Argument analysis: Justices struggle to define boundaries of Anti-Injunction Act
on Dec 2, 2020 at 5:37 pm
The Supreme Court in Tuesday’s argument in CIC Services v. Internal Revenue Service tried to clarify the scope of the Anti-Injunction Act, which generally prohibits lawsuits seeking to block the assessment or collection of a tax. The case specifically asks whether a company can sue to block the enforcement of an IRS notice that imposes certain reporting requirements, or whether the company must wait and sue only after the IRS assesses tax penalties for non-compliance with the notice. To arrive at an answer to that question, the court will have to resolve a clash between the AIA and another important federal statute: the Administrative Procedure Act.
The IRS notice at issue, Notice 2016-66, made certain types of captive insurance transactions “reportable transactions.” Such reportable transactions are ones that the IRS considers potentially abusive. CIC Services, as a “material adviser” to transactions covered in Notice 2016-66, is required under the notice to report matters such as clients it advised in these transactions – at great cost to the company. CIC believes the notice violates the Administrative Procedure Act because the IRS issued it without holding a formal public-comment period, and the company sued under the APA to block its enforcement.
But the penalty for failing to report the transactions in Notice 2016-66 is found in Chapter 68, Subchapter B of the Internal Revenue Code, and thus it is styled as a tax. Traditionally, these penalties have been understood as covered by the AIA, which prohibits lawsuits that have “the purpose of restraining the assessment or collection of any tax.” The question is whether that understanding should overcome the presumption in the APA that companies can usually bring pre-enforcement challenges to agency action.
Representing CIC, Cameron Norris made three major points. First, the purpose of the suit is to challenge the notice, not the assessment or collection of any tax. Second, the injury to CIC is not the payment of any tax, but rather the costs of complying with the reporting requirements in the notice. Third, CIC does not have meaningful access to a refund lawsuit – the typical mechanism for taxpayers to recoup unlawful taxes — because it is an adviser, not a taxpayer. In order to manufacture a refund suit, Norris argued, the company would have to violate the notice and risk receiving a large penalty styled as a tax, along with potential criminal sanctions. “The Anti-Injunction Act cannot require this,” Norris said.
One set of questions from the justices sought to determine how to turn the three prongs of Norris’ argument into a potentially workable three-part test. Justice Samuel Alito raised some concern that the inquiry of determining what is the purpose of a suit is complicated for a court to undertake. Norris responded that the inquiry is an objective one based on the language in the plaintiff’s complaint. That led Justice Sonia Sotomayor to raise a concern that an artfully drafted complaint could create an end-run around the AIA. Norris in response remarked that the second prong of the test, the injury sustained, helps to avoid mere artful pleading. Focusing on the injury, Norris said, distinguishes this case from Bob Jones University v. Simon and Alexander v. “Americans United” Inc., where the court applied the AIA to prohibit non-refund suits challenging the revocation of tax-exempt status of certain nonprofit entities. The injury sustained by those entities was the requirement to pay taxes because they were no longer non-profit entitles. Here, the injury is not a tax, but rather the cost of compliance with the reporting requirement, Norris said.
Both Justices Elena Kagan and Amy Coney Barrett suggested collapsing the test into a single inquiry deriving from South Carolina v. Regan: whether a refund suit is an available mechanism to a plaintiff to challenge an IRS action. If the answer to that question is yes, the pre-enforcement suit would be barred; if the answer is no, then the pre-enforcement suit would be permitted. Norris seemed to accept this view, though he seemingly preferred a broader result.
A second theme of questioning came from Chief Justice John Roberts and Justice Brett Kavanaugh. Both of them focused on the fact that the penalty associated with the IRS notice challenged here is one that Congress labeled a tax, and that it likely did that to fall under the AIA. Norris emphasized, though, that CIC’s suit is not focused on any tax collection itself, just the lawfulness of Notice 2016-66.
Kavanaugh also noted that the regulatory aspect of the notice is bound up with the tax aspect of the penalty enforcing it. He sought to find a distinction between challenging the underlying regulation and the tax itself – an attempt to limit the reach of Bob Jones and Americans United. Here again, Norris pointed out that unlike those cases, the injury here was not a tax, but compliance costs. He also emphasized that the refund suit channel is not available, because of the threat of criminal sanctions.
Finally, Justice Stephen Breyer asked whether CIC could seek judicial review by petitioning the IRS to engage in formal notice-and-comment rulemaking, and then, once the agency denied that petition, challenging the denial in court. Norris noted that such judicial review is not congruous, because the “arbitrary and capricious” standard in the posture of a denial of a petition for rulemaking is far more deferential to the IRS.
Assistant Solicitor General Jonathan Bond represented the government. In his opening, he highlighted that Notice 2016-66 is enforced by a penalty that Congress has styled a tax, and that the AIA bars suits restraining the assessment or collection of taxes. He said that if a company wanted to challenge Notice 2016-66, all it would have to do is file – in lieu of the notice’s required reporting – a letter saying that the company had a good faith belief that the government promulgated the notice improperly.
Many of the justices were concerned about the potential that a company would open itself to criminal sanctions by failing to comply with the notice. Both Alito and Justice Neil Gorsuch noted that it is incredibly problematic to require someone to face criminal sanctions before asking a court to rule that an agency action was unlawful. In response, Bond remarked that the filing of the good-faith letter would suffice to avoid criminal sanctions. When further pressed by Alito about whether the term “willful” in the tax code should have a different meaning from ordinary willfulness, Bond responded in the affirmative. He noted that most of the court’s precedents do have a heightened definition of “willfulness” in the criminal tax context as opposed to other criminal contexts.
Another line of questioning stemmed from whether the challenged regulatory action can be separated from the penalty styled as a tax. On this ground, Barrett and Justice Clarence Thomas focused on how close the link must be between the tax penalty and the challenged action. Bond said in this case the link is rather direct. He urged the court to reserve for another day the question of how attenuated the agency action must be from the tax in order for it to fall out of the AIA’s scope.
Kagan took a different tack. She noted that the tax here is completely derivative of the agency action in the notice. She told Bond that all CIC asks is to have the notice invalidated so that the company does not have to comply with the reporting requirements. Bond pointed to the company’s complaint, noting that CIC feels it must comply because of the tax penalty.
Kavanaugh revealed his hand during the government’s argument. He noted that most of the arguments fall in the government’s favor. Precedent leans toward the government. Direct Marketing Association v. Brohl – in which the court allowed a lawsuit challenging a state-tax reporting requirement to proceed – does not apply, because there was no tax there and here there is a tax. The criminal threat can easily be solved through the procedural mechanism and the heightened willfulness standard for tax crimes. The refund suit option is still available, which neutralizes the exception in South Carolina. But Kavanaugh raised a concern. The understanding of the APA, he noted, has evolved to favor pre-enforcement challenges to administrative actions. In light of that modern understanding, he questioned how much validity cases like Bob Jones and Americans United (which were decided in 1974) should have. Bond responded by noting a parallel evolution in the court’s jurisprudence since the court decided Bob Jones: the rise of textualism. Bob Jones and similar cases should be more favorable to the court, because, unlike previous AIA cases, they hewed far closer to the text of the statute. And the text seemingly does channel these sorts of challenges to post-enforcement refund suits, Bond said.
Finally, Breyer got into a heated discussion with Bond. The thrust of his question focused on the point that the only way for CIC to get judicial review was to violate the law or to comply with the reporting requirement and suffer an injury that was not a tax. Bond had trouble responding to Breyer. But he repeated that CIC would not have to spend money to comply with the new reporting requirements. All it needed to do was file a letter saying it was not complying because it had a good-faith belief that Notice 2016-66 was promulgated improperly. It could then sue after paying the penalty.
Overall, the argument focused a great deal on technical line-drawing, as one would expect from a tax case. Everyone seemed to struggle with trying to figure out exactly what the AIA, which dates back to the 19th century, means in our modern context, and especially in a world where the IRS is a major administrative agency. While predicting an outcome from an argument is always tough, CIC seemingly has a slightly better chance at prevailing. But what is clear is that in drafting its opinion, the court will struggle with trying to delineate the exact bounds of the AIA’s reach, and as a result, it may not provide the final word on the limits of this mysterious statute.