Opinion analysis: In tax refund case, justices decide a narrow question but leave much unresolved
on Feb 26, 2020 at 12:16 pm
Some Supreme Court decisions send shock waves across and beyond the legal universe. The court’s unanimous ruling Tuesday in Rodriguez v. Federal Deposit Insurance Corp. is not one of them. The result, a remand to the U.S. Court of Appeals for the 10th Circuit with instructions to try again, is unlikely to affect many case outcomes—and possibly won’t even alter the resolution of the case at hand.
The opinion does, however, serve to illustrate at least two important trends. One is the court’s continued cabining of “federal common law,” the set of doctrines developed by federal courts that are not based on the Constitution, acts of Congress or agency rules. The other is the court’s retreat in recent years from issues central to the interpretation of the Internal Revenue Code toward cases at the federal tax system’s periphery.
The narrow question resolved by Tuesday’s ruling is whether state law or federal common law determines the ownership of a federal tax refund paid to a parent company but arising out of losses and income generated by its subsidiary. In 2011, a Colorado-based bank holding company named United Western Bancorp, Inc., filed a consolidated federal tax return on behalf of itself and its federally insured subsidiary, United Western Bank. On that return, UWBI claimed a $4 million refund on account of losses incurred by United Western Bank in 2010, which offset taxable income earned by the bank subsidiary in 2008.
By the time the refund check arrived in 2015, federal regulators had shut down the bank subsidiary, and UWBI had filed for bankruptcy. Simon Rodriguez, the trustee for UWBI’s bankruptcy estate, and the Federal Deposit Insurance Corporation, the receiver for the bank subsidiary, both said that the refund belonged to their respective institutions.
The 10th Circuit, in a confusing opinion, sided with the FDIC. The appeals court said that “[f]ederal common law … provides a framework for resolving this issue,” specifically citing a decision of the neighboring U.S. Court of Appeals for the 9th Circuit in a 1973 case, In re Bob Richards Chrysler-Plymouth Corp., involving the bankruptcy of the Bob Richards Chrysler-Plymouth car dealer. The so-called “Bob Richards rule” holds that, absent a different agreement among the parties, a tax refund resulting solely from losses and income generated by one corporate subsidiary should inure to the benefit of that subsidiary—and not to the parent company that files consolidated tax returns on behalf of the whole corporate group. The 9th Circuit did not cite any statutory basis for this rule but said that, to its mind, allowing the parent company to keep the refund would be “unjust.”
Yet despite the 10th Circuit’s statement that Bob Richards governed its analysis, its ruling appeared to rest on a different ground. UWBI and United Western Bank—unlike the parent and subsidiary in Bob Richards—did have an agreement pertaining to tax liabilities and payments. Although the agreement did not explicitly address the ownership of refunds, it included a clause that said that any ambiguity would be resolved in favor of the federally insured bank. The 10th Circuit therefore awarded the refund to the FDIC.
Rodriguez sought Supreme Court review, pointing to a split between circuits that follow Bob Richards and circuits that look to state law to resolve refund-ownership disputes. The FDIC declined to defend Bob Richards at the Supreme Court, but argued that the rule was irrelevant to the outcome because the 10th Circuit had decided the case based on its interpretation of the contract rather than federal common law. Notwithstanding the FDIC’s implorations, the justices granted certiorari with a particular objective in mind: As Justice Neil Gorsuch writes in Tuesday’s opinion, “We took this case to decide Bob Richards’s fate.”
Framed as a test of Bob Richards, the result was almost inevitable. “The cases in which federal courts may engage in common lawmaking are few and far between,” Gorsuch writes, adding that “[t]his is one of the cases that lie between.” Outside of areas such as admiralty, in which Congress has authorized judges to craft federal common law, the Supreme Court has repeatedly said that “uniquely federal interests” must be at stake for federal common lawmaking to be legitimate. Gorsuch goes on to ask: “But what unique interest could the federal government have in determining how a consolidated corporate tax refund, once paid to a designated agent, is distributed among group members?”
The question is rhetorical. With neither party rising to the doctrine’s defense, it takes just a few paragraphs for Gorsuch to bury Bob Richards once and for all, and the entire opinion—at a slim six pages—is a model of judicial concision. The result, though, is that the long-running fight between Rodriguez and the FDIC will now drag on even longer. “Whether this case might yield the same or a different result without Bob Richards is a matter the court of appeals may consider on remand,” Gorsuch concludes.
Tuesday’s decision thus serves as one more reminder that federal common law is out of favor at 1 First Street. “We took this case,” Gorsuch writes, “to underscore the care federal courts should exercise before taking up an invitation to try their hand at common lawmaking.” The fate of Bob Richards, Gorsuch adds, is a “cautionary tale.”
But the moral of the story is not entirely straightforward. Judge-made rules abound across federal tax law: the substance-over-form doctrine, the sham transaction doctrine, the step transaction doctrine and many more. Often these doctrines direct federal courts in tax cases to disregard transactions that state law would honor. There is little indication in Rodriguez that the justices intended to upend these decades-old doctrines, though the line between legitimate and illegitimate federal common lawmaking remains something of a blur.
Rodriguez therefore illustrates the imprecision of the term “federal common law” and the uncertainty around its boundaries. The case also exemplifies the Supreme Court’s tendency in recent years to resolve fewer federal tax cases of great significance. From the mid-1950s through the early 2000s, the Supreme Court decided, on average, more than five cases about the interpretation of the Internal Revenue Code each term, grappling with many of the most important questions in federal tax law: What is the meaning of “income”? What is a gift? And when are business expenses deductible? More recently, and with the exception of Affordable Care Act cases that transcend the tax/nontax divide, the justices’ forays into federal tax law have numbered, at most, one or two each term, and have involved questions that would not rank on anyone’s list of the most important issues in federal taxation: whether lost wages and stock options are taxable compensation under the Railroad Retirement Tax Act, whether supplemental unemployment compensation benefits are taxable wages under the Federal Insurance Contributions Act, and here, how federal courts should resolve the relatively rare disputes between corporate parents and their subsidiaries over federal tax refunds. The Supreme Court remains an active player in state tax law, but on federal tax matters, the justices now rarely occupy center stage.
Why the court has withdrawn to the edge of the federal tax law arena is not entirely clear. The 2011 decision in Mayo Foundation for Medical Education and Research v. United States—which held that courts should generally defer to tax regulations that reflect reasonable interpretations of ambiguous tax code terms—may have made it easier for the IRS to resolve unsettled questions of federal tax law, lessening the need for the Supreme Court to intervene on important matters. The solicitor general has filed only a small handful of tax-related cert petitions in recent years. The fading frequency of IRS audits also may have reduced the number of potential flashpoints between taxpayers and federal tax authorities.
Rodriguez is characteristic of this pattern. As far as Supreme Court cases go, it’s hard to get much narrower than this. The immediate issue in the case—who gets to keep the $4 million refund—remains for the 10th Circuit to resolve on remand. And as for the broader question of where and when judges may rely on “federal common law,” there too the lower courts are largely left to sort it out on their own.