Renacci v. Testa (Slip Opinion)

[Until this opinion appears in the Ohio Official Reports advance sheets, it may be cited as

Renacci v. Testa, Slip Opinion No. 2016-Ohio-3394.]

NOTICE

This slip opinion is subject to formal revision before it is published in an

advance sheet of the Ohio Official Reports. Readers are requested to

promptly notify the Reporter of Decisions, Supreme Court of Ohio, 65

South Front Street, Columbus, Ohio 43215, of any typographical or other

formal errors in the opinion, in order that corrections may be made before

the opinion is published.

SLIP OPINION NO. 2016-OHIO-3394

RENACCI ET AL., APPELLANTS AND CROSS-APPELLEES, v. TESTA, TAX COMMR.,

APPELLEE AND CROSS-APPELLANT.

[Until this opinion appears in the Ohio Official Reports advance sheets, it

may be cited as Renacci v. Testa, Slip Opinion No. 2016-Ohio-3394.]

Taxation—R.C. 5747.15—Taxpayers had reasonable cause to resist paying tax

based on reasonable but mistaken interpretation of federal statutes—Tax

commissioner abused his discretion in refusing to refund double-interest

penalty.

(No. 2014-1893—Submitted March 8, 2016—Decided June 15, 2016.)

APPEAL and CROSS-APPEAL from the Board of Tax Appeals, No. 2012-1850.

____________________

PFEIFER, J.

{¶ 1} In this case, appellee and cross-appellant, the tax commissioner, first

imposed, and then declined to remit, a double-interest income-tax penalty for delay

of payment. The Board of Tax Appeals (“BTA”) affirmed. The income at issue

was tax year 2000 pass-through distributive-share income from a Subchapter S

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corporation whose shares were held by an “electing small business trust” (“ESBT”)

under federal law. A Subchapter S corporation is often referred to as an “S

corporation.” “Subchapter S of the Internal Revenue Code (Section 1361 et seq.,

Title 26, U.S.Code) permits the owners of qualifying corporations to elect a special

tax status under which the corporation and its shareholders receive conduit-type

taxation that is comparable to partnership taxation.” Ardire v. Tracy, 77 Ohio St.3d

409, 674 N.E.2d 1155 (1996), fn. 1. “For tax purposes, a Subchapter S corporation

differs significantly from a normal corporation in that the profits generated through

the S corporation are taxed as personal income to the shareholders. The taxable

income of an S corporation is computed essentially as if the corporation were an

individual.” Id.

{¶ 2} The delay in payment resulted from a legal dispute concerning the

taxability in Ohio of the income in question. Along with numerous other taxpayers

and their advisors, appellants and cross-appellees, James B. and Tina D. Renacci,

read the pertinent federal statutes as requiring the imposition of tax on the trust

rather than on the individual shareholder. The tax department took the contrary

position, which was ultimately vindicated through our decisions in Knust v. Wilkins,

111 Ohio St.3d 331, 2006-Ohio-5791, 856 N.E.2d 243; Lovell v. Levin, 116 Ohio

St.3d 200, 2007-Ohio-6054, 877 N.E.2d 667; and Brown v. Levin, 119 Ohio St.3d

335, 2008-Ohio-4081, 894 N.E.2d 35.

{¶ 3} The Renaccis ultimately made payment to the state and are pursuing

a refund of the double-interest penalty. The tax commissioner has discretion in his

decision whether to impose or remit the penalty, and in making that decision, he

considers whether the delay in payment was based on “reasonable cause” or

“willful neglect.” R.C. 5747.15(C). Although the statute vests broad discretion in

the tax commissioner, we conclude that in this instance, he abused his discretion in

denying the refund request. The tax commissioner appears to reject the Renaccis’

assertion that they acted in good-faith reliance on a reasonable interpretation of the

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law. The tax commissioner unaccountably exalts the pronouncements of his

information releases, which have no force of law, as though they impose binding

obligations that no taxpayer should dare to question.

{¶ 4} For these reasons, we find that the tax commissioner’s decisions to

impose and retain the double-interest penalty were arbitrary and unconscionable.

We therefore reverse the decision of the BTA and remand the cause to the tax

commissioner with instructions that the penalty be refunded, along with any interest

paid that was associated with that penalty.

BACKGROUND

{¶ 5} The issue in this case is whether the tax commissioner abused his

discretion with regard to imposing a penalty. But that question is tied to an

underlying dispute of substantive tax law that was resolved in two ways: a treasury

regulation issued by the federal government, codified at 26 C.F.R. 1.641(c)-1(k),

and decisions issued by this court in Knust, 111 Ohio St.3d 331, 2006-Ohio-5791,

856 N.E.2d 243, Lovell, 116 Ohio St.3d 200, 2007-Ohio-6054, 877 N.E.2d 667,

and Brown, 119 Ohio St.3d 335, 2008-Ohio-4081, 894 N.E.2d 35. That dispute

can be summarized with the question, Should S-corporation income be taxed to an

ESBT that holds the S-corporation shares or to the grantor of the trust?

{¶ 6} For individuals, income tax in Ohio is imposed on Ohio adjusted gross

income. R.C. 5747.02(A). That tax base is determined initially by reference to the

taxpayer’s federal adjusted gross income; certain adjustments that convert federal

adjusted gross income into Ohio adjusted gross income are then prescribed by R.C.

Chapter 5747. See R.C. 5747.01(A). Under this scheme of taxation, if an item of

income were properly omitted from federal adjusted gross income, then it would

not appear in Ohio adjusted gross income unless Ohio law required that the amount

be added back in (an “add-back”).

{¶ 7} In this case, the taxpayers read a provision of federal law, enacted in

1996, as requiring that the income be treated as income of the trust for income-tax

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purposes. That provision is 26 U.S.C. 641(c), which provides that the “portion of

any electing small business trust which consists of stock in 1 or more S corporations

shall be treated as a separate trust,” and that portion is then subjected to special

taxation rules by the statute as a trust.

{¶ 8} The tax commissioner read other provisions of the Internal Revenue

Code as superseding the requirement of separate-trust treatment when the trust at

issue qualifies as a “grantor trust.” A “grantor trust” is one in which the grantor

has retained control of the trust assets, such as the right to revoke the trust, see 26

U.S.C. 676. The grantor of a grantor trust must report and be taxed on the trust

income. 26 U.S.C. 671.

{¶ 9} Here, the tax commissioner argued that the “grantor-trust rule” of

treating trust income as income of the individual grantor would apply despite the

ESBT statutory language indicating the possibility that the portion of the trust

holding S-corporation shares should be subject to special rules of taxation. The tax

commissioner advanced his view in two information releases, one in 2000 and one

in 2002.

{¶ 10} In 2002, the United States Treasury Department promulgated 26

C.F.R. 1.641(c)-1, which states that “[t]he grantor portion of an ESBT is the portion

of the trust that is treated as owned by the grantor or another person under subpart

E [26 U.S.C. 671 et seq.],” which includes the grantor-trust provision. 26 C.F.R.

1.641(c)-1(b)(1). The taxpayers’ interpretation of the federal law is precluded by

the definition of the “S portion” of the ESBT, which is taxed to the trust. The S

portion of the trust must satisfy not just one but two conditions: it must consist of

S-corporation stock and it must not be “treated as owned by the grantor or another

person under subpart E” (including 26 U.S.C. 671). 26 C.F.R. 1.641(c)-1(b). Thus,

taxation as a separate trust occurs only when that portion of the trust is not a grantor

trust. The regulation specifically states that a “grantor * * * who is treated as the

owner of a portion of the ESBT includes in computing taxable income items of

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income, deductions, and credits against tax attributable to that portion of the ESBT

under [26 U.S.C.] 671.” 26 C.F.R. 1.641(c)-1(c).

{¶ 11} There is an important limitation on the effect of the treasury

regulation: it applies “generally” to taxable years of ESBTs “beginning on or after

May 14, 2002.” 26 C.F.R. 1.641(c)-1(k). Certain parts of the regulation (those

relevant here) are applicable only to “taxable years of ESBTs that end on and after

December 29, 2000.” Id. In this case, the Renaccis presented evidence that the

taxable year of the ESBT ended before December 29, 2000, with the result that their

situation is not controlled by the regulation.

The tax commissioner’s information releases

{¶ 12} Beginning with information release IT 2000-01 (issued Jan. 19,

2000), available at http://www.tax.ohio.gov/ohio_individual/individual/

information_releases/it200001.aspx, the Ohio Department of Taxation took the

position that the ESBT election did not change the obligation of the grantor of a

grantor trust to include the S-corporation income on his or her own individual

income tax return. The release states:

Effective for individual and estate taxable years beginning

after December 31, 1999, the Income Tax Audit Division will

require certain individuals and estates to include in their federal

adjusted gross income (“FAGI”) and Ohio taxable income all

relevant pass-through items of income, gain or loss from S

corporations when such items have been treated as reportable for

federal income tax purposes on a trust’s fiduciary income tax return

(Form 1041) because the trust has elected to be taxed as an Electing

Small Business Trust (“ESBT”) under Internal Revenue Code

(“IRC”) section 1361(e)(3). Specifically, if an individual or estate

would be treated as the owner of all or a portion of a trust pursuant

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to [26 U.S.C.] 671 et seq., then such individual or estate shall include

in his, her or its FAGI or Ohio taxable income all relevant S

corporation pass-through items as if the individual or estate were

itself the actual owner of the S corporation stock owned by the trust.

***

For taxable years beginning after December 31, 1999,

assessments for unpaid tax and all related failure-to-timely-pay and

failure-to-timely-file charges will apply (i) to such individuals and

estates who do not adjust their FAGI and Ohio taxable income (and

timely pay tax and related estimated tax thereon) in accordance with

this information release and (ii) to S corporations which do not

timely pay the 5% withholding tax and the related estimated tax with

respect to such S corporation distributive shares.

(Footnote deleted.)

{¶ 13} The discussion section states:

The Internal Revenue Code does not contain any provisions

which expressly state that an ESBT which also qualifies as and/or is

described as a grantor trust is exempt from the grantor trust

provisions. Neither does the “Blue Book” provide or address any

such exemption. In fact, the principal advocate of the ESBT

legislation has cautioned that the provisions of an ESBT’s governing

instruments “* * * should be limited so that no power would result

in the inclusion of trust assets or revenue in the trustee’s own estate

or income.” Thus, even the principal advocate of the ESBT

legislation implicitly recognizes that an ESBT which also qualifies

as and/or is described as a grantor trust is, in fact, subject to the

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grantor trust provisions for taxation rather than qualifying for the

special rules for taxation of ESBT’s under IRC section 641(c).

The Income Tax Audit Division recognizes that various tax

practitioners have differing interpretations of how the ESBT

provisions interplay with the grantor trust provisions of the Internal

Revenue Code. Some have advocated that the ESBT provisions

should take precedence over the grantor trust provisions, while

others believe that a grantor trust cannot make the ESBT election.

In light of the fact that neither the U.S. Treasury Department nor the

Internal Revenue Service has issued any guidance in this area, and

barring any change in the federal tax law or issuance of new U.S.

Treasury regulations to the contrary, the Income Tax Audit

Division’s position is that a grantor trust cannot make the ESBT

election.

(Footnotes deleted.)

{¶ 14} In 2002, the tax department took an even more forceful position in

PIT 2001-04 (issued July 3, 2002), available at

http://www.tax.ohio.gov/ohio_individual/individual/information_releases/pit2002

04.aspx, stating:

The Ohio Department of Taxation has initiated an audit

program to identify and assess individuals who are not “adding

back” to their federal adjusted gross income (“FAGI”) their

distributive shares of S corporation profit which they receive via a

trust qualifying as both an electing small business trust (“ESBT”)

and a grantor trust. This audit initiative is based upon the

Department’s January 19, 2000 information release directing

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taxpayers to make the add-back to the extent taxpayers did not

include such amounts in their FAGI. Effective for post-1999 taxable

years, the information release provides detailed authority supporting

the required add-back.

Using computer programs and IRS-supplied databases, the

Department will identify Ohio taxpayers who have not fully

complied with the requirements of that information release. Upon

identification of these taxpayers, the Department will issue

assessments for tax, interest (8% for 2000, 9% for 2001, and 7% for

2002), interest penalty (Ohio form IT-2210), and failure-to-pay

penalty.

The Renaccis’ 2000 return

{¶ 15} The Renaccis filed their joint Ohio tax return for taxable year 2000

without reporting and paying Ohio individual income tax on amounts earned by the

“James B. Renacci Tr 1998.” That trust owned shares of three S corporations,

whose combined corporate earnings in 2000, as reported on form FT 1120 S, were

over $14 million. Although the Renaccis did not report the income on their joint

return as individual taxpayers, they filed disclosures that showed that the S

corporations were owned by the James B. Renacci trust.

{¶ 16} In 2003, the tax commissioner audited and assessed the Renaccis in

relation to the unreported S-corporation income. The tax commissioner computed

the tax owed by “adding back” $13,899,960 of S-corporation income to the

Renaccis’ federal adjusted gross income. By the tax commissioner’s corrected

computation, the Ohio taxable-income figure was $13,730,440.

{¶ 17} The Renaccis filed a petition for reassessment, which was denied.

BTA No. 2006-Z-780, 2007 WL 1515135 (May 18, 2007). The Renaccis appealed

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to the Ninth District Court of Appeals. Subsequently, they dismissed that appeal,

made payment, and pursued a refund of the double-interest penalty.

From reassessment petition to refund claim

{¶ 18} In 2007, the Renaccis ceased contesting their tax liability based on

Knust, 111 Ohio St.3d 331, 2006-Ohio-5791, 856 N.E.2d 243, and Lovell, 116 Ohio

St.3d 200, 2007-Ohio-6054, 877 N.E.2d 667. They also sought a settlement

agreement with the tax commissioner, who transmitted an offer involving a

reduction of penalty if the taxpayer could pay in full within two weeks. The deal

fell apart when the Renaccis sought to pay on a longer schedule. The Renaccis then

shifted procedural gears by paying all amounts demanded by the state and pursuing

a refund claim for the penalty amount. (The details of the settlement discussions

form one of the grounds for the Renaccis’ claim that the commissioner abused his

discretion. Because we resolve this case in the Renaccis’ favor on other grounds,

we need not delve into the full details here.)

{¶ 19} In e-mail correspondence, the Renaccis sought assurance that they

could pursue the penalty remission through a refund claim. A tax-department

official expressed her belief that if a refund claim were filed, the tax commissioner

would issue a final determination that could be appealed to the BTA and thereafter

to the courts if the penalty was not abated.

{¶ 20} The Renaccis tendered payments of $140,000 on April 27, 2007;

$814,650 on August 29, 2007; $425,400 on December 20, 2007; and $359,822 on

July 15, 2008. The Renaccis dismissed their appeal from the BTA decision

addressing the reassessment petition and, on June 23, 2009, filed their refund claim,

seeking $359,822, the amount of penalty paid plus post-assessment interest. The

tax commissioner denied the refund claim on the sole ground that the Renaccis

“willfully filed their return contrary to a clear Department position.” The Renaccis

appealed to the BTA.

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Proceedings before the BTA

{¶ 21} Before the BTA hearing, the Renaccis attempted to depose former

and current tax-department personnel. Although their discovery efforts were not

entirely successful, they did subpoena former tax commissioner Thomas Zaino and

former income-tax counsel for the tax department Jeffrey Sherman to testify at the

BTA hearing.

{¶ 22} The hearing on March 3, 2014, was contentious, primarily because

the tax commissioner’s counsel insisted that evidence regarding statements of

department personnel was barred on the grounds that it was irrelevant or was

protected by the deliberative-process privilege. The BTA examiner at certain

points sustained the commissioner’s relevancy objection, and the Renaccis were

hindered in the presentation of their argument that they had acted in good faith. But

the Renaccis managed to adduce some evidence in support of their claim that they

had had reasonable cause to resist paying the tax. The record establishes the

following:

 Former income-tax counsel for the tax department Jeffrey Sherman

confirmed that he had stated at tax conferences that the tax

department—prior to the January 2000 information release—was not

taxing S-corporation pass-through income from grantor trusts that had

made the ESBT election.

 Former tax commissioner and tax-law practitioner Thomas Zaino

confirmed that the ESBT election created a possible tax strategy for S-

corporation shareholders to minimize Ohio individual income tax.

Zaino also confirmed his understanding that after he became tax

commissioner in 1999, the January 2000 information release reflected a

policy “that on a go-forward basis folks had to come forward and treat

the grantor trusts that chose to make an ESBT election as a grantor

trust.”

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 The tax department’s deputy tax commissioner was quoted by

Columbus Business First in 1998 as stating that there was “an

opportunity * * * to use this mechanism [an ESBT election for a grantor

trust] to avoid taxation.”

 The General Assembly considered legislation in 1998 that would ensure

that tax would be imposed on the S-corporation pass-through income as

a matter of state law, regardless of the proper treatment under federal

law.

{¶ 23} The tax commissioner offered the following evidence:

 An affidavit by Margaret Brewer, a tax-department employee,

indicating that the Renaccis were treated the same as similar claimants

who failed to comply with the 2000 information release or to settle their

cases.

 The two information releases quoted above.

 The testimony of an auditor to show that the tax department was

auditing the “grantor trust/ESBT device” even before the January 2000

information release. On cross-examination, however, it was revealed

that the auditor knew of only a single instance of an audit applying the

tax commissioner’s theory to a year prior to 2000 and that the audit

occurred after 2000.

The BTA decision

{¶ 24} The BTA rejected the tax commissioner’s argument that the BTA

lacked jurisdiction under R.C. 5703.60(A)(3). R.C. 5703.60 addresses the

procedure to be followed by the tax commissioner when a taxpayer files a petition

for reassessment. And R.C. 5703.60(A)(3) “clearly contemplates that the filing and

final adjudication of a petition for reassessment can be followed by the filing of an

application for refund, subject to one caveat—that objections decided on the merits

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on appeal of the petition for reassessment may not be relitigated through an

application for refund.” BTA No. 2012-1850, 2014 WL 5093565 *3 (Oct. 1, 2014).

{¶ 25} Turning to the merits, the BTA noted that the final determination

states that the Renaccis “ ‘willfully filed their return contrary to a clear Department

position.’ ” Id. at *4. Because the tax commissioner “provided clear direction as

to his change in policy regarding the taxation of income to grantors of ESBT trusts,

[the Renaccis’] failure to follow the commissioner’s clear instructions was

reasonably found by the commissioner to be willful neglect, and not action in good

faith.” Id. at *5. Thus, the BTA held, reliance on the absence of an IRS regulation

and the dissent in Knust did not suffice to establish good faith. The BTA affirmed

the denial of penalty remission, and the Renaccis appealed to this court. The tax

commissioner then filed a cross-appeal.

ANALYSIS

The Renaccis had the right to seek a refund of penalty under

the former version of R.C. 5747.11

{¶ 26} As a protective cross-appeal, the tax commissioner asserts that he

and the BTA lacked jurisdiction to grant the relief from penalty sought by the

Renaccis in these proceedings. At the time the present refund claim was initiated,

R.C. 5747.11(A) provided that the tax commissioner “shall refund to * * *

taxpayers * * * (3) Amounts in excess of one dollar paid on an illegal, erroneous,

or excessive assessment.” Am.Sub.H.B. No. 530, 151 Ohio Laws, Part IV, 6699.

In 2013, R.C. 5747.11(A) was amended to require that the tax commissioner

“refund to * * * taxpayers * * * the amount of any overpayment of such tax.” 2013

Am.Sub.H.B. No. 59. Under the amended version of the statute, the tax

commissioner has a strong argument for limiting the refund claim to the amount of

overpayment of tax. But the version in effect when the refund claim was filed

expressly authorizes a claim for refund of any payment on an “excessive”

assessment.

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{¶ 27} We see no reason to conclude that the language of the former version

does not authorize a penalty-only refund claim when, as in this case, the taxpayer

submits that the assessment of the penalty is excessive. Indeed, “excessive” is an

additional category that does not require that the amount assessed be illegal or

erroneous. The former statute thereby opens the door to a claim challenging the

penalty without challenging the tax. Because the wording of the statute appears to

broaden the scope of the relief available, we are bound to extend the statute’s

operation to its full breadth. See Phoenix Amusement Co. v. Glander, 148 Ohio St.

592, 76 N.E.2d 605 (1947), paragraph one of the syllabus (“Statutory provisions

for the refund of taxes illegally or erroneously paid or paid on an illegal or

erroneous assessment should be liberally construed in favor of the taxpayer”).

{¶ 28} The tax commissioner cites two decisions of this court that involve

the corporate franchise tax rather than the individual income tax. Neither case

addresses a claim of refund brought after full payment; instead, they both involve

a challenge to a deficiency assessment. See Internatl. Business Machines Corp. v.

Zaino, 94 Ohio St.3d 152, 761 N.E.2d 20 (2002); Lancaster Colony Corp. v

Lindley, 61 Ohio St.2d 268, 400 N.E.2d 905 (1980). Internatl. Business Machines

states, “When the tax commissioner has made an assessment under R.C. 5733.11,

the amount that may be contested and refunded under that statute is limited to the

amount paid on the deficiency assessment.” Id. at syllabus.

{¶ 29} The tax commissioner also cites sales-tax cases that were decided by

the Board of Tax Appeals. Stevens v. Tracy, BTA No. 94-H-1166, 1995 Ohio Tax

LEXIS 1265 (Oct. 20, 1995); Tenbrink v. Tracy, BTA No. 95-R-181, 1995 Ohio

Tax LEXIS 1487 (Dec. 8, 1995); and Clarkson v. Tracy, BTA No. 97-S-135, 1997

Ohio Tax LEXIS 1152 (Aug. 29, 1997). These cases provide no more guidance

than the franchise-tax cases cited above. Each of these decisions involves sales-tax

assessments during the 1990s against vendors who apparently failed to collect and

remit sales taxes to the state. The vendors apparently paid the full assessments,

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then sought refunds of the penalty amounts. Those decisions have no bearing on

this case because the sales-tax statutes of that time explicitly created separate

procedures for tax refunds and penalty remissions and the vendors had followed the

wrong procedures. See Clarkson at 6.

Determining whether a taxpayer had reasonable cause to resist paying

a tax requires considering whether the taxpayer acted in good-faith

reliance on a reasonable interpretation of the law

{¶ 30} The Renaccis’ first assignment of error is dispositive of this appeal

in their favor, so we will not address their other four arguments. The Renaccis

argue that the tax commissioner abused his discretion under R.C. 5747.15 by basing

his finding of willful neglect solely on their failure to comply with the precise

instructions of an information release.

{¶ 31} R.C. 5747.15(A)(2) provides that “a penalty may be imposed not

exceeding twice the applicable interest charged * * * for the delinquent payment.”

R.C. 5747.15(C) authorizes the tax commissioner to abate a penalty imposed under

R.C. 5747.15 “if the taxpayer * * * shows that the failure to comply with the

provisions of [the income-tax law] is due to reasonable cause and not willful

neglect.” The statute prescribes a standard for abating the penalty and entrusts the

determination whether to impose or to abate the penalty to the tax commissioner’s

ultimate discretion. The latter point is expressed by the statute’s use of the word

“may,” which we have held in similar contexts to constitute a grant of discretionary

authority. J.M. Smucker, L.L.C. v. Levin, 113 Ohio St.3d 337, 2007-Ohio-2073,

865 N.E.2d 866, ¶ 14-15.

{¶ 32} The discretionary nature of the tax commissioner’s determination

means that both the BTA and this court must review the denial of remission here to

determine whether the tax commissioner abused his discretion, not whether we

would have reached a different conclusion. Id. at ¶ 16 (“Because the Tax

Commissioner has discretion to grant or deny an abatement of a late-filing penalty,

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the BTA and the court must apply an abuse-of-discretion standard”). Abuse of

discretion connotes an unreasonable, arbitrary, or unconscionable attitude. Id.

The BTA erred by failing to acknowledge the taxpayers’

reasonable-cause argument

{¶ 33} The tax commissioner’s final determination recites only one reason

to support the finding of willful neglect, that “[t]he claimants willfully filed their

[2000] return contrary to a clear Department position.” The claimants “failed to act

in good faith,” according to the commissioner’s determination, because they were

“made aware of the Department’s change in policy” through the 2000 information

release and then failed to act in accordance with its terms.

{¶ 34} In upholding this determination, the BTA stated that the Renaccis’

challenge relied only on “the absence of IRS regulation on the issue” of their tax

obligation and on the dissenting opinion in Knust. (Emphasis sic.) 2014 WL

5093565, *5. That is a gross misstatement. The Renaccis have consistently stated

throughout these proceedings that they were relying on the interpretation of the

federal statute that the tax commissioner had abandoned, i.e., the interpretation that

the trust rather than the grantor was to report and pay tax on the distributive-share

income. That the tax commissioner changed his view of the federal statute does

not make the earlier reading unreasonable.

{¶ 35} By failing to acknowledge that federal law constituted an element of

the Renaccis’ reasonable-cause argument, the BTA acted unreasonably and

unlawfully in its review of the commissioner’s determination. That failure blinded

the BTA to the arbitrary nature of a determination that sustains a penalty without

consideration of any factor other than that the taxpayer did not abide by the tax

department’s information release.

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Equating a taxpayer’s good-faith insistence on its legal rights with willful

neglect shows an arbitrary and unconscionable attitude

{¶ 36} The tax commissioner’s insistence that any departure from his

published instructions negates the taxpayer’s good faith is arbitrary. The

reasonableness of the taxpayer’s interpretation of the federal statute is relevant to

the determination whether the taxpayer had reasonable cause to resist the tax

commissioner’s interpretation. Neither the commissioner nor the BTA even

considered whether the statute could fairly be read in favor of the Renaccis’

position. Instead, the tax commissioner’s information releases were deemed to be

fully dispositive. Moreover, it does not make sense to regard the mere publication

by the tax commissioner of his interpretation of federal law as establishing that the

taxpayer’s contrary view is unreasonable.

{¶ 37} An information release does not create legal obligations by its own

force—a fact that both the commissioner and the BTA ignore when they measure

the Renaccis’ good faith solely in terms of their willingness to abide by demands

set forth in the tax department’s pronouncements. We have repeatedly held that

when the tax commissioner seeks to exercise administrative authority in a

systematic way over a broad range of taxpayer claims, he must promulgate his

pronouncement as an administrative rule. See Progressive Plastics, Inc. v. Testa,

133 Ohio St.3d 490, 2012-Ohio-4759, 979 N.E.2d 280, ¶ 31 (tax commissioner

“ ‘cannot confer the force of law on a requirement without promulgating it as a

rule’ ”), quoting HealthSouth Corp. v. Testa, 132 Ohio St.3d 55, 2012-Ohio-1871,

969 N.E.2d 232, ¶ 33, citing McLean Trucking Co. v. Lindley, 70 Ohio St.2d 106,

114-116, 435 N.E.2d 414 (1982), and Condee v. Lindley, 12 Ohio St.3d 90, 92-92,

465 N.E.2d 450 (1984). The ambivalence of the IRS with respect to periods not

covered by the treasury regulation, coupled with the absence of Ohio statutory

authority for an add-back of the distributive share, militates strongly in favor of

requiring the tax commissioner to proceed by rulemaking in this context.

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{¶ 38} The tax commissioner also insists that the penalty is justified

because the Renaccis presented an unusually intransigent case of taxpayer

resistance to his demands. At oral argument, counsel for the tax commissioner

stated that “everybody else,” or “virtually everybody,” paid up front. Even

allowing some latitude for exaggeration, we find no support for this assertion. We

have issued no fewer than three decisions that addressed the ESBT issue: Knust,

111 Ohio St.3d 331, 2006-Ohio-5791, 856 N.E.2d 243; Lovell, 116 Ohio St.3d 200,

2007-Ohio-6054, 877 N.E.2d 667; and Brown, 119 Ohio St.3d 335, 2008-Ohio-

4081, 894 N.E.2d 35. Those three appeals presented a total of seven taxpayer

claims; of those, three sought refunds because the taxpayers had paid up front and

four involved taxpayers who had not paid up front. We conclude that the range of

taxpayer responses was much more divided than the tax commissioner

acknowledged.

{¶ 39} We hold that the BTA unreasonably and unlawfully permitted the

tax commissioner to predicate the reasonable-cause determination exclusively on

compliance with the tax department’s information releases that had no force of law.

We therefore reverse the BTA’s conclusion that the tax commissioner acted within

his discretionary authority in denying the claim for refund of the double-interest

penalty.

The Renaccis had reasonable cause to resist paying until our

2007 decision in Lovell v. Levin

{¶ 40} The tax commissioner also contends that even if the Renaccis had

reasonable cause to resist paying the tax when it was first assessed, reasonable

cause evaporated with the announcement of Knust, 111 Ohio St.3d 331, 2006-Ohio-

5791, 856 N.E.2d 243, on November 22, 2006. This argument places emphasis on

the delay of payment between that date and the Renaccis’ tender of payment in four

increments: $140,000 on April 27, 2007; $814,650 on August 29, 2007; $425,400

on December 20, 2007, and $359,822 on July 15, 2008. We find that the Renaccis

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had reasonable cause to resist paying the assessment until the announcement of

Lovell, 116 Ohio St.3d 200, 2007-Ohio-6054, 877 N.E.2d 667, on November 20,

2007, because the Renaccis argued that their situation was not controlled by the

treasury regulation, as the claim in Knust was. Only in Lovell did we address and

dispose of the claims of taxpayers who, like the Renaccis, claimed to be immune

because the federal regulation did not apply. Compare Knust, ¶ 30, with Lovell,

¶ 28.

{¶ 41} To be sure, Lovell placed little significance on the federal regulation,

citing Knust for the proposition that the regulation merely “amplifies” the statutory

basis for ruling in favor of the state’s position. Lovell, ¶ 28. But that ruling in

Lovell itself does not affect the claim of reasonable cause, because the claimants in

Lovell had a substantial argument that their cases should be treated differently than

those of the claimants in Knust.

{¶ 42} As explained earlier in this opinion, federal adjusted gross income

constitutes the starting point for determining Ohio adjusted gross income.

Arguably, if federal authorities treated the income as properly reportable by and

taxable to the trust instead of the grantor, the tax commissioner had no basis in Ohio

law for ordering an “add-back” for Ohio income-tax purposes. This was an

argument raised in Lovell. In this case, the tax commissioner has never contested

the Renaccis’ assertion that their situation is not subject to the treasury regulation.

Accordingly, we conclude that the Renaccis could reasonably have awaited the

outcome of Lovell for potential relief from the tax assessment against them.

Because Lovell was not decided until November 2007, when the Renaccis were

already in the process of paying their assessment, we hold that their claim of

reasonable cause extended into the time frame in which they were making payment.

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The taxpayers’ interpretation of the federal statutes was

reasonable even though mistaken

{¶ 43} The component of our analysis that is not yet explicit is the

reasonableness of the Renaccis’ interpretation of the federal statutes. As our

previous discussion indicates, we regard that interpretation as reasonable, even

though it proved to be mistaken. In 1996, the ESBT provision was added to the

Internal Revenue Code. Pub. L. No. 104-188, 110 Stat. 1755. Its terms prescribe

how the S-corporation portion of an ESBT is to be taxed as a trust. Namely, 26

U.S.C. 641(c) provides that the “portion of any electing small business trust which

consists of stock in 1 or more S corporations shall be treated as a separate trust,”

and that portion is then subjected to special taxation rules by the statute as a trust.

An initial reading could reasonably construe an intent to make a specific

dispensation with respect to ESBTs under subpart A (26 U.S.C. 641 et seq.) that

would exempt them from the operation of the grantor-trust rule in subpart E (26

U.S.C. 671 et seq.). In Knust, we held the contrary, construing the ESBT language

as meaning that “when an income tax is imposed on a trust, that tax is to be

calculated in a specified way.” Id., ¶ 25.

{¶ 44} The taxpayers’ alternative reading is not unreasonable. We

predicate our determination of reasonableness on our own reading of the federal

statutes plus the inferences that we draw from the tax commissioner’s information

releases when read in conjunction with our decisions in Knust, Lovell, and Brown.

CONCLUSION

{¶ 45} For the foregoing reasons, we reverse the decision of the BTA and

remand the cause to the tax commissioner with instructions that the double-interest

penalty be refunded, along with any interest paid that was associated with that

penalty.

Decision reversed

and cause remanded.

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O’DONNELL, LANZINGER, KENNEDY, FRENCH, and O’NEILL, JJ., concur.

O’CONNOR, C.J., concurs in judgment only.

_________________

Buckingham, Doolittle & Burroughs, L.L.C., Steven A. Dimengo, and

Matthew R. Duncan, for appellants and cross-appellees.

Michael DeWine, Attorney General, and Barton A. Hubbard, Assistant

Attorney General, for appellee and cross-appellant.

_________________

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