Obtaining Refund of Section 6707A and Section 6707 Penalties Paid for Failing to Properly Report Listed Transactions or Interest Transactions (including Notice 2007-83 and Notice 2016-66)

March 3, 2022, unanimously opinion written by its Chief Justice, the United States Court of Appeals for the Sixth Circuit struck down an IRS notice of registration on the grounds that the agency failed to comply with the Administrative Procedure Act (“APA ”) when the notice is published. In doing so, the court called into question the validity of the 36 current IRSs opinion identifying so-called “listed” operations, as well as the 6 opinion whereby the IRS identified “transactions of interest” to be reported to the agency.

In Mann Construction v. United States, the court was asked to consider whether the IRS could apply Notice 2007-83, which purported to require taxpayers to file Form 8886 (participants) or Form 8918 (significant advisers) to report certain transactions involving the use of employee benefit trusts to hold cash value life insurance policies. Although the IRS admitted that it did not follow the APA’s “notice and comment” requirements, it asserted that it was exempt from those requirements on the basis that (i) the notice in case was an interpretative rule as opposed to a statutory rule; and/or (ii) Congress had implicitly approved the IRS notification procedure as a valid replacement for APA procedures. The court agreed with the taxpayers on both counts, noting that “[i]f individuals ‘have to cut corners when dealing with the government’… ‘it is no exaggeration to expect the government to cut corners when dealing with them’.

Mann Construction’s opinion represents a significant setback for the IRS in its ongoing fight against collateral attacks on its enforcement procedures. In May of last year, the Supreme Court tenuous that the plaintiffs in CIC Services v. IRS should be allowed to advance their APA challenges against Notice 2016-66 (identifying “so-called” micro-captives as transactions of interest), notwithstanding federal anti-injunction law. On remand, in September 2021, the U.S. District Court for the Eastern District of Tennessee granted CIC Services’ request for an injunction against enforcement of the notice on the basis that the plaintiff was likely to prevail on the merits of his APA challenge. On March 21, 2022, as expected, the District Court granted CIC Service’s motion for summary judgment and struck down Opinion 2016-66, relying on the Sixth Circuit’s Mann Construction opinion. For good measure, the court also ruled that the IRS’ designation of micro-captive insurance companies as interest transactions was “arbitrary and capricious,” thereby invalidating Notice 2016-66 on a second ground.

In light of these events, taxpayers who paid penalties for failure to file Form 8886, or material advisors who paid penalties for failure to file Form 8918, report listed transactions, or report transactions interest should seriously consider filing a claim for reimbursement of these penalties, particularly if they reside in the Sixth Circuit. Under Section 6511(a) of the Internal Revenue Code, such claims can generally be filed within 2 years of the payment of the penalty payment, or 3 years from the time the corresponding tax return was filed. filed, whichever is later. Additionally, in light of the litigation trend, it makes sense to file a protective administrative refund claim with the IRS as soon as possible to protect against the statute of limitations on refund claims.