Walking a fine line: a theory of line drawing in tax law

In many contexts, tax law grants favorable tax treatment to transactions of one type and adverse treatment to transactions of another type. The task of tax authorities is to draw lines in legally gray areas to distinguish between economically similar transactions that should receive different treatment. Despite tax law’s propensity for line drawing, the manner in which tax authorities draw legal lines has received little attention. This article aims to fill this gap by providing guidance to tax authorities on how to select the best line-drawing instrument in a given situation. First, the article demonstrates that tax authorities employ four different line-drawing instruments: rulemaking, adjudication, private letter rulings, and licensing. Second, the article develops a theory of line drawing in tax law, which identifies three criteria by which tax authorities should choose line-drawing instruments: the ideal policy, the effect on taxpayers, and the effect on tax authorities. Finally, the article applies this theory of line drawing to explain line-drawing instruments currently in use.

TABLE OF CONTENTS

       I. INTRODUCTION 470

       II. LINE-DRAWING INSTRUMENTS EMPLOYED IN TAX LAW 476

       A. Line-Drawing Instruments in Action 476

         1. Rulemaking 476

         2. Adjudication 478

         3. Private Letter Rulings 481

         4. Licensing 483

       B. Alternative Choice of Line-Drawing Instruments 484

       III. CHOOSING AMONG LINE-DRAWING INSTRUMENTS 485

       A. Ideal Policy 485

       B. Effect on Taxpayers 487

         1. Taxpayers’ Uncertainty 487

         2. Compliance Burden 488

       C. Effect on Tax Authorities 489

         1. Tax Authorities’ Uncertainty  489

         2. “Wall Street Rule” 491

         3. Judicial Deference 492

         4. Precedential Effect 493

         5. Procedural Costs 494

       IV. POLICY ASSESSMENT495

       A. Controlled Foreign Corporation Rules 496

       B. Economic Substance Doctrine 497

       C. Corporate Spin-offs 498

       D. Charitable Organizations 500

       V. CONCLUSION 501

I. INTRODUCTION

One of the salient characteristics of tax law is its propensity for line drawing.1 In many different contexts, tax law grants favorable tax treatment to transactions of one type and adverse treatment to transactions of another type. Although the tax treatment of some transactions is clear, for many others it is not. Tax authorities,2 therefore, have to draw lines to distinguish between transactions that will be treated one way, and those that will be treated another way.

To illustrate, tax law treats debt and equity differently by allowing the deduction of interest payments but not of dividends.3 While certain *471 instruments are clearly debt and others are clearly equity, there is a vast range of instruments that fall between these two poles.4 Within this range, tax authorities must draw a line to distinguish between the similar instruments that will receive very different treatment.5 Likewise, tax law distinguishes between employees and independent contractors. Payments to employees for performing services are subject to withholding taxes, while similar payments to independent contractors are not.6 Although certain contracts clearly create employer-employee relationships and others create independent-contractor relationships, there are many contracts that create relationships that fall somewhere in between. In this gray area, tax authorities must draw a line classifying these contracts into the two separate legal categories.7

Line drawing is thus the process of determining whether an ambiguous provision of law, or desired legal treatment, should apply to a specific taxpayer. Despite tax law’s propensity for line drawing, the manner in *472 which tax authorities engage in this process has received little attention from legal scholars. Prior works have examined the normative principles that should guide tax authorities in drawing lines. David Weisbach, for example, has argued that line drawing in tax law should be based on the efficiency of competing rules, rather than on doctrinal concerns.8 But scholars have paid little attention to the legal instruments or devices that tax authorities use to draw these lines. This article fills this gap in the tax law literature by developing a theory to guide tax authorities in selecting the best line-drawing instrument in a given situation.

This article begins by demonstrating that tax authorities use four different line-drawing instruments. First, they frequently engage in rulemaking. That is, tax authorities issue rules to clarify which transactions, falling within a legally gray area, are entitled to a favorable tax treatment, and which are not. For example, in distinguishing between a temporary and permanent change of residence, which determines whether the costs of meals and lodging can be deducted, tax authorities have adopted a rule that focuses exclusively on the duration of the taxpayer’s travel. Similarly, to determine when an investment in a foreign corporation is used to artificially defer tax payments, tax authorities have adopted complex rules that define which taxpayers must include in their income specific amounts earned by the foreign entities they own.9

Second, tax authorities use adjudication to draw these lines. That is, tax authorities wait for taxpayers to act, and then rely on case-by-case determination to establish whether the transactions the taxpayers have undertaken are entitled to the favorable tax treatment.10 To illustrate, tax *473 authorities refrain from adopting regulation and rely solely on case-by-case adjudication to distinguish between financial instruments that are treated as debt and those that are treated as equity. Similarly, to determine which transactions lack economic substance, and are therefore not recognized for tax purposes, tax authorities avoid issuing rules or guidance, relying instead on adjudication.11

Third, tax authorities use private letter rulings. In a request for a private letter ruling, taxpayers ask tax authorities whether a transaction is entitled to the favorable tax treatment, before they act. For example, to determine which distributions of stock qualify as a tax-free spin-off, tax authorities allow corporations to request a private letter ruling on the tax consequences of a spin-off when these consequences are unclear. Private letter rulings are similarly used as a line-drawing instrument in the case of the tax-qualified status of employee pension plans.12

Fourth, tax authorities use licensing. In a licensing system, tax authorities require taxpayers to preapprove their transactions in order to qualify for favorable tax treatment.13To illustrate, tax authorities use licensing to draw lines between charitable and non-charitable organizations, *474 which determines whether an organization is entitled to a tax exemption. Therefore, all charitable organizations are required to apply for recognition of their tax-exempt status before they can benefit from this tax exemption.14

Thus, tax authorities use four different line-drawing instruments: rulemaking, adjudication, private letter ruling, and licensing. In light of the variety of existing line-drawing instruments at tax authorities’ disposal, it is natural to ask how tax authorities should choose among them.15 This article develops a theory of line drawing by identifying three criteria that should inform tax authorities’ choice of line-drawing instruments.

The first criterion is the degree of proximity a given line-drawing instrument allows to the ideal tax policy. An ideal policy would consider all relevant facts and circumstances when drawing lines between economically similar transactions that should be treated differently for tax purposes. Thus, more precise line-drawing instruments can account for a larger number of relevant factors and are therefore preferable. In this respect, rules, which can be used only to draw relatively arbitrary bright-lines, are disfavored relative to those line-drawing instruments that allow for finer distinctions between similar transactions to be drawn.16

The second criterion tax authorities should consider is the effect the chosen line-drawing instrument would have on taxpayers. Tax authorities should consider the effect of each particular instrument on taxpayer uncertainty as to the application of the law to their circumstances. Specifically, rulemaking reduces taxpayer uncertainty by publicizing the relevant rule in advance. Private letter rulings and licensing reduce uncertainty even further by enabling taxpayers to obtain an individual application of the law to their specific facts before the transactions are undertaken. In contrast, adjudication does little to alleviate taxpayer uncertainty.17 Tax authorities should also consider the compliance burden of potential line-drawing instruments. Rulemaking reduces the taxpayer compliance burden by providing some general guidance to taxpayers without the need to engage tax authorities on an individual basis. By contrast, private letter rulings and licensing require taxpayers to engage tax authorities individually through a request for such private letter rulings or licenses.18

The third criterion tax authorities should consider is the desirability of the chosen line-drawing instrument from their own perspective. Tax *475 authorities should consider their own uncertainty as to the lines drawn, mainly due the possibility that taxpayers may react to those lines in unexpected ways. In this respect, adjudication, private letter rulings, and licensing all allow for incrementalism and flexibility in line drawing (since these instruments allow for case-by-case decisions), whereas rulemaking, which adopts a single rule in all cases, does not.19 Tax authorities should also consider the “Wall Street Rule,” which may force tax authorities to concede to a lenient tax position after transactions have already taken place. This makes adjudication, in which lines are drawn after taxpayers have already acted, less desirable than other line-drawing instruments.20 Furthermore, tax authorities should consider the issue of judicial deference. Rulemaking guarantees greater judicial deference to tax authorities, while adjudication establishes little deference.21 Finally, tax authorities should consider the procedural costs that they will bear in utilizing each of the line-drawing instruments. In this respect, licensing seems to be the most costly line-drawing instrument, followed by private letter rulings, adjudication, and rulemaking respectively.22

After presenting the theory of line drawing in tax law, this article applies the theory to explain tax authorities’ choices of line-drawing instruments in several contexts, focusing on the Controlled Foreign Corporation Rules,23 the Economic Substance Doctrine,24 corporate spin-offs,25 and the recognition of charitable organizations for tax purposes.26

The article proceeds as follows: Part II demonstrates the four different line-drawing instruments employed by tax authorities. Part III develops a theory of line drawing, identifying the three key considerations at play when tax authorities choose line-drawing instruments: the ideal policy, the effect on taxpayers, and the effect on tax authorities. Part IV applies this theory to several areas of tax, aforementioned. The article concludes by noting the broad methodological implications of the article to our understating and appreciation of tax law.

II. LINE-DRAWING INSTRUMENTS EMPLOYED IN TAX LAW

A. Line-Drawing Instruments in Action

Tax authorities must regularly draw lines to distinguish between transactions that do and do not receive favorable tax treatment. Tax authorities may use four different line-drawing instruments to do so.

1. Rulemaking

Rulemaking is likely the most common line-drawing instrument in the tax law. Tax authorities engage in rulemaking when they pass a law or issue a regulation to distinguish between activities that are economically similar.

One simple example of tax authorities’ reliance on rulemaking as a line-drawing instrument is the rule regarding the deductibility of traveling expenses. As a general rule, taxpayers may not deduct personal, living, and family expenses when calculating adjusted gross income.27 Taxpayers are, however, allowed to deduct the cost of meals and lodging while temporarily away from home in the pursuit of a trade or business.28 But when is a taxpayer considered to be temporarily away from home, and when is he or she considered to have moved his or her home?

If a taxpayer travels to a different city for a week of business meetings, it clearly qualifies as being temporarily away from home. Therefore, the taxpayer may deduct the costs of meals and lodging. By contrast, if a taxpayer moves to a different city for five years to open a new branch of his or her business, taking along his or her family, that is clearly a case where the taxpayer’s home has moved, and therefore the costs of meals and lodging are not deductible. In closer cases, however, determining whether a taxpayer is temporarily away from home or has moved his or her home is not so simple. How do tax authorities go about determining in which case to allow taxpayers the deduction of the costs of meals and lodging? Tax authorities address this line-drawing problem by employing a simple rule. A taxpayer is treated as being temporarily away from home for any period under one year.29

Another example of tax authorities’ reliance on rulemaking as a line-drawing instrument is the controlled foreign corporations (CFC) rules. As a rule, the United States taxes the worldwide income of U.S. persons. Since foreign corporations are not U.S. persons,30 they are generally not subject to *477 U.S. income tax. Without the CFC rules, income earned by foreign corporations that are controlled by U.S. taxpayers would not be subject to U.S. taxation until it is repatriated. The CFC rules were enacted to limit the artificial deferral of tax by U.S. taxpayers operating through foreign subsidiaries.31 But when is an investment in a foreign corporation used to artificially defer tax payments?

While buying a few shares in Royal Dutch Shell is clearly not a case of artificial deferral of tax, channeling all of a company’s operations through a wholly owned Cayman subsidiary clearly is a case of artificial deferral. In many cases, however, determining whether foreign investments are used to artificially defer tax payments is not a simple task.

Tax authorities address this line-drawing problem by issuing detailed rules. The CFC rules define which classes of taxpayers must include in their income specific amounts earned by the foreign entities they own -- even if those foreign entities do not distribute those amounts to their shareholders. In general, a foreign corporation is a CFC if at least 50% of either the total voting power or total value of the stock of the foreign corporation is owned by U.S. persons,32 each of whom owns at least 10% of the voting power of the corporation (Ten Percent Shareholder).33 If a foreign corporation is a CFC for an uninterrupted period of at least 30 days in a year, its Ten Percent Shareholders are taxed on their share of the corporation’s “Subpart F Income.”34 This generally includes interest; dividends; rents; royalties; business income derived from transactions with related parties (unless the business in conducted entirely within the country in which the CFC is organized); and amounts invested in U.S. property, despite the fact that these amounts were not distributed by the CFC to its shareholders.35 Detailed regulations further define and elaborate on these rules.36

2. Adjudication

Adjudication occurs when a tax authority decides to distinguish between activities that are economically similar after a transaction is undertaken, on case-by-case basis. This is done through the determination of deficiency in tax.37

An example of tax authorities’ reliance on case-by-case adjudication as a line-drawing instrument is the debt-equity legal distinction. The most important legal implication of this distinction is that return on debt is treated as interest, and is therefore deductible to the borrower and taxable to the lender, whereas return on equity is treated as dividends or capital gain, and is therefore taxable to the investor but not deductible to the corporation.38

Some financial instruments, like voting common stock, are clearly equity; and others, like “an unqualified obligation to pay a sum certain at a reasonably close fixed maturity date along with a fixed percentage in interest payable regardless of the debtor’s income or lack thereof,”39 are clearly debt. But between these extreme cases, there is a spectrum where many types of financial instruments fall, each differing from its neighbor only in minor ways.40 For example, a debt instrument that entitles its holder to a share of the issuing corporation’s profits, or preferred stock that entitles its holder to receive a fixed return if earned, are not easily classified into these two legal categories.41 In such cases, how do tax authorities draw the line between equity and debt?42

Tax authorities address this line-drawing problem by relying on case-by-case adjudication, as the area is, currently, largely devoid of black letter law.43 A famous Third Circuit decision listed sixteen factors that must be considered in this determination, which included such vague concepts as the intent of the parties; the extent of participation in management by the holder of the instrument; and the “thinness” of the capital structure in relation to debt.44

Another example of the use of adjudication as a line-drawing instrument is the Economic Substance Doctrine. Tax authorities use this doctrine to determine whether tax shelters, or instruments used to reduce tax liability, are considered abusive and, therefore, not recognized for tax purposes. According to the doctrine, which was recently codified in the Health Care and Education Reconciliation Act of 2010,45 a transaction is considered to have economic substance only if it has an economic purpose and effect aside from a reduction of tax liability.46

Some transactions clearly have economic substance, and others clearly do not. For many transactions, however, the issue of economic substance remains unclear, which results in much uncertainty in the application of the *480 doctrine.47 For example, though largely based on comparative tax advantages, the choice between capitalizing a business enterprise with debt or equity is not considered an issue to which the Economic Substance Doctrine may apply.48 How do tax authorities go about defining which transactions have economic substance and will therefore be recognized for tax purposes?

Tax authorities address this line-drawing problem by mainly relying on case-by-case adjudication. The doctrine’s recent codification raised expectations among practitioners that the Internal Revenue Service (Service) would issue clear guidance on how the codified doctrine would be applied.49 Shortly after the doctrine’s codification, however, the Service stated that it does not intend to issue guidance regarding the types of transaction to which the Economic Substance Doctrine either applies or does not apply, and that it will not issue private letter rulings or determination letters regarding whether a transaction complies with the doctrine.50 This position effectively means that the determination of *481 whether transactions have economic substance will only be made in adjudication.51

3. Private Letter Rulings

A private letter ruling is a procedure that allows a taxpayer to inquire about the tax consequences of a contemplated transaction.52 Taxpayers turn to the tax authorities for a binding ruling on the tax consequences of the transaction, which allows tax authorities to distinguish between economically similar activities on a case-by-case basis. In light of the ruling, taxpayers decide whether to undertake the transaction.53

The tax treatment of corporate spin-offs is an example of an area of tax law where private letter rulings are often used. A spin-off is a process by which a corporation distributes the corporation’s shares in a subsidiary to the corporation’s shareholders, thus creating two independent corporations owned directly by the shareholders.

The business reasons for corporations to spin-off subsidiaries vary. A spin-off allows each business to focus on its own strategic and operational plans without diverting human and financial resources from the other business. It also enables each business to pursue the capital structure that is most appropriate for its business and strategy. Spin-offs also create distinct and targeted investment opportunities in each business, as each focused company may be considered more attractive to investors focused in a particular sector. A spin-off increases the effectiveness of equity-based compensation programs by tying the value of the equity compensation awarded to employees, officers, and directors more directly to the *482 performance of the business for which these individuals provide services. Lastly, by creating a separate publicly traded stock, a spin-off allows the newly created corporation to use this stock as consideration in future transactions.54

Generally, a distribution of property from a corporation to its shareholders results in the imposition of tax at the shareholder level, in a manner similar to the taxation of dividends.55 To the extent the property’s fair market value exceeds the corporation’s basis in it, a tax is also imposed at the corporate level.56 If a corporation spins-off a subsidiary it controls by distributing the corporation’s shares in the subsidiary to the corporation’s shareholders, however, that spin-off will not result in the imposition of taxation on either the shareholders or the corporation.

Because of the dramatic difference between the tax treatment of a standard distribution of property from a corporation, and a distribution of a corporation’s shares in a subsidiary in a spin-off transaction, there is a great incentive to mask the former as the latter. Given this concern, in order for a transaction to qualify as a tax-free spin-off, certain conditions have to be met. Some conditions are relatively clear: the distributing corporation must control the subsidiary,57 and it must distribute all its stock in the controlled subsidiary -- or an amount of stock sufficient to constitute control.58 Others are more vague: for example, both the distributing corporation and the controlled subsidiary must actively engage in a trade or business which has been conducted throughout the previous five-year period immediately after the distribution,59 the distribution cannot be principally a device for the distribution of earnings and profits of the distributing corporation;60 and the spin-off must have a real and substantial non tax purpose germane to the business of the distributing corporation or the subsidiary.61

As always, some distributions of stock clearly qualify as a tax-free spin-off and others clearly do not. In many cases however, given the vagueness of some of the requirements for a tax-free spin-off, the answer is *483 less clear. How do tax authorities go about determining which distribution of stock qualifies as a tax-free spin-off?

To address this line-drawing problem, in cases where it is unclear whether a transaction qualifies as a tax-free spin-off, tax authorities allow corporations to request a private letter ruling, in which the Service “interprets and applies the tax laws to a specific set of facts.”62 If a corporation chooses to request a private letter ruling, it must provide detailed information on the corporation and its subsidiary, for the preceding five years, including: stock ownership, financial data, information on employees and their positions, acquisitions or dispositions of stock or securities, description of assets held that are not related to the trade or business, and a description of the business purpose for the transaction.63

Requests for private letter rulings are also common with respect to the tax-qualified status of employee pension plans. Employers may submit their plan to the Service for a private letter determination as to the tax-qualified status of a plan.64

4. Licensing

Licensing, as a line-drawing instrument, is tax authorities’ decision to require that all taxpayers preapprove a contemplated transaction in order to obtain a favorable tax treatment. This allows tax authorities to distinguish between activities that are economically similar before transactions are undertaken, on a case-by-case basis.

*484 The tax treatment of nonprofit organizations is an example of tax authorities’ reliance on licensing as a line-drawing instrument. Organizations that operate exclusively for charitable or educational purposes are tax exempt,65 and taxpayers may deduct contributions to these organizations from their income.66 Some organizations clearly operate exclusively for charitable and educational purposes, and others clearly do not. In many cases, however, the answer to this question is not completely clear. How do tax authorities go about determining which organizations are entitled to this tax exemption?

Tax authorities address this line-drawing problem by requiring all organizations that wish to obtain a tax-exempt status based on their charitable and educational purposes to apply for recognition of that status.67 Applying organizations are required to provide their organizing document such as their articles of incorporation or articles of organization, and describe, among other things, their specific activities and the services they provide; their financial arrangements with officers, directors, trustees, employees, and independent contractors; their fundraising efforts; and other financial information.68 Unless an organization files an application for recognition of its tax-exempt status, it will be fully taxed.69

B. Alternative Choice of Line-Drawing Instruments

We see that, in various contexts, tax authorities employ four different line-drawing instruments: rulemaking, adjudication, private letter rulings, and licensing. In theory, one could imagine tax authorities employing these instruments in a different manner than they did in the aforementioned examples.

In the case of the rule determining when a taxpayer is temporarily away *485 from home, tax authorities could have relied more heavily on adjudication. Instead, the simple rule that the tax authorities imposed draws an artificial line that depends only on the duration of the taxpayer’s travel and ignores many factors that would otherwise seem natural to consider when deciding whether a taxpayer has moved his or her home. Alternatively, tax authorities could have allowed taxpayers to obtain a private letter ruling, asking whether, given all the facts and circumstances, a specific travel plan constitutes a move of one’s home. Similarly, in the CFC rules case, tax authorities could have relied more heavily on adjudication instead of issuing such detailed rules that often draw artificial lines that do not necessarily reflect the economic reality.

In the case of the debt-equity distinction, tax authorities could have issued rules or required corporations to preapprove their financial instruments (that is, to obtain a license) in order for these instruments to be recognized as debt for tax purposes. This would have provided taxpayers with better guidance as to the tax status of different financial instruments. Similarly, in the economic substance case, tax authorities could have issued detailed rules instead of mainly relying on adjudication. Alternatively, they could have allowed firms to request a private letter ruling in cases where it is unclear whether a transaction has economic substance.

In the corporate spin-off case, tax authorities could have required that their approval be obtained for a distribution of stock to qualify as a tax-free spin-off, instead of providing firms with the option to undertake a spin-off without prior approval. Alternatively, they could have issued more simple rules that would not require case-by-case determinations.

Finally, in the nonprofit organizations case, tax authorities could have allowed organizations to claim a tax-exempt status without prior approval, and focused instead on adjudicative enforcement against organizations that were not entitled to do so. Alternatively, they could have made it optional, rather than mandatory, to request an approval of a tax-exempt status through a private letter ruling.

What should guide tax authorities in their choice of line-drawing instruments?

III. CHOOSING AMONG LINE-DRAWING INSTRUMENTS

In this part, I present a theory of line drawing that explains how tax authorities should choose instruments to draw lines. I focus on three criteria that should be considered by tax authorities when making this choice.

A. Ideal Policy

Line drawing involves distinguishing between activities that are *486 economically similar. The ideal line would account for all the relevant facts and circumstances. Line-drawing instruments are more precise when they can account for a wider range of relevant factors when differentiating between factually similar activities or transactions that should be treated differently under the tax law, thus coming as close as possible to the ideal policy. Imprecise line-drawing instruments, by contrast, cannot account for all relevant factors. They allow only for relatively arbitrary bright lines between such activities or transactions, thus remaining relatively far from the ideal policy.

Line-drawing instruments vary widely in terms of precision. Some only allow for broad distinctions to be made, and others allow for finer distinctions. Specifically, rulemaking tends to be imprecise and usually does not allow for fine distinctions. It tends to be used to draw arbitrary lines that do not consider many factors. This is illustrated by the examples of rulemaking considered earlier. For example, the one-year rule, which determines whether a taxpayer is temporarily away from home, ignores other factors that one would naturally consider when determining whether one has moved his home to a different city,70 and instead draws an arbitrary line based entirely on one year of travel. Similarly, the CFC rules draw an arbitrary line based on a taxpayer’s ownership interest in a foreign corporation, and consequently treat taxpayers who own just over or just under ten percent of a foreign company’s stock very differently.

Unlike rulemaking, other line-drawing instruments are more precise, because they allow for finer lines to be drawn, and for distinctions that account for a variety of factors to be made. For example, in determining whether an individual is an employee rather than a contractor, adjudication allows for twenty factors to be examined.71 Because licensing and private letter ruling similarly allow tax authorities to consider many factors when drawing lines, they too are relatively precise instruments.72 Therefore, an advantage of adjudication, private letter rulings, and licensing over rulemaking is their relative precision. A disadvantage of rulemaking is its *487 relative imprecision.

B. Effect on Taxpayers

1. Taxpayers’ Uncertainty

Taxpayers are often uncertain about the application of tax law. Differing interpretations of the law, which could result in substantially different tax consequences, are often possible.73 In particular, there are often ambiguities concerning the application of the tax law to a specific factual situation.74 One study has shown that taxpayers think that ambiguity, defined as a situation where “[t]here are ambiguities in the law which may lead to more than one defensible position,” is a major factor in tax law complexity.75Drawing lines in a manner that reduces taxpayer uncertainty can encourage taxpayers to enter into socially useful transactions that may otherwise be too risky to engage in if their tax consequences were uncertain.

Given taxpayers’ uncertainty, an important advantage of rulemaking over adjudication is that it provides certainty to taxpayers as to most of the matters covered by the rule, thereby making it easier for taxpayers to comply with the tax laws.76

To illustrate, the one-year rule used to determine when a taxpayer is temporarily away from home may ignore factors other than the duration of travel, but it does provide taxpayers with certainty as to their exact tax position. Similarly, the CFC rules allow taxpayers to know their precise tax exposure given the size of their holdings in a company’s stock (though that exposure may also depend on the characteristics and holdings of other shareholders). Accordingly, taxpayers are no longer uncertain whether their *488 absence from home constitutes a relocation or travel or whether they own stock in a foreign corporation in a manner that impermissibly defers U.S. taxation of the corporation’s earnings.

Furthermore, by reducing taxpayers’ uncertainty, tax authorities can encourage taxpayers to enter into socially useful transactions that taxpayers may otherwise feel are too risky to engage in if their tax consequences were uncertain. This is demonstrated by tax authorities’ use of private letter rulings, which provide even more certainty to taxpayers than rulemaking, as they allow taxpayers to obtain information on the tax consequences of specific contemplated transactions.77 Thus, if a contemplated corporate spin-off is approved as tax-free in a private letter ruling, then any legal uncertainty with respect to the tax-free status of the corporate reorganization is eliminated. Licensing too overcomes the problem of taxpayers’ uncertainty. If a charitable organization is approved as tax exempt, then there is certainty with respect to its status, and taxpayers will know that they may deduct contributions to it from their income.78 Tax authorities’ use of private letter rulings to ensure taxpayers that certain spin-offs are tax-free or that certain charitable contributions are deductible encourages these taxpayers to enter into socially useful transactions.

Thus, both private letter rulings and licensing seem to provide taxpayers with the highest level of certainty. Rulemaking provides taxpayer with a somewhat lower certainty. Adjudication provides taxpayers with the least certainty.

2. Compliance Burden

As noted, rulemaking, private letter rulings and licensing all provide taxpayers with relative certainty as to the tax consequences of their transactions, thus making it easier for taxpayers to comply with tax laws. However, rulemaking provides certainty to taxpayers without the need for taxpayers to engage tax authorities. By contrast, private letter rulings and licensing provide certainty to taxpayers only if they engage tax authorities individually in a request for a private letter ruling or a license. As such, *489 taxpayers’ compliance burden is especially low under rulemaking, making it more appealing from the perspective of compliance burden.

The low compliance burden advantage is particularly important if many taxpayers can be expected to frequently encounter the uncertain legal tax situation. In those cases, rulemaking has a particular advantage over private letter rulings and licensing, as it significantly reduces the compliance burden taxpayers face.79 But if the legally ambiguous tax issue is not expected to arise frequently, then private letter ruling or licensing tend to be preferable, since although they are more burdensome to taxpayers, the likelihood that the particular application will never arise may make them less costly on balance.80

C. Effect on Tax Authorities

1. Tax Authorities’ Uncertainty

Tax authorities are often uncertain as to where lines that delineate differing tax treatment should be drawn. There may be factors that should have been taken into account when drawing a line, but were simply not thought of.81 Also, tax authorities may be uncertain as to how taxpayers will react to the line drawn. Specifically, taxpayers may react to drawn lines in an undesirable way, tweaking deals just enough to achieve their desired goals but generating considerable social waste in the process.82

Given tax authorities’ uncertainty, an important advantage of adjudication over rulemaking is its incrementalism,83 and the flexibility it provides in responding to new information.84 This point is well illustrated by the Treasury Department’s (Treasury) failed attempts to deal with the distinction between debt and equity using rules rather than adjudication.

The House version of the 1954 Code attempted to define debt and equity, but these definitions were dropped by the Senate. The Senate Finance Committee noted that “‘any attempt to write into the statute precise definitions which will classify for tax purposes the many types of corporate stocks and securities will be frustrated by the numerous characteristics of an interchangeable nature which can be given to these instruments.”’85 In 1980, the Treasury used its authority under section 385 of the Code to issue regulations distinguishing between debt and equity, but the “effective date [of these regulations] was extended twice because of criticism . . . . [I]nvestment bankers were quickly able to develop an instrument treated as debt under the regulations that no court would have treated as debt under prior law.” This resulted in the withdrawal of all versions of the regulation before they ever took effect.86 These failed attempts to use rules, and the relatively successful use of case-by-case adjudication since then, demonstrate the importance of incrementalism and flexibility in distinguishing between debt and equity.

With regard to taxpayer confidence, a relative disadvantage of rulemaking is uncertainty regarding taxpayers’ reactions. Adjudication, as well as licensing and private letter rulings, in which case-by-case decisions *491 are also made, are relatively advantageous instruments, because they allow tax authorities, when lacking comprehensive information, to try to draw lines, and adjust those lines in light of taxpayers’ reactions and information learned subsequently by tax authorities.

2. “Wall Street Rule”

One factor that distinguishes the different line-drawing instruments is the timing of line drawing -- that is, whether legal lines are drawn ex ante, before taxpayers act, or ex post, after they act. Specifically, rules are issued before taxpayers act,87 while adjudication takes place after taxpayers act. Licenses, like a request to approve a tax-exempt status, are issued before taxpayers act. Private letter rulings are issued before taxpayers act, though unlike under licensing, taxpayers are not obligated to request a private letter ruling.

The timing of line drawing matters because of the “Wall Street Rule.” According to this unofficial rule, known well among tax practitioners, the Service will not attack the tax treatment of a transaction if there is a generally accepted understanding of its expected treatment, or if the dollar amount involved is of significant magnitude.88 An example of the effect of the “Wall Street Rule” is the tax policy with respect to frequent flyer miles attributable to business or official travel. Based on any definition of taxable income, these frequent flyer miles should be included in taxable income; however, the Service has decided not to tax them.89 One explanation for this policy is the “Wall Street Rule,” that is the Service is reluctant to tax frequent flyer miles attributable to business or official travel because it is *492 already generally accepted among practitioners that these miles are not taxed, and because their taxation would involve very large dollar amounts.

Given the “Wall Street Rule,” a disadvantage of adjudication is that it takes place after taxpayers have already acted. Because of the timing of adjudication, tax authorities may be forced to adopt a lenient tax position, since an adverse position would go against common practitioners’ view and would negatively affect many taxpayers who have already acted. Rulemaking and licensing, by contrast, take place before taxpayers act, and therefore do not raise the “Wall Street Rule” problem. Private letter rulings also prevent this problem, but only when taxpayers choose to request a ruling and have lines drawn before they act.

3. Judicial Deference

Taxpayers may appeal a decision by the federal tax authorities in three different courts: the U.S. Tax Court,90 a federal district court,91 and the U.S. Court of Federal Claims.92 The possibility of an appeal may affect tax authorities’ choice of line-drawing instruments because this choice may affect the level of deference courts are willing to grant tax authorities.

If rules are used as line-drawing instruments, and they are adopted by Congress, they simply bind courts. The Treasury may also produce rules by issuing regulations. Until recently, some argued, based on National Muffler Dealers Association,93 that the standard of deference afforded Treasury regulations depends on whether the regulation in question was promulgated pursuant to a specific statutory grant of authority, in which case a high degree of deference applies, or pursuant to the general rulemaking grant to the Treasury under Code section 7805(a), in which case a lower level of deference applies.94 However, in 2011 the Supreme Court rejected the idea that unique standards of deference apply to Treasury regulations in  Mayo Foundation,95 and announced that the regular judicial deference standards apply when reviewing Treasury regulations. Thus, according to Mayo, lines *493 drawn using Treasury regulations are awarded Chevron deference,96 which means that a rule will be upheld as long as the “rule is a reasonable construction of what Congress has said.”97

If tax authorities use other line-drawing instruments, like private letter rulings or licensing, which are less formal, they will be reviewed under a less deferential standard than the Chevron standard, articulated in Skidmore v. Swift & Co.,98 as determined in United States v. Mead Corporation.99 Adjudicative decisions, which in the tax context are the determination of deficiency in tax, are subject to de novo judicial review.100

Thus, from tax authorities’ perspective, rulemaking has an advantage over other line-drawing instruments, since by using it tax authorities guarantee themselves greater judicial deference. Private letter rulings and licensing are awarded lower level of judicial deference, and adjudication is awarded the lowest level of judicial deference. 

4. Precedential Effect

When choosing a line-drawing instrument to implement a policy, tax authorities should consider whether they would like their policy to be precedential. That decision may depend on the confidence of the tax authorities in the lines they have drawn. If tax authorities are concerned that imperfections or ambiguities in the lines may result in opportunistic manipulation, they may want to preserve the flexibility to easily adjust them *494 in a gradual manner. The choice of a line-drawing instrument will often determine the precedential effect of a policy.

Rules are precedential, that is, they bind tax authorities and taxpayers in all future cases, unless they are formally changed. Tax authorities’ adjudicative decisions, which are determinations of deficiency in tax,101 are not published, and therefore cannot be precedential, since uninvolved taxpayers are unaware of them. If taxpayers appeal these determinations of tax deficiency, the court’s decision will be published, but until they do so these decisions are not made public.

The precedential value of private letter rulings is formally limited.102 Originally, private letter rulings were not published, but the Service began making them available to the public in the mid-1970s, after losing two freedom of information cases requesting their disclosure.103 This means that private letter rulings may have a de facto precedential effect,104 because of tax authorities’ duty of consistency toward similarly situated taxpayers.105

While the outcome of tax authorities’ decisions in a licensing process, such as a request for recognition of tax-exempt status, are often known, tax authorities do not formally publish these decisions and their reasoning. Here too, of course, an appeal in court makes the decision public.

5. Procedural Costs

The different line-drawing instruments involve different procedural costs, and this may affect tax authorities’ choice among those instruments.

The process of rulemaking, whether undertaken by Congress or by the *495 Treasury, is costly for tax authorities.106 Adjudication -- the determination of a tax deficiency -- is probably more costly than rulemaking. Unlike rules, which apply to all cases, adjudication requires case-by-case decisions on where to draw lines.

Private letter rulings and licensing are probably more costly than adjudication, since they require setting up a special administrative structure to answer requests. Licensing is probably more costly than private letter rulings. When private letter rulings are used as a line-drawing instrument, taxpayers may choose not to have their actions preapproved and wait for an adjudicative decision after they act. When licensing is used, all taxpayers have to preapprove their tax status.

Procedural costs increase as the associated procedure occurs more and more frequently. Accordingly, if many taxpayers act in a legal “gray area,” rulemaking becomes relatively more desirable than other line-drawing instruments; it allows tax authorities to reduce the number of individual costly engagements with taxpayers.107 For example, tax authorities are required to determine whether a taxpayer is temporarily away from home probably more than a million times each year. Employing the simple one-year rule, based entirely on the time of travel, is therefore especially appealing. If, on the other hand, most taxpayers undertake transactions that can be easily categorized for tax purposes and only a few act in legal gray areas, then instruments that rely on case-by-case decisions tend to be more desirable because of their precision.108

IV. POLICY ASSESSMENT

In this part, I demonstrate how the theory developed in Part III can be  *496 applied to explain and assess tax authorities’ choice of line-drawing instruments in particular cases. To do so, I draw upon the four examples of line drawing used in Part II.

A. Controlled Foreign Corporation Rules

Tax authorities use rulemaking as a line-drawing instrument to determine when an investment in a foreign corporation is used to defer tax payments artificially.109 The CFC rules identify which classes of taxpayers must include in their income specific amounts earned by foreign owned entities.

Let us assess this choice of line-drawing instrument using the theory developed in Part III. In terms of the ideal policy, the CFC rules are imprecise. They consider only a limited set of facts and circumstances, and thus draw arbitrary lines distinguishing taxpayers that are required to include in their income amounts earned by foreign entities they own from those that are not. That allows taxpayers to escape taxation by coming close to the line without crossing it, for instance by holding just under ten percent of a foreign company’s shares. Other line-drawing instruments that allow for case-by-case decision-making could consider a wider range of relevant facts, thus avoiding such arbitrary lines.

However, the CFC rules perform relatively well in terms of their effect on taxpayers. The CFC rules provide taxpayers with relative certainty regarding their tax position. Furthermore, the rules impose a relatively light compliance burden, because they apply uniformly, and do not require taxpayers to engage individually with tax authorities.

The CFC rules perform less well in terms of their effect on tax authorities. They do not effectively address tax authorities’ uncertainty as to the precise location of the legal line between justified and artificial cases of tax deferral. Other line-drawing instruments would enable tax authorities to adjust the line incrementally as they learn more information about taxpayers’ behavior. Still, the use of rulemaking rather than other line-drawing instruments provides tax authorities with greater judicial deference from courts. It also prevents the “Wall Street Rule” problem from arising, as tax authorities are not faced with the task of line drawing after firms have already acted. Thus, tax authorities are not forced to respect generally accepted practices regarding CFCs of which they do not approve. Lastly, since the CFC rules apply to all taxpayers and do not require individualized procedure, they do not impose high procedural costs on tax authorities.

To summarize, though the CFC rules seem to be imperfect measured *497 against the ideal policy, they perform well in terms of the effect on taxpayers because they reduce taxpayer uncertainty and compliance burden. The CFC rules also perform relatively well in terms of their effect on tax authorities, with the exception of tax authorities’ uncertainty.

In light of this analysis, let us consider an alternative line-drawing policy, which would rely on case-by-case determinations. That kind of policy would take into account more facts and circumstances, and would draws a more precise line between taxpayers that are required to include in their income amounts earned by foreign entities they own, and those that are not. It would also allow for a more nuanced approach to policy that accounts for tax authorities’ uncertainty regarding the precise location of the legal line in question. Such a change in line-drawing policy, however, would significantly increase taxpayers’ uncertainty. That problem may be addressed by allowing taxpayers to obtain private letter rulings in questionable situations. However, since millions of U.S. taxpayers hold shares in foreign corporation, questionable situations will arise very frequency. Private letter rulings involve high procedural costs. Therefore, addressing questionable situations with private letter rulings would simply be too expensive. Thus, the use of the CFC rules seems justified.

B. Economic Substance Doctrine

To determine which transactions lack economic substance tax authorities avoid issuing rules, instead relying on case-by-case adjudication.110 Using the theory developed in Part III, let us evaluate this choice of line-drawing instrument.

In terms of the ideal policy, the reliance on case-by-case adjudication as a line-drawing instrument allows for the consideration of many facts and circumstances in determining which transactions lack economic substance and should therefore be ignored for tax purposes, and which transactions are meaningful economically and should therefore be recognized for tax purposes. That flexibility allows tax authorities to come as close as possible to some ideal definition of economic substance.

Adjudication performs less well with respect to its effects on taxpayers. The exclusive reliance on case-by-case adjudication, without any sort of guidance, means that taxpayers are faced with a substantial degree of uncertainty regarding their tax position. As a result, taxpayers often need legal counsel to help assess whether contemplated transactions will be recognized for tax purposes. This results in a relatively high taxpayer compliance burden.

With respect to the effect on tax authorities, it seems that the reliance on adjudication in determining which transactions have economic substance provides tax authorities with maximum flexibility to make incremental decisions, reflecting their own uncertainty regarding the legal lines at issue. However, the use of adjudication means that tax authorities will be afforded only a low level of judicial deference from courts upon reviewed, especially relative to that afforded rulemaking. Furthermore, because adjudication takes place after taxpayers have already undertaken their transactions, the “Wall Street Rule” may apply, and tax authorities may be forced to recognize common yet improper transactions. Lastly, since the issue of economic substance has to be decided individually, on a case-by-case basis, it imposes high procedural costs on tax authorities.

To summarize, the use of adjudication in applying the economic substance doctrine is a good idea in terms of the ideal policy, but is undesirable in terms of the effect on taxpayers, as it results in both a high taxpayer uncertainty and compliance burden. With respect to the effect on tax authorities, adjudication effectively deals with tax authorities’ uncertainty, but is problematic in terms of judicial deference, the “Wall Street Rule,” and procedural costs.

Given this analysis, an alternative line-drawing policy could allow taxpayers to obtain private letter rulings with respect to the application of the Economic Substance Doctrine. This would allow taxpayers to reduce the legal uncertainty of their tax status, while still allowing tax authorities to stay close to some ideal definition of economic substance by considering a variety facts and circumstances. However, the de facto precedential effect of private letter rulings, resulting from their publication and tax authorities’ duty of consistency towards similarly situated taxpayers, may make tax authorities very wary of issuing rulings that will bind them in unforeseen future cases. By issuing private letter rulings, tax authorities risk forgoing the incrementalism they desire in light of their own uncertainty. Since incrementalism is crucial to tax authorities in the case of the Economic Substance Doctrine, the current choice of on case-by-case adjudication seems correct.

C. Corporate Spin-offs

Tax authorities rely on private letter ruling to determine which distributions of corporate stock qualify as a tax-free spin-off.111 This system allows corporations to make individual requests for a private letter ruling, in which the Service determines whether a specific spin-off will be tax-free. *499 Let us assess this choice of line-drawing instrument using the theory developed in Part II.

In terms of the ideal policy, using private letter ruling allows for case-by-case line drawing, and therefore for the consideration of many facts and circumstances in determining which spin-offs should be tax exempt. This allows tax authorities to come relatively close to some ideal characterization of spin-offs that should be tax-free.

In terms of the effect on taxpayers, private letter rulings provide taxpayers with certainty as to the tax consequences of the spin-off they are contemplating. Furthermore, in terms of the compliance burden on taxpayers, although taxpayers have to engage tax authorities individually when requesting a private letter ruling, they may also choose to undertake a spin-off without obtaining a private letter ruling. They will do that when they are relatively certain that the spin-off will be tax exempt. Therefore, taxpayers will limit their requests for rulings to cases in which tax law is uncertain, which means that compliance burden on taxpayers when private letter rulings are used is moderate.

With respect to the effect on tax authorities, the use of private letter rulings in determining which corporate spin-offs should be tax exempt provides tax authorities with the ability to make incremental decisions, and to consider many facts and circumstances. This is desirable in terms of tax authorities’ own uncertainty as to the legal line at issue. However, because private letter rulings are published, they have a de facto precedential effect. This means that every private letter ruling issued limits tax authorities’ flexibility in future cases, which may be difficult to foresee. That consequence may cause tax authorities to be reluctant to issue rulings in the first place.

Private letter rulings are issued at taxpayers’ initiative. If taxpayers expect the “Wall Street Rule” to force tax authorities to adopt a lenient ex post position when faced with spin-offs that has already occurred, they will not seek preapproval. This means that the “Wall Street Rule” may well has implications with respect to private letter line drawing. Still, in terms of a compliance burden, it imposes only moderate procedural costs on tax authorities because not all spin-offs have to be approved individually in a private letter ruling.

To summarize, the use of private letter ruling for recognizing corporate spin-offs as exempt from taxation is desirable in terms of the ideal policy and the effect on taxpayers. In terms of the effect on tax authorities, the situation is more complex.

In light of this analysis, it seems that the choice of private letter ruling as a line-drawing instrument in this context is justified. This line-drawing instrument could be improved if it were possible to keep the private letter *500 rulings actually private -- i.e., unpublished. That change is currently illegal,112 but as a theoretical matter it would allow tax authorities more flexibility in characterizing tax-exempt spin-offs. They no longer would be bound, at least de facto, by previous rulings, and would be able to incorporate new facts and circumstances unique to each transaction. This, of course, would compromise taxpayer uncertainty; publishing private letter rulings helps guide uninvolved taxpayers. Still, taxpayers who face serious uncertainty may always request an individual private letter ruling to confirm the consequences of a contemplated spin-off transaction.

D. Charitable Organizations

As noted, to determine which organizations are engaged in charitable activities and are therefore entitled to a tax exemption, tax authorities rely on licensing, requiring that all such organizations preapprove their tax-exempt status before they can benefit from this tax exemption. Let us assess this choice of line-drawing instrument using the theory developed in Part II.113

In terms of the ideal policy, the use of case-by-case licensing as a line-drawing instrument allows for the consideration of many facts and circumstances in determining which organizations are indeed charitable, thus coming as close as possible to some ideal definition of a charitable organization.

In terms of the effect on taxpayers, the use of licensing provides taxpayers with relative certainty as to their tax position, since taxpayers have their individual status approved by tax authorities before they undertake any activity. This however imposes a relatively high compliance burden on taxpayers, who have to engage tax authorities individually when applying for their tax-exempt status.

With respect to the effect on tax authorities, the use of licensing in this context provides tax authorities with a lot of flexibility to make incremental decisions, and the ability to consider many facts and circumstances, allowing them to manage their own uncertainty as to the legal line at issue. Furthermore, because licensing decisions are not published, there is no risk of setting a de facto precedent, which would limit tax authorities’ flexibility to adjust the line to new information. Because tax-exempt status must be individually approved before organizations benefit from that status, the “Wall Street Rule” does not come into play. Tax authorities are not faced with the difficult choice between denying a tax-exempt status to *501 organizations that have already utilized the status in their activities, or approving this status against tax authorities’ better judgment. Still, since tax-exempt status has to be decided individually, it imposes a high procedural cost on tax authorities.

To summarize, the use of licensing for awarding tax-exempt status to charitable organizations is a good idea in most respects as a matter of ideal policy, the effect on taxpayers, and the effect on tax authorities. The main problem with this line-drawing instrument is that it imposes a high compliance burden on taxpayers, as well as high procedural costs on tax authorities.

In light of this analysis, an alternative line-drawing policy would make it optional, rather than mandatory, to request an approval of a tax-exempt status through a private letter ruling. Such a policy would reduce the taxpayer compliance burden and the procedural costs borne by tax authorities under licensing, since only taxpayers who are uncertain as to their tax status would request a private letter ruling. The problem with such an alternative is the “Wall Street Rule.” If organizations can claim a tax-exempt status without prior approval, tax authorities may be reluctant to remove this status in adjudication, after these organizations have already acted and benefited from this status, particularly after many taxpayers have already deducted contributions to these organizations from their income. A licensing regime prevents such cases from arising, and may therefore be justified despite its high procedural costs.

V. CONCLUSION

In many different contexts, tax law draws lines in legal gray areas, distinguishing between economically similar transactions that should be treated differently. This article demonstrates, for the first time, that tax authorities employ four different line-drawing instruments, namely rulemaking, adjudication, private letter ruling and licensing. In light of this finding, the article addresses a fundamental question: how should tax authorities choose among the different line-drawing instruments at their disposal?

To address this question, this article has presented a theory of line drawing in tax law, identifying three criteria that should inform tax authorities when choosing a line-drawing instrument: the ideal policy, the effect on taxpayers, and the effect on tax authorities. This theory is then applied to explain tax authorities’ current choice of line-drawing instruments in several important tax contexts.

More broadly, this article has put into focus a central feature of tax law that is often thought to be too doctrinal to be of interest to academics. This *502 article highlights the importance of line drawing from a theoretical and a practical perspective. Applying a similarly methodological approach to other core doctrinal tax issues may lead to new insights and a deeper appreciation and understating of tax law.

(Editor: Zhang Chi)

Personal details:

Yehonatan Givati, Hebrew University of Jerusalem - Faculty of Law; George Mason University - Antonin Scalia Law School, Faculty

Footnotes: 

[a1] Visiting Professor, Columbia Law School, Associate Professor, Hebrew University Law School. I am grateful for helpful comments to Ilan Benshalom, Michael Doran, David Gliskberg, Ben Grunwald, Mitchell Kane, Louis Kaplow, Alex Raskolnikov, David Schizer, Daniel Shaviro, Stephen Shay, Joseph Tootle, Eric Zolt, and participants in workshops at Hebrew University and the American Law and Economics Association annual meeting at Stanford Law School.

[1] See David A. Weisbach, Line Drawing, Doctrine, and Efficiency in the Tax Law, 84 CORNELL L. REV. 1627, 1627 (1999) (“[O]ne can analyze doctrinal rules in disparate areas of tax law as a single class of problems -- line-drawing problems -- which are susceptible to solutions with a common structure.”).

[2] I use this term to refer to the Internal Revenue Service (Service), the Treasury Department (Treasury), and Congress acting in the area of tax law.

[3] See William T. Plumb, Jr., The Federal Income Tax Significance of Corporate Debt: A Critical Analysis and a Proposal, 26 TAX L. REV. 369, 372 (1971) (“The fact that the Code allows an income tax deduction for ‘all interest paid or accrued... on indebtedness’ but allows no such deduction for dividends paid, creates a powerful incentive for financing, to the maximum extent that credit and other business considerations permit, with debt rather than stock.”) (footnotes omitted).

[4] See  BORIS I. BITTKER & JAMES S. EUSTICE, FEDERAL INCOME TAXATION OF CORPORATIONS AND SHAREHOLDERS P 4.02[1], at 4-12 (6th ed. 1998) (“‘[D]ebt’ and ‘equity’ are labels for the two edges of a spectrum, between which lie an infinite number of investment instruments, each differing from its nearest neighbor in barely perceptible ways.”).

[5] See Anthony P. Polito, Useful Fictions: Debt and Equity Classification in Corporate Tax Law, 30 ARIZ. ST. L.J. 761, 779 (1998) (“[T]he continuous spectrum between paradigmatic debt and paradigmatic equity tends to frustrate the pursuit of clean regulatory categories.”).

[6] See John Bruntz, The Employee/Independent Contractor Dichotomy: A Rose is Not Always a Rose, 8 HOFSTRA LAB. & EMP. L.J. 337, 344 (1991) ( “Independent contractors are required to pay their own taxes.... In theory, the IRS should receive roughly the same revenue regardless of how a worker is classified, but in practice it is much harder to police independent contractors than to monitor employers withholding taxes from regular employees. The IRS has estimated that misclassification of workers costs $1.56 billion a year in lost revenue.”). Independent contractors also face fewer restrictions when deducting work-related expenses. See, e.g., I.R.C. § 67(a), (allowing the itemized deductions of expenses for employees only to the extent that they exceed two percent of the employee’s adjusted gross income).

[7] Cf., e.g., Transcript of Oral Argument at 13-14, Mayo Found. for Med. Educ. & Research v. United States, 562 U.S. 44 (2011) (No. 09-837), available at http://www.supremecourt.gov/oral_arguments/argument_ transcripts/09-837.pdf (statement of Chief Justice Roberts) (“[T]his basically [[is] a very familiar situation of an apprentice who is both an employee and both a student, and to try to draw the line in some categorical way doesn’t make sense. The only way you can draw the line is to have somebody say: This is going to be the line. And if anybody is going to say it, it ought to be the IRS.”).

[8] Weisbach,  supra note 1, at 1631 (“Tax policy decisions typically require drawing a line between two relatively fixed points.... Between the fixed points is a continuous range of transactions. Wherever the line is drawn, transactions on either side will be substantially similar (in the sense that they are substitutes for one another), and taxpayers will change their behavior to take advantage of the line. The tax-induced change in behavior will have efficiency effects, regardless of how arbitrary the line is or how doctrinally complex the subject matter might be. This Article argues that lines in the tax law should be drawn to be as efficient as possible.”). See also David A. Weisbach, An Efficiency Analysis of Line Drawing in the Tax Law, 29 J. LEGAL STUD. 71 (2000) (presenting a formal model of the concept discussed in Weisbach, supra note 1).

[9] See infra Part II.A.1.

[10] The administrative law literature has devoted much attention to the choice between rulemaking and adjudication, but tax scholars have ignored it. See  JAMES M. LANDIS, S. COMM. ON THE JUDICIARY, 86TH CONG., REP. ON REGULATORY AGENCIES TO THE PRESIDENT ELECT 22 (Comm. Print 1960) (“[P]olicy formulation can be made in various ways including the adjudicatory process. The failure to utilize other methods for policy formulation is due primarily to the pressure of business on the adjudicatory side.”); HENRY J. FRIENDLY, THE FEDERAL ADMINISTRATIVE AGENCIES 145 (1962) (“Although the case-by-case method should not be abandoned even if that were possible, it should be supplemented by greater use of two devices -- policy statements and rulemaking.”); Warren E. Baker, Policy by Rule or Ad Hoc  Approach - Which Should It Be?, 22 LAW & CONTEMP. PROBS. 658, 658 (1957) (“This article is not concerned with the legal question of where agency action must be adjudicatory or rule-making, but rather with the discretionary question of when a proposed action ought to be taken by rule-making instead of adjudication.”); Colin S. Diver, Policymaking Paradigms in Administrative Law, 95 HARV. L. REV. 393, 430 (1981) (“We need not cast all our weight on one side, for incrementalism and comprehensive rationality each offer unique advantages as well as conspicuous limitations. A fully mature theory of policymaking should be able to accommodate both, with each as master in its appropriate realm.”); Antonin Scalia, Back to Basics: Making Law without Making Rules, REGULATION, July/Aug. 1981, at 25 (arguing for a return from policymaking by rulemaking to policymaking through adjudicative decisions); David L. Shapiro, The Choice of Rulemaking or Adjudication in the Development of Administrative Policy, 78 HARV. L. REV. 921, 922 (1965) ( “Just what is the significance of an agency determination to proceed by rulemaking rather than by adjudication? If there are discernible advantages in rulemaking, both for the agency and for those it regulates, then why has there been so much reluctance to resort to it? If there is any fault, can part of it be allocated to the courts for failure to exercise sufficiently close supervision, or to Congress for failure to facilitate and encourage the issuance of regulations? Should any steps be taken in the future to promote better use of agency resources?”).

[11] See infra Part II.A.2.

[12] See infra Part II.A.3.

[13] Both private letter ruling and licensing have been overlooked by the administrative law literature, and have been highlighted in a recent article. See Yehonatan Givati, Game Theory and the Structure of Administrative Law, 81 U. CHI. L. REV. 481, 483 (2014) (“The administrative law literature has devoted much attention to the choice between rule making and adjudication. However, it has ignored the policy-making instruments of advance ruling and licensing.”).

[14] See infra Part II.A.4.

[15] A similar question, outside the area of tax law, is addressed in Givati, supra note 13.

[16] See infra Part III.A.

[17] See infra Part III.B.1.

[18] See infra Part III.B.2.

[19] See infra Part III.C.1.

[20] See infra Part III.C.2.

[21] See infra Part III.C.3.

[22] See infra Part III.C.5.

[23] See infra Part IV.A.

[24] See infra Part IV.B.

[25] See infra Part IV.C.

[26] See infra Part IV.D.

[27] I.R.C. § 262(a).

[28] I.R.C. § 162(a)(2).

[29] I.R.C. § 162(a).

[30] I.R.C. § 7701(a)(30).

[31] OFFICE OF TAX POLICY, DEP’T OF THE TREASURY, THE DEFERRAL OF INCOME EARNED THROUGH U.S. CONTROLLED FOREIGN CORPORATIONS 111-112 (2000) (“Subpart F of the Internal Revenue Code, enacted by the Revenue Act of 1962, was based on a proposal by President Kennedy outlined in his tax message to Congress on April 20, 1961.... Among the features of the U.S. tax system targeted in the President’s Tax Message was the availability of tax deferral for American firms operating abroad through foreign subsidiaries, the income of which was not taxed until repatriated as a dividend.”).

[32] This includes, among other things, domestic partnerships and corporations. I.R.C. § 7701(a)(30).

[33] I.R.C . § 957(a).

[34] I.R.C. § 951(a).

[35] I.R.C. §§ 952-956.

[36] Treas. Reg. §§ 1.951-1.964 (1958).

[37] I.R.C. § 6212(a); MICHAEL I. SALTZMAN, IRS PRACTICE AND PROCEDURE P 1.08[2], at 1-79 (rev. 2d ed. 2011) (“Determinations of deficiency in tax.... appear[] to constitute an adjudication within the meaning of the APA.”).

[38] Richard B. Stone, Debt-Equity Distinctions in the Tax Treatment of the Corporation and Its Shareholders, 42 TUL. L. REV. 251, 252 (1968) ( “Section 163(a) of the Internal Revenue Code allows the taxpayer to deduct ‘interest paid or accrued within the taxable year on indebtedness.’ There are no provisions in the Code, relevant for our purposes, regulating the deductions for interest paid by a corporation to its shareholders.”).

[39] Gilbert v. Commissioner, 248 F.2d 399, 402 (2d Cir. 1957).

[40] BITTKER & EUSTICE, supra note 4, P 4.02[1], at 4-12 (“‘[D]ebt’ and ‘equity’ are labels for the two edges of a spectrum, between which lie an infinite number of investment instruments, each differing from its nearest neighbors in barely perceptible ways.”).

[41] Id. (“Moving toward the center of the spectrum, away from both the classic definition of ‘debt’ and the more vague concept of equity, there exist such financial phenomena as debentures that are entitled to a share of the issuing corporation’s profits and are subordinated to the claims of general creditors, preferred stock that is entitled to receive a fixed return if earned and is to be redeemed at a specific price, and a host of other instruments with similarly blended characteristics.”).

[42] Stone, supra note 38, at 252-53 (“The inquiry in each case must be whether what purports to be a payment of interest on indebtedness would be more properly treated as a ‘distribution... with respect to... stock’ under section 301(a), and, therefore, not deductible by the corporation.”).

[43] BITTKER & EUSTICE, supra note 4, P 4.02[7], at 4-17 (“Because so many factors may be relevant to the ultimate decision in debt-equity cases, which arise in factual contexts that routinely overlap but never precisely coincide, judicial opinions regularly announce that earlier decisions are suggestive but not dispositive.”).

[44] See Fin Hay Realty Co. v. United States, 398 F.2d 694, 696 (3d Cir. 1968) (“In attempting to deal with this problem courts and commentators have isolated a number of criteria by which to judge the true nature of an investment which is in form a debt: (1) the intent of the parties; (2) the identity between creditors and shareholders; (3) the extent of participation in management by the holder of the instrument; (4) the ability of the corporation to obtain funds from outside sources; (5) the ‘thinness’ of the capital structure in relation to debt; (6) the risk involved; (7) the formal indicia of the arrangement; (8) the relative position of the obligees as to other creditors regarding the payment of interest and principal; (9) the voting power of the holder of the instrument; (10) the provision of a fixed rate of interest; (11) a contingency on the obligation to repay; (12) the source of the interest payments; (13) the presence or absence of a fixed maturity date; (14) a provision for redemption by the corporation; (15) a provision for redemption at the option of the holder; and (16) the timing of the advance with reference to the organization of the corporation.”).

[45] Health Care and Education Reconciliation Act of 2010, Pub. L. No. 111-152, § 1409(a), 124 Stat. 1029, 1067-68.

[46] I.R.C. § 7701(o). This section sets forth a conjunctive two-pronged test under which a transaction will be treated as having economic substance only if: (1) “the transaction changes in a meaningful way (apart from Federal income tax effects) the taxpayer’s economic position” (the objective prong) and (2) “the taxpayer has a substantial purpose (apart from Federal income tax effects) for entering into the transaction” (the subjective prong). Id.

[47] See  BORIS I. BITTKER, MARTIN J. MCMAHON & LAWRENCE A. ZELENAK, FEDERAL INCOME TAXATION OF INDIVIDUALS P 1.03[3], at 1-7 (3d ed. 2002) (“[I]t is almost impossible to distill useful generalizations from the welter of substance-over-form cases.”).

[48] See  HEATHER C. MALOY, INTERNAL REVENUE SERV., DEP’T OF THE TREASURY, LB&I-4-0711-01, GUIDANCE FOR EXAMINERS AND MANAGERS ON THE CODIFIED ECONOMIC SUBSTANCE DOCTRINE AND RELATED PENALTIES (2011) (“[I]t is likely not appropriate to raise the economic substance doctrine if the transaction being considered is related to the following circumstance[]: The choice between capitalizing a business enterprise with debt or equity....”).

[49] See, e.g., Jeremiah Coder, Will Economic Substance Codification be Worth It?, 127 TAX NOTES 16, 17 (Apr. 5, 2010) (“According to Cary D. Pugh of Skadden, Arps, Slate, Meagher & Flom LLP.... [t]axpayers and practitioners will want the IRS ‘to draw rules that are as clear as possible about the consequences of certain conduct and particular transactions’....Michael J. Desmond of Bingham McCutchen LLP agreed that key terms within the statute are ambiguous and would benefit from IRS guidance.”); Joseph DiSciullo, Guidance Sought on Codification of Economic Substance Doctrine, 128 TAX NOTES 281 (July 19, 2010); Monte A. Jackel, Dawn of a New Era: Congress Codifies Economic Substance, 127 TAX NOTES 289, 298 (Apr. 19, 2010) (“Guidance is necessary in a number of areas so that the new law can be applied with minimal disruption to taxpayers and advisers who are planning and implementing transactions. Guidance would also give the new law meaning consistent with its underlying objectives so the government’s interests are protected and enforced.”).

[50] See I.R.S. Notice 2010-62, 2010-40 I.R.B. 411, 412 (“The Treasury Department and the IRS do not intend to issue general administrative guidance regarding the types of transactions to which the economic substance doctrine either applies or does not apply.”); see also Amy S. Elliott, Practitioners Blast Economic Substance Guidance, 128 TAX NOTES 1212 (Sept. 20, 2010). However, a new directive issued on July 15, 2011 by the Service’s Large Business and International Division explains the analytical process that an examiner is expected to follow in determining whether to apply the codified economic substance doctrine.  MALOY, supra note 48. It includes lists of facts and circumstances in which the application of the doctrine likely is appropriate and not appropriate, and four situations in which examiners are not to raise the Economic Substance Doctrine.  Id.

[51] Cf. Scalia, supra note 10, at 27 (“The [Consumer Product Safety Commission], for example, must establish product safety standards by rule; but if it phrases a standard at a level of sufficient generality... then it effectively reserves the really significant decisions for the adjudicatory proceedings imposing sanctions for violation of the rule....”).

[52] The private letter ruling procedure is based on Treas. Reg. § 601.201 (1968). See also Rev. Proc. 2014-1, 2014-1 I.R.B. 1 (a yearly Revenue Procedure explaining how the Service provides advice to taxpayers through, among other things, private letter rulings).

[53] See Yehonatan Givati, Resolving Legal Uncertainty: The Unfulfilled Promise of Advance Tax Rulings, 29 VA. TAX REV. 137, 139 (2009) ( “Advance tax ruling is a procedure that allows taxpayers to achieve certainty concerning the tax consequences of a contemplated transaction. Before carrying out a transaction, the taxpayer turns to the tax authorities for a binding ruling on the tax consequences of the transaction. In light of the ruling, the taxpayer decides whether the transaction should be carried out.”); see also Donald E. Osteen et al., Obtaining Private Guidance from the Internal Revenue Service, 54 MAJOR TAX PLAN. 17-1 (2002), for an overview of the private letter tax ruling procedure.

[54] WACHTELL, LIPTON, ROSEN & KATZ, SPIN-OFF GUIDE 3 (2013).

[55] I.R.C. § 301.

[56] I.R.C . § 311(b).

[57] It must own at least eighty percent of either the total voting power or total value of the stock of the subsidiary. I.R.C. §§ 355(a)(1)(A), 368(c).

[58] That is, at least eighty percent of either the total voting power or total value of the stock of the subsidiary must be distributed. I.R.C. §§ 355(a)(1)(D), 368(c).

[59] I.R.C. § 355(a)(1)(C), (b).

[60] I.R.C. § 355(a)(1)(B); Treas. Reg. § 1.355-2(d) (1989) ( “Generally, the determination of whether a transaction was used principally as a device will be made from all of the facts and circumstances....”).

[61] Treas. Reg. § 1.355-2(b) (1989).

[62] Treas. Reg. § 601.201(a)(2). See also Rev. Proc. 2014-1, 2014-1 I.R.B. 1. An expedited private letter ruling process may be requested for a corporate spin-off private letter ruling. Id. at § 7.02(4). Some of the issues that the application of section 355 raises are included in the list of areas in which a private letter ruling will not be issued. Rev. Proc. 2011-3 § 3.01(39), 2011-1 I.R.B. 111. However, if the requested ruling addresses issues that are “significant” in the context of a section 355 distribution, the Service may issue a ruling relating to these issues. Rev. Proc. 2011-1 § 6.03, 2011-1 I.R.B. 1. A “significant” issue is an issue of law that is not essentially free from doubt or clearly and adequately addressed by any authority that will allow the taxpayer’s counsel to render an unqualified opinion on what the tax consequences of the transaction will be, and that is legally significant and germane to determining the major tax consequences of the transaction. Rev. Proc. 2011-3 § 3.01(38), 2011-1 I.R.B. 111.

[63] Rev. Proc. 96-30, 1996-1 C.B. 696 (as modified by Rev. Proc. 2003-48, 2003-2 C.B. 86).

[64] I.R.C. § 7476 (providing that the Tax Court may make a declaratory judgment with respect to the qualification of a retirement plan if the Service fails to make a determination on the plan’s qualification). During its fiscal year 2010, the Service issued 37,414 determination letters on employee pension plans. INTERNAL REVENUE SERV., DEP’T OF THE TREASURY, INTERNAL REVENUE SERVICE DATA BOOK, 2010, at 54 tbl.23 (2010) [hereinafter IRS DATA BOOK], available at http://www.irs.gov/pub/irs-soi/10databk.pdf.

[65] I.R.C. § 501(c)(3). This section includes a list of specific purposes that warrant a tax exemption (“[R]eligious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals....”). Id.

[66] I.R.C . § 170(a)(1), (c) (which includes the same list of specific purposes that warrant a tax exemption as in section 501(c)(3)).

[67] I.R.C. § 508(a); Treas. Reg. § 1.508-1(a) (2014). During its fiscal year 2010, the Service processed 59,945 requests for recognition of tax-exempt status based on section 501(c)(3) of the Internal Revenue Code (Code), of which 48,934 were approved. IRS DATA BOOK,  supra note 64, at 55 tbl.24.

[68] INTERNAL REVENUE SERV., DEP’T OF THE TREASURY, FORM 1023-APPLICATION FOR RECOGNITION OF EXEMPTION UNDER SECTION 501(C)(3) OF THE INTERNAL REVENUE CODE (2013).

[69] I.R.C. § 508(a).

[70] These may include factors such as place of affiliation with civic and religious organizations, place of bank branch one regularly uses, etc.

[71] Rev. Rul. 87-41, 1987-1 C.B. 296 (identifying 20 factors relevant to the distinction between employees and independent contractors, including factors such as: the right of one person to tell a worker when, where, and how he or she is to work; integration of the worker’s services into the business’s general operations; the requirement that services be rendered personally; set hours which the worker must work; and a worker’s direct interest in the profitability of the work accomplished).

[72] The application for recognition of tax-exempt status under section 501(c)(3), supra note 68, is twenty-six pages long and includes many factors that would be difficult to include in a simple rule.

[73] CENTRE FOR TAX POLICY AND ADMINISTRATION, ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT, COMPLIANCE MEASUREMENT - PRACTICE NOTE 4 (2001) ( “Generally, income tax laws are not clear cut, especially those applying to large corporates. There are significant areas within these laws which are uncertain or ambiguous (or grey), where taxpayers and tax administrations (and others) might have reasonable but differing interpretations of what the tax laws require.”).

[74] This is one of three sources of tax law ambiguity; the others being ambiguity concerning the precise meaning of statutory language and ambiguity concerning the type of evidence sufficient to establish necessary facts. Id.

[75] Susan B. Long & Judyth A. Swingen, An Approach to the Measurement of Tax Law Complexity, 8 J. AM. TAX’N ASS’N 22, 25, 29-31 (1987).

[76] E.g., Stanley S. Surrey, Complexity and the Internal Revenue Code: The Problem of the Management of Tax Detail, 34 LAW & CONTEMP. PROBS. 673, 697 (1969) (“The chief advantage of a detailed tax statute is that it provides certainty as to most of the matters covered by the detail.”).

[77] ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT, TAXPAYERS’ RIGHTS AND OBLIGATIONS 13 (1990) (emphasizing the importance of private letter rulings and noting that “[s]uch rulings are attractive for taxpayers since they enable them to evaluate correctly and with certainty the tax consequences of those actions.”); Mortimer M. Caplin, Taxpayer Rulings Policy of the Internal Revenue Service: A Statement of Principles, in PROCEEDINGS OF THE TWENTIETH ANNUAL INSTITUTE ON FEDERAL TAXATION 1, 1 (Henry Sellin ed., 1962) (“With complex tax laws and high tax rates, it is understandable why taxpayers frequently hesitate to move on important business transactions without some official assurance of the tax consequences.”).

[78] I.R.C. § 170(a)(1), (c).

[79] Cf. Louis Kaplow, Rules Versus Standards: An Economic Analysis, 42 DUKE L.J. 557, 577 (1992) (“[T]he greater the frequency with which a legal command will apply, the more desirable rules tend to be relative to standards. This result arises because promulgation costs are borne only once, whereas efforts to comply with and action to enforce the law may occur rarely or often.”).

[80] Cf. id. at 573 (“On one hand, a law may apply to an activity that is undertaken by many individuals: some federal income tax provisions apply to millions of individuals and billions of transactions. In such instances, rules tend to be preferable.... On the other hand, a law-or, as is often relevant, a particular component of a law, possibly a highly detailed one-may have a small likelihood of applying to any activity; consider the example of myriad unique accident scenarios. Then, standards tend to be preferable. Even if they are extremely costly to apply, the significant likelihood that the particular application will never arise may make standards much cheaper.”).

[81] That both taxpayers and tax authorities are uncertain when drawing lines is noted in Weisbach, supra note 1, at 1640 (“Between relatively fixed points, there is a continuous range of transactions, and within the range there is considerable doctrinal uncertainty.... Assuming that the end points are fixed, the difficult question for taxpayers and tax policymakers is how to deal with the transactions in the middle.”) (emphasis added).

[82]  This is a standard concern in tax law. See David M. Schizer, Frictions as a Constraint on Tax Planning, 101 COLUM. L. REV. 1312, 1315 (2001) (“[I]n recent years the government has used... narrow reforms that target specific planning strategies. Sometimes these transactional responses stop the targeted transaction. But in other cases taxpayers press on, tweaking the deal just enough to sidestep the reform. These avoidable measures cannot raise revenue or increase the tax burden on wealthy taxpayers. Instead, end runs consume resources and warp transactions, yielding social waste.”); Daniel N. Shaviro, Economic Substance, Corporate Tax Shelters, and the Compaq  Case, 88 TAX NOTES 221, 223 (July 10, 2000) (“[T]he desirability of an economic substance approach depends on two main things.... The second is the extent to which it succeeds in generating such deterrence rather than simply inducing taxpayers to jump through a few extra hoops before getting the desired tax consequences anyway.”).

[83] Diver, supra note 10, at 430 (“The singular advantage of incrementalism is its ability to accommodate uncertainty and diversity.”).

[84] Baker, supra note 10, at 661-62 (“The agency may not know enough about the particular problem to warrant issuance of rule-making.... It may, therefore, be necessary to proceed on a case-by-case basis until the necessary experience to draft an appropriate rule has been accumulated.... Such a broad rule can later be made more specific, when insight on the problem has been obtained through numerous ad hoc adjudications involving application of rule to factual situations.”).

[85] BITTKER & EUSTICE, supra note 4, P4.02[8][a], at 4-17 (quoting S. REP. NO. 83-1622, pt. 1, at 42 (1954)).

[86] Weisbach, supra note 1, at 1638 n.49.

[87] In other words, rules are prospective. I.R.C. §7805(b)(1) (prohibiting the retroactive application of internal revenue laws and regulations).

[88] Heather Bennett, Parker Debunks ‘Wall Street Rule,’ Pushes LTR Preconferences, 100 TAX NOTES 1634, 1634 (Sept. 29, 2003) (“[T]here are two accepted versions of the Wall Street Rule in the tax world: that the IRS can’t attack the tax treatment of a transaction if there is a long-standing and generally accepted understanding of its expected tax treatment, and that the IRS is deemed to have acquiesced in the tax treatment of a transaction if the dollar amount involved is of a ‘significant magnitude.”’). See also, Lee A. Sheppard, Business Revenue Raisers: Cleaning Up and Necessary Fixes, 82 TAX NOTES 760, 763 (Feb. 8, 1999) (“[T]he Wall Street rule, as enunciated by James Dahlberg of Deloitte & Touche at the January 16 meeting of the Corporate Tax Committee of the American Bar Association Section of Taxation, that the commissioner can be considered to have acquiesced in taxpayers’ chosen treatment of any security of which $ 100 billion dollars’ worth has been issued.”).

[89] I.R.S. Announcement 2002-18, 2002-1 C.B. 621 (“Consistent with prior practice, the IRS will not assert that any taxpayer has understated his federal tax liability by reason of the receipt or personal use of frequent flyer miles or other in-kind promotional benefits attributable to the taxpayer’s business or official travel.”).

[90] I.R.C. §§ 7441-7479.

[91] 28 U.S.C. § 1340 (2012).

[92] 28 U.S.C. § 1491(a)(1) (2012).

[93] Nat’l Muffler Dealers Ass’n v. United States, 440 U.S. 472 (1979).

[94] See Irving Salem et al., ABA Section of Taxation Report of the Task Force on Judicial Deference, 57 TAX LAW. 717 (2004); John F. Coverdale, Chevron ’s Reduced Domain: Judicial Review of Treasury Regulations and Revenue Rulings after Mead, 55 ADMIN. L. REV. 39 (2003); Kristin E. Hickman, The Need for Mead : Rejecting Tax Exceptionalism in Judicial Deference, 90 MINN. L. REV. 1537 (2006).

[95] Mayo Found. for Med. Educ. & Research v. United States, 562 U.S. 44 (2011).

[96] Chevron, U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837 (1984).

[97] Mayo, 131 S. Ct. at 716.

[98] Skidmore v. Swift & Co., 323 U.S. 134, 140 (1944) (“The weight [[accorded to an administrative] judgment in a particular case will depend upon the thoroughness evident in its consideration, the validity of its reasoning, its consistency with earlier and later pronouncements, and all those factors which give it power to persuade, if lacking power to control.”).

[99] United States v. Mead Corp., 533 U.S. 218 (2001).

[100] Sego v. Commissioner, 114 T.C. 604, 610 (2000) (“[W]here the validity of the underlying tax liability is properly at issue, the Court will review the matter on a de novo basis. However, where the validity of the underlying tax liability is not properly at issue, the Court will review the Commissioner’s administrative determination for abuse of discretion.”); Goza v. Commissioner, 114 T.C. 176, 181-182 (2000); SALTZMAN, supra note 37, P1.04[[4], at 1-41 (“Judicial review of the actions of agencies other than the Service is typically limited, because courts recognize (or follow explicit statutory directions) that the agency rather than the judiciary is to exercise the power or discretion Congress has delegated. Judicial review of IRS actions is far broader. Both the statutory refund and deficiency methods provide taxpayers de novo judicial review of IRS action in assessing tax or determining the amount of a deficiency.”);  see also Danshera Cords, Collection Due Process: The Scope and Nature of Judicial Review, 73 U. CIN. L. REV. 1021, 1028-1038 (2005).

[101] I.R.C. § 6212(a); SALTZMAN,  supra note 37, P 1.08[2], at 1-79 (“Determinations of deficiency in tax.... appear[] to constitute an adjudication within the meaning of the APA.”).

[102] I.R.C. § 6110(k)(3) (“[A] written determination may not be used or cited as precedent.”).

[103] Fruehauf Corp. v. IRS, 566 F.2d 574, 580 (6th Cir. 1977); Tax Analysts & Advocates v. IRS, 505 F.2d 350, 354 (D.C. Cir. 1974). See Donald E. Osteen, Lori J. Jones & Howard S. Fisher , The Private Letter Ruling Program at the Half Century Mark, 42 MAJOR TAX PLAN. 12-1, 12-11 to 12-15 (1990).

[104] LISA MARIE STARCZEWSKI, 621-2D TAX MANAGEMENT, IRS NATIONAL OFFICE PROCEDURES-RULING, CLOSING AGREEMENTS, A-43 (2002, updated through 2006) (“both taxpayers and courts have often disregarded § 6110(k)(3) in whole or in part and have given precedential value to written determinations.”).

[105] See United States v. Kaiser, 363 U.S. 299, 308 (1960) (“The Commissioner cannot tax one and not tax another without some rational basis for the difference.”); Lawrence Zelenak, Should Courts Require the Internal Revenue Service to be Consistent?, 40 TAX L. REV. 411 (1985);  see also Jason Chang et al., Private Income Tax Rulings: A Comparative Study, 10 TAX NOTES INT’L 738, 740 (Feb. 27, 1995) (“[I]n practice, private letter rulings are widely read and relied upon in tax planning.”).

[106] For Treasury regulation, the requirements of the notice and comment process have to be met. 5 U.S.C. §553 (2014). Though the Administrative Procedure Act does not require interpretive rules to undergo a notice and comment procedure, the Treasury Department does undertake these procedures when adopting such rules. SALTZMAN, supra note 37, P 3.02[2], at 3-5 to -6.

[107] Cf. Kaplow, supra note 79, at 577 (“[T]he greater the frequency with which a legal command will apply, the more desirable rules tend to be relative to standards. This result arises because promulgation costs are borne only once, whereas efforts to comply with and action to enforce the law may occur rarely or often.”).

[108] Cf. id. at 573 (“On one hand, a law may apply to an activity that is undertaken by many individuals: some federal income tax provisions apply to millions of individuals and billions of transactions. In such instances, rules tend to be preferable.... On the other hand, a law-or, as is often relevant, a particular component of a law, possibly a highly detailed one-may have a small likelihood of applying to any activity; consider the example of myriad unique accident scenarios. Then, standards tend to be preferable. Even if they are extremely costly to apply, the significant likelihood that the particular application will never arise may make standards much cheaper.”).

[109] See supra Part II.A.1.

[110] See supra Part II.A.2.

[111] See supra Part II.A.3.

[112] See supra note 103 and the related text.

[113] See supra Part II.A.4.