for us this morning in case twelve five sixty two united states versus woods mr stewart mr chief justice and may it please the court the merits question in this case is whether the substantial valuation misstatement penalty applies when a taxpayer overstates his basis and property in connection with a transaction that is later determined to be a sham the threshold jurisdictional question is whether the court in this tough or a partnership level proceeding has authority to decide that merits a shoot i'd like to begin with the jurisdictional question and before i focus the court's attention on the text i'd like to make two quick preliminary observations about jurisdiction the first is that the question we say is appropriate for resolution in partnership level proceedings is not whether any individual partner will actually be made to pay the penalty there's no question in this case that the determination of whether the penalty will actually be imposed on individual partners and if so in what amount is properly reserved for partner level proceedings the question is simply whether the court in the partnership level proceeding can make the threshold determination whether the sort of error that the i r s identifies on the partnership return can trigger a penalty down the road if the individual partner prepares his or her return in a manner consistent with the partnership return scuse me and i i thought i understood that to be the your point in your brief but i there's one thing missing from here i also thought you were saying that you could impose the penalty before the amount was determines on the partnership level with a tax that you could without a notice of deficiency require payment up front there are two separate questions here the first is what can be determined at the partnership level and once the partnership level proceedings are complete there are subsidiary partner level proceedings and some partner level proceedings require a deficiency notice some partner level proceedings do not know what is part of our position that once the applicability of the penalty has been determined at the partnership level the penalty can then be imposed on individual partners in partner level proceedings without a deficiency notice it can still be challenge through a refund proceeding but because there was never the imposition of additional part tops or penalties on the partnership itself that is than in cancun eighty of your position in my mind you claim that the decision of of whether or not or what the true value is of the basis and how much needs to be paid can't be determined until the partnership level until the partner level determination yet you're claiming that you're entitled to an amount of money before hand before that decision is made there's a tension in my mind about that at all let me explain as best i can the sequence of events that we think would unfold if this court of firmed our view of the both held that the courts below had jurisdiction and agreed with our view of the way the penalty is supposed to operate if the court agreed with the position that we take  part two of our marriage brief namely that a deduction that is claimed in connection with a transaction that is later to determine to be a sham can trigger the if they agreed if you agree with us on that legal issue then the s would examine the returns of the individual partners and it would verify that they did in fact claim deductions in connection with this transaction because they would have this court's agreement with the proposition that that's the sort of thing that can trigger the penalty they would then determine what the amount of the overpayment what of the underpayment was and they would presumably assess a forty percent penalty on that there would be a subsidiary question because that f but the final partnership administrative adjustment said that the partnerships were shams but it also said that the individual transactions the purchases and sales of the auctions and the currency and the stock they would be treated as though they had been engaged in by the individual partners and so at the partner level there might be further determinations about what a relatively small amount of tax the individual partners would owe on that and then if a partner if a penalty were assessed on the partner the partner would have to pay the penalty before challenging it in through a refund option but what we might want to ask on what ground could the partner want to challenge the penalty at that point the partner couldn't at that stage want to make the argument that's being made in this court namely that this is just not the sort of situation to which the substantial valuation misstatement penalty applies because that issue would have already been resolved against the partner in this proceeding but by hypothesis if the court agrees with us on the merits and so the partner would have had an opportunity to get that crche old legal issue resolved without prepaying the penalty first now if an individual partner wanted to raise the good faith reasonable cause defense that's provided  twenty six u s c six six six four c the partner would have to pay the penalty first before seeking a refund but that's pretty clearly consistent with congress intent because congress specified intent for itself that after the court in the partnership level proceeding has determined the applicability of the penalty the partner can still through refund proceedings contend that the penalty was erroneously imposed and that language tells us two things it tells us first that congress didn't see any necessary unfairness in requiring a partner to pay the penalty first before raising certain sorts of challenges and it also indicates that by applicability congress must have meant something different from  penalty alternately be imposed because of the partnership level determination that the penalty was applicable met that all of the requirements for imposition were satisfied there'd be no room for all the partner to argue down the road that the penalty was erroneous lee proceeding or we mean is that the court in the partnership level proceeding should resolve the legal issue that is addressed in part two of the respective briefs for the petitioner and the respondent that is the court should determine if it is the substantial valuation misstatement penalty the sort of penalty that can apply to a basis over statement that is produced through a sham transaction we wouldn't ask the court in the partnership level proceeding to go beyond that legal determination to ask whether individual partners had actually underpaid their tax or whether they had actually misstated basis it's always theoretically possible in a case like this that the partnership could be determined that the partner could participate in sham transactions but by the time it was he had to file his own return he could get cold feet or he could get legal advice that indicated this just isn't going to work and so it's possible that the partner could prepare as return in a way that was lawful and  after the partnership level proceedings were complete would have to look at the partner return in order to see what that would what would happen i think the main practical i'm sure she's going to ask you if the question  determent of whether the ship transaction is their own is statement the basis if that were determined at the partner level in a partnership proceeding would it be possible to have different outcomes yes absolutely the respective different partners absolutely and that and i think that's the main practical difference between the way the system would operate under our view of tougher and the way it would operate under respondants view that is under which any would have to read litigate the same issue under respondent spew the i r s was not required to say anything at all in the f pop about the potential imposition of basis over statement penalties down the road if the epa adjustments that shamming determination had been upheld at the partnership level under respondents few the i r s could then assess penalties against individual partners and if the individual partners raised in objection the same arguments that are raised in part two of the respondents merits briefs that would have to be litigated potentially by different judges in different partnership and but different partners level proceedings with potentially inconsistent outcomes legal it fair way to look at this to say that what you do in the partnership level is anything that doesn't require looking at an individual's tax return i think that's a fair way to put it another way we would put it is any question that will necessarily have the same answer for all partners should be resolved at the partnership level that is the legal issue that's brief in part two of the party's respective merits briefs we may be right despondent may be right but the answer is going to be the same for all partners either this is the sort of basis overstatement that can trigger the penalty or it isn't that the second practical difference that i wanted to allude to at least briefly between our position and the respondents is that sixty two twenty six f is the provision that deals with the court's jurisdiction in a partnership level proceeding sixty two twenty one is the provision that tells the i r s what it's supposed to do at the partnership level and it also tells the i r s determine the applicability of any penalty that's related to an adjustment to a partnership of adjustment that down the road could trigger the imposition of penalties that's the sort of thing an individual partner would want to know in deciding whether to challenge the adjustment is it correct that your position would allow the i r s to the normal statute of limitations i don't even see now i don't see how i'm i'm not sure exactly what argument you're referring to but there are i mean there are provisions that deal with the way the limitation periods runs depending on when the partnership return is filed and when the partner returns are filed but i don't see how about what happened we would still be subject in assessing penalty use against any individual partners to whatever limitations period the code provides and either we would or would not have obtained a legal ruling on the legal issue whether the penalties are the sort that could follow from this partnership or item adjustment but i don't think it would have implications for the statute of limitations and the adjustment to the park partnership item is the shamming determination the determination that the partnerships were not engaged in for business purposes that they were engaged in purely as tax avoidance measures and responde concedes that this is a partnership item because respondent concedes that the district court had authority to review the shamming determination i decided whether that determination was appropriate and that concession necessarily depends upon the proposition that the determination that the partnerships are shams was an adjustment to a partnership item and it make makes sense for two reasons first because the determination of whether these are valid partnerships necessarily underlies any other deter a nation that the i r s would make about the proper tax treatment of items reported on the partnership return and second it is the sort of determination that is going to have one answer for every partner either the partnership is a sham or it's not but it can't be the case that a particular partnership is a sham with respect to some partners and not others but judge sentinel said in his opinion the d c circuit is that based and agreeing with everything you've said that means that the misstatement of bases might be obvious on the individual partner's returns what's wrong with it with the obvious but it still is made on those returns and therefore that doesn't fall as a partnership  now we would agree with judge in till that outside basis in and of itself is not a partnership item and outside basis in an op itself is not designated as one of the things that the court in a partnership will proceeding can determine but there and usually it would be inappropriate to determine outside basis at that stage because typically outside basis will vary from partner to partner but there are some instances in which a court needs to determine outside basis when would it vary from partner partner i mean in the in the more typical case the outside basis would deter but depend upon the amount that a particular partner had paid for his own partnership interest and so in that situation not every partner would necessarily have have paid the same thing but there are fairly rare situations in which in order to make some determination that is specified in sixty two twenty six f the i or the court and the i r s along the way have to determine an outside basis and one example we gave on page thirty two of our brief we have a footnote that says it's not implicated here but outside basis is sometimes a component of a partnership item such as inside basis and we cite a case that was ultimately decided by this court but it's a case in which a partnership took advantage of code proceedings that said you can step up your inside basis to match the outside bases of your partner but are there isn't that your position in this case th the i arrest and the court would have to make certain to turn would would have to decide what is the proper outside basis in a sham partnership if a lawyer were asked were if a lawyer saw an adjustment that said we regard these partnerships as sham and the lawyer were asked does that mean that i could be subject to the substantial valuation misstatement penalty if i reported to duck sions on purported losses from that partnership the only way the lawyer would answer that question is to ask well what's i wouldn't i wouldn't put it that way i mean i think in this what and why is that because i think that's not really the reason we're saying the court needs to i pointed the court to a different case in which outside bases had to be determined at the partnership level for a different reason namely because it was a in that case it was a component of inside basis and since inside basis is a partnership item you can only determine that partnership item by reference to the outside basis here we have a somewhat different argument we're saying the thing that had to be determined at the partnership level was the applicability of the penalties and the only way you can decide whether the substantial valuation misstatement penalty is applicable is to determine what would be true bas if the government could choose either one would be good to have any choice i mean in some instances the government will the government will pick the one that it thinks is easiest to prove some of the penalties are limited to twenty percent whereas some can be bumped up to forty percent and we would look for the forty percent penalty but if i could on page eighteen a we're talking about section six six six two b and it says state under payment to which section applies and then it says this section shall apply to the portion of any underpayment which is attributable to one or more of the following and that was six items subsection three is the substantial valuation misstatement penalty that we're relying on here subsection six is a disallowance a claim tax benefits by reason of a transaction lacking you cannot mix substance that the two thousand and ten penalty note that the two point cited make or first it's very clear that many many cases that would fall under subsection six would also fall under subsection one or two that is they could involve negligence or disregard of rules  regulations they could also involve a substantial understatement of income tax which basically means any under statement of income tax that ten percent or more of the true tax oh and so if there is no income group in saying subsection should apply to some cases where one or two and two would also apply there shouldn't be any greater in congruity in saying it can apply to some cases where subsection three would apply the other point i would make pertains to the introductory language of that provision and it says this section shall apply to the portion of any underpayment which is attributable to one or more of the following and i think the primary practical significance of the one or more language is that it functions as an p stock and provision it tells you it doesn't matter whether you're under payment triggers only one of these penalties or all six of them you're still limited to twenty percent unless you can get the forty percent through some other provision so we can't take advantage of the fact that the penalty that more than one penalty applies to a particular transaction by get twenty percent on top of twenty percent on top of twenty percent but the very fact that congress used that language which is attributable to one or more of the following indicates that it anticipated situations in which particular under payments would be attributable to more than one of those penalties it didn't see any anomaly in the idea that a penalty that triggers subsection three could trigger subsection one or two and again there's no reason to think that there's a greater anomaly with respect to subsection six the other thing i would say is that in this case three and if it arose in connection with a transaction that occurred today three and six would be called terminus either of them would apply but there will be plenty of cases in which a substantial valuation misstatement penalty on our view could be triggered by a legal error in computing basis such as use of the wrong depreciation right that would do it if i could focus at a somewhat higher level of abstraction i understand the general underlying thrust of your friend's position to  that overstatement of basis goes to you know miscalculations unit it was actually one thousand dollars you say it's forty thousand dollars and that's where the penalty comes from well this case is quite different we're kind of wiping out the whole transaction and then you're kind of artificially saying well when and if you wipe out the whole thing when you come to basis it should be this and that and it's not sort of a miss or fraud or misstatement with respect to the base itself it follows from a broad sham determination and that sham determination is made at the partnership level not the partner level i guess the two things that are at least two things i would say in response to that are that here the whole point of the if we don't scheme was to create an artificially inflated basis that is a high high basis that sql aimed on the individual's returns was not simply a fortuitous result of an avoidance scheme that operated through some other means the whole point but if you want to claim a loss on a transaction where you didn't incur and actually economic loss you can do it either by under by understating the amount that you were paid for the asset or by overstating your basis and this is one of a number of toxic poison schemes that operate by overstating basis so it's true that the transaction was determined to be a sham but the sham determination was intimately balland up with the fact that the whole purpose of the scheme was to create an inflated basis and i understand it but if you were telling people what happened here maybe you would i don't know that your first statement would be they overstated their bases i think you would say they engaged in a completely sham transaction with had which had some obvious is as the d c circuit put it obvious consequences but still the driving determination was that it was a sham transaction i guess the the other couple points i would make or there's nothing illegal about engaging in a transaction that lacks economic substance that is if the partners had engaged in the use offsetting currency transactions but then had decided before filing their return that either we no longer believe that this is right conduct or we believe we're going to get caught and they have protect prepare their returns  lawful way nothing wrong bad would have happened to the thing that subjects them to potential penalties is the fact that they claimed a large loss on their tax returns and they did that by claiming a large false basis in the partnership that the second thing i would say is you know when i took math in junior high in high school the teacher would always tell us to show your work when you handed in an assignment don't just give the answer at the end indicate the process by which you arrived at that number and innocence in essence when the code says impose penalties on under two payments that are attributable to the following things it says that it means we're going to look at your work when we determine that you have paid too little tax we're going to look at the calculation process by which you arrive at the amount on your own return and figure out where you went wrong and if they did that here they would say the mistake is taxpayers made the reason that they didn't pay as much perhaps as they owed was not that they claim to have sold the assets the it was not that they claim to have sold the assets for less than they actually realized it was that they claimed a basis for that had no founding in reality and the last thing i would say and in connection with that is it's no accident that this scheme operated through the creation of sham partnerships that is if the taxpayers themselves had but the offsetting the long and short currency options there would have been kno you mr chief justice and may it please the court on both jurisdiction and the merits the government is asking this court to adopt an overly expansive interpretation of the code to reach a result that would upset the statutory scheme devised by congress and lead t further problems down the road now in jurisdiction i think the most important thing for the court to recognize is that outside basis the very thing as you can tell from my friend's arguments on the merits that the imposition of this penalty depends on  a partnership item in fact our it's seems as though you and the government if we sort of the nature of this problem which is you have a partnership item which is the sham determination that the it's to an adjustment in outside basis with which as you just said it's not a partnership item is instead an affected item and that leads to a penalty right so there's kind of three things two steps in the process and you say well that's not enough essentially because the penalty has to directly relate to a partnership item and they say it is enough because it's ok if it indirectly relates to the partnership item and i guess the question is in some sense you're both adding adjectives to the statute you say you add directly they add indirectly how do we pick between those where i think the government is asking the court at a great deal more than just go to the statutory tax with the provision that sixty two that outside basis is not a partnership and then it gives jurisdiction to the court to to determine penalties that relate to partnership items and what and what the government is asking this court to do is essentially to read this to say that relates to partnership items or that relates to non partnership affected items like outside basis and the reason why the question do that is first in the scheme that divides the world into partnership items that can be determined at the partnership level and non partnership items that must go to the partner level when congress says partnership item that's significant it has defined terms of non partnership item or affected item partnership item so we think that it necessarily excluded partnership affected items here and that's the way to read it and second if you read the relates to as broadly as the government says that it makes no sense the partnership item here might as well say affected item because you're right at some level of abstraction you can always say way partnerships can do many things just like individuals and corporations and they can engage in things that subject trigger penalties a partnership can misreport it's income a partnership can make a valuation a statement a partnership can in negligence and the court can determine those deplete the ability of those penalties now it's true that down the road a mathematical adjustment the court is looking to whether or not the partner repeated that error on its return but what's fundamentally different about this case is the penalty depends not on the partnership just the partnership item it depends on the outside basis determination that a court can't make and to put it another way are there are there are cases in which the partnership is liable for penalty no alternately you understand it and it's all passed through and so forth but suppose partnership does something that the sham that's a fraud and then and and files a partnership information retire with that with that information but then the partners find out either because of the ruling of the court that is void or because they have second thoughts that they're not going to do this so they change their individual if they change their their own tax return or could there be any penalty against the partnership in that instance that one of the partners don't actually the partnership does not pay the penalty but the  relate to the partners yes or no your honor yes in the sense that ultimately what you're looking in the proper proceeding is to truly whether or not the protein or repeated the error that's on the partnership with her but you can say at partnership level that penalty is a political because everything was complete all the elements can be determined the partnership that's in this report it's income in this case you just can't say that because outside basis isn't reported anywhere at all on the partner so what that is i mean as i understand it you agree that on the partnership level the i r s could say the following in a hypothetical log now give you the partnership says that this sas set has a basis of ten million dollars we sold it for eight therefore the partnership has a loss of two the i r s says the real value was not ten million dollar basis it was a two million dollar basis and therefore in fact you don't have a loss of two you have a gain of eight moreover your under statement was more than four hundred percent or whatever the percent is you know it was it was a yeah it was eight million dollars you know overstatement and therefore penalties a four hundred percent attach ok you agree they can say that at the partnership level because yeah i understand you're making this but what they've actually done there since it doesn't say anything about inside outside is they're saying partners to the extent that you use this on your own return remember there's a four hundred percent penalty attached ok you agree they can do that now what they've done here is they've said there is no partnership so the extent that you use this as your as a basis as you use this on your individual return remember there's a four hundred percent penalty attach because for a time zero or whatever it is your understand that so we haven't got any reference to inside outside bases here in both cases it seems to me they're doing roughly the same thing and so we're in the statute does it say they can't do it indeed a penalty attaches i think the use of this partnership by you the partner to reduce your taxes and not to the extent you don't use it of course you don't have to pay anything but to the extent you use it you have to pay whatever it is a plus the four hundred percent what the court in doing what the court is doing in both of those situations is fundamentally different in one case it's looking at the partnership return looking at how the partnership reported that they saw this and determined that the over statement penalty would apply because of the error committed by the partnership that is everything that we think the court can do under the statutory provision we just referred to if you determine the applicability of that penalty because it relates to a partnership item the partnerships statement of its income or basis on the partnership or term now what's happening here is the  the penalty is applying to the partner's statement of basis that outside basis doesn't appear then the question is this the question is does the words partnership item in the section scope of judicial review refer only to those items that the partnership in fact is concerned with or do they considering the partnership itself and the three thirty issue the three circuit court sort of address that have agreed with us and is just as jennifer interpreted the word partnership items in that statute and you're saying the partnership itself is not a partnership i don't know another dollar what no we're saying outside basis is not a partnership i don't know but that's just a question of how they use it on the return there are many ways in which a person could use a partnership item on the return if this is a partnership item i mean a person might for example have no tax i think that the confusion maybe is between the statement at issue here the statement at issue in this case is the basis that the partners reported on their individual returns as a result of these transactions if you go to the partnership return and go to page one sixty nine of the joint appendix it may be difficult to find out because of these fold outs but you'll  i was i understand here difference between the outside basis and the inside basis now what i'm trying to do is to figure out via the statute i think like what justice scalia was trying to do i think where does that matters in with some type of jurisdiction your honor and again i mean do i now understand that the two i'm still going to get the precise words of the statute that it would make a difference because in common sense it doesn't seem to me to make much difference but it may be in this statutory language it does so i want to know what words the words that matter is partnership item this is a statutory scheme that talks about non partnership items and protege now you just told me i said that i thought and you said no it didn't those weren't the right words but if you say those are the right words then explain to me why a partnership item cannot include a partnership itself the partnership part of your honor can include the partnership we're not we're not disputing that part of the sham determination my point is that the imposition of the penalty it depends on an additional determination which is a non partnership item and in that sense mr ghauri it strikes me as wrong to say that the words in dispute our partnership actually everybody agrees what partnership item means what it includes and what it doesn't include it doesn't include outside basis the government is perfectly happy to concede that it seems as though the words in dispute are what is related to mean and does relate to have to be relate to in this very direct way that excludes the center immediate step of adjusting outside basis right and the reason why and i think that gets back to partnership item because if you read relates to in the broad sense that the government is asking you to read it then in essence you are adding you're taking away the limitation of partnership by them and you're adding words that says were affected by them because what they're saying is look any time you have a partnership item that is in any way related to the position of held down the road then you can do it but another way the same not in the way the congress would have said if it meant it was courts you can determine have to go beyond a partnership item you have to determine a non partnership item in this kind of jurisdiction when would you not have to do that if if you're applying for the third right of the applicability of any penalty addition to tax or additional amount which relates to adjust it to a partnership again that will always require you to go down to the partner no one that when the penalty is complete is complete based on what the partnership has done you can determine the a picket billed you the penalty you can say all of the elements are met because of what the partnership jurisdiction to do that and of course that solves the merits question too because congress actually address the situation here on the merits and instead we have a government trying to fit a square peg into a round hole i'm not under a station before i go to the merits i just want to talk about the practical consequences of this ruling that's very significant from the standpoint of the taxpayers where the government wants to do is funnel all of these penalties terminations into a computational just as opposed to the deficiency proceeding which is the default wall und statute section sixty two thirty if you the taxpayer space perspective that it's huge consequences and taxpayers have to pay the refund upfront as as just sort of my or recognized that means that even when disputed penalties you have to pay all that upfront and then that limits their ability to challenge it means they can't go to the tax court to challenge it they have to do it in the more expediting faction the default rules deficiency proceedings that is where congress intended these penalty issues of the type that we have here that pertain to nonproductive purchase  me ask you something there's no reason to go into a sham transaction except to misstate the outside bases in the individual partnership level so  it's low hanging fruit according to the d c court but why shouldn't you be able to pick i mean what's sort of obvious just says it's obvious that if a partnership item or a miscalculation that the partner is going to include it in their tax return later that's why we permit the pen to be enclosed upfront and to pay the tax upfront because you're making an assumption that it's been included a roni asli on the part in it level think what you would be doing is assuming that a fact necessary to the penalty that outside basis was reported to zero for purposes of finding jurisdiction and we don't think the court could do that the that it's at least possible that the taxpayer in a fit of conscience or having fully more fully understood the transactions would not inflate its basis it would report zero basis and let nobody would know that in the partnership level proceeding because tax return not and not a income tax return right i mean ultimately we also know what kind of return you use no matter what the tax situation if the partnership real real value makes a difference you have to put it in of june in the individual yeah yeah in individual gift tax return maybe and state tax return maybe it's zero income tax return you do but the part where it effects the taxpayer differently and i'm just saying why does it any in my example to it will vary of course it will vary some people will use have no tax to pay no extra tax because their their income tax if they paid was in fact the government owed them refund so it didn't matter it varies in many ways so since it varies in many ways and varies by many returns it might vary depending upon whether it affected your outside basis or something else and then the fact that it can vary your owner is one of the reasons why congress  determinations made at the partner level and the other thing in the jurisdictional question i don't think the court could resolve this question looking into the sham partnership situation here sometimes transactions are sham sometimes partnerships are sham and the jurisdiction question or answer to the question should apply across the board and what if you have a situation where you have only a transaction and then the government would have to acknowledge that basis could be affected in many different ways in that situation again getting back could couldn't the government have pursued this instead of saying you know it's a sham partnership just could the government simply have said that the partnership overstated it's basis it couldn't because and it didn't because if you go if you go back to page one eighty six one sixty nine of the joint appendix everything about these transactions is accurately reported on that point which is in the partnership return the partnership actually reported again on these transactions the air comes in at the partner level and is only on the partner return in the situation and that's why you can't determine outside basis at the partnership level and that's why you can't determine the a at the partnership level you know if i have a second question which which i ask your friend as well is he correct that if we rule for you each partner may have a different result because different courts will find this to be a shame we're going to be shit no no your honor in a sense if this court resolves the merits question then that's that we're in whether the penalty applies or not in this context is going to apply to all partners so that that issue is not going to vary by partner what can happen by partner is different partners may have different outside bases even in the situation my friend acknowledged you could have a partner that never left reports zero as is basis in this situation  wouldn't couldn't one court say i don't think it's a shape partnership well that determination your honor is being made at the partnership level and we're agreed that it can be made at that level and that determination applies to all the partners there's no inconsistency about that the only question here is whether the partnership level court can determine the applicant guilty of the basis misstatement penley is the government calls it and it doesn't have jurisdiction to do that because it depends on that outside basis today i think  to say that that's not true because individual partners may respond differently to the partnership determination with respect to basis yes some of them are going to put in something else but somebody may put in zero for a number the reasons that the i r s is counsel suggested and now i suspect that those will be only in rare circumstances and i guess that's why the d c circuit said even though the result here may be obvious it nonetheless depends on the outside basis determination exactly what i understand your friend to be saying is it's not just that it's obvious but it's ineluctable and therefore doesn't depend on the outside partnership determinations so does your case hinge on the perhaps unusual situations where you have one of these partners having a fit of conscience and decides to put down the real real number or has some other adjustment to it i think largely yes but if i can explain that first i'm not presents the low hanging fruit situation the d c circuit result and we think they were right to say even if you think it's low hanging you're forbidden to pick it second here the partnership a sham but there are certainly cases where individual transactions are shand and if individual transactions are shams then the outside basis could vary widely based on the individual circumstances of the partners and so there in that situation it's not at all obvious or necessarily true that the basis is going to be overstated you have to look and again that's why it's a completely separate determination made me on a level concrete example because i'm not quite sure what you're talking about where you could have a partnership your honor that engages in many transactions and the iris would determine that one of the many transactions that it entered into was a sham that particular transaction was only designed for tax purposes but other transactions that engage in work legitimate in this case the i r s the same but the whole everything the partnership it is a sham but in my case some transactions are ok some are different and that case the individual partners outside basis there may have the right have tried to take advantage of the sham transaction to get all the other transactions affect their basis as well the partnership i'm a little confused on this example presumably it's only if they carry it forward which here sue me they would have done i carried forward the outside cases the penalty would have been determined just on that one transaction no because you that the penalty is based on what the individual partner claims as basis and that partner is going to be looking into everything that goes into his partnership interest the costs or investment in the partnership not only to the one transaction that we've part the size that's been shammed but many other transactions as well see you can't conclude either that there's been a misstatement or that any misstatement triggers the valuation the statement pulled here if i could talk a little bit about the merits on the merits  are fundamental question is that evaluation a statement penalty the congress devised in one thousand nine hundred one was not intended at all to apply to the fundamentally different situation here where the government is claiming not that you misstated the correct amount of the value or that you didn't have an accurate amount of the value of the number that you put for basis or value but that the thing that's a subjective evaluation of the basis doesn't exist at all and you know if you reception area where the government basis over statement penalty is the ok in the middle of the reception area here the most common situation in which basis misstatements are made the government acknowledges throughout its brief is where you miss the price or cost of a good and yet you're moving which is which is right the reference to just a basis makes sense in the statutory scheme here it covers that situation but saying you don't need to it goes far beyond that not only to the situation transaction that was an act in two thousand and ten was on the books what would happen is a court could determine the penalty which is based on what the partnership partnership proceeding and we would agree that the penalty applies all the problems are solved by what congress did to address this particular situation the government is trying to put that square peg in a round hole and if you add everything up i think what's what's interesting about the government's reply brief is it doesn't contest that if there's any a statute has to be read in favor of the staff of the taxpayer and that's because of the candidate this court has recognized that tax penalties are strictly construed in favor of the taxpayer here at a bare minimum there is ambiguity as to whether the congress that passed the valuation the statement penalty ever intended it to apply to this fundamentally different situation where no one disagrees about the numbers reporting on the return again if you go to the partnership return transactions are accurately reported if you go to the outside bases it's true that they reported a loss but that's because they were following the rules about how you treat contingent liabilities so that members actually accurate under the irises rules that's why the i r s has to come up with a shakedown to get rid of the property altogether and say that we're going to pretend that it doesn't exist at all but again that's not a valuation a statement with a typically talks about correct amounts about accuracy about value it's trying to get at the number the thing that is worth it is not concerned with a situation in which the i r s is claiming that the property doesn't exist at all and that is a different problem congress addressed it in a direct way and then on economic substance penalty so this court doesn't have to worry about this problem being on address but what it should do is correctly interpret the penalty that congress and acted which was on the books when these events occurred which is the valuation the statement penalty it is not the all encompassing basis overstatement penalty i think if you're going to read one of the b it talks about all the situations in which congress never applied this penalty to which would be swept in by the government's position here today thank you mr stewart you have five minutes  left mr chief justice justice kagan i agree with your point that on the jurisdictional issue the crucial contest of language is relates to and the issue is whether the basis overstatement penalty here relates to the shammy or how does it not partnership item is defined to include legal and factual the terminations that underlie the determination among other things of income credit gain loss ok whether there's a partnership at all does under law the determination of whether the partnership return which had all kinds of numbers on it that shows anything that's all right so therefore it's a partnership why does this penalty relate to a partnership idea i don't want to say that you're right for the wrong reasons you better be sure i'm right and that is the does it relate to a partnership item i just told you what a partnership item was it certainly seems to because this is a row is what it relates to let me let me pose perhaps a less friendly question  what do you do with your friends hypothetical on attack you share and you say i gave a painting to a charity worth a million dollars and in fact he did not and he says what you're doing is you're going to go in and say that wasn't worth a million dollars it was worth nothing when in fact what you should be saying is you didn't give the painting at all i think this is a different situation because the i arrested not determine that the underlying transactions the perp purchases and sale of currency options and so forth didn't occur it determined that the partnerships were shams and i think that this is an important point but if you determine that the partnerships were shams that's like saying there were no partnerships there were no and if you say i did you know i didn't really give the painting that means there wasn't any pain it seems to me that pretty close really parallel but what the f b i also said was because there were no partnerships the transaction should be treated as though they had were engaged in by the individual part maybe in a frame with a blank canvas well it and i think it's as  starting to say at the close of my opening argument it's no accident that partnerships were used to effectuate the scheme because if the individuals had bought and sold the offsetting foreign currency options they would have had no colorable rationale for contending that they were entitled to a deduction for the cost of the long option but they were not required to treat as income the amount they received from the short option it would have been absolutely clear that the transaction taken as a whole was a wash the only way that they could try to create the appearance of a paper loss was by manipulating the rules that govern the computation of basis in partnerships and shot so the shamming determination in effect was a determination that for tax purposes you can't try to take advantage of the helmer well that says that for computing basis in a partnership we will ignore the the contingent liability created by the short option that the one thing other thing i would say on the merits as to why we care about this case is that respondents argument doesn't just go to on subsection three doesn't just go to basis over statements that are produced through sham transactions it goes to all basis over statements that are produced through legal errors and i think we have you do you agree that the new legislation completely resolves this problem it completely resolves the specific problem posed by this almost completely resolves the specific problem subsection li would cover this case now subsection six the trigger for having a forty percent penalty rather than a twenty percent penalty is slightly different under subsection six you are if you disclose the relevant information on your tax return then even if it's later determined that the transaction the bhakti canonic substance you would be subject only to the twenty percent penalty under subsection three you can get the forty percent if the over statement is four hundred percent or more regardless of disclosure but it almost completely cover level proceeding to the finding that the outside basis was that if it was claimed in the partnership level it was zero with respect to jurisdiction the question simply goes to the allocation of responsibilities between the partnership level court and the partner level court when he says we're trying to avoid deficiency proceedings i think it ignores the fact that under our reading the important legal objections that respondent has made to the penalty namely the arguments that are set forth in part two of their brief cameras are under our theory can be resolved at the partnership level without prepayment penalties thank you counsel the case is submitted