Restricting Federal Jurisdiction Over State-Law Claims Involving Federal Tax Code Interpretation

Introduction

AMTAX Holdings 227, LLC v. CohnReznick LLP, decided April 30, 2025 by the Second Circuit, clarifies when federal courts may hear state-law claims that require interpreting federal tax statutes. AMTAX, a limited-partner investor in a low-income housing tax credit project, sued its auditor CohnReznick LLP in federal court for professional negligence, breach of fiduciary duty, unjust enrichment, and fraud. AMTAX alleged that CohnReznick miscalculated the purchase price under the partnership’s right-of-first-refusal agreement by omitting “exit taxes” contemplated by 26 U.S.C. § 42. The district court dismissed for lack of federal‐question jurisdiction under 28 U.S.C. § 1331, applying the Grable & Sons/Gunn test. On appeal, AMTAX argued that its claims necessarily raise substantial federal tax questions. The Second Circuit unanimously affirmed, holding that these routine state-law claims remain within the traditional state-court sphere.

Summary of the Judgment

The Second Circuit framed the issue under the “special and small” category of federal-question jurisdiction, in which a state-law claim can proceed in federal court only if it (1) necessarily raises, (2) actually disputes, (3) substantially implicates, and (4) fits within Congress’s allocation of federal and state judicial responsibilities. Even if AMTAX’s malpractice and fiduciary-duty claims required interpreting Section 42’s safe-harbor purchase price, the court found:

• The federal issue was not substantial to the federal system as a whole—no uniform body of federal tax law would be endangered by leaving the question to state courts.
• Exercising jurisdiction would disturb the federal-state balance—accountant malpractice claims have traditionally been resolved in state courts.

Consequently, the Second Circuit affirmed the dismissal for lack of subject matter jurisdiction.

Analysis

Precedents Cited

• Grable & Sons Metal Prods., Inc. v. Darue Eng’g & Mfg. (545 U.S. 308, 2005): Established that a state-law claim can confer federal jurisdiction if it “implicates significant federal issues” and detailed the four‐part test.
• Gunn v. Minton (568 U.S. 251, 2013): Held that legal malpractice claims concerning patent law do not automatically confer federal jurisdiction, underscoring state courts’ role in malpractice disputes.
• Empire Healthchoice Assurance, Inc. v. McVeigh (547 U.S. 677, 2006): Emphasized the narrowness of federal jurisdiction over state-law claims and the importance of evaluating the federal-state balance.

These decisions guided the court’s analysis of whether AMTAX’s state claims fit within the “special and small category” warranting federal jurisdiction.

Legal Reasoning

Applying the Grable-Gunn framework, the Second Circuit assumed for argument’s sake that AMTAX’s claims “necessarily raise” and “actually dispute” a federal question—namely, the correct interpretation of 26 U.S.C. § 42(i)(7)(B). The court’s analysis focused on the third and fourth factors:

1. Substantiality: A question is substantial only if it carries significance beyond the private dispute—either because it governs numerous future cases or because it challenges the action of a federal agency. Here, the dispute turned on interpreting a single contract’s mirroring of Section 42’s language. It did not threaten a uniform body of tax law nor involve the IRS directly.
2. Federal-State Balance: State courts are the traditional forum for professional negligence and fiduciary-duty claims against accountants and auditors. Allowing these disputes into federal court whenever a federal tax provision is referenced would upset the balance by inundating federal dockets with garden-variety malpractice suits.

Because AMTAX could pursue its state-law claims in state court without impairing any essential federal interest, federal jurisdiction was lacking.

Impact

This decision reinforces the narrow construction of federal question jurisdiction under § 1331 and the Grable-Gunn test. Key takeaways:

• Accountant and professional-negligence claims invoking federal tax code language will ordinarily remain in state court.
• Contract provisions that mirror federal statutes do not by themselves elevate routine disputes to the federal level.
• The ruling strengthens state courts’ authority over malpractice, fraud, and fiduciary-duty litigation, preserving forum diversity and judicial economy.

Complex Concepts Simplified

• Federal-Question Jurisdiction (§ 1331): Federal courts can hear cases “arising under” federal law, usually when a federal statute creates the cause of action.
• Grable-Gunn Test: A four-part inquiry determining when a state-law claim “implicates significant federal issues”:
  1. Necessarily raised
  2. Actually disputed
  3. Substantial to the federal system
  4. Compatible with the federal-state balance
• LIHTC Safe Harbor (26 U.S.C. § 42(i)(7)): A statutory formula that limits an investor’s tax liability upon exit from a low-income housing project if the partnership agreement sets a compliant purchase price.
• Exit Taxes: Potential federal income tax charges an investor faces on sale when tax losses exceed invested capital.
• Right of First Refusal (ROFR): A contractual option allowing a specified party—often a nonprofit affiliate—to match a third-party offer before a sale proceeds.

Conclusion

AMTAX Holdings 227, LLC v. CohnReznick LLP underscores that even when a state-law malpractice or fraud claim hinges on interpreting federal tax statutes, federal question jurisdiction remains the exception, not the rule. The decision preserves the traditional role of state courts in regulating professional conduct and ensures that federal courts reserve their dockets for cases of genuine national importance. As a result, professionals and litigants should expect state-law remedies for contract interpretation and negligence disputes, even where federal tax code language is echoed in their agreements.