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And Now for Something Completely Different: Supreme Court Holds Suit to Enjoin IRS Notice Not Barred by the Anti-Injunction Act by ROBERT S. HORWITZ

On May 17, 2021, the Supreme Court issued its unanimous opinion in CIC Services, Inc. v. Internal Revenue Service, holding that a suit challenging an IRS Notice regarding micro-captive insurance companies was not barred by the Anti-Injunction Act (“AIA”).[1]  We’ll start with some background.  The AIA was enacted shortly after the Civil War, in the wake of a series of lawsuits challenging the federal income tax enacted to fund the United States during the war.  It bars any “suit for the purpose of restraining the assessment of collection of any tax.”  In Bob Jones University v. Simon, 416 U.S. 725 (1974) and Alexander v. Americans United, 416 U.S. 752 (1974), the Supreme Court held that lawsuits seeking to enjoin the revocation of rulings granting the taxpayers exempt status under IRC § 501(c)(3)[2] were barred by the AIA, even though in both cases the taxpayers asserted that their suits were not to enjoin the assessment or collection of tax but to maintain donor contributions.  As a result of these twin cases, Department of Justice Tax Division attorneys were taught that any suit that would have the effect of restraining the assessment or collection of a tax was barred by the AIA unless it fell within an exception to the act.  And the courts generally accepted this argument, including the Sixth Circuit in this case and the D.C. Circuit in Florida Bankers Ass’n v. Dep’t of the Treasury, 799 F.3d 1065 (2015).  Which makes the Supreme Court’s decision potentially important.

CIC Services, Inc., is a “material advisor” to taxpayers regarding micro-captive insurance arrangements.  Because of the potential for abuse, the IRS in 2016 issued Notice 2016-66 which determined that certain micro-captive insurance arrangements were “reportable transactions.”  Under IRC § 6111, a “material advisor” for a reportable transaction is required to provide detailed information to the IRS.  Failure to comply with the reporting requirements can expose a material advisor to civil tax penalties under IRC §§ 6707 and 6707A.  Additionally, if the failure is willful, the material advisor is subject to the criminal misdemeanor provisions of IRC §7203.

CIC filed an action in district court to enjoin the enforcement of Notice 2016-66, alleging that it was issued without notice and comment procedures in violation of the Administrative Procedures Act and that it was arbitrary and capricious and unlawful.  The district court dismissed on the ground that the action was barred by the AIA and the Sixth Circuit affirmed, with one judge dissenting.

The Supreme Court framed the issue as whether the AIA prohibits “a suit seeking to set aside an information reporting requirement that is backed by both civil tax penalties and criminal penalties.”  Its answer was “NO.”

The Court recognized that the IRS has “broad powers to require the submission of tax-related information that it believes helpful in assessing and collecting taxes,” including information returns for material advisors.  It stated that “critically here” the civil penalties under §§ 6707 and 6707A are “deemed” taxes for purposes of the Code but the penalties for criminal violation are not “deemed” a tax.[3]

According to the Court, if CIC’s purpose in bringing the suit was not to enjoin the assessment and collection of any tax “it can go forward.”  In Direct Marketing Ass’n v. Brohl, 575 U.S. 1 (2015), the Court held that a suit to enjoin a Colorado law requiring out-of-state sellers to report to Colorado any sales to Colorado residents on which tax was not collected was not barred by the Tax Injunction Act[4], which prohibits federal courts from enjoining the assessment or collection of state taxes, since the Act was “not keyed to all activities that may improve a State’s ability to assess or collect taxes” but instead those “keyed to the acts of assessment [and] collection themselves.”  Thus, if Notice 2016-66’s reporting requirement was not backed by a statutory tax penalty “this case would be a cinch” and the AIA would not apply.

The issue was what was the purpose of the lawsuit.  According to the Court to determine that purpose “we inquire not into a taxpayer’s subjective motive, but into the action’s objective aim – essentially the relief the suit requests.”  This means that you look to the face of the complaint.  CIC’s complaint challenged the legality of Notice 2016-66, not the tax penalty that enforces the Notice.  The relief sought was from the Notice’s reporting obligations and not from any eventual tax obligation. 

The Court rejected the Government’s argument that an injunction against the Notice is the same as an injunction against the tax penalties under IRC §§ 6707 and 6707A for the following reasons:

  1. The Notice imposes reporting obligations that impose costs “separate and apart from the statutory tax penalty” and obeying the Notice involves significant time and expense; thus the suit seeks “to get out from under the [non-tax] burdens of a [non-tax] reporting obligation.”
  • The penalty was several steps removed from the reporting obligation imposed by the Notice (i.e., the penalty would only be imposed if CIC failed to report as required, the IRS conducted an investigation, determined noncompliance and determined to assess the penalty);
  • Violation of the Notice is punishable by separate civil and criminal penalties and, due to the potential criminal liability, it was not a situation where the CIC could pay the penalty and sue, since it would still face criminal exposure.

Rejecting the claim that CIC’s complaint was just “artful pleading” the Court stated:

That the Notice imposes an affirmative duty independent of the tax, entailing its own substantial costs; that the Notice and tax may remain forever divorced, depending on both CIC’s and the IRS’s choices; that not only the tax but also criminal penalties backstop the Notice—these facts, when combined, readily explain why CIC’s suit targets the upstream reporting mandate, not the downstream tax. And because that is the suit’s aim, the Anti-Injunction Act imposes no bar.

The Court finally rejected the Government’s in terrorem argument that ruling for CIC would result in a flood of pre-enforcement actions to shield transaction’s from tax consequences, since the cases the Government envisioned all involved conflicts over a tax and not a “separate legal mandate”:

Given that fact, the Anti-Injunction Act bars pre-enforcement review, prohibiting a taxpayer from bringing (as the Government fears) a “preemptive[ ]” suit to foreclose tax liability. Brief for Respondents 13. And it does so always—whatever the taxpayer’s subjective reason for contesting the tax at issue. If the dispute is about a tax rule—as it is in the run-of-the mine suits the Government raises—the sole recourse is to pay the tax and seek a refund.

Associate Justice Sotomayor concurred, pointing out that the result may have been different if the suit had been brought by a taxpayer and not a material advisor.  Associate Justice Kavanaugh joined the opinion but voiced his views that the opinion carved out an exception to Americans United and Bob Jones Univ.

In its panel decision in CIC Services the Sixth Circuit noted:

The problem with these ostensibly straightforward inquiries is that “courts lack an overarching theory of the AIA’s meaning and scope against which to evaluate individual [complaints].” Kristin E. Hickman & Gerald Kerska, Restoring the Lost Anti-Injunction Act, 103 Va. L. Rev. 1683, 1686 (2017). At times, the Supreme Court has given the AIA “literal force,” without regard to the character of the tax, the characterization of the preemptive challenge to it, or other non-textual factors. Bob Jones Univ. v. Simon, 416 U.S. 725, 742 (1974). At other times, it has given the AIA “almost literal” force, considering such factors with an eye towards furthering the AIA’s underlying purposes. Id. at 737, 742. The result, according to some commentators, has been “jurisprudential chaos.” Hickman & Kerska, supra, at 1686.

As Associate Justice Kavanaugh pointed out, the complaints in Bob Jones Univ. and Americans United did not on their face seek to enjoin the assessment or collection of any tax, although the Fourth Circuit in Bob Jones Univ.[5] noted that withdrawal of tax exempt status would subject both the University and its donors to increased taxes.  It appears for now that there will continue to be “jurisprudential chaos” in the application of the AIA.

Robert S. Horwitz is a Principal at Hochman Salkin Toscher Perez P.C., former Chair of the Taxation Section, California Lawyers’ Association, a Fellow of the American College of Tax Counsel, a former Assistant United States Attorney and a former Trial Attorney, United States Department of Justice Tax Division.  He represents clients throughout the United States and elsewhere involving federal and state administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions.

[1] Internal Revenue Code (“IRC”) §7421(a).

[2] Donations to an organization exempt from tax under § 501(c)(3) are deductible charitable contributions.

[3] Secs. 6707 and 6707A are contained in IRC Chapter 68B (“Assessable Penalties) and thus, under § 6671(a) are deemed tax for purposes of the IRC.  In National Federation of Independent Business v. Sebelius, 567 U.S. 519 (2012), the Supreme Court held that the challenge to the individual mandate penalty of the Affordable Care Act was not deemed a tax under the IRC and thus the AIA did not bar the suit.  I have written ad nauseam about why, in my view, the foreign information reporting penalties under Ch. 61A are not “deemed” tax and, thus, the provisions of the IRC relating to the assessment and collection of tax do not apply to those penalties.

[4] 28 U.S.C. § 1341.

[5] 472 F.2d 903.

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