Lesson From The Tax Court: The New Regulation On Supervisory Approval Of Penalties

Section 6751(b) requires supervisory approval before the IRS can assess certain penalties.  The statute is untouched by the recently enacted BBBA.  In late December Treasury published these final rules on how the IRS must comply with the statute.  Professor Caleb Smith shared some good thoughts on them on this Procedurally Taxing post.  This Lesson is an opportunity to see how they will work.

In one sense it is too early for the Tax Court to teach us a lesson on the new regulations because the regulations only apply to penalties assessed on or after December 23, 2024.  Treas. Reg. 301.6751(b)-1(f).

But in Ivey Branch Holdings LLC v. Commissioner, T.C. Memo. 2025-63 (June 9, 2025), Judge Lauber gives us an opportunity to see how the new regulations will work in Tax Court, both as to issues about the timing of supervisory approval, and as to how the approval process works when the taxpayer is examined by a team of IRS employees and not just a single IRS employee.

The timing lesson is useful because the regulations adopt what I call the horse-and-barn rule and reject what I call the Tax Court’s consequential moment rule.  Four Circuit Courts of Appeals have also adopted the horse-and-barn rule including the Circuit to which this taxpayer would take an appeal.  So Judge Lauber evaluates the IRS compliance with §6751(b) under what will become the governing rule per the regulations.

The teams lesson is also useful to learn because the stereotype of a single gimlet-eyed auditor acting alone is a myth.  The reality is that IRS employees will often seek advice and support from other employees on matters, especially now, as the IRS copes with incessant budget cuts by pooling resources.  For example, an RA may seek support from other IRS employees who are designated to provide subject matter support on a particular issue...such as penalty application!  Or the RA may seek support and direction from supervisors  Or different RA’s may be assigned to work different issues on the same examination.  The various back-and-forth communications between all these employees can sometimes make it difficult to see which “individual” IRS employee makes the “initial determination” that must then be approved.  The new regulations deal with that problem and so does Judge Lauber in today’s case, giving us a lesson on how both the Tax Court and the regulations evaluate compliance with 6751(b) when the examination is conducted by a team.

Details below the fold.

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NY Times Op-Ed: Justice Jackson Just Reset The DEI Debate

New York Times Op-Ed:  Justice Jackson Just Helped Reset the D.E.I. Debate, by David French (Author, Divided We Fall: America’s Secession Threat and How to Restore Our Nation (2020)):

At the heart of the debate over diversity, equity and inclusion is a question: How much should the law treat a person as an individual rather than as a member of a group?

For a very long time, American law and American institutions answered that question unequivocally. People were defined primarily by the group they belonged to, and if they happened to be Black or Native American or a woman, they were going to enjoy fewer rights, fewer privileges and fewer opportunities than the people who belonged to the categories white and male.

That was — and remains — a grievous injustice. At a minimum, justice demands that a nation and its institutions cease and desist from malicious discrimination. But doesn’t justice demand more? Doesn’t it also require that a nation and its institutions actually try to provide assistance to targeted groups to help increase diversity in employment and education and help targeted groups overcome the systemic effects of centuries of discrimination?

On Thursday the Supreme Court unanimously decided a case that was directly relevant to the latter question, and while the outcome wasn’t surprising, the court’s unanimity — and the identity of the author of the court’s opinion — certainly was.

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Lesson From The Tax Court: The Key Word In “Net Operating Loss”

Businesses fail.  That’s a feature of capitalism, not a bug.  Mark Twain discovered that when he lost his first fortune investing in a business that failed, the Paige Compositor.  He not only lost his fortune but some say he also lost his sense of humor.  Certainly his later works become more dystopian.  See e.g. The Mysterious Stranger, or A Connecticut Yankee in King Author's Court.

But sometimes businesses just go through a rough patch, netting a loss from operations in one year, but having profitable years before and/or after.  Section 172 permits taxpayers to take those Net Operating Losses (NOLs) as a deduction against the income earned in prior and later years.

But the key word in Net Operating Loss is “Operating.”  To get the NOL, the taxpayer must be able to show the loss arose from an existing business, one that was actually operating.  And it is not always easy to tell when a business actually starts operating.  That is the lesson we learn in James M. Root and Valerie K. Root v. Commissioner, T.C. Memo. 2025-51 (May 22, 2025) (Judge Toro).  There the taxpayers lost a lot of money in 2014 in what they later claimed was a recreational ranch business and attempted to take a §172 deduction on their 2017 and 2018 returns.  Judge Toro explains why their activities in 2014 did not amount to operating a business in that year.

Details below the fold. 

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Tax Prof Must Pay New York Non-Resident Income Tax On Days He Taught Law Students On Zoom From His Connecticut Home When Cardozo Was Closed During Covid

Bloomberg, NY Wins Another Round in Challenge to Taxation of Remote Work:

New York was right to tax a Cardozo Law School professor’s wages earned while working from his Connecticut home, even when pandemic restrictions barred him from the New York campus, a state tax tribunal affirmed.

The state’s convenience-of-the-employer rule “boils down to whether the employer established a nexus in another jurisdiction by directing its employee to perform personal services in that out-of-state location for its own necessity,” the New York Tax Appeals Tribunal said in an opinion obtained Friday by Bloomberg Law.

Edward Zelinsky hasn’t shown that Cardozo required him to perform the functions of this job from Connecticut, as opposed to anywhere else, the panel said. That means Zelinsky and his wife won’t get the refunds they sought of more than $10,000 for 2019 and more than $14,000 for 2020.

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Lesson From The Tax Court: No Equitable Tolling For Brain Farts

Tax practice is like comedy: timing is critical.  In tax, however, messing up timing is no laughing matter.  As the sainted Justice Holmes once wrote (in a tax case, nach): “Men must turn square corners when they deal with the Government.” Rock Island R.R. v. United States, 254 U.S. 141, 143 (1920).  That is especially true with deadlines.  Of all the corners in all the laws governing citizen interaction with government, the timing requirements in the Internal Revenue Code contain some of the squarest and sharpest, including the timing requirements for petitioning the Tax Court.

Some folks might think the Supreme Court’s decision in Boechler v. Commissioner, 596 U.S. ___, 142 S.Ct. 1493 (2022), would sand down some of those sharp timing corners.  In Boechler the Supreme Court held that the 30-day period in §6330(d)(1) for taxpayers to petition the Tax Court to review a Collection Due Process decision was subject to equitable tolling.  I think otherwise.  I have not yet seen anyone yet convince the Tax Court to apply equitable tolling to excuse a late CDP petition.  Few have even tried. See Reed v. Commissioner, T.C. Memo. 2025-4; Shaw v. Commissioner, T.C. Memo. 2024-48;  Stephens v. Commissioner, T.C. Memo. 2024-40.  I’m happy to be corrected on that.

Today we learn another lesson on what does not trigger equitable tolling: your attorney’s ordinary negligence. In Belagio Fine Jewelry Inc. v. Commissioner, 164 T.C. No. 7 (Apr. 15, 2025) (Judge Greaves), the taxpayer’s attorney’s staff sent the taxpayer’s petition using a FedEx service that guaranteed the petition would be delivered ... one day late!  Brain fart! (trigger warning—link is to a pretty funny collection of them).  Desperately seeking relief, the taxpayer argued for application of the timely-mailed-timely-filed rule, codified in §7502 and, failing that, asked for equitable tolling.  Judge Greaves finds that the FedEx mailing did not turn the very square corners of the statutory timely mailing rule and that brain farts are no basis to apply equitable tolling. 

Details below the fold.

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Lesson From The Tax Court: A Captivating Lesson On Insurance

I still don’t carry dental insurance.  I have not found a plan where the numbers make sense.  The benefits are so limited that by the time I would need them I will have paid more in premiums than the benefits are worth.  The game is not worth the candle.  So I take the money I would otherwise spend on premiums and save it up.  In effect I self-insure.

Businesses face the same choice in managing their various risks.  For most risks they can pay a third party, an insurance company.  But for some risks businesses cannot find a third-party insurance company willing to cover the risks at an acceptable price.  The game is not worth the candle.  It could be because the risks are too specific or esoteric, like covering the risk of bird flu for your chicken farm.  Lesson From The Tax Court: Not Every Decision Comes With An Opinion, TaxProf Blog (November 15, 2021)(discussing unpublished order in Puglisi et al. v. Commissioner). Or the risks might be so massive and the pool so shallow that no third-party insurance company will write coverage.  Here’s a blog post on that.  For those types of risks, businesses must self-insure.

Businesses that need to self-insure can do so by creating a captive insurance company to manage risk.  It’s a “captive” company when the business seeking risk management basically owns it.  And if it’s small enough---e.g. “micro”---it can claim some pretty sweet tax benefits under §831, benefits that help small businesses deal with unusual risk situations, like that bird flu.

But to get those tax benefits, the captive entity must be in the business of insurance.  That's our lesson for today.  In Jones, et al. v. Commissioner, T.C. Memo. 2025-25 (March 25, 2025), Judge Nega writes a really informative (and loooong) opinion about what that means. 

For the short lesson, see below the fold.

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11th Circuit Poised To Uphold Constitutionality Of Tax Court Despite President's Ability To Fire Judges Only For Cause

Bloomberg Law, Eleventh Circuit Eyes Tax Court History Amid Constitutional Test:

The Eleventh Circuit appeared ready to side with the government in a case challenging the legitimacy of the judges of the US Tax Court, but not without considering the court’s place in the government.

A US Court of Appeals for the Eleventh Circuit panel prodded counsel for taxpayer Fannie Wright on her argument about the constitutional authority of the Tax Court’s judges, and whether provisions allowing the president to remove them violate the Constitution. Wright, who had petitioned the Tax Court to contest penalties without success, argued Internal Revenue Code Section 7443, which addresses how the Court’s 19 judges are appointed, is flawed.

Either the Tax Court is a part of the executive branch, in which case the president should have more authority over the court than the statue provides; or the tax code section violates the separation of powers by allowing a member of the executive branch to remove a member of the judicial branch, Joseph A. DiRuzzo III of Margulis Gelfand DiRuzzo & Lambson LLC argued for Wright.

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Wallace & Davis: Brief Of Amici Curiae Tax Professors In South Carolina Amazon Case

Clint Wallace (South Carolina; Google Scholar) & Tessa Davis (South Carolina), Brief of Amici Curiae Tax Law Professors for the South Carolina Supreme Court in Support of Respondent: 

In this appeal, Petitioner Amazon Services, LLC challenges the holding of the Administrative Law Court, as affirmed by the Court of Appeals, that Amazon is a “retailer” or “seller” under the South Carolina tax statute that was in effect prior to 2019. That holding properly confirmed the authority of Respondent South Carolina Department of Revenue to collect sales tax from Amazon for retail sales of third-party merchant-owned products on Amazon’s website.

Amazon has attempted to advance an ahistorical, one-size-fits-all litigation and business strategy that has worked for Amazon in other states—but it has done so here with little or no regard for the specific legal context in South Carolina.

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Lesson From The Tax Court: After Loper-Bright, Hold The Mayo?

How much deference should courts give Treasury regulations?  Until 2011, courts answered that question differently from how they evaluated deference to regulations issued by other federal agencies.  In that year, however, the Supreme Court decided that Treasury regulations should be treated the same way as all federal regulations. Mayo Foundation v. United States, 562 U.S. 44 (2011).  That meant that Treasury regulations would be evaluated under the standard the Supreme Court had created in 1984 in Chevron U.S.A. Inc. v. Nat'l Res. Def. Council, 467 U.S. 837 (1984).

Last year the Supreme Court decided to change it’s general approach to how and when it would defer to regulations issued by federal agencies.  In Loper Bright Enterprises v. Raimondo, 603 U.S. 369 (2024), the Court said it would no longer follow the approach it had adopted 40 years prior in Chevron.  [Snark: not that the Supreme Court has ever really followed Chevron.  For an excellent demonstration of how Chevron was honored more in the breach than in the execution, see Ann Graham, Searching For Chevron In Muddy Watters: The Roberts Court And Judicial Review Of Agency Regulations, 60 Admin. L. Rev. 229 (2008) (reviewing all cases in a single term).

So what is Loper-Bright’s impact on how courts should review Treasury regulations?  That’s the lesson we learn in Judge Weiler’s thoughtful opinion in Alan Hamel and Estate of Suzanne Hamel v. Commissioner, T.C. Memo. 2025-19 (Feb. 15, 2025) (Judge Weiler).  There the taxpayers asked the Tax Court to reconsider a prior opinion where it had upheld a Treasury regulation under the Chevron standard.  In the course of rejecting the request, Judge Weiler teaches us how the Tax Court seems poised to interpret Loper-Bright as returning the law to it’s pre-Mayo status.  Tax exceptionalism alert!

Details below the fold.

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Lesson From The Tax Court: The Difficult Path To Equitable Tolling

When a taxpayer contests IRS collection actions in a Collection Due Process (CDP) hearing, the hearing is officially over when the Office of Appeals issues a formal Notice of Determination.  Section 6330(d)(1) gives taxpayers 30 days from the date of that Notice to petition the Tax Court for judicial review of the Office of Appeals decision.

We now know that the doctrine of equitable tolling can extend the 30-day limitation period in §6330 because that timing requirement is not jurisdictional.  Boechler v. Commissioner, 596 U.S. 199 (2022).  The fact that the deadline is non-jurisdiction, however, does not lessen its importance.  It just means that the petition gets dismissed for failure to state a timely claim rather than because the Tax Court lacks jurisdiction to hear the matter.  Nor does the doctrine of equitable tolling give taxpayers much wiggle room to avoid the deadline by pleading “not fair!”  To be “not fair” in the relevant sense, taxpayers must be able to show the right causality: how events beyond their control caused them to miss the deadline.

In Debra Reed and Timothy Reed v. Commissioner, T.C. Memo. 2025-4 (Judge Way) (Jan. 16, 2025), the taxpayers had their identify stolen in 2012.  It caused them no end of grief.  They attempted to use that unfortunate experience to justify filing their Tax Court petition after the petition deadline.  In response Judge Way became Judge “No Way” because the taxpayers were unable to show how the identify theft caused them to miss their CDP petition deadline...by some four years.

Details below the fold.

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Lesson From The Tax Court: The 150 Day Rule For Filing Tax Court Petitions

Section 6213 generally gives taxpayers 90 days after the IRS mails them a Notice of Deficiency (NOD) to petition the Tax Court for review.  That’s the 90-day rule.  But some lucky taxpayers get 150 days instead of the usual 90.  That’s the 150-day rule.  Who are those lucky taxpayers?  Well, the statute says the 150-day rule applies “if the notice is addressed to a person outside the United States.”  The Tax Court has interpreted that phrase to mean that taxpayers get the 150-day rule when they are outside on foreign travel when the IRS mails the NOD, or maybe when the Post Office delivers the NOD.  Hmmmm ... it's hard to say exactly because there is no bright line here.  Case law varies.  Not everyone who is outside the United States on one of those two days automatically gets the 150 period.  It just depends on whether the Tax Court believes that the travel interfered with the taxpayer’s ability to meet the 90 day deadline.  That’s partly what makes these taxpayers lucky.

Today we learn that a taxpayer who is in the country on both the day of mailing and the day of delivery will probably not be lucky.  Later travel outside the country will not trigger the 150 day deadline.  That’s one takeaway from Rosa M. Marcano v. Commissioner, T.C. Summ. Op. 2024-26 (Dec. 23, 2024) (Judge Abeit).  There, the taxpayer was in the country when the NOD was mailed and delivered.  But she then traveled outside the country for approximately 50 days and did not file her Tax Court petition until 107 days after the IRS mailed the NOD.  The Tax Court, however, did not give allow her the 150-day rule because, it said, “the crucial inquiry” (Op. p. 3) was the taxpayer’s location on two crucial dates: the date the IRS mailed the NOD and the date the Post Office delivered it.  Here, the taxpayer was in the country on both those particular days.  Unlucky!

It seems to me this is not the only lesson here.  Despite the language in Judge Arbeit's well-written opinion, I would resist reading this case as creating a bright-line rule.  Reading it that way makes it difficult to square with its past approaches.  Detail below the fold.

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Lesson From The Tax Court: The Limits Of IRS Assessment Powers

Many people imagine the IRS as a kind of huge and powerful being, “whose frown, and wrinkled lip, and sneer of cold command” regularly oversees enforcement of what many believe are outrageous penalties for errors in complying with increasingly twisted reporting requirements.

Today we learn a lesson about possible limits of the IRS powers to assess some of these reporting penalties, specifically the ones found in §6038 (titled “Information reporting with respect to certain foreign corporations and partnerships”).

In Raju J. Mukhi v. Commissioner, 163 T.C. No. 8 (Nov. 18, 2024) (Judge Greaves), the Tax Court reaffirmed its conclusion that the IRS has no authority to assess §6038 penalties.  Instead, the only way for the government to impose those penalties is by filing suit in court.  We learn that, at least in the Tax Court’s view, neither §6038 itself nor any other part of the Internal Revenue Code give the IRS authority to assess §6038 penalties.

Today’s case also teaches a lesson about the Tax Court’s relationship with other federal courts.  Often labeled “the Golsen rule” that relationship is not a simple one.  See e.g. Lesson From The Tax Court: The Rules For Penalty Approval Depend On Geography, TaxProf Blog (Oct. 20, 2023).  The Tax Court’s decision in this case directly conflicts with the D.C. Circuit’s interpretation of §6038.  See Farhy v. Commissioner, 100 F.4th 223 (2024) (overruling Tax Court’s interpretation of §6038).  Under the Golsen rule, however, the Tax Court is not bound by any Circuit Court of Appeals decision.  It is free to disagree with any other federal court ... except the U.S. Supreme Court!  So whether you are teaching students, advising clients, or litigating in Tax Court, you gotta pay close attention to what the Tax Court says.

Details below the fold.

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Vanguard Settles Class Action Lawsuit Over Capital Gains Distributions That Accelerated Investors’ Tax Liabilities

Following up on my previous posts:

• Wall Street Journal, The Huge Tax Bills That Came Out of Nowhere at Vanguard (Jan. 24, 2022)
• New York Times, Holders Of Vanguard Target Funds File Class Action Over Massive Capital Gain Tax Bills (Apr. 12, 2022)

Bloomberg, Vanguard Reaches $40 Million Settlement to End Investor Tax Suit:

Vanguard finalized its $40 million settlement with investors who say the firm breached its fiduciary duty when it restructured its mutual funds in such a way that caused them to pay surprise capital gains taxes.

The settlement, filed in the US District Court for the Eastern District of Pennsylvania on Wednesday, will benefit a class of US investors who held shares in the Vanguard Target Retirement series of mutual funds and received capital gains distributions from them in 2021. Vanguard continues to deny wrongdoing or liability.

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Lesson From The Tax Court: FBAR Penalties Are Not Tax Penalties ... Thank Goodness

We often talk about “the IRS” as if it were a person (or animal!).  Or we talk about the “Treasury Department” doing this or that.  But agencies are legal fictions.  They do not exist.  The actual work is done by actual people.  Thus when you read statutes that Congress writes, you see that Congress generally grants powers not to the agency but instead to just a single person, generally “the Secretary” of a department.  That person then delegates the powers to other specific categories of people within the relevant agency.  And those folks often then re-delegate their powers to yet other groups of folks.  It's a trail of delegations.

Specifically, Congress empowers one single person, the Secretary of the Treasury, to perform a lot of functions.  Some of those functions are assessing and collecting internal revenue taxes.  Others involve matters about the federal government’s finances and budget.  The Secretary has delegated to IRS officials the responsibly for assessing and collecting taxes.  But the Secretary has also delegated to the same folks the responsibility for assessing and collection certain non-tax liabilities, such as the penalty for failing to submit a proper Report of Foreign Bank and Financial Accounts (FBAR).

All of this leads to the lesson we learn in Stephen C. Jenner and Judy A Jenner v. Commissioner, 163 T.C. No. 7 (Oct. 22, 2024) (Judge Foley): just because the IRS assesses and collects a liability does not make it a tax liability. The Jenners were assessed a penalty for their failure to submit a proper FBAR.  Under its delegated authority, the IRS then sought to administratively collect the penalties by offsetting part of the Jenners’ Social Security payments through the Treasury Offset Program.  The Jenners sought a Collection Due Process (CDP) hearing.  Both the IRS and the Tax Court said they were not entitled to a CDP hearing because FBAR penalties are not taxes.  There are other reasons why CDP does not apply, but the Court did not get into those.

The bad news from this case is taxpayers like the Jenners have no recourse to the Tax Court to contest an FBAR penalty because … it’s not a tax!  The good news, however, is that the same taxpayers certainly do have the ability to obtain judicial review without having to fully pay the asserted penalty because … it’s not a tax! 

Details below the fold. 

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5th Circuit Affirms Tax Court: Tax Rule In Political Donations Tightened

Wall Street Journal, Tax Rule In Political Donations Tightened:

A federal appeals court narrowed the tax rule that has let conservative and liberal groups pour billions of dollars into political campaigns without disclosing their donors, and the case could restrict the flow of so-called dark money into politics [Memorial Hermann Accountable Care Organization v. Commissioner, No. 23-60608 (3d Cir. Oct. 28, 2024)].

The unanimous opinion from a three-judge panel of the 5th U.S. Circuit Court of Appeals came this week in a healthcare case that didn’t directly address politically active organizations. But the decision—from a conservative court—sets a tighter legal standard for tax-exempt status that the advocates for political donor transparency have long sought. from a three-judge panel of the 5th U.S. Circuit Court of Appeals came this week in a healthcare case that didn’t directly address politically active organizations. But the decision—from a conservative court—sets a tighter legal standard for tax-exempt status that the advocates for political donor transparency have long sought.

The court said groups can’t qualify for tax exemption under Section 501(c)(4) of the tax code if they have a substantial nonexempt purpose. That is a much stricter standard than the one in Internal Revenue Service regulations, which say groups only need a primary purpose that qualifies for the exemption. That has been interpreted to allow tax exemptions for groups that spend 51% of their money on lobbying or other clearly allowed activities—and 49% on politics.

“The people who are making the case that they can do up to 49%, do they have a leg to stand on? Their leg got a lot weaker,” said Phil Hackney, a University of Pittsburgh tax law professor.

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Lesson From The Tax Court: To Get Deductions For Criminal Activity, Make It Your Business

I was going to blog today on a great case involving application of the Cohan rule to help a taxpayer establish their basis in property when they had lost their records.  Pak v. Commissioner, T.C. Memo. 2024-86.  I decided not to because Les Book did such a nice job blogging about it here on Procedurally Taxing that I did not feel I would add much value.  However, one result of reducing these Lessons to once-a-month is that I easily found another case to teach a good Lesson.

Today’s lesson is about deductions for criminal activities.  It’s also a lesson about what I call the rule of ‘62’s.  Section 162 allows a deduction for “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.”  In contrast, §262 expressly disallows the deduction of “personal, living, or family expenses.”

The key idea behind these two statutes is to distinguish personal from business expenses.  Congress seeks to tax only net income of money made in a trade or business.  Since it takes money to make money, §162 generally permits taxpayers to deduct the money it takes from the money they make.  In contrast, expenses that are not connected to a trade or business activity (or other profit-seeking activity under §212) are not deductible; Congress seeks in such cases to tax the gross receipts of the taxpayer.

But what if the taxpayer’s trade or business is illegal?  Is their income still gross income?  Are their expenses still deductible?  There is a long and rich history regarding these questions, much of it arising from the activities of Chicago mobsters in the 1920’s, who were not always punctilious about their taxes.  The bottom line is that yes, illegal income is gross income and, yes, expenses to produce that income are likewise deductible under §162(a).  In contrast, expenses that are themselves illegal are not deductible, again regardless of the legality of the taxpayer’s trade or business.  §162(c).

Thus income earned by criminals is treated similarly to income earned by law-abiding taxpayers.  That means criminals still have to deal with the rule of ‘62’s.  That is, they must connect their expenses with some activity that amounts to a trade or business.  §162. The expenses cannot be just personal.  §262.  That is the lesson we learn in Jonathan Chang and Wei-Lin Chang v. Commissioner, T.C. Summ. Op. 2024-18 (Sept. 16, 2024) (Judge Panuthos), where the taxpayer sought to deduct the legal expenses he incurred in a criminal trial for wire fraud and money laundering.  The IRS said his criminal activity was not connected to any business, but was merely personal enrichment.  The Tax Court disagreed and allowed a deduction of over $360,000.

\Details below the fold.

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Lesson From The Tax Court: Form Trumps Substance On Phantom S Corp Income

This past June, the Supreme Court issued an opinion in Moore v. United States, 144 S.Ct. 1680 (June 20, 2024).  There, the taxpayers were shareholders of an American-controlled foreign corporation called KisanKraft and were being taxed on a portion of the corporation’s income that had been earned long ago and far away but never actually passed on to them substantively.  The unhappy taxpayers protested that Congress could not constitutionally tax them on income they had not realized through actual receipt.  To them it was phantom income.  Form could not, constitutionally, trump substance.

In explaining why the taxpayers were wrong, Justice Kavanaugh reviewed how Congress has historically chosen to make the owners of certain business entities responsible for paying tax on the entity’s income, regardless of what the entity actually does with that income.  He also reviewed how courts have routinely upheld that Congressional choice.

Today’s lesson is an example of that routine application of Congressional choice.  It also carries a cautionary lesson for taxpayers: choose your business partners carefully!  You do not want to go into business with Gru and Dru.  In James J. Maggard and Szu-Yi Chang v. Commissioner, T.C. Memo. 2024-77 (Aug. 7, 2021) (Judge Holmes), Mr. Maggard was a 40% shareholder of an S Corporation controlled by two other shareholders who, over the course of several years “made unauthorized distributions to themselves in excess of their proportionate ownership shares.” Op. at 1.  Judge Holmes translates this into plain English: they looted the corporation.  While the looting gave the taxpayer an argument to avoid taxation, it was not a winning argument.

Sad details below the fold.

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Bogdanski: Supreme Court's Tax Decisions (Moore, Estate Of Connelly) Undercut By Non-Tax Decisions (Loper Bright, Cover Post, Jarkesy)

Jack Bogdanski (Lewis & Clark), After the Sigh, a Gasp:

I wrote back in June about how relieved some of us were that the U.S. Supreme Court decided two tax cases this term in favor of the IRS. To have ruled in favor of the taxpayers in either of the cases would have wreaked havoc on the federal tax system.

But as the summer has worn on, a few other decisions that the Court rendered have come to us tax types' attention, and it appears they are going to make trouble for the tax system. Indeed, they're going to create a fair amount of tsuris for the entire federal government of which the tax system is a part.

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Federal Court Issues Injunction Prohibiting UCLA From Allowing Antisemitic Encampments To Block Jewish Students From Areas Of Campus

Frankel v. Regents of the University of California, No. 2:24-cv-04702 (C.D. Cal. Aug. 13, 2024):

In the year 2024, in the United States of America, in the State of California, in the City of Los Angeles, Jewish students were excluded from portions of the UCLA campus because they refused to denounce their faith. This fact is so unimaginable and so abhorrent to our constitutional guarantee of religious freedom that it bears repeating, Jewish students were excluded from portions of the UCLA campus because they refused to denounce their faith. UCLA does not dispute this. Instead, UCLA claims that it has no responsibility to protect the religious freedom of its Jewish students because the exclusion was engineered by third-party protesters. But under constitutional principles, UCLA may not allow services to some students when UCLA knows that other students are excluded on religious grounds, regardless of who engineered the exclusion. ...

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The Constitutional Line On Direct Taxes

Rob Natelson (Montana; Google Scholar), The Constitutional Line on Direct Taxes:

The idea of a federal wealth tax recently has become a popular cause among “progressives.” The question arises, however, of whether such a tax would be constitutional.

In theory, a federal wealth tax could pass constitutional muster. But unless it qualified under the Constitution as an “indirect tax” rather than as a “direct” one, its projected revenue would have to be allocated (“apportioned”) among the states according to their respective populations. The apportionment rule likely would render such a levy impractical.

Many wealth tax advocates contend, therefore, that wealth taxes qualify as “indirect.” But this contention seems plausible only because most Supreme Court pronouncements on direct and indirect taxes have been conflicting, uncertain—and wrong.

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Moore v. The United States: Will The Supreme Court Join The Whack-A-Tax Shelter Game?

Eugene Steuerle (Tax Policy Center; Google Scholar), Moore v. The United States: Will The Supreme Court Join The Whack-A-Tax Shelter Game?:

In  Moore v. the United States, the Supreme Court dodged the issue of whether the Constitution allows for the taxation of unrealized income, concluding that the “disagreement over realization” was among “potential issues for another day.” However, Justices Amy Coney Barrett and Samuel Alito, in a concurring opinion, and Justices Clarence Thomas and Neil Gorsuch, in the dissent, declared that realization was a Constitutional requirement.

This is not a minor issue. As my colleague Steven Rosenthal explains, their declarations open the Court to new challenges to the taxation of unrealized income. If the Court determines that “realization” is a Constitutional requirement, the decision would, at worst, threaten to gut the taxation of capital income. At best, it would require the Court to join Congress and the US Treasury Department in the endless game of whack-a-mole on tax shelters. ...

Will this whack-a-tax-shelter game be improved if the Supreme Court steps in as umpire?

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Lesson From The Tax Court: The Shrinking §469 Exception For Active Participation

Section 469 generally denies taxpayers the ability to use net losses from passive activities to offset income from active activities.  Renting real property is a passive activity.  But there are some exceptions when it comes to renting real estate.  Two are relevant for today’s lesson.  First, taxpayers who are real estate professionals can deduct such losses.  Second, individual taxpayers who actively participate in a rental activity can use up to $25k of net losses to offset other income ... if they are not too rich!

Today we learn how difficult it can be for taxpayers employed in a full-time job to claim they are a real estate professional.  We also learn how second exception is shrinking.  In Timothy L. Foradis and Jessica L. Moore v. Commissioner, T.C. Summ. Op. 2024-13 (July 11, 2024) (Judge Leyden), the married taxpayers attempted to deduct some $22k in net rental losses on their 2020 return.  But they were too rich!  That exception closes when taxpayers have AGI of over $150,000.  This couple had total wage income of just over $161k.  So they were forced to try and sell Mr. Foradis as a real estate professional.  It did not go well.

Details below the fold.

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More Evidence That ‘Direct Taxes’ Include Levies On Wealth And Income

Rob Natelson (Montana; Google Scholar), More Evidence That "Direct Taxes" Include Levies on Wealth and Income:

My July 12 entry provided links to Founding-era sources showing that the Constitution's category of "direct taxes" included levies on all kinds of wealth and on business profits and income. Direct taxes were not, as often claimed, limited to capitations and real property levies. Nor were they limited to taxes on "persons and property," as stated in the Supreme Court's opinion last month in Moore v. United States.

This post supplements the entry of July 12. Below you will find (1) citations to the four ratification-era comments mentioned in the earlier entry, (2) several additional ratification-era comments, with citations, and (3) links to more pre-Founding-era and Founding-era direct tax statutes.

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Clarifying The Uncertainty Over Direct And Indirect Taxes In Moore v. United States

Rob Natelson (Montana; Google Scholar), Clarifying the Uncertainty over Direct and Indirect Taxes in Moore v. United States:

The Supreme Court's June 20 decision in Moore v. United States continues the long-standing controversy over the Constitution's distinction between "direct" and "indirect" taxes. Writing for the Court, Justice Brett Kavanagh stated that "Generally speaking, direct taxes are those taxes imposed on persons or property" while indirect levies are "imposed on activities and transactions." Apparently based on that standard, he concluded that income taxes are indirect.

In her concurring opinion, Justice Ketanji Brown Jackson wrote, "[I]t appears the category [of direct taxes] was originally intended to encompass only land and head taxes."

From an originalist standpoint, these statements are wrong. A full review of the historical record leaves little doubt that the direct/indirect distinction was both clear to the Founders and quite different from either description in Moore.

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Kysar: Moore v. United States—The Stakes Of Constitutionalizing The Tax Law

TaxProf Blog Op-Ed: Moore v. United States—The Stakes of Constitutionalizing the Tax Law, by Rebecca Kysar (Fordham; Google Scholar): 

Since the ratification of the Sixteenth Amendment in 1913, the Court has generally left Congress to its own devices when it comes to tax law. [1] Indeed, a leading federal income tax casebook has observed that, in modern times, “the Constitution seems to stop where the Internal Revenue Code begins.” The Moore v. United States majority followed this general pattern of exercising restraint in the tax sphere by sidestepping the question presented—whether a gain must be realized to constitute income under the Sixteenth Amendment. Instead, the majority decided the case on a narrow rationale advocated by certain amici curiae (of which I am among) that the income targeted by the MRT was indeed realized at the entity level and that Congress could tax shareholders on their portion of that income.

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Lesson From The Tax Court: Finding Safe Harbors From The §72(t) Early Distribution Penalty

Congress wants taxpayers to save for retirement.  To encourage such savings, Congress authorizes a smorgasbord of tax-advantaged retirement plans that taxpayers can use.  Authority for such plans are scattered in different statutes, such as §401, §403, and §408.  Again, the purpose of these provisions is to allow taxpayers to save for retirement.  Congress give other ways for taxpayers to defer taxation on savings for other purposes, such as post-secondary education.  See e.g. §529.

To reinforce the focus on using these accounts for retirement and not for other purposes, Congress imposes a 10% penalty—er—I mean “addition to tax” when taxpayers take distributions from qualified retirement plans too soon before retirement.  §72(t).  Yeah, §72(t) is titled “10-percent additional tax on early distributions from qualified retirement plans.”  But as I explain in the Coda at end of this post, its operative language is indistinguishable from §72(q) which is titled as a “10-percent penalty....”  So let’s just call it what it is:  a penalty for early distributions.

How soon is too soon?  Age 59½.  §72(t)(2)(A).  Any distribution made before age 59½ is deemed to be an early distribution and subject to the 10% penalty.  I have no idea who came up with 59½ as the magic line.  I welcome comments from knowledgeable readers on whether it had anything to do with budget scoring.  I think of this as the general rule, applicable to all types of retirement accounts: early distributions pay the penalty.

Over the years Congress has created rules allowing early distributions to be made without penalty, but only if they are taken for certain purposes.  I think of these rules as exceptions—safe harbors—to the general rule of 59½.

These safe harbors can be complex and we learn today that you need to be very careful when trying to navigate into one of them.  In Edward George Shilkas v. Commissioner, T.C. Summ. Op. 2024-10 (June 20, 2024) (Judge Panuthos), the taxpayer took an early distribution that may have escaped penalty if taken from the right type of account.  But the taxpayer took it from the wrong type of account.  In Caren Kohl v. Commissioner, T.C. Summ. Op. 2024-4 (Apr. 25, 2024) (Judge Siegel), the taxpayer took a distribution that may have escaped penalty if taken in the right year.  She took it in 2018 for a purpose that Congress later decided should not be subject to the 10% penalty, but the later-created safe harbor was not available in 2018. 

Details below the fold. 

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Zhang: Moore And The Judicial Role In Tax Law

TaxProf Blog Op-Ed:  Moore, and the Judicial Role in Tax Law, by Alex Zhang (Emory; Google Scholar):

Most tax scholars breathed a sigh of relief last Thursday.  The Supreme Court, in a 5-2-2 split, upheld the mandatory repatriation tax on narrow grounds.  Others have commented on the doctrinal implications of the case.  I will focus here on what Moore tells us about the judicial role in tax law.

When the Court granted certiorari in Moore last June, many voiced their fear of a bombshell decision that could upend key aspects of the income tax and progressive aspirations for a tax on wealth or unrealized gains.  Indeed, past judicial interventions in tax law have not been perceived as a success.  Long gone were the days when Stanley Surrey could count tax as the largest subject matter on the Supreme Court’s docket.  Two key cases in the Moore litigation itself—Pollock v. Farmers’ Loan and Trust Co. and Eisner v. Macomber—generated sharp criticism during their times.  The majority in Moore said that much as to Pollock, and acknowledged the “significant confusion and controversy” it sparked.  Justice Jackson, citing the Court’s own words, noted that Macomber invited no warmer reception.  (I continue to think that Eisner v. Macomber turns on the absence of economic income, not realization, and allows Congress to tax objects or transactions constitutive of an actual accretion to wealth.  I am happy to see both the majority and Justice Jackson give credence to this possible reading.)

History thus did not inspire confidence in Moore’s outcome.  A memorable quip by Michael Graetz summed up the mood before oral argument:

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Graetz: Moore v. United States—Winning The Battle But The War Goes On

TaxProf Blog Op-Ed:  Moore v. United States—Winning the Battle but the War Goes On, by Michael Graetz (Columbia) (Author, The Power to Destroy: How The Antitax Movement Hijacked America (2024)):

The lawsuit by the Moores over $14,729 of tax was never about the tax (labelled the mandatory repatriation tax or MRT) enacted in 2017 to help fund the transition from a worldwide system that deferred taxes on unrepatriated income of USMNC’s CFCs to an exemption system for their foreign earnings, coupled with a minimum tax (the GILTI provision.) It was a vehicle for antitax forces to create a constitutional barriers to income taxes on unrealized appreciation of large holdings of securities or other assets by multimillionaires and billionaires and the even more remote prospects of an annual wealth tax on the extraordinarily rich, like those advocated by Elizabeth Warren and Bernie Sanders.

It was a case the Supreme Court should never have taken, but the Court was convinced to grant certiorari because of the unnecessary insistence by the panel of the Ninth Circuit that realization of income is not a constitutional requirement and the urging of numerous antitax organizations to grant certiorari. The Competitive Enterprise Institute, on whose board Moore’s father had been a member, was the principal mover in this case, a libertarian organization devoted as they say to “free enterprise, capitalism, and deregulation,” a common phrase used among antitax organizations. Importantly, the taxpayer’s cert petition was supported by many other libertarian and antitax organizations including the CATO institute, the Manhattan institute, the Liberty Justice Center, the Pacific Research Institute, the Landmark Legal Foundation, Saving America’s Family Enterprises, the Atlantic Legal Foundation, and last but not least, Grover Norquist’s Americans for Tax Reform. The Chamber of Commerce, a particularly important player in the Supreme Court, also urged the Court to take the case.

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More Moore Commentary

• Reuven Avi-Yonah (Michigan), Limiting The Blast Radius: Can Congress Save The Code From Realization?
• Josh Blackman (South Texas), Thoughts on Moore v. United States
• Moore Money, More Problems
• NFIB PTSD
• The Sixteenth Amendment did not "Overrule" Pollock
• Bloomberg, Democrats’ Wealth Tax Dreams Look Dim After Supreme Court Ruling
• Bloomberg, Foreign Tax Ruling Takes Pains to Limit Scope to Pass-Throughs
• Bloomberg, High Court Would Be Skeptical of Wealth Tax, Moore Attorney Says
• Bloomberg, Proposed Wealth Taxation Threatens Jobs, Savings, and Privacy
• Bloomberg, Supreme Court Ruling Leaves Door Cracked for Future Wealth Tax
• Steven Calabresi (Northwestern),  Moore v. United States: Joe Biden Thinks He Can Tax Gains in the Value of Your House When You Have Not Yet Sold It
• Stephen Carter (Yale), Is a Wealth Tax an Income Tax? Here's Why That Matters.
• Erik Jensen (Case Western), Moore’s Unrealized Potential
• Law360, Supreme Court Leaves Lifeline For Billionaire Income Tax
• Mother Jones, Will Congress’ Power Over Tax Policy Survive This Supreme Court?
• Steven Rosenthal (Tax Policy Center, Congress Wins A Battle For Its Taxing Authority, But More Challenges Are On The Horizon
• Vox, The Supreme Court’s New Tax Decision Is Great News for Billionaires
• Wall Street Journal Editorial, A Supreme Court Mistake on Wealth Taxes

TaxProf Blog Op-Eds on Moore v. United States, No. 22–800 (June 20, 2024):

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Grewal: Moore Decides Less

TaxProf Blog Op-Ed:  Moore Decides Less, by Andy Grewal (Iowa; Google Scholar):

When the Supreme Court granted certiorari in Moore v. United States, 602 U.S. ___ (2024), it agreed to decide whether the Sixteenth Amendment allows Congress to tax unrealized sums. Alas, the Moore opinion directly resolved only relatively dull and straightforward questions. In doing so, however, the Court touched on some major issues that may affect Congress’s taxation authority in the future.

Moore involved a claim that Section 965(a) violated the Sixteenth Amendment. Section 965(a), dubbed the Mandatory Repatriation Tax or MRT, requires only a simplified explanation here. Basically, the MRT says that shareholders in foreign corporations must include those corporations’ accumulated earnings in their own incomes. The Moores argued that the MRT, by taxing them on income they never touched, violated realization principles. They further argued that the Sixteenth Amendment’s reference to “taxes on incomes” incorporated a realization requirement. So, the Moores argued, the MRT violated the Constitution.

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FedSoc Debate: Is A Wealth Tax Constitutional?

• Akhil Reed Amar (Yale)
• David Schizer (Columbia)
• Moderator: Corinne Snow (Vinson & Elkins, Washington, D.C.)

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Galle: What's Next For Wealth And Mark-To-Market Taxes After Moore?

TaxProf Blog Op-Ed:  What's Next For Wealth And Mark-To-Market Taxes After Moore?, by Brian D. Galle (Georgetown; Google Scholar):

The Moore case was always about wealth taxes. Now that the Supreme Court has handed down its decision, and seems to have studiously avoided making any (technically) definitive statements about whether wealth taxes fit into the constitutional scheme, what’s next for proponents of wealth and mark-to-market taxes?

First, let’s review. Moore holds that the government can define an individual’s income to include the untaxed profits of a business entity in which the individual holds an equity stake. Thus, whether or not the Constitution in effect demands realization, taxing the equity owner would meet that demand, assuming the business entity itself has realized income. That holding allowed the Court to take a pass on determining whether there is any constitutional realization requirement. And the Court repeated several times, in several different ways, that a realization requirement could be a constitutional obstacle to wealth or mark-to-market taxes, and it was not deciding those questions.

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Brooks & Gamage: Moore v. United States—Initial Reactions

TaxProf Blog Op-Ed:  Moore v. United States—Initial Reactions, by  John R. Brooks (Fordham; Google Scholar) & David Gamage (Missouri-Columbia; Google Scholar):

In its decision in Moore v. United States on June 20, the Supreme Court upheld a broad government power to tax business entities, including corporations, on a pass-through basis. The taxpayers in Moore had challenged as unconstitutional the I.R.C. § 965 “mandatory repatriation tax,” a one-time shareholder-level tax on the accumulated, but undistributed, earnings of controlled foreign corporations. The taxpayers’ argument was that retained earnings of a corporation could not be considered the “income” of a corporation’s shareholders under the Sixteenth Amendment until that income was “realized” by the shareholders through a distribution to them. The Supreme Court originally granted certiorari on this question: whether “unrealized sums” could be income covered by the Sixteenth Amendment.

In its opinion, the Court declined to answer that question, however, because, the Court held, the income in question here was in fact realized—by the corporation. The real question therefore was whether that corporation’s income could be attributed to its shareholders. The Court held that it could be, saying essentially that there is no real constitutional distinction between partnerships and corporations on this issue—the income of any business entity can be attributed to its owners, without limitation. (The majority left some wiggle room on the question of whether an item of undistributed corporate income could be taxed both at the entity level and the owner level, though it was unclear whether that might be a Sixteenth Amendment issue or a Due Process issue.) Something like this result—a focus on attribution rather than realization—was widely predicted after oral argument, but we are somewhat surprised that the majority opinion didn’t take up the issue of realization at all.

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Avi-Yonah: Is A Mark To Market Tax Constitutional After Moore?

TaxProf Blog Op-Ed:  Is a Mark to Market Tax Constitutional After Moore?, by Reuven S. Avi-Yonah (Michigan; Google Scholar):

The main reason the Supreme Court granted certiorari in Moore was not to debate the constitutionality of the Mandatory Repatriation Tax (MRT). If that were all, there would be no need for any of the Justices to address whether taxation without realization is constitutional, because the MRT clearly involves income that was realized. As Justice Kavanaugh wrote for the majority,

Our analysis today does not address the distinct issues that would be raised by (i) an attempt by Congress to tax both the entity and the shareholders or partners on the entity’s undistributed income; (ii) taxes on holdings, wealth, or net worth; or (iii) taxes on appreciation...Those are potential issues for another day, and we do not address or resolve any of those issues here. Moore, at 8 fn. 2, 22.

This outcome was not satisfactory for either the concurrence or the dissent, who were eager to address precisely the question that the Court leaves unaddressed. In concurrence, Justices Barrett and Alito state that,

The question on which we granted review is “[w]hether the Sixteenth Amendment authorizes Congress to tax unrealized sums without apportionment among the states... The answer is straightforward: No.” Moore, concurrence at 2.

And in their dissent, Justices Thomas and Gorsuch state that,

Sixteenth Amendment “incomes” include only income realized by the taxpayer. The text and history of the Amendment make clear that it requires a distinction between “income” and the “source” from which that income is “derived.” And, the only way to draw such a distinction is with a realization requirement. Moore, dissent at 1.

The reason the concurrence and dissent address the constitutionality of realization is that this was why they granted certiorari. The main target of Moore was not the MRT, but the billionaire mark to market tax proposed by Senator Wyden and by President Biden.

Therefore, the most interesting question after Moore is whether such a tax remains viable.

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Clarke: Four More Takeaways From Moore

TaxProf Blog Op-Ed:  Four More Takeaways From Moore, by Conor Clarke (Washington University; Google Scholar):

Like everyone in the tax world, I read Thursday’s Moore opinion with great interest.  The result was both predictable and startling:  The government won on a narrow theory that many saw coming—but that win may be dulled by some mildly Pyrrhic elements that hint at unresolved conflicts to come.  More will certainly follow Moore.  Here are four quick reactions.

Kavanaugh’s dependability.  The central and narrow holding of Moore—that the 2017 tax at issue was a tax on realized income that did not need to be apportioned—was no surprise.  Here is what Kavanaugh (widely regarded as the likely swing justice in the case) said at the December oral argument: “[W]e have realization in this case. The entity realized income. The question then is attribution, and we’ve long held that Congress may attribute the income of the company to the shareholders or the partnership to the partners.”  And here is what Kavanaugh just wrote for the Court: “[T]he precise and narrow question that the Court addresses today is whether Congress may attribute an entity’s realized and undistributed income to the entity’s shareholders or partners, and then tax the shareholders or partners on their portions of that income. This Court’s longstanding precedents, reflected in and reinforced by Congress’s longstanding practice, establish that the answer is yes.”  There was truth in advertising.  Kavanaugh plainly stated a view at argument, and then converted that view into a holding.  As Daniel Hemel and others noted after the argument, that view seemed likely to win the day.  It did.

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Zelenak: Moore Thoughts

TaxProf Blog Op-Ed:  Moore Thoughts, by Lawrence Zelenak (Duke; Google Scholar):

In terms of its bottom line, the Supreme Court's Moore decision is no surprise to anyone who listened to (or read the transcript of) the oral argument last December. It seemed then nearly certain that the Court would uphold the mandatory repatriation tax (MRT) as a constitutionally permissible attribution to the Moores of income indisputably realized by their controlled foreign corporation, and the Court's opinion does exactly that.

There are, nevertheless, a couple of interesting surprises—at least to me—lurking in Justice Kavanaugh's majority opinion.

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7-2 Supreme Court Upholds Mandatory Repatriation Tax In Moore

Moore v. United States, No. 22–800 (June 20, 2024):

The [Mandatory Repatriation Tax] —which attributes the realized and undistributed income of an American-controlled foreign corporation to the entity’s American shareholders, and then taxes the American shareholders on their portions of that income—does not exceed Congress’s constitutional authority. ...

KAVANAUGH, J., delivered the opinion of the Court, in which ROBERTS, C. J., and SOTOMAYOR, KAGAN, and JACKSON, JJ., joined. JACKSON, J., filed a concurring opinion. BARRETT, J., filed an opinion concurring in the judgment, in which ALITO, J., joined. THOMAS, J., filed a dissenting opinion, in which GORSUCH, J., joined.

• Balls and Strikes
• Bloomberg
• Cato Institute
• Forbes
• Institute on Taxation and Economic Policy
• Law360
• Los Angeles Times
• National Review
• New York Times
• NYU Tax Law Center

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Todd: While Tax World Waits For Moore, Supreme Court Decides Important Connelly Estate Tax Case

TaxProf Blog op-ed:  While Tax World Waits For Moore, Supreme Court Decides Important Connelly Estate Tax Case, by Timothy M. Todd (Interim Dean, Liberty; Google Scholar):

Although the eyes of the tax world have been focused on the pending decision in Moore v. United States—a case that challenges the one-time “mandatory repatriation tax,” and depending on the contours of the decision could upend (or cement, depending on whom you ask) critical tax norms—the Supreme Court issued another tax decision this term that has important and weighty practical implications for countless closely held businesses and those who advise them.

In Connelly v. United States, the Supreme Court was called upon to resolve a circuit split that had arisen concerning the estate tax valuation of a closely held business that used an extremely common planning structure: the use of life-insurance proceeds to redeem the shares of a shareholder upon his or her death. Tax and business lawyers undoubtedly agree with Benjamin Franklin’s sentiment that “in this world, nothing is certain except death and taxes,” and prudent lawyers plan for both these certainties.

The circuit split concerned the interaction between the receipt of the life-insurance proceeds, which increases the value of the business, and the redemption obligation, which some have argued reduces the value of the business.

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Unanimous Supreme Court Affirms IRS's Position On Life Insurance Proceeds Used To Fund A Stock Redemption

Connelly v. United States, No. 23–146 (June 6, 2024):

Syllabus
Michael and Thomas Connelly were the sole shareholders in Crown C Supply, a small building supply corporation. The brothers entered into an agreement to ensure that Crown would stay in the family if either brother died. Under that agreement, the surviving brother would have the option to purchase the deceased brother’s shares. If he declined, Crown itself would be required to redeem (i.e., purchase) the shares. To ensure that Crown would have enough money to redeem the shares if required, it obtained $3.5 million in life insurance on each brother. After Michael died, Thomas elected not to purchase Michael’s shares,thus triggering Crown’s obligation to do so. Michael’s son and Thomas agreed that the value of Michael’s shares was $3 million, and Crown paid the same amount to Michael’s estate. As the executor of Michael’s estate, Thomas then filed a federal tax return for the estate, which reported the value of Michael’s shares as $3 million. The Internal Revenue Service (IRS) audited the return. During the audit, Thomas obtained a valuation from an outside accounting firm. That firm determined that Crown’s fair market value at Michael’s death was $3.86 million, an amount that excluded the $3 million in insurance proceeds used to redeem Michael’s shares on the theory that their value was offset by the redemption obligation. Because Michael had held a 77.18% ownership interest in Crown, the analyst calculated the value of Michael’s shares as approximately $3 million ($3.86 million x 0.7718). The IRS disagreed. It insisted that Crown’s redemption obligation did not offset the life-insurance proceeds, and accordingly, assessed Crown’s total value as $6.86 million ($3.86 million + $3 million).The IRS then calculated the value of Michael’s shares as $5.3 million ($6.86 million x 0.7718). Based on this higher valuation, the IRS determined that the estate owed an additional $889,914 in taxes. The estate paid the deficiency and Thomas, acting as executor, sued the United States for a refund. The District Court granted summary judgment to the Government. The court held that, to accurately value Michael’s shares, the $3 million in life-insurance proceeds must be counted in Crown’s valuation. The Eighth Circuit affirmed.

Held: A corporation’s contractual obligation to redeem shares is not necessarily a liability that reduces a corporation’s value for purposes of the federal estate tax.

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Lesson From The Tax Court: Proving Last Known Address

Many statutes require the IRS to send taxpayers notices.  What confuses my students (and many taxpayers) is that the statutes rarely require that the taxpayer actually receive a particular notice; they just require the IRS to properly send the notice.  And the IRS will always meet the statutory requirement if the IRS sends the notice in question to the taxpayer’s “last known address.”  As you can guess from the scare quotes, that phrase is a term of art.

Today we learn a lesson about that term of art.  It’s a lesson that has a wide application because the IRS sends out lots of notices and people move all the time.  Where they lived last year is not always where they live this year.  If they have multiple addresses, it may not be clear which one counts as their “last known address.”  If the IRS goofs up sending a notice, that generally means the notice is invalid ... if the Court is convinced about the goof.

Normally, it’s up to the taxpayer to persuade a court that the IRS goofed up.  The law presumes that the IRS does not goof up.  That presumption means the courts will find a notice was properly sent unless the taxpayer convinces the court otherwise.  That means even if the court has doubts about what was the proper last known address, the IRS still wins if the taxpayer cannot meet their burden of persuasion.

Sometimes, however, the burden shifts to the IRS.  That is the lesson we learn in Keith M. Philips v. Commissioner, T.C. Memo. 2024-44 (Apr. 16, 2024) (Judge Greaves).  There the IRS sent Mr. Phillips an Notice of Deficiency (NOD) but Mr. Phillips was able to shift the burden of persuasion so that doubts about whether the IRS properly sent the NOD to his last known address were resolved in his favor, not the IRS’s.  Thus, the NOD was invalid because the IRS could not convince the Judge Greaves that it sent the NOD to his last known address.  This well written opinion was a pleasure to read.  We can learn a good lesson here.

Details below the fold.

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Lesson From The Tax Court: When Is An Excise Tax Really A Penalty?

“The power to tax involves the power to destroy.” Justice John Marshall in McCulloch v. Maryland, 17 U.S. 316, 431 (1819).

“Sometimes a tax is...just a tax.” — Sigmund Freud’s Tax Advisor.

Today’s lesson is about how to tell when an excise tax is really a penalty.  The answer I learn is: “why do you want to know?”  I hope to explain why that answer makes the most sense.

In Clair R. Couturier Jr. v. Commissioner, T.C. Memo. 2024-6 (Jan. 17, 2024) (Judge Lauber), the IRS sent the taxpayer a Notice of Deficiency for over $8 million.  The basis for the proposed deficiency was that Mr. Couturier had made an excess contribution of over $25 million to his IRA, thus triggering the excise tax imposed by §4973 on excess IRA contributions.

In Tax Court, Mr. Courturier—well represented by Taylor, Nelson and Amitrano—argued that the §4973 “tax” was really a “penalty.”  If true, that meant that the IRS needed to have followed the supervisory approval procedures for penalties in §6751(b), which it had not.  The IRS argued that it did not have to follow the §6751(b) supervisory approval procedures before sending out the NOD because the tax was ... just a tax!

Judge Lauber’s opinion explains why the §4973 excise tax was not a penalty for purposes of the §6751(b) supervisory approval requirements.  Keith Fogg has a really good post on this issue here, where he suggests a potential tension between what he describes as the Tax Court’s textual analysis (focusing on the labels) and what he describes as the Supreme Court’s functional analysis about a similar excise tax in U.S. v. Reorganized CF & I Fabricators of Utah, Inc., 518 U.S. 213 (1996), a bankruptcy case.

I see the matter a bit differently than Keith.  Different statutes (e.g., bankruptcy statutes, statutes imposing interest) treat penalties differently than they treat taxes.  The lesson I learn is that looking to see whether an excise tax operates in some abstract sense as a penalty is not the strongest analysis.  Instead, the better analysis is to see whether treating it as a penalty is more appropriate under the relevant statutory scheme than treating it as a tax.  In other words, why do you want to know?

Details, and a fuller explanation, await those intrepid readers who continue below the fold.

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Lesson From The Tax Court: The Interplay Of SSDI Benefits And The §104(a)(1) Exclusion

When Congress giveth a tax benefit with one hand, it sometimes taketh the other hand and slaps the taxpayer silly, eliminating the benefit the taxpayer thought they had.  Today's lesson is an example of that phenomenon.  It’s kind of like a bad joke, an appropriate lesson for April 1st.

Specifically, the one hand is found in §104(a)(1).  It promises taxpayers they can exclude from gross income those “amounts received under workmen’s compensation acts as compensation for personal injuries or sickness.”

The other hand comes in §86(d).  In Donald Ecret and Kristen Ecret v. Commissioner, T.C. Memo. 2024-23 (Feb. 14) (Judge Lauber), the taxpayers got slapped by that statute with the result that most or all of otherwise excludable workers compensation payments became taxable income.  In today's case Ms. Ecret received workers compensation from the state of New York after becoming medically disabled.  When she became entitled to Social Security Disability payments, she actually received only a fraction of the benefits she was entitled to receive because of a federal statute that requires the Social Security Administration (SSA) to offset the entitlements by sate workers compensation received.  Judge Lauber give a very well-written lesson on why the taxpayer must report even the unpaid federal benefits as gross income: it’s because of §86(d).  So, yes, technically the state benefits were still excluded under §104(a)(1).  But the practical effect of the SSA offset was to reduce the exclusion by forcing the taxpayer to include in income those unpaid SSDI benefits, withheld from the taxpayer because of the offset.  In effect, §86(d) transmogrifies the excludable state benefits into taxable Social Security benefits. Thanks Congress!

Details below the fold.

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Lesson From The Tax Court: Choose Your Return Preparer Carefully

In Stephanie Murrin v. Commissioner, T.C. Memo. 2024-10 (Jan. 26, 2024), Judge Urda decided that the fraudulent acts of a return preparer starting in 1993, made an honest taxpayer liable for some $65,000 in deficiencies resulting from the 30-year old fraud of someone else, plus some $15k in §6662 penalties.  That is, the return preparer’s fraud opened up the unlimited period in §6501(c)(1) for the IRS to assess the deficiency against the taxpayer.  In doing so Judge Urda adhered to the Tax Court’s precedential opinion of Allen v. Commissioner, 128 T.C. 37 (2007).  It is no small irony to me that Allen was written by Judge Kroupa, who was later convicted of tax evasion.

Let me emphasize that there was no hint in the facts of today's case that the taxpayer knew or should have known of the return preparer’s fraud.  That is, the government made no attempt to impute the return preparer’s fraud to the taxpayer.  The government made no attempt to prove the taxpayer had any fraudulent intent to evade her tax obligations.  Yet here we are, over 30 years later with the government seeking to collect tax and penalties when the normal statute of limitations is three years.

Pull up your jaw.  Unless and until the Tax Court’s recent re-interpretation of the §6501(c) fraud exception to the general three year SOL for assessment gets changed, taxpayers and their representatives must deal with the results.

Sad details below the fold.

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Lesson From The Tax Court: For Whom The SOL Tolls

A recent Tax Court precedential decision raises a really interesting question about the application of §7451’s tolling provision to seemingly late-filed Tax Court Petitions.  In Madiodio Sall v. Commissioner, 161 T.C. 13 (Nov. 30, 2023) (Judge Buch), the deadline for the taxpayer to file his Petition fell on Thanksgiving Day.  We all know that means that the deadline got kicked to the next day, Friday.  Thanks §7503!  But the taxpayer did not file on Friday.  Nope.  The taxpayer did not even put his Petition in the mail until the following Monday.  For reasons I’ll get into below, Judge Buch ruled that §7451’s tolling provision applied to extend the filing deadline for two weeks after Friday. 

So for this taxpayer, the Statute of Limitations (SOL) for filing a timely Tax Court Petition was tolled.  But this taxpayer was attempting to file by hard-copy.  Another recent Tax Court precedential  opinion—also by Judge Buch—suggests that the question of for whom the SOL tolls may have a different answer if the taxpayer attempts to file electronically, as all taxpayers may choose to do so, and as many are required now to do.

Details below the fold.

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Moore v. United States: Avoiding A Damaging Limiting Principle In The 16th Amendment

Ari Glogower (Northwestern; Google Scholar), David Kamin (NYU), Rebecca Kysar (Fordham; Google Scholar), Darien Shanske (UC-Davis; Google Scholar), & Thalia T. Spinrad (NYU), Moore v. United States: Avoiding a Damaging Limiting Principle in the Sixteenth Amendment, 41 Yale J. on Reg.: Notice & Comment (Jan. 12, 2024):

The Supreme Court heard argument last month in Moore v. United States, a case with potentially broad implications for the income tax system. The case involves a challenge by the Moores, two individual taxpayers, to 26 U.S.C. 965, known as the Mandatory Repatriation Tax (“MRT”), which is a provision of the 2017 tax reform legislation. As the justices seemed to appreciate in the oral argument, however, a decision in the case could have effects far beyond that provision — and has the potential to undermine large swaths of the existing tax code enacted on a bipartisan basis over decades.

At oral argument, justices from across the ideological spectrum seemed focused on avoiding that outcome. However, even as the justices for the most part approached the petitioners’ claim skeptically, they raised questions for both sides in the case as to the appropriate limiting principle for determining what Congress can tax as income under the 16th Amendment.

In our amicus brief submitted to the Court, we explained why the Court does not have to define a limiting principle for the income tax in order to resolve this case.

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Cardozo Tax Prof Appeals Decision Subjecting Him To New York Teleworker Tax On Days He Works From His Connecticut Home

Following up on my previous post, Tax Prof Must Pay New York Non-Resident Income Tax On Days He Taught Law Students On Zoom From His Connecticut Home When Cardozo Was Closed During Covid:  Law360, Professor In Connecticut Asks NY Tribunal To Nix Teleworker Tax:

An administrative law judge created two undefined legal tests regarding virtual presence and temporary displacement from an office in upholding New York's tax on days a professor worked from home in Connecticut, he argued to the New York Tax Appeals Tribunal.

Edward Zelinsky, a professor at Yeshiva University's Benjamin N. Cardozo School of Law in Manhattan, argued in a brief filed Saturday that Administrative Law Judge Jessica DiFiore made a series of errors in her November determination saying he owed New York income tax on days worked remotely in 2019 and 2020.

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Harvard Law Review: '[This] Is A Tax Case. Fear Not. Keep Reading.'

Legal Case, Polselli v. IRS, 137 Harv. L. Rev. 430 (2023):

Internal Revenue Code § 7609 — Unnoticed Summons — Tax Exceptionalism — Surplusage Canon — Polselli v. IRS:

Polselli v. IRS¹ is a tax case.² Fear not, keep reading.³ 

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Colinvaux Files Amicus Brief On The Use Of Race In Awarding Charitable Grants

Brief of Professor Roger Colinvaux as Amicus Curiae in Support of Defendants-Appellees and Affirmance (American Alliance for Equal Rights v. Fearless Fund Management (11th Cir. No. 23-13138): 

Abstract
The Brief relates to a lawsuit alleging that a charity's use of race to award charitable aid violates section 1 of the Civil Rights Act of 1866. The Brief argues that the case is not just about the right-to-contract provisions of the Civil Rights Act but has much wider implications. At stake is potentially significant harm to charitable organizations and their freedom to fulfill their missions to further societal good under the broader law of charity. A ruling that implicates a charity’s right to exercise its well-rooted freedoms to determine its mission or advance social welfare by eliminating the effects of racial discrimination could have chilling effects on the more than 1.3 million charities registered in the United States and the many more millions of people they serve. The Brief encourages the Court to be mindful in any ruling of the role of charitable organizations in American society, the regulatory environment under which charities operate, the vast potential for uncertainty relating to providing charitable assistance to promote social welfare without risk of prosecution, and the chilling of lawful charitable speech to the detriment of civil society.

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Tax Prof Must Pay New York Non-Resident Income Tax On Days He Taught Law Students On Zoom From His Connecticut Home When Cardozo Was Closed During Covid

Law360, NY Telework Tax Applies To Conn. Tax Professor, ALJ Rules:

A tax professor who lives in Connecticut but teaches in New York falls under the jurisdiction of New York's policy of taxing nonresidents and is not entitled to a refund for days worked at home, including during the COVID-19 pandemic, according to a determination obtained Tuesday by Law360.

Administrative Law Judge Jessica DiFiore noted in her determination that professor Edward A. Zelinsky challenged the policy, known as the convenience of the employer rule, two decades ago. At that time, New York's highest court ruled against him in Zelinsky v. Tax Appeals Tribunal. This time, Zelinsky is seeking refunds for days worked in Connecticut in 2019 and in 2020, including days where his Manhattan law school, Yeshiva University's Benjamin N. Cardozo School of Law, was closed due to COVID.

Judge DiFiore said in the determination ... that for 2019, the facts in Zelinsky's current suit make the outcome controlled by the result of the previous case.

For the tax year 2020, in which Zelinsky had neither a classroom nor an office to go to in Manhattan amid the spread of COVID and related closures, the issue is one of first impression, Judge DiFiore wrote. However, she wrote, the outcome would be the same: The convenience of the employer rule applied. The judge wrote that Zelinsky was not required by Cardozo to work at home. ...

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Lesson From The Tax Court: Taxpayers Behaving Badly 2023

[Author's note: This will be my last new post until January. Next Monday, December 18, my annual Year Of Lessons From The Tax Court will appear in this space. It is a chronological listing of all the Lessons I posted in 2023, with links to each Lesson, the primary case discussed, and the judge who wrote the opinion. You can find last year's edition here.

I will be spending my days (except for Christmas Day) grading exams.  Grades are due Monday, January 2nd and then I resume teaching on January 8th, so you will see my next post on Monday January 22nd, when I will have some news to share.] 

Once again my last new post of the year presents cases where something in the facts made me just shake my head (SMH in texting parlance).  You can find the previous lists here (for 2018), here (for 2019), here (for 2020), here (for 2021) and here (for 2022).

This year I have six to share with you.  I present them in chronological order.  I invite you to consider which of theme may be examples of just an empty head and which are examples of something worse.  In addition, I once again have found a worthy recipient for the Norm Peterson award. 

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