Mann Constr. v. United States

651 F.Supp.3d 871

MANN CONSTRUCTION, INC. et al., Plaintiffs, v. UNITED STATES of America, Defendant.

Case No. 1:20-cv-11307

United States District Court, E.D. Michigan, Northern Division

Signed January 18, 2023

Robert Emmett Goff, Samuel J. Lauricia, III, Walter Lucas, Matthew C. Miller, Weston Hurd LLP, Cleveland, OH, for Plaintiffs.

Arie M. Rubenstein, Noah Daniel Glover-Ettrich, United States Department of Justice, Washington, DC, Stephanie Chernoff, DOJ-Tax, Washington, DC, for Defendant.

OPINION AND ORDER GRANTING PLAINTIFFS' MOTION TO ENFORCE MANDATE OF COURT OF APPEALS AND SETTING ASIDE IRS NOTICE 2007-83

THOMAS L. LUDINGTON, United States District Judge

In 2019, the Internal Revenue Service imposed penalties on Plaintiffs for failing to disclose their participation in an employee-benefit trust in violation of an agency regulation. Plaintiffs sued the Federal Government to recover the penalties they paid, alleging that the IRS did not comply with the required notice-and-comment procedures of the Administrative Procedure Act.

On appeal, the Sixth Circuit Court of Appeals held that Congress had not expressly excepted the IRS from the notice-and-comment procedures of the APA for promulgating legislative rules. Accordingly, the Sixth Circuit concluded that the Notice must be set aside.

The sole question presented is whether, in light of the Sixth Circuit's decision, the relevant IRS notice must be set aside under § 705 of the APA.

I.

The Sixth Circuit Court of Appeals aptly summarized the facts of this case as follows:

In collecting federal taxes, the Internal Revenue Service uses a "system of self-reporting." United States v. Bisceglia, 420 U.S. 141, 145, 95 S.Ct. 915, 43 L.Ed.2d 88 (1975). Much as there may not be "a patriotic duty to increase one's taxes" under that system, Helvering v. Gregory, 69 F.2d 809, 810 (2d Cir. 1934), there is a duty to report all of the financial information that Congress requires.

Congress delegated power to the Secretary of the Treasury, who, through the IRS, requires taxpayers to submit information needed to assess and collect taxes. See 26 U.S.C. § 6011; see also id. § 7701(a)(11)(B). This information-gathering imperative allows the government to ensure compliance with tax provisions and ferret out improper tax avoidance.

In 2004, Congress added 26 U.S.C. § 6707A to the IRS's arsenal of tools for identifying tax avoidance schemes. Designed to shed light on potentially illegal tax shelters, § 6707A permits the IRS to penalize the failure to provide information concerning "reportable" and "listed" transactions.

A "reportable transaction" is one that has the "potential for [illegal] tax avoidance or evasion." Id. § 6707A(c)(1). A "listed transaction" is one that "is the same as, or substantially similar to, a transaction" that the IRS has identified as a "tax avoidance transaction." Id. § 6707A(c)(2). The statute authorizes monetary penalties and criminal sanctions for noncompliance with these reporting requirements. Id. §§ 6707A(b), 7203.

Today's dispute centers on a listed transaction. In 2007, the IRS issued Notice 2007-83, entitled "Abusive Trust Arrangements Utilizing Cash Value Life Insurance Policies Purportedly to Provide Welfare Benefits." 2007-2 C.B. 960. The Notice designates certain employee-benefit plans featuring cash-value life insurance policies as listed transactions. A cash-value life insurance policy combines life insurance coverage with a cash-value investment account. As the IRS saw it, these transactions run the risk of allowing small business owners to receive cash and other property from the business "on a tax-favored basis." Id.

Brook Wood and Lee Coughlin collectively own Mann Construction, which is based in Michigan. The company provides general contracting, construction management, and similar services.

From 2013 to 2017, Mann Construction established an employee-benefit trust that paid the premiums on a cash-value life insurance policy benefitting Wood and Coughlin. The company deducted these expenses, while Wood and Coughlin reported as income part of the insurance policy's value. Neither the individuals nor the company reported this arrangement to the IRS as a listed transaction.

In 2019, the IRS concluded that this structure fit the description identified in Notice 2007-83. The agency imposed penalties on the company ($10,000) and both of its shareholders ($8,642 and $7,794) for failing to disclose their participation in the trust. All three paid the penalties for the 2013 tax year and sought administrative refunds, claiming the IRS lacked authority to penalize them. When the administrative process for challenging the penalties left the tax-payers empty-handed, they turned to federal court.

There, in 2020, the taxpayers sued the federal government to recover the penalties. See 28 U.S.C. § 1346(a)(1); 26 U.S.C. § 7422(a). They challenged the validity of the Notice and penalties on four grounds: (1) the Notice failed to comply with the notice-and-comment requirements of the Administrative Procedure Act; (2) it constituted unauthorized agency action; (3) it was arbitrary and capricious; and (4) even if the Notice was valid, the arrangement at issue did not fall within its scope.

Mann Constr. v. United States, 27 F.4th 1138, 1141-42 (6th Cir. 2022).

In May 2021, this Court granted Defendant's motion for summary judgment, holding that Congress authorized the IRS to promulgate the regulation without notice and comment. Id. This Court determined that "the text, structure, and history of § 6707A and related Treasury regulations express[ed Congress's] clear intent that the APA notice and comment procedures need not be followed," Mann Constr. v. United States, 539 F. Supp. 3d 745, 760 (E.D. Mich. 2021) (noting that Congress passed § 6707A after "IRS officials came and sat before Congress and asked for penalties to enforce their new reporting regime").

Plaintiffs appealed, and the Sixth Circuit reversed this Court's order. Mann Constr. v. United States, 27 F.4th 1138, 1144-48 (6th Cir. 2022) (holding that IRS Notice 2007-83 must be set aside because the IRS promulgated it without the requisite notice and comment). The Sixth Circuit reasoned that, because § 6707A "addresses a 'which transactions' question, not a 'what process' question," it did not expressly exclude IRS Notice 2007-83 from the APA's notice-and-comment requirements. Id. at 1146-47.

Three months after the remand, Plaintiffs filed a motion to enforce the Sixth Circuit's mandate, seeking an order that (1) vacates and sets aside IRS Notice 2007-83; (2) requires Defendants refund each Plaintiff, with interest, the penalties they paid; and (3) requires Defendant to rescind the penalties imposed on Plaintiffs in later years. ECF No. 53 at PageID.757-58.

In October 2022, Defendant filed a notice that "all penalties and interest at issue in this action have been refunded or abated, as applicable," ECF No. 67 at PageID.873, which Plaintiff corroborated at a November 8, 2022 status conference, ECF No. 68.

Thus, Plaintiffs' only remaining request not expressly addressed by the Sixth Circuit is whether to vacate and to set aside IRS Notice 2007-83.

II.

"The APA establishes the procedures federal administrative agencies use for 'rule making,' defined as the process of 'formulating, amending, or repealing a rule.' " Perez v. Mortg. Bankers Ass'n, 575 U.S. 92, 95, 135 S.Ct. 1199, 191 L.Ed.2d 186 (2015) (citing 5 U.S.C. § 551(5)). Under the APA, "[a] person suffering legal wrong because of agency action, or adversely affected or aggrieved by agency action within the meaning of a relevant statute, is entitled to judicial review thereof." 5 U.S.C. § 702.

The APA requires federal courts to set aside unlawful agency action. Id. § 706(2)(D) ("The reviewing court shall . . . hold unlawful and set aside agency action, findings, and conclusions found to be . . . without observance of procedure required by law . . . ."). The Sixth Circuit expressly acknowledged this obligation when it stated that "[b]ecause the IRS's process for issuing Notice 2007-83 did not satisfy the notice-and-comment procedures for promulgating legislative rules under the APA, we must set it aside." Mann Construction v. United States, 27 F.4th 1138, 1143 (6th Cir. 2022) (emphasis added).

Unlike most cases that come before a district court, "in which courts determine whether the application of a law to the named plaintiffs is lawful, the APA tasks courts with determining whether the rule itself is lawful." Texas v. United States, No. 6:21-CV-00016, 606 F.Supp.3d 437, 500 (S.D. Tex. June 10, 2022), cert. granted before j., — U.S. —, 143 S. Ct. 51, 213 L.Ed.2d 1138 (2022). So the "setting aside" or vacatur of an unlawful agency action is not limited to the named plaintiffs. Nat'l Min. Ass'n v. U.S. Army Corps of Eng'rs, 145 F.3d 1399, 1409 (D.C. Cir. 1998) (citing Harmon v. Thornburgh, 878 F.2d 484, 495 n.21 (D.C. Cir. 1989)); see also Mila Sohoni, The Power to Vacate a Rule, 88 GEO. WASH. L. REV. 1121, 1173 (2020) ("The term 'set aside' means invalidation—and an invalid rule may not be applied to anyone.").

In sum, if an agency action violates the APA, "then the court should invalidate the challenged action." Matthew N. Preston II, The Tweet Test: Attributing Presidential Intent to Agency Action, 10 BELMONT L. REV. 1, 7 (2022).

III.

Plaintiffs seek an order vacating and setting aside IRS Notice 2007-83 under 5 U.S.C. § 706(2).

Defendants advance three arguments in contest: (1) because the Sixth Circuit reversed this Court's judgment denying the refund, Plaintiffs are entitled to only that relief; (2) the law-of-the-case doctrine prohibits Plaintiffs from "resuscitating" their "forfeited claim for declaratory relief;" and (3) Plaintiffs cannot seek "nationwide relief" when the cash refund remedies their injury. See generally ECF No. 59.

But the APA's text belies Defendant's arguments. The APA requires reviewing courts to "set aside" or to vacate any unlawful...