## Facts

- Two high-income investors participated in a complex foreign-currency strategy marketed as a leveraged, high-yield investment known as a Bond Linked Issue Premium Structure (BLIPS).
- Investment vehicles were formed as LLCs taxed as partnerships, with investor-controlled entities as majority partners and promoter-related entities holding minority interests and management roles.
- Each investor contributed $1.5 million, and each partnership entered into a purported $66.7 million financing arrangement with a bank, consisting of $41.7 million labeled “principal” and $25 million labeled a “loan premium.”
- The full $66.7 million was maintained in a bank-controlled collateral account and was not meaningfully available as entrepreneurial capital; the bank had contractual ability to force an early termination after roughly 60–70 days.
- The partnerships exited during the initial phase (about 60 days) and claimed substantial tax losses based on a position that partnership basis was increased by the full $66.7 million but reduced only by the “principal,” not the “premium.”
- The IRS issued final partnership administrative adjustments disallowing losses and related items, asserting the transaction lacked economic substance and challenging the basis effects and related deductions.
- In a partnership-level proceeding, the district court held the BLIPS loan lacked economic substance, treated the premium as not a liability under I.R.C. § 752, allowed certain expense deductions, found no accuracy-related penalties, and directed issuance of a refund.

## Issues

1. Whether the BLIPS financing and related steps had economic substance sufficient to be respected for federal tax purposes.
2. Whether the “loan premium” constituted a partnership liability under I.R.C. § 752 affecting partners’ bases.
3. Whether operating expense deductions connected to the partnerships’ activities were allowable after disregarding the principal transaction.
4. Whether accuracy-related penalties applied notwithstanding taxpayers’ reliance on professional advice.
5. Whether a court in a TEFRA partnership-level proceeding had jurisdiction to order the IRS to issue a refund.

## Decision

- The court held the BLIPS loan transaction lacked economic substance and was disregarded for tax purposes, eliminating the claimed tax benefits tied to the artificial basis increase and resulting losses.
- The court agreed that the “loan premium” was not a genuine liability under § 752, but treated the issue as subordinate because the underlying transaction was disregarded for lack of economic substance.
- The court vacated and remanded the allowance of certain operating expense deductions for reconsideration in light of the transaction’s disregard and unresolved questions about attribution of motives and the proper characterization of the remaining activities.
- The court affirmed that accuracy-related penalties did not apply based on good-faith reliance on professional advice and the complexity of the transaction.
- The court vacated the district court’s order requiring the IRS to issue a refund, holding the court lacked jurisdiction to grant such relief in the partnership-level TEFRA action.
- Disposition: affirmed in part, vacated in part, and remanded.

## Legal Principles

- A transaction may be disregarded for federal tax purposes when, viewed objectively, it lacks economic substance apart from its tax effects.
- Lack of economic substance is sufficient to invalidate a transaction even if the taxpayer asserts non-tax motives; the objective absence of a reasonable pre-tax profit potential is determinative on the record presented.
- When a transaction is disregarded for lack of economic substance, claimed basis adjustments and related loss-generating partnership items derived from that transaction are not recognized.
- Accuracy-related penalties may be avoided where taxpayers demonstrate reasonable cause and good faith, including reliance on competent professional advice in a complex area, evaluated at the relevant level for the proceeding.
- In TEFRA partnership-level proceedings, courts determine partnership items but generally lack jurisdiction to order the IRS to issue refunds; refund relief proceeds through separate partner-level administrative and follow-on processes.

## Conclusion

The Fifth Circuit rejected BLIPS-based loss claims by disregarding the financing as lacking economic substance, affirmed the non-imposition of accuracy-related penalties, and vacated both the allowance of certain deductions and a direct refund order, remanding for further proceedings consistent with TEFRA’s division between partnership-level determinations and partner-level remedies.


Klamath Strategic Inv. Fund v. United States, 568 F.3d 537 (5th Cir. 2009)