Partner cannot avoid valuation penalty by conceding on other grounds

June 1, 2013

In a big win for the IRS, the Tax Court refused to grant partial summary judgment to a partner who had conceded his tax shelter case on grounds other than valuation in an attempt to avoid the 40% gross valuation misstatement penalty under Sec. 6662(a). This has been a common method used by taxpayers who have invested in tax shelters, in an attempt to avoid the draconian 40% penalty.

The IRS issued a final partnership administrative adjustment (FPAA) to Alan Ginsburg, a partner other than the tax matters partner in AHG Investments LLC, that disallowed more than $10 million in losses passed through from AHG to Ginsburg, for 2001 and 2002. The FPAA contained 14 alternative grounds for the disallowance, including that the losses were due to a gross valuation misstatement. The IRS also asserted 40% accuracy-related penalties for the portions of Ginsburg’s underpayments of tax resulting from adjustments of partnership items attributable to the gross valuation misstatement. Ginsburg conceded that the adjustments were correct under two of the FPAA’s other grounds, that he was not at risk under Sec. 465, and that the transaction did not have substantial economic effect under Regs. Sec. 1.704-1(b). Ginsburg then sought partial summary judgment that the IRS could not apply the 40% penalty.

In determining whether to grant Ginsburg’s request, the court was faced with its own precedents in McCrary, 92 T.C. 827 (1989), and Todd, 89 T.C. 912 (1987) (Todd I), as well as a case from the Ninth Circuit (Gainer, 893 F.2d 225 (9th Cir. 1990)) and the Fifth Circuit’s affirmance of Todd I, 862 F.2d 540 (5th Cir. 1988) (Todd II). These cases held that the legislative history of Sec. 6662(a) supported the interpretation that, when a taxpayer conceded a case on grounds other than a valuation understatement, the 40% penalty could not apply.

In rejecting the reasoning in McCrary, Todd, and Gainer, the Tax Court noted that the majority of appeals courts have held that that interpretation of the legislative history in these cases is incorrect and that even the Fifth and Ninth Circuits have suggested the majority rule is correct, while continuing to follow the minority rule. The Tax Court also explained that stare decisis (the doctrine that court precedent generally must be followed) should not apply when there is ample evidence that its earlier decisions were wrong.

The court also found that taxpayers had abused the rule it established in these earlier cases to avoid the 40% penalty. It further concluded that one of its goals for originally adopting the rule, that it would encourage taxpayers to settle cases and not burden the courts with difficult valuation issues, would be better achieved by discouraging taxpayers from engaging in tax avoidance in the first place.

A final consideration before overruling its own earlier decisions was whether doing so would conflict with the current precedent in the Fifth and Ninth Circuits (from Todd II and Gainer, respectively). To ensure that it did not, the court had to determine in which circuit an appeal of Ginsburg’s case would lie. The court found that there was no evidence where the partnership (which might not have still been in existence when the petition to the Tax Court was filed) had its principal place of business, which would normally be the jurisdiction for FPAA appeals. According to the court, where no jurisdiction can be determined and the parties have not stipulated to where the appeal would lie, the D.C. Circuit hears the case. Therefore, changing its position would not conflict with circuit precedent in the Fifth or Ninth Circuit.

Having decided to overrule its holdings in McCrary and Todd I, the Tax Court held that Ginsburg could not avoid the penalty by conceding on alternative grounds and denied his motion for partial summary judgment.

  AHG Investments, LLC, 140 T.C. No. 7 (2013)

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