IRS’s ERC Notice is valid

But only as guidance

An Arizona District Court ruled that the IRS’s Employee Retention Credit Notice 2021-20 did not violate the Administrative Procedure Act and was merely interpretive. Because of this, the Notice does not have the force of law, but the Court expects the IRS to be consistent with its public policy. The Court laid out its reasoning for this, ultimately agreeing with the Government on each point, but not without struggle. This issue will look at the main arguments and see if the Court got it right.

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What is the Administrative Procedure Act?

I have written about this case and the Administrative Procedure Act (APA) before, but here is a quick recap of the APA.

The APA is the law governing how administrative agencies propose and establish regulations. If you have followed the creation of any regulations by the IRS, you will be familiar with the notice and comment period that follows the publication of the initial proposed regulations before it is finalized. This is the process envisioned by the APA, which serves the basic purpose of the Act: to keep the public informed and facilitate public participation in the rulemaking process. When agencies want to issue enforceable rules, as opposed to those just offering guidance, they must follow the procedures outlined in the APA. Such rules have the force of law and are binding not only on the agency in question but also on taxpayers. Guidance, in contrast, does not bind either the Government or taxpayers and does not have to go through the notice and comment period.

This was not the process followed by the IRS in issuing Notice 2021-20.

Stenson Tamadoon LLC v. U.S. Internal Revenue Service

In this case, Stenson Tamaddon requested that the Court invalidate the Notice because it did not adhere to the APA requirements. The Government (Department of Justice representing the IRS) argued that it was not rulemaking but merely interpretive, and the IRS was not required to follow the APA’s notice and comment period. This also means that the Notice does not have the force of law, but is only a statement of the IRS’s interpretation of the statute.

Stenson challenged the Notice on three specific issues: the restriction that household employers are not considered to operate a trade or business, the definition of governmental orders and partial suspension, and the record-keeping requirement.

Definition of Trade or Business

In the first argument, the Court determined that the term “trade or business” was “not so ‘vague or vacuous’ that it [did] not supply the necessary substance for deriving an interpretive . . . rule.” As a direct result of this, “the IRS is only advising the public of its construction of that statutory language.” But anyone who has done more than a surface-level dive into this topic quickly understands how vague and vacuous that term is. This term is notoriously ambiguous, with its definition changing in every use case. The Court missed the mark on this because any definition produced by the Notice is more than just the construction of the statutory language, but the creation of a new definition.

Definition of Governmental Orders and Partial Suspension

Next, the Court turned to the definitions of governmental orders and partial suspension. The Court treated this as one topic, but addressed each point separately, and the first point of contention was dismissed relatively quickly. Essentially, the Court found that the definition of “appropriate government order” was broad enough to encompass the IRS’s interpretation to the point that the language in the statute was sufficient enough that even without the Notice, it would have been enforceable. But the question is not whether the statutory language was clear enough to enforce, but whether the IRS Notice created a new standard. The Court did not get to the question and failed to consider the IRS’s actions in this context properly.

Turning to partial suspension, Stenson argued that the 10% disruption safe harbor was being used as a binding legal standard. In support of this, Stenson produced public statements, individual adjudications, statements from the IRS, and IRS legal memos. But the Court was ultimately not persuaded. The Court found that the Notice’s language that a partial suspension should be a facts and circumstances analysis gave the IRS room to make determinations outside of the safe harbor. But acting in accordance with the Notice is not evidence of a legislative rule, but consistency with published policy.

But what is missing from this analysis is any evidence that the IRS actually considers facts and circumstances in its analysis, or whether it merely looks for the 10% decline. The Court gave the IRS a lot of benefit of the doubt that is not supported by any actions from the IRS.

Record-keeping Requirement

Finally, the Court looked at the record-keeping requirements of the Notice. Stenson attacked the Notice’s requirement that taxpayers maintain relevant employment tax records for at least four years, claiming this created a new requirement not found in the statute. Stenson did not address the Government’s argument that this is already required under Section 6001. The Court sided with the Government’s argument once again. Maybe I’m missing something, but this one seems to be the weakest argument and not fully developed by the plaintiff.

Was this the right result?

If you have read this far, then you won’t be surprised to hear me say no. But, while I think the Court made some errors, it is by no means an easy case. The Court admitted to struggling with this several times, stating that “‘the point at which a rule crosses [the] line is a question “enshrouded in considerable smog.”’” (citing another case), and that the analysis “is more art than science.” This was a motion for summary judgment, meaning in part that the Court had limited information to work with. So while I still think the Court should have ruled in the other direction on most points, I am sympathetic to the Court’s position here.

What does it mean?

This is a win for the IRS in the sense that the Notice has not been invalidated. But at the same time, the Notice does not have the force of law. The IRS cannot use it in litigation as a means to enforce a denial. However, taxpayers should still expect it to be used during exams and appeals, as it is the IRS’s policy.

Wrap-up

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The content of this article is for informational purposes only and should not be taken as tax, legal, benefits, financial, or HR advice. I am a lawyer, but receiving this newsletter does not mean I am your lawyer. Since rules and regulations change over time and can vary by location, consult a lawyer or HR expert for specific guidance.