Tax Court Holds that 6662A Penalty on Reportable Transaction Understatement Does Not Violate the Eighth Amendment Excessive Fine Clause (2/8/17)

Today, I post on Thompsom v. Commissioner, 148 T.C. ___, No. 3 (2017), here, in which the Tax Court held (i) based on a contemporaneous case, that the President's limited removal power for Tax Court Judges does not violate the Constitution and (ii) the penalty in § 6662A, here, penalty on reportable transaction understatements does not violate the Eight Amendment's Excessive Fines Clause.  I focus this blog entry only on the Excessive Fines Issue because that issue has arisen in prior blogs, particularly with respect to the FBAR willful penalty (see blogs listed and linked at the end of this blog).

The Court describes the Section 6662A penalty as follows:

Section 6662A(a) imposes a penalty on any reportable transaction understatement. If a taxpayer fails to adequately disclose a reportable transaction giving rise to an understatement under section 6662A, the penalty is imposed at a rate of 30%, and there are no available defenses. Secs. 6662A(c), 6664(d)(2). However, if a taxpayer sufficiently discloses the details of the transaction, the penalty rate is 20% of the amount of the reportable transaction understatement. Sec. 6662A(a). In this latter instance, a taxpayer may be able to avoid the penalty under section 6662A if he or she shows reasonable cause and good faith, as well as that there is or was substantial authority for a position he or she took on a tax return, and the taxpayer reasonably believed that such treatment was more likely than not the proper treatment of the transaction in question.  Sec. 6664(d)(1) and (2).

The Court then describes the Eight Amendment's Excessive fines clause as follows (case citations omitted):

The Eighth Amendment to the United States Constitution provides: “Excessive bail shall not be required, nor excessive fines imposed, nor cruel and unusual punishments inflicted.” “The Excessive Fines Clause limits the government’s power to extract payments, whether in cash or in kind, ‘as punishment for some offense.’” Austin v. United States, 509 U.S. 602, 609-610 (1993) (emphasis in Austin) (quoting Browning-Ferris Indus. of Vt., Inc. v. Kelco Disposal, Inc., 492 U.S. 257, 265 (1989)). 

In a case discussing application of the Double Jeopardy Clause to a State tax on possession of illegal drugs, the Supreme Court stated: “Criminal fines, civil penalties, civil forfeitures, and taxes all share certain features: They generate government revenues, impose fiscal burdens on individuals, and deter certain behavior. All of these sanctions are subject to constitutional constraints.” Dep’t of Revenue of Mont. v. Kurth Ranch, 511 U.S. 767, 778 (1994). At the same time, the Supreme Court recognized that taxes are typically motivated by revenue raising rather than punitive purposes. Id. at 779-780. “[N]either a high rate of taxation nor an obvious deterrent purpose automatically marks * * * [a] tax as a form of punishment.” Id. at 780. Nevertheless, “at some point, an exaction labeled as a tax approaches punishment, and our task is to determine * * * [when it] crosses that line.” Id.

IRS Designates Syndications Exploiting Improper Valuations for Conservation Easement Deductions (1/2/17)

I note at a couple of places in the Federal Tax Procedure Book that some of the most abusive tax shelters do not fail because the legal positions are faulty.  Rather, they fail because the legal positions are all based false facts, often a false valuation of property.  For example, in discussing the substantial and gross valuation misstatement penalties in §§ 6662(e) and (h), here, I state:

Section 6662(e)’s substantial valuation misstatement penalty and § 6662(h)’s gross valuation misstatement penalty are directed to return reporting positions where the law is correctly applied but a critical valuation is grossly erroneous, resulting in the substantial understatement of the tax liability.  In many of the abusive tax shelters over the years, the Achilles heel has been and continues to be inflated valuations.  The legal superstructure had some facial merit, but it was built on a factual house of cards because of gross overvaluation.  A facet of this problem was that, since tax professionals were not valuation experts, they could render their opinions without taking responsibility for the key valuation facts that supported the whole purported tax shelter superstructure.  For example, as to property otherwise qualifying for the old investment tax credit (10 percent of qualifying investment in property), tax shelter promoters would sometimes inflate the value of property to 10 or 20 times its true value and sell it to investment partnerships (where the partners were tax shelter investors) for the inflated value.  Of course, only crazy people would pay the inflated value, so the tax shelter investors paid only a small amount down and “paid” the balance by nonrecourse indebtedness (before the rules related to nonrecourse indebtedness and passive losses).  Assuming that the value was correct, the taxpayers would be entitled to the credit; the problem was in the valuation.  Many, many tax issues, not just tax shelter issues, rely upon valuations.  Thus, for example, estate and gift tax returns rely upon reasonably correct valuations.  The purpose of this penalty is to put some sting in overly aggressive valuations.

I have posted on variations of this theme.  Court Sustains Use of Regular Summons to Appraiser Investigated Even Though Third Party Taxpayers May be Identified (Federal Tax Crimes Blog 1/14/16), here.  See also Prominent and Very Rich Investor Indicted in SDNY (Federal Tax Crimes Blog 5/24/16), here.

Such overvaluations carry risk of criminal prosecution and significant civil penalties.

The IRS strikes again at a valuation shelter in a different package, this one syndications -- promoted "investments" -- offering conservation easement deductions.  Notice 2017-10, 2017-04 IRB, here.  The Notice describes the problem:

The promoters (i) identify a pass-through entity that owns real property, or (ii) form a pass-through entity to acquire real property. Additional tiers of pass-through entities may be formed. The promoters then syndicate ownership interests in the passthrough entity that owns the real property, or in one or more of the tiers of pass-through entities, using promotional materials suggesting to prospective investors that an investor may be entitled to a share of a charitable contribution deduction that equals or exceeds an amount that is two and one-half times the amount of the investor’s investment. The promoters obtain an appraisal that purports to be a qualified appraisal as defined in § 170(f)(11)(E)(i) but that greatly inflates the value of the conservation easement based on unreasonable conclusions about the development potential of the real property. After an investor invests in the pass-through entity, either directly or through one or more tiers of pass-through entities,  the pass-through entity donates a conservation easement encumbering the property to a tax-exempt  entity. Investors who held their direct or indirect interests in the pass-through entity for one year or less may rely on the pass-through entity’s holding period in the underlying real property to treat the donated conservation easement as long-term capital gain property under § 170(e)(1). The promoter receives a fee or other consideration with respect to the promotion, which may be in the form of an interest in the pass-through entity. The IRS intends to challenge the purported tax benefits from this transaction based on the overvaluation of the conservation easement. The IRS may also challenge the purported tax benefits from this transaction based on the partnership anti-abuse rule, economic substance, or other rules or doctrines.