Loper Bright
In Loper Bright Enterprises et al. v. Raimundo, the U.S. Supreme Court overturned the Chevron doctrine, a policy of deferring court discretion to federal agency regulations. Chief Justice John Roberts authored the majority (6-3) opinion.
Two commercial fishing companies challenged an administrative rule by the National Marine Fisheries Service, requiring the companies to cover the cost of a mandated government observer.
SCOTUS overturned the longstanding judicial deference to administrative agencies on interpretation of federal statutes. The U.S. Constitution and the Administrative Procedure Act 1946 leave statutory interpretations to the courts. The APA establishes the guidelines for implementation of federal administrative rules but allows for judicial review (Section 10) of “all relevant questions of law.”
Although prior case law interpreting the APA allowed judicial intervention based on the thoroughness, reasoning and consistency of the applicable administrative regulation, Chevron USA v. National Resource Defense Council, Inc. removed federal court interference from any “permissible” administrative interpretation. Thus, even if a federal court disagreed with an administrative interpretation, the court would yield to it if “reasonable.”
Chevron mandated a two-part process for courts to review a challenge to a statutory interpretation by a federal agency. First, if Congress addressed the issue, the law is clear and requires no administrative or other interpretation. If, however, the statute is ambiguous, the court must assess whether the regulatory agency has adopted a “reasonable interpretation” of the statute. The court must enforce any such reasonable regulatory interpretation.
The Chevron doctrine thus directed federal courts to defer to the reasonable interpretation by federal agencies regarding ambiguous federal law. Such judicial deference to regulatory agency interpretation essentially presumes enforceability when Congress reflects its intention that a regulatory body fill any gap in statutory coverage. Chevron thus required judicial deference to regulatory agency interpretation of ambiguous law or situations not addressed by federal statute. The Chevron doctrine had been followed for 40 years.
The federal district court in Loper found that the federal statute at issue clearly authorized the mandated observer and the associated cost to be paid by the fishing company. The D.C. Circuit Court of Appeal affirmed that the administrative regulation provided a reasonable interpretation of the statute – leaving the determination to the agency, per Chevron.
But Justice Roberts, writing for the majority, vacated the lower court rulings and overturned Chevron. Roberts relied on the traditional role of the courts to interpret all law and rejected the idea in Chevron that “statutory ambiguities are implicit delegations to agencies.” He harkened to the founders and the role of the courts “to decide legal questions by applying their own judgement.” In a concurrence, Justice Clarence Thomas confirmed that “Chevron deference also violates our Constitution’s separation of powers.”
Justice Roberts explained that the courts are free to defer to administrative regulation based on the court’s assessment of its thoroughness, reasoning and consistency. The courts must then, however, apply their independent judgement. Federal courts may now freely interpret otherwise ambiguous federal statutes.
The Court clarified that prior decisions based on Chevron remain enforceable. Unambiguous grants of power by Congress to the applicable administrative agency will also continue to be enforced. Legislative delegation of power is not a statutory gap or ambiguity.
Courts may now rely on their own interpretation of laws in dispute. Loper will impact tax as well as environmental, health care and other laws subject to any federal regulation. Interestingly, technical professionals outside the government will likely become integral to the judicial process. No longer must courts defer to the technical interpretation of federal agency technicians. Loper reframes an essentially mandatory enforcement of agency interpretation – favoring government agencies – to an open debate of statutory ambiguity.
You can likewise expect a wave of challenges to existing federal regulations.
Moore
In Moore v. United States, the Court upheld a constitutional challenge of IRC §965, the mandatory repatriation tax (MRT). The MRT is a one-time repatriation tax which passes through undistributed accumulated income of U.S.-controlled foreign corporations (CFCs). Part of the 2017 Tax Cuts and Jobs Act (TCJA), Section 965 addresses foreign business earnings, including CFCs, inversions and the Global Intangible Low-Taxed Income tax. TCJA generally taxes U.S shareholders owning 10% or more of a foreign corporation on otherwise tax-deferred foreign earnings.
Charles and Kathleen Moore were minority owners of KisanKraft, a CFC in India. The Moores paid $40,000 for 13% of the CFC in 2005. The CFC reinvested all profits into the business. Under the CFC rules (prior to MRT), tax did not generally accrue to CFC owners until distribution. The MRT eliminated the tax deferral from prior years by imposing income tax on CFC accumulated undistributed earnings. The Moores paid the MRT ($14,729) and sued for a refund in federal district court.
After ratification of the 16th Amendment in 1913, Congress enacted the federal income tax. A later case, Eisner v. Macomber (1920), limited the imposition of income tax on capital assets to only the economic benefit realized through sale or conversion.
The Moores thus contended that the MRT amounts to an unconstitutional taxation of unrealized income, as they could not access or benefit from accumulated CFC earnings. The government countered that the MRT is a tax on indirect income and that realization is not required.
The district court rejected the constitutional challenge to the MRT, and the Ninth Circuit Court of Appeals affirmed, based the government’s premise that income realization is not a determinative factor in assessing Congress’s power to tax. The appellate ruling raised the realization issue, specifically: Does the U.S. Constitution require realization of income before Congress may impose tax?
SCOTUS affirmed the appellate court ruling that U.S. owners of a CFC are subject to the MRT. But, writing for the majority, Justice Brett Kavanaugh restated the issue as “whether Congress may attribute an entity’s realized and undistributed income to the entity’s shareholders or partners, and then tax the shareholders or partners on their portions of that income. This Court’s longstanding precedents, reflected in and reinforced by Congress’s longstanding practice, establish that the answer is yes.”
The opinion clarified that “the MRT does tax realized income, namely income realized by the corporation KisanKraft.” Kavanaugh essentially equated the MRT to the long-accepted taxation of pass-through business income. It further started that the MRT taxed income realized by the Indian CFC. As income was realized at the entity level (in India), the Court found that defining “realized” became unnecessary. By attributing income realized by an entity to its owners, the Court avoided the issues of forced recognition of involuntary “pass-through” income earned in prior years and whether taxing “unrealized” income is constitutionally permissible.
Justice Kavanaugh made clear that the majority ruling only applies to (i) taxation of the shareholders of an entity, (ii) on the undistributed income realized by the entity, (iii) which has been attributed to the shareholders, (iv) when the entity itself has not been taxed on that income. In other words, “our holding applies when Congress treats the entity as a pass-through.” He also disclaimed any opinion on a realization requirement to taxing income. Tax on wealth or unrealized capital gains, he wrote, “are potential issues for another day.”
Connelly
In Connelly, as Executor of the Estate of Connelly v. United States, SCOTUS assessed whether the value for estate tax purposes of corporate-owned life insurance held to fund a mandatory shareholder redemption is included in the value of corporate equity held by a deceased shareholder.
Michael and Thomas Connelly together owned Crowne Supply Inc., a building supply company. Michael held about 77% of the stock outstanding and Thomas 23%. The brothers signed a buy-sell agreement, affording the surviving brother the option to purchase the deceased brother’s shares. Pursuant to the buy-sell arrangement, price per share was governed by an annual Certificate of Agreed Value, to be executed by the brothers or through appraisal. If the surviving brother opted out of purchasing the deceased’s equity (, based on an annual shareholder Certificate of Value), the corporation must redeem any remaining shares of the deceased. The redemption price is the appraised fair-market value of the shares. The corporation purchased life insurance to fund the redemption of a deceased brother. Each policy offered coverage of a $3.5 million, to ensure sufficient cash to cover a death buyout.
Upon Michael’s death in 2013, Thomas did not elect to purchase his shares, triggering the corporation’s obligation to redeem the shares (using $3 million of the $3.5 million life insurance proceeds). Michael’s estate, therefore, valued the company at just under $4 million (and Michael’s shares at $3 million). Michael’s son and Thomas agreed that the value of Michael’s shares was $3 million. Crown paid the agreed redemption price, which was the value reported on Michael’s estate tax return. Michael and Thomas failed to ever obtain a professional appraisal and never executed the annual Certificate of Agreed Value as stipulated in the buy-sell agreement. No post-death appraisal of the corporation was performed.
During the IRS audit, Thomas (the executor of Michael’s estate) hired an accounting firm to value Michael’s shares at death. The accounting firm determined that Crown was worth $3.86 million. That amount excluded the $3 million in insurance proceeds on the theory that insurance value was offset by the redemption obligation. The accounting firm’s exclusion of insurance value was based on Estate of Blount, a 2005 Eleventh Circuit Court of Appeals ruling that the value of life insurance proceeds owned by a corporation may be offset by the corporation’s obligation to redeem the decedent’s shares. For two decades, taxpayers have relied on the Blount ruling to shelter the value of insurance.
During the audit, Thomas submitted the CPA valuation report. The valuation included the $500,000 of the life insurance proceeds not used for the redemption but excluded the $3 million in proceeds used to purchase Michael’s stock.
The IRS took the position that Michael’s equity in Crown, part of his taxable estate, must be determined by valuing Crown to include the corporate life insurance proceeds used for the stock redemption. The IRS argued that the redemption obligation did not offset the value of the insurance proceeds from the value of the company. The IRS adjusted the estate tax return to include the value of the life insurance proceeds in the valuation of the company. The addition of life insurance to company value increased the value of the company to $6.8 million, with an increase in value of Michael’s shares to approximately $5.3 million. Thomas claimed that the corporation’s obligation to redeem Michael’s shares was a liability that offset the value of the life insurance proceeds. Pursuant to the IRS assessment, the estate owed an additional $889,914 in estate taxes. Thomas, on behalf of the estate, paid the estate tax and sued for a refund.
The district court held that the $3 million in life insurance proceeds must be included in valuing Crown and that the buy-sell agreement did not govern corporate valuation. The IRS often ignores valuation language in buy-sell agreements in determining stock value for estate tax purposes. In this case, the circuit court found that the Crown buy-sell agreement was a bona fide business arrangement but did not conclusively establish the value of shares because no professional valuation was performed, and the agreement did not set a fixed and determinable price for the shares. The Court granted summary judgment to the IRS. The Eighth Circuit Court of Appeals affirmed.
SCOTUS ruled that the obligation to redeem a deceased shareholder does not necessarily reduce a corporation’s value for estate tax purposes. Interestingly, the fact that life insurance increases corporate value was not at issue. The sole issue addressed was whether the value may be diminished or eliminated by an offsetting obligation to use the proceeds for a redemption. Justice Thomas authored the opinion.
SCOTUS based its ruling on an assessment of fair market value by an unrelated third-party buyer. A buyer would pay the $5.3 million, including the value of life insurance, because the redemption of shares consolidated share value, leaving the per share value unchanged. An arms-length buyer of the shares subject to redemption would expect to receive the fair market value of those shares, including $3.5 million of life insurance proceeds. SCOTUS dismissed Blount as incorrectly assessing corporate value post redemption. The opinion clarified that shareholders could alternatively use a cross-purchase agreement to avoid the addition of life insurance to company value. A cross-purchase arrangement permits the concentration of share value from redemption, financed by shareholder cash (unrelated to the company).
The Court limited its review to whether the obligation to redeem the decedent’s shares constituted a liability that reduced the value of Crown for estate tax purposes. SCOTUS held that the redemption obligation was not a liability reducing the value of Crown by the amount of the life insurance used to purchase the shares. A corporation’s contractual obligation to redeem at fair-market value does not reduce the value of the shares.
