federal income tax

United States v. Woods

Issues

Does a district court have jurisdiction to determine whether an overstatement penalty should be applied in a partnership-level proceeding?
Does the overstatement penalty apply to an underpayment in federal income tax where the transaction lacks economic substance because the sole purpose of the transaction was to inflate the taxpayer’s basis in property?

Court below

United States Court of Appeals for the Fifth Circuit

In November 1999, two business partners claimed a significant overstatement of adjusted basis in assets that allowed them to overstate financial losses by nearly $43 million. The partners claimed tax deductions on those losses, thereby significantly underpaying federal income taxes. After conducting an audit, the Internal Revenue Service filed a notice of Final Partnership Administrative Adjustment to the Respondent, Gary Woods. Woods then filed a petition with the court for a readjustment of the partnership items. The district court concluded, and the court of appeals affirmed, that the overstatement penalty was inapplicable in this case because there was a lack of economic substance. The Supreme Court will decide whether the district court had jurisdiction to consider the penalty and whether the overstatement penalty applies to a transaction that lacks economic substance. This case implicates the use of tax shelters and the possible penalties faced by alleged tax dodgers; it will decide what issues are appropriate in partner-level litigation; and it will determine the fate of billions of dollars hanging in the balance.

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Questions as Framed for the Court by the Parties

Section 6662 of the Internal Revenue Code prescribes a penalty for an underpayment of federal income tax that is "attributable to" an overstatement of basis in property. 26 U.S.C. 6662(a), (b)(3), (e)(l)(A) and (h)(l).

The question presented is as follows:

Whether the overstatement penalty applies to an underpayment of tax resulting from a determination that a transaction lacks economic substance because the sole purpose of the transaction was to generate a tax loss by artificially inflating the taxpayer’s basis in property.

In addition to the question presented by the petition, the parties are directed to brief and argue the following question: whether the district court had jurisdiction in this case under 26 U.S.C. § 6226 to consider the substantial valuation misstatement penalty.

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Facts

In November 1999, Gary Woods and his business partner, Texas billionaire Billy “Red” McCombs, collaborated in a series of investments through the creation of partnerships that engaged in transactions through a tax shelter called Current Options Bring Reward Alternatives (“COBRA”). See