Mann Constr., Inc. v. United States

• Decision Date: 03 March 2022
• Docket Number: No. 21-1500,21-1500
• Citation: 27 F.4th 1138
• Parties: MANN CONSTRUCTION, INC. ; Brook Wood; Kimberly Wood; Lee Coughlin; Debbie Coughlin, Plaintiffs-Appellants, v. UNITED STATES of America, Defendant-Appellee.
• Court: U.S. Court of Appeals — Sixth Circuit

27 F.4th 1138

MANN CONSTRUCTION, INC. ; Brook Wood; Kimberly Wood; Lee Coughlin; Debbie Coughlin, Plaintiffs-Appellants,

v.UNITED STATES of America, Defendant-Appellee.

No. 21-1500

United States Court of Appeals, Sixth Circuit.

Argued: December 9, 2021

Decided and Filed: March 3, 2022

ARGUED: Samuel Joseph Lauricia III, WESTON HURD LLP, Cleveland, Ohio, for Appellants. Ellen Page DelSole, UNITED STATES DEPARTMENT OF JUSTICE, Washington, D.C., for Appellee. ON BRIEF: Samuel Joseph Lauricia III, Walter A. Lucas, Matthew C. Miller, Randy L. Taylor, WESTON HURD LLP, Cleveland, Ohio, for Appellants. Ellen Page DelSole, Francesca Ugolini, Geoffrey J. Klimas, UNITED STATES DEPARTMENT OF JUSTICE, Washington, D.C., for Appellee.

Before: SUTTON, Chief Judge; STRANCH and BUSH, Circuit Judges.

SUTTON, Chief Judge.

Several taxpayers complain about the Internal Revenue Service's enforcement of an administrative regulation that requires them to report transactions involving cash-value life insurance policies connected to employee-benefit plans. The taxpayers claim that the IRS failed to meet a reporting requirement of its own by skipping the notice-and-comment process before promulgating this legislative rule. If individuals "must turn square corners when they deal with the government," the taxpayers insist, "it cannot be too much to expect the government to turn square corners when it deals with them." Niz-Chavez v. Garland , ––– U.S. ––––, 141 S. Ct. 1474, 1486, 209 L.Ed.2d 433 (2021). We agree with the taxpayers and reverse the district court's contrary decision.

I.

In collecting federal taxes, the Internal Revenue Service uses a "system of self-reporting." United States v. Bisceglia , 420 U.S. 141, 145, 95 S.Ct. 915, 43 L.Ed.2d 88 (1975). Much as there may not be "a patriotic duty to increase one's taxes" under that system, Helvering v. Gregory , 69 F.2d 809, 810 (2d Cir. 1934), there is a duty to report all of the financial information that Congress requires.

Congress delegated power to the Secretary of the Treasury, who, through the IRS, requires taxpayers to submit information needed to assess and collect taxes. See 26 U.S.C. § 6011 ; see also id. § 7701(a)(11)(B). This information-gathering imperative allows the government to ensure compliance with tax provisions and ferret out improper tax avoidance.

In 2004, Congress added 26 U.S.C. § 6707A to the IRS's arsenal of tools for identifying tax avoidance schemes. Designed to shed light on potentially illegal tax shelters, § 6707A permits the IRS to penalize the failure to provide information concerning "reportable" and "listed" transactions.

A "reportable transaction" is one that has the "potential for [illegal] tax avoidance or evasion." Id. § 6707A(c)(1). A "listed transaction" is one that "is the same as, or substantially similar to, a transaction" that the IRS has identified as a "tax avoidance transaction." Id. § 6707A(c)(2). The statute authorizes monetary penalties and criminal sanctions for noncompliance with these reporting requirements. Id. §§ 6707A(b), 7203.

Today's dispute centers on a listed transaction. In 2007, the IRS issued Notice 2007-83, entitled " Abusive Trust Arrangements Utilizing Cash Value Life Insurance Policies Purportedly to Provide Welfare Benefits." 2007-2 C.B. 960. The Notice designates certain employee-benefit plans featuring cash-value life insurance policies as listed transactions. A cash-value life insurance policy combines life insurance coverage with a cash-value investment account. As the IRS saw it, these transactions run the risk of allowing small business owners to receive cash and other property from the business "on a tax-favored basis." Id.

Brook Wood and Lee Coughlin collectively own Mann Construction, which is based in Michigan. The company provides general contracting, construction management, and similar services.

From 2013 to 2017, Mann Construction established an employee-benefit trust that paid the premiums on a cash-value life insurance policy benefitting Wood and Coughlin. The company deducted these expenses, while Wood and Coughlin reported as income part of the insurance policy's value. Neither the individuals nor the company reported this arrangement to the IRS as a listed transaction.

In 2019, the IRS concluded that this structure fit the description identified in Notice 2007-83. The agency imposed penalties on the company ($10,000) and both of its shareholders ($8,642 and $7,794) for failing to disclose their participation in the trust. All three paid the penalties for the 2013 tax year and sought administrative refunds, claiming the IRS lacked authority to penalize them. When the administrative process for challenging the penalties left the taxpayers empty-handed, they turned to federal court.

There, in 2020, the taxpayers sued the federal government to recover the penalties. See 28 U.S.C. § 1346(a)(1) ; 26 U.S.C. § 7422(a). They challenged the validity of the Notice and penalties on four grounds: (1) the Notice failed to comply with the notice-and-comment requirements of the Administrative Procedure Act; (2) it constituted unauthorized agency action; (3) it was arbitrary and capricious; and (4) even if the Notice was valid, the arrangement at issue did not fall within its scope.

The district court ruled for the government on all fronts.

II.

We begin, and end, with the notice-and-comment claim. Before an agency may promulgate a regulation that has the force of law—in this instance requiring taxpayers to report a transaction or face hefty financial penalties and criminal sanctions—the Administrative Procedure Act, 5 U.S.C. §§ 551, 553 – 59, 701 – 06, usually requires it to run through a light-shedding process of its own. Under normal circumstances, the agency must publish a notice about the proposed rule, allow the public to comment on the rule, and, after considering the comments, make appropriate changes and include in the final rule a "concise general statement of" its contents. Id. § 553 ; see Perez v. Mortg. Bankers Ass'n , 575 U.S. 92, 96, 135 S.Ct. 1199, 191 L.Ed.2d 186 (2015). The process serves regulated parties and the agency alike. "Notice and comment gives affected parties fair warning of potential changes in the law and an opportunity to be heard on those changes—and it affords the agency a chance to avoid errors and make a more informed decision." Azar v. Allina Health Servs. , ––– U.S. ––––, 139 S. Ct. 1804, 1816, 204 L.Ed.2d 139 (2019). The process also shines a light on delegations of authority from Congress to an executive-branch agency to ensure they remain subject to public scrutiny. Courts must "set aside" agency actions that fail to follow these requirements. 5 U.S.C. § 706(2)(D) ; see Tenn. Hosp. Ass'n v. Azar , 908 F.3d 1029, 1042 (6th Cir. 2018).

The IRS, all agree, did not follow these notice-and-comment procedures when it issued Notice 2007-83. But that reality does not end the case. The IRS offers two explanations for declining to follow the notice-and-comment process: (1) It says that Notice 2007-83 is merely an interpretive rule (which does not require notice and comment) as opposed to a legislative rule (which does require notice and comment); and (2) it says that, even if the Notice amounts to a legislative rule, Congress exempted the IRS from the APA's requirements with respect to these disclosure rules. Each defense deserves a turn.

Was this Notice a legislative rule? Yes. In explaining why, some background is in order. The APA distinguishes between "legislative rules" and "interpretive rules." Only the former are subject to the Act's notice-and-comment requirements. By statute, Congress has exempted interpretive rules from notice and comment. 5 U.S.C. § 553(b)(3)(A). Binding "substantive agency regulations" by contrast must satisfy the required procedures. Chrysler Corp. v. Brown , 441 U.S. 281, 295, 313–315, 99 S.Ct. 1705, 60 L.Ed.2d 208 (1979). Some guideposts offer some clues in distinguishing the two types of rules.

Legislative rules have the "force and effect of law"; interpretive rules do not. Perez , 575 U.S. at 96–97, 135 S.Ct. 1199 (quoting Shalala v. Guernsey Mem'l Hosp. , 514 U.S. 87, 99, 115 S.Ct. 1232, 131 L.Ed.2d 106 (1995) ). Legislative rules impose new rights or duties and change the legal status of regulated parties; interpretive rules articulate what an agency thinks a statute means or remind parties of pre-existing duties. Tenn. Hosp. Ass'n , 908 F.3d at 1042. When rulemaking carries out an express delegation of authority from Congress to an agency, it usually leads to legislative rules; interpretive rules merely clarify the requirements that Congress has already put in place. Id. at 1043.

Measured by these metes and bounds, Notice 2007-83 amounts to a legislative rule. The Notice has the force and effect of law. It defines a set of transactions that taxpayers must report, and that duty did not arise from a statute or a notice-and-comment rule. It springs from the IRS's own Notice. Taxpayers like Mann Construction had no obligation to provide information regarding listed transactions like this one to the IRS before the Notice. They have such a duty after the Notice. Obeying these new duties can "involve significant time and expense," and failure to comply comes with the risk of penalties and criminal sanctions, all characteristics of legislative rules. CIC Servs., LLC v. IRS , ––– U.S. ––––, 141 S. Ct. 1582, 1591, 209 L.Ed.2d 615 (2021) ; see also id. at 1592 ; Kristin E. Hickman, Unpacking the Force of Law , 66 Vand. L. Rev. 465, 524 (2013) (characterizing penalties as a leading indicator that a regulation is legislative rather than interpretive).

The Notice also stems from an express and binding delegation of rulemaking power. Congress tasked the IRS with determining "by regulations" how taxpayers must "make a return or statement" and the information they must provide to the IRS when doing so. 26 U.S.C. § 6011(a). Under the penalty provision for failing to report...