On October 17 the Federal Circuit issued an opinion that helps put an end to the bizarre argument made in Notice 2018-18, 2018-12 IRB 443. The court of appeals concluded that the taxpayers inappropriately determined that nonprofit entities aren't corporations (Charleston Area Medical Center Inc. v. United States, No. 2018-2226 (Fed. Cir. 2019), aff'g 138 Fed. Cl. 626 (2018)).
Charleston Area Medical Center Inc. was one of two section 501(c)(3) nonprofit medical centers that brought class action lawsuits against the United States to recover interest based on the statutory rate paid to corporations under section 6621(a)(1). In calculating the medical centers' refunds, the IRS used a lower interest rate because, in its view, the medical centers were corporations.
The Court of Federal Claims concluded that nonprofit entities incorporated under state law are corporations for purposes of section 6621(a)(1)’s interest calculation provision. It explained that in defining corporation, section 7701(a)(3) uses a non-exhaustive list of entities that includes associations, joint-stock companies, and insurance companies, and that the list is in no way intended to shrink the definition.
The lower court also relied on section 6621's use of the term “C corporation” in a later provision that came from the same legislation. Citing Supreme Court case law, the court explained: “Where Congress includes particular language in one section of a statute but omits it in another section of the same Act, it is generally presumed that Congress acts intentionally and purposefully.” This principle applies to various Tax Cuts and Jobs Act interpretations that the IRS is struggling with — including not respecting the use of “taxable year” in section 951A or in section 245A, the territorial dividends received deduction.
Citing Chevron, the claims court concluded that “corporation” is not an ambiguous term subject to interpretation by Treasury and the IRS. Affirming, the Federal Circuit noted that the court's logic and holding are consistent with decisions from the Second, Sixth, Seventh, and Tenth circuits, which have all held that nonprofit corporations are to be paid interest at the corporate rate under section 6621(a)(1). According to Notice 2018-18, the agency is set to argue that S corporations aren't corporations. Charleston Area Medical Center was the first case to add color to the notice — and to the type of corporation that can hold a carried interest under section 1061(c)(4)(A).
Taxing Carried Interest Beyond the Law
For purposes of the TCJA’s new carried interest holding period, section 1061(c)(4) provides that the term “applicable partnership interest” excludes any interest in a partnership directly or indirectly held by a corporation. Notice 2018-18, which was released March 1, 2018, announces that coming IRS regulations effective for tax years beginning after 2017 will exclude S corporations from the term “corporation.” This violates the plain wording of the statute and will result in another IRS loss if litigated.
In Charleston Area Medical Center, the Federal Circuit explained the following regarding Notice 2018-18:
The Taxpayers argue that the Notice supports its interpretation of the statute. . . . The Taxpayers characterize this Notice as “formal administrative guidance” that “holds that the term ‘corporation’ does not . . . encompass S corporations but instead means ‘C corporation.’” Appellant’s Br. at 39. . . . While we question whether the regulations described in the Notice, if codified, would be proper in view of the government’s position in this case that the Code incorporates the broad, common law meaning of “corporation,” we leave that issue for another day. Indeed, the Notice is just that — a Notice regarding regulations that do not yet, and may never, exist.
This decision confirms the arguments against Notice 2018-18 and explains why Treasury has failed to issue the rules described in it. The agency is racking up massive violations of executive power in taxing well beyond the law. Ultimately, Treasury will be known as the agency that did the most harm to the TJCA by moving forward with arguments destined to fail, which appear to point out what Treasury believes are the failures of the TCJA.
For a great discussion of why the notice fails to redefine the term "corporation" for S corporations, see Bruce Lemons and Richard Blau, “Are S Corporations ‘Corporations’ Under the Carried Interest Rules?” Tax Notes Federal, Sept. 2, 2019, p. 1567 (“One could feel some sympathy for the government if the government had not regularly and unfailingly recited the S-corporation-is-a-corporation mantra in urging courts to treat an S corporation as a corporation outside subchapter S. In litigation, the government uniformly took a position contrary to the administrative position that it now asserts.”).
Correction, October 18, 2019: An earlier version of this opinion conflated the plaintiffs’ and defendant’s positions.