The Supreme Court Bids Bob Richards Adieu, Limiting the Role of Federal Common Law by ROBERT S. HORWITZ
Section 1501 of the Internal Revenue Code allows a parent corporation and its subsidiaries to file a consolidated return that effectively treats the consolidated group as one entity for tax purposes. The IRS has issued detailed regulations concerning consolidated groups. It has not issued any regulations on how refunds to a consolidated group are to be distributed among members of the group. In 1973 the Ninth Circuit decided In re Bob Richards Chrysler-Plymouth, Inc., 473 F.2d 262, holding that absent a tax allocation agreement under federal common law the tax refund belongs to the group member responsible for generating the loss that resulted in the refund.
Western Bancorp, Inc., was the parent corporation of Western Bank Corporation. When the bank faced financial difficulties, it was placed in receivership and the FDIC was appointed receiver. Western Bancorp. filed a chapter 7 bankruptcy petition and Mr. Rodriquez was appointed chapter 7 trustee. As a result of net operating losses generated by the bank, the IRS issued a $4 million refund. This initiated a fight between the chapter 7 receiver and the FDIC over who was entitled to the refund. The Tenth Circuit in In re United Western Bancorp, Inc., 914 F. 3d 1262, 1269–1270 (2019), adopted the Ninth Circuit’s rule and held that the FDIC, as receiver for the bank, was entitled to a refund.
Because the Sixth Circuit had rejected the Bob Richards rule, the U.S. Supreme Court decided to hear the case in order “to decide Bob Richards fate.” In Rodriquez v FDIC, ___ U.S. ____ (Feb. 25, 2020), Justice Gorsuch, writing for a unanimous court, buried Bob Richards, holding that in the absence of a tax allocation agreement you look to state law, not federal common law.
According to the Court, “judicial lawmaking in the form of federal common law plays a necessarily modest role under a Constitution that rests the federal government’s ‘Legislative Powers’ in Congress and reserves most other regulatory authority to the States.” Citing Erie R. Co. v. Tompkins, 304 US 692 (a938) for the proposition that there is “no federal general common law,” the Court stated that absent express Congressional authorization, federal common lawmaking must be used only when “necessary to protect uniquely federal interests.” Since there was no unique federal interest in how a refund is allocated among members of a consolidated group once it is issued, the Court held that the issue must be decided under state law.
So who got the refund? The Supreme Court didn’t make that decision. Instead it remanded the case to the courts below “for further proceedings consistent with this opinion.”
There are a couple of points of interest. First, the Solicitor General, arguing on behalf of the FDIC, conceded that federal common law should not have been applied but that under state law the FDIC should get the refund.
Second, in tax cases federal courts normally look to state law to determine property rights, so in that sense the decision was not a major departure. The case itself may however be a preview of the Court’s retreat from expansive reading of the powers of the federal courts and, potentially, federal agencies.
Third: The federal courts have developed a body of rules concerning tax cases, including the sham transaction doctrine, the economic substance doctrine, the substance-over-form doctrine, and the tax benefit rule. The application of these rules may sometimes reach results different than those that would be reached if state law was applied, such as disregarding a transaction as a sham that a state court would respect. It is doubtful that the federal courts will revisit these rules in light of the Rodriquez case, but you may find taxpayers trying to argue that state law, and not “federal common law” should apply if it would result in more favorable treatment.
Query: Would the Court have reached a different decision if the IRS had issued a regulation on how a refund is allocated among members of a consolidated group, absent express authorization from Congress to make that determination?
Robert S. Horwitz at firstname.lastname@example.org or 310.281.3200 Mr. Horwitz is a principal at Hochman Salkin Toscher Perez P.C., former Chair of the Taxation Section, California Lawyers’ Association, a Fellow of the American College of Tax Counsel, a former Assistant United States Attorney and a former Trial Attorney, United States Department of Justice Tax Division. He represents clients throughout the United States and elsewhere involving federal and state administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at http://www.taxlitigator.com.