Peter Reilly on Real Estate Phantom Taxable Income Gaming the Audit Lottery (8/13/20)

Peter Reilly, a friend and frequent tax commenter, has this offering on his Forbes blog:  IRS Veteran Insists That IRS Is Missing Billions In Real Estate Gains (Forbes 8/11/20), here.  Basically, Peter deals with tools that the IRS has in its system that his informant asserts can locate large amounts of income that goes unreported through the phantom income that arises from real estate losses funded by nonrecourse debt.  I am not familiar with the IRS systems that could police the reporting of the income, but I do note (as does Peter) that there is a new IRS initiative for the partnership to report partner level basis.  See Notice 2020-43, here; see also Peter’s discussion on another blog Who Is IRS Aiming At In Recent Partnership Notice? (Your Tax Matters Partner 6/21/20), here.

Those who are partnership tax gurus will like Peter’s offerings and maybe even understand them.  As an aside, my practice over the recent years have not focused on partnership tax, so I am a bit long in the tooth on that.  (Except that I do cover the procedural aspects of the TEFRA and CPAR (often called BBA) regimes, and earlier in my private practice while substantially involved with real estate partnerships (and teaching Real Estate Taxation at UH Law School), I did have particular interest in partnership taxation originating from my handling of the appeal Diamond v. Commissioner, 492 F.2d 286 (7th Cir. 1974), here, a leading case in partnership taxation.  (The Diamond opinion was quite controversial, but in my mind just involved elemental tax principles correctly applied; but the real estate industry was quite powerful and managed to whittle away the results and essentially reverse through IRS administrative largesse, hence the carried interest notion, but I won't go off further on that rant here.)

Peter’s Forbes offering did cover some significant tax history related to Crane v. Commissioner, 331 U.S. 1, 14 n.37 (1947), here, and its tax infamous footnote 37. All tax students and practitioners should have at least a passing acquaintance with that footnote, said to be the most famous footnote in tax history.  Footnote 37 should also mitigate against the expression of apparent disdain for footnotes that Justice Scalia once made in oral argument (I cover Scalia’s statement in both editions of my book).  Footnote 37 said:

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.

That footnote spawned a myriad of offerings exploiting nonrecourse debt to generate deductions with the notion (or hope) that the taxpayer would not have to balance the books with so-called phantom taxable income at the end.  Those shelters proliferated particularly in the 1970s involving both real estate where lenders might make economic nonrecourse loans in the real world and in other contexts where the nonrecourse loan was basically phony (or magic).  The Supreme Court put an end to (or at least curbed somewhat) that magical thinking in Commissioner v. Tufts, 461 U.S. 300 (1983), here, requiring the taxpayer to include the amount of the nonrecourse debt in the amount realized part of the gain calculation upon foreclosure or deed in lieu of foreclosure, thus at least leaving the taxpayer with deferral and conversion shelter from playing the nonrecourse debt game.  

Chevron and Lenity (8/11/20)

Today, I discuss the related topics of Chevron deference and the rule of lenity.  Both topics deal with ambiguity in statutory text.  Chevron deference means that a court may apply some reasonable agency interpretation of statutory text even if the court is convinced that there is a better interpretation.  In other words, within the zone of ambiguity the interpretive tilt goes to the agency's interpretation.  In lenity, a criminal law concept, however, within the zone of ambiguity, the tilt goes to the defendant.

 I was drawn to this topic by a decision I read today, Gallardo v. Barr, 968 F.3d 1053 (9th Cir. 8/6/20), CA9 Slip Op. here; GS here.  The case involved the BIA’s interpretation of the term “aggravated felony” (and its subset, “obstruction of justice”) was subject to the rule of lenity.  The panel took the traditional view that the rule of lenity was not consistent with Chevron deference.  As thus formulated, the lenity issue would be a so-called Chevron Step Zero question (does the Chevron framework apply at all?) that could pre-empt the Chevron framework at the outset.  The panel sidestepped the question by applying the Chevron framework because a prior panel in an earlier appeal in the case had applied the Chevron framework.  (See Slip Op. 11-17.)  The Court offered this general discussion in a footnote (Slip Op. 14 n. 3, here)

   n3 Statutory ambiguity is a trigger for applying both the rule of lenity and Chevron deference. However, we apply the rule of lenity when a criminal statute is ambiguous so that "legislatures, not courts" define the scope of the statute. Crandon v. United States, 494 U.S. 152, 158 (1990). By contrast, we apply Chevron deference in construing ambiguity in other statutes because the lack of textual clarity is a signal that Congress expected an "agency to be able to speak with the force of law when it addresses [the textual] ambiguity." United States v. Mead Corp., 533 U.S. 218, 229 (2001). In other words, because lenity is a rule we apply to ensure that the legislature has the final say, and Chevron is a rule we apply to permit agencies to fill in the details of a statute, we do not typically apply both principles at the same time. See Whitman, 135 S. Ct. at 354 (Scalia, J., respecting the denial of certiorari) ("[O]nly the legislature may define crimes and fix punishments. Congress cannot, through ambiguity, effectively leave that function . . . to the administrative bureaucracy." (emphasis omitted)); see also Transcript of Oral Argument at 12, Esquivel-Quintana v. Lynch, 137 S. Ct. 1562 (2017) (Chief Justice Roberts stating that the rule of lenity and Chevron cannot "coexist" because, at least in that case, "[t]hey each point in the opposite direction based on the same predicate, which is a degree of ambiguity in the statutory provision"); William N. Eskridge, Jr. & Lauren E. Baer, The Continuum of Deference: Supreme Court Treatment of Agency Statutory Interpretations From Chevron to Hamdan, 96 Geo. L.J. 1083, 1115 (2008) (regarding "anti-deference" in the context of a criminal statute). However, some have discussed ways that the two rules may be harmonized. See Note, William T. Gillis, An Unstable Equilibrium: Evaluating the "Third Way" Between Chevron Deference and the Rule of Lenity, 12 N.Y.U. J.L. & Liberty 352 (2019).

 I offer the following (text only) (Those wanting the footnotes can get them with the text in pdf format here).

FTPB 2020 Update 01 - Reliance Regulations (Category of Proposed Regulations) (8/8/20)

I provide Federal Tax Procedure book update to the discussion on proposed regulations to add the category of reliance regulations.  The update is here.  (The cumulative list of updates is on the page linked in the right column titled Federal Tax Procedure Book Updates, here.)  In brief, although taxpayers may generally not rely on proposed regulations, they may rely if:  (i) there are no applicable final or temporary regulations and (ii) the IRS so states in the preamble to the proposed regulation.  In addition, IRS attorneys should should generally take positions consistent with proposed regulations.

Ninth Circuit Holds that Taxpayer Waived Attorney-Client Privilege and Factual Work Product Protection (8/8/20)

In United States v. Sanmina Corp., ___ F.3d ___ (9^th Cir. 2020), here, the taxpayer’s in-house counsel prepared two memoranda supporting a very large deduction the taxpayer claimed.  The taxpayer provided the memoranda to an outside law firm which prepared a valuation report supporting the claim.  The valuation report referenced the memoranda.  The taxpayer gave the  valuation report to the IRS in support of the claim.  The IRS summonsed the memoranda.  The taxpayer resisted, asserting the attorney-client privilege and work product protection.  The IRS petitioned to enforce the summons.  When the smoke cleared in the opinion, the Court held that the taxpayer’s disclosure to the firm preparing the valuation report waived the attorney-client privilege and was not consistent with work-product protection, so that the factual matter in the memoranda (as opposed to the opinion work product) must be disclosed to the IRS pursuant to the summons.

The holding is important but not that exceptional, so I provide readers here the summary offered by the Court of Appeals (a feature for Ninth Circuit precedential opinions similar to the Tax Court’s summary for T.C. opinions; the Ninth Circuit  summary is not precedential and is prepared by staff for the convenience of readers):

SUMMARY

Tax

The panel affirmed in part and reversed in part the district court’s determination, that taxpayer Sanmina Corporation  had waived attorney-client privilege and workproduct protection for certain memoranda prepared in support of a  worthless stock deduction on Sanmina’s federal tax return, in a petition by the Internal Revenue Service to enforce a summons for those memoranda.

The memoranda in question (Attorney Memos) were authored by Sanmina’s in-house counsel and referenced in a valuation report prepared by DLA Piper (DLA Piper Report) in support of the worthless stock deduction. The district court initially denied enforcement of the summons. This court remanded for in camera review of the Attorney Memos. On remand, the district court determined that the Attorney Memos were covered by both attorney-client privilege and work-product protection, but that those privileges had been waived. On appeal, the parties did not dispute that the Attorney Memos were privileged.

The panel first held that Sanmina expressly waived the attorney-client privilege when it disclosed the Attorney Memos  to DLA Piper. The panel next held that Sanmina did not expressly waive work-product immunity merely by providing the  Attorney Memos to DLA Piper, but it impliedly waived the privilege when it subsequently used the DLA Piper Report to support its tax deduction in an IRS audit, because such use was inconsistent with the maintenance of secrecy against its adversary. The panel ordered disclosure of only the factual content of the Attorney Memos on which the DLA Piper Report relies, and remanded for the district court to determine the specific portions of the Attorney Memos that  should be disclosed to the IRS.

JAT Comments:

True or False: "Treasury and the IRS do not have a great history of complying with APA procedures" (8/5/20; 10/27/22)

I have substantially revised this blog entry to address the issue of Chevron's period of being controversial.  In my original posting, I suggested that, despite claims to the contrary, Chevron was not always controversial.  The modifications here clarify that deference to reasonable agency interpretations of statutory text was not controversial, particularly at the Supreme Court level, pre-Chevron and then post-Chevron until fairly recently.  I provide more nuance on that claim and cite to academic "controversy" much longer than the core concept began certain Supreme Court Justices' recent noisings about Chevron deference.  I indicate in red (sort of like red-lining) the significant revised statements.

As I previously blogged, the Supreme Court granted the petition for writ of certiorari in CIC Services LLC v. IRS, 925 F.3d 247 (6th Cir. 2019), here, reh. den.  936 F.3d 501 (6th Cir. 2019), cert. granted 2020 U.S. LEXIS 2605 (U.S., May 4, 2020).  See Certiorari Granted in CIC Servs on AIA Application to Pre-enforcement Guidance Challenges (Federal Tax Procedure Blog 5/12/20), here.  The question in the Supreme Court is:

Whether the Anti-Injunction Act’s bar on lawsuits for the purpose of restraining the assessment or collection of taxes also bars challenges to unlawful regulatory mandates issued by administrative agencies that are not taxes.

Basically, the issue is whether the affected public (generally referred to in a tax context as “taxpayers”) may litigate IRS positions that may have penalty consequences soon after the IRS publishes the positions in some type of guidance document or must await enforcement of the penalties which may be years after publication.  Historically, taxpayers must await enforcement of IRS tax positions because of certain policies related to the need for prompt collection of revenue.  Those policies are most prominently seen in the Anti Injunction Act, § 7421(a), the focus of CIC.

There is a general rule in administrative law that agency positions may be challenged in pre-enforcement litigation.  That general rule may be subject to exceptions.  In the tax arena, that general rule has not applied for fiscal imperatives embodied in legislation, particularly the Anti-Injunction Act, § 7421(a), playing prominently in CIC.  I will not delve further into the merits of the issue the Supreme Court will consider.

But I do want to address something that I think is misinformation in the trajectory of CIC that may bleed into the Supreme Court’s consideration.  The original panel opinion in CIC, here, concluded with something like a lament that it drew from a law review article as follows (pp. 258-259):

The broader legal context in which this case has been brought is not lost on this Court. Defendants "do not have a great history of complying with APA procedures, having claimed for several decades that their rules and regulations are exempt from those requirements." Hickman & Gerska (sic), supra, at 1712-13. And despite the jurisdictional nature of this appeal, Plaintiff has made its thoughts on the merits abundantly clear, emphasizing that "Notice 2016-66's Issuance and Enforcement is an Obvious Violation of the APA." (Reply Brief for Appellant at 4.) But that does not  in and of itself give federal district courts subject matter jurisdiction over suits seeking to enjoin the assessment or collection of taxes. Absent further instruction from Congress or the Supreme Court, such suits are barred by the AIA.

The article cited is Kristin E. Hickman & Gerald Kerska, Restoring the Lost Anti-Injunction Act, 103 Va. L. Rev. 1683, 1686 (2017), here.  (In the quote, the Court does misspell Kerska, which is surprising because it got the spelling right when citing the article earlier in the opinion; and the misspelling may have been corrected by the time the case was printed for F.3d.)

The issue I address is the quoted proposition asserted in the article and apparently accepted by the Sixth Circuit panel.  To repeat that proposition is:  “Treasury and the IRS do not have a great history of complying with APA procedures, having claimed for several decades that their rules and regulations are exempt from those requirements.”  The Sixth Circuit thought the claim so significant that it quoted it in the conclusion to the opinion.  I think the claim is wrong.

2020 Federal Tax Procedure Book Editions Finished; Available on SSRN (8/1/20)

I just finished my 2020 Federal Tax Procedure Book Student and Practitioner Editions.  I have submitted them to SSRN.  They now appear on my SSRN author page (even though not yet formally approved by SSRN; I can't explain that, but just take it as it is).  These editions may be downloaded as follows:

• Federal Tax Procedure (2020 Student Ed.), here.
• Federal Tax Procedure (2020 Practitioner Ed.), here.

Information about these editions is presented on the page to the right titled "2020 Federal Tax Procedure Book," here.

SSRN Technical Note:  Those who look at my SSRN author page, here, may note that doing a reverse chronological sorting will not show these books as the latest.  I presume that is because SSRN has not yet approved; hence in the list on the author page there is no date.  I presume that a date is added on the SSRN author page listing when SSRN approves, so, for example, reverse chronological sorting by date posted will work.

The Unspotted Issue in an Audit; Ethics and Crimes (7/24/20; 8/2/20)

In an ABA Tax Section Court Procedure Virtual meeting on Wednesday, there was a one-hour discussion of ethical issues in handling a matter in the Tax Court.  The participants in the discussion were:

• Judge L. Paige Marvel, United States Tax Court, Washington, D.C.
• Elizabeth G. Chirich, Chief, Branch 1, Procedure & Administration, IRS Office of Chief Counsel, Washington, D.C.
• Guinevere Moore, Moore Tax Law Group, LLC, Chicago, IL
• Kandyce Korotky, Covington & Burling, Washington, D.C. (Moderator)
• Mitchell I. Horowitz, Buchanan Ingersoll & Rooney P.C., Tampa, FL

The discussion was excellent.  I highly recommend those who can access the recording of the event on the ABA web site to do so.  (I would provide a link but have not yet located the link, perhaps because the recording has not yet been put up.)

During the discussion I posted two questions which, apparently because of time, the participants did not respond to.  I offer the questions and some comment here.  The questions were:

1.        Question : What if the IRS sets up only one issue in the notice of deficiency and the IRS never spotted a big issue involving omitted income. There is no real gray area in the unspotted issue; the taxpayer clearly would owe tax if the unspotted issue were fully litigated (indeed taxpayer's counsel did not think she could even make a nonfrivolous argument that the omitted income should not have been included). After filing the petition, IRS Counsel offers to concede that one issue (the spotted issue in the NOD) and sends a stipulated decision document saying that the deficiency is $0. Because the taxpayers' counsel knows that stipulation that there is no deficiency is not true, can the taxpayers' counsel sign the stipulated decision?
2.        Question: This may be a philosophical question rather than one you can answer here:  What good are ethical rules when they don't provide answers -- i.e., when different ethical lawyers acting ethically can reach different conclusions -- does that simply reward the aggressive attorney (who may even be a lawyer who charges for the benefit offered to the taxpayer by being aggressive within the ambiguities -- even creative ambiguities -- in the ethical rules) and the taxpayer engaging this ethically aggressive attorney?  And would about the more conservative ethical attorney and his client?  Is the ethically conservative attorney providing less than ethically aggressive representation then not zealously representing the client?  There is more but I'll stop there?

The second question is more philosophical, so I will focus on the first question.  Here is the key background:

Supreme Court Notes of Revisions to Slip Opinions (7/15/20)

Readers of Supreme Court Slip Opinions have undoubtedly noticed the following caveat at the beginning of the majority or plurality opinions:

NOTICE: This opinion is subject to formal revision before publication in the preliminary print of the United States Reports. Readers are requested to notify the Reporter of Decisions, Supreme Court of the United States, Washington, D.  C. 20543, of any typographical or other formal errors, in order that corrections may be made before the preliminary print goes to press.

So, I suppose that if you are working from the Slip Opinion that you downloaded or perhaps cut and pasted in whole or in part (as I often do), it would behoove you to check for revisions.  I assume that the various standard services (WestLaw, Lexis-Nexis, etc.) routinely update their versions of the opinions for that, so users of those services can be reasonably assured that they are working from opinions with the revisions.  (I don't know whether those services alert readers that the text has been revised and, if so, what text was revised.)  But those working from the Slip Opinion (unless viewed on the web site that) should check for the revisions.

I just learned today that there is a way to determine whether the original Slip Opinion has been revised.  The Court publishes notice that opinions have been revised.  You have to look in a particular place, because my docket search for one case for which the Slip Opinion had been revised did not show that the opinion had been revised.  See e.g., the docket for Seila Law LLC v. CPFB, ___ U.S. ___, ___ S.Ct. ___ (2020).  The opinion is here and the docket is here.  Neither indicate that the opinion has been revised.

The Court's notice of revision appears in a reverse chronological list of opinions by term, that links to the opinion and shows, with links, the date(s) of revisions, if any. The list is here.  For the Seila Law opinion originally rendered in June 2020, noted above, the list shows as of today a revision on 7/8/20 and the linked document showing the revisions is here.  My quick review of the decided cases for the 2019 term did not indicate any revisions in tax cases.

I suppose there might be other places on the Court's website where changes are noted, but I don't know of them.  The safer bet would be to review the list linked above.

My thanks to an article in the Supreme Court Brief email today by Tony Mauro from Law.com under the title “Revisions in Decisions.”  The article notes that the Supreme Court began publishing notes of revisions in 2015 in response to a law review article critiquing the practice of otherwise secret revisions.  Prior to the new practice, when the Slip Opinion was revised, the Slip Opinion was changed on the Court’s site but no notice of where the revision was made was given.  Since 2015, the Court has given notice as indicated above.  The article notes:

Some of the revisions are minor but amusing, as in 2018 when Justice Stephen Breyer, a French-speaking francophile, misspelled “laissez faire” as “lassez faire.” But other revisions have some significance. Here are the changes made in June 2020 decisions: 

>> In Seila v. CPFB, Justice Clarence Thomas made reference to the 1988 Morrison v. Olson decision and “all nine members” who participated in the case. The revision clarified that Morrison was ruled on by eight justices, with Justice Anthony Kennedy recused. 

>> In Financial Oversight and Management Board for Puerto Rico v. Aurelius Investment Justice Sonia Sotomayor, in a concurrence, wrote that the “people of Puerto Rico approved the modified Constitution” of Puerto Rico in 1952. The revision stated that, in fact, Puerto Rico’s “constitutional convention approved the modified Constitution.” 

>> Three days later, a second change in Sotomayor’s concurrence established that after the convention was approved, “the people of Puerto Rico subsequently ratified modifications in another referendum.”  

So far, no revisions have been made in the 10 decisions issued by the court in the spillover period of July. 

Baude NYT Opinion Piece on Originalism and My Questions (7/10/20; 7/13/20)

I alert readers to William Baude's excellent opinion piece in NYT yesterday:  Conservatives, Don’t Give Up on Your Principles or the Supreme Court (NYT 7/9/20), here.  For persons interested in constitutional interpretation (and the subset of statutory interpretation, both being interpretations of law), I recommend the article.  Baude, here, is a professor at the University of Chicago Law School.  I have cited Baude frequently on this blog.  See here.

I was going to leave a comment on the NYT page addressed to Professor Baude (although not expecting him to respond to a comment on the News page but hoping to draw responses from others).  But, alas, I could not figure out how to leave a comment.  So, I will post here my intended comment to the opinion piece in the hope that any of the readers here might want to comment either on this blog page or by email to me at jack@tjtaxlaw.com.

The comment is:

I address this question to Professor Baude (who is probably too busy to respond) but encourage anyone else having ideas on my comments to weigh in. 

Professor Baude, 

I read your NYT op-ed today with great interest, since I became interested in statutory (and, by extension,  constitutional) interpretation incident to teaching tax procedure at the University of Houston law school.  I have read a lot of your work and find it generally excellent, even when I do not necessarily agree with it.  Always worth considering.  So thank you for your continuing offerings on this subject. 

You say good things about originalism.  I am curious about what brand of originalism you find most attractive.  For constitutional interpretation, my sense is that most originalists claim that they search for the "original public meaning." Original public meaning is not what the drafters meant by the text drafted and approved but what some mythical contemporaneous public person not involved in the legislative process would have interpreted the words to mean.  Jed Rakove tongue in cheek says that might be Joe the Ploughman.

Whose Intent is Relevant for Interpreting Text -- the Drafters of the Text (Constitution or Statute) Or the Mythical Contemporaneous Public Person, Say Joe the Ploughman? (7/8/20)

In Chiafalo v. Washington, ___ U.S. ___, ___ S.Ct. ___ (7/6/20), here, the Court held (from the Syllabus):  “A State may enforce an elector’s pledge to support his party’s nominee—and the state voters’ choice—for President.”  I’ll just take that bare holding (without nuance) as stated in the quote.  What I want to address today is the majority opinion in which the draft, Justice Kagan, and seven other Justices joined (except that Justice Gorsuch joined Justice Thomas’ consent for the part relevant to this discussion).

I speak here of the proper referent when looking to the original meaning of text—in this case, constitutional text but also including legislative text.  Much bandied about by conservatives and libertarians is the notion of “original public meaning” which is usually refers to the meaning that some hypothetical hearer or reader of the text (constitutional or legislative) might give the text at the time of adoption or enactment.  In Bostock v. Clayton County, 590 U.S. ___, ___ S.Ct. ___ (6/16/20), here, a statutory interpretation case, the Justices seem to sign onto the notion that original public meaning was the proper referent rather than the intent of the legislators.  See Supreme Court Case on Statutory Interpretation (Federal Tax Procedure Blog 6/16/20; 6/24/20), here.

In Chiafalo, a constitutional interpretation case, the majority did not mention any notion of referring to original public meaning and instead referred to the words of the Constitution and the words of the Framers.  In his dissent, Justice Thomas takes the majority to task on this issue as follows (dissenting opinion p. 12):  “[T]he Framers’ expectations aid our interpretive inquiry only to the extent that they provide evidence of the original public meaning of the Constitution.”  The majority opinion does not frame its use of the Framers’ words as being used solely to determine the original public meaning.

So, which is it?  I don’t know.

I do know that the drafters of constitutions or legislation is done not by mythical members of the original public but by duly chosen representatives (either in a constitutional convention or a legislature).  They were chosen to act for the constituencies they represented.  If representative democracy means anything, surely it means that these chosen representatives speak for the communities they represent and their intentions mean something.  What are they—potted plants?  (Evoking the famous words of Brendan Sullivan in the congressional hearings in the Iran-Contra scandal, see Wikipedia here.  To know what their intent (and by representation their constituencies’ intent), what they said is relevant  to the interpretation of the text.  What some mythical person at the time, like Joe the Ploughman, might have thought the words meant is not really relevant in a representative democracy.  (On Joe the Ploughman, see Jack N. Rakove, Joe the Ploughman Reads the Constitution, or, the Poverty of Public Meaning Originalism, 48 San Diego L. Rev. 575 (2011), here.)  If we are talking about lenity or some similar concept for penalties, that is another issue because the public's ability to discern the meaning from the text is relevant, but if outside that context, the drill ought to be to interpret the statute in a manner consistent with the text and the intent of the representative drafters.

That is why I continue to think that, particularly in my field of interest (taxation), the legislative history is worthy of consideration.  Generally, tax legislative history is pretty good because of the quality of the nonpartisan Joint Committee Staff that has a substantial hand in the process of producing legislative history.  That does not mean legislative history should control.  Some legislative history is persuasive; some is not.  Like any other evidence, the judge must be discerning.  It is their job to be discerning and not throw out the baby with the bath water.