Invalidating an IRS Notice: Lessons and What’s to Come from Feigh v. C.I.R.

A few weeks ago, the United States Tax Court decided Feigh v. Commissioner, 152 T.C. No. 15 (2019): a precedential opinion on a novel issue involving the Earned Income Tax Credit (EITC) and its interplay with an IRS Notice (Notice 2014-7). The petitioners in the case just so happened to be represented by my clinic, and the case just so happened to be a A Law Student’s Dream: fully stipulated (no pesky issues of fact), and essentially a single (and novel) legal issue. Because the opinion will affect a large number of taxpayers, I commend those working in low-income tax to read it. What I hope to do in this blog post is give a little inside-baseball on the case and, in keeping with the theme of this blog, tie it in a bit with procedural issues.

read more...

Posture of the Case

I frequently sing the praises of Tax Court judges in working with pro se taxpayers. This case provides yet another example. My clinic received a call from the petitioners less than a week before calendar. Apparently, the Tax Court (specifically Judge Goeke) had recognized that this was a novel issue of law and suggested to the low-income, pro se petitioners that they may benefit from contacting a Low-Income Taxpayer Clinic for help with the briefing.

By the time the client contacted me (again, only a few days before calendar) the IRS had moved for the case to be submitted fully stipulated under Rule 122. The Court had not yet ruled on the motion but I mostly found the stipulations unobjectionable (with one minor change, which the IRS graciously did not object to). Rather, what concerned me was the fact that it was designated as an “S-Case.” I wanted this case to be precedential, and I wanted to be able to appeal –neither of which are possible for S-Cases. See IRC § 7463(b). Yes, the Court can remove the designation in its own discretion (see post here), but I didn’t want to leave anything to chance. After consulting with my clients the first order of business was to move to have the S designation removed -which again saw no objection from the IRS. Now the table was set for briefing on the novel issue.

What’s At Issue?

I’m going to try hard not to dwell on the substantive legal issues in this case, important though they are. Nevertheless, an ever-so-brief primer on what was going on is necessary.

Our client (husband and wife) received Medicaid Waiver Payments for the services the wife provided to her disabled (non-foster) child. From conversations with local VITA organizations I already anecdotally knew that some people received these payments, but since taking this case on I have come to appreciate exactly how vast the Medicaid Waiver program is. For our client, the Medicaid Waiver Payments were made in the form of rather meager wages (a little over $7,000) that were subject (rightly or wrongly) to FICA. They were the only wages my clients had. When my clients went to file their income tax return, however, it looked like they were getting a fairly raw deal: namely, missing out on an EITC and Child Tax Credits cumulatively worth almost $4,000. Why? Because in 2014 the IRS decided that these Medicaid Waiver Payments were excluded from income as IRC § 131 “Foster Care” payments.

An exclusion from income sounds to most taxpayers like a good thing: it’s always better to have less taxable income, right? But the tax code is a complicated animal, and for lower-income taxpayers the exclusion of wages was actually a curse: to be considered “earned income” for both the EITC and Child Tax Credit (CTC), wages must be “includible” in income. By the IRS’s logic, this meant that you must exclude your $7,000 Medicaid Waiver Payment (with a tax benefit of $0 in some cases) and couldn’t thereafter “double-benefit” by also getting the EITC/CTC for those excluded wages.

It doesn’t quite seem fair for those who saw little or no tax benefit from the exclusion.

It seems even less fair when you consider that those who would actually phase out of the EITC (say, by receiving a large Medicaid Waiver Payment over $52,000, which has happened) not only would get a larger tax benefit from the exclusion, but could still potentially get the EITC if they had other wages (say, from the other spouse). Theoretically, a couple making $100,000 could get the EITC in this case if the greater portion of the income were Medicaid Waiver Payments. This would be the case because such payments would be disregarded for EITC eligibility calculation altogether. Probably not what Congress (or even the IRS) had in mind.

My clients felt like they should do something about this unfairness. So they did: they took both the exclusion of IRS Notice 2014-7 and the EITC based on the excluded wages. This of course led to a notice of deficiency and culminated in the precedential Feigh decision.

Our Legal Arguments

Because of our client’s novel stance, we had two points we had to make for our client to win: (1) that the wages could be included in income, and (2) basically, that was it. We wanted to make it a simple statutory argument: If the wages could be included, then they were “includible,” and that was all that was required of the EITC under IRC § 32(c)(2)(A)(i).

As to the first point -whether the payments could (maybe, should) be “included” in income- history was on our side. Prior to 2014 courts and the IRS agreed that such payments had to be included in income. Payments for adopted or biological children clearly did not meet the statutory language of excluded “Foster Care Payments” under IRC § 131. The only thing that changed in the intervening years was the IRS issuance of Notice 2014-7: there was no “statutory, regulatory, or judicial authority” that could anchor the change in treatment. As we argued, the IRS essentially transformed “earned income” into “unearned income” on its own. And that sort of change is a massive bridge too far through subregulatory guidance.

We won on that first issue handily. The Court noted that “IRS notices –as mere statements of the Commissioner’s position—lack the force of law.” Then, the Court applied Skidmore deference (see Skidmore v. Swift & Co., 323 U.S. 134 (1944)) to see whether the interpretation set forth by IRS Notice 2014-7 was persuasive.

It was not.

And the IRS could not, through the notice, “remove a statutory benefit provided by Congress” -like, say, eligibility for the EITC. That sort of thing has to be done through statute. For administrative law-hawks, the Tax Court reigning in the IRS’s attempts to rule-make without going through the proper procedures is probably the bigger win. (As an aside, I’m not entirely positive even a full notice-and-comment regulation could do what Notice 2014-7 tries to: I don’t think any amount of deference would allow a reading of IRC § 131 the way Notice 2014-7 does.)

So we cleared the first hurdle: the IRS can’t magically decree that what was once earned income is no more through the issuance of subregulatory guidance. But what of the second hurdle -the fact that our client undeniably did not include the wages in gross income?

Courts have (rightly) treated the terms “allowable” and “allowed” differently, as well as “excludible” vs. “excluded” in previous cases. The breakdown is that the suffix “able” means “capable of” whereas the suffix “ed” means “actually occurred.” See Lenz v. C.I.R., 101 T.C. 260 (1993). Coming into this case I was keenly aware of this distinction because of a law review article I read while writing a chapter on the EITC for Effectively Representing Your Client Before the IRS. Indeed, it was that aspect of the EITC statutory language (and not my familiarity with Notice 2014-7 or Medicaid Waiver Payments) which made me want to take this case from the beginning. I feel compelled to raise the value of that law review article (James Maule, “No Thanks, Uncle Sam, You Can Keep Your Tax Break,”) because so many law professors joke that no one reads law review articles, or that most articles are impractical (no comment on the latter).

Consistently with the distinction of “allowed” vs. “allowable,” the Court has previously ruled on the nuance of “included” vs. “includible.” See Venture Funding, Ltd. v. C.I.R., 110 T.C. No. 19 (1998). “Included” means it was reported as income, “includible” means that it could/should be reported in income. Since the Tax Court already found that we met the first hurdle (our client could include the payments in income and Notice 2014-7 can’t take that away), we were in the clear: it was “includible.”

And so our client has excluded income and the earned income credit derived from it… Impermissible double-benefit, you (and the IRS brief) say?

I disagree. Not only does treating excluded payments as earned income apply the statutory language correctly, and more in line with what Congress would want, I contend that it is the better way to protect the integrity of the EITC. To see why this is you have to look again at how the EITC is calculated, and how the phase-out applies. In so doing we see that the real problem would be in disregarding excluded income altogether.

The Integrity of the EITC

The EITC is means tested, but it calculates the taxpayers means through two separate numbers: (1) “earned income” and (2) “adjusted gross income (AGI).” See IRC § 32(a)(2) and (f).  Excluded income isn’t reflected in AGI, so people with high amounts of excluded income might escape the AGI means testing prong of the EITC -unless the excluded income is specifically caught through other IRC 32 provisions like limits on investment income or foreign income exclusions. (Note that excluded alimony payments post TCJA would not be incorporated in the means testing.)

However, if excluded income like Medicaid waiver payments is considered “earned income” (that is, if we don’t require that earned income be “included”) then people with large amounts of excluded earned income do begin to phase out under the “earned income” means testing prong. In other words, it more appropriately reserves the credit only for those who working and are (truly) of limited means, while denying it to those who (truly) are not. I think Congress would approve. I’d also note that the exclusion is necessarily worth more to higher income earners than to lower-income earners -and frequently worthless to EITC recipients, many of whom may not actually have a tax liability at all (thus providing a $0 benefit to the exclusion).

Finally, I’d note (and did in the brief) that Congress has essentially addressed this problem of excluded earned income before -only with non-taxable Combat Pay. A little history is helpful on that point.

For the majority of the EITC’s existence (from 1978 to 2001), earned income actually didn’t have to be “includible” in gross income. Then, in an effort to make the credit easier to compute (not an effort to limit eligibility), Congress added the includible requirement as part of the Economic Growth and Tax Relief Reconciliation Act of 2001. Mostly, Congress made this change because it wanted information returns to give taxpayers (and the IRS) all the information needed for calculating the EITC.

Unfortunately, this meant that active duty soldiers receiving combat pay (which is a mandatory statutory exclusion, and thus not “includible” under IRC § 112) could not treat that pay as qualifying for the EITC. A GAO report noted that this was likely an unintended consequence (see page 2), that accrued the bulk of the benefits to those that made the most money. The Congressional fix was IRC § 32(c)(2)(B)(vi), which allows taxpayers to “elect” to treat excluded combat pay as earned income (it still isn’t taxed). Congress had to make this change to fix an unintended consequence of their own (statutory) making. However, it would be absurd (we argued) to require Congress to fix an unintended consequence wholly created by the IRS through Notice 2014-7.

What Happens Next?

I’ve been in contact with the local VITA providers in my community that see Medicaid Waiver Payments on the front lines -apparently fairly frequently. Their main question is a practical one: what do we tell taxpayers now? The IRS VITA guidance before had been “you can’t get credit for those payments towards the EITC.” In the aftermath of Feigh, can they both exclude and get credit now (as my client did)?

That is an excellent question, which brings up some excellent procedural issues (finally: I promised I’d get to them). The main issue is whether the IRS may now consider Notice 2014-7 completely moribund, such that there is no exclusion period and the Medicaid Waiver Payments must be included. The Court noted that the IRS did not raise the argument that the payments should be includible in income for my client, so it was conceded. But is the IRS stuck with that position now? Can the IRS take a position that is contrary to its own published guidance? What if that guidance is essentially invalidated?

The best case on point for this sort of situation may be Rauenhorst v. Commissioner, 119 T.C. 157 (2002). In that case, the IRS essentially said it wasn’t bound by its own guidance (in that instance in the form of a Revenue Ruling) when the Commissioner took a litigating position directly contrary to it. After receiving something of a slap-down from the Tax Court, the IRS issued Chief Counsel Notice CC-2003-014 (sorry, I couldn’t find any free links), which provided that “Chief Counsel attorneys may not argue contrary to final guidance.” Final guidance includes “IRB notices” (i.e. notices that are published in the Internal Revenue Bulletin), which Notice 2014-7 was.

Further, it does not appear to matter that Feigh essentially invalidated Notice 2014-7. The Chief Counsel Notice specifically includes a section headed “Case law invalidating or disagreeing with the Service’s published guidance does not alter” the rule that Chief Counsel shouldn’t take a contrary position that is unfriendly to taxpayers. In other words, so long as IRS Counsel follows the CC Notice, they should continue to let taxpayers exclude the Medicaid Waiver Payments… And since they’ve already lost on whether those excluded payments are earned income, it is perhaps best of both worlds for taxpayers moving forwards.


Perhaps. But I’m not sure I’d bet the farm on the IRS following the Chief Counsel’s Notice in all cases (and especially for taxpayers working with IRS agents or appeals, rather than Counsel).

But the final procedural point I want to make takes the long-view of things: which is that this never should have happened in the first place, because the IRS never should have overstepped its powers by issuing Notice 2014-7 masquerading as substantive law without, at the very least, following the rigorous notice and comment procedures required of substantive regulations. Had the IRS done so the tax community could well have seen this before the regulation was finalized and it could have been addressed. This may echo from my soapbox, but Notice 2014-7 undoubtedly caused real harm to some of the most vulnerable taxpayers. I know from conversations in the tax community that many low-income earners lost out on a credit they rightfully deserved. I don’t think for a second that was the intention of the IRS when they issued Notice 2014-7. Nor does Judge Goeke in the opinion (see footnote 7).

But, again, tax is a complicated animal: legislating new rules should not be done lightly. Procedure, in other words, matters.

Ninth Circuit Reconsideration in Altera v. Commissioner

We welcome back guest blogger Stu Bassin. Stu has blogged with us on several occasions. He is a practitioner based in DC with an extensive controversy practice and provided a discussion of the Altera case earlier here. Les

Last week bought the latest twist in the saga of a challenge to a critical transfer pricing regulation—a rehearing by the Ninth Circuit of a since-vacated ruling upholding the regulation. The original unanimous reviewed decision by the Tax Court in Altera Corp. v. Commissioner, 145 T.C., No. 3 (2015), invalidated the regulation. A divided panel in the Ninth Circuit reversed, upholding the validity of the regulation over a strong dissent. The majority opinion was soon vacated and the case was reargued on October 16, 2018. Given the importance of the specific regulation at issue in transfer pricing cases, as well as the continuing discussion regarding questions concerning Administrative Procedure Act challenges to IRS regulations, the reargument has generated substantial attention in the tax community.

read more...

The underlying dispute involves a cost-sharing agreement governing allocation of stock-based compensation costs between entities related to the taxpayer and invocation by the IRS of Section 482 to recharacterize the terms of that agreement. Section 482 provides:

In any case of two or more organizations . . . owned or controlled directly or indirectly by the same interests, the Secretary may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses. In the case of any transfer (or license) of intangible property (within the meaning of section 936(h)(3)(B)), the income with respect to such transfer or license shall be commensurate with the income attributable to the intangible.

The taxpayer relied upon the undisputed fact that the terms of its cost-sharing agreement were consistent with the prices which unrelated parties would employ in comparable arms-length agreements, thereby satisfying the legal standard historically applied in evaluating cost-sharing agreements under Section 482. The IRS recharacterized the terms of the agreement, relying upon a regulation which specifically required affiliates to share stock-based compensation costs in a manner “commensurate with the income attributable to the intangible.” The taxpayer disagreed, contending that the regulation was invalid under the APA because it deviated from the comparable arms-length transaction test.

The Tax Court unanimously ruled in favor of the taxpayer, invalidating the regulation and rejecting the proposed Section 482 adjustment, focusing upon the second stage of the regulation validity inquiry mandated by Mayo Foundation v. United States, 562 U.S. 44 (2011) — whether the determinations reflected in the regulation were arbitrary and capricious. The opinion concluded that the regulation was invalid because the IRS failed to engage in actual fact-finding, failed to provide factual support for its determination that unrelated parties would share compensation costs in their cost-sharing agreements, failed to respond to significant comments, and acted contrary to the factual evidence before Treasury.

The IRS appeal to the Ninth Circuit was initially heard by a panel consisting of Chief Judge Thomas, Senior Judge Reinhardt, and Judge O’Malley of the Federal Circuit. Judge Thomas, joined by Judge Reinhardt, wrote the opinion for the court reversing the Tax Court opinion and upholding the validity of the regulation. He reasoned that the 1986 amendment of Section 482 (which added the language containing the “commensurate with income” standard) mandated that the IRS adopt regulations employing the commensurate with income standard in addition to the comparable arms-length transaction standard. Judge O’Malley dissented, urging invalidation of the regulation because it deviated from the arms-length standard.

Because the decisive vote was cast by Judge Reinhardt, who died after the argument and roughly 100 days before the opinion was issued. A footnote to the opinion states that “Judge Reinhardt fully participated in this case and formally concurred in the majority opinion prior to his death.” A procedural issue arose when Altera petitioned for rehearing. The remaining members of the panel were deadlocked, so the court withdrew the original opinion, assigned Circuit Judge Susan Graber (a Clinton appointee) to replace Judge Reinhardt on the panel, and scheduled the case for reargument last week.

At the argument, Judge Thomas was silent and Judge O’Malley appeared to reiterate the position stated in her dissent. So, all eyes focused upon Judge Graber, who was new to the panel and the likely decisive vote on the merits. She focused her inquiry upon statutory construction issues and the relationship between the historic standard of “comparable arms-length transactions” embodied in the first sentence of Section 482 and the “commensurate with income” standard embodied in the second sentence of Section 482. Noting that the statutory language of the second sentence applies only to “the income with respect to such transfer or license [of intangible property],” she questioned whether the cost sharing agreement was a “transfer or license” within the meaning of the statute. The taxpayer argued that its cost-sharing agreement was not a narrow “transfer or license” and that the second sentence’s “commensurate with income” standard was therefore inapplicable. In contrast, the government contended that the indirect role of the cost-sharing agreement in establishing the pricing on the arrangement between the two subsidiaries was sufficient to render the “commensurate with income” standard applicable and controlling.

Judge Graber also asked a series of questions focused upon reconciling the commensurate with income standard with the general requirement under Section 482 that the IRS must allocate costs in a manner consistent with the arms- length standard. The government argued that the legislative history reflects a congressional policy judgment and determination that, in those cases involving transfers of intangible property, only an allocation based upon the “commensurate with income” standard would satisfy the arms-length standard. The taxpayer countered by stating that the legislative history did not support such a construction and observed that, if the government’s construction were adopted, relatively few transactions would remain governed by the traditional arms-length standard.

Finally, Judge Graber inquired whether there was a factual basis or economic theory which supported the regulation’s finding that stock-based compensation costs must be allocated in a manner   commensurate with income to satisfy the arms-length standard. The taxpayer noted the absence of a factual record or economic theory supporting the IRS findings, arguing that the only evidence before the agency supported a finding that comparable arms-length transactions did not allocate stock-based compensation costs in the manner required by the IRS. In contrast, the government stated that such evidentiary support was not required to support the IRS determination.

Interestingly, the argument gave relatively little attention to the second stage of the Mayo analysis—the arbitrariness of the IRS determination. The degree of deference accorded regulations under Chevron was hardly discussed. Both sides and the court focused upon the statutory authority for the regulation. They all seemed to agree that, if the statute authorized the IRS to deviate from the arms-length standard, the regulation would survive.   Otherwise, the regulation was invalid.

The panel gave no indication of when it would render its decision. Full opinions on appeals to the Ninth Circuit tend to take a long time and the initial panel decision was not released until nine months after the argument. So, it seems likely that a decision will not be issued until early 2019.

 

Challenges to Regulations Update: Government Withdraws Appeal in Chamber of Commerce and New Oral Argument Set for Altera

One of the more interesting cases from last year was Chamber of Commerce v IRS, where a federal district court in Texas invalidated temporary regulations that addressed inversion transactions. The case raised a number of interesting procedural issues, including the reach of the Anti-Injunction Act and the relationship between Section 7805(e) and the APA.

Not surprisingly, the government appealed Chamber of Commerce. Over the summer, Treasury issued final regs that were substantively similar to the temporary regs that the district court struck down, and then the government filed a motion with the Fifth Circuit to dismiss its appeal with prejudice.

Last month the Fifth Circuit granted the motion.

read more...

The outcome in Chamber of Commerce illustrates the difficulty that taxpayers face when challenging regulations for process violations (i.e., failing to subject guidance to notice and comment) and in particular challenges to temporary regulations. After all, Treasury can (and did in this case) issue final regs, and Section 7805(b) provides that those regs take effect retroactively upon the earlier of the “date on which any proposed or temporary regulation to which such final regulation relates was filed with the Federal Register” or “the date on which any notice substantially describing the expected contents of any temporary, proposed, or final regulation is issued to the public.”

Chamber of Commerce is to be contrasted with challenges to regs that focus on the substantive way that the regulations interpret a statute; for example, earlier this summer the DC Circuit reversed the Tax Court in Good Fortune Shipping.There, the DC Circuit applied Chevron Step Two and held that Treasury regulations that categorically restricted an exemption to foreign owners of bearer shares unreasonably interpreted the Internal Revenue Code. The taxpayer in Good Fortune challenged the reg the old fashioned way– in a deficiency case as contrasted with the pre-enforcement challenge in Chamber of Commerce.

Probably the most watched procedural case of the year, Altera v Commissioner, also tees up a procedural challenge to regs, and like Good Fortune is also situated in a deficiency case. One of the main arguments that the taxpayer is raising in Altera is a cousin to the challenge in Chamber of Commerce; that is the taxpayer is challenging the way that the reg was promulgated (and the case also involves a Chevron Step Two challenge). In particular, the issue turns on whether the agency action [the regulation] is “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” 5 USC 706(2)(A). Altera involves Treasury’s compliance with § 706 of the APA as expanded on in the 1983 Supreme Court State Farm’s “reasoned decisionmaking” understanding of the clause prohibiting “arbitrary” or “capricious” agency action.

As Keith flagged a few weeks ago, after the Ninth Circuit reversed the Tax Court and found that Treasury did enough in its rulemaking and held that the cost-sharing regulation was valid, the Ninth Circuit withdrew the opinion. The Ninth Circuit has now scheduled a new oral argument in Altera for October 16.

Stay tuned.

White House Oversight of Tax Regulations

One of the more significant tax procedure developments of the past year is the new centralized OMB review  that applies to some tax regulations. In this post, Professor Clint Wallace from the University of South Carolina School of Law describes the new framework and notes the many areas that await further clarification. Clint discusses this in greater detail in Centralized Review of Tax Regulations, forthcoming in the Alabama Law Review. Clint is an important voice in the academy on tax administration and tax procedure. His article Congressional Control of Tax Rulemaking appeared this past year in the Tax Law Review. In that piece Clint discussed the special institutional capacity that the Joint Committee on Taxation plays in tax legislation, situating the JCT in the context of administrative law and principles of statutory interpretation. Les

Earlier this month, the Treasury Department and the Office of Management and Budget announced a “new framework” that appears likely require many more tax regulations to undergo OMB review.  In other contexts—for example, environmental or workplace rules—this sort of consultation between agency regulation-writers and OMB is commonplace.  Dating back to the Reagan administration, centralized review has been mandated for many regulations.  (The fountainhead of OMB’s authority to impose this review is Executive Order 12,866, which has been modified in some minor respects by subsequent EOs, but remains in effect).  When OMB reviews a “significant” regulation, it requires the drafting agency to quantify the costs and benefits of the rule, and it facilitates a process whereby other departments can weigh in on the proposals.  But OMB has never before required tax regulations to be subjected to this sort of review.

Some political commentators saw the framework as OMB winning a turf war against Treasury, and some tax professionals reacted with dismay that additional layers of analysis will delay new regulations.  Delays are a particular concern in the tax community right now because Treasury is scrambling to produce reams of important regulations to fill in the many blanks that Congress left when it hastily enacted the Tax Cuts and Jobs Act at the end of 2017.

But treating this as either an issue of shifting political power or simply a matter of stretching out a bureaucratic process both undersells and oversells the potential import of this move.  As of now, no one really knows what it means for the implementation of the Tax Cuts and Jobs Act, nor for the development of regulatory tax policy more generally.

read more...

The framework has three major components.  First, it requires Treasury to keep the Office of Information and Regulatory Affairs (the office within OMB charged with central authority to review regulations)abreast of its agenda by submitting quarterly “notices” of all “planned tax regulatory actions.”  This, of course, does not mark a significant change from current Treasury and IRS practices: Treasury and the IRS already produce an annual “Priority Guidance Plan,” with quarterly updates.  Further, these documents are already robust and useful versions of the sort of regulatory agenda-setting prescribed under Executive Order 12,866: Treasury does a good job of soliciting public input on agenda items, makes fairly accurate predictions of its capacity, and follows through on the items it places on the agenda. It looks like the new framework does not change anything about this agenda-setting process, but rather simply mandates that Treasury should provide the (already publicly available) agenda and updates directly to OIRA.  The framework specifies that “[a]t the election of the OIRA administrator, Treasury will engage in substantive consultation with OIRA regarding any” regulatory action that appears on the agenda.  It is not clear from the memorandum what such engagement might consist of; regardless, such engagement was not prohibited previously.

The second component of the framework is that it provides that OIRA will review any regulatory actions that “create a serious inconsistency or otherwise interfere with an action taken or planned by another agency,” or that “raise novel legal or policy issues, such as by prescribing a rule of conduct backed by an assessable payment.”  The treatment of this category of tax regulatory actions corresponds with the treatment of “significant” rules under E.O. 12,866.  Along similar lines, the third element of the framework requires that regulatory actions that have “an annual non-revenue effect on the economy of $100 million or more,” be subject to the comprehensive review that is required for “economically significant” regulations under E.O. 12,866.  This review calls for the drafting agency (i.e., Treasury) to produce quantified cost-benefit analysis of the proposed regulation and alternatives.   The framework provides OIRA with 45 days to review each rule, with additional time provided as necessary, and allows Treasury to request an “expedited” 10-business-day review—this is notably shorter than the standard 90-day review period provided for regulations from other agencies, which suggests Treasury and OIRA were mindful of timing concerns expressed from the tax community.

These changes potentially mark a sea-change in the process for producing tax regulations.  However, many important details—which could impact the effectiveness and significance of this new world of centralized review—remain to be determined.  Most prominently, the categories of tax regulatory actions subject to review are ill-defined:

  • The first category of tax regulations that OIRA plans to review—i.e., the category that aligns with “significant” regulations under Executive Order 12,866—applies if a proposed regulation presents a “serious inconsistency” with action taken by another agency. But it is unclear how OIRA will distinguish between serious and minor potential inconsistencies.  The other definitional prong is similarly vague: a “novel legal or policy issue” appears straightforward, but is then exemplified as a “rule of conduct backed by an assessable payment.”  In tax administration, such a rule is not novel; it is a tax or a penalty.  It is unclear whether OIRA intends to (or believes it is authorized to require) review of any rule that can affect the amount of tax or penalty owed, or if this is more limited.
  • The second category of tax regulations includes no explanation of how the “non-revenue effect on the economy of $100 million or more” will be calculated. The first descriptor, “non-revenue effect” makes clear that revenue estimates are not relevant.  Presumably this means that Treasury will be focused on the costs and benefits of compliance and behavioral changes.  If Treasury relies on its existing compliance cost estimates, this requirement will simply weight review towards regulations that affect more taxpayers.
  • Further, the $100 million amount is measured again a “no action” baseline, but it is unclear what sort of action that refers to—Does that mean a state of the world where Congress has not enacted a provision that requires regulatory action?Or where Congress has acted but Treasury provides no further guidance?  If it is the latter, then the baseline will often be defined by partial compliance with a law as enacted.

Additionally, a central feature of centralized review is quantified cost-benefit analysis.  But for most tax regulations, current CBA practices will not yield any benefits—a tax creates deadweight loss, and imposes compliance and administrative costs, and CBA does not account for benefits flowing from transfers to the government.  So how will CBA be used in the tax regulatory process?

The way that OMB and Treasury construe these provisions could be the difference between almost all regulations proposed this year and next being subject to centralized review, or almost none, so these are significant questions.

The framework allows OIRA to defer the “economically significant” style of review for up to a year (until April 2019), in order for Treasury and OIRA to hire necessary personnel. And shortly after the framework was released, OIRA announced that Kristin Hickman is acting as an advisor, presumably sorting through these sorts of issues.  I address many of these challenges in my forthcoming piece Centralized Review of Tax Regulations(this linked version is newly updated – the previous version was written prior to the release of Trump administration framework).