"substantial authority" and state law

George S. Mauerman v. Commissioner , TC Memo. 1993-23, 65 TCM 1772, Filed January 19, 1993


In its discussion of a "substantial authorit" issue, this case made the following comment relative to state law:

Although State law creates legal interests and rights, the Federal revenue acts designate how the interests or rights so created shall be taxed. United States v. Mitchell [71-1 USTC ¶9451 ], 403 U.S. 190, 197 (1971), and cases there cited. Once rights are obtained under State law, whatever they are called, these rights are subject to the Federal definition of taxability. Helvering v. Stuart [42-2 USTC ¶9750 ], 317 U.S. 154, 162 (1942). If an interest or right created by State law is intended by the Congress to be taxed, then the Federal law prevails no matter what name is given to the interest or right by State law. Morgan v. Commissioner [40-1 USTC ¶9210 ], 309 U.S. 78, 81 (1940).

In interpreting the words used in a Federal revenue act, State law is not controlling unless the Federal statute "by express language or necessary implication, makes its own operation dependent upon state law." Heiner v. Mellon, 304 U.S. 271, 279 (1938); Burnet v. Harmel [2 USTC ¶710 ], 287 U.S. 103, 110 (1932). -----------------------------


The above cited case involved a "substantial authority" issue in which state law was examined. The above language outlines how or when state law is used. For example, the issue of whether or not there has been a "fraudulent transfer" (an issue that could trigger a 6694 penalty), depends on an analysis of state law.

The Temporary regulations do not describe state law in its guidance on an "analysis" of the relevant "authorities." I believe that is a correctable omission in the Temporary Regulations. As another example, the existance or validity of a trust depends on state law and there are tax conseqences that depend on whether or not there is a valid trust.

This is simply a "heads up" that there are many tax issues that require one to be able to apply state law. The requirment that an undisclosed position be supported by an analysis of the relevant authority necessarily includes state law in some cases.

Given the complexity of applying state law, the Final Regulations could create a safe harbor for state law issues. On the other hand, the complexity of the law would be a "reasonable cause" consideration.