3M case, 8th Circuit says: "Statutes trump regulations", Applies Loper Bright, and Rejects IRS Position

"Statutes trump regulations."

With those three words, Circuit Judge David Stras of the Eighth Circuit Court of Appeals advanced a new era of judicial activity in tax. In a decision that marks a significant retreat for the Internal Revenue Service, the court ruled on October 1, 2025, that the agency had overstepped its authority by attempting to tax income that a taxpayer was legally prohibited from receiving. In this case, Brazilian law prevented the actual payment, but the IRS attempted to collect on the hypothetical income that would have been collected if not for the Brazilian restriction.

The case, 3M Company v. Commissioner, is a consequential application of the Supreme Court's Loper Bright decision. It follows a growing trend seen in cases like Mukhi and Varian, where courts are increasingly refusing to defer to the IRS's interpretations of the tax code and are instead independently determining the "best reading" of the law, as required by Loper Bright.

The Brazilian Standoff

The dispute at the heart of the 3M case involved the company's Brazilian subsidiary, 3M do Brasil. Under Brazilian law, there were strict caps on the amount of royalties a subsidiary could pay to a foreign controlling parent company for the use of intellectual property. 3M followed these laws, receiving and reporting only the $5.1 million in royalties that were legally permissible under the Brazilian law.

The IRS, however, disagreed. Utilizing its reallocation authority for consolidated groups of companies under Section 482 of the Internal Revenue Code, the agency "reallocated" nearly $23.7 million in additional royalty income to 3M. The IRS argued that this amount reflected what an unrelated entity would have paid at "arm's length," regardless of what Brazilian law allowed.

The IRS's Regulatory Weapon

To support its position, the IRS relied on its own "blocked-income" regulation (26 C.F.R. § 1.482-1(h)(2)), which essentially authorized the agency to ignore foreign legal restrictions when determining true taxable income:

(h) Special rules—(1) Small taxpayer safe harbor. [Reserved]

(2) Effect of foreign legal restrictions—(i) In general. The district director will take into account the effect of a foreign legal restriction to the extent that such restriction affects the results of transactions at arm's length. Thus, a foreign legal restriction will be taken into account only to the extent that it is shown that the restriction affected an uncontrolled taxpayer under comparable circumstances for a comparable period of time. In the absence of evidence indicating the effect of the foreign legal restriction on uncontrolled taxpayers, the restriction will be taken into account only to the extent provided in paragraphs (h)(2) (iii) and (iv) of this section (Deferred income method of accounting).

The Statute: Section 482

The Eighth Circuit, however, looked past the regulation to the underlying statute. Section 482 of the Internal Revenue Code provides:

"In any case of two or more organizations, trades, or businesses... owned or controlled directly or indirectly by the same interests, the Secretary may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses. [...] In the case of any transfer (or license) of intangible property [...], the income with respect to such transfer or license shall be commensurate with the income attributable to the intangible." (Emphasis added).

The IRS argued that while the first sentence might be limited by traditional concepts of income, the second sentence—added by Congress in 1986 for "intangible property"—created a new rule. According to the IRS, any income "attributable" to intellectual property should be taxed, even if it cannot legally be paid.

A Grammar Lesson in Statutory Interpretation

Judge Stras rejected the IRS's attempt to read the second sentence in isolation. Instead, he provided what he called a "grammar lesson" to reveal the statute’s true meaning.

The analysis hinged on the unmistakable link between the first and second sentences of Section 482. The first sentence introduces the mass noun "gross income" without an article. The second sentence, which deals with intangibles, refers twice to "the income."

In English grammar, the use of the definite article "the" signals a callback to a previously mentioned noun. As Judge Stras explained:

"The grammatical implication is unmistakable: the shorthand references to 'the income' in the second sentence are a callback to 'gross income,' the only possible antecedent in the statute. Same word, same meaning, at least in the absence of some textual clue ruling it out."

Because "the income" in the second sentence refers back to "gross income" in the first, it must carry the same legal definition.

Dominion and Control

From this grammatical analysis came the court's definitive conclusion: the IRS can only "allocate" income that the taxpayer has "dominion or control" over.

Citing the Supreme Court's 1972 decision in First Security Bank of Utah, Judge Stras emphasized that "income" only includes what a taxpayer "could have received." If a taxpayer is legally prohibited from receiving funds—whether by federal law or, as in this case, foreign law—those funds are not income and cannot be reallocated by the IRS.

The court flatly rejected the IRS's argument that 3M should have bypassed the royalty cap by paying dividends instead. Judge Stras called this argument "breathtaking in its potential reach," noting that royalties and dividends are distinct legal and economic instruments. The power to declare a discretionary dividend has no bearing on the contractual obligation to pay a royalty.

Conclusion: A Shift in the Balance of Power

The implications of the 3M case for multinational corporations are profound. It provides a robust defense against IRS attempts to reallocate income that is blocked by legitimate foreign legal regimes.

More importantly, the decision confirms that the judiciary is no longer a passive observer of the IRS's regulatory agenda. By conducting its own independent statutory analysis and disregarding a regulation that conflicted with the "best reading" of the law, the Eighth Circuit has sent a clear message: statutes trump regulations.

As the 2026 tax year unfolds, the "invisible shield" of agency deference has been shattered. The 3M decision stands as a landmark confirmation that courts, not agencies, are the final arbiters of what the law means.

Full Case Document: 3M Company v. Commissioner PDF