UNITED STATES v. WOODS
No. 12-562
SUPREME COURT OF THE UNITED STATES
December 3, 2013
571 U. S. ____ (2013)
Argued October 9, 2013
OCTOBER TERM, 2013
Syllabus
NOTE: Where it is feasible, a syllabus (headnote) will be released, as is being done in connection with this case, at the time the opinion is issued. The syllabus constitutes no part of the opinion of the Court but has been prepared by the Reporter of Decisions for the convenience of the reader. See United States v. Detroit Timber & Lumber Co., 200 U. S. 321, 337.
SUPREME COURT OF THE UNITED STATES
Syllabus
UNITED STATES v. WOODS
CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE FIFTH CIRCUIT
Respondent Gary Woods and his employer, Billy Joe McCombs, participated in an offsetting-option tax shelter designed to generate large paper losses that they could use to reduce their taxable income. To that end, they purchased from Deutsche Bank a series of currency-option spreads. Each spread was a package consisting of a long option, which Woods and McCombs purchased from Deutsche Bank and for which they paid a premium, and a short option, which Woods and McCombs sold to Deutsche Bank and for which they received a premium. Because the premium paid for the long option was largely offset by the premium received for the short option, the net cost of the package to Woods and McCombs was substantially less than the cost of the long option alone. Woods and McCombs contributed the spreads, along with cash, to two partnerships, which used the cash to purchase stock and currency. When calculating their basis in the partnership interests, Woods and McCombs considered only the long component of the spreads and disregarded the nearly offsetting short component. As a result, when the partnerships’ assets were disposed of for modest gains, Woods and McCombs claimed huge losses. Although they had contributed roughly $3.2 million in cash and spreads to the partnerships, they claimed losses of more than $45 million.
The Internal Revenue Service sent each partnership a Notice of Final Partnership Administrative Adjustment, disregarding the partnerships for tax purposes and disallowing the related losses. It concluded that the partnerships were formed for the purpose of tax avoidance and thus lacked “economic substance,” i.e., they were shams. As there were no valid partnerships for tax purposes, the IRS determined that the partners could not claim a basis for their partnership interests greater than zero and that any resulting tax under-
Held:
1. The District Court had jurisdiction in determining whether the partnerships’ lack of economic substance could justify imposing a valuation-misstatement penalty on the partners. Pp. 6–11.
(a) Because a partnership does not pay federal income taxes, its taxable income and losses pass through to the partners. Under the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), the IRS initiates partnership-related tax proceedings at the partnership level to adjust “partnership items,” i.e., items relevant to the partnership as a whole.
(b) Under TEFRA‘s framework, a court in a partnership-level proceeding has jurisdiction to determine “the applicability of any penalty . . . which relates to an adjustment to a partnership item.”
2. The valuation-misstatement penalty applies in this case. Pp. 11-16.
(a) A penalty applies to the portion of any underpayment that is “attributable to” a “substantial” or “gross” “valuation misstatement,” which exists where “the value of any property (or the adjusted basis of any property) claimed on any return of tax” exceeds by a specified percentage “the amount determined to be the correct amount of such valuation or adjusted basis (as the case may be).”
(b) Woods’ contrary arguments are unpersuasive. The valuation-misstatement penalty encompasses misstatements that rest on legal as well as factual errors, so it is applicable to misstatements that rest on the use of a sham partnership. And the partnerships’ lack of economic substance is not an independent ground separate from the misstatement of basis in this case. Pp. 12-16.
471 Fed. Appx. 320, reversed.
SCALIA, J., delivered the opinion for a unanimous Court.
NOTICE: This opinion is subject to formal revision before publication in the preliminary print of the United States Reports. Readers are requested to notify the Reporter of Decisions, Supreme Court of the United States, Washington, D. C. 20543, of any typographical or other formal errors, in order that corrections may be made before the preliminary print goes to press.
SUPREME COURT OF THE UNITED STATES
No. 12-562
UNITED STATES, PETITIONER v. GARY WOODS
ON WRIT OF CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE FIFTH CIRCUIT
[December 3, 2013]
JUSTICE SCALIA delivered the opinion of the Court.
We decide whether the penalty for tax underpayments attributable to valuation misstatements,
I. The Facts
A
This case involves an offsetting-option tax shelter, variants of which were marketed to high-income taxpayers in the late 1990‘s. Tax shelters of this type sought to generate large paper losses that a taxpayer could use to reduce taxable income. They did so by attempting to give the taxpayer an artificially high basis in a partnership interest, which enabled the taxpayer to claim a significant tax loss upon disposition of the interest. See IRS Notice 2000–44, 2000-2 Cum. Bull. 255 (describing offsetting-option tax shelters).
The particular tax shelter at issue in this case was developed by the now-defunct law firm Jenkens & Gilchrist and marketed by the accounting firm Ernst &
Over the next two months, acting through their respective wholly owned, limited liability companies, Woods and McCombs executed a series of transactions. First, they purchased from Deutsche Bank five 30-day currency-option spreads. Each of these option spreads was a package consisting of a so-called long option, which entitled Woods and McCombs to receive a sum of money from Deutsche Bank if a certain currency exchange rate exceeded a certain figure on a certain date, and a so-called short option, which entitled Deutsche Bank to receive a sum of money from Woods and McCombs if the exchange rate for the same currency on the same date exceeded a certain figure so close to the figure triggering the long option that both were likely to be triggered (or not to be triggered) on the fated date. Because the premium paid to Deutsche Bank for purchase of the long option was largely offset by the premium received from Deutsche Bank for sale of the short option, the net cost of the package to Woods and McCombs was substantially less than the cost of the long option alone. Specifically, the premiums paid for all five of the spreads’ long options totaled $46 million, and the premiums received for the five spreads’ short options totaled $43.7 million, so the net cost of the spreads was just $2.3 million. Woods and McCombs contributed the spreads to the partnerships along with about $900,000 in cash. The partnerships used the cash to purchase assets—Canadian dollars for the partnership that sought to produce ordinary losses, and Sun Microsystems stock
As the tax year drew to a close, Woods and McCombs transferred their interests in the partnerships to two S corporations. One corporation, Tesoro Drive Investors, Inc., received both partners’ interests in Tesoro Drive Partners; the other corporation, SA Tesoro Drive Investors, Inc., received both partners’ interests in SA Tesoro Investment Partners. Since this left each partnership with only a single partner (the relevant S corporation), the partnerships were liquidated by operation of law, and their assets—the Canadian dollars and Sun Microsystems stock, plus the remaining cash—were deemed distributed to the corporations. The corporations then sold those assets for modest gains of about $2,000 on the Canadian dollars and about $57,000 on the stock. But instead of gains, the corporations reported huge losses: an ordinary loss of more than $13 million on the sale of the Canadian dollars and a capital loss of more than $32 million on the sale of the stock. The losses were allocated between Woods and McCombs as the corporations’ co-owners.
The reason the corporations were able to claim such vast losses—the alchemy at the heart of an offsetting-options tax shelter—lay in how Woods and McCombs calculated the tax basis of their interests in the partnerships. Tax basis is the amount used as the cost of an asset when computing how much its owner gained or lost for tax purposes when disposing of it. See J. Downes & J. Goodman, Dictionary of Finance and Investment Terms 736 (2010). A partner‘s tax basis in a partnership interest—called “outside basis” to distinguish it from “inside basis,” the partnership‘s basis in its own assets—is tied to the value of any assets the partner contributed to acquire the interest. See
B
The Internal Revenue Service, however, did not treat the COBRA-generated losses as valid. Instead, after auditing the partnerships’ tax returns, it issued to each partnership a Notice of Final Partnership Administrative Adjustment, or “FPAA.” In the FPAAs, the IRS determined that the partnerships had been “formed and availed of solely for purposes of tax avoidance by artificially overstating basis in the partnership interests of [the] purported partners.” App. 92, 146. Because the partnerships had “no business purpose other than tax avoidance,” the IRS said, they “lacked economic substance“—or, put more starkly, they were “sham[s]“—so the IRS would disregard them for tax purposes and disallow the related losses. Ibid. And because there were no valid partnerships for tax purposes, the IRS determined that the partners had
Woods, as the tax-matters partner for both partnerships, sought judicial review of the FPAAs pursuant to
We granted certiorari to resolve a Circuit split over whether the valuation-misstatement penalty is applicable in these circumstances. 569 U. S. ___ (2013). See Bemont, supra, at 354-355 (Prado, J., concurring) (recognizing “near-unanimous opposition” to the Fifth Circuit‘s rule). Because two Courts of Appeals have held that District Courts lacked jurisdiction to consider the valuation-
II. District-Court Jurisdiction
A
We begin with a brief explanation of the statutory scheme for dealing with partnership-related tax matters. A partnership does not pay federal income taxes; instead, its taxable income and losses pass through to the partners.
Before 1982, the IRS had no way of correcting errors on a partnership‘s return in a single, unified proceeding. Instead, tax matters pertaining to all the members of a partnership were dealt with just like tax matters pertaining only to a single taxpayer: through deficiency proceedings at the individual-taxpayer level. See generally
Under TEFRA, partnership-related tax matters are
B
Under the TEFRA framework, a court in a partnership-level proceeding like this one has jurisdiction to determine not just partnership items, but also “the applicability of any penalty . . . which relates to an adjustment to a partnership item.”
The Government‘s theory of why the penalty was triggered is based on a straightforward relationship between the economic-substance determination and the penalty. In
Woods, however, argues that because outside basis is not a partnership item, but an affected item, a penalty that would rest on a misstatement of outside basis cannot be considered at the partnership level. He maintains, in short, that a penalty does not relate to a partnership-item adjustment if it “requires a partner-level determination,” regardless of “whether or not the penalty has a connection to a partnership item.” Brief for Respondent 27.
Because
Under TEFRA‘s two-stage structure, penalties for tax underpayment must be imposed at the partner level, because partnerships themselves pay no taxes. And imposing a penalty always requires some determinations that can be made only at the partner level. Even where a partnership‘s return contains significant errors, a partner may not have carried over those errors to his own return; or if he did, the errors may not have caused him to underpay his taxes by a large enough amount to trigger the penalty; or if they did, the partner may nonetheless have
Other provisions of TEFRA confirm that conclusion. One requires the IRS to use deficiency proceedings for computational adjustments that rest on “affected items which require partner level determinations (other than penalties . . . that relate to adjustments to partnership items).”
These considerations lead us to reject Woods’ interpretation of
Applying the foregoing principles to this case, we conclude that 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. 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. 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.
To be sure, the District Court could not make a formal adjustment of any partner‘s outside basis in this partnership-level proceeding. See Petaluma, 591 F. 3d, at 655. But it nonetheless could determine whether the adjustments it did make, including the economic-substance determination, had the potential to trigger a penalty; and in doing so, it was not required to shut its eyes to the legal impossibility of any partner‘s possessing an outside basis greater than zero in a partnership that, for tax purposes, did not exist. Each partner‘s outside basis still must be adjusted at the partner level before the penalty can be imposed, but that poses no obstacle to a partnership-level court‘s provisional consideration of whether the economic-substance determination is legally capable of triggering
III. Applicability of Valuation-Misstatement Penalty
A
Taxpayers who underpay their taxes due to a “valuation misstatement” may incur an accuracy-related penalty. A 20-percent penalty applies to “the portion of any underpayment which is attributable to . . . [a]ny substantial valuation misstatement under chapter 1.”
“there is a substantial valuation misstatement under chapter 1 if . . . the value of any property (or the adjusted basis of any property) claimed on any return of tax imposed by chapter 1 is 200 percent or more of the amount determined to be the correct amount of such valuation or adjusted basis (as the case may be).”
§6662(e)(1)(A) (2000 ed.).
If the reported value or adjusted basis exceeds the correct
The penalty‘s plain language makes it applicable here. As we have explained, the COBRA transactions were designed to generate losses by enabling the partners to claim a high outside basis in the partnerships. But once the partnerships were deemed not to exist for tax purposes, no partner could legitimately claim an outside basis greater than zero. Accordingly, if a partner used an outside basis figure greater than zero to claim losses on his tax return, and if deducting those losses caused the partner to underpay his taxes, then the resulting underpayment would be “attributable to” the partner‘s having claimed an “adjusted basis” in the partnerships that exceeded “the correct amount of such . . . adjusted basis.”
An IRS regulation provides that when an asset‘s true value or adjusted basis is zero, “[t]he value or adjusted basis claimed . . . is considered to be 400 percent or more of the correct amount,” so that the resulting valuation misstatement is automatically deemed gross and subject to the 40-percent penalty.
B
Against this straightforward application of the statute,
We are not convinced. To begin, we doubt that “value” is limited to factual issues and excludes threshold legal determinations. Cf. Powers v. Commissioner, 312 U. S. 259, 260 (1941) (“[W]hat criterion should be employed for determining the ‘value’ of the gifts is a question of law“); Chapman Glen Ltd. v. Commissioner, 140 T. C. No. 15, 2013 WL2319282, *17 (2013) (“[T]hree approaches are used to determine the fair market value of property,” and “which approach to apply in a case is a question of law“). But even if “value” were limited to factual matters, the statute refers to “value” or “adjusted basis,” and there is no justification for extending that limitation to the latter term, which plainly incorporates legal inquiries. An asset‘s “basis” is simply its cost,
To overcome the plain meaning of “adjusted basis,” Woods asks us to interpret the parentheses in the statutory phrase “the value of any property (or the adjusted basis of any property)” as a signal that “adjusted basis” is merely explanatory or illustrative and has no meaning inde-
Our holding that the valuation-misstatement penalty encompasses legal as well as factual misstatements of adjusted basis does not make superfluous the new penalty that Congress enacted in 2010 for transactions lacking in economic substance, see §1409(b)(2), 124 Stat. 1068–1069 (codified at
C
In the alternative, Woods argues that any underpayment of tax in this case would be “attributable,” not to the misstatements of outside basis, but rather to the determination that the partnerships were shams—which he describes as an “independent legal ground.” Brief for Respondent 46. That is the rationale that the Fifth and Ninth Circuits have adopted for refusing to apply the valuation-misstatement penalty in cases like this, although both courts have voiced doubts about it. See Bemont, 679 F. 3d, at 347–348; id., at 351-355 (Prado, J., concurring); Keller v. Commissioner, 556 F. 3d 1056, 1060–1061 (CA9 2009).
We reject the argument‘s premise: The economic-substance determination and the basis misstatement are not “independent” of one another. This is not a case where a valuation misstatement is a mere side effect of a sham transaction. Rather, the overstatement of outside basis was the linchpin of the COBRA tax shelter and the mechanism by which Woods and McCombs sought to reduce their taxable income. As Judge Prado observed, in this type of tax shelter, “the basis misstatement and the transaction‘s lack of economic substance are inextricably intertwined,” so “attributing the tax underpayment only to the artificiality of the transaction and not to the basis over-
Woods contends, however, that a document known as the “Blue Book” compels a different result. See General Explanation of the Economic Recovery Tax Act of 1981 (Pub. L. 97–34), 97 Cong., 1st Sess., 333, and n. 2 (Jt. Comm. Print 1980). Blue Books are prepared by the staff of the Joint Committee on Taxation as commentaries on recently passed tax laws. They are “written after passage of the legislation and therefore d[o] not inform the decisions of the members of Congress who vot[e] in favor of the [law].” Flood v. United States, 33 F. 3d 1174, 1178 (CA9 1994). We have held that such “[p]ost-enactment legislative history (a contradiction in terms) is not a legitimate tool of statutory interpretation.” Bruesewitz v. Wyeth LLC, 562 U. S. ___, ___ (2011) (slip op., at 17–18); accord, Federal Nat. Mortgage Assn. v. United States, 379 F. 3d 1303, 1309 (CA Fed. 2004) (dismissing Blue Book as “a post-enactment explanation“). While we have relied on similar documents in the past, see FPC v. Memphis Light, Gas & Water Div., 411 U. S. 458, 471–472 (1973), our more recent precedents disapprove of that practice. Of course the Blue Book, like a law review article, may be relevant to the extent it is persuasive. But the passage at issue here does not persuade. It concerns a situation quite different from the one we confront: two separate, non-overlapping underpayments, only one of which is attributable to a valuation misstatement.
*
*
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The District Court had jurisdiction in this partnership-level proceeding to determine the applicability of the valuation-misstatement penalty, and the penalty is applicable to tax underpayments resulting from the partners’ participation in the COBRA tax shelter. The judgment of the Court of Appeals is reversed.
It is so ordered.