The 40-Percenters

If you concede something besides a gross valuation misstatement in a 40-percenter (gross valuation misstatement) penalty case, you’re no longer off the hook in Tax Court.

Alan Ginsburg, though not the similarly-named poet, has a good reason to howl, in AHG Investments, LLC, Alan Ginsburg, A Partner Other Than the Tax Matters Partner, 140 T. C. 7, filed 3/14/13.

It’s another FPAA with fourteen (count ‘em, fourteen) grounds for torpedoing Alan’s deal, among them gross valuation misstatement, but plenty of others, like sham transaction, no economic substance, not at risk per Section 465 and the rest.

Alan concedes not-at-risk, takes the 20% hit but moves for partial summary judgment (judgment on the papers with no trial) knocking out the 40-percenter.

Judge Goeke speaks for the Tax Court, and overrules previous learning: “We have previously held that when the Commissioner asserts a ground unrelated to value or basis of property for totally disallowing a deduction or credit and a taxpayer concedes the deduction or credit on that ground, any underpayment resulting from the concession is not attributable to a gross valuation misstatement. Today we depart from this holding, instead ruling that a taxpayer may not avoid the gross valuation misstatement penalty merely by conceding a deduction or credit on a ground unrelated to value or basis of property.” 140 T. C. 7, at pp. 5-6.

Judge Goeke goes back through some old cases, even our old chum BLAK Investments (see my blogpost “It’s A Sham”, 9/25/12), exhaustively reviews facts, and says Tax Court misread ERTA (Economic Recovery Tax Act of 1981). Judge Goeke says, following Fifth Circuit, that Tax Court should read the ‘“blue book’ prepared by the staff of the Joint Committee on Taxation. Though not technically legislative history, the Supreme Court relied on a similar blue book in construing part of the Tax Reform Act of 1969, calling the document a ‘compelling contemporary indication’ of the intended effect of the statute’.” 140 T. C. 7, at p. 7.

So you look first at what the liability would have been without the gross valuation misstatement, and then look at what it was stated to be by the taxpayer with the misstatement. If the before-and-after test puts you in the penalty zone, you get hit. Or, more elegantly, “‘The portion of a tax underpayment that is attributable to a valuation overstatement will be determined after taking into account any other proper adjustments to tax liability. Thus, the underpayment resulting from a valuation overstatement will be determined by comparing the taxpayer’s (1) actual tax liability (i.e., the tax liability that results from a proper valuation and which takes into account any other proper adjustments) with (2) actual tax liability as reduced by taking into account the valuation overstatement. The difference between these two amounts will be the underpayment that is attributable to the valuation overstatement.’” 140 T. C. 7, at p. 8.

Apparently, the First, Second, Third, Fourth, Sixth and Eighth Circuits all agree that letting shamsters cop to something besides gross valuation misstatements, to wipe out the 40% hit, is a perverse incentive to do utterly phony deals, overvalue everything, and when caught, cop to economic substance. And the Fifth and Ninth Circuits don’t like letting the shamsters cop to drop, but ol’ stare decisis keeps them from doing anything about it.

Federal Appeals Circuit: “The Blue Book, in sum, offers the unremarkable proposition that, when the IRS disallows two different deductions, but only one disallowance is based on a valuation misstatement, the valuation misstatement penalty should apply only to the deduction taken on the valuation misstatement, not the other deduction, which is unrelated to valuation misstatement.” 140 T. C. 7, at p. 12 (Citation omitted).

After a quick bow in the direction of stare decisis (“do what you did the last time”), Judge Goeke reverses course: “Today we depart from our precedent following the minority rule and side with the majority rule. By doing so we recognize that an underpayment of tax may be attributable to a valuation misstatement even when the Commissioner’s determination of an underpayment of tax may also be sustained on a ground unrelated to basis or valuation. We agree with Judge Prado of the Court of Appeals for the Fifth Circuit that the Blue Book’s formula and example merely express ‘a straightforward principle in mathematical terms: Do not apply the valuation overstatement penalty to a tax infraction, such as an improper charitable deduction, that is unrelated to (i.e., incapable of being attributed to) the valuation overstatement’.” 140 T. C. Memo. 7, at pp. 18-19 (Footnote and citation omitted).

Even though Tax Court recognizes this might mean that there will be more valuation trials (bring on those expert witnesses, guys), Tax Court won’t combine any more.