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Plaintiffs Argue Anti-Injunction Act Doesn’t Bar Notice Challenge

FEB. 18, 2020

Govig & Associates Inc. et al. v. United States et al.

DATED FEB. 18, 2020
DOCUMENT ATTRIBUTES

Govig & Associates Inc. et al. v. United States et al.

[Editor's Note:

The exhibits can be viewed in the PDF version of the document.

]

Govig & Associates, Inc., et al.,
Plaintiffs,
v.
United States of America, et al.
Defendants.

IN THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF ARIZONA

Brandon A. Keim (028831)
Yale F. Goldberg (005245)
Frazer Ryan Goldberg & Arnold LLP
1850 N. Central Ave., Suite 1800
Phoenix, AZ 85004
Phone: (602) 277-2010
Email: bkeim@frgalaw.com
ygoldberg@frgalaw.com

Walter A. Lucas (0068150)
Samuel J. Lauricia III (0078158)
Matthew C. Miller (0084977)
WESTON HURD LLP
1301 E. 9th Street, Suite 1900
Cleveland, Ohio 44114
Phone: 216-241-6602; Fax: 216-641-8369
E-mail: WLucas@westonhurd.com
SLauricia@westonhurd.com
MMiller@westonhurd.com

Attorneys for Plaintiffs

PLAINTIFFS' OPPOSITION TO THE UNITED STATES' MOTION TO DISMISS

Oral Argument Requested

Plaintiffs oppose the United States' Motion to Dismiss as stated below.

INTRODUCTION

Plaintiffs have not engaged in an abusive tax transaction, nor have they failed to properly report their transaction to the IRS. And Plaintiffs are not liable for penalties for failing to file certain information reporting forms with the IRS. But Plaintiffs have not asked this Court to decide those issues. Plaintiffs filed this suit to request a pre-enforcement review of an IRS action that imposes a significant and costly time burden on them — approximately 440 hours. Because Plaintiffs are not challenging the assessment or collection of a tax, which may be pursued through other means provided by Congress, this lawsuit is Plaintiffs' only opportunity for pre-enforcement review of an IRS action that imposes a 440-hour burden on them.

Defendant argues in its motion that taxpayers should only have two options when falling within the realm of an IRS notice: comply with the notice or face civil and criminal penalties for noncompliance, and then seek review. But the IRS is not exempt from the Administrative Procedure Act (“APA”, 5 U.S.C. § 553). Mayo Found, for Med. Educ. & Research v. United States, 562 U.S. 44, 55 (2011). If the Court accepts Defendant's arguments, valid APA claims against the IRS will never be heard, and the IRS will continue to “envision 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, 726, 397 U.S. App. D.C. 33 (D.C. Cir. 2011) (en banc).

The IRS has a history of APA noncompliance. It cannot stand any longer. Plaintiffs ask this Court to find that the judiciary may hear a pre-enforcement challenge to an illegal IRS action, namely the IRS's issuance of Notice 2007-83. The bases for the suit are threefold. First, the IRS unlawfully issued Notice 2007-83, which qualifies as a “legislative-type rule,” without first complying with the mandatory notice-and-comment provisions of the APA. Second, Notice 2007-83 is arbitrary and capricious and ultra vires in nature, lacking underlying authority and the reasoned-analysis footing required by the APA (5 U.S.C. § 706(2)(A)). Third, Notice 2007-83 cannot “take effect” based upon the failure of the IRS to comply with the APA's notice-and-comment requirements. Plaintiffs challenge the validity of Notice 2007-83 so that Plaintiffs can presently and prospectively avoid the costly and burdensome reporting requirements that the Notice seeks to establish.

Background of Notice 2007-83

On or about November 5, 2007, the IRS issued Notice 2007-83 entitled “Abusive Trust Arrangements Utilizing Cash Value Life Insurance Policies Purportedly to Provide Welfare Benefits” (the “Notice”), which purports to identify certain plans as “abusive trust arrangements.” See Exhibit 1. The Notice states that these trust arrangements would be “listed transactions,” which must be reported to the IRS to avoid the penalty imposed by IRC § 6707A. The Notice never went through notice and comment or other necessary procedures for “regulations.” See 5 U.S.C. § 553(b)&(c).

Significantly, and not disputed by Defendant, the only penalty associated with Notice 2007-83 is a penalty for failure to file a Form 8886. (Id., see also. Complaint 19-20). In other words, the only requirement proposed by Notice 2007-83 is a reporting requirement. The Notice states:

Any transaction that has all of the following elements, and any transaction that is substantially similar to such a transaction, are identified as “listed transactions” for purposes of § 1.6011-4(b)(2) and §§ 6111 and 6112. . . .

(emphasis added)

Plaintiffs more fully describe the elements of the Notice in their Complaint (Doc. 1 at ¶¶ 15-23) and the Defendant describes the intended tax consequences and other features of the transactions identified in Notice 2007-83 in its Motion (Doc. 23 at pp. 11-13). As applied to these Plaintiffs, the unlawfulness of the Notice is easily observed. First, as detailed below, the Notice is not about the “assessment and collection” of taxes, despite what Defendant would have this Court believe. Nor is the purpose of this lawsuit to enjoin the “assessment and collection” of taxes. Rather, Plaintiffs seek to challenge the costly and burdensome reporting requirements mandated by the Notice.

Second, Defendant states, in reference to the disclosure requirement of the Notice, “[u]pon disclosure of such a transaction, the IRS could challenge the business's deductions and seek to include in the business owner's gross income the payments made to the trust.” (Doc. 23 at p. 7). If, as Defendant contends, disclosure is necessary for the assessment and collection of taxes. Plaintiffs do disclose the transaction on a Form 8275 in tax years when reporting deductions. (Doc. 1 at ¶ 31 and Exhibit A thereto). It just so happens that filing a Form 8275 is a less burdensome manner to disclose than the Form 8886 per the IRS's own records. Yet, because of a Notice that does not even comply with the IRS's obligation to specifically identify transactions, these Plaintiffs are arbitrarily mandated to comply with a more burdensome and costly manner of disclosure as apparently that is the only form of disclosure that does not hinder the assessment and collection of taxes, at least in Defendant's view.

When filing the Form 8275, Plaintiffs address the Notice because it makes substantive changes to the tax laws. While Courts have held the deductibility of the qualified cost of a welfare benefit fund is an evidentiary issue. Notice 2007-83 unilaterally and arbitrarily excludes various amounts from the definition of qualified cost. See, Curcio v. Commissioner, T.C. Memo 2010-115 (2010) (wherein the Tax Court described the determination of the qualified direct cost as an evidentiary issue).

Likewise, while Treasury Regulation 1.409(A)-1(a)(5) envisions a non-qualified deferred compensation plan and a bona fide welfare benefit plan to co-exist, the Notice nullifies such Regulation by labeling all such lawful plans as mere “purported” welfare benefit plans.

Finally, disclosure under the Notice is necessary only if the subject transaction is “substantially similar” to the transactions described therein. T. Reg. 1.6011-4(e)(4) (explaining the term “substantially similar”). However, the plan these Plaintiffs participated in is distinct from — and certainly not “substantially similar” to — the “purported” welfare benefit plans addressed in the Notice. To this point. Defendant prefaces its argument with the unsupported assertion that the Plaintiffs “engaged in an abusive tax transaction disguised as an employee benefit plan.” (Doc. 23 at p. 1). As alleged in Plaintiffs' Complaint, this assertion is plainly false and Plaintiffs object to any insinuation that the DBT/RPT, as defined in the Complaint at 30, is an abusive tax transaction or an abusive employee benefit scheme. (Doc. 1, see, e.g. ¶¶ 45-47). Plaintiffs submit that the DBT/RPT was not adopted for tax reasons, but rather for the business purpose of retaining key employees (as achieved through the substantial risk of forfeiture inherent in the RPT) and to provide a welfare benefit to employees. The plan further ensures liquidity in the event of the untimely death of a key employee to assure continuity of management and, thus, promoting profitability of the company. (Doc. 1 at ¶¶ 46-47). Far from abusive, this transaction is fully disclosed on a detailed Form 8275. (Doc.l at Exhibit A). Moreover, a large portion of money contributed to the DBT/RPT is subject to tax immediately despite the risk of forfeiture, and at vesting, if it occurs, a Form 1099 is provided by the independent trustee to the employee to the extent of any distributions from the RPT not previously subject to tax. (Doc. 1 at ¶ 61).

Under Defendant's theory, simply because a whole life insurance policy is used in the DBT/RPT, Plaintiffs must incur the substantial burden of filing a Form 8886 without regard to whether the transaction has the same intended or expected tax consequences of the transactions vaguely identified in the Notice. Defendant contends that the DBT/RPT is marketed “as a way to provide cash . . . to the business owners on a tax favored basis,” and that the business is “anticipating that after some years the arrangement would terminate and . . . the cash . . . would be distributed to the employees.” (Doc. 23 at p. 6).

In this case, eight non-owner employees and one minority shareholder employee are the only participants who might get any distribution, which would be taxable, from the subject trust. (Doc. 1 at ¶¶ 47, 61). At the same time, the designated charity might just as well receive a distribution of the assets if the event of forfeiture occurs in which event the employees and minority shareholder would get nothing. All money contributed to, and assets owned by, the Restricted Property Trust are subject to a substantial risk of forfeiture. (Id. at ¶ 58). This means that neither Plaintiffs nor any of the charitable beneficiaries, or any other person or entity have any rights, title, or interest in the restricted compensation until such time that the risk of forfeiture occurs or lapses pursuant to the terms of the plan. (Id.) The occurrence of the risk of forfeiture is beyond the control of everyone involved in the transaction, but if it occurs, the enforcement of the forfeiture is the sole obligation of an independent trustee. (Id. at ¶¶ 62-64). Defendant ignores these irrefutable aspects of the DBT/RPT in its recitation of the facts.

Here, Plaintiffs considered all the substantial differences between the DBT/RPT and the vaguely identified transactions addressed in the Notice, and determined that DBT/RPT was not the same as or substantially similar to transactions described in the Notice. Accordingly, Plaintiffs disclosed DBT/RPT on Form 8275, a much less burdensome mechanism that does not hinder — and indeed promotes — the IRS's ability to assess and collect taxes. If the Plaintiff filed the Form 8886, then this challenge could never proceed because the § 6707A penalty would never be imposed. Instead, Plaintiffs would have the substantial burden of filing the Form 8886 year after year.

Burden of Filing Form 8886

The IRS instructions for Form 8886 state that the average burden on taxpayers to complete this disclosure requirement is approximately 22 hours per taxpayer for a given tax year. See Exhibit 2. With respect to these four (4) Plaintiffs, that burden equates to 88 hours. Since the transaction is an irrevocable transaction for a minimum of five years, this is approximately 440 hours of time invested by the Plaintiffs, its employees, and its advisors, plus any and all expenses incurred in order to report a transaction on a Form 8886. (Doc. 1 at ¶¶ 46, 59).

On the other hand, per the IRS, preparing the Form 8275 results in a burden per taxpayer of less than 6 hours in a given tax year. See Exhibit 3. With respect to a transaction that is substantially different than those described in the Notice, this lesser burden should be viewed as nothing less than an act of civil disobedience, to challenge what appears to be unlawful conduct by the IRS when issuing Notice 2007-83 without specifically identifying transactions and changing substantive tax laws at the same time.

Defendant cannot reasonably dispute that Form 8275 disclosure promotes the IRS's ability to assess and collect taxes. The first inquiry on Form 8275 concerns the amount deducted, the tax form containing the deduction, the line on which it is deducted, and the authority for the deduction. Form 8886 contains no similar inquiry.1

SUMMARY OF THE ARGUMENT

In their Complaint, Plaintiffs contend that the IRS promulgated the Notice in violation of the Administrative Procedure Act, 5 U.S.C. § 500 et seq. Defendant moved to dismiss the Complaint for lack of subject matter jurisdiction, asserting that the Complaint is barred by the Anti-Injunction Act, 26 U.S.C. § 7421(a).

The issue before this Court is whether the Administrative Procedure Act (APA) must give way to the Anti-Injunction Act (AIA) and the Declaratory Judgment Act (DJA) in a case that does not involve the assessment and collection of taxes.

First, this Court must determine whether the AIA and the DJA apply to Plaintiffs' request for pre-enforcement judicial review and injunctive relief. If they do not, the Court must deny Defendant's Motion to Dismiss.

The AIA and the DJA do not apply in this case because the requested relief does not restrain the assessment and collection of taxes. By giving the proper construction to the terms “assessment,” “collection,” and “taxes,” it becomes clear that the reporting and information gathering requirements of Notice 2007-83 stand separate and apart from the actual assessment and collection of taxes. Moreover, the relief requested in this suit has nothing to do with “taxes.”2 Despite Defendant's attempt to recharacterize this suit. Plaintiffs only seek to invalidate the burdensome and costly reporting and information gathering requirements of Notice 2007-83. Put simply, this is not a dispute over taxes.

The controlling authority in this case is the Supreme Court's unanimous, recent decision in Direct Marketing Association v. Brohl. 135 S. Ct. 1124 (2015). Instead, Defendant urges the Court to follow Florida Bankers Ass'n v. U.S. Dep't of Treasury, 799 F.3d 1065 (D.C. Cir. 2015), a case roundly criticized by commentators and scholars for giving insufficient deference to Direct Marketing. See, generally, Krisitin E. Hickman and Gerald Kerska, Restoring the Lost Anti-Injunction Act, 103 Va. L. Rev. 1683, *1685-86 (2017); Stephanie H. McMahon, Pre-Enforcement Litigation Needed for Taxing Procedures, 92 Wash. L. Rev. 1317, 1367-68 (2017); Patrick J. Smith, D.C. Circuit Majority Opinion in Florida Bankers Not Consistent with Supreme Court's Direct Marketing Decisions, Procedurally Taxing (Aug. 17-18, 2015).

Second, if the AIA and the DJA apply, this Court must determine whether this case nevertheless fits the exception to the AIA set forth in South Carolina v. Regan, 465 U.S. 367 (1984). There is no meaningful remedy available to Plaintiffs other than preenforcement judicial relief The suggested alternative remedy — intentionally violating the tax laws to force a subsequent refund action with the IRS — is an illusory alternative and eviscerates the purpose of the APA.3 Arguably, every action by Plaintiffs has been to challenge the validity of the Notice. The Plaintiffs voluntarily aid the assessment and collection of taxes by filing the much less burdensome Form 8275, even disclosing therein Notice 2007-83. By its very nature, this alternative means that the only way for parties like Plaintiffs to challenge the reporting requirement “is to violate the law and risk financial ruin and criminal prosecution” — “precisely the bind that pre-enforcement judicial review was meant to avoid.” CIC Servs., LLC v. IRS, 925 F.3d 247, 263 (6th Cir. 2019) (J. Nalbandian, dissenting).

ARGUMENT

I. Subject Matter Jurisdiction

Because “subject-matter jurisdiction is an 'Art. Ill as well as a statutory requirement[,] no action of the parties can confer subject-matter jurisdiction upon a federal court.'” Akinseye v. District of Columbia, 339 F.3d 970, 971 (D.C. Cir. 2003) (quoting Ins. Corp. of Ir., Ltd. v. Compagnie des Bauxite de Guinea, 456 U.S. 694, 702 (1982)). On a motion to dismiss for lack of subject-matter jurisdiction pursuant to Rule 12(b)(1), the plaintiff bears the burden of establishing by a preponderance of the evidence that the court has subject-matter jurisdiction. Lujan v. Defenders of Wildlife, 504 U.S. 555, 561 (1992). The court may dismiss a complaint for lack of subject-matter jurisdiction only if it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief Esmay v. United States, 1993 U.S. Dist. LEXIS 20364, at *2 (D.Ariz. Oct. 26, 1993) citing Conley v. Gibson, 355 U.S. 41, 45-46 (1957).

As subject-matter jurisdiction focuses on the court's power to hear the claim, however, the court must give the plaintiffs factual allegations closer scrutiny when resolving a Rule 12(b)(1) motion than would be required for a Rule 12(b)(6) motion for failure to state a claim. Pert v. United States, 2011 U.S. Dist. LEXIS 50649, at *6 (D.Nev. May 10, 2011) citing Macharia v. United States, 334 F.3d 61, 64, 69 (D.C. Cir. 2003). ”To determine whether it has jurisdiction, the court may consider materials outside the pleadings.” Id.

Defendant's Motion is a facial challenge to this Court's jurisdiction. “If a defendant mounts a 'facial' challenge to the legal sufficiency of the plaintiffs jurisdictional allegations, the court must accept as true the allegations in the complaint and consider the factual allegations of the complaint in the light most favorable to the non-moving party.” Erby v. United States, 424 F. Supp. 2d 180, 181 (D.D.C. 2006); see also Halloum v. Intel Corp., 2003 U.S. Dist. LEXIS 20374, at *4 (D.Ariz. Nov. 5, 2003). “Additionally, unlike with a motion to dismiss under Rule 12(b)(6), the Court 'may consider materials outside the pleadings in deciding whether to grant a motion to dismiss for lack of jurisdiction.'” McZeal v. Jp Morgan Chase, 2013 U.S. Dist. LEXIS 201374, at *4 (C.D.Cal. Dec. 19, 2013) quoting Jerome Stevens Pharm., Inc. v. Food & Drug Admin., 402 F.3d 1249, 1253-54 (D.C. Cir. 2005); see also, Capitol Industries-EMI, Inc. v. Bennett, 681 F.2d 1107, 1118 (9th Cir. 1982), fn. 29.

II. The AIA and the DJA Do Not Bar Plaintiffs' Claims

Defendant's principal argument is that the AIA and the DJA bar the relief sought by Plaintiffs because it “would restrain the assessment or collection of tax — the penalty for failing to report” pursuant to the Notice. (Doc. 23 at p. 16). As detailed below. Defendant is factually and legally wrong.

The AIA provides, with statutory exceptions not relevant here, that “no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person.” 26 U.S.C. § 7421(a). Similarly, with stated exceptions not relevant here, the DJA expressly bars claims to declaratory relief “with respect to Federal taxes.” 28 U.S.C. § 2201(a). As a statutory bar to a court's jurisdiction, the AIA and DJA require a narrow interpretation and application. Direct Marketing Ass'n v. Brohl, 135 S.Ct. 1124, 1133 (2015).

The two-part rationale behind the AIA is: (1) to protect “the Government's need to assess and collect taxes as expeditiously as possible with a minimum of pre-enforcement judicial interference” and (2) “to require that the legal right to the disputed sums be determined in a suit for refund.” Bob Jones Univ. v. Simon, 416 U.S. 725, 736-37 (1974), quoting Enochs v. Williams Packing & Navigation Co., Inc., 370 U.S. 1, 7 (1962); see also Nat'l Fed'n of Indep. Bus. v. Sebelius, 567 U.S. 519, 543 (2012).

Suits that run afoul of the AIA or the DJA will be dismissed for lack of subject matter jurisdiction. Alexander v. Americans United, 416 U.S. 752, 758 (1974). In this case, the AIA and DJA do not bar pre-enforcement review of the Notice.

III. This Suit Seeks to Stop Unfair, Arbitrary and Burdensome Reporting Requirements, not the “Assessment” or “Collection” of Taxes

The question here is whether Plaintiffs' challenge is a “suit for the purpose of restraining the assessment or collection of any tax.” 26 U.S.C. § 7421(a). It is not. One need look no further than the Form 8275 Plaintiffs file to understand that Plaintiffs do not seek to restrain the assessment or collection of taxes; rather they seek to avoid a very burdensome reporting obligation, estimated at over 440 hours over the life of the subject transaction.

The key terms of the AIA — "assessment” and “collection” — are not “synonymous with the entire plan of taxation.” Hibbs v. Winn, 542 U.S. 88, 102 (2004). In other words, the AIA was not designed to prevent every suit that could have some eventual, nebulous impact on tax collection.

Notice 2007-83 does not itself impose a tax.4 Rather, at best, it vaguely identifies certain transactions as “listed transactions” and purports to alert taxpayers who participate in a vaguely identified transaction, or a transaction that is “substantially similar,” of their requirement to file a specific disclosure statement (Form 8886). (Exhibit 1 attached hereto). Failure to file the Form 8886 is punishable by penalty. Defendant contends that the Plaintiffs' challenge to the Notice would prevent the assessment and collection of taxes, in this case the penalty associated with failing to file a Form 8886. Defendant is wrong because Plaintiffs are challenging the information gathering requirements of the Notice which is distinct and separate from the assessment, levy, or collection phase established under the Federal Tax Code. See, Direct Marketing Assn. v. Brohl, 135 S.Ct. 1124 (2015).

In support of its flawed position. Defendant relies almost exclusively on the majority opinions in CIC Services and Florida Bankers. Each of these cases, especially CIC Services, is distinguishable from the DBT/RPT, which is fully disclosed to the IRS. Nonetheless, these majority opinions from the Sixth and D.C. Circuits attempt to distinguish Direct Marketing, a unanimous Supreme Court holding that restraining the assessment or collection of tax means to “stop” the assessment and collection, not to merely inhibit assessment and collection. Direct Marketing, at 1133. As explained in detail below, CIC Services and Florida Bankers are equally non-precedential and wrong, and this Court should follow the sound reasoning in Direct Marketing.

In Direct Marketing, a unanimous Supreme Court held that a broad interpretation of the AIA is wrong; restraining the assessment or collection of tax means to “stop” the assessment and collection, not to merely inhibit assessment and collection. Direct Marketing, at 1133. The Direct Marketing plaintiffs sought to enjoin the State of Colorado's imposition of a penalty against retailers who refused to file informational reports about e-commerce transactions. The plaintiffs complained that Colorado's statute violated the Colorado Constitution and the Federal Constitution. The State of Colorado argued that the requested injunctive relief was barred by the Tax Injunction Act, 28 U.S.C. § 1341 (TIA) because it impeded the “assessment” and “collection” of sales taxes.5

The Direct Marketing Court began by holding that the terms “tax,” “assessment,” and “collection” in the TIA and the AIA are synonymous and coextensive, with the former being modeled on the latter. Id. at 1129 (“We assume that the words used in both Acts are generally used in the same way . . .”). The Court proceeded to hold that “information gathering” by taxing authorities is a step removed from the “assessment” of taxes. Id. “[A]ssessment” and “collection” are two distinct phases of the taxation process that are distinct from “information gathering.” “[T]he Federal Tax Code has long treated information gathering as a phase of tax administration procedure that occurs before assessment, levy, or collection.” Id. The Court explained that “assessment” and “collection” refer to specific, subsequent phases of the tax administration process. “Assessment” means “the official recording of a taxpayer's liability, which occurs after information relevant to the calculation of that liability is reported to the taxing authority,” while “collection” means “the act of obtaining payment of taxes due.” Id. at 1130.

Under Direct Marketing, and oft repeated by the Ninth Circuit and its district courts, the AIA will only bar those suits that are “keyed to the acts of assessment, levy, and collection themselves, and enforcement of [ ] notice and reporting requirements is none of these." Id. at 1131 (emphasis added); see also, Fredrickson v. Starbucks Corp., 840 F.3d 1119, 1123 (9th Cir. 2016); Big Sandy Rancheria Ents. v. Becerra, 395 F. Supp. 3d 1314, 1322 (E.D.Cal. 2O19); Himple v. Bank of Am., N.A., 2018 U.S. Dist. LEXIS 227422, at *5-6 (C.D.Cal. July 2, 2018); Brinkmann v. AMB Onsite Servs. — W., 2017 U.S. Dist. LEXIS 103262, at *6-7 (D.Or. June 30, 2017).

In this case. Plaintiffs are not seeking to stop the assessment or collection of any tax. Just as in Direct Marketing, this suit is “keyed” to the illegal and burdensome disclosure mandate imposed by the Notice, not the penalty that follows a violation of that mandate. Merely inhibiting tax processes, absent a direct restraint on the imposition of an assessment, levy, or collection of a tax, is not barred by the AIA. Id. at 1133. See also. Chamber of Commerce of the United States v. IRS, 2017 U.S. Dist. LEXIS 166985, at *10-11 (W.D.Tex. Oct. 6, 2017) (holding that challenging the validity of an IRS rule determining who is subject to taxation precedes any assessment or collection of taxes).

For its part. Defendant wants to this Court to ignore Direct Marketing's narrow interpretation of “restrain.” Instead, Defendant urges this Court to side with two deeply divided circuit court decisions — CIC Services (6th Cir.) and Florida Bankers (D.C. Cir.). Again, it must be noted that neither of those cases involved any form of other disclosures to the IRS such as the Form 8275 filed by these Plaintiffs.

The Sixth Circuit's decision in CIC Services is contrary to the Supreme Court's reading of nearly identical statutory language in Direct Marketing. In CIC Services, a divided panel concluded that the IRS's decision to attach a tax penalty to punish violators of a reporting requirement revives the AIA's bar on suits that challenge the legality of the requirement.6

Judge Nalbandian issued a well-reasoned dissent. In his view, CIC's injury was not the tax liability but rather the significant amount of labor and money required to comply with the reporting requirements; accordingly, the case did not fall within the reach of the AIA. CIC Servs., LLC, 925 F.3d at 259. According to Direct Marketing, a suit to enjoin the enforcement of a reporting requirement is not a suit for the purpose of restraining assessment or collection of taxes. Id. at 260. Because Direct Marketing interpreted the similarly worded Tax-Injunction Act, Judge Nalbandian would have applied its reasoning to the issue addressed in the CIC Services case. Id.

Judge Nalbandian also emphasized the ramifications of the panel's opinion. First, it means that the only way for parties like CIC to challenge an illegal agency action “is to violate the law and risk financial ruin and criminal prosecution” — "precisely the bind that pre-enforcement judicial review was meant to avoid.” Id. at 263. Second, it has the effect of rendering any regulatory requirement unreviewable, so long as the agency slaps a tax penalty on it. Id. at 264. In sum. Judge Nalbandian concluded that the panel majority's interpretation of the Anti-Injunction Act did not fit with the text, precedent, or purpose of the statute.

CIC filed a timely petition for rehearing en banc, but it was unsuccessful in its request. Judge Thapar, writing for himself and six other judges, dissented from the denial of rehearing en banc.7 CIC Servs., 936 F.3d at 505. He observed that Direct Marketing resolves the question of whether the AIA applies to a suit that challenges the lawfulness of regulatory reporting and recordkeeping requirements. He explained that enjoining an underlying reporting requirement “cannot be understood to 'restrain[ ] the assessment or collection' of a tax just because it might inhibit the agency's future collection efforts.” Id. at 506, citing 26 U.S.C. § 7421(a); Direct Mktg., 135 S. Ct. at 1133. Judge Thapar also echoed Judge Nalbandian, arguing that a law should not require a taxpayer to violate the law and risk going to prison just so they can challenge the law. Id. at 505.

Defendant's reliance on CIC Services and Florida Bankers further ignores a significant circuit split as to the effect of a tax penalty on an otherwise permissible challenge to a reporting requirement. Compare CIC Services and Florida Bankers (applying the Anti-Injunction Act to bar pre-enforcement challenge), with Korte v. Sebelius, 735 F.3d 654, 669-70 (7th Cir. 2013) (allowing pre-enforcement suit), and Hobby Lobby Stores, Inc. v. Sebelius, 723 F.3d 1114, 1126-27 (10th Cir. 2013) (en banc) (same).

In Korte, the Seventh Circuit held that pre-enforcement challenges to the contraceptive mandate in the Affordable Care Act “[wejre not suits 'for the purpose of restraining the assessment or collection of a tax”; they “s[ought] relief from a regulatory mandate that exists separate and apart from the assessment or collection of taxes.” Korte v. Sebelius, 735 F.3d 654, 669 (7th Cir. 2013). The mandate was “not structured as a predicate to the imposition of a tax but [wa]s instead an independent regulatory mandate”; indeed, the “stiff tax penalties” attached to it were not the only “consequences for noncompliance.” Id. While the Seventh Circuit acknowledged that invalidating the mandate would “incidentally affect . . . tax liability” by making it impossible for individuals to be “liable for the tax penalty,” the court rejected this reasoning as too attenuated: “the Anti-Injunction Act does not reach all disputes tangentially related to taxes,” “the assessment or collection of a tax must be the primary purpose of the lawsuit,” and “[t]hese lawsuits target the mandate itself” Id. at 669-70 (cleaned up).

Likewise, the Tenth Circuit, sitting en banc, unanimously endorsed this same reading of the AIA. See Hobby Lobby, 723 F.3d at 1126-28; Id. at 1164 (Briscoe, J., concurring in part and dissenting in part); Id. at 1191 (Matheson, J., concurring in part and dissenting in part). Pre-enforcement challenges to the contraceptive mandate, the majority opinion explained, were “not challenging the IRS's ability to collect taxes;” rather they were “seeking to enjoin the enforcement, by whatever method, of one HHS regulation.” Id. at 1127 (emphasis added).

These decisions do not square with the decisions in CIC Services and Florida Bankers. Like the contraceptive mandate, the reporting requirements here are enforced with mechanisms other than the assessment and collection of taxes. But the interpretation of the AIA sought by Defendant would bar all pre-enforcement review of regulations with any relation to taxes. Alas, it is important to remember that the AIA does not reach “all disputes tangentially related to taxes.” Cohen v. United States, 650 F.3d 717, 727, 397 U.S. App. D.C. 33 (D.C. Cir. 2011); see also Pendleton v. Heard, 824 F.2d 448, 451-52 (5th Cir. 1987) (restraining the assessment or collection of a tax must be the primary purpose of the lawsuit, not an incidental effect of it, for the AIA to apply).

Unquestionably, there is a clear and divisive circuit split on the issue before this Court. And as Defendant acknowledges, the Ninth Circuit has yet to analyze Direct Marketing and address the issue at the heart of this circuit split. (Doc. 23 at p. 19).

Defendant further cites to Fredrickson v. Starbucks Corp., 840 F.3d 1119 (9th Cir. 2016). However, Fredrickson is distinguishable from this case. In Fredrickson, the plaintiffs challenged Starbucks' practice of withholding employment taxes from employees' paychecks based on cash tips. The Ninth Circuit concluded that the district court lacked jurisdiction to hear the claims because the relief the plaintiffs sought would “enjoin, suspend or restrain . . . the collection of state taxes.” Id. at 1122. The court noted that its holding was “consistent with the scope of the Tax Injunction Act outlined by the Supreme Court in Direct Marketing." Id. at 1123. In doing so, the court emphasized that “the [Tax Injunction Act] is 'keyed to the acts of assessment, levy, and collection themselves, and enforcement of the notice and reporting requirements is none of these.'” Id. (emphasis in original) quoting Direct Marketing at 1131; see also, Gessele v. Jack in the Box, Inc., 2019 U.S. Dist. LEXIS 196627 (D.Or. Nov. 13, 2019) (holding that the assessments at issue, unlike the deductions at issue in Fredrickson, were not a tax, and therefore, the Tax Injunction Act did not deprive the court of jurisdiction). Thus, while the facts of Fredrickson are distinguishable from the case at bar, the Ninth Circuit's analysis of Direct Marketing actually supports Plaintiffs' position.

Here, Plaintiffs' suit seeks to enjoin the enforcement of the reporting requirement in the Notice. Accordingly, this case is distinguishable from Fredrickson because, as noted above, “reporting requirements” have nothing to do with the assessment, levy and collection of taxes.

IV. Purpose of Plaintiffs' Case

To determine the 'purpose' of this suit, this Court should adopt the standard of the D.C. Circuit in Cohen v. United States, 650 F.3d 717, 727 (D.C. Cir. 2011) (en banc).

Cohen arose from a taxpayer suit to enjoin an IRS-proposed method of refunding illegally-collected excise taxes, which was dictated in a notice issued without notice-and-comment rule-making. Cohen, 650 F.3d at 721. When taxpayers sued to invalidate the notice under the APA, the IRS attempted to evade review via the AIA. Id. This should sound familiar by now.

Cohen rejected the IRS's argument that the 'purpose' of the suit was to squabble over refunds. “This is not a refund suit — [taxpayers] are seeking equitable relief rather than recovery of any internal revenue tax.” Id. at 734 (cleaned up). Thus, the taxpayer's APA suit was “consistent with the APA's underlying purpose — remov[ing] obstacles to judicial review of agency action,” Id. at 904 (quotations omitted). Cohen recognized that the taxpayer's suit was not about a tax, its assessment and collection, or a refund; “This suit is about the obstacle course [created by the IRS's notice], and the decisions made by the IRS while setting it up.” Id. at 736. Consequently, Cohen concluded the AIA was not implicated in a suit keyed to the legality of an IRS notice. Id.

To determine a suit's “purpose” for AIA applicability, courts must conduct “a careful inquiry into” (1) the remedy sought, (2) the statutory basis for that remedy, and (3) any implication the remedy may have on assessment and collection. Cohen, 650 F.3d at 727. These questions are easily answered in this case.

First, as in Cohen and as acknowledged by Defendant, the remedy sought by Plaintiffs is to enjoin the Notice. (Doc. 23 at p. 13). Nothing more. Plaintiffs' plan is a five year, minimum, irrevocable transaction for which a refund is not available, but absent the relief sought a substantial burden of filing a Form 8886 would be required each and every year. (Doc. 1 at ¶¶ 46, 59). This case is not a backdoor effort to litigate or block IRS assessments. By interpreting “restrain,” “assessment,” and “collection,” in their narrow sense (which they must be), the AIA will only apply in those eases where a taxpayer seeks relief at or after the assessment stage, e.g. after the IRS has targeted a particular taxpayer “based on information already reported to the taxing authority.” Direct Marketing 135 S.Ct. at 1130.

Second, the principal statutory basis for the requested remedy is the APA. As shown in Cohen (and later confirmed by its district court on remand), IRS notices of this type are subject to APA review and invalidation. In re Long-Distance Tel. Serv. Fed. Excise Tax Refund Litigation, 853 F.Supp.2d 138, 143 (D.D.C. 2012) (because Notice 2006-50 is binding . . . the defendant was required to abide by the APA's notice-and-comment requirements . . . or to, alternatively, provide good-cause for not doing so . . .  Accordingly, the court concludes that the defendant violated the procedural requirements of the APA).

Third, this ease has no direct implication on the assessment or collection of taxes. As discussed, supra, this suit will not increase or decrease the tax liability of anyone — and certainly not Plaintiffs, at least in 2015. See, e.g., NorCal Tea Party Patriots v. IRS, 2014 U.S. Dist. LEXIS 97229, at *35-36, (S.D. Ohio July 17, 2014) (when a taxpayer's claim would not result in a determination of their tax status and would not directly affect the assessment or collection of taxes, the AIA does not apply).

V. There is No Meaningful Remedy Available Except a Pre-Enforcement Action

An exception to the AIA was created by the Supreme Court in South Carolina v. Regan, 465 U.S. 367 (1984). South Carolina sought an injunction against a federal law which made interest on state-issued bearer bonds taxable. South Carolina, 465 U.S. at 370. South Carolina claimed that this effectively destroyed a market for its bonds in violation of the Tenth Amendment. Id. at 371-72. The Supreme Court observed that if the AIA applied. South Carolina would have to depend on third parties (the bond purchasers) to raise the State's constitutional challenge in their tax refund suits. Id. at 379-80. The Court reasoned that “Congress did not intend the [AIA] to apply where an aggrieved party would be required to depend on the mere possibility of persuading a third party to assert his claims.” Id. at 381. So, the Court created an exception to the AIA where Congress has not “provided an alternative avenue for an aggrieved party to litigate its claims.” Id.

Defendant argues that Plaintiffs have an adequate, alternative remedy — file a refund suit. According to Defendant, “[i]n a procedurally sound refund suit, the plaintiffs could challenge the § 6707A penalties assessed against them on any basis, including what they claim to be the IRS's failure to follow the APA in issuing the Notice.” (Doc. 23 at p. 21). Defendant's position is fatally flawed.

Defendant's suggested alternative “remedy” — a refund claim — is wholly illusory and is no remedy at all. This “remedy” would require Plaintiffs to ignore Notice 2007-83, be assessed penalties for ignoring Notice 2007-83, and pay hundreds of thousands of dollars in penalties, taxes and interest. Only then could Plaintiffs challenge Notice 2007-83. Yet, despite fully disclosing the transaction each and every year a tax benefit is claimed, Defendants argue Plaintiffs either must incur an 88 hour burden each year to file Form 8886 lest they risk tens or hundreds of thousands of dollars in civil or criminal penalties. Simply having a right to seek a refund for a given year does not lessen the burden and risks on Plaintiffs in subsequent years since each year stands on its own.

In his dissent in CIC Services, Judge Nalbandian highlighted the impossibility of the taxpayer's “options:”

(1) acquiesce to a potentially unlawful reporting requirement that will cost it significant money and reputational harm or (2) flout the requirement, i.e., “break the law,” to the tune of $50,000 in penalties for each transaction it fails to report. See 26. U.S.C. § 6707(a)-(b). CIC Servs., 925 F. 3d at 263.

This is the definition of being stuck between a rock and a hard place-which is even more ridiculous in the context of these Plaintiffs which advise the IRS of the “rock and hard place” when filing the Form 8275. The concept of first paying a large penalty and then suing for a refund as a methodology for the enforcement of APA public notice-and-comment provisions of the APA is nonsensical.

Defendant's “remedy” means that the only way for parties like Plaintiffs to challenge the reporting requirement “is to violate the law and risk financial ruin and criminal prosecution” — "precisely the bind that pre-enforcement judicial review was meant to avoid.” Id. citing Free Enter. Fund v. Pub. Co. Accounting Oversight Bd., 561 U.S. 477, 490, 130 S. Ct. 3138, 177 L. Ed. 2d 706 (2010) (“We normally do not require plaintiffs to 'bet the farm . . . by taking the violative action' before 'testing the validity of the law.'“) (quoting Medimmune, Inc. v. Genentech, Inc., 549 U.S. 118, 129, 127 S. Ct. 764, 166 L. Ed. 2d 604 (2007)); Medimmune. Inc., 549 U.S. at 128-29 (“[W]here threatened action by government is concerned, we do not require a plaintiff to expose himself to liability before bringing suit to challenge the basis for the threat.”); Gardner v. Toilet Goods Ass'n, 387 U.S. 167, 172, 87 S. Ct. 1526, 18 L. Ed. 2d 704 (1967) (concluding that a “proposed avenue of review [ ] beset with penalties and other impediments [is] inadequate as a satisfactory alternative to [pre-enforcement review]”). In practice. Defendant's “remedy” would only be conceivably available to wealthy, risktaking taxpayers.

VI. The Exception in Williams Packing Applies (Even Though The AIA Does Not)

In Enochs v. Williams Packing & Navigation Co., 370 U.S. 1 (1962), the Supreme Court held that “[t]he object of § 7421(a) is to withdraw jurisdiction from the state and federal courts to entertain suits seeking injunctions prohibiting the collection of federal taxes.” 370 U.S. at 5. This is significant as an initial matter because, as discussed supra. Plaintiffs are not seeking the prohibition of the collection of federal taxes.

Nevertheless, Williams Packing left open the possibility of injunctive relief in cases where “it is clear that under no circumstances could the Government ultimately prevail” and “equity jurisdiction otherwise exists.” Id. at 7. As explained below, Plaintiffs can conclusively show that the IRS exceeded its statutory authority by failing to provide affected parties with notice and an opportunity to respond.

Under the APA, an agency regulation must be set aside if it is “in excess of statutory jurisdiction, authority, or limitations,” or “otherwise not in accordance with law.” Id. § 706(2)(A), (C).

Before an agency adopts a rule carrying the force and effect of law, the APA requires it to comply with a specific set of procedures; it must issue a “notice of proposed rule making”; “give interested parties an opportunity to participate in the rule making through submission of written data, views, or arguments”; and promulgate a final rule only “[a]fter consideration of the relevant matter presented.” Id. § 553(b)-(c). It must then publish the rule at least “30 days before its effective date,” Id. § 553(d), to “afford persons affected a reasonable time to prepare for the effective date . . . or to take any other action which the issuance of rules may prompt,” S. Rep. No. 79-752, at 15 (1945). A rule issued in violation of these requirements must be set aside. California v. Azar. 911 F.3d 558, 575 (9th Cir. 2018).

Generally, for a court to have jurisdiction over claims seeking judicial review of an agency action under the APA, it must determine that the action is final. California Wilderness Coalition v. United States DOE, 631 F.3d 1072, 1099 (9th Cir. 2011); see also Ticor Title Ins. Co. v. Fed. Trade Comm'n, 814 F.2d 731, 746 n.2 (D.C. Cir. 1987) (noting that the finality requirement also applies to “agency action made reviewable by statute”). A final agency action “(1) 'marks the consummation of the agency's decision making process — it must not be of a merely tentative or interlocutory nature'; and (2) the action 'must be one by which rights or obligations have been determined or from which legal consequences will flow.'” San Francisco Herring Assn. v. United States DOT 946 F.3d 564 (9th Cir. 2019) (quoting Bennett v. Spear, 520 U.S. 154, 177-78 (1997)). A court therefore must consider “whether the agency's position is definitive and whether it has a direct and immediate effect on the day-to-day business of the parties.” Indep. Petroleum Ass'n of Am. v. Babbitt, 235 F.3d 588, 595-96 (D.C. Cir. 2001).

There can be no dispute that the IRS ignored these requirements here. Because the Notice has the “force and effect of law,” Treasury had to satisfy the APA's “notice-and-comment requirement.” Perez v. Mortgage Bankers Ass'n, 135 S. Ct. 1199, 1203-04 (2015). Notice 2007-83 goes far beyond providing “notice;” it is rulemaking.

As generally described in the Notice, but as more clearly applied by the IRS, Notice 2007-83 outlaws anything other than term life insurance in a welfare benefit fund. As applied by the IRS, the Notice excludes from the definition of “qualified cost” any amount other than a term premium. (Doc. 1 at ¶ 35). However, the IRS cannot cite to a single section of the Internal Revenue Code to support its position. Moreover, the Second Circuit in Curcio v. Commissioner concluded that the amount deductible for a contribution to a welfare benefit fund to provide a death benefit is an evidentiary issue and, based on the facts and circumstances, a whole life insurance policy premium could be an ordinary and necessary business expense. Curcio v. Commissioner, 689 F.3d 217, 227 (2d Cir. 2012). In sum. Notice 2007-83 is a bridge too far. Because the Notice has the force and effect of law, the IRS cannot avoid the APA's notice-and-comment requirement.

CONCLUSION

For the foregoing reasons. Plaintiffs respectfully request that the government's Motion to Dismiss be denied, and that, if necessary, Plaintiffs be granted leave to amend their complaint in the event this Court concludes that the complaint should be dismissed based upon one or more curable pleading defects. Plaintiffs join the Defendant in respectfully requesting oral argument.

Respectfully submitted,

Brandon A. Keim (028831)
Yale F. Goldberg (005245)
FRAZER RYAN GOLDBERG & ARNOLD LLP
1850 N. Central Ave, Suite 1800
Phoenix, AZ 85004
Phone: 602-277-2010; Fax: 602-277-2595
E-mail: bkeim@frgalaw.com
ygoldberg@frgalaw.com

Walter A. Lucas (0068150)
Samuel J. Lauricia III (0078158)
Matthew C. Miller (0084977)
WESTON HURD LLP
1301 E. 9th Street, Suite 1900
Cleveland, Ohio 44114
Phone: 216-241-6602; Fax: 216-641-8369
E-mail: WLucas@westonhurd.com
SLauricia@westonhurd.com
MMiller@westonhurd.com

Attorneys for Plaintiffs

FOOTNOTES

1The Plaintiffs do note that Instructions to Form 8886 were revised in December, 2019. As a result of the revised instructions, now at Lines 7(b), (c), and (d) on page 2 of the Form 8886, for the first time, taxpayers must report the total dollar of tax benefits claimed, the number of years the benefit is anticipated, and the total investment in the alleged reportable transaction. Attached as Exhibit 4 is the recently revised IRS Instructions for Form 8886.

2One must ask, why would the Form 8275, filed by these Plaintiffs, not provide the IRS its desired ability to assess and collect taxes?

3Plaintiffs engaged in a transaction that is irrevocable for at a minimum 5 years. As each tax year stands on its own. Plaintiffs must risk year after year violating the law by not filing Form 8886 if the relief requested herein is not granted.

4Arguably, it is only because of Notice 2007-83 that these Plaintiffs could even be subject to tax based on the facts of this transaction since Notice 2007-83 attempts, unlawfully, without notice and public comment, to modify existing statutory and regulatory law.

5Although the TIA concerns state as opposed to federal taxes, it was “modeled on” the AIA and the Supreme Court has long looked to one in construing the other. Id. at 1129.

6The Sixth Circuit denied en banc review in a sharply divided vote. Seven judges agreed with the panel dissent that “people should not have to risk prison time in order to challenge the lawfulness of government action” when the challenge focuses on a reporting requirement; “[s]imply put, this is not a case about taxes.” CIC Servs., LLC v. IRS, 936 F.3d 501, 505 (6th Cir. 2019).

7Judge Sutton concurred in the denial of rehearing en banc because he thought that only the Supreme Court could resolve the issue given the circuit split. Nevertheless, he opined that Judge Nalbandian's panel dissent “seems to be right as an original matter.” CIC Servs., LLC, 936 F.3d at 504.

END FOOTNOTES

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