The Sixth Circuit’s Summa Bomb-shell

We welcome back guest blogger Stu Bassin. Stu is a solo practitioner in Washington, D.C. who specializes in tax controversy work. Today he talks about Summa Holdings v Commissioner, where the Sixth Circuit disagreed with the IRS and Tax Court’s applying a substance over form analysis. The role of anti-abuse provisions in the tax law is controversial, and Stu discusses how taxpayers, the Service and courts are likely going to wrestle with these concepts when IRS challenges transactions that may technically satisfy statutory requirements but seem to be inconsistent with broader tax principles. Les

 The Sixth Circuit issued a remarkable opinion last week, giving the taxpayer a full victory in what the Service tried to characterize as a tax shelter. The decision in Summa Holdings v. Commissioner, No. 16-1712 (6th Cir. February 16, 2017), reversed a Tax Court ruling in favor of the Service and represents the most decisive and significant appellate victory for a taxpayer in the area of judicial doctrines in over a decade.


The Summa case arose out of a clever strategy in which a closely-held corporation employed a Domestic International Sales Corporation (“DISC”) and a Roth IRA to transfer corporate profits into its shareholders’ hands with a minimal tax bite. To briefly summarize, the statutory regime governing DISCs allows companies to defer income on the portion of the DISC’s which is distributed to the DISC’s shareholders as a dividend. The DISC’s shareholders receive the dividend without paying a corporate level tax. The novel twist in Summa was that the DISC’s shareholder was a Roth IRA—an entity which does not pay taxes on its earnings. Thus, neither the DISC nor the taxpayer would pay tax on the remainder of the dividend or on future earnings within the Roth IRA, although the taxpayer would pay an unrelated business income tax on a portion of the dividend received.

Upon audit, the Service recognized that the taxpayer’s strategy satisfied all of the statutory requirements for the treatment it sought under the DISC and Roth IRA statutory provisions. Nonetheless, the Service determined that the “substance over form” doctrine applied and that the payments would not be treated as DISC dividends, but would instead be treated as dividends from the parent company to the shareholders—a recharacterization which substantially increased the shareholders’ tax liability. To add insult to injury, the Service also added a substantial understatement penalty. The Tax Court upheld the Service’s determinations and the taxpayer appealed. In the Summa decision, the Sixth Circuit reversed, ruling that the Service could not apply the substance over form doctrine to the disputed transaction.

The issue, in the court’s view, was whether the Service had crossed the elusive “line between disregarding a too-clever-by-half accounting trick and nullifying a Code-supported tax-minimizing transaction”—the same broad issue which arises in many so-called “tax shelter” cases.  Both sides agreed that, in form, the transactions complied with the text of the Code, but disagreed whether the substance-over-form doctrine could nonetheless be invoked. Rejecting the Service’s position, the court observed that tax law is governed by a highly nuanced set of rules articulated with nearly mathematic precision, particularly in the DISC arena and that “all areas of law that should resist judicial innovation based on misty calls to higher purposes, this would seem to be it.” While endorsing application of judicial doctrines in some cases involving factual shams and transactions which have no legitimate non-tax business purpose, the court concluded that the doctrine “does not give the Commissioner a warrant to search through the  . . . Code and correct whatever oversights Congress happens to make or redo any policy missteps the legislature happens to make.” If Congress found the result improper, it could amend the statutes, but it was not the role of courts to legislate.

Read broadly, the Summa decision is a bomb-shell; it breaks a decade-long string of Service victories in appellate cases which rest upon application of judicial doctrines like the substance-over-form rule to undo transactions which the taxpayer designed to comply with the literal language of the Code (the most recent taxpayer victories were in 2001 in the 5th Circuit Compaq Computer v Commissioner and 8th Circuit in IES Industries v US). In almost all of the cases where the government prevailed, the taxpayer argued that it had complied with the Code and that it was inappropriate to invoke judicial doctrines or to judicially legislate based upon a judge’s gut reactions to particular transactions. While most of the appellate courts have sided with the Service, the opinion of the Sixth Circuit emphatically rejected the Service’s position—complete with an allusion to Caligula.

Where the case goes from here is a great topic for speculation.   The recurring question of the parameters of the judicial doctrines is not going to go away and Summa potentially represents a very important conflict between the circuits. However, presentation of that fundamental issue is probably something the Government will likely try to avoid; a large body of Service-favorable law has developed since the Supreme Court’s last “judicial doctrine” ruling–the 1978 Frank Lyon decision. The vitality of all that law would be in play if Summa were to reach the Supreme Court.

Recognizing the stakes which would be at risk in a Supreme Court ruling on Summa, the Service and the Solicitor General are more likely to dodge the issue by offering a narrow reading of Summa, attempting to confine its reach to cases involving statutory grants of narrow tax benefits to a particular favored category of taxpayers such as DISCs. Indeed, the argument for application of generalized judicial doctrines to avoid tax avoidance is much weaker where Congress has so explicitly granted specific benefits which allow tax avoidance—benefits like those granted to DISCs and applied in Summa. Of course, the Government prevailed in a comparable context in the Third Circuit’s Historic Boardwalk ruling (which involved statutory rehabilitation tax credits), and it would be difficult to reconcile the two cases, but the conflict would be far less significant and is likely a matter which the Government would let stand before it ran the risk of a new Supreme Court decision on the judicial doctrines.

Disclosure of Donald Trump’s Tax Returns

trumpSteve, Les and I vote in the battleground state of Pennsylvania which means we get more than our fair share of advertising on the upcoming election.  Over the past week much attention has been focused on the disclosure of three state tax returns allegedly filed by Mr. Trump.  Most of that discussion has centered on pundits seeking to interpret what the small snippet of information available in the state tax returns means about Mr. Trump’s tax liabilities 20 years ago and today.  As a procedural blog, our interest is not focused on the substance of his returns but on the procedural issues implicated by the disclosure.

1040sToday’s guest blogger, Stu Bassin, provides insight into the federal disclosure laws that govern the disclosure by the New York Times of the returns and, to a certain extent, the disclosure of the returns by the person who mailed the returns to the New York Times.  I say to a certain extent because there may be other laws governing the individual relating to how the information was obtained – something we do not know.

While the federal laws that Stu discusses provide a framework for thinking about the issue, the returns that were disclosed were state tax returns of three states, New York, New Jersey and Connecticut.  Neither we nor Stu practice in those states and we are not prepared to write opinions on the applications of the laws of those states to this situation.  You can find here, the comments on this subject provided by Slate which states that the disclosure does not violate the laws of the three states involved.  We know we have readers from the states involved and welcome comments that address the implications of the disclosure vis a vis the laws of those states.  Having persons disclose information in this fashion seems to be more popular today than in the past.  If current laws do not address this type of disclosure, the disclosure of Mr. Trump’s returns raises the issue of whether the federal or state laws should address this type of disclosure with civil or criminal penalties or whether the matter is one between the person making the disclosure and the person whose information is disclosed.

While we may wish that Mr. Trump would disclose his tax returns for whatever benefit we would derive from such disclosure, the disclosure of his returns, even 20 year old state returns which provide a basis for more speculation than true knowledge, also leaves us wondering how the system should treat the making public of someone’s returns who wants them to remain private and who filed them with that expectation.  Keith

Last week, the New York Times published excerpts from Donald Trump’s 1995 tax returns.  Soon thereafter, Mr. Trump’s spokesmen charged that the Times violated federal law by illegally disclosing Mr. Trump’s returns.  Invoking the First Amendment, the Times defended the publication.  Which side correctly read the tax law?

The public generally believes that federal tax returns are confidential and that disclosure of a taxpayer’s return or return information is illegal.  Indeed, Code Section 6103(a) provides that returns and return information are “confidential” and that government employees are prohibited from disclosing returns and return information.  Section 7431 authorizes civil damage claims for unauthorized disclosures and Section 7213 establishes criminal penalties for unauthorized disclosures.

Those general principles are qualified, however, by the specific language of the statute.  Section 6103(b) defines “return” as those returns filed with the Service.  Distinguishing between the signed return formally filed with the Service and other copies of the return, the courts have ruled that, when a government employee obtains a copy of a taxpayer’s Form 1040 from a source other than the Service, that tax form is not protected by Section 6103.  For example, where naval investigators obtained a copy of a return from a briefcase stored in the taxpayer’s government workspace, the Ninth Circuit held that Section 6103 did not apply because the return was not obtained from the Service.  See Stokwitz v. United States, 831 F.2d 893 (9th Cir.1987), cert. denied, 485 U.S. 1033 (1988).   Copies of returns obtained from the taxpayer’s accountant or through a grand jury subpoena are likewise not protected.

Similarly, the statutory language of the Section 6103 applies only to disclosures by federal employees and state employees.  Similar limiting language can be found in the statutes authorizing civil suits for unlawful disclosure and imposing criminal sanctions for unlawful disclosures.   The statutes simply do not reach publications of returns by persons other than government employee, such as the Times.

Section 6103 is not implicated by publication of Mr. Trump’s returns unless he can establish that the published actually came from the Service.  That issue of proof is complicated by the fact that a laundry list of regulatory agencies, lenders, and litigants, including Mr. Trump’s former spouses (and their representatives) have probably obtained copies of the returns during the past two decades.  Because the Times’ documents did not bear any IRS file-stamps and the fact that the disclosures included state tax returns which would not have been filed with the Service strongly suggests that the source was not the IRS.

Bottom line.   Section 6103 almost surely did not protect Mr. Trump’s returns and he has no wrongful disclosure claim against the Times or anyone else.

Court of Federal Claims Authorizes Deposition of Revenue Agent and Requires Production of Service Documents in Tax Refund Suit

We welcome back guest blogger Stu Bassin. Stu is a solo practitioner in Washington, D.C. who specializes in tax controversy work. Today he talks about a recent Court of Federal Claims case in which the Court rules on a discovery dispute that had several facets. The taxpayer in the case before the Court had not participated in the audit and she wanted information about what happened during the audit that a petitioner would not normally need and in another forum might not receive. The taxpayer wanted to depose the revenue agent concerning things he considered as a part of the audit. In some ways the issue sets up as a Greenberg Express issue if this were a Tax Court case and the taxpayer sought to go behind the notice of deficiency. In addition to the issue of whether discovery was appropriate to seek this type of information, the IRS also raised the issue of testimonial authorization. IRS employees, and employees of any federal agency, cannot be compelled to testify generally concerning matters related to their employment without an authorization from the agency from which they work. The authorization letters usually provide a fairly narrow authorization for the employee to testify and the agency requires the party seeking their testimony to provide a detailed description of the testimony sought after which the agency decides how much of the requested testimony the agency wishes to allow its employee to address through testimony. This dance regarding the testimony of a federal employee takes its form from the case of Touhy v US. Just as the Court of Federal Claims did not seem bothered by allowing discovery on a matter that “goes behind the notice” (I realize the case does not arise from a notice of deficiency) it also does not seem too concerned about the Touhy issue. Perhaps the case signals a broader approach to testimony of IRS agents than might previously have been anticipated. Keith

A recent Court of Federal Claims ruling illustrates several of the substantive and procedural concerns surrounding obtaining discovery from the Service and taking depositions of Service personnel in connection with the litigation of tax disputes. Herrmann v. United States, Fed. Cl. No. 14-941T (May 20, 2016, Judge Lettow).

The case’s unusual procedural history arose out of a bonus payment paid by a London-based partnership to Ms. Herrmann, a U.S. citizen living in London, employed by the partnership. Ms. Herrmann paid U.K. tax on the payment, but did not report the income on her U.S. return. The Service audited the partnership and determined that the bonus payment was a partnership distribution. Following the audit, the Service issued a Notice of Computational Adjustment to Ms. Herrmann, requiring her to pay additional tax based upon re-characterization of the bonus. Ms. Herrmann paid the tax, filed a refund claim, and later filed suit in the Court of Federal Claims.


As Ms. Herrmann was not involved in the audit of her employer’s partnership, she had much less knowledge of the facts and procedural history of the audit giving rise to her alleged tax liability than more typical taxpayers. Accordingly, she sought production of documents relating to the audit and a deposition of the revenue agent responsible for the partnership audit and the adjustment to her tax liability. The Service objected, challenging the relevance of the requested discovery, contending that it could limit the subject matter of the deposition, and that the taxpayer’s filing of a motion to compel the discovery was premature. In the recent order, the Court of Federal Claims granted Ms. Hermann much of the relief she sought.

The unique procedural posture of the case drove the court’s rejection of the Service’s relevance objection to production of the documents it obtained and generated during the partnership audit. Case law has always allowed discovery of the facts considered by the Service in making its audit determinations, but generally noted that the discovery was unnecessary because virtually all of the factual documentation underlying the determinations was already in the possession of the taxpayer. But, unlike the fact pattern in more typical suits, Ms. Herrmann did not participate in the audit and needed that documentation to prepare her case. The court’s decision requiring production of the documents therefore seems proper.

The Service’s attempt to restrict the scope of the revenue agent’s deposition presented another twist on the relevance question. The Service cited Treas. Reg. §301-9000 (the so-called Touhy regulations), under which agencies like the Service establish procedures authorizing a government employee to testify. Those regulations operate as a house-keeping procedure allowing the agency to supervise the testimony of their employees and protecting the employee from a contempt citation if the agency limits or prohibits the desired testimony. The regulations do not, however, establish a special right for government agencies to withhold relevant evidence or to prevent their employees from testifying about relevant information without consequence.

In this case, the Court of Federal Claims made its own determination on the relevance of the revenue agent’s testimony, determining that the deposition would go forward, subject to the terms of the testimony authorization. The issue not addressed in the opinion was what would happen if the Service asserted a non-meritorious relevance objection at the deposition. The Touhy regulations might insulate the Service employee from sanctions, but the agency would remain subject to court-ordered sanctions, just like any other litigant who refuse to provide testimony.

Resolution of the dispute about the deposition testimony was further complicated by the parties’ choice to litigate the dispute in the context of a list of approved topics for the deposition as set forth in the testimony authorization. The list of topics was necessarily somewhat general and left uncertainty regarding the specific questions which the taxpayer might ask at the deposition. In ruling on the motion, therefore, the court was required to anticipate the questions that the taxpayer might ask and could only rule in terms of broad principles. Later, when the parties conducted the deposition, they would inevitably have to apply those broad principles to specific questions which the court likely did not contemplate when it issued its ruling.

A better approach for litigating this type of dispute is for the court to allow the deposition to go forward, with government counsel instructing the witness not to answer questions beyond the testimony authorization, and for the taxpayer to file a motion to compel challenging any improper instructions from counsel. A court can then rule upon the propriety of specific questions and objections. Not only is this approach more likely to produce clear rulings on the precise dispute between the parties, but it allows the court to avoid trying to issue an advisory opinion upon a host of matters which may never require a ruling.