I previously posted a tax court opinion (here) holding that an overstatement of shareholder basis was not an omission of gross income for purposes of extending the regular three-year statute of limitations to the six-year statute of limitations. If you have access to the Journal of Accountancy, there is a good article explaining the debate here.
It seems the IRS has given up litigating (and losing); they are just going to change the law, via recent proposed and temporary regulations to there way of thinking. How can they do this you ask? "[So] long as the amended regulations are a reasonable interpretation of the statute . . . the IRS is entitled to amend its regulations in response to adverse judicial decisions." Laura Lee Mannino, Full-Time Medical Residents Not Exempt From FICA, Journal of Accountancy (Sept. 2009) (analyzing the Ninth Circuit's decision in Mayo Foundation v. United States, upholding a treasury regulation that nullified prior court decisions regarding the applicability of FICA tax to medical residents); click here for the article.
Although I do not have a good understanding of the separation of powers provision in the constitution, I would like to understand why the separation of powers provision is not implicated in this scheme. I suppose the logical response is that Congress, the Legislative Branch, has granted legislative power to the IRS, a part of the Executive Branch. And just as Congress is undoubtedly allowed to change the law in response to an adverse court decision, so to is the IRS having been given that legislative power by Congress.
In one sense, this is a very efficient scheme. It could take Congress months or even years to pass a bill to amend a portion of the internal revenue code. Passing a bill through both houses of Congress takes considerable time and cost. Through the process of proposing and codifying regulations, the law can be changed within weeks of an adverse court decision, with only the time and cost of a few people, namely those at the IRS.
On the other hand, this scheme puts significant power in the hands of just a few. However, the safeguard against the usurpation of power by a collective few is the requirement that the "regulations are a reasonable interpretation of the statute."