The Legality of Retroactive Treasury Regulations

One of the most common questions we get from clients that are themselves tax attorneys or CPAs is whether the U.S. Department of the Treasury can promulgate regulations with retroactive effect.

Standard Analysis

The 1996 Taxpayer Bill of Rights introduced relief from retroactive application of Treasury regulations.[1] Therefore, any cases prior to 1997 that permitted retroactivity were effectively overruled by statute.[2]

Internal Revenue Code section 7805(b) explicitly holds that any regulation promulgated within 18 months of a statute’s enactment has retroactive application to the date of enactment. If the final regulation is anticipated to be finalized beyond the 18-month threshold, Treasury, in order to preserve retroactivity of any future final regulation, must publicly publish (1) a notice substantially describing the contents of any proposed or temporary regulation, (2) an actual proposed or temporary regulation, or (3) file a regulation with the Federal Register.[3] Any one of these three “public publishing” regulatory actions will allow a final properly promulgated regulation to have retroactive application to the date of that specific tax law’s enactment.

Congress has also statutorily allowed retroactivity of a final regulation if the regulation is intended to prevent abuse,[4] if intended to correct procedural defects, if done so with explicit Congressional authority in the statute, or if allowed as an election designed to improve a taxpayer’s situation. Treasury may also limit a court ruling’s retroactive application for the benefit of taxpayers.[5] None of this applies, however, to internal Treasury regulations pertaining to departmental or agency policies, practices, and procedures.[6]

The two primary substantive exceptions to the 18-month and public publishing rules are the “prevention of abuse” and “congressional authorization” exceptions.

With regard to the “prevention of abuse,” the regulation, even if expressly designed to prevent abuse, must be designed to prevent the type of abuse that Congress sought to prevent in the underlying statute.[7] If it is not designed to prevent the type of abuse Congress intended to prevent, Treasury must have explicit statutory authorization to apply regulations retroactively.[8] Absent the use of the term “retroactive” in the statute with regard to Treasury’s regulation promulgating authority, a court will not find there to be an explicit grant of retroactive authority.

Thinking Out of the Box

The United States Constitution, Article 1, Section 10, Clause 1, declares that ex post facto laws are unconstitutional, which has come to be known as the Ex Post Facto Clause.[9] Although the Ex Post Facto Clause has been held not to apply to procedural laws,[10] the U.S. Supreme Court has held that courts must mandatorily look to the substance of the law itself rather than the classification of the law to determine whether it is substantive or procedural.[11] Federal courts have held that retroactive civil laws merely exposing a person to civil penalties warranted application of the Ex Post Facto Clause to invalidate it.[12] And the United States Court of Appeals for the Sixth Circuit has even found that mere administrative regulations were substantive enough to warrant classification as a “law” for the purpose of invalidating them under the Ex Post Facto Clause.[13]

Therefore, it is not impossible for the Ex Post Facto Clause to apply to Treasury regulations being applied retroactively even if Congress permitted it under Section 7805(b).

Conclusion

Theoretically, any Treasury regulation having retroactive application is subject to potential challenge under the Ex Post Facto Clause of the United States Constitution. Practically, if there has been no public publishing of a temporary or proposed regulation and regulatory action is not anticipated within 18 months from the date the statute was enacted, it would be incumbent upon taxpayers to engage in planning before there is a public publishing.

Application to Section 965

For example, in the context of Section 965, Congress did not explicitly grant the authority to promulgate retroactive regulations.[14] Therefore, in order to apply regulations retroactively in this context, Treasury must show that any future regulation is intended to prevent abuse.[15] However, Treasury is limited to retroactively applying any future regulations to prevent the type of abuse that Congress intended to prevent with the enactment of Section 965. The type of abuse Congress intended to prevent was the accumulation of corporate earnings and profits in low-tax or no-tax jurisdictions. Section 965 was not intended to capture innocent taxpayers living in jurisdictions with higher tax rates than the U.S., such as Australia, France, and the United Kingdom.

Therefore, in the context of Section 965 as applied to taxpayers in similar or higher-tax jurisdictions, regulations may only apply retroactively to the date of enactment if done so under the 18-Month or Public Publishing Exception. Even then, taxpayer may take the position that this violates the Ex Post Facto Clause and disclose their legal position on IRS Form 8275-R.


[1] See Taxpayer Bill of Rights 2, PL 104–168, Title XI, § 1101(a) (July 30, 1996).

[2] See Auto. Club of Mich. v. C.I.R., 353 U.S. 180 (1957) (now-reversed-by-statute holding that Secretary had sole and complete discretion to apply regulations retroactively); also see Dillon Ranch Supply v. U.S., 652 F.2d 873 (9th Cir. 1981); May Seed & Nursery Co. v. C.I.R., 242 F.2d 151 (8th Cir. 1957); but see C.I.R. v. Commodore, 135 F.2d 89 (6th Cir. 1943) (holding that if Congress did not authorize retroactivity for regulations, Commissioner could not make regulations retroactive). Other now-reversed-by-statute cases had held that regulations could even be promulgated and unfairly applied to matters pending litigation, which was patently inequitable for tax litigants and was the driving force behind the Taxpayer Bill of Rights of 1996. See Wilson v. U.S., 588 F.2d 1168 (6th Cir. 1978); Exel Corp. v. U.S., 451 F.2d 80 (8th Cir. 1971); U.S. v. Fenix & Scisson, Inc., 360 F.2d 260 (10th Cir. 1966). Thankfully, there were courts at that time that agreed that promulgating regulations to gain an advantage in pending litigation was undemocratic and inequitable. See Chock Full O’ Nuts Corp. v. U.S., 453 F.2d 300 (2d Cir. 1971).

[3] See IRC § 7805(b) Retroactivity of regulations. (1) In general.--Except as otherwise provided in this subsection, no temporary, proposed, or final regulation relating to the internal revenue laws shall apply to any taxable period ending before the earliest of the following dates: (A) The date on which such regulation is filed with the Federal Register. (B) In the case of any final regulation, the date on which any proposed or temporary regulation to which such final regulation relates was filed with the Federal Register. (C) The date on which any notice substantially describing the expected contents of any temporary, proposed, or final regulation is issued to the public.

[4] See Cemco Investors, LLC v. U.S., 515 F.3d 749 (7th Cir. 2008).

[5] Congressional blue book history shows this may only be exercised for the benefit of taxpayers; not to their detriment to deny refund claims.

[6] See IRC § 7805(b)(5).

[7] See Sala v. U.S., 552 F.Supp.2d 1167 (D.Colo. 2008); also see Murfar Farms LLC v. U.S., 88 Fed.Cl. 516 (Fed.Cl. 2009).

[8] See Stobie Creek Investments, LLC v. U.S., 82 Fed. Cl. 636 (2008), aff’d, 608 F.3d 1366 (Fed. Cir. 2010).

[9] See U.S. Const. art. I, § 10, cl. 1.

[10] See Donald v. Jones, 445 F.2d 601 (5th Cir. 1971).

[11] See Collins v. Youngblood, 497 U.S. 37 (1990).

[12]. Temple-Inland, Inc. v. Cook, 82 F. Supp. 3d 539 (D. Del. 2015)

[13] See Shabazz v. Gabry, 900 F. Supp. 118 (E.D. Mich. 1995), aff’d in part, rev’d in part, 123 F.3d 909 (6th Cir. 1997).

[14] See IRC § 965(o)(1)-(2).

[15] See IRC § 7805(b)(3).

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