Jeremiah Coder (Contributing Editor, Tax Analysts), Did the Federal Circuit Just Issue Another Murphy?, 127 Tax Notes 143 (Apr. 12, 2010):
When an appellate court is universally denounced for its legal reasoning, a hasty retreat and a withdrawn opinion usually follow. Everyone remembers the D.C. Circuit’s original opinion in Marrita Murphy v. IRS, holding that it was unconstitutional for the IRS to tax nonphysical compensatory damages. After that decision received extensive criticism, the court eventually reversed itself and found that the damage award was not excludable from income. Xilinx Inc. v. Commissioner is another example of a court reversing after facing strong criticism.
The Federal Circuit may have added to the pantheon of tax decisions with a limited shelf life [in Bush v. United States, No. 2009-5008 (Fed. Cir. Mar. 31, 2010)]. Admittedly, the 1982 Tax Equity and Fiscal Responsibility Act is an area few have mastered because of the complexity involved, so judges with no special tax expertise might be expected to get details of the regime wrong now and then. But the problem explored here has less to do with the court’s analysis of TEFRA than it does with the creation of a “harmless error” rule that has no apparent place in the statutory construction of the tax code. …
Central to the case was whether the IRS was required to give the Bushes a notice of deficiency. Although the general rule is that it would be, § 6230(a)(1) exempts computational adjustments from the notification requirement unless the adjustment relates to affected items. In deciding the parties’ cross-motions for partial summary judgment, the Court of Federal Claims held that the IRS’s adjustments were computational because the assessed liabilities were determined based on the closing agreement and taxpayers’ individual returns, and thus no deficiency notice was required.
On appeal, a majority of the Federal Circuit panel concluded that notice was required “because the assessments did not meet the definition of ‘computational adjustment[s]’ under § 6231(a)(6).” The closing agreement made no changes to any partnership items, so there was no change in treatment that would trigger the computational adjustment exclusion to notice, according to the Court. … But the court then took a strange turn by holding that even if notice was required, “the IRS’s failure to issue a notice of deficiency constituted harmless error under the circumstances of this case.” …
In a concurring opinion, Judge Sharon Prost … [criticized] the majority’s “legally unsound and practically harmful” rule. Nullifying taxpayers’ right to notice — which she described as a “categorical, nonnegotiable notice requirement, denial of which can never be harmless” — would lead to depriving them of a forum to contest IRS action because notice is a prerequisite to filing in Tax Court, she said. …
Stuart J. Bassin of Baker and Hostetler LLP said that Judge Prost’s concurring opinion was right to strongly object to the new, sweeping harmless error rule. “Most tax practitioners always thought that issuing notices and [final partnership administrative adjustments], and the effect it had on a court’s jurisdiction, were black letter rules. If you failed to satisfy the rules, the result was a jurisdictional flaw that could not be fixed,” he said. …
Bryan Camp, the George H. Mahon Professor of Law at Texas Tech University School of Law, said the right statutory interpretation wasn’t necessarily that clear. However, even if the majority was right as to whether a deficiency notice was required, it went too far on the second question of prejudicial effect, he said. “There is no harmless error exception for an invalid assessment,” he said. “I agree with all Judge Prost says in her concurrence on that subject.” …
As in Murphy, the court designed a remedy inconsistent with established precedent. If history is any guide, the ruling may not survive for long.
All Tax Analysts content is available through the LexisNexis® services.
