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Tax Regulatory Challenges Following Chevron Ruling Overturned

VORTEX:CASE STUDY CHEVRON IN ACTION

This Chevron the doctrine has often served to promote the interests of the IRS against taxpayers. For example, Chevron played an important role in the United States Tax Court’s decision in the case Whirlpool Financial Corp. v. Commissioner154 TC 142 (2020). The tax court referred to Chevron Dismiss Whirlpool’s challenge to the manufacturing industry provisions of Treasury Regulation section 1.954-3(b)(1)(ii). (The Tax Court’s decision was ultimately upheld by the United States Court of Appeals for the Sixth Circuit on other grounds.)

Hiring ChevronIn the two-step process, the Tax Court first asked whether Section 954(d)(2) of the Internal Revenue Code (Code) is ambiguous or silent regarding the distinction between production and sales branches. The Tax Court answered in the affirmative (“954(d)(2) (could) plausibly provide for regulation of any type of branch” and “there is nothing in the statute that prevents “Secretary for the prescription of regulations which also concern production industries”) and then turned to Chevronsecond step, the question of whether the State Treasury regulation is a “reasonable interpretation” of the Act. In a brief analysis, the Tax Court, as was often the case with courts, referred to the State Treasury and again answered in the affirmative. In the last paragraph, which emphasized Chevron laxity of the statutory framework, the Tax Court ruled in favor of the IRS because “whether section 954(d)(2) is viewed as ambiguous or silent,” those provisions constitute a “reasonable interpretation” of the statute, meaning that the statute does not “unequivocally preclude” the interpretation set forth in the regulations.

Not “clearly occupied” is a low bar, but Loper Light he picked it up. Without Chevron doctrine, courts can and must use all traditional tools of statutory interpretation to determine the best of everything interpretation of the statute, regardless of whether the statute is ambiguous and what the position of the IRS itself is.

LOPER LIGHTSCOPE: IMPLIED AND EXPRESS DELEGATIONS

Loper Light rejected Chevron because the Supreme Court rejected the notion that when the U.S. Congress enacts an ambiguous or incomplete statute, it intends for agencies to fill in the gaps. On the contrary, the Supreme Court held that when Congress is silent about the role of an agency in a given statute, it does not “impliedly delegate” interpretive authority to the agency. Instead, that authority falls to the courts.

However, the Code is often clearly delegates regulatory authority to the Treasury, either through a general grant of regulatory authority in Section 7805(a) or through specific grants in individual sections of the Code. For example, Section 1061(f) directs that “the Secretary shall prescribe such regulations . . . as . . . are necessary or appropriate to carry out the purposes of this section,” and Section 59A(i) provides that “the Secretary shall prescribe regulations . . . necessary to prevent the avoidance of the purposes of this section.”

Loper Light states that when there is an express delegation of authority to an agency to make regulations, courts will continue to analyze whether the agency is acting within the scope of the delegated authority and exercising its authority in accordance with the Administrative Procedure Act. However, here too, the case has significant implications for regulations that purport to rely on general rulemaking authority. In United States v. Mead Corp., 533 U.S. 218 (2001), for example, the Supreme Court held that Chevron deference is appropriate “when it appears that Congress has delegated authority to the agency” generally speaking, to create regulations that have the force of lawand that the agency interpretation requiring deference was promulgated in the exercise of that authority” (emphasis added). The same approach applies in the context of tax regulations, pursuant to Mayo Found. for Med. Ed. & Res. v. United States562 US 44 (2011), in which the Supreme Court refused to “isolate an approach to administrative review that would be good only for tax law” and therefore applied the standard Chevron doctrine for tax regulations.

As a result,Loper Lightwe expect courts to take a much less compliant attitude toward Treasury regulations that rely on general rulemaking authority, such as Section 7805(a) or even specific grants of rulemaking authority to “carry out the provisions” of a statute (or similar language). Courts will need to grapple more specifically with whether a challenged regulation exceeds the scope of the delegated authority, including by determining the best interpretation of the statutory text. In other words, taxpayer challenges to regulations that purport to rely on general rulemaking authority are likely to become more visible, with an increased likelihood of success.

NEW QUESTIONS WHERE REGULATIONS ARE TIGHTENING THE CODE

Many of the Code’s short provisions do not expressly delegate regulatory authority to the Treasury, but the agency nevertheless promulgates lengthy regulations, typically pursuant to its authority under Section 7805(a) to prescribe “all necessary rules and regulations to enforce this title.” For example, Section 482 of the Code (relating to transfer pricing) is only three sentences and less than 200 words long, yet its regulations are over 100 pages and almost 50,000 words long. This is one example in which the Treasury has overreached its general rulemaking authority. In such circumstances, the question arises whether, in a post-Loper Light era. The alleged “silence” of Code sections is no longer an implicit delegation of authority to fill gaps.

More specifically, the appropriateness of requiring the inclusion of amounts attributable to stock-based compensation under cost-sharing provisions has been on taxpayers’ radars since the contested decision of the Ninth Circuit Court of Appeals in To change Corp. v. Commissioner926 F.3d 1061 (2019). These new challenges, however, come from taxpayers outside the Ninth Circuit. In light of Loper LightWe anticipate that more taxpayers, including taxpayers in the Ninth Circuit, may challenge this aspect of the co-payment regulations.

IMPACT ON IRS APPEALS

The independent Office of IRS Appeals has historically been a good option for taxpayers who want to resolve their disputes without going to court. Unfortunately, a growing number of taxpayers feel that IRS Appeals has lost its independence and no longer fairly considers all relevant issues. (See Taxpayer Advocate Service, Annual Report to Congress 2023, pp. 132-42 (raising the “lack of independence” in IRS Appeals as a serious problem that “undermines taxpayer confidence”). One area of ​​particular frustration is IRS Appeals’ internal policy of not considering the validity of regulations: “In resolving cases, Appeals does not apply procedural jeopardy to arguments raised by a taxpayer regarding the validity of a Treasury regulation…” IRM 8.1.1.3.1(5). Worse, this internal policy is now embodied in proposed section 301.7803-2(c)(19) of the Treasury Regulations. This proposed rule is pending as of September 2022 and expressly prohibits IRS Appeals from hearing arguments that a Treasury regulation is invalid. It is difficult to reconcile this policy and proposed regulations with the claim that IRS Appeals assesses “litigation risks,” when the potential invalidity of the regulations in some cases may be the primary litigation risk from the IRS’s perspective.

In light of the fall Chevron and the anticipated wave of regulatory challenges, it is possible that IRS Appeals will reconsider its internal policy. The IRS may not want to push all of these regulatory validity challenges to court, where the IRS and the Treasury will be in the worst position in about 40 years. Pressing taxpayers to resolve regulatory validity issues may have been a sound strategy for the IRS when taxpayers were constrained by Chevronbut in Loper Light era, the results may be more taxpayer-friendly than the IRS had anticipated. It is not clear why IRS Appeals should view the argument about regulatory validity, which will now hinge on which interpretation of the statute is the best interpretation, as materially different from a taxpayer’s argument about the proper application of statutory or regulatory language, which does not involve a validity argument. In this new era, a better option would be to let IRS Appeals do what it does best: consider the risks associated with litigation.