The US Supreme Court announced it will review a suit involving the IRS' practice of imposing 40 percent penalties on allegedly abusive tax shelters.
The case stems from the use of a tax-avoidance strategy known as "current options bring reward alternatives" (COBRA) employed by Texas billionaire Billy Joe "Red" McCombs and his business partner Gary Woods. McCombs is cofounder of Clear Channel Communications and former owner of the Minnesota Vikings and San Antonio Spurs.
Under COBRA, the two men used paper losses to offset real gains and reduce their tax liability. McCombs and Woods bought and sold options on foreign currencies in 1999 to generate paper losses used to offset gains related to McCombs' professional sports team ventures.
The government said McCombs and Woods, acting on advice from Ernst & Young, were able to claim $45 million in losses from transactions that actually cost them only $1.37 million.
The case will test one aspect of the IRS' effort to recoup billions of dollars from high-income taxpayers who set up similar shelters in the 1990s and 2000s.
The IRS initially applied a 40 percent penalty on the unpaid taxes that the agency said were owed, but the Fifth US Circuit Court of Appeals in New Orleans ruled in 2012 that the 40 percent penalty did not apply in the Woods case.
Acting on behalf of the partnerships Woods and McCombs formed, Woods urged the Supreme Court not to hear the case. He contended the effect would be limited because Congress changed the law in 2010 to explicitly allow the 40 percent penalty for future cases.
The court's decision will only apply to cases brought prior to 2010, but the Obama administration's solicitor general is arguing that "hundreds of millions of dollars" in tax penalties are hanging in the balance, according to court filings.
The Supreme Court has not yet scheduled the case but said it will take it up during its nine- month term that starts in October.