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February 10, 2011
The State of Tax Guidance After Mayo

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By Jeremiah Coder

Some practitioners are fearing the worst following a recent Supreme Court decision prescribing greater judicial deference to Treasury and IRS administrative guidance, but the decision is unlikely to result in significant changes to the rulemaking process or different judicial outcomes.

Until recently, only a small segment of the tax community was actively seeking greater clarity and consistency in applying legal principles of administrative law to the tax realm. Courts have given more scrutiny to the area in the past several years, but the Supreme Court in Mayo outlined an unambiguous demand that courts apply a fairly rigid two-step test in assessing the validity of administrative tax regulations. (For Mayo Foundation for Medical Education and Research v. United States, Sup. Ct. Dkt. No. 09-837, see Doc 2011-609.)

Mayo Dissected

The Supreme Court's relatively short, unanimous opinion (from which Justice Elena Kagan recused herself) showcased remarkable agreement among the justices on one of their least favorite issues: tax law. But the decision really had more to do with administrative law fundamentals.

The January 11 decision minced no words in stating that the Court was finally willing to answer the question that had plagued lower courts for decades: How much deference should Treasury regulations receive? "The principles underlying our decision in Chevron apply with full force in the tax context," the Court declared.

Likewise, the Court seemed to view with disdain the tax bar's habit of parsing levels of deference based on the categorization of a regulation as legislative or interpretative -- unique descriptors outside the administrative law's categorization of regulations as specific or general. "Our inquiry in that regard does not turn on whether Congress's delegation of authority was general or specific," Chief Justice John G. Roberts Jr. wrote for the Court. Rather, "we are not inclined to carve out an approach to administrative review good for tax law only," he wrote.

In other words, outside our own little bubble, tax law isn't special.

In expressly requiring that courts apply Chevron U.S.A. Inc. v. Natural Resources Defense Council, 467 U.S. 837 (1984), when presented with challenges to Treasury regulations -- first looking to determine whether the statute is ambiguous, and if so, then evaluating whether the presented rule is reasonable -- the Court cast a vote for broad latitude to Treasury in the guidance process in part on the grounds of uniformity in the administrative rulemaking area. "Filling gaps in the Internal Revenue Code plainly requires the Treasury Department to make interpretive choices for statutory implementation at least as complex as the ones made by other agencies in administering their statutes," the Court said.

As an aside, it is interesting to note that Chief Justice Roberts seems to have a knack for writing unanimous tax opinions. He wrote the opinions for a unanimous Court in United States v. Clintwood Elkhorn Mining Co., 553 U.S. 1 (Apr. 15, 2008), and Knight v. Commissioner, 552 U.S. 181 (Jan. 16, 2008).

Guidance Process Changes Unlikely

A top government official recently said that Mayo could be a catalyst to issuing more guidance, more quickly. Clarissa Potter, IRS deputy associate chief counsel (technical), told attendees at a recent tax conference that the Court in Mayo recognized that "sometimes the best solution is not the perfect" legal rule. According to Potter, "that means more guidance, faster." (For prior coverage, see Tax Notes, Jan. 31, 2011, p. 538.)

Although that premise seems shaky, perhaps Potter's comments simply were meant to imply that agency guidance need not be comprehensive, reiterating recent suggestions by IRS Chief Counsel William J. Wilkins that the IRS will be open to issuing "pretty good guidance" to help create certainty within the tax system. If that's the case, the statement seems correct because those rules won't receive any less vetting by government attorneys.

To the extent that uncertainty exists because Congress has been unclear in writing tax law, thereby creating gaps for Treasury to fill, Chevron approves of Treasury and the IRS creating guidelines to improve tax administration. If the IRS thinks pretty good guidance is the best way to fill gaps, Chevron won't stand in the way of that.

But the level of deference that a court pays to Treasury regulations, notices, or other administrative guidance should not affect the development that occurs before litigation of an administrative tax rule. The deliberative process surrounding the creation of guidance should and will continue fairly undisturbed. A willingness to bypass or shorten the process, or to engage in subpar analysis in developing a final administrative position, will not be countenanced by courts simply because the IRS can point to Chevron deference.

The IRS understands that at a macro level, so comments suggesting a quicker guidance process were probably misinterpreted to suggest that the Supreme Court was greenlighting sloppy rulemaking. As Wilkins noted in a recent speech, Chevron is "based on agency competency and integrity" and requires that the government continue to "make choices based on wise public policy." (For Wilkins's prepared remarks, see Doc 2011-2194.)

Treasury should be expected to continue its normal deliberative process in creating regulations, consisting of many layers of review, analysis, and input. And if the government decides to rationalize rules favorable to a litigating position or to otherwise put taxpayers at a disadvantage, courts will not stand idly by without providing appropriate scrutiny.

The judiciary, always fiercely protective of its Marbury prerogative, does not hesitate to strike down rules that are out of sync with a statute's terms or purpose. Under Chevron step one, courts will be able to determine whether the content of a Treasury rule is not what Congress intended, either because of the plain meaning of the text or the divined legislative intent if a court considers that part of the step one analysis. (For discussion of the role of legislative intent in Chevron step one, see Tax Notes, Jan. 17, 2011, p. 257, Doc 2011-744.)

But as illustrated in a recent Third Circuit case, in requesting more deference under Chevron, Treasury will need to clearly articulate its reasons for promulgating a specific rule. In Mannella, a dissenting judge took the IRS to task for offering "deficient agency reasoning" in adding a two-year time limit to a filing requirement for equitable innocent spouse relief, stating that he would have held the reg invalid on those grounds. That view serves as a warning to the government that Treasury guidance must fully delineate the reasons behind, and the need for, a rule. (For Mannella v. Commissioner, No. 10-1308 (3d Cir. Jan. 19, 2011), see Doc 2011-1183.)

Mayo obviously shifts the deference argument in favor of the government when its rules go through significant vetting, even if not formal notice and comment procedures, and a new battleground will involve how far Chevron can be applied down the guidance chain beyond regulations. For example, do revenue rulings deserve more deference? The Justice Department has argued that they do, although that position so far has not found much receptivity. Treasury notices also stand out as a gray area that the DOJ might argue deserve more deference.

However, the further down the guidance chain the IRS seeks to apply Chevron deference, the more likely it is that taxpayers will try to hold the government to those positions when they are in their favor. It will be interesting to see how receptive the Tax Court, as well as other federal courts, is to applying Chevron principles beyond Treasury regulations.

APA Implications

Not addressed in Mayo but lurking in the background is how the Administrative Procedure Act (APA) applies to Treasury and IRS rulemaking. That issue could become a spoiler for the government if courts increase scrutiny of Treasury's compliance with APA requirements when pushing guidance out the door. The U.S. Court of Appeals for the District of Columbia is already considering whether a Treasury notice providing procedures for seeking a refund of illegally collected telephone excise taxes complied with APA requirements. (For prior coverage, see Tax Notes, Oct. 4, 2010, p. 26, Doc 2010-21326.)

It is true that in the past courts have shown more willingness to provide Chevron deference to regulations that have undergone notice and comment procedures. The APA is another layer of judicial review to ensure that Treasury carefully considered an administrative action before applying it to taxpayers.

Most Treasury regulations contain a statement in the preamble that the department has determined that section 553(b) of the APA doesn't apply because the reg is an interpretative rule. Treasury could help the tax system by agreeing that general rules promulgated under section 7805(a) are subject to APA requirements.

In making no distinction between the application of Chevron to general or specific regulations, the Supreme Court in Mayo did not answer whether APA noncompliance should be a consideration before moving to a deference analysis. A notice and comment period may be a good hallmark of the type of administrative guidance that the Court believes should carry the force of law and be subject to more deference, but subjecting section 7805(a) regulations to notice and comment procedures while disclaiming the applicability of the APA seems both disingenuous and open to taxpayer attack.

In fact, when courts seem uncomfortable with the IRS's position but feel constrained by Chevron to view the regulation as reasonable, APA challenges might be successful as an alternative approach for striking down a rule deemed misguided.

Tax Court judges have already begun taking more interest in APA issues. A concurring opinion in Intermountain suggested that the IRS's use of temporary regulations to attempt to extend the statute of limitations period when basis has been overstated on a tax return was invalid because notice and comment procedures weren't followed. (For Intermountain Insurance Service of Vail v. Commissioner, 134 T.C. No. 11 (May 6, 2010), see Doc 2010-10163.)

The IRS should concede that many of its rules -- including final and temporary regulations, and even some notices -- are legislative in nature because it intends them to have the force of law. In acquiescing to the formal strictures of the APA, the government would create a stronger case for increased deference to a wider array of rules, such as revenue rulings.

Litigation Bootstrapping

Much has already been said about practitioner ire over the IRS's temporary and final regulations adopting a six-year statute of limitations period for assessing tax deficiencies in overstated basis cases. (For prior coverage, see Tax Notes, Dec. 20, 2010, p. 1284, Doc 2010-26671.)

Many in the tax bar dislike the thought of the IRS using the rulemaking process in similar situations to administratively enshrine litigation positions that, under Chevron, could receive greater deference. Although there is no question after National Cable & Telecommunications Association v. Brand X Internet Services, 545 U.S. 967 (2005), that the Supreme Court is open to a government agency adopting a regulation that reflects a change in agency position, some constraints remain. As the Supreme Court stated in Mayo, "agency inconsistency is not a basis for declining" to apply Chevron, adding that it is "immaterial to our analysis that a 'regulation was prompted by litigation.'"

In a similar case several years ago, the Supreme Court was not troubled by an agency offering a different departmental interpretation of a prior position. "As long as interpretive changes create no unfair surprise . . . the change in interpretation alone presents no separate ground for disregarding" the rule, the Court wrote in Long Island Care at Home Ltd. v. Coke, 551 U.S. 158 (June 11, 2007). However, it also warned that "post hoc rationalizations" or the lack of "fair and considered judgment" could reflect poorly on the government in a way that might doom the apparent reasonableness of the rule at issue. But the Court clearly approved of new rules "even if the agency set those views forth in a legal brief."

So the IRS may have an easier time creating rules strengthening its position even as it encounters litigation challenges. As long as the government commits to an open process in developing its rules, courts are likely to approve position changes more often. While taxpayers might find that result unappealing, the Supreme Court seems unbothered by it. After all, a transparent process is better than the alternative, even if some taxpayers are left unsatisfied.

Tax Court Debate

The Supreme Court's call for Chevron deference for all tax regulations resolves a long-standing debate within the Tax Court. In jettisoning the less deferential standard established by National Muffler Dealers Association Inc. v. United States, 440 U.S. 472 (1979), Mayo relieves the Tax Court of determining which standard -- Chevron or National Muffler -- controls. In several recent high-profile cases in which the Tax Court examined the validity of Treasury regulations, a majority concluded that invalidating the regulation at issue was possible without examining the different level of deference that each standard might produce. In those cases, the so-called Golsen rule compelled the court to apply a circuit's particular deference rule to tax regulations. (See Golsen v. Commissioner, 54 T.C. 742 (1970), aff'd, 445 F.2d 985 (10th Cir. 1971).)

For example, in Intermountain, the court said it didn't need to resolve the parties' dispute over which deference standard applied, citing as "a formidable obstacle to deference" the Supreme Court opinion in Colony Inc. v. Commissioner, 357 U.S. 28 (1958). Likewise, in Lantz, the court said it did not need to revisit whether the proper standard of review is National Muffler or Chevron "insofar as there may be a difference between them." (For Lantz v. Commissioner, 132 T.C. No. 8 (Apr. 7, 2009), see Doc 2009-7979.)

But after Mayo, the Tax Court will have to follow Chevron when it declares a statute ambiguous, regardless of the circuit to which appeal lies.


As a large administrative agency, Treasury faces a challenge in setting good ground rules that ensure that the voluntary tax system runs effectively. Part of the solution is flexibility to address tax questions through administrative guidance. Sometimes that power seems to produce unlikable results, but an alternative of lower judicial deference poses systematic risks because of the increased possibility of legal challenge and hesitancy to engage in rulemaking. More transparency on both the government's and taxpayer's parts can help keep the guidance process fair and respected. Practitioners have already observed in blog posts, viewpoints, and e-mails that the idea of tax exceptionalism or tax myopia is dead, which the tax community must accept and move on. While it is easy to fear the worst from the IRS now that it has a strengthened hand in defending agency rules, the Supreme Court's clarity on deference should actually be seen as a positive, bringing more certainty to taxpayers facing compliance concerns or considering litigation. Taxpayers still have adequate grounds to attack genuinely illogical or overbroad Treasury rules.

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