TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Saturday, March 15, 2014

Burke Presents Woods: A Path Through the Penalty Maze at Northwestern

BurkeKaren C. Burke (Florida) presented Woods: A Path Through the Penalty Maze, 142 Tax Notes 829 (Feb. 24, 2014) (with Grayson M.P. McCouch (Florida)), at Northwestern on Thursday as part of its Tax Colloquium Series hosted by by Herbert Beller, Charlotte CraneDavid Cameron, Philip Postlewaite, Jeffrey Sheffield, and Robert Wootton:

The Supreme Court’s recent Woods decision answers two important questions concerning the applicability of penalties when a taxpayer reports artificial losses derived from an inflated basis in a sham partnership. One issue, which has generated a split among the circuits, is whether the 40 percent penalty can apply when the transaction lacks economic substance. The second issue is whether a court has jurisdiction in a partnership-level TEFRA proceeding2 to determine the applicability of penalties triggered by a partner’s misstatement of basis in a sham partnership. The Court has answered both questions in the affirmative, thereby overruling contrary decisions by the Fifth Circuit on the substantive issue and by the D.C. Circuit on the jurisdictional issue.

The Court’s resolution of the jurisdictional issue is especially welcome, not only because it clarifies the scope and sequence of partnership-level and partner-level proceedings in TEFRA cases, but also because it opens the way for prompt and conclusive penalty determinations in a large number of pending tax shelter cases. Although the type of shelter exemplified by Woods has been effectively shut down, a host of virtually identical transactions dating from the late 1990s and early 2000s have given rise to litigation involving billions of dollars in tax underpayments and penalties. Penalties are of particular concern because they represent the only real downside of the shelters (other than transaction and litigation costs) for die-hard taxpayers who turned down settlement offers and delayed paying most of their tax liability for more than a decade during protracted partnership-level proceedings. As those proceedings finally draw to a close, the Woods decision provides a glimmer of light at the end of the tunnel and focuses attention on the final stage of proceedings at the partner level. This report focuses on penalty determinations in TEFRA cases involving sham partnerships, beginning with a brief overview of TEFRA’s two-stage procedural framework and an analysis of the jurisdictional holding in Woods. The report explores the implications of the Supreme Court’s decision for partner-level proceedings and discusses the procedural alternatives and likely outcomes in those proceedings.

Colloquia, Scholarship, Tax | Permalink