In Mayo Found. for Med. Educ. & Rsch. v. United States, 131 S.Ct. 704 (2011), the Supreme Court of the United States made clear that administrative law rules apply to tax guidance like they do to other federal agency guidance. Since Mayo, the Supreme Court and other courts have provided further guidance—both in the tax and non-tax contexts—regarding the proper analysis in determining the validity of, and deference to, regulatory guidance.
Over the past decade, the number of taxpayer challenges to guidance issued by the Internal Revenue Service (IRS), whether in the form of regulations or subregulatory guidance (i.e., revenue rulings, revenue procedures, notices and announcements), has increased significantly. These challenges have taken a variety of forms, such as regulatory invalidity under Chevron USA, Inc. v. NRDC, 467 U.S. 837 (1984) and procedural invalidity under the Administrative Procedure Act (APA). Some successful challenges to the validity of IRS guidance and the ability to challenge such guidance in a pre-enforcement context include CIC Servs., LLC v. IRS, 141 S.Ct. 1582 (2021); United States v. Home Concrete & Supply, LLC, 132 S.Ct. 1836 (2012); Mann Construction, Inc. v. Commissioner, 27 F. 4th 1138 (6th Cir. 2022); Good Fortune Shipping SA v. Commissioner, 897 F.3d 256 (2018) and Liberty Global, Inc. v. United States, No. 1:20-cv-03501-RBJ (D. Colo. 2022). Many other challenges are pending both at the administrative level and in court.
The IRS and the US Department of the Treasury (Treasury) have noticed the increase in challenges to its published guidance. One important change is the more detailed discussions in preambles to final regulations regarding comments received and how the IRS views and incorporates said comments. This is a welcome development, although sometimes a tortuous one for taxpayers who must wade through hundreds of pages of preambles in some regulation packages. Another change, and the subject of this post, is the IRS's views on how to deal with such challenges during the administrative process.
A federal tax controversy can involve three levels of review: Examination, Appeals and litigation. At the Examination stage, revenue agents and other IRS personnel develop the facts and determine whether an adjustment is warranted. Importantly, "hazards of litigation" are not considered at the Examination level, meaning, issues are viewed as binary—in favor of the IRS or the taxpayer—and not negotiated as a percentage of the item. However, at the Appeals level, the Appeals team weighs "hazards of litigation" to determine whether a case can be settled by the parties. Hazards of litigation are also considered at the litigation level.
Validly promulgated tax regulations are approved at the highest levels of the IRS, Treasury generally carry the force and effect of law and are binding on taxpayers and the IRS. Subregulatory guidance is also approved at senior levels of the IRS and the Treasury. At the Examination level, the IRS will not entertain challenges to the validity of regulations or the procedural validity of subregulatory guidance. This makes administrative sense, given that hazards of litigation are not considered at the Examination level.
However, at the Appeals level, hazards of litigation are required to be considered. Thus, historically, taxpayers could at least raise validity challenges to published IRS guidance and have those challenges be heard and considered. Although it is difficult to convince an IRS Appeals Officer to offer a settlement based on such challenges, it has always been possible (and in our experience, has sometimes resulted in settlement by the parties). This possibility no longer exists.
On September 13, 2022, the IRS and the Treasury published proposed regulations in the Federal Register regarding the resolution of federal tax controversies at the Appeals level. The purpose of the proposed regulations is to reflect on amendments made by additions to Internal Revenue Code Section 7803 in the Taxpayer First Act of 2019 (TFA). We previously discussed some of the changes to IRS procedures and options by the TFA, focusing on changes to the IRS Independent Office of Appeals (IRS Appeals) process.
The TFA established the new IRS Appeals and provided that the right of appeal is "generally available to all taxpayers." The modified "generally" has been understood by many to mean that appeals may not be available where taxpayers who advance frivolous positions or refuse to extend the statute of limitations to allow for review by IRS Appeals or for matters where the IRS has designated the issue for litigation. The recently proposed regulations provide 24 specific exceptions (listed at the end of this post) to IRS Appeals consideration and invite comments on the proposed exceptions, as well as whether any additional exceptions are warranted.
Two of the exceptions concern challenges to validity of regulations and challenges alleging that a notice or revenue procedure is procedurally invalid. Unless there is an unreviewable decision from a federal court invalidating the regulation or subregulatory guidance at issue, IRS Appeals will not consider the challenge. (The proposed regulatory text for these two exceptions is provided at the end of this post.)
The proposed regulations contain other notable provisions. For example, Proposed Treasury Regulation § 301.7803-2(g)(2) provides that IRS Appeals and IRS Chief Counsel may coordinate on settlement authority before a docketed US Tax Court case is transferred to IRS Appeals. Further, the preamble to the proposed regulations envisions that IRS Chief Counsel may delay forwarding a case to IRS Appeals or may request the return of case from IRS Appeals before IRS Appeals has completed its consideration of a case.
The portion of the proposed regulations discussed above are to apply to requests for consideration by IRS Appeals made 30 days after the regulations are finalized. Comments on the proposed regulations are due within 60 days of the date of publication of the proposed regulations.
Despite the applicability date of 30 days after finalization, immediately following the publication of the proposed regulations, the IRS issued an internal memorandum to all IRS Appeals employees that essentially finalizes the proposed regulations with respect to the exceptions for challenges to IRS guidance (Appeals Memorandum). The Appeals Memorandum states that IRS Appeals "will not apply litigating hazards to arguments raised by a taxpayer regarding the validity of Treasury regulations or procedural validity of IRB notices or revenue procedures" unless "there is an unreviewable decision from a federal court hold the regulation, IRB notice, or revenue procedure invalid." The guidance is effective for all pending and future IRS Appeals cases and will be incorporated into Internal Revenue Manual 8.1.1. The Appeals Memorandum raises interesting issues given that the proposed regulations were just issued and are in the notice-and-comment rulemaking process, which is a requirement before any final regulations can be valid under the APA. Thus, the Appeals Memorandum could be viewed as an end-run around the APA's requirements given that it is effective immediately.
Practice Point: Many viewed the TFA as reflecting US Congress' intent to provide more access to IRS Appeals. However, that does not appear to be the case in the IRS's view. Taxpayers who have challenged or intend to challenge the validity of regulations or the procedural validity of subregulatory guidance should prepare for a long fight if their tax returns are selected for examination and the issue is identified. The IRS, through its proposed regulations and the Appeals Memorandum, prevents taxpayers from seeking resolution of a validity challenge at IRS Appeals, leaving litigation as the only recourse for resolution of such a challenge. It also seeks to allow more involvement by IRS Chief Counsel attorneys in docketed cases where taxpayers had not previously participated in the IRS Appeals process, which could lead to less potential for settlement of docketed cases than in the past. Interested taxpayers should consider submitting comments to the proposed regulations.
Exceptions to Appeals Consideration:
- Frivolous Positions
- Penalties Related to Frivolous Positions and False Information
- Whistleblower Awards
- Administrative Determinations Made by Other Agencies
- Taxpayer Assistance Orders
- Materials to Be Deleted from a Written Determination
- Denials of Access Under the Privacy Act
- Issues Settled by a Closing Agreement
- The IRS Erroneously Returns or Rejects an OIC
- Branded Prescription Drug Fee and Health Insurance Providers Fee
- IRS Automated Process of Certifying a Seriously Delinquent Tax Debt
- IRS's Automated Process of Certifying a Seriously Delinquent Tax Debt
- Issues Barred from Consideration in CDP Cases
- Authority Over the Matter Rests with Another Office
- Certain Technical Advice Memoranda
- Technical Advice from an Associate Office in a Docketed Case
- Letter Rulings Issued by an Associate Office
- Challenges Alleging that a Statute is Unconstitutional
- Challenges Alleging that a Treasury Regulation is Invalid
- Challenges Alleging that a Notice or Revenue Procedure is Invalid
- Case or Issue Designated for Litigation or Withheld from Appeals
- Appeals Issued the Determination that is the Basis of the Tax Court's Jurisdiction
- Appeals Consideration is a Prerequisite to the Jurisdiction of the Tax Court
- An Administrative Determination to Deny or Revoke a CPEO Certification
Proposed Treasury Regulation § 301.7803-2(c)
Exceptions to consideration by IRS Appeals. The following are federal tax controversies that are exempt from consideration by IRS Appeals or matters or issues that are otherwise ineligible for consideration by IRS Appeals because they are neither a federal tax controversy nor treated as a federal tax controversy under paragraph (b)(3) of this section. If a matter not eligible for consideration by IRS Appeals is present in a case that otherwise is eligible for consideration by IRS Appeals, the ineligible matters or issues will not be considered during resolution of the case. The exceptions are:
Proposed Treasury Regulation § 301.7803-2(c)(19)
Any issue based on a taxpayer's argument that a Treasury regulation is invalid unless there is an unreviewable decision from a federal court invalidating the regulation as a whole or the provision in the regulation that the taxpayer is challenging. This exception does not preclude IRS Appeals from considering a federal tax controversy based on arguments other than the validity of a Treasury regulation, such as whether the Treasury regulation applies to the taxpayer's facts and circumstances.
Proposed Treasury Regulation § 301.7803-2(c)(20)
Any issue based on a taxpayer's argument that a notice of revenue procedure published in the Internal Revenue Bulletin is procedurally invalid unless there is an unreviewable decision from a federal court holding it to be invalid. This exception does not preclude IRS Appeals from considering a federal tax controversy based on arguments other than the validity of a notice or revenue procedure, such as whether the notice or revenue procedures applies to the taxpayer's facts and circumstances.
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.