Last Monday, the Supreme Court handed down its ruling in a little known case that nonetheless will have a significant impact on an Internal Revenue Service (IRS) which has grown increasingly dismissive of the rules and procedures it’s meant to follow. The case, CIC Services v. Internal Revenue Service, didn’t make headline news but dealt overzealous tax collectors a unanimous loss before the highest court in the land.
The case concerned reporting requirements imposed by the IRS underNotice 2016-66, concerning certain insurance transactions. These reporting requirements were substantial, threatening to add to the massive economic cost of complying with the tax code already faced by taxpayers.
Yet despite the burdens it was imposing under Notice 2016-66, the IRS simply decided to impose them unilaterally, bypassing the notice-and-comment procedures every government agency is required to follow under the Administrative Procedure Act (APA). One company impacted by the notice, CIC Services, chose to challenge the regulation for not complying with the APA.
If you’re wondering how the IRS thought it can get away with such a blatant disregard for its legal obligations, it’s because of the IRS’s interpretation of the Anti-Injunction Act (AIA). The AIA, in essence, requires taxpayers to pay a tax assessment before challenging it in court. The purpose of this standard is to prevent taxpayers from filing lawsuits challenging tax collections with the intent of delaying the payment of the tax assessment. The IRS believed it could extend this to reporting requirements it issued, even when those requirements were imposed in an administratively improper manner. The IRS even got the trial judge and an appeals court to buy its argument that the AIA prevented the CIC Services case from even being heard.
The Supreme Court, however, unanimously rejected the IRS’s argument. The Court agreed that the IRS’s position would leave taxpayers in a “heads I win, tails you lose” situation, whereby they had to first pay the large fines and risk imprisonment for failure to comply with Notice 2016-66 before challenging its legality. Such a situation would effectively render the IRS immune to any obligation to follow the law.
For years, governments have hid behind the AIA and routinely claimed that taxpayers cannot challenge a law or a regulation if a result might be reduced revenue to the government. No longer. While the Supreme Court didn’t remove all obstacles to taxpayer challenges to unfair or illegal tax enactments, the justices made clear when the AIA doesn’t confer the total immunity the IRS claims it does.
A pending lawsuit in federal court against Maryland’s first-in-the-nationtax on digital advertising may be the next test of these limits. The punitively high rate of this likely-unconstitutional tax applies only to a handful of out-of-state companies. Maryland has predictably invoked the AIA, saying the lawsuit cannot proceed because it would reduce state tax revenue. The taxpayers argue the punitive rate and narrow base make it more like a punishment, exempt from the AIA. A federal judge will soon decide if taxpayers get their day in court.
With the Court’s decision in CIC Services, Notice 2016-66 is likely doomed, as it fairly blatantly violated the APA. That is also a big achievement, since the IRS has long refused to comply with the APA. If judges can now throw out IRS notices and regulations that don’t go through the proper process, that’s a big first step towards making the IRS more accountable to taxpayers.
