Full opinion text
AMENDED [CORRECTED] FINDINGS OF FACT AND CONCLUSIONS OF LAW SAYLOR, District Judge. This is a dispute concerning two complex tax shelter transactions. The plaintiffs in these consolidated actions are Fidelity International Currency Advisor A Fund, LLC and Fidelity High Tech Advisor A Fund, LLC. The tax matters partner, and the principal taxpayer who invested in and benefltted from the tax shelter transactions at issue, was Richard J. Egan. Richard Egan was one of the founders of EMC Corporation and the former ambassador to Ireland. He entered into the tax shelter transactions to avoid large tax liabilities on the sale of EMC stock and the exercise of non-qualifled stock options. Together with his wife, Maureen, Richard Egan claimed a tax loss of $158.6 million in 2001, a further tax loss of $1.7 million in 2002, and capital losses of $167.1 million in 2002 as a result of their participation in the tax shelter transactions. The IRS disallowed the tax treatment claimed by the Egans and issued Final Partnership Administrative Adjustments adjusting various partnership items and assessing accuracy-based tax penalties, This litigation followed. The case was tried before the Court over 44 trial days beginning in late 2008. The Court also received more than 3,700 exhibits, and heard extensive testimony from multiple expert witnesses. For the reasons set forth below, the Court con-eludes that the partnership item adjustments made by the IRS are correct, and accordingly will enter judgment for the United States. The Court also finds that various accuracy-related penalties are applicable. TABLE OF CONTENTS I.INTRODUCTION..........................................................65 A. Summary of Facts....................................................65 B. Summary of Legal Conclusions.........................................67 II.NATURE OF PROCEEDINGS..........................:...................69 III.FINDINGS OF FACT......................................................70 A. Jurisdictional Facts...................................................70 1. Fidelity High Tech...............................................70 2. Fidelity International.............................................71 B. EMC, the Egans, and Related Parties...................................72 1. EMC and Richard Egan..........................................72 2. The Egan Family................................................72 3. Carruth Management and Subsidiaries..............................73 4. Burke, Warren Law Firm.........................................74 C. The Tax Promoters and their Associates.................................74 1. The Diversified Group Incorporated................................74 2. Helios Financial LLC.............................................74 3. KPMG, LLP ....................................................74 4. Alpha Consultants, LLC..........................'................75 5. Samuel Mahoney.................................................75 6. Refco Capital Markets Limited ....................................75 7. Proskauer Rose, LLP ............................................75 8. Sidley Austin Brown & Wood, LLP.................................75 9. RSM MeGladrey, Inc...................'...........................75 D. The Egans’ Tax Problems..............................................75 1. Low-Basis EMC Stock...........................................75 2. Non-Qualified Stock Options ......................................76 E. The Delegation of Authority for Tax Affairs to Michael Egan and Carruth...........................................................76 F. Early Discussions Concerning Tax Shelters..............................77 G. The “Short Option Strategy”...........................................79 H. The May 2000 Meetings ...............................................80 1. The May 15, 2000 Meetings in New York............................80 2. The May 19, 2000 Meeting in Chicago...............................83 3. Denby’s Comparison of the Tax Strategies — May 2000 ................84 4. The May 25, 2000 Meeting in Massachusetts.........................85 I. Further Developments in July 2000 .....................................86 1. The July 10-13, 2000 Meetings in Chicago...........................86 2. The July 18, 2000 Meeting with Helios in Chicago....................88 3. Carruth’s Due Diligence Concerning the Promoters...................89 J. Formation of Fidelity Entities in July 2000...............................90 1. Fidelity High Tech Transaction Entities ............................90 2. Fidelity International Transaction Entities..........................90 K. Carruth Prepares to Implement the Strategies ...........................91 1. Denby’s Fax of July 20, 2000 ......................................91 2. Further Discussions in July 2000 ...................................91 3. The August 2, 2000 Meeting in Boston..............................92 L. IRS Notice 2000^44 and Its Aftermath ..................................92 1. The Issuance of IRS Notice 2000-44 ................................92 2. The Reaction to IRS Notice 2000-44................................93 3. The August 23, 2000 Conference Call...............................95 4. The Initial Draft Legal Opinions for Fidelity High Tech...............96 M. Carruth Resumes Implementation of the Capital Gains Strategy............97 1. The September 5, 2000 Memorandum...............................97 2. The Parties Begin Implementation of the High Tech Transaction......98 3. The Withdrawal of HSBC as the Counterparty.......................98 4. The Selection of Refco as the Substitute Counterparty................99 5. The First Registration of EMC Shares..............................99 6. Carruth Puts the Fidelity High Tech Transaction on Hold............100 7. The Year-End Transfer of Maureen Egan’s Fidelity High Tech Interest......................................................100 N. Resumption of the High Tech Transaction in January 2001 ................101 1. The January 23, 2001 Tax Analysis by Shea ........................101 2. The January 24, 2001 Memorandum from Shea......................101 3. The Initial Draft Legal Opinion Letter from Proskauer..............102 4. The January 29, 2001 Memorandum by Shea........................102 5. The Decision to Allocate 99% of the High Tech Transaction to Maureen Egan................................................103 6. Planning for Tax Reporting of the High Tech Transaction............103 7. The Second Registration of EMC Shares...........................104 O. Implementation of the Fidelity High Tech Transaction....................104 1. Index A and Option A Enter into Option Trades.....................104 2. The Possibility of a One-Option Payout............................105 3. The Capitalization of Fidelity High Tech...........................106 4. The Purported Increase in Basis..................................106 5. The Receipt of McData Stock Dividend ............................107 6. The Cover/Termination of NASDAQ 100 Options....................107 P. “Stuffing” of Additional Low-Basis Stock into Fidelity High Tech..........109 1. “Stuffing” Activities in May and June 2001 .........................110 2. Additional “Stuffing” in Late 2001 .................................Ill Q. The Change of Structure of the Fidelity High Tech Transaction............112 1. The Original Final Step of the Transaction.........................112 2. The October 31,2001 Tilevitz “Stock Dribble” Memorandum..........113 3. The Initial Proposal to Use a Subchapter S Corporation..............113 4. The Change to a Partnership.....................................114 5. The Transfer of Maureen Egan’s Interest to an LLP and Section 754 Elections.................................................114 6. Discussions at Year-End 2001 Concerning Sale of Stock..............116 7. The Sale of Stock Held by Fidelity High Tech in 2002................116 R. The Egans Continue to Explore an Ordinary Loss Strategy...............117 1. Exercise of Options...............................■...............117 2. The Search for Ordinary Income Strategies ........................118 S. The Design and Development of the FDIS Strategy......................120 1. DGI’s “2001 Partnership Strategy Memorandum”...................120 2. Further Development of the “Financial Derivatives Investment Strategy”....................................................120 3. The Foreign Partners — Mahoney and Hawkes......................121 4. The Model Opinion for FDIS Strategy.............................122 5. The 2001 FDIS Transactions .....................................122 T. KPMG and Helios Pitch the FDIS Strategy to the Egans.................123 1. The September 2001 KPMG PowerPoint Presentations...............123 2. Further Discussions and the “Outline of Proposed Transaction”.....124 3. The Decision to Adopt the FDIS Strategy..........................124 U. Implementation of the Fidelity International Transaction .................125 1. Step One: Creation of Entities....................................125 2. Step Two: Fidelity World Enters Into Interest Rate Options.........125 3. Step Three: Capitalization of Fidelity International .................126 a. The Contribution of Fidelity World............................126 b. The Purported Increase in Basis..............................127 c. Other Capital Contributions ..................................127 4. Step Four: Fidelity International Enters Into Foreign Currency Options......................................................128 a. The Terms of the Foreign Currency Options....................128 b. The Structure of the Foreign Currency Option Pairs.............129 c. The Possibility of a One-Option Payout........................130 d. Targeting of Gains...........................................131 5. Step Five: Termination of Gain Legs and Entering Into Replacement Legs ............................................131 6. Step Six: Buyout of Foreign “Partner” ............................134 7. Step Seven: Close Out of Interest Rate Options.....................134 8. Step Eight: Termination of Remaining Foreign Currency Options.....135 9. The Stockton and Mariner Investments............................136 10. The Actual Economic Loss From the Termination of the Foreign Currency Options.............................................136 V. Documentation of the Purported “Business Purpose” of the Fidelity International Transactions..........................................137 1. The October 5, 2001 Buesinger Memorandum.......................137 2. The Proposed David Henry Memorandum..........................138 3. “Business Purpose” Discussions in October-Deeember 2001 ..........138 4. Proposed Discussions with Samuel Mahoney........................139 5. The December 18,2001 Shea Memorandum.........................139 6. The March 12, 2001 Speiss Memorandum...........................140 W. The Proskauer and Sidley Austin Opinion Letters........................141 1. The Proskauer Legal Opinion for the High Tech Transaction.........141 2. The Sidley Austin Legal Opinion for the Fidelity International Transaction..................................................143 3. Payment of the Legal Fees of Proskauer and Sidley Austin...........146 X. Costs and Fees for the Transactions....................................147 1. Costs and Fees on the Fidelity High Tech Transaction...............147 a. Helios and KPMG Fees......................................147 b. Refeo Fees.................................................148 c. Other Fees.................................................149 2. Costs and Fees on the Fidelity International Transaction.............149 a. Helios and KPMG Fees......................................149 b. Refeo Fees.................................................149 e. Other Fees.................................................150 Y. The KPMG Engagement Letters ......................................150 1. KPMG Engagement Letter Policy for the Short Option Strategy.....150 2. The Initial Negotiations Concerning a High Tech Engagement Letter.......................................................151 3. The Proposed Modifications to the High Tech Engagement Letter.....151 4. The Fidelity International Engagement Letter......................152 5. The Egans’ Concerns about Appearing on a “List”...................153 6. Renewed Discussions Concerning the High Tech Engagement Letter.......................................................153 Z. The Preparation and Filing of the Egans’ 2001 Tax Returns...............155 1. The Partnership Tax Returns (Forms 1065) ........................155 2. The Individual Income Tax Return (Form 1040).....................155 3. The Impact of the New IRS Regulations in June 2002................156 4. The Proskauer Non-Disclosure Letter.............................157 5. KPMG’s Refusal to Sign the Egans’ 2001 Tax Return................159 AA. The Preparation and Filing of the Egans’ 2002 Tax Returns...............163 BB. The Tax Consequences of the Fidelity High Tech Transaction Claimed by the Egans......................................................163 1. The Egans’ Claimed Tax Basis in Their Partnership Interests in Fidelity High Tech............................................163 2. Fidelity High Tech’s Claimed Tax Basis in Stock Contributed by Egans.......................................................164 CC. The Reporting of the Fidelity High Tech Transaction on Partnership Returns (Form 1065)...............................................165 1. Form 1065 for the Short Tax Year Ending December 21, 2001.....165 2. Form 1065 for the Short Tax Year Ending December 31, 2001.....166 3. Form 1065 for the Tax Year Ending December 31, 2002..............166 a. Reporting of Claimed Losses .................................166 b. Other Required Explanations and Disclosures...................167 DD. Reporting of the Fidelity High Tech Transaction on the Egans’ 2002 Individual Return (Form 1040) ......................................167 EE. The Tax Consequences of the Fidelity International Transaction Claimed by the Egans..............................................168 1. Richard Egan’s Claimed Basis in His Partnership Interest in Fidelity International..........................................168 2. The Claimed Allocation of $163 Million Gain to Mahoney.............169 3. The Claimed Allocation of $163 Million Loss to Richard Egan.........169 4. The Capitalization of Fees........................................170 5. The Reallocation of Fees to Richard Egan..........................171 FF. The Reporting of the Fidelity International Transaction on the 2001 Partnership Return (Form 1065).....................................171 1. The Netting of Gains and Losses..................................171 2. The Reporting of the Loss as “Other Income”........................171 3. The Treatment of the Currency Option “Loss” as a Section 988 Loss.........................................................172 4. The Failure to File a Form 4797 ..................................172 5. The Failure to Report the Net Loss as a “Trade or Business” Loss.........................................................173 6. The False Entries on Schedules L and M-2.........................173 a. The Purpose of Schedule L...................................173 b. The 2001 Fidelity International Schedule L.....................173 (1) “Investment in Fidelity World” of $150,304,982 ..............174 (2) Investment in “Foreign Exchange Options” of $134,832,153...........................................174 (3) The Effect of the False Reporting on Schedule L.............175 7. The Purpose of Schedule M-2 ....................................175 8. The 2001 Fidelity International .Schedule M-2 ......................176 9. The Effect of the False Schedule M-2 on the Schedule K-l...........176 10. The Ultimate Effect of the False Schedules L and M-2 ..............177 11. The Failure to Disclose the Transaction Otherwise ..................177 a. Schedule K-l, Line 25.......................................177 b. Form 8275 .................................................177 c. Schedule K-l, Line G........................................178 GG. The Reporting of the Fidelity International Transaction on the 2002 Partnership Return (Form 1065).....................................178 1. The Reporting of the Capital Loss as an Ordinary Loss..............178 a. The Purported “Section 988 Loss”.............................178 b. The Failure to Report the Loss on Schedule D..................178 c. The Resulting Tax Benefit....................................179 d. A Capital Loss..............................................179 2. The Use of the Accrual Method of Accounting ......................179 3. The False Statements on Schedules L and M-2 and on Richard Egan’s Schedule K-l..........................................180 HH. The Reporting Of The Fidelity International Transaction on the Egans’ 2001 1040 Return..................................................181 1. The Reporting of the “Loss” as a “White-Paper Netting-Transaction” .................................................181 2. The Reporting of the “Loss” under “Miscellaneous Income’...........182 a. The Reporting on Statement 1................................182 b. The Reporting of the “Loss” on Schedule E.....................183 3. The Reporting of the Options Income as “Other Income”.............183 II. The Reporting of the Fidelity International Transaction on the Egans’ 2002 1040 Return..................................................183 1. The Reporting of the Claimed Loss................................183 2. The Resulting Tax Benefits.......................................184 JJ. The Egans Sought to Conceal the Transactions from the IRS..............184 1. Denby’s Discussions with Reiss in April 2000 .......................184 2. Denby’s May 2000 Analysis.......................................185 3. Discussions in July 2000 .........................................185 4. Discussions of Increased Risk after Notice 2000-44..................185 5. Later Discussions Concerning Reporting and Audit Risk.............186 KK. From a Subjective Standpoint, the Transactions Had No Business Purpose..........................................................187 LL. From an Objective Standpoint, the Transactions Had No Economic Substance ........................................................187 1. Reasonable Hedging or Risk-Shifting Function.....................188 2. Reasonable Possibility of Profit...................................188 MM. The Fidelity High Tech Transaction Lacked Economic Substance..........188 1. The Transaction Served No Reasonable Hedging Function...........188 a. The NASDAQ 100 Option Transactions Were Not a Rational Economic Hedge..........................................188 b. Various Components of the Transaction Served No Hedging Function.................................................189 2. There Was No Reasonable Possibility of Profit on the Fidelity High Tech Transaction.........................................190 a. The Costs and Fees for the Transaction Were Extremely High.....................................................190 b. The Expected Return on the Transaction Was Materially Negative.................................................191 c. The Net Present Value of the Options Was Materially Negative.................................................192 d. The One-Option Payout Was Not a Real Possibility..............192 e. The Options Were Not in Fact Profitable.......................192 NN. The Fidelity International Transaction Lacked Economic Substance........192 1. The Transaction Served No Reasonable Hedging Function...........192 a. The Interest Rate and Currency Option Transactions Were Not Rational Economic Hedges.............................192 (1) The Interest Rate Options ................................193 (2) The Currency Options....................................194 b. Various Components of the Transaction Served No Hedging Function.................................................195 2. There Was No Reasonable Possibility of Profit on the Fidelity International Transaction......................................195 a. The Capital Structure Was Not Rational .......................195 b. The Costs and Fees for the Transaction Were Extremely High.....................................................196 c. The Expected Rate of Return of the Transaction Was Materially Negative .......................................196 (1) The Expected Return Before Fees.........................197 (2) The Expected Return on the Transaction Was Materially Negative..............................................199 d. The One-Option Payout Was Not a Real Possibility..............200 e. The Court Does Not Credit the Conclusion of Plaintiffs Expert...................................................201 f. The Fidelity International Transaction Was Intended to be Profitless.................................................201 OO. Mahoney Was Not a Real Partner in Fidelity International................202 1. Mahoney Participated in 47 Identical Transactions in 2001............202 2. Mahoney’s Capital Contributions Were Treated as Costs of the Promoters ...................................................203 3. Any Value of the Remaining Interests of Mahoney Was Split Among the Promoters.........................................204 4. Mahoney Was Reimbursed for His Expenses and Paid a Fee for His Participation..............................................204 5. Mahoney Could Not Realize a Profit on the FDIS Transactions, Absent Fees..................................................204 PP. Fidelity High Tech Was a Sham Partnership for Federal Income Tax Purposes .........................................................206 QQ. Fidelity International was a Sham Partnership for Federal Income Tax Purposes .........................................................206 RR. The Step Transaction Doctrine Applies to Collapse Steps of the Fidelity High Tech Transaction......................................206 1. The Steps of the Fidelity High Tech Transaction Should Be Collapsed under the “Interdependence” Test .....................206 a. None of the Individual Steps Had an Independent Business Purpose..................................................206 b. Certain Intermediate Steps Had No Business Purpose...........207 (1) There Was No Business Purpose to the Formation and Use of the Index A and Option A to Acquire the Options...............................................207 (2) There Was No Business Purpose to the Transfer of Maureen Egan’s Interest to MEE Holdings...............207 2. The Steps of the Fidelity High Tech Transaction Should Be Collapsed Under the “Component” Test..........................208 SS. The Step Transaction Doctrine Applies to Collapse Steps of the Fidelity International Transaction ...................................208 1. The Steps of the Fidelity International Transaction Should Be Collapsed Under the “Interdependence” Test.....................208 a. None of the Individual Steps Had an Independent Business Purpose..................................................208 b. Certain Intermediate Steps Had No Business Purpose...........209 (1) There Was No Non-Tax Business Purpose for the Use of Fidelity World to Purchase the Options...................209 (2) None of the Other Intermediate Steps of the Transaction, Standing Alone, Had Any Independent Business Purpose ..............................................209 2. The Steps of the Fidelity International Transaction Should Be Collapsed Under the “Component” Test...........................210 TT. The Fidelity High Tech and Fidelity International Paired Options Were, Economically, Single Positions........... 210 1. The Parties Treated the Option Pairs as a Single Position............210 2. Separating the Paired Options Would Have Required Huge Amounts of Collateral or Margin................................211 UU. The Egans Did Not Receive Independent Legal Advice from Proskauer and Sidley Austin..................................................212 1. Proskauer and Sidley Austin Did Not Provide Independent Legal Advice.......................................................212 2. The Egans Knew That the Legal Advice from Proskauer and Sidley Austin Was Not Independent.............................213 W. The Proskauer Opinion for Fidelity High Tech Was Based on Unreasonable Factual Assumptions ..................................213 1. The Opinion Contained False and Misleading Factual Assumptions..................................................214 a. Investor Representation No. 1 Was False ......................214 b. Investor Representation No. 2 Was False ......................214 c. Investor Representation No. 3 Was False ......................215 d. Investor Representation No. 10 Was False or Misleading.........215 e. The Date of the Original Contribution of EMC Stock Was False....................................................216 2. The Opinion Omitted Essential Facts..............................216 3. Proskauer Knew That the Opinion Contained False and Misleading Factual Assumptions and Omitted Critical Facts.....216 4. Richard Egan Did Not Read the Certificate of Facts or the Proskauer Opinion Letter......................................217 WW. The Sidley Austin Opinion for Fidelity International Was Based on Unreasonable Factual Assumptions..................................217 1. The Opinion Contained False and Misleading Factual Assumptions..................................................217 a. Investor Representation No. 1 Was False ......................217 b. Investor Representation No. 2 Was False ......................218 c. Investor Representation No. 3 Was False ......................218 d. Investor Representation No. 9 Was False or Misleading..........218 2. The Opinion Omitted Essential Facts..............................219 3. Sidley Austin Knew That the Opinion Contained False and Misleading Factual Assumptions and Omitted Critical Facts.....219 4. Richard Egan Did Not Read the Investor Representation Letter.....220 XX. Both the Proskauer Opinion Letter and the Sidley Austin Opinion Letter Were Based on Unreasonable Legal Assumptions................220 YY. The Egans Did Not Reasonably Rely on Any Other Professional Advisors for Tax Advice............................................223 1. The Egans Did Not Reasonably Rely on the Tax Advice of KPMG.....223 2. The Egans Did Not Reasonably Rely on the Tax Advice of RSM McGladrey...................................................224 3. The Egans Did Not Reasonably Rely on the Tax Advice of Stephanie Denby..............................................224 IV. CONCLUSIONS OF LAW..................................................224 A. Jurisdiction and Nature of Proceeding..................................224 B. The Economic Substance Doctrine.....................................225 1. The Doctrine Generally..........................................225 2. The Doctrine in the First Circuit..................................228 3. The Objective Inquiry...........................................231 4. The Subjective Inquiry ..........................................232 C. The Treatment of Sham Partnerships ..................................233 D. The Step Transaction Doctrine........................................233 1. The “Interdependence” Test......................................234 2. The “End Result” Test ..........................................234 E. The Partnership Anti-Abuse Rules — Treasury Regulation § 1.701-2 .......234 F. Recharacterization of Transactions Based on Substance Rather than Form ............................................................235 G. Section 165(c).......................................................235 H. Accuracy-Related Penalties...........................................236 1. Gross Valuation Misstatement Penalty.............................237 2. Substantial Valuation Misstatement Penalty........................239 3. Substantial Understatement Penalty...............................239 a. “Substantial Authority”......................................240 b. “Adequately Disclosed” and “Reasonable Basis”.................240 c. Limitation on Relief for Tax Shelter Transactions ............... 241 4. Negligence or Disregard of Rules Penalty..........................241 5. Defense to Penalties.........................................'____242 V. SUMMARY FACTUAL CONCLUSIONS ....................................243 A. Fidelity High Tech...................................................243 B. Fidelity International ................................................244 C. Penalty Issues.......................................................244 D. Other Issues........................................................246 VI. CONCLUSION............................................................246 I. INTRODUCTION A. Summary of Facts Richard J. Egan was one of the founders of EMC Corporation, a large, publicly-traded manufacturer of computer storage devices. By the year 2000, Richard Egan and his wife Maureen had amassed enormous personal wealth, the great majority of which was in the form of EMC stock. The Egans were highly sophisticated taxpayers; Richard Egan was one of the most successful businessmen in the history of the United States. His personal and family financial affairs, including the management of his wealth and the payment of his taxes, occupied an entire organization of twenty or so employees, which included his three sons, at least two certified public accountants, and a variety of other business and financial specialists. Richard and Maureen Egan expressly delegated power over their tax affairs to their son Michael, and explicitly and implicitly delegated authority for those matters throughout the family organization. With the Egans’ wealth and income came potentially large tax liabilities. As of 2000, the Egans beneficially owned approximately 25 million shares of EMC stock. At its peak in September 2000, EMC shares traded at more than $100 per share. Because the Egans’ basis in those shares was extremely small — approximately two cents per share — the sale of any substantial portion of that stock would have produced huge capital gains, subject to a long-term capital gains tax at a rate of 20%. In addition, the Egans owned non-qualified options to purchase more than 8 million shares of EMC stock at very low strike prices. The exercise of those options would generate large amounts of ordinary income, subject to taxes at a marginal rate that approached 40%. In early 2000, Richard Egan and his son Michael became interested in investing in tax shelters to avoid taxes on the capital gains and ordinary income that was likely to result from the sale of EMC stock and the exercise of the options. With the assistance of an attorney from Chicago named Stephanie Denby, the Egans interviewed several tax shelter promoters in May 2000. They eventually selected the large international accounting firm KPMG. Through KPMG, the Egans were introduced to a small firm called Helios, which (with a related company called Diversified Group International, or DGI) had designed a highly complex tax shelter transaction that it was marketing to wealthy individuals. The original tax shelter scheme involved the contribution of both paired offsetting options (in large notional amounts) and appreciated assets (such as EMC stock) to an entity taxed as a partnership. In simplified terms, the promoters claimed that the purchased option was an asset, but that the sold option was not a liability; the taxpayer thus supposedly contributed assets to the partnership entity, but not liabilities, creating a grossly inflated basis in his interest in the entity. The taxpayer’s interest would then be sold, and the taxpayer would claim that the inflated basis (from the contribution of the options) “eliminated” any gain from the disposition of the stock or other assets. Variations of the scheme were designed to create artificial losses to offset ordinary income. A significant feature of the scheme was the fact that four major law firms — including Proskauer Rose and Brown & Wood, eventually Sidley Austin Brown & Wood— had been recruited by the promoters to provide favorable opinion letters. The taxpayers were told in advance that they could choose one of the four firms for their favorable opinion. The opinion letters were in essence intended to serve as insurance against tax penalties should the IRS ever discover the transactions, and thus to induce investors to invest in the tax shelters. By early August 2000, the Egans were on the brink of engaging in a transaction with KPMG and DGI/Helios that was designed to eliminate up to $200 million in capital gains by artificially inflating basis, and were considering a follow-up transaction designed to create up to $200 million in artificial losses to offset ordinary income. In August 2000, the IRS issued Notice 2000-44. That notice directly attacked the types of tax shelter schemes that the Egans were about to enter into, and stated that the IRS would not recognize transactions of the type described in the Notice. In the wake of Notice 2000^44, the promoters and their law firms concluded that it was too risky to proceed with the ordinary income portion of the scheme in its present form. The promoters and the Egans nonetheless pressed forward with the capital gains strategy, with a transaction designed to create $160 million in artificial basis. The strategy involved an orchestrated series of steps that were principally conducted through Fidelity High Tech Advisor A Fund, LLC. The essential steps of the transaction, other than the sale of the stock, were completed by early 2001. Unfortunately for the Egans, however, the price of EMC stock declined, to the point where they had created a purported “basis” of $160 million without sufficient offsetting assets to take advantage of it. The Egans accordingly decided to “stuff’ additional low-basis stock into Fidelity High Tech in an effort to use the artificial basis they had created. In the meantime, the Egans continued to speak with the promoters about a possible tax shelter strategy for ordinary income from the exercise of the options. By early 2001, the promoters had devised a new variation of the strategy that they called the “Financial Derivatives ■ Investment Strategy,” or FDIS. The FDIS strategy, among other things, generated paper “losses” for taxpayers by assigning any offsetting “gains” offshore — to one of two Irish confederates of the tax promoters (neither of whom, of course, filed U.S. tax returns). The Egans exercised their stock options at various points in 2001, resulting in a gain of $162.9 million. By early October 2001, the Egans had decided to use the FDIS strategy to shelter that income from taxes. Like the prior transaction, the strategy involved an orchestrated series of steps, this time through Fidelity International Currency Advisor A Fund, LLC. The various steps of the transaction were completed by the end of 2001. The IRS, however, continued its efforts to crack down on tax shelters. In June 2002 — before the Egans had filed their individual tax return for the year 2001— the IRS adopted a temporary regulation that required the filing of a disclosure statement if a taxpayer had participated in certain tax shelter transactions. KPMG, which was preparing the Egans’ return, concluded that such a disclosure statement was required with the Egans’ return. Rather than make the disclosure, however, the Egans fired KPMG and hired an accountant at another law firm — who was also a confederate of the promoters — to sign them return. Around the same time, and as promised by the promoters, the Egans received opinion letters from Proskauer Rose (as to the Fidelity High Tech transaction) and Sidley Austin (as to the Fidelity International transaction) purporting to opine that it was “more likely than not” that the proposed tax treatment would be upheld. The Egans also received a separate letter from Proskauer Rose opining that the disclosure insisted upon by KPMG was not required. The Fidelity International transaction resulted in the creation of artificial “losses” of $158.6 million in 2001, which the Egans used to offset the ordinary income of $162.9 million from the option exercise on their 2001 income tax return that year. The disclosure statement that was prepared by KPMG, and never filed, stated that “expected reduction in federal income tax liability” from the Fidelity International transaction was $65.5 million. The Egans also claimed a loss of $1.7 million from Fidelity International on them 2002 tax return. The Egans sold all of the stock in Fidelity High Tech in 2002, for $76.2 million in proceeds. The real basis for that stock was $8.7 million; the inflated claimed basis was more than $163 million. Instead of reporting a capital gain of $67.4 million from the sale of that stock for 2002, the Egans reported a huge loss. The IRS eventually learned of the scheme, and disallowed the treatment of the transaction on the various partnership returns on multiple grounds. B. Summary of Legal Conclusions In substance, plaintiffs Fidelity High Tech and Fidelity International seek to overturn the various adjustments made by the IRS to items on the partnership tax returns. The principal argument advanced by the government in response is premised on the economic substance doctrine, sometimes referred to as the sham transaction doctrine. A fundamental principle of tax law is that transactions without economic substance, or sham transactions, will not be recognized. The precise contours of the economic substance doctrine have not been set, and vary from circuit to circuit. Nonetheless, it is clear that courts are required to consider the substance of a transaction, rather than its mere form, in considering the tax effect to be given to it. In making that determination, courts normally are required to consider two aspects of a transaction: the subjective purpose of the taxpayer (that is, whether the taxpayer actually had a non-tax business purpose for entering into the transaction) and the objective purpose of the transaction (that is, whether the transaction, objectively viewed, had a reasonable possibility of profit or other business benefit). Here, the Egans claim that the principal purpose of the transactions, viewed objectively, was to serve as a hedge: to mitigate the risk of a decline in the price of EMC stock (in the case of the Fidelity High Tech transaction) or to mitigate the risk of fluctuating interest rates or foreign currency values (in the case of the Fidelity International transaction). From an objective standpoint, however, the transactions were entirely irrational; they were unnecessarily and extravagantly expensive, and did not hedge the purported risks effectively (or at all). The Egans also appear to claim that the transactions were entered into for profit. If so, they were also irrational for that purpose; the transactions were designed and intended to lose money, and in fact did so. The objective features of the transactions were irrational because, of course, the Egans subjectively had no actual business purpose for entering into them. None of the participants in these complex transactions believed that they were real business transactions, with any purpose other than tax avoidance. Indeed, it is highly doubtful that any participant believed, even for a minute, that the transactions would withstand legal scrutiny if discovered. No one with the slightest understanding of the tax laws could reasonably believe that $160 million in basis could be created out of thin air, or that $160 million in income could be made to vanish in a puff of smoke. In accordance with that belief, the Egans and their ad-visors went to great lengths to try to ensure that the IRS would never find out about the transactions — including, among other things, the filing of partnership and individual tax returns with multiple false and misleading entries. The Egans contend that their subjective intentions are irrelevant. In substance, they contend that as long as the transactions were not fictitious — that is, as long-as the entities existed, the money was transferred, and the options were purchased and sold — the economic substance doctrine does not apply. But the transactions at issue were “real” only in the sense that a performance by actors on stage is “real.” The actors are real human beings, and the stage sets are made of real wood and real paint. But the actors are reading from a script. No one watching “Macbeth” believes that they are witnessing the murder of a Scottish king, and the actors do not believe it either, Here, too, the participants were simply following a script — a script that had little or no connection to any underlying business or economic reality. ' The Egans also make a number of technical arguments, all of which assume that the transactions were real and should be respected. The linchpin of the scheme from a technical standpoint was a potential anomaly in the tax code: under a line of cases interpreting Section 752, a purchased option is an asset, but a sold option is only a contingent liability. The Egans thus take the position that a taxpayer can purchase offsetting options and contribute them to a partnership entity, and thereby contribute an asset but not a liability. From there, it is but a few steps to use the “asset” to inflate the basis of the partner’s interest in the entity. If the tax system depended entirely on form over substance, the argument might well pass muster. But tax liabilities are not so easy to dodge. It would be absurd to consider offsetting options — purchased and sold at the same time, and with the same counter-parties — as separate items, and to act as if the one item existed and the other did not. That is particularly true where (as here) the individual option positions were gigantic, and might bankrupt the taxpayer or the options dealer if no offset were in place. The Egans also point to the longstanding principle that it is perfectly legitimate to arrange one’s affairs so as to pay as low a tax bill as possible. That assertion is trae, as far as it goes, It is entirely appropriate, for example, for a taxpayer to decide to buy a house rather than to rent, in order to take advantage of the many tax advantages of home ownership. A taxpayer may buy a house with a mortgage in order to take advantage of the deductibility of mortgage interest. But a taxpayer cannot undertake phony or meaningless transactions and claim a tax advantage; he cannot, for example, lend money to himself, pay “interest” on the loan, and claim the interest deduction. If the tax laws permitted such a result, they would be nonsensical, and anyone who paid taxes would be a fool. The tax laws are neither so simple nor so easily evaded. Finally, the Egans claim that they relied in good faith on formal legal opinions issued by Proskauer Rose and Sidley Austin, two highly prominent law firms. It is true that both firms issued opinions to the Egans. And it is true that both firms opined that it was more likely than not that their tax treatment of the transactions would be upheld. But those opinions, too, were just additional acts of stagecraft. The lawyers were not in the slightest rendering independent advice; the promoters of the tax shelters had arranged favorable opinions from those firms well in advance, and as part of their marketing strategy. Indeed, the promoters (not the Egans) paid the law firms’ fees. More fundamentally, the opinions were themselves fraudulent: they were premised on purported “facts” that the Egans and the law firms knew were false, and reached conclusions that everyone involved knew could not possibly be correct. The opinions had but one purpose: to serve as a form of insurance against the imposition of penalties if the transactions were ever to come to light. The claim of good faith reliance on counsel is thus wholly without merit. The Egans knew that the opinion letters were simply part of the tax shelter scheme, and did not for a moment believe that they were receiving independent legal advice after a full disclosure of all underlying facts. In short, the Fidelity High Tech and Fidelity International transactions were complete shams, without any economic substance of any kind. For that reason, and for the other reasons set forth below, the transactions should not be recognized, and the adjustments made by the IRS will be upheld. II. NATURE OF PROCEEDINGS These consolidated cases were brought by Richard J. Egan pursuant to 26 U.S.C. § 6226 to challenge adjustments made by the Internal Revenue Service to tax returns filed by Fidelity High Tech Advisor A Fund, LLC and Fidelity International Currency Advisor A Fund, LLC for their 2001 and 2002 tax years. Richard Egan brought the matters in his capacity as tax matters partner and notice partner of both entities. See 26 U.S.C. § 6226(a). The IRS’s adjustments were set forth in various notices of Final Partnership Administrative Adjustment (“FPAAs”), issued in 2005 and 2006. Plaintiffs calculated the taxes due by reason of those adjustments and made deposits of those amounts with the IRS. Plaintiffs then filed these actions to obtain a refund of the deposits. Fidelity High Tech and Fidelity International are limited liability companies (“LLCs”). As LLCs, they are treated as partnerships for federal income tax purposes. See Treas. Reg. § 301.7701-2(a). Partnerships are “flow-through” entities and are not subject to an entity-level tax, although they must file annual informational returns (Forms 1065) reporting various items. 26 U.S.C. §§ 701, 6031(a). Tax liability on a partnership’s income is calculated and imposed at the partner level. Accordingly, Fidelity High Tech and Fidelity International did not pay federal income tax on their income; instead, they allocated their income among their partners. This Court has jurisdiction to determine all partnership items of Fidelity High Tech and Fidelity International that were raised in the FPAAs. See 26 U.S.C. §§ 6221 and 6226(f). Unlike other judicial tax proceedings, such a decision does not determine the amount of tax owed by a taxpayer or the amount of any refund of tax due to a taxpayer. Instead, the determination of partnership items in a case such as this is in the nature of a declaratory judgment. This proceeding determines the nature or amount of partnership items, and those determinations are then applied uniformly in subsequent, separate, partner-level proceedings to determine each partner’s separate tax liability. 26 U.S.C. § 6231(a)(5), (6). Although this proceeding generally addresses partnership-level items, not partner-level matters, it does not mean that the treatment of the two transactions on the Egans’ individual tax returns is irrelevant. To the contrary, the goal of the entire enterprise was to minimize the tax liability of Richard and Maureen Egan, and the tax shelter scheme included the making of false entries on the Egans’ individual tax returns in order to minimize the risk of audit and detection. The tax returns of the Egans are therefore discussed at some length in this opinion, although no adjustments to those individual returns are made in this proceeding. In summary, and for the reasons stated below, the Court will uphold the administrative adjustments made by the IRS as to the nature of the partnerships and the relevant transactions. Among other things, the Court concludes that (1) the Fidelity High Tech and Fidelity International transactions lacked economic substance; (2) that Fidelity High Tech and Fidelity International were sham partnerships, and should be disregarded for federal income tax purposes; (3) that Samuel Mahoney, the Irish citizen who was a purported “partner” in Fidelity International, was not in fact a true partner; and (4) that the offsetting options pairs should be treated as a single position for federal income tax purposes. The Court also finds that various accuracy-related penalties, including the 40% gross valuation misstatement penalty, are applicable. See 26 U.S.C. § 6662(f). For the sake of convenience, the Court will use the following terms, unless the context indicates otherwise: “Fidelity High Tech” means Fidelity High Tech Advisor A Fund, LLC, “Fidelity International” means Fidelity International Currency Advisor A Fund, LLC. “The Egans” means Richard and Maureen Egan and their son Michael, when acting on their behalf under a power of attorney or otherwise as their agent or representative. III. FINDINGS OF FACT A. Jurisdictional Facts 1. Fidelity High Tech 1. Fidelity High Tech Advisor A Fund, LLC (“Fidelity High Tech”) timely filed its U.S. Return of Partnership Income (Form 1065) with the IRS for its December 21, tax year by mailing it on April 15, 2002. (Id.). 2. Fidelity High Tech timely filed its tax return with the IRS for its December 31, tax year by mailing it on April 15, 2003. (Id.). 3. At the time he filed these actions, Richard Egan was the Tax Matters Partner (“TMP”) of Fidelity High Tech for its 2001 and 2002 tax years. (Ex. 108). 4. Richard Egan was the authorized and proper party to bring the Fidelity High Tech cases under section 6226(a). (Id.). 5. As a notice partner of Fidelity High Tech, Richard Egan was the authorized and proper party to bring the Fidelity High Tech cases under section 6226(b). (Id.). 6. On October 11, 2006, the IRS sent a Notice of Beginning of Administrative Proceeding (“NBAP”) to the TMP of Fidelity High Tech with respect to its December 31, 2002 tax year. (Id.). I. On October 13, 2006, the IRS mailed a Notice of Final Partnership Administrative Adjustment (“FPAA”) to the TMP of Fidelity High Tech with respect to its December 21, 2001 tax return. (Id.). 8. On October 13, 2006, the IRS mailed an FPAA to the TMP of Fidelity High Tech with respect to its December 31, 2002 tax return. (Id.). 9. On November 13, 2006, Richard Egan timely filed a complaint with respect to Fidelity High Tech’s December 21, 2001 tax year pursuant to section 6226. (Id.). 10. On November 13, 2006, Richard Egan timely filed a complaint with respect to Fidelity High Tech’s December 31, 2002 tax year pursuant to section 6226. (Id.). II. Prior to filing the complaint in the Fidelity High Tech cases, Richard Egan deposited $13.6 million with the IRS. (Id.). 12.At the time the complaints in the Fidelity High Tech cases were filed, Fidelity High Tech’s principal place of business was located in Westborough, Massachusetts. (Id.). 2. Fidelity International 13. Fidelity International Currency Advisor A Fund, LLC (“Fidelity International”) timely filed its tax return with the IRS for its 2001 tax year by mailing it on April 15, 2002. (Id.). 14. Fidelity International timely filed its tax return with the IRS for its 2002 tax year by mailing it on April 15,2003. (Id.). 15. Richard Egan was the TMP of Fidelity International for the 2001 and 2002 tax years. (Id.). 16. In his capacity as both the TMP and a notice partner of Fidelity International, Richard Egan was the authorized and proper party to bring the Fidelity International cases under section 6226(a) and (b). (Id.). 17. On April 6, 2005, the IRS mailed an FPAA with respect to Fidelity International’s 2001 tax return to the TMP ofFICAAFund. (Id.). 18. On September 1, 2005, Richard Egan timely filed a complaint with respect to Fidelity International’s 2001 tax year. (Id.). 19. On April 26, 2006, the IRS mailed an FPAA to the TMP of Fidelity International with respect to its 2002 tax return. (Ex. 265). 20. On June 30, 2006, Richard Egan timely filed a complaint with respect to Fidelity International’s 2002 tax year. (Ex. 108). 21. Prior to filing the complaints in the Fidelity International cases, Richard Egan deposited $62,600,000 with the IRS ($62,100,000 for its 2001 tax year and $500,000 for its 2002 tax year). (Id.). 22. At the times that the complaints in the Fidelity International cases were filed, Fidelity International’s principal place of business was located in West-borough, Massachusetts. (Id.). 23. Richard J. Egan died on August 28, 2009. (Docket # 513). 24. Michael J. Egan and John R. Egan, as co-executors of the estate of Richard J. Egan, have been substituted as plaintiffs for Richard J. Egan. (Docket # 513). B. EMC, the Egans, and Related Parties 1. EMC and Richard Egan 25. EMC Corporation is a large, publicly-traded corporation headquartered in Hopkinton, Massachusetts. It develops and sells, among other things, data storage and retrieval technology and products. In 2000, it had revenues of more than $8.8 billion and more than 24,000 employees. (Ex. 108; Ex. 788). 26. Richard Egan co-founded EMC in 1979. (Ex. 108). 27. Richard Egan held the position of Chief Executive Officer from the founding of EMC until 1992. (R. Egan, 1:111-12). 28. Richard Egan was the Chairman of the Board of Directors of EMC from January 1988 until January 17, 2001, when he was named Chairman E merit us. (Ex. 108). 29. Richard Egan resigned as Chairman E merit us of EMC on September 10, 2001. (Id.). 30. Richard Egan served as the U.S. Ambassador to Ireland from September 10, 2001, until January 31, 2003. (Id.). 31. EMC had its initial public stock offering, and became a publicly-traded company, in 1986. (R. Egan, 1:110, Exs. 108, 788). 32. Prior to EMC’s first public offering, Richard Egan owned approximately 70% of the stock of EMC. (R. Egan, 1:110). All, or almost all, of the EMC stock that the Egan family owned at the beginning of 2000 was unregistered founders stock. (Id. at 2:13; Denby, 28:42). 33. The number of EMC shares held by Richard Egan grew over time due to multiple stock splits. (R. Egan, 2:29-30). 34. As of September 7, 2001, Richard and Maureen Egan beneficially owned approximately 25 million shares of EMC stock. (Ex. 108). As of January 1, 2001, Richard and Maureen Egan also owned fully-vested options to purchase 8,320,000 shares of EMC stock at relatively low strike prices. (Ex. 1414). 35. Richard and Maureen Egan were subject to various restrictions on the sale of their stock, including SEC rules and EMC policies that restricted stock trades to certain windows of time. (Exs. 21, 22, 326). 36. On August 28, 2009, after the trial of this matter, Richard Egan died. (Docket # 507). 2. The Egan Family 37. Richard and Maureen Egan were married, (R. Egan, 1:107-08). 38. The Egans had three sons, Michael, John (also known as “Jack”) and Christopher, and two daughters, all of whom were adults at the relevant times. (Id. at 1:108). 39. Richard Egan was a resident of Massachusetts. (Id. at 1:107). 40. During the relevant years, Maureen Egan claimed residency in Florida, although the couple was not legally separated. (Id. at 1:108; M. Egan, 5:47). 41. Maureen Egan was a director of EMC from March 1993 until she resigned effective January 17, 2001. (Ex. 108). 3. Carruth Management and Subsidiaries 42. The appreciation in the price of EMC stock in the 1990’s rapidly increased the Egan family’s wealth. (R. Egan, 2:28; M. Egan, 5:36, 44). 43. In the early 1990’s, Richard Egan formed a “family office” to manage his wealth, make investments, and handle personal administrative matters. (Ex. 108; R. Egan, 2:26-30). 44. Michael Egan, who previously had worked at EMC, began working full-time at the family office in approximately 1992. (M. Egan, 5:29, 36). Jack Egan and Christopher Egan also began working for the family office in the 1990’s. (Id. at 5:78-79). 45. In the 1990’s, the Egan family office began to operate under the name Carruth Management. (Id. at 5:26). 46. Carruth Management LLC was formed in Delaware in 1997. (Ex. 120). It is located in Westborough, Massachusetts. (M. Egan, 5:26). Carruth is owned in equal parts by Michael, Jack, and Christopher Egan. (Exs. 120,108). 47. Michael Egan is the Chief Executive Officer of Carruth Management. During the relevant time, he had general authority to invest and manage Egan family assets. (R. Egan, 2:31, 39, 50). 48. In 2000-2001, the Egan family’s investments consisted principally of the following asset classes: EMC stock and options; commercial real estate; publicly-traded stocks and other securities; and private equity investments. (Exs. 73,120, 201). 49. Christopher Egan largely handled real estate investments for Carruth, and Jack Egan largely handled venture capital and private equity investments. (M. Egan, 5:78-79; Ex. 120). 50. Carruth Partners is a wholly owned subsidiary of Carruth Management. (M. Egan, 5:79). Carruth Partners was used to control the commercial real estate that the Egans owned. (Id.; Ex. 120). 51. Carruth Associates LLC was formed in Delaware in 2000, and is a wholly-owned subsidiary of Carruth Management. (Ex. 120). 52. During the period from 2001 to 2003, Carruth Associates had approximately twenty employees. (Reiss, 26:119). 53. The following persons were employees of Carruth Associates during the relevant time: (a) James Reiss was the Chief Financial Officer of Carruth Associates. (Id. at 26:112; Ex. 120). He has been a certified public accountant since 1989. (Reiss, 26:114). He joined the Egan family office in 1996. (Id. at 26:117). (b) Patrick Shea was the Chief Operating Officer of Carruth Associates. (Shea, 14:91; Ex. 120). He has been a certified public accountant since 1981. (Shea, 14:91). He joined Carruth on June 26, 2000. (Id. at 14:91, 15:128). Among other things, Shea was the supervisor of the tax and accounting group at Carruth. (Id. at 14:92). (c) Melissa Seaver was the Senior Tax Manager of Carruth Associates. She joined Carruth in July 2001. (Seaver, 25:116, 120). She has been a certified public accountant since 1999. (Id. at 25:119). (d) Carolyn Fiddy was the Manager of Investments at Carruth Associates until March 2002. (Calkins, 35:27-28). (e) Robin Calkins was an Investment Assistant at Carruth Associates in 2000. In March 2002, when Fiddy left Carruth, Calkins became Manager of Investments. (Id.; Ex. 120). (f) David Henry was the Director of Investments at Carruth Associates. He joined Carruth in March 2001. (Henry, 4:106; Ex. 120). 54. In the period from 2001 to 2003, Carruth was generally responsible for preparing and reviewing tax returns for Richard and Maureen Egan and various Egan family entities. (Seaver, 25:120-23). 55. Carruth also relied on outside accountants and advisors for tax advice and preparation of tax returns. (Seaver, 25:125; M. Egan, 5:67). 4. Burke, Warren Law Firm 56. The law firm of Burke, Warren, MacKay & Serritella, P.C. is located in Chicago, Illinois. 57. Stephanie Denby was a partner of Burke, Warren. (Denby, 28:8-9). Richard and Maureen Egan became clients of Denby in 1994, when she was hired by Michael Egan to assist them with estate planning. (Id. at 28:10-11; R. Egan, 2:54). C. The Tax Promoters and their Associates 1.The Diversified Group Incorporated 58. The Diversified Group Incorporated (“DGI”) was a self-described “boutique merchant banking firm” based in New York that, among other things, designed and marketed tax shelter products. (Ex. 811). 59. James Haber was the President of DGI. (Id.). 60. Orrin Tilevitz was Vice-President and General Counsel of DGI. (Id.). 61. Mox Tan was a Managing Director of DGI based in Chicago. (Id.). 62. Philip L. Kampf, Jr., was a Managing Director of DGI based in Chicago. (Id.). 2. Helios Financial LLC 63. Helios Financial, LLC was also a self-described “boutique merchant banking firm” based in Chicago. (Ex. 28). Helios ha