United States v. Woods

“(1) Whether Section 6662 of the Internal Revenue Code, which prescribes a penalty for an underpayment of federal income tax that is “attributable to” an overstatement of basis in property, applies to an underpayment 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. (2) Whether the district court had jurisdiction in this case under 26 U.S.C. §6226 to consider the substantial valuation misstatement penalty.”

Respondent used a “tax shelter” called Current Options Bring Reward Alternative (COBRA) to avoid income taxes. Respondent transferred his partnership’s assets into two Sub-chapter S corporations. The corporations sold the assets which generated artificial losses to offset actual income. The Internal Revenue Service found the losses reported by the corporations to be invalid for tax purposes and imposed several penalties for false tax reporting. Respondent sought judicial review of “final partnership administrative adjustments” imposed by the Internal Revenue Service.

The district court affirmed in part and reversed in part. The district court held that the COBRA transaction lacked economic substance and the losses were invalid for tax purposes. Additionally, the court reversed one of the IRS penalties holding that a taxpayer may not be penalized for valuation overstatement when a deduction is disallowed by the IRS. The court affirmed the remaining IRS penalties. In a Per Curiam, unpublished opinion by the Court of Appeals for the Fifth Circuit, the court affirmed the district court.

The Supreme Court granted certiorari and will decide “whether the overstatement penalty applies to an underpayment 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.” Additionally, the Supreme Court has directed the parties to argue the issue of whether the district court had jurisdiction pursuant to 26 U.S.C. §6226 in considering the substantial valuation misstatement penalty.