Taking a Hard Look at Court Review of Treasury Regulations

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As the holiday season is upon us, we are also in the season of lists: best movies, books, songs, to name a few. We have not taken the plunge with a post discussing our top posts of the year though my suggestion is just search Keith Fogg and pick up the last ten posts for a good place to start.

No doubt one of the most important tax procedure cases of 2015 and beyond is Altera, which Susan Morse and Stephen Shay discussed most recently in Treasury on the Right Side of the APA in Altera and in one of our most read posts of 2015 in Pat Smith’s A Massive Loss and a Huge Rebuke for the IRS from the Tax Court in Altera Decision. As our readers likely recall, in Altera, the Tax Court unanimously rejected parts of regulations under Section 482 requiring related parties to share stock based compensation costs. The case has major significance beyond the substance because it marked the first time that the Tax Court specifically held that Treasury regulations, whether issued under a grant of general authority or under a specific statutory mandate, were subject to the APA’s notice and comment requirements. After opening that door, the Tax Court applied a “traditional” administrative law arbitrary analysis under APA § 706(2)(A), which empowers a court to invalidate a rule that is “arbitrary” and “capricious.”  In invalidating the regulation, the Tax Court relied on case law including the 1983 Supreme Court State Farm decision which essentially imposed on agencies rulemaking principles embedded in the 1943 Supreme Court Chenery decision. Chenery stands for the general proposition that courts should evaluate agency action based on the reasons that motivated the agency at the time of the agency’s original action, rather than allow agencies to come up with after the fact explanations to justify earlier agency conduct.


IRS has appealed Altera and the case is teed up in the 9th Circuit. No matter how the case is resolved, the battle over the validity of Treasury regulations and other IRS guidance is one that is likely to place the courts in the difficult position of applying administrative law principles to test the procedural soundness of the agency’s conduct in issuing guidance.

With that in mind, I noted with interest Arbitrariness Review Made Reasonable: Structural and Conceptual Reform of the Hard Look, an article in the current Notre Dame Law Review by administrative law scholars Sidney Shapiro and Richard Murphy. In the article, Professor Shapiro and Professor Murphy provide a comprehensive history of how under the arbitrary standard in APA § 706(2)(A) court review of agency rulemaking morphed from a relatively light touch to a more thorough hard-look requiring that “an agency must establish that, at the time it took its action, it had a contemporaneous rationale sufficient to satisfy the requirements of ‘reasoned decisionmaking.’”

After detailing the ways that courts have shifted from a light touch, the authors make the policy argument and argue against the modern hard-look review that the Tax Court appears to be employing in Altera:

In the abstract, nothing could sound more reasonable than for courts to insist that agencies actually base their actions on good reasons. As implemented, however, modern arbitrariness review has made the rulemaking process unduly onerous and time-consuming, with important rules often taking many years to complete. Once completed, these rules are then subject to judicial review that can be political and unpredictable, making it difficult for agencies to guess whether an explanation for a rule will be upheld under hard look review. This state of affairs is all the more problematic given agencies’ notorious lack of sufficient resources to carry out their assigned statutory missions.

The authors propose allowing the agencies the opportunity to defend the substance of rulemaking on reasons that were not necessarily the ones the agency relied on in proposing the rules in the first instance:

[T]his Article proposes a simple reform that may, on first hearing, sound heretical but that proves to have surprisingly strong roots in both the history of administrative law and current judicial practice. Specifically, courts should relax their bar on post hoc rationales, allowing agencies to rely upon them so long as they are based on information exposed to outside scrutiny during the notice-and-comment process.

There is lots in this article, and I have not fully digested it nor the many proposals that administrative law scholars have offered over the years to cut back on the excesses of court review of agency rulemaking. As the authors make clear, the APA is riddled with at times competing values, and with hard-look review, “the courts advanced legitimate administrative law values, including accountability, accuracy, and fairness, but with a loss of agency effectiveness and efficiency, which are also administrative law values of the first rank.”

Finding the balance between these at times competing values is now what courts will be doing when evaluating Treasury regulations and perhaps subregulatory guidance as well. In IRS’s Budget Likely ‘Miserable’ for 2017 and Beyond [free link not available] earlier this week BNA’s Daily Tax Report reported how the prospects for IRS budgets in the near and mid-term look pretty bleak. To be sure, some fear a more efficient IRS and Treasury, and would be happy to tie the agency up in knots to ensure that the agency cannot promulgate rules that some view as overreaching. No doubt that the inclination to impose onerous process requirements on Treasury is at least atmospherically related to how far Treasury deviates from a clear statutory mandate to issue guidance. Yet as courts wrestle with some of these principles in cases of first impression we should be worried about hamstringing an agency that has a vast and complex statutory regime to administer, and often not enough resources to do all that Congress and taxpayers expect.





Avatar photo About Leslie Book

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


  1. Marty Van Acker says

    Appreciate the thoughtful and thorough analysis posted here on Court Review of Treasury Regulations.

    Does any recall an IRS Ruling dealing with whether a correction to a Treasury Regulations was necessary?

    Currently, I have a Form 8300 penalty case at the Audit Reconsideration stage. At my urging, IRS Exam Division is considering whether to request Technical Advice on the issue described below.

    My contention is that Internal Revenue Manual (IRM) section is currently in conflict with 26 CFR 301.6724-1(e)(1)(vi)(C)(1). I have urged the IRS Exam to request a Technical Advice Memo from IRS National Office because the current version of IRM takes a position that is not supported by 26 CFR 301.6724-1(e)(1)(vi)(C)(1). IRM states as follows.
    “If the trade or business fails to make one (or more) of the required solicitations under paragraphs (e)(1)(i) (Initial), (ii) (First Annual), and (iii) (Not required for Form 8300), the penalty will apply to the year in which the filer failed to make the initial solicitation.”

    In Taxpayer’s case, the “First Annual” solicitation was not made. However, Taxpayer made a “make-up solicitation” in the subsequent year. Notwithstanding the “make-up solicitation” that Taxpayer made, IRS assessed a penalty in Taxpayer’s case because IRM does not allow a taxpayer to establish reasonable cause by making a “make-up solicitation” in the subsequent year.

    It appears to me that the IRM comes to the conclusion that “make-up solicitation” are not allowed, for Form 8300 filers, based upon an example contained in the Treasury Regulation 301.6724-1(e)(1)(vi)(C)(2), rather than rules explicitly stated in the regulation. However, as indicated in IRM, TAM 200843031 and the following cases cited below, an example in a Treasury Regulation doesn’t establish rules beyond those stated in the Treasury Regulation itself. Below is a quote from TAM 200843031.
    “Although the use of illustrative examples can be useful in applying a rule to a set of facts, the underlying principles of the rule are not established or modified by accompanying examples. For example, generally, the language of a statute is not to be regarded as modified by examples set forth in the legislative history. Pension Ben. Guar. Corp. v. LTV Corp., 496 U.S. 633, 649, (1990). “An example, after all, is just that: an illustration of a statute’s operation in practice. It is not… a definitive interpretation of a statute’s scope.” Id. Likewise, examples incorporated into Treasury Regulations are generally considered illustrative only and are not to be considered as dispositive. See Tennessee Baptist Children’s Homes, Inc. v. U.S., 790 F.2d 534 [57 AFTR 2d 86-1477], (C.A.6 1986), Nico v. C.I.R., 565 F.2d 1234, 1238 [40 AFTR 2d 77-6090] (2d Cir.1977) (illustrative, hypothetical examples employing particular deductions did not contradict clear language of regulation); 1210 Colvin Avenue, Inc. v. United States, 81-1 U.S. Tax Case. (CCH) ¶ 9474 at 87,383 (W.D.N.Y.1981) (definition of controlled corporation not limited to illustrative examples utilizing particular percentage figures regarding extent of control); Solomon v. C.I.R., 67 T.C. 379, 386 (1976) (examples in Treasury regulations portraying particular form of corporate reorganization in context of deferral payments are merely illustrative and do not purport to limit application of statute), aff’d, 570 F.2d 28 [41 AFTR 2d 78-411] (2d Cir.1977), and aff’d sub nom. Katkin v. C.I.R., 570 F.2d 139 [41 AFTR 2d 78-614] (6th Cir.1978).”

    Treasury Regulation 301.6724-1(e)(1)(vi)(C)(1), in pertinent part, provides as follows.
    “If a filer fails to make one (or more) of the required solicitations under paragraphs (e)(1)(i), (ii), and (iii) of this section, the filer may satisfy the requirements of this section by—
    (1) Making two consecutive annual solicitations in subsequent years (“make-up solicitations”)………”

    Taxpayer’s position is Treasury Regulation subsection 301.6724-1(e)(1)(vi)(C), including only subparagraph (1), should apply in order to determine whether Taxpayer acted in a responsible manner within the meaning of Treasury Regulation 301.6724-1(a)(2). Taxpayer maintains that the subparagraph (starting with “For example”) following Treasury Regulation 301.6724-1(e)(1)(vi)(C)(2) does not apply to Form 8300 filings (only to Forms 1099INT etc., when the payee maintains an account at the business that is required to file an information report). Below is the quote from Treasury Regulation 301.6724-1(e)(1)(vi)(C)(2) that contains the example that I am referring to.
    “For example, a filer who has made none of the required solicitations may satisfy the requirements of this section by making two consecutive solicitations. In determining, whether a filer has made two consecutive solicitations, years to which paragraph (e)(1)(vi)(B) of this section applies shall be disregarded. If a filer fails to make the initial solicitation under paragraph (e)(1)(i) of this section, the make-up solicitations described in this paragraph (e)(1)(vi)(C) may be made in the years in which the first and second annual solicitations are required to be made; however the penalty will apply with respect to the year in which the filer failed to make the initial solicitation. The penalty will apply to failures with respect to years for which a required solicitation is not made and to failures with respect to all subsequent years until the filer conducts its make-up solicitations. The penalty will not apply with respect to the year in which the first make-up solicitation is made (unless it is also the year in which the filer fails to make its initial solicitation) if the second make-up solicitation is made in the following year.”

    Also, the legislative history of code § 6721 supports the notion that IRM is currently in conflict with 26 CFR 301.6724-1(e)(1)(vi)(C)(1).
    See the Preamble to Proposed Regulations: 7/9/200, Federal Register, Vol. 68, No. 131, p. 40857 as follows.
    “Section 6721 imposes penalties on failures to file, or file correct, information returns. Section 6721 creates a three-tiered penalty structure to encourage timely filing and prompt correction of errors in previously filed returns. Congress enacted the three-tiered penalty structure in the Omnibus Budget Reconciliation Act of 1989 (Public Law 101-239, 103 Stat. 2388, 2389). Section 6721 generally imposes a penalty in the amount of $50 for each return with respect to which a failure occurs, but not to exceed $250,000 per person per calendar year. However, if a filer corrects a failure within 30 days after the required filing date, the penalty with respect to such return shall be $15 in lieu of $50, but not to exceed $75,000 per filer per calendar year. Moreover, if a filer corrects a failure more than 30 days after the required filing date, but before August 1 of the calendar year in which the required filing date occurs, the penalty with respect to each return shall be $30 in lieu of $50, but not to exceed $150,000 per filer per calendar year. Section 6721 provides these penalties to encourage prompt corrections of failures to file, or file correct, information returns. See H.R. Rep. 101-386, at 648-649 (1989).”

  2. “The authors propose allowing the agencies the opportunity to defend the substance of rulemaking on reasons that were not necessarily the ones the agency relied on in proposing the rules in the first instance.”

    Congressional leaders will meet next month to discuss enactment of the Law of Unintended Consequences, permitting federal agencies to defend their rules not only with reasons that seemed good at the time but with ones that showed up later.

    Harland Dorrison, a spokesperson for the Joint Committee on Delegation of Legislative Authority, said “there is bipartisan support for allowing more leeway to the Executive Branch on matters where judges have been legislating from the bench. Rules first, reasons later. If we can’t trust the President’s appointees to do that, who can we trust?”

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