U.S. Tax Court Provides Its First Indication of the Effect of the Demise of the Chevron Doctrine on the Validity of Tax Regulations

By now, it is well known that the U.S. Supreme Court, in Loper Bright Enterprises v. Raimondo,[1] recently overruled the longstanding Chevron doctrine, under which courts previously afforded a high degree of deference to federal administrative agencies’ regulations interpreting ambiguous statutory provisions. Under Loper Bright, instead of deferring to agency regulations, courts are instructed to “exercise their independent judgment in deciding whether an agency has acted within its statutory authority.” How courts will apply Loper Bright in the context of tax regulations is a matter of great interest to taxpayers and their advisors, particularly in light of the long history of varying standards of judicial deference given to tax regulations.

In Varian Medical Systems Inc. v. Commissioner,[2] the U.S. Tax Court recently issued its first opinion applying Loper Bright to the interpretation of tax regulations. Varian involved an apparent drafting error by Congress in the effective dates of two amendments to the Internal Revenue Code (the Code) as part of the 2017 Tax Cuts and Jobs Act, which drafting error created a taxpayer benefit that was almost certainly unintended by Congress.[3] The Treasury Department attempted to correct this apparent error and erase the taxpayer benefit by promulgating a regulation in 2019 that purported to change one of the effective dates to conform to the other,[4] and asserted on the basis of the regulation a deficiency against a taxpayer that took advantage of the benefit. In Varian, the full Tax Court unanimously invalidated the regulation on the ground that a plain reading of the two effective date provisions entitled the taxpayer to the benefit. Citing the Loper Bright decision for the first time, the Tax Court held that it would not defer to the regulation because it exceeded Treasury’s delegated rulemaking authority, explaining that “the best (indeed the unambiguous) reading” of the two effective dates permitted the taxpayer benefit.

The Varian opinion signals that the Tax Court stands ready to apply the Supreme Court’s mandate in Loper Bright that it is up to the courts rather than the administrative agencies to determine the best reading of a statute. But, because Varian dealt with a regulation that was at variance with the plain language of the statute, the case offers little insight into the impact Loper Bright will have on challenges to tax regulations more generally. What should we expect moving forward?

By way of background, prior to Chevron, the level of deference given to federal tax regulations issued by the Treasury Department depended on whether they were promulgated pursuant to a specific grant of authority to define a particular statutory term or administer a particular statutory provision or instead under the general authority under section 7805(b) of the Code to “prescribe all needful rules and regulations for the enforcement of” the Code, the former so-called “legislative regulations” being given more deference than the latter. In the 1979 National Muffler case,[5] the Supreme Court held that the level of deference afforded to a general-authority tax regulation depended on such factors as its harmony with the language and purpose of the underlying Code provision, how contemporaneous it was with the enactment of the provision, the length of time the regulation had been in effect and the consistency of the Treasury Department’s interpretation over time. While the Supreme Court in the 1984 Chevron decision held that a statute’s ambiguity is an indication that Congress intended to delegate interpretive authority to the relevant administrative agency, with the result that a court should defer to the agency’s interpretive regulations, the Supreme Court for some 27 years after Chevron was decided continued to apply the National Muffler standard to general-authority tax regulations, seldom even citing Chevron. This era of apparent tax exceptionalism ended in 2011, when the Supreme Court in the Mayo Foundation case squarely held that the Chevron standard applies to general-authority tax regulations.[6]

Fast-forward to 2024, when the Supreme Court in Loper Bright, overruling Chevron, made it clear that courts are no longer to give automatic binding deference to an agency interpretation of a statute merely because the statute is ambiguous. Exactly what standard of deference is to replace Chevron in the tax arena is less clear. Among the Supreme Court’s guidance on this question in Loper Bright is that agency “interpretations issued contemporaneously with the statute at issue, and which have remained consistent over time, may be especially meaningful in determining the statute’s meaning,” and that where Congress has expressly and constitutionally delegated interpretive authority to an agency, “courts must respect the delegation, while ensuring that the agency acts within it.” As noted, prior to the Supreme Court’s 2011 decision in Mayo Foundation, contemporaneity and consistency were major factors in determining the level of deference to be given to general-authority tax regulations under the National Muffler standard, and a higher level of deference was applied to tax regulations promulgated under specific grants of regulatory authority. In this sense, Loper Bright may turn out to be a trip “back to the future” for tax regulations.

In any event, Loper Bright opens up the possibility of successfully challenging the validity of tax regulations that are either inconsistent with or unsupported by the language of the Code, an endeavor that, in the Chevron era, was typically considered a fool’s errand. Examples of the types of tax regulations that may be particularly susceptible to challenge are increasingly prevalent “anti-abuse” regulations that set out rules that are often difficult to square with the language of the Code but designed to discourage taxpayers from taking positions that are perceived by the Treasury Department to be abusive. As has always been the case, taxpayers take positions that are inconsistent with Treasury Department regulations at their peril. But, now that Chevron has been overruled, well-advised taxpayers will carefully consider the possibility that the courts will invalidate the regulation in question.

Co-authors Mark E. Berg, partner, and Sarah B. Herman, associate, are members of the Tax Practice Group at Klehr Harrison.

[1]           144 S. Ct. 2244 (2024), overruling Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984).

[2]           163 T.C. No. 4 (Aug. 26, 2024).

[3]           When a U.S. shareholder of a “controlled foreign corporation” claims a foreign tax credit in respect of non-U.S. taxes paid by the foreign corporation, the amount of such deemed-paid credit is generally included in the income of the U.S. shareholder as a dividend under section 78 of the Code. In 2017, as part of an overhaul of the Code’s international provisions, Congress both enacted a dividends-received deduction (“DRD”) and amended section 78 so as not to treat deemed dividends thereunder as dividends for purposes of applying the new DRD. However, while the 2017 legislation made the new DRD effective for dividends paid after December 31, 2017, the amendment to section 78 was made effective for tax years of foreign corporations beginning after December 31, 2017, creating a potential mismatch for taxpayers whose tax years end on a date other than December 31. The taxpayer in Varian was one such taxpayer, and argued on the basis of this effective date mismatch that the amendment to section 78 was not yet effective for its tax year that began on September 30, 2017, with the result that dividends deemed to be paid during the period January 1 – September 28, 2018 were eligible for the new DRD notwithstanding the amendment to section 78.

[4]           Treas. Reg. §1.78-1(a).

[5]           National Muffler Dealers Association, Inc. v. United States, 440 U.S. 472 (1979).

[6]           Mayo Foundation for Medical and Educational Research v. United States, 562 U.S. 44 (2011).