DC Circuit Interprets the § 751 Inventory Exception to Achieve a Result Congress Cannot Have Intended (7/29/24)

In Rawat v. Commissioner, 108 F.4th 891 (D.C. Cir. 2024), DCCir here and GS here, the Court held that the portion of a foreign person’s gain from sale of a partnership interest attributable to partnership inventory taxed under § 751 as other than capital gain is not U.S. sourced and therefore not subject to U.S. tax. The opinion really has nothing to do with tax procedure, except on the picky point that I note at the end of this blog.

As I see the issue (perhaps not from the same literalist reading of the statutes as the Court but as a high level overview of what I think Congress was trying to do), the purpose of recharacterizing what would be capital gain into ordinary income for the underlying appreciated inventory in the partnership is to give the partner treatment as if the partnership had sold the inventory, realized the gain, and allocated it to the foreign partner for U.S. tax. Judge Gustafson in the Tax Court reached that result well within the constraints of the language in the Code. See Rawat v. Commissioner, T.C. Memo. 2023-14 , here. Only by fixating on certain text does the D.C. Circuit panel avoid that result. The whole purpose of all judicial interpretive methodologies is to be the faithful agents interpreting the will or intent of Congress. Foregoing U.S. tax on the gain attributable to inventory certainly was not the intent of Congress.

I post on this case because it seems to me to be of the same genre of resolution as Gitlitz v. Commissioner, 531 U.S. 206 (2001), here, Justice Thomas' infamous literalist / textualist opinion oblivious to the overall design of the Code. I discuss in general terms the interpretive methodologies in the Federal Tax Procedure Book 2024 versions (Student Ed. at pp. 6-11) and (Practitioner Ed. at pp. 8-17). Specifically, in another part of the book (Practitioner Ed.  at p. 109 n. 505), I discuss Gitlitz as follows in a footnote regarding the chaos some Supreme Court opinions:

   n505Charles I. Kingson, How Tax Thinks, 37 Suffolk U. L. Rev. 1031 (2004) (critiquing two leading Supreme Court cases: Frank Lyon Co. v. United States, 435 U.S. 561 (1978) and Commissioner v. Brown, 380 U.S. 563 (1965)); see also Charles I. Kingson, Confusion Over Tax Ownership, 93 Tax Notes 409 (Oct. 8, 2001) (critiquing the same). I also cite Gitlitz v. Commissioner, 531 U.S. 206 (2001) as a prime example of Supreme Court’s mischief in this area. See René Matteotti, Struggling With Words in Tax Jurisprudence -- A Plea for an Equal Treatment Mode of Analysis in Construing Tax Statutes, 2005 TNT 130-30. My quip, not much of an overstatement, is that tax cases are too important to let the Supreme Court decide them.

DC Circuit Holds IRS Has Assessment Authority for § 6038(b) Penalty, Reversing Tax Court (5/3/24; 11/19/24)

In Farhy v. Commissioner, 100 F.4th 223 (D.C. Cir. 5/3/24), CADC here**, TN here, and GS here, the Court of Appeals (Judge Pillard author) held that the IRS has assessment authority for the § 6038(b) penalty. In so holding, the Court rejected the Tax Court holding that the IRS did not have assessment authority. Judge Pillard’s opinion is well-reasoned and presented. Although it is not a short opinion, I highly recommend reading the whole thing.

I will say that the opinion talks in terms of Congress’ intent. Thus, for example, summarizing the reasoning (Slip op. 13-14, emphasis supplied by JAT):

We need not embrace either party’s tax code-wide default rule to resolve this case. We accordingly do not pass on those broader theories beyond explaining why Farhy’s does not preclude assessment of section 6038(b) penalties. Instead, we conclude that a narrower set of inferences suffices to show that Congress intended to render those penalties assessable. Read in light of its text, structure, and function, section 6038 itself is best interpreted to render assessable the fixed-dollar monetary [*14] penalties subsection (b) authorizes. As a result, the Commissioner’s authority to assess all “assessable penalties” encompasses the authority to assess penalties imposed under section 6038(b).

My analysis is that there was no congressional intent on assessment authority issue. But given the schema, one can fairly infer that, had Congress had an intent on the assessment authority issue, it would have been to confer assessment authority on the IRS. That is simply filling in the gaps as a matter of statutory interpretation.

For my thoughts on the issue (noting particularly my skepticism on the Tax Court’s now reversed decision, see my prior blog posts (chronological order)):

• Tax Court Holds that IRS Has No Authority to Assess § 6038(b) Penalties for Form 5471 Delinquencies (Federal Tax Procedure Blog 4/3/23; 4/23/23), here.
• Regulations Interpreting Pre-1996 Code Provisions; Fixing Farhy (Federal Tax Procedure Blog 5/11/23; 5/12/23), here.

Added 5/3/35 9:00 pm:

JAT Comments:

Suspensions of Statute of Limitations Make Collection Suit Timely (5/27/20)

In United States v. Weiss (E.D. Penn Dkt. 19-502 Order dated 5/21/20), here [GS here], the Court denied the taxpayer’s statute of limitations defense in a collection suit where the Government seeks judgment on the assessment.  The issue was whether the Government timely filed its suit to obtain judgment on assessments based on delinquent returns filed on October 10, 1994.  The assessments were made later in October 1994.  Those assessments triggered the 10-year collection statute of limitations under § 6502(a)(1).  The Government brought the collection suit on February 5, 2019, over 14 years after the collection statute would have normally expired on in October 2004.  The devil, of course, is in the word "normally."  The IRS cannot unilaterally extend or suspend the statute of limitations, but the taxpayer can take actions that will do so.  The trajectory of those actions are what caused the collection suit to be timely.

In my view, there is nothing particularly surprising in the way the Court pieced together the events causing the suspensions to apply over the years.  Although not surprising, the trajectory is a good lesson particularly for students trying to understand how suspensions work.  Indeed, I used to teach these in my class, with examples, and then, on the exam, would have a fact pattern starting with a notice of deficiency through the Tax Court proceeding and appeal (including a petition for certiorari) and ask the students to answer the earliest date the IRS could assess and the latest date the IRS could assess.  For each answer I wanted a specific date and then the relevant Code section(s), with any further explanation the student desired.  Usually the Code section(s) would be sufficient to tell me that they had the basis for the answer.

So, this case reminded me of my teaching and examinations.  For students of tax procedure the case is a good read.  I won’t summarize it because it is fairly short and well written.  I will say that the key legal issue is whether a petition for certiorari is an appeal that is within the suspension period for appeals under § 6330(e)(1), here.  So, I offer the facts from the opinion (these are just the facts, with references to Code and Regulations sections, usually in footnotes, omitted).  I invite readers to perform their own analysis of the statute suspensions (Note that I am including in the block quote below only the facts I think pertinent for the analysis and am using the cleaned up technique to eliminate discussion not relevant to the fact trajectory):

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).

Second Circuit Resolves Standard of Review on Tax Court Appeals in Transferee Liability Case (11/18/13)

Peter Reilly has posted a good discussion of the Second Circuit decision in Diebold Found. v. Commioner,  736 F.3d 172 (2d Cir. 2013), here.  Peter's blog entry Charitable Foundation Haunted by 1999 Corporate Tax Assessment (Forbes 11/17/12), here.

The substantive decision in the case deals with the application of Section 6091 transferee liability.  The case gets into some esoterica of transferee liability, so I will leaves readers of the opinion and Peter's blog to ferret that out.  I will, however, just offer a gratuitous comment that the sophisticated players in the underlying game -- generically referred to as Midco transactions -- knew that when all the shuffling was over, the IRS would be left holding the bag for a large amount of tax dollars that was due and that those tax dollars not paid would be shared among the players in various ways intended to disguise the fact that they had just participated in key steps to evade federal taxes.  Evade may be a strong word here, but for the level of sophistication -- lawyers involved -- by the players I have observed in the game, they knew -- certainly should have known -- that was the consequence of their participation in the Midco game.  I think the Second Circuit gets that point and is not too bashful to say so.  In this regard, Calvin Johnson, UT Law Professor, is quoted as saying that the shareholders (including the Diebold Foundation) [a]s a matter of economics, * * * got a price for their shares that included, by my estimates, 85 percent of the value of the tax evaded.  Andrew Velarde, Second Circuit Holding on Midco Acquisitions Seen as Big Win for Government, 2013 TNT 223-3 (11/19/13).

Moving on, at the bottom of his blog, Peter addresses the procedural issue that the Second Circuit resolves at the threshold in reaching the substantive issue it addressed.  That procedural issue is the appropriate standard of review for appeals from the Tax Court.  Section 7482(a)(1), here, confers jurisdiction upon the courts of appeals to review decisions from the Tax Court "in the same manner and to the same extent as decisions of the district courts in civil actions tried without a jury."  Pretty straight-forward.  But the Second Circuit had to correct an error of its own making in order to calibrate the right standard for "mixed questions of law and fact."  The Court's discussion of the problem and its resolution is relative short, so I just cut and paste it.  However, in order to cut out some of the "noise," I omit most of the citations and some quotations marks.

In an appeal from the Tax Court, it is without dispute in this Circuit that we review legal conclusions de novo and findings of fact for clear error. While we have previously held the standard of review for mixed questions of law and fact to be one for clear error, all Courts of Appeals are to "review the decisions of the Tax Court . . . in the same manner and to the same extent as decisions of the district courts in civil actions tried without a jury." 26 U.S.C. § 7482(a)(1). Our case law enunciating the standard of review for mixed questions of law and fact in an appeal from the Tax Court is in direct tension with this statutory mandate. Following a civil bench trial, we review a district court's findings of fact for clear error, and its conclusions of law de novo; resolutions of mixed questions of fact and law are reviewed de novo to the extent that the alleged error is based on the misunderstanding of a legal standard, and for clear error to the extent that the alleged error is based on a factual determination. Two recent panels of our Court have recognized this contradiction between our case law and 26 U.S.C. § 7482(a)(1) but did not resolve the tension, as they determined that under either standard of review the outcome in the particular case would be the same. In the instant case, the standard of review affects the outcome, so our Court can avoid the question no longer. 

The standard that mixed questions of law and fact are reviewed under a clearly erroneous standard when we review a decision of the Tax Court was established in this Circuit's jurisprudence in Bausch & Lomb Inc. v. Comm'r, 933 F.2d 1084, 1088 (2d Cir. 1991). Bausch & Lomb imported the standard from the Seventh Circuit, which, in Eli Lilly & Co. v. Comm'r, 856 F.2d 855, 861 (7th Cir. 1988), held the clearly erroneous standard to be applicable. Eli Lilly in turn relied upon another Seventh Circuit case, Standard Office Bldg. Corp. v. United States, 819 F.2d 1371, 1374 (7th Cir. 1987), a tax case on review from the district court. None of these decisions mention 26 U.S.C. § 7482(a)(1), which has been a part of the Internal Revenue Code since 1954. In Standard Office Building, the Seventh Circuit indicated that one of the open questions in the appeal was "the kind of 'mixed' question of fact and law . . . that, in this circuit at least, is governed by the clearly-erroneous standard." Id. (emphasis added). That court then cited a handful of cases from their circuit that stated this standard from cases reviewing the decision of a district court. The Seventh Circuit uses the clearly erroneous standard of review for mixed questions of law and fact when reviewing both decisions of the Tax Court and those of the district courts. Its standard is thus not in tension with 26 U.S.C. § 7482(a)(1), unlike this Court's.