Opinion ID: 69326
Heading Depth: 3
Heading Rank: 3

Heading: Penalty Determination

Text: In addition to challenging the IRS’s treatment of the conduit transaction, Midcoast’s suit also challenges the imposition of a 20% underpayment penalty. We review the district court’s decision on the penalty issue for abuse of discretion. See Pan Amer. Life Ins. Co. v. United States, 174 F.3d 694, 696 (5th Cir. 1999). Midcoast makes two arguments against the district court’s ruling that the IRS was permitted to assess the 20% penalty. First, Midcoast argues that because it did not underpay, then no penalty could be assessed. This argument necessarily fails in light of our decision above that Midcoast understated its income tax liability for this transaction. Alternatively, Midcoast argues that, even if the IRS is entitled to disregard the form of the conduit transaction, the IRS could not assess the penalty because Midcoast had “substantial authority” to support its actions. The Internal Revenue Code generally provides for a 20% penalty for the “substantial understatement of income tax.” 26 U.S.C. § 6662(a)&(b). However, a taxpayer is not subject to the penalty if the understatement is attributable to “the tax treatment of any item by the taxpayer if there is or was substantial authority for such treatment.” Id. § 6662(d)(2)(B)(i). Even if there is substantial authority supporting the taxpayer’s tax treatment, though, a taxpayer cannot avoid the penalty in the case of tax shelters. Id. § 6662(d)(2)(C). The Code defines a tax shelter as, inter alia, an entity or plan or arrangement “if a significant purpose of such partnership, entity, plan, or arrangement is the avoidance or evasion of Federal income tax.” Id. The district court ruled that there was no substantial authority for Midcoast’s tax treatment of the transaction and that, in any event, the conduit transaction constituted a “tax shelter,” making the substantial authority exception inapplicable. This was not abuse of discretion. First, all of the 12 No. 08-20261 available authority indicated that this transaction -- motivated solely by the avoidance of taxes -- would be disregarded and that Midcoast would not be entitled to claim a stepped-up basis for the Bishop assets. This authority took the form of both Supreme Court and Fifth Circuit precedent. Second, the uncontroverted evidence shows that the arrangement at issue in this case had the sole purpose of avoiding federal income tax. Thus, it falls squarely within the Code’s definition of a “tax shelter.” It is clear that tax avoidance was, at a minimum, a “significant purpose” of the arrangement as required by the statute. Accordingly, we affirm the district court’s ruling that the IRS was permitted to assess a penalty against Midcoast pursuant to § 6662.