Supreme Court cases over tax enforcement of micro-captive transactions usually don’t make the front pages or inspire activists to picket the Court’s steps. But one particular case involving the Internal Revenue Service’s (IRS) ability to enforce regulations in a “tails I win, heads you lose” manner, CIC Services v. IRS, may well prove to have important consequences for making the IRS more accountable to taxpayers.
IRS Notice 2016-66 requires third parties advising on certain micro-captive transactions to follow extensive reporting procedures. Failure to comply with this regulation entails extensive penalties, including imprisonment of up to one year and fines of $25,000 for individuals and $100,000 for corporations.
Though reporting requirements are not a tax or a fine, they have tangible costs to businesses forced to comply with them. After all, the National Taxpayers Union Foundation has estimated the net burden of tax compliance at over $367 billion for last year alone.
Given this cost of compliance, one would hope that there would be a careful process to ensure that reporting requirements are not unnecessarily burdensome. With most federal regulations, notice-and-comment procedures under the Administrative Procedure Act (APA) ensure that the public has a chance to weigh in on important rules, but with this notice (and nearly 40 percent of others it produces) the IRS simply decided that this requirement did not apply.
One company required to report under Notice 2016-66, CIC Services, is challenging the notice on the basis that the IRS failed to follow the APA. In response, the IRS has cited the Anti-Injunction Act, a law which normally requires taxpayers to wait until they have paid a tax or received a tax notice until they can challenge the legality of the tax assessment.
This puts taxpayers in a position where they must, to quote a lower court judge on the issue, “report to prison first and challenge later,” since knowing failure to report material information to the IRS is a criminal violation. In other words, if potential litigants have to pay fines in the tens of thousands of dollars and face jail time simply to challenge the legality of a dubious notice.
The consequences of this case, therefore, can stretch well beyond a dispute over enforcement of a wonky tax provision. Rather, the case is about the IRS’s ability to insulate itself from taxpayer challenge and judicial oversight.
After all, it would not be the first time that relatively insignificant legal workarounds ballooned into far more significant infringements on taxpayers’ rights. Tools available to the IRS such as the designated summons power (the power to compel testimony from a witness deemed relevant to IRS operations) or joint liability for couples in tax disputes (where a taxpayer can be held liable for their spouse’s mistakes) have been used far more liberally than initially imagined without sufficient checks on the limits of these powers.
By ruling against the IRS in this case, the Supreme Court can send the agency a message that it remains accountable to the judicial system and the taxpayers it is meant to serve, and that it does not have the prerogative to ignore procedural requirements it finds inconvenient. Indeed, in oral arguments on the first of December, justices sounded skeptical of the IRS's sweeping assertion that the AIA insulates their notices from meaningful judicial review. Nevertheless, failure to do so risks an increasingly renegade IRS which tramples upon taxpayer rights.
