In a sharply-divided 5-4 opinion, the Supreme Court of the

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1 Home Concrete: The Story Behind the IRS s Attempt to Overrule the Judiciary and Lessons for the Future By Roger J. Jones and Andrew R. Roberson In a sharply-divided 5-4 opinion, the Supreme Court of the United States in United States v. Home Concrete & Supply LLP 1 rejected the Internal Revenue Service s position that an understatement of gain resulting from an overstatement of basis constitutes an amount omitted from gross income within the meaning of section 6501(e)(1)(A) of the Internal Revenue Court. The Court followed its 1958 decision in Colony, Inc. v. Commissioner, 2 which involved a predecessor statute involving almost identical operative language, and held that its interpretation of the language in that case was controlling. It further held that, because its interpretation was controlling, the IRS s contrary construction of section 6501(e) (1)(A) in its fighting regulations could not prevail. Home Concrete is a significant victory, both for taxpayers caught in the basis overstatement saga 3 and for taxpayers generally. The decision s reach is not limited to IRS-labeled tax shelters or listed transactions. It affects all taxpayers and all transactions in which basis is a factor, from an individual s sale of a rental property to partnership transfers, redemptions, or contributions involving a section 754 election that results in a step-up in basis under section 734 or 743. More fundamentally, Home Concrete provides guidance on coordinated efforts by taxpayers against IRS positions, the importance of administrative law principles in tax disputes, and current IRS litigation strategies on deference issues. That said, given the sharp divide among the Justices and the failure of a majority to clarify the application of Brand X or to address several arguments briefed by the parties, several questions remain. For example, the Court did not address the issues raised under the Administrative Procedure Act (APA) about the manner in which the IRS promulgated the regulations. Inasmuch as the APA is being implicated in more and more tax cases as demonstrated by lower court decisions in the basis overstatement saga, 4 the Supreme Court s decision in Mayo Foundation for Medical Education & Research v. United States, 5 and recent opinions involving the telephone excise tax, this is unfortunate. The Court in Home Concrete also did not address several other administrative issues, including the proper deference due to so-called fighting regulations (i.e., regulations issued in the midst of litigation, supporting the government s position), the definition of retroactivity and when it is permissible, and whether Congress s 1996 amendments to section 7805(b) were intended to preclude retroactivity for all regulations promulgated after 1996 or just those relating to statutory provisions enacted after Thus, it remains unclear whether Home Concrete will change the way government agencies, particularly the IRS, approach the rulemaking process. The government s approach on the basis overstatement/understatement of income issue and the courts response has been the subject of numerous articles in recent years. 7 This article does not attempt the analysis of those articles, but instead strives to provide the story behind the basis overstatement saga, starting with the enactment of the operative statutory language in 1934 and culminating with the decision in Home Concrete. The article examines unanswered questions raised by the parties and some interesting points in the public record that have not been widely discussed. It concludes with suggestions for tax professionals regarding coordinated efforts against IRS positions, applying administrative law principles in tax disputes, and current IRS litigation strategies that, if successful, could significantly change the deference landscape and guidance process. Former Section 275(c): The Genesis of the Dispute In 1934, Congress enacted former section 275(c) of the Code, providing for an extended five-year limitations period where a taxpayer omitted from gross income an amount in excess of 25 percent of the amount of gross income stated in the return. The provision was reenacted in the 1939 Code without change. Uncertainly regarding the proper scope of the extended limitations period surfaced almost immediately, leading to a split among the circuit courts of appeals. The Tax Court and the Sixth Circuit interpreted the new provision broadly, holding that it applied to situations where a taxpayer overstated his basis, leading to an understatement of gross income in excess of 25 percent. 8 Other Courts of Appeals disagreed, focusing on whether an overstated amount was an omission, whether disclosure trumped any omission, and whether the extended limitations period could apply when the dispute centered on the legal characterization of a transaction reported on the return. 9 The factual scenarios varied, from sales of goods or services in a trade or business to sales of real property (not a good or service) to an individual s failure to report wages as taxable income. In the midst of this litigation, Congress enacted the Internal Revenue Code in As part of this comprehensive reenactment of tax law, former section 275(c) was recodified as section 6501(e)(1) (A). The operative language was virtually untouched, but two new subparagraphs were added. In an apparent nod to the Uptegrove case, which held that former section 275(c) applied when a taxpayer fails to include some receipt or accrual in his computation of gross income and not in a more general ways to errors of whatever kind in that computation, subparagraph (i) provided that for trades and business, gross income meant the total of the amounts received or accrued from the sales of goods or services before the diminution by the cost of such sales or services. Subparagraph (ii) encapsulates the position that items that were adequately disclosed by the taxpayer are not included in calculating the amount omitted from gross income. November-December

2 The Colony Decision After the enactment of the 1954 Code, the Supreme Court granted certiorari in the Colony case to resolve whether an understatement of gross income resulting from an overstatement of basis was an omission from gross income under former section 275(c). Colony involved a developer that subdivided and sold lots of real property. In calculating the gain on the sale of the lots, the taxpayer understated its gross income by incorrectly including certain expenses in basis. Although the developer on his returns may have treated the lots as goods or inventory, these sales of real property were not sales of goods and the lots were not inventory. 11 Siding with the majority of the circuits, the Supreme Court held that the taxpayer s overstatement of basis did not constitute an omission from gross income. It reasoned that the critical statutory language was omits, and that this meant [t]o leave out or unmentioned; not to insert, include, or name. 12 It also considered the legislative history and found persuasive evidence that Congress was addressing itself to the specific situation where a taxpayer actually omitted some income receipt or accrual in his computation of gross income, and not more generally to errors in that computation arising from other causes. 13 Thus, Congress s intent was to give the Commissioner an additional two years to investigate tax returns in cases where, because of a taxpayer s omission to report some taxable item, the Commissioner is at a special disadvantage in detecting errors. 14 The Court found that the Commissioner s position would create a patent incongruity in the tax law by treating overstated basis differently from overstated deductions and noted that its holding was in harmony with the unambiguous language of section 6501(e)(1)(A). 15 In essence, the Court rejected the IRS s interpretation as contrary to the plain language of the statute and Congress s intent. Post-Colony Action (or Inaction) Little occurred during the next half a century, and all indications were that Colony governed disputes under section 6501(e)(1)(A). In 1965 Congress changed the heading of section 6501(e) from Omission from Gross Income to Substantial Omission of Items, and made no reference to the Colony decision. In 1968, the Fifth Circuit in Phinney v. Chambers 16 held that either a complete omission of an item of income of the requisite amount or misstating of the nature of an item of income can give rise to the extended six-year limitations period. The court found that the taxpayer s listing of an item on the wrong schedule did not overcome the income s being left out of the proper schedule of the tax return. Because of this misrepresentation of the nature of the income item, and because the 25-percent threshold was satisfied, the court held that the six-year limitations period applied. Referring to the Supreme Court s statement of Congress s intent, the Fifth Circuit intimated that that language of the court s opinion in Colony should control here. Over the years, several other courts applied Colony s clue test for purposes of determining whether the adequate disclosure safe harbor of subparagraph (ii) was met, indicating that the courts generally believed that Colony s holding and rationale remained controlling after the enactment of the 1954 Code. 17 In 1982, as part of the enactment of the Tax Equity and Fiscal Responsibility Act of 1982, Congress enacted section 6229(c)(2), the partnership-equivalent of section 6501(e)(1)(A) for partnerships, but did not include subparagraphs (i) and (ii) in the new section. The IRS initially accorded this omission significance, stating in 1995 that the disclosure exception did not apply to section 6229(c) (2). 18 It later changed course, however, stating that subparagraphs (i) and (ii) should be read into section 6229(c)(2). 19 In 1986, Congress re-enacted the Code again, retaining the same operative language in sections 6229(c)(2) and 6501(e)(1)(A). 20 In 1997, Congress enacted section 6248(c)(2), the partnership-equivalent of sections 6229(c)(2) and 6501(e)(1)(A) for electing large partnerships, 21 and as with its enactment of section 6229(c)(2) in 1982 it did not include subparagraph (i) or (ii). Finally, in 2010, Congress amended section 6229(c)(2) (but not section 6248(c)(2)) to cross-reference subparagraphs (i) and (ii) of section 6501(e)(1)(A) (which were renumbered at the same time). 22 Overall, Congress amended sections 6229 and 6501 dozens of times, including at least six substantive amendments to section None of these amendments changed the operative language that the Supreme Court interpreted in Colony. The IRS likewise seemed to accept that Colony applied to section 6501(e)(1)(A). In its brief in opposition to the taxpayer s petition for certiorari in Phinney, it argued that the case was not in conflict with Colony and that it was significant that the Supreme Court had observed that its conclusion was in harmony with section 6501(e)(1)(A). The IRS also repeatedly referred to Colony as the landmark case and recited the requirement that an actual income item be left out of the computation of gross income. 24 This view was expressed as late as the summer of 2000, 25 after many of the tax returns at issue in the basis overstatement cases had been filed. Colony Revisited by the IRS Although there are indications that the IRS believed that Colony controlled after the 1954 and 1986 re-enactments of the Code, no one can definitively say whether the IRS changed course or whether it simply did not have an official position and the issue did not arise. In any event, the IRS s discovery in the late 1990s of transactions that it believed abusive in nature and contrary to the Code was clearly a driving force in its litigating position in the basis overstatement saga. A brief background and timeline of these transactions and the IRS s activities is helpful to understanding how the basis overstatement issue ended up in litigation. On December 27, 1999, the IRS released Notice 99-59, 26 which was intended to shut down certain transactions involving distributions of encumbered property in which losses claimed for capital outlays have been recovered known as BOSS transactions, which were the precursor to the now infamous Son of Boss transactions at issue in many of the basis overstatement cases. In February 2000, the Office of Tax Shelter Analysis (OTSA) was created, 27 and in August 2000 the IRS issued Notice designating Son of Boss as a listed transaction. The IRS s assault on Son of Boss transactions continued, and the following occurred over the subsequent few years: 438 The Tax Executive

3 December 2001 OTSA issues report to Treasury; notes approval of issuance of letters to 22 different parties on purported tax shelter issues (including Son of Boss). 29 January 2002 Creation of standard listed transactions IDR. 30 September 2002 Market Segment Specialization Program (MSSP) Guide released, referring to Notice and containing a chapter on Tax Shelters. 31 April 2003 Summons issued to bank seeking list of investors in potentially abusive tax shelters defined in Treas. Reg T. 32 June 2003 Summons issued to law firm for names of taxpayers that participated in Son of Boss transactions. 33 June 2003 Treasury issues retroactive temporary regulations to shut down Son of Boss deals. 34 June 2003 Chief Counsel Notice to assist Chief Counsel attorneys advising field personnel on Son of Boss transactions. 35 May 5, 2004 IRS announces settlement offer for Son of Boss transactions. 36 May 17, 2004 Certain taxpayer information provided to IRS in response to summons. 37 The IRS s apparent strategy was to seek, from law firms and accounting firms, the identities of individuals who participated in Son of Boss transactions and then to initiate examinations of those individuals. Alas, while the foregoing was occurring, the deadline for assessing tax within the normal three-year period was fast approaching for taxpayers who engaged in Son of Boss transactions in 1999 and Indeed, as a result of the IRS s focusing on identifying individuals first and conducting partnership examinations later, the normal three-year period expired in many cases before the issuance of any notice of deficiency or notice of final partnership administrative adjustment. Thus, absent an exception to the normal rule, the IRS would be time-barred from assessing any tax. The IRS s first specific announcement of its position on the continuing viability of Colony in the basis overstatement saga came in a 2005 Chief Counsel Advice Memorandum. 38 There, the IRS contended that Colony was limited to the sale of goods or services by a trade or business and, therefore, that a basis overstatement could, in other instances, result in an omission from gross income within the meaning of sections 6229 and In support of this view, the Chief Counsel s Office relied in part on language in a footnote from the First Circuit s 2001 decision in CC&F W. Operations L.P. v. Commissioner that it was at least doubtful whether Colony s holding carried over to section 6501(e)(1). The Chief Counsel s Office also said it was retreating from its earlier position that the clue test enunciated in Colony was the proper inquiry for judging adequate disclosure. Having staked out its administrative position, the IRS needed the support of the courts. With several basis overstatement cases pending in courts where notices had been issued more than three but less than six years after the relevant tax return was filed, the stage was set. To buttress its litigating position, the IRS relied heavily on the substantive nature of the underlying transactions, even though the nature of the transactions was irrelevant to the legal (procedural) question whether Colony remained controlling after the re-enactments of the Code in 1954 and Contrary to its position in opposing certiorari in Phinney, the IRS argued that the Fifth Circuit had held that an understatement of gross income resulting from an overstatement of basis can be an omission from gross income. It also relied on the First Circuit s dicta in CC&F Western. Finally, the IRS focused on several Tax Court decisions defining the phrase gross income, 40 asserting that the cases stood for the proposition that an overstatement of basis can be an omission from gross income. As the IRS Chief Counsel recently noted, the IRS s position was driven in large part by its desire to prevent consumers of a particularly obnoxious tax shelter from avoiding taxes solely on statute of limitations grounds. 41 Colony Lives! The Tax Court was the first tribunal to address whether Colony had survived the 1954 Code. The answer was a resounding yes. On June 14, 2007, the court in Bakersfied held that the Supreme Court had answered the question almost 50 years ago and had specifically stated that the result that it reached was in harmony with the language of section 6501(e)(1)(A). 42 The court saw little change in the rationale of the applicable statute and concluded that the Supreme Court holding would apply equally to the case before it. 43 The court succinctly stated that omits means something left out and not something put in and overstated. 44 Approximately one month later, the Court of Federal Claims followed suit in Grapevine. 45 Or Does It? These victories were short-lived, as least at the trial court level. On July 30, 2007, the District Court for the Middle District of Florida in Brandon Ridge 46 issued an unpublished Order holding that Colony did not apply and that the binding precedent of Phinney compelled a decision in the government s favor. On November 9, 2007, the Court of Federal Claims in Salman Ranch 47 rejected both Bakersfield and its prior decision in Grapevine, instead agreeing with Brandon Ridge that Colony governed the case. The District Court for the Northern District of Texas soon fell in line with the government s position, holding in Burks v. United States 48 that it was bound by Phinney and that an omission from gross income includes overstatements of basis. Next up was the District Court for the Eastern District of North Carolina in Home Concrete, 49 which was influenced by, and followed, the Court of Federal Claims s opinion in Salman Ranch. The tone and analysis of these opinions suggest that the courts may have been troubled by the nature of the underlying transaction. During this period, the Tax Court was apparently content to await the result of the appeal in Bakersfield. Although it did issue an unpublished Order in Wilmington Partners, 50 the Order was not dispositive since other issues remained in that case. The court did not act on several pending motions for full summary judgment by taxpayers. Yes, It Does! On June 17, 2009, the Ninth Circuit upheld the Tax Court s decision in Bakersfield, finding that Colony was not limited to the trade or business context, Congress likely was clarifying and not rewriting November-December

4 existing law when it reenacted the 1954 Code, and the addition of subparagraph (i) did not render Colony s holding inapposite. 51 Near the end of its opinion, however, the court observed that, based on Brand X, [t]he IRS may have the authority to promulgate a reasonable interpretation of an ambiguous provision of the tax code, even if its interpretation runs contrary to the Supreme Court s opinion as to the best reading of that provision. On July 30, 2009, the Federal Circuit signalled its agreement with the Ninth Circuit by overturning the government s victory in Salman Ranch. 52 That was enough for the Tax Court. It soon began issuing memorandum opinions and unpublished Orders adhering to its view that Colony applied. 53 The opinions and orders covered taxpayers that resided in various circuits, giving rise to the possibility of a circuit split. During this time, the taxpayers in Home Concrete and Burks filed appeals with the Fourth and Fifth Circuits, respectively. Death by Regulation? Unbeknownst to many, the IRS had begun a regulations project after the Tax Court s, but before the Ninth Circuit s, decision in Bakersfield. The purpose of the project was to administratively overrule the Tax Court s holding by limiting Colony to cases involving the sale of goods or services by a trade or business. Many have assumed that the regulations were issued in response to the Ninth Circuit s dicta and implied invitation to promulgate regulations, but in fact drafts of the regulations were circulated within the IRS in On September 24, 2009, the IRS issued temporary and proposed regulations under sections 6229(c)(2) and 6501(e)(1)(A). 54 The temporary regulations provided that an understatement of gross income resulting from an overstatement of basis was an omission from gross income. No prior notice or opportunity for comment was provided, inasmuch as the IRS viewed the temporary regulations as interpretative rules and hence not subject to such a requirement under the APA. 55 The preamble to the temporary regulations explained that the IRS disagreed with the Ninth and Federal Circuits holdings that Colony applied to sections 6229(c)(2) and 6501(e)(1)(A) and expressly sought to overrule those decisions. The temporary regulations provided that the new rules apply to taxable years with respect to which the applicable period for assessing tax did not expire before September 24, According to the IRS, this meant that courts had to determine first whether the six-year limitations period was open as of September 24, 2009, without regard to what the standard for applying the limitations period might be; if so, the temporary regulations would apply. This was described in some briefs as an Alice-in-Wonderland approach designed to avoid the natural conclusion that the regulations had retroactive effect. The IRS ultimately promulgated final regulations in December 2010, dismissing the one official comment it received but not addressing several arguments advanced by taxpayers in pending litigation. 56 The only change to the final regulations was a modification of the effective date provision, which was made to address the Tax Court s rejection of the temporary regulations. Although the government has withheld much of the background information regarding the regulations from disclosure under the Freedom of Information Act (FOIA) under various asserted privileges, the released documents provide some insights into the process behind the promulgation of the temporary and final regulations. For example, in response to requests for background documents on the temporary and final regulations, the IRS FOIA Office produced documents showing that IRS and DOJ attorneys involved in litigating the statute of limitations issue in the Tax Court and Courts of Appeal were also involved in one or more of the following activities: (1) reviewing drafts of the regulations; (2) providing edits on the regulations; and (3) approving the regulations. A document dated November 19, 2010, (less than a month before final the regulations were completed) states: The regulations were drafted in response to a request by the Department of Justice (Solicitor General s Office) for regulations on this issue as a condition for pursuing appeal of this issue. The Department of Justice has strongly urged immediate publication of the final regulations in support of several cases currently on appeal. As of the date of this document, briefing and argument had occurred in several Courts of Appeals. Upon the promulgation of final regulations, the government filed notices of supplemental authority with these courts informing them of the finalization and arguing that any APA concerns regarding lack of an opportunity for notice and comment were moot. After issuing the temporary regulations, the IRS immediately moved to vacate or reconsider the Tax Court opinions or decisions that had not yet become final. 57 The primary purpose of the motions was to argue that court had erred and that the temporary regulations required acceptance of the IRS s position. The issuance of the temporary regulations, however, came too late for some Tax Court decisions. The government was therefore forced to file appeals in several circuits and argue, for the first time, that the temporary regulations required reversing the Tax Court. 58 The Tax Court, recognizing the importance of the issue and potential problems with the effective date of the government s regulations, issued orders in some cases requesting further information. For example, in Reynolds Properties v. Commissioner, 59 Judge Laro expressed skepticism over whether the temporary regulations could apply to pending cases and ordered additional briefing on the issue. One week later, the IRS issued a Chief Counsel Notice adding the phrase as interpreted in the temporary regulations to bolster its litigating position that the regulations did indeed apply to pending cases. 60 Amazingly, the government claimed in subsequent briefs before the Courts of Appeals that this document is entitled to deference and that the regulations confirmed its litigating position. Disagreement over the Validity of the Regulations The Tax Court first weighed in on the temporary regulations in Intermountain. 61 Not surprisingly, it viewed the regulations as an attempt by the IRS to bootstrap its failed litigating position under the guise of its authority under section 7805(a). The court held that the temporary regulations did not apply under the plain meaning November-December

5 their own effective date provisions, and that they were invalid and not entitled to deference. 62 A concurring opinion, written by Judges Halpern and Holmes, concluded that the temporary regulations failed to comply with the APA s notice-and-comment procedures and, further, that any opportunity for post-promulgation notice and comment would not cure this defect. The court then issued several unpublished Orders following Intermountain and disposing of similar cases on its docket. 63 The government appealed all of these decisions, with the exception of two cases that would have gone to the Tenth Circuit. 64 It is unclear whether this was a conscious decision or just an oversight. During the next year, taxpayers and the government filed briefs in the Second (Wilmington Partners), Fourth (Home Concrete), Fifth (Burks / M.I.T.A.), Seventh (Beard), Ninth (Reynolds Properties), Tenth (Salman Ranch), D.C. (Intermountain / UTAM) and Federal (Grapevine) Circuits. In each case, except for Wilmington Partners in the Second Circuit, the government focused heavily on the nature of the underlying transaction and attempted to influence the Court of Appeals by painting the case as involving an abusive tax shelter that was concealed from the IRS. The government s briefs did not mention that the regulations applied to all taxpayers, regardless of the nature of the transaction. Nor did the briefs mention that in 2004 Congress had enacted section 6501(c)(10), which extended the limitations periods in situations where a taxpayer failed to disclose a listed transaction. Although section 6501(c)(10) was prospective only, it highlighted that the government s position that it needed the six-year limitations period in section 6229(c)(2) or 6501(e)(1)(A) was limited to cases in which the three-year limitations period expired before the enactment of section 6501(c)(10). Thus, ironically, the government s position, if sustained, would apply in the future only to taxpayers that did not engage in listed transactions. During this time, Bausch & Lomb Incorporated (Bausch & Lomb), the parent company of the tax matters partner in Wilmington Partners, sought leave to file as an amicus in each Court of Appeals. With the exception of the Seventh Circuit, which has a history of denying such requests, 65 each appellate court allowed Bausch & Lomb to file an amicus brief. A major point in Bausch & Lomb s briefs was that the nature of the transaction was irrelevant to the statute of limitations issue. Bausch & Lomb also raised several arguments not previously touched on in detail by the taxpayers, including arguments related to APA violations and the impermissibly retroactive effect of the regulations. The Courts of Appeals struggled with the proper interpretation of Colony. The Seventh Circuit in Beard, 66 contrary to every other appellate case, determined that Colony was not applicable to section 6501(e)(1)(A) and, further, that the plain language of the statute mandated a decision in the government s favor (thereby making the regulations unnecessary). The Fourth and Fifth Circuits in Home Concrete 67 and Burks 68 rejected this view, finding that Colony controlled, the regulations were invalid, and it was up to the Supreme Court to hold otherwise. The Fifth Circuit also expressed its view that the regulations were not in compliance with the APA. The tide turned again though, as first the Federal and then the Tenth and D.C. Circuits adopted the government s position that, even if Colony was the law before the issuance of the regulations, the regulations were entitled to deference and mandated a decision for the government. 69 The Tax Court stuck to its guns, ruling that the regulations (now in final form) were also invalid. 70 Fight for Supreme Court Review Given the deep split in the circuits, it was inevitable that the dispute would land in the Supreme Court. The only question was which case would become the vehicle for review. 71 Not surprisingly, the government favored consideration of its victory in Beard. It faced a potential hurdle, however, because the deadline for filing a petition for certiorari in that case expired after the July 4, 2011, deadline for request review of the Home Concrete case. To thread this needle, on June 22, the government submitted an application to extend the time to file its petition in Home Concrete until August 3, 2011, which Chief Justice Roberts granted. Based on the Supreme Court s conference schedule for reviewing petitions, the extension meant that consideration of Home Concrete could potentially be pushed to after the conference at which Beard was to be considered. The government s strategic decision turned out to be a moot point. Perhaps wanting its own case before the Supreme Court, the taxpayers in Beard filed their petition for a writ of certiorari early on June 23. On July 27, the government filed its brief supporting the taxpayer s petition, reciting the circuit split, the amounts of taxes at issue, and the significant governmental and public interest in the uniform administration of the tax laws. Not all taxpayers agreed that Beard was the suitable vehicle for review, mainly because the Seventh Circuit s opinion was unfavorable; possibly influenced by the substantive nature of the underlying transaction, the appellate court contrary to every other circuit found that the plain language of section 6501(e)(1)(A) compelled a decision in the government s favor. The taxpayer in Home Concrete had understandably opposed the government s petition for certiorari (since it prevailed below), and Bausch & Lomb moved the Court to grant certiorari in that case because it was a better vehicle for review given the Fourth Circuit s consideration of the issues presented. The government rejected this view, arguing that Beard should be reviewed because it was first in time and addressed all the same issues decided in Home Concrete. 72 In a move that surprised many, 73 the Supreme Court granted certiorari in Home Concrete 74 and did not act on the petitions in Beard and several other cases. One view is that the Court viewed Home Concrete as a better vehicle for the reasons set forth in Bausch & Lomb s amicus brief. Another view, not raised in the mainstream media, is that by granting certiorari in Home Concrete the Court would have all nine Justices available to decide that case. The reason for this is that Justice Kagan was the Solicitor General at the time Beard and some of the other cases (e.g., Grapevine (Fed. Cir.) and Salman Ranch (10th)) were approved for appeal, and she may have recused herself had certiorari been granted in one of those cases. 75 This view is reinforced by the Supreme Court s April 30, 2012, Order disposing of all the other petitions for certiorari. That Order reflects that Justice Kagan took no part in the consideration or decision of the petitions in the cases in which she approved appeals of decisions adverse to the government. One wonders what practitioners and scholars would have made of this point if one other Justice had sided with the govern- 442 The Tax Executive

6 ment and Justice Kagan ended up being the swing vote. Home Concrete The Supreme Court The briefing in Home Concrete was done in November and December of In all, nine amicus briefs were filed in support of the taxpayers (not surprisingly, none was filed in support of the government). The amici included several taxpayers engaged in pending litigation (Bausch & Lomb, Grapevine Imports, Ltd., Daniel S. Burks, Reynolds Properties, L.P., UTAM, Ltd., and DSDBL, Ltd.), interested associations (American College of Tax Counsel, National Association of Home Builders, National Federation of Independent Business Small Business Legal Center, and CATO Institute), a U.S. territory (Government of the United States Virgin Islands), and a leading administrative law tax professor (Professor Kristin Hickman). The topics covered were diverse, ranging from deference to IRS guidance to APA violations to the possible effect of the decision on the Virgin Islands tax incentive program. Oral argument was held on January 17, Any hopes that the Supreme Court would signal its position were quickly dashed. Chief Justice Roberts and Justice Scalia seemed troubled by the notion that the IRS could overrule or limit the Court s opinion in Colony. Justice Breyer questioned the fairness of the IRS s actions, although he coined a memorable phrase: If you live by loopholes, you ll die by regulation. Justice Sotomayor played both sides of the fence, asking tough questions of each party. Justices Kagan and Ginsburg provided probably the clearest signal of which way they were leaning, voicing their opinion that Colony was limited to the 1939 Code, the Court had found an ambiguity in the predecessor statute, and that Brand X allowed for a different interpretation. Justices Kennedy and Alito asked a few questions and, to no one s surprise, Justice Thomas remained silent. Applying an unofficial questions asked test i.e., the party receiving the most questions usually loses the case the outcome was too close to call. The Majority Opinion A Reaffirmation of Stare Decisis A little over two months after oral argument, the Supreme Court rendered its decision. The Court was not swayed by the nature of the transaction before it, as evidenced by the lack of any detailed discussion of the factual background on the case. Instead, the Court jumped straight to the primary legal issue: Was the Supreme Court s 1958 Colony opinion, which addressed the same operative language in former section 275(c), controlling for purposes of interpreting 6501(e)(1)(A)? The Court conclusively answered in the affirmative: In our view, Colony determines the outcome of this case. The provision before us is a 1954 reenactment of the 1939 provision that Colony interpreted. The operative language is identical. It would be difficult, perhaps impossible, to give the same language here a different interpretation without effectively overruling Colony, a course of action that basic principles of stare decisis wisely counsel us not to take. 77 The Court s rationale continued its trend of reaffirming the strength of the doctrine of stare decisis in the post-brand X era. 78 In Brand X, the Supreme Court broadly stated 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 statutes. 79 Some viewed Brand X as weakening the doctrine of stare decisis by allowing an agency to adopt a statutory interpretation contrary to an existing decision so long as that decision did not use the words ambiguous or unambiguous. This view was rejected by Home Concrete, signalling that if a court (especially the Supreme Court) has previously interpreted a statute, an agency s contrary construction may face heightened scrutiny. The Court rejected the government s argument that Congress s addition of subparagraph (i) in 1954 required a different interpretation of the operative language that had been carried over nearly verbatim from former section 275(c), finding these points are too fragile to bear the significant argumentative weight the Government seeks to place upon them. 80 It further rejected the government s argument that subparagraph (i) would be rendered superfluous by applying Colony and observed that it had already rejected in Colony the same textual arguments advanced by the government in Home Concrete regarding any distinction between the use of item and amount in section 6501(e). The Court noted that to rely in the case before us on this solitary word change in a different subsection is like hoping that a new batboy will change the outcome of the World Series. 81 The majority in Home Concrete was plainly troubled by the government s position that it could essentially overrule Colony. The Supreme Court rejected any magic words requirement in testing whether a prior judicial interpretation forecloses a contrary agency construction of a statute. In its view, Colony has already interpreted the statute, and there is no longer any different construction that is consistent with Colony and available for adoption by the agency. 82 The Plurality Brand X Limited? In the last section of the Court s opinion, four of the Justices, constituting a plurality, faulted the government for relying blindly on Brand X while overlooking why it had held that a prior judicial construction might not trump a subsequent agency construction. The plurality went to great lengths to ascertain Congress s intent in enacting the predecessor statute and whether Congress had intended any change in enacting the current statute. Acknowledging that Colony found the same operative language not unambiguous, the plurality observed that the Colony Court had employed traditional tools of statutory construction and had determined that Congress did not intend for the longer limitations period to apply in the case of an overstatement of basis. The plurality concluded that Colony made clear that Congress did not leave a gap for the IRS to fill on this point and that the regulations therefore do not merit deference. 83 Justice Scalia s Concurrence Get Rid of Brand X In a strongly-worded concurring opinion, Justice Scalia declined to join the last section of the opinion. He chided the plurality for revising yet again the meaning of Chevron 84 and thereby avoiding taking Brand X head-on. His continuing view, which was November-December

7 thoroughly detailed in his dissent in Brand X, is that the Court should abandon Brand X. 85 It seems clear that Justice Scalia s view is that once the Supreme Court speaks, that is the law of the land and cannot be overruled except by legislation. 86 The Dissent Colony Is Obsolete The dissent, written by Justice Kennedy, 87 essentially adopted the government s argument that the differences between former section 275(c) and section 6501(e)(1)(A) were significant and that Colony reserved judgment on the interpretation of the latter because that version of the statute was not before it. The dissent believed that the 1954 changes were meaningful and strongly favor the government s position that Colony was limited to the 1939 Code. The dissent would have upheld the regulations as a permissible interpretation of the statute that did not change the law and, therefore, were not impermissibly retroactive. Reaction to Home Concrete Although taxpayers were obviously thrilled with the result in Home Concrete, the opinions produced mixed reactions given the approach taken by the Court. 88 Some expressed disappointment or highlighted that the Supreme Court did not take the opportunity to address or clarify the following: The proper role of Brand X in future disputes. 89 The IRS s ability to issue retroactive regulations during litigation. 90 Whether the initial promulgation of regulations in temporary form with only post-promulgation notice and comment violates the APA or affects the applicability of Chevron deference. 91 Whether legislative history is considered at Chevron s Step 1 or Step The IRS also expressed its view, focusing on the differences between pre- and post-chevron decisions of the Supreme Court. IRS Chief Counsel William J. Wilkins stated that pre-chevron decisions should be generally be read as final determinations not subject to change by regulations and that post-chevron decisions will have to be mined to determine whether the word ambiguous is used. 93 The Chief Counsel described the Court s position as being one that if we have spoken; resistance is futile. He observed, however, that the Court s adherence to its own statutory construction may not be the right path for lower courts, adding a circuit court decision cannot remove ambiguity the way the Supreme Court does. In the end, whether a regulation comes before or after a Supreme Court decision could be the controlling factor. In a similar vein, Deborah Butler, IRS Associate Chief (Procedure and Administration), commented that [i]f the Court has addressed an issue, that should be the end of the day. 94 She expressed her view that when the Supreme Court speaks, they mean it even if it is an oldie-goldie and that Brand X was not banished and that the decision remains available to allow agencies to write regulations even as litigation proceeds. Ms. Butler concluded that the IRS is considering whether changes should be made to the statute itself to prevent taxpayer abuse. Tamara Ashford, Deputy Assistant Attorney General (Appellate and Review) in the Justice Department s Tax Division, called the opinion disappointing all around but commented that she believes the decision has narrow application. 95 She agreed that pre-chevron opinions should be read as final decisions that cannot be changed by regulations, but said post-chevron cases must be examined to determine whether an ambiguity exists for the agency to exercise its regulatory power. Gilbert Rothenberg, Appellate Section Chief in the Tax Division, has also stated that that Supreme Court s holding was narrow, and that he is not sure it s going to have a long-standing impact, at least on various areas of controversy. 96 Finally, Tax Court Judge James Halpern commented that not a lot was settled by Home Concrete because the Chevron Step One questions addressed by the lower courts were not addressed by the Supreme Court. 97 He concluded, We haven t progressed very much and [n]ot much was learned. Lessons for Taxpayers and Their Advisers Home Concrete conclusively answered the question whether an overstatement of basis that results in an understatement of income is an omission from gross income for purposes of the six-year statute of limitations. The decision applies to all taxpayers and all transactions in which basis is a factor. Aside from the specific procedural issue, the Home Concrete saga provides some important lessons for tax professionals. First, Home Concrete shows that courts should not blindly follow guidance issued by the IRS (or any agency) that conflicts with prior judicial precedent and that the Supreme Court s recent tax decision in Mayo did not grant unbridled regulatory power to the IRS. The decision underscores the continuing importance of stare decisis in interpreting statutes. Second, the coordinated approach among the taxpayers and their counsel may have won the all-important fifth vote at the Supreme Court level. Part of the government s approach was to paint the particular taxpayers with a broad tax-shelter brush in hopes of influencing the courts. The taxpayers involved, however, were quick to point out that the government s position applied to all taxpayers; indeed, given the enactment of section 6501(c)(10) in 2004, the issue going forward would only affect non-listed transactions. Throughout the Tax Court and Court of Appeals proceedings, taxpayers and their counsel engaged in a coordinated effort to respond to the government s litigating position through the sharing of strategies and the filing of amicus briefs. One such strategy demonstrating that the nature of the underlying transaction was irrelevant appears to have been successful as the Supreme Court s majority opinion is devoid of any reference to a tax shelter or listed transaction. In future disputes regarding issues of general applicability, taxpayers and their advisers may want to consider the benefits of coordinated efforts. Third, although the Supreme Court did not pass on the issue, there was significant briefing and development of arguments on the applicability of the APA to IRS rules and regulations. Some Tax Court judges and the Fifth Circuit were clearly bothered by the IRS s practice of issuing immediately binding temporary regulations without notice and comment and then later curing any November-December

8 defect by providing for comment before promulgating final regulations. Given the apparent trend toward stricter enforceability of the APA in tax disputes, taxpayers and their advisers should familiarize themselves with the APA and keep informed of important developments in the area. Finally, although the IRS lost in Home Concrete, several deference issues were left unanswered. For example, the Supreme Court did not address the propriety of issuing fighting regulations during litigation to overrule non-final judicial decisions. The Supreme Court has said that there is nothing improper about the IRS changing its administrative position or promulgating or amending regulations to address a specific situation. That said, the Court has not definitively prescribed the permissible scope of retroactivity. Nor has any court addressed in detail whether the IRS has the authority, after the 1996 amendment to section 7805, to issue retroactive regulations at all absent the satisfaction of a specific exception in the statute. Another looming deference issue is the separate but related question of the proper deference to the IRS s interpretation of its own rules and regulations. In Auer v. Robins, 98 the Supreme Court reaffirmed an earlier holding that an agency s interpretation of its own ambiguous rule may be afforded controlling deference. The Court has noted several limitations on Auer deference over the years, 99 but the government has taken what could be viewed as aggressive interpretations of the doctrine in recent litigation. For example, in pending litigation involving the application of the section 6662(a) penalty to taxpayers that overstate refundable tax credits such as the earned income credit and the child tax credit the IRS is taking the position that statements made by IRS employees in unpublished internal memoranda that purport to interpret a tax regulation are entitled to controlling deference under Auer. 100 The government s position, if successful, could result in a pyrrhic victory by transforming private guidance into controlling authority whenever an ambiguous rule or regulation is at issue. Thus, taxpayers could search for IRS statements in briefs and private guidance that support their reading of a regulation and argue that such statements should be treated as controlling under Auer even though not binding or precedential in the ordinary sense. 101 The Supreme Court s decision in Home Concrete is a welcome development for taxpayers. Many weighty issues remain for another day, however, and the question is probably better framed as when, not if, the next fighting regulations will be issued and what are the limits on Auer deference. Roger J. Jones is a partner in the law firm of McDermott Will & Emery LLP, based in the firm s Chicago office. Roger specializes in tax controversy and litigation matters representing taxpayers, including numerous Fortune 500 companies. He received his B.A., M.A., Ph.D., and J.D. degrees from the State University of New York-Buffalo. He may be reached at rjjones@mwe.com. Andrew R. Roberson is a partner in McDermott Will & Emery s Chicago office. He specializes in tax controversy and litigation matters. He received his B.A. degree from the University of Washington, his J.D. degree from Pepperdine University School of Law, and his LL.M. degree from New York University School of Law. He may be contacted at aroberson@mwe.com. Messrs. Jones and Roberson represented the taxpayer in Home Concrete before the Supreme Court, filed briefs amicus curiae on behalf of Bausch & Lomb Inc. in various Courts of Appeals, and represent Wilmington Partners L.P. in its case involving the same issue S. Ct (2012). Justice Breyer wrote the opinion, which Chief Justice Roberts and Justices Thomas and Alito joined in its entirety. Justice Scalia joined all but the last section of the opinion, which addresses deference to the regulations at issue in light of National Cable & Telecommunications Association v. Brand X Internet Services, 545 U.S. 967 (2005), and Chevron, U.S.A. Inc. v. Natural Resources Defense Council, 467 U.S. 837 (1984), and which Justice Scalia criticized in a concurring opinion U.S. 28 (1958) (holding that, under identical language in the predecessor to current sections 6229 and 6501, an overstatement of basis is not an omission from gross income). 3. The Supreme Court acted swiftly on other pending petitions for review on the basis overstatement issue. On April 30, 2012, the Court granted a writ of certiorari and vacated and remanded cases that were contrary to Home Concrete. 182 L. Ed. 2d 865. It denied certiorari in the cases that followed Home Concrete. 182 L. Ed.2d 882. On remand, the government conceded the statute of limitations issue in each case, and the appeals were dismissed. 4. See, e.g., Burks v. United States, 633 F.3d 347, 360 n.9 (5th Cir. 2011); Carpenter Family Investors, LLC v. Commissioner, 136 T.C. 373, 381 & n.8 (2011); id. at (Halpern and Holmes, JJ., concurring); Intermountain Insurance Services of Vail, LLC v. Commissioner, 134 T.C. 211, (2010) (Halpern and Holmes, JJ., concurring) S. Ct. 704, 713 (2011). 6. See, e.g., Cohen v. United States, 650 F.3d 717 (D.C. Cir. 2011); Cohen v. United States, 578 F.3d 1 (D.C. Cir. 2009); In re Long-Distance Telephone Service Federal Excise Tax Refund Litigation, 2012 U.S. Dist. LEXIS (Apr. 10, 2012). 7. See, e.g., Kim Boylan, Roger Jones & Andrew Roberson, Absolute Power Corrupts Absolutely: Basis Overstatements and the Six-Year Limitations Period Should the IRS Be Allowed to Re-Write the Law Retroactively?, 52 Tax Management Memorandum 235 (Jun 6, 2011); 39 The Lawyer s Brief 22, Articles VII-IX (2009) (reprinting trio of articles by the authors on the basis overstatement issue). 8. See Reis v. Commissioner, 142 F.2d 900 (6th Cir. 1944); Estate of Gibbs v. Commissioner, 21 T.C. 443 (1954); American Liberty Oil Co. v. Commissioner, 1 T.C. 386 (1942). 9. Goodenow v. Commissioner, 238 F.2d 20 (8th Cir. 1956); Davis v. Hightower, 230 F.2d 549 (5th Cir. 1956); Deakman-Wells v. Commissioner, 213 F.2d 894 (3d Cir. 1954); Uptegrove Lumber Co. v. Commissioner, 204 F.2d 570 (3d Cir. 1953); see also Lazarus v. United States, 136 Ct. Cl. 283 (1956). 10. Act of Jan. 6, 1954, ch. 736, 68A Stat See, e.g., W.C. & A.N. Miller Development Co. v. Commissioner, 81 T.C. 619, 628 & n.5 (1983). 12. Colony, 357 U.S. at Id. at Id. at The Tax Executive