wil seek either a protective order, or other such relief, including a sty if

necessary, to protect the importt interests of law enforcement. Counsel for the United States
has notified petitioners that, in addition to Rule 6(e) of the Federal Rules of

Criminal Prur

which protects grand jury information, the IRS criminal fies are also privileged and not subject to discovery at this time.
III. ContentioDs/ssues.

The Magistate Judge has asked the paries to identify and describe the paies' the litigation. The following is a summar table listing the contentions and issues of the paries which is offered for the beefit of the Court, but is not
contentions and the issues at this stage of

intended to waive any contentions or issues not listed:
A. PetitioDer Carmel Partners' Contentions/ues.
1. Petitioner properly determined all items of income, losses, deductions,

and credits for the 1999 ta year.
2. Petitioners properly calculated and reportd the loss generted by BAMC
lnc.'s sale of

bonds, which was allocted to the Taxpayers for the 1999 ta

year as follows: (a) $48,825,463 was allocated to Camferdam; (b)

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$11,713,479 was allocted to Adam; (c) $6,829,165 was allocte to
Michener; and (d) $1,366,108 was alloc to Trigilio.

3. Petitioners properly calculated and caued to be reprted a loss on BAMC,
Inc.'s IRS Form 1 iiOS and the corrsponding Schedules K-l for ta yea

1999 in the amount of$68,734,21S.
4. All basis calculations and determinations made by th Petitioners with respect to ta yea 1999 were valid and proper. .
S. All of the petitioner entities wer validly create, existing, and regniz

for all stte and federal law pures, including federal income ta
puroses for ta yea 1999.
6. Neither the petitioners that

ar entities, nor the entities that were formed

by or on behalf of any of the petitioners with respe to the COBRA - transaction (collecively, the "Petitioner Entities") were shams for federa

income ta purpses for ta year 1999.
7. None of the Petitioner Entities lacked economic substce for federal income ta purposes for ta year 1999.

8. No par of the Petitioner Entities or the Trasactions may be disregarded,
ignored or recharcterized on the basis that they lacked economic substce, business purpse or otherwise constted a sham for federl income ta purpses.

9. The losses and other benefits claimed by the Petitioners on their federal
ta returns canot be disallowed on the basis that either the Trasactions

or any of the entities involved consttu shams or lacked busines
purpose or economic substance because none of these doctrnes is
incorporated into or otherwise a part of

the Code.

10. Disallowance of the losses or other benefrt claimed by the Petitioners in

this case on the basis of either the sham transaction, business purpse or economic substance theories assrtd by the Commissioner would violate the separation of power provisions of the United States Constitution. .
11. The Petitioner Entities were not formed or availed of in connection with a

transaction or transactions in a maner inconsistent with the intent of
Subchapter K of the Coe and may not otherwise be disregarded, nor may any of their trsactions be reharactezed, in whole or in. pa, under the
authority of Treas. Reg. § 1.701-2 for

ta yea ending December 27,1999.

12. Treas. Reg. § 1.701-2 is invalid and inapplicable to the facts of

this case.

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13. The obIigations under the Short Options sold do not constute liabili1es under Code Section 752. Consequently, neiter the petitioners' nor any of any or all of those obligations should the Petitioner Entities' assumpton of be regared as a distibuton of money under the Code for ta yea 1999.

14. Even if the Options do constitute liabilties under Code Setion 752 and
the applicable regulations, the amount of the "liabilty" trsferre under

the Options is $0. . As such, the bass in the Petitioner Entities caot be
reduce by any par of

the Options trsferr to the Pettioner Entitiès.

15. The amounts treated as contributed under Section 722 of the Internl Revenue Code are not reuced by the amounts reeived from the sale of
the Short Options.

16. Temporar Treas. Reg. 1.752-6T is invalid and inapplicable to the fact of this case.
17. Code Section I65(c)(2) does not operte to disallow the losses or other ta benefits .claimed in this cae for ta year 1999.
18. PetitionerS propely determined and reported the basis of the Foreign
Currency transferrd in ta year 1999.

19. Petitioners properly computed and reported the basis of an transations in

tax year 1999.
20. In every other respect, the federal ta conseuences of the transactions at

issue in this case are as set fort in the legal opinions discussed above and
as reported by Petitioners on their federal ta retus.

21. Petitioners are not subject to penalties under Code Section 6662 beuse
any tax liabilty ultimately determined by this Court against them is not
attbutable to: (a) negligence or disrgard or rules or regulations; (b) any

substtial understement of income ta; or ( c) any substatial or gross
valuation misstatement under Chaptr 1.

22. Petitioners are not subject to penalties under Code Section 6662 because .
any understatement ultimately detennined by the Court is attibutble to

items for which the relevant facts were adequately disclosed in Petitioners'
retus or in a statement attched to the returns; and there is a reasonable

basis for the ta treatment of such item by the taayer.

23. The Transactions at issue in this case do not constitute a ta shelter.
24. In the alternative, even if the Transactions do constitute a tax shelter,

Petitioners are not subject to penalties under Code Section 6662 because
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any understtement ultimately detrmined by the Court is, baed on the
foregoing, atibutable to tle ta trtment of items for which ther is or

was substtial authority for such trtment, and, fuermore, Petitioners
reanably believed that the ta treatment of such item by Pettioner was
more likely than not the prope trent.

25. Pettioners are not subject to pealties under Code Section 6662(b)(1)

beause they were not negligent nor did. they disregard any roles or regulations as contemplated by Code Section 6662.
26. Pettioners are not subject to pealties under Code Section 6662(b)(2)

because there is no substatial understatement of income ta as
contemplated by Section 6662.
27. Pettioners are not subject to pealties under Code Section 6662(b)(3) beause there is no substatial or gross valuation misstaement as

contemplated by Code Section 6662.
28. Petitioners are not subject to penalties under Code Section 6662 on any

underpyment ultimately detennined because there was, based on the foregoing, reasonable cause for such underpyment and Pettioner acted
in goo faith as contemplated by Code Section 6664(c)(I).

29. Petitioners relied on the advice provided by ta professionals including,

but not limited to, Jenkens & Gilchris, P.C., Brown & Wood, LLP and

Ernst & Young, LLP. In addition, the reliance on such advice was reasonable and in goo faith. Thus, under the authonty of Coe Section
6664(c)(I) and Treasury Regulation § 1.6664-4, Petitioners are not subject to the penalties imposed by the IRS under Code Section 6662.
30. Petitioners are not subject to penalties because the Government
retroactively changed the definition of

"liabilty" under IRC § 752.

B. Petitioners SA Tesoro Investment Partners' and Tesoro Drive Parters'

Contentionsßssues.
i. Petitioners properly determined all items of income, losses, deductions,

and creits of SA TI Parters and TD Parers for the ta year ending

December 27, 1999.
2. Petitioners properly calculat and reported the net short tenn capital gain
of

TO Parers in the amount of $5,037 for tax year ending December 27, 1999.

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3. Petitioners properly caculat and report the ta exempt interest of
SATI Parer in the amount of

$958 for the ta yea ended December 27J

1999.
4. Petitioners properly calculated and reported ordinar income of TO Parers in the amount of $650,000 for ta year ending Decembe 27,

1999. Petitioner properly compute and repord ordinar income of
SATI Parter in the amount of $50,000 for th ta year ending Decebe
27, 1999.

5. Taxpayers properly determined the Parers' outside basis in 1D Parers
and ,SA TI Parers for ta year ending December 27, i 999.

. 6. 1D Parers and SA TI Parters are parerships validly created, existing,

and reognized for all st and federl law purpses, including federal income ta purposes for ta yea ending December 27, 1999.

7. TO Parters and SA TI Parers were not shas for federal income tax purposes for ta year ending Decmber 27,1999.

8. TO Parers and SA TI Parers did not lack economic substace for
federl income ta puroses for ta year ending December 27, 1999.

9. No par of the Parerships or the Trantions may be disrgared,
ignored or recharcteried on the basis that they lacked economic

subsce, business purpose or otherwise constituted a sham for federal
income ta purpses.

10. The losses.and other benefits claimed by the Petitioners on their federal ta returns canot be disallowed on the basis that either the Transaons or any of the entities involved constitued shas or lacked business

purpse or economic substance beuse none of these doctrines is
incorporated into or otherwise a part of

the Code.

i i. Disallowance of the losses or other benefits claimed by the Petitioners in

this case on the basis of either the sham trnsaction, business purse or
economic substace theories asserted by the Commissioner would violate
the separation of powers provisions of

the Unite States Constution.

12. TO Parers and SA Tl Parners were not formed or availed of in
connection with a transaction or transations in a manner inconsistent with

the intent of Subchapter K of the Code and may not otherwis be
disregarded, nor may any of

their transactions be recharacterized, in whole

or in par under the authority of Treas. Reg. § 1.701-2 for ta year ending
December 27,1999.

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13. Treas. Reg. § 1.701-2 is invalid and inapplicable to the facts of

this ca.

14. The obligations under the Short Options sold do not constitute liabilites

under Code Secion 752. Consequently, both TD Parrs' an SATI
Parers' assumption of

those obligatons is not regarded as a distbution

ofnioney to the Parers under the Code for ta yea ending December 27,

1999.
15. Even if

the Options do constitute liabilties under Code Section 752 and

the applicable regulations, the amount of the "liabilty" trferr to the

Parerships under the Options is SO. As such. the Parer' bass in the

Parterships canot be reuced by any pa of the Options transferr to
the Parerships.

16. The amounts trted as contributed by the Parers under Section 722 of
the Internal Revenue Code ar not reduced by the amounts reeived by the
Parers from the sae of

the Short Options.

17. Temporary Treas. Reg. 1.752-6T is invalid and inapplicable to the facts of this cas.

18. Coe Section 165( c )(2) does not operate to disallow the losss or other ta benefits claimed by the Parners in this case for ta year ending Decembe
27, 1999.

19. Pettioners properly determined and reported the basis of the Foreign

Currency transferred from TD Parters to Tesoro Drive Investors, Inc. for
ta year ending December 27, 1999.

20. Petitioners properly computed and reported the basis of the Shares

trsferred form SA TI Parters to SA Tesoro Investrs, Inc. for the tax
year ending December 27, 1999.
21. In every other respect, the federal ta conseuences of

the transactions at

issue in this cas are as set fort in the Legal Opinions discussed above .
and as reported by Petitioners on their federal ta returns.

22. Pettioners are not subject to penalties under Code Section 6662 because
any ta liabilty ultimately determined by this Cour against them is not
attibutable to: (a) negligence or disregard or rules or regulations; (b) any

substantial understatement of income ta; or (c) any substantial or gross

valuation missttement under Chapter i.
23. Petitioners are not subject to penalties under Code Section 6662 because
any understatement ultimately detennined by the Court is attibutble to

items for which the relevant facts were adequately disclosed in Petitioners'
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res or in a statement attched to the retus; and there is a reonable

basis for the ta trtment of such item by the tapayer.
24. The Trasaons at issue in ths cas do not constitue a ta shelter.

25. In the alterntive, even if the Tractions do consitute a ta shelter,
Petitioner are not subjec to penalties under Code Section 6662 beus
any understaement ultimately determined by the Cour is, bas on the
foregoing, attbutable to the ta tratment of items for which ther is or

was substtial authority for such tratment, and, fuerore, Petitioners

reasnably believed that the ta tratent of such itm by Petioners was
more likely th not the proper treatment. .
. 26. Petitioners are not subject to penalties under Code Section 6662(b)(I)

beuse they were not negligent nor did they disregard any rules or
~egulations as contemplated by Code Section 6662.
27. Petitioner ar not subject to penalties under Code Section 6662(b )(2)

because there is no substntial understatement of income tax as

contemplated by Secton 6662.
28. Petitioner ar

not subject to penalties under Code Section 6662(b)(3)

because there is no substtial or gross valuation misstatement as

contemplated by Code Secon 6662.
29. Petitioner are not subject to penalties under Code. Section 6662 on any

underyment ultimately determined beause there was, based on the
foregoing, reaonable cause for such underpayment and Petitioner acted
in good faith as contemplated by Code Section 6664(c)(1).
30. Petitioners relied on the advice provided by ta professionals including,

but not limited to, Jenkens & Gilchrist, P.C., Brown & Wood, LLP and

Ernst & Young, LLP. In addition, the reliance on such advice wa
reasonable and in goo fath. Thus, under the authority of Code Section

6664(c)(I) and Treasury Regulation § 1.6664-4, Petitioners are not subject to the penalties imposed by the IRS under Code Section 6662.
3 I . Petitioner ar not subject to penaltes because the Government
retrctively changed the definition of

..

"liabilty" under IRC § 752.

C. The United States' ContentionslIsues.
i. The United States contends that the Internal Revenue Service corrtly

determined that even if Carel Parers, SA Tesoro Investent Parters and
Tesoro Drive Parers existe as parerships under state law, the entities were

shams for federal income ta purposes. That is, the LLCs did not "join together
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as parers to conduct business actvit for a purpse other than ta avoidance."

ASA Investerings P'ship v. Comm'r,201 F3d 505, 513 (D.C.Cir.2000). " '(The absence of a nonta business purpose is fatal' to the argument that the
Commissioner should repect an entity for federal ta purses." Saba P'ship v.

Comm'r, 273 F.3d 1135, 1141 (D.C.Cir. 2001), quting AS Investerings P'ship v.
Comm'r, 201 F.3d at 512. At this ealy ste of discver, the fudamental

factual basis of this position is that this purortd entity was not formed or availed
of for a valid business purpse. Rather, it was organized and availed of solely for

purses of ta avoidance which was to be accomplished by artificially inflating
the basis of

the parers' paersip interests.

2. The United States also conteds that the Inteal Revenue Serice
. correctly determined that the purhase of

the offsetng option trsactions and

their contrbution to Carel Parer SA Tesoro Investment Parers and Tesoro Drive Parers, respectively, was an economic sham. First, these offtting option
trsactions did not have objective ecnomic substce. At this eary ste of discvery, the principal factual basis of that position is that absent the ~ benefits, there was no reasnable possibilty tht the LLCs or the purportd parership would reaize a prfit in excess of the enormous fees and transaction costs on these transactions. Apar from the individual tapayers personal fees on these transactions, they and their purrted entities had to incur fees to the
promoters amounting to 9Yi % of fees, combined with the marginal chances of the end of their terms, neither the purprted parers (the LLCs ) their desire ta

losses. Given these enormous

the options being "in the money" at

nor the purprted

parership had a realistic possibilty of realizing an economic profit on these

tranactions. Moreover, with the spread between the two offsetting positions being just a fraction of a cent, there was virtally no chance that just one of the offettng positions would be acted upon. Indeed, because the Deutsche Ban as the calculating agent, could choose to accept or disregar any spot rate, when combined with the increibly close proximity of the trgger spot rates (hundredths
of a penny apar), the chances of just one of

the paired position being exercise,

was virually niL. As a result, these offsetting option positions amounted to, in reaity, a contractual wager, wit the chances of winning the wager being no different than that of winning the lottery - it was not going to happen. It is expected that expert testimony wil also address this issue.

3. The Unitd States contends that these offsettng option 1rsactions had no
purpose (business or otherwise) other than the creation of income ta losss. At
this early stage of discovery, the principal factual basis of sole purpse of

this position is that the

these 1rsations was to generate a huge paper ta loss on the

sale of former parnership propert which was not economically inherent in these

transactions, but creted arificially "by machinations whose only purose and
effect was to give rise to the desired tax consequences." ACM Parership et at v.

Commissioner, i 57 F.3d 231, 245 (3rd Cir. 1998). Accordingly, the Internal Revenue Service corrctly determined that the purorted paership and the
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offsettng option tranactions describe above should be disregarded in full and:
(1) any purrt losses resultng from these transaons ar not allowable as

deductions; and (2) increases in basis in parership intere and increas in basis of assets are not allowed to eliminate gain for federl income ta puroses.
4. The United State contends that the Internal Revenue Service correctly

determined that Carmel Parers SA Tesoro Investent Parers and Tesoro
Drve Parer were each shams, lacked economic substace and; under § 1.701-2
transaction or transactions in table yea 1999, a principal purpse of

ofIncome Tax Regulations, were formed and availed of in connection wit a which was to reuce substntially the present value of its parers' aggregate federa ta liabilty in a manner that is inconsistent with the intent of Subchapter K of the Internal Revenue Code.
5. The United States contends that the Internal Revenue Service corrly

determined that the Carel Parers, SA Tesoro Invesent Parrs and Tesoro Drive Parers should be disregarded and that all transactions engaged in by the purported parerships should be treated as engaged in diretly by its purprted
parters. This includes the determination that assets purprtedly acquired by
Carmel Parters, SA Tesoro Investent Parers and Tesoro Drive Parers,

including but not limited to foreign currency options, were acquired directly by

the purortd parers.
6. The United States contends that the Internal Revenue Service correcly

determined that the foreign currency option(s), purprtdly contrbuted to or
assumed by Carel Parers, SA Tesoro Investment Parers and Tesoro Drive
Parers, should be treated as never having ben contributed to or assumed by said

parerships and any gains or losss purportedly realized by Carel Parers SA
Tesorn Investment Parters and Tesoro Drive Parters on the option(s) should be
treated as having been realized by its parters.

7. The United States conteds that the Interal Revenue Service corrctly

determined that the purprted parters of Carel Parers, SA Tesoro Invesent
Parters and Tesoro Drive Parers should be treated as not being paer in

Carmel Parter, SA Tesoro Investent Parers and Tesoro Drive Parters.
8. The United States contends that the Internal Revenue Service corrctly

determined that contributions of Carmel Parters, SA Tesoro Investent Parers
and Tesoro Drive Parers should be adjusted

to reflect clealy the parerhip's

or purrted parters' income.
9. The United States contends that Internal Revenue Service correctly
determined that the formation of

and Tesoro Drive Parners and the contribution of

Carel Parters, SA Tesoro Investment Parer the offsetting option

transactions to Carmel Parers SA Tesoro Investment Parers and Tesro Drive
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Parers violated the Anti-Abuse regulations of Subchapter K of

the Inteal

Revenue Coe - i.e., Tre. Reg. §1.70i-i.
10. The Unite State conteds tht the Inteal Revenue Serce correctly
determined that the obligations inherent in the short positons (wrtt call

options) transferrd to Cael Parer, SA Tesoro Investment Parers and
Tesoro Drve Parer consttute liabilites for purses of Secon 752 and Trea. liabilties, Reg. §1.752-6T. The term "liabilty" in Section 752 encompasses all the obligations under the including contingent liabilities. Thus, assumption of short positions consitted a distribution of money to the purrt parers under Section 752(b), therby decreasing their basis in the purorted parerhip.
Moreover, Helmerv. Commissioner, 34 T.C.M. (CCH) 727, T.C.M (1975) is

. inapposite to these facts because lt did not involve simultaeously execute long
and short options of the same underlying propert with virtally identica tes,

which offsetting options eliminted all financial risk to the purprted parer in excess of the net premiums paid by them. Also, Helmer did not involve offseting

option trsactions which were entere into as par of an elaborate and
prearged scheme to avoid federal income taes.
1 1. The United States fuer contends that the Internal Revenue Servce

correctly determined that the purorted parers of Carel Parers, SA Tesoro Investment Parers and Tesoro Drive Parter did not acquire the option(s)
positions or contrbute them to the purported parerships for the prncipal

purpose of realizing a profit for purpses of 26 U .S.C. Section i 65( c )(2).
12. The United State contends that the Inteal Revenue Service correctly

determined that the purrtd parers of Carel Parers, SA Tesoro Investent
Parers and Tesoro Drive Parers did not acquire the option(s) positions or

contrbute them to the purported partership for the principal purose of realizing
a profit.

13. The United States contends that the Interal Revenue Service correctly

determined that even if Carmel Parers, SA Tesoro Investment Parers and
Tesoro Drive Parer are trted as parerships for federal income ta purpses

and even if the foreign currency option(s) are therefore treted as having been

contrbuted to this partership, these nominally separte offsettng (long and short) options were in substace a "single" position. It a foundational principle of the tax law that the substance of a transaction controls for federal income ta purpses. At this early stage of the discvery, the principal fact supportng this
position are that in form, these nominally separte options reuired huge gross . premiums (totaling many milions of dollars) and expsed the option wñters to

losses. In substance, however, these nominally separte private trades economically nearly totally offset each other, thereby only requiring a relatively small net premium. Moreover, because of their incredibly close strke prices, there was virtally no risk that only one position would be exercised. Thus, assuming these aIieged trades were not "factual shams," these nominally
massive potential

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separte positions constuted in substace and in relity, a single position. As
such, the basis of

thes offseting option positions would be limited to the net

premium paid on their acquisitin - with the corrsponding resuh that the
contrbuting parers'. basis of

their paerhip intest would also be limite to

this net preium amount. It is expect that exrt tesmony wil also address
this issue.
14. The United States contends that the Inteal Revenue Serice corrtly
detenrined that the adjusted basis of

the offtting options and other propert

contrbuted to Cael Parers, SA Tesro Investent Parer and Tesoro Drve
Parers is zero. Even though the offseting options,must be viewed as a "single

position" with the result that the basis of these offg options would be equal
. to the net premium paid for these positions, the burden is on the plaintiff to
esblish that they made a net "out of pocket' payment for these options and also

to establish the amount of this net cah payment.

15. The United States contends that the burden is on the petioners to
estblish what was the adjusted basis in the hands of the purportd parers of

the

other propert contributed to the purportd paership. However, even assuming that plaintiff sustins it burden of showing what net amounts were paid for the offetting options, the basis of these option positions would stil be zero if thes
transactions were determined to be factual or economic shams.
i 6. The United States contends that the Internal Revenue Service correctly
the purported parers' nominal trnsfer of their parership interests to the purrt Subchapter S corprations (BAMC, Inc., Tesoro Drve Investors, Inc. and SA Tesoro Investors, Inc.), the bais of their determined that in the case of

purPorted parership interes (both before and after the transfer) is zero. See 26 U.S.C. §§ 705 and 722, which provide, in relevant par that the basis of a

contrbuting parer's parerhip interest is equal to the adjusted basis ofthe
contributed propert at the time of contribution. Since petitioner have not estblished what was the net (out of poket) amount of the premium payments for

the offseting positions, the adjusted basis of such options is zero - with the result tht the basis of the contributing paers' purprted parership interests must also be zero.

17. The United States conteds that the step transaction docne is applicable
in this case, requiring that the individual steps of the COBRA trsaction be
collapsed. The purprted parership in this scheme was simply used as a conduit

to create an arificially inflated basis in the purrted paers' parnership interests, which inflated basis could, in turn, then be alloced to propert distributed to the purrted Subchapter S corporation upon the prearanged
dissolution ofthe purportd parership. The purrted Subchapter S corporation
paper ta loss on the sale of this propert whose basis had been arificially inflated, which loss could then be passed through the individual tapayers. Under the step transaction doctrine, the 20 was also simply used as a conduit to generate a

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steps of

the trsfer of

the offsetting options to the purprted parership and the

distribution of the parership propert on the liquidation of the parership .to the purorted subchapter S corporation ar disregarded. With these steps disrgarded, the basis of propert distributed to the Subchaptr S corpration would therfore this propert - and not the arificially be required to equal the actual cost of the disregarded paership intest. Thus, the disposition of inflted basis of
such propert would not give not rise to an arificially-genera ta loss. At this

stge of discovery, the principal facts supportng this position are the marketing
materials of the promoter which make it crystal clea that each of COBRA transaction was meticulously preanged the steps of this with the ultimate end result in

mind to achieve an arificially-generated ta loss for the individual investors.
18. . The United States contends tht the offtting option transactions may be
factual sham. That is, it appears that while these trsacions ar, at lea to
some of

extent, documented on paper, this documentation may not reflect the reaity
these transactions. Based on the allegations in the investors' suits against the

promoters, these option contracts may ultimately be determined to be ilusory. The principal facts to support this position wil only be known after full discvery (documenta and depositions) has been conducted upon the Deutsche Bank.
19. The United States contends that the "at risk" rules ofI.R.C. § 465 apply
here to preclude the allowance of

the claimed losses. Section 465(a)(1) provides

that individuals may claim losses and deductions only to the extent of the aggregate amount to which the taxpayer is at risk. Section 465(b) provides that a at risk with respect to amounts protected against loss taxpayer is not considered through some related agreement. At this early stage of discover, the principal facts supporting this legal position are that the COBRA transactions were carefully designed to limit the financial risk ofthe investors, their LLCs and their
purprted parership. The offsetting options were expressly designed to ensure

that the investors. thrugh their LLCs and their parership, were exposed to risk the net premium paid to the Deutsche Bank. Moreover, the only to the extent of operation of the offsetting options limited their risk because the values of the options moved in opposite directons in economically offsetting alounts. The amount that could be gained or lost was therefore fixed at the time the offsetting
options came into existence. As neither the LLCs nor Carel Paers, SA

Tesoro Investment Parers and Tesoro Drive Parers were "at risk" for more
than the amount of

the net premium, §465 precludes Carel Parers, SA Tesoro

Investment Parers and Tesoro Drive Parners from claiming a basis in the .
offsetting option positions in excess of

the net premium.

20. The United States furter contends that the FP AA corrctly deterined
that the paers are liable for four accuracy-related penalties: a 20-percent

penalty for negligence, a 20-percent penalty for a substatial underpyment of
ta, a 20-percent penalty for a substantial valuation misstatement, and a 40-

percent penalty for a gross valuation misstatement.
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2 i. Section 6662(a) imposes an accurcy-relate penalty on certin
underpayments of

ta. The acurcy-related penalty is equa to 20 pet ofilt

portion of an underpayment that is attibutale to, among other things: (1)

income ta and (3) any substatial valuation misstement. See, § 6662(b)(1) - (b)(3), Appeix A, infra. the underayment if The penalty increes to 40 perct of the underpyment is
negligence, (2) any substatial undertement of

due to a gross valuation misstteent See, §6662(h). Two reent caes have
confined that the stary term ''valuation misstement' includes inflated basis

propert. See, Long Term Capital Holdings, Ltd, v. United States, 330 F. Supp. 2d 122, 199 (D. Conn. 2004), afd (unpublished order) (2nd Cir. Sept; 27,2005); Sana Monica Pictures, LLC v. Commissioner, 89 T.C.M. (CCH) i 157 ( May 11,
of . . misstatement

2005) (on appeal C.A. 2). The United States contends that the gross valuation penalty is applicable as a matter of law with respct to the oversttements of basis in the COBRA trsactions. Ther is no stacking of the accuracy-related penalty components, Treas. Reg. § 1.6662-2 (c). In other. words,

the maximum accura relat penalty impose on any porton of an .

underpayment is 20 percnt, or 40 percent in the cas of grss valuation
misstatement, even if one tye that portion of

the underayment is attibutable to more than

of misconduct.

22. The United States fuer contends that the adjustment of parersip
items of

Carmel Parers, SA Tesoro Invesents Parers and Tesoro Drive

Parers are attibutable to a ta shelter for which no substial authority has been established for the position taen and no showing of renable belief by the
parership or its parers that the position taen was more likely than not the
correct treatment of

the ta shelter and related trtion.

23. The United States contends that the substce of

the foreign curncy trsactions, not the form ofthe trsactions should control the ta tratment of

the foreign currency transactons. See, 26 U.S.C. § 988 and the regulations

thereunder.
24. Accordingly, the Internal Revenue Service correctly determined that the

purprted parership and the offetting option transactions desribed above should be disregarded in full and: (i) any purprted losses resulting from these
transactions are not allowable as deductions; and (2) increaes in basis in

parership interests and increases in basis of assets ar not allowed to eliminate
gain for federal income ta purpses.

25. Wheter the various paersips meet the critena for a partnership under applicable stte and federal laws.
26. Whether the parerships have a legitiate business purse and therefore

should be respeted for federal income tax purpses.

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27. Whether the paership exists as a matr of fact or whether it is a: facual
sham.
28. Whether the offetting option transactions have ecnomic substce and

therefore should be respeted for fedral income purose?

29. Wheter the individual petioners and the parershp petitioners could reasnably expct to reliz a pi-ta prfit on the offseting opton trsacion.
30. Whether there was a legitimate business purse for the contrbution of

the offsetting option tranctions to the parership.
3 I. Whether the trsation should be disrgarded or re in whole or in

. pa due, to the violation ofTrea. Reg. § 1.701-2 (the paerip anti-abuse

rules) which regulation list various factors to be considered including .
consideration of the purported business purp and claimed ta benefits reulting

from the trsaction.

32. Whether the offetting options constitute a single position for federal
income purses.

33. Whether the step trsation doctne applies to require the steps of the
COBRA trsactions to be collapsed because they were preplaned with the
single objective in mind of generating massive paper ta losses, which could then

be passed through to the individual invesors.

34. Whether Treas. Reg. § 1.752-6T applies to reduce the outside basis in the
paership of the peitioners who contributed the options.in the amount of

the

nominal premium received for the short option.
35. Whether the legal and promoter fees and other "out-of-pocket expeses"

paid by the individual investors or the parership with respect to the COBRA trsactions wer fees paid in connection with ta shelter activities and are

therefore not deductible?

36. Whether the economically offtting option positions contributed to the parterhip constitute an argement under I.R.C. § 465(b)(4) to limit exposure to risk of loss.

37. Whether, under all the facts and circumstances, the transaction was conducted in such a manner as to warant application of the accuracy-related penalties?
38. Whether the notice parers qualify for relief from the accurcy-related penalties under the reasonable cause provisions ofl.R.C. § 6664(c).

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iv. Pretrial Pleadin2S and Disclosures

The partes propose the following dates for the Case Management Plan:

A. Initial Disclosures. The paries have served thir Fed. R. Civ. P. 26 initial
disclosure.

B. Pettioners' PreUmiDarv Witnes and Exhibit Lists. Petitioners shall fie
preliminar witness and exhibit list on or before March 21, 2006.
C. Respondent's Preliminary Witness and Exhibit ListL Respondent shall file

preliminar witness and exhibit lists on or before March 21, 2006.

D. Dedline for Amendiu Pleadin2S or Addin2 Partes. All motions for leave to
amend the pleadings and/or to join additional paries shall be fied on or before June 1, 2006. The United States reserves the right to seek a furtr enlargement
of the agred upon scheduling deadlines to

the extent such amendment or addition of paries adds additional issues that have not already been pled.

E. Settlement Demand Deadline. Petitioners shall serve on Respondent (but not
fie with the Court) a sttement of special damages, if any, and make a settlement

demand, on or before March 21, 2006. Respondent shall see on Petitioners (but not file with the Court) a response thereto within 30 days after receipt.

F. Expert Disclosure. The paries shall disclose th name, address, and vita of all
expert witnesses, and shall serve the report required by Fed. R. Civ. P. 26(a)(2)(B)

on or before November 15, 2006. However, if a par uses expert witness
tesmony at the sumar judgment stage, that par shall make such disclosures no later than 60 days prior to the summary judgment deadline. The paries shall

all disclose the name, address, and vita of all rebuttl expert witnesses, and shall
serve the report required by Fed. R. Civ. P. 26(a)(2)(B) for such exper rebut witnesses on or before December 15,2006.
G. Deadline for Motion to Exclude or Limit Expert Testimonv. Any par who

wishes to limit or preclude expert testimony at tral shall fie any such objectons

no later than February 1,2007. Any par who wishes to preclude expert witness temony at the summary judgment stage shall fie any such objections with their
responsive brief

within the briefing schedule esblished by Local Rule 56.1.

H. Final Witness and

Exhibit Lists. All parties shall fie and serve their final

witness and exhibit lists on or before February 1,2007.

I. Bifurcation. Any par who believes that bifurcation of discovery and/or trial is
appropriate with respect to any issue or claim shall notify the Cour as. soon as
practicable.

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J. Medical Experts. The paries do not anticipate that medical expert wil be
utilized in this case.
V. Discoverv and Dispositive Motions.

A. DispOsitive Motions. Petitioner believe that cein issues may be ripe for
sumar . judgment and anticipate filing motions for summar judgment,
challenging the validity of cein regulations upon which Respondent bas its determinations in the FPAA. Resndent does not concur.
B. Track 4. The Paries recommend a custom plan under Track 4 where dispositive
motions ar expeted and shall be filed no later than April

1, 2007; non-expert

and expert witness discovery shall be completed! by February 1,2007.
C. Results of Conference Under FED.R.CIv.P. 26m. The Pares have conferr as
required under FED.R.CIv.P. 26(f). While the Pares agree tht they should

coordinate third-par factul discovery in the MDL litigation with other similar

cases, the Parties appear to have a broad disgrement regarding the scope and
extent of

perissible discovery.

VI. PreTrial/Settlement Conferences.

A. Settlement ConfereDce.

. Petitioners believe that certin issues may be ripe for Petitioners believe that a settlement conference with the Magistate Judge would likely be appropriate as son as possible.
The United States does not concur.
B. Proposed Trial Dates
1. Petitioners. Both the. Carel and the Tesoro Investment Parter

Petitioners request a trial date of June 2007. The trials are bench trials

and both the Carel and the Tesoro Petitioners expect the presentation of their cas to last no more than seven days.
2. Respondent. Given the amount of tral prearation and coordination that
wil be required for all of

thes actions, the United States requests that the

first trial in these cases be scheduled no ealier than September 2007, with trial dates to be scheduled sequentially thereafter for the remaining actions in three month intervals.
i The term "completed," as used in Section IV.B, meas that counsel.mus serve their discover requests in
suffcient time to receive response before this deadline. Counsel may not sere discoery requests wiin the 30-

day period before this deadline unless they seek leave of Cour to see a belated request and show good cause for
the same. In such event, the proposed belated discovery reues shall be filed with the motion, and the opposing

par will receive it with sece of the motion but ned not rend to the sam until such time as the Cour grts
the motion.

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The Unite States request that the Cael and Tesoro cas not be scheduled for trial at or about the sae time due to poteal conflict in
both counsel and witness schedules. Until Respondent complets

discver, it wil not be able to make an acure estate as to th lengt
of these tral~. At