…and Charging Fees to Cover Their Costs

Federal agencies under the Obama Administration are taking regulating to a new level and, in many cases, essentially legislating. Also, in some cases, fees are being charged to cover the costs of the excessive regulatory activities.

Congress can delegate to federal agencies the power to essentially make law, via legislative regulations. A legislative regulation is one the is created by a statutory grant of authority to an agency by Congress to essentially fill gaps in a statutory scheme. As an almost absolute rule, such regulations are lawful.

Agencies also have the power to issue administrative (i.e. interpretive) regulations. These regulations are not law. However, in accordance with a 1984 U.S. Supreme Court case, Chevron Inc. v. National Resources Defense Council, administrative regulations that fill statutory gaps are generally upheld by courts as long as they are reasonable. However, regulations cannot make law where Congress has made law or specifically acted not to make law. In this regard, absent a law or Constitutional provision prohibiting activity, U.S. citizens are free to do whatever they wish in the U.S. It is in the area of administrative regulations where agencies have essentially been creating law, without lawful authority.

Under Article I, Section 8 of the U.S. Constitution, only Congress can make law or tax. Congress has granted agencies the power to charge fees for special benefits provided by agencies and has allowed fees to be charged for use of certain federal assets (e.g. the national parks).

In the area of taxes, the Obama Administration acted quickly after the 2009 inauguration to pass laws to close the “tax gap” between taxes due and taxes collected. That gap was estimated at more than $450 billion. Successful legislative efforts include codification of the “economic substance” doctrine, whereby tax benefits of transactions undertaken without business purpose or economic substance are eliminated. Another success requires much greater disclosure of foreign financial interests, including foreign trusts information. Steep penalties apply to failures to disclose.

In some cases, the Administration has had the Treasury Department act where legislative efforts have failed. An example is the Taxpayer Protection and Assistance Act of 2007 (TPAA), which did not pass Congress. For many years, the Treasury Department has had a limited ability to regulate the practice of representatives of persons before the IRS with respect to audit and tax collection matters. If enacted, TPAA would have, among other things, expanded the regulatory ability of the Treasury Department to cover tax return preparation matters. When the bill did not pass, Treasury nevertheless applied a twisted interpretation of existing law to issue regulations that grant it the power to regulate the tax return preparation industry.

To make matters worse, citing the “user fee” statute as authority, Treasury also recently began charging tax return preparers to be able to prepare returns for compensation. It did so by requiring return preparers to acquire and pay for a preparer tax identification number (PTIN). The statute that Treasury substantially relied upon to charge fees is one that permits Treasury to require ID numbers be placed on returns by preparers. This statute was designed to help the IRS track down unscrupulous preparers. In the past, the user fee statute has generally only been used to charge persons for licensing or for services requested by the person, such as a private letter ruling request with respect to a tax matter. Along with two other attorneys, Jerry Froelich, Jr. and Mark Spix, I recently filed a class action in the U.S. District Court for the Northern District of Georgia on behalf of tax return preparers, requesting the court to rule that charging of these fees is unlawful and requiring reimbursement of fees paid.

Another sad example of excessive regulation in the tax area that pre-dates the Obama Administration is the “use it or lose it” rule with respect to cafeteria plans. Under this rule, an employee must guesstimate how much he’ll spend on health care out-of-pocket costs before the year begins and if he overestimates, he loses the excess. Thus, many people spend part of their holiday season spending money on contact lenses, etc. that they often don’t need in order to spend the remaining balance in their flexible spending account.

What is the authority for the use it or lose it rule? A proposed regulation that has existed for decades. The statute under which the regulation was created merely prohibits the deferral of compensation. Instead of requiring return to the employee of unused amounts coupled with taxation in the year for which the amount was elected (i.e. a logical means of handling), an illogical rule that is not supported by statutory authority or legislative history was created that virtually all companies follow. Some justify the rule based on another rule without statutory basis created in proposed regulations issued under the same Code section: the uniform coverage rule. Under this rule, an employee can use the entire amount elected for the year on any day of the year, regardless of how much money has been withheld from his paychecks. So, an employee who elected $5,000 of withholding for the year and had a major operation on January 2nd that consumed all $5,000 could use the $5,000 for medical out-of-pocket costs even if he quit on January 3rd and had $0 withheld from his pay for the year. (In 2005, I wrote an article explaining why there was no legal basis for the use it or lose it rule, and further pointing out the wrongfulness of the rule. I sent a draft of the article to the Treasury Department. Shortly thereafter, Treasury issued a notice that permitted employers to add up to an additional two and a half months to the ordinary one year period for utilization of fund balances.)

As many court decisions note, a proposed regulation is not law. Rather, it is an agency’s interpretation of an issue or a matter.

Recently, a bill was proposed that would call for repeal of the use it or lose it rule. So, a legislative proposal exists to repeal an agency’s interpretation of the law!

One final example of improper action by the Treasury Department is the prior “same desk” rule, under which the Treasury Department interpreted a statute allowing distributions upon “separation from service” as prohibiting distribution of 401(k) elective deferrals in an asset sale situation. I had a client that was experiencing hardship due to the rule. After thoroughly researching the rule, I concluded that distributions should be permitted in asset sale situations. The rule was created via two private letter rulings and hardened by an act of Congress that made two exceptions to the “rule” created by the private letter rulings. I sent my draft article to Treasury, pointing out that revenue rulings issued many years earlier had defined an asset sale a something that clearly would result in a separation from service. Treasury then issued Revenue Ruling 2000-27, essentially gutting the rule. (Shortly before the Ruling was issued, I received a call from a Treasury Department employee, informing me that my article had “broken the logjam” on the matter.) Later, in 2001, the wording of the applicable statute was changed to completely eliminate the issue.

Outside the tax area, the U.S. Department of Labor also has been creating rules where statutory authority is lacking. With respect to pension plans, for years, the Labor Code has required fiduciaries who manage pension plan assets not to purchase unnecessary services and to pay no more than an arm’s length price (i.e. fair market value) for the services received with respect to amounts charged to the plan’s assets. For many years, interpretive regulations had existed that basically applied a facts and circumstances test to determine if the law was followed. Significant penalties potentially apply for failure to follow the rule.

Five to ten years ago, the Labor Department determined that fees in the pension plans area were excessive. It made significant efforts to make its views known. Professionals who work in the area took notice and advised their clients of the need to make sure they were complying with the law. The matter was closely scrutinized by the pension industry. Thus, any problems were worked out in a few years. Nevertheless, the Department of Labor issued regulations providing that a fiduciary automatically violates the rule unless it receives a breakdown of “sub-fees” of persons with which it contracted to provide a combination of services.

Many in the industry don’t like these rules. But, the options for fighting them are very limited. Fighting generally means legal costs and potentially other costs. In the pension disclosure area, anyone fighting could be accused of hiding something. Why wouldn’t more disclosure be good? It’s not good when there’s no need for it to reduce costs and adding it will only increase costs and reduce freedom.

In the tax area, usually it’s hard for any single person or company to fight a tax issue without expending substantial cash. The fact that a favorable ruling would benefit many ordinarily is a secondary consideration to cost. Generally, class actions are not feasible with respect to tax matters. Often, when a rule goes years without being challenged, an agency will argue in court the inaction is proof that Congress accepted the rule as law.

What’s wrong with what’s happening in these cases? Agencies are essentially acting for Congress. In many cases, an agency is acting in an area where Congress specifically refused to act. Individual and business freedom is reduced without justification, often resulting in increased cost to someone.

Perhaps more importantly, the balance of power is being upset. The Administrative Branch of government is essentially making laws. When gridlock exists, as is presently the case, this reality is particularly convenient to an administration. But, it’s wrong. What is supposed to happen is existing law is to remain as is unless and until Congress acts to change it. Unless Congress acts to limit the power of agencies (as it could do), these injustices will continue unless citizens and companies bring legal actions to protect themselves.