DC District Court Following LovingTakes Down Part of Circular 230 Contingent Fee Rules

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The implications of Loving are starting to be felt beyond the question of the IRS’s ability to regulate unlicensed preparers. Earlier this week the DC District Court in Ridgely v Lew relied on Loving to invalidate Treasury Circular 230 10.27 insofar as it prevents the charging of contingent fees for refund claims practitioners charge for preparing and filing refund claims after an original filing and before the Service has commenced an audit. In the case, CPA Ridgely sued under the APA and Declaratory Judgment Act seeking injunctive and declaratory relief. He claimed that the 2007 10.27 Circular 230 rules led to a “loss of clients and significant revenue.”

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In Ridgely, the District Court held that the preparing and filing of refund claims prior to any IRS examination or other matter for which a representative would have submitted a power of attorney is not practice within the meaning of Title 31 Section 330(a)(1), the same statutory authority that was at issue in Loving. According to the Ridgely Court:

At Chevron step one, then, this case boils down to the following question: does Section 330 unambiguously foreclose the IRS’s interpretation that CPAs act as “representatives” who “practice” before the IRS when they prepare and file Ordinary Refund Claims?

Plain Text Analysis

The Court drew from Loving in its analysis that the plain text analysis of Section 330(a) precluded the Service’s ability to restrict contingent fees in what it called “ordinary refund claims”:

This Court, however, is not the first to venture down this particular rabbit hole. Earlier this year, in Loving v. IRS, 742 F.3d 1013 (D.C. Cir. 2014), the D.C. Circuit grappled with the question of “whether the IRS’s authority to ‘regulate the practice of representatives of persons before the Department of the Treasury’ encompasses authority to regulate tax-return preparers,” Loving, 742 F.3d at 1016 (emphasis added), whom the Court in turn defined as persons who “‘prepare[] for compensation, or who employ[] one or more persons to prepare for compensation, all or a substantial portion of any return of tax or any claim for refund of tax under the Internal Revenue Code,’” id. (quoting 26 C.F.R. § 301.7701-15(a)). The Court held that the text, history, structure, and context of Section 330 “foreclose[d] and render[ed] unreasonable” the IRS’s interpretation of Section 330. Id. at 1022. In other words, the IRS’s interpretation failed at both Chevron step 1 and Chevron step 2. Id. …

The plain text of Section 330(a) limits the regulatory authority of the Secretary of the Treasury to “the practice of representatives of persons before the Department of the Treasury.” 31 U.S.C. 330(a)(1). As the Loving court explained, two terms in this provision are key: “representative” and “practice.” To fall under Section 330’s purview, the regulated conduct must be “practice” and must be undertaken by a “representative.”

As to the meaning of the term “representative,” Loving is clear: a “representative” is traditionally one “with authority to bind others.” 742 F.3d at 1016. Tax-return preparers neither “possess legal authority to act on the taxpayer’s behalf” nor can they “legally bind the taxpayer by acting on the taxpayer’s behalf.” Id. at 1017. They are, as a result, “not agents.” Id. As mentioned earlier, the Loving court defined “tax return preparers” to expressly include those preparing refund claims, but even if the court’s holding fails to directly cover CPAs preparing and filing Ordinary Refund Claims, the court’s reasoning applies straightforwardly. CPAs preparing and filing such claims before possessing any power of attorney possesses no “legal authority to act on behalf of taxpayers.” Id. at 1017. In Loving’s words, these individuals merely “assist[]” the taxpayer. Id. Thus, Section 330’s use of the term “representative” excludes refund claim preparers, just as it did tax-return preparers in Loving.

History, Context and Dismissal of the IRS Argument

Beyond the plain text analysis, in pages 10-11 Ridgely mirrored the lower court’s Loving opinion  and also looked to the context and history of Section 330 to find that the statute did not cover “mere preparation and filing of refund claims.”

Starting on page 12, it also discounted the IRS’s argument:

The IRS offers only one non-conclusory argument in response to the Court’s statutory interpretation as guided by Loving: that because Ridgely is a CPA, he “is a representative who practices before the Department and is therefore subject to the terms of Circular 230.” IRS Mot. [Dkt. No. 35-1] at 25. In other words, according to the IRS, it has authority to regulate all actions of CPAs who—at some point—“practice” before it, regardless of “whether they’re acting in a representational or non representational capacity.” Hearing Tr. at 26. This argument, however, poses three problems. First, it is inconsistent with the use of the word “practice” in Section 330. The statute does not regulate “practitioners” generally; it regulates a specific kind of activity they may undertake: “practice . . . before the [IRS].” 31 U.S.C. § 330(a)(1). Second, the IRS’s position would read the word “representative” out of Section 330. As Loving made clear, Section 330 only applies to individuals when they represent taxpayers. Third, adhering to the IRS’s position would lead to absurd results. According to the IRS, it could broadly regulate the actions of CPAs no matter what they were doing—even if their conduct was nowhere close to “practicing” before IRS—simply because, say, the CPAs “practiced” before the IRS once a year. Meanwhile, the IRS would impose no contingent fee restrictions on the preparation and filing of Ordinary Refund Claims by non-CPAs and those who never “practice” before the IRS. Nothing in the statutory text (or, for that matter, the context and history of Section 330) gives the IRS this kind of authority over CPAs specifically. Further, nothing in Section 10.27 indicates that the IRS was concerned with CPA conduct in particular instead of with the ethics of fee arrangements for preparation and filing generally. The Court therefore disagrees with the IRS that simply because CPAs may at times practice before the IRS, the IRS has authority to regulate their conduct without limit.

The IRS also argued that it had “inherent authority” to regulate those who, like Ridgely as a CPA, practice before it in other capacities. The Court rejected that as foreclosed by Loving.

Result and Initial Reaction

After finding that the IRS overstepped its bounds, the Court granted Ridgely a declaratory judgment that the IRS lacked statutory authority to promulgate contingent fee restrictions on those preparing and filing ordinary refund claims. It also agreed to permanently enjoin the IRS from enforcing the regulation (pages 14-15).

This is a blow to the IRS and suggests that we are just beginning to see the fallout from Loving. Following the decision, some IRS officials were suggesting Loving should be narrowly construed. Ridgely suggests courts may not agree with that. The notion that practice begins at a certain time in all tax matters potentially has broader implications for the validity of other parts of Circular 230.  Commentators have already questioned the effect on IRS’s ability to control aggressive tax shelter advice. Ridgely also brings into question, for example, the part of the voluntary certification proposal for unlicensed preparers which asks preparers to opt in to part of Circular 230 in connection with preparing tax returns. In the weeks and months ahead, with the AICPA suit challenging the voluntary preparer regulation proposal (and no doubt other cases too) there will be an emphasis on just how far Loving and its rationale reach in terms of providing limits on the IRS and potentially upsetting the Circular 230 landscape. It does not seem, at least in the short term, Congress will help the IRS out with legislation and we can expect the courts defining the limits of Loving and its rationale.

As to broader questions of administrative law, many tax practitioners feared that, after Mayo Foundation’s adoption of the deferential Chevron test for regulatory review, we would rarely see courts invalidating Treasury regulations.  Both Loving and Ridgely are proof that Chevron has teeth.

UPDATE

Professor Steve Johnson, one of the most thoughtful commentators on tax procedure and Loving in particular has an excellent reaction piece in Tax Prof

Prior PT Posts on Loving

We extensively covered the Loving case in the past year. Two of the more recent posts are below:

Recent Developments in the Regulation of Return Preparers (Larry Gibbs)

Loving Victory is Final and Why That’s a Good Result For Taxpayers and Preparers (Dan Alban)

About Leslie Book

Professor Book is a Professor of Law at the Villanova University Charles Widger School of Law.

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