CIC: Supreme Court Review?

We have discussed CIC Services v IRS on the blog numerous times. As readers may recall, CIC involves an IRS Notice that imposes additional reporting obligations on captive insurance companies and their advisors. CIC, a manager of captives, and an individual who also managed captives and provides tax advice to them, sued. The suit claimed 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 Sixth Circuit, affirming the district court, held that the Anti-Injunction Act (AIA) barred an APA challenge to the Notice.

In August the Sixth Circuit denied a petition for rehearing (see here for my prior blog post discussing that denial). Judge Sutton in his concurring opinion accompanying the rehearing denial strongly encouraged that the Supreme Court grant cert to resolve open questions concerning the reach of the Anti-Injunction Act. 

Since that time CIC filed a cert petition. The Harvard Tax Clinic (through Keith, Carl and students Tyler Underwood, Lauren Hirsch and Oliver Roberts), Meagan Horn (at Thompson and Knight in Dallas serving as pro bono counsel to the clinic) and I have filed an amicus brief flagging the importance of the issue. In our amicus brief we emphasize that the implications of the case extend to low and moderate-income taxpayers. The amicus brief, as well as an amicus from the American College of Tax Counsel and the cert petition itself, can be found on the SCOTUSblog cite.  The government originally was supposed to respond by February 24th but it has asked the Court for a one- month extension.

As an aside, I, along with one of  my colleagues on the Saltzman/Book IRS Practice and Procedure treatise, Contributing Author Marilyn Ames, have posted on SSRN The Morass of the AIA: A Review of the Cases and Major Issues. The article will be published in the Summer 2020 issue of the Tax Lawyer and is based on the heavily rewritten Chapter 1.6 of the Saltzman Book treatise which likewise discusses and analyzes the AIA.  As the article is in draft form I encourage readers to offer comments. This, and other developments such as the Silver case Keith discussed here, suggest that the reach of the AIA is a very hot issue in tax procedure. Stay tuned.

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.

Time for the Supreme Court to Step In?: Sixth Circuit Denies Petition for Rehearing in CIC Services v IRS

Last month the Sixth Circuit declined to grant a petition for rehearing en banc in the case of CIC Services v IRS. The case, which I discussed following the original panel decision in In CIC Sixth Circuit Sides With IRS in Major Anti Injunction Act Case, involves the reach of the Anti Injunction Act (AIA). But the frank concurring opinions and the dissent accompanying the denial of the en banc petition reveal differing views on the role of the modern administrative state and how tax administration fits in with broader administrative law norms. At issue is when taxpayers or advisors can challenge tax rules: the AIA has pushed challenges to issues like IRS compliance with the Administrative Procedure Act (APA) rulemaking requirements (including whether the rule was issued under the APA’s notice and comment regime) to deficiency cases or refund proceedings. 

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CIC highlights some differences between the IRS and other federal agencies. First, tax practitioners and the IRS itself refer to regulations as guidance. IRS treats certain non-regulatory guidance published in its Internal Revenue Bulletin, including the Notice in the case at issue, as binding on the IRS (and for that matter taxpayers can rely on it). Other agencies distinguish between regulations and guidance, with those agencies treating regulations as binding but guidance as not.  In addition, other agencies generally expect that they will face pre-enforcement judicial challenges to the regulations that they issue. In contrast, pre-enforcement challenges to tax regulations or other binding IRS guidance are unusual, in large part because the AIA prevents suits to restrain the assessment or collection of tax.

So, tax administration rests somewhat uneasily within the broader framework of administrative law. To recap, the AIA generally pushes challenges to IRS rulemaking to traditional tax controversy venues, that is in Tax Court in deficiency cases (if the tax or penalty is subject to deficiency procedures) or federal courts in refund matters after having to fully pay and comply with the Flora full payment rule. Many other agencies gear up for challenges immediately after they promulgate binding rules rather than having to wait for enforcement proceedings. 

All of this comes into sharp focus in CIC. The IRS issued informal guidance (a Notice) without going through APA notice and comment. The Notice imposed additional reporting obligations on captive insurance companies and their advisors. Failure to comply with the requirements could trigger substantial civil penalties that are not subject to deficiency procedures. Failing to comply with the reporting theoretically could result in criminal sanctions for willful noncompliance. CIC, a manager of captive insurance companies, and an individual who also managed captives and provides tax advice to them, sued. They claimed that the Notice imposed substantial costs and that the IRS effectively promulgated legislative rules without complying with the APA’s notice and comment requirements. The plaintiffs sought to enjoin the IRS from enforcing the Notice and asked the district court to issue a declaratory judgment claiming that the notice was invalid.

The district court dismissed the suit, and the Sixth Circuit affirmed. That led to the petition for rehearing and last month’s brief but telling order accompanied by two concurring opinions and a dissent. In rejecting the petition for rehearing, one of the concurring opinions (authored by Judge Clay, who wrote the majority Sixth Circuit opinion), largely stuck to his guns and framed the issue as one that is covered by existing AIA precedent:

A suit seeking to preemptively challenge the regulatory aspect of a regulatory tax “necessarily” also seeks to preemptively challenge the tax aspect of a regulatory tax because invalidating the former would necessarily also invalidate the latter. Bob Jones Univ.,; see also NFIB, (“The present challenge to the mandate thus seeks to restrain the penalty’s future collection.” (emphasis added)). Otherwise, a taxpayer could simply “characterize” a challenge to a regulatory tax as a challenge to only the regulatory aspect of the tax and thereby evade the AIA. Fla. Bankers,. And “as the Supreme Court has explained time and again . . . the [AIA] is more than a pleading exercise.” see also RYO Machine, LLC v. U.S. Dep’t of Treasury, (6th Cir. 2012) (“Regardless of how the claim is labeled, the effect of an injunction here is to interfere with the assessment or collection of a tax. The plaintiff is not free to define the relief it seeks in terms permitted by the [AIA] while ignoring the ultimate deleterious effect such relief would have on the Government’s taxing ability.” (quotation and many citations omitted)).

Judge Sutton also concurred in the opinion denying the petition but his concurrence has a different flavor altogether.

(As an aside, this summer  I listened to the very entertaining Malcom Gladwell podcast Revisionist History. Season 4 Episode 1 (Puzzle Rush) and Episode 2 (The Tortoise and the Hare) feature Judge Sutton as one of the protagonists in Gladwell’s take down of the LSAT and the metrics for deciding who should gain entry into the nation’s elite law schools. Spoiler: Judge Sutton, who clerked for the late Justice Scalia and who attended the very respectable but not top five Moritz College of Law at THE Ohio State University is Gladwell’s poster child for why the LSAT and for that matter the way most law schools test students are in need of a major makeover).  

For one thing, Judge Sutton states that he agrees with the dissent’s view on the merits of whether the AIA prevents the courts from hearing the challenge to the Notice. Yet, Judge Sutton still believes that the case was not appropriate for an en banc hearing. His reason is that the Supreme Court, rather than the entire Sixth Circuit, should step in: 

[T] his case does not come to us on a fresh slate. Whatever we might do with the issue as an original matter is not the key question. As second-tier judges in a three-tier court system, our task is to figure out what the Supreme Court’s precedents mean in this setting. That is not easy because none of the Court’s precedents is precisely on point and because language from these one-off decisions leans in different directions.

Judge Sutton notes that the views are fairly well drawn on the issue—between the dissent in the panel opinion and the dissent in the denial of the petition by Judge Thapar, as well as the Florida Bankers DC Circuit opinion (authored by now Justice Kavanaugh) there is enough fodder for the Supreme Court to put together the seemingly (although not necessarily) contradictory approaches in the Direct Marketing and circuit court precedent on the reach of the AIA:

The last consideration is that we are not alone. The key complexity in this case—how to interpret Supreme Court decisions interpreting the statute—poses fewer difficulties for the Supreme Court than it does for us. In a dispute in which the Court’s decisions plausibly point in opposite directions, it’s worth asking what value we would add to the mix by en-bancing the case in order to create the very thing that generally prompts more review: a circuit split. As is, we have Judge Thapar’s dissental and Judge Nalbandian’s dissent at the panel stage on one side and Judge Clay’s opinion for the court on the other. These three opinions together with then-Judge Kavanaugh’s opinion say all there is to say about the issue from a lower court judge’s perspective. All of this leaves the Supreme Court in a well-informed position to resolve the point by action or inaction—either by granting review and reversing or by leaving the circuit court decisions in place.

The final part of the denial is Judge Thapar’s stinging dissent. Taking up the mantle of Judge Nalbandian’s dissent in the Sixth Circuit panel opinion, Judge Thapar discusses the differing legal takes on the reach of the AIA (and whether challenges to reporting requirements that are backstopped by penalties really count as a challenge to a tax rather than a challenge to the reporting requirement), but he also ups the rhetoric around how the majority approach to the AIA is out of sorts with broader principles of fairness. He warns of the parade of horribles associated with unchecked IRS power and a read of the AIA that requires parties to violate tax rules (and possibly have to go to jail) to get their day in court. For good measure, he points to how the IRS (at Congress’ direction) has taken on a more expansive role in society beyond collecting revenues.  This mission creep of the IRS makes the exceptional approach to the timing of when agency guidance is subject to challenge less justifiable. Absence of a right to pre-enforcement challenge, according to Judge Thapar, is inconsistent with principles of our constitutional system of checks and balances:

The Founders gave Congress the “Power To lay and collect Taxes.” U.S. Const. art. I , § 8 , cl. 1. They limited this power to Congress because they understood full well that “the power to tax involves the power to destroy.” M’Culloch v. Maryland, 17 U.S. 316 ,431 (1819) (Marshall, C.J.). But today, the IRS (an executive agency) exercises the power to tax and to destroy, in ways that the Founders never would have envisioned. E.g., In re United States ( NorCal Tea Party Patriots ), 817 F.3d 953 (6th Cir. 2016). Courts accepted this departure from constitutional principle on the promise that Congress would still constrain agency power through statutes like the Administrative Procedure Act. 5 U.S.C. § 500 et seq. We now see what many feared: that promise is often illusory.
 

Conclusion

Underlying the technical legal issues surrounding the reach of the AIA are fundamental policy questions concerning the power that the IRS has to issue guidance that is effectively and at times practically absent from meaningful court review. There are many good reasons for rethinking the path that requires taxpayers to not comply before having an institutional check on the IRS’s fidelity to the APA—especially if the challenged tax or penalty is not subject to deficiency procedures. As Judge Clay notes in his opinion affirming the denial of the petition, these policy questions raise issues that seem to call for a legislative fix. I discussed the need for possible legislation in a post earlier this year in the post Is it Time to Reconsider When IRS Guidance is Subject to Court Review?  In the absence of legislation, the opinions accompanying the denial of the request for en banc provide a strong signal that this issue is headed to the Supreme Court. CIC may be the vehicle that gets it there.

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.

 

 

Challenges to Regulations Update: Government Withdraws Appeal in Chamber of Commerce and New Oral Argument Set for Altera

One of the more interesting cases from last year was Chamber of Commerce v IRS, where a federal district court in Texas invalidated temporary regulations that addressed inversion transactions. The case raised a number of interesting procedural issues, including the reach of the Anti-Injunction Act and the relationship between Section 7805(e) and the APA.

Not surprisingly, the government appealed Chamber of Commerce. Over the summer, Treasury issued final regs that were substantively similar to the temporary regs that the district court struck down, and then the government filed a motion with the Fifth Circuit to dismiss its appeal with prejudice.

Last month the Fifth Circuit granted the motion.

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The outcome in Chamber of Commerce illustrates the difficulty that taxpayers face when challenging regulations for process violations (i.e., failing to subject guidance to notice and comment) and in particular challenges to temporary regulations. After all, Treasury can (and did in this case) issue final regs, and Section 7805(b) provides that those regs take effect retroactively upon the earlier of the “date on which any proposed or temporary regulation to which such final regulation relates was filed with the Federal Register” or “the date on which any notice substantially describing the expected contents of any temporary, proposed, or final regulation is issued to the public.”

Chamber of Commerce is to be contrasted with challenges to regs that focus on the substantive way that the regulations interpret a statute; for example, earlier this summer the DC Circuit reversed the Tax Court in Good Fortune Shipping.There, the DC Circuit applied Chevron Step Two and held that Treasury regulations that categorically restricted an exemption to foreign owners of bearer shares unreasonably interpreted the Internal Revenue Code. The taxpayer in Good Fortune challenged the reg the old fashioned way– in a deficiency case as contrasted with the pre-enforcement challenge in Chamber of Commerce.

Probably the most watched procedural case of the year, Altera v Commissioner, also tees up a procedural challenge to regs, and like Good Fortune is also situated in a deficiency case. One of the main arguments that the taxpayer is raising in Altera is a cousin to the challenge in Chamber of Commerce; that is the taxpayer is challenging the way that the reg was promulgated (and the case also involves a Chevron Step Two challenge). In particular, the issue turns on whether the agency action [the regulation] is “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” 5 USC 706(2)(A). Altera involves Treasury’s compliance with § 706 of the APA as expanded on in the 1983 Supreme Court State Farm’s “reasoned decisionmaking” understanding of the clause prohibiting “arbitrary” or “capricious” agency action.

As Keith flagged a few weeks ago, after the Ninth Circuit reversed the Tax Court and found that Treasury did enough in its rulemaking and held that the cost-sharing regulation was valid, the Ninth Circuit withdrew the opinion. The Ninth Circuit has now scheduled a new oral argument in Altera for October 16.

Stay tuned.

Some Additional Reading on IRS Notice Regarding State and Local Deductions

My post last week discussing the IRS’s Strategic Plan briefly referred to the IRS notice indicating that Treasury intended to issue proposed regulations that will “assist taxpayers in understanding the relationship between the federal charitable contribution deduction and the new statutory limitation on the deduction for state and local tax payments.”

For those wanting some more on the IRS notice, I recommend Two Cheers for IRS Guidance on the New SALT Cap on Medium by University of Chicago Law School Professor Dan Hemel.  Dan’s post distinguishes between what is in the IRS notice’s crosshairs, i.e., plans enacted or on the books that allow taxpayers to get credit for charitable contributions to state-linked funds, from other state plans, like the NY State Employer Compensation Expense Program, that allow employees to claim credits if as Dan notes the “employer opts into a new payroll tax regime.”

Dan discusses some interesting procedural issues as well, emphasizing that a 2011  informal Chief Counsel memorandum,which some have used as legal support for the deduction of proceeds contributed to state linked charitable funds, is not precedential. (For those wanting some more substance on the support for the workaround see Federal Income Tax Treatment of Charitable Contributions Entitling Donor to a State Tax Credit, an article posted on SSRN by Dan, Joe Bankman, Jacob Goldin, David Gamage, Darien Shankse, Kirk Stark, Dennis Ventry and Manoj Viswanathan).

Dan’s post discusses how states may be able to avoid the reach of the Anti-Injunction Act (AIA) to bring a pre-enforecement judicial challenge to any future regs. Dan’s main point here is that absent a pre-enforcement challenge, states would have little direct chance to challenge the regulations when they are eventually promulgated. As Dan discusses, in 1984 the Supreme Court in South Carolina v Reagan allowed states to challenge legislation that pegged the federal income tax exemption of interest from state and local obligations to bonds issued in registered rather than bearer form. Despite objections from the federal government that the AIA should restrict a state’s ability to challenge that legislation, the Court disagreed:

In sum, the Anti-Injunction Act’s purpose and the circumstances of its enactment indicate that Congress did not intend the Act to apply to actions brought by aggrieved parties for whom it has not provided an alternative remedy. In this case  if the plaintiff South Carolina issues bearer bonds, its bondholders will, by virtue of 103(j)(1), be liable for the tax on the interest earned on those bonds. South Carolina will incur no tax liability. Under these circumstances, the State will be unable to utilize any statutory procedure to contest the constitutionality of 103(j)(1). Accordingly, the [AIA]cannot bar this action.

Dan’s flagging of South Carolina v Regan and its allowing states to challenge the future guidance seems spot on to me.

Stay tuned, both for 1) more IRS/Treasury guidance on this and other workaround plans and 2) states challenging whatever regulations Treasury eventually promulgates.

Government Files Brief in Chamber of Commerce Case/Supreme Court Resolves Circuit Split on Tax Obstruction Statute

Today’s post will bring readers up tp date on two significant developments, the first involving the heavily watched Chamber of Commerce case in the Fifth Circuit and the other a Supreme Court opinion in Marinello v US that resolved a circuit split that concerned an important criminal tax issue.

Chamber of Commerce Appeal

One of the more significant tax procedure cases of last year was Chamber of Commerce v IRS, where a district court in Texas invalidated Treasury’s temporary regulation that attempted to put a stop to corporate inversions.

The government appealed the decision to the Fifth Circuit, and this week the government filed its brief spelling out why the circuit court should reverse. In addition to arguing that the district court erred in finding that the plaintiff had standing, the government urges the Fifth Circuit to find that the Anti-Injunction Act bars a pre-enforcement challenge to the regulations, and argues that Section 7805 allows it to issue prospective temporary regs without notice and comment.

Treasury’s view on temporary regulations I find strained, as I discuss in the latest update to Chapter 3 Saltzman and Book IRS Practice and Procedure, but I suspect that the AIA may allow the Fifth Circuit to sidestep that issue.

Here is the summary of the government AIA argument from its brief:

But even if plaintiffs have standing, their suit is barred by the Anti-Injunction Act and the tax exception to the Declaratory Judgment Act, which ban the issuance of declaratory and injunctive relief against the assessment or collection of federal taxes. Plaintiffs cannot have it both ways: their contention that they have standing because their members are threatened with increased tax liabilities would necessarily mean that their suit falls squarely within the AIA’s prohibition against suits “for the purpose of restraining the assessment or collection of any tax.” The District Court erred in its overly restrictive construction of the AIA. The AIA’s prohibition on injunctive relief applies broadly, reaching not only actions directly involving assessment or collection, but also those that might affect assessment or collection indirectly. The AIA clearly bars attempts, such as this one, to enjoin a Treasury Regulation affecting the existence or amount of a tax liability.

The AIA has long been an important barrier walling off IRS/Treasury guidance from pre-enforcement challenges. As we have discussed on PT, with cases like Direct Marketing, which considered the reach of an analogous statute that bars challenges to state tax statutes, advocates have been probing for ways to get courts to consider the procedural and substantive validity of rules such as in this case.

The brief discusses and distinguishes Direct Marketing. No doubt the Chamber of Commerce disagrees. We will keep an eye on this case.

Supreme Court Resolves Split in Circuits on Obstruction Statute

In Marinello v US, the Supreme Court resolved a circuit split involving Section 7212(a),  involving the tax specific obstruction statute. The Court held that a conviction under the statute requires that there be an ongoing investigation of the defendant, with the defendant both knew about and intended to obstruct. The opinion leaves open, however, the possibility for a conviction if the proceeding was reasonably foreseeable by the defendant.

In addition to resolving the split, the opinion provides a nice window into competing strands of statutory interpretation. The dissent, penned by Justice Thomas and joined by Justice Alito, relied on a more literal approach. The statute prohibits “corruptly . . . obstruct[ing] or imped[ing], or endeavor[ing] to obstruct or impede, the due administration of this title.” Noting that the title at issue was Title 26, and that encompasses all aspects of the tax code, the dissent, as a few other circuits, would have not limited the statute’s application to situations when there is awareness of (or reason to be aware of) the investigation.

As support for that view, the dissent looks to the Direct Marketing discussion of tax administration, which identified the four components of tax administration as involving “information gathering, assessment, levy, and collection.”

‘[D]ue administration of this Title’ refers to the entire process of taxation, from gathering information to assessing tax liabilities to collecting and levying taxes.

The majority opinion leans on context, looking to related interpretations of the general obstruction statute, a concern that the government’s approach leaves too much discretion to prosecutors and the potential use of the tax obstruction statute to encompass more run of the mill tax misdemeanors.