Oakbrook Land Holdings v Commissioner is the latest salvo in the Tax Court’s effort to apply administrative law to the process and substance of tax regulations. Concerning the validity of Reagan-era tax regulations, the opinion eats up 128 pages and includes concurring and dissenting opinions that squarely reject the majority’s approach to evaluating whether the regulations comport with requirements under the Administrative Procedure Act (APA).
Guest contributor Monte Jackel discussed the case and its multiple opinions a couple of weeks ago. In this post, like Monte’s excellent post, I focus on whether IRS/Treasury (hereinafter just IRS) failed to do what is required under the APA’s notice and comment process. I am choosing to omit nuance, including 1) the relationship between procedural challenges and substantive challenges to regulations embodied in Step Two of the Chevron analysis, a topic I explore in detail in Chapter 3 in Saltzman and Book, and 2) whether the concurring opinion is correct in its view that the statute alone is enough to put the kibosh on the deduction without getting into the muddy administrative law issues that the case raises.
This post is a follow up to Monte’s post. My goal is to situate the issue within the APA, and in particular its discussion as to what is required when there are challenges to legislative rules.
At ultimate issue in Oakbrook is whether the taxpayer was entitled to a charitable deduction under Section 170 (the accompanying memorandum decision concludes no). To set the stage I will summarize the main statutory and regulatory concepts. I will conclude today’s post by discussing the case’s possible significance for future procedural challenges to regulations and potentially other IRB guidance that may in fact be a legislative rule.
Legal and Factual Background
When donating property other than money, the charitable deduction is equal to the property’s fair market value at the time the donor makes the gift. When donating noncash property, the Code generally prohibits a charitable contribution deduction when the donor fails to donate the entire interest in the property.
There is a statutory exception to the requirement that a donor transfer the entire interests for “qualified conservation contributions” like easements over a portion of land involved in this case. One of the statutory requirements for qualified conservation contributions is that the done uses the contributed property exclusively for conservation purposes. In discussing that requirement, the Code provides that a donation will not be treated as made exclusively for conservation purposes unless “unless the conservation purpose is protected in perpetuity” (the “perpetuity rule”).
Now that we have situated the broad statutory scheme let’s focus on how IRS put some flesh on the perpetuity rule. Three years after the statutory rules for conservation easements came about in 1980 in the Tax Treatment Extension Act, IRS proposed regulations. One of the items in the proposed regulations addressed how to satisfy the perpetuity rule with the reality that circumstances may change and prevent a property’s use for conservation purposes. Recall that conservation purpose is not perpetual if the donee organization that holds the easement is unable to carry on the conservation purpose.
To allow satisfaction of the perpetuity rule, the proposed regulations and final regs required that the contract between the donor and donee provide that the proceeds of a sale of be used in a manner consistent with the conservation purposes and that the proceeds split in a way that reflected the proportionate fair market value of the easement relative to the whole property at the time of the donation. The proposed regulations, and the final regulations which essentially adopted the proposed regs’ approach to divvying up sale proceeds after a judicial extinguishment of the easement, did not take into account any investments or improvements that the donor could have made following the contribution, notwithstanding that the donor’s actions might account for post-contribution changes in market value.
After issuing the proposed regulations, IRS received over 90 comments. As the regulations addressed issues other than the perpetuity rule only one commenter criticized the proposed regs’ failure to address how a donor’s improvements might account for increasing the value of the land. In finalizing the regulation, the preamble stated that IRS considered all of the comments it received but did not specifically address the critical comment that addressed donor improvements. IRS made some minor tweaks to the perpetuity rule regulations (that is the way the regs required a proportionate division in a sale following a judicial extinguishment) and made other changes to other provisions in the final regs, which it discussed in the regulations’ preamble published in a Treasury Decision.
What Does the APA Require For Issuing Tax Regulations?
Before I discuss the opinion, I quote from Saltzman and Book, IRS Practice & Procedure ¶3.02[a], Historical Classification of Regulations, where treatise Contributing Author Greg Armstrong and I discuss how the APA intersects with the tax regulation process:
Before embarking on a consideration of the categorization of Treasury Regulations….the only types of rules that are specifically referred to in the APA are interpretative rules, policy statements, and rules of agency organization and practice. Those categories are not defined, but rather are listed as exceptions to the notice and comment procedures (discussed at IRS Practice & Procedure ¶ 3.02 The Drafting Process).
In the treatise, we discuss how the APA does not mention the term legislative rules. For many years, the IRS and most in the tax academy (including one of my mentors and the original author of IRS Practice & Procedure, Michael Saltzman) have generally thought of tax regulations that were issued pursuant to the general authority to issue rules under Section 7805 as interpretative (or the more modern interpretive) rules that did not require agency to use the APA’s notice and comment process under 5 USC § 553. (For an even deeper dive into this see Bryan Camp’s Duke Law Journal article A History of Tax Regulation Prior to the Administrative Procedure Act; Leandra Lederman’s 2012 article on fighting regs and judicial deference also has an excellent discussion of the historical classification of regs).
As we discuss in the treatise, the understanding that most tax regs were interpretative was rooted in part on the notion that Congress could not delegate its constitutional duty to make law to the executive. In time, the nondelegation doctrine lost force (though is on the comeback trail), and, as academics like Kristin Hickman have emphasized, the consequences for failing to comply with Treasury regulations include sanctions and have both practical and legal effects. In part due to the persuasive writing of Professor Hickman, the consensus has shifted and the modern view shared by most but not all is that Treasury regulations, whether promulgated under the Code’s general authority or a specific grant within a substantive statute, are legislative rules that require the IRS to comply with the notice and comment requirements in the APA (as I mentioned the term legislative rule has no home in the APA but over time courts and commentators began referring to them as such because of their reputation to carry the force of law).
What are the APA’s notice and comment requirements? As the opinion summarizes, to “issue a legislative regulation consistently with the APA an agency must: (1) publish a notice of proposed rulemaking in the Federal Register; (2) provide “interested persons an opportunity to participate * * * through submission of written data, views, or arguments”; and (3) “[a]fter consideration of the relevant matter presented,* * * incorporate in the rules adopted a concise general statement of their basis and purpose.”
The primary procedural issue in Oakbrook was whether the IRS satisfied the third requirement, which I will refer to as the consideration requirement though it is best thought of as two related requirements, that the agency consider the comment and show its consideration by explaining the choices it made.
What are the consequences if a court finds that the IRS failed to satisfy the notice and comment requirements? Under the APA a court is required to invalidate agency action if the agency failed to satisfy them because it would be “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” Whether IRS satisfied the consideration requirement is, as Monte discussed, where the majority, concurring and dissenting opinions parted ways. All the opinions agreed that the regs at issue were legislative (As an aside, I note and expand in the treatise that the issue of whether an agency rule, including IRS IRB guidance, is legislative involves dense administrative law case law. The majority opinion in this case adds a slightly different gloss on that issue compared to what the Tax Court said in its last major opinion on the issue, SIH Holdings v Comm’r, with the emphasis in this opinion on the regulations imposing a requirement that is “not explicitly set forth in the statute”).
The Majority Opinion’s Approach to Whether the IRS Considered Comments and Explained Itself Adequately
The opinion’s discussion of the consideration requirement notes that while the court itself cannot provide an agency explanation for the agency’s choices it will “uphold a decision of less than ideal clarity if the agency’s path may reasonably be discerned.” (citing Bowman Transp., Inc. v. Ark.-Best Freight Sys., Inc., 419 U.S. 281, 285 (1974)). This sweeps in the Supreme Court’s 1983 State Farm decision: for agency action to satisfy the arbitrary and capricious standard, the agency action “must be the product of ‘reasoned decision-making,’ and the agency must, at the time it takes the action being reviewed, provide a reasoned explanation for why it made the particular decision it did.”
In finding that the IRS’s actions were adequate in this case, the majority notes that the preamble discussed the IRS’s efforts at effectuating Congressional policy choices and that the preamble flagged “that ‘[t]he most difficult problem posed in this regulation was how to provide a workable framework for donors, donees, and the * * * [IRS] to judge the deductibility of open space easements,’ inviting public comments on this and other points.”
Finding the general statement in the preamble that it considered all comments important, the opinion also notes that the preamble discussed the seven groups of comments it received and that it was not required to address all of the comments. The opinion also notes that IRS clearly considered the judicial extinguishment rule, pointing to the changes in the final regs in response to some of the comments IRS received.
What about the absence of specific discussion of the comment on donor improvements? In the majority’s view, that was insufficient find invalidate the reg. It gets to that conclusion by framing the one comment as essentially insignificant:
Only one of the 90 commenters mentioned donor improvements, and it devoted exactly one paragraph to this subject. That commenter, NYLC, was concerned about facade easements on historic structures, as opposed to “perpetual open space easements,” with which Treasury was chiefly concerned
Moreover, the majority opinion suggests that a comment may be considered significant (and thus likely requiring the agency to address to pass muster) if the comment offers proposed remedies and in this case the commenter “offered no suggestion about how the subject of donor improvements might be handled; it simply recommended “deletion of the entire extinguishment provision.”
In finding that the IRS also complied with its requirement to provide a concise general statement of the regulation’s basis and purpose, the opinion notes that the failure to discuss its rationale in not changing the final regs to reflect value issues stemming from donor improvements was not grounds for invalidating the reg:
[That] provision represented one subparagraph of a regulation project consisting of 10 paragraphs, 23 subparagraphs, 30 subdivisions, and 21 examples. No court has ever construed the APA to mandate that an agency explain the basis and purpose of each individual component of a regulation separately.
Adding some support for its conclusion, the majority notes that context matters, looking to things like the subject matter of the regs and the nature of the comments received:
The broad statements of purpose contained in the preambles to the final and proposed regulations, coupled with obvious inferences drawn from the regulations themselves, are more than adequate to enable us to perform judicial review. We find that Treasury’s rationale for the judicial extinguishment rule “can reasonably be discerned and * * * coincides with the agency’s authority and obligations under the relevant statute.”
As Monte suggests in his post, the majority opinion provides guidance for those submitting comments on regs, as the “case seems to indicate that a comment letter should state that the issue is material, fully discuss the issue, and propose a practical alternative if one is available.”
What about future courts confronting procedural challenges? Monte’s post does an excellent job of highlighting how the concurring and dissenting opinions approach the issue of a regulation’s procedural validity under the APA. As the concurring and dissenting opinions emphasize, the 2012 Federal Circuit case Dominion Resources is an example of a court invalidating a tax regulation on procedural grounds. Future litigants unhappy with way that regulations apply to their positions will be taking aim at the process and looking at this opinion to help frame their arguments.
One thing that is clear is that cases applying the APA to agency issuance of legislative rules is that an agency need not respond to all comments it receives. The key is whether the comment is significant, a term that is hard to pin down, though the dissenting opinion attempts to provide guidance. Building on the majority opinion’s discussion that a comment is more likely to require agency response if it offers an alternative, the dissent refines that by requiring the comment “identify a specific and objective issue created by the language of the proposed rule and give some explanation for why that language is troublesome.” Framed as the what and why test , i.e., “(1) what is the problem; and (2) why is it a problem?” the dissent notes that agencies are not required to speculate or offer hypotheticals on their own.
It remains to be seen how other courts will address challenges to regulations that predate the more modern Treasury practice of throwing the kitchen sink in preambles, though the SIH Holdings case (also involving decades old regs, though in that case there were no comments as an excellent Tax Prof post from Bryan Camp discussed) suggests that courts are hesitant to apply today’s more exacting standards to regulations that were issued decades earlier. As the majority opinion highlights at times the Tax Court has upheld regulations even in the absence of a stated purpose if the basis and purpose were obvious.
The concurring opinion in Oakbrook emphasized the inadequacy of the preamble to the final reg (e.g., only two pages in the face of hundreds of pages of comments, and hours of public comments at a hearing) and Home Box Office, an important DC Circuit case from the late 1970s, that discussed the benefit to agency rulemaking when there is a dialogue between an agency and commenters making significant points in the rulemaking process. The concurring opinion also rightly notes when promulgating the reg in this case the IRS likely “was simply following its historical position that the APA’s procedural requirements did not apply to these types of regulations.”
In concluding that the reg failed to satisfy the APA’s procedural requirements, the concurring opinion ends by citing language from a Supreme Court case noting that the reasoned explanation requirement is “not a high bar but an unwavering one.” (citing Judulang v Holder).
Oakbrook suggests that the bar may be lower for longstanding tax regulations, and highlights the way that these challenges arise in deficiency cases rather than at a time closer to the rule’s promulgation. Of course that makes no sense, but that takes us to other issues and how perhaps it is time to allow a more orderly challenge to IRS guidance outside the traditional tax controversy process.