District Court Dismisses APA Challenge to IRS ESOP Information Request Procedure

(Parker Tax Publishing May 2026)

A district court dismissed a lawsuit brought by taxpayers that established an employee stock ownership plan (ESOP), arguing that the IRS violated the Administrative Procedure Act (APA) when it sent the ESOP a Form 4564, Information Document Request, stating that the ESOP was not qualified under Code Sec. 401(a) and the trust was not exempt under Code Sec. 501(a). The court found that the IDR was a routine administrative enforcement action rather than a legislative rule subject to the APA's notice and comment requirements as the taxpayers contended. Daines et al. v. IRS, 2026 PTC 107 (E.D. Wis. 2026).

Background

Jeffrey and Elisha Daines, Jeffrey and Stephanie Federwitz, Solid Ground Inc., and Solid Ground Transportation, Inc. (the taxpayers) sought to establish an employee stock ownership plan (ESOP). To do so, they enlisted Lex J. Byers and his company, who touted a proprietary system that would afford certain tax benefits. They set up the ESOP, thus creating the Solid Ground Transportation Inc. Employee Stock Ownership Plan, and for years things went as the taxpayers had expected.

The IRS then began to look closer at the methods that Byers employed for the taxpayers and other clients. The IRS eventually disqualified the ESOP at issue here. The taxpayers challenged that decision in the Tax Court. However, the also filed suit in a district court arguing that the IRS's actions constituted legislative rulemaking and violated the Administrative Procedure Act (APA) because the IRS did not follow the APA's notice and comment procedure. The IRS moved to dismiss the taxpayers' amended complaint, arguing that there is no such thing as the Byers Rule and the agency actions the taxpayers were complaining about were not subject to the APA.

The taxpayers said the "Byers Rule" is a Form 4564, Information Document Request (IDR), issued by the IRS to Solid Ground Transportation, Inc. The IDR set forth the IRS's determination that Solid Ground Transportation Inc. Employee Stock Ownership Plan was not qualified under Code Sec. 401(a) and the Trust was not exempt under Code Sec. 501(a). The IDR also stated that, once the plan was disqualified, the earnings that the Trust's assets realized were taxable, and the Trust's earnings had to be reported on Form 1041, U.S. Income Tax Return for Estates and Trusts.

According to the taxpayers, by concluding that ESOPs that employed "the Byers Proprietary ESOP System" were required to submit Forms 1041, the IRS created a new legislative rule since no Code provision requires a From 1041 from a qualified ESOP trust. In other words, the taxpayers argued that the IRS created a new rule requiring an ESOP trust to file Form 1041.

Analysis

The district court granted the government's motion to dismiss the taxpayers' amended complaint with prejudice. In the court's view, the taxpayers were trying to fit the square peg of a routine administrative enforcement action into a ground hole of a rulemaking under the APA.

The court found that the IDR was not requiring an ESOP trust to submit a Form 1041; it was requiring Solid Ground Transportation, Inc. to submit a Form 1041 because Solid Ground Transportation, Inc. Employee Stock Ownership and Profit-Sharing Plan was not an ESOP trust. Requiring a non-exempt entity to submit a Form 1041, the court found, does not constitute a new rule; it is a conclusion that follows a finding that an entity was not exempt. The court said that the taxpayers' characterization of the language and nature of the IDR highlighted what this case was really about -- the taxpayers' disagreement over whether Solid Ground Transportation Inc. Employee Stock Ownership Plan was a qualified ESOP trust under Code Sec. 401 and thus exempt under Code Sec. 501(a). In the court's view, the taxpayers failed to plausibly allege that this decision was the result of any rulemaking.

The court found that the IRS's interpretation and application of the law to reach the conclusion that Solid Ground Transportation, Inc. Employee Stock Ownership and Profit-Sharing Plan was not an ESOP trust, and therefore must submit a Form 1041, did not render the IRS's decision a rule. The court observed that agencies routinely (if not necessarily) interpret statutes and regulations to adjudicate matters. According to the court, if the taxpayers believed that the IRS's conclusion was wrong, their remedy would ultimately lie in the Tax Court.

The court also noted that, even if the taxpayers could characterize the IDR, or the IRS's non-qualification determination, as a final agency action, the APA permits review only where there is no other adequate remedy in a court. The taxpayers' core claim, the court found, remained that the IRS erred in concluding that the plan was not qualified and as a result improperly assessed taxes and penalties. Those issues were the subject of pending Tax Court proceedings, and the court said that the taxpayers could not avoid that proceeding by recasting the IRS's audit documents as rulemaking.

The court rejected the taxpayers' contention that the IRS's decision affected not just the taxpayers but all plans created using Byers's system. The court said that adjudicative matters routinely have broader effects, and that does not transform them into legislative rules. Indeed, for purposes of the present motion the court presumed that the IRS applied a top-down approach, evaluating first the propriety of Byers's system and then initiating enforcement actions against taxpayers that employed the system. The court found that this was consistent with the IRS's broad investigation and enforcement powers. The court added that even if this is how the IRS came to undertake its individualized investigation of the taxpayers, it would not give rise to a "Byers Rule" that required notice and comment under the APA. Rather, the court said that such top-down approaches are routine means of administrative actions which ensure even-handed enforcement.

Finally, the court said that insofar as the taxpayers were arguing that the IRS enforcement action constituted or was premised on a new rule because it reflected a change in the IRS's years-long practice of implicitly accepting the Byers ESOP system, that argument was without merit. It is well established, the court found, that our tax system is based on a system of self-reporting. The IRS cannot police every transaction, and it commonly may take action only after years of apparent acquiescence. The court found that such inaction does not estop later enforcement.

For a discussion of employee stock ownership plans, see Parker Tax ¶33,560.

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