New Tax Rule Challenges May Follow Memorandum Release

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By Alison Bennett

Sept. 26 — The release of a decades-old memorandum exempting most tax regulations from a high level of federal review could give ammunition to taxpayers who want to push back on a broad range of IRS rules, tax attorneys told Bloomberg BNA.

“I think this is significant. I think you're going to see taxpayers use it in challenging regulations,” former Internal Revenue Service Chief Counsel Donald Korb said Sept. 26.

The 1983 memorandum, recently released under the Freedom of Information Act, cites an agreement between the Treasury Department and the Office of Management and Budget waiving OMB review of virtually all IRS regulations not deemed “major legislative regulations” or those that would have a “significant economic impact” of $100 million or more.

The document highlights a growing debate over whether tax regulations are interpretive or legislative at a time when more taxpayers are taking those regulations to court, in cases dealing with such issues as cost-sharing and techniques for “stripping” income out of the U.S. Korb, now of counsel with Sullivan & Cromwell LLP, said the memorandum could serve as “an arrow in the quiver” for more cases—including attacks on older rules.

Impact on Economy

To date, the IRS has taken the position that nearly all of its regulations are interpretive, not legislative, and wouldn't have a big impact on the economy—a stance sharply criticized by all the attorneys interviewed.

“The idea that a tax regulation doesn't have a significant impact on the U.S. economy is egregious on its face,” Robert J. Kovacev, a partner with Steptoe & Johnson LLP, said Sept. 23. “The memorandum raises serious questions about how the government has handled its review. I think it's evidence that the IRS and Treasury really have not been following the rules.”

Kovacev and others said the memorandum could add momentum to the idea that IRS rules should be subject to the Administrative Procedure Act, which requires federal regulations to meet a variety of requirements.

The IRS has frequently said in the preambles to its regulations that the guidance is interpretive and won't have a significant economic impact, without further explanation.

Treasury, OMB Defend Memorandum

A Treasury spokeswoman declined to comment on the agreement with OMB Sept. 23. However, Treasury Assistant Secretary for Tax Policy Mark Mazur defended it to the Government Accountability Office in an Aug. 18 letter.

“In recent years, no change in circumstances has occurred that would warrant changes to or a reaffirmation of the agreement,” Mazur wrote in the letter, which was attached to a September GAO report calling for a fresh look at the IRS regulatory review process (173 DTR G-3, 9/7/16).

However, Mazur said, “Treasury and OMB are examining the relevance of the long-standing agreement” discussed in a draft version of the report. He also said Treasury will consider ways to better notify taxpayers of regulations, as well as possibly seeking comments “on the economic or other impact of certain proposed rules.”

Separately, a top OMB official defended the memorandum Sept. 22 at a hearing of the Senate Homeland Security and Governmental Affairs Subcommittee on Regulatory Affairs and Federal Management.

Howard Shelanski, administrator of OMB's Office of Information and Regulatory Affairs, said the purpose of the document is to acknowledge that the “vast majority” of IRS rulemakings are purely interpretive rules that are directly implementing statutory directives from Congress into the tax code. “And often those have to be put in place rather quickly so people can do new tax planning, and there’s very little value to another layer of review,” Shelanski told Subcommittee Chairman James Lankford (R-Okla.).

`Force and Effect of Law.'

Tax attorneys told Bloomberg BNA the idea that the majority of IRS regulations are interpretive just doesn't take facts into account.

In a Sept. 26 interview, Brian Kittle, a partner at Mayer Brown LLP, said the IRS “has never disagreed that their regulations have the force and effect of law,” and the government's position that taxpayers have to follow the rules or face penalties makes them legislative. “I do think the IRS needs more stringent internal policies to understand when something might be subject to different levels of review,” Kittle said. “Taxpayers need more transparency into the rulemaking process.”

Edward Froelich, of counsel with Morrison & Foerster LLP, said Sept. 26 that over the past 30 years, “the incredible process of regulations stemming from the code itself has simply ballooned. There are so many things that have a major economic impact.”

At the Senate subcommittee hearing on Sept. 22, the Shelanski reiterated the government's position that the majority of rules are interpretive, but stressed that “the IRS is in fact not exempt from OIRA review.” Rules that don't fit the description of “interpretive” do come to his office—the IRS just does few of those, he said.

Inversions Rules Reviewed

The OMB official said his office reviewed two IRS rules intended to crack down on multinational corporations that move overseas to shrink their tax bills, a strategy known as corporate inversions. “Those would not fall within the exemption or the memorandum of understanding,” he said “because those don’t fit the definition of interpretive rules.”

Cause of Action Institute, the conservative group that filed the FOIA request, said it is high time IRS rules undergo more scrutiny. “Agencies of the federal government should not operate by secret agreement with the White House,” Alfred J. Lechner, the institute's president and chief executive officer, said in a Sept. 23 statement. “Lawful prepublication reviews are critical to the regulatory process to ensure that rules are developed in a fair and transparent manner. The IRS has skirted these rules for far too long.”

The Institute describes itself as a tax-exempt public interest law firmthat represents pro bono clients in government investigations and public law matters. Progressive media watchdog groups, including the Center for Media and Democracy, have said the institute has close ties to the conservative Koch brothers.

With assistance from Cheryl Bolen in Washington.

To contact the reporter on this story: Alison Bennett in Washington at

To contact the editor responsible for this story: Meg Shreve at

For More Information

Text of the Treasury-OMB memorandum is in TaxCore.

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