Tax Briefs Oct 12 2021
IRS clarifies extension timeframes for COBRA Premium Elections and Payments; Interim Final Rules Implement Provisions of the No Surprises Act; Former Wife Is Entitled to Innocent Spouse Relief; Promoter of Offshore Trusts Liable for Penalties ...
Second Circuit Shoots Down States' Constitutional Challenges to SALT Deduction Cap
The Second Circuit affirmed a district court's ruling rejecting four states' constitutional challenges to the $10,000 limit on the deduction for state and local taxes (SALT) under Code Sec. 164(b)(6) enacted by the Tax Cuts and Jobs Act. The court found that the SALT deduction is not constitutionally mandated and that the $10,000 cap on the deduction is a valid exercise of Congress's authority to influence tax policy rather than an unconstitutional coercion to change the states' fiscal policies. State of New York v. Yellen, 2021 PTC 323 (2d Cir. 2021).
Tax Court Allows Alimony Deduction for Health Insurance Purchased with Pre-Tax Earnings
The Tax Court held that neither the double deduction common law principle nor Code Sec. 265 applies to prevent the deduction of alimony where a married couple separated and, pending a final decree of divorce, created an agreement that included continued health care coverage as provided by the payor spouse's employer, the premiums of which were properly excluded from the payor's gross income and included in the recipient spouse's gross income under pre-TCJA rules. Thus, a taxpayer who was paying alimony relating to a pre-2019 divorce decree was entitled to deduct an amount equal to the alimony payments from his gross income. Leyh v. Comm'r, 157 T.C. No. 7 (2021).
Court Rejects Government Attempt to Value Gifts Using Estate Tax Rules
A district court denied a government motion for partial summary judgment on the question of whether discounts are appropriate in valuing gifts of partial interests in timberland properties for federal gift tax purposes. The court rejected the government's argument that, if there would be no discount in determining the value of property for purposes of the estate tax, the interests in the property should be aggregated and there should be no discount in determining the value of those interests for gift tax purposes. Buck, 2021 PTC 309 (D. Conn. 2021).
IRS Can't Assess Underpayment Interest Where Overpayment Credits Exceed Deficiency
The Fifth Circuit affirmed a district court's ruling that the statutory interest portion of proceeds awarded to a taxpayer in connection with the disposition of her stock in a corporation via a cash-out merger was properly classified as taxable interest income. However, on an issue of first impression, the Fifth Circuit reversed the district court and held that the IRS improperly assessed underpayment interest on the taxpayer's later-determined deficiency during a period where the IRS had use of enough credit-elect overpayment funds to satisfy that deficiency throughout the interest assessment period. Goldring v. U.S., 2021 PTC 319 (5th Cir. 2021).
Court Denies Refund Claim Because Taxpayer Missed Deadline for Changing Filing Status
A district court held that the IRS properly denied a taxpayer's claim for a refund because her claim, filed on an amended return, sought to change her filing status from married filing separately to married filing jointly outside of the three-year period for changes of election status in Code Sec. 6013(b). The court concluded that the three-year period for changing a taxpayer's filing status applies without regard to any extensions and cannot be read to contain an equitable tolling provision. Huff-Rousselle v. U.S., 2021 PTC 299 (D. Mass. 2021).
IRS Can't Setoff Bankrupt Farm's Overpayment Against Post-Petition Taxes
A district court affirmed a bankruptcy court's ruling in a chapter 12 bankruptcy and held that the IRS did not have the right to set off the debtor's refund of post-petition taxes under 11 U.S.C. Section 1232(a) against the government's general unsecured claim for taxes arising from the debtor's sale of farm assets. The court concluded that the debtors were allowed to de-prioritize all of their liabilities to which Section 1232 applied, not just a portion, and that allowing the setoff would violate the terms of the confirmed plan. U.S. v. Richards, 2021 PTC 313 (S.D. Ind. 2021); 2021 PTC 314 (S.D. Ind. 2021).
Employee Benefits
IRS clarifies extension timeframes for COBRA Premium Elections and Payments: In Notice 2021-58, the IRS explains the application of prior guidance which extended the timeframes regarding elections and payments of Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) premiums during the COVID-19 National Emergency. The notice provides that the disregarded period for an individual to elect COBRA continuation coverage and the disregarded period for the individual to make initial and subsequent COBRA premium payments generally run concurrently.
Healthcare
Interim Final Rules Implement Provisions of the No Surprises Act: In T.D. 9955, the Treasury Department issued interim final rules implementing certain provisions of the No Surprises Act, which was enacted as part of the Consolidated Appropriations Act, 2021. These interim final rules implement provisions that provide for a federal independent dispute resolution process to permit group health plans and health insurance issuers offering group or individual health insurance coverage and nonparticipating providers, facilities, and providers of air ambulance services to determine the out-of-network rate for items and services that are emergency services, nonemergency services furnished by nonparticipating providers at participating facilities, and air ambulance services furnished by nonparticipating providers of air ambulance services, under certain circumstances.
Innocent Spouse Relief
Former Wife Is Entitled to Innocent Spouse Relief: In Todisco v. Comm'r, T.C. Summary 2021-35, the Tax Court held that a couple, who divorced in 2016 but filed joint tax returns for 2010 and 2015, was not entitled to deduct in 2010 unreimbursed employee business expenses incurred by the husband when traveling away from home to work on construction projects. The court also granted innocent spouse relief to the former wife after concluding that it would be inequitable to hold her liable for the deficiencies attributable to understatements of tax for 2010 and 2015 because she did not know and had no reason to know of the items giving rise to the understatements.
Penalties
Promoter of Offshore Trusts Liable for Penalties: In Crim v. Comm'r, T.C. Memo. 2021-117, the Tax Court upheld a notice of intent to levy issued by the IRS in a collection due process case involving penalties of more than $250,000 assessed against an individual who promoted a tax shelter scheme involving domestic and offshore trusts and falsely represented to taxpayers that these shelters could be used to eliminate their federal tax liabilities. The court concluded that the IRS settlement officer in charge of the case did not abuse his discretion in determining that the individual was ineligible for collection relief.
Fraud Penalties Apply to Auto Body Repair Shop Owner Who Failed to Report Income: In Clark v. Comm'r, T.C. Memo. 2021-114, the Tax Court held that a taxpayer who owned an auto body shop, rental properties, a large home, and numerous trucks, automobiles, and utility vehicles, but who reported taxable income of $114 one year and $0 for three years had fraudulently underreported his income. The court rejected the argument by the taxpayer's lawyer that the taxpayer lacked the sophistication and acumen to purposefully underreport his income and agreed with the IRS that the taxpayer was liable for the tax deficiencies at issue as well as fraud penalties assessed under Code Sec. 6663 for each of the years at issue.
Procedure
IRS Proposes Increase for Special Enrollment Examination for Enrolled Agents: In REG-100718-21, the IRS issued proposed regulations which would increase the amount of the user fee for each part of the special enrollment examination for enrolled agents from $81 per part to $99 per part. The proposed regulations also remove the user fee for the special enrollment examination for enrolled retirement plan agents (ERPA SEE) because the IRS no longer offers the ERPA SEE or new enrollment as an enrolled retirement plan agent.
Tax Court Upholds Rejection of Whistleblower's Award: In McCrory v. Comm'r, T.C. Memo. 2021-116, the Tax Court sustained the rejection by the IRS Whistleblower Office (WBO) of 19 whistleblower claims filed by the taxpayer. The court concluded that, while the taxpayer's concerns about the accuracy of third-party income reporting might be sincere, the administrative record established that the WBO did not abuse its discretion with respect to her whistleblower claims.
Second Circuit Shoots Down States' Constitutional Challenges to SALT Deduction Cap
The Second Circuit affirmed a district court's ruling rejecting four states' constitutional challenges to the $10,000 limit on the deduction for state and local taxes (SALT) under Code Sec. 164(b)(6) enacted by the Tax Cuts and Jobs Act. The court found that the SALT deduction is not constitutionally mandated and that the $10,000 cap on the deduction is a valid exercise of Congress's authority to influence tax policy rather than an unconstitutional coercion to change the states' fiscal policies. State of New York v. Yellen, 2021 PTC 323 (2d Cir. 2021).
Background
The state and local tax deduction under Code Sec. 164 has long permitted taxpayers to deduct from their taxable income all the money paid in state and local income and property taxes (SALT). In 2017, however, Congress passed the Tax Cuts and Jobs Act (TCJA) (Pub. L. 115-97) which added Code Sec. 164(b)(6). That provision imposes a $10,000 cap on the SALT deduction (SALT deduction cap). The immediate impact of the new cap was felt most acutely in states where the state and local tax liability of residents often exceeds the $10,000 maximum. Four of the states most affected - New York, Connecticut, New Jersey, and Maryland - sued the federal government in a district court, asserting that the SALT deduction cap either is unconstitutional on its face or that it unconstitutionally coerces them to abandon their preferred fiscal policies. In State of New York v. Mnuchin, 2019 PTC 375 (S.D. N.Y. 2019), the district court dismissed the states' complaint for failure to state a claim. The states appealed to the Second Circuit.
The states argued that the SALT cap is unconstitutional because, under the Sixteenth Amendment, a deduction is required for all or a significant portion of state and local taxes. According to the states, Congress was constitutionally foreclosed from eliminating or curtailing the SALT deduction because it had never done so until 2017. The states contended that principles of federalism protect each state's sovereign authority to raise revenue and determine their own fiscal priorities and bar the federal government from crowding states out of traditional revenue sources. The states further argued that the SALT cap violated the Tenth Amendment by coercing them to abandon their preferred fiscal policies in favor of lower taxes and reduced spending. According to the states, their taxpayers were likely to bear the brunt of the SALT deduction cap as a disproportionate share of their taxpayers' state and local tax burdens exceed the $10,000 maximum. The states argued that the cap therefore increased the effective cost of state and local property taxes, making homeownership more expensive, depressing home equity values, and leading to job losses in their states.
The government argued that the states lacked standing because their claims of lost tax revenues as a result of the SALT cap were a generalized grievance that is not cognizable for purposes of standing. It also asserted that the states' lawsuit was barred by the Anti-Injunction Act, codified in Code Sec. 7421(a), which prohibits lawsuits brought for the purpose of restraining the assessment or collection of any tax.
Analysis
The Second Circuit affirmed the judgment of the district court. First, the Second Circuit found that the states had standing and that their claims were not barred by the Anti-Injunction Act. In the court's view, the states' loss of tax revenues as a result of a decrease in the frequency and price at which taxable real estate transactions occur was a specific injury that sufficed to support standing. The court also found that the Anti-Injunction Act applies only when Congress has provided an alternative legal avenue to challenge the validity of a tax and concluded that the states had no alternative avenue other than to bring an action in a federal court.
Turning to the merits, the court rejected the states' Sixteenth Amendment argument after finding that they failed to show how the SALT deduction cap unconstitutionally undermined their state sovereign authority over fiscal matters or their ability to raise revenue. In the court's view, the states failed to plausibly allege that their taxpayers' total federal tax burden is now so high that they cannot fund themselves. The court said that while the states argued that the SALT deduction lowers "the effective cost of state and local taxes," the states pointed to nothing that compelled the federal government to protect taxpayers from the true costs of paying their state and local taxes.
The court rejected the states' argument that Congress's power to limit the deduction is subject to constitutional limitations. The court explained that even if the Constitution is silent, a limitation on Congress's power can be inferred from historical understanding and practice. The court noted that there have long been individual legislators who believed the SALT deduction reflected good tax policy and equitably divided scarce resources between the federal government and the states, but found that their voices had over time been drowned out by the overall statutory history of the deduction. For instance, in 1986, Congress eliminated the deduction for state and local sales taxes, and curtailed the deduction again in 1990 when it introduced the so-called Pease limitation which reduced the deduction amount for taxpayers with adjusted gross incomes exceeding certain specified thresholds. The court inferred from these changes that, prior to 2017, Congress did not view its authority to limit the SALT deduction as subject to any relevant constitutional constraints.
The court also found that the states failed to state a Tenth Amendment claim. The court explained that Congress may use its taxing and spending authority to influence states' policy choices but that such pressure may not amount to compulsion. The court observed that the Supreme Court has only once - in National Federation of Independent Business v. Sebelius (NFIB), 2012 PTC 167 (S. Ct. 2012) - deemed a condition unconstitutionally coercive in violation of the Tenth Amendment. In NFIB, the issue was Congress's threat to withhold all of a state's Medicaid grants unless the state accepted expanded funding and complied with the conditions that came with it. The Second Circuit said that two factors especially drove the result in NFIB. First, Congress had required that the states comply with the conditions to receive not only new Medicaid funding but also Medicaid funding (upon which the states had come to rely) that would have been available even under the preexisting regulatory scheme. Second, Congress had threatened to withhold funds constituting over 10 percent of state budgets.
The Second Circuit agreed with the district court that the states were making an improper comparison by alleging that their taxpayers will pay hundreds of millions of dollars in additional federal taxes, relative to what they would have paid had Congress enacted TCJA without the SALT cap. In the court's view, this told it nothing about the actual financial effects of cap on the states' taxpayers. Moreover, the court found that even if such a comparison were instructive, the cost to individual taxpayers paled in comparison to the threatened deprivation of 10 percent of the states' budgets at issue in NFIB. The court said there were similar problems with the states' claims regarding the effect of the SALT cap on home equity values. While the states contended that the cap could cause home equity values in New York state alone to plummet by over $60 billion, in-state spending to decrease by $1.26 to $3.15 billion, and the economy to lose up to 31,300 jobs, the court said that without baseline figures to put these numbers in context, it was implausible that the amounts in question gave rise to a constitutional violation.
ates' argument that the SALT deduction cap violated the principle of equal sovereignty among the states and unfairly targeted them. The court reasoned that the outsized effect of the cap on the states arose only because those states previously benefited most from the SALT deduction, not because the cap applies to some states and not others. In the court's view, the SALT deduction cap is not unlike countless federal laws whose benefits and burdens are unevenly distributed across the country and among the states. The court conclude that at most, the states' allegations reflected that lawmakers were focused on the permissible legislative purpose of influencing tax policy.
Tax Court Allows Alimony Deduction for Health Insurance Purchased with Pre-Tax Earnings
The Tax Court held that neither the double deduction common law principle nor Code Sec. 265 applies to prevent the deduction of alimony where a married couple separated and, pending a final decree of divorce, created an agreement that included continued health care coverage as provided by the payor spouse's employer, the premiums of which were properly excluded from the payor's gross income and included in the recipient spouse's gross income under pre-TCJA rules. Thus, a taxpayer who was paying alimony relating to a pre-2019 divorce decree was entitled to deduct an amount equal to the alimony payments from his gross income. Leyh v. Comm'r, 157 T.C. No. 7 (2021).
Background
In 2012, Charles Leyh filed for divorce in Pennsylvania from his then wife, Cynthia Leyh. The couple filed and signed an agreement in 2014 (i.e., the 2014 agreement) incident to their divorce proceedings in which Charles agreed to pay Cynthia alimony until the divorce was finalized. As part of the 2014 agreement, Charles said he would pay for Cynthia's health and vision insurance. Charles's employer offered a cafeteria plan under which employees could use pre-tax earnings to pay for health-related benefits, such as health and vision insurance. In 2015, under this cafeteria plan, Charles paid $10,683 for Cynthia's health insurance premiums as pretax payroll reductions from his wages (alimony payments).
On his 2015 Form 1040, Charles excluded from his gross income the total amount of health care coverage premiums he and Cynthia received through his employer's cafeteria plan (health insurance compensation) and also claimed an alimony deduction for the alimony payments. The IRS audited Charles's 2015 tax return and issued a notice of deficiency after disallowing Charles's deduction for the alimony payments and determining a Code Sec. 6662(a) accuracy-related penalty.
Observation: Generally, effective for any divorce or separation instrument executed before January 1, 2019, amounts received as alimony or separate maintenance payments are includible in income in the year received (pre-2019 Code Sec. 71) and are deductible by the payor in the same year (pre-2019 Code Sec. 215). The Tax Cut and Jobs Act of 2017 (TCJA) repealed Code Sec. 71 and Code Sec. 215. Thus, effective for any divorce or separation instrument executed after December 31, 2018, or for any divorce or separation instrument executed on or before December 31, 2018, and modified after that date (if the modification expressly provides that the TCJA changes apply to such modification), alimony and separate maintenance payments are excluded from the payee's income and no deduction is allowed to the payer.
Before the Tax Court, the IRS argued that permitting the alimony deduction in this instance created a "windfall" to Charles by granting him the practical equivalent of multiple deductions for the same economic outlay. The IRS also cited S. Rept. No. 77-1631, at 83 (1942), and a statement from the Senate Finance Committee describing the creation of the alimony deduction as an attempt by Congress to relieve a payor-spouse from the tax burden of whatever part of an alimony payment was "includible in the payor's gross income."
Analysis
The Tax Court held that Charles was entitled to deduct, as alimony, an amount equal to the premiums paid to provide health insurance coverage for Cynthia. The court noted that Charles received the health insurance compensation while Cynthia was still considered his spouse as Pennsylvania law recognizes only divorce, not legal separation, and a final decree of divorce was not granted until 2016.
The court observed that, as a married couple awaiting a final decree of divorce under Pennsylvania law, Charles and Cynthia could have chosen to file a joint return for 2015 and avoid the alimony regime altogether. If they had, the court said, they would have had an exclusion from gross income equal to the amount of the health insurance compensation, no alimony deduction for that amount, and no alimony income inclusion for that amount. Instead, the couple chose to file separately and treat the alimony payments as alimony. But for the alimony regime, Cynthia would not have been required to include any portion of the alimony payments in her gross income. It follows, the court said, that, per the general matching design of the alimony regime, if Cynthia was required to include the alimony payments in her income, then Charles should be permitted a corresponding deduction for those payments to preserve this equilibrium. In other words, Charles's alimony deduction should be properly viewed as being matched against Cynthia's alimony income, not against his excluded wage income.
In response to the IRS's argument that Charles would receive a windfall if the alimony deduction was allowed, the court noted that there was no such risk of a windfall to Charles because disallowing the alimony deduction in this circumstance would instead leave Charles with a greater tax burden and that would run counter to the intended purpose and operation of the general alimony regime as previously interpreted by the Tax Court.
With respect to the IRS's argument regarding comments in the alimony sections of the Senate Finance Committee Report, the Tax Court agreed that those sections clearly state that a payor of alimony may deduct such expenses to the extent they constitute alimony and are includible in the recipient's gross income. The court noted that the IRS recognized that these elements were present in Charles's case by conceding that the alimony payments met the Code Sec. 71(b) definition of alimony and would otherwise be deductible under Code Sec. 62 and Code Sec. 215 but for Charles's exclusion of the health insurance compensation from his gross income. However, with respect to the IRS's concern that Charles's situation might create an unanticipated statutory "loophole" (which the court did not believe was the case in Charles's situation), the court said it would be up to Congress, not the IRS or the Tax Court, to retroactively address this issue. This legislative history, the court said, cannot be read to override the plain text of Code Sec. 62, Code Sec. 215, and Code Sec. 71 by interpreting these comments as imposing a precondition not present in the statutes themselves. According to the court, these sections are clear that a payor of alimony may deduct such expenses to the extent they constitute alimony and are includible in the recipient's gross income.
Finally, the court noted that it was unaware of, and the IRS had not directed it to, any case in which an alimony deduction has been disallowed on the basis of the double deduction principle as codified in Code Sec. 265. This common law doctrine, the court observed, has been limited to instances in which a taxpayer has attempted to claim the practical equivalent of multiple deductions for the same
Court Rejects Government Attempt to Value Gifts Using Estate Tax Rules
A district court denied a government motion for partial summary judgment on the question of whether discounts are appropriate in valuing gifts of partial interests in timberland properties for federal gift tax purposes. The court rejected the government's argument that, if there would be no discount in determining the value of property for purposes of the estate tax, the interests in the property should be aggregated and there should be no discount in determining the value of those interests for gift tax purposes. Buck, 2021 PTC 309 (D. Conn. 2021).
Background
Between 2009 and 2013, Peter Buck purchased $82,853,050 in tracts of timberland in upstate Maine and Vermont. From 2010 to 2013, he gifted interests in these tracts to his two sons, Christopher and William. Each son received a 48 percent interest in each tract, while Buck retained a 4 percent interest for himself.
Under Code Sec. 2501, a gift tax is imposed for each calendar year on the transfer of property by gift by U.S. citizens, U.S. residents, and nonresident aliens. For gift tax purposes, Code Sec. 2512(a) provides that the value of the transferred property on the date of a gift is considered the amount of the gift. Reg. Sec. 25.2512-1 provides that this value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts.
Each year, from 2010 to 2013, Buck reported and paid gift tax on the transfers to his sons as two separate gifts, each representing the gifted 48 percent interest in given tracts. He valued the gifts using discounts meant to account for the possibility that the interests were less valuable to hypothetical buyers than they might be otherwise. While the combined purchase price of the properties was $82,853,050, Buck declared the discounted value of each 48 percent fractional interest to be $18,496,249, a total of $36,992,498 for the gifts to his two sons. This represented a 55 percent discount from the total purchase price.
The IRS challenged Buck's valuations and issued a deficiency notice with respect to Buck's United States Gift (and Generation-Skipping Transfer) Tax Returns (Forms 709) for tax years 2010 - 2013. For 2010 through 2013, the IRS determined an increase in gift tax, penalties, and interest of approximately $4.3 million, $3.7 million, $775,000, and $774,000, respectively, based on an increase in the value of the gifts. Buck paid the assessment in full and then filed refund claims for the amounts paid. The IRS did not respond to the refund claim.
Buck brought a refund action in district court and asked the court to order the government to refund the alleged overassessment of gift taxes, penalties, and interest. According to Buck, the fractional interests in the tracts of timberland that he gifted to his sons from 2010 to 2013 warranted valuation discounts of at least 40 percent due to the lack of marketability, lack of control, and other factors relevant to those interests. The overarching principle, Buck stated, was that a hypothetical willing buyer, with full knowledge of all relevant facts, would pay significantly less for a minority interest in a tract of timberland where the other interests in the tract are owned by a family whose objective is to hold the tract for the long term and manage it on a break-even basis, and who would vigorously oppose any effort by an outside buyer to partition out the minority interest.
In response, the government moved for partial summary judgment. It asked the court to conclude as a matter of law that no discount should be available for a gift of a fractional interest unless the taxpayer held such interest in fractional form before the gift, rather than viewing several simultaneously gifted portions of the property as fractional interests in the hands of the donor for purpose of valuing the gift. The government argued that gift tax law categorically prohibits such a discount because it is contrary to one of the primary purposes of the gift tax since the value of the property to which the gift tax applies is the fair market value of the properties transferred, minus the portion of each that served to enhance Buck's 4-percent interest. According to the government, it is not appropriate to apply fractional interest discounts in valuing a gift of land to more than one individual; instead the value of each donee's interest is simply the value of the whole times the ownership percentage. Thus, the government suggested that the fractional interests should be combined and valued together, rather than separately.
In support of its position, the government argued that, if the properties at issue passed under a will bequeathing 48 percent interests to each of Buck's sons and 4 percent to a divisee whose bequest would be deductible and thus effectively not taxed, there would be no discounts based on the separate values of the interests received by each son. The government cited three cases, Merrill v Fahs, 324 U.S. 308 (1945), Comm'r v. Converse, 163 F.2d 131 (2d Cir. 1947), and Heringer v. Comm'r, 235 F.2d 149 (9th Cir. 1956), for the proposition that the gift tax and the estate tax are in pari materia and must be construed together so that a transfer of property results in the same tax liability regardless of whether it is a lifetime gift or a transfer at death.
Analysis
The district court denied the government's motion for partial summary judgment on the question of whether discounts are appropriate in valuing gifts of partial interests in timberland properties for federal gift tax purposes. With respect to the cases cited by the government, the district court said that all they supported was (1) the conclusion that the same words appearing in the gift tax statute and the estate tax statute should be understood to have the same meaning, and (2) the conclusion that a taxpayer should not also be required to pay gift tax where the value of property retained by the taxpayer after purportedly making a gift will be included in the taxpayer's gross estate for estate tax purposes. However, the court said, the cases cited did not provide support for the legal conclusion advocated by the government, i.e., that if there would be no discount in determining the value of property for purposes of the estate tax, the interests in the property should be aggregated and there should be no discount in determining the value of those interests for purposes of the gift tax. Under applicable law, the court stated, the gifts at issue were not a single 96 percent interest but two 48 percent interest given to two different donees, and the gifts must be valued separately at the time of transfer.
The government's justifications for urging the court to ignore a material distinction between the gift tax and estate tax regimes fell flat. First, the court said, the government offered an overbroad reading of the "in pari materia" principle of construction, by mistakenly asserting that the transfer of property must result in the same tax liability regardless of whether it is a lifetime gift or a transfer at death. Second, the court said, the government misread the rule that a gift is measured "by the value of the property passing from the donor," mistakenly asserting that it permits aggregation of gifts for valuation purposes. Noting that the case at hand is a gift tax case, the court found absolutely no support for the government's position that the focus of the case should be on the relationship to the estate tax.
IRS Can't Assess Underpayment Interest Where Overpayment Credits Exceed Deficiency
The Fifth Circuit affirmed a district court's ruling that the statutory interest portion of proceeds awarded to a taxpayer in connection with the disposition of her stock in a corporation via a cash-out merger was properly classified as taxable interest income. However, on an issue of first impression, the Fifth Circuit reversed the district court and held that the IRS improperly assessed underpayment interest on the taxpayer's later-determined deficiency during a period where the IRS had use of enough credit-elect overpayment funds to satisfy that deficiency throughout the interest assessment period. Goldring v. U.S., 2021 PTC 319 (5th Cir. 2021).
Background
In 1997, Jane Goldring held 120,000 shares of stock - roughly a 15 percent stake - in Sunbelt Beverage Corporation (Sunbelt), a privately held Delaware corporation. In August of 1997, Sunbelt engaged in a cash-out merger, which resulted in Goldring's Sunbelt shares being cancelled and converted into the right to receive $45.83 per share. Goldring sued Sunbelt and its directors in a Delaware court seeking a rescission of the merger and the restoration of her stake in Sunbelt or, in the alternative, the fair value of her Sunbelt shares as of the merger date plus interest and costs. In 2010, a Delaware court rejected Goldring's request for rescissory relief and instead awarded her the fair value of her shares as of the merger date, which the court determined to be $114.04 per share. The court also awarded Goldring court costs and expert fees. Finally, the Delaware court exercised its statutory discretion to award Goldring interest for the period between the merger date and the date the judgment was paid, calculated at the rate established under Delaware law.
On her 2010 tax return, Goldring reported the entire litigation award as income from the disposition of a capital asset - i.e., her Sunbelt shares - taxable as long-term capital gain. However, Goldring recognized that the IRS might subsequently determine that the interest portion of the award was ordinary income taxable at the higher ordinary income rate, which would render Goldring deficient on her 2010 taxes. In an attempt to avoid assessment of underpayment interest in the event of a later-determined deficiency, Goldring overpaid her reported 2010 tax liabilities by an amount sufficient to cover any later-determined deficiency for the 2010 tax year. She elected under Code Sec. 6402 and Reg. Sec. 301.6402-3(a)(5) to credit the overpayment forward to her estimated 2011 tax liabilities - an action known as a credit-elect overpayment. Goldring continued to make credit-elect overpayments on her tax returns through the 2016 tax year and consistently maintained overpayment balances with the IRS sufficient to cover any potential deficiency for the 2010 tax year.
In 2015, the IRS completed an audit of Goldring's 2010 tax return and determined that the interest award should have been reported as ordinary income. Based on this determination, the IRS concluded that Goldring had underpaid her 2010 taxes by $5,250,549 and issued a notice of deficiency. In August of 2017, the IRS assessed the following amounts against Goldring for the 2010 tax year: (1) the principal deficiency of $5,250,549 (2010 deficiency); and (2) underpayment interest of $603,335. The IRS retroactively satisfied the 2010 deficiency through application of Goldring's existing credit-elect overpayment balances and retroactively assessed underpayment interest. For the period April 15, 2011, through April 15, 2012, the IRS determined that Goldring's credit-elect overpayment for 2010 offset the 2010 deficiency and suspended the running of underpayment interest. However, the 2010 credit-elect overpayment was deemed by the IRS to be applied in payment of Goldring's 2011 tax liabilities on April 15, 2012, and was no longer available for offset against the 2010 deficiency moving forward. Therefore, the IRS determined that underpayment interest would run on the 2010 deficiency from April 16, 2012 until the deficiency was deemed satisfied, which occurred on April 15, 2017.
Goldring filed a refund claim with the IRS but the IRS took no action. Goldring then filed suit in a district court, seeking a refund of the underpayment interest amount and a declaration that the full amount of the litigation award, including the interest, was properly classified and taxed as a capital gain. The district court held that the interest award was properly classified as ordinary income and that the IRS properly assessed underpayment interest on Goldring's 2010 deficiency.
Goldring appealed to the Fifth Circuit. She argued that the interest award should be taxed as a capital gain because it was tied to the fair market value of her Sunbelt shares and that, under the origin-of-the-claim doctrine, the interest was part of a judgment intended to compensate her for the loss of a capital asset (the Sunbelt shares) and was therefore paid in lieu of her claim for restoration of those shares. Regarding the underpayment interest, Goldring based her argument on the use-of-money doctrine, which provides that a taxpayer is liable for interest only when the government does not have the use of the money it is lawfully due. According to Goldring, the IRS improperly assessed underpayment interest because it had continuous possession of her credit-elect overpayment funds sufficient to satisfy the 2010 deficiency.
The IRS acknowledged that it had continuous use of sufficient credit-elect overpayment funds to satisfy Goldring's 2010 deficiency from April 16, 2012, through April 15, 2017. However, the IRS argued that it was permitted under Code Sec. 6402(a) and (b), Code Sec. 6513(d), Reg. Sec. 301.6402-3(a)(5) and Reg. Sec. 301.6513-1(d), to assess underpayment interest during this period. The IRS further argued that the assessment of underpayment interest was proper under FleetBoston Fin. Corp. v. U.S., 483 F.3d 1345 (Fed. Circ. 2007). In FleetBoston, a corporate taxpayer overpaid its taxes for the 1984 and 1985 tax years and elected to credit each year's overpayment to the following year's tax liabilities. The IRS subsequently determined that the taxpayer's 1984 and 1985 tax returns were deficient. Although the taxpayer's overpayments exceeded the 1984 and 1985 deficiencies and were not needed to pay its taxes in subsequent years, the IRS nonetheless charged underpayment interest on the deficiencies. A majority of the Federal Circuit found that because the overpayments were designated as credit-elect overpayments, the funds could not be credited to any later-determined deficiency since under Code Sec. 6513(d) and Reg. Sec. 301.6402-3(a)(5), the IRS must apply credit-elect overpayments as payment of the taxpayer's estimated taxes for the following year. However, the FleetBoston dissent argued that under the use-of-money principle, underpayment interest does not accrue for any period the IRS possesses sufficient funds from the taxpayer to satisfy the later-determined deficiency. The dissent said the majority disregarded the fact that, throughout the period for which the IRS assessed underpayment interest, the IRS possessed funds belonging to the taxpayer in an amount exceeding the later-determined deficiency.
Analysis
The Fifth Circuit affirmed the district court's ruling that Goldring's interest award was ordinary income but reversed the district court on the interest underpayment issue and ordered a refund of the underpayment interest to Goldring. In rejecting Goldring's assertion that the interest award was tied to the value of her shares and thus should not be considered ordinary income, the Fifth Circuit noted that the Delaware court calculated the interest portion of the award separately through the application of the Delaware statutory interest rate and that the Delaware court had statutory discretion to award interest and to select the rate at which interest was computed. Thus, the Fifth Circuit said, the interest was properly classified as ordinary income since under Delaware law the purpose of a statutory interest award is to fairly compensate the stockholder for her inability to use the fair value of her shares during a certain time period. The court also found that the origin-of-the-claim doctrine required that the interest be treated as ordinary income because it was awarded in lieu of what Goldring might have earned on the fair value of her shares for the period between the merger and the court's final judgment.
Turning to the interest underpayment issue, the Fifth Circuit noted that the application of the use-of-money principle to a scenario where, as here, the IRS assessed underpayment interest on a tax deficiency, even though it possessed credit-elect overpayment funds sufficient to satisfy that deficiency throughout the interest period, was an issue of first impression. The court observed, however, that in Avon Products, Inc. v . U.S., 588 F.2d 342 (2d Cir. 1978), the Second Circuit applied the use-of-money principle and concluded that interest may not run during any period the IRS possesses enough credit-elect overpayment funds to satisfy a later-determined deficiency. The Fifth Circuit also noted that several district courts have consistently applied the use-of-money principle to reach similar holdings. The Fifth Circuit also rejected the IRS's argument that it was authorized under the statute and regulations to assess underpayment interest against Golding. The court found that the provisions cited by the IRS did not address the IRS's ability to assess underpayment interest on a later-determined deficiency during periods where the IRS possesses credit-elect overpayment funds from the taxpayer sufficient to satisfy that deficiency. The court pointed out that in fact, the provisions relied upon by the IRS make no reference whatsoever to underpayment interest or Code Sec. 6601(a).
The Fifth Circuit agreed with the FleetBoston dissent. In the court's view, the government's argument - like the FleetBoston majority - fixated on the theoretical migration of credit-elect overpayment funds from one tax year to another, while ignoring the simple, undisputed fact that the IRS was never deprived of its use of the money Goldring owed it at any point during the assessment period. In the absence of clear statutory authority, the Fifth Circuit applied the established use-of-money principle and concluded that the IRS improperly assessed underpayment interest against Goldring.
Court Denies Refund Claim Because Taxpayer Missed Deadline for Changing Filing Status
A district court held that the IRS properly denied a taxpayer's claim for a refund because her claim, filed on an amended return, sought to change her filing status from married filing separately to married filing jointly outside of the three-year period for changes of election status in Code Sec. 6013(b). The court concluded that the three-year period for changing a taxpayer's filing status applies without regard to any extensions and cannot be read to contain an equitable tolling provision. Huff-Rousselle v. U.S., 2021 PTC 299 (D. Mass. 2021).
Background
On April 15, 2013, Peter Huff-Rousselle filed a Form 4868, Application for Extension of Time to File Individual Income Tax Return, to request an extension of time to file his 2012 tax return, and paid an estimated tax payment of $20,000 for the 2012 tax year. His request did not include his wife Margaret Huff-Rousselle's name or social security number. Margaret claimed that she filed her own Form 4868 for 2012, but the IRS had no record of her extension request.
On November 12, 2014, nineteen months after the April 2013 deadline for the return, Margaret filed her 2012 tax return with a status of married filing separately. She made this election in part because of her husband's medical condition. Peter passed away on June 24, 2015, without having filed a tax return for the 2012 tax year. On October 15, 2016, Margaret filed an amended tax return on a Form 1040X, which she filled out as a joint return with the status of married filing jointly. The amended return reported a 2012 tax liability of $45,106 for the Huff-Rousselles against $52,253 in payments (which included estimated payments made by Peter with his 2012 Form 4868 and credits on his account from prior years' overpayments). The proposed amended return requested a refund of the difference: $7,147.
The IRS denied the refund claim, asserting that Code Sec. 6013(b)(2)(A) does not allow amended returns based on a married couple's change of election of filing status to be filed three or more years after the original due date. Margaret brought an action in district court for a refund.
Under Code Sec. 6511(a), a claim for a refund or credit of an overpayment must be filed within the later of three years from when the return was filed or two years from the time the tax was paid. In U.S. v. Brockamp, 519 U.S. 347 (1997), the Supreme Court held that a prior version of Code Sec. 6511 was not subject to equitable tolling. The following year, Congress amended the statute to provide that certain deadlines in Code Sec. 6511 may be suspended during any period that the taxpayer is financially disabled. The tolling provision in Code Sec. 6511(h) is narrow and suspends the deadlines only under Code Sec. 6511(a), (b), and (c), and only where the individual meets the definition of being financially disabled.
Under Code Sec. 6013(b), a taxpayer may switch to a joint return after initially electing to file as married filing separately. Code Sec. 6013(b)(2)(A) provides that amendments to filing status must be made no later than three years from the due date for filing the return for that tax year, determined without regard to any extensions of time granted to either spouse. Unlike Code Sec. 6511, Code Sec. 6013(b) does not contain a tolling provision and does not extend the three-year deadline to reflect any extensions to file obtained by the taxpayer.
In her complaint, Margaret pointed out that she had filed a Form 4868 to obtain a six-month extension to file her 2012 return and argued that her husband's declining health prior to his death should have suspended the statute of limitations for filing the return. The government responded with a motion for summary judgment, contending that Margaret's Form 1040X improperly sought to change her 2012 filing status more than three years after the deadline to file the return. Specifically, because the 2012 return was due April 15, 2013, the government said that the time to change Margaret's election status expired on April 15, 2016. Thus, the Form 1040X filed on October 15, 2016, was six months too late. The government reasoned that, because the three-year period under Code Sec. 6013(b)(2)(A) is without regard to any extensions of time granted by the IRS to file the original return, Margaret's assertion that she obtained a six-month extension was ultimately immaterial.
Analysis
The district court granted the government's motion for summary judgment after finding that the IRS properly applied the Code when it denied Margaret's refund claim as an untimely change of status under Code Sec. 6013(b)(2)(A).
First, the court found that the limitations in Code Sec. 6013(b)(2) applied to Margaret even though Peter never filed a 2012 return (and thus never made an election as to his filing status). The court reasoned that although Code Sec. 6013(b) was primarily aimed at cases where both spouses previously elected to file separate returns, Congress did not narrow the reach of Code Sec. 6013(b) to reach only these cases - as evidenced by the repeated use of the singular "return" when referencing the previously filed separate returns. Moreover, the court found that Congress expressly contemplated those cases where only one spouse filed a separate return in Code Sec. 6013(b)(3)(A), which sets forth the date a joint return should be deemed to have been filed, and which depends on whether both spouses filed separate returns prior to making the joint return or only one spouse filed a separate return prior to the making of the joint return.
Next, the court determined that Margaret was not excused from the three-year limitations period in Code Sec. 6013(b)(2)(A) because of her husband's medical condition. The court said that, for the same reasons that the Supreme Court concluded in Brockamp that the three-year period in Code Sec. 6511 (before Congress amended it) was not subject to equitable tolling, equitable tolling is also not available for the three-year provision in Code Sec. 6013(b)(2)(A). Those reasons included the language of the statute, which in the court's view could not easily be read as containing implicit exceptions, and the avoidance of the administrative problems that would arise if the IRS had to respond to a large number of late requests for equitable tolling. The court noted that Congress responded to the Brockamp decision not by adding a broad-reaching tolling provision but rather with a targeted and stringent provision that, by its terms, extends only certain specifically enumerated periods, which does not include the three-year period for change of election status in Code Sec. 6013(b)(2). The court therefore concluded that Congress did not intend the equitable tolling doctrine to apply to the time limitations in Code Sec. 6013((b)(2). The court remarked that, while the result may seem unfair, it was the result required by the statutory scheme.
IRS Can't Setoff Bankrupt Farm's Tax Refund Against Post-Petition Taxes
A district court affirmed a bankruptcy court's ruling in a chapter 12 bankruptcy and held that the IRS did not have the right to set off the debtor's refund of post-petition taxes under 11 U.S.C. Section 1232(a) against the government's general unsecured claim for taxes arising from the debtor's sale of farm assets. The court concluded that the debtors were allowed to de-prioritize all of their liabilities to which Section 1232 applied, not just a portion, and that allowing the setoff would violate the terms of the confirmed plan. U.S. v. Richards, 2021 PTC 313 (S.D. Ind. 2021); 2021 PTC 314 (S.D. Ind. 2021).
Background
