Justice Sandra Day O'Connor, Tufts, Chevron Deference, Dobson Deference, and APA § 706 (12/2/23)

Yesterday, Sandra Day O’Connor died. See Linda Greenhouse, Sandra Day O’Connor, First Woman on the Supreme Court, Is Dead at 93 (NYT 12/1/23), here. She served many iconic roles in our legal history. I won’t attempt to catalog those roles and her achievements. I present in this blog some of her history in a tax and administrative law context that I hope is of some interest to some readers. 

In 1983, Justice O’Connor burst into my consciousness because of her concurring opinion in Tufts v. Commissioner, 461 U.S. 300 (1983), here. Tufts addressed an issue arising from the then infamous footnote 37 in  Crane v. Commissioner, 331 U. S. 1  14 n. 37 (1947), here. See for an illustrative discussion of Crane’s importance in the tax law in a series on important cases in different disciplines, Vada W. Lindsey, The IRS’s Hollow Victory in Crane v. Commissioner, 331 U.S. 1 (1947), here. (noting that, by itself, Crane may not seem important but its importance ever after is in the term “tax shelter,” which I discuss below)

Crane addressed the issue of how to treat the taxpayer’s disposition of property subject to a nonrecourse debt. The taxpayer there had acquired the property subject to a nonrecourse debt equal to the value of the property; the taxpayer included the nonrecourse debt in the basis for the property, and, while she held the property, had taken depreciation on tax basis including the nonrecourse debt. The taxpayer then disposed of the property subject to the nonrecourse debt. The question was whether, in reporting the tax consequences on disposition, the taxpayer should include the nonrecourse debt and any other consideration (there $2,500 cash) in amount realized. The amount realized is the minuend of the calculation of gain realized; from that minuend, basis is subtracted (subtrahend) to compute gain realized. The Court held that the nonrecourse debt was included in the calculations as follows:

1	Cash (net)	$2,500
2	Nonrecourse debt	$200,000
3	Amount Realized (1+2)	$202,500
4	Less Undepreciated Basis *	($175,000)
5	Yields Gain Realized (3-4)	$127,500

This calculation comports with the actual tax results, where the taxpayer had taken $25,000 in depreciation offsetting other income but had walked away with cash of $2,500 net from dealing in property. The tax books balance by including the nonrecourse debt in amount realized. If the Court had held the amount of the nonrecourse debt was not included in the amount realized calculation, the tax books would not have balanced because the taxpayer would have gained the interim depreciation offsetting other income without some balancing to account for the fact that the debt was nonrecourse meaning the taxpayer never paid for the tax deductions (either in cash or an equivalent amount of offsetting income).

Crane involved property worth the value of the nonrecourse debt at acquisition and disposition. The Court said in fn. 37:

   n37 Obviously, if the value of the property is less than the amount of the mortgage, a mortgagor who is not personally liable cannot realize a benefit equal to the mortgage. Consequently, a different problem might be encountered where a mortgagor abandoned the property or transferred it subject to the mortgage without receiving boot. That is not this case.

Crane and its implications, fn. 37 in particular, spawned many tax shelters (abusive and otherwise) where taxpayers could acquire property subject to nonrecourse debt, claim the tax benefits of a “cost” basis in the property including the nonrecourse debt that would never cost anything, and then, to the extent that the nonrecourse debt exceeded the value of the property, never have a balancing tax entry because not included in calculation of amount realized.

Most of the abusive tax shelters have a familiar theme generally—false excessive valuations of the property with false deductions for depreciation or some other tax benefits (e.g., credits). The current in vogue abusive tax shelter is the syndicated conservation easement, the abusive variety of which depend on grossly excessive valuations to “justify” claimed charitable contribution deductions. In earlier times based on what some read as the implications of Crane, shelter promoters “sold” the opportunity for deductions that would never cost anything (including never being reversed by income inclusions). (Of course, the more “white-shoe” variety of abusive tax shelters, the transfer pricing abuse, involve abusive valuations in transfer pricing.)

Tufts involved just such a tax shelter case where the property was disposed of subject to nonrecourse debt exceeding the value of the property. The Fifth Circuit held that the excess was excluded from the amount realized on disposition of the property, citing Crane fn 37, thus allowing the taxpayer his cost-free deductions without balancing the tax books. The Supreme Court held that the excess was included in amount realized, thus balancing the tax books. The holding was a deference holding, deferring to the agency’s interpretation (pp. 314-315, 317):,

(i)           “the facial meaning of the statute [is] ambiguous”

(ii)        The agency interpretation interprets “the statutory mandate in a reasonable manner,” citing National Muffler Dealers Assn. v. United States, 440 U. S. 472, 476 (1979).

The Supreme Court majority opinion did not state that the IRS interpretation it applied was not the best interpretation; that may be a fair implication but it is not expressly said. (Remember, as I have developed, real deference exists only when the court defers to an agency interpretation that is not the best interpretation.)

Justice O’Connor concurred, also on deference grounds but said that her concurrence in deference involved real deference—deferring to an agency not best interpretation. The best interpretation, she claimed, citing an amicus brief by Professor Wayne Barnett of Stanford Law School, was to characterize the disposition transaction as 2 separate tax events as follows—

• sale or other disposition of the property with amount realized equaling the value of the property (treated as a deemed repayment of the nonrecourse debt in that amount); and
• cancellation of indebtedness in the amount of the nonrecourse debt in excess of the value of the property.

That would make the tax books balance but do it in a way more logically consistent with including nonrecourse debt in basis on the acquisition by analogizing it to recourse debt.

The main point is that Tufts was a deference opinion as recognized by both majority (although its waffles on real deference) and Justice O’Connor concurring. Essentially, although it is not stated as crisply as Chevron, the deference was the same as the Chevron Court applied deference just one year later—ambiguous statute and reasonable interpretation. (In an upcoming article I argue that historic deference prior to Chevron and even the APA had those two key characteristics and thus may rightly be called Chevron deference without the Chevron label.)

The teaching of Tufts offers even more to the deference discussion. This blog entry is long already, so I will simply highly summarize—maybe too cryptically summarize—this aspect. As noted, Tufts addressed Crane’s famous fn. 37. The Crane opinion itself is interesting for deference because of Justice Robert Jackson’s short dissent joined by Justices Frankfurter and Douglas. Justice Jackson invoked his earlier opinion in Dobson v. Commissioner, 320 U.S. 489 (1943) to reason that the statute was ambiguous as to

(i)        Whether, as the Tax Court held, the taxpayer in Crane acquired an equity only (that is the value of the property less the nonrecourse debt) in which case her basis would have been zero and the nonrecourse debt would not be included in amount realized on disposition. (This interpretation would mean that the taxpayer should not have taken depreciation by including the nonrecourse debt in basis, but Justice Jackson said (p. 16) : “We are not required in this case to decide whether depreciation was properly taken, for there is no issue about it here)” or

(ii)       Whether the taxpayer acquired the property subject to the debt (rather than just an equity), in which case she properly included the amount of the nonrecourse debt in basis and must include the amount of the debt as gain realized on disposition. (Note Crane did not involve the phenomenon of the property having a value less than the nonrecourse debt at any relevant time).

Now this just requires us to go back to Dobson to determine its contribution to the deference discussion.

I cryptically summarize Dobson and refer readers for detail to my upcoming article where I cover Dobson in detail in developing the proper application of APA § 706 (5 U.S.C.).With that caveat, Dobson, a unanimous opinion authored by Justice Jackson, held that courts should review Tax Court statute interpretations with deference  because

(i)         the Tax Court was an agency as the statute specifically said for which traditional deference to agency interpretations applied; and

(ii)       more importantly, the statute prescribed a scope of review to determine if Tax Court interpretations are “not in accordance with law.” Dobson held that those words in the statute commanded deference. Then, although there are other reasons to believe that § 706 [APA § 10(e)] when enacted in 1946] included deference, § 706 [APA § 10(e)] includes the “not in accordance with law” standard for review of agency legal interpretations that the Dobson said included deference.

Whew!

 Thanks for readers or skimmers who got this far.

One aside on Justice O'Connor's concurring opinion in Tufts.

As an aside war story, I made the same argument in John A. Townsend, Footnote 37 of Crane: What Is the Nature of the Income?, 4 Rev. of Tax. of Indiv. 128 (1980). After Tufts was decided, Professor Barnett who made the argument Justice O’Conner found persuasive wrote me a letter saying that he should have pressed the argument harder or more persuasively and should have cited my article which he commended because he thought it was the right result that had been subverted by the government’s interpretations receiving deference. (No, I did not keep the letter; there is some more intrigue related to my development of the argument and publication of the article, but that is an unnecessary detour here.)