David Stewart 0:02

Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: Taxes at the High Court. Every summer the United States Supreme Court releases a flurry of opinions before adjourning in June. Though, unfortunately, they can't all be tax-related, this year the court took on two important tax cases: CIC Services and Americans for Prosperity Foundation. The court has released its opinion in CIC services, but we're still waiting on the decision in the latter . So what do these cases entail and how will they affect the tax world? Well, later on we'll talk to Tax Notes contributing editor Kristen Parillo about CIC Services and the Supreme Court's decision. But first we'll start with the one that's outcome is still uncertain. Joining me now to talk about the Americans for Prosperity Foundation case is Tax Notes legal reporter Jennifer McLoughlin. Jennifer, welcome back to the podcast.

Jennifer McLoughlin 1:56

Thank you . It's good to be back.

David Stewart 1:57

All right. Well, let's start with the basics. What is this case all about?

Jennifer McLoughlin 2:00

So at the heart of this case is the constitutionality of the California attorney general's requirement that charitable organizations soliciting within the state must submit a copy of their Schedule B attached to their IRS Form 990. And that schedule contains the names, addresses, and contributions of major donors. So according to California, this requirement assists with the state's regulatory and law enforcement efforts, and more specifically it assists in the state's efforts to police charitable fraud. So throughout this case, California has continually stressed that the Schedule Bs are submitted confidentially and they are safeguarded from disclosure to the public. Although the state has acknowledged that there have been past lapses in terms of public disclosure, but they have said they have taken efforts to rectify such lapses and prevent future lapses. However, California's disclosure requirement does not have a shortage of critics, including the two organizations whose cases were heard by the Supreme Court late last month. Those two organizations — the Americans for Prosperity Foundation, which we know for its affiliation with the Koch brothers, and the Thomas More Law Center. Those organizations have claimed that California's disclosure requirement violates the First Amendment freedoms of association and speech, and they claim it will subject their donors to threats and harassment. The organizations have argued that California has alternative means to advance its interest in regulating charitable entities. And they have stressed concerns that California is not protected the confidentiality of Schedule Bs and information has leaked in the past, which feeds into their concerns about public retaliation against their donors. The history of these cases goes back quite a bit. And the current appeals before the U.S. Supreme Court came from a decision issued by Ninth Circuit panel, which upheld California's disclosure requirement against the organization's facial and as applied constitutional challenges. So that's where we are at this time.

David Stewart 4:02

All right . So you mentioned that there's two different organizations that are involved in this — Americans for Prosperity Foundation and the Thomas More Law Center —s o this is a joint case. Are there any major differences between the two organizations' cases?

Jennifer McLoughlin 4:15

So both appeals the U.S. Supreme Court and were brought by the two organizations arose from the same Ninth Circuit decision, but the two organizations have presented distinct questions to the U.S. Supreme Court, and they have offered some varying arguments. For example, both have taken issue with the standard of scrutiny that the Ninth Circuit applied in the underlying decision. But they each have advanced separate arguments regarding what the appropriate standard of scrutiny should be, with the Americans for Prosperity Foundation advocating for exacting scrutiny with a narrowly tailored element, and the Thomas More Law Center advocating for strict scrutiny. While each organization has challenged the constitutionality of California's disclosure requirement, they've offered what they have called "different approaches" for resolving the questions presented in the two cases. Likewise the as applied challenges are distinct as they relate to facts that are unique to each organization, such as the threats and harassment that each organization has alleged its donors have been subjected to in the past and could face in the future. In fact, there was a joint motion filed by the organizations in which they asked the U.S. Supreme Court for what is called divided argument with each organization seeking 15 minutes of the petitioner's total allotted argument time to present their individual perspectives and arguments. However, the Supreme Court ultimately denied the motion and only one of the petitioner's attorneys argued during the argument last month. So they are similar, but they're different.

David Stewart 5:57

Well, you mentioned oral arguments and those happened in late April. What did we learn from them?

Jennifer McLoughlin 6:02

I think broadly the oral arguments just demonstrated how many underlying issues are under consideration in this case. There are a lot of moving pieces. To just name a few, the justices' lines of questioning touched on multitude of issues, including the proper standard of scrutiny, California's rationale for requiring submission of the Schedule Bs and its ability to protect the confidentiality of the information and schedule base, and whether the case should be decided on a facial challenge or as applied challenge. So those are just a few issues. Something that stood out for me and what I found interesting was Justice Thomas's observations and questions that highlighted what is an increasingly divisive environment in our country. He raised questions regarding whether the analysis might change — the legal analysis in the case might change — depending on whether an organization is considered controversial or non-controversial . And during the petitioner's argument, the attorney noted that what is considered controversial now might not have been considered controversial just a few years back. Thomas also touched on the notion that organizations might be subject to public accusations, even what he called loose accusations of being perhaps a racist group, or homophobic group, or a white supremacist group. And he asked California's attorney hypothetically about a donor who may want to contribute to such a group, and whether it's reasonable that they would be chilled because they have little or no confidence that their donation or their identity will be kept confidential. So I think that went to both California's ability to maintain the confidentiality of contributions and also the present day environment. So I think that's yet another element at play in this case, specifically the present day landscape in which we're seeing in some circles increasing hostility to other's views. And I'll be really curious if and how that element plays into the court's calculus.

David Stewart 8:09

Speaking of the court's calculus, is there any sense from these oral arguments or from reactions from stakeholders of how the Supreme Court might end up deciding this case?

Jennifer McLoughlin 8:19

I think predicting how the U.S. Supreme Court will rule in a case is often an exercise in reading tea leaves, and this case is certainly no exception. From what I have heard it seems like the most common prediction is that California will likely lose the case — at least to some degree. The question I'm hearing more is not whether or not California will or will not lose, it's more how will the state lose? Or what would the court's ruling look like? So there seems to be a more common belief among practitioners and those who are watching the court that California could lose this case.

David Stewart 8:58

So what do nonprofits and others have to say about what it means if this California law is upheld or what might it mean if this California law is struck down?

Jennifer McLoughlin 9:07

So what we have seen and what we have heard is that not all nonprofits are on one side of this case. Not all nonprofits support these two organizations that are before the U.S. Supreme Court. During the merit stage of these consolidated cases there was a wave of amicus briefs in support of the two organizations, including briefs from a variety of groups. Sometimes they file individually, sometimes several join in a brief. Likewise, there were not as many, but there were several amicus briefs filed in support of California, and there's a slew of various concerns raised throughout the briefs. One thing that the two primary organizations in this case, the two petitioners, have particularly emphasized is the potential chilling effect of California's disclosure requirement. What they have stressed is that California's disclosure requirement presents the risk of information being leaked in part because of the leaks that have occurred in the past. And that this puts their donors in the position of potentially facing threats, harassment, and violence because of the fact that they have donated to a group others might consider controversial. And faced with this potential retaliation, their donors might refrain from contributing to a charitable organization or to their charitable organizations . So that's that chilling effect is something that we hear from both these organizations and a few other groups. On the other side, if California's requirement is struck down, there's one concern that I've heard that regulation of charities will be undermined or impeded. And further from there the public trust and charitable sector could diminish, so that individuals who donate time and money into nonprofits might start withholding their support because they're not confident that they're — in particular their money — is going to the purpose for which it was donated. So those are a couple of concerns. There was a law professor who spoke at a recent ABA panel and he indicated that the federal rules could also be in jeopardy depending on how the Supreme Court rules. And he suggested that if the justices hold that "the mere reporting on a confidential basis a substantial contributor information to the government significantly burdens First Amendment rights" that could really put federal rules in jeopardy, including the federal rule that requires — the federal rule to provide substantial contributor information to public charities to the IRS. So there is a slew of concerns across the board, and those are just a few that we've heard.

David Stewart 11:47

Before I let you go, is there any sense of when this decision might come out? I know the oral arguments were in late April. Is there any idea of when we might actually have a resolution to this case?

Jennifer McLoughlin 12:00

Again the most common prediction or I guess the wide expectation is that the Supreme Court will release its decisions sometime in June, probably later in the month. But of course we are keeping an eye out for a potentially earlier release.

David Stewart 12:17

All right . Well, this has been great. Jennifer, thank you for being here.

Jennifer McLoughlin 12:18

Thank you so much for having me.

David Stewart 13:16

Now we turn to another case, this one recently decided by the U.S. Supreme Court: CIC Services. I'm joined by Tax Notes contributing editor Kristen Parillo. Kristen , welcome back to the podcast.

Kristen Parillo 13:27

Thanks for having me, Dave.

David Stewart 13:29

Why don't you start us off with some background about the case? What is this all about?

Kristen Parillo 13:32

The key issue in this case is really on the timing of when a taxpayer can legally challenge a Treasury or IRS rule or regulation before there's been any violation of the rule and punishment for noncompliance . In non-tax cases people typically can bring a pre enforcement challenge arguing that an agency regulation is procedurally or substantively invalid under the Administrative Procedure Act. But in the tax world, we have a statute called the Anti-Injunction Act, which bars federal courts from hearing lawsuits that will restrain the government's ability to assess and collect taxes. So historically this has meant that taxpayers can't challenge a Treasury or IRS tax rule until they've paid the tax, and can then sue for a refund. In this case, CIC Services filed a lawsuit in 2017 arguing that a 2016 IRS notice flagging microcaptive transactions as transactions of interests violated the Administrative Procedure Act because it was issued without a formal comment period. I won't go too deeply into what microcaptive transactions are, but basically they're insurance arrangements that smaller companies create to cover risks and losses that traditional insurance policies don't cover. The IRS believes that some taxpayers are abusing the tax benefits from microcaptives. By putting out this notice and calling them transactions of interest, all taxpayers and advisers who created these microcaptive arrangements have to report certain information to the IRS every year. If they don't, the IRS can impose a penalty. CIC Services is a consulting company that advises companies on forming microcaptive insurance arrangements. They're considered a material adviser under this IRS notice so they're required to report whatever information is required. They think this is a huge and unnecessary burden, so they want a court to rule that the notice is invalid under the APA. However, they haven't been able to get the case heard on the merits because of the Anti-Injunction Act. Both the district court and the Sixth Circuit said that because the penalty for noncompliance is treated as a tax under the tax code, any lawsuit challenging the notice is in essence trying to impede the assessment or collection of taxes, and thus is barred by the Anti-Injunction Act. CIC Services asked the Supreme Court to review the case. The court accepted, and it heard oral arguments in December 2020.

David Stewart 16:16

How did those arguments go? Was it clear during them how this decision was going to come out?

Kristen Parillo 16:21

Yeah, we could tell that the justices were pretty unsympathetic to the government's position. That CIC Services's only option basically was to violate the notice, pay a penalty, and then challenge the notice in a refund lawsuit. Several of the justices pointed out that not complying with the reporting requirements could subject taxpayers and advisers to criminal penalties. They suggested that that's clearly unreasonable to force someone to violate the law just to get their day in court.

David Stewart 16:54

The Supreme Court handed down a decision on May 17. How did they come out on it?

Kristen Parillo 16:58

Well, the court unanimously rejected the government's position that the Anti-Injunction Act bars pre-enforcement challenges of IRS reporting requirements backed by penalties that are treated as tax, as they are in this notice. The court said you have to look at the purpose of the lawsuit. And in this case, CIC Services is challenging the reporting requirements and not a tax that the IRS has discretion to impose. The court said there were three reasons why this wasn't a tax case in disguise as the government had claimed. First, the notice imposes affirmative reporting obligations, which it said inflicts costs separate and apart from the statutory tax penalty. Number two, the reporting obligations and the tax penalty are several steps removed from each other. And number three, the fact that noncompliance result in criminal penalties reinforces that the suit is challenging the notice and seeking relief from the reporting obligations.

David Stewart 17:57

How did practitioners respond to this opinion?

Kristen Parillo 18:00

Well, the result was expected so it wasn't a huge surprise. But the fact that this was a unanimous decision is obviously still a big deal. We now have some clarity on the scope of the Anti-Injunction Act, but people are still sorting through what this means for Treasury and IRS rulemaking , especially for the reportable transaction regimes.

David Stewart 18:23

What does it mean next for CIC Services? Where does this case go next?

Kristen Parillo 18:26

So the case now goes back to the district court in Tennessee where CIC Services and the IRS will argue about the validity of the notice and whether it complied with the rulemaking requirements of the Administrative Procedure Act. In some ways we're back to square one.

David Stewart 18:44

Well, it's good for us. It's definitely something to keep an eye on as it progresses again. Kristen, thank you for being here.

Kristen Parillo 18:49

Well, thanks for having me, Dave.

David Stewart 18:53

And now, coming attractions. Each week, we highlight new and interesting commentary in our magazines. Joining me now from his home is Executive Editor for Commentary Jasper Smith. Jasper, what will you have for us?

Jasper Smith 19:03

Thanks, Dave. In Tax Notes Federal, Victor Thuronyi considers whether the Internal Revenue Code should be redrafted. Ted Stotzer examines possible tax law changes to homeownership, retirement savings, and student debt. In Tax Notes State, four Deloitte practitioners examine possible limits on the reach of states’ income tax nexus after Wayfair. Four tax professionals respond to proposals on taxing the collection of consumer data for business use. In Tax Notes International, four KPMG practitioners highlight potential audit risks, misuses, and misunderstandings associated with country-by-country reporting. Nicholas Kuria examines the economic substance rules that ensure that legal entities are properly taxable in the British Virgin Islands. On the Opinions page, Marie Sapirie reviews the expanded child tax credit. Doug Sheppard explores the career of Marilyn Wethekam, the first female chair of the Council On State Taxation.

David Stewart 20:03

You can read all that and a lot more in the pages of Tax Notes Federal, State, and International. That's it for this week. You can follow me online at @TaxStew, that's S-T-E-W, and be sure to follow @TaxNotes for all things tax. If you have any comments, questions, or suggestions for a future episode, you can email us at podcast@taxanalysts.org . And as always, if you like what we're doing here, please leave a rating or review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.