In Mayo,1 the US Supreme Court ended the longstanding debate over the standard of review for tax regulations under I.R.C. § 7805(a) (at least those issued after notice-and-comment) by clarifying that the Chevron and Mead framework2 governs. While Mayo arguably raises the bar for challenges to tax regulations, it leaves unanswered questions surrounding the role of legislative history in reviewing regulations, the necessity for tax regulations to comply with the Administrative Procedures Act (APA), the ability of an agency to promulgate regulations to overrule court decisions that are not yet final and the extent to which tax regulations can be issued so as to apply retroactively.3
Heightened Deference for Tax Regulations
The issue in Mayo was the validity of general authority tax regulations addressing whether medical residents who generally work more than 40 hours per week are students exempt from paying certain employment taxes. The regulations, which were promulgated after notice-and-comment under the general authority provided by I.R.C. § 7805(a) to "prescribe all needful rules and regulations for the enforcement" of the Internal Revenue Code, provided a prospective rule that any employee normally scheduled to work 40 hours or more per week does not, per se, qualify for this student exception.4 Mayo Foundation argued that the regulations were invalid because the plain language of the statute provided otherwise.
Finding the statutory text ambiguous, the Supreme Court had to decide whether a special administrative review standard applies for tax law only, as implied by National Muffler and subsequent opinions, or whether it should apply the same standard to tax regulations as to the rules of any other agency. The Court expressly rejected the idea of a special tax standard, obsoleting National Muffler and Rowan,5 and clarifying that the Chevron and Mead framework applies.
The Supreme Court explained that its opinion in Mead provides that Chevron deference is appropriate when: (A) it appears that Congress delegated authority to the agency generally to make rules carrying the force of law; and (B) the agency interpretation claiming deference was promulgated in the exercise of that authority. It found that the authorization provided in I.R.C. § 7805(a) is a "very good indicator" of congressional delegation, and that the use of notice-and-comment procedures is a "significant" sign that regulations merit Chevron deference. The Court easily found that the regulations at issue, which were put through notice-and-comment procedures, met these requirements.
The Supreme Court’s application of Chevron’s two-pronged test6 was straightforward. First, it found that neither the plain text of the statute nor the district court’s interpretation of the student exemption demonstrated that Congress had directly addressed the precise question at issue. Moving to step two, the Supreme Court found that the regulations were a "reasonable interpretation" of the statutory text, acknowledging that regulatory action often requires the drawing of lines and finding the 40-hour limitation to be a sensible way of distinguishing between workers who study and students who work.
Future Impact of Mayo
The future impact of Mayo will likely be a subject of much debate and litigation. The Supreme Court recognized the importance of maintaining a uniform approach to judicial review of administrative action and thereby arguably raised the bar for challenges to APA compliant tax regulations.7 However, the Court’s rationale and focus on the specific facts may limit its application in future cases.
The silver lining for taxpayers is that the Court’s approach can be read to clarify the importance of the APA in evaluating the validity of tax regulations. The Internal Revenue Service’s (IRS) current position is that regulations issued pursuant to I.R.C. § 7805(a) are not subject to the APA’s strict notice-and-comment requirements because they are exempt as "interpretative" rules (i.e., they are not "legislative" rules which are subject to notice-and-comment). However, in administrative law, "legislative" rules are understood to encompass binding regulations that carry the force of law. This arguably conflicts with the IRS’s general litigating position that all tax regulations are binding and carry the force of law. After Mayo, courts may be more receptive to taxpayer arguments that general authority regulations are "legislative" rules subject to the APA’s notice-and-comment requirements.
In Mayo, the Supreme Court confined its analysis of congressional intent to the text of the statute, without considering legislative history or its role in determining the validity of regulations. Moreover, the Court’s reliance on legislative history and its importance in the Chevron analysis has fluctuated over the years, depending on whether the authoring judge falls more in the textualist or the purposivist camp.8 Until the Supreme Court explicitly addresses this issue, which it did not do in Mayo, litigants will continue to argue this point.9
Finally, Mayo says nothing about the appropriateness of retroactive regulations or whether an agency can overrule the Supreme Court’s construction of a statute. Although the Mayo Court observed that in a prior case it had invited the IRS to amend its regulations if troubled by the Court’s opinion, this statement was made in the context of a 2001 opinion that interpreted the consolidated return regulations in a manner different from the IRS’s interpretation.10 It remains to be seen whether this rationale will be extended to situations where the Supreme Court has rejected an agency’s litigating position and the agency then promulgates new regulations codifying its rejected position.
While the Supreme Court’s opinion in Mayo reflects a recent shift toward granting heightened deference to agency rules and regulations, it leaves many questions for another day. That day may be coming soon, given the spate of cases currently pending in the appellate courts challenging the validity of regulations on the six-year limitations periods under I.R.C. §§ 6229 and 6501 and regulations on equitable relief under I.R.C. § 6015(f).