Blaine Saito writes that the end to the Chevron deference doctrine could lead to a return to the National Muffler standard that grants judicial deference to long-standing agency rules and rules promulgated contemporaneously with Congressional statute. This may mean that the courts overturn newer taxation rules, though the Internal Revenue Code provides explicit discretionary rulemaking power to the Treasury and Internal Revenue Service, which should further limit Loper Bright’s impact on the agency.
This article is part of a series that explores how Loper Bright and the end to the Chevron deference doctrine will impact the ability of the federal agencies to regulate the economy. You can read the other articles in the series already published here.
The recent Supreme Court decision in Loper Bright Enterprises v. Raimondo, overruled the long-standing precedent in administrative law of Chevron v. NRDC (1984). The effect on the Internal Revenue Service and taxation is uncertain. But there are some key matters that are worth watching as we see the Department of the Treasury, which oversees the IRS, and the courts muddle through this new regime.
A bit of background is worthwhile. Chevron provided a two-step test for reviewing whether a court should support or overturn an agency’s regulation that interpreted a Congressional statute. First, a court would look to see if the language of the statute was clear. If so, and if the regulation ran afoul, it was struck. But if the language was ambiguous, courts would proceed to a second step and see if the agency’s interpretation was reasonable. If so, the regulation survived. An agency could even change its interpretation of the ambiguous statute in a future regulation so long as the latter promulgated interpretation fell within a zone of reasonableness.
Loper Bright rejected this approach. Chief Justice John Roberts, writing for the Court, said that all questions of law, which includes statutory interpretation, are the sole province of the judiciary. The Court relied on both the structure of the Constitution’s separation of powers and on the language of the Administrative Procedure Act that said courts are to decide all questions of law. Of particular concern to the Court was a sense that agencies could change regulations too easily under Chevron, whipsawing regulated parties.
But the Court did not really give clarity as to what standard of review would replace the Chevron deference doctrine to guide judicial review in the future. At times, the Court seemingly approved of a de novo standard, meaning that courts have a free hand and give no deference to an agency’s interpretation. At other points, the Court seemingly supported so-called Skidmore deference, which is based on the persuasive power of the agency’s reasoning and its expertise. What exactly is the standard has caused some debate.
Furthermore, the Court also said that “Congress may [confer discretionary authority on agencies], subject to constitutional limits.” That may mean that if Congress explicitly and clearly confers discretionary authority to an agency in a statute, then the agency may have a freer hand in developing regulations. With such an explicit delegation of authority the standard reviewing regulations may not be de novo.
There are three strands that one can draw from these observations as they apply to the Treasury Department and thus the IRS. First, under Section 7805(a) of the Internal Revenue Code, the Treasury has an explicit and clear statutory delegation of authority to promulgate “all needful rules and regulations for the enforcement of this title.” The language serves as an explicit grant of authority to provide regulations that Chief Justice Roberts mentions in the opinion. It should, thus, cut against a pure de novo standard of review for tax regulations.
Second, certain provisions of the Code actually have what are called specific grants of authority to issue regulations. For example, the Code provides that certain commonly owned corporations can file a return on a consolidated basis. I.R.C. Section 1502 says, “[t]he Secretary shall prescribe such regulations as he may deem necessary.” Indeed, the law around consolidated returns is mostly regulatory. Under standard views of statutory interpretation, language cannot be superfluous. Thus, when a specific provision provides a grant of authority to the Treasury, it should have greater deference and a freer hand than what is available under I.R.C. Section 7805(a) alone to avoid that superfluous language issue.
Third, the demise of Chevron may revive the old National Muffler (1979) test for the validity of tax regulations. The National Muffler standard fell to the wayside in the 2011 decision in Mayo Foundation for Medical Education and Research v. United States. Roberts, who also authored this opinion, endorsed Chevron as the standard for regulations that clarify ambiguous statutes, stating that tax is no different from other areas of the law.
Under the National Muffler test, which was developed based on the general grant of authority in I.R.C. Section 7805(a), a court first looks to the language of the statute to see if the regulation fits with the language. If it is not clear, courts grant greater deference to regulations contemporaneously promulgated with the statute’s enactment, as there is a presumption of understanding Congressional intent. If a regulation is not contemporaneously promulgated, the courts will look to how the regulation evolved, as well as “the length of time the regulation has been in effect, the reliance placed on it, the consistency of the [IRS’s] interpretation, and the degree of scrutiny Congress has devoted to the regulation during subsequent re-enactments of the statute.” Thus, National Muffler gives greater deference to contemporaneously promulgated regulations and long-standing regulations upon which taxpayers have relied.
National Muffler actually speaks to the same concerns the Court expressed in Loper Bright regarding regulatory whipsaws. Any changes to longstanding regulations or those that the Treasury promulgated contemporaneously with a statute’s passage would thus get extra scrutiny from the courts. To overcome such a situation, the Treasury would need strong reasons why it made these changes. Indeed, while National Muffler was a tax case, Dan Deacon has argued that after Loper Bright other areas of administrative law may take a similar approach. Readopting a National Muffler type standard need not lead to some tax exceptionalism.
These three points work together to create the following predictions. Pure de novo review is unlikely. I.R.C. Section 7805(a) is a clear grant of authority to the Treasury. Additionally, the National Muffler test looks ripe for renewal. Absent a change to the statute, for provisions that rely on the general grant of authority, any changes to regulation that the Treasury contemporaneously promulgated with the enactment or modification of a particular provision of the Code, or that has existed from a long time, would be difficult. The agency would need to have strong reasons for their changes, in line with the ideas outlined in Skidmore deference.
If there is a specific statutory command in a particular provision that delegates authority, then the IRS and Treasury should have a freer hand in issuing regulations. It should likely get some level of deference and there would be less scrutiny of changes to older regulations or those contemporaneous with promulgation.
One useful area to serve as a thought experiment for how the courts may apply these standards to the IRS is transfer pricing, which is the accounting method for valuing the price of a service one part of a commonly controlled company (e.g. a subsidiary) charges another. How a company calculates transfer pricing has implications for the taxes it pays. Section 482 is a short paragraph, and most of the law in the area comes from regulations that fill in the statutory gaps of what “clearly reflects” the income of different entities under common ownership and control. If one reads section 482 to have an explicit grant of authority to interpret the language, then the Treasury has greater leeway to adjust their regulations. But if not, if Treasury tried to move away from the long existing arm’s-length standard in the regulations which looks to see if the transactions between commonly controlled entities is similar to what would happen between parties acting at arm’s length, to a formulary apportionment method, which requires apportioning incomes between commonly controlled entities based on a formula like sales and employee head-count, that may get overturned on substance. That is because the old arm’s length standard has a great deal of reliance interests, and has mostly existed since the enactment and reenactment of section 482.
Overall, courts will likely overturn more tax regulations, but it may not be a free-for-all. Additionally, one practical consideration bears mentioning. While there are often hot button issues involved in tax regulations, contested issues tend to have a level of detail and complexity. Most of the judges who will hear challenges to tax regulations, including at the important appellate level, are generalist judges. As a practical matter, these judges who have to keep their dockets flowing may functionally defer to the IRS and Treasury in some of these tax cases to get them off the docket. That said, if there seems to be some political tensions behind certain issues and the level of technicality is lower, the courts may be more likely to intervene.
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