TAXLITIGATOR – Tax Controversy (Civil & Criminal) Report

We are pleased to announce that Sandra Brown, along with Jonathan Black, Sharyn Fisk and Lois Dietrich will be speaking at the upcoming 13th Annual NYU Tax Controversy Forum webinar, “Focus on Tax Practitioners: Ethical and Penalty Issues” on Thursday, June 24, 2021, 3:00 p.m. – 4:00 p.m. (PST).

Tax practitioners are the gatekeepers to the country’s tax system and are subject to standards and penalties designed to ensure that practitioners give taxpayers clear and impartial advice about how to comply with the tax law. The Office of Professional Responsibility is charged with enforcing these standards and penalties and the IRS recently established the Office of Promoter Investigations to focus on practitioners who promote abusive tax transactions. This panel discusses tax practitioner standards and how the IRS enforces those standards.

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We are pleased to announce that Michel Stein Sandra Brown and Evan Davis will be speaking at the upcoming CalCPA webinar, “Cryptocurrency Tax Compliance in the Post $50,000 Bitcoin World” on Tuesday, June 15, 2021, 9:00 a.m. – 10:00 a.m. (PST).

The program will provide tax advisers and compliance professionals with a practical look at IRS guidance to calculating and reporting income and gain on cryptocurrency (e.g., Bitcoin) transactions. We will discuss the IRS position on cryptocurrency as property rather than cash, analyze IRS efforts to increase compliance, and define proper reporting and the tax treatment for hard forks, “mining,” and exchanging cryptocurrency. We will address recently released IRS Revenue Ruling 2019-24 and the updated FAQs regarding the taxation of cryptocurrency, with a particular focus on the recent IRS enforcement initiatives to identify virtual currency activity, how the IRS soft letter campaign fits into the voluntary disclosure practice, and the risks of criminal prosecution related to unreported and improperly reported cryptocurrency transactions.

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We are pleased to announce that Steven Toscher and Michel Stein will be speaking at the upcoming CSTC webinar, “New Developments in Cryptocurrency Reporting and Enforcement” on Wednesday, June 9, 2021, 10:00 a.m. – 11:40 a.m. (PST).

The program will provide tax advisers and compliance professionals with a practical look at IRS guidance to calculating and reporting income and gain on cryptocurrency (e.g., Bitcoin) transactions. We will discuss the IRS position on cryptocurrency as property rather than cash, analyze IRS efforts to increase compliance and define proper reporting and the tax treatment for hard forks, “mining” and exchanging cryptocurrency. We will address recently released IRS Revenue Ruling 2019-24 and the updated FAQs regarding the taxation of cryptocurrency, with a particular focus on the recent IRS enforcement initiatives to identify virtual currency activity, how the IRS soft letter campaign fits into the voluntary disclosure practice and the risks of criminal prosecution related to unreported and improperly reported cryptocurrency transactions.

Click Here for more information.

Whenever I read a new FBAR willful penalty I get a distinct feeling of déjà vu all over again, to quote the great Yogi Berra.  Elements:

• Did the taxpayer have a foreign bank account – check.
• Did the taxpayer know of the foreign bank account – check
• Did the taxpayer fail to tell the return preparer about the foreign bank account – check
• Did the taxpayer fail to report income from the foreign bank account – check
• Did the tax return check the box on Schedule B “NO” to the question of whether there were offshore accounts – check
• Did the taxpayer sign the return under penalty of perjury – check

Conclusion: the taxpayer willfully failed to file an FBAR report.  Case in point: the Eleventh Circuit’s recent opinion in United States v. Rum, Docket No. 19-14464 (April 23, 2021).   The defendant, Said Rum, was a naturalized U.S. citizen who owned and operated several businesses.   In 1998 he opened a numbered account at UBS with $1.1 million transferred from his accounts in the U.S.  He claimed he did so to conceal the funds from potential judgment creditors.  He directed UBS to hold mail.  Despite no judgment being entered against him, he did not repatriate the funds to the U.S.

Between 2002 and 2008, UBS sent Rum account statements containing a statement that the information was being provided to help in preparing his U.S. income tax returns.  In 2002, UBS advised him that it was required to report his earnings from U.S. securities to the IRS.  Rather than fill out a W-9, Rum directed UBS to not invest in any U.S. securities and signed a form that he was liable for tax in the U.S. as a U.S. person.  In October 2008, UBS notified Rum that it was closing accounts of U.S. citizens.  Rum transferred the funds in his UBS account to a numbered account at Arab Bank in Switzerland. 

Rum admitted he never told his return preparer about the Swiss accounts.  He listed the Swiss accounts on a mortgage application to show his financial position, but did not list his foreign account or report income from his foreign account on his tax returns and did not disclose it on applications for federal aid for his children’s college tuition.  He signed his returns under penalties of perjury.  The “No” box was checked in response to the question on Schedule B whether he had any foreign financial accounts.

In 2008, Rum’s 2006 tax return was audited.  He told the revenue agent that he had closed the UBS account but did not tell her about the Arab Bank account.  The agent determined a tax deficiency but did not propose a fraud penalty or any FBAR penalty.  Rum filed an FBAR for 2008 in October 2009, after the June 30 filing deadline, and only after he was notified by UBS that his account was within the scope of a Treaty Request from the IRS.  In November 2009, after being notified by Arab Bank that it was closing his account, Rum transferred his offshore funds to an account in the U.S. 

During 2009, Rum had approximately $300,000 investment income from his foreign accounts.  He only reported $40,000 of that income.  The IRS audited his 2005 and 2007-2010 income tax returns.  The IRS determined deficiencies in tax and fraud penalties.  Given the amount in his offshore account, the assertion of deficiencies and fraud penalties, he was not eligible for the willful penalty to be mitigated under the Internal Revenue Manual (IRM) guidelines.  The IRS asserted a 50% FBAR willful penalty for 2007, which was sustained on appeal.

Since Rum failed to pay the FBAR assessment, the Government filed a suit to reduce the assessment, plus interest and late fees, to judgment.  The district court granted summary judgment for the Government and Rum appealed.  He raised the following claims on appeal: (a) that the district court used the wrong standard for determining willfulness; (b) that genuine issues of material fact were in dispute, precluding summary judgment; (c) that Reg. §1010.820(g)(2) limits the maximum FBAR penalty to $100,000; (e) the IRS’s factfinding procedures were arbitrary and capricious; and (f) that the district court erroneously rejected his challenge to interest and late fees.  The Eleventh Circuit rejected all of Rum’s arguments and affirmed the district court.

The first issue addressed by the Eleventh Circuit was the standard of review.  Since both parties urged a de novo standard of review for the willfulness determination, whether there were genuine issues of material fact and for legal issues, and this was the standard of review adopted by the Fourth Circuit in the Horowitz and Williams cases, the Eleventh Circuit adopted the de novo standard for these issues.  For questions regarding the IRS’s decision to impose the willful penalty and amount of the penalty, the arbitrary and capricious standard was adopted. 

The Court then turned to the issue of what is the proper standard for determining willfulness for the civil FBAR willful penalty.  In Safeco. Ins. Co. v. Burr, 551 U.S. 47 (2007), the Supreme Court held that willfulness includes recklessness for purposes of determining willfulness for alleged violations of the Fair Credit Reporting Act.  The Third Circuit in Bedrosian, the Fourth Circuit in Horowitz and the Federal Circuit in Norman had all held that willfulness for purposes of the FBAR civil penalty includes reckless disregard.  In Malloy v. United States, 17 F.3d 329, the Eleventh Circuit held that willfulness for purposes of the trust fund recovery penalty includes reckless disregard of a “known and obvious risk that trust funds may not be remitted to the Government, such as failing to investigate or to correct mismanagement after being notified that withholding taxes have not been duly remitted.”  The Eleventh Circuit concluded that willfulness for purposes of the civil FBAR penalty includes reckless disregard. 

Under the Safeco standard as articulated by the courts of appeal in Bedrosian, Horowitz and Norman, recklessness exists if the defendant “(1) clearly ought to have known that (2) there was a grave risk an accurate FBAR was not being filed and if (3) he was in a position to find out for certain very easily.”  Applying this standard to the undisputed facts, the Eleventh Circuit held that Rum acted with reckless disregard and thus willfully failed to file an FBAR for 2007.  Thus there was no genuine issue of material fact and the district court correctly granted summary judgment on the issue of willfulness.

After determining that the district court correctly held that Rum acted willfully, the remaining dominos fell in quick succession.  First, the regulation setting the maximum FBAR willful penalty at $100,000 was promulgated prior to the amendment making the maximum FBAR willful penalty 50% of the amount in the account.  In amending the penalty provision, Congress did not intend for the maximum penalty to be $100,000.  As a result, the Eleventh Circuit joined the Fourth and Federal Circuits in rejecting the argument that the maximum penalty is $100,000.

Next to fall was the claim that the IRS’s factfinding procedure for determining the amount of the penalty was arbitrary and capricious.  The IRM had guidelines for determining the amount of the penalty, the revenue agent’s recommendation required managerial approval and was reviewed by IRS area counsel, Form 886-A explained the facts and law upon which the determination was based and Rum had an opportunity to appeal the determination.  Thus, the IRS’s factfinding procedures were not arbitrary and capricious.  His argument about interest and late fees was similar to that concerning the IRS’s factfinding and was rejected as being without merit.

So there you have it.  Another FBAR willful appeal, another Court of Appeals upholding the Government’s positions.  The appeal in United States v. Schwarzbaum (SD Fla 2020) is pending before the Eleventh Circuit.  Luckily for Mr. Schwarzbaum, the United States voluntarily dismissed its cross-appeal.

Robert S. Horwitz is a Principal at Hochman Salkin Toscher Perez P.C., former Chair of the Taxation Section, California Lawyers’ Association, a Fellow of the American College of Tax Counsel, a former Assistant United States Attorney and a former Trial Attorney, United States Department of Justice Tax Division.  He represents clients throughout the United States and elsewhere involving federal and state administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at http://www.taxlitigator.com.

The Biden administration’s vision for increased information reporting, depending on implementation specifics, may have a new obstacle to contend with: the Supreme Court’s recent decision shortening the reach of the Anti-Injunction Act (AIA).

In its decision, the Supreme Court gave as one reason why the AIA did not apply was that there were several steps between a reporting rule and an assessment.

“Robert Horwitz of Hochman Salkin Toscher Perez PC also noted that if the IRS received a Form 1099 with an interest or dividend income reporting discrepancy, it would not automatically make an assessment on the taxpayer, but rather would inform the taxpayer and ask for an explanation.”

Robert S. Horwitz is a Principal at Hochman Salkin Toscher Perez P.C., former Chair of the Taxation Section, California Lawyers’ Association, a Fellow of the American College of Tax Counsel, a former Assistant United States Attorney and a former Trial Attorney, United States Department of Justice Tax Division.  He represents clients throughout the United States and elsewhere involving federal and state administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at http://www.taxlitigator.com.

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We are pleased to announce that Sandra Brown will be speaking at the upcoming 21st Annual Oregon Tax Institute webinar, “John Doe Summonses: A Deeper Look at a Key IRS Information Gathering Tool and What Its Increased Use May Mean to Non-Compliant Taxpayers” on Friday, June 4, 2021, 2:50 p.m. – 3:50 p.m. (PST).

In addition to Ms. Brown’s presentation on Friday afternoon, this year’s virtual Oregon Tax Institute will feature a stellar lineup of tax topics and presenters including “Inside the IRS: New Directives and Fresh Perspectives” from the IRS Commissioner Charles Rettig. Following Thursday’s afternoon sessions attendees have the opportunity to participate in a virtual social hour on Remo with a snack box delivery.  Please see the event brochure for the entire two-day agenda and snack box order and delivery details.

Click Here for more information.

I thought after my last series of blogs on recent FBAR cases that it would be safe to venture into the waters of Title 26 cases.  But just when I was starting to work on some blogs on interesting tax cases, a school of Title 31 willful FBAR penalty cases broke the surface, jaws open, circling in the… .  You get the picture.  This blog will consider two recent Court of Federal Claims FBAR cases, Mendu v. United States, Case No. 17-cv-738T (April 7, 2021), and Landa v. United States, Case No. 18-365 (April 19, 2021).  The next blog will discuss the Eleventh Circuit’s decision in United States v. Rum.       

Mendu addresses the question of whether the Title 31 FBAR penalty is an “internal revenue” penalty. The Third Circuit, in a footnote in Bedrosian v. United States, stated that FBAR penalties, although found in Title 31of the United States Code, and not Title 26, are “internal revenue” penalties, requiring full payment under Flora v. United States, 362 U.S. 145 (1960), before a person can sue for refund.  Mendu had paid $1,000 towards a $752,000 FBAR penalty and the Government counter claimed for the balance.

Mendu was the co-founder of an Indian venture capital company.  He had signature authority over the company’s overseas accounts.  He also had a personal account where he deposited rental income from a home he owned in India.  He did not file a 2009 FBAR by the due date.  After learning about the requirement to file FBARs, he filed a 2009 FBAR in 2011 and an amended 2009 FBAR in 2012.  The IRS audited Mendu, determined his failure to file was willful and assessed the penalty that was in issue.

While the case was pending, the Federal Circuit issued its opinions in Norman and Kimble, affirming decisions in favor of the Government in FBAR willful penalty cases and holding that the Treasury Regulation imposing a $100,000 cap on the FBAR penalty was rendered void by the 2004 amendment to 31 U.S.C. 5321 and that signing a return falsely answering “no” to the question whether the taxpayer has a financial interest in or signature authority over a foreign account has acted with reckless disregard and, thus, willfully.  This double whammy apparently gave Mendu second thoughts about the sagacity of seeking a refund in the Court of Federal Claims.  He therefore filed a motion to dismiss the case for lack of subject matter jurisdiction, arguing that the FBAR penalty was an “internal revenue” penalty and, therefore the Flora full-payment rule applied.  The Government argued that the Flora rule does not apply to the FBAR penalty since it is in Title 31, not Title 26, the Internal Revenue Code, that the FBAR penalty was not subject to IRS collection procedures, and apply Flora to FBAR penalties would not further any policy.  It also argued that if the court determined it was without jurisdiction it should transfer the case to the Central District of California. 

The Court held that FBAR penalties are not internal revenue penalties.  The Court began by noting that it had jurisdiction over claims of illegal exaction of money by the United States, including for the refund of any illegally exacted penalty.  Unless the FBAR penalty was an “internal revenue penalty” within the meaning of 28 U.S.C. sec. 1346(a)(1) (which gives district courts jurisdiction over tax refund suits), the full-payment rule did not apply and it had jurisdiction over Mendu’s case.

The Internal Revenue Code was created “to consolidate and codify the internal revenue laws of the United States.”  The Court reasoned that since the FBAR penalty was in Title 31 and not in Title 26, the references in Title 26 equating penalties to tax do not apply.  Further, there were no statutory references equating the FBAR penalty to a tax or a penalty under the Internal Revenue Code.  To reach its decision in Flora, the Supreme Court looked to the nature of internal revenue taxes and the refund scheme Congress devised and noted that permitting refund suits without full payment could seriously impair the collection of tax and would effectively be a declaratory judgment that would contravene the prohibition on declaratory judgments in tax cases.  These concerns don’t apply to the FBAR penalty, since enforced collection is usually through a suit to recover a civil penalty and there is no administrative collection procedure a civil suit would interfere with.

The Court noted that Bedrosian was a Third Circuit case that was not binding on it and the Bedrosian court noted it was leaving a definitive holding to another day.   The Court also noted that the Bank Secrecy Act has a regulatory purpose and Congress termed the FBAR penalty a “civil money penalty,” noting that in Simonelli, 614 F.Supp. 2d 241 (D. Conn. 2008), the court held that the FBAR penalty was not a tax penalty and thus was not discharged in bankruptcy. While the FBAR penalty had some similarities with Internal Revenue Code sec. 6038 return reporting penalties, the Tax Court in Flume v. Commissioner, 113 T.C.M. 1097, held that the IRC 6038 penalty that can be collected by administrative levy.  [Those familiar with the issue know that the current Taxpayer Advocate, Erin Collins, and I both are of the opinion that IRC 6038 penalties are not “tax” and may not be assessed or collected as a tax.]

The Court concluded that the fact the FBAR penalty is in Title 31 and not subject to traditional tax collection procedures “demonstrates that Congress did not intend to subject the FBAR penalty to the Flora full payment rule.”

Which brings us to an FBAR case where the court seemed sympathetic with the plaintiff, but upheld the willful penalty, Landa.  In 1939, with the clouds of war gathering, Landa’s grandfather opened a bank account in Switzerland.  Landa was born in the Ukraine.  In 1975 he emigrated with his parents and brother to the United States, eventually becoming a naturalized U.S. citizen.  They opened a jewelry business.   His father told him about the Swiss bank account in 1980 and in 1985 gave Landa, his mother and his brother power of attorney on the account.  Landa and his father annually traveled to Switzerland for a jewelry convention.  While there, they would visit the bank where the account was .  By the beginning of this century they had accounts at UBS and Credit Suisse.  In 2001, Landa and his brother took over management of the accounts from their father.

In 2008, UBS announced it would no longer provide private banking services to U.S. citizens.  A banker at. Credit Suisse advised Landa move the money to a bank with no U.S.  operations, BSI.  He opened a numbered account at BSI and moved the money in UBS and Credit Suisse to BSI.  On the application he listed himself as the sole account holder and had a mail hold placed on the account.

When it came time to prepare his 2009 return,  Landa did not tell his CPA about the Swiss account and his return did not report the income from that account. The “no” box was checked in response to the Schedule B question whether he had a financial interest in or signatory authority over any offshore accounts.  Landa signed the return, which was filed with the IRS.

Notice 2010-11 gave persons with signatory authority over, but no financial interest in, a foreign account until June 30, 2011, to file the 2009 FBAR.  Landa filed the 2009 FBAR in February 2011.  He listed himself as power of attorney for the UBS and Credit Suisse accounts and as trustee for the BSI account.  The FBAR reported the balance in the BSI account at $6,395,493.  The IRS determined that Landa willfully failed to file the 2009 FBAR by the due date and assessed a $3,173,464 penalty.  Landa paid it in full and filed suit to recover the funds as an illegal exaction.  He alleged that he did not have a financial interest in the account and thus his filing was timely under Notice 2010-11. 

The Government moved for summary judgment on the ground that Landa had a financial interest in the account and the Notice did not apply.   At the time the 2009 FBAR was filed regulations defining “financial interest” had not yet been issued.  The 2009 FBAR instructions defined it as an account in which the person is record owner or has legal title, whether the funds are held for his benefit or the benefit of others.  Landa argued that Swiss law should apply in determining whether he had a financial interest and since he was holding the funds in trust for his family under Swiss law he would not have a financial interest.  The Court rejected this argument.   Under sec. 5321 the Secretary of Treasury is authorized to impose penalties on U.S. persons who fail to report a financial interest in a foreign account.  The Secretary had delegated authority to the IRS and its definition of financial interest controlled.  Since Landa was the owner of record of the BSI account he had a financial interest in the BSI account even if he held the funds for the benefit of his family.   Since he had a financial interest in the account, the Notice did not apply and Landa’s 2009 FBAR was late.

Although Landa did not challenge the penalty on the ground that he was not willful, the Court addressed the question of willfulness.  Noting that many of the factors present in the Norman and Kimble cases were in Landa’s case, the Court held he acted willfully under the reckless disregard standard.  The Court did not discuss whether Landa’s belief that he did not have a financial interest and thus could file under the Notice negated willfulness.

Two other issues were considered by the Court: whether the $3.2. million FBAR penalty violated the Eight Amendment prohibition on excessive fines and whether imposition of the penalty was an abuse of discretion.  Noting that the Eighth Amendment prohibits fines and penalties that are punishment for an offense and not civil penalties that are remedial in nature, the Court analogized the FBAR penalty to civil tax penalties, which do not implicate the Eight Amendment, the Court held that the Eighth Amendment doesn’t apply to the civil FBAR penalty.    The Court also held that the imposition of the maximum 50% penalty was not an abuse of discretion.   In its conclusion, the Court threw out a sop to Landa:

The Court appreciates the plaintiff’s unusual family history. These funds were hidden from the Nazis and subsequently hidden from the Communist authorities in the Soviet Union, where the Landa family resided until fleeing to the West. That history may help explain the plaintiff’s behavior, but it cannot relieve the plaintiff of a broadly applicable filing requirement.  The law is unambiguous in its application to cases like the plaintiff’s.

            Unlike cases involving the non-willful FBAR penalty, things look continually bleak for U.S. persons against whom the IRS assesses a willful penalty.

Robert S. Horwitz is a Principal at Hochman Salkin Toscher & Perez P.C., former Chair of the Taxation Section, California Lawyers’ Association, a Fellow of the American College of Tax Counsel, a former Assistant United States Attorney and a former Trial Attorney, United States Department of Justice Tax Division.  He represents clients throughout the United States and elsewhere involving federal and state administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at http://www.taxlitigator.com.

We are pleased to announce that Sandra R. Brown has been named to the list of “Top Women Lawyers of 2021,” by the Daily Journal. The award honors excellent lawyering and leadership skills among women attorneys in California, seeking to recognize attorneys making an impact in the legal profession and cutting-edge legal work in their field.

Sandra, a former Acting United States Attorney and Chief of the Tax Division of the United States Attorney’s Office for the Central District of California, is a nationally promi­nent tax attorney, who focuses on complex and sophisticated civil tax controversies and litigation as well as representing individuals and entities in criminal tax investigations and prosecutions. She is a Fellow of the American College of Tax Counsel, Co-Chair of the American Bar Association’s Section of Taxation Sentencing Subcommittee, Civil & Criminal Tax Penalties (CCTP) Committee and Co-Chair of the NYU Institute on Federal Taxation, Tax Controversies Section. During her tenure with the government, Sandra was honored with the IRS Chief Counsel’s Mitchell Rogovin National Outstanding Support Award and the IRS Criminal Investigation Chief’s Award, respectively, the highest honors that can be conferred by those offices to a Department of Justice trial attorney.

“I’m extremely honored to be listed along with so many of my peers in California’s premier legal publication,” said Sandra. “I’m grateful for all of the dedicated attorneys I have had the pleasure to work alongside, and I appreciate that the many successes obtained on behalf of our clients in the recent year wouldn’t have been possible without their hard work and support.”

After decades of public service and well-deserved recognition, Sandra became a principal at Hochman Salkin Toscher Perez, P.C. in 2018. Since joining the firm, Sandra has played a lead role in obtaining favorable results for clients, including a declination in a criminal tax investigation involving over $20 million of unreported income, a declination in a high dollar tax evasion case, obtaining a non-prosecution in one of the largest international tax investigations in US history, obtaining non-criminal dispositions in matters involving both domestic and international gambling, and obtaining a multitude of resolutions of civil tax and international reporting investigations that concluded with no or de minimis penalties being imposed against the clients. We are very proud of Sandra for her achievements and for being selected to be one of the Top Women Lawyers in California.  

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We are pleased to announce that Dennis Perez, Sandra Brown and Cory Stigile will be speaking at the upcoming Strafford webinar, “High-Income Non-Filers: Handling IRS Examinations, Voluntary Disclosure Program, Criminal Investigations” on Wednesday, June 2, 2021, 10:00 a.m. – 11:30 a.m. (PST), 1:00 p.m. – 2:30 p.m. (EST).

This webinar will discuss the IRS’ recent campaign to bring high-income non-filers into compliance. Our panel of income tax experts will cover bringing these taxpayers into compliance, minimizing penalties and consequences of noncompliance, and handling the complexities of these IRS examinations.

The IRS issued IR 2020-34 on Feb. 18, 2020, announcing its intent to visit non-filers to bring these taxpayers into compliance. The agency uses data-analytics, whistleblower reports, and even tips from neighbors to track down high-income non-filers.

For these taxpayers, those making more than $100,000 and not filing, failure to respond to initial requests can have major repercussions. These can include referral for criminal investigation, prison time, and of course, substantial penalties. The IRS offers a Voluntary Disclosure Program for domestic taxpayers. Taxpayers willing to admit that they “willfully failed to comply” with tax filing obligations may be able to resolve their noncompliance and minimize repercussions. Advisers working with high-income non-filers need to understand when to consider this alternative.

The examination process is detailed and lengthy. Communicating with the IRS, the information document request, mediation, appeals, and, when warranted, litigation are a few of the examination process stages. Tax advisers handling IRS audits must understand the process and how to best represent the taxpayer.

Listen as our panel of IRS examination experts explains how the IRS identifies high-income non-filers, the IRS Voluntary Disclosure Program and when it can be a sensible solution, and tips for handling the IRS audit from start to finish.

We are also pleased to announce that we will be able to offer a limited number of complimentary and reduced cost tickets for this program on a first come first serve basis. If you are interested in attending, please contact Sharon Tanaka at sht@taxlitigator.com. 

Click Here for more information.

Please join us.

On May 17, 2021, the Supreme Court issued its unanimous opinion in CIC Services, Inc. v. Internal Revenue Service, holding that a suit challenging an IRS Notice regarding micro-captive insurance companies was not barred by the Anti-Injunction Act (“AIA”).[1]  We’ll start with some background.  The AIA was enacted shortly after the Civil War, in the wake of a series of lawsuits challenging the federal income tax enacted to fund the United States during the war.  It bars any “suit for the purpose of restraining the assessment of collection of any tax.”  In Bob Jones University v. Simon, 416 U.S. 725 (1974) and Alexander v. Americans United, 416 U.S. 752 (1974), the Supreme Court held that lawsuits seeking to enjoin the revocation of rulings granting the taxpayers exempt status under IRC § 501(c)(3)[2] were barred by the AIA, even though in both cases the taxpayers asserted that their suits were not to enjoin the assessment or collection of tax but to maintain donor contributions.  As a result of these twin cases, Department of Justice Tax Division attorneys were taught that any suit that would have the effect of restraining the assessment or collection of a tax was barred by the AIA unless it fell within an exception to the act.  And the courts generally accepted this argument, including the Sixth Circuit in this case and the D.C. Circuit in Florida Bankers Ass’n v. Dep’t of the Treasury, 799 F.3d 1065 (2015).  Which makes the Supreme Court’s decision potentially important.

CIC Services, Inc., is a “material advisor” to taxpayers regarding micro-captive insurance arrangements.  Because of the potential for abuse, the IRS in 2016 issued Notice 2016-66 which determined that certain micro-captive insurance arrangements were “reportable transactions.”  Under IRC § 6111, a “material advisor” for a reportable transaction is required to provide detailed information to the IRS.  Failure to comply with the reporting requirements can expose a material advisor to civil tax penalties under IRC §§ 6707 and 6707A.  Additionally, if the failure is willful, the material advisor is subject to the criminal misdemeanor provisions of IRC §7203.

CIC filed an action in district court to enjoin the enforcement of Notice 2016-66, alleging that it was issued without notice and comment procedures in violation of the Administrative Procedures Act and that it was arbitrary and capricious and unlawful.  The district court dismissed on the ground that the action was barred by the AIA and the Sixth Circuit affirmed, with one judge dissenting.

The Supreme Court framed the issue as whether the AIA prohibits “a suit seeking to set aside an information reporting requirement that is backed by both civil tax penalties and criminal penalties.”  Its answer was “NO.”

The Court recognized that the IRS has “broad powers to require the submission of tax-related information that it believes helpful in assessing and collecting taxes,” including information returns for material advisors.  It stated that “critically here” the civil penalties under §§ 6707 and 6707A are “deemed” taxes for purposes of the Code but the penalties for criminal violation are not “deemed” a tax.[3]

According to the Court, if CIC’s purpose in bringing the suit was not to enjoin the assessment and collection of any tax “it can go forward.”  In Direct Marketing Ass’n v. Brohl, 575 U.S. 1 (2015), the Court held that a suit to enjoin a Colorado law requiring out-of-state sellers to report to Colorado any sales to Colorado residents on which tax was not collected was not barred by the Tax Injunction Act[4], which prohibits federal courts from enjoining the assessment or collection of state taxes, since the Act was “not keyed to all activities that may improve a State’s ability to assess or collect taxes” but instead those “keyed to the acts of assessment [and] collection themselves.”  Thus, if Notice 2016-66’s reporting requirement was not backed by a statutory tax penalty “this case would be a cinch” and the AIA would not apply.

The issue was what was the purpose of the lawsuit.  According to the Court to determine that purpose “we inquire not into a taxpayer’s subjective motive, but into the action’s objective aim – essentially the relief the suit requests.”  This means that you look to the face of the complaint.  CIC’s complaint challenged the legality of Notice 2016-66, not the tax penalty that enforces the Notice.  The relief sought was from the Notice’s reporting obligations and not from any eventual tax obligation. 

The Court rejected the Government’s argument that an injunction against the Notice is the same as an injunction against the tax penalties under IRC §§ 6707 and 6707A for the following reasons:

1. The Notice imposes reporting obligations that impose costs “separate and apart from the statutory tax penalty” and obeying the Notice involves significant time and expense; thus the suit seeks “to get out from under the [non-tax] burdens of a [non-tax] reporting obligation.”

• The penalty was several steps removed from the reporting obligation imposed by the Notice (i.e., the penalty would only be imposed if CIC failed to report as required, the IRS conducted an investigation, determined noncompliance and determined to assess the penalty);

• Violation of the Notice is punishable by separate civil and criminal penalties and, due to the potential criminal liability, it was not a situation where the CIC could pay the penalty and sue, since it would still face criminal exposure.

Rejecting the claim that CIC’s complaint was just “artful pleading” the Court stated:

That the Notice imposes an affirmative duty independent of the tax, entailing its own substantial costs; that the Notice and tax may remain forever divorced, depending on both CIC’s and the IRS’s choices; that not only the tax but also criminal penalties backstop the Notice—these facts, when combined, readily explain why CIC’s suit targets the upstream reporting mandate, not the downstream tax. And because that is the suit’s aim, the Anti-Injunction Act imposes no bar.

The Court finally rejected the Government’s in terrorem argument that ruling for CIC would result in a flood of pre-enforcement actions to shield transaction’s from tax consequences, since the cases the Government envisioned all involved conflicts over a tax and not a “separate legal mandate”:

Given that fact, the Anti-Injunction Act bars pre-enforcement review, prohibiting a taxpayer from bringing (as the Government fears) a “preemptive[ ]” suit to foreclose tax liability. Brief for Respondents 13. And it does so always—whatever the taxpayer’s subjective reason for contesting the tax at issue. If the dispute is about a tax rule—as it is in the run-of-the mine suits the Government raises—the sole recourse is to pay the tax and seek a refund.

Associate Justice Sotomayor concurred, pointing out that the result may have been different if the suit had been brought by a taxpayer and not a material advisor.  Associate Justice Kavanaugh joined the opinion but voiced his views that the opinion carved out an exception to Americans United and Bob Jones Univ.

In its panel decision in CIC Services the Sixth Circuit noted:

The problem with these ostensibly straightforward inquiries is that “courts lack an overarching theory of the AIA’s meaning and scope against which to evaluate individual [complaints].” Kristin E. Hickman & Gerald Kerska, Restoring the Lost Anti-Injunction Act, 103 Va. L. Rev. 1683, 1686 (2017). At times, the Supreme Court has given the AIA “literal force,” without regard to the character of the tax, the characterization of the preemptive challenge to it, or other non-textual factors. Bob Jones Univ. v. Simon, 416 U.S. 725, 742 (1974). At other times, it has given the AIA “almost literal” force, considering such factors with an eye towards furthering the AIA’s underlying purposes. Id. at 737, 742. The result, according to some commentators, has been “jurisprudential chaos.” Hickman & Kerska, supra, at 1686.

As Associate Justice Kavanaugh pointed out, the complaints in Bob Jones Univ. and Americans United did not on their face seek to enjoin the assessment or collection of any tax, although the Fourth Circuit in Bob Jones Univ.[5] noted that withdrawal of tax exempt status would subject both the University and its donors to increased taxes.  It appears for now that there will continue to be “jurisprudential chaos” in the application of the AIA.

Robert S. Horwitz is a Principal at Hochman Salkin Toscher Perez P.C., former Chair of the Taxation Section, California Lawyers’ Association, a Fellow of the American College of Tax Counsel, a former Assistant United States Attorney and a former Trial Attorney, United States Department of Justice Tax Division.  He represents clients throughout the United States and elsewhere involving federal and state administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at http://www.taxlitigator.com.

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[1] Internal Revenue Code (“IRC”) §7421(a).

[2] Donations to an organization exempt from tax under § 501(c)(3) are deductible charitable contributions.

[3] Secs. 6707 and 6707A are contained in IRC Chapter 68B (“Assessable Penalties) and thus, under § 6671(a) are deemed tax for purposes of the IRC.  In National Federation of Independent Business v. Sebelius, 567 U.S. 519 (2012), the Supreme Court held that the challenge to the individual mandate penalty of the Affordable Care Act was not deemed a tax under the IRC and thus the AIA did not bar the suit.  I have written ad nauseam about why, in my view, the foreign information reporting penalties under Ch. 61A are not “deemed” tax and, thus, the provisions of the IRC relating to the assessment and collection of tax do not apply to those penalties.

[4] 28 U.S.C. § 1341.

[5] 472 F.2d 903.