The IRS has been issuing a large number of frequently asked questions pages (referred to as FAQs) to deal with tax law in recent years, particularly with regard to issues under the Tax Cuts and Jobs Act and later legislation. The agency, in the case of Scholl, et al v. Mnuchin, et al, USDC ND CA, Case No. No. 4:20-cv-05309[1] had argued, among other things, that these FAQs are not “final agency actions” and thus not subject to review by the courts under the Administrative Procedures Act (APA) even in cases where the IRS is taking action directly related to the FAQ holdings.

The case involved the IRS FAQ, published on May 6, 2020, that in Q&A 15 took the position that incarcerated individuals were not eligible to receive an economic impact payment (EIP) under the CARES Act. The agency eventually took action to retrieve payments that had already been made to such individuals, asked any who had received them and not had them retrieved to send the money back and refused to issue any additional payments to such individuals.

The IRS took the position that the FAQ, being an informal IRS publication on the agency’s web page, was not subject to review under the APA since it was a not a final agency action—no regulations had been issued, nor had any sub-regulatory ruling been issued by the agency at that time. The District Court disagreed with that position in this case.

The opinion outlines the conditions that must exist for a court to be able to review the agency’s actions under the APA:

There are two conditions for an agency action to be final under the APA: “First, the action must mark the consummation of the agency’s decision-making process — it must not be of a merely tentative or interlocutory nature. And second, the action must be one by which rights or obligations have been determined, or from which legal consequences will flow.” U.S. Army Corps of Eng’rs v. Hawkes Co., 136 S. Ct. 1807, 1813 (2016) (quoting Bennett v. Spear, 520 U.S. 154, 177–78 (1997)); see also Or. Nat. Desert Ass’n v. U.S. Forest Serv., 465 F.3d 977, 982 (9th Cir. 2006) (“[T]he core question is whether the agency has completed its decisionmaking process, and whether the result of that process is one that will directly affect the parties.” (alteration in original) (citation omitted)).[2]

In the situation in question in this case, the Court found that the FAQ and related IRS actions amounted to a final agency action:

…[S]everal facts indicate that the IRS’s decision-making process was final and not interlocutory or tentative. In the preliminary injunction order, the court determined that the action was final because the FAQ took the unequivocal position that incarcerated individuals were ineligible to receive EIPs, defendants submitted a declaration that did not indicate any change to the agency’s position was forthcoming, the IRS changed its internal manual, and the timing of the CARES Act made further agency determination unlikely. Dkt. 50 at 15–16.

Defendants do not contest these facts, but rather characterize them as a response to a rapidly developing situation that has continued to evolve in the months following enactment of the CARES Act. While this is an accurate description of the initial roll-out of the CARES Act, once the IRS changed its mind and determined that incarcerated individuals are ineligible for EIPs in early May 2020, the agency has been consistent in that interpretation and has shown no indication whether publicly or in this litigation that it intends to further change its position. For that reason, this case is similar to San Francisco Herring Association v. Department of the Interior, 946 F.3d 564, 575 (9th Cir. 2019), where the Ninth Circuit determined an agency’s decision to be final where the agency “repeatedly declared its authority . . . in formal notices, refused to change its position when pressed, and then enforced its fishing ban against individual fishermen. . . .”

Second, as the court determined in its prior order and reaffirms in this order, the CARES Act requires the IRS to issue EIPs to eligible individuals who meet the criteria established by Congress. Accordingly, the decision to deny those payments to a specific segment of the population is one where a right has been determined.

Accordingly, the court finds that the IRS’s determination that incarcerated individuals are ineligible for an EIP is a final agency action.[3]

The opinion notes that even if there is a final agency action, the court cannot grant relief under the APA if adequate remedies exist. The IRS argued that since this was merely an advance payment of a refundable 2020 credit, the taxpayer could take action when and if the IRS denied their claim for the credit on the 2020 tax return.

But the opinion notes, citing its original preliminary injunction’s reasoning, that:

There is no refund action for the lack of the EIP itself and
As well, a refund claim on a 2020 return is not an adequate remedy to the harm done through the denial of the EIP.[4]

The opinion reasons that the refund claim section (IRC §7422(a)) is not applicable to the matter at hand:

Generally, section 7422(a) requires a taxpayer to file a claim with the IRS before bringing suit for the recovery of any internal revenue tax. See United States v. Clintwood Elkhorn Min. Co., 553 U.S. 1, 4 (2008) (“A taxpayer seeking a refund of taxes erroneously or unlawfully assessed or collected may bring an action against the Government either in United States district court or in the United States Court of Federal Claims.” (citations omitted)). In its prior order, the court reasoned that plaintiffs’ claims fell outside section 7422 for two reasons. First, plaintiffs did not allege that a tax was erroneously or illegally assessed or collected, a penalty was collected without authority, or any sum is alleged to be excessive. Dkt. 50 at 18–19. Second, plaintiffs sought injunctive and declaratory relief and such equitable relief fell outside the relief permitted by the statute. Id. at 19 (citing King v. Burwell, 759 F.3d 358, 366 (4th Cir. 2014), aff’d, 576 U.S. 473 (2015); Cohen v. United States, 650 F.3d 717, 732 (D.C. Cir. 2011) (en banc)).[5]

But even if the court were to ignore that issue, the opinion finds that §7422(a) relief of an eventual 2020 claim for a credit would not be adequate in this case:

A remedy is inadequate if it only offers “doubtful and limited relief.” Bowen, 487 U.S. at 901. For example, in Hawkes, 136 S. Ct. at 1815, the Court rejected an alternative remedy where “a landowner [would] apply for a permit and seek judicial review in the event of an unfavorable decision” because “the permitting process can be arduous, expensive, and long.” As persuasively reasoned by the district court in Amador v. Mnuchin, — F. Supp. 3d — , 2020 WL 4547950, at *9 (D. Md. Aug. 5, 2020), forcing plaintiffs to file a 2020 tax return, wait until the IRS denies their request for a CARES Act tax credit, file an administrative claim with the IRS seeking reconsideration, and only then file a suit in district court would amount to the “arduous, expensive, and long process” that was rejected in Hawkes. For this separate reason, plaintiffs have no adequate alternative remedy to the APA.[6]

The court then moves on to see if the agency acted in an arbitrary and capricious manner in issuing this guidance and taking the related actions. The Court found that the arbitrary and capricious standard was met:

Here, plaintiffs argue that defendants’ policy is arbitrary and capricious because defendants have failed to provide an adequate reason for its decision. MSJ at 13. Next, the policy relies on factors that Congress did not intend it to consider. Id. at 14. Plaintiffs contend that, to the extent defendants claim the policy was adopted as an anti-fraud measure, that reason is a post-hoc declaration offered in this lawsuit and defendants have not logically connected instances of fraud to the broader decision not to disburse any payments to incarcerated individuals. Id. In response, defendants argue that because section 6428 does not require the IRS to issue advance refund payments to plaintiffs, the IRS has not acted arbitrarily and capriciously. Dkt. 70 at 16.

The court’s prior order determined that plaintiffs were likely to succeed on the merits because defendants had not directed the court to any evidence indicating that the Treasury Department or the IRS gave any reason for the decision to exclude payments to incarcerated individuals, much less an adequate one. Dkt. 50 at 27–28. Defendants have not advanced any convincing explanation or reason to deviate from the court’s prior finding.[7]

The opinion significantly notes that the agency has to give its reasons supporting the position taken when it issues the guidance, something it did not do here, advancing a reason only after the fact in this litigation:

For example, defendants cited a concern on the part of the IRS that it regularly received information about possible fraudulent tax refunds or other frivolous tax activity involving incarcerated individuals. See Dkt. 70 at 6–7; Dkt. 44-1, ¶¶ 5–6. Yet, this explanation was not publicly advanced by the agency at the time it reached its determination and therefore constitutes an impermissible post hoc rationalization. See Dep’t of Homeland Sec. v. Regents of Univ. of Cal., 140 S. Ct. 1891, 1909 (2020) (“While it is true that the Court has often rejected justifications belatedly advanced by advocates, we refer to this as a prohibition on post hoc rationalizations, not advocate rationalizations, because the problem is the timing, not the speaker. The functional reasons for requiring contemporaneous explanations apply with equal force regardless whether post hoc justifications are raised in court by those appearing on behalf of the agency or by agency officials themselves.”).[8]

It is important to note that the facts of this situation are a bit unique, so it remains to be seen how broad a net is cast over the flood of IRS guidance by FAQ by this ruling. But at least it suggests that the agency does not avoid having to explain its positions in all cases by posting its position on its website and calling it an FAQ.

The IRS may be reacting to this case and other criticism of issuing material guidance by FAQ. In an article published on October 7, 2020 in Tax Notes Today Federal[9], Nathan Richman quoted IRS Chief Counsel Michael J. Desmond from a webcast sponsored by Crowell & Moring, LLP as stating the agency was open to adding some FAQs to the Internal Revenue Bulletin, allowing taxpayers to rely on them or converting some FAQs to published guidance such as notices.

[1] Scholl, et al v. Mnuchin, et al, USDC ND CA, Case No. No. 4:20-cv-05309, October 14, 2020, Copy of case can be downloaded from https://caresactprisoncase.org/resources/ link (https://www.lieffcabraser.com/pdf/order-re-summary-judgment.pdf retrieved October 16, 2020)

[2] Scholl, et al v. Mnuchin, et al, USDC ND CA, Case No. No. 4:20-cv-05309, pp. 15-16

[3] Scholl, et al v. Mnuchin, et al, USDC ND CA, Case No. No. 4:20-cv-05309, pp. 16-18

[4] Scholl, et al v. Mnuchin, et al, USDC ND CA, Case No. No. 4:20-cv-05309, p. 18

[5] Scholl, et al v. Mnuchin, et al, USDC ND CA, Case No. No. 4:20-cv-05309, pp. 18-19

[6] Scholl, et al v. Mnuchin, et al, USDC ND CA, Case No. No. 4:20-cv-05309, p. 20

[7] Scholl, et al v. Mnuchin, et al, USDC ND CA, Case No. No. 4:20-cv-05309, pp. 33-34

[8] Scholl, et al v. Mnuchin, et al, USDC ND CA, Case No. No. 4:20-cv-05309, p. 34

[9] Nathan J. Richman, “IRS Open to Placing More FAQs in the Internal Revenue Bulletin,” Tax Notes Today Federal, October 7, 2020, 2020 TNTF 194-3, (https://www.taxnotes.com/tax-notes-today-federal/practice-and-procedure/irs-open-placing-more-faqs-internal-revenue-bulletin/2020/10/07/2d1c2 retrieved October 16, 2020, subscription required)