A challenge to IRS Notice 2016-66 died last week. In CIC Services LLC et al. v. IRS et al.; No. 3:17-cv-00110, the Plaintiffs petitioned the Court for a declaratory judgement that Notice 2016-66 was invalid. On Friday November 3, Judge McDonough dismissed the Plaintiffs’ challenge by granting the Government’s motion to dismiss.
By way of background, Notice 2016-66 classifies many IRC § 831(b) captive insurance arrangements as “transactions of interest.” In general, the Notice requires captive insurance companies, their insureds, and owners of the insureds, to file Forms 8886 if the captive has made loans or other tax-free transfers of capital to a shareholder or if insured losses and claim expenses amount to less than 70 percent of premiums received by the captive over a 5-year period. Material advisors are also subject to their own disclosure requirements and must file Forms 8918.
On March 27, the Plaintiffs filed a petition seeking relief under the Declaratory Judgement Act (DJA). Shortly after, the Plaintiffs filed a motion requesting a preliminary injunction barring enforcement of the of the Notice’s disclosure requirements. In this motion, the Plaintiffs argued that the reporting requirements of Notice 2016-66 will cause them irreparable harm as “Material Advisors.” Furthermore, they asserted that the Notice is invalid because 1) it is a legislative type rule that failed to meet the Administrative Procedures Act notice-and-comment requirements, 2) it is arbitrary and capricious, and 3) it fails to meet the requirements of the Congressional Review of Agency Rule-Making Act because the IRS failed to submit the Notice to Congress and the Comptroller General. However, On April 21, the Court denied the Plaintiffs request for the preliminary injunction on the grounds that the “Plaintiffs were unlikely to succeed on the merits of their claims because such claims are likely barred by the Anti-Injunction Act (“AIA”).”
On May 30, the Government countered with their own motion to dismiss arguing that the Plaintiffs do not have “subject-matter jurisdiction due to the AIA and the tax exemption to the DJA.” Ultimately, the Court agreed.
In coming to its decision, the Court first looked to the AIA and DJA. Generally, all law suits seeking to restrain the Government’s ability to access and collect taxes are barred under the AIA. Although there are exceptions to this general rule, the Plaintiffs did not claim that they applied in this case. In addition to being barred by the AIA, suits challenging Federal taxes are also barred under the DJA. Normally, the DJA provides litigants an outlet to challenge a legal right when no other avenue for remedy exists. However, the DJA specifically exempts Federal taxes. Writing for the Court, Judge McDonough theorized that one possible reason for this exemption is a taxpayer’s ability to file a suit following the denial of a refund claim.
Next, the Court had to determine whether the disclosure requirements of Notice 2016-66 contained a tax. To do this, the Court looked at the Notice’s penalty requirements. Notice 2016-66 provides that parties failing to comply with the disclosure requirements of the Notice will be subject to penalties under IRC §§ 6707(a), 6707A, and 6708(a). After reviewing the statutes and several cases involving penalties under Chapter 68B of the IRC, the Court determined that the penalties under the Notice were to be considered taxes. The Court also stated that the reporting requirements of the Notice couldn’t be challenged in a vacuum. Therefore, a challenge to the reporting requirements of the Notice was also a challenge to the underlying penalty. Thus, the Plaintiffs were in fact seeking to restrain the Government’s ability to collect a tax.
Although taxpayers may not challenge Notice 2016-66 under the AIA and DJA, other challenges to the Notice may not be barred completely. In the present case the Plaintiffs complied with the Notice’s reporting requirements and sought relief under the DJA. However, the Court opined that had the Plaintiffs failed to comply with the Notice and pay the resulting penalties, they could have challenged the Notice through a claim for refund.
As a result, the requirements to comply with Notice 2016-66 and file Forms 8886 and 8918 remain intact. While the initial May 1st deadline has passed, it is important to remember that these disclosure requirements must be met on an annual basis, meaning Forms 8886 and 8918 must accompany your yearly tax returns if the captive remains active. Because the penalties for failing to file a complete and timely disclosure are so severe, it is important to consult with a competent tax advisor when completing this forms. Please contact Steven Miller, alliantgroup, LP’s National Director of Tax, at Steven.Miller@alliantgroup.com, should you have any questions about these forms or your specific disclosure requirements.