The compliance of tax regulations with administrative law was a major theme in notable federal tax decisions in the first half of 2022, while the U.S. Supreme Court revived a law firm's day-late levy challenge in the U.S. Tax Court.

Here, we review those changes and other significant tax rulings by federal courts in the first half of the year.

APA Regulatory Challenges

In March, a Sixth Circuit panel found that the U.S. Department of the Treasury complied with notice-and-comment requirements under the Administrative Procedure Act in issuing a regulation addressing the distribution of proceeds following judicial extinguishment of conservation easements.

The Sixth Circuit affirmed a decision by the U.S. Tax Court that denied a roughly $9.5 million conservation easement deduction to Oakbrook Land Holdings, which had challenged the agency's APA compliance in issuing the regulation used to reject its tax break. Oakbrook had claimed the deduction under Internal Revenue Code Section 170(h) on its 2008 returns after donating 106 acres to a land conservancy.

The Oakbrook decision set up a circuit split with the Eleventh Circuit regarding the same regulation. In December, an Eleventh Circuit panel deemed the proceeds rule invalid, finding Treasury failed to comply with the APA in finalizing it. The court said that the administrative law mandates an agency to sufficiently respond to significant public comments when finalizing regulations.

The Eleventh Circuit decision came in a case brought by David and Tammy Hewitt, who had claimed a $2.8 million deduction for their easement split in 2012, 2013, and 2014. The federal government has said it would not challenge the Eleventh Circuit's decision in the U.S. Supreme Court.

Also in March, a Sixth Circuit panel revived an Ohio construction company's challenge to a 2007 Internal Revenue Service notice requiring the disclosure of possibly abusive benefit trust arrangements on pain of penalty. The Sixth Circuit panel said IRS Notice 2007-83 imposed new rules to disclose potentially abusive trust arrangements using cash-value life insurance policies and should've been put through formal notice-and-comment procedures. The IRS’ failure to do that flouted the APA, the court said.

Mann Construction had asked the Sixth Circuit to overturn a Michigan federal court decision upholding more than $26,000 in penalties against the company for violating the notice.

In April, a Colorado federal court partially sided with telecommunications firm Liberty Global in its case seeking to invalidate temporary Treasury rules. Those regulations limited deductions on repatriated earnings. The court found Treasury had failed to provide a sufficient notice-and-comment period under the APA in issuing the temporary regulations, which retroactively applied to a transaction Liberty Global undertook in 2018. However, the court didn't review whether Treasury had the authority to issue the rules or to make them retroactive.

The regulatory validity issue central to the Hewitt and Oakbrook cases could influence future regulatory releases by Treasury, said Nancy McLaughlin, a professor at the University of Utah's S.J. Quinney College of Law. Regarding the agency's need to respond to comments, she said, "what constitutes a significant comment — that's in the eye of the beholder."

"How is this going to affect decades-old regulations that are fundamental to tax law?' she asked. "Going forward, how is it going to affect how the Treasury has to promulgate regulations?"

Bryan Camp of the Texas Tech University School of Law said that Treasury will face pressure to submit IRS guidance to additional review due to the APA litigation. Another option would be for Treasury to require the IRS to put all guidance through the notice-and-comment process, which would delay its release, he said.

"The more delay that you bake into the system, the guidance system, the more delay you put in it, the more it hurts honest taxpayers because they don't know how to do things correctly," Camp said.

Guidance delays also affect tax practitioners because they don't know how to advise their clients properly, and delays could encourage some taxpayers to "play the audit lottery" and take extreme positions, he said.

There will likely be more cases brought forward challenging regulations and subregulatory guidance under the APA, Camp said. Challenges to the validity of subregulatory guidance under the APA are already commonplace outside tax, he said.

"Practitioners are committing malpractice if they don't consider challenging unfavorable guidance," he said. "They will want to attack that guidance as a disguised legislative rule under the APA, and then say, 'Hey, it didn't go through proper notice-and-comment procedure, so it's invalid.'"

Day-Late Levy Suit

In April, the Supreme Court unanimously decided the Tax Court had the authority to consider a one-day-late challenge brought by North Dakota law firm Boechler PC against an IRS levy. The justices said a 30-day deadline under Section 6330(d)(1) for bringing lien and levy challenges wasn't a jurisdictional bar to clear for Tax Court consideration.

The justices remanded the case for further proceedings on whether equitable tolling — which in some cases can extend the statute of limitations — should apply to Boechler's petition. The firm's dispute with the IRS centered on a notice the firm got in 2015 detailing a discrepancy between information Boechler reported to the agency and to the Social Security Administration, per court filings.

The firm didn't respond to the IRS correspondence, and the IRS then indicated it would levy its property, a determination affirmed in collection-due-process hearings. Boechler missed its deadline to file a Tax Court petition challenging that determination by one day, court filings show.

Camp said the decision was consistent with prior rulings on statutory timing requirements in other areas of law. There aren't a large number of applications asking for equitable tolling, Camp said, so he doesn't expect the decision will result in significant changes. However, the decision does open the door for IRS Office of Chief Counsel attorneys and judges to respond in varying ways to missed deadlines.

"When you take a rule and you start allowing exceptions, you now are putting discretion in the hands of the various judicial actors," he said. "Whenever you have discretion, there's always room for inconsistency, if you will."

FOIA Suit Revived

The Eighth Circuit in June revived a public records suit by a Harvard law professor and tax clinic director against the IRS seeking portions of the Internal Revenue Manual instructing agency employees on how to confirm the identities of third parties that claim to represent taxpayers. The agency has started requiring representatives to verify their identities by furnishing their Social Security numbers, according to the Eighth Circuit.

The appellate court found that a Minnesota federal court abused its discretion by not privately reviewing parts of the manual that were withheld from T. Keith Fogg's Freedom of Information Act request when considering whether the agency was right to hold on to them.

The agency's affidavit supporting withholding of those parts of the manual incorrectly called the IRS a law enforcement agency when it's actually a federal agency with mixed law enforcement and administrative roles, the Eighth Circuit said.

Fogg said the case matters for other FOIA litigation in showing the IRS serves as more than just a law enforcement agency. He said the Eighth Circuit's concern about the affidavit's focus should cause the IRS to better craft its statements to the court down the road.

"The case has potential importance if practitioners can learn what happens to their personal identifying data as part of client representation," he said. "Because the Eighth Circuit remanded the case for an in camera inspection, the outcome on this point remains unknown."

Published on July 11, 2022