Opinion ID: 703228
Heading Depth: 2
Heading Rank: 3

Heading: The Penalty Under I.R.C. Sec. 6661(a) for Substantial Understatement of Tax.

Text: 71 The version of the Code that applies to appellants' 1982 returns provides: If there is a substantial understatement of income tax for any taxable year, there shall be added to the tax an amount equal to 25 percent of the amount of any underpayment attributable to such understatement. I.R.C. Sec. 6661(a) (1986). It is undisputed that the deficiencies that we have affirmed in Section I of this opinion were substantial understatements of tax as defined by Sec. 6661(b). Nonetheless, the statute provides that the amount of an understatement shall be reduced by the portion of the understatement which is attributable either, 1) to tax treatment that was supported by substantial authority, or, 2) to tax treatment about which the relevant facts were adequately disclosed in the return or in a statement attached to the return. I.R.C. Sec. 6661(b)(2)(B). Furthermore, the Commissioner may waive any such penalty on a showing by the taxpayer that there was reasonable cause for the understatement and that the taxpayer acted in good faith. I.R.C. Sec. 6661(c). 72 The Tax Court concluded that appellants' tax treatment of the options was not supported by substantial authority. We review this conclusion of law de novo. See Norgaard v. Commissioner, 939 F.2d 874, 878 (9th Cir.1991). Substantial authority supports a position only if the weight of the authorities supporting the treatment is substantial in relation to the weight of authorities supporting contrary positions. Treas.Reg. Sec. 1.6661-3(b)(1). Appellants' treatment of the options does not meet this test. They have relied heavily upon ambiguous legislative history from 1976 Tax Reform Act that was created subsequent to the enactment of Sec. 83. The principle authorities supporting the contrary position include the plain meaning of the statute, and a regulation promulgated by Treasury interpreting that statute. These authorities far outweigh those cited by appellants. The Tax Court properly refused to reduce appellants' penalties pursuant to the substantial authority exception. 73 The Tax Court also found that appellants did not adequately disclose the facts relevant to their tax treatment of the options. We review this finding of fact for clear error. See Fed.R.Civ.P. 52(a). Appellants do not even challenge the Tax Court's finding that rather than disclosing the relevant facts, their 1982 returns actually concealed the true nature of the option proceeds. Cramer and Monaghan both claimed basis in the options, even though they knew they had none. Also, Cramer and Boynton both listed the options in sections labeled for stock, even though the returns contained separate sections for options. These unexplained misrepresentations appear designed to avoid audit. Furthermore, we reject appellants' argument that their filing of Sec. 83(b) elections in 1978 and 1979 provided adequate disclosure. Sec. 6661(b)(2)(B)(ii) explicitly requires that the disclosure be attached to the return itself. Therefore, the Tax Court properly refused to reduce appellants' penalties pursuant to the disclosure exception. 74 The Tax Court also found that appellants did not act in good faith. We review this finding of fact for clear error. See Fed.R.Civ.P. 52(a). The concealment described in the previous paragraph, coupled with appellants' decision to ignore Reg. Sec. 1.83-7(b)(2), amply supports this finding. Therefore, the Tax Court correctly concluded that the good faith/reasonable cause waiver did not apply in this case. 75 Accordingly, we affirm the Tax Court's decision to uphold the entire penalty for substantial understatement of tax.