Ninth Circuit Upholds $8 Million Penalty Against Promoter of Timeshare Donation Scheme

(Parker Tax Publishing September 2023)

A panel of the Ninth Circuit affirmed a district court's judgment imposing over $8 million in penalties against a taxpayer for promoting a tax-avoidance scheme that involved charitable deductions claimed in connection with the donation of unwanted timeshares. The panel affirmed the district court's determination on summary judgment that the scope of the "activity" to be penalized under Code Sec. 6700(a) encompassed the taxpayer's entire timeshare donation business, and not just the funds directly coming from the false statement appraisals of the timeshares. Tarpey v. U.S., 2023 PTC 227 (9th Cir. 2023).

Background

James Tarpey, a lawyer and businessman, formed Project Philanthropy, Inc. d/b/a/ Donate for a Cause (DFC) around 2006. DFC facilitated the donation of timeshares for timeshare owners who no longer wanted to pay timeshare fees or otherwise wanted to dispose of their timeshare properties. Tarpey promised potential customers that they could receive generous tax savings from donating their unwanted timeshares to DFC. Tarpey himself appraised the value of some of the properties donated to DFC, and other properties were appraised by his sister, Suzanne Tarpey, and real property appraisers Ron Broyles and Curt Thor.

Tarpey formed DFC as a nonprofit and obtained tax-exempt status from the IRS. He touted this arrangement as "the only way to get rid of an unwanted timeshare and still make some money." He also formed a for-profit timeshare closing service called Resort Closings that handled the real estate closings for timeshares donated to DFC. DFC and Resort Closings marketed the generous tax savings that a customer could gain by donating a timeshare. When a customer decided to donate an unwanted timeshare, DFC would accept the timeshare, and open a "closing file" with Resort Closings to handle the property closing and transfer. Donors paid a donation fee to DFC plus shouldered the timeshare transfer fees. DFC accepted at least 7,600 timeshare donations during the period at issue, 2010-2013.

In a prior proceeding, the government alleged that Tarpey was operating a "bogus tax scheme" using conflicted appraisers who overstated the value of the timeshares. According to the government, Tarpey "falsely told customers that they could deduct the full appraised amount of the timeshare, conducted by DFC, and the associated processing fees." A district court entered six orders permanently enjoining Tarpey, his sister, Broyles, Thor, Resort Closings, and DFC from continuing to appraise and accept timeshare donations. The consent judgment against Tarpey permanently enjoined him from preparing property appraisals in connection with federal taxes, encouraging others to claim charitable contribution deductions on their taxes, and promoting any plan regarding charitable contribution deductions claimed on federal tax returns.

In the present action, the IRS assessed penalties under Code Sec. 6700 for Tarpey's timeshare donation business. Tarpey paid a portion of the penalties and then filed suit, alleging that he was not liable for penalties, and alternatively, the IRS's penalty calculations were inaccurate. The government countersued, moving for summary judgment on Tarpey's liability under Code Sec. 6700, and later for penalties owed. The district court addressed the issues in this case in three orders, two on summary judgment and one after a bench trial.

The district court held on summary judgment that Tarpey was liable for penalties under Code Sec. 6700. Code Sec. 6700(a) imposes a penalty on promoters and others involved in the organization or sale of tax shelters if they make false statements or exaggerate valuation. In this circumstance, to establish liability under Code Sec. 6700(a)(2)(A), the government had to show that (1) Tarpey organized or sold, or participated in the organization or sale of, an entity, plan, or arrangement; (2) Tarpey made, or caused to be made, false or fraudulent statements concerning the tax benefits to be derived from the entity, plan, or arrangement; (3) Tarpey knew or had reason to know that the statements were false or fraudulent; and (4) Tarpey's false or fraudulent statements pertained to a material matter. Tarpey challenged only the second and third elements.

Code Sec. 6700(a) provides two methods for computing penalties, depending on whether a "gross valuation overstatement" or a false statement is involved. The parties agreed that the computation method for conduct that involves false statements applied. Under this method, Code Sec. 6700(a)(2)(B) provides that the penalty equals "50 percent of the gross income derived (or to be derived) from such activity." Before the district court, the parties disputed the breadth of "activity" under the statute. Tarpey sought to limit the "activity" to appraisals he performed for DFC, limiting his penalty to income derived from those appraisals. The government argued that "the activity" encompassed the entire timeshare donation scheme.

The district court agreed with the government that the "activity" giving rise to the penalty encompassed the entire arrangement facilitated and organized by Tarpey to solicit timeshare donations, appraise the timeshares, and direct profits to his other organizations. The government's expert, Brian Dubinsky, determined that Tarpey earned $22,323,437 in gross income from the activity between 2010 and 2013. Dubinsky's calculation would result in a penalty of $11,161,718, though the government requested that the court order Tarpey to pay the original penalty assessed of $8,465,000 plus interest. The district court agreed with Dubinsky's calculation and ruled for the government.

Tarpey appealed to the Ninth Circuit, raising three issues. He challenged the district court's ruling that, as a matter of law, Broyles and Thor were disqualified as appraisers. Tarpey also contended that the district court's "cumulative definition of 'activity'" contravened the text of Code Sec. 6700(a). According to Tarpey, the appraisal portion of his business was the only activity linked to making a false statement and therefore, the penalty applied only to that part of the business. Finally, Tarpey urged that the court applied the wrong definition of "gross income" and erroneously included money held in escrow.

Analysis

A panel of the Ninth Circuit affirmed the district court's judgment. The panel upheld the district court's determination on summary judgment that Tarpey was liable for the appraisals of Broyles and Thor because, as a matter of law, Tarpey knew or had reason to know Broyles and Thor were disqualified as appraisers under Reg. Sec. 1.170A-13(c)(5)(iv) since they appraised timeshares primarily, if not exclusively, for DFC.

The panel also affirmed the district court's determination that the scope of the "activity" to be penalized under Code Sec. 6700(a) encompassed Tarpey's entire timeshare donation business. In the panel's view, it would go against the text and common sense to limit liability only to the false statements when Congress's goal was to punish abusive tax shelters. The panel noted that Code Sec. 6700 defines activity broadly to include any "plan" or "arrangement" and thus mandated that Tarpey's gross income be calculated from his organizational and sale conduct, rather than solely from the false statements he made about the activity alone.

The panel also found that the district court applied the correct definition of gross income provided in Code Sec. 61(a) and properly included money held in escrow. The panel clarified that, rather than deciding that money held in escrow could, as a matter of law, be included in the calculation of gross income, the district court more narrowly concluded that the "escrow account" here was not a true escrow account. In the panel's view, a powerful piece of evidence for including the funds as part of gross income was Tarpey's inclusions of these funds on his tax returns - a fact that the district court said demonstrated conclusively that the money in the account remained within Tarpey's control.

For a discussion of the penalty for promoting an abusive tax shelter, see Parker Tax ¶253,170.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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