Observations on Changes in the Ninth Circuit’s Second Altera Decision

As we posted earlier here (with a link to the new decision), the Ninth Circuit issued a new decision in Altera after replacing the late Judge Reinhardt with Judge Graber on the panel. But the result was the same as the withdrawn July 2018 decision—the Ninth Circuit upheld the validity of Treasury’s cost-sharing regulation that requires taxpayers to include the cost of employee stock options under qualifying cost sharing arrangements (QCSAs). Today, we present some observations after comparing the majority and dissent in the new decision with those in the Ninth Circuit’s withdrawn decision.

In the new decision, Judge Thomas recycled much of the language and logic from his withdrawn opinion, and Judge O’Malley reused much of her original dissent. Although they are few, some changes in the two opinions are interesting and notable. Overall, the changes serve to sharpen the disagreements between the parties (and the disagreements between the majority and dissent) in ways that will focus the discussion in the likely event of a rehearing en banc petition (or possible petition for certiorari). We focus here on two aspects of the changes.

Was There a Transfer of Intangibles that Implicated the Commensurate-With-Income Language in the Second Sentence of Section 482?

The majority did not address this issue in its withdrawn opinion, so some background is in order. When Treasury proposed cost-sharing regulations that explicitly required related parties to include employee-stock-option costs in the pool of shared costs, commenters put forward evidence that unrelated parties do not share employee-stock-option costs. But Treasury did not heed those comments and ultimately determined that the arm’s-length standard would be met if the regulations required taxpayers in QCSAs to include the cost of employee stock options in the pool of shared costs, regardless of what a comparability analysis might show about whether unrelated parties share those costs. So in order to uphold the Treasury Regulations, the majority had to conclude that the arm’s-length standard under section 482 does not mandate the use of comparable transactions.

In reaching that conclusion, the majority relied on the history of section 482 and especially on the addition of the second sentence of section 482. That second sentence provides that “[i]n the case of any transfer (or license) of intangible property…, the income with respect to such transfer or license shall be commensurate with the income attributable to the intangible.” The majority held that the Congressional intent behind the addition of that language in 1986 is what made it reasonable for Treasury to conclude that it was permitted “to dispense with a comparable transaction analysis in the absence of actual comparable transactions.”

Was there a “transfer (or license) of intangible property” such that Treasury could invoke the commensurate-with-income language to justify dispensing with a comparable-transaction analysis? There was indeed a transfer of intangibles at the outset of the QCSA in this case; Altera transferred intangible property to its QCSA with its foreign subsidiary. But that initial transfer is unrelated to the disputed employee-stock-option costs. Those stock-option costs relate to subsequently developed intangibles, not to the value of the pre-existing intangibles that Altera initially contributed. Then-applicable Treasury Regulation § 1.482-7A(g)(2) required a buy-in payment only for “pre-existing intangibles.”

It is, then, wholly unclear how those employee-stock-option costs for as-yet undeveloped intangibles constitute a “transfer (or license) of intangible property” such that the commensurate-with-income language is implicated at all. The taxpayer argued—both in its initial and supplemental briefing—that by its own terms, the commensurate-with-income language is not implicated once a QCSA is in place and therefore that language is irrelevant to the dispute. The taxpayer reasoned that “no ‘transfer (or license)’ occurs when entities develop intangibles jointly” because jointly developed intangibles “are not transferred or licensed between the parties, but rather are owned upon their creation by each participant.”

The majority said little about this issue in its withdrawn opinion and did not address the taxpayer’s argument. In its new opinion, the majority addressed the argument and declared itself “unpersuaded.” It held that “[w]hen parties enter into a QCSA, they are transferring future distribution rights to intangibles, albeit intangibles that are yet to be developed.” The majority does not, however, explain how “intangibles that are yet to be developed” are “pre-existing intangible property” under Treas. Reg. § 1.482-7A(g)(2) or, perhaps more importantly, how such undeveloped future intangibles can constitute intangible assets at all under the words of the statute. Instead, the majority leaned on the language in the second sentence of section 482 providing that the commensurate-with-income standard applies to “any” transfer of intangible property, holding that “that phrasing is as broad as possible, and it cannot reasonably be read to exclude the transfers of expected intangible property.”

The dissent seized on whether there was any transfer of intangibles that implicated the commensurate-with-income language. The dissent stated that “[t]he plain text of the statute limits the application of the commensurate with income standard to only transfers or licenses of intangible property.” And it observed that there is a contradiction between the majority’s conclusion that QCSAs “constitute transfers of already existing property” and Treasury’s own characterization (in the very preamble of the disputed regulations) of QCSAs “as arrangements ‘for the development of high-profit intangibles,’” inferring that parties cannot transfer something that is not yet developed. The dissent concluded that Treasury’s failure to make “a finding that QCSAs constitute transfers of intangible property” should be, as a matter of review under the APA, fatal to Treasury’s cost-sharing regulations.

Has the Arm’s-Length Standard Historically Required a Comparable-Transaction Analysis?

The majority made several changes from its withdrawn opinion in its account of the history of the arm’s-length standard under section 482. The changes appear to be aimed at bolstering the majority’s conclusion that Treasury was justified in concluding that the arm’s-length standard does not necessitate a comparable-transaction analysis. These changes take a couple of forms.

First, the changes add justifications for the proposition that the arm’s-length standard has not always mandated a comparable-transaction analysis in all cases. The withdrawn opinion included some evidence for this historical account, recounting the Tax Court’s Seminole Flavor decision from 1945 (where the Tax Court “rejected a strict application of the arm’s length standard in favor of an inquiry into whether the allocation…was ‘fair and reasonable’”). In its new opinion, the majority added the observation that Treasury provided for an unspecified fourth method for pricing intangibles in its 1968 regulations. And the majority refined its discussion of the Ninth Circuit’s 1962 decision in Frank, still quoting the language from that opinion denying that “‘arm’s length bargaining’ is the sole criterion for applying” section 482 (as it did in the withdrawn opinion) but then adding the new assertion that the “central point” of Frank is that “the arm’s length standard based on comparable transactions was not the sole basis” for reallocating costs and income under section 482. (As the dissent pointed out, a later Ninth Circuit decision limited the holding in Frank to the complex circumstances in that case and noted that the parties in Frank had stipulated to apply a standard other than the arm’s-length standard.)

Second, the majority made changes to add a series of new and more sweeping assertions that under section 482, Treasury has always had the leeway to dispense with comparable-transaction analyses in deriving the correct arm’s-length price. For instance, as a rejoinder to the taxpayer’s argument that the arm’s-length standard requires a comparable-transaction analysis, the majority wrote that “historically the definition of the arm’s length standard has been a more fluid one” and that “courts for more than half a century have held that a comparable transaction analysis was not the exclusive methodology to be employed under the statute.” It added similarly broad historical statements elsewhere in the new opinion, all in service of concluding that Treasury acted reasonably in dispensing with a comparable-transaction analysis in its cost-sharing regulations: “[a]s demonstrated by nearly a century of interpreting § 482 and its precursor, the arm’s length standard is not necessarily confined to one methodology” (p. 33); “the arm’s length standard has historically been understood as more fluid than Altera suggests” (p. 41); and “[g]iven the long history of the application of other methods…Treasury’s understanding of its power to use methodologies other than a pure transactional comparability analysis was reasonable” (p. 49).

In one of the subtler but more interesting changes from the withdrawn opinion, the majority’s new opinion removed a single word. In its withdrawn opinion, the majority said that Treasury’s 1988 White Paper “signaled a dramatic shift in the interpretation of the arm’s length standard” by advancing the “basic arm’s length return method…that would apply only in the absence of comparable transactions….” (emphasis added). But consistent with its conclusion in the new opinion that “for most of the twentieth century the arm’s length standard explicitly permitted the use of flexible methodology,” the majority appears to have concluded that shift in the White Paper was not so “dramatic,” dropping that word altogether in its new opinion. (In this vein, the majority also removed its assertion in the withdrawn opinion that “[t]he novelty of the 1968 regulations was their focus on comparability.”)

The new dissenting opinion disputed the majority’s historical account, stating that the first sentence of section 482 “has always been viewed as requiring an arm’s length standard” and that before the 1986 amendment, the Ninth Circuit “believed that an arm’s length standard based on comparable transactions was the sole basis for allocating costs and income under the statute in all but the narrow circumstances outlined in Frank.” And the dissent observed that even with the 1986 addition of the commensurate-with-income language, “Congress left the first sentence of § 482—the sentence that undisputedly incorporates the arm’s length standard—intact,” thus requiring a comparable-transaction analysis everywhere that comparable transactions can be found. The dissent pointed out that the White Paper clarified that this was true “even in the context of transfers or licenses of intangible property,” quoting Treasury’s own statement in the White Paper that in that context the “‘intangible income must be allocated on the basis of comparable transactions if comparables exist.’”

Briefing Complete in Kisor

The petitioner has now filed his reply brief in Kisor, and the case is fully briefed in preparation for the oral argument later this week on March 27.  Given the government’s partial retreat from defending Auer deference (see our prior post here), which the petitioner describes as a “sharp retreat,” the reply brief responds to two different briefs.  First, it responds directly to an amicus brief by a group of law professors (linked in our prior post) that put forth a full-throated defense of Auer deference.  Second, it acknowledges that the government’s “Auer-light” position is “preferable to existing Auer deference,” but it still rejects that position and argues that complete overruling of Auer is the correct approach.  The reply brief concludes that the existing principles of Skidmore deference satisfactorily address the policy goals described in the government’s brief without improperly permitting “an agency to exert its expertise in binding fashion without any participation by the regulated public.”

Kisor – Petitioner Reply Brief

 

Treasury and IRS Issue Joint Policy Statement on the Tax Regulatory Process

Earlier this week, the Treasury Department issued a policy statement on the tax regulatory process.  A significant section of the statement describes the approach that will be taken in Tax Court litigation to arguments based on judicial deference to regulations.  Treasury states that it will not claim Auer deference in such litigation to interpretations set forth in subregulatory guidance, such as revenue rulings, nor will it claim Chevron deference to such interpretations.  That apparent abandonment of Auer deference arguments goes beyond the position the Justice Department has taken in the Supreme Court in the Kisor case, where the government has argued for a significant narrowing of Auer but stops short of stating that it should be overruled.  See our reports on Kisor here.  Note that the Treasury Department statement by its terms applies only to Tax Court litigation, which is handled by the IRS, not to refund suits where the Justice Department handles the litigation.

The Treasury Department statement also addresses topics other than judicial deference, including: when to issue subregulatory guidance; legislative vs. interpretative regulations; and temporary regulations.  For a fuller analysis of the Treasury Department statement, please read this Miller & Chevalier Tax Alert.

Government Brief Filed in Kisor

The government was faced with something of a dilemma in filing its response brief in the Kisor case addressing the level of deference owed to an agency’s interpretation of its own regulation. See our prior reports here. On the one hand, the government was defending the agency action in this case and the decision below, which rested on paying Auer deference to the agency’s interpretation. On the other hand, conservative legal theorists have long been critical of Auer deference, following Justice Scalia’s lead, and the views of the political appointees in this administration about Auer likely range from unenthused to hostile. But on the third hand, the government’s institutional interests would generally be better served by a strong principle of Auer deference, since that would make challenges to agency action more difficult.

The government’s brief attempts to juggle these conflicting imperatives, and the result is a bit schizophrenic. The bottom line is that the government argues that Auer should not be overruled, but that its applicability should be substantially narrowed. In the end, the government does not rely on Auer to defend the agency action in this case, but instead argues that the regulation is clear on its face without the need to consider the agency interpretation at all.  (Although outgunned by the cascade of amicus briefs filed in support of the petitioner, two amicus briefs were filed on the government’s side, including one by a group of administrative law professors (linked below) who argue that Auer “is sound and should be maintained.”)

The first, and longest, section of the government’s brief is a full-fledged assault on the doctrine of Auer deference. The government contends that the doctrine: (1) is not well grounded historically; (2) is not supported by any consistent rationale; (3) is in tension with the APA’s distinction between interpretive and legislative rules; and (4) can have harmful practical consequences by discouraging agency resort to notice-and-comment rulemaking. Notably, the government states that the reasons that support Chevron deference do not apply to Auer, and thus the brief does not signal that the current administration will argue against Chevron deference in a future case.

The government argues, however, that Auer should not be overruled because of stare decisis considerations, including that doing so “would upset significant private reliance interests” because it allegedly “could call into question” earlier decisions that rested on Auer deference. In contrast to the opening part of its brief, this section praises Auer deference where it is limited to “its core applications,” such as “when the agency announces its interpretation in advance in a widely available guidance document.” The government states that the task of choosing among reasonable interpretations is more appropriately performed by administrators than by judges, that Auer deference would promote national uniformity, that it recognizes the technical expertise of agencies, and that it fosters regulatory certainty and predictability—in contrast to a system “in which the meaning of a regulation must be determined de novo in every judicial proceeding.” In addition, the government disagrees with the petitioner’s argument that Auer deference poses a separation-of-powers problem, stating that an agency’s actions in making rules and conducting adjudications are both exercises of “executive power.”

Accordingly, the government proposes “significant limits” on the doctrine that will thread the needle, neither overruling Auer nor further entrenching it. First, the government states that deference should not be paid to an agency interpretation that is “unreasonable,” describing this seemingly benign limitation as a “rigorous predicate.” If the agency interpretation is judged to be within the range of reasonable readings of the regulation, then the government argues that deference is appropriate “only if the interpretation was issued with fair notice to regulated parties; is not inconsistent with the agency’s prior views; rests on the agency’s expertise; and represents the agency’s considered view, as distinct from the views of mere field officials or other low-level employees.”

It is hard to say at this point what the Court will do with the various permutations that have been presented to it for moving forward, but it appears that Auer deference in its current form stands on very shaky ground.

Oral argument is scheduled for March 27.

Kisor – Government Response Brief

Kisor – Amicus Brief by Administrative Law Scholars in Support of Auer

Government Brief Filed in MassMutual

The government has filed its opening brief in MassMutual contesting the Court of Federal Claims’ conclusion that the taxpayer could accrue the amount of certain policyholder dividends in the year before they were paid.  See our prior post on this case and the New York Life case here.  The government’s brief raises three distinct objections to the decision.

The primary argument is that the liability to pay the dividends was not “fixed” under the all-events test.  The government contends that no individual obligation was fixed at the close of the year, even if all the premiums had been paid, because the dividend would not be paid unless the policy remained in force on the anniversary date.  This is the same argument that was accepted by the Second Circuit in New York Life, and the government’s brief here argues that the cases are indistinguishable (asserting that the Second Circuit’s effort to distinguish them was based on a misperception of the facts in MassMutual).

The brief argues that the case “clearly fits the General Dynamics fact pattern,” which it describes as one where the “potential obligee has taken some action that renders him preliminarily eligible to receive the payment, subject only to some other condition that is within his exclusive control” – here, “forgoing the right to surrender the policy for its cash value prior to the next anniversary date.”  It rejects the proposition argued by the taxpayer that this alleged final condition is not a genuine “event,” but rather just a continuation of the status quo.  The government points to a comment in the Restatement (Second) of Contracts stating that “a duty may be conditioned upon the failure of something to happen . . ., and in that case its failure to happen is the event” that constitutes a condition precedent.  And it rejects the contrary suggestion in Burnham Corp. v. Commissioner, 878 F.2d 86 (2d Cir. 1989), as misguided.  Finally, the brief argues that the taxpayer’s all-events-test interpretation proves too much because its logical implication is that the amount of the dividend could be accrued even if the company had not passed a board resolution in the taxable year guaranteeing an aggregate dividend – a position that the taxpayer has not argued.

Second, the government argues that the dividend guarantees did not even give rise to an obligation, fixed or otherwise, because they were not communicated to the persons who were to benefit from them.  Thus, the government argues, the taxpayer could have walked away from the guarantees at any time.  In addition, the government argues, the guarantees were not a meaningful “substantive undertaking” because, based on the historical data, the guaranteed payments were “already virtually certain to occur in the ordinary course of the companies’ business operations, independent of any ‘guarantee’ to that effect.”  There is some degree of irony in this argument; on its face, certainty that the amounts will be paid would appear to be an argument in favor of accrual, not against it.  But the certainty of which the government speaks refers to the aggregate amount of payment; it is not a concession with respect to an individual obligation being fixed.

Third, the government contests the Court of Federal Claims’ holding that the dividends fell within the “recurring item” exception.  The government’s primary point here is that this determination turns on the meaning of “rebate, refund, or similar payment” in Treas. Reg. § 1.461-4(g)(3), and therefore the court should have deferred to the IRS’s interpretation of that regulation – even if that interpretation did not conclusively emerge until this litigation and is at odds with some earlier internal guidance on the regulation’s meaning.  The general principle of so-called Auer or Seminole Rock deference to an agency’s interpretation of its own regulations has come under fire recently, with Justice Scalia stating that it should be abandoned and Chief Justice Roberts and Justice Alito indicating that they are at least open to reconsidering it.  See Decker v. Northwest Environmental Defense Center, No. 11-338 (Mar. 20, 2013).  So it will be interesting to see how the Federal Circuit responds to this argument, which presents a relatively weak case for deference because the claimed agency interpretation is just based on its litigation position.

The taxpayer’s brief is due April 4.

MassMutual – Gov’t Opening Brief

D.C. Circuit Holds in Loving that IRS Lacks Authority to Regulate Tax-Return Preparers

February 12, 2014 by  
Filed under Loving, Regulatory Deference

Yesterday, the D.C. Circuit unanimously held in Loving v. IRS, that the IRS lacks statutory authority to regulate tax-return preparers.  See our previous coverage here.  In its February 11 decision, the court characterized the IRS’s interpretation as “atextual and ahistorical,” and, more humorously, as a large elephant trying to emerge from a small mousehole.

In 2011, the IRS for the first time attempted to regulate tax-return preparers, issuing regulations requiring that paid tax-return preparers pass an initial certification, pay annual fees, and complete at least 15 hours of continuing education courses each year.  The IRS estimated that the regulations would apply to between 600,000 and 700,000 tax-return preparers.  Before 2011, the IRS had never taken the position that it had the authority to regulate tax-return preparers.  According to the D.C. Circuit panel (Kavanaugh, Sentelle, and Williams): “In light of the text, history, structure, and context of the statute, it becomes apparent that the IRS never before adopted its current interpretation for a reason:  It is incorrect.”

The IRS claimed that 31 U.S.C. § 330 provided statutory authority for the regulations.  That statute authorizes the IRS to “regulate the practice of representatives of persons before the Department of Treasury.”  31 U.S.C. § 330(a)(1).  The D.C. Circuit cited the familiar two-step Chevron standard of review:  (1) is the statute ambiguous, and (2) if so, is the agency’s interpretation reasonable.   The court of appeals concluded that the “IRS’s interpretation fails at Chevron step 1 because it is foreclosed by the statute,” and, in any event, “would also fail at Chevron step 2 because it is unreasonable in light of the statute’s text, history, structure, and context.”  The court of appeals cited six reasons foreclosing the IRS’s interpretation of the statute:

First, the D.C. Circuit concluded that the term “representative” generally is understood to refer to an agent with authority to bind others.  “Put simply, tax-return preparers are not agents.  They do not possess legal authority to act on the taxpayer’s behalf.”  Second, the preparation of a tax return does not constitute “practice . . . before the Department of the Treasury.”  “Practice before” an agency generally implies an investigation, adversarial hearing, or other adjudicative proceeding.  Moreover, a related section of the statute allows the Secretary of the Treasury to require that a representative admitted to practice before the agency demonstrate four qualities, one of which is “competency to advise and assist persons in presenting their cases.”  31 U.S.C. § 330(a)(2).   Filing a tax return is not understood in ordinary usage to be “presenting a case.”  Third, the original version of the statute, enacted in 1884, referred to “agents, attorneys, or other persons representing claimants before [the] Department.”  The court of appeals concluded that this original language clearly would not encompass tax return preparers.  When the statute was recodified in 1982, the phrase, “agents, attorneys, or other persons representing claimants” was simplified to “representatives of persons,” but the language change expressly was not intended to effect a substantive change.  Fourth, the IRS’s interpretation is inconsistent with the “broader statutory framework,” in which Congress has enacted a number of statutes specifically directed at tax-return preparers and imposing civil penalties.  Those statutes would not have been necessary, the court reasoned, if the IRS had authority to regulate tax-return prepares.  Fifth, if Congress had intended to confer such broad regulatory authority upon the IRS, allowing it to regulate “hundreds of thousands of individuals in the multi-billion dollar tax-preparation industry,” the statute would have been clearer.  Referring to the statutory language, the court of appeals concluded:  “we are confident that the enacting Congress did not intend to grow such a large elephant in such a small mousehole.”  Sixth, the court noted that the IRS in the past had made statements and issued guidance indicating that it did not believe it had authority to regulate tax-return preparers.  The court found it “rather telling that the IRS had never before maintained that it possessed this authority.”

The decision ends with the court of appeals noting that new legislation would be needed to allow the IRS to regulate tax-return preparers.

Given that the membership of the D.C. Circuit has recently expanded to include three additional judges, the government might believe that it is worthwhile to seek rehearing en banc before the full court.  A petition for rehearing would be due on March 28.  If the government does not seek rehearing, a petition for certiorari would be due on May 12.  Whether it pursues the litigation further or not, the government can be expected to seek new legislation that would give the IRS the regulatory authority that the court of appeals refused to find.

Loving – Court of Appeals Opinion

Government Faces Sharp Questioning from D.C. Circuit in Loving

The D.C. Circuit heard oral argument on September 24 in the government’s appeal in Loving from the district court decision enjoining the IRS from enforcing its new registration regime for paid tax return preparers.  The panel consisted of Judges Sentelle, Williams, and Kavanaugh.  The court was active, jumping in with questions in the first minute of the government’s opening presentation.  The court asked several questions of the plaintiffs’ counsel as well, but those questions seemed to evince less skepticism of the advocate’s position.  While it is always hazardous to predict the outcome based on the oral argument, the court of appeals certainly seemed to be leaning towards affirming the district court.

As we have previously discussed, the government’s position relies heavily on Chevron deference to its new tax return preparer regulations.  It argues that the statutory authority to regulate practice before Treasury is sufficiently broad to encompass tax return preparers — specifically, that the term “practice of representatives of persons before the Department of the Treasury” is ambiguous and could reasonably be construed by the regulations to include persons who prepare tax returns.  The relevant language is currently codified at 31 U.S.C. § 330(a)(1), but it dates back to 1884, when Congress responded to complaints about misconduct by claims agents who represented soldiers with claims for lost horses or other military-related compensation from the Treasury.

Just 30 seconds after the argument began, Judge Sentelle stepped in to challenge the premise of government counsel Gil Rothenberg that the Treasury regulations were valid because the statute did not “foreclose” them.  Judge Sentelle maintained that the question instead was whether the statute “empowered” Treasury to regulate in this area, and the case could not be analyzed by assuming that Treasury had unlimited power except to the extent that Congress had explicitly foreclosed it.  Shortly thereafter, Judge Williams questioned the government’s failure, in his view, to provide any support for the notion that the ordinary use of the statutory terms, like “representative” or “practice,” could encompass a tax return preparer who merely helps a taxpayer “fill out a form” that he is obliged to file with the IRS.  Mr. Rothenberg responded that, although there were no cases on point, return preparers do more than “fill out a form” and that the statutory term “representative” cannot be limited to an agency relationship because the term was intended to retain the same meaning as the original 1884 statute, which applied to “agents, attorneys, or other persons representing claimants.”

Judge Sentelle then suggested that the fact that Treasury had not claimed any authority to regulate tax return preparers until now, even though the statute had been on the books for more than a century, cast some doubt on the existence of that authority.  Judge Kavanaugh added that Congress’s enactment of legislation regulating tax return preparers during that period also suggested that Congress did not think that it had delegated that authority to the Treasury Department.  Mr. Rothenberg responded that the administrative process is an “evolving process,” and Treasury was free to “choose” not to regulate for many years and then later to invoke its latent authority to regulate.  Later, he added that the need to regulate the competence of tax return preparers is greater today than it was decades ago when taxpayers could more easily avail themselves of direct assistance from the IRS in filling out their return.  With respect to the legislation, Mr. Rothenberg distinguished laws that impose after-the-fact sanctions on return preparers from the Treasury initiative to impose up-front “admission” requirements.  Judge Sentelle questioned why the regulations are limited to paid return preparers, but do not cover persons who prepare tax returns for free.  Mr. Rothenberg responded that Treasury was tackling the problem one step at a time and reasonably believed that the biggest problem was with unqualified persons marketing their ability to prepare returns.

Judge Kavanaugh then zeroed in on the statutory text, pointing out that section 330 (a)(2)(D) states that Treasury “may . . . require” that “representatives” demonstrate their “competency to advise and assist persons in presenting their cases.”  That language indicates that Congress understood that the “representatives” who could be regulated were persons who would assist in “presenting cases,” not just filling out returns.  Mr. Rothenberg disagreed, arguing that Treasury was not compelled to impose all of the requirements set forth in subsection (a)(2) and that the other three requirements could apply to tax return preparers.  Judge Sentelle expressed some doubt whether that position was consistent with the statutory use of the conjunctive “and” in joining the four subsections of (a)(2).  Judge Williams then suggested that these were four different characteristics of representatives, but that the language of (a)(2)(D) in that case still bore some relevance to interpreting the term “representatives” in (a)(1).  Mr. Rothenberg again disagreed, stating that the discussion was now focused on what he believed to be the fundamental error of the district court — namely, treating all four characteristics of section (a)(2) as mandatory, because that would exclude otherwise able practitioners from representing taxpayers before Treasury simply because they lacked advocacy skills.  He also noted the position taken in the amicus brief of former IRS Commissioners that the “presenting a case” language could encompass preparing a tax return, but Judge Sentelle retorted that this would be an “awfully strange” use of the language.

Mr. Rothenberg then closed his argument by reiterating the government’s position that the district court erred in reading (a)(2) as limiting the language of (a)(1) and that (a)(1) itself did not foreclose Treasury from regulating tax return preparers.  Therefore, Chevron deference is owed to those regulations.

Counsel for the plaintiffs, Dan Alban, began his argument by maintaining that there was no statutory authorization for the regulation.  He described the statute as clearly focused on Treasury’s controversy and adjudicative functions, such as examination of returns and appeals before the agency, and not on what he described as “compliance” functions like filing a tax return.  He also pointed to the “presenting their cases” language in subsection (a)(2), stating that no “case” exists until there is a dispute over the taxpayer’s return.  Judge Williams asked about evidence that the scope of the original 1884 statute was limited to claims that were being resisted by the government — that is, controversies.  Mr. Alban replied that it was clear that the statute was addressing claims that the claimants chose to bring, rather than a mandatory function like filing a tax return.  In addition, he noted, the legislative history indicates that these were “contested” claims and that the representatives were standing in the shoes of the claimants.  Here, by contrast, tax return preparers are not “representatives” before the agency.  Judge Kavanaugh then asked who the preparers are representing.  Mr. Alban replied that they are not representatives of anyone; they are just performing a service in assisting preparation of the return, but the taxpayer himself has to sign it.  He noted in that connection that tax return preparers are not required to obtain a power of attorney, unlike taxpayer representatives in agency proceedings.

The court challenged Mr. Alban when he argued that the “level of policy decision” here warranted caution in allowing an agency, rather than Congress, to implement this new regulatory regime.  Judge Sentelle noted that counsel couldn’t get much “traction” with that argument when the D.C. Circuit frequently deals with “sweeping regulations” that create major changes in the regulatory landscape.  Judge Kavanaugh observed that, even if counsel was merely stating that the significance of the change ought to color the court’s approach to finding ambiguity, the suggestion was unworkable because it is hard for a court to decide what is “major.”

Finally, Judge Sentelle asked about the impact of the Supreme Court’s recent decision in City of Arlington holding that Chevron deference is owed to an agency’s determination of the scope of its jurisdiction.  Mr. Alban stated that the decision was not directly applicable, but in any case the Supreme Court had made clear in that case the importance of seriously applying the limitations on Chevron deference.  Here, because the statute was not ambiguous, Mr. Alban stated, the government’s position fails at Chevron Step 1, and therefore no deference is owed.  Putting aside the discussion of broader administrative law principles, it was not apparent that any of the judges on the panel disagreed with the plaintiffs on that basic point regarding section 330(a).

Mr. Rothenberg began his rebuttal with a general discussion of Chevron principles, stating that all the prior cases in which the D.C. Circuit had invalidated regulations at Chevron Step 1 were situations where the agency action was more clearly foreclosed by a specific Congressional determination found in the statutory text, but he was met with considerable resistance.  The judges observed that his list did not appear to be “exhaustive.”  In particular, Judge Sentelle suggested that this case was perhaps analogous to the American Bar Ass’n case, which he described as invalidating FTC regulations directed at the legal profession on the ground that Congress had not empowered the FTC to regulate that profession.  When Mr. Rothenberg answered in part that Chevron Step 1 sets a “low bar,” Judge Kavanaugh disagreed, stating that a court is to use all the tools of interpretation at Step 1 and that City of Arlington did not reflect a “low bar.”

Finally, Judge Kavanaugh asked Mr. Rothenberg to respond to Mr. Alban’s point that the IRS does not require tax return preparers to obtain a power of attorney.  He replied that the power of attorney is required for “agents,” and tax return preparers are not agents.  Mr. Rothenberg then repeated the point made in his opening remarks that the original 1884 statute covered “agents,” but other persons as well.  Judge Williams interjected that the government appeared to be placing too much weight on the statutory reference to “other persons,” because canons of statutory construction provide that the scope of broad language like that is limited by the specific terms that precede it — here, “agents” and “attorneys.”  Mr. Rothenberg noted that he disagreed, but his time expired before he could elaborate.

The case was heard on an expedited schedule, and therefore it is reasonable to expect that a decision will issue in the next couple of months.

Attached below is the plaintiffs’ response brief and the government’s reply brief, which were not previously posted on the blog.  The government’s opening brief and two amicus briefs in support of the government were previously posted here and here.

Loving – Plaintiffs’ Response Brief

Loving – Government Reply Brief

 

 

Two Amicus Briefs Filed in Loving, Including One by a Group of Former IRS Commissioners

[Note:  Miller & Chevalier member and former Commissioner of Internal Revenue Lawrence B. Gibbs is among the five former Commissioners who filed an amicus brief in support of the Government in the Loving appeal.]

Five former IRS Commissioners filed an amicus brief in support of the Government’s appeal of the district court decision invalidating the IRS’s registration regime for paid tax return preparers.  The former Commissioners “take no position regarding whether the manner in which the Treasury has chosen to regulate tax return preparers is advisable, but they strongly disagree with the District Court’s view that Congress has not empowered Treasury to do so.”  Under 31 U.S.C. § 330, the Treasury Department is authorized to “regulate the practice of representatives of persons before the Department of Treasury.”  The district court held that, although the statute did not define “the practice of representatives,” the surrounding statutory text made clear that Congress used “practice” to refer to “advising and assisting persons in presenting their case,” not simply preparing returns.  In their amicus brief, the former Commissioners argue that filing a tax return does, in fact, constitute presenting a case.  The amicus brief explains that an increasingly wide variety of government assistance programs are administered through the federal income tax system, including a number of refundable tax credits (the earned income credit, health insurance cost credit, etc.).  Accordingly, the tax return preparer is not simply calculating tax liability; he or she also is often representing the taxpayer in pursuing claims for federal assistance.  Because disbursements of benefits under these government assistance programs is administered largely through self-reporting on a tax return, it is essential, the former Commissioners argue, that paid tax return preparers be regulated so that taxpayers can identify the credits and benefits to which they are entitled and so that both the government and taxpayers are protected against fraud.

The National Consumer Law Center and National Community Tax Coalition also filed a joint amicus brief arguing for reversal of the district court’s decision.  That brief documents “rampant” fraud and incompetence in the paid preparation industry, especially on the part of fringe return preparers, such as payday loan stores.

Loving – Former Commissioners’ Amicus Brief

Loving- NCLC/NCTC Amicus Brief

 

 

 

Reply Brief Filed on Stay Motion in Loving

Yesterday, in Loving v. IRS (the subject of a recent post), the Government filed its reply brief in support of its motion to stay the district court’s injunction of the new registration regime for paid tax-return preparers.  With respect to its likelihood of success on the merits, the Government argued the ambiguity of the statute authorizing Treasury to “regulate the practice of representatives of persons before” it.   With respect to the threat of irreparable harm, the Government argued that the injunction risked delaying the implementation of the regulatory regime until the 2015 return-preparation season and that the problem of unregulated return preparers represents a “major public concern.”

Loving – USG Reply Brief re Motion for Stay

Government Seeks Appellate Stay of Order Enjoining Enforcement of New Registration Regime for Paid Tax Return Preparers

The Government has appealed to the D.C. Circuit from the district court decision enjoining the IRS from enforcing its new registration regime for paid tax return preparers.  Loving v. IRS, D.C. Cir. No. 13-5061.  The Government has also asked the court of appeals to stay the decision pending appeal, after the district court declined to grant a stay.  The Government’s stay motion recites that, the appeal has not yet been authorized by the Solicitor General’s office, but that, if the appeal is authorized, the Government intends to file its opening brief in March and to move for an expedited oral argument.

To recap the district court’s decision:  In 2011, the Treasury Department promulgated regulations that extended Circular 230 (the regulations that govern practice before the IRS) to non-attorney, non-CPA tax-return preparers who prepare and file tax returns for compensation.  Under the new regulations, tax-return preparers must register before they can practice before the IRS, and they are deemed to practice before the IRS even if their only function is to prepare and submit tax returns.  In order to register initially, tax return preparers must pass a qualification exam and pay a fee.  To maintain their registration each year, they must pay a fee and take at least fifteen hours of continuing education courses.  The IRS estimated that the new regulation sweeps in 600,000 to 700,000 new tax return preparers who were previously unregulated at the federal level.

Three tax return preparers who were not previously regulated by Circular 230 brought suit challenging the 2011 regulations and seeking declaratory and injunctive relief.  In January 2013, the U.S. District Court for the District of Columbia (Boasberg, J.) granted the plaintiffs’ motion for summary judgment.  The court recognized that, under Mayo Foundation, the two-step analysis of Chevron should be applied to determine the validity of the regulations.  The court explained, however, that “the battle here will be fought and won on Chevron step one” because “Plaintiffs offer no independent argument for why, if the statute is ambiguous, the IRS’s interpretation would be ‘arbitrary or capricious . . .’ under Chevron step two.” Focusing in this way on the unambiguous statutory text, the court held that the Treasury Department lacked statutory authority to issue the regulations.

The court rejected the Government’s argument that the agency had inherent authority to regulate those who practice before it, because a statute (31 U.S.C. § 330) specifically defined the scope of the Treasury Department’s authority.  Under that statute, the Treasury Department is authorized to “regulate the practice of representatives of persons before the Department of Treasury.”  The district court held that, although the statute did not define “the practice of representatives,” the surrounding statutory text made clear that Congress used “practice” to refer to “advising and assisting persons in presenting their case,” not simply preparing returns.  Turning to provisions in the Internal Revenue Code that regulate tax return preparers, the court reasoned that Congress could not have intended § 330 to be the authority for regulating tax return preparers because “statutes scattered across Title 26 of the U.S. Code create a careful, regimented schedule of penalties for misdeeds by tax-return preparers.”  The court rejected the Government’s resort to policy arguments.  “In the land of statutory interpretation, statutory text is king.”  Holding that the new regulations were ultra vires, the court enjoined the IRS from enforcing the registration regime.

In the motion for a stay pending appeal filed with the district court, the Government argued that the injunction substantially disrupted the IRS’s tax administration and that shutting down the program would be costly and complex. The district court was not persuaded, concluding that “[t]hese harms, to the extent they exist are hardly irreparable, and some cannot even be traced to the injunction.”

The Government’s stay motion in the court of appeals, filed February 25, argues that “[f]ailure to grant the stay will work a substantial and irreparable harm to the Government and the taxpaying public, crippling the Government’s efforts to ensure that individuals who prepare tax returns for others are both competent and ethical.”  According to the Government’s brief, the “IRS estimates that fraud, abuse, and errors cost the taxpaying public billions of dollars annually.”  In their March 8 response, the Plaintiffs/Appellees argue that the Government failed to establish any imminent irreparable harm traceable to the injunction, noting that even the Government acknowledged that most of the alleged harms would not occur until 2014.  The tax return preparers also emphasize that the injunction merely preserves the historical status quo.

Loving – District Court Opinion Granting Injunction

Loving – District Court order denying stay and modifying injunction

Loving – Government Motion for Stay

Loving – Appellees’ Response to Motion for Stay

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