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

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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.


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Stephen J. Olsen’s practice includes tax planning and controversy matters for individuals, businesses and exempt entities for the law firm Gawthrop Greenwood, PC.


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