Judicial Deference to the IRS: Supreme Court Holds that Chevron Deference Applies to “Interpretive” Treasury Regulations

Sullivan & Cromwell LLP - January 14, 2011

On January 11, 2011, the U.S. Supreme Court held, in Mayo Foundation for Medical Education and Research v. United States (the “Case”), that a Treasury regulation issued under a general grant of regulatory authority (rather than a specific delegation of authority) was entitled to deference under the standard set forth in Chevron U.S.A. Inc. v. Natural Resources Defense Council Inc. Under the Chevron standard, an interpretive rule will be upheld if: (i) Congress has not “directly addressed the precise question at issue” and (ii) the rule is not “arbitrary, capricious or manifestly contrary to the statute.”

The question presented by the Case involved a Treasury regulation governing a social security tax exemption. However, the Case is likely to have an impact on any judicial challenge made in the future to the validity of a final “interpretive” Treasury regulation (i.e., a regulation promulgated under a general grant of rulemaking power under the Internal Revenue Code of 1986, as amended (the “Code”), rather than pursuant to a specific delegation of authority in a particular Code section) issued under normal IRS procedures. Prior to the Supreme Court’s decision, uncertainty had existed regarding whether interpretive tax regulations should be subject to a standard permitting more in-depth court review than the rule provided in Chevron. By applying the principles of Chevron to an interpretive Treasury regulation, the Supreme Court resolved much of this ambiguity. However, the Chevron standard is highly deferential to an administrative agency. A taxpayer seeking to challenge an interpretive Treasury regulation should, accordingly, carefully consider whether its position is likely to be sustained under a Chevron analysis, particularly if that regulation was issued under the IRS’s standard “notice and comment” procedures. The impact of the Supreme Court’s decision on temporary regulations and other Treasury regulations issued outside the IRS’s “notice and comment” procedures is less certain.