D.C. Circuit Majority Opinion in Florida Bankers Not Consistent with Supreme Court’s Direct Marketing Decision (Part 1)

Florida Bankers is a challenge by two bankers associations to the validity of regulations issued by the IRS and Treasury requiring U.S. banks to report to the IRS information concerning interest earned by non-resident aliens on accounts they hold in the banks. Although this interest is not subject to income taxation in the U.S., the IRS and Treasury claim the reporting requirement is necessary in order to make it possible for the U.S. to comply with information sharing agreements it has entered into with other countries that benefit the U.S. by providing information on bank accounts held by U.S. citizens in banks in those countries.

The bankers associations argue that in issuing the regulations, the IRS and Treasury violated the Administrative Procedure Act’s arbitrary and capricious standard under 5 U.S.C. § 706(2)(A) by failing to give sufficient weight to the likelihood that some non-resident aliens would respond to the information reporting requirement by withdrawing funds from U.S. banks, not because they wish to avoid paying tax to their home countries on the interest earned on the accounts, but instead because they fear the information either will be misused by their home country governments or will not be protected by those governments against misuse by others. In the district court, the government argued that the suit was barred by the Anti-Injunction Act, section 7421(a) of the Internal Revenue Code, which provides that, with certain exceptions, such as Tax Court deficiency actions, “no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person.”

The government argued that even though the information that the banks were required to report related to interest that is not subject to income taxation in the U.S., nevertheless, the Anti-Injunction Act applied to bar the suit because of the penalty that banks would be subject to if they failed to comply with the reporting requirement that is imposed by the regulations, and because this penalty is treated as a tax for purposes of the Anti-Injunction Act, under section 6671(a) and the Supreme Court’s decision in NFIB v. Sebelius. The district court held that the Anti-Injunction Act did not apply for several reasons ( Les’ January 2014 post discussing the district court opinion, with links to that decision, can be found at APA and Challenges to Agency Guidance: Florida Bankers v US and More on Halbig v Sebelius).    First, the penalty would be imposed only if one of the banks that are members of the associations that brought the challenge violated the reporting requirement, but none of these banks has either violated the requirement or threatened to do so. The challenge is not to the penalty but rather to the reporting requirement itself. Second, the D.C. Circuit, in a 1987 decision, Foodservice and Lodging Institute, Inc. v. Regan, had held that a challenge to the validity of another information reporting requirement that did not relate directly to the assessment or collection of taxes but, that was subject to the same penalty that applied to the information reporting requirement at issue in Florida Bankers, was not barred by the Anti-Injunction Act. Finally, in Seven-Sky v. Holder, the D.C. Circuit decision addressing the same issue subsequently decided by the Supreme Court in NFIB v. Sebelius, the D.C. Circuit had noted that the Anti-Injunction Act “has never been applied to bar suits brought to enjoin regulatory requirements that bear no relation to tax revenues or enforcement.” 661 F.3d 1, at 9 (D.C. Cir. 2011).

However, the district court rejected the challenge on the merits. I have explained in two Tax Notes articles here and here why I believe the district court’s decision on the merits was incorrect. However, the D.C. Circuit did not reach the merits. Instead, the majority opinion, written by Judge Kavanaugh, held the suit was barred by the Anti-Injunction Act, and while the dissenting judge, Judge Henderson, disagreed with that conclusion, nevertheless, she did not express a view on the merits.

As noted earlier, the majority opinion in Florida Bankers is incorrect because it is clearly at variance with a Supreme Court decision that was issued in March of this year. Less than a month after the February oral argument in Florida Bankers, the Supreme Court issued its opinion in Direct Marketing Association v. Brohl. As I noted in a post here soon after that decision was issued and at greater length in a subsequent Tax Notes article, while the Direct Marketing decision did not deal directly with the Anti-Injunction Act, but instead with a different provision, the Tax Injunction Act, in a different title of the United States Code, a provision that imposes restrictions similar to those in the Anti-Injunction Act on the jurisdiction of federal district courts to hear cases involving taxes imposed by the states, nevertheless, the strong similarities between the two provisions, and the nature of the Court’s reasoning in the Direct Marketing decision, support the conclusion that the Court’s analysis in Direct Marketing would be equally applicable with respect to the Anti-Injunction Act.

Like the Anti-Injunction Act, the Tax Injunction Act prohibits suits that would “restrain” the “assessment” or “collection” of taxes. In Direct Marketing, the Court held that because the two provisions are so similar, and because the Tax Injunction Act was modeled on the Anti-Injunction Act, the words in the Tax Injunction Act should be given the narrow, technical meaning those words have in the Internal Revenue Code. According to the Court, in the Internal Revenue Code, the words “assessment” and “collection” refer to well defined and specific phases of the overall process of obtaining tax revenue, and information reporting is not part of either of those phases, even where the information being reported bears directly on someone’s tax liability. In addition, according to the Court, the word “restrain” does not mean that any suit that might have the effect of “inhibiting” the collection of state tax revenue is barred by the Tax Injunction Act.

As a result of the foregoing reasoning, the Colorado statute that was being challenged in Direct Marketing, which required out-of-state retailers to provide the state with information reports on their sales to residents of the state, was not sufficiently closely connected with the collection or assessment of tax for the challenge to be barred by the Anti-Injunction Act. Although the Court had ruled in two cases in 1974, Bob Jones University 416 U.S. 725 (1974). and Americans United 416 U.S. 752 (1974), that suits challenging the IRS’s revocation of the tax-exempt status of an organization was barred by the Anti-Injunction Act because of the effect that the challenge would have, if it were successful, on the deductibility by contributors to the organization of their contributions, and although those decisions have been interpreted by the Courts of Appeals to mean that the Anti-Injunction Act bars any suit that, if successful, could have any sort of negative effect on the collection of tax revenue, nevertheless, the reasoning and the conclusion in Direct Marketing are clearly inconsistent with that type of broad reading of the Anti-Injunction Act.

Another recent D.C. Circuit decision involving the application of the Anti-Injunction Act is Z Street v. Koskinen 791 F.3d 24 (D.C. Cir. 2015). In this case, in contrast to Florida Bankers, both the oral argument and much of the briefing came after the Direct Marketing decision. I discussed the opinion in this case in an op-ed at TaxProf Blog, and I discussed the oral argument in this case in my Tax Notes article that discussed the Direct Marketing decision. (Les also wrote on the Z Street DC Circuit opinion here).

This case involved a challenge by an organization that had applied to the IRS for tax-exempt status to a delay in processing the application that the organization alleged was caused by an “Israel special policy” that the IRS allegedly applies in processing tax exemption applications by organizations with an interest in Israel. Under this alleged policy, organizations with views on Israel that do not coincide with those of the administration are treated less favorably, at least in terms of the speed with which the applications are processed, than organizations whose views on Israel coincide with those of the administration.

The government filed a motion to dismiss the case in the district court on the grounds that the suit was barred by the Anti-Injunction Act. The applicability of the Anti-Injunction Act was the only issue before the D.C. Circuit. Because of the procedural posture of the case, the court was required to assume the correctness of the organization’s allegations regarding the existence of an “Israel special policy.”

At the oral argument, the panel was clearly very hostile to the position taken by the government. The panel expressed unhappiness with the fact that the government’s reply brief, which was filed after the Direct Marketing decision, had referred to that decision only in a footnote. That footnote argued that since the Direct Marketing decision had not cited the Bob Jones or Americans United decisions, the Direct Marketing decision should not be read as overruling those decisions by implication. The questions and comments by the panel at oral argument suggested that they viewed the Direct Marketing decision as being centrally relevant to the issue in Z Street.

Based on the oral argument, it was no surprise that the D.C. Circuit opinion in Z Street held the Anti-Injunction Act inapplicable to the case. However, the tone of the opinion was considerably milder than might have been expected based on the oral argument. In addition, the decision that the Anti-Injunction Act did not apply was not based on the Direct Marketing decision, but rather on the Supreme Court’s 1984 decision in South Carolina v. Regan, 465 U.S. 367 (1984) which held that the Anti-Injunction Act does not apply in cases where the party challenging IRS action has no other mechanism for bringing its challenge than a suit in district court. The D.C. Circuit panel held that the suit Z Street had brought in district court was the only way the organization could challenge the alleged IRS delay in processing the application.

While the Z Street opinion did not rely on Direct Marketing for its conclusion that the Anti-Injunction Act did not apply, nevertheless, there is important dictum in the Z Street opinion bearing on the relevance of Direct Marketing for the interpretation of the Anti-Injunction Act. In response to the government’s argument that Bob Jones and Americans United require a broad application of the Anti-Injunction Act under which the only way tax issues can ever be litigated is through tax refund suits and Tax Court proceedings specifically authorized by provisions of the Internal Revenue Code, the Z Street opinion noted that the D.C. Circuit had previously rejected this position in 2011 in its en banc opinion in Cohen v. United States 650 F.3d 717 (D.C. Cir. 2011). In that case, the en banc D.C. Circuit held that a suit challenging the validity of a procedure adopted by the IRS for refunding taxes that had been improperly collected was not barred by the Anti-Injunction Act. I discussed the Cohen decision in a Tax Notes article in 2011. In Z Street, the court noted that “[I]n Cohen we rejected this view of ‘a world in which no challenge to [the IRS’s] actions is ever outside the closed loop of its taxing authority.’”

Z Street then had the following observations on Direct Marketing:

Our rejection of the Commissioner’s broad reading of the [Anti-Injunction] Act finds support in the Supreme Court’s recent decision in Direct Marketing Association v. Brohl. There, interpreting the Anti-Injunction Act’s cousin, the Tax Injunction Act, which serves a similar function for federal court challenges to state taxes, the Court read “restrain” in that statute as having a “narrow[] meaning…captur[ing] only those orders that stop…assessment, levy and collection” rather than “merely inhibit” those activities….Brohl’s holding is significant here because the Court “assume[s] that words used in both Acts are generally used in the same way.”

Against this background, it would have been expected that Direct Marketing would play a central role in the D.C. Circuit opinion in Florida Bankers. And, in fact, Direct Marketing plays a central role in Judge Henderson’s dissenting opinion. Much of this dissenting opinion is what I would have expected to read in a unanimous opinion for the panel. Judge Henderson’s dissenting opinion is nearly twice as long as Judge Kavanaugh’s majority opinion. In tomorrow’s second part to the post, I will discuss the dissenting opinion, and how in my view the dissent’s view is correct in light of the developments I have discussed today.