The IRS’s Judicial Power

by Andy Grewal — Tuesday, Nov. 25, 2014

I’ve previously written about how Section 7805(b)(8) of the tax code may provide relief from King v. Burwell for persons who purchase policies on federal health care exchanges. Although I still believe that Section 7805(b)(8) provides an effective tool for the administration and enrollees, I’ve come to form some questions about its wisdom and possibly its constitutionality.

For a long time, Section 7805 allowed the IRS to deny retroactive effect to its rulings only. Congress enacted this statute in 1934, believing that if the IRS faced the same restrictions as Article III courts, its rulemaking procedures would be unduly restricted. That is, because courts find law rather than make it, their decisions generally relate back to the date of the statutes they interpret. If this rule extended to the IRS, then each change in agency policy would cause major headaches, as the IRS might have to re-audit taxpayers each time a ruling came out. Also, a taxpayer’s settled expectations might be disrupted by nothing more than a sudden change in agency policy. So Congress said that the IRS could issue rulings that applied only prospectively.

In 1996, Congress amended Section 7805 such that the IRS could prescribe the retroactive effect of “any judicial decision.” Thus, Article III courts no longer controlled the effect of their tax decisions. And in circumstances where the statute at issue had already been amended (such that the dispute related only to old law), a court’s opinion would, in a loose sense, be advisory — the exercise of authority under Section 7805(b)(8) could deny effect to the court’s opinion.

Luckily, the IRS has not whimsically applied Section 7805(b)(8). Rather, it generally uses that statute to provide taxpayers relief from adverse rulings. So, Section 7805(b)(8) has aided taxpayers, not hurt them.

The potential use of Section 7805(b)(8) in connection with any adverse decision in King v. Burwell presents a novel situation. If the IRS fully denies effect to the opinion, then it will have helped many taxpayers (health care enrollees) but it will have hurt others (those trying to claim the affordability exception or employers who face tax penalties when their employees enjoy tax credits).

I don’t have a crystal ball, but I suspect that the IRS would narrow its use of Section 7805(b)(8) such that it applied in a favorable manner only. Still, the broad sweep of the statutory language is a bit shocking. Read literally, a class of taxpayers could fight the IRS in court regarding their tax treatment for past years, win in court, but then have their victory nullified by Section 7805(b)(8).

I would not expect the IRS to invoke its authority in that manner, and other statutes or principles probably restrict the IRS. Denying a taxpayer a court win might be a per se abuse of discretion under the APA, for example.

Still, I think Section 7805(b)(8) is rather odd, and I would be curious if any other agency enjoys similar authority. It’s one thing for an agency to exercise enforcement discretion and show mercy on some persons negatively affected by a court decision, but the codification of a broad rule strikes me as a bit of an overstep. I would have guessed that matters related to the effective date of a judicial decision come entirely within the scope of the Judicial power and cannot be transferred to the executive branch. And it seems especially strange that Section 7805(b)(8) would be extended to judicial decisions, when the statute was originally premised on the idea that IRS rulings fundamentally differ from judicial rulings.

Also, there may have been a time when one could say that a particular court decision hurt almost all taxpayers vis-a-vis the IRS, and the use of Section 7805(b)(8) would necessarily contemplate beneficial treatment. But now that the tax code is apparently being used to administer social programs, a given interpretation might pit the interests of two classes of private persons against each other. In these circumstances, I’m not sure that the IRS should be able to fudge with the retroactive effect of judicial decisions. I welcome responses to my tentative views on this subject.

– Andy Grewal

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