How Tax Rules Impacting Charitable Giving Are Made - Part II: A Brief Review of the Regulatory Process

How Tax Rules Impacting Charitable Giving Are Made - Part II: A Brief Review of the Regulatory Process

Article posted in Legislative on 21 December 2000| comments
audience: National Publication | last updated: 15 September 2012
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Summary

The second article in this two-part series explores the regulatory process involved in making the tax rules governing charitable giving, including the roles of the IRS and Treasury.

by: Emanuel J. Kallina, II, Esquire & Jonathan D. Ackerman, Esquire

Click here for Part I

Introduction

This article and the previous article in this two-part series explore the processes by which tax laws and regulations governing charitable giving come into effect. A review of these processes may assist charities, donors and advisors in following the status of a particular proposal and in evaluating the likelihood that the proposal could become applicable to them. Some proposals are favorable and some are unfavorable. In either case, once a new law or regulation on charitable giving becomes effective, charities, donors and advisors must follow the law or regulation.

This first article focused on the legislative process and how bills are proposed and passed in Congress. As the article explained, once an identical bill has been passed by both Houses of Congress, the President receives the bill for consideration. In general, a bill becomes law when the President signs it. However, as described in the first article, a bill may sometimes become law without the President's signature.

This article now reviews the regulatory process. Essentially, regulations interpreting charitable giving tax laws are made by the executive branch of the government. Key players in this process are the Treasury Department and its Internal Revenue Service division.

As the first article noted, the judiciary may also play an important role in determining the rules that apply to charitable giving. The judiciary's role is beyond the scope of these articles.

The Regulatory Process

The Treasury Department is part of the executive branch of the federal government. The Treasury Department consists of the Office of the Secretary and various bureaus or offices. The Secretary of the Treasury is appointed by the President. The duties of the Secretary of the Treasury include formulating and recommending tax policy. The Deputy Secretary of the Treasury assists and advises the Secretary, particularly with respect to policy formulation and execution. Various offices are in turn headed by Assistant Secretaries.1

The Internal Revenue Service (the "IRS") is a division of the Treasury Department. It is responsible for collecting taxes by administering and enforcing the Internal Revenue laws. Its mission statement is as follows: "Provide America's taxpayers top quality service by helping them understand and meet their tax responsibilities and by applying the tax law with integrity and fairness to all." The IRS was established by Congress in 1862 as the Bureau of Internal Revenue. The name was changed in 1953. A Commissioner heads the IRS. The organizational structure of the IRS is currently under review.2

Legislative, Interpretative and Procedural Regulations

Regulations may describe the position of the IRS on a particular Code3 provision and may set out rules for complying with or operating under a Code provision.4

A regulation is considered a legislative regulation if a provision of the Code specifically authorizes the IRS to prescribe operating rules.5 Although not binding on a court unless the regulation is within the agency's granted power, issued with proper procedures and reasonable, legislative regulations are generally deemed to have the force and effect of a law.6

A regulation is considered an interpretative regulation if it describes the IRS's position on a section of the Code.7 In contrast to legislative regulations, interpretative regulations are not passed under a specific grant of authority in the applicable Code Section. Instead, interpretative regulations are passed under the general authority granted in Code Section 7805. Interpretative regulations do not bind a court but they do bind the IRS and the Treasury Department to the interpretation of the law given in the regulation.8

A regulation is considered procedural if it contains a non-mandatory directive.9 Procedural regulations are usually promulgated by the Commissioner of the IRS as Statements of Procedural Rules. With some exceptions, the IRS is bound by a procedural regulation when a taxpayer's interests are vitally at stake.10

If a regulation deals with a taxpayer's obligations to file a form or information and was promulgated with notice and hearings, it should be kept in mind that the regulation may be deemed to have the force of law similar to a legislative regulation. Also, regulations that interpret procedural or administrative provisions of the Code are usually considered to be interpretative regulations rather than procedural regulations.11

Proposed, Temporary and Final Regulations

A proposed regulation is a tentative rule designed to "provide timely guidance when delays inherent in the preparation of temporary or final regulations would be unwise or when additional input is required before a final position can be adopted by the IRS."12 Proposed regulations must be issued in Notices of Proposed Rule Making, which are published in the Federal Register. Anyone interested in doing so may comment on a proposed regulation within the time frame indicated in the Notice of Proposed Rule Making. A public hearing may be held. At some point after the comments are received and the hearing, if any, has been held, the IRS will usually issue a final regulation, sometimes with modifications, to replace the proposed regulation. In most cases, a taxpayer may not rely on a proposed regulation to support a tax return position.13

As the name suggests, temporary regulations are regulations that exist for a limited period of time. Under Code Section 7805(e), as noted below, temporary regulations must expire within 3 years of the date they are issued. As is the case with final regulations, temporary regulations are issued in Treasury Decisions. Notices of Proposed Rule Making need not be issued with temporary regulations, but because Code Section 7805(e) now requires that each temporary regulation also be issued as a proposed regulation, the IRS will sometimes use the text of the temporary regulation for the required Notice of Proposed Rule Making. Temporary regulations have the same status in terms of required taxpayer compliance with them as do final regulations, until the related final regulations are issued.14

A final regulation is the ultimate version of an IRS regulation. In most cases, a final regulation is preceded by a proposed or temporary regulation. Final regulations are issued in Treasury Decisions and taxpayers may rely on them to support tax return positions. In general, taxpayers must also comply with final regulations to avoid penalties.15

For example, Regulation Section 1.6662-3(b)(2), which deals with the accuracy-related penalties applicable to taxpayers who disregard IRS rules or regulations, states, "The term 'rules or regulations' includes the provisions of the Internal Revenue Code, temporary or final Treasury regulations issued under the Code, and revenue rulings or notices (other than notices of proposed rulemaking) issued by the Internal Revenue Service and published in the Internal Revenue Bulletin." Note that this definition of rules and regulations includes both temporary and final regulations but excludes proposed regulations.

Procedures

The Treasury Department and the IRS have internal procedures for promulgating regulations.16 In general, the Assistant Secretary of the Treasury for Tax Policy and the Assistant Secretary's legal counselors are responsible for drafting regulations.17 However, they are not usually the first persons to start working on a particular regulation. When a regulation is to be promulgated or an existing regulation is to be amended, the Associate Chief Counsel (Technical) will give the regulation project to the best-suited division of the IRS. Then, with the assistance of a lawyer from the Treasury Department, a lawyer in that IRS division will prepare the initial draft of the regulation. Other people in the IRS or Treasury may assist in the drafting. Teams are created and they will seek agreement on the position to be taken in the regulation. Other lawyers or supervisors in the department will review the draft during this process and assist the team in reaching an agreement. Various Associate and/or Assistant Chief Counsel may review the draft as well. Typically, a regulation will be reviewed and approved in sequence by the Associate Chief Counsel (Technical), the Chief Counsel, the IRS Commissioner and the Assistant Secretary of the Treasury for Tax Policy.18

When a regulation is proposed, it is published in the Federal Register. The Notice of Proposed Rule Making typically establishes a date for public comments and for a hearing on the proposed regulation.19 Generally, there must be at least 30 days between the date the Notice of Proposed Rule Making is published and its effective date.20 People who are interested in the proposed regulation may submit comments and, if a hearing is to be held and the procedures in the Notice for submitting outlines are followed, may testify at the hearing.21

As noted above, a temporary regulation is more authoritative than a proposed regulation. The IRS may issue a proposed regulation and a temporary regulation on the same matter at the same time in an effort to give guidance to tax practitioners while also allowing the IRS to gather comments on the proposed change. Temporary and final regulations are issued as Treasury Decisions and are also published in the Federal Register. A Treasury Decision includes a preamble discussing the regulations and the Commissioner's reasons for the changes, as approved by the Secretary of the Treasury. In addition, the Treasury Decision will give the name and telephone number of a contact person at the IRS. Regulations are in turn incorporated into Title 26 of the Code of Federal Regulations each year.22

Statutory Rules

Tax regulations are authorized by the Internal Revenue Code. In many cases, Code provisions authorize or direct that related regulations be issued. In other cases, the Treasury Department issues regulations under the general authorization of Code Section 7805. Code Section 7805 states that the Secretary of the Treasury is to "prescribe all needful rules and regulations for the enforcement" of the Internal Revenue Code unless that authority has expressly been given to some person other than a Treasury Department officer or employee. This authority includes the authority to pass "rules and regulations" that are necessary because of an alteration in the internal revenue laws.23

Code Section 7805(b) limits the ability of a regulation to take effect retroactively. Before the enactment of the Taxpayer Bill of Rights 2 in 1996,24 the law presumed that a final regulation would be retroactive unless the IRS specified otherwise or retroactive application would be an abuse of the Commissioner's discretion. Under current law, a final regulation is typically effective from the date a related proposed or temporary regulation was published in the Federal Register.25 Specifically, Code Section 7805(b) states, in general, that a proposed, temporary or final regulation will not apply to a taxable period ending before the earlier of (i) the date when the regulation is filed with the Federal Register; (ii) for a final regulation, the date when any proposed or temporary regulation relating to the final regulation was filed with the Federal Register; or (iii) the date when a notice is issued to the public substantially describing the contents that a proposed, temporary or final regulation is expected to have.26

There are certain exceptions to this rule against the retroactivity of regulations. The exceptions are (i) regulations filed or issued within 18 months from the date the applicable statute (a Code provision) was enacted; (ii) regulations designed to prevent abuse; (iii) regulations designed to correct procedural defects in prior regulations; (iv) regulations applicable to internal Treasury Department procedures, policies and practices; (v) regulations passed pursuant to Congressional authorization to supersede the retroactivity limitation; or (vi) regulations allowing a taxpayer to elect retroactive application. Code Section 7805(b)(8) also indicates that the Secretary of the Treasury may specify "the extent, if any, to which any ruling (including any judicial decision or any administrative determination other than by regulation) relating to the internal revenue laws shall be applied without retroactive effect."27

In addition to the general grant of authority noted above, Code Section 7805 also charges the Secretary of the Treasury with preparing and distributing regulations as well as instructions, directions, forms, stamps, blanks and other matters "pertaining to the assessment and collection of internal revenue."28

Regulations sometimes explain how to make an election for some tax treatment permitted by the Code. This is authorized by Code Section 7805(d), which gives the Secretary of the Treasury the ability to prescribe the time and manner for making any elections provided for in the Code except as otherwise provided.29

As indicated above, Code Section 7805(e) provides that the Secretary is to issue any temporary regulation as a proposed regulation also. Temporary regulations must expire within 3 years of their issuance under this Code Section.30

Examples

The following is a brief description of a few examples of the regulatory process that are likely to be particularly familiar to charities, donors and advisors. These examples give a general sense of the time frame and procedural steps in the regulatory process.

Charitable Remainder Trust Regulations

The IRS published a Notice of Proposed Rule Making describing some proposed regulations dealing with charitable remainder trusts under Code Sections 664 and 2702 in the Federal Register on April 18, 1997.31 The IRS received comments on the proposed regulations and a public hearing was held on November 18, 1997. In addition to the explanatory material describing the proposed regulations in the Notice of Proposed Rule Making, the IRS included a discussion of the proposed regulations in Chapter P, "Thirty Years After the 1969 TRA - Recent Developments Under Chapter 42," in the Exempt Organizations Continuing Professional Education Text for Fiscal Year 1999. The regulations were finalized, with modifications, in Treasury Decision 8791 on December 9, 1998. The provisions in the regulations were generally effective on December 10, 1998.

Son of the Accelerated Charitable Remainder Trust Regulations

On October 18, 1999, the IRS issued a Notice of Proposed Rule Making containing proposed regulations under Code Sections 664 and 643 dealing with an abusive charitable remainder trust transaction32 which became known as the "son of the accelerated charitable remainder trust" or "chutzpah trust" transaction because its similarity to the infamous accelerated charitable remainder trust transaction.33 The IRS received comments on these proposed regulations and a public hearing was held on February 9, 2000. Some of the concerns about the proposed regulations presented to the IRS included questions about the IRS's administrative authority to issue the regulations under Code Section 643 and about retroactive application of the proposed rules. So far, these proposed regulations have not yet been finalized.

Ghoul Charitable Lead Trust Regulations

In a Notice of Proposed Rule Making, the IRS issued proposed regulations under Code Sections 170, 2055 and 2501 designed to stop taxpayers from using an unrelated individual - who is seriously ill but not "terminally ill" within the meaning of the current Section 7520 Regulations - as the measuring life for the term of a charitable lead trust to artificially inflate the charitable deduction.34 Because of the ghoulish nature of this transaction, the proposed regulations are sometimes referred to as the "ghoul trust" regulations. A public hearing on the proposed regulations was set for June 29, 2000, but the hearing was cancelled when no one asked to speak. These proposed regulations have not been finalized as of this date.

Conclusion

Charities and donors must follow the tax laws and regulations governing charitable giving. Often, a proposal for a change in these rules will be of great interest to charities and donors but following the actual status of the proposal can sometimes be confusing. This two-part article reviews how laws and regulations typically get made in an effort to assist charities and donors and their advisors in following and understanding the status of a particular proposal.

As noted in the first article of this two-part series, a bill proposing a new charitable giving tax law must be enacted in exactly the same form by both the House and Senate. It is only after both Houses of Congress have reached this agreement that the proposal goes to the President for approval or veto. In some cases, a proposal can become law without the President's signature. Various Constitutional or procedural requirements apply to each stage of a bill's life.

Regulations interpreting charitable giving tax laws come from the executive branch of the government. As described above, the Internal Revenue Service and the Treasury Department play major roles in the regulatory process.


Footnotes


  1. U.S. Treas. Dept., "Frequently Asked Questions," July 5, 1999, available in www.ustreas.gov.back

  2. Id.back

  3. All references to the Code in this article are to the Internal Revenue Code of 1986, as amended from time to time.back

  4. "Standard Federal Income Tax Reporter," CCH ¶43,282.0121.back

  5. Id.back

  6. Michael I. Saltzman, IRS Practice and Procedure ¶ 3.02[4] (2d ed.).back

  7. "Standard Federal Income Tax Reporter," CCH ¶43,282.0121.back

  8. Michael I. Saltzman, IRS Practice and Procedure ¶ 3.02[4] (2d ed.).back

  9. "Standard Federal Income Tax Reporter," CCH ¶43,282.0121.back

  10. Michael I. Saltzman, IRS Practice and Procedure ¶ 3.02[4] (2d ed.).back

  11. Id.back

  12. "Standard Federal Income Tax Reporter," CCH ¶43,282.0123.back

  13. Id.back

  14. "Standard Federal Income Tax Reporter," CCH ¶43,282.0122.back

  15. "Standard Federal Income Tax Reporter," CCH ¶43,282.0121.back

  16. See Treas. Directive 28-01 (1989).back

  17. Michael I. Saltzman, IRS Practice and Procedure ¶ 3.02[2] (2d ed.).back

  18. Id.back

  19. Jay A. Shuman, "Federal Tax Research for Beginners," April 1996, available in www.nyu.edu.library.back

  20. Michael I. Saltzman, IRS Practice and Procedure ¶ 3.02[3] (2d ed.).back

  21. Id.back

  22. See generally Jay A. Shuman, "Federal Tax Research for Beginners," April 1996, available in www.nyu.edu.library.back

  23. IRC §7805(a).back

  24. P.L. 104-168.back

  25. IRC §7805(b)(1)(B).back

  26. IRC §7805(b).back

  27. Id.back

  28. IRC §7805(c).back

  29. IRC §7805(d).back

  30. IRC §7805(e).back

  31. REG-209823-96.back

  32. REG-116125-99.back

  33. IRS Notice 94-78 described the original accelerated charitable remainder trust transaction. The original accelerated charitable remainder trust transaction was essentially put to rest by changes to the charitable remainder trust Code provisions enacted by Congress in the Taxpayer Relief Act of 1997 and by the new charitable remainder trust regulations finalized on December 10, 1998.back

  34. REG-100291-00.back

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