United States v. Woods, 134 S. Ct. 557

Background

Woods and McCombs used a COBRA offsetting-option tax shelter: they purchased option spreads (long and nearly offsetting short options) and contributed those spreads plus cash to two partnerships to generate large tax losses.
They calculated outside partnership basis by counting only the long options and ignoring the short legs, producing an inflated outside basis (~$48M) from an actual cash/spread contribution of about $3.2M.
The partnerships liquidated; S corporations sold partnership-distributed assets for modest gains but reported huge losses based on the inflated basis; the IRS issued FPAAs disallowing the losses and treating the partnerships as sham (lacking economic substance).
The IRS characterized partners’ outside-basis overstatements as valuation misstatements and asserted the 40% gross valuation-misstatement penalty under 26 U.S.C. §6662(h) (as then in effect), because a zero correct basis (sham) makes any positive claimed basis a gross misstatement under Treasury Reg. §1.6662–5(g).
District Court found partnerships sham but held the valuation‑misstatement penalty did not apply; Fifth Circuit affirmed. The Supreme Court granted certiorari to resolve whether the penalty applies and whether a partnership‑level court has jurisdiction to determine its applicability.

Issues

Issue	Plaintiff's Argument (Woods)	Defendant's Argument (U.S.)	Held
Whether a partnership‑level court has jurisdiction under TEFRA to determine applicability of a penalty that depends on partner‑level items	TEFRA bars partnership courts from deciding penalties that require partner‑level determinations; penalties tied to outside basis (an affected item) must await partner‑level proceedings	TEFRA authorizes partnership courts to provisionally decide applicability of any penalty that "relates to" a partnership‑item adjustment; such determinations are provisional and avoid duplicative litigation	The Court: Partnership courts have jurisdiction to determine the applicability of penalties that relate to partnership‑item adjustments; the determination is provisional and partners may raise defenses later
Whether the valuation‑misstatement penalty (§6662) applies when an asserted outside basis results from a transaction later disregarded as lacking economic substance	"Value"/"valuation" means factual value only; legal shams do not produce a valuation misstatement; the sham determination is an independent legal ground, so the penalty is inapplicable	Overstating adjusted basis is a valuation misstatement; "adjusted basis" includes legal elements and misstatements of law fall within §6662; if correct basis is zero, regulation deems the misstatement gross	The Court: The valuation‑misstatement penalty applies; misstatements of adjusted basis grounded in legal error (sham) fall within the statute and when correct basis is zero the misstatement is gross
Whether a sham determination is an independent ground that precludes attributing underpayment to a basis misstatement	The sham ruling, not the basis overstatement, is the operative cause of any underpayment; they are distinct	The basis overstatement and sham are inextricably linked in shelters like COBRA; the underpayment is attributable to the basis misstatement caused by the sham	The Court: The sham finding and basis misstatement are not independent here; the underpayment is "attributable to" the valuation (adjusted‑basis) misstatement
Whether statute/regulatory math (division by zero) or other interpretive rules bar treating zero correct basis as a 400%+ misstatement	Mathematical/interpretive concerns render the regulation/penalty inapplicable when correct amount is zero	Treasury regulation treats claimed basis vs. zero correct basis as gross misstatement; statute and regulation apply	The Court: Assumes validity of the Treasury regulation and applies it; a zero correct basis is treated as a gross misstatement for penalty purposes

Key Cases Cited

United States v. Detroit Timber & Lumber Co., 200 U.S. 321 (affirming that a syllabus is not part of the Court's opinion)
Powers v. Commissioner, 312 U.S. 259 (legal questions can govern valuation determinations)
Reiter v. Sonotone Corp., 442 U.S. 330 (conjunctions like "or" ordinarily give separate meanings)
Bemont Invs., LLC v. United States, 679 F.3d 339 (5th Cir. case holding valuation‑misstatement penalty inapplicable; Court critiques and reverses that approach)
Jade Trading, LLC v. United States, 598 F.3d 1372 (Fed. Cir. precedent on partnership/penalty jurisdiction cited in circuit split)
Petaluma FX Partners, LLC v. Commissioner, 591 F.3d 649 (D.C. Cir. decision addressing TEFRA jurisdiction and penalty scope)