Introduction

The arrival of spring has not yet brought guidance projects to full bloom (no corporate alternative minimum tax (CAMT) proposed regulations, no stock repurchase excise tax final regulations). However, March featured the release of final regulations addressing the direct pay election for green energy credits and the advanced manufacturing investment credit, along with proposed rules implementing protections in the Taxpayer First Act of 2019 governing IRS contact with third parties. Judicial developments were modest, with court decisions and meaningful progression in cases pertaining to section 41 research and experimentation (R&E) credits, foreign tax credits (FTCs) and section 965 "offset earnings," captive insurance, and issues of Tax Court jurisdiction. Here are the key takeaways for March. 

Tax Fact: As of March 22, 2024, the IRS had processed 79.2 million individual returns in this year's filing season. The average refund at this point is $3,081, which is about $178 higher than last year.

"It's April 15, tax day. The federal tax code is over 74,000 pages long. But stick with it because after page 72,000, it gets really good." – Conan O'Brien

Notice 2024-28 Provides Ideal Opportunity For Taxpayers Seeking IRS Guidance

Marc Gerson and Layla Asali

On March 7, 2024, the Internal Revenue Service (IRS) issued Notice 2024-28, 2024-13 I.R.B. 1, Public Recommendations Invited on Items to be Included on the 2024-2025 Priority Guidance Plan. The Priority Guidance Plan (PGP) identifies the guidance projects (regulations, revenue rulings, revenue procedures, notices, and other published administrative guidance) that the Department of the Treasury (Treasury) and the IRS intend to prioritize and actively work on during the published guidance plan year (July 1 through June 30).

Notice 2024-28 provides an ideal opportunity to submit recommendations for items to be included on the 2024-2025 PGP. In reviewing recommendations and selecting additional projects for inclusion on the 2024-2025, Treasury and the IRS consider a variety of factors, including whether the recommended guidance resolves significant issues relevant to a broad class of taxpayers, whether the recommended guidance reduces controversy and lessens the burden on taxpayers or the IRS and whether the recommended guidance relates to recently enacted legislation.

Although taxpayers are not required to submit recommendations for guidance in any particular format, Notice 2024-28 suggests that they should briefly describe the recommended guidance, explain the need for the guidance, and may also include analysis of how the issue should be resolved. In our experience, the more robust the submission is, the greater chance that the recommended guidance will be included in the PGP. Furthermore, the submission presents an ideal opportunity to provide substantive comments in advance of any formal rulemaking process, which can ultimately influence the issuance of favorable guidance.

It is important to note that competition to be included in the PGP is quite stiff, given the number of recommendations that the IRS receives, a concerted IRS effort over recent years to reduce the number of guidance projects in the PGP, and, as noted above, the emphasis on including guidance projects related to recently enacted legislation (particularly given the recent significant demand for guidance under the Inflation Reduction Act). It may take multiple annual recommendations before a recommendation is included in the PGP, if at all. Regardless of whether it is ultimately included in the PGP, a recommendation can be used as a mechanism to highlight an issue to the IRS and to the taxpayer community (given that all recommendations are subject to public disclosure).

Although taxpayers can submit recommendations for guidance at any time during the year, recommendation for possible inclusion in the original 2024-2025 PGP are due by Friday, May 31, 2024. 

Final Regulations on Direct Pay and Transferability, Advanced Manufacturing Investment Credit

Andy Howlett and Sam Lapin 

On March 5, 2024, Treasury and the IRS issued final regulations under sections 6417 and 48D(d) providing much anticipated guidance relating to the direct pay election for certain green energy credits and the advanced manufacturing investment credit (the CHIPS credit), respectively. The regulations under sections 6417 and 48D(d) are similar and generally address two issues: (1) how to make the direct pay election, and (2) the effects of the direct pay election. 

The final regulations address the nuts and bolts of making the direct pay election, whether under section 6417 or 48D(d). Before a taxpayer can elect to treat its credit as a direct payment, it must register with the IRS and provide information via an online portal relating to eligibility for the credits for which an election is being made. For taxpayers making the election with respect to green energy credits, the regulations provide that the election is made on a facility-by-facility basis. For taxpayers claiming the CHIPS credit, the election must be made for each qualified investment. The taxpayer will receive a unique registration number for each facility or qualified investment, as the case may be.

The final regulations also address the effects of making a valid direct pay election. An elective payment is treated as made as of the filing of the return. As a result, the elective payment amount (which is not subject to the section 38(c) limitation on general business credits) cannot be used to reduce quarterly estimated tax payments. Electing taxpayers (with the exception of partners and shareholders in an S corporation) may only reduce their estimated payments by the amount of the applicable credit for which they would otherwise be eligible, subject to the limitation in section 38(c). On this point, the preambles to the final regulations under both section 6417 and 48D(d) stated that "payments made under section [6417 or 48D] are no different than other kinds of payments a taxpayer may make as part of filing a timely return (excluding extensions) or making a payment with a timely filed application for extension." In other words, final regulations view the payment made under a direct pay election (to the extent it exceeds the credit otherwise available) as a payment made at the time the return is filed. Thus, these amounts cannot be used to reduce estimated taxes. The preamble recognized that this had caused some confusion among stakeholders, so taxpayers will welcome the clarity, if not the result, in the final regulations.

In addition, the regulations address the application of the "double benefit" rules in sections 6417 and 48D. In each case, the "double benefit" rules in the section 6417 and 48D(d) regulations provide that "The full amount of the [green energy or CHIPS] credits for which an elective payment election is made is deemed to have been allowed for all other purposes of the Code, including, but not limited to, the basis reduction and recapture rules imposed by section 50 and calculation of any underpayment of estimated tax under sections 6654 and 6655 of the Code." Treas. Reg. §§ 1.6417-3(e)(3) and 1.48D-6(e)(3). Treasury and the IRS revised the steps for computing a taxpayer's elective payment amount in the final regulations, to avoid in most cases treating the direct pay amount as credits for purposes of the section 38(b) ordering rules. In doing so, Treasury and the IRS intended to prevent taxpayers from having to to defer the use of other general business credits, such as R&E credits, indefinitely. For all other purposes, however, including the determination of taxpayers' base-erosion and anti-abuse tax (BEAT) liability and CAMT credit, the regulations provide that electing taxpayers must treat the credit as having been allowed in full.

See our past coverage of the proposed direct pay election here. 

Proposed Regulations Regarding Third-party Contacts

Rob Kovacev and Jaclyn Roeing

On March 22, 2024, Treasury and the IRS issued a notice of proposed rulemaking that would update Treasury Regulation § 301.7602-2 for changes made to IRC § 7206 by the Taxpayer First Act of 2019 (TFA). P.L. 116-25, 133 Stat. 981. Prior to the TFA, the IRS could contact a third party in an audit or collection action after giving "reasonable notice in advance" to the taxpayer. See § 7602(c)(1) (1998). The IRS routinely argued that this reasonable notice requirement was met by the mailing of Publication 1, "The Taxpayer Bill of Rights," that included a short statement that the IRS might contact third parties. See, e.g., J.B. v. United States, No. 16-1599, 2019 WL 923717 (9th Cir. Feb. 26, 2019). The TFA revised section 7602(c) to impose more robust notice requirements on the IRS, including a 45-day notice period. Among other things, this extended period allows taxpayers an opportunity to dialogue with the IRS about potential alternatives to third-party contact. 

The proposed regulations would require that the IRS provide notice of third-party contacts in writing "to ensure compliance with the advance notice requirement and to eliminate any potential confusion as to the date on which notice was provided to the taxpayer or the contents of the third-party contact notice." The notice would cover third-party contacts for a period of up to one year. Successive notices could be issued to cover periods greater than one year. The IRS may not issue a notice of third-party contact unless the IRS intends, at the time it issues the notice, to contact third parties during the period described in the notice. 

Furthermore, the proposed regulations would create four categories of exceptions to the standard 45-day notice period.

1. In inspections of tax-exempt dyed fuel under section 4083 as part of the IRS' Fuel Compliance Program, notice would be provided immediately before the third-party contact. These inspections are time sensitive and may require immediate action by the IRS to avoid the spoilation of evidence about the improper use of tax-exempt dyed fuel. 
2. In nonjudicial sales of taxpayer property, notice would be provided 10 days before the third-party contact. The IRS has 120 days from the date of a nonjudicial sale to redeem property subject to a federal tax lien if the IRS believes that it can obtain a higher price for the property. The ability of the IRS to investigate properties and make the required determination would be hampered if the standard notice period for third-party contacts were to apply.
3. When the statute of limitations for assessment (section 6501) is one year or less, and certain circumstances place an enhanced burden on the IRS, notice would be provided 10 days before the third-party contact. These circumstances include: (i) a taxpayer's refusal to extend the statute for assessment, and the IRS case involves an issue with respect to which the IRS would bear the burden of proof in court; and (ii) in investigations of potential liability for the trust fund recovery penalty under section 6672, a "highly fact-intensive and challenging" investigation.
4. When the statute of limitations for collection (section 6502) is one year or less, and certain circumstances place an enhanced burden on the IRS, notice would be provided 10 days before the third-party contact. These circumstances include: (i) the IRS intends to prepare a suit referral to the Department of Justice (DOJ) and a 45-day notice would prevent the timely referral; and (ii) there is insufficient time for collection activities with a 45-day notice period because the taxpayer refuses to pay or the IRS is unable to contact the taxpayer.

Taxpayers may comment and request a public hearing on the proposed regulations through May 21, 2024. Taxpayers who deal regularly with the IRS — particularly in the context of the exceptions outlined above — may wish to review the proposed regulations and consider whether to comment. Furthermore, taxpayers with activities or tax years that may meet the exceptions should watch for the publication of final regulations under section 7602(c) and consider how the reduced notice periods may impact their interactions with the IRS and with third parties. The notice of proposed rulemaking states that any final regulations will become effective for third-party contacts made on or after the date 30 days after publication. 

DOJ Surfaces New Argument in FedEx Foreign Tax Credit Dispute

Jeffrey Tebbs, Candice James, and Omar Hussein

Recent filings in the FedEx case indicate that the DOJ plans to assert an alternative legal basis for disallowing FTCs associated with section 965 "offset earnings." DOJ had not previously presented this theory when it sought (and failed to obtain) summary judgment in September 2022. Taxpayers with an existing or potential claim to credit foreign taxes with respect to the distribution of offset earnings should continue to monitor developments in FedEx, as the case may provide a preview of DOJ's nationwide litigation strategy. 

More than a year ago, the district court granted FedEx's motion for partial summary judgement, concluding that Treas. Reg. § 1.965-5(c)(1)(ii) was substantively invalid, to the extent it disallowed an FTC for offset earnings distributed before the effective date of amendments to section 960. (See our prior coverage.) Since that ruling, FedEx and DOJ jointly endeavored to compute the amount of the refund due to FedEx. However, on March 8, 2024, FedEx moved the court for entry of judgment, stating that DOJ no longer intends to jointly propose an amount for final judgment and instead intends to raise a "new legal argument." FedEx's motion contends that DOJ waived its opportunity to raise this "novel argument," and nevertheless "prophylactically addresses what FedEx understands to be the government's new argument." 

In a motion for extension of time, DOJ stated that it has not yet prepared a written statement of its new position, but it has "received an analysis from IRS Chief Counsel." Based on FedEx's characterization of the government's forthcoming position, DOJ intends to assert that regulations issued under the "haircut" rules of section 965(g) should partially disallow a portion of the disputed FTCs. See Treas. Reg. § 1.965-5(c)(1)(i). In adopting this position, DOJ would be aligning with a position the IRS has already applied in the examination of at least one unrelated taxpayer. Specifically, Sysco Corporation's April 2023 petition to the U.S. Tax Court states that, in the alternative, the IRS partially disallowed certain FTCs based on the application of Treas. Reg. § 1.965-5(c)(1)(i).

DOJ's opposition is due on April 12. Without that briefing, it is challenging to see how DOJ's position is not precluded by the law-of-the-case doctrine. The partial disallowance of FTCs required by section 965(g) only applies to foreign taxes paid or accrued with respect to amounts for which a deduction is allowed under section 965(c). Congress established the partial deduction under section 965(c) to allow accumulated foreign earnings to be taxed at an effective rate between 8.0 and 15.5 percent, rather than the historic statutory rate of 35 percent. To that end, the deduction under section 965(c) is allowed only for amounts that were included as subpart F income under section 965(a). In its 2023 order on cross motions for partial summary judgment, the court effectively concluded that offset earnings are not treated as included in gross income by a U.S. shareholder for any purpose other than the exclusion from gross income afforded by section 959.

The DOJ's dilatory approach may frustrate taxpayers seeking to resolve identical legal claims through the IRS Independent Office of Appeals (IRS Appeals), rather than litigation. Under interim guidance, IRS Appeals will not apply litigating hazards to arguments raised by a taxpayer regarding the validity of Treasury regulations, until there is an unreviewable decision from a federal court holding the regulation invalid. See Memorandum for IRS Independent Office of Appeals Employees, AP-08-0922-0011 (Sept. 14, 2022) (incorporated into the Internal Revenue Manual, 8.1.1, Appeals Function, Appeals Operating Directives and Guidelines); see also Prop. Reg. § 301.7803-2(c)(19) (exception to consideration by Appeals for challenges to regulatory validity), Notice of Proposed Rulemaking, 87 Fed. Reg. 55,934 (Sept. 13, 2022). The latest developments will delay the entry of judgment, resolution of subsequent appeals, and the date on which the decision in FedEx becomes unreviewable. 

Culp v. Commissioner: Government Asks Supreme Court to Reconsider Availability of Equitable Tolling to File a Tax Court Petition

Kevin Kenworthy and Sam Lapin

The U.S. government has asked the Supreme Court to review a decision by the Third Circuit Court of Appeals that could have important ramifications for practice before the Tax Court. Last year, the Third Circuit held in Culp v. Commissioner, 75 F.4th 197, that failure to file a Tax Court petition within the 90-day period prescribed by Code section 6213(a) did not necessarily deprive the court of jurisdiction to hear the case. Instead, a tardy taxpayer could seek to invoke the principle of equitable tolling to excuse the untimely filing. As noted in our prior coverage, in reaching this conclusion, the Third Circuit leaned heavily on the Supreme Court's recent decision in Boechler v. Commissioner, 142 S. Ct. 1493 (2022), where the Court held that timely filing a collection due process petition before the Tax Court under section 6330(d)(1) is not a jurisdictional requirement and could be excused in extraordinary circumstances.

To prevail on the merits, the government will have to show that Boechler is not controlling. But the government's petition for certiorari does not dwell on Boechler. Instead, the petition argues at some length that the Supreme Court should review Culp because the text of and statutory context for section 6213(a) reveals that Congress intended that timely filing a petition for redetermination of a deficiency is a jurisdictional requirement. The government lays out the history of section 6213(a) and related provisions and how Congress, the Tax Court, and almost all courts of appeal have long viewed the necessity of timely filing to give the Tax Court jurisdiction to redetermine a deficiency. The Third Circuit declined to consider the admittedly non-controlling decisions of its sister circuit courts. But as the government contends, the resulting circuit split on this issue creates uncertainty for the IRS and taxpayers alike. 

The government also makes an alternative argument based on the facts of the case. The petition argues that, irrespective of whether a timely petition for redetermination is a jurisdictional requirement, Tax Court lacked jurisdiction because there was no longer a deficiency. The taxpayers filed their petition almost three years after receiving the notice of deficiency, during which time the IRS assessed and collected the tax at issue. The petition argues that the assessment, mandated by section 6213(c), left the Tax Court with no deficiency within its jurisdiction to redetermine. A decision on this alternative argument would, however, leave the circuit split unresolved.

Look for the Supreme Court to act on the government's request to hear this case in the coming months.

Tax Court Denies Early Sampling in Section 41 Credit Dispute

George Hani, Rob Kovacev, Sam Lapin, and Omar Hussein

On March 12, 2024, the Tax Court in Kapur v. Commissioner, T.C. Memo. 2024-28 (2024) denied a taxpayer's request to limit discovery and trial to a sample of two projects in a section 41 credit dispute. Taxpayer, the owner of a civil and environmental engineering firm (an S corporation), claimed flow-through qualified research expenditures (QREs) for employee wages paid as part of 2,000-3,000 research projects. 

Essential to the analysis under section 41 is the identification of the proper business component(s) to which the analysis should be applied. Often, a taxpayer will claim section 41 credits for large numbers of business components. At the examination stage, Rev. Proc. 2011-42 provides a procedure for using statistical sampling to select a subset of a taxpayer's business components as to which the examination team will focus their audit. Likewise, when a section 41 credit is litigated, the taxpayer and the IRS often will agree to a sampling approach, where they limit the dispute to a representative subset of business components and extrapolate the results to the remaining projects. See, e.g., Little Sandy Coal v. Comm'r, T.C. Memo. 2021-15, aff'd, 62 F.4th 287 (7th Cir. 2023); Union Carbide Corp. & Subs. v. Comm'r, T.C. Memo. 2009-50, 2009 WL 605161, aff'd, 697 F.3d 104 (2d Cir. 2012). 

In Kapur, the taxpayer claimed flow-through section 41 credits from the S corporation on their Form 1040s in the years at issue. The IRS disallowed the credits, and the taxpayer filed suit. The IRS first issued informal discovery requests seeking information on all of the claimed QREs. The taxpayer limited their response to the two largest projects, which accounted for over 72 percent of the claimed QREs. The IRS then issued formal discovery requests (interrogatories, requests for production, and a Motion to Compel deposition), seeking the same information. The taxpayer responded by requesting, again, that the scope be limited to the two projects and also filed a Motion for Protective Order requesting that the court limit discovery and trial to the two projects. 

The Tax Court denied the taxpayer's request. The court held that, at a minimum, the taxpayer must identify all the business components at issue before a representative sample could be considered. The court noted that it had the discretion to impose a sampling method over the IRS's objections if broader discovery would be disproportionate to the needs of the case. Here, however, the court concluded that a protective order would "improperly relieve[] the taxpayer of its burden of proving entitlement to [the section 41 credit]." 

The Kapur case highlights the importance of providing sufficient support for all business components as to which a taxpayer's claims section 41 credits. While there may be opportunities to limit the scope of an audit or litigation to a subset of those business components, a taxpayer cannot assume that the IRS or a court will agree.

Tax Court Rules That Another Microcaptive Fails to Qualify as Insurance

Maria Jones and Andrew Beaghley*

The U.S. Tax Court continued its barrage against section 831(b) microcaptive insurance programs with another case decided against the taxpayers in Patel v. Commissioner, T.C. Memo. 2024-34 (Mar. 26, 2024). In this case, the Tax Court ruled that insurance premiums paid to the microcaptives were not deductible and that the companies did not qualify as insurance companies because they failed to distribute risk and did not qualify as insurance in the commonly accepted sense. The court first examined a reinsurance arrangement established through Capstone and concluded that it did not provide for risk distribution. Unfortunately, in reaching this conclusion, the court once again relied on a misapplied "circular flow of funds" argument and neglected to recognize the economics of the arrangement. The court also failed to recognize the importance of the quota-share nature of the arrangement in the determination of risk distribution, and the fact that the reasonableness of the quota share reinsurance premiums is based on the reasonableness of the direct premiums. The microcaptives' direct policies fared no better in providing risk distribution. The court failed to recognize each separate patient visit to a doctor as a risk exposure, and held that the "issuance of policies to, at most, one to three entities is insufficient to achieve risk distribution." 

The court also ruled that the taxpayer's microcaptives did not qualify as "insurance in the commonly accepted sense" based on a review of commonly considered factors, most of which the court determined were "neutral" or favored the Patels. The court's conclusion ultimately rested on its determination that the taxpayers' reasons for establishing the captives were based on tax motives rather than insurance needs and that the taxpayer did not perform expected due diligence regarding the reinsurance arrangement with Capstone. The court concluded that the premiums were not reasonable, noting that the premiums were targeted to the $1.2 million limit. The court also found the premium pricing to be unreasonably expensive, highlighting for example that the taxpayer paid "premiums for the legal expense policy [of] $14,000 for $20,000 of coverage." The court also found the actuary, Al Rosenbach, to be lacking credibility. (As the court noted, Mr. Rosenbach was involved in Avrahami and Swift). Based on the absence of risk distribution, and the findings regarding insurance in its commonly accepted sense, the court determined that the microcaptives failed to qualify as insurance and sustained the Commissioner's disallowance of the deductions. In doing so, the court also specifically rejected the Patels' arguments regarding deference to state regulators on determinations regarding whether the transactions qualified as insurance.

The superficial review of some of the technical issues in this case is disappointing, and it seems that Tax Court was just checking boxes in reaching its holding here. In addition, the court seemed to give undue weight to the taxpayer's alleged motivation for setting up the captives, and just assumed that a tax planning motive necessarily meant that the program must not be real insurance. But a taxpayer's motivation is not and should not be part of the test for insurance. There are some significant and obvious flaws in this decision, and we will be waiting to see if the taxpayer decides to appeal.

*Former Miller & Chevalier attorney

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