June 7, 2024
Tax Briefs
Registration Requirements for Clean Fuel Production Credit Provided; Court Cannot Order Immediate Restitution for Filing False Returns; Excise Tax Assessment Was Not Grounds for Expungement of Illegal Gambling Conviction ...
Partnership Did Not Have To Substantiate Assets In Order to Make Valid BBA Election
The Tax Court held that a partnership made a valid election to apply the audit rules under the Bipartisan Budget Act of 2015 (BBA) (Pub. L. 114-74) (BBA election) for its 2016 tax year and therefore, a notice of final partnership administrative adjustment issued by the IRS under the repealed rules under the Tax Equity and Fiscal Responsibility Act (TEFRA) (Pub. L. 97-248) was invalid. The court rejected the IRS's argument that under Reg. Sec. 301.9100-22(b)(2), the partnership was required to provide proof that it had sufficient assets to pay an imputed tax liability and that its failure to do so invalidated its BBA election. SN Worthington Holdings LLC v. Comm'r, 162 T.C. No. 10 (2024).
Supreme Court: Estate's Value Includes Insurance Proceeds Used to Redeem Shares
The Supreme Court affirmed a decision of the Eighth Circuit and held that a closely held corporation's contractual obligation to redeem shares did not reduce the corporation's value for purposes of the federal estate tax. The court found that, because a fair-market-value redemption has no effect on any shareholder's economic interest, no hypothetical buyer purchasing the decedent's shares would have treated the company's redemption obligation as a factor that reduced the value of those shares. Connelly v. U.S., 2024 PTC 196 (S. Ct. 2024).
IRS Issues Proposed Regulations on Clean Electricity Production and Investment Credits
The IRS issued proposed regulations relating to the clean electricity production credit under Code Sec. 45Y and the clean electricity investment credit under Code Sec. 48E, both of which were established by the Inflation Reduction Act of 2022 (Pub. L. 117-169). The proposed regulations provide guidance for owners of qualified clean electricity facilities and energy storage technology placed in service after December 31, 2024. REG-119283-23.
Eleventh Circuit Invalidates Notice Identifying Conservation Easements as Listed Transactions
The Eleventh Circuit held that Notice 2017-10, which identified syndicated conservation easement transactions as listed transactions, was issued by the IRS unlawfully without public notice and comment. The court found that the notice was a legislative rule and that Congress did not did not expressly exempt the IRS from notice-and-comment rulemaking. Green Rock LLC v. IRS, 2024 PTC 185 (11th Cir. 2024).
Whistleblower's Info Failed to Meet $2 Million Threshold; Larger Reward Denied
The Tax Court granted summary judgment to the IRS after concluding that the IRS Whistleblower Office did not abuse its discretion in determining an award to a whistleblower. The court found that the record clearly showed that the proceeds collected by the IRS because of the whistleblower's information did not meet the Code Sec. 7623(b)(5) $2 million threshold which would have made the whistleblower eligible for a higher award. McCrory v. Comm'r, T.C. Memo. 2024-61.
Tenth Circuit: Denial of Taxpayer's Motion to Dismiss by Tax Court Cannot Be Appealed
The Tenth Circuit held that taxpayers who filed a motion to dismiss for lack of jurisdiction in the Tax Court on the grounds that a notice of deficiency was invalid could not appeal the Tax Court's denial of their motion to dismiss. The Tenth Circuit found that the denial of a motion to dismiss, even one based upon jurisdictional grounds, is not a final decision subject to immediate appellate review. Watson v. Comm'r, 2024 PTC 183 (10th Cir. 2024).
Consent Order Signed by Debtor and IRS Does Not Preclude Additional Tax Assessments
The Eleventh Circuit affirmed the Tax Court and held that a Consent Order signed by a debtor in bankruptcy and the IRS was not a final determination of the debtor's tax liability for the years at issue. As a result, the IRS is not barred by res judicata or collateral estoppel from filing additional notices of deficiency for those years. Breland v. Comm'r, 2024 PTC 184 (11th Cir. 2024).
Credits
Registration Requirements for Clean Fuel Production Credit Provided: In Notice 2024-49, the IRS provides guidance on the registration requirements for the clean fuel production credit determined under Code Sec. 45Z. A taxpayer must have a signed registration letter from the IRS dated on or before January 1, 2025, for the taxpayer to be eligible to claim the Code Sec. 45Z credit for production starting January 1, 2025.
Criminal
Court Cannot Order Immediate Restitution for Filing False Returns: In U.S. v. Lavigne, 2024 PTC 168 (E.D. Mich. 2024), a district court held that the government was not entitled to immediately enforce a restitution order in a criminal judgment against an individual for filing false income tax returns in violation of Code Sec. 7206(1), but instead must wait until the individual is released from prison and begins his term of supervised release. The court found that federal courts are authorized to order restitution as a condition of supervised release for any criminal offense, including tax crimes, but immediate restitution is not allowed because the Mandatory Victim Restitution Act does not authorize restitution as an independent part of the sentence for tax offenses.
Excise Tax Assessment Was Not Grounds for Expungement of Illegal Gambling Conviction: In U.S. v. Groppo, 2024 PTC 179 (9th Cir. 2024), a panel of the Ninth Circuit affirmed a district court's denial of an individual's motion to expunge his conviction for aiding and abetting the transmission of wagering information for his role as a "sub-bookie" in an unlawful international sports gambling enterprise. The individual argued that the IRS's assessment, in reliance on his criminal proceedings, of a potential tax liability of over $100,000 in excise tax and penalties was highly disproportionate to the amount he agreed to forfeit in his plea deal, but the panel found that a district court is powerless to expunge a valid arrest and conviction solely for equitable considerations, including alleged misconduct by the IRS.
Deductions
Judge Cannot Deduct Expenses Under Fee-Based Public Official Exception: In Banuelos v. Comm'r. T.C. Summary 2024-7, the Tax Court held that a taxpayer was not entitled to deduct unreimbursed employee business expenses related to his employment as an administrative law judge under the exception for fee basis public officials in Code Sec. 62(a)(2)(C). The court found that the taxpayer did not receive fees directly from the public in exchange for services rendered.
Foreign
Reporting Requirements for Qualified Derivative Payments Postponed to 2027: In Notice 2024-43, the IRS announces that it intends to amend the regulations under Code Secs. 59A and 6038A to defer the applicability date of certain provisions of the regulations relating to the reporting of qualified derivative payments until tax years beginning on or after January 1, 2027. Taxpayers may rely on the provisions in Notice 2024-43 before the issuance of the amendments to the final regulations.
IRS Further Extends Phase-In Period for Complying with Final Section 871(m) Regs: In Notice 2024-44, the IRS issued additional guidance for complying with the final regulations on dividend equivalents under Code Secs. 871(m), 1441, 1461, and Code Sec. 1473 in 2025, 2026, and 2027. Specifically, the guidance extends for two years the period during which the enforcement standards provided by Notice 2022-37 will apply.
Court Has No Discretion to Reduce FBAR Late Payment Penalty: In U.S. v. Reyes, 2024 PTC 173 (E.D. N.Y. 2024), a district court rejected a taxpayers' request that the court apply a lower penalty rate than the six-percent late-payment penalty rate the taxpayers owed under 31 U.S.C. Sec. 3717(e)(2) due to their failure to timely file a Report of Foreign Bank and Financial Accounts (FBAR). The court found that the late-payment penalty applies to unpaid FBAR penalties and that courts have no ability to reduce the amount of the late-payment penalty to a rate lower than the six-percent rate prescribed by the statute and regulations.
Payments to Foreign Captive Insurer Are Subject to 30 Percent Tax on FDAP Income: In CCA 202422010, the Office of Chief Counsel advised that, in an abusive micro-captive arrangement involving a foreign entity (Captive), a revenue agent may propose an adjustment to include purported interest payments made by a domestic entity (Insured) to the Captive as U.S.-source fixed, determinable, annual or periodical (FDAP) income subject to the 30-percent gross tax under Code Sec. 881. The Chief Counsel's Office added that the proposed FDAP adjustment to the Captive may be made even if a denial of the Insured's claimed deduction for the same payments has been asserted.
Procedure
IRS Makes Direct File Permanent and Extends It to All 50 States: In IR-2024-151, the IRS announced that it will make Direct File a permanent option for filing federal tax returns starting in the 2025 tax season. The IRS added that for the 2025 filing season, it will work with all states that want to partner with Direct File, and there will be no limit to the number of states that can participate in the coming year.
Tax Exempt Organizations
IRS Obsoletes Rev. Proc. 82-2 Due to Material Changes in State Laws: In Rev. Proc. 2044-22, the IRS obsoletes Rev. Proc. 82-2, which identified state laws and circumstances that the IRS previously concluded would permit an organization to satisfy Reg. Sec. 1.501(c)(3)-1(b)(4). The IRS stated that many of the state laws identified in Rev. Proc. 82-2 have materially changed, and a procedure cannot be relied upon to the extent it is predicated on state law and that state law has materially changed.
IRS Obsoletes Rev. Rul. 75-38 Due to Material Changes in State Laws: In Rev. Rul. 2024-10, the IRS obsoletes Rev. Rul. 75-38, which identified the state laws and circumstances that the IRS previously concluded would permit an organization to satisfy the private foundation governing instrument requirements of Code Sec. 508(e). The IRS stated that a number of the state laws identified in Rev. Rul. 75-38 have materially changed, and a revenue ruling cannot be relied upon to the extent it is predicated on state law and that state law has materially changed.
Partnership Did Not Have To Substantiate Assets In Order to Make Valid BBA Election
The Tax Court held that a partnership made a valid election to apply the audit rules under the Bipartisan Budget Act of 2015 (BBA) (Pub. L. 114-74) (BBA election) for its 2016 tax year and therefore, a notice of final partnership administrative adjustment issued by the IRS under the repealed rules under the Tax Equity and Fiscal Responsibility Act (TEFRA) (Pub. L. 97-248) was invalid. The court rejected the IRS's argument that under Reg. Sec. 301.9100-22(b)(2), the partnership was required to provide proof that it had sufficient assets to pay an imputed tax liability and that its failure to do so invalidated its BBA election. SN Worthington Holdings LLC v. Comm'r, 162 T.C. No. 10 (2024).
Background
In 1982, Congress enacted the Tax Equity and Fiscal Responsibility Act (TEFRA) (Pub. L. 97-248) to provide procedures by which the IRS determined deficiencies relating to certain partnerships. Under TEFRA, adjustments were determined at the partnership level, but the assessment and collection of tax attributable to partnership items occurred at the partner level. In 2015, the TEFRA procedures were replaced with new, streamlined procedures under the Bipartisan Budget Act of 2015 (BBA) (Pub. L. 114-74). The BBA procedures allow audits, adjustments, and payments to all occur at the partnership level. The BBA partnership audit procedures included a delayed effective date, generally applying to partnership returns for tax years beginning after December 31, 2017. Thus, under the default rules, any return with a tax year beginning before January 1, 2018, remains subject to TEFRA.
Although enacted with a delayed effective date, the BBA specifically authorized partnerships to elect, in the form and manner prescribed by the Treasury Secretary, into the BBA procedures for partnership tax years beginning after November 2, 2015, and before January 1, 2018. The regulations in Reg. Sec. 301.9100-22 set forth the form and manner for making such an election. To make an election into the BBA procedures, Reg. Sec. 301.9100-22(b)(2) requires that a partnership provide a written statement in which the partnership makes a series of representations. One of those representations, set forth in Reg. Sec. 301.9100-22(b)(2)(ii)(E)(4), is that "the partnership has sufficient assets, and reasonably anticipates having sufficient assets, to pay a potential imputed underpayment" that may be determined by the IRS.
SN Worthington Holdings LLC (SN Worthington) is an Ohio limited liability company that is classified as a partnership for federal income tax purposes. SN Worthington filed a partnership return for 2016. The IRS notified SN Worthington that its 2016 return was selected for examination. In response, SN Worthington submitted to the IRS an election to be subject to the BBA audit procedures. In doing so, SN Worthington represented that it had sufficient assets to pay an imputed underpayment.
The IRS determined that SN Worthington's BBA election was invalid because it appeared that SN Worthington did not have sufficient assets. It sent SN Worthington a letter stating that it determined that SN Worthington would not be able to pay an imputed underpayment and that that if the partnership disagreed, it could submit supporting documents to the IRS within 30 days. SN Worthington did not respond. The IRS sent a second letter again stating that SN Worthington's BBA election was invalid because "proof of sufficient available assets to pay a potential imputed tax liability was never provided." SN Worthington did not respond to the second letter.
In June of 2020, SN Worthington raised with the IRS its view that its examination was being conducted under the wrong procedures. The partnership's position was that the examination of its 2016 return should not have been occurring under TEFRA procedures because it had elected into the BBA procedures. SN Worthington told the IRS that there was no requirement that it provide proof of sufficient assets to pay an imputed tax liability. The IRS did not address SN Worthington's argument. In August of 2020, the IRS issued a notice of final partnership administrative adjustment (FPAA). In response, SN Worthington filed a petition with the Tax Court, challenging the IRS's determination. SN Worthington filed a motion to dismiss and asked the Tax Court to declare the FPAA invalid.
The IRS argued that allowing an election into the BBA procedures when a partnership fails to establish that it had, and would continue to have, sufficient assets to pay a potential imputed underpayment would frustrate the purpose of the BBA procedures. Alternatively, the IRS argued that SN Worthington should be equitably estopped from arguing that it made a valid election into the BBA procedures "based on its misleading silence and later statements regarding the applicability of TEFRA, to which [the IRS] relied upon to [its] detriment."
Analysis
The Tax Court held that SN Worthington made a valid BBA election because it satisfied the requirement to make a representation that it had, and anticipated continuing to have, enough assets to pay a potential imputed underpayment.
The court held that taxpayers make valid elections when they comply with the text of the election requirements. According to the court, the manner of making an election can be set forth in various ways, but once it is established, the IRS may not add ad hoc additional requirements. When determining whether an election is valid, the IRS may not require the taxpayer to satisfy more stringent requirements than the provision authorizing the election.
The court rejected the IRS's contention that it would frustrate the purpose of the BBA for a partnership to elect early into the BBA when it does not have sufficient assets to pay an imputed underpayment that may become due. The court found that the BBA procedures themselves refuted that argument. Under Code Sec. 6232(f)(1)(B), if a partnership does not promptly pay an imputed underpayment, the IRS can assess and collect from the partners of the partnership their proportionate shares of the imputed underpayment. Thus, the court found that the BBA procedures contemplate the situation in which a partnership has insufficient assets to satisfy an imputed underpayment.
The court also rejected the IRS's argument that SN Worthington should be equitably estopped from arguing that the BBA procedures applied. In order for the doctrine of equitable estoppel to apply, the IRS had to show: (1) a false representation or misleading silence on the part of SN Worthington: (2) an error originating in a statement of material fact, not in opinion or a statement of law; (3) that the IRS did not know the facts; (4) that the IRS actually and reasonably relied on the acts or statement of SN Worthington; and (5) that the IRS was adversely affected as a consequence of its reliance. The court noted that SN Worthington did not inform the IRS that it had made an incorrect determination regarding the BBA election until 2020, after the period of limitations to make adjustments for the 2016 tax year had expired. However, the court further found that the misleading silence went to a question of law, not a statement of fact. The court also found that, regardless of when SN Worthington informed it that it disagreed with the IRS's application of the law, the IRS possessed all of the information necessary to apply its own regulations.
Supreme Court: Estate's Value Includes Insurance Proceeds Used to Redeem Shares
The Supreme Court affirmed a decision of the Eighth Circuit and held that a closely held corporation's contractual obligation to redeem shares did not reduce the corporation's value for purposes of the federal estate tax. The court found that, because a fair-market-value redemption has no effect on any shareholder's economic interest, no hypothetical buyer purchasing the decedent's shares would have treated the company's redemption obligation as a factor that reduced the value of those shares. Connelly v. U.S., 2024 PTC 196 (S. Ct. 2024).
Background
Michael and Thomas Connelly were the sole shareholders in Crown C Supply, a small but successful building supply corporation in St. Louis, Missouri. Michael owned 77.18 percent of Crown's outstanding shares and Thomas owned the remaining 22.82 percent. The brothers entered into an agreement to ensure that Crown would stay in the family if either brother died. Under that agreement, the surviving brother would have the option to purchase the deceased brother's shares. If he declined, Crown itself would be required to redeem (i.e., purchase) the shares. To ensure that Crown would have enough money to redeem the shares if required, it obtained $3.5 million in life insurance on each brother. After Michael died in 2013, Thomas elected not to purchase Michael's shares, thus triggering Crown's obligation to do so.
Michael's son and Thomas agreed that the value of Michael's shares was $3 million, and Crown paid the same amount to Michael's estate. As the executor of Michael's estate, Thomas then filed a federal tax return for the estate, which reported the value of Michael's shares as $3 million. The IRS audited the return. During the audit, Thomas obtained a valuation from an outside accounting firm. That firm determined that Crown's fair market value at Michael's death was $3.86 million, an amount that excluded the $3 million in insurance proceeds used to redeem Michael's shares on the theory that their value was offset by the redemption obligation. The firm's analyst took as given the holding in Estate of Blount v. Comm'r, 428 F.3d 1338 (11th Cir. 2005), which concluded that insurance proceeds should be "deduct[ed] ... from the value" of a corporation when they are "offset by an obligation to pay those proceeds to the estate in a stock buyout." The analyst thus excluded the $3 million in insurance proceeds used to redeem Michael's shares, and determined that Crown's fair market value at Michael's death was $3.86 million. Because Michael had held a 77.18 percent ownership interest in Crown, the analyst calculated the value of Michael's shares as approximately $3 million ($3.86 million x 0.7718).
The IRS took a different view. It insisted that Crown's redemption obligation did not offset the life-insurance proceeds, and accordingly, assessed Crown's total value as $6.86 million ($3.86 million + $3 million).The IRS then calculated the value of Michael's shares as $5.3 million ($6.86 million x 0.7718). Based on this higher valuation, the IRS determined that the estate owed an additional $889,914 in taxes. The estate paid the deficiency and Thomas, acting as executor, sued for a refund. In Connelly v. U.S., 2021 PTC 302 (E.D. Mo. 2021), a district court granted summary judgment to the government. The court held that, to accurately value Michael's shares, the $3 million in life-insurance proceeds must be counted in Crown's valuation. Thomas appealed, and in Connelly v. U.S., 2023 PTC 154 (8th Cir. 2023), the Eighth Circuit affirmed on the same basis. The estate appealed the Eighth Circuit's decision to the Supreme Court and was granted certiorari.
Before the Supreme Court, Thomas argued that a contractual obligation to redeem shares is a liability that offsets the value of life-insurance proceeds used to fulfill that obligation. He accordingly contended that any purchasing "a subset of the corporation's shares would treat the two as canceling each other out." Thomas further argued that Crown's redemption obligation "would make it impossible" for a hypothetical buyer seeking to purchase 77.18 percent of Crown "to capture the full value of the insurance proceeds." Thomas reasoned that, because the insurance proceeds would leave the company as soon as they arrived to complete the redemption, the buyer would thus not consider the proceeds as net assets. Finally, Thomas asserted that affirming the Eighth Circuit's decision would make succession planning more difficult for closely-held corporations. He argued that if life-insurance proceeds earmarked for a share redemption are a net asset for estate-tax purposes, then "Crown would have needed an insurance policy worth far more than $3 million in order to redeem Michael's shares at fair market value."
Analysis
The Supreme Court affirmed the Eighth Circuit and held that Crown's contractual obligation to redeem Michael's shares did not diminish the value of those shares.
The Court found that an obligation to redeem shares at fair market value does not offset the value of life-insurance proceeds set aside for the redemption because a share redemption at fair market value does not affect any shareholder's economic interest. The Court provided a hypothetical example to prove the point. Consider a corporation with one asset - $10 million in cash - and two shareholders, A and B, who own 80 and 20 shares respectively. Each individual share is worth $100,000 ($10 million 100 shares). Thus, A's shares are worth $8 million (80 shares x $100,000) and B's shares are worth $2 million (20 shares x $100,000). To redeem B's shares at fair market value, the corporation would have to pay B $2 million. After the redemption, A would be the sole shareholder in a corporation worth $8 million and with 80 outstanding shares. A's shares would still be worth $100,000 each ($8 million 80 shares). Economically, the redemption would have no impact on either shareholder. The value of the shareholders' interests after the redemption - A's 80 shares and B's $2 million in cash - would be equal to the value of their respective interests in the corporation before the redemption. Thus, the Court concluded that a corporation's contractual obligation to redeem shares at fair market value does not reduce the value of those shares in and of itself.
The Court reasoned that, because a fair-market-value redemption has no effect on any shareholder's economic interest, no willing buyer purchasing Michael's shares would have treated Crown's redemption obligation as a factor that reduced the value of those shares. At the time of Michael's death, Crown was worth $6.86 million: $3 million in life-insurance proceeds earmarked for the redemption plus $3.86 million in other assets and income-generating potential. According to the Court, anyone purchasing Michael's shares would acquire a 77.18 percent stake in a company worth $6.86 million, along with Crown's obligation to redeem those shares at fair market value. A buyer would therefore pay up to $5.3 million for Michael's shares ($6.86 million x 0.7718) - i.e., the value the buyer could expect to receive in exchange for Michael's shares when Crown redeemed them at fair market value.
The Court rejected Thomas's argument that a hypothetical buyer would not consider the life-insurance proceeds as a net asset because they would leave the company as soon as they arrived to complete the redemption. The Court noted that under Code Sec. 2033 and Reg. Sec. 20.2031-1(b), the value of Michael's gross estate had to be determined by including the value of all property to the extent of his interest therein at the time of his death. A hypothetical buyer thus would, in the Court's view, treat the life-insurance proceeds that would be used to redeem Michael's shares as a net asset. The Court further found that Thomas's view ran contrary to the basic mechanics of stock redemptions. When a shareholder redeems his shares he is essentially "cashing out" his shares, and that transaction necessarily reduces the corporation's total value. Because there are fewer outstanding shares after the redemption, the remaining shareholders are left with a larger proportional ownership interest in the less-valuable company. The Court said that Thomas's understanding would turn this ordinary process upside down. In Thomas's view, Crown's redemption of Michael's shares left Thomas with a larger ownership stake in a company with the same value as before the redemption. Thomas argued that Crown was worth only $3.86 million before the redemption, and thus that Michael's shares were worth approximately $3 million ($3.86 million x 0.7718). But, he also argued that Crown was worth $3.86 million after Michael's shares were redeemed. According to the Court, that cannot be right: A corporation that pays out $3 million to redeem shares should be worth less than before the redemption. Thomas's argument thus could not, in the Court's view, be reconciled with an elementary understanding of a stock redemption.
The Court also disagreed with Thomas's assertion that affirming the Eighth Circuit's decision will make succession planning more difficult. The Court explained that the result in this case was a consequence of how the Connelly brothers chose to structure their agreement and noted that there were other options. For example, the Court said that they could have used a cross-purchase agreement - an arrangement in which shareholders agree to purchase each other's shares at death and purchase life-insurance policies on each other to fund the agreement. Such an agreement would have allowed Thomas to purchase Michael's shares and keep Crown in the family, while avoiding the risk that the insurance proceeds would increase the value of Michael's shares. The drawback to such an agreement, the Court observed, is that it would have required each brother to pay the premiums for the insurance policy on the other brother, creating a risk that one them would be unable to do so. And, the Court noted that it would have had its own tax consequences. By opting to have Crown purchase the life-insurance policies and pay the premiums, the Connelly brothers guaranteed that the policies would remain in force and that the insurance proceeds would be available to fund the redemption. As the Court explained, however, this arrangement also meant that Crown would receive the proceeds and thereby increase the value of Michael's shares.
IRS Issues Proposed Regulations on Clean Electricity Credits
The IRS issued proposed regulations relating to the clean electricity production credit under Code Sec. 45Y and the clean electricity investment credit under Code Sec. 48E, both of which were established by the Inflation Reduction Act of 2022 (Pub. L. 117-169). The proposed regulations provide guidance for owners of qualified clean electricity facilities and energy storage technology placed in service after December 31, 2024. REG-119283-23.
Background
The renewable electricity production credit determined under Code Sec. 45 (Section 45 credit) is generally available for qualified facilities described in Code Sec. 45(d), which provides that the construction of the qualified facilities must begin before January 1, 2025. Similarly, the energy credit determined under Code Sec. 48 (Section 48 credit), which is an investment credit under Code Sec. 46, is generally available for energy property the construction of which begins before January 1, 2025. Therefore, as long as construction begins on the relevant qualified facility or energy property before January 1, 2025, a taxpayer may be able to claim a Section 45 credit or Section 48 credit, respectively, even if the taxpayer places the qualified facility or energy property in service after December 31, 2024.
Code Secs. 45Y and 48E were added by the Inflation Reduction Act of 2022 (IRA) (Pub. L. 117-169). The clean electricity production credit determined under Code Sec. 45Y (Section 45Y credit) applies to facilities placed in service after December 31, 2024. The clean electricity investment credit determined under Code Sec. 48E (Section 48E credit) applies to property placed in service after December 31, 2024. Code Secs. 45Y and 48E generally replace Code Secs. 45 and 48 with respect to qualified facilities, and for Code Sec. 48E, with respect to energy storage technology, that is placed in service after December 31, 2024.
Clean Electricity Production Credit
Code Sec. 45Y(a)(1) provides that for purposes of the general business credit under Code Sec. 38, the Section 45Y credit for any tax year is an amount equal to the product of the kilowatt hours of eligible electricity produced by a taxpayer at a qualified facility, multiplied by the applicable amount with respect to such qualified facility. Eligible electricity is electricity that is either (1) sold by the taxpayer to an unrelated person during the tax year or (2) in the case of a qualified facility that is equipped with a metering device that is owned and operated by an unrelated person, sold, consumed, or stored by the taxpayer during the tax year.
Under Code Sec. 45Y(a)(2), the applicable amount used in calculating the Section 45Y credit is either a base amount of 0.3 cents or a higher alternative amount of 1.5 cents. Under Code Sec. 45Y(a)(2)(B), the alternative amount of 1.5 cents applies in the case of any qualified facility (1) with a maximum net output of less than 1 megawatt (as measured in alternating current), (2) the construction of which begins prior to the date that is 60 days after the Treasury Secretary publishes guidance on the prevailing wage requirements of Code Sec. 45Y(g)(9) and the apprenticeship requirements of Code Sec. 45Y(g)(10), or (3) that satisfies Code Sec. 45Y(g)(9) and, with respect to the construction of such facility, satisfies Code Sec. 45Y(g)(10). Both the base and alternative amounts are adjusted for inflation. Code Sec. 45Y(g)(7) provides for an increase in the Section 45Y credit amount for any qualified facility located in an energy community, and Code Sec. 45Y(g)(11) provides for an increase if the domestic content bonus requirement in Code Sec. 45Y(g)(11)(B)(i) is satisfied.
Clean Electricity Investment Credit
For purposes of Code Sec. 38, which includes the investment credit under Code Sec. 46, Code Sec. 48E(a)(1) provides a credit for any tax year in which a qualified investment is made with respect to any qualified facility and any energy storage technology (EST). Generally, under Code Sec. 48E(b)(1) the qualified investment with respect to a qualified facility for any tax year is the sum of (1) the basis of any qualified property placed in service by the taxpayer during such tax year that is part of a qualified facility plus (2) the amount of expenditures that are paid or incurred by the taxpayer for qualified interconnection property that is properly chargeable to capital account of the taxpayer.
The Section 48E credit amount equals to the applicable percentage of the qualified investment in any qualified facility and any EST. Code Sec. 48(E)(a)(2) provides a base rate of 6 percent and a higher alternative rate of 30 percent for the applicable percentage. Under 48E(a)(2)(A)(ii), the alternative rate of 30 percent applies in the case of any qualified facility (1) with a maximum net output of less than 1 megawatt (as measured in alternating current), (2) the construction of which begins prior to the date that is 60 days after the Treasury Secretary publishes guidance on the prevailing wage requirements of Code Sec. 48E(d)(3) and the apprenticeship requirements of Code Sec. 48E(d)(4), or (3) that satisfies Code Sec. 48E(d)(3) and, with respect to the construction of such facility, satisfies Code Sec. 48E(d)(4). Similarly, Code Sec. 48E(a)(2)(B)(ii) provides that the alternative rate of 30 percent applies in the case of an EST (1) with a capacity of less than 1 megawatt, (2) the construction of which begins prior to the date that is 60 days after the Treasury Secretary publishes guidance on the prevailing wage and apprenticeship requirements, or (3) that satisfies Code Sec. 48E(d)(3) and with respect to the construction of such EST, satisfies Code Sec. 48E(d)(4).
Code Sec. 48E(a)(3)(A) provides for an increase in credit rate for a qualified facility or EST located in an energy community (as defined in Code Sec. 45(b)(11)(B)). Code Sec. 48E(a)(3)(B) similarly provides for an increase in credit rate for a qualified facility or EST that meets the domestic content bonus requirements.
Previous Guidance
In August of 2023, the IRS issued proposed regulations (REG-100908-23) providing guidance on the prevailing wage and apprenticeship (PWA) requirements under Code Secs. 45, 45Y, 48, and Code Sec. 48E and several other Code sections (August Proposed Regulations). The August Proposed Regulations also proposed guidance on the 1-megawatt exception under Code Secs. 45, 45Y, 48, and Code Sec. 48E. In November of 2023, the IRS issued proposed regulations (REG-132569-17) providing guidance under Code Sec. 48 (November Proposed Regulations). Among other matters, the November Proposed Regulations withdrew and reproposed the regulations in Prop. Reg. Sec. 1.48-13 from the August Proposed Regulations regarding the PWA requirements under Code Sec. 48, the 1-megawatt exception under Code Sec. 48(a)(9)(B)(i), and the recapture rules under Code Sec. 48(a)(10)(C).
Proposed Regulations
On May 29, the IRS issued proposed regulations relating to the Section 45Y and Section 48E credits. The proposed regulations affect all taxpayers who produce clean electricity and claim the clean electricity production credit with respect to a facility or the clean electricity investment credit with respect to a facility or energy storage technology, as applicable, that is placed in service after 2024.
The proposed regulations under Code Sec. 45Y are organized in five sections, Prop. Reg. Sec. 1.45Y-1 through Prop. Reg. Sec. 1.45Y-5 (Section 45Y regulations). Prop. Reg. Sec. 1.45Y-1 provides an overview of the Section 45Y regulations, generally applicable definitions, and general rules applicable to Code Sec. 45Y, including a rule for calculating the credit for a CHP property. Prop. Reg. Sec. 1.45Y-2 provides rules relating to qualified facilities for purposes of the Section 45Y credit. Prop. Reg. Sec. 1.45Y-3 is reserved for rules relating to the increased credit amount for meeting the prevailing wage and apprenticeship requirements. Prop. Reg. Sec. 1.45Y-4 provides the rules of general application under Code Sec. 45Y, including rules that attribute production to the taxpayer, rules for the expansion of a facility and incremental production, and rules for retrofits of an existing facility. Prop. Reg. Sec. 1.45Y-5 provides rules pertaining to the determination of a greenhouse gas (GHG) emissions rate for a facility under Code Sec. 45Y.
The proposed regulations under Code Sec. 48E are also organized in five sections, Prop. Reg. Sec. 1.48E-1 through Prop. Reg. Sec. 1.48E-5 (Section 48E regulations). Prop. Reg. Sec. 1.48E-1 provides an overview of the Section 48E regulations, generally applicable definitions, and the rules applicable to the calculation of Section 48E credit. Prop. Reg. Sec. 1.48E-2 provides rules relating to a qualified facility, a qualified investment, a qualified property, and an EST. Prop. Reg. Sec. 1.48E-3 is reserved for rules relating to the increased credit amount for meeting the prevailing wage and apprenticeship requirements. Prop. Reg. Sec. 1.48E-4 provides the rules of general application under Code Sec. 48E, including the rules regarding the inclusion of qualified interconnection costs in the basis of a low-output associated qualified facility, rules for expansion of a facility and incremental production, rules for retrofitting an existing facility, rules for the ownership of a qualified facility or an EST, rules regarding the coordination of the Section 48E credit with other federal income tax credits, and rules for credit recapture. Prop. Reg. Sec. 1.48E-5 provides rules pertaining to the determination of a GHG emissions rate for a facility under Code Sec. 48E.
Eleventh Circuit Invalidates Notice Identifying Conservation Easements as Listed Transactions
The Eleventh Circuit held that Notice 2017-10, which identified syndicated conservation easement transactions as listed transactions, was issued by the IRS unlawfully without public notice and comment. The court found that the notice was a legislative rule and that Congress did not did not expressly exempt the IRS from notice-and-comment rulemaking. Green Rock LLC v. IRS, 2024 PTC 185 (11th Cir. 2024).
Background
Green Rock LLC is a limited liability company based in Birmingham, Alabama. It raises money from investors and serves as a material advisor for syndicated conservation easement arrangements. In those arrangements, an investor buys into a pass-through entity that holds real property; the pass-through entity donates a conservation easement that agrees to restrict land uses associated with the property; and the investor claims a tax deduction under Code Sec. 170(h) for the value of the donation.
In Notice 2017-10, the IRS designated certain conservation easement transactions as presumptively tax-avoidant listed transactions. The notice covers transactions in which three criteria are present: first, where a taxpayer purchases a property interest through a "syndicate" or pass-through entity; second, where the taxpayer is solicited through "promotional materials" that tout an available charitable deduction; and third, where the taxpayer is promised a deduction that values the donated easement at or above "two and one-half times the amount" invested in the syndicate.
Green Rock served as a material advisor to transactions covered by Notice 2017-10. It never violated Notice 2017-10, and it complied with the reporting requirements for several years. In 2021, Green Rock filed suit in a district court under the Administrative Procedure Act (APA). It sought to set aside Notice 2017-10 as a legislative rule improperly issued without notice-and-comment procedures, and as arbitrary, capricious, and otherwise contrary to law. In December of 2022, while the lawsuit was pending, Congress amended Code Sec. 170(h) in the Consolidated Appropriations Act, 2023 (Pub. L. 117-328), to provide that syndicates would no longer be allowed to write off easement donations at inflated valuations. The legislation effectively eliminated the deductions that Notice 2017-10 subjected to disclosure, but the amendment is not retroactive and therefore did not apply in this case. After Congress eliminated conservation easement deductions at inflated valuations, Green Rock ceased syndicating conservation easements.
The district court granted summary judgment for Green Rock. It adopted the reasoning of Mann Construction, Inc. v. U.S., 2022 PTC 63 (6th Cir. 2022), where the Sixth Circuit held that Notice 2007-83, which identified certain trust arrangements as listed transactions, violated the APA because it was issued without following the APA's notice-and-comment requirements. The district court also found that Congress had not expressly exempted listed transactions from notice-and-comment rulemaking. The IRS appealed to the Eleventh Circuit.
Code Sec. 6707A was enacted by the American Jobs Creation Act of 2004 (2004 Act) to provide civil penalties for violators of the reportable transaction regime. Code Sec. 6707A(c)(1) defines a "reportable transaction" as "any transaction with respect to which information is required to be included with a return or statement because, as determined under regulations prescribed under section 6011, such transaction is of a type which the Secretary determines as having a potential for tax avoidance or evasion." Under Code Sec. 6707A(c)(2), a "listed transaction" means "a reportable transaction which is the same as, or substantially similar to, a transaction specifically identified by the Secretary as a tax avoidance transaction for purposes of section 6011."
The designation of a listed transaction triggers significant reporting and recordkeeping requirements. Under Code Sec. 6011(a) and Reg. Sec. 1.6011-4(d), a taxpayer must file a Form 8886, Reportable Transaction Disclosure Statement, for each listed transaction. Additionally, a material advisor must file a Form 8918, Material Advisor Disclosure Statement and keep detailed records for each listed transaction. Penalties may be imposed on taxpayers and material advisors who violate these reporting and recordkeeping requirements.
The APA requires that when federal agencies promulgate "legislative rules" - those that are binding or have the force of law - they must abide by the notice-and-comment procedures prescribed by 5 U.S.C. Sec. 553(b). Specifically, the agency must publish a notice of proposed regulation, offer the public an opportunity to voice comments and concerns, consider and respond to feedback, and include in the final regulation a concise general statement of the basis and purpose of the regulation. Under 5 U.S.C. Sec. 559, Congress may choose to exempt an agency from notice and comment if "it does so expressly." In Marcello v. Bonds, 349 U.S. 302 (1955), the Supreme Court explained that exemptions from the terms of the APA are "not lightly to be presumed," but Congress need not "employ magical passwords in order to effectuate an exemption."
Observation: In Green Valley Investors, LLC, et al, v. Comm'r, 159 T.C. 80 (2022), the Tax Court held that Notice 2017-10 was improperly issued in violation of the APA's notice-and-comment requirements. In 2022, the IRS issued proposed regulations in REG-106134-22 that identify syndicated conservation easements as listed transactions. The IRS stated in the preamble to the proposed regulations that it disagreed with the Tax Court's decision in Green Valley as well as the Sixth Circuit's decision in Mann Construction and would continue to defend Notice 2017-10 and other notices identifying listed transactions in circuits other than the Sixth Circuit.
Before the Eleventh Circuit, the IRS argued that when Congress enacted Code Sec. 6707A, it ratified the existing final regulations under Code Sec. 6011, including Reg. Sec. 1.6011-4(b)(2) which states that the IRS may identify listed transactions "by notice, regulation, or other form of published guidance." According to the IRS, because Congress was aware of the regulation and adopted parts of its language in the statute, Congress must have also intended to endorse the notice-listing process. The IRS hung its hat on the statutory phrase "as determined under regulations prescribed under section 6011" embedded in the definition of "reportable transaction" in Code Sec. 6707A(c)(1). The IRS contended that the preposition "under" is best understood in context to mean "in accordance with." So, according to the IRS, Code Sec. 6707A(c)(1) means that Congress intended for the process for defining reportable and listed transactions to be provided by - to be "determined in accordance with" - Reg. Sec. 1.6011-4(b)(2). The IRS further argued that holding that Congress did not authorize notice-based listing would eliminate every listed transaction to date. According to the IRS, it would be absurd for Congress to "invalidate sub silentio each and every one of the listed transactions already identified" in the 2004 Act, which provided penalties to strengthen the listing regime.
Analysis
The Eleventh Circuit affirmed the district court's order setting aside Notice 2017-10 with respect to Green Rock.
The Eleventh Circuit agreed with the Sixth Circuit that Code Sec. 6707A describes the "types" of transactions that are subject to penalties for non-reporting. In the court's view, the phrase highlighted by the IRS defines which transactions are reportable: transactions that are "determined under" the regulations issued under Code Sec. 6011. The court noted that Code Sec. 6707A is a definitional provision and reasoned that the phrase "determined under" can be fairly read to allow the IRS to define the substance of a reportable transaction through regulations issued under the IRS's Code Sec. 6011 authority. But the court said that an indirect series of cross-references hardly suffices as the "express" indication necessary to supplant the baseline procedures of the APA.
In the court's view, holding that Congress did not authorize notice-based identification of listed transactions would not eliminate every listed transaction as the IRS argued. The court noted that other listed transactions were issued in a different regulatory context. The court explained that the pre-2004 listed transactions - that is, 28 of the 34 existing listed transactions - were not backed by statutory penalties at the time of their issuance. And "penalties and criminal sanctions," the court observed, are what render a listing notice a legislative rule subject to notice and comment to begin with.
The court clarified that it did not purport to rule on the validity of any listed transaction not before the court. The court said that its decision is specific to Notice 2017-10. The court concluded that, because the notice was a legislative rule and Congress did not expressly exempt the IRS from notice-and-comment rulemaking, Notice 2017-10 is not binding on Green Rock.
Whistleblower's Info Failed to Meet $2 Million Threshold; Larger Reward Denied
The Tax Court granted summary judgment to the IRS after concluding that the IRS Whistleblower Office did not abuse its discretion in determining an award to a whistleblower. The court found that the record clearly showed that the proceeds collected by the IRS because of the whistleblower's information did not meet the Code Sec. 7623(b)(5) $2 million threshold which would have made the whistleblower eligible for a higher award. McCrory v. Comm'r, T.C. Memo. 2024-61.
Background
In 2018, Suzanne McCrory filed seven Forms 211, Application for Award for Original Information, with the IRS Whistleblower Office (WBO) relating to seven separate taxpayers. McCrory based each of the seven claims on publicly available information about settlement or arbitration awards that may have been received by the target taxpayers, but not reported on their returns as taxable income.
The WBO assigned a claim number to each of the seven Forms 211 but processed them together as one consolidated claim. With respect to five of the claims, the IRS took no action based on McCrory's information because the allegations were not specific, were not credible, or were speculative, or because the classifier could not identify the target. With respect to the sixth claim, McCrory alleged that the target taxpayer may have failed to report an arbitration award of approximately $442,000. For the seventh claim, McCrory alleged that the target taxpayer may have failed to report an award of approximately $3 million. With respect to the last claim, a revenue agent surveyed the target's return, determined that the target was in compliance, and took no further action. The sixth claim, however, prompted the IRS to audit the target's return and, ultimately, to determine approximately $293,000 in total adjustments, resulting in a tax deficiency, plus penalty and interest, of nearly $180,000.
In 2022, the WBO issued to McCrory a Final Award Decision Under Section 7623(a) (Decision Letter). The Decision Letter stated that the WBO made a final decision to award $1,694 to McCrory. The Decision Letter did not identify which claim numbers the award related to but explained the award computation in an attached Determination Report. That Report stated that the final tax, penalties, interest, and other amounts collected based on information provided by McCrory was $179,672 and that the recommended award percentage was 1 percent, subject to a modest reduction under provisions enacted in the Budget Control Act of 2011, Pub. L. No. 112-25.
Code Sec. 7623 provides for discretionary and nondiscretionary awards by the IRS to individuals (i.e., whistleblowers) who alert the IRS to taxpayers that are, or have, underpaid their taxes. Under the discretionary provisions of Code Sec. 7623(a), the IRS can pay an award to an individual for: (1) detecting underpayments of tax, or (2) detecting and bringing to trial and punishment persons guilty of violating the internal revenue laws or conniving at the same. Any amount payable under this provision is paid from the proceeds of amounts collected by reason of the information provided, and any amount so collected must be available for such payments.
Under the nondiscretionary provisions of Code Sec. 7623(b), an individual is entitled to an award for bringing to the IRS's attention information under which the government moves forward with an administrative or judicial action relating to the detection of tax underpayments or the detecting and bringing to trial and punishment persons guilty of violating the internal revenue laws or conniving at the same. The individual providing such information is entitled to receive an award of at least 15 percent but not more than 30 percent of the collected proceeds (including penalties, interest, additions to tax, and additional amounts) resulting from the action (including any related actions) or from any settlement in response to such action.
Code Sec. 7623(b)(4) provides that the Tax Court may review mandatory award determinations made under Code Sec. 7623(b), but generally may not review discretionary payments properly made under Code Sec. 7623(a).
Under Code Sec. 7623(b)(5), the whistleblower award rules apply with respect to any action (1) against any taxpayer, but in the case of any individual, only if such individual's gross income exceeds $200,000 for any tax year subject to such action, and (2) if the tax, penalties, interest, additions to tax, and additional amounts in dispute exceed $2 million. Reg. Sec. 301.7623-2(e) defines the "amount in dispute" as the greater of (1) the maximum total of tax, penalties, interest, additions to tax, and additional amounts that resulted from the action(s) with which the IRS proceeded based on the information provided, or (2) the maximum total of such amounts that were stated in formal positions taken by the IRS.
McCrory filed a petition with the Tax Court disputing the amount awarded to her. She argued that the WBO abused its discretion in determining her award and that IRS's own regulations require it to apply the same rules and procedures to determine discretionary whistleblower awards under Code Sec. 7623(a) and mandatory awards under Code Sec. 7623(b) and that the IRS applied those rules and procedures incorrectly in calculating her award. The IRS responded with a motion for summary judgment on the ground that the proceeds in dispute did not meet the $2 million statutory threshold thus precluding review by the Tax Court.
Analysis
The Tax Court granted summary judgment to the IRS and held that the record clearly showed that the proceeds in dispute did not meet the $2 million threshold under Code Sec. 7623(b)(5) for a mandatory award. The court noted that, of the seven claims McCrory filed, the IRS began an audit against only one of the named targets. McCrory's allegation that the target may have not reported income from a $442,000 arbitration award on the target's tax return was ultimately confirmed in part, leading the IRS to increase the target's income by approximately $293,000, resulting in a total tax deficiency, plus penalty and interest, of nearly $180,000.
The court observed that, if McCrory's allegation in her claim that this target may have failed to report as much as $3 million in income was true, then the IRS would have asserted that the target owed more than $2 million with respect to that income. But, the court said, that did not happen. Under Code Sec. 7623(b)(5), the court noted, the term "proceeds in dispute" does not refer simply to the amount a whistleblower alleges might have been underpaid but instead refers to proceeds actually disputed in an IRS action against a target taxpayer.
The court found that, while the regulations expand the inquiry as to the proceeds in dispute to include not just amounts actually collected but also "the maximum total of such amounts that were stated in formal positions taken by the IRS in the action(s)," they still focus on positions the IRS actually took, not just positions the whistleblower suggested. Because the IRS did not take further action on the claim at issue after surveying it, the court determined that what McCrory alleged about the potential proceeds that might have been in dispute did not change the ultimate conclusion.
The court also rejected McCrory's secondary argument that the IRS's own regulations require it to apply the same rules and procedures to determine discretionary whistleblower awards under Code Sec. 7623(a) and mandatory awards under section 7623(b) and that the IRS applied those rules and procedures incorrectly in calculating her award. The court noted that the gating issue before it was whether one of the monetary thresholds of Code Sec. 7623(b)(5)(B) had been satisfied. Since none of those thresholds were satisfied, the court said, then the IRS was entitled to summary judgment under the statute without regard to the merit of McCrory's arguments about the regulations and how those regulations might apply to discretionary awards under Code Sec. 7623(a).
Tenth Circuit: Denial of Taxpayer's Motion to Dismiss by Tax Court Cannot Be Appealed
The Tenth Circuit held that taxpayers who filed a motion to dismiss for lack of jurisdiction in the Tax Court on the grounds that a notice of deficiency was invalid could not appeal the Tax Court's denial of their motion to dismiss. The Tenth Circuit found that the denial of a motion to dismiss, even one based upon jurisdictional grounds, is not a final decision subject to immediate appellate review. Watson v. Comm'r, 2024 PTC 183 (10th Cir. 2024).
The IRS sent Michael and Tracey Watson, the Watson Family Insurance Company, and the Watson Insurance Company (i.e., the Watsons) notices of deficiency for multiple tax years. The Watsons filed petitions in the Tax Court and filed motions to dismiss for lack of jurisdiction arguing that the notices of deficiency were invalid. The Tax Court consolidated the cases and denied the motions to dismiss. The Watsons filed an interlocutory appeal in the Tenth Circuit, seeking immediate review of the Tax Court's denial.
Under Code Sec. 7482(a)(1), the circuit courts have jurisdiction to review the Tax Court's decisions "in the same manner and to the same extent as decisions of the district courts in civil actions tried without a jury." Generally, the circuit courts may review only the Tax Court's final decisions. In Luna-Garcia v. Holder, 777 F.3d 1182 (10th Cir. 2015), the Tenth Circuit held that a final decision "ends the litigation on the merits and leaves nothing for the court to do but execute the judgment."
The Watsons argued that the Tenth Circuit had jurisdiction over their appeal because the Tax Court denied their potentially dispositive motions to dismiss. They also asserted that the Tenth Circuit had jurisdiction based on the collateral order doctrine. For the collateral order doctrine to apply, the order must (1) conclusively determine the disputed question, (2) resolve an important issue completely separate from the merits, and (3) be effectively unreviewable on appeal from a final judgment.
The Tenth Circuit dismissed the Watsons' appeal. The court found that in cases before the district courts, it is well established that the denial of a motion to dismiss - even one based upon jurisdictional grounds - is not a final decision subject to immediate appellate review. And because it reviews the Tax Court's decisions in the same circumstances in which it reviews decisions by the district courts, the Tenth Circuit concluded that the Tax Court's order denying the Watsons' motions to dismiss was not final. The Tenth Circuit also rejected the Watsons' argument that the collateral order doctrine applied. The court noted that the Supreme Court consistently has held (for example, in Van Cauwenberghe v. Biard, 486 U.S. 517 (1988)) that the denial of a claim of lack of jurisdiction is not an immediately appealable collateral order because the denial is effectively reviewable on appeal after the district court (or, in this instance, the Tax Court) enters a final judgment.
Consent Order Signed by Debtor and IRS Does Not Preclude Additional Tax Assessments
The Eleventh Circuit affirmed the Tax Court and held that a Consent Order signed by a debtor in bankruptcy and the IRS was not a final determination of the debtor's tax liability for the years at issue. As a result, the IRS is not barred by res judicata or collateral estoppel from filing additional notices of deficiency for those years. Breland v. Comm'r, 2024 PTC 184 (11th Cir. 2024).
Background
In 2009, Charles Breland, Jr. filed for Chapter 11 bankruptcy in the Southern District of Alabama. The IRS subsequently filed a proof of claim for taxes, interest, and penalties that it said Breland owed for tax years 2004 through 2008. The IRS amended that proof of claim four times. The last proof of claim was for approximately $6.8 million. In 2010, Breland filed a Chapter 11 Plan of Reorganization, which the IRS objected to based in part on the ground that the plan did not provide for payment of the entire amount of taxes the IRS claimed that Breland owed. To resolve the objection, the IRS and Breland entered into a Consent Order in which the IRS withdrew its $6.8 million claim and reinstated a prior claim of approximately $2.02 million. The Consent Order further provided that Breland would preserve his objection to the IRS's proof of claim and the IRS's right to assess taxes would be reinstated upon default by Breland.
Despite reaching an agreement via the Consent Order, the IRS continued to investigate the amount of taxes Breland owed and subsequently sought to amend its claim to add additional taxes. The bankruptcy court denied the requested amendment. The IRS appealed that decision to the District Court of Southern Alabama which remanded the appeal to the bankruptcy court. On remand, the bankruptcy court again denied the motion to amend. The IRS again appealed that decision to the District Court of Southern Alabama which affirmed the decision. In 2016, the bankruptcy court entered an order closing the 2009 bankruptcy case.
In June of 2012, while the bankruptcy case was on remand, the IRS issued a deficiency notice to Breland for tax years 2004, 2005, and 2008. Breland filed suit in the Tax Court, disputing the deficiencies, and arguing that the amounts sought were barred by collateral estoppel and res judicata because the Consent Order from the bankruptcy proceeding was, he argued, a final determination of his tax liability for years 2004-2008. The Tax Court case was stayed until the resolution of the 2009 bankruptcy case in 2016.
After the stay was lifted, Breland moved for summary judgment in the Tax Court case. In Breland v. Comm'r, 152 T.C. 156 (2019), the Tax Court denied Breland's motion, holding that the Consent Order did not bar the deficiencies. The Tax Court held that res judicata did not apply because the causes of action were not the same. In other words, the Tax Court was asked to redetermine Breland's total tax liability, while the Consent Order resolved the IRS's objection to a bankruptcy reorganization plan. The Tax Court emphasized that the facts necessary to the deficiency case before it (i.e., Breland's income, deductions, and credits) were not necessarily considered during the bankruptcy plan confirmation proceeding, which primarily addressed viability of a proposed reorganization. The court noted that certain taxes are nondischargeable and cited case law for the proposition that confirmation of a plan of reorganization does not fix nondischargeable tax liabilities. With respect to Breland's argument that the Consent Order was issued under the bankruptcy court's authority to determine taxes under 11 U.S.C. Sec. 505, the Tax Court held that the Consent Order was not issued under that provision of the Bankruptcy Code because the Consent Order did not cite that provision or otherwise state that it was issued pursuant to the bankruptcy court's authority to determine taxes under that section.
Ultimately, the Tax Court agreed with Breland's argument that, if the Consent Order had fixed his total federal tax liability for the years at issue then it would have preclusive effect. But, the Tax Court said, the bankruptcy court had only resolved the amount of the IRS's claim to be allowed in the plan of reorganization and, under the Bankruptcy Code and case law, allowing a claim does not constitute a final determination of federal tax liabilities. Thus, the Tax Court concluded that the IRS was not precluded from asserting additional nondischargeable debts and that Breland owed a deficiency for 2004 and was owed a refund for 2008. As to 2005, the parties stipulated that the notice of deficiency had been issued after the statute of limitations had run and so Breland did not owe anything for that year.
Breland appealed to the Eleventh Circuit, arguing that the Consent Order was a final determination of his tax liability for the years in question, and thus collateral estoppel and res judicata barred the IRS from assessing additional taxes for those years. Additionally, Breland argued that the IRS relinquished its right to assess additional taxes because the Consent Order stated that the IRS's right to assess taxes was prohibited unless Breland defaulted on the IRS's claim, which he did not do.
Analysis
The Eleventh Circuit rejected Breland's arguments and held that the Consent Order was not a final determination of Breland's tax liability for the years in question. Instead, the court said, the Consent Order merely determined the amount of taxes that the bankruptcy estate would pay, but it did not fix the total amount of Breland's underlying, nondischargeable tax debt nor did it prevent the IRS from assessing additional taxes beyond what was contemplated by the plan.
The Eleventh Circuit observed that a bankruptcy court has the power to determine tax debts under 11 U.S.C. Sec. 505, whether or not the tax was previously assessed or adjudicated. However, the court said, in order to invoke Section 505, one of the parties typically must file a motion requesting that the bankruptcy court make a determination under 11 U.S.C. Sec. 505 and that did not happen in this case. Citing its decision in In re Gurwitch, 794 F.2d 584 (11th Cir. 1986), the Eleventh Circuit noted that unlike determinations under 11 U.S.C. Sec. 505, the claims-allowance and plan-confirmation processes in bankruptcy do not result in a final determination of the amount of nondischargeable tax debts for res judicata purposes. That is because, the court said, unless 11 U.S.C. Sec. 505 is invoked, the only issue before the bankruptcy court at the time of a claim objection is the amount that will be paid by the bankruptcy estate - not the total amount of the underlying debt.
Observation: In In re Gurwitch, the Eleventh Circuit rejected a debtor's argument that a Chapter 11 plan that had been confirmed had fixed the amount of taxes he owed and any other taxes added after confirmation were barred by res judicata. The Eleventh Circuit explained that the Bankruptcy Code makes clear under 11 U.S.C. Sec. 1141(d)(2) that the confirmation of a plan of reorganization does not fix tax liabilities made nondischargeable under 11 U.S.C. 523 and that such taxes are nondischargeable whether or not a claim for such tax was filed or allowed.
Addressing Breland's argument that his case was distinguishable from In re Gurwitch because he and the IRS signed a Consent Order, the court said that the mere fact that the claim amount was stipulated to in a Consent Order did not bring his case outside the sweep of In re Gurwitch and its progeny. No matter how the claim amount was reached, the court said, unless the bankruptcy court acted under its Section 505 authority, the bankruptcy court's role in the process was to determine the amount to be paid by the bankruptcy estate, not to fix the total amount of the underlying debt.
The court also rejected Breland's argument that (1) the Consent Order in his case was unique because the IRS expressly gave up or relinquished its right to assess additional income taxes, and (2) because he did not default on the agreement, the IRS's assessment powers were never reinstated and so the IRS could not assess any additional taxes. The best reading of the Consent Order, the court explained, was not that it was a blanket prohibition on the IRS's ability to assess additional taxes against Breland generally, but that it only prohibited the IRS from assessing the taxes set out in the plan as it prohibited the IRS from assessing taxes unless Breland defaulted on "the plan" by not fully paying the taxes contemplated in the plan. Thus, the court concluded, the prohibition was limited to assessing the taxes contemplated in the plan and nothing about the Consent Order suggested to the court that it was meant to fix Breland's total tax liability or apply to taxes outside those covered in the plan.
