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Taxpayers Benefit from Courts Declining Agency Deference

(This article was originally published by Law360 on March 18, 2019.)

When challenging a state tax assessment outside the tax agency that issued the assessment, taxpayers face a variety of obstacles. One is the presumption of correctness that often attaches to a tax agency’s determination. Judicial deference to a tax agency’s interpretation of a tax statute or regulation makes the taxpayer’s task even more difficult.

A few recent decisions suggest deference to state tax agency interpretations may be on the decline, or at least less of a sure thing than in years past. Of note, these decisions run parallel to developments at the federal level whereby the fate of judicial deference to federal agency interpretation of certain regulations is pending before the United States Supreme Court. If the recent rash of judicial and administrative decisions involving deference are any indication, successful taxpayer challenges to state tax agency interpretations may be on the rise.

Wisconsin
In Tetra Tech EC Inc. and Lower Fox River Remediation LLC v. Wisconsin Department of Revenue,1 the Wisconsin Supreme Court held judicial deference to administrative agencies’ conclusions of law violates the Wisconsin Constitution.2

Tetra Tech involved paper companies required to remediate the environmental impact of chemicals released into the Fox River during the manufacturing process.3 The paper companies hired Tetra Tech to perform the remediation activities. Tetra Tech subcontracted a portion of the work. After dredging sediment from the river, Tetra Tech’s subcontractor separated the sediment into its components—water, sand and waste sludge.4

The Wisconsin Department of Revenue assessed (1) sales tax on Tetra Tech’s sales of remediation services and (2) use tax on Tetra Tech’s purchases of its subcontractor’s services. The department asserted the subcontractor’s activities constituted the “processing” of tangible personal property subject to sales and use taxes.5 The issue before the lower courts was the interpretation of the statutory term “processing” in Wisconsin Statutes Section 77.52, Subsection (2)(a)(11).6 Both the circuit court and the court of appeals affirmed the department’s assessment.7

Before addressing the merits, the Wisconsin Supreme Court engaged in an extensive discussion of the state’s then-current standard for reviewing administrative agency decisions. Wisconsin has a statute setting forth two specific directions regarding judicial review of such decisions.8

From this statute, the court explained how Wisconsin courts had developed a “contextualized, three-tiered treatment of an administrative agency’s conclusions regarding the interpretation and application of statutory provisions.”9 Specifically, the courts gave agency conclusions either: (1) “great weight” deference (i.e., the court must adopt an interpretation if reasonable); (2) “due weight” deference (i.e., “a ‘tie goes to the agency’ rule in which deference is required unless the court’s interpretation is more reasonable than that of the agency”); or (3) no deference at all.10

Considering whether the foregoing deference standard is compatible with the Wisconsin Constitutional separation of powers doctrine, the court explained, “exercising judgment in the interpretation and application of the law in a particular case … within the judicial branch” was “the very thing that distinguishes the judiciary from the other branches.”11 The court held that “great weight” deference violated the separation of powers doctrine by ceding the judiciary’s core powers to the executive.12

The court also found that “due weight” deference—as applied by the judiciary over time—improperly ceded core judicial power.13 Moving forward, “due weight” deference is given to the “experience, technical competence, and specialized knowledge of the agency involved.”14 The court emphasized, though, that an “agency should be prepared to explain how its experience, technical competence, and specialized knowledge give its view of the law a significance or perspective unique amongst the parties, and why that background should make the agency’s view of the law more persuasive than others.”15

Returning to whether the activities of Tetra Tech’s subcontractor constituted taxable “processing,” the court found that “‘processing’ encompasses the performance of a mechanical or chemical operation on tangible personal property, a task that can be completed without transforming the property into a new product or adding anything to it that was not already there.” The court found “processing” encompasses the subcontractor’s separation of river sediment into its components.16 The court “gave little weight to the Commission’s understanding of the term.”17

New Jersey
The New Jersey Superior Court, Appellate Division’s unpublished decision in Paz v. Director, Division of Taxation18 also tackled judicial deference. The primary issue was whether the gain from a deemed asset sale of a New Jersey-based S corporation was sourced to New Jersey.19 The Division of Taxation sourced the income from the sale as non-operational (i.e., nonbusiness) income, allocated to the domiciliary state of the corporation.20 The taxpayers argued the gain should be sourced to the assets’ location or based on a three-year average of their allocation factors under the income tax rules for sourcing gain on the sale of assets in the liquidation of sole proprietorships and partnerships.21

The Tax Court agreed with the Division of Taxation and allocated the income to the domiciliary state of New Jersey.22 Before independently analyzing the law, however, the Tax Court addressed the standard of review, asserting its review “begins with the presumption that determinations made by the [d]irector are valid” and that “[d]eterminations by the [d]irector are afforded a presumption of correctness.”23 On appeal, the taxpayers argued the Tax Court “improperly deferred” to the Division of Taxation’s arguments.24

The Appellate Division substantially affirmed the Tax Court’s opinion.25 However, the Appellate Division then addressed the taxpayers’ contention the lower court had improperly deferred to the Division of Taxation’s legal arguments regarding statutory construction.26 The Appellate Division agreed the lower court had “overstated the deference” to be afforded the Division of Taxation by using the terms “presumption of correctness” and “presumption of validity.” But the court “detect[ed] no instance where the judge failed to fully and fairly review the record … before properly making her own independent determinations on the questions of law.”27

Louisiana
States have varying levels of administrative appeal to challenge tax assessments. Recently, the Louisiana Board of Appeals displayed a distaste for deference to a tax agency’s statutory interpretations. For example, the Board recently held the Louisiana Department of Revenue’s occasional sale rule for businesses in the “manufacturing, merchandising and other business” category exceeded the statute.28 The out-of-state taxpayer sold its 100 percent interest in a limited liability company doing business in Louisiana as a cementing tool manufacturer and included the gain from the sale in its Louisiana sales factor denominator but not the numerator.29 The department excluded the receipts from the sales factor altogether under its occasional sale rule.30

The department’s rule provided:

For the formula provided by R.S. 47:287.95(F), the revenue ratio consists of the ratio of net sales made in the regular course of business and other gross apportionable income attributable to this state to the total net sales made in the regular course of business and other gross apportionable income of the taxpayer. Sales not made in the regular course of business are not included in the formula provided by R.S. 47:287.95(F).31

While acknowledging the first sentence of the regulation tracked the governing statute—Louisiana Revised Statutes section 47:287.95(F), the board took issue with the second sentence.32 The board found that to adopt the department’s interpretation under the regulation would render the statutory phrase “other gross apportionable income” meaningless.33 Consequently, the board agreed with the taxpayer that the department’s interpretive regulation exceeded the taxing jurisdiction of the statute.34

Tide Changing at Federal Level
Judicial deference and its discontents are not new, but the momentum for overturning long-standing agency deference precedent, particularly at the federal level, is at a critical fulcrum point. Less than six months after Justice Anthony Kennedy announced his retirement and called for the U.S. Supreme Court to “reconsider” the seminal administrative law doctrine known as Chevron deference35 in a concurring opinion in Pereira v. Sessions,36 the U.S. Supreme Court granted certiorari in James L. Kisor v. Peter O’ Rourke, Acting Secretary of Veteran Affairs.37

Kisor is not a tax case, but its implications for taxpayers could be significant. The sole question to be considered is whether the court should overrule its controversial opinions in Auer v. Robbins38 and Bowles v. Seminole Rock & Sand Co.39 Those opinions held that an agency is uniquely positioned to interpret any ambiguity in its own regulations and, therefore, such interpretations should be afforded controlling deference if reasonable.

A decision to reject the reasoning underlying Auer and Bowles is likely to cast considerable doubt on other deference doctrines, particularly the “Chevron deference”40 standard. This would set the stage for the court to “reconsider” Chevron as advanced by Justice Kennedy (and supported by at least three current justices). Oral argument in Kisor is set for March 27, 2019.

Concluding Thoughts
Taxpayers should be encouraged by the recent state and federal challenges to existing judiciary deference standards. For example, the Wisconsin courts are already applying the new deference standard in Tetra Tech.41 Regulations, administrative rulings or other guidance through which an agency expresses its interpretation of the governing tax laws may now be subject to a fresh look by a reviewing court not only in Wisconsin but in other jurisdictions.

Also, for taxpayers affected at the state level with various provisions of the Tax Cuts and Jobs Act (currently or in the future), the U.S. Supreme Court’s decision to grant certiorari in Kisor is particularly important. This is because the deference afforded the Internal Revenue Service’s interpretations of its own ambiguous regulations may be limited. As the IRS promulgates new regulations in the wake of the TCJA, Kisor has the potential to shake up the landscape. As states look to implement various portions of the TCJA, fallout from Kisor could affect how states proceed—potentially unmoored from federal and state agency interpretations.

Decisions at both state and federal levels underscore the tension between the proper roles of two co-equal branches. Taxpayers may benefit from this tension and should approach challenges with an eye to present questions of statutory interpretation as in the purview of the judicial branch and not to be left to the agency.


  1. Tetra Tech EC Inc. and Lower Fox River Remediation LLC v. Wisconsin Department of Revenue, 382 Wis.2d 496 (Wis. 2018).
  2. Id. at 584 (Bradley, J., concurring).
  3. Id. at 512.
  4. Id. at 512-13.
  5. Id. at 513-14.
  6. Id. at 514. Wisconsin Statutes Section 77.52, Subsection (2)(a)(11).
  7. Id.
  8. Id. at 516. Wisconsin Statutes section 227.57, subsections (5) and (10), instruct courts to (1) “set aside or modify the agency action if it finds that the agency has erroneously interpreted a provision of law and a correct interpretation compels a particular action, or it shall remand the case to the agency for further action under a correct interpretation of the provision of law” and (2) accord “due weight” to “the experience, technical competence, and specialized knowledge of the agency involved, as well as discretionary authority conferred upon it,” respectively.
  9. Id. at 517.
  10. Id. at 517.
  11. Id. at 541, 543 (emphasis in original).
  12. Id. at 545-46.
  13. Id. at 557-59. In addition to running afoul of the separation of powers, the Court also discussed how demanding deference affects due process by providing a “systematic favor” to the government that “deprives the non-governmental party of an independent and impartial tribunal.” Id. at 554. The Court explained that “deference threatens the most elemental aspect of a fair trial” when it allows an agency, which has an “obvious interest in the outcome of a case to which it is a party”, to “authoritatively tell[] the court how to interpret and apply the law that will decide its case.” Id. at 556.
  14. Id. at 560, quoting Wisc. Stat. § 227.57(10). Subsequent to the decision in Tetra Tech, the Wisconsin Legislature amended Wisconsin Statutes section 227.57, subsection (11), to read: “Upon review of an agency action or decision, the court shall accord no deference to the agency’s interpretation of law.” 2017 Wis. Act 369, Sec. 80 (enacted Dec. 14, 2018).
  15. Id. at 561.
  16. Id. at 579-81.
  17. Id. at 581-82.
  18. Paz v. Director, Division of Taxation, 2019 WL 385725 (N.J. App.Ct. 2019) (unpublished).
  19. Xylem Dewatering Solutions Inc. v. Dir., Division of Taxation, 30 N.J. Tax 41, 45-46 (N.J. Tax Ct. 2017).
  20. Id. at 63.
  21. Id. at 48, 64.
  22. Id. at 65.
  23. Id. at 50.
  24. Paz at * 1.
  25. Id.
  26. Id.
  27. Id.
  28. Davis Lynch Holding Co. Inc. v. Sec’y, Louisiana Dep’t of Revenue, B.T.A. Docket No. 1103D (La. Bd. of Appeals, Oct. 23, 2018).
  29. Id.
  30. Id.
  31. La. Admin. Code 61:1.1134(D).
  32. Davis Lynch Holding, supra.
  33. Id.
  34. Id. Similarly, the California Office of Tax Appeals recently rejected the California Franchise Tax Board’s broad interpretation of “doing business” under California Revenue and Taxation Code section 23101 by refusing to attribute the business activities of a limited liability company in California to an entity holding a non-managing minority interest in that company. Appeal of Satview Broadband, Ltd., OTA Case No. 18010756 (Sept. 25, 2018).
  35. Chevron USA Inc. v. Natural Resources Defense Council Inc., 467 U.S. 837 (1984)
  36. Pereira v. Sessions, 585 US 2105 (2018). Justices Clarence Thomas and Neil Gorsuch have separately called for reconsideration of Chevron. Further, Justice Brett Kavanaugh, the newest justice, was a leading critic of the Chevron deference doctrine during his tenure on the U.S. Court of Appeals for the D.C. Circuit.
  37. Kisor v. Wilkie, 139 S. Ct. 657 (2018).
  38. Auer v. Robbins, 519 US 452 (1997).
  39. Bowles v. Seminole Rock & Sand Co., 325 US 410 (1945).
  40. The doctrine instructs that when reviewing certain agency interpretations of statutes, courts should defer to the agency’s construction if the statute is ambiguous and the agency’s construction is reasonable. Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 US 837 (1984).
  41. See Healthcare Servs. Group, Inc. v. Wisc. Dep’t of Revenue, 383 Wis.2d 699, 707 (Wis. Ct. App. 2018).