Tuesday, June 6, 2017

On Chevron and Lenity (6/6/17; 6/7/17)

Note:  I made a mistake in the text toward the end of this blog.  The mistake involved Regs. 1.6662-3(b)(2).  On 6/7/17, I corrected the mistake on 6/7/17 by revising the blog below and the the linked full text with footnotes.  Apologies to readers.

I am in the process of revising my Federal Tax Procedure Book in  anticipation of the next edition in August 2017.  I have spent inordinate amounts of time on Chevron and the APA.  In the process, I added one section dealing with lenity and Chevron.  I thought I would post that section here because the text (absent the footnotes) is relatively short and on topic for the Federal Tax Crimes Blog.  For those who can't live without footnotes (or question whether I can support the statements in the text), I offer the text with footnotes here.

By way of introduction, Chevron and its progeny hold that agency regulations adopting a reasonable interpretation of ambiguous statutory text will control, even if the interpretation is not the only reasonable interpretation or even the best reasonable interpretation.  That is a greatly simplified statement of the rule, but it should work for this posting.  The application of Chevron is usually viewed as adopting requiring two steps.  I offer the following from the text of the book (without the footnotes):
The First Step – often called Step One – inquires whether the meaning of the statute is unambiguous?  (Other synonyms for unambiguous used in this First Step are plain and clear; one does not get past Step One if the text is unambiguous, is plain or is clear; I will generally use the word unambiguous but readers should be alert to the synonyms plain and clear used by other authors, some of whom I quote.)  If so, the regulation is irrelevant because the unambiguous meaning of the statute itself pre-empts the interpretive field.  A regulation inconsistent with the unambiguous meaning is invalid.
The Second Step – often called Step Two – reached only if the text is determined to be ambiguous in Step One is whether the agency interpretation is unreasonable? Under this Second Step reached if the text is ambiguous, the agency’s interpretation in the regulations is given deference so long as it is not arbitrary, capricious or manifestly contrary to the statute it seeks to interpret (I generally just truncate this litany to “unreasonable”; so that, in Step Two, deference is given if the agency interpretation is reasonable and is not given if the agency interpretation is unreasonable.). In other words, the agency may choose between or among reasonable interpretations within the scope of the statutory ambiguity (sometimes referred to as the Chevron space). Some have argued that, in practice, the Chevron two-step inquiry is often conflated into a single inquiry – deference is given if the regulation is reasonable without first doing the Step One drill; but, at least in my observation, Courts will pay homage to Step One before determining reasonableness which is the Step Two inquiry.  This Step Two reasonableness analysis appears to be the same or at least coextensive with the APA requirement that the agency have engaged in reasoned decision-making so as to avoid being characterized as arbitrary and capricious, an inquiry short-handed to State Farm named for the leading case.
I would appreciate comments from readers, particularly challenging what I say or offering corrections to substance, presentation or syntax.  You can offer such comments either by comment here or by email to me (jack@tjtaxlaw.com).

Here is the text without footnotes:

(8) Chevron, the Rule of Lenity and Criminal and Civil Penalties.

“The rule of lenity requires ambiguous criminal laws to be interpreted in favor of the defendants subjected to them.”  This sounds like a Chevron Step One inquiry for criminal laws, albeit through another interpretive technique.  Lenity requires that the ambiguous statute be interpreted in the defendant’s favor;  Chevron, if applicable, would require that the ambiguous criminal statute must be interpreted as the agency interprets it in regulations unless the interpretation is unreasonable.  Now, I think that everyone would agree that the agency cannot interpret an ambiguous criminal statute in a way adverse to a criminal defendant.  Lenity trumps Chevron.  For example, in the tax area, the IRS could not by a regulation interpret the willfulness element of tax crimes different from the definition developed by the Supreme Court – intent to violate a known legal duty. Thus, it appears that, in tax crimes requiring willfulness or some equivalent of willfulness, the rule of lenity, if it applied, and the willfulness element fully or substantially overlap to assure that a defendant cannot be convicted if the criminal statute is ambiguous.

The finer question is whether an agency could, by regulation interpret a substantive provision that it administers which could then cause a violation of a criminal statute.  Focusing on that crimes with a willfulness element, if the substantive law is not clear (i.e., ambiguous), the taxpayer cannot have intended to violate that law and thus cannot be guilty of a crime requiring willfulness – intent to violate a known and knowable legal duty.  For that reason, the Government only prosecutes where the substantive legal duty allegedly violated is clear (unambiguous).  Here too, the rule of lenity and the criminal tax willfulness element of intent to violate a known and knowable legal duty overlap and assure ambiguous substantive tax provisions are not the basis for criminal prosecution.  The question then is whether facially ambiguous statutory text can be made unambiguous by an agency regulation entitled to Chevron deference and thus form the basis for a criminal tax prosecution which requires intent to violate a known and knowable legal duty.  For example, the IRS can adopt a regulation interpreting a substantive tax provision, such as § 162 for trade or business expenses, and that interpretation will be entitled to Chevron deference within the Chevron space.  If the regulations’ interpretation resolving the statutory ambiguity is entitled to Chevron deference, does that interpretation then set the legal duty that could give rise to a tax willfulness crime if the taxpayer intentionally violates the law as thus interpreted?  I think the answer to that question is yes, but doubt that the interpretive choice even if applicable retroactively for civil tax purposes would be retroactive for criminal tax purposes.  There are many permutations of this issue that I have just not thought through yet, but this should give a sense of the issues involved.
Turning to civil penalties (such as, in the tax arena, the 20% or 40% accuracy related penalties in § 6662 and 75% civil fraud penalty in § 6663), the rule of lenity is not applicable because it only applies in the criminal context.  The IRS could and does invoke its authority to interpret the civil penalties in the Chevron space.  For example, the negligence penalty applies to “Negligence or disregard of rules or regulations.”  The statute mandates that “disregard of rules or regulations” includes “careless, reckless or intentional disregard of rules or regulations.”  Is there Chevron Step One ambiguity in the quoted terms – careless, reckless, intentional disregard, or rules or regulations?  Certainly, so the Regulations provide finer definitions – interpretive choices in Chevron’s lingo – of those concepts within the Chevron space.  And Courts routinely apply the definitions for the application of the penalty.

Perhaps more importantly, the Congressional mandate that disregard of “rules or regulations” will attract the penalty is clear congressional recognition that there is Chevron space for the IRS to adopt rules or regulations not necessarily mandated by the text of the substantive statute (otherwise Congress would have imposed the penalty for violation of that text instead of the rules or regulations).

This illustrates that (i) there is Chevron space in the civil penalty provision itself and (ii) there is Chevron space in the substantive law provision, neither of which are affected by the rule of lenity.  But, if either the civil penalty provision or the substantive law to which it points is ambiguous and the ambiguity has not been clarified by regulations (or by prior court cases), the courts will be free to apply interpretive techniques free of the Chevron deference framework to the task of deciding whether the taxpayer is properly subject to the civil penalty.

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