Posted by: Robert Horwitz | October 1, 2018

Tax Court to IRS: Rules of Administrative Law Apply to You by Robert S. Horwitz

Since Mayo Foundation v United States, 562 US 544 (2011), the IRS has given lip service to the proposition that rules governing judicial review of administrative agency action apply to the IRS.  The Tax Court’s order granting the taxpayer’s summary judgment motion in Renka, Inc. v. Commissioner, Dkt. No. 15988-11 R (Aug. 16, 2018), here, shows that the IRS has yet to fully understand what that means.

Renka, Inc., petitioned the Tax Court to determine whether the ESOP that owned 100% of its stock qualified as a tax-exempt trust for tax years ending December 31, 1998, and subsequent plan years.  Renka was the exclusive agent for American Nutrition Corp. (ANC) in soliciting, negotiating and securing orders for ANC products.  The IRS’s determination had two stated bases: first, Renka and ANC were a controlled group under IRC §414(h) and second, Renka and ANC were an affiliated service group under IRC §414(m)(5).  If either were correct, then Renka and ANC would have to be considered together to determine whether non-highly compensated employees benefitted equally with highly compensated employees.

Initially, the IRS moved for summary judgment on the ground that ANC and Ranka were a controlled group in 1999.  The Tax Court denied the motion, holding that a) Renka and ANC were not a controlled group and b) under the Chenery doctrine (named after SEC v. Chenery Corp., 332 U.S. 194 (1947)), a court is required to judge an agency’s action by the grounds invoked by the agency at the time of the action rather than by after-the-fact rationalizations.  Since the IRS determination dealt with the year ending December 31, 1998, facts relating to 1999 could not be considered.

The parties then filed cross-motions for summary judgment.  Renka argued that its ESOP qualified in 1998.  The IRS argued that Renka and ANC were an affiliated service group based on facts relating to 1999.

The Tax Court denied the IRS motion and granted the taxpayers’ motion.  First, the Court noted that Chenery prevents the IRS from using facts from 1999 to uphold a determination for 1998.  The Court rejected the IRS’s argument that if it strips away all extraneous matter, the determination is correct.  According to the Court, this was like saying “if we ignore all the things he (IRS) did wrong, then he was right.”  The IRS admitted the grounds given in the determination letter were wrong.  The upshot: the determination an abuse of discretion.

Next, the Court held that the IRS could not justify its determination by claiming it was a “continuing determination” since it applied to all years because the determination was made for the 1998 tax year; if the ESOP didn’t qualify for 1998, it didn’t qualify in later years.

The Court also rejected the IRS’s argument that a proposed regulation supported its position.  Even if Chenery did not apply, the proposed regulation would have no more weight than an argument in a brief and, contrary to the IRS, the regulation did not state that marketing was tantamount to managing.  Additionally, the regulation was withdrawn in 1993, so that it couldn’t be relied on to justify the IRS’s action for the 1998 tax year.  There was no way the IRS could “edit the rationale he gave into something that isn’t an abuse of discretion.”

ROBERT S. HORWITZ – For more information please contact Robert S. Horwitz – or 310.281.3200   Mr. Horwitz is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., a former Assistant United States Attorney of the Tax Division of the Office of the U.S. Attorney (C.D. Cal) and represents clients throughout the United States and elsewhere involving federal and state, administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at


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