January 31, 2014
The Fifth Circuit has finally issued its opinion in NPR (as reflected in our prior coverage, this case was argued almost two years ago), a case involving a Son-of-BOSS tax shelter in which the district court absolved the taxpayers of penalties. The taxpayers were not as fortunate on appeal, as the Fifth Circuit handed the government a complete victory.
The court’s consideration of the two issues before the court of broadest applicability were overtaken by events — specifically, the Supreme Court’s December 2013 decision in United States v. Woods. See our report here. In line with that decision, the NPR court held that the penalty issue could be determined at the partnership level and that the 40% penalty was applicable because the economic substance holding meant that the basis in the partnership was overstated. This latter holding reversed the district court, which had relied on the Fifth Circuit precedents that were rejected in Woods.
The other issues resolved by the Court were mostly of lesser precedential value. First, the court affirmed the district court’s conclusion that a second FPAA issued by the IRS was valid because NPR had made a “misrepresentation of a material fact” on its partnership return.
Second, the court rejected the district court’s holding that the taxpayers could avoid penalties on the ground that there was “substantial authority” for their position. It criticized the district court for basing its “substantial authority” finding in part on the existence of a favorable tax opinion from a law firm (authored by R.J. Ruble who eventually went to prison as a result of his activities in promoting tax shelters). The court explained that a legal opinion cannot provide “substantial authority”; that can be found only in the legal authorities cited in the opinion. Here, the legal opinion had relied on the “Helmer line of cases,” which establish that contingent obligations generally do not effect a change in a partner’s basis. The court of appeals held that Helmer did not constitute substantial authority in a situation in which the transactions lack economic substance and in which the partnership lacked a profit motive. The court also observed that the IRS was correct in arguing that its Notice 2000-44 should be considered as adverse “authority” for purposes of the “substantial authority” analysis — albeit entitled to less weight than a statute or regulation.
Finally, the court overturned the district court’s finding that the taxpayers had demonstrated “reasonable cause” for the underpayment of tax. With respect to the partnership, the court stated flatly that “the evidence is conclusive that NPR did not have reasonable cause.” With respect to the individual partners, the court left a glimmer of hope, ruling that an individual partner’s reasonable cause can be determined only in a partner-level proceeding. Thus, the court merely vacated the district court’s finding of reasonable cause and left the individual partners the option of raising their own individual reasonable cause defenses (whatever those might be) in a partner-level proceeding.