SCOTUS SEC Fraud Ruling Could Affect Tax Penalty Disputes

According to Law360, The U.S. Supreme Court's groundbreaking decision to curb the U.S. Securities and Exchange Commission's in-house fraud enforcement could hamper the IRS' ability to assert certain penalties, including in contested conservation easement cases, and challenge the U.S. Tax Court's authority to review them.

In a 6-3 decision in a case known as SEC v. Jarkesy et al., a majority of the Supreme Court justices in June struck down the SEC's longtime use of tribunal administrative proceedings to impose securities fraud penalties on a hedge fund manager and his investment firm. They said the antifraud provisions the agency had sought to enforce mirrored common-law fraud, which warrants a federal jury trial to adjudicate them under the Seventh Amendment.

Although the underlying dispute in the Jarkesy case does not pertain to the tax code, the opinion's constraints on SEC enforcement may trickle down to other regulatory agencies, including the Internal Revenue Service. The effect could be a further restriction of tax administration amid other Supreme Court decisions this summer that have reduced agencies' powers, including in Loper Bright Enterprises v. Raimondo, Relentless Inc. v. Department of Commerce and Corner Post Inc. v. Board of Governors.

The current Supreme Court majority is "very suspicious of administrative power and administrative overreach, and is doing things to rein in lawmaking and regulatory work through the executive branch," Christopher J. Walker, professor at University of Michigan Law School, told Law360.

Individuals, businesses and other entities are starting to pounce on the opportunity to use the Jarkesy opinion as another arrow in their legal quiver to challenge the IRS' penalties.

For example, six partnerships with pending U.S. Tax Court disputes have already asked the court to toss the civil fraud penalties the IRS has assessed against them under Internal Revenue Code Section 6663. They all made similar claims influenced by the Jarkesy case that the Tax Court, which is unable to provide a jury trial, is not the forum to adjudicate the fines, which have amounted to millions of dollars for some partnerships.

Some practitioners told Law360 that the decision could implicate other IRS penalties, such as fees levied on tax filing inaccuracies and on promoting arrangements the agency deems to be abusive tax shelters.    

The Jarkesy decision also raises the question on whether the Tax Court — which settles disputes between the IRS and taxpayers — is indeed the appropriate forum to formally judge tax penalties.

Frank Agostino of Agostino & Associates PC said if those challenges are successful, it could prevent the IRS from assessing the penalties in the first place.

"The hope," he said, is that the Jarkesy decision "will get the Tax Court out of the penalty business and thereby essentially stop the IRS from asserting the penalties."

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