After The Shutdown: Dealing with Time Limitations, Part III

Today Professor Bryan Camp returns for Part III of the series “After the Shutdown,” in which he examines the time limit for appealing a notice of deficiency. Now that the government has reopened, Professor Camp’s analysis may soon be tested in the Tax Court. The Tax Court’s website advises that the court will resume full operations on Monday, January 28, and that the February 25 trial sessions will proceed as scheduled. Christine

Part I discussed how a reopened Tax Court might apply the Guralnik case to ostensibly late-filed petitions.  The Tax Court is likely to apply Guralnik narrowly which means petitions not filed on the first day the Court reopens will be outside their Statutes of Limitation, putting the SOL in SOL.  Equitable tolling could help cure that problem but the Tax Court takes the position that it cannot apply equitable doctrines to the time periods for taxpayers to petition the Tax Court because, in its view, those time periods are jurisdictional restrictions on its powers.   

Part II explained the new thinking about how jurisdictional time periods differ from non-jurisdictional.  I read the opinions and drew out five indeterminate factors that the Supreme Court instructs lower courts to consider when deciding whether a particular statutory time period is jurisdictional or merely a “claims processing rule.”   

Today’s post applies the rules to the 90/150 day period in §6213.  The most reasonable conclusion under the new thinking is that §6213 is not a jurisdictional time period. That means that the Tax Court can apply equitable principles to decide whether an ostensibly late-filed petition is timely or not.  And when the Tax Court is closed for more than 33 days in a row, that is a big start to an equitable tolling analysis for those cases that cannot fit within a narrow or even a broad application of Guralnik.

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Four of the five factors point to treating §6213 as a claims processing rule.  Again, this is basically a summary of what I have written in this paper posted on SSRN.  As usual, please comment on any errors or omissions that you spot. 

  1. Mandatory Language

As it currently reads, §6213(a) now contains five sentences.  The first sentence contains the limitations period, as follows: “Within 90 days, or 150 days if the notice is addressed to a person outside the United States, after the notice of deficiency authorized in section 6212 is mailed … the taxpayer may file a petition with the Tax Court for a redetermination of the deficiency.” 

Notice there is no mandatory language.  Nothing in that sentence tells the reader what happens if the taxpayer misses the 90/150 day deadline.  And nothing in that sentence gives the Tax Court the power to hear or decide matters raised in the petition. 

  1. Magic Words

The word “jurisdiction” does not appear in the first sentence.  One finds the jurisdictional grant to the Tax Court over in §6214, which provides that the Tax Court has “jurisdiction to redetermine the correct amount of the deficiency even if the amount so redetermined is greater than the amount of the deficiency…and to determine whether any additional amount, or any addition to the tax should be assessed, if claim therefor is asserted by the Secretary at or before the hearing or a rehearing.”  The §6214 power to redetermine a deficiency is simply not hooked into the §6213 timing rule.  

The fourth sentence of §6213 does contain the magic word “jurisdiction.”  But, as I explain in much greater detail in my paper on SSRN, while the word “jurisdiction” does appear in the fourth sentence, it is not there tied to the Court’s power to redetermine a deficiency.  It was added to the Tax Court much, much, later than first sentence and later than the §6214 jurisdictional language.  

  1. Statutory Context

 As I explain in my SSRN paper, Congress first gave the Tax Court jurisdiction to redetermine a proposed deficiency in 1924.  It did that in a statute separate from the 90/150 day limitation period.  The codifiers also put that jurisdictional grant in a separate section of the Tax Code, both in the 1939 Code and the 1954 Code.

Much later, in 1954, Congress added to the Tax Court’s jurisdiction the power to enjoin the IRS from assessing or collecting a tax liability when the taxpayer had filed a timely petition.  The codifiers put that injunctive power in the same statute as the 90/150 limitation period and conditioned that power on a timely petition being filed.  But the Tax Court’s jurisdiction to redetermine a deficiency is still in a separate statute.

As applied to the shutdown, that distinction possibly makes a difference.  The IRS computers will automatically set up an assessment if no IRS employee inputs the Transaction Code (TC) indicating that a petition has been filed in the Tax Court.  To account for notification delays, the computers are programmed to wait 110 days after the NOD date before setting up the assessment.  Readers should understand that assessments are made in bulk.  Each week, all the assessments that are ready to be made are aggregated into a single document that is signed, either physically or electronically, by a designated official and, hey presto, all of the taxpayers who were set up for that week are now assessed.

The problem in the shutdown is that the IRS computers keep counting the shutdown days as part of the 110 days.  So if and when the Tax Court decides that a petition ostensibly filed 140 days late is actually timely, whether under a narrow or broad reading of Guralnik or under equitable principles, the question arises as to what to do about that assessment.  The IRS should abate the assessment as §6404 authorizes when an assessment “is erroneously or illegally assessed.” 

  1. Judicial Context

 This is the only factor that supports reading §6213 as jurisdictional.  But it’s not especially strong because it consists only of lower court precedent that relies on other lower court precedent.  As I explained in Part II, the Supreme Court has not hesitated to scrub even long-standing lower court precedent when it believes the new thinking requires a different result.  The only judicial context that counts for the Supremes is their own former opinions!      

Still, there is plenty of lower court precedent holding that §6213 is jurisdictional.  First, the most recent Tax Court case to express an opinion about §6213 was—you guessed it— Guralnik.  That was in 2016.  But the Court in Gurlanik chose to look exclusively at only this factor and gave no analysis on the other four factors, saying:

In cases too numerous to mention, dating back to 1924, we have held that the statutorily-prescribed filing period in deficiency cases is jurisdictional. See, e.g., Satovsky v. Commissioner, 1 B.T.A. 22, 24 (1924); Block v. Commissioner, 2 T.C. 761, 762 (1943). Even if the “equitable tolling” argument advanced by petitioner and amicus curiae were otherwise persuasive, which it is not, we would decline to adopt that argument solely on grounds of stare decisis.

The error here is in relying on old thinking.  As I explained in Part II and also in my paper, the Supreme Court keeps emphasizing that courts should not rely solely on precedent developed under the old thinking.  In particular, my paper looks at both the cases cited by Guralnik here and not only shows how neither is particularly useful but also discovers that the Tax Court itself no longer follows Block’s rationale on how to count jurisdictional time periods!   

The most recent Circuit Court opinion of note is Tilden v. Commissioner, 846 F.3d 882 (7th Cir. 2017).  There, Judge Easterbrook gave two reasons for holding that §6213 was jurisdictional.  First, he swooned over the magic word “jurisdiction” in §6213 and totally ignored how it related, or did not relate, to the 90/150 time period.  Second, he relied on—wait for it—wait for it—Guralnik!

For many decades the Tax Court and multiple courts of appeals have deemed § 6213(a) as a whole to be a jurisdictional limit on the Tax Court’s adjudicatory competence. [String cite omitted]. We think that it would be imprudent to reject that body of precedent, which places the Tax Court and the Court of Federal Claims, two Article I tribunals, on an equal footing. So we accept Guralnik’s conclusion and treat the statutory filing deadline as a jurisdictional one.

What is especially sad here is that the string cite that I omitted from the quote does not contain a single case after 1995.  Nor could it.  There is not a single court case—much less one from the Supreme Court—that actually analyzes §6213 under the Supreme Court’s new thinking and applies all the factors.   

  1. Legislative Context

The legislative context of §6213(a) also supports reading the provision as a claims-processing rule and not as a jurisdictional requirement.  The legislative context is very similar to that which the Supreme Court found so important in Henderson v. Shinseki, 562 U.S. 428 (2011) discussed in Part II.  In brief, Congress created the original Board of Tax Appeals to give taxpayers a theretofore unavailable judicial remedy.  The legislation creating the BTA was manifestly remedial.   

The remedial nature of deficiency proceedings has been long recognized by the Supreme Court.  I think Helvering v. Taylor, 293 U.S. 507 (1935) is particularly instructive.  There, the taxpayers proved that the Notice of Deficiency contained significant error.  The government argued that taxpayers had to not just show the NOD was wrong but also had to prove up their correct tax.  The Supreme Court responded this way: “The rule for which the Commissioner here contends is not consonant with the great remedial purposes of the legislation creating the Board of Tax Appeals.”

The Tax Court itself has used the remedial nature of deficiency proceedings to soften the effect of its continued holding that §6213 is jurisdictional.  In effect, the Tax Court “cheats” on applying §6213 by choosing from among multiple starting dates to help taxpayers meet the 90 day requirement.  It does so because it recognizes the legislative context of the deadline.  I explain this in my article Equitable Principles and Jurisdictional Time Periods, Part II, 159 Tax Notes 1581 (free download here).

It would be no stretch at all for the Tax Court to apply that precedent to an analysis of whether §6213 is jurisdictional in the first place.  

Under the new thinking, then, four of the five factors point towards reading §6213 as a claims processing rule and not a jurisdictional rule.

After The Shutdown:  Dealing with Time Limitations, Part II

In the second post of the series “After the Shutdown” Professor Bryan Camp connects the shutdown with the thorny issue of when a time limit is jurisdictional. Les

Part I discussed how a reopened Tax Court might apply the Guralnik case to ostensibly late-filed petitions.  I explained how it might apply the case narrowly or broadly.  This post moves beyond Guralnikand starts exploring the correctness of the Court’s underlying assumption: that time limits in the Tax Code for taxpayers to petition the Tax Court to hear their disputes with the IRS are jurisdictional.  A possible silver lining to the shutdown may be that it gives the Court an opportunity to revisit that assumption.

Guralnik is essentially a work-around to equitable tolling.  The Tax Court says it cannot apply equitable principles to most statutes of limitation in the Tax Code because those statutes are, in its view, part and parcel of the Congressional grant of subject matter jurisdiction to the Tax Court.  I believe that view is based on an outdated understanding of the law.  I have posted a paper on SSRN that goes into great detail on what the current law is and how it should apply to three limitation periods in the Code: §6213, §6330(d), and §6015(e).  Today’s post is a summary of what I call the “new thinking” about jurisdictional time periods that the Supreme Court has been wrestling with for the past 10-15 years. For fuller treatment, please see my paper on SSRN.  For the Cliff Notes version, read on.

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Starting in Kondrick v. Ryan, 540 U.S. 443 (2004), the Supreme Court became obsessed with distinguishing between jurisdictional time periods and “mere” claims processing rules.  At that time, courts routinely presumed that all time limits were jurisdictional in nature. By 2013, however, the Court had totally flipped the traditional presumption.  The new thinking is that time limits are presumed non-jurisdictional unless Congress had done something special to indicate otherwise.  Here is how the Court summed it up in Sebelius v. Auburn Regional Medical Center, 568 U.S. 145 (2013).  Be sure to empty your mouth of liquid before you read on.

To ward off profligate use of the term jurisdiction, we have adopted a readily administrable bright line for determining whether to classify a statutory limitation as jurisdictional. We inquire whether Congress has clearly stated that the rule is jurisdictional; absent such a clear statement, we have cautioned, courts should treat the restriction as nonjurisdictional in character. This is not to say that Congress must incant magic words in order to speak clearly. We consider context, including this Court’s interpretations of similar provisions in many years past, as probative of whether Congress intended a particular provision to rank as jurisdictional. 568 U.S. at 153.

The spit-take is on the phrase “readily administrable bright line.”  It makes you wonder what planet the Justices had just visited.  Folks, there is no bright line.  There are, by my count, five indeterminate factors that the Court instructs lower courts to consider.  But fear not!  The task is not hopeless; it is merely very difficult.

Please note that all my case cites are to Supreme Court cases after 2000.  I’ve read what I think are all the relevant ones in order to synthesize these factors.  Note further that you simply cannot trust any court case before then.  And you cannot really trust many lower court cases before the Supreme Court’s “we-really-mean-it” decisions in 2013 (Auburn Regional) and 2015 (Kwai Fun Wong).  If someone cites a case to you, go look at the date to see if it is even attempting to reflect the Supreme Court’s new thinking.  Here is my summary of that thinking, divided into five factors.

  1. Mandatory Language

 The first factor any court will consider is the text of the relevant statute.  If  the text expressly refers to subject-matter jurisdiction or speaks in jurisdictional terms, then that will generally be the end of the analysis.  Under the old presumption, a statute that used mandatory language was presumed jurisdictional and mandatory language made it difficult to overcome the presumption.  Under the new thinking, however, while mandatory language is still one factor to consider, it is no longer very important.  Words like “shall” or “must” just don’t cut it anymore.  The Supreme Court has repeatedly rejected the idea that mandatory language alone—even really emphatic language—makes a time period jurisdictional. Musacchio v. United States, 136 S.Ct. 709 (2016)(defendant in criminal prosecution not allowed to raise statute of limitations for first time on appeal because the limitation period was not jurisdictional despite its mandatory language); United States v. Kwai Fun Wong, 135 S.Ct. 1625 (2015)(limitations period which said a claim brought after the deadline date “shall be forever barred” was not jurisdictional).

  1. Magic Words

A second factor is the presence or absence of the term “jurisdiction.”  It turns out that while the word “jurisdiction” is important, it is not determinative.  The Supreme Court has found a statute jurisdictional even without the word “jurisdiction” in it. Miller-El v. Cockrell, 537 U.S. 322 (2003)(finding that the statutory context of 28 U.S.C. §2253 made it jurisdictional even though it did not contain the magic word “jurisdiction”).  And on the flip side, the Court has also found a statute of limitations to be non-jurisdictional even though the statute contained the word “jurisdiction” in it! SeeReed Elsevier v. Muchnick, 559 U.S. 154 (2010)(overruling widespread agreement among Circuit Courts to hold that the term “jurisdiction” in 17 U.S.C. §441(a) was not a clear enough statement because it just described a court’s ability to hear a particular issue in a larger copyright infringement suit and not the courts ability to hear the rest of the suit).

  1. Statutory Context

A third important factor to consider is the relationship of the limitation period to the surrounding statutory scheme.  That is statutory context.  The Supreme Court has focused on this factor to explain its reluctance to label a limitation period as “jurisdictional” when the limitation period is present in the same statutory section as a concededly jurisdictional grant.  SeeGonzalez v. Thaler, 565 U.S. 134 (2012)(even though 28 U.S.C. §2253(c)(1) was a jurisdictional provision, the neighboring limitation in §2253(c)(3) was not);Sebelius v. Auburn Regional Medical Center, 568 U.S. 145 (2013)(rejecting argument that proximity of 42 U.S.C. §1395oo(a)(3) to concededly jurisdictional requirements in §1395oo(a)(1) and §1395oo(a)(2) made the (a)(3) time requirements also jurisdictional).

  1. Judicial Context

This is just another word for “precedent.”  The Court has not been reluctant to reverse long-standing precedent…when the precedent is from lower courts.  See e.g.Reed Elsevier v. Muchnick, 559 U.S. 154 (2010).  But it’s a different story when the long-standing precedent is of the Supreme Court’s own making.  SeeBowles v. Russell, 551 U.S. 205 (2007)(deciding that the time limits in 28 U.S.C. §2107 were jurisdictional simply because of “our longstanding treatment of statutory time limits for taking an appeal”); J.R. Sand and Gravel v. United States, 552 U.S. 130 (2008)(holding that time limits in 28 U.S.C. § 2501 were jurisdictional because of four prior Supreme Court cases said so and “petitioner can succeed only by convincing us that this Court has overturned, or that it should now overturn, its earlier precedent.”).

  1. Legislative Context

The final type of context that the Supreme Court has factored into its jurisdictional analysis is what I call the legislative context.  Others might call it legislative purpose.  Whatever you call it, the Court has sometimes looked to see whether finding a limitation period jurisdictional would further or hinder the policy goals of the underlying statutory scheme.   I would not put a whole lotta faith in this factor right now because the current composition of the Supreme Court seems to me (and to this USA Today article) to tilt towards textualists. And textualists don’t seem to like looking to purpose unless they get really desperate.

But there is hope.  I think the clearest example of where the Court found legislative context to be the deciding factor is Henderson v. Shinseki, 562 U.S. 428 (2011).  And that opinion was authored by Justice Alito.  There the Court held that the limitation period in 38 U.S.C. §7266(a) for a veteran to obtain court review from an adverse Veterans Administration agency decision was not jurisdictional.  After first finding that neither the factors of text nor precedent pointed clearly in one direction or another, Justice Alito turned to the legislative context.  “While the terms and placement of §7266 provide some indication of Congress’ intent, what is most telling here are the singular characteristics of the review scheme that Congress created for the adjudication of veterans’ benefits.” Focusing then on the Congressional intent, Justice Alito found that Congress meant for the entire statutory scheme for veterans benefits to be highly remedial.

The reason I go into some detail on the Henderson case is because I think it is pretty relevant to how a court might approach interpreting the limitation provisions in the Tax Code.  After all, the whole point of the U.S. Tax Court’s existence is to give taxpayers a pre-payment remedy.  It’s a big-time remedial scheme.  That is, I think, particularly important when considering the limitation periods in §6213, §6330(d), and §6015(e).  More on that in Part III, coming soon.

After The Shutdown:  Dealing with Time Limitations, Part I

Professor Bryan Camp offers the first of a series of posts discussing the shutdown and its impact on taxpayers receiving IRS stat notices and notices of determinations. This is a particularly timely post as we heard at the ABA Tax Section meeting that IRS and Tax Court staff and practitioners are meeting today to discuss the shutdown. Bryan offers some suggestions to minimize the impact of the shutdown on taxpayers with Tax Court filing deadlines. Les

The Tax Court officially closed its doors on December 28, 2018.  During one of the panels at the ABA Tax Section Pro Bono and Tax Clinics Committee meeting this past weekend in New Orleans, the question arose of how the shutdown affected the various administrative and judicial time periods for taxpayers to take various actions.  For example, if the 90 day period in § 6213 for filing a petition expired during the shutdown, would the taxpayer still be able to file a timely petition on the day the Tax Court reopens?

Like Winter, litigation is coming.  The point of this series of posts is to help readers prepare.

The Tax Court may actually have already given us one answer to the question of how the shutdown affects various time periods.  In Guralnik v. Commissioner, 146 T.C. 230 (2016), the Court held that a day the Tax Court was physically closed would not count as part of the §6330(d) time period to protest a CDP Notice of Determination.

Keith Fogg and I have slightly different takes on how Guralnik might apply and he kindly invited me to post my thoughts on the matter.  Today’s post will explain why I believe that Guralnik is strong support for the proposition that none of the shutdown days are days that count for jurisdictional time periods.

In future posts I will explain how taxpayers and the Tax Court might actually make some lemonade from this lemon of a shutdown.  The Tax Court currently holds that the following time periods are jurisdictional: the 90/150 day period in §6213; the 30 day period in §6330(d); and the 90 day period in §6015(e).  That means that the IRS Office of Chief Counsel cannot simply stipulate away the problem.  The looming litigation gives the Tax Court a wonderful opportunity to revisit its thinking about the jurisdictional nature of these statutes.  So in the next series of posts I will summarize a paper I posted on SSRN that explains: (1) the current Supreme Court doctrine for evaluating whether a statutory time period is truly a limitation on a court’s subject matter jurisdiction; and (2) how that doctrine applies to the time periods in §6213, §6330 and §6015(f).

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Facts and Holding in Guralnik

In Guralnik, the taxpayer (TP) was trying to file a collection due process (CDP) petition.  On the day before the 30thday, the TP sent his petition using Fed Ex “First Overnight” service.  Fed Ex was unable to physically deliver the petition the next day (the last day of the 30 days) because the Tax Court was officially closed that day due to a snowstorm. Fed Ex successfully delivered the petition the next day, one day late.  The question was whether the petition was timely.

The TP first asked for equitable tolling.  Keith Fogg and Carl Smith filed an amicus brief in the case, arguing the Court could do that because the 30 day period was not jurisdictional.  The Tax Court rejected the argument because, it said, §6330(d) made the timely filing of the CDP petition part of the jurisdictional grant. The Tax Court reasoned that while it could apply equitable tolling to what it called “claim-processing rules” it could “not apply equitable tolling to a jurisdictional filing requirement.”

The TP next argued for the §7502 statutory mailbox rule.  The Tax Court rejected that argument because the particular Fed Ex service used (“First Overnight”) was not listed as an approved private delivery service.  If the TP had just used “Standard Overnight” that would have been fine.  But the “First Overnight” was a new service and the IRS had not updated the list of approved private delivery services to include it. And you wonder why people hate lawyers.

The TP next argued that the snow day was a “legal holiday” within the meaning of §7503.  The Tax Court said “nope.”

But the Tax Court then latched onto a really nifty idea.  It decided that Tax Court Rule 1(b) allowed it to adopt the rules for counting days contained in Federal Rules of Civil Procedure (FRCP) 6.  Included in FRCP 6 is a rule for dealing with days when a court is inaccessible.  FRCP 6(a)(3)(A) says that

 Unless the court orders otherwise, if the clerk’s office is inaccessible…on the last day for filing…then the time for filing is extended to the first accessible day that is not a Saturday, Sunday, or legal holiday.

The Tax Court happily reasoned that

procedural rules for computing time are fully applicable where the time period in question embodies a jurisdictional requirement. Rather than expanding a court’s jurisdiction, Civil Rule 6 simply supplies the tools for counting days to determine the precise due date. (Internal quotes and cites omitted).

The Tax Court then applied FRCP 6(a)(3) to the facts of the case and did not count the snow day as part of the 30 day time period set out in §6330(d).  Wrote Judge Lauber:

We conclude that Civil Rule 6(a)(3) is “suitably adaptable” to specify the principle for computing time when our Clerk’s Office is inaccessible because of inclement weather, government closings, or other reasons. Civil Rule 6(a)(3) provides that the time for filing is then “extended to the first accessible day that is not a Saturday, Sunday, or legal holiday.” Because the petition was filed on February 18, 2015, the first accessible day after the Court reopened for business, the petition was timely filed and we have jurisdiction to hear this case.

Application of Guralnik to Shutdown Cases:  The Good, the Bad, and the Different.

One could read Guralnik as a supersized mailbox rule.  It would apply to taxpayers faced with a time period that expired during the shutdown.  Such taxpayers could still successfully file a timely petition so long as they did so on “the first accessible day after the Court reopen[s] for business.” I think this is how Keith and most folks read the case and I admit it’s the most solid reading.  Let’s call it the narrow reading.

The Good

The narrow reading of Guralnik has the advantage of letting the Court avoid messy equitable inquiries.  It’s a bright-line counting rule and could really help process a bunch of cases into the system and get them to a quicker resolution on the merits.  That’s good.  And it will probably give relief to a large number of taxpayers who are actually able to quick-like-a-bunny file on the day the Tax Court reopens.  It will also give relief to taxpayers who have attempted to file but whose petitions were undeliverable because of the shutdown and are being held for re-delivery by their chosen delivery service.  That’s also good.

The Bad

The first downside of the narrow reading is that it would only help those taxpayers whose deadline hit during the shutdown.  While that is likely the largest group of affected taxpayers, there may be some who received their Ticket to the Tax Court (be it a Notice of Determination or Notice of Deficiency or other ticket) at some point during the shutdown but at a time where their deadline comes after the shutdown ends.

For example, let’s say a taxpayer received an NOD 40 days ago, when the shutdown had not begun.  There are still 30 days left to petition the Tax Court, but the shutdown has prevented the taxpayer from dealing with the NOD, either by filing a petition or by going to Appeals.  Or perhaps a taxpayer receives an AUR NOD during the shutdown.  I have heard of taxpayers still receiving automated notices of intent to levy during the shutdown (and having no one to call), but I welcome comments on whether some IRS automated processes are still spitting out NODs.

For these types of taxpayers, the narrow reading of Guralnik means they must ignore the shutdown and plan on the Tax Court reopening in time for them to make a timely filing without having the usual opportunity to resolve the matter with Appeals or other IRS office.

The second downside to the narrow reading is that it requires taxpayers to assiduously monitor the shutdown situation and the Tax Court’s status.  They cannot plan.  They, or their representative must carefully monitor the Tax Court’s status because the shutdown has essentially reduced their limitations period to one day.  Especially if the Tax Court reopens with no warning, very few taxpayers would be able to meet the  “the first accessible day after the Court reopen[s] for business.”  So the cautious use of Guralnik would help only those taxpayers who filed their petition on the FIRST day the Court reopens (hereinafter “the Magic Day”).

One way the Court could ameliorate this second downside is to delay its reopening after the Shutdown Ends.  For example, the Court could post an order that says it will remain closed for the first 10 business days after the President signs an appropriation bill funding the Court.  That would not only allow taxpayers time to get their acts (and petitions) together to file on the Magic Day, it will also allow Tax Court personnel to clear the decks of accumulated work, re-calendar cases, and prepare for the Magic Day snowstorm of filings.  This idea was floated at the ABA Tax Section Meeting last week.  I think Keith came up with it, but cannot recall for sure.

A Different Understanding of Guralnik?

The narrow reading of Guralnik limits its application to only those situations where the last day of the applicable deadline falls on an inaccessible day.  But the Court could also apply Guralnik more broadly, in a way that would ameliorate both downsides.  I take this idea from Judge Lauber’s reasoning: “Rather than expanding a court’s jurisdiction, Civil Rule 6 simply supplies the tools for counting days to determine the precise due date.”  The idea here is to read FRCP 6 as a tolling provision and not just as a bulked-up mailbox rule.

Judge Lauber’s reasoning recognizes the underlying concern of FRCP 6’s counting rule:  unpredictable events should not count against limitation periods.  The idea of unpredictability was central to the D.C. Circuit’s opinion in In re Swine Flu Immunization Prod. Liab. Litig., 880 F.2d 1439 (D.C. Cir. 1989), a case the Tax Court relied on in Guralnik.  The Swine Flu court used Civil Rule 6(a) “as a guide to interpreting the `jurisdictional’ statute establishing the time for filing with the agency,”  (emphasis supplied). The court there  applied the idea of FRCP 6 to an administrative deadline, excluding both the final Sunday and the following day when government offices were closed on account of a snowstorm.  Notice that, by its plain language, FRCP 6 deals only with counting dates relating to court filings.  But the idea of unpredictability is larger than the words.  Put another way, the words of FRCP 6 embody an idea.  The idea of unpredictability.  The D.C. court explained: “we find it inconceivable that Congress would have wished to bar plaintiffs who fail to anticipate on Friday that the Government will decide to close a filing office the following Monday due to a snowstorm.”

Both Judge Lauber’s reasoning and the D.C. Circuit’s reasoning allow for a more generous reading of Guralnik.   If the principle underlying FRCP 6(a)(3) is truly that we do not count inaccessible days that arise because of unpredictable or extraordinary circumstances—whether they be snowstorms or shutdowns—then such days should not count, period.  No logic limits the counting rule to only the situations where the last day of the deadline falls on an inaccessible day.

This broader reading of Guralnik would not be decision that forces the Court to apply equitable principles to each case.  It would be a decision simply about whether the days when the Court is inaccessible were predictable or not.  Saturdays and Sundays and federal holidays are predictable.  They are on the calendar.  But snowstorms and shutdowns are not predictable.  So those days should not “count” for limitation periods.

One obvious barrier to this broader reading of Guralnik is that the text of FRCP 6 talks only about situations where the last day falls on an inaccessible day.  But, again, just as the D.C. Circuit applied FRCP 6 to a situation that was not covered by its plain language, so can the Tax Court here apply the idea of FRCP 6—the purpose of FRCP 6—to the shutdown situation.  Again, in the words of the D.C. Circuit: “Statutory provisions laying down time periods for taking appeals, like any other enactments, must be interpreted and applied by courts; in so doing, we use the federal rules as guides. Surely, the jurisdiction of the federal courts to construe the jurisdictional provisions of a statute cannot be a matter of serious dispute.” (citations and internal quotes omitted).

The insight of the D.C. Circuit, adopted by the Tax Court in Guralnik is that taxpayers should not be held accountable for situations which they cannot neither predict or control.  The unpredictability of the shutdown mirrors the unpredictability of snowstorms.  Nay, it magnifies that unpredictability.  No one can predict precisely when the shutdown will end.  This inability makes it impossible for taxpayers and their representatives to plan their filings.  They simply cannot determine the precise due date.  Every day the shutdown continues is another day that some deadlines have run and is another penultimate day for other deadlines.  Will the shutdown continue the next day?  Will the shutdown continue for three more days?  Who the heck knows!  Similarly, taxpayers subject to a 90 day deadline who received their Tax Court ticket before the shutdown will have unexpectedly lost all the days of the shutdown to resolve their case in the Office of Appeals.

Remember, the FRCP is just a standardized rule of procedure, promulgated by the Supreme Court.  The courts can, and do, regularly interpret the FRCPs using a common law case-by-case approach.  Recent opinions on the meaning and application of FRCP 8(a)(2) are good examples.  So if the D.C. Circuit can apply FRCP 6 to an agency deadline by using the idea that it was “inconceivable” that Congress intended the limitation period to include inaccessible days, the Tax Court can do the same here and for the same reason: it is inconceivable that Congress intended the 30 and 90 day periods within which to petition the Tax Court for relief to be swallowed up by a government shutdown that is now over 30 days in length.  Those shutdown days simply should not count towards the applicable limitation period.

An alternative approach to applying this broader reading of Guralnik to the shutdown situation would also treat FRCP 6 more as a tolling provision, but in a more limited way than allowing any and all inaccessible days to not count towards the applicable limitation period.  Again, keep in mind we are not talking about equitable tolling.  The question is about finding an administrable bright-line counting rule to deal with the cases filed after the shutdown ends, both those cases filed on the Magic Day, and those cases that miss the Magic Day but are still filed timely….if you don’t count the shutdown days.

The alternative approach would recognize that a single inaccessible day in the middle of a 90 day period or 2 year period would be little more than a Saturday or Sunday or holiday in terms of impact.  It would not interfere with planning nor with the ability of the taxpayer to determine the precise due date for the Tax Court petition the way that this interminable shutdown does.  But when, as here, the inaccessible days keep piling up and their end point is unknowable, the FRCP 6(a)(3) could be applied to acknowledge that difference.  One bright line interpretation would stop counting inaccessible days when they reach some percentage of the applicable limitations period, perhaps over a third.  Another bright line would be to say inaccessible days do not count when they are in excess of four in a row (longer than any three day weekend).

Next Posts

The Court could also take an equitable tolling approach by apply FRCP 6 to the Magic Day filings but then evaluating all other filings on a case by case basis.  That would require the Court to depart from its long-standing view that sections 6213, 6330(d) and 6015(e) are jurisdictional statutes.  I think there is a very good case to be made why the first two are not jurisdictional and a very weak case for the third.  That is the subject of future posts in this series.

IRS Updates Contingency Plan

Frequent contributor Bob Kamman discusses the IRS’s updated lapsed appropriations contingency plan for the filing season. Les

The first thing to realize about the IRS Filing Season Contingency Plan is that it is already outdated. As the Overview states,

“The IRS Lapse in Appropriations Contingency Plan describes actions and activities for the first five (5) business days following a lapse in appropriations. The plan is updated annually in accordance with guidance from the Office of Management and Budget (OMB) and the Department of Treasury. While we do not anticipate using the plan, prudent management requires that agencies prepare for this contingency.”

Although the cover sheet is dated January 15, 2019, that excerpt from Page 5 is dated January 11, 2019.  Filing season, it states, runs from January 1 through April 30, 2019.  What happens after the first five days?

“In the event the lapse extends beyond five (5) business days, the Deputy Commissioner for Operations Support will direct the IRS Human Capital Officer to reassess ongoing activities and identify necessary adjustments of excepted positions and personnel.”

In lay terms, this is known as “flying by the seat of your pants.”

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The general rule is that all IRS employees must stay home because they are not essential and there is no money to pay them.  (Of course, history tells us that they will be paid when the shutdown ends.)  The exception to the rule is that they must work, without pay, if they fall into one of several “excepted” categories.

Category “A” includes activities that (A1) are already funded, like those related to TCJA implementation and disaster relief; activities (A2)  “authorized by statutes that expressly permit obligations in advance of appropriations; and the catch-all (A3) “authorized by necessary implication from the specific terms of duties that have been imposed on, or of authorities that have been invested in, the agency.”  Until anyone objects, this A3 means what any given lawyer says it means on any given day.

Then there are “excepted” employees (remember, these are the ones who must show up to work) in Category B.  Their jobs are necessary to safeguard human life (see Police Officers, below) and, more often, to protect government property.

To understand this category, note that “tax revenues constitute Government property which the Service must safeguard.”  But not just money is involved:

 “…the Service may continue processing tax returns to ensure the protection of those returns that contain remittances. Activities necessary to protect other types of Government property, including computer data and Federal lands and buildings, may continue during a shutdown as well.”

In fact, not just money, buildings, and computers are at stake.  It is the IRS reputation itself.  The agency must “maintain the integrity of the federal tax collection process.” (This mostly seems to come under A3, not B, for those keeping score at home.)

Finally, there is the “turn out the lights” Category C, for activities that “provided for the orderly termination of those functions that may not continue” during a shutdown.

Those are the rules.  Here are some examples of how they are being applied.

Category A1: This includes “Income Verification Express Service (IVES) and Revenue & Income Verification Service (RAIVS) Photocopy Programs.”  These allow mortgage lenders  to verify taxpayer incomes.  It was recently determined that this was “excepted” work, perhaps because it is funded by user fees.

Category A2: This one is easy.  IRS does not have any.  It just shows up in the report because Treasury needs it for other reports.

Category A3: “Maintaining minimum staff necessary to handle budget matters related to the lapse in appropriations.”  Presumably these employees will have other work to do, when the lapse ends.

Category A3 also includes “Activities necessary for the payment of refunds, including processing electronic returns through issuance of refunds; processing “Paper Refund Tax Returns” through issuance of refunds; and processing “1040X Amended Refund Returns Adjustments including Carrybacks, Amended Returns, Duplicate Filed Returns (DUPF), Correspondence, Injured Spouse Claims, Disaster Claims, F843 Claim for Refund and Request for Abatement in support of issuing refunds.”

Issuing those refunds is necessary, not because they are government property, but because they are part of a system that maintains IRS integrity.

For Category B, there is a long list of activities necessary for the protection of human life or government property.  “The risk to life or property must be near at hand and demand an immediate response. To ensure that employees only perform functions that meet this requirement, each business unit will conduct regular meetings throughout a lapse in appropriations to identify actual imminent threats and activate excepted personnel only as required to perform related excepted activities.”   Here are just some of these examples:

  • Completion and testing of the upcoming Filing Year programs
  • Processing Remittances including Payment Perfection
  •  Responding to taxpayer filing season questions (call sites)
  • Continuing the IRS’ computer operations to prevent the loss of data
  • Protection of statute expiration, bankruptcy, liens and seizure cases
  •  Protecting Federal lands, buildings, and other property owned by the United States
  • Upcoming Tax Year forms design and printing
  • Maintaining criminal law enforcement and undercover operations

(You might find it odd that designing next year’s forms has at least the same priority as criminal law enforcement.  You will agree, however, once you see this year’s forms.)

Those are the activities that are necessary.  Here are some examples of work that is not:

  •  Non-automated collections
  •  Legal counsel
  • Taxpayer services such as responding to taxpayer questions (call sites) (But only during Non-Filing Season.  During Tax Season, they hope to operate.)
  • All audit functions, examination of returns, and processing of non-electronic tax returns that do not include remittances

So let’s not call it a shutdown.  When audit and collection work is suspended, let’s call it a holiday.  Were it not for the staff trying to prevent statute expirations, we could almost call it amnesty.

Here are some details from the latest plan:

Chief Counsel

“Chief Counsel’s primary responsibility during a lapse is to manage pending litigation, the time-sensitive filing of motions, briefs, answers and other pleadings related to the protection of the government’s material interests. Due to Counsel’s separate litigation function, the number of excepted Counsel positions will not align with excepted activities authorized in other IRS business units. Counsel’s plan assumes that the Federal and District Courts will be open, and that litigation will continue uninterrupted. The plan excepts, on an as needed basis, those personnel assigned to litigation that is scheduled for trial or where there is a court-imposed deadline during the first five days of a lapse. Personnel are not generally excepted to perform litigation activities where a trial or other court-imposed deadline is scheduled more than five days after the start of the lapse. Personnel assigned to those cases should seek continuances as part of an orderly shutdown. If a continuance is denied, the case will be reviewed to determine if work on the case may be excepted. . . .

“Chief Counsel personnel are also excepted, on an as needed basis to provide required legal advice necessary to protect statute expiration, and the government’s interest in bankruptcy, lien, and seizure cases.”

Taxpayer Advocate Service

There are now two “excepted” Category B employees allowed in each local office: The local TA, and either a group manager or a “lead case advocate.”  Their jobs are to “Check mail to comply with the IRS’s requirement to open and process checks during a shutdown while also complying with the statutory requirements that TAS maintain confidential and separate communications with taxpayers and that TAS operate independently of any other IRS office . . .Screen the mail for incoming requests for Taxpayer Assistance Orders and notify the appropriate Business Unit that a request has been made tolling any statute of limitations.”

It doesn’t sound like they are allowed to answer the phone or work cases.  Protecting IRS integrity doesn’t extend this far?

Small Business / Self Employed

In this operating division, 2,614 of the 2,938 Category B employees are in Collection and another 264 are in Examination. But wait – what happened to that  holiday?

Most of them are Collection Representatives who “carry out revenue protection activities that include responding to taxpayers who have received a collection notice through the Automated Collection System and clarifying the payment process; assisting taxpayers with setting up installment agreements for tax payments; assist taxpayers with general collection processes; serve as the gateway for transferring taxpayers to Accounts Management for appropriate filing season inquiries;  and provide assistance with releasing levies and liens as required by law.” In other words, you can contact them but they won’t contact you.

Those in Examination “protect statute expiration/assessment activities, bankruptcy or other revenue generating issues.   Open incoming mail to identify documents required to be processed to protect the government’s interest during shutdown. Complete computer operations required to determine necessary actions, prevent data loss and route documents associated with imminent statutes.”

Wage And Investment

These are the workers at 10 Service Centers and 15 call sites,  most of whom are in Category A3.  IRS hopes that 12,961 show up for Submission Processing, and 17,520 show up for Accounts Management, which includes call sites.

From other sources, I find that at least 6,600 of these employees are seasonal.  Would you take a temporary job with IRS in January, with the hope of being paid by April? It might make a difference if you needed to pay for daycare.

How many in W&I “Refundable Credits Policy & Program Management” will work on “Pre-refund case selection to protect improper payments from being released to ineligible taxpayers and perfect refunds to verify the refund is appropriate”?  An army of 51.

Compare that with the 469 needed for the IVES and RAIVS programs.  IVES “provides express return transcript, W-2 transcript, and 1099 transcript delivery services to mortgage lenders and others within the financial community to confirm the income of a borrower during the processing of a loan application. RAIVS services taxpayer request for copy of tax return.”

Online Services

In Category B, 25 employees are needed because “Online Services (OLS) is responsible for the development and continuity of operations for IRS.gov, which is the agency’s exclusive external facing website servicing the public. IRS.gov is the means in which taxpayers may continue to file returns and submit remittances online. OLS anticipates that 9 employees will be needed for the duration of the shutdown to maintain the IRS.gov website.”

Facilities Management

Did you know IRS has Police Officers?  There are nine of them kept on duty who along with 13 Security Specialists and five Safety Officers “support general security services that increase as the IRS population escalates in excepted employees during the Filing Season.   Additionally, security and emergency response actions are influenced by other external activities such as bomb threats, suspicious packages and threats to employees. Situational Awareness Management Center/Threat Incident Reporting is operational 24/7 during a shutdown.”

Leave (Not Brexit) Policy

Finally, current and former IRS employees should find this interesting.  I am not sure it  is how the situation was handled in previous shutdowns, but maybe I am thinking of snow days.

“Managers should advise employees who are scheduled to be on annual, sick, court, or military leave that, if a lapse in appropriations occurs while they are on leave, their leave will be canceled, and they will be placed in a furlough status. According to 5 CFR § 752.402, a furlough means ‘the placing of an employee in a temporary status without duties and pay because of lack of work or funds or other non-disciplinary reasons.’”

What IRS Taught Me about Building Barriers

During the IRS and Tax Court shutdown, we have less material to work with and more time for observations and reminiscences from readers.  Chronic contributor Bob Kamman assures us that there must be others who can do better than this. 

I have stories about shutdowns that I could tell from my time at the government but mostly my impression of shutdowns is that they are an incredible waste. I feel it would not take much to find a better way to fight over disagreements about the budget.  

Bob tells us a story about barriers and Service Centers. Having been at several Service Centers, I can say that the barriers to entry there pale by comparison to entry to the Martinsburg Computing Center where the IRS stores the masterfile information and creates significant barriers to entry. Keith

Before I get to that story, here is something to watch for when this “partial government shutdown” finally ends.

In November 1995, the IRS was shut down for only four days. Some of the rest of the government then closed again for 22 days, when negotiations between President Clinton and Speaker Gingrich failed, but IRS was spared.

The White House was not reluctant to place blame on Congress, so it released a report showing how much tax was not assessed or collected during the brief furlough of examination and collection employees. The Treasury Department calculated that $400 million was lost by lack of enforcement action by IRS over a four-day period. That round number of $100 million a day translates to $165 million in today’s dollars, or about a billion dollars for every six working days.

This estimate was confirmed in a White House report on the costs of the October 2013 federal government shutdown. “IRS enforcement and other program integrity measures were halted,” it stated. “IRS was unable to conduct most enforcement activities during the shutdown, which normally collect about $1 billion per week.” (Emphasis in original.)

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Will similar numbers be provided this time? Or maybe there will be a compromise. Most federal budget analysts agree that every dollar IRS spends on enforcement brings in about $10 of revenue. The Democrats have offered $1.6 billion for border security. The President could refuse such a large sum. “Just give me $500 million more for IRS,” he could say. “Then let me spend the $5 billion it produces, how I want.”

(Much of that half billion would be paid in salaries and come back to the government anyway. IRS employees are notorious for paying their income taxes.)

But the current impasse reminds me of my IRS days, in the mid-1970s, when I was an intern in the National Office’s Taxpayer Service division. Interns were not unpaid college students brought in for the summer (like my son in 2003, at the White House photo office). We were full-time permanent employees, recruited nationally for training that would create the next generation of IRS leadership. The assignment lasted for a year, followed by placement in some essential program.

There were only three of us in Taxpayer Service, but there were more than 20 “Admin” interns who rotated among what were then the four divisions of the Administration function (if I remember them correctly): Personnel; Facilities Management; Training; and Fiscal.

There were occasional “classes” for interns when senior executives would lead discussions of IRS problems and how they had been solved. When it was the turn for Facilities Management, the topic for discussion was whether a rather large sum should be spent to build fences around Service Centers.

I doubt any of us had ever considered this question. Service Centers are huge buildings on large parcels of real estate. For example, the one in Ogden, Utah, is a single-story brick building with 504,741 gross square feet located on a 60-acre site. It operates 24 hours a day, 7 days a week, and provides work space for approximately 2,500 federal employees.

 

That would require a lot of chain link, we agreed. Of course, security is an important issue for all government buildings, but especially IRS work locations. Who would argue with fencing them off?

But fences are meant either to keep people in (not an issue at IRS) or to keep people out. So whom were we trying to exclude?

This was before daily headlines about terrorist threats. But there have always been angry taxpayers, including some with mental-health issues. And by then the “Anarchist Cookbook” had instructions for building bombs. So fences were necessary.

Or were they? The class was asked to imagine a potential bomber driving past the Service Center, noticing a fence around it, and therefore deciding it was not worth the effort to penetrate. If this person existed, then the cost of the fence would justify discouraging the “casual bomber.” But of course, someone intent on bombing IRS could probably figure out a way to get over, under, around or through that fence.

The point was: The fence is not there for security. It is there to create the appearance of security. The otherwise-determined bomber, it was hoped, would decide that “if there is that much security on the perimeter, there must be a lot more of it inside.” So according to the cost/benefit analysis of the day, the fences were built and the contractors paid.

This anecdote may have nothing to do with current affairs, but for me there are always reminders.   For example, I thought of it when I saw this April 2018 story about what happened to a fence at the Fresno Service Center – which, however, was breached from the inside out.

 

A Question of Identity – Interest Netting, Part 2

Today, guest blogger Bob Probasco brings us the second part of his post on interest netting. At the end of this part he refers to an article in the most recent edition of The Tax Lawyer. If you are a member of the ABA Tax Section you can link through to the article after signing in as a member. If you are not a member but have access to Heinonline, Westlaw or Lexis you can also get to articles of The Tax Lawyer. As the editor of that law review, I invite you to look at the articles there which explore issues in much more depth than we are able to do on the blog. I hope you would agree with me that after 70 years it continues to be a premier tax law review. If you have a law review article on tax you want to publish, consider sending it to The Tax Lawyer. Keith

We’re continuing to explore the “same taxpayer” issue for interest netting under Section 6621(d), for which the Federal Circuit issued an important decision in November. In Part 1 of this two-part series, I discussed other approaches to netting, the background of Section 6621(d), early IRS guidance, and the first of four major cases that have addressed this question. In Part 2, I’ll wrap up with the remaining cases plus some thoughts about the future.

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The evolution of “same taxpayer”

Section 6621(d) allows netting only of equivalent overpayments and underpayments “by the same taxpayer.” Part 1 covered what I consider one of the more interesting attempts at IRS guidance on this issue, Field Service Advice 2002-12028,. It concluded that to qualify for this benefit, one must “both be liable for the underpayment of tax, and entitled to the overpayment of tax.” This kept the restrictive adjective “same” while creating exceptions for mergers and consolidated returns by attributing overpayments or underpayments of one corporation to another. As taxpayers starting filing cases for expansive interpretations of “same taxpayer,” the DOJ retreated from the IRS guidance to very narrow interpretations that would, in practice, make interest netting virtually impossible for the large corporations that most need it.

Balances that arose prior to consolidation: Energy East Corp. v. United States, 645 F.3d 1358 (Fed. Cir. 2011), aff’g 92 Fed. Cl. 29 (2010). This case involved acquisitions in which the subsidiaries survived as members of an affiliated group and tried to net overpayments and underpayments for pre-acquisition tax years. The taxpayers lost. That was probably the right result, although I still have some reservations. The case was decided by a “temporal requirement” that later cases borrowed. Read Part I for the gory details.

And now on to the other three cases.

Attribution of an overpayment on a consolidated return to its members: Magma Power Co. v. United States, 101 Fed. Cl. 562 (2011). Magma Power had an underpayment for its 1993 tax return; it was acquired by CalEnergy on February 24, 1995; it was included thereafter on consolidated tax returns with CalEnergy and other subsidiaries; and the consolidated group overpaid its taxes for 1995-1998. The question was whether Magma’s 1993 underpayment could be netted against the consolidated group’s overpayments. If the situation were reversed – a 1993 overpayment by Magma and consolidated group underpayments for 1995-1998 – it would be an easier decision because all group members are severally liable for group underpayments. But this fact pattern is the one that FSA 200212028 answered as “theoretically possible.”

Magma provided an affidavit to the effect that a substantial portion of the overpayments by the consolidated group were attributable to Magma. How substantial? More than 100% of the reduction of consolidated taxable income resulting in the 1995 and 1997 overpayments; 92% of the reduction of consolidated taxable income resulting in the 1996 overpayment; and 79% of the reduction of consolidated taxable income resulting in the 1998 overpayment. The government disputed the plaintiff’s methodology and amounts but conceded that some portion of the overpayments were attributable to Magma.

The Court of Federal Claims’ opinion is one of the best and most comprehensive analyses of this issue I’ve read – kudos to the court and the litigants. I think it’s also potentially the most important for future developments in interpretation of Section 6621(d). The court interpreted “same taxpayer” as “same TIN.” In that respect it accepted the government’s argument. But the court also concluded that overpayments could be attributed to individual members of a consolidated group, not just underpayments (for which all members are severally liable per regulation); the government appeared to concede neither. The court also rejected the “complete identity” or “exact DNA identity” argument of the government. Key to the decision was the court’s observation that the group is not itself a taxpayer, merely a method of combining all the members for computing tax liability; the members of the group are the taxpayers. Further, the tax liability of the consolidated group must be allocated to individual members as part of tracking E&P for each member pursuant to Section 1552. Either individual members pay their allocated share of the tax liability or the amount they don’t pay would be treated as a contribution from the other member who did pay, Treas. Reg. section 1.1502-33(d)(1). Because the tax liability is allocated and payments by the group are allocated, that should be enough to allocate overpayments to individual members as well, shouldn’t it?

After a careful consideration of legislative history, previous IRS guidance, and the remedial nature of the legislation, the court held that pre-merger Magma Power and post-merger Magma Power “should be properly considered the same taxpayer to the extent the consolidated group’s overpayment can be traced to the company” (emphasis added). Because there had not yet been an agreement by the parties or determination by the court of how much of the overpayments could be attributed, the court ordered the parties to propose further proceedings to resolve the case.

The parties entered a stipulation as to the amount owed about eleven months later – interest computations can be difficult and securing the required government approvals for settlement can drag out – and the court entered judgment. The government filed a notice of appeal on November 20, 2012, and then filed a motion in the Federal Circuit to dismiss the appeal on December 12, 2012. We have no assurance of how the Federal Circuit would rule on this issue but apparently, DOJ was not confident or at least wanted to avoid the risk of an adverse precedent.

This analysis seems to follow the “attribution to a single entity” framing of FSA 200212028 rather than a “two entities are treated as the same taxpayer” framing.

Statutory mergers, various scenarios: Wells Fargo & Co. v. United States, 827 F.3d 1026 (Fed. Cir. 2016), aff’g in part and rev’g in part 119 Fed. Cl. 27 (2014). Stephen Olsen posted here a few years ago when the Court of Federal Claims and Federal Circuit opinions came out.

This case included many different factual circumstances, resulting from a series of seven mergers and 64 separate refund claims. The government and Wells Fargo identified three “test claims”; the principles would govern all of the claims. Wells Fargo (represented by the same firm that represented Magma Power) argued that merged corporations are always treated as the “same taxpayer,” regardless of the timing of the payments. The government argued that taxpayers are only the “same taxpayer” if they have the same TIN at the time of the payments.

Scenario One: Wachovia had an overpayment for 1993; First Union had an underpayment for 1999. The two merged in a statutory merger in 2001, and First Union survived. The government argued that the netting was not available because the two corporations had different TINs and were unaffiliated at the time of both the overpayment and the underpayment.

Scenario Two: First Union had an overpayment for 1993, underwent four statutory mergers between 1993 and 1999 (in each of which it was the surviving corporation), and First Union had an underpayment for 1999. The government conceded the availability of netting in this situation; “the underpaying and overpaying company retained the same TIN because it was the surviving corporation in the mergers.”

Scenario Three: CoreStates had an overpayment for 1992 and merged with First Union in 1998 with First Union surviving. Then First Union had an underpayment for 1999. The government argued that netting was not available because the two corporations had different TINs.

The Federal Circuit mentioned the “same taxpayer = same TIN” rule from Magma Power, without explicitly adopting the rule. But it mischaracterized the Court of Federal Claim’s application of the rule as that “the consolidated group or corporations met the ‘same taxpayer’ requirement because they shared a single TIN.” As discussed above, that is not what the CFC did in Magma Power. The court focused on the TIN of the subsidiary, Magma Power, rather than the consolidated group. It allowed netting, but only if the consolidated return’s overpayment could be traced or attributed to the company.

Based on merger law, the Federal Circuit concluded that two merging corporations are the “same” regardless of which survives. The Court of Federal Claims declined to apply the temporal requirement from Energy East because joining an affiliated group (when both corporations maintain their separate identity) differs from a statutory merger (in which only once corporation survives). But the Federal Circuit disagreed, applied the temporal requirement, and allowed netting in Scenario Three but not in Scenario One.

In Energy East, the Federal Circuit seemed to say that the taxpayer must be the same before both the underpayment and the overpayment. Of course, that was the situation being decided; the court wasn’t dealing with a situation with an overpayment made prior to the acquisition. But in Wells Fargo, the court allowed netting in Scenario Three, when the overpayment was made prior to the merger. Apparently, the requirement is that the taxpayer must be the same when the overpayments or underpayments are made. That seems plausible; there are no overlapping balances to be netted until the second balance comes into existence.

I don’t find the temporal requirement imposed in Energy East and Wells Fargo completely persuasive. The court interpreted an overpayment or underpayment as being associated with a particular date rather than a period. That’s understandable, given the language in Sections 6601(a) and 6611(b). But I think the antiquated language of the Code has effectively been superseded by Avon Products Co. v. United States, 588 F.2d 342 (2d Cir. 1978), and the realities of tax administration. In Avon Products, the Second Circuit concluded that individual transactions must be netted into a single balance before computing interest. The IRS has acquiesced in not only the result of that case but also the reasoning. Over a period of time, the single balance required by Avon Products may change from underpayment to overpayment back to underpayment, and the traditional determinations of the “date” of an overpayment and underpayment no longer fit well. They are better considered in terms of a period rather than a particular date when they arise. Admittedly, no court has yet reached the same conclusion.

Further, the “last antecedent rule” is simply an interpretative standard, not an ironclad rule any more than other canons of statutory construction. Given the remedial nature of netting, it would have been possible to interpret the provision more broadly. Even if both the underpayments and overpayments began before the merger or joining into an affiliated group, netting might be permissible if both are still outstanding afterward. At that point, once the two corporations become the “same taxpayer,” the harm that Section 6621(d) is intended to remedy exists. Netting might be allowed from that point. This argument is likely stronger for mergers than for affiliated groups that file consolidated returns.

But that’s not what the court ruled.

Not part of the parent’s consolidated return: In Ford Motor Company v. United States, 908 F.3d 805 (Fed. Cir. 2018), aff’g 132 Fed. Cl. 104 (2017), the court concluded that Ford Motor Company (“Ford”) and a wholly-owned subsidiary were not the “same taxpayer” for purposes of interest netting. Against the backdrop of the earlier cases, Ford seems an even harder case for the taxpayer to win. Ford formed Ford Export Services B.V. (“Export”), its wholly-owned subsidiary, in 1984 as a foreign sales corporation. Because FSCs must be foreign rather than domestic corporations and a consolidated group cannot include foreign corporations, Ford and Export filed separate U.S. income tax returns between 1990 and 1998. Ford had an overpayment for the 1992 tax year and Export underpaid its taxes for 1990-1993 and 1995-1998. Ford claimed that Ford and Export were the same taxpayer because Ford “exercised near complete control over Export’s operations” and “Export never performed any activity that Ford did not direct.”

Instead of relying on a dictionary, the Federal Circuit concluded that the meaning of “same taxpayer” depended on “background legal principles” at the time Congress enacted Section 6621(d). One of those background legal principles was that a parent corporation and its subsidiaries are separate taxable entities. (Cases cited in the opinion concluded that even if the parent and subsidiaries join to file a consolidated return, the group is not as a single entity and individual members retain their identity.) The court identified “the unique legal effects of a merger” as an exception to that general rule, citing Wells Fargo. Ford argued that the FSC statute was another relevant background legal principle that would constitute an exception to the general rule, but the court disagreed. There was no statutory provision for FSCs comparable to the continuation of the identity of the acquired corporation in the successor corporation after a merger.

The plaintiff’s arguments here were based on control and direction because of the factual situation: Export was not a member of the affiliated group that filed a consolidated return. That suggests that the decision may be relatively narrow in scope and may also help explain why the court reached this decision. This level of “control and direction” will most often occur with a subsidiary that meets the 80% voting and value test for an includible corporation in an affiliated group (even if not includible for other reasons such as being a foreign corporation). Consider three categories such subsidiaries might fall into: (a) included in the affiliated group; (b) not included in the affiliated group but a foreign corporation with no US income; and (c) not included in the affiliated group but a corporation that files a US tax return. If the Federal Circuit eventually blesses netting involving attribution from consolidated returns, similar to FSA 2001-12028 and Magma Power, the effect of the decision in Ford may be limited to category (c). Further, allowing netting based on control and direction, rather than attribution from a consolidated return, would impose more of an administrative burden on the IRS because the factual determination is more difficult. It’s not well suited for a general background legal principle to apply as an interpretation of “same taxpayer.” On the other hand, netting with subsidiaries who meet the 80% test but are not includible for other reasons, might be a viable test.

What does the future hold?

The boundaries of “same taxpayer” are still not entirely clear. Because most netting claims include a request for additional overpayment interest, these cases will usually be brought in the Court of Federal Claims rather than district court. Review by the Supreme Court and legislative action both seem unlikely in the extreme. So the Federal Circuit’s decisions carry a lot of weight. But there are some possibilities the Federal Circuit has not yet ruled on.

In a statutory merger, the Federal Circuit will allow netting of a pre-merger balance against a post-merger balance but not if both balances are from pre-merger years. If a taxpayer or the government wants to change that, it will be difficult to do just through litigation.

The Federal Circuit has never directly ruled on netting in the context of consolidated returns. Energy East and Wells Fargo involved mergers; a Magma Power appeal was dismissed on the government’s request; and Ford involved a subsidiary that was not consolidated. The opinion in Ford seems to suggest that these situations are not an exception to the general rule that a parent and its subsidiaries are separate entities and therefore are not the same taxpayer. I don’t think that necessarily precludes netting, though.

First, I suspect that as a practical matter the IRS has been allowing netting administratively, and thus there have been no lawsuits, in circumstances where one member has an overpayment based on a separate tax return and the consolidated return has an underpayment. We haven’t seen such a case in the Federal Circuit and I would expect to by now if the IRS were disallowing the claims. If that’s correct, I’m not sure that the opinion in Ford will be enough for the IRS to change its administrative practice.

Second, treating a parent and its subsidiaries as separate entities does not preclude netting if you allow attribution of underpayment and overpayments to individual members of the affiliated group. Then, as in Magma Power, you are dealing with a single taxpayer; the attribution results in one taxpayer having equivalent overpayments and underpayments outstanding at the same time. The Federal Circuit has not addressed the attribution theory and, based on its mischaracterization of Magma Power in Wells Fargo, may not have considered it yet.

Netting in the context of consolidated returns, under an attribution theory, will still create administrative issues. Even in simple netting claims, the taxpayer cannot use balances if it has previously used them for netting. For example, if Corporation A nets a 2001 underpayment against a 2004 overpayment, Corporation A cannot later net the same 2001 underpayment against a 2006 overpayment. This would apply for netting under an attribution theory in the context of consolidated returns. Further, the netting claim would have to provide documentation to support the attribution. But such administrative issues should not be an impediment. Revenue Procedure 2000-26 simply shifts the burden to the taxpayer requesting netting. A more significant problem with netting in the context of consolidated returns might arise with respect to disputes between members of the group about the attribution – particularly after a member has left the group but still wants to net past balances as part of the group against post-departure balances.

Are there situations other than mergers and consolidated returns that might supply “background legal principles” to justify netting? Contractual assignments of tax liabilities and the right to refunds of overpayments might be a possibility, although courts are often reluctant to be bound by those when deciding tax issues. There may be others.

Even if the Federal Circuit is unlikely to approve netting in the consolidated return context or other situations, it’s worth still contesting issues on which the Federal Circuit has not yet ruled. Interest disputes for the largest corporations can involve significant amounts, which alone justifies taking a shot. Ford, as an example, involved a $20 million claim while Wells Fargo involved a $350 million claim (although that included items other than netting).

Postscript

As I was finishing this post up, I received the latest volume of The Tax Lawyer, which includes an article “More of the ‘Same’: Section 6621(d) in the Federal Circuit” by David Berke, an associate at Skadden, Arps. He and I are not in complete agreement, but for those with an interest in a different perspective on this topic, it’s worth perusing.

 

A Question of Identity – Interest Netting, Part 1

We welcome back guest blogger Bob Probasco who brings us a discussion of an important recent decision in the Federal Circuit. Bob directs the low income taxpayer clinic at Texas A&M Law School but he comes to that position after a career or representing large taxpayers while working at a large law firm (Thompson and Knight). His background representing large taxpayers gives him a perspective on this issue which turns on who is a sufficiently related corporate entity to allow interest owed to the IRS to net with interest owed to a taxpayer. For most of our clients interest is a painful reminder of consequences of owing additional taxes but for some large taxpayers the issue of netting can have consequences in the millions of dollars. Keith

On November 9, 2018, the Court of the Appeals for the Federal Circuit issued its decision in Ford Motor Company v. United States, 908 F.3d 805 (Fed. Cir. 2018), aff’g 132 Fed. Cl. 104 (2017). The Court concluded that Ford Motor Company and a wholly-owned subsidiary were not the “same taxpayer” for purposes of the interest netting provision in Section 6621(d).

Procedurally Taxing addressed this issue a few years ago when the last major case on Section 6621(d) was decided. With the decision by the Federal Circuit in Ford, now seems a good time to revisit the issue – both in Ford and the earlier cases – as well as speculate where it may be heading.

In Part 1, I will review the background of Section 6621(d), other netting methods, early IRS guidance on the “same taxpayer” question, and the first of four major cases interpreting that aspect of the provision. In Part II, I’ll cover the other three cases as well as take a look at the future.

Spoiler alert: this is a complex, confusing area of tax procedure. I think some of the cases could have, and perhaps should have, come out differently. But this is what we have.

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Why interest netting?

With some exceptions, the government charges taxpayers interest on unpaid tax liabilities and pays taxpayers interest on refunds. There were some rate differences in the earliest years of the modern income tax, but for a long period of time the government used the same interest rate for both underpayments and overpayments. That’s still the case for non-corporate taxpayers but changed for corporate taxpayers over 30 years ago.

In the Tax Reform Act of 1986, Congress created a 1% difference in Section 6621(a) between the base rate it charges corporations on underpayments of tax (the federal short-term rate + 3%) and the base rate it pays corporations on overpayment of tax (the federal short-term rate + 2%). As a result of subsequent changes, the gap can be much larger. The Omnibus Budget Reconciliation Act of 1990 added Section 6621(c), establishing the “large corporate underpayment” or “hot interest” rate (the federal short-term rate + 5%) for underpayments exceeding $100,000. The Uruguay Round Agreements Act of 1994 added the flush language at the end of Section 6621(a)(1), establishing the “GATT interest” rate (the federal short-term rate 0.5%) for overpayments exceeding $10,000. The proper application of hot interest and GATT interest is itself a complex issue beyond the scope of this post, but many large corporations will be subject to rates that differ by as much as 4.5%.

What happens when a corporation has both an outstanding overpayment of tax and an outstanding underpayment of tax, accruing interest during the same period of time? Might a corporation find itself paying more interest than it receives on equivalent amounts? Prior to the enactment of interest netting, taxpayers had two protections against that.

“Annual interest netting” addresses situations where a taxpayer has both an overpayment and an underpayment with respect to the same tax return outstanding during a given period. For example, Big Corp’s income tax return for 2012, filed on 3/15/2013, shows an overpayment of $3,000,000, which the IRS does not refund until 1/5/2015. After an audit, the IRS assesses additional tax of $5,000,000 for 2012. The IRS might try to assess interest on the $5,000,000 underpayment, from 3/15/2013 until paid, while paying Big Corp interest (at a lower rate) on the $3,000,000 original overpayment, from 3/15/2013 until 1/5/2015. In Avon Products Co. v. United States, 588 F.2d 342 (2d Cir. 1978), the Second Circuit concluded that individual transactions must be netted into a single balance before computing interest. Thus, the IRS would assess interest only on the net $2,000,000 underpayment from 3/15/2013 until 1/5/2015, and on $5,000,000 thereafter until paid. The IRS acquiesced not only in the result but also in the reasoning of Avon Products, although it has occasionally argued for a different result in particular cases. Revenue Procedure 94-60 and Revenue Ruling 99-40 are interpretations of the Avon Products doctrine; in recent years the IRS changed interest computation software and (somewhat) its methodology. (Revenue Ruling 99-40 actually – and likely unintentionally – mischaracterizes Avon Products in a subtle manner that obscures another procedural problem concerning recovery of excessive overpayment interest. The problem is potentially significant, although few people seem to be aware of it. But that is beyond the scope of this post.) However, “annual interest netting” only applies when the overpayment and underpayment are for not only the same type of tax but also the same tax return.

In other circumstances, the IRS exercise of its authority under Section 6402(a) to credit overpayments against outstanding tax liabilities, rather than issuing a refund, results in the elimination of the rate differential problem. A Section 6402(a) credit, of course, is not intended to and does not by itself accomplish netting. It is merely a collection method, almost always applied automatically to credit an overpayment under one TIN against an underpayment for exactly the same TIN. When the IRS makes such a credit, however, any interest rate differential is eliminated because of specific interest computation provisions. If an overpayment for 2010 is applied to an underpayment for 2011, for example, Section 6611(b)(1) provides that interest on the overpayment runs only to the due date of the 2011 underpayment – the same date that interest on 2011 underpayment starts accruing. If an overpayment for 2011 is applied to an underpayment for 2010, Section 6601(f) provides that there is no interest on that portion of the underpayment “for any period during which, if the credit had not been made, interest would have been allowable with respect to such overpayment.” This avoids an overlap period with interest accruing both on an overpayment and an underpayment, but a Section 6402(a) offset is only available if both balances are still outstanding. If the overpayment was refunded or the underpayment was paid, Section 6402(a) won’t help.

Those two solutions still left unresolved some instances of overlapping overpayments and underpayments. When Congress created the 1% rate differential in 1986, it asked the IRS to implement “the most comprehensive netting procedures that are consistent with sound administrative practice.” It continued to request IRS action as the rate differential widened to 3% and then 4.5%, and again when it enacted the Taxpayer Bill of Rights, but Treasury pushed back because it had no statutory authority for such netting. Congress eventually enacted Section 6621(d) in the Internal Revenue Service Restructuring and Reform Act of 1998. That provision requires that for any period when there are “equivalent underpayments and overpayments by the same taxpayer of tax imposed by this title, the net rate of interest under this section on such amounts shall be zero for such period.” I’ve always referred to this as “global interest netting,” to differentiate it from “annual interest netting,” but I’ve dealt with some DOJ attorneys who prefer “net interest rate of zero.” For the remainder of this post, I’ll use “netting” to refer only to Section 6621(d).

Netting is available, under its terms, for taxes other than income tax. However, it only applies if underpayment interest is payable and overpayment interest is allowable during that period. Various “restricted interest” provisions of the Code state that under appropriate circumstances interest is not payable/allowable. Thus, if during the relevant period the taxpayer’s overpayment balance does not earn interest, there is no elimination or reduction of the interest rate on the equivalent underpayment balance. (Annual interest netting, however, does effectively net balances even if interest is not payable/allowable for one of the balances. In fact, that was the situation in Avon Products.)

The IRS computers cannot readily identify situations in which netting would be available. As a result, the IRS requires taxpayers to specifically request such netting on a refund claim. Revenue Procedure 2000-26 sets forth the requirements.

The evolution of “same taxpayer”

The legislative history for Section 6621(d) didn’t really explain what “same taxpayer” means. The meaning would be clear if we were talking about individuals. But corporations can change their corporate identity, through mergers, and join affiliated groups that file consolidated tax returns. What effect does that have? The IRS issued guidance as it began dealing with how to apply netting, and courts decided at least four major cases, including Ford, to clarify the boundaries of the term.

One of the IRS early attempts at guidance, Field Service Advice 2002-12028, required that one corporation “both be liable for the underpayment of tax, and entitled to the overpayment of tax.” This kept the restrictive adjective “same” while creating exceptions for mergers and consolidated returns. The principles it applied were:

  • In a statutory merger, as a matter of law the surviving corporation is liable for any underpayment and entitled to any overpayment of the non-surviving corporation, so netting is permissible even for balances from tax years prior to the merger. (Situations 5 and 7)
  • But in an acquisition in which both corporations survive, netting is impermissible because neither is liable for underpayments or entitled to overpayments of the other. Actual payment of the underpayment is not sufficient, absent legal liability for it. (Situation 6)
  • All members of an affiliated group are severally liable for underpayments of the consolidated return, Treas. Reg. section 1502-6(a), so they can net their own overpayments against the group’s underpayments. (Implied from the reasoning for Situations 8 and 9)
  • But a subsidiary is not liable for the group’s underpayment for tax years for which it was not a member of the group. Therefore, the subsidiary can’t net the group’s underpayment against its own overpayments. This applies when the subsidiary was acquired or came into existence after the year of the group’s underpayment (Situations 3 and 4), or if the subsidiary was owned by the parent during that year but was not part of the affiliated group (Situations 8 and 9).
  • It is unclear whether subsidiaries would be entitled to some or all of the group’s overpayments for tax years when they were members of the groups and therefore able to net the group’s overpayments against their own underpayments. It is theoretically possible but that will depend on the facts and circumstances of the particular case. (Situations 1 and 2) The IRS reiterated this position in Chief Counsel Advice 2004-11003 but later walked back this concession in Chief Counsel Advice 2007-07002.

This was not a perfect, or complete, analysis but it was a good start. When I first read it years ago, I thought it was an interesting way to frame the analysis. Although we sometimes use a shortcut and say that this issue is whether Company A and Company B are the “same taxpayer,” this FSA focuses on whether a single taxpayer – Company A – has equivalent overlapping overpayment and underpayment. But in doing so, it allows under appropriate circumstances the attribution of overpayments or underpayments on Company B’s tax returns to Company A. There is solid support for many of the attributions in FSA 200212028.

Litigation ensued and the courts began fleshing out the nuances. In that litigation, the government pushed for a much more restrictive interpretation than in FSA 200212028. At various times, DOJ advanced three alternative arguments that would substantially limit or eliminate the ability of affiliated groups to obtain the benefits of netting. First, the TIN associated with the overpayment must be identical to the TIN associated with the underpayment. Thus, an overpayment or underpayment of the affiliated group could never be netted against an underpayment/overpayment of individual members; further, balances of the surviving corporation in a statutory merger could never be netting against pre-merger balances of the non-surviving corporation. Second, even if the TIN were identical, the taxpayer must not have undergone any substantial change between the two years. Thus, any addition or removal of members of an affiliated group or merger with another corporation – among other changes – would eliminate the ability to net interest. This would effectively eliminate netting for the largest corporations, which are those most likely to benefit from netting. Third, Congress did not intend netting to be available for overpayments or underpayments by consolidated returns at all. The Federal Circuit has accepted the first argument, with exceptions carved out, but has not (yet) adopted the more extreme interpretations.

Balances that arose prior to consolidation: Energy East Corp. v. United States, 645 F.3d 1358 (Fed. Cir. 2011), aff’g 92 Fed. Cl. 29 (2010). Energy East Corporation acquired Central Maine Power Company (“CMP”) in 2000 and Rochester Gas & Electric Corporation (“RG&E”) in 2002. Both subsidiaries became part of Energy East’s affiliated group and were included in consolidated returns from that point forward. The refund claim requested that CMP’s and RG&E’s overpayments for 1995, 1996, and 1997 be netted against Energy East’s underpayment for 1999. Thus, all of the balances began before the subsidiaries were acquired by Energy East.

The Court of Federal Claims used a dictionary definition of “same” – “being one without addition, change, or discontinuance: identical.” By that definition, CMP and RG&E were no longer the same taxpayers after the acquisition by Energy East, as they became part of an affiliated group. I’m often uneasy about a court’s use of dictionary definitions and this is no exception. Not only did it open the door for DOJ to argue for an overly narrow definition, but it also fails to recognize multiple different shades of meaning. For example, since I got married 31 years ago, I have moved twice, got a law degree, changed jobs four or five times and professions twice, lost weight, qualified for Medicare, etc. In one sense, yes, people would say I’m “not the same person” I was 31 years ago. But “same person” is also commonly used more broadly so that “not the same person” would refer to, say, major psychological changes – or The Invasion of the Body Snatchers. “Same” just raises the questions “to what extent” or “in what essentials” and becomes a vaguely ontological inquiry. So, dictionary definitions are a (minor) pet peeve just because of the flexibility and nuances of human language makes them too susceptible to manipulation and an ineffective guide to Congressional intent. I’m not a fan of the CFC’s definition of “same” for this issue.

The CFC also noted that “although they later became members of the consolidated group, [Energy East], CMP, and RG&E were different taxpayers with different employer identification numbers at the time of their overpayments and underpayments.” There was no support for treating them as the same for tax years prior to joining the group. This temporal requirement became an important part of the analytical framework, although I argue in Part 2 that it’s not necessarily the right way to look at this issue.

The Federal Circuit agreed that the consolidated return regulations provided no basis for concluding that individual members of the group should be treated as the “same” for years prior to their joining the group. It also rejected Energy East’s alternative argument that the focus of the “same taxpayer” determination should be when interest (to be netted) was accruing. Instead, the court concluded that they had to be the “same taxpayer” on the date of the underpayment and overpayments, based on the “last antecedent rule.” It said that “by the same taxpayer” referred to “equivalent overpayments and understatements” in Section 6621(d); thus, “the statute provides an identified point in time at which the taxpayer must be the same [by virtue of being members of an affiliated group], i.e., when the overpayments and underpayments are made.” As I’ll discuss in Part 2, this may not be precisely correct, at least in other contexts.

The court did not state that these three companies were the same taxpayer for years in which they were included in consolidated returns. That determination was not necessary for the decision, as the parties agreed the companies were not the same taxpayer for the years when the overpayments and underpayments were made.

Under the “attribution to a single entity” framing of FSA 200212028, this decision was clearly right. CMP and RG&E had no connection to Energy East’s underpayment for 1999 that would allow attribution under existing rules. Under a “two entities are treated as the same taxpayer” framing, it’s not as clear. I’ll return to that in Part 2, in the discussion of the Wells Fargo case.

That’s it for Part 1. Stay tuned for Part 2, where the action heats up.

 

Section 6662: Owe A Little Tax? Pay The Penalty. Owe A Lot More? Maybe Not.

Frequent commenter/guest blogger Bob Kamman brings us a post about the weird way the IRS is choosing to impose the substantial understatement penalty. He brought a couple of Tax Court cases seeking to establish some precedent in the area but the Chief Counsel attorneys handling the cases conceded and prevented him from obtaining court review of the IRS practice in this area. Because the fact pattern he has identified usually involves a relatively small amount of money, taxpayers will struggle to find representation in these cases and may find it easier to concede than to fight.  A case in which the taxpayer contests all or part of the underlying tax may provide the more likely vehicle for a test.  If you see this issue in your client’s case, consider following Bob’s example and seek to set precedent. Even if Chief Counsel’s office continues to concede the issue, maybe someone in that office will speak to the IRS about the bad practice that may be a result of computer programming or maybe just an unusual view of the type of behavior that should be penalized. Keith

I won a couple of Tax Court cases in 2018 that I had expected to lose. My clients are happy that IRS settled. But I’m disappointed, because I hoped a Tax Court opinion would at least highlight the issue. At least along the way I learned a few things. For example, there is the Doctrine of Absurdity.

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But first, some background. Suppose that you are a Member of Congress and on a committee that oversees tax laws and IRS. You think penalties are sometimes needed to encourage tax compliance. You consider two cases:

 

Taxpayer A, in a 15% bracket, wins $32,000 on a slot machine, has no tax withheld when the casino issues Form W-2G, and does not report the income on Form 1040. The IRS computer-matching system eventually discovers the omission and assesses $4,800 tax.

Taxpayer B, in a 25% bracket, withdraws $20,000 from a retirement account, requests federal tax withholding at a 20% rate, and thinking like many others that “I already paid tax on it,” does not report the income on Form 1040. IRS document matching catches this error also, and sends a bill for $1,000 because the withholding is not sufficient to cover the additional tax.

Not as someone with a sense of fairness and logic, but as a Member of Congress you would reach the same result that according to IRS was enacted nearly thirty years ago. Taxpayer A pays $4,800 but no penalty. Taxpayer B pays not only $1,000 but an additional $200 penalty.

That’s how Section 6662, together with Section 6664, operates. These Internal Revenue Code penalty provisions come up frequently, and deserve a closer look. They require findings of an “underpayment” and an “understatement,” which IRS tells us are not the same thing.

Section 6662 assesses a 20% penalty on several varieties of “underpayment.” The two seen most frequently are those due to “negligence or disregard of rules or regulations,” and to “any substantial understatement of income tax.”

IRS computers, lacking human interaction with taxpayers, don’t yet have the intelligence to make accusations of “negligence or disregard.” So the “substantial understatement” clause is invoked when proposed assessments are based only on matching information returns to a Form 1040.

And acknowledging the legal maxim de minimis non curat lex – “the law does not deal with trifles” – Section 6662(d)(1)(A) adds that on individual returns, a “substantial understatement” occurs only if the amount exceeds the greater of—

(i) 10 percent of the tax required to be shown on the return for the taxable year, or

(ii) $5,000.

In most cases, the $5,000 minimum rule applies. So you might ask, why will IRS assess a penalty to our Taxpayer A, who only owed $1,000? The answer is that no credit is given for withholding, when determining if there is an “understatement,” even though the withholding is considered when figuring the “underpayment” amount on which the 20% penalty is calculated.

At least, that is how IRS interprets the Regulations to these two sections. I am not sure the IRS understands the Regulations, nor am I confident the Regulations correctly describe what Congress enacted. Some day perhaps a Tax Court judge will reach the same conclusions.

Here is an example from a Tax Court case in which IRS decided it was not worth arguing with me. My client withdrew money from a retirement account, and had tax withheld. Because she thought the taxes had already been paid, she did not mention it to her tax preparer or report it on her return. The additional tax was $9,158. The withholding was $7,325. The difference was $1,833, which when contacted by IRS she gladly paid with interest. But IRS still wanted $367 “substantial tax understatement penalty.”

(Had the return been filed late, a penalty of $458 would also have been proposed, but under the IRS “one time free pass” policy, it could be abated.)

My client is not a low-income taxpayer but she had a high-respect government career. I did not charge a fee for filing the Tax Court petition, or for several phone conversations with a Chief Counsel paralegal (in Phoenix) who handled settlement of the case in our favor. I did furnish reasons that this case might qualify under the “reasonable cause” exception of Section 6664(c) because my client had acted “in good faith.” These arguments seldom prevail at IRS administrative levels. The settlement process took more than four months, from petition filing to stipulation signing.

And here is another example from a Tax Court case. My clients unintentionally omitted some W-2 income from their joint return. They and their preparer had rushed to meet the April 15 deadline after receiving a complex, high-dollar Schedule K-1 on April 10. The additional tax was $6,230 and the withholding only $2,012. The difference of $4,218 was not quite as substantial as the $5,000 minimum contemplated by Section 6662(d)(1)(A). Nevertheless, IRS proposed a “substantial understatement” penalty of $844, because the deficiency before withholding exceeded $5,000.

This case was settled by a Chief Counsel attorney (in Dallas) in less than six weeks after the petition was filed. I did not earn a fee on this case either, but as the preparer I avoided reimbursing my clients for an error for which I shared responsibility.

I did not have to ask the Dallas attorney for a copy of the signed managerial approval now required for such assessments. It might not have existed. In Phoenix, the paralegal showed me what the Service Center considers adequate.   I thought it was ambiguous.

In researching these cases, I came across the “Doctrine of Absurdity,” which is discussed in a 2017 Tax Court opinion, Borenstein, in which Keith Fogg of the “Harvard Clinic” filed an amicus brief. (The opinion does not state whether he supported the anti-absurdity argument, which was just one of several.) The opinion explains:

The “anti-absurdity” canon of construction dates back many years. See Rector of Holy Trinity Church v. United States, 143 U.S. 457, 460 (1892) (“If a literal construction of the words of a statute be absurd, the act must be so construed as to avoid the absurdity.”); Scalia & Garner, supra, at 234-239 (“A provision may be either disregarded or judicially corrected as an error * * * if failing to do so would result in a disposition that no reasonable person could approve.”); 2A Sutherland Statutes and Statutory Construction, sec. 46:1 (7th ed.).

The “anti-absurdity” canon, while of ancient pedigree, is invoked by courts nowadays quite rarely. In order for a party to show that a “plain meaning” construction of a statute would render it “absurd,” the party must show that the result would be “so gross as to shock the general moral or common sense.” Crooks v. Harrelson, 282 U.S. 55, 60 (1930); see Tele-Commc’ns, Inc. & Subs. v. Commissioner, 95 T.C. 495, 507 (1990) (citing Harrelson as supplying the relevant standard but upholding the plain language construction of the statute), aff’d, 12 F.3d 1005 (10th Cir. 1993).

Of course the application of the “substantial understatement” penalty to taxpayers who owe small amounts is absurd. But is it more so than many other IRS procedures? Eventually a Tax Court judge may decide that question, if Chief Counsel stops conceding before trial.

Otherwise, it’s unlikely that Congress will revisit the Section 6662 penalty procedures and make sense of a rule where now there is none.