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Partnership form and IRS penalties: Supreme Court hears tax case

The U.S. Supreme Court does not accept tax cases very often. But earlier this month, the Court heard oral arguments in United States v. Woods, a case involving a challenge by two businessmen to the severe tax penalty imposed on them by the IRS.

The two businessmen formed a partnership that used losses from a tax shelter to offset a windfall gain that one of the partners was expecting. The partner expecting the windfall was a high-profile Texan named Red McCombs, who has owned such sports teams as the San Antonio Spurs and Minnesota Vikings.

The IRS performed an audit and then sought to collect not only back taxes, but also a hefty tax penalty of 40 percent. Lower courts have determined that the type of tax shelter that the partners used was improper. But the Supreme Court has agreed to decide whether the partnership form used by McCombs and the other businessman should protect them from the IRS tax penalty.

The two taxpayers are arguing that the tax penalty does not apply to them as individuals. Their contention is that the penalty applies only to the partnership that they formed.

Not surprisingly, the government takes the contrary view. The IRS asserts that when individuals file returns that are consistent with the partnership return, a tax penalty against the partnership can be applied against the individuals who make up the partnership.

The Supreme Court is expected to rule on the case by next June. The Court's decision should help to clarify the role that partnerships can play in creating viable tax shelters.

Source: Reuters, "Tax penalty for two Texans? Supreme Court weights partner problem," Patrick Temple-West, Oct. 9, 2013

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