Reasserting Its Role As Final Interpreter Of The Law, The Supreme Court Rejects IRS 'Fighting Regulation' In United States v. Home Concrete & Supply, LLC, Et Al.

On April 25, 2012, the Supreme Court issued a 5-4 opinion, written by Justice Breyer, concluding that Treasury Regulation § 301.6501(e)-1(a)(iii) was invalid. The regulation required overstatements of basis to be treated as substantial omissions of gross income under Internal Revenue Code § 6501(e)(1)(A) to the extent such overstatements resulted in a reduction of income exceeding 25% of the reported gross income. Under this Code section, a six-year statute of limitations period on assessment of tax would then apply to the return, reflecting the overstated basis instead of the general three-year limitations period.1 The Court's rejection of the regulation was based on (i) the principle of stare decisis in respect of the 1958 Supreme Court opinion on point, Colony, Inc. v. Commissioner, 357 U.S. 28, and (ii) a clarification of its deference jurisprudence. With last year's high court decision in Mayo Foundation for Medical Education & Research v. United States ("Mayo"), in which the Court upheld notice and comment regulations in view of ambiguous statutory language, and the 2005 decision in National Cable & Telecommunications Association v. Brand X Internet Services ("Brand X"), which endorsed agency rules over contrary prior judicial decisions, the Government likely anticipated victory in this case. It came close. The Court issued a 5-4 decision. Justice Scalia provided the fifth vote for the majority, joining all but one subpart of Justice Breyer's opinion, and also wrote a separate concurrence. Justice Kennedy penned the dissent, which reasoned that amendments to the Code since Colony indicated that the relevant provision now had a different meaning. As a result of the decision, on April 30, the Court disposed of nine cases, including vacating Government-favorable decisions in the Tenth, D.C., and Federal Circuits.

ISSUANCE OF FINAL REGULATIONS

The Treasury and IRS promulgated the regulation at issue in an attempt to salvage audits involving certain tax shelters that apparently depended upon an overstatement of basis to achieve the desired tax benefit. Faced with a three-year limitations period, the IRS was prevented from assessing a number of taxpayers who had engaged in these shelter transactions. The remedy, which the Treasury found readily at hand, was to promulgate what are commonly called "fighting regulations." The IRS had previously attempted to litigate the position that the statute itself provided for the basis overstatement rule and later issued temporary regulations to support that position. The judiciary was not entirely receptive to either approach. See Salman Ranch Ltd. v. United States, 573 F.3d 1362 (Fed. Cir. 2009) (rejecting IRS's proposed construction of statute) and Intermountain Insurance Service of Vail v. Commissioner, 134 T.C. 11 (2010) (holding temporary regulations were invalid). (The Tax Court was later reversed by the D.C. Circuit, 650 F.3d 691 (D.C. Cir. 2011).)

The Government enjoyed some success after the issuance of the final regulation in December 2010. See Beard v. Commissioner, 633 F.3d 616 (7th Cir. 2011); Grapevine Imports, Ltd. v. United States, 636 F.3d 1368 (Fed. Cir. 2011); and Salman Ranch Ltd. v. Commissioner, No. 09-9015 (10th Cir. 2011). However, the Fourth and Fifth Circuits prevented a complete sweep of the appellate bench. See Home Concrete & Supply, LLC v. United States, 634 F.3d 249 (4th Cir. 2011) (invalidating regulation) and Burks v. United States, 633 F.3d 347 (5th Cir. 2011) (same). Central to the Government losses was the Supreme Court decision in Colony in which the Court rejected the Government's interpretation with respect to materially identical statutory language in the predecessor 1939 Internal Revenue Code. In the preamble to the final regulations, the Treasury and IRS explained the basis for their...