Interior Glass Systems, Inc. v. United States ( 2019 )

FOR PUBLICATION
UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
INTERIOR GLASS SYSTEMS, INC., No. 17-15713
Plaintiff-Appellant,
D.C. No.
v. 5:13-cv-05563-EJD
UNITED STATES OF AMERICA,
Defendant-Appellee. OPINION
Appeal from the United States District Court
for the Northern District of California
Edward J. Davila, District Judge, Presiding
Argued and Submitted September 13, 2018
San Francisco, California
Filed June 26, 2019
Before: A. Wallace Tashima, Johnnie B. Rawlinson,
and Paul J. Watford, Circuit Judges.
Opinion by Judge Watford
2 INTERIOR GLASS SYSTEMS V. UNITED STATES
SUMMARY *
Tax
The panel affirmed the district court’s summary
judgment in favor of the United States in a tax refund action
by taxpayer Interior Glass Systems, Inc.
Taxpayer joined a Group Life Insurance Term Plan
(GLTP) to fund a cash-value life insurance policy owned by
its sole shareholder and only employee. Under Notice 2007-
83, the Internal Revenue Service requires disclosure of
certain “listed transactions” that involve cash-value life
insurance policies, because of their potential for use in tax-
avoidance schemes. The parties agree that taxpayer’s
transaction satisfies three of the four elements of a listed
transaction. The district court determined that taxpayer’s
transaction—joining the GLTP—was substantially similar
to a listed transaction and should have been disclosed, and
the panel agreed.
The panel also held that taxpayer’s procedural due
process rights were not violated when it was required to pay
penalties for non-disclosure in full before seeking judicial
review. The panel held that taxpayer was not entitled to pre-
collection judicial review under Jolly v. United States, 764
F.2d 642 (9th Cir. 1985).
*
This summary constitutes no part of the opinion of the court. It
has been prepared by court staff for the convenience of the reader.
INTERIOR GLASS SYSTEMS V. UNITED STATES 3
COUNSEL
John P. McDonnell (argued), Law Offices of John P.
McDonnell, Los Altos, California, for Plaintiff-Appellant.
Teresa E. McLaughlin (argued) and Geoffrey J. Klimas,
Attorneys; David A. Hubbert, Acting Assistant Attorney
General; Thomas Moore, Assistant United States Attorney;
Brian Stretch, United States Attorney; Tax Division, United
States Department of Justice, Washington, D.C.; for
Defendant-Appellee.
OPINION
WATFORD, Circuit Judge:
The Internal Revenue Service (IRS) requires taxpayers
to disclose their participation in certain transactions, known
as “listed transactions,” that the agency has designated for
close scrutiny. 26 C.F.R. § 1.6011-4(a), (b)(2); see
26 U.S.C. § 6011(a). To compel compliance with this
obligation, Congress has authorized the IRS to impose
monetary penalties on those who fail to file the required
disclosure statement. 26 U.S.C. § 6707A(a). The IRS
determined that the taxpayer in this case, Interior Glass
Systems, Inc., failed to disclose its participation in a listed
transaction in three different tax years and imposed a penalty
of $10,000 per year. Interior Glass paid the penalties and
then challenged their imposition by seeking an
administrative refund. When that challenge failed, the
company filed this action in the district court to recover the
money it had been forced to pay. See 28 U.S.C.
§ 1346(a)(1); 26 U.S.C. § 7422(a). The district court granted
4 INTERIOR GLASS SYSTEMS V. UNITED STATES
the government’s motion for summary judgment,
concluding that the penalties were properly imposed.
On appeal, Interior Glass raises two principal arguments.
First, it contends that the penalties were wrongly imposed
because it did not actually participate in a listed transaction
and thus had nothing to disclose. Second, Interior Glass
contends that its due process rights were violated because it
was not afforded an opportunity for pre-collection judicial
review. We find neither contention meritorious and
accordingly affirm.
I
Treasury Regulation § 1.6011-4, which imposes the
disclosure obligation, defines the term “listed transaction” as
follows: “A listed transaction is a transaction that is the
same as or substantially similar to one of the types of
transactions that the Internal Revenue Service (IRS) has
determined to be a tax avoidance transaction and identified
by notice, regulation, or other form of published guidance as
a listed transaction.” 26 C.F.R. § 1.6011-4(b)(2); see also
26 U.S.C. § 6707A(c)(2) (providing similar definition of the
term). As the regulation states, one of the ways the IRS
identifies listed transactions is by issuing published notices.
In 2007, the IRS issued Notice 2007-83, titled “Abusive
Trust Arrangements Utilizing Cash Value Life Insurance
Policies Purportedly to Provide Welfare Benefits.” 2007-2
C.B. 960, 960. The Notice designates certain transactions
involving cash-value life insurance policies as listed
transactions because, in the agency’s view, they improperly
allow small business owners to receive cash and other
property from the business “on a tax-favored basis.” Id. The
transaction takes place in two steps: A small or closely held
business transfers funds to a trust; that trust then pays the
INTERIOR GLASS SYSTEMS V. UNITED STATES 5
premium on the business owner’s cash-value life insurance
policy. Cash-value policies function differently from “term”
life insurance, which guarantees coverage for a specified
period of time. Under a term policy, the insurer pays out the
so-called death benefit only if the policyholder dies during
the coverage period. In contrast, with a cash-value policy, a
portion of the premium goes into an investment account.
The policyholder controls how the funds are invested, and
when the plan terminates, the policyholder can withdraw the
cash value that has accumulated within the policy, called the
surrender value. Id.The IRS required disclosure of these transactions given
their potential for use in tax-avoidance schemes. In the
typical arrangement, the business deducts its contributions
to the trust, thereby reducing its taxable income. But the
business owner does not include the payments as part of his
own taxable income; at most, he reports “significantly less
than the premiums paid on the cash value life insurance
policies.” Id. In effect, the business owner shifts the pre-tax
earnings of the business into his own personal investment
vehicle. Even when a death benefit is provided—such that
there is a component of term life insurance grafted onto the
transaction—“the arrangements often require large
employer contributions relative to the actual cost of the
benefits currently provided under the plan.” Id. Thus, the
IRS explained, the transfers to the trust could be, in
substance, distributions of dividend income or deferrals of
compensation. Id. at 960–61. Upon disclosure of the
transaction, the IRS could challenge the deductions by the
business and seek to include the payments made to the trust
in the business owner’s gross income.
Notice 2007-83 states that the listed transaction
described above consists of four elements. Simplified
6 INTERIOR GLASS SYSTEMS V. UNITED STATES
somewhat, and as relevant for our purposes, the four
elements are:
• the transaction involved “a trust or other
fund described in [26 U.S.C.] § 419(e)(3)
that is purportedly a welfare benefit
fund”;
• contributions to the trust or other fund
were not governed by the terms of a
collective bargaining agreement;
• the trust or other fund paid premiums on
one or more cash-value life insurance
policies that accumulated value; and
• the employer took a deduction that
exceeded the sum of certain amounts.
Id. at 961–62.
The Notice also identifies as a listed transaction “any
transaction that is substantially similar” to a transaction with
the four specified elements. Id. at 961. Although the term
“substantially similar” appears in the penalty-imposing
statute, 26 U.S.C. § 6707A, the statute does not define the
term. The IRS has defined it in Treasury Regulation
§ 1.6011-4. (Interior Glass does not challenge the validity
of the regulation here.) That definition states in relevant
part:
The term substantially similar includes any
transaction that is expected to obtain the same
or similar types of tax consequences and that
is either factually similar or based on the
same or similar tax strategy. . . . [T]he term
INTERIOR GLASS SYSTEMS V. UNITED STATES 7
substantially similar must be broadly
construed in favor of disclosure. For
example, a transaction may be substantially
similar to a listed transaction even though it
involves different entities or uses different
Internal Revenue Code provisions.
26 C.F.R. § 1.6011-4(c)(4). The regulation includes two
examples by way of illustration. In the first, the taxpayer
inflates the basis in a partnership interest in a different
manner from the listed transaction; in the second, the
taxpayer employs an intermediary of a different type from
that used in the listed transaction to prevent recognition of a
gain. § 1.6011-4(c)(4), Examples 1 & 2. Both transactions
remain substantially similar despite the change in form. As
is often the case elsewhere in tax law, the disclosure
obligation does not “exalt artifice above reality,” which
would “deprive the statutory provision in question of all
serious purpose.” Gregory v. Helvering, 293 U.S. 465, 470
(1935).
The IRS concluded that Interior Glass participated in a
transaction substantially similar to the listed transaction
identified in Notice 2007-83 during the 2009, 2010, and
2011 tax years. Specifically, Interior Glass joined the Group
Term Life Insurance Plan (GTLP) to fund a cash-value life
insurance policy owned by its sole shareholder and only
employee, Michael Yates. All agree that this transaction
satisfies three of the Notice’s four elements. The GTLP
transaction lacks the first element because its intermediary
was a tax-exempt business league, rather than a trust or
§ 419(e)(3) welfare benefit fund. The business league,
however, performed the same functions as the trust or
welfare benefit fund described in the Notice.
8 INTERIOR GLASS SYSTEMS V. UNITED STATES
We agree with the district court that Interior Glass was
required to disclose its participation in the GTLP transaction.
Under the definition contained in the applicable Treasury
Regulation, the GTLP transaction is substantially similar to
the listed transaction identified in Notice 2007-83.
First, the GTLP transaction was “expected to obtain the
same or similar types of tax consequences.” 26 C.F.R.
§ 1.6011-4(c)(4). The transaction identified in the Notice
seeks to “provide cash and other property to the owners of
the business on a tax-favored basis.” 2007-2 C.B. at 960.
Those favorable tax consequences are achieved through (1) a
deduction of the contributions by the business and (2) a
failure by the business owner to declare the payments as
income. The GTLP transaction promised similar tax
benefits. On that score, the plan documents represented that
“[c]ontributions [were] currently deductible” by Interior
Glass and that only the cost of group-term life insurance (in
contrast to the premium on the cash-value policy) may have
been includible in Yates’ income.
Second, the GTLP transaction is both “factually similar”
to the listed transaction described in the Notice and “based
on the same or similar tax strategy.” 26 C.F.R.
§ 1.6011-4(c)(4). As to factual similarity, the GTLP
transaction involved a small business, a cash-value life
insurance policy that benefits the business owner, and
payment of the premiums on the policy through an
intermediary. The GTLP combined those three aspects in
pursuit of the same tax strategy discussed in the Notice. By
using the intermediary, the business and its owner attempted
to do what they could not do outright: deduct payments made
to the owner’s investment vehicle without declaring the
benefits as income.
INTERIOR GLASS SYSTEMS V. UNITED STATES 9
Interior Glass identifies two differences between the
GTLP transaction and the listed transaction in Notice
2007-83, but neither difference is material. First, as noted
above, the GTLP transaction was filtered through a tax-
exempt business league instead of a trust or welfare benefit
fund. Second, rather than invoking 26 U.S.C. § 419’s rules
for welfare benefits, the GTLP transaction purported to
provide § 79 group-term life insurance benefits, even though
it also involved a cash-value life insurance policy. But the
IRS’s definition of “substantially similar” explicitly states
that neither of these differences is sufficient to prevent a
transaction from qualifying as a listed transaction: “[A]
transaction may be substantially similar to a listed
transaction even though it involves different entities or uses
different Internal Revenue Code provisions.” 26 C.F.R.
§ 1.6011-4(c)(4). Just as in the examples accompanying the
regulation, Interior Glass cannot evade a finding of
substantial similarity solely by claiming a deduction on a
different basis or by using a different intermediary to
complete the transaction.
Interior Glass contends that, if read to encompass the
GTLP transaction, the definition of “substantially similar” is
unconstitutionally vague. That contention is without merit.
For a civil penalty like 26 U.S.C. § 6707A, the definition is
constitutionally valid so long as “a person of ordinary
intelligence” could determine which transactions are
substantially similar to the listed transaction identified in
Notice 2007-83. Fang Lin Ai v. United States, 809 F.3d 503,
514 (9th Cir. 2015). As explained above, the regulation’s
definition of “substantially similar” is detailed enough to
make that determination an easy one in this case. The only
differences between the GTLP transaction and the listed
transaction are expressly addressed—and expressly rejected
as immaterial—in the definition itself.
10 INTERIOR GLASS SYSTEMS V. UNITED STATES
II
We also find no merit in Interior Glass’ contention that
its procedural due process rights were violated.
To obtain judicial review of the penalties imposed by the
IRS, Interior Glass first had to pay the penalties in full. See
28 U.S.C. § 1346(a)(1); Flora v. United States, 362 U.S.
145, 177 (1960). Interior Glass argues that, under the Due
Process Clause of the Fifth Amendment, it should have been
afforded an opportunity to obtain judicial review before
having to part with its money. Neither the Supreme Court’s
nor our court’s precedent supports that proposition.
As a general rule, the government may require a taxpayer
who disputes his tax liability to pay upfront before seeking
judicial review. Being compelled to part with one’s money
constitutes a deprivation of property, but the government’s
vital interest in securing tax revenues justifies a pay-first,
litigate-later scheme of judicial review. Phillips v.
Commissioner, 283 U.S. 589, 595, 597–98 (1931);
Franceschi v. Yee, 887 F.3d 927, 936 (9th Cir. 2018). Under
that rule, Interior Glass’ ability to obtain post-collection
judicial review would suffice, without more, to satisfy due
process.
In Jolly v. United States, 764 F.2d 642 (9th Cir. 1985),
however, we applied the three-factor framework from
Mathews v. Eldridge, 424 U.S. 319 (1976), when deciding
whether a taxpayer was entitled to pre-collection judicial
review of a tax penalty. Applying that framework here, we
conclude that Interior Glass was not entitled to pre-collection
judicial review. See Larson v. United States, 888 F.3d 578,
585–87 (2d Cir. 2018) (upholding full-payment rule for
related tax penalty).
INTERIOR GLASS SYSTEMS V. UNITED STATES 11
The first factor is “the private interest that will be
affected by the official action.” Mathews, 424 U.S. at 335.
Interior Glass’ interest in the lost use of its property for the
pendency of the refund action is “noteworthy, but not that
substantial.” Jolly, 764 F.2d at 645. After all, post-
deprivation proceedings will provide “full retroactive relief”
if the taxpayer prevails on its refund suit. Mathews, 424 U.S.
at 340. Interior Glass would no doubt prefer to retain its
money while litigating the validity of the penalties, but this
is not a case in which an individual faces abject poverty in
the interim. See Goldberg v. Kelly, 397 U.S. 254, 264
(1970).
The second factor is “the risk of an erroneous
deprivation” of the private interest. Mathews, 424 U.S. at
335. The IRS’s listed-transaction determination turns on a
side-by-side comparison of the listed transaction identified
in an IRS notice or regulation and the transaction at issue.
The decision to impose a penalty under 26 U.S.C. § 6707A
“does not require any determinations of credibility of
witnesses or claims, and would not be aided in most cases by
a face-to-face meeting with the taxpayer before a penalty is
assessed.” Jolly, 764 F.2d at 646. The IRS is therefore
unlikely to err in “the generality of cases,” which is the
proper focus for our analysis. Mathews, 424 U.S. at 344.
The risk of an erroneous deprivation is further mitigated
by the availability of pre-collection review of the taxpayer’s
liability in an administrative forum. See Larson, 888 F.3d
at 586. Taxpayers have two (likely mutually exclusive)
routes to obtain review in the IRS Office of Appeals: an
appeals conference or a collection-due-process hearing.
26 U.S.C. § 6330(c)(2)(B); 26 C.F.R. § 601.103(c)(1); see
Lewis v. Commissioner, 128 T.C. 48, 59–60 (2007). If the
taxpayer files a timely protest, an appeals officer will review
12 INTERIOR GLASS SYSTEMS V. UNITED STATES
the taxpayer’s arguments and determine whether the
taxpayer engaged in a listed transaction. See, e.g., Our
Country Home Enterprises, Inc. v. Commissioner, 855 F.3d
773, 781 (7th Cir. 2017). Although the IRS Office of
Appeals may not rescind a listed-transaction penalty, see
26 U.S.C. § 6707A(d)(1)(A), that simply precludes the
Office from exercising prosecutorial discretion in deciding
whether the penalty should stand. See 26 C.F.R.
§ 301.6707A-1(d)(3)–(5). The Office can still determine
whether the penalty was erroneously imposed in the first
place and, if so, revoke the penalty altogether. See
§ 601.106(f)(1).
Finally, the third factor, which measures the
government’s interest in retaining the full-payment
prerequisite to this refund action, also weighs in the IRS’s
favor. See Mathews, 424 U.S. at 335. Even with the
disclosure obligation on the books, “the IRS often did not
learn of the existence of tax shelters until after it conducted
audits.” Smith v. Commissioner, 133 T.C. 424, 427 (2009).
Congress added the § 6707A penalty provision in 2004 to
encourage voluntary disclosure of listed transactions. This
important objective “could be jeopardized if full-scale pre-
deprivation hearings and court cases are required whenever
the government attempts to collect” the authorized penalties.
Jolly, 764 F.2d at 646; see Larson, 888 F.3d at 586–87.
In sum, the combination of pre-collection administrative
review plus post-collection judicial review satisfies the
requirements of the Due Process Clause. Interior Glass
received all the process it was due in this context.
AFFIRMED.