Estate of Robert G. Kluener, Donald E. Hathaway, Co-Executor, Charlotte J. Kluener v. Commissioner of Internal Revenue

WELLFORD, Circuit Judge,

concurring in part and dissenting in part.

I concur with my colleagues in affirming the Tax Court with respect to the deficiency judgment of $284,247 against the estate of Robert G. Kluener set out in Parts I and II of the majority opinion. I respectfully dissent, however, from the majority’s decision to reverse the penalty against -the estate and, therefore, express my disagreement with Part III of the opinion.

First, I believe that the appellants have come perilously close to waiving their challenge to the penalty assessed in this case by failing to cite any compelling authority to support their position except regulatory language. In their 45-page brief, the appellants devoted only two paragraphs to their argument on the penalty question. They claim that the imposition of the penalty “strains credulity,” because “the IRS had absolutely no authority to assess such a penalty.” To support that argument, they cite to the regulations which suggest that there may be more that one position with respect to the same issue, and that “substantial authority” does not mean “predominant authority.” See 26 C.F.R. § 1.6662 — 4(d)(8)(i). However, the appellants never identify any conflicting positions on the issues involved, and counsel for the appellants did not discuss the propriety of the p'enalty assessed at oral argument; Rather, all of counsel’s energies challenged the propriety of the deficiency itself. It seems that the appellants have rested their argument regarding the penalty on the outcome of the underlying deficiency issue. Under these circumstances, it seems that the appellants may have waived their challenge to the penalty in light of the fact that the deficiency assessment has been upheld.

Even if the appellants did not waive this issue, however, I would affirm the penalty as assessed by the Tax Court. It appears to this writer that the same standard of-review should be applied to a penalty for negligent failure to report as for substantial understatement of tax under 26 U.S.C. § 6661 or § 6662. Without an in-depth analysis of this issue, the court in Norgaard v. Commissioner, 939 F.2d 874 (9th Cir.1991), simply stated that “[d]e novo review is proper because the existence of ‘substantial authority’ is a legal question.” Id. at 878 . The Norgaard court went on to hold that “ ‘[substantial authority’ is ... stricter than a reasonable basis standard.” Id. at 880 . The court explained that “a taxpayer’s position with respect to the tax treatment of an item that is arguable but fairly unlikely to prevail in court would satisfy a reasonable basis standard but not the substantial authority standard.” Id. (emphasis added). The majority in this case apparently approved of that standard of review, and concluded that we should “review de novo [a lower court’s] evaluation of the law and its application of the law to the relevant facts. We review its underlying factual findings only for clear error.”

I would affirm the Tax Court’s assessment of the penalty in this case under the standard endorsed by the majority. The appellants argue that “substantial authority” existed to support their tax treatment of the horse sales. The legal authority upon which the appellants rely is the same as that relied upon to challenge the deficiency itself. The appellants cite cases which hold “that funding of corporate operations [is] a valid business purpose.” I do not disagree with this legal premise. The appellants’ argument, however, presupposes that Kluener in fact transferred the proceeds of the horses to APE CO to fund corporate operations. We *641 have unanimously found that Kluener had no valid business purpose in the transfer of the horses. In essence, the appellants’ entire argument regarding the penalty is a factual one, and it must rise or fall depending on the disposition of the deficiency issue. Because the absence of a valid business purpose undermines the appellants’ legal arguments, the argument that “substantial authority” existed for their tax treatment of the horses must fail.

The appellants boldly assert that “it is the policy of the Internal Revenue Service to assess penalties in virtually every situation ... in the hopes of setting up straw men to use as the basis under which to extract some settlement from a taxpayer.” Appellants do not, however, suggest that the ássessment of the penalty in this ease was merely a “bargaining chip” which the government intended to use against the estate. Conspicuously, they cite no cases to support their argument that the use of the penalty in this case was inappropriate.

Thus, I would find that the Tax Court was not clearly erroneous in its factual findings and was not incorrect in its legal conclusion that the penalty at issue was appropriate. Accordingly, I dissent on that issue and would AFFIRM the Tax Court in its decision on all issues in this appeal.