Supreme Court's Mayo Foundation opinion grants Chevron deference to Treasury regulations.

• Author: Sloan, Clifford M.

For decades, many taxpayers and the government have disagreed over the level of deference that courts should grant to Treasury regulations. In Mayo Foundation for Medical Education & Research v. United States, 131 S. Ct. 704 (2011), the Supreme Court of the United States, in an opinion authored by Chief Justice John Roberts, unanimously and emphatically resolved that disagreement in favor of the government. Henceforth:

* Courts will apply the two-part Chevron inquiry to Treasury regulations and therefore will defer to a properly issued Treasury regulation if that regulation reasonably resolves a statutory ambiguity.

* All Treasury regulations, whether issued pursuant to the general grant of rulemaking authority in section 7805(a) of the Internal Revenue Code or pursuant to a more specific congressional grant of rulemaking authority, will be evaluated under the Chevron framework.

* The history of the regulation, such as whether it represents a reversal of Treasury policy or whether it was issued in response to government litigation losses, is irrelevant to the question whether the regulation is valid.

* The Supreme Court, absent strong justification, will not treat tax law differently from other areas of administrative law.

The most immediate effects of the Mayo Foundation decision will be felt in litigation, where challenges to regulations will center on the substance of the regulations rather than their history. But the effects of the decision are unlikely to be limited to litigation. Mayo Foundation may change the way that both Treasury and the Internal Revenue Service approach the issuance of guidance. The decision may also have subtle effects on the interaction between taxpayers and those responsible for drafting revenue legislation in Congress. Finally, the decision, which rejects the concept of tax "exceptionalism," may undermine the sense among tax practitioners, inside and outside the government, that tax law is distinct from all other areas of administrative law.

The Mayo Foundation litigation

1. Background

   Mayo Foundation arose out of a recurring dispute between the IRS and the medical community over whether medical residents are "students" who are therefore exempt from FICA taxation. The "student exemption" dates back to 1939, and provides that employment, for FICA tax purposes, shall not include "service performed in the employ of a... university.., if such service is performed by a student who is enrolled and regularly attending classes." I.R.C. [section] 3121(b)(10). For more than 50 years, the Treasury regulations have provided "[a]n employee who performs services in the employ of a school, college, or university as an incident to and for the purpose of pursuing a course of study at such school, college, or university has the status of a student in the performance of such services." See T.D. 6190, [section] 31.3121(b)(10)-2(c), 1956-2 C.B. 605, 653.

   Medical residents inhabit a netherworld between student and professional status. On the one hand, residents at the Mayo Clinic take part in a "formal and structured educational program," which includes assigned readings, weekly lectures, and written examinations. Mayo Foundation, 131 S. Ct. at 708-09. On the other hand, Mayo residents "spend between 50 and 80 hours a week caring for patients," are paid "annual 'stipends' ranging between $41,000 and $56,000," and receive "health insurance, malpractice insurance, and paid vacation time." Id. at 708.

   In 1998, the Eighth Circuit held that medical residents were students for purposes of the Social Security Act's student exception, which is identical to the FICA student exemption. See Minnesota v. Apfel, 151 F.3d 742, 743 (8th Cir. 1998). The Apfel decision triggered an "avalanche" of litigation and "prompted the filing of more than 7,000 claims with the IRS, as medical schools sought refunds of FICA taxes on medical resident 'wages,' based on the student exception." Mayo Foundation for Medical Education & Research v. United States, 568 F.3d 675, 676-77 (8th Cir. 2009). After the government lost many of these cases, it decided to change the rules of the game. In 2004, after giving public notice and soliciting comment, the Treasury Department issued new regulations that set forth a simple rule: Any full-time employee (including any employee who works more than 40 hours a week) cannot qualify for the student exemption from FICA. Treas. Reg. [section] 31.3121(b)(10)-2(d)(3)(iii). Given the notorious working hours of most medical residency programs, the regulation effectively denied the student exemption to all medical residents.

   Mayo Foundation brought litigation asserting that the regulation was invalid. The district court agreed and struck down the regulation. 503 F. Supp. 2d 1164 (D. Minn. 2007). The Eighth Circuit, however, reversed the district court and reinstated the regulation. See 568 F.3d 675 (8th Cir. 2009). At the urging of Mayo Foundation and numerous amici from the medical community, the Supreme Court granted certiorari. 130 S. Ct. 3353 (2010).

2. National Muffler or Chevron?

   In his unanimous 8-0 opinion for the Court, (1) Chief Justice John Roberts first concluded that the definition of a "student" in the FICA student exemption was ambiguous. Because of conflicting Supreme Court precedents, however, it was not clear what the Court should do after concluding that the statutory text was ambiguous. Two of the Court's precedents created a conflict that for years had divided the lower courts: National Muffler Dealers Association, Inc. v. United States, 440 U.S. 472 (1979), and Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984), applied different standards to administrative agency regulations that resolved statutory ambiguities.

   National Muffler, which had deferred to a Treasury regulation, suggested that the Court should examine the history of the regulation to determine whether it merited judicial deference:

   In determining whether a particular regulation carries out the congressional mandate in a proper manner, we look to see whether the regulation harmonizes with the plain language of the statute, its origin, and its purpose. A regulation may have particular force if it is a substantially contemporaneous construction of the statute by those presumed to have been aware of congressional intent. If the regulation dates from a later period, the manner in which it evolved merits inquiry. Other relevant considerations are the length of time the regulation has been in effect, the reliance placed on it, the consistency of the Commissioner's interpretation, and the degree of scrutiny Congress has devoted to the regulation during subsequent reenactments of the statute. National Muffler, 467 U.S. at 477.

   By contrast, Chevron, a later decision that deferred to an Environmental Protection Agency regulation, offered a different approach to judicial review of regulations:

   When a court reviews an agency's construction of the statute which it administers, it is confronted with two questions. First, always, is the question whether Congress has directly spoken to the precise question at issue. If the intent of Congress is clear, that is the end of the matter; for the court, as well as the agency, must give effect to the unambiguously expressed intent of Congress. If, however, the court determines Congress has not directly addressed the precise question at issue, the court does not simply impose its own construction on the statute, as would be necessary in the absence of an administrative interpretation. Rather, if the statute is silent or ambiguous with respect to the specific issue, the question for the court is whether the agency's answer is based on a permissible construction of the statute. Chevron, 467 U.S. at 842-43 (footnotes omitted). Entirely absent from Chevron's two-part test was any inquiry into the motivations for and history of the challenged regulation.

   In the years after the two cases were decided, the Supreme Court cited both National Muffler and Chevron when evaluating challenges to Treasury regulations. See, e.g., United States v. Cleveland Indians Baseball Co., 532 U.S. 200, 219 (2001) (citing National Muffler); Cottage Sav. Association v. Commissioner, 499 U.S. 554, 560-61 (1991) (same); United States v. Boyle, 469 U.S. 241, 246 n.4 (1985) (citing Chevron).

   The lower courts were justifiably confused about the proper standard for reviewing Treasury regulations. The Tax Court held that Chevron did not displace the National Muffler inquiry in tax cases. See Swallows Holding, Ltd. v. Commissioner, 126 T.C. 96, 131 (2006), rev'd, 515 F.3d 162 (3d Cir. 2008); see also id. at 180-81 (Holmes, J., dissenting) (cataloging positions of courts of appeals). Several circuits continued to cite National Muffler after Chevron. See, e.g., United States v. Tucker, 217 F.3d 960, 965 (8th...