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. 

The Barrier of the Anti-Injunction Act for Low Income Taxpayers

Today we welcome back guest blogger Omeed Firouzi, who discusses a recent case involving a dispute over employees’ tax withholding. Omeed notes that withholding disputes may become more frequent as the payroll tax deferral plays out. Christine

The Tax Anti-Injunction Act has been the subject of several posts on this site over the years. The law garnered national political attention in the summer of 2012 in the aftermath of the U.S. Supreme Court’s NFIB v. Sebelius decision. In NFIB, the Supreme Court upheld the Affordable Care Act’s individual mandate on the basis that the shared responsibility payment was within Congress’ taxing authority. The Tax Anti-Injunction Act (26 U.S.C. Section 7421) reads, in relevant part:

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.

This law was at the center of a recent case decided in the U.S. District Court for the District of Oregon in July 2020. The plaintiff in this case, Alex Wright, alleged in a class action suit that his employer, Atech Logistics, Inc., wrongly withheld more taxes than they should have. Wright alleged unpaid wages and unpaid overtime as well.

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With regard to the federal tax component of his case, Wright specifically alleged that Atech improperly rounded up his Federal Insurance Contributions Act (FICA) withholding on his paychecks to the next penny “instead of down as required by 26 C.F.R. Section 31.3102-1(d).” Consequently, Wright “on behalf of a proposed class of all current and former Atech employees…[sought] a $200 statutory penalty, a declaratory judgment that Atech violated the law, and attorney’s fees and costs.”

The magistrate judge agreed with Atech’s claim that the Anti-Injunction Act and the Declaratory Judgment Act “bar Wright’s claims relating to Atech’s alleged FICA tax miscalculation.” Virtually all of the court’s analysis relies on controlling precedent in the Ninth Circuit courtesy of the very similar case Fredrickson v. Starbucks Corp., 840 F.3d 1119, 1124 (9th Cir. 2016). In Fredrickson, the Ninth Circuit ruled that the Anti-Injunction Act barred Starbucks employees’ claims of improper federal and state tax withholding that the employees alleged was “based on an improper estimate of tips received.” The Fredrickson court cited U.S. Supreme Court precedent to justify its ruling, specifically United States v. Am. Friends Serv. Comm., 419 U.S. 7, 10 (1974), a case that found an employer’s withholding of taxes to be a kind of collection that can’t be enjoined under the Anti-Injunction Act. The Wright magistrate here, in turn, cited these precedents to recommend that the district court “grant Atech’s motion to dismiss.” The magistrate states plainly that Wright and his fellow employees could not challenge their employer’s tax withholding because the employees were attempting to restrain a collection of tax in direct contravention of the Anti-Injunction Act.

The court’s ruling here presents a frustrating predicament for taxpayers like Mr. Wright. When employers actively withhold more taxes than they should, workers are seemingly left with little recourse because of courts’ sweepingly broad interpretation of a decades-old statute. Such rulings mean that taxpayers like Mr. Wright are forced to pursue other options. One such option might be a refund suit, as suggested by the court in a footnote (“he can seek a refund of any amount Atech improperly withheld.”)

This route would lead Mr. Wright down a path of paying, through withholding, taxes that he should not have to pay, in violation of the “right to pay no more than the correct amount of tax,” per the Taxpayer Bill of Rights. He would then need to file a return or make a claim on which he would somehow seek a refund of the improperly withheld taxes. If that fails, he would then possibly have to file a refund suit (six months after filing the return or within two years from a notice of disallowance) – something he could of course only do after having paid all the taxes in full thanks to the Flora rule much discussed on this blog. During this entire process, it is unclear, per that very same Am. Friends case, whether he could seek injunctive relief against his employer, because of the Anti-Injunction Act, if he continues to work for him and the employer continues to withhold improperly.

What to make of the fact that this timeline may not yield success and could be cumbersome? The Supreme Court made clear in Am. Friends that the “frustrat[ing]” or “inadequate” nature of a refund suit does not change the fact the Anti-Injunction Act bars such suits. There are at least a couple of perplexing questions that come to mind here. First, if a worker can sue their employer under the Fair Labor Standards Act (FLSA) for failure to pay them proper wages or overtime pay, why can’t a worker sue their employer for failure to pay them enough in net take-home pay after tax deductions? The same principle of adequate, proper pay under federal law would seem to apply in the case of FICA deductions as would apply in FLSA cases (and of course both FICA and FLSA are products of the same New Deal progeny of the Depression-era federal social safety net overhaul).

Second, a worker can challenge their active misclassification, for example, as an independent contractor. If the worker succeeds, and their employer is ineligible for Section 530 safe harbor protections, the employer would have to abide by the IRS SS-8 determination and start withholding income and employment taxes. The tax withholding would change in real time as a result of the worker’s action to challenge their status; no separate proceeding is required. In addition to filing form SS-8, workers can also file a Form 3949-A to report “failure to pay tax” or “failure to withhold,” among other tax violations. If workers are permitted, even with the Anti-Injunction Act on the books, to take these actions related to their employers’ withholding, why should Mr. Wright’s claims be barred?

If these results seem inconsistent, consider the vexing nature of the Anti-Injunction Act that was articulated in the Supreme Court’s aforementioned NFIB decision. In NFIB, the Court famously saved the Affordable Care Act and its individual mandate partly on the grounds that the penalty for lack of health insurance (“the shared responsibility payment”) functionally amounted to a tax that Congress had the power to create.

But the Court interestingly held that the Anti-Injunction Act was not applicable to the shared responsibility payment because Congress specifically structured it as a “penalty” rather than as a “tax” that would be couched in the language of the Anti-Injunction Act. Therefore, while the individual mandate was upheld, the tax that enforces it was considered a “penalty” that was constitutionally a tax but notably not a tax for purposes of the Anti-Injunction Act – so suits against it could be maintained and the court could rule on its merits.

If Congress decided to recategorize FICA taxes in a way that did not explicitly tie them to the language of the Anti-Injunction Act, then Mr. Wright may have gotten past the initial barrier here. However, even with the Anti-Injunction Act firmly in place, we likely have not heard the final say on this matter.

Consider that currently some employers are following through on President Trump’s recent executive order on suspension of the employee share of FICA taxes. Absent congressional action, these taxes will have to be repaid. That could lead to large amounts of FICA withholding on some paychecks right before the deadline for repayment. That could mean miscalculations and inaccuracies, whether intentional or not, that produce improper withholding on paychecks. In turn, frustrated taxpayers might turn to the courts to recoup unauthorized deductions as workers try to make ends meet during an economic crisis. It remains to be seen how all of these developments will unfold considering courts’ generally broad reading of the Anti-Injunction Act.

Why a Win for CIC Services Would Be a Win for Tax Shelters

We welcome a group of guest bloggers who filed an amicus brief in CIC Services earlier this week.  Professors Susie Morse, Clint Wallace and Daniel Hemel and attorneys at Gupta Wessler filed a brief on behalf of former government officials Lily Batchelder, Mark Mazur, Eileen O’Connor, Leslie Samuels, Stephen Shay and George Yin.  Today, they provide us with an explanation of why the Supreme Court should uphold the decision of the 6th Circuit, which held that the Anti-Injunction Act bars CIC Services’ suit.  The Supreme Court has now scheduled this argument for December 1, 2020.  Keith

This week, a group of former government officials filed an amicus brief in support of the government in CIC Services v. IRS, the Anti-Injunction Act case before the Supreme Court this term. The case involves a tax shelter promoter that seeks to prevent the IRS from imposing penalties on the promoter and its clients if they fail to comply with tax-shelter reporting requirements. A ruling for CIC Services would, as the Solicitor General emphasizes in its brief, go a long way toward gutting the 153-year-old Anti-Injunction Act. It would also—as our brief demonstrates—deal a serious blow to the IRS in the agency’s decades-long battle to combat abusive tax shelters.

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Ever since the first wave of abusive tax shelters gathered momentum in the 1960s, Congress has taken a series of actions to give the IRS tools to fight back. Those include the at-risk rules in the Tax Reform Act of 1976, the passive activity loss limitations in the Tax Reform Act of 1986 and, at issue here, the reportable transaction disclosure regime in the American Jobs Creation Act of 2004. Specifically, in the 2004 law, Congress required tax shelter promoters and their clients to disclose certain large-dollar shelter transactions to the IRS, and it enacted new penalties so that those disclosure requirements had teeth. Of particular importance to this case, Congress placed those penalties in Subchapter 68B of the Code, which means that they qualify as “taxes” for purposes of the AIA.

The disclosure regime was, by most accounts, a resounding success. Prior to the disclosure rules, the IRS often found itself “looking for the tax shelter needle in the haystack of a complicated business tax return.” By requiring parties who arrange and participate in specific potentially abusive transactions to identify themselves to the IRS or face stiff penalties, Congress made it possible for the IRS to find the needle. To be sure, taxpayers still have the opportunity to argue that their transactions claim legal tax benefits. What they can’t do any more is keep their transactions outside the IRS’s view.

The reportable transaction scheme is designed to be agile. Congress wanted the IRS, upon learning of a new shelter, to require disclosure from promoters of the shelter and their clients. Congress specifically blessed the IRS’s practice of issuing reportable-transaction designations under already-existing authority (section 6011). That regime provides for issuance of designations by the IRS via notice in the Internal Revenue Bulletin—backed by penalties under the AJCA for failure to comply. Indeed, the IRS has designated dozens of transactions in this way, starting before Congress enacted the penalties for failure to report in the AJCA and continuing in recent years. CIC Services’ substantive argument is that the IRS should promulgate these notices through Administrative Procedure Act rulemaking rather than relying on the section 6011 framework. We think the AJCA endorsed the IRS’s approach. But in any event, the only issue here is whether CIC Services can obtain a pre-enforcement injunction that would block the IRS from imposing penalties for nondisclosure.

Allowing pre-enforcement challenges to these penalties—i.e., allowing taxpayers to challenge reportable transaction designations and to delay revealing to the IRS their participation in such transactions—would have severe consequences for the effort to fight abusive tax shelters. As we detail in our brief, injunctions of the sort that CIC Services seeks would yield three specific effects. First, they would prevent the IRS from detecting many abusive transactions. Second, when injunctions delayed detection, it would be likelier that the statute of limitations would lapse before the IRS could assess taxes that are rightfully owned. Third, in cases where the IRS is able to assess taxes before the statute of limitations runs out, delaying assessments would increase the risk of non-collection. The longer the delay, the likelier it is that taxpayers will have spent down their assets or moved their wealth beyond the IRS’s reach.

The petitioner wants to cast its effort in a different light. By its telling, the case has nothing to do with tax shelters at all. Petitioner tells the Court in its brief that its micro-captive products allow for “customized” risk management and a “more seamless claims process,” though it advertises itself to clients as a provider of a “legal tax shelter” that “can often double a business owner’s wealth.”

As readers of Procedurally Taxing know, petitioner’s argument received support from Professors Fogg and Book, who joined with the Center for Taxpayer Rights in an amicus brief opposing the Sixth Circuit’s interpretation of the AIA. Their brief argues that low-income taxpayers are especially disadvantaged when forced to rely on the AIA’s required remedy of post-enforcement judicial review. As Professor Fogg has written, under the Flora full-payment rule, in practice this can mean that post-payment judicial review for low-income taxpayers who face failure-to-report penalties is out of reach. And as Professor Book has written, the government’s approach to enforcing the tax law applicable to low-income taxpayers may excessively target taxpayers who make unintentional mistakes and lack access to constructive government guidance about how to comply.

Like Professors Fogg and Book, the authors of this blog post are concerned about the interaction between tax law enforcement and the situations faced by low-income taxpayers. But we think the remedy is to relax the full-payment rule in cases where it forces hardship for low-income individuals, and not to exempt CIC Services from the Anti-Injunction Act’s plain text.

The immediate result of a ruling for CIC Services would be to make it easier for tax-shelter promoters and their predominantly high-income clients to avoid paying the taxes they owe. That would result in less revenue overall, and more of the federal tax burden would be borne by lower-income taxpayers. The distributive result would be regressive.

Also, a ruling for petitioner is unlikely to provide relief for low-income taxpayers fighting the IRS. Petitioner’s theory is that it is challenging a “regulatory mandate” unrelated to its own tax liability. “Win or lose,” petitioner says in its brief, “the IRS will collect no additional revenue from CIC.” Petitioner accepts that taxpayers litigating about their own liabilities are covered by the Anti-Injunction Act but asks the Court to distinguish tax shelter promoters like CIC Services who are litigating about penalties for failure to disclose other taxpayers’ transactions. 

We agree with the government that the distinction that CIC Services draws is not a valid one. (Whether CIC Services wins or loses will affect the ability of the IRS to collect penalties from CIC Services itself under §§ 6707 and 6708—penalties that Congress has deemed to be taxes.) But let’s imagine that the Court disagrees and accepts CIC Services’ argument. That helps tax shelter promoters, but what does it accomplish for low-income taxpayers seeking to claim the earned income tax credit or the child tax credit? They are arguing about their own taxes and tax credits. 

In addition, a ruling for the government in CIC Services would leave undisturbed any equitable exceptions to the Anti-Injunction Act, which would allow low-income taxpayers to seek prepayment remedies in a case of clear government overreach. In the Bob Jones case, the Court said that such an equitable exception could be available where a plaintiff can show both a “certainty of success on the merits” and “irreparable injury.”  CIC Services has not sought that exception, and as our brief argues, it would not be eligible anyway. But Bob Jones may provide relief for low-income taxpayers in situations like the ones that Professors Fogg and Book highlight.  

The AIA lies at the foundation of federal tax administration and the modern tax shelter disclosure regime. That regime relies on a nimble IRS, backed by the threat of penalties for failure to disclose. Permitting tax shelter promoters to resist disclosure requirements with strategic lawsuits and pre-enforcement injunctions would mean trouble for tax collection.

Center for Taxpayer Rights Files Amicus Brief in Support of CIC in Supreme Court

Readers are likely familiar with CIC v IRS, which we originally discussed back in 2017 when a federal district court in Tennessee dismissed a suit that a manager of captive insurance companies and its tax advisor had brought that sought to invalidate IRS disclosure obligations on advisors and participants in certain micro captive insurance arrangements. Having made its way through a Sixth Circuit opinion affirming the district court and a colorful and divided denial of a request for an en banc hearing, the Supreme Court granted cert earlier this spring. 

This week the Center for Taxpayer Rights, under the leadership of Nina Olson, filed an amicus brief in support of CIC, with Keith, Carl Smith, and Meagan Horn of Thompson & Knight LLC, on behalf of the Harvard Tax Clinic, and I, all as counsel for the Center.

The issue in the case involves whether the Anti Injunction Act (AIA) shields the IRS’s information gathering requirements issued in IRS Notice 2016-66 from APA scrutiny outside traditional tax enforcement proceedings. The Sixth Circuit reasoned that the presence of a potential penalty for failing to comply with the Notice that would be assessed in the same manner as taxes shielded the IRS from pre-payment APA review. 

The case provides an opportunity to explore the reach of the AIA in light of a number of recent developments, including the 2015 Supreme Court opinion in Direct Marketing Association v Brohl and recent scholarship from Professor Kristin Hickman and Gerald Kerska calling into question whether the AIA should bar pre-enforcement challenges.

Our brief requests that the Supreme Court reverse the decision of the Sixth Circuit because in our view it improperly restricts taxpayers from challenging certain IRS requests for information in situations where the taxpayer is not bringing suit to contest the underlying merits of the tax liability. 

In our brief, consistent with the mission of the Center for Taxpayer Rights, which is dedicated to furthering taxpayers’ awareness of and access to taxpayer rights, we highlight the potential negative effect that the Sixth Circuit’s approach may have for a wide spectrum of taxpayers, including low income taxpayers. To bring that point home we explore past IRS practices requiring information from refundable credit claimants and the possible harm that future information reporting efforts could have on participation and the welfare of low income taxpayers .

As we discuss in the brief, we believe that the Sixth Circuit’s holding is inconsistent with the Court’s holding in Direct Marketing Ass’n v. Brohl:

[Direct Marketing] demonstrates that the AIA’s reach is limited with respect to challenges to requests for information by taxing authorities. The Internal Revenue Service cannot avoid this limitation by threatening taxpayers with a penalty if they do not comply with the rule-making (even if such penalty is “assessed and collected in the same manner as taxes” under the Code). If the Sixth Circuit’s overly broad interpretation stands, low-income taxpayers will be subjected to potentially severe adverse effects. The IRS will hold the unilateral right to shield their rule-making from APA scrutiny by choosing to include the right to impose a potential penalty for noncompliance. The low-income taxpayer will be at the mercy of the IRS in these circumstances with no practical ability to contest the rule-making authority of the IRS without first violating the rule established by the IRS and then paying the full amount of the penalty imposed.

The case is teed up for the fall term, and there will likely be many amicus briefs filed in the coming days.

Update: late yesterday CIC filed its opening brief, emphasizing that challenges to tax reporting requirements that are backstopped by penalties should not implicate the AIA. The brief explores the implications of Direct Marketing, questions whether the presence of an assessable penalty should meaningfully distinguish the case from Direct Marketing, argues that the Sixth Circuit’s holding furthers neither the interest of the APA or the AIA, and considers the practical consequences of an approach that prevents challenges until after a potentially sizable penalty is assessed.

For readers interested in a nuance, I note that CIC’s brief raises an issue that lurks below the main issue, namely whether the AIA is a jurisdictional statute or merely a claim processing rule (see page 23). That issue is teed up because CIC argues that the principle that jurisdictional rules should be clear merits a finding that it should be able to bring the challenge. The brief does not, however, concede on the issue that the AIA is jurisdictional , and in so doing refers to a concurring opinion by now Justice Gorsuch in the 2013 Tenth Circuit Hobby Lobby opinion. I explore the issue of whether the AIA is jurisdictional in the upcoming update to Chapter 1.6 in Saltzman Book IRS Practice and Procedure. The issue of whether the AIA is jurisdictional may be more important if the Supreme Court affirms the Sixth Circuit.