"Tax - What Goes Around," Crowell & Moring's Litigation Forecast 2016
Contributor: David Fischer.
This could be a banner year for companies seeking to overturn burdensome tax regulation, thanks to a landmark ruling by the U.S. Tax Court.
Last July, in Altera v. Comm'r, the court confirmed that the Department of the Treasury must engage in reasoned decision-making under the Administrative Procedure Act (APA) when promulgating tax regulations—the first time that particular test has been applied to tax rules. The decision opens up an avenue for challenging IRS regulations for which the agency hadn't sufficiently explained its position at the time of the rulemaking.
"Every case involving a regulation that hurts you will include an investigation as to whether Treasury engaged in proper rulemaking," says David Fischer, a partner in Crowell & Moring's Tax Group. "Whether the IRS properly addressed comments made during the rulemaking process will be especially important."
There's much irony in the Tax Court's decision, says Fischer. The IRS has long asserted that its interpretations of the Internal Revenue Code by tax regulation deserve the same level of deference from courts as regulations issued by all other agencies, and the Supreme Court agreed by granting the agency so-called Chevron deference. At the same time, the IRS has asserted that it did not have to satisfy the APA, as other agencies must. "We've expected this ruling, or something like it," Fischer says. "If the IRS wants Chevron deference, they have to follow the rules."
How many IRS rules could be threatened? One academic found that more than 40 percent of IRS regulations did not properly follow the APA's notice-and-comment rulemaking procedures.
CALLING FOR BACKUP
To fight these battles and others in 2016, the IRS may be calling in reinforcements in the form of outside counsel. Many government agencies routinely employ outside counsel, but not the IRS. So litigators across the country were surprised recently when the agency first engaged a prominent law firm in a large tax case. "The IRS already has both the Department of Justice (DOJ) and its own district counsel attorneys at its disposal," notes Fischer. "Now it is expending additional resources to target particular businesses even as it faces severe budget cuts."
State tax authorities are also starting to engage outside counsel, says Fischer, who expects the practice will continue—and that relationships between the parties will take on a harder edge. "Litigation may be more expensive than before," he says. "It will be less cordial, more formal, and more hardball."
Beware of Tax "Bounty Hunters" and Whistleblowers
Watch out: states are increasingly calling in tax bounty hunters—private tax consultants engaged under contingent fee arrangements—to identify and develop tax assessments. "The financial motivation may be a contingency fee rather than simply finding the accurate amount of taxes owed," Fischer says. "Taxpayers are questioning the fundamental fairness of a government activity like taxation being outsourced to firms that may be motivated by profit, rather than accuracy." The best way to fight the bounty hunters, Fischer asserts, is to work directly with the taxing authorities to ensure that the figure owed is accurate—and to argue against the use of a firm motivated by contingency fees.
Meanwhile, plaintiffs' attorneys are increasingly working with internal whistleblowers on tax-related class actions in areas such as sales tax collection. The suits are most common in gray areas such as Internet commerce. "The main way to avoid these suits is to do the right thing from an ethical standpoint, use effective methods of training, and keep meticulous records," Fischer says.