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Tax Advisors May Now Sue IRS

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Tax Advisors May Now Sue IRS

In CIC Services LLC v. Internal Revenue Service decided in May 2021, the United States Supreme Court held the Anti-Injunction Act (AIA), section 7421(a) of the Internal Revenue Code (Code), does not preclude a pre-enforcement challenge to an IRS notice enforced through civil and criminal penalties. The AIA generally precludes pre-enforcement challenges to the assessment or collection of any tax so the flow of tax payments cannot be disrupted by litigation. The Supreme Court has held the AIA does not prevent an information reporter/tax advisor from challenging an Internal Revenue Service (IRS) notice under the Administrative Procedure Act (APA).

This is a significant victory for taxpayers’ advisors. Taxpayers generally lack the power to sue the IRS unless the IRS claims the taxpayer owes taxes. In a unanimous opinion written by Justice Kagan, CIC Services, LLC v. Internal Revenue Service, the Supreme Court held that taxpayers’ advisors have the right to sue the IRS to set aside or invalidate IRS Notices.

CIC Services a micro captive manager and strategist. A micro captive company manages insurance contracts for related parties that are governed by Section 831 of the Code.  The IRS had issued IRS Notice 2016-66 that addressed micro captive transactions that the IRS believed were abusive. Understandably, CIC Services did not want to subject itself to onerous civil or criminal penalties. The company brought a lawsuit challenging the lawfulness of Notice 2016-66. But the lawsuit never got a chance to proceed on the merits. That is because the government argued, and the District Court agreed, that CIC Services’ suit to have Notice 2016-66 set aside any lawsuit brought “for purposes of restraining the assessment or collection of tax”. Because the AIA prohibits all prospective litigation preventing the IRS from assessing or collecting tax, the IRS, the District Court, and the Court of Appeals for the Sixth Circuit all agreed CIC Services could not bring a lawsuit seeking to invalidate Notice 2016-66, because it would “restrain” the IRS from assessment and collection of civil penalties.

The Supreme Court reversed and remanded the case, holding the AIA does not bar CIC Services suit complaining Notice 2016-66’s reporting requirements and penalty regime violate the APA. Justice Kagan noted a reporting requirement is not a tax, and a suit to set aside a reporting rule does not interfere with the IRS’s ability to assess or collect taxes. Notice 2016-66 did create requirements “backed up by a statutory tax penalty.” CIC Services argued the suit should proceed because it was brought to invalidate the Notice and eliminate its reporting requirements, while the IRS argued the suit was an attempt to stop assessment of the penalty applicable for violating the Notice. The Supreme Court held it was distinct and several steps removed from a potential penalty.

Finally, the Notice carried civil and criminal penalties. “Willful failure to comply with the Notice’s reporting rules can lead to as much as a year in prison.” Justice Kagan explained, “That fact cinches the case for treating a suit to set aside the Notice as different from one brought to restrain its back-up tax.” The Supreme Court correctly noted CIC Services was in a no-win situation – either stop conducting business, or conduct business and risk criminal prosecution. The lack of a viable alternative “explains why an entity like CIC must bring an action in just this form, framing its request relief in just this way.” CIC did not ask for an injunction against enforcing the penalty applicable under Notice 2016-66, it asked for an injunction against the Notice itself. This distinction made the difference in determining whether the suit was barred by the AIA.

Potential Outcomes

The litigation over the validity of IRS Notice 2016-66 is not over. CIC Services has been remanded back to District Court, where CIC Services will have its day in court on whether Notice 2016-66 should be declared invalid. The Supreme Court’s decision in CIC Services will likely lead to additional pre-enforcement challenges to Treasury and IRS rules and regulations under the APA, and further judicial scrutiny of Treasury and IRS administrative practices. Proponents of tax exceptionalism will try to limit the reach of the CIC Services decision to third-party information reporting requirements, tax advisers, or instances in which criminal prosecution has been threatened. Justice Kagan’s opinion imposes none of those limitations expressly and contains several hints the Court may favor narrowing the AIA further to permit pre-enforcement judicial review of a broader array of Treasury and IRS rules and regulations under the APA. The trend against tax exceptionalism continues — with more to come!

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