Estimated Tax Penalty a Tough Nut to Crack: Cal Pure Pistachios v US

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The Cal Pure Pistachios v US district court case from April (free link not available, CV 14-5237-DMG, Central District CA) interested me not only because it affords the chance to inject a pun into a title, but because it demonstrates the reach of estimated tax penalties. The case also shows how at times judges will defer to the government’s interpretation of an arguably ambiguous term, even in the absence of guidance.

I will summarize the facts and describe the law that produced a harsh result for the taxpayer.

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The case was before the court on the taxpayer’s summary judgment motion. Here are the facts, as set forth in the opinion, with references to the record omitted:

For the tax year ending August 31, 2008, Plaintiff {Note: Cal Pure Pistachio is a C Corporation] filed a return reflecting a tax liability of “$0.00.” Based on the 2008 tax return and pursuant to section 6655(d)(1)(B)(ii), Plaintiff did not make any estimated tax payments for the tax year ending August 31, 2009. As a result, Defendant assessed against Plaintiff a penalty in the amount of $94,671.53, plus interest, for failure to pay estimated taxes for the 2009 taxable year.

Section 6655(a) generally provides for a penalty for corporate taxpayers who underpay estimated income taxes. Section 6655(d)(1)(A) provides that “the amount of any required installment shall be 25 percent of the required annual payment.” The opinion discusses the the annual payment requirement:

IRC section 6655(d) states that the required annual payment for failure by a corporation to pay estimated income tax shall be the lesser of “(i) 100 percent of the tax shown on the return for the taxable year (or, if no return is filed, 100 percent of the tax for such a year), or (ii) 100 percent of the tax shown on the return of the corporation for the preceding taxable year.” 26 U.S.C. § 6655(d).

Section 6655(d)(1)(B) has a safe harbor exception, which was at issue in the case:

Clause (ii) [of Section 6655(d)(1)(B)] shall not apply if the preceding taxable year was not a taxable year of 12 months, or if the corporation did not file a return for such preceding taxable year showing a liability for tax.” Id. In other words, if a corporation did not file a return for a preceding taxable year showing a liability for tax, the corporation cannot take advantage of clause (ii)-the “safe harbor” provision-by paying “100 percent of the tax shown on the return of the corporation for the preceding taxable year.” Id. (emphasis added).

The case turned on the emphasized bolded language. Cal Pure Pistachios claimed that the 2008 return showing zero liability was a return showing a liability for tax; the government argued that because the “2008 return reflects “$0.00” for tax, and therefore no liability, [Cal Pure Pistachios] cannot utilize the Section 6655(d)(1)(B)(ii) safe harbor to avoid any addition to tax for the 2009 taxable year.”

In support of its argument, the government looked to a plain meaning argument of liability:

Defendant relies on the plain meaning of “liability,” which indicates that “zero (representing no tax due) connotes precisely the absence of [] an obligation, liability or debt.”

The government backstopped its argument by pointing out the “legislative intent behind Section 6655(d)(1)(b)(ii), evident in the IRC’s treatment of the addition to tax for failure to make estimated payments in provisions relating to taxpayers other than C corporations, to show that “$0.00” liability means no liability.” To that end, it pointed to differing rules for S Corps and individuals, and in particular that there is no requirement for S Corps or individuals to file a return for the prior year in order to take advantage of the exception:

Congress’s omission of the requirement that an S corporation file a tax return for the preceding taxable year “showing a liability for tax” in section 6655(g)(4)(D) and the absence of such requirement for individuals under Section 6655(d)(1)(B)(ii) indicate that “Congress intended that the requirements have a separate and special significance for C corporations, such as plaintiff.”

In reading the opinion before getting to the conclusion, you know the taxpayer was in trouble when the opinion refers to the taxpayer’s argument “as a series of unsupported assertions.” Cal Pure essentially argued that “[t]he term “liability for tax” includes and has always included zero,” “[t]he definition of “tax liability” everywhere it appears in the Code includes zero,” and Section 6655(g)’s definition of “tax” “also undisputedly includes zero.” It also noted that the regs under 6655 do not provide otherwise.

The court disagreed:

Section 6655(d)(1)(B) plainly states that clause (ii) is inapplicable where a corporation did not file a return for the preceding taxable year showing a liability for tax. Plaintiff attempts to skirt the exception to the safe harbor by arguing that filing a tax return reflecting “$0.00” in liability is somehow distinguishable from not filing a return showing a liability for tax. The Court sees no distinction between the two. Plaintiff filed a 2008 tax return showing zero liability for tax-whether zero is expressed as “$0.00,” “0,” “N/A,” “nada,” “zilch,” or through the absence of filing, the result is the same: Plaintiff did not file a return showing a tax liability. (emphasis added)

Some Loose Ends

The outcome seems pretty harsh. The opinion for good measure felt that the taxpayer’s argument could lead to an absurd result:

If corporations that claimed no tax liability in a prior year could take advantage of the safe harbor provision by simply filing a return stating “$0” rather than not filing a return at all, they would all have an option to pay nothing, as opposed to what they actually owe for the current taxable year. “[S]tatutory interpretations which would produce absurd results are to be avoided.” Ma v. Ashcroft, 361 F.3d 553, 558 (9th Cir. 2004).

That does not seem absurd to me, but absurdity is in the eye of the beholder.

Cal Pistachio not surprisingly disagreed and argued that the government’s interpretation was irrational:

The results of Defendant’s hypothetical syllogism: that one only is excused from the penalty if the prior return reflects a liability greater than zero, is irrational and arbitrary. For example, if Cal Pure’s prior tax return reported $1.00 in tax, Defendant would presumably excuse the penalty it asserted, but because Cal Pure paid less, it now, according to the Defendant, is obligated to pay some $95,000. What if Cal Pure paid five cents ($.05) with the tax return? Would a rational interpretation of the code impose $95,000 penalty or a $95,000,000 penalty for the failure to pay a nickel? That is the logic the government is suggesting the Court apply in this case.

The court was unsympathetic, and moreover stated that the government’s interpretation was entitled to deference:

Even if it were reasonable to surmise that Cal Pure would ever owe only $1 or $.05 in tax, “[t]he IRS’s understanding of the terms of the Code is entitled to considerable deference.” United States v. Nat’l Bank of Commerce, 472 U.S. 713, 730 (1985); see also Omohundro v. United States, 300 F.3d 1065, 1069 9th Cir. 2002) (applying Skidmore v. Swift & Co., 323 U.S. 134, 65 S. Ct. 161, 89 L.Ed. 124 (1944), standard of deference to the IRS’s interpretation of the I.R.C.). [some cites omitted]

I am not sure why the government’s position should have received any deference.   There was no formal or informal guidance on the issue. The government’s position is just a litigating position.

As a parting gesture, the opinion quoted approvingly from the government’s opposition to the motion for summary judgment: “[t]he fact that application of tax statutes sometimes presents harsh results does not negate the fact that the law must be enforced as written by Congress.”

Harsh indeed.

About Leslie Book

Professor Book is a Professor of Law at the Villanova University Charles Widger School of Law.

Comments

  1. Robert Nassau says

    I’m going to predict a taxpayer victory on appeal (but I’ve been wrong many times before).

    • Bob Kamman says

      I agree with you and disagree with Carl Smith, who gives Congress more credit than it deserves for being a logical, rational organism. I would be interested in knowing when the two estimated-tax penalties, one for individuals and the other for corporations, were first enacted. Fifty years apart, perhaps? And while at it, did Congress intentionally enact relief for individual farmers, and not corporate farmers? We know how much Congress favors agriculture.

      The real reason the pistachioans are being penalized is for breaking the unwritten rule, “thou shalt not file your tax cases in District Court, we have enough work already.”

  2. Anonymous says

    Does this ‘opinion’ fulfill the elements of the ‘arbitrary and capricious’ standard?

  3. Carl Smith says

    But, the language in the statute seems to require this silly result. Congress used different language for the 6654 penalty against individuals. Section 6654(d)(1)(B) provides: “Clause (ii) shall not apply if the preceding taxable year was not a taxable year of 12 months or if the individual did not file a return for such preceding taxable year.” Note that there is no mention there of the return for the preceding year showing a liability. When Congress uses different words, those words should be given meaning, not rendered superfluous. This is something I think Congress intended — dumb policy as it may be.

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