Supreme Court Decision Alert - December 3, 2013

Yesterday (December 3, 2013) the Supreme Court issued two decisions, described below, of interest to the business community.

Taxation—Penalties for Overstating Basis—District Court Jurisdiction Forum-Selection Clauses—Proper Venue—Transfer Between Districts Taxation—Penalties for Overstating Basis—District Court Jurisdiction

United States v. Woods, No. 12-562 (previously discussed in the March 25, 2013, Docket Report)

Section 6662(e) of the Internal Revenue Code imposes a penalty for an underpayment of income tax that is "attributable to" an overstatement of the value or basis of property. Today, the Supreme Court, in a unanimous opinion by Justice Scalia, held that the overstatement penalty is applicable to an underpayment resulting from a basis-inflating transaction subsequently disregarded for lack of economic substance. The Court also decided that district courts have jurisdiction to consider the applicability of tax penalties in partnership-level proceedings.

Woods arose from an IRS determination that two partnerships involving the same two individuals had engaged in a sham transaction—the COBRA tax shelter promoted during the 1990s—for the sole purpose of generating tax losses. The district court upheld the IRS determination disregarding the partnerships as shams. But the court overturned the assessment of a valuation-misstatement penalty, based on Fifth Circuit precedent excepting the total disallowance of a deduction from the penalty for valuation overstatements. Woods v. United States, 794 F. Supp. 2d 714, 717 (W.D. Tex. 2011). The IRS appealed, and the Fifth Circuit affirmed in a per curiam opinion, holding that the issue was "well settled" in the circuit.

The Supreme Court reversed. As an initial matter, the Supreme Court held that the district court had jurisdiction to determine the applicability of the tax penalty even though the proceeding was at the partnership level rather than the partner level. (Partnerships file tax returns but do not pay taxes or penalties.) The Court held that Section 6224(f) of the Internal Revenue Code gives courts in partnership-level proceedings "jurisdiction to determine the applicability of any penalty that could result from an adjustment to a partnership item, even if imposing the penalty would also require determining affected or non-partnership items such as outside basis." The Court emphasized, however, that "such a partnership-level applicability determination is provisional: the court may...