Scholl v. Mnuchin and Economic Impact Payments

Scholl v. Mnuchin and Economic Impact Payments

Legal Sidebari

Scholl v. Mnuchin and Economic Impact
Payments
March 26, 2021
Congress established a new temporary refundable tax credit in the Coronavirus Aid, Relief, and Economic
Security Act (CARES Act), Pub. L. No. 116-136, codified in Internal Revenue Code (IRC) Section 6428.
The CARES Act credit for each “eligible individual” equals up to $1,200, plus an additional $500 per
qualifying child. The CARES Act authorized the Treasury Secretary to disburse advance refund payments
in 2020 to “eligible individuals” in the amount of the credit allowable on the individual’s 2020 tax return.
These direct payments are commonly referred to as the first round of Economic Impact Payments (EIPs).
Initially, the Internal Revenue Service (IRS) disbursed EIPs to incarcerated individuals. However, the IRS
later reversed its position.
On August 1, 2020, in Scholl v. Mnuchin, a group of incarcerated individuals and formerly incarcerated
individuals who did not receive EIPs (Plaintiffs) filed a lawsuit in the U.S. District Court for the Northern
District of California. The Plaintiffs alleged that the Treasury Secretary, the IRS Commissioner, the
Treasury Department, the IRS, and the United States (Defendants) failed to comply with the CARES Act
when they declared incarcerated individuals ineligible for EIPs and declined to issue EIPs to them. The
Plaintiffs’ asserted that: (1) Defendants unlawfully withheld EIPs in violation of Section 706(1) of the
Administrative Procedure Act (APA); (2) Defendants’ denial of EIPs to Plaintiffs was contrary to law, in
excess of statutory authority, and arbitrary and capricious under APA Sections 702 and 706(2); and (3)
federal courts had jurisdiction to hear Plaintiffs’ civil claims against the United States pursuant to the
Little Tucker Act, 28 U.S.C. § 1346(a)(2) because Defendants denied payments authorized by the CARES
Act. The Plaintiffs sought to certify a nationwide plaintiff class comprised of individuals who met the
CARES Act criteria for receipt of EIPs but were denied the payments based solely on their incarcerated
status. As relief, the Plaintiffs sought a declaratory judgment that Defendants lacked statutory authority to
deny EIPs based solely on incarcerated status and an injunction barring the Defendants from continuing to
deny EIPs based solely on incarcerated status.
On September 24, 2020, the district court issued an order that provisionally certified the plaintiff class and
granted a preliminary injunction enjoining the Defendants from withholding EIPs based solely on an
individual’s incarcerated status. On October 14, 2020, the court issued an order certifying the plaintiff
class and granting Plaintiffs’ motion for summary judgment on their claim alleging that the Defendants’
action violated the APA because it was contrary to law, in excess of statutory authority, and arbitrary and
capricious. The court therefore converted its preliminary injunction into a permanent injunction, ordering
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the Defendants to terminate their policy of excluding individuals from receiving EIPs solely based on
their incarcerated status. Following the permanent injunction, the IRS resumed processing incarcerated
individuals’ requests for EIPs. The American Rescue Plan Act of 2021, Pub. L. No. 117-2, establishing
the third round of economic impact payments, and the Consolidated Appropriations Act, 2021, Pub. L.
No. 116-260, establishing the second round of economic impact payments, did not adjust the definition of
“eligible individuals” to exclude incarcerated individuals from receiving economic impact payments.
Scholl is one of a few lawsuits brought by groups seeking to clarify their eligibility for relief under the
CARES Act. The court’s rulings in Scholl could impact these other pending cases and could change how
Treasury and the IRS issue future guidance for recently enacted legislation. This Legal Sidebar discusses
how the CARES Act defined an individual who was eligible for an EIP, how Treasury and the IRS
interpreted that definition, and the parties’ main arguments in Scholl, with an eye to understanding how
this litigation might illuminate larger issues surrounding Treasury and IRS guidance interpreting who is
eligible for tax benefits under established statutory criteria.
Eligibility for EIPs Under the CARES Act
Under the CARES Act, an “eligible individual” is “any individual” other than (1) a nonresident alien,
(2) an individual who can be claimed as a dependent on another taxpayer’s return, and (3) an estate or
trust. On May 6, 2020, the IRS published responses to frequently asked questions (FAQs) on its website,
which included a response that declared incarcerated individuals ineligible for EIPs. Question 15 asked,
“Does someone who is incarcerated qualify for the [EIP]?” The IRS responded:
A15. No. A Payment made to someone who is incarcerated should be returned to the IRS by
following the instructions about repayments. A person is incarcerated if he or she is described in
one or more of clauses (i) through (v) of Section 202(x)(1)(A) of the Social Security Act (42 U.S.C.
§ 402 (x)(1)(A)(i) through (v)). For a Payment made with respect to a joint return where only one
spouse is incarcerated, you only need to return the portion of the Payment made on account of the
incarcerated spouse. This amount will be $1,200 unless adjusted gross income exceeded $150,000.
On June 18, 2020, the IRS updated its Internal Revenue Manual to reflect this policy. The IRS also took
steps to intercept EIPs to incarcerated individuals and updated its FAQs to instruct incarcerated
individuals to return EIPs.
In a report dated June 30, 2020, the Treasury Inspector General for Tax Administration (TIGTA) raised
concerns about paying EIPs to incarcerated individuals. The TIGTA report stated that the IRS’s initial
response to TIGTA’s inquiries was that incarcerated individuals were eligible for EIPs because the
CARES Act did not prohibit them.
Standing and Ripeness
Article III, Section 2, clause 1 of the U.S. Constitution authorizes federal courts to adjudicate actual
“cases” and “controversies.” Under this constitutional provision, federal courts are limited to hearing
cases in which the plaintiff has suffered an actual injury, thereby establishing that the party has “standing”
and that the issues are “ripe” for judicial review. The Defendants in Scholl argued both standing and
ripeness were absent because the Plaintiffs did not sustain an injury in 2020. The Defendants contended
that, even though the Plaintiffs were denied EIPs in 2020, they would sustain an injury only after they
claimed the new temporary refundable tax credit on their 2020 tax returns (to be filed in 2021) and the
IRS denied their claims. The district court rejected that argument, applying the same analysis to hold that
the IRS’s policy of withholding EIPs from incarcerated individuals, including the FAQ response, and its
deprivation of EIPs in 2020 were injuries that satisfied both Article III conditions.
The Defendants also argued the Plaintiffs’ claims failed to meet the distinct “prudential” ripeness
requirement for obtaining judicial review. The APA authorizes judicial review of a “final agency action

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for which there is no other adequate remedy in a court.” Administrative actions satisfy the prudential
ripeness requirement under the APA when the challenging party feels the effects of an administrative
decision in a concrete way. In Scholl, the Defendants asserted the district court lacked subject matter
jurisdiction to hear the case because the FAQ response was not a “final” agency action within the
meaning of the APA. The district court disagreed with the Defendants’ analysis. Quoting Supreme Court
precedent, the district court held that an agency’s actions under the APA are final and reviewable when
two conditions are met: “First, the action must mark the consummation of the agency’s decision-making
process–it must not be of a merely tentative or interlocutory nature. And second, the action must be one
by which rights or obligations have been determined, or from which legal consequences will flow.” In the
preliminary injunction order, the court highlighted several facts it believed conveyed that the Defendants’
decision to exclude EIPs to incarcerated individuals was final. The court reasserted these facts in the
permanent injunction order. The court found: the FAQ response described the IRS’s unequivocal change
in position that incarcerated individuals did not qualify for EIPs; the Defendants submitted a declaration
repeating the position taken in the FAQ response; the IRS changed the Internal Revenue Manual to reflect
the change in position; and the CARES Act’s requirement to disburse all EIPs by December 31, 2020
made more changes to the Defendants’ position unlikely.
APA Claims
Following the district court’s preliminary injunction order, the Plaintiffs filed a motion for summary
judgment on their first two causes of action: (1) violation of APA Section 706(1); and (2) violation of APA
Sections 702 and 706(2). The district court already had determined in the order granting the preliminary
injunction that it need not defer to the Defendants’ interpretation of who was eligible for EIPs because the
Defendants had not issued regulations and did not follow APA notice-and-comment rulemaking
procedures when the IRS issued its FAQ response on incarcerated individuals.
In the motion for summary judgment, the Plaintiffs asked the district court to compel the Defendants to
disburse EIPs to incarcerated individuals who met the CARES Act criteria, pursuant to APA Section
706(1). Section 706(1) authorizes a reviewing court to “compel agency action unlawfully withheld or
unreasonably delayed.” Although the court agreed with the Plaintiffs that the CARES Act compelled
Treasury and the IRS to take a discrete agency action with regard to EIPs, it denied the motion for
summary judgment on this claim on the ground that the Plaintiffs were challenging how Treasury and the
IRS carried out the action—i.e., issued EIPs to incarcerated individuals, then reversed course and sought
to claw back EIPs that were issued—instead of a failure to act.
The district court granted Plaintiffs’ motion for summary judgment on their second claim that the
Defendants’ decision to exclude payments to incarcerated individuals was contrary to law and in excess
of statutory authority. Under APA Section 706(2), a reviewing court can hold unlawful and set aside an
agency action, finding, or conclusion that is: “arbitrary, capricious, an abuse of discretion, or otherwise
not in accordance with law”; “in excess of statutory jurisdiction, authority, or limitations, or short of
statutory right”; or “without observance of procedure required by law.” Relying on the language and
structure of the CARES Act, the court concluded that the Act requires the IRS to issue EIPs to individuals
meeting the statutory criteria. In the preliminary injunction order, the court determined that the definition
of “eligible individual” was not open-ended and that the Treasury Secretary lacked the discretion to
change the definition. In the permanent injunction order, the court reiterated the facts it found persuasive.
It noted that a previous version of IRC Section 6428, passed in response to the 2008 financial crisis,
demonstrated Congress knew how to exclude payments to incarcerated individuals if desired, and
Congress had not done so here. The court also found persuasive the fact that the IRS had asserted three
different interpretations of who constituted an “eligible individual,” both publicly and in the litigation.
The court observed that the IRS first disbursed EIPs to incarcerated individuals, later declared
incarcerated individuals ineligible for EIPs in its FAQs and Internal Revenue Manual, and then, during

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litigation, stated that it planned to issue EIPs to individuals who were only incarcerated for part of the
year. Thus, the court ruled the definition of “eligible individual” under the CARES Act does not exclude
incarcerated individuals, and the Defendants’ decision to exclude incarcerated individuals was contrary to
law and in excess of statutory authority in violation of Section 706(2).
The district court also granted Plaintiffs’ motion for summary judgment on their second claim on the
alternative ground that the Defendants’ decision to deny payments to incarcerated individuals without
stating an adequate reason for that decision was arbitrary and capricious under APA Section 706(2). In its
preliminary injunction order, the court noted that the Defendants did not direct the court to any evidence
that provided a reason for Treasury and the IRS’s decision to exclude EIPs to incarcerated individuals. In
the permanent injunction order, the court remarked that the Defendants had “not advanced any convincing
explanation or reason to deviate from the court’s prior finding.” As an example, the court cited the
Defendants’ explanation that Treasury and the IRS adopted the policy as an anti-fraud measure. The court
held that the Defendants’ explanation constituted an impermissible post hoc rationalization because the
Defendants did not publicly advance this explanation when they decided to deny EIPs to incarcerated
individuals.
Considerations for Congress
The district court’s orders in Scholl, and other CARES Act relief eligibility cases pending in courts
around the country, could have long-lasting effects on how and when Treasury and the IRS respond to
rapidly developing situations following the enactment of tax legislation. After the enactment of the
CARES Act, the IRS issued FAQs to provide the public with timely guidance on EIP eligibility and
information on how to obtain EIPs. The IRS might delay issuing similar tax guidance in the future out of
concern that courts are more likely to find that judicial deference is unwarranted when Treasury and the
IRS’s interpretations of statutes are conveyed in tax guidance other than regulations and do not provide an
explanation of the agencies’ reasoning. Scholl suggests that in order to ensure that the intended recipients
of tax benefits receive them quickly, Congress could consider whether to define precisely in the statute
whom the legislation is and is not intended to benefit, leaving little room for judicial or agency
misinterpretation.

Author Information

Milan N. Ball

Legislative Attorney

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