December 16, 2013
The taxpayer has filed its responsive brief in Quality Stores, setting forth both its basic position that SUB payments are not FICA “wages” and responding in detail to the government’s contrary arguments. The taxpayer’s affirmative case begins with the income tax withholding provisions that the government has argued are irrelevant. The taxpayer argues that the payments are not “remuneration . . . for services” within the meaning of Code section 3401(a) and, in particular, cannot be “wages” because they fall within the category of payments that section 3402(o) describes in its title as “certain payments other than wages” and in the text provides that they “shall be treated as if [they] were a payment of wages.” That statutory argument is supplemented by examination of the legislative history of the passage of section 3402(o) and by a detailed parsing of other statutory provisions suggesting that Congress did not regard these payments as “wages.” The taxpayer also points to statements made by the Court about SUB benefits in another context in Coffy v. Republic Steel Corp., 447 U.S. 191 (1980), to the effect that such payments are not “compensation for work performed” because “they are contingent on the employees being thrown out of work.”
The brief also responds to the arguments made by the government. It dismisses the broad definition of FICA wages in Social Security Bd. v. Nierotko, 327 U.S. 358 (1946) — made in the context of back pay to a current employee — as not probative here where the recipient is not in a current employment relationship with the employer. The taxpayer also takes issue with the government’s reliance on the historical treatment of “dismissal payments,” arguing that these payments are not synonymous with SUB payments.
The taxpayer invokes the Court’s Rowan decision in support of its basic position that “wages” must be construed the same for both FICA purposes and income tax withholding purposes. As noted in our previous report, the government has chosen to oppose this argument without relying on the so-called “decoupling amendment” that Congress enacted in the wake of Rowan. The taxpayer disputes the government’s argument that the consistency rationale of Rowan is best served by treating SUB payments as “wages” for both purposes. To the contrary, the taxpayer argues, there is a sound policy reason for treating such payments as “wages” for income tax withholding (preventing a heavy year-end tax burden), but no corresponding policy reason to do so in the FICA context.
The taxpayer’s brief devotes considerable attention to arguing that no deference should be paid to the IRS’s Revenue Rulings defining what kind of severance payments constitute “wages.” This topic is also the focus of an amicus brief filed by Professor Kristin Hickman, which asks the Court to hold that such rulings are not entitled to Chevron deference because they are not promulgated in compliance with the Administrative Procedure Act. This focus is a bit surprising since the government’s brief does not argue for deference to its Revenue Rulings, and government officials have previously publicly stated that the Justice Department will no longer argue in court that Revenue Rulings are entitled to Chevron deference. The government’s brief, however, does discuss its relevant Revenue Rulings in some detail, in the nature of background for why it believes Congress addressed income tax withholding in the way that it did. The taxpayer treats this discussion as reflecting an “implicit (and incorrect) presumption” that the Court must defer to the Revenue Rulings and, taking no chances, the taxpayer tackles that presumption head-on.
Oral argument is scheduled for January 14.
December 9, 2013
In a somewhat unusual move, the Ninth Circuit issued an order last week suggesting that the parties pursue mediation in the Bergmann case. The order came two days after the court heard oral argument. The order states that “the court believes this case may be appropriate for mediation” and therefore it is being referred to the Ninth Circuit’s Mediation Office. A mediator will then contact the parties to determine their interest, but the parties are not required to elect mediation. The Circuit Mediator is directed to report back to the panel by January 4. In the meantime, the court will not act on the appeal.
The oral argument in this case was held on December 3 before Ninth Circuit Judges Gould, Paez, and District Court Judge Marilyn Huff, sitting by designation. As we have previously reported, the issue in this case is whether the taxpayer was insulated from penalties for participating in a tax shelter because he filed a qualified amended return. The outcome turns on the applicability of Treasury regulations that delineate when it is, in effect, too late for a taxpayer to save himself by filing an amended return because it is understood that he is doing so only because IRS actions have tipped him off that the shelter is being audited. As the parties framed the issue at oral argument, the dispute boils down to whether the current Treasury regulation (which describes what IRS actions are to be understood as tipping off the taxpayer) was merely a clarification of the previous regulation that was in effect at the time that the taxpayer filed his amended return. The taxpayer’s counsel conceded that applying the terms of the current regulation would have terminated the right to avoid penalties by filing an amended return; government counsel conceded that it is the older regulation, not the current one, that applies.
A couple of questions were asked at oral argument of each side, but nothing unexpected arose that obviously should have prompted the panel to suggest mediation. Towards the end of the argument, however, after the panel had established that few, if any, taxpayers remain governed by the terms of the older regulation, District Judge Huff asked government counsel whether the parties had considered mediation (noting that she did not even know if the Ninth Circuit had a mediation program). Not surprisingly, both government counsel and later taxpayer counsel said that they would not rule anything out and would be willing to entertain mediation.
The Ninth Circuit, of course, has an established mediation program — to which this case is now being referred — but that program ordinarily kicks in at the outset of the appeal, not after briefing and oral argument. In fact, in this case the parties participated in the first stage of that process, a telephone settlement assessment conference, back in March 2012. Thereafter, on March 15, 2012, the Court issued an order stating that the case was not selected for the mediation program, and it then proceeded to briefing.
The panel is now suggesting that the parties take a fresh look and decide whether they can reach a middle ground. There is no middle ground if the appeal proceeds to a decision: either the qualified amended return was timely and effective to protect against penalties or the taxpayer’s ability to achieve that protection was terminated before he filed the amended return. The panel perhaps decided that a fairer result lies somewhere in the middle — given that the text of the older regulation appears to lean towards the taxpayer but resolving the case on that basis might be regarded as allowing the taxpayer to benefit from a poorly drafted regulation when it should have been too late, as a policy matter, to avoid penalties by filing an amended return. Whatever the court was thinking, the oral argument and this order have given each side reason for concern that it might lose if the appeal proceeds to judgment. On the one hand, the judges did not question the government’s assertions that its interpretation of the regulation was entitled to deference and that it would be a bad policy result to allow the taxpayer to escape penalties here. On the other hand, the court — particularly Judge Gould who questioned government counsel on this point — did not appear entirely convinced that the current regulation can be viewed as a “clarification” because the text of the older regulation is not easily read to support the government’s position. It is entirely possible that both sides will seize this opportunity to split the baby and will reach a settlement through the mediation process.
December 3, 2013
The Supreme Court this morning ruled 9-0 in favor of the government on both issues in Woods, holding that: (1) there is partnership-level TEFRA jurisdiction to consider the appropriateness of a penalty when the partnership is invalidated for lack of economic substance; and (2) the 40% valuation overstatement penalty can apply in that setting on the theory that the basis of a sham partnership is zero and therefore the taxpayers overstated their basis. See our prior coverage here. The opinion, authored by Justice Scalia, is concise and appears to resolve definitively both issues that had previously divided the lower courts.
On the jurisdictional issue, the Court began by pointing to Code section 6226(f), which establishes partnership-level jurisdiction for “the applicability of any penalty . . . which relates to an adjustment to a partnership item.” Accordingly, the Court found, the question “boils down to whether the valuation-misstatement penalty ‘relates to’ the determination” that the partnerships were shams. On that point, the Court agreed with the government’s “straightforward” argument that “the penalty flows logically and inevitably from the economic-substance determination” because the trigger for the valuation overstatement calculation is the conclusion that a sham partnership has zero basis.
The Court rejected the taxpayer’s argument (previous adopted by the Federal and D.C. Circuits) that there can be no partnership-level determination regarding “outside basis” because some partner-level determinations are necessarily required to conclude that outside basis has been overstated. The Court found that this approach is inconsistent with TEFRA’s provision that the applicability of some penalties must be determined at the partnership level. If the taxpayer’s position were correct, the Court stated, it “would render TEFRA’s authorization to consider some penalties at the partnership level meaningless.” The Court stressed that the partnership-level applicability determination is “provisional,” meaning that individual partners can still raise partner-level defenses, but the partnership-level proceeding can determine an overarching issue such as whether the economic-substance determination was categorically incapable of triggering the penalty. In the Court’s view, “deferring consideration of those arguments until partner-level proceedings would replicate the precise evil that TEFRA sets out to remedy: duplicative proceedings, potentially leading to inconsistent results, on a question that applies equally to all of the partners.”
With respect to the merits issue of the applicability of the 40% penalty, the Court relied on what it regarded as the “plain meaning” of the statute. The text applies the penalty to tax underpayments attributable to overstatements of “value . . . (or the adjusted basis)” of property. Finding that the parentheses did not diminish or narrow the import of the latter phrase, the Court concluded that a substantial overstatement of basis must trigger the 40% penalty and that such an overstatement occurred in this case. Because the term “adjusted basis” “plainly incorporates legal inquiries,” the Court was unpersuaded by the taxpayer’s argument that the penalty applies only to factual misrepresentations of an asset’s value or basis. As we have previously noted (see here and here), both the taxpayer and an amicus brief filed by Prof. David Shakow set forth considerable evidence that the intent of Congress in enacting the 40% penalty was to address factual overstatements, not overstatements that flow from legal errors. The Court, however, stated that it would not consider this evidence, which is found in legislative history and in the IRS’s prior administrative practice, because “the statutory text is unambiguous.”
In addition, the Court rejected the reasoning of the Fifth Circuit that the underpayment of tax was “attributable to” a holding that the partnership was a sham, not to an overstatement of basis. The Court instead adopted the reasoning of Judge Prado’s opinion in the Fifth Circuit (which had questioned the correctness of binding circuit precedent) that, “in this type of tax shelter, ‘the basis understatement and the transaction’s lack of economic substance are inextricably intertwined.'”
At the end of the opinion, the Court addressed an issue of statutory interpretation that has broader implications beyond the specific context of Woods. The taxpayer had relied on language in the Blue Book, and the Court stated in no uncertain terms that the Blue Book is not a relevant source for determining Congressional intent. Rather, it is “post-enactment legislative history (a contradiction in terms)” that “is not a legitimate tool of statutory interpretation.” The Court acknowledged that it had relied on similar documents in the past, but suggested that such reliance was a mistake, stating that more recent precedents disapprove of that practice. Instead, the Blue Book should be treated “like a law review article”— relevant only if it is persuasive, but carrying no special authority because it is a product of the Joint Committee on Taxation.