Tuesday, July 26, 2011
Petitioner operated his Web site business using the accrual method of accounting. In 2007 petitioner worked 1,000 hours developing the Web site. Petitioner charges unrelated parties between $45 and $55 an hour for performing work similar to that which he performed on his Web site development. Petitioner's proprietorship, the Web site, did not pay him for any services he performed for himself. Petitioner's proprietorship accrued $50,000 as a liability for payment to petitioner for his work to set up his Web site, and the accrued expense was deducted on Schedule C of the return. ...
On the issue of his accrual, petitioner testified that he is an accountant. As an accountant petitioner should be familiar with the concept of imputed or implicit expenses or costs (imputed expenses). Imputed expenses are the opportunity costs of time and capital that the manager of a business has invested in producing "the given quantity of production and the opportunity cost of making a particular choice" among alternatives. Siegel & Shim, Dictionary of Accounting Terms (Barron's Business Guides) 234 (5th ed. 2010). An imputed expense is one that is not actually incurred but is used to compare with an actual cost. Oxford Dictionary of Accounting 227 (Gary Owen & Jonathan Law eds., 4th ed. 2010); Tracy, Accounting for Dummies 237 (3d ed. 2005). An imputed cost is not recorded in the books of account and is not accurately measurable but is a hypothetical cost used in making comparisons; an example is "salaries of owner-directors of sole proprietorship firms." Rajasekaran & Lalitha, Cost Accounting 12 (2011).
From an accounting standpoint, the time petitioner spent on his own Web site instead of earning $45 to $55 an hour from unrelated parties is an opportunity cost, an imputed expense to petitioner and his business. It is not an incurred expense, is not reflected in the financial statements, and is not an actual cost. ....
Respondent cited several cases for petitioners' and the Court's consideration on this issue. In Maniscalco v. Commissioner, T.C. Memo. 1978-274, the Court observed that "Whatever may be said in behalf of taking into account the value of one's own services in lieu of paid labor, such services are not considered an element of the deduction under sec.162(a). ... Petitioner argues that all these cases involve cash basis taxpayers, and he agrees that a cash basis taxpayer cannot deduct a payment to himself in the same year. However, he argues inexplicably that because his business was on the accrual method the cases respondent cites not only are inapposite but also support his position. [Fn.2]
[Fn.2: Petitioner cited Remy v. Commissioner, T.C. Memo. 1997-72, as supporting his position. The Court in that case held that a cash basis taxpayer could not deduct the value of his labor under sec. 162 because it was not paid or incurred. Petitioner interprets the case to mean that an accrual basis taxpayer can deduct the value of his labor, a logical fallacy.]
Perhaps petitioner did not read Rink or he failed to read it carefully. The Court pointed out in that case that the taxpayer took the position, as petitioner does, that "he should be permitted to accrue currently, as a liability, amounts owed by him to himself on account of his labors, but include the value of such labor in income only when and if such labor gives rise" to income in the future. The Court found the argument to be without any merit; "For one thing, we have found that the petitioner incurred no liability, in favor of himself or anyone else, to pay for the value of his services." Id. at 753-754 (emphasis added). ...Neither accounting principles, tax law, nor common sense supports a deduction by petitioners for contract labor as a result of an accrual of an amount "owed" by petitioner to himself for his own labor.
- Jim Maule (Villanova), The Value of Tax Education
- Tax Lawyer's Blog, Accountant Tries to Deduct Value of His Own Services
- Tax Update Blog, If Time Is Money, Why Can't I Deduct It?
Wednesday, July 13, 2011
The D.C. Circuit’s recent en banc decision in Cohen v. United States, No. 08-5088, in some ways represents a significant statement regarding the availability of judicial review for Administrative Procedure Act (APA) procedural challenges in the tax context. At a minimum, the court’s decision embraces the Supreme Court’s recent rejection of tax exceptionalism in Mayo Foundation for Medical Educ. & Research v. United States, 131 S.Ct. 704 (2011). Nevertheless, the decision’s practical implications for APA procedural challenges against Treasury and IRS actions are substantially less clear and potentially minimal.
[T]he issues we must decide are: (1) Whether the estate is entitled to deduct [$1,240,000] as an expense the claim on the estate tax return for services rendered by Anthony M. Olivo (Mr. Olivo), the son of Emilia W. Olivo (decedent) to decedent before her death; (2) whether the estate is entitled to deduct the [$44,200] administrator’s commission paid to Mr. Olivo; and (3) whether the estate is entitled to deduct the [$55,000] accountant’s and attorney’s fees claimed by Mr. Olivo.
Mr. Olivo, the administrator of the estate, resided with decedent at the time of her death and had provided care for her for many years before her death. Mr. Olivo began providing nearly full-time care for decedent and her late husband, Matthew W. Olivo, his parents (we sometimes refer to Matthew W. Olivo as his father), around September 18, 1994. ...
[D]uring September 1994, Mr. Olivo began to find it increasingly difficult to maintain his practice as an attorney. He had received his J.D. from Rutgers University School of Law (Camden) in 1976 and his LL.M. in taxation from New York University School of Law in 1979. Mr. Olivo practiced law at private firms in Cherry Hill, New Jersey, from 1976 until 1988, when he began his own practice. However, his solo practice began to disintegrate during the mid-1990s, in part because of the amount of time he devoted to his parents’ health problems. He earned no significant income from his law practice during the period when he was caring for his parents, from 1994 through 2003....
Mr. Olivo’s care for decedent during the last years of her life was extraordinary, and the efforts he expended on her behalf are commendable. However, we conclude that the estate has not established that Mr. Olivo is entitled to recover for that care....
Applying the statutory formula to the estate value of $1,711,163.81 reported on the return yields an administrator’s commission of $52,223.28. ...
The record shows that Mr. Olivo did perform some legal services for the estate, in addition to his services as administrator. For instance, he filed the estate’s tax return,handled the IRS examination on behalf of the estate, and filedthe estate’s original petition with this Court. However, the record does not establish the value of his legal services. Mr. Olivo kept no records of the time he spent performing legal services for the estate. Instead, he merely estimated the numberof hours and used a billing rate of $150 per hour. On account of the lack of corroborating evidence in the record concerning theattorney’s fees issue, we decline to accept Mr. Olivo’s estimates of the amount of time he spent performing legal services for the estate.
(Hat Tip: Bob Kamman.)
Wednesday, July 6, 2011
Marciano had argued that the audit could reveal money owed to the government that he believes former employees mishandled. In dismissing the suit on Friday, U.S. District Court Judge Henry Kennedy Jr. noted that the property rights protected under the Fifth Amendment don't guarantee anyone's right to pay taxes.
In his complaint, Marciano claimed that he uncovered evidence of “substantial financial irregularities” in his personal and business affairs around 2005. He believed he was the victim of identity theft, fraud, embezzlement and a host of other financial crimes.
As part of his investigation into these irregularities, Marciano alleges that he repeatedly asked the IRS for copies of previous years’ tax returns, but was told that they were unavailable. He claims he also asked the IRS to do an audit of his previous returns, but they refused. ...
The IRS moved to dismiss the suit, claiming Marciano had failed to state a viable claim and that the court lacked jurisdiction.
In his opinion,Kennedy sided with the IRS, finding that Marciano had failed to exhaust administrative remedies and that Marciano could not sue the IRS through statutes designed to give individuals legal remedies in cases where the IRS is demanding payment. ...
“The extraction by the government of money or property via taxation implicates a constitutionally protected property interest, but, as noted above, Marciano has asserted repeatedly that he owes the government money, rather than the reverse,” Kennedy wrote. “The Court is aware of no precedent establishing a protected property interest in the ability to pay taxes.”
Saturday, July 2, 2011
A divided federal appeals court in Washington said a group of taxpayers will be allowed to challenge the procedure the IRS set up to refund billions of dollars collected through an unlawful tax on telephone calls. [Cohen v. United States, No. 08-5808) (D.C. Cir. July 1, 2011) (en banc)]
The full U.S. Court of Appeals for the D.C. Circuit voted 6-3 to send back to the trial court a dispute over whether the IRS refund procedure is unconstitutional. The 10 plaintiffs want an injunction ordering the IRS to craft a new refund method.
The appeals court did not take a stance on the merits of the IRS’s refund scheme, instead addressing only whether the court has oversight. The court ordered additional proceedings in the U.S. District Court for the District of Columbia. ...
At issue is whether the plaintiffs must first file refund claims with the IRS and then litigate their dispute in tax suits or whether the group of taxpayers can sue under the Administrate Procedure Act without taking any of the earlier steps. A report issued by the Treasury Inspector General for Tax Administration said the IRS illegally collected $8 billion between February 2003 and August 2006.
The six judges in the majority, including Janice Rogers Brown, who wrote the opinion for the court, rejected the IRS claim that the suit is barred because it seeks restraint of the assessment and collection of taxes. The IRS, the majority said, sees a world in which “no challenge to its actions is ever outside the closed loop of its taxing authority.”
“This suit is not about the excise tax, its assessment or its illegal collection. Nor is it about the money owed the taxpayers,” Brown said. “This suit is about the obstacle course, and the decisions made by the IRS while setting it up.”
Brown said the suit is permitted under the Administrative Procedure Act because it “questions the administrative procedures by which the IRS allows taxpayers to request refunds for the wrongfully collected excise tax.” ...
The IRS, Brown wrote, is no victim. The taxpayer plaintiffs “are not raiders in pursuit of an unwarranted windfall.” The plaintiffs, the court said, “are aggrieved citizens in search of accountability.”
Wednesday, June 22, 2011
Much like the Federal Circuit, the D.C. Circuit applied Chevron analysis to conclude that § 6501 is ambiguous and that Treasury's interpretation of that provision is reasonable. Because the statute is ambiguous, the Supreme Court's decision in Colony does not foreclose Treasury's interpretation. Whether or not the temporary regulations were procedurally flawed for APA purposes, Treasury finalized them using notice and comment. Treasury's “searching consideration” of the sole comment received in that process, as expressed in the preamble to the final regulations, demonstrated a sufficiently “open mind” to “cure” any procedural problem posed by the use of temporary regulations. (The court did not address at all whether or not the use of temporary regulations without notice and comment complies with the APA. Instead, the court only addressed the argument that the final regulations were procedurally flawed because they had been initially adopted as temporary regulations without notice and comment and the agency failed to keep an open mind in promulgating the final regulations.)
Update: For more, see Miller & Chevalier's Tax Appellate Blog.
Prior TaxProf Blog coverage:
- Johnson: Intermountain, Interpretive Regulations, and Brand X (May 20, 2010)
- Johnson: Intermountain and the Importance of Administrative Law in Tax Law (Aug. 25, 2010)
- Federal Circuit Exacerbates Split on Overstatement of Basis and 6-Year SOL (Mar. 12, 2011)
- Harvard Law Review on Intermountain (Mar. 24, 2011)
Monday, June 20, 2011
Schering-Plough further complains that the IRS had inappropriate motives for pursuing its audits and requests discovery to explore this allegation further. The language from IRS documents that Schering-Plough quotes indicates that at least one IRS agent thought that Schering-Plough’s approach to determining its tax liabilities was less than conscientious, given prior findings of evasion (which were upheld by this circuit, as the District Court noted, see Schering-Plough Corp.). The chutzpah of this argument is notable. To the extent that the IRS pursued Schering-Plough more vigorously because Schering-Plough had a history of failing to comply with the tax laws, this represents commendable agency diligence in the light of past experience, not some kind of impermissible bias against Schering-Plough. Schering-Plough offers no persuasive basis for us to order further discovery.
(Hat Tip: Richard Jacobus.) For more, see Subpart F and Schering-Plough, 60 Emory L.J. 503 (2010).
Thursday, June 16, 2011
The IRS's seven year campaign against questionable charitable deductions for the donation of historic building facade easements has ratcheted up another notch. On Tuesday, the Department of Justice filed a lawsuit seeking to enjoin the non-profit Trust for Architectural Easements from practices that allegedly promote improper and inflated easement deductions.
The suit, filed in Federal District Court in Washington, D.C., also demands the names of 800 property owners in New York City, Boston and Baltimore who have claimed charitable deductions totaling more than $1.2 billion for the donation of easements to the Trust. ...
The government’s 38-page lawsuit alleges, among other things, that the Trust made “false and fraudulent” statements to prospective donors about the tax benefits available for donating facades; steered donors to appraisers who had been “coached” by it to go along with its questionable practices; helped donors to claim deductions before donations were final; and allowed donors to terminate easements they had already granted. ...
The IRS itself has come under criticism from some tax practitioners for its aggressive stance on historic easement donations, which it included in its “Dirty Dozen” list of tax scams for 2005 and 2006. In a 2009 report, the IRS Advisory Council said that the agency’s “strict view” was “diluting” the tax incentive Congress created in 1976 for the donation of easements that protect a historic property by restricting facade changes or development in perpetuity. The IRS’ aggressive audits, the report added, “have added to the perception that the IRS is overreaching on this issue.”
Tuesday, June 14, 2011
Mr. Woodsum terminated the swap ahead of its set termination date because his watchful eye noted that it was not performing satisfactorily as an investment. That is, when his own receiving of income was in question, Mr. Woodsum was evidently alert and careful. But when he was signing his tax return and reporting his tax liability, his routine was so casual that a halfmillion- dollar understatement of that liability could slip between the cracks. We cannot hold that this understatement was attributable to reasonable cause and good faith.
(Hat Tip: Bob Kamman.)
Monday, June 13, 2011
As the criminal case against the former Hollywood tax lawyer Matthew Krane heads to a conclusion — Mr. Krane is to be sentenced after pleading guilty to tax evasion and making a false statement on a passport application — the Treasury Department can breathe a little easier about the deficit.
According to a supplemental sentencing memorandum filed Wednesday with the United States District Court for the Western District of Washington in Seattle, Mr. Krane has entered an agreement with the IRS, his former client Haim Saban, and others under which the federal government is to receive $23 million of the approximately $46.6 million Mr. Krane and others were accused of siphoning from a Saban deal in 2002.
- ABA Journal, Suspended LA Lawyer Gets 32 Months, Must Repay $41M, in Quellos Tax-Shelter
- Accounting Today, Lawyer Sentenced in Quellos Tax Shelter Scheme
- Forbes, Show Biz Lawyer Finally Sentenced in Massive Fraud Case
- Sacramento Bee, CA Man Gets 2 1/2 Years in Prison for Tax Evasion
(Hat Tip: Bob Kamman.)
Following up on last week's post, Attorney Can Deduct Some, But Not All, Expenses of Caring for 70-80 Foster Cats:
Wall Street Journal, Stray Cat Strut: Woman Beats IRS, by Laura Saunders:
When Jan Van Dusen appeared before a U.S. Tax Court judge and a team of Internal Revenue Service lawyers more than a year ago, there was more at stake than her tax deduction for taking care of 70 stray cats.
Hanging in the balance were millions of dollars in annual tax deductions by animal-rescue volunteers across the nation—and some needed clarity on the treatment of volunteers' unreimbursed expenses for 1.55 million other IRS-recognized charities.
Early this month, Ms. Van Dusen learned she had won her case. "I was stunned," she said. "It feels great to have established this precedent."
The Tax Court allowed her to take a charitable deduction for expenses she incurred while taking care of the cats in her home for an IRS-approved charity, Fix Our Ferals. Among the $12,068 in expenses she deducted: food, veterinarian bills, litter, a portion of utility bills, and other items such as paper towels and garbage bags.
The decision, in Van Dusen v. Commissioner, paves the way for volunteers of animal-rescue groups like the ASPCA and Humane Society of the U.S. to deduct unreimbursed expenses that further the groups' missions, such as fostering stray animals.
It also clarifies rules for anybody deducting unreimbursed charitable expenses of $250 or more, especially if they involve use of a home.
Strip Club Liable for $125k Sales Tax; Lap Dances Are Not Tax-Exempt as 'Musical Performances' or 'Theater-in-the-Round'
Albany Times-Union, Court: Lap Dances Aren't Tax-Exempt:
While a lap dance might prompt a strong reaction from an audience, it doesn't rise to the level of art -- at least according to a state appellate court.
Thursday's ruling said entertainers at a local strip club are subject to sales taxes, and their expressions are not considered choreographed artistic performances that would be exempt.
Nite Moves, an adult "juice bar" on Route 9 in Latham, has been fighting the tax law -- first in an administrative hearing and then in court -- following a 2005 audit by the state Division of Taxation that concluded the club owed nearly $125,000 in sales tax, plus interest for door admission charges and private dance sales. The Appellate Division of state Supreme Court upheld that decision in an unanimous opinion.
Patrons at Nite Moves "view exotic dances performed by women in various stages of undress," the decision said. Revenue is generated from admission charges, "couch sales" -- the fee charged when a dancer performs for a customer in one of the club's private rooms -- as well as register sales from the non-alcoholic beverages sold and house fees paid by the dancers to the club.
- Daily Mail, 'Stripping Is NOT Art': NY Ruling Means Lap Dancing Is a Taxable Service
- NY Daily News, Lap Dance Tax? Court Says Erotic Dances Are Not Art, Subject to Sales Tax
- NY Post, Taxman in $lap Dance: Hand in Clubs' Pockets
- Reuters, NY Court Rules Private Lap Dances Not Tax Exempt
- Wall Street Journal, NY Court Says Juice Bar's Lap Dances are Taxable
- Washington Post, NY Court: Strip Club Has to Pay Taxes on Lap Dances Because They’re Not Artistic Performances
Saturday, June 11, 2011
As a law professor, I routinely commute from my home in New Haven, Connecticut to Manhattan where I teach my classes at the Cardozo Law School of Yeshiva University. On most days when I don’t teach, I work at home. Modern technology (e.g., the internet, email, legal databases like Lexis and Westlaw) allows me to research and write at my residence in Connecticut while staying in touch electronically with my Cardozo students and colleagues. Given its obvious benefits, such “telecommuting” is blossoming.
On days when telecommuting nonresidents like me work at our out-of-state homes, New York takes the irrational position that we are really working in the Empire State, though in fact we are outside New York’s borders. By the legal fiction known as the “convenience of the employer” doctrine, New York assesses income taxes for nonresident telecommuters’ work-at-home days – even though we do not set foot in New York on those out-of-state days. New York’s convenience of the employer doctrine typically results in double taxation on the days nonresident telecommuters work at their out-of-state homes.
When I challenged New York’s convenience of the employer rule as unconstitutional, I found myself in a prolonged and public controversy over New York’s irrational taxation of nonresident telecommuters. I ultimately lost my case in New York’s highest court.
John J. Barker of New Canaan, Connecticut now finds himself enmeshed in an equally convoluted controversy about New York’s self-destructive tax policies vis-a-vis nonresidents of the Empire State. Mr. Barker was an investment manager who commuted regularly from his home in New Canaan to his office in Manhattan. ... New York concedes that the Barkers were domiciled in Connecticut from 2002 through 2004. Nevertheless, New York insists that the Barkers were New York residents and owe a second, New York income tax on their investment income by virtue of the modest beach house the Barkers owned in Napeague, New York. The Barkers used this house for short, sporadic vacations. In 2002, for example, the Barkers used their small New York beach house five times for a total of only nineteen days. ...
New York’s Tax Appeals Tribunal recently sustained this double tax. Even though the Barkers stayed at their small New York beach house for a handful of days each year, the Tribunal let the Department tax the Barkers as New York residents by virtue of their minimally-used vacation home.
Mr. Barker thus threatens to displace me as the poster boy for New York’s systematic overtaxation of nonvoting nonresidents.
Prior TaxProf Blog coverage:
- Bill to Prohibit NY Tax on Prof's Salary Attributable to Work in CT Home Office (Sept. 15, 2004)
- NY Court of Appeals to Hear Telecommuter Tax Case (Jan. 3, 2005)
- NY Court of Appeals Upholds Tax on Non-Resident Telecommuter (Mar. 30, 2005)
- Update on NY Telecommuter Tax (May 8, 2005)
- WSJ: NY Alters Telecommuter Tax Rule (May 31, 2006)
- NY Times: Taxing Telecommuters (Aug. 6, 2006)
- Zelinsky: NY's "Convenience of the Employer" Rule Is Unconstitutional (May 9, 2008)
- Swine Flu, Telecommuting and NY’s Taxation of Nonresidents’ Incomes (May 6, 2009)
- NY's 'Convenience of the Employer Test' (Dec. 30, 2009)
- Court: NY Can Tax Income of Owner of NY Vacation Home Used 17 Days/Year (Feb. 11, 2011)
Monday, June 6, 2011
- Is an accused person deprived of the right under Article III and the Sixth Amendment to be tried only by a jury of the community where venue is proper, when factual questions determinative of whether venue has been correctly laid are determined solely by a jury selected in the place challenged by the defendant as incorrect?
- Where venue is a contested factual issue in a criminal trial, does the government bear a burden of proof beyond a reasonable doubt or only by a preponderance of the evidence?
Van Dusen, a resident of Oakland, California, is an attorney who cared for cats in her private residence in 2004. Van Dusen volunteered for an organization called Fix Our Ferals and argues that her out-of-pocket expenses for caring for cats qualify as charitable contributions to that organization. The parties stipulate that Fix Our Ferals is a § 501(c)(3) organization. ...
Van Dusen was a Fix Our Ferals volunteer in 2004. She trapped feral cats, had them neutered, obtained vaccinations and necessary medical treatments, housed them while they recuperated, and released them back into the wild. She also provided longterm foster care to cats in her home. She attempted to place long-term foster cats in one of two no-kill shelters, Berkeley East Bay Humane Society or East Bay Society for the Prevention of Cruelty to Animals, or otherwise find them adoptive homes. Some foster cats, however, stayed with her indefinitely. In 2004, Van Dusen had between 70 and 80 cats total, of which approximately 7 were pets. The pet cats had names, but the foster cats generally did not. Most cats roamed freely around Van Dusen’s home (except for bathrooms) and resided in common areas. Less domesticated cats stayed in a separate room called the “feral room”. Some cats lived in cages for taming. Others lived in cages because of illness.
Van Dusen devoted essentially her entire life outside of work to caring for the cats. Each day she fed, cleaned, and looked after the cats. She laundered the cats’ bedding and sanitized the floors, household surfaces, and cages. Van Dusen even purchased a house “with the idea of fostering in mind”....
We find that taking care of foster cats was a service performed for Fix Our Ferals, a § 501(c)(3) organization that specializes in the neutering of wild cats. Some of Van Dusen’s expenses are categorically not related to taking care of foster cats and are therefore not deductible. These expenses are the cost of cremating a pet cat, bar association dues, and DMV fees. Some of Van Dusen’s other expenses are not solely attributable to foster cat care and are not deductible. These expenses are the cost of repairing her wet/dry vacuum and her membership dues at a store.
Other expenses are attributable to the services Van Dusen provided to Fix Our Ferals. These expenses are 90% of her veterinary expenses and pet supplies and 50% of her cleaning supplies and utility bills. Some payments to Orchard Supply Hardware and Lowe’s for pet supplies, however, are disallowed because the amounts spent on pet supplies cannot be determined with precision. In deciding whether Van Dusen kept adequate records of the expenses attributable to her volunteer services, we hold that the regulatory requirements for money contributions govern Van Dusen’s expenses of less than $250. Van Dusen has met the requirements for these less than $250 expenses. Her records are acceptable substitutes for canceled checks under the substantial compliance doctrine. For expenses of $250 or more, however, Van Dusen does not have contemporaneous written acknowledgment from Fix Our Ferals. Therefore, these expenses are not deductible.
(Hat Tip: Bob Kamman.)
Sunday, June 5, 2011
Last December, an Iowa federal district court came out with a decision on the “John Edwards gambit” (Watson v. United States, 107 A.F.T.R.2d 311 (IA D.C. 2010)) TaxProf blog coverage here and here.] Some musings:
In Watson, the taxpayer formed an S corporation of which he was the sole shareholder. The S corporation was a partner in an accounting firm partnership. The other partners were also one-person S corporations. In 2002, Watson’s S corporation received profit distributions of $203,651 from the the partnership. In 2003, it received $175,470 in profit distributions. In each of those years, the S corporation paid Watson a salary of $24,000 per year, let the balance of the income “flow through” as nonwage income, and paid it to Watson as a dividend. The court concluded that Watson’s salary and dividend payments were an effort to avoid federal employment taxes, and that the dividends paid to Watson were remuneration for services performed. Interestingly, the court did not conclude, at it might have, that the dividends paid were income for services and subject to federal employment taxes. As expert witness testified that fair market value of Watson’s services for the years in question was about $91,044 per year, and only the difference between that amount and $24,000 was held to be subject to federal employment taxes, interest, and penalties.
Watson does not sound the death knell to the John Edwards technique. Iowa federal district courts are not the last word on tax matters. The salary the taxpayer took, while not de minimis, was quite small. Finally, and most importantly, the court looked not to the income generated by the taxpayer’s services in calculating his employment income, but rather what a third-party expert said the value of his services were worth. A significant amount of income generated by the taxpayer’s services, about $110,000 in 2002 and about $85,000 in 2003 still avoided employment taxes.
In some ways, the court’s holding provides an additional incentive to use the technique. The court’s holding permits significant amounts of income earned through services to avoid federal employment taxes, taxpayers just cannot be too greedy. Query whether it would be worth it to the Service to litigate a case where salaries equal to the social security tax maximum were paid, since it is more likely that the fair market value of services will be relatively close to such a number. Note that under the Court’s reasoning in Watson at issue is not the fair market value of the taxpayer’s own services, but those of an average, similarly situated taxpayer, whose services might be worth less than that of a given taxpayer’s. Indeed, that allegedly is what John Edwards did. According to the New York Times, he took a salary of $360,000 per year on income over 4 years of $27 million. The salary was supposedly based on what the average personal injury lawyer earned in North Carolina. Under the Iowa court’s reasoning, his approach would have survived challenge.
At this point, the future of the technique is uncertain. The Iowa court keeps the door open, indeed may open it wider, for those taking substantial salaries. However, another court might conclude that all the income is federal employment income, which would disallow the technique entirely. Further, there is a bill pending in Congress which would largely also shut this technique down.
The Health Care and Education Affordability Reconciliation Act of 2010, starting on January 1, 2013, applies an additional .9% Medicare tax on earned income exceeding certain thresholds (generally these thresholds are $250,000 if married, filing jointly, and $200,000 for single taxpayers). (The Act’s 3.8% tax on net investment income should not apply to “dividends” as S corporation shareholder receives.) The .9% tax should provide an additional incentive to use the technique.
This note analyzes the “definition” of “reasonable compensation” under the IRS's revenue ruling and how the Tax Code applies that definition in determining employment-tax liability. The revenue ruling requires compensation to shareholder-employees of a small corporation to be reasonable. The IRS’s subsequent re-characterization of “unreasonable” payments – i.e., those that should have been originally characterized as wages – subjects the re-characterized portion to penalties, interest, and additional taxes; specifically, taxes under the FICA. The case, here, involves a shareholder-employee of a Subchapter S corporation. The IRS challenged the shareholder-employee’s amount of FICA-tax liability after determining his salary was unreasonably low, by re-characterizing a portion of his distributions, or dividends, he received from his S-corporation.
Prior TaxProf Blog coverage:
- Court Gives IRS Rare Win in 'John Edwards Sub S Tax Shelter' Case (Jan. 24, 2011)
- More on the 'John Edwards Sub S Tax Shelter' (Feb. 6, 2011)
Saturday, June 4, 2011
Aiming to put an end to the systemic gender discrimination at KPMG, a former female Senior Manager filed a $350 million class action discrimination lawsuit against the company today in the U.S. District Court for the Southern District of New York. The Plaintiff, Donna Kassman, lives in New York and worked in KPMG's New York office for seventeen years before resigning as a result of gender discrimination. ...
Plaintiff Kassman alleges that KPMG engages in systemic discrimination against its female Managers, including but not limited to Managers, Senior Managers and Managing Directors. The lawsuit is intended to change KPMG's discriminatory pay and promotion policies and practices, as well as its systemic failure to properly investigate and resolve complaints of discrimination and harassment. The Plaintiff is filing this action on behalf of a class of thousands of current and former female employees who have worked as Managers at KPMG from 2008 through the date of judgment.
KPMG promotes fewer women to Partner (18%) than the industry average (23%) and fewer women to Senior Manager (35%) than the industry average (44%). "Across the accounting industry, women are conspicuously absent from leadership positions; but at KPMG, women fare even worse," said Janette Wipper. "As soon as women come within reach of partnership, the Company's male-dominated owners find ways to block their advancement,"
Wednesday, June 1, 2011
- Miller & Chevalier Tax Appellate Blog, 10th Circuit Sides With Government on Intermountain Issue
- TaxProf Blog, Fed. Cir. Exacerbates Split on Overstatement of Basis, 6-Year SOL (Mar. 12, 2011)
Thursday, May 26, 2011
Tax expenditure analysis, despite its contribution to tax policy debate, is ill-suited as a tool of constitutional decisionmaking. Sometimes tax provisions are, for constitutional purposes, equivalent to direct monetary outlays; sometimes they are not. That equivalence can only be evaluated on a case-by-case basis, considering the nature of the specific tax provision and the particular constitutional clause at issue. Contrary to the approach of the Winn dissent, the Court is ill-advised to invoke tax expenditure analysis as a tool of constitutional decisionmaking. At the end of the day, we do not know what a tax expenditure is.
This article analyzes Friedland [T.C. Memo. 2011-90 (Apr. 25, 2011)], a recent Tax Court memorandum opinion, and concludes that in light of recent Supreme Court opinions, the Tax Court was wrong to hold that the 30-day period to file a petition in a whistleblower award action cannot be equitably tolled.
All Tax Analysts content is available through the LexisNexis® services.
Wednesday, May 25, 2011
Whether, in direct conflict with the Third Circuit, the Ninth Circuit erred in holding that Petitioners' convictions of filing, and aiding and abetting in filing, a false statement on a corporate tax return in violation of 26 U.S.C. §§ 7206(1) and (2) were aggravated felonies involving fraud and deceit under 8 U.S.C. § 1101(a)(43)(M)(i), and Petitioners were therefore removable.
Legal scholars say a recent Supreme Court decision upholding Arizona's tax credits for scholarship donations could contain the seeds of defeat for a pending California challenge to the housing allowance enjoyed by pastors. ...
The ruling sends a signal that the Freedom From Religion Foundation (FFRF) cannot rely on Flast in its current federal challenge to ministerial housing allowances, said church law expert Richard Hammar.
Notre Dame law professor Rick Garnett agrees. He noted a separate mid-April ruling by the Seventh District Court of Appeals, which dismissed the FFRF complaint that the presidential proclamation of a National Day of Prayer amounted to government establishment of religion. The Seventh Court said that since FFRF was not directly injured, it lacked legal standing.
"The ruling suggests that the Supreme Court is not alone in thinking that Flast should not be read over-broadly," Garnett said. "It is powerful, persuasive authority for the claim that the foundation lacks standing to challenge the pastoral housing exemption."
- DOJ Press Release
- ABA Journal
- New York Law Journal
- New York Times
- Wall Street Journal
- Washington Post
Sunday, May 22, 2011
A Toronto lawyer who left Bay Street in 2006 in an abortive attempt to make it as a professional Internet poker player has failed in a bid to write off the $120,000 loss he ran up that year before slinking back to practice. Steven A. Cohen claimed he made the career switch in December 2005 after Goodmans LLP deferred a decision on elevating him to partner for a second consecutive year.
His master plan envisioned a $150,000 annual profit by targeting weak, inexperienced players in small-stakes games, before elevating in the long-term to higher stakes for a $500,000 annual return, the same level he would have made as partner at Goodmans, according to the ruling in Cohen v. The Queen. ...
But things didn’t quite go as planned, and his $80,000 in winnings for 2006 were dwarfed by the $200,000 he ploughed into the venture. ... In the May 12 ruling, Tax Court of Canada Justice Frank Pizzitelli decided Cohen’s actions did not suggest the poker venture was conducted in a business-like way, and refused Cohen’s appeal of his tax assessment which denied his bid to deduct his $120,000 losses. ... The decision also delivered a damning verdict on Cohen’s poker skills.
(Hat Tip: Francine Lipman.)
Saturday, May 21, 2011
Petitioner attended college in the early 1980s. Petitioner borrowed $19,986.72 from the Connecticut Student Loan Foundation (CSLF) in order to finance his college education. At some point petitioner became delinquent in his loan payments. In 1988 CSLF filed a complaint in the Connecticut Superior Court. Petitioner received personal service of the complaint, failed to appear at the judicial proceeding, and a default judgment was entered on May 17, 1989, for $27,655.30. ... On December 28, 2005, petitioner mailed CSLF a personal check for $45,000 to extinguish his then-outstanding liability of approximately $73,258.
In February 2006 CSLF filed documents in the Connecticut Superior Court evidencing petitioner's satisfaction of the judgment and a release of CSLF's claim against petitioner. CSLF issued a Form 1099-C, Cancellation of Debt, to petitioner for 2006 reporting income of $27,821. ...
Petitioner did not present any evidence that the basis of the agreement with CSLF to extinguish the debt for less than the full amount was based on these positions or any good-faith claim that he was not liable for some or all of the debt. On this record, we conclude petitioner did not have a good-faith dispute with respect to the indebtedness with CSLF in the amount claimed by the creditor.
It sometimes pays to check a map. The mortgage lender in this case did not, and as a result it recorded an interest in Tammy Church's property in the wrong county. Luckily for the public fisc, the IRS, which also placed a lien on Church's property, did not make the same mistake. When the lender realized what had happened, it sued, seeking in equity what it could not get in law -- a declaration that it had the superior claim to the property. Equity does not save the lender in this instance, and we therefore affirm.
Wednesday, April 13, 2011
In 2005, Bruce Brown held a life insurance contract with Northwestern Mutual Life Insurance Company. On December 18, 2005, Northwestern terminated the contract, using its entire cash value of $37,365.06 to pay policy debt. Petitioners (the Browns) did not report any gain or loss on their 2005 federal income tax return from the termination of the life insurance contract.
In a notice dated December 24, 2007, respondent (the IRS) determined a deficiency in tax of $8,553 for tax year 2005. The deficiency was the result of the IRS’s determination that Mr. Brown recognized a taxable gain of $29,093.30 on termination of the Northwestern contract. The IRS also determined that the Browns were liable for a penalty of $1,711 under § 6662. The Browns dispute those determinations. ...
Bruce Brown is a commercial litigation attorney who has been licensed since 1973. His wife, Carol Anfinson Brown, is also an attorney. She has a master of laws degree (LL.M.) in taxation. ...
Northwestern sent Mr. Brown a Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. The Form 1099-R showed a gross distribution of $37,365.06 and a taxable amount of $29,093.30. ... According to Northwestern’s calculations, the $29,093.30 taxable amount was equal to the policy’s cash value of $37,365.06 minus what it called “net cost” of $8,271.76. ... [W]e agree with the IRS that the Browns were required to include $29,093.30 in gross income from the termination of the Northwestern life insurance contract. ...[T]he Browns’ experience, knowledge, and education weigh against them: both are licensed attorneys, and one has a master of laws degree (LL.M.) in taxation. In short, the Browns have failed to show that they had reasonable cause for and acted in good faith regarding the underpayment. We therefore find that the IRS correctly determined that the Browns are liable for the substantial understatement penalty under § 6662(a).
(Hat Tip: Bob Kamman.)
Update: Tax Update Blog, The Perils of Too Much Education
Tuesday, April 5, 2011
The U.S. Supreme Court, in a case involving separation of church and state, provided rhetorical backing for congressional Republicans who argue that government grants and tax credits aren’t equivalent.
The court yesterday upheld an Arizona program that gives taxpayers a credit for contributions made to groups that provide scholarships to private schools, including religious institutions. The 5-4 majority on the court said such tax expenditures, unlike spending programs, involve private funds that don’t reach the government’s coffers.
“When the government collects and spends taxpayer money, governmental choices are responsible for the transfer of wealth,” Justice Anthony Kennedy wrote for the majority. “Here, by contrast, contributions result from the decisions of private taxpayers regarding their own funds.” That distinction led the majority to determine that the taxpayers suing Arizona lacked standing, or the right to challenge the program as a constitutional violation. Politically, the decision provides support for lawmakers who argue against lowering the budget deficit by curbing tax expenditures, no matter how much they resemble spending programs.
“Cases like this encourage more government spending, rather than less,” said Edward Kleinbard, a law professor at the University of Southern California and former chief of staff of the congressional Joint Committee on Taxation. “It simply encourages that spending to take the form of ever sillier tax credits and other targeted tax breaks.” ...The question of whether tax expenditures are equivalent to spending has been roiling the Republican Party in recent months. ...
If tax credits aren’t considered government spending, [Kleinbard] said, Congress could just add pages to the income tax form to give tax filers an unlimited number of credits and decisions about how to spend them. “And then having done that,” Kleinbard said, “we will declare that we’ve shrunk the size of government to zero.”
Monday, April 4, 2011
(Hat Tip: Bob Kamman.)
Even the IRS acknowledged that former television news anchor Anietra Hamper kept meticulous records of the clothes and other items she bought for business use.
But detailed receipts weren’t enough. An IRS audit — and a tax judge — concluded that nearly all the business expenses that Hamper listed as deductions on her 2005-08 federal income-tax returns were invalid, and they slapped her with a bill for nearly $20,000.
“I would hate for anyone else to go through this,” said Hamper, 38, who decided to share her story as a tale of caution during tax season.
For years, Hamper had deducted the cost of the clothing she wore on air and for business functions, as well as other expenses she incurred while working as an anchor for WCMH-TV (Channel 4) and WBNS-TV (Channel 10) in Columbus.
Other TV anchors told her they did it, and professionals who prepared her taxes over the years told her it was fine. ...
Hamper thought her deductions were legitimate, so she took the case to U.S. Tax Court, where she explained the deductions to a judge last fall. The judge ruled against her in late February and ordered her to pay $16,492 in back taxes, plus a penalty of $3,298.
“The general rule is that, where business clothes are suitable for general wear, a deduction for them is not allowable,” the judge wrote. Most professionals, the decision said, “typically do not wear their business clothes for private or personal wear,” yet they cannot deduct the cost of those clothes.
The judge also ruled that most other items Hamper used as deductions were personal, not business, expenses. They included contact lenses that helped her read the teleprompter, makeup, haircuts, manicures, teeth whitening and subscriptions to magazines and newspapers.
The decision doesn’t surprise Donald B. Tobin, associate dean of the Ohio State University Moritz College of Law. Tobin teaches a class on federal income-tax law and uses the case of a saleswoman at a high-end clothing store as an example. In that case, the saleswoman argued that she had to wear clothing from the store while she worked, but that she never would have worn it otherwise, so she deducted the cost as a business expense. The IRS disallowed the deduction. “It only cares about whether you can use it, not if you actually do use it,” Tobin said. ...
She’s not ... happy about a New York Daily News story about the tax-court decision in her case. The story, which traveled around the world, listed thong underwear among the items she deducted.
Thursday, March 31, 2011
(Hat Tip: Bob Kamman.)
In 1991 petitioner was working two jobs to support herself and her two young children. One job was as the owner of an H&R Block franchise; the other was in a prison detention center. She had recently divorced, her father had recently died, and her mother had moved into her house to help take care of the children. About this time petitioner became involved with a man working at her H&R Block office, and he moved in with her. She later learned that he had an extensive criminal record and a violent temper.
Petitioner's relationship with the boyfriend was marked by intimidation and physical abuse. When she failed to do his bidding or attempted to leave him, he reacted violently. He once threw her from a moving car. Another time when she threatened to leave him, he placed a gun against her forehead and cocked the hammer. On another occasion, in midwinter, he hit her in the head with a beer bottle and threw her from a boat into a lake. On another occasion, she testified credibly, he "gave me a picture of my daughter with her face shot out, and told me that's what would happen to her if I tried to leave."
At some point after becoming involved with petitioner, the boyfriend obtained a video poker license and opened an establishment in Monroe, Louisiana. After only a few months, he lost his license for misdeeds that included selling liquor to a minor. The boyfriend convinced petitioner to open her own video poker business.
In 1996 petitioner acquired two video poker licenses in her own name. Because, according to petitioner's testimony, the licenses were required "to be run separately", she opened two sandwich shops next door to each other in Farmerville, Louisiana, each with a video poker machine. Petitioner worked in the shops making sandwiches and dealing with the public. The boyfriend took charge of the finances and the books and had check-signing authority on the business bank accounts. Virtually all the shops' income resulted from video poker revenue.
Petitioner and the boyfriend had no agreement regarding his compensation. Rather, as petitioner testified, he "set his own compensation". He did this by writing checks to himself or to cash, signing either his name or petitioner's name. In this manner he withdrew from petitioner's business accounts $114,000 during 1997 and $96,000 during 1998. He used these funds to pay his personal expenses, including his child support obligations.
Petitioner knew that the boyfriend was writing checks and taking money out of her business accounts. But she did not know beforehand when he might write checks or for how much. Consequently, she was left in constant uncertainty about the balances in her business checking accounts. To avoid overdraft fees, she worked out an arrangement with a friend who worked at her local bank and who knew of petitioner's troubles with the boyfriend. Each morning petitioner would call her friend at the bank to determine how many of her checks were set to clear the accounts that day. As long as petitioner made a cash deposit to cover the checks by noon of any given business day, the bank would honor the checks and not charge overdraft fees. ...
There is no dispute about any item of petitioner's income or deductions other than the deductions that petitioner claims with respect to the amounts the boyfriend received, stipulated to have been $114,000 for 1997 and $96,000 for 1998. ... [W]e conclude that ... all these amounts are deductible as theft losses under § 165. ...
A preponderance of the evidence convinces us that the boyfriend's taking of funds from petitioner's business accounts for his personal purposes constituted theft within the meaning of Louisiana law. The evidence does not suggest, and respondent does not contend, that petitioner consented before the fact to the boyfriend's writing checks from petitioner's business accounts to pay his personal expenses. To the contrary, as previously discussed, the evidence shows that petitioner would often find out about these checks only after the fact by making inquiries at the bank. We infer that petitioner proceeded in this manner to avoid physical confrontation with the boyfriend.
On brief, respondent contends that the boyfriend's takings should not be viewed as thefts or conversions because petitioner "never objected to the transfers and there is no evidence that she reported any theft to the appropriate authorities". Under Louisiana law, however: "In order to consent to the theft of his property, an owner must do more than passively assent to the taking." State v. Johnson, 408 So. 2d 1280, 1283 (La. 1982). We do not believe that petitioner ever gave more than passive assent to the boyfriend's taking her business funds. But even if petitioner might be thought in some general way to have consented to the boyfriend's compensating himself with her business funds, we do not believe that it was effective consent, but rather that it was induced by force and threats by the boyfriend, who had on more than one occasion threatened to kill petitioner and her children. For similar reasons, we assign little significance to the fact that she did not report the thefts to the authorities.
Respondent contends that because petitioner and the boyfriend lived together at times, she personally benefited from the withdrawals, such that they should be considered her nondeductible living expenses pursuant to § 262. We are not convinced by respondent's argument, which is inconsistent with our finding, based upon petitioner's unopposed proposed finding of fact, that the boyfriend used the funds taken from petitioner's business to pay his personal expenses.
Monday, March 14, 2011
According to the petitioner, the respondent "was convicted of conspiring with others to create and implement illegal tax shelters for clients of Ernst & Young as well as for his own personal tax benefit. This scheme included making false statements and providing false documents to the IRS as well as understating his personal income." Further, the respondent "was convicted of filing a fraudulent U.S. Individual Income Tax Return, Form 1040, which substantially understated his taxable income." The respondent does not object to this description of the offense, but points out that he "was not convicted of filing a false tax return which substantially understated his taxable income. Rather, the tax evasion counts of [the] conviction[s] related to the tax returns of clients of . . . Ernst & Young." Further, the respondent consents to his name being stricken from the roll of attorneys.
See Legal Profession Blog, Disbarred For Tax Shelter Advice.
Sunday, March 13, 2011
Shaw said the IRS audited the alliance's tax returns for 2008 and 2009 and disallowed all of its business deductions. She said that although dispensaries throughout the state are being audited by the IRS, the alliance is the first to be told it can't deduct business expenses. "Every dispensary in the nation, past, present and future is dead if this is upheld," Shaw said. ...
Shaw said the IRS disallowed her deductions — for buying marijuana, hiring employees, securing office space and more — based on § 280E of the federal tax code, which states that no deduction shall be allowed for any business trafficking in controlled substances.
Under federal law, marijuana is classified as a schedule I controlled substance, a category of drugs not considered legitimate for medical use — despite voters' 1996 approval of Proposition 215, which legalized the use of marijuana for medical purposes in California.
(Hat Tip: Bob Kamman.) The title is courtesy of Country Joe and the Fish:
Don't bogart that joint, my friend
Pass it over to me.
Don't bogart that joint, my friend
Pass it over to me.
Saturday, March 12, 2011
Kristin Hickman (Minnesota):
Whereas the Seventh Circuit in Beard found that the statute unambiguously supports the government, and other circuits have found that the statute unambiguously (especially in light of Colony) supports the taxpayers, the Federal Circuit in Grapevine concludes that the statute is ambiguous and, in light of Mayo, Brand X, and Chevron, defers to the government. The court only briefly addresses the procedural shortcomings of the regulations at issue, concluding that any procedural flaws of the temporary Treasury regulations were rendered moot when Treasury issued the final regulations.
Miller & Chevalier Tax Appellate Blog, Federal Circuit Adds to Intermountain Conflict by Deferring to New Regulations That Apply Six-Year Statute to Overstatements of Basis:
The Federal Circuit has ruled for the government in Grapevine, throwing the circuits into further disarray by adopting an approach that differs from all three of the courts of appeals that have previously addressed the Intermountain issue subsequent to the issuance of the new regulations. Becuase the Federal Circuit had already rejected the government’s construction of the statute in Salman Ranch, the Grapevine case starkly posed the question whether the new regulations had the effect of requiring the court to disregard its prior decision and reach the opposite result. As we previously reported, at oral argument the day after the decision in Mayo Foundation, the government told the Federal Circuit that Mayo compelled that result. The court has now agreed. ...
The Grapevine decision is significant in the specific context of the Intermountain cases, as it virtually ensures that a circuit conflict on the issue will persist even if the Seventh Circuit reconsiders its decision in Beard. And it is the first appellate decision to address in detail the merits of the government’s primary argument that it can overturn the prior adverse decisions in this area by regulation. More generally, the case is a great illustration of Treasury’s power under the combination of Mayo and Brand X. The Federal Circuit was keenly aware of the implications of its decision, summarizing it as follows: “This case highlights the extent of the Treasury Department’s authority over the Tax Code. As Chevron and Brand X illustrate, Congress has the power to give regulatory agencies, not the courts, primary responsibility to interpret ambiguous statutory provisions.” Presumably, Treasury will continue to test the limits of how far it can go in exercising that “primary responsibility.”
Miller & Chevalier Tax Appellate Blog, Seventh Circuit to Consider Petition for Rehearing in Beard:
On March 7, the taxpayer filed a petition for rehearing en banc with the Seventh Circuit in Beard, emphasizing that both the Fifth and Fourth Circuits had explicitly disagreed with that decision and reached the opposite result on the Intermountain issue. Although courts of appeals often deny such petitions without a response, the Seventh Circuit almost immediately directed the government to file a response, which is due March 23.
Today’s pro-government decision by the Federal Circuit in Grapevine perhaps takes a little steam out of the possibility of rehearing since a circuit conflict will likely persist even if the Seventh Circuit rehears the case and reverses itself.
Friday, March 11, 2011
In Whitney v. Commissioner, 13 T.C. 897, 899 (1949), this Court observed that "the losses allowable under § 23(e)(3) [a predecessor to § 165] are specifically limited to losses of property arising from casualty, and damages paid for injuries and wrongful death are plainly without the provisions of the statute." (Emphasis added.) This Court has consistently held that settlement payments which result from automobile accidents do not constitute deductible casualty losses. Tarsey v. Commissioner, 56 T.C. 553 (1971); Dickason v. Commissioner, 20 B.T.A. 496 (1930); Mulholland v. Commissioner, 16 B.T.A. 1331 (1929); Peyton v. Commissioner, 10 B.T.A. 1129 (1928); Hall v. Commissioner, T.C. Memo. 1980-485.
The Pangs maintain, however, that their $250,000 settlement payment is deductible under § 165(c)(3) as a casualty loss because Webster's Dictionary defines "casualty" as "[l]osses caused by death, wounds" and the accident victim's death in December 2002 was certainly a casualty.
This issue is resolved not by Webster's definition of "casualty" but by the Code's provisions for "casualty loss" quoted above. Moreover, the Pangs' position conflates two distinct things -- the victim's casualty (which occurred when he died in 2002) and the Pangs' financial loss (which occurred when they made their payment in 2004) -- and does not explain how the "casualty" of the victim results in a deductible "casualty loss" for the Pangs under § 165.
This Court has held that "physical damage or destruction of property is an inherent prerequisite in showing a casualty loss." Citizens Bank of Weston v. Commissioner, 28 T.C. 717, 720 (1957), affd. 252 F.2d 425 (4th Cir. 1958). ... As a result, to obtain the deduction the Pangs must demonstrate that the claimed casualty loss is attributable to physical damage to their property (e.g., damage caused to their vehicle during the accident). They have not done so -- and any damage to their property occurred in 2002, not 2004.
The Pangs' claimed loss is attributable not to property damage but to the monetary settlement of a wrongful death claim. To the extent the Pangs are arguing that the payment constitutes a loss of their property, we find that to be beyond the scope of § 165(c)(3). The term "losses of property" in § 165(c)(3) does not include a taxpayer's monetary payment to a third party or a decrease in the taxpayer's net worth
Update: Tax Update Blog, Tax Court: No Casualty Loss Deduction for Casualties You Inflict.
Wednesday, February 23, 2011
If DOMA were not on the books, Edie Windsor would not have had to pay the IRS $363,000 in taxes. Since the Executive Branch is still enforcing DOMA, that means that the case will have to be litigated to conclusion before Windsor knows whether she is entitled to the refund or not. And even if the Attorney General is not willing to defend DOMA, it seems likely that Congress will step in and defend the law.
Section 2036(a) hauls back into a decedent’s gross estate, for federal estate tax purposes, property that she gave away while alive, if the decedent retained at death the income from the property or the right to designate who should enjoy or possess the property. Routinely applied to trusts, this provision has also been held applicable to other types of retained interests, including interests in property transferred to family partnerships and family limited liability companies. Quite often, applying § 2036(a) unravels valuation discounts that the decedent had hoped to use in determining the bases of the gift and estate taxes.
In a recent case, a split panel of the Second Circuit vacated and remanded a Tax Court ruling that § 2036(a) required inclusion of a 49% tenant-incommon interest that a decedent had given to her son in the final year of her life. The appeals court majority opinion raises intriguing questions about how the estate tax should apply to undivided real property interests created by a decedent, particularly when the co-tenants occupy a portion of the real estate together both before and after the co-tenancy is created. This report seeks to identify and answer some of the questions that the circuit court decision has presented, especially the apportionment issue that the circuit court has directed the Tax Court to address on remand.
All Tax Analysts content is available through the LexisNexis® services.
Bernard Shapiro and Cora Jane Chenchark lived together for twenty-two years, but they never married. Over those twenty-two years, Chenchark cooked, cleaned, and managed their household. When they broke up, she filed a palimony suit against him in state court. While the suit was pending, he died. In the context of this tax refund lawsuit filed by Shapiro’s estate, the district court held that Chenchark’s homemaking services did not, as a matter of law, provide sufficient consideration to support a cohabitation contract between Shapiro and Chenchark, and that therefore, an estate tax deduction for the value of Chenchark’s claim was properly disallowed. Because the district court’s holding was premised upon a misconstruction of Nevada law regarding contracts between cohabitating individuals, we reverse. ...
The United States argues that Chenchark’s claim is not deductible because it is not supported by “adequate and full consideration in money or money’s worth.” We do not disagree with the government’s point that, under § 2053(c)(1)(A), a claim founded on a promise or agreement, like Chenchark’s claim, is only deductible “to the extent [it was] contracted bona fide and for adequate and full consideration in money or money’s worth” —but the district court never reached this specific issue. Homemaking services such as those provided by Chenchark can be quantified and have a value attached to them. Our point is simply that these services are not of zero value as a matter of law, as the district court apparently believed.
This is not to say that, even if a factfinder determines that Chenchark’s claim was supported by “adequate and full consideration,” the Estate is necessarily entitled to the full deduction it seeks. Rather, the value of Chenchark’s claim is a factual issue that precludes summary judgment. The value of the claim (and the corresponding allowable estate tax deduction) remains for the district court to determine on remand. Whether her claim was worth $1 million (as it was eventually settled for) or some other amount is for the district court to decide.
Judge Tashima filed a vigorous dissent on this point:
Although the majority is correct that § 2053(a) “allows a deduction for ‘claims against the estate . . . as are allowable by the laws of the jurisdiction . . . under which the estate is being administered,’" a valid state law claim is a necessary condition for the deduction, but not necessarily a sufficient one. Section 2053 also requires that, to be deductible, claims “founded on a promise or agreement[ ] be limited to the extent that they were contracted . . . for an adequate and full consideration in money or money’s worth[.]" § 2053(c)(1)(A). This requirement is not satisfied merely because a claim is “legally binding and enforceable against [an] estate” under state law. ...
The statute’s requirement that deductions based on promises or agreements be supported by full consideration in money’s worth is based on a need to protect the estate tax. Without this limitation, there would be nothing to “prevent testators from depleting their estates by transforming bequests to the natural objects of their bounty into deductible claims.” ... Accordingly, any contract between a decedent and someone who would be a natural object of his or her bounty is viewed with suspicion, requiring exceptional circumstances to be treated as something other than “simply an agreement to make a testamentary disposition to persons who are the natural objects of one’s bounty.” ...
Accordingly, any love and affection provided to Shapiro by Chenchark must not, and cannot, be treated as consideration for purposes of § 2053, even if it would support a contract under state law. “Nevada law regarding contracts between cohabiting individuals” ... is simply irrelevant to determining the adequacy of consideration under § 2053. ... Even assuming that anything Chenchark provided to Shapiro out of love and affection would support a deduction of its full dollar value, the Estate has presented no evidence here that would create a genuine issue of material fact that Chenchark enhanced the value of the Estate in money’s worth. Although there is evidence that Chenchark supervised Shapiro’s household staff, including a maid, gardener, and a pool man, and that she cooked, cleaned, and provided emotional support to Shapiro, the Estate presented no evidence that these services have a cash value or what that cash value would be. ... Thus, the Estate has not raised a genuine issue of material fact to support its contention that Chenchark’s claim against the Estate, assuming arguendo that it was contracted bona fide, was supported by full consideration in money’s worth for the purpose of federal tax law. Accordingly, I would affirm the district court on this issue.
(Hat Tip: Bob Kamman.)
Update: Joe Kristan notes that "[t]his his could open the door for a do-it-yourself marital deduction for unmarried couples."
Saturday, February 12, 2011
Friday, February 11, 2011
(Hat Tip: Doug Levene.)
Connecticut and New Jersey residents with a Hamptons summer cottage or a Manhattan pied-a-terre are about to get a nasty surprise: New York state wants more taxes from them.
A New York court ruled last month that all income earned by a New Canaan, Conn., couple is subject to New York state taxes because they own a summer home on Long Island they used only a few times a year. They have been hit with an additional tax bill of $1.06 million. [In re Barker, No. 822324 (NY Tax App. Jan. 13, 2011).] ....
For years, New York law stated that residents of another state who spend more than 183 days a year in New York have to pay taxes on any income they make in this state. But they generally haven't had to pay New York taxes on income they make outside of the state or on their spouses' income if they work elsewhere.
Under the recent ruling, this might change for many out-of-state residents who own vacation homes or apartments here. In effect, it reinterprets what counts as a permanent residence.
In defining a "permanent place of abode," New York tax code specifically excludes "a mere camp or cottage, which is suitable and used only for vacations." New York tax experts say the new ruling is the first they recall that counts summer homes as permanent residences. ....
[The judge] ruled that the couple's Long Island vacation home qualifies under the law as a permanent abode because it was suitable for living year-round—whether or not the couple actually stayed in the home wasn't relevant. Under the ruling, if an owner doesn't spend a single a day in a home it could still count toward a permanent residence.
The Napeague, Long Island, house was purchased by John and Laura Barker for $260,000 in 1997, according to court documents. From 2002 to 2004, the period that was assessed for back taxes, the Barkers said they spent only  days a year at the home, usually during the summer.
Thursday, February 10, 2011
Howard Bashman reports that the Pennsylvania has agreed to hear an interesting case on the meaning of the phrase "purely public charity" in the Pennsylvania constitution:
The specific question that the court has granted review to consider and resolve is: Whether the Pennsylvania Legislature's enactment of criteria in Act 55 for determining if an organization qualifies as a "purely public charity" under Pennsylvania's Constitution is deserving of deference in deciding whether an organization qualifies as "a purely public charity" under Pennsylvania's Constitution, or has the test provided in Hospital Utilization Project v. Commonwealth, 487 A.2d 1306 (Pa. 1985), occupied the constitutional field, leaving no room for legislative influence and input?
Wednesday, February 9, 2011
Although we hold that § 6501(e)(1)(A) is unambiguous and its meaning is controlled by the Supreme Court’s decision in Colony, we note that even if the statute was ambiguous and Colony was inapplicable, it is unclear whether the Regulations would be entitled to Chevron deference under Mayo Foundation for Medical Research v. United States, 131 S. Ct. 704, 711 (2011). See, e.g., Home Concrete & Supply, LLC v. United States, No. 09- 2353 (4th Cir. Feb. 7, 2011) (declining to afford the Regulations Chevron deference because the statute is unambiguous as recognized by the Supreme Court in Colony). In Mayo, the Court held that the principles underlying its decision in Chevron “apply with full force in the tax context” and applied Chevron to treasury regulations issued pursuant to § 7805(a). Significantly, in Mayo the Supreme Court was not faced with a situation where, during the pendency of the suit, the treasury promulgated determinative, retroactive regulations following prior adverse judicial decisions on the identical legal issue. ...Moreover, Mayo emphasized that the regulations at issue had been promulgated following notice and comment procedures, “a consideration identified . . . as a significant sign that a rule merits Chevron deference.” 131 S. Ct. at 714. Legislative regulations are generally subject to notice and comment procedure pursuant to the Administrative Procedure Act. See 5 U.S.C. § 553(b)(A). Here, the government issued the Temporary Regulations without subjecting them to notice and comment procedures. This is a practice that the Treasury apparently employs regularly. See Kristin E. Hickman, A Problem of Remedy: Responding to Treasury’s (Lack of) Compliance with Administrative Procedure Act Rulemaking Requirements, 76 Geo. Wash. L. Rev. 1153, 1158-60 (2008) (noting that the treasury frequently issues purportedly binding temporary regulations open to notice and comment only after promulgation and often denies the applicability of the notice and comment procedure when issuing its regulations because that requirement does not apply to regulations that are not a significant regulatory action, while continuing to assert that the regulations are entitled to legislative regulation level deference before the courts). That the government allowed for notice and comment after the final Regulations were enacted is not an acceptable substitute for pre-promulgation notice and comment.
Monday, February 7, 2011
Tuesday, February 1, 2011
Monday, January 31, 2011
The evidence showed that, prior to selling the business in 2000, the defendants caused the firm to spend a total of $3.6 million on eight “Loss of Income” insurance policies, the purpose of which was to provide substantial tax deductions to the company and to the owners. ... The evidence also demonstrated that these insurance policies were a sham. The evidence further showed that [the defendants] attempted to conceal their participation in these sham arrangements by establishing offshore nominee entities in foreign countries, such as Nevis.
- National Law Journal, Former In-House Counsel of Buddy's Carpet Gets Prison for Tax Fraud
Thursday, January 27, 2011
Wednesday, January 26, 2011
Update: State Bar of Wisconsin, Seventh Circuit Court of Appeals Distinguishes 1958 Tax Case to Reject Taxpayer's Defense.
Monday, January 24, 2011
- 3d Cir. Joins 7th Cir. in Reversing Tax Court and Upholding Innocent Spouse Reg (Jan. 20, 2011)
- Hickman: Dismayed by Mayo? Check Out the Mannella Dissent (Jan. 20, 2011)
Steve Johnson (UNLV), More on Mannella:
The most fun part of Mannella to ruminate about is Judge Ambro's dissent. He agreed with the majority that Chevron is the controlling standard and that, at Step One of the Chevron analysis, the statute does not speak directly to the time frame for making § 6015(f) claims for relief of joint and several liability. At Chevron Step Two (reasonableness), however, Judge Ambro would have invalidated the reg imposing a two-year limit on such claims. Although death at Step One is the more common approach when a court chooses to invalidate an agency position under Chevron, Judge Ambro's dissent reminds us that Step Two has some teeth also -- surviving Step One does not guarantee a regulation will be upheld.
Judge Ambro's Step Two concern is that Treasury failed to explain its reasons for imposing the two-year limit. There are some previous tax cases discussing "failure to explain" in the context of challenges to tax regulations, but there aren't a lot. E.g., American Standard, Inc. v. United States, 602 F.2d 256, 268-69 (Ct. Cl. 1979) (discussing the issue under APA § 553(c)). And, some commentators have adressed it. E.g., Patrick J. Smith, Omissions From Gross Income and the Chenery Rule, 128 Tax Notes 763 (Aug. 16, 2010); Patrick J. Smith, Mayo and Chenery: Too Much of a Shift in Rationale?, 129 Tax Notes 454 (Oct. 25, 2010). The Mannella dissent undoubtedly will cause taxpayers' counsel to raise the "failure to explain" rationale more frequently in future cases. This is good because, first, this aspect of the law deserves some clarification and, second, it reminds tax lawyers that they ignore general administrative law concepts only at peril to their clients.
Judge Ambro's argument is worth considering, but much more analysis will be required before one could declare the argument right or wrong. Administrative law usually more closely resembles tall wheat in a stiff wind than an iron rod embedded in concrete, that is, administrative law rules exist but they are wavy and fluid rather than fixed. Context is the wind that gives shape to those rules and their application. Here are some of the matters that one would like to explore in thinking about Judge Ambro's argument:
- The dissent several times cites the Supreme Court's 1983 State Farm case as authority with respect to the obligation of an agency to explain its rationale. In several ways, however, the context of State Farm differs from that of Mannella. Moreover, State Farm was refined by the Supreme Court's 2009 Fox Television decision, which is no model of clarity. Fox was a 5 to 4 decision in which a total of six opinions were written.
- "Failure to explain" appears in ad. law cases under several headings: (i) APA § 553(c) (requiring agencies -- including Treasury -- to incorporate "a concise general statement of their basis and purpose" into the regs the agencies promulgate); (ii) APA § 706(2)(A) (allowing courts to set aside agency actions found to be arbitrary and capricious); (iii) administrative common law; and (iv) as part of the Chevron Step Two reasonableness analysis (as in Mannella). In deciding which precedents are applicable, one would want to think about whether "failure to explain" has the same substantive contents in the various contexts.
- Concerned that "failure to explain" not be treated in an overly technical fashion, some tax and nontax cases recognize an exception to an explanation requirement when it is obvious why the regulation was promulgated. Arguably, that could be the case in Mannella. Why are statutes of limitations ever adopted with respect to claims against the government? The usual SOL considerations involve finality and evidentiary staleness, of course, and related administrability concerns also operate. Cf. the Supreme Court's Jan. 11, 2011 Mayo decision, in which the Court unanimously upheld a different tax regulation under Chevron, noting administrability as a factor supporting the reg's reasonableness. Could it be said that these purposes were "obvious," so didn't have to be explicitly identified by Treasury in the notices and administrative record accompanying the § 6015(f) reg?
It will be fun to see what future cases and commentary do with these and other questions as to "failure to explain."
My comments above relate to the contention in Judge Ambro's dissent that the § 6015(f) regs are invalid as to the two-year limit on claims because Treasury failed to explain its reasons for that limit. I address here some other aspects of Mannella.
1. The Supreme Court's 2000 Brown & Williamson decision has been read by some as establishing or reaffirming a "major questions" exception to Chevron deference, that is, matters that are too fundamental or too political should be decided by Congress, not by agencies. There's a debate in Ad. Law circles about whether such an exception exists and, if so, what the contours of the exception may be. I am attracted to such a principle and would apply it to tax as well as other areas. This is why, notwithstanding unanimous contrary case law, I don't believe the "check the box" regulations should receive Chevron deference.
Even if one accepts, as I do, that there should be such an exception, it clearly would not apply to the Mannella/Lantz situation. The Mannella majority quoted the Third Circuit's 2008 Swallows Holding decision to the effect: "Drawing [a] temporal line [to claim a tax deduction] is a task properly within the powers and expertise of the IRS." Right. Chevron is about filling statutory gaps. One can argue that Congress itself should be forced to fill in the big gaps (like whether entity classification is elective or mandatory), rather than be allowed to punt the decision to an agency. Filling small gaps (like the timing issues in Swallows and Mannella) is an appropriate role for Treasury.
Of course, a major problem with the "major questions" exception is the "eye of the beholder" quality of "major," the absence of criteria by which to divide big from little. One persuaded differently from me could maintain that whether § 6015(f) should have any SOL is a big choice. It may be that debate along these lines cannot rationally proceed until courts or commentators offer criteria of bigness. However, here's one argument for Mannella involving a little, not big, matter. The Mannella majority notes that courts typically fill in SOLs when Congress omits an SOL from the statute. If courts can legitimately do that, why can't Treasury, especially since Chevron emphasized that filling statutory gaps is more properly a job for agencies than courts?
2. Relatedly, Mannella implicates another line of cases. There are many tax and nontax decisions -- although they tend to be older cases -- that say that an agency cannot add requirements that are not in the statute. E.g., the Supreme Court's 1936 Koshland decision and the Tax Court's 1993 Hughes Int'l Sales Corp. decision. How do Mannella and Lantz fit with those cases? I think the answer lies along the lines described above. It is too late in the day to argue that regs can't add any substantive requirement whatsoever to the statutue. Cases like Koshland and Hughes probably stand today for nothing more than "an agency can't add requirements to the statute unless they are matters of detail rather than fundamental matters."
3. The Supreme Court decided Mayo eight days before the Third Circuit decided Mannella. There are two points at which the decisions are in some tension. (a) Chief Justice Roberts' opinion for the Court in Mayo emphasized statutory text and structure in the Chevron Step Two analysis. Mannella, quoting a prior Third Circuit case (which had quoted a 1985 Supreme Court decision), also identified legislative history as a relevant touchstone. No surprise -- depends on whether the opinion is being written by a textualist or purposivist judge. (b) Mannella recites the "specific authority regs get more deference than general authority regs" chestnut that Mayo buried.
4. The Mannella majority and dissent clashed about the burden and standard of proof at Chevron Step Two. It is true, of course, that the agency's interpretation need only be reasonable to survive Step Two scrutiny. The Mannella majority interpreted that to mean that the taxpayer has the burden to "clearly demonstrate that Congress intended that requests for relief under § 6015(f) not be subject to a two-year filing deadline." (Page 23) The dissent questioned the "presumption of validity" used by the majority, arguing: "But [the agency's] first call must be reasonable." (Dissent page 4) Who then bears the burden? Does the agency have the burden of establishing that its position is at least reasonable, or does the challenger bear the burden of overcoming a presumption of validity? In most cases, location of the burden will not matter much to the outcome. In some cases, it might.
5. The Mannella dissent argued that SOLs are considered substantive, not procedural rules. This distinction might have mattered in this context before Mayo because procedural regs under § 6015 are specific authority while nonprocedural regs under § 6015 arguably are general authority. Mayo renders that moot for present purposes. One may note, however, that the "are SOLs procedural or substantive" question comes up in many different contexts, and the answer is not always "substantive." For example, in transferee liability cases, the substantive basis of liability usually is a matter of state law (state fraudulent conveyance law), while procedures -- including the SOL under § 6901(c) -- are matters of federal law.
6. Mannella did not resolve the case for the IRS. The court was only passing on the IRS's motion for summary judgment. The Third Circuit remanded the § 6015(f) portion of the case to the Tax Court to consider the taxpayer's equitable tolling argument. Presumably, the Third Circuit did so because of the harsh consequences of applying the two-year limitation. And, as a matter of policy, it might be better to evaluate fairness through a case-specific doctrine like equitable tolling than by allowing any § 6015(f) claim to be brought at any time, without limit (or, more accurately, allowing timing to be considered as only one of potentially many aspects of fairness). One will be interested to see what the taxpayer can muster on this issue on remand. My guess at this early juncture is that the equitable tolling argument is unlikely to be a winner for the taxpayer.
7. The Mannella dissent several times cites Prof. Beerman's "End the Failed Chevron Experiment Now" article. A growing number of commentators agree with Beerman. I'm one of them. I think that, as long as Chevron exists, tax agencies should be subject to it like all other agencies, but Chevron itself has failed and should be abandoned, again for all agencies not just tax agencies. So there is some irony in the fact that Mayo (and to a lesser extent circuit court cases like Mannella, Lantz, and Swallows) are bringing the tax maverick into the larger Chevron herd at the time that Chevron itself is increasingly viewed as discredited.
[A] recent U.S. district court case [was] won by the IRS against David Watson, a CPA in West Des Moines, Iowa. At issue: a common tax-cutting maneuver available to the owners of millions of closely held businesses.
The case, David E. Watson P.C. v. United States [No. 4:08-cv-442 (S.D. Iowa Dec. 23, 2010)], revolved around Mr. Watson's low pay as the sole owner and shareholder of a so-called S Corporation. ... According to the decision, the firm made profit distributions of $203,651 and $175,470 to Mr. Watson through his Sub-S for 2002 and 2003, respectively, the years in question.
Mr. Watson, who had a graduate degree in tax and 20 years' experience, received only $24,000 of salary for each of those years, far less than the $40,000 a year earned by recent graduates in accounting with no experience, according to one expert for the IRS.
The agency cried foul, saying his pay was far too low. Why object? Unlike profit distributions, all salary is subject to a 2.9% Medicare tax and some is subject to a 12.4% Social Security, or FICA, tax. ... By reporting low pay Mr. Watson didn't save any income taxes, but he did save nearly $20,000 in payroll taxes for the two years, the IRS said, pegging Mr. Watson's true pay at $91,044 for each year.
Judge Robert W. Pratt agreed, ruling that the CPA owed the extra tax plus interest and penalties.
Mr. Watson plans to appeal the decision. "The IRS can disallow a tax deduction for unreasonably high compensation, but the law doesn't give it the authority to raise pay in order to collect extra payroll taxes," he says. Independent tax expert Robert Willens in New York says this will be a hard argument to win. ...
Recent IRS statistics suggest why the agency might focus on Sub-S pay. Over the past decade and a half, when executive paychecks exploded, the salaries of Sub-S owners declined as a percentage of total income, from 52% in 1995 to 39% in 2007, according to the latest data available. (The remaining income is taxable to the owners as well, but doesn't incur payroll taxes.) During the same 12-year period, Sub-S income doubled, while salaries increased only 26%. The average pay for a Sub-S owner was recently was $38,400, according to Martin Sullivan, an expert with Tax Analysts, a nonprofit publisher near Washington.
What is a fair ratio of profits to pay? There isn't one answer, experts say. A company with substantial capital or assets, such as a manufacturer, often is able to justify lower pay than one selling personal services like a law or accounting firm. Says Mr. Willens: "I would tell a client that for personal services, 70% would be the absolute floor and might not get the job done," he says.
In Mr. Watson's case, his revised compensation came to only about 40% of his total return from the company. The upshot: Pay can vary—but it can't be too low.
- Tax Update Blog, WSJ Spotlights Area CPA S Corp Court Loss (Jan. 22, 2011)
- Tax Update Blog, Court Sets 'Reasonable' Comp for CPA S Corp Shareholder (Dec. 30, 2010)
- Tax Lawyer's Blog, S Corp Wages and Distributions: Basic Tax Planning (May 5, 2009)
- Tax Update Blog, John Edwards Shelter Targeted by IRS (Mar. 12, 2005)
- TaxProf Blog, WSJ Charges Kerry-Edwards with Tax Hypocrisy (July 14, 2004)
- Thinking Like, S Corps Help Owners Save on Taxes: John Edwards Saved $600k With His S Corp
Thursday, January 20, 2011
Following up on my prior posts (links below) on Mayo Foundation for Medical Education & Research v. United States, No. 09-837 (U.S. Jan. 11, 2011); and . Mannella v. Commissioner, No. 10-1308 (3d Cir. Jan. 19, 2011): Kristin Hickman (Minnesota), Dismayed by Mayo? Check Out the Mannella Dissent:
The majority opinion in Mannella offers a rather straight-forward and unremarkable application of Chevron review to uphold Treas. Reg. § 1.6015-5(b)(1), save for two minor observations:
- Like the Seventh Circuit in Lantz, the Mannella majority reserves consideration of legislative history to the more deferential Chevron step two. At least part of the argument against a two-year limitations period for equitable relief claims under § 6015(f) relies upon legislative history. Consistent with a number of Supreme Court opinions, other circuits are more willing to consider legislative history at Chevron step one.
- The Mannella majority, in so many words, finds § 6015(f) ambiguous for its silence regarding a potential limitations period. Numerous judicial opinions applying Chevron caution courts against automatically equating statutory silence with ambiguity.
In short, the circuit courts do not always agree on the proper scope of Chevron step one, and those who support the Tax Court’s conclusion that Treas. Reg. § 1.6015-5(b)(1) fails at Chevron step one may yet find a sympathetic panel in another circuit.
Particularly for members of the tax community lamenting the demise of the National Muffler standard from last week’s Supreme Court decision in Mayo, however, the Mannella dissent is worth a careful read. After agreeing with his colleagues regarding the ambiguity of § 6015(f), Judge Ambro nevertheless would have invalidated Treas. Reg. § 1.6015-5(b)(1) at Chevron step two on the ground that Treasury failed in promulgating the regulation to explain why it felt a two-year limitations period was necessary. In so doing, Judge Ambro relied on two key lines of administrative law jurisprudence worth noting.
- In Motor Vehicle Mfrs. Ass’n v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29 (1983), the Supreme Court held that the arbitrary and capricious standard of Administrative Procedure Act § 706(2)(A) requires agencies to articulate their reasons for choosing the particular interpretation adopted instead of another permissible alternative. Parties often argue, and courts sometimes agree, that agency regulations are arbitrary and capricious under State Farm irrespective of whether the interpretation in question is substantively permissible under Chevron. In other cases, however, as Judge Ambro has done here, courts have folded the State Farm inquiry into Chevron step two analysis and declined to defer to a potentially reasonable interpretation for lack of sufficient explanation. In the words of Judge Ambro, “Here, however, the IRS has not advanced any reasoning for its decision to impose a two-year limitations period on taxpayers seeking relief under subsection (f), leaving us no basis to conduct the analysis mandated by Chevron step two. … Because the IRS has not articulated its reasoning, we cannot discern whether the two-year limit falls into the permissible, or the arbitrary and capricious, category.”
- In SEC v. Chenery Corp., 318 U.S. 80 (1943), the Supreme Court held that courts should not create their own justifications for an agency’s choices and instead should limit their evaluation to the reasons offered by the agency in the administrative record. Judge Ambro criticized the Seventh Circuit in Lantz particularly for offering its own justifications for Treas. Reg. § 1.6015-5(b)(1) rather than merely evaluating Treasury’s reasons (or lack thereof) articulated in the administrative process.
It is perhaps notable that Judge Ambro was on the panel in the Swallows Holding case, in which the Third Circuit also rejected the Tax Court’s application of Chevron and upheld another Treasury regulation; he does not seem reflexively inclined to apply Chevron aggressively to invalidate Treasury regulations. Rather, Judge Ambro’s opinion is entirely consistent with mainstream Chevron jurisprudence, and also with the Supreme Court’s suggestion in Mayo that tax cases are not an exception from general administrative law norms.