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Argument analysis: Justices focused on jurisdictional problem in tax penalties dispute

On Wednesday morning, the Justices started with what might seem to be a minor tax case, United States v. Woods.  The Justices apparently took the case in response to a circuit split that, generally speaking, relates to the application of an “overstatement” penalty in the tax code (penalizing taxpayers that substantially misstate items on their tax returns) when the misstatement arises from an abusive tax-motivated partnership. When they granted the federal government’s petition, however, the Justices also asked for briefs on a related jurisdictional problem.  The question is whether the IRS should determine the propriety of the penalty in (a) the process related to partnership issues (this case is a challenge arising out of that process); or (b) in later proceedings determining the tax liability of the individual partners.  That question turns out to matter a great deal to taxpayers, because if the penalty is determined at the partnership level, then, at least in the view of the IRS, the individual partners can’t challenge the penalty without first paying it.

Veteran Deputy Solicitor General Malcolm Stewart appeared to defend the IRS’s position. It was understandable, though probably unfortunate, that he started with the jurisdictional question on which the Court asked for briefing, as the questioning from Justices trying to clarify his position on that point consumed more than half of his argument before he even reached the merits question, on which the federal government had sought review.  On the bright side, though, as he neared the end of that discussion, Justice Scalia pressed the point that the IRS’s position (determining whether penalties apply at the partnership level rather than the partner level) is the only way to be sure that all partners are treated equally and that the IRS has to litigate the question only once.  This was not one of the major points in the Solicitor General’s brief, but Mr. Stewart understandably embraced the life-line Justice Scalia tossed him.

At last, far past the halfway point of his argument, Justice Ginsburg invited Stewart to turn to the merits, taking him directly to the strongest point of the taxpayer’s brief: if the IRS is correct in arguing that the overstatement penalty applies here, why did Congress need to add the non-economic substance penalty? Stewart shifted focus a bit from his brief, where he argued that it was common for  multiple penalties to apply.  Here, he emphasized that the beginning of the relevant section referred to underpayments “attributable to one or more of the following.”  That language, he argued, showed that Congress expected the various subsections to overlap: he called it a stacking provision, designed to ensure that taxpayers paid only a single penalty.  Although certainly not a complete answer to Justice Ginsburg’s question, it was much crisper than the discussion in the Solicitor General’s reply brief. Ominously enough for Stewart, the Chief Justice consumed the rest of his time with a colloquy suggesting that he found Stewart’s reading of the statute much less natural than the taxpayer’s.

When former Solicitor General Gregory Garre rose to argue for the taxpayer, Justice Kagan did him the favor of taking him straight to the text of the jurisdictional question.  All agree (she explained) that the question is whether the partnership-level proceedings can consider a penalty based on an adjustment to a partner-level item (the so-called “outside basis” of the partner in the partnership).  She offered Garre her view that both sides want to add a word to the statute: the IRS wants to add “indirectly” (so that partnership-level proceedings can consider partner-level items that they affect only indirectly); the taxpayer wants to add “directly” (so that partnership-level proceedings are limited to items that they affect directly).

Garre answered her question forthrightly, arguing that the statute directly distinguishes between “partnership items” and “non-partnership items,” and thus that the IRS’s reading gives too little weight to the statute’s choice of the former term to describe the reach of the partnership-level proceedings.

At that point, with a tone suggesting Garre had overreached, Scalia jumped in to emphasize that the jurisdiction extended not only to partnership items, but also, in a separate sentence, to “the applicability of any penalty * * * which relates to an adjustment to a partnership item.”  Because the penalties will always be at the partner level – partnerships don’t pay tax, only their partners – doesn’t the statute strongly suggest that the applicability of the penalties is exactly what Congress had in mind? Garre’s answer to that problem was less successful, at least in Justice Scalia’s mind – he dragged Garre back to belabor that point when Garre tried to move from it to answer a series of questions from Justice Breyer.

Finally, as the jurisdictional questioning wound down, Justice Scalia asked Garre the same question he’d offered Stewart: whether the taxpayer’s rule would lead to inconsistent determinations.  Garre firmly rejected that idea.  He explained that he always had conceded that the “sham” determination should be made at the partnership level. The only thing he wanted determined at the partner level was the partner’s individual penalty.  Because that penalty always depends on attributes of the partner’s return, it doesn’t need to be made at the partnership level, and leaving it to the partner level won’t result in unjustifiably inconsistent determinations.

Like Stewart, the Justices let Garre turn to the merits just a few minutes before the end of his time. With the brief time available, he decided to emphasize his “parenthetical” point.  The relevant statute authorizes penalties for overstatements of the “value . . . (or the adjusted basis)” of the property.  Garre argues that “adjusted basis” is a small clarification, parenthetically added to indicate how value might matter.  The IRS, by contrast, argues that the penalty applies when there is only an overstatement of basis, even if there is no overstatement of value.  Garre closed with a flourish, offering the following hypothetical:

If you had a contract for a wedding that provided for flowers (or plants) you would understand that to mean flowers or plants like lilies or ferns that would accompany flowers in the wedding.  You wouldn’t read that to include an oak tree in the middle of the reception area.  Well, the Government’s basis overstatement penalty is the oak tree in the middle of the reception area here.

If we learned anything from the argument here, we learned that the Justices are much more interested in the question they gave the parties – the jurisdictional problem – than they are in the merits question that the parties brought to them.  It is much harder to see how they’ll come out on the jurisdictional question, though Justice Scalia pretty clearly showed his hand in favor of the IRS’s position.  Still, on the merits, to the extent the brief discussion of that topic suggests anything, it suggests a general predisposition in favor of the taxpayer. Indeed, one way to read the argument is that the Justices focused on the jurisdictional question only because they thought the merits question was too easy to justify attention.

Recommended Citation: Ronald Mann, Argument analysis: Justices focused on jurisdictional problem in tax penalties dispute, SCOTUSblog (Oct. 10, 2013, 11:29 AM),