The U.S. Supreme Court upheld a tax-shelter penalty on partnerships used by Billy Joe “Red” McCombs, the billionaire co-founder of Clear Channel Communications Inc. (CCMO:US) and former owner of pro football’s Minnesota Vikings.
The justices today unanimously backed the Internal Revenue Service’s interpretation of a provision that permits a 40 percent penalty on people who understate their capital-gains tax liability by inflating their “basis” -- that is, the cost of acquiring property that is later sold.
The case tested one aspect of the IRS’s effort to recoup billions of dollars from high-income taxpayers who set up shelters in the 1990s and 2000s.
The justices rejected contentions that the penalty provision doesn’t apply when the IRS treats the entire transaction as a sham, as it did in the case of McCombs and his business partner, Gary Woods.
“This is not a case where a valuation misstatement is a mere side effect of a sham transaction,” Justice Antonin Scalia wrote for the court. “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.”
Under COBRA, taxpayers used paper losses to offset real gains -- and reduce their tax liability. The two men used the tax-avoidance strategy in 1999, when McCombs was expecting high income because of a National Football League expansion.
The government said McCombs and Woods, acting on advice from the accounting firm Ernst & Young LLP, were able to claim $45 million in losses from transactions that actually cost them only $1.37 million.
The high court case concerned only the 40 percent penalty, not the underlying transactions. Lower courts were divided on the applicability of the penalty in sham-transaction cases. Congress changed the law in 2010 to explicitly allow the penalty for future cases.
The lawyer representing the partnerships, Greg Garre, declined to comment on the ruling.
The case is United States v. Woods, 12-562.
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