August 27, 2013 / 9:57 PM / 4 years ago

IRS wins tax-shelter court case, harsh penalties can apply

WASHINGTON (Reuters) - U.S. tax authorities can assess penalties broadly on taxpayers using tax shelters, an appeals court said on Tuesday, in a decision that could influence a similar case set for oral arguments at the U.S. Supreme Court in October.

With a long winning streak on tax-shelter court cases, the IRS has been proving that the financial transactions in dispute lack “economic substance”, meaning they existed solely to generate tax breaks. Still unsettled - and an issue the high court will review - is whether the IRS can also add penalties in addition to the original tax bill.

In a decision released on Tuesday, the U.S. Court of Appeals for the Seventh Circuit in Chicago agreed with the IRS that the financial transactions in this tax shelter case lacked economic substance and also “should be punished” with harsh penalties.

The three-judge panel said the dollar amount of tax penalties “has not yet been determined,” although the decision written by Judge Richard Posner did not explain why. The case was appealed from U.S. Tax Court.

When taking a related tax shelter case, the Supreme Court acknowledged there was a split among appeals courts about whether penalties can be assessed on taxpayers when their financial transactions lack economic substance.

GENERATING LOSSES

As with most alleged tax shelters, the case before the Seventh Circuit involved financial transactions that generated losses to yield tax deductions that could offset the taxable gains for a group of taxpayers.

This case involved transactions known as “distressed asset/debt” or “DAD,” which the IRS has listed as a tax shelter since 2007. The taxpayers, who set up a number of partnerships, bought the distressed assets from a Brazilian retailer and claimed tax-deductible losses.

The lawyer representing the taxpayers in the case, John Rogers, was barred in 2011 from promoting tax shelters after the Justice Department said those he had previously promoted had generated more than $370 million improper tax deductions.

Rogers could not be reached for comment on Tuesday.

In issuing its decision ahead of the Supreme Court arguments in “United States v Woods,” the Seventh Circuit judges might have been trying to influence the High Court, said Andrew Roberson, a partner with law firm McDermott Will & Emery LLP.

“For the Supreme Court, it might be helpful guidance,” Roberson said of the Seventh Circuit’s decision.

The case is Superior Trading LLC et al v Commissioner of Internal Revenue, No. 12-3367.

Reporting By Patrick Temple-West; Editing by Ken Wills

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