Summary Opinions for week ending 02/27/15

Before the roundup, a quick thank you to our guest posters from the week ending February 27th.  Michael Desmond joined us once again, posting on the likelihood of legislative responses to the court’s stopping regulation of paid preparers.  We also welcomed Marilyn Ames as a first time poster, writing about the binding effect of an OIC.

To the procedure from that week:

  • The Service issued Rev. Proc. 2015-16, which provides updated guidance on adequate disclosure for reducing accuracy related penalties and the tax return preparer penalties under Section 6694(a).  The Revenue Procedure appears to be very similar to the prior guidance found in Rev. Proc. 2014-15, and reincorporates some examples from the guidance in 2013, which the Service decided it should not have removed.
  • The facts of a substantial valuation misstatement penalty case in Na v. Commissioner, which the taxpayer won, are fairly interesting.  In Na, the Service used the bank deposit method to recreate a taxpayer’s income.  Prior to the year in question, the taxpayer did not have much annual income and never gambled.  The taxpayer also spoke little English.  During the audited year, the taxpayer had income and deposits of over a $1M in gambling earnings, plus substantial distributions from her employer’s companies.  She explained that her employer used her personal accounts to run distributions from his companies and his gambling activity through.  The Court found her evidence and testimony credible, and greatly reduced her liability.  The Court did not address the specifics of the substantial valuation penalty, and instead said that was for the parties to review and calculate following the order.  Anyone want to give odds on the chances of seeing a TC case in the employer’s name in the near future?
  • The Service issued Rev. Proc. 2015-20, providing updated guidance for small businesses tying to comply with the final tangible personal property regulations issued in 2013 regarding capitalization of costs regarding TPP.  The Service has also promulgated some FAQs on the topic.  There has been a lot of consternation regarding whether or not these will require all businesses to request a change in accounting method and file Form 3115.  For some small businesses, the Form will not be required.
  • From the legal gossip blog, Above the Law, comes a glowing recommendation for the TV show Better Call Saul, stating that it is a far more accurate representation of the practice of law than most other legal shows.  I’ve watched the first few episodes, and am completely hooked.  In full disclosure, I was a huge fan of Breaking Bad, and this is a spin off.  Not particularly representative of my life though.  I had far less anguish over hush money and the persuasive power of violence.
  • The Tax Court held that state law applied in determining what the successor in interest was for an entity that transferred assets to a related taxpayer.  See TFT Galveston Port. LTD v. Comm’r.
  • IRS scams on the front page of CNN.
  •  Last August, we touched on FDIC v. AmFin in SumOp, which was based on a dispute over ownership of a refund issued to the parent of a consolidated group.  SCOTUS didn’t find the issue that interesting, and denied cert.
  • Do banks get title insurance before foreclosing on properties?  The District Court for the Southern District of Indiana in First Financial Bank v. US Dept. of Treas. tossed an action for quiet title filed by the bank where a subsequent title search turned up a tax lien after a deed in lieu of foreclosure.  The Court found that the Service met its burden under Section 7425 in that it had a valid lien, which was recorded at least thirty days prior to the sale, and the Service wasn’t given notice of the sale.
  • In the saga that is the Aloe Vera unlawful disclosure case, Aloe Vera won a significant (although not monetarily) victory last month.  The District Court for the District of Arizona found the IRS wrongfully disclosed to the Japanese taxing authority confidential return information, which was actually found to be false and the Service knew the same at the time of disclosure.  Unfortunately, for Aloe Vera, no actual damages were found, so the statutory damages were the extent of the recovery.

What Type of Fruit is a Polar Bear? Petaluma and Interpretive Choice

Today’s guest post is a return to the blog for Professor Andy Grewal of the University of Iowa College of Law who continues his discussion of novel issues raised in Petaluma FX Partners v. United States, a case on appeal in the DC Circuit Court of Appeals. Les

Two weeks ago,in TEFRA Jurisdiction and Sham Partnerships-Again? I wrote about how the Supreme Court’s resolution of the jurisdictional issue in United States v. Woods might not have resolved the jurisdictional issue in Petaluma. Today, I want to discuss the merits issue and show how the Court’s opinion also leaves that issue open.


In Woods, the Court held that the Section 6662 gross valuation misstatement penalty applies when a partnership is disregarded under the economic substance doctrine and a partner’s outside basis is consequently reduced to zero. In so holding, the Court focused on whether the reduction of the basis was “attributable to” a valuation misstatement, as required to trigger the penalty.   But the Court noted my argument (see pages 20-21 of my brief) that Treas. Reg. 1.6662-5(g), which extends the gross valuation misstatement penalty to zero basis circumstances, may be invalid. The taxpayer, however, chose not to embrace that argument, so the Court said it would assume the validity of the regulation for purposes of deciding the case.

In Petaluma, the taxpayer makes the argument that the Woods taxpayers did not. Petaluma squarely argues that the gross valuation misstatement penalty applies only when a taxpayer’s claimed basis is “400 percent or more” of the true basis, and the percent by which its claimed basis (about $25M) exceeds its true basis ($0) is undefined. Consequently, the statutory condition is not satisfied (“undefined” does not mean “400 percent or more”), and the Treasury regulation that simply treats zero basis circumstances as satisfying that standard is invalid.

Believe it or not, circuit precedent about “division by zero” actually supports the taxpayer’s position. See Lee’s Summit v. Surface Transp. Bd., 231 F. 3d 39, 41–42. But I’d like to skip the doctrinal analysis and address a more fundamental issue:   When does a statute give rise to ambiguity such that an agency’s interpretation merits deference?

To understand that issue, one must draw a distinction between nonsensical questions and ambiguous ones. Consider this question, for example:

What type of fruit is a polar bear?

This question is nonsensical. A polar bear is an animal, and it makes no sense to classify it as any type of fruit.

But this question is not ambiguous. There are no interpretive choices between, for example, classifying a polar bear as a banana as opposed to a peach. And if Congress passed a statute taxing the sales of bananas and peaches, a Treasury regulation that treated a polar bear as either one would be invalid.

Petaluma, of course, does not involve questions about Arctic beasts. Rather, the merits question asks:

Is the claimed $25M basis 400 percent or more of the true $0 basis?

Maybe it’s harder to see than in the question about polar bears and fruits, but this question makes no sense and consequently leaves no room for Treasury rulemaking authority. To determine what percent one number is of another number, one must divide the first number by the second number. So, for example, 5 is 500 percent of 1, because 5/1=5.00, and 12 is 300 percent of 4, because 12/4 = 3.00. But in Petaluma, one must divide by zero ($25M/0) to apply the statutory formula, and that makes no sense. You can explain to someone what it means to divide a pizza into ten pieces, but how do you explain what it means to divide a pizza into zero pieces?

When a statute, as applied to a particular set of factual circumstances, makes no sense, an administrative agency does not enjoy the authority to re-write the statute to reach those circumstances. The Treasury can no more fit zero-basis circumstances into the valuation misstatement penalty regime than can it classify a polar bear as a fruit.

Too often, though, courts ignore this commonsense principle. Rather than ask whether a statute suffers from some ambiguity, a court will blandly acknowledge confusion over a statutory regime and approve of an agency’s rulemaking authority to address that confusion.

It would be far better for courts to focus on whether the relevant statutory language yields some interpretive choice for the agency. That is, an administrative agency enjoys authority to fill gaps within the statutes that it oversees, but it cannot re-write them to reach its preferred policy result.

Going back to Petaluma,readers should watch how the D.C. Circuit addresses the scope of the Treasury’s rulemaking authority. When it comes to administrative law matters, the D.C. Circuit stands in the shadow of only the Supreme Court, and the hypertechnical nature of the court’s inquiry should not hide the fundamental nature of the issues it will address.

Summary Opinions for 02/14/2014

In honor of Presidents’ Day (yesterday), here is a copy of the NYT’s front page the day Vice President Agnew admitted to tax fraud.  Also, a special thanks to Jamie Andree for her Valentine’s Day Innocent Spouse post.  Good stuff this week.  Updates on the IDR process, Ty Warner, and the King of Pop.  Also some new summons cases,  NPR commentary, and the depressing Treasury budget.

  • Oh, and Keith is featured in the newest edition of the Tax Lawyer, with his article, Taxation with Representation: The Creation and Development of Low-Income Taxpayer Clinics.  TaxProfBlog has coverage.
  • The new IDR process for large cases, which Keith has discussed before here, has been delayed.  Initially, the procedures were to be effective January 2, 2014, but have now been pushed out until March 3, 2014 to allow LB&I to clarify how they work.  The news release can be found here.
  • The DOJ has filed a protective appeal in the Ty Warner case relating to the sentencing of the Beanie Baby mogul. Jack Townsend’s Federal Tax Crimes Blog has a post with more details and some quotes found here.  Readers will probably recall that Mr. Warner only received probation for his substantial tax evasion.  The protective appeal does not mean the DOJ will proceed with the appeal, but is simply a notice protecting its rights while it makes a decision.  Mr. Townsend indicates in his post that although the sentence seemed light, the DOJ would likely have an uphill battle to overturn the Judge.
  • The Tax Times has a post regarding the new federal budget, and the 4.4% cut in the IRS budget for the year.  It will be interesting to see what the IRS automates this year (link is to my post last week on the increased use of automated services, and the reduced ability to get advice from a person at the Service).   USA Today had a related article about the poor customer service by the Service.
  • From the MauledAgain blog on February 14, James Maule wrote about income inequality in light of the debate about how terrible things are for the much maligned ultra-rich (except Ty Warner, who should be ecstatic about probation).   Related, here is an article about Larry Summers and the Downton Abbey economy.
  • NPR Investments, LLC –which I’m fairly certain is how Nova, The Street, and Downton Abbey get all their scratch — lost again against the Service, with the Fifth Circuit upholding the District Court’s imposition of penalties, and which found the Service acted properly in issuing a second FPAA a few months after issuing a no-change letter for the same tax year. The Miller and Chevalier blog has coverage, and a copy of the opinion here. The M&C blog did not find the FPAA item as interesting as I did, but I will still cover it in a bit of detail.  In general, Section 6223(f) provides that only one FPAA should be issued for any given year.  Taxpayer success!?!?  But, there is a provision that allows the Service to issue a second when the taxpayer is a real jerk (“absence a showing of fraud, malfeasance, or misrepresentation of a material fact”).  The Fifth Circuit found that checking the box indicating the entity was not a TEFRA partnership on its return was sufficient to meet that jerk standard.  I believe this is the only Circuit Court to have reviewed this matter.  Interestingly, reliance by the Service and the intent of the taxpayer were not particularly important in the analysis.
  • Some of this has to be sensationalized, right?  The Journal of All that is Correct and Respectable, TMZ,  is covering the tax troubles of Michael Jackson’s Estate, which apparently took the position that MJ’s net worth at death was around $7MM.  The Service, however, thought that amount was slightly closer to $1.125BB.  What a Thriller.  Dollar here, dollar there, and it starts to add up.  The Service told the estate to Beat It and doubled the penalty due to the Bad numbers under Section 6662(h)(1).  Apparently, the Service is seeking $702MM, which is enough to make you Scream.  These matters are never Black or White, and the amount will probably end up in the middle, but the estate’s position seems Dangerous and borderline (Smooth) Criminal. It is Human Nature to want to reduce your tax bill…I should stop, this is getting pretty silly.
  • A few summons orders were issued.  First, an order quashing an attempt to block the IRS from seeking information from banks in the United States that was done by the Service to assist the Competent Authority for India in investigating the taxpayer in India.  The taxpayer argued an improper purpose, but the Court found the Service statements that the competent authority request was valid was sufficient to carry the Service’s slight burden.  SCOTUS will be hearing an improper purpose case in Clarke shortly (covered in SumOp before), where it will determine if a taxpayer is entitled to a hearing after alleging improper purpose.  We will be following Clarke closely.
  • The second summons case involved a tax attorney trying to quash a summons based on confidentiality, but the case was dismissed because of procedural defects.  In Patel v. United States, decided in March of 2013, the Southern District of Florida dismissed the motion to quash because the filing party (a third party) was not entitled to file a motion to quash, which is reserved for only the taxpayer under Section 7609.

Summary Opinions for 12/20/2013

Happy Holidays!!  And, sorry for the lack of posts over the last week or two. This will likely be the last post until the week of December 30.  We will be taking a brief respite to enjoy family time and the holidays (Keith is a new grandpa; Les is a newlywed—Congrats Les!!!), but will be back in full force in 2014.  Until then, there are a few procedure items below.  Have a happy and safe new year!

  • Jack Townsend has been prolific over the last week on both his Federal Tax Procedure Blog and his Federal Tax Crimes Blog.  It is all worthwhile, but one item I found very interesting was his write up on his Federal Tax Crimes Blog on the Clarke case.  The post is regarding the government filing a cert petition with SCOTUS, which we had previously indicated was coming.  Jack’s post has the entire 11th Circuit holding, which is somewhat counter to other circuits’ view of the issue, and portion of the filings, including the questions presented.  It comes down to whether a taxpayer is entitled to an evidentiary hearing on a summons if the taxpayer alleges improper purpose.  In Clarke, the taxpayer alleged that summons was only being issued to extend the statute of limitations.  Jack also includes large portions of his book to explain the issue, which is very useful; Saltz Book hits the circuit split in the issue in the update coming out in the next month.  Great write up, and a case that we will be watching.
  • Earlier this week I wrote about a client of mine who was the target of an IRS scam.  Wandering Tax Pro this week posted a very similar story here.
  • The Supreme Court has denied cert in Stocker v. United States, where the taxpayer has requested SCOTUS review the Sixth Circuit’s jurisdictional dismissal of a refund suit based on the taxpayer’s failure to show he filed amended returns within the three year period under Section 6511(a).  In declining to review the case, SCOTUS failed to address a circuit split on taxpayers using methods other than those under the statute to establish presumption of delivery.  The underlying issue is interesting here, but so is the fact that the 6th Circuit referred to Section 6511(a) as jurisdictional.  The trend over the last few years in non tax areas and some tax deadlines (including the look back period under 6511) has been to hold that many statutory time limits are not jurisdictional.  A few weeks ago, SCOTUS declined to review Boeri; the underlying Court of Appeals for the Federal Circuit decision can be found here.  Boeri applied to Section 6511(b), and clearly states this is not jurisdictional, relying on SCOTUS language. I will hopefully have more on Boeri soon. Regarding the evidence rule, the Sixth Circuit held that Section 7502 provided the sole exceptions to the physical delivery rule, and it would not look at additional evidence.  The Tax Court and various other Circuit Courts have allowed other evidence to show the document was timely mailed.  Had the Sixth Circuit determined Section 6511 was not jurisdictional, the taxpayer may have had an easier time making equitable arguments regarding the evidence and the treatment of its mailing.
  • TaxProfBlog has a summary of an article written by Calvin Johnson, which argues that for the reasonable cause exception to penalties, taxpayers should not be able to rely on the opinions of their own accountants or lawyers due to the inherent conflict in the practitioner desiring to retain the business.  We have lamented the attack on advisor reliance as a defense here at Procedurally Taxing, but this article approaches the matter in different way.  This is somewhat an extension of the promoter rationale for disallowing the defense.  I understand the position, but think it would be unrealistic for most taxpayers to go to those lengths.  Perhaps over the holiday, I will read the entire article and see if this is addressed.
  • The Service has released PMTA 2013-15, which has a good question and answer summary of various potential late filing scenarios with partnerships and S-corps, and what, if any, penalties should be imposed.
  • The Northern District of Florida has granted the Service’s request to levy the homestead of taxpayers in In Re Sanders, finding there were no reasonable alternatives and the property was not exempt under the state homestead exemption.  Case can be found at 112 AFTR2d 2013-7021.  Docket number is 4:13-cv-00352.  I could not find a link to the order – Sorry about that.
  • In the wake of Woods, SCOTUS has declined cert in two additional valuation misstatement cases, Alpha, LP v. United States and Crispin v. Comm’r.
  • In Bibby v. Comm’r, a somewhat unusual CDP case arising under 6330(f), which gives the taxpayer the right to a hearing within a reasonable time after a jeopardy levy.  This case involved a jeopardy levy and refund scam involving inflated credits.  The Tax Court sustained the levy and Appeals’ rejection of taxpayer’s suggested installment agreement because the taxpayer did not cooperate or respond to information requests. The refund scam included $203,000 of overstated withholding credits, among other inaccuracies.  The taxpayer’s behavior prior to his appeal, combined with the lack of responsiveness and cooperation by the taxpayer (who was represented), persuaded the Court that there was no abuse of discretion by Appeals in sustaining the levy and denying the installment agreement.
  • So 2013 doesn’t seem like a great year for MC Hammer.  Jay-Z gives him a shot out in Holy Grail, which would seem cool, except it is highlighting how he lost everything in the late ‘90s.  “I’m the [man], caught up in all these lights and cameras, but look what that [stuff] did to Hammer…bright lights is enticing…but soon as all the money blows, all the pigeons take flight.”  Jay-Z does also give a shout out to the Service in the song, but the language is a little colorful for these pages.  Mr. Hammer also seems to have some trouble with the Service, with TMZ reporting the IRS dropped an $800,000 lien on him.  Best bad pun line from TMZ is that “He got to PAY just to make it today”.  Hammer apparently tweeted that he had paid this debt, and has a receipt “stamped by a US Federal Judge”.  Do judges take payment and give receipts?
  • I’ve noted my interest in both the estate tax and tax procedure before on the blog, so I’m of course thrilled to comment on the Service’s release of PMTA 2013-014, which provides the Service’s position on whether CDP rights arise for a transferee of property from an estate when there has been an estate tax lien under Section 6324(a)(1), or the “like lien” described in (a)(2).  Chief Counsel has taken the position that the transferee is not entitled to CDP rights, and the regulations only allow CDP notice and hearing for “taxpayers”.  Prior guidance indicated that CDP rights did arise with a “like lien”, so this is a change in policy.  Practitioners handling a “like lien” situation should review this and prior guidance, and may find that an argument can be made in favor of providing CDP rights.
  • The Service has issued updated guidance on authorizing agents to act under Section 3504 for FICA and employment taxes.

Summary Opinions for 12/06/2013

I’m sure you all know Nelson Mandela died this week.  One of the first political discussions I can remember having was with my father about Nelson Mandela.  Not really a discussion; more of him explaining Mr. Mandela’s imprisonment.  I was probably five, maybe six, and it was prompted by hearing The Specials’ song “Nelson Mandela”/ “Free Nelson Mandela”.  I was dumbfounded by how he could be locked up, as everyone (my father & the Specials) so clearly knew he was wrongly jailed.  The unfolding of his story impressed upon me how lucky I was in the United States, where I now get to write for a blog that routinely criticizes aspects of the government, how much stronger he was then I probably ever could have been, and the power of music to help spread stories and political ideas such as his.  I am saddened by his passing, and very thankful for what he was able to accomplish.  To the tax procedure:

  • Let’s start with a little more on Woods, which we had some initial coverage on here.  Jack Townsend’s initial post highlighted Justice Scalia’s take down of the Bluebook as a persuasive document in statutory construction, which is found here, and was echoed by various other sources, including TaxProfBlog.  Professor Steve Johnson from Florida State posted his initial reactions on TaxProfBlog here, and as expected they are insightful and illuminating.  Professor Johnson’s first point is that TEFRA’s “utility [has] passed”.  I can recall Professor James Maule hammering this point in Partnership Tax years ago.  Professor Andy Grewal also posted on the Jurist.  Professor Grewal had filed an amicus brief in the matter, raising issues with the calculations under the regulations, which had not been raised by the taxpayers.  In his post, he also highlights the likely invalidity of the 1987 temporary regulations, which is a worthwhile discussion for this case and all others that deal with stale temporary regs post-Mayo. Jack Townsend on his Federal Tax Procedure Blog had a follow up post regarding Scalia potentially backdooring some legislative history into his review.  Another good post can be found at Jackeltaxlaw, where Monte Jackel provides a good summary and some interesting commentary.  As a side note, and I mean no offense by this, Monte Jackel is a great name.  It seems like he should be a PI in a gritty crime novel, or a wealthy, nefarious criminal.  There is a great back and forth between The Jackel and Andy Grewal (far less intimidating name) in the comment section regarding SCOTUS expressing explicitly or not an opinion on the district court’s application of the economic substance doctrine, which is also worth a read.  It ends with a planned meeting, involving booze, where the two of them are going to save the tax system.  It is not inconceivable that the two of them, intoxicated, could best Congress.
  • World Cup news, which I’m sure many of you have seen, has the US playing Ghana, Germany and Portugal in the first round.  This will be a tough row to hoe.  Also, a brutal travel schedule for the Yanks.  I’ll work on figuring out how to tie this to tax procedure before games start in June.
  • Anyone know Jeff Stimpson who writes the tax round up for Accounting Today?  The round up is great; with one glaring omission.  He never links us.  If you know him, please nudge him to start following us, so he can bask in –and share- our informative and entertaining post.
  • One (actually a couple) Billion Dollars!!  Is apparently what the Fisc is losing every year to fraud on stolen EINs.  Accounting Today covers the TIGTA report here.
  • The Tax Policy Center has a very clear explanation of Treasury’s efforts to reign in 501(c)(4) organizations’ political activities. It nicely describes the proposed rules, the backstory on how we are where we are in light of the 2010 Supreme Court Citizens United decision, and some tough questions that will persist even if the rules are adopted.
  • The Northern District of George granted summary judgment to the Service in Buckley v. US earlier this week, which allowed the service to continue to charge annual fees for PTINs.  I can’t link this yet, but am happy to send a PDF upon request.  The Court stated it had two questions to review.  From the Court:

First, this court must determine whether [Section 6109(a)(4)] permits the United States Treasury Department to issue regulations that assess user fees as well as annual renewal fees associated with PTIN assigned to those who prepare tax forms for compensation.

Second, this court must determine whether the annual renewal fee assessed for renewing one’s PTIN is either arbitrary and capricious or excessive.

As to the first point, the Court relied upon the 11th Circuit’s holding in Brannen, which specifically stated that the user fee was valid.  The Court did recognize the petitioner’s argument that this is a different fee (renewal not initial), but concluded this was of little significance.  The Court goes on further to give no love to Loving, holding it was inapplicable to this case, as it pertained to the competency testing and continuing education requirements for “registered tax return preparers”, not the PTIN fee.  Those are authorized under different statutory provisions.  As to the second point, the Court found the cost reasonable and that it was calculated by the Service in a reasoned way.

  • The wandering tax pro chimed in on whether the RTRP should survive.  He said the current regime will likely not survive Loving, and he thinks it should not, but he does believe some sort of voluntary designation and credentialing should be created.
  • Carlton Smith highlighted the order in O’Neill v. Comm’r, which I have linked here.  As Mr. Smith pointed out to us, this case has a nice summary as to why the Court doesn’t usually allow the Service to depose folks against their will.
  • From the Volunteer State, the DOJ is trying to stop a Tennessee tax return preparer, Stephanie Edmond, and her companies, the Tax factory and the Tax Factory Enterprise, from engaging in tax preparation and related services.  The Progressive Accountant has coverage.  Ms. Edmond allegedly was creating fake business, with fake deductions, and improperly claiming the EITC and other credits for her clients.
  • And, a recap, in addition to covering Woods, Keith responded to an argument about oversight of offers based on Thornberry, and Les wrote about the Jackson order and the SCOTUS holding in Ford. Today, Jack Townsend on his Federal Tax Procedure Blog has chimed in on Ford also.


SCOTUS – District Courts Have Jurisdiction to Review Partner’s 40% Accuracy Penalty in TEFRA Cases

Busy tax procedure day for SCOTUS.  The Supreme Court has decided US v. Woods, issuing its opinion today, which can be found here.  We previously covered the Woods issue here while oral argument was occurring. The Supreme Court found the lower court had jurisdiction to review the partner’s accuracy related penalty in the TEFRA proceeding, and the plain language of the statute applied it to basis misstatements.  Jack Townsend’s Federal Tax Procedure Blog has some initial commentary, which can be found here.  We may add some additional commentary in a separate post later.


Justice Scalia wrote the unanimous opinion, and the holding was as follows:

1. The District Court had jurisdiction to determine whether the partnerships’ lack of economic substance could justify imposing a valuation-misstatement penalty on the partners.

(a) Because a partnership does not pay federal income taxes, its taxable income and losses pass through to the partners. Under the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), the IRS initiates partnership-related tax proceedings at the partnership level to adjust “partnership items,” i.e., items relevant to the partnership as a whole. 26 U. S. C. §§6221, 6231(a)(3). Once the adjustments be­come final, the IRS may undertake further proceedings at the part­ner level to make any resulting “computational adjustments” in the tax liability of the individual partners. §§6230(a)(1)–(2), (c), 6231(a)(6).

(b) Under TEFRA’s framework, a court in a partnership-level proceeding has jurisdiction to determine “the applicability of any penalty . . . which relates to an adjustment to a partnership item.” §6226(f). A determination that a partnership lacks economic sub­stance is such an adjustment. TEFRA authorizes courts in partner­ship-level proceedings to provisionally determine the applicability of any penalty that could result from an adjustment to a partnership item, even though imposing the penalty requires a subsequent, part­ner-level proceeding. In that later proceeding, each partner may raise any reasons why the penalty may not be imposed on him specif­ically. Applying those principles here, the District Court had juris­diction to determine the applicability of the valuation-misstatement penalty.

2. The valuation-misstatement penalty applies in this case.

(a) A penalty applies to the portion of any underpayment that is “attributable to” a “substantial” or “gross” “valuation misstatement, ”which exists where “the value of any property (or the adjusted basis of any property) claimed on any return of tax” exceeds by a specified percentage “the amount determined to be the correct amount of such valuation or adjusted basis (as the case may be).” §§6662(a), (b)(3), (e)(1)(A), (h). The penalty’s plain language makes it applicable here. Once the partnerships were deemed not to exist for tax purposes, no partner could legitimately claim a basis in his partnership interest greater than zero. Any underpayment resulting from use of a non­-zero basis would therefore be “attributable to” the partner’s having claimed an “adjusted basis” in the partnerships that exceeded “the correct amount of such . . . adjusted basis.” §6662(e)(1)(A). And un­der the relevant Treasury Regulation, when an asset’s adjusted basis is zero, a valuation misstatement is automatically deemed gross.

(b) Woods’ contrary arguments are unpersuasive. The valuation ­misstatement penalty encompasses misstatements that rest on legal as well as factual errors, so it is applicable to misstatements that rest on the use of a sham partnership. And the partnerships’ lack of eco­nomic substance is not an independent ground separate from the misstatement of basis in this case.


Superior Trading can’t shake superior penalty as 7th Circuit sides with majority of other Circuits on eve of SCOTUS oral argument on imposition of gross valuation penalty when underlying transaction lacks economic substance

In Superior Trading  LLC v. Comm’r, the Seventh Circuit has joined eight other Circuits in holding that the 40% gross valuation misstatement penalty under Section 6662(h) can be imposed when the transaction is disallowed completely because it lacked economic substance.  Professor Paul Caron at the TaxProfBlog has posted a block quote of the salient language here.

There is currently a split on this issue, with the vast majority of Circuits agreeing with the Seventh Circuit.  The Fifth and Ninth Circuits, however, have held that a complete disallowance is not a valuation misstatement, but instead an improper deduction, and the higher 40% penalty for substantial valuation misstatement cannot be imposed.  The Supreme Court expects to hear oral argument on the matter on October 9th.  A decision should be issued by June at the latest.

For a review of the prior holdings, along with the often repeated but great description of the taxpayer transactions as what they are, “bull$#*! tax shelters”, see Jack Townsend’s Tax Procedure blog here, here, and here.  This is also covered in great detail in Saltzman Chapter 7B.03[2][c].


The Seventh Circuit opinion was not terribly interesting as regard the 6661(h) issue.  Only about four paragraphs are devoted to the issue, and the opinion is very much in line with the other majority Circuit statements.  A more interesting summary of the differing views of the “Blue Book” that may have given rise to the split can be found in a recent Tax Court case, AHG Investments, LLC v. Comm’r, where the Court switched its prior holding to be in line with the majority of the Circuits.  This case also highlights how the Fifth and Ninth Circuit are wavering in their positions on the matter.

The result “feels” right, as you would not expect a transaction lacking economic substance to be less penalized than one that merely undervalued something.  I suspect SCOTUS will find a well-reasoned way to follow the majority, but taxpayers currently facing this unfortunate issue should probably preserve appeal rights in case SCOTUS follows the rationale of the Fifth and Ninth Circuit.

There is a TEFRA jurisdictional issue, which could possibly result in SCOTUS deciding it lacks jurisdiction to hear the case. The Miller & Chevalier blog has a brief summary of the taxpayer’s position here and here.  The argument is that the penalty at issue relates to the outside basis in the entity, which is a partner item and not a partnership item, making the review by the lower court in a partnership proceeding under Section 6226 inappropriate.  Although this penalty does related to outside basis which is a partner item, the government has responded by arguing the individual partner’s situation is inapplicable to the inflation of all the outside basis in a transaction by the partnership that lacks economic substance.  Further, requiring this type of review at the partner level would reinstate inefficiencies that Congress had tried to remove by have partnership proceedings.  So, there may be a tax procedure issue before SCOTUS, a holding on which gets thwarted by a tax procedure issue.