The deduction limit on state and local tax payments, new taxes on foreign income, and state efforts to tax out-of-state sellers in the wake of a 2018 U.S. Supreme Court ruling are among the hot-button legal issues to watch in the new year.
The nation’s highest court also will jump into high-profile battles over access to President Donald Trump’s financial documents, with a ruling expected to drop in the midst of the 2020 presidential campaign.
Observers are also closely tracking tax disputes involving Facebook Inc., Exxon Mobil Corp., and other major corporations, as well as a case concerning when tax regulations can be challenged.
Here is what you should know as these legal battles loom:
Some states are challenging the 2017 tax law’s $10,000 deduction cap on state and local tax payments and the Internal Revenue Service’s attempt to curb their efforts to shield residents from higher tax bills.
New York, Connecticut, Maryland, and New Jersey are continuing to challenge the SALT cap, even after the U.S. District Court for the Southern District of New York dismissed the case in September. The states appealed the case, State of New York v. Mnuchin, to the U.S. Court of Appeals for the Second Circuit.
The states have argued that the cap violates the Constitution by interfering with state sovereignty and exceeding Congress’ individual income taxing power.
“Most see the states’ position there as a little bit of a long shot, but it highlights one of the top state and local issues, which is sort of a federal issue,” said Timothy Noonan, who leads the New York state residency practice at Hodgson Russ LLP.
A second SALT lawsuit in State of New Jersey v. Mnuchin argues that an IRS final rule (T.D. 9864) meant to curb state workarounds of the SALT cap is inconsistent with tax code Section 170, which sets out when a charitable deduction is allowed. That case, brought by New Jersey, New York, and Connecticut, was filed in the U.S. District Court for the Southern District of New York in July.
“That’s one I’m keeping an eye on,” said Andy Grewal, a professor at the University of Iowa College of Law who focuses on tax issues.
State Taxation of Foreign Income
The 2017 tax law created a new category of foreign income and a corresponding federal tax to ensure multinational companies pay a minimum amount on their offshore profits. The global intangible low-taxed income comes from a company’s controlled foreign corporations.
Multiple states have already decided to take a slice of GILTI, requiring companies to pay state taxes on the foreign income. That could raise legal challenges under the foreign commerce clause of the U.S. Constitution, which has been read by courts to prohibit forms of discrimination against international commerce.
Darien Shanske, a professor at the University of California, Davis Law School, doubted the merit of the foreign commerce clause challenge given that GILTI is premised on the idea that some income isn’t actually foreign-sourced, but instead is shifted abroad to avoid taxes.
“Once you reasonably believe there’s income shifting you are allowed to bring it back,” he said.
The issue of when states can tax businesses that don’t have a physical presence may head back to the courts in 2020.
The Supreme Court, in its 2018 ruling in South Dakota v. Wayfair, created a framework for states to collect sales taxes from remote retailers and tossed out its 1992 physical presence standard affirmed in Quill Corp. v. North Dakota.
Since the Wayfair decision, most states have begun collecting remote sales tax based on a measure of economic activity, instead of physical presence. While states are generally being conservative, people are going to challenge the new state laws one way or another, Shanske said.
Major Corporate Cases
High-profile tax disputes involving major corporations will continue to work their way through the legal system over the next year.
Facebook Inc. in February will head to trial before the U.S. Tax Court over a tax bill from 2010. The case, Facebook, Inc. v. Commissioner, concerns the value of intangible property—such as trademarks and copyrights—that it transferred to an Ireland unit. An IRS victory would affect Facebook’s tax bills in subsequent years as well.
Coca-Cola Co. is awaiting a Tax Court decision in a $3.3 billion tax dispute with the IRS. The agency argued that the Atlanta-based company should have allocated more income to the U.S. parent by charging more in royalties to its subsidiaries in Europe, Africa, and South America for the use of its trademarks and formulas from 2007-09. Proceedings in the case, Coca-Cola Co. v. Commissioner, wrapped up this year after an 8-week-long trial in 2018.
Energy giant Exxon Mobil Corp. is also awaiting a court ruling in a billion dollar IRS case. The agency rejected $1.36 billion in tax refunds claimed by the company, rejecting arguments that Exxon should receive the refunds because its gross income calculation should have excluded an alcohol fuel tax credit and because certain transactions in Qatar and Malaysia count as mineral leases instead of purchases. The U.S. District Court for the Northern District of Texas heard the case, Exxon Mobil Corp. v. United States, in June 2019.
Observers are waiting to see if Intel-owned Altera Corp. decides to seek Supreme Court review in a closely-watched tax case. Altera unsuccessfully challenged IRS regulations (T.D. 9088) governing the taxation of stock option compensation that has been shifted between U.S. and foreign entities of a multinational company.
Major companies including Facebook Inc., Google LLC, and Apple Inc. have weighed in on the case, Altera Corp. v. Commissioner. The companies argued the Ninth Circuit’s decision to uphold the regulations “threatens to shatter the hard-won but fragile international consensus on treatment of hundreds of billions of dollars of intercompany payments.”
Challenging Tax Regulations
CIC Services LLC has until Jan. 17 to ask the Supreme Court to review the Sixth Circuit’s decision in CIC Servs. LLC v. IRS.
The company challenged the agency’s action against micro-captive transactions, in which a taxpayer or someone related to them treats a company as a captive insurance company in an attempt to reduce taxable income. CIC Services was an adviser on the transactions when the IRS issued guidance declaring them to be reportable for tax purposes.
The firm has argued that the Anti-Injunction Act shouldn’t prevent it from being able to challenge a tax regulation in court before the regulation has been enforced against it.
“It’s hard to say whether the Court actually will grant cert or whether the issue will arise in another circuit court case in 2020,” said Kristin Hickman, a professor at the University of Minnesota Law School and former special adviser to the administrator of the Office of Information and Regulatory Affairs.
A strong divide between Sixth Circuit judges suggests the high court could seriously consider taking the case, but the justices may still conclude the issue doesn’t rise to the level of review because there isn’t a split among the circuit courts.
Trump Tax Returns
One issue already on the Supreme Court’s docket for next year is Trump’s efforts to block subpoenas for his financial documents.
The court scheduled arguments in March on three case involving the president’s records.
In Trump v. Vance, a New York grand jury subpoenaed the president’s accounting firm, Mazars USA LLP. In Trump v. Mazars USA LLP, the House Oversight and Reform Committee subpoenaed financial documents from Mazars. In Trump v. Deutsche Bank AG, the House Financial Services and Intelligence committees subpoenaed financial documents.
A ruling in those cases is expected by the time the Supreme Court wraps up its 2019-2020 term, which typically happens in late June.
Other lawsuits focused on Trump’s tax returns are still winding their way through lower courts, including the House Ways and Means Committee’s lawsuit seeking to obtain years of the president’s personal and business returns.