There have been a lot of big federal tax issues in the spotlight in 2023, following are some of the biggest!

Less is Moore

A lot of people have a lot to say about Moore v. United States, which is now pending at the U.S. Supreme Court. Moore is a U.S. shareholder of a controlled foreign corporation who paid the Internal Revenue Code § 965 one-time mandatory repatriation tax (MRT) for the 2017 tax year. Moore sued for a refund, arguing the MRT is unconstitutional because he did not realize income under the 16th Amendment and if so, because it is not a tax on 16th Amendment income, the MRS is void ab initio. Both the district court and the Ninth Circuit have rejected Moore’s challenge as the tax is an income tax under the 16th Amendment.

The Moore case is notable in its success in obtaining review by the Supreme Court, given that 16th Amendment arguments have been consistently rejected and are often made by tax protesters. Commentators have expressed concern that a decision to invalidate the MRT and venerable case law supporting the government’s position could result in the invalidation of other federal tax provisions.

What will happen to Moore? Will the Supreme Court affirm the lower courts? Will it reverse and hold for the taxpayer? If so, what collateral effects will there be?

Red Card for ERC Claims

Companies are constantly getting offers to help them make Employee Retention Credit claims. What is a company to do, especially when it sounds like free money with no strings attached? The answer is – be prudent. 

In March 2023, the IRS added aggressive promoters making offers for ERC claims that are too good to be true to the IRS’s “Dirty Dozen” list. Later in 2023, the IRS put a moratorium, effective September 14, 2023 on processing new claims for Employee Retention Credit through the end of 2023 to give it time to add more safeguards to prevent future abuse and to protect businesses from predatory tactics. And, the IRS also announced that it is working with the Justice Department to pursue fraud fueled by aggressive marketing.

Does this mean that companies should not submit ERC claims? No, but the company making the claim must assume that the IRS will examine it and prepare to prove their claim. ERC claims may be filed based on the bright-line test of a decline in gross receipts or the facts and circumstances test of a full or partial suspension of operations due to one or more orders from an appropriate governmental authority. The gross receipts test is relatively straightforward, but the facts and circumstances test, requires well thought out documentation including: documentation proving the existence of a relevant government order; evidence showing how the government order or other issue directly caused the challenges and forced suspension of operations; and, documentation concerning the full or partial suspension of operations.

The ERC will likely be a big issue for years to come.

Deference or No

Loper Bright Enterprises v. Raimondo, Docket No. 22-451, now pending before the Supreme Court asks whether Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984) which created the federal rule of giving effect to clear statutory language but deferring to an agency’s interpretation of silent or ambiguous statutory language. The Chevron rule has been controversial since it was articulated; taxpayers and government agencies alike, especially the IRS, will be watching this case.

Only One Bittner at the Apple

The Supreme Court in Bittner v. United States, 598 U.S. 85 (2023) answered the question of whether the Bank Secrecy Act’s $10,000 maximum penalty for the nonwillful failure to file a compliant Report of Foreign Bank and Financial Accounts (“FBAR”) accrues on a per-report, not a per-account, basis. The BAS generally requires taxpayers to report their interests in foreign bank accounts. U.S. citizens must file a single annual report (called an “FBAR”) for anyone with an aggregate balance over $10,000 in foreign accounts. The BSA authorizes a $10,000 maximum penalty for any non-willful violation. Obviously, the IRS’s position that the penalty applies on a per-account basis generally resulted in much higher penalties.

The federal Courts of Appeal were split as to whether the penalty applied on a per-report basis [United States v. Boyd, 991 F.3d 1077 (9th Cir. 2021)] or a per-account basis [United States v. Bittner, 19 F.4th 734 (5th Cir. 2021)]. So, the Supreme Court took the case to resolve the split and did so in a taxpayer- friendly decision.

On Second Thought

The Supreme Court in In re Grand Jury, 143 S. Ct. 543 (2023) considered a case in which a law firm refused to comply with a federal criminal grand jury subpoena for documents that contained privileged advice concerning tax laws and non-privileged tax concerning tax return preparation. The law firm sought to protect the dual-purpose documents by arguing privilege under the Significant Purpose Test. The district court ordered the documents be redacted and produced. The Ninth Circuit affirmed.

The federal Courts of Appeal are split, which is likely why the Supreme Court decided to review the case. In this regard, the Seventh Circuit’s rule is that dual-purpose documents are never privileged. The Ninth Circuit employs a primary purpose test in which a dual-purpose communication is privileged if the primary purpose of the communication was to obtain or provide legal advice. And, the D.C. Circuit employs a significant purpose test in which dual-purpose communication is privileged so long as a significant purpose of the communication was to obtain or provide legal advice.

The Supreme Court reviewed briefs and heard oral arguments concerning the application of attorney-client privilege to dual-purpose communications. But, instead of issuing an opinion, the Court dismissed the petition as improvidently granted. Could the Supreme Court handle the Moore case this way?

No Notice Required

Polselli v. IRS, 143 S. Ct. 1231 (2023) concerns IRC § 7609, which requires the IRS to provide notice to each taxpayer identified in a summons to a third-party record-keeper to allow such taxpayer an opportunity to dispute the request, but no notice is required when the IRS issues a summons “in aid of the collection of an assessment made or judgment rendered against the person with respect to whose liability the summons is issued.” IRC § 7609(c)(2)(D)(i). In this case, the IRS entered an official assessment against Polselli for unpaid taxes and penalties. TheIRS issued summonses to multiple banks for financial records of third-parties including the taxpayer’s wife and law firms, but the IRS provided no notice to the third-parties. However, the banks that received the summonses told the third parties. And, the third-parties sought to quash the summons, arguing that for the §7609(c)(2)(D)(i) exception to providing notice to apply, the taxpayer must have some legal interest or title in the object of the summons, based on a Ninth Circuit case. Here, however, the Sixth Circuit rejected the Ninth Circuit’s test and allowed the IRS to issue the summons without notice. The Supreme Court opined that the text of the notice exemption does not contain a limitation so that the IRS may issue a summons without notice to third-parties, and as such, third-parties have no standing to quash a summons.

Strategic, Yet Cryptic, Retreat

Tax issues arise with cryptocurrency all the time. Jarrett v. United States, 79 F.4th 675 (6^th Cir. Aug. 18, 2023) concerns a circumstance in which a taxpayer sought a refund of federal income tax paid on newly- issued cryptocurrency units. The taxpayer received the units as a validator on the blockchain network where he staked units as security and used his own computing power to validate new transactions. The taxpayer paid the income tax, filed an amended tax return seeking a refund, and then filed suit for the requested refund. He challenged the IRS position in Notice 2014-21, which classified cryptocurrencies as property but took the position that the fair market value of the cryptocurrency is includible in gross income for mined currency. Taxpayer argued that as self-created property, the value of such is not subject to income tax until it is disposed. But, the IRS refunded the tax paid, and district court dismissed the case as moot. Taxpayer sought appeal, but the Sixth Circuit affirmed the dismissal. And, the IRS issued Rev. Rul. 2023-14 stating that cryptocurrency earned from staking constitutes taxable income in the year the taxpayer gains dominion and control of the validation rewards.

Easement Does It

The IRS has extensively litigated conservation easement transactions. According to the IRS in its “Dirty Dozen” release, “A conservation easement is a restriction on the use of real property. Generally, taxpayers may claim a charitable contribution deduction for the fair market value of a conservation easement transferred to a charity if the transfer meets the requirements of Internal Revenue Code section 170.” However, the IRS has taken the position that, “promoters are syndicating conservation easement transactions that purport to give an investor the opportunity to claim charitable contribution deductions and corresponding tax savings that significantly exceed the amount the investor invested.” Notwithstanding the IRS’s position, taxpayers have prevailed in challenged by the IRS to their conservation easement deductions.

Do Over, Please

The IRS has recognized that tax law generally allows businesses to create ‘captive’ insurance companies to protect against insurance risks and provides that certain small non-life insurance companies can choose to pay tax only on their investment income under Internal Revenue Code section 831(b) (‘micro-captives’). But, the IRS has aggressively pursued micro captives.

The IRS issued Notice 2016-66, which identified micro-captive insurance transactions as listed transactions, in violation of the APA’s procedural notice and comment requirements. See CIC Services, LLC v. IRS, No. 3:17-cv-110, slip op. at 4 (E.D. Tenn. June 2, 2022).  In response, the IRS and Treasury Department issued proposed regulations on April 11, 2023, which again seeks to identify micro-captive insurance transactions as listed transactions and certain other transactions as transactions of interest.

The IRS has received public comments and can be anticipated to move forward to finalize the proposed regulations.

Let’s Reschedule

IRC § 280E applies to disallow federal tax deductions and tax credits of state-legal but federally illegal cannabis companies, though cannabis companies may deduct cost of goods sold to compute federal taxable income. So, while the effective federal tax rate on corporations is 21% or less, the effective federal tax rate on cannabis companies can be 70% or 80% or more because of IRC § 280E.

The Department of Health and Human Services (“HHS”) has recommended to the Drug Enforcement Administration (“DEA”) that cannabis be reclassified as a schedule III drug under the Controlled Substances Act (“CSA”). Rescheduling cannabis to schedule III would be monumental for state-legal cannabis businesses because, for example, although rescheduling would not federally legalize the state-legal programs, it would eliminate the IRC § 280E tax burden that currently applies to such businesses.

States that have legalized cannabis, including Illinois and Missouri, have begun decoupling from IRC § 280E. Is this the next trend?

“A martini, shaken not stirred..” James Bond in Goldfinger (1964).

Which of the above is your favorite federal tax cocktail? Perhaps you will agree that the above are some of the biggest federal tax issues of 2023?  It’s been a very big year so far!

This is a modified version of Mark A. Loyd’s regular column, Tax in the Bluegrass, “2023’s Biggest Federal Tax Issues” which appeared in Issue 4, 2023 of the Kentucky CPA Journal.