The Article begins with an overview of the current approach to targeting tax shelters, which the authors describe as an “activity-based” approach to tax enforcement that targets “specific activities and transactions that may be abusive.” Specifically, when taxpayers “participate in certain activities that qualify as ‘reportable transactions,’” they are required to make disclosures to the IRS. Reportable transactions include “listed transactions,” which are tax avoidance strategies that the IRS quite literally lists on its website as examples of abusive transactions, such as the bond and options sales strategy (BOSS) and the custom adjustable rate debt structure (CARDS).
Reportable transactions also include “transactions of interest,” which the IRS has identified as “potentially abusive” but lacks “‘enough information’ about the structure and purpose” to determine whether they are actually abusive. Finally, reportable transactions include certain transactions that contain “features that have appeared in situations where tax shelter promoters have marketed tax avoidance strategies to taxpayers,” such as very large tax losses, regardless of whether the underlying activity is fully compliant with the law. The purpose of these rules—and their associated penalties—are to “require taxpayers to raise red flags” about potentially abusive tax strategies, to allow IRS officials to “communicate to taxpayers that they view specific transactions as abusive,” and to “deter taxpayers from engaging in abusive tax planning.”
However, the authors argue that this activity-based disclosure regime also has serious limitations. Most obviously, both the “listed transactions” and “transactions of interest” rules depend on the IRS becoming aware of certain types of transactions that are being marketed to taxpayers as tax avoidance strategies. Most of the time, a strategy won’t be subject to the disclosure rules until the IRS learns about it—making it hard for the IRS to target emerging tax shelters. Even if the IRS does identify an avoidance strategy, there is a risk that it will define the strategy “in terms that are either too narrow or too broad to result in effective disclosure.” Finally, the reportable transaction rules “generally necessitate administrative, rather than legislative, action,” forcing the IRS to rely on notices to designate “listed transactions” and “transactions of interest.”
Enter CIC Services. In that case, the petitioner challenged the issuance of IRS Notice 2016-66, which designated certain “micro-captive insurance strategies” as “transactions of interest” subject to the mandatory disclosure regime. The petitioner argued that the IRS Notice was subject to notice and comment procedures under the Administrative Procedure Act (APA). The government argued that the lawsuit was premature, and that the Anti-Injunction Act (AIA) required the plaintiffs to pay the tax liability due and then seek a refund from the IRS. The Supreme Court disagreed with the government, holding that “the petitioner’s pre-enforcement suit to enjoin the IRS Notice designating a transaction as a reportable transaction was not barred by the AIA, even though noncompliance with the Notice could result in a tax penalty.”
Regardless of whether the taxpayers prevail on their substantive claims, the authors argue that CIC Services stands to undermine the current disclosure regime. First, after CIC Services, “taxpayers and their advisors may be able to bring APA challenges to the IRS notices designating transactions as listed transactions or transactions of interest before paying any applicable taxes or penalties.” Furthermore, they argue that “[i]f petitioners are successful in enjoining the IRS from enforcing reportable transaction notices, the IRS may be unable to effectively detect and deter abusive tax strategies by designating them as reportable transactions through its current procedures.”
After explaining the trouble of targeting tax shelters through this activity-based approach, the authors present their proposal: implement a new, actor-based approach to enforcement to supplement the existing framework. Under the actor-based approach, “high-income or wealthy taxpayers could be subject to increased tax penalty rates, longer periods of assessment, narrower tax penalty defense, and expanded information reporting obligations.” Specifically, the proposal would increase the penalties high-income taxpayers face for underpayment (regardless of whether the underpayment is related to a reportable transaction). It would lengthen the statute of limitations, giving the IRS more time to detect misconduct. And it would eliminate high-income taxpayer’s right to rely on tax opinions as a defense.
The authors argue that the actor-based approach has several benefits over the activity-based approach, including the ability to target the taxpayers who account for the highest proportion of revenue lost through noncompliance, have the most access to sophisticated tax advice, and impose the greatest social costs through their noncompliance. In effect, the authors want to flip the current system on its head. As the authors acknowledge, the current system often makes actor-based adjustments “inconsistently and in some cases impose[s] greater burdens on lower-income taxpayers.” In contrast, the authors push for heightened oversight and penalties that would target high-income earners.
This proposal is thoughtful and intended to mirror the progressive tax system more generally. However, I can’t help but wonder whether the actor-based approach may be problematic in other applications. For example, the history of enforcement efforts targeting Earned Income Tax Credit recipients and conservative organizations may point to the dangers of formalizing an actor-based approach to tax compliance enforcement. Still, this Article identifies an important problem with the current enforcement rules and offers a creative solution that is worth taking seriously. This Article will be of interest to tax scholars focused on tax procedure and administration, tax compliance, and tax evasion.