Court Agrees with $8.46 Million Penalty on Promoter of Time-Share Donation Scheme

(Parker Tax Publishing January 2022)

A district court upheld an $8.46 million Code Sec. 6700 penalty imposed by the IRS on a taxpayer who promoted an abusive tax shelter scheme involving a timeshare donation program in which timeshare owners could donate their unwanted timeshares in exchange for tax deductions. The court determined that the government's penalty accurately reflected the gross income the taxpayer made from his fraudulent timeshare scheme and rejected the taxpayer's objections to the way the government calculated the gross income that was subject to the penalty. Tarpey v. U.S., 2021 PTC 394 (D. Mont. 2021).

Background

James Tarpey formed Donate for a Cause (DFC) in 2006. DFC was a timeshare donation program where timeshare owners could donate their unwanted timeshares in exchange for generous tax deductions. Tarpey also operated Vacation Property Appraisers (VPA), which he used to appraise - for a cost - the donated timeshares. In addition, Tarpey founded a for-profit timeshare closing service, Resort Closings, Inc., which Tarpey used to handle the real estate closings for timeshares donated to DFC. Tarpey also operated two more entities, Charity Marketing and Timeshare Specialist, to advertise the timeshare donation program to potential donors.

In 2015, the government filed an action to enjoin Tarpey, DFC, Resort Closings, and others from engaging further in the timeshare donation program and appraisals. A district court determined that DFC used conflicted appraisers who overstated the value of the timeshares and that DFC falsely told donors they could deduct the full amount of the timeshare and the processing fees charged by DFC. The government estimated that since 2010, the timeshare donation program caused more than $19.4 million in improper tax deductions for timeshares alone. The court agreed with the government that the timeshare donation program constituted a bogus tax scheme and entered final judgments of permanent injunction against Tarpey and the entities. The IRS then assessed penalties against Tarpey under Code Sec. 6700 for promoting an abusive tax shelter. Tarpey brought a preemptive action alleging that he had not overstated the value of the timeshares and that the IRS inaccurately assessed penalties against him. In the district court, the government filed a counterclaim against Tarpey for the unpaid penalty amount and moved for summary judgment on the issue of Tarpey's liability under Code Sec. 6700.

To establish Code Sec. 6700 liability, the government had to show that (1) Tarpey organized or participated in the organization of an entity, plan, or arrangement; (2) Tarpey made false or fraudulent statements concerning the tax benefits derived from the entity, plan, or arrangement; (3) Tarpey knew or should have known that the statements were false or fraudulent; and (4) the statements pertained to a material matter. Tarpey conceded the first element and made no argument on the fourth. Concerning the second element, the court found that the overstated appraisals of the timeshares to be donated to DFC constituted false statements because Tarpey, who had prepared the appraisals himself, lacked the required independence from DFC to be considered a qualified appraiser and his inflated appraisals resulted in tax avoidance. Concerning the third element, Tarpey signed a "Declaration of Appraiser" for each appraisal that he performed. Part of these forms required Tarpey to acknowledge the treasury regulation that excluded him from serving as the appraiser. Tarpey's acknowledgment that he knew the regulations, and his repeated appraisals performed for DFC demonstrated to the court that he knew or had reason to know that his statements were false. Thus, the court concluded that Tarpey was liable for penalties under Code Sec. 6700.

Under Code Sec. 6700(a), an individual is liable for a penalty equal to 50 percent of the gross income derived from the activity when the individual organized an entity, plan, or arrangement under Code Sec. 6700(a)(1) and made false or fraudulent statements in connection with the organization of an entity, plan, or arrangement. Thus, the penalty amount was 50 percent of the gross income that Tarpey derived from the "activity" at issue. The court determined that the "activity" encompassed the entire arrangement facilitated and organized by Tarpey to solicit timeshare donations, appraise the timeshares, and direct the profits to other organizations that he controlled. The court also concluded that the income derived from DFC could be imputed to Tarpey.

The final issue before the court was the penalty amount against Tarpey. Initially, the government simply submitted the IRS Forms 4340 to support its penalty calculation. The court found that the forms provided no detail about how the government calculated the penalty and, more importantly, the numbers did not add up. The court requested that the government "present a thorough and accurate assessment of Tarpey's penalty amount, to ensure that no double-counting or errors occur." To calculate the penalty, the gross income derived from the "activity" had to be calculated, and the court determined that the activity from January 1, 2010, through December 31, 2013, represented the appropriate time period for this calculation. The government's expert, Mr. Dubinsky, determined that Tarpey earned $22,323,437 in gross income from the activity between 2010 and 2013, which resulted in a penalty of $11,161,718 under Code Sec. 6700(a). The government requested, however, that the court order Tarpey to pay a penalty of $8,465,000, plus interest. That amount represented the penalty originally requested by the government in its counterclaim.

Tarpey raised four issues with Dubinsky's calculation of gross income. First, Tarpey asserted that Dubinsky incorrectly included transactions that went through a checking account which served as an escrow account. Tarpey said that his gross income did not include money paid into the escrow account because he lacked complete dominion over it. Second, Tarpey argued that he should be allowed to capitalize expenses under Code Sec. 263A because he acted as a dealer in real property. Tarpey noted that he originally organized DFC as a tax exempt Code Sec. 501(c)(3) organization and asserted that the IRS's revocation of DFC's tax exempt statute should lead the court to consider DFC to a be a for-profit corporation dealing in real property and thus subject to the provisions of Code Secs. 263 and 61(a)(3). Third, Tarpey contended that under a signed agreement between DFC and its clients, DFC was obligated to make donations to legitimate charities through Tarpey's businesses and that such charitable donations should be deducted from the government's gross income calculation. Fourth, Tarpey claimed that his wife owned 50 percent of Timeshare Specialist, one of the entities involved in the activity, during 2013.

Analysis

The district court upheld that the government's penalty determination after finding that none of Tarpey's objections had merit.

The court found that Tarpey did not maintain a true escrow account because the checking account he used was not operated at arm's length from Tarpey since a Tarpey-owned entity, Resort Closings, Inc., operated as the escrow agent. The court said that it already determined that the "activity" giving rise to the penalty encompassed "the related for-profit entities" involved in the timeshare donation scheme which included Resort Closings, Inc. In the court's view, Tarpey exercised complete dominion over the checking account as evidenced by the commingling of funds from multiple donors and frequent bulk transfers from the account without delineating to whom the money belonged. According to the court, Tarpey's complete dominion over the account demonstrated that the account did not operate as an escrow account but served instead as another way for Tarpey to transfer income from one of his entities to another entity.

The court also rejected Tarpey's argument that he should be allowed to capitalize his expenses because he acted as a dealer in real property. The court noted that Tarpey chose to organize DFC as a Code Sec. 501(c)(3) entity and that Tarpey's malfeasance caused DFC to lose its tax exempt status. In the court's view, Tarpey never contemplated operating DFC as a dealer in real property during his time running the company. Tarpey chose to organize DFC as a nonprofit, the court noted, and his malfeasance caused DFC to lose its tax exempt status. The court observed that Tarpey was asking the court to transform that punishment into a potential benefit.

The court further rejected Tarpey's contention that he should be allowed to deduct charitable contributions after finding that, similar to his alleged escrow account, Tarpey exercised complete dominion over the money he eventually donated to charities. The court observed that the charitable donations simply represented another business expense for Tarpey to pay, and that business expenses should not be deducted from gross income for purposes of the penalty calculation. Finally, with respect to Tarpey's argument that his wife's interest in one of the entities involved in the timeshare should have been deducted from gross income, the court noted that Tarpey was bound by a judicial admission that he had sole ownership and control of all of the entities involved in the timeshare scheme.

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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