Courtney v US Illustrates Limits of Taxpayer Challenges to Allegedly Improper IRS Collection

The recent unpublished Fifth Circuit opinion in Courtney v US nicely illustrates the challenges that taxpayers face when they allege that the IRS has taken improperly used its administrative collection powers.

Courtney pled guilty to income tax evasion from over a million dollars of improper employer reimbursements for personal expenses that he disguised to look like service payments to a company that he controlled.  After a district court restitution order, a 2012 notice of deficiency, and an assessment, the IRS began to try to collect on the unpaid taxes.

Those efforts included a levy on Courtney’s personal individual retirement account, a notice of a federal tax lien, an attempt to seize assets from an irrevocable trust which benefits his wife and children, and levies against two limited liability companies affiliated with Courtney.

In the fall of 2021, Courtney sued the IRS, seeking damages under Section 7433 for allegedly improper collection and an injunction barring further collection actions against him, the limited liability companies and the irrevocable trust.

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The district court tossed the suit for two main reasons. First, Courtney had failed to exhaust his administrative remedies before seeking damages under Section 7433. Second, it held that the Anti Injunction Act barred his demand that the IRS cease collection.  In affirming the district court, the Fifth Circuit expanded on why Courtney could not use the courts at this stage to examine the IRS’s conduct.

Section 7433 requires that taxpayers file a claim with the IRS before going to court. In responding to the government’s argument that he neglected to meet that requirement, Courtney argued that bringing an administrative claim would be futile. Some cases have held that futility can lead a court to overlook the statutory requirement to file a clam with the IRS before going to court.

In rejecting that argument, the Fifth Circuit noted that the futility doctrine is extremely narrow. Even assuming that the “IRS has been unresponsive, difficult to work with, and disingenuous of previous arrangements agreed upon by the parties” it was insufficient. Futility requires  a court to conclude that the filing of a claim would be a useless formality, and Courtney did not meet that standard.

As to the Anti-Injunction Act preventing his demand that the IRS cease collection, Courtney argued that his claims fit under the Enochs v. Williams Packing exception “which applies only if “(1) it is clear that under no circumstances could the Government ultimately prevail…[and] (2) equity jurisdiction otherwise exists.”

Both prongs are difficult to meet; the first requiring a court to prove with certainty that the plaintiff would prevail on the merits and the second requiring a showing of irreparable harm.

The Fifth Circuit declined to find that the Enochs v. Williams Packing exception applied, concluding that it was not a certainty that it would decide on the merits that the government’s collection efforts were improper. Courtney claimed that the government failed to refute his allegations that the levies against the trust and LLCs were improper. In rejecting Courtney’s claim, the court noted that while the government must prove some factual connection between the LLCs, the trust and Courtney, the taxpayer bears the ultimate burden of persuasion. Here, the government had done enough to link Courtney with the entities and Courtney himself had possession of facts necessary for a court to determine whether any collection efforts were lawful.

If Courtney had plausibly alleged that the government had obstructed his ability to prove that the government’s collection actions were improper, perhaps the court would have addressed prong two of the Enochs v. Williams Packing test.  That prong is not easily satisfied anyway, with courts often reflexively stating that refund procedures are adequate, regardless of the taxpayer’s ability to pay.

Given Courtney’s long history with the IRS, it was unsurprising that he went to court. As the opinion reflects, outside CDP, it is not easy to get a court to consider the IRS’s collection, and taxpayers must follow the preliminary path of bringing allegations of improper conduct to the agency itself.

11th Circuit Affirms That Anti-Injunction Act Prevents Taxpayer Seeking Access to Appeals

In Hancock County Land Acquisitions v US the taxpayer brought an action alleging that the IRS’s failure to refer its case to the IRS’s Independent Office of Appeals violated the Taxpayer First Act’s addition of Section 7803(e)(4) and its mandate that Appeals “shall be generally available to all taxpayers.”  The Eleventh Circuit, in an unpublished opinion, held that the Anti-Injunction Act (AIA) barred the lawsuit.

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The facts in Hancock involve an IRS examination that eventually led to the IRS’s issuance of a Final Partnership Administrative Adjustment (FPAA) pertaining to a charitable contribution deduction of approximately $180 million for a conservation easement Hancock had donated on land it owned. IRS had asked Hancock to extend the SOL on assessment prior to issuing the FPAA. Hancock refused but then changed its mind; at that point the IRS had moved on and issued the FPAA.

Hancock filed a suit in federal court asking for injunctive relief:

(1) compelling the IRS to agree to extend the statute of limitations,

(2) compelling the IRS to provide Hancock with “independent review” of its tax case by the Appeals Office,

(3) enjoining the IRS from violating I.R.C. § 7803(e), and

 (4) temporarily enjoining the IRS “from issuing an FPAA” until after providing Hancock with “an independent review of its case by the Appeals Office.”

The district court dismissed the case, finding that the suit was barred by the AIA and its close cousin, the tax exception to the Declaratory Judgment Act (DJA). I discussed some of the preliminary filings in the district court case, as well as a Tax Notes article by Kristen Parillo in More On The Implications of CIC Services last May.

Earlier this month the 11th Circuit affirmed the district court, applying CIC Services. The 11th Circuit described the Supreme Court’s holding as follows:

Three considerations led to that conclusion in CIC Services. First, the reporting rule at issue “impose[d] affirmative reporting obligations, inflicting costs separate and apart from the statutory tax penalty,”  second, the taxpayer was “nowhere near the cusp of tax liability” because the “reporting rule and the statutory tax penalty [were] several steps removed from each other,”  and third, the requirement was enforced through criminal penalties in addition to tax penalties.

These considerations did not favor Hancock County:

First, Hancock will not be subject to any “costs separate and apart” from the tax penalty that may result from the FPAA.

Second, Hancock was on “the cusp of tax liability” when it filed its suit, because the FPAA is the statutory prerequisite to assessing a tax on Hancock, see I.R.C. § 6232(b), and Hancock concedes that “if the FPAA is allowed [to] stand, the IRS will be able to immediately assess a tax.”

Third, Hancock will suffer no criminal punishment by following the AIA’s “familiar pay-now-sue-later procedure.” [LB: in fact, Tax Court allows the pay later approach]

As the Eleventh Circuit framed the challenge, Hancock’s suit was, “[a]t its heart…a ‘dispute over taxes’”(quoting CIC Services):

Unlike in CIC Services, the “legal rule at issue” here,  is a tax provision, not a reporting requirement backed up with a tax provision. Hancock’s single claim alleged that the IRS violated § 7803(e)(4) by failing to provide Hancock with administrative review of its tax case. To remedy that alleged violation, Hancock sought to compel the IRS to provide it with administrative review and, until it did, to prevent the IRS from issuing an FPAA (which the IRS had already issued). The FPAA that the IRS had issued finds that Hancock improperly claimed a $180 million deduction on its 2016 tax return, resulting in an underpayment of taxes. Because the relief Hancock’s lawsuit seeks would restrain the IRS from assessing and collecting those taxes, it is barred by the AIA.

The 11th Circuit also easily dismissed the taxpayer’s alternate argument that even if the AIA applied, the taxpayer should be entitled to benefit from the narrow Enoch v Williams Packing exception if they will “suffer irreparable injury if collection [of the tax] were effected” and show that “it is clear that under no circumstances could the [IRS] ultimately prevail.” As to the first prong, the taxpayer could seek substantive redress in Tax Court (albeit without the confidentiality that comes with a possible administrative resolution). As to the second prong, the opinion noted that it was not clear that the statute required Appeals access at the time the taxpayer sought it, noting that 7803(e)(5) provides for referral to the Appeals Office for “any taxpayer which is in receipt of a notice of deficiency” and that could also be read to mean the analogous FPAA.

Conclusion

CIC Services arose in the context of a pre-enforcement taxpayer challenge to IRS rulemaking. But many aggrieved taxpayers will attempt to get around the AIA in the context of direct IRS inquiries to the positions taken on tax returns. In administrative law parlance, these latter challenges pertain to the IRS’s adjudicatory powers.

Following on the heels of last week’s First Circuit opinion in Harper v Rettig that held that the AIA did not bar a constitutional challenge to the IRS’s use of John Doe summons, we are seeing courts struggle to apply the Supreme Court’s CIC Services opinion. 

I am having a hard time squaring this case and Harper v Rettig. The same considerations the 11th Circuit discusses in Hancock County Land Acquisitions would prevent a challenge to the IRS’s John Doe summons process. The logical conclusion of the First Circuit’s approach in Harper v Rettig is a much more permissive use of courts to challenge all sorts of IRS actions in the course of the IRS’s attempt to gather information, not just those that arise in connection with the issuance of a John Doe summons.

On the other hand, one byproduct of Hancock is that it essentially renders meaningless the TFA mandate that taxpayers have access to Appeals, thus frustrating a fundamental taxpayer right.  While it is difficult to envision a partisan Congress taking this on, perhaps it is time for Congress to take a fresh look at the AIA and the important issue of when and in what circumstances taxpayers can challenge IRS actions. A perhaps less steep hill to climb would involve Congress narrowly providing a specific exception to the AIA for supposed violations of the right to Appeals in Section 7803(e)(4). In the meantime, I suspect that we will soon have another opportunity for other circuits and perhaps the Supreme Court wrestling with the meaning of a 19th century statute that continues to present challenges.

 

First Circuit Finds Anti-Injunction Act Does Not Bar Challenge to IRS’s Use of John Doe Summons That Gathered Taxpayer’s Virtual Currency Transactions

In a major decision that considers the implications of last year’s CIC Services opinion the First Circuit in Harper v Rettig has held that the Anti-Injunction Act (AIA)  does not bar a constitutional challenge to IRS’s use of its John Doe Summons authority that allowed it to obtain information about a taxpayer’s virtual currency transactions.

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IRS has been actively using its John Doe summons powers to get taxpayer information from virtual currency exchanges. One of those cases involved a summons on Coinbase as part of an investigation into the reporting gap between the number of virtual currency users Coinbase claimed to have and the number of U.S. bitcoin users reporting gains or losses to the IRS during 2013 through 2015.

After Coinbase refused to comply, the government moved to enforce the summons. Following a skirmish about the scope of that summons, and a district court’s decision to allow a third party to intervene under Federal Rule of Civil Procedure 24, the court issued an order enforcing the summons. I discussed some of the procedural skirmishes a few years back in A PT Anniversary and Court Finds IRS Summons on Coinbase Suggests an Abuse of Process.

Fast forward a few years. IRS has been using the information it received to contact taxpayers it believes have failed to properly report their income from the virtual currency transactions.  One of those taxpayers was James Harper. IRS sent Harper a letter that informed him of the requirements for reporting virtual currency transactions. It helpfully told him if he believed he had not accurately reported such transactions, he should file amended or delinquent returns. The letter also warned that if he had not “accurately report[ed his] virtual currency transactions,” then he “may be subject to future civil and criminal enforcement activity.”

Shortly after receiving the letter Harper filed suit in a federal district court in New Hampshire. One aspect of the suit involved a request for injunctive and declaratory relief, alleging that the IRS unlawfully obtained his financial information from virtual currency exchanges in violation of the Fourth and Fifth Amendments.

The District Court held that the AIA deprived the court of subject matter jurisdiction over the taxpayer’s claims for injunctive and declaratory relief. 

Harper appealed and claimed that the AIA did not bar his suit because his suit pertained to the information gathering function of IRS activity, rather than the assessment or collection process.

The government and district court distinguished CIC Services, noting that in that case the plaintiff sought to avoid the economic burdens of providing information about other taxpayers to the IRS and challenged its legal obligation to do so. According the government, and unlike in CIC Services, Harper “simply does not want the IRS to possess information bearing on his tax liability.”

Back when the Supreme Court issued its opinion in CIC Services PT had many posts that discussed the uncertain boundaries of that opinion, and whether courts may apply it more broadly than the circumstances of that challenge. See for example Bryan Camp in Supreme Court Reverses the Sixth Circuit in CIC Services – Viewpoint and my post Further Initial Thoughts on CIC Services.

In a relatively brief opinion, the First Circuit reversed, finding that CIC Services and the earlier Direct Marketing opinion opened the door to Mr. Harper’s challenge because the summons authority and IRS activities to enforce the summons “clearly fall with in the category of information gathering, which the Supreme Court has distinguished from acts of assessment and collection.” As such, the court held that Harper’s suit “challenges the IRS’s information-gathering authority and the Anti-Injunction Act limits our jurisdiction only in suits involving assessment and collection.”

The government sought to distinguish CIC Services and argued that the purpose of Harper’s suit was to restrain IRS assessment and collection power. According to the government

the substance of the suit’ is directed at the alleged harm of having the IRS retain and use information about [appellant]’s virtual currency transactions for use in determining [his] compliance with his income tax obligations,” and “[t]he ‘relief requested’ is the expungement of information that would allow the IRS to do so.” (Emphasis added.) See CIC Servs., 141 S. Ct. at 1589 (“In considering a ‘suit[‘s] purpose,’ [courts] inquire not into a taxpayer’s subjective motive, but into the action’s objective aim — essentially, the relief the suit requests.”)

The First Circuit disagreed:

As the Court observed in CIC Services, however, “[t]he Anti-Injunction Act kicks in when the target of a requested injunction is a tax obligation — or stated in the Act’s language, when that injunction runs against the ‘collection or assessment of [a] tax.'” Id. at 1590. Here, the target of the requested injunction is the IRS’s continued retention of appellant’s personal financial information, which appellant alleges the IRS acquired in violation of the Constitution and 26 U.S.C. §7609(f)

Drilling even deeper into the nature and purpose of the AIA vis a vis the relief Harper sought, the court viewed his suit as not attempting to limit IRS’s ability to redetermine his tax:

Contrary to the IRS’s suggestion that appellant’s suit is “a ‘preemptive’ suit to foreclose tax liability” (which would be barred by the Anti-Injunction Act), this suit, like the suit at issue in CIC Services, “falls outside the Anti-Injunction Act because the injunction it requests does not run against a tax at all.”  Rather, “[t]he suit contests, and seeks relief from, a separate legal” wrong — the allegedly unlawful acquisition and retention of appellant’s financial records. Like the plaintiff in CIC Services, appellant “stands nowhere near the cusp of tax liability,”  and “the dispute is [not] about a tax rule,” where “the sole recourse” in light of the Anti-Injunction Act “is to pay the tax and seek a refund,.” 

Conclusion

This case is remanded back to the district court to consider whether Harper has stated a claim on which relief can be granted. That is an uphill battle. The IRS appears to have lawfully obtained the information through the summons process, but this interim victory is important as it reflects at least one circuit’s view that courts are to liberally apply CIC Services and not limit it to situations when third parties are challenging IRS’s information reporting obligations.

CIC Fallout: Anti Injunction Act Bars Motion for Protective Order

US v Meyer presents a somewhat unusual context for a court’s application of the Anti Injunction Act. Meyer stems from an injunction action due to allegations that Meyer promoted “an abusive tax scheme that result[ed] in scheme participants claiming unwarranted federal income tax deductions for bogus charitable contributions.” In 2018, the parties settled that suit and filed a joint motion for permanent injunction. The settlement expressly did not preclude the US from “pursuing other current or future civil or criminal matters or proceedings,” or preclude Defendant from “contesting his liability in any matter or proceeding.”

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Following the settlement, the IRS began a civil investigation and proposed approximately $7 million in Section 6700 civil penalties. Following the proposed assessment, Meyer sought a protective order from the federal district court that had previously been the forum for the injunction proceeding. In particular, Meyer alleged that the IRS’s computation of the proposed 6700 penalty improperly relied on admissions he had made in the injunction proceeding, in violation of Federal Rule of Civil Procedure 36(b). FRCP 36(b) provides that “an admission under [Rule 36] is not an admission for any other purpose and cannot be used against the party in any other proceeding.”

The request for a protective order was initially heard by a magistrate judge.  In April, that judge issued a report and recommendation concluding that Meyer’s request for relief was barred under the AIA. In so doing, the magistrate judge held that the AIA applied even though Meyer did not bring the suit but instead sought a protective order in a suit that the US had brought (recall that the AIA 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….”). Meyer had sought relief based upon a federal district court’s broad power under Fed Rule Civ Procedure 26 which upon a showing of “good cause,” provides that a court may issue a protective order providing a variety of remedies, such as precluding discovery altogether or “specifying terms … for the disclosure or discovery.”

In finding that the AIA barred the request for a protective order stemming from an alleged violation of Fed Rule Civ Procedure 36 from a government-brought injunction case, the magistrate noted that there was no case law squarely on point but looked to analogous cases applying the AIA where taxpayers sought to limit information that the IRS could use in civil proceedings. According to the magistrate, Meyer’s relief request was essentially requiring the IRS to recalculate the penalty and “preclude the IRS from using certain information to assess a tax penalty and is, therefore, impermissible under [the AIA].”

In finding that the AIA did not allow the court to issue a protective order, the magistrate punted on the issue as to whether Rule 36 had any impact on the IRS’s proposed penalty assessment, and whether a “proceeding” for Rule 36 purposes also included an IRS civil penalty examination.  The magistrate noted that the substantive issue could be teed up in a refund proceeding.

Following the magistrate’s report, Meyer timely appealed the recommendation, with the district court then as per Fed Rule Civ Procedure 72 reviewing the matter on a de novo basis. The federal district court judge affirmed and adopted the magistrate’s order, though the opinion is somewhat noteworthy because it addresses Meyer’s additional filings with the court briefly dismissing Meyer’s argument that CIC Services supported finding that the AIA did not apply:

In the present case, the relief Defendant seeks falls squarely within the contours of the Anti-Injunction Act—namely, to limit the information the IRS may consider in its assessment of $7,066,039.00 in tax penalties under  § 6700. See ECF No. [98] at 5 (requesting that the Court “issue an order preventing the Government and its client, the IRS, from using [Defendant’s] Rule 36 Admissions to support factual conclusions in the IRS’s Section 6700 Penalty examination.”); ECF No. [105] at 10 (“request[ing] that this Court enter an order directing the Government that it may not use the Defendant’s RFA Responses for any purpose other than as admissions in this proceeding.”) (emphasis in original); see also CIC Serv., 141 S. Ct. at 1593 (“suits sought to prevent the levying of taxes … [cannot] go forward.”). Thus, the Court agrees with [the magistrate judge’s] conclusion that Defendant’s Motion is barred under the Anti-Injunction Act.

Conclusion

As did the magistrate judge’s, the district court’s order ended with a statement that Meyer was not without recourse as he could bring a refund proceeding and thus get a court to address the merits of Meyer’s claim that Federal Rule of Civil Procedure 36(b) should bar the IRS from using admissions from a separate injunction in calculating a 6700 penalty in a civil exam. Of course, a refund suit is predicated on Meyer satisfying Flora, though the 6700 penalty has special statutory rules allowing for partial payment to secure court review.

More On The Implications of CIC Services

We are starting to see some fallout from last month’s CIC Services opinion. For example, Tax Notes’ Kristen Parillo discusses[$] Hancock Land Acquisitions v US , another microcaptive case. Parillo’s article explores the parties’ post CIC Services supplemental filings in a case where the taxpayer brought an action alleging that the IRS’s failure to refer its case to Appeals violated the Taxpayer First Act’s addition of Section 7803(e)(4) and its mandate that Appeals’ “shall be generally available to all taxpayers.” Immediately following the Supreme Court opinion, the government filed a supplemental brief claiming that CIC does not alter that the challenge is barred by the AIA, emphasizing that the partnership was not challenging a reporting obligation and that the relief requested was close to an assessment on the partners.

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The partnership responded, claiming that its challenge squarely fits in with the three CIC factors that led the Court to conclude that the challenge was not to a tax, including that its relief looks to a remedy for alleged violations of their procedural rights and that any impact on assessment or collection is just a downstream consequence.  

Earlier this week there was also a very interesting blog post on CIC Services in Notice & Comment, the administrative law blog. The post, Do you C what I C? – CIC Services v. IRS and Remedies Under the APA, from Professor Mila Sohoni, explores what CIC Services offers more broadly for admin law purposes: 

The Court’s opinion in CIC Services throws some much-needed light on two important points of contention within that debate: what do litigants mean when they ask a court to “enjoin” a rule or “declare” a rule “unlawful” in an APA action, and what does the APA mean when it says that a court may “hold unlawful and set aside” a rule?

For readers interested in those issues I suggest reading the brief but powerful post.  The post focuses mostly on APA 706 and whether APA violations can lead to vacating regs/rules in their entirety or rather a more narrow focus on the individual plaintiff. The takeaway from the post is that there has been some uncertainty in admin law circles on the scope of a federal court’s powers when in a preenforcement action it finds that an agency (not just the IRS) violates the APA. As Sohoni discusses the Sessions led DOJ in the Trump Administration issued litigation guidelines that adopted the narrow view. Others have argued that the courts have much broader powers to enjoin agency action. Sohoni argues forcefully that CIC Services provides support for the latter view:

The opinion in CIC Services shows that the Court does not hold this [the narrow] view of the meaning of “set aside.” Throughout its opinion, the Court treats “set aside” as a type of relief. (See, e.g., CIC Servs., slip op. at 4-5 (“So the complaint asks the court to ‘set[] aside IRS Notice 2016-66 …’”); id. at 11 (“the existence of criminal penalties explains why an entity like CIC must bring an action in just this form, framing its requested relief in just this way”). Moreover, the Court not only treats “set aside” as a kind of relief, but the Court also necessarily is using the term “set aside” in its conventional sense: to mean “invalidate,” not merely to “ignore.” 

These developments are just the opening rounds on the impact of CIC Services. Stay tuned.

Further Initial Thoughts on CIC Services

In this brief post and following on Professor Bryan Camp’s discussion, I offer some initial observations on the Supreme Court’s CIC Services opinion.  As Keith noted in his introduction to Bryan’s post, I am not disinterested in this issue-with the Harvard Clinic and on behalf of the Center for Taxpayer Rights I helped write an amicus brief seeking cert and another in support of the plaintiffs at the Supreme Court.

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I also come at the issue not as someone who reflexively believes that IRS action is improper, or that IRS systemically runs roughshod over the APA. I do think, however, that tax administration would benefit from a defined and prompt path for litigants to challenge IRS rulemaking apart from traditional enforcement proceedings.  Pre-enforcement challenges to agency rulemaking are the norm outside tax law. The CIC Services decision does not change the norm in tax administration, with the exception of some (or maybe all) challenges relating to information reporting rules. (Justice Kavanaugh’s concurrence offers a broader take on the opinion as he believes the opinion’s focus on the object of the suit rather than the downstream effect as the Court previously held in Americans United and Bob Jones blesses pre-enforcement suits challenging a regulation backed by a tax penalty; I will need to think further on this).

Why do I hedge though about challenges to information reporting? The opinion seems to offer wide berth to challenges to all information reporting regimes. To that end, see page 6 of the slip opinion, where the majority states that a “reporting requirement is not a tax; and a suit brought to set aside such a rule is not one to enjoin a tax’s assessment or collection.”

Later though it does leave the door ajar to distinctions when at page 9 it sets out a three part test to evaluate whether the action is a “tax action in disguise.” The three-part test is that 1) the regime imposes affirmative costs other than the underlying tax, 2) there are several steps between the reporting and any penalty that the IRS would impose on a party failing to report and 3)  there are potential criminal penalties for noncompliance.  For now I will focus on part two, that the reporting rule “and the statutory tax penalty are several steps removed from each other. “

The opinion notes that for CIC Services before any penalty could arise a number of steps must occur, including that CIC fails to provide the required information about the micro captive transactions, the IRS must determine that there has been a violation of the Notice, and then IRS must exercise its discretion to impose the penalty.  One question that lower courts will likely explore is whether the steps between not complying and possible penalty imposition are similar enough in other information reporting regimes to lead to a conclusion that a challenge to a different information reporting is to the reporting rather than a tax penalty.  That the CIC opinion did not explicitly address how its approach would affect for example the interest reporting regime that bankers challenged in the Florida Bankers case suggests perhaps some wiggle room, though on balance I think a better reading of the majority opinion is that there is little basis to offer a distinction with a difference. In my view, under the CIC approach, Florida Bankers comes out differently.

Similarly while Justice Sotomayor in her concurrence suggests perhaps a different outcome if the challenge related to a taxpayer’s own reporting (a distinction not made in the opinion), I think most of the likely challenges that will come from third parties anyway. No doubt that as Congress considers new statutory reporting rules on banks as part of its efforts to clamp down on the tax gap, I suspect we may soon see some opportunity to see bankers and other financial institutions mount fresh challenges.

While Bryan and I differ in our takes on the case, like Bryan I also think a fitting outcome would be for Congress to take a fresh look at the AIA and perhaps allow parties the opportunity to challenge tax rules or regulations in preenforcement proceedings (to that end see my post Is It Time To Reconsider When IRS Guidance Is Subject to Court Review? ) That post discusses such a proposal by Professor Kristin Hickman and Gerald Kerska as well as a separate proposal from Stephanie Hunter McMahon.

Supreme Court Reverses the Sixth Circuit in CIC Services – Viewpoint

Today, the Supreme Court handed down a unanimous opinion in CIC Services.  The Court holds that the Anti-Injunction Act does not bar a suit challenging a IRS notice that requires a non-taxpayer to provide information even though the failure to provide the information could result in a penalty.  Today, we bring an observation about the case from Professor Bryan Camp who has blogged with us several times before.  Professor Camp filed an amicus brief with the Supreme Court in support of the government’s position that the AIA did bar this action.  Soon, depending on how grading exams goes, we will publish a counterpoint to Professor Camp’s post by Les.  Les joined the tax clinic at Harvard Law School in filing an amicus brief on behalf of the Center for Taxpayer Rights supporting the plaintiff in this case.  Here is a copy of the amicus brief filed by Professor Camp and here is a copy of the amicus brief filed by the Center for Taxpayer Rights.  We have previously blogged this case many times.  A sample of prior posts can be found here (in a post by authors of another amicus brief in support of the government whom we hope might have more to say here in coming days), here and here.

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Here’s what it got wrong.  Justice Kagan rests her opinion on a distinction between “information gathering” on the one hand and “assessment/collection” on the other hand.  The Anti Injunction Act, 26 USC §7421, prohibits suits to restrain the latter, she says, not the former.  All CIC Services was doing was seeking to restrain the IRS from collecting information from it.  

Here’s why that’s wrong.  Assessment is a process, not an event.  And the process starts with reporting information to the IRS!  Heck, lots of folks are doing that today.  The wrinkle in this case is that it was not a taxpayer reporting information to the IRS; it was a third party (CIC Services).  So the Court says hey, information reporting by taxpayers may be part of assessment (because the IRS, after all, assesses tax in large part based on the information taxpayers self-report).   You see this most explicitly in Justice Sotomayor’s concurrence.   But information reporting by third parties, says the Court, is not part of assessment or collection tax.

The heck it isn’t!  

Saying that information reporting by third parties is different than information reporting by taxpayers reflects a deep confusion about tax administration.  Congress created third-party information reporting requirements in the first place as an integral part of the tax assessment and collection process.  When Congress re-started the income tax in 1913 it experimented with what we are now very used to: third party withholding of taxes.  That’s what employers now routinely do for employees.  But Congress got lots of blow-back for that.  So it quickly abandoned the requirement for third parties to withhold actual dollars.  Instead, Congress substituted third-party information reporting for withholding.  This was in the War Revenue Act of 1917, 40 Stat. 300.  The Senate Finance Committee explained that third-party information reporting was a “substitute for the previous collection strategy of tax withholding.”  It was “conducive to a more effective administration of the law in that it will enable the Government to locate more effectively all individuals subject to the income tax and to determine more accurately their tax liability. This is of prime importance from a viewpoint of collections.” Sen. Rpt. 65-103 (August 6, 1917) at 20 (emphasis added).  

Since 1917 Congress has added dozens and dozens of third-party information reporting requirements to the Tax Code.  And always for the same reason: such reporting is integral, is vital, to the proper assessment and collection of tax.  When the IRS did its tax gap studies it found that taxpayers are far more likely to properly self-report transactions (and the income from such transactions) when they know a third party is reporting as well.  No duh!  So that is why a suit attempting to restrain a third-party information reporting requirement is well within the scope of the Anti-Injunction Act’s prohibition against suits to restrain the “assessment or collection” of “any tax” regardless of whether the person suing “is the person against whom such tax was assessed.”  That’s the language in §7421.

Here’s what getting it wrong means.  As Justice Kavanaugh pointed out, this decision creates a new exception to the Anti Injunction Act.  It will require litigation for courts to figure out just how big or small that exception is.  For example, when Justice Kavanaugh was on the D.C. Circuit he authored an opinion in Florida Bankers Association holding for the IRS on a very, very, very similar issue.  This CIC Services opinion nukes Florida Bankers.  …or DOES it??  Hello litigation!  

The bigger picture here is the Court is revisiting what it thinks should be the proper relationship of courts and the IRS.  This decision allows courts to give greater and closer supervision of how the IRS administers the tax system.  It has the potential to greatly slow down the IRS’s ability to detect tax cheats, such as the micro-captive insurance arrangements that CIC was promoting.  That will lead to significant losses in tax revenue while companies like CIC will continue to be able to create and promote new ways for wealthy taxpayers to avoid paying taxes.  

But there are two silver linings.  First, the decision might spur Congress to actually revise the Anti-Injunction Act to bring it into the 21st Century.  Congress wrote the AIA in 1867, after all and the basic operative language is unchanged.  For example, there was no third party reporting in 1867 the way there is now.   Second, even without the AIA, this ruling does not mean that courts will suddenly stop all third-party information reporting.  A court will not enjoin the IRS from enforcing a contested reporting requirement unless the party seeking the injunction can meet the traditional requirements to obtain an injunction: (1) the party is likely to win on the merits; and (2) the party will suffer irreparable harm if the court does not enjoin. 

Another District Court Applies The Anti-Injunction Act to Dismiss A Pre-Enforcement Challenge to IRS Notice

Readers of Procedurally Taxing are familiar with the Anti-Injunction Act (AIA) and the CIC Services case that is pending in the Supreme Court. CIC Services raises whether the AIA bars a challenge brought under the Administrative Procedure Act in a pre-enforcement proceeding. It involves the hefty penalties under Section 6707A for failing to comply with information reporting obligations. Last week, in Govig and Associates v US a federal district court in Arizona considered a similar issue. In Govig, the taxpayers claimed that an IRS notice identifying listed transactions violated the APA because it was issued without going through the notice and comment process. In Govig the court concluded that the AIA precluded a pre-enforcement challenge to the IRS notice that triggered the immediately assessable penalty under Section 6707A.

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At issue in Govig is Notice 2007-83. That notice informed taxpayers that tax benefits claimed for a category of trust arrangements were not allowable for federal tax purposes and designated as “listed transactions” trust arrangements that had been “promoted to small businesses and other closely held businesses as a way to provide cash and other property” to owners “on a tax-favored basis.” As the opinion notes, the Notice targeted transactions where businesses used trusts to create welfare benefit funds that included cash-value life insurance policies.

The taxpayers in Govig are participants in trusts that have been designated as “listed transactions” under the Notice.  The plaintiffs in the case paid the penalties that were assessed in 2019 for violations relating to the 2015 year. They then filed a complaint in federal court, alleging that the IRS failed to comply with the notice and comment regime generally required for legislative rules under the APA and asking the court to set aside the notice as arbitrary and capricious.

In granting the government’s motion to dismiss for lack of jurisdiction, the district court explicitly embraced the reasoning of the DC Circuit in the Florida Bankers case. (For prior posts on Florida Bankers, see my discussion here and Patrick’s Smith’s two part post here and here). As the opinion notes, the challenge was framed as one directed to the “information gathering mandated by the Notice’s disclosure requirement and has nothing to do with the assessment or collection of a tax.”  The court reasoned that this is a “distinction without difference”  and agreed with the conclusion reached by then-Judge Kavanaugh in Florida Bankers, that the AIA applies “even if the plaintiff claims to be targeting the regulatory aspect of the regulatory tax . . . because invalidating the regulation would directly prevent collection of the tax.” 799 F.3d at 1070-71.

It also distinguished the Direct Marketing opinion, emphasizing differences in the text between the Tax Injunction Act (TIA) and the AIA at issue in Govig (and CIC Services):

The pertinent part of the TIA provides that federal district courts “shall not enjoin, suspend or restrain the assessment, levy or collection of any tax under State law.” 28 U.S.C. § 1341 (emphasis added). The AIA in contrast states that “no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court.” 26 U.S.C. § 7421 (emphasis added).

In reasoning that Direct Marketing should not be read to support pre-enforcement challenges to federal information reporting  requirements backstopped by Title 26 penalties the Govig court leaned in on the differences in wording between the TIA and AIA, noting that those differences mattered in the majority Direct Marketing opinion:

There the Court, applying the cannon against surplusages as well as Noscitur a sociis, found that: the words “enjoin” and “suspend” are terms of art . . . referring to different equitable remedies that restrict or stop official action to varying degrees, strongly suggesting that “restrain” does the same. As used in the TIA . . . “restrain” acts on a carefully selected list of technical terms — “assessment, levy, collection” — not on an all-encompassing term, like “taxation.” To give “restrain” the broad meaning selected by the Court of Appeals would be to defeat the precision of that list, as virtually any court action related to any phase of taxation might be said to “hold back” “collection.” Such a broad construction would thus render “assessment [and] levy” — not to mention “enjoin [and] suspend” — mere surplusage, a result we try to avoid.

In Govig, these differences led the district court to conclude that while the TIA and AIA are similar the differences were enough to justify the AIA’s barring of the pre-enforcement challenge:

The AIA is not so limited by “technical” or “precise” language. Instead, it contains a broader restriction on any suit “for the purpose of” restraining the assessment or collection of taxes. 26 U.S.C. § 7421. The Court can only conclude this different wording is intended to carry a different broader meaning; a conclusion supported by the Supreme Court’s prior applications of the AIA

Finally, the district court in Govig held that the case did not implicate exceptions to the AIA, including the South Carolina v. Regan exception when there is no alternative for posing a legal challenge and the Williams Packingexception when “(1) it is ‘clear that under no circumstances could the government ultimately prevail’ and (2) ‘equity jurisdiction’ otherwise exists, i.e., the taxpayer shows that he would otherwise suffer irreparable injury.”Church of Scientology v. United States, 920 F.2d 1481, 1485 (1990) (citing Commissioner v. Shapiro, 424 U.S. 614, 627 (1976) (quoting Williams Packing, 370 U.S. at 7)).

Conclusion

The Govig case itself breaks no new ground.  While it recognizes that the challenge in Govig is to a reporting regime, rather than the underlying tax, its approach in rejecting the challenge closely follows the reasoning in Florida Bankers.  In the next few months we will see whether this approach is the law of the land, as CIC Services tees this issue up directly.

What is not clear to me from reading the opinion (admittedly I did not dig deeper into the pleadings or underlying briefs) is why the taxpayers did not bring their APA challenge in a refund proceeding. The opinion notes that the plaintiffs fully paid the assessed penalties imposed under Section 6707A. In a refund proceeding, the plaintiffs could have raised the same allegations, i.e., that the alleged IRS notice was issued contrary to the APA. In addition, while the plaintiffs asked the court to take judicial notice that violations of the reporting requirements could lead to criminal penalties, the court declined, noting that Section 6707A merely preserves the possibility for other penalties. The issue of potential criminal liability for violating these notices is also raised in CIC Services, where the plaintiff has alleged that the possibility of criminal liability itself makes the traditional refund process inadequate as a forum for raising alleged violations of the APA.