U.S. Supreme Court Rulings Affect Challenges to Tax Regulations

Upon closing its October 2023 term, the U.S. Supreme Court issued two significant opinions – despite neither being a tax case – that will have broad consequences for taxpayers seeking to challenge tax regulations and other issued guidance. First, in Loper Bright Enterprises v. Raimondo (Loper Bright), the Court jettisoned the long-standing Chevron doctrine, in which courts would defer to an agency's "permissible" statutory interpretation if the statute was silent or ambiguous, even if the court would have interpreted the statute differently. Days later, in Corner Post, Inc. v. Board of Governors of the Federal Reserve System (Corner Post), the Court concluded that, for purposes of the relevant six-year statute of limitations, a claim under the Administrative Procedure Act (APA) does not accrue until such time the plaintiff is injured by final agency action.

What did the Court say, and how do its rulings in Loper Bright and Corner Post affect challenges to tax regulations and subregulatory guidance?

Loper Bright

The APA was enacted in 1946 and bestowed courts with independent judicial review of agency action. Then, in 1984, a six-justice panel of the Supreme Court departed from independent statutory review and gave us what became known as Chevron deference.¹ Chevron deference required courts to defer to an agency's interpretation of a statute if 1) the statute was silent or ambiguous as to a particular issue and 2) the agency's interpretation was based on a permissible construction of the statute. Such agency deference applied even if the reviewing court would have interpreted the statute differently.

In Loper Bright, the Court concluded that "the deference that Chevron requires of courts reviewing agency action cannot be squared with the APA." The Court determined that leaving statutory interpretation to agencies violated the APA's mandate that a "reviewing court shall decide all relevant questions of law, interpret constitutional and statutory provisions, and determine the meaning and applicability of the terms of an agency action."² The Court was also troubled that deferring to agencies' statutory interpretations undermined constitutional separation of powers principles.

Corner Post

The threshold issue in Corner Post was the time at which "a right of action first accrues" on an APA claim for purposes of six-year statute of limitations on suits brought against the federal government. The agency action at issue was a regulation promulgated by the Federal Reserve System's Board of Governors capping the amount of fees payment networks such as Visa or Mastercard could charge retailers for debit card transactions. Corner Post, a retailer in North Dakota, challenged the regulation under the APA, and the Board of Governors argued the suit was time-barred under the six-year limitations period on suing the government.

The Court held that the right of action first accrues when the plaintiff suffers an injury. In its ruling, the Court firmly rejected the Board of Governors' argument that the right of action accrues when the agency action becomes final – i.e., when the regulation is promulgated. The Court rightly noted that adopting the Board's position would cause the six-year window to bring a suit to operate as a statute of repose (determined by reference to timing of the defendant's acts) instead of a statute of limitations (determined by reference to timing of the plaintiff's injury). This distinction was critical given the fact that Corner Post did not exist when the regulation became final, let alone suffer an injury related to the regulation. The Court further noted that the Board's argument necessitated would create separate limitations rules within the same statute – a position the Court concluded was untenable.

Tax Litigation Moving Forward

In light of the decisions in Loper Bright and Corner Post, what should we expect moving forward? Short answer: more litigation. Taxpayers have already experienced success using the APA to challenge IRS guidance.³ The U.S. Department of the Treasury and IRS publish more than 200 regulations and subregulatory guidance every fiscal year. The majority of guidance is noncontroversial and provides certainty to taxpayers and IRS examiners. A small subset of the guidance creates controversy, and taxpayers may be willing to challenge the validity of such guidance. Sometimes, the regulations come in the form of "fighting regulations," designed to shut down a transaction or perceived abuse. Recent examples include the regulations invalidated in Liberty Global, Inc. v. United States under Internal Revenue Code (Code) Section 245A and the Section 385 regulations (debt versus equity).

Once the Treasury Department finalizes a regulation, a taxpayer generally will not be able to challenge that regulation unless the taxpayer receives an assessment or files an amended return and sues for a refund. A taxpayer generally is unable to sue the IRS in advance of an audit or payment of taxes under the Tax Anti-Injunction Act. Cf. CIC Servs., LLC v. IRS, 593 U.S. 209 (2021) [Challenge to an IRS Notice 2016-66 was not barred by Anti-Injunction Act]. Corner Post is important in this aspect considering a taxpayer might not suffer a justiciable injury until years after the Treasury Department finalizes a regulation. Adopting an agency-centric statute of repose could eliminate a claim before a taxpayer ever becomes subject to regulation that serves as the basis for the claimed injury. Taxpayers may be able to challenge regulations that were finalized decades ago because the injury first becomes ripe within the last six years.

What legal standard will courts use going forward now that Chevron is no more? The end of Chevron does not equate to courts altogether ending deference. Though the Court declared that the APA "requires courts to exercise their independent judgment in deciding whether an agency has acted within its statutory authority," courts can still rely on agency viewpoints when exercising their independent judgment. In Loper Bright, the Court expressly did not disturb Skidmore⁴ deference and the courts' ability to "seek aid from the interpretations" of the agencies "responsible for implementing particular statutes." Under Skidmore, courts can use agency judgment as an interpretive tool and give such judgments appropriate weight based on the agency's thoroughness in consideration and validity of its reasoning. Expect that to continue. The difference between the two levels of deference – Skidmore and Chevron – is that under Skidmore, courts can use agency interpretation as one consideration, whereas Chevron would have required adopting it.

Observations

• It is clear that the APA will be a prevailing factor in tax cases involving fighting regulations for years to come.
• As to specific authority tax regulations, the Loper Bright decision will require IRS to ask Congress when a statute is enacted that the statute contain language regarding specific authority as to tax regulations – i.e., "The Secretary shall prescribe such regulations as are necessary to carry out the provisions of this section."
• The reviewing court will then review the regulation under the prism of the APA – i.e., whether the regulation is arbitrary, capricious or otherwise not in accordance with the law to determine whether the IRS has carried out Congress' intent or exceeded its authority.
• Regarding general authority tax regulation, the Supreme Court referred continuously to Skidmore and the APA. Query: Has National Muffler Dealers Assn., Inc. v. United States, 440 U.S. 472 (1979)⁵ been resurrected after being overturned in Mayo Foundation for Medical Education and Research v. United States?⁶

• It should be anticipated, either when promulgated or during litigation, that as to fighting regulations, the IRS will raise common judicial doctrines such as economic substance; sham, substance-over-form inquiry to determine whether a party was a bona fide partner to boot strap the regulation. See Liberty Global, Inc. v. United States, 132 A.F.T.R.2d 2023-6406, (D. Colo. 2023) (slip copy),⁷ appeal pending; Historic Boardwalk Hall, LLC v. Comm'r, 694 F.3d 425 (3d Cir. 2012);⁸ see also REG-124593-23 ("Basis-Shifting Regulations") and Rev. Rul. 2024-14, 2024-28 IRB 1, Notice 2024-54.

• The decision in Corner Post makes certain that unless Congress intervenes, decisions such as Valley Park Ranch, LLC v. Commissioner, 162 T.C. No. 6 (2024) will continue as taxpayers are facing regulations that were issued when the IRS did not fully comply with the notice and comment requirements of the APA.⁹
• As a result of Corner Post, taxpayers may be able to raise claims against older regulations that may be procedurally or substantively defective. This could lead to an increase in tax litigation.
• Finally in light of Corner Post, what is to become of Temporary Regulations that remain in the Code before Congress added Section 7805(e) (requiring Temporary Regulations to sunset after three years)? Temporary Regulations generally did not comply with the APA's notice and comment requirements.

Notes

¹ Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984).

² 5 U.S.C. § 706.

³ See, e.g., CIC Services, LLC v. Internal Revenue Service, 593 U.S. 209 (2021); Green Rock LLC v. Internal Revenue Service, 104 F.4th 220 (2024).

⁴ Skidmore v. Swift & Co., 323 U.S. 134 (1944).

⁵ In National Muffler, the Supreme Court implied that a special administrative standard of review applies for tax law. Deference to tax regulations promulgated under general tax authority was accorded under the following six factors:

• A regulation may have particular force if it is a substantially contemporaneous construction of the statute by those presumed to have been aware of congressional intent.
• If the regulation dates from a later period, the manner in which it evolved merits inquiry.
• Other relevant considerations are the length of time the regulation has been in effect, the reliance placed on it, the consistency of the Commissioner's interpretation and the degree of scrutiny Congress has devoted to the regulation during subsequent reenactments of the statute." Id., at 477.

⁶ In Mayo Foundation for Medical Education and Research v. United States, 562 U.S. 44 (2011), the IRS urged the Supreme Court that Treasury Department regulations should be entitled to the same standard in Chevron U.S.A. Inc. v. Natural Resources Defense Council Inc., 467 U.S. 837 (1984) (Chevron deference) as are other agency regulations. The Supreme Court agreed with the IRS that the same deferential standard of review applicable to other agency rules should "apply with full force in the tax context." Essential to the Supreme Court's decision was the fact that the regulation had been issued through the notice and comment process, which the Supreme Court found was "a very good indicator of delegation meriting Chevron treatment" and a "significant sign that a rule merits Chevron deference." Thus, the price of Chevron deference is that the IRS and Treasury Department must comply with the APA.

⁷ In Liberty Global, the government successfully raised an economic substance argument as to a check-the-box election.

⁸ In Historic Boardwalk Hall, the government successfully prevented a partnership from utilizing rehabilitation tax credits on the grounds that there the partnership was not bona fide, i.e., the partner's net after-tax economic benefit was insufficient when compared to partner's intent to share income and losses.

⁹ In Valley Park Ranch, LLC v. Commissioner, 162 T.C. No. 6 (2024), the U.S. Tax Court held that Treas. Reg. § 1.170A-14(g)(6)(ii) (Proceeds Regulation) was procedurally invalid under the APA.

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