The voices of Tax Policy Center's researchers and staff
Tomorrow, the US Supreme Court will hear oral arguments in CIC Services v. IRS, a case that threatens to damage the integrity of the tax system. While the lawsuit has received little attention, it could gut the ability of the IRS to limit abusive tax shelters.
And it could do even wider damage to the agency’s ability to use regulations to implement tax law. Tax shelter promoters could use lawsuits to hobble the IRS’ efforts to combat abuses, and other aggressive taxpayers could use the same strategy to hold up regulations that clarify and implement tax laws.
CIC Services is a firm that sells a product called “micro-captive insurance” that it advertised as “a legal tax shelter.” While micro-captive insurance can be a legitimate business arrangement, it often is an abusive tax shelter that generates tax benefits without any real business purpose. But the details of CIC’s business are less important than the issues the case raises about the ability of the IRS to block abusive practices.
The IRS can’t challenge shelters until it has enough information to evaluate whether a particular arrangement has a true business purpose. So the IRS issued a notice requiring taxpayers to report information on types of micro-captive insurance transactions most likely to reflect tax abuse. Taxpayers would face penalties if they fail to provide the information.
This type of notice with a penalty for non-compliance is allowed under the American Jobs Creation Act of 2004 (AJCA), which gave those penalties protection granted by a post-Civil War law called the Anti-Injunction Act of 1867. As a result, taxpayers are required to pay the penalty or pay taxes before they challenge IRS enforcement of the law or regulations.
But CIC Services asked the Supreme Court to let it challenge the validity of the IRS notice on procedural grounds before it either gives the IRS the information or pays the penalty. If the Court accepts CIC’s argument, the IRS would be unable to get information on captive insurance companies until challenges to the notice have been resolved by the courts, which could take years.
It is important to note that the government is not asking the High Court to give special judicial protection or deference to tax law (a practice known as “tax exceptionalism”). Instead, the government is relying on a routine approach to statutory interpretation that focuses on the plain language of the relevant statutes. (A “friend of the court” brief joined by one of the authors covers these issues in more detail.)
A Supreme Court ruling for CIC Services could send ripples of damage into the tax system. It could gut the bipartisan ACJA that allowed the IRS to quickly respond to waves of tax shelter activity by requiring information reporting on specified transactions. Other promoters already are backing CIC’s argument. A group representing conservation easement syndicators—an industry in the spotlight given its own widespread abuses—supports CIC’s High Court appeal.
Promoters of other tax shelters could seek similar injunctions to block the IRS from requiring information reporting until the promoters exhaust all their legal challenges. Because the IRS usually has just three years to assess additional tax, promoters could use litigation to run out the clock on the statute of limitations, letting abusive transactions continue.
If the Supreme Court’s ruling is broad enough, it could damage tax administration even more broadly by allowing taxpayers to use litigation to hold up any regulations.
Allowing taxpayers to litigate before regulations apply and impose any real cost will make the tax system more litigious, more uncertain, and less effective. Given that taxpayers prefer to defer paying taxes, the strategy seems obvious: litigate regulations that would impose new taxes in hope that the IRS eventually overturns or modifies the rules.
A tax system that is increasingly dependent on litigation poses additional risks. The IRS often is out-manned and out-gunned in these disputes, where well-heeled businesses turn to high-powered legal counsel to press their claims. In addition, cases may be decided by judges who are not well-versed in tax law. Relying on litigation does not bode well for a well-functioning revenue collection system—or the public interest.
The Supreme Court should do the right thing and support the Trump Administration’s arguments. It would uphold an important aspect of the tax system and help the IRS close down abusive tax shelters.
Posts and comments are solely the opinion of the author and not that of the Tax Policy Center, Urban Institute, or Brookings Institution.
J. Scott Applewhite/AP Photo