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Supreme Court Strips Lawsuit Protection From IRS Reporting Rules

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What You Need to Know

  • The federal Anti-Injunction Act normally keeps taxpayers from challenging taxes before they pay the taxes.
  • The IRS wants taxpayers to send it reports about micro captive insurance arrangements.
  • Justices held, unanimously, that the reporting requirement is not a tax, and that taxpayers can challenge it without having to violate it.

The U.S. Supreme Court has handed down a unanimous decision that could help everyone —from tax advisors and the wealthy to low-income individuals and other taxpayers — fight IRS reporting requirements in court.

The court ruled 9-0 Monday, in CIC Services LLC v. IRS (19-930), that an IRS information reporting requirement for users and advisors of micro captive insurance arrangements is different from a tax, even though a taxpayer that violates the reporting requirement might have to pay a penalty.

The federal Anti-Injunction Act of 1867 usually keeps taxpayers who have not yet paid, or intentionally failed to pay, federal taxes from suing for “injunctions,” or court rulings that restrain the the government from ever trying to collect the taxes.

The IRS cannot use the Anti-Injunction Act to shield IRS reporting requirements from lawsuits seeking injunctions against enforcement of the reporting requirements, the court held.

Letting the IRS use the Anti-Injunction Act to block suits seeking injunctions against a reporting requirement would be unconstitutional, Justice Elena Kagan wrote in an opinion for the court. This is because, under the current rules, the only way for a taxpayer to challenge the requirement would be to violate the requirement and face the risk of spending a year in prison.

“And that is not the kind of thing an ordinary person risks, even to contest the most burdensome regulation,” Kagan wrote. “So the criminal penalties here practically necessitate a pre-enforcement, rather than a refund suit — if there is to be any suit at all.”

The Case

CIC is a Knoxville, Tennessee-based company that has helped business owners form “micro captives,” or small insurance companies that serve only the owners.

Most micro captives insure the owners against property and casualty risks, but some micro captives invest assets in corporate-owned life insurance or have other connections with life insurance.

The IRS has argued for years that some taxpayers set up micro captives simply to evade income taxes. The agency announced in 2016 that the captive owners and advisors would have to send it reports on all micro captive transactions.

CIC and other captive owners and advisors have argued that the IRS violated federal regulation-writing rules by imposing the reporting requirement without providing a comment period or other chance for affected parties to challenge the requirements.

When CIC sued, the IRS said micro captives should challenge the reporting requirement by disobeying the requirement and then suing for refunds of any tax penalties paid.

A federal district court judge in Tennessee sided with the IRS. The 6th U.S. Circuit Court of Appeals agreed with the district court. The Supreme Court has now reversed the 6th Circuit ruling and sent the case back down into the court system for further action.

The federal courts have not yet ruled on the merits of CIC’s case.

The Impact

The new CIC ruling could affect a wide range of IRS information reporting requirements, such as Affordable Care Act health coverage reporting requirements.

The Harvard Law School tax clinic, a service that helps low-income people with tax disputes, suggested, in a brief supporting CIC services, that the current IRS approach to applying the Anti-Injunction Act blocks many efforts by low-income people to object to IRS information-reporting requirements.

The Americans for Prosperity Foundation argued in another brief that both the IRS and other agencies have been using the threat of massive civil penalties as a weapon to shield actions from judicial review.

If the Supreme Court had sided with the IRS, that would have had “profound, real-world impacts radiating far beyond this case by insulating an array of Treasury and IRS rules from judicial review,” the foundation told the Supreme Court.

The Affordable Care Act Question

Kagan referred specifically in the CIC opinion to a 2012 Supreme Court ruling upholding the constitutionality of the Affordable Care Act, National Federation of Independent Business (NFIB) v. Sebelius. The court held in NFIB that, in connection with the Anti-Injunction Act, Congress can direct that a penalty should be treated as a tax.

The Patient Protection and Affordable Care Act — part of the Affordable Care Act — imposes a penalty on people without what the government classifies as adequate health coverage .

The court concluded in NFIB that the individual coverage ownership mandate penalty is a tax protected by the Anti-Injunction Act.

Congress zeroed out the penalty in 2017.

Attorneys general from Texas and other states are questioning whether the zeroed-out penalty is still a tax and still has Anti-Injunction Act protection. If not, the Texas attorney general’s coalition contends, the mandate provision is simply an unconstitutional requirement for people to own health coverage.

Because the Affordable Care Act contains no provision saving the rest of the law if one part is thrown out in court, a finding that the mandate is unconstitutional should kill the entire Affordable Care Act, according to the coalition.

The Supreme Court heard oral arguments on California v. Texas in November. The court could rule on that case at any time between now and late June.

(Photo: Diego M. Radzinschi/ALM)