8th Circuit Holds Reasonable Basis Defense to Negligence Penalty Requires Taxpayers to Prove Actual Reliance on Authorities

On April 24, 2020 the Eighth Circuit Court of Appeals upheld the district court’s determination that Wells Fargo was not entitled to a tax credit on its 2003 tax return arising from a transaction the company entered into with a British bank. In Wells Fargo v. United States, No. 17-3578, the court determined that Wells Fargo was liable for a negligence penalty after claiming that credit. And, perhaps the most important takeaway from this holding was the Eighth Circuit’s conclusion that the reasonable basis defense to the negligence penalty, which Wells Fargo raised, requires a taxpayer to prove that they actually relied on relevant legal authority rather than prove objectively the authority supported the taxpayer’s position.

In 2002, Wells Fargo entered into a structured trust advantaged repackaged securities transaction (STARS) with Barclays Bank, a corporate citizen of the United Kingdom. The government argued that STARS was an unlawful tax avoidance scheme in which Wells Fargo exploited the differences between the tax laws of the U.S. and the U.K.. In 2003, Wells Fargo claimed foreign-tax credits on its federal tax return arising from STARS, but the Internal Revenue Service (IRS) disallowed those credits and found that Wells Fargo owed additional taxes. After paying the resulting tax deficiency, Wells Fargo filed a lawsuit to challenge the IRS’s decision and to obtain a refund. The government responded by imposing a “negligence penalty” on Wells Fargo as an offset defense because Wells Fargo underpaid its 2003 taxes after claiming this credit.

Under 26 U.S.C. § 61(a), the U.S. government taxes the income of its citizens, which includes corporations, “from whatever source derived.” To offset the problem of double taxation on income that is also taxed by a foreign jurisdiction, the Internal Revenue Code created the foreign-tax credit, in which the taxpayer can claim a dollar-for-dollar tax credit against its federal tax liability for taxes it paid to another country. However, this tax credit is granted only if there is a valid transaction. This article will not discuss the granular aspects of the complicated structure of the STARS transaction between Wells Fargo and Barclays besides the fact that the STARS comprised both a loan component and a trust component. The trust structure produced disputed foreign tax credits and the loan structure generated disputed interest deductions. The Eight Circuit found that the STARS’s trust component was a sham transaction, but not the loan component. A transaction is illegitimate if it is structured solely to obtain a tax benefit- meaning that it lacked economic substance outside of its tax considerations. Because the court found that the trust component of the transaction was a sham, Wells Fargo was not entitled to claim credits for any foreign taxes that it paid which arose from that transaction.

The Eighth Circuit also rejected Wells Fargo’s appeal that the district court erred in applying a negligence penalty. The district court imposed the negligence penalty on Wells Fargo because it found that the entity did not display prudence when preparing its tax return, warranting an $11.8 million penalty. Note, the Eighth Circuit upheld the district court’s determination requiring the government to refund to Wells Fargo a net amount of $13.65 million. Under 26 U.S.C. § 6662(b)(1) of the Internal Revenue Code, a taxpayer is liable for a “negligence penalty” of twenty percent of an underpayment of its taxes attributable to its “negligence.” The Code of Federal Regulations, the applicable regulation 26 C.F.R. § 1.6662-4(d)(3)(iii) creates a defense to the negligence penalty if the taxpayer’s “return position” was reasonably based on one or more of the authorities set forth in the regulation. The regulation defines a “return position” as the particular position a taxpayer adopts when the taxpayer determines its tax liability with respect to a particular item of income, deduction, or credit. The dispute between Wells Fargo and the government was whether a reasonable-basis defense requires evidence that the taxpayer actually relied on relevant legal authority to support its return position. Wells Fargo argued the standard need only be objectively reasonable. The government, on the other hand, argued the reasonable-basis defense required Wells Fargo to prove, through evidence, that they subjectively relied on the relevant authority.

The Eighth Circuit agreed with the government’s argument. The court looked to the plain meaning of the phrase “reasonably based” and found that in order to ‘base’ a return position on particular legal authority, a taxpayer may show that it actually relied upon those authorities in forming its position. And, citing previous cases, the court highlighted that in determining whether the negligence penalty applies, the focus is on the taxpayer’s conduct. Thus, the Eighth Circuit interpreted 26 C.F.R. § 1.662-3(b)(1) and (b)(3) to include a reliance requirement, even though the word “reliance” or similar language does not appear in the regulation.

Wells Fargo also argued that a subjective standard would result in the taxpayer waiving attorney-client privilege in order to prove that it actually relied on the relevant legal authority. The court noted this argument had “some appeal” but gave it short shrift. As a policy matter, the court noted that the actual reliance requirement “incentives taxpayers to actually conform to the requisite standard of care rather than simply taking the chance that there may be a reasonable basis for their underpayment of tax.”

While Judge Grasz did join the majority opinion in finding the transaction to be a sham, he provided a fiery dissent on the imposition of the negligence penalty. Judge Grasz argued the 26 C.F.R. § 1.6662-3(b)(3) does not necessitate a taxpayer show actual reliance on certain authorities to qualify for the reasonable-basis defense because such language is absent in the regulation. On the other hand, he points to a different regulation, 26 C.F.R. § 1.662-4, which is cross-referenced with the  § 1.6662-3(b)(3) which explicitly includes the language that the taxpayer “analyzes the pertinent authorities in the manner described in this section and in reliance upon that analysis.” Citing to the Supreme Court’s reasoning regarding the canon of statutory construction, when Congress includes specific language in one section of a statute but omits it from another section of that same statute, it is presumed that Congress intended to omit such language. Thus, he concluded the fact that the regulation at issue does not specify actual reliance reveals there is no such requirement and an objective standard should govern.

Normally under a negligence standard, the conduct at issue is analyzed by asking what a reasonably prudent person would do under the same circumstances. That is to say, an objective test is applied. After this decision, a taxpayer could face penalties for adopting a return position even if it has plausible legal support. Wells Fargo is the first appellate opinion to hold that the reasonable basis for penalty defense purposes is based on a subjective rather than objective standard.

VW Contributor: Skylar Young
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Federal Trade Commission To Evaluate Endorsements and Testimonials in Advertising

On February 12, 2020, the Federal Trade Commission (“FTC”) announced that it is seeking public comment regarding endorsements and testimonials in advertising, including those on consumer review websites. The FTC is interested in learning about the connections between the endorser, reviewer, the underlying business, and the medium in which the endorsement is posted.

The FTC is charged with enforcing the Endorsement Guides, as enacted in 1980 and amended in 2009. The Guides provide rules for businesses and other organizations to follow when using endorsement and testimonial advertising, including a requirement to disclose material connections of the endorser. The intent is to ensure that the consumer understands the connections in order to properly evaluate the credibility of the endorsement and testimonial. Based on the evolution of technology, the FTC is particularly concerned with the use of consumer review websites and whether they properly disclose the various connections and incentives.

The FTC is accepting comment from the public regarding these rules and, based on statements from commissioners on the rise of influencers and fake reviews, this could be an area that the FTC decides to revise rules and have stricter enforcement. For businesses and organizations that use consumer reviews and endorsements as a form of advertising, this is the time to ensure that the advertising and marketing efforts comply with the Guides.

VW Contributor: Alex Rainville
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Separating Claim Recovery and Lawsuit Fees: 2nd Circuit Paves Way for Better Negotiations in FLSA Claims

In Fair Labor and Standards Act (FLSA) lawsuits, recovering damages for claims is typically only one part of the discussion when negotiating settlements. Employers engaged in FLSA lawsuits and settlement negotiations with employees and their representative counsel, can quickly become aware that lawsuit costs and plaintiff’s attorney fees are a factor in the overall bargaining process. On February 4, 2020, the Second Circuit, in Fisher v. SD Protection Inc., 2020 WL 550470 (2d Cir. 2020) held that attorneys’ fee awards in FLSA claim settlements are not limited by the principle of “proportionality” in that such fees are not limited or subject to a 1/3 cap based on the amount of the overall settlement.

In the Second Circuit, settlements in FLSA lawsuits were typically subject to strict court scrutiny court review to ensure that the agreed upon terms, including the amount of attorneys’ fees, were fair and reasonable. Thus, many of the district courts within the Second Circuit applied the rule of “proportionality” and refused to approve fee amounts greater than an amount 1/3 of the total settlement.

In Fisher, however, the Second Circuit held that such a rule is at odds with the purpose of the FLSA and has the potential to discourage competent lawyers from taking on cases for low-wage workers due to such limitations on collecting attorneys’ fees. The issue in Fisher arose from a wage dispute brought by an hourly employee, which is a normal cause of action under FLSA lawsuits. The employee sued under the FLSA based on the employer’s alleged failure to pay overtime and provide mandatory accurate wage statements.

The parties reached a settlement before a class was certified, with the total settlement amount at $25,000, including fees and costs. In submitting approval for the settlement from the district court, the parties disclosed that the plaintiff would be paid only $2,000 of that amount, with the remaining $23,000 going to the employee’s attorney. The district court judge disagreed with the terms and reduced the attorneys’ fee to only $8,250, or 1/3 of the total settlement amount as a matter of general policy.

The plaintiff appealed the district judge’s actions to the Second Circuit, and in a detailed decision, the Court reversed and remanded, disapproving of the district court’s requirement of “proportionality” between the amount of the settlement and the size of the fee award. The Second Circuit held that such a rule is not mandated by either the text or the purpose of the FLSA statute. While acknowledging that the proposed split of $23,000 to the plaintiff’s attorney and $2,000 to the plaintiff “understandably gave the district court pause,” the Court rejected an “explicit percentage cap” on fee awards. The Second Circuit justified this decision as in most FLSA wage dispute cases, the plaintiffs are generally hourly workers, and favorable settlement outcomes result in limited recovery. Limiting attorney fees can dissuade competent attorneys from taking on FLSA cases when fee recovery would be proportional to only 1/3 of total recovery. The Second Circuit also criticized the district court judge for rewriting the settlement agreement instead of just simply rejecting the agreement and having the parties revise it. The Second Circuit concluded that in rewriting the agreement, the district court judge exceeded his authority.

The ruling in Fisher is good news for employers in the negotiation process of FLSA lawsuits. In practice it should allow for more free negotiating of settlements, without limitations imposed on fee awards. This ruling will hopefully foster settlements and drive down costs for all parties involved.

VW Contributor: Ryan J. Coufal
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Will New York be Next to Enact a Robust Privacy Law?

Technology has driven disruption in virtually every industry and created an opportunity for businesses to compete in manners previously thought impossible but, with such opportunities, new regulations have emerged at both the state and federal level. Specifically, most businesses have elected to implement new policies, procedures, and safeguards to ensure compliance with the California Consumer Privacy Act (“CCPA”) and the European Union General Data Protection Regulation (“GDPR”). However, one more law that might be added to the list is the New York Privacy Act, currently under consideration by the New York State Legislature.

 

The New York State Senate, not to be left behind California and the EU, has been actively discussing the New York Privacy Act, which proposes to be the most robust consumer privacy and data protection regulation passed in the United States. The proposed law will regulate any use, storage, or disclosure of personal data of a consumer, and will apply to anyone that does business in New York. These principals are similar to those included in the GDPR and CCPA, however, New York intends to bolster these rules by adding a fiduciary duty, further transparency, and additional notice obligations.

 

The latest hearing by the New York State Senate in November of 2019 suggested the legislature would be reluctant to pass the legislation if the United States Congress ultimately passes federal legislation, but noted that failure to move at a federal level will result in state legislation. For businesses, this would mean further adjustments to privacy, data security, and technology policies and procedures. Given the myriad of regulations and their evolving nature, each business will need to evaluate how they intend to comply with the regulations and monitor new obligations. As always, the attorneys at Vandenack Weaver are available to provide assistance with these matters.

VW Contributor: Alex B. Rainville
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Protesting Property Tax Valuations: Reasons to Protest

Previously this Blog has discussed the Key Dates and Deadlines to remember for 2020 when protesting property valuations, and the process of protesting property valuations. This post will explore the reasons to protest the county’s assessed valuation of your property and considerations to make when deciding whether your property has been overvalued.

Property valuations are a local government’s way of determining the amount of the following year’s property taxes on an individual’s real property. A lower valuation generally means lower property taxes, while the opposite is true for higher valuations and taxes. A valuation should accurately reflect current market value and should be comparable with other similarly situated properties in the area.

There are several ways a property owner can prove or find evidence and support of the current property value of their real property. A recent sale can help prove current value, or alternatively a property owner can research sales for comparable properties. Property owners can check their county of residence’s property records, and also research assessed valuations for similar properties.

Once you have proven a valuation of your property, there may be numerous reasons why the county’s assessed valuations on your property are wrong. Below are just a few examples of scenarios in which a property valuation may be overvalued by the county and need to be protested:

• Real property may be overvalued when it is damaged, such as a cracked foundation or a damaged roof, and not be included in county’s valuation.
• Real property may be overvalued if the county makes a mistake and miscalculates the square footage of a building.
• Real property may be overvalued if it sits on the market too long and is at a price different than the county’s previous valuation.
• Office buildings may be overvalued if there is less leasable space than the county’s records show.
• Office Buildings or Multi-Family Properties may be overvalued because the county compares them other similar buildings, but does not take into consideration that the overvalued building may be equipped for less tenants than the buildings compared against.
• Multi-Family or Commercial Hospitality Properties may be overvalued because the county miscalculated the valuations when considering income, expenses, and vacancy rates of the buildings.

If you have property that you believe has been overvalued, you should take a few steps before filing a protest with the county during the protest time period each year. First, as mentioned above, gather information about your real property, to see if a protest of the assessed value is warranted.

• Verify information such as the dimensions, square footage, age, and condition of structures on your property.
• Research the assessed valuations of properties in the area around your own property.
• Monitor the real estate market to see what houses in your area are selling for.

If, after doing your research you conclude the assessed valuation is overvalued, set up an informal discussion with the county assessor to attempt to resolve the issue with your property. The county assessor should be able to explain to you the assessed value of your property, answer questions you have, and review additional information you can provide. If the issue is not resolved after discussions with the county assessor, then consider the formal protest process with your respective county’s Board of Equalization.

The property tax valuation protest process at times can be complex and daunting. Attorneys at Vandenack Weaver can assist you at any step of the protest process and help identify why the county’s valuation is wrong and help you, the property owner, save money on property taxes for the upcoming tax year.

VW Contributor: Ryan Coufal
© 2019 Vandenack Weaver LLC
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Property Tax Valuation Protest Process

Previously this Blog discussed the Key Dates and Deadlines to remember for 2020 when protesting property tax valuations. To build upon that, this Blog Post Entry will discuss the actual Property Tax Valuation Protest Process itself. Just as it is important to remember the deadlines for protesting property tax valuations, it is important to understand the process in how to protest the valuations.

Under Nebraska Statute, all real property subject to taxation shall be assessed by the County Assessor as of January 1st at 12:01 a.m. and be used as a basis of taxation until the next assessment unless the property is destroyed, and the County Assessor is required to complete this assessment by either March 19th or 25th depending on whether the county in which you reside has under or over one hundred and fifty thousand residents (150,000), respectively. Then, on or before June 1st the County Assessor is required to notify the owner of record of the property as of May 20, of every item of real property that is assessed at a value different than the previous year. That notice shall be given by first-class mail addressed to the owner’s last known address, and must identify the item of real property, state the old and new valuation, the date of convening of the county board of equalization, and the dates for filing a protest.

When you, as a property owner, receive notice of a change in your property tax valuation and you disagree with that valuation, or you disagree with a previous year’s valuation, you may file a written protest with your County Board of Equalization. The deadline to do so is June 30th. Each protest must be filed with the county clerk of the county in which the property is assessed. The protest must also:

• Be signed by the property owner, or a person authorized to protest on behalf of the owner, and indicate such
• Contain, or have attached, a statement the reasons why a change to the county’s valuation should be made
• Contain a description of the protested property.
o If real property, a description of each parcel protested shall be included.
o If tangible personal property, a physical description of the property shall be included

It is vitally important that these requirements be met when submitting a written protest, or the County Board of Equalization will dismiss the protest. Only in the event of the person signing the protest not being the property owner or an authorized person, will the county clerk mail a copy of the owner of the property and notify them.

The County Board of Equalization will meet for the purpose of reviewing, conducting hearings, and deciding upon written protests from June 1st through July 25th of each year. If the county has a population greater than one hundred and fifty thousand (>150,000), they may extend the deadline of hearings through August 10th. The County Board of Equalization shall fairly and impartially equalize the values of all items of real property so that all real property is assessed uniformly and proportionately.

If, after the decision of a County Board of Equalization, a property owner is not satisfied with the decision of the Board, they may file an appeal with the Tax Equalization and Review Commission (TERC). The TERC consists of three commissioners, with each being from one of the federal congressional districts and appointed by the Governor with approval of a majority of the Nebraska Legislature. Appeals must be made by August 24th, or September 10th if the county adopted a resolution extending the deadline for the hearings to August 10th. At an appeal hearing before the TERC, a property owner will be afforded to present evidence and argue their case in an evidentiary hearing setting. The property owner on appeal must provide evidence that the County Board of Equalization’s decision was incorrect, or it was unreasonable or arbitrary. The burden is on the property owner to rebut the presumption that the County Board of Equalization failed to faithfully perform their duties.

If, after a decision of the TERC, a property owner is still not satisfied with the decision, they may appeal the TERC’s decision to the Nebraska Court of Appeals, subjecting themselves to Nebraska judiciary rules and statutes. However, the Court of Appeals will have limited scope to only reviewing errors on the record before the TERC.

The property tax valuation protest process at times can be complex and daunting. Attorneys at Vandenack Weaver can assist you at any step of the protest process and help identify why the county’s valuation is wrong and help you, the property owner, save money on property taxes for the upcoming tax year.

VW Contributor: Ryan Coufal
© 2019 Vandenack Weaver LLC
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U.S. Supreme Court to Decide Whether a Software Interface is Protected under Copyright Law

In a case that pertains to technology originally developed in the 1990s, the United States Supreme Court has granted certiorari in Google LLC v. Oracle America, Inc. The dispute between these two technology giants focuses on application programming interfaces (API) that Oracle developed through its predecessor, Sun Microsystems, Inc. At issue for the technology industry is whether an API is copyrightable and, therefore, protected.

The API is critical to most technology companies, especially those with complex and multi-layered tech stacks, because it allows the company to integrate and communicate with other software developers. By way of example and at issue in the case, the Android operating system uses the API originally created by Oracle to allow third-party developers to integrate into the operating system. Although most consumers will not understand how the API works, the use of third-party applications in the Google owned Android operating system is made possible through the API. As a result of its importance in modern commerce, many technology companies protect the structure, sequence, and organization of the API, even if they share how to connect to it.

Regardless of the decision by the Supreme Court on whether the API is protectable under copyright law, the ramifications will be significant. In fact, most of the prominent global technology companies have filed briefs in this case to voice their opinion on the matter. When the Supreme Court decides the case in 2020, every company that interfaces and integrates into the software of another company will need to re-evaluate their intellectual property protection strategies.

VW Contributor: Alex Rainville
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