Tax Law

Tax shelter misstatement due to legal error merits the max in IRS penalties, Supreme Court says

Resolving a circuit split, the U.S. Supreme court has sided with the Internal Revenue Service in a dispute over the maximum penalty that can be assessed when a taxpayer misstates the value of a tax shelter partnership due to incorrect legal analysis.

In a unanimous opinion (PDF) Tuesday authored by Justice Antonin Scalia, the nation’s top court reversed a decision by the 5th U.S. Circuit Court of Appeals and held that the top penalty rate of 40 percent applies, reports Forbes.

The taxpayer, Texas billionaire Billy Joe “Red” McCombs, had argued that the 40-percent penalty rate should only apply when a factual misstatement is made.

The U.S. v. Woods case concerned a COBRA (“Current Options Bring Reward Alternatives”) tax shelter developed by the now-shuttered Jenkens & Gilchrist law firm and marketed by the Ernst & Young accounting firm. If treated as valid, the shelter would have allowed a $3.2 million investment made by McCombs and his business partner, Gary Woods, in 1999 to shield more than $45 million in income from being taxed, Scalia said in the opinion.

While the decision is not what taxpayers would have wished for, it does at least clarify the risks involved in participating in a tax shelter later determined by the IRS to be abusive, attorney Charles Ruchelman of Caplin & Drysdale told Forbes. He was not involved in the Supreme Court case.

“We have resolution now of an uncertainty in interpreting these complicated tax partnership provisions and their interplay with the penalty provisions,” he said, noting that millions of dollars are at issue in the Woods case alone. “There’s a lot of money involved, and there are a lot of cases waiting out there across the country.”

Bloomberg, Reuters and the San Antonio Express-News also have stories.

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