11th Cir. Invalidates Proportionate Sharing Regulations As Procedurally Arbitrary and Capricious for Failing to Address a Significant Comment (12/30/21; 12/31/21)

Subsequent blog entry adding some procedural nuance:  Regulations Interpreting Pre-1996 Code provisions; Fixing Hewitt (Federal Tax Procedure Blog 1/6/22), here.

In Hewitt v. Commissioner, 21 F.4th 1336 (11th Cir. 2021), 11^th Cir. here and GS here, the Court invalidated regulation § 1.170A-14(g)(6)(ii) denying charitable donations of partial interests (such as easements) for conservation purposes if the deed requires that, upon extinguishment, the proceeds be shared between donor and charitable donee ratably to the value between the conservation easement and the donor’s retained property rights as of the time of the donation.  Specifically, the regulations did not permit in that sharing calculation, the subtraction of value of post-donation improvements incurred by the donor.  Such subtraction, if allowed, would allocate that portion of the value exclusively to the donor rather than sharing with the charitable donee according to the date of donation values).  The Regulation interpreted the § 170(h)(5)(A) requirement that:

(A) Conservation purpose must be protected
A contribution shall not be treated as exclusively for conservation purposes unless the conservation purpose is protected in perpetuity.

Two issues are potentially implicated.

(i)              Was the regulation properly promulgated under the procedural requirements for regulations in the Administrative Procedure Act (“APA”)?  Those requirements include a statement of purpose addressing significant comments in the Notice and Comment process (sometimes called Reasoned Decisionmaking) which may be tested under the APA’s arbitrary and capricious standard under 5 USC 706(2)(A).  This is sometimes referred to as the State Farm test.  Motor Vehicles Mfrs. Ass’n v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29, 43 (1983).  This test is a procedural regularity test only and, as to interpretations in the regulation, do not test the validity of the interpretation.  (Thomas Merrill, a noted scholar, has suggested that Reasoned Decisionmaking or some variation including a reasoning concept is better called “process review,” to avoid confusing it with the ambiguous requirement of “reasonableness,” which is the deference test for an interpretation. Thomas W. Merrill, Re-Reading Chevron, 70 Duke L. J. 1153, 1171-1172 (2021); process review seems to focus better on the inquiry into the procedural validity of the regulation.).

(ii)            Was the interpretation in the regulation a valid interpretation either because it is the best interpretation of the statute (regardless of deference) or, if not the best interpretation, subject to Chevron deference?  Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837 (1984).  In this regard, a Notice and Comment regulation interpretation adopted in a procedurally invalid way is not entitled to Chevron deference but should still carry the day if it is the best interpretation of the statute.  BTW, this is why an interpretive regulation differs from a legislative regulation; if a legislative regulation is procedurally defective or even does not exist, there is no law in the statute to apply; if an interpretive regulation is procedurally defective or does not exist, there is still the statute a court can apply based on its best interpretation.  For example, the quintessential tax legislative regulations are the consolidated return regulations; if there are no consolidated return regulations or they are procedurally invalid, there is no law for consolidated returns; by contrast, most tax regulations are interpretive regulations where if there were no interpretive regulations or if the interpretation in the regulations were not valid (qua interpretation), there would still be the statute which the court could interpret to resolve the dispute.

The 11^th Circuit held in Hewitt that the regulation failed the procedural regularity test in (i) above because, in adopting the Final Rule, Treasury failed to consider and discuss a material significant comment regarding the extinguishment formula as to whether the value of post-donation improvements by the donor must be shared with the charitable donee.  Failing the procedural regularity test, the regulation was invalid thus precluding any Chevron deference.  Had the regulation passed the procedural regularity test in (i), Chevron deference might have been an issue.

In its Conclusion (Slip Op. p. 36), the Court summarized (cleaned up):

            Because Treasury, in promulgating the extinguishment proceeds regulation, failed to respond to NYLC’s significant comment concerning the post-donation improvements issue as to proceeds, it violated the APA’s procedural requirements. We thus conclude that the Commissioner’s interpretation of § 1.170A-14(g)(6)(ii), to disallow the subtraction of the value of post-donation improvements to the easement property in the extinguishment proceeds allocated to the done, is arbitrary and capricious and therefore invalid under the APA’s procedural requirements. Accordingly, we reverse the Tax Court’s order disallowing the Hewitts’ carryover charitable deductions as to the donation of the conservation easement and remand for further proceedings.

It is not clear to me whether the opinion as written is a final disposition on the issue of the validity of the interpretation.  The Hewitt court seems only to have held that the regulation was invalid because it failed the procedural regularity test.  The Court never engaged with the issue of whether the interpretation (as opposed to the regulation) was a valid interpretation of the governing statute, § 170(h)(5)(A).  There is thus the possibility that the IRS could or should still prevail if the interpretation is the best interpretation of the statute.  (In determining the best interpretation or even whether the statute is ambiguous under Chevron, the court may consider the agency interpretation under Skidmore v. Swift & Co., 323 U.S. 134, 140 (1944).)  I am agnostic on the issue of whether, fully considered, the Treasury interpretation is the best interpretation of the statute.  To repeat, fairly read, the opinion only holds that the regulation is invalid, not that the interpretation of the statute is invalid.

JAT Comments:

Although perhaps not related to its holding that the regulation was procedurally invalid, the opinion has some administrative law junk along the way.  The background for these points is my recent revised and update article, John A. Townsend, The Report of the Death of the Interpretive Regulation Is an Exaggeration (SSRN last revised 12/15/21), here, linking to the article for reviewing or downloading.

1.  I’ll start with the mundane.  The Court calls (Slip Op. 3) the APA the “Administrative Procedures Act.”  The APA is the “Administrative Procedure Act.”  See 5 U.S. Code Subchapter II - ADMINISTRATIVE PROCEDURE, Notes, here, (“The provisions of this subchapter and chapter 7 of this title were originally enacted by act June 11, 1946, ch. 324, 60 Stat. 237, popularly known as the “Administrative Procedure Act”.).  To be sure this slight misnaming of the APA is common, but that does not make it right.

2.  More substantively, the Court has this at Slip Op. 11:

            The APA “prescribes a three-step procedure for so-called ‘notice-and-comment rulemaking.’” Perez v. Mortg. Bankers Ass’n, 575 U.S. 92, 96 (2015); accord 5 U.S.C. § 553. First, an agency “must issue a ‘[g]eneral notice of proposed rulemaking,’ ordinarily by publication in the Federal Register.” Perez, 575 U.S. at 96 (alteration in original) (quoting § 553(b)). Second, “if ‘notice [is] required,’ the agency must ‘give interested persons an opportunity to participate in the rule making through submission of written data, views, or arguments,’” and the agency “must consider and respond to significant comments received during the period for public comment.” Id. (alteration in original) (quoting § 553(c)). Third, in promulgating the final rule, the agency “must include in the rule’s text ‘a concise general statement of [its] basis and purpose.’” Id. (alteration in original) (quoting § 553(c)). As the Supreme Court has explained, “Rules issued through the notice-and-comment process are often referred to as ‘legislative rules’ because they have the ‘force and effect of law.’” Id. (quoting Chrysler Corp. v. Brown, 441 U.S. 281, 302–03 (1979)).

This type of statement based on Perez and it’s purported reliance on Chrysler is not uncommon, but that does not make it right.  Bottom line, only legislative regulations require Notice and Comment; interpretive rules may be adopted with Notice and Comment and, if they are (as Treasury interpretive regulations are), then they become subject to procedural regularity requirements but they are not transformed into legislative regulations by adoption with Notice and Comment.  I have particularly addressed the errors in Perez and its erroneous citation to Chrysler in my article p. 40 (see particularly n. 160) and 45-46. 

3. The Court said (p. 32):

            Simply put, NYLC’s comment was significant and required a response by Treasury to satisfy the APA’s procedural requirements. And the fact that Treasury stated that it had considered “all comments,” without more discussion, does not change our analysis, as it does not “enable [us] to see [NYLC’s] objections and why [Treasury] reacted to them as it did.” Lloyd Noland, 762 F.2d at 1566.

 I find it interesting  to note the parallel between the requirement for Reasoned Decisionmaking and FRCP Rule 52(a) and its Tax Court counterpart § 7459, Rule 52(a) provides “In an action tried on the facts without a jury or with an advisory jury, the court must find the facts specially and state its conclusions of law separately.”  Section § 7459, provides “The Tax Court shall report in writing all its findings of fact, opinions, and memorandum opinion.”  Yet, courts (particularly the Tax Court) not infrequently dismiss arguments without even identifying or discussing them.  E.g., examples one T.C. and another T.C.M., Belk v. Commissioner, 140 T.C. 1, 15 (2014) (“We have considered all the arguments of the parties, and, to the extent we have not addressed them, we find them to be irrelevant, moot or meritless.”) and Holland v. Commissioner, T.C. Memo. 2021-129 *11 (“We have considered all remaining arguments petitioner made and, to the extent not addressed, we find them to be irrelevant or meritless.”).  On the comparison to Rule 52(a), see my article p.2 n. 7. 

4. Added 12/31/21 1:30pm:  On the positive side, the Hewitt Court seemed not to have any difficulty recognizing that the arbitrary and capricious procedural regularity review under 706(2)(A) and State Farm (also called the “hard look” review) is not the same as the Chevron reasonableness of interpretation review, although it does not address that issue specifically.  I thought it might be helpful to say something about the difference because of confusion on that issue.

The confusion in the current discourse seems to be based on less than careful reading of footnote 7 of Judulang v. Holder, 565 U.S. 42, 52 n.7 (2011), GS here, which some read erroneously to conflate the two types of review.  Thoughtful judges and scholars that do address the issue recognize that there is a distinction.  E.g., Catskill Mountains Chapter of Trout Unlimited, Inc. v. EPA, 846 F.3d 492, 521-523 (2d Cir. 2017), GS here (noting the confusion and making the distinction between arbitrary and capricious review and Chevron review), cert. denied, sub nom New York v. EPA, 583 U.S. ___, 138 S. Ct. 1164 (2018).  I address that issue in more detail in my article pp. 94-99.

I was reviewing a law review article this morning that has an apt illustration of the difference in the context of H.L.A. Hart’s iconic example on interpretation of statutes.  Cary Coglianese, Chevron's Interstitial Steps, 85 Geo. Wash. L. Rev. 1339 (2017), drawing the illustration from H.L.A. Hart, Positivism and the Separation of Law and Morals, 71 Harv. L. Rev. 593, 607-08 (1958)  Most readers of this blog will recognize the example from their basic law school education.  The statute says “No vehicles in the park.”  What does “vehicles” mean?  The example is perhaps far-fetched but it does make the point (footnotes omitted):

To illustrate the difference between Step 2 [Chevron reasonableness of interpretation test] and arbitrary and capricious review, consider the familiar example of a statute that declares, "No vehicles in the park."  "Vehicles" is ambiguous. An agency charged with implementing such a statute could reasonably consider automobiles and motorcycles to be vehicles, and thus prohibit them from the park. Bicycles, roller skates, and scooters might present closer calls. But consider a further possibility: the agency charged with implementing the statute confronts a serious problem of persistent litter in the park discarded by picnickers, and the trash has also started to attract bears and create a safety risk for visitors. Imagine that the park agency carefully studies the problem, assesses all the relevant evidence on trash levels and bear sightings, considers a broad range of alternative solutions, prepares a model benefit-cost analysis, and, in the end, provides cogent reasons for its decision to construe the "no vehicles in the park" provision to ban picnicking in the park. The agency could have fully met even the most rigorous demands of hard look review under the arbitrary and capricious standard, but it would still be precluded from interpreting "vehicles" to mean eating.  Construing "no vehicles" as "no picnicking" would prove unreasonable on interpretive grounds - no matter how reasonable and well-reasoned such a prohibition might be on the kind of policy grounds addressed by the arbitrary and capricious standard.