COVID-19 began to spread across the United States in early 2020. Fearing another Great Depression, Congress acted swiftly in passing multiple rounds of relief legislation. Through enactment of the CARES Act and other legislative efforts, individuals and businesses received much needed economic relief through the Paycheck Protection Program, economic impact payments, and the employee retention credit (ERC).
But expediency in the legislative process can have its costs. Because priority was given to the distribution of funds to those in need, Congress did not fully vet, debate, and rigorously consider the statutory language, leaving many key details omitted from the legislation. For example, the CARES Act provides that an eligible employer qualifies for the ERC if, among other things, the employer’s operations were fully or partially suspended due to a COVID-19 governmental order. What constitutes a “partial suspension” of business operations was not addressed clearly in the statutory language or in the legislative history.
Ambiguities in statutes—even those passed outside national pandemics—are relatively common. In these instances, governmental agencies usually step in to provide their own interpretation of the statute. The guidance may be formal (e.g., regulations) or informal (e.g., notices or advice on the agency’s website).
If the agency seeks to implement guidance through a “legislative rule,” though, special requirements apply for the courts to enforce the rule. Generally, legislative rules impose additional or new legal requirements beyond that of the statutory language. Conversely, “interpretative rules” are issued to advise the public of an agency’s interpretation of the statute or the rules that it administers. Legislative rules carry the force of law; interpretative rules do not.
Because legislative rules carry more legal weight, agencies that seek to implement them must jump through additional hoops. Specifically, the Administrative Procedure Act (APA) requires the government to follow a three-step process to request courts to enforce them. First, the agency must issue or publish a notice informing the public of its intent to create a new legislative rule. Second, the public must have an opportunity to participate in the rulemaking process through providing comments on the new proposed rule. Third, if the agency chooses to adopt the rule, it must include a statement for the basis and purpose of the rule. If these “notice-and-comment” procedures are not followed, federal courts may strike down or “set aside” the rule as unlawful.
The IRS is not immune to the requirements of the APA. And, in more recent years, federal courts have consistently reminded the agency of this truism. Although the IRS has vigorously defended its guidance in federal courts, it has suffered a series of present-day losses. In 2021, the Supreme Court held in CIC Services v. IRS, 141 S. Ct. 1582 (2021) that the Anti-Injunction Act (AIA) did not apply to a pre-enforcement action under the APA. In 2022, the Tax Court held in Green Valley Invs., LLC v. Comm’r, 159 T.C. No. 5 (Nov. 9, 2022) that Notice 2017-10—characterizing syndicated conservation easements as listed transactions—was invalid under the APA because the IRS had failed to comply with the notice-and-comment requirements.
Based on a more recent filing in the United States District Court for the Central District of California, an IRS notice related to the ERC may suffer a similar fate. In Southern California Emergency Medicine, Inc. v. United States et. al., No. 5:23-cv-02450, a California employer contends that IRS rules set forth in Notice 2021-20 should be held invalid under the APA because the IRS failed to comply with the notice-and-comment procedures. The complaint requests the court to issue a national injunction barring the IRS from enforcing Notice 2021-20. Of particular interest, the complaint contends that various rules related to the partial suspension test should be held unlawful, including the IRS’s requirement that a business show more than a “nominal” disruption to its overall business.
Given the high stakes involved, interested readers should anticipate a vigorous defense from the government. Although that response is forthcoming, expect the government to raise some viable arguments, notwithstanding its string of recent APA defeats. As an initial matter, the CARES Act provided Treasury with the authority to “issue forms, instructions, regulations, and guidance as are necessary” to implement the ERC program. With this language, the government will likely contend that Congress intended to bypass the APA. However, to succeed on this contention, the IRS must demonstrate that Congress clearly intended to do so. This can be a tall hurdle.
Additionally, the government may cite to the “good cause” exception to the APA’s notice-and-comment procedures, which exempts APA requirements where “impracticable, unnecessary, or contrary to the public”. Expect the government to contend that it falls under this exception because of the exigencies of the COVID-19 pandemic. The complaint apparently anticipates this argument as well, contending that Notice 2021-20 was issued almost a year after enactment of the CARES Act. In other words, the government could have just as easily issued the guidance through the APA’s notice-and-comment procedures.
Without doubt, the invalidation of Notice 2021-20 would be far-reaching. In issuing guidance on the ERC, the IRS relied almost entirely on notices and Frequently Asked Questions (FAQs). Presumably, if Notice 2021-20 is declared unlawful, so too is this guidance. Recognizing the potential invalidation of all such guidance, the IRS’ next move will be an interesting one.