Cic Servs., LLC v. Internal Revenue Serv.

592 F.Supp.3d 677

CIC SERVICES, LLC, Plaintiff,

v.INTERNAL REVENUE SERVICE, Department of Treasury, and the United States of America, Defendants.

Case No. 3:17-cv-110

United States District Court, E.D. Tennessee, Northern Division, at Knoxville.

Filed March 21, 2022

Adam R. Webber, Pro Hac Vice, Beavercreek, OH, E. Jerome Melson, John M. Kizer, Gentry, Tipton & McLemore, PC, Knoxville, TN, Kenneth A. Lazarus, Pro Hac Vice, Lazarus & Associates, Washington, DC, for Plaintiff.

Kyle Lamar Bishop, Richard Jeremy Hagerman, Moira Goodwin, Nishant Kumar, U.S. Department of Justice, Tax Division, Washington, DC, for Defendants.

Elizabeth Johnson Bondurant, Nikole M. Crow, Womble Bond Dickinson (US) LLP, Atlanta, GA, for Amicus The North Carolina Captive Insurance Association.

MEMORANDUM OPINION

TRAVIS R. MCDONOUGH, UNITED STATES DISTRICT JUDGE

Before the Court are the following motions: (1) Plaintiff CIC Services, LLC's ("CIC") motion to reconsider the scope of preliminary injunction (Doc. 87); (2) CIC's motion for summary judgment (Doc. 97); (3) Defendants Internal Revenue Service ("IRS"), Department of Treasury, and the United States of America's (collectively, the "Government") motion for summary judgment (Doc 99); (4) CIC's objection to the magistrate judge's order denying discovery (Doc. 105); and (5) the Government's motion to strike CIC's reply brief in support of its motion for summary judgment (Doc. 116). For the following reasons, CIC's motion to reconsider the scope of the preliminary injunction and the Government's motion to strike will be DENIED AS MOOT . CIC's objection to the magistrate judge's order denying discovery will be OVERRULED AS MOOT . CIC's motion for summary judgment will be GRANTED , and the Government's motion for summary judgment will be DENIED .

I. BACKGROUND

A. Statutory and Regulatory Background

Through the Internal Revenue Code, Congress requires that certain taxpayers provide the IRS with information regarding "reportable transaction[s]." 26 U.S.C. § 6707A(c)(1). Congress defines a "reportable transaction" as "any transaction with respect to which information is required to be included with a return or statement because, as determined under regulations prescribed under section 6011, such transaction is of a type which the Secretary determines as having a potential for tax avoidance or evasion." Id. Consistent with this requirement, Congress delegated to the Secretary of the Department of Treasury (the "Secretary") the authority to "prescribe regulations which ... provide such rules as may be necessary to carry out the purposes of this section." 26 U.S.C. § 6111(c)(3). Congress also authorized the IRS to assess penalties to taxpayers and material advisors who fail to make required disclosures regarding reportable transactions. 26 U.S.C. §§ 6707(a), 6708(a). Taxpayers and material advisors who willfully fail to make required disclosures are potentially subject to criminal prosecution. See 26 U.S.C. § 7203.

Consistent with the authority delegated by Congress, the Secretary has promulgated regulations specifying that taxpayers and material advisors must provide to the IRS information about defined types of reportable transactions, including, but not limited to:

• "Listed transactions"—"a transaction that is the same or substantially similar to one of the types of transactions that the Internal Revenue Service (IRS) has determined to be a tax avoidance transaction and identified by notice, regulation, or other form of published guidance as a listed transaction";

...

• "Transactions of interest"—"a transaction that is the same or substantially similar to one of the types of transactions that the IRS has identified by notice, regulation, or other form of published guidance as a transaction of interest."

26 C.F.R. § 1.6011-4(b)(1)–(6).

On November 1, 2016, the IRS issued Notice 2016-66 (the "Notice"). (Doc. 98, at 381–95.) In the Notice, the IRS expressed concern that "micro-captive transactions" had the potential for tax avoidance or evasion and classified these transactions as "transactions of interest" for the purposes of 26 C.F.R. § 1.6011-4 and 26 U.S.C. §§ 6011 and 6012. (Id. at 382–83.) Based on this classification, the Notice directs that: (1) "[p]ersons entering into these transactions on or after November 2, 2006, must disclose the transaction" to the IRS; and (2)"[m]aterial advisors who make a tax statement on or after November 2, 2006, with respect to transactions entered into on or after November 2, 2006, have disclosure and maintenance obligations under §§ 6111 and 6112" of the Internal Revenue Code.¹ (Id. at 391.) The Notice further provides that taxpayers and material advisors are required to file a disclosure statement regarding these transactions prior to January 30, 2017, and that persons who fail to make required disclosures "may be subject to [ ] penalty" under 26 U.S.C. §§ 6707(a), 6707A, and 6708(a). (Id. at 394.) Finally, the Notice requests comment "on how the transaction might be addressed in published guidance." (Id. at 395.)

B. Procedural History

On March 27, 2017, CIC initiated the present action.² (Doc. 1.) According to its initial verified complaint, CIC is "a manager of captive insurance companies." (Id. at 3.) In this capacity, CIC asserts that it is subject to the Notice's disclosure requirements for material advisors and that complying with the Notice's disclosure requirements will force it to incur significant costs. (Id. at 10.) CIC asserts, however, that the Notice: (1) constitutes a "legislative-type rule" that fails to comply with mandatory notice-and-comment requirements under the Administrative Procedures Act ("APA"), 5 U.S.C. § 533, et seq. ; and (2) is "arbitrary and capricious and ultra vires in nature." (Id. at 2.) Based on these allegations, CIC's initial verified complaint sought, among other things, a preliminary injunction prohibiting the IRS from enforcing the disclosure requirements set forth in the Notice based on the IRS's failure to comply with the APA's notice-and-comment requirements. (Id. )

On April 21, 2017, the Court denied the initial motion for preliminary injunction, finding that CIC was unlikely to succeed on the merits of its claims because the claims were foreclosed by Anti-Injunction Act ("AIA"). (Doc. 24.) Then, on November 2, 2017, the Court dismissed the case, finding it lacked subject-matter jurisdiction because the claims were barred by the AIA. (Docs. 35, 36.) CIC appealed the Court's dismissal of its claims, and, ultimately, on May 19, 2021, the Supreme Court of the United States held that the AIA did not deprive the Court of subject-matter jurisdiction over CIC's claims against the IRS. CIC Servs., LLC v. I.R.S , ––– U.S. ––––, 141 S.Ct. 1582, 209 L.Ed.2d 615 (2021).

On July 12, 2021, after the mandate was returned to this Court, the Court entered a scheduling order. (Doc. 57.) CIC then filed a renewed motion for preliminary injunction, again seeking to enjoin the IRS's enforcement of Notice 2016-66. (Doc. 59.) On September 15, 2021, CIC moved the Court to reconsider its scheduling order, arguing that it should be modified "to permit discovery into the IRS's basis for Notice 2016-66." (Doc. 80, at 1.) It also filed a motion seeking to supplement the administrative record, arguing that the administrative record filed by the IRS was "wholly inadequate." (Doc. 84.)

On September 21, 2021, the Court granted CIC's motion for preliminary injunction, finding that CIC was likely to succeed on its claim that Notice 2016-66 is a legislative rule that is invalid because the IRS failed to observe the notice-and-comment procedures required by the APA. (Doc. 82.) As a result, the Court enjoined the IRS from enforcing Notice 2016-66 against CIC. (Id. at 12.) On October 18, 2021, CIC filed a motion for reconsideration, arguing that the Court's injunction was too narrow and that the preliminary injunction should "enjoin the enforcement of Notice 2016-66 in toto. " (Doc. 87.) On November 1, 2021, consistent with the Court's scheduling order, the parties filed cross-motions for summary judgment. (Docs. 97, 99.)

On November 4, 2021, United States Magistrate Judge H. Bruce Guyton entered an order denying CIC's motion requesting discovery into the IRS's basis for Notice 2016-66 and denying CIC's motion to supplement and complete the administrative record. (Doc. 101.) CIC, after filing an amended verified complaint,³ objected to Magistrate Judge Guyton's order to the extent it denied the opportunity to conduct discovery in this case. (Doc. 105.)

The parties then filed response briefs in support of their cross-motions for summary judgment. (Docs. 112, 113.) On January 21, 2022, CIC filed a reply brief in support of its summary-judgment motion. (Doc. 114.) The IRS then moved to strike CIC's reply brief, or in the alternative, for leave to file a sur-reply. (Doc. 116.)

On March 3, 2022, the United States Court of Appeals issued its opinion in Mann Construction. v. United States , 27 F.4th 1138 (6th Cir. 2022). Because Mann Construction bears on many of the issues presented in this case, the Court entered an order inviting the parties to file supplemental briefing as to its effect on this case (Doc. 120), which the parties have now done (Docs. 121, 122). The parties’ cross-motions for summary judgment are ripe for the Court's review.

II. ANALYSIS

A. The Parties’ Cross-Motions for Summary Judgment

In cases challenging whether an administrative agency complied with the requirements of the APA, the normal summary-judgment standard set forth in Rule 56(a) of the Federal Rules of Civil Procedure does not apply. Coe v. McHugh , 968 F. Supp. 2d 237, 239 (D.D.C. 2013) ; Oak Ridge Env't Peace All. v. Perry , 412 F. Supp. 3d 786, 808 (E.D. Tenn. 2019). Rather, the Court's role is limited to reviewing the administrative record to determine if the agency complied with the requirements of the APA. Coe , 968 F. Supp. 2d at 239 ("Summary judgment thus serves as the mechanism...