Tales from the Tax Court, Part 1: Tax Court opinions and how to make sense of them
Tax Court decisions help taxpayers and tax professionals shed light on complicated issues
Editor’s note: This article has been reviewed for changes following the passage of the 2017 Tax Cuts and Jobs Act. The information provided in this article was not affected by the 2017 TCJA.
The Tax Institute’s experts analyze many Tax Court decisions to help provide the most comprehensive tax law analysis. This series will explore the Tax Court and how taxpayers and tax professionals use its decisions. In Part 1, we’ll start by explaining what the Tax Court is and how it works.
How the Tax Court works
Congress established the U.S. Tax Court to provide an opportunity for taxpayers to dispute a federal tax liability before paying the tax. The Tax Court remains separate from the IRS to ensure an unbiased interpretation of the Code.
Taxpayers who receive an IRS Notice of Deficiency (otherwise known as a 90-day letter) may be able to resolve the issue through the IRS Office of Appeals (also an independent entity). Otherwise, they have 90 days from the date of the notice to file a petition with the Tax Court. Taxpayers outside the U.S. have 150 days to file a petition.
Once the case goes to Tax Court, the court will analyze the taxpayer’s facts, and the opposing positions of the taxpayer and the IRS, in light of the Code, regulations, and possibly earlier court decisions. The court will then render an opinion.
Depending on the type of case, an opinion may set precedent. A Tax Court precedent doesn’t necessarily change the law of the land (as a Supreme Court decision would), but it does provide authoritative and clear resolution of an issue. Some types of cases don’t set precedent, but may still be cited in other courts of law and appealed by taxpayers or the IRS. And some types of cases simply provide scholarly and useful interpretations of tax law in real-world situations.
The Tax Court hears two types of cases: regular and small cases. Here’s more about each of them, and the kinds of opinions that may result.
Regular cases involve amounts of more than $50,000
In regular Tax Court cases, the chief judge will issue the opinion as a Tax Court opinion, a memorandum opinion, or a bench opinion.
Tax Court opinions interpret the Code, set precedent, and can be cited and appealed
Judges issue Tax Court opinions in regular cases when a particular aspect of the tax law may have more than one interpretation. In these cases, the court must analyze the law, decide what it means, and apply it to the taxpayer’s circumstances.
One example is Voss v. Commissioner. Unrelated owners of a residence together owed several millions of dollars in mortgage debt. The court had to decide whether the debt limitation for deducting mortgage interest applied to all owners of a residence in total (the IRS’ position), or to each owner separately (the taxpayer’s position). The court decided in favor of the IRS. A Tax Court opinion like the one in Voss sets precedent and may be cited in a court of law and appealed.
If Voss had stopped in Tax Court, multiple owners of a residence would have been limited to deducting mortgage interest based on their respective shares of the total debt. But the taxpayers appealed the case to the Court of Appeals for the Ninth Circuit, which reversed the lower court’s opinion and found in favor of the taxpayers.
Memorandum opinions don’t set precedent but show how the law is applied to specific facts
When a case is based on applying relatively straightforward tax law to the facts of a taxpayer’s situation, the court will issue a memorandum opinion. For example, in Riley v. Commissioner, the court had to determine whether the loss resulting from a taxpayer’s rather unfortunate investment choices met the definition of a theft loss.
The taxpayer in this case had given large sums of money to a coworker to “invest” in a start-up company. She eventually realized that she wasn’t likely to see a return on her investment, and tried to deduct a theft loss on her tax return. The definition of a theft loss and the criteria for claiming a deduction for one weren’t open to interpretation. Rather, the court decided that the taxpayer’s circumstances didn’t meet all of the criteria. A memorandum opinion like the one in Riley does not set a precedent, but may be cited in court and appealed.
Small cases involve amounts of less than $50,000
Generally, when a tax dispute is less than $50,000, taxpayers can use the small tax case procedures, which minimize the formality, expenses, and delay of traditional cases. Only certain cases qualify.
Small tax cases go before a division of the Tax Court known as the S Court. S court decisions are final; no other court can review them. See the Tax Court website for more information on the kinds of cases heard by the S Court and a petition packet.
Small tax cases produce either a summary opinion or a bench opinion to resolve factual issues.
Summary opinions resolve factual issues, don’t set precedent, and can’t be cited or appealed
Small case Tax Court decisions usually result in a summary opinion. A summary opinion is similar to a memorandum opinion in that it involves relatively straightforward matters of law. The question in these cases is not how to interpret the law, but how the taxpayer’s facts apply to straightforward tax law concepts. Summary opinions don’t set precedent and can’t be cited in court or appealed.
For example, in Hess v. Commissioner, the court issued a summary opinion determining that the taxpayer’s Amway activity was a hobby rather than a business. The law and regulations provide well-established factors that are used to classify a particular activity, and this taxpayer’s activity did not meet most of them. Because this is a summary opinion, the taxpayer has no right of appeal. Although the court ruled in favor of the IRS in this case, the government can’t use this case as a precedent or cite it as an example in other “business vs. hobby” situations. Tax professionals, however, can find this discussion useful, as many clients might assume that any direct marketing activity such as this would automatically be a business.
Judges issue bench opinions in regular or small cases
Sometimes, judges may decide to issue a bench opinion in a regular or small case. The judge delivers the opinion orally in court during trial. Then, the court prepares a transcript of the opinion, provides it to the taxpayer, and posts it online. A bench opinion in a small case can’t be relied on as precedent, cited in court, or appealed.
If memorandum and summary opinions don’t set precedent and involve mostly settled matters of law, why discuss them?
Even though memorandum and summary opinions don’t set precedent, they do provide examples of how to apply the law, regulations, and other guidance to real-world situations.
For example, in Jackson v. Commissioner, a summary opinion, the court carefully explained when an individual can have equitable ownership of a home and deduct mortgage interest. The taxpayer in Jackson didn’t meet any of the criteria, so he wasn’t allowed to take the deduction. While this opinion can’t be cited and doesn’t set precedent, it is helpful because the court clarified how these facts apply to the rules for equitable ownership. Based on Jackson, taxpayers may determine that if they don’t meet any of the criteria, then they likely do not have an equitable ownership that qualifies for the mortgage interest deduction.
The following chart summarizes the aspects of each type of Tax Court opinion. Decisions are available on the Tax Court’s opinion search page.
|Tax Court opinion||Memo opinion||Summary opinion|
|May be cited in court||Yes||Yes||No|
The second part of this series will delve more deeply into actual cases that taxpayers brought before the court, and how they turned out.