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A Fresh Look at Tax Exceptionalism: Tax Is A Little Different

Posted on Sep. 28, 2016

Today we welcome first-time guest poster Professor James Puckett from Penn State Law School.  Past posts have wrestled with tax procedure’s place in the world of broader administrative law principles. James’ thoughtful recent Georgia Law Review article Structural Tax Exceptionalism takes on these issues. Situating tax adjudications and the mix of IRS guidance into broader administrative law norms, James suggests that some of the unique aspects of the IRS’s guidance and review process serve as a check on the wholesale adoption of those norms.

This issue is closely related to the discussion surrounding Treasury and IRS’s longstanding practice of exempting tax regulations from normal agency review procedures, an issue discussed in this month’s GAO report on IRS guidance practice and the subject of a recently released memorandum of understanding between IRS and OMB that dates from 1983. How tax fits in with broader and nontax specific agency practice will be an important issue in tax administration and tax procedure for the foreseeable future. Les

Amid a scholarly near-consensus that tax exceptionalism is dead or dying, my recent article, Structural Tax Exceptionalism examines some of the distinctive features of tax administration that remain viable. “Tax exceptionalism,” as it relates to tax procedure, holds that tax is so different, special, complicated, or important that otherwise applicable administrative law principles do not apply. This kind of tax exceptionalism was probably fatally undermined by the Supreme Court’s 2011 decision in Mayo Foundation v. United States. Perhaps leaving a crack in the door for future litigants to bring an adequate “justification,” the Court declared that it was “not inclined to carve out an approach to administrative review good for tax law only.”

In Structural Tax Exceptionalism, I argue that the peculiarities of tax rulemaking and adjudication severely constrain the potential for effectively mapping general administrative law principles onto tax. To be clear, the intent of the article is not to revive tax exceptionalism as an analytical guide. The APA is essentially a template, and Congress has customized tax rulemaking and adjudication. I argue that these modifications are important and should not be unraveled as a result of looking to the APA to start. In this post, I sketch the atypical features of tax rulemaking and adjudication, as well as their interplay.

A prototypical agency may find rulemaking relatively burdensome and accordingly prefer to fall back on adjudication. Outside of tax, pre-enforcement challenges to rules promulgated by administrative agencies are commonplace. Whereas the Supreme Court has interpreted the Anti-Injunction Act (26 U.S.C. § 7421) broadly to bar pre-enforcement challenges to tax regulations, no such limitation applies under the APA. Moreover, in the event of a successful procedural challenge, assuming the agency tries again, it cannot backdate a newly issued replacement rule. With exceptions for interpretative rules, statements of policy, and “good cause,” APA § 553(d) generally requires publication of a final rule to precede its effective date by at least 30 days. Thus, low-risk pre-enforcement challenges may succeed in pushing back effective dates of legislative rules even if the agency ultimately prevails and the contents of the eventual valid rule come as no surprise to the public.

Even with the risk of post-enforcement litigation, APA challenges to tax rules have multiplied post-Mayo. Sometimes, of course, there will be a more fundamental flaw with the guidance, e.g., that it is unreasonable or contrary to the Code. However, my article argues that in cases involving procedural technicalities, the IRS and Treasury Department may be able to solve some enforcement problems by backdating a replacement rule. Final tax regulations, under the authority of I.R.C. § 7805(b)(1)(B), are routinely backdated to the date of the notice of proposed rulemaking (NPRM). Perhaps in the case of replacement regulations it would be more appropriate to label the NPRM relating to the invalidated regulation a “notice substantially describing the expected contents” of the replacement regulation (I.R.C. § 7805(b)(1)(C)).

Part III.A of the article expands on this and other potential arguments relating to the backdating of tax rules. Beyond the basic § 7805(b) argument outlined above, there are other potential arguments under the Code (e.g., prevention of abuse, as well as the more flexible predecessor to Section 7805(b), which arguably still applies in some cases). Moreover, no examination of rulemaking procedures would be complete without an examination of the vexing legislative-interpretative rule distinction. Although I would not go so far as some in classifying tax rules as legislative, the IRS and Treasury have probably been too quick to claim exemption from the APA for “interpretative rules.”

Outside of tax, a recurring complaint about agencies is that they fail to engage in sufficient rulemaking, instead opting to make policy through case-by-case adjudication. The IRS clearly has to undertake a great deal of adjudicative activity in reviewing tax returns. However, courts review deficiency determinations as well as typical refund claims de novo. Part III.B. of my article expands on how this differs from the deferential judicial review ordinarily afforded to agency formal adjudication.

Stephanie Hoffer and Chris Walker argue in their excellent article on The Death of Tax Court Exceptionalism and in their posts on Procedurally Taxing discussing that article that the Tax Court’s review should be deferential where the APA has not been overridden (e.g., innocent spouse relief and collection due process). Like Hoffer and Walker, I am intrigued by the potential benefits of deferential review and remands in appropriate cases. Moreover, I agree that there may be more room for courts to explore discretionary remands to the IRS.

In any event, for the time being, adjudication does not present the same attraction to the IRS as it would to the prototypical agency. To substantially improve the odds of a court following the IRS’s position on an issue, rulemaking offers more promise. The prospect of de novo review of IRS adjudication, along with the potential flexibility of backdating rules under § 7805(b), represent sticks and carrots that may push the IRS and Treasury toward rulemaking—at least relative to a prototypical agency’s incentives. This may be a good thing, if we are hoping for more published tax guidance.

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