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Supreme Court Strikes Down Rule for Allocating Tax Refunds Among Members of Consolidated Groups

(Parker Tax Publishing March 2020)

The Supreme Court held that the Bob Richards rule, a federal common law rule which generally provides that a consolidated group's tax refund belongs to the member of the consolidated group responsible for the losses that led to the refund unless the parties' tax allocation unambiguously states otherwise, is not a legitimate exercise of federal common lawmaking because the rule is not supported by any sufficiently significant federal interest. The Court found that state law is well-equipped to handle disputes involving corporate property rights, including ones that involve federal bankruptcy and a tax dispute. Rodriguez v. FDIC, 2020 PTC 72 (S. Ct. 2020).

United Western Bank (Bank) entered receivership and was taken over by the Federal Deposit Insurance Corporation (FDIC). Not long after that, Bank's parent, United Western Bancorp, Inc. (Bancorp), was forced into bankruptcy. Simon Rodriguez was appointed the trustee of Bancorp in the bankruptcy. Bank and Bancorp were part of an affiliated group that filed a consolidated federal tax return under Code Sec. 1502. When the IRS issued a $4 million refund, both Rodriguez and the FDIC sought to claim the money and, unable to resolve the dispute, the parties took the matter to court. The case wound its way through a bankruptcy court and a federal district court before eventually landing in the Tenth Circuit. The Tenth Circuit ruled for the FDIC, as receiver for the subsidiary bank, rather than for Rodriguez, as trustee for the corporate parent.

The Tenth Circuit applied a federal common law rule called the Bob Richards rule, named after a Ninth Circuit case: In re Bob Richards Chrysler-Plymouth Corp., 473 F.2d 262 (1973). The rule originally said that if no tax allocation agreement exists, a consolidated group's tax refund should be allocated to the group member responsible for the losses that led to it. The rule evolved into a more expansive general rule, which some courts follow unless the parties' tax allocation agreement unambiguously specifies a different result. The Tenth Circuit examined the parties' tax allocation agreement, applied the more expansive version of the Bob Richards rule, and ruled for the FDIC. Rodriguez appealed to the Supreme Court.

Before the Supreme Court, the FDIC argued that, even if the Bob Richards rule was an improper application of federal common lawmaking, the Tenth Circuit properly consulted applicable state law and its decision followed naturally from state law. The FDIC also argued that the Tenth Circuit's decision was supported by the rules in Reg. Sec. 1.1502-77(a) and (d). Rodriguez disagreed and contended that, absent the Bob Richards rule, the Tenth Circuit would have reached a different result.

The Supreme Court vacated and remanded the Tenth Circuit's decision. First, the Court noted that the Bob Richards rule is not followed in all circuits. For example, in FDIC v. AmFin Financial Corp., 757 F.3d 530 (2014), the Sixth Circuit observed that federal common law "constitutes an unusual exercise of lawmaking" and held that there is no conflict between a federal policy or interest and state law that justifies resorting to federal common law in cases involving tax refund allocations.

The Supreme Court explained that federal common lawmaking plays a modest role under the Constitution because legislative powers are vested in the Congress and most other regulatory authority is reserved to the states. According to the Court, before federal judges may engage in common lawmaking, strict conditions must be satisfied - one of which is that, in the absence of congressional authorization, common lawmaking must be necessary to protect uniquely federal interests.

In the view of the Court, there was no uniquely federal interest to protect in this case. The Court reasoned that the federal government may have an interest in how it receives taxes from corporate groups and in regulating the delivery of a refund to a corporate group. But the Court did not see what unique interest the federal government could have in determining how a consolidated corporate tax refund, once paid to a designated agent, is distributed to group members. The Court agreed with the Sixth Circuit that the Bob Richards decision, and the courts applying and extending the rule, had not identified the federal government's interest in such a case but simply bypassed the question.

The Court went on to reason that state law is well-equipped to handle disputes involving corporate property rights, given that corporations are creatures of state law. In the Court's view, the fact that this case involved corporate property rights in the context of a federal bankruptcy and tax dispute did not change the outcome. The Court pointed out that the determination of property rights in a bankruptcy is made under state law and that the Internal Revenue Code generally does not create property rights.

The Court also rejected the FDIC's argument that the Tenth Circuit's decision should stand even if it improperly applied the Bob Richards rule. The Court explained that it did not take this case to decide how it should be resolved under state law or to determine how IRS regulations might interact with state law. Rather, the Court said that it took this case only to underscore the care federal courts should exercise before taking up an invitation to try their hand at common lawmaking. In the Court's view, whether this case might yield the same or a different result without Bob Richards was a matter for the Tenth Circuit to consider on remand.

For a discussion of consolidated income tax returns for C corporations, see Parker Tax ¶42,120.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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