United States: Supreme Court Docket Report - March 25, 2013

On March 25, 2013, the Supreme Court granted certiorari in one case of interest to the business community:

Taxation—Penalties for Overstating Basis—District Court Jurisdiction

Section 6662(e) of the Internal Revenue Code imposes a penalty for an underpayment of income tax that is "attributable to" an overstatement of the value or basis of property. Today, the Supreme Court granted certiorari in United States v. Woods, No. 12-562, to decide whether that penalty "applies to an underpayment resulting from a determination that a transaction lacks economic substance because the sole purpose of the transaction was to generate a tax loss by artificially inflating the taxpayer's basis in property." The Supreme Court's decision may also address the broader question whether the IRS may impose an overvaluation penalty even when the claimed tax benefit could be disallowed on grounds unrelated to valuation (e.g., when an inflated charitable contribution might be disallowed in full because the taxpayer lacked donative intent).

Woods arose from an IRS determination that two partnerships involving the same two individuals had engaged in a sham transaction—the COBRA tax shelter promoted during the 1990s—for the sole purpose of generating tax losses. The district court upheld the adjustment and most of the penalties that the IRS imposed. The court overturned the assessment of a penalty under Section 6662(e)(1)(A) for gross misstatement of valuation, however, citing "clearly established" Fifth Circuit precedent that precludes imposition of a penalty for a valuation overstatement when the IRS "totally disallows a deduction." Woods v. United States, 794 F. Supp. 2d 714, 717 (W.D. Tex. 2011).

The IRS appealed, and the Fifth Circuit affirmed in a per curiam opinion, holding that the issue was "well settled" in the circuit under Bemont Investments, L.L.C. v. United States, 679 F.3d 339 (5th Cir. 2012). In Bemont, the Fifth Circuit had adhered to its prior decisions excepting total disallowance of a deduction from the penalty for valuation overstatements (see Heasley v. Comm'r of Internal Revenue, 902 F.2d 380 (5th Cir. 1990); Todd v. Comm'r of Internal Revenue, 862 F.2d 540 (5th Cir. 1988)), but the entire Bemont panel joined a concurring opinion that recognized the "near-unanimous opposition to the Todd/Heasley rule" in other circuits (679 F.3d at 354 (Prado, J., concurring)). The Bemont concurrence also suggested that the Todd/Heasley rule "may be misguided," particularly when a basis misstatement is "the vehicle behind the sham transaction" Id. at 351, 354.

In addition to the question raised by the petitioner in Woods, the Supreme Court directed the parties to brief and argue "[w]hether the district court had jurisdiction in this case under 26 U.S.C. § 6226 to consider the substantial valuation misstatement penalty." Neither the parties nor the lower courts had raised any question as to jurisdiction; and the Supreme Court's jurisdictional concern is unclear. The jurisdictional provision in I.R.C. § 6226 permits the tax-matters partner of a partnership to challenge adjustments and associated penalties in district court upon a deposit of the contested amount. The Court may be concerned about the status of the tax-matters partner in the case, or the fact that the tax liability ultimately fell upon the individuals' Subchapter S corporations rather than the partnerships, or another technical issue.

The Court's decision will be important to all taxpayers engaging in basis-increasing transactions that may be challenged by the IRS as lacking economic substance. The Court's decision on the jurisdictional issue may also affect the mechanics of tax litigation involving partnerships.

Absent extensions, amicus briefs in support of the petitioner will be due on May 16, 2013, and amicus briefs in support of the respondent will be due on June 17, 2013.

* * *

On March 25, 2013, the Supreme Court also invited the Solicitor General to file briefs expressing the views of the United States in the following cases of interest to the business community:

POM Wonderful LLC v. Coca Cola Co., No 12-761: The question presented is whether the court of appeals erred in holding that a private party cannot bring a Lanham Act claim challenging a product label regulated under the Food, Drug, and Cosmetic Act.

Fifth Third Bancorp v. Dudenhoeffer, No. 12-751: The questions presented are (1) whether the Sixth Circuit erred by holding that respondents were not required to plausibly allege in their complaint that the fiduciaries of an employee stock ownership plan abused their discretion by remaining invested in employer stock, in order to overcome the presumption in the Employee Retirement Income Security Act that their decision to invest in employer stock was reasonable; and (2) whether the Sixth Circuit erred by refusing to follow Supreme Court precedent by holding that filings with the Securities and Exchange Commission become actionable ERISA fiduciary communications merely by virtue of their incorporation by reference into plan documents.

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