On March 21, 2022, the US District Court for the Eastern District of Tennessee ruled in favor of CIC Services, LLC (“CIC”) in their case against the IRS regarding Notice 2016-66 (the “Notice”). In CIC Services, LLC v. IRS (“CIC Services”), the ruling stated that IRS did not comply with the mandatory notice-and-comment requirements under the Administrative Procedures Act (“APA”) and the IRS’ issuance of the Notice was arbitrary and capricious as set forth under the APA. Relying on the Sixth Circuit’s opinion in Mann Construction v. US, the District Court ruled that Notice 2016-66 be vacated in its entirety and the IRS is ordered to return all documents and information collected under the Notice to taxpayers and material advisors.
Background of the Ruling
For additional background, in 2016 the IRS issued Notice 2016-66, which identified certain captive insurance transactions as “transactions of interest” and required certain persons involved in the transaction to disclose it to the IRS on Form 8886 to avoid penalties. In 2017, CIC initiated a complaint against the IRS in the US District Court for the Eastern District of Tennessee, seeking preliminary injunction against the IRS regarding Notice 2016-66 based on the IRS’s failure to comply with the APA’s mandatory notice-and-comment requirements. The District Court dismissed the case based on lack of subject-matter jurisdiction, noting the claims were prohibited by the Anti-Injunction Act (“AIA”).
CIC then appealed the District Court decision with the US Court of Appeals for the Sixth Circuit and the Court of Appeals affirmed the District Court, dismissing the case for lack of subject-matter jurisdiction, noting the claims were in violation of the AIA. In 2020, the Supreme Court of the United States agreed to hear the CIC Services case against the IRS and in 2021, the Supreme Court unanimously held that the AIA does not prohibit a pre-enforcement challenge of IRS rules which may result in a penalty and remanded the case back to the District Court.
In 2021, the District Court granted CIC a preliminary injunction, enjoining the IRS from enforcing the Notice against CIC while the case was being litigated. CIC filed a motion for reconsideration arguing the preliminary injunction was too narrow and it should “enjoin the enforcement of Notice 2016-66 in toto”. The District Court granted CIC’s motion for summary judgement, vacating the Notice in its entirety and ordered the IRS to return all documents and information collected under the notice.
The CIC Services decision is certainly a welcome win for the captive participant taxpayers, captive managers, material advisors and practitioners. Of importance, the District Court did not prohibit the IRS from using any information gathered in response to Notice 2016-66 in judicial and administrative proceedings.
In light of the IRS’s historical, continued focus and scrutiny of micro-captives, taxpayers and practitioners are encouraged to consult their tax advisor regarding how to apply the CIC Services decision to their respective facts.