Hickman on Swallows Holding: The Third Circuit Gets It Right, Mostly

Kristin E. Hickman (Minnesota) offers her thoughts on the Third Circuit's decision last week in Swallows Holding, Ltd. v. Commissioner, No. 06-3388 (3d Cir., 2/15/08), rev'g 126 T.C. 96 (2006):

The Third Circuit’s opinion in Swallows Holding is an important one in the ongoing disagreement over the appropriate standard for judicial review of Treasury regulations promulgated pursuant to general authority under I.R.C. § 7805. The Tax Court’s majority and dissenting opinions neatly reflected the scholarly debate over whether the tax-specific judicial deference standard articulated in National Muffler or the more general Chevron deference standard applies to general authority Treasury regulations. Contrary to the Tax Court’s majority, but correctly in my view, the Swallows Holding decision clearly holds that Chevron rather than National Muffler provides the appropriate evaluative standard. The Third Circuit thus continues a post-Mead trend in the circuit courts of rejecting tax exceptionalism in judicial deference toward Treasury regulations. Yet the opinion is also interesting for the questions it leaves unresolved.

The Third Circuit’s opinion in Swallows Holding takes two clear and unequivocal positions regarding judicial deference in the tax context, both of which I consider absolutely correct. First, the court made clear its belief that Chevron and National Muffler represent distinct and, to some extent, incompatible standards. The court recognized that the Supreme Court and lower courts have cited National Muffler as requiring Treasury regulations and rules to be reasonable – “a proposition that is not at odds with Chevron’s core teachings.” Considering National Muffler more particularly as requiring judicial evaluation of several factors, however, the court rejected as “not mandatory or dispositive inquiries under Chevron” at least two of those factors – contemporaneity and congressional reenactment – along with giving weight to earlier judicial interpretations of ambiguous I.R.C. provisions. Second, to the extent that Chevron and National Muffler yield different results, the court held that Chevron controls the outcome.

The Third Circuit’s application in Swallows Holding of the Mead case to conclude that § 7805 regulations are entitled to Chevron rather than the lesser Skidmore deference is also correct but, by my lights, is based on analysis that is unfortunately incomplete. The taxpayers argued that the Treasury regulation at issue was an interpretive rule rather than a legislative one. Thus, to the extent that general rather than tax-specific deference principles governed the case, the taxpayers argued that the less deferential (and arguably more like National Muffler) Skidmore standard should apply rather than Chevron. The Third Circuit dodged the question of the taxpayer’s characterization of § 7805 regulations as interpretive. Instead, in applying Mead’s two-part test for deciding between Chevron or Skidmore, the court decided that Chevron applied principally because the government put the regulation at issue through public notice and comment, “a move that is indicative of agency action that carries the force of law.” Thus ends the court’s reasoning for why Chevron rather than Skidmore applies.

Because the Mead Court expressly mentioned notice-and-comment rulemaking as an indicator of Chevron’s applicability, the lower courts often seem to regard notice and comment as synonymous with Chevron’s applicability. In most cases they are probably right. Agencies typically utilize the notice-and-comment process because the legal force of their regulations requires adherence to those procedures. Compliance with notice and comment thus serves as a convenient proxy for Mead’s inquiry into whether regulations carry the force and effect of law. Yet Treasury and the IRS routinely proclaim that they are not required to pursue notice and comment in promulgating § 7805 regulations. The Swallows Holding opinion does not address the implications of that position for the government’s claim to Chevron deference.

Courts and scholars have recognized that an agency cannot bootstrap an otherwise Chevron-ineligible rule into Chevron deference merely through the utilization of notice and comment. Hence, the real question under Mead is not whether regulations were promulgated using notice and comment but rather whether they carry legal force. No one seriously doubts that § 7805 regulations do. As I have argued elsewhere, this is why § 7805 regulations are entitled to Chevron deference and why Treasury and the IRS are wrong in their assertion that notice and comment are optional. In the event a court holds that notice and comment are not required for § 7805 regulations, however, the Third Circuit’s limited analysis in Swallows Holding may provide a loophole for arguing again that Skidmore rather than Chevron deference should apply. Nevertheless, at a minimum, the Third Circuit has clearly repudiated the continued vitality of National Muffler as an independent, tax-specific evaluative standard for Treasury regulations. In my view, that’s progress.