Earlier this week, the Seventh Circuit issued its opinion in Roberts v. Commissioner , holding that a taxpayer’s efforts regarding his race horses amounted to a business under the tax code, and not a mere hobby, such that the taxpayer could enjoy various deductions. The court reversed the Tax Court’s contrary determination, finding that the lower court “felt itself imprisoned by a goofy regulation.” (If this casual language leads you to guess that Judge Posner authored the 7th Circuit’s opinion, you would be correct.)
The regulation, 26 C.F.R. 1.183-2(b), sets forth a number of facts relevant to determining whether an activity is not engaged in for profit (i.e., is a hobby) or is instead related to business/profit-oriented endeavors. Nine specific factors are described in detail, but (here’s the “goofy” part) the regulation seems to say that those factors don’t necessarily matter. Under the regulation, “[n]o one factor is determinative,” and the factors are not even exhaustive– “it is not intended that only the factors described . . .are to be taken into account.” And a quantitative analysis of the factors also does not necessarily help, because the IRS also warns that determinations should not “be made on the basis that the number of factors . . . indicating a lack of profit objective exceeds the number of factors indicating a profit objective, or vice versa.”
In thinking about this regulation, some broad issues related to Auer deference came to mind. Under Auer v. Robbins, courts offer a degree of deference to an agency’s construction of its own regulations, and this deference arguably implicates separation of powers concerns. Consequently, Auer has come under attack from some Justices and scholars. Critics argue that Auer may encourage an agency to draft deliberately ambiguous regulations, strategically reserving the power to address ambiguities in their favor as they arise.
The jury remains out on the extent to which agency officials would actually act this way, but the “goofy regulation” in Roberts nicely illustrates how Auer deference could be perverted into a device for agency gamesmanship. Roberts did not involve the construction of a legal ambiguity in the regulation but, if an agency wanted to act in bad faith, 26 C.F.R. 1.183-2(b) would provide a nice template for that behavior. The agency could list a number of factors relevant to an important determination, announce that none of them really matter (thereby creating the ambiguity), and then claim Auer deference when a legal question arose regarding the construction of the regulation.
I don’t mean to suggest that the IRS acted in bad faith when it promulgated 26 C.F.R. 1.183-2(b). The exquisite vagueness of the regulation accommodates the necessarily fact-intensive determinations related to a taxpayer’s motive for entering an activity. (There are many other, better examples of bad IRS behavior.) However, as scholars and courts continue to debate whether to retain Auer, they should keep in mind that some agency regulations are left deliberately vague. And even if noble intentions drive that vagueness, Auer deference perhaps offers an unfair advantage to the relevant agency and might encourage more of the odd disclaimers seen in the “goofy regulation” at issue in Roberts.