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):

Principal Life -- A Masterpiece of Tax Procedure (11/29/13)

In my last Tax Procedure Class, we spent most of the class discussing Principal Life Ins. Co. v. United States, 95 Fed. Cl. 786 (Fed. Cl. 2010).  The Court's slip opinion is here; students can link to a nonofficial version (Harvard Caselaw Access Project) but with local page citations, here.  I do ask, however, that students download the actual case with the local page citations. 

The reasons I think the case is important are: (i) it is a tax procedure case; (ii) it is a tour de force tax procedure case; and (iii) it covers a lot of ground that we covered earlier in the class.  I promised the students that I would post a blog on the case in order to help them learn Tax Procedure and, even, study for the examination.  THIS POSTING IS NOT INTENDED AND SHOULD NOT BE USED AS A SUBSTITUTE FOR ACTUALLY READING AND STUDYING THE CASE.

Judge Allegra (Wikipedia here) introduces the case as follows:

"The procedural aspects of the tax laws are of overriding importance in many controversies," one commentator has noted, "eclipsing or making moot substantive issues such as the allowance of deductions or credits, recognition or deferral of income, and methods of accounting." Theodore D. Peyser, 627-3rd Tax Management Portfolio, "Limitations Periods, Interest on Underpayments and Overpayments, and Mitigation" at 1 (2010). At times, the questions spawned by these procedures take on an almost "metaphysical" cast, Baral v. United States, 528 U.S. 431, 436, 120 S. Ct. 1006, 145 L. Ed. 2d 949 (2000), like "when is taxable income taxed?" The ontology needed to solve such abstruse inquiries comes not from philosophical tomes, but from Chapters 63 through 66 of the Internal Revenue Code of 1986, which supply interfused rules mapping the contours of commonly-used, but frequently-misunderstood, tax concepts such as "assessment," "deposit," and "overpayment." 

Though the background provided by these rules can be numbing in its intricacy, the dispute presented by the cross-motions for summary judgment pending before the court can be stated simply: Plaintiff, Principal Life Insurance Company and Subsidiaries (plaintiff or Principal) argues that it is entitled to certain overpayments because its taxes were not timely assessed by the Internal Revenue Service (IRS). Defendant responds that the taxes in question were timely assessed and that even if they were not, they are not recoverable as an overpayment. Plaintiff is wrong; defendant is right. It remains to explain why.

KEY FACTS:

Litigating Trust Fund Recovery Penalties -- the Flora Rule, Divisible Taxes and Unfairness (10/11/13)

UPDATE, most of the discussion below is still good, but Judge Wheeler of the Court of Federal Claims issued a new opinion going the opposite way and finding jurisdiction.  I posted a blog entry on the new opinion on 1/29/14.  See Revised Opinion in TFRP Case Involving Flora Full Payment Requirement (Federal Tax Procedure Blog 1/29/14), here.

Tax procedure enthusiasts will know the venerable Flora Rule, sometimes referred to as the Flora rule, after the case of Flora v. United States, 362 U.S. 145 (1960).  The following is a cut and paste of my explanation of this rule in my Federal Tax Procedure book (footnotes omitted):

In order to file a claim for refund and then sue for refund, the taxpayer must be able to assert that he or she overpaid taxes.  The critical question has been how much the taxpayer must pay in order to assert an overpayment.  The historical answer was that the taxpayer must have fully paid the assessment (which includes penalties and interest) in order to bring a refund suit.  This is referred to as the prepayment requirement which tax practitioners sometimes refer to as the Flora rule, after the Supreme Court case, Flora v. United States, 362 U.S. 145 (1960). 

Why is a prepayment rule important?  As the Supreme Court in Flora viewed the history and fabric of the procedures Congress adopted for tax litigation, any other rule would be counterproductive to those procedures.  Congress created the Tax Court as the forum for litigating most tax controversies.  The Tax Court is a prepayment judicial forum, and is the only prepayment judicial forum we have for resolving the merits of tax liabilities (excepting of course collection suits in the district courts).  If the IRS could assert a deficiency of, say, $100,000 and the taxpayer could get a prepayment remedy simply by paying $1 against the assessment that follows, the taxpayer could effectively turn the district courts into a prepayment forum. 

Of course, this highlights one of the problems with the prepayment rule.  A taxpayer who does not have the money to pay (the $100,000 assessed amount in the above example) doesn't really have a choice.  He or she must pursue the prepayment remedy in the Tax Court.  Is that fair?  Do citizens get better choices solely because they have substantial resources?  That is a policy question, and of course the answer is yes (just as substantial resources open up better and more choices throughout the law and life). 

Many authorities and commentators felt that Flora required full payment of not only the principal amount of tax liability, but also any penalties and interest assessed by the IRS.  This, of course, makes the cost of entry to refund litigation more expensive, particularly if distant years are involved where the interest can be more than the tax or penalties.  It is not unusual in tax cases involving old years to have the interest alone, because of the passage of time, cause the total bill with interest to triple or quadruple the principal amount involved.  With this “cost” of refund litigation, many taxpayers are forced to pursue the Tax Court route if it is available to them, as it is when income tax, estate and gift tax and certain types of miscellaneous tax liabilities are in dispute. 

As you can see, one of the issues is whether it is fair to force litigation into the Tax Court simply because the taxpayer is not rich.  (OK, that is a bit of hyperbole, but makes the point.)  And, some taxes and penalties like the TFRP cannot even get to the Tax Court (except late in the process via a CDP hearing, which is a relatively recent development). Accordingly, as I note in the book, the Courts have developed the divisible tax concept to mitigate some unfairness in the Flora rule.  The divisible tax concept (again from my book with only one footnote quoted) is:

Court of Federal Claims Holds that Unlimited Civil Statute of Limitations Requires Taxpayer's Fraud (10/3/13)

In BASR Partnership et al. v. United States, 113 Fed. Cl. 181 (2013), here, the Court of Federal Claims (Judge Susan G. Braden), in a partnership TEFRA proceeding, held that Section 6501(c)(1), here, required the taxpayer's fraudulent intent in order for the unlimited statute of limitations to apply.  In so holding, the Court rejected the reasoning and holding of Allen v. Commissioner, 128 T.C. 37, 40 (2007), here, and of the Second Circuit in City Wide Transit, Inc. v. Commissioner, 709 F.3d 102 (2d Cir. 2013), here.  (Note:  I think the is Judge Braden's bottom-line holding, although one has to work through the TEFRA context and special Section 6229 rules to get there; see the TEFRA summary at the end of the blog.)

In BASR, the partnership reported a fraudulent tax shelter item that, under the partnership reporting rules found its way to the ultimate taxpayer's returns in a way that was less visible to the IRS.  Apparently in order to test the legal position that Section 6501(c)(1) applied at the partnership level solely by virtue of the return finding its way to individual taxpayer's return, the IRS did not urge that the taxpayers signing the ultimate returns had the required fraudulent intent.  Hence, the only issue was whether the reporting of a fraudulent item on the ultimate taxpayers' returns was alone sufficient to invoke Section 6501(c)(1).

The statutory text at issue is as follows (Section 6501(c)(1)):

(1) False return. -- In the case of a false or fraudulent return with the intent to evade tax, the tax may be assessed, or a proceeding in court for collection of such tax may be begun without assessment, at any time.

Textually, there is no requirement that the requisite intent be the taxpayer's intent.  Read literally, therefore, fraud on the return will invoke Section 6501(c)(1).  Essentially, that is the holding of the Judge Kroupa in Allen.  Judge Kroupa in Allen just could not find any other persuasive interpretive sources that could permit her to say that the statute should be read to limit the "intent" to the taxpayer's intent.

A literalist or strict constructionist such as Justice Scalia would, I project, have reached the same conclusion as Judge Kroupa.  The statute appears plain on its face and contains no explicit or implicit ambiguity regarding who must be the author of the fraud that is on the return.

The question is whether there are other sources for interpretation that would permit a court to hold that a limitation that it be the taxpayer's fraudulent intent can be read into the text (meaning, I supposed, that the text is not so plain when the other sources are consulted).  When and how courts undertake such an extra-textual inquiry is a broad subject in the law, so I cannot do little more than say that it is undertaken if the reviewing court finds the text itself not to be plain.  It all depends upon what plain is.  That is the process that Judge Braden undertook.

Judge Braden started her analysis with Section 6501(a) which states the general rule that the assessment statute of limitations is three years from the date the return is filed.  Judge Braden noted the following text in Section 6501(a) that the return in question is  "the return to be filed by the taxpayer (and does not include a return of any person from whom the taxpayer received an item of income gain, loss, deduction, or credit)."  In other words, for example, a partnership return does not affect the application of Section 6501(a) to the partner's return even though the partner reports partnership items.  That is an unstartling proposition.

Good Review Case on Claims for Refund and Variance for Tax Procedure Students (9/14/13)

In Cencast Services, L.P. v. United States, 729 F.3d 1352 (Fed. Cir. 2013), here, the Federal Circuit (Judge Dyk) held that 

1.  "Cencast's liability for employment taxes under the Federal Unemployment Tax Act ('FUTA') and the Federal Insurance Contribution Act ('FICA') is determined by reference to the employees' "employment" relationships with the common law employers for which Cencast remits taxes (i.e., the production companies), and that the common law employers cannot decrease their liability by retaining entities such as Cencast to actually make the wage payments to the employees."

2.  Cencast is barred by the doctrine of variance from raising a theory in its refund suit not raised in its claim for refund.  The new argument was that some of the workers were independent contractors rather than employees.

First, it is useful to note the role served by Cencast and the other companies involved in the suit because it offers a small window into the movie production business.  Here is the background from the opinion:

The evolution of the motion picture and television industries over the past century has resulted in this tax case concerning FUTA and FICA tax liability. In the early part of the twentieth century, motion picture productions were primarily controlled by large, major motion picture and television studios, and production workers enjoyed long-term, continuous employment relationships with those studios. These studios paid wages to these employees, and, as the common law employers of these workers, were liable for employment taxes on those wages, and remitted those taxes directly to the Internal Revenue Service ("IRS"). 

Since the late 1970s, however, many smaller production companies have emerged and have created movies and television programs independently from the large studios. As a result of this trend, many production workers are now employed by several different production companies during the course of a year, rather than by a single large production studio. Thus, in any given year, a given production worker might earn wages from several production companies, all of whom (being common law employers) would be individually liable for employment taxes on those wages. The complex web of production companies and production workers that evolved made administration of payroll, benefits, collective bargaining agreements, and taxes increasingly difficult. 

Entities like Cencast, which are also known as payroll service companies ("Service Companies"), emerged to address these problems. Over the last twenty-five years, virtually all independent production companies have contracted with Service Companies for payroll and related services. Cencast and other Service Companies compute and pay compensation to production workers, report and pay compensation to multi-employer pension and benefit funds, provide post-production financial reporting, and pay employment taxes to the IRS. 

Although they contract with the Service Companies, production companies both hire and supervise the individual production workers—as they had done in the pre-Service Company era. In general, Cencast and other Service Companies have no role in selecting or supervising production workers. The only change is that entities like Cencast—and not the production companies—now pay the production workers and administer the production companies' payroll and employment tax obligations. It is undisputed in this case that Cencast is not the common law employer of production workers.

Appeals Judicial Approach and Culture Project (AJAC) (9/10/13)

Stephen Olsen blogs on the Procedurally Taxing blog on IRS's appeals new initiative / approach, called Appeals Judicial Approach and Culture Project (AJAC).  See Stephen Olsen, AJAC is here! (Procedurally Taxing 9/9/13), here.  I highly recommend that blog entry to tax procedure afficionados.  (Note that one advantage is that the authors of the Procedurally Taxing Blog has appropriate materials from and references to the Saltzman and Book treatise which is the most cited treatise on tax procedure.)

I had recently blogged on AJAC's new issues approach, New Policy Statement That Appeals Is Not to Raise New Issues (Federal Tax Procedure Blog 7/23/13), here.