U.S. Supreme Court Reverses Sixth Circuit on FICA Withholding for Severance Payments

Seal_of_the_United_States_Supreme_Court.svgOn Tuesday, March 25, 2014, the United States Supreme Court reversed the Sixth Circuit Court of Appeals decision in U.S. v. Quality Stores, Inc.

Find earlier discussion of the Sixth Circuit decision here.

Read the full opinion here:
United States v. Quality Stores, No. 12-1408 (March 25, 2014)

Court of Appeals Rules that IRS Cannot Regulate Return Preparers

The D.C. Circuit Court of Appeals has affirmed the ruling of the lower court and held that the IRS does not have the statutory authority to regulate tax return preparers.

In a unanimous and rather direct opinion, the Court of Appeals listed six reasons why the 130 year old statute, 31 U.S.C. § 330, relied upon by the IRS was insufficient to authorize regulation of non-accountant and non-attorney tax return preparers.

  1. Tax return preparers do not represent taxpayers, they assist them;
  2. Tax return preparers do not practice before the IRS;
  3. Tax return preparers are not representing taxpayers a contested proceeding;
  4. If valid, the authority of the underlying statute would make all other statutes regulating tax return preparers, e.g. the IRC, moot;
  5. The statute’s text and legislative history do not support the broad regulatory powers claimed by the IRS; and
  6. Finally, the IRS didn’t apply the century-old statute to regulate tax return preparers until 2011 and before that the agency’s statements about return preparer regulation were inconsistent with the current interpretation.

The court summarized its view: “the traditional tools of statutory interpretation – including the statute’s text, history, structure, and context – foreclose and render unreasonable the IRS’s interpretation of Section 330.” It also advised the IRS that if it wishes to regulate tax return preparers it should introduce and pass new legislation.

Despite the resounding defeat, the IRS may still petition the appellate court a for rehearing en banc, which would presumably include the three recently appointed members of the D.C. Circuit. The deadline for that motion is March 28.

If the IRS seeks a writ for certiorari with the U.S. Supreme Court, it must file a petition by May 12.

Read the entire opinion here:
Loving v. IRS, No. 13-5061 (D.C. Cir. Feb. 11, 2014)

U.S. Supreme Court Grants Certiorari in IRS Summons Case

us-supreme-courtOn January 10, 2014, the U.S. Supreme Court granted a writ of certiorari to hear arguments in a IRS Summons enforcement proceeding that originated in the 11th Circuit Court of Appeals. At issue is whether a taxpayer is entitled to an evidentiary hearing to determine whether an IRS Summons was issued for an improper purpose.

An IRS Summons is issued in good faith when it meets the four part test set forth in United States v. Powell, 379 U.S. 48, 57-58 (1964), to wit: (1) “the investigation will be conducted pursuant to a legitimate purpose”; (2) “the inquiry may be relevant to the purpose”; (3) “the information sought is not already within the Commissioner’s possession”; and (4) “the administrative steps required by the [Internal Revenue] Code have been followed.”

Respondents (taxpayers) argued that IRS issued the Summons for an improper purpose and requested discovery and an evidentiary hearing. The District Court found that respondents made no meaningful allegation of improper purpose and ordered enforcement. The taxpayers appealed.

In an unpublished, per curium opinion, the 11th Circuit reversed the trial court holding that it had abused its discretion when it declined to hold an evidentiary hearing. The appellate court relied on its prior decision in Nero Trading, LLC v. U.S. Dep’t of Treasury, 570 F.3d 1244, 1248 (11th Cir. 2009) quoting from that opinion: “in situations such as this, requiring the taxpayer to provide factual support for an allegation of an improper purpose, without giving the taxpayer a meaningful opportunity to obtain such facts, saddles the taxpayer with an unreasonable circular burden, creating an impermissible ‘Catch 22.’”

While the unpublished opinion which prompted the petition for certiorari was of no precedential value (only published opinions may be relied upon in the 11th Circuit), the government argued that the decision created a split in the Circuits. The high court may be in agreement because it granted the petition for certiorari.

Read the Government’s Petition for Certiorari: Government’s Petition for Writ of Certiorari

Read the Respondents’ Brief in Opposition: Respondent’s Brief in Opposition to Writ of Certiorari

Supreme Court Adopts IRS Position on Jurisdiction and Application of Partnership Penalties

Gary Woods and his partner, Billy Joe McCombs, generated substantial tax losses using the COBRA tax shelter. The COBRA shelter used offsetting options to inflate the basis of property distributed by a partnership, which is then contributed and sold to another partnership or pass through entity, resulting in a large tax loss without a corresponding economic loss. Messrs. Woods & McCombs reaped ordinary income losses of $13 million and capital losses of $32 million when they used the COBRA structure to purchase and sell $3.2 million of options.

After the IRS disallowed their losses, Woods filed a refund claim (which was denied) and pursued that claim with a complaint filed in the U.S. District Court. After Woods prevailed on certain issues in the 5th Circuit, the government petitioned the U.S. Supreme Court for certiorari. The case selected by the high court to resolve a split in the circuits. The Fifth, Federal and D.C. Circuits had all found for the taxpayers. Other circuits had adopted the government’s position.

The Supreme Court addressed two questions in an opinion authored by Justice Scalia. The Court first considered whether the district court has jurisdiction under TEFRA (Tax Equity and Fiscal Responsibility Act of 1982) to determine valuation-related penalties at the partnership level. This is important because partnerships are not taxed as entities for Federal income tax purposes. The income and losses determined at the partnership level pass-through to each partner where they are taxed on the partner’s individual or corporate tax return.

One purpose of TEFRA was to allow determinations at the partnership level and prevent the need for multiple proceedings to determine the tax liabilities of items common to all partners in the partnership. The jurisdictional question has been widely litigated and this decision will affect many millions of dollars of pending tax penalties.

The second, related, question was whether the 40% gross valuation overstatement penalty under I.R.C. Sec. 6662 applied when a partnership was found to not have economic substance. A partnership lacking in economic substance ceases to exist for tax purposes.

The Court ruled for the government on both questions. On the first question, the Court held that there was jurisdiction to consider the penalty question at the partnership level. The court essentially adopted the position suggested at oral argument by Deputy Solicitor General Malcolm Stewart that “any question that will necessarily have the same answer for all partners should be presumptively be resolved at the partnership level.” Justice Scalia opined that “deferring consideration of those arguments until partner-level proceedings would replicate the precise evil that TEFRA sets out to remedy: duplicative proceedings, potentially leading to inconsistent results, on a question that applies equally to all of the partners.”

Relying on the “plain language” of the penalty the Court also held that the 40% substantial or gross valuation penalty applied to the overstated basis of the partners. “[O]nce the partnerships were deemed not to exist for tax purposes, no partner could legitimately claim a basis in the partnership greater than zero.” The Court adopted the observation of Fifth Circuit Judge Prado that “the basis understatement and the transaction’s lack of economic substance are inextricably intertwined” and therefore the penalties were “attributable to” the overstatement of basis that occurred once the partnership ceased to be recognized for tax purposes.

In an final note of interest to tax practitioners, Justice Scalia rejected the taxpayer’s reliance on the “Blue Book” – a publication of the Joint Committee of Taxation often published after the enactment of tax legislation explaining the legislative history of the statute – and clearly stated that this publication is not a relevant source of Congressional intent.

Read the entire opinion here:
U.S. v Woods, 517 U.S. __, No. 12-562 (Dec. 3. 2013).

IRS Recognizes Same-Sex Marriages in All States

irs-sealThe U.S. Department of the Treasury and the Internal Revenue Service (IRS) today ruled that legally married same-sex couples will be treated as married for federal tax purposes. In other words, all marriages will be treated identically for all federal tax purposes. The ruling is in response to the June 26 decision in U.S. v. Windsor that invalidated section 3 of the Defense of Marriage Act (DOMA).

The ruling applies regardless of the residence of the married couple – whether that is in a jurisdiction that recognizes same-sex marriage or a jurisdiction that does not recognize same-sex marriage.

The ruling applies to federal tax provisions where the terms “marriage”, “spouse”, “husband”, “wife”, or “husband and wife” is a factor. Examples of such instances include filing status, claiming personal and dependency exemptions, taking the standard deduction, employee benefits, contributing to an IRA and claiming the earned income tax credit or child tax credit. The IRS will begin applying the guidance on September 16, 2013.

Any same-sex marriage legally entered into in any state, the District of Columbia, a U.S. territory or a foreign country will be covered by the ruling. However, the ruling does not apply to registered domestic partnerships, civil unions or similar formal relationships recognized under state law.

Legally-married same-sex couples generally must file their 2013 federal income tax return using either the married filing jointly or married filing separately filing status. Couples may also file original or amended returns choosing to be treated as married for federal tax purposes for one or more prior tax years still open under the statute of limitations.

The IRS indicated that further guidance will be released to allow streamlined procedures for employers who wish to file refund claims for payroll taxes paid on previously-taxed health insurance and fringe benefits provided to same-sex spouses. Additional guidance will also be forthcoming on cafeteria plans and on how qualified retirement plans and other tax-favored arrangements should treat same-sex spouses for periods before the September 16 effective date.

Read the Revenue Ruling here: Revenue Ruling 2013-17

Read the IRS FAQ here.

DOD Adopts Uniform Policy on Same-Sex Marriage

Last week Secretary of Defense Chuck Hagel announced that the Armed Forces (Army, Navy, Air Force, Marine Corps, Coast Guard) will comply with the U.S. Supreme Court’s decision in U.S. v. Windsor ruling by September 3, 2013. Windsor declared Section 3 of the Defense of Marriage Act (DOMA) unconstitutional.

Sec. Hagel explained that the domestic partner provisions put in place in February will be supplanted by official recognition of same-sex marriages. Recognizing that many same-sex couples have to travel to another jurisdiction to marry, the Department of Defense has amended Department of Defense Instruction 1327.06 “Leave and Liberty Policy and Procedures” to allow “non-chargeable marriage leave where a Service member is a part of a same-sex couple and is assigned to a duty station located more than 100 miles from a U.S. state (or the District of Columbia) that allows same-sex couples to get married.”  Eligible Service members may be granted non-chargeable leave for up to 7 days if they are assigned within the continental U.S (CONUS).  If they are stationed outside the continental U.S. (OCONUS), they will be granted non-chargeable leave for a period of up to 10 days. Same-sex couples will be able to use this nonchargeable marriage leave once in their career.

The memo indicates that there could be more changes to follow, as the Joint Benefits Review Working Group is focusing its efforts on extending spousal benefits to same-sex spouses.  It also gave a firm timeline for enforcement stating that all entitlements are retroactive to the date of the Supreme Court’s decision, June 26, 2013.  

Read the memoranda here:
Extending Benefits to Same-Sex Spouses of Military Members

Further Guidance on Extending Benefits to Same-Sex Spouses of Military Members

DOMA Doomed by Estate Tax Refund Claim

us-supreme-courtThe United States Supreme Court has struck down the Defense of Marriage Act (DOMA) as an unconstitutional violation of the “equal liberty” protections of the 5th Amendment.

The dispute in U.S. v. Windsor began when Edie Windsor filed a claim for refund of estate taxes paid after the death of her same-sex spouse, Thea Spyer. Though the court makes little mention of the $353,053 refund claim in its historic opinion, the high court’s ruling affirmed the Second Circuit Court of Appeals’ decision to award the refund.

Read the entire opinion here:
U.S. v. Windsor, Docket No. 12-307 (U.S.S.C. June 26, 2013)

Supreme Court Allows Foreign Tax Credits for U.K. Windfall Tax

us-supreme-courtThe U.S. Supreme Court has resolved a split in the circuits on the U.S. tax treatment of U.K. windfall tax payments made by U.S. utilities. In a unanimous opinion authored by Justice Thomas, the Court held that the windfall tax qualified as a “creditable tax” for U.S. foreign tax credit purposes. The result is that the appellant here, PPL, and Entergy, who had the companion case, will be able to take a credit against their U.S. income taxes for the amounts paid to the United Kingdom.

The central issue was whether the U.K. tax was a tax on income, the general standard for creditable foreign taxes. The ultimate decision was a bit more nuanced and scholars surely will continue to debate the issue including the algebra (don’t see that often in the tax world) and the potential distinction between the regulatory phrase “in the U.S. sense” and Justice Thomas’ phrase “if enacted in the U.S.”

Practitioners, being the practical folks that they are, will look to expand the decision for the benefit of other clients that may have paid taxes similar to the windfall tax but not received the benefit of foreign tax credits against their U.S. income.

This is what happens when the Supreme Court issues a tax opinion. There will be more to come, as the estate tax case that may decide the fate of DOMA has been heard and likely will be decided this year and another tax case (on overpayment penalties) is being briefed for the Supremes right now. Expect a decision in the latter case, U.S. v. Woods, sometime in 2014.

Read the PPL opinion here:
PPL Corp. v. Commissioner, Docket No. 12-43 (U.S.S.C. May 20, 2013)

Two Weeks Left to File 2009 FICA Refund Claims for Severance Payments

url2The deadline for filing 2009 FICA refund claims based on U.S. v. Quality Stores, Inc. is fast approaching. Corporate taxpayers who experienced layoffs, reductions in force, and/or facility closures in 2009 or thereafter may file a protective refund claim for FICA taxes withheld from severance payments made to involuntarily terminated employees. Taxpayers have until April 15, 2013, to file a protective refund claim for all four quarters filed in 2009.

The refund claims are predicated on the Sixth Circuit Court of Appeals’ holding in U.S. v. Quality Stores, Inc., previously reported here, which held that certain severance payments are not subject to FICA withholding. The ruling specifically applies to taxpayers in Kentucky, Michigan, Ohio, and Tennessee (the states within the jurisdiction of the Sixth Circuit) but taxpayers across the country have been filing claims to protect their right to potential refunds.

The government is still considering whether to challenge the decision in the United States Supreme Court. The original deadline for filing a petition for writ of certiorari was April 4, 2013, but last week the Supreme Court granted the government’s request for a 30-day extension. Those waiting to see if government would seek the high court’s review before filing a protective claim will now have to make a decision without that knowledge. The government’s deadline for filing a petition is May 3, 2013.

Today: Supreme Court to Hear Arguments in DOMA Tax Case

Seal_of_the_United_States_Supreme_Court.svgToday, the United States Supreme Court will hear arguments about the Constitutional rights of homosexual couples courtesy of the Internal Revenue Code.

The Court may rule on a variety of grounds in United States v. Windsor including standing (was the couple’s marriage recognized under New York law) and the proper Constitutional standard (does Intermediate Scrutiny apply to homosexuals) but the case started with a tax return.

Edie Windsor and Thea Spyer were New York residents and a couple for over 40 years. In 2007, they were married in Canada where same-sex marriage was legal. Upon Thea’s death, Edie filed a federal estate tax return, Form 706. Thea’s estate paid $363,053 in federal estate taxes because she was not eligible for the unlimited marital deduction under IRC §2056(a) – a benefit routinely applied to married couples of different sexes. Edie filed a claim for refund of the estate taxes paid. When that claim for refund was denied she filed suit in federal district court.

The refund denial was reversed by the U.S. District Court for the Southern District of New York and the Second Circuit Court of Appeals. Read opinions published in those cases here and here.

Whether not the Supreme Court issues a sweeping or narrow opinion on the rights of homosexuals, there is little question that the tax code touches everyone. After all, that’s where this case started.