The Supreme Court held that a suit brought by a company that was a material adviser to taxpayers engaging in microcaptive insurance transactions, challenging the validity of Notice 2016-66, which imposes information reporting requirements on taxpayers engaging in microcaptive insurance transactions and their material advisers with respect to the transactions, was not precluded by the Anti-Injunction Act.
Background
As a part of the American Jobs Creation Act of 2004, P.L. 108-357, Congress enacted Sec. 6707A. This Code section delegates authority to the IRS to identify and gather information about potential tax shelters. Under that authority, the IRS requires taxpayers and certain third parties to maintain and submit records pertaining to any "reportable transaction[s]." In November 2016, the IRS identified certain microcaptive insurance transactions as reportable transactions in Notice 2016-66.
Notice 2016-66 states that taxpayers entering into the reportable transactions described in the notice must disclose the transactions to the IRS under Sec. 6011, and material advisers associated with such transactions have disclosure and list maintenance obligations under Secs. 6111 and 6112. The notice also provides that persons who fail to comply with it are subject to civil "penalty" under Secs. 6707(a), 6707A, and 6708(a). Under Sec. 7203, taxpayers and material advisers that willfully fail to meet the reporting requirements are subject to criminal penalties.
CIC Services LLC is a manager of captive insurance companies that qualifies as a material adviser to taxpayers participating in microcaptive insurance transactions. The company believed it was subject to Notice 2016-66's disclosure requirements for material advisers and that complying with those disclosure requirements would cause it to incur significant costs.
Before the first reporting date specified in the notice (and, thus, before it committed a reporting violation or incurred any penalty for doing so), CIC filed suit in district court, asking the court to declare Notice 2016-66 invalid and to enjoin its enforcement. CIC asserted that the notice was invalid because the IRS violated the Administrative Procedure Act (APA) by issuing it without notice-and-comment procedures and that the notice is arbitrary and capricious under the APA because it imposes new reporting requirements without proven need.
The IRS moved to dismiss the action based on the Anti-Injunction Act (Sec. 7421). The Act provides: "[N]o suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person." The practical effect of the Act is that a person can typically challenge a federal tax only after paying the tax and suing for a refund. Under Sec. 6671, the civil penalties the IRS can impose under Notice 2016-66 are deemed to be taxes for all Code purposes, including the Anti-Injunction Act. Thus, the IRS argued, the relief sought by CIC would prevent the IRS from assessing a tax penalty against material advisers, in violation of the Act. According to the IRS, the correct way for CIC to challenge the notice was to disobey its reporting requirements and sue for refund of any penalty resulting from its failure to meet the requirements.
The district court agreed with the IRS and dismissed CIC's suit because it was barred by the Anti-Injunction Act. On appeal, the Sixth Circuit affirmed the district court's decision. CIC then filed for certiorari with the Supreme Court, which agreed to hear the case.
The Supreme Court's decision
In a unanimous decision, the Supreme Court held that CIC's suit to enjoin enforcement of Notice 2016-66 did not violate the Anti-Injunction Act and could go forward. The Court concluded the suit did not violate the Act because CIC's purpose in bringing the suit was to challenge the legality of Notice 2016-66 and prevent enforcement of the notice's reporting rules, not to block any tax that might arise out of violations of those requirements. The Court also found that its holding would not weaken the Anti-Injunction Act and cause a substantial increase in the number of pre-enforcement suits brought by taxpayers.
Purpose of the suit: The Court found that the issue in the case was best stated as "whether the Anti-Injunction Act bars CIC's suit complaining that Notice 2016-66's reporting requirements violate the APA." Because the Act bars a suit "for the purpose of restraining the assessment or collection of any tax," the Court found that the purpose of the suit determines whether it violates the Act. In considering a suit's purpose, the Court determined that the proper inquiry is not into a taxpayer's subjective motive for the suit but into the suit's objective aim, which is, essentially, the relief the taxpayer requested.
CIC and the IRS disagreed about the proper characterization of the purpose of CIC's suit. CIC argued the suit's aim was to invalidate Notice 2016-66 and thereby eliminate its reporting requirements — not to block the downstream tax penalty that might be assessed if a taxpayer did not meet the requirements. The IRS contended that the suit's purpose was to stop the collection of the tax itself. The IRS reasoned that because the notice is enforced through tax penalties, enjoining its enforcement meant preventing the IRS from collecting taxes. According to the IRS, avoiding the reporting requirements of the notice and avoiding the tax for failing to comply with the requirements were "two sides of the same coin." Thus, by framing this suit as an attack on Notice 2016-66, CIC was trying to "eva[de] the Anti-Injunction Act through artful pleading."
The Court found that the company was asking for injunctive relief from Notice 2016-66's reporting rules because it was procedurally and substantively flawed and was not asking for relief from any impending or eventual tax obligation. The Court concluded that a request in an APA action to "enjoin the enforcement" of an IRS reporting rule is most naturally understood as a request to "set aside" that rule, not to block the application of a penalty that might be imposed for some violation that has not yet occurred.The Court also rejected the IRS's
argument that an injunction against Notice 2016-66 would be the same as one against the tax penalty. It found that three aspects of the regulatory scheme refuted the idea that CIC's suit was "a tax action in disguise."
First, the Court stated that Notice 2016-66 imposes affirmative reporting obligations, inflicting costs separate and apart from the statutory tax penalty. Therefore, by the suit, CIC was attempting to avoid the nontax costs of complying with a nontax reporting requirement. While having the notice invalidated would remove the possibility of the tax penalty, the Court found that this would be the suit's aftereffect.
Second, the Court observed that Notice 2016-66's reporting rule and the statutory tax penalty are several steps removed from each other; to owe any tax, CIC would have to first violate the notice, the IRS would then have to find noncompliance, and the IRS would further have to exercise its discretion to levy a tax penalty. The Court determined, as the IRS admitted in oral arguments, that where the chain of connection between an upstream duty and a downstream tax is too attenuated, a suit challenging the duty should not be viewed as aiming to restrain the assessment or collection of a tax. Here, because CIC was not yet near the "cusp of tax liability," the Court found it was hard to characterize the company's suit's purpose as enjoining a tax.
Third, according to the Court, the possibility of criminal penalties in addition to civil penalties, "clinches the case for treating a suit brought to set aside the Notice as different from one brought to restrain its back-up tax." The IRS's proposed alternative procedure of having a person disobey Notice 2016-66, pay the resulting tax penalty, and then bring a suit for a refund, could subject the person to criminal penalties. The Court stated that the possible criminal penalties were "not the kind of thing an ordinary person risks," so they practically necessitated that a person bring a pre-enforcement suit rather than a refund suit and that the suit be aimed at eliminating the notice rather than the downstream tax penalty.
The IRS also argued that a ruling in favor of CIC would "enfeeble" the Anti-Injunction Act. In the IRS's eyes, if CIC was allowed to move forward with its suit, a wave of pre-enforcement suits will follow, with plaintiffs asserting nontax reasons (including objections to regulatory demands) for contesting the imposition of taxes.
The Court stated that this was not the case because CIC's suit did not offend the Anti-Injunction Act because it did not challenge a tax, but instead it sought relief from a regulatory mandate that was separate from any tax. The Court explained that in the case of a challenge to any revenue-raising tax, such as a tax assessed on earning income, selling stock, or entering into a business transaction, the Act would still bar pre-enforcement actions. Furthermore, the Act would continue to apply to a regulatory tax (i.e., a tax designed to influence private conduct rather than raise revenue) because the Supreme Court had held previously that the Anti-Injunction Act applied equally to both types of suits, even if the suit was brought to challenge the effect of the regulatory tax. The Court noted that if the IRS had imposed a tax on microcaptive transactions, a suit challenging the tax would have been barred by the Act; however, the IRS had chosen to address its concerns through a nontax reporting obligation, and thereby suits contesting the IRS's response were not subject to the Act.
Reflections
While CIC has won a battle, it is a long way from winning the war. The case will now move back to the district court, where the company will present its arguments on the always thorny issues of whether an agency rule is a legislative rule subject to the APA notice-and-comment procedures or an interpretative rule that is not, and whether under the APA the rule is an arbitrary and capricious exercise of the IRS's rulemaking power.
If CIC is ultimately successful, however, its victory may not mean much to taxpayers that are engaging in questionable microcaptive transactions. The IRS has made abusive microcaptive transactions a priority issue, and if it is denied the information required to be reported by Notice 2016-66, it will develop other ways of identifying such transactions. Moreover, if the courts invalidate Notice 2016-66, the IRS will likely respond by imposing new reporting requirements in a way that avoids whatever APA problems the courts identify with Notice 2016-66.
CIC Services, LLC, No. 19-930 (U.S. 5/17/21)
