Wednesday, June 22, 2011

The Effect Of Mayo On The Precedential Value Of Regs And Other IRS Pronouncements

The Supreme Court's decision in Mayo Foundation v. U.S., (S Ct 1/11/2011) 107 AFTR 2d 2011-341, purported to resolve a long-standing dispute regarding the level of deference afforded to interpretive Treasury regs. This two-part Practice Alert examines various types of IRS pronouncements, their weight as authority, and their practical use to tax professionals and taxpayers. Part I, in this article, considers the effect of the Mayo case on their precedential value. Part II (see ¶43) continues the discussion of different types of IRS documents and also addresses which are “substantial authority” for purposes of the accuracy-related and return preparer penalties.

Regulations. These may be final (no prefix before the word “Reg.”), temporary (designated with the letter T in the citation), proposed (“Prop Reg”), or proposed reliance regs (designated as “Prop Reg... Taxpayers may rely”).

A final reg represents IRS's authoritative explanation and interpretation of a Code provision. Final regs sometimes are not amended until many years after enactment of tax laws (or court cases) that affect the subject of a final reg and, until then, may be of little use in interpreting a current Code provision.

Before the Supreme Court's decision in Mayo, the precedential value of a final reg depended on whether it was legislative (i.e., enacted pursuant to a specific grant of authority mandated by the Code itself) or interpretive (enacted under the IRS's general authority to issue Code-related rules and regs). Interpretive regs were typically subject to the standard set out in National Muffler, (S Ct 1979) 43 AFTR 2d 79-828, under which the reg was evaluated for whether it harmonized with the language, origin, and purpose of the statute, considering factors such as the consistency of IRS's interpretation and whether the reg was contemporaneous with the statute's enactment. Legislative regs were generally subject to “Chevron deference,” meaning that they were afforded controlling weight unless “arbitrary, capricious, or manifestly contrary to the statute.” (Chevron U.S.A. Inc. v. Natural Res. Def. Council, Inc., (S Ct 1984) 467 U.S. 837) However, there was confusion among the courts and tax practitioners as to which standard governed interpretive regs following Chevron, especially in situations where IRS's authority to issue guidance was implicit (i.e., to address an ambiguity or fill in gaps in the enacted law). Many commentators reasoned that tax law was simply different from other types of law, and tax regs should continue to be analyzed under the National Muffler standard.

In early 2011, the Supreme Court spoke on the issue in the Mayo case. The Court clarified that Treasury regs, whether legislative or interpretive, that are issued under the Administrative Procedures Act's (APA's) “notice and comment” procedures (which was previously identified by the Supreme Court in Mead Corp., 553 US 218, as an indication that Chevron deference is warranted) and fall within the statutory grant of authority are entitled to Chevron deference. In so holding, the Court largely repudiated National Muffler and its factor-based test.

Observation: It's not completely clear, however, whether the National Muffler approach will still be viable for regs or other pronouncements that aren't subject to the notice and comment process.

However, despite the Supreme Court's seemingly clear pronouncement, subsequent case law has shown that there is still room for interpretation. For instance, there is currently a split among the courts as to the validity of regs stating that an overstatement of basis is an omission of income for purpose of the six-year limitations period under Code Sec. 6501(e)(1)(A). These retroactively effective regs were issued by IRS issued after a number of taxpayer victories on the issue. The Fourth Circuit, citing Mayo, stated that Chevron deference didn't apply to the reg since the underlying statute was unambiguous. (Home Concrete & Supply, LLC v. U.S., (CA 4 2/7/2011) 107 AFTR 2d 2011-767) The Tax Court, also citing Mayo, held that the Supreme Court's decision in Colony, Inc. v. Com., (S Ct 1958) 1 AFTR 2d 1894, that the extended limitations period applies to omissions and not overstatements, remained binding until clearly and unequivocally repudiated by IRS's regs. (Carpenter Family Investments, LLC, (2011) 136 TC No. 17) Thus, while Mayo has clarified a number of issues and arguably made it more difficult to challenge an IRS reg, its precise effect remains to be seen.

A temporary reg provides taxpayers with guidance they can follow pending issuance of final regs, and has the same precedential value as a final reg. (Temporary regs issued after Nov. 10,’88 expire three years after their issuance date, which is why they also must be issued as proposed regs.)

A proposed reg is issued to give taxpayers and practitioners notice of how IRS interprets a provision, and the opportunity to comment on and critique that interpretation. It has little precedential value. Courts have said proposed regs “carry no more weight than a position advanced on brief” and are “suggestions made for comment; they modify nothing.” The Court of Federal Claims similarly stated that “[i]n general, proposed regulations have no legal force or effect until they become final.” (Yocum v. U.S., (2006, Ct Fed Cl) 96 AFTR 2d 2005-5030)

Nevertheless, proposed regs are useful for tax planning. In many cases (although there have been notable exceptions), final regs follow the broad outline presented in proposed regs. One court has ruled that where a taxpayer relies on proposed regs, differing final regs cannot be imposed to his detriment. This was so even though the proposed regs were not ones IRS said the taxpayer could rely on. (Elkins, Paul, (1983) 81 TC 669) However, other courts have leaned the other way. For example, the Court of Appeals for the Federal Circuit held that where existing final regs provided an unfavorable result to a taxpayer while proposed amendments to those regs indicated a position more favorable to him, the taxpayer's reliance on the proposed regs wasn't justified. (Garvey Inc v. U.S., (1983, Cl Ct) 51 AFTR 2d 83-721, 1 Ct Cl 108, 83-1 USTC ¶9163, affd (1984, CA Fed Cir) 53 AFTR 2d 84-776, 726 F2d 1569, 84-1 USTC ¶9214)

A proposed reliance reg is one which states that taxpayers may rely on it, with any more stringent provisions in a later final reg to be effective only prospectively. These regs can be relied on as if they are final regs. In an infrequently used variation, IRS states that it will not challenge tax return positions that are consistent with a proposed reliance reg.

Revenue Ruling (“Rev Rul”). Rev Ruls are official interpretations by IRS that have been published in the Internal Revenue Bulletin (IRB) reflecting IRS's conclusion on how the law is applied to a specific set of facts. Because Rev Ruls are interpretive, IRS may issue then without complying with the notice and hearing requirements of the APA. (National Restaurant Assn. v. Simon, (1976, DC Dist Col) 37 AFTR 2d 76-1144) They are issued only by the Associate Office and are published for the information and guidance of taxpayers, IRS personnel, and others concerned. They may arise from various sources, e.g., private letter rulings to taxpayers, technical advice to district offices, or court decisions. Most Rev Ruls apply retroactively unless otherwise stated. (Code Sec. 7805(b)(8)) A Rev Rul's conclusions are limited to the pivotal facts stated in it.

Rev Ruls don't have the force and effect of regs, but may nonetheless be cited and relied on. (See Exxon Mobil Corp & Affiliated Co., (2011) 136 TC No. 5) Assuming that the facts and circumstances at issue are substantially the same as those in a Rev Rul, practitioners and their clients generally may rely on it and don't have to ask for a private ruling for their particular cases. However, Rev Ruls, like regs, can become outdated (e.g., by the passage of subsequent legislation) and may be modified or distinguished by subsequent rulings.

The Supreme Court stated in Skidmore v. Swift & Co., (1944) 323 U.S. 134, that it was not bound by Rev Ruls, and that the weight that they are afforded is dependent on their persuasiveness and the consistency of IRS's position over time. However, this standard has done little to resolve the precise level of deference afforded, and is often cited for the proposition that Rev Ruls are entitled to “some” deference. (See, e.g., U.S. v. Mead, (2001, Sup Ct) 533 U.S. 218)

Cases over the past decade have afforded Rev Ruls varying degrees of deference. For instance, in Ammex, Inc., (2004, CA6) 93 AFTR 2d 2004-2187, the Sixth Circuit held that Rev Ruls should get the same level of deference as regs, reasoning that they are issued in the same manner and under the same authority. (This reasoning is debated—commentators cite differences ranging from the submission of regs for public comment to who formulates and supervises each.) However, in PSB Holdings, Inc., (2007) 129 TC 131, the Tax Court stated that it isn't bound by an interpretation in a Rev Rul.

Revenue Procedure (“Rev Proc”). Rev Procs are statements of practice and procedure published in the IRB. They also are published in the Federal Register when required by the APA. They contain information that affects the rights or duties of taxpayers and other members of the public under the tax law and related statutes, or they contain information that should be made public even if it does not affect the rights and duties of the public. They address broad subjects such as accounting method changes, how to compute depreciation allowances, or how to obtain innocent-spouse equitable relief. The precedential value of a Rev Proc is the same as that of a Rev Rul. However, unlike Rev Ruls, Rev Procs fall outside of Code Sec. 7805(b) and apply prospectively.

Observation: Although Mayo didn't address the level of deference afforded to Rev Ruls or other similar types of IRS guidance, there was speculation following the decision that arguments advocating for such published rulings to receive Chevron deference would soon follow. However, on May 7, Gilbert, Rothenberg, appellate section chief in the Department of Justice's (DOJ's) Tax Division, announced that the DOJ would not argue that Chevron deference applies to Rev Ruls or Rev Procs.

Announcement (“Ann”) or Notice (“Not”). These address a timely topic of wide interest (e.g., extension of the period in which a Roth IRA can be recharacterized) and can be relied on and cited as precedent by taxpayers. IRS is bound to what it says in an Announcement or Notice to the same extent it would be with a Rev Rul or Rev Proc.

News release or information release (“IR”). This document is issued to the press to bring public attention to general-interest items, rather than items of a technical nature. IRS's statement of policy in an IR has been held to bind it in its dealings with taxpayers.

General Counsel Memorandum (“GCM”). This is a legal memo prepared by the IRS's Chief Counsel's Office in response to a formal request from within IRS ranks for legal advice. It can't be used or cited as precedent. Some courts have held that a GCM can be relied on for interpretive guidance, but IRS has resisted this conclusion. IRS stopped issuing GCMs after’95.

Observation: In a case of first impression, the Second Circuit relied substantially on what IRS had said in GCMs. It noted that while it wasn't giving precedential value to the GCMs cited, it was necessary to rely on them for interpretive advice. (Morganbesser v. U.S., (1993, CA2) 71 AFTR 2d 93-825) IRS subsequently nonacquiesced in the decision and revoked a GCM relied on in that case.

Action on Decision (“AOD”). This is a legal memo prepared by IRS Chief Counsel when IRS loses a court case. It sets forth the issue, a brief discussion of the facts, and the reasoning behind the recommendation to acquiesce (“acq,” follow) or nonacquiesce (“nonacq,” not follow) a decision, or to acquiesce in result only. IRS says that an AOD isn't an affirmative statement of its position, isn't intended to serve as public guidance and can't be cited as precedent. As a practical matter, acqs or nonacqs can be relied on (e.g., if the taxpayer's situation is the same as the one decided in a court case to which IRS has acquiesced, the taxpayer may assume his position won't be challenged by IRS).

Observation: However, in a December 2010 speech, Commissioner Douglas Shulman cautioned taxpayers not to “read too much” into IRS's AOD regarding the Tax Court's 2009 VERITAS transfer pricing decision (133 TC No. 14), stating that IRS's attorneys will continue to litigate these types of cases when appropriate to do so.

No comments: