Rehearing Denied in Burks

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.

Seventh Circuit Denies Rehearing in Beard

The Seventh Circuit today denied the taxpayer’s rehearing petition in Beard.  Coupled with the Fourth Circuit’s denial of rehearing in Home Concrete a few days ago, this action removes the faint theoretical possibility of resolving the circuit conflict in the Intermountain cases short of the Supreme Court.  A petition for certiorari in Beard would be due on July 7.

D.C. Circuit Leans Toward Government at Intermountain Oral Argument

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

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

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

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

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

Beard – US response to rehearing petition

Home Concrete – Petition for Rehearing

Seventh Circuit to Consider Petition for Rehearing in Beard

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.

Beard – Petition for rehearing

Federal Circuit Adds to Intermountain Conflict by Deferring to New Regulations That Apply Six-Year Statute to Overstatements of Basis

The Federal Circuit has ruled for the government in Grapevine, throwing the circuits into further disarray by adopting an approach that differs from all three of the courts of appeals that have previously addressed the Intermountain issue subsequent to the issuance of the new regulations.  Because the Federal Circuit had already rejected the government’s construction of the statute in Salman Ranch, the Grapevine case starkly posed the question whether the new regulations had the effect of requiring the court to disregard its prior decision and reach the opposite result.  As we previously reported, at oral argument the day after the decision in Mayo Foundation, the government told the Federal Circuit that Mayo compelled that result.  The court has now agreed.

A key section of the court’s opinion considers whether the Supreme Court’s decision in Colony defeats the government’s deference argument.  The court says it does not because Colony itself stated that it did not regard the statutory text as unambiguous and, even considering the Colony court’s review of the legislative history, the court did not believe that “Congress’s intent was so clear that no reasonable interpretation could differ.”  Therefore, Colony did not resolve the case under Chevron Step 1 and, under Brand X, Treasury was free to issue a regulation that contradicts Colony.  (In its analysis, the Federal Circuit appears to have sided with the view, based on footnote 9 of Chevron, that legislative history can be considered at Chevron Step 1 (see our previous post)).  The court then applies the Chevron analysis to the new regulations and concludes that they are reasonable based on exactly the same government arguments that the court rejected in Salman Ranch when it was construing the statute in the absence of a regulation.  Finally, the court rules that Treasury did not abuse its discretion in applying the new regulations retroactively to years that were still open under the six-year statute.

The Grapevine decision is significant in the specific context of the Intermountain cases, as it virtually ensures that a circuit conflict on the issue will persist even if the Seventh Circuit reconsiders its decision in Beard.  And it is the first appellate decision to address in detail the merits of the government’s primary argument that it can overturn the prior adverse decisions in this area by regulation.  More generally, the case is a great illustration of Treasury’s power under the combination of Mayo and Brand X.  The Federal Circuit was keenly aware of the implications of its decision, summarizing it as follows:  “This case highlights the extent of the Treasury Department’s authority over the Tax Code.  As Chevron and Brand X illustrate, Congress has the power to give regulatory agencies, not the courts, primary responsibility to interpret ambiguous statutory provisions.”   Presumably, Treasury will continue to test the limits of how far it can go in exercising that “primary responsibility.”

Federal Circuit opinion in Grapevine

Update on Kawashima

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.

Fifth Circuit Rules for Taxpayer on Intermountain Issue and Cautions on the Limits of Mayo

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.

Fifth Circuit opinion in Burks

Seventh Circuit Sets Up Likely Supreme Court Showdown By Reversing Tax Court on Intermountain Issue

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.

Seventh Circuit decision in Beard

Supreme Court Opts for Chevron Analysis of Treasury Regulations, Discarding the Traditional National Muffler Dealers Analysis

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.

 Mayo Foundation – Supreme Cout opinion

« Previous Page — Next Page »