Latest news with #TaxCourt
Forbes
5 days ago
- Business
- Forbes
The End Of ‘Smelly' Arguments? Tax Court Targets Easement Abuses
United States Tax Court building in Washington DC Judge Ronald L. Buch has issued a warning to the syndicated conservation easement industry and their attorneys about the litigation that is piling up in the Tax Court. When I think of the Tax Court issuing sanctions, I usually think of stubborn pro se litigants like Brian Swanson. This May the Eleventh Circuit denied him relief from a $25,000 Tax Court frivolity penalty. You have to work your way up to that amount. Usually the Tax Court starts off with a warning. And that is what happened with Mr. Swanson, for whom I have a grudging admiration. Judge Buch's warning, on the other hand, is going out to some of the best represented taxpayers currently in the Tax Court dockets and the attorneys themselves, but let's look at the case that it came up in - Veribest Vesta, LLC. About Veribest Veribest owned 55 acres of land in Oglethorpe County, Georgia near the city of Elberton. The parcel was referred to as the old Grimes quarry site. Elberton is known as the Granite Capital of the World as it sits on a granite belt that is approximately 35 miles long, 6 miles wide and 2 to 3 miles deep. By my reckoning that would make for over 130,000 acres where you know that if you dig deep enough you will hit granite. As Judge Buch observes, in order to mine granite as a business you need access to acres like that. You also need an experienced crew with a capable leader, capital to acquire the necessary equipment and to operate the business, and a market into which to sell the granite. A man carrying a block of granite as he prepares the blocks for hand tooling at a granite quarry in ... More Elberton, Georgia, circa 1950. So central to the economy of Elberton is granite that the city is known as the 'Granite Capital of the World'. (Photo by Herbert C. Lanks/Keystone View Company/FPG/) When Veribest donated a conservation easement on the old Grimes quarry site, all it had of the several requirements was the site. Since there is not a lot of buying and selling of easements, they are generally valued by taking the value of the land before the easement and subtracting from it the value of the land as encumbered by the easement. The argument is usually about the before value. Veribest valued the land at over $20,000,000 which after subtracting an after value of $100,000 yielded a charitable contribution of $20,310,000. According to Judge Buch locals understand quarry properties to be worth around $2,000 per acre. Contemporaneous sales records in the surrounding region reflect a range of values from $1,999 to $2,840 per acre. The old Grimes quarry according to evidence at trial was subpar, having been quarried and abandoned. Two years before the donation it had changed hands for $1,818 per acre. Nonetheless the IRS expert went wild and crazy and came in with a $3,000 per acre value, which Judge Buch views as a concession. All that made for a donation value of $111,000. The difference between that and the $20,310,000 claimed by Veribest is according to Judge Buch "a vast difference. It is vast enough to qualify for the gross valuation misstatement penalty. I guess "vast" is a few steps up from "gross" even though it sounds a little classier. The Valuation At trial, Veribest presented two experts. One argued for a before valuation somewhere between $23 and $33.5 million and the other came up with $15,460,000. These were based on the present value of the cash flow from a hypothetical mining operation. As a backup, one of the appraisers computed a valuation based on hypothetical royalty income which came in at $12,170,000. The IRS before valuation based on comparable sales was $165,000. Judge Buch went with the IRS. This result follows along with the recent Tax Court decisions in similar cases. The thinking is that a mining operation on the land is not inherent in the value of the land and that that is not how real estate changes hands. The principle is reinforced in this case by the fact that there had been quarrying going on and it was abandoned because the granite coming out was not of very high Warning This case is from the 2018 tax year so there is an actual assessment against the partnership of an "imputed underpayment" of $7,514,000 and valuation penalty of $3,005,880. This was based on a total disallowance of the charitable contribution. The result of the decision will pare that back very slightly. Assuming, as is likely, that the partnership will not be able to pay, the underpayment will get pushed out to the partners, but we really don't have experience with how well that is going to work out in practice. 2018 is the first year that these new rules are in effect. What really stands out about this case is the warning that Judge Buch issued. He pointed out that Code Section 6673(a)(1) which allows for a penalty of up to $25,000 where it appears that Tax Court proceedings have been instituted or maintained primarily for delay, the taxpayer's position is frivolous or groundless or the taxpayer unreasonably failed to pursue administrative remedies. Frankly with the numbers floating around in this case and others $25,000 doesn't seem like much a concern. But there is more. Code Section 6673(a)(2) provides that when it appears to the Tax Court that an attorney has multiplied the proceedings unreasonably and vexatiously that such attorney may be required to personally pay the excess costs,expenses and attorneys' fees reasonably incurred because of such conduct. Judge Buch states that valuing a property at more than 100 times its actual value is patently frivolous. The value was arrived at not by valuing the property but by valuing a hypothetical business to be situated on the property. Judge Buch quotes from some recent cases. "It is not credible to posit that a buyer would pay -for the easement property alone- the entire NPV of a hypothetical business on the property." He notes that the Tax Court has written that valuing land based on the going concern value of a business operating on the land "defies economic logic and common sense." He also has older appellate opinions that support the same notion. The Fourth Circuit when faced with a situation where the deduction was eight times what was paid a year earlier does not pass any reasonable smell test. And now he is facing a situation where 200 times was claimed. Judge Buch then notes all the time and aggravation involved in the two week trial. He notes that True North Resources, the partnership representative in the case, has ten other cases before the Tax Court and provides warning that 'continuing to pursue similarly incredible, nonsensical, and quite frankly, smelly arguments may result in sanctions on petitioner or its counsel'. Other Tax Court Action The case of Paul-Adams Quarry Trust LLC is scheduled for trial this week. Judge Emin Toro has ordered that the parties be prepared to discuss their views on Veribest and Rock Cliff Reserve, another syndicated conservation easement decision that did not go well for the taxpayers. There is an intriguing footnote Rock Cliff Reserve: "Mr. Collins understood the valuation method for a conservation easement (the value of the land before the easement minus the value of the land after the easement) but repeatedly balked on the stand at admitting that the value of a conservation easement could not exceed the value of a fee simple interest in the land." Is The Industry Based On Nonsense? When I first heard about the idea of buying land and then selling it to people who would take deduction for donated conservation easements, I thought it was one of the stupidest ideas I had ever heard. That's because I believed that an easement could not be worth more than the fee simple interest in the land and that the market for unimproved land, while imperfect, is not full of a lot of stupid people. Although the notion that an easement can be worth more than the land was floating around, I had not seen it being argued in court until recently. Jones Day made the argument in Beaverdam Creek Holdings. Judge Goeke was not impressed. Jones Day is representing Paul-Adams Quarry Trust. It is difficult to give the Jones Day argument justice without going longer than I care to here. Basically the idea is that only sales between fully knowledgeable and capable parties count as comparable sales. So when the syndicator buys land from a farmer for $1,000 per acre, it is possible that the land can really be worth $100,000 per acre. Here is an article in Bloomberg Tax written by Jones Day people that explains it more fully. Reaction Lew Taishoff has a piece titled Judge Buch Says It All Here where he quotes more extensively than I do. Jack Townsend has a passionate piece - Tax Court Rejects a ******** Tax Shelter False Valuation Claim with Warning of Sanctions for Taxpayers, their Counsel, and Expert Witness Proffering the ******* (7/16/25; 7/18/25). I bowdlerized his title based on my understanding of the standards of this platform. The ******* represent Townsend's characterization of abusive tax shelters. The poetic reference is to bovine excrement. Kirsten A. Parillo has Tax Court Warns of Frivolous Argument Penalties in Easement Cases behind the Tax Notes paywall. In that piece she quotes Frank Agostino, who represents taxpayers - 'Having an expert testify that in his or her professional opinion DCF produces the most accurate value is within the province of the expert. The trial attorney has an obligation to represent the taxpayer zealously. It should be a rare case where damages under section 6673 are appropriate. Those cases are resolved by summary judgement.' I followed up with Mr. Agostino and he wrote me the following: "The Veribest Vesta decision is a stark warning for attorneys and taxpayers who rely on non-cash charitable contribution deductions, especially in the context of conservation easements. The Tax Court made clear that even a 'qualified appraisal' by a credentialed expert will not protect taxpayers from severe penalties if the Tax Court judge concludes that underlying assumptions are speculative or unsupported by the facts. For practitioners, the message is clear: formal compliance with appraisal requirements is not enough if the Tax Court judge concludes that the facts do not support the claimed value. As the legal landscape evolves, especially in light of recent Supreme Court decisions on administrative penalties, there may be growing calls to expand taxpayer and tax practitioner access to jury trials in valuation penalty based cases to ensure procedural fairness and maintain trust in the tax system." I also heard from Steve Small, an authority on private land protection, who has probably done more than anyone to expose abusive conservation easements in the interest of preserving the legitimate use of the technique. "The rule for valuing federal income tax charitable contribution donations has been the same for decades, in both easement cases and any other valuation of charitable gift cases: willing buyer, willing seller, comparable sales in the relevant marketplace. The price you recently paid for the property is the best evidence of fair market value. There are no other acceptable methods. In very limited circumstances a DCF can be ok but only in situations that are not based on fanciful assumptions. A 'correct' value determined by a 'correct' DCF should be substantially close to a value determination by comparable sales. The problem is that counsel for well bankrolled syndicators have been trying to convince people that the rule is something different. It's not. They keep blowing smoke, with claims and arguments that are nothing more than red herrings. They are bluffing, the wizard is still behind the curtain, all of these efforts are a totally valid attempt, under the American judicial system, to convince the IRS and the courts that the rule is something different – it is not something different. They are simply representing what they believe to be the best interests of their clients, that's all. But enough is enough. The courts are FINALLY starting to say 'what part of 'willing buyer willing seller based on comparable sales in the relevant marketplace' don't you understand?'"
Yahoo
19-06-2025
- Business
- Yahoo
Jamie Golombek lays out everything you need to know about the new Canada Disability Benefit
Applications for the new, much anticipated Canada Disability Benefit (CDB) open on June 20. The tax-free monthly CDB payments are meant to provide financial support to qualifying people with disabilities. The program is administered by Service Canada and the first month of eligibility is June, with the first payments beginning in July for applications received and approved by June 30. To qualify for the CDB, you must be between 18 and 64 years old and be approved for the disability tax credit (DTC). The DTC is a non-refundable tax credit that's intended to recognize the impact of various non-itemizable, disability-related costs. For 2025, the value of the federal credit is 14.5 per cent of $10,138, or $1,470. But add the provincial or territorial tax savings and the combined annual value can be worth up to $3,200, depending on where you live. To qualify for the DTC, you must complete the Canada Revenue Agency's Form T2201, Disability Tax Credit Certificate, upon which a medical practitioner must certify that you have a 'severe and prolonged impairment in physical or mental function.' This form can be completed online or in paper format. Once the form is completed and sent in, the Canada Revenue Agency will either approve the DTC or deny it. If your application is denied, you can appeal the CRA's decision to the Tax Court. If you're still under 18, you can apply for the CDB as early as age 17 1/2, but your application won't be processed until your 18th birthday. This means that you won't get an eligibility decision or any payments until after you turn 18. Assuming you qualify, you'll begin receiving CDB payments the month after your application is received and approved. But don't panic if you don't get approved right away. If you only find out about the CDB well after July 2025, you can get back payments for past months that you were eligible for, but only for up to 24 months from when the government gets your application (and only for months from July 2025 onwards). Individuals who have been approved for the DTC and who meet most of the eligibility criteria will likely have already received a letter this month that includes a unique application code and instructions on how to apply. To complete the application, you'll need your social insurance number and your direct deposit information, as Service Canada is encouraging all applicants to sign up for direct deposit for the 'fastest and most reliable way to get your payments.' If you didn't receive a letter from the government with an application code but you still think you're eligible for the CDB, you can still apply, but you will also need to provide your mailing address and your net income from line 23600 of your recent 2024 notice of assessment. Applications for the CDB can be submitted on the web via the application portal, by phone and in person at a Service Canada Centre as of June 20. To apply for the CDB, you and your spouse or common-law partner (if applicable) must have filed your 2024 federal income tax return(s), and you must be a Canadian resident for income tax filing purposes, among other criteria. Benefit amounts for the July 2025 to June 2026 payment period are calculated using your adjusted family net income for the 2024 tax year. The maximum amount you could receive from July 2025 to June 2026 is $2,400 ($200 per month). This amount will be adjusted upwards for inflation each year to reflect changes in the cost of living. Because the CDB is an income-tested benefit, the benefit amount you will receive will start to decrease after your 'adjusted family net income' reaches a certain threshold. This is basically equal to your combined family net income as reported on line 23600 of both you and your spouse or partner's returns. If your adjusted family net income is considerably above that threshold, your benefit amount could be zero. How exactly your income affects your benefit amount is complicated and will depend on three factors: your marital status; whether you and/or your spouse or partner have income from employment or self-employment and whether you and your spouse or are both receiving the CDB. Note that a certain amount of income from employment or self-employment is excluded when calculating your benefit amount. This is called the 'working income exemption.' If you are single, up to $10,000 of working income will be exempt, and if you're married or living common-law, up to $14,000 of combined working income will be exempt. The government has provided an estimator to find out how much money you could get from the CDB. To get an accurate estimate, start with your and your spouse's or partner's 2024 notices of assessment to input the exact numbers from various lines on the assessments. Finally, keep in mind that the DTC not only entitles you to the new CDB, but it's also the gateway credit to opening up a registered disability savings plan (RDSP). These plans are designed to help build long-term savings for individuals with disabilities. Individuals may contribute up to $200,000 on behalf of a beneficiary who qualifies for the DTC. There is no tax on earnings or growth while in the plan. In addition to the power of tax-deferred compounding, Canada Disability Savings Grants (CDSGs), with a lifetime maximum of $70,000 per beneficiary, and Canada Disability Savings Bonds (CDSBs), with a lifetime maximum of $20,000 per beneficiary, may be received up until the end of the year in which the beneficiary turns 49, depending on family income. Jamie Golombek: July brings a greater opportunity for income splitting Lack of documentation can be fatal when claiming expenses on taxes Original contributions are not taxed when disability assistance payments are ultimately made to the beneficiary, but earnings, growth and government assistance are included in the beneficiary's income. If the beneficiary has zero or minimal other income, the basic personal amount combined with the DTC may allow most or all of the funds to come out of the RDSP tax-free. Jamie Golombek, FCPA, FCA, CFP, CLU, TEP, is the managing director, Tax & Estate Planning with CIBC Private Wealth in Toronto. If you liked this story, in the FP Investor newsletter. Error in retrieving data Sign in to access your portfolio Error in retrieving data Error in retrieving data Error in retrieving data Error in retrieving data
Forbes
18-06-2025
- Business
- Forbes
New Self-Employment Tax Risks For U.S. Investors In Global Funds
A new Tax Court ruling is a warning for U.S. limited partners in global funds, imposing new ... More self-employment (SECA) tax risks. U.S. limited partners in foreign funds like Cayman or Luxembourg partnerships must ensure passive roles to avoid costly SECA tax liabilities. The U.S. Tax Court decided Soroban Capital Partners LP v. Commissioner (T.C. Memo 2025-52) in May 2025 leaving financial, tax and legal advisors concerned. The court upended assumptions about the self-employment tax exemption for limited partners in hedge funds, and by analogy to venture capital, and private equity partnerships both in the U.S. and abroad. U.S. citizens and green card holders who are limited partners in hedge funds or similar businesses, including those in foreign countries, should understand the effects of this decision. The case signals a shift away from a state or local law definition of a 'limited partner' toward a more comprehensive evaluation of the partner's actual role to determine if the 'limited partner' exclusion from Self-Employment Contributions Act taxes should apply. The Soroban court applied a 'functional analysis test' to determine whether limited partners' distributive share of partnership income is subject to SECA taxes. The decision has far-reaching SECA implications for how limited partners will structure their roles and manage their tax obligations. This article explores the Soroban ruling, what it means for U.S. limited partners, especially for those working with hedge funds or other businesses abroad that use a limited partnership structure. First, it is helpful to understand generally why funds often use a limited partnership vehicle. A limited partnership for U.S. purposes is comprised of both general and limited partners. General partners manage the fund and have unlimited liability. Limited partners contribute capital, and their liability is limited to their investment. The limited partnership structure is tax transparent for U.S. tax purposes, meaning it provides pass-through taxation of income, credits and deductions to its partners. The partnership entity itself is not subject to U.S. income tax, and the partners report their distributive shares on their individual U.S. tax returns. The structure also provides significant flexibility in governance. For all these reasons, the limited partnership is often ideal for private funds. Self-employment income is taxed at a rate of 15.3% (12.4% for Social Security and 2.9% for Medicare). A SECA exclusion exists under Internal Revenue Code Section 1402(a)(13) for a limited partner's distributive share of partnership income. The Tax Court rejected the notion that state law classifications of limited partners should be determinative for purposes of this exclusion. Instead, it applied a functional analysis test to Soroban's limited partners and concluded that these partners were 'limited in name only.' As such, the limited partners' distributive share did not qualify for the SECA exclusion. The court carefully examined the activities of the limited partners and found they were heavily involved in generating the partnership's income by overseeing day-to-day management, working full-time for the business, and that marketing material listed them as essential to the success of the partnership. In addition, the capital contributions made by the limited partners were viewed as insignificant when compared to the fees Soroban charged. This comparison suggested that the limited partner's distributive share was not a passive return on investment but rather compensation for active participation. The label 'limited partner' alone, is not enough to guarantee the SECA exclusion. Instead, the functional analysis test requires a thorough analysis of the facts and a careful examination of the partner's role in the enterprise. The factors include how integral the partner is in generating revenue, the degree of participation in the business, whether the partner is working full-time in the business, whether marketing materials indicate the partner plays a key role and whether the partner's capital investments truly reflect a passive investment. For U.S. limited partners, particularly those in hedge funds or other investment vehicles, the Soroban holding invites the IRS and courts to closely scrutinize the actual activities of limited partners to determine SECA liability. While the Soroban case focused on a U.S. hedge fund, its principles can apply to any partnership structure in which U.S. citizens or green card holders are limited partners. The holding can apply to a vast range of industries operating globally where U.S. partners are contributing expertise and management. Private equity firms, venture capital funds, and other businesses often use a limited partnership structure. A limited partner in an overseas real estate partnership or tech startup fund could face scrutiny if the role involves active management or income generation. Only truly passive investors are meant to benefit from the SECA exclusion and while local law will be important in the analysis, the IRS will be looking beyond any local law label of 'limited partner' to scrutinize eligibility. Various jurisdictions have limited partnership structures closely resembling the U.S. model. The most popular jurisdictions having limited liability for limited partners as well as generally having flow-through tax treatment include the Cayman Islands, British Virgin Islands, Luxembourg, Hong Kong and Ireland. While these jurisdictions appeal to global funds because of their tax and regulatory regimes which parallel the U.S. in important respects, limited partners should be ready to consider a heightened compliance burden given the holding in Soroban. Adding to the additional possible tax burden, the U.S. limited partner abroad will be unhappy to learn that self-employment income subject to SECA tax is not reduced by the foreign earned income exclusion. U.S. limited partners should reassess their involvement in the partnership to make sure they qualify as passive investors entitled to the SECA exclusion. This may mean a significant reduction of day-to-day management responsibilities or restructuring their roles to emphasize capital investment over active participation. For U.S. limited partners in foreign funds, the statute of limitations for SECA tax assessments is generally three years from the due date or actual filing date of the income tax return, whichever is later. However, the statute of limitations for tax matters can be extended several years and even indefinitely, depending on the facts. Crucially, if a U.S. partner fails to file a required foreign information return, such as Form 8938 (Statement of Specified Foreign Financial Assets) or Form 8865 (Return of U.S. Persons With Respect to Certain Foreign Partnerships), the statute of limitations does not start for the entire tax return. This gives the IRS the ability to assess SECA tax at any time in the future. U.S. limited partners should be proactive and planning for a possible IRS challenge to a claimed exclusion from SECA. U.S. limited partners should first consult an experienced tax advisor to assess their involvement in the fund and optimize tax outcomes. Next, meticulously document management roles, time commitments, and public representation to ensure compliance with IRS scrutiny and minimize the risk of tax exposure. Partnership agreements should be examined. If feasible, partnership agreements may need to be amended to clarify the role of limited partners as passive investors, emphasizing capital contributions over operational involvement. Limited partners who blur the line between passive investment and active management could find a surprising increase in their U.S. tax liability with their distributive shares subject to SECA taxes. The Soroban case may be appealed, and staying informed on this topic is critical. Investors should be looking out for any future IRS guidance or legislation that might refine the functional analysis test. I help with tax matters around the globe. Reach me at vljeker@ Visit my US tax blog
Fox News
12-06-2025
- Business
- Fox News
Gorsuch warns Supreme Court decision gives IRS 'powerful new tool to avoid accountability'
Justice Neil Gorsuch wrote a dissent to the Supreme Court's decision to limit the U.S. Tax Court's authority in certain Internal Revenue Service (IRS) cases, asserting that the federal tax collecting service could avoid accountability in the future. Gorsuch wrote the dissent to the high court's opinion in Commissioner of Internal Revenue v. Zuch, a case that centers on Jennifer Zuch's dispute with the IRS that began in 2012 over the agency's moves regarding her late 2010 federal tax return filing. "Along the way, the Court's decision hands the IRS a powerful new tool to avoid accountability for its mistakes in future cases like this one," Gorsuch wrote in his dissent. In this case, Zuch claimed that the IRS made a mistake, crediting a $50,000 payment to her then-husband's account instead of her own. The IRS disagreed and sought to collect her unpaid taxes with a levy to seize and sell her property. Over the years after the dispute began, Zuch filed several annual tax returns showing overpayments. Instead of being issued refunds, the IRS applied these to her outstanding 2010 tax liability. Once the IRS settled Zuch's outstanding sum, her liability reached zero, and the IRS no longer had a reason to levy her property. The IRS then moved to dismiss Zuch's case in Tax Court, arguing that Tax Court lacked jurisdiction since there was no longer a levy on her property. The Tax Court agreed. The Supreme Court upheld that Tax Court no longer had jurisdiction without a levy. "Because there was no longer a proposed levy, the Tax Court properly concluded that it lacked jurisdiction to resolve questions about Zuch's disputed tax liability," read the high court's opinion. The decision will not only prevent Zuch from recouping her overpayments that she believes the IRS has wrongly retained, but give the IRS a way to avoid accountability, Gorsuch wrote in his dissent. "The IRS seeks, and the Court endorses, a view of the law that gives that agency a roadmap for evading Tax Court review and never having to answer a taxpayer's complaint that it has made a mistake," the justice wrote.
Forbes
09-06-2025
- Business
- Forbes
In Facebook Case, the Cost-Sharing Regulations Pass Their First Test
Although Tax Court Judge Cary Douglas Pugh rejected the IRS's position on almost every key methodological detail in Facebook Inc. v. Commissioner, 164 T.C. No. 9 (2025), her opinion vindicated the general legitimacy of the method and the regulatory scheme that introduced it. Like most other major section 482 cases, especially those involving contributions to cost-sharing agreements (CSAs), Facebook was largely a clash between the parties' economists. Both sides leaned heavily on valuation reports by expert witnesses to support their vastly differing valuations of Facebook's platform contributions to a 2010 CSA with its Irish subsidiary, which included core technologies and a preexisting user base. In this battle of economists, the IRS clearly lost. Pugh's opinion repeatedly expressed frustration with both parties' valuation experts for acting more like advocates than experts. However, she found the IRS's expert witness to be particularly unreliable. The two most critical inputs when applying the income method under the 2009 temporary cost-sharing regulations (T.D. 9441) are financial projections and discount rates, and Pugh rejected the IRS lead witness's testimony on both. Pugh was even more critical of the IRS's reliance on an unusual and aggressive variation of the income method. The cumulative monetary effect of these setbacks for the IRS will be dramatic. The final platform contribution transaction (PCT) value won't be official until Rule 155 computations are complete, but Pugh estimated that applying the income method with reliable inputs would yield a roughly $7.8 billion PCT value — far closer to Facebook's $6.3 billion valuation than to the $19.9 billion value derived from the IRS's method. Based on this estimate, less than 11 percent of the IRS's total PCT value adjustment would stand. The tax revenue gain will still exceed the IRS's litigation costs, but in purely monetary terms, Facebook hardly looks like a major IRS victory. However, a win for Facebook on the facts isn't necessarily a loss for the IRS. The $12.2 billion difference between the IRS's PCT valuation and the value tentatively cited by Pugh was entirely attributable to inputs and other methodological details. These were ultimately questions of fact, and their relevance is limited to the facts of this case. On questions of statutory and regulatory interpretation, which have ramifications that extend far beyond this case, Facebook was a resounding IRS win. Billions of dollars are at stake in Facebook, and the case pairs one of the world's best-known and most polarizing companies with one of U.S. tax law's most widely exploited and frequently criticized profit-shifting tools. But Facebook is, above all, the first judicial test of the cost-sharing regulatory regime created by the 2009 temporary regulations, which was the product of a painstaking effort to fix the loopholes (real or perceived) responsible for the IRS's losses in Veritas Software Corp. v. Commissioner, 133 T.C. 297 (2009), nonacq., AOD 2010-05, and Inc. v. Commissioner, 148 T.C. No. 8 (2017), aff'd, 934 F.3d 976 (9th Cir. 2019). In Veritas and again in Amazon, which was later affirmed by the Ninth Circuit, the Tax Court held that the buy-in requirement for 'preexisting intangible' contributions in the 1995 regulations (T.D. 8632) excluded residual business assets like goodwill and intangibles developed over the life of the CSA. This was a consequence of restrictions that, according to the Tax Court and Ninth Circuit, followed from reg. section 1.482-4(b)'s definition of intangible and the modifier 'preexisting.' Because the buy-in payments derived from the IRS's discounted cash flow (DCF) valuations included the value of residual business assets and later developed intangibles, courts held that the 1995 regulations prohibited their use. To stop the uncompensated transfers of valuable assets allowed by this interpretation, the 2009 temporary regulations and the substantially identical 2011 final regulations (T.D. 9568) replaced the term 'preexisting intangible' with 'platform contribution.' This decoupled CSA participants' PCT payment obligations from any definitional limitations inherited from reg. section 1.482-4(b). It also clarified that the PCT value must include the value of intangibles developed under the CSA to the extent that their development benefited from access to the platform contribution. Arguably more important than these terminology changes was the introduction of specified PCT valuation methods that mechanically prevent artificial exclusions. The 1995 cost-sharing regulations cross-referenced reg. section 1.482-4 for pricing methods, and DCF valuations are permitted by reg. section 1.482-4 only as 'unspecified methods.' Courts thus consistently turned to the comparable uncontrolled transaction method, which allows for the kinds of exclusions that DCF valuations do not. It also indulged the historical judicial preference for transactional methods. The specified PCT valuation method at issue in Facebook is the income method, and it is a close cousin of the DCF valuations rejected in Veritas and Amazon. Similar to a DCF valuation, it derives the PCT value by discounting projected income to present value, and it provides no plausible basis for carving out excluded items. The IRS's ability to defend its selection of the income method in Facebook was thus the first test of the new regulatory scheme's ability to prevent another Veritas or Amazon. To some, it seemed hard to conceive of any plausible basis for reading the old exclusions and methodological preferences into the new law. It would be counterintuitive, to say the least, if the interpretations of the 1995 regulations that compelled Treasury and the IRS to draft a more elaborate version of reg. section 1.482-7 from scratch somehow remained viable under the new regulatory scheme. Construing the 2009 cost-sharing regulations to exclude residual business asset value and prioritize transactional methods would be like reading Prohibition into the 21st Amendment. It would turn the regulatory scheme on its head. But this view was never unanimous. Undaunted tax advisers proposed ways to resurrect the old loopholes, and skeptics criticized the whole effort for legitimizing an irredeemably flawed profit-shifting technique. Until the Tax Court released its Facebook opinion, the only real signal of how courts would interpret the new regulations was in a footnote to the Ninth Circuit's Amazon opinion: "If this case were governed by the 2009 regulations or by the 2017 statutory amendment, there is no doubt the Commissioner's position would be correct." What's correct may not have been in doubt. What would actually happen when a taxpayer tested this prediction certainly was. Facebook's briefs attest to what must have been a determined and all-encompassing search for a winning legal theory, and some of Pugh's comments at trial arguably suggested skepticism toward the income method. The legal questions presented in Facebook won't be definitively resolved until at least one or, more likely, multiple appeals courts confirm the answers. But in Facebook, the income method and the regulatory scheme that introduced it passed their first major test. What was clearly correct to the Ninth Circuit panel that decided Amazon was clear to Pugh as well. Any inferences to the contrary drawn from Pugh's questions at trial and dissent in 3M Co. v. Commissioner, 160 T.C. No. 3 (2023), were apparently misguided. Pugh found that the IRS derived its PCT value from a severely flawed application of the income method, and these findings had a drastic effect on the PCT value. But she unequivocally affirmed the general validity of the income method, and by extension the regulatory scheme, despite Facebook's determined effort to discredit it. As the opinion concludes: 'Applying the statute and regulations, we conclude that using the income method to determine the requisite PCT Payment value and resulting payments for 2010 produces an arm's-length result if the correct inputs are used. . . . The regulations themselves are not invalid merely because they impose a limit on the expected return on [intangible development costs] at a discount rate reflecting market-correlated risks.' The basic premise underlying the income method is that, for CSAs in which only one party makes any nonroutine platform contribution, the PCT value should equal the difference between the net present value (NPV) of entering the CSA and the NPV of entering the best realistic alternative transaction. The PCT value is thus the difference between the NPV of the PCT payer's reasonably anticipated operating income under the cost-sharing alternative and the NPV of its operating income under the hypothetical best realistic alternative. In general, although not in Facebook, the PCT payer's best realistic alternative is to license the right to exploit the cost-shared intangibles from an independent developer. The NPV of the best realistic alternative is thus the present value of the PCT payer's expected returns as a hypothetical licensee, as determined using either the comparable profits method or the CUT method. In effect, the income method forces the PCT payer to hand the expected NPV excess associated with CSA participation back to the participant responsible for the nonroutine platform contribution. This leaves the PCT payer with an expected return on the cash it invests in the CSA equal to the cost-sharing alternative discount rate, which represents the return that a market investor could expect to earn on an investment with the same risk profile as the CSA activity. If the PCT payer makes nonroutine contributions specific to its own territory, the income method requires that the payer's best realistic alternative be adjusted to reflect a return on its contributions. This approach follows from the general 'investor model,' which provides that all PCT valuation methods should offer CSA participants a return on their aggregate net investment commensurate with the CSA activity's risk profile. A corollary of this principle is that all cash contributions included in 'aggregate net investment' should have a uniform expected rate of return, regardless of whether they take the form of a PCT payment or a cost contribution. As reg. section 1.482-7(g)(2)(ii) explains: 'The relative reliability of an application of a method also depends on the degree of consistency of the analysis with the assumption that, as of the date of the PCT, each controlled participant's aggregate net investment in the CSA Activity (including platform contributions, operating contributions . . . and cost contributions) is reasonably anticipated to earn a rate of return (which might be reflected in a discount rate used in applying a method) appropriate to the riskiness of the controlled participant's CSA Activity over the entire period of such CSA Activity.' The method's logic is sound. The income method is appropriate only when the PCT payer makes no nonroutine platform contributions, so the payer's principal contribution to the CSA will be the cash it invests through the PCT payment and cost contributions. The arm's-length return for a cash contribution is the expected return available to market investors for bearing the risk associated with the CSA activity, and this is what the CSA discount rate represents. Unless the PCT payer makes nonroutine contributions of its own, any excess in its expected returns over the CSA discount rate must be attributable to the PCT payee's platform contribution. One could reasonably suggest that the discount rate for developing sophisticated and potentially extraordinarily valuable technologies, which Pugh found to be 17.7 percent in Facebook, overcompensates PCT payers that don't functionally contribute to cost-shared intangible development. But it prevents the far more egregious results made possible under the 1995 regulations by the residual business assets exclusion, the use of decay curves and finite useful lives, and the general judicial aversion to income-based valuation methods. The income method generates an aggregate PCT value that reflects the full NPV difference between alternatives, and it provides no basis for carving out value attributable to excluded assets. If the income method didn't establish a meaningful limit on profit shifting, a taxpayer like Facebook wouldn't make such a determined effort to invalidate it. Facebook upheld the general validity of a method that aggregates the value of all platform contributions, and in doing so, it implicitly rejected the notion that a residual business asset exclusion survives hidden somewhere in the 2009 and 2011 regulations. Pugh expressly rejected that notion as well, and in short order: 'Petitioner also spends a couple of pages in its opening brief on an argument that Facebook Ireland should not be required to compensate Facebook US for residual business assets. It is true that the definition of intangible property in the second sentence of section 482 in 2010 was limited to the intangible property listed under section 936(h)(3)(B). But the first sentence of section 482 has no such limits; the statute does not constrain the contributions to a CSA that might be compensable through a PCT Payment.' Facebook's more intricate methodological objections, including its 'zero NPV' critique, fared no better. During briefing, Facebook's zero NPV argument seized on the arithmetic relationship between the PCT value and the NPVs of the two alternatives. Because the PCT value is equal to the NPV of the cost-sharing alternative minus the NPV of the licensing alternative, the post-PCT NPV difference between the two alternatives is, by definition, zero. In other words, the income method requires that the PCT payer transfer all of the incremental value associated with entering the CSA back to the PCT payee. According to Facebook, the arm's-length standard entitles cost-sharing participants to retain some of the NPV excess associated with CSA participation. However, as Pugh rightly observed in her opinion, claiming that a PCT payer's cost contributions have an expected rate of return in excess of the discount rate would discredit every PCT method based on the investor model. This claim, the opinion explains, implies that PCT payers should receive a preferential rate of return in excess of what a market investor would receive on the same investment: 'Petitioner's objection that a generic investor would seek a return that is greater than its cost of capital proves too much. It necessarily assumes that this investment should be more attractive than another similar investment. The arm's-length standard does not require a preferred return (a positive NPV); it requires a return comparable to returns on other similar investments. Moreover, petitioner does not explain why in a controlled transaction, such as this, a positive NPV for Facebook Ireland would not result in a negative NPV for Facebook US.' Another way in which the income method allegedly shortchanges PCT payers is by denying them a return for the entrepreneurial risks and functions associated with exploiting the cost-shared intangibles in their territory. Echoing reg. section 1.482-7(g)(4)(vi)(E), Pugh explained that any such contributions can be accounted for by properly valuing the licensing alternative: 'To the extent petitioner's objection is that Facebook Ireland receives no return for its entrepreneurial contributions, that is addressed by proper comparables for the licensing alternative. . . . It is incorrect therefore to conclude that the income method denies an economic profit for any entrepreneurial efforts of the PCT Payor. Petitioner's objections are addressed through selection of the proper inputs into the income method.' Consistently applying this reasoning also led Pugh to reject the way in which the IRS applied the income method in Facebook. The regulations generally assume that the PCT payer's best realistic alternative transaction will be to license the cost-shared intangibles from the developer. This assumption shifts all development risk to the developer, but it leaves the risks associated with exploiting the cost-shared intangibles with the PCT payer. As the final cost-sharing regulations provide (in reg. section 1.482-7(g)(4)(i)): 'In general, the best realistic alternative of the PCT Payor to entering into the CSA would be to license intangibles to be developed by an uncontrolled licensor that undertakes the commitment to bear the entire risk of intangible development that would otherwise have been shared under the CSA. [Emphasis added.] But the IRS valuation expert instead used a 'services alternative' as the best realistic alternative, which treated Facebook Ireland as though it were a low-risk marketing services provider. Under the services alternative, Facebook Ireland received a cost-plus markup of 8 percent, which was nominally based on a set of marketing services companies that bore none of the exploitation risk typically associated with the licensing alternative. Although the 8 percent markup was within the interquartile range (6.8 to 14.2 percent) for the comparables set, it was well below the median value (13.9 percent). Whether it's necessary or appropriate to reward PCT payers with an expected return consistent with the returns of real risk-bearing licensees is open for debate. But the reason that Facebook's theoretical criticism of the income method failed is also the reason that, at least under the regulations, the IRS's services alternative approach was inappropriate. Calculating the PCT value by reference to alternatives with drastically different risk profiles also raises major practical problems, including those associated with a wide discount rate differential that cannot be attributed to a specific risk. Unlike a services alternative, the licensing alternative can differ from the cost-sharing alternative in narrow and predefined ways that relate only to development risk. It's unclear why the IRS opted to use a novel and more aggressive variation of the income method when the method's overall validity was at stake. But it was logically consistent for Pugh to uphold the income method in general while rejecting the method's application in Facebook, and the trade-off for the IRS was a favorable one. By confirming the income method's general validity, Facebook tentatively vindicates the foundations of the current cost-sharing regulations. Pugh rejected Facebook's attempts to create a new residual business asset exclusion and invalidate the investor model, both of which were critical for the regulatory scheme to function. But Pugh's endorsement of the income method's arm's-length bona fides in Facebook followed from her interpretation of the arm's-length standard in general, which could have implications that extend far beyond cost sharing. For Facebook, the income method's zero-NPV effect is invalidating because it creates a conflict between reg. section 1.482-7(g)(4) and the arm's-length standard. This assumes that Treasury and the IRS had an obligation to conform reg. section 1.482-7(g)(4) to the arm's-length standard. It also assumes that the arm's-length standard is a transactional and comparables-based concept, regardless of what the regulations say on the matter. As noted in Facebook, this interpretation implies that any transactional evidence at all takes priority over the methodological reliability standards specified by regulation: 'Where there are no uncontrolled comparables, petitioner maintains, the arm's-length standard requires a 'method that is expected to most closely approximate the way in which unrelated parties price transactions.' Petitioner submits that this approximation can be accomplished through sources such as peer-reviewed academic literature and broad industry standards.' The two assumptions underlying Facebook's argument are related, and the distinction between the two is often blurred. But they are distinct. Whether Treasury and the IRS have a statutory obligation to adhere to something that falls within the ambit of the arm's-length standard is one question, and whether they have to interpret the arm's-length standard in a narrow and archaic way is another. On the first question, Pugh emphasized that the applicable statutory standard established by the first sentence of section 482 is a clear reflection of income. Her opinion observes that 'neither sentence of section 482 expressly adopts the arm's-length standard,' which 'originated in the regulations promulgated under the Revenue Act of 1934.' Only the sentence added by the Tax Reform Act of 1986 directly addresses controlled intangible transfers, Pugh said, and it does not support Facebook's contention: 'The only statutory touchstone relating to intangibles in section 482 is the 'commensurate with the income' requirement. That addition seems to move the statute away from, not toward, an 'arm's length' standard, at least as petitioner defines it; it requires compensation commensurate with the income earned in the transaction. [Emphasis added.] The Facebook opinion doesn't directly say whether Treasury and the IRS could issue regulations that openly repudiate the arm's-length standard. But if the statute doesn't bind Treasury and the IRS to the arm's-length standard, then any obligation to apply it would be a self-imposed regulatory restraint on their broader statutory authority. It would follow that Treasury and the IRS have the right to specify the terms of that self-imposed restraint. However, in Facebook and other best method cases, the authority to openly abandon the arm's-length standard is less important than the discretion to interpret it. On the second question, Pugh was unequivocal. Drawing heavily on the Ninth Circuit majority's reasoning in Altera Corp. v. Commissioner, 926 F.3d 1061 (9th Cir. 2019), rev'g 145 T.C. 91 (2015), Pugh rejected the antiquated interpretation of the arm's-length standard favored by Facebook and other taxpayers: 'In Altera, the Ninth Circuit expressly held that in the light of concerns over third-party comparables, a focus on internal allocations that follow economic activity is an appropriate method to reach an arm's-length result.' Pugh's unqualified reliance on Altera in Facebook is significant in multiple respects. Although Altera is binding circuit precedent in Facebook, Pugh's opinion reflects a broader acceptance of the Ninth Circuit's reasoning. It also confirms that, at least in the Tax Court's view, the Ninth Circuit's holding was unaffected by Loper Bright Enterprises Inc. v. Raimondo, 603 U.S. 369 (2024). Therefore, all taxpayer validity challenges targeting the cost-sharing regulations' treatment of stock-based compensation, including in Abbott Laboratories v. Commissioner, No. 20227-23, and McKesson Corp. v. United States, No. 3:25-cv-01102, should fail. Perhaps even more significant, Pugh's reliance on Altera in a best method case thwarts a ubiquitous and foundational element of taxpayers' arguments in methodological disputes. As the Facebook opinion explains: 'Petitioner attempts to convert the arm's-length standard, as defined in Treas. Reg. section 1.482-1, into an independent rule. But nothing in the text of section 482 bars Treasury from prescribing what arm's length means when no comparable transactions can be identified. Section 482 does not contain the words 'arm's length'; rather, its focus is on clear reflection of income and preventing tax evasion in controlled transactions.' In other words, neither section 482 nor reg. section 1.482-1's general articulation of the arm's-length standard provides any basis for invalidating the method-specific provisions that apply them. This is critical because manufacturing such conflicts has become the basis for taxpayer attacks on all income-based methods, including the CPM in Medtronic Inc. v. Commissioner, T.C. Memo. 2022-84. If legitimized by courts, those conflicts would twist the section 482 regulations into an ineffectual knot. The significance of upholding one of the centerpieces of the 2009 cost-sharing regulations, and by extension the regulatory scheme itself, in Facebook can't be understated. But the Tax Court's broader acceptance of Altera, and the corresponding rejection of an inappropriately narrow interpretation of the arm's-length standard, is arguably even more important. For the IRS, these victories on the law far outweigh its loss on the facts in Facebook.
