Victory! U.S. Supreme Court Rules Unanimously Against IRS in CIC Services Case

Taxpayers won one today in the U.S. Supreme Court, which unanimously ruled that the Internal Revenue Service (IRS) cannot block a challenge to one of its regulations by invoking the federal Anti-Injunction Act (AIA). The decision sides with NTUF’s brief to the Court in the case, and as a result, taxpayers in this case and others in the future can have their day in court.

The case involves a notice issued by the IRS in November 2016 that any taxpayer engaging in certain micro-captive transactions (or their tax advisor) must comply with extensive (and expensive) reporting and record-keeping requirements. Noncompliance can result in fines of up to $100,000 and imprisonment up to one year.

CIC Services LLC sued the IRS over the requirements, pointing out that the agency issued them without advance notice or accepting public comments as required by the Administrative Procedure Act (APA). The IRS invoked the AIA, saying that because the lawsuit would impact revenue collection (the fines imposed for noncompliance by the tax code), the lawsuit must be dismissed. The AIA stops taxpayers from filing lawsuits for the purpose of restraining the assessment or collection of any tax” (italics added, our brief in the case parsed each of those words in turn). The trial and appellate courts agreed with the IRS.

In a unanimous opinion authored by Justice Elena Kagan, the Supreme Court held that the IRS is wrong:

  • The Court first reiterates that the case would be an even easier one if the fines weren’t imposed in the tax code: the taxpayer would win hands down in that case. If it were simply a challenge to IRS reporting requirements, “[t]he Anti-Injunction Act would not apply and the suit could proceed” even though such regulations “help the IRS bring in future tax revenues.” This is an important point by the Court, as some academic scholars have pushed the view that any impact to revenue collection precludes a pre-assessment lawsuit against the IRS. The Court cites its 2015 opinion in Direct Marketing Association v. Brohl as authority, another important clarification because some scholars have tried to distinguish the AIA from the similar Tax Injunction Act at issue in that case. The words used in both laws are generally used in the same way, the Court writes.

  • Determining what the “purpose” of a lawsuit is – remember, the AIA bans lawsuits with the purpose of halting tax assessment or collection – involves “not…a taxpayer’s subjective motive, but…the action’s objective aim.” The Court therefore rejects the IRS’s argument that the taxpayer’s real purpose was “to stop the collection of the tax itself.” Justice Kagan writes that the IRS is wrong for three reasons:

    • First, the lawsuit is about “the (non-tax) burdens of a (non-tax) reporting obligation” that is “inflicting costs separate and apart from the statutory tax penalty.” While a victory for CIC on the merits means they won’t have to pay the penalty, “that is the suit’s after-effect, not its substance.”

    • Second, there are several steps between the IRS requirements and the tax penalty. CIC would have to refuse to provide information to the IRS, the agency must decide CIC is in violation, and the IRS must impose a tax penalty. It would be “too attenuated a chain of connection” for all of that to be considered a restraint on tax assessment and collection covered by the AIA.

    • Third, noncompliance is also punished by imprisonment, making it untenable for any ordinary person to challenge the rule only after violating it. “[T]he criminal penalties here practically necessitate a pre-enforcement, rather than a refund, suit—if there is to be a suit at all.” The IRS attempted to reassure the Court that it would not seek prison time for “good faith” violations, but in footnote 3 of its opinion, the Court rejected that effort, reminding the IRS that good faith belief by a taxpayer that they are right is not a defense in criminal prosecution.

In short, the Court writes, “this suit falls outside of the Anti-Injunction Act because the injunction it requests does not run against a tax at all.” The answer might be different in a case where a “tax imposes a cost on perfectly legal behavior,” rather than here where there is a standalone “sanction for noncompliance with the reporting obligation.” The “IRS chose” to do this, and “by that choice, they took suits to enjoin their regulatory response outside the Anti-Injunction Act’s domain.”

Two justices joined the Court’s opinion but wrote separately to make additional points. Justice Sonia Sotomayor notes that CIC is an advisor to the taxpayer, and an identical case involving a taxpayer itself refusing to provide information to the IRS might lead to a different result for “a tax on noncompliance may operate as a rough substitute for the tax liability she has evaded by withholding required information.” Justice Brett Kavanaugh writes that the Court should be more explicit in rejecting sweeping language in two earlier cases interpreting the AIA that suggested that a lawsuit’s effects on revenue matters more than the object of the lawsuit.

As we said in our brief to the Court, it is no accident that the IRS set up a situation where they claimed their one-sided and burdensome regulation was both exempt from the Administrative Procedure Act and also unable to be challenged because of the Anti-Injunction Act. The IRS strongly resists efforts to subject its sweeping powers to even basic protections and safeguards. We asked the Court to keep in mind that the IRS has an obligation to establish more transparent, reliable rulemaking” and use this case to “set the IRS on this path.” They now have.

For CIC Services, they can now challenge the IRS’s regulation which is likely doomed as it rather blatantly ignored APA requirements. If that’s the result, the IRS will be on notice to be less lackadaisical about following notice-and-comment procedures for future regulations.

For other taxpayers, this case gives clearer guidance about what IRS and state actions can be challenged prior to an assessment being issued. The Court today clearly rejected the routine government position that anything that impacts revenue collection is barred by the AIA, although they didn’t throw open the door completely either. The pending lawsuit against Maryland’s digital ad tax may be the next big test of how the AIA impacts taxpayers.

The case is CIC Services, LLC v. Internal Revenue Service, No. 19-930.