May 14, 2021

Podcast - Tax & Tequila Talks: CIC Services v. IRS

The Eyes on Washington Podcast Series

In this episode of our Public Policy & Regulation Group's "The Eyes on Washington Podcast" series, Tax Partners Nicole Elliott and Josh Odintz talk all things tax and tequila. This episode focuses on the U.S. Supreme Court case of CIC Services, LLC v. Internal Revenue Service. Our hosts discuss the much-anticipated SCOTUS decision, potential outcomes and future impacts on tax policy, plus provide a few fun tequila facts.


Nicole Elliott: Hey listeners, welcome to Tax & Tequila. My name is Nicole Elliott, and I'm joined by my colleague Josh Odintz, both partners at the law firm of Holland & Knight and self-proclaimed tax nerds and lover of all things tax. Our goal is to bring you interesting tax news and entertain you with some very smart and interesting tidbits. Today we're going to talk to you about CIC Services v. Internal Revenue Service.

Josh Odintz Thanks Nicole. So, yes, today we are going to talk about a case before the U.S. Supreme Court, CIC Services v. IRS, which is fully briefed and awaiting decision at any minute from the Supreme Court. So Nicole and I both have submitted amicus briefs, and we are waiting at the edge of our seats for that opinion. We're going to talk for the next 20 minutes or so about what this case is about and what it all means. So just to disclaimer, the views expressed are our own, ours alone. And as former government employees of the Treasury and the IRS, we have the utmost respect for our former colleagues. And once again, these are not their opinions, these are our opinions. So, Nicole, what are the taxpayer and the IRS fighting about?

The Crux of CIC Services: Relationship between AIA and APA

Nicole Elliott: Let me take a step back first. Again, we're going to try to make this as succinct as possible, but it requires us to take one little step back. So in 2004, Congress gave the IRS the authority to identify reportable transactions, and those were transactions that included what are called transactions of interest, basically transactions where the IRS suspects there is some funny business going on — and maybe they were designed for tax avoidance and tax evasion — but the IRS doesn't think, it doesn't have enough information about this particular transaction. So the Congress basically said, IRS, we are giving you authority to designate reportable transactions, which includes transactions of interest under regulation. IRS did a little clever thing, which is that it did issue a regulation. And we'll talk a little bit about what a regulation is, but it's basically a formal piece of guidance that the IRS issues that has the opportunity for public comment, and it's published in the Federal Register. But even though Congress said, IRS, you can do this, you have to identify these transactions in regulation. The IRS issued a regulation, in fact, but then gave itself additional authority to do that in a notice. And a regulation and a notice are very different in part, as I mentioned, because the regulation goes through very formal procedures, which includes public comment. But the notice can be done really pretty much at the spur of the moment. There's no formal requirement to solicit public feedback. And so in 2016 IRS issued one of these notices. It was 2016-66 and basically said this thing called micro-captive transactions are, we think there are trends that we're going to designate transactions of interest. And the current Supreme Court decision is brought by CIC Services. They were implicated in this notice. Because once the notice was issued, they had to file additional information with the IRS. So CIC Services is the plaintiff in this action, and what they're complaining about fundamentally is this notice and the rules that come along with the designation, which is this additional filing of information with the IRS that is pretty, pretty significant, pretty burdensome and carries with it some significant penalties if they fail to file this additional information.

Josh Odintz: I think it's important our listeners understand what a micro-captive insurance product is or what is micro-captive insurance, and it's when a company pays insurance to another entity. The word "captive" comes from the idea that the payer is paying to a subsidiary or another related party, but it's effectively a form of self-insurance and that the insurance company is owned by the insured. The way the tax code functions, there are tax savings that are available in this type of transaction. But the IRS is concerned about certain flavors of this transaction and whether, in fact, this transaction really is insurance.

Nicole Elliott: That's exactly right, Josh, and so what the IRS was doing is again, saying transaction of interest, and once so designated not only taxpayers, but material advisors — and material advisors are the folks that help the taxpayers, like the lawyers or the accountants or, in this case, CIC Services — to require this additional form. Now, the usual rule — taking aside CIC, so this case in particular — there has been a rule that existed since 1867, and it's called the Anti-Injunction Act. And the general rule under this thing called, this law called the Anti-Injunction Act is pay first, sue later. The reason behind the Anti-Injunction Act is an important one: We can't have taxpayers avoiding their taxes and suing the government left and right. But the issue here is that whether this law, which really is, the language is for the purpose of restraining the assessment or collection of any tax, precludes CIC Services from challenging the notice. And that is what the Supreme Court will have to decide. 

Josh Odintz: And once again, Nicole, the AIA or the Anti-Injunction Act, is narrow, and it is once again designed to prevent taxpayers from suing the government to prevent the collection or assessment of taxes. But there's also another area of law called the Administrative Procedures Act, which comes into force almost 100 years later. So AIA is from Civil War Era, and actually there was even a version of it pre-1867. The current version and iterations are 1867 and onward. But during the Civil War there was a concern that individuals could stop the Union from collecting taxes to try to fight the war. So close to 100 years later, we have the Administrative Procedures Act, which is a law that applies to all federal agencies. And so whenever Congress passes a law, the federal agency charged with that law or agency charged that law have to provide interpretations. And under the APA, that means that there's notice and comment. There's an opportunity for the public to receive notice of what the intended rule would be, and it gives the public and any interested stakeholder an opportunity to provide comments. And those comments can be written or can be oral or a combination of the two. And there are certainly rules where besides regulations, where the IRS does follow notice and comment, but there are less formal rules, and sometimes the IRS does not provide that notice and comment. So in the question of a transaction of interest, which is at issue in CIC Services, the IRS has regulatory authority to treat certain transactions as of interest, and it issued a notice doing so. It did not go through the notice and comment giving taxpayers the ability to comment. And so really the issue is whether CIC Services can sue now, because in claiming that the notice is invalid because the IRS failed to go through notice and comment, or whether there has to wait for the IRS to find out that the taxpayer didn't file the required notices, which could trigger penalties and interest. And then at that point, could the taxpayer sue to claim that the notice was invalidly promulgated? So that's really the crux of the matter: Do you have to wait years and wait for the IRS to knock, or can you take the bull by its horn and challenge the validity of a regulation or other guidance now?

Nicole Elliott: And I think CIC Services made a good point: In addition to the really significant civil penalties, there's criminal implications here. So CIC Services is really asking, "Do I really have to wait until the IRS tracks me down and potentially asserts criminal or other civil penalties before I can challenge this? And by the way, what about my reputational risk? I'm a known entity in the space. How am I supposed to basically ignore this? I have to comply with this. There's no way I can't not comply with this. And so I'm really in this untenable situation of wanting to challenge this notice, but not willing to basically willfully violate the notice by failing to file this additional information."

Josh Odintz: Nicole, absolutely agree. And look, these rules are very burdensome for businesses to have to comply with, so they have to pull together, within 30 days of receiving a request, all the information regarding any entity that they advised that had entered into the transaction. And they're effectively disclosing them. That probably would hurt business, to put it mildly, especially if it's a plain vanilla transaction. So, I mean, this is, this is a really huge issue for CIC Services and for any taxpayer that has to comply with disclosing information to the service under these rules.

Nicole Elliott: I think because of this really fundamental issue about the interplay between the Anti-Injunction Act and the Administrative Procedure Act or the APA, we saw a great deal of interest in the tax community in general over this case. There were quite a few briefs filed, mostly supporting CIC Services, because of the result that would happen if, in fact, the AIA did block their challenge. And I should say that the District Court and the Sixth Circuit agreed that the AIA blocked. At the Sixth Circuit, there was dissent, but, you know, CIC Services is not the prevailing party here before the Supreme Court.

Predictions for the Case Outcome, Potential Implications

Josh Odintz: It's also important to note, why did the Supreme Court take this case? I mean, normally the Supreme Court avoids tax cases. Well, while this is a tax case and it's certainly very important to the tax community, it's really the intersection of the APA with another law, because Congress did not figure out how the APA should work with the AIA, and there's silence in the space. There's a split of authorities. We have a case authored by a current Supreme Court justice in Florida Bankers. And then we have a split opinion in the Fifth Circuit with Chamber of Commerce involving the anti-inversion regulations. And in Chamber of Commerce the taxpayer was allowed to proceed with an APA challenge, pre-enforcement or assessment or collection. And the flip side holding occurred in Florida Bankers. So it's really right for the Supreme Court to weigh in, and it is a fairly important tax case for the community. Nicole, looking into your crystal ball, we both listened to the oral arguments. What did you think of the oral arguments? What do you think is going to happen?

Nicole Elliott: So the oral arguments were telephonic, which was very interesting, and my overall impression is that it didn't, wasn't a very good day for the government. I think the justices were pretty skeptical of the government's position and also really skeptical of the result if they were to hold that the AIA would be a bar to CIC Services. If I had the crystal ball, I think CIC Services comes out the winners on this one.

Josh Odintz: So I see it both ways. I can see how CIC Services should win, but I think that the justices are going to be concerned about what this could do to the IRS. Are they going to look for some middle ground? Are they going to try to craft a new rule to figure out how the APA and the AIA should interact? Because, look, everyone in this country deals with the IRS every year on April 15 or certainly by October 15, and so the justices are not blind to that. There's a long history of the AIA, and frankly, it wasn't until relatively recently in Mayo that the Supreme Court announced that the APA applied to the IRS and the Treasury. There was a lot of navel gazing and views that tax was exceptional and that the APA did not apply. So I think it's hard. I must say, I'm surprised that oral argument occurred in December and we don't have an opinion. This is not one of the cases I would have expected to drag out into June, but we're getting perilously close to June.

Nicole Elliott: And so, Josh, now that we've brought our crystal balls for everyone, what are the, what does this all mean? So say CIC Services is successful. And obviously there's a huge question of do the justices blow up the AIA, which we don't think they will, but we don't really know where they're going to draw the lines of what may move forward or the parameters of their exception potentially to the APA. But what does this mean for our listeners, for our clients, taxpayers in general?

Josh Odintz: So let's assume that the Supreme Court holds that a taxpayer can challenge the validity of guidance or the constitutionality of a statute before having to file a return. So that would really open the opportunities for taxpayers to take on fighting regulations. So what do I mean by fighting regs? Well, those are regulations where the IRS tries to shut down a transaction or issues guidance to taxpayers viewed as anti-taxpayer and possibly not supported by the statute. So an example is the guidance that was issued to address the guilty gap period, the gap period between December 31, 2017, and the first fiscal year beginning in 2018. There was a gap between guilty and the old system, and some taxpayers undertook transactions during that period. The IRS did not like those transactions and backfilled that period with a rule. And I think there's a really interesting debate about whether those regulations are valid, and taxpayers would like to be able to challenge those regulations immediately so they know if they either have to pay the tax, reserve for it, etc., but they don't want to have to wait 10 years after they go through the audit process, go to appeals, appeals passes on it, end up in the tax board and then litigate all the way. They'd like to be able to run to court sooner rather than later. So it would give taxpayers the opportunity to challenge that small group of regulations that I think taxpayers view as fighting regulations. So it could be very powerful and give taxpayers a new tool that otherwise they'd have to wait until the audit plays out or they could pay the tax and sue for a refund that could take them to the front of the line. But there's a timing element with that as well.

Nicole Elliott: And we also talked, I think, a little bit about what might be a congressional response or how IRS might rethink their guidance process, knowing now that they're vulnerable to more litigation if they do not follow the APA.

Josh Odintz: Yeah, I absolutely expect the IRS to freak out, and that's a technical term, if they lose. The IRS will, you know, they're already feeling the pressure of taking on a lot more burdens with the Affordable Care Act, with TCJA [Tax Cuts and Jobs Act], with all these rounds of COVID relief that are really important. A lot more is running through the Internal Revenue Code and through the IRS, and the IRS headcount was down 20 percent as of last year over the last decade. So they need more resources and money, and if they now have to play whack a mole with every potential regulation, that will tie up resources. And so I expect the IRS will respond that they need some certainty and that there need to be some guardrails around the APA that limit the ability of taxpayers to challenge regulations. I'll just note that there are certain limitations on time frames in other areas like in nuclear licensing. There are very strict guidelines that provide an interested party must sue within 60 days to challenge the validity of guidance. So Congress knows how to provide guardrails, and it could do so. I think, once again, expect the IRS would complain loudly.

Nicole Elliott: And from our perspective, I think there is the danger that we want some guardrails, but we also don't want to totally tie the hands of the IRS. They issue a lot of guidance that isn't technically a regulation. They issue FAQs. They issue instructions to their forms and things that help us as tax practitioners try to understand the laws that Congress wrote. So I think there is a balance to be had there, that there is a desire to have certainty in some areas, but certainly in other areas where we think that the APA should apply and there should be a rather formal procedure.

Tequila Fun Facts

Josh Odintz: I agree. Absolutely agree. Let's finish our tax and tequila conversation with some interesting facts about tequila, and maybe in the future we'll come up with tasting recommendations as well. But first, very much like wines, like champagne or wine from Bordeaux, tequila has an appellation of origin. It can only be produced in one of five regions in Mexico. But I'll just let you know far and away the largest producer is Jalisco. So that's important to know. And then tequila comes from agave plants, and it's worth noting that the agave plant is not a cactus. So it is spiky, but it comes from a succulent plant that is closely related to the lily plant. I hope we have piqued your interest in tax and especially CIC Services. Stay tuned for our next episode of Tax & Tequila, where we will take seemingly mundane subjects of tax and try to do our best to entertain and educate you.

Nicole Elliott: Until then, stay tuned, stay tax compliant.

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