Kisor v. Wilkie
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Eighth Circuit Applies Subjective Standard to Reasonable Basis Penalty Defense

On April 24, 2020, the US Court of Appeals for the Eighth Circuit published its opinion in Wells Fargo & Co. v. United States, No. 17-3578, affirming a district court’s holdings that the taxpayer was not entitled to certain foreign tax credits and was liable for the negligence penalty for claiming the credits. Much has been written about the substantive issue, which we will not discuss here. Instead, we focus on the Eighth Circuit’s divided analysis relating to the reasonable basis defense to the negligence penalty.

In Wells Fargo, the taxpayer relied solely on the reasonable basis defense to the government’s assertion of penalties. Under Internal Revenue Code (IRC) section 6662(b)(1), a taxpayer is liable for penalty of 20% of an underpayment of its taxes attributable to its “negligence.” Various defenses are potentially applicable to the negligence penalty, which we recently discussed in detail here. One such defense is if the taxpayer can show it had a “reasonable basis” for its position. Under Treas. Reg. § 1.6662-3(b), this defense applies if the taxpayer’s return position was “reasonably based on” certain authorities specified in the regulations.

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Supreme Court Tackles Tax-Related Cases

The United States Supreme Court has picked up the pace this week, already issuing eight regular opinions and four opinions relating to orders as of today. We discuss the tax-related items here.

In Rodriguez v. FDIC, the question was how to decide which member of a consolidated group of corporations is entitled to a tax refund. The Internal Revenue Service (IRS) issued a refund to the designated agent of an affiliated group, but the dispute centered on how that refund should be distributed among the group’s members. Some courts have looked at state law to resolve the distribution issue while others crafted a federal common law rule providing that, in the absence of an unambiguous tax allocation agreement, the refund belongs to the group member responsible for the losses that led to the refund. The Supreme Court rejected the latter common law rule, finding that it was not a legitimate exercise of federal common lawmaking. In reaching its decision, the Court noted that federal judges may craft such types of rules only in limited areas and it must be “necessary to protect uniquely federal interest.” The Court, however, did not decide who, in the case before it, was entitled to the refund, but remanded the case for further proceedings.

In Baldwin v. United States, Justice Thomas dissented from the denial of certiorari in a case asking the Court to reconsider National Cable & Telecommunications Assn. v. Brand X Internet Services, 545 U.S. 967 (2005). We previously discussed Baldwin here, in which the US Court of Appeals for the Ninth Circuit held that, under Brand X, its prior construction of Internal Revenue Code section 7502 did not preclude a different interpretation by the IRS because the prior construction was based on filling a statutory gap in a reasonable manner. Because the IRS’s subsequent regulatory interpretation was reasonable (in light of ambiguous statutory language), the Ninth Circuit effectively overruled its prior precedent and accepted the IRS’s subsequent contrary interpretation.

Justice Thomas, the author of Brand X, had a change of heart and wrote that his dissent that the prior opinion appeared to be inconsistent with the Constitution, the Administrative Procedure Act (APA) and traditional tools of statutory construction. In his dissent, he called into question the continuing viability of Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984), expressing the view that Chevron “is in serious tension with the Constitution, the APA, and over 100 years of judicial decisions.”

Practice Point: These latest developments from the Supreme Court should be noted by taxpayers and practitioners. As with the highly contested opinion in Kisor v. Wilkie last term, it is clear that many Justices are uncomfortable with granting a high level of deference to government agencies. Deference issues continue to be in the forefront in several tax cases, and likely will continue to be highly relevant in forthcoming challenges to many regulations in the wake of tax reform in 2017.




Government Files Its Brief in Auer Deference Case

As we discussed in a prior post and in our article for Law360, the Supreme Court is poised to decide in Kisor v. Wilkie whether to overrule the Auer deference doctrine. This doctrine, which originated in the 1945 Seminole Rock case, generally affords controlling deference to an agency’s interpretation of its own ambiguous regulations. To date, the petitioner has filed its brief, several amici have filed briefs and the government has filed its brief (links to these documents can be found here). Argument is currently scheduled for March 27, 2019, and an opinion is anticipated by the end of June 2019.

The government’s brief, filed on February 25, 2019, acknowledges that Auer deference raises serious concerns. Specifically, the government states that the basis for the doctrine is unclear, the doctrine is in tension with the Administrative Procedures Act (APA) and overly broad deference to agency interpretations can have harmful practical consequences. However, relying on principles of stare decisis, the government advocates for maintaining Auer deference subject to certain prerequisites that would limit the doctrine. These prerequisites include applying deference only after all traditional tools of construction have been exhausted and only if the agency’s interpretation has reasonably interpreted any ambiguity. In deciding whether to defer to the agency’s interpretation, a reviewing court should look at whether the interpretation: (1) was issued with fair notice to regulated parties, (2) is not inconsistent with the agency’s prior views, (3) rests on the agency’s expertise and (4) represents the agency’s considered view (i.e., not merely the views of “mere field officials or other low-level employees”). Presumably these limits would curtail the application of Auer deference in circumstances where the agency’s interpretation is first widely known only because of a litigating position.

Practice Point: The Supreme Court’s decision in Kisor v. Wilkie will be important for taxpayers and their representatives in light of the substantial regulatory guidance issued in the wake of tax reform. We will continue to follow this case and provide updates after argument is held and the case is decided.




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