The U.S. Supreme Court will hear a case that may affect whether some taxpayers get a day in court to challenge procedures the IRS uses to promulgate regulations and guidance.
Challenge to IRS Notice
IRS Notice 2016-66 classifies certain “micro-captive” transactions with captive insurance companies (subsidiaries that are created by a parent company to provide the parent with insurance) as reportable transactions. The IRS requires taxpayers and certain third parties (including “material advisors”) to maintain and submit records pertaining to reportable transactions. Failure to adhere to these IRS requirements can result in significant penalties.
In CIC Services, LLC, a material advisor to taxpayers engaging in micro-captive transactions challenged Notice 2016-66, claiming the IRS promulgated the Notice in violation of the Administrative Procedure Act (“APA”), (5 U.S.C. § 500 et seq). and the Congressional Review Act (“CRA”) (5 U.S.C. § 801 et seq), and sought to enjoin its enforcement.
Circuit Court: No Jurisdiction to Hear Challenge
The IRS claimed that the complaint was barred by the Anti-Injunction Act and the tax exception to the Declaratory Judgment Act (28 U.S.C. § 2201) (collectively, the “AIA”). These statutes divest federal district courts of jurisdiction over suits “for the purpose of restraining the assessment or collection of any tax.”
The Sixth Circuit opinion observed that the U.S. Supreme Court in Direct Marketing Association v. Brohl (135 S. Ct. 1124 (2015)) held that the Tax Injunction Act (“TIA”) did not bar the plaintiff’s suit. The TIA is similar to the AIA but addresses state taxes. The plaintiff in that case sought to enjoin the enforcement of a Colorado law that required certain retailers to maintain and submit records pertaining to sales on which the retailers did not collect state sales and use taxes.
However, the Sixth Circuit based its opinion on a D.C. Circuit case (Florida Bankers Ass’n v. U.S. Dep’t of the Treasury). The Florida Bankers court held the penalty at issue was a tax for the purposes of the AIA because of the penalty’s location within the Tax Code.
The Sixth Circuit rejected the argument that the advisor sought relief not from the penalty but from the underlying regulatory mandate.
Dissent: Dispute is over compliance requirement—not tax
The dissenting opinion found that “a suit to enjoin the enforcement of a reporting requirement is not a ‘suit for the purpose of restraining the assessment or collection of any tax.'”
The dissent noted that Florida Bankers relied on cases challenging IRS letter rulings revoking tax-exempt status, and that “challenges to IRS letter-rulings revoking tax-exempt status are inextricably linked to the assessment and collection of taxes.” The dissent found that the regulation that the advisor seeks to enjoin does not directly result in any tax liability.
The dissent contrasted the typical Anti-Injunction Act case, in which to seek judicial review, the plaintiff must pay the tax and sue for a refund, with the situation in this case, in which the plaintiff faces “threats of penalties, fines, and prosecution.”
Comment: In other words, unlike in other types of tax cases in which the taxpayer can simply pay the tax and then petition the court, in this case to be eligible to challenge the provision, the taxpayer would have to first violate the provision and then be assessed and pay the penalty. In violating the provision, the taxpayer could be subject to additional disciplinary action.
Finally, the dissent, noted that commentators have predicted the reasoning of Florida Bankers would apply to most if not all Treasury regulations and IRS guidance documents, quoting a Virginia Law Review article, that, as a consequence “many of those regulations and guidance documents will be rendered ‘effectively unreviewable.’” The Law Review article, quoted by the dissent:
- traces the history and interpretation of the AIA back to its Civil War origins.
- observes that since its adoption in the 1860s, the only amendments to the AIA have come when Congress wanted to expand the availability of judicial review and, correspondingly, to make clear Congress’s intention to limit the AIA’s reach; and
- proposes adoption of an “engagement test”–through either court decisions or Congressional action—that would limit the AIA’s scope to cases in which the IRS has initiated enforcement proceedings against a taxpayer.
Supreme Court to decide
The U.S. Supreme Court will make the final decision on whether the AIA bars the challenge to Notice 2016-66. Interestingly, and inauspiciously for taxpayers, the Florida Bankers decision was written by Brett Kavanaugh, now a U.S. Supreme Court justice.