In more detail 

Under section 6111, material advisors to reportable transactions, including listed transactions, have reporting requirements. If the material advisor fails to meet the reporting requirement, the material advisor faces a penalty under section 6707A. Failure to report may also subject the material advisor to criminal liability under section 7203. In this case, CIC Services challenged the validity of Notice 2016-66 (“Notice”), which created a “transaction of interest” for so-called “micro-captive” insurance transactions. CIC Services challenged the Notice as being contrary to the notice and comment procedure under the APA and being arbitrary and capricious under the APA, alleging that there is no need for the reporting requirement in such transactions.

The AIA, in part, states that “no suit for the purposes of restraining the assessment or collection of any tax shall be maintained in any court by any person.” The AIA prevents injunctions from being issued against the IRS as a preemptive method of not paying a tax.

The IRS argued that the AIA applied to CIC Services’ APA suit because the challenge to invalidate the Notice effectively prevented the IRS from assessing and collecting the section 6707A penalty. The IRS argued that the reporting requirement and the penalty are “two sides of the same coin,” making the suit barred by the AIA. The IRS’s position was that, to challenge the Notice and comply with the AIA, the advisor should ignore the reporting requirement, pay the penalty if imposed, and sue for a refund.

The District Court held for the IRS and dismissed the suit. The Sixth Circuit in a divided opinion affirmed the District Court. The Supreme Court reversed the Sixth Circuit, holding that the AIA did not apply. First, the Court addressed the parties’ dispute regarding how the underlying APA complaint should be characterized. The advisor argued that the underlying complaint was narrow and only sought APA review of the Notice. The IRS argued that the complaint was broader and effectively covered both the Notice and the associated penalty. The Supreme Court sided with the advisor.

Next, the Court analyzed whether the AIA applied to the cause of action in the complaint. The Court held that the AIA did not apply for three reasons. First, based on the conclusion about the construction of the complaint, the Court said the cause of action was limited to avoiding the reporting requirement and the associated costs of complying. Second, the Court summarized the intervening steps between the reporting requirement and the application of the penalty, including the IRS audit, the determination of whether the Notice applies to the advisor’s behavior, and the IRS’s decision to impose the penalty. Third, the Court cited the fact that an intentional failure to meet the reporting requirement could subject a material advisor to criminal liability, which made the IRS proposed method to challenge the Notice’s reporting requirement unworkable.

The Supreme Court summarized its opinion as:

CIC’s suit aims to enjoin a standalone reporting requirement, whose violation may result in both tax penalties and criminal punishment. That is not a suit “for the purpose of restraining the [IRS’s] assessment or collection” of a tax, and so does not trigger the Anti-Injunction Act.

Justice Sotomayor wrote a concurrence stating that the result may have been different if the person filing the suit challenging the reporting requirement were a taxpayer, rather than a tax advisor. She based the distinction that the taxpayer reporting requirement “may operate as a rough substitute for the tax liability…” Thus, while Justice Sotomayor agreed that “it will often be correct to conclude that a tax advisor challenging an IRS reporting requirement is not doing so ‘for the purpose of restraining’ a tax on noncompliance, the analysis may be different when it comes to taxpayers.”

Because of a lack of standing for the taxpayer’s position regarding the AIA, the Court’s decision allowed CIC’s suit to go forward to address the merits of whether the IRS violated the APA in issuing the Notice. On 21 September 2021, US District Court for the Eastern District of Tennessee issued a preliminary injunction in favor of CIC Services. The APA classifies administrative rules as either legislative or interpretive. CIC Services argued the Notice was a legislative rule; the IRS argued it was an interpretative rule. In ordering the injunction, the Court determined that the Notice was a legislative rule under the APA because it created new duties and obligations on the material advisor; thus, the Notice was likely invalid because the IRS did not comply with the notice and comment provisions of the APA that applied to legislative rules. The court held that CIC Services had shown that it was likely to win on the merits of the violation of the APA and that there was some evidence of irreparable harm. The injunction prohibits the IRS from enforcing the disclosure requirement against CIC Services.

Another recent US District Court case also allowed a taxpayer to bring an APA challenge against an IRS notice creating a listed transaction as opposed to a transaction of interest, for which the taxpayer had been penalized. Mann Construction, Inc., v. U.S., 127 AFTR.2d 2021-2000 (E.D. Mich. 13 May 2021). The court ruled against the taxpayers on the merits holding that Congress authorized the IRS to create a listed transaction without following the APA by the structure of the penalty for failure to disclose a listed transaction under section 6707A.

It will take a few years to see how important CIC Services will be. Courts will have to outline the separation between certain regulatory actions that are exempt from the AIA and those tax provisions that are subject to the AIA.