Member Article

Bunge argues that the section 7805(b) limitation on retroactive regulations was meant to apply to all regulations issued after July 30, 1996, regardless of when the underlying statute was enacted.

A. Retroactive Treasury Regulations Generally

Many legal systems discourage or disallow retroactive laws in various contexts.¹ The U.S. Constitution prohibits states and the federal government from making ex post facto criminal laws,² and there are various limitations on retroactive civil laws.³ In Bowen,⁴ the Supreme Court held that retroactive regulations⁵ are generally prohibited and are allowed only under a specific grant of congressional authority.

1. Origins of Treasury''s retroactive regulation authority. Issuing regulations is the single biggest role Treasury has in setting tax policy. The rules and procedures it must follow are outlined in provisions throughout the code and under other statutes, such as the Administrative Procedure Act (APA),⁶ as well as judicial doctrines. Treasury''s general rulemaking authority is granted in section 7805(a), while other code provisions give Treasury a more specific grant of authority.⁷

The Supreme Court has said that agencies can issue valid regulations under either explicit or implicit authority from Congress, but that a retroactive regulation is valid only if promulgated under an explicit grant of authority to make retroactive regulations.⁸ Before 1996 the IRS, unlike other U.S. administrative agencies, had general, explicit authority to make its regulations retroactive. The old iteration of section 7805(b) provided that Treasury could "prescribe the extent, if any, to which any ruling or regulation, relating to the internal revenue laws, shall be applied without retroactive effect" (emphasis added). The government maintains that old section 7805(b) continues to apply to any regulation made under a statute passed before July 30, 1996.⁹

The history of that rule of presumed retroactivity dates to the Revenue Act of 1921, long before there was a rule against retroactivity for agencies in general.¹⁰ The original rule for retroactivity stemmed from the historic notion that a statute has a single meaning when it is enacted and that any agency guidance is merely an attempt to interpret it.¹¹ From that principle, it followed that any change to interpretive agency rules would be retroactive because the new rule was merely an update to a "more correct" attempt at finding the statute''s true, single meaning.¹² In allowing Treasury discretion to apply a new regulation without retroactivity, Congress wanted to both reduce the harshness of presumed retroactivity for taxpayers and ease the administrative burden on the IRS that would result from having to change its disposition of several previous matters upon a new interpretation of the statute.¹³ In this sense, the original rule of "merely presumed" retroactivity was taxpayer friendly and allowed flexibility when general administrative law was harsh.

For most agencies, the historic rule favoring retroactivity was supplanted by the general rules of the APA and case law such as Bowen, which almost completely disallow retroactive regulations. For Treasury, however, the mollifying rule that allowed more fairness and flexibility in 1921 turned into a relatively government-favorable rule that still allowed presumptive retroactivity until 1996. For most agencies, the landscape completely changed from retroactivity as a matter of law to a strong presumption against retroactivity, but the rule for Treasury remained the same. This discrepancy between tax administrative law and general administrative law is just one piece of the "tax exceptionalism" that has pervaded administrative law.¹⁴

2. Historic limitations on retroactive regulation authority. While Treasury had broad authority under the pre-1996 version of section 7805(b), there were seemingly few instances in which regulations were actually promulgated with retroactive effect.¹⁵ Two main restrictions may have produced this result: judicial limitations and self-restraint.

a. Judicial limitations. Even with old section 7805(b)''s explicit authorization for retroactive regulations, courts were still uneasy when confronting retroactive Treasury regulations. Courts relied on two, perhaps indistinct, theories for invalidating them: abuse of discretion and equitable estoppel.¹⁶ The Second Circuit put it this way: Although retroactive Treasury regulations are "presumptively permissible, it is in each case for the court to determine whether under all the circumstances retroactive application would be warranted."¹⁷ Courts put considerable weight on the type of regulation -- that is, whether it was merely interpretive or instead introduced new law or changed settled law.

In practice, courts applied these doctrines only when the regulations seemed most unfair. A frequent rationale for upholding retroactive regulations was that Treasury''s interpretive power was used to merely refine or correct the interpreted meaning of a statute -- in the spirit of the declaratory theory of statutory law -- rather than to unfairly change the prior interpretation.¹⁸ Later cases may show a trend away from the declaratory theory, especially in applying estoppel when the IRS has issued guidance contrary to that of pending regulations.¹⁹

b. Administrative restraint. The other reason retroactive regulations are somewhat rare is Treasury''s restraint in using its power to issue them. A report by the American Bar Association Section of Taxation found that only one of the nine regulations studied was mandatorily retroactive.²⁰ However, there are still examples of Treasury using the full extent of its retroactive regulation power. For example, the regulation at issue in Home Concretewas issued with retroactive effect, adopting a statutory interpretation that was contrary to Supreme Court precedent. The cases discussed below also addressed mandatorily retroactive regulations.

In hearings before Congress, Treasury argued against the 1996 amendment to section 7805(b) on the grounds that it had previously been responsible and fair in issuing retroactive regulations.²¹ The tax section''s comments on the proposed legislation likewise stated that Treasury had generally exercised good discretion in choosing when to apply regulations retroactively.²² Those comments focused on Treasury''s need to have a reasonable period after a statute''s enactment to issue interpretive regulations. That concern was addressed in the statutory exception for regulations "timely issued" within 18 months. The tax section''s comments reflected the IRS''s agreement that retroactive legislative regulations are generally unfair.

B. Effective Date Is Ambiguous

Section 7805(b) was amended by the Taxpayer Bill of Rights II, effective July 30, 1996. The statute previously said: "The Secretary may prescribe the extent, if any, to which any ruling or regulation, relating to the internal revenue laws, shall be applied without retroactive effect."

As amended, the statute provides a general rule in section 7805(b)(1): "Except as otherwise provided in this subsection, no temporary, proposed, or final regulation relating to the internal revenue laws shall apply to any taxable period ending before the earliest of the following dates." It then lists a set of three dates considered to put taxpayers on notice of the contents of the regulation. Section 7805(b)(2) through (b)(7) lists six exceptions to the general rule against retroactivity: regulations filed within 18 months of the statutory enactment; regulations "to prevent abuse"; regulations to correct procedural defects; regulations "relating to internal Treasury Department policies, practices, or procedures"; regulations under a superseding congressional authorization; and regulations in which retroactivity is elective for the taxpayer. Finally, section 7805(b)(8) preserves the previous, presumptive retroactivity for rulings, as distinct from regulations.

The effective date language of amended section 7805(b) is found in section 1101(b) of the Taxpayer Bill of Rights II; it is not codified. The provision says that the amendment "shall apply with respect to regulations which relate to statutory provisions enacted on or after the date of the enactment of this Act."²³

At first blush, the effective date language seems to mean that if a regulation is made under a statute that was enacted before July 30, 1996, the amended version of section 7805(b) does not apply and the former, presumptive retroactivity applies. Grammatically, however, it is not entirely clear that the language "enacted on or after the date of enactment of this Act" is intended to modify "statutory provisions." That language could also modify "regulations" in the full phrase "regulations which relate to statutory provisions."

1. Traditional rules of statutory interpretation and ambiguity. As stated in Sutherland''s treatise, "Where the language is plain and admits of no more than one meaning the duty of interpretation does not arise and the rules which are to aid doubtful meanings need no discussion."²⁴ A statute''s language is ambiguous when "reasonably well-informed persons" can understand it in more than one way.²⁵ Courts will also say, as a way out of the plain or unambiguous language, that they are not bound by the plain language if it produces an unreasonable or absurd result.²⁶

The treatise is suspicious of courts resorting to a holding that the plain language is clear and unambiguous without analysis that goes beyond the isolated words of the particular provision.²⁷ Often, clear meaning is found when the court limits the context to particular words, phrases, and punctuation marks without regard to any broader context.²⁸ Also, even though courts often say that outside sources cannot be consulted if the statute''s meaning is clear from the plain language, they still look beyond the words of the statute in holding that the statute has a clear meaning on its face.²⁹

a. Arguments for ambiguity. Because rightly or wrongly, courts first look to the isolated words of the statute, an argument for ambiguity needs to at least start with the isolated words. Analysis of the syntax and grammar of the section 7805(b) effective date language shows that there is more than one way a reasonable person could interpret it.

In formal American English, "which" is generally understood to introduce a nonrestrictive relative clause, whereas "that" is used to introduce a restrictive relative clause. A comma should precede a nonrestrictive clause beginning with "which," while no comma should precede a restrictive clause beginning with "that." A nonrestrictive relative clause, which merely adds information, is unnecessary to the overall meaning of the sentence. A restrictive relative clause is a clause that is necessary to the sentence''s meaning.³⁰

In section 7805(b)''s effective date language, the clause "which relate to statutory provisions" is used without any comma setting it off. If there were commas, it would seem clear that "enacted on or after" modifies "regulations," instead of "statutory provisions."³¹ If the phrase used "that" instead of "which," it would seem more likely, but not conclusive, that "enacted on or after" modifies "statutory provisions."

In context with the rest of the section, it makes a lot of sense to read "which relate to statutory provisions" as a nonrestrictive clause. Section 1101 of the enacting legislation starts by generally disallowing retroactive regulations, then makes an exception for "internal regulations," among others, and then clarifies that the new restriction is not applicable to "rulings." If "which relate to statutory provisions" is read as a nonrestrictive clause, it serves to clarify and promote internal consistency by specifying that the amendment will apply only to regulations that relate to statutes, as opposed to "internal regulations" and "rulings."

b. Arguments against ambiguity. There are counterarguments to the notion that the language is ambiguous. For example, the first blush reading would indicate that "enacted on or after" modifies "statutory provisions." To find ambiguity, one has to think a bit about the immediate context and alternative ways to read the language.

The Supreme Court did not address the effective date language in its Home Concrete opinion because it invalidated the regulation at issue on other grounds.³² However, the parties and some amici curiae briefed the issue, and it came up once in oral argument. The taxpayer''s counsel argued that the effective date language could and should be interpreted to mean that all regulations promulgated after 1996, even those under the 1954 statute at issue, are subject to the new section 7805(b) limitation. Justice Elena Kagan responded by saying, "I take your point about the purpose, but you would have to ignore every rule of grammar that there is in order to read it your way, don''''''''t -- wouldn''t you?"³³ The taxpayer''''''''s counsel responded that all it takes to change the meaning of the language is to read "regulations which relate to statutory provisions" as a single phrase, as mentioned above.

Another argument against ambiguity would be to look at the context of common legal meanings. In common legal parlance, regulations are "promulgated" and statutes are "enacted." Thus, use of the word "enacted" might imply that it modifies "statutory provisions" instead of "regulations." This argument is not conclusive either, however, because regulations can also be "enacted."³⁴

Another argument against ambiguity is to look at "interpretive canons." "The Rule of the Last Antecedent" is a rule of contract and statute construction that dictates that a modifying word or phrase should generally be construed to modify only the nearest preceding noun, or "last antecedent."³⁵ Under a similar rule, the nearest-reasonable-referent canon, a modifier generally applies only to the nearest reasonable referent.³⁶ When applied to new section 7805(b)''''''''s effective date language, these canons could dictate that "enacted on or after" should be read to modify "statutory provisions" because that is the last antecedent and the nearest referent. However, these canons are merely aids to interpretation, and it is arguable whether language is truly unambiguous if interpretive canons need to be applied in the first place.

2. Court cases in which the effective date of section 7805(b) was at issue. Several courts have either explicitly or implicitly decided whether the section 7805(b) effective date means that retroactivity is generally allowed for regulations under pre-1996 statutes. Some courts have taken Treasury''''''''s position that the effective date language means that the previous, presumptive retroactivity applies when a regulation is made under a statute passed before July 30, 1996. However, none of the pro-Treasury courts addressed any ambiguity in the effective date language, so it is reasonable to conclude that they thought the language was plain and unambiguous. Other courts have reached a different conclusion, while not specifically addressing the effective date language.³⁷

a. Cases in which old section 7805(b) was applied to a regulation under a pre-1996 statute. The Tenth Circuit directly addressed the effective date language in Salman Ranch.³⁸ The court applied the previous, presumptive retroactivity of old section 7805(b) because it found the regulation at issue to be "under" a pre-1996 statute.³⁹ In summarizing the effective date language, the court merely said, "This amended provision applies for regulations related to statutory provisions enacted on or after July 30, 1996."⁴⁰ Notably, the court did not use the particular phrasing of the statute, "regulations which relate to statutory provisions enacted on or after," in finding that new section 7805(b) did not apply.

The Eight Circuit has discussed the applicability of new section 7805(b) in dicta, stating that the amended provision would not help the taxpayer even if it applied, since "it is effective only for regulations that relate to statutory provisions enacted on or after July 30, 1996, and Congress enacted Section 401 . . . prior to 1996."⁴¹Notably, the court used the word "that" instead of "which" in summarizing the effective date language and did not discuss any possible ambiguity in that language. The Federal Circuit has also held that old section 7805(b) applied.⁴² However, in that case there was apparently no dispute between the parties about which version applied.⁴³

b. Cases in which new section 7805(b) was applied to a regulation under a pre-1996 statute. Other courts have analyzed the validity of regulations in a way that assumes section 7805(b) applies to regulations under pre-1996 statutes, but those courts did not explicitly address and interpret the effective date language. In Murfam Farms,⁴⁴ the Court of Federal Claims analyzed the section 7805 framework in determining that a retroactive regulation was invalid. Reg. section 1.752-6, which had retroactive effect as promulgated, was at issue. The IRS was trying to apply the regulation retroactively to prevent use of a partner''s inflated outside basis resulting from a COBRA contingent liability tax shelter transaction. The court first determined that the regulation was not within the specific grant of authority in section 309(c) of the Community Renewal Tax Relief Act of 2000 (the 2000 Tax Act).⁴⁵ It follows from this conclusion that the regulation would therefore be issued under the general regulatory authority of section 7805(a) and that the regulation is interpretive of section 752, whose statutory language has been unchanged since 1954. If the court believed that new section 7805(b) applied only if the regulation was issued under a statute enacted after July 30, 1996, it would have analyzed the retroactive regulation at issue through the lens of old section 7805(b). However, the court analyzed the regulation under new section 7805(b), concluding that the abuse prevention exception of section 7805(b)(3) did not apply.⁴⁶ It never addressed the effective date language; its reasoning implied that new section 7805(b) should apply even if the regulation was issued under a 1954 statute.

It may have been an oversight for the Murfam Farms court to not consider the applicability of new section 7805(b) in light of its conclusion that the regulation was not promulgated under the 2000 statute. The court did, however, quote the statutory language of the effective date provision before addressing the applicability of the section 7805(b) exceptions.⁴⁷ The parties settled the case with a stipulation that the transaction lacked economic substance, and the government sought to have the Murfam Farms holding vacated because the stipulation rendered the applicability of the regulation moot, but the court refused to vacate its conclusion that the regulation could not have retroactive effect.⁴⁸

The courts in Sala⁴⁹ and Stobie Creek⁵⁰ followed similar lines of reasoning as in Murfam Farms in disallowing retroactive application of reg. section 1.752-6. All three courts concluded that the post-1996 statute did not authorize the regulation, but they then analyzed the regulation under the new section 7805(b) framework anyway. The Sala and Stobie Creek courts did not address the effective date language.

The biggest difference in the reasoning of courts that analyzed the retroactive regulation under new section 7805(b) is that those courts first dealt with the argument that the regulation was issued under a post-1996 statute. Even though those courts rejected the IRS''s contention that the regulation was permitted under the more specific grant of authority in a more recent statute, the courts subjected the regulation to the more rigorous treatment of the new restriction while deciding whether the regulation was valid retroactively as an interpretation of a 1954 statute.

It is also notable that the IRS relied on the exceptions in new section 7805(b) in issuing the final regulation, rather than attempting to invoke the old version of the statute -- it would have been incongruent to use old section 7805(b) while claiming authority under the 2000 statute.⁵¹ It seems that the IRS was faced with a choice between two main challenges to the regulation: (1) that it is not a valid regulation under the 2000 legislative authority, or (2) that it is not permitted to be retroactive because new section 7805(b) applies to all new regulations, even when issued under a 1954 statute. The IRS took its chances on option (1) and lost.

The reasoning of these courts highlights the incongruity of the IRS''''''''s interpretation of the effective date language. The courts rejected the contention that the regulation was under a newer, more specific grant of authority. So why should it follow that the regulation is subject to less scrutiny regarding retroactivity because it was made under an older, more general grant of authority -- especially when one of the exceptions to the new restriction is for when there is specific congressional authority to make retroactive regulations?⁵²

C. Correct Interpretation of Effective Date

The plain language of new section 7805(b)''s effective date leaves at least a window of ambiguity because reasonable persons could read it in more than one way. When a statute''''''''s plain language is ambiguous, legislative intent and statutory scheme come into play.⁵³ Both of those factors point toward the conclusion that the section 7805(b) limitation on retroactive regulations applies to all regulations issued after July 30, 1996, regardless of when the underlying statute was enacted.

1. Legislative intent. Congress clearly stated the problem it was trying to address: "Retroactive regulations are generally inappropriate."⁵⁴ That purpose does not comport with the fact that the new legislation would not apply to new regulations promulgated under a majority of code sections if the IRS''''''''s interpretation is accepted.⁵⁵

It is difficult to see how the confusing language in section 7805(b)''s effective date got there in the first place. The 1992 Congress, with a Democratic majority in both the House and Senate, passed a bill containing a version of new section 7805(b).⁵⁶ President George H.W. Bush vetoed that bill on March 20, 1992, and the House failed to override the veto.⁵⁷ The effective date language found in the final 1992 version clearly made the restriction apply to all new regulations.⁵⁸ In April 1996, the House and Senate each resurrected a version of the bill containing very similar effective date language. Those bills were sent to the House Ways and Means and Senate Finance committees, respectively.⁵⁹ The effective date language in those bills also made it clear that the restriction would apply to all new regulations. Those bills also provided that the abuse prevention exception would be available only for regulations issued under new statutes, which would have made these versions essentially stricter on regulations under old statutes than under new statutes. Those bills, each titled "Taxpayer Bill of Rights 2," did not come back out of committee, but a very similar bill, the one that was eventually enacted, was introduced in September 1995 as H.R. 2337. That version contained the same effective date language as the final version,⁶⁰and there was no mention of the change in the effective date language by any of the members of Congress or committees that spoke or reported on the bill.

In the Ways and Means Committee hearing on the April 1995 version that was sent to committee, Treasury testified that the effective date for the provision, which was then retroactive to apply to all regulations issued after January 5, 1993, was counterproductive to the rest of the proposal in that the statutory limitation on retroactivity was itself retroactive.⁶¹ The next version that was introduced contained the current effective date language. Clearly, the Ways and Means Committee addressed the concern that the statute itself was retroactive, but it is unclear why the language changed to what it is now by the time it was reintroduced in September 1995. None of the testimony against the provision objected to the restriction applying to new regulations under old statutes.

Most of the comments focused on the need for a reasonable amount of time for the IRS to issue regulations under a new statute and have those regulations retroactive to the date of enactment of the new statute.⁶² That concern was addressed by the "18-month" exception in section 7805(b)(2) for promptly issued regulations. Other comments emphasized that retroactivity sometimes helps taxpayers; that concern was addressed by the exception for taxpayer-elective retroactivity in section 7805(b)(7). Treasury''s other concern was the need to apply regulations retroactively to prevent abusive interpretations of new statutes, especially in the tax shelter context.⁶³That concern was addressed by the prevention of abuse exception in section 7805(b)(3).

Going through the legislative history, there is never a change of tone by members of Congress in describing what the limitation on retroactive regulations was intended to do; Congress thought all along that it was going to fix the problem of unfair retroactive regulations.⁶⁴ All congressional discussion focused on the unfairness of making regulations that change the result for a taxpayer based on reliance on an old regulation or on a reasonable interpretation of a statute. There is no argument for, or mention of, the notion that the restriction should apply only to regulations under new statutes, and that is because such an exception makes no sense as part of the statutory scheme.

2. Statutory scheme. The full structure of section 7805 shows how section 7805(b) should work. Section 7805 is the meat of Treasury''s statutory authority to make regulations. Section 7805(a) generally allows Treasury to promulgate any needful regulation, and a regulation made purely under section 7805(a) is sometimes called an interpretive rather than legislative regulation. Other subsections of section 7805 restrict or qualify Treasury''''''''s general authority. Section 7805(e) requires that all temporary regulations also be issued as proposed regulations. Section 7805(f) requires Treasury to consider and submit for review each regulation''s impact on small businesses. Of course, section 7805(b) generally disallows retroactive regulations. The effective dates for section 7805(e) and (f) make them clearly applicable to all new regulations.⁶⁵ Nowhere else in the tax code or the entire U.S. code is there language that seems to restrict only regulations made under new statutes, as the language in section 7805(b)''''''''s effective date is said to do.

If Congress had wanted to have the restriction apply only to regulations under newly enacted statutes, which at that time was a tiny fraction of the code, why would none of the enumerated exceptions or any discussion leading up to enactment mention that intention? There are six enumerated exceptions for various special situations, and there is also section 7805(b)(8), which makes clear that the old rule of presumptive retroactivity still applies to rulings. It is hard to imagine that Congress thought it prudent to specify that the new restriction, which never mentions rulings anyway, does not apply to rulings, but at the same time failed to mention that the restriction would not apply to regulations under, at the time, 99 percent of the code.

It is also hard to understand the specific exception for promptly issued regulations⁶⁶ in conjunction with the IRS''s interpretation. Congress clearly responded to feedback from the IRS and others in making an exception for when regulations are issued within 18 months of a statute''s enactment. But if read the way that the IRS argues, section 7805(b) would mean that regulations issued within 18 months of a statute''s enactment can be retroactive, and that regulations can also be retroactive if they are issued at least 18 years after the statute was enacted.

Another problem is what the effective date would mean, even under the IRS''s interpretation. Under that interpretation, the restriction would apply when a regulation is "relating to" a statute passed after July 30, 1996, but it is hard to understand what Congress would mean by "relating to" in that context. Can the IRS simply argue that a new regulation relates to an old portion of a code section, even though other parts of the same section were enacted later? These difficulties and ambiguities would be avoided by interpreting the effective date to apply to all newly enacted regulations.

D. Conclusion

Consider the history of how regulations are viewed in our legal system. When the first statute on similar subject matter to section 7805(b) appeared in the code in 1921, regulations were considered mere attempts at finding the "single" meaning of the statute, and changes to regulations were just Treasury trying to get closer to the single meaning. Back then, courts gave little deference to agency interpretations because it was ultimately the courts'''''''' job to decide what a statute really means. Now we have Chevron,⁶⁷ holding that courts must give full deference to any valid regulation that contains one of several "reasonable" interpretations of a statute; Brand X,⁶⁸ holding that a regulation with retroactive effect that otherwise meets the Chevron test can be validly applied to overrule a court''s prior decision on the meaning of a statute; and Mayo,⁶⁹ holding that Chevron applies to all Treasury regulations, whether interpretive or legislative.⁷⁰ It is obvious that a retroactive regulation in 1921, and even in 1996, meant something vastly different than a retroactive regulation in 2014. Patrick J. Smith even argued that this change in meaning should itself be enough to have a court decide that the former rule of presumptive retroactivity should not apply to new regulations, regardless of whether the words of the statute allow it or not.⁷¹

There is no way for the IRS''s interpretation of section 7805(b)''s effective date language to be reconciled with Congress''s view that retroactive regulations are generally inappropriate. Congress provided the IRS a series of well-thought-out exceptions for when it would be appropriate for a regulation to have retroactive effect, and none of those exceptions indicate that Congress was less concerned about regulations under pre-1996 statutes. Those exceptions should be the only way for a regulation to be retroactive, even if -- but really, especially if -- the regulation reinterprets a 60-year-old statute.

Bunge argues that the section 7805(b) limitation on retroactive regulations was meant to apply to all regulations issued after July 30, 1996, regardless of when the underlying statute was enacted.