The U.S. Court of Appeals for the District of Columbia, sitting en banc on September 29, raised serious questions in a suit seeking refund of telephone excise taxes paid to the Internal Revenue Service (IRS). A decision on the arguments raised could have far-reaching consequences for the IRS, potentially requiring it to conform to the Administrative Procedure Act (APA) when issuing guidance.

The case involves 26 U.S.C. § 4251, a three percent excise tax on long-distance phone calls for which the charges varied based only on transmission time, which five circuit courts declared invalid in 2005 and 2006. In May 2006, the IRS declared that it would no longer impose the tax and would allow taxpayers to claim refunds for excise taxes. The guidelines for claiming the refund, which were outlined in Notice 2006-50, required taxpayers to affirmatively request the refund on their 2006 federal tax return and precluded other administrative remedies.

A number of taxpayers filed suit to overturn the Notice, claiming that it represented final agency action that “arbitrarily, unreasonably, and unlawfully limits restitution of the funds unlawfully exacted.” In re Long-Distance Tel. Serv. Fed. Excise Tax Refund Litig., 501 F.Supp.2d 34, 38-39 (D.D.C. 2007). Taxpayers protested the fact that they were not allowed to seek refunds in any other manner than that set forth in the Notice. This, they argued, constituted “final agency action” subject to judicial review under the APA, and that the Notice was laden with mandatory language and created new obligations for taxpayers in violation of the rules of administrative procedure.

The IRS argued in Cohen v. United States, No. 08-5088 (D.C. Cir. Aug. 7, 2009), that the decision of whether or not to process refund requests was entirely up to the IRS’s discretion and that its methods were unreviewable under the APA. The IRS also insisted that the guidelines set forth in the Notice did not preclude other administrative action. The Court disagreed, noting that the taxpayers had no other remedy at law than to challenge the Notice on the grounds that it violated the APA. In response to the government’s contention that the Anti-Injunction Act (AIA) precluded the suit, taxpayers said the statute was inapplicable because the IRS had already collected the tax. The AIA only affects lawsuits while the agency is in the process of assessing or collecting a tax.

Gilbert Rothenberg, acting deputy assistant attorney general to the Justice Department Tax Division, pointed out during the en banc hearing that Congress had established procedures taxpayers must follow to obtain a refund—procedures the taxpayers had ignored in this case—and that the statute of limitations was in fact still open. It would be unprecedented, he said, for a court to find that it had jurisdiction to hear a case challenging compliance with the APA when a taxpayer had not first used the appropriate refund process. But the judges questioned how the IRS could be immune from the APA and criticized the terms of the Notice.

If the court finds that the IRS failed to adequately adhere to the APA in constructing the procedures in the Notice, the consequences could be significant. A ruling for the taxpayers could require the IRS to follow formal notice-and-comment procedures when formulating guidance—such as Revenue Rulings, Revenue Procedures, and Notices—that have the effect or force of law.