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Supreme Court to weigh IRS penalties on alleged tax dodges

By Patrick Temple-West

WASHINGTON (Reuters) - The U.S. Internal Revenue Service's practice of slapping steep, 40-percent penalties on participants in certain alleged tax shelters will soon come to trial before the Supreme Court.

Though it rarely hears tax matters, the court has decided to weigh in on a case involving Texas billionaire Billy Joe "Red" McCombs, a former owner of professional sports teams.

The court's decision, not expected until June 2014, will likely have implications beyond McCombs' case, tax lawyers said.

Oral arguments will be scheduled when the high court's next term begins in October.

The Obama administration's solicitor general is arguing that "hundreds of millions of dollars" in tax penalties are hanging in the balance, according to court filings. However, the decision will only apply to cases brought prior to 2010.

The case being taken up by the court involves a 1999 transaction undertaken by McCombs and his business partner, Gary Woods. The government contends it had no purpose other than tax avoidance. The transaction was known as "current options bring reward alternatives," or COBRA.

According to the government, Woods and McCombs bought and sold options on foreign currencies to generate paper losses used to offset gains chiefly related to McCombs's sports ventures.

The IRS initially applied a 40-percent penalty on the unpaid taxes that the agency said were owed, but the 5th U.S. Circuit Court of Appeals in New Orleans ruled in 2012 that the 40-percent penalty did not apply in the Woods case.

Woods is already subject to a 20 percent tax penalty on COBRA and the Supreme Court need not step in, Woods's lawyer has argued in court filings.

The lawyer representing Woods did not respond to requests for comment. Calls to San Antonio-based McCombs Partners, an investment management business which lists both Red McCombs and Gary Woods on its website, were not returned.

The IRS did not comment.

The government is arguing Woods and McCombs claimed more than $45 million in losses in 1999, from transactions that cost them only $1.37 million.

The COBRA strategy has drawn attention beyond the Woods case. COBRA was among a number of alleged tax shelter strategies subject to an IRS crackdown a decade ago.

Congress in 2010 passed the Health Care and Education Reconciliation Act, which slapped a 40-percent penalty on transactions such as COBRA. The penalty was to apply to taxpayers found by the IRS to have made "gross valuation misstatements" on their tax filings.

With Congress ensuring that transactions like COBRA cannot escape the 40-percent penalty, a government win in the Woods case "won't have much impact on the future," said Andrew Roberson, a partner with law firm McDermott Will & Emery LLP.

For pre-2010 cases still in limbo, "it's obviously important for the IRS to get a win at the highest level," he said.

The Woods tax shelter was promoted by Big Four accounting firm Ernst & Young, according to court documents. This month, Ernst agreed to a $123 million settlement to resolve a federal investigation into tax shelters it promoted.

The case is United States v Woods No. 12-562 (http://www.supremecourt.gov/Search.aspx?FileName=/docketfiles/12-562.htm).

(Editing by Kevin Drawbaugh and Andrew Hay)

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