The opinion of the court was delivered by: Judge Joan B. Gottschall
MEMORANDUM OPINION AND ORDER
Petitioner Cemco Investors, LLC*fn1 ("Cemco") brought this action against respondent, the United States of America, seeking, pursuant to I.R.C. § 6226 (2006), judicial review of a final partnership administrative adjustment ("FPAA") issued to Cemco by the Internal Revenue Service ("IRS"). In the FPAA, the IRS determined that Cemco was a sham partnership existing as an illegal tax shelter, disallowed certain items claimed by Cemco on its year 2000 Form 1065 tax return of partnership income, and assessed several penalties against Cemco for filing an inaccurate return. In this action, Cemco challenges several of the determinations made by the IRS in the FPAA. Both Cemco and respondent have moved for summary judgment. For the reasons set forth below, Cemco's motion for summary judgment is denied and respondent's motion for summary judgment is granted.
This case centers on the tax implications of a series of business transactions that took place in December of 2000. The facts relating to these transactions, which are those material to the parties' respective summary judgment motions, are not in dispute; this case turns instead on the application and interpretation of specific portions of the Internal Revenue Code ("I.R.C.").*fn2
Three entities were involved in the underlying transactions: Cemco, Cemco Investors Trust ("CIT"), and Cemco Investment Partners ("CIP"). Cemco was a limited liability company, CIT was a grantor trust, and CIP was a general partnership. The participants in all three entities were virtually the same. During the relevant time period, both Cemco and CIP consisted of only two partners: Steven Kaplan ("Kaplan") and Forest Chartered Holdings, Ltd. ("Forest"). CIT's beneficiaries were also Kaplan and Forest, and its trustee was Paul Daugerdas ("Daugerdas"). According to respondent, Forest was basically a shell company through which Daugerdas orchestrated the tax shelter scheme at the heart of this case; Daugerdas was Forest's president and sole shareholder, and the address Forest listed as its principal place of business was Daugerdas' residence.*fn3 Forest was the designated tax matters partner of both Cemco and CIP, and the year 2000 Form 1065 tax returns of partnership income of both Cemco and CIP were prepared and signed by Daugerdas on behalf of Forest.
On December 4, 2000, CIT entered into two foreign exchange digital option transactions with Deutsche Bank ("DB"), a German-based international bank, whereby CIT simultaneously bought a digital foreign currency option for $3,600,000 (the "long" or "purchased" option) and sold a foreign digital currency option for $3,564,000 (the "short" or "sold" option). The following day, December 5, 2000, CIT assigned the offsetting option contracts to CIP. On December 18, 2000, CIP purchased 55,947.19 in euros ("€") for $50,000 through DB. CIP then terminated its and DB's rights and obligations under the option contracts by entering into a "Termination Agreement" with DB on December 19, 2000. Pet'r Statement Undisputed Material Facts ¶ 8d. On December 21, 2000, CIP was liquidated and ninety-nine percent of its property was distributed to CIT by way of a transfer from CIP's DB account to CIT's DB account. At the time of its liquidation, CIP's only assets were $45,847.27 and the €55,947.19 in euros CIP had purchased from DB. On December 26, 2000, CIT "contributed" the euros to Cemco, again by way of deposit to Cemco's DB account. Id. ¶8g. Finally, on December 29, 2000, Cemco sold the majority of the €55,947.19 in euros for $51,324.58.
Cemco filed its Form 1065 tax return of partnership income for the year ending December 31, 2000, in September of 2001. On that return, Cemco reported a loss of $3,563,211.71, which Cemco claimed was a net loss due to the disposition of nonfunctional currency under I.R.C. § 988 (2006)-the sale of the euros on December 29, 2000. According to Daugerdas, this loss is premised on the theory that the euros contributed to Cemco by CIT on December 26, 2000, had an adjusted basis of $3,614,536.29. Decl. Paul M. Daugerdas ¶ 13. Daugerdas' theory regarding the adjusted basis of the euros begins with CIP. Daugerdas asserts that CIP calculated the adjusted basis of the options assigned to it by CIT on December 5, 2000, at $3,600,000 by taking into account only the amount paid by CIT for the long, or purchased, option, and not the amount CIT received for the short, or sold, option. Id. ¶ 13a-c. According to Daugerdas, when CIP was liquidated, the adjusted basis of the long option was assigned by operation of law to the €55,947.19 in euros CIP had purchased on December 18, 2000, giving the euros an adjusted basis of $3,614,536.29.*fn4 Id. ¶ 13d. The adjusted basis was then carried forward to Cemco when CIT contributed the euros to Cemco on December 26, 2000. Id. ¶ 13e. Thus, according to Daugerdas, Cemco's sale of the euros-which had an adjusted basis of $3,614,536.29-for $51,324.58 on December 29, 2000, resulted in a loss of $3,563,211.71 to Cemco. Id. ¶ 13.
On September 21, 2004, the IRS issued the FPAA from which this case arises to Forest, Cemco's tax matters partner. In the FPAA, the IRS determined that Cemco "was a sham, lacked economic substance, or, under § 1.701-2 of the Income Tax Regulations, was formed or availed of in connection with a transaction or transactions in taxable year 2000, a principal purpose of which was to reduce substantially the present value of its partners' aggregate tax liability"-in other words, that Cemco was an illegal tax shelter and would not be regarded as a partnership for tax purposes. Decl. Paul M. Daugerdas Ex. A. The FPAA disallowed both Cemco's claimed loss of $3,563,211.71 and its claimed capital contributions of $5,144,536, reducing both partnership items to zero. The FPAA also assessed four separate accuracy-related penalties pursuant to I.R.C. § 6662 (2006): a twenty-percent penalty for negligence, a twenty-percent penalty for substantial underpayment of tax, a twenty-percent penalty for substantial valuation misstatement, and a forty-percent penalty for gross valuation misstatement. While the FPAA adjusted Cemco's year 2000 return, the IRS did not issue a similar FPAA to CIP.
On December 20, 2004, Cemco filed its petition seeking judicial review of the FPAA with this court. Cemco has since amended its petition twice with the court's permission. In its second amended petition, Cemco challenges the adjustments the FPAA made to Cemco's partnership items-i.e., the disallowance of Cemco's claimed capital contributions of $5,114,536 and the disallowance of Cemco's claimed loss of $3,563,211.71-as well as all of the accuracy-related penalties imposed by the FPAA. The portions of Cemco's second amended petition at issue in the parties' summary judgment motions are those challenging the disallowance of the $3,563,211.71 loss and the penalties for gross valuation misstatement and substantial valuation misstatement. See Second Am. Pet. ¶¶ 6b-6d.
Summary judgment is appropriate when "the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law." Fed. R. Civ. P. 56(c). As noted above, none of the facts material to either party's motion for summary judgment are in dispute; the parties agree as to the underlying events upon which the FPAA is based. The parties do disagree vehemently, however, about the tax consequences that should flow from the relevant events. Each party has moved for summary judgment on the same two aspects of Cemco's second amended petition: (1) Cemco's challenge to the FPAA's disallowance of Cemco's claimed loss of $3,563, 211.71; and (2) Cemco's challenge to the FPAA's imposition of accuracy-related penalties for substantial valuation misstatement and gross valuation misstatement. The court considers the parties' arguments with respect to each portion of Cemco's second amended petition in turn.
A. Cemco's Claimed Loss of $3,563,211.71
Before the court considers the parties' disagreements regarding Cemco's claimed loss, it is important to highlight one point upon which they agree: the loss of $3,563,211.71 claimed on Cemco's year 2000 return was fictional. Of course, Cemco did not actually suffer a loss of $3,563,211.71 when it sold the euros because the euros were purchased for only $50,000 (by CIP) and the adjusted basis assigned to them by CIP (and carried forward to Cemco) did not take into account that CIT received $3,564,000 from the sale of the digital foreign currency option at the same time CIT purchased it. Cemco's argument for overturning the FPAA is not that it truly suffered a loss of $3,563,211.71, but that it was required to report such a loss because CIP determined that the euros had an adjusted basis of $3,614,536.29. At the outset, however, the court notes that it is undisputed that CIP's determination of the adjusted basis of the euros was premised on an outdated interpretation of I.R.C. § 752 (2006), the section dealing with the treatment of liabilities by partners and partnerships.
Until recently, the law respecting whether an option contract should be treated as a liability under section 752 actually supported CIP's position. In Helmer v. Commissioner, 34 T.C.M. (CCH) 727 (1975), the Tax Court held that a contingent obligation, such as a short or sold option, is not a liability under section 752 because a partnership's obligation under the option does not become fixed ...