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Courts Split on Supervisory Approval Requirement for Tax Penalties

Since Chai v. Commissioner, an opinion by the US Court of Appeals for the Second Circuit subsequently followed by the US Tax Court in several opinions, there has been a substantial number of cases litigating issues involving supervisory approval of federal civil tax penalties. Two recent additions to that list include decisions from the Ninth and Eleventh Circuits, where both Courts departed from the Tax Court’s analysis and ruling on the issue. The disagreement centers on when approval must occur. (Some of our prior discussions on this topic are linked below.)

LAIDLAW’S AND THE NINTH CIRCUIT

In Laidlaw’s Harley-Davidson Sales, Inc. v. Commissioner, the Ninth Circuit, reversing the Tax Court’s ruling, applied a textualist approach and held that approval is required only before the assessment of a tax penalty and not before the Internal Revenue Service (IRS) communicates a proposed penalty to the taxpayer. The Court reasoned that the “language of [Internal Revenue Code (Code) section 6571(b)] provides no reason to conclude that an ‘initial determination’ is transformed into ‘something more like a final determination’ simply because the revenue agent who made the initial determination subsequently mailed a letter to the taxpayer describing it.” While the Court was “troubled” by the manner in which the IRS communicated the potential imposition of the penalty, it explained that a court’s role is to “apply the law as it is written, not to devise alternative language.” In reaching its decision, the Ninth Circuit disagreed with the position developed by the Tax Court in recent years.

KRONER AND THE ELEVENTH CIRCUIT

In Kroner v. Commissioner, the Eleventh Circuit followed Laidlaw’s Harley Davidson Sales and similarly concluded that the IRS satisfies Code Section 6751(b) so long as a supervisor approves the penalty before it is assessed. The Court explained that this was the best reading of the statute because (1) it is more consistent with the meaning of the phrase “initial determination of such assessment,” (2) it reflects the absence of any express timing requirement in the statute, and (3) it is a workable reading in the light of the statute’s purpose. The Court suggested that the IRS may be wise “to have a supervisor approve proposed tax penalties at an early juncture…but the text of the statute does not impose an earlier deadline.”

The Eleventh Circuit was explicit in its departure from Chai and Tax Court precedent, stating that “the Chai court missed an important aspect of the statute’s purpose: it is not just about bargaining, it is also a check on the imposition of erroneous penalties.” The Court also explained that “appropriate penalties should be assessed and collected. Chai’s analysis of these competing interests leaned heavily on the former to the detriment of the latter when justifying its departure from the statutory text.”

Practice Point: It remains to be seen whether this issue will make its way to the Supreme Court of the United States given the apparent circuit split on the issue as [...]

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IRS Appeals Will Not Consider Regulatory Invalidity and Subregulatory Procedural Invalidity Challenges

In Mayo Found. for Med. Educ. & Rsch. v. United States, 131 S.Ct. 704 (2011), the Supreme Court of the United States made clear that administrative law rules apply to tax guidance like they do to other federal agency guidance. Since Mayo, the Supreme Court and other courts have provided further guidance—both in the tax and non-tax contexts—regarding the proper analysis in determining the validity of, and deference to, regulatory guidance.

Over the past decade, the number of taxpayer challenges to guidance issued by the Internal Revenue Service (IRS), whether in the form of regulations or subregulatory guidance (i.e., revenue rulings, revenue procedures, notices and announcements), has increased significantly. These challenges have taken a variety of forms, such as regulatory invalidity under Chevron USA, Inc. v. NRDC, 467 U.S. 837 (1984) and procedural invalidity under the Administrative Procedure Act (APA). Some successful challenges to the validity of IRS guidance and the ability to challenge such guidance in a pre-enforcement context include CIC Servs., LLC v. IRS, 141 S.Ct. 1582 (2021); United States v. Home Concrete & Supply, LLC, 132 S.Ct. 1836 (2012); Mann Construction, Inc. v. Commissioner, 27 F. 4th 1138 (6th Cir. 2022); Good Fortune Shipping SA v. Commissioner, 897 F.3d 256 (2018) and Liberty Global, Inc. v. United States, No. 1:20-cv-03501-RBJ (D. Colo. 2022). Many other challenges are pending both at the administrative level and in court.

The IRS and the US Department of the Treasury (Treasury) have noticed the increase in challenges to its published guidance. One important change is the more detailed discussions in preambles to final regulations regarding comments received and how the IRS views and incorporates said comments. This is a welcome development, although sometimes a tortuous one for taxpayers who must wade through hundreds of pages of preambles in some regulation packages. Another change, and the subject of this post, is the IRS’s views on how to deal with such challenges during the administrative process.

A federal tax controversy can involve three levels of review: Examination, Appeals and litigation. At the Examination stage, revenue agents and other IRS personnel develop the facts and determine whether an adjustment is warranted. Importantly, “hazards of litigation” are not considered at the Examination level, meaning, issues are viewed as binary—in favor of the IRS or the taxpayer—and not negotiated as a percentage of the item. However, at the Appeals level, the Appeals team weighs “hazards of litigation” to determine whether a case can be settled by the parties. Hazards of litigation are also considered at the litigation level.

Validly promulgated tax regulations are approved at the highest levels of the IRS, Treasury generally carry the force and effect of law and are binding on taxpayers and the IRS. Subregulatory guidance is also approved at senior levels of the IRS and the Treasury. At the Examination level, the IRS will not entertain challenges to the validity of [...]

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Tax Court Relaxes COVID-19 Protocols

Courts have been relaxing their COVID-19 protocols over the past several months, and on August 23, 2022, the US Tax Court announced its latest position. In Administrative Order No. 2022-01, the Tax Court detailed new protocols for entry into the Washington, DC, courthouse, as well as in-person proceedings at all the locations in which it holds court.

As of August 29, 2022, court personnel and contractors will no longer be required to show a COVID-19 attestation form, a vaccination card or a negative COVID-19 test to enter the Washington, DC, courthouse. Instead, anyone entering will be required to self-certify whether they have or have been exposed to COVID-19. Additionally, individuals who test positive for COVID-19 within five days of entering the Washington, DC, courthouse are requested to notify the Tax Court.

Trial participants, witnesses and members of the public attending in-person proceedings must complete the COVID-19 self-certification requirement via QR code for entry into a Tax Court proceeding at any location. Additionally, entrants to both the Washington, DC, courthouse and Tax Court in-person proceedings at any location are requested to follow the current guidelines provided in the Court Standards and Protocols to Protect Public Health.

Practice Point: COVID-19’s effects on the administration of Tax Court proceedings lingers on more than two years after the outbreak. If you plan to attend a court proceeding in person, we suggest checking the Tax Court’s website in advance to ensure that you are in compliance with its procedures before showing up.




Courts Outline Boundaries of the Anti-Injunction Act Post-CIC Services

Since the Supreme Court of the United States’ decision in CIC Servs., LLC v. IRS was issued in May 2021, courts have grappled with how to apply the Anti-Injunction Act (AIA) in other contexts. The US Court of Appeals for the Eleventh Circuit recently affirmed the dismissal of a lawsuit under the AIA in Hancock County Land Acquisitions, LLC v. United States, while the Court of Appeals for the First Circuit recently held that the AIA does not prevent a challenge to the Internal Revenue Service’s (IRS) use of John Doe summons in Harper v. Rettig.

In July, we posted about a circuit split between the Sixth and Eleventh Circuits over claimed Administrative Procedure Act (APA) violations. As discussed below, these post-CIC Services decisions are shaping the boundaries of challenges based upon the APA and the AIA.

THE ELEVENTH CIRCUIT

The taxpayer in this case reported a $180 million deduction for a conservation easement on land it owned in Mississippi. The IRS audited the taxpayer and requested an extension of the statute of limitations on assessment in Internal Revenue Code (IRC) Section 6501. The taxpayer initially declined, but 11 months after the request it agreed to extend the limitations period. At that point, the IRS had almost finished with its examination, and the parties never executed the extension. The IRS issued a Notice of Final Partnership Administrative Adjustment (FPAA), and the taxpayer was unable to pursue an administrative resolution with the IRS Office of Independent Appeals (IRS Appeals). The taxpayer filed suit in US federal district court, arguing, among other things, that the IRS violated the APA when it did not send the case to IRS Appeals, resulting in the taxpayer being deprived of pre-litigation administrative resolution of its tax dispute. The IRS moved to dismiss the complaint for lack of subject matter jurisdiction, which the district court granted.

On appeal, the taxpayer argued that the suit was not barred by the AIA, citing CIC Services. The Eleventh Circuit, however, explained that the three considerations that led to that conclusion in CIC Services were the “same three considerations [that] lead to the opposite conclusion here.” The Court found that the taxpayer: (1) would not be subject to any costs separate and apart from the tax penalty from the FPAA; (2) was on the cusp of liability when it filed its suit and (3) would not suffer any criminal punishment by following the AIA’s “familiar pay-now-sue-later procedure.” The Court stated, “at its heart, this suit is a ‘dispute over taxes,’” and it was far from clear that under no circumstances could the IRS prevail on the merits of the taxpayer’s claim.

THE FIRST CIRCUIT

In 2013, the taxpayer in this case opened an account with a digital currency exchange. He deposited bitcoin into his account in 2013 and 2014. In 2015, he started to liquidate his Bitcoin holdings, which lasted until 2016 when his holdings were depleted. At that [...]

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Supreme Court Requests Government Response to Whirlpool’s Petition

We previously discussed the petition for writ of certiorari that was filed in the Supreme Court of the United States by Whirlpool Financial Corporation & Consolidated Subsidiaries and Whirlpool International Holdings S.a.r.l. & Consolidated Subsidiaries (collectively, Whirlpool); the amici briefs filed by The National Association of Manufacturers, the Silicon Valley Tax Directors Group, and three of the “Big 4” accounting firms in support of Whirlpool’s petition; and how the case is now up for consideration at the Supreme Court’s upcoming conference on September 28, 2022. We also noted how the US government waived its right to file a response to Whirlpool’s petition.

In the latest update regarding Whirlpool’s petition, in a minute entry on the docket sheet, the Supreme Court has requested that the government provide a response by September 19, 2022. That response will then be considered by the Supreme Court at its September 28 conference, absent a relisting of the matter for a later conference. We will continue to monitor further developments in Whirlpool’s case and provide any further updates as they are made available.




Huge Win for Refined Coal: DC Appeals Court Permits Tax Credits

On August 5, 2022, the US Court of Appeals for the District of Columbia Circuit upheld the US Tax Court’s bench opinion in favor of partners and investors in a refined coal business. The Internal Revenue Service (IRS) has consistently fought taxpayers’ attempts to claim a tax credit for refining coal despite a clear congressional mandate in Internal Revenue Code section 45(c)(7)(A). The IRS has repeatedly taken the position that the partnerships formed to utilize the tax credits generated by the refined coal business are not bona fide because the partnerships could never make an economic profit without the tax credits.

In Cross Refined Coal LLC, the IRS examined the partnership’s 2011 and 2012 tax years and disallowed $25.8 million of refined coal production tax credits and $25.7 million of claimed operating losses. The IRS argued that:

  • The partnership did not exist as a matter of fact.
  • The partnership was not, in substance, a partnership for federal income tax purposes because it was not formed to carry on a business or for the sharing of profits and losses from the production or sale of refined coal by its purported members/partners, but rather was created to facilitate the prohibited transaction of monetizing refined coal tax credits.
  • The transaction was entered into solely to purchase refined coal tax credits and other tax benefits.
  • Claimed expenses were not ordinary and necessary or credible expenses in connection with a trade or business or other activity engaged in for profit.

After a two-week trial involving several witnesses and thousands of exhibits, the Tax Court held that the partnership was legitimate because its partners made substantial contributions to the partnership, participated in its management and shared in its profits and losses. The IRS appealed to the DC Circuit.

In affirming the Tax Court, the DC Circuit held that the partners intended to form a partnership and had legitimate non-tax motives for the business. The Court diffused any concern that the partnership included tax benefits, explaining that “there was nothing untoward about seeking partners who could apply the refined-coal credits immediately, rather than carrying them forward to future tax years.” The Court also recognized that “Congress expressly provided for coal refiners to employ this investment strategy, for the tax code specifies how the credit must be divided when a refining facility has multiple owners.” The Court was not persuaded by the IRS’s concern that the partners did not enter the partnership to obtain a pre-tax profit: “[a]ccording to the Commissioner, Cross’s partners did not have the requisite intent to carry on a business together because Cross was not ‘undertaken for profit or for other legitimate nontax business purposes.’” The Court disagreed, explaining:

As a general matter, a partnership’s pursuit of after-tax profit can be legitimate business activity for partners to carry on together. This is especially true in the context of tax incentives, which exist precisely to encourage activity that would not otherwise be profitable.

The DC Circuit found [...]

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Amici Support Whirlpool’s Request for Supreme Court Review

As we previously discussed, toward the end of June Whirlpool Financial Corporation & Consolidated Subsidiaries and Whirlpool International Holdings S.a.r.l. & Consolidated Subsidiaries (collectively, Whirlpool) asked the Supreme Court of the United States to review the US Federal Circuit Court of Appeals for the Sixth Circuit’s decision that income earned by a Luxembourg controlled foreign corporation was foreign base company sales income (FBCSI) under the branch rule of Internal Revenue Code (IRC) section 954(d)(2) and taxable to the corporation as “subpart F income.” (For an excellent dissection of the Sixth Circuit’s decision, please see our colleagues’ article, “Implications of the Sixth Circuit’s Whirlpool Opinion.”)

Several amici recently filed briefs with the Supreme Court supporting Whirlpool. The docket sheet for the case, titled Whirlpool Financial Corp. et al., Petitioners, v. Commissioner of Internal Revenue, No. 22-9, is available here.

On August 3, 2022, the National Association of Manufacturers (NAM) submitted its brief, setting forth two arguments:

First, the Sixth Circuit applied an entirely novel interpretation—not found anywhere in the Code or Treasury regulations and not advanced by the agency nor adopted by the Tax Court—that conflicts with decades-old regulations promulgated contemporaneously with the underlying statute and at Congress’s express command in section 954(d)(2) itself.

 

Second, reliance on validly promulgated regulations—and therefore regulated parties’ ability to comply with the laws—is the bedrock of administrative law. If taxpayers must follow regulations or face the prospect of civil (and perhaps even criminal) penalties, then so too must the government be held to its binding, published actions.

On August 4, 2022, PricewaterhouseCoopers LLP, Deloitte Tax LLP and KPMG LLP (collectively, Accounting Firms) joined forces to bring the “exceptionally important” nature of the case to the Supreme Court’s attention. (The brief states that Ernst & Young LLP did not participate as amicus curiae because it is Whirlpool’s financial statement auditor.) In their brief, the Accounting Firms assert:

The Sixth Circuit’s disregard of the regulations in its attempt to interpret the requirements of the statute creates substantial uncertainty with respect to the efforts to comply with the Internal Revenue Code and the Amici who advise them. Review by this Court is necessary to reassure taxpayers that when Congress expressly conditions tax provisions on the issuance of Treasury Regulations, courts will take those regulations into account in interpreting the requirements of the Internal Revenue Code.

Also on August 4, a third brief was submitted by the Silicon Valley Tax Directors Group, the National Foreign Trade Council, the Information Technology Industry Council and TechNet. These amici assert:

This Court should alleviate [the] disparate treatment among taxpayers—or even the same taxpayer in different federal courts—by recognizing the importance of the clear statutory command that branch income “shall constitute” FBCSI only “under regulations prescribed by the Secretary [of the Treasury].” 26 U.S.C. § 954(d)(2). Restoring taxpayer reliance on those regulations is crucial for preserving Congress’s desired uniform scheme and [...]

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Sixth Circuit Denies Proceeds Regulation Rehearing Request, Sets Up a Circuit Split

The US Court of Appeals for the Sixth Circuit recently denied a taxpayer’s request for a rehearing en banc in Oakbrook Land Holdings, LLC v. Commissioner, No. 20-2117, leaving a highly contested conservation easement regulation in place and setting up a split between the Sixth and Eleventh Circuits.

In Oakbrook, the taxpayer argued that Treas. Reg. § 1.170A-14(g)(6)(ii), known as the “proceeds regulation,” was invalid because it did not satisfy the Administrative Procedure Act’s (APA) notice-and-comment rulemaking procedures. The regulation addresses how to allocate proceeds between donors and donees if an easement is judicially extinguished and the property is sold. In May 2020, the US Tax Court held that the regulation was “procedurally and substantively valid” under the APA. The Sixth Circuit agreed with the Tax Court, upholding the regulation.

The Sixth Circuit’s order issued July 6, 2022, indicated that neither the judges on the original panel nor any other judge on the full court requested a vote for a suggested rehearing. Last year, however, the Eleventh Circuit reached the opposite conclusion in Hewitt v. Commissioner, finding that the same regulation was invalid because it violated the APA. Thus, there is a clear circuit split on the issue.

Practice Point: The government did not seek a review of the Hewitt decision from the Supreme Court of the United States, so that ruling stands in the Eleventh Circuit. It remains to be seen whether the taxpayer in Oakbrook files a petition for a writ of certiorari to the Supreme Court. With a split between the Sixth and Eleventh Circuits, it is possible this conservation easement battle could be headed to the Supreme Court to determine the fate of the proceeds regulation.




Will the Supreme Court Rule on Whirlpool’s Subpart F Income Case?

A war is currently waging in the tax world over when courts should give deference to the US Department of the Treasury’s regulations. (We have written extensively on this subject here and here.) However, another potential war looms: Can courts disregard validly promulgated regulations relied on by taxpayers in favor of their own statutory interpretation? This question lies at the heart of the Whirlpool case.

On June 30, 2022, Whirlpool asked the Supreme Court of the United States to review the US Federal Circuit Court of Appeals for the Sixth Circuit’s decision that income earned by a Luxembourg controlled foreign corporation was foreign base company sales income (FBCSI) under the branch rule of Internal Revenue Code (IRC) section 954(d)(2) and taxable to the corporation as “subpart F income.”

During the trial phase of the litigation, the US Tax Court held that the branch income regulations (and the regulatory manufacturing exception therein), were validly promulgated and interpreted the regulations in a manner favorable to the Internal Revenue Service (IRS). (See 154 T.C. 142 (2020).)

Whirlpool appealed, and the Sixth Circuit affirmed in a 2-1 decision. (See 19 F.4th 944 (6th Cir. 2021).) Unlike the Tax Court, which reached its decision by harmoniously reading the statute and regulations, the Sixth Circuit ruled in favor of the IRS based solely on its interpretation of IRC section 954(d)(2), ignoring the relevant regulations and how the IRS and other courts have interpreted them. For an excellent dissection of the Court’s ruling, please see our colleagues’ article, “Implications of the Sixth Circuit’s Whirlpool Opinion.”

Whirlpool sought rehearing and rehearing en banc in the Sixth Circuit. The National Association of Manufacturers (NAM) and the Silicon Valley Tax Directors Group also filed amicus briefs supporting Whirlpool (McDermott acted as counsel for NAM in this capacity). However, the Sixth Circuit denied Whirlpool’s request for rehearing and rehearing en banc.

Now, Whirlpool is seeking the guidance of the Supreme Court, asking “whether or in what circumstances a statute that is expressly conditioned on regulations to be promulgated by an agency may be enforced without regard to such regulations.” In seeking certiorari, Whirlpool argues:

The divided Sixth Circuit below held that a tax statute explicitly conditioned on regulations to be promulgated by the Secretary of the Treasury delineating the income subject to taxation could be enforced without consulting the Secretary’s regulations, even though the regulations bound the Internal Revenue Service (“IRS”) and the IRS actually imposed tax based on the regulations. That decision directly contravenes [the Supreme] Court’s precedents and settled administrative-law principles. It upsets the reliance interests of taxpayers who, for more than 50 years, have relied on the regulations in structuring their operations. And this issue is outcome-determinative because — as the dissent below concluded — the income at issue is not taxable under a proper reading of the regulations (emphasis in original).

Whirlpool further argues that left unchecked, the Sixth Circuit’s decision [...]

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Late CDP Petitions May Still Be Entitled to Tax Court Review

In a unanimous decision in Boechler, P.C. v. Commissioner issued on April 21, 2022, the Supreme Court of the United States reversed the US Court of Appeals for the Eighth Circuit’s ruling (which affirmed the US Tax Court) and held that the 30-day time limit to file a petition with the Tax Court in a collection due process (CDP) case is a non-jurisdictional deadline subject to equitable tolling. The Supreme Court remanded the case to determine whether the taxpayer is entitled to equitable tolling.

The one-day-late showdown started in 2015, when the Internal Revenue Service (IRS) notified Boechler, P.C. (Boechler), a North Dakota law firm, of a tax discrepancy. Boechler did not respond, which triggered the assessment of an “intentional disregard” penalty along with a notice that the IRS intended to seize Boechler’s property to satisfy the penalty. Boechler requested a CDP hearing before the IRS Independent Office of Appeals (IRS Appeals), arguing that: (1) there was no discrepancy in its tax filings and (2) the penalty was excessive. IRS Appeals rejected these arguments and sustained the proposed levy. Boechler then had 30 days to file its Tax Court petition but missed the deadline by one day. The Tax Court dismissed the petition for lack of jurisdiction, holding that the 30-day filing deadline is jurisdictional and cannot be equitably tolled. The Eighth Circuit affirmed.

The Supreme Court granted certiorari. The US government argued that the deadline was jurisdictional and the Tax Court lacks the power to accept a tardy filing by applying the doctrine of equitable tolling. Boechler argued that equitable tolling applied, and the Tax Court had jurisdiction over its case. The Supreme Court, continuing a trend of distinguishing between claim processing rules and jurisdictional rules, agreed with Boechler.

Internal Revenue Code (Code) Section 6330(d)(1) states, “[t]he person may, within 30 days of a determination under this section, petition the Tax Court for review of such determination (and the Tax Court shall have jurisdiction with respect to such matter).” The Supreme Court explained that a procedural requirement is treated as jurisdictional “only if Congress ‘clearly states’ that it is” Arbaugh v. Y & H Corp., 546 U. S. 500, 515 (2006), although US Congress need not “incant magic words.” Sebelius v. Auburn Regional Medical Center, 568 U. S. 145, 153 (2013).

The Supreme Court clarified that the question was whether the statutory language limits the Tax Court’s jurisdiction to petitions filed within that timeframe. That answer turned on the meaning of the phrase “such matters.” The first independent clause explains what a taxpayer may do, (“The person may, within 30 days of a determination under this section, petition the Tax Court for review of such determination.”) However, the phrase “such matters” does not clearly mandate the jurisdictional reading and lacks clear antecedent. In addition, the Supreme Court also explained that Code Section 6330(d)(1) lacked in comparable clarity as to other tax provisions enacted around the same time. Finally, the Supreme [...]

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