We recently received two cases involving the same issue from two different courts. Both cases involved the total denial of a charitable contribution deduction on grounds other than valuation. In RERI Holdings I, LLC v. Commissioner, the Tax Court held that a partnership failed to comply with the substantiation requirements of Reg. §1.170A-13(c)(4)(ii)(E) because it failed to provide its cost or other adjusted basis on its Form 8283, Noncash Charitable Contributions. In Partita Partners LLC v. United States, the Southern District of New York disallowed the charitable contribution deduction with respect to the donation of a façade easement because the donation did not preserve the entire building as required by §170(h)(4)(B)(i)(I).
After concluding that neither taxpayer was entitled to any deduction on grounds other than valuation, both the Tax Court and the Southern District of New York held that the taxpayers could nonetheless be liable for the §6662 valuation misstatement penalties. According to these courts, the underpayment was still “attributable to” one or more gross valuation misstatements pursuant to §6662.
These cases were decided one week apart. After reading the RERI Holdings case the previous week, I figured that the Partita case would cite the same exact cases in coming to the same conclusion. However, I was wrong. While the Partita case does mention the RERI Holdings case in a footnote, the two cases seemed to go about coming to the same conclusion based upon different case law.
The Partita case relied heavily on the Supreme Court case United States v. Woods. The Woods case dealt with a sham transaction in which the Court totally disallowed a loss because it held that the partners did not have any basis in their underlying partnership interest. In overturning both the district court and the Fifth Circuit, the Supreme Court held the partners liable for the 40% gross valuation misstatement penalty stating that the “partnerships’ lack of economic substance is not an independent ground separate from the misstatement of basis in this case.”
I find it interesting that the RERI Holdings case does not even mention the 2013 Woods opinion. Instead, the Tax Court focused on its own precedents. In so doing, the Tax Court expressly overruled its earlier case of 885 Inv. Co. v. Commissioner, another case involving the disallowance of a charitable deduction.
As a result of the disallowance of the entire charitable contribution on grounds other than valuation, the RERI Holdings court conducted an exhaustive analysis of the valuation of the charitable contribution at issue in RERI Holdings. The court concluded that the taxpayer was liable for the 40% gross valuation misstatement penalty because it overstated its deduction by more than 400%, i.e., the taxpayer claimed a charitable deduction of $33,019,000 but would only have been entitled to a deduction of $3,462,886 had it complied with all the rules and regulations.
If it were not for one statement in the RERI Holdings case, I would not have thought too much about the holding as it seems to follow the prevailing case law in the area. Further, it would seem unlikely that Congress would have wanted to “encourage” taxpayers to be in a position to concede a case on a technicality as a method to get out of the gross valuation penalty. However, in analyzing Todd v. Commissioner, a case in which the Tax Court had previously held that the gross valuation misstatement penalty did not apply, the RERI Holdings court stated:
The deductions and credits claimed by the Todd taxpayers, however, were disallowed because their property had not been placed in service until after the year in issue. Therefore, we held that the underpayment of those taxpayers was not “attributable to the valuation overstatement” …. Congress had enacted section 6659 [the predecessor to 6662] to enable us to reduce our caseload. The Commissioner's interpretation of that section, we reasoned, would require us to determine the existence of a valuation overstatement even when we chose to determine the taxpayer's underlying tax liability on other grounds. “Such a requirement”, we wrote, “would prolong and multiply litigation, is contrary to sound judicial administration, and appears contrary to congressional intent to reduce our case load.” [Emphasis added.]
I went back and read Todd and looked at the Congressional intent argument. According to Judge Cohen:
The conferees note that a number of the provisions of recent legislation have been designed, in whole or in part, to deal with the Tax Court backlog. Examples of these provisions are the increased damages assessable for instituting or maintaining Tax Court proceedings primarily for delay or that are frivolous or groundless (sec. 6673), the adjustment of interest rates [sec. 6621(c)], the valuation overstatement and substantial understatement penalties (secs. 6659 and 6661) * * *
Judge Cohen went on to state:
In appropriate circumstances, we have applied section 6659 without hesitation …. We do not believe, however, that we should be precluded from deciding a case on one issue that leads to disallowance of all deductions and credits merely because deciding another issue would bring into play an addition to tax. Such a requirement would prolong and multiply litigation, is contrary to sound judicial administration, and appears contrary to congressional intent to reduce our case load.
Looking at the exhaustive – not to mention imprecise – analysis required by the RERI Holdings case in determining the actual value of the charitable contribution deduction, one has to wonder whether Judge Cohen’s analysis makes more sense in the context of the disallowance of charitable contributions? The cases cited by Partita, including Woods, involved instances where the penalty will be calculated based upon the entire disallowance of the underlying deduction or credit, i.e., a court will typically not be required to conduct any analysis as the penalty will be based on the entire amount of the claimed deduction. In the charitable contribution scenario, courts will generally still be required to conduct an exhaustive analysis typically involving a battle of the experts.
In any case, I doubt it matters at this point. While the Fifth and Ninth Circuits still have cases out there that have declined to invoke the value misstatement penalties where the underlying deduction was disallowed on grounds other than valuation, I suspect that both will eventually overrule their previous positions, especially the Fifth Circuit as it was overruled on this issue in Woods.
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