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Jack Cummings
Treasury Regulations Still Subject to Invalidation

Despite recent Tax Court decision in Mayo.

February 10, 2011
by Jack Cummings, JD

Many practitioners are concerned that the Supreme Court's recent decision in Mayo Foundation for Medical Education and Research et al. v. United States, 107 A.F.T.R. 2d 2011-341 (01/11/2011) means that taxpayers will never again win a dispute with the IRS over the validity of its regulations. Not to worry; the decision does not have so broad a reach.

The Supreme Court rejected a challenge to Treasury's 2004 regulation defining a medical resident as a worker and not a student for purposes of Federal Insurance Contributions Act (FICA) taxation. It made clear that the standard of deference to regulations announced in Chevron U. S. A. Inc. v. Natural Resources Defense Council, Inc., 467 U. S. 837 (1984) applied, rather than a special standard peculiar to tax regulations known as the National Muffler test.

The opinion suggests that it will result in more — rather than less — deference for Treasury regulations and many practitioners fear that Treasury will exceed its proper power in writing regulations. However, the concerns are overblown.

Facts

Mayo Clinic didn't want to treat its medical residents as employees for tax purposes, relying on an exemption in the statute for students, defined as:

  • a student,
  • who is enrolled in a school that employs the student and
  • who is enrolled in and regularly attends classes at the school.

Mayo's residents fit all three requirements. But the IRS found that the residents did not satisfy the test that the educational aspect must be "incident to and for the purposes of pursuing a course of study."

The Eighth Circuit ruled in 1998, with respect to the Social Security Act equivalent of the student exception, that the Social Security Administration could not automatically eliminate medical residents from the student category because its regulations provided for a "case-by-case approach." This lead to the IRS receiving a flood of claims seeking FICA tax refunds on the ground that medical residents qualified as students under Section 3121(b)(10). In 2004, Treasury revised the regulations to preclude a student working a normal work week of 40 hours from ever being treated as a student, regardless of the educational component of the work.

Court's Reasoning

The Supreme Court rejected Mayo Clinic's challenge to the regulation by reasoning that the statute was ambiguous and Treasury's interpretation was a reasonable one. The Court was not concerned that Treasury had changed its regulation to overturn a court ruling. The Court applied the Chevron standard of deference to administrative regulations even though this regulation was isssued under code section 7805(a), which historically has been viewed as authorizing interpretive regulations, as contrasted with legislative regulations, like the consolidated return regulations.

Analysis of Opinion

The Merits. The opinion basically allowed the Treasury to ignore the fact that medical education is occurring while the resident works because "in the vast majority of cases ... employees who are working enough hours to be considered full-time employees ... have filled the conventional measure of available time with work, and not study." That is, the opinion adopted a sort of "close enough for government work" justification for a rule that actually might not be properly applied to a true work/study overlap case.

If the Court had recognized that full-time work could also be study, Mayo Clinic might still have lost under the general rule, which Mayo did not contest, that the study aspect must be predominant.

Tax Is Not Special

The Mayo opinion clearly brings tax regulations into the mainstream of the courts' authority to review agency regulations and ends the view of tax practitioners that "tax is special" for this purpose. The surprising aspect of this announcement is that the opinion indicates the traditional test for tax regulations was less deferential to Treasury than the Chevron text.

The older Supreme Court opinions frequently said things like the Treasury and IRS were "masters of the subject," which sounded pretty deferential. But the Mayo opinion thought the former standard put too much emphasis on facts like whether the Treasury had been consistent in its interpretation or whether it had waited too long to issue regulations. Mayo says those factors don't matter. All that matters is whether the statute is ambiguous and whether the regulation is a reasonable interpretation.

Interpretive v. Legislative Regulations Distinction. Most persons with general knowledge of the status of Treasury regulations are familiar with the traditional distinction between a "legislative regulation" and an "interpretive regulation." The former is thought to invest a lot of discretion in the Treasury because the congress told it to write the regulation as it saw fit; the latter is thought to invest little discretion because courts can figure out what a statute means as well as the Treasury.

The Mayo opinion ignored the distinction and indicated that what have been called interpretive regulations are subject to Chevron deference so long as the court also found that the statute was ambiguous, meaning it did not resolve the particular issue of the case.

Notice and Hearing. Treasury promulgated the regulation at issue under the notice and hearing process prescribed by the Administrative Procedure Act for regulations that are not merely interpretive regulations. The Mayo opinion noted this fact as one of several indicia that the regulation was due Chevron deference. It did not state that notice and hearing is a necessary precondition of Chevron deference, and it should not be. That would install an arbitrary determinant for deference. Surely, Treasury could not prevent effective review of a regulation that was clearly contrary to the statute by the ploy of issuing it with notice and hearing.

Conclusion

Some are reading Mayo to mean that Treasury can write pretty much any regulation it wants and the courts must uphold them. That is not likely to be true in practice, at least if the case gets to the Supreme Court. The problem for taxpayers will be that government litigators will adopt a Treasury-always-wins gloss on Mayo, particularly if the regulation is issued after notice and hearing. Taxpayers must stand firm and argue that notice and hearing does not immunize regulations. They also must continue to stress the importance of all evidence of Congress' intent in both steps of the Chevron analysis.

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Jack Cummings, Alston & Bird LLP, Raleigh, NC 919-862-2302. He was an IRS Associate Chief Counsel (Corporate) in 2000 and 2001.

2011 Jasper L. Cummings, Jr.