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Supreme Court’s Review of Valuation Misstatement Penalty Leaves the Door Open for Appellants

April 16, 2013

By David J. Shakow

On March 25, the Supreme Court accepted certiorari in U.S. v. Gary Woods.  (Supreme Court order) The issue presented to the Court arose from a split in the Circuits over whether a taxpayer can avoid the valuation misstatement penalties of section 6662(e) and (h) by conceding that there was no economic substance to its return position (and thus that the valuation misstatement was not the basis for its tax deficiency).  Compare, e.g., Todd v. Commissioner, 862 F.2d 540 (5th Cir. 1988) (no penalty imposed under predecessor of section 6662), with e.g., Gustashaw v. Commissioner, 110 A.F.T.R.2d 2012-6169 (11th Cir. 2012) (9/28/12) (criticizing Todd).

In accepting the case, the Supreme Court also directed the parties to address an additional matter – whether the trial court even had jurisdiction under section 6226 (dealing with TEFRA partnership-level proceedings) to consider the valuation misstatement penalty.

Taxpayers who have disputed and lost cases involving the same issue would be wise to preserve their appeal rights, if still available, so that they can potentially benefit from a favorable decision by the Supreme Court.

A Concrete Show for Brand X?

April 30, 2012

By David J. Shakow

David J. Shakow is counsel in the Philadelphia office of Chamberlain, Hrdlicka, White, Williams & Aughtry and is professor emeritus at the University of Pennsylvania Law School.

The Supreme Court’s decision in Home Concrete raises new questions about the deference to be given to administrative pronouncements that conflict with prior judicial decisions. Unfortunately, the opinions of a divided Court leave practitioners to puzzle over the boundaries of its decision.

This article originally appeared in Tax Notes.

Copyright 2012 David J. Shakow.
All rights reserved.

* * * * *

The Supreme Court has decided Home Concrete1 and handed taxpayers a victory by holding that the statute of limitations was not increased from three to six years for taxpayers who overstated their bases in assets.

The case involved a son-of-BOSS tax shelter that improperly inflated the basis of assets. Under section 6501(e)(1)(A), the statute of limitations for assessing a deficiency against a taxpayer is extended from three to six years when she omits from gross income an amount in excess of 25 percent of the gross income stated on the return. The question was whether the reduction of gross income that results from the offset of the inflated basis against an amount realized on a disposition of the asset extends the statute of limitations under section 6501(e)(1)(A).

The question was complicated by two special circumstances. First, in 1958 the Supreme Court in Colony Inc. v. Commissioner2 interpreted identical language in the 1939 code to mean that the extended statute of limitations did not apply. But in 2010, while Home Concrete was in litigation, the government issued regulations stating that the extended statute applied.3

Once the regulations were issued, the Chevron4 doctrine of administrative law was called into play. Chevron requires courts to defer to an administrative interpretation of a statute unless the statute is unambiguous (Chevron step one) or, if the statute is ambiguous, to defer to it unless the interpretation is not a permissible interpretation of the statute (Chevron step two). In Mayo,5 decided last year, the Court held that Chevron applies in tax cases the same way it applies in other areas of administrative law.

Is an administrative agency constrained in its interpretation if a court has already interpreted the statute? In Brand X,6 decided in 2005, the Court held that an administrative pronouncement could override a prior judicial interpretation of a statute. That is, if the administrative pronouncement passed the Chevron test, the administrative agency could overturn a judicial decision.

But Brand X has never been applied to allow an administrative agency to overturn a decision of the Supreme Court; perhaps such an application is too broad. On the other hand, the Court in Colony said, in reference to the statutory language before the Court in that case and in Home Concrete, that “it cannot be said that the language is unambiguous.” If the Supreme Court says the language is ambiguous, why not allow the administrative agency to clarify it?

Justice Stephen G. Breyer wrote the opinion in Home Concrete, with Chief Justice John G. Roberts and Justices Clarence Thomas and Samuel A. Alito in agreement. Justice Anthony M. Kennedy wrote the dissent, with Justices Ruth Bader Ginsburg, Sonia Sotomayor, and Elena Kagan joining him. Justice Antonin Scalia’s opinion, concurring in part and concurring in the judgment, was the swing vote.

The majority found that because the language in Home Concrete was identical to the language it interpreted in Colony, the same result should apply. It rejected the government’s argument (which the dissenters accept) that changes made to related sections of the statute in 1954 require a reconsideration of the meaning of the language before the Court. In addition, it refused to defer to the regulations the IRS finalized in 2010. Breyer argues that in this context, once the Court interprets the statute, there is no other interpretation available for adoption by the agency. In explaining why Brand X does not apply, Breyer does not necessarily give special deference to every Supreme Court opinion. Instead, he interprets Brand X to mean that deference is to be given to an administrative interpretation only when there is evidence that Congress delegated gap-filling authority to an agency.

Thus, we are to understand Chevron step one (is the language unambiguous?) simply as an example of a situation when Congress clearly did not delegate gap-filling authority to the agency.7 But even if the language is ambiguous, the agency apparently can’t act unless there is an indication that Congress intended that it exercise its gap-filling authority. And in what might be the most novel point of Breyer’s opinion, he quotes Chevron to the effect that “if 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.”8 In other words, it would appear that if “traditional tools of statutory construction” result in one interpretation of a statute,9 there is no room for an administrative agency to take a contrary position. If that is the law, it would seem to significantly limit the role of Chevron and, even more so, Brand X.

Note that while that could be the most novel point in Breyer’s opinion, it is not the most novel point of the majority. The section of the opinion in which that discussion is found was the part in which Scalia did not join, thus making it the position of only Breyer and the three Justices who accepted all of his opinion. But Scalia did not disagree with that discussion because he believed it went too far; instead, as the dissenter in Brand X, he believes that any court decision prevents an administrative agency from thereafter requiring that court to interpret the statute otherwise. In other words, if the Third Circuit decides to interpret a statute in a particular way, any contrary interpretation from the administrative agency is properly ignored by the Third Circuit.10

Scalia characterized Breyer’s position to be that if a pre-Chevron holding concludes that a statute is ambiguous, the court must also have found “that Congress wanted the particular ambiguity in question to be resolved by the agency”11 if the agency is to invoke its Brand X “gap-filling” power. Presumably, the reason Scalia limits that approach to pre-Chevron decisions is that if a court after Chevron characterizes a statute as ambiguous, it is inviting an agency to supply any permissible interpretation in accordance with Chevron. But Scalia is not clear on that proposition: Perhaps he would extend the argument to post-Chevron cases, too. As for the dissenters, they take the position that the changes made in 1954 should have put taxpayers on notice that the language interpreted in Colony was subject to reinterpretation. Thus, in the absence of any authoritative interpretation of section 6501(e)(1)(A), the government was free to interpret it as it chose. Under that view, the case before the Court did not raise the delicate question whether Brand X (under which an administrative agency can overturn a judicial interpretation of a statute) would apply even to a decision of the Supreme Court.12 Because the dissenters argued that the changes made in 1954 necessarily left the language of section 6501(e)(1)(A) ambiguous, it was open for the IRS to interpret it anew without any constraint from the Court’s decision in Colony.

The continuing significance of Home Concrete is unclear. The Court’s decision certainly means that reg. section 301.6501(e)-1, as amended in 2010, is invalid to the extent it conflicts with Colony. The more important question is whether the Court has further undermined the rickety Chevron structure.13 Breyer suggests that any administrative agency’s attempt to use Brand X logic to overturn a pre-Chevron decision now faces an additional hurdle. The agency would apparently now have to show that Congress delegated gap-filling authority in that circumstance. Presumably, Scalia would sign on to that position, although it is more limited than his approach.

But the logic of Breyer’s opinion in Home Concrete suggests that administrative actions taken to overturn a post-Chevron opinion may also face that additional hurdle. If a court opinion does not explicitly indicate that a statute is ambiguous for Chevron purposes, would Breyer insist that a court must determine whether a statute effectively delegates to an agency the power to fill a gap? The logic of his opinion suggests that he would. But would a majority of the Court go along with that approach?

It looks like tax practitioners, like other administrative law practitioners, will have to return to the Supreme Court for more guidance. Tax practitioners — welcome to the wonderful world of Chevron.

FOOTNOTES

1 Home Concrete & Supply LLC v. United States, Sup. Ct. Dkt. No. 11-139 (2012), Doc 2012-8781 , 2012 TNT 81-11 , aff’g 634 F.3d 249 (4th Cir. 2011), Doc 2011-2674 , 2011 TNT 26-7.

2 357U.S. 28 (1958).

3 Reg. section 301.6501(e)-1.

4 Chevron USA Inc. v. Natural Resources Defense Council Inc., 467U.S. 837 (1984).

5 Mayo Foundation for Medical Education and Research v. United States, 131 S. Ct. 704 (2011), Doc 2011-609 , 2011 TNT 8-10.

6 National Cable & Telecommunications Assn. v. Brand X Internet Services, 545U.S. 967 (2005).

7 Slip op. at 9.

8 Slip op. at 10 (emphasis in original). It is interesting that after reviewing the analysis in Colony, Breyer said, “It may be that judges today would use other methods to determine whether Congress left a gap to fill.” That leaves yet another area for observers to argue about the precise scope of Breyer’s approach.

9 That the Court in Colony said the statutory language is “not unambiguous” is irrelevant, because the Court there was not speaking in the context of Chevron (which had not yet been decided). Instead, the fact that the Court in Colony interpreted the statute in a particular way meant that any lurking ambiguity is irrelevant for Chevron purposes. Slip op. at 10.

10 Although Scalia is not clear on that point, his argument does not seem to be limited to decisions of the Supreme Court. As he said in his Brand X dissent, “When a court interprets a statute . . . its interpretation . . . is the law.” 545U.S. at 1019.

11 Scalia concurrence, slip op. at 3 (emphasis in original).

12 See Kennedy dissent, slip op. at 6.

13 I discussed the uncertain state of Chevron jurisprudence in “Who’s Afraid of the APA?” Tax Notes, Feb. 13, 2012, p. 825, Doc 2011-27082 , or 2012 TNT 30-11.

END OF FOOTNOTES

Innocent Spouse Relief After Mayo: Congress Strikes Back?

May 2, 2011

By David Shakow

Following the Supreme Court’s decision in Mayo Foundation v. United States, in which the Court ruled that tax regulations receive deference from courts under the Chevron doctrine that applies to non-tax regulations, many commentators acknowledged the decision’s anticipated impact on disputes about the validity of tax regulations.  The new standard gives the IRS much wider latitude in issuing regulations that fill gaps caused by statutory ambiguities. In our prior discussions of the decision, we speculated:

The IRS may be wise to keep in mind that neither it, nor the courts, are the final arbiters of the tax law. Congress ultimately will decide what is the law. And when Congress decides that the IRS has acted too boldly, it has more than one way to rein in the agency.

The IRS may be on a collision course with Congress now, over the question of the statute of limitations that applies to an innocent spouse who wishes to raise an equitable defense under Code section 6015(f) to joint tax liability.  Section 6015(f) is silent about whether an equitable defense must be raised within a specified time period; however, IRS regulations issued under that section allow for only a two-year period from the date of the first collection action taken by the IRS.  While courts have not always gone along with this rule, the IRS has two circuit courts on its side, Manella v. Comm’r, No. 10-1308 (3d Cir. 2011); Lantz v. Comm’r, 607 F.3d 479 (7th Cir. 2010), and it continues to push the issue. (more…)

Pass The Mayo Foundation: The Supreme Court Says Goodbye To National Muffler

January 14, 2011

By David Shakow

The Supreme Court’s decision this week in Mayo Foundation for Medical Education and Research v. United States clarifies the approach courts should take in determining the validity of IRS regulations.  The decision is a victory for the IRS, but it leaves many issues unresolved.  One thing is very clear, however: the IRS can be expected to push the decision aggressively in future challenges to its regulations.

(more…)

Do High State Taxes Discourage Economic Growth?

December 6, 2010

By David Shakow

As previewed by my earlier post, State Tax Notes today published an article in which I argued generally that claims that high state taxes discourage economic development may be flawed because they look at statistics selectively and fall prey to the fallacy that correlation implies causation.  In particular, I considered an article by Arthur Laffer which argued that the introduction of income taxes by various states over the past fifty years has in all cases led to a decrease of per capita income when compared to the United States average per capita income in the relevant period.

Starting with the data on per capita income by state published by the Bureau of Economic Analysis of the U.S. Department of Commerce, I determined that, in fact, seven of the eleven states that have introduced an income tax have had an increase in their per capita income when compared to the per capita income of the United States as a whole.  Moreover, while, as Laffer argued, gross state product did decrease for each of those states, the data for gross state product per capita can be read to indicate that the introduction of taxes had no significant effect on a state’s productivity.

The article itself is available for you here:

2010.12.06-STN-Article

And for those readers who would like to see the underlying data, it is available here:

Per Capita Income By State

Population and GDP By State

Unemployment By State

Per Capita Income by State (Inflation-Adjusted)

Do High State Taxes Discourage Economic Growth–Background Data

November 22, 2010

By David Shakow

In an article to be published in State Tax Notes‘ December 6 issue, I argue generally that claims that high state taxes discourage economic development may be flawed because they look at statistics selectively and fall prey to the fallacy that correlation implies causation.  In particular, I consider an article by Arthur Laffer in the Wall Street Journal in October, in which data on personal income per capita do not appear to be consistent with the relevant government-issued data.  The Laffer article argued that the introduction of income taxes by various states over the past fifty years has in all cases led to a decrease of per capita income when compared to the United States average per capita income in the relevant period.

Starting with the data on per capita income by state published by the Bureau of Economic Analysis of the U.S. Department of Commerce, I determined that, in fact, seven of the eleven states that have introduced an income tax have had an increase in their per capita income when compared to the per capita income of the United States as a whole.  Moreover, while, as Laffer argued, gross state product did decrease for each of those states, the data for gross state product per capita can be read to indicate that the introduction of taxes had no significant effect on a state’s productivity.

For those of our readers who might enjoy playing around with the data, we have posted the underlying spreadsheets on which my article was based, as well as other spreadsheets that can be used to compare various economic statistics by state.  However, remember, as the article warns, that correlation does not imply causation.

Population and GDP By State

Per Capita Income By State

Per Capita Income by State (Inflation-Adjusted)

Unemployment By State

We will have a link to the article when it is published.

Say That Again: A Summary of AJACTLA

June 1, 2010

By David Shakow

If you haven’t memorized the 433 pages of the latest version of the American Jobs and Closing Tax Loopholes Act of 2010 (undoubtedly named to allow for the euphonious acronym, AJACTLA), you are denying yourself a unique treat.  (To get the true flavor, don’t forget the fifteen pages of amendments included with the House passage of the bill on May 28.)  We will allow others to give you a full rundown of the 206 sections of the bill and content ourselves with a summary of the highlights.

(more…)

Container Corp. v. Comm’r, 134 T.C. No. 5 (2010)

February 23, 2010

By David Shakow

In a decision that will not simplify the convoluted taxation of financial products, the Tax Court held, in Container Corp. v. Comm’r, 134 T.C. No. 5 (2010) that guarantee fees paid by a U.S. company to its Mexican parent were properly treated as non-U.S. source income and therefore not subject to U.S. withholding taxes. (For the text of the decision, see here.) Arguing that the guarantee fees were more akin to interest paid on a loan (which would be treated as U.S.-source income), the IRS analogized the guarantee payments to acceptance and confirmation commissions like those at issue in Bank of America v. United States, 680 F.2d 142 (Ct. Cl. 1982), which treated such commissions like interest. The Tax Court rejected the analogy, however, because the Mexican company in this case was simply augmenting the credit of its U.S. subsidiary, not becoming primarily liable for the underlying debt as in Bank of America. Though recognizing that its distinction between guarantee fees and acceptance commissions might be viewed as a distinction without a difference, the court nevertheless concluded that the provision of a guarantee was more akin to a service and therefore was properly sourced outside the United States.

The difficulty faced by the Tax Court in distinguishing between guarantee fees and acceptance commissions reflects the problems courts generally face when dealing with financial products, where equivalent economic arrangements can be structured through the use of instruments that produce different tax results. (For a classic example, the “put-call parity theorem,” which demonstrates the equivalence of owning a share of stock and the right to put it, on the one hand, and an option to buy the stock along with a riskless zero-coupon bond, on the other, see the following article the following article by Professor Knoll.) The court’s discussion of interest and financial products in this case may prove useful in analyzing the tax treatment of other financial products.


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