Regulations Interpreting Pre-1996 Code Provisions; Fixing Farhy (5/11/23; 5/12/23)

In Farhy v. Commissioner, 160 T.C. No. 6 (4/3/23), TN here and GS here, the Tax Court held that the Code did not give the IRS authority to assess § 6038(b)(1) or (2) penalties, here. Specifically, the Tax Court held that § 6201(a) did not authorize these penalties. I posted some concerns about the correctness of Farhy in a blog. Tax Court Holds that IRS Has No Authority to Assess § 6038(b) Penalties for Form 5471 Delinquencies (Federal Tax Procedure Blog 4/3/23; 4/23/23), here. Is there some possible self-help fix the IRS could use to pre-empt the Tax Court’s Farhy decision?

An interpretive regulation could fix the problem for the IRS. I noted such a fix for the Eleventh Circuit’s opinion in Hewitt v. Commissioner, 21 F.4th 1336 (11th Cir. 2021),  11^th Cir. here and GS here holding an interpretive regulation from the 1980s procedurally invalid for the foot-fault of failing to respond in the regulation to a comment which the Court second-guessed to be material to the rulemaking enterprise. The fix is for Treasury to adopt a replacement interpretive regulation and make it retroactive to the effective date of the regulation or retroactive to some point in between that would pick up all the syndicated shelters currently in the pipeline. Regulations Interpreting Pre-1996 Code Provisions; Fixing Hewitt (Federal Tax Procedure Blog 1/6/22; 5/12/23), here. That proposed fix was anchored in the pre-1996 § 7805(a), which generally unquestionably allowed retroactivity for interpretive regulations and that authority remained for pre-1996 Code provisions.

The same fix can work for § 6201(a). The relevant statutory language is:

The Secretary is authorized and required to make the inquiries, determinations, and assessments of all taxes (including interest, additional amounts, additions to the tax, and assessable penalties) imposed by this title.

That text’s "including" clause should be sufficiently capacious to be read as including provisions not specifically enumerated. § 7701(c) (“The terms ‘includes’ and ‘including’ when used in a definition contained in this title shall not be deemed to exclude other things otherwise within the meaning of the term defined.”) That avoids a dumb result -- Congress imposes a penalty treated generally as a tax without authority to assess which is just a formal recording of a liability Congress clearly meant to impose.

Just as in the statute in Hewitt, the § 6201(a) statutory language long preceded the key date of 1996. See 6201(a), here, under the Notes tab showing no amendments to the quoted portion of § 6201(a). Therefore, as noted in the Fixing Hewitt blog linked above, Treasury has authority to promulgate an interpretative regulation with retroactive effect. (Actually, the 1996 change to § 7805 did not change the ability to adopt interpretive regulations to apply retroactively, but there are some who think that it did; hence, I will not waste time addressing that erroneous notion. See John A. Townsend. The Report of the Death of the Interpretive Regulation Is an Exaggeration 54-64 (SSRN December 14, 2021), here with extensive discussion of the trajectory of § 7805 from inception through the 1996 amendments establishing both that before and after 1996 interpretive regulations under § 7805 can be retroactive under the APA, but the key point here is that interpretive regulations under pre-1996 Code provisions clearly can be retroactive regardless of any alleged change in 1996.

To close the loop on that, it is clear that, if within the reasonable interpretive space allowed by Chevron, the Treasury has interpretive authority over that space even if there is a prior judicial opinion. See  National Cable & Telecommunications Association v. Brand X Internet Services, 545 U.S. 967 (2005), here. Of course, this all depends upon what, if anything, the Court determines on the merits in Loper Bright Enterprises v. Raimondo (SEC) (Dkt 22-451). See Supreme Court Grants Cert to Consider Overruling or Clarifying Chevron (Federal Tax Procedure Blog 5/1/23), here.

And, if the IRS appeals Farhy and prevails (meaning the DC Circuit to which Farhy is appealable thinks the IRS position is the best interpretation), the regulation would then virtually assure other Courts of Appeals and the Tax Court would follow suit because it would certainly be a reasonable interpretation entitled to Chevron deference (again, depending upon the outcome of Loper Enterprises). (Note, a reader advised me that Farhy is appealable to the DC Circuit rather than the 9th Circuit; I have corrected that point and thank the reader for the need to correct.)

Added 5/12/23 11:00 am:

I suggested above an interpretive regulation with retroactive effect as I had suggested for  the conservation easement regulations in Hewitt. See Regulations Interpreting Pre-1996 Code Provisions; Fixing Hewitt (Federal Tax Procedure Blog 1/6/22; 5/12/23), here.  I have just updated that blog entry to discuss Treasury's fix by proposed regulation to impose a new reporting obligation after the proposed regulations are finalized for past unreported transactions. I encourage readers to consider that discussion as a potential solution to the issue in Farhy.