Opinion ID: 743498
Heading Depth: 2
Heading Rank: 2

Heading: Valuation Overstatement Penalties

Text: 43 First, Zfass argues that the valuation overstatement penalty does not apply in the instant case. Second, he argues that even if it applies, the penalty should have been waived because he acted in good faith by relying on the advice of his accountant. The second issue can be dealt with easily because the Tax Court did not abuse its discretion in determining that Zfass did not act in good faith by relying on his accountant. Therefore, the Tax Court did not abuse its discretion in holding that Zfass was not entitled to a waiver under § 6659(e) since he did not act in good faith. 44 As to the issue of whether § 6659 applies to the instant case, Zfass argues that § 6659 should not apply because in the instant case a deduction was disallowed not overvalued. However, disallowance of the deduction was because it was overvalued. Section 6659 provides that if a taxpayer owes additional taxes due to a valuation overstatement, the taxpayer may be assessed a penalty of 30% of the underpayment attributable to the overvaluation. § 6659(b). 45 Zfass principally relies on Heasley v. Commissioner, 902 F.2d 380 (5th Cir.1990). 8 In Heasley, the IRS disallowed a deduction and an investment tax credit for energy saving units. The IRS imposed a value overstatement penalty for the underpayment of tax attributable to a valuation overstatement. 26 U.S.C. § 6659(a). The Tax Court upheld the IRS's determination. The Fifth Circuit reversed. It held that 46 whenever the IRS totally disallows a deduction or credit, the IRS may not penalize the taxpayer for a valuation overstatement included in that deduction or credit. In such a case, the underpayment is not attributable to a valuation overstatement. Instead, it is attributable to claiming an improper deduction or credit. 47 Heasley, 902 F.2d at 382-383. The court determined that to eliminate entirely is not an overstatement but a complete eradication of a value. 48 However, the Fifth Circuit's approach has not been followed by other circuits. The Second, Sixth, and Eighth Circuits have held that when an underpayment stems from deductions that are disallowed due to a lack of economic substance, the deficiency is attributable to an overstatement of value and is subject to penalty under § 6659. See Massengill v. Commissioner, 876 F.2d 616, 619-20 (8th Cir.1989); Illes v. Commissioner, 982 F.2d 163, 167 (6th Cir.1992); Gilman v. Commissioner, 933 F.2d 143, 151 (2d Cir.1991), cert. denied, 502 U.S. 1031, 112 S.Ct. 871, 116 L.Ed.2d 776 (1992). 49 In any event, the IRS did not follow the Fifth Circuit's approach in Heasley and instead chose to follow the Second, Sixth and Eighth Circuit's approach. The IRS determined that since the deduction in the present case was a sham and lacked economic substance, the overvaluation penalty applied. 50 The Tax Court also followed the Second, Sixth and Eighth Circuits and held that when a transaction lacks economic substance, the correct basis is zero; any amount claimed is a valuation overstatement. Zfass v. Commissioner, 71 T.C.M. (CCH) 2670, 1996 WL 146800 (1996). The Tax Court determined that in the instant case a value overstatement was a primary reason for the disallowance of the claimed tax benefits and that the valuation overstatement penalty applied. We agree with the Tax Court that the reasoning of the Second, Sixth and Eighth Circuits is applicable here. 51 Zfass argues that the Tax Court improperly relied on Charlton and that the facts of Charlton are not facts in the instant case. He argues that there is no evidence in the record regarding the market values of the leases and there is no evidence in the record that Zfass's estimation of the leases' value was improper. Zfass is correct that the facts in Charlton are not quite the same as those in the instant case, but Charlton 's legal rule remains. Thus, the finding in Charlton that the plan lacked economic substance is binding upon Zfass. The reason that the plan lacked economic substance is because of the over valuation of the master leases. 52 In addition, the Tax Court concluded that in the present case [i]t is obvious from the record in this case that valuation overstatement was a primary reason for the disallowance of the claimed tax benefits. Such a conclusion is supported by the record, and the Tax Court's findings in this regard were not clearly erroneous. We agree with the Tax Court that the taxpayer's underpayment stems from excessive deductions that were disallowed due to the lack of economic substance; therefore, the deficiency is attributable to a value overstatement.