Canada: U.S. Supreme Court Overrules Long-Standing Rule on Review of Tax Regulations

The U.S. Supreme Court ruled recently that Treasury Regulations should be reviewed under the same standard that applies to non-tax regulations and not a stricter multiple-factor test long thought to apply. As a result of this decision taxpayers will face far greater difficulty successfully challenging a Treasury Regulation in court. In particular, the decision eliminates the relevance of the history and context of the promulgation of the regulation and instead focuses solely on its reasonableness.

In Mayo Foundation for Medical Education and Research v. United States,1 the U.S. Supreme Court considered the validity of Treasury Regulation § 31.3121(b)(10)-2(d)(3), an employment tax regulation known as the "full-time employee rule". The full-time employee rule provides that a statutory exemption for employment taxes applicable to services performed in the employ of a school, college, university, or similar organization "by a student who is enrolled and regularly attending classes at such school, college, or university" does not apply to full-time employees and that students whose normal work schedule is 40 hours or more per week are full-time employees. Treasury enacted this regulation in the face of more than 7,000 refund claims for employment taxes paid on medical resident wages following a 1998 decision by the Court of Appeals for the Eighth Circuit, which held that medical residents could not be categorically excluded from student status under the Social Security Act.2 Mayo sued for a refund of employment taxes paid on services of its medical residents and challenged the full-time employee rule as an invalid exercise of Treasury's authority.

The District Court ruled in favor of Mayo and held that Treasury Regulation § 31.3121(b)(10)-2(d)(3) was invalid because it was inconsistent with the unambiguous text of the statute. The District Court also analyzed the validity of the regulation under a factor test set forth in National Muffler Dealers Assn., Inc., v. U.S.3 Under National Muffler, a Treasury Regulation is evaluated by considering the length of time between the enactment of the statute and the promulgation of the Treasury Regulation, the length of time the Treasury Regulation has been in place, reliance placed on the Treasury Regulation by taxpayers, and other factors.

The Court of Appeals reversed, applying the test set forth in Chevron U.S.A. Inc. v. Natural Resource Defense Council, Inc., which courts have used to determine the validity of non-tax regulations.4 Under the Chevron test, if Congress has not unambiguously addressed the question at issue, deference is given to an administrative agency's interpretation of a statute as long as that interpretation is reasonable.

The Supreme Court applied the first step of the Chevron framework and determined that Congress had not directly addressed the precise question at issue, i.e., whether employees working full-time could qualify for the student exemption. Finding that the term "student" used in the statute was ambiguous, the Court then applied the second step in the Chevron test -- determining whether the Treasury Regulation was a reasonable interpretation of the text -- and found that the regulation was reasonable.

Importantly, the Supreme Court explicitly rejected application of the National Muffler standard. In addressing why it applied Chevron deference instead of the National Muffler multi-factor test, the Court held that the Chevron test was applicable whenever Congress appeared to have delegated authority to an agency to make rules carrying the force of law, whether that delegation of authority was explicit of under a general grant of authority such as § 7805(a) of the Internal Revenue Code, which allows Treasury to "prescribe all needful rules and regulations for enforcement" of the Code. The Court found that "the administrative landscape has changed significantly" since it decided National Muffler and that Congress would have intended the general grant of authority under § 7805(a) to permit Treasury to issue gap-filling regulations such as the full-time employee rule.


1.No. 09-837 (Jan. 11, 2011).

2.Minnesota v. Apfel, 151 F.3d 742 (8th Cir. 1998); 42 U.S.C. § 410(a)(10). The Social Security Administration attempted to exclude medical residents from a student exemption in the Social Security Act by issuing Social Security Ruling 78-3. The Court of Appeals held that the ruling was not entitled to deference and was erroneous because it was inconsistent with the Social Security Administration regulations at 20 C.F.R. § 404.1028(c), which contemplate a case-by-case examination to determine if an individual's relationship with a school is primarily for educational purposes or primarily to earn a living.

3.440 U.S. 472 (1979).

4.467 U.S. 837 (1984).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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