Varian Medical Ruling Shows Loper Bright Case’s Continued Power

A Tax Court ruling this summer should prompt the Treasury Department to consider withdrawing measures that effectively prevent the IRS Independent Office of Appeals from reviewing validity challenges to regulations. That ruling highlights just one of the ripple effects of the end of Chevron; we are only starting to understand what that means for tax administration.

In 2022, the Treasury proposed regulations that constrain what kinds of issues Appeals may hear. Prop. Reg. Section 301.7803-2(c)(19), which is still pending finalization, says Appeals can’t consider issues based on invalidity arguments “unless there is an unreviewable decision from a Federal court invalidating the regulation as a whole or the provision in the regulation that the taxpayer is challenging.”

While the rule was still in its proposed form, the IRS issued interim guidance (AP-08-0922-0011) directing Appeals not to settle cases “on the basis of validity challenges if a court has not yet held the regulation in question is invalid or that the IRB notice or revenue procedure in question is procedurally invalid.”

On the surface, it may seem that the IRS has taken this position because of fairness and institutional legitimacy considerations that incentivize the IRS to come to the same result for similarly situated taxpayers. Those considerations warrant agency-wide attempts at uniformity that these regulations were presumably meant to achieve.

The other reasons the Treasury and IRS offered aren’t compelling. For instance, the Treasury cited the regulatory process and said that validity questions “are determinations of general applicability resolved at the highest levels of the Treasury Department and the IRS.” It also extolled the care and effort that goes into the review and approval of Treasury regulations before promulgation.

But that process and the officials’ rank aren’t credible reasons for precluding Appeals from exercising its independent judgment about tough legal questions based on an assessment of the IRS’s hazards of litigation.

The proposed regulations strip Appeals of its important role in resolving tax disputes without litigation for an entire subset of disputes. This might have made sense in the Chevron world, in which promulgated regulations were presumptively valid.

The Tax Court’s unanimous August decision in Varian Medical Systems v. Commissioner, however, suggests that stripping Appeals of this role for validity challenges doesn’t make sense in the post-Loper Bright world.

The Varian Medical decision is unremarkable in terms of the result it reached. The Tax Court decided the petitioner, a fiscal-year taxpayer, was entitled to take the dividends-received deduction under tax code Section 245A for some amounts treated as deemed dividends under Section 78—despite the IRS and Treasury’s attempt to regulate otherwise.

The court focused on the statutes, which unambiguously provide that the TCJA extended some DRD benefits to such fiscal-year taxpayers due to the effective dates for the DRD under Section 245A and the statutory amendment disallowing that DRD for Section 78 dividends. The Tax Court had little trouble dismissing the IRS’s arguments that it could enact regulations that were contrary to the statute.

What is remarkable about the Varian Medical decision is what it indicates about how Loper Bright has upended the order of things when it comes to disputes involving Treasury regulations.

From an IRS examination-function standpoint, the dispute that brought this Varian Medical case before the Tax Court followed a typical pattern. The taxpayer claimed a deduction, the IRS examiner consulted the Treasury regulations and applied the pertinent regulation (as it was required to do) to disallow the deduction, leading to a notice of deficiency. The taxpayer disagreed with the resulting adjustment and filed a petition in Tax Court.

If this issue had been brought to the Tax Court before Loper Bright, the core dispute would have been about the validity of that Treasury regulation and whether it applied to disallow the DRD. The Tax Court would have analyzed the statutes and regulation under Chevron.

But in Varian Medical, the Treasury regulation wasn’t the focus—the court got through nearly its entire opinion before it addressed the regulation at all. And when it did, the Tax Court didn’t linger over it.

The Varian Medical decision highlights the pronounced disparity between what constitutes the “law” that applied on audit and the “law” that the taxpayer thinks will apply (the “law” in the hands of the courts who ultimately decide tax disputes). If taxpayers and auditors can’t agree on the law that applies, it is quite likely that the case ends up unagreed at the end of an audit.

The potential glut of unagreed cases ought to cause the Treasury and the IRS to reconsider the 2022 proposed regulations and the interim guidance about challenges to regulation. The best option may be to discard them altogether.

If taxpayers and auditors arrive at the same issue with distinct versions of what the “law” is on that issue, the parties likely will have to litigate to get to an answer. But Appeals’ core function is to resolve disputes without the need for litigation.

Perhaps the proposed regulations made sense before the Supreme Court reversed Chevron. But after Loper Bright, they may undermine the core function of Appeals and unnecessarily force more cases into litigation.

The case is Varian Medical Systems v. Commissioner, T.C., 8435-23, 8/26/24.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Steve Dixon is partner at DLA Piper with focus on issues at the forefront of IRS controversies, such as transfer pricing disputes and challenges to Treasury regulations.

Henry Cheng is tax controversy and litigation partner at DLA Piper in San Francisco.

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