Another Bull Shit Shelter Bites the Dust (12/19/13)

We have yet another of the genre out of the Tenth Circuit, this time proving Michael Graetz's famous observation that an abusive tax shelter is “[a] deal done by very smart people that, absent tax considerations, would be very stupid.”  The new case is Blum v. Commissioner, 737 F.3d 1303 (10th Cir. 2013), here.

Before discussing the case, I offer this description of tax shelters from my Federal Tax Procedure Book (footnotes omitted):

Abusive tax shelters are many and varied.  Some are outright fraudulent, usually wrapped in a shroud of paper work designed to present the shelter as a real deal.  The more sophisticated are often without substance but do have some at least attenuated, if superficial, claim to legality.  Some of the characteristics that I have observed for tax shelters that the Government might perceive as abusive are that (i) the transaction is outside the mainstream activity of the taxpayer, (ii) the transaction is incredibly complex in its structure and steps so that not many (including specifically IRS auditors) will have the ability, tenacity, time and resources to trace it out to its illogical conclusion (this feature is often included to increase the taxpayer’s odds of winning the audit lottery); (iii) the transaction costs of the arrangement and risks involved, even where large relative to the deal, still have a favorable cost benefit/ratio only because of the tax benefits to be offered by the audit lottery, (iv) the promoters of the adventure make a lot more than even an hourly rate even at the high end for professionals (the so-called value added fee, which is often insurance type compensation to mediate shift potential penalty risks to the tax professional or the netherworld between the taxpayer and the tax professional) and (v) the objective indications as to the taxpayer's purpose for entering the transaction are a tax savings motive rather than any type of purposive business or investment motive.  More succinctly, Michael Graetz, a Yale Law Professor, has described an abusive tax shelter as “[a] deal done by very smart people that, absent tax considerations, would be very stupid.”  Other thoughtful observers vary the theme, e.g. a tax shelter “is a deal done by very smart people who are pretending to be rather stupid themselves for financial gain.”

Blum fits the pattern.

Mr. Blum was a very successful businessman.  He was apparently very capable in assessing risks and rewards of financial ventures.  Mr. Blum retained KPMG who sold him one of its tax shelter products which it marketed in the 1990s and early 2000s.  This particular product was OPIS, a basis enhancement strategy. The abusive basis enhancement strategies claimed to create large amounts of basis without the taxpayer having to incur a cost for the basis.  The taxpayer would then use the artificial basis to offset otherwise taxable gain, thereby artificially reducing the tax liability.  Mr. Blum got into the deal when he had a large gain that would otherwise be taxed.

When KPMG's representative made the pitch, Mr. Blum "claims he saw an investment opportunity; the Commissioner claims Mr. Blum saw a tax evasion opportunity."  (Emphasis supplied.) Mr. Blum bought the pitch and made a representation to KPMG that he was doing the deal for a legitimate nontax business or investment purpose.  (That representation was essential to KPMG's participation in implementing the transaction.)  Bottom-line, the Tax Court concluded and the Tenth Circuit concluded that the representation was false.

Is a Party Entitled to a Hearing in a Summons Enforcement Case Based Solely on Allegations of Improper Purpose? (12/13/13)

The United States has petitioned the Supreme Court in United States v. Clarke, 517 Fed. Appx. 689, 2013 U.S. App. LEXIS 7773 (11th Cir. 2013), here, an unpublished decision.  The Eleventh Circuit's opinion in Clarke is short and pithy, so I quote it all (except I omit the caption and two of the three footnotes):

This case involves the Internal Revenue Service's (IRS) issuance of five administrative summonses, pursuant to 26 U.S.C. § 7602, during an investigation into the tax liabilities of Dynamo Holdings Limited Partnership (Dynamo). Specifically, [List of summonsed parties omitted] appeal the district court's orders granting the IRS's petitions to enforce the summonses. After careful review of the record, and having had the benefit of oral argument, we vacate the district court's order enforcing the summonses and remand for the district court to hold a hearing. 

To obtain enforcement of a summons, the IRS must make a four-part prima facie showing that (1) "the investigation will be conducted pursuant to a legitimate purpose," (2) "the inquiry may be relevant to the purpose," (3) "the information sought is not already within the Commissioner's possession," and (4) "the administrative steps required by the Code have been followed." United States v. Powell, 379 U.S. 48, 57-58, 85 S. Ct. 248, 13 L. Ed. 2d 112 (1964); see also Nero Trading, LLC v. U.S. Dep't of Treasury, IRS, 570 F.3d 1244, 1248 (11th Cir. 2009). Once the IRS makes its prima facie showing, the burden shifts to the party opposing the summons to either (1) disprove one of the four elements of the IRS's prima facie case, or (2) "convince the court that enforcement of the summons would constitute an abuse of the court's process." Nero, 570 F.3d at 1249 (internal quotation omitted). The Supreme Court has stated that because the district court's process is used to enforce a summons, the court should not permit its process to be abused by enforcing a summons that was issued for an improper purpose. See Powell, 379 U.S. at 58. According to the Powell Court, an improper purpose may include any purpose "reflecting on the good faith of the particular investigation." Id. 

In Powell, the Supreme Court also explained that a party opposing a summons is entitled to an adversary hearing before enforcement is ordered, and that, at the hearing, the opponent "may challenge the summons on any appropriate ground." Id. (internal quotation omitted). Subsequently, in United States v. Southeast First National Bank of Miami Springs, we held that "an allegation of improper purpose is sufficient to trigger a limited adversary hearing where the taxpayer may question IRS officials concerning the Service's reasons for issuing the summons." 655 F.2d 661, 667 (5th Cir. 1981) (footnote omitted). More recently, we have reaffirmed Southeast First National Bank, calling it "the legitimate offspring of the Supreme Court's seminal decision in Powell." Nero, 570 F.3d at 1249. 

Appellants contend they were entitled to discovery and an evidentiary hearing before the district court granted the IRS's petitions to enforce the summonses because they alleged the IRS may have issued and sought to enforce the summonses for at least four improper purposes.One of the reasons the IRS may have issued the summonses, according to Appellants, was solely in retribution for Dynamo's refusal to extend a statute of limitations deadline. Although Appellants raised the possibility of numerous improper purposes, federal pleading standards allow claims and defenses to be pled in the alternative, and do not require them to be consistent. See Fed. R. Civ. P. 8(d)(2) & (d)(3). If the IRS issued the summonses only to retaliate against Dynamo, that purpose "reflect[s] on the good faith of the particular investigation," and would be improper. See Powell, 379 U.S. at 58. 

Public Policy as a Basis for Denying OICs (12/10/13)

Can the IRS deny an otherwise proper offer in compromise because the taxpayer has been involved in some type of activity that the IRS deems against the public interest?  For example, can the IRS deny an offer solely because the taxpayer was prosecuted for evasion of assessment or even payment of the taxes in question?  Or, even if not prosecuted, the taxpayer's activity had the characteristics of being prosecuted?

Keith Fogg of the Procedurally Taxing Blog has an interesting blog on the issue of whether developments in the law "will soon eliminate the ability of the IRS to make public policy or best interest of the government the basis for rejecting an offer in compromise."  See Keith Fogg, Oversight of Offers – Response to Comment raising Thornberry v. Commissioner (Procedurally Taxing Blog 12/6/13), here.  The article has a short summary of the history of the OIC and some valuable links. Professor Fogg believes that the IRS retains some residual right to reject claims on public policy or public interest bases.  The discussion is quite good, so I recommend it generally.

I have posted some comments on the issue on my Federal Tax Crimes Blog.  See Criminal and FBAR Noncompliance, Offers in Compromise and the Public Interest (Federal Tax Crimes Blog 12/10/13), here.

Ford Wants Overpayment Interest While Its Remittance Was Held as a Deposit (12/6/13)

In Ford Motor Co. v. United States, 571 U.S. ____ (2013), here, the Supreme Court entered the following order on Ford's petition for certiorari (caption omitted):

PER CURIAM. 

When a taxpayer overpays his taxes, he is generally entitled to interest from the Government for the period between the payment and the ultimate refund. See 26 U.S.C. § 6611(a). That interest begins to run "from the date of overpayment." §§ 6611(b)(1), (b)(2). But the Code does not define "the date of overpayment." 

In this case, after the Internal Revenue Service advised Ford Motor Company that it had underpaid its taxes from 1983 until 1989, Ford remitted a series of deposits to the IRS totaling $875 million. Those deposits stopped the accrual of interest that Ford would otherwise owe once the audits were completed and the amount of its underpayment was finally determined. See § 6601; Rev. Proc. 84-58, 1984-2 Cum. Bull. 501. Later, Ford requested that the IRS treat the deposits as advance payments of the additional tax that Ford owed. Eventually the parties determined that Ford had overpaid its taxes in the relevant years, thereby entitling Ford to a return of the overpayment as well as interest. But the parties disagreed about when the interest began to run under 26 U.S.C. § 6611(b)(1). Ford argued that "the date of overpayment" was the date that it first remitted the deposits to the IRS. Ibid. The Government countered that the date of overpayment was the date that Ford requested that the IRS treat the remittances as payments of tax. The difference between the parties' competing interpretations of § 6611(b) is worth some $445 million. 

Ford sued the Government in Federal District Court, asserting jurisdiction under 28 U.S.C. § 1346(a)(1). The Government did not contest the court's jurisdiction. See Brief in Opposition 3, n. 3. The District Court accepted the Government's construction of § 6611(b) and granted its motion for judgment on the pleadings. A panel of the Court of Appeals for the Sixth Circuit affirmed, concluding that § 6611 is a waiver of sovereign immunity that must be construed strictly in favor of the Government. 508 Fed. Appx. 506 (2012). 

Ford sought certiorari, arguing that the Sixth Circuit was wrong to give § 6611 a strict construction. In Ford's view, it is 28 U. S.C. § 1346 -- not § 6611 -- that waives the Government's immunity from this suit, and § 6611(b) is a substantive provision that should not be construed strictly. See Gómez-Pérez v. Potter, 553 U.S. 474, 491 (2008); United States v. White Mountain Apache Tribe, 537 U.S. 465, 472-473 (2003). In its response to Ford's petition for certiorari, however, the Government contended for the first time that § 1346(a)(1) does not apply at all to this suit; it argues that the only basis for jurisdiction, and "the only general waiver of sovereign immunity that encompasses [Ford's] claim," is the Tucker Act, 28 U.S.C. § 1491(a). Brief in Opposition 3, n. 3. Although the Government acquiesced in jurisdiction in the lower courts, if the Government is now correct that the Tucker Act applies to this suit, jurisdiction over this case was proper only in the United States Court of Federal Claims. See § 1491(a). 

This Court "is one of final review, 'not of first view.'" FCC v. Fox Television Stations, Inc., 556 U.S. 502, 529 (2009) (quoting Cutter v. Wilkinson, 544 U.S. 709, 718, n. 7 (2005)). The Sixth Circuit should have the first opportunity to consider the Government's new contention with respect to jurisdiction in this case. Depending on that court's answer, it may also consider what impact, if any, the jurisdictional determination has on the merits issues, especially whether or not § 6611 is a waiver of sovereign immunity that should be construed strictly. 

The petition for certiorari is granted, the judgment of the Sixth Circuit is vacated, and the case is remanded for further proceedings. 

It is so ordered.

Did Justice Scalia Smuggle Legislative History Into the Woods Opinion? (12/6/13)

Justice Scalia touts his disdain for legislative history, at least when he is noisy about it.  Others may have noted that Justice Scalia is prone to hyperbole.  He wrote the unanimous opinion in United States v. Woods, ___ U.S. ___ (2013), here, so in order to hold the unanimity, he was a little more muted about the subject, saying in fn 5:

We do not consider Woods’ arguments based on legislative history. Whether or not legislative history is ever relevant, it need not be consulted when, as here, the statutory text is unambiguous. Mohamad v. Palestinian Authority, 566 U. S. ___, ___, 132 S. Ct. 1702, 1709, 182 L. Ed. 2d 720 (2012). Nor do we evaluate the claim that application of the penalty to legal rather than factual misrepresentations is a recent innovation. An agency’s failure to assert a power, even if prolonged, cannot alter the plain meaning of a statute.

The question I address today is whether Justice Scalia smuggled some legislative history into his opinion and that smuggled history did affect his decision?  I think the answer to that question is yes.  Readers should know that my answer is an inference of a fact and not necessarily proof of a fact.  So, I state the basis for my inference.

After Justice Scalia states the facts and the procedural posture, he opens his legal analysis "with a brief explanation of the statutory scheme for dealing with partnership-related tax matters."  Then in very few words, he states the purpose for the TEFRA partnership rules for unified audits and litigation:

A partnership does not pay federal income taxes; instead, its taxable income and losses pass through to the partners. 26 U. S. C. § 701. A partnership must report its tax items on an information return, § 6031(a), and the partners must report their distributive shares of the partnership’s tax items on their own individual returns, §§ 702, 704. 

Before 1982, the IRS had no way of correcting errors on a partnership’s return in a single, unified proceeding. Instead, tax matters pertaining to all the members of a partnership were dealt with just like tax matters pertaining only to a single taxpayer: through deficiency proceedings at the individual-taxpayer level. See generally §§6211-6216 (2006 ed. and Supp. V). Deficiency proceedings require the IRS to issue a separate notice of deficiency to each taxpayer, §6212(a) (2006 ed.), who can file a petition in the Tax Court disputing the alleged deficiency before paying it, § 6213(a). Having to use deficiency proceedings for partnership-related tax matters led to duplicative proceedings and the potential for inconsistent treatment of partners in the same partnership. Congress addressed those difficulties by enacting the Tax Treatment of Partnership Items Act of 1982, as Title IV of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA). 96 Stat. 648 (codified as amended at 26 U. S. C. §§ 6221-6232 (2006 ed. and Supp. V)). 

Under TEFRA, partnership-related tax matters are addressed in two stages. First, the IRS must initiate proceedings at the partnership level to adjust “partnership items,” those relevant to the partnership as a whole. §§ 6221, 6231(a)(3). It must issue an FPAA notifying the partners of any adjustments to partnership items, § 6223(a)(2), and the partners may seek judicial review of those adjustments, § 6226(a)-(b). Once the adjustments to partnership items have become final, the IRS may undertake further proceedings at the partner level to make any resulting “computational adjustments” in the tax liability of the individual partners. § 6231(a)(6). Most computational adjustments may be directly assessed against the partners, bypassing deficiency proceedings and permitting the partners to challenge the assessments only in post-payment refund actions. § 6230(a)(1), (c). Deficiency proceedings are still required, however, for certain computational adjustments that are attributable to “affected items,” that is, items that are affected by (but are not themselves) partnership items. §§ 6230(a)(2)(A)(i), 6231(a)(5).

More on the Supreme Court's Opinion in Woods on TEFRA and the 40% Basis Overstatement Penalty (12/4/13)

I offer more detailed comments on United States v. Woods, ___ U.S. ___ (2013), here.  This blog entry is primarily for students.

1.  The opinion has a good summary of the state of the law leading to the original enactment of the TEFRA partnership provisions.  Slip Op. 6 & 7.  This context is important to understand the general nature of the TEFRA partnership provisions and its policy choices.  The context is useful far beyond the context of the immediate issue.

2.  The immediate threshold question was the court's jurisdiction to determine penalty issues in the unified TEFRA proceeding.  The penalty in question was one of the accuracy related penalties.  In 1997, the TEFRA provisions were amended to have such penalties determined at the partnership level with respect to partnership items despite the fact that at least one critical component of the Section 6662 penalty has a defense of reasonable cause and good faith -- see Section 6664(c)(1), here -- that must be asserted by a partner at the partner level and not in the partnership level proceeding.  The statutory solution to this problem is to permit the partner to assert the defense at the partner level but in a separate refund proceeding (rather than in a Tax Court proceeding pursuant to a notice of deficiency).  Justice Scalia said pithily:  "Barring partnership-level courts from considering the applicability of penalties that cannot be imposed without partner-level inquiries would render TEFRA’s authorization to consider some penalties at the partnership level meaningless."  (Slip Op. 9.) Justice Scalia then reasons (Slip Op. 10):

Applying the foregoing principles to this case, we conclude that the District Court had jurisdiction to determine the applicability of the valuation-misstatement penalty — to determine, that is, whether the partnerships’ lack of economic substance (which all agree was properly decided at the partnership level) could justify imposing a valuation-misstatement penalty on the partners. When making that determination, the District Court was obliged to consider Woods’ arguments that the economic-substance determination was categorically incapable of triggering the penalty. Deferring consideration of those arguments until partner-level proceedings would replicate the precise  [*20] evil that TEFRA sets out to remedy: duplicative proceedings, potentially leading to inconsistent results, on a question that applies equally to all of the partners.
To be sure, the District Court could not make a formal adjustment of any partner’s outside basis in this partnership-level proceeding. See Petaluma, 591 F. 3d, at 655. But it nonetheless could determine whether the adjustments it did make, including the economic-substance determination, had the potential to trigger a penalty; and in doing so, it was not required to shut its eyes to the legal impossibility of any partner’s possessing an outside basis greater than zero in a partnership that, for tax purposes, did not exist. Each partner’s outside basis still must be adjusted at the partner level before the penalty can be imposed, but that poses no obstacle to a partnership-level court’s provisional consideration of whether the economic-substance determination is legally capable of triggering the penalty.  n2
   n2 Some amici warn that our holding bodes an odd procedural result: The IRS will be able to assess the 40-percent penalty directly, but it will have to use deficiency proceedings to assess the tax underpayment upon which the penalty is imposed. See Brief for New Millennium Trading, LLC, et al. as Amici Curiae 12-13. That criticism assumes that the underpayment would not be exempt from deficiency proceedings because it would rest on outside basis, an “affected ite[m] . . . other than [a] penalt[y],” 26 U. S. C. § 6230(a)(2)(A)(i). We need not resolve that question today, but we do not think amici’s answer necessarily follows. Even an underpayment attributable to an affected item is exempt so long as the affected item does not “require partner level determinations,” ibid.; see Bush v. United States, 655 F. 3d 1323, 1330, 1333-1334 (CA Fed. 2011) (en banc); and it is not readily apparent why additional partner-level determinations would be required before adjusting outside basis in a sham partnership. Cf. Petaluma FX Partners, LLC v. Commissioner, 591 F. 3d 649, 655, 389 U.S. App. D.C. 64 (CADC 2010) (“If disregarding a partnership leads ineluctably to the conclusion that its partners have no outside basis, that should be just as obvious in partner-level proceedings as it is in partnership-level proceedings”).

Supreme Court Applies 40% Penalty to Bullshit Basis Enhancement Shelters (12/3/13)

In United States v. Woods, ___ U.S. ___ , 134 S. Ct. 557 (12/3/13), here, the Court rejected procedural arguments and applied the special 40% accuracy related penalty for valuation and basis overstatements.  §§6662(a), (b)(3), (e)(1)(A), (h).  The unanimous opinion is written  by Justice Scalia, the plain language justice, who not surprisingly concludes:  "The penalty’s plain language makes it applicable here."

I am sure others and even I will have a lot to say about the opinion and its ramifications later. (Here is my follow through post, More on the Supreme Court's Opinion in Woods on TEFRA and the 40% Basis Overstatement Penalty (Federal Tax Procedure Blog 12/4/13), here.

For now, this caught my eye as Justice Scalia jabs at the use of the Blue Book (what else could he do with such a tempting target):

Woods contends, however, that a document known as the “Blue Book” compels a different result. See General Explanation of the Economic Recovery Tax Act of 1981 (Pub. L. 97–34), 97 Cong., 1st Sess., 333, and n. 2 (Jt.Comm. Print 1980). Blue Books are prepared by the staff of the Joint Committee on Taxation as commentaries on recently passed tax laws. They are “written after passage of the legislation and therefore d[o] not inform the decisions of the members of Congress who vot[e] in favor of the [law].” Flood v. United States, 33 F. 3d 1174, 1178 (CA9 1994). We have held that such “[p]ost-enactment legislative history (a contradiction in terms) is not a legitimatetool of statutory interpretation.” Bruesewitz v. Wyeth LLC, 562 U. S. ___, ___ (2011) (slip op., at 17–18); accord, Federal Nat. Mortgage Assn. v. United States, 379 F. 3d 1303, 1309 (CA Fed. 2004) (dismissing Blue Book as “a post-enactment explanation”). While we have relied on similar documents in the past, see FPC v. Memphis Light, Gas & Water Div., 411 U. S. 458, 471–472 (1973), our more recent precedents disapprove of that practice. Of course the Blue Book, like a law review article, may be relevant to the extent it is persuasive. But the passage at issue here does not persuade. It concerns a situation quite different from the one we confront: two separate, non­overlapping underpayments, only one of which is attributable to a valuation misstatement. 

In my Federal Tax Procedure book (not yet revised for the above, which, I doubt, is the last word on the issue), I discuss the Blue Book as follows (footnotes omitted):

Appeals from the Tax Court (12/2/13)

I write today to point readers to the excellent blog Procedurally Taxing blog entry:  Keith Fogg, Appellate Venue in Tax Court cases – Taking Care in Applying Golsen in non-deficiency cases (11/26/13), here.  I strongly recommend that readers of this blog link to it and read it.

Inspired by the posting, I have revised my Federal Tax Procedure text to include the points that some Tax Court appeals are exclusively to the Court of Appeals for the District of Columbia Circuit and that, at least as to those appeals for now, the application of the Golsen rule will mean that the District of Columbia Court of Appeals will set uniform national law on the issues, meaning that certiorari to the Supreme Court will be based exclusively on importance of the issue and not on conflict among the circuits.  (That is overbroad, but a sufficient generalization for now.)

The concept of a single court of appeals, variously formulated, for tax cases has been around for many years, with many proponents and opponents.  It is a long history which is suggested by the following quote from an article (in a footnote, no less):  Ruth Bader Ginsburg and Peter W. Huber, The Intercircuit Committee, 100 Harv. L. Rev. 1417, 1429 n. 61 (1987):

There may be a few discrete bodies of law so arcane and complex that no other solution will do. The Federal Circuit now satisfies the need for early appellate declaration of national law in certain areas, notably, patent disputes. See 28 U.S.C. § 1295 (1982) (assigning to the United States Court of Appeals for the Federal Circuit exclusive jurisdiction over enumerated matters, including appeals from the district courts in patent cases, appeals from the Merit Systems Protection Board, appeals from the agency boards of contract appeals, and appeals from the district courts in certain cases against the United States); see also S. REP. NO. 275, 97th Cong., 2d Sess. 3, 4, reprinted in 1982 U.S. CODE CONG. & ADMIN. NEWS 11, 13, 14. Congress believed that the federal judicial system lacked sufficient capacity "to provide reasonably quick and definitive answers to legal questions of nationwide significance." Id. at 13. It therefore established the Federal Circuit to adjudicate definitively in areas where the legislators found "special need for nationwide uniformity." Id. at 14. 

A single court of tax appeals could promote uniformity and coherence in another federal law domain populated by specialist advocates and rarely benefited by the labors of generalist judges, including those on the Supreme Court. See H. FRIENDLY, FEDERAL JURISDICTION: A GENERAL VIEW 161-71 (1973); Ginsburg, Making Tax Law Through the Judicial Process, 70 A.B.A. J. 74 (1984); Griswold, The Need for a Court of Tax Appeals, 57 HARV. L. REV. 1153 (1944).