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How much authority do revenue rulings have?

Tax advisers must understand the weight (or deference) courts give to revenue rulings when they determine a level of authority (e.g., reasonable basis, substantial authority, or more-likely-than-not) for a tax return position that implicates a revenue ruling. If a revenue ruling clearly supports the tax return position, the taxpayer can rely on it; see Regs. Sec. 601.601(d)(2)(v)(e). If, however, the ruling is contrary to the proposed tax return position, tax advisers must first determine the judicial standard under which they should analyze the ruling.

The courts have uniformly deferred to long-standing revenue rulings that Congress has either implicitly or explicitly approved. In contrast, they have wrestled for years with the issue of how much weight to give other ("garden variety") revenue rulings. Some courts, including the Tax Court, historically have given no weight to revenue rulings, on the theory a ruling is merely an interpretation of the law asserted by one of the parties in litigation. Other courts historically have deferred to revenue rulings that are reasonable and consistent with prevailing law. Although there is still controversy among the courts over this issue, the Supreme Court reshaped the debate in Mead Corp., 533 US 218 (2001), which sheds light on the Court's likely view of the weight revenue rulings deserve.

Congressionally "Blessed" Revenue Rulings

All revenue rulings are not created equal. Some actually have the force and effect of law, according to Supreme Court precedent. For example, the Supreme Court anointed a ruling involving the so-called "overnight rule" under the statute permitting business travelers to deduct meal and lodging expenses. In Correll, 389 US 299 (1967), it upheld the Service's determination that a salesman could not deduct meal expenses incurred on business trips that did not require either sleep or rest away from home. The Court held that the overnight rule had gained the effect of law because Congress was aware of the rule, as evidenced by legislative history, when it re-enacted the underlying statute in the 1954 Code and chose not to overturn the rule. "Treasury regulations and interpretations [such as revenue rulings] long continued without substantial change, applying to unamended or substantially reenacted statutes, are deemed to have received congressional approval and have the effect of law." Courts now call this rule the "reenactment doctrine"; see, e.g., ABC Rentals of San Antonio, Inc., 97 F3d 392 (10th Cir. 1996).

Garden Variety Revenue Rulings

Although Correll elevates longstanding rulings that have Congressional approval to some type of legal status on par with statutes, the average revenue ruling does not fall into that category. Historically, appeals courts applied conflicting standards to revenue rulings. Many courts deferred to revenue rulings that were reasonable and consistent with prevailing law; see, e.g., Salomon Inc., 976 F2d 837 (2d Cir. 1992), and also Galler, "Judicial Deference to Revenue Rulings: Reconciling Divergent Standards," 56 Ohio St. LJ 1037 (1995) (discusses cases applying the "reasonable and consistent" standard).They gave deference to rulings in these instances even if a taxpayer's contrary position was also reasonable. In contrast, other courts gave little weight to revenue rulings; see Stubbs, Overbeck & Associates, Inc., 445 F2d 1142 (5th Cir. 1971) (a revenue ruling is "merely the opinion of a lawyer in the agency"), and also Stark, 86 TC 243 (1986) ("a revenue ruling merely represents the Commissioner's position with respect to a specific factual situation"). In fact, the issue was so muddled that, in some circuits, different three-judge panels within the circuit applied different standards; compare Stubbs, Overbeck & Associates with Miami Beach First Nat'l Bank, 443 F2d 475 (5th Cir. 1971) (a ruling is "entitled to be given weight as expressing the studied view of the agency whose duty it is to carry out the statute").

Since 2001, the debate over revenue rulings has shifted due to a Supreme Court case involving a U.S. Customs Service tariff ruling; see Mead. A Customs Service tariff ruling is an informal rulemaking by an administrative agency (in this case, the Customs Service). The Supreme Court held that the courts should use a standard contained in a prior Supreme Court case (Skidmore v. Swift & Co., 323 US 134 (1944)), to determine the appropriate weight an informal rulemaking deserves. The Mead Court determined that the weight given to an informal rulemaking under the Skidmore standard depends on the "thoroughness evident in [the agency's] consideration, the validity of its reasoning, its consistency with earlier and later pronouncements, and all those factors which give it the power to persuade...." This item will refer to the rule in Mead as the Skidmore deference.

The Ninth Circuit has held that the Mead decision requires lower courts to give Skidmore deference to revenue rulings because they are closely akin to Customs Service tariff rulings, to which the Mead Court applied the Skidmore deference standard; see Omohundro, 300 F3d 1065 (9th Cir. 2002). Likewise, the Sixth Circuit has applied the Skidmore deference standard to revenue rulings in Ammex, Inc., 367 F3d 530 (6th Cir. 2004). In that case, the court applied the Skidmore deference factors outlined in Mead to find that the revenue ruling at issue possessed the power to persuade and should be followed. Specifically, the court reasoned that revenue rulings in general are "written and reviewed at the same level of the IRS and the Treasury Department as are Treasury regulations, demonstrating that a 'central board or office' accords a great 'degree of ... care' to their issuance." It further reasoned the IRS possesses expertise in applying often very complex Federal tax law provisions to particular facts. Additionally, the court noted the IRS had consistently held the position in the revenue ruling for over three decades, which demonstrated to the court the soundness of the IRS's initial decision. Lastly, the taxpayer failed to identify any flaws in the ruling's analysis; see also Del Commercial Properties, Inc., 251 F3d 210, 214 (DC Cir. 2001) (Skidmore deference afforded to revenue rulings); Federal National Mortgage Assoc'n, 379 F3d 1303 (Fed. Cir. 2004) (applying the Skidmore deference standard to a revenue procedure but finding the revenue procedure lacked the power to persuade because it contained no rationale supporting its position); and U.S. Freightways Corp., 270 F3d 1137 (7th Cir. 2001) (applying the Skidmore deference standard to the Service's litigation position).

Contrary to the Sixth and Ninth Circuits, the Eighth Circuit has refused to apply the Skidmore deference standard to revenue rulings; see O'Shaughnessy, 332 F3d 1125 (8th Cir. 2003). The Eighth Circuit noted that the Supreme Court reserved the issue of whether revenue rulings are entitled to deference in Cleveland Indians Baseball Co., 532 US 200 (2001). Interestingly, the Court decided Cleveland Indians two months before Mead; because the Mead decision is later in time, it suggests that the Court would apply the Skidmore deference standard to revenue rulings. The Eighth Circuit, however, did not apply this reasoning. Rather, it appeared to apply a similar but not well-defined standard from an earlier Eighth Circuit case that gives revenue rulings some evidentiary weight if they are able to persuade the court based on their technical analyses; see generally Keller, 725 F2d 1173 (8th Cir. 1984), and also Black & Decker Corp., 436 F3d 431 (4th Cir. 2006) (despite citing to a Sixth Circuit opinion that applied the Skidmore deference standard to a revenue ruling, the court noted that the precise degree of deference owed to the ruling at issue was unclear).

Practical Application of Skidmore Deference

Even though there is still no uniformity among appeals courts on the proper deference to give to revenue rulings, the trend appears to be moving toward applying the Skidmore deference standard to rulings. Two cases with almost identical facts--one a "pre-Mead" decision and the other a "post-Mead" decision--highlight the trend's practical significance. In Aeroquip-Vickers, Inc., 347 F3d 173 (6th Cir. 2004), rev'g Trinova Corp., 108TC 68 (1997) (a post-Mead decision), a taxpayer transferred property for which it had received investment tax credits (ITCs) to a wholly owned subsidiary in its consolidated group. Immediately after this transfer, the taxpayer transferred all of the subsidiary's shares to one of its shareholders in a tax-free reorganization under Sec. 368(a)(1)(D).

The Tax Court held the transactions did not trigger ITC recapture because the regulations do not require recapture when property subject to ITC recapture (Sec. 38 property) is transferred within a consolidated group. Moreover, the regulations contain an example under which one company transferred Sec. 38 property to another member of the consolidated group in 1967, and then, in 1969, the group's parent sold the stock of the transferee corporation to a third party. Under the regulation, the 1969 sale did not trigger recapture; see Trinova Corp.

The Tax Court, which historically has given little or no weight to revenue rulings, ignored Rev. Rul. 82-20, which held recapture was appropriate under facts almost identical to the facts before the court. In this revenue ruling, the IRS held that the transfer of Sec. 38 property between members of a consolidated group is subject to ITC recapture if the property ultimately leaves the consolidated group in a transaction that was planned at the time of the initial intra-group transfer. The Tax Court believed this ruling was inconsistent with the example in the regulations.

On appeal, the government argued that both Rev. Rul. 82-20 and the step-transaction doctrine mandated recapture. The Sixth Circuit held that the revenue ruling did not conflict with the regulations because the ruling addressed pre-planned transactions, while the example in the regulations involved transactions that were two years apart and contained no reference to the transactions being part of a single plan. Moreover, the court found the revenue ruling was a persuasive interpretation by the Service of the statute and regulations, and thus adopted its reasoning. The court further reasoned the step-transaction doctrine mandated the same result.

The facts in Aeroquip-Vickers are very similar to the facts in Salomon Inc., a pre-Mead case in which the Second Circuit held that Rev. Rul. 82-20 required the court to hold for the government. In fact, the Second Circuit held it did not need to address the step-transaction doctrine because Rev. Rul. 82-20 was directly on point and controlling. The court reasoned that revenue rulings are entitled to great deference unless they are unreasonable or inconsistent with Code provisions. In that case, it found that the revenue ruling was reasonable and consistent with both the Code and the regulations.

Unlike the Second Circuit in Salomon, the Sixth Circuit in Aeroquip-Pickers thought it necessary to analyze the step-transaction doctrine. Would the Sixth Circuit have interpreted Rev. Rul. 82-20 differently had it found the step-transaction doctrine did not apply to the transactions at issue? Perhaps it would have; the rationale in the ruling appears to rest on the step-transaction doctrine, which may have led the court to find the ruling persuasive. Importantly, the Sixth Circuit felt it had to address the step-transaction doctrine issue when the Second Circuit had already held that Rev. Rul. 82-20 controlled the outcome of the case, thus making the step-transaction issue moot. This difference in approaches arguably stems from the fact that under the Skidmore deference standard, the courts can be persuaded by revenue rulings, but will not automatically defer to them (as the Second Circuit did in Salomon).

In categorizing the deference or weight afforded revenue rulings, Salomon's "reasonable and consistent" standard would place great weight on revenue rulings, and the Tax Court's standard would place very little weight on them. The Skidmore deference standard is between these two standards; it requires courts to look behind revenue rulings to assess their persuasive power before giving them deference. Thus, because many appeals courts applied the "reasonable and consistent" standard before 2001, the trend toward the Skidmore deference standard may actually result in revenue rulings generally being given less weight by the courts in the future.

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Author:Rood, Joan L.
Publication:The Tax Adviser
Date:Jun 1, 2006
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