The IRS Building in D.C.
I have previously written about the efforts of captive manager CIC Services, LLC, to set aside IRS Notice 2016-66 on the grounds that the Administrative Procedures Act (“APA”) was not fully complied with at the time of the issuance of the Notice. The case was initially dismissed, then reinstated by the U.S. Supreme Court, and finally on March 21, 2022, the U.S. District Court for the Eastern District of Tennessee finally resolved the case on the merits
In a nutshell, the court held that the IRS flubbed its compliance with the APA in issuing Notice 2016-66, which designated so-called “microcaptive transactions”, i.e., certain risk-pooled 831(b) captives, to be “transactions of interest”. The relief afforded by the court, however, was mixed: Notice 2016-66 was vacated, and the court ordered the IRS to return to taxpayers whatever documents they had sent to the IRS in complying with the Notice. However, the court denied CIC’s request for what amounted to a blanket injunction against the IRS using whatever documents it had received in litigation. Both sides will now likely appeal to the U.S. Court of Appeals.
This case was always a strange fish in that Notice 2016-66 was simply that, a notice, which did not change the substantive law relating to the IRS’s challenges to microcaptive transactions. None of the U.S. Tax Court opinions in the cases of Avrahami, Reserve Mechanical, Syzygy, or Caylor Land, were predicated upon Notice 2016-66 and so getting rid of Notice 2016-66 will not operate to reverse those decisions. Rather, those decisions were based upon a substantial body of tax law that pre-dated Notice 2016-66, and in fact Notice 2016-66 was premised at least in part on that existing law. Also, it must be remembered that Notice 2016-66 was not vacated because it was wrong, but rather that the IRS was sloppy in promulgating the Notice.
Where vacating Notice 2016-66 might make a difference — and quite possibly the reason that CIC Services is pushing this case so hard — is that in the absence of Notice 2016-66 the IRS might have a more difficult time assessing promoter penalties against captive managers. This isn’t going to help the numerous captive owners who have since wound up their captive and entered into deals with the IRS whereby they basically lost all the tax benefits of their captive, and it might or might not help other captive owners still in audit or docketed in the U.S. Tax Court. We’ll have to wait and see.
What we do know is that there is a large mass of egg splattered on the face of the IRS General Counsel’s office, which — even if the IRS obtains a reversal of this ruling — has made the General Counsel’s office appear to be some degree of incompetent. Heads, or least a head, should roll from this fiasco.
In the past, the IRS has simply designated abusive transactions as “listed transaction”, which basically means a presumed tax shelter. The IRS had great success doing this in the early 2000s against the numerous tax shelters then promoted by the major U.S. accounting firms and their complicit tax law firms. A few years later, the IRS had great success in doing this with so-called 412(i) and 419 plans. Folks knew what “listed transaction” meant, and it caused the marketing and sale of those plans to crash to an immediate halt.
The IRS General Counsel’s office played too cute, however, when it decided to designate microcaptive transactions as a “transaction of interest” — a term whose meaning is even now hotly debated within the U.S. tax bar. A fair contextual reading of this term goes something like that the IRS rather suspects that a transaction is not kosher, but doesn’t really know for certain. This characterization actually says a lot more about the IRS than it does about the transaction itself, but back in December of 2016, when Notice 2016-66 first appeared, many tax practitioners figured that the IRS would use it to conduct a bunch of audits and then come out with some real guidance that delineated exactly what was inappropriate and make that a full listed transaction. Of course, that’s not what has happened, at least until now.
Instead, it seems that the IRS preferred to leave its guidance in a muddle, not telling taxpayer exactly what it did or not like when it came to 831(b) captive insurance companies, as that gave it the greatest flexibility in challenging all the variations of such structures and related transactions. While that may sound good in the abstract, that is in fact what the IRS cannot do — a function of the IRS is to clarify tax law and now leave folks guessing about what does or does not pass muster. Thus, the U.S. Tax Court was basically called in to do the IRS’s work for it, and while the U.S. Tax Court in fact did accomplish that through its decisions, this left the IRS’s own guidance in the aforementioned muddle. Of course, even that muddled guidance no longer exists as we sit here today because Notice 2016-66 has been vacated.
The point being that the IRS needs to quit futzing around with this “transaction of interest” junk, get its act together, and finally come out with a new Notice that designates certain varietals of microcaptive transactions as full listed transactions. I would suggest that the IRS should similarly do this with conservation easements, where the IRS’s guidance has also been a mess and has arguably hurt the IRS’s position and caused the IRS to take it on the chin in what should have been slam-dunk cases. Which is all to say that “transaction of interest” notices should be confined to the dustbin of history.
Likewise, it is boggling that the IRS essentially mailed in their effort at complying with the APA in promulgating Notice 2016-66. Complying with the APA is not rocket science, as numerous other agencies quite competently and successfully comply with the APA every day. It was a relatively simple matter for the IRS to comply with the notice-and-comment requirements that, by its own tacit admission, it just completely blew off. Again, the IRS played it too cute and argued that the APA didn’t apply at all, and then got egg all over its face with the U.S. District Court didn’t agree. Perhaps the IRS will still pull this rabbit out of the hat before the U.S. Court of Appeals, but whatever the outcome there the IRS should go forward with a full listed transaction and do it right from the beginning. The opinion from the U.S. District Court is basically telling the IRS that it what it should do, and the IRS should heed the court’s advice.
CIC Services, LLC v. IRS, E.D.Tn. Case No. 17-CV-110, Memorandum Opinion dated March 22, 2022, Doc# 123. https://captiveinsurancecompanies.com/cases/cicryan/CIC_Order_220321.pdf