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Friday, September 27, 2024

Weekly SSRN Tax Article Review And Roundup: Saito Reviews Marks’s Winning By Losing: The Strategy Of Adverse Letter Rulings

This week, Blaine Saito (Ohio State; Google Scholar) reviews a new work by Noah Hertz Marks (Duke), Winning by Losing: The Strategy of Adverse Letter Rulings, 66 B.C. L. Rev. __ (2025).

Blaine saito

Tax law is rich with sources. We have sources of binding law in the forms of statutes, regulations, and court cases. But there is also a rich set of sub-regulatory guidance. One of note are Private Letter Rulings (PLRs). While PLRs are only binding on the IRS with respect to a specific taxpayer, those in practice frequently consult PLRs, as they provide insight into the IRS’s reasoning on key issues for which there may be no other form of guidance. PLRs are issued through a collaborative process. When the IRS determines that there may be an adverse ruling in a PLR, it provides numerous off-ramps. Yet, these adverse PLRs exist. Noah Marks explores this puzzle in Winning by Losing: The Strategy of Adverse Letter Rulings. Marks shows that adverse letter rulings exist for numerous reasons, including strategic normative power. His work thus adds not only to tax scholarship, but also our understanding of the long shadow of agency actions.

PLRs are voluntary program whereby a taxpayer submits a request to the IRS for a ruling on particular transactions. The taxpayer pays a user fee to help cover the cost of resources. The IRS and the taxpayer work collaboratively regarding the PLR. The taxpayer submits information about the transaction to the IRS. The IRS and the taxpayer often meet. During these meetings the IRS shares its thinking. Prior to signing and issuing a PLR, the IRS confirms their rulings. If there are adverse rulings coming, the taxpayer is aware of them and the IRS provides significant ways out of the PLR. Once signed the PLR is binding on the taxpayer and the IRS for the covered transactions. If it is adverse and the taxpayer continues their position, they open themselves up for audit. A finalized PLR is sent around the IRS, and, since 1977, it is publicly published though with redactions to protect taxpayer privacy.

PLRs are important, because even though they are technically not binding, they are often the only source of the IRS’s thinking on a particular issue. Thus, it creates a sort of shadow law toward which practitioners and policymakers look.

Marks then turns his attention to adverse PLRs. He assembled a dataset based on the PLRs that the IRS made public starting in 1977. Adverse PLRs were those that were adverse to the taxpayer on all issues on which they sought a ruling.

Marks notes that when he found these adverse PLRs, they received outsized attention. Accounting firms noted them on tax positions for audited financial statements. Third parties were more likely to cite them. And they changed taxpayer behavior regarding subsequent PLRs, often chilling the tendency for follow-on carbon copy PLRs that often arise.

Marks then outlines four reasons for adverse PLRs. The first is human foibles. General folk wisdom says this is the reason for adverse PLRs. But Marks’s data and analysis show that while significant, it is not the only reason.

A second reason for adverse PLRs is external forces or facts. There are often non-tax reasons that a PLR is required. For example, in the public utility context, these companies often need PLRs that deny accelerated depreciation to meet state regulatory requirements. In other instances, instead of a non-tax reason, there are just low personal stakes. These arise when another party indemnifies the taxpayer for adverse consequences.

The third reason is assurance value. One form of assurance comes when a PLR takes an adverse ruling that is not the worst outcome possible for the taxpayer. Another is to resolve disagreements between parties about how a transaction is treated for tax purposes that is key in the structure of a transaction.

But perhaps the most fascinating reason is the normative strategic use of an adverse PLR. While small in the dataset in terms of numbers, these are the ones that often receive outsized attention. One strategic use is forcing public backlash. One key example here was in the context of LGBTQIA+ rights. A PLR stated that when an employer extended health insurance to a domestic partner of an employee, the amount of the additional coverage was considered taxable income, unlike for a spouse, where it was not taxable income. The PLR was used as a tool to show the unequal treatment of LGBTQIA+ couples who could not get married.

Another strategic use arises in a competitive market. If a certain player is doing better only because of an aggressive tax position, getting an adverse PLR can shut down that position. One notable example was a PLR regarding Real Estate Investment Trust (REIT) management fees to sponsors. The IRS rejected the aggressive strategy. That shut down many of these structures and transactions to the benefit of other REIT sponsors who chose not to take this aggressive route.

Marks then makes some suggestions for the future of PLRs. One is to formalize the publication, through a Chief Counsel Advice (CCA), of adverse guidance even if a taxpayer takes the offramp. These CCAs probably would not take much more time, given all the work that went into developing the PLR, and it would provide greater transparency. Second, he suggests that directly affected third parties be brought into the PLR process. Limiting it to directly affected third parties makes it more manageable, but it also helps prevent undermining these third parties’ rights.

Finally, Marks points to potentially using PLRs for the public interest. While not an easy task and quite resource intensive, doing so gets around some of the complex barriers to litigation. Thus, there can be some potential to using PLRs to shut down some forms of what people consider abusive tax positions.

Marks’s excellent piece forces us to consider the importance of PLRs within the overall structure of tax administration and development of the law. It shows the heretofore ignored importance of the PLRs in not just creating guidance, but almost creating another type of quasi-regulatory outlet. In particular, the normative strategic use of the PLRs shows that while we have important processes for high level binding guidance through regulations, a lot happens in the background.

Second, the revelations of the PLRs show another dimension as to how tax shapes the world around us. Transactions and structures in a competitive market are greatly affected by taxation, and the strategic adverse PLR fits that story of how tax planning can sometimes drive significant parts of transactions. The adverse PLR for domestic partners shows too the human consequences of taxation.

Finally, the piece also shows the importance of having greater transparency with the IRS. Marks’s proposal to have CCAs of withdrawn adverse PLRs is important. It allows some level of oversight on the IRS, and it helps to add to some of the dialogue as to how the tax laws evolve over time. PLRs are thus important because of not only their shadow law effect, but how they reveal and push forward the tax discourse.

Here’s the rest of this week’s SSRN Tax Roundup:

https://taxprof.typepad.com/taxprof_blog/2024/09/blaine-saito-reviews-marks-winning-by-losing-the-strategy-of-ad.html

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