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Code Trumps Regulations Trumps Revenue Rulings

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    Code Trumps Regulations Trumps Revenue Rulings

    I could not believe my luck when I came across this post. Finding something like this makes research worthwhile. Can you imagine the time it would take to develop these ideas:

    Tax practitioners know that tax law is a morass of gray areas. Multiple interpretations of the same language can be found resulting in tax liabilities where a taxpayer claims there is none or tax benefits where the IRS claims there is none. Sometimes, these disagreements end up in court.

    Even stranger, although not uncommon, are the following two situations:

    1) When the IRS writes a regulation that is in conflict with the statute (the Code); and

    2) When the IRS takes a position (via a revenue ruling or some other writing) that conflicts with the IRS-written regulations.


    Why does this matter? Well, there may be the RARE occasion when you are preparing a return that includes an issue in one of these gray areas. You talk to your client and tell her that she may be able to take a position on her return that could save her a significant amount of tax. She gives you the go ahead to look into it further. You prepare the research and find that the Code and Regulations are in your client's favor, but that a revenue ruling, a GCM or some other IRS writing take a position to the contrary. You go to your client, explain the situation and the options as well as the possible consequences. She gives you the go ahead to prepare the return with the position that is advantageous to you. You have her sign a document acknowledging all of the above. And here is why it matters: You can sign the return knowing that the Code and Regulations support the position despite an extra-regulatory writing by the IRS to the contrary.


    Following is a brief, non-exhaustive discussion of the situations described above.

    When Regulations Conflict w/ the Code

    The joint Houses (Senate & Congress) write and propose the law (the Internal Revenue Code); the president approves it with his signature. The IRS writes the Regulations (generally, interpretations of the Code, but also "law" when allowed by the Code (cf. §482, "the secretary may . . .")).

    It is well settled law that the IRS cannot override congressional intent via its (the IRS's) regulatory authority. In Union Bed & Spring Co. v. Comm., 8 AFTR 10516 (39 F.2d 383), 03/29/1930 (U.S. Court of Appeals, Seventh Circuit), the Court wrote, "The statute and the regulation are to be construed together, and, if there be a conflict, the regulation must give way." (Emphasis added) The exact same language is used in The Citizens & Southern National Bank, BTA Memo 1939-541 (Board of Tax Appeals).

    In Peters v. Comm., 20 AFTR 2d 6016, 11/01/1967 (U.S. Court of Appeals, Fourth Circuit), the Court wrote: "To accept the estate's contention would be impliedly to hold that the treatment of value required by § 20.2040-1(a)(2) of the regulations conflicts with § 2040 of the Code, and that in this conflict the regulation prevails over the statute. This we could not do, even if we accepted the estate's reading of § 20.2040-1(a)(2), for clearly in the event of conflict, the statutory provision would prevail." (Emphasis added)


    When IRS Positions Conflict with Regulations

    The IRS can also write commentaries on the Regulations for clarification; e.g., revenue rulings, GCMs, TAMs, etc. These writings, are, in essence, what the IRS says they "meant" when they wrote the Regulations. They should be given deference; however, when the actual Regulations say one thing, but the IRS says, "We meant something else." the courts have said, in effect, "Too bad. If you don't like the results of the Regulations as written, then re-write them." (Now, that does not give the IRS carte blanche to re-write the Regulations. If the legislative history clearly supports the Regulations as written and does not support the IRS' "We meant something else." position, then they would probably lose in court again.)

    In Palm Beach Plant Factory, Inc., Docket No. 21510-95 (10/23/95), the IRS asserted that the built-in gains tax should apply to settlement proceeds received by a corporation following its conversion to S status even though the corporation had not filed a claim for damages as of the date of its conversion. The IRS's position was that the taxpayer's unfiled claim against an unrelated third party 1) constituted a built-in income item (under §1374(d)(5)(A)); and 2) that the settlement proceeds received by the taxpayer following its conversion to S status constituted a recognized built-in gain. However, the IRS's position is inconsistent with the accrual-method test in the final §1374 regulations, and is directly in conflict with Regulations §1.1374-4(a)(3), Example 2. Now this is a case where the IRS did not wait for the court to slap them down. The IRS subsequently withdrew its position that the settlement proceeds constituted a built-in gain item. (Thus, only the docket citation above.)

    Woods Investment Co. v. Comm., 85 TC 274, is the seminal case standing for the proposition that the IRS cannot take a position contrary to the regulations. In Woods, the taxpayer was determining the gain on the sale of subsidiary stock. It computed the sub's E&P, in part, by calculating depreciation using the straight-line method (as mandated by the consolidated return regulations). The IRS claimed that E&P had to be reduced by accelerated depreciation because the sub used that method on its tax returns. To do otherwise would give the parent company a double deduction. (SL depreciation results in a higher basis in the sub and, thus, a lower gain.) The Court rejected the IRS's position because the taxpayer followed the regulations and the IRS's position was in direct conflict with the regulations. Further, the Court opined that the IRS could use its authority to amend the regulations.

    The Court wrote, "Based upon the foregoing, we conclude that petitioner [Woods] reached the result mandated by respondent's [IRS] consolidated return regulations and section 312(k) in computing its basis in the subsidiaries' stock. We believe that judicial interference sought by respondent is not warranted to alter this result. This Court will apply these regulations and the statute as written. If we were to make a judicial exception with respect to the adjustment for depreciation, we would be opening our doors for respondent every time he was dissatisfied with a certain earnings and profits adjustment. If respondent believes that his regulations and section 312(k) together cause petitioner to receive a "double deduction," then respondent should use his broad power to amend his regulations. . . . Since respondent has not taken steps to amend his regulations, we believe his apparent reluctance to use his broad power in this area does not justify judicial interference in what is essentially a legislative and administrative matter." (Emphasis added)

    In Trinova v. Comm. 108 TC 68, the Tax Court declined to follow Rev. Rul. 82-20, a Second Circuit decision (Solomon) and a Ninth Cicuit Decision (Walt Disney), concerning ITC recapture with respect to a §355 tax-free spin-off. The Tax Court held in Trinova that ITC recapture was not required when Trinova Corp. contributed assets that were the subject of ITCs to its subsidiary and distributed the stock of the subsidiary to one of its shareholders. This ruling was despite the conclusions to the contrary in the above-mentioned revenue ruling and the circuit decisions.

    The decision in Trinova reaffirmed the doctrine established in Woods Investment (supra); i.e., when the literal language of the regulations supports a taxpayer's position, the court will not change the result even when it involves an unwarranted benefit to the taxpayer.
    This posting is for general discussion purposes and is not meant to be reliable tax advice.

    #2
    Thanks! I printed this out to read someday soon.
    JG

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      #3
      dito, thank you.

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