July 27, 2012
The taxpayers have filed their opening brief (literally! only 18 pages!) in Cadrecha. They focus on two points. First, they argue that the Court of Federal Claims mistakenly relied on an IRS official’s affidavit for conclusions about what transpired in telephone conversations, when the taxpayers were not given an adequate opportunity to dispute those facts. Therefore, the court erred in ruling at the motion to dismiss stage. Second, they argue that their claim should be viewed as timely in any event. The taxpayers reason that, since the IRS’s notice of disallowance referred to a May 2007 claim, the timely March 2007 claim was never actually disallowed and the two-year statute of limitations did not begin to run. More generally, the taxpayers throw themselves on the mercy of the Federal Circuit, relying on the unfairness of having been denied a refund to which they had a substantive entitlement, when the IRS’s processing of their timely claim contributed to the apparently late filing of a refund suit.
The government’s brief is due September 7.
May 30, 2012
In Cadrecha v. United States, No. 11-152 (Apr. 2, 2012), the Court of Federal Claims ruled that the taxpayers could not escape the clutches of the statute of limitations, even though the failure to file a timely lawsuit was largely attributable to contradictory and confusing IRS communications. The taxpayers have now appealed, hoping that the Federal Circuit will be more sympathetic.
The Court of Federal Claims acknowledged that the result was “harsh” on these facts. The taxpayers filed a timely amended return in March 2007, styled as a protective claim for refund, on the theory that a recent Court of Federal Claims decision (Fisher) entitled the taxpayers to a refund of gains reported from the sale of stock received as a result of an insurance company demutualization. (That decision was affirmed by the Federal Circuit in October 2009). After the three-year statute of limitations had expired, the IRS responded by asking for more “supporting information” and invited the taxpayers to file another claim identifying the court case on which it relied. The taxpayers replied to this letter in May 2007, identifying the case.
The IRS then sent a couple of letters indicating that it needed more time to respond. Thereafter, in August 2007, it sent a notice disallowing the claim on the ground that it was untimely. This disallowance was patently erroneous, as the IRS apparently overlooked the March 2007 amended return and instead treated the May 2007 supplementary letter as if it were the original refund claim. The letter disallowing the claim invited the taxpayers to appeal the disallowance to the IRS Appeals Office and also stated that the taxpayers had two years to file a refund suit.
The taxpayers immediately responded with a letter pointing out that the IRS had erred in ignoring the March 2007 filing. There ensued a succession of communications from the IRS — at least seven letters plus some oral conversations — in which the IRS reported various transfers to different IRS offices and that it needed more time to research the issue. By the time the taxpayer lost patience with this process and filed suit in the Court of Federal Claims, more than two years had elapsed since the disallowance letter was sent. The court therefore dismissed the suit as untimely — even though there was no question that the IRS’s ground for disallowance (an allegedly untimely refund claim) was erroneous and that the taxpayer’s position was correct on the merits under Federal Circuit precedent. The court acknowledged that this result was “harsh” because the untimeliness was, in large part, attributable to the IRS’s own behavior; the court found that “[a]s a result, to some degree, of the IRS’s actions, plaintiffs may have come to believe that the IRS was continuing to analyze their refund claim and that the IRS was in the process of reconsidering the notice of disallowance.”
The court held, however, that there was no legal basis for excusing the taxpayers’ failure to file suit within the two-year limitations period. The taxpayers relied upon cases that excused apparent statute of limitations problems on the ground that the IRS had orally withdrawn a notice of disallowance. The court found those cases distinguishable, observing that neither the notice of disallowance nor the timeliness issue was mentioned in any of the IRS correspondence — though that correspondence certainly suggested that the taxpayers’ claim was still under active consideration at the IRS. The court then added that the law does not permit equitable tolling of the statute of limitations and therefore, if the notice was not withdrawn, it made no difference “if the actions of the IRS misled or confused the taxpayer.”
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 constrained 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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
July 29, 2011
The government has now filed its response to the taxpayer’s petition for certiorari in Beard, the first of the Intermountain cases to reach the Supreme Court. As expected, the government filed an “acquiescence,” meaning that it told the Court that the Seventh Circuit had correctly ruled against the taxpayer, but the government agreed that it is appropriate for the Supreme Court to hear the case in order to resolve the conflict in the circuits. In the words of the response, “[a]lthough the decision below is correct, . . . [i]n light of the square circuit conflict, and the importance of the uniform administration of federal tax law, the petition for a writ of certiorari should be granted.”
It is very likely that the Supreme Court will agree to hear the case in light of the government’s acquiescence. The Court does not issue orders on certiorari petitions over its summer recess, but will sometimes issue them during the week before the Court’s formal return on the first Monday in October. Look for an order granting certiorari to issue on September 26 or soon thereafter.
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.
June 22, 2011
The D.C. Circuit yesterday reversed the Tax Court in Intermountain, handing the government more ammunition to use if, as appears increasingly likely, the Supreme Court considers the question of the applicability to overstatements of basis of the six-year statute of limitations found in Code sections 6229(c)(2) and 6501(e)(1)(A). This now makes the score 4-2 for the government and represents the third straight court of appeals to adopt the government’s primary argument that courts owe Chevron deference to the relatively recent Treasury regulations interpreting the six-year statutes to apply to overstatements of basis.
The D.C. Circuit’s opinion is comprehensive, tracing the same ground as the Federal Circuit’s Grapevine decision, but also supplementing that court’s analysis. In particular, the D.C. Circuit explores in detail the background of Colony and the legislative history of the 1954 Code in order to justify the conclusion that section 6501 does not unambiguously provide that overstatements of basis do not trigger the six-year statute — even though the same statutory term “omission from gross income” in the 1939 Code was construed in Colony not to include overstatements of basis. Having reached that conclusion, the D.C. Circuit found that the Chevron step two analysis was “easy,” and there was no justification for suggesting that the Treasury regulation was an unreasonable interpretation of the statute.
One item of interest is the court’s refusal to address a couple of arguments made by Intermountain’s counsel because they were not raised in a timely fashion. The court’s analysis distinguishing current law from the 1939 Code provision addressed in Colony relies heavily on the 1954 addition of section 6501(e)(1)(A)(i), which specifically addresses “gross income” in the case of a trade or business. Intermountain contended at oral argument that this analysis ought to be irrelevant in a case that involved only section 6229, not section 6501. The court, however, refused to consider that argument, stating that Intermountain had never before argued “that the two sections have different meanings outside the trade or business context.” The court also refused to consider, as raised too late, Intermountain’s reliance on positions taken by the Commissioner on the meaning of Colony before the son-of-BOSS cases arose. One might see these arguments raised and addressed in the Supreme Court down the road.
The Intermountain opinion also governs the companion UTAM case that was argued in tandem. The D.C. Circuit did issue a separate opinion in UTAM addressing an issue unique to that case — whether a final partnership administrative adjustment (FPAA) tolls an individual partner’s limitations period under section 6501 in the same way section 6229(d) tolls the section 6229(a) “minimum period.” The court ruled for the government on that issue as well, and we plan to address that opinion in another post.
Intermountain is likely the last that will be heard from the courts of appeals on the six-year statute issue before it moves to the Supreme Court. (The Federal Circuit, as expected, denied rehearing in Grapevine on June 6. Reynolds Properties v. Commissioner, No. 10-72406, has been fully briefed in the Ninth Circuit, but oral argument is not yet scheduled.) The government’s recent successes in the courts of appeals give it a lot of momentum heading to the Court. Of course, it is often said that momentum is only as good as the next day’s starting pitcher, and in the end the Supreme Court will make up its own mind without regard to the score in the courts of appeals. The government’s anticipated petition for certiorari in Home Concrete is due July 5.
May 31, 2011
The Tenth Circuit, after a long period of deliberation, has reversed the Tax Court in Salman Ranch. (Opinion linked here.) This now makes the score 3-2 in favor of the government in the series of appeals that have spread to most circuits. See our original report here.
The Tenth Circuit’s opinion closely tracks the reasoning of the Federal Circuit in Grapevine. The court first looked at the Supreme Court’s decision in Colony and concluded that it should not be read as holding that the statute unambiguously supports the taxpayer’s position. (The Tenth Circuit did note its disagreement with the Seventh Circuit’s conclusion in Beard that the statute unambiguously resolves the issue in the government’s favor.) Having found that Colony was not an obstacle to the issuance of valid Treasury regulations, the court proceeded to apply the Chevron test to the regulations and, like the Federal Circuit, ruled that the regulations surmounted the relatively low bar of being a reasonable interpretation of the statute. The Tenth Circuit stated: “Although we are not convinced the IRS’s interpretation is the only permissible one or even the one we would have adopted if addressing this question afresh, we are satisfied that it is a ‘permissible construction’ within the mandate of Chevron.”
The Salman Ranch case presented one interesting wrinkle not found in the other Intermountain cases. The Salman Ranch partnership had already prevailed on the identical issue in the Federal Circuit for a different tax year. See Salman Ranch Ltd. v. Commissioner, 573 F.3d 1362 (Fed. Cir. 2009). Ordinarily, that decision would have collateral estoppel effect in other litigation on the same issue between the same parties, and therefore it would have controlled the outcome in the Tenth Circuit. The Tenth Circuit ruled, however, that there was no collateral estoppel effect because the “rules” had changed in the interim — because of the issuance of the new regulations. The Federal Circuit had observed in Grapevine that the Chevron doctrine gives “regulatory agencies, not the courts, primary responsibility to interpret ambiguous statutory provisions.” The Tenth Circuit’s decision goes that statement one better with respect to the power of agencies to make law, at least in this particular context. It potentially gives regulatory agencies more power than even Congress to change the law, as Congress usually does not act retroactively when it enacts new legislation to overturn a court decision. Without retroactive effect, new legislation would not destroy the collateral estoppel effect of a court decision.
If the taxpayer wishes to seek rehearing, the petition would be due on July 18. By that time, the issues could be on their way to the Supreme Court because the government’s deadline for seeking certiorari in Home Concrete, the most advanced of these cases, is July 5.
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.
April 15, 2011
The taxpayer has filed a petition for rehearing en banc in the Federal Circuit in Grapevine. Because Grapevine is the first appellate decision to rely on the new regulations (see here), the petition focuses part of its argument on criticizing the Federal Circuit’s decision to defer to those regulations, especially after the same court in Salman Ranch had rejected the statutory interpretation embodied in the regulations. The petition also argues that applying the regulations to Grapevine is unlawful, even if the regulations could be controlling in future cases, because Grapevine had already obtained a favorable judgment from the Court of Federal Claims before the regulations were promulgated.
With the courts of appeals hopelessly conflicted already on the Intermountain six-year statute of limitations issue, it is a longshot to expect the Federal Circuit to want to wade into these issues en banc. At this point, that court most likely will be inclined to sit back and see what the Supreme Court has to say.
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.
April 5, 2011
On April 5, the D.C. Circuit (Judges Sentelle, Randolph, and Tatel) heard oral argument in Intermountain and its companion case, UTAM. The court’s questions generally indicated that the most likely outcome is a reversal of the Tax Court and another point for the government in the circuit court competition that is currently tied at 2-2. (See our recent report on the Federal Circuit’s decision in Grapevine.)
Judge Randolph in particular was an advocate for the government’s position. He dismissed the argument that Congress could be regarded as having adopted the Colony result under the doctrine of reenactment, and he expressed the view that Colony could not be controlling for an issue arising under the 1954 Code. He also indicated his belief that an overstatement of basis is logically encompassed within the phrase “omission from gross income.”
Judges Sentelle’s questions were more evenhanded. Both he and Judge Tatel indicated some skepticism about the government’s textual argument that a basis overstatement is an “omission” from gross income. Judge Sentelle also pressed government counsel on the Supreme Court’s statement in Colony that the 1954 Code was unambiguous. But he seemed satisfied with government counsel’s response that the Court’s statement must be read in light of the additions made to the 1954 Code that the Seventh Circuit relied upon in Beard.
Judge Tatel followed up on this issue, pressing taxpayer’s counsel to explain why those additions did not defeat the taxpayer’s reliance on Colony. Taxpayer’s counsel argued that these additions did not exist in the partnership statute, section 6229, and also directed the court to the Federal Circuit’s decision in Salman Ranch Ltd. v. Commissioner, 573 F.3d 1362 (Fed. Cir. 2009), for an explanation of why these additions were fully consistent with applying Colony to an individual under the 1954 Code. But it was not apparent that these arguments were making headway. Judge Tatel also jumped in to squash taxpayer counsel’s attempt to get mileage from the fact that the controversy was well underway before the temporary Treasury Regulations issued.
Overall, most of the argument was devoted to Colony and to parsing the statutory text and the differences between the 1939 and 1954 Code provisions. All three judges appeared comfortable with the notion that, if they found Colony not to be controlling, then Brand X and the principle of Chevron deference to Treasury regulations would lead inexorably to a ruling for the government. That is probably the most likely outcome, though, as we have noted previously, it is likely that the Supreme Court will have the last word.
One glimmer of light for the taxpayers was Judge Tatel’s exploration at the end of the argument of the question whether the taxpayers had made an adequate disclosure that would defeat the six-year statute of limitations. Government counsel conceded that this issue remained open and that it should be addressed by the Tax Court on remand if the decision is reversed.
New Government Filings Try to Unify Courts of Appeals Behind the Six-Year Statute for Overstatements of Basis
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.
March 11, 2011
On March 7, the taxpayer filed a petition for rehearing en banc (attached below) with the Seventh Circuit in Beard, emphasizing that both the Fifth and Fourth Circuits had explicitly disagreed with that decision and reached the opposite result on the Intermountain issue. Although courts of appeals often deny such petitions without a response, the Seventh Circuit almost immediately directed the government to file a response, which is due March 23. Today’s pro-government decision by the Federal Circuit in Grapevine perhaps takes a little steam out of the possibility of rehearing since a circuit conflict will likely persist even if the Seventh Circuit rehears the case and reverses itself, but the full Seventh Circuit still may want to consider whether the panel had a sound basis for disagreeing with so many other courts. The Grapevine decision, of course, rests on a different ground from Beard — namely, deference to the new regulations. With respect to the statutory issue addressed by the Beard panel, the Federal Circuit also is in disagreement with the Seventh Circuit.
Federal Circuit Adds to Intermountain Conflict by Deferring to New Regulations That Apply Six-Year Statute to Overstatements of Basis
March 11, 2011
The Federal Circuit has ruled for the government in Grapevine, throwing the circuits into further disarray by adopting an approach that differs from all three of the courts of appeals that have previously addressed the Intermountain issue subsequent to the issuance of the new regulations. Because the Federal Circuit had already rejected the government’s construction of the statute in Salman Ranch, the Grapevine case starkly posed the question whether the new regulations had the effect of requiring the court to disregard its prior decision and reach the opposite result. As we previously reported, at oral argument the day after the decision in Mayo Foundation, the government told the Federal Circuit that Mayo compelled that result. The court has now agreed.
A key section of the court’s opinion considers whether the Supreme Court’s decision in Colony defeats the government’s deference argument. The court says it does not because Colony itself stated that it did not regard the statutory text as unambiguous and, even considering the Colony court’s review of the legislative history, the court did not believe that “Congress’s intent was so clear that no reasonable interpretation could differ.” Therefore, Colony did not resolve the case under Chevron Step 1 and, under Brand X, Treasury was free to issue a regulation that contradicts Colony. (In its analysis, the Federal Circuit appears to have sided with the view, based on footnote 9 of Chevron, that legislative history can be considered at Chevron Step 1 (see our previous post)). The court then applies the Chevron analysis to the new regulations and concludes that they are reasonable based on exactly the same government arguments that the court rejected in Salman Ranch when it was construing the statute in the absence of a regulation. Finally, the court rules that Treasury did not abuse its discretion in applying the new regulations retroactively to years that were still open under the six-year statute.
The Grapevine decision is significant in the specific context of the Intermountain cases, as it virtually ensures that a circuit conflict on the issue will persist even if the Seventh Circuit reconsiders its decision in Beard. And it is the first appellate decision to address in detail the merits of the government’s primary argument that it can overturn the prior adverse decisions in this area by regulation. More generally, the case is a great illustration of Treasury’s power under the combination of Mayo and Brand X. The Federal Circuit was keenly aware of the implications of its decision, summarizing it as follows: “This case highlights the extent of the Treasury Department’s authority over the Tax Code. As Chevron and Brand X illustrate, Congress has the power to give regulatory agencies, not the courts, primary responsibility to interpret ambiguous statutory provisions.” Presumably, Treasury will continue to test the limits of how far it can go in exercising that “primary responsibility.”
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.
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.
February 2, 2011
The government has filed its reply brief in the D.C. Circuit in Intermountain. Although there are no surprises, the brief is a useful resource because it contains in one place the government’s arguments concerning three recent developments favorable to its case, which it has been calling to the attention of other courts piecemeal in supplemental filings. Those developments are the Seventh Circuit’s Beard decision (see here); the Supreme Court’s decision in Mayo Foundation (see here), and the issuance of final regulations (see here). Despite its recent victory in Beard on purely statutory grounds, the government still seems to believe that Chevron deference to the new regulations is its best bet. The reply brief devotes 3 pages to the statutory argument and 23 pages to the regulatory deference argument.
Oral argument is scheduled for April 5.
January 26, 2011
It took less than a day for the government to try out its new Mayo Foundation toy – that is, the Supreme Court’s ruling that deference to Treasury regulations is governed by the same Chevron principles that apply to regulations issued by other agencies. (See our report on the Mayo decision here.) The Intermountain-type litigation posed the perfect opportunity to examine the impact of Mayo, as the regulations at issue in those cases clearly are more vulnerable under the National Muffler approach of looking to factors like whether the regulation is contemporaneous or designed to reverse judicial decisions. Accordingly, the government promptly filed notices of supplemental authority in those cases calling the various courts’ attention to Mayo.
The Federal Circuit did not have much time to ruminate on the supplemental filing, as oral argument in Grapevine was set for the next day. Even so, the government was not bashful about embracing Mayo. Acting Deputy Assistant Attorney General Gil Rothenberg began his argument by telling the court that Mayo “foreshadows” how the case should be decided because of the “striking . . . parallels” between Mayo and Grapevine. That opening triggered immediate pushback from an active panel (Judges Bryson and Prost, with Judge Lourie remaining mostly silent during the argument). The judges pointed to the obvious difference between the cases, the existence of a Supreme Court decision (The Colony, Inc. v. Commissioner, 357 U.S. 28, 32-33 (1958)) that has already construed the statutory language at issue in Grapevine. What ensued was a lively oral argument that focused almost entirely on the rules for Chevron analysis and very little on any topics that would be standard fare for a tax practitioner.
The Chevron jurisprudence issue that dominated the argument is the scope of the Supreme Court’s decision in Nat’l Cable and Telecommunications Ass’n v. Brand X Internet Servs., 545 U.S. 967 (2005). As noted in our first post on these cases, Brand X says that Chevron deference is owed even to a regulation that conflicts with judicial precedent – as long as that judicial precedent did not hold that the statute was unambiguous (a so-called Chevron Step 1 conclusion that would leave no room for interpretation by the agency). That limiting principle arguably defeats the deference argument in the Intermountain cases because the Supreme Court in Colony had construed the “omission from gross income” language as not covering cases of overstated basis. On the other hand, in reaching that conclusion, the Court had remarked that the statutory text was not “unambiguous” and had looked to legislative history as well. 357 U.S. at 33. Thus, the government argues that the Brand X limiting principle does not apply because the Supreme Court did not declare the statutory text unambiguous.
The case thus raises a fundamental question of Chevron jurisprudence: to what extent, if any, can a court look beyond the statutory text at Chevron Step 1? Chevron itself clearly answered this question. In defining Step 1 in which no deference is owed if the regulation conflicts with the “unambiguously expressed intent of Congress,” the Court explained in a footnote that a court is to determine Congress’s intent “employing traditional tools of statutory construction,” which presumably allows reference to legislative history. Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 843 n.9 (1984). Brand X stated that “[t]he Chevron framework governs our review.” 545 U.S. at 980. So did Brand X reaffirm the statement in Chevron that the Step 1 analysis goes beyond the text and includes analysis of the legislative history? Not so fast. The Brand X opinion was authored by Justice Thomas, no fan of legislative history, and that opinion’s formulation of Chevron Step 1 in Brand X was notably more restrictive; deference is owed unless the “prior court decision holds that its construction follows from the unambiguous terms of the statute.” 545 U.S. at 982 (emphasis added).
The judges at the Grapevine argument focused on this question – in particular pressing government counsel on the contours of the government’s position. Counsel tried to walk a fine line, hoping to significantly marginalize the role of legislative history at Step 1 without blatantly disregarding the language of Chevron. He stated that legislative history is relevant at Step 1 only for the very limited purpose of determining the meaning of a “term” in the statute, but not for determining the general purpose of the statute and using that as an aid to statutory construction. (This approach is more nuanced that the position advanced in the government’s brief, which appeared to argue that legislative history can never be examined at Chevron Step 1.) The court questioned both whether this line could truly be drawn and whether in any event it would aid the government’s position in this case where the Colony Court had used legislative history to construe the statutory phrase “omission from gross income.” Judge Prost specifically asked government counsel whether he was arguing that Brand X had overruled Chevron. In response, he characterized Brand X as “narrowing” the broad language of Chevron and later acknowledged that he believed that Brand X is “not completely consistent” with footnote 9 of Chevron. With respect to the question whether his argument failed in any event because Colony had construed a statutory term, government counsel argued that Colony had construed the 1939 Code and therefore was not authoritative on the meaning of the same language in the 1954 Code.
Taxpayer’s counsel got a similar grilling from the panel when he took the podium and tried to argue that the court should simply follow Chevron footnote 9 and not worry about any possible retrenchment from that position found in Brand X. Judge Bryson observed that there is only a “tiny sliver” left of Chevron deference if one applies footnote 9 aggressively – that is, by allowing a determination of general congressional intent through legislative history to play a significant role at Step 1. Taxpayer’s counsel looked to Mayo for help, observing that Mayo had cited approvingly to pp. 842-43 of Chevron, the very pages that included footnote 9. Judge Bryson, however, quickly retorted that the Mayo citation did not mention footnote 9.
Taxpayer’s counsel spent some of his argument time seeking affirmance on narrower grounds, such as that the new regulations could not apply to Grapevine’s case either because they were promulgated after the trial court issued its final judgment or because, as the Tax Court majority held, the new regulations by their terms did not apply to cases outside the three-year statute of limitations. But the Federal Circuit showed little sympathy for these arguments. Instead, it appears likely that the Federal Circuit’s decision will wade into the question of how Chevron and Brand X apply to the new regulations. The court did not tip its hand, although to this observer it appeared more likely to conclude that the taxpayer should prevail – because Colony was a sufficiently definitive interpretation of the statutory text under Chevron Step 1 that Brand X does not leave room for it to be overruled by regulation.
One interesting aspect of the argument was the failure of anyone to discuss the point made by Justice Stevens in his one-paragraph concurring opinion in Brand X. Justice Stevens noted that he fully joined the majority opinion, “which correctly explains why a court of appeals’ interpretation of an ambiguous provision in a regulatory statute does not foreclose a contrary reading by the agency.” 545 U.S. at 1003 (emphasis added). Justice Stevens added, however, that “[t]hat explanation would not necessarily be applicable to a decision by this Court that would presumably remove any pre-existing ambiguity.” Id. Justice Stevens’ suggested distinction between court of appeals decisions and Supreme Court decisions makes Grapevine an easy case. If Colony is understood to remove any ambiguity in the statutory text, then there is no room for Chevron deference to the new regulations and no need to get into the morass of determining whether Brand X modified Chevron. Taxpayer’s counsel did not raise this point, however, and none of the judges asked about it. (We note that the Tenth Circuit has addressed and rejected Justice Stevens’ suggested distinction between courts of appeals and the Supreme Court in applying Brand X. Hernandez-Carrera v. Carlson, 547 F.3d 1237, 1246-48 (10th Cir. 2008).).
A decision from the Federal Circuit would ordinarily be expected sometime in the spring. Judge Prost did ask government counsel about the status of the other Intermountain cases, and he responded that Grapevine marked the fifth case to be argued, with argument scheduled in the D.C. Circuit in April. But the Federal Circuit did not give the impression that it planned to sit tight and let other circuits sort out these issues. As we report elsewhere, the Seventh Circuit got the ball rolling today by deciding the Beard case – ruling for the government on statutory grounds without relying on the regulations. That decision should not have much impact on the Federal Circuit, which has already rejected the Seventh Circuit’s reasoning in Salman Ranch Ltd. v. Commissioner, 573 F.3d 1362 (Fed. Cir. 2009). If the Federal Circuit determines to rule for the government, it will have to rely on the regulations.
January 26, 2011
The Seventh Circuit today became the first court of appeals to weigh in on the Intermountain issue subsequent to the issuance of the temporary regulations, and it handed the government a big victory. Interestingly, the court did not rely on the regulations, instead ruling that the term “omission from gross income” is best read to include overstatements of basis – at least in “non-trade or business situations.” The Court ruled that Colony did not control this issue because that case involved a construction of the 1939 Code, not the 1954 Code. Describing it as a “close call,” the Seventh Circuit ruled that “a close reading of Colony” (which includes explaining away the Colony Court’s observation that the language in the 1954 Code is unambiguous) justifies the conclusion that “an overstatement of basis can be treated as an omission from gross income under the 1954 Code.”
The Seventh Circuit acknowledged that its decision directly conflicts with the two court of appeals decisions that prompted the Treasury Department to attack this issue by issuing temporary regulations, 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). The court explained that it disagreed with the reasoning in those decisions, and cited approvingly to Judge Newman’s dissenting opinion in Salman Ranch. Thus, there is a clear conflict in the circuits, and the only way that conflict could disappear would be if the government prevails in every single circuit (including the Federal and Ninth Circuits) on its post-regulation appeals. Such a clean sweep is unlikely. With the government anxious to have this issue heard by the Supreme Court, and claiming that $1 billion is at stake, it appears almost inevitable that the Court will ultimately decide the Intermountain issue sometime in 2012.
As we noted in our original post on these cases, the Seventh Circuit panel was the most sympathetic to the government at oral argument and seemed particularly troubled by the bottom line outcome of allowing the taxpayers to retain massive tax benefits from what the court regarded as a tax shelter. That attitude is reflected in the opinion as well, which goes out of its way to commend the government’s description of the transaction as an “abusive . . . tax shelter.” Thus, the court’s reliance on a somewhat strained statutory interpretation might be understood as the least disruptive way to reach what it believed to be the “right result,” while avoiding having to make broad pronouncements on difficult issues of deference owed to temporary regulations. The court indeed stated explicitly that, “[b]ecause we find that Colony is not controlling, we need not reach” the issue of deference to the regulations.
Curiously, though, the court then added two sentences stating in conclusory fashion that it “would have been inclined to grant the temporary regulation Chevron deference,” simply citing some cases in which the court had previously accorded deference to Treasury regulations. Whatever the court’s motivation for adding this dictum, it does not address the difficult issues involved in deferring to these particular regulations. Accordingly, the dictum is unlikely to carry much weight with other courts of appeals that do not agree that Colony is irrelevant to construing the statutory text and therefore are struggling with the question of the degree of deference owed to the regulations.
January 7, 2011
The taxpayer has filed its response brief in the D.C. Circuit in Intermountain. The brief does not add much new to the debate, which is hardly surprising at this point. It relies in the alternative on all of the different rationales advanced by the various Tax Court opinions for rejecting the IRS’s position (and adds an additional argument that the basis was adequately disclosed on the return). The taxpayer does not jump into the National Muffler Dealers vs. Chevron debate, content to argue that there is no Chevron deference owed in these circumstances under the established rules for Chevron analysis. The taxpayer does not directly address whether the issuance of final regulations changes that analysis, instead arguing that it is too late for the government to rely on the issuance of the final regs because it did not refer to them in its opening brief.
In the companion UTAM case, the briefing lags the Intermountain schedule by a month. The government has just opened the briefing in that case, and the taxpayer’s response brief is due February 7, 2011. Again not surprisingly, the government’s brief looks a lot like the brief it filed in Intermountain a month ago, though it does refer to the final regulations. The new briefs in the two cases are attached below.
The cases are both scheduled for oral argument on April 5, 2011.
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.
December 13, 2010
We recently surveyed the nationwide litigation addressing the government’s efforts to apply a six-year statute of limitations to Son-of-BOSS cases, including its efforts to have the courts defer to a late-issued temporary regulation. The government has now filed its opening brief in the D.C. Circuit in Intermountain, the case in which the Tax Court addressed the issue. Of note, the brief contains an extensive argument for applying Chevron deference to the temporary regulation, rather than “the differing standards of pre-Chevron jurisprudence” (an apparent reference to National Muffler Dealers, though the brief declines to acknowledge that case by name), and notwithstanding the lack of opportunity for notice and comment. As we have discussed before here and here, the Supreme Court may shed some light in the next few months on the extent to which Chevron deference applies to Treasury regulations.
The taxpayer’s response brief is due January 5, 2011.
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.