With my colleague Marilyn Ames we are revising our subchapter on the Anti-Injunction Act in Chapter 1 of Saltzman and Book IRS Practice and Procedure to take into account last month’s CIC Services decision. Embedded in our discussion of the AIA is a discussion of its cousin, the Declaratory Judgment Act. Under the Declaratory Judgment Act, a federal court may issue a declaration resolving the parties’ competing legal rights “[i]n a case of actual controversy within its jurisdiction, except with respect to Federal taxes.”
Gilbert v US is a recent Ninth Circuit opinion that discusses and applies the DJA in the context of a contract dispute between a foreign entity that owned Arizona property and the Gilberts, US citizens that bought the property. In this post I will discuss the case and the somewhat unusual path that led to the court’s finding that the DJA prevented the court from reaching the merits of the dispute.
read more…The Gilberts entered into a contract to buy residential property in Arizona. The contract called for a $1.2 million purchase price to be paid over the course of about five years. A few years into the contract and the Gilberts informed the seller that future payments were subject to withholding under the Foreign Investment in Real Property Tax Act (FIRPTA) and the Fixed, Determinable, Annual, or Periodical income (FDAP) rules. The sellers disagreed, informing the Gilberts that they were exempt nonresidents. The Gilberts sought a declaratory judgment from a federal district court that would establish that withholding money from their agreed purchase price to pay the federal taxes required under FIRPTA and the FDAP rules was not a breach of their real estate contract.
The district court dismissed the case and the Ninth Circuit affirmed. In dismissing the case, the Ninth Circuit summarized US withholding rules. FIRPTA applies to non US sellers of US real estate and triggers a withholding requirement on a purchaser to ensure that funds to pay the required taxes are collected under FDAP rules.
The Gilberts argued that the DJA did not apply because they were seeking an order with respect to their obligations to withhold on behalf of another’s liability. Moreover, according to the Gilberts, since there had yet to be an assessment or collection of taxes, the order would not restrain assessment or collection.
The Ninth Circuit disagreed. In doing so, it noted that while the DJA’s language sweeps more broadly than the AIA (it covers all actions “with respect to taxes” rather than the AIA’s “for the purpose of restraining the assessment or collection of any tax”) courts have applied the statutes coextensively. Looking to AIA cases, the court noted that the cases do not require assessment to apply. Here, as the Ninth Circuit noted and citing the 4th Circuit case International Lotto Fund case, withholding is a method of tax collection, and there is no “justification for treating withholding from a foreign corporation as anything other than the collection of a tax.”
The opinion also acknowledges that the Gilberts were not seeking to stop the government from collecting taxes but instead “seek to comply with their asserted FIRPTA and FDAP obligations but in a way that avoids any adverse contractual consequences.” Despite that intent, the opinion concludes that the action is barred, emphasizing that a prepayment determination on FIRPTA and FDAP would be binding and undermine the standard refund procedures:
The Supreme Court has recognized that the government’s vital interest in securing tax revenues justifies a “pay-first, litigate-later” system of judicial review. See Flora, 362 U.S. at 164 & n.29. The Gilberts’ attempt to litigate the existence, or extent, of their withholding obligation before paying withheld funds to the government departs from this longstanding principle. There can be no dispute that the ultimate issue in this case is the parties’ tax obligations flowing from their real estate transaction. And even though the Gilberts are not seeking to avoid tax liability, Congress has made clear that the court lacks jurisdiction over their request for declaratory relief. 28 U.S.C. § 2201(a).
CIC Services came out a few days before Gilbert but the Ninth Circuit does not cite it or address its impact. While withholding and information reporting are closely connected tools to address the tax gap, actions like this that have a direct impact on tax collection differ from challenges to reporting regimes. While CIC Services suggests a focus away from the downstream circumstances withholding is a method of tax collection rather than a regulatory mandate. The DJA and AIA are still formidable hurdles to consideration of disputes that relate, even indirectly, to tax liability.
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I just read the opinion in Gilbert. It does not address CIC and cannot be reconciled with CIC. My only question is whether the government confesses error or waits for the Ninth Circuit/Supreme Court to do it for them.
The Gilbert courts lack jurisdiction. A government concession cannot confer jurisdiction.
Third-party withholding and collection regimes are not all created alike. Some are more remote from (further upstream from) tax collection than others. The reportable transaction example in CIC was quite far away from the collection of material advisor penalties, let alone taxes assessed on participants in reportable transactions. Other regimes are closer to tax collection. For instance FATCA collects information about specific taxpayers — that’s closer than reportable transaction reporting. Even closer to tax collection is 1099 reporting, because of the intertwined relationship of 1099 reporting and tax filing, including line-item checks of 1099-reported items and obligations in some cases to backup withhold. W-2 reporting is even closer to tax collection than 1099, since it is a record of taxes actually withheld and remitted with respect to wages. FIRPTA in this case seems most like the W-2 category if it involved the remittance of taxes. It does not seem inconsistent with CIC Services, even if the language of the Declaratory Judgment Act were as narrow as the AIA language considered in CIC Services, and as Les’ post points out the language referring to taxes is broader in the DJA compared to the AIA.
1099 reports taxes actually withheld and remitted with respect to 26 USC section 3406. That’s how an IRS employee was able to embezzle those withholdings and get jailed. 26 USC section 31 says those withholdings shall be credits but courts disagree.
i.e., “Third-party withholding, collection and reporting regimes are not all created alike.”
At what point did this case become moot? The foreign seller (Namaca) today owns the real estate. They recorded a Notice of Forfeiture in December 2017, but perhaps that default was defective because another Notice of Forfeiture was recorded in December 2019. A May 2019 deed shows the Gilberts at the same address but buying another home nearby for $1.7 million to use as primary residence.
In 2011 the Gilberts were living about three miles farther north, when IRS recorded a tax lien for $134,019 owed for 2007 and 2009 taxes. That was released in July 2015 – after their 2014 purchase from Namaca through a “contract for deed” arrangement not usually used in Arizona, and not requiring title insurance.
Meanwhile, Namaca Management (an “Unincorporated Business Trust Organization,” whatever that means) was plaintiff in a 2015 Arizona District Court case in which IRS commissioner John Koskinen was sued along with an IRS Revenue Officer. Case number 2:2015cv00257. I might look it up after I get some work done.
If you want a tour of the house, which Zillow now says is worth $2 million but another online source claims only $1.4 million, here are 31 photos:
https://www.realtor.com/realestateandhomes-detail/22114-N-90th-Ave_Peoria_AZ_85383_M22948-35291