Chevron and the IRS

Overturning the Chevron Doctrine

In a year of major Supreme Court decisions, one of the most consequential and controversial ones may not have had the same spotlight and focus as the rest. On June 28, 2024, the Supreme Court overturned the Chevron doctrine in Loper Bright Enterprises v. Raimondo, No. 22-451. In brief, the Chevron doctrine arose from a 40-year old Supreme Court case of Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837. This landmark decision established the requirement (i.e., the Chevron doctrine) that courts must defer to a federal agency’s reasonable interpretation of an ambiguous statute even where the court concluded that a different interpretation was better supported. The reasonableness was applicable so long as the interpretation was not “arbitrary, capricious or manifestly incompatible with the statute.” The courts had to do so by first reviewing whether or not Congress directly spoke to the issue. If so, the agency’s interpretation must echo Congress’s direct intent. If Congress was silent on the issue, the court must hold in favor of the agency’s (reasonable) interpretation.

The Internal Revenue Service (“IRS”) was one of the agencies empowered to interpret otherwise ambiguous sections of the law – specifically the Internal Revenue Code (the “Code”) – in a favorable way to the agency’s goals. The reasonableness of the interpretation was also weighed heavily by the courts in favor of the agency.  

With the 6-3 Loper Bright decision, the Chevron doctrine has been overturned. Now taxpayers will have new opportunities to challenge both existing case law that was settled in favor of the IRS and even those regulations that previously appeared out of reach due to the application of Chevron doctrine. Loper Bright removed the presumption of deference to agency interpretations and instead held that it is up to the courts to decide the best reading of an ambiguous statute. An agency’s interpretation of a statute will not receive the same, if any, level of judicial deference. In other words, both a taxpayer and the IRS must argue for the best interpretation of an ambiguous law.

IRS Regulations

How does this affect current IRS regulations, Revenue Rulings, and other agency rules issued by the Treasury?

Congress usually authorizes the IRS to promulgate whatever regulations it feels is necessary to enact a given section of the Code. For example, Code Section 954(b)(5) directs the IRS (via the Secretary of the Treasury) to issue regulations on which deductions are ‘properly allocable’ to certain categories of income. Historically, this has been settled law and such regulations would be enforced by the courts as the only reading of a specific Code section. Now, it is much less clear what sort of deference the courts will give to IRS regulations where the authority for rule-making has been directly ceded to the agency.

Another big question is how much deference the courts will grant to the “catch all” provision of the code in Section 7805(a), which directs the IRS to “prescribe all needful rules and regulations for the enforcement of this title.” In United States v. Mead Corp., 533 U.S. 218 (2001), the Supreme Court stated that Chevron deference is appropriate “when it appears that Congress delegated authority to the agency generally to make rules carrying the force of law, and that the agency interpretation claiming deference was promulgated in the exercise of that authority.” Now, Chevron is no more. This provision, then, is unlikely to be enough to save a “reasonable” agency reading of an otherwise ambiguous Code section relying on general rulemaking authority in light of the Loper Bright decision. Even the aforementioned specific grants of authority may be looked at with more scrutiny.

Courts have previously decided tax cases on Chevron doctrine grounds. For example, Chevron played a major role in Whirlpool Financial Corp. v. Commissioner, 154 T.C. 142 (2020). The Tax Court relied on Chevron to reject Whirlpool’s challenge to the manufacturing branch rule in IRS Treas. Reg. 1.954-3(b)(1)(ii), holding that “whether section 954(d)(2) is viewed as ambiguous or silent,” the regulations are a “reasonable interpretation” of the statute and that the statute does not “unambiguously foreclose” the interpretation set forth in the regulations. This case would have almost certainly been decided differently today.

There are even more headaches in store for the IRS. A number of challenges to the most recent IRS regulations arising from the 2017 Tax Cuts and Jobs Act are currently going through the courts.
These include Sections 78 (grossing up income by deductions for foreign taxes for which a taxpayer also claims a foreign tax credit), 245A (providing a participation exemption for dividends from certain foreign subsidiaries), 951A (providing for US taxation of global intangible low-taxed income or GILTI), and 960 (deeming certain foreign taxes as paid by US shareholders for purposes of the foreign tax credit). In these cases taxpayers have often argued that IRS regulations are contrary to the plain language of a given statute. The IRS, on the other hand, has argued that the relevant statutes are ambiguous (and should therefore be resolved in the agency’s favor). Now the IRS argument holds much less weight – probably none at all. If a court determines that Congress did not explicitly give the IRS authority to prescribe an exact regulation, the “best” interpretation will now hold the most sway (at least as determined by a given court).

Certainly the IRS will continue to rely on and reference its own regulations in all tax controversies and matters before any court. This will, then,  cause more litigation as taxpayers will undoubtedly pressure-test the extent of the Loper Bright decision. For the first time in a long time, the historical tactic of the IRS to pressure litigation is flipped, as agencies all over the country can no longer rely on the blunt instrument of the Chevron doctrine.

About the Author

Yuri Mitchell concentrates his practice in the representation of businesses and individuals in a variety of tax and corporate matters. His clients rely on him for his understanding of the legal and financial landscape in the areas of entity choice and formation, mergers and acquisitions, restructurings, and the associated tax impact of a particular transaction. Learn more.