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Superior Trading, LLC v. United States

December 11, 2008


The opinion of the court was delivered by: Thomas I. Vanaskie, Judge


This action is one of at least eleven actions in which petitions to quash IRS summonses have been filed in connection with an ongoing IRS investigation into whether the petitioners engaged in an improper tax shelter scheme involving the purchase of Brazilian debt for the purpose of harvesting "bad debt" tax deductions that were passed through to investors subject to federal taxes. See In re: Good Karma, LLC, 528 F. Supp. 2d 1361, 1362 (J.P.M.L. 2007) (finding centralization of the actions unwarranted). Pending before the Court are Petitioner Superior Trading, LLC's*fn1 Petition to Quash Summons (Dkt. Entry 1), the United States of America, Department of the Treasury, Internal Revenue Service's ("IRS") Motion to Enforce the IRS Summons (Dkt. Entry 14), and Petitioner's Motion for an Evidentiary Hearing.*fn2 (Dkt. Entry 29.) For the reasons that follow, the Court will deny the Petition to Quash and the Motion for an Evidentiary Hearing, and grant the Government's Motion to Enforce IRS Summons.*fn3


A. The IRS Investigation

The IRS is currently examining the use of distress assets (including creditors' interests in debt) to shift economic losses from a tax-indifferent party to a United States taxpayer. (Coordinated Issue Paper ("CIP"), Dkt. Entry 14-4; Br. Supp. Mot. Quash, Dkt. Entry 14-5, at 8.) A distressed asset/debt ("DAD") transaction typically involves the use of a limited liability company, taxed as a partnership, to shift losses among partners entering and exiting the partnership. (CIP, at 1.) The United States taxpayer claims a significant tax loss that has passed through the partnership to offset other income or gain.*fn4 (Id.) The transaction occurs in the following manner:

Essentially, a foreign entity that does not pay U.S. taxes, sells purportedly high-basis, low-value debt to a U.S. entity taxed as a partnership (such as an LLC) in exchange for a payment that is a very small percentage of the face value of the debt. In turn, the U.S. entity contributes the distressed debt to other entities taxed as partnerships, interests in which are subsequently sold to tax shelter participants. The tax shelter participants then claim the full or a percentage of the face value of the distressed debt as a loss to offset income earned from other sources. (Br. Supp. Mot. Quash, Dkt. Entry 14-5, at 3-4.) (internal citations omitted)

In this matter, United States taxpayer-participants purportedly engaged in these transactions with Superior Trading, and claimed losses on their federal income tax returns aggregating approximately $39,000,000 in 2003 and $119,000,000 in 2004. (Weinger Decl., Dkt. Entry 14-2, ¶ 3.) The DAD transactions were purportedly consumer accounts receivable obtained from one or more Brazilian retailer stores. (Id. at ¶ 2.)

The IRS, in connection with its audit of Superior Trading for the tax years ending in December 31, 2003, and December 31, 2004, issued Information Document Requests ("IDRs") to Superior Trading. (Id. at ¶ 9.) The IRS made other document requests in 2006. (Id. at ¶ 10.) Superior Trading asserts that it made every effort to comply with the requests and worked amicably with the IRS. (Id. at ¶¶ 11 -14.) In 2007, the IRS allegedly sent Formal Document Requests ("FDRs") to Superior Trading.*fn5

Based on its examination thus far, the IRS believes that Gerard A. Powell may have purchased and engaged in DAD tax shelter transactions involving Superior Trading. (Id. at ¶ 17.) According to IRS Agent Larry Weinger, Mr. Powell indirectly owned 96.04% of Superior Trading for the period ending December 31, 2003, and 98% for the period ending December 31, 2004. (Id. at 16.) Losses from Superior Trading were recognized on its respective tax returns and, because Superior Trading is a pass through entity, those losses flowed through to the Mr. Powell's individual tax returns. (Id. at ¶ 16.) These loses, according to the IRS, may be disallowed for the following reasons: failure to substantiate the basis of the distressed assets; failure to make a contribution within the meaning of 26 U.S.C. § 721; abuse of subchapter K of the Internal Revenue Code; step-transaction doctrine; lack of economic substance; substance over form; and lack of profit motive. (Id. at ¶ 18.)

In order to fully examine Superior Trading's Forms 1065 Partnership Income, for the taxable period of January 1, 2003 through December 31, 2004, the IRS' Audit Team issued a summons to Mr. Powell on June 21, 2007. The IRS believes that Mr. Powell, as an investor, will have information about the receivables contributed to Superior Trading, the value of the receivables at the time of the contribution and thereafter, and the motive and business purpose for engaging in the transaction. (Id. at ¶ 19.) The summons requires him to give testimony and produce for examination books, papers, records, and other data as described in the summons. (Id. at ¶ 7.) The information sought by the IRS falls into four categories:

1) documents related to legal or tax advice with respect those transactions; 2) documents related to the anticipated tax and non-tax benefits of those transactions; 3) engagement letters, invoices, and billing records for legal, management, or tax advice; and 4) correspondence and notes of discussions regarding the entity at issue in each summons. (Weinger Decl., Dkt. Entry 14-2, ¶ 11.) Agent Weinger testified that the IRS is not in possession of the summoned information. (Id. at ¶ 10.) He also believes Mr. Powell has information about the due diligence performed by the persons and entities participating in the transactions.

B. Superior Trading's Petition to Quash

Superior Trading has petitioned this Court to quash the summons issued to Mr. Powell by the IRS. Superior Trading claims the summons at issue "is part of a nationwide harassment effort on the part of the IRS . . . ." (Pet. Quash, at ¶ 4.) In support of its petition, Superior trading has submitted the affidavits of attorneys John E. Rogers and Sweta Shah. (Rogers Aff., Dkt. Entry 21-3; Shah Aff., Dkt. Entry 21-4.)

Superior Trading claims that the IRS investigation is not conducted for a legitimate purpose. (Pet. Quash, at ¶ 23.) It alleges that the audit is a pre-litigation discovery tool and that the IRS is using its summons power to obtain records beyond the scope of discovery. (Id. at ¶¶ 24-25.) Mr. Rogers testified that Agent Weinger told him "that the auditors were being guided by district counsel who planned to litigate regardless of the results of the audit and notwithstanding whether petitioners were able to prove bad business debt through the audit." (Rogers Aff. ¶ 31.) Mr. Rogers further testified that the "transactions are entirely lawful." (Id. at ¶ 37.)

Superior Trading also alleges that the IRS actions are excessively burdensome and amount to harassment. The IRS allegedly threatened sanctions for non-compliance. (Pet. Quash, at ¶¶ 27-28.) Attorney Shah states she received a letter dated December 20, 2006, from IRS Agent Elise Gardner, which informed Attorney Shah that her response to previously requested information was incomplete and that "the Territory Manager will further review the matter to the Director of Practice for disciplinary proceedings." (Shah Aff. ¶ 4; see Ex. D, Dkt. Entry 21-8). According to the Petition to Quash, this was another attempt by the IRS, after months of harassing telephone calls and letters, and countless IDRs and FDRs, to intimidate Superior Trading. (Pet. Quash, at ¶ 29.) Attorney Shah further stated that IRS Agent Tabor told her that her "proposed response date for the IDRs was unacceptable and he would be forced to take action pursuant to 'Circular 20.'" (Shah Aff. ¶ 3.)

Superior Trading further contends that the information sought by the IRS is already in the IRS' possession.*fn6 (Pet. Quash, at ¶ 32.) Mr. Rogers' testified that: "I made myself available to discuss details of the transaction, made documents available to the IRS and, at one meeting, made petitioners' accountant, John Gabel, available to the IRS." (Rogers Aff. ¶ 28.)

In addition, the Motion to Quash asserts that the information sought by the IRS is available through standard audit procedures and that administrative steps required by the IRS have not been followed. (Pet. Quash, at ¶ 36.) Finally, Superior Trading claims the IRS summons is unconstitutional in that it deprives it of property without due process of law, violates separation of power principles, and infringes on the right to petition the government for redress of grievances in violation of the First Amendment. (Id. at ¶ 44.)

Agent Weinger disagrees with Superior Trading's contentions. He argues that the summons is issued for the valid purpose of determining the correctness of Petitioner's returns, and not for harassment or any improper purpose. (Weinger Decl. ΒΆ 23.) He also states that the investigation is not merely a tool to obtain discovery before ...

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