On October 9, 2013, the U.S. Supreme Court heard oral arguments in United States v. Woods, 471 Fed. Appx. 320 (5th Cir. 2012), cert. granted, 133 S. Ct. 1632 (Mar. 25, 2013) (No. 12-562). The original question presented to the Court by petitioner was whether the 40% gross valuation misstatement penalty applies to transactions that lack economic substance. When the Court granted the certiorari petition, however, it expressly asked the parties to brief and argue the additional question of whether the district court had jurisdiction in the case under I.R.C. section 6226 to consider the substantial valuation misstatement penalty at issue. And it was this jurisdictional question that dominated oral argument before the Court.
Both the parties and the Court focused on the statutory language granting a court jurisdiction at the partnership level. Specifically, I.R.C. section 6226(f) grants a court jurisdiction to determine “all partnership items . . . and the applicability of any penalty . . . which relates to an adjustment to a partnership item.” Justice Kagan attempted to narrow the issue to whether the penalty was directly or indirectly “related to” a partnership item, and accused both parties of adding something to the statute: the taxpayer requiring the penalty “directly” relate, and the government asking the Court to read the statute to include any penalties “indirectly” relating to a partnership item. Counsel for the taxpayer-Respondent explained that Congress separately defined an “affected item”, which includes outside basis, and could have explicitly expanded the statute to include penalties related to the partnership item and affected items, but it did not. Respondent later reminded the Court that tax penalties are strictly construed in favor of the taxpayer and that any ambiguity must be resolved in the taxpayer’s favor.
On the merits, Respondent’s counsel focused on Congress’ intent and the context of the statute, arguing that the statute deals with a different situation than the one before the Court: the statute addresses a misstatement of value, not an entirely disallowed transaction. Respondent explained the distinction by analogy, “if I donate a painting that I say that is worth $1 million to a church and I put that on my return, but, in fact, it turns out that I didn’t donate the painting, I may have committed a fraud . . . but I haven’t made a valuation misstatement, nor have I misstated my basis.” As multiple Justices recognized, Congress enacted a new statute in 2010 to directly address that problem, in a noneconomic substance penalty. See I.R.C. ยง 7701(o). Both parties before the Court agreed that the noneconomic substance penalty would apply to the current case had that penalty been on the books at the time of the transaction.
Neither advocate had much time to argue the merits of the case, and, interestingly, the Justices asked few questions during those parts of the arguments. On the other hand, questions from the bench commanded the jurisdictional arguments. While tax practitioners may be hoping for a decisive answer to the question on the merits, it is possible the Court will issue a more narrow ruling that it lacks jurisdiction in this case to answer that question. Of course, predictions based on oral arguments alone are like writing in the wind and the running water. It is difficult to predict whether the Justices will rule on the merits of the case, much less what that ruling may be.
Adam Pierson, a member of Dentons’ Litigation practice, co-authored this article.
