Growing scrutiny has put the Treasury Department on the defensive when issuing new tax regulations that can impact major areas of American life—from taxes on asset-shifting multinationals to donor-disclosure rules for nonprofits.
Key court decisions and greater White House oversight have spurred the change, driving Treasury to explain its decisions more fully and prove it has complied with rulemaking requirements, tax professionals and academics said.
The department’s explanations not only give taxpayers and their advisers insight into Treasury’s thinking, but can also strengthen Treasury’s defenses if rules are challenged in court.
In final rules (T.D. 9898) last month, for example, the IRS exempted certain nonprofits from having to report the names and addresses of substantial donors on tax forms. The rules’ 10-page preamble highlighted the agency commissioner’s broad authority to decide what information must be reported and when to offer relief, and the rules later said comments opposing the change were “misplaced.”
The preamble is just the latest example of a growing trend, academics said.
“It’s a real recognition that litigants are going to attack regulations on procedural grounds and that courts are going to look carefully at whether the IRS is engaging with significant comments,” said Leslie Book, a law professor at the University of Villanova and author of a treatise on tax procedure and administration.
Courts could begin providing even more scrutiny of Treasury actions, depending on the outcome of a case the U.S. Supreme Court has agreed to hear in an upcoming term, CIC Services, LLC v. Internal Revenue Service.
The justices will consider how far a Civil War-era statute goes in protecting Treasury from lawsuits challenging regulatory actions that haven’t yet been enforced against a taxpayer.
Treasury declined to answer questions about the regulatory process, including the effects of recent and pending court decisions.
Courts Add Pressure
The Administrative Procedure Act, or APA, requires federal agencies to give notice and respond to significant comments for final “legislative rules,” meaning rules that carry the independent force of law.
For years, Treasury argued that many of its rules didn’t need to go through notice-and-comment because they were merely “interpretive rules” that offered constructions of statutes. But a turning point came with the Supreme Court’s 2011 decision in Mayo Foundation for Medical Education and Research v. United States, where the court said it wasn’t inclined “to carve out an approach to administrative review good for tax law only” without justification.
“The light bulb went off right after the Mayo case,” Book said. While the case didn’t have to do with the notice-and-comment process, it was a “fundamental shift in thinking about how administrative law norms generally apply to what the IRS does,” he said.
Treasury in 2019 affirmed its “commitment to sound regulatory practices,” including treating the notice-and-comment process as the “best practice for agency rulemaking.”
Major court rulings have also upped the pressure on the department.
Two prominent cases are Altera Corp. v. Comm’r and Bullock v. Internal Revenue Service. In Altera, the U.S. Tax Court unanimously invalidated regulations on asset shifting, although it was later overruled by the U.S. Court of Appeals for the Ninth Circuit. In Bullock, a Montana federal court struck down Treasury’s initial attempt to ease disclosure rules for some nonprofits using a revenue procedure rather than regulations, saying the rules needed to go through the typical notice-and-comment process.
“The fact that Treasury has had more than one regulation challenged on APA-based grounds certainly has to be influencing them to take more care in explaining their choices in the preambles to the regulations,” said Kristin Hickman, a law professor at the University of Minnesota who focuses on tax and administrative law issues.
Tax and Politics
Challenges to regulations on politically divisive issues have fueled the need for strong explanations to support the government’s positions.
The Affordable Care Act and its corresponding regulations, for example, have been at the center of several court battles—primarily driven by Republican-led states with the backing of the Trump administration.
The guidance on nonprofit donor disclosure has similarly been the focus of both political and legal conflicts. Senate Finance Committee ranking member Ron Wyden (D-Ore.) said removing the disclosure requirement for some groups has “opened the floodgates” for dark money to pour into the U.S. election system.
“Anytime you have a regulation like that—that the administration considers important and also seems destined to be challenged or to be fought over—I think any administration is going to take additional time and try to put additional support for the position in the final regulations,” said Tom West, who worked at Treasury from 2014 to 2018 and is now a principal in KPMG LLP’s Washington National Tax practice.
Major lawsuits aren’t the only source of recent scrutiny for Treasury. In 2018, the Office of Information and Regulatory Affairs (OIRA) entered into a new agreement with the department to create a process for reviewing major tax regulatory actions in a way similar to how the office has long conducted such reviews for other federal agencies.
Hickman, who served as special adviser to the administrator of OIRA from 2018 to 2019, said it was very apparent from her time working there that the new review process was having a meaningful impact on the degree to which Treasury was explaining its actions in its regulatory preambles.
“OIRA review combined with greater judicial scrutiny, together I suspect are prompting Treasury to take greater care in drafting their explanations,” Hickman said.
The review process is expected to continue to shape Treasury’s guidance-writing approach. The department declined to comment on how OIRA review has impacted the drafting process.
“It clearly is having an impact as well because having another systemic check within the executive branch is something that has not been the norm. I can’t speak directly to that process, but it’s clearly part of the changed atmosphere,” Book said.