Court Opinion

ID: 4474965
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:11:14.613361+00
Date Added: 2024-06-11T14:53:53.043239
License: Public Domain

Halpern, J., dissenting: I. Introduction We here face a task common in courts reviewing the actions of an administrative agency; i.e., we must construe an agency’s statute and regulations and consider the agency’s interpretation of those authorities. I agree with neither the approach the majority takes nor the conclusion it reaches. I agree with much of what Judge Kroupa writes but wish to emphasize how my approach differs from that of the majority. II. The Language of the Regulation That regulations, like statutes, are interpreted pursuant to canons of construction is a basic principle of regulatory interpretation. E.g., Black & Decker Corp. v. Commissioner, 986 F.2d 60, 65 (4th Cir. 1993), affg. T.C. Memo. 1991-557. In every case involving questions of statutory or regulatory interpretation, the starting point is the language itself. E.g., Bd. of Educ. v. Harris, 622 F.2d 599, 608 (2d Cir. 1979) (quoting Greyhound Corp. v. Mt. Hood Stages, Inc., 437 U.S. 322, 330 (1978)). The regulations we here construe are sections 301.7701-1 through -3, Proced. & Admin. Regs, (the so-called check-the-box regulations). We are particularly concerned with the language in section 301.7701-2(a), Proced. & Admin. Regs., describing what happens when a business entity with only one owner is disregarded as an entity separate from that owner; viz, “its activities are treated in the same manner as a sole proprietorship, branch, or division of the owner.” Given that Pierre LLC’s owner, petitioner, is an individual, Pierre LLC’s activities are treated in the same manner as those of a sole proprietorship. See id. Missing from the instruction (sometimes, the activities instruction), however, is its scope. Ostensibly, section 301.7701-l(a)(l), Proced. & Admin. Regs., provides that scope, stating that the activities instruction applies for “federal tax purposes”. Section 2501(a) imposes a tax on the transfer of property by gift. The tax is an excise tax imposed on the value of the property transferred. See id.; Dickman v. Commissioner, 465 U.S. 330, 340 (1984) (“The gift tax is an excise tax on transfers of property”.). Section 2512(a) provides that the amount of a gift of property is the value of the property on the date of the gift. Respondent argues that, because petitioner elected to treat Pierre LLC as a disregarded entity, petitioner is properly “treated as transferring cash and marketable securities, as opposed to Pierre LLC interests, for federal gift tax purposes.” Petitioner responds: “[T]he issue is the gift tax treatment of transfers of interests in an LLC”, “not the imposition of a tax due as a result of the activities of a single-member LLC.” In effect, petitioner argues that the activities instruction is irrelevant to any inquiry concerning her transfers of interests in the LLC, since that inquiry concerns her own activities and not her LLC’s activities. Petitioner’s position bespeaks a distinction between a sole proprietor and her business that the activities instruction will not bear. A sole proprietorship is generally understood to have no legal identity apart from the proprietor. 18 C.J.S., Corporations, sec. 4 (2007) (“A sole proprietorship has no separate legal existence or identity apart from the sole proprietor.”). Judge Richard A. Posner applied that rule of unity nicely in Smart v. Intl. Bhd. of Elec. Workers, Local 702, 315 F.3d 721, 723 (7th Cir. 2002): “Two plaintiffs are listed, but one is a sole proprietorship and the other the proprietor, so they are one, not two, in the eyes of the law * * *, and the one is the proprietor * * * not the proprietorship.” I would read the activities instruction as plainly saying that Pierre LLC and petitioner constitute only one actor (i.e., petitioner) for Federal tax purposes (which, of course, encompass the Federal gift tax), so that any gift by petitioner of an interest in Pierre LLC is, as respondent argues, a gift of an interest in that LLC’s cash and marketable securities.1 Others may find the activities instruction to be ambiguous, so I will proceed as if the instruction is not clear from the plain language of the regulation. I reject (and the majority does not contend) that the regulation plainly precludes considering the LLC’s property (or at least interests therein) as the property petitioner transferred when she transferred interests in the LLC. III. The Intent of the Secretary If we accept that the activities instruction is ambiguous, then we must construe that provision. With respect to that task: “It is axiomatic that any regulation should be construed to effectuate the intent of the enacting body.” United States v. Miller, 303 F.2d 703, 707 (9th Cir. 1962). Indeed, hornbook law holds: In construing an administrative rule or regulation, the court must necessarily look to the administrative construction thereof where the meaning of the words used is in doubt, and the courts will ordinarily show deference to such construction and give it controlling weight. 73 C.J.S., Public Administrative Law and Procedure, sec. 212 (2004) (emphasis added); accord Oteze Fowlkes v. Adamec, 432 F.3d 90, 97 (2d Cir. 2005) (“An agency’s interpretation of its own statute and regulation must be given controlling weight unless it is plainly erroneous or inconsistent with the regulation.” (citations and internal quotation marks omitted)); Lantz v. Commissioner, 132 T.C. 131, 144 n.10 (2009) (the same). There is ample evidence that the Secretary, in the person of the Commissioner, construes the activities instruction to require that the wrapper be disregarded in determining the property the owner of a single-member disregarded entity transfers when she transfers an interest in the entity. That is, of course, respondent’s position, which, because it is consistent with the Commissioner’s administrative position for at least 10 years, cannot be dismissed as a mere litigating position.2 Implementation of the check-the-box regulations has required the Commissioner to issue numerous interpretations. Ten years ago, in Rev. Rul. 99-5, 1999-1 C.B. 434, the Commissioner addressed the Federal income tax consequences of the sale by A, the owner of a single-member disregarded entity (an LLC), of a 50-percent ownership interest in the entity to B, with the result that the disregarded entity was converted into a partnership. The Commissioner held that B’s purchase of 50 percent of A’s ownership interest in the LLC is treated as the purchase of a 50-percent interest in each of the llc’s assets, “which are treated as held directly by A for federal tax purposes.” Id. Therefore, the Commissioner continued: “Under § 1001, A recognizes gain or loss from the deemed sale of the 50% interest in each asset of the LLC to B.” Id. In the intervening 10 years, the Commissioner has issued numerous letter rulings consistent with, and relying on, his interpretation in Rev. Rul. 99-5, supra, that a transfer by the owner of all or a part of his interest in a single-member disregarded entity is to be treated as the transfer by the owner of a proportional interest in the entity’s assets.3 Rev. Rul. 99-5, supra, and the letter rulings are cited not as precedent, see sec. 6110(k)(3), but to show the Commissioner’s consistency over a decade in disregarding the wrapper and treating the transfer of an interest in a single-member disregarded entity as a transfer of an interest in the disregarded entity’s assets, see, e.g., Hanover Bank v. Commissioner, 369 U.S. 672, 686 (1962) (“[Private letter] rulings do reveal the interpretation put upon the statute by the agency charged with the responsibility of administering the revenue laws.”). Granted, the interpretations address sales and other dispositions for purposes of the income tax, and the Commissioner apparently has made no interpretation particular to section 2501(a) and the gift tax. Yet, as the Court of Appeals for the District of Columbia Circuit recently observed in Murphy v. IRS, 493 F.3d 170, 185 (D.C. Cir. 2007) (admittedly an income tax case, but the court was speaking generally about gifts): “A gift is the functional equivalent of a below-market sale”. See also sec. 25.2512-8, Gift Tax Regs. (“Transfers reached by the gift tax * * * embrace * * * sales, exchanges, and other dispositions of property for * * * [an inadequate] consideration”.). Simply put, the difference between a sale and a gift is a difference in degree, not in kind. Given the assumed ambiguity of the activities instruction in section 301.7701-2(a), Proced. & Admin. Regs., and the deference we show to the Secretary’s construction of his regulations, I accept respondent’s reading of the activities instruction as a plausible construction. That is, because petitioner elected to treat Pierre LLC as a disregarded entity, petitioner is properly “treated as transferring cash and marketable securities, as opposed to Pierre LLC interests, for federal gift tax purposes.” I next consider the validity of the regulation. IV. Chevron Deference I review the validity of the regulation because, although the majority denies that it seeks to invalidate the regulation, I believe that it does not simply reject the meaning respondent ascribes to the activities instruction but, rather, accepts that meaning and rejects the activities instruction itself as an invalid construction of the statute.4  The validity of the check-the-box regulations, at least as they applied to imposing employment tax obligations directly on the owner of a single-member disregarded entity, has been upheld by this Court, Med. Practice Solutions, LLC v. Commissioner, 132 T.C. 125 (2009), and two U.S. Courts of Appeals, McNamee v. Dept. of the Treasury, 488 F.3d 100 (2d Cir. 2007), and Littriello v. United States, 484 F.3d 372 (6th Cir. 2007).5 Barring stipulation to the contrary, appeal of this case will lie to the Court of Appeals for the Second Circuit. See sec. 7482(b)(1)(A), (2). In McNamee, the taxpayer had elected to treat his single-member LLC as a disregarded entity. The Commissioner sought to recover employment taxes from the taxpayer that the LLC had failed to pay, on the ground that the LLC was disregarded for Federal tax purposes. The taxpayer objected that no regulation could deprive him of the protection from liability that local law afforded him as a member of an LLC and argued that the check-the-box regulations “‘directly contradict the relevant statutory provisions of the Internal Revenue Code’”. McNamee v. Dept. of the Treasury, supra at 104. The relevant statutory provisions were the first three paragraphs of section 7701(a), defining the terms “Person”, “Partnership”, and “Corporation”. Id. at 106.6  In upholding the check-the-hox regulations against challenge in McNamee v. Dept. of the Treasury, supra at 105, the Court of Appeals applied the following standard: In reviewing a challenge to an agency regulation interpreting a federal statute that the agency is charged with administering, the first duty of the courts is to determine “whether the statute’s plain terms ‘directly addres[s] the precise question at issue.’” National Cable & Telecommunications Ass’n v. Brand X Internet Services, 545 U.S. 967, 986 * * * (2005) * * * (quoting Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 843 * * * (1984)). “If the statute is ambiguous on the point, we defer ... to the agency’s interpretation so long as the construction is ‘a reasonable policy choice for the agency to make.’” National Cable, 545 U.S. at 986 * * * (quoting Chevron, 467 U.S. at 845 ***).*** The Court of Appeals found the definitions ambiguous with respect to the classification of single-member LLCs. Id. at 106-107. Emphasizing the taxpayer’s choice in having his LLC disregarded or treated as a corporation, the court concluded that the check-the-box regulations “[provided] a flexible response to a novel business form” and “are [not] arbitrary, capricious, or unreasonable.” Id. at 109. In other words, notwithstanding the protection from the liabilities of his LLC that Mr. McNamee enjoyed under local law, see id. at 107, nothing in the relevant section 7701(a) definitions deprived the Secretary of the authority to write a regulation permitting Mr. McNamee to waive that protection, at least as it pertained to the employment tax liabilities of the entity, in exchange for escaping the double taxation that would result if he failed to make that waiver, see id. at 109, 111. The Court of Appeals thus rejected Mr. McNamee’s contention that the limited liability rights he enjoyed under local law protected him from the Commissioner’s action to collect his LLC’s unpaid payroll taxes. Id. at 111. Contrary to the majority’s suggestion that State law, not Federal law, defines for valuation purposes under the Federal gift tax the property rights and interests a donor transfers (see majority op. p. 35), McNamee v. Dept. of the Treasury, supra, stands for the proposition that Federal law, in the form of the check-the-box regulations, does define the property rights and interests so transferred. In other words, the Court of Appeals in McNamee construed the check-the-box regulations to modify the bundle of rights that Mr. McNamee enjoyed under local law and that constituted ownership of the LLC. We are not at this point discussing the meaning of the activities instruction, having settled that in section III., supra, of this separate opinion. We are considering only the validity of the regulation, section 301.7701-2(a), Proced. & Admin. Regs., setting forth that instruction. In the light of McNamee v. Dept. of the Treasury, supra,7 I find that the first three paragraphs of section 7701(a), which, as in that case, appear to be the relevant statutory provisions, do not plainly speak to the question of whether, for gift tax purposes, the Secretary may write a regulation requiring that the wrapper be disregarded in determining what property the owner of a single-member disregarded entity transfers when she transfers an interest in the entity. As to the question of what constitutes the bundle of rights enjoyed by the owner of a single-member disregarded entity, the Court of Appeals clearly stated that, at least for payroll tax purposes (under the preamendment version of the regulation), the limited liability that local law accorded the owner is ignored. McNamee v. Dept. of the Treasury, supra at 111. Indeed, section 301.7701-l(a)(l), Proced. & Admin. Regs., provides: “Whether an organization is an entity separate from its owners for federal tax purposes is a matter of federal tax law and does not depend on whether the organization is recognized as an entity under local law.” If the definitions in section 7701(a)(1) through (3) are consistent with disregarding one right in the bundle of rights enjoyed by the owner of a single-member disregarded entity, why are they not consistent with disregarding more than one right in that bundle; indeed, why are they not consistent with disregarding the entirety of the bundle (i.e., the wrapper) that separates the owner from the underlying assets? McNamee thus convinces me that, in the context of this case, the check-the-box regulations are not arbitrary, capricious, or unreasonable, and, therefore, are valid. As I point out in section III., supra, of this separate opinion, the Commissioner has plainly taken the position that, pursuant to the check-the-box regulations, for purposes of the income tax, the wrapper is disregarded and the owner of a single-member disregarded entity transferring an interest in the entity is deemed to transfer an interest in the underlying assets of the entity. Neither petitioner nor the majority suggests that transfers of interests in single-member disregarded entities cannot be treated as described. While the income tax provisions of the Internal Revenue Code are not to be construed as though they were in pari materia with the gift tax provisions, Farid-Es-Sultaneh v. Commissioner, 160 F.2d 812, 814 (2d Cir. 1947), revg. 6 T.C. 652 (1946), there is nothing in the definitions in section 7701(a)(1) through (3) of “Person”, “Partnership”, and “Corporation” that indicates that those terms should have different meanings for purposes of the income and gift tax provisions of the Internal Revenue Code. While the majority does not acknowledge that it is addressing the validity of the check-the-box regulations, I believe that it is rejecting the activities instruction as an invalid construction of the statute. See supra note 4 and accompanying text. Its reason for doing so is that “the Commissioner cannot by regulation overrule the historical Federal gift tax valuation regime contained in the Internal Revenue Code and substantial and well-established precedent in the Supreme Court, the Courts of Appeals, and this Court”. Majority op. p. 36. While certainly the Secretary cannot by regulation overrule the Internal Revenue Code, judicial construction of a statute must, except in one instance, give way to later administrative construction: A court’s prior judicial construction of a statute trumps an agency construction otherwise entitled to Chevron deference only if the prior court decision holds that its construction follows from the unambiguous terms of the statute and thus leaves no room for agency discretion. * * * [Natl. Cable & Telecomms. Association v. Brand X Internet Servs., 545 U.S. 967, 982 (2005).] Moreover, while application of the check-the-box regulations to section 2501(a) may well result in a radical departure from settled rules, as the majority suggests, see majority op. p. 35, the majority fails to acknowledge that, at the time of their adoption, the check-the-box regulations represented a radical departure for income tax purposes from prior caselaw and regulatory precedent, beginning with the seminal Supreme Court case of Morrissey v. Commissioner, 296 U.S. 344 (1935). The Supreme Court in Morrissey used various factors to classify business trusts as either true trusts or associations taxable as corporations (associations). Subsequent regulations extended the factors approach to the classification of other business entities. The check-the-box regulations, in effect, overrule Morrissey by providing that, with certain exceptions, an unincorporated organization comprising two or more associates may elect its classification, as a partnership or corporation, for Federal tax purposes, regardless of the number of corporate characteristics it possesses under State (or foreign) law. Moreover, the right of an unincorporated single-member organization with a preponderance of corporate characteristics, which constitutes an entity separate from its owner under State (or foreign) law, to elect to be disregarded for Federal income tax purposes was unprecedented under the then-existing law.8 The check-the-box regulations thus constituted a radical departure from existing jurisprudence that prompted many commentators to question their validity. See Dover Corp. & Subs. v. Commissioner, 122 T.C. 324, 331 n.7 (2004). That concern has been put to rest by McNamee v. Dept. of the Treasury, 488 F.3d 100 (2d Cir. 2007), Littriello v. United States, 484 F.3d 372 (6th Cir. 2007), and Med. Practice Solutions, LLC v. Commissioner, 132 T.C. 125 (2009), all of which concerned single-member disregarded entities. If the check-the-box regulations trump Supreme Court precedent regarding the role of State law in determining entity classification for Federal income or employment tax purposes, then surely they must also supersede judicial precedent respecting State law concepts of property rights for Federal gift (and estate) tax purposes. Yet that is precisely the conclusion the majority denies. Respondent’s interpretation of section 301.7701-2(a), Proced. & Admin. Regs., is a valid construction of section 7701(a)(1) through (3). V. Conclusion As stated above, section 2501(a) imposes a tax on the transfer of property by gift and section 2512(a) provides that the amount of a gift of property is the value of the property on the date of the gift. We are here required to identify for purposes of those provisions the property petitioner transferred when she conveyed two 9.5-percent interests in Pierre LLC to two trusts. Respondent argues that, because petitioner elected to treat Pierre LLC as a disregarded entity, she is properly treated as transferring two 9.5-percent undivided interests in the LLC’s assets rather than two 9.5-percent interests in the LLC itself. Respondent relies on the check-the-box regulations as authority to so identify the property petitioner transferred. After applying traditional tools of statutory and regulatory construction to the pertinent language of the regulations, I agree with respondent as to the identity of the property transferred. In conclusion, I note that, when identifying the property transferred for purposes of the gift tax, applying the check-the-box regulations in the manner respondent construes them will not always be adverse to taxpayers. If the donor transfers a controlling interest in her single-member disregarded entity holding, say, real property, the discount attaching to the undivided interest in the real property deemed transferred may exceed the discount, if any, attaching to the controlling interest nominally transferred.9 The check-the-box regulations put the choice of entity classification in the hands of the taxpayer. That the taxpayer bears any burden along with the benefits seems only fair. Kroupa and Holmes, JJ., agree with this dissenting opinion.   Treating the transfer of an interest in a single-member disregarded entity as a transfer of an interest in the entity’s assets is in no way inconsistent with applying the “willing buyer, willing seller” standard for valuation purposes, see sec. 25.2512-1, Gift Tax Regs., as Judge Cohen suggests in her concurring opinion, p. 37. The willing buyer and willing seller are purely hypothetical figures. See Estate of Newhouse v. Commissioner, 94 T.C. 193, 218 (1990). That the hypothetical willing buyer is deemed to purchase an interest in the entity’s assets (to value a hypothetical gift of that interest) is not inconsistent with the fact that a real buyer (and, by extension, a donee) would receive an interest in what has become a two-member unincorporated entity; i.e., for Federal tax purposes, a partnership. See sec. 301.7701-3(0(2), Proced. & Admin. Regs. Thus, respondent’s position does not require the real buyer to disregard the LLC, for it is an interest in an LLC with which he winds up.    In Lantz v. Commissioner, 132 T.C. 131, 151 (2009) (Halpern, J., dissenting), I dismissed the Commissioner’s interpretation of sec. 301.9100-l(c), Proced. & Admin. Regs., as no more than a litigating position without merit, since it was “‘plainly erroneous’ and ‘inconsistent with the regulation’ ”. That is not so here.    E.g., Priv. Ltr. Rul. 200825008 (Mar. 7, 2008) (limited partnership’s distribution of membership interests in LLC, a single-member disregarded entity, “will be treated as a distribution of LLC’s assets and liabilities to the Partners”); Priv. Ltr. Rul. 200824009 (Mar. 6, 2008) (trust’s distribution to beneficiaries A and B of interests in X, a single-member disregarded entity, “should have been treated as a non-taxable pro rata distribution of d% of Xs assets to A and e% of Xs assets to B * * * as if such assets had been distributed outright from Trust to A and B“); Priv. Ltr. Rul. 200709036 (Nov. 28, 2006) (“Although Taxpayer transferred its interest in * * *, a disregarded entity, the sale of such interest is treated as a sale of the assets of the disregarded entity for federal income tax purposes.”); Priv. Ltr. Rul. 200251008 (Sept. 11, 2002) (For purposes of sec. 1031 like-kind exchange provisions: “[TJransfer of all the interest in * * * [disregarded entity] will be treated as a transfer of the assets of * * * [disregarded entity].”).    The majority at least conditionally accepts respondent’s reading of the check-the-box regulations: “If the check-the-box regulations are interpreted and applied as respondent contends, they go far beyond classifying the LLC for tax purposes.” Majority op. p. 35. Indeed, the majority speculates that the result of respondent’s reading would be to “[overturn] the long-established Federal gift tax valuation regime * 5:5 * as to single-member LLCs”. Majority op. p. 35. That, the majority concludes, “would be ‘manifestly incompatible’ with the Federal estate and gift tax statutes as interpreted by the Supreme Court. See sec. 7701.” Majority op. p. 35. The majority thus seems to accept respondent’s reading of the check-the-box regulations but to conclude that that reading, and thus the activities instruction itself, is invalid because “manifestly incompatible” with the Internal Revenue Code. In this section of this separate opinion, I show that the regulation in issue, including the activities instruction, is a valid interpretation of the statute. In sec. III., supra, of this separate opinion, I have set forth the reasons respondent’s reading of that regulation must be accepted.    For employment taxes related to wages paid on or after Jan. 1, 2009, a disregarded entity is treated as a corporation for purposes of employment tax reporting and liability. Sec. 301.7701-2(c)(2)(iv), Proced. & Admin. Regs.    In pertinent part, sec. 7701(a) provides as follows: SEC. 7701. DEFINITIONS. (a) When used in this title, where not otherwise distinctly expressed or manifestly incompatible with the intent thereof— (1) Person. — The term “person” shall be construed to mean and include an individual, a trust, estate, partnership, association, company or corporation. (2) Partnership —The term “partnership” includes a syndicate, group, pool, joint venture, or other unincorporated organization, through or by means of which any business, financial operation, or venture is carried on, and which is not, within the meaning of this title, a trust or estate or a corporation * * (3) Corporation. — The term “corporation” includes associations * * *    In considering the persuasive value of another court’s opinion, we must consider not only the result but the rationale for that result. See Seminole Tribe of Fla. v. Florida, 517 U.S. 44, 67 (1996) (“When an opinion issues for the Court, it is not only the result but also those portions of the opinion necessary to that result by which we are bound.”).    See, e.g., Hynes v. Commissioner, 74 T.C. 1266, 1286 (1980) (State law trust with a single beneficiary classified as an association because it possessed a preponderance of corporate characteristics, including associates and a joint profit motive); Barnette v. Commissioner, T.C. Memo. 1992-371 (German GmbH wholly owned by U.S. corporation classified as an association because it possessed a preponderance of the remaining four corporate characteristics after disregarding the two corporate characteristics absent from both one-man corporations and sole proprietor-ships; viz, “associates” and an objective to carry on a business for “joint” profit), affd. without published opinion 41 F.3d 667 (11th Cir. 1994); see also Wirtz & Harris, “Tax Classification of the One-Member Limited Liability Company”, 59 Tax Notes 1829 (June 28, 1993).    Here it appears that petitioner has not claimed a discount on account of any undivided interest in property transferred.