Federal Case Law Weighs In On Partnership Interests, Charitable Contributions

A Valuation Misstatement Results in Tax Underpayment; An Appraisal is “Not Qualified.”

In Alpha I, L.P., v. United States, Judge O’Malley of the U.S. Court of Appeals for the Federal Circuit considers the legitimacy of certain partnership transfers to charitable remainder unitrusts (CRUTs).  In Rothman v. Commissioner, Judge Laro at the U.S. Tax Court rules on the importance of a “qualified appraisal.” 

Alpha I, L.P. v. United States
2012 U.S. App. LEXIS 12216
June 15, 2012
Judge O’Malley
United States Court of Appeals for the Federal Circuit

Summary:

Plaintiff taxpayers, partnerships, and individuals, and defendant United States Internal Revenue Service (IRS) filed appeals from the United States Court of Federal Claims, which dismissed for lack of jurisdiction, the IRS’s determination that certain individual taxpayers’ transfers of their partnership interests to charitable remainder unitrusts (CRUTs) in a Son-of-BOSS arrangement were sham transactions, and that accuracy-related penalties were applicable. 

The partnerships paired short-sale losses with capital gains to reduce their tax liability. The Court of Claims determined it lacked jurisdiction to determine the identity of the true partners in the partnership at issue. The Federal Circuit reversed, holding that such a finding was appropriately determined at the partnership level because partnership identity could affect the distributive shares reported to the partners. The IRS had determined that the losses should be disregarded, or at least not be deductible, and that the transfers of the partnership interests to the CRUTs were shams, so none of the transactions of the partnership increased the amount considered at-risk for an activity under 26 U.S.C.S. § 465(b)(1).

The lower court found that taxpayers’ concession of the IRS’s adjustments rendered the valuation misstatement penalties moot.

That finding was vacated, because the underpayment of tax was attributable to the alleged valuation misstatement. The court erred when it granted the taxpayers summary judgment on the issue whether a 40%  penalty should apply. Whether a negligence penalty applied was premature until the distributive shares were determined.  The holding that a gross valuation penalty is inapplicable was vacated, and those issues were remanded. Taxpayers’ appeal of the negligence penalty was dismissed without prejudice to reassertion as premature.

Rothman v. Commissioner
T.C. Memo 2012-163
June 11, 2012
Judge Laro
United States Tax Court

Summary:

Petitioner taxpayers, a married couple who had claimed a $247,010 non-cash charitable contribution deduction in connection with their donation of a conservation easement to a § 501(c)(3) entity, and respondent IRS, which disallowed the deduction and imposed penalties, cross-moved for partial summary judgment as to whether the appraisal obtained in connection therewith was a “qualified appraisal” within the meaning of 26 U.S.C.S. § 170.

Petitioners had obtained an appraisal in connection with their donation of a conservation easement. The IRS disallowed it on findings that petitioners did not satisfy § 170 and did not show that the easement’s value was $290,000. In seeking review, petitioners argued that the appraisal actually or substantially complied with Treas. Reg. § 1.170A-13(c)(3) while the IRS claimed that most of the regulatory criteria were not met.

The court granted the IRS’ motion. First, the appraisal not only lacked a valuation method, but also failed to explain how identified factors impacted value and lacked a qualitative analysis of the easement’s terms and conditions. The appraisal’s substantial defects also foreclosed application of the substantial compliance doctrine. Next, it held that the appraisal, when taken as a whole, did not actually or substantially comply with the requirements of § 1.170A-13(c)(3). Among the deficiencies were that the appraisal was made earlier than 60 days before the contribution date, that the record was unclear as to whether the report was prepared by a “qualified appraiser,” and that the description of the donated property was inaccurate and otherwise insufficient. 

The court concluded that the appraisal was not a “qualified” one because it failed to include a valuation method or a specific basis for the value determined as required by § 1.170A-13(c)(3) and that the substantial compliance doctrine did not apply. It thereupon granted partial summary judgment to the IRS on the issue of whether the appraisal was “qualified.”

SAS Inv. Partners v. Commissioner
T.C. Memo 2012-159
June 6, 2012
Judge Vasquez
United States Tax Court 

Summary:

This was is a partnership-level proceeding subject to the unified audit and litigation procedures of the Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. No. 97-248, 96 Stat. at 648. 

The sole issue for decision was whether petitioner partnership had a valid I.R.C. § 6664(c)(1) reasonable cause defense to the penalties respondent IRS determined as a result of a Son-of-BOSS transaction in 2001.  The court determined that the transaction at issue, known as a Son-of-BOSS transaction, would have reduced the partner’s total income by nearly $2 million.

The partnership claimed that it relied on advice from numerous professionals and, therefore, had a reasonable cause defense under I.R.C. § 6664(c)(1). The record revealed that the partnership was not created for the purpose of carrying on a trade or business, but, rather, as part of a tax shelter that would allow the partner to receive partnership property with an inflated basis. Any reliance placed on advice from certain professionals lacked good faith because there was no question that one of those professionals was a “promoter” of the 2001 Son-of-BOSS transaction. 

He participated in structuring the transaction, arranged the entire deal, provided a copy of the opinion letter, and profited from selling the transaction to numerous clients. He also based his fee on a percentage of the tax benefits he produced.

Because that professional promoted the transaction and the partner knew of his conflict of interest, the partner, on behalf of the partnership, could not rely on his advice or an opinion letter he obtained in good faith.  The court entered a decision for the IRS.

Peter H. Agrapides, MBA, AVA, is a Principal at Western Valuation Advisors, which has offices in Salt Lake City, Utah, and Las Vegas, Nevada. Mr. Agrapides’ practice focuses primarily on valuations for gift and estate tax reporting. He has experience valuing companies in a diverse array of industries. These engagements have ranged from small, family owned businesses to companies over $1billion. Reach him at panayotiagra@yahoo.com.