Home Concrete Decision Leaves Administrative Law Questions Unsettled While Excluding Overstatements of Basis from Six-Year Statute of Limitations

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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.

Supreme Court opinion in Home Concrete

Lively Oral Argument in Home Concrete Leaves Outcome in Doubt

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January 22, 2012

The Supreme Court heard oral argument in the Home Concrete case on January 17, with the Justices vigourously questioning both sides on both the statutory and administrative deference issues.  The Court will issue its decision by the end of June.  The following is a recap of the argument that is also published at SCOTUSblog.  A full transcript of the oral argument can be found here.

Home Concrete involves the scope of the extended six-year statute of limitations applicable when a taxpayer “omits from gross income an amount properly includible therein.”  The case presents two main issues:  (1) whether that statutory language covers overstatements of tax basis, even though the Supreme Court construed the same phrase in a predecessor statute not to do so; and, (2) if the Court does not accept the government’s statutory argument, whether it must defer to a recent Treasury regulation that adopts the government’s proffered interpretation.  The argument was lively, with all Justices save Justice Thomas asking questions at some point.  It was also somewhat disjointed, as the discussion jumped from topic to topic without any obvious agreement among the Justices concerning which issue would be the ground for resolving the case.

Arguing on behalf of the United States, Deputy Solicitor General Malcolm Stewart began by making a determined effort to persuade the Court that it should prevail on a standard statutory analysis without the need to resort to Chevron deference.  In response to questions from the Chief Justice and Justice Scalia suggesting that the Court’s decision in The Colony, Inc. v. Commissioner derails that argument from the start, Stewart argued that Colony did not purport to give a definitive definition of the “omits from gross income” language wherever it appears in the Code.  Rather, it just interpreted the language for the 1939 Code, and the 1954 Code should be read differently because of the additional subsections that were added.

Several Justices (the Chief Justice, Justice Scalia, and Justice Sotomayor) expressed skepticism that Congress would have used such an obscure mechanism to change the interpretation of the “omits from gross income” phrase.  Stewart responded that he would agree if Colony had been on the books when the 1954 Code was enacted.  But in fact Colony was not decided until 1958, and Congress was acting against the backdrop of the existing circuit conflict on the meaning of the 1939 Code.  Justices Kennedy and Scalia immediately questioned that response, stating that it is “very strange” to say that the same language would have a different meaning depending upon when Colony was decided.  Justice Scalia then elaborated on his skepticism over the government’s attempts to prevail on the statute alone, stating that “we’re not writing on a blank slate here.”  “I think Colony may well have been wrong, but there it is.  It’s the law.  And it said that that language meant a certain thing.”

At that point, Justice Kagan sought to rescue Stewart by interjecting that the government has two arguments and the second one – that Treasury had the power to reinterpret the statute in regulations – was independent of Colony’s interpretation of the statutory language.  Although Stewart first tried to steer the Court back to the statute, Justice Kagan persisted, and the Chief Justice then entered the fray to question the linchpin of the government’s deference argument – namely, that Colony had found the statute to be “ambiguous.”  The Chief Justice pointed out that Justice Harlan, in using that word in 1958, “was writing very much in a pre-Chevron world” and likely was using the word not as “a term of art,” but rather in an attempt to be gracious to the lawyers and courts that had taken the opposite position.  Justice Ginsburg, however, pointed out that the Court had characterized the new subsection in the 1954 Code as “unambiguous” and therefore should be taken at its word that the 1939 Code was ambiguous.

Another line of questioning explored the extent to which there was ever a well-entrenched view that Colony controlled the meaning of the 1954 Code.  Stewart rejected the taxpayer’s position that everyone understood Colony as controlling prior to the Son-of-BOSS litigation, stating that there was a “surprising dearth of law” on the point, but the only arguably relevant case was a 1968 Fifth Circuit decision that suggested that Colony was not controlling.  The taxpayer and the Fifth Circuit dispute that reading of the case.  (No one observed that the likely reason there was no case law on this issue was because the IRS accepted Colony as controlling and therefore never attempted to invoke the six-year statute for overstatements of basis.)  Justice Breyer asked about a 2000 IRS guidance document that appeared to adopt the taxpayer’s view of Colony, but government counsel dismissed it as merely the view of a single District Counsel.  That prompted the Chief Justice to ask acerbically “at what level of the IRS bureaucracy can you feel comfortable that the advice you are getting is correct?”

When Gregory Garre took the podium on behalf of the taxpayer, Justice Kagan asked why Congress had added the new subsection addressing a trade or business.  Garre argued that it was designed to resolve the Colony issue favorably to the taxpayer, noting that there was nothing problematic about the fact that the new subsection addressed the specific problem of cost of goods sold instead of explicitly sweeping more broadly.  That answer triggered a more extensive discussion of why Congress acted as it did and whether it was drawing a distinction between sales of goods and services (addressed in the new subsection) and sales of real estate (at issue in Colony).

The key administrative law precedent at issue on the deference argument is National Cable & Telecommunications. Ass’n v. Brand X Internet Services, in which the Court accorded deference to a regulation that overturned existing court of appeals precedent.  The Court did not show any interest in backing away from Brand X, but it did suggest that it might read the case somewhat more narrowly than the government would like.  In Brand X, Justice Stevens wrote a short concurring opinion stating that the holding would not apply to a Supreme Court opinion because at that point no ambiguity would be left.  At the beginning of the argument, Justice Scalia echoed that view when he objected to Stewart’s reliance on the statement in Colony that the statute was “not unambiguous” by observing:  “Yes, but once we resolve an ambiguity in the statute, that’s the law and the agency cannot issue a regulation that changes the law just because going in the language was ambiguous.”  The Chief Justice returned to this point at the argument’s close.  He asked the only questions during the government’s rebuttal argument, seeking to confirm that the Court has never applied Brand X to one of its own decisions – that is, that “we’ve never said an agency can change what we’ve said the law means.”

The more open-ended issue concerning the scope of Brand X is what exactly was meant in that case by the statement that the judicial construction can trump a later regulation “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.”  The Court’s exploration of this point began with a lighthearted comment by Justice Scalia that the question in the case boils down to whether indeed Colony meant “ambiguous” when it used that term.  Justice Alito followed up, however, pointing out that every statutory interpretation question in the Supreme Court “involve[s] some degree of ambiguity . . ., [s]o what degree of ambiguity is Brand X referring to?”

Garre’s response to this question was to go back to the original Chevron decision, which “looks to whether Congress has addressed the specific question presented.”  Under that approach, Colony should be regarded as having found the degree of clarity necessary to insulate it from being overturned by regulation, because the Court concluded that Congress had addressed this specific question.  Justice Kagan, later seconded by Justice Ginsburg, questioned that approach, commenting that the relevant question is “how clearly did Congress speak to that specific situation?”  Because the Colony Court stated that the text was ambiguous and had to do a lot of “tap dancing” through the legislative history to resolve the case, she stated that Colony must be read as indicating “a lot of ambiguity.”  Justice Breyer then jumped in to express agreement with the taxpayer’s argument that the Colony Court’s resort to legislative history was just a standard mode of statutory construction that did not require treating that case as finding an ambiguity under Brand X.  Instead, Justice Breyer stated, “[t]here are many different kinds of ambiguity and the question is, is this of the kind where the agency later would come and use its expertise”?

The argument devoted relatively little attention to the retroactivity question.  The Chief Justice observed that, in light of Brand X, a taxpayer could never feel confident about a tax precedent because the IRS can change the rule and apply it retroactively.  This observation, however, did not obviously elicit much concern from the other Justices, with the notable exception of Justice Breyer who had stated early on that it was “unfair” for the IRS to promulgate “a regulation which tries to reach back and capture people who filed their return nine years before.”  Later, Justice Breyer acknowledged that merely tagging the retroactivity as unfair “is not enough” and asked Garre an incredibly long question designed to explore possible justifications for avoiding the retroactive application of the regulations even if the Court were to defer to them on a prospective basis.  These ideas, however, did not appear to gain any traction with the other Justices.

Predicting the outcome on the basis of this oral argument is dicey.  Justice Kagan appeared sympathetic to the government’s position, while Justice Breyer was very troubled by the unfairness of it.  Justices Ginsburg and Sotomayor seemed to tilt towards the government.  But most of the Justices expressed enough difficulty with both sides that their votes cannot reasonably be forecast.  Overall, however, it did appear that the Court is more likely heading towards a relatively narrow decision than towards one that would break new ground in administrative law.  The Court’s approach to Colony will likely be critical.  If the Court treats Colony as precedential with respect to the 1954 Code, as it was generally regarded for fifty years, then it would not be difficult to rule for the taxpayer.  Brand X might be distinguished because Colony is a Supreme Court decision, or perhaps on the ground that the case should not be treated as finding an “ambiguity” in Chevron terms.  Conversely, if the Court views Colony as inapplicable to the 1954 Code, then, notwithstanding Justice Scalia’s observation to the contrary, the Court will essentially be writing on a blank slate.  If so, Brand X would likely lead to a ruling for the government.

Home Concrete Argument Preview

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January 15, 2012

The long journey of the Intermountain cases toward a definitive resolution enters its final phase on Tuesday morning when the Supreme Court hears oral argument in the Home Concrete case.  (The final brief, the government’s reply brief, was filed last week.)  Each side will have 30 minutes for its argument, with the government going first and having the opportunity for rebuttal (using whatever portion of the 30 minutes that remains after its opening argument).  Deputy Solicitor General Malcolm Stewart (the Deputy SG in charge of tax cases) will argue for the government.  Gregory Garre, who served as Solicitor General during the last few months of the Bush administration in 2008-09, will argue for the taxpayer.  Both counsel have many Supreme Court arguments under their belts.

Regular readers of the blog know that we have covered these issues extensively since the Tax Court issued its decision in Intermountain.  The following is a preview of the argument that summarizes the issues for those who have not been following it so closely (or perhaps have gotten tired reading about it and want a refresher course).  A shorter version of this argument preview appears at SCOTUSblog.

We will return later in the week with a report on the argument.

Introduction

Depending on how the Court resolves a threshold statutory construction issue, Home Concrete could yield a decision of broad importance or one of interest only to tax lawyers.  The ultimate issue concerns the scope of an extended statute of limitations applicable only to tax cases.  The first possible ground for decision is purely a matter of interpreting the language of the tax statutes.  But the government faces significant hurdles on that ground, notably the Court’s 1958 decision in The Colony, Inc. v. Commissioner, which interpreted the same words in a predecessor statute in the 1939 Code in accordance with the taxpayer’s position.  If the Court rejects the government’s position that the statutory language alone is dispositive, the case will move to the second issue presented – whether the Court must adopt the government’s statutory construction because Chevron requires it to defer to recently promulgated Treasury regulations.  A decision on that issue could be a significant administrative-deference precedent that would have broad ramifications outside the tax context as well.

Background

Generally, the IRS has three years from the date a tax return is filed to assess additional tax on the ground that a taxpayer underreported its tax liability.  Under 26 U.S.C. § 6501(e)(1)(A), however, there is an extended six-year statute of limitations if the taxpayer “omits from gross income” a significant amount that it should have included.  A similar provision governing partnership tax returns is found at 26 U.S.C. § 6229(c)(2).  The question presented in Home Concrete is whether that “omits from gross income” language includes a situation where a taxpayer overstates its basis. 

The textual question at the heart of this case goes back almost 70 years.  The 1939 Internal Revenue Code, which was later superseded by the 1954 Code, contained a provision with language identical to that of current section 6501(e)(1)(A).  Taxpayers argued that the extended statute of limitations applied only when there was a literal omission of gross income – that is, a failure to list an item of gross income on the return.  The government argued that the extended statute also applied when there was an overstatement of basis, because that leads to an understatement of gross income.  The issue generated a circuit conflict and eventually made it to the Supreme Court in the Colony case. 

In the meantime, Congress enacted the 1954 Code, which largely carried forward the previous statute.  Congress did not change the “omits from gross income” language and did not directly address the then-existing dispute about its scope.  Congress did add a new subsection that specifically defined “gross income” in the case of a trade or business, and it defined that term so that an overstatement of basis could not possibly be an omission of “gross income.”

Thereafter, the Colony case arrived in the Supreme Court.  Construing the 1939 Code, the Court ruled for the taxpayer, holding that “the statute is limited to situations in which specific receipts or accruals of income are left out of the computation of gross income” and therefore it did not apply to overstatements of basis.  Little did the Court know that 50 years later litigants would be parsing its reasoning to see how the case fits into the framework of Chevron – specifically, whether the Colony Court should be understood to have found the statutory language before it unambiguous.  Two statements by the Colony Court are particularly relevant.  First, the Court stated that, although the statutory text “lends itself more plausibly to the taxpayer’s interpretation, it cannot be said that the language is unambiguous.”  The Court then looked to the legislative history, where it found persuasive support for the taxpayer, and also concluded that the government’s interpretation would apply the statute more broadly than necessary to achieve Congress’s purpose.  Second, having been urged by the parties to consider whether the new legislation shed any light on the meaning of the 1939 Code, the Court stated that its conclusion was “in harmony with the unambiguous language” of the 1954 Code.

Fast forward 50 years.  The issue has lain dormant, as everyone assumed that Colony controlled the interpretation of the identical language in the 1954 Code.  The IRS learned that many taxpayers had engaged in a series of securities transactions that came to be known as a Son-of-BOSS transaction.  The IRS views this transaction as a tax avoidance scheme that manipulates certain tax rules to produce an artificially inflated basis for an asset that is then sold, producing either a noneconomic paper loss or a smaller gain than it should.  The IRS has successfully challenged these transactions, with the courts generally concluding that they lack “economic substance” and therefore the taxpayers cannot take advantage of the apparent tax benefits.  But in many cases, the IRS discovered that more than three years had elapsed before it could challenge the tax treatment, and therefore the standard statute of limitations had expired.

Seeking to recover what it estimated as almost $1 billion in unpaid taxes, the IRS began to argue that the extended six-year statute of limitations applied to these transactions because they involved an overstatement of basis.  It contended that Colony was not controlling because the Court’s decision should be limited to the 1939 Code and that a different result should obtain in the Son-of-BOSS cases (which arise outside the “trade or business” context and hence are not encompassed within the new subsection added in 1954).  This argument initially fell flat in the courts, as the Tax Court and the Ninth and Federal Circuits held that Colony controls the interpretation of the “omits from gross income” language of the 1954 Code.

The government then moved on to Plan B.  The Treasury Department issued temporary regulations interpreting the “omits from gross income” language to include overstatements of basis.  (These regulations have since been issued without material change as final regulations after a notice-and-comment period.)  The government then filed a motion for reconsideration in the Intermountain case, arguing that the Tax Court should reverse its decision because of an “intervening change in the law” requiring it to accord Chevron deference to the new regulatory interpretation.  The Tax Court was unimpressed, voting 13-0 (in three different opinions giving three different grounds) against the government.

Unfazed, the government filed appeals in several cases heading to different circuits, and the tide began to turn.  First, the Seventh Circuit became the only court thus far to agree with the government’s statutory argument.  The Fourth and Fifth Circuits quickly rejected that view and also rejected the government’s Chevron argument, holding that after Colony there was no ambiguity for the Treasury Department to interpret.  Three other court of appeals decisions followed in short order, however, and all three circuits ruled for the government on Chevron deference grounds.  Of particular note on that point is the Federal Circuit’s decision, since the Federal Circuit had already rejected the government’s pre-regulation statutory interpretation.  The Federal Circuit explained that it still believed that the taxpayer had the best reading of the statute, but that it was required to defer to the regulation because it could not say that the regulation’s interpretation was unreasonable.  The Court granted certiorari in Home Concrete, the Fourth Circuit case, to resolve the conflict.

Arguments

With respect to the meaning of the statute, the taxpayer rests primarily on Colony, characterizing the IRS as having “overruled” that decision.  The taxpayer argues that its reliance on stare decisis is buttressed by the fact that Congress reenacted the same statutory language in later years against the background of Colony, thereby putting a legislative stamp on the Court’s determination that the words “omits from gross income” should be interpreted not to include overstatements of basis. 

The government in turn argues that Colony is irrelevant because it involved a different statute, which was materially changed in 1954 when Congress added a subsection making clear that there is no extended statute of limitations for overstatements of basis by a trade or business.  Implicit in Congress’s decision to make that addition was its understanding that overstatements of basis would be covered outside of the trade or business context; otherwise, the new provision would be superfluous.  The taxpayer responds that the new subsection is not superfluous and that it is absurd to conclude that the 1954 Code cut back on taxpayers’ statute of limitations protections when the only changes made to the statute favored taxpayers. 

In addition to the Colony-related arguments, both sides argue that their position reflects the best reading of the statutory text and purpose.  The taxpayer argues that “omits” means leaving something out, while the government emphasizes that overstatements of basis inevitably cause an understatement (that is, an “omission” of a portion) of gross income.

The taxpayer makes a couple of other narrow arguments that could theoretically divert the Court from reaching the deference issue:  (1) that the regulations were procedurally defective; and (2) that by their terms, the regulations do not apply to cases like this one, where the three-year statute had already expired before the regulations were promulgated.  These arguments did not prevail in any court of appeals, and the Court is unlikely to adopt them.  That will lead the Court to a deference issue of potentially broad doctrinal significance.

Back in 1971, the Second Circuit thought it obvious that the Treasury Department did not have the power to affect pending litigation that the government claims here, stating that “the Commissioner may not take advantage of his power to promulgate retroactive regulations during the course of litigation for the purpose of providing himself with a defense based on the presumption of validity accorded to such regulations.”  But the D.C. Circuit, in reversing the Tax Court’s reviewed Intermountain decision, said that the Second Circuit’s statement has been “superseded” by Supreme Court precedent.  The Home Concrete case is well positioned to determine who is right.

Basically, the government argues that the Court’s Chevron jurisprudence has already crossed all the lines that are necessary to get to its desired end result here.  In Smiley v. Citibank, N.A., the Court afforded deference to a regulation in a case that was already pending when the regulation was issued, stating that it was irrelevant whether the regulation was prompted by litigation.  In National Cable & Telecomms. Ass’n v. Brand X Internet Servs., the Court afforded deference to a regulation that overturned existing court of appeals precedent, holding 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.”  Put those two together, the government argues, and there is no justification for failing to defer to Treasury’s interpretation because Colony had described the 1939 statute as not “unambiguous.” 

Not so fast, says the taxpayer, arguing that, after Colony, the law was settled and there was no ambiguity that could permissibly be “clarified” by regulation.  Smiley is different, because the regulation there did not overturn a previously settled interpretation.  Brand X is not applicable because Colony is properly read as having held that Congress did unambiguously express its intent not to include overstatements of basis.  More generally, the taxpayer contends that the retroactive effect of the government’s position is a bridge too far that is not authorized by these precedents.  Among the several amicus briefs filed in support of the taxpayer, one filed by the American College of Tax Counsel focuses exclusively on the retroactivity question, asserting that “retroactive fighting regulations” 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.

Analysis

At the end of the day, the deference issue may turn on the Court’s comfort level with the amount of authority the government is asking courts to concede to agencies – particularly an agency frequently in a position to advance its fiscal interest through regulations that will affect its own litigation.  That general topic has been flagged in the court of appeals opinions.  In the Federal Circuit decision holding that the new regulation trumped that court’s precedent, the court observed that the case “highlights the extent of the Treasury Department’s authority over the Tax Code” because “Congress has the power to give regulatory agencies, not the courts, primary responsibility to interpret ambiguous statutory provisions.”  Conversely, Judge Wilkinson cautioned in his concurring opinion in Home Concrete that “agencies are not a law unto themselves,” but must “operate in a system in which the last words in law belong to Congress and the Supreme Court.”  In his view, the government’s invocation of Chevron deference in this case wrongly “pass[es] the point where the beneficial application of agency expertise gives way to a lack of accountability and risk of arbitrariness.”

In recent years, the Court has not evinced much concern over the amount of power that its Chevron jurisprudence has given to agencies.  But this case could induce it to look more closely at the big picture.  Justice Scalia’s position will be of particular interest.  Justice Scalia was an early force in the development of Chevron deference, dating back to his time on the D.C. Circuit shortly after Chevron was decided.  But recently, he has expressed some uneasiness that the way in which the doctrine has developed had given agencies too much power.  He dissented in Brand X, commenting that the decision was creating a “breathtaking novelty:  judicial decisions subject to reversal by executive officers.”  And just last June, he noted in a concurring opinion in Talk America, Inc. v. Michigan Bell Telephone Co., that he would be open to reconsidering Auer v. Robbins (a decision that he authored in 1997) because its rule of extreme deference to an agency’s interpretations of its own regulations “encourages the agency to enact vague rules which give it the power, in future adjudications, to do what it pleases.”  Justice Scalia’s questions at oral argument, and the reaction of other Justices to them, will be worth watching. 

 

Taxpayer and Supporting Amicus Briefs Filed in Home Concrete

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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.

Home Concrete – Taxpayer’s Supreme Court brief

Home Concrete – Amicus Brief of American College of Tax Counsel

Home Concrete – Grapevine Amicus Brief

Home Concrete – Amicus Brief of Burks and Reynolds Properties

Home Concete – Amicus Merits Brief of Bausch & Lomb

Supreme Court Briefing Underway and Argument Date Set in Home Concrete

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November 23, 2011

The Supreme Court has set January 17 as the date for the oral argument in Home Concrete, the case in which it will decide the “Intermountain” issues concerning the applicability of the six-year statute of limitations to overstatements of basis, on which we have reported extensively many times before.  (See here and here for a sample.)  In the meantime, the briefing has commenced with the filing of the government’s opening brief (linked below).

The brief covers what is mostly familiar ground at this point, but it does further develop some of the arguments that have emerged in the course of the court of appeals litigation, with particular reliance on the D.C. Circuit’s decision in Intermountain.  The government divides its argument into three sections.  The first analyzes the statutory text, structure, and purpose, emphasizing a broad definition of the word “omission” and arguing that its position is supported by other subsections within section 6501(e).  Second, the government argues for deference to the final regulations.  Finally, the third section argues that the Supreme Court’s Colony decision is not controlling.

With respect to the administrative deference point that is of the broadest significance in this case, the government not surprisingly offers up arguments that will enable the Court to rule in its favor without exploring the outer limits of the power that the Court’s recent precedents arguably confer on the Treasury Department.  But the government does not shirk from pushing those limits in case its other arguments are unpersuasive. 

For example, although the government argues that the Colony decision is inapplicable because it involved a 1939 Code provision that has since changed in some ways, the government maintains that it should still prevail even if no changes had been made to the statute in the 1954 Code.  “Under Brand X,” the government states, “the new Treasury Department regulation would be entitled to Chevron deference even if that rule construed precisely the same statutory provision that was before the Court in Colony.”  Thus, the government is not bashful about claiming an extraordinary amount of power for the Treasury Department.  Congress can pass a law establishing a particular rule, and the Supreme Court can construe that law, but the Treasury Department can turn it all upside down as long as the Court did not declare the statutory language unambiguous. 

The government’s brief also addresses the additional objection that the regulations operate retroactively.  The government argues that they are not truly retroactive, because they supposedly “clarified rather than changed existing law” (notwithstanding Colony and two court of appeals decisions that were unquestionably on point) and addressed “procedures,” rather than the legality of the conduct.  In the end, however, the government maintains that “the rule would be valid even if it had retroactive effect.” Thus, the government fully embraces an expansion of the Treasury Department’s power beyond that recognized in Mayo — arguing that an agency not only has the power to promulgate rules that overturn settled judicial precedents, but also has the power to apply those new rules to prior years.  Given that even Congress is usually constrained in adopting retroactive legislation, it will be interesting to see if the Court balks at conferring this kind of power on unelected officials.

The taxpayer’s brief is due December 15.

Home Concrete – U.S. Supreme Court opening brief

Supreme Court Agrees to Hear Home Concrete Case to Address Six-Year Statute Issues

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September 27, 2011

The Court this morning granted certiorari in the Home Concrete case from the Fourth Circuit, thus paving the way for a definitive, nationwide resolution of the issues presented in the Intermountain cases.  We had previously indicated that it was more likely that the Court would hear the Beard case, since the petition in that case was filed first.  It is ironic that the Court chose to hear the Home Concrete case, since that is the one case that neither party urged the Court to take.  (The government asked the Court to grant Beard and hold the Home Concrete case, and the taxpayer asked the Court to deny certiorari. See our previous report here.)  Perhaps the Court thought that Home Concrete was the preferable vehicle because the court of appeals had addressed the applicability of the regulations; perhaps the Court was just being ornery and wanted to resist the government’s efforts to manipulate the docket by contriving to have the Beard case jump ahead of the earlier-decided Home Concrete case.  See our previous report here.

In the long term, it does not appear to make much difference which case the Court agreed to review.  The Court can be expected to resolve the six-year statute question in this case, likely addressing the effect of the regulation.  In the short term, the Court’s choice does affect the briefing schedule.  Since the government is the petitioner in Home Concrete, its brief will be due first, and it will have the opportunity to file a reply brief.  This schedule gives taxpayers interested in filing an amicus brief a bit more time to prepare one than they would have had if Beard were the lead case, as such a brief would be due seven days after the taxpayer’s brief, which will now not be due until mid-December.

The Court took no action on the petitions in Beard and Grapevine.  The petitions in these cases will likely be held and acted upon only after the Home Concrete case is decided.

The government’s opening brief in Home Concrete is due November 14.  The case will likely be argued in January, or possibly February, and the Court will issue its decision before the end of June 2012.

Update on Intermountain Cases

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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.

Grapevine – U.S. response

UTAM Order Denying Rehearing and Amending Opinion

Intermountain Order Denying Rehearing and Amending Opinion

Home Concrete – Cert petition

Home Concrete – Brief in Opposition

Beard Becomes First Intermountain Case to Reach the Supreme Court

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June 30, 2011

We have been noting for the past few months that the Intermountain issue would be heading to the Supreme Court soon, with the government’s petition in the Home Concrete case due on July 5.  The taxpayers in Beard have jumped the line, however, by seeking certiorari ahead of the deadline, and that case is now docketed in the Supreme Court as No. 10-1553.  Meanwhile, the government has obtained a 30-day extension until August 3 to file its certiorari petition in Home Concrete.  Thus, unless the taxpayer in either Salman Ranch, Grapevine, or one of the D.C. Circuit cases sprints to the Court with its own cert petition well before the deadline, it looks like Beard will be at the head of the line by a good margin.

The petition does not add much to the arguments on the merits of the dispute.  The goal of a certiorari petition is to explain to the Court why it is important for it to hear the case.  If cert is granted, there is plenty of opportunity for the litigant to address the merits.  One of the best ways to convince the Court that it has to step in to a dispute is to demonstrate a conflict among the various courts of appeals, which will lead to different outcomes in similar cases unless the Court steps in.  Making that showing on the Intermountain issues is like shooting fish in a barrel.  The Beard petition sensibly focuses on discussing the circuit conflicts, both on the statutory interpretation issue (where the Seventh Circuit in Beard is the only court to have ruled that, even without the regulations, the statute should be construed as providing for a six-year statute of limitations (see here)), and on the question whether Chevron deference is owed to the regulations.

There are two items worth noting in the petition that relate to the merits.  The petition signals that the taxpayer will argue that Chevron is getting completely out of hand if deference is paid in the context of this case.  Specifically, the petition states that the government’s position that “the Treasury is empowered to reject and overrule longstanding precedent of this Court and other courts that it disfavors, simply through the issuance of temporary regulations without notice and public comment threatens obvious, far-reaching consequences.”  Second, the petition briefly responds to the argument that Colony should be read as applying only to cases involving a trade or business by pointing out that, although Colony itself did involve a trade or business, the Court was seeking there to establish a rule that would resolve a circuit conflict, and some of the conflicting cases did not involve a trade or business.

The next step is a response by the government, currently due on July 27.  In most cases, of course, the government’s response to a cert petition is to oppose the petition and argue that the Court should leave standing the court of appeals decision in favor of the government.  Sometimes, however, when there is a circuit conflict on an important issue, the government will “acquiesce” in the petition — meaning that it will tell the Court that the court of appeals decision was correct but that it agrees with the petition that the Supreme Court should hear the case so that it can pronounce a rule that will apply uniformly throughout the country. 

The government is virtually certain to agree that the Court should resolve the Intermountain dispute.  The only question would seem to be a tactical one:  will the government acquiesce in the Beard petition and have the dispute resolved in that case, where the government prevailed below?  Or will the government instead try to steer the Court towards a different case where perhaps it believes the facts are more favorable or where the taxpayer prevailed below.  The request for an extension in Home Concrete is a pretty good indication that the government is content to let the issue be resolved in Beard.

As far as timing, the government routinely secures extensions of time to respond to certiorari petitions.  (You may recall that the government got four extensions to respond to the Kawashima petition.  See here).  But if the government decides to acquiesce in Beard, that would be a very simple filing, and the government has had plenty of time already to decide what it wants to do in these cases.  Thus, it is possible that the government’s response will be filed on July 27.

The Beard petition is linked below.

Beard Petition for Certiorari

Fourth Circuit Denies Rehearing in Home Concrete

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April 6, 2011

On April 5, the Fourth Circuit denied rehearing in Home Concrete, one of the Intermountain-type cases that went for the taxpayer.  This now becomes the first of the cases for which there is no recourse left other than seeking Supreme Court review.  The government is very likely to pursue that course of action.  A petition for certiorari would be due on July 5.

New Government Filings Try to Unify Courts of Appeals Behind the Six-Year Statute for Overstatements of Basis

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March 24, 2011

As we have reported extensively (e.g. here and here), the courts of appeals appear to be hopelessly split on the “Intermountain” issue of whether a six-year statute of limitations applies to overstatements of basis.  Nevertheless, the government has not given up on the possibility of winning this issue in all courts of appeals and thus eliminating the need for it to go to the Supreme Court.  To that end, it filed in two cases at the rehearing stage yesterday. 

In the Beard case in the Seventh Circuit, the government filed a response opposing the taxpayer’s petition for rehearing en banc.  It argued that the Seventh Circuit’s pro-government decision was correct and pointed out that the Seventh Circuit “cannot by itself resolve this conflict” in the circuits even if it grants rehearing, because there are multiple circuits that have ruled on both sides of the issue.

In the Home Concrete case in the Fourth Circuit, the government filed its own petition for rehearing en banc.  It argued that the Fourth Circuit erred and should instead adopt the reasoning of either the Seventh Circuit in Beard or the Federal Circuit in Grapevine.  Lawyers being what they are, the government’s own petition managed to avoid pointing out to the Fourth Circuit that it “cannot by itself resolve this conflict.”  The petition did state that the government also plans to seek rehearing in the next few days in the Burks case in Fifth Circuit — the other court of appeals that has rejected the government’s position even after the new regulations issued.

For now, these filings seem to put the Beard case back in the lead as the first case likely to be ready for Supreme Court review.  But that can change depending on the respective speed with which the different courts of appeals rule on the rehearing petitions.

Beard – US response to rehearing petition

Home Concrete – Petition for Rehearing

Fourth Circuit Rules for Taxpayer on Intermountain Issues

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February 8, 2011

The Fourth Circuit, in an opinion authored by Judge Wynn and joined by Judges Wilkinson and Gregory, has solidified the circuit conflict on the Intermountain issue by ruling for the taxpayer in the Home Concrete case.  (See our original post on these cases here.)  First, the court held that the statutory issue was resolved by the Supreme Court’s decision in Colony, rejecting the argument recently accepted by the Seventh Circuit in Beard (see here) that Colony addressed the 1939 Code and should be understood as applying to identical language in the 1954 Code only to the extent that the taxpayer is in a trade or business.  The court concluded that “we join the Ninth and Federal Circuits and conclude that Colony forecloses the argument that Home Concrete’s overstated basis in its reporting of the short sale proceeds resulted in an omission from its reported gross income.”

Second, the court held that the outcome was not changed by the new Treasury regulations.  The court held that the regulations by their terms could not apply to the 1999 tax year at issue, because “the period for assessing tax” for that year expired in September 2006.  See Treas. Reg. § 301.6501(e)-1(e).  The government argued that the new regulations apply to all taxable years that are the subject of pending cases, but the court held that this position could not be squared with the statutory text of Code section 6501.  In any event, the court continued, no deference would be owed to the regulations under the principles of Brand X because the Supreme Court had already conclusively construed the term “omission from gross income” in Colony and therefore there was no longer any room for the agency to resolve an ambiguity by regulation.

Judge Wilkinson wrote a separate concurring opinion to elaborate on this last point.  He observed that Brand X allows a regulation to override a prior court decision only if that decision was not based on a Chevron “step one” analysis — that is, on a conclusion that the statute is unambiguous.  This can be a difficult inquiry when examining pre-Chevron decisions in which the court had no reason to analyze the case through the lens of the two-step Chevron framework.  Judge Wilkinson explains why he “believe[s] that Colony was decided under Chevron step one,” concluding that the Supreme Court’s statement that it could not conclude that the 1939 Code language is unambiguous was “secondary in importance  to the thrust of the opinion” and the Court’s assessment of the statutory purpose.  (As previously discussed here, this question of whether Colony should be viewed as a “step one” decision, and the related question of how relevant legislative history is at “step one,” was the focus of the Federal Circuit’s attention in the oral argument in Grapevine.)

Judge Wilkinson then goes on to make some more general observations about the limits of Chevron deference in the wake of the Mayo Foundation case.  He states that Mayo “makes perfect sense” in affording “agencies considerable discretion in their areas of expertise.”  He cautions, however, that “it remains the case that agencies are not a law unto themselves.  No less than any other organ of government, they operate in a system in which the last words in law belong to Congress and the Supreme Court.”  In Judge Wilkinson’s view, the government’s attempt to reverse Colony by regulation “pass[es] the point where the beneficial application of agency expertise gives way to a lack of accountability and a risk of arbitrariness.”  He concludes that “Chevron, Brand X, and more recently, Mayo Foundation rightly leave agencies with a large and beneficial role, but they do not leave courts with no role where the very language of the law is palpably at stake.”

The Fourth Circuit’s decision seems to eliminate the slim possibility that the Intermountain issue could be definitively resolved short of the Supreme Court.  There are now two circuits (the Fourth and the Seventh) that have come down on opposite sides, though both had the opportunity to consider the recent developments of the final regulations and the Mayo decision.  At this point, the government is likely to seek Supreme Court review, either by acquiescing in a taxpayer certiorari petition (possibly in Beard) or by filing its own petition in Home Concrete.  Unless petitions for rehearing are filed, the parties have 90 days from the date of final judgment to file a petition for certiorari in these cases.

Son-of-BOSS Statute of Limitations Issue Inundates the Courts of Appeals

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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 CircuitGrapevine 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 CircuitHome 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 CircuitBurks 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 CircuitBeard 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 CircuitReynolds 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.

Home Concrete – Taxpayer’s opening brief

Home Concrete – United States response brief

Home Concrete – Taxpayer’s reply brief

Beard – United States opening brief

Beard – Taxpayer’s response brief

Beard – United States reply brief