In Ax v. Commissioner, 146 T.C. No. 10, the U.S. Tax Court held that the IRS could raise new arguments in court for the first time in deficiency cases despite the Administrative Procedure Act. This case confirms that the IRS’s notice of deficiency does not have to include all issues for these cases.

Facts & Procedural History

The taxpayers formed a captive insurance company and deducted the premiums. The IRS disallowed the deductions and stated in the notice of deficiency: “You did not establish that the amount shown was (a) insurance expense, and (b) paid.”

The taxpayers brought suit against the IRS in the U.S. Tax Court to dispute the notice of deficiency. The IRS filed an answer that did not make any affirmative allegations as to the disallowed insurance expense deductions.

After the case was stricken from a trial calendar and continued generally, the IRS moved for leave to amend his answer to assert “that a) [taxpayers’] use, through solely controlled flow-through entities, of a micro-captive insurance arrangement in 2009 and 2010 lacked economic substance; and b) amounts paid as premiums through the micro-captive arrangement were neither ordinary nor necessary” and to allege facts in support of those assertions.

The taxpayers opposed the IRS’s motion for leave, citing the U.S. Supreme Court’s Mayo Foundation for Med. & Educ. Research v. United States, 562 U.S. 44, 55 (2011) decision.

As argued by the taxpayers, Mayo stands for the proposition that “the Administrative Procedure Act and Securities and Exchange Commission v. Chenery Corp., 318 U.S. 80 (1943), case bar the IRS from raising new grounds to support his final agency action beyond those grounds originally stated in the notice of deficiency.

Court Conclusion 

The court concluded that Chenery may restrict a reviewing court from relying on reasons not considered by an agency in its determinations, but only as to matters that Congress has exclusively entrusted to the administrative agency.

Here, the court noted that Congress expressly authorized the U.S. Tax Court to redetermine tax liabilities in a deficiency case in Sections 6212 and 6213 . The court reasoned that the enactment of the Administrative Procedures Act did not change this regime for deficiency litigation that Congress had previously enacted.

Thus, the court concluded that in a deficiency case (i.e., a case where the taxpayer is asking the court to determine its tax liability), the IRS may plead grounds not in the notice of deficiency.

The court also argued that this allowance is not at odds with the uniform approach to judicial review of administrative action that is called for in Mayo Foundation.

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