Over the last few weeks, we posted three of a four part series of blog articles regarding the Tax Court's recent opinion in Bosque Canyon Ranch, TC Memo 2015-130. The first blog post, which is found here, discusses the facts of the case and foreshadows subsequent discussions on the various issues addressed by the Court. The second post, which is found here, analyzes issues regarding “floating homesites,” i.e., reserved rights to build homes on property subject to the easements. The third post, which is found here, discusses the Court's analysis of the “baseline” requirement. This final post analyzes the Court's holding that the taxpayer was liable for the gross valuation misstatement penalty, irrespective of the value of the properties contributed. This last issue has the most far-reaching implications to taxpayers making charitable contributions, conservation easements or otherwise.
The taxpayer in Bosque granted a conservation easement in December 2005 (the “2005 Easement”) and another conservation easement in September 2007 (the “2007 Easement”). As discussed in our prior blog posts, the Court denied both deductions on technical grounds – lack of perpetuity and inadequate baseline documentation. The Court never determined the value of either the 2005 or the 2007 Easement. Nevertheless, the Court determined the taxpayer was liable for the gross valuation misstatement penalty for both years under I.R.C. §§ 6662(e)(1)(A) and 6662(h).
Bosque marks the first time a court has applied the gross valuation misstatement penalty in an instance where the value of the charitable contribution was never addressed. The Bosque opinion departs from the Tax Court's prior rulings that a valuation misstatement penalty would not apply in instances where a charitable contribution deduction was denied on technical grounds. See, e.g., Derby v. Comm'r, TC Memo 2008-45 (“Because there is a separate, independent ground for disallowing those deductions, the overvaluation penalty may not be imposed.”). Although the Tax Court based its departure from its prior position on the Supreme Court's decision in United States v. Woods, 134 S. Ct. 557 (2013), our reading of Woods leads us to conclude that the Supreme Court did not intend its ruling to stretch this far. In Woods, the Supreme Court specifically stated that its holding is limited to instances where a penalty (in that case, the economic substance penalty) and the basis for a disallowance “are inextricably intertwined.”
The Bosque penalty holding will have drastic consequences. Bosque apparently applies the strict liability, 40% penalty to every charitable contribution of property in which a deduction is disallowed, even if only on technical grounds. Imagine an individual that buys property for a $1 Million and then donates it to the Boy Scouts a few days later, claiming a deduction in the amount for which he purchased the property. He then receives a “thank you” letter from the charity, but the charity fails to provide the required language in the letter stating that the charity did not provide the taxpayer with any “goods or services” in return for the donation (the required “contemporaneous written acknowledgement” of I.R.C. § 170(f)(8)). Under the Tax Court's holding in Bosque, this taxpayer would lose his charitable contribution deduction AND he would be liable for the 40% gross valuation misstatement penalty (because the value claimed, $1 Million, exceeds the final allowed deduction, $0, by more than 200%). The gross valuation misstatement penalty would apply even if all parties recognize and stipulate that the value of the donated property was exactly what was claimed on the taxpayer's return. Furthermore, the normal “reasonable cause” relief would not apply; in effect imposing strict liability. I.R.C. § 6664(c)(3). This is hardly the outcome reasonable taxpayers and tax professionals would have expected in this instance.
The Bosque decision is being appealed. However, IRS is already applying the Bosque penalty holding to numerous cases in our practice or “where we are involved.” Because of the far-reaching consequences of Bosque, we plan to write an article on the penalty issue, and will update our readers when it is published.
Bonus Blog Coming. In Bosque, the Tax Court also addressed an issue related to partnership taxation. The partnership “disguised sale” issue will be the subject of an upcoming “bonus blog,” which will be posted next week.