Emily Cauble explores the extent to which the tax system allows taxpayers “to benefit from hindsight” in her article, Taxpayers’ Tax Election Regrets. Cauble uses concrete tax election examples to categorize the types of hindsight that cause taxpayers regret and to offer recommendations on how the tax system should approach hindsight to “bring more coherence to tax law’s approach and better align its approach with underlying policy goals.”
Cauble’s focus is on explicit, rather than implicit, tax elections; thus, the focus is on elections that require a formal indication of choice to the IRS. Cauble further considers the availability of filing a late election, revoking an election, and filing a protective election. Cauble analyzes formal election processes to highlight when an election-related decision may bring a taxpayer regret and when a taxpayer is able to use hindsight to make an adjustment to the original choice. The article concludes with recommendations for improvements to how the tax system allows hindsight, with the recommendations guided by tax policy goals relating to revenue-raising, fairness, and administrability.
Cauble describes four types of hindsight that arise in the context of tax elections and then groups them into two pairs, one pair that is generally benign or even enhances the fairness of the tax system and one pair that is generally harmful to the tax system.
Taxpayers who experience regret over their elections because they made a mistake of tax law (“Mistake of Tax Law Hindsight”) or failed to account for a fact that was knowable at the time of the election (“Mistake of Knowable Fact Hindsight”) are often afforded greater opportunity to benefit from hindsight under existing law and, Cauble argues, should generally be able to benefit when underlying tax policy is considered.
Conversely, taxpayers who experience regret over their elections because they failed to predict future facts correctly (“Misprediction of Fact Hindsight”) or because they failed to predict the IRS response (“Misprediction of Service Challenge Hindsight”) generally have less opportunity to benefit from hindsight under existing law and should have less opportunity.
Cauble uses multiple concrete examples to illustrate the current operation of these hindsight types and to recommend adjustments. One example involves elections under § 754. Under this Code section, partnerships make an election that will require tax basis adjustments relating to both the purchase of partnership interests and to partnership distributions.
A § 754 election is revocable only with government permission, so the partnership must predict the impact of the election on future taxable years when deciding whether to make the election. At the same time, a partnership generally has the information needed to determine whether making the election provides a net benefit for the first taxable year it is in effect. Thus, as Cauble highlights, § 754 elections are partly forward-looking because they are difficult to revoke and affect future taxable years (thus, requiring prediction of facts), but § 754 elections are also partly backward-looking as the partnership can know whether it will provide a benefit during the first year to which it would apply.
Hindsight could arise in the context of a § 754 election in at least two situations: a partnership could fail to make the election and then want permission to file it late, or a partnership could file the election and then seek to revoke it. Cauble analyzes both situations to highlight that Treasury Regulations and IRS letter ruling practice generally allow taxpayers to use Mistake of Tax Law Hindsight and Mistake of Knowable Fact Hindsight but usually prohibit the other two types of hindsight. As an example of Mistake of Law Hindsight, Cauble points to a 2021 letter ruling providing an extension to file a § 754 election because the taxpayer’s advisor failed to provide information about the availability of the election. As an example of Mistake of Knowable Fact Hindsight, Cauble describes a letter ruling granting an extension because the partnership did not know that a particular partner had died.
Cauble argues persuasively that these two types of hindsight should generally be permitted as “the taxpayer merely obtains the same beneficial tax treatment that a well-advised taxpayer could have obtained without the use of hindsight.” She recognizes that tax revenue could be lost as a result of allowing these two types of hindsight but also points out that lawmakers presumably intended to afford all eligible taxpayers access to the election. In addition, she argues that any tax revenue treated as lost could be “recouped in fairer ways” as a taxpayer using these two types of hindsight is “simply obtaining the tame tax outcome available to well-advised taxpayers.”
In contrast, the tax agencies generally limit the ability to use Misprediction of Fact Hindsight or Misprediction of Service Challenge Hindsight. For example, the § 754 regulations make clear that taxpayers who simply failed to predict facts, such as asset values, correctly will not obtain the benefit of revocation. This approach helps preserve tax revenue and also provides a fairer approach when taxpayers know the facts and have access to sophisticated advice but fail to correctly predict the future.
Cauble further argues persuasively that taxpayers could disguise the use of Misprediction of Fact Hindsight through offering explanations grounded in Mistake of Law Hindsight. In the § 754 context, Cauble notes that the IRS often states in letter rulings involving late election relief “that the partners had contractually agreed to make the election” as evidence that a procedural mistake occurred, rather than a misprediction of fact. Cauble posits that this shows insufficient skepticism as the IRS would never have reason to see these agreements as to partnerships that decide not to make the election. Cauble further asserts that the IRS should exercise greater scrutiny if there was even the “potential for the facts to change in a way that would affect whether the election was advantageous.”
This brief review of Cauble’s article only focused on one example—§ 754 elections—but Cauble explores many other interesting examples (such as the § 83(b) election and the § 475(f) mark-to-market election), and those descriptions encourage the reader to develop their own examples. Cauble shows how the tax law responds in the context of elections to taxpayer regret caused by hindsight. As a result, not only does Cauble’s article provide a comprehensive and engaging window into what could otherwise seem a somewhat dry procedural issue, her article could be used as a roadmap for developing future research and insight into how the tax system should react to taxpayers’ regret over tax decision making.
