Oh Mann: The Sixth Circuit Holds IRS Notice Issued in Violation of the APA; District Court in CIC Services Finds Case is Binding Precedent

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Preface: This discussion of Mann Construction v US discusses the possible implications of the opinion on the remanded case of CIC Services v IRS, mentioned in the conclusion of this post. Last night in CIC Services v IRS, a federal district court in Tennessee held that the opinion in Mann Construction “is binding on this Court and applies equally to the arguments advanced by the IRS regarding Notice 2016-66 in this case. Accordingly, and for the same reasons previously stated by the Court in granting CIC’s motion for preliminary injunction…, Notice 2016-66 is a legislative rule that is invalid because the IRS failed to observe notice-and-comment procedures required by the APA. ” The district court also held that the notice was “set aside under the APA because the IRS acted arbitrarily and capriciously in issuing the Notice.” In finding that the IRS acted arbitrarily and capriciously, the court explained that the IRS insufficiently examined the relevant data and failed to articulate a satisfactory explanation for its decision to designate micro-captive transactions as a “transaction of interest” based on the potential for tax avoidance or evasion. In fashioning relief, the court decided to vacate the notice in its entirety, resolving the debate discussed below as to the appropriate remedy. We will discuss CIC Services v IRS more in a later post. Les

In reversing a federal district court opinion, the Sixth Circuit in Mann Construction v US held that the IRS’s issuance of a 2007 notice including certain employee-benefit plans featuring cash-value life insurance policies as listed transactions was invalid because the IRS issued it without providing notice or the opportunity for comment. The case is significant; it is a forceful repudiation of the IRS’s penchant for sidestepping the normal regulatory process and yet another circuit court opinion that views IRS action through the same administrative law prism that applies to other agencies.

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As background, Congress added Section 6707A to the Code to help fight shelters and abusive transactions. The statute permits the IRS to penalize the failure to provide information concerning “reportable” and “listed” transactions. While reportable and listed transactions are statutorily defined, over the years the IRS has issued notices, rather than regulations after notice and comment, to identify reportable and listed transactions that in the absence of recordkeeping and reporting can generate hefty civil penalties.

Mann Construction, and its owners, failed to comply with the reporting obligations for its investment in the employee-benefit plan that was identified in the 2007 notice.

The IRS assessed penalties, and Mann Construction filed a refund claim and eventually a suit that after some preliminary procedural skirmishes was narrowed to considering whether the 2007 notice was a legislative rule under the APA that was improperly issued without public notice and comment.

At the district court, the IRS argued that its notice was an interpretive rule, such that it was not required to issue and promulgate the rule only after notice and comment.

In the alternative, the IRS argued that Congress excepted the IRS from the normal notice and comment requirements when it came to fighting the scourge of tax shelters. That alternative argument brings into sharp focus 5 USC § 559, which limits the ability of a subsequent statute (like IRC § 6707A) to modify or supersede the APA’s procedures “except to the extent that it does so expressly.” 

The district court opinion rejected the government’s primary argument that the notice was an interpretive rule, but still held in favor of the government because it agreed with the government’s alternative argument.

At the district court, the opinion referred to the 2004 addition of Section 6707A, which defined “reportable transactions” by reference to Treasury regulations that had been issued following notice and comment and permitted the IRS to identify those transactions through “notice, regulation, or other form of published guidance.”

In summary, the district court found that in adding Section 6707A, and in subsequent legislative amendments to the statute, Congress expressed a clear intent to deviate from the norm of notice and comment rulemaking.  In essence, the district court found that there was enough evidence to find an express legislative directive for the IRS to skip notice and comment when it came to identifying reportable and listed transactions.

On appeal, the Sixth Circuit panel reversed. First, like the district court below, it rejected the government’s primary argument that the rules themselves were interpretive and not required to be issued after notice and comment:

The Notice has the force and effect of law. It defines a set of transactions that taxpayers must report, and that duty did not arise from a statute or a notice-and-comment rule. It springs from the IRS’s own Notice. Taxpayers like Mann Construction had no obligation to provide information regarding listed transactions like this one to the IRS before the Notice. They have such a duty after the Notice. Obeying these new duties can “involve significant time and expense,” and failure to comply comes with the risk of penalties and criminal sanctions, all characteristics of legislative rules.

(Citing Kristin Hickman’s article Unpacking the Force of Law, 66 Vand. L. Rev. 465, 524 (2013))

I will not dig deeper into the legislative versus interpretive muddy waters other than to note that not everyone agrees with the Sixth Circuit’s approach; see Jack Townsend, Sixth Circuit Invalidates Notice Identifying Listed Transaction Requiring Reporting and Potential Penalties:

There is no question that the Treasury made a rule by regulation that, under any fair reading, permits Treasury to identify listed transactions subject to the reporting requirement by guidance documents, such as Notices, without notice-and-comment regulations. Since Congress clearly intended Treasury to have law-making authority as to reporting transactions within the scope of § 6011(a) and, as a result, permitting penalties for failure to meet the requirements, it seems to me that the “law” is (or should be) that persons subject to the reporting requirement in the regulation by identification in the Notice is sufficient to sustain the penalties.

(For those wanting a deeper dive from Jack, see The Report of the Death of the Interpretive Regulation Is an Exaggeration, which is up on SSRN).

Where the Sixth Circuit parted with the court below is that it held that Congress’s actions did not amount to an express repudiation of the APA’s notice and comment requirements.  In finding that Congress in Section 6707A did not disrupt the APA’s requirement for an agency to issue a legislative rule using notice and comment, the Sixth Circuit held that the statute did not expressly deviate from that norm:

Note to begin the absence of any express variation of the APA’s notice-and-comment procedures. The statutes do not say anything, expressly or otherwise, that modifies the baseline procedure for rulemaking established by the APA. Id. §§ 6011, 6707A. Nor did Congress expressly displace those requirements by creating a new procedure for these regulations. The statutes do not provide any “express direction to the” agency “regarding its procedure” for identifying reportable and listed transactions, let alone procedures “that cannot be reconciled with” notice-and-comment requirements or any other indication within the statutory text that “plainly expresses a congressional intent to depart from” the normal APA procedures. Asiana Airlines, 134 F.3d at 398. The statutes merely establish a disclosure and penalty regime for the IRS to administer. As to the statutory text, Congress did not change the background procedural requirements of the APA or otherwise indicate an exemption from those requirements in a “clear” or “plain” way that would make the APA’s procedures inapplicable to the IRS. See Lockhart, 546 U.S. at 145–46.

The opinion acknowledged that Congress was aware of the regulatory directive giving IRS the power to identify listed transactions using notices issued without notice or comment, like in this case. Yet Congressional awareness of those regulations and even subsequent acquiescence after amendments to IRC 6707A was not tantamount to the express exemption from the APA’s rules that 5 USC 559 requires.

Conclusion

As PT readers are likely aware, this is not the only high profile case involving a challenge to the IRS’s issuance of a notice to identify transactions subject to the 6707A reporting regime. The CIC Services case, currently on remand to a district court in Tennessee in a case that is appealable to the Sixth Circuit, involves another APA challenge. Unlike Mann Construction, which comes from a refund suit, CIC Services involves a pre-enforcement challenge to a 2016 notice. As you may recall CIC Services generated an important Supreme Court decision on the scope of the AIA, which allowed its pre-enforcement proceeding to survive. We now await a merits determination following cross motions for summary judgment after the district court granted a request for a preliminary injunction.

Tax Notes’ Kristen Parillo reported last week ($$) that both the government and the CIC Services have filed documents with the district court on the impact of Mann Construction. CIC Services argues that the case is fully dispositive of the issues and the Justice Department cautions the district court that there is time for the government to decide whether to seek en banc review or file a petition for certiorari with the Supreme Court.

The Justice Department response to CIC Services’ filing also highlights an issue I have previously discussed, namely the scope of a court’s remedial powers if it finds that the IRS’s notice (or other rule) was improperly issued without notice and comment or otherwise in violation of the APA.  In Mann Construction, the Sixth Circuit stated in conclusion that the notice should be “set aside”. In its letter to the CIC Services district court, the DOJ referred to the “set aside” conclusion as dicta given that the only cause of action was a refund suit and thus should not be controlling precedent. That distinction seems, at least on the surface, to matter because in Mann Construction the court was specifically applying its analysis in the context of the individualized request for relief in the form of a refund and not injunctive relief.

The skirmish on the scope of a court’s remedy should it find that the IRS acted in violation of the APA in a pre enforcement challenge is a hot issue generally in administrative law. See my post from last year, Update on CIC Services: The Scope of Relief Available if A Court Finds That An Agency’s Rulemaking Violates the APA.  We will be closely watching for further developments as APA litigation continues to make inroads in the tax realm.   

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Professor Book is a Professor of Law at the Villanova University Charles Widger School of Law.

Comments

  1. Robert Kantowitz says

    Two points. First, without notice and comment, legislative regulation is on thinner constitutional ice. There is a limit to Congress’s ability to delegate. A blanket authority, even if explicit, for Treasury just to announce broad swaths of reportable transactions and penalties might not be upheld. Second, if the only basis in Mann Construction to order the refund is the invalidity of the Notice — which is a binary question: yes or no — then the statement that the Notice is invalid appears to be the holding and controlling precedent, not dicta, even in the absence of a request for an injunction.

  2. Lance Wallach says

    I was an expert witness against CIC but left the case after my client wanted me to lie. Promoters of abusive shelters are getting bolder and the IRS is becoming more aggressive After meeting the IRS Commissioner and some of his managers I am convinced that the IRS will continue with additional resources to attack. I also respect Sean King, CIC and the good job that was done in the Supreme Court case.

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