Opinion ID: 14441
Heading Depth: 1
Heading Rank: 2

Heading: Substantial Understatement

Text: 63 The majority next errs in concluding that the tax court abused its discretion in holding the appellants liable for a substantial understatement penalty pursuant to former § 6661 of the Internal Revenue Code. Section 6661, repealed after the tax years at issue in this case, provided for the imposition of a penalty based on a taxpayer's substantial understatement of tax liability for a taxable year. See 26 U.S.C.A. § 6661(a) (West 1989) (repealed in 1989). The section provided that, for purposes of computing the penalty, the amount of the taxpayer's understatement of tax liability is reduced by that portion of the understatement which is attributable to ... the tax treatment of any item by the taxpayer if there is or was substantial authority for such treatment. Id. § 6661(b)(2)(B)(i). The taxpayer bears the burden of proving the existence of substantial authority. See Westbrook, 68 F.3d at 882. 64 The majority concludes that, from a factual standpoint, substantial authority for a taxpayer's position within the meaning of § 6661 exists unless  'there was a record upon which the Government could obtain a reversal under the clearly erroneous standard'  had the tax court accepted the taxpayer's position. Streber, 138 F.3d at 223 (quoting Osteen v. Commissioner, 62 F.3d 356, 359 (11th Cir.1995)). This construction of the substantial authority standard contravenes § 6661's interpretive regulations. Section 1.6661-3 of the Treasury Regulations indicates that § 6661's substantial authority standard does not contemplate substantial evidentiary authority. Rather, the regulation provides an exclusive list of potential sources of authority, all of which are legal sources, which indicates that § 6661 contemplates only substantial legal authority. Section 1.6661-3 provides in relevant part as follows: 65 Types of authority. In determining whether there is substantial authority ..., only the following will be considered authority. Applicable provisions of the Internal Revenue Code and other statutory provisions; temporary and final regulations construing such statutes; court cases; administrative pronouncements (including revenue rulings and revenue procedures); tax treaties and regulations thereunder, and Treasury Department and other official explanations of such treaties; and Congressional intent as reflected in committee reports, joint explanatory statements of managers included in conference committee reports, and floor statements made prior to enactment by one of a bill's managers. 66 26 C.F.R. § 1.6661-3(b)(2) (1997) (emphasis added). Noticeably absent from this list of potential sources of authority is any mention of factual evidence favorable to the taxpayer's position. 67 Furthermore, the majority's construction of the substantial authority standard implies that, in many circumstances, if a taxpayer is able to survive summary judgment, he is shielded from liability for substantial understatement penalties because substantial authority--in the form of some evidence--supports his tax position. 2 Moreover, when a taxpayer's entitlement to a particular tax benefit hinges upon facts that will be elucidated by witness testimony, the taxpayer need only lie about the facts that would entitle him to the benefit in order to shield himself from liability for a substantial understatement penalty resulting from his improperly claiming the benefit. In such a circumstance, the taxpayer's testimony would constitute some evidence indicating his entitlement to the benefit, and, the majority opinion in this case notwithstanding, it is doubtful that we would be in a position on appeal to conclude that the trial court would have clearly erred had it credited the taxpayer's testimony. Surely Congress did not intend to impose such a toothless penalty for substantial understatement of tax liability. 3 68 The majority's erroneous construction of the substantial authority standard is rendered even more unfortunate by the fact that it is entirely gratuitous. The majority independently concludes that the IRS abused its discretion by declining to waive the substantial understatement penalty pursuant to § 6661(c) because the appellants relied in good faith on the advice of counsel in choosing to treat the joint venture income as a gift. As I indicated above in my discussion of the majority's treatment of the tax court's imposition of negligence penalties, the majority errs in this regard by making an independent assessment of the factual issue of whether the appellants truly acted in good-faith reliance on the advice of counsel. However, the majority's conclusion that the appellants were entitled to waiver of the penalty provides an independent, albeit legally unsound, basis for its decision to reverse the tax court's imposition of the substantial understatement penalty. Nevertheless, the majority proceeds to heap one legal error onto another by promulgating in dicta a construction of the substantial authority standard that fails to comport with the treasury regulations interpreting § 6661 and that robs the statute of much of its value as a deterrent of taxpayer misconduct. I therefore respectfully dissent.