Subscribe Sign In May 20, 2021,12:37am EDT U.S. Supreme Court Rules On Anti-Injunction Act In Microcaptive Context Jay AdkissonContributor Personal Finance I cover Wealth Preservation in its legal permutations Listen to article U.S. Supreme Court building GETTY I've previously written about the attempts by some managers of so-called microcaptive insurance companies to challenge the propriety of the IRS's publication of Notice 2016-66 in my articles here and here. Basically, the lawsuit challenges whether the IRS in promulgating Notice 2016-66 correctly followed the Administrative Procedures Act (APA), which just by the way is an Act whose provisions the IRS seems prone to flub. The merits of the lawsuit, being whether the IRS flubbed the APA again in relation to Notice 2016-66, have yet to be heard. What happened is that the lawsuit against the IRS which challenged Notice 2016-66 was filed in the U.S. District Court, but that court decided that it could not even hear the lawsuit because of the Anti-Injunction Act (AIA), an Act passed by Congress in 1867, being just two years past the close of the Civil War. The AIA provides to the effect that nobody can bring a lawsuit to stop the IRS from assessing or collecting taxes. The natural consequence of the AIA is that somebody seeking to challenge a federal tax can only do so by first paying the tax and then asking for a refund. Anyway, the U.S. District Court dismissed the action challenging Notice 2016-66 based on the AIA, and a divided Sixth Circuit affirmed. The case then made its way up to the U.S. Supreme Court, which decided to hear the matter. In a unanimous opinion written by Justice Kagan, the Court pointed out that the IRS doesn't just collect taxes, but also seeks information on a wide variety of tax-related topics, including whether certain persons are "material advisors" to certain sorts of questionable tax transactions (read: promoters of tax shelters). In the context of Notice 2016-66, the Court noted: "A micro-captive transaction is typically an insurance agreement between a parent company and a 'captive' insurer under its control. The Code provides the parties to such an agreement with tax advantages. The insured party can deduct its premium payments as business expenses. See §162(a). And the insurer can exclude up to $2.2 million of those premiums from its own taxable income, under a tax break for small insurance companies. See §831(b). The result is that the money does not get taxed at all. That much, for better or worse, is a congressional choice. But no tax benefit should accrue if the money is not really for insurance — if the insurance contract is a sham, which the affiliated companies have entered into only to escape tax liability." The Court noted that the purpose of Notice 2016-66 is to create reporting requirements so that the IRS can ferret out the microcaptive transactions which are shams. But, the Court noted, it is not just the sham transactions that Notice 2016-66 ferrets out, since the notice also seeks information on the promoters of these transactions who themselves could face significant monetary penalties — which are themselves deemed to be a "tax" under the Internal Revenue Code — and also criminal penalties carrying a term of up to one year at Club Fed (although the criminal penalties are not deemed a "tax"). MORE FOR YOU How To Get Approved For Student Loan Forgiveness Student Loan Forgiveness Won’t Be Available For Everyone, But This Plan Is Available Now Biden Cancelled $1.5 Billion Of Student Debt For Borrowers, But You Can Still Apply Now The challenge here, however, was not to the penalties that might result for non-compliance with Notice 2016-66, but rather to the reporting requirements of that notice which was allegedly issued without the IRS following the notice-and-comment procedures of the APA. To challenge the reporting requirements, if the Anti-Injunction Act was strictly followed, would require challenging party to, first, disobey those reporting requirements, second, to pay the penalty for violating the reporting requirements, and then, third, to seek a refund of the penalty. But is a suit asserting an APA challenge to a reporting requirement a "suit for the purpose of restraining the assessment or collection of any tax"? Generally, an IRS reporting requirement is not considered a "tax", but here the "downstream tax penalty," as the Court called it, complicated matters: Because penalties might arise later, and those penalties would be considered a tax, then rears the ugly head of the Anti-Injunction Act to potentially block suits challenging just the reporting requirements. The Court rejected the IRS's assertion that a challenge to a reporting requirement is a challenge to the tax which might accrue should the reporting requirement be violated, since Notice 2016-66 itself levied no tax, but potentially caused very costly record collection and record keeping requirements by those who fell within its ambit. The Court also noted that Notice 2016-66 is "several steps removed" from the possible tax penalties which might arise from noncompliance. Thus the Court: "Between the upstream Notice and the downstream tax, the river runs long. So it is again hard to characterize the suit's purpose as enjoining a tax." That a violation of Notice 2016-66 could potentially also result in criminal penalties was an issued noted by the Court, since that would require a party making an APA challenge to Notice 2016-66 to be at risk of criminal penalties. Such a result would be absurd, and thus the Court held that a party making a APA challenge to Notice 2016-66 should be able to do so by way of a lawsuit requesting an injunction as the plaintiffs in this case had originally done. The Court also rejected the IRS's argument that to allow such challenges to reporting requirements would have the effect of neutering the Anti-Injunction Act and thus harm the IRS's ability to assess and collect taxes. But the IRS's argument here fell flat for the same reason that Notice 2016-66 does not itself impose any tax, but merely reporting requirements. The result of the opinion in this case was that the Court held that the Anti-Injunction Act did not bar a lawsuit for an injunction against the reporting requirements of Notice 2016-66, and the case would be remanded back to the lower courts to go forward on the merits, i.e., the case starts again at ground zero as if it were just filed, but with no hurdle to be leapt over the Anti-Injunction Act which was held not to apply. ANALYSIS In my last article on this case, I noted that "Notice 2016-66 has already had 99.9% of its intended effect," because the reporting that the IRS sought through that notice has already been provided to the IRS, along with probably tens-of-thousands of Form 8886 disclosures. Thus, even if this case restarts at ground zero and ends with a determination that Notice 2016-66 violated the APA, it is difficult to see what the practical effect would be. Disabling Notice 2016-66 on APA grounds is not going to reverse the result of any of the four U.S. Tax Court decisions, and probably will not make a difference in any case now pending before the U.S. Tax Court. If folks who are litigating microcaptive cases with the IRS thinks that this is the light at the end of the tunnel, well, sorry, but's that is still the light of the oncoming train. What this case does do in the larger construct of American tax law is to provide future litigants with a mechanism to challenge future reporting requirements on APA grounds. Thus, when the next tax shelter appears (and there will always be another tax shelter), the promoters have a chance of obtaining an injunction to block the reporting requirements if the IRS has been sloppy in following the APA. By like token, for the IRS this means that they need to run a tighter ship when it comes to the APA, i.e., designate somebody in the IRS General Counsel's office to give future notices a second thorough examination to make sure that the APA has been fully complied with, and not just presume that the particular drafter has complied with the APA. From the viewpoint of those involved with microcaptives, this decision is really awful and a full step backwards for the reason that the U.S. Supreme Court has in a unanimous opinion now stated that "But no tax benefit should accrue if the money is not really for insurance — if the insurance contract is a sham, which the affiliated companies have entered into only to escape tax liability." Presumably, somebody in the IRS is now preparing (if they haven't already) a filing with the 10th Circuit to supplement the briefing in the Reserve Mechanical case with this quote. Now, the 10th Circuit no longer must to guess what the U.S. Supreme court will hold: It now knows that the U.S. Supreme Court is willing to apply the sham transaction doctrine to microcaptive transactions. Even worse, this statement by Justice Kagan has the potential to bleed over into all insurance-related transactions, and thus threaten the larger captive industry. Whether this terrible result was worth getting a ruling on the highly technical issues of whether the Anti-Injunction Act prevented challenges under the APA is one that I will leave to tax professionals to decide, but it was not a good day at all for those faced with challenges to microcaptives. Expect to see this quote appear regularly and often in IRS briefings. "But no tax benefit should accrue if the money is not really for insurance — if the insurance contract is a sham, which the affiliated companies have entered into only to escape tax liability." CITE AS CIC Services, LLC v. IRS, (U.S., May 17, 2021). Follow me on Twitter or LinkedIn. Check out my website or some of my other work here. Jay Adkisson I am a partner of Adkisson Pitet LLP and licensed to practice law in Arizona, California, Nevada, Oklahoma and Texas. My... Read More Reprints & Permissions Cookies on Forbes YOUR CHOICES REGARDING COOKIES ON THIS SITE Please choose whether this site may use cookies or related technologies such as web beacons, pixel tags, and Flash objects ("Cookies") as described below. You can learn more about how this site uses cookies and related technologies by reading our privacy policy linked to below. Your choices on this site will be applied globally. This means that your settings will be available on other sites that set your choices globally. You can change your mind and revisit your preferences at any time by accessing the "Cookie on Forbes" button on the left side of this site. While we need to use required cookies to make our site work, we won't set optional cookies unless you enable them. 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