Center for Taxpayer Rights Files Amicus Brief in Support of CIC in Supreme Court

Readers are likely familiar with CIC v IRS, which we originally discussed back in 2017 when a federal district court in Tennessee dismissed a suit that a manager of captive insurance companies and its tax advisor had brought that sought to invalidate IRS disclosure obligations on advisors and participants in certain micro captive insurance arrangements. Having made its way through a Sixth Circuit opinion affirming the district court and a colorful and divided denial of a request for an en banc hearing, the Supreme Court granted cert earlier this spring. 

This week the Center for Taxpayer Rights, under the leadership of Nina Olson, filed an amicus brief in support of CIC, with Keith, Carl Smith, and Meagan Horn of Thompson & Knight LLC, on behalf of the Harvard Tax Clinic, and I, all as counsel for the Center.

The issue in the case involves whether the Anti Injunction Act (AIA) shields the IRS’s information gathering requirements issued in IRS Notice 2016-66 from APA scrutiny outside traditional tax enforcement proceedings. The Sixth Circuit reasoned that the presence of a potential penalty for failing to comply with the Notice that would be assessed in the same manner as taxes shielded the IRS from pre-payment APA review. 

The case provides an opportunity to explore the reach of the AIA in light of a number of recent developments, including the 2015 Supreme Court opinion in Direct Marketing Association v Brohl and recent scholarship from Professor Kristin Hickman and Gerald Kerska calling into question whether the AIA should bar pre-enforcement challenges.

Our brief requests that the Supreme Court reverse the decision of the Sixth Circuit because in our view it improperly restricts taxpayers from challenging certain IRS requests for information in situations where the taxpayer is not bringing suit to contest the underlying merits of the tax liability. 

In our brief, consistent with the mission of the Center for Taxpayer Rights, which is dedicated to furthering taxpayers’ awareness of and access to taxpayer rights, we highlight the potential negative effect that the Sixth Circuit’s approach may have for a wide spectrum of taxpayers, including low income taxpayers. To bring that point home we explore past IRS practices requiring information from refundable credit claimants and the possible harm that future information reporting efforts could have on participation and the welfare of low income taxpayers .

As we discuss in the brief, we believe that the Sixth Circuit’s holding is inconsistent with the Court’s holding in Direct Marketing Ass’n v. Brohl:

[Direct Marketing] demonstrates that the AIA’s reach is limited with respect to challenges to requests for information by taxing authorities. The Internal Revenue Service cannot avoid this limitation by threatening taxpayers with a penalty if they do not comply with the rule-making (even if such penalty is “assessed and collected in the same manner as taxes” under the Code). If the Sixth Circuit’s overly broad interpretation stands, low-income taxpayers will be subjected to potentially severe adverse effects. The IRS will hold the unilateral right to shield their rule-making from APA scrutiny by choosing to include the right to impose a potential penalty for noncompliance. The low-income taxpayer will be at the mercy of the IRS in these circumstances with no practical ability to contest the rule-making authority of the IRS without first violating the rule established by the IRS and then paying the full amount of the penalty imposed.

The case is teed up for the fall term, and there will likely be many amicus briefs filed in the coming days.

Update: late yesterday CIC filed its opening brief, emphasizing that challenges to tax reporting requirements that are backstopped by penalties should not implicate the AIA. The brief explores the implications of Direct Marketing, questions whether the presence of an assessable penalty should meaningfully distinguish the case from Direct Marketing, argues that the Sixth Circuit’s holding furthers neither the interest of the APA or the AIA, and considers the practical consequences of an approach that prevents challenges until after a potentially sizable penalty is assessed.

For readers interested in a nuance, I note that CIC’s brief raises an issue that lurks below the main issue, namely whether the AIA is a jurisdictional statute or merely a claim processing rule (see page 23). That issue is teed up because CIC argues that the principle that jurisdictional rules should be clear merits a finding that it should be able to bring the challenge. The brief does not, however, concede on the issue that the AIA is jurisdictional , and in so doing refers to a concurring opinion by now Justice Gorsuch in the 2013 Tenth Circuit Hobby Lobby opinion. I explore the issue of whether the AIA is jurisdictional in the upcoming update to Chapter 1.6 in Saltzman Book IRS Practice and Procedure. The issue of whether the AIA is jurisdictional may be more important if the Supreme Court affirms the Sixth Circuit.

In Altera Reply Brief, Taxpayer Doubles Down on Flawed Argument That the Government Changed Its Tune.

We welcome back guest bloggers Susan C. Morse and Stephen E. ShayThey bring us a further update on the efforts of the taxpayer in the Altera case to have the Supreme Court accept the case for argument.  Keith

Previously we blogged here (crossposted at Yale JREG Notice & Comment) about the government’s May 14 brief in opposition to the taxpayer’s petition for certiorari in Altera v. Commissioner. On June 1,  Altera replied to the government’s brief, as explained here by Chris Walker. The case has been distributed for a Supreme Court conference later in June.

The Altera reply brief doubles down on an argument that the government brief has already persuasively dispatched: that Treasury gave the impression during the rulemaking process that comparability analysis – i.e., the analysis of comparable transactions between unrelated parties – was relevant to the determination of an arm’s length result under the transfer pricing regulation at issue, and that then the government changed its tune.

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First, some background to level-set for any new readers. In its cert petition, the taxpayer asked the Supreme Court to review a Ninth Circuit decision upholding a 2003 amendment to an existing tax regulation governing intra-group cost-sharing arrangements for the development of intangible property. (We submitted amicus briefs on behalf of the government to the Ninth Circuit in earlier stages of this litigation here (with coauthors Leandra Lederman and Clint Wallace), here and here.)

The regulation conditions the benefits of a qualified cost sharing arrangement, or QCSA, on including stock-based compensation deductions related to developing intangible property in the pool of costs to be shared. If this (and other) QCSA conditions are met, the cost-sharing party — typically an offshore subsidiary of a U.S. multinational firm — owns a share of the rights in intangible property, even though this intangible property is often developed within the United States. Allowing an offshore subsidiary to own a share of intangible property means that a U.S. multinational firm can attribute some profit from intangibles to the offshore subsidiary. This in turn means that the U.S. multinational firm can avoid paying U.S. corporate income tax on some of its profit.

Altera proposes that the Supreme Court should take this case because it is an opportunity to place limits on an inappropriate exercise of administrative agency power. The taxpayer’s cert petition argues that Treasury did not provide a reasoned explanation for the regulation as required under  State Farm, in light of evidence cited by commenters that unrelated parties to similar types of arrangements did not share stock-based compensation costs; that the government in litigation engaged in post hoc rationalization to defend the regulation, in violation of Chenery I; and that the Ninth Circuit accorded Chevron deference to a procedurally defective regulation.

The government in response observed that the taxpayer conflates the arm’s length standard with comparability analysis. It explained that the government has maintained a consistent argument throughout the rulemaking process and this litigation.  That is, the government has consistently maintained that the 2003 regulation’s rejection of comparability analysis as a means of determining an arm’s-length result in this limited context is consistent with both the “commensurate with income” language of the statute adopted in 1986 and the accompanying legislative history.

The core of Altera’s argument is that the government surprised taxpayers and tax advisers by making a “sea change in tax law without providing any notice of the change or opportunity to comment on it” (Reply Br. 1) and by taking a “new position” in litigation (Reply Br. 2) about the meaning of the arm’s length standard.  Altera’s reply brief states this claim in at least three ways. None hold up.

The first thing Altera claims is that “The arm’s length standard has a settled meaning: A transaction meets the arm’s length standard if it is consistent with evidence of how unrelated parties behave in comparable arm’s length transactions.” (Reply Br. 5) Altera may wish that this sentence stated doctrinal transfer pricing tax law, but it does not. As the government’s brief in opposition to the cert petition correctly explains, Altera’s statement conflates the arm’s length standard with comparability analysis. Comparability analysis is not a predicate for determining an arm’s length result. One clear indication of that reality is the residual profit split transfer pricing method contained in regulations promulgated in 1994.

The second claim Altera makes is that the government initially suggested that comparability analysis is relevant to the determination of an arm’s-length result under the regulation at issue in this case, but then changed its mind. This is also incorrect. As the government’s brief explains, Treasury promulgated the 2003 amendment to make explicit what it had consistently argued was implicit in the prior (1995) cost-sharing regulation: that QCSA stock-based compensation costs must be shared to produce an arm’s-length result, without regard to evidence of allegedly comparable transactions. And it consistently pointed to the commensurate-with-income language of the statute and the related legislative history to support its position. It referred to commensurate-with-income both in the 2002 Notice of Proposed Rulemaking and in the 2003 Preamble.

This government’s position in this regard has been at the heart of a longstanding and well-known disagreement between taxpayers and the government. In 2002, lawyers at Baker & McKenzie explained the already-long history, in a comment to the proposed regulations written on behalf of Software Finance and Tax Executives Council:

On audit, in Advance Pricing Agreement negotiations, in docketed Tax Court cases, in published field service advice, and in speeches by Service officials … the Service has taken the position that stock-based compensation … must be included in related parties’ cost sharing pools. … Taxpayers have steadfastly and vehemently disagreed[, … absent] any evidence that unrelated parties … share stock option “costs” in their own cost sharing pools. 

The third claim that Altera makes is that taxpayers did not realize that the government was promulgating a rule that did not rest on comparables and were caught by surprise. It writes that “none of the companies, industry groups, or tax professionals that participated in the rulemaking noticed” (Reply Br. 2) that the 2003 amendment made evidence of allegedly comparable uncontrolled transactions not determinative of an arm’s length result in this context. This claim also does not hold up.  Indeed, the amended regulation itself – in both its proposed and final form – unequivocally states that a QCSA will achieve an arm’s-length result “if, and only if,” the parties share all development-related costs (including stock-based compensation costs) in proportion to anticipated benefits.

In written submissions and at the 2002 hearing to consider the proposed regulation, commenters certainly realized that the regulation was not based on evidence of comparables. A representative for the American Electronics Association stated that the regulation identified an arm’s-length result “by fiat,” implicitly acknowledging that the government had rejected a comparables-based inquiry. A Fenwick & West partner explained that the regulation “deem[ed] a result to be arm’s length without providing any evidence.” A tax partner at PricewaterhouseCoopers noted the perception that the amendment “seem[s] contrary to the arm’s length standard as evidenced by actual transactions ….”  The rest of the regulatory record is consistent. Commenters understood. Taxpayers and tax advisers knew exactly what Treasury was doing.

Altera says it is making an administrative law argument, but it is really interested in a tax policy outcome. The asserted “immense prospective importance” (Reply Br. 4) is illusory. Even if the Court were to grant the petition and then hold that the 2003 amendment is procedurally defective, Treasury could simply re-promulgate the rule without substantive change but with a more detailed explanation. As for past tax years, Altera’s and similarly-situated companies’ financial statements have already incorporated the possibility that corporate income tax will be due based on compliance with the regulation. The real importance of the case for taxpayers lies in the hope that the Supreme Court goes beyond the administrative law issue and expresses a pro-taxpayer view as to the merits. But this tax issue is not presented.

Rather, the cert petition raises a procedural administrative law issue. It works for the taxpayer only if the government changed its tune. But to the contrary, the government has been singing the same tune for two decades or more.

The government did not surprise taxpayers and tax advisers with never-before-seen interpretations of the arm’s length standard. The government consistently explained that evidence of allegedly comparable transactions is not determinative of an arm’s-length result in this context. It consistently referred to the commensurate-with-income statutory language and legislative intent in support of its position. The government has been faithful to its argument and explanation since before the 2003 amendment and continuing through every stage of this litigation. There has been no surprise or change of course. Rather, this case involves the government making the same argument and explanation, over and over again. 

Oakbrook Land Holdings v Comm’r: A Follow-Up Post Exploring the Impact of Administrative Law on Validity of Tax Regulations

Oakbrook Land Holdings v Commissioner is the latest salvo in the Tax Court’s effort to apply administrative law to the process and substance of tax regulations. Concerning the validity of Reagan-era tax regulations, the opinion eats up 128 pages and includes concurring and dissenting opinions that squarely reject the majority’s approach to evaluating whether the regulations comport with requirements under the Administrative Procedure Act (APA). 

Guest contributor Monte Jackel discussed the case and its multiple opinions a couple of weeks ago. In this post, like Monte’s excellent post, I focus on whether IRS/Treasury (hereinafter just IRS) failed to do what is required under the APA’s notice and comment process. I am choosing to omit nuance, including 1) the relationship between procedural challenges and substantive challenges to regulations embodied in Step Two of the Chevron analysis, a topic I explore in detail in Chapter 3 in Saltzman and Book, and 2) whether the concurring opinion is correct in its view that the statute alone is enough to put the kibosh on the deduction without getting into the muddy administrative law issues that the case raises.

This post is a follow up to Monte’s post. My goal is to situate the issue within the APA, and in particular its discussion as to what is required when there are challenges to legislative rules.

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At ultimate issue in Oakbrook is whether the taxpayer was entitled to a charitable deduction under Section 170 (the accompanying memorandum decision concludes no).  To set the stage I will summarize the main statutory and regulatory concepts.  I will conclude today’s post by discussing the case’s possible significance for future procedural challenges to regulations and potentially other IRB guidance that may in fact be a legislative rule.

Legal and Factual Background

When donating property other than money, the charitable deduction is equal to the property’s fair market value at the time the donor makes the gift.  When donating noncash property, the Code generally prohibits a charitable contribution deduction when the donor fails to donate the entire interest in the property. 

There is a statutory exception to the requirement that a donor transfer the entire interests for “qualified conservation contributions” like easements over a portion of land involved in this case. One of the statutory requirements for qualified conservation contributions is that the done uses the contributed property exclusively for conservation purposes. In discussing that requirement, the Code provides that a donation will not be treated as made exclusively for conservation purposes unless “unless the conservation purpose is protected in perpetuity” (the “perpetuity rule”).

Now that we have situated the broad statutory scheme let’s focus on how IRS put some flesh on the perpetuity rule. Three years after the statutory rules for conservation easements came about in 1980 in the Tax Treatment Extension Act, IRS proposed regulations. One of the items in the proposed regulations addressed how to satisfy the perpetuity rule with the reality that circumstances may change and prevent a property’s use for conservation purposes. Recall that conservation purpose is not perpetual if the donee organization that holds the easement is unable to carry on the conservation purpose.

To allow satisfaction of the perpetuity rule, the proposed regulations and final regs required that the contract between the donor and donee provide that the proceeds of a sale of be used in a manner consistent with the conservation purposes and that the proceeds split in a way that reflected the proportionate fair market value of the easement relative to the whole property at the time of the donation. The proposed regulations, and the final regulations which essentially adopted the proposed regs’ approach to divvying up sale proceeds after a judicial extinguishment of the easement, did not take into account any investments or improvements that the donor could have made following the contribution, notwithstanding that the donor’s actions might account for post-contribution changes in market value.

After issuing the proposed regulations, IRS received over 90 comments.  As the regulations addressed issues other than the perpetuity rule only one commenter criticized the proposed regs’ failure to address how a donor’s improvements might account for increasing the value of the land. In finalizing the regulation, the preamble stated that IRS considered all of the comments it received but did not specifically address the critical comment that addressed donor improvements. IRS made some minor tweaks to the perpetuity rule regulations (that is the way the regs required a proportionate division in a sale following a judicial extinguishment) and made other changes to other provisions in the final regs, which it discussed in the regulations’ preamble published in a Treasury Decision.

What Does the APA Require For Issuing Tax Regulations?

Before I discuss the opinion, I quote from Saltzman and Book, IRS Practice & Procedure ¶3.02[2][a], Historical Classification of Regulations, where treatise Contributing Author Greg Armstrong and I discuss how the APA intersects with the tax regulation process:

Before embarking on a consideration of the categorization of Treasury Regulations….the only types of rules that are specifically referred to in the APA are interpretative rules, policy statements, and rules of agency organization and practice. Those categories are not defined, but rather are listed as exceptions to the notice and comment procedures (discussed at IRS Practice & Procedure ¶ 3.02[3] The Drafting Process).

In the treatise, we discuss how the APA does not mention the term legislative rules. For many years, the IRS and most in the tax academy (including one of my mentors and the original author of IRS Practice & Procedure, Michael Saltzman) have generally thought of tax regulations that were issued pursuant to the general authority to issue rules under Section 7805 as interpretative (or the more modern interpretive) rules that did not require agency to use the APA’s notice and comment process under 5 USC § 553. (For an even deeper dive into this see Bryan Camp’s Duke Law Journal article A History of Tax Regulation Prior to the Administrative Procedure Act; Leandra Lederman’s 2012 article on fighting regs and judicial deference also has an excellent discussion of the historical classification of regs).

As we discuss in the treatise, the understanding that most tax regs were interpretative was rooted in part on the notion that Congress could not delegate its constitutional duty to make law to the executive. In time, the nondelegation doctrine lost force (though is on the comeback trail), and, as academics like Kristin Hickman have emphasized, the consequences for failing to comply with Treasury regulations include sanctions and have both practical and legal effects. In part due to the persuasive writing of Professor Hickman, the consensus has shifted and the modern view shared by most but not all is that Treasury regulations, whether promulgated under the Code’s general authority or a specific grant within a substantive statute, are legislative rules that require the IRS to comply with the notice and comment requirements in the APA (as I mentioned the term legislative rule has no home in the APA but over time courts and commentators began referring to them as such because of their reputation to carry the force of law).

What are the APA’s notice and comment requirements? As the opinion summarizes, to “issue a legislative regulation consistently with the APA an agency must: (1) publish a notice of proposed rulemaking in the Federal Register; (2) provide “interested persons an opportunity to participate * * * through submission of written data, views, or arguments”; and (3) “[a]fter consideration of the relevant matter presented,* * * incorporate in the rules adopted a concise general statement of their basis and purpose.”

The primary procedural issue in Oakbrook was whether the IRS satisfied the third requirement, which I will refer to as the consideration requirement though it is best thought of as two related requirements, that the agency a consider the comment and show its consideration by explaining the choices it made. 

What are the consequences if a court finds that the IRS failed to satisfy the notice and comment requirements? Under the APA a court is required to invalidate agency action if the agency failed to satisfy them because it would be “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” Whether IRS satisfied the consideration requirement is, as Monte discussed, where the majority, concurring and dissenting opinions parted ways.  All the opinions agreed that the regs at issue were legislative (As an aside, I note and expand in the treatise that the issue of whether an agency rule, including IRS IRB guidance, is legislative involves dense administrative law case law. The majority opinion in this case adds a slightly different gloss on that issue compared to what the Tax Court said in its last major opinion on the issue, SIH Holdings v Comm’r, with the emphasis in this opinion on the regulations imposing a requirement that is “not explicitly set forth in the statute”).

The Majority Opinion’s Approach to Whether the IRS Considered Comments and Explained Itself Adequately

The opinion’s discussion of the consideration requirement notes that while the court itself cannot provide an agency explanation for the agency’s choices it will “uphold a decision of less than ideal clarity if the agency’s path may reasonably be discerned.” (citing Bowman Transp., Inc. v. Ark.-Best Freight Sys., Inc., 419 U.S. 281, 285 (1974)). This sweeps in the Supreme Court’s 1983 State Farm decision: for agency action to satisfy the arbitrary and capricious standard, the agency action “must be the product of ‘reasoned decision-making,’ and the agency must, at the time it takes the action being reviewed, provide a reasoned explanation for why it made the particular decision it did.”

In finding that the IRS’s actions were adequate in this case, the majority notes that the preamble discussed the IRS’s efforts at effectuating Congressional policy choices and that the preamble flagged “that ‘[t]he most difficult problem posed in this regulation was how to provide a workable framework for donors, donees, and the * * * [IRS] to judge the deductibility of open space easements,’ inviting public comments on this and other points.”

Finding the general statement in the preamble that it considered all comments important, the opinion also notes that the preamble discussed the seven groups of comments it received and that it was not required to address all of the comments. The opinion also notes that IRS clearly considered the judicial extinguishment rule, pointing to the changes in the final regs in response to some of the comments IRS received.  

What about the absence of specific discussion of the comment on donor improvements? In the majority’s view, that was insufficient find invalidate the reg. It gets to that conclusion by framing the one comment as essentially insignificant:

Only one of the 90 commenters mentioned donor improvements, and it devoted exactly one paragraph to this subject. That commenter, NYLC, was concerned about facade easements on historic structures, as opposed to “perpetual open space easements,” with which Treasury was chiefly concerned

Moreover, the majority opinion suggests that a comment may be considered significant (and thus likely requiring the agency to address to pass muster) if the comment offers proposed remedies and in this case the commenter “offered no suggestion about how the subject of donor improvements might be handled; it simply recommended “deletion of the entire extinguishment provision.”

In finding that the IRS also complied with its requirement to provide a concise general statement of the regulation’s basis and purpose, the opinion notes that the failure to discuss its rationale in not changing the final regs to reflect value issues stemming from donor improvements was not grounds for invalidating the reg: 

[That] provision represented one subparagraph of a regulation project consisting of 10 paragraphs, 23 subparagraphs, 30 subdivisions, and 21 examples. No court has ever construed the APA to mandate that an agency explain the basis and purpose of each individual component of a regulation separately.

Adding some support for its conclusion, the majority notes that context matters, looking to things like the subject matter of the regs and the nature of the comments received: 

The broad statements of purpose contained in the preambles to the final and proposed regulations, coupled with obvious inferences drawn from the regulations themselves, are more than adequate to enable us to perform judicial review. We find that Treasury’s rationale for the judicial extinguishment rule “can reasonably be discerned and * * * coincides with the agency’s authority and obligations under the relevant statute.”

Future Implications

As Monte suggests in his post, the majority opinion provides guidance for those submitting comments on regs, as the “case seems to indicate that a comment letter should state that the issue is material, fully discuss the issue, and propose a practical alternative if one is available.”

What about future courts confronting procedural challenges? Monte’s post does an excellent job of highlighting how the concurring and dissenting opinions approach the issue of a regulation’s procedural validity under the APA. As the concurring and dissenting opinions emphasize, the 2012 Federal Circuit case Dominion Resources is an example of a court invalidating a tax regulation on procedural grounds. Future litigants unhappy with way that regulations apply to their positions will be taking aim at the process and looking at this opinion to help frame their arguments.

One thing that is clear is that cases applying the APA to agency issuance of legislative rules is that an agency need not respond to all comments it receives. The key is whether the comment is significant, a term that is hard to pin down, though the dissenting opinion attempts to provide guidance. Building on the majority opinion’s discussion that a comment is more likely to require agency response if it offers an alternative, the dissent refines that by requiring the comment “identify a specific and objective issue created by the language of the proposed rule and give some explanation for why that language is troublesome.” Framed as the what and why test , i.e., “(1) what is the problem; and (2) why is it a problem?” the dissent notes that agencies are not required to speculate or offer hypotheticals on their own.

It remains to be seen how other courts will address challenges to regulations that predate the more modern Treasury practice of throwing the kitchen sink in preambles, though the SIH Holdings case (also involving decades old regs, though in that case there were no comments as an excellent Tax Prof post from Bryan Camp discussed) suggests that courts are hesitant to apply today’s more exacting standards to regulations that were issued decades earlier. As the majority opinion highlights at times the Tax Court has upheld regulations even in the absence of a stated purpose if the basis and purpose were obvious.

The concurring opinion in Oakbrook emphasized the inadequacy of the preamble to the final reg (e.g., only two pages in the face of hundreds of pages of comments, and hours of public comments at a hearing) and Home Box Office, an important DC Circuit case from the late 1970s, that discussed the benefit to agency rulemaking when there is a dialogue between an agency and commenters making significant points in the rulemaking process. The concurring opinion also rightly notes when promulgating the reg in this case the IRS likely “was simply following its historical position that the APA’s procedural requirements did not apply to these types of regulations.”

In concluding that the reg failed to satisfy the APA’s procedural requirements, the concurring opinion ends by citing language from a Supreme Court case noting that the reasoned explanation requirement is “not a high bar but an unwavering one.” (citing Judulang v Holder).

Oakbrook suggests that the bar may be lower for longstanding tax regulations, and highlights the way that these challenges arise in deficiency cases rather than at a time closer to the rule’s promulgation. Of course that makes no sense, but that takes us to other issues and how perhaps it is time to allow a more orderly challenge to IRS guidance outside the traditional tax controversy process.

Pending Cert Petition in Altera: Tax Law in an Administrative Law Wrapper

Susan Morse & Stephen Shay return to discuss the Altera case. This piece is cross posted at JREG’s Notice & Comment blog. Keith

Each day of the COVID crisis we see unprecedented administrative action to respond to the pandemic. At the same time, litigants continue to ask courts to consider whether administrative agencies have exceeded their authority, sometimes relying on claims of deficient process. One such case is Altera v. Commissioner, in which the taxpayer filed a cert petition that asks the Supreme Court to review a Ninth Circuit decision upholding a tax regulation. The government submitted its brief in response on May 14, and the Court will presumably consider the case in conference before its summer recess. The taxpayer has not filed a reply as of this writing.

In its brief, the government stays squarely on the administrative law playing field laid out by the taxpayer’s petition. The government’s reply takes on – and, we think, successfully defeats – the core premise that underlies the taxpayer’s administrative law arguments.

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In 2015, Altera won a unanimous decision in the Tax Court, which invalidated a 2003 regulation as arbitrary and capricious under State Farm. Then the government won in the Ninth Circuit before the original three-judge panel in 2018 (withdrawn because of the death of Judge Reinhardt), before a revised three-judge panel in 2019, and when the Ninth Circuit denied the taxpayer’s request for a rehearing en banc in 2019. We contributed amicus briefs [here (with coauthors Leandra Lederman and Clint Wallace), here and here] on behalf of the government before the Ninth Circuit, and have blogged previously about the case here and here. In February, the taxpayer submitted a petition for certiorari to the Supreme Court.

The tax issue in Altera involves a final Treasury regulation promulgated in 2003. The reg applies to qualified cost-sharing agreements, or QCSAs, made between U.S. firms and their offshore subsidiaries. A QCSA requires an offshore subsidiary to pay its share of the costs of developing IP. If QCSA requirements are met, the offshore subsidiary owns non-U.S. rights to intangible property developed by its U.S. parent company for tax purposes. Then the firm can shelter resulting offshore profit from U.S. tax. As relevant here, the 2003 regulation at issue in Altera conditions the favorable tax treatment available for QCSAs on the inclusion of stock-based compensation costs in the pool of shared costs.  

Technology and other multinational firms that use stock option compensation (and use strategies to shift profit from intellectual property across borders) have had an understandable and longstanding interest in this issue. An appendix to Altera’s cert petition lists 82 companies that noted the Altera issue in their public financial statements. One entry alone – that of Alphabet, Inc. – reports $4.4 billion at stake.

We think the regulation gets it right as a matter of tax policy. It properly prevents stock-based compensation deductions from reducing U.S. taxable income when these expenses support foreign profit. The regulation falls securely under the Commissioner’s statutory discretion (under I.R.C. Section 482) and responsibility to ensure clear reflection of income. It squares with modern financial accounting rules. And it aligns with OECD and other international efforts to combat base erosion and profit shifting to low-tax jurisdictions.

But the hook in the cert petition is not the tax issue. It is an administrative law issue. The taxpayer hopes to persuade four justices that Altera is an attractive opportunity to rein in an administrative agency’s power and further limit the case law that supports administrative agency discretion. Perhaps it appears particularly juicy because the administrative agency at issue is the Treasury, given the complicated history and relationship between Treasury regulations and administrative law. Indeed, the regulation in this case was promulgated well before the Supreme Court held, in its 2011 Mayo case, that Chevron deference (rather than National Muffler review) applies to tax regulations just as it applies to other federal regulations.

The taxpayer’s administrative procedure argument includes two main claims. The first is that Treasury did not provide a reasoned explanation for the regulation and that the regulation was therefore arbitrary and capricious under State Farm. The second is that the government engaged in post hoc rationalization to defend the regulation, in violation of Chenery I. (A third claim, derivative of the first two, asks whether, assuming a regulation is held procedurally defective, a court may nevertheless uphold it under Chevron.)

Five out of six filings submitted to the Supreme Court on behalf of the taxpayer – including the primary cert petition and four out of five amicus briefs – hang their respective hats on a single premise. This premise is that Treasury first suggested that comparability analysis was relevant under the stock-based compensation QCSA regulation, and then Treasury broke its word. The government’s brief takes this premise head-on and, we think, persuasively disproves it.

Altera’s petition claims that in 2002 and 2003, “the government never said it was … adopting a new approach to cost-sharing” (8) and that the rationale that the “commensurate with the income” language supported the new approach “appeared nowhere in the rulemaking record.” (10-11) Amicus briefs argue that the government advances “a new statutory interpretation” in litigation (Chamber of Commerce 16), describe the government’s allegedly “newfound litigation position that comparables are irrelevant” (Cisco 11), assert a “transparent post hoc rationalization” (National Association of Manufacturers 15) and claim that there would have been comments on “the applicability and scope of the arm’s length standard” in notice-and-comment if taxpayers had only been aware that the government meant to make comparability analysis irrelevant to the determination of an arm’s-length result for stock-based compensation costs in the QCSA context. (PricewaterhouseCoopers 16).

Interestingly, the fifth of five amicus contributions supporting Altera – a brief filed by a group of former foreign tax officials – paints a picture of continuity, rather than change, in arguments made by Treasury and the IRS. It acknowledges that both in 2002 and 2003 and also in litigation before the Ninth Circuit, the government “ignor[ed] … potentially comparable transactions” and simultaneously “claim[ed] that its approach comported with the arm’s length standard.” (9-10) 

The government argues as follows in its brief in opposition to Altera’s cert petition: The taxpayer’s arguments “conflate (i) the arm’s length standard … and (ii) the use of comparability analysis” and “misunderstan[d] the relationship between the two concepts.” (19) In its rulemaking, the government did not suggest that empirical analysis and comparability were relevant to the determination of an arm’s length result in this context. Rather, the internal method adopted by the regulation is “an alternative to comparability analysis as a means of achieving an arm’s length result,”(20) consistent with the statute, as “Section 482 does not require any analysis of identified comparable transactions between unrelated parties.” (21) Moreover, the rulemaking and litigation record shows a constant commitment to a method that is not based on evidence of comparables. The government’s rulemaking record, as well as its arguments in litigation, consistently references the “commensurate with income” statutory language added in 1986. (24) So the “commensurate with income” argument made in litigation was not new either.

The government’s narrative gets this right. As the government’s brief explains, the regulatory history – not to mention the plain language of the regulation describing an arm’s-length result in this context – makes clear that interested taxpayers and tax advisers knew that “the proposed regulation would make any evidence of comparable transactions irrelevant” in the context of QCSAs. (22) Taxpayers certainly understood the proposed regs’ departure from comparability analysis. They just didn’t agree with it. Indeed, the battle lines over comparability analysis in the context of stock-based compensation costs were already clearly drawn, well before Treasury issued its Notice of Proposed Rulemaking in 2002. As the Software Finance and Tax Executives Council explained during the 2002 notice and comment period: 

On audit, in Advance Pricing Agreement negotiations, in docketed Tax Court cases, in published field service advice, and in speeches by Service officials … the Service has taken the position that stock-based compensation … must be included in related parties’ cost sharing pools. … Taxpayers have steadfastly and vehemently disagreed[, … absent] any evidence that unrelated parties … share stock option “costs” in their own cost sharing pools. 

This disagreement between taxpayers and the government was a tax policy dispute over the role of comparables in transfer pricing between related parties. Taxpayers argued that the arm’s length principle required comparables, even in the specific case covered by the QCSA regulation. The government consistently took the opposite position, beginning well before 2002 and continuing through the present cert petition in Altera.

Taxpayers may still disagree with the government on the tax policy issue. But that ship has sailed. Indeed, there are other examples of transfer pricing methods that do not rely on comparable transactions. One is the 1994 promulgation of the residual profit split method, also contained in a final regulation issued under I.R.C. Section 482.  

The issue before the Supreme Court is an administrative law issue. A necessary premise of Altera’s argument is that Treasury started with, but then abandoned, a commitment to empirical comparables analysis for its rule covering stock-based compensation in QCSAs. And as the government explains, this premise does not hold up.

Executive Order on Regulatory Relief to Support Economic Recovery

Monte Jackel returns to discuss an executive order issued this week by the President. Keith

On May 19, 2020, the President signed an executive order (Order) relating to regulatory relief to support economic recovery from the coronavirus crisis. Section 1 of the Order states:

“Agencies should address this [crisis] by rescinding, modifying, waiving, or providing exemptions from regulations and other requirements that may inhibit economic recovery, consistent with applicable law and with protection of the public health and safety, with national and homeland security, and with budgetary priorities and operational feasibility. They should also give businesses, especially small businesses, the confidence they need to re-open by providing guidance on what the law requires; by recognizing the efforts of businesses to comply with often-complex regulations in complicated and swiftly changing circumstances; and by committing to fairness in administrative enforcement and adjudication.”

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The reference to “regulations” is to EO 13892, section 2(g), which states that the term means a legislative rule under section 553 of 5 USC, the Administrative Procedure Act (APA). This means that the executive order would only apply to tax regulations to the extent they are legislative rules and not interpretative rules. The IRS view is that most tax regulations are interpretative and not legislative but the courts have recently deviated from following the IRS view. [see this prior post here on PT for further discussion].

The Order then states:

“The heads of all agencies are directed to use, to the fullest extent possible and consistent with applicable law, any emergency authorities that I have previously invoked in response to the COVID-19 outbreak or that are otherwise available to them to support the economic response to the COVID-19 outbreak. The heads of all agencies are also encouraged to promote economic recovery through non-regulatory actions.”

This provision of the Order, as it could apply to federal tax matters, seems to authorize continued and expanded use of the tax related provisions of sections 7508 and 7508A. See below.

The Order then states:

“The heads of all agencies shall identify regulatory standards that may inhibit economic recovery and shall consider taking appropriate action, consistent with applicable law, including by issuing proposed rules as necessary, to temporarily or permanently rescind, modify, waive, or exempt persons or entities from those requirements, and to consider exercising appropriate temporary enforcement discretion or appropriate temporary extensions of time as provided for in enforceable agreements with respect to those requirements, for the purpose of promoting job creation and economic growth, insofar as doing so is consistent with the law and with the policy considerations identified in… this order.”

Does the Order apply to tax regulations and, if so, how? In cases outside of tax, it is relatively easy to determine what is and is not a legislative rule. Outside of FAQs not being legislative rules because they are not “authority” under section 6662 in the first place, the determination of what is a legislative rule in the tax realm at present is being determined by the courts on a case-by-case basis. Essentially, from where we stand right now, legislative rules are those that impose substantive rights and duties not directly dealt with in the applicable statute.

Assuming that there is some uniform approach taken by the Treasury Secretary to implement the Order on the issue of tax legislative rules, the next question is what action can the Treasury Secretary take with tax regulations and other items considered legislative rules for this purpose?

The following are possibilities:

  1. Tax regulations that raise revenue because of the substance of the rule would seem to impede economic growth and recovery because the taxpayer has less net after-tax cash than if the rule provided otherwise. Does this mean that all tax regulations, if deemed legislative rules, should be rescinded or suspended if such action would reduce the taxpayer’s net after-tax economic position? That is not likely to be how the IRS views the situation but guidance may be needed to flush this out.
  2. As briefly noted earlier above, the Order seems to lean in favor of the IRS issuing more extensions of applicable due dates pursuant to the authority of section 7508A due to the March 1, 2020 emergency presidential declaration on the coronavirus. This would mean that the IRS’s announced position that tax due dates will not be extended beyond July 15, 2020 may need to be re-examined by that agency. How else could the Order be interpreted in this area of law?
  3. There was a prior regulatory effort under executive orders previously issued by the president relating to withdrawing regulations deemed too burdensome or perhaps lacking legal authority and limiting the use of new regulations generally, among other matters.  A limited list of regulations was produced by the IRS and Treasury a few years back and action was taken on a number of those items. Does the subject Order mean that this process will need to be repeated by Treasury and the IRS, perhaps more thoroughly than previously? Guidance should perhaps be issued on that as well.

As Professor Hickman and others have espoused over the years, due to the long period where tax regulations were, more or less, given a free pass under the APA, it is often not clear today how regulatory edicts generally, such as the subject Order, are to be applied to tax regulations given that the process of how and to what extent tax regulations are subject to the APA continues to be a developing area of law. Now would appear to be a good time to push this process along.

Conservation Easement Donation and the Validity of Tax Regulations

Monte Jackel returns to discuss the Tax Court’s latest attempt at squaring the APA and the tax regulation process. Les

In Oakbrook Land Holdings LLC (154 T.C. No. 10, May 12, 2020), the Tax Court, in a reviewed opinion, upheld the validity of a Treasury regulation (reg. §1.170A-14(g)(6)) issued under section 170 of the Code relating to conservation easement donations and the perpetuity requirement. A concurrently issued memorandum opinion issued the same day (T.C. Memo 2020-54) had held that if the regulation was valid, the taxpayer was in violation of it. 

At issue in the opinion was the validity of the regulation at issue. This commentary focuses its attention on the requirement of the Administrative Procedure Act (APA) that a “legislative rule” contain a concise statement of the basis and purpose of the proposed rule. The Chevron doctrine, also addressed by the court, is not discussed here. 

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The majority opinion first stated that the regulation at issue was a legislative rule and not an interpretative one because it set forth a substantive requirement (sharing of proceeds if easement terminated) that was not set forth in the statute and which, if violated, would cause loss of the deduction. 

Underlying this conclusion was the majority’s view of a legislative rule:

“Administrative law distinguishes between interpretive and legislative agency rules. “An interpretive rule merely clarifies or explains preexisting substantive law or regulations….A legislative rule, on the other hand, “creates rights, assigns duties, or imposes obligations, the basic tenor of which is not already outlined in the law itself.”…Legislative rules have “the force and effect of law.”….

The majority then turned to the APA that sets forth the notice and comment requirement for legislative rules:

“Legislative rules are subject to APA notice-and-comment rulemaking procedures. See 5 U.S.C. sec. 553(b)…To issue a legislative regulation consistently with the APA an agency must: (1) publish a notice of proposed rulemaking in the Federal Register; (2) provide “interested persons an opportunity to participate…through submission of written data, views, or arguments”; and (3) “[a]fter consideration of the relevant matter presented,…incorporate in the rules adopted a concise general statement of their basis and purpose.” See 5 U.S.C. sec. 553(b) and (c).”

It was the third requirement that was in dispute in the case (the “concise general statement of basis and purpose requirement”). The majority opinion concluded that the concise general statement of basis and purpose requirement was satisfied in this case. 

“The APA provides that a reviewing court shall set aside agency action that is “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” 5 U.S.C. sec. 706(2)(a). The scope of our review “is a narrow one” because “[t]he court is not empowered to substitute its judgment for that of the agency.”…We consider only whether the agency “articulate[d] a satisfactory explanation for its action.”…. While we cannot provide a reasoned basis for agency action that the agency itself did not supply, we will “uphold a decision of less than ideal clarity if the agency’s path may reasonably be discerned.”….“So long as an agency’s rationale can reasonably be discerned and that rationale coincides with the agency’s authority and obligations under the relevant statute, a reviewing court may not ‘broadly require an agency to consider all policy alternatives in reaching decision.’” …Indeed, “regulations with no statement of basis and purpose have been upheld where the basis and purpose w[ere] considered obvious.”….

The majority concluded that this test had been met even though the final regulation preamble did not specifically address the comment that pertained specifically to the regulation provision at issue. This was so principally because the point raised in the comments was only one comment out of many submitted and that specific comment did not fully address the provision at issue and alternatives to what was proposed. The majority stated:

“[A]n agency cannot reasonably be expected to address every comment it received. The APA “has never been interpreted to require the agency to respond to every comment, or to analyze every issue or alternative raised by the comments, no matter how insubstantial.” …“We do not expect the agency to discuss every item of fact or opinion included in the submissions made to it.” …“An agency need not respond to every comment.”…. In any event, “[t]he administrative record reflects that no substantive alternatives to the final rules were presented for Treasury’s consideration.” …“A comment is * * * more likely to be significant if the commenter suggests a remedy for the purported problem it identifies.”…. The APA requires “consideration of the relevant matter presented” during the rulemaking process. 5 U.S.C. sec. 553(c). 

The majority then laid out the reasons for denying the assertion of an APA violation:

“Our review of the administrative record leaves us with no doubt that Treasury considered the relevant matter presented to it…. And we find equally little merit in petitioner’s assertion that Treasury failed to “incorporate in the rules adopted a concise general statement of their basis and purpose.” See 5 U.S.C. sec. 553(c)…. No court has ever construed the APA to mandate that an agency explain the basis and purpose of each individual component of a regulation separately. “[T]he detail required in a statement of basis and purpose depends on the subject of the regulation and the nature of the comments received.” …This statement need only “contain sufficient information to allow a court to exercise judicial review.”….

There was also a concurring opinion and a dissenting opinion in the case. 

The concurring opinion, among other issues, separately addressed the APA procedural point. After concluding that the text of the statute precluded the deduction, the concurring opinion nevertheless set forth its views on both Chevron and the APA. 

On the latter point, which is the focus of this commentary, the concurrence states:

“Treasury might not have found itself in this predicament under Chevron if it had followed more carefully the APA’s procedural requirements, which are designed to help agencies consider exactly this type of issue before a rule becomes final. 

And then came the dissenting opinion. The dissent, as one would expect, disagreed with the majority’s reasoning on the APA procedural point. It states:

“In today’s case, we hold that the Treasury Department gets to ignore basic principles of administrative law that require an agency “to give reasoned responses to all significant comments in a rulemaking proceeding.” ….A court is supposed to ensure that an agency has taken “a ‘hard look’ at all relevant issues and considered reasonable alternatives.”…But if the majority is right, the Treasury Department can get by with the administrative-state equivalent of a quiet shrug, a knowing wink, and a silent fleeting glance from across a crowded room…. [T]he majority, I fear, has missed the main root of [the taxpayer’s] argument–that at the time of the regulation’s promulgation, commenters made significant comments, and Treasury failed to address them in its statement of the regulation’s basis and purpose…. The Final Rule’s statement of basis and purpose shows absolutely no mention of the [regulation provision at issue]–and no reasoned response to any of the public’s comments on those provisions…. 

The dissent then zeroed in on its objections to the conclusions of the majority:

“[W]hile we don’t demand a perfect explanation for Treasury’s decisionmaking, …we should demand some,… And here, there wasn’t any….. [T]he analysis shouldn’t stop there–what is the nature of a comment that triggers an agency’s obligation to respond? The caselaw tells us to look at a comment’s significance. Agencies must “give reasoned responses to all significant comments in a rulemaking proceeding.”….This is because “the opportunity to comment is meaningless unless the agency responds to significant points raised by the public.”….“It is not in keeping with the rational process [of APA section 553(c)] to leave vital questions, raised by comments which are of cogent materiality, completely unanswered”). So, though an agency doesn’t have to respond to all comments, it must respond to all significant comments.

The dissent then cites a series of Treasury decisions that, as a matter of fact, make the same statement that “all comments were considered” or words of similar import. But, as the dissent states, “the APA,…has no provision for agencies to use ritual incantations to ward off judicial review.” 

Where does this take us? This case shows that the Treasury and IRS need to pay more attention as to (1) what is a legislative rule as compared to an interpretative rule, and (2) has it considered all “significant” public comments and fully addressed them in the final rule. 

And for commenters to regulations, this case seems to indicate that a comment letter should state that the issue is material, fully discuss the issue, and propose a practical alternative if one is available.

All of this is clearly an area to watch in the near future.

The Proper Role of FAQs

Monte A. Jackel, a practitioner at Jackel Tax Law, Silver Spring, returns for a timely guest post on the IRS’s use of frequently asked questions (FAQ’s). The IRS’s growing use of FAQ’s, rather than guidance documents published in the Internal Revenue Bulletin or through regulations, has drawn attention in the past. See, for example, the former NTA Nina Olson’s blog post from a few years ago, IRS Frequently Asked Questions Can Be a Trap for the Unwary. The issue is getting renewed attention given the pressures on the IRS to push information out quickly as Congress passes fast moving tax legislation in response to the pandemic. Les

This FAQ is not included in the Internal Revenue Bulletin, and therefore may not be relied upon as legal authority. This means that the information cannot be used to support a legal argument in a court case.

So said a recent update to the frequently asked questions (FAQs) with respect to the employee retention credit under the CARES Act. FAQs have been a frequent tool, most recently in relation to the CARES Act, to aid the government in issuing guidance to the public without going through the detailed, rigorous and time-consuming process of issuing regulations. With FAQs, gone are the headaches of soliciting comments from the public, of publishing proposed versions of the rules before finalizing them, and of making changes to the rules after initial issuance without input from the public. 

This all seems like a good thing. And, provided that the public is advised of the limitations of FAQs, as the IRS has started to do, see above, the tax system would seem to be the better for it. The question at hand is whether this situation is acceptable or needs to be either modified or rejected.

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A recent report issued by the Government Accountability Office (GAO) states that the IRS should have added a disclaimer to the FAQs on virtual currency, stating that the FAQs “were not legally binding”. The GAO report states that “The Commissioner of Internal Revenue should update the FAQs issued in 2019 to include a statement that the FAQs may serve as a source of general information but cannot be relied upon by taxpayers as authoritative since they are not binding on the IRS.” To this, the IRS responded that “We disagree with this recommendation. The FAQs are illustrative of how longstanding tax principles apply to property transactions. Further, the IRS does not take positions contrary to public FAQs.” 

How reassuring! I am sure that we have all heard the “trust us” slogan from the IRS and Treasury before. 

Section 6662 imposes what is known as an accuracy related penalty for certain underpayments attributable to positions taken on a tax return. Generally, this penalty generally applies, absent reasonable cause and good faith, unless the position is either disclosed on the tax return (or deemed to be so disclosed) or there is what is known as “substantial authority” for the position taken. 

Substantial authority exists for a position if the weight of authorities supporting the treatment is substantial in relation to the weight of authorities supporting the contrary treatment. The pertinent regulations list the types of authority that may be taken into account, including applicable provisions of the Internal Revenue Code, proposed, temporary and final regulations, revenue rulings and revenue procedures, court cases, legislative history to statutes, various forms of guidance published in the Internal Revenue Bulletin, and other enumerated items. FAQs are not one of the listed items of authority. FAQs can apparently be “authority” if incorporated into an IRS notice because the latter is published in the Internal Revenue Bulletin. Otherwise, tough luck. 

Section 6011(a) provides that when required by the regulations, every person subject to tax shall make a return or statement “according to the forms and regulations prescribed”, and such person “shall include therein the information required by such forms or regulations”. Note that this regulation only requires that tax returns include information required either by regulations or by an IRS form. This  should include instructions to that form. 

FAQs are not listed in either the pertinent statute or the section 6011 regulations as information that must be included on a tax return. As such, a taxpayer can file a true, accurate and complete tax return without complying with any information putatively required by FAQs. 

In a policy statement (Policy Statement) issued on March 5, 2019, the Treasury Department stated, with respect to so-called “sub-regulatory guidance”, that “Unlike statutes and regulations, sub-regulatory guidance does not have the force and effect of law. Taxpayers can have confidence, however, that the IRS will not take positions inconsistent with its sub-regulatory guidance when such guidance is in effect.” Once again, there is that “trust me” slogan again.

The Policy Statement defines sub-regulatory guidance so as to not include FAQs, which are not mentioned or even cited there because such guidance “means sub-regulatory guidance published in the Internal Revenue Bulletin.” Included in this list are revenue rulings, revenue procedures, notices, and announcements, but not FAQs. 

Which raises the question…Are FAQs rules subject to prior notice and comment under section 553 of the Administrative Procedure Act (APA)? The APA makes a critical distinction between rules that must first be published for comment in the Federal Register before going into effect so as to obtain public comment first, and so-called “interpretative rules” where prior notice and comment are not required. 

Given their lack of authority status, FAQs should not be treated as rules subject to the APA. Although I am not aware of any guidance that says so expressly, logically, a non-authority for purposes of section 6662 should not qualify as a rule, much less a legislative rule under the APA. This is so even if the IRS promises it will follow it and not revoke it retroactively. 

But future developments in the courts could end up changing that conclusion. Two fairly recent court cases come to mind in this regard.

First, in Bullock v. IRS401 F. Supp. 1144 (Dist. Ct. Mt. 2019), the district court set aside an IRS revenue procedure that effectively amended the terms of a final regulation (as apparently authorized in that final regulation by granting the power to provide exceptions to the regulation to the IRS Commissioner) because the court deemed the revenue procedure to be a rule that was a legislative rule and not an interpretative rule. The court stated that “The APA requires federal agencies to follow the notice-and-comment rulemaking procedures before it creates or amends legislative rules and regulations. …An interpretive rule remains consistent with the regulation that it seeks to interpret….A legislative rule “effectively amends a prior legislative rule.” ….[The revenue procedure at issue] effectively amends the previous rule that required tax-exempt organizations to file substantial-contributor information annually….[The revenue procedure at issue]…, as a legislative rule, requires the IRS to follow the notice-and-comment procedures pursuant to the APA.” Setting aside a revenue procedure deemed to be a legislative rule because it amended a prior legislative rule (the regulations themselves) is not the only recent development of note pertaining to the APA and tax regulations and rules. Putting aside questions relating to standing, the second case I wanted to mention is a U.S. district court opinion  in Texas. Chamber of Commerce v. IRS, No. 1:16-cv-00944 (Dist. Ct. W.D. TX., 2017), held that an immediately effective temporary regulation was invalid under the APA for failure to give prior notice and opportunity to comment to the public. [note: Les discussed the Chamber of Commerce litigation and linked to the case and PT’s prior coverage in Challenges to Regulations Update: Government Withdraws Appeal in Chamber of Commerce and New Oral Argument Set for Altera]

The case dealt with an immediately effective temporary regulation that was issued contemporaneously with proposed regulations, a common practice by the IRS. The court invalidated the regulation because it believed that the regulation at issue was a legislative or substantive rule, and not an interpretative rule, thus triggering the prior public notice and comment requirement of the APA. This was because the court believed that the regulation at issue affected substantive rights that expanded upon what was provided in the statute at issue.  

True. FAQs are neither a revenue procedure or a temporary regulation or even sub-regulatory guidance. Still, the IRS has promised to follow them although recent caveats added to FAQs warns that they are not authoritative. That is a distinction that most average taxpayers will not understand.

To make matters worse. FAQs on a particular subject are not easy to find on IRS.gov. There is no subject matter or code section index with the limited exception of an easy to find listing of items relating specifically to the coronavirus pandemic. Why is there no separate database containing only FAQs that could be found on the IRS website? Also, when FAQs are changed the prior versions are no longer posted on IRS.gov. Only the date last reviewed is given. 

Issuing FAQs, although easy and convenient for the IRS and providing fast guidance to taxpayers and their advisors, lack both prior public notice and prior public comment before the “rule” is issued to the public. FAQs are not even “sub-regulatory guidance” within the meaning of the Policy Statement. What gives?

Yes, issuing FAQs allows the IRS to get information out to the public in a very quick fashion and FAQs are easily changed, supplemented and amended, unlike regulations. Witness the IRS’s recent outstanding performance in getting out guidance under the CARES Act through the use, in substantial part, of FAQs.

But FAQs, unlike the traditional form of sub-regulatory guidance, are not “authority” under section 6662 and, if the practice of issuing FAQs is to be continued by the IRS, the regulations under section 6662 must be amended to count FAQs as authority under that section. At a minimum, a disclaimer about the limited usefulness of FAQs should be appended to each series of FAQs as a standardized practice of the IRS in issuing FAQs on a going forward basis.

Michael Desmond, IRS Chief Counsel, was recently quoted as saying during a May 6 Tax Analysts’ webinar that “The IRS isn’t planning to turn every FAQ on the Coronavirus Aid, Relief, and Economic Security Act….and the Families First Coronavirus Response Act….into a “full-blown notice or a Treasury decision or proposed regulation”…. 

I found this statement by the IRS Chief Counsel to be both interesting and curious at the same time. IRS notices are documents that are subject to review before issuance. So are FAQs, which are reviewed before issuance. 

It should be noted, however, that Internal Revenue Manual (IRM) 32.2.2, entitled “Summary of the Published Guidance Process”, does not discuss, cite or mention FAQs. There is now a subject matter listing for FAQs on the IRS website, but it does not discuss whether FAQs are authority or not and, as noted, FAQs do not make an appearance in the IRM discussion of what is the published guidance process. So, what does this say about FAQs? 

FAQs are easily added to, changed and supplemented. Notices, on the other hand,  need to be modified by other notices or perhaps by revenue rulings, revenue procedures or the like. FAQs do not leave a researchable trail of prior amendments and changes-only the latest version is available to the public on the IRS website. 

Notices are authority under section 6662 but FAQs that are not incorporated in notices are not authority. Putting aside IRS motives one way or another in deciding between which of the two to issue, it seems that FAQs are preferred because they are very easily amendable, supplemented or replaced.

Originally issued guidance in a notice seems to be amenable to speed more or less the same way as FAQs are, except that the writing style of FAQs is easier to do whereas notices are more formalized. That makes FAQs faster to get out to the public. 

But how much faster… because the cost of that speed is the lack of taxpayer reliance on the FAQs. And you can make legal errors in FAQs that are easily correctable, giving even more speed to the process. Given all of that, which one would you choose?In the end, the IRS and Treasury need to decide whether to keep FAQs, in which case I think that they need to be elevated to “authority” status. In addition, FAQs should be subject in some form to prior public notice and comment absent truly exceptional circumstances (such as the coronavirus pandemic). 

How Does the Regulatory Flexibility Act Impact Tax Regulations?

In a decade in which the Administrative Procedure Act (APA) has become a mainstream topic for tax lawyers, the case of Silver v. United States, Case No. 1-19-cv-247-APM (D.D.C. 2019) decided on Christmas eve seeks to usher in for the next decade of administrative law the proper application of the Regulatory Flexibility Act (RFA) as it applies to tax regulations.  At issue in this case specifically are the regulations enacted to interpret new section 965 as enacted in the Tax Cuts and Jobs Act; however, the issue of the application of the RFA goes well beyond the specific regulations at issue in that case.

The government predictably moved to dismiss the case, asserting both a lack of standing on the part of the plaintiff and the application of the Anti Injunction Act (AIA).  The court’s decision allows the case to get past the initial procedural hurdles.  Plaintiff still must establish the RFA as a provision to which the IRS must pay much more attention.  Plaintiff’s argument raises an issue that reminds me of the early years of arguments about the APA following Kristin Hickman’s articles exposing the gap between the APA and the regulations as promulgated by the IRS/Treasury.

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Mr. Silver is a tax lawyer and a reader of PT.  Although a US citizen, he has a law office in Israel from which he dispenses advice on US tax issues.  He brought the suit because the recently enacted regulations interpreting IRC 965 create a significant recordkeeping burden.  While he did not owe any tax in 2018 as a result of this law change, he still seeks to challenge the regulations because of the burden and cost of compliance.  He was one of many who commented on the regulations and the burden they would impose on small businesses such as his.  He argues that the IRS inappropriately failed to address this burden.  Because he challenges the regulations outside of a deficiency or refund proceeding but rather in a straight up suit designed to strike the application of the regulations, the IRS began its defense by arguing that Mr. Silver lacked standing to challenge the regulations and that in any event the court lacked jurisdiction given the reach of the Anti Injunction Act.

The D.C. district court has allowed the challenge to move forward, marking a major victory for Mr. Silver.  In allowing the case to move forward and finding that Silver had standing to challenge the regs, the court found:

Here, Plaintiffs allege what is known as a “procedural injury,” that is, an injury resulting from the violation of a procedural right created by statute. See Ctr. for Law & Educ. v. Dep’t of Educ., 396 F.3d 1152, 1157 (D.C. Cir. 2005). In such cases, the redressability and imminence requirements of standing are relaxed. See Wildearth Guardians v. Jewell, 738 F.3d 298, 305 (D.C. Cir. 2013). The plaintiff need not show that “but for the alleged procedural deficiency the agency would have reached a different substantive result.” Id. at 306. Rather, she need only establish that the agency violated a procedural right designed to protect her interests, and that it is plausible “‘that the procedural breach will cause the essential injury to the plaintiff’s own interest.’” Ctr. for Law & Educ., 396 F.3d at 1159 (quoting Fl. Audubon Soc. v. Bentsen, 94 F.3d 658, 664–65 (D.C. Cir. 1996) (en banc)). In other words, “the requirement of injury in fact is a hard floor of Article III jurisdiction that cannot be removed by statute.” Summers v. Earth Island Inst., 555 U.S. 488, 497 (2009). “A procedural injury claim therefore must be tethered to some concrete interest adversely affected by the procedural deprivation . . . .” WildEarth Guardians, 738 F.3d at 305.

Plaintiffs’ alleged injury is the cost associated with complying with the TJCA’s transition tax regulations, which include certain “collection of information” and “recordkeeping obligations.”

As part of its efforts to dismiss the suit based on standing, the IRS argued that Mr. Silver’s real complaint was with the statute itself and not with the regulation.  As such, he could not attack the statute by seeking to change the regulation.  The district court disagreed, holding:

Plaintiffs are not challenging any specific regulation that might or might not be traceable directly to the TCJA. Rather, Plaintiffs allege that the agencies neglected to undertake procedural measures designed to protect small business from the burden of unwieldy and cost-intensive regulations—namely, the publishing of an initial and a final regulatory flexibility analysis, 5 U.S.C. §§ 601, 603(a), and a certification that the regulation has reduced compliance burdens on small businesses, 44 U.S.C. § 3506. Plaintiffs alleged injuries are therefore traceable to Defendants’ alleged violation of these separate statutory requirements, not the TCJA. Causation is easily satisfied.

In perhaps the most surprising aspect of the opinion, the court allowed the plaintiffs to move forward with its RFA challenge despite the broad reach of the AIA as typified by the DC Circuit’s prior opinions in Florida Bankers and Maze. (Guest blogger Pat Smith discussed Florida Bankers in two parts here and here, and Les blogged the Maze opinion here.) Readers may recall that the AIA prevents suits for the purpose of restraining the assessment or collection of taxes. The DC Circuit has previously taken a hard view on cases challenging the validity of regulations, and IRS predictably raised an AIA defense to the RFA challenge. Here, the district court suggested that courts may be willing to put the IRS to the burden of additional procedural hoops even if perhaps the AIA might ultimately prevent the court from granting the relief on the merits that Silver seeks, that is, a stay on enforcement of the regs.

With respect to the AIA, the district court disagreed with the IRS, stating:

Although “[t]he IRS envisions a world in which no challenge to its actions is ever outside the closed loop of its taxing authority[,]” the Act’s prohibition does not sweep so broadly: “‘assessment’ is not synonymous with the entire plan of taxation, but rather with the trigger for levy and collection efforts, and ‘collection’ is the actual imposition of a tax against a plaintiff.” Id. (cleaned up). Accordingly, the D.C. Circuit has refused to “read the [Anti-Injunction Act] to reach all disputes tangentially related to taxes.” Id. at 726–27. Rather, the Circuit has instructed that whether the Anti-Injunction Act prohibits a suit depends on whether the action is fundamentally a “tax collection claim,” id. at 727 (quoting We the People Found., Inc. v. United States, 485 F.3d 140, 143 (D.C. Cir. 2007)), which the court must determine based upon “a careful inquiry into the remedy sought, the statutory basis for that remedy, and any implication the remedy may have on assessment and collection,” id….
 
Plaintiffs do not seek a refund or to impede revenue collection. Instead, they challenge the IRS’s adopting of regulations without conducting statutorily mandated reviews designed to lessen the regulatory burden on small businesses. As relief, they ask the court simply to compel the agencies to do what the law requires—Regulatory Flexibility Act and Paperwork Reduction Act analyses. Tax revenues and their collection are unaffected by such relief. The Anti-Injunction Act therefore presents no barrier to Plaintiffs’ claims.

We hope to have Mr. Silver and his attorney, Stu Bassin, who has written several prior PT guest posts, write for us in the near future to expand on this brief introduction to the case.  For those interested in the issue, a good place to start is a GAO report discussing the failure of some agencies to appropriately follow the RFA.  According to the complaint in this case, the IRS regularly fails to comply with the RFA requirements.  For those interested in the specifics of this case please see the amended complaint, the motion to dismiss, the IRS brief in support of its motion and plaintiff’s brief opposing the motion.

The ability to challenge a regulation and overcome the hurdle of the AIA has become a hot issue.  Les wrote about it here in the context of CIC Services.  He has also recently added a significant discussion of the scope of AIA in the Saltzman-Book treatise, IRS Practice and Procedure at ¶1.6.  That revision is set to be published in the treatise next month. We expect CIC Services to seek cert and offer the Supreme Court the opportunity to step in and clear the murky waters surrounding the application of the AIA to challenges regarding tax regulations.  Of course, Mr. Silver’s case goes beyond raising the AIA challenge and throws down a significant challenge to the IRS practice of promulgating regulations as it relates to compliance with the RFA.  With the initial success here, it will not be surprising to see this issue raised much more frequently as parties challenge regulations.