Blow for IRS as Court sets aside Notice 2016-66

The District Court of Eastern Tennessee has struck down the IRS’s controversial Notice 2016-66, which labels micro captive arrangements as potentially abusive and requires their disclosure.

In the latest blow to the Internal Revenue Service, the District Court found that the notice was arbitrary and capricious. The federal judge found the agency had failed to justify its decision to flag the transactions as potentially abusive and failed to comply with Administrative Procedure Act (APA) requirements to secure public feedback.

Accepting the challenge by microcaptive manager CIC Services, judge Travis McDonough ordered the notice to be set aside.

“While the IRS may ultimately be correct that microcaptive insurance arrangements have the potential for tax avoidance or evasion and should be classified as transactions of interest, the APA requires that the IRS examine relevant facts and data supporting that conclusion,” the opinion said.

“The administrative record in this case simply does not include underlying facts and data showing that microcaptive insurance arrangements have a potential for tax avoidance or evasion.”

The decision follows a string of defeats for the IRS over the issue. Judge McDonough noted that the Sixth Circuit Court had expressly rejected the government’s arguments contending that the Notice 2016-66 was not required to go through requirements for notice and comment under the APA. The notice, it said, was akin to a legislative rule, building on existing law and creating new requirements.

Finding against the IRS, Judge McDonough ordered it to return documents and other materials obtained from taxpayers under the notice.