REASONABLE TAX RULES: ADVANCING PROCESS VALUES WITH REMEDIAL RESTRAINT.

• Author: Puckett, James M.

INTRODUCTION 279 I. TAX RULES PROVIDE (UN)WELCOME "GUIDANCE" 285 II. CHALLENGES TO AGENCY RULES 291 A. Impermissibility Under the Organic Statute 293 B. Timing of APA-Based Challenges to Rules 294 C. "Hard Look" Review 298 D. Notice and Comment and Related Problems of Retroactivity 300 E. Remedies for the Violation of APA Requirements 303 III. REMEDIAL RESTRAINT 304 A. The Rule of Prejudicial Error 305 B. Circumstances Indicative of Harmless Error 309 1. Inadequate Explanation 309 2. Notice and Comment 311 C. No Tax-Specific Considerations Against Remedial Restraint 314 1. Congressional Control 315 2. Judicial Review 318 3. Self-Assessment and Voluntary Compliance 319 4. Public Participation in Tax Rulemaking 322 IV. CLARIFYING THE TAX ADMINISTRATION'S FRICTION WITH THE APA 324 A. Tax Rules (Including Regulations) May Qualify as "Interpretative Rules" 325 1. Defining "Interpretative" Rules 326 2. The I.R.C.'s Retroactivity Provisions Corroborate the Concept of Interpretative Tax Rules (Including Regulations) 332 B. Retroactivity of Tax Rules 334 C. Principal Challenges 341 1. Inadequate Explanation Challenges 343 2. Challenges Alleging Defective Notice and Comment 345 3. Retroactivity 347 CONCLUSION 348 INTRODUCTION

The tax administration is at risk of an overcorrection with respect to its rulemaking process. Tax rules include regulations, revenue rulings, revenue procedures, and more informal guidance to the public. Following the Supreme Court's 2011 decision in Mayo Foundation for Medical Education & Research v. United States, (1) Administrative Procedure Act-based challenges to tax rules have gained traction in the courts. (2) Meanwhile, the weight of tax scholarship criticizes "tax exceptionalism" (3)--the notion that tax is deeply different from other fields of law or requires special administrative procedures or judicial review. Overcorrection, however, could also represent a kind of exceptionalism. This Article argues that judicial review of the tax administration's compliance with the Administrative Procedure Act (4) (APA) should avoid reflexive vacatur of rules that experienced process defects. Moreover, this argument does not amount to tax exceptionalism; scholarship and jurisprudence outside of tax inspire and support an approach to judicial review involving nuance and restraint.

Scholars concerned about exceptionalism rightly urge the tax administration to comply with the APA. (5) This could amount to more of an attitude adjustment than an earthquake. This is especially true if, as this Article suggests, the courts proceed to take a flexible approach to review of tax rules. Over time, such an approach may help distinguish policy preferences of tax practitioners from prejudicial errors of the tax administration. Thus, implementing a more thoughtful, systematic compliance with the APA should not end up wrecking the tax administration.

The tax community, to be sure, is still digesting the Supreme Court's landmark decision in Mayo Foundation. (6) The Mayo Foundation challenged a Treasury regulation clarifying whether medical residents qualified as students. (7) Given that the Treasury Department took an unremarkable notice and comment procedure before finalizing the regulation, the Supreme Court deferred under Chevron? This clarification has not been uncontroversial among the tax bar. Practitioners also have pivoted from the Court's skepticism about "an approach...good for tax law only" (9) to bring APA-based challenges to tax regulations. (10)

In this period of borrowing, learning, deconstruction, and growth, the avoidance of exceptionalism should not be talismanic. There is a clear risk of oversimplification as tax lawyers, scholars, and jurists wrestle with APA concepts that have relatively recently started to come into focus. (11) Undoubtedly, the implication will sometimes be that courts subject tax rulemaking to costly procedural requirements under the APA or perhaps disallow administrative action that is apparently permitted by the I.R.C. (12) At the same time, a wide-ranging general administrative law literature and jurisprudence cautions against over-proceduralization of administrative action. (13)

At the risk that it may resemble exceptionalism, this Article posits that the case against hyper-formal compliance with the APA will benefit from tax-specific context. This is not to suggest that the tax administration should take a system-wide free pass. Rather, it is important to anticipate the critique that anything but rigid compliance with the APA would be unacceptable or exceptionally harmful in the tax administration. Nothing about this context, however, gives great cause for concern.

Given the text of the I.R.C., the history of tax collection and administration, and the current context, (14) the general argument for judicial restraint maps naturally onto tax administration. Litigation about tax rules will be particularly imbalanced, even compared with a larger administrative state that is easily dominated by regulated groups. Taking this into account does not render the project an example of "exceptionalism" or "tax exceptionalism." The intent is to consider whether there is any cause for concern about a general approach to balancing agency effectiveness, public participation, and other values. (15) Even if there are important patterns in tax administration, courts should carefully consider the unique facts of each case. In general, courts reviewing agency action soften rules, if not openly balance, and are wary of imposing procedures that are not explicitly required. Even so, compliance is costly. (16) Whatever the potential benefits, additional funding for tax administration seems quite unlikely to be on the horizon. (17)

Professor Kristin Hickman and Mark Thomson have argued for opening the door--but seemingly just a crack--to a harmless error analysis in judicial review of postpromulgation comment. (18) Although this may be a step in the right direction, their proposal has a limited scope. Arbitrary and capricious review may prove more of a threat to tax rules than the timing of public comment. Moreover, Hickman and Thomson would put a heavy burden on agencies to show harmless error. (19) The showing they have envisioned would emphasize open-mindedness on the part of agencies. (20) This would be especially troublesome in the tax administration. Because standing to litigate tax matters is especially hard to demonstrate, the open mind would, even more than usual, tend to move in favor of special interests. If this approach leads to more litigation and provides false hope, it could be worse than a strict compliance approach.

This Article, in contrast, recommends a more flexible approach, drawing on many administrative law scholars who have questioned the benefits of rigid adherence to the APA. Even for seemingly bright-line rules, context matters, or should matter. (21) It is appropriate to question the benefits and costs of procedures or remedies--particularly when not explicitly required by statute. (22) In addition, judges have, at least implicitly, struck a balance. To avoid tax exceptionalism, these themes must be considered carefully.

Executive orders, other forms of presidential control, or internal discretion may result in additional limits on the Treasury Department and IRS. (23) For example, on March 5, 2019, the Treasury Department announced a general, nonbinding policy of endeavoring to use notice and comment rulemaking to issue regulations, even if the APA does not require it; of avoiding the issuance of temporary regulations without good cause; and of forgoing claims of deference for subregulatory guidance. (24) Not long afterwards, the IRS Office of Chief Counsel issued a notice suggesting that it could still argue for a lesser form of deference for subregulatory guidance. (25) In addition, an October 9, 2019, executive order requires notice and comment for the issuance of a "significant guidance document"; this may or may not be intended to supersede the apparent allowance of subregulatory guidance in the Policy Statement. (26)

Importantly, these general policies are not particularly sticky. Either of these policies could be waived or applied creatively by the Treasury or the President, respectively. Indeed, shortly afterwards, the Treasury Department issued temporary regulations claiming good cause for an APA exception from the usual notice and comment procedures. (27) Moreover, executive orders or policy statements can be reversed without any public participation. (28)

This Article proceeds in four parts. Part I notes that taxpayers call for rules on which they may rely, while the government also needs to craft more limiting rules to constrain tax avoidance. Safe harbors would be welcome by the public and difficult to challenge, whereas limiting rules are increasingly subject to challenge. Part II surveys challenges to rules under the APA, including some nuances in the tax administration. In Part III, the Article integrates the administrative law literature on remedial restraint. In short, courts and scholars should not neglect the rule of prejudicial error. Part IV seeks to limit and clarify the tax administration's friction with the APA. It argues that there is ample play in the joints under existing law for tax rules and regulations to qualify for the APA exception for interpretative rules. It explains how the retroactivity provisions of the I.R.C. may also be able to limit the impact of errors. (29) The Article concludes that a robust application of harmless error to the tax administration may save many rules. It cautions that robust and diverse public participation cannot be ensured by even a strict compliance approach and calls for additional attention to this problem.

1. TAX RULES PROVIDE (UN)WELCOME "GUIDANCE"

   Before proceeding to the problem of procedural challenges to tax rules, this section provides a brief background on two of the most critical...