Federal Taxation - Donald R. Bly and Michael H. Plowgian

JurisdictionUnited States,Federal
Publication year2004
CitationVol. 55 No. 4

Federal Taxationby Donald R. Bly* and Michael H. Plowgian**

I. Introduction

In 2003 the United States Court of Appeals for the Eleventh Circuit published few tax decisions of any importance. In the Circuit's highest profile tax case of 2003, the court vacated a lower court decision that had held section 527(j) of the Internal Revenue Code1 unconstitutional.2 In other procedural cases, the court held that Rule 183 of the Tax Court Rules of Practice and Procedure3 did not raise due process concerns,4 and, in a case of first impression, ruled that in determining the total revenue lost in cases concerning fraudulent corporate and personal returns, the losses from unreported corporate income and unreported personal income must be aggregated without reducing the personal income for corporate taxes that should have been paid.5 In the most important substantive tax case of 2003, the court held that bill credits paid by a public utility to refund previously collected amounts were rate reductions and thus did not qualify for special treatment under section 1341.6

II. Constitutionality of Section 527(j)

In Mobile Republican Assembly v. United States,7 the Eleventh Circuit vacated a controversial lower court decision, which held section 527(j) unconstitutional.8 Section 527 provides that political organizations organized primarily to accept contributions and to make campaign expenditures (often referred to as "section 527 organizations") are generally exempt from income tax on their fundraising proceeds.9 In 2000 Congress enacted sections 527(i) and (j), subjecting would-be section 527 organizations to certain disclosure requirements.10 Section 527(i) requires a section 527 organization to provide the Secretary of Treasury with notice of its section 527 status before taking advantage of the tax exemption.11 Section 527(j) requires section 527 organizations to file periodic reports detailing the identity of contributors making donations of more than $200 and the purpose and recipient of expenditures greater than $500.12 Failure to file these reports subjects a section 527 organization to a tax (calculated at the highest corporate rate under section 11) on the amounts to which the failure relates.13

Plaintiffs in Mobile Republican, six section 527 organizations and one contributor,14 alleged that sections 527(i) and (j) were unconstitutional as violations of the First, Fifth, and Tenth Amendments to the United States Constitution.15 After finding that the section 527 organizations had standing, the district court addressed the substantive constitutional issues. As to the First and Fifth Amendment claims, the district court concluded that although the requirement to disclose contributors did not violate the Constitution, the section 527(j) requirement to disclose the recipients of the organization's expenditures violated both Amendments. In drawing this line between the penalties for failure to disclose contributors and for failure to disclose expenditures, the district court highlighted the "double trouble" feature of section 527(j).16

As an illustration of this point, assume that a political organization collected a single $1000 contribution during 2003. In the absence of section 527, the organization would owe a thirty-five percent corporate tax on this amount, or $350. Under this scenario section 527 can be said to confer a $350 subsidy on the organization. Under section 527(j), however, if the organization fails to disclose the contributor, it will incur a tax on that $1000 at the same thirty-five percent corporate rate. Thus, as the district court stated, the penalty imposed for failure to disclose the contributor could be said to represent "the permissible withdrawal of a tax subsidy through a corresponding, offsetting penalty, so that no First Amendment issue is implicated."17 Assume that the same organization spent the $1000 to influence an election and similarly failed to disclose the recipient and purpose of its expenditure. Section 527(j) would impose an additional $350 penalty for such failure. Thus, in the eyes of the district court, the penalty for failure to disclose expenditures is an exaction that goes beyond a withdrawal of the subsidy provided by section 527, and, as such, is subject to much stricter scrutiny under the First and Fifth Amendments.18 The district court found the provision did not meet the higher threshold under either Amendment.19

In concluding its opinion, the district court found that section 527(j) violated the Tenth Amendment to the extent it required disclosure by organizations operating at the state and local level.20 The district court reiterated its view of section 527(j) as a penalty in excess of any potential subsidy, one designed primarily to coerce, not to raise revenue.21 It concluded that section 527(j) unconstitutionally regulates the state and local electoral process.22 on appeal the Eleventh Circuit vacated the district court's decision, but not because of its disagreement with the district court's handling of the substantive issues in the case.23 Rather, the Eleventh Circuit disagreed with the district court's denial of the Government's motion to dismiss for lack of jurisdiction a year earlier.24 In 2001 the Government argued that plaintiffs' claims were barred by the "Anti-Injunction Act," better known as section 7421(a).25 Section 7421(a) provides that, with few and rarely relevant exceptions, "no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person, whether or not such person is the person against whom such tax was assessed."26 In enacting section 7421(a), Congress established a rule of "pay now, sue later," preventing the Internal Revenue Service and courts from dealing with problems inherent in simultaneous jurisdiction.27 Section 7421(a) is not without its limitations, however.28 Courts have created a number of exceptions; one of the most notable for these purposes is a requirement that the assessment relate to a "tax" instead of a "penalty."29 on the Government's motion to dismiss, plaintiffs argued that section 527(j) constituted a penalty excepted from the application of section 7421(a).30

Not surprisingly, the district court held that amounts due under section 527(j) constituted a "penalty" for these purposes.31 Among the significant factors in the district court's analysis were the heading to section 527(j)(1) ("Penalty for failure [to disclose expenditures and contributions]") and the Internal Revenue Service's description of the amount as a "penalty" on Form 8872 (the relevant form for section 527(j) payments).32 The district court also compared this provision to the Code's most explicit penalty provisions, such as sections 6672, 6675, 6677, 6683, and found the terminology among the provisions nearly identical.33 Thus, the district court refused to deny itself jurisdiction to hear plaintiffs' claim by reason of the Anti-Injunction Act.34

The Eleventh Circuit, though agreeing with the district court's analysis of the statutory framework governing the motion, disagreed completely with its characterization of section 527(j) as a penalty.35 In the eyes of the Eleventh Circuit, section 527(j) is "part of the overall tax scheme" and thus governed by section 7421(a).36 The court cited a United States Supreme Court case, Regan v. Taxation with Representa-tion,37 that was squarely on point.38 The taxpayer in that case was a tax "think-tank" who challenged the Internal Revenue Service's denial of tax-exempt status. The denial followed from the language of the Code, which denies tax-exempt status under section 501(c)(3) to organizations that dedicate a substantial portion of their activities to influencing legislation.39 The taxpayer argued that this prohibition unconstitutionally limited its free speech rights under the First Amendment and disadvantaged it, as compared to other similar organizations, in violation of the Fifth Amendment.40 The Supreme Court rejected the organization's claims, finding that section 501(c)(3) was a tax subsidy provided to organizations that were willing to refrain from lobbying, a form of speech that Congress was free not to subsidize.41

The Eleventh Circuit noted that the Supreme Court "analyzed the condition within the context of the overall tax scheme, rather than as a separate provision or penalty."42 Stated differently, the Supreme Court viewed taxable status as the universal baseline.43 Just as Congress is permitted to provide exceptions from this baseline for certain activities it wants to subsidize, it is also permitted to define the contours and conditions applicable to organizations who volunteer for such excep-tions.44 Viewed in this light, the Eleventh Circuit found it irrelevant that the penalty for failure to disclose expenditures under section 527(j) may result in a higher tax bill for noncomplicit political organizations:

[T]he fact that some self-declared section 527 organizations may later choose to withhold disclosure and, as a result, may pay more in taxes than they would have paid without tax-exempt status does not make the initial decision to register under section 527 any less voluntary. Rather, we consider the statutory scheme as a whole and treat the consequences of violating the conditions of the subsidy as part of the tax framework.45 @@@

Because the Eleventh Circuit found that penalties imposed by section 527(j) for violations under section 527 were a tax for purposes of section 7421(a), plaintiffs could not seek injunctive relief, and the case was remanded to the district court with instructions to dismiss for lack of jurisdiction.46 of course, as the Eleventh Circuit acknowledged, any plaintiff will be able to bring essentially the same suit once it has paid the penalty.47 However, given the Eleventh Circuit's complete disagreement with the district court's analysis48 and its reliance on Regan,49 plaintiffs are unlikely to...

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