Petitions for Cert Filed in Bullshit Tax Shelters to Resolve Lopsided Circuit Split on Gross Valuation Misstatement Penalty (1/16/13)

Tax Notes Today reports that two petitions for certiorari have been filed asking the Supreme Court to resolve the issue of whether a taxpayer's concession of a threshold problem -- such as lack of economic substance -- with a tax shelter precludes the IRS from applying the Section 6662(h), here, gross valuation misstatement penalty.  Notice that, in this statement of the issue presented, I have used the polite term -- tax shelter.  The equally accurate, less polite term that gives appropriate nuance to the stinkiness of the tax shelter is "bullshit tax shelter."  In effect, in these cases, the IRS applies the penalty and, upon filing the litigation, the taxpayer concedes that the tax shelter was a bullshit tax shelter so that the issue of whether the gross valuation misstatement was a disqualifier is never reached and therefore the penalty does not apply. So, in my view, we have a bullshit argument intended to mitigate the intended costs of taxpayer's investing in bullshit tax shelters.  Amazingly, two Circuits -- the Fifth and the Ninth -- have accepted the bullshit argument about the bullshit tax shelter.  Fortunately, critical mass among the circuits is against the bullshit argument -- 8 circuits reject it.  But the Fifth and Ninth Circuits remain intransigent, bestowing a largesse on taxpayers with bullshit tax shelters in their circuits that taxpayers in the other circuits do not get.

So the Government is asking the Supreme Court to resolve the conflict by applying the penalty.  (See docket here.)  The case is Woods v. United States, 471 Fed. Appx. 320 (5th Cir. 2012), a nonprecedential short-shrift opinion in its entirety as follows:

This Court has considered this appeal on the basis of the briefs and the record on appeal. Having  done so, we are convinced that this issue is well settled and that the district court should be affirmed. See Bemont Invs., L.L.C. v. United States, No. 10-41132,     F.3d    , 679 F.3d 339, 2012 U.S. App. LEXIS 8505, 2012 WL 1435608 (5th Cir. Apr. 26, 2012); 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).

The other petition for certiorari is filed by a taxpayer in one of the majority 8 circuits rejecting the bullshit argument in another bullshit tax shelter.  The case is Alpha I, L.P. v. United States, 682 F.3d 1009 (Fed. Cir. 2012).  The Supreme Court docket is here. The taxpayer there, having lost, claims offense that taxpayers in the Fifth and Ninth Circuits get better treatments for their bullshit tax shelters.  The taxpayer wants the Supreme Court to fix that problem by granting relief to the taxpayers in all circuits.

I offer quotes from the two petitions for things that interested me:

1.  The taxpayer's petition in Alpha I bootstraps a Chevron / Skidmore argument to attempt to hoist the Government on its own petard (see Wikipedia entry, here):

The IRS' own administrative guidance agrees with the Fifth and Ninth Circuit's application of the Blue Book's formula. In a Litigation Guideline Memorandum, the IRS' attorneys stated that "[o]ne result of applying the formula is that where a taxpayer claims a deduction or credit that is disallowed for reasons unrelated to a valuation overstatement, none of the underpayment is attributable to the valuation overstatement, even if there is also a valuation overstatement with respect to that same deduction or credit." Litigation Guideline Memorandum TL-68 (Rev.), 1992 LGM LEXIS 14, at *17-18 (Aug. 12, 1992). Moreover, the Litigation Guideline Memorandum agrees with the Fifth Circuit that the valuation misstatement penalties are inapplicable where a "taxpayer timely concedes the deduction or credit prior to trial on a ground 'independent of and wholly separable from' overvaluation." Id. at *29. Finally, the Litigation Guideline Memorandum agrees with the Fifth Circuit and Tax Court that not imposing the valuation misstatement penalties when a taxpayer concedes the underlying adjustment to tax on a ground unrelated to valuation or basis is consistent with the policy of the valuation misstatement penalties to "provide the court tools for managing the large backlog of valuation and tax shelter cases." Id. at *30. The IRS Chief Counsel recently reiterated the positions set out in the Litigation Guideline Memorandum and advised IRS lawyers that it is their responsibility to oppose purportedly "abusive" concessions. See Notice CC-2012-001, 2011 CCN LEXIS 18 (Oct. 5, 2011). 

The Litigation Guideline Memorandum is entitled to deference under Skidmore v. Swift & Co., 323 U.S. 134 (1944). "The fair measure of deference to an agency administering its own statute has been understood to vary with circumstances, and courts have looked to the degree of the agency's care, its consistency, formality, and relative expertness, and to the persuasiveness of the agency's position." United States v. Mead Corp., 533 U.S. 218, 228 (2001) (citing Skidmore, 323 U.S. at 139-40). The Federal Circuit should have deferred to the Litigation Guideline Memorandum, since it is a thorough, well-reasoned explication of the valuation misstatement penalties and because the IRS has maintained its position on the valuation misstatement penalties for almost twenty years.

2.  The Government's petition advises the Court that, even some judges of the Fifth Circuit question whether its holdings are misguided:

[In Bemont, a predecessor case], Judge Prado issued a concurring opinion, which was joined by the other two members of the panel. Bemont Invs., 679 F.3d at 351. The concurring opinion explained that, although "a routine application of the Todd/ Heasley rule decides this case," that "rule may be misguided." Id. at 351, 353. Judge Prado explained that "[a]rguably, if the Todd/Heasley rule did not bind us, tax underpayment in this case would be 'attributable to' a valuation overstatement." Id. at 353. The "basis misstatement and the transaction's lack of economic substance," Judge Prado reasoned, "are inextricably intertwined" because "[t]he basis misstatement was the engine of, the vehicle behind the sham transaction." Id. at 354. The concurrence further observed that "disregarding the deduction for a lack of economic substance pulls the correct basis to zero, which eliminates the claimed loss, and renders the tax underpaid." Ibid. As a result, "disregarding the transaction for a lack of economic substance does not alter the reality that the tax underpayment was ultimately 'attributable to' the basis misstatement -- or so one could argue, in a world without Todd/Heasley" Ibid.
In his Bemont Investments concurrence, Judge Prado also noted "[t]he near-unanimous opposition to the Todd/Heasley rule" among other courts of appeals. 679 F.3d at 354. "Except for the Ninth Circuit," he explained, "every sister circuit that has considered the issue has concluded that the valuation misstatement penalty may apply even if the deduction is totally disallowed because the underlying transaction lacked economic substance." Ibid. And although "the Ninth Circuit has not joined the majority because it is bound by its own precedent to follow the Todd/Heasley rule, it has questioned the rule's wisdom." Id. at 355 (citing Keller v. Commissioner, 556 F.3d 1056, 1060-1061 (9th Cir. 2009)). 

Judge Prado further observed that "the Todd/Heasley rule could incentivize improper tax behavior" because it rewards taxpayers who do not merely misstate their basis in property but who "craft[ ] a more extreme scheme." Bemont Invs., 679 F.3d at 355. As a result, "[a] taxpayer could generate an enormous improper tax benefit by overstating an asset's basis, but then could escape the overvaluation penalty by strategically conceding a deficiency on the ground of economic substance." Ibid. Despite their misgivings about the Todd/Heasley rule, however, Judge Prado and the other panel members ultimately concluded that, in light of binding circuit precedent, "our hands are tied." Ibid. 

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B. Eight Circuits Have Rejected The Fifth Circuit's Interpretation Of Section 6662's Overstatement Penalty, While Only The Ninth Circuit Has Adopted It 

There is a lopsided but intractable division among the circuits over whether a taxpayer's underpayment of tax can be "attributable to" a misstatement of basis where the transaction that created an inflated basis is disregarded in its entirety as lacking economic substance. Eight circuits have concluded that "when an underpayment stems from deductions that are disallowed due to a lack of economic substance, the deficiency is attributable to an overstatement of value and is subject to the penalty of [Section 6662]." Merino v. Commissioner, 196 F.3d 147, 155 (3d Cir. 1999) (quoting Zfass v. Commissioner, 118 F.3d 184, 190 (4th Cir. 1997)). Only the Ninth Circuit has adopted the Fifth Circuit's interpretation, although some judges on the Ninth Circuit (like the members of the Bemont Investments panel) have expressed skepticism about that approach. See Keller v. Commissioner, 556 F.3d 1056, 1061 (9th Cir. 2009). In denying rehearing en banc in this case despite Judge Prado's concurrence in Bemont Investments, the Fifth Circuit has now made clear that it has no intention of revisiting its "well settled" precedent. App., infra, 2a. This Court should accordingly resolve the circuit conflict.

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2. Departing from the approach taken by the majority of circuits, the Ninth Circuit has adopted the holdings of both Todd and Heasley. As a result, the IRS has been prevented from collecting overstatement penalties from taxpayers who employ abusive tax shelters in circuits covering more than 90 million people.

For a prior Federal Tax Crimes Blog entry on the majority holdings, see Substantial / Gross Valuation or Basis Misstatement Majority Rule Case (9/29/12), here.