Discussion of Criminal Tax Issues in Oral Argument in CIC Services (12/5/20)

Earlier this week, the Supreme Court held oral argument in CIC Servs., LLC v. IRS, 925 F.3d 247 (6th Cir. 2019), reh., en banc, denied 936 F.3d 501 (2019), cert. granted 140 S. Ct. 2737 (2020), a case involving the interface of tax law and administrative law.  I discuss the oral argument on my Federal Tax Procedure Blog.  CIC Services Supreme Court Oral Argument (12/3/20), here, where I link the oral argument recording and transcript.  In the oral argument some of the discussion turned to willfulness and the difference between willfulness for tax crimes and for other types of crimes.  Readers of this blog will know that for most Title 26 tax crimes,  where an element of the crime is that the defendant act “willfully,” a very high level of intent  is required -- The intentional violation of a known legal duty.  See Cheek v. United States, 498 U.S. 192 (1991). 

I thought I would offer here certain excerpts of the discussions on willfulness and potential criminal liability.  First some key background.  CIC wanted to contest an IRS notice that imposed reporting obligations on captive insurance companies and their advisors.  Arguably, failure to comply with the reporting obligations could subject those captive insurance companies and advisors to significant civil penalties and potentially even criminal penalties.  CIC complained that, if the AIA (§ 7421(a)) precluded pre-enforcement review, then the only way to contest the administrative action in the Notice in question would be to not file the disclosures required by the notice and potentially be subject to those civil and criminal penalties.  The key potential criminal penalty is failure to file in § 7203 which has a requirement that the defendant act willfully in failing to file.  Willfully, as noted, would be met if the defendant knew the legal obligation and failed to meet it.  The problem, though, is that if the defendant knew of the Notice, in good faith did not think it was lawfully imposed, and failed to file on that belief, he could subject himself to the risk of civil and criminal penalties by awaiting the normal channel of tax litigation on the substantive merits in a tax refund suit.  That risk is unacceptable and should justify a pre-enforcement review, which for much administrative rulemaking is the norm.

Key to the discussion is that the penalty, as with many tax penalties, is defined as a tax, thus potentially invoking the AIA.

CIC’s argument is that imposing the obligation by Notice rather than notice and comment regulation is unlawful. 

So that sets up the problem articulated by several of the justices.  Should a taxpayer or advisor have to risk civil or criminal penalties for failure to comply with an administrative rule which they do not think was validly imposed?  This concern is expressed throughout the argument and seems to have some gravitas with several of the Justices.  I select only a portion of the discussion on the criminal willfulness issue.  The page numbers are to the transcript which is here:

[*4]

MR. NORRIS [CIC Counsel)

Third, CIC cannot raise its claims in a refund suit. There is no tax for CIC to pay here. The notice is not a tax, and CIC is a material advisor, not the  taxpayer. To file a refund suit, CIC would have [*5] to gin up a tax by violating the reporting  requirements, risking criminal and professional sanctions, and hoping the IRS agrees to assess it a penalty. The Anti-Injunction Act cannot require this, as this Court held in South Carolina versus Regan.

* * * * 

[*21]

And I think, while South Carolina [in South Carolina v. Regan, 465 U.S. 367 (1984)] truly had no refund suit available, we are in the same situation in the sense that the only way we can get a refund is by committing a crime, risking imprisonment and massive fines, and violating our professional obligations as attorneys and accountants.

[*29]

JUSTICE BARRETT: Would it be cleaner for us to go the Regan [South Carolina v. Regan] route but maybe, you know, phrase it this way, that this is covered by the AIA; however,  because you would have to incur criminal penalties in -- in -- in order to sue, that you have no adequate alternative remedy, so even though the AIA applies, it doesn't bar your suit? Would you be satisfied [*30] with that approach?

 MR. NORRIS: We would, Justice Barrett. We just want to go litigate our APA claims, and that -- that resolution would be  fine with us.

 JUSTICE BARRETT: Thank you. 

* * * *

MR. NORRIS

According to the government, however, [*31] what CIC should have done is deliberately  violate the tax code. The government's path would require CIC's members to commit a crime,  violate their ethical obligations, and convince the IRS to assess it tax penalties. No  law-abiding company or individual would ever do this.

* * * *

MR. BOND [SG ASSISTANT]

[*32]

Petitioner leans heavily on a third provision, Section 7203, which makes certain willful violations a misdemeanor and which it says requires committing  a crime to obtain judicial review. But Petitioner misreads that provision, which does not criminalize the very avenue of review this Court commended  93 years ago in Sullivan and has reaffirmed since, of filing a timely return that asserts a good faith [*33] objection to reporting certain information in  order to obtain review.

 Petitioner can do that by incurring the penalty, paying it, and suing for a refund. But even if 7203's application were ambiguous, the way to harmonize all three provisions is to  hold that Congress meant what it said  unambiguously in 6671 and the AIA, that these  penalties are treated as taxes that must be litigated in refund suits, and resolve any lingering dispute about "willfully" to preserve Congress's choice.

* * * * 

[*45]

JUSTICE ALITO: The code says that willfully failing to comply with the reporting requirement is a crime. So I really don't see how they can get review without committing a crime.

MR. BOND: And I think the answer is in this Court's decisions in Sullivan and subsequently in Garner, where the Court said in -- in both the precursor of 7203 and 7203, that it is not a willful violation to file a return or to subject yourself to examination and assert your good-faith objection to providing the information.

JUSTICE ALITO: Well, why is it not a willful violation? Under Cheek, it's certainly willful. They say, look, I understand that [*46] under this guidance and under IRS regulations I'm required to do this, but I sincerely believe that it's unlawful.

Isn't that exactly the situation in Cheek, where somebody says I'm not going to file  a tax return, although I know that the Internal  Revenue Code requires me to file a tax return,  but I sincerely believe that the Internal Revenue Code and the Internal Revenue Service are unconstitutional. I don't see the difference.

MR. BOND: Well, I'd say a couple of things. First, Cheek -- Cheek in Footnote 10 expressly distinguished the kind of procedure that we're describing from Sullivan and later cases. It cites a case called Murdock that is to the same effect.

The second, to the line you're drawing between -- you're suggesting between saying the action is unlawful versus I don't believe I'm actually required to do it, I don't think that line works in Petitioner's favor here. 

Petitioner's argument at bottom is that it is not required to provide this information because the statute only requires it  [*47] to submit information covered by regulations.

 And, here, the IRS has not issued a  valid regulation. I think Petitioner's argument falls on the first side of that line.

 Now I understand the concern that the  divide --

JUSTICE ALITO: I don't understand -- I don't understand that at all. They say that -- that I am not required to do this because the guidance is unlawful, right? 

MR. BOND: They say that the guidance is not a regulation and only regulations can require them to supply information. That is their --

JUSTICE ALITO: Yeah, and that's – is there a difference between what you just said and saying that the guidance is unlawful? 

MR. BOND: I think it's a fine distinction that was the focus of the debate between the majority and the concurrence in Cheek.

And to the extent you think there's some uncertainty, I think the way to resolve it is to say: Look, we know what Congress intended to happen to these penalties because it said in [*48] 6671 they are taxes and that means they're subject to the AIA.

So I think you would resolve any tension by saying, whatever "willfully" means in some other context, in this context, it does not  criminalize the avenue of review that Congress clearly made the avenue for this particular kind  of penalty.

 And I think the other --

JUSTICE ALITO: So this is a rule of willfulness that applies only to -- only under the Internal Revenue Code?

MR. BOND: Well, I think that's what Cheek recognizes, that "willfulness," as the Court has said in other contexts, depends --takes its meaning from context.

And the Court in the majority in Cheek was clear that the meaning of "willfulness" is particular in the tax context. It has a heightened meaning. And  although Cheek doesn't flesh out exactly what that means in the context of the procedure that we've identified that Sullivan and Garner approved, means I don't think Cheek disturbed that.

So I don't think that it's remarkable [*49] to say that the meaning of "willfulness" is  different in this context. It has been different for decades under this Court's  decisions. And we're simply applying that consistent with what this Court has said is the appropriate avenue for a taxpayer to raise its  challenges to requirements it believes are  invalid.

 And I think it's not any – any different from any taxpayer who believes that a particular tax, a substantive tax, is invalid if --

JUSTICE ALITO: All right. I – I understand the position of the United States.  Thank you.

*

[*54]

JUSTICE KAGAN: I -- I guess what I'm asking is, isn't the tax penalty here completely derivative and what they're really seeking is what they're objecting to, what they have problems with, is the demand that they disclose information?

And remember that that demand is [*54] backed up not only by the tax penalty but also by a provision that allows criminal penalties, you know, put you in jail, fine you. So why -- why shouldn't we understand that that's an independent regulatory requirement, independent of the tax that they're objecting to, so it's not for the purpose of stopping a tax?

[*60]

JUSTICE KAVANAUGH

* * * *

The criminal point, Justice Alito's point, you just said the Court could flat-out say that it's not a willful violation when you're challenging the reporting requirement [*61] being unlawful. So that -- we could -- we could say that.

* * * *

[*68]

MR. NORRIS

The government's only response to all of this is that it would not be a crime for us to take the route that it offers. But criminality only really goes to our  due process argument. Our South Carolina versus Regan argument just requires that the governor – the government's avenue be illegal. And violating the statutory reporting requirements would certainly be illegal. My friend never said otherwise in his argument. 

He did cite a case, Sullivan, about the Fifth Amendment privilege, but that case actually confirms that it is, in fact, unlawful not to file your reports.

[*69] 

And Cheek in Footnote 10 distinguishes  Fifth Amendment privilege cases and says those  are fundamentally different.

Now as to -- this -- the government invites this Court to say that it would not be willful for us to take this path, but it has not asked this Court to overrule Cheek, and that's what the Court would have to do to reach that  outcome.

Cheek draws a clear distinction between taxpayers who do not understand whether the tax code applies to them and taxpayers who know that -- know that it applies to them but believe a provision is invalid. 

That latter camp, which is clearly where we fall, is a willful violation and would subject us to criminal risks.

And I would just close by saying this Court frequently hears arguments from the government that -- don't worry, we won't apply a criminal statute according to its text, but those types of arguments rarely succeed. They've been rejected in cases like Marinello, Stevens, and others. And this version of that argument from the government is [*70] particularly unsatisfying because it took the government until the Supreme Court to make it. It never said that it wouldn't be a crime  anywhere below.

And the government's argument now directly contradicts Sections 40.05 and 10.05 of the Criminal Tax Manual, which adopts our reading of Cheek and is what live prosecutors  would actually use to make charging decisions.  

JAT Comments:

1.  The discussions of the Cheek requirements are not as crisp as I think they should have been.

2.  Perhaps the best Supreme Court discussion of the differing standards for willfulness in criminal cases is in Bryan v. United States, 524 U.S. 184, 194 (1998), GS here.

3.  I am not sure that Cheek supports the proposition that a person who knows of the obligation to report can just not report without the risk of criminal prosecution simply because he thinks the obligation is illegal and is willing to contest the matter in civil litigation consistent with the AIA (here, particularly a refund suit).

4.  Justice Barrett's South Carolina v. Regan solution seems to me to be a good solution.  I will have to think about that a bit more.