Tax practitioners have been struggling with a number of issues with respect to the validity and enforceability of Internal Revenue Service regulations. What discretion is given to the IRS to interpret statutory language where Congress has given no express authority to the IRS to make those interpretations? Can IRS regulations be given retroactive effect? Do the requirements of the Administrative Procedures Act apply to IRS regulations?
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A number of court cases, and particularly a surprising number of recent Supreme Court cases, have touched on these issues. Unfortunately, much still remains unclear.
THE CHEVRON STANDARD
Last year's Supreme Court decision in Mayo clarified that the Chevron standard, rather than the National Muffler standard, for review of agency regulations applies to both IRS legislative regulations (those with specific statutory language authorizing regulations under that statute) and IRS interpretive regulations (those without such specific statutory authority, relying on only general statutory authority to issue regulations interpreting the tax law). The Chevron standard is a two-step inquiry:
1. Is the statutory language ambiguous?, and, if so,
2. Is the regulation a reasonable interpretation of the statute?
If both questions can be answered in the affirmative, the regulation stands.
This year's Supreme Court decision in Home Concrete invalidated a regulation where the statute was ambiguous and the IRS regulation was a reasonable interpretation of the statute. The problem, in the majority's view in a 5-4 decision, was that a prior Supreme Court case had already interpreted substantially similar language and reached a different result from the regulatory interpretation. In essence, the court held that the Supreme Court's prior decision had eliminated the ambiguity in the statute.
However, the Supreme Court decision in Brand X had held that the IRS interpretation of a statute was to be given deference even in the face of contrary court decisions. A majority in Home Concrete failed to either endorse or reject the Brand X analysis, so it appears to remain good law, at least as to court decisions other than Supreme Court decisions. The majority opinion discussed the possible application of Brand X only where Congress had granted "gap-filling" authority to the IRS, but this portion of the opinion was supported by only four members of the court.
The net result of Mayo, Chevron, Brand X and Home Concrete is that you apply a Chevron analysis in evaluating an IRS regulation. However, if the ambiguity in the statute has already been addressed in a Supreme Court decision, that resolves the ambiguity. Given the relative paucity of Supreme Court decisions interpreting Internal Revenue Code provisions, Home Concrete does not appear to stand for too much beyond the facts of that and similar cases involving overstated basis and the application of a six-year statute of limitations.
APPLICATION OF THE APA
Under the Administrative Procedures Act, an arbitrary and capricious standard is to be applied in interpreting an agency regulation. Courts have interpreted the APA standard to require that the agency must engage in reasoned decision-making and must explain the reasons for its decision when issuing regulations. The Supreme Court, in the recent case of Judulang -- not a tax case -- stated that the arbitrary and capricious standard under the APA was equivalent to the Chevron two-step analysis.
In Dominion Resources, the Federal Circuit invalidated an IRS regulation on the basis that it failed to satisfy the APA requirements because the IRS failed to provide an explanation for its position when it promulgated the regulation. The IRS has long taken the position that it is not required to give a reason for the positions it takes in promulgating regulations. In final or revised proposed regulations, the IRS will often, in response to comments received from the public, explain why it accepted or rejected a particular suggestion, but it remains unclear whether the IRS can correct in final regulations an APA deficiency in issuing proposed regulations.
It has been suggested that, if a proposed regulation has a potential adverse affect on a client, practitioners have a duty to submit a comment because, under the APA, the IRS has a duty to take that comment into account in finalizing the regulations.
RETROACTIVE EFFECT OF IRS REGS
Historically, IRS regulations were presumed to have retroactive effect. This was based on the concept that the IRS was interpreting previously effective statutes and merely explaining what the statute meant from the beginning. This presumption was changed in 1996 to a presumption of prospective effect. This change only applies, however, to additions to the tax law since that date, with the majority of the Tax Code still being of earlier origins, and also a number of exceptions were provided. Furthermore, the IRS continues to argue that it has the authority to issue regulations with retroactive effect, under its general statutory authority to issue regulations interpreting the tax laws and also under the Chevron and Brand X standards.
In Intermountain II, the IRS made these arguments for retroactive application of the same regulations at issue in Home Concrete. However, the Tax Court rejected the IRS position on another basis and did not address the retroactivity issue. The Supreme Court in Home Concrete also failed to address the retroactivity issue. The scope of the IRS's current authority to issue retroactive regulations remains unresolved.
The current state of the law would appear to still give the IRS considerable discretion in issuing regulations. The Chevron two-step review standard would appear to still apply to both IRS legislative and interpretive regulations after Mayo. Discussion in Home Concrete about using Brand X authority for regulations to overcome prior lower court decisions where Congress had granted specific gap-filling authority to the IRS would appear to open up the possibility that a future Supreme Court case might again differentiate between legislative and interpretive regulations: applying Chevron to interpretive regulations, but applying both Chevron and Brand X to legislative regulations.
The IRS may have to start taking more account of APA requirements in providing more explanations for the rationale for its positions in proposed regulations, as well as continuing to provide reasons for its responses to comments received in response to those regulations. Tax practitioners may have to become familiar with non-tax cases that have developed the interpretations of the APA to determine how the APA applies to tax regulations. Under the APA, tax practitioners may have more of a duty to submit comments to proposed regulations that threaten to have an adverse impact on clients.
The scope of the IRS's current authority to issue retroactive regulations still needs to be clarified, at least with respect to statutory language enacted after 1996.
George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at CCH Tax and accounting, a Wolters Kluwer business.