Shleifer Case Highlights Tax Trap for the Unwary

Receiving notice that you are being audited by the IRS is stressful, but losing an IRS audit that you should have won is far worse. That’s what happened to the Shleifers. They made procedural errors in their refund claim and subsequent audit that later prevented them from asserting a valid argument in court. The mistake – they failed to comply with an esoteric tax rule known as the variance doctrine.

In tax law, the variance doctrine (also known as the substantial variance doctrine) is a judicially created rule that limits a taxpayer’s ability to raise new legal or factual grounds in a tax refund lawsuit that were not clearly stated in the original refund claim filed with the IRS. The doctrine’s stated purpose is to give the IRS a fair opportunity to consider and resolve a taxpayer’s claim administratively before litigation.

Mr. Shleifer travelled often for business in his role as a partner in an investment firm. Rather than take commercial airfare, which would have been reimbursed by his firm, Mr. Shleifer formed a single-member LLC to acquire a $19.6 million fractional interest in a private jet. Mr. Shleifer used the jet for work-related travel, and he did not operate the jet to earn a profit from third parties.

Mr. Shleifer filed a joint tax return with his wife in 2014, and on that return, the Shleifers claimed a $2.6 million deduction on their return for unreimbursed travel expenses relating to the expenses of operating the private jet. About three years later, before the expiration of the statute of limitations for the 2014 tax return, the Shleifers filed an amended tax return claiming a refund of $1.9 million, claiming they “inadvertently neglected” to deduct $5.9 million of depreciation on the jet. The Shleifers claimed the depreciation deduction on Schedule C dealing with profit and loss from a business of the amended tax return, stating the “business” of operating the jet incurred a loss.

On audit, the IRS disallowed the Shleifers’ refund claim. As part of that audit, the Shleifers’ accountant spoke to the IRS revenue agent and orally explained that the deduction should have been claimed on Schedule E of the tax return (as an unreimbursed partnership expense), instead of Schedule C as a trade or business expense, but that the amount of the deduction would have been the same either way. The IRS agent noted the conversation in his Examining Officer’s Activity Record and acknowledged that the deduction might have been valid if it had been claimed on Schedule E. Importantly, though, neither the Shleifers nor their accountant submitted anything to the IRS agent on this point in writing.

The Shleifers filed a refund lawsuit in the U.S. District Court for the Southern District of Florida and moved for summary judgment. The summary judgment motion was predicated on the notion that the facts were not in dispute and the law clearly permitted the depreciation deduction. The government responded with its own motion for summary judgment, arguing that the deduction was properly disallowed, and that even if it was a permissible deduction on Schedule E, the variance doctrine precludes the court from considering the argument.

On June 9, 2025, the District Court issued a decision on the motions in favor of the government. It ruled that the deduction was not a Schedule C deduction because the LLC was not engaged in a trade or business, and that the variance doctrine prevented the Shleifers from arguing it was a proper Schedule E deduction.

The court first agreed with the government that the depreciation deduction would have been valid on Schedule C only if the jet was used in the conduct of a trade or business. The court noted that the parties agreed the jet was not used in the conduct of a trade or business, meaning that the primary purpose of using the jet was not to generate income. The LLC that owned the jet did not offer to lease it to third parties and did not pay wages or other operating costs (except depreciation).

With regard to a deduction on Schedule E for unreimbursed partnership expenses, the court refused to consider the Shleifers’ argument that the deduction would have been proper on that form. The court explained that the “variance doctrine is one of fairness” and that its purpose is to “afford the IRS an opportunity to consider and dispose of a claim without the time and expense of litigation.” The court also relied on Reg. §301.6402-2(b)(1), which states that a taxpayer –

[M]ust set forth in detail each ground upon which a credit or refund is claimed and facts sufficient to apprise the [IRS] of the exact basis thereof. The statement of the grounds and facts must be verified by a written declaration that it is made under the penalties of perjury. A claim which does not comply with this paragraph will not be considered for any purpose as a claim for refund or credit.

The court noted that the Shleifers’ amended tax return included only a statement that they “inadvertently neglected to claim a depreciation deduction for a business asset purchased and placed in service in 2014.” The fact that the Shleifers included a Schedule E on their original return, and did not propose to deduct the depreciation on Schedule E in the amended return, “would have diverted the agent’s attention from the possibility of seeking a deduction through the Schedule E since [they] explicitly included other unreimbursed partnership expenses but excluded the private jet’s depreciation.” Because the amended return did not provide the IRS with the facts necessary to address and dispose of the claim, the court held it did not have jurisdiction to consider the matter. The court therefore did “not reach the question as to whether [the Shleifers] are entitled to a deduction as an unreimbursed partnership expense.”

A harsh result – yes. The Shleifers’ accountant told the IRS agent orally that the deduction should have been filed on Schedule E, and the IRS agent even acknowledged as much in his official notes. At that point, one could argue the IRS had all the facts it needed to properly consider and dispose of the claim; in fact, the Shleifers argued that their refund suit “is for the same tax year, the same asset, involves the same depreciation calculation, and most crucially, results in the exact same overpayment as described in [their] 2014 Form 1040-X.” However, a counterargument is that the Shleifers did not verify their Schedule E deduction “by a written declaration” that was “made under the penalties of perjury.” The regulations make that a requirement for any claim for refund or credit.

The result in this case is hard to swallow because the Shleifers could have claimed a deduction for unreimbursed partnership expenses on Schedule E. The court noted, however, that their entitlement to such a deduction would have required them to bring forward additional proof, such as whether the partnership agreement required Mr. Shleifer to pay certain expenses out of his own funds. In other words, this is not simply a case of a taxpayer using the wrong form; in order to substantiate the claim, the IRS agent would have had to examine Mr. Shleifer’s investment firm, his role in the firm, and the firm’s policies regarding partnership expenses and reimbursements for travel. By not including the deduction on Schedule E, the Shleifers denied the IRS a full and fair opportunity to audit the claim administratively and to resolve the dispute without litigation.

The takeaway here is to assert all arguments, and include all facts relevant to such arguments, on the face of any claim for refund or credit. As the court stated, “mere notice is insufficient to evade preclusion by the variance doctrine,” and the taxpayer has the burden to provide the IRS with “more than a good lead” and to substantiate the claim for the refund sought.

The Shleifer case also highlights the importance of retaining a qualified tax advisor to file your tax returns and to represent you before the IRS.