Adviser Argues for Injunction in Captive Insurance Notice Case

CIC SERVICES, LLC
Plaintiff,
v.
INTERNAL REVENUE SERVICE, et al.,
Defendants.

UNITED STATES DISTRICT COURT
FOR THE EASTERN DISTRICT OF TENNESSEE
NORTHERN DIVISION (KNOXVILLE)

CHIEF JUDGE TRAVIS R. McDONOUGH

REPLY TO DEFENDANTS' OPPOSITION TO PLAINTIFF'S MOTION FOR PRELIMINARY INJUNCTION (Doc. # 68)

CIC Services, LLC, by its counsel, in reply to the IRS's Opposition to Plaintiff's Motion for a Preliminary Injunction (“Opposition,” Doc. # 68), submits as follows:

Introductory Note

The IRS's Opposition basically asserts three bases for denying CIC Services's motion for interim injunctive relief: first, CIC Services has failed to establish a likelihood of success on the merits; second, CIC Services is unable to demonstrate irreparable harm in the absence of a preliminary injunction; and third, the public interest does not favor the issuance of a preliminary injunction.¹ Additionally, the IRS urges that any interim injunctive relief that may be granted should be limited to only CIC Services. These points are treated in turn below.

As an initial matter, it is important to note that the IRS offers no objection to CIC Services's request for no bond or a nominal bond.

I. Likelihood of Success On the Merits

The record before the Court is already replete with arguments in support of the likelihood of Plaintiff's success on the merits.² The IRS makes three basic arguments why it believes it did not violate the Administrative Procedure Act (“APA”); the first argument was conceded earlier in this case, the other two are unpersuasive.

A. For the very first time, the IRS claims that Notice 2016-66 is not a legislative rule. It is wrong.

The IRS begins by claiming that CIC Services never cited “a single case or other binding authority” to argue that the IRS had to comply with notice and comment rulemaking when it issued Notice 2016-66.But the IRS has a short memory: in its original filing, CIC Services laid out precisely why Notice 2016-66 is a legislative rule and therefore required notice-and-comment rulemaking. (Doc. 9; PageID# 97-99). In its response to that motion, the IRS never denied that Notice 2016-66 was a legislative rule. (Doc. 17). CIC Services specifically noted that the IRS never challenged this point of law. (Doc. 21; PageID# 243).

That the IRS now disputes this is even more shocking given that the Supreme Court has already spoken on this issue. The IRS correctly notes that “[l]egislative rules 'grant rights, impose obligations, or produce other significant effects on private interests.'” (Doc. 68; PageID #858)(citing United States v. Cinemark USA, Inc., 348 F.3d 569, 580 (6th Cir. 2003)). In contrast, interpretive rules are statements as to what an agency thinks a statute or regulation means. Dismas Charities, Inc. v. United States DOJ, 401 F.3d 666, 681 (6th Cir.2005); and see American Tort Reform Ass'n v. O.S.H.A., 738 F.3d 387 (D.C. Cir. 2019); Fed. Proc. §2.73. The IRS has always maintained that Notice 2016-66 imposes new obligations on new taxpayers.

Already in this case the U.S. Supreme Court has ruled that Notice 2016-66 subjects CIC Services to “civil tax penalties and criminal penalties.” CIC Services, LLC v. IRS, 141 S.Ct. 1582, 1586 (2021). The Supreme Court took pains to list all the obligations imposed and consequences threatened upon CIC Services and other taxpayers by Notice 2016-66. Id. at 1587. And the Court held that the threat of criminal penalties on CIC Services “clinches the case . . . [and] explains why an entity like CIC must bring an action in just this form, framing its requested relief in just this way.” Id. at 1592 (emphasis added)

The IRS's argument that, it's not Notice 2016-66 that carries these consequences, it's the statutes that backup the Notice is similarly flawed. Put another way: the IRS claims that it is not the IRS's push off the cliff that kills you, it's the ground. There is no interpretation of the reportable transaction statutory scheme that could have possibly subjected CIC Services to any consequences before Notice 2016-66. Further, this argument was completely rejected in Mann Construction (a non-precedential case which CIC Services believes is distinguishable for other reasons but a case to which the IRS thinks this Court should slavishly adhere). Mann Construction, Inc. v. U.S., 2021 U.S. Dist. LEXIS 91344, *28 (E.D. Mich. May 13, 2021)(holding that the Notice is a legislative rule because it changes taxpayers' rights and obligations).

CIC Services may be forgiven for giving short shrift to the question of whether Notice 2016-66 is a legislative rule under the APA; this was a threshold argument the IRS conceded in 2017. In light of the Supreme Court's holding in this case, it defies imagination that the IRS now argues that it is a mere interpretive or procedural regulation that could put taxpayers in jail.

B. The IRS's claimed self-exemption from notice and comment rulemaking is invalid.

The IRS next serves up a warmed-over version of an argument that it advanced in 2017: the IRS claims it has exempted itself from APA regulatory rulemaking and Congressional decree when it comes to defining reportable transactions. The IRS was wrong then, and it is wrong now.

As outlined in greater detail in CIC Services's first briefing on this subject (Doc. 21; PageID# 240), in 2004, Congress codified the IRS's earlier attempt at the reportable transaction concept but, in doing so, Congress provided that future changes to the definition of “reportable transactions” had to be made “under regulation.” 26 U.S.C. §6707A (emphasis added). This Congressional command means what it says. In re Canada, 2016 Bankr. LEXIS 2234, at *30-33 (N.D. Tex. June 7, 2016) (explaining that reportable transactions are to be determined “via regulation”); United States v. Mead Corp., 533 U.S. 218, 227-30 (2001) (“When Congress has explicitly left a gap for an agency to fill” it must do so “by regulation”).

The IRS has an excuse for why it did not make a regulation here, but it is too-convenient-by-half. It argues that it satisfied this command to define reportable transactions “under regulation” by creating a regulation that allows it to define reportable transactions without making a regulation: 26 C.F.R. 1.6011-4(b)(6). Never mind that this self-exemption offends all of the democratic rulemaking ideals inherent in the APA and even the IRS's own policy statement. (Exhibit 2, Doc. 59-2; PageID# 809). Instead, once again, the IRS maintains its policy of tax exceptionalism for purposes of the APA. “The IRS envisions a world in which no challenge to its actions is ever outside the closed loop of its taxing authority.” Cohen v. United States, 650 F.3d 717, 723 (D.C. Cir. 2011) (en banc) (“The IRS is not special in this regard; no exception exists shielding it — unlike the rest of the Federal Government — from suit under the APA”); accord, Mayo Found. for Med. Edn. & Research v. U.S., 562 U.S. 44, 55 (2011) (holding that there is no “carve out” to administrative law for tax regulations”).

A regulation that allows the IRS to identify transactions of interest by interpretive rule and issuing subject taxpayers to criminal and civil penalties — i.e., by issuing mere guidance — flouts Congress's express statutory command.26 U.S.C. §6707A. Only by legislative rule may such a goal be properly accomplished.

C. Congress never “excused” the IRS's disregard for the APA. And Mann Construction is distinguishable.

Next, the IRS claims that its self-exemption from the APA and everything flowing from it was “blessed” by Congress. The IRS also claims its position is supported by Mann Construction,Inc. v. U.S., (available at 2021 WL 1923412 at *12-14), a decision reached by the U.S. District Court for the Eastern District of Michigan on May 13, 2021, prior to the Supreme Court's unanimous decision in this case on May 19, 2021. Again, the IRS is wrong.

First, the IRS glosses over the timeline with respect to the supposed Congressional benediction.Again, as more fully set forth in its first briefing (Doc. 21; PageID# 241-42), Congress statutorily authorized the reportable transaction scheme in 2004 and created 26 U.S.C. §6707A. That statute creates two categories of transactions:

26 U.S.C. §6707A(c)(emphasis added). Congress's decision to treat “listed transactions” and “reportable transactions” differently is striking — the former requires definition via “regulation” and the latter can merely be “identified” by the IRS.

Then, in 2007 — well after the supposed 2004 Congressional benediction of the IRS's reportable transaction scheme — the IRS created the new “transactions of interest” category of reportable transactions, which is the applicable category in this case. Transactions of interest are circularly defined as “a transaction . . . that the IRS has identified by notice, regulation, or other form of published guidance as a transaction of interest.” 26 C.F.R. 1.6011-4(b)(6); 72 FR 43146. Congress can hardly be said to have ratified a 2007 regulation via a 2004 law.

The IRS also claims that Mann Construction is their freshly-minted saving grace, but that case involves “listed transactions,” not reportable transactions or its sub-species, “transactions of interest.” This fully distinguishes Mann Construction. Indeed, the difference in the two categories' Congressional treatment in §6707(A) is so stark that the taxpayer in Mann Construction was forced to concede that the IRS can identify “listed transactions” by mere notice, i.e. without regulation. Mann Construction, Inc. v. U.S., 2021 U.S. Dist. LEXIS 91344, *28 (E.D. Mich. May 13, 2021). And, in order to avoid compelling caselaw from the D.C. Circuit, the court in Mann Construction specifically distinguished itself because it was dealing specifically with listed transactions. Id. at *38, fn 10 (distinguishing itself from Cohen v. U.S., 599 U.S. 652 (D.C. Cir. 2010)(en banc) which held that an IRS Notice was void without notice and comment).

Notice 2016-66 involves “transactions of interest” rather than “listed transactions.” Verified Complaint, Doc. #1, at ¶19 and Exhibit 1. The difference is significant in that the IRS treats “transactions of interest” as reportable transactions, but provides that the transaction is not reportable unless the IRS determines that the transaction likely involves tax evasion. 26 U.S.C. §6707A(c)(1). Yet here, the IRS admits that it lacks sufficient information to identify the characteristics that permit such conclusion. Doc. #1 at Exhibit 1.

There is simply no reason to believe that Congress excused the IRS from the APA when defining reportable transactions; it specifically commanded the IRS to do so “under regulation.”

D. It is likely that Notice 2016-66 is unlawful.

At this point and for the grant of interim injunctive relief, CIC Services only need show the “likelihood” that Notice 2016-66 is unlawful. This is said not to diminish the fact that this burden weighs heavily on CIC Services but to point out that the purpose of Rule 65 is only intended to preserve the status quo and that it may be modified as needed until such time as a final judgment is entered in the case. It is also especially relevant to note that CIC Services is unable to seek money damages to recover the losses that it will incur during the pendency of this case against the government while the government will incur no significant disadvantage by the grant of interim injunctive relief in the circumstances of this case.

II. Showing of Irreparable Harm

A. The IRS's claim of delay is contrived and not relevant.

The IRS claims that CIC Services's claims of irreparable harm are undermined by its “steady failure” to seek expedited review over the four years since its case was dismissed by this Court on November 2, 2017. See Opposition (Doc. # 68) at 1, 5, 12-14. However, if anything, it was the IRS's assertion of and reliance on an ultimately wrong legal position that caused the delay in reviewing Notice 2016-66. Nevertheless, this Court had solid ground under it in overruling CIC Services's first preliminary injunction based upon the Anti-Injunction Act in 2017. (Doc. #24). It is nonsensical that CIC Services would lose its right to interim relief because of occasional and reasonable delays on its way through the Sixth Circuit and the Supreme Court.

III. Irreparable Harm Revisited

Attached hereto is the Supplemental Declaration of Sean King regarding factual issues raised by the IRS's Opposition (Doc. #86). This Supplemental Declaration refutes a number of errors and misrepresentations made by the IRS with respect to: the variety of taxpayers it serves in satisfaction of Notice 2016-66 (King Supp. Decl. at ¶¶ 1-3 and 5); the failure of the IRS to establish any meaningful criteria that distinguish alleged “tax avoidance” transactions from any other 831(b) transactions (Id., at ¶ 4); the effect of Notice 2016-66 on its client base (Id., at ¶¶ 5, 6); and the effect of Notice 2016-66 on its balance sheet (Id., at ¶ 7). This document is submitted in further evidentiary support of CIC Services's pending motion. See also Doc. #9, at 14-15.

IV. Public Interest Favors Preliminary Injunction

Importantly, in its latest brief, it appears that the IRS has now conceded the error of the fundamental premise of its first opposition to injunctive relief: that an injunction in this case would thwart the downstream collection of tax penalties. Further, the IRS admits that most material advisors have already provided all or nearly all the information required of them. (Doc. 68; PageID# 852-53 (discussing the singular disclosure required of material advisors). It is now very hard to see what, if any, harm would arise from enjoining Notice 2016-66.

On the other side of the ledger, Notice 2016-66 continues to assault a legitimate industry. In 2016, the U.S. Congress strengthened its policy support for small captive insurance companies authorized by IRC §831(b). See Pub. L. 114-113, §333. This legislation reaffirmed the validity of §831(b) captives and increased the incidental tax benefits conferred upon them by increasing the amount of the authorized insurance premium ceiling from $1.2M to $2.2M.

Beginning in or about 2012, the IRS initiated a broad-based, dragnet-type audit program, generally claiming that IRC §831(b) fostered abusive tax-shelter arrangements. See Verified Complaint (Doc. #1, at ¶12)³ The IRS is clearly maintaining a massive effort to shut down the entire small captive insurance industry by tar-brushing all small captives through inclusion in its infamous “Dirty Dozen” list of “Tax Scams.” See, e.g., IRS Public Statement (IR 2020-226), dated October 1, 2020; November 20, 2020 Statement of IRS Chief Counsel Michael Desmond; IRS Public Release on April 13, 2021; Field Attorney Advices (FAAs) issued May 5, 2021. With all due respect, public policy goals are established by lawmakers, not by IRS bureaucrats.

Only a few brave souls, including CIC Services's principals, have had the courage to step up to confront this massive governmental effort.This effort is particularly troubling given a number of recent combined Department of Justice and IRS efforts to target certain organizations for unfavorable treatment. Regarding overreach by the IRS and DOJ, the Sixth Circuit observed:

Among the most serious allegations a federal court can address are that an Executive agency has targeted citizens for mistreatment . . . No citizen — Republican or Democrat, socialist or libertarian — should be targeted or even have to fear being targeted on those grounds [re the selective granting of tax-exempt status]. Yet those are the grounds on which the plaintiffs allege they were mistreated by the IRS here.

. . .

The lawyers in the Department of Justice have a long and storied tradition of defending the nation's interests and enforcing its laws — all of them, not just selective ones — in a manner worthy of the Department's name. The conduct of the IRS attorneys in the district court falls outside that tradition.

In re U.S. v. NorCal Tea Party Patriots, 817 F.3d 953, 955 (6th Cir. 2016).Again, in Summa Holdings, Inc. v. Commissioner, 848 F.3d 779 (6th Cir. 2017), the Sixth Circuit roughly chastised the IRS for demonstrating a stubborn resistance to adopting the Sixth Circuit's teaching that the IRS is not permitted to punish taxpayers for making the most of tax-minimizing opportunities that are lawfully enacted by Congress.

V. Proper Scope of Interim Injunctive Relief

Finally, the IRS urges that the injunctive relief should be limited to only CIC Services. The APA, however, provides that “[a] person suffering legal wrong because of agency action, or adversely affected or aggrieved by agency action within the meaning of the relevant statute, is entitled to judicial review thereof.”5 U.S.C. § 702.The APA further empowers this Court to “hold unlawful and set aside agency action, findings, and conclusions found to be . . . without observance of procedure required by law.” 5 U.S.C. §553 (emphasis added). The APA was not followed, and this Court is not prohibited by law from setting aside Notice 2016-66.

Indeed, the Supreme Court specifically scrutinized the Complaint in this case and acknowledged that it was properly pleaded and should be understood as a request to “set aside” Notice 2016-66, not to simply enjoin its enforcement against one lone taxpayer. CIC Services, LLC v. IRS, 141 S.Ct. 1582, 1590. This is not a new concept. The IRS cites Skyworks, Ltd. v. Centers for Disease Control and Prevention, 2021 WL 2228676 (N.D. Ohio, decided June 3, 2021) (Doc. #68 at 22), which devotes particular attention to National Mining Ass'n v. U.S. Army Corps of Eng'rs, 143 F.3d 1399, 1409 (D.C. Cir. 1998) (“when a reviewing court determines that agency regulations are unlawful, the ordinary result is that the rules are vacated — not that their application to the individual practitioners is prescribed”).

It is also important to appreciate that, since most of CIC Services's work in satisfaction of Notice 2016-66 is done on behalf of its clients, at a minimum and in order to provide full interim relief to CIC Services, this Court would need to extend such relief to all of CIC Services's clients, future clients, and others as well. See King Decl., Doc. #59, Ex. 3 at ¶¶ 3, 5, 6 and 8, and King Supp. Decl., attached hereto, at ¶¶ 3,.5 and 6-7. This sort of arrangement would likely be very difficult to follow and administer by all concerned through limited interim relief.

Accordingly, CIC Services respectfully requests that its motion be granted and that the IRS be restrained pendent lite from enforcing Notice 2016-66.

Date: August 17, 2021

Respectfully submitted,

Kenneth A. Lazarus (admitted pro hac vice)
LAZARUS & ASSOCIATES
1055 Thomas Jefferson St., NW, Suite M-100
Washington, D.C. 20007
Tel: (202) 295-2330 (Direct Line)
E-mail: lazaruslaw@aol.com

— and —

Adam R. Webber (admitted pro hac vice)
ELLIOTT FAULKNER & WEBBER, LLC
4244 Indian Ripple Road, Suite 150
Beavercreek, Ohio 45440
Tel: (937) 264-8719
E-mail: awebber@elliottfaulknerlaw.com

— and —

John M. Kizer (TN Bar No. 029846)
Gentry, Tipton & McLemore, PC
900 South Gay Street, Suite 2300
Knoxville, TN 37902
Tel: (865) 525-5300
E-mail: jmk@tennlaw.com

COUNSEL FOR CIC SERVICES, LLC