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Both sides can claim victory of a sort, though their wins come at a price.

The Obama Administration and congressional Democrats won on the mandate’s enforceability. But they now own it politically as a tax.

The States won a real choice on Medicaid expansion. But they may not wish to have to make that choice.

The challengers won real limits on federal regulatory power under the Commerce Clause. But they lost on the ultimate judgment of constitutionality.

The real winner of this decision is Chief Justice Roberts. Today’s decision makes clear that this is the Roberts Court, not the Kennedy Court, as many have called it.

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Four owners of a trucking company sold the business’s sole remaining asset–a warehouse–and retired. After selling the warehouse, the businessmen sold their company stock to an investment company that promised to pay the company’s taxes. The investment company never did pay those taxes, and the IRS came after the former owners of the trucking company for the tax bill, which was in the neighborhood of $880,000. The IRS said the transaction with the investment company was a tax shelter scam, but the Tax Court sided with the former owners of the trucking company. A split panel of the Fourth Circuit affirmed. Judge Davis wrote the opinion for the Court in Starnes v. Commissioner, in which Judge Niemeyer joined. Judge Wynn wrote a dissenting opinion.

Depending on one’s view of the facts, either (a) the former owners of the trucking company were victims of unscrupulous cheats, persecuted by an overeager federal government out to take away their hard-earned retirement money, or (b) they pulled a fast one on the federal government, saving themselves over $100,000 each in taxes. Depending on one’s view of the law, either (a) the government should have stayed its hand because it misunderstood North Carolina law, or (b) the government was denied the benefit of federal law elevating substance over form in evaluating the tax consequences of transactions like the one at issue here.

The first few paragraphs of Judge Wynn’s dissent summarize his view of the case:

This case involves a straightforward transaction made complicated so as to facilitate the fraudulent avoidance of a tax liability. Simply put, the petitioners, former shareholders of Tarcon, reduced the sole asset of Tarcon to cash by selling that asset, a warehouse, for $3,180,000. After that October 30, 2003 sale, Tarcon had $3,091,955 in its bank account and no  tangible assets. As a result of the warehouse sale, Tarcon incurred a federal tax liability of $733,699 and a North Carolina tax liability of $147,931, for a total of $881,628. If the story had ended there, the four former shareholders, each of whom owned 25 percent of Tarcon, would have completed the liquidation of Tarcon by paying those tax liabilities and dividing the remaining sum, allowing each to receive a distribution of approximately $552,582.

Of course, the story doesn’t end there. Instead, MidCoast entered with a fraudulent scheme that would allow the former shareholders to avoid paying their $881,628 tax liability. Under its proposal, MidCoast would pay the former shareholders $2,621,136 for their Tarcon stock and legal fees; in return, Tarcon would transfer its sole asset, roughly $3.1 million in cash, to MidCoast. Why, though, would the shareholders turn over Tarcon’s $3.1 million to MidCoast and receive only $2.6 million in return?

The answer is evident when Tarcon’s outstanding tax liabilities of $881,627 are factored into the equation. Indeed, it then becomes clear that the former shareholders actually negotiated to be paid $2.6 million in cash—for cash that in reality totaled only $2,210,425, resulting in a windfall of $410,711. That windfall was, in fact, a cut from Tarcon’s $881,627 tax liability, transferred to MidCoast when it purchased the former shareholders’ stock, and which it undoubtedly was scheming to avoid under the guise of offering an “asset recovery premium.” While I recognize the intricacies of MidCoast’s subsequent actions to avoid paying the full liability of $881,627, this transaction cannot escape its ultimately simple  label: a transparent scam designed by the parties to fraudulently evade paying taxes. Accordingly, I must respectfully dissent.

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The lead story this evening at TPM bears the headline “John Roberts May Have Tipped His Hand on ‘Obamacare’ Reasoning.” The gist is that the Chief Justice’s dismissal of the challengers’ contention that the insurance requirement and tax penalty in 26 U.S.C. 5000A are inseparable “may have opened the door to finding that Congress’ power to impose the mandate springs from its broad taxing power.”

I disagree with this characterization. If anything, the government’s taxing power position looked weaker after today’s arguments than before.

In suggesting that Section 5000A is an integrated whole for purposes of evaluating the applicability of the Anti-Injunction Act, Chief Justice Roberts first described the suit as one to challenge penalties, not taxes, then said that the label makes no difference, and concluded by stating that it makes no sense to separate the punishment from the crime. To the extent such statements suggest a position on the taxing power, it goes against the federal government–particularly the language of punishment and crime. Here’s the interchange:

CHIEF JUSTICE ROBERTS: The whole point -­ the whole point of the suit is to prevent the collection
of penalties.

MR. KATSAS: Of taxes, Mr. Chief Justice.

CHIEF JUSTICE ROBERTS: Well, prevent the collection of taxes. But the idea that the mandate is something separate from whether you want to call it a penalty or tax just doesn’t seem to make much sense.

MR. KATSAS: It’s entirely separate, and let
me explain to you why.

CHIEF JUSTICE ROBERTS: It’s a command. A mandate is a command. Now, if there is nothing behind the command, it’s sort of, well, what happens if you don’t follow the mandate? And the answer is nothing, it seems very artificial to separate the punishment from the crime.

For balance, the TPM piece quotes challenger-lawyer Randy Barnett, and I think he has it exactly right: “The only thing I think Chief Justice Roberts was expressing resistance to was our argument that the mandate was separate from the penalty for purposes of the [Anti-Injunction Act]. . . . That is only one of the bases on which the AIA does not foreclose consideration on the merits. I don’t think he was signaling anything at all about the constitutionality of the mandate penalty, the subject of tomorrow’s argument. If he was, however, I expect to get a much better sense of that tomorrow so we won’t have to wait long to find out.”

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The Fourth Circuit today issued a published opinion affirming a Tax Court judgment rejecting various claims by Capital One related to taxes owed on late-fee income and deductions for projected costs of miles rewards redemptions. Judge Wilkinson wrote the opinion for the panel in Capital One Financial Corporation v. Commissioner, which was joined in by Judges Niemeyer and Floyd.

Tax law junkies can read the opinion in full. For everyone else, here a few excerpts to provide some of the flavor of the opinion, which is quite interesting even to a non-tax specialist reader:

  • “As to late-fee income, Capital One seeks to retroactively change accounting methods years after it selected and implemented an alternative method. The purported change would reduce Capital One’s taxable income for 1998 and 1999 byapproximately $400,000,000. To allow such changes without the prior consent of the Commissioner would roil the administration of the tax laws, sending revenue projection and collection into a churning and unpredictable state. Belated attempts to change accounting methods “would require recomputationand readjustment of tax liability for subsequent years and impose burdensome uncertainties upon the administration ofthe revenue laws.” Pac. Nat’l Co. v. Welch, 304 U.S. 191, 194(1938). For that reason, the Supreme Court has held that once a taxpayer has reported income according to a particular method it must live with that choice—the taxpayer has “madean election that is binding upon it and the commissioner.” Id.at 195.
  • “While we appreciate Capital One’s expressed enthusiasm for complying with the requirements of the TRA, it is impossible to overlook its financial incentives to make the retroactive change. Capital One maintains that it was not trying to obtain a better tax result but only to comply with the TRA. Capital One’s persistent effort in litigation to reduce its taxable income by approximately $400,000,000, however, speaks for itself. In all events, the alleged reason or motive for a change in method of accounting does not eliminate the need to obtain consent.”
  • “There is a line between a loan and a sale and it is important that we keep it bright. To characterize a loan as the sale of lending services is artful pleading and clever wordsmithing, but it is dubious law to say the least.”

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