November 2007

November 2007

November 2007

November 2007

EMPLOYMENT & LABOR LAW
JUDICIAL LAW

• Whistleblowing.The failure of a nursing home administrator to meet safety standards warranted her termination and negated any pretextual claim of violation of the Minnesota whistleblower statute. Affirming this ruling from the U.S. District Court in Minnesota, the 8th Circuit Court of Appeals upheld that the close proximity between the time the claimant objected to a policy that she believed was unlawful and her subsequent termination was not sufficient to overcome the legitimate safety reasons for her termination. Buytendorp v. Extendicare Health Services, Inc., 2007 WL 2376338 (8th Cir. 2007).

• Discrimination; Gender. An employee, who was terminated for improper conduct including a threat to kill a married coworker with whom she had an affair, was not entitled to pursue a gender discrimination claim against the U.S. Postal Service. The discrimination claim failed because there was no showing that the supervisor was motivated by gender-bias in the termination, which followed the employee’s arrest for the murder threat. Shaffer v. Potter, 2007 WL 2375770 (8th Cir. 08/22/07).

• Discrimination; Defamation. The written response by one of the defense attorneys to a terminated employee’s claim of age and sex discrimination, in which the attorney cited the employee for insubordination and poor performance, could not give rise to a defamation claim. The company’s reply to the request of the employee’s attorney for a reasonable severance based upon sex and age discrimination was privileged because it was made in response to a threatened lawsuit. Humann v. KEM Electric Cooperative, Inc., 497 F.3d 810 (8th Cir. 2007).

• ERISA; Long Term Disability Benefits.An employee’s long term disability benefits properly ceased after the employer was twice acquired and the successor employer was not required to perpetuate the prior plan under the Employment & Retirement Income Security Act (ERISA). The employee, who needed two liver transplants, challenged the termination of his benefits by the successor-former employer, claiming that there were procedural irregularities that warranted heightened judicial review of the decision by the plan administrator to end the benefits. But the 8th Circuit disagreed, upholding the decision on a more lenient abuse-of-discretion standard. LaSalle v. Mercantile Bancorporation, 2007 WL 2331890 (8th Cir. 08/17/07).

• Workers Compensation; Ancillary Jurisdiction.Clarifying precedent, the Minnesota Supreme Court held that when a direct claim for workers compensation benefits is made and the employer asserts a claim of insurance coverage, the latter claim falls within the ancillary jurisdiction of the workers compensation tribunal. This doctrine of ancillary jurisdiction, although implied in precedent case law, is now made explicit. On the merits, coverage existed because the insurer was estopped from denying coverage based upon representation made by its agent to an “unsophisticated” business owner. But, the employer, who prevailed on the coverage issues, was not entitled to reimbursement of attorneys fees, which is impermissible under a breach of contract doctrine. Schmitt v. Innovative Law Systems, Inc., 2007 WL 2874943 (Minn. 09/26/07).

• Unemployment Compensation; Temporary Employee; Full-Time. An employee of a temporary agency, who worked 32 or more hours, was presumed to be employed on a full-time basis for purposes of eligibility for unemployment compensation benefits, but was disqualified because he voluntarily quit his job. Working 32 or more hours gives rise to a presumption of full-time employment and the presumption was not overcome in this case. However, the employee was ineligible for benefits because he quit his job without good cause and was not covered by any statutory exemption from disqualification. Lamah v. Doherty Employment Group, Inc., 787 N.W.2d 595 (Minn. 2007).

LEGISLATION

• Discrimination, Arbitration Legislation Considered. A pair of major federal bills making their way through the legislative process would, if enacted, have significant impact upon the rights and obligations of employers and employees.

One measure, the Employment Non-Discrimination Act, would forbid employers from discriminating against individuals in employment decisions based upon their sexual orientation. Twenty jurisdictions, including Minnesota, have similar laws, although one has never been enacted at the federal level. The bill has strong support in the House of Representatives, but its fate is uncertain in the Senate and could run into a presidential veto. Under the law, employers could not base hiring, firing, promotion, or pay decisions on sexual orientation or gender identity. The bill would exempt religious organizations and the military.

Supporters of the measure claim that it extends equal treatment to individuals regardless of sexual orientation. Opponents claim the bill would undermine the rights of people who oppose homosexuals or who object to the requirements for religious reasons.

Another measure, the Arbitration Fairness Act of 2007, would amend the Federal Arbitration Act, 9 U.S. §1 et seq. The major change would provide that a clause in employment agreements calling for mandatory arbitration would not be enforceable if the agreement is entered into before a dispute actually arises. Similar provisions would apply to consumer transactions and franchise disputes. Under existing law, those agreements generally are upheld unless they are unconscionable or cost-preclusive for participants. The measure would also clarify that the act does not apply to collective bargaining agreements between employers and labor unions.

The purpose of the measure is to prevent employees from being forced to accept mandatory arbitration as a condition of employment. Its proponents view the amendment as a way of overcoming unequal bargaining power between employers and employees. Opponents, however, see the measure as an unnecessary means of intruding into rights of management. Similar to the anti-gay discrimination law, the measure is progressing in the House of Representatives, and is likely to be acted upon there before it faces an uncertain future in the Senate.

 — Marshall H. Tanick
Mansfield Tanick & Cohen, P.A.

November 2007

ENVIRONMENTAL LAW
JUDICIAL LAW

• Wetlands—Minnesota; “Waters of the United States” Standard; Rapanos. The United States District Court for the District of Minnesota recently issued its first opinion and order involving the definition of “waters of the United States” since the U.S. Supreme Court’s decision in Rapanos v. United States, 126 S.Ct. 2208 (2006). In its opinion and order, the district court determined that the U.S. Army Corps of Engineers (“the Corps”) has jurisdiction over a wetland if the wetland satisfies the “waters of the United States” standard set forth under either the plurality’s opinion in Rapanos (continuous connection to a relatively permanent body of water) or the “significant nexus” test created under Justice Kennedy’s concurring opinion in that case.

In the case at bar, the defendant had constructed an access road within a site that he had planned to develop into lakeside residences. The defendant’s contractor had constructed the road using material excavated from the site. The Corps had previously informed the defendant that he would need a Clean Water Act §404 permit before placing dredged or fill material on the site. The Corps later denied his after-the-fact §404 permit application and ordered him to restore the property to its pre-road-construction condition at his own expense. When he refused, the Corps brought an action in the district court to enforce its restoration order.

After determining that satisfaction of either of the Rapanos standards would suffice to establish the Corps’ jurisdiction, the district court found the Corps had met its burden of showing that the defendant’s property was a wetland constituting a “water of the United States.” First, it found that the Corps had presented evidence that the wetland extended to the edge of the nearby lake and thus “bordered” or was “contiguous” to the lake. Second, the district court found that even if the wetland did not actually extend to the edge of the lake, the Corps had presented sufficient evidence that the wetland is nevertheless “adjacent” within the Corps’ definition of that term under 33 C.F.R. §328.3(c). The district court determined those factors were enough to satisfy Justice Kennedy’s “significant nexus” test, which was enough to find the Corps had jurisdiction over the defendant’s site. U.S. v. Bailey, No. 05-2245 (D. Minn. 09/25/07).

To date, three U.S. courts of appeals have issued reported decisions on the question of which of the standards established under Rapanos is appropriate for determining whether a wetland constitutes a “water of the United States.” The 1st Circuit Court of Appeals determined, as here, that satisfaction of either the plurality or Justice Kennedy’s standards will establish the Corps’ jurisdiction over a disputed site. The 7th and 9th circuits, in their respective opinions, chose to apply only Justice Kennedy’s standard. The 8th Circuit Court of Appeals has yet to take a position on this issue.

— Bill Hefner
The Environmental Law Group

November 2007

FEDERAL PRACTICE
JUDICIAL LAW

• 8th Circuit; Notable Dissents. Two recent and otherwise run-of-the-mill 8th Circuit decisions are most notable for their dissenting opinions. The first case involved a claim against an insurer for bad faith denial of benefits under South Dakota law. The district court had awarded summary judgment to the insurer and a divided 8th Circuit panel affirmed. However, Judge Bye excoriated the majority in his dissent, accusing it of failing to undertake the “fundamental task” of construing the record in favor of the appellant, “misconstru[ing] the record in order to justify an outcome,” and “completely ignor[ing] issues raised by the appellant which may be dispositive.” Hammonds v. Hartford Ins. Co., ___ F.3d ___ (8th Cir. 2007).

The latter case involved an appeal from summary judgment in a case raising ADEA and MHRA claims. Summary judgment was affirmed by a divided 8th Circuit panel, which found, among other things, that the appellant had waived one argument by failing to raise it in the district court. Judge Beam concurred in the result, but dissented from the rejection of the argument not raised in the district court, citing a recent en banc decision by the 8th Circuit in a criminal case, United States v. Lucas, ___ F.3d ___ (8th Cir. 2007) (en banc), in which the court considered an argument the government had failed to raise both in the trial court and in front of the 8th Circuit panel that had initially heard the appeal. While expressing the view that the en banc decision “presents procedural and substantive problems” making “meaningful appellate review [] almost impossible,” Judge Beam noted that the en banc decision reflected the law in the circuit at present. Carraher v. Target Corp., ___ F.3d ___ (8th Cir. 2007).

• Rule 68; Offer of Judgment to Class Representatives; Case-or-Controversy Requirement. Adopting a report and recommendation by Magistrate Judge Noel, Judge Tunheim rejected one defendant’s attempt to moot a purported FLSA class action and obtain a dismissal under Fed. R. Civ. P. 12(b)(1) by serving Fed. R. Civ. P. 68 offers of judgment on the named plaintiffs prior to their motion for class certification. Judge Tunheim found that plaintiffs’ identification of other potential class members provided evidence that the action would not be mooted by the offers of judgment, and also held that “allowing such a defensive strategy would frustrate the FLSA’s collective action provision allowing for the aggregation of small claims, and would endorse an unacceptably narrow understanding of Article III’s case-or-controversy requirement.” Roble v. Celestica Corp., 2007 WL 2669439 (D. Minn. 09/06/07).

• Expert Witness Stricken; Rule 702; Daubert.Judge Schiltz struck plaintiffs’ purported expert in a product liability case under Fed. R. Civ. P. 702 and Daubert, and, finding no evidence of causation in the absence of expert testimony, entered summary judgment for the defendant. Polski v. Quigley Corp., 2007 WL 2580550 (D. Minn. 09/05/07).

• Removal; Failure to Obtain Defendants’ Consent. Judge Magnuson granted plaintiffs’ motion to remand, finding that the removing defendant had failed to obtain all defendants’ consent as required by 28 U.S.C. §1441(a), and that there was no “separate and independent claim” to support removal under 28 U.S.C. §1441(c). Murrin v. Mosher, 2007 WL 2821799 (D. Minn. 09/25/07).

• Access to Judicial Records. Acknowledging a “common law right of access to judicial records,” but refusing to decide whether the 1st Amendment “creates a presumptive right of access to judicial records in civil cases,” Judge Frank granted in part and denied in part a media intervenor’s motion to unseal documents that had been filed in connection with defendants’ motion for summary judgment. In Re Guidant Corp. Implantable Defibrillators Prod. Liab. Lit., MDL No. 05-1708 (DWF/AJB) (D. Minn. 10/03/07).

— Josh Jacobson
Law Office of Josh Jacobson

INTELLECTUAL PROPERTY
JUDICIAL LAW

• Patents; Mental Process Combined with Machine. The Court of Appeals for the Federal Circuit remanded a case to the patent office to determine whether the addition of computers or communication devices to an otherwise “unpatentable mental process” would be patentable. Comiskey, the patentee, claimed an invention directed to an arbitration system performed through a computer or communication device. The patent office rejected the invention as obvious. The appellate court noted that though pure mental processes (the arbitration system) are not patentable, if those processes are combined with machines, patentable subject matter may result. The patentable subject matter must still be nonobvious, however. The court warned that the “routine addition of modern electronics to an otherwise unpatentable invention typically creates a prima facie case of obviousness,” but that the prima facie case might be overcome if evidence of long-felt need for the combination of the mental process and a communication device or computer existed. Evidence of long-felt need for the mental process alone is not enough. In re Comisky, 2007 U.S. App. LEXIS 22414, 2006-1286 (Fed. Cir. 09/20/07).

• Patents; Invalidity Defense; Assignor Estoppel. Judge Schiltz dismissed Swift’s patent-invalidity defense based on the doctrine of assignor estoppel. Superior sued Swift for infringement of a patent covering a new axle. The two inventors of the patented axle, Murphy and Schmidgall, had earlier assigned the patent to Superior. At the time of the assignment, Murphy was the founder of Swift. After being sued, Swift asserted that the patent was invalid for naming Schmidgall as an inventor, because allegedly Schmidgall merely oversaw development of the axle. Superior responded that Swift’s invalidity defense should be barred under the assignor estoppel doctrine because Murphy had assigned the patent to Superior. Under the doctrine, one who assigns a patent cannot later challenge its validity. The court agreed, finding that Murphy’s privity with Swift barred its invalidity defense. The court also rejected Swift’s argument that assignor estoppel should not apply when invalidity is based on incorrect inventorship. Superior Indus., LLC v. Swift Mfg. Co., 2007 U.S. Dist. LEXIS 71124, 05-CV-2167 (D. Minn. 09/24/07).

• Trade Secrets; Discovery; “Substantial Factual Basis.” Judge Montgomery overruled Equifax’s objections to Magistrate Judge Mayeron’s order granting Fair Isaac’s motion to compel production of an algorithm trade secret. Fair Isaac sued Equifax for unfair competition and false advertising after Equifax developed a competing algorithm that calculates consumer credit scores. Equifax objected to an order compelling production of the algorithm and proposed that the court adopt a new standard for analyzing trade secret discovery disputes. Equifax argued that a new standard would increase the plaintiff’s burden by requiring it to show a “substantial factual basis” for the claims before obtaining discovery of the trade secret. Judge Montgomery expressed doubt that the factual basis requirement was necessary under the old test and agreed with Judge Mayeron’s conclusion that even if a substantial factual basis was required under the test, Fair Isaac fulfilled it. As a result, in the future, the court may include the substantial factual basis factor in its analysis of trade secret discovery disputes. Fair Isaac Corp. v. Equifax, Inc., 2007 U.S. Dist. LEXIS 71187, 06-4112 (D. Minn. 09/25/07).

— Tony Zeuli
— Beth Zidones
Merchant & Gould

November 2007

REAL PROPERTY
JUDICIAL LAW

• Judgment Lien; Creditor Redemption from Foreclosure Sale. During the homeowner’s redemption period of a mortgage foreclosure sale, a property investor purchased a conciliation court judgment against the homeowner and tendered a transcript of the judgment, the assignment of the judgment, and an affidavit of identification of the judgment debtor to the district court administrator. However, the district court administrator did not docket the judgment until 19 days later, which was the homeowner’s last day to redeem from the foreclosure sale. The judgment was docketed about an hour and a half after the judgment creditor had recorded its notice of intent to redeem as a junior creditor. After the homeowner failed to redeem, the judgment creditor attempted to redeem from the foreclosure purchaser’s assignee by tendering certified redemption funds to the sheriff. The sheriff issued a certificate of redemption, but the purchaser’s assignee subsequently refused to accept the redemption funds and returned the funds to the sheriff claiming that the judgment creditor did not have a right to redeem due to the fact that its notice of intent to redeem was recorded before its judgment was docketed.

The district court ruled that the purported redemption was invalid and that the judgment creditor’s assignee did not have valid title to the property. The issue on appeal was whether the judgment creditor had a right to redeem when its purported lien upon which the redemption was based had not yet been docketed when its notice of intent to redeem was recorded. The Court of Appeals affirmed the district court’s ruling. The Court of Appeals noted that Minnesota appellate courts have strictly construed the judgment-docketing requirements and have held that a judgment does not become a lien upon real property until it is docketed. Because the docketing of a judgment is necessary to create a judgment lien, a notice of intent to redeem that is recorded before docketing is void.

The Court of Appeals applied this principle despite the fact that the judgment creditor had submitted the necessary documentation to the court administrator 19 days earlier and the delay in docketing was apparently through no fault of the judgment creditor. The Court of Appeals cited to Minn. Stat. §548.08, subd. 3 which states the court administrator is liable to a person damaged by the administrator’s failure to docket the judgment in the sum of five dollars and noted that the statute does not provide that the judgment is considered docketed if the administrator violates the statute. The Court of Appeals rejected the judgment creditor’s public policy argument of harsh results due to bureaucratic backlogs in favor of the public policy of consistency in determining lien priority among judgment creditors. The Court of Appeals also rejected the judgment creditor’s argument that the purchaser’s assignee lacked standing to challenge the redemption because the purchaser’s assignee became the owner of the property upon the expiration of the debtor’s redemption period. C & M Real Estate Services, Inc. v. Thondikulam, 2007 WL 2829170 (Minn. App. 2007).

• Cartways; Waterways. A landowner on the west side of an island on Leech Lake petitioned the county for a cartway to provide access to his land from the east side of the island over land owned by others. The western shore of the island is steeper than the eastern shore and lacks the shelter of the eastern side, which petitioner claimed prohibited access on the west side of the island during poor weather. A platted trail starts on the east shore of the island and runs west to the lots on the western shore. However, at certain places along the platted trail, topography on the island makes it more convenient to access the island over private land. A bulldozed trail follows the platted trail except at two points where it strays from the platted trail and follows the island’s topography over private land. After failing in a separate proceeding to gain access to his land using the existing trail over private property under the theories of statutory dedication, common-law dedication, easement by implication, easement by necessity, and easement by prescription, the petitioner brought this action by petitioning the county for a cartway. The petitioner claimed that Minnesota’s cartway statute should be interpreted to allow him access to his property from the east side of the island over the private land when poor weather prohibits travel to the west side of the island. The county denied the cartway petition. The district court affirmed the county’s denial of the cartway petition, finding that the petitioner already had access to his property across Leech Lake. The district court rejected the petitioner’s interpretation of the cartway statute, claiming it would wreak havoc upon nearly every island upon every body of water in Minnesota. The Court of Appeals affirmed the district court in denying the cartway petition, stating that the purpose of a cartway is to connect a petitioner’s land with a public road and that a lake is not a public road for cartway purposes. The court declined to rely on case law purportedly analogizing navigable streams to highways for non-cartway purposes, and instead relied on the fact that waterways are not included in the types of roads and highways defined in the statutes relevant to cartways. In the Matter of the Petition of Michael C. Rollins, 2007 WL 2769889 (Minn. App. 2007).

— Michael Kreun
Beisel & Dunlevy

TAX
JUDICIAL LAW

• Property Tax: Special Assessment for Sewer Project. The Minnesota Court of Appeals upheld the imposition of Minnesota property tax on a special assessment for the installation of a sewer system because the taxpayers received a net benefit from the improvement to their properties. The project provided sewer system capabilities to properties that had only septic systems; increased the available sewage output capacity from the properties; and increased the fair market value of the properties because of the ability to hook up to the sewer system. Therefore, the taxpayers failed to prove that the special assessment was greater than the benefit. Steinke v. ColumbusTownship, A06-1009, 2007 WL 1674272 (Minn. App. 06/12/07).

• Real Property: Valuation of Residential Apartment Building. The Minnesota Tax Court reduced the January 2, 2004 assessment on a three-story apartment building containing 36 bedroom units with 14 parking spaces located in the Powderhorn neighborhood of Minneapolis from $1,706,000 to $1,671,000, payable 2005. The taxpayer’s expert, although thoroughly familiar with investment assets and possessing an MBA in finance and accounting, was not certified as an expert, but testified to value only as a lay person. The county’s expert was qualified as expert but the court found that both value witnesses had flaws in their approaches to determining value. Because of the age of the building, the cost approach was not used by either party. The comparable sales method was used by both witnesses but had substantial flaws and was disregarded by the court, which solely relied on the income analysis of the county’s expert. Powderhorn Quarters, Inc. v. County of Hennepin, No. 32360 (Minn. T. Ct. 08/06/07).

• Real Property: Valuation; “Highest and Best Use.” The Minnesota Tax Court determined that the “highest and best use” for the Sears department store located in the Burnsville Center was as vacant land for redevelopment and improvement as an anchor store, and concluded that the fair market value should be increased to $8.75 million in 2003 and to $8.375 million in 2004. The issues in the case related to the fair market value for the assessment dates of January 2, 2003 and January 2, 2004, as well as the property’s “highest and best use.” The court accepted the county’s contention that the land may not be continued in use as an anchor store in operation but, rather, for an alternative use. The assessor placed a January 2, 2003 estimated market value on the property of $7.795 million and a January 2, 2004 estimated market value of $7.795 million. The cost approach was used by the court only to determine the land value. The sales and income approach were then reconciled and the fair market value in 2003 was determined to be $8.75 million and $8.375 million in 2004. The taxpayer’s appraisal for the income and sales approach was found to lack explanation and support, and therefore was disregarded. Sears, Roebuck & Co. v. County of Dakota, C4-04-7619, C8-05-7374, 2007 WL 2481290 (Minn. T. Ct. 08/30/07).

• Procedure: Company President Liable for Withholding-Tax Defaults. The Minnesota Tax Court held the president of a mortgage banking business personally liable for the withholding taxes for the third quarter of 2004 pursuant to Minn. Stat. §270C.56 and §290.92. Applying the “functional” test set forth in Benoit v. Commissioner of Revenue, 453 N.W.2d 336 (Minn. 1990), the court found that the taxpayer (1) served as corporate president and was on the board of directors for approximately two years preceding the quarter for which tax liability was asserted; (2) had check-signing authority as of May 11, 2004 for approximately two months prior to the period for which tax liability is alleged; (3) hired and fired various employees within the company; (4) had access to all financial records and information of the business during the quarter in which withholding tax was unpaid; and (5) held 11 percent of the company’s stock. The court refused to allow personally liable taxpayers to escape their obligation where they have the ability, control, and responsibility and they simply chose not to exercise it. Id. A corporate officer’s delegation of duties and powers does not relieve him of personal liability if he remains in legal control, even though he chooses not to exercise that control. Bradley Erpelding v. Commissioner of Revenue, No. 7854 (Minn. T. Ct. 09/12/07).

• Installment Payment Agreement Refused; Current Ability to Pay Considered. The 8th Circuit ruled that an IRS appeals officer properly considered a marketing company’s current ability to pay when the officer declined to enter into an installment agreement that would have allowed the company to repay its employment tax arrearages. The business contended that, in declining to enter an installment agreement in which it would make payments of between $50,000 and $100,000 a month, an IRS appeals officer failed to consider its current ability to make payments. Additionally, the taxpayer said the officer failed to balance the need for efficient tax collection against the need to minimize the intrusiveness of such collection. In reviewing the record, the court found the IRS properly rejected the agreement because the business would not be able to comply with its own proposal. Below Sales & Marketing, Inc. v. U.S., 100 AFTR 2d ¶ 2007 – 5551 (8th Cir. 2007).

• Installment Payment Agreement Refused; Abuse of Discretion. The Minnesota Supreme Court found that the IRS abused its discretion in rejecting a company’s proposed installment agreement, and ordered the IRS to reconsider the offer. After suffering a downturn in business, the company crept out of the red in 2006 under new ownership. In response to notices of intent to levy for unpaid 2005 employment taxes, the company proposed an installment plan. It offered to (1) pay $6,000 monthly in the 2005 liabilities, (2) timely file returns for the first quarter of 2006 and pay half its liability for that period, and (3) make timely deposits for the second quarter of 2006. The appeals officer advised the company’s counsel that he would give a green light to the levy unless the company could immediately pay the taxes owed for the first quarter of 2006, which it was unable to do. After the appeals officer rejected the proposed installment agreement; the company filed a CDP appeal. The court concluded that the appeals officer, in summarily rejecting the company’s offer, had violated IRC §6330, failing to balance the interests of efficient collection of the tax with the need to make the collection no more intrusive than necessary. Lofgren Trucking Service Inc. v. United States, 100 AFTR 2d ¶ 2007-5244 (Minn. 09/10/07).

• Interest on Unpaid Taxes Not Recoverable While Funds in Escrow. The Court of Appeals for the Federal Circuit ruled that taxpayers are not entitled to recover the interest they paid on unpaid taxes. The funds belonged to the company and were subject to IRS levy. The funds were being held in an escrow account established by the taxpayers and IRS awaiting the outcome of litigation on the proceeds. The court found that an IRS levy against the taxpayer’s assets and the placement of their funds in an escrow account did not constitute “payment” of their tax liability under IRC §6601. The taxpayers contended that their taxes should be deemed to have been fully paid when IRS levied on their assets in December 1985. According to the taxpayers, after the attachment of the levy, IRS had full dominion and control over the levied assets. The IRS argued that underpayment of interest did not stop accruing at the time of the levies on the taxpayer’s assets because the IRS did not realize funds from the levies and did not apply their funds to satisfy the jeopardy assessments made against the taxpayers. LaRosa International Fuel Co. Inc. v. U.S., 100 AFTR 2d ¶ 2007-5275 (Fed. Claims, 2007).

• Non-Physical Personal Injury Awards Taxable. The Court of Appeals for the D.C. Circuit denied the taxpayer’s request for a rehearing by the full court of its reversal of its controversial decision that taxing awards for non-physical personal injury unrelated to lost wages or earnings was unconstitutional. Thus, this decision lets stand the court’s revised holding (on rehearing) that awards for non-physical personal injury unrelated to lost wages or earnings aren’t excludable under IRC §104(a)(2). Such awards are included in gross income under IRC §61, and a tax on them is within Congress’ powers. Murphy v. IRS, 100 AFTR 2d ¶ 2007-5277 (C.A. D.C., 2007).

• Promissory Note Constituted Gross Income. The $1.5 million that a grocery store operator received from its principal supplier during the year did not constitute a loan, and thus was includable in its gross income. Following the reasoning of Commissioner of Internal Revenue v. Indianapolis Power & Light Co., 493 U.S. 203 (1990), the court determined that the amount was an advance payment rather than a loan because the taxpayer had some guaranty that it would be allowed to retain the funds. Here, a supplier agreed to make $1.5 million immediately available to the grocer, evidenced by a promissory note. The supply agreement required the grocer to repay the note in six annual payments of $250,000. However, if the grocer met the supply requirement for the previous calendar year by purchasing the stipulated amount from the supplier’s products, the $250,000 due and owing for that year would be forgiven. Karns Prime & Fancy Food Ltd. v. Commissioner, 100 AFTR 2d ¶ 2007-5282 (3rd Cir., 2007). (The court distinguished the decision in WestPac Pacific Food, et al. v. Commissioner, 451 F.3d, 970 (9th Cir. 2006). After the decision in Karns Prime, the IRS advised the court that the IRS had just issued a revenue procedure following WestPac. See Rev. Proc. 2007-53, 2007-30 IRB 1.)

• “Small Tax Case”: Question is Amount Unpaid, Not Amount in Dispute. The U.S. Tax Court ruled that even though the tax liability actually being disputed by taxpayers was less than $50,000, the taxpayers still do not qualify for the “small tax case” procedures under IRC §7463(f)(2) if the total amount of unpaid tax exceeds $50,000 for agreed and disagreed issues. Patrick Leahy v. Commissioner, 129 T.C. No. 8 (09/17/07) and Petrone v. Commissioner, 129 T.C. No. 1 (2007). See also Schwartz v. Commissioner, 128 T.C. 6 (2007) (same issue in the collections due process settting: relief encompasses both assessed and unassessed interest and penalties and agreed and disagreed amounts).

• Transferred Property Part of Estate if Right to Income Retained. The 9th Circuit ruled that the full value of a property transferred inter vivos to a partnership formed to facilitate the transfer of the property to the property owner’s children and grandchildren was a testamentary substitute, and was part of the gross estate for federal income tax purposes if the former owner retained the right to the income under IRC §2036. She retained for her life the right to the rental income from the property and its economic benefit under an implied agreement that the court found. Estate of Bigelow v. Commissioner, 100 AFTR 2d ¶ 2007- 5271 (9th Cir. 2007).

• Collection: Opportunity to Dispute Liability Denied. The Tax Court held that a taxpayer didn’t have an opportunity dispute his underlying tax liability under IRC §6330(c)(2)(B) in a hearing before a levy where his request to appeal an increased assessment under IRC §6213(b)(2) was denied before the hearing was scheduled. However, the court also concluded that the taxpayer’s challenges to his underlying tax liability were groundless. As a result, the IRS refusal to consider them at his levy hearing was harmless error. Perkins, 129 T.C. No. 7 (2007).

• Royalty Deductions Disallowed On Grounds of “Sham.” The Massachusetts Appellate Tax Board held that the transfer and license-back transactions between a Massachusetts parent corporation and its out-of-state intangible holding company subsidiaries were “sham transactions” because they lacked “economic substance” and any “business purpose.” Consequently, the revenue commissioner properly disallowed the parent corporation’s deductions for royalties paid to certain wholly-owned foreign subsidiaries, and abatement was properly denied. The TJX Companies, Inc. v. Commissioner of Revenue, Mass. App. T. Bd., No. C-262229-31 (08/15/07).

• Combined Reporting Not Required for Parent and Subsidiary Marketing Company. The New York Tax Appeals Tribunal upheld the ALJ’s ruling that a company’s separate state income tax return for 1999 accurately reflected its business, income, activities and capital in New York and thus it was not required to file on a combined basis with its parent. In reaching this conclusion, the tribunal found that even though the company had substantial intercorporate transactions with its parent, the company was operating on an arm’s-length basis with its parent and the company’s transfer pricing report rebutted the presumption of distortion. Further, in the transfer pricing report, the tribunal found that the company “diligently sought to comply” with New York case law and “engaged recognized experts to apply the methods required in the section 482 regulations.” In the Matter of the Petition of Hallmark Marketing Corp., No. 819956 (N.Y. Tax App. Tribunal 07/19/07).

• Nexus: No Physical Presence in State. An out-of-state intangible holding company that did not have a physical presence in Massachusetts had substantial nexus with the commonwealth because it “purposefully sought to reap economic benefits from the Massachusetts retail marketplace by licensing its assets for use in Massachusetts by [related entities].” In reaching this conclusion, the Appellate Tax Board found the following supportive of a finding of “substantial nexus:” the company’s trademarks were used extensively by the related entities in Massachusetts; the company had the ability to regulate the use of its trademarks in the commonwealth as it had rights of approval over promotional activities, product standards, and store conditions which might damage the value of the trademarks; and the commonwealth provided rights and protections to the company in connection with the use of the trademarks, including access to the judicial system. Moreover, the board found that “[t]he receipt of substantial royalty income over the course of the years at issue represented the realization of the desired economic benefits from Massachusetts.” On the sourcing of the royalty income, the board held that because the company had no property and payroll in Massachusetts, these apportionment factors were inapplicable. Thus, the company’s net income should be apportioned to Massachusetts solely on the sales factor. Geoffrey, Inc. v. Commissioner of Revenue, No. C271816 (Mass. App. 07/24/07).

• Tax on “Non Business Income.” Illinois attempted to tax an approximately $1 billion gain realized by MeadWestvaco Corp. when, in 1994, it sold its investment in Lexis/Nexis (which it acquired in 1968 for $6 million and which functioned for 26 years as an independent, non-unitary business). The Supreme Court recently granted certiorari and is expected to evaluate the move in light of Supreme Court precedent and the Due Process and Commerce clauses of the Constitution. MeadWestvaco Corp. v. Illinois Department of Revenue, No. 06-1413.

• Time to Petition for Redetermination of Liability; Timing of Notice of Deficiency. The Tax Court held that taxpayers were entitled to challenge their underlying tax liability during an IRC §6330 hearing where they received a Notice of Deficiency only 12 days (rather than the typical 90 days) before the period to file a Tax Court petition expired. The court held that 12 days was insufficient time for the taxpayers to petition the court for redetermination on their Notice of Deficiency under IRC Regulation 301.6330-1(e)(3). Accordingly, the taxpayers were not barred from contesting the underlying liability at the IRC §6330 hearing. Kuykendall, 129 T.C. No. 9 (2007).

ADMINISTRATIVE ACTION

• Foreclosure Tax Relief Available. The IRS website, irs.gov has a questions and answers section for people who have lost their homes due to foreclosure. For more information and additional links, see News Release IR-2007-159.

• Soft Water Equipment and Service Dealers. On June 25, 2007, the commissioner adopted a sales and use tax rule (Rule 8130.9000) for soft water equipment and service dealers to reflect that the tax applies to charges for delivery and installation of rented equipment and tanks, including charges to replace or exchange such equipment and tanks, even if those charges are separately stated and if the installation is performed by the lessor of the equipment and tanks. Previously, the rule provided that certain installment and replacement charges related to water-softening equipment were exempt as a personal service. In addition, a rule provision stating that sales of minerals, cells, chemicals, equipment, tanks, parts, and materials to water-softener dealers are taxable when used in conjunction with a water-softening service is repealed. Minnesota Rules, Chapter 8130.9000.

• Employment and Excise Taxes: Disregarded Entities. Final regulations treat qualified Subchapter S subsidiaries and single-owner eligible entities that are “disregarded entities” as separate entities for employment and related reporting requirements. They also treat these “disregarded entities” as separate entities for certain excise taxes reported on Forms 720, 730, 2290, and 11-C, as well as for excise tax refunds or payments claimed on Form 8849, and excise tax registration on Form 637. Therefore, each disregarded entity will be required to obtain its own EIN and report its own payroll, income tax withholdings and FICA, Medicare, and FUTA taxes. Consequently, the cost of payroll compliance could increase substantially. TD 9356; Reg. §1.34-1; Reg. §1.1361-4; Reg. §301.7701-2.

• “Built-In Gain” Rules; Application in Assets-Over Partnership Mergers. IRS issued proposed regs that would provide rules on how the “built-in gain” rules of IRC §704(c)(1)(B) and IRC §737 apply to distributions of property after two partnerships engage in an assets-over merger. Preamble to Prop. Reg. (08/21/2007); Prop. Reg. §1.704-3; Prop. Reg. §1.704-4; Prop. Reg. §1.737-2; and Prop Reg. §1.737-5, found in Federal Register Vol. 72, No. 162, p. 46932.

• Trust’s “Material Participation” for PAL Purposes Measured by Trustees’ Activities. A Technical Advice Memorandum concluded that a trust materially participates in an activity for purposes of the IRC §469 passive activity loss (“PAL”) rules if its fiduciaries participate in the operations of the activity on a regular, continuous, and substantial basis. Further, where a trust’s “special trustees” lack discretionary powers, they aren’t considered fiduciaries for PAL purposes and their activities aren’t taken into account in determining whether the trust “materially participated” in a business. PLR 200733023.

• Circular 230 Rules Modified. IRS issued proposed regulations that would modify the Circular 230 tax return preparation standards to reflect changes made to the “first-tier” return preparer penalty by the Small Business and Work Opportunity Act of 2007 (the Small Business Act, P.L. 110-28). The changes would be effective when the regulations are finalized, but not earlier than January 1, 2008. Under the proposed regulations, a practitioner couldn’t sign a tax return as a preparer unless the practitioner had a reasonable belief that the tax treatment of each position on the return would more likely than not be sustained on its merits, or there was a reasonable basis for each position and each position was adequately disclosed to IRS. A practitioner couldn’t advise a client to take a position on a tax return, or prepare the portion of a tax return on which a position was taken, unless: (1) the practitioner had a reasonable belief that the position satisfies the more likely than not standard; or (2) the position had a reasonable basis and is adequately disclosed to IRS. Prop. Reg. §10.34 of Circular 230, REG-138637-07.

• New Online Employer Identification Number Application. Taxpayers can now request an Employer Identification Number (“EIN”) through a web-based system that instantly processes requests and generates identification numbers in real time. Here’s how it works. A taxpayer accesses the Internet EIN system through irs.gov and enters the required information. If the information passes the automatic validity checks, the IRS issues a permanent EIN to the taxpayer. If the information does not pass the validity checks, it is rejected. The taxpayer then has an opportunity to correct the information and resubmit the application. IR-2007-161.

• Redesigned Allowable Living Expense Standards. The IRS issued the 2007 allowable living expense standards used to determine the ability of a taxpayer to pay a delinquent tax liability. They are effective October 1, 2007. See News Release IR-2007-163.

• Updated Meals and Lodging Rules. The IRS updated the rules for determining the amount of an employee’s ordinary and necessary business expenses for lodging, meals and incidental expenses incurred while traveling away from home that are deemed substantial under IRC Regulation 1.274-5. Revenue Procedure 2007-63, IRB 2007 42 (10/15/07).

LEGISLATION

• New Canadian and U.S. Treaty. The United States and Canada signed a tax treaty in September. This is the fifth updated agreement between the U.S. and Canada since the two countries signed the original treaty in 1980. The protocol would eliminate withholding on cross-border interest payments and provide for binding arbitration of unresolved cases involving double taxation. It still must be approved by the U.S. Senate and the Canadian Parliament. See Daily Tax Report No. 182, at p. 1 (Thursday, 09/20/07).

LOOKING AHEAD

•  Both the president and the Congress have discussed ways of easing the tax burden of home loan debt forgiveness for homeowners, who are losing their homes to foreclosure. The legislation would be geared toward middle-income people and not general relief. On September 26, 2007, the House Ways and Means Committee unanimously approved H.R. 3648, the “Mortgage Forgiveness Debt Relief Act of 2007.” See Daily Tax Report No. 170, at p. G-3 (Tuesday, 09/04/07) and No. 183, at p. G-2 (Friday, 09/21/07).

— Jerry Geis
Briggs & Morgan