## Facts

- The Caracci family owned and operated three home-health agencies that converted from tax-exempt entities to for-profit entities owned by the family.
- The Commissioner issued deficiency notices asserting over $250 million in excise taxes under I.R.C. § 4958 for alleged “excess benefit transactions,” based on an internal IRS valuation claiming a net excess benefit of $18.5 million.
- The taxpayers petitioned the Tax Court to challenge the asserted deficiencies.
- At trial, the Commissioner conceded for the first time that the deficiency notices were “excessive and erroneous,” and the Tax Court found the Commissioner’s valuation expert made “significant errors.”
- Despite those findings, the Tax Court sustained the imposition of § 4958 excise taxes, concluding the transferred assets’ fair market value exceeded assumed liabilities by over $5 million, and entered decisions totaling $69,702,390 in excise taxes.
- On appeal, the Commissioner did not dispute the deficiency notices were erroneous and conceded the Tax Court made a $1.78 million mistake in its valuation analysis, but argued the net excess benefit finding and resulting taxes were still correct.

## Issues

1. Whether the Tax Court erred as a matter of law by sustaining § 4958 excise taxes after the Commissioner conceded the deficiency notices were erroneous and failed to prove the assessments were correctly calculated.
2. Whether the Tax Court erred as a matter of law in selecting the valuation methodology for the transferred assets and liabilities in the exempt-to-for-profit conversion.
3. Whether the Tax Court’s valuation findings (including the net excess benefit calculation) were clearly erroneous.

## Decision

- The Fifth Circuit reversed the Tax Court.
- The court held the Tax Court erred as a matter of law in sustaining excise taxes after the Commissioner failed to meet his burden to prove the taxes were correctly assessed.
- The court held the Tax Court erred as a matter of law in selecting the valuation method for the transferred assets and liabilities.
- The court held the Tax Court made clearly erroneous factual findings in applying its valuation method, undermining the net excess benefit determination and resulting excise taxes.

## Legal Principles

- When the Commissioner concedes or materially abandons the theory embodied in deficiency notices in a § 4958 excise-tax case, the Commissioner must affirmatively prove the correctness of any assessment ultimately sought; the Tax Court cannot sustain liability without a reliable evidentiary basis.
- A conceded erroneous notice and discredited valuation evidence prevents reliance on a presumption of correctness to bridge an evidentiary gap as to the amount of excise tax.
- Valuation for § 4958 “excess benefit transaction” determinations must use methodologies suited to the economic characteristics of the subject enterprises; using an inappropriate model is legal error and can lead to clearly erroneous valuation findings.

## Conclusion

The Fifth Circuit set aside the § 4958 excise-tax liabilities because the Commissioner conceded the original notices were erroneous and did not prove a reliable alternative valuation, and because the Tax Court selected an improper valuation method and made clear errors in applying it to support the asserted net excess benefit and taxes.


Caracci v. Comm’r of Internal Revenue, 456 F.3d 444 (5th Cir. 2006)