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Court Order Could Spur Reform of IRS FAQs

Posted on Oct. 16, 2020

The IRS will likely start including explanations in substantive FAQs after a district court held that an FAQ denying economic impact payments (EIPs) to prisoners violated the Administrative Procedure Act (APA), practitioners say.

The U.S. District Court for the Northern District of California’s October 14 order in Scholl v. Mnuchin could have far-reaching implications for the drafting of FAQs and taxpayers’ ability to obtain judicial review of IRS decision-making set out in informal guidance, former National Taxpayer Advocate Nina Olson told Tax Notes.

It’s unlikely the order will prompt the IRS to stop using FAQs entirely, “but at the very least, they’re going to have to start explaining the conclusions they make in FAQs when there’s nowhere else you can find any analysis,” said Olson, now executive director of the Center for Taxpayer Rights.

The dispute focused on a May 6 FAQ in which the IRS announced that incarcerated individuals are ineligible for EIPs under the Coronavirus Aid, Relief, and Economic Security Act (P.L. 116-136), despite Congress’s mandate that CARES Act benefits be distributed “as rapidly as possible” and without regard to a person’s incarcerated status.

The IRS had initially distributed EIPs to prisoners but reversed course after a June 30 Treasury Inspector General for Tax Administration report questioned the inclusion of prisoners in those disbursements.

The flip-flop prompted attorneys to file a class action lawsuit August 1 on behalf of Colin Scholl, a prisoner working as a porter and part-time artist, and other incarcerated individuals denied EIPs by the IRS. Their complaint asserted that the IRS’s policy of withholding EIP benefits from prisoners based solely on their status as incarcerated people exceeded the agency’s statutory authority under the CARES Act, was contrary to law, and was arbitrary and capricious under the APA.

The plaintiffs scored a win September 24 when District Judge Phyllis J. Hamilton issued an order enjoining the IRS from withholding EIPs from prisoners and provisionally certifying a class for purposes of the preliminary injunction. The latest order, which granted the plaintiffs’ summary judgment motion on the APA claims, converted the earlier preliminary injunction into a permanent one.

Arbitrary and Capricious

Agreeing with the plaintiffs’ arguments on standing and ripeness, Hamilton rejected the Justice Department’s position that the lawsuit wasn’t reviewable under the APA because a section 7422(a) refund action already provides an adequate alternative remedy.

Hamilton said that the government was mischaracterizing the nature of the plaintiffs’ suit. They weren’t challenging an erroneously assessed or collected tax or penalty; rather, they were questioning the administrative procedures by which the IRS arrived at its decision and whether that decision was lawful, she said.

Likewise, Hamilton rejected the government’s contention that the FAQ wasn’t a final agency action for APA purposes. The government had argued that the IRS’s policy denying EIPs to prisoners wasn’t the consummation of a decision-making process, but rather a response to a rapidly developing situation following enactment of the CARES Act.

According to Hamilton, the FAQ represented a final agency action because the IRS took the unequivocal position that prisoners were ineligible to receive EIPs and had shown no indication that it intended to change its position.

Regarding the substantive APA claims, Hamilton held that the FAQ was contrary to law and exceeded the IRS’s statutory authority because incarcerated individuals aren’t excludable as an “eligible individual” under the CARES Act.

Hamilton further held that the FAQ was arbitrary and capricious because the IRS didn’t provide “any reason for the decision to exclude payments to incarcerated individuals, much less an adequate one.” She dismissed the Justice Department’s argument that the IRS’s decision was based on information about possible fraudulent tax refunds or other frivolous tax activity involving prisoners, saying that “this explanation was not publicly advanced by the agency at the time it reached its determination and therefore constitutes an impermissible post hoc rationalization.”


The court’s conclusion that a section 7422(a) refund suit isn’t a taxpayer’s only path to challenging IRS decision-making under the APA is “incredibly important — I think we’re just beginning to think about how that can be used,” said Olson, who added that the judge “absolutely demolished” the Justice Department’s arguments on standing and ripeness.

Hamilton’s pointed comments on the lack of explanation in the FAQ were also significant, Olson said. “That really does have the markings of arbitrary and capricious,” she said, noting that the IRS has a history of issuing FAQs regarding eligibility for economic stimulus payments that provide no explanation or analysis. “That kind of behavior by the government absolutely undermines trust.”

The order will likely prompt the IRS to do a better job of explaining its decision-making in FAQs, Olson said.

Kristin Hickman, a tax and administrative law professor at the University of Minnesota School of Law, said, “It was only a matter of time before a court called the IRS to account for its failure to comply with the APA with its more substantive FAQs.”

The court’s reasoning in Scholl would apply equally to other FAQs, said Hickman. She added that she was pleased to hear IRS Chief Counsel Michael Desmond’s recent comments that the agency was thinking about publishing some FAQs in the Internal Revenue Bulletin. “Perhaps the court's decision in Scholl will prompt the IRS to reform its use of FAQs in this and other ways,” she said.

Other Consequences

James Creech of the Law Offices of James Creech said the Scholl case could signal a new future in tax litigation. “The tax practice might begin to have more of these APA-style federal court cases appear, which I personally have mixed feelings about.”  

Creech said that while he believes Hamilton correctly held that the IRS’s decision-making violated the APA, he nevertheless felt “there were some conclusions in the opinion that made me uneasy.”

“I am still a little surprised that the judge got to the legal conclusion that this case was ripe and that the FAQ was a final agency action so easily,” Creech said. “Though I will say that the fact the IRS took efforts to stop prisons from delivering paper EIP payments probably played a large role in getting to that conclusion. I would not be confident bringing a similar suit against an FAQ that did not have corresponding agency actions that made it clear that rights and responsibilities flowed from the official statement, because it is an accepted principle that an FAQ is not binding on either the IRS or the taxpayer.”

The order’s discussion regarding the finality of the FAQ was also interesting, said Creech, adding, “It seems to suggest that FAQs become final agency action once they have been publicly available for a length of time.”

“The judge seemed to give the IRS some latitude to issue FAQs as part of a response that was evolving with the situation, but she said that once the IRS was no longer pressed for time, the FAQs became a final action,” said Creech. “This could have some ramifications for many other areas of tax. To me, this really devalues FAQs for the IRS. One of the best things about FAQs is that you can push out information rapidly and if things change in 18 months, the FAQs can change as well. Or they can simply be relegated to and don't require any additional thought or effort by an overworked agency. Now the IRS seems to have a situation where if they respond to a rapidly developing situation they not only have to get useful information to taxpayers, but they seem to have this additional requirement to review it so it stays purely informational instead of creating new judicially reviewable rights.” 

Creech said he fears the net result could lead to the IRS issuing fewer FAQs. “Given that formal guidance has declined in recent years, having a situation where informal guidance declines as well means that taxpayers might have less information overall,” he said. “This leads to more guesses and more effort to either audit and collect or simply less revenue.”

Monte A. Jackel of Jackel Tax Law questioned the impact of the order, given that it was only from a district court. “Even if the Ninth Circuit gets the case and agrees, it is only one circuit,” he said. “The IRS will not give up. Congress must act or it will take years before the judicial landscape becomes settled.”

The plaintiffs in Scholl v. Mnuchin, No. 4:20-cv-05309 (N.D. Cal. 2020), are represented by attorneys with Lieff Cabraser Heimann & Bernstein LLP and the Equal Justice Society.

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