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Whirlpool Update: New Filings and Distribution for Supreme Court Conference

On November 2, 2022, the Supreme Court of the United States announced that the case of Whirlpool Financial Corp., et al., Petitioners v. Commissioner of Internal Revenue, No. 22-9, has been distributed for consideration at its upcoming conference on November 18, 2022. Meaning, we should have an answer in the next few weeks as to whether the Supreme Court will hear the case.

The Supreme Court’s distribution for the conference follows the government’s brief, submitted on October 19, 2022, in opposition to Whirlpool’s petition for a writ of certiorari.

In its brief, the government summarizes its position as follows:

Petitioners contend (Pet. 17) that 26 U.S.C. 954(d)(2) is “conditioned on the promulgation of regulations” by the Treasury Department and thus may not “be enforced without regard to such regulations.” But as the court of appeals correctly held, Section 954(d)(2)’s text itself establishes clear “conditions” and “consequences,” Pet. App. 12a, and when applied to this case, that text “mandate[s]” that the income at issue is FBCSI, id. at 18a. The phrase “‘under regulations prescribed by the Secretary’” delegates to the Treasury Department authority to “implement the statute’s commands,” but not to “vary from them,” ibid., so the court permissibly declined to articulate a separate rationale in this case based on the implementing regulations. Petitioners concede (Pet. 33) that the decision below does not conflict with that of any other court of appeals. Nor does it conflict with this Court’s precedent because petitioners’ cited cases involved meaningfully distinct statutory schemes. And resolving the question presented lacks practical importance because the Treasury Department’s former regulations would dictate the same result as the statutory text, and the revisions that were made to the regulations in 2008 removed any potential doubt about that result. This Court’s review is unwarranted.

The government’s position is an interesting one. It seems to accept that a court is free to ignore regulations relied on by the public if the court determines that the government’s position is supported by the statutory language and the statute is not entirely conditioned on the operation of a regulation. Additionally, the government believes here that US Congress did not entirely condition operation of Internal Revenue Code (Code) Section 954(d)(2) on regulations.

Perhaps sensing the difficulty in prevailing on this argument, the government (similar to what it did in the rehearing proceedings in the US Court of Appeals for the Sixth Circuit) seeks to limit Whirlpool to the specific statute at issue. However, this ignores the fact that the same or substantially the same language is used in other Code provisions, making it difficult to limit the government’s argument to Code Section 954(d)(2).

In another attempt to discourage review, the government essentially argues that the substantive issue is an issue of first-and-last impression because the regulations at issue were amended for tax years subsequent to Whirlpool’s. Again, this ignores the fact that Whirlpool involves important administrative law issues that will remain regardless of the amendment.

Finally, [...]

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IRS Changes Position on Approval for Assertion of Codified Economic Substance Doctrine

In March 2010, Congress codified the economic substance doctrine in Internal Revenue Code (Code) Section 7701(o). The codification clarified that a conjunctive analysis applies in determining if the doctrine applies. The codified economic substance doctrine applies when a transaction does not have economic substance or lacks a business purpose. When the doctrine applies, a taxpayer is subject to a 20% strict liability penalty (40% in the case of undisclosed transactions) on any underpayment attributable to the disallowed tax benefit claimed.

Congress acknowledged that the codified economic substance doctrine should be applied sparingly, and the Joint Committee on Taxation, in a report issued prior to the enactment of the doctrine, provided detailed guidance on when the doctrine should apply. The Internal Revenue Service (IRS) issued guidance shortly after the codification acknowledging these points. The IRS also put in place detailed procedures for examiners to follow in determining whether to assert the codified economic substance doctrine.

One of the procedures put in place was the approval by the Director, Field Operation before the codified economic substance doctrine could be formally asserted. An approval request was to be made after consultation with the revenue agent’s manager and local counsel. Additionally, taxpayers were to be provided “the opportunity to explain their position.”

On April 22, 2022, the IRS’s Large Business & International (LB&I) Division issued a memorandum—LB&I-04-0422-0014—to all LB&I and Small Business/Self Employed examination employees (Updated Guidance). The Updated Guidance removes the requirement to obtain executive approval before asserting the codified economic substance doctrine. The Updated Guidance states that this change aligns penalties for lack of economic substance with other assessable penalties which do not require executive approval. However, the changes do not remove the supervisory approval requirement under Code Section 6751.

In connection with the Updated Guidance, revisions are being made to the relevant provisions of the Internal Revenue Manual (IRM). The IRM revisions eliminate some of the considerations previously set forth in the four-step process that revenue agents were required to undertake in determining whether the doctrine should be applied.

Practice Points: Although the Updated Guidance has no impact on the substance of the codified economic substance doctrine itself, the change is disappointing news. As a result of the relaxed rules for the doctrine’s assertion, taxpayers can reasonably assume that the doctrine may more frequently be asserted on audit. Thus, it is now even more important to properly document transactions to demonstrate they have sufficient economic substance and a business purpose.




IRS Announces Nonacquiescence in Mayo Tax Regulation Invalidity Holding

We previously wrote here and here about decisions made by the District Court of Minnesota and the US Court of Appeals for the Eighth Circuit in Mayo Clinic v. United States regarding challenges to the validity of certain Treasury Regulations promulgated under Internal Revenue Code (Code) Section 170. In that case, the Eighth Circuit held for the taxpayer in part and the government in part and remanded to the district court to further develop the record and address certain issues.

The Internal Revenue Service (IRS) recently announced in an Action on Decision (AOD) that it will not acquiesce in the Eighth Circuit’s holding, which invalidated Treas. Reg. § 1.170A-9(c)(1)’s requirement that the primary function of an education organization described in Code Section 170(b)(1)(A)(ii) must be the presentation of formal instruction. This means that in all cases not appealable to the Eighth Circuit, the IRS will not follow this holding and will continue to litigate the issue.

The IRS’s policy is to announce at an early date whether it will follow the holdings in certain cases, and it does so by making an announcement in an AOD. A nonacquiescence is not binding on courts or the taxpayers but merely signals the IRS’s position that it disagrees with a court decision. (Sometimes the IRS will acquiesce in a decision.) Given that an AOD is published in the Internal Revenue Bulletin, it could be argued that the IRS’s action constitutes published guidance taxpayers can rely on. The IRS’s list of AODs, with links to each action, can be found here.




Does Latest IRS Guidance Signal New Firm Stance on Research Credit Refund Claims?

On October 15, 2021, the Internal Revenue Service (IRS) issued a press release related to required information for valid research credit refund claims. The press release contains a link to a memorandum by two IRS employees, which will be used to evaluate such claims, and states that there will be a grace period (until January 10, 2022) before such information will be required to be included with timely filed research credit refund claims.

The guidance referred to in the press release is from the IRS’s Office of the Chief Counsel, Memorandum 20214101F (the IRS Research Memo) dated September 17, 2021, which focuses on administrative claims for refunds respect to the Internal Revenue Code (IRS) section 41 research credit.

First, we recommend reviewing the IRS Research Memo because it does a good job explaining the necessary elements to claim the credit. Second, the IRS Research Memo is a good reminder that the first requirement is to file a refund claim that is sufficiently detailed in order to give the IRS notice on both the technical and factual basis of the refund claim. In the context of the IRC Section 41 credit, the IRS Research Memo provides the following as minimum requirements for a refund claim:

  • Identify all the business components to which the IRC Section 41 research credit claim relates for the year for which a refund is sought.
  • For each business component:
    • Identify all research activities performed
    • Identify all individuals who performed each research activity
    • Identify all the information each individual sought to discover
  • Provide the total qualified employee wage expenses, total qualified supply expenses and total qualified contract research expenses for the claim year (this may be done using Form 6765, Credit for Increasing Research Activities).
  • The refund claim must be signed under penalties of perjury attesting to the veracity of the facts and information stated therein.
  • Supporting facts should be in the form of a written statement and merely incorporated by reference to documents attached to the claim.
  • The refund claim must be filed within the period of limitations stated in IRC Section 6511. Typically, taxpayers must file a valid claim within three years of the date Form 1040 or Form 1120 was filed or two years from the time the tax was paid—whichever period expires later.

Importantly, the IRS Research Memo does not advise taxpayers on how much information the IRS believes is sufficient to make a valid claim for refund. The IRS Research Memo does, however, highlight some recent court decisions where taxpayers were denied a refund because they did not include sufficient facts in their IRC Section 41 refund claim. In those cases, the courts ruled that the refund claims were defective and untimely.

Practice Point: The IRS Research Memo is a good reminder that when it comes to refund claims, generally, more description and detail is better. Interestingly, if the taxpayer had claimed a research credit on the original return, there would be [...]

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Infrastructure Bill Provision Expands Cryptocurrency Reporting Requirements

On August 1, 2021, the US Senate unveiled the draft text of the Infrastructure Investment and Jobs Act (Bill), a highly anticipated $1 trillion infrastructure package negotiated by the White House and a bipartisan group of senators. As discussed below, the Bill includes a provision (Section 80603) that, if enacted in its current form, would amend the Internal Revenue Code (Code) to extend certain reporting requirements for transactions involving digital assets, including cryptocurrencies such as Bitcoin and Ether and other forms of digital tokens. The provision, which would generally go into effect on January 1, 2023, is intended to address a “tax gap” resulting from the underreporting of cryptocurrency transactions.

BROKER REPORTING

Code Section 6045 generally imposes reporting requirements on “every person doing business as a broker” with respect to sales affected by the broker on behalf of its clients. Under current law, such reporting is currently limited to sales of corporate stock, interests in trusts and partnerships, debt obligations, certain commodities and various associated derivatives. Pursuant to regulations, such sales are reported by the broker on Form 1099-B and the information required to be reported includes identifying information about the taxpayer and the property sold, the sale date and gross proceeds of the sale—and only with respect to the sale of a “covered security,” the adjusted basis of the property sold and the character of the gain or loss on the sale (i.e., long- or short-term capital gain).

For purposes of 1099-B reporting, a “broker” is defined to include a “dealer, a barter exchange, and any other person who (for a consideration) regularly acts as a middleman with respect to property or services.” A typical example of a broker subject to 1099-B reporting is a brokerage firm that facilitates transactions for customers in stocks, bonds and/or commodities.

The Bill expands the definition of a broker to include “any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.” Unless otherwise provided by the US Department of the Treasury’s regulations, a “digital asset” means “any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by [Treasury].” A cryptocurrency exchange would be considered a broker under this language.

The “basis” reporting under Section 6045 only applies to “covered securities.” Under current law, the term covered securities generally includes corporate stock shares, debt obligations, certain designated commodities (and derivatives thereof) and other financial instruments. The Bill would expand the definition of covered securities to include any “digital asset.” Accordingly, brokers subject to Section 6045 will be required to report the adjusted basis and the character of the gain or loss upon the sale of digital assets, including utility tokens, stablecoins and asset-backed tokens.

BROKER-TO-BROKER AND BROKER-TO-NON-BROKER TRANSFER REPORTING

Under current law, Code Section 6045A imposes additional reporting requirements that are generally applicable to the transfer of covered securities by one broker to another. Specifically, the transferor broker must [...]

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Eighth Circuit Holds the Mayo in Tax Regulation Invalidity Case

In the latest tax regulation deference case, the Eighth Circuit provided guidance to taxpayers and tax practitioners on the “analytical path” to resolve the question of whether a tax regulation is a valid interpretation of the Internal Revenue Code. The court held that the regulation was invalid in part because it unreasonably added conditions to the statutory requirements for qualified educational organizations, however, it was valid as to its interpretation regarding the permissible scope of the taxpayer’s activities to fit within the applicable statute. The opinion is noteworthy for its detailed examination of statutory and legislative history, judicial interpretations and agency position during legislation in its analysis of Congress’ intent.

Deference is one topic that captivates many, and tax cases referencing Chevron, Skidmore and Auer (and more recently Kisor) always grab attention. The latest deference case in the tax area is Mayo Clinic v. United States, No. 19-3189 (8th Cir. May 13, 2021). For some background on deference, including the district court proceedings in the Mayo Clinic case, see here.

In the Mayo Clinic case, the question was whether the taxpayer was a “qualified organization” exempted from paying unrelated business income tax (UBIT) on unrelated debt-financed income under Internal Revenue Code (Code) Section 514(c)(9)(C)(i). Answering this question required determining whether the taxpayer was an “educational organization which normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activity are regularly carried on” within the meaning of Code Section 170(b)(1)(A)(ii). Relying in part on Treasury Regulation Section 1.170A-9(c)(1), the government asserted that the taxpayer was not a qualified organization because it was not an educational organization because its primary function was not the presentation of formal instruction (primary-function requirement) and its noneducational activities were not merely incidental to the educational activities (merely-incidental requirement). The district court – Mayo Clinic v. United States, 412 F.Supp.3d 1038 (D. Minn. 2019) – held in favor of the taxpayer and invalidated the regulation, holding that the primary-function requirement and the merely-incidental requirement were not intended by Congress to be included in the statute. The Eighth Circuit reversed and remanded the decision. Implementing the longstanding two-pronged deference test under Chevron U.S.A. Inc. v. NRDC, 467 U.S. 837 (1984) and acknowledging recent precedent in Kisor v. Wilkie, 139 S.Ct. 2400 (2019), the Mayo Clinic court emphasized that the question before it was whether the government “stayed within the bounds of its statutory authority.” To answer this question, the court stated that to determine whether the statute was unambiguous required examining the statutory history and applying traditional tools of statutory construction. This led the Eighth Circuit to trace the evolution of the Code over more than a century, focusing on changes to statutory language, legislative history, agency positions during the legislative process and judicial interpretations of the law.

Based on this exhaustive analysis of the evolution of [...]

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IRS Issues Practice Unit on Section 965 Transition Tax

One of the most pressing audit issues for large taxpayers today centers on the Internal Revenue Code (Code) Section 965 transition tax. The Internal Revenue Service (IRS) has designated Code Section 965 as a campaign issue and is actively auditing taxpayers’ transition tax calculations and positions, along with other tax reform items. The stakes are high, particularly given the potential to pay this tax over a period of eight years.

On March 23, 2021, the IRS released a Practice Unit that provides an overview of the Code Section 965 transition tax with references to relevant resources. Unfortunately, unlike some other Practice Units, guidance is not provided as to the type of information revenue agents should be requesting from taxpayers.

Practice Point: Practice Units are presentation-type materials compiled by the IRS as a means for collaborating and sharing knowledge among IRS employees. They provide helpful guidance to revenue agents in the form of an overview of the law in a specific area, examination tips and guidance and references to relevant resources. Although the Code Section 965 transition tax Practice Unit does not provide insights into the types of questions and information that revenue agents may seek on audit, it is still useful for taxpayers to review to understand the IRS’s perspective in this area.




The Tax Impact of Recent Federal Actions Relating to COVID-19

On March 13, 2020, President Trump signed a Proclamation on Declaring a National Emergency Concerning the Novel Coronavirus Disease (COVID-19) Outbreak under the Robert T. Stafford Disaster Relief and Emergency Assistance Act (the “Stafford Act”).

By invoking the Stafford Act, the President provides the Internal Revenue Service (IRS) and US Department of the Treasury (the “Treasury”) significant authority to offer tax relief to those in federally designated disaster areas. While it is not uncommon for a state or locality to be designated as an emergency or disaster area, the severity of the COVID-19 outbreak has required a national response. The President’s declaration has led the Federal Emergency Management Agency (FEMA) to declare an emergency in every state, territory and certain tribal lands. A list of each declaration is available on FEMA’s website and will be updated as more specific forms of relief are authorized.

Access the full article.




Court Rules That Wind Farm Did Not Provide Proof of Development Fee to Receive 1603 Cash Grant

On June 20, 2019, the United States Court of Federal Claims published its long-awaited opinion in California Ridge Wind Energy, LLC v. United StatesNo. 14-250 C. The opinion addressed how taxpayers engaging in related party transactions may appropriately determine the cost basis with respect to a wind energy project under the Internal Revenue Code (IRC). Central to the case was whether the taxpayer was allowed to include a $50 million development fee paid by a project entity to a related developer in the cost basis of a wind project for purposes of calculating the cash grant under Section 1603 of the American Recovery and Reinvestment Tax Act of 2009 (Section 1603). Section 1603 allowed taxpayers to take a cash grant in lieu of the production tax credit of up to 30% of the eligible cost basis of a wind project. The eligible cost basis under Section 1603 is determined in the same manner as under Section 45 for purposes of the investment tax credit (ITC). The Justice Department disagreed with the taxpayer’s position that the development fee should be included in the cost basis for calculating the Section 1603 cash grant. The Justice Department argued that the development fee was a “sham.”

The court agreed, and held for the government. The court’s opinion focused on the taxpayer’s failure to provide evidence that the payment of the development fee had “economic substance.” Indeed, the court was troubled that none of the taxpayer’s witnesses could explain what was actually done to earn the $50 million development fee. Other than a three‑page development agreement and the taxpayer’s bank statements identifying the wire transfers for payment of the development fee, which started and ended with the same entity, the court found that the taxpayer provided no other factual evidence to support the payment of the fee. Indeed, the court pointed to the taxpayer’s trial testimony, which the court found lacked the specificity needed to support the development fee. Because the taxpayer failed to carry its burden of proof and persuasion, the court concluded that the taxpayer was not entitled to include the $50 million development fee in the cost basis of the wind project for purposes of computing the Section 1603 cash grant.

Importantly, the court did not, however, rule that a development fee paid to a related party is not permitted to be included in the cost basis of a facility for purposes of determining the Section 1603 cash grant. Instead, the court simply ruled that the taxpayer failed to provide it with sufficient proof that in substance the taxpayer performed development services for which a development fee is appropriately considered part of the cost basis of a facility for purposes of determining the Section 1603 cash grant.

Practice Point: In court, the plaintiff has the burden of proving its entitlement to the relief sought. Before filing a case, it’s best to make sure that you have all of the evidence you need to prove your case. Without substantial and [...]

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A Notice of Deficiency Is Not Set in Stone

A recent case decided by the United States Court of Appeals of the Tenth Circuit reminds taxpayers to be aware that the Internal Revenue Service (IRS) is not necessarily locked in to the positions and arguments stated in the Notice of Deficiency. In particular, the IRS is allowed to revise penalty determinations, or to make penalty determinations for the first time, during litigation in the Tax Court, notwithstanding any arguably inconsistent determination in the Notice of Deficiency.

In Roth v. Commissioner, 123 AFTR.2d 2019-1676 (10th Cir. 2019) , the taxpayers owned 40 acres of land in Prowers County, Colorado. In 2007, the taxpayers donated to the Colorado Natural Land Trust a conservation easement, which prohibited them from mining gravel upon the land. The taxpayers valued the easement at $970,000 and claimed charitable contribution deductions with respect to this amount on their 2007 and 2008 income tax returns.

The IRS examined the position, and determined that the easement was worth only $40,000. The revaluation resulted in underpayments of tax. The IRS revenue agent assigned to the case imposed an enhanced 40% gross valuation misstatement penalty pursuant to Internal Revenue Code (IRC) section 6662(h), because the claimed value of the easement had exceeded 200% of its actual value. The 40% penalty was approved on IRS administrative review, but due to an alleged clerical error, the Notice of Deficiency sent to the taxpayers listed only the standard 20% accuracy-related penalty under IRC section 6662(a).

The taxpayers filed a Petition in the US Tax Court. In its Answer, the IRS reasserted the 40% penalty. The taxpayers challenged the imposition of the enhanced penalty, citing IRC section 6751(b), which provides that a penalty can only be assessed pursuant to an approved “initial determination.” The taxpayers argued that the Notice of Deficiency was the “initial determination,” and because the enhanced penalty was not stated in the Notice of Deficiency, the IRS did not have the authority to impose a penalty in excess of the amount indicated thereon. The Tax Court ruled in favor of the IRS, considering itself bound by its decision Greav v. Commissioner (Graev III), 149 T.C. 485 (2017), which allows the IRS to assert additional penalties in an Answer to a taxpayer’s Tax Court petition.

The Tenth Circuit affirmed the Tax Court’s ruling. The Tenth Circuit rejected the taxpayers’ argument that the “initial determination” of a penalty was the amount shown on a Notice of Deficiency. The Tenth Circuit noted that IRC section 6212(a) provides that the IRS is authorized to send a Notice of Deficiency after having determined a tax deficiency, suggesting that the “initial determination” of a tax deficiency or penalty can occur prior to the sending of a Notice of Deficiency. The Tenth Circuit concluded that the 40% penalty determined by the IRS revenue agent was the “initial determination” for purposes of IRC section 6751(b).

The Tenth Circuit also cited Graev III for the proposition that an IRC section 6751(b) initial determination can be made by an IRS attorney in [...]

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