WASHINGTON (CN) - Uncle Sam properly penalized a billionaire whose participation in a complicated tax shelter resulted in underpayments, the Supreme Court ruled Tuesday.
The case involves two partnerships created in a tax-avoidance scheme for the assets of Texas philanthropist Billy Joe "Red" McCombs, a former owner of the San Antonio Spurs and the Minnesota Vikings.
Gary Woods had spent the past 30 years as the "right-hand man" to McCombs and acted as president of McCombs Enterprises, the umbrella surrounding McCombs' various interests.
The pair decided in November 1999 to participate in a tax shelter known as "Current Options Bring Reward Alternatives," or COBRA, which they implemented by forming three sets of business entities, including the two partnerships, Tesoro Drive Partners and SA Tesoro Investment Partners.
Those partnerships bought shares in Sun Microsystems, and Tesoro Drive Partners sold its Sun Micro shares in December, resulting in a short-term capital gain of $5,000. Before the year was out, both partnerships were effectively liquidated. Woods and McCombs then claimed that the sale of the Tesoro Drive Investors assets resulted in an ordinary tax loss of $13.3 million. They said that unloading the other partnership's Sun shares resulted in a $32.2 million short-term capital loss for tax purposes.
Deeming those losses as invalid, however, the Internal Revenue Service sought to apply a 40 percent penalty for gross valuation misstatements,
Woods sought judicial review, and U.S. District Judge Harry Hudspeth ultimately agreed that the valuation-misstatement penalty did not apply even though the partnerships were properly disregarded as shams.
It unanimously decided Tuesday that "the penalty is applicable to tax underpayments resulting from the partners' participation in the COBRA tax shelter."
The 20-page decision defends the penalty under the Tax Treatment of Partnership Items Act of 1982, as Title IV of the Tax Equity and Fiscal Responsibility Act (TEFRA) of 1982.
"We hold that TEFRA gives courts in partnership-level proceedings jurisdiction to determine the applicability of any penalty that could result from an adjustment to a partnership item, even if imposing the penalty would also require determining affected or nonpartnership items such as outside basis," Justice Antonin Scalia wrote for the court.
In the case at hand, "the District Court had jurisdiction to determine the applicability of the valuation-misstatement penalty - to determine, that is, whether the partnerships' lack of economic substance (which all agree was properly decided at the partnership level) could justify imposing a valuation-misstatement penalty on the partners." (Parentheses in original.)
"When making that determination, the District Court was obliged to consider Woods' arguments that the economic-substance determination was categorically incapable of triggering the penalty," Scalia added. "Deferring consideration of those arguments until partner-level proceedings would replicate the precise evil that TEFRA sets out to remedy: duplicative proceedings, potentially leading to inconsistent results, on a question that applies equally to all of the partners."
Subscribe to Closing Arguments
Sign up for new weekly newsletter Closing Arguments to get the latest about ongoing trials, major litigation and hot cases and rulings in courthouses around the U.S. and the world.