Federal Circuit Plunges Deep Into the Weeds of Chevron Analysis in Grapevine Oral Argument
January 26, 2011
It took less than a day for the government to try out its new Mayo Foundation toy – that is, the Supreme Court’s ruling that deference to Treasury regulations is governed by the same Chevron principles that apply to regulations issued by other agencies. (See our report on the Mayo decision here.) The Intermountain-type litigation posed the perfect opportunity to examine the impact of Mayo, as the regulations at issue in those cases clearly are more vulnerable under the National Muffler approach of looking to factors like whether the regulation is contemporaneous or designed to reverse judicial decisions. Accordingly, the government promptly filed notices of supplemental authority in those cases calling the various courts’ attention to Mayo.
The Federal Circuit did not have much time to ruminate on the supplemental filing, as oral argument in Grapevine was set for the next day. Even so, the government was not bashful about embracing Mayo. Acting Deputy Assistant Attorney General Gil Rothenberg began his argument by telling the court that Mayo “foreshadows” how the case should be decided because of the “striking . . . parallels” between Mayo and Grapevine. That opening triggered immediate pushback from an active panel (Judges Bryson and Prost, with Judge Lourie remaining mostly silent during the argument). The judges pointed to the obvious difference between the cases, the existence of a Supreme Court decision (The Colony, Inc. v. Commissioner, 357 U.S. 28, 32-33 (1958)) that has already construed the statutory language at issue in Grapevine. What ensued was a lively oral argument that focused almost entirely on the rules for Chevron analysis and very little on any topics that would be standard fare for a tax practitioner.
The Chevron jurisprudence issue that dominated the argument is the scope of the Supreme Court’s decision in Nat’l Cable and Telecommunications Ass’n v. Brand X Internet Servs., 545 U.S. 967 (2005). As noted in our first post on these cases, Brand X says that Chevron deference is owed even to a regulation that conflicts with judicial precedent – as long as that judicial precedent did not hold that the statute was unambiguous (a so-called Chevron Step 1 conclusion that would leave no room for interpretation by the agency). That limiting principle arguably defeats the deference argument in the Intermountain cases because the Supreme Court in Colony had construed the “omission from gross income” language as not covering cases of overstated basis. On the other hand, in reaching that conclusion, the Court had remarked that the statutory text was not “unambiguous” and had looked to legislative history as well. 357 U.S. at 33. Thus, the government argues that the Brand X limiting principle does not apply because the Supreme Court did not declare the statutory text unambiguous.
The case thus raises a fundamental question of Chevron jurisprudence: to what extent, if any, can a court look beyond the statutory text at Chevron Step 1? Chevron itself clearly answered this question. In defining Step 1 in which no deference is owed if the regulation conflicts with the “unambiguously expressed intent of Congress,” the Court explained in a footnote that a court is to determine Congress’s intent “employing traditional tools of statutory construction,” which presumably allows reference to legislative history. Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 843 n.9 (1984). Brand X stated that “[t]he Chevron framework governs our review.” 545 U.S. at 980. So did Brand X reaffirm the statement in Chevron that the Step 1 analysis goes beyond the text and includes analysis of the legislative history? Not so fast. The Brand X opinion was authored by Justice Thomas, no fan of legislative history, and that opinion’s formulation of Chevron Step 1 in Brand X was notably more restrictive; deference is owed unless the “prior court decision holds that its construction follows from the unambiguous terms of the statute.” 545 U.S. at 982 (emphasis added).
The judges at the Grapevine argument focused on this question – in particular pressing government counsel on the contours of the government’s position. Counsel tried to walk a fine line, hoping to significantly marginalize the role of legislative history at Step 1 without blatantly disregarding the language of Chevron. He stated that legislative history is relevant at Step 1 only for the very limited purpose of determining the meaning of a “term” in the statute, but not for determining the general purpose of the statute and using that as an aid to statutory construction. (This approach is more nuanced that the position advanced in the government’s brief, which appeared to argue that legislative history can never be examined at Chevron Step 1.) The court questioned both whether this line could truly be drawn and whether in any event it would aid the government’s position in this case where the Colony Court had used legislative history to construe the statutory phrase “omission from gross income.” Judge Prost specifically asked government counsel whether he was arguing that Brand X had overruled Chevron. In response, he characterized Brand X as “narrowing” the broad language of Chevron and later acknowledged that he believed that Brand X is “not completely consistent” with footnote 9 of Chevron. With respect to the question whether his argument failed in any event because Colony had construed a statutory term, government counsel argued that Colony had construed the 1939 Code and therefore was not authoritative on the meaning of the same language in the 1954 Code.
Taxpayer’s counsel got a similar grilling from the panel when he took the podium and tried to argue that the court should simply follow Chevron footnote 9 and not worry about any possible retrenchment from that position found in Brand X. Judge Bryson observed that there is only a “tiny sliver” left of Chevron deference if one applies footnote 9 aggressively – that is, by allowing a determination of general congressional intent through legislative history to play a significant role at Step 1. Taxpayer’s counsel looked to Mayo for help, observing that Mayo had cited approvingly to pp. 842-43 of Chevron, the very pages that included footnote 9. Judge Bryson, however, quickly retorted that the Mayo citation did not mention footnote 9.
Taxpayer’s counsel spent some of his argument time seeking affirmance on narrower grounds, such as that the new regulations could not apply to Grapevine’s case either because they were promulgated after the trial court issued its final judgment or because, as the Tax Court majority held, the new regulations by their terms did not apply to cases outside the three-year statute of limitations. But the Federal Circuit showed little sympathy for these arguments. Instead, it appears likely that the Federal Circuit’s decision will wade into the question of how Chevron and Brand X apply to the new regulations. The court did not tip its hand, although to this observer it appeared more likely to conclude that the taxpayer should prevail – because Colony was a sufficiently definitive interpretation of the statutory text under Chevron Step 1 that Brand X does not leave room for it to be overruled by regulation.
One interesting aspect of the argument was the failure of anyone to discuss the point made by Justice Stevens in his one-paragraph concurring opinion in Brand X. Justice Stevens noted that he fully joined the majority opinion, “which correctly explains why a court of appeals’ interpretation of an ambiguous provision in a regulatory statute does not foreclose a contrary reading by the agency.” 545 U.S. at 1003 (emphasis added). Justice Stevens added, however, that “[t]hat explanation would not necessarily be applicable to a decision by this Court that would presumably remove any pre-existing ambiguity.” Id. Justice Stevens’ suggested distinction between court of appeals decisions and Supreme Court decisions makes Grapevine an easy case. If Colony is understood to remove any ambiguity in the statutory text, then there is no room for Chevron deference to the new regulations and no need to get into the morass of determining whether Brand X modified Chevron. Taxpayer’s counsel did not raise this point, however, and none of the judges asked about it. (We note that the Tenth Circuit has addressed and rejected Justice Stevens’ suggested distinction between courts of appeals and the Supreme Court in applying Brand X. Hernandez-Carrera v. Carlson, 547 F.3d 1237, 1246-48 (10th Cir. 2008).).
A decision from the Federal Circuit would ordinarily be expected sometime in the spring. Judge Prost did ask government counsel about the status of the other Intermountain cases, and he responded that Grapevine marked the fifth case to be argued, with argument scheduled in the D.C. Circuit in April. But the Federal Circuit did not give the impression that it planned to sit tight and let other circuits sort out these issues. As we report elsewhere, the Seventh Circuit got the ball rolling today by deciding the Beard case – ruling for the government on statutory grounds without relying on the regulations. That decision should not have much impact on the Federal Circuit, which has already rejected the Seventh Circuit’s reasoning in Salman Ranch Ltd. v. Commissioner, 573 F.3d 1362 (Fed. Cir. 2009). If the Federal Circuit determines to rule for the government, it will have to rely on the regulations.
Seventh Circuit Sets Up Likely Supreme Court Showdown By Reversing Tax Court on Intermountain Issue
January 26, 2011
The Seventh Circuit today became the first court of appeals to weigh in on the Intermountain issue subsequent to the issuance of the temporary regulations, and it handed the government a big victory. Interestingly, the court did not rely on the regulations, instead ruling that the term “omission from gross income” is best read to include overstatements of basis – at least in “non-trade or business situations.” The Court ruled that Colony did not control this issue because that case involved a construction of the 1939 Code, not the 1954 Code. Describing it as a “close call,” the Seventh Circuit ruled that “a close reading of Colony” (which includes explaining away the Colony Court’s observation that the language in the 1954 Code is unambiguous) justifies the conclusion that “an overstatement of basis can be treated as an omission from gross income under the 1954 Code.”
The Seventh Circuit acknowledged that its decision directly conflicts with the two court of appeals decisions that prompted the Treasury Department to attack this issue by issuing temporary regulations, Salman Ranch Ltd. v. Commissioner, 573 F.3d 1362 (Fed. Cir. 2009); Bakersfield Energy Partners, LP v. Commissioner, 568 F.3d 767 (9th Cir. 2009), aff’g, 128 T.C. 207 (2007). The court explained that it disagreed with the reasoning in those decisions, and cited approvingly to Judge Newman’s dissenting opinion in Salman Ranch. Thus, there is a clear conflict in the circuits, and the only way that conflict could disappear would be if the government prevails in every single circuit (including the Federal and Ninth Circuits) on its post-regulation appeals. Such a clean sweep is unlikely. With the government anxious to have this issue heard by the Supreme Court, and claiming that $1 billion is at stake, it appears almost inevitable that the Court will ultimately decide the Intermountain issue sometime in 2012.
As we noted in our original post on these cases, the Seventh Circuit panel was the most sympathetic to the government at oral argument and seemed particularly troubled by the bottom line outcome of allowing the taxpayers to retain massive tax benefits from what the court regarded as a tax shelter. That attitude is reflected in the opinion as well, which goes out of its way to commend the government’s description of the transaction as an “abusive . . . tax shelter.” Thus, the court’s reliance on a somewhat strained statutory interpretation might be understood as the least disruptive way to reach what it believed to be the “right result,” while avoiding having to make broad pronouncements on difficult issues of deference owed to temporary regulations. The court indeed stated explicitly that, “[b]ecause we find that Colony is not controlling, we need not reach” the issue of deference to the regulations.
Curiously, though, the court then added two sentences stating in conclusory fashion that it “would have been inclined to grant the temporary regulation Chevron deference,” simply citing some cases in which the court had previously accorded deference to Treasury regulations. Whatever the court’s motivation for adding this dictum, it does not address the difficult issues involved in deferring to these particular regulations. Accordingly, the dictum is unlikely to carry much weight with other courts of appeals that do not agree that Colony is irrelevant to construing the statutory text and therefore are struggling with the question of the degree of deference owed to the regulations.
Update on Canal Corp. and NPR Investments
January 21, 2011
In our prior post on these cases, we compared the different factual findings made by the courts in analyzing penalty exposure under section 6664 and discussed the very factual nature of a reasonable cause and good faith penalty defense. Both cases were subsequently appealed. Canal Corp.looks like it is going to settle with the Fourth Circuit granting a motion to hold the appeal in abeyance pending finalization of that settlement (the company is in bankruptcy). Thus, those hoping for an appellate smack-down of the penalty supporting opinion from the Tax Court will be disappointed. NPR Investments is a different story. Briefs are due in that appeal (which lies in the Fifth Circuit) starting on February 19th. So Government hopes of another Son-of-Boss penalty success live on. If we see anything interesting, we will report on it.
Oral Argument Scheduled in Container
January 20, 2011
The Fifth Circuit has scheduled the oral argument in Container for Thursday March 3, 2011, in New Orleans. The identity of the three-judge panel will be announced at a future time.
Notice of Supplemental Authority Filed in Virginia Historic
January 19, 2011
On January 18, 2011, the taxpayers filed a Notice of Supplemental Authority, drawing the court’s attention to the Tax Court’s recent opinion in Historic Boardwalk Hall, LLC v. Commissioner, 136 T.C. 1 (Jan. 3, 2011). According to the taxpayers in Virginia Historic, the new Tax Court case involves many factual and legal issues similar to those in the instant case. We’ll have an analysis of the recent decision and its potential impact on the issues in Virginia Historic in the near future.
Oral argument is scheduled in Virginia Historic for January 25, 2011.
January 18, 2011
As can be seen by the sheer number of our posts that deal with it, the unified partnership audit procedures of the Tax Equity and Fiscal Responsibility Act (“TEFRA”) can cause confusion. In fact, they can be downright bewildering. It is particularly easy to get lost if one walks into the TEFRA wilderness without keeping one eye fixed at all times on the overarching purpose of TEFRA. The case of Bush v. United States, et. al., Fed Cir. Nos. 2009-5008 and 5009, is a textbook example of what happens when you lose sight of that landmark. An apparently innocuous TEFRA proceeding resulted in a startling panel opinion authored by Judge Dyk and joined by Judge Linn that has baffled TEFRA practitioners. (Judge Prost concurred in the result on a theory that comports with the common understanding of TEFRA.) Bush v. United States, et. al., 599 F.3d 1352 (Fed. Cir. 2010). Instead of ending the case, that opinion has triggered a flurry of activity that should eventually lead to an en banc decision by the full court. Thus far, the panel decision has generated two sets of petitions for rehearing and responses, a vacated panel opinion, an order from the en banc court identifying four sets of questions to be addressed in new briefs, and at least one new amicus brief. And the en banc briefing process is just getting started. In order to keep from drawing the reader too far into the wilds ourselves, we describe the issue and the law first and then explain what happened to get us to where we are.
The facts in Bush are relatively simple. The taxpayers had TEFRA partnerships. Those TEFRA partnerships were audited, and a TEFRA partnership proceeding was brought. That proceeding was settled by the taxpayers. The Internal Revenue Service sent notices of computational adjustment to the taxpayers to reflect the adjustments agreed in the settlement; no notices of deficiency were sent. The taxpayers paid the amounts reflected in the notices of computational adjustment. Later, the taxpayers filed claims for refund with respect to the amounts they paid pursuant to the settlement and eventually sued in the Court of Federal Claims seeking to recover those amounts.
Now for the law. The purpose of TEFRA is to determine the tax treatment of “any partnership item” at “the partnership level.” Section 6221. This ensures “consistent . . . treatment” among partners and between the partners and the partnership. Section 6222. Consistency and unity is so important that the Service is empowered to issue “computational adjustments” to make the partners’ individual returns consistent with the partnership return. Section 6222(c)(2). Section 6226 provides the sole mechanism to judicially challenge the Service’s proposed adjustment of a “partnership item” – namely, filing a petition in court in response to the notice of final partnership adjustment issued by the Service. The notice of deficiency process, found in subchapter B of Chapter 63 of the Code, is specifically integrated with the TEFRA process outlined above (which is found in subchapter C of Chapter 63 of the Code), by section 6230. As relevant here, section 6230(a) contains the rules for when the IRS is required to issue a notice of deficiency under subchapter B with respect to various items, and section 6230(c) contains rules that allow a taxpayer to challenge a computational adjustment.
Section 6230 leaves a relatively narrow gap within which the standard notice of deficiency process is to operate in TEFRA partner-level proceedings. Setting aside a very specific (and irrelevant for our purposes) innocent spouse rule, section 6230(a)(2) provides that a notice of deficiency must be issued with respect to “affected items which require partner level determinations” and “items which [although they had been partnership items] have become nonpartnership items.” For all other “computational adjustments” related to: (i) partnership items; or (ii) affected items that do not require partner level determinations “subchapter B of this chapter shall not apply.” Section 6230(a)(1). This limitation on the notice of deficiency requirement, however, does not leave the partner facing a computational adjustment without recourse. Section 6230(c) allows the partner to file a claim for refund in several cases including, among others: (i) to apply a partnership settlement; or (ii) to seek a credit or refund of an overpayment attributable to the application of such a settlement. Section 6230(c)(1)(A)(ii) and (B). Critically, under either of these refund claim provisions, substantive review of the “treatment of partnership items” resolved in the settlement is verboten. Section 6230(c)(4). This is necessarily the case because the whole unifying purpose of TEFRA would be undermined if a later proceeding could affect the treatment of items properly agreed in a settlement by the parties at the partnership level.
Readers that are still awake will see that there are really only two nuts to crack in order to resolve Bush. First, were the items subject to the settlement either partnership items or affected items that do not require partner level determinations (which would mean that there was no notice of deficiency requirement)? Second, assuming they were, did the questions raised in the claim attempt to substantively re-review the determination of those items (which, again, is a statutory no-no)? As to the first question, the item at issue in Bush was the section 465 “at-risk” amount (basically, the amount that the taxpayer has placed at risk in the venture and thus as to which deductions are allowed). At-risk amounts are affected items to the extent they are not partnership items. Treas. Reg. §301-6231(a)(5)-1(c). The settlement agreement set out that the taxpayers’ at-risk amounts were equal to their capital contributions to the partnership and actually specified the dollar amount. Thus, it is arguable that the affected item in Bush is actually a partnership item. See Treas. Reg. §301-6231(a)(3)-1(a)(4)(i) (considering capital contributions generally as partnership items). Regardless, it is certainly not an “affected item which require[s] partner level determinations” because it was finally resolved in the settlement agreement and the partner’s specific situation doesn’t affect it at all. Therefore, no notice of deficiency was required under section 6230. Having made it this far, even a blind squirrel in the dark TEFRA forest can find and crack the second nut; if the settlement agreement resolved the item, and if that item doesn’t require a partner-level determination, then a claim challenging the substantive application of that item is barred by section 6230(c)(4).
The foregoing analysis is consistent with Federal Circuit precedent. Olson v. United States, 172 F.3d 1311, 1318 (Fed. Cir. 1999) (no notice of deficiency required where the computational notices involved “nothing more than reviewing the taxpayers’ returns for the years in question, striking out the [items] that had been improperly claimed, and re-summing the remaining figures”). It is also essentially the analytical methodology applied by the Court of Federal Claims in denying the taxpayers’ refund claim. See Bush v. United States, 78 Fed. Cl. 76 (Fed. Cl. 2007). But someplace between here and there, the Federal Circuit majority got turned around over the definition of a computational adjustment vis-à-vis section 6230(a)(1). It affirmed the trial court, but only after a convoluted analysis that began with the conclusion that the Service had erred in failing to issue a notice of deficiency to the taxpayers as a prerequisite to assessing the amounts agreed to in the settlement.
Section 6231(a)(6) defines a computational adjustment as “the change in the tax liability of a partner which properly reflects the treatment under this subchapter of a partnership item.” Perhaps this language, like much in TEFRA, could be clearer, but it is hard to imagine that Congress intended to give it the construction adopted by the Federal Circuit majority. The majority read the statute as associating the term “change,” at the beginning of the subsection, with the term “partnership item,” at the end of the subsection; meaning that there always has to be a “change” in a “partnership item” in order for any adjustment to be “computational.” However, based on the language itself, the statute is better read as including all situations involving a change in tax liability driven by any “treatment of a partnership item,” and not just those involving a “change” in that treatment. The word “change” directly modifies only tax liability and the use of the word “treatment” (as opposed to “change”) to define the connection to a partnership item appears to be an intentional distinction. Furthermore, any computational adjustment “affect items,” and “affected item” is defined as an item “to the extent such item is affected [not necessarily “changed”] by a partnership item.” If the partner’s tax liability changed (which it did), and that change “properly reflect[ed] the treatment” of a partnership item (and didn’t require any partner-level determinations), it is a computational adjustment. This reading also harmonizes sections 6230 and 6231 and is consistent with the broader purpose of TEFRA in unifying partnership proceedings and making partners’ returns consistent with partnership returns. See generally section 6222 (which contemplates changes to partner returns by “computational adjustment” to make them consistent with partnership returns); see also Judge Prost’s concurrence, 599 F.3d at 1366.
But the majority disagreed. And having made it this far into the woods, it turned around only to find that all of its breadcrumbs had been eaten. Worse, it could see the right answer (the taxpayer loses), but couldn’t easily get there from its entanglement in the thicket of TEFRA. Creatively, the majority got to the desired destination by stepping out of the TEFRA forest to stand on the federal harmless error statute, 28 U.S.C. §2111 (a provision, it is fair to say, that is not regularly seen in tax cases). The Federal Circuit applied section 2111 to find that the Service’s failure to issue a notice of deficiency was harmless because the taxpayer had other methods to challenge the underlying issue including both their original proceeding and a hypothetical collection due process hearing. See section 6330. If you are not badly in need of a GPS at this point, you are doing very well.
The parties filed dueling petitions for rehearing. The taxpayers did their best to take advantage of the panel opinion’s vulnerabilities (vulnerabilities that were created by the majority getting so tangled up in TEFRA it had to reach out of the tax code to solve the problem). Positing that a valid assessment was a prerequisite for the Government to retain timely made payments, the taxpayer argued that section 6213 must be mechanically followed in order to legitimately assess taxes, and therefore the alternative methods suggested by the Federal Circuit would be ineffective and could not render the error harmless. For its part, the Government tried to reorient the court to the correct reading of “computational adjustment” and pointed to Lewis v. Reynolds, 284 U.S. 281 (1932), which might allow the taxpayers a refund (due to some of the payments apparently being made after the assessment statute had closed) in spite of the court’s harmless error analysis. (As an aside, on the valid assessment point, Judge Allegra’s recent opinion in Principal Life Ins. Co. v. United States, 2010 U.S. Claims LEXIS 856 (Fed. Cl. 2010), drawing from Lewis, nicely slays the chimera that is the “requirement” of “valid assessment” for non-time-barred years)
Thankfully, the Court vacated the panel opinion and granted rehearing en banc limited to the following four issues:
a) Under I.R.C. § 6213, were taxpayers in this case entitled to a pre-assessment deficiency notice? Were the assessments the results of a “computational adjustment” under § 6230 as the term “computational adjustment” is defined in § 6231(a)(6)?
b) If the IRS were required to issue a deficiency notice, does § 6213 require that a refund be made to the taxpayers for amounts not collected “by levy or through a proceeding in court”?
c) Are taxpayers entitled to a refund under any other section of the Internal Revenue Code? For example, what effect, if any, does an assessment without notice under § 6213 have on stopping the running of the statute of limitations?
d) Does the harmless error statute, 28 U.S.C. § 2111, apply to the government’s failure to issue a deficiency notice under I.R.C. § 6213? If so, should it apply to the taxpayers in this case?
The parties are in the process of briefing these issues. The taxpayer’s brief is here, the government’s brief is here, and the taxpayer’s reply brief is here. We are hopeful that the Court has found its compass and is diligently working its way out of the trees. Harmless error has nothing to do with the resolution of this case and neither do the technicalities of assessment. The taxpayers agreed to the treatment of various items in a partnership proceeding. There was no need for a partner-level determination in order to compute an adjustment with respect to those items. Therefore, no notice of deficiency was required. If the taxpayers had a complaint about how those calculations were performed that did not involve a substantive challenge to the agreed at-risk amount, they would have a claim. They don’t, so they lose.
Sunoco Oral Argument Rescheduled for January 25
January 12, 2011
The Third Circuit has revised its January oral argument calendar and rescheduled the oral argument in Sunoco for the morning of Tuesday, January 25. The case had been scheduled for argument on the previous day. The panel that will hear the case is Chief Judge Theodore McKee, Judge D. Brooks Smith, and Judge Richard Stearns, a district judge from the District of Massachusetts who is sitting by designation.
Supreme Court Opts for Chevron Analysis of Treasury Regulations, Discarding the Traditional National Muffler Dealers Analysis
January 11, 2011
The Supreme Court this morning issued its opinion in the Mayo Foundation case, ruling unanimously that medical residents are not “students” exempt from FICA taxation. As previously discussed several times on this blog (see here, here, and here), the Mayo case carried the potential for broad ramifications beyond its specific context because the parties had framed the question of whether deference to Treasury regulations is governed solely by general Chevron principles that supersede the deference analysis previously developed in tax cases like National Muffler Dealers. The Court in fact addressed that question and has now endorsed use of the Chevron standard in tax cases, thereby providing the IRS with a big victory that will make it more difficult for taxpayers to prevail in court in the face of contrary regulations, even if they are “bootstrap” regulations designed primarily to influence the outcome of litigation. And for good measure, the Court obliterated the long-held view by many in the tax world that “interpretive” regulations promulgated pursuant to Treasury’s general rulemaking authority under Code section 7805(a) are entitled to less deference than “legislative” regulations promulgated pursuant to more specific rulemaking authority.
The Court’s opinion was authored by the Chief Justice, who was the Justice who spoke out most forcefully during the oral argument in favor of the position that Chevron had superseded earlier decisions in tax cases, as noted in our previous post. Thus, the opinion sought to be very clear on this point and to identify some of the familiar approaches to regulatory deference in tax cases that the Court was now consigning to the trash heap. First, the Court pinpointed some of the key factors that had been identified as important under the National Muffler Dealers analysis, stating that under that analysis “a court might view an agency’s interpretation of a statute with heightened skepticism when it has not been consistent over time, when it was promulgated years after the relevant statute was enacted, or because of the way in which the regulation evolved.” Slip op., at 8-9 (citing Muffler Dealers, 440 U.S. at 477). The Court continued: “Under Chevron, in contrast, deference to an agency’s interpretation of an ambiguous statute does not turn on such considerations.” Id. at 9.
The Court amplified its rejection of the Muffler Dealers analysis by citing a series of non-tax decisions under Chevron that decline to attribute significance to these considerations. Thus, the Court remarked that it had “repeatedly held that ‘[a]gency inconsistency is not a basis for declining to analyze the agency’s interpretation under the Chevron framework’” (quoting National Cable & Telecommunications Assn. v. Brand X Internet Services, 545 U.S. 967, 981 (2005)); “that ‘neither antiquity nor contemporaneity with [a] statute is a condition of [a regulation’s] validity’” (quoting Smiley v. Citibank, N.A., 517 U.S. 735, 740 (1996)); and that it is “immaterial to our analysis that a ‘regulation was prompted by litigation’” (quoting Smiley, 517 U.S. at 741). Trying to link these decisions to its tax law jurisprudence, the Court then observed that in United Dominion Industries, Inc. v. United States, 532 U.S. 822, 838 (2001) (which involved the calculation of product liability losses for affiliated entities under Code section 172(j)), it had “expressly invited the Treasury Department to ‘amend its regulations’ if troubled by the consequences of our resolution of the case.” Mayo slip op., at 9. The Court emphasized that it saw no good reason “to carve out an approach to administrative review good for tax law only.” Id. Thus, the Court concluded: “We see no reason why our review of tax regulations should not be guided by agency expertise pursuant to Chevron to the same extent as our review of other regulations.” Id. at 10.
Second, the Court moved to squash another area where it discerned a difference between Chevron principles and those developed in tax cases – even though the parties had not focused on that point. Pointing to an amicus brief filed by Professor Carlton Smith arguing for reduced deference because the regulations in Mayo were “interpretive” regulations promulgated pursuant to Treasury’s general rulemaking authority under 26 U.S.C. § 7805(a), the Court acknowledged that there is pre-Chevron authority for the proposition that courts “‘owe the [Treasury Department’s] interpretation less deference’ when it is contained in a rule adopted under that ‘general authority’ than when it is ‘issued under a specific grant of authority to define a statutory term or prescribe a method of executing a statutory provision’” (slip op., at 10-11 (quoting Rowan Cos. v. United States, 452 U.S. 247, 253 (1981)). The Court tossed that precedent aside as well, ruling that the Rowan statement was not compatible with the current approach to administrative deference, which is unaffected by “whether Congress’s delegation of authority was general or specific.” Slip op., at 11.
With the Chevron analytical framework in place, the Court made short work of the FICA issue before it. It reasonably concluded that the statutory text did not unambiguously resolve whether medical residents qualify for the FICA student objection. Hence, the Court moved to “Chevron stage two” – namely, whether the regulation was a “reasonable interpretation” of the statute. Observing that “[r]egulation, like legislation, often requires drawing lines” (slip op., at 13), the Court held that it was reasonable for Treasury to establish a rule that anyone who works a 40-hour week, even a medical resident, is not a “student” for purposes of the FICA student exception.
In sum, the Court’s decision in Mayo resolves the deference issues that have recently divided the lower courts in a way that is extremely favorable to the government. Treasury likely will be emboldened to issue regulations that seek directly to overturn cases that the government loses in court on statutory interpretation issues, or to issue regulations even earlier to sway the outcome of pending litigation before the courts interpret the statute in the first place. Of course, we have seen that phenomenon already in the Mayo case itself, with respect to the statute of limitations issue litigated in Intermountain and a host of other cases (see here and here), and in other settings. The Mayo decision will further encourage the Treasury Department to issue such regulations and will make it tougher for taxpayers to prevail in court in the face of those regulations.
Taxpayer’s Brief Filed in Intermountain
January 7, 2011
The taxpayer has filed its response brief in the D.C. Circuit in Intermountain. The brief does not add much new to the debate, which is hardly surprising at this point. It relies in the alternative on all of the different rationales advanced by the various Tax Court opinions for rejecting the IRS’s position (and adds an additional argument that the basis was adequately disclosed on the return). The taxpayer does not jump into the National Muffler Dealers vs. Chevron debate, content to argue that there is no Chevron deference owed in these circumstances under the established rules for Chevron analysis. The taxpayer does not directly address whether the issuance of final regulations changes that analysis, instead arguing that it is too late for the government to rely on the issuance of the final regs because it did not refer to them in its opening brief.
In the companion UTAM case, the briefing lags the Intermountain schedule by a month. The government has just opened the briefing in that case, and the taxpayer’s response brief is due February 7, 2011. Again not surprisingly, the government’s brief looks a lot like the brief it filed in Intermountain a month ago, though it does refer to the final regulations. The new briefs in the two cases are attached below.
The cases are both scheduled for oral argument on April 5, 2011.