The Supreme Court unanimously ruled against the Internal Revenue Service in a decision enabling taxpayers to sue the IRS over tax regulations, even before any penalty has been assessed.
The case involves a CIC Services, a company in Knoxville, Tennessee, that specializes in helping small and midsized business owners set up their own captive insurance companies to protect their assets. In 2016, the IRS issued
However, on Monday, which happened to be the tax deadline, the Supreme Court sided with CIC in a 9-0 decision, and remanded the case back to the district court for a determination on whether or not Notice 2016-66 should be formally enjoined.
The ruling is likely to bolster the ability of companies like CIC to offer micro-captive arrangements and give other taxpayers and professionals the ability to challenge other tax notices and arrangements from the IRS, even though they would otherwise be barred by the Anti-Injunction Act because they involve tax penalties. The Anti-Injunction Act says that “no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person.”
“Absent the tax penalty, this case would be easy: The Anti-Injunction Act would pose no barrier,” wrote Justice Elena Kagan in her majority
The Supreme Court decision gave several reasons why the IRS’s argument wasn’t persuasive, first pointing out that the IRS notice imposes affirmative reporting obligations, inflicting costs that are separate and apart from the statutory tax penalty.
“Second, it is hard to characterize CIC’s suit as one to enjoin a tax when CIC stands nowhere near the cusp of tax liability; to owe any tax, CIC would have to first violate the Notice, the IRS would then have to find noncompliance, and the IRS would then have to exercise its discretion to levy a tax penalty,” Kagan wrote. “Third, the presence of criminal penalties forces CIC to bring an action in just this form, with the requested relief framed in just this manner. The government’s proposed alternative procedure — having a party like CIC disobey the Notice and pay the resulting tax penalty before bringing a suit for a refund — would risk criminal punishment. All of these facts, taken together, show that CIC’s suit targets the Notice, not the downstream tax penalty. Thus, the Anti-Injunction Act imposes no bar.”
The IRS did not immediately respond to a request for comment.
The court doesn’t expect the case to lead to a flood of lawsuits against IRS tax regulations. “Allowing CIC’s suit to proceed will not open the floodgates to pre-enforcement tax litigation,” Kagan wrote. “When taxpayers challenge ordinary taxes, assessed on earning income, or selling stock, or entering into a business transaction, the underlying activity is legal, and the sole target for an injunction is the command to pay a tax. In that scenario, the Anti-Injunction Act will always bar pre-enforcement review. And the analysis is the same for a challenge to a so-called regulatory tax — that is, a tax designed mainly to influence private conduct, rather than to raise revenue.”
She pointed to an earlier case involving Bob Jones University as showing the Anti-Injunction Act draws no distinction between regulatory and revenue-raising tax laws; the Anti-Injunction Act kicks in even if a plaintiff’s true objection is to a regulatory tax’s regulatory effect.
“By contrast, CIC’s suit targets neither a regulatory tax nor a revenue-raising one; CIC’s action challenges a reporting mandate separate from any tax,” Kagan wrote. “Because the IRS chose to address its concern about micro-captive agreements by imposing a reporting requirement rather than a tax, suits to enjoin that requirement fall outside the Anti-Injunction Act’s domain.”
CIC hailed the decision, saying it would set a precedent. "This case is hugely significant given that the IRS has made issuing illegal regulations and enforcing them against taxpayers part of its standard operating procedure," said Sean King, general counsel for CIC Services, in a statement Monday. "An alarming percentage of substantive obligations that the IRS imposes upon taxpayers each year by fiat don't comply with the procedural requirements of the Administrative Procedures Act, and so are illegal, and yet are still shamelessly enforced by the service."
The IRS has focused in recent years on micro-captive transactions as abusive transactions and has gone after companies that offer them as a way for businesses to lower their tax bills. Last month, the IRS issued a
"In multiple cases before the courts, judges have held that these 'fanciful' and 'unreasonable' arrangements don't add up to insurance in the commonly accepted sense," said IRS Commissioner Chuck Rettig in a statement in April. "I strongly urge participants in these arrangements to get independent legal advice separate from those who helped steer them into these abusive arrangements."
