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

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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.

Comments

  1. Robert Kantowitz says

    With all due respect, this blog post is much more a political manifesto than a legal analysis.

    1. Whether or not the TIA applies here is a question of law that depends not one whit on policy issues like whether (i) the IRS is too inept to find tax shelter activity or the law makes it too easy to hide, (ii) one result or another is regressive or redistributive or whether the indigent are disadvantaged by the Flora rule or by lack of access to good advice or (iii) whether the promoters or their customers will get away with not paying their “fair share” (a political, not legal, term). In that regard, the petitioner is correct that the fact that this arises in a tax shelter context is just not relevant.

    2. The purpose of the TIA was to prevent the undue delay or interdiction of tax collection. Rooting out tax shelter activity is just not a collection of tax, and where penalties are codified is not relevant; Congress can put them in Title 26 of the USC to its heart’s content, but that does not make them taxes subject to the TIA. The first Obamacare case established that something can be a tax even if Congress expressly says that it is not a tax. The case currently on appeal to the Supreme Court may well hold that a so-called tax that raises no revenue is, by definition, not a tax. As I have written in the NY State Bar Ass’n Journal (“Grand Larsony”), an alleged promoter’s liability to pay an enormous amount that looks like the litany of round numbers in Title 18 and bears no rational relationship whatsoever to an amount of tax that the promoter allegedly or actually wrongfully failed to pay may have crossed the line from tax to criminal punishment. If the IRS presses too hard here, they may lose not only on the TIA but on the standard of proof to impose a tax shelter-related penalty and possibly on the whole scheme as excessive under the Eighth Amendment. (Of course, taxes have been held not to be criminal penalties, but that was long ago; when Flora was decided over 60 years ago, the amount at issue could have bought a new Cadillac for each of the nine Justices, but it was minuscule compared to what is at issue in tax shelter cases.)

    Congress can fix some of this, but not all of it. The best remedies are (i) low interest rates, so deferrals are less valuable, (ii) reductions in the top marginal rates, so it is worth less to play around, and (iii) simplification of rules and definitions so there is less to play with and so that what is going on will be more obvious from a tax return.

  2. @ Robert: you say “Rooting out tax shelter activity is just not a collection of tax.” That is the conclusion that CIC wants the Court to adopt. CIC says collection of information is not collection of tax. But one can reasonably think otherwise: collection of information is a tax collection tool just like tax withholding is a tax collection tool. At least that is what Congress thought in War Revenue Act of 1917 when it first required third parties to submit “returns of information” to the IRS. See 40 Stat. 300, 336-337. The Finance Committee explained how third-party information reporting was a substitute for the previous collection strategy of tax withholding:

    “The proposed amendment is 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 of prime importance from a viewpoint of collections. *** It is the Treasury Department’s judgment based upon close observation and study of the…withholding feature of the income tax law…that information at the source is a foundation upon which the administrative structure must be built if the income-tax law is to be rendered most effective….” Sen. Rpt. 65-103 (August 6, 1917) at 20.

  3. Jack Townsend says

    I agree with the amici that a Supreme Court reversal would be a win for tax shelters. I also think there would be other unintended consequences and would only, well at least principally, benefit only well-heeled taxpayers and might redound to the detriment of the rest of us.

    What also concerns me is an irrelevancy slapped into the majority panel decision (925 F.3d 247, 258 (Clay)) and picked up in dissent on rehearing (936 F.3d 501, 507 (Thapar)) that the IRS does not follow the rules of administrative law, including specifically the APA. Those judges must have thought it important to make this statement (the majority panel states it in its Conclusion). Even if that statement were true, it was not relevant to the outcome in the case as presented in the panel majority or even to the dissenting opinion on rehearing. That alone might the reason that most of the amicus briefs and the Solicitor General’s brief for the IRS ignored it. (See below.) Beyond being irrelevant to the outcome, however, the notion is just wrong in my opinion.

    The appellate opinions cite one source for the notion, Professor Hickman and a co-author in a law review article. Professor Hickman has made the argument for a long time. As best I can understand her principal support for the notion is that Treasury’s long-time practice of making Temporary Regulations issued under Section 7805 immediately or even sometimes retroactively effective violates the APA. The basis for her argument, as I understand it, is that Section 7805 confers legislative regulation authority rather than interpretive regulation authority. What’s the difference? Legislative regulations can generally be effective only 30 days after promulgation of the final regulation after notice and comment and reasoned decisionmaking. In effect, the argument is that Temporary Regulations intended to be effective and apply to conduct before the final regulations are promulgated violate the APA. The argument is correct only if Section 7805 regulations are legislative in the meaning of the APA.

    If, however, Section 7805 regulations are interpretive, under the APA, Temporary Regulations can be immediately effective without a good cause statement because interpretive rules are not subject to notice and comment and reasoned decisionmaking before they can be effective. Indeed, interpretive regulations can be retroactive, a no-no for legislative regulations. Retroactivity would be subject to the limits in Section 7805(b), but there are no limits other than prudential on retroactivity for interpretive regulations for statutes enacted before the 1996 effective date of the amendment to Section 7805(b)). So, if regulations, whether final or Temporary, issued under § 7805 are interpretive, the basis for the claim that the IRS has not historically complied with the APA is wrong because they are exempted from APA compliance required for legislative regulations. And to close the loop, I argue that Section 7805 regulations are interpretive and that Section 7805 does not grant legislative rulemaking authority.

    I am concerned that the Supreme Court might pick up that notion and repeat it, as it were relevant, important, and true, as did the majority and the dissenter in the CIC appellate opinions.

    I see that the notion is asserted in the following briefs, but is not mentioned by the other briefs:
    • petition for cert (pp. 28-29)
    • petitioner brief (p. 33)
    • amicus brief for Americans for Prosperity Foundation (p. 17)

    Interestingly, Professor Hickman in her amicus brief does not reiterate this notion as being relevant to the issue.

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