This issue of Best Practice focuses on two cases just decided by the US Supreme Court that will have sweeping impact on the scope and powers of federal regulatory agencies.
These decisions may be viewed as a Supreme Court whose majority felt it needed to right an imbalance among the three branches of government, and effectively reaffirm the separation of powers. These two major decisions, along with previous decisions by this court, will further curtail the powers of many administrative federal agencies.
A third decision is a tax case where the IRS imposed a tax on gains not received by the taxpayer, and is included here for its judicial innovation. The majority decision side-stepped the very reason they agreed to hear the case. Many hoped the case would bring clarity regarding the constitutionality of a wealth tax. It did not.
Supreme Court Strikes down 40-year-old Chevron
The Supreme Court has overturned a 40-year old case which gave federal administrative agencies sweeping powers to impose regulations over businesses and individuals, with the ruling now making it easier for those regulations to be challenged in a court of law instead of administrative courts.
The decision is expected to significantly curb the muscle power of federal regulatory agencies such as the SEC, Department of Labor, the EPA, and other powerful agencies, which increasingly have been criticized for overreaching their stated authority.
The question in two underlying combined cases centered on the Supreme Court’s 1984 decision in Chevron v. Natural Resources Defense Council, in which the Court ruled that where the text of a law is silent or ambiguous, courts must, unless unreasonable, defer to the regulatory agencies’ interpretation. This became known as the Chevron Deference principle. Currently, over 30 federal agencies may be affected by this ruling.
In writing for the 6-3 majority, Chief Justice Roberts said that the long standing precedent in Chevron gave federal agencies priority in interpreting laws, rather than having courts interpret the law. He added that Chevron’s presumption that statutory ambiguities are implicit delegations of authority by Congress to federal agencies “is misguided because agencies have no special competence in resolving statutory ambiguities. Courts do.”
The majority dismissed the idea that earlier cases decided by the Chevron doctrine would be invalidated, saying that today’s ruling to overturn Chevron does “not call into question prior cases that relied on the Chevron framework. The holdings of those cases that specific agency actions are lawful–including the Clean Air Act holding of Chevron itself–are still subject to statutory stare decisis despite our change in interpretive methodology.”
Justice Kagan wrote for the minority, which included Sotomayor and Jackson, saying that Chevron should be upheld because “Congress knows that it does not–in fact cannot–write perfectly complete regulatory statutes. It knows that those statutes will inevitably contain ambiguities that some other actor will have to resolve, and gaps that some other actor will have to fill. And it would usually prefer that actor to be the responsible agency, not a court.”
Chevron’s momentous overturn was sparked by two cases, one involving the tiny herring, in which fishermen challenged a rule that required commercial fishing boats to bear the cost of on-board, human federal observers to enforce fishing regulations.
The cases were Loper Bright Enterprises, Inc., v. Raimondo, and Relentless Inc. v. Dept. of Commerce from which the Supreme Court issued one opinion. The Court granted certiorari in these cases but limited it to the question of whether Chevron USA. Inc. v. Natural Resources Defense Council, Inc., 467 U. S. 837, should be overruled or clarified.
Supreme Court Limits Use of In-House Administrative Courts
The Supreme Court Thursday significantly reduced the enforcement powers of the Securities & Exchange Commission and ruled that the agency’s use of Administrative Law Judges (ALJs) to adjudicate and decide civil fraud cases is unconstitutional because it denies the defendant their Seventh Amendment right to trial by jury.
In-house administrative courts have been one of the SEC’s key tools in its enforcement of securities laws.
In the case of SEC v. Jarkesy, the Court considered whether the Seventh Amendment permits the SEC to compel a defendant to be adjudicated by the agency’s own administrative court which is presided over by an in-house ALJ, rather than before a jury in federal court. In its 6-3 decision, the Court ruled that when the SEC seeks civil penalties against a defendant for securities fraud, the Seventh Amendment entitles the defendant to a jury trial.
The case began in 2013 when hedge fund manager George Jarkesy was charged by the SEC for securities fraud and mismanagement of two hedge funds. An SEC in-house judge found Jarkesy guilty and barred him from the industry. He in turn sued the SEC, arguing that its enforcement powers and structure violated the Constitution.
Jarkesy further argued that the 2010 Dodd-Frank Act provision, which allowed the SEC to seek penalties administratively for alleged securities fraud, was unconstitutional. Jarkesy said the SEC didn’t have the right to deny him a trial by jury in a federal court. The 5th Circuit Court of Appeals agreed with Jarkesy and the SEC appealed to the Supreme Court.
Writing for the majority, Chief Justice Roberts said that “a defendant facing a fraud suit has the right to be tried by a jury of his peers before a neutral adjudicator. Rather than recognize that right, the dissent would permit Congress to concentrate the roles of prosecutor, judge and jury in the hands of the Executive Branch. That is the very opposite of the separation of powers that the Constitution demands.”
This decision extends beyond the SEC, and also will have major implications on the enforcement powers of other federal agencies with in-house judges, including the Department of Labor, National Labor Relations Board, and the EPA. Entities and individuals charged by those agencies now will be able to challenge in-house court proceedings and be heard in federal courts, with a jury.
Supreme Court coins the term “Realized but Undistributed Gains”
In this tax case the elephant in the Supreme Courtroom was the Constitutional question of whether “unrealized” gains can be taxed. Proponents of taxing both income and wealth thought this could be the door-opener.
However, while standing at the doorstep of a “wealth tax,” while emphatically declaring the narrowness of its ruling, the majority upheld the constitutionality of an IRS provision that applies to pass-through entities and imposes a one-time tax on what the majority described as “realized” but “undistributed” gains from foreign investments.
In the case of Moore v. US, plaintiffs Charles and Kathleen Moore sued over the IRS’s Sec. 965 transition tax, arguing that under the 16th Amendment, income must be realized before it can be taxed. The Moores argued that the tax, enacted in 2017 as the Mandatory
Repatriation Tax (MRT) under the Tax Cuts and Jobs Act (TCJA), was unconstitutional. It had increased their 2017 tax liability by $15,000. They paid the tax and then sued for a refund.
The tax liability stemmed from a 2005, $40,000 investment in an India-based company owned by a friend, in exchange for 11% of the company’s common shares. At the time of the investment, US taxpayers weren’t liable to pay US taxes on foreign earnings until those earnings were distributed to them. The Moores said any income made by the company was ploughed right back into the company and not received by them. They added that since they never realized income on their holdings, they were being taxed on property (their shares in a foreign company) and not income.
Under the TCJA, Sec 965 was amended to impose a one-time transition tax on untaxed foreign earnings at a rate of 8% to 15.5%. The tax applied whether or not the foreign earnings were distributed. Under this new interpretation, earnings were considered repatriated, and therefore could be taxed.
Justice Kavanaugh, who delivered the 7-2 majority opinion wrote: “So the precise and narrow question that the Court addresses today is whether Congress may attribute an entity’s realized and undistributed income to the entity’s shareholders or partners, and then tax the shareholders or partners on their portions of that income. This Court’s longstanding precedents, reflected in and reinforced by Congress’s longstanding practice, establish that the answer is yes.”
In disclaiming that the decision would green-light the constitutionality of a wealth tax, the majority said: “Our analysis today does not address the distinct issues that would be raised by (i) an attempt by Congress to tax both the entity and the shareholders or partners on the entity’s undistributed income; (ii) taxes on holdings, wealth, or net worth; or (iii) taxes on appreciation.” Justices who joined the majority included Kavanaugh, Roberts, Barrett, Alito, Sotomayor, Kagan and Jackson.
Strong dissent came from Justice Thomas, joined by Justice Gorsuch, who criticized the majority for avoiding the question that was the reason the case was originally granted a hearing: whether the 16th Amendment allows Congress to tax unrealized income. In their view, the 16th Amendment was limited to taxes on realized income.
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