The civil penalty protection provisions of the Internal Revenue Code are a taxpayer’s last line of defense when the Internal Revenue Service seeks to punish the taxpayer. This Article examines the evolution of legislative, administrative, and judicial attitudes toward penalizing taxpayers and predicts that, if current trends continue unabated, the penalty protection that taxpayers now receive from relying on the advice of their tax advisors will be effectively eliminated in many cases. Because the district court’s decision to impose substantial penalties on the taxpayers in Long Term Capital Holdings v. United States was well publicized and came at a critical juncture in that evolution, the case and its wake provide a useful framework for understanding those legislative, administrative, and judicial trends and evaluating their potential future impact. Although the district court’s opinion of the aggressive tax planning employed in that case was ultimately approved on appeal, several of the bases for its decision to deny penalty protection represented significant departures from pre-existing, taxpayer-friendly case law in this area, were arguably misguided, and could discourage taxpayers considering less controversial tax planning. Fortunately, those bases have not been widely adopted in subsequent cases. Nevertheless, the persistence of pro-penalty legislative and administrative trends in Long Term Capital Holdings’ wake suggests that many taxpayers may ultimately be prevented from relying on outside tax advisors for protection from penalties when their attempts to properly apply our increasingly intricate tax laws to complicated business transactions go awry.
Taxpayer Civil Penalty Protection: Long Term Capital Holdings and Its Wake
Volume 81, No. 4, Winter 2008