TaxProf Blog op-ed: Initial Impressions of Woods, by Steve R. Johnson (Florida State):
On December 3, the Supreme Court issued its unanimous decision in United States v. Woods, No. 12-562, with Justice Scalia writing for the Court. The Court held first that the TEFRA “unified” partnership audit and litigation provisions give “courts in partnership-level proceedings jurisdiction to determine the applicability of any penalty that could result from an adjustment to a partnership item, even if imposing the penalty would also require determining affected or non-partnership items such as outside basis.” Woods, slip op. at 9-10. The Court held second that the “substantial valuation misstatement” base of the accuracy-related penalty, IRC sec. 6662(b)(3), (e) & (h), applies when a taxpayer claims deductions based on claimed partnership outside basis and, as a result of the economic substance doctrine, there is no valid partnership and so no partnership basis to claim. These issues arose out of IRS adjustments to tax benefits claimed through a COBRA tax shelter.
Here are my initial reactions to Woods:
First, I think the TEFRA holding was correct, but Woods illustrates the folly of our holding on to TEFRA long after its utility passed. As I and some others have argued before, TEFRA should be abolished. TEFRA made sense in the days when there were thousands of shelters, each with scores or hundreds of “investors.” All that ended with enactment of sec. 469. Tax shelters these days typically have only a few “investors” each. (There were only two meaningful partners in the Woods partnerships.) That being so, the IRS should be able to handle partnership adjustments at the partner level. We do not need, as TEFRA requires, partnership-level actions followed by partner-level action, with complex and confusing rules to separate which items may be considered at which level.
The Court spent almost half of the analytical portion of its Woods opinion addressing TEFRA jurisdiction, and it told two circuit courts that they had misunderstood TEFRA jurisdiction. See Jade Trading, LLC v. United States, 598 F.3d 1372 (Fed. Cir. 2010); Petaluma FX Partners, LLC v. Comm’r, 591 F.3d 649 (D.C. Cir. 2010). And let no one think that Woods ends all confusion about TEFRA. Woods acknowledged that the language of the relevant TEFRA provision is “essentially indeterminate,” requiring the dispute to be resolved by reference to contextual indicators. Woods, slip op. at 8. Numerous additional jurisdictional and other issues lurk in the TEFRA weeds. See, e.g., Woods, slip op. at 11 n.2 (commenting on, but leaving for another day the resolution of, an “odd procedural result” asserted by amici). There is no need to pay the costs in time, money, and confusion that TEFRA imposes. TEFRA’s costs now outweigh its benefits.
Second, I think the penalty holding also was correct. The Court sided with the majority view of the lower courts as to this issue, and there were loud rumblings of discontent with the minority view (held only by the Fifth and Ninth Circuits) from even some judges of courts taking the minority view. Moreover, the majority view was consistent with a Treasury regulation. Reg. sec. 1.6662-5(g). The Court noted amicus Andy Grewal’s observation that the regulation contorts math principles. (But many tax statutes and regulations refer to “a principal purpose,” which also is a head-scratcher from the standpoint of math.) In any event, the taxpayer did not challenge the regulation, so the Court assumed its validity for the purpose of deciding Woods. Woods, slip op. at 12 & n.4.
The Court suggested that “valuation” for purposes of the penalty base includes legal as well as factual errors. It was right to do so. The “fact versus law” distinction has been so slippery in many contexts that avoiding the distinction whenever possible is wise. The Court also noted that the statutory language embraces “adjusted basis” (a concept mixing factual and legal determinations) as well as “value.” Moreover, the Court rejected the contention that sham was an independent legal ground from overstatement of outside basis. The valuation misstatement was not “a mere side effect of a sham transaction. Rather, the overstatement of outside basis was the linchpin of the COBRA tax shelter.” Woods, slip op. at 15.
Third, Woods may have given ammunition to the Government in its effort to overthrow Loving v. IRS, 917 F. Supp. 2d 67 (D.D.C. 2013), on appeal, No. 13-5061 (D.C. Cir.), in which the court invalidated regulations regulating the practice of previously largely unregulated tax return preparers. (My article about Loving is forthcoming in volume 60 of the Villanova Law Review.) The asserted statutory basis for the regulations is 1884 legislation, the terms of which, the Government argues, are broad enough to cover the regulations. Part of the hesitancy about the regulation is that the Government had not until 2011 attempted to use the statute in this fashion. Yet the Woods Court said: “An agency’s failure to assert a power, even if prolonged, cannot alter the plain meaning of a statute.” Woods, slip op. at 15 n.5. Several cases, including FDA v. Brown & Williamson Tobacco Corp., 529 U.S. 120 (2000), arguably are in tension with this statement but may be distinguishable.
Fourth, as tax decisions usually are, Woods is interesting from the standpoint of statutory interpretation. Three points. (a) The Court referred to “the plain meaning of ‘adjusted basis’.” I think that’s a stretch. This characterization reminds one that “plain meaning, like beauty, is sometimes in the eye of the beholder.” Florida Power & Light Co. v. Lorion, 470 U.S. 729, 737 (1985).
(b) Woods turns up the heat on the long simmering dispute as to the interpretive utility of the Joint Committee’s General Explanations, aka Blue Books. Justice Scalia acknowledged that the Court has “relied on similar documents in the past” but stated that the Court’s “more recent precedents disapprove of that practice.” Woods, slip op. at 16. He offered that “the Blue Book, like a law review article, may be relevant to the extent it is persuasive.” Id. However, Reg. sec. 1.6662-4(d)(3)(iii) does not put these two sources on the same legal plane. It says that Blue Books are authority for substantial authority purposes, while law review articles are not. The last act of this drama has not yet been written.
(c) Unsurprisingly, Justice Scalia took the following position as to committee reports generally: “We do not consider Woods’ arguments based on legislative history. Whether or not legislative history is ever relevant, it need not be consulted when, as here, the statutory text is unambiguous.” Woods, slip op. at 15 n.5. No justice demurred (either because they agreed or because they didn’t consider disagreeing worth the effort). The idea that committee reports are irrelevant when the text is clear is not limited to the textualist wing of the Court. See, e.g., Milner v. Department of Navy, 131 S. Ct. 1259, 1267 (2011)(per Justice Kagan) (“Legislative history, for those who take it into account, is meant to clear up ambiguity, not create it.”).