Category Archives: Federal

District Court: Estate Tax Marital Deduction Triggers Unconstitutional Ruling on DOMA

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In a case that begin with a claim for a refund of estate taxes paid, Judge Barbara S. Jones of the Southern District of New York ruled that the Defense of Marriage Act (DOMA) is unconstitutional under the Equal Protection Clause of the 5th Amendment.

Edie Windsor and Thea Spyer were a couple for over 40 years and in 2007 were married in Canada where same-sex marriage was legal. Their marriage was later recognized in their home state of New York. Upon Thea’s death, Edie paid $363,053 in federal estate taxes because she was not eligible for the unlimited marital deduction under IRC Section 2056(a) – a benefit routinely applied to married couples of different sexes. Edie filed a claim for refund of the estate taxes on the grounds that DOMA denied her equal protection under the law as protected by the 5th Amendment to United States Constitution.

Frequent readers know that when possible we like to note interesting procedural aspects of the cases we feature here and this cases qualifies in two aspects. First, was the question of the parties. The case was filed in November of 2010. In February of 2011, Attorney General Eric Holder announced that the Department of Justice would not defend the constitutionality of DOMA. Given that DOJ would no longer defend the suit, the Bipartisan Legal Advisory Group (BLAG) of the U.S. House of Representatives moved to intervene under F.R.C.P. 24 and defend the matter in the place of the Department of Justice. The group’s order was granted. Thus, the parties to the final order were Ms. Windsor as plaintiff and BLAG as defendant-intervenor.

The second interesting procedural note before the court was Edie’s standing to bring the suit. Standing generally requires three elements: (1) an injury in fact, (2) a causal connection between the defendant and the injury, and (3) a means of remedy within the power of the court. The defendant-intervenor argued that Ms. Windsor did not satisfy the second of these elements. The court disagreed noting the State of New York’s recognition of Edie and Thea’s marriage at the time of death as a factor in its finding.

On the ultimate question, the District Court granted Ms. Windsor’s motion on summary judgment ruling that section 3 of DOMA was unconstitutional because it failed to establish a rational basis for advancing a legitimate government under the Equal Protection Clause. The court ordered a that Edie’s refund claim be paid with interest.

Read the entire opinion here:
Windsor v. U.S., No. 10-cv-08435 (SDNY June 6, 2012)

Tax Court: Related Party S Corps Can “Share” Distributions to Preserve Losses

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The Tax Court found that shareholders in two related S corporations may receive a distribution of intangible assets from one of their S corporations and contribute those assets into another one of their S corporations in order to increase their basis in the latter entity and realize the losses generated by that entity.

The court followed its opinions in Ruckriegel v. Commissioner, T.C. Memo. 2006-78; Yates v.
Commissioner, T.C. Memo. 2001-280; and Culnen v. Commissioner, T.C. Memo. 2000-139, rev’d and remanded on another issue, 28 Fed. Appx. 116 (3d Cir. 2002) noting that “the fact that funds lent to an S corporation originate with another entity owned or controlled by the shareholder of the S corporation does not preclude a finding that the loan to the S corporation constitutes an ‘actual economic outlay’ by the shareholder.”

The Court noted that “so long as the underlying distributions and contributions actually occurred” it was of no consequence that the petitioner’s actions may have been motivated by tax considerations.

Read the opinion here:
Maguire v. Commissioner, TC Memo 2012-160

Tax Court: Donation of Conservation Easement Denied

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A recent Tax Court opinion offers two new elements for consideration when making a charitable donation of a conservation easement under Section 170.

In Mitchell v. Commissioner, the Tax Court denied taxpayer’s deduction for the charitable contribution of a qualified conservation easement. The court found that where a mortgage subordination agreement is not in place at the time of the donation, the subordination requirement of the regulations has not been satisfied. The court also ruled that the so-remote-as-to-be-negligible standard of Treas. Reg. Sec. 1.170A-14(g)(3) does not to apply to determine whether a donation has satisfied the requirements of Treas. Reg. Sec. 1.170A-14(g)(2) (subordination of the easement).

Read the opinion here:
Mitchell v. Commissioner, 138 T.C. No. 16 (2012)

District Court: Colorado Use Tax is Unconstitutional

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In an unusual ruling from a U.S. District Court on a state tax matter, the U.S. District Court for the District of Colorado has struck down as unconstitutional a Colorado statute requiring out-of-state retailers to file information reports on sales made to Colorado customers for which no Colorado sales or use tax was collected. The District Court claimed jurisdiction to hear the claim under 28 USC 1331 (federal question) and gave standing to the Direct Marketing Association (DMA) on behalf of their members who businesses and organizations market products directly to consumers via catalogs, magazine and newspaper advertisements.

On motions for summary judgment, the DMA argued that the Colorado’s use tax reporting requirement discriminates against interstate commerce and places an undue burden on interstate commerce both of which violate the dormant commerce clause of the United State Constitution. The DMA sought a declaratory judgment finding that the Colorado statute was unconstitutional and an injunction preventing enforcement of the statute’s requirements.

The district court, in an order by Judge Blackburn, ruled in favor of the DMA on both claims finding that the Colorado act discriminated against interstate commerce and placed an undue burden on interstate commerce. The court granted both the declaratory and injunctive relief sought by the DMA.

Read the court’s order here:
Direct Marketing Assoc. v. Huber, No. 10-cv-10546-REB-CBS (D.C. Colo., March 30, 2012)

4th Circuit: Denial of Transferee Liability for Intermediary Transaction Tax Shelter Affirmed

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The Fourth Circuit Court of Appeals affirmed the Tax Court’s decision in favor of four taxpayers who were alleged to have participated in what the IRS describes as an Intermediary Transaction tax shelter. The majority opinion, authored by Circuit Judge Davis, held that the Tax Court properly identified and applied the controlling legal principles and did not commit clear error in its factual findings.

At issue was the application of IRC § 6901 which provides for collection of liabilities from transferees in certain transactions. The transaction that prompted the allegedly transferred tax liability was the sale of a closely held C corporation. The IRS characterized the sale as substantially similar to an abusive tax shelter as described in Notice 2001-16, later modified by Notice 2008-111 (Intermediary Transaction).

The IRS attacked this transaction by asserting transferee liabilities under IRC § 6901 against the four former shareholders of the dissolved corporation. As noted by the Tax Court, section 6901 does not independently impose a tax liability but rather is a procedural device by which the IRS may collect unpaid tax owned by the transferor of an asset to a transferee. Thus, the transferee liability argument was pursued only as a basis for attaching the tax liability of the corporation to the former individual shareholders. The primary tax argument advanced by the IRS was that the sale of the company resulted in a direct distribution of proceeds (and corresponding tax liabilities) to the taxpayers.

In a 33-page memorandum decision, the Tax Court denied the government’s attempt to assert transferee liability against the former shareholders. The Tax Court followed the U.S. Supreme Court’s guidance in Commissioner v. Stern, 357 U.S. 39 (1958), which defined the application of the predecessor section to section 6901, and found that the former shareholders were not liable for the transferred assets under laws of the state of North Carolina.

The appellate tribunal examined Stern closely noting that the Supreme Court had interpreted section 6901 as requiring a two-part analysis. The first was a procedural finding that section 6901 applied as a matter of federal law. The second analytical step was to determine if the transferee was liable for the transferor’s debts under state law. The Court of Appeals agreed with the Tax Court and found that section 6901 applied as a matter of procedural law but that the government had failed to prove that the former shareholders were liable for the transferee’s debts under state law. Since the governing state law did not establish a liability for the former shareholders, the IRS could not use section 6901 to collect the alleged tax liability.

Read the entire opinion here:
Starnes v. Commissioner, Nos. 11-1636 et. al. (4th Cir. May 31, 2012)

Tax Court: Donation of Conservation Easement Upheld

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The Tax Court affirmed the proposition that a conservation easement is still a Congressionally sanctioned charitable contribution under IRC §170(h). Conservation easements and the corresponding charitable contribution deduction for the donation of such easements have been a topic of heightened scrutiny by the IRS in recent years. So much so, that we might have forgotten that there is a legitimate basis in public policy for this deduction.

In Butler v. Commissioner, the IRS sought to disallow deductions related to conservation easements that protected thousands of acres of undeveloped rural property and impose penalties upon the donors who made the contribution. The Tax Court, however, found for the taxpayers on the validity of the qualified conservation contributions, made some adjustments to the valuation of the properties based on the testimony of several experts, and dismissed the penalties.

For those interested in the mechanics of tax litigation, Butler is instructive on two additional points. First, the petitioners prevailed in shifting the burden of proof to the government on select issues under Section 7491(a) – a feat more often considered than accomplished. Second, the court ruled on the admissibility of an expert report prepared by an expert who died before the trial began. Petitioners sought to have the deceased expert’s report admitted as evidence of fair market value, invoking alternative exceptions to the hearsay rule under Federal Rules of Evidence 804(b)(1) and 807. The court denied petitioners’ requests but admitted the report for the limited purpose of establishing reasonable cause to avoid penalties under Section 6664.

Read the opinion here:
Butler v. Commissioner, T.C. Memo. 2012-72

Altria Settles 14 Years of SILO/LILO Transactions for $500 Million

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On May 22, Altria announced that it executed a closing agreement with the Internal Revenue Service settling the federal income tax treatment of fourteen years of leveraged lease transactions (commonly known as lease-in/lease-out (LILO) and sale-in/lease-out (SILO) transactions) entered into by Altria’s wholly-owned subsidiary, Philip Morris Capital Corporation.

Altria had defied the IRS challenges to these transactions in a number of pending cases. In October 2006, Altria filed a complaint in the United States District Court for the Southern District of New York to claim refunds related to its LILO and SILO transactions for 1996 and 1997. In July 2009, following an eleven day trial, a jury returned a unanimous verdict in favor of the IRS. Altria filed motions for judgment as a matter of law or, in the alternative, for a new trial. On March 17, 2010, the court denied Altria’s post-trial motions and, on April 19, 2010, entered final judgment in favor of the IRS.

Altria appealed the final judgment to the United State Court of Appeals for the Second Circuit. In an opinion released on September 27, 2011, the Second Circuit affirmed the District Court’s ruling, and the jury’s findings, against Altria. Altria had a similar tax refund claim pending in the Southern District of New York for the same transactions applicable to the 1998 and 1999 tax years.

According to the press release issued by Altria, the settlement included the 1996 through 1999 tax years and tax years through 2003, in all of which the IRS had disallowed the tax benefits claimed from these transactions. The settlement also covered the tax years 2004 through 2009 for which Altria claimed tax benefits generated by the LILO and SILO transactions but which the IRS was expected to disallow. Altria did not claim tax benefits pertaining to the LILO and SILO transactions in the 2010 and 2011 tax years and, under the terms of the settlement agreement, will not claim such benefits in future tax years.

Altria expects to pay approximately $450 million in federal income taxes and related estimated interest with respect to the 2000 through 2010 tax years. The payment is net of federal income taxes that Altria paid on gains associated with the sales of assets leased in the LILO and SILO transactions from January 1, 2008 through December 31, 2011. Of the $500 million, Altria also expects to pay approximately $50 million of state taxes and related estimated interest. The tax component of these payments represents an acceleration of federal and state income taxes that Altria would have otherwise paid over the lease terms of the LILO and SILO transactions. Pursuant to the settlement agreement, the IRS will not assess penalties against Altria for the LILO and SILO transactions in any tax year, open or closed, through the 2010.

Read the Altria Group, Inc. press release here:
Altria PMCC Press Release May 22, 2012

Read the Second Circuit’s Opinion here:
Altria Group v. US, No 10-2404 (2d Cir. 2011)

IRS Issues Guidance for Schedule UTP Concise Descriptions

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The IRS revised the Instructions for Schedule UTP in early February but one thing that it did not change was the definition of the concise description required to accompany each uncertain tax position. The IRS later publicly expressed concerns over the small number of taxpayers (about 133) who offered inadequate concise descriptions on the Schedule UTP attached to their 2010 returns. On May 11, the IRS addressed this issue by publishing specific guidance for preparing concise descriptions on the 2011 Schedule UTP.

Schedule UTP instructs a taxpayer to draft a concise description as follows:

Provide a concise description of the tax position, including a description of the relevant facts affecting the tax treatment of the position and information that reasonably can be expected to apprise the IRS of the identity of the tax position and the nature of the issue. In most cases, the description should not exceed a few sentences. Stating that a concise description is “Available upon Request” is not an adequate description.

The new IRS guidance offers five examples of hypothetical concise descriptions that rather clearly do not meet the requirements of the instructions. One such example is,

This is an issue for which we have recorded of reserve because the appropriate tax treatment of this position is unsettled and we are awaiting published guidance and we are awaiting the outcome of pending litigation.

The other examples of clearly insufficient descriptions indicate that the issue is under audit or that the item is subject IRS scrutiny. The IRS notes that descriptions like this are inadequate because they do not provide relevant facts affecting the tax treatment of the item nor do they identify the tax position and the nature of the issue.

Of greater instruction for most practitioners, are the four examples in this guidance that clearly identify the tax issue but still still fall short of the IRS standard for a proper concise description. The second set of examples compare specific hypothetical concise descriptions for the same tax position, one of which is insufficient and one of which is sufficient.

The first of these examples uses the following insufficient concise description:

This is a research credit issue.

The guidance suggests the following is a better description of a potential research credit issue:

The taxpayer incurred support department costs that were allocated to various research projects based upon the methodology the taxpayer considers reasonable. The issue is whether the taxpayer’s method of allocating these costs is acceptable by the IRS.

Another example starts with the following insufficient description:

The taxpayer claimed a domestic production activities deduction. The domestic production activities deduction is highly factual and subject to review by the IRS.

The guidance indicates that a sufficient concise description for a domestic production activities deduction would read as follows:

The taxpayer claimed the domestic production activities deduction on certain production activities income for 2010. The issue is whether costs incurred for product aging processes that occur in designated areas located at the taxpayer’s distribution facility are considered manufacturing or production costs of the tangible personal property, and therefore, a component of Qualified Production Activities Income.

These guidelines will be helpful to determine the scope and extent of the necessary concise description as practitioners consider their Schedule UTP disclosures for 2011.

Read the complete IRS guidance here:
Schedule UTP Guidance for Preparing Concise Descriptions

Tax Court: HP’s Tax Credit Generator Denied on Debt/Equity Grounds

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The Tax Court, in a memorandum opinion by Judge Goeke, characterized Hewlett-Packard’s investment in a foreign corporation as a loan rather than equity for federal income tax purposes, thereby denying HP the benefit of foreign tax credits generated by the foreign entity. Though the court found for the government, it declined to consider the government’s arguments that the economic substance doctrine or the step-transaction doctrine applied and rested its decision solely on a debt/equity analysis.

The court adopted the Ninth Circuit’s 11 factor debt/equity analysis to determine the merits of the debt according to the Golsen rule, which requires the Tax Court to follow the law of the federal circuit where an appeal would lie. The Ninth Circuit analysis is notable because Hewlett-Packard has a pending suit in a U.S. District Court in the Ninth Circuit seeking a refund of foreign tax credits generated in other tax years attributable to the same transaction in question in the Tax Court case.

To the best of our knowledge, this is the first court decision to address a Tax Credit Generator transaction.

Read the entire opinion here:
Hewlett-Packard Company v. Commissioner, T.C. Memo 2012-135

Tax Court: Historical Easement Denied, Cash Contributions Allowed

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The Tax Court, in a memorandum opinion by Judge Goeke, found that the donation of a facade easement of a Tribeca condo building for historical preservation purposes did not meet the requirements of IRC Section 170(h) as a qualifying charitable contribution. The court found that the petitioners failed to establish a value in the easement sufficient to support the claimed deduction.

The court did allow cash contributions made by some condo owners to the National Architectural Trust, the beneficiary of the easement, as deductible charitable contributions. The court also declined to assess accuracy-related penalties against the condo owners, finding that they established reasonable cause for their positions under IRC Section 6664(c).

Read the entire opinion here:
Dunlap v. Commissioner, T.C. Memo. 2012-126.