Home Concrete Decision Leaves Administrative Law Questions Unsettled While Excluding Overstatements of Basis from Six-Year Statute of Limitations
May 3, 2012
[A shorter version of this blog post appears on SCOTUSblog.]
The Supreme Court last week ruled 5-4 in favor of the taxpayer in Home Concrete, thus putting an end to the long-running saga of the Intermountain litigation on which we have been reporting for the past 18 months. The opinion was authored by Justice Breyer and joined in full by three other Justices, but Justice Scalia joined only in part. The result is a definitive resolution of the specific tax issue – the six-year statute of limitations does not apply to an overstatement of basis. But the Court’s decision provides a much less definitive resolution of the broader administrative law issues implicated in the case.
As foreshadowed by the oral argument (see our previous report here), the tax issue turned on the continuing vitality of the Court’s decision in The Colony, Inc. v. Commissioner, 357 U.S. 28 (1958). To recap, the Court held in Colony that the “omits from gross income” language in the 1939 Code did not encompass situations where the return understates gross income because of an overstatement of basis, and hence the extended six-year statute of limitations did not apply in those situations. The government argued that Colony did not control the interpretation of the same language in current section 6501(e) of the 1954 Code, because changes elsewhere in that section suggested that Congress might have intended a different result in the 1954 Code.
The administrative law issues came into play because, after two courts of appeals had ruled that Colony controlled the interpretation of the 1954 Code, the government tried an end run around that precedent. Treasury issued regulations interpreting the “omits from gross income” language in the 1954 Code as including overstatements of basis, thus bringing those situations within the six-year statute of limitations. Under National Cable & Telecommunications Ass’n v. Brand X Internet Services, 545 U.S. 967 (2005), the government argued, an agency is empowered to issue regulations that define a statute differently than an existing court decision, so long as the court decision did not declare the statutory language unambiguous. Because the Colony opinion had indicated that the 1939 Code language standing alone was “not unambiguous,” the government argued that Treasury’s new regulations were entitled to Chevron deference, which would supplant any precedential effect that Colony would otherwise have on the interpretation of the 1954 Code provision.
The Court’s Opinion
Justice Breyer wrote the opinion for the Court, joined in full by Chief Justice Roberts and Justices Alito and Thomas. Justice Scalia joined Justice Breyer’s analysis of the statute, but departed from his analysis of the administrative law issues.
The opinion dealt straightforwardly with the basic tax issue. First, the Court emphasized that the critical “omits from gross income” language in the current statute is identical to the 1939 Code language construed in Colony, and it recounted the Colony Court’s reasoning that led it to conclude that the language does not encompass overstatements of basis. Colony is determinative, the Court held, because it “would be difficult, perhaps impossible, to give the same language here a different interpretation without effectively overruling Colony, a course of action that basic principles of stare decisis wisely counsel us not to take.” With respect to the statutory changes made elsewhere in section 6501(e), the Court concluded that “these points are too fragile to bear the significant argumentative weight the Government seeks to place upon them.” The Court addressed each of these changes and concluded that none called for a different interpretation of the key language (and that one of the government’s arguments was “like hoping that a new batboy will change the outcome of the World Series”).
The Court then turned to the administrative law issues, reciting the government’s position that, under Brand X, the new regulations were owed deference despite the Court’s prior construction of the language in Colony. The opinion first responded to that position with a two-sentence subsection: “We do not accept this argument. In our view, Colony has already interpreted the statute, and there is no longer any different construction that is consistent with Colony and available for adoption by the agency.”
Standing alone, that was not much of a response to the government’s Brand X argument, because Brand X said that the agency can adopt a construction different from that provided in a prior court decision so long as the statute was ambiguous. These two sentences were enough for Justice Scalia, however, and he ended his agreement with Justice Breyer’s opinion at this point. In a separate concurring opinion, Justice Scalia explained that he is adhering to the view expressed in his dissent in Brand X that an agency cannot issue regulations reinterpreting statutory language that has been definitively construed by a court.
With the other Justices in the majority not feeling free to ignore Brand X, Justice Breyer’s opinion (now a plurality opinion) then proceeded to explain why Brand X did not require a ruling for the government. According to the plurality, Brand X should be given a more nuanced reading than that urged by the government, one that looks to whether a prior judicial decision found a statute to be “unambiguous” in the sense that the court concluded that Congress intended to leave “‘no gap for the agency to fill’ and thus ‘no room for agency discretion.’” Under Chevron jurisprudence, the opinion continued, unambiguous statutory language provides a “clear sign” that Congress did not delegate gap-filling authority to an agency, while ambiguous language provides “a presumptive indication that Congress did delegate that gap-filling authority.” That presumption is not conclusive, however, and thus this reading of Brand X leaves room for a court to conclude that a judicial interpretation of ambiguous statutory language can foreclose an agency from issuing a contrary regulatory interpretation. In support of that proposition, the plurality quoted footnote 9 of Chevron, which states that “[i]f a court, employing traditional tools of statutory construction, ascertains that Congress had an intention on the precise question at issue, that intention is the law and must be given effect.”
The plurality then ruled that the Court in Colony had concluded that Congress had definitively resolved the legal issue and left no gap to be filled by a regulatory interpretation. Given its analysis of the scope of Brand X, the plurality explained that the Colony Court’s statement (26 years before Chevron) that the statutory language was not “unambiguous” did not necessarily leave room for the agency to act. Rather, the Colony Court’s opinion as a whole – notably, its view that the taxpayer had the better interpretation of the statutory language and had additional support from the legislative history – showed that the Court believed that Congress had not “left a gap to fill.” Therefore, “the Government’s gap-filling regulation cannot change Colony’s interpretation of the statute,” and the Court today is obliged by stare decisis to follow it.
The Concurring and Dissenting Opinions
Justice Kennedy’s dissent, joined by Justices Ginsburg, Sotomayor, and Kagan, reached a different conclusion on the basic tax dispute. The dissent looked at the statutory changes made in the 1954 Code and concluded that they are “meaningful” and “strongly favor” the conclusion that the “omits from gross income” language in the 1954 Code should not be read the way the Colony Court read that same language in the 1939 Code. Given that view, the administrative law issue – and the resolution of the case – became easy. The dissent stated that the Treasury regulations are operating on a blank slate, construing a statute different from the one construed in Colony, and therefore they are owed Chevron deference without the need to rely on Brand X at all.
Justice Scalia’s concurring opinion declared a pox on both houses. He was extremely critical of the plurality’s approach, accusing it of “revising yet again the meaning of Chevron . . . in a direction that will create confusion and uncertainty.” He also criticized the dissent for praising the idea of a “continuing dialogue among the three branches of Government on questions of statutory interpretation,” when the right approach should be to say that “Congress prescribes and we obey.” Justice Scalia concluded: “Rather than making our judicial-review jurisprudence curiouser and curiouser, the Court should abandon the opinion that produces these contortions, Brand X. I join the judgment announced by the Court because it is indisputable that Colony resolved the construction of the statutory language at issue here, and that construction must therefore control.”
What Does It Mean?
The Home Concrete decision provides a clear resolution of the specific tax issue. The six-year statute of limitations does not apply to overstatements of basis. The multitude of cases pending administratively and in the courts that involve this issue will now be dismissed as untimely, leaving the IRS unable to recover what it estimated as close to $1 billion in unpaid taxes.
Indeed, in a series of orders issued on April 30, the Court has already cleared its docket of the other Intermountain-type cases that had been decided in the courts of appeals and kept alive by filing petitions for certiorari. In Burks and the other Fifth Circuit cases in which the taxpayers had prevailed, the Court simply denied certiorari, making the taxpayers’ victory final. For the certiorari petitions filed from courts of appeals that had sided with the government, such as Grapevine (Federal Circuit), Beard (Seventh Circuit), Salman Ranch (Tenth Circuit), and Intermountain and UTAM (D.C. Circuit), the Court granted the petitions and immediately vacated the court of appeals decisions and remanded the cases to the courts of appeals for reconsideration. Now constriained by Home Concrete, those courts will enter judgments in favor of the taxpayers in due course.
Notably, although the retroactive nature of the Treasury regulations was a significant point of contention in the litigation, retroactivity did not play a role in the final resolution. The Court held that Colony is controlling and leaves no room for the agency to construe the “omits from gross income” language differently. Thus, Treasury does not have the ability to use its regulatory authority to extend the six-year statute to overstatements of basis even prospectively. Any such extension will have to come from Congress.
The effect of the decision on administrative law generally is considerably more muddled. First, a couple of observations on what the Court did not do. It did not signal any retreat from Mayo. Treasury regulations addressed to tax issues will continue to be judged under the same Chevron deference principles that apply to regulations issued by other agencies. Furthermore, as noted above, the Court did not rely on the retroactive aspect of the regulations. Thus, the decision does not provide guidance one way or another on the extent to which Treasury is constrained in its ability to apply regulations to earlier tax years.
What the Court did do, however, is to weaken the authority of Brand X. Under the reasoning of Justice Breyer’s plurality opinion, courts are now free to decline to defer to a regulatory interpretation that construes ambiguous statutory language – if the court concludes that a prior court decision, using “traditional tools of statutory construction” that go beyond the text, determined that Congress intended to resolve the issue rather than leave a gap for the agency to fill. Although there were only four votes for that proposition, Justice Scalia’s approach would lead him to agree with such a result just as he did in Home Concrete, so lower courts may treat the plurality opinion as controlling. There is, however, room for debate about the impact of the Home Concrete approach. Justice Breyer’s opinion emphasizes the fact that Colony was decided long before Chevron, and lower courts may disagree regarding its impact when the court decision at issue is post-Chevron and, in particular, post-Brand X. At a minimum, the Home Concrete decision should make agencies less confident in their ability to use regulations to overturn judicial interpretations of statutes and should give taxpayers more ammunition to challenge such regulations if necessary.
Interestingly, Justice Breyer’s approach, and in particular his invocation of Chevron’s footnote 9 reference to “traditional tools of statutory construction,” was previewed in the argument in the Federal Circuit in the Grapevine case. As we reported at the time, that argument involved considerable discussion of whether the determination of “ambiguous” at Chevron step 1 must be based entirely on the statutory text, as Brand X suggests, or can be based on other “traditional tools of statutory construction,” as Chevron footnote 9 declares. In its decision, the Federal Circuit stuck to the statutory text and ruled for the government.
Justice Breyer’s opinion, however, supports the proposition that Chevron step 1 analysis can look beyond the statutory text. If that portion of Justice Breyer’s opinion had commanded a majority, it would be extremely significant because it would justify looking beyond the statutory text not only in assessing the impact of Brand X when there is a court decision on the books, but also in considering a Chevron deference argument in the first instance. A court could decide, under the approach suggested by Justice Breyer, that a statute whose text standing alone is ambiguous nonetheless leaves no room for agency interpretation – if other tools of statutory construction show that Congress intended to resolve the issue rather than leaving a gap for the agency. On this point, however, the plurality opinion cannot be treated as controlling because Justice Scalia would surely look askance at a decision that used legislative history to find a lack of ambiguity at Chevron Step 1. By the same token, the dissenters had no occasion to address this point, so we do not know if any of them would have agreed with Justice Breyer’s approach. For now, it is fair to say that Justice Breyer has heightened the visibility and potential importance of Chevron footnote 9, but that Home Concrete alone probably will not yield a significant change in how courts approach Chevron step 1.
In sum, Home Concrete may be a bit of a disappointment to those observers who thought that the decision would bring great clarity to the administrative law issues presented. In that respect, it joins a long list of administrative law cases that reach the Supreme Court and seem to yield as many questions as answers. But for the taxpayers with millions of dollars riding on the difference between a three-year and six-year statute of limitations, the decision is not disappointing at all. It is a huge victory.
December 28, 2011
The taxpayer has filed its brief in Home Concrete. The brief argues forcefully that the case is controlled by Colony, characterizing the underlying statutory issue as “settled by stare decisis.” The brief disputes the government’s arguments that the changes made by Congress in the 1954 Code had the effect of extending the six-year statute to overstatements of basis outside the trade or business context, observing that the 1954 Code changes were all designed to favor taxpayers.
With respect to the regulations, the taxpayer first argues that Colony should be understood as having held that the statutory language was unambiguous, thus foreclosing Treasury from issuing regulations that would require a different statutory interpretation. (As we previously reported, this particular point was the focus of oral argument before the Federal Circuit in Grapevine, with the court ultimately resolving that point in favor of the government and deferring to the regulation.) Second, the brief argues that the regulation would in any event be invalid because of its retroactive effect on pending litigation. In addition, the brief makes some narrower arguments about this particular regulation, maintaining that by its terms the regulation does not cover cases like Home Concrete and that the regulation is procedurally defective.
At least eight amicus briefs were filed in support of the taxpayer. A brief filed by the American College of Tax Counsel focuses on the retroactive application of the regulations, elaborating on the taxpayer’s arguments in asserting that “retroactive fighting regulations” that are designed to change the outcome of pending litigation “are inconsistent with the highest traditions of the rule of law” and should not be afforded Chevron deference. The brief invokes general principles against retroactive legislation and also argues that Code section 7805(b)’s prohibition on retroactive regulations applies. The government argues that section 7805(b) does not apply to regulations interpreting statutes enacted before 1996, a position that was not heavily disputed by taxpayers in the court of appeals litigation of these cases.
Four other amicus briefs were filed by taxpayers who litigated the Home Concrete issues in other circuits and whose cases will be controlled by the outcome — one filed by Grapevine Imports (Federal Circuit), one filed by UTAM, Ltd. (D.C. Circuit), one filed jointly by Daniel Burks (5th Circuit) and Reynolds Properties (case pending in the 9th Circuit), and one filed by Bausch & Lomb (cases pending in the Second Circuit). The latter brief emphasizes that Bausch & Lomb’s case does not involve a son-of-BOSS tax shelter, but rather a more standard business transaction, and also that it involves only section 6229, which does not contain the statutory changes from the 1939 Code found in section 6501 and on which the government heavily relies to distinguish Colony. Amicus briefs were also filed by the Government of the U.S. Virgin Islands, the National Association of Home Builders, and the National Federation of Independent Business, Small Business Legal Center. Copies of the taxpayer’s brief and some of the amicus briefs are attached.
The oral argument in Home Concrete is scheduled for January 17. The government’s reply brief is due on January 10.
September 15, 2011
Although our blog coverage might reasonably be accused of hibernating over the summer, court calendars inexorably marched on, and there were several developments in the various Intermountain cases. If the Supreme Court grants cert in Beard on September 26, as we have predicted, these developments will not be of much moment, since all of the cases will likely be governed by the Supreme Court’s decision in Beard. The one possible exception is the Federal Circuit’s decision in Grapevine, where the taxpayer’s cert petition has been fully briefed and is ready for consideration by the Supreme Court on September 26 together with Beard. In any event, for those keeping score, here is an update, along with a selection of the filings, which are somewhat duplicative.
Federal Circuit: The Federal Circuit denied rehearing in Grapevine on June 6. The taxpayer petitioned for certiorari, docketed as No. 11-163, and the government responded by asking the Court to hold the petition and dispose of it as appropriate in light of its decision in Beard. The government filed its response early, thus allowing the Court to consider the petition in tandem with Beard on September 26. Thus, the Court could conceivably agree to hear both cases, or agree to hear Grapevine alone (because the regulatory deference issue is fleshed out in the court of appeals opinion in that case). The government, however, does not urge either of those approaches. Instead, it asks the Court to grant cert in Beard alone, following its usual practice of hearing the earliest-filed case when two petitions raise the same issue.
D.C. Circuit: The taxpayers in both Intermountain and UTAM filed petitions for rehearing. The court denied the petition in Intermountain on August 18 and denied the petition in UTAM earlier today on September 15. In both cases, the court slightly amended its opinion to provide what it believed to be a better response to certain relatively narrow arguments made by the taxpayers.
Fourth Circuit: The government filed a petition for certiorari in Home Concrete, asking the Court to hold the case for Beard. The taxpayer filed a brief in opposition asking the Court to deny certiorari on the grounds that the Fourth Circuit got it right and that Congress has closed the son-of-BOSS loophole for future years. Good luck with that. The Home Concrete petition will also be considered at the Court’s September 26 conference. If the Court grants cert in Beard or Grapevine, it will surely hold the Home Concrete petition pending consideration of those cases.
Fifth Circuit: The government filed a cert petition in Burks, docketed as No. 11-178, and asking that that case also be held pending the disposition of Beard. The taxpayer did not file an early response, and that case will not be ready for consideration at the Court’s September 26 conference.
Ninth Circuit: The Ninth Circuit’s Reynolds Properties case lagged behind those in the other circuits because the briefing schedule was delayed for some time by the mediation process. Undeterred for now by the prospect that the Supreme Court will resolve the issue, the Ninth Circuit is marching ahead. The case is now fully briefed and is scheduled for oral argument on October 13, 2011.
Tenth Circuit: The court denied rehearing in Salman Ranch on August 9. The taxpayer obtained a stay of the mandate so that it can file a petition for certiorari, which will surely be held if the Court grants cert in one of the other cases.
We will be back soon with a report on what, if anything, the Court does at its September 26 conference.
April 21, 2011
On April 15, the Fifth Circuit denied the government’s rehearing petition in Burks. Not surprisingly, the courts of appeals are showing little interest in sitting en banc to address the Intermountain issue when they cannot eliminate the circuit conflict. To recap, a rehearing petition is pending in the Federal Circuit, but the other three circuits to rule (the Fourth, Fifth, and Seventh) have denied rehearing, and the time is running to file petitions for certiorari in those cases. The first deadline on the horizon is in the Home Concrete case from the Fourth Circuit, where the certiorari petition is due July 5.
March 29, 2011
As promised, the government filed a petition for rehearing en banc in the Fifth Circuit in the Burks case. The filing has one wrinkle that differs from the numerous other recent filings on this issue. The petition claims an intracircuit conflict as a basis for rehearing en banc, arguing that the panel’s decision conflicts with Phinney v. Chambers, 392 F.2d 680 (5th Cir. 1968), a case that the panel had found distinguishable. See our previous report on the Burks decision here.
February 9, 2011
The Fifth Circuit announced today its ruling in favor of the taxpayer in the two consolidated cases pending before it on the Intermountain issue, Burks v. United States, and Commissioner v. MITA. As we previously noted, the Fifth Circuit had decided what the government regarded as the most favorable precedent on this issue before the Son-of-BOSS cases, Phinney v. Chambers, 392 F.2d 680 (5th Cir. 1968), but the court at oral argument appeared to be leaning towards finding that case distinguishable. And so it did, creating the anomaly that the Seventh Circuit in Beard has given Phinney a much broader reading than the Fifth (see here). In any event, the Fifth Circuit rejected the reasoning of Beard and concluded that Colony is controlling with respect to the meaning of the phrase “omits from gross income” in the 1954 Code. The court addressed this argument in some detail, relying heavily on the “comprehensive analysis” of the Ninth Circuit in favor of the taxpayer’s position in Bakersfield Energy Partners, LP v. Commissioner, 568 F.3d 767 (9th Cir. 2009).
The court devoted comparatively little attention to the government’s reliance on the new regulations. It concluded that the statute was unambiguous and therefore there was no basis for affording deference to the regulations. In addition, the court stated that the new regulations by their terms were inapplicable because they should be read as reaching back no more than three years — an argument accepted by the Tax Court majority but that does not appear to be among the taxpayers’ strongest, especially after the final regulations were issued.
The most provocative discussion in the opinion is a long footnote 9 near the end, which points out some possible limitations on the impact of the Supreme Court’s recent Mayo Foundation decision (discussed here). Although its conclusion that the statute is unambiguous made the regulations irrelevant, the court went on to state that it would not have deferred to the regulations under Chevron even if the statute were ambiguous. On this point, the court emphasized an important difference between Mayo and the Intermountain cases — namely, the retroactive nature of the regulations at issue in the latter cases. Noting that the Supreme Court has said that it is inappropriate to defer “to what appears to be nothing more than the agency’s convenient litigating position” (quoting Bowen v. Georgetown Univ. Hosp., 488 U.S. 204, 213 (1988)), the Fifth Circuit stated that the “Commissioner ‘may not take advantage of his power to promulgate retroactive regulations during the course of a litigation for the purpose of providing himself with a defense based on the presumption of validity accorded to such regulations’” (quoting Chock Full O’Nuts Corp. v. United States, 453 F.2d 300, 303 (2d Cir. 1971)). In addition, the court questioned the efficacy of the government’s request for deference to final regulations that were largely indistinguishable from the temporary regulations: “That the government allowed for notice and comment after the final [perhaps should read "temporary"] Regulations were enacted is not an acceptable substitute for pre-promulgation notice and comment. See U.S. Steel Corp. v. U.S. EPA, 595 F.2d 207, 214-15 (5th Cir. 1979).”
Thus, we have perfect symmetry between the conflicting decisions of the Fifth and Seventh Circuits. The Seventh Circuit says that the statutory language supports the government, so there is no need to consider the regulations. But if it did consider the regulations, it would defer. The Fifth Circuit says that statutory language unambiguously supports the taxpayer, so there is no justification for considering the regulations. But if it did consider the regulations, it would not defer. The Supreme Court awaits, and it may well have something to say about the Fifth Circuit’s observations in footnote 9.
December 21, 2010
As we have previously discussed, the IRS sought to buttress its reliance on the six-year statute of limitations in Son-of-BOSS cases by issuing temporary regulations that interpret the term “omission” of gross income in Code sections 6229 and 6501 to include understatements of gross income attributable to overstatements of basis. Because that interpretation strains the language of the statute and flies in the face of the Supreme Court’s decision in Colony, Inc. v. Commissioner, 357 U.S. 28, 32-33 (1958), the government has argued for application of Chevron deference to the temporary regulations. The Tax Court has rejected that argument, and it is now pending in several courts of appeals. Last week, the IRS issued final regulations that supplant the temporary regulations. The final regulations have the same effective date as the temporary regulations (Sept. 14, 2009), and they are essentially the same, although they do clarify what the Tax Court majority in Intermountain found to be an ambiguity — making clear that the regulations are intended to apply to all cases for which the six-year statute of limitations remained open on the effective date.
The government is now submitting the final regulations as supplemental authority to the appellate courts considering the Intermountain issue. (This is an example of the government’s supplemental submission, taken from the Fifth Circuit cases, with the final regulations attached.) In the government’s view, the issuance of the final regulations strenghtens the argument for Chevron deference. Taxpayers have objected that such deference was not owed to the temporary regulations because, among other reasons, they were temporary and issued without notice-and-comment. Indeed, more than a quarter of the pages of argument in the government’s opening brief in Intermountain (here) were devoted to arguing that the temporary regulations were valid and entitled to deference notwithstanding the absence of notice-and-comment. The final regulations arguably eliminate those objections, since the final regulations provided notice and opportunity for comment (even if the comments were disregarded). Notice-and-comment aside, however, the government’s deference argument still faces the formidable obstacle of the contrary Supreme Court decision in Colony.
November 30, 2010
The government has successfully challenged understatements of income attributable to stepped-up basis in so-called Son-of-BOSS tax shelters. See, e.g., American Boat Co., LLC v. United States, 583 F.3d 471, 473 (7th Cir. 2009). But it has been stymied in some cases by the three-year statute of limitations for issuing notices of deficiency. Code section 6501(e)(1)(A) provides for a six-year statute “[i]f the taxpayer omits from gross income an amount” that exceeds the stated gross income by 25 percent. Section 6229(c)(2) provides a similar six-year statute for cases governed by the TEFRA partnership rules. The IRS has argued, unsuccessfully so far, that this section applies when there is a substantial understatement of income that is attributable not to a direct omission of income but rather to an overstatement of basis of sold assets.
The major obstacle to the government’s argument is that the Supreme Court long ago rejected essentially the same argument with respect to the predecessor of section 6501(e)(1)(A) (§ 275(c) of the 1939 Code). The Colony, Inc. v. Commissioner, 357 U.S. 28, 32-33 (1958). The IRS argued there that the six-year statute applies “where a cost item is overstated” and thus causes an understatement of gross income. Id. at 32. The Court agreed with the taxpayer, however, that the six-year statute “is limited to situations in which specific receipts or accruals of income items are left out of the computation of gross income.” Id. at 33. The Court added that, although this was the best reading, it did not find the statutory language “unambiguous.” Id. Accordingly, the Court noted that its interpretation derived additional support from the legislative history and that it was “in harmony with the unambiguous language of [the newly enacted] section 6501(e)(1)(A).” Id. at 37. Based largely on the precedent of Colony, the Tax Court and two courts of appeals have already rejected the government’s attempts to invoke the six-year statute of limitations in Son-of-BOSS cases. See Salman Ranch Ltd. v. Commissioner, 573 F.3d 1362 (Fed. Cir. 2009); Bakersfield Energy Partners, LP v. Commissioner, 568 F.3d 767 (9th Cir. 2009), aff’g, 128 T.C. 207 (2007).
Seeking to rescue numerous other cases that were still pending in the courts or administratively, the government responded by issuing temporary regulations on September 24, 2009, that purported to provide a regulatory interpretation of the statutory language to which the courts would afford Chevron deference. The temporary regulations provide that “an understated amount of gross income resulting from an overstatement of unrecovered cost or other basis constitutes an omission from gross income for purposes of [sections 6229(c)(2) and 6501(e)(1)(A)].” Temp Regs. §§ 301.6229(c)(2) – 1T, 301.6501(e)-1T.
The Tax Court was the first tribunal to consider the efficacy of this aggressive (one might say, desperate) effort to use the regulatory process to trump settled precedent, as the IRS moved the Tax Court to reconsider its adverse decision in Intermountain Ins. Service v. Commissioner, T.C. Memo. 2009-195, in the wake of the temporary regulations. The reception was underwhelming. The Tax Court denied the motion for reconsideration by a 13-0 vote, generating three different opinions. The majority opinion, joined by seven judges, was the only one to base its ruling on rejecting the substance of the government’s argument that courts should defer to the regulations notwithstanding the Supreme Court’s Colony decision. (Four judges stated simply that the new contention about the temporary regulations should not be entertained on a motion for reconsideration; two judges stated that the temporary regulations are procedurally invalid for failure to submit them for notice and comment.)
The government’s deference argument rests on Nat’l Cable and Telecommunications Ass’n v. Brand X Internet Servs., 545 U.S. 967, 982 (2005), which ruled that a “court’s prior judicial construction of a statute trumps an agency construction otherwise entitled to Chevron deference only if the prior court decision holds that its construction follows from the unambiguous terms of the statute and thus leaves no room for agency discretion.” (In a concurring opinion, Justice Stevens stated his view that this rule would not apply to a Supreme Court decision, since that would automatically render the statute unambiguous, but that remains an open question.). The Tax Court majority ruled that the Supreme Court’s statement in Colony that the statute was ambiguous “was only a preliminary conclusion,” but “[a]fter thoroughly reviewing the legislative history, the Supreme Court concluded that Congress’ intent was clear and that the statutory provision was unambiguous.” Accordingly, the majority concluded that Brand X did not apply, and “the temporary regulations are invalid and are not entitled to deferential treatment.” (The two judges who found the regulations procedurally invalid questioned the majority’s reasoning and suggested that the Court should not have reached the substantive issue).
The Tax Court’s decision in Intermountain is just the first skirmish in what will be an extended battle over the temporary regulations. The Justice Department has asserted that there are currently 35-50 cases pending in the federal courts that raise the same issue, with approximately $1 billion at stake. Accordingly, the government is pursuing an appeal to the D.C. Circuit in Intermountain, and it is arguing for deference to the temporary regulations in other cases pending on appeal in other circuits, even where those regulations were not considered by the trial court. The government seems determined to litigate the issue in every possible court of appeals, presumably hoping that it can win somewhere and then persuade the Supreme Court to grant certiorari and reconsider Colony. The current map looks like this:
D.C. Circuit: Briefing schedules have been issued in Intermountain, No. 10-1204, and in an appeal from another Tax Court case, UTAM Ltd. v. Commissioner, No. 10-1262. The government’s opening brief is due in Intermountain on December 6, 2010, and in UTAM on January 6, 2011. The panel assigned to both cases is Judges Sentelle, Tatel, and Randolph.
Federal Circuit: Grapevine Imports, Ltd. v. United States, No. 2008-5090, is fully briefed and scheduled for oral argument on January 12, 2011. The Federal Circuit has already rejected the government’s invocation of the six-year statute in Salman Ranch, but the government is arguing in Grapevine that the Federal Circuit should reverse its position in light of the temporary regulations, which were not previously before the court.
Fourth Circuit: Home Concrete & Supply, LLC v. United States, No. 09-2353, is fully briefed and was argued on October 27, 2010, before Judges Wilkinson, Gregory, and Wynn. In that case, the district court had ruled for the government, distinguishing Colony as limited to situations in which the taxpayer is in a trade or business engaged in the sale of goods or services. That was the rationale of the Court of Federal Claims in the Salman Ranch case, but that decision was reversed by the Federal Circuit.
Fifth Circuit: Burks v. United States, No. 09-11061 (consolidated with Commissioner v. MITA, No. 09-60827) is fully briefed and was argued on November 1, 2010, before Judges DeMoss, Benavides, and Elrod. In its briefs on this issue in various courts, the government has often invoked the Fifth Circuit’s decision in Phinney v. Chambers, 392 F.2d 680 (1968), the only court of appeals decision that has applied the six-year statute in the absence of a complete omission of gross income. In Phinney, the taxpayer on her return had mislabeled proceeds from payment of an installment note as proceeds from a sale of stock with basis equivalent to the proceeds, reporting no income from that sale. The Fifth Circuit accepted the government’s contention that the six-year statute applied, finding that it applies not only in the Colony situation where there is “a complete omission of an item of income of the requisite amount,” but also where there is a “misstating of the nature of an item of income which places the Commissioner . . . at a special disadvantage in detecting errors.” 392 F.2d at 685. The government has argued that Phinney essentially involved an overstatement of basis, and therefore strongly supports its position in the Son-of-BOSS cases. Indeed, the district court in Burks ruled for the government based on Phinney. The government therefore likely viewed the Fifth Circuit as the most favorable appellate forum for the current dispute.
At oral argument, however, the panel appeared sympathetic to the taxpayer’s position that Phinney involved a situation where the taxpayer had taken steps akin to a direct omission that would make it difficult for the IRS to discover the potential tax liability. Therefore, the taxpayer maintains, Phinney is fully consistent with the position that the six-year statute does not generally apply to overstatements of basis.
In addition, the discussion of the temporary regulation at oral argument specifically addressed the debate over whether deference to Treasury regulations is governed by Chevron principles or by the less deferential National Muffler Dealers standard. As we have discussed elsewhere, the Supreme Court may resolve that question in the next few months in the Mayo Foundation case.
Seventh Circuit: Beard v. Commissioner, No. 09-3741 is fully briefed and was argued on September 27, 2010, before Judges Rovner, Evans, and Williams. Although the panel, particularly Judge Rovner, expressed skepticism about some of the IRS’s legal arguments, Judges Williams and Evans appeared troubled by the prospect of allowing the taxpayer to escape scrutiny on statute of limitations grounds. Judge Williams suggested that the taxpayer still ought to have the relevant records and that there was no apparent reason why a misstatement should be treated different from an omission. Judge Evans emphasized that the taxpayer’s position with respect to tax liability was very weak and suggested that Colony might be distinguishable because it involved a return that was much easier for the IRS to decipher than the complex return involved in Beard. Thus, to some extent, the government seemed to have found a sympathetic ear in the Seventh Circuit, though that will not necessarily translate into a reversal of the Tax Court.
Ninth Circuit: Reynolds Properties, L.P. v. Commissioner, No. 10-72406. The court of appeals vacated the briefing schedule to allow the parties to participate in the court’s appellate mediation program. The government, however, has indicated that the case is not suitable for mediation, and therefore a new briefing schedule is likely to be issued soon. The Ninth Circuit has already ruled in Bakersfield that the six-year statute does not apply to overstatements of basis. Presumably, the government will ask the court to reverse itself in light of the temporary regulations, which were not previously before the court.
Tenth Circuit: Salman Ranch Ltd. v. United States, No. 09-9015, is fully briefed and was argued on September 22, 2010, before Judges Tacha, Seymour, and Lucero. This case comes from the Tax Court, but involves the same partnership that prevailed in front of the Federal Circuit.
Attached below as a sampling are the briefs filed in the Fourth and Seventh Circuit cases.