The Courts Weigh In: Mortgages, Penalties, and Taxes

Federal Cases Examine Bankruptcy, Valuation Standards

The Court of Appeals for the Eleventh Circuit weighs in on penalties for “gross valuation misstatement” in Gursthaw v. Commissioner, and the U.S. Bankruptcy Court for the Eastern District of Tennesee rules on the value of mortgage liens In re: Williams.

Gusthaw v. Commissioner
2012 U.S. App. LEXIS 20379
September 28, 2012
Judge Hull
United States Court of Appeals for the Eleventh Circuit

Summary:

Petitioner taxpayers sought review of a decision of the U.S. Tax Court, which affirmed the IRS’ imposition of the penalties. The taxpayers claimed substantial tax benefits from a tax shelter. The IRS later disallowed the claim and determined deficiencies in tax and accuracy-related penalties, including gross valuation misstatement penalties and a negligence penalty. The taxpayers conceded the deficiencies in tax, but contested the penalties. 

The Tax Court found that the taxpayers were liable for the 40% gross valuation misstatement penalty for 2000 through 2002, concluding that the underpayments in tax for those years resulted from claiming a basis in foreign currency on their 2000 return of $11,739,258, rather than a basis of zero, which was the correct amount when a transaction lacked economic substance. The taxpayers contended that because the tax-sheltered transaction lacked economic substance, there was no value or basis to misstate as to trigger the valuation misstatement penalties, and the penalties should not have been applied as a matter of law.

As a matter of first impression, the court considered whether the taxpayers were liable for the assessed gross valuation misstatement penalties when the IRS disregarded the Custom Adjustable Rate Debt Structure (CARDS) tax-sheltered transaction in its entirety because it lacked economic substance. The court concluded that the tax underpayments were “attributable to” a gross valuation misstatement within the meaning of 26 U.S.C.S. § 6662 and adopted the rule used in the majority of circuits, that the valuation misstatement penalty applied.  The judgment of the Tax Court was affirmed.  

In re Williams
2012 Bankr. LEXIS 4701
October 5, 2012
Judge Ducker
United States Bankruptcy Court for the Eastern District of Tennessee

Summary:

A creditor holding a second in priority deed of trust in a Chapter 13 debtor’s residence objected to a debtor’s plan that proposed to treat the claim as unsecured pursuant to 11 U.S.C.S. § 1322(b)(2).  The debtor contended that the value of the residence did not exceed the sum of the first lien and the real estate taxes, but the court disagreed. The court found that the appropriate timing for the valuation of the property was the date of confirmation. At the hearing, an experienced appraiser for each party qualified as an expert for valuing residential properties, but the court concluded that the value of the house was substantially closer to the value presented by the creditor’s appraiser than that given by the debtor’s appraiser. It reflected arm’s length transactions closer to the date of the confirmation hearing. Because the value of the house exceeded the sum of the first lien and the real estate taxes, the court did not permit the debtor to treat the creditor’s claim as unsecured.  The court sustained the creditor’s objection to the plan. 

Blak Investments v. Commissioner
T.C. Memo 2012-273
September 25, 2012
Judge Vasquez
United States Tax Court

Summary:

Petitioner tax matters partner filed an action against respondent Commissioner of the Internal Revenue Service, seeking judicial review of the commissioner’s determination that a California general partnership was a sham. In a prior ruling, the court found that the partnership was a sham. In this proceeding, the court addressed the issue of whether the partnership was liable under I.R.C. § 6662 for a 40%  penalty for a gross valuation misstatement. 

Although the tax matters partner initially contested the commissioner’s determination of the partnership, he subsequently conceded that the partnership was a sham and lacked economic substance, and that it was to be disregarded for federal income tax purposes. However, the partner disputed the commissioner’s determination that the partnership was subject to a 40%  accuracy-related penalty under I.R.C. § 6662(h) and moved for summary judgment on his claim.

The court noted that the U.S. Courts of Appeals were divided on the issue of when and under what circumstances the 40% penalty applied. However, the U.S. Court of Appeals for the Ninth Circuit had held that when a deduction or credit was disallowed in full, the resulting underpayment was not attributable to a valuation overstatement, and because California law governed the partnership, it was liable under Ninth Circuit precedent for the smaller 20%  accuracy-related penalty that was permitted under § 6662(a). 

The court stated that it would enter an order which found that the partnership was not liable for the 40% penalty for a gross valuation misstatement.