Tax shelters and the Code: navigating between text and intent

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

At the same time, courts sometimes refuse to construe the Code in favor of the taxpayer when they conclude that they have enough information to infer congressional intent to impose a tax. For example, in F.E. Schumacher Company, Inc. v. United States, (65) the taxpayer had filed its payroll taxes in the correct amount and within the statutory time frame, but had not used the Electronic Federal Tax Payment System (EFTPS), as required under the relevant Treasury Regulation. (66) Section 6656 calls for penalties to be assessed for failure to deposit payroll taxes as follows:

  (a) Underpayment of deposits.--In the case of any failure by any
  person to deposit (as required by this title or by regulations of the
  Secretary under this title) on the date prescribed therefore any
  amount of tax imposed by this title in such government depository as
  is authorized under section 6302(c) to receive such deposit, unless it
  is shown that such failure is due to reasonable cause and not due to
  willful neglect, there shall be imposed upon such person a penalty
  equal to the applicable percentage of the amount of the
  underpayment. (67)

The taxpayer claimed that the penalty did not apply since it had deposited the required funds in a timely manner. The Service argued that by not doing so "as required by this title or by regulations of the Secretary under this title" it came within the penalty provisions.

Relying on the plain language of the statute, the structure of the statute, and a Revenue Ruling, which the court found helpful though not dispositive, the court held for the government. As for the rule that tax laws are to be construed in favor of the taxpayer, the court made the following comment:

  Although these principles inform Tax Code interpretation, they do not
  authorize fragmentary exploitation of any one section in the interest
  of avoiding compliance with the Code or tax liability reduction. The
  Court is without doubt in this case. A cohesive construction of the
  relevant Internal Revenue Code sections permits only one conclusion:
  Section 6656 authorizes penalties for Plaintiff's failure to deposit
  its employment taxes electronically under the EFTPS. (68)

The court further inferred that Congress had intended the penalties to apply when the taxpayer failed to comply with the procedures set forth in the regulations. (69)

Applying the principle that ambiguities in tax laws should be construed narrowly mirrors a parallel approach in the application of the rule of lenity. In 1961, Justice Frankfurter noted the following in an opinion:

  But that "rule," [i.e., the rule of lenity] as is true of any guide to
  statutory construction, only serves as an aid for resolving an
  ambiguity; it is not to be used to beget one. "To rest upon a formula
  is a slumber that, prolonged, means death." The rule comes into
  operation at the end of the process of construing what Congress has
  expressed, not at the beginning as an overriding consideration of
  being lenient to wrongdoers. That is not the function of the
  judiciary. (70)