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Supreme Court Overrules Chevron, Opening the Door to Extensive Challenges to Tax Regulations

(Parker Tax Publishing July 2024)

The Supreme Court overruled Chevron U.S.A. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984), under which courts generally defer to permissible agency interpretations of ambiguous statutes those agencies administer, potentially opening the door to challenges to even longstanding IRS regulations. The Court held that when interpreting statutes administered by federal agencies, courts are required to exercise their independent judgment and may not defer to an agency interpretation of the law simply because a statute is ambiguous. Loper Bright Enterprises, et al. v. Raimondo; Relentless, Inc. et al. v. Dept. of Commerce, et al., 2024 PTC 237 (S. Ct. 2024).

The Chevron Doctrine

In determining whether an administrative agency (the IRS, for example) has exceeded its statutory authority in promulgating a rule or regulation, courts applied the two-step analysis set forth in Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984). First, the court determined "whether Congress has directly spoken to the precise question at issue." If congressional intent was clear, that was the end of the inquiry. But if the court determined that the statute is silent or ambiguous with respect to the specific issue at hand, the court was required, at Chevron's second step, to defer to the agency's interpretation if it "is based on a permissible construction of the statute."

An example of a recent case involving the application of the Chevron rule in the tax context is a case decided earlier this year by the Southern District of New York: State of New Jersey, State of New York, and State of Connecticut v. Mnuchin; Village of Scarsdale, N.Y. v. IRS, 2024 PTC 120 (S.D. N.Y. 2024). In that case, several states and a locality sought to invalidate a 2019 IRS regulation that generally prevented them from using state or local tax credits as a "workaround" for the $10,000 limit on the state and local tax (SALT) deduction enacted by the Tax Cuts and Jobs Act (TCJA). Applying Step 1 of Chevron, the court found that the Code does not unambiguously address the specific question of whether contributions made to state and local governments in exchange for tax credits are deductible as charitable contributions under Code Sec. 170. Proceeding to Step 2, the court found that the IRS's interpretation of "contribution or gift" as being offset by the amount of any "return benefit" was a permissible construction of Code Sec. 170. The court said that under the "rather minimal requirement" of Chevron, the IRS had provided a reasoned explanation for its promulgation of the final regulations.

Loper Bright Enterprises

For years, conservative legal scholars and interest groups have argued that Chevron gave administrative agencies too much power and impermissibly reduced the role that courts play in interpreting federal statutes.

In 2023, the Supreme Court agreed to reconsider Chevron when it granted certiorari in two cases involving challenges to a regulation on fishing vessels that operate in the Atlantic herring fishery. The fishing vessels objected to a federal regulation that required them to pay for observers on board their vessels for the purpose of collecting data necessary for conservation and management of the fishery. In two separate cases, the D.C. Circuit and the First Circuit applied the Chevron doctrine and upheld the validity of regulation. In granting certiorari, the Supreme Court limited its review to the question whether Chevron should be overruled or clarified.

Supreme Court's Analysis

In an opinion delivered by Chief Justice Roberts, a 6-3 majority of the Supreme Court overruled Chevron. The Court held that the Administrative Procedure Act (APA) requires courts to exercise their independent judgment in deciding whether an agency has acted within its statutory authority and may not defer to an agency interpretation of the law simply because a statute is ambiguous.

The Court began by noting that that the Constitution gives the federal judiciary the responsibility and power to adjudicate "Cases" and "Controversies." According to the Court, it was the Framers' understanding that the final "interpretation of the laws" would be the province of the courts. This understanding was embraced by the Supreme Court in the foundational decision of Marbury v. Madison, where Chief Justice Marshall famously declared that it is the duty of the courts "to say what the law is." The Court observed that, even as the New Deal ushered in a rapid expansion of the administrative state and new agencies with new powers proliferated, the Court continued to adhere to the traditional understanding that questions of law were for courts to decide, exercising their independent judgment.

The Court also found that when Congress enacted the APA in 1946, it provided procedures for agency action but also delineated the basic contours of judicial review of such action. Section 706 of the APA directs that "to the extent necessary to decision and when presented, the reviewing court shall decide all relevant questions of law, interpret constitutional and statutory provisions, and determine the meaning or applicability of the terms of an agency action." Section 706 further requires courts to "hold unlawful and set aside agency action, findings, and conclusions found to be ... not in accordance with law." In the Court's view, Section 706 makes clear that agency interpretations of statutes - like agency interpretations of the Constitution - are not entitled to deference. The Court stated that the APA, in short, incorporates the traditional understanding of the judicial function, under which courts must exercise independent judgment in determining the meaning of statutory provisions.

The deference that Chevron requires of courts reviewing agency action cannot, in the Court's view, be squared with the APA. The Court said that Chevron, decided in 1984 by a bare quorum of six Justices, triggered a marked departure from the traditional approach. In the Court's view, Chevron defies the command of the APA that "the reviewing court" - not the agency whose action it reviews - is to "decide all relevant questions of law" and "interpret statutory provisions." Chevron requires a court to ignore, not follow, "the reading the court would have reached" had it exercised its independent judgment as required by the APA. Moreover, the Court noted that Chevron demands that courts mechanically afford binding deference to agency interpretations, including those that have been inconsistent over time. This is true, the Court noted, even when a pre-existing judicial precedent holds that the statute means something else - unless the prior court happened to also say that the statute is "unambiguous."

The Court noted that under Skidmore v. Swift & Co., 323 U.S. 134 (1944), courts exercising their independent judgment may seek aid from the interpretations of those responsible for implementing particular statutes. In Skidmore, the Court found that such interpretations "constitute a body of experience and informed judgment to which courts and litigants may properly resort for guidance" consistent with the APA. In a case involving an agency, the Court said that the statute's meaning may well be that the agency is authorized to exercise a degree of discretion. Congress has often enacted such statutes - for example, some statutes expressly delegate to an agency the authority to give meaning to statutory terms, and others empower an agency to prescribe rules to fill in the details of a statutory scheme or to regulate subject to the limits imposed by the statute. According to the Court, when the best reading of a statute is that it delegates discretionary authority to an agency, the role of the reviewing court under the APA is, always, to independently interpret the statute and effectuate the will of Congress subject to constitutional limits.

The contention advanced by the government and the dissent that statutory ambiguities are implicit delegations to agencies was rejected by the Court. Ambiguities may, the Court found, result from an inability on the part of Congress to squarely answer the question at hand, or from a failure to even consider the question with the requisite precision. According to the Court, Chevron's presumption is perhaps most fundamentally misguided because "agencies have no special competence in resolving statutory ambiguities. Courts do." The point of the traditional tools of statutory construction, the Court said, is to resolve statutory ambiguities, and that is no less true when the ambiguity is about the scope of an agency's own power. The Court said that in that context, abdication in favor of the agency is perhaps least appropriate.

The Court clarified that its ruling does not mean that Congress cannot confer discretionary authority on agencies. Congress may do so, the Court noted, and often has. But to ensure that courts do not engage in discretionary policymaking that is the province of the political branches, the Court said that judges need only to fulfill their obligations under the APA to independently identify and respect such delegations of authority, police the outer statutory boundaries of those delegations, and ensure that agencies exercise their discretion consistent with the APA.

Observation: Regulations issued under a specific grant of authority from Congress (legislative regulations) are more likely to withstand taxpayer challenges than regulations that simply provide the IRS's interpretation of the controlling statute (interpretive regulations). In addition, under Skidmore (which remains good law), courts will continue to take into account the IRS's expertise when considering challenges to regulations. In this vein, Tax Court Judge Elizabeth A. Copeland stated at a June 28 tax controversy forum at New York University that "Treasury and the IRS have special expertise in interpreting tax statutes" and that she would "continue to give substantial weight to statutory interpretations in Treasury regulations."

The Court noted that, although it overruled Chevron, it did not call into question prior cases that relied on the Chevron framework. The holdings of those cases that specific agency actions are lawful are still subject to statutory stare decisis despite the Court's change in interpretive methodology. Mere reliance on Chevron, the Court stated, cannot constitute a "special justification" for overruling such a holding.

In a dissenting opinion joined by Justices Sotomayor and Jackson, Justice Kagan wrote that for 40 years, Chevron deference was understood by the Court to be rooted in a presumption of legislative intent. Justice Kagan said that Congress knows it does not - in fact cannot - write perfectly complete regulatory statutes. Inevitably, Justice Kagan reasoned, those statutes will contain ambiguities that some other actor will have to resolve. And in the view of Justice Kagan, Congress would usually prefer that actor to be the responsible agency, not a court, given that interpretive issues often involve scientific or technical subject matter about which agencies have expertise and courts do not. Justice Kagan also said that statutory interpretations often involve policy tradeoffs and observed that agencies report to a President, who is politically accountable, whereas courts have no such accountability and no proper basis for making policy.

Observation: In another case decided just days after Loper Bright, the Supreme Court held that a lawsuit under the APA challenging the validity of a regulation does not accrue for purposes of the six-year statute of limitations under 28 U.S.C. Section 2401(a) until the plaintiff is "injured by final agency action" (Corner Post, Inc. v. Board of Governors of the Federal Reserve System, 2024 PTC 239 (S. Ct. 2024)). Previously, some courts had held that the six-year period of limitations began to run when the final regulation was published. Under Corner Post, even longstanding IRS regulations may be subject to taxpayer challenges if those challenges are brought within six years of a taxpayer's having been "injured" by the final rule.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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