IRS rulemaking continues to be called into question
What’s the impact on taxpayers?
Andrew Seifert, JD, tax consultant, Wipfli LLP | February/March 2023 Footnote
Editor's note: Updated January 31, 2023
Tax regulations and guidance provided by the U.S. Department of the Treasury and the Internal Revenue Service are regularly relied upon by taxpayers. As federal agencies, the Treasury Department and IRS are subject to the rulemaking standards instituted by the Administrative Procedures Act (APA).
An interesting trend in recent case law shows that the Treasury Department and IRS have not always followed the proper rulemaking standards of the APA when creating these regulations and guidance. As a result, the validity of some of these rules has been called into question.
History of the Administrative Procedures Act
In response to the Great Depression, between 1933 and 1939, President Franklin D. Roosevelt enabled the broad expansion of federal agencies through the New Deal. To answer for the growing concern surrounding the expansion of federal agency powers, the APA was enacted in 1946 under President Harry Truman.
1
According to the Attorney General’s Manual on the APA of 1947, the goals of the APA were to,
“require agencies to keep the public currently informed of their organization, procedures and rules, provide for public participation in the rulemaking process, prescribe uniform standards for the conduct of formal rule making and adjudicatory proceedings, and restate the law of judicial review.”2
To meet the stated goals, the APA requirements were imposed upon rulemaking agencies.
3 The fundamental requirements for agency issued rules are:
- They must be issued in proposed form.4
- They must have a notice and comment period.5
- The issuing agency must consider comments and respond to significant comments.6
- The agency must issue a concise general statement of finding.7
APA requirements
Rulemaking can be formal or informal. The level of formality determines which APA procedural requirements apply.
8 The APA distinguishes between “legislative rules,” which are subject to formal rulemaking requirements and “interpretive rules,” which are not subject to the formal rulemaking requirements. Legislative rules have the “force and effect of law;” interpretive rules do not. Legislative rules are subject to the APA’s notice-and-comment requirements;
9 whereas, interpretive rules are exempted from notice-and-comment requirements.
10
The APA permits agencies to finalize some legislative rules without first publishing a proposed rule in the Federal Register, if the agency has “good cause” to find the notice and the comment process would be “impracticable, unnecessary or contrary to public interest,” and the agency states its good cause in the preamble of the final rule.
11 Some examples of good cause are minor or technical amendments, concerns for public safety or when Congress has already directed a specific regulatory outcome.
12
APA compliance
The Treasury Department and the IRS have taken the position that most Treasury regulations are not subject to the legislative rule requirements of the APA. Rather, they consider their regulations to be interpretative because the underlying statute implemented by the regulation contains the necessary legal authority for said action and any effect of the regulation flows directly from that statute.
13 Because of this position, the IRS has issued numerous regulations without the notice-and-comment period or a statement of good cause.
Additionally, the Treasury Department and the IRS have taken the position that subregulatory guidance is not subject to the APA’s notice-and-comment requirements. The Treasury Department and the IRS have defined the following as subregulatory guidance: revenue rulings, revenue procedures, notices and announcements.
14
Cases involving taxpayers and the Administrative Procedures Act
Taxpayers who have been challenged by the IRS under some of these rules and regulations are starting to find reprieve within the courts. The APA states, “A person suffering legal wrong because of agency action, or adversely affected or aggrieved by agency action within the meaning of a relevant statute, is entitled to judicial review thereof.”
15 The first hallmark case involving the IRS and the APA arose in 2011, under Mayo Foundation for Medical Education and Research v. United States.
16
In Mayo, the U.S. Supreme Court validated the Treasury Department’s full-time employee rule as a reasonable construction of an ambiguous statute. In addition to validating the Treasury Department’s full-time employee rule, the court also made it clear that tax regulations are subject to the same standards of rules as any other agency.
The court stated, “We are not inclined to carve out an approach to administrative review good for tax law only.”
17 The court also noted that the Treasury Department only issued their full-time employee rule after the notice-and-comment procedures required by the APA. So began the snowball of taxpayer challenges to tax regulations that have not met the rulemaking standards set by the APA.
Recently, the U.S. Court of Appeals for the 6th Circuit found the IRS failed to satisfy the APA’s notice-and-comment procedures.
18 In Mann v. U.S., the court held that Notice 2007-83, which identified a certain type of employee benefit plan as a “listed transaction,” was invalid. The court stated that the notice rose to the level of a legislative rule, because it had “the force of law,” and because the IRS did not satisfy the APA’s notice-and-comment period, it was found to be invalid.
In CIC Services v. IRS, the U.S. District Court for the Eastern District of Tennessee similarly found that Notice 2016-66, which required taxpayers to report micro-captive insurance transactions, was invalid.
19 The district court cited the opinion on Mann and held the notice “is a legislative rule that is invalid because the IRS failed to observe notice-and-comment procedures required by the APA.”
Finally, in November 2022, the Tax Court invalided the IRS’s Notice 2017-10, which designated some syndicated conservation easement transactions as listed transactions.
20 Taxpayers who failed to disclose participation in these transactions were subject to penalties under IRC Section 6662A. The court stated that Notice 2017-10 was issued without notice-and-comment period, as required by the APA. The court ruled in the taxpayers’ favor.
Possible relief for taxpayers
The IRS and Treasury Department have adjusted some recent guidance to reflect compliance with the requirements of the APA.
21 However, until the IRS and Treasury Department can determine how to address the historic guidance that does not meet the rulemaking standards of the APA, there is still an outstanding question concerning the validity of said guidance. So long as the IRS and/or Treasury Department enforce rules that have not met the rulemaking requirements of the APA, taxpayers will continue to have the opportunity to seek relief in the courts.
Andrew Seifert, JD, is a member of the national tax office of Wipfli LLP, where he assists clients with complex tax issues, transactional advising and overall business consulting. An MNCPA member, Andrew frequently presents on tax-related matters. You may reach him at aseifert@wipfli.com or 651-766-2856.
1 Pub. L. No. 79-404, 60 Stat. 237 (1946).
2 Administrative Conference of the United States, ACUS and the APA: Celebrating 75 Years of the Administrative Procedure Act (June 07, 2021).
3 5 U.S. Code Sec. 553(b).
4 5 U.S. Code Sec. 553(b).
5 5 U.S. Code Sec. 553(c).
6 Perez v. Mortg. Bankers Ass’n, 135 S. Ct. 1199 (2015).
7 5 U.S.C. Sec. 553(c).
8 Formal Rulemaking. 5 U.S.C. Sections 553, 556, and 557 govern formal rulemaking. Informal Rulemaking. 5 U.S.C. Sec. 553 governs informal rulemaking.
9 Pub. L. No. 79-404, 60 Stat. 237, § 4 (1946).
10 5 U.S.C. Sections 553(b)(3)(A).
11 5 U.S.C. Sections 553(b)(B), (d)(2) and (3).
12 Mack Trucks, Inc. v. E.P.A., 682 F.3d 87, 94 (D.C. Cir. 2012); Jifry v. F.A.A., 370 F.3d 1174, 1179-80 (D.C. Cir. 2004); and Asiana Airlines v. F.A.A., 134 F.3d 393, 398 (D.C. Cir. 1998).
13 IRM Sections 32.1.5.4.7.4.1 (08-21-2018) and 32.1.1.2.6 (09-23-2011).
14 Department of the Treasury, Policy Statement on the Tax Regulatory Process, Footnote 1 (March 5, 2019).
15 Pub. L. No. 79-404, 60 Stat. 237, Sec. 10 (1946). 5 U.S. Code Sec. 702.
16 Mayo Foundation for Medical Education and Research v. United States, 562 U.S. 44 (2011).
17 Id at 55.
18 Mann Construction, INC. v.
U.S., 27 F.4th 1138 (6th Cir. 2022).
19 CIC SERVICES, LLC v. IRS, 129 AFTR 2d 2022-1119 (DC TN 2022).
20 Green Valley Investors, LLC, ET AL., v. IRS, 159 T.C. 5 (T.C. 2022).
21 See T.D. 9969, Section Summary of Comments and Explanations of Revisions for IRS account of compliance with notice-and-comment period.
