Judge Halpern Synthesizes Taxpayer and IRS Burdens when Seeking a Tax Result Based on Substance Rather than Form (5/31/21)

In Complex Media Inc. v. Commissioner, T.C. Memo. 2021-14 (as revised 3/31/21), TN here and TC Dkt entry 87 here, in a 103 page opinion, Judge Halpern had some interesting discussion on issues important to tax procedure fans.  I won’t try to slice and dice the entire opinion but will just point out the discrete parts that caught my attention.

1. “This Court has never accepted the Danielson rule. And, because the cases before us are not appealable to the Third Circuit (or to any other appellate court that has accepted the Danielson rule), the Golsen doctrine does not require us to apply that rule here.”  (Slip Op. 53-54.)

2. More interesting is the Court’s discussion as to the different burdens when the IRS and the taxpayer seeks to avoid the form of the transaction.  The key excerpt is (Slip Op. 63-64):

In sum, as our caselaw has evolved, it has become more hospitable to taxpayers seeking to disavow the form of their transactions. While we no longer reject those arguments out of hand, as we did in Swiss Oil Corp., J.M. Turner & Co., and Television Indus., we have repeatedly indicated that taxpayers may face a higher burden than the Commissioner does in challenging transactional form. On occasion, as in Glacier State Elec. Supply, we have suggested that the taxpayer's higher burden might be an evidentiary one. But we have not identified specific factual questions that should be subject to a higher burden than that imposed by Rule 142(a) or articulated the quantum of evidence necessary to meet that burden. [*64] Nor have we offered a clear justification for imposing on the taxpayer a higher burden to prove facts relevant to the disavowal of form than the generally applicable preponderance of the evidence standard.

Therefore, we now conclude that the additional burden the taxpayer has to meet in disavowing transactional form relates not to the quantum of evidence but instead to its content--not how much evidence but what that evidence must show by the usual preponderance. The Commissioner can succeed in disregarding the form of a transaction by showing that the form in which the taxpayer cast the transaction does not reflect its economic substance. For the taxpayer to disavow the form it chose (or at least acquiesced to), it must make that showing and more. In particular, the taxpayer must establish that the form of the transaction was not chosen for the purpose of obtaining tax benefits (to either the taxpayer itself, as in Estate of Durkin, or to a counterparty, as in Coleman) that are inconsistent with those the taxpayer seeks through disregarding that form. When the form that the taxpayer seeks to disavow was chosen for reasons other than providing tax benefits inconsistent with those the taxpayer seeks, the policy concerns articulated in Danielson will not be present.

I have revised the relevant discussion in my Federal Tax Procedure book working draft to be published in August.  I link here a pdf of the discussion with the changes redlined.  Note that the page numbers and footnote numbers will be different in the final version published in August.

JAT comments:

Supreme Court Holds in CIC Services that IRS Micro-Captive Notice May Be Contested Pre-Enforcement (5/17/21; 5/18/21)

This morning, the Supreme Court released its opinions in CIC Services, LLC v. IRS, 583 U.S. ___ (2021), here.  The main opinion is a unanimous opinion authored by Justice Kagan.  Justices Sotomayor and Kavanaugh joined the main opinion but also filed concurrences.

I have not studied the opinion, so offer at this time only the syllabus and a couple of quick comments:

Internal Revenue Service (IRS) Notice 2016–66 requires taxpayers and “material advisors” like petitioner CIC to report information about certain insurance agreements called micro-captive transactions. The consequences for noncompliance include both civil tax penalties and criminal prosecution. Prior to the Notice’s first reporting deadline, CIC filed a complaint challenging the Notice as invalid under the Administrative Procedure Act and asking the District Court to grant injunctive relief setting the Notice aside. The District Court dismissed the action as barred by the Anti-Injunction Act, which generally requires those contesting a tax’s validity to pay the tax prior to filing a legal challenge. A divided panel of the Sixth Circuit affirmed.

Held: A suit to enjoin Notice 2016–66 does not trigger the Anti-Injunction Act even though a violation of the Notice may result in a tax penalty. Pp. 5–16.

(a) The Anti-Injunction Act, 26 U. S. C. §7421(a), provides that “no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person.” Absent the tax penalty, this case would be easy: the Anti-Injunction Act would pose no barrier. A suit to enjoin a requirement to report information is not an action to restrain the “assessment or collection” of a tax, even if the information will help the IRS collect future tax revenue. See Direct Marketing Assn. v. Brohl, 575 U. S. 1, 9–10. The addition of a tax penalty complicates matters, but it does not ultimately change the answer. Under the Anti-Injunction Act, a “suit[’s] purpose” depends on the action’s objective purpose, i.e., the relief the suit requests. Alexander v. “Americans United” Inc., 416 U. S. 752, 761. And CIC’s complaint seeks to set aside the Notice itself, not the tax penalty that may follow  [*2] the Notice’s breach. The Government insists that no real difference exists between a suit to invalidate the Notice and one to preclude the tax penalty. But three aspects of the regulatory scheme here refute the idea that this is a tax action in disguise. First, the Notice imposes affirmative reporting obligations, inflicting costs separate and apart from the statutory tax penalty. Second, it is hard to characterize CIC’s suit as one to enjoin a tax when CIC stands nowhere near the cusp of tax liability; to owe any tax, CIC would have to first violate the Notice, the IRS would then have to find noncompliance, and the IRS would then have to exercise its discretion to levy a tax penalty. Third, the presence of criminal penalties forces CIC to bring an action in just this form, with the requested relief framed in just this manner. The Government’s proposed alternative procedure—having a party like CIC disobey the Notice and pay the resulting tax penalty before bringing a suit for a refund—would risk criminal punishment. All of these facts, taken together, show that CIC’s suit targets the Notice, not the downstream tax penalty. Thus, the Anti-Injunction Act imposes no bar. Pp. 5–13.

(b) Allowing CIC’s suit to proceed will not open the floodgates to pre-enforcement tax litigation. When taxpayers challenge ordinary taxes, assessed on earning income, or selling stock, or entering into a business transaction, the underlying activity is legal, and the sole target for an injunction is the command to pay a tax. In that scenario, the Anti-Injunction Act will always bar pre-enforcement review. And the analysis is the same for a challenge to a so-called regulatory tax—that is, a tax designed mainly to influence private conduct, rather than to raise revenue. The Anti-Injunction Act draws no distinction between regulatory and revenue-raising tax laws, Bob Jones Univ. v. Simon, 416 U. S. 725, 743, and the Anti-Injunction Act kicks in even if a plaintiff’s true objection is to a regulatory tax’s regulatory effect. By contrast, CIC’s suit targets neither a regulatory tax nor a revenue-raising one; CIC’s action challenges a reporting mandate separate from any tax. Because the IRS chose to address its concern about micro-captive agreements by imposing a reporting requirement rather than a tax, suits to enjoin that requirement fall outside the Anti-Injunction Act’s domain. Pp. 13–15.

JAT Comments:

Mayo -- the other Mayo -- reversed by CA8, Sustaining Regulations Interpretation (5/13/21)

In Mayo Clinic v. United States, 2021 U.S. App. LEXIS 14143 (8th Cir. 5/13/21), here, the Eighth Circuit reversed the district court’s invalidation of a regulation’s test for meeting the “qualified organization” requirement that turned upon being an educational organization under § 170(b)(1)(A)(ii).  Reg. § 1.170A-9(c)(1) defined a charitable organization as one whose “primary function is the presentation of formal instruction” and whose noneducational activities “are merely incidental to the educational activities.”  As stated by the Court, the district court “held that the Treasury Regulation is invalid ‘because it adds requirements — the primary-function and merely-incidental tests — Congress intended not to include in the statute.’”

A quick digression, I wrote on the district court opinion:  District Court Invalidates Interpretive Regulation at Chevron Step One (Federal Tax Crimes Blog 8/8/19; 3/11/19), here.  I concluded as follows:

I don't think the Court's reasoning is compelling.  The conclusion may be right.  I just don't think the reasoning articulated by the Court compels the conclusion that the statutory text does not offer sufficient ambiguity to permit the interpretation adopted by the IRS.

In reversing the district court, the Eighth Circuit panel did not adopt my implicit reasoning—that there was sufficient ambiguity in the statute to permit Chevron space for reasonable interpretations at Chevron Step Two.  (Although, if Chevron is conceptualized as a single step, all the work really could be done at Chevron Step One but I won’t go down that detour here.)  Rather, the Eighth Circuit panel stops at Step One because it found that the regulation was permitted by the unambiguous text of the statute, at least the unambiguous text as the Eighth Circuit panel interpreted the text.  (Because the regulations test is  not compelled by the statutory text and requires interpretation for it to be compelled, that means, in  my mind, that there is interpretive space in the statute; if there is interpretive space, then the court or the agency may fill that interpretive space, but if the agency has done it, the interpretation, is usually tested at Step Two)

Of course, at Chevron Step One, the usual tools of statutory interpretation apply to determine whether the statute is ambiguous and whether the interpretive regulation is within the scope of the ambiguity.  I gather what the Court did was to apply those interpretive tools to determine that there was no ambiguity and thus no remaining interpretive space under the Chevron Framework because the regulation was consistent with that unambiguous interpretation.  If that is true, then it seems to me that it is the statute that is the law and not the regulation, consistent with traditional distinctions between legislative and interpretive regulations.  Hence the interpretive regulation which is then consistent with the unambiguous statutory text (as interpreted) becomes the law and per se the regulation interpretation a is valid interpretation of the statute.  (Compare the Treasury’s adoption in some interpretive regulations of language mimicking the statute; what work and what validity do the regulations have in that context?)

 Two things further on Chevron:

Follow by Email Feedburner Email Notice Service Being Discontinued (5/10/21)

Some readers of the Federal Tax Procedure Blog have signed up for and have been receiving email notifications of new blog entries via a service called Feedburner through the “Follow by Email” widget that formerly was in the right hand column on this blog.  The Feedburner service is being discontinued in July 2021.  I am therefore eliminating that widget so that Follow by Email will not longer be available for new subscribers to that service and,  I gather, the Follow by Email service will stop working in July 2021 for persons who were already registered.

There are other services that, I understand, can provide that functionality, but I just have not spent the time to try to figure out how they work and how to implement them on the blog site.  If and when I figure that out, I will try to get a replacement Follow by Email.

I have downloaded the email addresses of those who were registered as of today.  So, if I get a substitute service for this functionality, I will email those persons with notice so that they can register.  I will also post a blog entry notifying of the replacement service (if I set up one).