Regulations Interpreting Pre-1996 Code Provisions; Fixing Hewitt (1/6/22; 5/12/23)

Note: See discussion at the bottom of this blog entry of the Proposed Regulations to impose a new reporting obligation for past transactions not disclosed under  Notice 2017–10.

My immediate past posting was on Hewitt v. Commissioner, 21 F.4th 1336 (11th Cir. 2021),  11^th Cir. here and GS here.  See 11th Cir. Invalidates Proportionate Sharing Regulations As Procedurally Arbitrary and Capricious for Failing to Address a Significant Comment (12/30/21; 12/31/21), here.  In that blog entry, I discussed some administrative law issues, mostly the Administrative Procedure Act ("APA").  As I noted, the effect of Hewitt holding is only to declare the regulation invalid because of procedural irregularity under the APA's arbitrary and capricious standard in 5 U.S.C. § 706(2)(A), here (also called variously the State Farm test, the hard look test, and testing the regulation for the agency's reasoned decisionmaking).

Today, I add that Treasury may fix the regulations problem retroactively by a new round of Notice and Comment and promulgating a new regulation adopting an interpretation of the statute that will pass the arbitrary and capricious test of procedural regularity.  (Whether the regulation would be precisely the same as the one invalidated would depend on whether in light of experience and the comments the older invalidated regulation needs to be updated.)

Tax procedure enthusiasts will know that § 7805(b) provides limitations on retroactivity of regulations promulgated under § 7805(a).  I won't go through those limitations now but link the Code section here.  Those limitations were adopted in 1996.  Prior to 1996, Treasury regulations under § 7805(a) could be retroactive to the effective date of the statute being interpreted.  The reason is that, contrary to ill-considered claims by some courts and scholars of relatively recent vintage, § 7805(a) regulations are interpretive regulations which interpret the statute and do not create new law (a requirement for legislative regulations).  The current limitations in § 7805(b) as revised in 1996 do not apply to Code provisions enacted prior to 1996, so that the law of retroactivity for § 7805(a) regulations applies.  (I cover this in my 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, at pp. 61-62.  (As an aside, this retroactivity feature for regulations interpreting pre-1996  Code provision was the whole point of the United States v. Home Concrete & Supply, LLC, 566 U.S. 478, 504-505 (2012) where the regulation interpretation was retroactive and failed only because the interpretation (as opposed to the regulation) was foreclosed by the Supreme Court’s earlier Colony case (see particularly Justice Kennedy's dissent).) 

Thus, Treasury could adopt the interpretation now in a procedurally valid process.  So long as the interpretation was either the best interpretation (considering, if necessary, Skidmore) or no other interpretation was a better interpretation, it could prevail.  Indeed, depending upon how one reads Chevron, the interpretation might even prevail if another interpretation was a better interpretation, so long as the Treasury interpretation is lesser but reasonable  As I argue in the article I think the latter circumstance is a rare application of Chevron.  (See the Postscript to the article beginning on p. 118 of  the article, linked above but the Postscript only may be viewed and downloaded here.)

Finally, as I noted in the prior blog, the interpretation might prevail if IRS can argue that it is the most persuasive interpretation of the Code provision (considering Skidmore) or even if a court is in equipoise as to the best interpretation of the Code provision.  A new regulation might not be required.

Added 1/6/22 2:30pm:

Just for clarity, this is not a "Brand X" issue.  See Nat'l Cable & Telecomm. Ass'n v. Brand X Internet Servs., 545 U.S. 967 (2005) which held that a judicial interpretation of statutory text can be changed by a subsequent agency regulation unless the prior judicial interpretation precluded any different interpretation of the statutory text, a phenomenon encountered in Home Concrete.  I am not sure that Brand X can apply to a Circuit Court opinion at all to preclude an agency interpretation.  But even assuming it could, the 11th Circuit's opinion in Hewitt does not definitively and preclusively interpret the statutory text.  Indeed, as I read the opinion the only issue Hewitt addresses is the procedural validity of the regulation.  It does not interpret the statutory text at all.  Thus, although Brand X would permit Treasury to promulgate its interpretation even if Hewitt had held that the interpretation (as opposed to the regulation) was not correct, Treasury could adopt a regulation, retroactive as noted above, with the interpretation and have it prevail over any interpretation Hewitt might have adopted.  (As I said before, I don't think Hewitt adopted an interpretation of the statute.)

Added 1/7/22 10:45am

Section 170(h), the Code section in question was enacted in 1980. Tax Treatment Extension Act of 1980 (1980 Act), Pub. L. No. 96-541, sec. 6, 94 Stat. at 3206. The regulation in question was promulgated on January 14, 1986. T.D. 8069, 1986-1 C.B. 89.  The enacted date is the key date; so long as the enactment preceded 1996, the prior version of §  7805(b) applies.  The prior version was:  “(b) Retroactivity of regulations or rulings. The Secretary may prescribe the extent, if any, to which any ruling or regulation, relating to the internal revenue laws, shall be applied without retroactive effect.”  I cover the history of retroactivity under 7805(a) in my article pp. 54-64 and show that, as interpretive regulations, subject to general administrative law and APA interpretation, § 7805(a) regulations were retroactive except to the extent Treasury exercised its discretion to make them prospective only or perhaps to of public notice of the interpretation (such as a public Notice).  In any event, it is Treasury's sole discretion to forego retroactivity for a § 7805(a) regulation interpreting the statute enacted prior to 1996.  In this regard, the retroactivity of § 7805(a) regulations is consistent with the general administrative law rule before and after the APA that interpretive regulations are retroactive.  See article pp. 47-52.  

If it be thought that the 1996 amendments to § 7805(b) had the effect of repealing the prior version of § 7805(b) for pre-1996 statutes (a thought with no authority by the way), that would leave § 7805(b) as a nullity in its pre-1996 version and would leave the consistent interpretation of § 7805(a) regulations as being retroactive (which was the law from original enactment and was the reason §  7805(b) was needed in the first place).  That reading of §  7805(a) was consistent with administrative law and the APA.

As to the equities of applying a new regulation with the same interpretation retroactively, the public has been on notice of the Treasury interpretation of the Code provision since 1986.  All that has happened is that the Hewitt Court found a procedural footfault.  The Code provision has been ambiguous and in need of interpretation since its enactment.  Hence, Justice Kennedy's analysis in Home Concrete is quite on point where he noted that an interpretation by regulation that addresses a statutory ambiguity from enactment does not upset any settled expectations.  (See article p. 51.)  To repeat, here the public has on notice since 1986 of the interpretation within the scope of the statute's ambiguity.  No taxpayers can credibly claim that they were not on notice or that after 1986 they had any settled expectations as to a contrary interpretation.

Finally (at least for now), if Treasury can promulgate now a valid interpretive regulation to apply retroactively (with prudence perhaps dictating that it apply only back to 1986 when the procedurally failed regulation was adopted putting the public on notice of the interpretation (I think the law is clear that Treasury can)), the interpretation should be entitled to Chevron deference because again, no settled expectations as to any other interpretation.  That is for whatever marginal benefit Chevron deference may supply.  I repeat my claim in the Postscript of the article that, in fact, Chevron deference is marginal if even existent when a careful analysis is given.  Readers caring at all about my views should pull down the article and read the Postscript where I lay out the basis for my conclusions about the marginal, if any, real outcome determinative impact of Chevron.  If I am correct or even close to correct, the brouhaha about Chevron masks another agenda (mostly political and mostly rhetoric of the bad kind).

Added 5/12/23 11:00am:

As I suggested, the IRS could “fix” Hewitt with a new retroactive interpretive regulation. The IRS has proposed regulations for reporting parties and has skirted the retroactivity issue by imposing a new reporting obligation for transactions not previously disclosed under Notice 2017-10 beginning with the date of publication of the final regulations.  See 87 FR 75185, html here and pdf here (Explanation of Provisions, at ¶ VI. Effect of Transaction Becoming a Listed Transaction Under These Regulations, pp. 75193-75194 and ¶ VII. Applicability Date, p. 75194.) 

• For taxpayers, the look-back period for the new reporting obligation period for the new disclosure is the “the period of limitations for assessment of tax, including any applicable extensions, for any taxable year in which the taxpayer participated in the transaction has not ended on or before [DATE OF PUBLICATION OF FINAL RULE IN THE  FEDERAL REGISTER].” 
• Note that the statute of limitations on assessment is extended until “one year after the earlier of the date the participant discloses the transaction or the date a material advisor discloses the participation pursuant to a written request under section 6112(b)(1)(A).” 
• For material advisors “only if they have made a tax statement on or after [DATE 6 YEARS BEFORE DATE OF PUBLICATION OF FINAL RULE]."