Pass The Mayo Foundation: The Supreme Court Says Goodbye To National Muffler

By David Shakow

The Supreme Court’s decision this week in Mayo Foundation for Medical Education and Research v. United States clarifies the approach courts should take in determining the validity of IRS regulations.  The decision is a victory for the IRS, but it leaves many issues unresolved.  One thing is very clear, however: the IRS can be expected to push the decision aggressively in future challenges to its regulations.

The animating dispute of Mayo arose from a simmering contradiction in Supreme Court precedent about the standards to be used to assess the validity of IRS regulations.  In National Muffler Dealers Assn., Inc. v. United States, 440 U.S. 472 (1979), the Court articulated a multi-factor test to determine the validity of an IRS regulation.  Assuming the statute was not clear on the issue, National Muffler pointed to a number of issues that a court might consider in determining the regulation’s validity:

A regulation may have particular force if it is a substantially contemporaneous construction of the statute by those presumed to have been aware of congressional intent. If the regulation dates from a later period, the manner in which it evolved merits inquiry. Other relevant considerations are the length of time the regulation has been in effect, the reliance placed on it, the consistency of the Commissioner’s interpretation, and the degree of scrutiny Congress has devoted to the regulation during subsequent reenactments of the statute.

Id., at 477.

Five years later, in Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984), the Court concluded that a regulation would be upheld unless it is “arbitrary or capricious in substance, or manifestly contrary to the statute.”  Chevron was not decided in the context of a tax regulation, and even after Chevron, the Court continued to cite the more limiting National Muffler standard in testing an IRS regulation.  E.g., Cottage Savings Assn. v. Commissioner, 499 U.S. 554, 560-561 (1991).  As a result, practitioners and courts remained unsure whether the Chevron test or the National Muffler test should be applied in determining the validity of a tax regulation.

Where Congress granted the IRS broad authority to write regulations in a specific area, the resulting “legislative” regulations were likely to be given the broad deference of Chevron.  However, when the IRS issued “interpretive” regulations under its general authority under section 7805, there was great confusion as to which standard to apply.  See, for example, the many opinions in Swallows Holding Ltd. v. Comm’r, 126 T.C. 96 (2006), rev’d, 515 F.32d 162 (3d Cir. 2008).

In Mayo, the Court clarified that the two-step Chevron analysis rather than the National Muffler standard is the test to be applied to all IRS regulations.  The first step of this analysis is to determine whether Congress has “directly addressed the precise question at issue.”  If it has, then a regulation to the contrary is invalid.  If it has not, a court should next determine “whether the agency’s answer is based on a permissible construction of the statute”— that is, whether the agency rule is “arbitrary or capricious in substance, or manifestly contrary to the statute.”

The Chevron test omits many of the other issues that were previously considered under the National Muffler standard in challenges to interpretive IRS regulations, such as whether the IRS has changed positions over time, whether the regulation was promulgated long after the statute was enacted, or whether the regulation was issued to favor the IRS’s position in litigation that was before the courts.  The Supreme Court in Mayo, however, went further and also explicitly rejected drawing any distinction in the deference to be accorded interpretive, as opposed to legislative regulations.  Previously, it was often assumed that the IRS had more discretion in drafting regulations when the legislation at issue specifically authorized regulations on the particular issue.  Under Mayo, regulations promulgated under the IRS’s authority under section 7805(a) are to be given the same deference as those issued under a specific grant of authority to “define a statutory term or prescribe a method of executing a statutory provision.”

Just a day after Mayo was issued, the IRS was already citing it in an oral argument in a case involving an important dispute between the Government and taxpayers.  In Grapevine Imports Ltd. v. United States, the Court of Federal Claims held that a taxpayer whose deficiency is a result of overstated basis is subject to the extended six year statute of limitations in section 6501(e)(1)(A) because it has omitted more than 25% of its gross income.  The Government reportedly argued, among other things, that any legislative history accompanying the statute is of extremely limited importance once the IRS has promulgated regulations in the area.  Although the judges expressed skepticism in reaction to this argument, that is not a clear indication of how the courts will incorporate the Chevron test into the IRS’s administrative process.

One big issue that remains untouched, but not unaffected, by Mayo is the deference to be accorded IRS pronouncements other than regulations.  In particular, will Mayo require courts to give more deference to Revenue Rulings than they have in the past?  Writing for the Court in Mayo, Chief Justice Roberts was careful to note that the regulations in question were issued “only after notice-and-comment procedures, . . . a consideration identified in our precedents as a ‘significant’ sign that a rule merits Chevron deference.”  Here, too, though, the Government can be expected to argue for greater deference than has been accorded in the past to IRS pronouncements other than regulations.

Mayo is just the start of a new path that tax practitioners must follow in interpreting the tax law.  Tax practitioners will have to bone up on the general case law relating to deference to administrative actions, such as National Cable & Telecommunications Assn. v. Brand X Internet Services, 545 U.S. 967 (2005).  Meanwhile, the IRS may be emboldened to act more broadly than it might have otherwise when it writes regulations such as the “economic substance” regulations under new section 7701(o).

How the courts will react to Mayo remains to be seen.  Some judges may be happy to defer to the IRS when the alternative is a painful examination of tax precedent.  More adventurous judges who feel uncomfortably constrained by Mayo may look more carefully at Chevron’s first step and try to discern clear guidance on the issues before them in the language of the statute.

In any event, the IRS may be wise to keep in mind that neither it, nor the courts, are the final arbiters of the tax law.  Congress ultimately will decide what is the law.  And when Congress decides that the IRS has acted too boldly, it has more than one way to rein in the agency.  Oldtimers at the IRS may remind those who weren’t around in 1978 that Congress can simply instruct the IRS that it cannot issue any new regulations or rulings in a particular area (in that case, the employee-independent contractor distinction).  Such a reaction is not necessarily caused by a careful examination by the Congress of a substantive area.  Rather, it may reflect the political reality that, for too many members of Congress, the IRS will always be perceived by their constituents as having gone too far.

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2 Comments on “Pass The Mayo Foundation: The Supreme Court Says Goodbye To National Muffler”


  1. [...] underlying our decision in Chevron apply with full force in the tax context.”  Thus, the tax bar generally took Mayo as relegating the less-deferential National Muffler standard to history, but the Fifth [...]


  2. [...] Tax Blawg readers know, after the Supreme Court’s Mayo decision adopted the deferential Chevron standard for determining the validity of Treasury regulations (instead of [...]


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