The Tax Times: The IRS Still Has 3 Defenses To Fall Back On After Chevron's Demise

According to Law360, the U.S. Supreme Court's landmark decision to eliminate federal agencies' ability to rely on the 40-year-old Chevron doctrine to defend their interpretations of ambiguous laws will likely trigger more litigation against the IRS, but that doesn't mean the agency is completely defenseless against such suits.

The three defense options for the IRS following Chevron's demise include:

1. Administrative Procedure Act

The IRS has recently learned a major lesson in rulemaking after losing several suits brought by taxpayers that criticized its promulgation of certain regulations: Strictly adhere to the APA, including its notice-and-comment procedures.

For a long time, the IRS believed it was immune from most of the requirements of APA because the agency ascribed to the theory known as tax exceptionalism, which is the idea that much of its rulemaking is spared from administrative law requirements.

"Treasury and the IRS, however well-intentioned, have not always been as transparent in their decision-making, as the APA requires," Hickman said. "They haven't always been quite so careful about following the procedural requirements of the APA."

The IRS has since continued to carefully promulgate rules that follow administration law, including those concern the Malta retirement funds as listed transactions and rules that implement the Inflation Reduction Act's clean energy tax provisions.

2. State Farm

As the IRS continues to adhere to administrative law, it will likely look to an APA framework that was set in a Supreme Court's 1983 decision in the State Farm case, which challenged the National Highway Transportation Safety Administration's repeal of safety rules for new vehicles, experts said.

In that decision, the high court said agencies should examine relevant information and provide a satisfactory explanation in implementing a regulation that can meet the APA's arbitrary-and-capricious test, also known as the "hard look" review.

"If you can show the reasoned decision-making and the rational connection between the facts found and the decision made, then the regulation should withstand scrutiny," said Michelle Levin, a shareholder at Dentons Sirote.

However, pursuing this process will likely be time-consuming, Levin said. The IRS is resource-constrained, so "it'll take longer for regulations to get out," she said.

3. National Muffler

The outcome in the Loper Bright case may revive a multifactor test to determine the validity of an IRS regulation that the Supreme Court set in its 1979 decision in the National Muffler case.

In that ruling, the court established a complicated set of factors that judges had to consider in reviewing interpretative regulations, including whether the IRS' construction of the statute was contemporaneous with the law's passage, and the consistency of the commissioner's interpretation.

Courts then relied on the 1979 opinion to determine the validity of IRS regulations when statutes were not clear, even after the Supreme Court established Chevron deference five years later, which was in a case that did not address tax regulations.

That changed in the 2011 opinion in the Mayo Foundation case, in which the justices clarified that Chevron's two-step analysis, rather than National Muffler opinion's multifactor test, applied to ambiguous tax regulations, according to Gil Rothenberg, former chief of the Appellate Section of the U.S. Department of Justice, Tax Division.

Because of the Supreme Court's emphasis on contemporaneousness and consistency in the Loper Bright decision, the courts may return to using the National Muffler case's multifactor test in tax cases, said Rothenberg.

The National Muffler factors, which used to be irrelevant under Chevron, may be coming back to life.

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