The U.S. Tax Court recently held in SN Worthington Holdings LLC v. Commissioner, 162 T.C. No. 10 (2024), that the petitioning partnership had properly elected into the Bipartisan Budget Act of 2015 (BBA)1 procedures for the year in issue. As a result, the Notice of Final Partnership Administrative Adjustment (FPAA) that the IRS issued under the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA)2 procedures was invalid.
BBA Background
Although enacted in 2015, the BBA procedures included a delayed effective date, generally applying to partnership returns for tax years beginning after Dec. 31, 2017. See BBA § 1101(g)(1), 129 Stat. at 638. Under the default rules, any return with a tax year beginning before Jan. 1, 2018, remained subject to TEFRA. Id. However, the BBA specifically authorized partnerships to elect into the BBA procedures for partnership tax years beginning after Nov. 2, 2015, and before Jan. 1, 2018. See BBA § 1101(g)(4), 129 Stat. at 638.
SN Worthington Holdings LLC
In 2018, the IRS notified SN Worthington that its partnership return for 2016 had been selected for examination. Within 30 days of the notification, SN Worthington submitted to the IRS a timely election to be subject to the BBA partnership audit procedures for the 2016 year. See Treas. Reg. § 301.9100-22(b)(2)(ii)(E)(4). The IRS responded that after reviewing the partnership tax return, it had determined that the partnership did not have sufficient assets to pay the imputed underpayment that might ultimately be determined.
Two years into the audit, SN Worthington wrote to the IRS that the examination needed to be conducted under the BBA procedures instead of TEFRA. The partnership's letter further stated that there was no requirement that a taxpayer provide proof of sufficient assets to pay an imputed tax liability. The IRS denied the request and proceeded under the TEFRA procedures. The IRS later issued an FPAA under the TEFRA procedures, and the tax matters partner petitioned the Tax Court.
The petitioner filed a motion to dismiss for lack of jurisdiction, asserting that the FPAA was invalid because SN Worthington elected into the BBA procedures and therefore the BBA procedures – not the TEFRA procedures – applied. The IRS disagreed on two alternative grounds: 1) SN Worthington's election was invalid, or alternatively 2) SN Worthington should be equitably estopped from arguing that the election was valid.
Opinion
The Tax Court held that SN Worthington complied with the plain text of the regulation, satisfied the requirements of the Treas. Reg. § 301.9100-22(b)(2) and, therefore, timely elected into the BBA procedures for years before 2018. As a result, the TEFRA procedures were inapplicable, and the FPAA was invalid. As to the equitable estoppel argument, the IRS failed to establish that at least two of the five necessary elements were satisfied, and thus equitable estoppel did not apply.
Timely Election
Treas. Reg. § 301.9100-22(a) sets forth the form and manner for making an election to be subject to the BBA prior to the default rule. To make this election, a partnership must provide a written statement that includes a representation that "[t]he partnership has sufficient assets, and reasonably anticipates having sufficient assets, to pay a potential imputed underpayment with respect to the partnership taxable year that may be determined under subchapter C of chapter 63 of the Internal Revenue Code as amended by the BBA." Treas. Reg. § 301.9100-22(b)(2)(ii)(E)(4). It was undisputed that SN Worthington made the statement and, thus, satisfied the regulation.
The IRS ignored the language of its own regulation and argued that to make a valid election into the BBA procedures, the partnership must establish (and not merely represent) that it has sufficient assets to satisfy an imputed underpayment. The IRS argued that failing to establish that it had sufficient assets would defeat "the purposes of section 1101 of the BBA." See Treas. Reg. § 301.9100- 22(a) and the preamble to Temporary Treas. Reg. § 301.9100-22T. See T.D. 9780, 2016-38 I.R.B. 357.3
The Tax Court noted that the BBA regulations themselves refute the IRS' position. Under the BBA procedures, 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. I.R.C. § 6232(f)(1)(B) (BBA).
Because SN Worthington satisfied all the requirements listed in Treas. Reg. § 301.9100-22(b)(2), the BBA procedures applied, and the FPAA issued to SN Worthington under the inapplicable TEFRA procedures was invalid.
As to the IRS' estoppel argument, the Tax Court concluded that equitable estoppel did not apply because 1) the mistake arose from a mistake in law and not fact, and 2) the IRS knew the relevant facts to make the correct determination. Accordingly, SN Worthington was not equitably estopped from arguing that the BBA procedures apply.
Observations
- The IRS sought to interpret its own regulation, Treas. Reg. § 301.9100-22(a),4 in a manner inconsistent with the regulation's plain language by adding an ad hoc substantiation requirement.
- Although not raised by the Tax Court, the specter of Kisor v. Wilkie, 588 U.S. 558 (2019), was present. The Tax Court answered the matter correctly, finding the clear language of the regulation to be dispositive of the matter and refusing to accept the IRS' attempt to interpret the regulation in a manner contrary to its plain meaning.5
- The Tax Court noted two occasions where the IRS misinterpreted two distinct BBA regulations. The BBA regulations are complex, and even the IRS will struggle to interpret and implement these regulations.
If you have questions about the implications of this case or other doctrines on tax planning and tax controversies, please contact the authors or another member of Holland & Knight's Tax Controversy and Litigation Practice.
Notes
1 Bipartisan Budget Act of 2015 (BBA), Pub. L. No. 114-74, § 1101(a), (g), 129 Stat. 584, 625, 638.
2 Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. No. 97- 248, §§ 401–407, 96 Stat. 324, 648–71.
3 The preamble to Temporary Treas. Reg. § 301.9100-22T states: "An election is also not valid if it frustrates the purposes of section 1101 of the BBA, which include the collection of any imputed underpayment that may be due by the partnership under section 6225(a) as amended by the BBA." T.D. 9780, 2016-38 I.R.B. at 358.
4 The IRS position taken in SN Worthington calls into question whether the IRS intends to adhere to the policies stated in the Policy Statement on the Tax Regulatory Process, May 5, 2019. The Policy Statement on the Tax Regulatory Process provided that the IRS would limit its use of seeking judicial deference.
5 In Kisor, the U.S. Supreme Court severely limited the concept that the government's interpretation of its regulations should have deference. See Auer v. Robbins, 519 U.S. 452 (1997). For deference to be given, a series of tests must be met under Kisor. The first test is that the regulation must be "genuinely ambiguous" in applying statutory tools of construction to the regulation. Id. at 574. As the Supreme Court stated: "Deference in that circumstance would permit the agency under the guise of interpreting a regulation to create de facto a new regulation. Id. at 575. The IRS did not pass this first test, in part, because the U.S. Tax Court implicitly found that the IRS was in effect attempting to rewrite and create a de facto new regulation. Thus, the Tax Court gave no deference to the IRS' litigating position.
