On November 1, 2016, the IRS issued Notice 2016-66 imposing new reporting requirements on micro-captives and their material advisors (see prior post describing the Notice). On March 27, 2017, CIC Services, LLC and Ryan, LLC filed a complaint against the IRS seeking a preliminary injunction prohibiting the IRS from enforcing the disclosure requirements in the Notice. They argued that as material advisors subject to the Notice’s disclosure requirements, complying with the Notice’s disclosure requirements will force them to incur significant costs. In addition, they argued that the Notice constitutes a legislative-type rule that fails to comply with the mandatory notice-and-comment requirements under the Administrative Procedures Act. CIC Services had previously filed a lawsuit on December 28, 2016 against the IRS seeking an injunction but voluntarily withdrew the suit hoping that lobbying efforts undertaken on behalf of the captive insurance industry would result in the IRS eliminating or modifying the reporting requirements.
In denying the injunction, the US District Court for the Eastern District of Tennessee found that the Tax Anti-Injunction Act (AIA) prohibits injunctive relief restraining the assessment or collection of any tax and that the penalties assessed for noncompliance with the Notice are taxes within the AIA’s injunctive relief prohibition. However, the Court notes that the AIA does not prevent the plaintiffs from obtaining judicial review of the Notice, but only after they fail to report, pay the penalties and sue for a refund.
The Court conceded that the plaintiffs demonstrated that they are likely to suffer at least some irreparable harm in the absence of an injunction. The plaintiffs estimate that they and similarly situated captive insurance companies will expend at least $60,000 per year to comply with the Notice’s requirements. However, in weighing the public’s interest for the disclosures, the Court found that the public interest would not be served by issuing the injunction because Congress gave the IRS authority to designate certain transactions as “reportable transactions” as a way to identify transactions that have the potential for tax avoidance or evasion. During hearings on the motion, the principal and founder of CIC testified that captive insurance agreements can “most definitely” be used for tax avoidance or evasion purposes. As a result, the Court concluded that the public interest in identifying transactions potentially aimed at tax avoidance or evasion outweigh any incidental effect on entities forced to comply with the IRS’s reporting requirements.