On March 25th, the Supreme Court granted the government’s petition for certiorari in United States v. Woods, No. 12-562. The issue raised in the petition concerns the applicability of the valuation overstatement penalty to an overstatement of basis. The case involves overstatement of basis attributable to a transaction lacking “economic substance” and thus disregarded for tax purposes. Section 6662(a) and (b) apply a 20% penalty in the case of a 20% or greater overstatement of basis, referred to as a “substantial valuation misstatement.” Section 6662(e)(1)(A) applies a separate 20% penalty in when the overstatement is 150% or more than the correct value or basis. Section 6662(h)(2)(A)(i) provides a 40% when the overvaluation is 200% or more of the correct amount. This matter primarily effects transactions prior to March 30, 2010 when Congress passed §6662(i) imposing a 40% penalty on underpayments of tax liability due to a nondisclosed noneconomic substance transaction.
Circuit Courts have split on this question: The Fifth Circuit has held that the valuation overstatement penalty does not apply to tax attributes flowing from the insubstantial transaction because the understatement was not attributable to valuation overstatement, and the Ninth Circuit has followed with similar reasoning. Other Circuits have, however, interpreted applied the penalty to all tax attributes flowing from the failed transaction.
The Court has also added the question, for the parties to brief, of whether the district court had jurisdiction under §6226 to consider the substantial valuation misstatement penalty. This issue centers around whether the TEFRA issues should be resolved at a partner-level, or can be resolved at the partnership level.