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Saturday, June 20, 2015

The IRS Scandal, Day 772: D.C. Circuit Refuses To Dismiss Z Street's Claim That The IRS Delayed Tax-Exempt Status Due To Its Pro-Israel Views

SmithTaxProf Blog op-ed: D.C. Circuit Opinion in Z Street v. Koskinen Denies Application of Anti-Injunction Act in Suit over Delay in Processing Application for Tax Exemption, by Patrick J. Smith (Ivins, Phillips & Barker, Washington, D.C.):

On Friday, June 19, 2015, the D.C. Circuit issued its opinion in Z Street v Koskinen.  In this suit, an organization that had filed an application for tax-exempt status with the IRS brought suit against the IRS in U.S. district court alleging that the IRS was delaying processing of the application because the organization’s activities related to Israel and because, according to the organization’s allegations, the IRS has an “Israel Special Policy” requiring delayed processing for such organizations if their views on Israel do not coincide with the policies of the Obama Administration.  The government filed a motion to dismiss, relying primarily on the argument that the suit was barred by the Anti-Injunction Act.  Based on the procedural posture, the district court assumed the truth of the organization’s allegations, and denied the motion, holding that the suit was not about assessment or collection of taxes but rather about allegations of unconstitutional discrimination in the processing of the application for tax-exempt status.

The oral argument in the case took place on May 4 of this year, and during this oral argument the panel of three D.C. Circuit judges was clearly extremely hostile to the position taken by the IRS and the Justice Department on behalf of the IRS.  A significant part of the questioning by the judges related to the Supreme Court’s recent decision in Direct Marketing Association v. Brohl, 135 S. Ct. 1124 (2015).  The judges on the panel suggested in their questions to the attorney representing the IRS that the Direct Marketing decision would strongly support the conclusion that the Anti-Injunction Act should not apply under the circumstances of this case. 

As I discussed in a recent Tax Notes article, Challenges to Tax Regulations: the APA and the Anti-Injunction Act, while the Direct Marketing decision related to the Tax Injunction Act, which imposes limitations on the types of suits relating to state taxes that may be heard in federal district court, while the Anti-Injunction Act imposes limitations on the types of suits relating to federal taxes that may be brought in federal district court, nevertheless, because of the strong similarities between these two provisions, and because the Supreme Court in Direct Marketing relied on these parallels to read the words “assessment,” “collection,” and “levy” in the Tax Injunction Act in a narrow, technical way, based on the meaning these words have in the Internal Revenue Code, the narrow reading the Court gave the Tax Injunction Act in Direct Marketing would suggest that the Anti-Injunction Act should be given a similarly narrow reading, contrary to the broad reading given to the Anti-Injunction Act in the 1974 Supreme Court decision Bob Jones University v. Simon, 416 U.S. 725 (1974).

However, while the opinion issued by the D.C. Circuit in Z Street affirmed the district court and held that the Anti-Injunction Act did not apply to bar the suit, nevertheless, the tone of the opinion was much milder than might have been expected based on the tone of the oral argument.  In addition, while the opinion noted that the court’s conclusion “finds support in” the Direct Marketing decision, it was not on this basis that the court decided the Anti-Injunction Act did not apply.  Instead, the court relied on the Supreme Court’s 1984 decision in South Carolina v. Regan, 465 U.S. 367 (1984), which held that the Anti-Injunction Act does not apply to bar a suit in cases where the party bringing the suit has no alternative way of bringing its challenge to IRS action in court.  The court held this principle applied in this case because the alternative remedies suggested by the government, a tax refund suit, or a challenge in Tax Court under section 7428 for a determination relating to qualification for tax-exempt status, would not give the organization a way to make its challenge to the delay in processing its application on allegedly unconstitutional grounds.

Thus, while the outcome in the case is welcome, this decision is somewhat disappointing in that it leaves for another day a determination of the effect of the Direct Marketing decision on the scope of the Anti-Injunction Act and the Bob Jones decision.  The court notes that while the D.C. Circuit’s earlier en banc decision in Cohen v. United States, 650 F.3d 717 (D.C. Cir. 2011) (en banc), rejected the IRS position that because of the Anti-Injunction Act, the only way to litigate tax issues is through the types of tax litigation specifically authorized in the Internal Revenue Code, such as tax refund suits and Tax Court deficiency actions, nevertheless, the Cohen decision, which preceded the Direct Marketing decision by several years, also noted that the Anti-Injunction Act means that a suit’s “implications” for assessment and collection must be considered. 

Another currently pending D.C. Circuit case, Florida Bankers Association v. Treasury, No. 14-5036 (D.C. Cir.), is likely to address more directly the issue of what Direct Marketing means for the Anti-Injunction Act.  I discussed the Anti-Injunction Act issue in this case in my recent Tax Notes article, and I discussed the merits issue in the case in two earlier Tax Notes articles.  Although the briefing and the oral argument in this case preceded the issuance of the Direct Marketing decision, nevertheless, the plaintiffs filed a submission with the D.C. Circuit after the Direct Marketing decision notifying the court of the relevance of this case.  This case involves a challenge to the validity of IRS regulations requiring banks to file information returns with the IRS reporting interest earned by non-resident aliens on accounts at the reporting banks.  In addition to arguments on the merits, the government argues the suit is barred by the Anti-Injunction Act.  The district court held the Anti-Injunction Act did not apply, both because the case involves information reporting regarding income that would not in any event be subject to U.S. tax and because the penalty that would be imposed on the banks for failing to comply with the reporting requirements was not sufficient to implicate the Anti-Injunction Act because none of the banks had violated this requirement and none had indicated an intention to do so.

During the D.C. Circuit oral argument, one of the judges on the panel, Judge Brett Kavanaugh, who wrote the opinion in Loving v IRS, 742 F.3d 1013 (D.C. Cir. 2014), holding invalid the IRS regulations imposing restrictions on tax return preparers, was particularly interested in the Anti-Injunction Act issue.  The fact that there has been a somewhat long delay since the oral argument without the opinion in this case being issued (over four months, compared to six weeks between oral argument and opinion in Z Street), suggests that the opinion when it comes out should illuminate the D.C. Circuit’s view on the significance of the Direct Marketing decision for the Anti-Injunction Act.  There is no overlap in the panels between Z Street and Florida Bankers.

Prior TaxProf Blog coverage:  

http://taxprof.typepad.com/taxprof_blog/2015/06/the-irs-scandal-day-772-dc-circuit-refuses-to-dismiss-z-streets-claim-that-irs-delayed-tax-exempt-st.html

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