At the request of Senator Hatch and other lawmakers, the Government Accountability Office recently released a report on various IRS guidance procedures.  The report’s title (“Treasury and OMB Need to Reevaluate Long-standing Exemptions of Tax Regulations and Guidance”) gives away its conclusion — the Treasury and OMB have not carefully considered why the government creates special sets of rules for tax guidance that can sometimes compromise the democratic principles espoused in various rulemaking statutes.  

I was pleased to see that top tax officials (Assistant Secretary of Tax Policy Mark Mazur and IRS Chief Counsel Williams Wilkins) thoughtfully responded to the report, expressing their general agreement with recommendations made by the GAO.  The report also contains numerous other nuggets of important information and is worth reading in full.  However, here are some quick reactions:

1. The IRS and White House drafted a confidential memo in 1983 explaining why they would exempt tax regulations from rulemaking procedures that otherwise apply to agency guidance.  The GAO report suggests that government officials today are not exactly sure why that memo was adopted (see page 26), and they have not given thought to whether the original justifications for the memo remain valid.  I strongly support the GAO’s recommendation that the IRS should consider disclosing the memo or its reasoning to the public (see page 35), so that the tax community can examine whether the special treatment for IRS regulations remains justified. 
2. The GAO notes that the IRS essentially never considers its regulations “economically significant” or “major” under the relevant authorities (i.e., for purposes of Executive Orders and the Congressional Review Act). However, the GAO notes that the IRS has classified as “economically significant” some highly controversial and highly publicized corporate earnings stripping regulations recently proposed under Section 385. (See page 19 of GAO report.)  Though I applaud the IRS for recognizing the significance of these regulations, it’s difficult to understand why Section 385 regulations would be economically significant (or potentially “major”) while so many other regulations that have similar economic effects, like the anti-inversion regulations under Section 7874, are not classified as economically significant.  The IRS should explain this discrepancy or, better yet, more frequently recognize the economic effects of its regulations.
   
3. As noted above, the IRS almost never characterizes regulations issued under the tax code as economically significant.  Interestingly, the IRS has sometimes jointly issued regulations along with other agencies, and those other agencies, in their respective regulatory preambles, will describe the jointly issued regulations as economically significant. (See page 20 of GAO report.)  This discrepancy between the IRS’s views and the other agencies’ views should be explained.
4. A recurring theme throughout the GAO report relates to the IRS’s view that the tax code is itself to blame (or to credit) for the various rules contained in the regulations.  This approach explains why the IRS claims various exemptions from the Administrative Procedure Act, the Congressional Review Act, Executive Orders, and so on.  In a prior post, I explained why the IRS’s view was wrong.  However, it appears that this “tax regulations do nothing” approach is firmly entrenched in the agency, and if there is a way for that approach to be challenged judicially, taxpayers should proceed.  If the IRS recognizes, or is forced to recognize, the costs associated with its regulations, that would strengthen taxpayer safeguards and would have ripple effects on various procedural statutes.
5. The GAO recognizes that the IRS puts out many forms of guidance, but notes that the IRS’s procedures for choosing one method of guidance (e.g., regulations) as opposed to another (e.g., Revenue Rulings, Announcement, Procedures) is a bit of a mess.  The IRS understandably needs flexibility as it pursues projects, and guidance that initially seems fit for a regulation project might eventually be better communicated through a different format.  However, the GAO recommends that the IRS at least adopt some general standards governing determinations related to paths of guidance, which seems wise.  Additionally, the GAO recommends that the IRS better describe the legal effects of the guidance it proposes.  For example, sometimes the IRS issues guidance in the form of Frequently Asked Questions that are binding on the agency, but sometimes FAQs have no more authoritative value than an IRS form or publication.  Tax professionals will recognize the difference between FAQs contained in the I.R.B. and those published on the IRS website, but many others might not.

I hope that the GAO report helps move the IRS towards a more principled approach to rulemaking.