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) (AHG Investments, LLC, 140 T.C. No. 7 (2013)). 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) for AHG that disallowed more than $10 million in losses to Alan Ginsburg, a partner, for 2001 and 2002. The FPAA contained 14 alternative grounds for the disallowance, and Ginsburg conceded that the adjustments were correct, claiming that the disallowance was not due to a valuation understatement but to his not being at risk under Sec. 465 and the transaction’s not having substantial economic effect under Regs. Sec. 1.704-1(b). (Both of those grounds were included in the 14 grounds in the FPAA.) 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.
Before deciding to reject 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 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 noted 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 noted that taxpayers had abused the ruling to avoid the 40% penalty. One justification the court had originally used for adopting the rule, that it would encourage taxpayers to settle cases and not burden the courts with difficult valuation issues, was also found to be unpersuasive, as the Tax Court now found that the same goal of judicial economy could be better achieved by discouraging taxpayers from engaging in tax-avoidance practices in the first place.
A final consideration before overruling its own earlier decisions was to ensure that it would not conflict with the case law in the Fifth and Ninth circuits (Todd II and Gainer, respectively). To do so, the court had to determine which circuit’s law would apply to Ginsburg’s case. 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. 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, and the Tax Court determined that that circuit had not ruled on the 40% penalty issue.
Having decided to overrule its earlier decisions 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.
—Sally P. Schreiber (email@example.com) is a JofA senior editor.