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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More Reaction To The Supreme Court Oral Argument In Moore v. United States

Following up on yesterday's post, Hot Takes On Yesterday's Moore v. United States Supreme Court Oral Argument:  

David Schizer (Columbia), Moore v. United States — Post-Argument SCOTUScast

Wall Street Journal Editorial, The Supreme Court and a Wealth Tax:

During oral arguments, the Solicitor General claimed the MRT is no different than some other income taxes that Congress imposes, such as on undistributed earnings of partnerships and S-Corps. Invalidating the MRT, she warned, would “cause a sea change in the operation of the tax code and cost several trillion dollars in lost tax revenue.”

But this need not be so. Under the High Court’s doctrine of constructive realization, Congress can tax income that hasn’t been physically received but which a taxpayer can still control or utilize. This is how Congress justified taxing income earned by “controlled foreign corporations” as the income of their controlling U.S. shareholders.

But the Moores couldn’t control or demand payment of the reinvested earnings on which they were taxed. This distinguishes the MRT from the other taxes the SG cites. The Court could rule in the Moores’ favor and overturn the Ninth Circuit without upending the tax code.

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Hot Takes On Yesterday's Moore v. United States Supreme Court Oral Argument

Following up on yesterday's post, More on Moore:

• Associated Press, Supreme Court Signals It Will Uphold a Tax on Foreign Income and Leave a Wealth Tax for Another Day
• Bloomberg, Court Arguments in Moore Case Ease Concerns Over Ripple Effects
• Bloomberg, Supreme Court Suggests Support for 2017 Tax on Foreign Earnings
• Courthouse News Service, Supreme Court Sees Path to Uphold Trump Tax Law Without Commenting on Wealth Tax
• Financial Times, U.S. Supreme Court Appears Wary of Upending Tax Law in Closely Watched Case
• The Hill, ‘Quadrillion-Dollar’ Tax Case Leaves Supreme Court Justices Exploring Narrow Resolution 
• Huffington Post, Supreme Court Unlikely To Shield Corporations And Billionaires From Trillions In Tax Payments
• Law Dork, The Moores' Big Tax Case Quickly Deflated Once the Supreme Court Heard It
• Law360, Justices Wary Of Repatriation Tax Review Consequences
• MarketWatch, Supreme Court Weighs How Far to Go in ‘Super Bowl’ Tax Case That Could Nix Wealth Tax
• The New Republic, The Supreme Court Might Actually Pass on a Chance to Protect the Rich
• New York Sun, Justices Probe for Narrow Resolution to Case That Has Potential To Upend Tax Code
• New York Times, Justices Seem Skeptical of Challenge to Trump-Era Tax Provision
• Roll Call, Supreme Court Airs Caution on Limiting Congressional Tax Power
• SCOTUSblog, Oral Argument Suggests Narrow Ruling to Uphold Disputed Tax

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Listen To Moore v. United States Supreme Court Oral Argument Today At 10:00 AM ET

The oral argument in Moore v. United States is available live on C-Span today at 10:00 am ET: 

• American Spectator, The Scariest SCOTUS Case This Term: Moore v. United States
• Bloomberg, Moore Petitioners Make Strongest Case to Toss Repatriation Tax
• Bloomberg, Tax World Is Nervous as Court Arguments in Moore Case Approach
• Steven Calabresi (Northwestern), The Amar Brief in Moore Should Not Be Embraced: Part 2
• Steven Calabresi (Northwestern), Moore v. United States: Income Must Be Realized
• Steven Calabresi (Northwestern), Chief Justice Roberts' Chance to Redeem Himself!
• Steven Calabresi (Northwestern), Final Post on Moore v. United States
• Conor Clarke (Washington University), The Supreme Court Takes On Yet Another Made-Up Controversy
• Foreign Policy, This Corporate Law Case Could Accidentally Overturn U.S. Taxes
• Erik Jensen (Case Western), Supreme Court Must Go the Distance in Moore to End Tax Confusion
• Just Taxes Blog, With the Moore vs. United States Case, the Supreme Court Could Unleash Chaos on Our Tax System

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Thorndike: Moores Lean On 1916 Tax Expert To Argue No Realization Means No Income

Joseph J. Thorndike (Tax Analysts), Tax History: Moores Lean on 1916 Tax Expert to Argue No Realization Means No Income, 181 Tax Notes Fed. 1356 (Nov. 20, 2023):

Apparently, Charles G. Moore and Kathleen F. Moore are in thrall to a certain Columbia University economist from the early 20th century. Edwin R.A. Seligman is a big player in Moore v. United States, No. 22-800 — no small feat for a scholar who’s been moldering in a Brooklyn cemetery these past 84 years.

Still, Seligman’s prominence in the Moore case is worthy of note, even if Keynes would have found it predictable. The petitioners have cited Seligman repeatedly, using him to support their claim that unrealized income is not really income at all — at least not as far as the 16th Amendment is concerned.

As well they should: The Moores could hardly have asked for a better historical champion. If you’re trying to argue that the original meaning of the 16th Amendment hinges on the concept of realization, then Seligman is your man.

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Lesson From The Tax Court: Taxpayers Cannot Invoke The 'Augusta Rule' With Unplayable Lie

In the past few years there have apparently been a lot of excited Tik Tok posts about how closely held businesses can use the “Augusta Rule” to get a double tax benefit: a deduction for the business under §162 and tax free income to the business owner under §280A(g).

In Kunjlata J. Jadhav and Jalandar Y. Jadhav v. Commissioner, T.C. Memo. 2023-140 (Nov. 21, 2023) (Judge Vasquez), the taxpayers get lured by the promise of tax free income under the August Rule into making what turned out to be an unplayable lie on their tax returns.  They did not get a mulligan.  They did get penalties.  The problem was these taxpayers were unable to show that the rental payments their S Corp made to them and their sons were “ordinary and necessary” under §162.  That requirement is not usually a difficult one to meet but when you are trying to play the system, it can be tricky to get through the rough and avoid the hazards to make the hole.

Details below the fold.

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Lesson From The Tax Court: A Lesson In Pathfinding

I cannot say it enough: the IRS is not an entity.  It’s a vast organization with various offices that perform various functions.  And one key idea is that taxpayers may have multiple paths to get to a successful result.  If one office cannot help you perhaps a different one can.  At the IRS that often means if you cannot get good results in Exam or Collection you might get them in Appeals.  And sometimes you can get to Tax Court from Appeals.  But sometimes not.  It's path dependent as we learn today.

In Rita Renee Pilate v. Commissioner, T.C. Memo. 2023-136 (Nov. 9, 2023) (Judge Gustafson), the IRS was seeking to collect a tax liability.  The taxpayer was able to obtain a CDP hearing.  That path put her in front of the Office of Appeals.  She said she wanted to make an Offer In Compromise (OIC).  But she did not submit one to Appeals as part of the CDP hearing.  She did not choose that path.  After Appeals closed her CDP hearing, Ms. Pilate timely petitioned the Tax Court for review.  She also now submitted an OIC but, since her CDP case had closed, that submission put her on a different path.  The OIC was accepted but a dispute later arose on whether she complied with its terms and Appeals issued a letter defaulting her.  Since her CDP petition was still before the Tax Court, she asked the Court to review the Appeals decision to default her OIC.  The Tax Court said it could not make that review, because an OIC outside of CDP is not on the correct path for judicial review.

Details below the fold.

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Lesson From The Tax Court: Merely Winning Does Not Entitle Taxpayer To Attorneys Fees

Section 7430(a) permits a court to award “reasonable administrative costs” and “reasonable litigation costs” (the largest being attorneys fees) to a taxpayer who is a “prevailing party” in a dispute with the IRS.  I use all those scare quotes to emphasize that these are all terms of art.  And the scariest, or artiest, one is perhaps “prevailing party.”

Today’s lesson teaches us that a taxpayer is not going to be a prevailing party just because they win a remand in the Court of Appeals and then win in Tax Court on the remand.  The case is Champions Retreat Golf Founders, LLC v. Commissioner, T.C. Memo. 2023-143 (Nov. 8, 2023) (Judge Pugh).  It is the coda on the taxpayer’s 13 year slog to claim a $10.8 million charitable deduction for a conservation easement on a golf course.  The Tax Court initially found that the easement was not a qualified charitable contribution.  It got reversed by the Eleventh Circuit.

The parties then battled over the proper valuation of the donation and, again, the taxpayer won, although Judge Pugh cut down the contribution amount by about $3 million. See Lesson From The Tax Court: Fake It Till You Make It, TaxProf Blog (Oct. 24, 2022) (“The lesson is kind of like the old joke that you don’t have to outrun the bear: a taxpayer’s valuation does not have to be the best possible; it just has to be better than the IRS’ valuation.”).

Now the taxpayer is back, asking for the Court to make the government pay its litigation costs per §7430 because it claims to be a prevailing party.  Well, without the scare quotes, that may seem intuitively right.  After all, the taxpayer won in the Circuit Court and then in Tax Court on remand!

But the lesson we learn is that even a winning taxpayer is not entitled to litigation costs when the government’s losing position was “substantially justified.”  Again with the scare quotes!  That’s because, dear readers, this term is yet another term of art.  We learn today that the term is a facts and circumstances determination.  While winning is an important factor, winning isn’t everything.  Details below the fold. 

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Lesson From The Tax Court: §6662 Is Sometimes Multiple Penalties For Supervisory Approval Purposes But Sometimes Not

This week we learn a lesson about the interplay between the supervisory approval requirement in §6751(b) and the §6662 penalty regime.  While §6662(a) seems to impose a single penalty for accuracy-related error, we learn that if the IRS is either careful or lucky, it can cure one defective §6662 approval by later asserting in Tax Court a seemingly different §6662 penalty and getting the proper supervisory approval for that second bite at the penalty apple.

In Stephen R. Kelley and Isabelle Kelley v. Commissioner, T.C. Memo. 2023-126 (Oct. 23, 2023) (Judge Copeland), the NOD asserted a §6662(a) penalty for substantial understatement.  But the IRS employee had not obtained the appropriate supervisory approval before the NOD went out.  So when the case got to Tax Court, the IRS conceded the substantial understatement penalty and the IRS Chief Counsel attorney asserted a §6662(a) penalty for negligence or disregard of rules or regulations.  The taxpayers argued that the penalty imposed by §6662(a) is singular and so the failure to obtain supervisory approval for the NOD precluded any later assertion of penalties under §6662(a).

The Tax Court rejected the taxpayer’s argument and held that the §6662(a) penalty for substantial understatement was different than the §6662(a) penalty for negligence or disregard.

This decision seems in tension with a prior precedential Tax Court opinion, Jesus R. Oropeza v. Commissioner, 155 T.C. 132 (2020), where the Tax Court seemingly held that it would treat §6662 as imposing a single penalty for §6751(b) purposes.  I blogged that in Lesson From The Tax Court: §6662 Penalties Treated As One For Supervisory Approval Requirement, TaxProf Blog (Oct. 19, 2020).

Judge Copeland does not mention Oropeza in her otherwise very comprehensive 19 page opinion, much less seek to distinguish it.  I think the cases are reconcilable but it makes for an awkward lesson: sometimes §6662 imposes a singular penalty and sometimes it imposes multiple penalties for supervisory approval purposes.  This awkwardness seems unavoidable under any interpretation of §6751(b).  It comes from the ambiguity of §6662 and not the nonsensical text of §6751(b).

Details, as always, below the fold.

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Lesson From The Tax Court: The Rules For Penalty Approval Depend On Geography

Tax law is supposed to be uniform.  The thousands of pages of statutes and regulations are supposed to be applied to taxpayers living in Texas in the same way as taxpayers living in California.  The IRS is a single federal agency charged with applying the law uniformly.  And the Tax Court is a single national trial court that can and does travel to every corner of the United States to resolve most disputes that arise between taxpayers and the IRS.

But tax law is not uniform.  One reason is because there are 11 geographic Circuit Courts of Appeals (Circuits 1-11 plus the D.C. Circuit) in the federal system.  Their decisions are binding within the geographic boundaries of the Circuit, but are not binding on the other Circuits.  So when one Circuit Court of Appeals disagrees with another on how to interpret a tax statute, the law is not uniform.  Under what is known as the “Golsen rule” the Tax Court will generally follow the law of the Circuit to which a taxpayer would take an appeal.

Today we learn another reason tax law is not uniform: the Tax Court itself.  In Wolfgang Frederick Kraske v. Commissioner, 161 T.C. No. 7 (Oct. 26, 2023) (Judge Gale), the taxpayer was arguing that the IRS could not assert penalties because the penalties were not properly approved under §6751(b).  That argument was a winner under the Tax Court’s interpretation of that statute, but was a loser under the interpretation given by every one of the four Circuit Courts of Appeals to interpret the statute, including the Circuit to which the taxpayer would take an appeal.  This might have been a good case for the Tax Court to change its interpretation and bring uniformity to tax administration.  Sadly, that did not happen.  Instead Judge Gale applied the Golsen rule, which teaches us another good lesson: the Golsen rule is not automatic!

Details, as usual, below the fold.

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Lesson From The Tax Court: What Makes A NOD Invalid?

When the IRS determines a deficiency of tax, it is then “authorized to send notice of such deficiency to the taxpayer.”  §6212(a).  That’s called a Notice of Deficiency (NOD).  The taxpayer generally has 90 days from the date of the NOD to petition the Tax Court to ask for a “redetermination of the deficiency.” §6213(a).

The procedures outlined in §§6212 and 6213 carry several important consequences.  First, the IRS is prohibited from sending a second NOD for the tax year(s) covered by the NOD. §6212(c)(1).  Second, the IRS is prohibited from assessing the proposed deficiency until after the Tax Court has issued a decision and it has become final. §6213(a).  Third, the statute of limitations for the IRS to make an assessment is suspended for the same period during which the IRS is prohibited from assessing, plus 60 days. §6503(a).

None of those consequences happen if the NOD is invalid.  If a taxpayer convinces the Court that the NOD is not valid, the Tax Court will dismiss the case.  That dismissal hurts the IRS because, almost always, the limitation period for assessment will have expired, barring the IRS from re-doing the NOD.

So what makes an NOD invalid?  It is not what many taxpayers think.  Taxpayers may think that an indecipherable NOD is invalid.  Or taxpayers might think that if the process leading to the NOD was defective, then the NOD is invalid.  Today we learn that is not the case.  The lesson comes from Michael J. Watson and Tracy L. Watson, et al. v. Commissioner, Docket No. 12220-21 plus five others (Aug. 31, 2023) (Judge Weiler). Note that this is an unpublished order, so the link takes you to the Docket Sheet and you have to scroll down to find the Order.

But even though this is just an unpublished order, I think it’s worth attention because it is very well written and can teach us something about how the Tax Court evaluates the validity of an NOD.

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Zelenak: Reading The Taxpayers’ Brief In Moore

Lawrence A. Zelenak (Duke; Google Scholar), Reading the Taxpayers’ Brief in Moore, 181 Tax Notes Fed. 101 (Oct. 2, 2023):

In this article, Zelenak explains that the strategy of the taxpayers’ brief in Moore is to distinguish the mandatory repatriation tax from other provisions that arguably violate Eisner v. Macomber, rather than to claim that those other provisions are also unconstitutional; he also analyzes several serious weaknesses in the brief’s arguments.

Other briefs of note:

• Brief of Petitioners
• Brief of the United States

• Amicus Brief of Tax Prof Hank Adler (Chapman)
• Amicus Brief of Tax Prof Calvin Johnson (Texas)
• Amicus Brief of Tax Prof Ted Seto (Loyola-L.A.)

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Hellwig: Hoops And The Tax Treatment Of Nonqualified Deferred Compensation Obligations Transferred In The Sale Of Employer’s Assets

Brant J. Hellwig (NYU), Exploring Hoops, 181 Tax Notes Fed. 89 (Oct. 2, 2023):

The Seventh Circuit recently issued its opinion in Hoops LP v. Commissioner [77 F.4th 557 (7th Cir. 2023)] concerning the tax treatment of nonqualified deferred compensation obligations that are transferred in connection with the sale of the employer’s assets. The appellate court affirmed the determination of the Tax Court [T.C. Memo. 2022-9] that, despite the inclusion of the deferred compensation obligations in the amount realized by the original employer upon the sale of its assets, section 404(a)(5) requires the original employer to defer its deduction for the deferred compensation to when the compensation is actually paid by the purchaser and included in the employee’s gross income. ...

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Lesson From The Tax Court: The Limits Of Collection Due Process

One lesson I teach my students is that taxpayers are generally best off resolving issues with the IRS before seeking judicial help. Another lesson is that taxpayers have multiple opportunities to work with the IRS in the collection process.  So just because one opportunity fails does not mean the taxpayer is out of options.

Today we see a great example of both lessons in Eric Wilfred Olson v. Commissioner, T.C. Memo. 2023-123 (Oct.10, 2023) (Judge Weiler).  There, the taxpayer attempted to use the Collection Due Process (CDP) opportunity to stave off enforced collection of some $77,000 of tax liabilities.  He was also trying to get spousal relief for his wife.  The Tax Court gave him no relief because he had failed to properly try and resolve these issues at the administrative level.  However, just because CDP relief was not available did not mean the taxpayer was out of options to obtain the relief he appears to have sought.

The case also shows the limits of CDP’s delay benefit.  While delay is certainly a common benefit of the CDP process, that benefit was limited in this case for two reasons.  First, this was a tax lien CDP case, which mean the IRS had already established the priority of the tax lien by filing a Notice of Federal Tax Lien (NFTL) before the CDP process started. §6320(a).  So the CDP process in such cases does not affect the IRS ability to use its lien powers.  Second, the taxpayer here filed his Tax Court petition in October 2022 and Judge Weiler issued his decision less than one year later.  That’s awesomely fast for a CDP case.  See Lesson From The Tax Court: The Long And Short Of CDP, TaxProf Blog (Apr. 6, 2020).  No wonder Lew (“Don’t Contact Me”) Taishoff gives Judge Weiler the cognomen “Speedy”!

Details below the fold. 

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Lesson From The Tax Court: The Designated Payment Rule

Payroll taxes present particularly prickly problems.  The problems often arise from a failure to make timely deposits of the correct amounts.  That can happen for lots of reasons, some innocent, some willful.  But once the employer gets too messed up, fixing the problem can be tricky because the IRS will take whatever payments are made and apply those payments in the best interest of the government.  That may not always be in the best interest of the taxpayer.

Today we learn a lesson that will help taxpayers mitigate payroll tax goofs: a voluntary payment allows taxpayers to designate how the IRS should apply the payment.  It's a useful lesson for any kind of tax but especially for payroll taxes.  In Raymond S. Edwards v. Commissioner, T.C. Summ. Op. 2023-29 (Sept. 27, 2023) (Judge Panuthos), the taxpayer got crosswise with the IRS on unpaid payroll taxes and sent in payments that he specifically designated to cover only the taxes owed for five specified quarters, not the accrued interest and penalties, which he wanted to contest.  But the IRS instead applied the payments to interest and penalties.  Judge Panuthos explains why the IRS must honor a taxpayer’s designation of voluntarily remitted taxes.  Not sure this was more than a pyrrhic victory, but it makes for a good lesson.

Details below the fold.

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Lesson From The Tax Court: Equitable Tolling During Government Shutdown?

Like winter, a shutdown is coming.  And last week, the Tax Court issued a really important reviewed decision about equitable tolling of CDP hearings.  The two are connected because the Tax Court lesson may become very useful for taxpayers faced with an inaccessible IRS during periods of government shutdown

For those of us having a hard time keeping track, this Wikipedia entry gives a useful history of federal government shutdowns.  Going in reverse chronological order, it appears that top three were: (1) during the Trump administration—one at the start of 2018 and then also a long 35-day shutdown from the end of 2018 into 2019; (2) during the Obama administration—16 days in 2013; and (3) during the Clinton administration—21 days in in 1995–1996.  We may well be on the way to another one when the 45-day Continuing Resolution passed yesterday expires.

Last week's opinion in Organic Cannabis Foundation v. Commissioner, 161 T.C. No. 4 (Judge Goeke), may help taxpayers who must deal with a closed IRS during the next shutdown.  In that case, fourteen of the sitting Tax Court judges interpreted §6320 to permit equitable tolling of the 30-day period that taxpayers have to request a CDP hearing after the IRS files a Notice of Federal Tax Lien (NFTL).  Three judges thought that interpretation squarely conflicted with the applicable Treasury Regulation and wanted to hear arguments on the validity of the regulation.  The Court’s reasoning applies as much to §6330 CDP hearings as well, making it even more consequential.

What makes this a really useful decision is the idea that a government shutdown might indeed qualify taxpayers for equitable tolling.  Details below the fold.

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Lesson From The Tax Court: Supervisory Approval Of Automated Penalties

Section 6751 requires the IRS to ensure adequate supervisory approval of tax penalties before those penalties are assessed.  But it does not require such approval for any “penalty automatically calculated through electronic means.” §6751(b)(2)(B).

Today we learn a surprisingly nuanced lesson about what constitutes a penalty automatically calculated through electronic means.  In Piper Trucking & Leasing v. Commissioner, 161 T.C. No. 3 (Sept. 14, 2023) (Judge Foley), the IRS assessed penalties against the taxpayer, under §6721, for Piper’s alleged failure to file required information returns.  The initial letter proposing such penalties was automatically generated, based on information received from the Social Security Administration.  But the proposed penalties were the most severe of several alternatives, alternatives that depended on the facts.  Yet no IRS employee was supposed to review the penalty unless and until the taxpayer responded to the initial letter in time.  In this case, the taxpayer made no timely response.  For that reason, the Tax Court held that these penalties fell within the statutory exception and required no human decisionmaker.

This lesson is just another reason why taxpayers need to be sure to respond to all correspondence received from the IRS.  Details below the fold.

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