Severity Under Scrutiny: The U.S. Supreme Court Battle Over the FBAR Penalty

Abstract In recent years, Congress strengthened federal regulation of foreign bank accounts held by United States citizens. In 1970, Congress passed the Bank Secrecy Act (BSA), requiring U.S. citizens to report their foreign bank accounts using a form called the Foreign Bank Account Report, or “FBAR.” However, the Treasury Department rarely enforced this requirement. After the Patriot Act’s passage came the Bank Secrecy Act 2004 amendment, allowing the Treasury Department to delegate enforcement of U.S. foreign bank account reporting to the Internal Revenue Service (IRS) through the FBAR. The amendment’s major change to the law concerned new penalties for non-willful FBAR non-compliance. The language of the amendment created ambiguity concerning how the IRS should penalize taxpayers whose non-compliance was not willful. The BSA language failed to specify whether the failure to report penalties should be calculated per account or per unreported FBAR form. The United States government argued for the calculation of penalties to be per account, and those faced with the penalties argued the calculation should be done per form. The Ninth and Fifth U.S. Circuit Courts of Appeal differed on this issue, with the Ninth Circuit ruling in favor of per form and the Fifth Circuit ruling in favor of per account. The Supreme Court ultimately granted certiorari of the case from the Fifth Circuit and ruled in favor of per form. This article examines: (1) the history of U.S. taxpayer foreign bank account reporting requirements; (2) the changes to reporting requirements over the years; (3) the decision on what penalties the IRS could impose passed down by both the U.S. Ninth and Fifth Circuit Court of Appeals; (4) the Ninth and Fifth Circuits’ arguments regarding per form versus per account; (5) an overview of the Supreme Court’s decision in Bittner v. United States; and (6) the future effects of the Supreme Court’s decision.

I.          Introduction

Many United States citizens hold interests in financial accounts in foreign countries, but up until recently many of those account holders preferred not to disclose those holdings.[3] In fact, this has been a major source of frustration for the U.S. Treasury Department.[4] However, no one in the Treasury Department is more frustrated than the department tasked with enforcing the regulation, the IRS.[5] When Congress passed the BSA in 1970, they thought they solved this problem.[6] The BSA required U.S. taxpayers to report their foreign financial accounts using the FBAR.[7] The BSA also required taxpayers to keep records of their foreign accounts.^[8] Willful failure to comply could lead to both civil and criminal penalties.^[9] Most taxpayers knew of, but rarely complied with, this requirement through the early 2000s.[10] All that was about to change.[11] In 2004, Congress amended the BSA to include new penalties for non-willful violations and increased penalties for willful violations.^[12] Before this amendment, there had been no penalties for non-willful non-compliance.[13] After the amendment’s passage, the Treasury Department tasked the IRS with enforcing these regulations, including the new requirement from the amendment.[14] Since then, IRS efforts to penalize non-willful FBAR noncompliance have come under judicial review in at least two U.S. circuit courts.^[15] Both cases centered around whether the IRS could assess its annual penalty for non-willful violations (1) per bank account the taxpayer failed to report or (2) per FBAR form not properly filed.^[16] Imposing penalties per account can produce very large aggregate penalties.[17] Penalized taxpayers argue that penalties thus imposed can quickly become excessive.^[18] However, the IRS argues that the statute requires the reporting of each foreign bank account and, therefore, imposing penalties per FBAR is far too narrow an interpretation.^[19] Such a narrow reading of the statute would—in the eyes of the IRS—reduce compliance penalties to the point of defeating Congress’s intention to deter tax evasion and fraud.[20] The Ninth Circuit held with the taxpayer, ruling in favor of a per-form penalty.[21] However, the Fifth Circuit later held with the IRS, ruling in favor of per-account penalties.[22] The United States Supreme Court ultimately agreed with the Ninth Circuit and ruled in favor of a per-form penalty.^[23] Part I of this article provides the history of the FBAR filing requirement and the statute authorizing the requirement. Part II explains current FBAR statutory regulations and details the filing requirements more specifically. Part III discusses the analysis behind the Ninth Circuit’s ruling that the IRS can only penalize non-willful noncompliance on a per-FBAR basis. Part IV discusses the Fifth Circuit’s disagreement with the Ninth Circuit, the reasoning behind its holding, and its subsequent ruling, which favored per-account penalties as the correct interpretation of 31 U.S.C. § 5314. Part V explains the arguments behind the Fifth Circuit and Ninth Circuits’ arguments regarding per form versus per account. Part VI outlines the Supreme Court’s decision in Bittner v. United States and the implications of the Court’s decision going forward.

II.         The History of the BSA of 1970 and Its FBAR Reporting Requirements

A.  The Inception and Intent of the BSA of 1970

The BSA of 1970—codified in Title 31 (Money and Finance) of the U.S. Code—contains the statutory language establishing the filing requirement that U.S. citizens must report their foreign bank accounts and financial interests.^[24] With the BSA of 1970, Congress sought to require taxpayers to file disclosure reports and retain financial records that might later help the Treasury Department successfully prosecute criminal, tax, and regulatory investigations.[25] These reports are included as part of the FBAR.[26] The BSA, as codified in 31 U.S.C. § 5314, provides, in pertinent part: [T]he Secretary of the Treasury shall require a resident or citizen of the United States or a person in, and doing business in, the United States, to keep records, file reports, or keep records and file reports, when the resident, citizen, or person makes a transaction or maintains a relation for any person with a foreign financial agency.^[27] Essentially, § 5314 creates two requirements: (1) filing an annual report detailing each foreign bank account and financial interest held by U.S. citizens,[28] and (2) retaining those financial account records for five years.[29] Each requirement brings its own mandates. The first reads, in pertinent part: Each United States person having a financial interest in, or signature or other authority over, a bank, securities, or other financial account in a foreign country shall report such relationship . . . for each year . . . and shall provide such information as shall be specified in a reporting form . . . to be filed by such persons.^[30] While the requirement to retain records reads, in pertinent part: Records of accounts . . . shall be retained by each person having a financial interest in or signature or other authority over any such account. Such records shall contain the name in which each such account is maintained, the number . . . of such account, the name and address of the foreign bank . . . with whom such account is maintained, the type of such account, and the maximum value of each such account during the reporting period. Such records shall be retained for a period of 5 years . . . .^[31] 31 CFR § 1010.306(c) says: “Reports required to be filed by § 1010.350 shall be filed . . . on or before June 30 of each calendar year with respect to foreign financial accounts exceeding $10,000 maintained during the previous calendar year.”[32] Thus, according to the above statute and regulations, a person must file an FBAR if the person is a U.S. person with any financial interest in—or signature or other authority over—any financial accounts located outside the United States with an aggregate value exceeding $10,000 at any time during any calendar year.^[33] U.S. citizens who willfully fail to comply with the FBAR filing requirement could face steep penalties.[34] However, proving willfulness in court has historically been difficult[35] and thus has limited the ability of the IRS to enforce these penalties.[36] As the U.S. Supreme Court noted in Cheek v. United States, the government must overcome a high evidentiary standard to prove willfulness.^[37] It requires proving (1) “the law imposed a duty on the [taxpayer],” (2) “the [taxpayer] knew of this duty,” and (3) the taxpayer “voluntarily and intentionally violated that duty.”[38] Carrying this burden requires defeating any claim of ignorance, misunderstanding of the law, or “a good-faith belief that [the taxpayer] was not violating any of the provisions of the tax laws.”^[39] If the IRS can prove willfulness, increased legal penalties become available.[40] In the case of willful transactional violations, the maximum penalty is the greater of $100,000 or fifty percent of the amount of the transaction (not to exceed $100,000).[41] Similarly, when a taxpayer willfully “fail[s] to report the existence of an account or any [of the] identifying information required,” the maximum penalty is the greater of $100,000 or fifty percent of “the balance in the account at the time of the violation.”[42] In summary, if the IRS can establish willful noncompliance with § 5314, the penalty could range from $100,000 to fifty percent of a theoretically unlimited amount.^[43] While the BSA codified these provisions, the IRS rarely enforced them.[44] There were numerous reasons for the lack of enforcement.[45] “First, the government found it difficult to gather sufficient admissible evidence of undisclosed foreign financial accounts.”[46] Taxpayers hiding money overseas often put their money in financial “institutions located in countries with [very] strong [bank] secrecy laws and no tax treaty with the United States.”[47] This creates a thoroughly difficult discovery process.[48] Second, even if a foreign country has “a mutual legal assistance arrangement in place with the United States,” obtaining the right information is a “cumbersome, time-consuming process.”^[49] Third, the target taxpayers who avoid filing FBARs often commit other violations, such as “money laundering, tax evasion, and fraud.”[50] Prosecutors often bring these other charges rather than FBAR violations in court.[51] In many cases, prosecutors could charge taxpayers with both fraud and failing to file an FBAR, but only pursue a fraud charge because it is easier to prove in court.[52] Prosecutors find it too difficult to meet the evidentiary standard established in Cheek.[53] Simply put, proving a taxpayer acted “willfully” in not filing an FBAR is incredibly difficult, so prosecutors often do not prosecute FBAR violations.[54] Therefore, the Treasury Department estimated FBAR compliance at less than twenty percent before the 2004 changes.^[55] Between 1993 and 2002, the U.S. government only considered imposing monetary penalties in twelve cases.^[56] Of this dozen, only two taxpayers received penalties.^[57]

B.   The 2004 Amendment and Its Impact on BSA and FBAR Enforcement

After the terrorist attacks of September 11, 2001 and the subsequent passage of the Patriot Act, everything changed.[58] The U.S. government expanded its powers in every direction and decided to address the deficiencies in the Executive Branch’s enforcement abilities.[59] With this expansion of powers came the ability to enforce FBAR violations.[60] First, in April 2003, the U.S. Treasury Department Financial Crimes Enforcement Network (FinCEN) delegated enforcement of civil violations (such as failing to properly file an FBAR) to the IRS.^[61] Then, on October 22, 2004, Congress passed the American Jobs Creation Act of 2004 (Jobs Act).^[62] Under the Jobs Act, the Treasury Secretary (and the IRS) may impose a civil penalty on any person who violates § 5314.^[63] As discussed, this violation encompasses both failures to file an FBAR properly and failures to retain all of the necessary records concerning those foreign financial accounts.[64] In the case of non-willful violations, the IRS may now impose a maximum penalty of $10,000 per violation.^[65] However, the IRS cannot impose such a penalty if both of the following conditions are met: (1) the “violation was due to reasonable cause”; and (2) “the amount of the transaction or the balance in the account at the time of the transaction was properly reported.”^[66] The new law also allows for a higher maximum penalty for willfulness.[67] For willful violations, the IRS could now impose a penalty of $100,000 or fifty percent of the transaction amount, whichever is greater.^[68] In situations “involving a failure to report the existence of an account” or any required account information, the IRS may assess a penalty of $100,000 or 50% of the account balance when the violation occurred, whichever is greater.^[69] The 2004 amendment made three changes.[70] First, it added a new penalty for cases involving non-willful violations of 31 U.S.C. § 5314.^[71] Second, it changed the burden of proof in certain situations.[72] Previously, the IRS needed to demonstrate the violator’s willfulness.[73] Under the new law, the IRS could assess a penalty anytime a taxpayer failed to properly file an FBAR or maintain the required records.^[74] Third, the amendment increased the maximum assessable penalty for willful violations.[75] The previous penalty ranged from $25,000 to $100,000, depending upon the transaction amount or the account balance.[76] Now, the lower limit of the penalty range has increased to $75,000 per violation, and the range has no monetary ceiling—just a cap of half the account balance ^[77] The amendment made failing to file an FBAR a serious offense with major financial consequences for taxpayers holding large sums of money in undisclosed foreign financial accounts.[78] Congress’s intent is clear: “taxpayers must disclose, disclose, disclose, or suffer the consequences.”^[79]

III.       Ninth Circuit Interpretation of the IRS Ability to Assess Penalties

A.  United States v. Boyd

On September 1, 2020, the U.S. Ninth Circuit Court of Appeals heard United States v. Boyd.^[80] Jane Boyd, an American citizen, held financial interests in fourteen accounts in the United Kingdom.[81] After her father died in 2009, she deposited her inheritance into those various accounts, increasing the balances significantly.[82] Boyd then received interest and dividend income from those accounts but did not report the income on her 2010 return, file the required 2010 FBAR, or disclose the accounts to the IRS.[83] In 2012, she disclosed her income from those accounts and filed an accurate FBAR for each of the years and accounts the IRS required her to report.[84] The filed FBAR for 2010 listed fourteen foreign accounts, with a total balance exceeding $10,000.[85] The IRS concluded Boyd committed thirteen non-willful violations of the reporting requirement under 31 U.S.C. § 5314, and assessed one violation per account she failed to timely disclose for 2010.^[86] The issue in Boyd was whether the IRS should assess non-willful violations of 31 U.S.C. § 5314 per FBAR (i.e., per noncompliant year) or per undisclosed account on the incorrectly filed FBAR.[87] In this instance, the IRS counted the violations per account the taxpayer failed to disclose for that particular year.[88] The taxpayer argued the IRS should asses the penalties only per FBAR, so she would only be noncompliant for filing the 2010 FBAR untimely.[89] Although she accurately completed the form, she filed it late.[90] The Ninth Circuit ultimately held that the IRS could not count violations per undisclosed account.[91] Instead, the Court held that the IRS could only penalize the taxpayer per FBAR improperly or untimely filed for each year, and not per account the taxpayer failed to properly disclose.^[92]

B.   Parties’ Arguments of Per Account v. Per Form and the Ninth Circuit’s Analysis

Boyd argued that the statutory language of 31 U.S.C. § 5314 did not support a separate penalty for each account on the 2010 FBAR she filed untimely.[93] Rather, Boyd argued that the statutory language provides that a non-willful, untimely, but accurate FBAR constitutes a single violation subject to the maximum penalty of $10,000.[94] As such, Boyd asserted the IRS’s $47,279 penalty was incorrect and the IRS should have assessed a $10,000 penalty.[95] The government disagreed, arguing that a single late but accurate FBAR may generate multiple non-willful violations since the 31 U.S.C. § 5314 reporting requirements extend to each foreign account.[96] In the government’s view, Boyd’s interpretation of the 31 U.S.C. § 5314 amendment is incompatible with the original statute’s language.[97] Even in relation to the penalties for non-willful violations, the language addresses the specific accounts held, and not simply the filing of the FBAR.^[98] The court opined that while the language of the penalties for willful violations is clear, the language used for penalties of non-willful violations is vague.[99] The language in 31 U.S.C. § 5321(a)(5)(A) provides for the assessment of a monetary penalty on any person “who violates, or causes any violation of[,] any provision of section 5314.”^[100] The court contends that “Congress did not define ‘provision.’”[101] The court thereby interpreted “provision” as meaning the regulatory mechanisms by which § 5314 would be enforced.[102] The language says that a U.S. citizen with foreign financial accounts must report them to the IRS and maintain records. The mechanism for doing so is the FBAR, which discloses these accounts; without the FBAR, there is no way for the taxpayer to comply with the statute.[103] The court then reviewed the nature of Boyd’s violation.[104] Though she had failed to disclose her foreign financial accounts in a timely manner, she did disclose them, and her FBAR was accurate.[105] The court stated that Boyd did not violate 31 C.F.R. § 1010.350(a), the regulation that delineates the content of the report (FBAR).[106] Though she was not timely in filing her 2010 FBAR, the FBAR and its contents were accurate.[107] The court thereby disagreed that she had committed multiple non-willful violations of § 5314, simply because she failed to file the 2010 FBAR in a timely manner.^[108] The government then argued that the word “any” before “violation” in § 5321(a)(5)(A) indicates that several violations may occur.[109] The court was unpersuaded, and again referred to the provision prescribing the FBAR as the mechanism for enforcing § 5314.[110] The court found that since the statute cannot be enforced without filing the FBAR, the violation the taxpayer committed was the failure to use the mechanism to comply with § 5314.[111] The new penalty provision in § 5321(a)(5)(B)(i) does not expressly authorize multiple non-willful violations, while the willful violation language is very clear.[112] The court therefore held that if non-willful violations were meant to be enforced in the same manner as willful violations, then the language authorizing that would be plainly stated, as it was for willful violations.[113] The court stated, “Congress generally acts intentionally when it uses particular language in one section of a statute but omits it in another.”^[114] Therefore, the court “presume[d] that Congress purposely excluded [any] per-account language from the non-willful penalty provision” while keeping per-account language in the willful violation section of § 5314.[115] Based upon that presumption, the court further presumed that Congress acted intentionally in omitting that language.[116] Therefore, the IRS did not follow the statutory intent of Congress when it penalized Boyd per account.[117] As the court said, “[w]e decline to read into the statute language that Congress wrote in the willful penalty provision but omitted from the non-willful penalty provision.”^[118]

C.   The Dissent

Of the Ninth Circuit panel’s three judges, two judges held in favor of Boyd and one judge dissented.[119] The dissent argued that the creators of the Bank Secrecy Act and 31 U.S.C. § 5314 intended to combat the “widespread use of foreign financial institutions . . . [to violate or evade] domestic criminal, tax, and regulatory enactments.”^[120] The dissent went on to state that IRS penalties are an extremely effective enforcement tool, and that the majority’s interpretation of the statute narrows the scope to the point of limiting the statute’s ability to deter these criminal acts.[121] The dissenting judge opined that the clearest interpretation of 31 U.S.C. § 5314 was that a non-willful violation could be penalized per account, and declared “[the majority’s] interpretation is contrary to the language of the relevant statutes and regulations as well as being implausible in context . . . .”^[122] The dissent believed the court should consider the source of the penalties to be the language of 31 U.S.C. § 5314, as opposed to the provision which created the mechanism for enforcing it.[123] The statute clearly states that it addresses U.S. taxpayers hiding foreign financial accounts, not violating the reporting requirement.[124] Since penalties arise from the government’s interest in the accounts rather than the mechanism for reporting them, the statute should take precedence over the provision.[125] As such, the IRS should assess penalties per account instead of per form.[126] The dissent also disagreed on the relevance of whether a violation is willful or non-willful.[127] Regardless, the violation is the same: the failure to report a single account or a single transaction.^[128] As the court noted, “the applicable statute and regulations make clear that any failure to report a foreign account is an independent violation, subject to independent penalties.”^[129] In the dissent’s view, the majority conflates the reporting form (the FBAR) with the contents that are required to be reported (the foreign bank accounts themselves).^[130]

IV.       Fifth Circuit Interpretation

A.  United States v. Bittner

On November 30, 2021, the Fifth Circuit Court of Appeals decided United States v. Bittner.^[131] Bittner, a Romanian-American dual citizen, moved back to Romania in 1990 and lived there until 2011 after living in the United States for eight years.[132] He never renounced his American citizenship.[133] While living in Romania, Mr. Bittner generated considerable income and opened numerous foreign bank accounts.[134] His investment ventures revealed him to be a sophisticated businessman.[135] In addition, the district court highlighted that “Mr. Bittner demonstrated at least some level of awareness about his tax obligations as a United States citizen, as he filed United States income tax returns for 1991, 1997, 1998, 1999, and 2000” despite living in Romania during those years.[136] The government assessed $2.72 million in civil penalties against him—$10,000 for each of the 272 bank accounts he had failed to disclose for all the years he had not filed an FBAR.^[137] However, Bittner did not return to the United States until 2011.[138] Upon learning of his § 5314 obligations, he hired a CPA, who then filed his FBARs for the years 2007–2011.[139] Bittner, at first, argued in court for a reasonable-cause defense.[140] The BSA imposes no penalty for a non-willful violation of § 5314 if the violation results from reasonable cause and the individual filed the FBAR accurately.^[141] However, the court rejected his reasonable-cause defense, as Bittner was a sophisticated businessman with businesses all over the world.[142] He even admitted he did not see a reason to file an FBAR while he was living in Romania.[143] That admission confirmed his awareness of the FBAR requirement and directly refuted any possible claim of reasonable cause.[144] The court saw through this argument, rejected his reasoning, and affirmed that it was unreasonable for Bittner to claim he had reasonable cause for not filing his FBARs for the five years in question.^[145] After rejecting his reasonable-cause defense, the issue became whether the IRS should penalize non-willful violations of § 5314 on a per account or per FBAR basis.[146]

B.   The Fifth Circuit’s Reasoning and Analysis in Bittner

Just as in the Ninth Circuit case, the Fifth Circuit debated which portion of § 5314 should take precedence when applying penalties.[147] In this case, the Fifth Circuit held that the IRS could penalize per account, rejecting the Ninth Circuit’s per form interpretation.[148] The Fifth Circuit instead agreed with the Ninth Circuit's dissenting judge and held that each failure to report a qualifying foreign account constitutes a separate reporting violation subject to its own penalty.[149] The court began its proceeding by looking at the statutory text of § 5314.[150] The court used a stricter interpretation, opining that “[i]nterpretation of a word or phrase depends upon reading the whole statutory text, considering the purpose and context of the statute, and consulting any precedents or authorities that inform the analysis.”^[151] In court, the Department of Justice argued against the Ninth Circuit’s position, disputing that the regulations take precedence over the statutory language of 31 U.S.C. § 5314.[152] The Fifth Circuit agreed, finding the per-form interpretation inconsistent with the text of the BSA and its regulations.^[153] Because § 5321(a)(5)(A) penalizes a violation of any provision of § 5314, the court analyzed application of the penalty.[154] The Fifth Circuit once more affirmed that the language of the statute should take precedence by stating, “Congress generally acts intentionally when it uses particular language in one section of a statute but omits it in another.”^[155] The filing of reports only comes after one has foreign financial accounts exceeding $10,000.[156] The Fifth Circuit opined, “The regulations themselves distinguish (1) the substantive obligation to file reports disclosing each account from (2) the procedural obligation to file the appropriate reporting form.”^[157] It continued, “The regulations thus consistently implement the distinction between the reports themselves (substance) and the reporting forms (procedure).”[158] The Fifth Circuit went further in clarifying its argument that the statutory provisions of § 5314, rather than its corresponding regulations, are the source of penalties.[159] “The district court reasoned that a violation of section 5314 attach[es] directly to the obligation that the statute creates”, which is the filing of a single report.[160] The Fifth Circuit disagreed, stating that 31 U.S.C. § 5314 “does not create the obligation to file ‘a single report.’”[161] “Rather, it gives the Secretary discretion to” determine how best “to fulfill the statute’s requirement of reporting [all] qualifying accounts.”^[162] By the Fifth Circuit’s logic, the U.S. government could replace the FBAR entirely with another instrument.[163] The statute requiring U.S. citizens to disclose foreign accounts held overseas remains intact, regardless of what method or form the IRS determines best fulfills the statute’s intended purpose.[164]

C.   Bittner’s Arguments Addressed on Appeal

The Fifth Circuit affirmed that Bittner’s reasonable-cause defense lacked merit.[165] Bittner argued that a per-account reading would lead to exorbitant fees, which would be an absurd result.[166] The Fifth Circuit disagreed.[167] The court again pointed to Congress’s original intent: for the U.S. government to fight the use of foreign financial accounts as a means to evade taxes and hide wealth.[168] The court affirmed “[i]t is not absurd—it is instead quite reasonable—to suppose that Congress would penalize each failure to report each foreign account.”[169] Finally, “[a]s a last resort, Bittner turn[ed] to legislative history,” which, according to the court, is “highly disfavored in the Fifth Circuit.”^[170] The court concluded: The text, structure, history, and purpose of the relevant statutory and regulatory provisions show that the “violation” of section 5314 contemplated by section 5321(a)(5)(A) is the failure to report a qualifying account, not the failure to file an FBAR. The $10,000 penalty cap therefore applies on a per-account, not a per-form, basis.^[171]

V.        The Fifth and Ninth Circuits’ Arguments to the Supreme Court

While the Fifth Circuit favored per account and the Ninth Circuit favored per FBAR, both circuits raised important reasons for siding with its preferred method.[172] Understanding the arguments for per FBAR versus per account will clarify how the Supreme Court arrived at its decision.[173]

A.  The Argument for Punishment Per FBAR and Deference to Provision

The central question in Bittner is how a non-willful violation of 31 U.S.C. § 5314 should be penalized.[174] Failure to disclose foreign financial accounts may result in a non-willful violation of 31 U.S. § 5314, for which willfulness is not required.^[175] To prove willfulness, the government must show the defendant committed a “voluntary, intentional violation of a known legal duty” beyond mere ignorance.[176] That is likely why Congress amended the BSA and expanded its enforcement powers.[177] A taxpayer who commits a non-willful violation can still be penalized, even if they claim ignorance.[178] The penalties for willful violations are far greater than for non-willful violations, so Congress likely did not decide to replace one word with another when the punishment is the same.[179] Presumably, Congress intended to make a distinction between willful and non-willful violations. However, the penalties for willfully violating § 5314 are clearly spelled out, and taxpayers can be penalized per account.[180] That is presumably why the Ninth Circuit held that if Congress intended for non-willful violations to be penalized in the same manner, the amendment would state as much.[181] Since it did not, the Ninth Circuit seemingly inferred that the penalty must be different.[182] The only determinable difference would be if the non-willful violators were penalized per FBAR rather than per account, as willful violations would be.[183] Punishment per account would make non-willful violations no different from willful violations, which the Ninth Circuit found to be contrary to Congress’s intent.[184] One also must consider the mechanism of action. In both the Fifth and Ninth Circuit cases, the defendants disclosed their foreign financial accounts to the IRS.[185] While they filed the FBAR late, they still provided an accurate assessment of their foreign accounts.^[186] Non-willful violators are presumably not often tax evaders, terrorists, or money launderers, as these individuals do not intend to break the law.[187] The purpose of non-willful disclosures is to promote unwilling compliance through required disclosure.[188] Criminals, terrorists, and tax evaders likely have no interest in complying.[189] Since willful and non-willful violators are viewed differently, one can infer that their penalties should be viewed as separate and based upon a different standard.[190] It may make more sense to penalize willful violators per account because they are willfully defying 31 U.S.C. § 5314.[191] Non-willful violators ultimately comply  through disclosure; therefore, it is just a matter of when compliance occurs, as in Boyd and Bittner.[192] While non-willful violators have accounts subject to the § 5314 filing requirements, they have limited interactions with actual regulations because of the requirement to file their annual FBAR.[193] Non-willful violators need not fear IRS investigation, as they are generally not tax evaders, terrorists, or money launderers, for whom the law was presumably intended to deter.[194]

B.   Argument for Per Account Penalties and the Expansion of Executive Power

The Fifth Circuit disagreed with the Ninth Circuit’s reasoning, holding that U.S.C. § 5321(a)(5) is the origination of the penalties for both willful and non-willful violators.[195] If Congress intended willful and non-willful violators to have different penalty standards, Congress would have stated as much.[196] Since Congress did not, the Fifth Circuit followed precedent and used the statute as the basis for the penalties.[197] If holding foreign financial accounts are the basis of the statute’s regulatory power, then any penalty should be based on the holding of undisclosed foreign financial accounts rather than the single FBAR.[198] To interpret the statute to mean that the single FBAR determines the penalties, and not the holding of undisclosed foreign financial accounts is to read the statute too narrowly.[199] When Congress amended the BSA in 2004, its focus was broad, not narrow.[200] Congress added the non-willful violation and expanded the enforcement powers of the IRS, specifically to reach individuals taking advantage of the difficulty in proving willfulness in court.[201] Before this, the IRS tried enforcing the regulation with one proverbial hand tied behind its back.[202] Now, it possessed the tools to do its job.[203] There is a serious and contentious debate over the congressional intent behind the language used in the 2004 amendment.[204] Those on the side of the provisions say that if Congress intended non-willful violations to be punished the same way as willful violations, the statute would state so clearly.[205] Those with this position grapple with the fact that Congress likely added the non-willful violation language to expand the Executive Branch’s enforcement powers and tools.[206] As the Fifth Circuit opined, “[t]he government argues the district court erred in determining what constitutes a ‘violation’ under [§] 5314 by focusing on the regulations under [§] 5314 to the exclusion of [§] 5314 itself. We agree.”^[207] This goes straight to the core of the penalty per account argument.[208] The per FBAR penalty circumvents § 5314 itself, essentially rendering it toothless. The sole purpose of the penalty per account interpretation could then be attributed to the FBAR itself and its filing as opposed to the foreign financial accounts disclosed through the FBAR.[209] To penalize per FBAR is to exclude § 5314 altogether and assume the regulation stemming from it is a self-standing statute, instead of a regulation deriving its power from § 5314.[210] As the Fifth Circuit further enumerated, “A per-form interpretation is inconsistent with the text of the BSA and corresponding regulations.[211] Here, the Court rejected the “contention that [a] single statement by the Supreme Court, taken out of context, should be used . . . to reject the clear and express provisions of the [statute].”^[212]

VI.       The Supreme Court’s Decision of Bittner and Future Implications

On February 28, 2023, the Supreme Court released the decision to answer the contentious issue over whether non-willful violators are penalized on a per account or per FBAR basis.[213] In a 5-4 decision, the Court held for per FBAR.[214] The slight majority used the tools of plain language, administrative guidance documents, the history of the BSA, and the rule of lenity.[215] However, the dissenters argued for per account using plain language and alluding briefly to the administrative documents but avoided any discussion over the history of the BSA and the rule of lenity.[216]

A.  Majority Decision

The majority looked at four factors: (1) the plain language of §§ 5314 and 5321; (2) the government’s handling of the BSA to the public; (3) the history of the non-willful provision and the BSA’s purpose; and (4) the rule of lenity.[217] While most of the Court agreed with these principles, Justice Gorsuch and Jackson were the only justices to join the rule of lenity portion of the opinion.[218]

1.                   Plain Language of §§ 5314 and 5321

Beginning with the language of §§ 5314 and 5321, the Court kept it plain and simple.[219] The word “reports” appears in § 5314, not “accounts.”[220] There is not a single mention of “accounts” until § 5321(B)(ii) under the reasonable cause exception within the non-willful provision.[221] The lack of the word “accounts” and inclusion of “reports” demonstrates that a § 5314 violation is binary, dependent on the filing of a report.[222] The information regarding the accounts is irrelevant for purposes of violating § 5314 under its filing requirement.[223] Therefore, a taxpayer is a violator for failing to file a report, not incorrectly reporting information over an account.[224] Whether a taxpayer makes a mistake on the account information or does not file willfully or non-willfully is not a determining factor.[225] The only consideration under § 5314 for the filing requirement is the FBAR filing.[226] The majority furthered this argument by noting that § 5321 lays out the potential types of violators for incompliance with § 5314—the non-willful and willful violators.[227] Before discussing the types of violators, the Court pointed out how Congress in § 5321(a)(5) allows civil penalties for “any violation. . . of Section 5314.”[228] If “any violation” under § 5314 depends on “reports,” then the exact language of “any violation” under § 5321 would also depend on reports unless stated otherwise.[229] Further, the non-willful provision does not change the violations of § 5314 by tailoring penalties per account; however, the willful provision does tailor penalties per account.[230] Therefore, the non-willful provision would remain per FBAR as in § 5314, while the willful provision would change to per account.[231] However, the dissent harped on how the language of “accounts” is mentioned in the reasonable exception under the non-willful provision specifically to tailor penalties per account.[232] The majority rejected the dissent’s argument using “expressio unius est exclusio alterius.”[233] This common law principle echoes that Congress uses different and particular language in sections of the same statute “to convey a difference in meaning. . . .”[234] Notably, Congress did not use the word “accounts” in the same manner under non-willfulness as it did in the willful provision.[235] The willful provision looks to Subsection (D)(ii) to tailor penalties upon the amount dependent on the balance of the foreign “accounts.”[236] Under the non-willful provision, Congress uses “accounts” to demonstrate that giving accurate information will prove there was no intended deception, allowing taxpayers to use the reasonable cause exception.[237] Ultimately, the majority finds the language of these two statutes as plain in its similarities and differences, and thus the majority cannot ignore them.[238]

2.                   The Government’s Handling of the BSA to the Public

The majority then looked at how the Government has handled the enforcement of the BSA through its issuance of public documents.[239] While the majority admitted that these documents are not controlling in statutory interpretation, the Court could use the agency’s interpretation to find an undermining by its inconsistent application “with [an agency’s] earlier pronouncements.”[240] The Court looked at several public documents such as an IRS letter, IRS tax form, and issuance of notice from the Department of the Treasury.[241] Each document had language that signified to the public that failure to file an FBAR could lead to a penalty not exceeding $10,000.[242] The Court reasoned that the government’s now-interpretation of a per-account basis for failure to file an FBAR is incongruent with how they have previously handled the current penalties for non-willful violation.[243] Therefore, the government’s prior publication of non-willful violations demonstrated that there has always been a different penalty structure depending on the type of violator.[244]

3.                   History of the Non-willful Provision, the BSA’s Purpose, and Logical Implications

The majority then examined the history of the BSA’s willful provision, Congress’ statement of purpose, and several illustrations with implications for the BSA.[245] Congress adopted the BSA in 1970, but willful violations for failure to file FBARs were not per-account. Congress did not even implement per-account penalties until 1986 for the willful provision.[246] Yet, the non-willful provision did not manifest until 2004, which did not replicate the language of per-account penalties in the willful provision.[247] Since Congress already knew how to create a per-account penalty, Congress could have simply mirrored the same 1986 language for the non-willful provision.[248] Since Congress did not do so, the majority argued that Congress did so intentionally.[249] Additionally, the Court looked at Congress’ statement of purpose under 31 U.S.C. § 5311.[250] Congress declared “that the BSA’s ‘purpose’ is ‘to require’ certain ‘reports’ or ‘records’ that may assist the government in everything from criminal and tax to intelligence and counterintelligence investigations.’”[251] Since Congress’ purpose was filing the “reports,” § 5314 should be per FBAR as this would be congruent to the goal in § 5311.[252] Finally, the majority had several illustrations to denote that a per-account basis under the non-willful provision would hurt the BSA’s purpose due to illogical implications.[253] However, one of the examples seems to demonstrate the confusing consequences.[254] If one individual had 12 million dollars in one account and another individual had an aggregate of $10,001 over 12 accounts and both non-willfully violated by failing to file an FBAR, the individual with $12 million would be subject to a $10,000 fine.[255] In contrast, the individual with $10,001 would be subject to a potential $120,000 penalty.[256] Logic would seem to insinuate that Congress would not attribute penalties in a fashion whereby the smaller taxpayer is paying exorbitantly more solely because of more accounts.[257] Therefore, Congress’ purpose of the BSA on “reports” would only be furthered per FBAR to avoid illogical penalties.[258]

4.                   Rule of Lenity

Finally, Justice Gorsuch, joined by only Justice Jackson in the majority, agreed to use the rule of lenity, which justices use to construe a statute “imposing penalties . . . ‘strictly’ against the government and in favor of individuals.”[259] The Court gave two reasons for rejecting per account under the rule of lenity.[260] First, the rule of lenity protects taxpayers’ due process by giving them a fair warning with clarity to understand the law.[261] Second, the government’s ability to impose civil penalties in § 5321 and criminal penalties in § 5322 leads to higher scrutiny to ensure fair penalties for the taxpayer.[262] With the principle of fair notice, the Court discussed the public guidance documents.[263] The issued guidance demonstrated that non-willful violators would face penalties per FBAR.[264] However, professional tax accountants were confused and unaware of the FBAR penalties.[265] This confusion showed that an ordinary individual would not have received fair notice since professional accountants did not even understand the penalties from the public tax documents.[266] With § 5322, this Section handles criminal penalties and uses “violation” in the same manner as § 5321.[267] Therefore, the violations would be focused on filing reports unless stated otherwise.[268] With the criminal penalties under § 5322, the Court used the facts of Bittner to demonstrate the ramifications of a per-account basis creating impossible criminal penalties.[269] For each misstated or late-reported account rather than a late or deficient FBAR, this per-account basis would give rise to the “possibility of a $250,000 fine and five years in prison.”[270] In the facts of Bittner, which involved five reports and 272 accounts, that would mean that he would face “a $68 million fine and 1,360 years in prison rather than a $1.25 million fine and 25 years in prison.”[271] The Court opined that 25 years of prison alongside the $1.25 million fine would be more aligned with “common sense” in penalizing a non-willful violator.[272] Therefore, this type of reading of § 5322 would require an interpretation that follows the suit of § 5321 to favor the taxpayer and ensure common sense penalties.[273]

B.   The Dissenting Opinion

The four dissenting justices conclusively agreed that the plain language of § 5314 should lead any reader of the BSA that a per-account basis is also for non-willful violators.[274] The dissenters understood the requirements under § 5314 to attach to each account.[275] Section 5314 requires firstly filing when there is a “relation to” a foreign individual account, which means each separate account acts as a trigger to file an FBAR.[276] And if any particular account is missing, the taxpayer fails the reporting requirement because they missed a trigger for filing, which, in the eyes of the dissenters, is the sole concern of § 5314—the foreign accounts.[277] The dissent also looked at the second requirement for record-keeping under § 5314.[278] The dissenting justices noted that taxpayers can only record-keep per account because there are records for each account.[279] And if record keeping is per account, then the other requirement under § 5314 should follow suit.[280] Since the duties are parallel, each requirement begins once a “relation” exists to an individual foreign account.[281]

C.   The Effects of the Supreme Court’s Decision in Bittner

The implications of the Bittner decision are seemingly advantageous for non-willful violators but also lead to new questions. While there is an immediate answer for non-willful violators, there are questions regarding refunds for wrongfully penalized non-willful violators, the standard for willfulness, and the potential higher scrutiny from the IRS on FBAR filings.[282]

1.       The Immediate Effect and the Continued Issue of Per-Account

Immediately, non-willful violators of the BSA will solely be penalized on a per-FBAR basis regardless of the account number.[283] However, the government argued how the Treasury could turn the now-per-FBAR analysis for non-willful violators into a per-account basis.[284] The government noted how, theoretically, the Treasury could request that a taxpayer file an FBAR filing per bank account.[285] If an individual had ten accounts, the Treasury could make a new rule requiring ten FBAR filings.[286] This new rule would essentially be the Treasury disguising per account under per FBAR. While the Court side-stepped this potential issue, this interesting hypothetical opens the door for a potential per-account basis under the non-willful provision.[287] Additionally, there may be a potential argument for per FBAR in the willful provision due to its two-prong requirement where the first prong does not mention “accounts.”[288] Theoretically, taxpayers could argue the majority’s analysis to demonstrate that “accounts” was not mentioned to keep the per FBAR basis.[289] While the Supreme Court would presumably echo that Congress created per account specifically for the willful provision, there is still, nonetheless, an argument available.

2.       Refunds for Past Non-Willful Violators

Past non-willful violators who have already paid any amount exceeding the $10,000 penalty for the annual FBAR filing are left wondering if they will be refunded.[290] While the IRS may create a refund program, the IRS may not have the authority or be obligated to do so.[291] Yet, the answer remains likely a yes to refunds for two reasons. First, the Supreme Court has held that States have had to remedy incorrect tax impositions due to basic due process.[292] Second, the taxpayers may make claims under the Tucker Act of 1887.[293] In Harper v. Virginia Dep’t of Taxation, the Supreme Court held that when a State imposed an impermissible tax, “the Due Process Clause of the Fourteenth Amendment obligate[d] the State to provide meaningful backward-looking relief to rectify any unconstitutional deprivation.”[294] The States have discretion in handling the process for this remedy, but a remedy is required.[295] Similarly, the federal government would likely have to rectify this issue because the government imposed an impermissible tax.[296] With the Tucker Act, taxpayers who paid these excessive taxes may file a claim in the Court of Federal Claims, arguing that the government collected money illegally.[297] Unfortunately, this pathway of recovery would be barred unless the taxpayer made a claim within six years of accrual.[298] Therefore, non-violators making a claim under the Tucker Act before 2017 may have an issue with statutory limitations.[299] Ultimately, the handling of refunds remains an issue whereby the IRS has not given any sense of how they may handle these overpaid penalties. Time will tell how the IRS may address the potential problems with statutory of limitations and who may be entitled to a refund.

3.       Higher Scrutiny on “Willful” Violators

The IRS will have lost money due to the inability to penalize non-willful violators at more than $10,000 per FBAR compared to per account.[300] The IRS will seemingly become more stringent in finding willfulness in violators to recover some of the lost money. However, how will the IRS handle the standard for “willfulness”? The Federal Circuit has already found willfulness by failing to review one’s tax returns that would reveal the FBAR requirement.[301] Further, in Bedrosian v. United States Department of Treasury, the Third Circuit expanded willfulness where a taxpayer “ought to have known” or “was in a position to find out for certain very easily.”[302] How the IRS will judge willfulness will be an interesting aspect to focus upon going forward.

VII.      Conclusion

With the 2004 BSA Amendment, the Legislative Branch chose to expand the Executive Branch’s power to enforce compliance with 31 U.S.C. § 5314.[303] Before this change, the Secretary of Treasury estimated that less than 20% of U.S. citizens complied with § 5314.[304] Many U.S. citizens did not comply due to the government’s difficulty in proving willful non-compliance in court.[305] After the September 11, 2001 terrorist attacks, the Patriot Act gave the government a way to enforce § 5314 compliance.[306] They simply created a new kind of violator: the non-willful.[307] The non-willful violator is now compelled to reveal themself through their disclosures or face penalties.[308] However, Congress failed to clearly spell out penalties for the non-willful violator.[309] The statute could be interpreted to read that non-willful violations should be penalized according to the number of foreign accounts the non-willful violators hold or the number of FBARs that they fail to file; however, the latter potentially leads to serious and far-reaching consequences.[310] In Boyd, the Ninth Circuit decided upon the per FBAR interpretation of the debate.[311] The Court opined that the statute did not express penalties for non-willful violations, so if Congress intended to have the same penalty (per account) as willful violations, Congress would state such clearly.[312] They decided upon enforcement of the provision of § 5314, permitting penalties according to their failure to file the document maintaining compliance with the IRS rather than to the accounts you held that would make you a party to § 5314.[313] The Court’s narrow focus limited the ability of the IRS to execute its newfound power.[314] In United States v. Bittner, the Fifth Circuit held that the per account side of the argument should apply and struck down the reasoning in Boyd.[315] The Court used precedent to determine that the statute must take precedence over the statutory provision.[316] A provision cannot exist without first having a statute from which it arises.[317] A penalty should be determined by the statute from which it arises, as the statute is the point of origin in the matter at hand.[318] The provision, FBAR, is only a means of enforcing the statute.[319] The Fifth Circuit also clarified the intent of Congress.[320] Congress intended the 2004 BSA amendment to solve the problems preventing BSA enforcement.[321] Narrowing the focus of the new penalties subverts the Congressional intent of the amendment.[322] The Supreme Court decision in Bittner has ultimately clarified the ongoing disagreement between assessing penalties per account versus per FBAR.[323] Finally, the fate of non-willful penalties has been decided. The Supreme Court favored the per FBAR assessment of penalties. One would think that this decision would clear all problems for non-willful violators. Yet, new questions have arisen. The main question for past non-willful violators will be when they get refunds, if any. While past non-willful violators may not receive refunds soon, all non-willful violators will receive safety from a per-account basis.[324] [sc name="notes1569"][/sc]

Proposed Regs Could Cast a Wider Net for Microcaptive Scrutiny

by Chandra Wallace The microcaptive reportable transaction regulations proposed April 10 mean a whole new set of transactions are now listed transactions — considered abusive by the IRS and subject to challenge — tax advisers warn. The proposed regs ( REG-109309-22 ) designate two microcaptive transaction types as “listed transactions” and one as a “transaction of interest” — categories that require disclosures to the IRS Office of Tax Shelter Analysis. But the proposal defines transactions subject to its requirements to include transactions “substantially similar to” those described in the notice. Transactions structured to get around a prior version of disclosure obligations for microcaptives — the now-obsolete Notice 2016-66 , 2016-47 IRB 745 — may fall within the scope of these proposed regs if the IRS considers them substantially similar to those described in the regs, according to David J. Slenn of Akerman LLP. “Now that this is a listed transaction, you’d better be really confident” that a transaction isn’t “wrapped up into the ‘substantially similar’ designation, because if it is, you’re going to be facing pretty stiff penalties,” Slenn said.

Sequencing New Regs

In prior years, Treasury and the IRS issued notices on reportable transactions under existing regulations at reg. section 1.6011-4(b)(2) through (b)(6), but those notices were challenged on procedural grounds, Slenn explained. Notably, Notice 2017-10 for syndicated conservation easement transactions and Notice 2016-66 for microcaptive transactions were both sidelined by court rulings that the government failed to comply with the formal notice and comment process mandated by the Administrative Procedure Act. The government put “those notices out there under those categories and thought that was okay — and obviously it wasn’t,” Slenn said. Slenn expects the IRS to continue adding to the regulations defining reportable transactions under section 6011 . The IRS is “now sequentially going, starting with dash 9 for conservation easements . . . dash 10 for listed [ microcaptive transactions], and dash 11 for” microcaptive transactions of interest, he said. In December 2022 Treasury and the IRS issued proposed reg. section 1.6011-9 defining and identifying syndicated conservation easements as listed transactions. The current proposed regulations add reg. section 1.6011-10 and reg. section 1.6011-11, setting out microcaptive transactions that the government now considers to be listed transactions and transactions of interest, respectively. “You can expect the same sequential process to occur for other transactions” the IRS considers to be abusive or potentially abusive, Slenn said. Issuance of proposed regs moves the IRS and Treasury away from fighting over the procedural validity of their scrutiny of microcaptives and into focusing on the substance of the transactions, according to David J. Warner of Holtz, Slavett & Drabkin APLC.

Loan Backs

One substantive characteristic of some microcaptive transactions that the government spotlighted for listed transaction treatment is the inclusion of a financing element. “IRS is clearly more concerned with microcaptive transactions involving financing like loans or other means of returning deducted premiums to related parties and, as such, has made these listed transactions that will be challenged by IRS,” Beckett G. Cantley of Cantley Dietrich told Tax Notes . “They’ve determined that you’re in the worst category automatically if you’ve made a loan back within the last five years,” Charles J. Lavelle of Dentons said. He noted that such loans are probably significantly less common than before Notice 2016-66 was issued, and that there have been cases in which microcaptive arrangements that included loans back to the insured company passed muster with the IRS. Cantley, who chairs the Captives Subcommittee of the American Bar Association Section of Taxation, noted that “the e^ect of the splitting of microcaptive transactions into listed transactions and transactions of interest generally sorts transactions into ‘bad guys’ and ‘maybe bad guys.’” Despite that sorting, Cantley expects microcaptive reporting “to be looked at with heavy skepticism inside IRS for both transaction categories.” The IRS “intends to challenge” the microcaptive listed transactions described in reg. section 1.6011-10 and “may challenge” the transactions of interest identified in reg. section 1.6011- 11, according to the proposed regs. The government “may also challenge the purported tax benefits from these transactions based on the economic substance, business purpose, or other rules or doctrines if applicable based on the facts of a particular case.”

Captive Insurance

Captive insurance arrangements depend on the intersection of two tax treatments. First, companies can generally claim tax deductions for the cost of insurance coverage premiums. Second, nonlife insurance companies that meet the criteria in section 831(b) can elect to pay an alternative tax based on their taxable investment income only — not including premium income received. The statute caps the amount of premium they can receive and still qualify to make the election at $2.2 million, indexed for inflation. In captive insurance arrangements, companies enter into insurance (or reinsurance) contracts with related entities that elect alternative tax treatment under section 831(b) . The related entity is referred to as a “captive” or “ microcaptive ” because it is at least partially owned by the company it is insuring, and the premium cap under section 831(b) means that the related entities are generally small companies. The insured company deducts its payments to the related entity as insurance premium — reducing its taxable income — but the related entity doesn’t include the payments it receives in its taxable income. And while some companies use the section 831(b) election as a tax benefit to reduce the cost of insurance, according to Treasury, others abuse the election to claim a tax benefit without any true insurance activity or purpose underlying the arrangement.

What Is Insurance?

This leaves regulators with the difficult task of parsing what a true insurance arrangement is for federal income tax purposes. Neither Congress nor Treasury has formulated a definition of insurance in this context, despite acknowledgement by IRS officials of the long-term problem. Courts look to whether the arrangements bear hallmarks of what people commonly consider to be insurance, whether there is an insurance risk, and whether there is a shifting or distribution of risk. But the case that defined that analysis, Helvering v. LeGierse , 312 U.S. 531 (1941), was decided more than 80 years ago.

Civil War II : The Constitutionality of California’s Travel Bans

Abstract

California, along with a few other states leaning toward the liberal side of America’s political system, enacted a series of laws banning state-funded or state-sponsored travel to other states identifying more as conservative. While other states enacted these mandates through gubernatorial executive orders, California legislated its ban. Multiple states have attempted Supreme Court challenges to California’s law under the Court’s Article III original jurisdiction. Yet, the Court twice declined the opportunity to hear the issue. Justice Thomas and Justice Alito wrote extensive dissents against the majority’s rejection, arguing that the Court must exercise its jurisdiction in controversies between the states. This Article analyzes the Court’s history of original jurisdiction cases and seeks to answer why the Court likely did not address the constitutionality of California’s laws. Further, this Article analyzes whether California’s statute is unconstitutional under Article I of the U.S. Constitution and the Dormant Commerce Clause. Finally, this Article concludes with an analysis of possible likely outcomes of California’s laws and other states’ reactions.

Introduction

“Two households, both alike in dignity . . . from ancient grudge break to new mutiny.” [1] Much like the Houses of Montague and Capulet, the individual states within the United States often find themselves diametrically opposed to each other’s political views. While America’s political divide has undeniably grown deeper over the years, it seems to be widening at a staggering pace recently. Of late, this higher level of political grudge appears in the form of California’s legislation banning state-funded or state-sponsored travel to twenty-two sister states. [2] At the forefront of this political showdown is Texas. California and Texas are not only America’s two most populous states, but they are also economic and political giants sitting on fundamentally opposite ends of the political spectrum. Sharing a history of fiery disagreements and political clashes, the two states are the exemplification of a country so dangerously divided it is almost reminiscent of a Shakespeare play. The scene opens with California, a Democrat exemplar, escalating historically political disagreements to the economic stage by prohibiting state-funded or state-sponsored travel to any state failing to meet California’s civil rights standards regarding sexual orientation, gender identity, or gender expression. [3] Unsurprisingly, the Republican stronghold of Texas is cast as the villain by California and thus made the top of California’s list of travel ban states. [4] The metaphorical stage is now set. If California were a nation, it would be one of many nations banning state-funded travel to countries with whom they have political hostilities. [5] The United States has similar bans for Venezuela, Cuba, and North Korea, just to name a few. [6] But California is not an independent nation. It is only a state, albeit an influential one, and its legislative lashings are setting an exceedingly dangerous precedent for the nation as a whole. The image of an America in which each state freely imposes state-funded travel bans to other states with whom they have political disagreements is a somber picture to imagine, and one that questions the textual meaning and purpose of a United States. With the days of both Texas’s and California’s independent nationhood long past, their legislative and ideological clash must be confined to the limits of the U.S. Constitution and federal law. However, when Texas challenged California’s bans in the U.S. Supreme Court, the motion for leave to file a bill of complaint was denied, despite the Court’s majority consisting of Republican justices. [7] This Article examines Supreme Court precedent in deciding cases under its original and exclusive jurisdiction of controversies between two or more states. [8] Additionally, this Article analyzes the possibility of the Court hearing such controversies under the Dormant Commerce Clause instead. [9] Ultimately, the question is not whether the Supreme Court can resolve this inter-state brawl, but whether it will choose to do so or instead let the people seek out their own resolutions. As of August 2022, California’s travel ban prohibits state-sponsored or state-funded travel to twenty-two states, effectively targeting roughly 44% of the nation. [10] Although the Texas challenge is the most recent, Arizona’s motion for leave to file a bill of complaint on this same issue was denied by the Supreme Court in February of 2020. [11] Justice Thomas and Justice Alito disagreed with the interpretations of the majority, which reads Article III’s “[i]n all Cases . . . in which a State shall be [a] Party, the supreme Court shall have original Jurisdiction” to mean that the Court may have original jurisdiction. [12] Justice Thomas explained that if the Court does not exercise jurisdiction over a controversy between two states, then the complaining state has no judicial forum in which to seek relief. [13] Yet, in five years of these issues being brought to the Court, Justice Thomas and Justice Alito have failed to persuade other Supreme Court Justices to hear these inter-state issues. Justice Thomas previously held a different opinion, but now “has since come to question” that opinion and believes the Court should accept Arizona’s and Texas’s invitation to reconsider its discretionary approach. [14] This Article will review the Court’s discretionary approaches, comparing Texas and Arizona’s precedent. If Article III is not enough for the Court to exercise jurisdiction, this Article explores the alternative of raising the issue through Article I’s Dormant Commerce Clause instead. The U.S. Constitution grants Congress the power to “regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes.” [15] Although the Commerce Clause only addresses the power given to Congress, the Supreme Court has long recognized that the Commerce Clause also limits states from enacting statutes affecting interstate commerce. [16] This limitation on state power is known as the Dormant Commerce Clause. The Clause’s purpose is to prevent a state from “retreating into economic isolation or jeopardizing the welfare of the Nation as a whole” by burdening the flow of commerce across state borders. [17] If any of the affected states were to bring challenges to California’s bans through the Dormant Commerce Clause, it could give the Court a window to hear cases in an area with which the Court has a history of frequent involvement. As author Levon Kalanjian warns, these unanswered issues may escalate to an economic civil war between the states. [18] However, it is likely that citizens and U.S. businesses in particular will be at the forefront of either convincing the Court to hear these issues or resolving them through alternative means, like legislation. This Article explores those possibilities as well.

I. Article III’s Discretionary Precedent

The Supreme Court’s discretion to hear cases is wide. Under 28 U.S.C.A. § 1254, the Supreme Court may review cases from a court of appeals by either granting a writ of certiorari to review a party’s petition in any civil or criminal case, or by certifying questions of law from the courts of appeals. [19] Not every petition is granted a writ of certiorari, and the Supreme Court can deny certifications for questions of law. Similarly, 28 U.S.C.A. § 1257 gives the Court the ability to review decisions from the highest court of any state. [20] Article III of the U.S. Constitution states that, “[i]n all Cases . . . in which a State shall be [a] Party, the Supreme Court shall have original Jurisdiction.” [21] The Court also has exclusive power to hear disputes between two states, which leaves no other court in the country to opine on cases brought between the states. [22] There are also protections in place against the Court exercising jurisdiction to hear a case when it should not. The Supreme Court is the only court in the country which can hear cases between California and the states on California’s travel ban list. Thus, the question becomes whether the Court has mandatory jurisdiction over cases when the Supreme Court has declined to do so. In America’s relatively brief existence, the Court has addressed this issue many times. However, as the Arizona and Texas cases demonstrate, there is still disagreement on the Court’s duty in these kinds of cases.

A. Cohens v. Virginia

In Cohens v. Virginia, [23] the parties, one of which was the State of Virginia, sought to have their claims heard by the Supreme Court, so they asked the Court to exercise its original jurisdiction instead of its appellate jurisdiction. The case placed a question of law before the Supreme Court, [24] arriving at the Supreme Court through a writ of error in which one party accused the lower courts of misinterpreting the U.S. Constitution. It was argued that in circumstances in which a case can be heard by the Court through either of the two methods, then the Court must exercise original jurisdiction to hear the case. [25] The Court extensively analyzed when it should or must hear a case brought under the Court’s original jurisdiction. Ultimately, the Court declined to exercise original jurisdiction. [26] Chief Justice Marshall, writing for the Court, stated, “It is most true that this Court will not take jurisdiction if it should not: but equally true, that it must take jurisdiction if it should.” [27] He opined that, unlike the legislature, the judiciary cannot, “avoid a measure because it approaches the confines of the Constitution.” [28] Chief Justice Marshall further stated that the Court “[w]ith whatever doubts, with whatever difficulties, a case may be attended” must still hear and decide the case. [29] He was adamant that the Court cannot avoid questions out of a simple preference not to address them. [30] However, Article III does not extend the judicial power to every violation of the Constitution which may possibly take place, only to a case in law or equity. [31] So with this language, it is puzzling when the Supreme Court turns away cases in law or equity in which it has original jurisdiction, as it did with Texas and Arizona. While quarrels between states are to be expected, these disputes often come at a cost to the American people. In Cohens, Chief Justice Marshall wrote that American people “believe[] a close and firm Union to be essential to their liberty and to their happiness” and are “taught by experience, that this Union cannot exist without a government for the whole.” [32] He opined that Americans are also taught that “this government [is] a mere shadow, that must disappoint all of their hopes, unless invested with large proportions of that sovereignty which belongs to independent States.” [33] In Cohens, the Court acknowledged that states have a degree of independence to enact their own laws, while still operating within the constitutional constraints designed to protect against abuse of power by any state. [34] The California travel ban may potentially be such an abuse of power. In many other instances, the Court had little restraint in deciding when states have stepped over the line, but the Court’s decision not to do so with the travel ban issue is noteworthy and yet not completely unfounded. However, Cohens primarily addressed the Court’s appellate jurisdiction. Other precedent is more enlightening on the Court’s decision not to take on the assignment to rule in the Texas and Arizona cases.

B. Louisiana v. Texas

Nearly a century after Cohens, the Supreme Court reluctantly decided to hear Louisiana v. Texas. The Governor of Louisiana asked the Court for leave to file a bill of complaint against the State of Texas, its Governor, and its Health Officer. [35] Louisiana was permitted to file the bill of complaint because the Court decided that it was the best course of action for the case. [36] Demurrer to the bill was sustained, and then subsequently dismissed. [37] The case concerned two lines of railroad, the Southern Pacific and the Texas & Pacific. [38] The railroads ran directly from New Orleans through Louisiana and Texas, and into other states and territories of the United States and Mexico. [39] The Texas Legislature enacted laws granting the Texas Governor and Health Officer extensive power “over the establishment and maintenance of quarantines against infectious or contagious diseases, with authority to make rules . . . for the detention of vessels, . . . and property coming into the state from places infected, or deemed to be infected, with such diseases.” [40] At the time, Texas was increasingly concerned about viruses, like yellow fever, spreading through the import of various goods from port cities, including New Orleans. [41] Yellow fever first appeared in the United States in the 1700s and rampaged through cities for nearly two hundred years, killing hundreds and sometimes thousands of people in a single summer. [42] The virus was especially devastating for Eastern seaports and Gulf Coast cities. [43] The cause of the spread was unknown and occurred in epidemic proportions. In August of 1899, “a case of yellow fever was officially declared to exist in the city of New Orleans.” [44] In response, Texas immediately placed an embargo on all interstate commerce between the City of New Orleans and Texas, consequently prohibiting “all common carriers entering the state of Texas from bringing into the state any freight or passengers, or even the mails of the United States coming from the City of New Orleans.” [45] Louisiana accused Texas of trying to destroy commerce from New Orleans, taking “away the trade of the merchants and business men of the city,” and transferring that trade to “rival business cities in the state of Texas.” [46] The question before the Court was whether the Texas law granting the Governor such extensive power over commerce constituted a controversy between the states. [47] The Court decided that a mere “maladministration” of the laws of a state, to the injury of the citizens of another state, does not constitute a controversy between states, and is therefore not justiciable in the Supreme Court. [48] Primarily, the Court looked to Article III of the U.S. Constitution to adjudicate the Louisiana case. Clauses 1 and 2 of Article II read as follows: The judicial power shall extend to all cases, in law and equity, arising under this Constitution, the laws of the United States, and treaties made, or which shall be made, under their authority; to all cases affecting ambassadors, other public ministers, and consuls; to all cases of admiralty and maritime jurisdiction; to controversies to which the United States shall be a party; to controversies between two or more states; between a state and citizens of another state; between citizens of different states; between citizens of the same state claiming lands under grants of different states; and between a state, or the citizens thereof, and foreign states, citizens, or subjects. In all cases affecting ambassadors, other public ministers, and consuls, and those in which a state shall be party, the Supreme Court shall have original jurisdiction. In all the other cases before mentioned, the Supreme Court shall have appellate jurisdiction, both as to law and fact, with such exceptions and under such regulations as the Congress shall make. [49] The Court interpreted the words “controversies between two or more states” to mean that “the Framers of the Constitution intended that they should include something more than controversies over territory or jurisdiction.” [50] In the Court’s words, Louisiana’s complaint did not plead enough facts to show that Texas had “authorized or confirmed the alleged action of her health officer as to make it her own, or from which it necessarily follows that the two states are in controversy within the meaning of the Constitution.” [51] In his concurrence, Justice Harlan noted that the Court has often declared that “the states have the power to protect the health of their people” through regulations. [52] Since Louisiana’s complaint was brought against not just Texas, but also the Health Officer and the Governor, the Supreme Court could not deem that this was a suit between two states, and dismissed Louisiana’s bill. [53] With this case, the Court began unveiling a pattern of preference in avoiding exercising its jurisdiction on issues between two states.

C. Massachusetts v. Missouri

Several decades later, the Supreme Court opined on an estate and tax related controversy between two states in Massachusetts v. Missouri. [54] Massachusetts filed a motion for leave to file the proposed bill of complaint against Missouri asking the Court for an adjudication concerning the right of the respective states to impose inheritance taxes on transfers of the same property. [55] The Supreme Court, predictably, denied the Massachusetts motion. [56] Unlike the Texas and Arizona cases, the Court provided insight into its decision in Massachusetts. The Court found that Massachusetts’s proposed bill of complaint did not present a justiciable controversy between the states: “To constitute such a controversy, it must appear that the complaining state suffered a wrong through the action of the other state, furnishing ground for judicial redress.” [57] Otherwise, it appear that the state is asserting a right against the other state which is susceptible to judicial enforcement. [58] Massachusetts’s prayer for relief was for the Supreme Court to determine which state had jurisdiction to impose inheritance taxes on transfers of property covered by trusts which were created by deceased residents of Massachusetts, including securities held by trustees in Missouri. [59] The Court held that Missouri did not harm Massachusetts by claiming a right to recover taxes from the trustees or in proceedings for collection of taxes. [60] When both states have individual claims, one of them exercising their rights should not impair the rights of the other. [61] The Court decided to deny the bill of the proposed complaint, reasoning that the claims could be litigated in state courts in either Massachusetts or Missouri and thus the Supreme Court did not need to exercise its original jurisdiction over the matter. [62] Article III Section 2 grants the Supreme Court original jurisdiction in cases where a “state is a party, . . . [meaning] those cases in which, . . . jurisdiction might be exercised in consequence of the character of the party.” [63] Here, the Supreme Court did not think that Missouri would close its courts to a civil action brought by Massachusetts to recover the alleged tax due from the trustees. [64] However, the Attorney General of Missouri argued against Massachusetts filing such an action in Missouri state courts or a Missouri federal district, saying that such a suit would present a justiciable case or controversy, therefore requiring adjudication from the Supreme Court instead. [65] The Court reasoned that any objections that the courts in one state will not entertain suit to recover taxes due to another state’s claim goes to the merits of the case, not the jurisdiction, and therefore raises a question district courts are competent to decide. [66] As a result, the Court avoided yet another instance in which it was asked to settle a question of law between two states.

D. Ohio v. Wyandotte Chemicals Corp.

The 1970s saw the continuation of many liberal movements that started in the 1960s. [67] For example, when Americans voiced a growing concern about the environment, the country legislated the National Environmental Policy Act, the Clean Air Act, and the Clean Water Act all within one decade. [68] With this national trend in the background, the State of Ohio moved for leave to file a bill of complaint seeking to invoke the Supreme Court’s original jurisdiction against citizens of other states regarding the pollution of Lake Erie from mercury dumping. [69] The Court denied the motion. [70] Although the Supreme Court has original and exclusive jurisdiction over suits between states, for suits between a state and citizens of another state, the Court is granted original jurisdiction but not exclusivity. [71] The Court stated that while Ohio’s complaint does state a cause of action falling within the compass of original jurisdiction, the Court nevertheless declined to exercise that jurisdiction. [72] The Court explained that it had jurisdiction and the complaint on its face revealed the existence of a genuine case or controversy between one state and citizens of another. [73] Previously, the Court declined to review similar cases if a party sought to embroil the tribunal in political questions. [74] Although the question in Wyandotte did not involve the political question doctrine and the Court could hear the case, the Court looked to policy rationales to deny Ohio’s motion. [75] The Court recognized that it is a “time-honored maxim of the Anglo-American common-law tradition that a court possessed of jurisdiction generally must exercise it.” [76] Yet, the Court was convinced of changes in the American legal system and American society, which make it untenable, as a practical matter, for the Court to adjudicate all or most legal disputes arising “between one State and a citizen or citizens of another even though the dispute may be one over which the Court does have original jurisdiction.” [77] Primarily, the Court noted that its responsibilities in the American legal system have evolved to bring “matters to a point where much would be sacrificed, and little gained by [the Court] exercising original jurisdiction over issues bottomed on local law” and not federal law. [78] The Court based its reasoning on an analysis of the Court’s structure and general functions. The Court explained that it is “structured to perform as an appellate tribunal” but is ill-equipped for fact-finding in original jurisdiction cases. [79] While it is true that the Court most commonly exercises its appellate powers, it is clear the Court is not structured for information-gathering in original jurisdiction cases. It has declined multiple opportunities to exercise original jurisdiction in cases like Wyandotte. The Court further clarified that its denial to hear the case was backed by more than just a lack of structural capability. Its decision was compounded by the fact that, for every case in which it might be called upon to determine the facts and apply unfamiliar legal norms, it would unavoidably reduce the attention the Court could give to matters of federal law and national import. [80] Stated in simpler words: the Court did not want to spend its time and judicial resources on such matters. Because the Court “found even the simplest sort of interstate pollution case an extremely awkward vehicle to manage” and the case was extraordinarily complex, the Court decided not to burden itself with the fact-finding required to adjudicate Ohio’s claims. [81] The Court’s policy analysis of the ever-changing American judicial system and its preference for appellate jurisdiction foreshadowed its decision to decline Arizona’s and Texas’s bills decades later.

E. Arizona v. New Mexico

Just a few years later, the Supreme Court once again denied a state’s motion for leave to file a bill of complaint, this time against another state. The Court denied Arizona’s request to invoke the Supreme Court’s original jurisdiction when Arizona sought declaratory judgement against New Mexico’s electrical energy tax. [82] Arizona argued that the tax was unconstitutionally discriminatory and a burden upon interstate commerce, that the tax denied Arizona due process and equal protection under the law in violation of the Fourteenth Amendment, and that the tax abridged the privileges and immunities secured by the U.S. Constitution. [83] Regardless, the Supreme Court thought that a state court would be a more appropriate forum. [84] The State of Arizona (as a consumer) and its citizens (as consumers) regularly purchased electrical energy generated by three Arizona utilities operating generating facilities within New Mexico. [85] In 1975, New Mexico passed the Electrical Energy Tax Act, which imposed a tax on the generation of electricity. [86] The Supreme Court explained: “ The tax is nondiscriminatory on its face: it taxes all generation regardless of what is done with the electricity after its production. However, the 1975 Act provides a credit against gross receipts tax liability in the amount of the electrical energy tax paid for electricity consumed in New Mexico.” [87] Other states consuming energy produced within New Mexico, including Arizona, did not receive such credit. [88] Arizona argued that (1) the economic incidence and burden of the electrical energy tax fell upon the state and its citizens and that (2) the tax discriminated, as intended, against the citizens of Arizona. [89] The three Arizona utilities involved chose not to pay the new tax and instead sought a declaratory judgement in an action filed in the District Court for Santa Fe County. [90] That action raised the same constitutional concerns as the State of Arizona had in the instant case. [91] In deciding whether to grant Arizona’s motion, the Supreme Court noted that its original jurisdiction should be invoked sparingly. [92] The Court considered the seriousness and dignity of the claim and whether there was another forum available with jurisdiction over the named parties in which the issues could be litigated and in which appropriate relief could be had. [93] In this case, the Court was persuaded to deny Arizona’s motion because of the pending action before the New Mexico Supreme Court, which was an appropriate forum for the dispute. [94] Further, the U.S. Supreme Court found it wise to wait to hear the case on appeal if the state court held the energy tax unconstitutional. If the tax was held unconstitutional, then Arizona would be vindicated, and if it was held constitutional, the issues could be appealed to the Court through the direct appeal process. [95] Accordingly, the Court chose not to exercise original jurisdiction because it felt the state courts were able to adjudicate the issues and were the better forum for addressing Arizona’s claims. [96]

F. Maryland v. Louisiana

In 1981, the Supreme Court finally chose to exercise original jurisdiction in Maryland v. Louisiana. [97] Several states, joined by the United States and several pipeline companies, challenged the constitutionality of Louisiana’s “First-Use Tax” imposed on certain uses of natural gas brought into Louisiana. [98] Due to the nature of the case participants, a Special Master was appointed to facilitate the handling of the suit. [99] The Special Master filed a report, but exceptions to the Master’s Report were filed as well. [100] Justice White, writing for the Supreme Court, held that: (1) the individual states, as major purchasers of natural gas whose cost increased as a direct result of the tax, were directly affected in a real and substantial way so as to justify the exercise of the Court’s original jurisdiction; (2) jurisdiction was also supported by the individual states’ parens patriae; and (3) the case was an appropriate exercise of the Court’s exclusive jurisdiction even though state court actions were pending in Louisiana. [101] After establishing the Court’s intention to exercise original jurisdiction, the Court found the First-Use Tax to be unconstitutional under the Commerce Clause. [102] The analysis of the tax’s constitutionality under the Commerce Clause will be discussed later in this Article. Louisiana argued that the states lacked standing to bring the suit under the Court’s original jurisdiction and that the bare requirements for exercising original jurisdiction were not met. [103] The Special Master rejected both arguments. [104] The Court agreed with the Special Master. [105] In order to constitute a true controversy between two or more states under the Court’s original jurisdiction, [I]t must appear that the complaining State has suffered a wrong through the action of the other State . . . or is asserting a right against the other State which is susceptible of judicial enforcement according to the accepted principles of the common law or equity systems of jurisprudence. [106] Rejecting Louisiana’s arguments that the tax was imposed on pipeline companies and not directly on consumers, the Court reasoned that standing to sue “exists for constitutional purposes if the injury alleged ‘fairly can be traced to the challenged action of the defendant, and not injury that results from the independent action of some third party not before the court.’” [107] In the instant case, the First-Use Tax was “clearly intended to be passed on to the ultimate consumer,” despite it being imposed on pipeline companies. [108] The Court found it “clear that the plaintiff States, as major purchasers of natural gas whose cost has increased as a direct result of Louisiana’s imposition of the First-Use Tax, are directly affected in a ‘substantial and real’ way so as to justify their exercise of this Court’s jurisdiction.” [109] The Court also found support for exercising jurisdiction “by the “States’ interest as parens patriae.” [110] States cannot “enter a controversy as a nominal party in order to forward the claims of individual citizens.” [111] However, a state can “act as the representative of its citizens in original actions where the injury alleged affects the general population of a State in a substantial way.” [112] The Court held that the states “alleged substantial and serious injury to their proprietary interests as consumers of natural gas as a direct result of the allegedly unconstitutional actions of Louisiana.” [113] Further, such a direct injury is reinforced “by the States’ interest in protecting its citizens from substantial economic injury presented by imposition of the First-Use Tax.” [114] The Court explained, “[I]ndividual consumers cannot be expected to litigate the validity of the First-Use Tax given that the amounts paid by each consumer are likely to be relatively small.” [115] Instead, the states should represent their citizens in such litigation––a point which supported the Court’s choice to exercise original jurisdiction. [116] The Court deemed the case appropriate for exercise of its exclusive jurisdiction, despite similar claims pending in state courts. [117] The Court elaborated that it determines whether exclusive jurisdiction is appropriate by weighing “not only ‘the seriousness and dignity of the claim,’ but also ‘the availability of another forum with jurisdiction over the named parties.’” [118] Exclusive and original jurisdiction are exercised sparingly. [119] In choosing to exercise exclusive jurisdiction, the Court distinguished Maryland from New Mexico. Specifically, in New Mexico, it was “uncertain whether Arizona’s interest as a purchaser of electricity had been adversely affected,” but in Maryland, the adverse effect upon the plaintiff states’ interests were far more certain. [120] The issue in the New Mexico case did not “sufficiently implicate the unique concerns of federalism forming the basis of [the Court’s] original jurisdiction.” [121] In Maryland, the magnitude and effect of the tax was far greater because the anticipated 150 million dollars in annual tax was being passed on to millions of American consumers in over thirty states, exactly as intended. [122] The Supreme Court was willing to set the Maryland case apart from precedent and justify the use of original jurisdiction. Therefore, when examining recent actions brought by Arizona and Texas, the question becomes: why did the claims of Arizona and Texas fall within the Court’s pattern of refusing to exercise original jurisdiction rather than the approach followed in Maryland?

G. Texas and Arizona’s Place Within the Precedent

In denying Texas and Arizona’s motions for leave to file a bill of complaint, the Court did not provide its reasoning for denial as it did in Maryland, Wyandotte, New Mexico, Massachusetts, Cohens, and Louisiana. Although Justice Thomas and Justice Alito wrote detailed dissents on why the Court should hear the cases, there was little insight into the majority’s decision-making. However, with decades of precedent explaining the need to exercise original jurisdiction sparingly, [123] perhaps the Court’s reasoning is not needed. Following the analysis of prior case law, Texas and Arizona’s claims would be first judged on their “seriousness and dignity.” [124] Essentially, the two states would have to show that they are directly and negatively affected by California’s travel bans. [125] The states also would need to persuade the Court that the injury alleged affects the general population of their states in a substantial way. [126] Finally, the states would have to show that there is no other forum that could adjudicate the claims. [127] Turning to the first point, the states would illustrate their alleged injury: California law bans state-funded travel to over twenty-two states, except under limited circumstances. [128] Specifically, California will not: Approve a request for state-funded or state-sponsored travel to a state that . . . has enacted a law that voids or repeals, or has the effect of voiding or repealing, existing state or local protections against discrimination on the basis of sexual orientation, gender identity, or gender expression, or has enacted a law that authorizes or requires discrimination against same-sex couples or their families or on the basis of sexual orientation, gender identity, or gender expression, including any law that creates an exemption to antidiscrimination laws in order to permit discrimination against same-sex couples or their families or on the basis of sexual orientation, gender identity, or gender expression. [129] The travel ban has exceptions, which include travel for: litigation; meeting contractual obligations; complying with the federal government committee appearances; participating in meetings or training required by a grant or required to maintain grant funding; completing job-required training necessary to maintain licensure or similar standards; and protecting the public health, welfare, or safety. [130] Given these exceptions, when does California’s travel ban actually apply? It is difficult to imagine an instance where state-funded travel would be banned given the relatively lengthy list of exceptions. California intended the ban to frame the state as a leader in protecting civil rights and preventing discrimination, but even LGBTQ groups accuse California of using the ban as “a cheap political trick to make some headlines for vote-hungry politicians in the blue state.” [131] The law’s extensive exceptions also make it difficult for the plaintiff-states to illustrate their injury. College sports provide the most likely example of state injury, but even that has proven difficult. In 2017, California’s ban included travel to the State of Tennessee. [132] That same year, the UCLA Men’s Basketball Team made it to the “Sweet 16” in the NCAA Tournament. [133] According to the ban, California should have refused to let the team play in the game against Kentucky held in Tennessee, unless the game was moved to another state not on the travel ban list, since UCLA is a state-funded school. [134] Instead, California used “non-state” funds to send the team to Tennessee. [135] Non-state funds are comprised of money that comes from donations and other resources. [136] California keeps these “non-state” funds separate from state funds. [137] Essentially, when travel does not fit into one of California’s many exceptions, the state will still find a way to permit the travel if there is substantial state interest. [138] Imagine the following hypothetical: Texas or Arizona host a major sports tournament, California denies funding for its own public university team to travel and compete in the tournament, and the denial causes the tournament to be moved to another state simply to accommodate California’s travel ban. One can then imagine the plethora of economic and political injuries to Texas or Arizona. However, a dilemma like this hypothetical has yet to happen. And the U.S. Supreme Court will not exercise its original jurisdiction in a case in which a state’s injuries are unclear. [139] The complaints filed by Texas and Arizona demonstrate the exact type of cases the Court detailed as its preference to avoid in Wyandotte. [140] Next, it would have been difficult for the Supreme Court to find that the alleged injury affected the general population of Arizona and Texas. [141] The California travel ban does not target state-funded business with the plaintiff-states or individual businesses or people within the plaintiff-states. [142] Additionally, the travel ban does not in any way restrict the flow of goods or people between California and these states. [143] Aside from knowing the state received California’s stamp of disapproval, citizens of Texas and Arizona are not affected by California’s travel ban. In Maryland, Louisiana’s tax affected more than thirty different states, and the burden of the tax was directly passed to the taxpayers in those states. [144] Although there are many states on California’s travel ban list, [145] the burden of California’s law is not upon the people of those states. Finally, the Supreme Court likely denied the plaintiff-states’ request for adjudication under original jurisdiction in Arizona v. California and Texas v. California because the states can challenge California’s laws in another forum. [146] In New Mexico, the Court mentioned its preference of hearing the case on appeal upon the plaintiff-state’s loss in defendant-state’s courts. [147] In Maryland, the Court did not think that a state forum was more appropriate for the claims because it was abundantly clear that the interests of the plaintiff-states were adversely affected. [148] The same is not true in the Arizona and Texas cases. The Court likely aligned the plaintiff-states’ claims with those in New Mexico. Even Justice Alito, writing in the dissent for Texas, mentioned that the Court would likely reverse if a lower court found in favor of California. [149] Perhaps filing in a different forum is a path the current plaintiff-states should contemplate. It is clear a controversy exists between two states in both Arizona and Texas. It is also clear the controversy is mostly political, based solely on California’s condemnation of a number of states in the nation who will not align with California’s political ideals. The Court can invoke the political question doctrine when there is a lack of judicially manageable standards which prevent the case from being decided on the merits. [150] Although the Court did not explicitly invoke the doctrine, California’s politically charged statutory language could have added to the Court’s reluctance to exercise original jurisdiction. Ultimately, the Court had a long list of precedent supporting the decision to decline exercising original jurisdiction in both Texas and Arizona. While actual injury to the travel ban states is not abundantly clear, the plaintiff-states should consider challenging California’s law under Article I instead of Article III in federal court.

II. The Article I Alternative [151]

The Constitution grants Congress the power to “regulate Commerce with foreign Nations, and among the several states, and with the Indian tribes.” [152] The U.S. Supreme Court has long recognized that the Commerce Clause also restricts states from enacting law which may affect interstate commerce. [153] This limit on state power is often referred to as the Dormant Commerce Clause. The Dormant Commerce Clause prevents economic protectionism by prohibiting states from enacting laws designed to benefit in-state economic interests as the expense of out-of-state competitors. [154] State-implemented travel bans are likely to affect interstate commerce, since their sole purpose is to cause negative economic impact on the targets of the ban. Although the earlier discussion about the travel ban’s exceptions and practice raise questions as to whether the California law is truly effective, there are still colorable arguments supporting the law’s interference with interstate commerce. The U.S. Supreme Court’s approach for analyzing the Dormant Commerce Clause is a balancing test in which the burden on interstate commerce may not be greater than the benefits to the state. [155] The weight of the balancing depends on whether a state statute is facially discriminatory or facially neutral. [156] State statutes are facially neutral if they treat their residents and other states’ residents alike, although the statute may still affect interstate commerce. [157] Facially neutral statutes only violate the Dormant Commerce Clause if the burdens they impose on interstate trade are clearly excessive in relation to local benefits. [158] State statutes that distinguish between residents in their jurisdiction and residents outside their jurisdiction are facially discriminatory. [159] Since California’s travel ban explicitly names other states, the statute is facially discriminatory. Even though the ban is facially discriminatory, there are three exceptions to when states may pass facially discriminatory laws , outlined below.

A. Exceptions to Facially Discriminatory Statutes, Applied to California’s Ban

Facially discriminatory statutes are generally deemed unconstitutional but can still be upheld under three exceptions: (1) Congress authorized them; (2) they serve a legitimate state or local purpose; or (3) the state is acting as a market participant. [160] Below is an analysis of these three exceptions as applied to California’s travel ban. The first exception is Congressional authorization. It is clear from the statute language that California is not relying upon any kind of congressional authority. When Congress permits states to regulate commerce in ways that would otherwise be impermissible, authorization must be unmistakably clear. [161] The legislative history behind California’s travel ban clearly shows there was no Congressional authorization to enact such a ban. [162] The legislative history shows reliance upon Obergefell v. Hodges to support validation of the ban. [163] This Supreme Court case upheld marriage equality for LGBTQ individuals, [164] but there is no mention of anything close to the possibility of states enacting travel bans for state-funded travel. [165] In summary, “Congress did not grant California the authority to prohibit other states from discriminating against LGBTQ individuals.” [166] Thus, California’s travel ban law fails the first exception for facially discriminatory statutes. Second, for facially discriminatory statutes to be constitutional, they must serve a legitimate local purpose. States must show not only that the regulation serves a legitimate local purpose, but also that the local purpose could not be achieved by any other nondiscriminatory means. [167] Essentially, California would have to prove their clearly punitive travel ban serves a local purpose which could not otherwise be achieved. [168] The California legislative history lists two reasons for enacting the statute: (1) to prevent the use of state funds to benefit a state that does not adequately protect the civil rights of certain classes of people; and (2) to prevent a state agency from compelling an employee to travel to an environment in which he or she may feel uncomfortable. [169] However, punishing other states for not meeting California’s civil rights standards does not serve a local purpose in California. [170] On the one hand, California may argue that the law protects state employees who could experience—or fear—LGBTQ discrimination in travel ban states. On the other hand, critics argue that the travel ban does little to protect LGBTQ interests and does “nothing more than exacerbate political divisions.” [171] Even if California argues that the statute protects its state employees, California ignores the fact that it must prove there are no other nondiscriminatory alternatives. [172] California’s legislative history indicates that the statute was not developed to protect state employees and that other alternatives were not considered. Instead, the legislative history makes it abundantly clear that California intended the statute to punish other states. [173] The final exception is if a state acts as a market participant, rather than a market regulator. [174] For example, if a city law specifies that construction projects funded by the city must employ a percentage of city residents, then the law does not violate the Dormant Commerce Clause because by funding the city projects the government is acting as a participant. [175] However, if a state is selling timber and its laws require the successful bidder to partially process the timber within the state before shipping, then this law goes further than simply burdening the market in which it operates. [176] California could attempt to argue that the Dormant Commerce Clause does not apply because the state government is participating in the market for travel. But because the ban imposes restrictions intended to reach beyond California by banning commercial transactions in target states, this argument fails, and the Dormant Commerce Clause applies. California’s travel bans are facially discriminatory and are therefore unconstitutional under Article I of the Constitution. Only the U.S. Congress can regulate the nation’s commerce, not the individual states. [177] There is a long history of restricting states from enacting laws that interfere with federal commerce or benefit in-state economic interest by discriminating against other out-of-state actors. California’s ban on state-funded travel openly discriminates against almost half of the country by banning state-funded travel to states with whom California disagrees over standards regarding treatment of the LGBTQ community. [178] The desire to be a leading state in the protection of LGBTQ civil rights does not fit into any of the three exceptions that would allow California to enact such a law. California’s ban was not authorized by Congress. It serves no local purpose. No nondiscriminatory alternatives were ever discussed or considered. California, in enacting the statute, is acting as a market regulator and not as a market participant. That is unconstitutional. This analysis leaves critics with disagreements in predicting how, when, or whether California’s unconstitutional travel ban will be addressed. Some believe that other states will follow California’s example and enact similarly discriminatory laws until the country is entwined in a social and economic civil war. [179] The less dramatic and more likely outcome is a continued lack of enforcement of the statutes, or a demand in statutory change from residents of the states who are legislating such bans.

III. Power By The People: The Likely Outcome

As previously explained, the U.S. Supreme Court is unlikely to intervene on behalf of states that have found themselves on California’s travel ban. The states will likely need to bring their claims in other forums first and then pursue the appeals route to the U.S. Supreme Court. Given the extensive list of exceptions and lack of enforcement in practice, the overarching economic effect (and therefore success) of California’s ban is, at best, unclear. It is still disheartening to see that one of our states opted to single out twenty-two sister states seemingly without reason. There are a few consequences that may result from such actions. The first possibility is other states will enact retaliatory bans or similar bans against states with whom they disagree politically. California’s first bans were seen in 2017, and in the past few years, several other states and territories have legislated travel bans. [180] Although New York issued executive orders in 2015 similarly banning state-funded travel to Indiana for LGBTQ discrimination issues, [181] and several other states joined New York in banning state-funded travel to North Carolina for its controversial “bathroom law,” [182] there is little indication that these bans have actually achieved their purpose of negatively impacting the economies of the targeted states. For example, it is calculated that Indiana lost about $60 million in revenue after passing an anti-gay law. [183] Notably, this loss of revenue stemmed from a cut in tourism and the migration of businesses out of Indiana, not because of a lack of state-funded travel from places like California. [184] Further, when corporations or businesses condemn perceived anti-gay state laws, the ramifications are much more profound than any ban on state-funded travel. California state-funded travel likely has very limited presence in the Texas economy, and so its effect is similarly unnoticed. However, when companies like Apple make business decisions while considering states’ laws impacting its LGBTQ population, the results would be felt much more profoundly than the loss of California’s state-funded travel. Additionally, if corporations were to act in this arena, they would not be challenging the U.S. Constitution in the same way as California. Yet, Texas has not lost business because of its anti-discrimination laws. On the contrary, Texas has seen an explosion of migration of California businesses to Texas. [185] Though these business migrations are linked to lower housing costs, lower tax rates, and fewer regulations, it is still noteworthy that Texas’s LGBTQ laws did not deter California tech giants from moving operations to the red state. [186] Texas’s experience with tech migration may be unique compared with the other states on California’s ban list, but it remains unclear whether California’s ban has influenced any state’s economy in a substantial way. All things considered, California’s legislation purpose is less of an attempt to weaken Texas’s or other states’ economies and more of an attempt to pander to voters within California. The true danger of California’s travel ban stems from power-hungry and vote-hungry politicians’ dedication to making headlines. The ban provides such a plethora of exceptions that its actual effect is severely curtailed to the point of virtual nonexistence. Meanwhile, the political chatter surrounding the law only grows. With such minimal economic effect, even if all the states decide to pass similar laws, then the only thing achieved is more of the political animosity already so prevalent between the two political parties. Another possible consequence is that the law will largely go unenforced, as it is now, and its purpose will diminish and subside out of the nation’s attention. A third possible consequence is a challenge to the statute’s constitutionality from within California or a repeal of the statute through the legislature. Of the possible outcomes, an economic civil war is truly unlikely. This is a political game with very little economy in the equation. A political civil war might be a different story.

Conclusion

California’s travel ban now effectively targets about 44% of the nation by prohibiting state-sponsored or state-funded travel to twenty-two sister states. [187] Other states have followed California’s example. [188] The challenges to the ban came from the States of Texas and Arizona, which would ordinarily place the cases within the original jurisdiction of the Supreme Court. However, the Supreme Court declined the opportunity to adjudicate the matter in both cases. The Court has a history of avoiding political questions [189] and exercising its original jurisdiction only in extremely limited circumstances. [190] Based on the analysis of Article I, California’s statute is facially discriminatory. It does not fall within one of the exceptions, so the law is unconstitutional. [191] With the Supreme Court refusing to hear arguments brought by Texas or Arizona, the states will need to seek another path to Supreme Court adjudication. If the states desire a judicial ruling on the issues, they should find other forums in which to challenge California’s law and then appeal any unfavorable decision to the Supreme Court. However, the judicial path may prove problematic for the states, as the lack of true economic effect makes it difficult if not impossible to argue actual damages. California’s law failed to impact the economies of the target states, but it succeeded in widening the political divide in the nation. It is no secret that for the past few years, Americans have lived in an increasingly divided country. As LGBTQ organizations have noted, the travel ban does little to promote equality for LGBTQ individuals in red states. [192] Instead, California’s legislation serves as a political platform for politicians’ reelection campaigns. From a birds-eye-view, the result is something of a Shakespearean play: it’s funny, it’s tragic, and it’s oh-so-dramatic. Hopefully, the nation can end the narrative of the travel ban as a Shakespearean comedy with a happy ending, instead of a Shakespearean tragedy currently looming on the horizon for a divided and weary nation with our collective patience wearing thin.

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* Professor Beckett Cantley University of California, Berkeley, B.A. 1989; Southwestern University School of Law, J.D. cum laude 1995; and University of Florida, College of Law, LL.M. in Taxation 1997. Teaches International Taxation at Northeastern University and is a shareholder in Cantley Dietrich, P.C. Professor Cantley would like to thank Melissa Cantley and his law clerk, Leela Orbidan, for their contributions to this Article. ** Geoffrey Dietrich, Esq. U.S. Military Academy at West Point, B.S. 2000; Brigham Young University Law School, J.D. 2008. Shareholder in Cantley Dietrich, P.C.

The Ruling on Reserve Mechanical Corp. v. Commissioner, and Impact to Captive Insurance Tax Benefits

Beckett Cantley  Geoffrey Dietrich This article provides an overview of the May 13 th , 2022, U.S. Tenth Circuit Court of Appeals decision in Reserve Mechanical Corp. v. Commissioner ,  and analyzes its likely impact on the aggressive captive insurance company (“CIC”) industry. A much longer and broader discussion of this topic will be published in our forthcoming article in the U.C. Davis Business Law Journal.

How Reserve Mechanical Corp v Comm affects captive insurance tax benefits

A storm has been brewing in the tax world, and there may be no safe harbor in sight for participants in aggressive captive insurance schemes. On May 13th , 2022, the U.S. Tenth Circuit Court of Appeals handed down a major defeat to one of these aggressive captive insurance schemes.  In a landmark case, Reserve Mechanical v. Commissioner , the Court found that the transactions that the Captive Insurance Company (CIC) Reserve Mechanical had engaged in were not insurance and therefore Reserve Mechanical was not an insurance company. As a result, Reserve Mechanical could not take advantage of the federal income tax exemption under Internal Revenue Code (“IRC”) Section 501(c)(15). This tax exemption allows a CIC to not pay tax on whatever premiums are paid to it, up to a certain threshold.  Tax planners would be paid to set up CICs for business owners and the business owners would then pay premiums to the new CIC while the CIC books those premiums as tax exempt income. These premiums are often determined without actuarial data and with a poorly produced risk pool consisting of other CICs managed by the tax planners engaged in the scheme.

The benefits of Captive Insurance Companies (CICs)

With correct planning CICs stand to obtain favorable tax treatment under IRC Sections 501(c)(15) and 831(b). This creates a tax exemption for insurance companies whose gross receipts for the tax year do not exceed $600,000 under IRC Section 501(c)(15) or $2.3 Million under IRC Section 831(b).  These exemptions are treated identically with the only difference being the level of exemption permitted under the statute. The use of CICs for businesses with a true and real economic need for them does not, in and of itself, constitute an abusive tax transaction. However, despite the real economic circumstances that would call for the use of CICs, the practices of several tax planners in the CIC world have become flagrantly abusive. This abuse has colored CICs in the IRS’ eyes such that even those who have a very real need for the use of CICs may become potential targets of IRS audits.

As a CIC, Reserve was owned by the same people that owned Peak.

The original Reserve Mechanical Corp. v. The Commissioner case came down before the U.S. Tax Court on June 18 th , 2018. Reserve Mechanical Corp (“Reserve”) was a CIC formed to insure Peak Mechanical & Components Inc. (“Peak”). As a CIC, Reserve was owned by the same people that owned Peak. The three issues at hand in this case were

1. whether the transactions that Reserve engaged in were insurance resulting in the right to the IRC Section 501(c)(15) exemption;
2. whether Reserve was a domestic corporation under IRC Section 953(d); and
3. if Reserve was not an insurance company and did not make a valid IRC Section 953(d) election, whether it could be taxed 30%.

This article will only address the first question as to whether or not Reserve was an insurance company. In the IRS’s view, Reserve was solely created so that the owners of Peak could take advantage of the tax deduction and Reserve could take advantage of the tax exemption, rather than because Peak needed insurance that it could not get elsewhere, and thus the transactions Reserve engaged in lacked economic substance.

Factors that drove IRS’s assessment that Reserve was not an insurance company

The IRS’s assessment that Reserve was not an insurance company was based on several factors.

• The first, was that the transactions that Reserve engaged in constituted a circular flow of funds. Peak would pay premium payments to Reserve for direct coverage.
• Reserve would then take these premiums and pay them to the CIC risk pool, PoolRe, as reinsurance by attempted risk distribution across a number of other CICs also paying into the risk pool. Peak would then also pay premiums to PoolRe in exchange for stop-loss insurance from PoolRe.
• Lastly, PoolRe would pay the same stop-loss premium amount it received from Peak to Reserve to insure the same stop-loss coverage it had with Peak.

The court determined that the flow of premiums between these three entities constituted an improper circular cash flow of funds. Next, the IRS focused on how the premiums that Reserve charged were determined. Several experts testified that they had used actuarial tables to calculate them but could not provide those tables and could not explain how Reserve somehow managed to charge each year the exact amount of premiums that would result in the greatest tax exemption for the CIC.  The IRS argued that premium calculation method used was bogus. The Tax Court ruled in favor of the IRS and held that Reserve did not issue insurance contracts. Thus, Reserve was not an insurance company, and was thereby ineligible for the Section 501(c)(15) exemption. Therefore, the premiums that Reserve received were now treated as investment income and could be taxed at a 30% withholding rate. The Tax Court determined that the premiums that were paid to Reserve by Peak and then to PoolRe and vice versa constituted a circular cash flow of funds. They also determined that the premiums paid were determined by what would produce the greatest tax deduction rather than based on actuarially determined insurance need. The Tax Court noted the strangeness of some of the facts of Reserve. For instance, after Peak formed Reserve its insurance costs went up 400%.  In the Tax Court’s estimation there is no reasonable and ordinary explanation for why a company would increase its insurance costs by such a staggering amount. After the Tax Court decision, Reserve was appealed to the Tenth Circuit Court of Appeals.

IRS ruled in favor of the IRS on all issues.

The Tenth Circuit ruled in favor of the IRS on all issues. The Tenth Circuit’s ruling against Reserve was damning. In the words of the court:

• Reserve has not presented any argument as to why a factfinder could not infer that Peak’s intent was simply the intent to create a plausible insurance company through which Peak could obtain a substantial tax deduction without reducing the funds available to its two owners. The intent behind the act does not change just because the act failed to achieve its purpose.  [Emphasis added]
• The Tenth Circuit’s comments make it clear that it does not see Reserve as being run like a legitimate business. The court found that there was no evidence of any reasonable risk assessments to determine whether Peak needed any of the additional policies. The court noted that Reserve prepared policies that only lasted for a month in a rush to obtain a large business deduction for Peak in 2008, and that this behavior was “laughable”.
• The Tenth Circuit also held that the re-insurance policies that Reserve held with PoolRe did not distribute risk and that if anything the previous Tax Court decision understates the compelling evidence that these re-insurance arrangements were a “sham”.
• The Tenth Circuit held that they would have emphasized different evidence than the Tax Court, but that the Tax Court’s conclusions were supported by overwhelming evidence in the record.

Reserve raised no persuasive challenges to the Tax Court’s conclusion.

No experience, expertise, or studies supported the need for Peak to obtain the issued policies.  Further, the Tenth Circuit found that Reserve raised no persuasive challenges to the Tax Court’s conclusion.  Despite one of Reserve’s expert witness’ testimony that commercial insurance policies were available as an alternative to several of the Reserve policies, Reserve provided no evidence that anyone compared the rates on such policies or otherwise considered industry standards in determining its premium rates. Instead, the record suggests that Reserve based the rates on the premiums charged by other captive insurers managed by Capstone.

Inconsistencies in Reserve’s business practices created doubt in perception as a bonafide insurance company

The Tenth Circuit doubted the actuarial methodology used to determine the premiums, and determined that these insurance contracts were not negotiated at arm’s length.  The many inconsistencies in Reserve’s business practices made it impossible for the Tenth Circuit to take seriously Reserve’s claim that it was a bonafide insurance company engaged in the business of insurance. As a result, the Tenth Circuit’s decision that Reserve’s policies were not actual insurance feels like a layup and the intensity of the court’s contempt for this aggressive CIC program should be very concerning to other similarly situated CIC owners.

Decision in Reserve Mechanical Corp. – a major boost in the IRS’s overall attack on aggressive CIC tax programs

The 10 th Circuit decision in Reserve Mechanical was a major boost in the IRS’s overall attack on aggressive CIC tax programs. If Reserve had won on appeal, then the aggressive CIC industry would have at least one major case to stand on. The IRS’s Reserve Mechanical win was the biggest in a line of IRS wins in cases on similar grounds. As such, the aggressive CIC industry must either change its ways or close up shop, because the IRS appears determined to shut it down one way or another, and the judiciary is giving it all the ammunition it needs to do so. View Original Document

CIC Services v. IRS: the Supreme Court Hands the IRS a Major Loss