The Internal Revenue Service in recent weeks has acknowledged that it targeted applicants for tax-exempt organization status based on their political viewpoint, in violation of basic First Amendment principles. That was, obviously and admittedly, a big mistake. But under a little-noticed provision of the Internal Revenue Code, citizens who claim that the IRS has made a mistake risk paying a large fine if it turns out that they are wrong. That provision, too, betrays a lack of concern for First Amendment values that should trouble all American taxpayers.
Under our Constitution, no agency is beyond criticism or reproach. To that end the First Amendment expressly protects the right to petition the government for redress of grievances. According to a law enacted in 2007 and amended in 2010, however, if your grievance is that the IRS has collected too much tax, and you claim you are entitled to a refund, the IRS can assess a 20 percent fine, based on the size of your refund claim, if it rejects your claim. In many cases, the IRS can levy this fine even though you had a good-faith basis for your refund request. For large businesses that often have multimillion-dollar disputes with the IRS, the penalty could amount to hundreds of thousands or even millions of dollars. The effect on individuals could be even more devastating, even when the dollar amounts at stake are smaller. This penalty on the right to petition has an understandably chilling effect, and is plainly unconstitutional.
Imagine that some Tea Party groups subjected to special monitoring by the IRS were considering suing the agency for violations of their speech, association and equal protection rights. If the Internal Revenue Code imposed a large fine on anyone who unsuccessfully sued the IRS, we would all recognize that as an impermissible penalty on the right to petition. Yet that's exactly how the refund penalty provision works. Imposing a penalty will deter people from seeking refunds in close cases, out of fear that if they lose, they could end up owing a hefty fine. By deterring refund claims, the IRS insulates its own decision-making from legal challenges and impairs citizens' rights to seek relief from their own elected government.
The First Amendment's right to petition, the U.S. Supreme Court reiterated just two years ago, "protects the right of individuals to appeal to courts and other forums established by the government for a resolution of legal disputes." It is a fundamental aspect of the rule of law, for it guarantees that individuals are free to call their government to account for wrongdoing. In that sense, it is the right that undergirds all other rights.
The Supreme Court has guarded this right assiduously. The right covers petitioning the legislature, the executive branch or the courts. It prohibits any sanction — whether a fine, tort liability or even a retaliatory investigation — on the right to petition. And, according to the Noerr-Pennington doctrine, named for a pair of cases decided in the 1960s, the First Amendment protects all petitions unless they are "shams," which the courts have interpreted to require that the petition be both "objectively baseless" and "subjectively motivated by bad faith."
How does this square with the tax code? Not well. Section 6676(a) provides that any unsuccessful claim that the IRS deems to lack a "reasonable basis" will be subject to a 20 percent penalty (calculated on the basis of the refund unsuccessfully claimed). This section of the code does not define "reasonable basis," but the IRS has said in another context that "reasonable basis" requires more than an "arguable" or "colorable" claim. But a refund claim having an arguable or colorable basis would plainly be protected by the right to petition, because it would not be "objectively baseless." Indeed, the petition clause protects even "objectively baseless" claims if they are not brought in bad faith.
The situation is even worse for refund claims concerning transactions that the IRS considers to lack "economic substance," and to have been undertaken solely for tax purposes. Here, the statute provides that any unsuccessful claim, regardless of how strong its basis, and even if brought entirely in good faith, will be automatically assessed a 20 percent penalty — a penalty that, as noted above, can amount to hundreds of thousands or even millions of dollars. As one court has noted, "[t]he law of economic substance, it must be said, is not a model of clarity." Nevertheless, the law imposes the 20 percent penalty even if you had a perfectly reasonable basis — including the advice of an attorney — to believe that the transaction had economic substance.
As recent events have shown, the IRS, like all other agencies, is not immune from mistakes. Like all other agencies, it must not be beyond reproach. As citizens, we should have the right to claim that it has made a mistake, without being afraid that if we are unsuccessful, we will have to fork over a hefty penalty — for doing nothing more than exercising our constitutional right.
The IRS has for some time been considering adopting regulations to implement the refund-claim sections of the tax code. Yet it has done nothing to allay citizens' fears, apparently preferring to deter refund claims rather than to honor the Constitution.
The solution is fairly simple: The IRS can reconcile the statute with its obligation to honor the First Amendment by announcing, clearly and unambiguously, that it will not seek to assess penalties for unsuccessful refund claims unless they are a "sham" — objectively baseless and filed in bad faith. Only by doing so can the IRS reassure taxpayers that they are free to express their disagreements with the agency by petitioning for redress.
David Cole, a professor of constitutional law at Georgetown University Law Center, is a consultant to taxpayers.