The ABA Tax Times Spring 2021 issue addressed the recent Tax Court opinion in Caylor Land v. Commissioner. Caylor represented the fourth straight IRS victory over abusive micro-captive transactions. Yet although the IRS has an unblemished record in the Tax Court against micro-captives on substantive grounds, it has faced numerous procedural battles in cases related to micro-captives.
These recent procedural battles include the Supreme Court’s decision in CIC Services v. Commissioner and a recent Tax Court case, Puglisi v. Commissioner. In CIC Services, the Supreme Court held the Anti-Injunction Act did not prevent a material advisor from challenging the validity of Notice 2016-66 (requiring reportable transaction reporting), thereby remanding the case to the district court. In Puglisi v. Commissioner, the taxpayers attempted to force the IRS to trial even though the IRS conceded all tax, interest and penalties associated with the taxpayers’ micro-captive deductions. As described in more detail below, the IRS recently filed a motion for summary judgment in CIC Services and a motion for decision in Puglisi.
I. Other Micro-Captive Cases of Interest
There are other pending cases worth noting but not covered in this article. The Delaware Department of Insurance is appealing a district court order granting an IRS petition to enforce a summons seeking certain Delaware micro-captive insurance company records. In addition, Moore Ingram Johnson & Steele LLP, a law firm that also provides captive management services, is appealing a Georgia district court order granting an IRS summons. Moore Ingram’s arguments on appeal involve the appropriateness of categorical privilege logging and whether collateral estoppel applies to privileged information that was at issue in two Kentucky district court privilege rulings. Moore Ingram’s oral argument begins with an observation about the IRS’s actions in the case as being part of a larger initiative to eliminate micro-captive insurance companies. Finally, in Celia R. Clark v. USA, an attorney who also provided captive management services in the first-decided micro-captive case, Avrahami v. Commissioner, is suing for a refund of section 6700 penalties and for improper disclosure of her return information under section 7431. The complaint also contains an allegation accusing the IRS of wrongful actions.
[It] has sought to destroy the microcaptive insurance industry. It has not done so by promulgating regulations, issuing revenue rulings, or providing affirmative guidance that taxpayers and tax practitioners could follow. Rather, the IRS has engaged in the unlawful “administrative repeal” of IRC Section 831(b), thwarting Congress’s intent by wrongfully penalizing taxpayers and practitioners in the microcaptive space, in a concerted effort to drive them out of that business.
The complaint further alleges that the IRS engaged in abusive tactics by allowing section 6700 penalties to accumulate against the plaintiff for years, “rather than provid[ing] clarity.”
II. CIC Services v. Commissioner
A. Notice 2016-66 & the Administrative Procedures Act
In CIC Services, the IRS argued that CIC (a company that provides captive management services) was prohibited from challenging Notice 2016-66 under the Anti-Injunction Act. The Supreme Court ruled the Anti-Injunction Act did not bar the taxpayer’s challenge, thereby setting the stage for CIC and the IRS to battle once again in federal district court, this time over whether Notice 2016-66 was invalid due to, inter alia, the IRS’s failure to engage in the Administrative Procedures Act (APA) notice and comment rulemaking requirements.
The broader implication in this case is whether the IRS may issue notices requiring reporting obligations for reportable transactions (or a particular category of reportable transactions) without first engaging in the APA requirements. The IRS issued Notice 2016-66 describing a micro-captive transaction as a “transaction of interest” because the IRS and Treasury Department believe certain micro-captive transactions “have a potential for tax avoidance or evasion, but for which the IRS and Treasury lack enough information to determine whether the transaction should be identified specifically as a tax avoidance transaction.”
On remand, CIC sought and obtained a preliminary injunction on September 21, 2021 enjoining the IRS from enforcing the Notice against CIC. Although the court granted the injunction, it was limited to CIC, as opposed to a national, outright injunction as to Notice 2016-66. On October 8, 2021, CIC requested that the court reconsider the scope of the injunction and issue a national, outright injunction as initially requested. While reconsideration of the national injunction matter is pending, the IRS moved to dispose of the case on its merits through a motion for summary judgment (MSJ) on November 1, 2021.
B. IRS Motion for Summary Judgment
In its MSJ, the IRS acknowledged that the Court found CIC’s argument persuasive at first glance, but it suggested that a fuller examination of the issues should result in an IRS victory.
The MSJ addresses CIC’s three main arguments that the IRS violated the APA by not engaging in required notice and rulemaking requirements, engaged in arbitrary and capricious conduct by issuing Notice 2016-66, and did not comply with the Congressional Review Act. In its MSJ, the IRS argued that the Court focused on the wrong authorities for purposes of issuing its preliminary injunction. The IRS then argued that the notice and rulemaking requirements do not apply to Notice 2016-66 due to the scope of section 6707A and referencing Congressional enactments supporting the argument that notice and rulemaking were not required. The IRS also cited a recent Sixth Circuit opinion that found that IRS issuance of a notice regarding a listed transaction did not violate the APA. These arguments are discussed in more detail below.
1. Code Sections 6011 and 6707A & Treas. Reg. Section 1.6011-4
Section 6111 of the Code imposes reporting obligations on “material advisors.” When the court granted the injunction, it focused on section 6111(c), which authorizes the Secretary to “prescribe regulations which … provide such rules as may be necessary to carry out the purpose of this section.” Section 6111(c), however, is not the appropriate authority for issuing Notice 2016-66; instead, the relevant authorities for that notice’s issuance are section 6011 and Treas. Reg. section 1.6011-4. One only turns to section 6111 after a reportable transaction has been identified.
Section 6011 requires the filing of a return or statement when required by regulations. Treasury regulations promulgated under section 6011 provide the authority for the IRS to identify certain micro-captive transactions as “transactions of interest” through issuance of notices, as was done with certain micro-captive transactions through Notice 2016-66.
In its MSJ, the IRS argues that the court should have considered the interplay between section 6707A and Treas. Reg. section 1.6011-4, which the Court did not focus on when it issued the injunction. Although section 6111 imposes reporting obligations on material advisors, one cannot be a material advisor unless an underlying reportable transaction has first been identified pursuant to section 6011 and the regulation promulgated under that section. The potential for penalties for failure to include reportable transaction information with a return is found in section 6707A. The IRS then described the exceptions under the APA and turned to the history of these Code and Regulation sections as support for its argument that it did not violate the APA when it issued Notice 2016-66.
2. Administrative Procedures Act
Generally, federal agencies must go through notice and comment rulemaking before promulgating a rule. This means the agency must notify the public of the proposed new rule, give the public an opportunity to comment on the new rule, and then address the comments received. The IRS argues it does not need to engage in notice and comment rulemaking when Congress expressed a clear intent that an agency may use another procedure or when issuing “interpretive” rules. The IRS argues that Notice 2016-66 falls under both exceptions to notice and comment rulemaking.
3. Notice 2016-16 & Congressional Intent
The IRS notes that notice and rulemaking was conducted in 2003 when the IRS finalized a regulation under section 6011 allowing it to identify potentially abusive transactions, including six categories of reportable transactions. Congress enacted section 6707A in 2004, which required reporting of transactions identified under section 6011, with the potential for penalties due to non-compliance. At that time, regulations were already in existence that authorized the IRS to identify listed transactions by “notice, regulation, or other form of published guidance.”
The IRS notes that CIC did not challenge the section 6011 Treasury regulations identifying listed transactions and transactions of interest as reportable transactions. In its complaint, CIC challenged the IRS’s failure to engage in notice and rulemaking only as to Notice 2016-66. The IRS argues that a finding that Notice 2016-66 violated the APA would not make sense given the legislative history behind sections 6011 and 6707A, which in turn authorizes the Treasury Department to define a listed transaction and a reportable transaction.
The IRS also points to an amendment to the section 6011 regulations in 2007, where “transactions of interest” were added as a category of reportable transactions. The Treasury Decision publishing these regulations notes that “several commentators requested that the IRS and Treasury Department provide notice to taxpayers that the IRS and Treasury Department are considering designating a particular transaction as a transaction of interest and requesting comments prior to publishing guidance identifying a transaction as a transaction of interest.” As to this request for comments, the amendment provides “[t]he IRS and Treasury Department do not believe that the regulations should be amended to include language requiring the IRS and Treasury Department to provide advance notice for transactions of interest as suggested by the commentators. However, the IRS and Treasury Department may choose to publish advance notice and request comments in certain circumstances. The determination of whether to provide advance notice and a request for comments will be made on a transaction by transaction basis.”
The IRS points to another amendment to section 6707A in 2010. By this time, it states, the IRS had already started to identify transactions of interest under the 2007 regulation, without notice and comment. Congress, the IRS notes, would have been aware of this since it expressly described how “listed transactions” and “transactions of interest” were identified by “publications issued by the Treasury Department.” The IRS cites the Technical Explanation of Tax Provisions in Senate Amendment 4594 to H.R. 5297. The Joint Committee on Taxation provided a summary of then-current law (i.e., as of 2010) which included statements indicating that transactions of interest were described in publications issued by the Treasury Department.
There are five categories of reportable transactions: listed transactions, confidential transactions, transactions with contractual protection, certain loss transactions and transactions of interest.
Transactions falling under the first and last categories of reportable transactions are transactions that are described in publications issued by the Treasury Department and identified as one of these types of transaction. A listed transaction is defined as a reportable transaction which is the same as, or substantially similar to, a transaction specifically identified by the Secretary as a tax avoidance transaction for purposes of the reporting disclosure requirements. A “transaction of interest” is one that is the same or substantially similar to a transaction identified by the Secretary as one about which the Secretary is concerned but does not yet have sufficient knowledge to determine that the transaction is abusive.
4. Mann Construction, Inc. v. United States
The IRS then points to a recent decision in the Eastern District of Michigan involving a challenge to a notice issued with respect to a listed transaction. In Mann Construction, Inc. v. United States, the court was faced with “whether an IRS notice requiring disclosure of a potentially abusive transaction was issued without notice and comment in violation of the APA.”
The Mann court recounted the IRS’s struggle with a “new generation of tax shelters” during the 1990s, when Treasury developed a reporting regime but lacked the authority to penalize taxpayers for failure to disclose. The court noted the resolution of the issue.
Congress addressed this problem in 2004 by passing the American Jobs Creation Act of 2004, Pub. L. 108-357, 118 Stat. 1418 (2004), which created I.R.C. § 6707A. Section 6707A laid the statutory foundation for the new reporting regime by establishing penalties for nondisclosure and defining “reportable transaction” and “listed transaction” by reference to Treasury regulations. See U.S.C. § 6707A. Since then, the IRS has identified many listed transactions by notice, in effect requiring taxpayers to disclose their participation or face substantial penalties under I.R.C. S 6707A. One of these revenue notices is IRS Revenue Notice 2007-83, the subject of controversy here.
The Mann court ruled in favor of the IRS, dismissing the taxpayers’ complaint. Its holding noted the reference to section 6707A and identification of applicable transactions through various means.
Congress responded with section 6707A, which not only added penalties for the failure to disclose reportable transactions, but [also] defined “listed transaction” by reference to Treasury regulations that allow the IRS to identify listed transactions by “notice, regulation, or other form of published guidance.” 26 U.S.C. § 6707A; 26 C.F.R. § 1.6011-4. This reference is significant because revenue notices, like revenue rulings and procedures, are normally issued without the notice and comment required by the APA.