Update on CIC Services And More On The Legislative vs Interpretive Rule Difference

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This is an update on the CIC Services litigation. Following the March 2022 decision where a federal district court granted CIC’s motion for summary judgment and vacated the IRS Notice, the government filed a motion for reconsideration. It did not challenge the underlying merits determination that the IRS violated the APA by issuing the Notice without notice and comment. Nor did it challenge the court’s order to set aside the Notice. Instead, it challenged the court’s decision to order the IRS to return documents and information furnished to the IRS by nonparties pursuant to the Notice.

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The court granted the motion and last week issued a revised order that retracted its mandate that the IRS return the nonparty documents. It did so because CIC’s lawsuit was not brought on behalf of nonparties and was not a class action lawsuit:

Despite possessing a procedural device to assert claims and request injunctive relief on behalf of similarly-situated nonparties, CIC did not do so. As a result, while nonparty taxpayers and material advisors necessarily benefit from CIC successfully demonstrating that the Notice must be set aside and are no longer be required to produce documents and information pursuant to the Notice, CIC does not have any basis to seek affirmative injunctive relief requiring the IRS to return documents to nonparty taxpayers and material advisors.

Despite finding that the court originally overstepped its authority when it ordered the IRS to return what it had received pursuant to the invalidated notice, the court still could not resist taking shots at the IRS for what it perceived as the IRS’s unjust enrichment from issuing a notice that was procedurally invalid:

To be sure, this determination operates as a windfall to the IRS in that it allows the IRS to retain documents and information it was not entitled to collect from nonparty taxpayers and material advisors. If this were simply a matter of determining an equitable result, the IRS would have to return all documents and information produced pursuant to the Notice, especially considering the Sixth Circuit’s observations [ed: citing the circuit in the CIC case] that the IRS has a history of APA noncompliance.

A Different Take On Whether The IRS Was Required to Use Notice And Comment Procedures

One final point addressing whether a reg or IRB guidance requires notice and comment under the APA. I commend readers to a contrarian discussion from Jack Cummings, who, in a letter to Tax Notes [$], and in related work that he and Jack Townsend have separately undertaken (see, e.g., Townsend, The Report of the Death of the Interpretive Regulation Is an Exaggeration for a deep dive into the issue), argue that courts and many current academic takes are off the mark.  In Cummings’ letter to Tax Notes, he disagrees with the Sixth Circuit in Mann (and other courts) that held that a reg or IRB guidance is deemed legislative and thus requires notice and comment under the APA because not complying with the rule might lead to a penalty or higher taxes. This, to Cummings, proves too much:

But to begin, instead, with the fact that the person owed tax or penalty as a result of the rule, could make every tax rule legislative. Each tax rule has some negative effect on taxpayers.

Under the APA, agency rulemaking is not required to be issued using the notice and comment procedures if the rule is interpretative (or sometimes referred to as interpretive). For decades, IRS, Treasury, and practitioners have thought that most guidance Treasury or IRS issues pursuant to its general rulemaking authority under Section 7805(a) was not required to be issued using notice and comment procedures under 5 USC § 553(b). That historical view was the consensus at the time of the passage of the APA in the mid-20th century.

What constitutes an interpretative rule? Cummings argues that the inquiry should focus more on the statute that triggered the IRS guidance as compared to the possibility of penalties if one chooses not to comply. In Mann and CIC Services, that takes us to Section 6707A and its trigger for reporting on transactions that have a potential for tax avoidance or evasion.

From Cummings’ letter:

It’s reasonable to interpret section 6707A to mean that Congress understood the section’s standard as too vague for taxpayers to enforce on their own. So Congress gave the IRS discretion to select among more or less abusive transactions the ones that should be reported. That’s a grant of legislative rulemaking authority.

In contrast, if the statutory language were capable of interpretation off a starting point that was not hopelessly vague, Cummings would have held that the rule was interpretative (and not required to be issued with notice and comment).

More from Cummings:

If the statute says, in effect, “We’re unsure what the rule should be, so you write it,” then the rule is legislative. If the statute says, for example, that a taxpayer can deduct ordinary and necessary business expenses, and then the agency wrote a regulation stating its views on those words, those views would normally be considered to be interpretive.

So, while Cummings’ approach would not have led to a different conclusion in CIC Services (or Mann), it leads to finding the rule legislative on a different rationale. It would matter a lot in other cases when courts and the agency have to determine whether IRS is required to use notice and comment, and the rule has a statutory starting point capable of agency interpretation.

With colleagues Rochelle Hodes and Greg Armstrong, we are in the process of revising the considerable APA content in an extensive rewrite of Chapters 1 and 3 of Saltzman and Book, IRS Practice and Procedure (the first part of the rewrite on subregulatory guidance will be released this summer). This issue, among many others, will generate heavy discussion, as the relevance of administrative law principles in tax cases continues to become one of the key issues in tax procedure and tax administration.

About Leslie Book

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

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