District Court Invalides and Vacates Listed Transaction Reporting Regulation (4/18/26)

In Drake Plastics Ltd. Co. v. IRS, ___ F. Supp. 3d ___ (S.D. Tex. 4/15/26), CL here, and GS here [to come], the court (Judge Lee Rosenthal) considered APA claims of invalidity of the regulations determinations of “transactions of interest” and “listed transactions” for micro-captive insurance companies (from the conclusion):

          The court grants in part the plaintiffs’ motion for summary judgment and a permanent injunction, (Docket Entry No. 58), and grants in part the defendants’ cross-motion for summary judgment, (Docket Entry No. 63). The defendants (1) appropriately designated micro-captive transactions as transactions of interest through 26 C.F.R. § 1.6011-11; but (2) exceeded their statutory authority in designating micro-captive transactions as listed transactions through 26 C.F.R. § 1.6011-10. The court declares unlawful 26 C.F.R. § 1.6011-10 and vacates it. The case is remanded to the Department of the Treasury and the Internal Revenue Service for further agency action consistent with this opinion.

          The vacatur is stayed until May 1, 2026, to avoid taxpayer confusion on Tax Day. Cf. Purcell v. Gonzalez, 549 U.S. 1, 4–5 (2006) (“Court orders . . . can themselves result in . . . confusion . . . .”). Final judgment is entered separately.

I am not sure what the last paragraph stay is about, but I do understand the holdings in the first paragraph.

The court’s holding turns upon interpretation of the statutory requirement that "transactions of interest" have the “potential” for tax avoidance but that “listed transactions” that have tax avoidance, at least presumptive tax avoidance, rather than just the potential for tax avoidance. The court reasoned that the IRS did not adequately explain microcaptive arrangements identified in the "listed transaction" regulation.

Judge Rosenthal is a very good judge, so I respect her analysis, even though I am not convinced that it is correct.

The key statutory text that the court interpreted is that “listed transactions” are those “identified by the Secretary as a tax avoidance transaction for purposes of section 6011.” The court contrasts that requirement with the transactions of interest requirement that the transaction have the potential for tax avoidance. Adopting other courts’ conclusion that the listed transaction text requires the IRS to determine that there must be at least “presumptive” tax avoidance (presumptive is not in the statutory text), the court further refines/interprets presumptive to mean more than half the time. In the context of the characteristics identified in the Final Rule, the court seems to be saying that the IRS must have determined and specifically state in adopting the Final Rule its proof for believing that more than half the transactions with the characteristics would be tax avoidant transactions. Obviously, the statutory text must be interpreted to require that the IRS determine that those characteristics will appear in many, albeit perhaps not all, tax-avoidant transactions. I think it fair that the statutory text be interpreted to apply only where many transactions with the characteristics would be tax-avoidant. But I am not sure where the court’s interpretation of more than half comes from. Nor am I sure that the IRS could even make a meaningful statement with support that more than half the transactions with those characteristics would be tax avoidant. I think that all the IRS can say is that in the abusive micro-captive transactions it has reviewed, the characteristics have usually been present and that transactions with those characteristics are worth further review.

I will just offer some other comments not on the underlying merits:

1. The court notes that the IRS regularly wins the micro-captive insurance cases on the underlying merits. (Slip Op.6-7.)

2. The issue in Drake Plastics was not the merits of any particular insurance arrangement but whether the IRS had properly adopted regulations for “transactions of interest” and “listed transactions.” As noted, the court distinguished between “transactions of interest” which have the potential for tax avoidance and “listed transactions” which required that, in identifying the listed transactions, the IRS determine that the transactions identified be tax-avoidant rather than just the potential for tax avoidance. Although the court addresses (Slip Op.15) the two APA requirements that the rule (regulation) not be in excess of statutory authority (APA § § 706(2)(C)) and that the rule not be arbitrary and capricious (§ 706(2)(A)), the court found (Slip Op. 17-35) that the “listed transactions” regulation (§ 1.6011-10) exceeded the statutory authority in § 1.831 for the reasons noted. Then, for the general test in § 1.6011-11 for potential tax-avoidant transactions, the court held (Slip Op. 35-50) that the IRS tests were not arbitrary for purposes of determining potential for tax avoidance.

3. The court notes (Slip Op. 12):

           Challenges to the Final Rule followed in the Eastern District of Tennessee; the Northern District of Texas; and, here, in the Southern District of Texas. The district court in the Eastern District of Tennessee recently granted summary judgment in the government’s favor, holding that the Treasury neither exceeded its statutory authority nor acted arbitrarily or capriciously in enacting the Final Rule. CIC Servs., LLC v. IRS, No. 3:25-CV-146, 2026 WL 622836, at *9 (E.D. Tenn. Mar. 5, 2026). The district court in the Northern District of Texas, on the government’s motion to dismiss, held that the Final Rule did not exceed Treasury’s statutory authority but ruled that the plaintiff adequately alleged that the Final Rule is arbitrary and capricious. Ryan, 2025 WL 3089415, at *14. That litigation is ongoing.

4. There is at least one Loper Bright lurking in the court’s analysis. The court reaches its statutory interpretation that the regulation exceeded statutory authority based on the Loper Bright imperative that the court reach the best interpretation without deference to the agency interpretation. Interestingly, the statute text does not in explicit language resolve the issue; through statutory interpretation (Slip Op. 17-26), the court interprets the statute to resolve the issue.

I understand the Court’s statutory interpretation analysis. I think it is masterful, although I am not convinced that it is necessarily correct for the reasons noted above. The question I ask here is whether the statute’s text could be viewed as ambiguous on the issue the court decided. I think many read Loper Bright as requiring a court to reach the best interpretation without acknowledging ambiguity. I am not convinced that Loper Bright did or could eliminate the phenomenon of statutory ambiguity. See Comments on Highly Recommended Article Extending Skidmore "Deference" Approved in Loper Bright (3/7/26; 3/8/26), here (where I discuss in the blog and the comments the continuing possibility of ambiguity). Statutory ambiguity is simply a possibility that cannot be eliminated by ex cathedra type statements from the Supreme Court. If the statute is indeed ambiguous (meaning simply that there is no determinable best interpretation), I argue that the tie means that the agency wins under § 706(2)(A) (requiring that in order to find the agency rule not in accordance with law, the court must be able to find affirmatively that there is a best interpretation other than the agency interpretation, meaning that the tie goes to the agency).

5. One other picky point. The court relies (Slip Op. 25) on legislative history to discern the legislative intent (later determining what Congress “understood”) on the interpretive issue. Any attempt to discern a legislative “intent” to explain statutory text that is not ambiguous may be problematic for textualists and their ilk, although some textualists rely on legislative history if it confirms their best interpretation of the statutory text. The court cites some document in the record but cites no actual legislative history. The court does cite the Joint Committee Staff Explanation, which is not technically legislative history which precedes enactment; rather the JCT Staff Explanation, often called the Blue Book, is compiled after the enactment to state the JCT Staff Explanation of the enacted statute.