Court Declares IRS Micro-Captive Notice 2016-66 Unlawful: What Taxpayers Should Do Now

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Matthew L. Roberts

Matthew L. Roberts



Mr. Roberts is a Principal of the firm. He devotes a substantial portion of his legal practice to helping his clients successfully navigate and resolve their federal tax disputes, either administratively, or, if necessary, through litigation. As a trusted advisor he has provided legal advice and counsel to hundreds of clients, including individuals and entrepreneurs, non-profits, trusts and estates, partnerships, and corporations.

Having served nearly three years as an attorney-advisor to the Chief Judge of the United States Tax Court in Washington, D.C., Mr. Roberts leverages his unique insight into government processes to offer his clients creative, innovative, and cost-effective solutions to their tax problems. In private practice, he has successfully represented clients in all phases of a federal tax dispute, including IRS audits, appeals, litigation, and collection matters. He also has significant experience representing clients in employment tax audits, voluntary disclosures, FBAR penalties and litigation, trust fund penalties, penalty abatement and waiver requests, and criminal tax matters.

Often times, Mr. Roberts has been engaged to utilize his extensive knowledge of tax controversy matters to assist clients in their transactional matters. For example, he has provided tax advice to businesses on complex tax matters related to domestic and international transactions, formations, acquisitions, dispositions, mergers, spin-offs, liquidations, and partnership divisions.

In addition to federal tax disputes, Mr. Roberts has represented clients in matters relating to white-collar crimes, estate and probate disputes, fiduciary disputes, complex contractual and settlement disputes, business disparagement and defamation claims, and other complex civil litigation matters.


On May 17, 2021, the United States Supreme Court handed the IRS a significant loss when it concluded that CIC Services, LLC (“CIC”) could continue its lawsuit against the IRS for violations of the Administrative Procedure Act (“APA”).  A summary of the Supreme Court’s decision in CIC Services can be found here.

Although CIC won the battle, it had not yet won the war.  Rather, CIC won on procedural grounds when the Supreme Court held that the Anti-Injunction Act did not foreclose the federal courts from reviewing its merit-based APA challenge.  Accordingly, CIC was required to continue its fight against the IRS to prove that the IRS had failed to comply with the APA.  The case was therefore remanded back to the United States District Court for the Eastern District of Tennessee (“Federal Court”) for a decision on the merits.

But prior to the Federal Court reaching a decision on the APA issue, things really got interesting.  Specifically, on March 3, 2022, the Sixth Circuit Court of Appeals (the court in which CIC’s appeal would lie) rendered its decision in Mann Construction, Inc. v. United States, No. 21-1500 (6th Cir. Mar. 3, 2022).  More on that case is here.  In that case, the Sixth Circuit held that another IRS Notice—Notice 2007-83was invalid because the IRS failed to comply with the notice-and-comment procedures of the APA.

A few weeks after Mann Construction was decided, the Federal Court issued its decision in CIC Services, LLC v. IRS, No. 3:17-cv-110 (E.D. Tenn. Mar. 21, 2022).  This article discusses that decision.

The Federal Court Finds the Notice is Unlawful

CIC raised two arguments in its summary judgment motion regarding the lawfulness of the Notice.  First, CIC contended that the Notice must be set aside under the APA because it was a “legislative rule,” which required notice-and-comment procedures.  Second, and alternatively, CIC contended that the Notice was unlawful because the IRS had acted arbitrarily and capriciously in issuing the Notice.

The Federal Court agreed with CIC on both points.  As an initial matter, the Federal Court spent little time in concluding that the Notice was a legislative rule—rather than an “interpretative rule,” as argued by the IRS, particularly in light of the Sixth Circuit’s recent decision in Mann Construction.  And similar to the decision in Mann Construction, the Federal Court held that the IRS had failed to follow the required notice-and-comment procedures for implementation of the legislative rule.

As an additional matter, the Federal Court also agreed with CIC that the IRS had acted arbitrarily and capriciously in promulgating the Notice.  More specifically, under the APA, the Federal Court correctly observed that a court must “hold unlawful and set aside agency action, findings, and conclusions found to be . . . arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with the law.”  7 U.S.C. § 706(2)(A).  And in determining whether an agency action is arbitrary and capricious under the APA, courts must  “determine only whether the [agency] examined ‘the relevant data’ and articulated ‘a satisfactory explanation’ for [its] decision, ‘including a rational connection between the facts found and the choice made.’”  Dep’t of Com. V. New York, 139 S. Ct. 2551, 2569 (2019).

Under the above standard, courts are generally limited to evaluating the agency’s contemporaneous explanation in light of the existing administrative record.  Dep’t of Com., 139 S. Ct. at 2573.  Then, courts must examine the administrative record to determine if the agency:

Atrium Med. Ctr., 766 F.3d at 567.

In analyzing the IRS’s actions under these standards, the Federal Court agreed with CIC that the administrative record failed to include relevant data and facts regarding the IRS’s determination to designate micro-captive transactions as “transactions of interest,” i.e., reportable transactions.  Under the plain language of the Notice, the IRS simply stated that it was aware of micro-captive transactions and “believed” that these transactions may have the potential for tax avoidance or evasion.  However, the IRS failed to articulate more on any facts that would support its belief.  The Federal Court also criticized the administrative record itself as being inadequate to support any basis to hold in favor of the IRS.

The Federal Court Sets the Notice Aside as Unlawful

After concluding that the IRS had failed to comply with the APA, the Federal Court turned to the proper relief to provide to CIC.  In its complaint, CIC Services requested for the Federal Court to:  (i) enter a judgment declaring the Notice unlawful and setting it aside; (ii) enjoin all agencies from enforcing the notice and offering documents produced by any individual or entity in response to the Notice in judicial or administrative proceedings; and (iii) require the IRS to destroy or return materials produced in response to the Notice.  The Federal Court agreed that some, but not all, of the requested relief was warranted:

Parting Thoughts

The Federal Court’s decision in CIC Services is another win for taxpayers.  Although it is anyone’s guess as to whether the IRS chooses to appeal the decision, it seems unlikely given the Sixth Circuit’s governing law under Mann Construction.

Significantly, the Sixth Circuit’s decision in Mann Construction and the Federal Court’s decision in CIC Services only applies to limited taxpayers in those courts.  That is, other federal courts may not necessarily agree with the rationale of those decisions.  Accordingly, taxpayers in other jurisdictions should watch carefully to see how other federal courts decide these issues in the future.

Moreover, taxpayers who have already paid civil penalties related to IRS notices—particularly those at issue in Mann Construction and CIC Services—should seek the advice of tax counsel to determine whether certain actions should be taken, such as the filing of a refund or protective refund claim.  Taxpayers in these circumstances should be aware that they may forever lose entitlement to a refund of the civil penalty if they fail to follow these procedures within prescribed deadlines.