By David I. Kempler, Esq., and Elizabeth Carrott Minnigh, Esq.
Buchanan Ingersoll & Rooney PC, Washington, DC
In AHG Investments, LLC v. Comr., 140 T.C. No. 7 (3/14/13), the Tax Court held that a taxpayer may not avoid application of the gross valuation misstatement penalty under §6662, merely by conceding on grounds unrelated to valuation or basis. In its decision, the Tax Court overruled the minority rule previously adopted by the Tax Court and instead adopted the rule of the majority of the circuit courts.
Under §6662(h), a taxpayer may be liable for a 40% penalty on any portion of an underpayment of tax attributable to a gross valuation misstatement. Section 6662(h)(2)(A) provides that a gross valuation misstatement exists if the value or adjusted basis of any property claimed on a tax return is 400% or more of the amount determined to be the correct amount of that value or adjusted basis. Pursuant to Regs. §1.6662-5(h)(1) whether a gross valuation misstatement exists in the partnership context must be determined at the partnership level.
The IRS issued a notice of final partnership administrative adjustment (FPAA) to Taxpayer, a partner of AHG Investments, LLC (AHG). The major adjustment in the FPAA was to disallow $10,069,505 in losses allocated to Taxpayer for taxable years 2001 and 2002. Taxpayer conceded the adjustments on grounds other than valuation or basis, namely that Taxpayer was not at risk under §465 and thus was not entitled to deduct certain attributed losses and that the transaction at issue did not have substantial economic effect under Regs. §1.704-1(b). Taxpayer then asserted that the 40% gross valuation misstatement penalty did not apply because Taxpayer had conceded the correctness of adjustments proposed in the FPAA on grounds unrelated to valuation or basis.
The Tax Court had previously held in McCrary v. Comr., 92 T.C. 827 (1989), and Todd v. Comr., 89 T.C. 912 (1987), that when the IRS asserts a ground unrelated to value or basis of property for completely 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. Similarly, the Fifth Circuit affirming the decision in Todd v. Comr.,862 F.2d 540 (5th Cir. 1998), and the Ninth Circuit in Gainer v. Comr., 893 F.2d 225 (9th Cir. 1990), aff'g T.C. Memo 1988-416, each held that the gross valuation misstatement penalty may be avoided merely by conceding a deduction or credit on a ground unrelated to value or basis of property. However, the majority opinion among courts of appeal - the First Circuit in Fid Int'l Currency Advisor A Fund, LLC v. U.S., 661 F.3d 667 (1st Cir. 2011), the Federal Circuit in Alpha I, L.P. v. U.S., 682 F.3d 1009 (Fed. Cir. 2012, and the Eleventh Circuit in Gustashaw v. Comr., 696 F.3d 1124 (11th Cir. 2012), aff'g T.C. Memo 2011-195 - was that the gross valuation misstatement penalty may not be avoided merely by conceding a deduction or credit on a ground unrelated to value or basis of property. Moreover, the Fifth Circuit in Bemont Invs. L.L.C. v. Comr.,679 F.3d 339 (5th Cir. 2012), and the Ninth Circuit in Keller v. Comr., 556 F.3d 1056, 1061 (9th Cir. 2009), aff'g in part, rev'g in part T.C. Memo 2006-131, have each suggested in other rulings that the majority rule was correct, but were bound by stare decisis.
The Tax Court noted that split in circuits was predicated on differing interpretations of the Joint Committee on Taxation's legislative explanation set forth in the General Explanation of the Economic Recovery Tax Act of 1981, commonly called the "Blue Book." Though not technically legislative history, in FPC v. Memphis Light, Gas & Water Div., 411 U.S. 458, 472 (1973), 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 effect of a statutory provision. In affirming Todd, the Fifth Circuit followed the Tax Court's interpretation of the Blue Book as requiring that any underpayments attributable to other adjustments must be taken into consideration before applying the valuation penalty. Conversely, the First Circuit in Fidelity International found that the Blue Book formula was "designed to avoid applying the penalty to an upward adjustment that was unrelated to the overstatement but due solely to some other tax reporting error."
As a general rule, the doctrine of stare decisis requires that absent a special justification a court should follow the holding of a previously decided case. The Tax Court concluded, however, that the IRS had met its burden to persuade the court to overrule its precedent established by Todd and McCrary. In those cases, the Tax Court reasoned that if another ground besides valuation overstatement supports a deficiency, that deficiency cannot be attributable to a valuation overstatement. However, the Tax Court noted that the alternative view has been adopted by the majority of the U.S. Courts of Appeals. Moreover, the Tax Court noted that, because AHG failed to establish a place of business, and it had not been stipulated that the case would be appealed to a specific U.S. Court of Appeals, then, under §7482(b)(1), an appeal of the Tax Court's decision would be to the Court of Appeals for the D.C. Circuit, which has not ruled on this issue. Accordingly, the Tax Court departed from its precedent following the minority rule and sided with the majority rule. Therefore, the Tax Court held that a taxpayer may not avoid application of the gross valuation misstatement penalty merely by conceding on grounds unrelated to valuation or basis.
For more information in the Tax Management Portfolios, see Tarr and Drucker, 634 T.M., Civil Tax Penalties, and in Tax Practice Series, see ¶3830, Penalties.
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