The Internal Revenue Service (“IRS”) is notorious for flouting regulatory procedures that are designed both to legitimize the administrative state’s exercise of lawmaking power and to constrain the worst abuses of that authority through information gathering tools and judicial review.  One reason the IRS is able to avoid the traditional regulatory process is because the Anti-Injunction Act prevents most lawsuits that would invalidate rules that the IRS promulgates outside that process.

Last week, the IRS acknowledged some of those shortcomings in a policy statement announcing changes to the way it rolls out new rules.  These changes are on top of last year’s revocation of a decades-old exemption from White House pre-publication review and approval.

The Administrative Procedure Act (“APA”) has different processes for legislative and interpretative rules, i.e., rules that create new legal obligations on private parties and those that purportedly don’t.  The IRS has long maintained that nearly all its rules are interpretative and thus exempt from the APA and notice-and-comment regime.  This is a dubious claim, at best.  Notwithstanding this self-bestowed exemption, the IRS magnanimously still puts its supposedly interpretative rules out for notice and comment.  But it does so without following all of the required procedures, which it justifies by claiming that any process it is following is voluntary anyway, so it can follow which procedures it wants to.  In its policy statement, the IRS confirmed that it “will continue to adhere to [its] longstanding practice of using the notice-and-comment process for interpretive tax rules.”

IRS Won’t Seek Deference

An issue that has plagued the IRS is the use of subregulatory guidance to explain the IRS’s view on how it will apply statutes and regulations; these guidance documents often come in the form of revenue rulings, revenue procedures, notices, and announcements.  Although these documents are supposed to be interpretative and explanatory, in many cases they create new legal obligations and are thus actually legislative in nature.

For example, the IRS used a subregulatory mechanism to announce new “transactions of interest” that captive insurance companies must report to the IRS or face a penalty and enforcement.  This is a classic case of a new law that affects private parties that was slipped through in a policy document, without notice and comment, and which should be invalidated on those grounds.

The IRS now seems to be conceding the issue broadly, although not with regard to the example above, and announced in its policy statement that:

When proper limits are observed, subregulatory guidance can provide taxpayers the certainty required to make informed decisions about their tax obligations.  Such guidance cannot and should not, however, be used to modify existing legislative rules or create new legislative rules.  The Treasury Department and the IRS will adhere to these limits and will not argue that subregulatory guidance has the force and effect of law.  In litigation before the U.S. Tax Court, as a matter of policy, the IRS will not seek judicial deference under Auer v. Robbins, 519 U.S. 452 (1997) or Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984), to interpretations set forth only in subregulatory guidance.

This is a positive development, but it remains to be seen whether IRS attorneys really will abide by the constraint when faced with a rule that they’re trying to save in court.  Further, the policy only applies in “litigation before the U.S. Tax Court,” and so will not apply when challenges are brought to federal district court, as many procedural challenges to rulemaking are.  Another limitation of the statement appears to be that the IRS is only forswearing seeking deference to interpretations of subregulatory tax guidance and not other rules that litigants might dispute the IRS has violated, such as the APA or the Regulatory Flexibility Act, which the IRS claims does not apply to nearly all of its rules.

“Good Cause”

One of the APA procedures the IRS sidesteps is providing “good cause” for when interim final rules become immediately effective upon publication.  Treasury and the IRS have decided to now “commit to include a statement of good cause when issuing any future temporary regulations under the Internal Revenue Code.”  This is a good, if minor, change and adherence to general practice used elsewhere in the government.

The biggest issue plaguing the IRS’s compliance with procedural rules that constrain the agency is the Anti-Injunction Act, which prevents many challenges that would clean up the IRS’s lack of compliance.  Unless and until there is a shift in judicial interpretation of that provision or Congress exempts Title 5 challenges to IRS rules, we will continue to see the IRS operate outside the bounds of standard administrative practice.  The IRS’s recent policy statement does nothing to change that.

James Valvo is counsel and senior policy advisor at Cause of Action Institute.