CSG Law Alert: Tax Practice and Treasury Regulations in a Post-Chevron World
This past June, the U.S. Supreme Court released a consequential opinion in Loper Bright Enterprises v. Raimondo, 603 U.S. ___ ) 2024 (“Loper”), overruling Chevron U.S.A. Inc. v. Natural Resources Defense Council. Inc., 467 U.S. 837 (1984) (“Chevron”), the most frequently cited administrative law case in the history of the Supreme Court. This decision effectively puts an end to a 40-year period of courts granting broad deference (i.e., “Chevron Deference”) to agencies interpreting ambiguous statutes in their rule-making processes. Under Loper, courts will have a greater say in determining whether a given agency action is within the scope of its statutory authority and have the power to strike down regulations they deem inconsistent with congressional intent. While this holding is expected to have a significant regulatory impact on many areas of the law, it could be particularly relevant in the world of tax law, where so much of the practice relies on Internal Revenue Service (“IRS”) regulations and guidance. This article examines the pre-Chevron regulatory landscape, the era of Chevron Deference, and how the tax practice may be affected by the Loper decision.
The Skidmore Era
Prior to Chevron, administrative agencies (including the IRS) were given limited deference in interpreting ambiguous statutes which they claimed granted them authority to create rules in their respective sectors. Indeed, in Skidmore v. Swift & Co., 323 U.S. 134 (1944) (“Skidmore”), the Supreme Court held that it was the court’s responsibility, rather than an agency’s, to determine the best reading of a statute. In doing so, the Court established a standard whereby courts would evaluate whether an agency’s statutory interpretation was persuasive to this effect, based on 1) the thoroughness of the agency’s investigation into the relevant issue or industry being regulated, 2) the validity of the agency’s reasoning in its rule-making process, and 3) the consistency of the agency’s statutory interpretation with its previous guidance. In the tax realm, this standard granted courts significant power to strike down IRS regulations when they were challenged by taxpayers. While the Skidmore standard has continuously been applied by courts evaluating sub-regulatory IRS guidance (e.g., Revenue Rulings), the standard applied to treasury regulations changed dramatically in 1984.
The Chevron Era
The Skidmore regulatory landscape was overhauled by the Chevron decision in 1984, when the Supreme Court shifted interpretative authority from the courts to the rulemaking agencies themselves. Under Chevron, it became the agency’s role, not the courts’, to determine Congress’ intent in its delegation of rulemaking authority. The role of the Court was limited to determining only whether the agency’s interpretation was reasonable. The Chevron standard, while not explicitly applied to treasury regulations until the 2011 Supreme Court decision in Mayo Foundation v. U.S., 562 U.S. 44 (2011), emboldened the IRS to take a much more active role in dictating tax policy and promulgating tax regulations over the past three decades. With the Supreme Court’s decision in Loper, this dynamic is expected to change dramatically.
The Loper Decision
In Loper, the Supreme Court explicitly overruled Chevron, reestablishing the courts’ role as the ultimate authority to decide “all relevant questions of law” when evaluating an agency’s interpretation of ambiguous statutes. The Supreme Court signaled that, going forward, courts should revert to applying the less deferential Skidmore standard (described above), with an added emphasis on the consistency factor, as well as a new focus on whether a challenged regulation was passed contemporaneously with the enactment of the authority-granting statutes (i.e., regulations passed years after the statute was enacted are less likely to be upheld). While the Court specifically proscribed the retroactive application of Loper to regulations that had been previously challenged and upheld under Chevron, old regulations that have yet to be tested may still be ripe for challenge.
Life After Chevron
The Loper decision will likely lead to an influx of litigation, with challenges to new government-friendly regulations promulgated by the IRS. It will also open the door for challenges to previously enacted treasury regulations that were issued pursuant to ambiguous statutes and have thus far gone untested.
One set of regulations that could be particularly susceptible to challenge are the Substantial Economic Effect (“SEE”) regulations—passed pursuant to code Section 704(b)—which govern the allocation of items of income and loss among partners in a partnership. The SEE regulations are some of the most complex ever promulgated under the Internal Revenue Code and have been a point of contention between the IRS and taxpayers for decades. The SEE regulations are particularly ripe for challenge in the post-Chevron era for four primary reasons:
- Section 704(b) is ambiguous as to the definition of SEE, stating only that the allocation methodology laid out in a partnership will be disregarded if it “does not have substantial economic effect.”.
- Section 704(b) is silent with respect to rule-making authority (unlike section 704(c), which explicitly delegated authority to the IRS to issue regulations concerning the contribution of property to partnerships).
- The 704(b) regulations conflict with the Loper standard, which highlights the importance of regulations be issued contemporaneously with its corresponding statute (Section 704(b) was amended in 1976 to codify the phrase “substantial economic effect,” while the regulations were not promulgated until 1985).
- The regulations have not been challenged on the grounds that the IRS exceeded the scope of its authority and are therefore vulnerable to challenge under Loper.
For these reasons, there is a real possibility that the SEE regulations could be successfully challenged in the future. In the meantime, tax practitioners may try to get a head start on this litigation by implementing more aggressive tax planning strategies when drafting partnership or operating agreements.
The SEE rules are just one example of the kind of regulations that may be vulnerable in a post-Chevron world. There are several other, more recently promulgated regulations that are also expected to face scrutiny. These include the proposed estate and gift tax regulations limiting the benefits of the anti-claw back rules, or the proposed rules under Section 401(a) concerning after-death IRA payouts. Some regulations, such as the partnership anti-abuse rules of Treas. Reg. § 1.701-2, are already being litigated and are expected to hinge on the new Loper standard.
Going forward, in order to preempt future challenges, the IRS is likely to be more cautious when promulgating new regulations. To this end, the IRS may be more responsive to taxpayers during the notice-and-comment phase of the rule-making process. In such cases, it will be important for tax practitioners and industry leaders to track rule proposals and to advocate on behalf of taxpayers.
Conclusion
The Loper decision marks the beginning of what will likely be a sweeping change in the regulatory landscape, as well as in the tax practice. It will be important for tax practitioners to track the progress of post-Loper litigation and IRS rulemaking, as there should be several new tax planning opportunities arising from the commotion.