Peerless Industries, Inc. v. United States

Peerless Industries, Inc. (Peerless) (plaintiff) manufactured boilers. LVC was a small, private tax-exempt educational institution. Eugene Fish was Peerless’s president and served on LVC’s board and finance committee. Inspired by a transaction between another for-profit company and another tax-exempt educational institution, Fish arranged a transaction in which Peerless issued a $20 million 50-year bond to LVC for a $23,066 purchase price (the expected present value of $20 million). Peerless retained the right to retire the bond early at a discount at any time after August 1986. For example, Peerless could retire the bond in August 1986 for $45,377. Peerless deducted $399,539 on its corporate income tax returns for 1985–1987, an amount it claimed reflected deductible accrued interest on the LVC bond. Significantly, if Peerless had retired the bond in August 1986, it would have paid LVC $22,311 ($45,377 minus $23,066) but would have received approximately $2 million ($399,539 times five years) in tax deductions. The United States (defendant) disallowed Peerless’s interest deductions and imposed a 25 percent addition to tax (i.e., penalty) of $129,771 on Peerless pursuant to Internal Revenue Code (code) § 6661 for substantially understating its tax liability. Peerless sued the United States, arguing that (1) the deductions were proper because the bond transaction had economic substance and Peerless intended to help LVC and (2) even if not, the penalty was unwarranted because there was substantial authority for the deductions within the meaning of § 6661(b)(2)(B). The United States countered that (1) the bond’s form should be disregarded in favor of its substance because it was a sham transaction and (2) Peerless did not have substantial authority for the deductions.