The US Supreme Court ruling in the CIC Services case against the Internal Revenue Service (IRS) has been described by Ryan Work, vice president, government relations at Self-Insurance Institute of America (SIIA), as “an important victory” for the captive insurance industry.
On 17 May, the US Supreme Court ruled in favour of the CIC Services in their case against the Internal Revenue Service (IRS) over Notice 2016-66, in an unanimous decision.
The court ruled that the Anti-Injunction Act does not prevent Federal Courts from enjoining the IRS's enforcement of illegal regulations when the regulation imposes affirmative reporting obligations that inflict costs on taxpayers separate and apart from any tax or tax penalty.
In addition, when any potential tax that may someday be assessed is many steps downstream from the present lawsuit, and when non-compliance with the illegal regulation is also backed by the threat of criminal penalties.
Commenting on the win for the captive industry, Ben Whitehouse, senior counsel at Butler Snow, says: “It is only fair that the IRS uses the enforcement tools at their disposal fairly and not as a weapon to indiscriminately punish whole classes of taxpayers by driving up their compliance costs.”
Whitehouse suggests it’s “rather remarkable” that the court’s unanimous opinion called out the IRS for writing Notice 2016-66 in a way that maximised the punitive effects while trying to shield it from any sort of meaningful judicial review.
Also weighing in, Jesse Olsen, director at Strategic Risk Solutions (SRS), says the court’s unanimous decision “is telling and, frankly, not surprising following the oral arguments”.
In December 2020, the counsel of the IRS faced tough questions at the oral arguments in front of the Supreme Court Justices.
In the oral arguments, Justice Samuel Alito asked Jonathan Bond, representative of the IRS: “The code says that willfully failing to comply with the reporting requirement is a crime. So I don't see how they [CIC Services] can get a review without committing a crime.”
Tom Adams, president and CEO of the North Carolina Captive Insurance Association, says: “We believed as the case went from District Court, to Circuit Court and finally to the Supreme Court that the IRS was wrong and the case deserved to be determined by the courts.”
“Justice Kagan’s well written decision on behalf of the court did an excellent job of working through the issues in the case. The time and expense in the development of Amicus briefs at each level were well spent,” Adams adds.
The IRS has targeted micro captives for many years, but in more recent times they have ramped up their efforts to do so, including them on its ‘Dirty Dozen’ list of tax scams since 2014, along with other actions.
In 2016, the Department of Treasury and IRS issued Notice 2016-66, which formally labelled micro captives as ‘transactions of interest’. The IRS advised that these transactions have the potential for tax avoidance or evasion.
Under section 831(b) of the US tax code, captive insurers that qualify as small insurance companies can elect to exclude limited amounts of annual net premiums from income, so that the captive pays tax only on its investment income.
SIIA’s Work states that “captive insurers, and in fact many other business sectors, have long expressed concern over IRS tactics in issuing costly and complex regulatory reporting requirements, such as Notice 2016-66, without public comment”.
He highlights: “This has led to a dangerous precedent at the IRS that knowingly seeks to impose onerous and costly regulatory burdens on an industry, in addition to being contrary to baseline government transparency.”
Work believes that while the court was careful in explaining its tailored opinion regarding the Anti-Injunction Act, what was clear in its unanimous opinion is that the IRS has overstepped its boundaries.
He comments: “At no point in time should a captive manager or advisor have to knowingly violate a law or Notice, under criminal and monetary penalty, in order to object to an IRS reporting requirement.”
“Simply stated, the IRS’ ongoing stance of guilty until proven innocent remains faulty. It also demonstrates the IRS’ lack of willingness to impartially engage with industry participants which, should it undertake, may assist in efforts to better understand appropriate captive structures,” he adds.
The Supreme Court has now remanded the case back to the District Court for a determination on whether or not Notice 2016-66 should be formally enjoined.
Olsen says: “Now that the case has been remanded back to the District Court, we look forward to the judicial proceedings wrapping up in due course.”
“Assuming CIC prevails in District Court, lifting the onerous requirements demanded of material advisors by Notice 2016-66 will remove an unnecessary burden on captive managers, a welcome development for the industry,” Olsen explains.
Work outlines that while SIIA looks forward to continuing its support of this case as it is remanded to the lower court, the IRS will no doubt continue to look into certain captive transactions.
“As it does so, SIIA’s industry advocacy and education will continue, as should efforts within the industry itself to proactively move forward through the strengthening of practices and growth of capabilities,” he concludes.
