Earlier this month, the United States Court of Appeals for the D.C. Circuit held in Florida Bankers Ass’n v. U.S. Dep’t of the Treasury, No. 14-5036 (D.C. Cir. Aug. 14, 2015) that the Anti-Injunction Act (AIA, codified at 26 U.S.C. § 7421(a)) barred two state banking associations from challenging Treasury regulations that: (1) required banks to annually report interest paid to certain foreign account-holders, and (2) imposed a penalty on banks that fail to do so. Notwithstanding attempts to reconcile the holding with recent precedent, the majority’s decision directly conflicts with the recent unanimous Supreme Court decision in Direct Mktg. Ass’n v. Brohl, 135 S. Ct. 1124 (March 3, 2015) (DMA), which found that the Tax Injunction Act (TIA, codified at 28 U.S.C. § 1341) did not bar a retail association’s challenge to comparable Colorado notice and reporting requirements (and accompanying penalty) imposed on out-of-state retailers. The TIA is modeled off of, and has consistently been interpreted to apply in the same fashion as its federal companion, the AIA. Given the striking similarities between the two cases, it is hard to reconcile the expansive application of the AIA in Florida Bankers with the narrow analysis of the TIA in DMA.
The majority opinion begins by highlighting the fact that the penalty imposed on the banks is technically a “tax” for purposes of the AIA because it is found in a specific section of the Internal Revenue Code (IRC, Ch. 68, Subchapter B) that states as much. See 26 U.S.C. § 6671(a). The majority emphasized that the Supreme Court recently confirmed that these types of penalties are treated as taxes when analyzing the application of the AIA, citing to the Nat’l Fed. of Indep. Bus. v. Sebelius decision. The majority distinguishes DMA on the basis that, unlike the tax-penalty in Chapter 68B of the IRC, the Colorado penalty imposed on out of state retailers that failed to report was not—or at least the parties never argued or suggested that it was—itself a tax. The majority was clear that “[i]f the penalty here were not itself a tax, the Anti-Injunction Act would not bar this suit.” Because the penalty was a “tax”, a favorable ruling for the plaintiffs “would invalidate the reporting requirement and restrain (indeed eliminate) the assessment and collection of the tax paid for not complying with the reporting requirement.” Because of this, the majority held that the banking associations’ challenge to the reporting requirements was barred by the AIA.
Practice Note: The majority relies heavily on the technical tax-penalty distinction in reaching their holding that the AIA applied. In making this distinction, the majority suggests that the label given to a penalty is controlling in determining whether the AIA and TIA apply to shut the door to federal district court. While at first glance it would appear that the holding is limited in scope to federal tax issues, it has the potential to spill over into the state tax world since many states have specifically conformed to the IRC in this respect, adopting an identical or substantially similar provision for their penalties. See, e.g., Ala. Code § 40-29-72(a); Ga. Code § 48-7-126(a); 72 Pa. Cons. Stat. § 7267(a). The court’s reasoning is problematic and contrary to the general principle that the name or terminology applied to a particular financial burden imposed by a legislature or other public body is not conclusive in determining whether or not it is a tax. Rather, the effect of a legislative assessment is more important than its label for purposes of determining its character. Specifically, if a particular charge clearly involves the idea of punishment for infraction of the law, it constitutes a penalty regardless of legislative label or designation as a “tax.” See, e.g., U.S. v. La Franca, 282 U.S. 568, 51 S. Ct. 278 (1931). Conversely, although the legislature may call that which is distinctly a tax by some other name, it nevertheless may be characterized or treated as a tax. If the label given to a tax or penalty is permitted to carry as much weight as the majority suggests, it would give states the unchallenged ability to flip the TIA on and off by superficially labeling a provision as a tax or penalty, respectively.
In a persuasive dissent, Judge Karen LeCraft Henderson pointed to DMA and several D.C. Circuit precedents that “make plain the AIA does not apply.” Specifically, she notes that the Treasury regulation imposes a pre-assessment tax-reporting requirement with a tax penalty attached, which the Supreme Court explicitly determined in DMA is not barred. She explained that the facts of the case are “even further removed from assessment or collection than Direct Marketing,” citing to the fact that the IRS does not even tax the interest earned by the non-resident aliens, but instead exchanges the information with other countries that provide information about U.S. citizens with foreign bank accounts, which the IRS only then assesses tax and interest upon.
Furthermore, the AIA (and TIA) articulate a bright-line rule, barring only suits that “restrain” (defined narrowly) the “assessment or collection” (defined narrowly) of taxes. Thus, even if a tax is involved, there still must be a “restraint” on the “assessment or collection” thereof. As indicated by the Supreme Court, this “restraint” must stop assessment, levy or collection, not merely inhibit them. See DMA, 135 S. Ct. 1124, 1133 (narrowly defining “restraint”). Because no “restraint” has occurred and the reporting requirements do not implicate an “assessment or collection” it was misguided of the majority to trigger the AIA.
The dissent also pointed to the faulty logic of the majority, highlighting the fact that just because the AIA is inapplicable when a penalty is not a tax does not mean the inverse is also true (i.e., if a penalty is a tax, then the AIA applies).
Finally, Judge Henderson points out that while D.C. Circuit “cases assume the AIA is a ‘jurisdictional’ bar” to suit, “it may be high time to revisit this assumption” in light of the Supreme Court’s recent attempts to bring some discipline to the use of the term.” See Florida Bankers, fn. 3. This is an interesting proposition, which would allow cases like DMA to continue in federal court as long as neither party raised the TIA.
Practice Note: Given the fact that the majority opinion in Florida Bankers appears to sidestep the controlling precedent established by the Supreme Court this March, one would hope that the plaintiffs file (and the D.C. Circuit grants) a request to rehear the case en banc. Oral arguments and briefing in the case occurred before the release of the DMA decision, lending itself to the possibility that the majority made up their mind before DMA was released, and attempted to mold the Supreme Court opinion to fit their analysis (as opposed to the other way around). Given the holes in the majority’s analysis (and the fact that the Supreme Court precedent is controlling), there is a legitimate case for simply ignoring this misguided opinion and continuing to follow the Supreme Court’s narrow interpretation of the TIA in DMA.
The practical implications are harsh as well—the majority concluding that taxpayers must violate the law (and risk severe business and regulatory implications), pay the penalty and then sue for refund to get their day in court and challenge the reporting requirements. The pre-assessment penalty here really isn’t a tax (rather it has been deemed a tax by the IRS). Ultimately, the purpose of the TIA and AIA is to protect the government’s ability to collect a consistent stream of revenue, which allowing a challenge to the pre-assessment reporting requirements only tangentially inhibit.