Argument preview: Can the Treasury Department’s statutory interpretation trump the Court?
on Jan 14, 2012 at 12:00 pm
Depending on how the Court resolves a threshold issue, United States v. Home Concrete & Supply, LLC (scheduled for oral argument on January 17) could yield a decision of broad importance or instead one of interest only to tax lawyers. The ultimate issue concerns the scope of an extended statute of limitations applicable only to tax cases. The first possible ground for decision is purely a matter of interpreting the language of the tax statutes. But the government faces significant hurdles on that ground, notably the Court’s 1958 decision in The Colony, Inc. v. Commissioner, which interpreted the same words in a predecessor statute in accordance with the taxpayer’s position. If the Court rejects the government’s position that the statutory language alone is dispositive, the case will move to the second issue presented – whether the Court must adopt the government’s statutory construction because Chevron requires it to defer to recently promulgated Treasury regulations. A decision on that issue could be a significant administrative-deference precedent that would have broad ramifications outside the tax context as well.
Generally, the IRS has three years from filing to assess additional tax. Under 26 U.S.C. § 6501(e)(1)(A), however, there is an extended six-year statute of limitations if the taxpayer “omits from gross income” a significant amount that it should have included. A similar provision governing partnership tax returns is found at 26 U.S.C. § 6229(c)(2). The question presented in Home Concrete is whether the phrase “omits from gross income” includes a situation where a taxpayer overstates its tax “basis.” (Basis is a tax concept that reflects adjusted cost; overstating the basis of sold property causes an understatement of the gross income from the sale.)
The textual question in this case goes back almost seventy years. The 1939 Internal Revenue Code, which was later superseded by the 1954 Code, contained a provision with language identical to that of current Section 6501(e)(1)(A). Taxpayers argued that the extended statute of limitations applied only to a failure to list an item of gross income on the return. The government argued that the extended statute also applied when there was an overstatement of basis, because that leads to an understatement of gross income. The issue generated a circuit conflict and eventually made it to the Supreme Court in the Colony case.
In the meantime, Congress enacted the 1954 Code, which largely carried forward the previous statute. Congress did not change the “omits from gross income” language, but it did add a new subsection that specifically defined “gross income” in the case of a trade or business in a way that prevents an overstatement of basis from being an omission of “gross income.”
Thereafter, the Colony case arrived in the Supreme Court. Construing the 1939 Code, the Court ruled for the taxpayer, holding that “the statute is limited to situations in which specific receipts or accruals of income are left out of the computation of gross income.” Little did the Court know that fifty years later litigants would be parsing its reasoning to see how the case fits into the framework of Chevron – specifically, whether the Colony Court should be understood to have found the statutory language before it unambiguous. Two statements by the Colony Court are particularly relevant. First, the Court stated that, although the statutory text “lends itself more plausibly to the taxpayer’s interpretation, it cannot be said that the language is unambiguous.” The Court then found additional support for the taxpayer in the legislative history. Second, having been urged by the parties to consider whether the new legislation shed any light on the meaning of the 1939 Code, the Court stated that its conclusion was “in harmony with the unambiguous language” of the 1954 Code.
Fast forward fifty years. The issue has lain dormant, as everyone assumed that Colony controlled the interpretation of the identical language in the 1954 Code. The IRS learned that many taxpayers had engaged in a series of securities transactions that came to be known as a Son-of-BOSS transaction. Sparing you the gory details, the IRS views this transaction as a tax avoidance scheme that manipulates certain tax rules to produce an artificially inflated basis. The IRS has successfully challenged these transactions, with the courts generally concluding that they lack “economic substance” and therefore the taxpayers cannot take advantage of the apparent tax benefits. But in many cases, the standard three-year statute of limitations had expired before the IRS could challenge the tax treatment.
Accordingly, the IRS began to argue that the extended six-year statute of limitations applied to these transactions because they involved an overstatement of basis. It contended that Colony was not controlling because the Court’s decision should be limited to the 1939 Code and that a different result should obtain in the Son-of-BOSS cases (which arise outside the “trade or business” context and hence are not encompassed within the new subsection added in 1954). This argument initially fell flat in the courts, as the Tax Court and the Ninth and Federal Circuits held that Colony controls.
The government then moved to Plan B. The Treasury Department issued temporary regulations interpreting the “omits from gross income” language to include overstatements of basis. (These regulations have since been issued without material change as final regulations after a notice-and-comment period.) In a motion for reconsideration, the government then asked the Tax Court to reverse its position on the ground that an “intervening change in the law” required it to accord Chevron deference to the new regulatory interpretation. The Tax Court was unimpressed, voting thirteen to zero against the government in three different opinions resting on distinct grounds.
Unfazed, the government filed appeals in several circuits and succeeded in generating a circuit conflict. One court agreed with the government’s statutory argument. Two courts ruled for the taxpayer, holding that after Colony there was no ambiguity for the Treasury Department to interpret and thus no room for deference. Three courts ruled for the government on Chevron deference grounds. The Court granted certiorari in Home Concrete to resolve the conflict.
With respect to the meaning of the statute, the taxpayer rests primarily on Colony, characterizing the IRS as having “overruled” that decision. The taxpayer argues that its reliance on stare decisis is buttressed by Congress’s reenactment of the same statutory language in later years, thereby putting a legislative stamp on the Court’s interpretation of the words “omits from gross income” in Colony.
The government in turn argues that Colony is irrelevant because it involved a different statute, which was materially changed in 1954 when Congress added a subsection making clear that there is no extended statute of limitations for overstatements of basis by a trade or business. Implicit in Congress’s decision to make that addition was its understanding that overstatements of basis would be covered outside of the trade or business context; otherwise, the new provision would be superfluous. The taxpayer responds that the new subsection is not superfluous and that it is absurd to conclude that the 1954 Code cut back on taxpayers’ statute of limitations protections when the only changes made to the statute favored taxpayers.
In addition to the Colony-related arguments, both sides argue that their position reflects the best reading of the statutory text and purpose. The taxpayer argues that “omits” means leaving something out, while the government emphasizes that overstatements of basis inevitably cause an understatement (that is, an “omission” of a portion) of gross income.
The taxpayer makes a couple of other narrow arguments that could theoretically divert the Court from reaching the deference issue: (1) the regulations were procedurally defective; and (2) by their terms, the regulations do not apply when the three-year statute of limitations had already expired before the regulations were promulgated. These arguments did not prevail in any court of appeals, and the Court is unlikely to adopt them, which would lead the Court to the deference issue.
Back in 1971, the Second Circuit stated that “the Commissioner may not take advantage of his power to promulgate retroactive regulations during the course of litigation for the purpose of providing himself with a defense based on the presumption of validity accorded to such regulations.” Basically, the government argues that the Court’s Chevron jurisprudence has overridden this view. In Smiley v. Citibank, N.A., the Court afforded deference to a regulation in a case that was already pending when the regulation was issued, stating that it was irrelevant whether the regulation was prompted by litigation. In National Cable & Telecommunications Ass’n v. Brand X Internet Services, the Court afforded deference to a regulation that overturned existing court of appeals precedent, holding that 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.” Put those two together, the government argues, and there is no justification for failing to defer to Treasury’s interpretation because Colony had described the 1939 statute as not “unambiguous.”
Not so fast, says the taxpayer, arguing that, after Colony, the law was settled and there was no ambiguity that could permissibly be “clarified” by regulation. Smiley is different, because the regulation there did not overturn a previously settled interpretation. Brand X is not applicable because Colony is properly read as having held that Congress did unambiguously express its intent not to include overstatements of basis. More generally, the taxpayer contends that the retroactive effect of the government’s position is a bridge too far that is not authorized by these precedents. Among the several amicus briefs supporting the taxpayer, the brief of the American College of Tax Counsel focuses on this point, asserting that “retroactive fighting regulations” designed to change the outcome of pending litigation “are inconsistent with the highest traditions of the rule of law” and should not be afforded Chevron deference.
At the end of the day, the deference issue may turn on the Court’s comfort level with the amount of authority the government is asking courts to concede to agencies – particularly an agency frequently in a position to advance its fiscal interest through regulations that will affect its own litigation. That general topic has been flagged in the court of appeals opinions. In the Federal Circuit decision holding that the new regulation trumped that court’s precedent, the court observed that the case “highlights the extent of the Treasury Department’s authority over the Tax Code” because “Congress has the power to give regulatory agencies, not the courts, primary responsibility to interpret ambiguous statutory provisions.” Conversely, Judge Wilkinson cautioned in his concurring opinion in this case that “agencies are not a law unto themselves,” but must “operate in a system in which the last words in law belong to Congress and the Supreme Court.” In his view, the government’s invocation of Chevron deference in this case wrongly “pass[es] the point where the beneficial application of agency expertise gives way to a lack of accountability and risk of arbitrariness.”
In recent years, the Court has not evinced much concern over the amount of power that its Chevron jurisprudence has given to agencies, but this case could induce it to take a closer look. Justice Scalia’s position will be of particular interest. Justice Scalia was an early force in the development of Chevron deference, but recently he has expressed some uneasiness about its scope. He dissented in Brand X, commenting that the decision was creating a “breathtaking novelty: judicial decisions subject to reversal by executive officers.” And just last June, he noted in a concurring opinion in Talk America, Inc. v. Michigan Bell Telephone Co., that he would be open to reconsidering Auer v. Robbins (a decision that he authored in 1997) because its rule of extreme deference to an agency’s interpretations of its own regulations “encourages the agency to enact vague rules which give it the power, in future adjudications, to do what it pleases.”