May 5, 2014
The taxpayer filed its reply brief in the BMC Software case last week. As in its opening brief, BMC cites Fifth Circuit precedent for the tax law definition of “indebtedness” as an “existing unconditional and legally enforceable obligation to pay.” BMC argues that it is undisputed that the accounts receivable created under Rev. Proc. 99-32 do not meet that definition—they neither existed nor were legally enforceable during the testing period for related-party indebtedness under section 965. (BMC observes that instead of disputing this point, the Commissioner tried to distinguish that case law, much of which comes from the debt-equity context. And BMC points out that the Commissioner’s argument implies different definitions of “indebtedness” may apply depending on the posture of the case.) In our first post on this case, we speculated that the outcome in this case may depend on whether the Tax Court took the legal fictions in Rev. Proc. 99-32 too far. That issue lurks beneath this definitional dispute: That the accounts receivable are deemed to have arisen during the testing period does not settle whether those accounts were “indebtedness” during the testing period.
BMC then turns to the closing agreement, which makes no mention of section 965 or the term “indebtedness.” BMC therefore relies on the legal principle that closing agreements must be construed to bind the parties “only to the matters expressly agreed upon.” BMC also addresses the Commissioner’s other arguments based on the closing agreement.
Finally, BMC makes a strong policy argument against the result in the Tax Court. BMC observes that the Commissioner concedes that the clear purpose of the related-party-indebtedness rule in section 965 is that it is meant to ensure “that a dividend funded by a U.S. shareholder, directly or indirectly, and that does not create a net repatriation of funds, is ineligible for the benefits” of section 965. Of course, no taxpayer could fund a dividend by way of deemed accounts receivable created after the dividend was paid. Therefore, BMC concludes, the case does not implicate the underlying purpose of the related-party-indebtedness rule under section 965.
We will provide updates once oral arguments are scheduled.
January 28, 2014
The taxpayer filed its opening brief in the Fifth Circuit appeal of BMC Software v. Commissioner. As we described in our earlier coverage, the Tax Court relied on the legal fiction that accounts receivable created pursuant to Rev. Proc. 99-32 in a 2007 closing agreement were indebtedness for earlier years (2004-06) in order to deny some of the taxpayer’s section 965 deductions. There are three main avenues of attack in the taxpayer’s brief.
First, the taxpayer argues that the Tax Court incorrectly treated those accounts receivable as “indebtedness” as that term is used in the exception to section 965 for related-party indebtedness created during the testing period. The taxpayer contends that the Tax Court looked to the Black’s Law definition of “indebtedness” when it should have looked to the tax law definition. And the taxpayer argues that the tax law definition—that “indebtedness” requires “an existing unconditional and legally enforceable obligation to pay”—does not include the fictional accounts receivable created under Rev. Proc. 99-32. The taxpayer argues that those accounts did not exist and were not legally enforceable until 2007 (after the section 965 testing period) and therefore did not constitute related-party indebtedness during the testing period for purposes of section 965.
Second, the taxpayer argues that the Tax Court was wrong to interpret the 2007 closing agreement to constitute an implicit agreement that the accounts receivable were retroactive debt for purposes of section 965. The taxpayer observes that closing agreements are strictly construed to bind the parties to only the expressly agreed terms. And the taxpayer argues that the parties did not expressly agree to treat the accounts receivable as retroactive debt for section 965 purposes. Moreover, the taxpayer argues that the Tax Court misinterpreted the express language in the agreement providing that the taxpayer’s payment of the accounts receivable “will be free of the Federal income tax consequences of the secondary adjustments that would otherwise result from the primary adjustments.” The taxpayer then makes several other arguments based on the closing agreement.
Finally, the taxpayer makes some policy-based arguments. In one of these arguments, the taxpayer contends that the Tax Court’s decision is contrary to the purpose of section 965 and the related-party-indebtedness exception because the closing agreement postdated the testing period and therefore cannot be the sort of abuse that the related-party-indebtedness exception was meant to address.
October 25, 2013
In BMC Software v. Commissioner, 141 T.C. No. 5, the Tax Court was faced with considering the effect that some legal fictions (created under a Revenue Procedure regarding transfer pricing adjustments) have on the temporary dividends-received deduction under section 965. And while both the section 965 deduction and the legal fictions under the Revenue Procedure appear to have been designed to benefit taxpayers by facilitating tax-efficient repatriations, the Tax Court eliminated that benefit for some repatriated amounts. The taxpayer has already appealed the decision (filed on September 18) to the Fifth Circuit (Case No. 13-60684), and success of that appeal may hinge in part on whether the Tax Court took the legal fictions in the Revenue Procedure too far.
First, some background on the section 965 deduction: In 2004, Congress enacted the one-time deduction to encourage the repatriation of cash from controlled foreign corporations on the belief that the repatriation would benefit of the U.S. economy. To ensure that taxpayers could not fund the repatriations from the United States (by lending funds from the U.S. to the CFC, immediately repatriating the funds as dividends, and then later treating would-be dividends as repayments of principal), Congress provided that the amount of the section 965 deduction would be reduced by any increase in related-party indebtedness during the “testing period.” The testing period begins on the earliest date a taxpayer might have been aware of the availability of the one-time deduction—October 3, 2004—and ends at the close of the tax year for which the taxpayer elects to take the section 965 deduction. Congress thus established a bright-line test that treated all increases in related-party debt during the testing period as presumptively abusive, regardless of whether the taxpayer had any intent to fund the repatriation from the United States.
BMC repatriated $721 million from a controlled foreign corporation (BSEH) and claimed the section 965 deduction for $709 million of that amount on its 2006 return. On that return, BMC claimed that there was no increase in BSEH’s related party indebtedness between October 2004 and the close of BMC’s 2006 tax year in March 2006. In the government’s view, however, this claim became untrue after the IRS reached a closing agreement with the IRS in 2007 with respect to BMC’s 2003-06 tax years.
That agreement made transfer pricing adjustments that increased BMC’s taxable income for the 2003-06 tax years. The primary adjustments were premised on the IRS’s theory that the royalties BMC paid to its CFC were too high. By making those primary adjustments and including additional amounts in income, BMC was deemed to have paid less to its CFC for tax purposes than it had actually paid.
The typical way of conforming BMC’s accounts in this circumstance is to treat the putative royalty payments (to the extent they exceeded the royalty agreed in the closing agreement) as deemed capital contributions to BSEH. If BMC were to repatriate those amounts in future, they would be treated as taxable distributions (to the extent of earnings and profits). But Rev. Proc. 99-32 permits taxpayers in this circumstance to elect to repatriate the funds tax-free by establishing accounts receivable and making intercompany payments to satisfy those accounts. The accounts receivable created under Rev. Proc. 99-32 are, of course, legal fictions—the taxpayer did not actually loan the funds to its CFC. BMC elected to use Rev. Proc. 99-32 and BSEH made the associated payments.
To give full effect to the legal fiction, Rev. Proc. 99-32 provides that each account receivable is “deemed to have been created as of the last day of the taxpayer’s taxable year for which the primary adjustment is made.” So although BMC’s accounts receivable from BSEH were not actually established until the 2007 closing agreement, those accounts receivable were deemed to have been established at the close of each of the 2003-06 tax years. Two of those years (those ending March 2005 and March 2006) fell into the testing period for BMC’s section 965 deduction. The IRS treated the accounts receivable as related-party debt and reduced BMC’s section 965 deduction by the amounts of the accounts receivable for those two years, which was about $43 million.
BMC filed a petition in Tax Court, arguing (among other things) that the statutory rules apply only to abusive arrangements and that the accounts receivable were not related-party debt under section 965(b)(3). The government conceded that BMC did not establish the accounts receivable to exploit the section 965 deduction, but argued that there is no carve-out for non-abusive transactions and the accounts receivable were indebtedness under the statute.
The court held that the statutory exclusion of related-party indebtedness from the section 965 deduction is a straightforward arithmetic formula devoid of any intent requirement or express reference to abusive transactions. The court also held that the accounts receivable fall under the plain meaning of the term “indebtedness” and therefore reduce BMC’s section 965 deduction under section 965(b)(3). So even though both the section 965 deduction and Rev. Proc. 99-32 were meant to permit taxpayers to repatriate funds with little or no U.S. tax impact, the mechanical application of section 965(b)(3) and Rev. Proc. 99-32 eliminated that benefit for $43 million that BMC repatriated as a dividend.
This does not seem like the right result. And here it seems the culprit may be the legal fiction that the accounts receivable were established during the testing period. The statute may not expressly address abusive intent, but that is because Congress chose to use the testing period in the related-party-debt rule as a blunt instrument to stamp out all potential abuses of the section 965 deduction. This anti-abuse intent is baked into the formula for determining excluded related-party debt because the opening date of the testing period coincides with the earliest that a taxpayer might have tried to create an intercompany debt to exploit the section 965 deduction. BMC did not create an intercompany debt during the testing period; the accounts receivable were not actually established until after the close of the testing period. Perhaps the court took the legal fiction that the accounts receivable were established in 2005 and 2006 one step too far. And perhaps the Fifth Circuit will address this legal fiction on appeal.
September 25, 2013
The D.C. Circuit heard oral argument on September 24 in the government’s appeal in Loving from the district court decision enjoining the IRS from enforcing its new registration regime for paid tax return preparers. The panel consisted of Judges Sentelle, Williams, and Kavanaugh. The court was active, jumping in with questions in the first minute of the government’s opening presentation. The court asked several questions of the plaintiffs’ counsel as well, but those questions seemed to evince less skepticism of the advocate’s position. While it is always hazardous to predict the outcome based on the oral argument, the court of appeals certainly seemed to be leaning towards affirming the district court.
As we have previously discussed, the government’s position relies heavily on Chevron deference to its new tax return preparer regulations. It argues that the statutory authority to regulate practice before Treasury is sufficiently broad to encompass tax return preparers — specifically, that the term “practice of representatives of persons before the Department of the Treasury” is ambiguous and could reasonably be construed by the regulations to include persons who prepare tax returns. The relevant language is currently codified at 31 U.S.C. § 330(a)(1), but it dates back to 1884, when Congress responded to complaints about misconduct by claims agents who represented soldiers with claims for lost horses or other military-related compensation from the Treasury.
Just 30 seconds after the argument began, Judge Sentelle stepped in to challenge the premise of government counsel Gil Rothenberg that the Treasury regulations were valid because the statute did not “foreclose” them. Judge Sentelle maintained that the question instead was whether the statute “empowered” Treasury to regulate in this area, and the case could not be analyzed by assuming that Treasury had unlimited power except to the extent that Congress had explicitly foreclosed it. Shortly thereafter, Judge Williams questioned the government’s failure, in his view, to provide any support for the notion that the ordinary use of the statutory terms, like “representative” or “practice,” could encompass a tax return preparer who merely helps a taxpayer “fill out a form” that he is obliged to file with the IRS. Mr. Rothenberg responded that, although there were no cases on point, return preparers do more than “fill out a form” and that the statutory term “representative” cannot be limited to an agency relationship because the term was intended to retain the same meaning as the original 1884 statute, which applied to “agents, attorneys, or other persons representing claimants.”
Judge Sentelle then suggested that the fact that Treasury had not claimed any authority to regulate tax return preparers until now, even though the statute had been on the books for more than a century, cast some doubt on the existence of that authority. Judge Kavanaugh added that Congress’s enactment of legislation regulating tax return preparers during that period also suggested that Congress did not think that it had delegated that authority to the Treasury Department. Mr. Rothenberg responded that the administrative process is an “evolving process,” and Treasury was free to “choose” not to regulate for many years and then later to invoke its latent authority to regulate. Later, he added that the need to regulate the competence of tax return preparers is greater today than it was decades ago when taxpayers could more easily avail themselves of direct assistance from the IRS in filling out their return. With respect to the legislation, Mr. Rothenberg distinguished laws that impose after-the-fact sanctions on return preparers from the Treasury initiative to impose up-front “admission” requirements. Judge Sentelle questioned why the regulations are limited to paid return preparers, but do not cover persons who prepare tax returns for free. Mr. Rothenberg responded that Treasury was tackling the problem one step at a time and reasonably believed that the biggest problem was with unqualified persons marketing their ability to prepare returns.
Judge Kavanaugh then zeroed in on the statutory text, pointing out that section 330 (a)(2)(D) states that Treasury “may . . . require” that “representatives” demonstrate their “competency to advise and assist persons in presenting their cases.” That language indicates that Congress understood that the “representatives” who could be regulated were persons who would assist in “presenting cases,” not just filling out returns. Mr. Rothenberg disagreed, arguing that Treasury was not compelled to impose all of the requirements set forth in subsection (a)(2) and that the other three requirements could apply to tax return preparers. Judge Sentelle expressed some doubt whether that position was consistent with the statutory use of the conjunctive “and” in joining the four subsections of (a)(2). Judge Williams then suggested that these were four different characteristics of representatives, but that the language of (a)(2)(D) in that case still bore some relevance to interpreting the term “representatives” in (a)(1). Mr. Rothenberg again disagreed, stating that the discussion was now focused on what he believed to be the fundamental error of the district court — namely, treating all four characteristics of section (a)(2) as mandatory, because that would exclude otherwise able practitioners from representing taxpayers before Treasury simply because they lacked advocacy skills. He also noted the position taken in the amicus brief of former IRS Commissioners that the “presenting a case” language could encompass preparing a tax return, but Judge Sentelle retorted that this would be an “awfully strange” use of the language.
Mr. Rothenberg then closed his argument by reiterating the government’s position that the district court erred in reading (a)(2) as limiting the language of (a)(1) and that (a)(1) itself did not foreclose Treasury from regulating tax return preparers. Therefore, Chevron deference is owed to those regulations.
Counsel for the plaintiffs, Dan Alban, began his argument by maintaining that there was no statutory authorization for the regulation. He described the statute as clearly focused on Treasury’s controversy and adjudicative functions, such as examination of returns and appeals before the agency, and not on what he described as “compliance” functions like filing a tax return. He also pointed to the “presenting their cases” language in subsection (a)(2), stating that no “case” exists until there is a dispute over the taxpayer’s return. Judge Williams asked about evidence that the scope of the original 1884 statute was limited to claims that were being resisted by the government — that is, controversies. Mr. Alban replied that it was clear that the statute was addressing claims that the claimants chose to bring, rather than a mandatory function like filing a tax return. In addition, he noted, the legislative history indicates that these were “contested” claims and that the representatives were standing in the shoes of the claimants. Here, by contrast, tax return preparers are not “representatives” before the agency. Judge Kavanaugh then asked who the preparers are representing. Mr. Alban replied that they are not representatives of anyone; they are just performing a service in assisting preparation of the return, but the taxpayer himself has to sign it. He noted in that connection that tax return preparers are not required to obtain a power of attorney, unlike taxpayer representatives in agency proceedings.
The court challenged Mr. Alban when he argued that the “level of policy decision” here warranted caution in allowing an agency, rather than Congress, to implement this new regulatory regime. Judge Sentelle noted that counsel couldn’t get much “traction” with that argument when the D.C. Circuit frequently deals with “sweeping regulations” that create major changes in the regulatory landscape. Judge Kavanaugh observed that, even if counsel was merely stating that the significance of the change ought to color the court’s approach to finding ambiguity, the suggestion was unworkable because it is hard for a court to decide what is “major.”
Finally, Judge Sentelle asked about the impact of the Supreme Court’s recent decision in City of Arlington holding that Chevron deference is owed to an agency’s determination of the scope of its jurisdiction. Mr. Alban stated that the decision was not directly applicable, but in any case the Supreme Court had made clear in that case the importance of seriously applying the limitations on Chevron deference. Here, because the statute was not ambiguous, Mr. Alban stated, the government’s position fails at Chevron Step 1, and therefore no deference is owed. Putting aside the discussion of broader administrative law principles, it was not apparent that any of the judges on the panel disagreed with the plaintiffs on that basic point regarding section 330(a).
Mr. Rothenberg began his rebuttal with a general discussion of Chevron principles, stating that all the prior cases in which the D.C. Circuit had invalidated regulations at Chevron Step 1 were situations where the agency action was more clearly foreclosed by a specific Congressional determination found in the statutory text, but he was met with considerable resistance. The judges observed that his list did not appear to be “exhaustive.” In particular, Judge Sentelle suggested that this case was perhaps analogous to the American Bar Ass’n case, which he described as invalidating FTC regulations directed at the legal profession on the ground that Congress had not empowered the FTC to regulate that profession. When Mr. Rothenberg answered in part that Chevron Step 1 sets a “low bar,” Judge Kavanaugh disagreed, stating that a court is to use all the tools of interpretation at Step 1 and that City of Arlington did not reflect a “low bar.”
Finally, Judge Kavanaugh asked Mr. Rothenberg to respond to Mr. Alban’s point that the IRS does not require tax return preparers to obtain a power of attorney. He replied that the power of attorney is required for “agents,” and tax return preparers are not agents. Mr. Rothenberg then repeated the point made in his opening remarks that the original 1884 statute covered “agents,” but other persons as well. Judge Williams interjected that the government appeared to be placing too much weight on the statutory reference to “other persons,” because canons of statutory construction provide that the scope of broad language like that is limited by the specific terms that precede it — here, “agents” and “attorneys.” Mr. Rothenberg noted that he disagreed, but his time expired before he could elaborate.
The case was heard on an expedited schedule, and therefore it is reasonable to expect that a decision will issue in the next couple of months.
Attached below is the plaintiffs’ response brief and the government’s reply brief, which were not previously posted on the blog. The government’s opening brief and two amicus briefs in support of the government were previously posted here and here.
April 10, 2013
[Note: Miller & Chevalier member and former Commissioner of Internal Revenue Lawrence B. Gibbs is among the five former Commissioners who filed an amicus brief in support of the Government in the Loving appeal.]
Five former IRS Commissioners filed an amicus brief in support of the Government’s appeal of the district court decision invalidating the IRS’s registration regime for paid tax return preparers. The former Commissioners “take no position regarding whether the manner in which the Treasury has chosen to regulate tax return preparers is advisable, but they strongly disagree with the District Court’s view that Congress has not empowered Treasury to do so.” Under 31 U.S.C. § 330, the Treasury Department is authorized to “regulate the practice of representatives of persons before the Department of Treasury.” The district court held that, although the statute did not define “the practice of representatives,” the surrounding statutory text made clear that Congress used “practice” to refer to “advising and assisting persons in presenting their case,” not simply preparing returns. In their amicus brief, the former Commissioners argue that filing a tax return does, in fact, constitute presenting a case. The amicus brief explains that an increasingly wide variety of government assistance programs are administered through the federal income tax system, including a number of refundable tax credits (the earned income credit, health insurance cost credit, etc.). Accordingly, the tax return preparer is not simply calculating tax liability; he or she also is often representing the taxpayer in pursuing claims for federal assistance. Because disbursements of benefits under these government assistance programs is administered largely through self-reporting on a tax return, it is essential, the former Commissioners argue, that paid tax return preparers be regulated so that taxpayers can identify the credits and benefits to which they are entitled and so that both the government and taxpayers are protected against fraud.
The National Consumer Law Center and National Community Tax Coalition also filed a joint amicus brief arguing for reversal of the district court’s decision. That brief documents “rampant” fraud and incompetence in the paid preparation industry, especially on the part of fringe return preparers, such as payday loan stores.
April 5, 2013
The Government has filed its brief in the taxpayers’ appeal to the Ninth Circuit of the Tax Court’s decision that the mortgage interest deduction applies on a per residence rather than per taxpayer basis. See our previous coverage here. Section 163(h)(3) limits deductible mortgage interest to “acquisition indebtedness” of $1,000,000 and “home equity indebtedness” of $100,000. With their Beverly Hills home and Rancho Mirage secondary residence, domestic partners Bruce Voss and Charles Sophy had considerably more indebtedness, and argued that, together, they should be able to deduct interest paid on up to $2.2 million of acquisition and home equity indebtedness because the limitations should be applied on a per taxpayer rather than per residence basis. In its opposition brief, the Government argues that the statutory text supports a per residence limitation. The statute refers to acquisition or home equity indebtedness “with respect to any qualified residence of the taxpayer.” According to the Government, “the word ‘indebtedness’ is used in direct relation to the ‘residence,’ and the word ‘taxpayer’ is used only in connection with the ‘residence,’ not with the ‘indebtedness.’” The Government also finds support for its position in the Code’s definition of “acquisition indebtedness” as indebtedness incurred in acquiring a residence, not as indebtedness secured in acquiring a taxpayer’s portion of a residence. Turning to policy arguments, the Government observes that the taxpayers’ interpretation would create an unintended marriage penalty. Married taxpayers filing separately are limited to acquisition and home equity indebtedness of one-half the otherwise allowable amount, or $500,000 and $50,000 respectively.
In their reply brief, the taxpayers argue that the general rule of section 163(a) (“There shall be allowed as a deduction all interest paid within the taxable year on indebtedness.”) must be read as referring to the taxpayer’s indebtedness. This “clearly implied” meaning, they argue, should inform the interpretation of the mortgage interest deduction provisions. The taxpayers also seek support for their interpretation in references in the legislative history to the indebtedness on the qualified residence as being “the taxpayer’s debt.” With respect to the Government’s marriage penalty argument, the taxpayers note that the Code often treats married couples as a single taxpayer, and married couples enjoy many benefits from that treatment, benefits that are not enjoyed by domestic partners. The reply brief concludes with the following: “Once Congress made the decision to treat spouses as a single taxpayer, the resulting benefits and burdens must be respected equally. In this case, Taxpayers should not be assigned the burden (or penalty) that results from the Tax Court’s convoluted reading of section 163(h)(3) which treats Taxpayers as a married couple, when they receive none of the marriage benefits.”
April 2, 2013
Two days after the D.C. Circuit denied its motion for stay pending appeal, the Government moved for an expedited appeal and concurrently filed its opening brief. The Government seeks an expedited resolution of its appeal of the decision of the U.S. District Court for the District of Columbia (Judge James E. Boasberg) invalidating a licensing regime for paid federal tax return preparers. Under the Government’s proposed briefing schedule, briefing would be complete by May 31, 2013. The Appellees have consented to the Government’s proposed briefing schedule.
In its opening brief, the Government argues that the tax return preparer regulations are a reasonable interpretation of an ambiguous statutory grant of authority to regulate the “practice of representatives before the Department of Treasury.” The district court had held that the Treasury Department was not entitled to any Chevron deference because the statute, 31 U.S.C. 330(a)(1) unambiguously did not authorize the regulation of individuals whose only role is the preparation of the return. The Government argues that “neither the actual language nor the overall context of 31 U.S.C. 330(a) unambiguously forecloses the Secretary’s interpretation that the term ‘ practice of representatives before the Department of the Treasury’ includes the practice of tax-return preparers.” The Government pointed to the absence of a definition — either in the Code or in ordinary meaning — of “practice” that would exclude mere return preparation. The Government also seizes on language in 31 U.S.C. 330(a)(2) authorizing the Secretary of the Treasury to require that representatives who practice before it demonstrate “necessary qualifications to enable the representative to provide to persons valuable service.” The Government reasons that, because tax return preparers provide a “valuable service,” they should be deemed to “practice” before the Treasury Department. Acknowledging that the statute authorizes the Treasury Department to require a representative to demonstrate “competency to advise and assist persons in presenting their cases,” the Government contends that Congress did not intend by that language to limit the Treasury Department’s authority to regulate tax-return preparers whose representation ends with preparing the tax return.
March 15, 2013
Yesterday, in Loving v. IRS (the subject of a recent post), the Government filed its reply brief in support of its motion to stay the district court’s injunction of the new registration regime for paid tax-return preparers. With respect to its likelihood of success on the merits, the Government argued the ambiguity of the statute authorizing Treasury to “regulate the practice of representatives of persons before” it. With respect to the threat of irreparable harm, the Government argued that the injunction risked delaying the implementation of the regulatory regime until the 2015 return-preparation season and that the problem of unregulated return preparers represents a “major public concern.”
Government Seeks Appellate Stay of Order Enjoining Enforcement of New Registration Regime for Paid Tax Return Preparers
March 13, 2013
The Government has appealed to the D.C. Circuit from the district court decision enjoining the IRS from enforcing its new registration regime for paid tax return preparers. Loving v. IRS, D.C. Cir. No. 13-5061. The Government has also asked the court of appeals to stay the decision pending appeal, after the district court declined to grant a stay. The Government’s stay motion recites that, the appeal has not yet been authorized by the Solicitor General’s office, but that, if the appeal is authorized, the Government intends to file its opening brief in March and to move for an expedited oral argument.
To recap the district court’s decision: In 2011, the Treasury Department promulgated regulations that extended Circular 230 (the regulations that govern practice before the IRS) to non-attorney, non-CPA tax-return preparers who prepare and file tax returns for compensation. Under the new regulations, tax-return preparers must register before they can practice before the IRS, and they are deemed to practice before the IRS even if their only function is to prepare and submit tax returns. In order to register initially, tax return preparers must pass a qualification exam and pay a fee. To maintain their registration each year, they must pay a fee and take at least fifteen hours of continuing education courses. The IRS estimated that the new regulation sweeps in 600,000 to 700,000 new tax return preparers who were previously unregulated at the federal level.
Three tax return preparers who were not previously regulated by Circular 230 brought suit challenging the 2011 regulations and seeking declaratory and injunctive relief. In January 2013, the U.S. District Court for the District of Columbia (Boasberg, J.) granted the plaintiffs’ motion for summary judgment. The court recognized that, under Mayo Foundation, the two-step analysis of Chevron should be applied to determine the validity of the regulations. The court explained, however, that “the battle here will be fought and won on Chevron step one” because “Plaintiffs offer no independent argument for why, if the statute is ambiguous, the IRS’s interpretation would be ‘arbitrary or capricious . . .’ under Chevron step two.” Focusing in this way on the unambiguous statutory text, the court held that the Treasury Department lacked statutory authority to issue the regulations.
The court rejected the Government’s argument that the agency had inherent authority to regulate those who practice before it, because a statute (31 U.S.C. § 330) specifically defined the scope of the Treasury Department’s authority. Under that statute, the Treasury Department is authorized to “regulate the practice of representatives of persons before the Department of Treasury.” The district court held that, although the statute did not define “the practice of representatives,” the surrounding statutory text made clear that Congress used “practice” to refer to “advising and assisting persons in presenting their case,” not simply preparing returns. Turning to provisions in the Internal Revenue Code that regulate tax return preparers, the court reasoned that Congress could not have intended § 330 to be the authority for regulating tax return preparers because “statutes scattered across Title 26 of the U.S. Code create a careful, regimented schedule of penalties for misdeeds by tax-return preparers.” The court rejected the Government’s resort to policy arguments. “In the land of statutory interpretation, statutory text is king.” Holding that the new regulations were ultra vires, the court enjoined the IRS from enforcing the registration regime.
In the motion for a stay pending appeal filed with the district court, the Government argued that the injunction substantially disrupted the IRS’s tax administration and that shutting down the program would be costly and complex. The district court was not persuaded, concluding that “[t]hese harms, to the extent they exist are hardly irreparable, and some cannot even be traced to the injunction.”
The Government’s stay motion in the court of appeals, filed February 25, argues that “[f]ailure to grant the stay will work a substantial and irreparable harm to the Government and the taxpaying public, crippling the Government’s efforts to ensure that individuals who prepare tax returns for others are both competent and ethical.” According to the Government’s brief, the “IRS estimates that fraud, abuse, and errors cost the taxpaying public billions of dollars annually.” In their March 8 response, the Plaintiffs/Appellees argue that the Government failed to establish any imminent irreparable harm traceable to the injunction, noting that even the Government acknowledged that most of the alleged harms would not occur until 2014. The tax return preparers also emphasize that the injunction merely preserves the historical status quo.
Home Concrete Decision Leaves Administrative Law Questions Unsettled While Excluding Overstatements of Basis from Six-Year Statute of Limitations
May 3, 2012
[A shorter version of this blog post appears on SCOTUSblog.]
The Supreme Court last week ruled 5-4 in favor of the taxpayer in Home Concrete, thus putting an end to the long-running saga of the Intermountain litigation on which we have been reporting for the past 18 months. The opinion was authored by Justice Breyer and joined in full by three other Justices, but Justice Scalia joined only in part. The result is a definitive resolution of the specific tax issue – the six-year statute of limitations does not apply to an overstatement of basis. But the Court’s decision provides a much less definitive resolution of the broader administrative law issues implicated in the case.
As foreshadowed by the oral argument (see our previous report here), the tax issue turned on the continuing vitality of the Court’s decision in The Colony, Inc. v. Commissioner, 357 U.S. 28 (1958). To recap, the Court held in Colony that the “omits from gross income” language in the 1939 Code did not encompass situations where the return understates gross income because of an overstatement of basis, and hence the extended six-year statute of limitations did not apply in those situations. The government argued that Colony did not control the interpretation of the same language in current section 6501(e) of the 1954 Code, because changes elsewhere in that section suggested that Congress might have intended a different result in the 1954 Code.
The administrative law issues came into play because, after two courts of appeals had ruled that Colony controlled the interpretation of the 1954 Code, the government tried an end run around that precedent. Treasury issued regulations interpreting the “omits from gross income” language in the 1954 Code as including overstatements of basis, thus bringing those situations within the six-year statute of limitations. Under National Cable & Telecommunications Ass’n v. Brand X Internet Services, 545 U.S. 967 (2005), the government argued, an agency is empowered to issue regulations that define a statute differently than an existing court decision, so long as the court decision did not declare the statutory language unambiguous. Because the Colony opinion had indicated that the 1939 Code language standing alone was “not unambiguous,” the government argued that Treasury’s new regulations were entitled to Chevron deference, which would supplant any precedential effect that Colony would otherwise have on the interpretation of the 1954 Code provision.
The Court’s Opinion
Justice Breyer wrote the opinion for the Court, joined in full by Chief Justice Roberts and Justices Alito and Thomas. Justice Scalia joined Justice Breyer’s analysis of the statute, but departed from his analysis of the administrative law issues.
The opinion dealt straightforwardly with the basic tax issue. First, the Court emphasized that the critical “omits from gross income” language in the current statute is identical to the 1939 Code language construed in Colony, and it recounted the Colony Court’s reasoning that led it to conclude that the language does not encompass overstatements of basis. Colony is determinative, the Court held, because it “would be difficult, perhaps impossible, to give the same language here a different interpretation without effectively overruling Colony, a course of action that basic principles of stare decisis wisely counsel us not to take.” With respect to the statutory changes made elsewhere in section 6501(e), the Court concluded that “these points are too fragile to bear the significant argumentative weight the Government seeks to place upon them.” The Court addressed each of these changes and concluded that none called for a different interpretation of the key language (and that one of the government’s arguments was “like hoping that a new batboy will change the outcome of the World Series”).
The Court then turned to the administrative law issues, reciting the government’s position that, under Brand X, the new regulations were owed deference despite the Court’s prior construction of the language in Colony. The opinion first responded to that position with a two-sentence subsection: “We do not accept this argument. In our view, Colony has already interpreted the statute, and there is no longer any different construction that is consistent with Colony and available for adoption by the agency.”
Standing alone, that was not much of a response to the government’s Brand X argument, because Brand X said that the agency can adopt a construction different from that provided in a prior court decision so long as the statute was ambiguous. These two sentences were enough for Justice Scalia, however, and he ended his agreement with Justice Breyer’s opinion at this point. In a separate concurring opinion, Justice Scalia explained that he is adhering to the view expressed in his dissent in Brand X that an agency cannot issue regulations reinterpreting statutory language that has been definitively construed by a court.
With the other Justices in the majority not feeling free to ignore Brand X, Justice Breyer’s opinion (now a plurality opinion) then proceeded to explain why Brand X did not require a ruling for the government. According to the plurality, Brand X should be given a more nuanced reading than that urged by the government, one that looks to whether a prior judicial decision found a statute to be “unambiguous” in the sense that the court concluded that Congress intended to leave “‘no gap for the agency to fill’ and thus ‘no room for agency discretion.’” Under Chevron jurisprudence, the opinion continued, unambiguous statutory language provides a “clear sign” that Congress did not delegate gap-filling authority to an agency, while ambiguous language provides “a presumptive indication that Congress did delegate that gap-filling authority.” That presumption is not conclusive, however, and thus this reading of Brand X leaves room for a court to conclude that a judicial interpretation of ambiguous statutory language can foreclose an agency from issuing a contrary regulatory interpretation. In support of that proposition, the plurality quoted footnote 9 of Chevron, which states that “[i]f a court, employing traditional tools of statutory construction, ascertains that Congress had an intention on the precise question at issue, that intention is the law and must be given effect.”
The plurality then ruled that the Court in Colony had concluded that Congress had definitively resolved the legal issue and left no gap to be filled by a regulatory interpretation. Given its analysis of the scope of Brand X, the plurality explained that the Colony Court’s statement (26 years before Chevron) that the statutory language was not “unambiguous” did not necessarily leave room for the agency to act. Rather, the Colony Court’s opinion as a whole – notably, its view that the taxpayer had the better interpretation of the statutory language and had additional support from the legislative history – showed that the Court believed that Congress had not “left a gap to fill.” Therefore, “the Government’s gap-filling regulation cannot change Colony’s interpretation of the statute,” and the Court today is obliged by stare decisis to follow it.
The Concurring and Dissenting Opinions
Justice Kennedy’s dissent, joined by Justices Ginsburg, Sotomayor, and Kagan, reached a different conclusion on the basic tax dispute. The dissent looked at the statutory changes made in the 1954 Code and concluded that they are “meaningful” and “strongly favor” the conclusion that the “omits from gross income” language in the 1954 Code should not be read the way the Colony Court read that same language in the 1939 Code. Given that view, the administrative law issue – and the resolution of the case – became easy. The dissent stated that the Treasury regulations are operating on a blank slate, construing a statute different from the one construed in Colony, and therefore they are owed Chevron deference without the need to rely on Brand X at all.
Justice Scalia’s concurring opinion declared a pox on both houses. He was extremely critical of the plurality’s approach, accusing it of “revising yet again the meaning of Chevron . . . in a direction that will create confusion and uncertainty.” He also criticized the dissent for praising the idea of a “continuing dialogue among the three branches of Government on questions of statutory interpretation,” when the right approach should be to say that “Congress prescribes and we obey.” Justice Scalia concluded: “Rather than making our judicial-review jurisprudence curiouser and curiouser, the Court should abandon the opinion that produces these contortions, Brand X. I join the judgment announced by the Court because it is indisputable that Colony resolved the construction of the statutory language at issue here, and that construction must therefore control.”
What Does It Mean?
The Home Concrete decision provides a clear resolution of the specific tax issue. The six-year statute of limitations does not apply to overstatements of basis. The multitude of cases pending administratively and in the courts that involve this issue will now be dismissed as untimely, leaving the IRS unable to recover what it estimated as close to $1 billion in unpaid taxes.
Indeed, in a series of orders issued on April 30, the Court has already cleared its docket of the other Intermountain-type cases that had been decided in the courts of appeals and kept alive by filing petitions for certiorari. In Burks and the other Fifth Circuit cases in which the taxpayers had prevailed, the Court simply denied certiorari, making the taxpayers’ victory final. For the certiorari petitions filed from courts of appeals that had sided with the government, such as Grapevine (Federal Circuit), Beard (Seventh Circuit), Salman Ranch (Tenth Circuit), and Intermountain and UTAM (D.C. Circuit), the Court granted the petitions and immediately vacated the court of appeals decisions and remanded the cases to the courts of appeals for reconsideration. Now constriained by Home Concrete, those courts will enter judgments in favor of the taxpayers in due course.
Notably, although the retroactive nature of the Treasury regulations was a significant point of contention in the litigation, retroactivity did not play a role in the final resolution. The Court held that Colony is controlling and leaves no room for the agency to construe the “omits from gross income” language differently. Thus, Treasury does not have the ability to use its regulatory authority to extend the six-year statute to overstatements of basis even prospectively. Any such extension will have to come from Congress.
The effect of the decision on administrative law generally is considerably more muddled. First, a couple of observations on what the Court did not do. It did not signal any retreat from Mayo. Treasury regulations addressed to tax issues will continue to be judged under the same Chevron deference principles that apply to regulations issued by other agencies. Furthermore, as noted above, the Court did not rely on the retroactive aspect of the regulations. Thus, the decision does not provide guidance one way or another on the extent to which Treasury is constrained in its ability to apply regulations to earlier tax years.
What the Court did do, however, is to weaken the authority of Brand X. Under the reasoning of Justice Breyer’s plurality opinion, courts are now free to decline to defer to a regulatory interpretation that construes ambiguous statutory language – if the court concludes that a prior court decision, using “traditional tools of statutory construction” that go beyond the text, determined that Congress intended to resolve the issue rather than leave a gap for the agency to fill. Although there were only four votes for that proposition, Justice Scalia’s approach would lead him to agree with such a result just as he did in Home Concrete, so lower courts may treat the plurality opinion as controlling. There is, however, room for debate about the impact of the Home Concrete approach. Justice Breyer’s opinion emphasizes the fact that Colony was decided long before Chevron, and lower courts may disagree regarding its impact when the court decision at issue is post-Chevron and, in particular, post-Brand X. At a minimum, the Home Concrete decision should make agencies less confident in their ability to use regulations to overturn judicial interpretations of statutes and should give taxpayers more ammunition to challenge such regulations if necessary.
Interestingly, Justice Breyer’s approach, and in particular his invocation of Chevron’s footnote 9 reference to “traditional tools of statutory construction,” was previewed in the argument in the Federal Circuit in the Grapevine case. As we reported at the time, that argument involved considerable discussion of whether the determination of “ambiguous” at Chevron step 1 must be based entirely on the statutory text, as Brand X suggests, or can be based on other “traditional tools of statutory construction,” as Chevron footnote 9 declares. In its decision, the Federal Circuit stuck to the statutory text and ruled for the government.
Justice Breyer’s opinion, however, supports the proposition that Chevron step 1 analysis can look beyond the statutory text. If that portion of Justice Breyer’s opinion had commanded a majority, it would be extremely significant because it would justify looking beyond the statutory text not only in assessing the impact of Brand X when there is a court decision on the books, but also in considering a Chevron deference argument in the first instance. A court could decide, under the approach suggested by Justice Breyer, that a statute whose text standing alone is ambiguous nonetheless leaves no room for agency interpretation – if other tools of statutory construction show that Congress intended to resolve the issue rather than leaving a gap for the agency. On this point, however, the plurality opinion cannot be treated as controlling because Justice Scalia would surely look askance at a decision that used legislative history to find a lack of ambiguity at Chevron Step 1. By the same token, the dissenters had no occasion to address this point, so we do not know if any of them would have agreed with Justice Breyer’s approach. For now, it is fair to say that Justice Breyer has heightened the visibility and potential importance of Chevron footnote 9, but that Home Concrete alone probably will not yield a significant change in how courts approach Chevron step 1.
In sum, Home Concrete may be a bit of a disappointment to those observers who thought that the decision would bring great clarity to the administrative law issues presented. In that respect, it joins a long list of administrative law cases that reach the Supreme Court and seem to yield as many questions as answers. But for the taxpayers with millions of dollars riding on the difference between a three-year and six-year statute of limitations, the decision is not disappointing at all. It is a huge victory.
February 27, 2012
The Supreme Court (opinion attached below) has affirmed the Ninth Circuit’s decision in Kawashima, ruling that resident aliens who pled guilty to making (or assisting in making) a false tax return in violation of Code section 7206 had committed “aggravated felonies” that made them deportable. The vote was 6-3, with Justice Thomas writing the opinion and Justices Ginsburg, Breyer, and Kagan dissenting.
As we have previously reported, the Kawashima case involves the interplay between two subsections of the deportation statute’s definition of aggravated felonies, 8 U.S.C. § 1101(a)(43). Subsection (M)(i) broadly includes offenses “involv[ing] fraud or deceit”; subsection (M)(ii) adds violations of Code section 7201 (tax evasion). The Kawashimas argued that subsection (ii) is addressed to tax offenses and therefore the statute does not include the less serious tax offenses covered by section 7206. The government argued that section 7206 offenses involve “fraud or deceit,” and therefore they are covered by subsection (ii). (See here for a more detailed analysis of the Supreme Court briefing).
The majority agreed with the government, applying a literal and technical approach to the statutory language that did not afford much weight to the historical understanding of the criminal tax provisions. The Court first found that the conduct of willfully submitting a false tax return inherently involves ‘deceit” and therefore is encompassed within subsection (i). The Court then rejected the Kawashimas’ primary argument that this conclusion was untenable because it would make subsection (ii) entirely superfluous (since tax evasion also involves deceit). To support that conclusion, the Court accepted the government’s technical argument that subsection (ii) was not superfluous because there was theoretically a situation where tax evasion does not involve “deceit” – namely, when a taxpayer files a truthful tax return but evades payment by moving his assets beyond the reach of the IRS. Thus, the Court ruled that, “[a]lthough the Government concedes that evasion-of-payment cases will almost invariably involve some affirmative acts of fraud or deceit, it is still true that the elements of tax evasion pursuant to §7201 do not necessarily involve fraud or deceit.”
The dissenters characterized the majority’s construction of the statute as “dubious,” criticizing in particular its contortions to avoid the conclusion that its construction “effectively renders Clause (ii) superfluous.” According to the dissent, the government’s proposed instances of tax evasion not involving “deceit” are not just “rare,” they are “imaginary.” Given that the Court has previously “declined to interpret legislation in a way that ‘would in practical effect render [a provision] entirely superfluous in all but the most unusual circumstances,” the dissent argued that the majority’s reading is unsustainable. Pointing to an amicus brief filed by former IRS Commissioner Johnnie Walters, the dissent also stated that the Court’s decision would have adverse consequences for the efficient handling of tax prosecutions. In particular, it will discourage aliens from pleading guilty to the lesser section 7206 offense instead of going to trial on a tax evasion charge, because of the risk of deportation.
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.
Supreme Court Struggles With Confusing Criminal Tax and Deportation Interplay in Kawashima Oral Argument
January 6, 2012
We are finally getting around to updating Kawashima, the Supreme Court case involving the question of whether a conviction under section 7206 is a deportable offense under the immigration laws. The Court heard argument on the case back in November. The argument transcript can be found here. Petitioners’ reply brief can be found here. A decision likely will be issued this spring. It’s hard to read which way the Court is leaning based on the arguments. Several Justices seemed to balk at petitioners’ technical argument that a false statement on a return (under section 7206) can be something less than intending to deceive the IRS (a crime involving “fraud or deceit” is deportable under the immigration laws — see our prior post).
The argument first focused on the Code’s “willfulness” concept and whether the requirement in section 7206 that the false statement be submitted willfully in fact turned an act that — without willfulness — might not be intended to deceive into something that showed intent to deceive. Petitioners’ counsel tried to focus the Court on the concept that intent to deceive required intent to induce an action or reliance and not merely intent to make a false statement. This position seemed to concern several Justices given that the false statement was on a document submitted to the government for a specific purpose (reporting taxes). The argument also briefly turned to the question of the case law — largely Tax Court case law — which historically held that a conviction under section 7206 did not automatically trigger the extended limitations period for fraud unless the IRS independently proved fraud. The Justices did not substantively comment on this point during petitioners’ time but came back to it during the government’s argument and it seemed to get some traction with the Chief Justice.
Petitioners’ counsel and Justice Scalia spent a substantial amount of time discussing whether the inclusion of both section 7201 and the “fraud or deceit” provision in the deportation law rendered the former superfluous if the government’s reading was adopted. This involved a discussion of the text of section 7201, which has long been textually framed as an attempt “to evade or defeat any tax” and does not specifically use the words fraud or deceit. While the Justices did not seem to be happy with the responses by petitioners’ counsel, an amicus brief submitted by Johnnie Walters — a former IRS Commissioner — deals with the history and meaning of section 7201 quite compellingly. And when questioning the government’s counsel, Justices Ginsburg and Kagan both seemed concerned that the government’s position could read one part of the deportation statute out of the law based on this historic reading of section 7201. This led Justice Breyer to introduce the idea that section 7206 does not seem to meet the common law definitions of fraud or deceit — a point not raised by counsel as best as we can tell — but something that could be relevant in determining Congressional intent.
Piercing through the government’s argument, Justice Kagan was able to get its counsel to admit that even the evasion-of-payment cases under section 7201 have to involve some sort of fraud in order to be prosecuted under that statute. Counsel also basically admitted that the IRS/DOJ has never prosecuted a section 7201 case that didn’t involve fraud. This triggered a question by Justice Breyer as to whether the government’s position would make every single perjury statute a deportable offense — something that would profoundly impact both defendants and the system. Justice Kagan then returned to the circularity of the government’s arguments regarding superfluity (a point we have made a few times previously).
As we said at the outset, it is difficult to see where all of this is going. Petitioners do seem to us to have the stronger case when you consider the historic meaning of section 7201 (which is fundamental to criminal tax practice) but the statutory text could be confusing when read outside of that context. We will update you as soon as we see a decision.
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.
December 9, 2011
In Magma Power v. United States, Case No. 09-419T, the Court of Federal Claims tackled the arcane topic of interest netting. The issue in Magma Power was a narrow question of statutory interpretation, but the broader topic of interest netting warrants a word of explanation.
The government charges interest on tax underpayments at a higher rate (under section 6601) than it pays on tax overpayments. Because it often takes several years or more to determine whether a taxpayer has an overpayment or underpayment for a particular tax year and the amount of that overpayment or underpayment, there are sometimes post-return periods during which a taxpayer has overlapping overpayments and underpayments. When this occurs, the taxpayer should owe no interest on the overlapping amount. If the overlapping amounts are not netted, however, the rate disparity results in net interest in the government’s favor. To correct this inequity, Congress enacted section 6621(d), which provides that “to the extent that, for any period, interest is payable . . . and allowable . . . on equivalent underpayments and overpayments for the same taxpayer, . . . the net rate of interest on such amounts shall be zero.”
The narrow statutory-interpretation issue in Magma Power is the meaning of the term “same taxpayer” under section 6621(d). The IRS had denied section 6621(d) relief to Magma Power on the theory that Magma Power was no longer the “same taxpayer” after becoming a member of a consolidated group.
Magma Power filed a return for its 1993 tax year sometime in 1994. In February 1995, CalEnergy Company acquired Magma Power and subsequently included Magma Power on its consolidated tax returns. The IRS later determined a deficiency for Magma Power’s 1993 tax year, and Magma Power paid that deficiency and over $9 million in associated underpayment interest in 2000 and 2002. The CalEnergy consolidated group overpaid its taxes in four consecutive tax years from 1995 through 1998. Despite some disagreement between the parties, the court found that some portion of these overpayments were attributable to Magma Power’s activities. In 2004 and 2005, the IRS refunded those overpayments plus the associated overpayment interest to the consolidated group agent (which by then was MidAmerican Energy Holdings Company). There were overlapping underpayments and overpayments for the period that began with the filing of the 1995-98 returns and ended with the satisfaction of Magma Power’s 1993 underpayment. Magma Power claimed interest-netting refunds for that period. The IRS denied the refund on the theory that the consolidated group could not net its overpayments with Magma Power’s underpayments because of the “same taxpayer” requirement of section 6621(d).
The court’s plain-language analysis of section 6621(d) is straightforward and decisively rebuts what appears to be a flimsy position taken by the IRS. The essence of the court’s conclusion is that becoming a member of a consolidated group does not fundamentally alter a taxpayer’s identity. The court rests this decision on the uncontroversial premise that the taxpayer identification number (or EIN, for corporations like Magma Power) is the sine qua non of taxpayer identity. And because Magma Power retained the same EIN (and therefore same identity) after its inclusion in the consolidated group, the court held that Magma Power was the same taxpayer for section 6621(d) purposes for the 1993 underpayment and its allocable portion of the 1995-98 overpayments.
Although the court addresses several arguments made by the government, the only notable bump in the court’s road to its conclusion was some language in another Court of Federal Claims decision, Energy East v. United States, 92 Fed. Cl. 29 (2010), aff’d 645 F.3d 1358 (Fed. Cir. 2011). Interpreting the meaning of “same taxpayer” for interest-netting purposes in Energy East, the lower court cited the dictionary definition of “same” and decided that section 6621(d) requires that the taxpayer must be “identical” and “without addition, change, or discontinuance.” (The issue on appeal was narrower and the Federal Circuit did not reject or adopt this aspect of the lower court’s opinion.)
The court in Magma Power had little difficulty distinguishing Energy East: Energy East was trying to net the overpayment years of acquired companies against its own underpayment years. The hitch was that both the underpayment years and overpayment years came before Energy East acquired those companies. In Magma Power, the court held that the Energy East situation was “radically different” than Magma Power’s attempt to net its own 1993 underpayment against its own later overpayments (albeit encompassed within the Cal Energy consolidated group).
The government may well appeal Magma Power based on the broad language in the lower court’s decision in Energy East. If they do, we’ll keep you posted.
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.
October 18, 2011
The petitioners’ and respondent’s briefs have been filed in Kawashima v. Holder, Sup. Ct. Docket No. 10-577, appealing 615 F.3d 1043 (9th Cir. 2010). As described in our original post, that case involves the question of whether pleas to section 7206 offenses (subscribing to false statements and assisting same) are “aggravated felonies” that result in deportation under the immigration laws. The case turns largely on the statutory interpretation of the relevant portion of 8 U.S.C. §1101(a)(43)(M).
The petitioners’ position is essentially the same as it was below (although more developed). The primary argument is based on the language of 8 U.S.C. §1101(a)(43)(M), which provides, in relevant part, that an aggravated felony includes an offense that:
(i) involves fraud or deceit in which the loss to the victim or victims exceeds $10,000; or
(ii) is described in section 7201 of the Internal Revenue Code of 1986 (relating to tax evasion) in which the revenue loss to the Government exceeds $10,000.
The crime to which petitioners pled is plainly not an aggravated felony under the second prong, because petitioner pled to section 7206 and not to section 7201. Petitioners argue that section 7206 offenses cannot be covered by the first prong either. They base this argument on ordinary principles of statutory construction.
First, petitioners argue that the use of the term “revenue loss” in the second prong of the statute indicates Congressional intent that the term “loss to the victim or victims” in the first prong does not include a revenue loss to the government. The purposeful use of different terms in each section seems to imply such an intent. Furthermore, the response that this difference simply reflects a different purpose for each prong (one that focuses on governmental loss and one that does not) ultimately supports petitioners’ overall argument that the first prong was not intended to reach losses to the government such as through non-section 7201 tax crimes.
Second, petitioners posit that interpreting tax crimes to fall into the first statutory prong would render the second superfluous. As we previously discussed, this seems to be a strong argument. At a minimum, it would be odd for Congress to place one tax crime in a specific statutory provision and all other tax crimes in a vague and broad provision that covers many other offenses. And the analysis in Leocal v. Ashcroft, 543 U.S. 1 (2004) (cited by petitioners) strongly implies that Congress should not be considered to have intended that meaning.
Finally, petitioners argue that the reference in the second prong to “tax evasion” helps to define (and limit) the scope of the term “fraud or deceit” in the first prong and that the sentencing guidelines support this view. Petitioners’ analysis in this respect is largely based on the application of the interpretative canon that the specific limits the more general. Because terms like “revenue loss” and “tax evasion” are used in the second prong, it is not appropriate — under petitioners’ application of this canon — to read those terms into the first prong. Petitioners’ reliance on the sentencing guidelines seems to be a stretch given that there is no direct support for the premise that Congress actually considered these guidelines when formulating the aggravated felony definition. (Petitioners argue that Congress “likely” considered same given the timeline of adoption of the various provisions.)
In the alternative, the Kawashimas argue that their pleas did not involve fraud or deceit (and thus could not be included in the first prong anyway) and that, even if they might be included in that prong, the whole scheme is so confusing that the rule of lenity should apply to exempt them from a strict application. The first argument relies on the elemental approach to the determination of whether a crime is an aggravated felony as applied by the Court in Nijhawan v. Holder, 555 U.S. 1131 (2009) and earlier rulings. Under that approach, courts are supposed to determine whether the relevant factors for aggravated felony purposes (here, among others, fraud or deceit) were necessarily elements of the crime for which the defendant was convicted and not to focus on the specific conduct committed by the specific defendant. See also Leocal, 543 U.S. at 7. Because the elements of section 7206 do not require a finding of fraud or deceit (petitioners characterize it, not altogether unfairly, as a tax perjury statute), under this “elements and nature” approach, a section 7206 offense cannot amount to an aggravated felony under the first prong of 8 U.S.C. §1101(a)(43)(M). This second argument is a Hail Mary and implicitly relies on the confusing state of the immigration law in this area as demonstrated in the rest of petitioners’ brief. While immigration rules are ludicrously complex in this area, so is much of criminal law. Unless the members of the Court are prepared to hold that any issue complex enough to find its way into their hands is necessarily unclear or confusing enough to give rise to the rule of lenity, it would seem an odd way to resolve the case (although a refusal by the Court to apply ludicrously complex rules might convince Congress to be more rational in drafting statutes).
The Solicitor General’s brief generally tracks the petitioners’ arguments in substance but not in order. The government takes issue with the petitioners’ assertion that section 7206 does not require an element of fraud or deceit by focusing more on the dictionary definition of deceit than the historic application of section 7206 in jurisprudential context. As to the question of fraud, the government attempts to equate material falsehoods (required for section 7206) with fraud (or at least deceit). This appears to be a difficult argument to sustain unless the Court is prepared to depart from principles that are fairly well settled in the lower courts. The Tax Court and several Circuit Courts of Appeals have held that a conviction under section 7206 does not necessarily trigger fraud penalties or the fraud period of limitations in the civil side of the Internal Revenue Code. See, e.g., Wright v. Commissioner, 84 T.C. 636 (1985). It is hard to reconcile the government’s argument with these authorities. Perhaps the best way to distinguish these authorities is on the basis that the material falsehoods at issue did not amount to a showing that the taxpayer intended to prepare a fraudulent return (i.e., to commit tax evasion) and that the aggravated felony test asks the (different) question of whether any fraud was conducted against a “victim.” The logical problem with this argument is that it assumes that there is some other way for the government to suffer a loss than the fraudulent return. If the fraud has to be linked to the loss, then the interpretation of section 7206 in cases like Wright seems inconsistent with the government’s argument in its brief.
The government attacks petitioners’ specific-over-general argument on the basis that the second prong does not by its terms encompass all tax offenses (it refers only to section 7201, the capstone tax offense). While this is true, it raises the question of why Congress would have isolated one tax offense from all of the others (assuming all of the others are included in the first prong). This, in turn, drives into petitioners’ superfluity argument. On that question (where much of the merit rests in our opinion), the government starts with the premise that Congress sometimes wishes to be superfluous. It then argues that the failure of the second prong to cover all tax offenses (as opposed to section 7201) would render that prong ambiguous. This argument seems baseless. The only way prong one is rendered ambiguous by petitioners’ argument is if you are predisposed to assume that all tax offenses are either in prong one or in prong two. If you come to the statutory interpretation exercise without that excess luggage, it is perfectly natural for prong two to deal with the sole exemplar of a tax offense that is an aggravated felony and for prong one to include no tax offenses at all. (This is arguably the most natural reading of the provision). The government’s efforts to force ambiguity into prong one by arguing that Congress might have wanted to make really, really, really sure that a tax statute — section 7201 — that for all time has stood as the capstone of tax fraud/evasion would be interpreted as involving fraud or deceit seem to us a bit of a stretch.
The government finishes by focusing on the legislative disconnect between the aggravated felony rules and the sentencing guidelines (fairly chastising petitioners for failing to prove a direct connection). It also dismisses the applicability of the rule of lenity on the ground that mere ambiguity is insufficient to trigger that rule (the case law indicates the ambiguity must be grievous). Finally, the government notes that the agency never formally addressed the question of whether non-section 7201 tax crimes can be aggravated felonies. In the government’s view the agency should be allowed to do so on any remand and any such decision should be accorded Chevron deference. As mentioned above, we doubt that the Court will resolve the case on either of these bases.
Petitioners’ reply brief is due October 31, and the case is scheduled for oral argument on November 7.
September 20, 2011
The Ninth Circuit issued its opinion in Samueli v. Commissioner, Nos. 09-72457 and 09-72458, on September 15, 2011, largely affirming the Tax Court (opinion linked below, and see our prior coverage here). In upholding the decision in favor of the IRS, the Ninth Circuit added a couple of wrinkles to the Tax Court’s rationale in responding to the taxpayers’ arguments on appeal.
The court first dispensed with the taxpayers’ argument that, contrary to the Tax Court’s finding, the transactions at issue did not reduce the purported lenders’ opportunity for gain (a statutory element of I.R.C. § 1058 non-recognition). The court found that not only did taxpayers have an extremely limited right to recall the securities (the interest strips were recallable on two days out of approximately 450), thereby limiting the opportunity to take advantage of potential short term swings in value, but also the lending agreement further constrained taxpayers by adding another layer of pricing risk that could have made recalling the securities economically infeasible. Accordingly, the Ninth Circuit ruled that section 1058 was inapplicable as a more or less routine matter of statutory interpretation.
But the court didn’t stop there. Responding to the taxpayers’ argument that section 1058 is merely a safe harbor and does not definitively delineate securities loans that should be afforded non-recognition treatment, the court held that taxpayers’ purported loan did not align with the policy animating section 1058 (the facilitation of liquidity for the securities markets), and therefore the transaction was not eligible for tax-favored treatment. The court was clearly exercised by its assessment that the taxpayers’ “loan, a tax shelter marketed as such for which the borrowing broker did not pay the lender any consideration, clearly was not ‘the thing which the statute intended.’” (quoting Gregory v. Helvering, 293 U.S at 469). The court reasoned that, because the taxpayers’ transaction was inconsistent with the purpose of the statutory provision at issue, taxpayers could not avail themselves of some sort of common law penumbra around the statute (assuming one exists in the first instance–a debatable proposition).
As we noted in our earlier post, the taxpayers argued in their reply brief that irrespective of section 1058, the transactions were in substance the purchase of a contractual right later terminated, and therefore eligible for capital gains treatment pursuant to I.R.C. § 1234A. Noting that the government had successfully argued application of substance-over-form, the court nonetheless opined that “[it] does not mean that [the taxpayers] therefore must have the right to call the transaction whatever they want after the fact.” Tacitly applying a version of what some practitioners refer to as the Danielson doctrine, the court held that the taxpayers were stuck with their form and could not recast the transactions to avoid the tax consequences of the Service’s recharacterization. See, e.g., Comm’r v. National Alfalfa Dehydrating & Milling Co., 417 U.S. 134, 149 (1974) (“while a taxpayer is free to organize his affairs as he chooses, nevertheless, once having done so, he must accept the tax consequences of his choice, whether contemplated or not, . . .and may not enjoy the benefit of some other route he might have chosen to follow but did not”); Comm’r v. Danielson, 378 F.2d 771, 775 (3d Cir. 1967) (“a party can challenge the tax consequences of his agreement as construed by the Commissioner only by adducing proof which in an action between the parties to the agreement would be admissible to alter that construction or to show its unenforceability because of mistake, undue influence, fraud, duress, etc.”).
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 22, 2011
While we wait to see what the government will say to the Supreme Court on the Intermountain issue, litigation continues in the courts of appeals. (The government’s response to the certiorari petition in Beard is currently due on July 27.) The taxpayer has filed a petition for rehearing en banc in Salman Ranch. It is hard to imagine that the Tenth Circuit will head down that road when it appears that the Supreme Court will address the issue. Salman Ranch, however, does present one wrinkle not present in the other cases — namely, whether the government was precluded by collateral estoppel from relitigating the issue against this taxpayer because Salman Ranch had prevailed in the Federal Circuit on the same issue in another tax year. The Tenth Circuit panel ruled that collateral estoppel did not apply because, in light of the issuance of the regulations, it was not true that the “applicable legal rules remain unchanged.”
The petition for rehearing, as well as the other briefs in this case, are linked below.
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.
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.
May 23, 2011
The Supreme Court this morning granted certiorari in one case, Kawashima v. Holder, on which we have been reporting for some time. See our original post here. As we observed in our report on the cert petition, the Court always has the option of limiting its grant of certiorari to a subset of the questions presented in the petition, and it has exercised that option here. The Court will resolve only the first question presented — namely, whether violations of 26 U.S.C. 7206 (subscribing to a false statement on a tax return) are “aggravated felonies” that can justify deportation of a resident alien. The Kawashimas argue that only tax evasion convictions under section 7201 are aggravated felonies, and the courts of appeals have divided on the issue. Now the Supreme Court will resolve the dispute.
The case will now be briefed over the summer and argued in the fall of 2011, with a decision likely in the spring of 2012. The Kawashimas’ opening brief is due July 7.
May 9, 2011
After four extensions, the government finally filed its response to the petition for certiorari in Kawashima. As we previously reported (see here and here), that petition raises a question on which the courts of appeals are in conflict — whether a tax offense other than tax evasion can be an “aggravated felony” for purposes of the immigration laws, which would justify deportation of a resident alien. Maybe the government was spending all that extra time considering whether to “acquiesce” in the petition and invite the Supreme Court to resolve the conflict, or maybe it was just taking its sweet old time. In any event, the government has filed a brief urging the Court to deny certiorari.
The brief in opposition acknowledges that there is a conflict in the circuits, terming it “a narrow disagreement.” But the government argues that there is no need for the Court to resolve that disagreement. In particular, the government argues that the Court’s recent decision in Nijhawan v. Holder, 129 S. Ct. 2294 (2009), supports the government’s position and, since the Third Circuit’s contrary decision was issued before Nijhawan, “the narrow disagreement in the courts of appeals may be resolved without further intervention of this Court.” On the merits, the government resists the petition’s statutory construction analysis by arguing that “fraud or deceit” is not necessarily an element of tax evasion under 26 U.S.C. § 7201. If it is not, then theoretically 8 U.S.C. §1101(a)(43)(M)(ii) is not superfluous, as the petition argues.
In their reply brief, petitioners vigorously contest the government’s premise that “fraud or deceit” is not necessarily an element of tax evasion under 26 U.S.C. § 7201 by analyzing the structure of the Code’s criminal tax provisions. Among other things, petitioners state that the government’s “reasoning defies logic: the greater offense [section 7201] does not necessarily involve ‘fraud or deceit,’ but the lesser offense [section 7206] necessarily does.” With respect to the government’s assertion that this circuit conflict does not warrant the Supreme Court’s attention, petitioners maintain that the need to stop unlawful deportations presents a compelling reason for Supreme Court review.
The Court is likely to act on the petition on May 16.
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 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. Becuase 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 10, 2011
We noted back in November that the taxpayer had filed a petition for certiorari in Kawashima v. Holder, 615 F.3d 1043 (9th Cir. 2010), on the question whether Code section 7206 offenses provide a basis for deportation — an issue on which the circuits are split. We stated that the Court could be expected to rule on the petition in early 2011, even if the government obtained a fairly routine 30-day extension of its December 2, 2010 response date.
There is no ruling yet because the government has now obtained three such extensions. That is fairly unusual and may indicate that the government’s lawyers are struggling with how to respond. In any case, it is unlikely that the Court would grant another extension. If a response is filed on the current due date of March 4, 2011, then the Court will likely issue its ruling on its April 4 order list.
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.
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.
Supreme Court Opts for Chevron Analysis of Treasury Regulations, Discarding the Traditional National Muffler Dealers Analysis
January 11, 2011
The Supreme Court this morning issued its opinion in the Mayo Foundation case, ruling unanimously that medical residents are not “students” exempt from FICA taxation. As previously discussed several times on this blog (see here, here, and here), the Mayo case carried the potential for broad ramifications beyond its specific context because the parties had framed the question of whether deference to Treasury regulations is governed solely by general Chevron principles that supersede the deference analysis previously developed in tax cases like National Muffler Dealers. The Court in fact addressed that question and has now endorsed use of the Chevron standard in tax cases, thereby providing the IRS with a big victory that will make it more difficult for taxpayers to prevail in court in the face of contrary regulations, even if they are “bootstrap” regulations designed primarily to influence the outcome of litigation. And for good measure, the Court obliterated the long-held view by many in the tax world that “interpretive” regulations promulgated pursuant to Treasury’s general rulemaking authority under Code section 7805(a) are entitled to less deference than “legislative” regulations promulgated pursuant to more specific rulemaking authority.
The Court’s opinion was authored by the Chief Justice, who was the Justice who spoke out most forcefully during the oral argument in favor of the position that Chevron had superseded earlier decisions in tax cases, as noted in our previous post. Thus, the opinion sought to be very clear on this point and to identify some of the familiar approaches to regulatory deference in tax cases that the Court was now consigning to the trash heap. First, the Court pinpointed some of the key factors that had been identified as important under the National Muffler Dealers analysis, stating that under that analysis “a court might view an agency’s interpretation of a statute with heightened skepticism when it has not been consistent over time, when it was promulgated years after the relevant statute was enacted, or because of the way in which the regulation evolved.” Slip op., at 8-9 (citing Muffler Dealers, 440 U.S. at 477). The Court continued: “Under Chevron, in contrast, deference to an agency’s interpretation of an ambiguous statute does not turn on such considerations.” Id. at 9.
The Court amplified its rejection of the Muffler Dealers analysis by citing a series of non-tax decisions under Chevron that decline to attribute significance to these considerations. Thus, the Court remarked that it had “repeatedly held that ‘[a]gency inconsistency is not a basis for declining to analyze the agency’s interpretation under the Chevron framework’” (quoting National Cable & Telecommunications Assn. v. Brand X Internet Services, 545 U.S. 967, 981 (2005)); “that ‘neither antiquity nor contemporaneity with [a] statute is a condition of [a regulation’s] validity’” (quoting Smiley v. Citibank, N.A., 517 U.S. 735, 740 (1996)); and that it is “immaterial to our analysis that a ‘regulation was prompted by litigation’” (quoting Smiley, 517 U.S. at 741). Trying to link these decisions to its tax law jurisprudence, the Court then observed that in United Dominion Industries, Inc. v. United States, 532 U.S. 822, 838 (2001) (which involved the calculation of product liability losses for affiliated entities under Code section 172(j)), it had “expressly invited the Treasury Department to ‘amend its regulations’ if troubled by the consequences of our resolution of the case.” Mayo slip op., at 9. The Court emphasized that it saw no good reason “to carve out an approach to administrative review good for tax law only.” Id. Thus, the Court concluded: “We see no reason why our review of tax regulations should not be guided by agency expertise pursuant to Chevron to the same extent as our review of other regulations.” Id. at 10.
Second, the Court moved to squash another area where it discerned a difference between Chevron principles and those developed in tax cases – even though the parties had not focused on that point. Pointing to an amicus brief filed by Professor Carlton Smith arguing for reduced deference because the regulations in Mayo were “interpretive” regulations promulgated pursuant to Treasury’s general rulemaking authority under 26 U.S.C. § 7805(a), the Court acknowledged that there is pre-Chevron authority for the proposition that courts “‘owe the [Treasury Department’s] interpretation less deference’ when it is contained in a rule adopted under that ‘general authority’ than when it is ‘issued under a specific grant of authority to define a statutory term or prescribe a method of executing a statutory provision’” (slip op., at 10-11 (quoting Rowan Cos. v. United States, 452 U.S. 247, 253 (1981)). The Court tossed that precedent aside as well, ruling that the Rowan statement was not compatible with the current approach to administrative deference, which is unaffected by “whether Congress’s delegation of authority was general or specific.” Slip op., at 11.
With the Chevron analytical framework in place, the Court made short work of the FICA issue before it. It reasonably concluded that the statutory text did not unambiguously resolve whether medical residents qualify for the FICA student objection. Hence, the Court moved to “Chevron stage two” – namely, whether the regulation was a “reasonable interpretation” of the statute. Observing that “[r]egulation, like legislation, often requires drawing lines” (slip op., at 13), the Court held that it was reasonable for Treasury to establish a rule that anyone who works a 40-hour week, even a medical resident, is not a “student” for purposes of the FICA student exception.
In sum, the Court’s decision in Mayo resolves the deference issues that have recently divided the lower courts in a way that is extremely favorable to the government. Treasury likely will be emboldened to issue regulations that seek directly to overturn cases that the government loses in court on statutory interpretation issues, or to issue regulations even earlier to sway the outcome of pending litigation before the courts interpret the statute in the first place. Of course, we have seen that phenomenon already in the Mayo case itself, with respect to the statute of limitations issue litigated in Intermountain and a host of other cases (see here and here), and in other settings. The Mayo decision will further encourage the Treasury Department to issue such regulations and will make it tougher for taxpayers to prevail in court in the face of those 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.
November 16, 2010
As we expected, a petition for certiorari has been filed in Kawashima v. Holder, 615 F.3d 1043 (9th Cir. 2010). To review, that case involves the question of whether pleas by Mr. and Mrs. Kawashima to section 7206 offenses of subscribing to false statements (and assisting same) as to their corporation’s 1991 tax return could be “aggravated felonies” under the immigration laws. As noted in our initial blog post, the relevant section of 8 U.S.C. §1101(a)(43)(M), if read holistically, would seem to preclude that conclusion but a divided panel of the Ninth Circuit (after changing its mind a few times in the interim) ultimately held that section 7206 offenses do provide a basis for deportation.
In addition to pointing out the circuit split (the Third Circuit – in another divided panel – previously adopted the Kawashimas’ position), the petition cites myriad statutory construction cases for the premise that (M)(i), involving “fraud or deceit,” cannot encompass section 7206 when M(ii) specifically references only section 7201 (the crime of tax evasion). We were disappointed to see that our favorite case on this subject (United Savings Association of Texas v. Timbers of Inwood Forest Associates, 484 U.S. 365 (1988)) wasn’t cited:
Statutory construction . . . is a holistic endeavor. A provision that may seem ambiguous in isolation is often clarified by the remainder of the statutory scheme – because the same terminology is used elsewhere in a context that makes its meaning clear . . . or because only one of the permissible meanings produces a substantive effect that is compatible with the rest of the law.
Id. at 371. Perhaps that gem will make it into a merits brief if certiorari is granted.
The petition also takes on the question of whether a section 7206 crime necessarily involves fraud, citing Considine v. United States, 683 F.2d 1285 (9th Cir. 1982) for the proposition that it doesn’t. The petition also makes arguments based on rule of lenity as frequently applied in the immigration context. See generally INS v. St. Cyr, 533 U.S. 289 (2001).
Finally, the petition presents a second question – an interesting procedural question of whether the Ninth Circuit acted outside of its authority under Federal Rule of Appellate Procedure 41 by amending its second opinion as to Mrs. Kawashima (which found she had not committed an aggravated felony on grounds that the loss amount has not been proven) after the date the mandate allegedly was required to issue as to her, because the petition for rehearing was filed only as to Mr. Kawashima. This is a potential home-run argument for one of the petitioners, but the question lacks the broad applicability that would ordinarily interest the Supreme Court. The Court is free under its rules to grant certiorari limited to one of the questions presented in the petition if it so chooses. It will be interesting to see if it does so in this instance.
The government’s response is currently due on December 2, but the government routinely requests extensions of 30 days or more to respond to petitions for certiorari. The Court can be expected to rule on the petition early in 2011.
Mayo Foundation Oral Argument Tilts Towards the Government and Raises Doubts About the Continuing Vitality of National Muffler Dealers
November 10, 2010
At oral argument on November 8, several Supreme Court Justices expressed skepticism regarding the claim that medical residents fall within the “student exemption” from FICA taxation. Although it is always hazardous to predict the outcome of a case from the questions asked at oral argument, it is difficult to envision the taxpayer getting the five votes needed to overturn the court of appeals’ rejection of the exemption.
The Justices’ objections to the taxpayer’s position came from a variety of angles. Justice Sotomayor focused on the essence of what a medical resident does, suggesting that a person working unsupervised for more than 40 hours per week, and for signficant remuneration, is “really not a student.” Justice Ginsburg focused more on Congress’s intent, suggesting that the exemption seemed directed at “the typical work/study program in a college.” Chief Justice Roberts observed that the line between student and worker is a difficult one to draw and suggested that it was therefore appropriate to let the IRS draw the line in a categorical way and then defer to the IRS’s interpretation. Justice Breyer took a different tack, arguing that the IRS’s position was a valid interpretation of a requirement that had been in the regulations for a long time – namely, that the employment has to be “incident” to the study. Full-time employment, he suggested, would not be “incident” to the study because it is “so big in comparison to the study.”
Justice Alito seemed the most sympathetic to the taxpayer. He rose to the taxpayer’s defense by offering an alternative reading of word “incident.” Later, he challenged the government’s counsel to explain why medical residents should not be eligible for the exemption when law students who write briefs are eligible, arguing that the medical residents should be treated as students if their primary motivation is to complete a course of study rather than to earn money. Justice Ginsburg and the Chief Justice also questioned government counsel, though not as sharply as they had questioned the taxpayer’s counsel. Justices Scalia and Kennedy were uncharacteristically silent during the argument. In accordance with his usual practice, Justice Thomas did not speak. Justice Kagan is recused in the case because of her prior involvement when she was Solicitor General.
In our prior posts on this case (see here, here, and here), we discussed the possibility that this case could be a vehicle for the Supreme Court to address the correct standard for deference to Treasury regulations – that is, whether the more generic Chevron analysis has superseded the more specific, and in some respects less deferential, approach set forth in National Muffler Dealers Ass’n v. United States, 440 U.S. 472 (1979). The Justices did not exhibit any independent interest in this issue, as their questions focused on the meaning of the statute, not on deference to the regulation. At one point in his opening argument, taxpayer’s counsel noted that the new regulation was issued only after the government had repeatedly lost in court (a fact that would argue for less deference under the National Muffler Dealers approach), but that point did not elicit any reaction from the Justices.
Thus, the oral argument did not touch on the Chevron/National Muffler Dealers issue until the very end when taxpayer’s counsel affirmatively raised it during his few minutes of rebuttal time. Counsel sought again to persuade the Court that the government’s position is suspect because it is a recent invention that seeks to overturn a series of adverse court decisions, and this time phrased the argument explicitly in terms of the standard for deferring to a regulation. Taxpayer’s counsel argued that deference to the new Treasury Regulation is inappropriate under “[t]he National Muffler standards, which we understand still to be appropriate to evaluate deference given to an IRS regulation,” because the regulation “is not a contemporaneous regulation.” Justice Sotomayor quickly objected, asserting that the Court has “said that agencies can clarify situations that have been litigated and positions that they have lost on.” (She was referring here not to tax cases, but to decisions that apply the Chevron analysis.). Shortly thereafter, Chief Justice Roberts zeroed in on the issue, asking:
Why are we talking about National Muffler? I thought the whole point of Chevron was to get away from that kind of multifactor ad hoc balancing?
Taxpayer’s counsel tried to respond by arguing that the National Muffler Dealers factors were “sensible factors” that the Court should continue to apply in the case of a “regulation that pops up 65 years of the enactment of the statute, after the government has lost five cases.” But the Chief Justice was dismissive, stating simply: “If Chevron applies, those considerations are irrelevant, right?”
The outlook for the case therefore is that the Court will likely affirm the Eighth Circuit’s ruling that medical residents do not come within the student exemption from FICA. Such a decision would not necessarily require a discussion of deference to Treasury regulations, but if there is such a discussion, the Court may well be ready to conduct the analysis explicitly in the Chevron framework and consign National Muffler Dealers to the dustbin of history. As noted in our previous post, that would in some respects be an unfortunate outcome – giving too much deference to regulations that may well be unduly influenced by the IRS’s narrow interest in maximizing tax revenues rather than a neutral effort to implement the will of Congress.
Attached below are links to the taxpayer’s reply brief and to the transcript of the oral argument. A decision is expected in the next few months.
October 20, 2010
In our initial post on the Mayo Foundation case pending in the Supreme Court, which concerns whether medical residents are exempt from FICA taxation, we noted that the case potentially raised a broad question that has surfaced in the courts of appeals and the Tax Court in recent years – namely, whether Chevron deference principles have supplanted the traditional Muffler Dealers approach to analyzing the deference owed to Treasury regulations. Although that issue was not flagged by the parties at the certiorari stage, we later observed that the taxpayers’ opening merits brief served that ball into the government’s court by relying heavily on some of the Muffler Dealers factors that are not ordinarily part of the Chevron analysis. The government has now responded by directly challenging the continuing vitality of Muffler Dealers. (The government’s brief is attached below.) As a result, there is a good chance that the Supreme Court will address the question and resolve the disagreement between the Tax Court and some courts of appeals on the proper analysis of deference to Treasury regulations.
The government’s brief does not mince words. It states that Muffler Dealers “has been superseded by Chevron” and therefore “the considerations on which [taxpayers] rely are largely irrelevant.” In particular, the government identifies three Muffler Dealers factors relied upon by the taxpayers that are allegedly irrelevant under Chevron: (1) “the recency of [the] adoption” of the regulation; (2) that the new regulation “was enacted ‘to overturn judicial decisions’ interpreting the student exemption”; and (3) that “Treasury’s interpretation of the student exemption has purportedly been inconsistent.”
It is by no means a foregone conclusion that the Supreme Court will resolve the question of the proper deference standard, as there are many ways to resolve the ultimate question of the applicability of the FICA exemption without having to decide on a deference standard. Nor is it as clear as the government would like that Chevron did or should supersede Muffler Dealers. (If it were, the question probably would not still be open 26 years after Chevron was decided). The IRS is often in an adversarial relationship with taxpayers; it has an inherent fiscal interest in interpreting the Internal Revenue Code in a way that maximizes tax revenues. Therefore, there are good reasons for the courts to afford less deference to Treasury regulations that would determine the outcome of tax disputes than to regulations of more neutral agencies that are merely administering a federal statute. Can the government really respond to an IRS defeat in court by promulgating a regulation to overturn the decision and then expect the courts to defer to that regulation without taking any account of how it came to pass? Or can it reverse a regulatory interpretation simply because it determines that the reversal will benefit the public fisc, without paying some price in terms of judicial deference? Perhaps the Supreme Court will answer those questions soon.
Oral argument in the Mayo Foundation case is scheduled for November 8.
September 17, 2010
On September 14, 2010, the tax matters partner (“TMP”) for Castle Harbour LLC filed its response brief in TIFD III-E Inc. v. United States, No. 10-70 (2nd Cir.) (brief linked below). For our prior coverage of this case, see here. As many readers are no doubt aware, this is the second time this case is before the Second Circuit.
In the response brief , the TMP frames the issues as: (1) whether the district court, upon remand, correctly determined the investment banks were partners under I.R.C. section 704(e)(1), (2) whether the IRS can reallocate income under I.R.C. section 704(b) despite the section 704(c) “ceiling rule,” and (3) whether the district court correctly decided that I.R.C. section 6662 accuracy-related penalties were not applicable.
First, the TMP argues that section 704(e)(1) creates an independent, objective alternative to the Culbertson test, with the critical issue being whether the purported partner holds a “capital interest.” The TMP contends that, because the banks’ interests were economically and legally equivalent to preferred stock, and because preferred stock is treated as equity for tax purposes even though it possesses many characteristics of debt, the banks held “capital interests” under section 704(e)(1). Accordingly, the TMP argues that the banks were bona fide partners in Castle Harbour, the Second Circuit’s application of Culbertson notwithstanding.
Second, the TMP contests the IRS’s ability to reallocate income under I.R.C. section 704(b) in spite of application of the section 704(c) ceiling rule (assuming the banks were bona fide partners). The regulations under section 704(c) were amended to allow such a reallocation for property contributions occurring after December 20, 1993, which is after the contributions at issue in the case. Accordingly, the TMP takes the position that the IRS is attempting an end-run around the effective date of the amended regulations.
Finally, the TMP also argues that victory at trial, based on the careful findings of fact by the district court, demonstrates that the transactions were primarily business-motivated, and furthermore, that substantial authority existed for the TMP’s return position. Accordingly, the TMP contends that accuracy-related penalties should not apply, even if the IRS’s adjustment is ultimately upheld.
September 12, 2010
Lately, the IRS has had a successful run of attacking transactions involving purported securities loans. See Anschutz Co. v. Commissioner, 135 T.C. 5 (July 2010); Calloway v. Commissioner, 135 T.C. 3 (July 2010); Samueli v. Commisioner, 132 T.C. 4 (March 2009). Two of the cases, Samueli and Anschutz, involve the construction of I.R.C. section 1058, which provides for non-recognition treatment of a loan of securities that meets the following criteria: (1) the loan agreement provides for the return of securities identical to the securities transferred; (2) the agreement provides for payments to the transferor of amounts equivalent to all interest, dividends, and other distributions which the owner of the securities is entitled to receive during the period of the loan; and (3) the agreement does not reduce the risk of loss or opportunity for gain of the transferor of the securities in the securities transferred.
In Samueli, the Tax Court held that a series of transactions between a taxpayer and a broker/dealer did not qualify for section 1058 treatment because the purported securities loan reduced the taxpayer’s opportunity for gain (the taxpayer was the lender of securities under the form of the transactions). The transactions consisted of: (1) taxpayer’s purchase of $1.7 billion in mortgage-backed interest strips on margin (the broker/dealer allowed the taxpayer to purchase the securities on credit); (2) a securities loan of the interest strips back to the broker/dealer, with a transfer of $1.7 billion in cash collateral to the taxpayer; and (3) the taxpayer paying interest on the cash collateral at a variable rate (with the broker/dealer paying a relatively small amount of interest on taxpayer’s funds deposited in its margin account). The arrangement further provided that taxpayer could recall the securities only on two specified dates during the term of the loan, or at maturity. Ordinarily, securities loans are callable at any time. The Tax Court determined that the limited ability of the taxpayer to retrieve its securities reduced the taxpayer’s opportunity for gain, because taxpayer did not have the right to take advantage of favorable swings in the price of the securities if they occurred at a time when taxpayer did not have the right to call the loan.
Interestingly, the Tax Court went a step further than merely holding that non-recognition treatment was improper under section 1058. Cursorily invoking the substance-over-form doctrine, the court also held that as a matter of economic reality there was no securities loan at all; rather, in the court’s view there was a wash sale at the outset (purchase of the securities by taxpayer immediately followed by a resale to the broker/dealer for no gain), and a subsequent purchase under a constructive forward contract followed by a resale to the broker/dealer, resulting in a modest short-term capital gain. Because there was no true indebtedness, the court held, taxpayer’s interest deductions were not allowable.
The taxpayer has appealed the Tax Court’s decision to the Ninth Circuit, and the case has been fully briefed. The Tax Court’s opinion and the appellate briefs are linked below. In the opening brief, the taxpayer argues that the Tax Court: (1) misinterpreted section 1058 by adding a “loan terminable upon demand” requirement, (2) erroneously construed the section 1058 requirements as the sine qua non of securities loans for federal tax purposes (cf. Provost v. United States, 269 U.S. 443 (1926) (for purposes of the stamp tax, the borrowing of stock and the return of identical stock to the lender are taxable exchanges)), (3) recharacterized the transactions in a manner inconsistent with their economic reality, and (4) even if the recharacterization stands, improperly treated the deemed disposition of the forward contract shares as short-term capital gain.
In its response, the government contends that the Tax Court correctly determined that the arrangement was not eligible for non-recognition treatment under section 1058 because it reduced the taxpayer’s opportunity for gain in the securities, contrary to section 1058(b)(3). Furthermore, the government argues, the court correctly held that the overall arrangement was not a loan in substance, and therefore the purported interest paid on the collateral is not deductible.
In the reply, the taxpayer changes tack somewhat and argues that the focus on section 1058 heretofore has been a mistake by all involved. The taxpayer contends that the tax treatment of the transactions should be the same regardless of the application of section 1058—long-term capital gain and deductible interest, based on the notion that taxpayer received basis in a contractual right at the outset, which was later disposed of at a gain, and that taxpayer’s payment of interest on the collateral was consideration for the broker/dealer’s forbearance of the use of the collateral.
We will continue to follow the case as it develops. According to news reports, the taxpayer in Anschutz intends to appeal the Tax Court’s decision as well, and we will post on that case as soon as the appeal is filed (which will likely be in the 10th Cir.).
September 1, 2010
On August 30, 2010, the Ninth Circuit granted Petitioner’s Motion to Stay the Mandate in Kawashima. This stays the mandate in the case pending the filing of a petition for writ of certiorari and confirms our prior speculation that petitioner is going to try to make a run at the Supreme Court. We will be watching the case with interest and will post the petition when it appears.
August 18, 2010
On August 4, 2010, the Ninth Circuit denied panel and en banc rehearing in a case applying 8 U.S.C. § 1101(a)(43)(M)(i) to hold that a tax offense other than tax evasion is a crime involving fraud or deceit and thus an aggravated felony under the immigration laws (which allows for deportation). Kawashima v. Holder, 2010 U.S. App. LEXIS 16125 (9th Cir. Aug. 4, 2010). This is actually the fourth opinion issued by the Ninth Circuit in the case, appending a three-judge dissent from denial of en banc rehearing to the third panel opinion issued back in January 2010. Kawashima v. Holder, 593 F.3d 979 (9th Cir. 2010). (The first two panel opinions (Kawashima v. Mukasey, 530 F.3d 1111 (9th Cir. 2008), and Kawashima v. Gonzalez, 503 F.3d 997 (9th Cir. 2007)), were withdrawn so that the panel could reconsider the case in light of new Ninth Circuit and Supreme Court decisions.) The Ninth Circuit has now placed itself squarely in conflict with the decision of a divided panel of the Third Circuit (Ki Se Lee v. Ashcroft, 368 F.3d 218 (3d Cir. 2004), in which then Judge (now Justice) Alito was the dissenter. The Fifth Circuit, however, adopted the same basic reasoning as Kawashima in Arguelles-Olivares v. Mukasey, 526 F.3d 171 (5th Cir. 2008), cert. denied, 130 S. Ct. 736 (2009).
The primary question in these cases is one of statutory interpretation. 8 U.S.C. §1101(a)(43)(M) provides that an aggravated felony includes an offense that:
(i) involves fraud or deceit in which the loss to the victim or victims exceeds $ 10,000; or
(ii) is described in section 7201 of the Internal Revenue Code of 1986 (relating to tax evasion) in which the revenue loss to the Government exceeds $ 10,000;
Mr. Kawashima pled guilty to section 7206(1), a tax crime that involves subscribing to a false statement on a tax return; his wife pled to section 7206(2), a tax crime involving aiding and assisting in the preparation of a false tax return. Neither pled to section 7201, tax evasion.
The dispute between the circuits rests on how much the interpretation of (M)(i) should be guided by the existence of (M)(ii). As the Third Circuit and a strongly worded dissent in Kawashima both note, “statutory text must be read in context.” 2010 U.S. App. LEXIS 16125 at *28. When read in context, it appears that the only tax crime that was intended to be covered is tax evasion as set out in (M)(ii). This is so because if tax crimes are governed by (M)(i), then (M)(ii) would be superfluous. Superfluities are a red flag in statutory interpretation. See, e.g., Market Co. v. Hoffman, 101 U.S. 112, 115 (1879) (“We are not at liberty to construe any statute so as to deny effect to any part of its language. It is a cardinal rule of statutory construction that significance and effect shall, if possible, be accorded to every word.”).
The majority in Kawashima evaded this reasoning on the basis that if Congress had not wanted (M)(i) to apply to tax offenses “Congress surely would have included some language in that provision to signal that intention.” U.S. App. LEXIS 16125 at *13. Apparently, the language in the next clause, (M)(ii), doesn’t count. And the majority’s opinion does not convincingly address the problem of creating superfluities. Merely because the language of (M)(i) is broad enough to cover tax offenses other than tax evasion when that subsection is read in isolation, that doesn’t mean that one can divine Congressional intent to actually do so when the statute is read holistically. Regardless, two circuits have now adopted the view that a tax offense other than tax evasion can be an “aggravated felony.”
It is too early to tell if a petition for certiorari will be filed in Kawashima but given the split and the substantial number of amici involved in the circuit filings, one might reasonably expect one. That said, the same conflict was presented in Arguelles-Olivares yet the Court denied certiorari, apparently persuaded by the Solicitor General’s suggestion that the Court “should wait for further developments.” Having the Ninth Circuit join the Fifth Circuit in agreeing with the government may not be the kind of development the Supreme Court had in mind. A petition for certiorari would be due on November 2, 2010. The final Ninth Circuit opinion and the United States brief in opposition in Arguelles-Olivares are attached.