ARE THE MATERIAL PARTICIPATION REGS INVALID? by Steve Mather

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Steve’s recent case of Rogerson v. Commissioner, T.C. Memo. 2002-49, raises an interesting question. Activities are classified as passive or nonpassive based on whether the taxpayer meets the “material participation” standard in I.R.C. §469(h). IRS for decades has relied on “temporary” regulations to apply this material participation standard. The opinion in Rogerson suggests these regulations are no longer valid.

         As added to the Code in 1986, the definition of material participation is: 

         (h) MATERIAL PARTICIPATION DEFINED, -- For purposes of

              this section –

                  (1) IN GENERAL – A taxpayer shall be treated as

                       materially participating in an activity only if the

                       taxpayer is involved in the operations of the activity on

                       a basis which is –

                       (A)         regular,

                       (B)         continuous, and

                       (C)         substantial

100 Stat. 2237, reprinted at 1986-3 C.B. (Vol. I) 154. 

         Treasury Regulations are generally acknowledged as the appropriate exercise of respondent’s authority to administer the Internal Revenue Code. Bittiker & Lokken, Federal Taxation of Income, Estates and Gifts, ¶110.5; I.R.C. §7805(a). In fact, I.R.C. §469(k) as originally enacted in 1986 specifically delegated the authority to IRS to “. . .prescribe such regulations as may be necessary or appropriate to carryout the provisions of this [passive activity] section. . .” 100 Stat. 2240, reprinted at 1986-3 C.B. (Vol. I) 157.  

         The material participation regulations were enacted as temporary regulations in February 1988. T.D. 8175. The assumed benefit of a temporary tax regulation was it could be issued without complying with the notice and comment process required for regulations generally under the Administrative Procedure Act (APA). 

         This belief in the “tax exceptionalism” of temporary tax regulations was rejected by the Supreme Court in Mayo Foundation for Medical Research v. United States, 562 U.S. 44 (2011).  Mayo ultimately upheld the Treasury Regulation at issue because it had been promulgated following notice and comment procedures. See, Hickman, “Unpacking the Force of Law,” 66 Vand. L. Rev. 465, 502 (2013).

         More recent authorities go even further. Recent case law and commentary asserts that temporary regulations are entirely invalid without a notice and comment process. Chamber of Commerce of the U.S. v. IRS, 120 AFTR 2d 2017-5967 (W.D. Tex. 2017). See also, Salzman & Book, IRS Practice and Procedure, at ¶3.02(3)(d).

          Congress also limited the life of temporary regulations issued after November 20, 1988 by causing them to expire within three years of enactment. I.R.C. §7805(e); Pub. L. 100-647 §6232(b).

         The material participation temporary regulations pre-date the Congressional sunset provision but are nevertheless of questionable effect after Mayo because they were issued without notice and comment. The Tax Court showed this concern in Rogerson. The Court acknowledged the doubtful status of the material participation regulations and (sort of) refused to apply them. The Court nevertheless ruled against Rogerson, holding the concepts underlying the regulations were consistent with the statutory material participation definition so it did not matter if the regulations were valid.

         We have appealed Rogerson to the Ninth Circuit and will challenge the Tax Court’s tacit use of these otherwise invalid regulations. More to come.