Posted tagged ‘regulations’

Tax Court May Be The Forum Of Choice For Taxpayers Seeking To Challenge Treasury Regulations

June 23, 2011

By Dustin Covello & Phil Karter

As Tax Blawg readers know, after the Supreme Court’s Mayo decision adopted the deferential Chevron standard for determining the validity of Treasury regulations (instead of the less deferential National Muffler standard that taxpayers preferred), taxpayers and practitioners have speculated that seeking to invalidate a regulation may be a fool’s errand.   Since Mayo, many of the U.S. Circuit Court of Appeals (but not all) have shown a proclivity towards deference.  Extrapolating from these precedents, on the heels of the Mayo decision, it appears that the pendulum has swung heavily toward courts routinely deferring to Treasury regulations.  The question thus arises: is there a litigating forum where a challenge to regulatory deference might be more favorably received?  Surprisingly, the answer may be the U.S. Tax Court.

As reported in Tax Notes yesterday (subscription required), Judge Holmes of the Tax Court recently shared with practitioners a list of rarely utilized strategies for challenging the validity of Treasury regulations.   While the content of the Judge’s speech is useful information regardless of the litigating forum, the speech also reinforces a pattern that has emerged this year.  Despite the decision in Mayo, the Tax Court has exhibited a stubborn streak in resisting the routine deference towards Treasury Regulations that other courts now seem to prefer.

The Tax Court’s resistance to regulatory deference has been demonstrated in at least two opinions issued this year since Mayo.   In April, the Tax Court stuck to its guns in Carpenter Family Investments, LLC v. Commissioner by striking down for the second time Treasury regulations promulgated under section 6501(e), even though two Circuit Courts that deferred to the regulations did so while criticizing the Tax Court’s first opinion in Intermountain Insurance Services v. Commissioner.   Likewise, last month, in Pullins v. Commissioner, the Tax Court struck down regulations imposing an uncodified, two-year statute of limitations on innocent spouse cases under section 6015(f), even though the Seventh Circuit had reversed a 2009 opinion in which the Tax Court reached the same result.

Moreover, further reflecting the Tax Court’s general reluctance to defer to the IRS, Judge Holmes’ remarks were not limited solely to challenging the validity of Treasury Regulations.   In his speech, he also criticized so-called Auer deference, under which courts will generally defer to an agency’s interpretation of its own rules.   Although Auer has historically been accepted as well-settled, Judge Holmes cited a recent concurring opinion by Justice Scalia in Talk America, Inc. v. Michigan Bell Telephone Co., in which the Justice wrote that he would consider overturning Auer on separation-of-power grounds.

Challenging the validity of Treasury regulations has always been an uphill battle.   Nonetheless, Judge Holmes’ comments, coming on the heels of these recent decisions, demonstrates the Tax Court’s apparent reluctance to follow the trend of regulatory deference, which is important information to consider when choosing a litigating forum involving a regulatory challenge.

A final word of caution is that taxpayers would be well-advised to consider the law of the circuit to which an appeal of a favorable Tax Court result may lie, as reversals in cases such as Intermountain demonstrate.   Despite these concerns, the recent Tax Court developments suggest that, like any pendulum that has swung too far in one direction, the deference pendulum may eventually  swing back the other way.   Perhaps the Tax Court is where it is swinging back first.

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.

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Treasury Finalizes New Debt Modification Regulations

January 10, 2011

By Jonathan Prokup

On Friday, the Treasury Department issued final regulations under Code section 1001 relating to the modification of debt instruments.  In relevant part, the regulation provides that, following the modification of a debt instrument, the classification of the modified instrument as debt or equity for federal income tax purposes does not take into account any deterioration in the financial condition of the obligor.  Treas. Reg. § 1.1001-3(f)(7)(ii)(A).

The only public comment on the proposed regulations noted that the existing regulation does not contain rules for determining whether a modified debt instrument remains debt for federal tax purposes.  As a result, the comment expressed concern that the regulation could be read to suggest that it would apply only “to determine whether an exchange has occurred, and not the determination of the character of a new instrument resulting from a significant modification.”  The final regulations add language to the general rule of Treas. Reg. § 1001-3(b) to make clear that the new rules apply to determine whether (i) an exchange has occurred and (ii) retains its prior characterization as debt for federal tax purposes.

As we previously discussed, absent this rule, holders of the debt of troubled obligors might be less willing to restructure the debt because of the risk of the restructuring being treated as an exchange, and therefore a recognition event, for federal income tax purposes.  If any financial deterioration of the obligor were taken into account, that factor could increase the risk that the debt would be recharacterized as something else following the modification.  Thus, the proposed regulations were a welcome (if incomplete) step to facilitating modifications of the debts of troubled obligors.

The Schedule UTP Regulation: Is The IRS Gearing Up For Battle?

September 13, 2010

By Jonathan Prokup and Dustin Covello

Last week, the IRS issued a proposed regulation that would generally require corporations to attach Schedule UTP (Uncertain Tax Position Statement) to their returns.  The regulation effectively would give the IRS authority to require that the schedule be filed; but the issuance of the regulation raises an interesting question: is the IRS setting the stage to argue that the requirement to file Schedule UTP should be permitted on the basis of deference to the IRS’s regulatory authority?

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When Is Debt No Longer Debt? Treasury Proposes To Ease Debt-Modification Regulations

June 18, 2010

By Jonathan Prokup

Times are tough, and many troubled companies are facing the need to modify debts that were issued when times were better (and the companies were financially much stronger).  For companies that wish to modify their debts, and for investors that hold those debts, federal tax law imposes an unfortunate limitation.  An outstanding debt that undergoes a “significant modification” is treated as having been exchanged for a new instrument with the modified terms.  See Treas. Reg. § 1.1001-3.  As a result, holders of the debt will generally be required to recognize gain or loss on the deemed exchange of the debt and, in some instances, the issuer may be forced to recognize income as well.  Thus, the question of whether a modification will result in a deemed exchange of the debt for federal income tax purposes has the potential to complicate, or even derail, potentially beneficial debt modifications.

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A Four-Letter Word Causes The IRS Trouble

May 12, 2010

By Buck Buchanan

Last summer, the Ninth Circuit Court of Appeals handed the IRS a defeat that the IRS did not take lightly.  The Ninth Circuit ruled that an overstated basis, no matter how large, is simply not omitted income.  See Bakersfield Energy Partners, LP v. Commissioner , 568 F.3d 767 (2009).  The key to the decision is the definition of a four letter word, omit, which means “left out,” whereas an overstated basis by definition is stated on the return, i.e., not left out.  Without an omission of income, the three year statute of limitations applies, not the extended six year period.  The Ninth Circuit relied heavily upon a Supreme Court decision that came to the same conclusion.  Colony, Inc. v. Commissioner, 357 U.S. 28 (1958).

After Bakersfield, the IRS suffered a series of losses.  Not one to stand idly by, the IRS took matters into its own hands and seized upon a small opening left in the Ninth Circuit’s decision: “The IRS may have the authority to promulgate a reasonable reinterpretation of an ambiguous provision of the tax code, even if its interpretation runs contrary to the Supreme Court’s ‘opinion as to the best reading’ of the provision. . . . We do not.” Bakersfield, 568 F.3d at 778 (citations omitted).  With that, the Treasury Department issued Temp. Reg. §§ 301.6229(c)(2)-1T and 301.6501(e)-1T, which provided “an understated amount of gross income resulting from an overstatement of unrecovered cost or other basis constitutes an omission from gross income.”  With the new regulation in hand, the IRS went about attempting to overturn a series of unfavorable decisions.

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