(Bloomberg) The U.S. Supreme Court will use a case involving billionaire Billy Joe “Red” McCombs to decide whether the federal government can impose hundreds of millions of dollars in penalties for the use of abusive tax shelters.
The justices said this week that they will hear an Obama administration appeal of a ruling favoring McCombs, the co-founder of Clear Channel Communications Inc. and former owner of the Minnesota Vikings and San Antonio Spurs.
The case will test one aspect of the Internal Revenue Service’s effort to recoup billions of dollars from high-income taxpayers who set up shelters in the 1990s and 2000s.
At issue is the scope of a provision that lets the IRS impose 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.
A federal appeals court said 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.
The two men used a tax-avoidance strategy known as COBRA in an effort to limit taxes in 1999, when McCombs was expecting high income because of the expansion of the National Football League. Under COBRA, taxpayers used paper losses to offset real gains -- and reduce their tax liability.
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 concerns only the 40 percent penalty, not the underlying transactions. A federal trial judge concluded that the losses should be disregarded for tax purposes and imposed a 20 percent penalty under a separate provision of the Tax Code. Woods and McCombs aren’t appealing on that issue.
Lower courts are divided on the applicability of the 40 percent penalty in sham-transaction cases. In court papers, the Obama administration said the rulings by the two federal appeals courts that have barred the penalties “will continue to cost the federal fisc hundreds of millions of dollars in forgone penalties.”
Woods, acting on behalf of the partnerships he and McCombs formed, urged the Supreme Court not to hear the case. Woods contended the effect would be limited because Congress changed the law in 2010 to explicitly allow the 40 percent penalty for future cases.
The Supreme Court will take up the case during the nine- month term that starts in October. The case is United States v. Woods, 12-562.