Source: https://appellatetax.com/category/procedure/
Timestamp: 2019-04-25 04:28:32+00:00

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Oral argument is tentatively scheduled for the last week in February.
The district court has ordered enforcement of the IRS’s summonses in its high-profile audit of Microsoft. As we have previously discussed, Microsoft’s objections to the summonses centered on the IRS’s novel decision to bring in an outside law firm (Quinn Emanuel) as a consultant to whom certain tasks would be delegated. The objections also touched on the issue being litigated in the Clarke case concerning the appropriateness of enforcing a summons that is arguably designed to assist the IRS in Tax Court litigation. (See prior posts on Clarke here.) The district court’s decision in Microsoft turns on its analysis of the factual record and does not break any new legal ground.
With respect to the law firm’s involvement, the essence of the court’s holding was its conclusion that nothing in Code section 7602 prohibits the degree of involvement by an outside contractor that had been shown by the evidence. (Microsoft had argued that, by its terms, section 7602 authorizes only the Secretary of the Treasury (or his specified delegates within Treasury) to “take testimony” or otherwise exercise the summons power.) The court did not affirmatively endorse the IRS’s involvement of the law firm. To the contrary, the court remarked that it was “troubled by Quinn Emanuel’s level of involvement in this audit. The idea that the IRS can ‘farm out’ legal assistance to a private law firm is by no means established by prior practice, and this case may lead to further scrutiny by Congress.” But the court held that it would take further action by Congress to prohibit such involvement; current law does not impose any bar. Because it found no statutory problem, the court saw no need to consider Microsoft’s arguments challenging the validity of the recent temporary regulation that explicitly addresses the IRS’s use of outside contractors.
The district court’s decision appears to end this aspect of the Microsoft litigation, as Microsoft is likely to comply with the summons enforcement order rather than seek to have it stayed so that it could appeal. The action on the question of the IRS’s ability to use the summons power to aid in Tax Court litigation now shifts to the Eleventh Circuit, where briefing is nearly complete in the Clarke case and the court has indicated that oral argument will likely be scheduled for the last week of February 2016.
After obtaining a one-month extension, the government has now filed its response brief in the Eleventh Circuit in the Clarke summons enforcement case. See our prior reports here. The brief raises three points in response to the appellants’ argument that the IRS had an improper purpose in seeking to enforce the summonses after Tax Court litigation had begun.
First, the government argues that the appellants are essentially arguing for a blanket rule that a summons cannot be enforced once litigation has commenced in the Tax Court. Such a restriction is not found in the statute, and accordingly the government argues that the appellants’ position violates the Supreme Court’s instruction that “restrictions upon the IRS summons power should be avoided absent unambiguous directions from Congress.” Tiffany Fine Arts v. Commissioner, 469 U.S. 310, 318 (1985). Second, the government argues that, in any event, the appellants are misguided in arguing that the enforcement decision was an improper evasion of the Tax Court’s discovery rules. The government contends that Ash v. Commissioner, 96 T.C. 459, 472 (1991), establishes to the contrary that “the Tax Court has categorically ruled that summonses issued prior to the commencement of litigation . . . do not threaten the integrity of its discovery rules.” The government adds that, if summons enforcement is judged to be an evasion of the Tax Court’s discovery rules, the proper remedy would be for the Tax Court itself to issue a protective order limiting the use of evidence obtained through the summons, not for the district court to quash the summons. Third, the government argues that, as a matter of law, the enforceability of a summons must be judged as of the time it is issued. If the summons was issued for a valid investigative purpose, that is enough, and it is irrelevant what the motivation may have been for deciding to bring an enforcement action months later.
With respect to the appellants’ objection to the district court’s failure to allow introduction of new evidence on remand, the government argues that the appellants did not make an offer of proof and hence they failed to preserve their objection. In any event, the government continues, the court acted well within its discretion in declining to delay the enforcement action further when there was no apparent need for further evidentiary proceedings.
The appellants’ reply brief is due December 14.
The government has filed its opening brief in the Eleventh Circuit in the Clarke case. The case is now back in that court for the second time after a remand from the Supreme Court that did not persuade the district court to retreat from its prior denial of an evidentiary hearing. See our previous report here.
On the merits, the appellants’ primary argument is that they are entitled to a hearing to explore their allegation that the government is misusing the summons enforcement process to obtain discovery for pending Tax Court proceedings. To that end, the appellants ask the court not to restrict its consideration of the validity of the summons to the situation existing on the date it was issued, but instead to look at the later decision to enforce the summons – well after the statute of limitations had expired. Secondarily, the appellants argue that the district court erred in refusing to allow them to make supplemental submissions in the wake of the Supreme Court’s remand, which arguably changed the legal standard to be applied to appellants’ contentions.
The government’s response brief is due in late September.
In the Microsoft case, the district court held an evidentiary hearing on August 25 and has ordered the parties to submit supplemental briefs on September 2.
While the Eleventh Circuit begins the process of reconsidering the Clarke summons enforcement case following the Supreme Court’s remand (see our prior reports here), a federal district court is poised to address similar issues much sooner in a case that has garnered extensive publicity. (Incidentally, briefing is now underway in Clarke, with the respondents’ opening brief on appeal due on August 14.).
Microsoft has vigorously challenged the legality of the IRS’s engagement of Quinn Emanuel. The IRS contends that its action is authorized by a temporary regulation promulgated without notice-and-comment on June 9, 2014, which provides that third-party contractors “may receive books, papers, records, or other data summoned by the IRS and take testimony of a person who the IRS has summoned.” 26 C.F.R. § 301.7602-IT(b)(3). The IRS contends that Quinn Emanuel did not commence work under the contract until approximately a month after the regulation was issued, although technically it was retained earlier.
Microsoft has pursued its challenge on multiple fronts. It submitted several FOIA requests to the IRS, and its FOIA requests for documents relating to promulgation of the temporary regulation and its contacts with the private law firms are the subject of pending lawsuits in federal district court in Seattle (Western District of Washington). (An earlier FOIA suit was dismissed after the IRS capitulated and turned over its contract with Quinn Emanuel.) The immediate action, however, lies in a summons enforcement suit pending before the same judge as the FOIA cases (Judge Ricardo Martinez).
After issuing more than 200 IDRs, the IRS issued several designated summonses seeking additional information. Microsoft forced the IRS to go to court to seek enforcement of the summonses and then argued that it was entitled to an evidentiary hearing (and discovery of the documents being sought in the FOIA litigation) before being required to comply. Microsoft’s objections centered on the Quinn Emanuel engagement, with Microsoft contending that the IRS had improperly delegated key aspects of the tax audit and that it was entitled to a hearing to explore exactly what was the firm’s role.
With respect to Microsoft’s specific objection to Quinn Emanuel’s participation, the court made a more convincing case for a hearing to explore factual issues. The court found that the language of the contract suggested that the firm “may be participating in components of the audit examination for which delegation is statutorily proscribed, such as inspecting books and taking testimony.” The court also found that, given the timing of the firm’s retention, Microsoft had plausibly raised an inference that the firm had “played an unauthorized role in the issuance of several IDRs” and might have been provided taxpayer information in violation of section 6103.
The court, however, stated that it was not prepared to accede to Microsoft’s request for document discovery regarding the issuance of the summons. Asserting that a “more stringent” showing of wrongdoing is required to warrant discovery, the court ruled that it would consider the discovery request after the evidentiary hearing, which it scheduled for July 21.
The parties have been skirmishing in advance about how the hearing should be conducted, and those disputes give concrete expression to the concerns the government expressed in Clarke about burdensomeness if evidentiary hearings are too readily allowed in summons enforcement proceedings. The IRS has put forth an official to testify at the hearing who it asserts has the most knowledge of the circumstances surrounding the issuance of the summons. Microsoft, however, wants to examine a more senior official about the bigger picture and has urged the court to require the IRS to make available at the hearing or for deposition Heather Maloy, the soon-to-be ex-Commissioner of LB&I. (Ms. Maloy’s last scheduled day at the IRS is tomorrow, July 10.) Microsoft has also asked the court to order the IRS to provide, 10 days in advance, summaries of the substance of the testimony it intends to introduce at the hearing. The government, for its part, has asked the court to clarify several evidentiary and procedural matters surrounding the hearing. The court heard argument on these various pre-hearing requests at a telephone conference on July 7.
Thus, in addition to the remand decision in Clarke itself, the high-profile Microsoft case promises to shed further light on how the lower courts will approach evidentiary hearings in summons enforcement actions in the wake of Clarke.
As we previously reported, the Supreme Court’s decision in the Clarke summons enforcement case was not a complete victory for the government. The Court set forth a standard that appeared to leave a little more room than before for summoned parties to obtain an evidentiary hearing in resisting summons enforcement actions. The Court left open the possibility that the lower courts on remand could require a hearing in Clarke itself at which IRS officials would have to testify.
The Eleventh Circuit elected not to address this question in the first instance after the Supreme Court remand. Instead, it sent the case straight back to the district court with instructions to reconsider its original enforcement order in light of the Eleventh Circuit and Supreme Court opinions. But the district court saw no reason to change its tune on remand. First, it refused the private respondents’ request to introduce additional evidence in opposition to the summons enforcement request. The district court then issued a six-page opinion rejecting point-by-point—in some instances for lack of evidence—the arguments made by the respondents for why the summons might be thought to be improperly motivated. The respondents have now appealed that latest decision back up to the Eleventh Circuit.
That legal issue is now teed up for the court of appeals. The district court’s new opinion on remand essentially repeated the brief analysis of this point from its first opinion, stating that “events occurring after the date of issuance but prior to enforcement should not affect enforceability.” The court of appeals will review that ruling de novo. Having reversed the district court and ordered an evidentiary hearing when it last considered the case, it would not be surprising to see the court of appeals reach the same outcome as before and hold that the government’s conduct in the Tax Court proceedings provides enough justification for the court to hold an evidentiary hearing to explore the IRS’s motivation for issuing the summons.
The Eleventh Circuit has not yet issued a briefing schedule.
As expected, the Court this morning reversed the Eleventh Circuit’s decision in Clarke based on the Court’s agreement with the government’s position that the Eleventh Circuit erroneously had required an evidentiary summons enforcement hearing based on nothing more than the bare allegation of an improper purpose. See our previous report here. But the Court’s unanimous opinion, authored by Justice Kagan, went on to attempt to provide guidance for future disputes over the availability of such hearings, including the resolution of this case on remand, and that guidance could perhaps lead courts to allow such hearings more often than in the past.
The immediate result of the decision is a remand to the Eleventh Circuit to determine whether the district court’s refusal to order an evidentiary hearing comported with this standard. The Court did not express a view on whether the evidence that the private parties had put forth (alleging retaliation for failure to agree to a statute of limitations extension and an ulterior motive to conduct the equivalent of discovery for the Tax Court case) met the standard, stating that whether those purposes would be improper was not within the question presented to the Court. But the Court did set forth some principles for how the Eleventh Circuit should go about reviewing the district court’s decision.
In that connection, the Court proceeded to state that this second caveat encompassed the issue to which the private parties have attached considerable importance – namely, the contention that the IRS was seeking to enforce the summons only in order to obtain discovery for the Tax Court proceedings. The district court had agreed with the government that this would not constitute an improper purpose because the validity of a summons should be judged as of the time of issuance (which was before the Tax Court proceedings were initiated), not as of the time the IRS moves to enforce the summonses. The Supreme Court declined to endorse that argument, inviting the Eleventh Circuit to consider it as a legal issue on which it owes no deference to the Tax Court.
Thus, the government has dodged a bullet in Clarke, with the Supreme Court reversing the Eleventh Circuit and rejecting the proposition that IRS agents can be hauled into an evidentiary hearing on the basis of a bare allegation of improper purpose. But the government could well find itself facing a loss again on remand when the Eleventh Circuit applies the standard set forth in Clarke to the evidence in this case. There is nothing in the Supreme Court’s opinion to discourage the Eleventh Circuit (presumably the same judges who already voted once to afford an evidentiary hearing in this case) from concluding that the private parties here did make a sufficient showing because, as a matter of law, it is improper for the IRS to move to enforce a summons for the purpose of obtaining information to be used in pending Tax Court proceedings. It will be worth following the remand proceedings in the court of appeals to see how the Eleventh Circuit deals with this issue.
Oral argument is set for April 23.
The basic summons enforcement rules are long established, but the devil can be in the details. Under United States v. Powell, 379 U.S. 48 (1964), a summons is to be enforced if the IRS demonstrates that: (1) “the investigation will be conducted pursuant to a legitimate purpose”; (2) “the inquiry may be relevant to the purpose”; (3) the IRS does not already have the information; and (4) the IRS followed the proper administrative steps. The IRS generally carries its initial burden simply by producing an affidavit from the investigating agent, which then shifts the burden to the party contesting the summons. At that point, it gets a little murkier. If the party contesting the summons raises a “substantial question” as to whether the summons is an abuse of process, then it is entitled to an “adversary hearing” at which it “may challenge the summons on any appropriate ground.” Id. at 58.
What happened here is that the IRS wanted to look more carefully into a partnership’s tax returns, particularly its claim of $34 million in interest expenses over two years. Although the partnership agreed to two extensions of the statute of limitations, it declined to extend the period a third time. Shortly thereafter, the IRS issued six summonses to third parties connected to the partnership, but those parties did not comply with the summonses. Just before the limitations period closed, the IRS issued a notice of Final Partnership Administrative Adjustment (FPAA) to the partnership, and the partnership challenged the FPAA by filing a petition in the Tax Court. A couple of months later, the IRS filed summons enforcement actions.
The summoned parties, who are the respondents in the Supreme Court, responded by contending that the summonses were not issued for a legitimate purpose and requesting an evidentiary hearing and discovery. They basically made two arguments. First, they contended that the summons was issued in retaliation for the partnership’s refusal to extend the statute of limitations, pointing to the fact that the summonses were issued very soon after that refusal was communicated. Second, they contended that the summonses were designed to circumvent the Tax Court’s restrictions on discovery. They advanced some evidence to support this contention, including the IRS’s request for a continuance in the Tax Court on the ground that the summonses were outstanding.
The district court (for the Southern District of Florida) ordered the summonses enforced, stating that a hearing is not required based on a “mere allegation of improper purpose” to retaliate. With respect to respondents’ second contention, the district court said that a finding that the IRS was using the summons process to avoid discovery limitations in the Tax Court would not be a valid ground for quashing a summons.
The difference in the way the two parties have phrased the question presented reflects the two different grounds on which the respondents challenged the summonses. The allegation that the summonses were a form of retaliation or punishment, instead of for a legitimate investigative purpose, is pretty close to an “unsupported allegation.” That the summons followed closely on the heels of the decision not to extend the statute of limitations is weak evidence of an improper retaliatory purpose, though, as the respondents point out, it is hard to have strong evidence of a retaliatory purpose without having discovery or a hearing. Thus, the respondents may have a hard time defending the court of appeals decision on its own terms.
On the other hand, the respondents will be able to advance their second basis for challenging the summonses as an alternate ground for affirmance, even though the court of appeals did not rely upon it. On that ground, the respondents have more than an “unsupported allegation” – they are more like “substantial allegations” – that the summonses were designed to obtain evidence for use in the Tax Court proceedings that could not have been obtained through discovery. The government’s response on this point is the same as that of the district court – namely, that these allegations, if true, would not demonstrate an illegitimate purpose and would not be grounds for quashing the summons. Two courts of appeals have reached this issue and have agreed with the government. On the other hand, respondents have a logical argument that a summons is an investigative tool and the investigation phase is over by the time the FPAA has issued and the case has been docketed in the Tax Court. Respondents note in this connection that the IRS’s own Summons Handbook states that, “[i]n all but extraordinarily rare cases, the Service must not issue a summons” after a notice of deficiency is mailed because at that point “the Service should no longer be in the process of gathering the data to support a determination because the [notice of deficiency] represents the Service’s presumptively correct determination and indicates the examination has been concluded.” This second ground not reached by the court of appeals thus may prove to be the more interesting and closely contested aspect of this case.
To add a little more spice to this case, the Court’s determination to revisit summons enforcement comes at a time when the IRS may significantly increase its use of its summons power. On January 2, 2014, a new policy went into effect for audits of the largest taxpayers that threatens the issuance of a summons when a taxpayer fails to timely respond to requests for documents and/or information. The new policy sets out a mandatory timeline for warning letters and a drop-dead due date, after which the examining agent will initiate procedures for the issuance of a summons. This policy could well lead to many more summons enforcement proceedings. For more information on the IRS’s new IDR enforcement policy, please contact George A. Hani (ghani@milchev.com) or Mary W. Prosser (mprosser@milchev.com).
The government’s opening brief is due February 24. The case will be argued in late April and a decision is expected by the end of June.
The Supreme Court this morning ruled 9-0 in favor of the government on both issues in Woods, holding that: (1) there is partnership-level TEFRA jurisdiction to consider the appropriateness of a penalty when the partnership is invalidated for lack of economic substance; and (2) the 40% valuation overstatement penalty can apply in that setting on the theory that the basis of a sham partnership is zero and therefore the taxpayers overstated their basis. See our prior coverage here. The opinion, authored by Justice Scalia, is concise and appears to resolve definitively both issues that had previously divided the lower courts.
On the jurisdictional issue, the Court began by pointing to Code section 6226(f), which establishes partnership-level jurisdiction for “the applicability of any penalty . . . which relates to an adjustment to a partnership item.” Accordingly, the Court found, the question “boils down to whether the valuation-misstatement penalty ‘relates to’ the determination” that the partnerships were shams. On that point, the Court agreed with the government’s “straightforward” argument that “the penalty flows logically and inevitably from the economic-substance determination” because the trigger for the valuation overstatement calculation is the conclusion that a sham partnership has zero basis.
At the end of the opinion, the Court addressed an issue of statutory interpretation that has broader implications beyond the specific context of Woods. The taxpayer had relied on language in the Blue Book, and the Court stated in no uncertain terms that the Blue Book is not a relevant source for determining Congressional intent. Rather, it is “post-enactment legislative history (a contradiction in terms)” that “is not a legitimate tool of statutory interpretation.” The Court acknowledged that it had relied on similar documents in the past, but suggested that such reliance was a mistake, stating that more recent precedents disapprove of that practice. Instead, the Blue Book should be treated “like a law review article”— relevant only if it is persuasive, but carrying no special authority because it is a product of the Joint Committee on Taxation.
The taxpayers have filed their response brief in the Supreme Court in the Woods case, contending first that the courts lacked jurisdiction to impose the penalties requested by the IRS and, second, that, if jurisdiction exists, the Fifth Circuit correctly held that the valuation misstatement penalty could not be imposed.
On the merits of the penalty, the brief begins with a different argument from the one relied upon by the Fifth Circuit – maintaining that “there was no ‘valuation misstatement’ to begin with.” Pointing to the common meaning of the word “valuation” in the statutory text, and to the legislative history, the taxpayers argue that “Congress meant the penalty to address misstatements about valuation—an inherently factual concept concerning the worth or cost of property.” Therefore, the penalty should not be “triggered by transactions that are accurately reported but deemed not to exist based on a legal conclusion that they lack economic substance,” even if the result of that legal conclusion is to restate the basis claimed by the taxpayer.
The taxpayers also point to the penalty provision added in Congress’s recent enactment of an economic substance provision. They argue that the penalty associated with that provision (see Code section 6662(b)(6) and (i)) could impose a 40% penalty for the reporting in this case and therefore its enactment indicates that the existing valuation misstatement penalty should not be construed to cover economic substance cases.
As a fallback argument, the taxpayers argue for adopting the rationale of the Fifth Circuit – namely, that the underpayment of tax is “attributable to” a finding of no economic substance and hence is not attributable to a basis overstatement. Finally, the taxpayers rely on language from Supreme Court decisions in the 1930s to argue that doubts about the meaning of ambiguous tax statutes should be resolved in favor of the taxpayer.
An amicus brief in support of neither party was filed by Professor Andy Grewal. That brief discusses the state of the law in the courts of appeals regarding the substance of the economic substance doctrine, but urges the Court to “reserve its opinion on the broader economic substance issues implicated in this case.” Four amicus briefs were filed in support of the taxpayers, on either one or both issues, by other taxpayers involved in pending litigation that would potentially be affected by the Court’s holding. See here, here, here, and here.
The government’s reply brief is due August 18. Oral argument has been scheduled for October 9.
The government has filed its opening brief in the Supreme Court in the Woods case, which involves whether the 40% gross valuation overstatement penalty applies in the context of a basis-inflating transaction held not to have economic substance. See our earlier report here.
The brief also addresses a question not presented in the petition for certiorari, but instead added to the case by the Supreme Court – namely, whether the district court had jurisdiction under Code section 6226 to decide the penalty issue. This issue concerns the two-level structure established by TEFRA for judicial proceedings involving partnerships. Partnerships are not taxable entities themselves; tax attributes from the partnership flow through to the tax returns of the individual partners. Accordingly, before 1982, tax issues raised by a partnership tax return could be resolved only through litigation with individual partners, leading to duplicative proceedings and often inconsistent results. The TEFRA scheme calls for proceedings at the partnership level to address “the treatment of any partnership item,” which would be issues common to all the individual partners. Adjustments that result from those proceedings flow down to the individual partners, and the IRS can make assessments on the individual partners based on those partnership-level determinations without having to issue a notice of deficiency or otherwise initiate a new proceeding. Issues that depend on the particular circumstances of individual partners, however, are determined in separate partner-level proceedings.
In this case, the penalty determination was made at the partnership level. That seems logical in one sense because the conclusion that the transaction lacked economic substance – and therefore did not have the effect on basis claimed by the taxpayer – was a partnership-level determination that would not depend on an individual partner’s circumstances. The Tax Court agrees with that approach, but the D.C. Circuit and the Federal Circuit have stated that such determinations do not involve “partnership items” within the meaning of TEFRA and hence a penalty determination like the one in this case should be made at the individual partner level. See Jade Trading, LLC v. United States, 598 F.3d 1372 (Fed. Cir. 2010); Petaluma FX Partners, LLC v. Commissioner, 591 F.2d 649 (D.C. Cir. 2010). The reason is that the basis at issue here is an “outside basis,” that is, the partner’s basis in his or her partnership interest. A partner’s outside basis is not a tax attribute of the partnership entity (unlike, for example, the basis of an asset held by the partnership). These courts did not dispute the assertion that outside basis is an “affected item” (that is, an item affected by a partnership item) and that the conclusion underlying the penalties obviously follows from the partnership item determination; it is obvious that there is zero outside basis in a partnership that must be disregarded on economic substance grounds. But these courts ruled that obviousness is not a good enough reason to get around the jurisdictional limitations of the statutory text; “affected items” must be determined in a partner-level proceeding.
The taxpayer’s brief is due July 22.
As we previously reported, Day 1 of last week’s oral argument in the Supreme Court on the challenges to the health care legislation focused on whether the Anti-Injunction Act bars the lawsuits. The excitement about the argument on that issue was largely gone as soon as it was over, because it was fairly apparent that the Court will not find the Act to be an obstacle to reaching the merits of the health care dispute. Indeed, Robert Long, the lawyer who argued as amicus for that position, has predicted that he will not get a single vote. Certainly the argument was almost completely forgotten by the next day when the Court’s questioning on the constitutionality of the individual mandate led many observers to conclude that the mandate will be invalidated. (For the record, my opinion is that the health care legislation will survive, but that topic is beyond the scope of this blog.) Still, the Court’s decision to reject the applicability of the Anti-Injunction Act could have precedential significance, depending on the rationale that the Justices use. Therefore, we briefly recount the argument here with that issue in mind.
A court does not have the authority to create its own jurisdiction, even if both parties want it to hear the case. Thus, if a statute is “jurisdictional,” a court is obliged to examine jurisdiction on its own and to dismiss the case if it finds that the statutory conditions are not met. Conversely, if a statutory condition is not jurisdictional, then a party can waive satisfaction of that condition and the court can proceed to hear the case. (For example, many exhaustion requirements or statutes of limitations are not jurisdictional, see Reed Elsevier, Inc. v. Muchnick, 130 S. Ct. 1237 (2010); Day v. McDonough, 547 U.S. 198, 205-06 (2006)). In the health care litigation, although the United States wanted the lawsuits to proceed, it took the position that the Anti-Injunction Act is “jurisdictional” and therefore (in contrast to the challengers to the law) argued that the Court could proceed to hear the case only if it concluded that the Anti-Injunction Act by its terms did not apply to the “penalty” for failing to obtain insurance.
If the Court were to resolve the case on waiver grounds, concluding that the Anti-Injunction Act is not jurisdictional, that could create opportunities for taxpayers in future cases if a government attorney overlooks an Anti-Injunction Act defense. It also would give the government flexibility to assert the defense when it wants, but to allow cases like the health care challenge to go forward if the government determines that it wants a prompt answer. The government, however, is concerned about a holding that the Anti-Injunction Act is not jurisdictional, because courts are freer to adopt equitable exceptions to non-jurisdictional statutes.
As the argument progressed, however, it appeared less likely that a majority would coalesce around this position. Justice Breyer volunteered that he was inclined to agree that the Anti-Injunction Act is jurisdictional, but that he doubted it applied to the health care legislation. Sotomayor indicated that she thought this position, which is what was being espoused by the government, was the least problematic. Justice Ginsburg suggested that she sided with the position that the Act did not apply, observing that this conclusion would make it unnecessary to resolve the thornier “jurisdictional” question.
Although it is always hazardous to predict outcomes based on questions asked at oral argument, the most likely outcome appears to be that the majority of Justices will address the merits of the Anti-Injunction Act issue, rather than relying on the government’s waiver of the defense. If so, the decision will not foreclose courts in the future from applying the Anti-Injunction Act when the government has failed to raise the defense or deliberately chosen not to raise it.
A decision is expected in the last week of June, perhaps June 28, and will surely be overshadowed by the Court’s contemporaneous decision on the constitutionality of the health care legislation.
But leading all of this off on March 26 in HHS v. Florida, No. 11-398, is a tax issue – whether the challenges to the law are barred by Code section 7421, the Tax Anti-Injunction Act. Former Solicitor General Paul Clement is slated to argue the other three issues for the challengers to the law, but has left the tax issue for someone else. He remarked (tongue-in-cheek, I believe) that the Court was playing a “practical joke” on the public in its scheduling and that the folks who wait in line all night to attend the first day of arguments on March 26 are going to end up sitting through “the most boring jurisdictional stuff one can imagine.” Tax lawyers might disagree (or they might not). Either way, the section 7421 issue could hijack the case and have the effect of prolonging the uncertainty over the constitutionality of the law for several more years.
The issue is simple on its face. Section 7421 forbids federal courts from maintaining any suit “for the purpose of restraining the assessment or collection of any tax.” Rather, one generally must wait until the tax is imposed and then contest the liability through a refund claim or in defending against an enforcement proceeding. The individual mandate in the statute is enforced by imposing a “penalty” on individuals who are required to purchase insurance but fail to do so. The relevant provision is section 5000A of the Internal Revenue Code, which requires individuals to report on their tax return information about their compliance with the mandate and pay a penalty if necessary. That Code section also generally provides that the amounts owed are to be assessed and collected in the same manner as other penalties under the Code.
If the health insurance penalty is a “tax” subject to section 7421, then the current challenges to the mandate (which in essence are challenging the imposition of a penalty for failure to purchase insurance) are premature. Rather, the legality of the penalty would have to be contested after it is imposed, like other taxes. The individual mandate does not kick in until 2014, so an income tax return that self-reports penalty liability, thereby potentially triggering an assessment, would not be filed until 2015. The Fourth Circuit adopted this view and dismissed a suit challenging the health care statute, telling the plaintiffs to come back in a few years. Other circuits have disagreed, finding that, despite its presence in the Code and linkage to the assessment procedures for more conventional tax penalties (which are generally treated as “taxes”), the health care penalty has nothing to do with income tax and ought not to be governed by section 7421. Of course, the issue is not that simple. A concise and more nuanced summary of the respective arguments can be found in this article (see page eight) by our colleague George Hani.
One interesting sidelight to the Court’s consideration of this issue is that the Court had to appoint counsel to argue that section 7421 bars the suit. The challengers, of course, have argued all along that section 7421 is no bar. The government initially raised section 7421 as a defense, but later reversed course and abandoned that position because it did not want uncertainty over the legislation’s legality to linger. Thus, in the Supreme Court, both sides are arguing that section 7421 does not bar the lawsuit. The Court appointed Robert Long, an experienced Supreme Court practitioner, as an amicus curiae to brief and argue the position that section 7421 does bar the suit.
The oral argument on the morning of March 26 will proceed as follows: Robert Long, arguing as amicus for 40 minutes that the challenges are barred; Solicitor General Donald Verrilli, arguing for the government for 30 minutes that section 7421 does not bar the challenges, and Gregory Katsas, arguing for the challengers for 20 minutes also that section 7421 does not bar the challenges.
The Court has announced that a transcript and audio of the argument will be posted on its website by 2:00 that afternoon. We will be back sometime after that with some observations on the argument.
The Supreme Court briefs filed on this issue can be found here. The Court is likely to issue its decision during the last week of June.
The last post in this series discussed differences in procedural posture that cause differences in the application of penalties. Court splits in how the various and sundry penalty provisions in the Code are applied is an even more confusing area. The two principal confusions are in the areas of TEFRA and valuation misstatements. We will deal with TEFRA in this post.
Partnerships are not taxpaying entities. They flow income, losses, deductions, and credits through to their partners who pay the tax. Nevertheless, since Congress enacted the Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. No. 97-248, 96 Stat. 324, 648-71 (TEFRA), some partnerships have been subject to audit (and litigation of those audit adjustments in court) directly at the partnership level. Because individual partners still have tax issues that are not related to the partnership, tax items have to be divided between those that are handled in the partnership proceeding (so-called “partnership items”) and those that are handled at the level of the partners (so-called “non-partnership items”). (There is a third category of items that are affected by partnership items, appropriately named “affected items,” which we don’t need to address for purposes of this discussion.) As one can imagine, dividing the partnership tax world up into these two sorts of items is not always the easiest thing to do where you have items that are factually affected both by actions taken by the partnership and by actions taken by the partners.
In an apparent attempt to clarify this treatment in a small way, in 1997 Congress decreed that penalties that relate to partnership items are determined at the partnership level (i.e., the penalties themselves are partnership items). Seesection 6221. The difficulty implementing this provision is that, although partnerships are subject to audit, they are often owned and run by people and those people are often the partners. When one takes this fact into account in the context of the various penalty defense provisions, such as section 6664, which protects against penalties if a taxpayer has “reasonable cause and good faith,” you have a dilemma. Namely, if penalties are determined at the partnership (and not partner) level, whose conduct can you look at to determine if the partnership (and not the partners) had reasonable cause and good faith?
Regulations require that if an individual partner invokes section 6664 as a personal defense, that invocation has to be done in a partner level proceeding (generally, a refund action after the TEFRA proceeding is completed). Treas. Reg. § 301.6221-1(d). The IRS position as to how this applies in practice appears to be that the only conduct that is relevant for purposes of applying section 6664 in a TEFRA proceeding is what the partnership did through its own non-partner employees or, perhaps (it is unclear), the “tax matters partner” who manages the tax affairs of the partnership. From the IRS perspective, if a partner asserts conduct for purposes of section 6664, that assertion has to be parsed to see if the partner intended his or her conduct to be attributed to the partnership or, rather, asserted it on their own behalf. See Pet. for Rehearing at 8-10, Klamath Strategic Investment Fund v. United States, 568 F.3d 537 (5th Cir. 2009) (Docket No. 07-40861) (the petition was denied, it is included here to show the IRS position). Exactly how one is to conduct this hair-splitting (some might say hare-brained) analysis is hard to fathom. The best evidence of whether a partner’s conduct was on his or her behalf, or the partnership’s, will be the partner’s own statement. Presumably, any well-advised partner will say that he or she intended the conduct on behalf of the partnership if the desire is to raise the defense on behalf of the partnership, and only badly advised partners won’t. Surely, this is not a sustainable test.
Courts are split. The Fifth Circuit in Klamath rejected the IRS theory and looked to the actions of partners to impute reasonable cause and good faith to the partnership. 568 F.3d at 548. The Court of Federal Claims had at least two competing views. Stobie Creek Investments, LLC v. United States, 82 Fed. Cl. 636, 703 (2008) generally went the same way as Klamath, looking to the managing partners’ actions. But in what has to be the most thorough analysis of the issue, Judge Allegra in Clearmeadow Invs., LLC v. United States, 87 Fed. Cl. 509, 520 (2009) ruled for the Government giving deference to: (i) the regulatory edict that actions of the partners are only to be considered in the later refund proceeding and not in the TEFRA proceeding; and (ii) the language of section 6664 and regulations thereunder, which focuses on “taxpayers” and distinguishes partnerships from taxpayers. Based on the docket, Clearmeadow is not being appealed.
Regardless of your persuasion, at least Clearmeadow seemed to have debunked the idea that it could somehow matter (and, even more strangely, somehow be determined by the judge) whether the partner intended the conduct on his or her own behalf or on behalf of the partnership. Id. at 521. Relying on the discretion of a litigant to determine jurisdiction does seem off-base. Yet that is exactly what the Federal Circuit did on appeal in Stobie Creek, affirming on the basis that the Court had jurisdiction because the partnership “claim[ed] it had reasonable cause based on the actions of its managing partner.” Stobie Creek Invs. LLC v. United States, 608 F.3d 1366, 1381 (Fed. Cir. 2010). Given that the Court went on to find that there was no reasonable cause, a cynic might say that the Court was anxious to give itself jurisdiction so it could reject the penalty defense definitively and prevent the taxpayer from taking another bite at the apple in a later refund proceeding, perhaps in district court. In any event, Stobie Creek has reignited the debate about whether a self-serving statement about intent controls jurisdiction and doesn’t seem to resolve the questions of: (i) when a partner is acting on his or her own behalf versus the partnership’s or (ii) whether the rules apply differently to managing versus non-managing partners. The state of the law in this area of penalty application is indeed still schizophrenic.
The next post in the penalties series will skip past valuation allowances (where there is also a circuit split we will come back to) and deal with reasonable reliance on tax advisers (for which we will surely get some hate mail).

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