Tax Notes legal reporter Jennifer McLoughlin and contributing editor Kristen Parillo discuss two important tax cases heard by the Supreme Court: Americans for Prosperity Foundation and CIC Services.
This transcript has been edited for length and clarity.
David Stewart: Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: Taxes at the High Court. Every summer, the Supreme Court releases a flurry of opinions before adjourning in June. Though, unfortunately, they can't all be tax-related, this year the court took on two important tax cases: CIC Services and Americans for Prosperity Foundation.
The court has released its opinion in CIC Services, but we're still waiting on the decision in the latter. What do these cases entail, and how will they affect the tax world? Later on, we'll talk to Tax Notes contributing editor Kristen Parillo about CIC Services and the Supreme Court's decision.
First, we'll start with the one that's outcome is still uncertain. Joining me now to talk about the Americans for Prosperity Foundation case is Tax Notes legal reporter Jennifer McLoughlin. Jennifer, welcome back to the podcast.
Jennifer McLoughlin: Thank you. It's good to be back.
David Stewart: Let's start with the basics. What is this case all about?
Jennifer McLoughlin: At the heart of this case is the constitutionality of the California attorney general's requirement that charitable organizations soliciting within the state must submit a copy of their Schedule B attached to their IRS Form 990. That schedule contains the names, addresses, and contributions of major donors.
According to California, this requirement assists with the state's regulatory and law enforcement efforts. More specifically, it assists in the state's efforts to police charitable fraud. Throughout this case, California has continually stressed that the Schedule Bs are submitted confidentially and they are safeguarded from disclosure to the public. The state has acknowledged that there have been past lapses in terms of public disclosure. They have said they have taken efforts to rectify such lapses and prevent future lapses.
However, California's disclosure requirement does not have a shortage of critics, including the two organizations whose cases were heard by the Supreme Court late last month. Those two organizations are — the Americans for Prosperity Foundation, which we know for its affiliation with the Koch brothers, and the Thomas More Law Center. Those organizations have claimed that California's disclosure requirement violates the First Amendment freedoms of association and speech, and they claim it will subject their donors to threats and harassment.
The organizations have argued that California has alternative means to advance its interest in regulating charitable entities. They have stressed concerns that California is not protected the confidentiality of Schedule Bs and information has leaked in the past, which feeds into their concerns about public retaliation against their donors.
The history of these cases goes back quite a bit. The current appeals before the Supreme Court came from a decision issued by Ninth Circuit panel, which upheld California's disclosure requirement against the organization's facial and as-applied constitutional challenges. That's where we are at this time.
David Stewart: You mentioned that there's two different organizations that are involved in this — Americans for Prosperity Foundation and the Thomas More Law Center — so this is a joint case. Are there any major differences between the two organizations' cases?
Jennifer McLoughlin: Both appeal the Supreme Court and were brought by the two organizations arose from the same Ninth Circuit decision, but the two organizations have presented distinct questions to the Supreme Court, and they have offered some varying arguments. For example, both have taken issue with the standard of scrutiny that the Ninth Circuit applied in the underlying decision.
But they each have advanced separate arguments regarding what the appropriate standard of scrutiny should be. The Americans for Prosperity Foundation has advocated for for exacting scrutiny with a narrowly tailored element while the Thomas More Law Center has been advocating for strict scrutiny. While each organization has challenged the constitutionality of California's disclosure requirement, they've offered what they have called different approaches for resolving the questions presented in the two cases.
Likewise, the as-applied challenges are distinct as they relate to facts that are unique to each organization, such as the threats and harassment that each organization has alleged its donors have been subjected to in the past and could face in the future. In fact, there was a joint motion filed by the organizations in which they asked the Supreme Court for what is called divided argument with each organization seeking 15 minutes of the petitioner's total allotted argument time to present their individual perspectives and arguments. However, the Supreme Court ultimately denied the motion and only one of the petitioner's attorneys argued during the argument last month. They are similar, but they're different.
David Stewart: You mentioned oral arguments. Those happened in late April. What did we learn from them?
Jennifer McLoughlin: I think the oral arguments demonstrated how many underlying issues are under consideration in this case. There are a lot of moving pieces. Just to name a few, the justices' lines of questioning touched on multitude of issues including the proper standard of scrutiny, California's rationale for requiring submission of the Schedule Bs and its ability to protect the confidentiality of the information and schedule base, and whether the case should be decided on a facial challenge or as-applied challenge.
Something that stood out for me was Justice Clarence Thomas's observations and questions that highlighted what is an increasingly divisive environment in our country. He raised questions regarding whether the legal analysis in the case might change depending on whether an organization is considered controversial or not. During the petitioner's argument, the attorney noted that what is considered controversial now might not have been considered controversial just a few years back.
Thomas also touched on the notion that organizations might be subject to public accusations, even what he called loose accusations of being perhaps a racist, homophobic, or a white supremacist group. He asked California's attorney hypothetically about a donor who may want to contribute to such a group, and whether it's reasonable that they would be chilled because they have little or no confidence that their donation or their identity will be kept confidential.
I think that went to both California's ability to maintain the confidentiality of contributions and also the present day environment. I think that's yet another element at play in this case, specifically the present day landscape in which we're seeing in some circles increasing hostility to other's views. I'll be really curious if and how that element plays into the court's calculus.
David Stewart: Speaking of the court's calculus, is there any sense from these oral arguments or from reactions from stakeholders of how the Supreme Court might end up deciding this case?
Jennifer McLoughlin: I think predicting how the Supreme Court will rule in a case is often an exercise in reading tea leaves, and this case is certainly no exception. From what I have heard, it seems like the most common prediction is that California will likely lose the case — at least to some degree.
The question I'm hearing more is not whether or not California will or will not lose; it's more how will the state lose? Or what would the court's ruling look like? There seems to be a more common belief among practitioners and those who are watching the court that California could lose this case.
David Stewart: What do nonprofits and others have to say about what it means if this California law is upheld or what might it mean if this California law is struck down?
Jennifer McLoughlin: What we have seen and what we have heard is that not all nonprofits are on one side of this case. Not all nonprofits support these two organizations that are before the Supreme Court.
During the merit stage of these consolidated cases, there was a wave of amicus briefs in support of the two organizations, including briefs from a variety of groups. Sometimes they filed individually; sometimes, several joined in a brief. Likewise, there were not as many, but there were several amicus briefs filed in support of California, and there's a slew of various concerns raised throughout the briefs.
One thing that the the two petitioners have particularly emphasized is the potential chilling effect of California's disclosure requirement. They have stressed that California's disclosure requirement presents the risk of information being leaked in part because of the leaks that have occurred in the past. This puts their donors in the position of potentially facing threats, harassment, and violence because of the fact that they have donated to a group others might consider controversial. Faced with this potential retaliation, their donors might refrain from contributing to a charitable organization or to their charitable organizations. That's that chilling effect is something that we hear from both these organizations and a few other groups.
On the other side, if California's requirement is struck down, there's one concern that regulation of charities will be undermined or impeded. Further from there the public trust and charitable sector could diminish, so that individuals who donate time and money into nonprofits might start withholding their support because they're not confident that their money in particular is going to the purpose for which it was donated.
There was a law professor who spoke at a recent American Bar Association panel who indicated that the federal rules could also be in jeopardy depending on how the Supreme Court rules. He suggested that if the justices hold that "the mere reporting on a confidential basis a substantial contributor information to the government significantly burdens First Amendment rights" that could really put federal rules in jeopardy, including the federal rule to provide substantial contributor information to public charities to the IRS.
There is a slew of concerns across the board, and those are just a few that we've heard.
David Stewart: Is there any idea of when we might actually have a resolution to this case?
Jennifer McLoughlin: The most common prediction, or I guess the wide expectation, is that the Supreme Court will release its decisions sometime in June, probably later in the month. But of course we are keeping an eye out for a potentially earlier release.
David Stewart: This has been great. Jennifer, thank you for being here.
Jennifer McLoughlin: Thank you so much for having me.
David Stewart: Now we turn to another case, this one recently decided by the Supreme Court: CIC Services. I'm joined by Tax Notes contributing editor Kristen Parillo. Kristen, welcome back to the podcast.
Kristen Parillo: Thanks for having me, Dave.
David Stewart: Why don't you start us off with some background about the case? What is this all about?
Kristen Parillo: The key issue in this case is really on the timing of when a taxpayer can legally challenge a Treasury or IRS rule or regulation before there's been any violation of the rule and punishment for noncompliance. In nontax cases people typically can bring a pre enforcement challenge arguing that an agency regulation is procedurally or substantively invalid under the Administrative Procedure Act.
But in the tax world, we have a statute called the Anti-Injunction Act (AIA) which bars federal courts from hearing lawsuits that will restrain the government's ability to assess and collect taxes. Historically, this has meant that taxpayers can't challenge a Treasury or IRS tax rule until they've paid the tax and can then sue for a refund.
In this case, CIC Services filed a lawsuit in 2017 arguing that a 2016 IRS notice flagging microcaptive transactions as transactions of interests violated the APA because it was issued without a formal comment period. I won't go too deeply into what microcaptive transactions are, but basically they're insurance arrangements that smaller companies create to cover risks and losses that traditional insurance policies don't cover.
The IRS believes that some taxpayers are abusing the tax benefits from microcaptives. By putting out this notice and calling them transactions of interest, all taxpayers and advisers who created these microcaptive arrangements have to report certain information to the IRS every year. If they don't, the IRS can impose a penalty.
CIC Services is a consulting company that advises companies on forming microcaptive insurance arrangements. They're considered a material adviser under this IRS notice so they're required to report whatever information is required. They think this is a huge and unnecessary burden, so they want a court to rule that the notice is invalid under the APA.
However, they haven't been able to get the case heard on the merits because of the AIA. Both the district court and the Sixth Circuit said that because the penalty for noncompliance is treated as a tax under the tax code, any lawsuit challenging the notice is in essence trying to impede the assessment or collection of taxes, and thus is barred by the Anti-Injunction Act.
CIC Services asked the Supreme Court to review the case. The court accepted, and it heard oral arguments in December 2020.
David Stewart: How did those arguments go? Was it clear during them how this decision was going to come out?
Kristen Parillo: We could tell that the justices were pretty unsympathetic to the government's position. That CIC Services' only option basically was to violate the notice, pay a penalty, and then challenge the notice in a refund lawsuit.
Several of the justices pointed out that not complying with the reporting requirements could subject taxpayers and advisers to criminal penalties. They suggested that that's clearly unreasonable to force someone to violate the law just to get their day in court.
David Stewart: The Supreme Court handed down a decision on May 17. How did they come out on it?
Kristen Parillo: The court unanimously rejected the government's position that the AIA bars pre-enforcement challenges of IRS reporting requirements backed by penalties that are treated as tax, as they are in this notice. The court said you have to look at the purpose of the lawsuit. And in this case, CIC Services is challenging the reporting requirements and not a tax that the IRS has discretion to impose.
The court said there were three reasons why this wasn't a tax case in disguise as the government had claimed. First, the notice imposes affirmative reporting obligations, which it said inflicts costs separate and apart from the statutory tax penalty. Second, the reporting obligations and the tax penalty are several steps removed from each other. And third, the fact that noncompliance result in criminal penalties reinforces that the suit is challenging the notice and seeking relief from the reporting obligations.
David Stewart: How did practitioners respond to this opinion?
Kristen Parillo: The result was expected, so it wasn't a huge surprise. But the fact that this was a unanimous decision is obviously still a big deal. We now have some clarity on the scope of the AIA, but people are still sorting through what this means for Treasury and IRS rulemaking, especially for the reportable transaction regimes.
David Stewart: What does it mean next for CIC Services? Where does this case go next?
Kristen Parillo: The case now goes back to the district court in Tennessee where CIC Services and the IRS will argue about the validity of the notice and whether it complied with the rulemaking requirements of the APA. In some ways we're back to square one.
David Stewart: Well, it's good for us. It's definitely something to keep an eye on as it progresses again. Kristen, thank you for being here.
Kristen Parillo: Well, thanks for having me, Dave.