Richard J. Todd and Denese W. Todd, Petitioners-appellees, v. Commissioner of Internal Revenue, Respondent-appellant, 862 F.2d 540 (5th Cir. 1988)

Taxpayers Richard and Denese Todd appealed deficiencies and penalties assessed by the Commissioner of Internal Revenue. The Tax Court denied the taxpayers' claimed depreciation deductions and investment tax credits. In a later opinion, the Tax Court refused to impose the Commissioner's requested penalties under Internal Revenue Code Sec. 6659 for tax underpayments attributable to valuation overstatements. The Commissioner appeals that determination. We affirm.

* Beginning in 1980, FoodSource, Inc. sold investors interests in refrigerated food containers. The containers were designed to preserve perishable agricultural products during shipment to foreign and domestic markets. Each investor paid a fraction of the alleged purchase price of part or all of a refrigerated unit, signing a promissory note for the balance. FoodSource managed the containers, renting them to food transporters and regularly reporting profits supposedly earned by each investor.

Appellees Richard and Denese Todd purchased two FoodSource containers on December 8, 1981, and a third on October 14, 1982. The Todds paid $52,000 to FoodSource for each unit, signing notes to raise the "purchase price" of each container to $260,000. Using the $260,000 figure as the basis of each unit, the Todds claimed investment tax credits and depreciation deductions for the 1981 and 1982 tax years, carrying unused portions of the investment tax credits back to 1979 and 1980. However, due to a payment dispute with FoodSource, the manufacturer retained control of all three containers purchased by the Todds until 1983.

The Internal Revenue Service assessed deficiencies and penalties against many investors in the FoodSource program, including the Todds. The Todds participated with various other "test case petitioners" in litigation before the Tax Court, challenging the IRS actions. In Noonan v. Commissioner of Internal Revenue,¹  the Tax Court determined that the Todds were not entitled to their claimed deductions and credits for 1979-82, since none of their containers had been placed in service until 1983. Other investors, such as the Hillendahls and the Hendricks, did have containers placed in service during the years for which they claimed tax benefits. Finding the obligations represented by the promissory notes illusory, the Tax Court limited the maximum adjusted basis taxpayers could claim in each FoodSource container to the lesser of its $60,000 fair market value or the actual cash payments made by the investor. Consequently, investors like the Hendricks and Hillendahls, though purchasing their containers with an actual profit motive, still received substantially smaller deductions and tax credits due to their reduced basis in their assets. These investors were also found liable under IRC Sec. 6659 for a 30% addition to tax on portions of their tax deficiencies "attributable to [ ] valuation overstatement [s]."

Upon remand for calculation of deficiencies, the Commissioner assessed a Sec. 6659 penalty against the Todds. The Todds appealed once again to the Tax Court. In Todd v. Commissioner of Internal Revenue,²  the Tax Court refused to allow the Sec. 6659 addition to tax. It reasoned that the Todds' deductions and credits were disallowed on the Commissioner's alternative ground that the food storage units had not been placed in service during the tax years in issue. Consequently, the Tax Court decided, the taxpayers' underpayments of tax could not be "attributable to" the valuation overstatements contained in their tax returns. The court refused to read Sec. 6659 as imposing a penalty anytime a tax underpayment had been accompanied by a valuation overstatement. The Commissioner now asks us to reverse the Tax Court's decision.

II

The statute we must construe, IRC Sec. 6659(a), provides:

(a) Addition to the tax.--If--

(1) an individual, or

(2) a closely held corporation or a personal service corporation,

has an underpayment of the tax imposed by chapter 1 for the taxable year which is attributable to a valuation overstatement, then there shall be added to the tax an amount equal to the applicable percentage of the underpayment so attributable.

The penalty only applies if the tax underpayment attributable to the overstated valuation equals at least $1000 and the claimed property value or adjusted basis is at least 150 percent of the actual value or basis.³  The parties agree that, under the Tax Court ruling in Noonan, the Todds overstated the value of their FoodSource containers by 500%. If Sec. 6659 applies, the Todds will be liable for an addition to tax of 30% of underpayments attributable to the valuation overstatements.⁴ 

The parties divide only over the meaning of the words "attributable to" in the statute. The Commissioner asks us to hold the Todds liable under Sec. 6659, basing his arguments on the statute's language, its legislative history, its underlying policy, and the Commissioner's perception of inequity in the Tax Court's result. First, the government argues that "attributable" ordinarily means "capable of being attributed." Thus, it contends that Sec. 6659 applies anytime a taxpayer's underpayment is "capable of being attributed" to a valuation overstatement, regardless of the actual ground relied on to uphold the deficiency. Unfortunately, the Commissioner's formulation merely substitutes one ambiguity for another. Whether a given underpayment is "capable of being attributed" to a valuation overstatement depends on the meaning of "capable." In one sense, that urged by the government, there can be several problems with a particular deduction and the resulting tax deficiency is, then, capable of being attributed to any of them. In this case, however, the Commissioner asserted and the Tax Court found that the Todds' FoodSource units had not been placed in service until after the 1982 tax year. Given those circumstances, no deductions or credits could legally be taken with respect to these food containers on the Todds' 1981 and 1982 tax returns. Thus, the value claimed for the containers became irrelevant to the Todds' tax liability, since it played no part in calculating the tax they actually owed. One can certainly argue the position that a tax underpayment is not "capable of being attributed" to an irrelevant figure on the income tax return. While a client might be "capable" of kicking the bottom of her lethargic lawyer in an abstract sense, one might still say she was "incapable" of doing so at a time when the two were a thousand miles apart. Thus, we find the language of the statute ambiguous, and look instead to the legislative history.⁵ 

Congress initially enacted Sec. 6659 as part of the Economic Recovery Tax Act of 1981. The House Ways and Means Committee recognized the large number of property valuation disputes clogging the tax collection system, and added the overvaluation penalty to discourage those taxpayers who would inflate the value of property on their tax returns in hopes of "dividing the difference" with the IRS.⁶  Unfortunately, none of the formal legislative history provides a method for calculating whether a given tax underpayment is attributable to a valuation overstatement.

Such a formula is found, however, in the General Explanation of the Economic Recovery Tax Act of 1981, or "blue book," prepared by the staff of the Joint Committee on Taxation. Though not technically legislative history, the Supreme Court relied on a similar blue book in construing part of the Tax Reform Act of 1969, calling the document a "compelling contemporary indication" of the intended effect of the statute.⁷  The committee staff explained Sec. 6659's operation as follows:

The portion of a tax underpayment that is attributable to a valuation overstatement will be determined after taking into account any other proper adjustments to tax liability. Thus, the underpayment resulting from a valuation overstatement will be determined by comparing the taxpayer's (1) actual tax liability (i.e., the tax liability that results from a proper valuation and which takes into account any other proper adjustments) with (2) actual tax liability as reduced by taking into account the valuation overstatement. The difference between these two amounts will be the underpayment that is attributable to the valuation overstatement.² 

Applying this formula, the Tax Court determined that no portion of the Todds' tax underpayment was attributable to their valuation overstatements. The Todds' actual tax liability, after adjusting for the failure to place the food containers in service before 1983, did not differ from their actual tax liability adjusted for the valuation overstatements. In other words, where the deductions and credits for these refrigeration units were inappropriate altogether, the Todds' valuation of the property supposedly generating the tax benefits had no impact whatsoever on the amount of tax actually owed. Since the legislative history of Sec. 6659 provides no alternative method of applying the statute, we are persuaded that the formula contained in the committee staff's explanation evidences congressional intent with respect to calculating underpayments subject to the penalty.

Our conclusion that Congress intended this formula to be applied in determining liability for the Sec. 6659 addition to tax is fortified by the legislative history of a closely related tax provision. In the Tax Reform Act of 1986, Congress added Sec. 6659A providing, in statutory language and structure almost identical to Sec. 6659, for an addition to tax where a tax underpayment "is attributable to an overstatement of pension liabilities."⁹  This time, the House Ways and Means Committee report explained the provision:

The bill provides a new penalty in the form of a graduated addition to tax applicable to certain income tax overstatements of deductions for pension liabilities. As an addition to tax, this penalty is to be assessed, collected, and paid in the same manner as a tax. This addition to tax applies only to the extent of any income tax underpayment that is attributable to such an overstatement.

The portion of a tax underpayment that is attributable to a valuation overstatement is to be determined after taking into account any other proper adjustments to tax liability. Thus, the underpayment resulting from a valuation overstatement is the excess of the taxpayer's (1) actual tax liability (i.e., the tax liability that results from a proper valuation of deductions for pension liabilities and takes into account any other proper adjustments) over (2) actual tax liability as reduced by taking into account the valuation overstatement.¹⁰ 

Obviously, the second paragraph repeats, almost word for word, the test contained in the committee staff's explanation of Sec. 6659. Given that Congress modelled Sec. 6659A after Sec. 6659, we conclude that the same formula should be applied under each statute--the formula contained in the legislative history of Sec. 6659A and in the committee staff's explanation of Sec. 6659.¹¹ 

The Commissioner asserts, however, that the formula was only meant to apply "in the simple case where there are separate, unrelated adjustments to an individual's tax, one of which is concededly attributable to a valuation overstatement."¹²  He contends that this case is more complex because all of the adjustments to the Todds' tax liability "stem from their participation in the FoodSource shelter."¹³  The Commissioner's attempted distinction finds no support in the language of the statute, its legislative history, or in the description of the committee staff's formula. The formula instructs us to determine Sec. 6659 liability "after " taking account of "any other proper adjustment to tax liability." It does not distinguish among other tax adjustments based on their degree of relationship to the valuation overstatement.

Finding no explicit support for his position, the Commissioner argues that the policies underlying Sec. 6659 mandate imposition of the addition to tax in this instance. He notes that Congress wanted to make tax shelters based on property overvaluations less attractive. To allow the Todds to significantly overvalue the adjusted basis of these food containers on their tax returns without suffering an addition to tax would supposedly frustrate the policies behind Sec. 6659. We point out, of course, that the Todds did not benefit from their tax shelter, since their depreciation deductions and investment tax credits were denied in full. Further, it is probable that Congress was balancing competing policies when it determined how to apply Sec. 6659. First, Congress may not have wanted to burden the Tax Court with deciding difficult valuation issues where a case could be easily decided on other grounds.¹⁴  Second, Congress may have wanted to moderate the application of the Sec. 6659 penalty so that it would not be imposed on taxpayers whose overvaluation was irrelevant to the determination of their actual tax liability.¹⁵  We cannot say for certain why Congress chose this test to measure Sec. 6659 liability, rather than modifying the formula to address the Commissioner's concerns. However, we remain convinced that the formula set out above represents Congress' intent for determining whether to impose the Sec. 6659 addition to tax in any given case.

Finally, appellant argues that the Tax Court decision leads to anomalous results. He points out that some investors in the FoodSource program, like the Hillendahls and Hendricks, were found liable for the Sec. 6659 penalty since their FoodSource units had been placed in service. Yet, arguably, the only difference between the Todds on the one hand and the Hendricks and Hillendahls on the other is that the deductions and credits claimed by the Todds suffer from greater infirmities. The Commissioner also raises the spectre that under the Tax Court ruling, taxpayers might avoid Sec. 6659 penalties by denying they had a profit motivation in entering the transactions in issue.

We admittedly hesitate to ascribe an intent to Congress which might, at first blush, seem inequitable. However, though incongruous results can be considered in construing statutes, once a court knows Congressional intent, it may not vary the rules to avoid what it considers an undesirable outcome.¹⁶  Having set forth the reasons for believing Congress intended to impose the committee staff's formula as the method for determining the application of Sec. 6659, the results appellant complains of do not persuade us to reverse the Tax Court.

We note, however, that the results the Commissioner deplores may not be as inequitable as he argues. First, while the Hendricks and Hillendahls had to pay a Sec. 6659 penalty, they were also allowed to retain a portion of their claimed depreciation deductions and investment tax credits. The Todds, on the other hand, while escaping the Sec. 6659 penalty, were denied any of their claimed deductions and credits for the years in question. Further, to say that the Todds' claimed tax benefits were subject to greater infirmities than those claimed by the Hillendahls and Hendricks does not mean that the Todds were more at fault. As the Tax Court noted, "the failure to place the containers in service during the years of purchase was due to circumstances beyond the control of the Todds and may not have been known to the Todds."¹⁷ 

Finally, the fear that taxpayers will deny profit motivation to avoid Sec. 6659 penalties is unimpressive. Significant penalties attach to tax underpayments attributable to fraud, negligence, or tax motivated transactions. To the extent a taxpayer took the position that he entered a transaction without profit motive, but still claimed tax benefits relating to the transaction, he might well win a Pyrrhic victory, escaping Sec. 6659 penalties only to subject himself to a much larger seventy-five percent penalty for fraud.

III

We hold that the Tax Court applied the correct formula for determining when to impose penalties under Sec. 6659. The Commissioner has failed to persuade us that an alternative test was intended by Congress. The Tax Court decision is AFFIRMED.