Tax shelters and the Code: navigating between text and intent

Virginia Tax Review, Spring, 2007 by Steven A. Dean, Lawrence M. Solan

In affirming the overnight rule, the Court relied upon what it inferred to be the intent of the legislature, based upon a number of factors. First, the language of the statute itself suggests this limitation. The conjunction "meals and lodging" suggests that these expenses were intended to be a unit, and such a unit applies only when the taxpayer stays away from home overnight. Second, at the time Congress enacted section 162(a)(2), the Service had already taken this position through a regulation then in place. The Court thus relied on the canon of interpretation which holds: "Treasury regulations and interpretations long continued without substantial change, applying to unamended or substantially reenacted statutes, are deemed to have received congressional approval and have the effect of law." (34) Third, the Court found it appropriate to defer to the Commissioner since Congress had delegated rulemaking authority to the Service, not the courts. Fourth, the Court recognized the overnight rule as reasonably fair. In some sense, everyone who leaves his or her house has "traveled away from home." There is, however, no conceivable reason why the person who works near his or her abode should be able to deduct breakfast at the local diner while the person who works at home should not. Similarly, why should the person who commutes from New York to Washington in a single day be permitted to deduct a fancy lunch at the expense of the taxpayers? Finally, the Court relied, in a footnote, upon the legislative history of several bills that were intended to repeal the overnight rule, demonstrating that Congress was aware of this rule and failed to change it. (35)

We believe that were this case decided today, nothing very different would happen. Most of the arguments put forward by the Court--the coherence of the rule; its support in the statutory language; a canon of construction taking into account a regulation in place prior to legislative enactment; and deference to the Service--would be accepted by most judges. In contrast, reliance on the legislative history of unenacted bills is considered a weak argument at best, and would probably carry little weight, even with those justices willing to consider it at all. (36)

Correll, however, differs from tax shelter cases in a crucial sense. Mr. Correll did not carefully organize his life to come within the letter of the statute granting the deduction. Rather, he made conventional arguments concerning the interpretation of the Code, and the Supreme Court responded with conventional statutory analysis. Things change when tax attorneys create transactions that take into account ex ante the tools available to a court and navigate through them. As noted earlier, (37) they might create transactions about which the Code is silent or ambiguous and hope for a favorable ruling.

Given this dynamic, courts are likely to have a difficult time disallowing a tax shelter whether or not they rely on legislative history. While courts rely upon legislative intent in making their decisions, they do not rely upon unexpressed legislative intent. The tax planner who is able to take advantage of gaps in the Code and regulations, or who is able to make fair notice arguments whether dealing with a gap or an ambiguity, has a good chance of succeeding.