D.C. Circuit: Tax Settlement Information on LILO Arrangements Exempted from Disclosure under FOIA

Holding:

In this appeal, appellant Mayer Brown LLP and appellee Internal Revenue Service (“IRS”) disputed whether disclosure of certain IRS settlement information could risk “circumvention of the law” — a category exempted from disclosure under the Freedom of Information Act (“FOIA”), 5 U.S.C. § 552 and § 552(b)(7)(E). On cross-motions for summary judgment, the U.S. District Court for the District of Columbia held the settlement information is covered by FOIA exemption 7(E). On appeal, the U.S. Court of Appeals for the District of Columbia Circuit affirmed, stating that the information falls within the FOIA exemption because the disclosure of such information could risk circumvention of the law. The D.C. Circuit explained that although the settlement guidelines requested are not “how to” manuals for law-breakers, the exemption under 7(E) clearly protects information that would train potential violators to evade the law or instruct them how to break the law. In this regard, the D.C. Circuit held that 7(E) exempts from disclosure information that could increase the risks that a law will be violated or that past violators will escape legal consequences. Accordingly, the D.C. Circuit concluded that although the information here does not necessarily provide a blueprint for tax shelter schemes, it could encourage decisions to violate the law or evade punishment.

Detailed Summary:

The sole issue in this case is whether the information requested by Mayer Brown meets FOIA exemption 7(E).

By way of background, the FOIA request in this case involved lease-in/lease-out (“LILO”) arrangements between tax-exempt entities and taxable entities. LILO arrangements occur when a tax-exempt entity owns and uses property but shifts significant tax deductions by signing a long-term lease with a taxable entity, reserving the right to cancel the lease. The tax-exempt owner then “subleases” the property back from the taxable entity. Arguably, the only purpose of the LILO scheme is to reduce the tax burden of the taxable entity, who otherwise has no ownership interest in the property.

In 1999, the IRS disallowed deductions based on LILO schemes. In 2004, Congress made LILOs illegal, but the statute had only prospective effect. Opinion, p. 2, citing 26 U.S.C. § 470. The IRS continued to audit taxpayers engaged in LILO transactions and disallowed the reported deductions. Many of these cases were settled.

In 2004, Mayer Brown LLP filed a FOIA request for various information relating to the IRS’s LILO settlement practices. Through the course of litigation, the IRS turned over numerous documents, and the parties resolved almost all other issues by agreement. The only remaining issue concerns one small class of information, described by the district court as “settlement strategies and objectives, assessments of litigating hazards, (and) acceptable ranges of percentages for settlement.” Id., pp. 2-3, citing Mayer Brown v. IRS, No. 04-2187, at 3 (D.D.C. Nov. 28, 2006) (order granting motion for clarification).

On cross-motions for summary judgment and after reviewing the information in camera, the district court held that the IRS does not have to turn over the remaining settlement information because FOIA exemption 7(E) applies.

Exemption 7(E) states in part: “(b) This section (i.e., mandatory FOIA disclosure) does not apply to matters that are . . .

(7) records or information compiled for law enforcement purposes, but only to the extent that the production of such law enforcement records or information . . .

(E) . . . would disclose guidelines for law enforcement investigations or prosecutions if such disclosure could reasonably be expected to risk circumvention of the law.” Id., p. 3, citing 5 U.S.C. § 552(b) (emphasis added).

Applying the foregoing provision of the FOIA, the D.C. Circuit held that although the settlement guidelines requested are not “how to” manuals for law-breakers, the exemption is broader than that. Specifically, the D.C. Circuit wrote, exemption 7(E) clearly protects information that would train potential violators to evade the law or instruct them how to break the law. But it goes further. The D.C. Circuit explained that this provision under the FOIA exempts from disclosure information that could increase the risks that a law will be violated or that past violators will escape legal consequences. Though the information here does not necessarily provide a blueprint for tax shelter schemes, it could encourage decisions to violate the law or evade punishment.

The D.C. Circuit further wrote: “While there may be some legitimate uses of the requested information, the potential for misuse amply supports the IRS’s argument for exemption. People prepared to do the right thing would simply negotiate in good faith. Disclosure in this case would clearly be of enormous benefit to potential evaders and past violators hoping to escape punishment. FOIA exemption 7(E) covers these circumstances, exempting disclosure when the information ‘could reasonably be expected to risk circumvention of the law.’ Settlement guidelines fall squarely within this category, and, therefore, the information requested in this case is not subject to mandatory disclosure.” Id., p. 11.

On the basis of the foregoing, the D.C. Circuit affirmed the district court’s decision.

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