November 3 Tax Policy Update

• Lapse in government funding continues
• Some Tax Court special trial sessions continue, as general trial sessions halted by shutdown
• Suit to quash IRS summons under U.S.-Italy tax treaty
• Amicus brief supports taxpayer regarding substantial variance doctrine

It appears the government shutdown will this week surpass the 35-day shutdown of 2018-2019 as the longest in American history. Lapses in appropriations have resulted in government shutdowns since then-Attorney General Benjamin Civiletti issued opinions in 1980 and 1981 that the Antideficiency Act requires government shutdowns during funding lapses. The Antideficiency Act generally prohibits government agencies from authorizing expenditures in excess of the amount provided by Congress.

The continuing resolution (CR) passed by the House in September expires in several weeks, on November 21. The House remains out of session. The Senate continued its attempts to take up and pass the House bill but failed for the 13th time last week. There have been signs of some progress among congressional appropriators on some of the 12 separate appropriations bills. Agreement on some of those bills could spur a CR to cover the other areas.

President Trump called for Senate Republicans to change the Senate’s procedural rules so that the Senate can pass the funding bill with a majority vote, and without the need for 60 votes to overcome the filibuster. More than three Republican Senators have said that they will not do so.

Despite the Tax Court’s cancellation of general trial sessions for the week of November 3, special trial sessions will continue on a case-by-case basis. As background, the Tax Court holds two types of trial sessions: general and special. General trial sessions take place in one of multiple cities across the U.S. and can include up to 200 cases. Special trial sessions, by contrast, are extended proceedings devoted to a single (or consolidated) case(s).

In Cottonpatch Timber Co. LLC v. Commissioner, Judge Gustafson confirmed that IRS Counsel assigned to the case was not affected by the ongoing government shutdown. Consequently, he issued an order stating that the trial will proceed as scheduled on December 15. Cottonpatch Timber Co. LLC is a conservation easement case. Judge Gustafson cautioned petitioner’s counsel against advancing any frivolous arguments. The Tax Court has previously criticized certain valuation methodologies used in conservation easement cases, deeming them frivolous under Tax Code section 6673(a)(2).

Judge Gustafson also indicated his intent to deliver an oral “bench opinion” immediately following the trial. The use of bench opinions, while uncommon in complex valuation matters, is growing in the conservation easement context. Judges are now reading 40- to 60-page opinions into the record immediately after week-long or multi-week trial sessions. This trend reflects the Tax Court’s efforts to address the growing backlog of conservation easement cases—and perhaps to encourage other taxpayers in the midst of conservation easement disputes with the IRS to settle.

An heiress to the Publix grocery store chain fortune, Julia Jenkins Fancelli, asked a Florida federal court to quash an IRS summons seeking her bank information on behalf of Italian tax officials. Mrs. Jenkins Fancelli argues that the agency’s request goes beyond what is permitted by the U.S.-Italy tax treaty. Mrs. Jenkins Fancelli is a resident of the U.S. who spends time in Italy. In seeking to determine if she was a resident of Italy for tax purposes, Italian tax officials launched an investigation in 2024 that resulted in the summons at issue in this case.

The IRS generally has the authority to issue summonses to taxpayers, transferees, or third parties to obtain information relevant to determining a tax liability. Summonses are not self-enforcing, and the IRS does not have the power on its own to compel compliance. If a summoned party refuses, in whole or in part, to comply with a summons, and the IRS wishes to obtain full compliance, the IRS (through the main Justice Department or a U.S. Attorney’s office) can file an action to enforce the summons. Before the IRS may compel compliance, a person entitled to notice of summons has the right to begin a proceeding to quash. If a notice party files a petition to quash with their respective federal district court, the IRS may also seek compliance with the summons. In this case, the IRS issued a summons to a bank related to Mrs. Jenkins Fancelli, who was a notice party in the summons. She then filed a petition to quash.

The procedural twist in this case is that the IRS issued a summons on behalf of the Italian taxing authority. Just as the IRS has the authority to issue summonses to assist in the determination, assessment, and collection of U.S. taxes, it also has the authority to obtain information by summons to assist in fulfilling the U.S.’s obligations to other countries under bilateral tax treaties or tax information exchange agreements. When a treaty partner, like Italy, seeks information from the IRS under a treaty, the partner makes a request through the U.S. Competent Authority.

In determining whether to enforce a summons, courts apply the factors set out by the Supreme Court in United States v. Powell, 379 U.S. 48 (1964): (1) the investigation will be conducted for a legitimate purpose; (2) the inquiry will be relevant to the purpose; (3) the information sought is not already in the Service’s possession; and (4) the administrative steps required by the Tax Code have been followed.

In general, the Powell factors also apply when the IRS attempts to enforce a summons on behalf of a foreign jurisdiction. One key difference between summonses issued on behalf of a foreign jurisdiction and one issued by the U.S. is the notice provision, which is relatively relaxed compared with non-treaty requests.

Mrs. Jenkins Fancelli characterizes the summons as a “fishing expedition” the IRS is conducting on behalf of Italy. Further, she argues that U.S. taxing authorities are requesting information that Italian taxing authorities are not seeking and is not covered by the Italy-U.S. tax treaty. Thus, the IRS did not issue the summons in compliance with the Powell factors. “The information the IRS seeks cannot ‘be relevant to [a] legitimate purpose’ given it does not relate back to the specific request made to it from the Italian Revenue Agency,” Mrs. Jenkins Fancelli argues.

The American College of Tax Counsel filed an amicus brief with the Eleventh Circuit, arguing that a Florida federal district court improperly used the substantial variance doctrine to block a fund manager and his wife (Mr. and Mrs. Shleifer) from seeking a $1.9 million tax refund. The doctrine bars taxpayers from making claims in federal court that were not made in previous submissions to the IRS in the case. More specifically, the issue before the Eleventh Circuit is whether the doctrine bars a taxpayer from bringing a refund suit for failure to report a deduction on the correct form.

The substantial variance doctrine applies to taxpayers bringing suit against the United States for a refund of taxes. Under Tax Code section 7422, a taxpayer cannot sue the United States for a refund until they file a refund claim with the IRS. This claim must, among other things, set forth in detail each ground upon which a credit or refund is claimed and provide facts sufficient to apprise the IRS of the basis for the claim. Subsequent litigation of the government’s denial of a refund claim is then limited to the grounds fairly contained within the refund claim filed with the IRS. As a consequence, the Tax Court has held that a court has no jurisdiction to entertain taxpayer allegations that impermissibly vary or augment the grounds originally specified by the taxpayer in the administrative refund claim. In contrast, the Federal Circuit has held this requirement is not jurisdictional. Brown v. United States, 22 F.4th 1008, 1012 (Fed. Cir. 2022).

In an order denying Mr. and Mrs. Shleifer’s motion for summary judgment, Judge Robin Rosenberg of the United States District Court for the Southern District of Florida ruled that the basis of a suit for refund varied from the claim submitted with the IRS. In 2014, Mr. Shleifer was a partner at an investment firm, which required him to travel domestically and abroad. He was also the sole owner of SLS Travel LLC, an entity that holds his business travel assets, and was not operated to generate a profit. SLS purchased a 37.5% undivided interest in a private jet for $20 million.

The Shleifers timely filed a joint income tax return in 2014 and timely paid the attendant tax liability. The original return included a Schedule E “Supplemental Income and Loss” and a corresponding Supplemental Business Expense Worksheet to claim $2.7 million in deductions for travel expenses and unreimbursed partnership expenses.

In 2018, they jointly filed an amended return for 2014, seeking a refund of $1.9 million. The amended return included a Form 4562 reporting a depreciation deduction related to the private jet in the amount of $6 million. The deduction was composed of an ordinary business deduction under sections 167(a)(1) and 168(a), and a bonus depreciation deduction under section 168(k)(1)(A). The bonus depreciation rules provided for a special depreciation allowance equal to 50% of the adjusted basis for qualified property placed in service during the 2014 tax year. The Shleifers’ stated reason for the amended return was that they “inadvertently neglected to claim a depreciation deduction for a business asset purchased and placed in service in 2014.” They included the depreciation deduction in the amended return through Form 1040 Schedule C “Profit or Loss from Business,” which also reported that SLS had no gross profits or income. By claiming a depreciation deduction on Schedule C in connection with the acquisition of a private jet, the Shleifers reduced their tax liability by $1.9 million.

The IRS requested information from the Shleifers’ accountant to substantiate the Shleifers’ entitlement to the deduction as reported on Schedule C in their amended return. The Shleifers’ accountant eventually contacted the IRS agent, stating the depreciation deduction was reported as an unreimbursed partnership expense in 2015 and subsequent years. Further, he explained that such a deduction should have been reported on Form 1040 Schedule E, rather than Schedule C. In his written report, the IRS agent acknowledged that the depreciation deduction might have been valid if it had been claimed on Schedule E. However, the IRS disallowed the deduction because the deduction was not claimed on Schedule E. The Shleifers then sued for a refund, and parties filed cross-motions for summary judgment.

On summary judgment, the court found for the IRS, holding: (1) the Shleifers were not entitled to the depreciation deduction as a Schedule C expense because SLS was not operated for the primary purpose of generating income, and (2) the substantial variance doctrine precludes the court from considering whether the Shleifers could claim the deduction on a Schedule E as an unreimbursed partnership expense. With respect to the second point, the court found that the Shleifers’ original claim for a refund was limited to a depreciation deduction for a business loss sought through Schedule C. Additionally, although the taxpayers included a Schedule E on both their original and amended returns, neither included a claimed deduction for an unreimbursed partnership expense. Thus, given the original claim’s presentation, the examining agent was only apprised of the Shleifers’ desire to claim the depreciation deduction through Schedule C.

The Shleifers made three arguments: (1) the claim does not impermissibly vary from the original claim; (2) the substantial variance doctrine is not intended to preclude consideration of a claim simply due to a taxpayer’s choice of form; and (3) the IRS was sufficiently notified that the taxpayer had intended to include the deduction on Schedule E instead of Schedule C.

To the first argument, the court ruled refund claims must do more than merely notify the IRS of a deduction sought, and, instead, identify the essential requirements of every refund claimed. To the second, it ruled that without claiming the depreciation deduction as an unreimbursed partnership expense, the IRS was not sufficiently apprised of the need to investigate or examine the claim and is not required to do so on its own. Third, the court ruled that the Shleifers’ accountant notifying the IRS agent of their intention to claim the deduction on their Schedule E was insufficient to evade preclusion by the substantial variance doctrine.

The Shleifers appealed the ruling to the Eleventh Circuit.

The American College of Tax Counsel amicus brief supports the taxpayer and urged the Eleventh Circuit to clarify the substantial variance doctrine so that district courts in the circuit “apply it in a manner consistent with its historical origins and practical purpose.” The brief argues the court’s “overly restrictive approach is out of step with the substantial variance doctrine’s purpose and history.” The doctrine operates as a “limited and pragmatic principle that balances the Government’s interest that it should not have to litigate claims it did not have a fair opportunity to address administratively against the taxpayer's right to have those claims heard in court.” In this case, the brief argues, the IRS had adequate opportunity to consider the Shleifers’ claim that the deduction should be allowed under Schedule E because their accountant had made this argument to the IRS, as documented by the IRS agent. “The substantial variance doctrine serves as a procedural shield to protect the integrity of the administrative process. It should not be a weapon for the IRS to wield in cutting down refund claims it prefers not to litigate when it had the grounds and facts of the claim during the course of the administrative process.”