On May 17, 2021, a unanimous Supreme Court issued its opinion in the long-awaited case interpreting the Anti-Injunction Act as applied to the Internal Revenue Service. CIC Services, LLC v. Internal Revenue Service was a rare loss for the government. The Supreme Court held that CIC Services has jurisdiction to question the IRS’ ability to demand burdensome record-keeping information from taxpayers and “material advisors” regarding certain micro-captive insurance companies. Justice Kagan delivered the opinion of the Court and held that because the taxpayer had not yet violated the IRS disclosure requirement and thus owed no penalties, i.e. taxes, the taxpayer was justified in its quest for an injunction against the IRS to prevent the agency from requiring the burdensome reporting. The Anti-Injunction Act generally prevents taxpayers from filing lawsuits that interfere with the IRS’ ability to collect taxes, unless the taxpayer pays the tax liability first and then sues for a refund. (The U.S. Tax Court is a pre-payment forum for taxpayers to challenge tax liability after the taxes have been assessed, but not to challenge reporting requirements.) The Supreme Court unanimously ruled that the Anti-Injunction Act did not prevent CIC Services from pursuing its lawsuit requesting an injunction to prevent the IRS from enforcement of the reporting requirements set forth in IRS Notice 2016-66. The case was remanded back to the lower court for further proceedings regarding whether the IRS should be enjoined from requiring the information under the Administrative Procedures Act.
As indicated, the source of the lawsuit is Notice 2016-66 issued by the IRS. That Notice requires taxpayers and material advisors to provide substantial information about individuals and entities, including the clients of a material advisor, involved with micro-captive insurance companies. If the information is not provided, the IRS has the ability to impose substantial monetary penalties against all parties involved in the captive, including their material advisors. In addition, criminal penalties were available to the IRS to criminally indict said parties for noncompliance with the IRS Notice. CIC Services estimated this reporting requirement would require it to incur approximately $60,000 annually in compliance costs. The Supreme Court remanded the case back to the lower court to consider the substance of the lawsuit: whether the Notice’s reporting requirements violate the Administrative Procedures Act. Therefore, the case is not over. The taxpayer just cleared the first hurdle.
An interesting inquiry is whether the Supreme Court’s ruling provides any opportunities for other taxpayers, including nonprofit entities, to challenge the substantial information required by the IRS under a myriad of situations. The requirements imposed through IRS Notices and/or Treasury Regulations are most likely to be challenged in reliance on this Supreme Court decision in CIC Services. Reporting required by the Internal Revenue Code will be much more difficult to challenge. Thus, any action depends upon the reporting requirement and the source of the requirement. It also depends upon whether taxes are owed by the plaintiff at the time of the lawsuit. Should liability for taxes already be an issue, this new exception created by the Supreme Court as to interpretation of the Anti-Injunction Act is not likely to apply.
The Anti-Injunction Act has long been interpreted as a prohibition to any challenges to the IRS’ ability to collect taxes. However, nonprofits generally do not owe taxes. Therefore, this presents an opportunity. Nonprofits are exempt from tax and so theoretically the Anti-Injunction Act would not apply to prevent a nonprofit from challenging a reporting requirement. Many of the nonprofit reporting requirements are extremely burdensome. While there is societal benefit to the requirement that nonprofits justify their exemption through transparency and financial disclosures, there is also societal benefit to relieve charities from onerous and time-consuming work satisfying government edicts for information that has no, or minimal, apparent use. For example, IRS Notice 2017-10 imposes extensive reporting requirements on those involved with charitable conservation easements, somewhat similar to the requirements connected with captive insurance transactions. The listed transaction disclosure requirement for conservation easements could now be challenged pursuant to the authority provided by CIC Services.
The government made the argument that a ruling in favor of CIC Services could unleash a cascade of other lawsuits from those wanting to be relieved from reporting requirements. That is not a bad thing. Entities and individuals spend an inordinate amount of time and treasure trying to comply with the onerous reporting requirements imposed by the Federal government. Having the ability to challenge some of those reporting requirements is healthy in a democracy. Without that curb on government authority to continually increase the amount of information required of taxpayers, the cost of compliance becomes increasingly burdensome. Productive activities by taxpayers and nonprofits are potentially thwarted due to the high cost of compliance. The Supreme Court’s ruling is a welcome win for the taxpayer.