Conservative Ninth Circuit Judges Unsuccessfully Question Constitutionality of Pass-Through Taxation without "Realization" (12/25/22)

We don’t normally encounter constitutional issues in federal tax. There are some, however. See e.g., Justice Ginsburg' successful constitutional attack in Moritz v. Commissioner, 469 F.2d 466 (10th Cir. 1972), cert. denied, 412 U.S. 906 (1973), memorialized in the movie On the Basis of Sex (see Sex and Tax (Federal Tax Crimes Blog 1/7/19) here, where the pre-Judge/Justice Ginsburg with her husband Marty (best tax lawyer ever) in the background succeeded in having a Code provision declared unconstitutional.  

Another instance not yet successful but imagined is asserted by a minority of the Ninth Circuit in a dissent to denial of petition for rehearing en banc. Moore v. United States, 53 F.4th 507 (9th Cir. 11/22/22), CA9 here and GS here, denying the petition from Moore v. United States, 36 F.4th 930 (9th Cir. 2022), CA9 here and GS here. 

While Moore is not a tax procedure case, I mention it because it illustrates the lengths to which conservative-bent judges will go to try to restrain the federal government in a way that can throw a monkey-wrench into settled expectations of our tax system. They often mount these attacks in tax procedure cases, with the APA a tool of their angst (see Bryan Camp, The APA Is Not A Hammer (Procedurally Taxing Blog 6/24/22), here. The judges on the Moore dissent were authoring Judge Bumatay (Trump) and joiners Ikuta (Bush), Callahan (Bush), and Vandyke (Trump). A frequent target for such types is the administrative state. The target this time was Congress in enacting a statute that required a type of pass-through taxation for certain foreign corporations. By pass-through, I mean requiring the owner of an entity to include in the owner’s income for tax purposes the income earned by the entity even if the income is not distributed from the entity to the shareholder. Readers of this blog who, I hope, are familiar with the tax structure we have, know that there are any number of pass-through entities that are essential to the tax we have. To mention a few, S Corporations, partnerships, and some foreign corporations. I cannot recall any serious claims by serious people that the pass-through taxation was unconstitutional.

First Circuit Sustains Holding That Late Filed Return Is Not a Return for Bankruptcy Discharge (11/25/22)

As readers of this blog know, there are a lot of fun facts about the Internal Revenue Code and the twists and turns it has taken from passage, amendment, and application by the IRS and the Courts (including interpretation). Sort of like the line from the Major-General’s song in G&S’s Pirates of Penzance:

About binomial theorem I'm teeming with a lot o' news,
With many cheerful facts about the square of the hypotenuse.

OK, no more diversions. The topic today is the famous “hanging paragraph” (sometimes called the “so-called hanging paragraph,” the “unnumbered hanging paragraph,” etc.) in the Bankruptcy Code at 11 USC § 523(a), here [I link the Code section because you just have to see it in context to fully enjoy it; it appears sort of just out there at the end of subsection (a) and just before subsection (b)]. The hanging paragraph is also referred to as “§ 523(a)(*)” (or some variation with an asterisk). In full, the hanging paragraph is:

For purposes of this subsection, the term “return” means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements). Such term includes a return prepared pursuant to section 6020(a) of the Internal Revenue Code of 1986, or similar State or local law, or a written stipulation to a judgment or a final order entered by a nonbankruptcy tribunal, but does not include a return made pursuant to section 6020(b) of the Internal Revenue Code of 1986, or a similar State or local law.

There are other hanging paragraphs in the U.S. Code (either the positive law Codes or the compilation Codes (on which see On the Internal Revenue Code (Title 26), the U.S. Codes, and Statutes, here).

This Bankruptcy Code’s hanging paragraph has created discordant notes in the courts as to the meaning of the statutory text: “the term ‘return’ means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements).”  (Emphasis supplied.) Specifically, does “applicable filing requirements” mean that the return has to be timely in order to achieve a discharge? This often comes up in the context of the IRS having prepared a substitute for return (“SFR”) pursuant to § 6020(b) after the taxpayer failed to file a return. The tax computed in the SFR is assessed. The IRS tries to collect. The taxpayer dodges and weaves. The taxpayer, wanting to rid himself (or herself) of this nuisance, then checks out the possibility of a bankruptcy discharge. The taxpayer’s lawyer, unaware of or unconcerned about the hanging paragraph commotion in the courts, advises that the taxpayer needs to file a return and wait two years before filing for bankruptcy. So he files a tax return mimicking the results of the SFR, waits two years, seeks bankruptcy protection and, hopefully, discharge of the tax liability. 

Supreme Court Denies Cert in Whirlpool Financial; On Phantom Regulations (11/23/22)

I previously wrote on the petition for writ of certiorari (colloquially “cert petition”) stage in Whirlpool Fin. Corp. v. Commissioner, 19 F.4th 944 (6th Cir. Dec. 6, 2021), CA6 here and GS here. See Petition for Cert in Whirlpool, SG Waiver of Response, and Several Amici Arguing for Cert (Federal Tax Procedure Blog 8/5/22; 8/16/22), here. My even earlier blog on the Sixth Circuit opinion is: Whirlpool's BS Tax Shelter Fails in the 6th Circuit; on Statutory Interpretation and Legislative History (12/7/21; 2/22/22), here. In the blog on the cert petition, I noted that the Solicitor General in effect claimed that the cert petition was a nothingburger (to use a popular term), by filing a one-sentence waiver of response. Despite the waiver, the Supreme Court ordered the SG to respond. See the Supreme Court docket entries here. The SG filed a brief in opposition (colloquially a “brief in opp”). On that record before the Court, on November 21, 2022, the Supreme Court denied the cert petition.

There is nothing substantive that I think would be helpful to readers to add. I thought that, particularly for students, it might be helpful to offer something briefly on the “phantom regulation” concept which is not mentioned in the Sixth Circuit opinion but are mentioned in the cert petition. I will only try to summarize at a high level, but direct to my discussion in my book Federal Tax Procedure (2022 Practitioner Ed.) (SSRN https://ssrn.com/abstract=4180710. I there note that the issue is often raised by the taxpayer seeking a benefit where the statute seems to command a regulation for the benefit and ask the question whether the IRS can deny the benefit by simply not promulgating a regulation? Here, the shoe is on the other foot, with the IRS achieving the benefit where, in one way of reading the statute, the IRS has not promulgated a regulation required by the statute. I state how the Tax Court has dealt with the issue (p. 69, footnotes omitted):

In a 2016 * reviewed opinion, the Tax Court concluded the task is to determine whether the statutory text, considered in light of the legislative history or other interpretive tools, can be applied without further explication in a regulation. The analysis turns upon whether “Congress couched its delegation of rulemaking authority in mandatory or permissive terms.” If mandatory, the Court could treat the delegation of authority as  self-executing” and could discern from the statutory text as interpreted the result that Congress intended the IRS to adopt and apply in the case at hand.

    * The quote in the book says it is a 2017 opinion; the opinion was 2016: 15 West 17th Street LLC v. Commissioner, 147 T.C. 557 (2016) (Reviewed opinion) (I will correct in the 2023 editions). 

That quote is focused on a taxpayer seeking the benefit in the absence of regulations. Does the same analysis apply if the IRS seeks the benefit in the absence of a statutory delegation of requirement or authority to promulgate regulations? Arguably, that is what the Sixth Circuit did without mentioning the term phantom regulations. At least that is what Whirlpool Financial claimed in its cert petition, albeit indirectly by citing (p. 3) Andy Grewal, The Sixth Circuit Conjures Phantom Regulations, Yale J. on Regul. Notice & Comment (Feb. 21, 2022), here. In its response, the SG did not mention the term. In its reply, Whirlpool Financial only mentions the term in citing Grewal’s article.

Court of Federal Claims Rejects Defective § 6603 Strategy for Multiple Transferee Liabilities (11/21/22)

In Dillon Trust Company LLC v. United States, ___ Fed. Cl. ___, 2022 U.S. Claims LEXIS 2575 (11/10/22), FC here and GS here, the Government moved for partial dismissal for lack of jurisdiction and for partial summary judgment with respect to plaintiff’s interest-related claim. I focus here on the interest-related claim.

The background is an intermediary or Midco transaction by a family corporation with the assets stripped out of the corporation by direct or indirect transfer to shareholders without paying the large tax corporate liability generated by the corporation. In initially reporting the transaction, the corporation claims the benefit of a bullshit tax shelter to effectively zero out the gain and tax, but on audit and denial of bullshit tax shelter benefit, the gain is taxed to the corporation which has no assets (because the shareholders stripped them out directly or indirectly). So, the IRS has to chase the “transferees” – here the shareholders – to collect the payment through transferee liability under § 6901.  I cover these transactions in Federal Tax Procedure (2022 Practitioner Ed.), here, at pp. 745-746. In a footnote, I quote Alterman Trust v. Commissioner, T.C. Memo. 2015-231, at *2:

Courts, including this court, have been plagued by Midco cases. Rarely do these cases present themselves for a determination of the underlying liabilities. Instead, these cases are postured so that the courts are asked to determine whether someone other than the taxpayer should be on the hook for the taxpayer's liability. They are transferee liability cases, and so are these cases.

The corporate taxpayer involved was Humboldt Shelby Holding Corporation (“HSHC”) which was unable to pay the tax, the gross valuation misstatement penalty, and the interest on each. The corporate liabilities as of August 2014 were “a federal income tax deficiency of $25,617,887 and a gross valuation misstatement penalty of $10,247,155, plus interest, which remained unpaid.” The transferees the IRS targeted were certain Dillon family trusts (with the parties agreeing that the results would apply to all of the family trusts as direct or indirect transferees). 

Among other arguments in this refund suit, the trusts argue that they cannot be held for transferee liability for the gross valuation misstatement penalty “because they lacked knowledge of HSHC’s plan to carry out the tax shelter scheme that formed the basis of the I.R.C. § 6662 penalty.”  Good luck to them on that. 

But in this case, the  court only addressed interest issues. The interest issue arose from the trusts’ apparent desire to invoke § 6603 to prevent the running of interest during the period of the deposit. I cover § 6603 in Federal Tax Procedure (2022 Practitioner Ed.) pp. 268-272. The rules of § 6603 are not particularly complex, but the application of those rules in the Dillon Trust case was complex because of the machinations involved where the trusts, as putative persons liable for transferee liability, apparently thrusted about to achieve some purpose to avoid interest but did so in which appears to be a haphazard fashion. The result is that, although the IRS had the deposit money in a large amount and for a significant period, the taxpayer and the transferees achieved no interest benefit under § 6603 that might have been achieved had they structured the deposits/payments differently.

District Court Holds IRS Tax Shelter Notice Imposing Obligations Invalid as a Legislative Rule Without Notice-and-Comment But Limits Holding to Parties (11/20/22)

In GBX Associates, LLC v. United States (N.D. Ohio Case No. 1:22cv401 Dkt. # 21 Memo. Opinion & Order 11/14/22), CL here and GS here, the Court held consistent with Sixth Circuit (including lower court) opinions that IRS Notice 2017-10, entitled “Listing Notice- Syndicated Conservation Easement Transactions,” was invalid because it was a legislative rule adopted without notice-and-comment.  After reaching that conclusion, the court focused on the APA language in 5 USC § 706(2) that the court “hold unlawful and set aside agency action” found to be “not in accordance with law” or ” without observance of procedure required by law “ The question was whether the scope of the remedy could include not only the plaintiff a material (investment advisor) before the court but universal applying throughout the country to all similarly situated parties.  The relief could either be granted by a universal injunction commanding the IRS not to apply the Notice or by “vacatur” declaring the rule null and void which would cover IRS action against all parties similarly situated not before the court.  The latter is sometimes call universal or nationwide vacatur.

I think the opinion is quite good in discussing the issues.  In a nutshell, the issue is whether an invalid rule (here the Notice requirements) adopted without the notice-and-comment required for legislative rules, making it void ab initio, should allow or require piecemealing the remedy, requiring it to be litigated by various aggrieved persons throughout the country.  The Court said (Slip Op. p. 18, cleaned up):

As noted above, GBX asserts that the Notice 2017-10 should be in vacated in whole (and not just as to GBX itself) because, by its very nature, the “set aside” remedy of vacatur set forth in APA § 706(2) acts against the agency action itself—not the government actor. GBX asserts that, under established case law from the Third, Ninth, and D.C Circuit Courts of Appeals, the “ordinary result” upon a finding of unlawful agency action is that the [agency action] itself is vacated—not that its application to the individual petitioners is proscribed. Defendants strongly disagree, arguing the law on this issue is, in fact, unsettled and “hotly contested.” Defendants emphasize, in particular, that the Sixth Circuit has not expressly ruled on this issue and that at least one district court in this Circuit has rejected GBX’s argument and declined to order universal relief under § 706(2).

The Court in GBX exercised her discretion in concluding (Slip Op. p. 32): "The Court declares that Notice 2017-10 is unlawful and hereby sets that Notice aside as to Plaintiff GBX Associates, LLC only."

This litigant-only or universal application issue is presented in Texas v. United States, 40 F. 4th 205 (5^th Cir. 2022) (per curiam), GS here, a nontax case.  The Fifth Circuit opinion summarized its holding (at 212, emphasis supplied by JAT):

Tax Court in Reviewed Opinion Invalidates Notice Identifying Reportable Transactions (11/10/22)

In Green Valley Investors, LLC v. Commissioner, 159 T.C. 80 (2022) (reviewed opinion), TCPamphlet here,, TN here and GS here, the Court held that Notice 2017-10, 2017-4 I.R.B. 544 was invalid because the Notice is a legislative rule improperly issued by the IRS without notice and comment. As a result, the Court “set aside” the Notice and prohibited the imposition of § 6662A (here) accuracy-related penalties for understatements for reportable transactions identified in the Notice. The case turns upon the application of the APA requirement that legislative rules be promulgated as notice-and-comment regulations except for contemporaneous “good cause” statement or congressional exception to the notice-and-comment, neither of which the Court found to apply.

In high level overview, the question was whether the IRS must identify transactions subject to the penalty in a regulation (either Final or Temporary (interim final)) or could identify transactions in a Notice which is subregulatory guidance. The statute referred to transactions identified in regulations under § 6011. The regulations under 6011 defined reportable transaction as a transaction that is the same or substantially similar to one of the types of transactions that the IRS has determined to be tax avoidance transactions and identified by notice, regulation, or other form of published guidance. Reg. § 1.6011-4(b)(2).

The Court reasoned that the Notice which clearly was not a regulation did not meet the statutory command that the transaction be identified in a regulation. Although it included a lot more words and reasons, that is the guts of the holding. As a result, the Court invalidated the application of the penalty in the case and stated (p. 24 n. 22): “Although this decision and subsequent order are applicable only to petitioner, the Court intends to apply this decision setting aside Notice 2017-10 to the benefit of all similarly situated taxpayers who come before us.” 

This holding is a big deal. Syndicated conservation easements as they have been reported in many cases are clearly the type of abusive transactions that Congress intended the penalty to apply once the IRS identified them. The Court held that the IRS improperly identified these transactions by subregulatory guidance rather than by regulation, a procedural footfault. A lot of people clearly abusing the system will escape penalties clearly meant to apply to them and that would have applied except that the Court held that  the IRS promulgated the rule in a procedurally incorrect way.

First Circuit Holds that Target of JDS May Bring Challenge to JDS Prior to Tax Enforcement Against Target (11/9/22)

I am late posting on Harper v. Rettig, 46 F.4th 1 (1st Cir. 2022), 1^st Cir. here and GS here. So the principal point of this blog is to point to the excellent writings of others, which I provide below.

The basic holding of the case (as I understand it) is that, based on CIC and Direct Marketing, the Anti-Injunction Act, § 7421(a) (“AIA”)) does not apply to IRS actions to gather information as opposed to actions to assess and collect tax. As a result, under CIC, a taxpayer can have pre-enforcement review challenging the validity of the JDS and the resultant unlawful acquisition and retention of his financial information, on the notions that; (i) the APA § 702 contemplates pre-enforcement review of IRS information gathering activity (as opposed to assessing or collecting activity) and (ii) the ex parte John Doe Summons (“JDS”) is an information gathering function rather than a tax assessing or collecting function.

My only comment is that the underlying issue as to whether a taxpayer can get pre-enforcement review of the validity of a JDS is an important one.  The holding seems to portend a wide swath of pre-enforcement challenges in various other IRS information-gathering activities.  In a comment posted to a  PT Blog, I asked (cleaned up for typos):

Justice Gorsuch's Newest Rant on Chevron and the Administrative State (11/7/22; 11/8/22)

Justice Gorsuch continues his ranting against Chevron and the administrative state in a dissent today from a denial of a petition for certiorari.  Buffington v. McDonough, 143 S. Ct. 14 (Sup. Ct. Case No. 21–972 11/7/22), SC here and GS here; Supreme Court docket entries here.  

As with his concurring opinion in Gutierrez-Brizuela v. Lynch, 834 F.3d 1142, 1153 (10th Cir. 2016), GS here, he rants alone, unable to attract any other Justices’ concurrence in his concurrence.  I will write more later today or tomorrow on his rantings; in the meantime, readers can read the rant (only 16 pages) without being distracted by my counter-rant.  I will say that my text search indicates that he does not repeat his Brizuela concurring rhetoric about elephant in the room. At least that is good, but he does have some other rhetorical sound bites that may play well with persons who hate the administrative state as much as he does.

When I write more, I will post it to this blog entry and note the date and time I added it.

Added 11/8/22 ___ pm 2:15 pm:

1. Justice Gorsuch makes clear that he does not like Chevron “deference” because, he believes, it allocates interpretive power to agencies that should belong to the courts. I think readers interested in this area should respectfully consider his arguments (sort of like Skidmore respect for arguments in non-majority opinions.). I do not deal in detail with the arguments because they are addressed in my article,  The Report of the Death of the Interpretive Regulation Is an Exaggeration  (SSRN December 14, 2021), here. (Referred to in this blog entry as Report of the Death.)

2. I disagree with two major points in Justice Gorsuch’s argument:—

 (i) courts did not defer to agency interpretations before Chevron was elaborated after the decision in 1984 but instead only gave respectful consideration to agency interpretations a la some Skidmore-type respect to determine the best interpretation);  and

(ii) the APA § 706 allocated to the courts all interpretive power over ambiguous statutory text just as the Constitution requires from the sound bite in Marbury v. Madison.

Gorsuch Claims in Bittner Oral Argument that "nobody promulgates regulations anymore": True or False? (11/4/22)

This post discusses a claim that Justice Gorsuch made in oral argument in Bittner v. United States (No. 20-40597), SC docket here and SCOTUSblog docket here (I offer SCOTUSblog link because the Supreme Court link does not seem to work.) The link for the typed transcript is here; the link for the audio is here.

The issue in Bittner is whether the FBAR nonwillful penalty of up to $10,000 applies per form (regardless of the number of foreign accounts not reported) or per account (for each account that should have been but was not reported on an FBAR for the year).

In the context of discussing guidance documents, Justice Gorsuch said (Tr. p. 64): "[N]obody promulgates regulations anymore. It's too troublesome."

That claim is demonstrably false. He may have meant that agencies disfavor and mostly do not use formal rulemaking (which does not require promulgation of regulations), although agencies regularly use informal rulemaking requiring promulgating notice and comment regulations. Here is the difference between the two as I explain Federal Tax Procedure (2022 Practitioner Ed.), SSRN here, at p. 57 n. 256.

   n256 The informal rulemaking process is described in 5 U.S.C. § 553, whereas the formal rulemaking process is described in § 556. David L. Franklin, Legislative Rules, Nonlegislative Rules, and the Perils of the Short Cut, 120 Yale L.J. 276, 282 (2010) ("The first technique, so-called 'formal' rulemaking, involves onerous trial-type hearings and is rarely required unless a specific statute calls for rules to be 'made on the record after opportunity for an agency hearing.' Far more common is the second technique, variously known as 'informal,’ 'notice-and-comment,' or 'section 553' rulemaking.").  The formal rulemaking process is rarely used in agencies generally.  See Perez v. Mortgage Bankers Assn., 575 U. S. 92, 128 n5 (2015) (Thomas, concurring) (noting that (i) "almost all rulemaking is today accomplished through informal notice and comment," in contrast to the formal rulemaking process requiring "elaborate trial-like hearings in which proponents of particular rules would introduce evidence and bear the burden of proof in support of those proposed rules," citing 5 U. S. C. §556; and (ii) "formal rulemaking is the Yeti of administrative law" with "isolated sightings of it in the ratemaking context, but elsewhere it proves elusive.”). Informal rulemaking is permitted unless the authorizing statute mandates formal rulemaking.  United States v. Florida East Coast R. Co., 410 US 224, 236-238 (1973). 

I am not trying to pick on Justice Gorsuch, but he is an administrative law wannabe expert as shown by his ranting about Chevron and related confusion I address in my article The Report of the Death of the Interpretive Regulation Is an Exaggeration  (SSRN December 14, 2021), here, at pp.  110-116 under the caption "b. Gorsuch's Imagined Elephant in the Room.").

Added 11/7/22 3:30 JAT Comment:

1. Justice Gorsuch continues his ranting against Chevron and the administrative state in a dissent today from a denial of a petition for certiorari.  Buffington v. McDonough (Sup. Ct. Case No. 21–972 11/7/22), SC here and GS here.  As with his concurring opinion in Gutierrez-Brizuela v. Lynch, 834 F.3d 1142. 1153 (10th Cir. 2016), GS here, Justice Gorsuch could not get any other Judge (this time 8 others rather than 2) to agree with what he has to say. (Of course, any of the other Justices could have not joined his opinions for a host of reasons rather than his over the topic rhetoric and questionable claims about the history of deference.  I will post a separate blog entry on his dissent in Buffington.

3rd Circuit Holds that Collection Statute of Limitations Is Suspended through Supreme Court Finality (11/2/22; 11/3/22; 11/7/22)

Section 6330(e)(1) ( provides that certain levy actions and certain statutes of limitations (including collection) are suspended while Collection Due Process (“CDP”) “hearing and appeals therein are pending.”  Readers will recall that the taxpayer invokes the CDP hearing by making a timely request and then, if not satisfied, can petition the Tax Court for review.  The Tax Court will then review, and that taxpayer and the IRS have the standard appeals processes to the Court of Appeals and, by petition for writ of certiorari, to the Supreme Court.

In United States v. Weiss, 52 F.4th 546 (3rd Cir. 11/2/22), CA3 here, the Court held that, for statute of limitations suspension in CDP cases, “appeals therein” and “pending” mean not until all appeals processes (including Supreme Court, if invoked as it was in Weiss) are final.  That holding stated that way makes sense—even common sense. 

But, it was not so simple for the Third Circuit.  The authoring judge, Judge Phipps, seized the opportunity to elaborate in 15 pages not including the cover caption page -- bringing out the dictionaries and other interpretive tools to tackle the weighty issue of what “appeals therein” and “pending” mean.  Stating the standard pablum that you look to the meaning of statutory words at the time of enactment, the judge holds forth on that and finds some potential ambiguity that can be cleaned by going through dictionaries and maxims. 

For those interested in reading footnotes, I commend footnotes 2-4, covering most of pages 8-10, particularly n4 where he holds forth on the “autohyponym.”  That was a new word for me.  He explains in the footnote: