IRS Gives Nod to Its Regulatory Noncompliance, Doesn’t Address Real Issues

The Internal Revenue Service (“IRS”) is notorious for flouting regulatory procedures that are designed both to legitimize the administrative state’s exercise of lawmaking power and to constrain the worst abuses of that authority through information gathering tools and judicial review.  One reason the IRS is able to avoid the traditional regulatory process is because the Anti-Injunction Act prevents most lawsuits that would invalidate rules that the IRS promulgates outside that process.

Last week, the IRS acknowledged some of those shortcomings in a policy statement announcing changes to the way it rolls out new rules.  These changes are on top of last year’s revocation of a decades-old exemption from White House pre-publication review and approval.

The Administrative Procedure Act (“APA”) has different processes for legislative and interpretative rules, i.e., rules that create new legal obligations on private parties and those that purportedly don’t.  The IRS has long maintained that nearly all its rules are interpretative and thus exempt from the APA and notice-and-comment regime.  This is a dubious claim, at best.  Notwithstanding this self-bestowed exemption, the IRS magnanimously still puts its supposedly interpretative rules out for notice and comment.  But it does so without following all of the required procedures, which it justifies by claiming that any process it is following is voluntary anyway, so it can follow which procedures it wants to.  In its policy statement, the IRS confirmed that it “will continue to adhere to [its] longstanding practice of using the notice-and-comment process for interpretive tax rules.”

IRS Won’t Seek Deference

An issue that has plagued the IRS is the use of subregulatory guidance to explain the IRS’s view on how it will apply statutes and regulations; these guidance documents often come in the form of revenue rulings, revenue procedures, notices, and announcements.  Although these documents are supposed to be interpretative and explanatory, in many cases they create new legal obligations and are thus actually legislative in nature.

For example, the IRS used a subregulatory mechanism to announce new “transactions of interest” that captive insurance companies must report to the IRS or face a penalty and enforcement.  This is a classic case of a new law that affects private parties that was slipped through in a policy document, without notice and comment, and which should be invalidated on those grounds.

The IRS now seems to be conceding the issue broadly, although not with regard to the example above, and announced in its policy statement that:

When proper limits are observed, subregulatory guidance can provide taxpayers the certainty required to make informed decisions about their tax obligations.  Such guidance cannot and should not, however, be used to modify existing legislative rules or create new legislative rules.  The Treasury Department and the IRS will adhere to these limits and will not argue that subregulatory guidance has the force and effect of law.  In litigation before the U.S. Tax Court, as a matter of policy, the IRS will not seek judicial deference under Auer v. Robbins, 519 U.S. 452 (1997) or Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984), to interpretations set forth only in subregulatory guidance.

This is a positive development, but it remains to be seen whether IRS attorneys really will abide by the constraint when faced with a rule that they’re trying to save in court.  Further, the policy only applies in “litigation before the U.S. Tax Court,” and so will not apply when challenges are brought to federal district court, as many procedural challenges to rulemaking are.  Another limitation of the statement appears to be that the IRS is only forswearing seeking deference to interpretations of subregulatory tax guidance and not other rules that litigants might dispute the IRS has violated, such as the APA or the Regulatory Flexibility Act, which the IRS claims does not apply to nearly all of its rules.

“Good Cause”

One of the APA procedures the IRS sidesteps is providing “good cause” for when interim final rules become immediately effective upon publication.  Treasury and the IRS have decided to now “commit to include a statement of good cause when issuing any future temporary regulations under the Internal Revenue Code.”  This is a good, if minor, change and adherence to general practice used elsewhere in the government.

The biggest issue plaguing the IRS’s compliance with procedural rules that constrain the agency is the Anti-Injunction Act, which prevents many challenges that would clean up the IRS’s lack of compliance.  Unless and until there is a shift in judicial interpretation of that provision or Congress exempts Title 5 challenges to IRS rules, we will continue to see the IRS operate outside the bounds of standard administrative practice.  The IRS’s recent policy statement does nothing to change that.

James Valvo is counsel and senior policy advisor at Cause of Action Institute.

Sixth Circuit Should Follow Supreme Court’s Precedent and Recognize Limits of Anti-Injunction Act

Today, Cause of Action Institute filed an amicus brief in CIC Services, Inc. v. IRS in the U.S. Court of Appeals for the Sixth Circuit.  At issue in the case is whether the Anti-Injunction Act prohibits courts from reviewing whether the IRS complied with the Administrative Procedure Act (“APA”) when it issued a notice related to captive insurance companies.  We urged to appellate court to reverse the district court’s ruling that the Act blocks the suit and to resist the temptation to extend the D.C. Circuit’s flawed reasoning from Florida Bankers.

Notice 2016-66 and Captive Insurance

The rule at issue is contained in Notice 2016-66.  The IRS believes that small companies are using captive insurance companies (i.e., a type of self-insurance vehicle owned by the company or an affiliate) as a tax shelter.  But the IRS isn’t really sure if they are or what types of captives could be problematic.  So the IRS created a new category of “reportable transaction” known as a “transaction of interest,” which requires companies to proactively disclose when they are using a captive insurance company to self-insure.

The problem is that this creates a recordkeeping and reporting burden on small businesses and threatens fines if they do not comply.  CIC Services, the plaintiff-appellant in the case, estimates it would require hundreds of hours of labor and more than $100,000 to comply with the notice.  Further, “reportable transactions” are a scarlet letter in the tax world, and many businesses would rather avoid the underlying behavior than disclose they are engaging in a “reportable transaction.”

The IRS is doing all of this without notice and comment, without studying the adverse impact of its fishing expedition, and in conflict with Congress repeatedly authorizing captive insurance vehicles for small businesses.  CIC Services is also challenging whether the IRS can create a “transaction of interest” without issuing a formal regulation because Congress has limited the IRS’s ability to make “reportable transactions” to those “as determined under regulations prescribed” by the agency.[1]  A simple notice does not meet this standard.

An Overbroad Use of the Anti-Injunction Act Stands in the Way

The parties’ dispute over Notice 2016-66 and whether it violates substantive and procedural limitations on the agency has all the makings of a rather pedestrian APA case.  This is why we have preenforcement judicial review of agency rulemaking.  Enter the Anti-Injunction Act, which prohibits suits “for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person.”[2]  The district court agreed with the IRS that the Act blocked the CIC Services suit.

But Notice 2016-66 deals with neither the “assessment” nor the “collection” of any tax; it creates a reporting requirement.  The U.S. Supreme Court unanimously has held that “notice and reporting requirements precede the steps of ‘assessment’ and ‘collection’” and that suits challenging reporting requirements do not “restrain” those activities and do not trigger the Anti-Injunction Act.[3]    But the D.C. Circuit recently ignored the Supreme Court’s decision in Direct Marketing in Florida Bankers[4] and the Six Circuit may be tempted to extend the D.C. Circuit’s ruling.  CoA Institute submitted an amicus brief in support of a cert petition in Florida Bankers, but the Supreme Court declined to hear the case.

CoA Institute Shows the Court the Consequences of an Overbroad Anti-Injunction Act

The litigants in the case will present the court with all of the issues above.  CoA Institute’s contribution was to introduce the court to the consequences of allowing IRS rulemaking to go unreviewed.  We presented the research underlying our recent investigative report, Evading Oversight: the Origins and Implications of the IRS Claim that its Rules Do Not Have an Economic Impact.  The danger of allowing the IRS to continue to use an over-expansive reading of the Anti-Injunction Act to block judicial review of its rulemakings is that the IRS will continue to ignore the substantive and procedural limitations on its authority.

Congress and the president have established a series of oversight mechanisms to ensure that agencies are complying with procedural requirements, taking public comments into account, and properly mitigating the adverse impacts of their rules, when possible.  But the IRS has erected a series of self-made exemptions from these oversight requirements.  One of those exemptions is at issue in CIC Services: does the IRS have to comply with the APA when it promulgates legislative rules?  A broad reading of the AIA blocks the courts from answering that question and so the IRS continues to flout the rules.


The Sixth Circuit should reject any invitation to extend Florida Bankers, adhere to Supreme Court precedent from Direct Marketing, and reverse the district court’s ruling that the Anti-Injunction Act prevents preenforcement judicial review of whether the IRS complied with the APA when it issued Notice 2016-66.

James Valvo is Counsel and Senior Policy Advisor at Cause of Action Institute.  He is the principal author of Evading Oversight.  You can follow him on Twitter @JamesValvo.

[1] 26 U.S.C. § 6707A(c)(1).

[2] 26 U.S.C. § 7421.

[3] Direct Mktg. Ass’n v. Brohl, 135 S. Ct. 1124, 1131 (2015).

[4] Florida Bankers Ass’n v. Dep’t of Treasury, 799 F.3d 1065 (D.C. Cir. 2015)

IRS Seeks to Halt Fifth Circuit Appeal of Controversial Inversion Rule, Submits Final Rule for White House OMB Review

In January, Cause of Action Institute released a report highlighting IRS exemptions from various regulatory oversight mechanisms.  This report kicked off a flurry of activity, and Treasury and OMB are now in talks about whether and how the IRS should continue to be functionally exempt from White House review of IRS rulemakings.  A recent development in a closely watched Fifth Circuit case challenging an Obama-era rulemaking on inversions shows the effort may be bearing fruit.

In April 2016, the Obama Administration issued a controversial rule attempting to block inversions, a business reorganization technique designed to provide relief from high U.S. corporate taxes.  The IRS made this rule by issuing a Notice and publishing a proposed rule in the Federal Register.  Because IRS rules are effective from the date of the Notice, the agency was in no hurry to complete the Administrative Procedure Act (“APA”) rulemaking process that it had begun with the proposed rule and request for comment.  The Obama Administration ended without the rule ever being finalized but the Notice continued to be in effect.

The Chamber of Commerce sued the IRS over the inversion rule, claiming that the agency failed to comply with APA rulemaking procedures and that the substantive rule was in excess of its statutory authority.  The IRS tried to use the Anti-Injunction Act (“AIA”) to block the suit, as it often does.  But, in October 2017, a district court in Texas ruled that the AIA did not deny the court jurisdiction over the case and that the IRS did indeed violate the APA.  The court than invalidated the temporary rule.  The IRS promptly appealed to the Fifth Circuit.

IRS Moves to Stay Appeal of Inversion Rule Decision

But, in a twist, last week the IRS moved the appellate court to stay the proceedings because it was restarting the long-dormant APA process and finalizing the underlying rule.  In its motion seeking a stay (or a 45-day extension), counsel for the IRS wrote that it needs “to reevaluate whether [the IRS] should proceed with th[e] appeal[.]”  The IRS also told the Fifth Circuit that:

Having completed notice and comment, Treasury and the IRS plan to finalize the proposed regulation. That process is nearly complete. A draft of the final regulation has been prepared, and it has been submitted to the Office of Management and Budget for review. The final regulation would replace the temporary regulation that is at issue in this case, which will be removed.

Accordingly, we respectfully request that briefing of this case be stayed until a final regulation is published in the Federal Register, during which time the Government will evaluate whether it should proceed with this appeal or dismiss it.

This is an interesting development.  The inversion rule remains controversial and whether it is still necessary, following the recent changes to the corporate tax rate, is an open question.  But it now appears that Treasury and IRS are rethinking whether it is wise to press the government’s current disadvantage on the AIA and APA compliance in the Fifth Circuit.  This case could provide a clear circuit split with the D.C. Circuit (following Florida Bankers, which held the AIA blocked pre-enforcement review in APA challenges to IRS rules) on the proper application of the AIA.  So we may be seeing a strategic retreat by the IRS trying to limit the damage from its earlier loss in the district court.  But it is good to see that the agency is involving OMB in this finalization process.

We’ll have to wait to see what OMB says about the rule, whether the IRS does indeed finalize the rule, what form that final inversion rule will take, whether the Fifth Circuit grants the stay, and, ultimately, whether the IRS will back out of this appeal.  Stay tuned.

Update: The Fifth Circuit did not act on the stay motion before the deadline for the IRS to file its opening brief, which it timely did on March 16.

Update 2: On March 22, the Fifth Circuit denied the stay motion and the case is proceeding.

James Valvo is Counsel and Senior Policy Advisor at Cause of Action Institute.  He is the principal author of Evading Oversight.  You can follow him on Twitter @JamesValvo.