The government’s reply brief has now been filed in Quality Stores, completing the briefing. The Court will hear oral argument on January 14.
Also linked below are three amicus briefs that have been filed in support of the taxpayer. The brief filed by the ERISA Industry Committee comprehensively addresses the question presented, examining the relevant statutes, legislative history, administrative pronouncements, and judicial precedents. The brief filed by the American Payroll Association engages in a statutory analysis and examines the administrative pronouncements, concluding that the government’s position “would replace the straightforward definition provided by Congress with a cumbersome and essentially unadministrable definition.” The brief filed by the American Benefits Council focuses almost exclusively on the IRS’s Revenue Rulings. Admittedly “derived from an article” previously published by the brief’s author, the amicus brief argues that the regime established by the Revenue Rulings is “incoherent and unsupported” and should be rejected by the Court in favor of the taxpayer’s position, which is “coherent, sensible, and easily understood.”
Mayo Foundation Oral Argument Tilts Towards the Government and Raises Doubts About the Continuing Vitality of National Muffler Dealers
At oral argument on November 8, several Supreme Court Justices expressed skepticism regarding the claim that medical residents fall within the “student exemption” from FICA taxation. Although it is always hazardous to predict the outcome of a case from the questions asked at oral argument, it is difficult to envision the taxpayer getting the five votes needed to overturn the court of appeals’ rejection of the exemption.
The Justices’ objections to the taxpayer’s position came from a variety of angles. Justice Sotomayor focused on the essence of what a medical resident does, suggesting that a person working unsupervised for more than 40 hours per week, and for significant remuneration, is “really not a student.” Justice Ginsburg focused more on Congress’s intent, suggesting that the exemption seemed directed at “the typical work/study program in a college.” Chief Justice Roberts observed that the line between student and worker is a difficult one to draw and suggested that it was therefore appropriate to let the IRS draw the line in a categorical way and then defer to the IRS’s interpretation. Justice Breyer took a different tack, arguing that the IRS’s position was a valid interpretation of a requirement that had been in the regulations for a long time – namely, that the employment has to be “incident” to the study. Full-time employment, he suggested, would not be “incident” to the study because it is “so big in comparison to the study.”
Justice Alito seemed the most sympathetic to the taxpayer. He rose to the taxpayer’s defense by offering an alternative reading of word “incident.” Later, he challenged the government’s counsel to explain why medical residents should not be eligible for the exemption when law students who write briefs are eligible, arguing that the medical residents should be treated as students if their primary motivation is to complete a course of study rather than to earn money. Justice Ginsburg and the Chief Justice also questioned government counsel, though not as sharply as they had questioned the taxpayer’s counsel. Justices Scalia and Kennedy were uncharacteristically silent during the argument. In accordance with his usual practice, Justice Thomas did not speak. Justice Kagan is recused in the case because of her prior involvement when she was Solicitor General.
In our prior posts on this case (see here, here, and here), we discussed the possibility that this case could be a vehicle for the Supreme Court to address the correct standard for deference to Treasury regulations – that is, whether the more generic Chevron analysis has superseded the more specific, and in some respects less deferential, approach set forth in National Muffler Dealers Ass’n v. United States, 440 U.S. 472 (1979). The Justices did not exhibit any independent interest in this issue, as their questions focused on the meaning of the statute, not on deference to the regulation. At one point in his opening argument, taxpayer’s counsel noted that the new regulation was issued only after the government had repeatedly lost in court (a fact that would argue for less deference under the National Muffler Dealers approach), but that point did not elicit any reaction from the Justices.
Thus, the oral argument did not touch on the Chevron/National Muffler Dealers issue until the very end when taxpayer’s counsel affirmatively raised it during his few minutes of rebuttal time. Counsel sought again to persuade the Court that the government’s position is suspect because it is a recent invention that seeks to overturn a series of adverse court decisions, and this time phrased the argument explicitly in terms of the standard for deferring to a regulation. Taxpayer’s counsel argued that deference to the new Treasury Regulation is inappropriate under “[t]he National Muffler standards, which we understand still to be appropriate to evaluate deference given to an IRS regulation,” because the regulation “is not a contemporaneous regulation.” Justice Sotomayor quickly objected, asserting that the Court has “said that agencies can clarify situations that have been litigated and positions that they have lost on.” (She was referring here not to tax cases, but to decisions that apply the Chevron analysis.). Shortly thereafter, Chief Justice Roberts zeroed in on the issue, asking:
Why are we talking about National Muffler? I thought the whole point of Chevron was to get away from that kind of multifactor ad hoc balancing?
Taxpayer’s counsel tried to respond by arguing that the National Muffler Dealers factors were “sensible factors” that the Court should continue to apply in the case of a “regulation that pops up 65 years of the enactment of the statute, after the government has lost five cases.” But the Chief Justice was dismissive, stating simply: “If Chevron applies, those considerations are irrelevant, right?”
The outlook for the case therefore is that the Court will likely affirm the Eighth Circuit’s ruling that medical residents do not come within the student exemption from FICA. Such a decision would not necessarily require a discussion of deference to Treasury regulations, but if there is such a discussion, the Court may well be ready to conduct the analysis explicitly in the Chevron framework and consign National Muffler Dealers to the dustbin of history. As noted in our previous post, that would in some respects be an unfortunate outcome – giving too much deference to regulations that may well be unduly influenced by the IRS’s narrow interest in maximizing tax revenues rather than a neutral effort to implement the will of Congress.
Attached below are links to the taxpayer’s reply brief and to the transcript of the oral argument. A decision is expected in the next few months.
In our initial post on the Mayo Foundation case pending in the Supreme Court, which concerns whether medical residents are exempt from FICA taxation, we noted that the case potentially raised a broad question that has surfaced in the courts of appeals and the Tax Court in recent years — namely, whether Chevron deference principles have supplanted the traditional Muffler Dealers approach to analyzing the deference owed to Treasury regulations. Although that issue was not flagged by the parties at the certiorari stage, we later observed that the taxpayers’ opening merits brief served that ball into the government’s court by relying heavily on some of the Muffler Dealers factors that are not ordinarily part of the Chevron analysis. The government has now responded by directly challenging the continuing vitality of Muffler Dealers. (The government’s brief is attached below.) As a result, there is a good chance that the Supreme Court will address the question and resolve the disagreement between the Tax Court and some courts of appeals on the proper analysis of deference to Treasury regulations.
The government’s brief does not mince words. It states that Muffler Dealers “has been superseded by Chevron” and therefore “the considerations on which [taxpayers] rely are largely irrelevant.” In particular, the government identifies three Muffler Dealers factors relied upon by the taxpayers that are allegedly irrelevant under Chevron: (1) “the recency of [the] adoption” of the regulation; (2) that the new regulation “was enacted ‘to overturn judicial decisions’ interpreting the student exemption”; and (3) that “Treasury’s interpretation of the student exemption has purportedly been inconsistent.”
It is by no means a foregone conclusion that the Supreme Court will resolve the question of the proper deference standard, as there are many ways to resolve the ultimate question of the applicability of the FICA exemption without having to decide on a deference standard. Nor is it as clear as the government would like that Chevron did or should supersede Muffler Dealers. (If it were, the question probably would not still be open 26 years after Chevron was decided). The IRS is often in an adversarial relationship with taxpayers; it has an inherent fiscal interest in interpreting the Internal Revenue Code in a way that maximizes tax revenues. Therefore, there are good reasons for the courts to afford less deference to Treasury regulations that would determine the outcome of tax disputes than to regulations of more neutral agencies that are merely administering a federal statute. Can the government really respond to an IRS defeat in court by promulgating a regulation to overturn the decision and then expect the courts to defer to that regulation without taking any account of how it came to pass? Or can it reverse a regulatory interpretation simply because it determines that the reversal will benefit the public fisc, without paying some price in terms of judicial deference? Perhaps the Supreme Court will answer those questions soon.
Oral argument in the Mayo Foundation case is scheduled for November 8.
The Supreme Court has released the oral argument schedule for its November session. The argument in Mayo Foundation is scheduled as the second case on Monday November 8, meaning it will begin around 11:00. A decision is expected to issue in the spring, almost certainly no later than June 2011. We will provide a report on the argument in November.
The taxpayers have filed their opening brief in Mayo Foundation, a copy of which is attached. They argue primarily that the statutory language of the exemption unambiguously includes medical residents, and therefore there is no occasion to consider the reasonableness of the IRS regulation. Secondarily, they argue that the regulation is in any event arbitrary and unreasonable.
With respect to the question of the correct deference analysis discussed in our previous post, the brief relies heavily on the National Muffler Dealers factors. It identifies five factors that militate against the reasonableness of the regulation: (1) does not harmonize with the origin and purpose of the statute; (2) not contemporaneous; (3) did not “evolve in an authoritative manner” because it was designed to overturn adverse judicial decisions; (4) has not been in effect for long; and (5) the government’s position has been inconsistent. Although the first factor is basic to any analysis of the reasonableness of a regulation, the other four all come from National Muffler Dealers and are not commonly associated with the Chevron deference analysis applied to non-tax statutes.
The taxpayers have not asked the Court to choose between Chevron and Muffler Dealers. To the contrary, they have finessed the possible tension between two lines of cases by purporting to examine “the factors that indicate the reasonableness of a tax regulation under this Court’s decisions in Chevron and National Muffler” and observing that the “Court has given special consideration to several factors identified in National Muffler” “in determining the reasonableness of a regulation interpreting a revenue statute.” As discussed in our previous post, this approach is entirely consistent with the way the Supreme Court has approached this issue in recent years – that is, citing to the National Muffler Dealers factors in tax cases without addressing whether the analysis is fully consistent with Chevron. But the courts of appeals have begun to question whether the two approaches are compatible. It will be interesting to see whether the government’s brief challenges the continuing vitality of the National Muffler Dealers analytical framework. That brief is due on September 27.
In Mayo Foundation, et al. v. United States, No. 09-837, the Supreme Court will consider whether medical residents are exempt from FICA taxation, with the decision likely to turn on the level of deference the Court is willing to accord to a recent regulatory change. Although the issue may seem obscure, there are 8,000 residency programs in the United States, and the government estimates that $700 million in taxes per year is at stake, with $2.1 billion in refund claims pending.
The issue involves the meaning of the “student exemption” to FICA, which excludes from the definition of “employment” “service performed in the employ of a school” by a “student who is enrolled and regularly attending classes at such school.” I.R.C. § 3121(b)(10). The regulations implementing that statute long provided that “student” status depends on the relationship between the employee and the institution and that when the services are performed “incident to and for the purpose of pursuing a course of study,” the employee can qualify for the student exemption. Beginning in the late 1990s, there have been several cases addressing whether this exception applies to medical residents, who work more than full-time and earn a $40,000-$60,000 stipend, but perform their duties as part of an educational process in which they also attend classes.
In 2003, a federal district court in Minnesota ruled that the Mayo Clinic’s residents qualified for the student exception under the statute and existing regulations. The government responded by amending the regulations, effective April 1, 2005, to provide a bright-line rule that does not allow full-time employees to qualify for the exception. Thereafter, four other courts of appeals ruled against the government, stating that the residents fell within the terms of the statutory exception. All four of those cases, however, involved pre-2005 periods, and therefore the courts did not directly consider the impact of the amended regulation. In this case, the first to address the new regulation, the Eighth Circuit held that it owed Chevron deference to the new regulation as a reasonable interpretation of an ambiguous statute. Thus, contrary to the other four circuits, it sided with the government and held that the residents are subject to FICA taxation.
Most tax cases reach the Supreme Court on the strength of a request for further review by the government, but in this case the Court granted a petition filed by the taxpayers over the government’s opposition. The taxpayers predictably argued that the circuit conflict, and dollars at stake, necessitated Supreme Court review. In situations like this, the government often acquiesces in certiorari, because the IRS likes to get circuit conflicts resolved to promote its own institutional interest in uniformity. In this case, however, the government sought to avoid taking its chances in the Supreme Court by arguing that there was no genuine circuit conflict, because the other four circuits had not considered the new regulation. Evidently, the government hoped that it could build on this decision and use it to get the other circuits to retreat from their prior decisions and adopt a rule going forward under the new regulation that would subject medical residents to FICA taxation. The Court, however, was apparently persuaded by the taxpayers that the new regulation is unlikely to lead to a different result in those circuits — because they had already indicated a view that medical residents qualify for the exception under the unambiguous statutory language, which would leave no room for Chevron deference to the new regulation.
A decision by the Court will, of course, resolve the question of FICA taxation of medical residents — unless Congress steps in. But the decision could have a much broader impact because it implicates the general topic of deference to IRS regulations, particularly the question whether Chevron deference principles have superseded the more specialized analysis developed over the years in tax cases dating back to National Muffler Dealers Ass’n v. United States, 440 U.S. 472 (1979). In recent years, courts of appeals have begun to trend towards applying standard Chevron analysis in tax cases, but the Tax Court has resisted. See, e.g., Swallows Holding Ltd. v. Commissioner, 126 T.C. 96 (2006), rev’d, 515 F.3d 162 (3d Cir. 2008). The Supreme Court has not specifically addressed the issue.
There is not a huge difference in the two deference approaches, and, in most cases, choosing between them is not likely to affect the outcome. Like Swallows Holding, however, this case could be an exception. Among the factors listed in Muffler Dealers for determining deference that have been oft-applied in later cases are whether the regulation is contemporaneous with the statute and “the consistency of the Commissioner’s interpretation.” 440 U.S. at 477; see also, e.g., United States v. Cleveland Indians Baseball Co., 532 U.S. 200, 220 (2001); Cottage Savings Ass’n v. Commissioner, 499 U.S. 554, 561 (1991). In this case, those factors support the taxpayers’ rejection of the regulation, as the government is arguing for reliance on a new regulatory approach that departs from a 65-year old regulation. Contemporaneity and consistency, however, play no role in the Chevron analysis, which does not penalize the agency for inconsistency or for promulgating new regulations designed to overturn adverse court decisions. Indeed, the Court has specifically ruled that prior contrary judicial constructions of a statute do not foreclose owing Chevron deference to a subsequent regulation, unless the court decision had determined that the statute is unambiguous. National Cable & Telecommunications Ass’n v. Brand X Internet Services, 545 U.S. 967, 982-86 (2005).
The parties did not tee up this potential issue in the briefs filed at the certiorari stage. The court of appeals’ opinion straddled the fence, purporting to apply Chevron but also stating that the Muffler Dealers factors were “instructive” on the second part of the Chevron inquiry – whether the regulation is a reasonable interpretation of the statute. The certiorari petition focused mostly on the circuit conflict. To the extent it discussed the merits of the case, it argued that the Eighth Circuit’s decision was inconsistent with Chevron and and did not cite the Muffler Dealers line of cases. (The petition argued that the Eighth Circuit had “effectively eliminate[d]” the first step of Chevron analysis in tax cases when it stated that, when common words are found in “a provision of the Internal Revenue Code, a Treasury Regulation interpreting the words is nearly always appropriate.”) The government’s brief was happy to embrace the notion that Chevron governs the deference inquiry. It will be interesting to see whether the taxpayers try to get more mileage out of Muffler Dealers and its progeny at the merits stage.
The parties will be briefing the case over the summer, with the taxpayers’ opening brief currently due on August 6, 2010. Oral argument is expected to be scheduled for November or December. One important note is that this is one of the cases in which Elena Kagan has stated her intent to recuse because she participated in the case as Solicitor General. That means the case will be decided by an eight-Justice Court, with the possibility of a 4-4 split. If that occurs, the Court would issue a one-line order affirming the Eighth Circuit’s decision by an equally divided court. The government’s victory in this case would stand, but the decision would have no precedential value, and the issue would remain in play outside the Eighth Circuit.
The opinion of the Eighth Circuit and the parties’ briefs at the certiorari stage are linked below. We will provide the briefs on the merits after they are filed.