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Tax Court Addresses “Issue of First Impression” Defense to Penalties

by | Aug 3, 2017 | ,

We previously posted on what we called the “issue of first impression” defense to penalties and the recent application of this defense by the United States Tax Court (Tax Court) in Peterson v. Commissioner, a TC Opinion. We noted that taxpayers may want to consider raising this defense in cases where the substantive issue is one for which there is no clear guidance from the courts or the Internal Revenue Service. Yesterday’s Memorandum Opinion by the Tax Court in Curtis Investment Co., LLC v. Commissioner, addressed the issue of first impression defense in the context of the taxpayer’s argument that it acted with reasonable cause and good faith in its tax reporting position related to certain Custom Adjustable Rate Debt Structure (CARDS) transactions. For the difference between TC and Memorandum Opinions, see here.

The Tax Court (and some appellate courts) has addressed the tax consequences of CARDS transactions in several cases, each time siding with the Internal Revenue Service (IRS). In its opinions in those other cases, the Tax Court has found that the CARDS transaction lacks economic substance. The court in Curtis Investment concluded that the CARDS transactions before it was essentially the same as the CARDS transactions in the other cases with only immaterial differences. Applying an economic substance analysis, the Tax Court held the taxpayer issue lacked a genuine profit motive and did not have a business purpose for entering into the CARDS transactions. (more…)



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Senate Attempts to Repeal Chevron Deference

by and | Jul 31, 2017 | , ,

In Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc. 467 US 837 (1984), the Supreme Court of the United States established a framework for assessing an agency’s interpretation of statutory provisions. First, a reviewing court must ask whether Congress “delegated authority to the agency generally to make rules carrying the force of law,” and whether the agency’s interpretation was promulgated under that authority. United States v. Mead Corporation, 533 US 218, 226–27 (2001). Delegation may be shown in a variety of ways, including “an agency’s power to engage in adjudication or notice-and-comment rulemaking, or by some other indication of a comparable congressional intent.” Id. at 227. If an agency has been delegated the requisite authority, the analysis is segmented into two steps.

Under step one, the reviewing court asks whether Congress has clearly spoken on the precise question at issue. See Chevron, 467 US at 842. If so, both the court and agency must follow the “unambiguously expressed intent of Congress,” and the inquiry ends. Id. at 842–43.

If the statute under review is ambiguous or silent, the reviewing court moves to step two: whether the agency’s interpretation is based on “a permissible construction of the statute.” Id. at 842. This inquiry asks whether the interpretation is reasonable and not “arbitrary, capricious, or manifestly contrary to the statute.” Chevron, 467 US at 843; see also Judulang v. Holder, 565 US 42, 53 n.7 (2011); Encino Motorcars, LLC v. Navarro, 579 US ____, 136 S. Ct. 2117, 2125 (2016). If the agency’s interpretation passes muster, then the agency’s interpretation is given Chevron deference, and afforded the force of law. The Chevron two-part analysis applies to tax regulations issued by the United States Department of the Treasury and the Internal Revenue Service. Mayo Foundation for Medical Education & Research v. United States, 562 US 44, 55 (2011). (more…)



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Tax Court Rejects IRS Reliance on “Cursory” Analysis in Revenue Ruling

by | Jul 19, 2017 | , ,

We have previously discussed, in March and October of 2016, the various levels of deference given to Internal Revenue Service (IRS) guidance, whether it is in published or private form. For revenue rulings, courts traditionally apply Skidmore deference, which essentially looks at the persuasiveness of the ruling. Under this standard, and the IRS’s position in its procedural regulations, if a ruling contains the same material facts and its analysis is persuasive, courts will generally defer to it.

The Tax Court’s recent opinion in Grecian Magnesite Mining, Industrial & Shipping Co., SA, v. Commissioner, 149 TC No. 3 (July 13, 2017), is a friendly reminder that just because a revenue ruling addresses the same material facts present in a taxpayer’s case does not automatically mean that courts will side with the IRS. In Grecian, a revenue ruling contained three fact patterns which were essentially the same as the taxpayer’s facts. The ruling held that gain realized by a foreign partner upon disposing of its interest in a United States partnership should be analyzed on an asset-by-asset basis, and that to the extent the partnership’s assets would give rise to effectively connected income (ECI) if sold by the partnership, the departing partner’s pro rata share of such gain should be treated as ECI. Despite this conclusion, the Tax Court rejected the IRS’s argument that the ruling was entitled to deference and required upholding the IRS’s deficiency determination. Rather, the court noted that the ruling’s discussions of the relevant partnership provisions was “cursory in the extreme” and it criticized the ruling’s treatment of the United States taxation of international transactions. As a result, the court declined to accord any deference to the ruling and ultimately found that the taxpayer’s position was correct as to the issue addressed in the ruling.

Practice Point: Although many revenue rulings contained detailed discussions and analysis of the tax laws, some are based on blanket statements of law that are not supported by relevant authorities. In these situations, taxpayers and their advisors should carefully consider whether a court would afford any deference to such a blanket statement.



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Courts Rejects Challenge to OVDP Transition Rules

by and | Jul 18, 2017 | , , ,

The Internal Revenue Service (IRS) currently offers non-compliant US taxpayers several different relief programs to report foreign assets and/or income to become compliant with US rules related to the disclosure of offshore income. See here for a link to the different options. The two main programs are the Offshore Voluntary Disclosure Program (OVDP) and the Streamlined Filing Compliance Procedures (SFCP). The IRS launched the OVDP in 2012 to enable a taxpayer with undisclosed foreign income or assets to settle most potential penalties he may be liable for through a lump sum payment of 27.5 percent of the highest aggregate value of the taxpayer’s undisclosed foreign assets for the voluntary disclosure period, which is the previous eight years. The OVDP replaced prior offshore voluntary disclosure programs and initiatives from 2009 and 2011. OVDP has a number of filing and payment requirements, including paying eight years’ worth of accuracy-based penalties. The IRS updated and revised the OVDP in 2014.

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Tracking Tax Guidance and Court Cases

by and | Jul 14, 2017 | , , ,

Oftentimes, taxpayers rely on various authorities in planning transactions and reporting them for tax purposes, as well as defending them during an Internal Revenue Service (IRS) audit, appeals or in litigation. These sources include authorities like the Internal Revenue Code, legislative history and other legislative materials, Treasury regulations and other IRS published guidance (e.g., revenue rulings, revenue procedures, notices, announcements), IRS private guidance (e.g., chief counsel advice, technical advice memoranda, private letter rulings, etc.), and case law. As we have discussed previously, these authorities are afforded different weight by courts and the IRS, and can serve different purposes in your matter.

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Are You Required to Disclose Supporting Legal Authorities During Discovery?

by and | Jun 30, 2017 | , , ,

Discovery in tax litigation can take many different forms, including informal discovery requests (in the US Tax Court), request for admissions, interrogatories and depositions. In addition to obtaining facts, litigants frequently want to know the legal authorities on which the other side intends to rely. Over the years, we have seen numerous requests, both during examinations and in litigation, where the Internal Revenue Service (IRS) requests a listing of the legal authorities supporting a taxpayer’s position.

Sometimes it is beneficial for a taxpayer to disclose those authorities. For example, in some IRS audits it may be worthwhile to point out to the IRS agent the applicable authority and cases that directly support the taxpayer’s position. However, once a case progresses to litigation, it is clear that the parties disagree and that simply pointing out relevant authorities will not help the IRS to concede the case. This raises the question of how to respond to such a request while in litigation.

The Tax Court recently addressed this issue in a pending case involving issues under Internal Revenue Code Section 482 (see here). The IRS issued interrogatories that requested information seeking to obtain the taxpayer’s legal arguments. The taxpayer objected on the grounds that this was inappropriate. The Tax Court, in an unpublished order, agreed:

Tax Court Rule 70(b) does not require a party to disclose the legal authorities on which he relies for his positions.  See Zaentz v. Commissioner, 73 T.C. 469, 477 (1970). Other courts have held that interrogatories requiring a party to disclose legal analyses and conclusions of law are impermissible. See, e.g., Perez v. KDE Equine, LLC, 2017 WL 56616 at *6 (W.D. Kentucky Jan. 4, 2017); In re Rail Freight Fuel Surcharge Antitrust Litigation, 281 F.R.D. 1, 11 (D.D.C. Nov. 17, 2011).

Practice Point:  Although this unpublished order technically reflects only the view of the issuing Judge, it is an important point that litigants should remember. There are numerous ways to determine an adversary’s legal position. Generally, however, discovery requests directly asking for an opponent’s supporting legal authorities are not an appropriate technique. Techniques to make that determination include: issuing requests for admissions relating to the elements of potential legal theories, filing a dispositive motion like summary judgment which will invoke a response from the other side, and discussing with your opponent whether the case should be submitted (in Tax Court) fully stipulated. And sometimes the most efficient way to get the information is to pick up the phone and just ask. Typically, litigants are wary of putting their legal theories down in writing and pinning themselves down early in a case. But most lawyers love to hear themselves talk!



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The Bruins Score! Court Rules Away from Home Meals Are 100 Percent Deductible

by and | Jun 28, 2017 | , ,

In a surprising decision, the US Tax Court (Tax Court) concluded that the pregame away-city meals provided to the Boston Bruins hockey team was not subject to the 50 percent deduction disallowance on the basis that the meals were both for the “convenience of the employer” and were provided at an “employer operated eating facility.” In Jacobs v. Commissioner, 148 TC No 24 (June 26, 2017), the court found that meals—consisting of dinner, breakfast, lunch and snacks—were served in a room provided without charge by the hotel and to all employees of the Bruins traveling to the games.

Most businesses are well aware of the 50 percent deduction disallowance provided in Internal Revenue Code (IRC) Section 274(n)(1), which applies to meals provided to executives or other employees traveling for the business purpose of the employer. “De-minimis” meals (those which are provided infrequently and low in value), however, are excepted from the 50 percent disallowance. Also exempt are those meals provided at employer-operated eating facilities, (e.g., the company cafeteria) and meeting the following requirements:

  • the facility is located on or near the business premises of the employer;
  • the revenue derived from the facility normally equals or exceeds the direct operating costs of the facility; and
  • the facility is available on substantially the same terms to each member of a group of employees that is defined under a reasonable classification which does not discriminate in favor of highly compensated employees.

IRC Section 119(a) allows an employee to exclude the value of any meals furnished by or on behalf of his employer if the meals are furnished on the employer’s business premise for the convenience of the employer. Generally, the expenses of IRC Section 119 meals can be used to satisfy the requirement that the revenue from the eating facility equal direct operating costs.

In Jacobs, the Tax Court concluded that the group meals served in the away-city hotel rooms provided at the hotels where the Bruins hockey team stayed for the games was an “employer operated eating facility,” which deems the rooms as the “eating facility” and “on the business premises of the employer” for purposes of the requirements. The rooms were also considered the business premises of the employer for purposes of the IRC Section 119 requirement. In light of its holding, the Tax Court did not need to address the taxpayer’s alternative argument that the meals were expenses for entertainment sold to customers under IRC Section 274(n)(2)(A).

Practice Point: The decision in Jacobs is seemingly expansive in permitting employers to deduct meals provided away from what has traditionally been considered an employer facility. The decision may provide an opportunity to employers to seek additional expense deductions.



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Tax Court Considering Requiring Notice of Non-Party Subpoenas

by | Jun 26, 2017 | , ,

We previously wrote about the lack of a US Tax Court (Tax Court) rule requiring notice to other parties before service of non-party subpoenas for the production of documents, information, or tangible things and inconsistent practices for Judges at the Tax Court. See here and here. To recap, Tax Court Rule 147 allows a party to issue a subpoena to a non-party but does not require that prior notice be given to the other side of the issuance. Prior notice is required under the Federal Rules of Civil Procedure, which govern federal cases before the US district courts. As previously discussed, this absence of a Tax Court rule has led to inconsistent orders from the Tax Court on the subject.

Change may be coming soon, according to comments from Tax Court Chief Judge Marvel on June 16, 2017 at the New York University School of Professional Studies Tax Controversy Forum. Judge Marvel indicated that the Tax Court is considering amendments to Tax Court Rule 147 to conform to the Federal Rules of Civil Procedure. This would be a welcome development for taxpayers, as the Internal Revenue Service (IRS) would no longer be able to issue subpoenas and gather information from non-parties without a taxpayer’s knowledge and access to the same materials.

Practice Point: The Tax Court has not indicated when the next amendments to its Rules will be released. Until that time, taxpayers in litigation should not expect that the IRS will provide notice of subpoenas issued to non-parties. As we have pointed out before, taxpayers should routinely and regularly issue discovery requests on the IRS seeking: (1) a list of all third-party contacts, including the documents sent and received; (2) copies of all subpoenas, including a copy of all documents sent and received; and (3) a list of the dates on which the third-party contacts occurred, including phone calls and meetings. These requests should be made at the beginning of every case, and it should be stated that the requests are continuing in nature.



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Former Tax Court Judge Diane L. Kroupa Sentenced in Connection with Tax Evasion Matter

by | Jun 22, 2017 | ,

We have previously blogged on the criminal tax proceedings related to former US Tax Court Judge Kroupa (see here and here). In October 2016, Judge Kroupa pleaded guilty to multiple tax criminal charges related to her tax returns and interactions with the Internal Revenue Service. Based on sentencing guidelines, the recommended sentence was between 30‒37 months. Judge Kroupa and the government submitted filings on the appropriate sentence, in which Judge Kroupa provided detailed reasons why she believed the court should impose a sentence of 20 months imprisonment. These filings can be found here and here. According to a report in today’s BNA Daily Tax Report, the court sentenced Judge Kroupa to 34 months in prison and ordered her to pay $457,000 in restitution, which is owed jointly with her former husband. She was also sentenced to three years of supervised release. Judge Kroupa’s former husband was sentenced to 24 months in prison and one year of supervised release.



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The “Issue of First Impression” Defense to Penalties

by | Jun 14, 2017 | ,

The Internal Revenue Code (Code) contains various provisions regarding the imposition of penalties and additions to tax. The accuracy-related penalty under section 6662(a), which imposes a penalty equal to 20 percent of the amount of any understatement of tax, is commonly asserted on the grounds that the taxpayer was negligent, disregarded rules or regulations, or had a substantial understatement of tax. Over the years, the Internal Revenue Service (IRS) has become increasingly aggressive in asserting penalties and generally requires that taxpayers affirmatively demonstrate why penalties should not apply, as opposed to the IRS first developing the necessary facts to support the imposition of penalties.

There are many different defenses available to taxpayers depending on the type and grounds upon which the penalty is asserted. These defenses include the reasonable basis and adequate disclosure defense, the substantial authority defense, and the reasonable cause defense.

Another defense available to taxpayers is what we will refer to as the “issue of first impression” defense. The Tax Court’s recent opinion in Peterson v. Commissioner, 148 T.C. No. 22, reconfirms the availability of this defense. In that case, the substantive issue was the application of section 267(a) to employers and employee stock ownership plan (ESOP) participants. The court, in a published T.C. opinion (see here for our prior discussion of the types of Tax Court opinions) held in the IRS’s favor on the substantive issue but rejected the IRS’s assertion of an accuracy-related penalty for a substantial understatement of tax on the ground that it had previously declined to impose a penalty in situations where the issue was one not previously considered by the Tax Court and the statutory language was not entirely clear.

The Tax Court’s opinion in Peterson is consistent with prior opinions by the court in situations involving the assertion of penalties in cases of first impression. In Williams v. Commissioner, 123 T.C. 144 (2004), for instance, the substantive issue was whether filing bankruptcy alters the normal Subchapter S rules for allocating and deducting certain losses. The Tax Court agreed with the IRS’s position, but it declined to impose the accuracy-related penalty because the case was an issue of first impression with no clear authority to guide the taxpayer. The court found that the taxpayer made a reasonable attempt to comply with the code and that the position was reasonably debatable.

Similarly, in Hitchens v. Commissioner, 103 T.C. 711 (1994), the court addressed, for the first time, an issue related to the computation of a taxpayer’s basis in an entity. Despite holding for the IRS, the court rejected the accuracy-related penalty. It stated “[w]e have specifically refused to impose additions to tax for negligence, etc., where it appeared that the issue was one not previously considered by the Court and the statutory language was not entirely clear.” Other cases are in accord. See Braddock v. Commissioner, 95 T.C. 639, 645 (1990) (“as we have previously noted, this issue has never before, as far as [...]

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