Update on APA Challenges to Notice of Deficiency

In an earlier blog post, we discussed the US Tax Court’s ruling in QinetiQ U.S. Holdings, Inc. v. Commissioner, No. 14122-13 (Dec. 27, 2013). The taxpayer had argued that the Internal Revenue Service’s (IRS’) notice of deficiency containing a one-sentence reason for the deficiency determination violated the Administrative Procedure Act (APA) because it was “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” The Tax Court disagreed, emphasizing that it was well settled that the court is not subject to the APA. To refresh, the APA provides a general rule that a reviewing court that is subject to the APA must hold unlawful and set aside an agency action unwarranted by the facts to the extent the facts are subject to trial de novo by the reviewing court.

The taxpayer recently filed its reply brief with the US Court of Appeals for the Fourth Circuit, arguing that the Tax Court erred in its conclusion that it was not subject to the APA. First, the taxpayer argued that the Tax Court is a “reviewing court” under the APA. The taxpayer noted that the legislative history accompanying the APA’s passage in 1946 “makes clear that Congress understood the Tax Court to be a reviewing court subject to . . . the APA.” Specifically, the taxpayer pointed to citations in both the House and Senate Reports where Congress cited the “Tax Court” as an example of a venue to which the APA’s standard-of-review provisions would apply. The taxpayer also argued that Congress reinforced the Tax Court’s status as a “reviewing court” in 1969 when Congress changed the Tax Court’s status from “an independent [executive] agency” to a “court of record” under Article I of the Constitution. The taxpayer did not cite to the Supreme Court of the United States’ opinion in Freytag v. Commissioner, 501 U.S. 868 (1991), which held that the Tax Court is a court of law.

The taxpayer also countered IRS arguments that Internal Revenue Code (IRC) Section 7522 displaces the APA’s arbitrary-and-capricious standard. Section 7522 provides a general rule for the content required in an IRS deficiency notice (e.g., a description and amount (if any) of adjustment). Importantly, Section 7522 also states that “[a]n inadequate description under the preceding sentence shall not invalidate such notice.” The taxpayer argued that a provision cannot displace the APA unless the provision does so expressly. Neither Section 7522 nor its legislative history, as the taxpayer pointed out, mentions the APA.

There may be a middle ground here. Under IRC Section 7491 and the Tax Court’s interpretation of Section 7522, the burden of proof can shift to the IRS in certain circumstances.  In ExxonMobil Asia Pacific PTE. Ltd. v. American Samoa Govt., Dkt. No. CA: 38-14 (High Ct. of American Samoa Aug. 17, 2015), a case which we are handling, the High Court of American Samoa recently granted a motion to shift the burden of proof where the notices of deficiency contained the amounts of the deficiencies but provided no description or explanation for the basis for the deficiencies.

It remains to be seen how the Fourth Circuit resolves the APA issues in QinetiQ, but the ultimate resolution could have far-reaching consequences. A resolution in the taxpayer’s favor would likely have a significant impact on the IRS’ process of issuing notices of deficiency to taxpayers. It might also open the door to APA challenges in other parts of the tax world. Taxpayers and their advisors should continue to follow this area of the law given the heightened importance of the APA in tax matters.

Jeffrey M. Glassman
Jeffrey M. Glassman is experienced in defending businesses and individuals in all stages of federal tax controversies. He represents clients in US Internal Revenue Service (IRS) examinations, administrative appeals, voluntary disclosures, and litigation. Jeffrey has settled multiple tax disputes with IRS legal counsel avoiding litigation in court, when possible. He has significant experience advising clients on strategic and procedural considerations in US Tax Court and other federal courts. Read Jeffrey Glassman's full bio.

McDermott Will & Emery
McDermott Will & Emery partners with leaders around the world to fuel missions, knock down barriers and shape markets. Our team works seamlessly across practices, industries and more than 20 locations to deliver highly effective—and often unexpected—solutions that propel success. More than 1,200 lawyers strong, we bring our personal passion and legal prowess to bear in every matter for our clients and the people they serve.




jd supra readers choice top firm 2023 badge