The IRS’s journey back to Cheyenne, Wyo., to defend its denial of a penalty refund left it wincing from more than the blowing snow.
The government’s Washington-based attorneys likely hadn’t planned a return trip after Judge Nancy Freudenthal, on a pleasant Wyoming summer day in 2015, dismissed Corbin McNeill’s $4.59 million penalty refund claim, finding that McNeill couldn’t bring an individual action to challenge the penalty. Freudenthal went with the IRS’s argument that McNeill’s role as tax matters partner in a tax shelter partnership barred him from pursuing a partner-level defense.
McNeill, a former nuclear submarine commander and former chairman of Exelon Corp., who had retired to Jackson, Wyo., wasn’t one to give up without a fight. He took the battle down Interstate 25 to the federal appeals court in Denver. His case landed with a panel that included U.S. Supreme Court nominee Neil Gorsuch, who, fortunately for McNeill, believes in following the letter of the law.
That law, the Tax Equity and Fiscal Responsibility Act (TEFRA), didn't contain any language that would prevent the “managing (or tax matters) partner from pursuing a reasonable cause/good faith defense in later partner level proceedings,” Gorsuch said, contrary to the IRS’s interpretation.
After being overturned once by a possible future Supreme Court justice, Freudenthal composed a very thorough findings of fact and conclusions of law, issued Feb. 24, ruling this time in favor of McNeill. He had reasonable cause to claim on his tax return a $20 million paper loss from a distressed asset/debt (DAD) tax shelter, she ruled, and did so in good-faith reliance on Ernst & Young, which prepared his tax return, and the law firm that provided him with an opinion letter blessing the tax aspects of the transaction.
Appeals courts give deference to a trial court’s findings of fact, so the IRS will face an uphill battle if it decides to appeal the case. The agency can thank Gorsuch for opening the door to McNeill to present those facts.
Freudenthal’s findings and conclusions didn’t provide any citable case law for attorneys representing taxpayers like McNeill who were led into tax shelters by questionable promoters, but as Tom Cullinan of Eversheds Sutherland (US) LLP told Bloomberg BNA, they did provide “a road map of how the government litigates a penalty case.”
TEFRA will be replaced in 2018 with a new partnership tax regime that will allow the IRS to collect taxes at the partnership level. The new regime will do away with the two-level approach under TEFRA in which the IRS conducts audits at the partnership level but collects taxes at the partner level. Although TEFRA will technically be laid to rest at the end of the year, it is expected to enjoy a long afterlife in the courts as only departed tax provisions can, making Gorsuch’s decision relevant for some time to come.
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