Challenging the IRS … and Winning
Sometimes, it seems the IRS always prevails over the little guy. But this CIC Services case establishes a new direction for successful lawsuits against the agency.
With its stated mission, the Internal Revenue Service (IRS) says that it seeks to provide America’s taxpayers with “top-quality service by helping them understand and meet their tax responsibilities,” while the agency enforces the law “with integrity and fairness to all.” Subsections of this mission include:
- In the United States, the Congress passes tax laws and requires taxpayers to comply.
- The taxpayer’s role is to understand and meet his or her tax obligations.
- The IRS’s role is to help the large majority of compliant taxpayers with the tax law, while ensuring that the minority who are unwilling to comply pay their fair share.
For the most part, the IRS does a good job of upholding these standards. The agency has brought down the likes of Al Capone and continues to challenge organized crime and criminal enterprises through the work of its criminal investigation division.
Although much of the IRS’s work is good and responsible, many taxpayers and business owners in recent years have been unfairly targeted by an organized and illegal IRS FUD (fear, uncertainty, and doubt) campaign. Companies that utilize captive insurance, in particular, have been unfairly maligned, burdened, and attacked by the IRS for engaging in so-called “abusive tax shelters.” However, affected taxpayers were relieved of some of the burdens of the IRS’s illegal conduct when CIC Services challenged the IRS and won a unanimous decision in the U.S. Supreme Court.
The Case: What Happened?
In 2016, the IRS issued Notice 2016-66, which imposed onerous reporting obligations on entities engaging in the most common types of captive insurance transactions. Taxpayers that failed to comply would be subjected to unappealable fines of up to $50,000 per transaction and the possibility of criminal charges.
CIC Services believed that this notice was issued in violation of the Administrative Procedures Act (APA) and took the IRS to court. Initially, the IRS did not deny that the notice was illegal. Instead, the agency argued that, even if the notice was illegal, the courts were powerless to do anything about it, thanks to the Anti-Injunction Act of 1867 (the “Tax Anti-Injunction Act”). That act prohibits lawsuits that would restrain the assessment or collection of taxes.
A federal district court accepted the IRS’s position and dismissed the case. CIC Services appealed that decision to the U.S. Court of Appeals for the Sixth Circuit. There, a three-judge panel voted 2-1 to affirm the trial court’s decision, and that decision was later re-affirmed in an 8-7 en banc decision by the entire Sixth Circuit.
CIC Services then petitioned the U.S. Supreme Court to hear its case, and remarkably the court granted the petition. The Supreme Court eventually ruled 9-0 in CIC Services’ favor, holding that the Tax Anti-Injunction Act does not prevent the courts from reviewing and enjoining illegal IRS conduct where the lawsuit doesn’t seek to prevent the IRS from assessing or collecting any particular tax owed by any particular taxpayer.
Following this Supreme Court victory, the case was remanded back to the U.S. District Court for the Eastern District of Tennessee. There, Judge Travis McDonough ruled that Notice 2016-66 is illegal and unenforceable. He specifically ruled that the IRS’s justification for issuing the notice—its finding that such captives were being used in abusive ways—was “arbitrary and capricious,” and not justified by any facts in the administrative record.
This was a major victory for taxpayers, and its implications extend far beyond captive insurance. Still, it did not cure all harms caused by the notice. The thousands of taxpayers that previously complied with the now-dead IRS Notice 2016-66 will never again see the tens of thousands of dollars they spent meeting the IRS’s illegal, arbitrary, and capricious demands.
Opening the Doors
Since our victory, a number of other taxpayers have successfully challenged IRS notices. One such case in the First Circuit involved a taxpayer who had previously possessed an account on a digital-currency exchange. Through this exchange, he had deposited bitcoin into the account in 2013 and 2014, before beginning to liquidate his holdings in 2015 and 2016. The taxpayer subsequently declared and paid taxes, lawfully and properly, on his holdings.
However, in 2019, the IRS used information it obtained directly from the exchange to send the taxpayer threatening letters, implying that he had not properly reported his cryptocurrency transactions. The IRS warned the taxpayer that he faced potential criminal or civil enforcement actions if he had incorrectly reported the transactions. In response, the taxpayer filed a lawsuit alleging, among other things, that the third-party summons the IRS had used to obtain his information directly from the exchange violated his rights. The IRS sought dismissal of the case, asserting once again that it enjoyed a special privilege protecting it from court review, thanks to the Tax Anti-Injunction Act.
Siding with the taxpayer and relying in part upon CIC Services’ Supreme Court victory, the court ruled that the IRS enjoys no such privilege if the IRS has not yet sought to assess or collect a particular amount of tax. The taxpayer’s lawsuit against the IRS was permitted to continue.
Another case citing the CIC Services decision as precedent was a taxpayer’s challenge of an IRS notice concerning conservation easements. In the Sixth Circuit case of Mann Construction, Inc. v. United States, 27 F. 4th 1138 (2022), the court ruled that an IRS notice requiring taxpayers to disclose their participation in conservation easement programs could be challenged by some affected taxpayers as illegal because, once again, the IRS enjoys no special exemption against such challenges when specific tax liabilities are not in dispute. Rejecting the IRS’s contention that forcing it to comply with the basic requirements of the APA is too burdensome, the court noted that if individual taxpayers are expected to work through and comply with complicated and involved rules, then it is only fair to expect the IRS to do the same.
An additional case referencing CIC Services v. Internal Revenue Service and its precedent-setting victory is a lawsuit challenging IRS surveillance methods.
Implications for the Future
Thanks to these decisions, it’s now clear that the IRS must, like every other federal agency, comply in its rulemaking with the requirements of the APA. No longer can the IRS issue illegal rules by fiat and enforce them against taxpayers while denying those same taxpayers the protection of the courts. Taxpayers can now successfully challenge such illegal regulations—and more and more are doing so, now that the IRS’s shroud of perceived invincibility has been lifted.
How the IRS adjusts and responds to these losses in the next few years will be telling. The agency is already attempting to reverse our Supreme Court victory, lobbying Congress to restore its former powers so that it can again pressure taxpayers into compliance with illegal audits.
The CIC Services v. Internal Revenue Service case represents a tectonic shift in the balance of power between the IRS and taxpayers. Regardless of what happens next, the CIC Services case and subsequent cases have opened the door for real conversations about just how much power the IRS should rightfully have.