Search Results for: the lost anti-injunction act

Review of “Restoring the Lost Anti-Injunction Act”

We welcome back guest blogger Sonya Watson who has changed her last name since the last time she posted. Sonya, a former student at Villanova who studied under both Les and me while obtaining her LLM, is back in her home town and her “home” law school of UNLV where she is an assistant professor in residence and the director of the Rosenblum Family Foundation Tax Clinic. Today she launches a new feature on PT – a review of law review articles addressing issues of tax procedure. Last year we launched a new feature on designated orders which allows us to examine the critical orders issued by the Tax Court that tend to go unnoticed. Sonya and others to be introduced soon will provide a similar regular guest feature providing insight on the latest thinking from those writing longer articles on tax procedures issues we cannot easily address in our blog posts. The first article being reviewed is co-authored by Kristin Hickman and Gerald Kerska. Kristin is a professor at University of Minnesota Law School and a prolific writer who deserves great credit for her pioneering work to push for recognition of the Administrative Procedure Act’s applicability to tax law. Gerald is a 2017 graduate of University of Minnesota Law School. We hope you enjoy their excellent article examining the history and logic of the anti-injucntion act. Keith

In “Restoring the Lost Anti-Injunction Act,” Kristin Hickman & Gerald Kerska, 103 Virginia Law Review 1683 (2017) the authors ask whether Treasury regulations and IRS guidance documents, such as IRS Revenue Rulings, should be eligible for pre-enforcement judicial review. The answer depends on how courts interpret the Anti-Injunction Act (“AIA”). The AIA prohibits tax lawsuits that would “restrain the assessment or collection of [a] tax.” A broad interpretation of the AIA, such that the AIA applies whenever the issues in a tax case even remotely relate to the assessment or collection of taxes, would tend to preclude pre-enforcement judicial review of Treasury regulations and IRS guidance documents. A narrower interpretation would allow application of the AIA only when the issues in a tax case involve the imminent assessment or collection of taxes. Hickman and Kerska argue that the AIA should be construed narrowly.

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The AIA prohibition of lawsuits that restrain the assessment or collection of taxes is not without exceptions. One familiar statutory exception is that which provides the right to file suit in the U.S. Tax Court when the IRS proposes a tax deficiency. Case law creates further exceptions to the AIA.

Some courts have interpreted the AIA so broadly that the government may invoke the AIA to preclude judicial review of just about any case that may relate to the assessment or collection of taxes, no matter how tangential the relation. For example, in the case of California v. Regan, 641 F.2d 721 (9th Cir. 1981) the Court found that the AIA precluded a lawsuit challenging an ERISA regulation that required the State of California to file annual information returns concerning its employees’ pension plan. The Court reasoned that the AIA applied because the IRS could use the information in the returns to determine whether employees qualified for favorable tax treatment, which in turn would “have an impact on the assessment of federal taxes.” Such broad interpretations contributed to the court’s finding in Florida Bankers Ass’n v. U.S. Department of the Treasury, 799 F.3d 1065 (D.C. Cir. 2015) that pre-enforcement judicial review of a set of Treasury Regulations was precluded under the AIA. However, the court in Chamber of Commerce v. IRS, No. 1:16-CV-944-LY, 2017 WL 4682049 (W.D. Tex. Sept. 29, 2017) came to the opposite conclusion, holding that the AIA does not preclude pre-enforcement judicial review of Treasury regulations. The conflicting opinions in Florida Bankers and Chamber of Commerce could lead to a split in the circuits, adding to the long history of jurisprudential inconsistency regarding the application of the AIA.

As outlined in detail in Hickman and Kerska’s article, courts have had to rely on a hodgepodge of case law to determine when the AIA applies to preclude a tax case, sometimes coming to conclusions that do not mesh well with prior precedent. In their article, Hickman and Kerska propose what appears to be workable, if not perfect, as acknowledged by Hickman and Kerska, solutions to what has thus far been an incoherent framework regarding the scope and meaning of the AIA.

Hickman and Kerska believe that a narrower interpretation of the AIA is warranted to protect taxpayers’ presumptive right to pre-enforcement judicial review of agency rules and regulations under the Administrative Procedure Act (“APA”). They argue that this is especially true in light of the IRS’ less than stellar history of complying with the APA; the historical context of the AIA itself; the jurisprudence surrounding the Tax Injunction Act (“TIA”), which Congress modeled after the AIA; and the many Treasury regulations and IRS guidance documents that relate to the IRS’ function as the middleman for social policy efforts rather than its function as tax assessor and collector.

Hickman and Kerska note that the IRS has viewed itself as the exception to the rule when it comes to the APA, emphasizing that for decades the IRS has claimed that many of its rules and regulations are outside the purview of the APA. The APA applies to regulations that carry the force of law. In the past, Treasury regulations have been labeled as either legislative or interpretative based on whether the regulations were the result of specific legislative authority (legislative) or general authority provided by I.R.C. Section 7805(a) (interpretive). Although courts have held that both legislative and interpretative regulations carry the weight of law, and are therefore subject to the APA, Hickman and Kerska assert that the IRS has continued to attempt to distinguish between legislative and interpretive regulations in attempts to sidestep the APA. Hickman and Kerska further note that even when the Treasury purports to comply with the APA, its compliance is dubious, choosing to follow some provisions of the APA and ignore others. Further, regarding IRS guidance documents such as revenue rulings, revenue procedures, and notices, the Treasury does not even purport to comply with the APA. The foregoing highlights why it is important to determine whether the AIA applies to pre-enforcement judicial review of Treasury regulations and IRS guidance documents. Allowing the government to invoke the AIA regarding Treasury regulations and IRS guidance documents may encourage the government to feel further empowered to ignore the APA.

The AIA is the result of Civil War-era tax legislation, which used significantly different procedures for the assessment and collection of tax than are used today. Hickman and Kerska examine the history of the mechanisms of assessment and collection during the Civil War to show that it was not Congress’ intent to use the AIA to prevent lawsuits that are only tangentially related to the assessment or collection of taxes.

Congress created the income tax in 1861 to help finance the Civil War. At that time, and again in 1862, it created administrative procedures for the assessment and collection of tax. The process by which taxes were assessed and collected was lengthy:

Congress tasked assistant assessors with receiving tax returns, with visiting taxpayers in their districts individually to investigate their potential liability for taxes, and, if a taxpayer either failed to file or submitted a fraudulent return, with preparing a return on the taxpayer’s behalf “according to the best information” available. Based on the returns filed and investigations performed, assistant assessors had thirty days after the statutory filing deadline to provide the assessors with alphabetized lists of taxpayers and the taxes they allegedly owed. The assessors then made the lists publicly available, advertising in county newspapers and posting in public places the time and location where taxpayers might examine the lists. These lists served as tentative assessments, informing taxpayers of their proposed tax liabilities. Taxpayers could appeal from those proposed assessments, and assessors were responsible for considering such appeals before submitting final lists of “sums payable” to their respective collection districts. Upon receiving said final lists from the assessors, collectors were charged with publishing the lists again, this time designating the listed taxes as due. People who failed to pay the taxes owed within a specified period after such publication—ten days generally, but thirty days for income taxes, for example—were assessed an additional ten percent penalty and given another ten days to comply. After that, a delinquent taxpayer’s personal or real property could be levied, “distrained” (i.e., seized), and sold.

Over time, procedures for collection and assessment of tax evolved but what remained the same, until fairly recently, was that people paid their taxes yearly and there was a period of time between when taxes were assessed and when they were collected. In contrast, today we overwhelmingly pay our taxes all throughout the year by way of withholding and estimated payments. During the Civil War-era up until World War II, there sometimes wasn’t a large and steady enough stream of revenue for the government to operate, making it vital that there be some way to prevent hinderances to the assessment or collection of taxes. This is why Congress created the AIA in 1867; to make sure the government had the funds it needed to operate. Today, for the most part, such hindrances are more the exception than the rule.

During Civil War-era tax administration when the AIA was created, because of the mechanisms of assessment and collection then in place, as described above and diagramed below, taxpayers had multiple opportunities to halt assessment or collection of taxes.

 

 

 

 

 

Taxpayers of the time frequently took advantage of these opportunities. Seeing that multiple opportunities to file a lawsuit to halt the assessment or collection of taxes were a barrier to the government’s goal of raising revenue to pay for the Civil War, Congress enacted the AIA. Given this historical context, Hickman and Kerska argue that the AIA was and is meant to prevent only a lawsuit that will imminently prevent the assessment or collection of taxes such that the government’s stream of revenue may be stopped. Therefore, they argue, the government should not be allowed to invoke the AIA in the face of just any lawsuit that is conceivably related to the assessment or collection of taxes. Further, the government certainly should not be allowed to invoke the AIA for lawsuits pertaining to pre-enforcement judicial review of Treasury regulations and IRS guidance documents given that at the time of the AIA’s enactment, taxing authorities would have been required to strictly adhere to the letter of the AIA and not allowed to adopt broad, legally substantive pronouncements that would legally bind taxpayers, as compared to taxing authorities’ power today to make rules and regulations that have the effect of law.

Recent TIA jurisprudence provides evidence for Hickman and Kerska’s assertion that the AIA should not preclude pre-enforcement judicial review of Treasury regulations and IRS guidance documents. The TIA, Tax Injunction Act, provides that federal district courts may not retain jurisdiction of tax cases regarding the assessment or collection of state taxes where the taxpayer may readily seek a remedy in a state court. Congress created the TIA, modeled after the AIA, for the purpose of protecting state revenue collection. In Direct Marketing Ass’n v. Brohl, 135 S. Ct. 1124 (2015) interpreting the TIA, the Court found that the assessment or collection of taxes were “discrete phases of the taxation process that do not include informational notices or private reports of information relevant to tax liability.” In other words, pre-enforcement judicial review of agency promulgated rules and regulations is distinct from judicial review of the assessment or collection of taxes. Hickman and Kerska argue that, given the connection between the TIA and AIA, the Court’s finding in Direct Marketing should apply when the government attempts to invoke the AIA to prevent pre-enforcement judicial review of Treasury regulations and IRS guidance documents.

The fact that many Treasury regulations and IRS guidance documents pertain to social policy considerations more so than to the assessment and collection of taxes provides another reason why Treasury regulations and IRS guidance documents should not be precluded from pre-enforcement judicial review under the AIA. Modern tax laws, Treasury regulations, and IRS guidance documents provide not only for taxation of income but also for the transfer of benefits meant to improve society as a whole and policy considerations also intended to benefit society. As Hickman and Kerska note, many Treasury regulations and IRS guidance documents concern “the environment, conservation, green energy, manufacturing, innovation, education, saving, retirement, health care, childcare, welfare, corporate governance, export promotion, charitable giving, governance of tax exempt organizations, and economic development,” which may not directly relate to the mechanisms for the assessment and collection of taxes. Such being the case, Hickman and Kerska note that

[p]arties subject to these regulations are not in the traditional position of paying more taxes with their tax return and then suing for a refund or filing a return documenting their noncompliance and opting to generate a deficiency notice. Absent pre-enforcement review, such regulations may be permanently shielded from judicial oversight, no matter how egregiously the IRS disregards APA requirements.

Hickman and Kerska propose two solutions to prevent the misuse of the AIA in the context of pre-enforcement judicial review of Treasury regulations and IRS guidance documents.

First, to ensure that the AIA is not applied to cut off lawsuits that are only tangentially related to the assessment or collection of taxes, they propose an engagement test. The engagement test would allow the AIA to apply only in cases where the IRS has initiated enforcement procedures against a particular taxpayer. Under such a test, the government could invoke the AIA only by demonstrating that it is engaged with a taxpayer regarding a potential issue or liability, which would be an easy burden for the government to meet given the paper trail it creates when pursuing an issue or liability regarding a particular taxpayer. Moreover, such a test would require taxpayers to exhaust administrative procedures prior to seeking a judicial remedy. Recognizing that courts may feel constrained in favor of prior precedents, however, Hickman and Kerska also offer a legislative fix as an alternative to the engagement test.

Hickman and Kerska provide proposed legislative language that would prevent the government from invoking the AIA in cases involving pre-enforcement judicial review of Treasury regulations and IRS documents:

Notwithstanding section 7421(a), not later than 60 days after the promulgation of a rule or regulation under authority granted by this title, any person adversely affected or aggrieved by such rule or regulation may file a petition for judicial review of such regulation with the United States Court of Appeals for the District of Columbia or for the circuit in which such person resides or has their principal place of business.

Jurisprudence providing exceptions to the AIA may leave taxpayers, practitioners, and judges alike befuddled when it comes to deciding when the AIA applies to prevent any tax case from going forward. Adding the question of when the AIA should apply to prevent a tax case from going forward for the purpose of determining whether pre-enforcement judicial review of Treasury regulations or IRS guidance documents further confuses the issue. Hickman and Kerska’s article provides considerable food for thought on how to determine the proper application of the AIA.

 

 

Trying to Find Order in the Anti-Injunction Act and the Tax Injunction Act

We welcome back Marilyn Ames who has blogged for us several times in the past.  She graciously agreed to write about some recent litigation that highlights the confusion currently surrounding these provisions.  Keith

In the past few weeks, I have been revising the subchapter in Saltzman and Book, IRS Tax Practice and Procedure on the Anti-Injunction Act.  It has been an exercise in frustration, as, although the Supreme Court says it likes “rule[s] favoring clear boundaries in the interpretation of jurisdiction statutes,” it doesn’t necessary mean what it says.  That’s a quote from Direct Marketing Association v. Brohl, 135 S. Ct. 1124, 1131 (2015), discussing the lesser known sibling of the AIA, the Tax Injunction Act, which is aimed at preventing federal courts from hearing suits intended to restrain the assessment, levy, and collection of state taxes.  And in the midst of this attempt to make some sort of order out of something which does not have any, two district courts have added their opinions to the fray.

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In State of New York, et al. v. Mnuchin, which can be found here, the Southern District of New York takes on the issue of whether the Anti-Injunction Act prevents four states from bringing suit to litigate the constitutionality of the $10,000 ceiling placed on the deduction of state and local taxes (SALT) by the 2017 Tax Cuts and Jobs Act. The federal government raised three challenges to the Court’s subject matter jurisdiction, including the limitation imposed by the Anti-Injunction Act (AIA). The AIA, located at 26 USC § 7421(a) provides, with numerous exceptions, that “no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person, whether or not such person is the person against whom such tax was assessed.”  (For those of you interested in historical/legal trivia, the initial iteration of the AIA was passed in 1867.) In addition to the exceptions to the AIA actually contained in the statute, the Supreme Court created a judicial exception to the AIA in Enochs v. Williams Packing & Navigation Co.,370 U.S. 1 (1962), requiring the plaintiff to meet a two-part test to overcome the bar of the AIA: (1) it is clear at the time the suit is filed that under no circumstances could the government prevail on the merits; and (2) the action at issue will cause the plaintiff irreparable injury. And with this opinion, the race began to explore the boundaries of this court-made exception. 

One of these cases, and the one relied on by the court in State of New York v. Mnuchin, is South Carolina v. Regan,465 US 367 (1984).  In Regan, South Carolina invoked the Supreme Court’s original jurisdiction and asked leave to file a complaint against Donald Regan, the Secretary of the Treasury at the time to litigate whether a provision of TEFRA was unconstitutional. The provision in question required state obligations to be issued in registered rather than bearer form in order to qualify as tax exempt under IRC § 103.  The government raised the AIA in its objection to South Carolina’s motion, arguing that the state did not fall within any of the specific exceptions or within the judicial exception created in Williams Packing.  The Supreme Court then created an exception to its exception, holding that the AIA was not intended to bar a suit when Congress has not provided the plaintiff with an alternative legal way to challenge the validity of a tax.  Because South Carolina was not liable for a tax which it could then pay and use as the basis for a refund suit, it had no other way to litigate the constitutionality of the TEFRA provision.  In this situation, the Supreme Court said “a careful reading of Williams Packing and its progeny supports our conclusion that the [AIA] was not intended to apply in the absence of such a remedy.”

In State of New York v. Mnuchin, four states that impose lots of state and local taxes sued to have the $10,000 ceiling on the deduction of SALT declared unconstitutional.  The federal government argued that the suit was barred by the AIA and that the Williams Packing exception did not apply.  This is not like South Carolina v. Regan, the federal government argued, because the taxpayers affected in these four states have a motivation to file refund actions to challenge the law.  (It’s not clear from the opinion why the federal government felt that the bond holders in Regan who bought bonds that no longer qualified as tax exempt would not have a similar motivation.) The district court rejected the federal government’s argument, and noted that in both Regan and the suit before the court, the plaintiff-states were seeking to protect their own interests, rather than those of their taxpayers. In this situation, the court in State of New York v. Mnuchin held, a state has no other legal remedy to assert its sovereign interests. When a plaintiff has no other legal remedy to litigate the issue, then the AIA does not apply even if the plaintiff cannot meet the Williams Packing test.  Having won the jurisdictional battle, the states in New York v. Mnuchin then lost the war when the district court held that the ceiling on SALT deductions is constitutional.  Lots for everyone to argue about on appeal.

The second opinion of American Trucking Associations, Inc. v. Alviti, 377 F.Supp.3d 125 (D.R.I. 2019)involves the Tax Injunction Act, 28 USC § 1341, which provides “the district courts shall not enjoin, suspend or restrain the assessment, levy or collection of any tax under State law where a plain, speedy and efficient remedy may be had in the courts of such State.” As the Supreme Court recognized in Williams Packing, the TIA “throws light on the proper construction to be given” to the AIA.  In other words, these statutes have similar language and purpose. In the Alviti case, which can be found here, the plaintiffs are long distance trucking companies and associations that filed suit against the state of Rhode Island challenging the constitutionality of a bridge toll scheme.  The statute, known as the “Rhodeworks” Act, expressly prohibits the imposition of the bridge toll on any vehicles other than large commercial trucks. Under the Rhodeworks Act, the toll is set by state agencies in terms of the amount and the locations where it will be collected, and the funds go into a special account to be used only for the replacement, rehabilitation, and maintenance of bridges. The scheme instituted sets maximum daily amounts that can be collected based on the routes traveled, which the plaintiffs argue falls more heavily on trucks involved in interstate rather than intrastate travel.

The state of Rhode Island raised the TIA as a defense to the suit, arguing that although the fees were labelled as tolls, they were actually taxes subject to the TIA.  Although the Supreme Court has indicated it prefers clear boundaries, the district court framed the issue as one “which pits the actual language of the TIA and the context surrounding its enactment in the 1930s against several more modern decisions of the First Circuit that attempt to distinguish between fees and taxes.” In other words, let’s make this more confusing. The district court then cited a number of cases decided prior to enactment of the TIA, including one decided by the Supreme Court in 1887, that a toll is not a tax and that they are distinct and serve different purposes. Despite these decisions, the court then discussed whether the exaction in question fell within the three-pronged test of San Juan Cellular Telephone Co. v. Pub. Serv. Comm’n of P.R., 967 F.2d 683 (1st Cir. 1992), the purpose of which is to decide if a challenged assessment is more like a tax or a regulatory fee.  Despite finding that two of the three prongs were more in the nature of a fee, the court relied on the final prong of the test to decide the bridge tolls were actually taxes, and the suit was thus barred by the TIA. The case has been appealed to the First Circuit, and as the trucking company plaintiffs note in the brief to the circuit, this is the first case involving an exaction labelled a toll that has been found to be a tax.

It seems that while the mirage of clear boundaries for the AIA and the TIA is out there, the courts have difficulties in making their way to it.  I am reminded of a scene from Monty Python and the Holy Grail – “Bring me a shrubbery.” “Not THAT shrubbery.”

And we go on trying to make sense of what the courts really want.

In CIC Sixth Circuit Sides With IRS in Major Anti Injunction Act Case

Earlier this summer there were two major circuit court opinions examining the validity of guidance. First, there was Altera v. Commissioner, where the Ninth Circuit again reversed the Tax Court and upheld the validity of regulations under Section 482. The second opinion is CIC Services v IRS. That case generated a little less fanfare than Altera, but it is significant and it highlights fundamental differences in the interpretation of the Anti Injunction Act (AIA). In CIC, the Sixth Circuit found that the AIA barred an APA challenge to an IRS notice that required the reporting of micro captive insurance companies as transactions of interest under Section 6011.

In this post I will discuss the CIC case. We may return to Altera – that case in its multiple permutations remains the most blogged about case on PT; in my read the recent Altera opinion follows the approach of the prior panel, with the majority and dissents authored by the same judges. Jack Townsend’s overview and comments are worth reading, here.

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The AIA is codified at IRC § 7421(a). It provides that “no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person.” While the language is straightforward, recent opinions have struggled to apply its reach, especially in the context of challenges to information reporting requirements backstopped by the possible imposition of penalties.

CIC is a case we discussed previously when a district court in Tennessee dismissed the suit. CIC, a manager of captives, and an individual who also managed captives and provides tax advice to them, sued claiming in part that the Notice imposed substantial costs and that the IRS in the Notice effectively promulgated legislative rules without complying with the APA’s mandatory notice and comment requirements. The plaintiffs sought an injunction prohibiting the IRS from enforcing the Notice and a declaratory judgment claiming that the notice was invalid.

The district court and now the Sixth Circuit held that the AIA prohibited the suit. The AIA landscape when considering challenges to reporting requirements is somewhat in flux as a result of the Supreme Court’s discussion of the related Tax Injunction Act (TIA) in the Direct Marketing case from a few years ago. As you may recall, Direct Marketing involved a Colorado law that required out-of-state retailers to provide the state with information reports on their sales to residents of the state. In Direct Marketing, the Supreme Court held that the requirements were not sufficiently connected with the collection or assessment of tax for the challenge to be barred by the Tax Injunction Act, legislation that is similar to though slightly different from the AIA in that it imposes restrictions on cases involving taxes imposed by the states rather than the federal government.

Shortly after Direct Marketing, in Florida Bankers the DC Circuit (in an opinion by then Judge Kavanaugh) held that the AIA prevented bankers from challenging heightened reporting requirements when the failure to comply would lead to civil tax penalties under Subchapter 68B of the Code. In Florida Bankers the DC Circuit, relying in large part on the ACA case Nat’l Fed’n of Indep. Bus. v. Sebelius, held that the civil penalty for violating the reporting requirements was a tax and thus subject to the AIA’s reach.

Not surprisingly the plaintiffs in CIC attempted to situate the case within Direct Marketing and focused their arguments on the challenge to the IRS’s implicit regulatory regime rather than a challenge to the assessment or collection of any tax.

The Sixth Circuit in CIC disagreed, and adopted the Florida Bankers rationale in finding that the AIA prevented the suit challenging the IRS Notice. In so doing it focused on the consequences to failing to comply with the reporting requirements; that is, the civil penalties for failing to compile and maintain records relating to reportable transactions:

Plaintiff argues that the “information gathering” and “records maintenance” requirements of the Notice are focused on the act of reporting to the taxing authority information used to determine tax liability, not the discrete, subsequent acts of assessment or collection of that liability. This argument misses the mark.

While it is true that information reporting is a separate step in the taxation process that occurs before assessment or collection, see Direct Marketing, 135 S. Ct. at 1130, Plaintiff’s argument presupposes that the relevant taxes in this AIA analysis are the third-party taxes the collection of which the Notice is designed to facilitate. As previously discussed, that is incorrect. Like the challenged regulation in Florida Bankers, the Notice is indeed “two or three steps removed” from any third-party taxes. 799 F.3d at 1069. But once it is established that the relevant tax is the penalty imposed for violation of the Notice’s requirements, it becomes clear that Plaintiff’s suit is focused on that tax’s assessment or collection. Plaintiff’s suit seeks to invalidate the Notice, which is the entire basis for that tax. If successful, Plaintiff’s suit would “restrain (indeed eliminate)” it. Id. at 1067.

After finding that the matter was covered by the AIA, the majority opinion concluded that the narrow “no alternative remedy” exception to the AIA  did not apply because there was the opportunity to challenge the notice by failing to comply with its requirements, paying the associated penalties and then pursuing a refund suit.

Conclusion

The majority opinion (as does the dissent) extensively cites the Hickman and Kerska article Restoring the Lost Anti-Injunction Act, 103 Va. L. Rev. 1683, 1686 (2017), an article PT has reviewed and I discussed earlier this year. In the opinion’s conclusion, there is an explicit acknowledgement (in part based on that article and related scholarship) that there may be legitimate grievances associated with limits on challenging the IRS’s purported failure to comply with the APA.  As I said earlier this year in PT and in an upcoming article in Temple Law Review, perhaps it is time for a fresh legislative look at ways taxpayers can challenge IRS guidance – an idea that I adopt from a 2017 article from Professor Stephanie Hunter McMahon (blogged by PT here), also cited by the dissent (as is Pat Smith, who has written about these issues for PT too).

One final point. This brief blog post does not dive deeply into the argument that Florida Bankers is wrongly decided. The dissent believes that to be the case.

In Florida Bankers, a divided panel of the D.C. Circuit held that the Anti-Injunction Act barred a similar suit challenging the legality of a reporting requirement that the IRS enforced with a tax. See 799 F.3d at 1072. That is because, the court reasoned, the tax is “imposed as a direct consequence of violating the regulation,” and so “[i]nvalidating the regulation would directly bar collection of that tax.” Id. at 1069. For the D.C. Circuit majority, this distinguished the case from Direct Marketing because “the tax . . . is not two or three steps removed from the regulation in question.” Id. In other words, there was no attenuation between the assessment and collection of the tax, on the one hand, and invalidating the regulation on the other.

That misses the mark. Enjoining a reporting requirement enforced by a tax does not necessarily bar the assessment or collection of that tax. That is because the tax does not result from the requirement per se. The only way for the IRS to assess and collect the tax is for a party to violate the requirement. So enjoining the requirement only stops the assessment and collection of the tax in the sense that a party cannot first violate the requirement and then become liable for the tax. Surely, this is the kind of attenuated relationship between “restrain,” “assessment,” and “collection” that Direct Marketing rejected.

Underlying the dissent’s different take on the reach of the AIA is its practical concern for the consequences of the majority’s approach, including the difficult position people find themselves in if they believe that the guidance that the IRS issues is either procedurally or substantively improper:

Under the majority’s decision, CIC now only has two options: (1) acquiesce to a potentially unlawful reporting requirement that will cost it significant money and reputational harm or (2) flout the requirement, i.e., “break the law,” to the tune of $50,000 in penalties for each transaction it fails to report. See 26. U.S.C. § 6707(a)–(b). Only if it (or someone else) follows the latter path—and only when (or if) the Government comes to collect the penalty—will any court be able to pass judgment on the legality of the regulatory action.

The dissent goes on to note that there are possible criminal sanctions under 7203 for willfully failing to keep the records that the Notice required:

In other words, the only lawful means a person has of challenging the reporting requirement here is to violate the law and risk financial ruin and criminal prosecution. That is probably enough to test the intestinal fortitude of anyone. And it leaves CIC in precisely the bind that pre-enforcement judicial review was meant to avoid.

I strongly suspect we will see more circuit opinions and perhaps the Supreme Court weigh in on whether it is possible to reconcile Direct Marketing and the DC Circuit’s approach. For more on these issues and the tension between Direct Marketing and Florida Bankers, including a detailed discussion of how the term “restrain” may differ in the context of the TIA and AIA (including an analysis of the Tenth Circuit’s approach to the issue in the 2017 decision Green Solution Retail which like CIC emphasized the differences between the TIA and the AIA), see the most recent update to IRS Practice and Procedure at ¶ ¶ 1.06[2] Restraining the Assessment or Collection of Tax: The Necessary Nexus to Assessment or Collection.

Is It Time To Reconsider When IRS Guidance Is Subject to Court Review?

I have been working on an essay that looks at the possible way that Congress could breathe more life into the 2015 codification of the taxpayer bill of rights. My essay Giving Taxpayer Rights a Seat at the Table, which is in draft form and up on SSRN, makes a relatively simple claim: before IRS issues guidance it should be statutorily required to consider whether in its view the guidance is consistent with the taxpayer rights that the IRS adopted in 2014 and that Congress codified in 2015. In making my claim, I acknowledge the limits of the current statutory taxpayer rights framework, which arguably provides no direct way to hold the IRS accountable for actions that violate taxpayer rights unless the right relates to a separate specific cause of action for its violation.*

In researching my article on taxpayer rights, I came back to a stubborn problem with the IRS guidance process and for taxpayers and third parties who believe that the IRS guidance violates a procedural requirement under the Administrative Procedure Act:  there are at times insurmountable obstacles to challenging IRS guidance for procedural adequacy. That problem has led me to think about some interesting and important articles that have addressed this issue in the past few years.

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In the tax world, unlike other areas of federal law, statutes like the Anti-Injunction Act and the Declaratory Judgment Act, have proven formidable barriers to test the adequacy of IRS fidelity to for example the notice and comment requirements under the APA until well after the rule has been in place. In other words, a taxpayer or third party often has to wait for a refund or deficiency case (i.e., an enforcement proceeding) to argue that there was a procedural infirmity that would result in the court’s possibly invalidating the regulation or possibly subregulatory guidance.

This has contributed to some calling for a careful look at the Anti-Injunction Act, with Professor Kristin Hickman and her co-author Gerald Kerska arguing in Restoring the Lost Anti-Injunction Act in the Virginia Law Review (reviewed here by Sonya Watson) that history supports a reading of the AIA that would generally allow pre-enforcement challenges to IRS guidance. The article takes as a starting point that IRS has not always been faithful to APA requirements and not every possible challenge neatly fits into an enforcement proceeding. On top of that, as Professor Hickman has highlighted in prior work as well, it is questionable that there would be an adequate remedy in certain instances even if a court were to find a procedural infirmity in the context of a challenge that arises in a deficiency or refund case.

Despite my sympathy with a reading of current law that would allow for greater pre-enforcement challenges, there are strong legal and policy arguments against courts on their own extending the circumstances when there will be challenges to the procedural adequacy of IRS guidance. For example, expanding the opportunity for procedural challenges will naturally soak precious agency resources.  As Professor Daniel Hemel, in The Living Anti-Injunction Act in the Virginia Law Review online edition argues in an essay responding to Hickman and Kerska’s article, it would be best institutionally for Congress rather than the courts to open the door to pre-enforcement challenges.

Professor Stephanie Hunter McMahon in a 2017 Washington Law Review article Pre-Enforcement Litigation Needed for Taxing Procedures also takes up the subject of challenging IRS guidance. In her article, she sizes up the current landscape:

While Congress only permits procedural challenges late in the tax collection process, this offers little to most taxpayers. The delay in litigating procedural complaints reduces what is challenged and affects taxpayer behavior throughout the period from its promulgation until someone, eventually, challenges the procedures. In the process, delayed litigation requires that taxpayers plan their affairs under the spectre of guidance that might not survive a procedural challenge. Moreover, in deciding whether to follow the tax guidance, taxpayers must not only assess its substance but also the procedures used to create it under procedural requirements that are not consistently interpreted by the courts.

Professor Hunter McMahon drills deeper on the disincentives associated with challenging tax guidance in enforcement proceedings:

Disincentives are increased because, unlike in other areas of law that permit pre-enforcement litigation, people are not suing in post- enforcement tax litigation simply to perfect the agency’s procedures. Instead, they are suing over their own tax obligations. The personal nature of the result and that the costs are already imposed likely changes the way people perceive the litigation. With pre-enforcement litigation, a judge remanding a case to the agency to correct the procedures would be a victory. In a tax refund or deficiency case, remand is insufficient to accomplish the goal of reducing the taxes owed. If courts are likely to remand procedural matters without vacating the rule, the taxpayer has little incentive to challenge the rules because the personal outcome remains the same.

These issues are even more pernicious when the rules in question relate to lower income or marginalized taxpayers, who are less likely to be able to get to court and as Professor Hunter McMahon aptly points out may not have the means or resources to influence the guidance process in the first instance. (That latter point is indirectly highlighted by the draft article “Beyond Notice-and-Comment: The Making of the § 199A Regulations” by Shu-Yi Oei and Leigh Osofsky that Keith discussed recently).

Professor Hunter McMahon proposes a legislative fix. That fix would be to allow an amendment to the Anti-Injunction and Declaratory Judgment Act to allow for a limited time period challenges to the procedural adequacy of the guidance:

[T]his proposal would permit pre- enforcement litigation of procedural requirements and a judicial evaluation of whether the process used, including the clarity of the statement and the comment period, suffices for APA purposes.

As Professor Hunter McMahon notes, the benefit of allowing a limited time to challenge to procedural adequacy is that it could focus attention on procedural issues early in the life of the guidance, which would allow for consistency in application of the substantive rules. A second part of Professor Hunter McMahon’s legislative fix is for Congress to delineate more specifically which forms of guidance are required to go through notice and comment—she focuses on guidance that is intended to change taxpayer behavior rather than define prior action as the candidate for a default requirement to go through the notice and comment process.

Conclusion

I believe that Professor Hunter McMahon’s approach merits serious consideration. I am reflecting further on my proposal about ways to give the taxpayer rights provisions more teeth -my proposal relies heavily on the Taxpayer Advocate Service and enhancing its institutional role in the guidance process, including giving the National Taxpayer Advocate specific authority to comment on regulations (something that the NTA herself as recommended in both Purple Books that accompanied the last two annual reports). As Congress signals a further willingness to take on IRS reform issues, I believe that it should directly address the current reach of the Anti-Injunction Act and the issue of when and to what extent taxpayers and third parties should be able to test the adequacy of IRS guidance conforming to APA requirements.

As part of this approach I am intrigued by the possibility of tying in the IRS’s fidelity to taxpayer rights principles in the rulemaking process. I would be grateful for comments on my draft article or reactions to any of the issues raised in this post.

*An example of how a taxpayer right relates to a specific cause of action is taxpayer right number 7, the right to privacy, and Section 7213, which authorizes a suit for unauthorized disclosure of a taxpayer’s any tax return or return information. An example of a taxpayer right that does not so relate to a cause of action is right number 5, the right to appeal an IRS decision in an independent forum, which as we discussed last year in connection with the Facebook case does not seem to carry with it a direct way to challenge IRS action that arguably conflicts with that right.

 

 

Review of Stephanie Hunter McMahon’s “The Perfect Process is the Enemy of the Good: Tax’s Exceptional Regulatory Process”

We welcome guest blogger Sonya Watson who teaches at UNLV law school where she is an assistant professor in residence and the director of the Rosenblum Family Foundation Tax Clinic. In the last few weeks, with decisions in Altera and Good Fortune, we have seen major circuit courts of appeal opinions considering whether Treasury’s regulations withstand challenge. Professor Watson returns to provide us with another review of a tax procedure article that directly considers the relationship of Tax regulations and broader administrative law concepts. Keith

Earlier this year I reviewed Professor Kristin Hickman’s article, “Restoring the Lost Anti-Injunction Act,” in which she argued that that a narrow interpretation of the Anti-Injunction Act (“AIA”) is warranted to protect taxpayers’ presumptive right to pre-enforcement judicial review of agency rules and regulations under the Administrative Procedure Act (“APA”).  While the AIA prevents pre-enforcement review of tax laws, the APA allows pre-enforcement review. Hickman argues that it is especially important that taxpayers are able to invoke the APA and hold the IRS to the APA’s standards because of Treasury’s and IRS’ belief than in many instances, the APA does not apply to them. Today I review Professor Stephanie McMahon’s “The Perfect Process is the Enemy of the Good: Tax’s Exceptional Regulatory Process” in which McMahon plays devil’s advocate. McMahon argues that tax is exceptional and as such, Treasury and IRS shouldn’t be bound to the letter of the APA. Rather, Treasury and IRS should follow the spirit of the APA. She argues that this is especially true considering that the APA is not without flaws and that other agencies may not properly adhere to the APA either.

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Because the procedures set out in the APA don’t always accomplish the APA’s goals, rather than focusing on whether agencies strictly adhere to the procedures set out in the APA, we should focus on whether the procedures that the agency does employ are in line with the goals underlying the procedures provided in the APA. The goals underlying the APA’s procedures include: the promotion of public deliberation; reasoned agency decision-making with few errors; and agency accountability to the public and Congress. McMahon argues strict adherence to the APA can thwart accomplishment of these goals. In particular, she takes issue with the APA’s notice and comment process.

The notice and comment process, along with the hard look doctrine, which requires agencies to “consider all comments and to explain why it was not persuaded by all but frivolous comments,” may cause agencies to delay or defer issuing guidance because doing so is too burdensome in terms of resources. Producing guidance costs money:

When not excepted from notice and comment procedures, agencies face significant costs associated with compliance. Although it is impossible to calculate all of the costs of rulemaking because data is unavailable or immeasurable, Professor David Franklin notes, “Congress, the President, and the courts have all taken steps that have made the notice-and-comment rulemaking process increasingly cumbersome and unwieldy. Even critics of tax exceptionalism note that the “procedures are quite burdensome.” Many federal agencies have responded by foregoing notice and comment and issuing interpretative tools, policy statements, and informal guidance. “[B]usy staffs, tight budgets, and a variety of competing priorities” may affect how agencies weight the choice of rulemaking tools.

Further, there is always the risk that that courts may invalidate a rule to which Treasury and IRS have devoted its scare resources.

Aside from being a drain on resources, the notice and comment process creates the potential for agency capture. Agency capture occurs when an interested party influences an agency by dominating it “in ways that are detrimental to the public purpose for which it was created.” There are several ways to capture an agency, one of which is with information. In the context of the IRS, the notice and comment process may lead to information capture if an interested taxpayer inundates the IRS with large amounts of information—evidence and arguments pertaining to a rule—which then may have the effect of drowning out other voices or overcomplicating the issues, making it more difficult for less sophisticated taxpayers to participate. Because the APA’s notice and comment process does not provide a way to effectively filter information so that agencies aren’t overwhelmed by the information received, the process may not achieve its goal of increased public participation in rulemaking. Further, the notice and comment process may be unnecessary considering that “[i]nformal meetings, roundtables, speeches and leaks, advisory committees, and negotiated rulemaking are ways to really get information from the public.”

To the extent that Treasury can promote the goals underlying the APA without following the APA, McMahon believes it makes sense for Treasury to do so. To this end she states that Treasury is justified in availing itself of the good cause exemption to the APA. The good cause exemption allows agencies to issue binding guidance without notice and comment by explaining why notice and comment would be “impracticable, unnecessary, or contrary to the public interest.” Regarding Treasury’s use of the good cause exemption, McMahon writes:

Good arguments can be made for the good cause exemption to apply widely in the tax context. Currently tax provisions are tied to the federal government’s budget and there are restrictions on both deficit spending and the national debt. As a part of the federal fiscal planning, tax provisions are almost always estimated to have immediate effect, and that estimation is necessary in order to accomplish other goals of federal budgeting. In other words, if tax provisions were given delayed effective dates to permit time for notice and comment, this delay would alter the cost calculation of the federal budget.

The foregoing is in addition to the consideration that taxpayers and tax practitioners need Treasury to create guidance quickly in order to be able to better ensure compliance with the ever evolving tax laws.

Courts’ deference to agency rules is another important consideration in the debate over whether Treasury should be required to adhere to the APA. The more likely it is that courts will defer to an agency, the more important it is to make sure that the agency follows proper procedure in creating a rule. Final, legislative regulations enjoy significant deference but interpretative, proposed and, temporary regulations, as well as other types of guidance (revenue rulings, etc.) may enjoy less deference. This is because although agencies theoretically have broad discretion under Chevron, courts often apply tax-specific standards when deciding the extent to which they should defer to tax guidance, making deference harder to secure in the tax arena. Therefore, the idea that courts’ deference to agency rules make it vitally important that agencies follow proper procedure should be tempered with the knowledge that courts often don’t defer to agencies and that this is especially true in the case of Treasury and IRS.

Finally, adherence to the APA might inhibit the use of heuristics. The notice and comment process is meant to provide a means for an agency to receive information it should consider when creating guidance. However, it is unlikely that an agency will receive information regarding all the considerations it should make in creating guidance. So rather than relying on the notice and comment process to receive the information it needs to create good guidance, Treasury should create and rely on heuristics whenever possible. Heuristics are rules of thumb that aid decision making. Using heuristics in the administration of the Internal Revenue Code would allow non-experts to participate by giving them rules that are easier to apply. It also allows Treasury to keep up with changes in the law—because the Code continuously evolves, it is impossible to create guidance that will cover all possible scenarios. Heuristics don’t provide the specificity that regulations do, so using heuristics helps ensure compliance by those who might otherwise plan around the rules. Anyway, taxpayers and practitioners already use heuristics to understand and apply the code:

Developed through common law and now incorporated into practice by the IRS, tax lawyers know that gross income is interpreted broadly while deductions are construed narrowly as a matter of legislative grace, income is to be taxed to earners, substance prevails over form, and (although possibly threatened by codification) transactions need economic substance. These ideas, among others, guide the practice of law and the choices taxpayers make when they report the tax consequences of their activities. Without such guideposts, every new tax provision must be fully and singularly explicated, and any ambiguity litigated from scratch.

McMahon does acknowledge, however, that more detailed guidance may be necessary when heuristics are insufficient.

 

 

Unsuccessful Constitutional Challenges to the Collection Treaty Provision in the Tax Treaty between Canada and the United States

This summer I visited Canada twice, Montreal and Toronto. Canada and the United States have long seemed like best friends. I wondered if I would be treated any differently now that our government policies do not seem to treat Canada as our best friend. Happy to report the Canadians remain as friendly as ever on the personal level. They do, however, want to collect the taxes due to them and that results in the case of Retfalvi v. United States, No. 5:17-cv-00468 (E.D.N.C. Aug., 15, 2018).

I have written before about the collection language that exists in two of the five tax treaties that have this special language, France and Denmark. Canada, along with the Netherlands and Sweden, is one of the other three countries that have the collection provision in their tax treaty with the United States. The Canadians invoked the treaty to ask the Unites States, specifically the IRS, to collect some unpaid Canadian taxes from an individual who at one point was a Canadian citizen but who had become a citizen of the United States. The taxpayer raised a number of constitutional arguments regarding the treaty to collect taxes. Most individuals raising constitutional arguments bring the phrase ‘tax protestor’ to mind but these were legitimate and well-argued constitutional arguments. In the end, the taxpayer lost but we gain insight regarding the constitutional underpinnings of the collection treaty provisions.

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Mr. Retfalvi moved from Hungary to Canada and became a citizen in 1993. He later moved to the United States and obtained permanent resident status in 2005 followed by citizenship in 2010. In 2006 he sold a pair of condominiums he had purchased earlier in Vancouver before he knew he was moving to the United States. He and his wife reported the sales on their Canadian tax returns; however, the returns were selected for audit. The audit resulted in a proposed increase in tax of over $100,000. He did not petition the Canadian Tax Court to fight the assessment of this additional tax. After the assessment became final, Canada invoked the treaty to secure the assistance of the IRS in collecting the taxes.

As the treaty requires, the IRS sprang into action. In November of 2015 it sent to Mr. Retfalvi a “Final Notice – Notice of Intent to Levy” giving him a chance to pay the liability before the IRS took administrative collection action against him. He objected to the notice of intent to levy and let the IRS know that he did not owe the tax. The IRS let him know that he had no ability to contest the tax in the United States. He filed a Form 12153 seeking a Collection Due Process (CDP) or equivalent hearing. The IRS let him know that he could not use the CDP process but could seek a CAP appeal. The IRS subsequently denied his CAP appeal because he tried to use the CAP process to challenge the underlying liability.

After failing to obtain a CDP hearing and losing the CAP appeal, Mr. Retfalvi filed suit in the United States District Court for the Eastern District of North Carolina seeking declaratory and injunctive relief from the collection action. The IRS moved to dismiss for lack of subject matter jurisdiction and failure to state a claim. The court dismissed the case citing the anti-injunction statute. Mr. Retfalvi then paid the tax and filed a suit for refund. The IRS rejected his claim for refund and he filed this suit because of alleged constitutional infirmities with the collection treaty provisions. He cited to nine specific constitutional problems with the treaty:

  • Article 26A [the collection provision of the treaty] violates the Origination Clause because it is a bill to raise revenue that did not originate in the House of Representatives:
  • Article 26A is invalid because it is not self-executing;
  • Article 26A violates the Taxing Clause because Congress has the exclusive authority to lay and collect taxes;
  • Article 26A violates the Taxing Clause because Congress cannot use its taxing power to levy or collect taxes of a foreign country;
  • Article 26A violates the Taxing Clause because it purports to amend the Internal Revenue Code;
  • The IRS is not authorized to assess and collect taxes imposed by Canadian laws;
  • Article 26A denies taxpayers due process;
  • Article 26A denies taxpayer equal protection of the law that is available to taxpayers who have had taxes assessed under the Internal Revenue Code; and
  • Article 26A creates an impermissible sub-classification of United States taxpayers.

The court addressed each of the nine alleged grounds for striking the treaty provision. It found as to each that a basis existed for the provision to be deemed constitutional. As a result, it struck his refund suit. I do not know if he has the ability to bring a refund suit in Canada but that is where he must go next if he wants the return of his money.

I am not going to go through each of the separate reasons that the court found the treaty provision constitutional but anyone with an interest in treaties and in constitutional law may find the opinion interesting. It provides a fair amount of detail with respect to each of the claimed bases for unconstitutionality including case citations and, in some instances, analysis of the treaty language as it relates to the constitution. The case also provides a good discussion of what is a tax bill that must originate in the House of Representatives and what is not.

This case continues the general theme of the collection treaty cases both here and in the other treaty countries. That theme, succinctly stated, is that if you want relief you must seek it in the country in which the liability arose. The country to whom the liability is sent pursuant to the treaty provision simply goes out and collects the money with basically no questions asked about the correctness of its origins.

 

Mr. Smith Continues to Suffer from His Failure to File and Other Updates on Late Filed Returns

I have not written about the one day late rule in bankruptcy cases for some time. The litigation has cooled off, but the final fate of the issue remains unresolved. See prior posts on the issue here, here, here, here, and here if you need a reminder of the problems taxpayers suffer in bankruptcy when they fail to timely file their returns. While the tide seems to have turned against the one day rule which set up an absolute bar to discharge, taxpayers in circuits other than the 1st, 5th, and 10th still suffer the consequences of filing late as well. Mr. Smith is one.

Mr. Smith brought the case that is currently the leading opinion regarding the discharge of taxes on a late filed return in the 9th Circuit. Though the 9th Circuit declined to adopt the one day rule, it still found that Mr. Smith did not discharge his tax liability in a case in which the IRS had filed a substitute for return before he filed Form 1040 for the year at issue. In a case decided on March 7, 2018, the District Court for the Northern District of California turned back Mr. Smith’s latest effort to rid himself of the liability stemming from failing to timely filing his 2001 return and having the IRS do it for him.

In addition to recounting Mr. Smith’s latest travail, I discuss two recent lower court opinions on the failure to timely file issue.

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Mr. Smith failed to timely file his 2001 return, eventually leading to the IRS preparing a substitute for return. Seven years after his return was due and three years after the IRS assessed a liability based on the SFR, he filed a Form 1040 reporting about $40,000 more than the IRS assessed. After submitting the Form 1040, he waited more than two years before filing his bankruptcy petition. The IRS agreed with Mr. Smith that the $40,000 liability shown on the late filed Form 1040 was discharged but argued that the liability shown on the SFR was not. The 9th Circuit agreed with the IRS.

Having taken his case to the Circuit Court and lost, Mr. Smith now returns to the bankruptcy court with new arguments in an attempt to rid himself of the tax assessment created by the SFR. First, he argues that since the 9th Circuit found his Form 1040 was a nullity he is entitled to “an abatement of taxes since the IRS lacked authority to assess the additional tax amount of $40,095 based on the Form 1040” he filed seven years late. Second, he argues that because he is forever barred from filing a 2001 return, he should receive declaratory judgment relief that he need not comply with I.R.C. 6012. Third, he moves for a class action seeking a declaratory judgment for all taxpayers who failed to timely file a return resulting in an SFR who lacked reasonable cause and another class action for those taxpayers who filed Form 1040 that did not constitute a return.

The bankruptcy court found that Mr. Smith lacked standing to bring this action. It also found there is no actual controversy with respect to the $40,095 assessment. Additionally, the court pointed out that even if he had standing to sue, I.R.C. 6404(b) states that “no claim for abatement shall be filed by the taxpayer in respect of any assessment of any tax imposed under Subsection A.” Further, the court found that the Anti-Injunction Act also bars the relief he sought and no waiver of sovereign immunity exists. The arguments put forth by Mr. Smith basically allowed the bankruptcy court to touch almost all procedural bases for dismissing a case.

The bankruptcy court shows no sympathy for Mr. Smith since he created his own problem, he moves to almost tax protestor like arguments, and he provides the court with no legal basis for granting the relief he sought. The case demonstrates the frustration of owing a non-dischargeable tax especially when it would have been relatively easy for the taxpayer to avoid the problem. The case also shows the limitations of trying alternative arguments to the straightforward discharge argument under B.C. 523(a)(1)(B) as well as the limitations of seeking to bring a class action to stop the IRS by seeking a declaratory judgment.

Smith shows the limitations of continuing to fight about the discharge when taxpayer files a late return. Two cases on this issue were recently decided, Word v. IRS and IRS v. Davis, in which taxpayers filing late returns did not receive a discharge. These cases deserve brief mention in the continuing saga of the two decade old issue.

In Wood, the taxpayers filed a chapter 7 petition on May 29, 2015. The issue turned on whether their 2010 return was filed. Mr. Wood passed away before the trial occurred. Mrs. Wood testified that they routinely prepared and filed their returns over a 20 year period and that Mr. Wood, a CPA, would prepare it, discuss it with her, and then file it. She presented a filed extension and a copy of the return signed by her and her husband on September 19, 2011; however, the IRS denied ever receiving the return. The IRS put on testimony of a bankruptcy specialist who searched the IRS records and found no evidence of a return. The Court found that Mrs. Word’s testimony about what happened could not overcome the IRS records regarding lack of receipt. Mrs. Wood was hampered in presenting her case because her husband had handled the mailing of the return. The Court expressed sympathy but could not get past the absence of evidence to overcome the presumption of regularity in the IRS records.

Based on the fact that the issue arises in the bankruptcy context, I presume that the taxpayers filed the return, or planned to file the return, without remittance or with only partial remittance; however, I would have liked some discussion about that fact. It seems that she should have known about the remittance aspect of the case and that would have made her story more convincing. The couple also owed for 2009 and may have filed the 2009 return without remittance as well since no mention is made in the opinion of audits. Almost no returns have prior credits exactly equal to the liability shown on the return. Taxpayers generally talk about the monetary consequences of filing a return and anticipate results based on those consequences, e.g., anticipating a refund check or anticipating an immediate bill. The discussions surrounding the money may have provided her with more detail about the mailing of the return with which she could have persuaded the bankruptcy court or the absence of those discussions may have been persuasive.

The Wood case does not present the same issue as Smith and the line of cases involving late filed returns. Rather, it presents the straightforward issue of whether the taxpayers filed a return. Although a slightly different issue, the issue of whether the taxpayer filed a return in the first place regularly presents itself in these cases.

In Davis, the IRS brings an appeal of a bankruptcy court decision and the district court reverses based on the Third Circuit’s recent decision regarding late filed returns. Mr. Davis failed to timely file his 2005 and 2006 returns. The IRS prepared SFRs and made assessments based on the SFRs. Subsequently, he filed Forms 1040 for the two years, waited more than two years, and filed his chapter 7 bankruptcy petition on July 12, 2012. After receiving his chapter 7 discharge, he filed a chapter 13 petition on August 11, 2014. The fight over the impact of the chapter 7 discharge arose in the chapter 13 case when the IRS filed a proof of claim asserting a tax due on 2005 and 2006. The bankruptcy court held that filing the Forms 1040 and waiting two years before filing bankruptcy allowed him to discharge the taxes. Subsequent to the bankruptcy court’s decision discharging the tax debt for the late filed returns, the Third Circuit issued its opinion in Giacchi v. United States, 856 F.3d 244 (3d Cir. 2017). In that opinion, blogged here, the Court found that filing a Form 1040 after the IRS made an assessment based on an SFR did not meet the part of the Beard test requiring “an honest and reasonable attempt to comply with tax law.” The Third Circuit did not say that a debtor in these circumstances could never satisfy the fourth prong of the Beard test, but it provided no guidance on how a debtor might do so.

The IRS argued in the Davis appeal that his case did not involve close facts and the district court agreed. The most interesting aspect of the case may not involve the application of Giacchi, but how the IRS was able to take the appeal. I have not gone back to read the motions filed but it appears that the debtor may have kept open the time for the IRS to bring an appeal of the bankruptcy court decision by seeking to directly appeal to the Third Circuit in the original case and then failing to follow through, but in the process keeping the door sufficiently open to allow the IRS to appeal the adverse bankruptcy decision to the district court. The short shrift the district court gives to the arguments of Mr. Davis suggests that in the Third Circuit the fact pattern of an SFR assessment prior to the filing of the Forms 1040 may be fatal to the attempt to discharge the liability.

 

IRS Wins Latest Battle on Voluntary Return Preparer Testing and Education Though Other Battles Likely Remain

Last week in AICPA v IRS the DC District Court ruled in favor of the IRS in the latest round of the AICPA’s fight to dismantle the IRS’s Annual Filing Season Program. As some of you may recall, the Annual Filing Season Program (AFSP) was the IRS’s reaction to losing in its efforts to impose on unlicensed preparers a mandatory testing and education regime in Loving v IRS. Rather than force unlicensed preparers to take an entrance test and take continuing education, the IRS now allows preparers to opt in, with the benefit that those who sign on appear in an online searchable database of preparers. The AFSP also imposes a cost to those who do not opt in; they are not permitted to engage in limited representation of the clients whose returns the IRS audits.

Last year the DC Court of Appeals, reversing the District Court, held that the AICPA had standing to bring the suit challenging the AFSP. After the case was remanded to the District Court and prior to that court getting to the heart of the merits argument, IRS filed another motion to dismiss, this time not on constitutional standing grounds (where it lost on appeal). Instead, IRS argued that the case should be dismissed because AICPA was not within a zone of interests that Congress sought to protect. In last week’s opinion, the District Court held that while AICPA had standing to bring the suit the suit should be dismissed because AICPA was not within the zone of interests protected by 31 U.S.C. § 330(a) (dealing with regulating practice before Treasury and conditioning practice upon qualifications) and 31 U.S.C. § 330 (b) (comprising of penalties and rules for the disbarment of practitioners).

In this post I will briefly discuss the zone of interests issue and also address some of the procedural implications of the opinion, including how the opinion foreshadows other challenges to the AFSP.

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The AICPA is Not in the Zone of Interests

As last week’s opinion discusses, the zone of interests question is not a constitutional standing question (though it is similar); instead, “it is a ‘statutory question’ that asks ‘whether ‘a legislatively conferred cause of action encompasses a particular plaintiff’s claim.’ Mendoza v. Perez, 754 F.3d 1002, 1016 (D.C. Cir. 2014). Likely for this reason, satisfaction of the zone-of-interests test is no longer a “jurisdictional requirement” and is instead “a merits issue.” Crossroads Grassroots, 788 F.3d at 319 (citations omitted).

Was AICPA within the class of persons Congress sought to protect with 31 U.S.C. § 330(a) and (b)? The court said no. The upshot of the opinion is that AICPA brought this suit because it felt that the Annual Program would threaten its members’ market share; worried that the public would view the Annual Filing Season as a credential that would draw consumers from CPAs during tax season, the AICPA sought to stop the program:

AICPA’s objective here, as it relates to its competitive injury, is to “remov[e] the AFS Rule’s spurious credential from the marketplace.” Opp. at 2; see id. at 3 (“[A]s competitors of unenrolled preparers, AICPA members’ interests” consist of, inter alia, “ensuring that their hard- won qualifications are not diluted by the Rule’s unlawful credential.”). Digging deeper, however, its interest relates to “maximizing . . . profits, apparently by avoiding competition with” unenrolled preparers in the market for tax services. See Liquid Carbonic Indus. Corp. v. F.E.R.C., 29 F.3d 697, 705 (D.C. Cir. 1994).

That, according to the District Court ran counter to the protective purpose of 31 USC § 330, which Congress enacted in the mid-19th Century as a means to protect Civil War veterans against unscrupulous agents:

On the surface, it seems difficult to square AICPA’s interest in dismantling the IRS’s program with Congress’s goal of safeguarding consumers. In creating the AFS Program, the IRS aimed to improve unenrolled preparers’ knowledge of federal tax law, thereby “protecting taxpayers from preparer errors.” Rev. Proc. 2014-42, § 2. This objective appears closely aligned with Congress’s goal of ensuring taxpayers are provided “valuable service.” 31 U.S.C.
§ 330(a)(2)(C). AICPA does not impugn the IRS’s motive in creating the program or otherwise argue that, apart from the risk of “consumer confusion” – i.e., that consumers might confuse a more-qualified but higher-priced CPA with a less-qualified but cheaper unenrolled preparer – the AFS program does not flow logically from Congress’s objective of protecting consumers. Rather, it seeks to eliminate the Program notwithstanding its potential benefit to consumers precisely because the program’s “‘government-backed credential[]’” renders “unenrolled preparers . . . ‘better able to compete against other credentialed preparers,’ ‘uncredentialed employees of [AICPA] members,’ and ‘CPAs and their firms.’” Opp. at 10 (quoting AICPA II, 804 F.3d at 1197-98).

The zone of interests test is more nuanced than this snapshot provides, and I leave to those who wish to dig deeper to read the opinion itself as well as Ed Zollar’s excellent write up of the case and that issue in Federal Tax Developments.

Not the Final Word on Challenges to the IRS Program

In addition to providing a roadmap on the zone of interests test, the opinion itself is worth a careful read for its suggestion that other parties may in fact have a beef with IRS even if the AICPA does not. To that end, while Judge Boasberg, the judge who wrote the district court Loving opinions, carefully recounts the history of IRS efforts to regulate preparers, he also offers a not so subtle critique of the IRS’s decision to use a Revenue Procedure to promulgate the AFSP. He does so by reminding that he issued a clarifying opinion after IRS lost in Loving.  There he rejected IRS’s request for a stay of the injunction pending appeal, though he noted that IRS might choose to keep in place some of the apparatus of its licensing regime as “it is possible that some preparers may wish to take the exam or continuing education even if not required to. Such voluntarily obtained credentials might distinguish them from other preparers.” He notes that “[p]erhaps taking this clarification to heart, the IRS decided to retain much of the rule’s infrastructure, but did so by relying on tax preparers’ willingness to voluntarily participate.”

While referring to the IRS’s possibly taking his advice, this opinion also discusses that IRS put this process in place in a revenue procedure, “albeit without notice and comment.” The IRS use of revenue procedures to carry the hefty weight of meaningful rules is something we have discussed before; as is the IRS penchant for getting rules in place without formal notice and comment (see Dan Hemel’s post  earlier this week for the Chamber of Commerce challenge to Treasury’s inversion regs, for example).

More from the opinion and the hint to other challengers:

A final word. While AICPA does not have a cause of action under the APA to bring this suit, the Court has little reason to doubt that there may be other challengers who could satisfy the rather undemanding strictures of the zone-of-interests test. “The same claim may be viable in the hands of one challenger and not in those of another that, for example, has interests that make it less than a reliable private attorney general to litigate the issue of the public interest in the . . . case.” HWTC IV, 885 F.2d at 925-26 (citations and quotation marks omitted). Given the points raised in the merits briefing, which the Court now has no occasion to consider, Defendant may wish to ensure that its Program was properly promulgated before a suitable party mounts its own challenge.
 (emphasis added)

A few years ago I wrote an article explaining why I thought it was important for IRS to seek greater input especially on rules that have a significant impact on those whose interests are not typically represented through trade associations or lobbying groups. In writing the article, I drew upon a deep literature in administrative law that discusses the pros and cons of requiring agencies to more closely adhere to the requirements to use the notice and comment procedure to promulgate rules. I am no zealot on these issues, and while it has been a while since I deeply waded in those waters I am sympathetic to those who feel IRS should more meaningfully and systematically engage with those whose perspective would improve the quality of the rules the IRS issues. As an added benefit it would also likely engender greater acceptance of the rules from those who may not necessarily like the outcome but who feel that their voice was heard. (I do recognize that before IRS did come up with its ill-fated mandatory testing and education program that the courts invalidated IRS did seek input in the form of hearings and an informal comment period).

We likely have not seen the last of the challenges to the IRS Annual Filing Season Program; nor have we seen the last procedural challenge to the issuance of rules. While this round is a nice IRS victory, Judge Boasberg’s opinion is perhaps a reminder that IRS ignores strict adherence to some administrative law norms at its peril.