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Court Decision Places Challenges on Previous Treasury Regulations
On 11 January 2011, the US Supreme Court decided Mayo Foundation for Medical Education and Research, et al. v. US, upholding a Treasury regulation that classifies medical residents who work more than 40 hours per week as full-time employees and thus ineligible for the "student" Federal Insurance Contributions Act (FICA) tax exemption. However, beyond its precise holding against these particular medical students, the Court used this decision to clarify a point of administrative law and dealt a severe, if not fatal, blow to taxpayers seeking to overturn "interpretative" Treasury regulations promulgated under Internal Revenue Code (IRC) Section 7805(a). Mayo is the culmination of three decades of agency administrative law review decisions by the Supreme Court and the end result of increasing judicial deference to IRS and other federal agency regulations. Taxand US discusses how this could have broad implications, not just for taxpayers dealing with IRS regulations, but for the entire field of administrative law.
Before the Mayo decision, the two main standards of review used to evaluate the validity of agency regulations were established by the Supreme Court in National Muffler and Chevron. According to the Court's analysis in these cases, the authoritative weight of a final Treasury regulation (and the judicial deference to such regulation) depended on whether the regulation was legislative or interpretative.
While it may be true that Chevron's two-step analysis is simpler to apply than National Muffler's multi-factor analysis, Chevron's requirement that an agency's regulations be given deference unless they are "arbitrary, capricious, and manifestly contrary to the statute" will be a difficult if not an impossible standard to meet for many taxpayers challenging interpretative Treasury regulations. Thus, in light of the Supreme Court's decision, it will be difficult for taxpayers to convince most courts that inconsistent or overreaching IRS interpretative regulations satisfy this high threshold and therefore should be found invalid. By affirming that courts must use the Chevron two-step analysis when reviewing both legislative and interpretative Treasury regulations, the Supreme Court appears to have completely eliminated the importance of the factors enumerated in National Muffler that have been part of the judicial analysis of interpretative Treasury regulations over the past 30 years.
Thus, the Mayo decision, and the corresponding increased deference that the IRS will argue should be given to interpretative, as well as legislative Treasury regulations, will make it much more difficult for taxpayers to successfully challenge interpretative IRS regulations that do not reflect Congressional intent or are inconsistent with the statute to which they relate.
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