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CIC Services Looks to Change the Tax Controversy Landscape

Posted on Dec. 14, 2020
[Editor's Note:

This article originally appeared in the December 14, 2020, issue of Tax Notes Federal.

]
Andrew Weiner
Andrew Weiner

Andrew Weiner is director of the graduate tax program and a practice professor of law at Temple University Beasley School of Law. He thanks Alice Abreu for her helpful comments and Alice Elmer for her excellent research assistance.

In this article, Weiner argues that the petitioner in CIC Services, which was recently argued before the Supreme Court, presents an unconvincing case for reading the Anti-Injunction Act to allow pre-enforcement challenges to tax rulemaking, and he explains why that interpretation wouldn’t necessarily benefit taxpayers.

Weiner previously served as lead counsel for the government in Florida Bankers Association, a case related to CIC Services. The opinions expressed in this article are his own.

Copyright 2020 Andrew Weiner.
All rights reserved.

Introduction

It is black letter tax law that taxpayers generally have two options to dispute issues of federal tax: They can either go to the Tax Court on a prepayment basis in a deficiency proceeding,1 or they can pay the asserted tax in full and sue for a refund in district court or the Court of Federal Claims.2 As Justice Sandra Day O’Connor observed, courts are limited by the Anti-Injunction Act (AIA) to resolving “concrete disputes over specific sums of money.”3 The Supreme Court’s decision in CIC Services4 will determine whether that remains the case.

The AIA provides that “no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court.”5 The plaintiff in CIC Services argues that the AIA is no bar to a pre-enforcement challenge to tax rulemaking. At issue is a pre-enforcement challenge to the validity of a reporting requirement subject to a tax for noncompliance. There is a compelling argument that the plaintiff’s particular suit should be allowed to proceed under the existing framework for applying the AIA, including a judicially recognized exception for injunction actions involving claims that otherwise have no path to judicial review. But the plaintiff advocates for a fundamental reshaping of that framework.

In this article, I argue that the Supreme Court should follow long-standing precedent interpreting the AIA and preserve the current role of judicial review in the U.S. tax system. Allowing pre-enforcement challenges is contrary to the language and purpose of the AIA, and the implications are worrisome for tax administration and taxpayers alike. It would open up a new front in disputes with the IRS based on — again quoting O’Connor — “abstract tax controversies.”6 For over a half century, the AIA has been thought to prevent such suits.

History of the AIA

Before diving into the particular dispute in CIC Services, it is useful to trace some of the history of the AIA and its role in the statutory scheme providing for judicial review of the assessment and collection of tax.

The AIA traces back to 1867, when it appeared as an amendment to the predecessor of what is now section 7422. The original statute provided:

No suit shall be maintained in any court for the recovery of any tax alleged to have been erroneously or illegally assessed or collected, until appeal shall have been duly made to the commissioner of internal revenue . . . and a decision of said commissioner shall be had thereon, unless such suit shall be brought within six months from the time of said decision.7

The AIA was added as an amendment, stating that “no suit for the purpose of restraining the assessment or collection of tax shall be maintained in any court.”8 It denied taxpayers the ability to use injunction actions as an end run around the requirement to file an administrative appeal and then sue for “the recovery of any tax alleged to have been erroneously or illegally assessed or collected.”

The “manifest purpose” of the AIA, as the Supreme Court has repeatedly recognized, “is to permit the United States to assess and collect taxes alleged to be due without judicial intervention, and to require that the legal right to the disputed sums be determined in a suit for refund.”9 The AIA moreover protects “the collector from litigation pending a suit for refund.”10 Coupled with the requirement that taxpayers file an administrative claim for refund and give the IRS an opportunity to evaluate and respond to claims before they become the subject of litigation, the AIA allows the IRS, “not a host of private plaintiffs, [to] determine the focus of the collector’s energies.”11

In 1867 there was no Tax Court or forum in which taxpayers could challenge their tax liability on a prepayment basis. Congress recognized that such suits were barred by the AIA.12 It created the Board of Tax Appeals, the predecessor to the Tax Court, to review tax disputes on a prepayment basis, and it authorized suits to enjoin assessment or collection that intruded on the opportunity for prepayment review. This became an express exception to the AIA.13 Other discrete exceptions followed, as did language that extended the AIA to suits of third parties. But the core of the AIA has remained consistent for over 150 years.

In contrast, the Supreme Court’s application of the AIA through its history has not been nearly so stable. The Court itself described “a cyclical pattern of allegiance to the plain meaning of the Act, followed by periods of uncertainty caused by a judicial departure from that meaning, and followed in turn by the Court’s rediscovery of the Act’s purpose.”14 In one particularly notorious example, Standard Nut Margarine,15 the Supreme Court declined to read the AIA as evidence of Congress’s intent “to abrogate the salutary and well established rule” that a suit to restrain the assessment or collection of a tax may be maintained when there are “special and extraordinary circumstances sufficient to bring the case within some acknowledged head of equity jurisprudence.”16 That reading, the Court would later recognize, “effectively repealed the Act, since the Act was viewed as requiring nothing more than equity doctrine had demanded before the Act’s passage.”17

The Supreme Court’s later opinion in Williams Packing18 marked a return to the plain meaning of the AIA divorced from equity. The Court construed the language of the statute as barring suits to restrain the assessment or collection of a tax, except “if it is clear that under no circumstances could the Government ultimately prevail” on the merits.19 In that event, the Court reasoned, there is no “tax” to assess or collect, rendering the language of the AIA inapplicable. To be sure, equitable relief as a general matter requires that a plaintiff show irreparable injury. But as to whether the AIA bars that relief as an initial matter, Williams Packing established that equity plays no part in that determination.

The Supreme Court next turned to the scope of the AIA in Bob Jones20 and its companion case, Americans United,21 in which the plaintiffs disavowed an intent to restrain the assessment or collection of any tax. Bob Jones University refused to admit Black students on religious grounds and advised the IRS that it had no intention of altering that policy after Rev. Rul. 71-447, 1971-2 C.B. 230, which stated that private schools with racially discriminatory admissions policies would no longer quality as tax exempt and appear on the cumulative list of tax-exempt organizations relied on by donors.22 The IRS sought to revoke the university’s tax-exempt status, which action the university claimed violated its right to the free exercise of religion.

The Supreme Court would ultimately reject the university’s argument on the merits in a landmark opinion recognizing the government’s compelling interest in eliminating racial discrimination in education.23 That was the second suit brought by the university — an action for the refund of employment tax that the university owed after it lost its tax-exempt status.

The university’s first suit, brought years earlier, sought to enjoin the IRS from revoking its tax-exempt status in the first place. In the Supreme Court, the university argued that its suit fell outside the AIA’s scope primarily for two reasons. First, according to the university, the purpose of its suit was not to restrain the assessment or collection of any tax, but rather to preserve a flow of contributions that depended on their deductibility.24 The Supreme Court rejected that argument as “belie[d]” by the university’s own allegations that it would bear substantial federal income tax liability. Anticipating the second suit, the Court also stated that the university would unquestionably owe employment taxes even if its deductions resulted in it owing no income tax.25 The Court further considered it “speculative” and “unlikely” that the university’s donors would abandon it en masse, in which case the university’s suit sought to restrain the collection of taxes from its remaining donors.26 The Court stated that the suit “falls squarely within the literal scope of the Act” because it would “necessarily preclude” the collection of all those taxes.27

Second, the university argued that Rev. Rul. 71-447 and the attendant revocation of its tax-exempt status had nothing to do with tax revenue and everything to do with regulating private schools’ admission policies.28 The Court indicated that the AIA applies regardless of whether a taxpayer purports to challenge the regulatory aspect of a regulatory tax. It invoked George,29 in which the AIA barred a suit to enjoin the child labor tax on the ground that it constituted an invalid regulation of labor practices.30 The Court also noted that the AIA draws no distinction between revenue-raising taxes and regulatory taxes.31

Had the Supreme Court gone the other way in response to either argument, that would have kicked off another cycle of departure from the meaning and purpose of the AIA. The AIA would amount to little more than a pleading exercise if plaintiffs merely had to identify a purpose for bringing suit other than restraining the assessment or collection of tax. Instead, the Court read the AIA as requiring plaintiffs to obtain judicial review through a refund action or proceedings in the Tax Court. There was no question that these avenues were available to Bob Jones University, and the AIA required it to use them notwithstanding the hardship.

Finally, in South Carolina,32 the Supreme Court confronted the opposite situation: The plaintiff lacked redress outside of an injunction action. South Carolina sought to challenge the constitutionality of a federal statute denying tax-exempt treatment to state bearer bonds as an infringement on the state’s essential right to borrow, but it had no ability to dispute the tax owed not by the state but by bondholders.33 The Court concluded that the AIA “was not intended to bar an action where, as here, Congress has not provided the plaintiff with an alternative legal way to challenge the validity of a tax.”34

CIC Services

Back to CIC Services. CIC Services LLC advises taxpayers that engage in microcaptive transactions. In a microcaptive transaction, related entities — the captive insurer and the insured — enter into an insurance contract, and the captive insurer makes an election under section 831(b) to exclude up to $2.2 million of net premium income while the insured still gets to claim deductions on those payments.35 The IRS observed that these transactions have “potential for tax avoidance or evasion.”36 For example, a policy might cover implausible risks far above market rates or double-cover ordinary risks to generate deductions on the payment of premiums.37

In Notice 2016-66, 2016-47 IRB 745, the IRS exercised its authority under sections 6011, 6111, and 6112, and reg. section 1.6011-4(b)(6) to require taxpayers that engage in microcaptive transactions to report information on transactions that meet designated thresholds and to require material advisers to provide a list of advisees and a description of the transactions.38 These reporting requirements are enforced by assessable penalties39 in subchapter 68B that are considered a tax for purposes of the AIA.40 Further, a person who “willfully fails” to satisfy a reporting requirement commits a misdemeanor punishable by a fine up to $25,000 ($100,000 for a corporation) and imprisonment up to one year.41

CIC Services brought a pre-enforcement challenge against Notice 2016-66 under the Administrative Procedure Act (APA)42 and sought to enjoin its enforcement. Both the district court and a divided Sixth Circuit panel concluded that the suit was barred by the AIA.43 The Sixth Circuit then narrowly denied a petition for rehearing en banc, in which Judge Jeffrey Sutton concurred, but in an unusual move called on the Supreme Court to address the issue.44 The Supreme Court later granted CIC Services’s petition for certiorari.

CIC Services should prevail in the Supreme Court based on reasoning the Court laid out in South Carolina — that the AIA does not bar injunction actions in which the plaintiff otherwise lacks access to judicial review. To incur the tax and bring a refund action challenging the validity of Notice 2016-66, CIC Services would need to willfully violate the reporting requirement and risk criminal prosecution.

The term “willful” in federal criminal tax statutes means a “voluntary, intentional violation of a known legal duty.”45 The fact that CIC Services believes the reporting requirement is invalid does not negate willfulness. The Supreme Court rejected that argument in Cheek, in which the taxpayer faced criminal changes for failing to file tax returns purportedly based on a good-faith belief that the Internal Revenue Code is unconstitutional. The Court explained:

Of course, Cheek was free in this very case to present his claims of invalidity and have them adjudicated, but like defendants in criminal cases in other contexts, who “willfully” refuse to comply with the duties placed upon them by the law, he must take the risk of being wrong.46

The Supreme Court has not specifically addressed whether the South Carolina exception extends to situations in which a plaintiff runs the risk of criminal prosecution in order to challenge the validity of a tax. But that seems like a small and intuitive step.47

A modest expansion of the South Carolina exception is not the result CIC Services seems to be aiming for, however. It does not even mention South Carolina until the second-to-last paragraph of its argument.48 Instead, CIC Services, along with several amici, argue that the AIA does not bar pre-enforcement review of tax rulemaking.

CIC Services’s argument, in a nutshell, is that its pre-enforcement challenge to the reporting requirement does not seek to restrain the assessment or collection of a tax that is “several steps removed.”49 But the same could have been said of the university’s suit in Bob Jones. The university sought to enjoin the IRS from revoking its tax-exempt status under Rev. Rul. 71-447 because of its racially discriminatory admissions policy — before the conclusion of administrative proceedings and any tax being owed by the university or its donors. That did not dissuade the Supreme Court from concluding that the university’s suit sought to restrain the assessment and collection of tax, because it would necessarily preclude those taxes. The AIA bars CIC Services’s suit by the same logic. CIC Services seeks to enjoin tax that would result from the failure to report information about microcaptive insurance transactions, just as Bob Jones University sought to enjoin tax that would result from its failure to change its admissions policy.

The Supreme Court should reject attempts to eliminate the AIA as a bar against pre-enforcement review, contrary to how the law has been understood for more than a half century. As discussed, the manifest purpose of the AIA is to insulate the assessment and collection of tax from judicial intervention and to channel disputes either to refund actions in district court or deficiency proceedings in the Tax Court. The availability of pre-enforcement review undermines this statutory scheme.

As a practical matter, given the amount of tax revenue taken in by Treasury, as well as Treasury’s borrowing power, the concern is less about ensuring the lifeblood of government than it is about conserving government resources needed to respond to pre-enforcement challenges. But protecting the IRS is part of what the statutory scheme is designed to do, and given the IRS’s long-standing budget constraints, its resources are at a premium.

The statutory scheme also has the effect of promoting the resolution of disputes at the administrative level, including through the requirement that taxpayers file an administrative claim for refund and impartial review by the IRS Office of Appeals. Pre-enforcement challenges bypass those mechanisms. Certainly, there are benefits to this approach; a judicial opinion determining the validity of a rule promotes clarity in the tax law. But litigation is slow and expensive, and it may be unnecessary if an issue can be resolved administratively after it has ripened into a tax dispute of a specified sum.

Still another reason not to allow pre-enforcement review lies in the collateral and unpredictable consequences, particularly for taxpayers. Pre-enforcement challenges presumably would be subject to the general six-year statute of limitations on civil actions against the United States.50 For procedural challenges like the one brought by CIC Services — claiming that the IRS violated the APA by imposing reporting requirements without notice and comment — the clock starts when the rule becomes final.51 This is true even in cases in which some plaintiffs lacked the opportunity to raise a timely claim. “Strict enforcement of the statutory time limit is necessary to preserve finality in agency decisionmaking and to protect justifiable reliance on agency rules.”52 As a result, the limitations period could nip most challenges to existing rules or new rules with latent effects in the bud.

The Ninth Circuit provided a warning along these lines in Altera,53 one of the most watched tax cases in recent years. Altera involved a procedural challenge to transfer pricing cost-sharing regulations that became effective in 2003. After a lengthy IRS examination of its 2004 return, Altera filed a timely petition in the Tax Court challenging the validity of the regulations in 2012. In the Ninth Circuit, the court invited the parties to file supplemental briefs on whether the six-year statute of limitations applied. Both parties argued that it did not, because the AIA would have barred a suit within the six-year period and because the commissioner waived the affirmative defense in any event. Altera also argued equitable tolling. The court agreed about waiver, and therefore it declined to address its own question.54 If the Supreme Court in CIC Services removes the AIA as a bar to pre-enforcement challenges, plaintiffs may be pinning their hopes on equitable tolling.

Pre-enforcement challenges would also give rise to a host of questions surrounding Article III standing. To date, scant attention has been paid to this prerequisite to bringing suit in the context of tax cases, because most challenges arise in a post-enforcement refund action or deficiency proceeding in which the standing of the party bringing suit is a given. Standing requires an injury in fact that is “concrete and particularized” and “actual or imminent,” “a causal connection between the injury and the conduct complained of,” and a likelihood that the injury will be “redressed by a favorable decision.”55 In a procedural challenge, the imminence and redressability requirements are relaxed.56 District courts recently concluded that plaintiffs have standing to challenge the validity of rules anticipated to impose compliance costs57 or tax liability.58 In both cases, however, standing was contested, based not on general principles, but on the particular circumstances and whether the alleged injury was sufficiently imminent and traceable to the rule in question. It will take time for the case law to settle on the thresholds for standing to bring a pre-enforcement challenge to a tax rule, during which time the six-year limitations period may be running. The irony is that lifting the bar imposed by the AIA is likely to increase, at least temporarily, the uncertainty of procedural challenges because plaintiffs do not face these preliminary issues in refund suits or deficiency proceedings.

This is not to suggest that pre-enforcement actions won’t increase absent the AIA standing in the way. Certainly, they would. It is worth considering how Treasury and the IRS might react to the increased scrutiny of their rules. Greater adherence to the APA would be welcome. It has been only a little more than a decade that Treasury regulations were unambiguously subject to APA orthodoxy.59 Tax rulemaking has been catching up to those requirements ever since.60 But it is unrealistic to expect that Treasury and the IRS can effectively administer and enforce the tax law solely using notice and comment rulemaking. Maintaining the integrity of our tax system requires nimble responses to potential gaps. CIC Services challenges one response of expanding the scope of existing reporting requirements by IRS notice. Treasury also has the authority under section 7805 to issue temporary regulations at the same time as proposed regulations and to apply regulations retroactively.61 In Chamber of Commerce,62 which raised a pre-enforcement challenge to temporary anti-inversion regulations that surprisingly survived the AIA, the government invoked section 7805 as allowing Treasury to do what it did by issuing temporary regulations without notice and comment. The court disagreed.63 In the event the floodgates open on pre-enforcement actions, expect Treasury and the IRS to continue to press the limits of their rulemaking authority and exercise that authority more regularly.

Conclusion

CIC Services does not lay out a convincing case for allowing pre-enforcement challenges to tax rulemaking. The language of the AIA, its purpose, and more than a half-century of Supreme Court precedent all stand to the contrary. Moreover, plaintiffs’ ability to pursue pre-enforcement challenges faces hurdles absent the AIA, and many plaintiffs may be better off raising their claims in a refund action or deficiency proceeding. When a serious impediment to those options exists, as in CIC Services, the South Carolina exception to the AIA should be adequate to the task of ensuring that those claims can be heard.

FOOTNOTES

3 South Carolina v. Regan, 465 U.S. 367, 386 (1984) (O’Connor, J., concurring).

4 CIC Services LLC v. IRS, No. 19-930 (S. Ct. 2020).

6 South Carolina, 465 U.S. at 386 (O’Connor, J., concurring).

7 Internal Revenue Act of July 13, 1866, section 19.

8 Act of March 2, 1867, section 10. The word “any” before “tax” was added by revisers after enactment. Snyder v. Marks, 109 U.S. 189, 192 (1883).

9 Enochs v. Williams Packing & Navigation Co., 370 U.S. 1, 7 (1962).

10 Id. at 8.

11 South Carolina, 465 U.S. at 387 (O’Connor, J., concurring).

12 See H.R. Rep. No. 68-179, at 7 (Feb. 11, 1924) (“Although under existing law a taxpayer may, after payment of a tax, bring suit for the recovery thereof and thus secure a judicial determination of the questions involved, he cannot, in view of section 3224 of the Revenue Statutes, which prohibits suits to enjoin the collection of taxes, secure such determination prior to the payment of the tax.”); S. Rep. No. 68-398, at 8 (Apr. 10, 1924) (same).

13 An Act to Consolidate and Codify the Internal Revenue Laws of the United States, ch. 36, section 3653(a) (1939).

14 Bob Jones University v. Simon, 416 U.S. 725, 742 (1974).

15 Miller v. Standard Nut Margarine Co., 284 U.S. 498 (1932).

16 Id. at 509.

17 Bob Jones, 416 U.S. at 744.

18 Williams Packing, 370 U.S. 1.

19 Id. at 7.

20 Bob Jones, 416 U.S. 725.

21 Alexander v. “Americans United” Inc., 416 U.S. 752 (1974).

22 Bob Jones, 416 U.S. at 735.

23 Bob Jones University v. United States, 461 U.S. 574, 604 (1983).

24 Bob Jones, 416 U.S. at 738.

25 Id. at 738-739.

26 Id. at 739 and n.10.

27 Id. at 733. The “necessarily preclude” language echoes the lower court’s opinion that “the common sense of the matter is that where as we have shown, the necessary result of granting the relief prayed would be to prevent the assessment of any tax, section 7421 is applicable.” Bob Jones University v. Connally, 472 F.2d 903, 906 (4th Cir. 1973). Determination of a suit’s “purpose” for AIA purposes, in other words, is guided by the practical implications of the relief requested. This approach makes for a relatively clear standard without the need for fact finding, both of which are “major virtue[s]” when it comes to the question whether a court has the power to hear a case. Hertz Corp. v. Friend, 559 U.S. 77, 94 (2010).

28 Bob Jones, 416 U.S. at 739-740.

29 Bailey v. George, 259 U.S. 16 (1922).

30 Bob Jones, 416 U.S. at 740.

31 Id. at 740 n.12.

32 South Carolina, 465 U.S. 367.

33 Id. at 371-372, 380.

34 Id. at 374.

35 Notice 2016-66, 2016-47 IRB 745, section 2.01.

36 Id. at preamble.

38 Notice 2016-66, section 3.01.

40 Section 6671; and National Federation of Independent Business v. Sebelius, 567 U.S. 519, 544 (2012).

42 5 U.S.C. sections 500 et seq.

43 CIC Services LLC v. IRS, No. 3:17-cv-00110 (E.D. Tenn. 2017), aff’d, 925 F.3d 247 (6th Cir. 2019).

44 CIC Services, 936 F.3d 501.

45 Cheek v. United States, 498 U.S. 192, 201 (1991) (citation omitted).

46 Id. at 206. The government asserts that a taxpayer does not willfully violate a reporting requirement by filing a return that omits information in good faith. Brief for the Respondents at 46, CIC Services, No. 19-930 (S. Ct. Sept. 15, 2020). But that flies in the face of Cheek and the definition of willfulness. Moreover, the case the government cites for that proposition, United States v. Sullivan, 274 U.S. 259 (1927), is unavailing. Sullivan recognized a taxpayer’s right to Fifth Amendment protection against self-incrimination for information called for on a return. Id. at 263. It is a case about the Fifth Amendment, not willfulness. Further, the Supreme Court typically does not “rely upon prosecutorial discretion to narrow the statute’s scope.” Marinello v. United States, 138 S. Ct. 1101, 1108 (2018).

47 Gerald Kerska provides a trenchant analysis of this issue in his article, “Criminal Consequences and the Anti-Injunction Act,” 52 Minn. L. Rev. 51 (2020), cited in Brief for Petitioner at 37, CIC Services, No. 19-930 (S. Ct. July 15, 2020).

48 Id. at 36-37.

49 Id. at 25.

50 28 U.S.C. section 2401(a).

51 Hardin v. Jackson, 625 F.3d 739, 743 (D.C. Cir. 2010); and JEM Broadcasting Co. v. FCC, 22 F.3d 320, 326 (D.C. Cir. 1994).

52 JEM Broadcasting, 22 F.3d at 326 (quoting Raton Gas Transmission Co. v. FERC, 852 F.2d 612, 615 (D.C. Cir. 1988)) (alteration omitted).

53 Altera Corp. v. Commissioner, 926 F.3d 1061 (9th Cir. 2019).

54 Id. at 1075 n.6.

55 Lujan v. Defenders of Wildlife, 504 U.S. 555, 560-561 (1992) (citations omitted).

56 See Massachusetts v. EPA, 549 U.S. 497, 518 (2007) (“When a litigant is vested with a procedural right, that litigant has standing if there is some possibility that the requested relief will prompt the injury-causing party to reconsider the decision that allegedly harmed the litigant.”).

57 See Silver v. IRS, 1:19-cv-00247 (D.D.C. 2019).

58 See Chamber of Commerce of the United States of America v. IRS, No. 1:16-cv-00944 (W.D. Tex. 2017) (amended order dated Oct. 6, 2017).

59 Mayo Foundation for Medical Education and Research v. United States, 562 U.S. 44, 55 (2011).

60 Kristin E. Hickman and Kerska, “Restoring the Lost Anti-Injunction Act,” 103 Va. L. Rev. 1683, 1712-1716 (2017).

62 Chamber of Commerce, No. 1:16-cv-00944.

63 The government appealed the judgment of the district court, but then dismissed its appeal as moot following Treasury’s issuance of final regulations. Appellant’s Unopposed Motion to Dismiss Its Appeal Voluntarily, Chamber of Commerce v. IRS, No. 17-51063 (5th Cir. July 26, 2018).

END FOOTNOTES

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