In 2011, in Mayo Foundation for Medical Education and Research v. United States, the Supreme Court unanimously (with Justice Kagan abstaining) told the tax community that it was “not inclined to carve out an approach to administrative review good for tax law only,” thereby signaling to Treasury and the IRS that they ought to clean up their act respecting their compliance with general administrative law requirements, doctrines, and norms. Over the past ten years, the courts, the Government Accountability Office, and the Office of Information and Regulatory Affairs have slowly but surely prodded Treasury and the IRS in that direction. With its decision this week in CIC Services, LLC v. IRS, the Supreme Court has said to Treasury and the IRS — again unanimously — “yes, we really mean it.”
The CIC Services case concerned the scope of the Anti-Injunction Act (AIA), 26 U.S.C. § 7421(a), and its implications for pre-enforcement judicial review of Treasury and IRS rules and regulations. Since its 1967 decision in Abbott Labs v. Gardner, the Court has interpreted the Administrative Procedure Act (APA) as adopting a presumption in favor of pre-enforcement judicial review of agency rules and regulations generally. By comparison, the AIA precludes lawsuits brought “for the purpose of restraining the assessment or collection of any tax” except as otherwise authorized by the Internal Revenue Code. The effect of the provision generally is to defer judicial review of tax cases to post-enforcement refund and deficiency actions, and thus to require individuals or entities seeking to challenge the validity of a Treasury or IRS rule or regulation to “pay the tax and seek a refund.”
In this case, CIC Services brought a pre-enforcement lawsuit challenging the validity of IRS Notice 2016-66, claiming that the Notice violated the APA for its lack of notice-and-comment rulemaking procedures and reasoned decisionmaking. The Notice imposed a third-party reporting requirement on tax advisers like CIC Services who facilitate certain micro-captive insurance transactions, requiring CIC Services to collect and report information about its clients’ transactions. But the Notice did not impose a direct tax liability on CIC Services except for potential tax penalties in the event that CIC Services declined to comply with the Notice. Instead, CIC Services would have to decline to comply with the reporting requirement in an effort to trigger a tax penalty, which it could then pay and seek to recover. At least in theory (as came up repeatedly in the litigation), pursuing that course of action could open CIC Services to criminal prosecution in addition to civil tax penalties. Throughout the litigation, CIC Services rejected the idea of deliberately violating the Notice to obtain post-enforcement relief. Accordingly, the question for the Court was whether the pre-enforcement APA challenge brought by CIC Services against IRS Notice 2016-66 was for the purpose of restraining the assessment or collection of taxes, and thus barred by the AIA.
A divided Sixth Circuit had held that the AIA precluded judicial review of CIC Services’ APA claim. In an earlier case, Florida Bankers Ass’n v. U.S. Department of the Treasury, a divided D.C. Circuit panel had reached the same conclusion regarding a different third-party reporting regulation, with then-Judge Kavanaugh writing the majority opinion. In CIC Services, the Supreme Court unanimously decided otherwise, holding that suit before it was not brought for the purpose of restraining the assessment and collection of taxes, and thus that the AIA did not apply. Writing for the Court, Justice Kagan crafted a very careful opinion that avoided grand pronouncements and instead emphasized the facts and circumstances of the particular third-party reporting requirements at stake in that case. At the same time, however, Justice Kagan managed to avoid putting the Court in too tight of a box with respect to future cases, and she drew lines and sent signals that could allow a future Court the flexibility to expand the range of Treasury and IRS rules and regulations eligible for pre-enforcement judicial review without running afoul of the CIC Services decision.
First, Justice Kagan characterized the purpose of CIC Services’ challenge to IRS Notice 2016-66 by looking to the remedy sought — here, setting aside the Notice, enjoining its enforcement, and declaring it unlawful — rather than the eventual “downstream” effect of avoiding a future tax penalty. Declaratory and injunctive relief of the sort requested by CIC Services is the standard remedy under the APA when agency pronouncements are procedurally invalid or arbitrary and capricious for lack of reasoned decisionmaking. In a footnote, Justice Kagan noted the government’s concession that a pre-enforcement challenge to Environmental Protection Agency (EPA) regulations governing the resale of diesel fuel and enforced partly through a tax penalty would not be precluded by the AIA. She then rejected the idea that the AIA should apply merely because the IRS rather than the EPA administers a regulatory mandate.
Justice Kagan also emphasized three conditions as demonstrating that the purpose of CIC Services’ suit was not for the purpose of restraining the assessment and collection of taxes: (1) that IRS Notice 2016-66 “inflict[ed] costs separate and apart from the statutory tax penalty”; (2) that “the Notice’s reporting rule and the statutory tax penalty are several steps removed from each other”; and (3) that “violation of the Notice is punishable not only by a tax, but by separate criminal penalties,” with emphasis on the fact that the only way that CIC Services could challenge the Notice otherwise was to disobey its mandate in order to trigger a tax penalty. It may be tempting to turn the listed conditions into a three-part test for avoiding the AIA, but that does not appear to have been Justice Kagan’s intent. Although the three listed conditions are clearly sufficient to overcome the AIA, Justice Kagan never said that all three conditions are necessary to achieve that goal.
Instead, the critical dividing line drawn by Justice Kagan’s opinion is between regulatory taxes “designed mainly to influence private conduct, rather than raise revenue” versus regulatory mandates backed by tax penalties, where the rule being challenged imposes “a separate legal mandate” where “the tax appears on the scene … only to sanction that mandate’s violation.” Like revenue-raising taxes, regulatory taxes fall within the AIA’s scope. After the CIC Services decision, regulatory mandates backed by tax penalties do not. Third-party reporting requirements like those at issue in CIC Services are the obvious example of a regulatory mandate, given the circumstances of the case itself, but they are not the only regulatory mandates backed by tax penalties contained in the Internal Revenue Code. And see again that footnote regarding EPA regulations governing the resale of diesel fuel and enforced partly through a tax penalty. Drawing the line between regulatory taxes and regulatory mandates backed by tax penalties may not always be as simple as it was with the third-party reporting requirements in CIC Services. The Internal Revenue Code often uses “tax” and “penalty” as synonymous terms. Justice Kagan’s three conditions certainly helped in making that distinction here. But in other cases, the Court might decide that two of the three conditions or a different combination of conditions are sufficient to reach the same conclusions — i.e., that a particular requirement is a regulatory mandate backed by a tax penalty rather than a regulatory tax, or that pre-enforcement judicial review of a Treasury or IRS rule or regulation is appropriate.
Justices Sotomayor and Kavanaugh joined Justice Kagan’s opinion for the Court but also wrote separate concurring opinions to emphasize particular points. Justice Sotomayor’s principal focus was to distinguish between tax advisers like CIC Services and taxpayers facing similar reporting requirements and suggest that “the analysis may be different” for the latter. Maybe she is right, although even if Justice Sotomayor would be inclined to analyze a case involving a reporting obligation imposed on a taxpayer differently, she wrote for herself alone in this opinion, and Justice Kagan’s opinion did not limit its analysis in this way. Moreover, Justice Sotomayor’s discussion of tax advisers versus taxpayers seemed limited to reporting requirements and said nothing about other types of regulatory mandates.
Meanwhile, Justice Kavanaugh wrote separately to discuss the implications of the Court’s decision for the Court’s 1974 decisions in Alexander v. “Americans United” Inc. and Bob Jones University v. Simon, and to defend the lower courts’ prior reliance on those decisions in interpreting the AIA. In Americans United and Bob Jones, the Court held that IRS decisions to revoke the tax-exempt status of a nonprofit organization and a university were unreviewable under the AIA, and in doing so characterized the AIA’s scope in very broad terms. Congress shortly thereafter amended the Internal Revenue Code to make similar IRS revocations of tax-exempt status judicially reviewable. Given the swift congressional rejection of the holdings of those cases, one wonders whether lower courts ought to have taken the Court’s sweeping rhetoric quite so seriously. Regardless, as a D.C. Circuit judge, Justice Kavanaugh interpreted the AIA as more or less an absolute bar against judicial review in tax cases except through the avenues specifically authorized in the Internal Revenue Code. In those opinions, he cited Americans United and Bob Jones, although he also relied on other arguments. Justice Kavanaugh was not alone in reading the AIA more broadly as a lower court judge. Citing particularly his Florida Bankers opinion, a majority of the Sixth Circuit in the CIC Services litigation read the AIA similarly. Regardless, Justice Kavanaugh now concurs that the AIA’s text should be read more narrowly to allow pre-enforcement review of at least some — and perhaps even many — Treasury and IRS rules and regulations.
The litigation over the validity of IRS Notice 2016-66 is not over. The case merely returns to federal district court for consideration of the merits of CIC Services’ APA claims. Meanwhile, the Court’s decision in CIC Services almost certainly will 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 undoubtedly will try to limit the reach of the CIC Services decision to third-party information reporting requirements, or tax advisers, or instances in which criminal prosecution has been threatened. Justice Kagan’s opinion imposes none of those limitations expressly and additionally contains several hints that 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. Regardless, the trend against tax exceptionalism continues — decisively!
Cross-posted at OfInterest.blog.