by John Anthony Castro, J.D., LL.M.
One question that comes up quite often with our clients is why some of our legal positions are contrary to established Treasury regulations. Yes, it is lawful to take a legal position contrary to an established regulation. For that reason, IRS Form 8275-R, Regulation Disclosure Statement, exists. You can read the Instructions for Form 8275-R by clicking here.
There is a misconception in the public that a properly promulgated regulation is akin to federal law. As attorneys, we know that nothing could be further from the truth, but we also appreciate that not everyone has a law degree, so we now publish this article to clarify how and when a Treasury regulation will be respected by the federal courts and, more importantly, when it will be invalidated by a federal court.
General Counsel for the U.S. Department of the Treasury and the IRS Office of the Chief Counsel should pay special attention to this article because it is the only way they will successfully navigate the new hostile environment in the federal judiciary that is effectively applying strict scrutiny to Treasury regulations.
What follows below is the new gauntlet that all Treasury regulations must survive in order to be deemed a valid regulation entitled to judicial deference.
1. Is the applicable portion of the Treasury regulation or treaty technical explanation arguably in your favor?
a. Yes. This is the rare scenario where the regulation, as written, clearly supports your position, but the IRS is arguing an unreasonable interpretation of their own regulation. Argue the regulation or technical explanation is clear on its face to win pursuant to Kisor v. Wilkie, No. 18-15 (S. Ct. 2019) (Only genuinely ambiguous regulations are entitled to deference; if the regulation is unambiguous, the Court will hold them to the clear wording.). Any surrender to the notion that the regulation is not clear will result in defeat since the court will be bound to defer to the agency’s interpretation. This is a viable litigation strategy in any federal court. BEWARE: If the statute was amended after the promulgation of the regulation, the U.S. Court of Appeals for the Federal Circuit held that the previously promulgated regulation is effectively superseded by a future statutory amendment. Norman v. U.S., 942 F.3d 1111 (Fed. Cir. 2019). However, if Treasury updates the regulation without taking into account the statutory amendment, then a strong case can be made that Treasury made an intentional decision to keep the regulatory limitation on said statute. In the treaty context, this holds true as well; however, there is one major difference. If the treaty's Technical Explanations (legal equivalent of bilateral regulations) interpret a treaty in a manner that is incompatible with the plain meaning of the treaty's actual terms, the other country can object to that interpretation and initiate the Mutual Agreement Procedures to settle the matter. The settlement will likely be upheld in a U.S. federal court as long as it is reasonable. If, however, the settlement agrees on an interpretation that clearly conflicts with the plain meaning of the terms in the treaty, it may be overturned by the courts.
b. No. Go to # 2.
2. Read the full and complete applicable statute or treaty provision word-for-word. Identify the portion relevant to your issue. Is the relevant portion of the statute or treaty clear on its face and in your favor with regard to your specific issue (e.g., there are no ambiguities or gaps)?
a. Yes. The portion of the regulation purporting to interpret the statute is invalid pursuant to Intermountain v. C.I.R., 134 T.C. 211 (2010) (If a Court rules that a statute is unambiguous, it forecloses Treasury's ability to fill-in any “gaps;” Treasury regulations cannot fill-in any gaps and are thus not entitled to Chevron judicial deference). You need to dig-in your heels are ague the wording is clear and unambiguous in order to prevail. Again, Any surrender to the notion that the statute of treaty provision is not clear will result in defeat since the court will be bound to defer to the agency’s interpretation. File the case with the U.S. Tax Court for an instant victory based on the Intermountain case as binding precedent.
b. No. Go to # 3.
3. Identify the relevant portion of the statute or treaty. Grab a set of various dictionaries and research the plain meanings of each term in the relevant portion. Does the IRS interpretation stretch the plain meaning of any term in the statute or treaty in such a way that, if not for that unreasonable interpretation, it would go in your favor?
a. Yes. The regulation is invalid pursuant to U.S. v. Home Concrete & Supply, LLC, 132 S. Ct. 1836 (2012) (the definition of “omission” cannot reasonably include an “overstatement” in basis; conflicts with plain meaning in statute). You must be prepared to explain why their interpretation is unreasonable. For example, in the U.S. Supreme Court case of Home Concrete, it was the fact that the definition of "omission" is something that you leave out of the return; not something you add in. In that case, the taxpayer overstated basis, which was not an outright omission of income subject to the penalty for omitting income. Adding something to the return is the opposite of leaving something out; hence, an overstatement of basis could not be classified as an omission despite the logical fact that it results in lower taxable income. However, in the recent case of Association for Community v. U.S., No. 19-5212 (D.C. Cir. July 17, 2020), the taxpayer tried to argue that the IRS's interpretation of "short-term limited duration insurance" was unreasonable even though the IRS interpreted in a manner that was less than industry average. The taxpayer lost because the IRS's interpretation of the term was, in fact, reasonable. Had the taxpayer's attorneys read this article, they would have known to focus on the Congressional Bluebook.
b. No. Go to # 4.
4. Research the Congressional Bluebook on the statute or treaty. Read floor statements made by members of the House and Senate. Identify the original intent of Congress in enacting the statute; look for any expressed intent in the congressional record or statements by the Joint Committee on Taxation. Identify the specific and limited issues that Congress was trying to address and resolve. With this newfound understanding of Congressional intent in enacting the statute or treaty and any amendments or protocols thereon, do any parts of the regulation or technical explanation at issue exceed Congressional intent? In other words, is the agency twisting the original purpose and intent of the statute or treaty?
a. Yes. The regulation is invalid pursuant to Dominion Res., Inc. v. U.S., 681 F.3d 1313 (Fed. Cir. 2012) (regulations cannot exceed the unambiguously expressed intent of Congress); also see Nat’l Westminster Bank, PLC v. U.S., 512 F.3d 1347 (Fed. Cir. 2008) (regulations cannot be inconsistent with the treaty’s purpose and intent.). File your case with the U.S. Court of Federal Claims in Washington, DC, for an instant victory based on the binding precedent cited here.
b. No. Go to # 5.
5. Is the regulation reasonable? In a recent case from the U.S. Court of Appeals for the Third Circuit (SIH Partners v. C.I.R., 923 F.3d 296 (3d Cir. 2019)), the court held that reasonableness is determined at the time of promulgation notwithstanding information or insight acquired later. Absent the regulation being nonsensical, random, unclear, unusual, and unnecessarily burdensome, it will be upheld. This severely weakened regulations attacks based on the Administrative Procedures Act. Regulations are generally always clear, methodical, based on formulae, rational to effectuate legislative intent, and straightforward to comply with. For that reason, it's the final consideration. Did the promulgation of the regulation comport with the Administrative Procedures Act?
a. Yes. The regulation is valid. You have no recourse and must fully comply with the regulation.
b. No. The regulation is invalid as a matter of law. File your case with the U.S. Court of Federal Claims in Washington, DC, for the highest likelihood of victory. The U.S. Court of Federal Claims will give a higher degree of deference to a ruling from a U.S. Court of Appeals whereas other courts are more likely to review de novo.
As you can see, this is not an easy task. Regulations are not infallible. Regulations are not law unless valid in accordance with the rules herein. It is lawful tax planning to have a well-articulated legal position contrary to an established regulation as long as there is a well-supported argument as to why the regulation is invalid.
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If you or your client are facing a regulation that you believe is invalid, contact our firm today to schedule a free consultation by clicking here to submit your information online and be contacted by our firm.
About the Author
John Anthony Castro, J.D., LL.M., is the Managing Partner of Castro & Co., the author of International Taxation in Plain English as well as International Estate Planning in Plain English, an esteemed graduate of Georgetown University Law Center in Washington DC, an OPM Fellow at Harvard Business School, and an internationally recognized tax attorney with offices in New York, Los Angeles, Miami, Chicago, Dallas, and Washington DC.
Bluebook Citation: John Anthony Castro, Step-by-Step Guide to Challenging the Validity of Treasury Regulations, Castro Int’l Tax Blog (October 8, 2019) url.