Notice & Comment

Carrying Out Agency Threats

In 1992, the IRS issued proposed regulations designed to combat a tax strategy used by the May Department Stores Company. Although the regulations were not immediately effective, the IRS announced that it when it finalized them, the regulations would apply retroactively to 1989. Consequently, some taxpayers took the proposed regulations into account in structuring their affairs, even though they technically lacked any legal effect. Apparently content with this state of affairs, the IRS let the proposed regulations sit on the shelf for a long time, even as May Company itself disappeared and folded into Macy’s.

But last month, the IRS withdrew the 1992 proposed regulations and in doing so, failed to carry out its promised threat. The IRS replaced the proposed regulations with temporary regulations, which are immediately effective but operate only prospectively.

Was this appropriate? One commentator has argued that the IRS’s about-face raises fairness concerns, because taxpayers who followed the 1992 regulations paid higher taxes while taxpayers who flouted them got away with it.

I agree that there’s a problem here, but I don’t think that the practitioner comments get to the root of it. Rather, I think the problem here stems from the IRS’s unique statutory authority to issue regulations retroactively. If an agency enjoys the power to change the law after the fact, taxpayers must always conduct their affairs under a cloud of uncertainty. I previously blogged about that point here.

The problems because further compounded when the agency does not respect the Administrative Procedure Act. One might laud the IRS for issuing the new regulations prospectively and backing off of its threat, but the new regulations were issued in temporary form, without notice and comment.

The IRS probably made the new regulations operate prospectively because the substance of those regulations differ substantially from the proposed regulations. Given these material differences, the IRS should have followed the APA and given the public a chance to comment on the new regulations, rather than make them immediately effective.

The May Company regulations nicely highlight another instance of the IRS acting differently from other agencies. Mayo v. United States may have killed tax exceptionalism in principle, but until the IRS decides to follow it, taxpayers will lack the democratic safeguards otherwise ensured by the APA.

By Andy Grewal

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