The Applicability of the Administrative Procedure Act to Federal Tax Litigation.

• Author: Harris, Brian
• Position: Tax Law

When Congress enacted the Administrative Procedure Act (APA) in 1946, the resulting legislation represented a delicate balance of opposing political interests seeking to complement the evolving role of administrative agencies in government regulation and the preservation of individual liberties. (1) Section 702 of the APA symbolizes this premise of individual rights: "A person suffering legal wrong because of agency action, or adversely affected or aggrieved by agency action within the meaning of a relevant statute, is entitled to judicial review thereof." (2) The APA, thus, provides a mechanism to obtain judicial review of agency actions.

Nonetheless, the legislative history of the APA reveals that the protections afforded individuals were not intended to usurp existing procedural mechanisms. (3) Section 703 of the APA specifically invokes such reasoning by providing that "[e]xcept to the extent that prior, adequate, and exclusive opportunity for judicial review is provided by law, agency action is subject to judicial review in civil or criminal proceedings for judicial enforcement." (4) Against these two divergent concerns, courts have been called upon to consider the applicability of the APA to the final actions of agencies, such as the IRS and Treasury Department, for which Congress has also enacted specific statutes addressing aspects of judicial review or rulemaking authority for that agency.

One particular venue that has consistently held that the APA does not govern its review of final agency actions is the U.S. Tax Court. (5) IRS audits of individuals and corporations (as opposed to some partnership audits that are governed by the different TEFRA procedures, though not for long) generally conclude with the IRS issuing a notice of deficiency for which the taxpayer may then seek judicial review in the U.S. Tax Court. (6) The notice of deficiency may state to varying degrees of specificity the facts and law upon which the IRS relies for its proposed assessment. Subsequent litigation the Tax Court has historically been de novo both as to the facts and legal theories that the government might develop during litigation to support the assessment. This sort of de novo review in the Tax Court is in contrast to the more traditional procedure for judicial review of final agency actions under the APA.

One of the principal purposes of the APA was bestowing adjudicative powers upon administrative agencies similar to the traditional judicial process. (7) Agencies are specifically responsible for gathering facts and making conclusions of law within the context of the adjudicative process. (8) The existence of a record is a fundamental aspect of the agency adjudicative process through which the parties submit evidence and challenge the introduction of facts through traditional methods of inquiry characteristic ofjudicial procedure. (9) Typically, a reviewing court is confined to the record established at the agency level. (10) This reasoning encourages a reviewing court to focus its analysis on the record originally established when the agency made its decision, rather than imbuing the record with the reviewing court's opinion. (11) Typically, the reviewing court's role is limited to determining whether the evidence in the administrative record permitted the agency to reach its conclusions as a matter of law. (12) In SEC v. Chenery Corp., 318 U.S. 80 (1943), which predates the APA, the Supreme Court acknowledged the importance of confining a court's review of agency decisionmaking to the record at least with respect to issues to which Congress has specifically delegated to the agency. (13)

Taxpayers have recently argued for the application of the APA to Tax Court proceedings largely because the IRS did not adequately develop the facts or legal grounds supporting the proposed deficiency. That is, if the APA governed the Tax Court's review, then the Tax Court would be confined to only reviewing the facts and legal grounds the IRS developed during the audit and articulated in the notice of deficiency, and as a result the IRS' proposed assessment would not pass judicial review. It is within this perspective the Tax Court has considered the application of the APA to its review of IRS audits.

In the Tax Court's recent decision in Ax v. Commissioner, 147 T.C. No. 10 (2016), the IRS challenged the deductibility of the taxpayer's payment of insurance premiums to a captive insurance company. (14) The IRS sought to amend its answer to raise new matters in support of its challenge to the deductibility of the premiums paid. (15) That is, the IRS sought to uphold the proposed deficiency on grounds that it had not articulated in its final agency action. The taxpayer argued that the APA and precedent confined the IRS to those stated in the notice of deficiency. (16) The taxpayer relied significantly on Chenery. The taxpayer also pointed to the Supreme Court's refusal in Mayo Foundation for Medical Education & Research v. United States, 562 U.S. 44 (2011), to distinguish administrative review of tax law from other areas of law. (17) However, the Tax Court found both Chenery and Mayo to be distinguishable. (18)

The Ax court noted that Chenery was inapposite because the court there addressed a scenario in which agency action was not reviewable by a court. (19) The Mayo court was faced with assessing the weight of agency regulations when interpreting an ambiguous statute. (20) The Tax Court also countered that the analysis in Mayo did not address the scenario in which adequate opportunity for judicial review predates the relief proffered by the APA and was, thus, incongruous. (21) At the time of the enactment of the APA, the Internal Revenue Code of 1939 had already given...