Ninth Circuit Slams IRS for Not Giving Proper Notice Before Issuing Summons by Robert S. Horwitz
The Internal Revenue Service has broad authority to examine books and records and interview witnesses for the purposes of determining the liability of any person for taxes, penalties or interest and collecting any liability. This authority includes the power to issue summonses, including to third-parties. Under Powell v United States, 379 U.S. 48 (1964), the IRS is required to meet four requirements before a summons will be enforced: a) that the summons was issued for a legitimate purpose, b) the inquiry is relevant to that purpose, c) the information sought is not already in the government’s possession and 4) the IRS followed the procedures required under the Internal Revenue Code. The IRS normally establishes these requirements by submitting a declaration from the agent conducting the investigation.
Because of the adverse impact an IRS audit could have on a taxpayer’s business or reputation, as part of the IRS Restructuring and Reform Act of 1998, Congress added subsection (c) to Internal Revenue Code sec. 7602, which provides that the IRS “may not contact any person other than the taxpayer with respect to the determination or collection of the tax liability of such taxpayer without providing reasonable notice in advance to the taxpayer that contacts with persons other than the taxpayer may be made.” Although this provision has been part of the Internal Revenue Code, no published court of appeals decision has addressed what constitutes “reasonable notice in advance” until February 26, 2019, when the Ninth Circuit issued its opinion in J.B. v. United States, Docket No. 16-15999, http://cdn.ca9.uscourts.gov/datastore/opinions/2019/02/26/16-15999.pdf.
The taxpayers are “an elderly married couple.” The husband accepts appointments by the California Supreme Court to represent indigent criminal defendants in death penalty cases. They had been audited for prior years, but in 2013 received notice from the IRS that they had been selected for a “compliance research audit” of their 2011 income tax return. A compliance research audit is an in-depth examination that is so demanding that in 1988 Congress discontinued a similar program. Briefly stated, it is the IRS equivalent of a proctology exam.
Included with the letter was an IRS publication, “Publication 1: Your Rights as a Taxpayer,” which had on page two a statement that the IRS normally deals with taxpayer and their authorized representatives directly, but sometimes seeks information from third parties. After the letter, the IRS sent the taxpayers a document request. The taxpayers responded by requesting that they be excused from the compliance research audit due to their advanced age and health and included declarations from the husband’s physician. When the IRS refused the request, the taxpayers sued to stop the audit in district court. Despite the pending suit, the IRS continued its audit, issuing a summons to the California Supreme Court seeking copies of all documents relating to payments to the husband in 2011.
The taxpayers first learned of the summons when their daughter, who was their representative, received notice of service by mail. The taxpayers filed a petition to quash with the district court. The district court found that the IRS satisfied the first three Powell requirements but not the fourth, since it determined that the statement about third party contacts in Publication 1did not constitute reasonable advance notice. The district court reasoned that to constitute “reasonable advance notice” the notice had to be specific to a particular third party and not a general generic notice. The IRS appealed to the Ninth Circuit. The Ninth Circuit affirmed the district court holding that the IRS did not provide the required advance notice.
To interpret the phrase “reasonable notice in advance” the Ninth Circuit looked to Supreme Court cases interpreting notice provisions in other contexts: to be adequate, notice must be “reasonably calculated, under all circumstances, to apprise interested parties” and “afford them an opportunity to present their objections.” According to the Court, this interpretation was consistent with both the context in which the phrase is used and the broader context of the Internal Revenue Code as a whole. While the Code generally prohibits disclosure of taxpayer information, sec. 7602(a) allows disclosure to ascertain “’the correctness of any return, making a return where none has been made, determining the liability of any person … or collecting any such liability.’” Sec. 7602(c) was meant to protect taxpayers from unnecessary third-party contacts. The exceptions to the notice requirement ( a) pending criminal investigation, b) a good cause belief notice will jeopardize the IRS’s collection efforts or subject a third party to reprisal and c) taxpayer authorization for the contact) showed that Congress meant to give the taxpayer a meaningful opportunity to respond to the IRS request.
The Court further held that “reasonable notice in advance” did not require the IRS to provide the taxpayer with a list of people it might contact in advance, since what notice is reasonable depends on the facts. It rejected the IRS argument that the title of subsection (c)(1), “General Notice,” made the section ambiguous. The Court found in the legislative history support for the proposition that Congress intended IRS to provide notice reasonably calculated to apprise taxpayers that the IRS may contact third-parties. The Court also noted that Treas. Reg. sec. 301.7602-2 nowhere suggests that the notice requirement is satisfied by mailing Publication 1.
Finally, the Court rejected the IRS’s argument that other courts have endorsed the notice in Publication 1, finding that district courts that have addressed the issue evaluated the totality of the circumstances in determining whether reasonable advance notice was given and that the Second Circuit, in an unpublished summary order, embraced a “totality of the circumstances” approach to determine whether the IRS provided reasonable advance notice.
Based on the facts of the case, the Ninth Circuit held that Publication 1 did not provide the taxpayers with reasonable advance notice that gave them a meaningful opportunity to volunteer their own records to avoid third-party contacts. It noted that while the holding was based on the facts of the case “we are doubtful that Publication 1 alone will ever suffice to provide reasonable notice in advance to the taxpayer.”
In this case, the only notice to the taxpayers was in Publication 1, which was sent independent of any request for information. There was no evidence that the IRS ever provided any later notice, even after the taxpayers requested that the audit be halted and had not provided documents requested by the IRS. Thus, under the circumstances, the notice provided in Publication 1 was not adequate.
The Court also pointed out that there was no urgency in the IRS requesting information, since the research audit is designed to help the IRS improve its tax collection system and not because there is a belief that the taxpayers may have underreported tax. Further, the summons was issued two years after commencement of the audit, to the California Supreme Court, which was effectively the taxpayer’s employer, and the IRS knew that the documents sought were potentially covered by attorney-client privilege and other litigation-related privileges. Further, the records sought were ones that the IRS would have expected the taxpayers to have and to provide once the dispute over whether they should remain in the research audit program was resolved.
Finally, the Court noted that given the ongoing litigation, the IRS had the opportunity to inform the taxpayers if they did not provide the documents it would contact third parties for the information. The Ninth Circuit ended its opinion as follows:
The IRS must comply with its statutory obligation to provide reasonable notice in advance of contacting third parties. Courts are not in the position to prescribe the exact form of notice that is reasonable in every circumstance. Under the circumstances here, however, reliance on Publication 1 was plainly unreasonable, and there are no doubt numerous other circumstances where the IRS needs to take further steps to provide the reasonable and meaningful notice Congress mandated. When the IRS seeks information from an employer of a party with whom it is currently in litigation and much of the information sought is covered by common law and state-recognized privileges, additional reasonable measures must be taken to provide meaningful notice and an opportunity to respond, in order to avert the potential third-party contact.
Taxpayers rarely prevail in summons enforcement proceedings. The National Taxpayer Advocate reported in her 2014 Annual Report to Congress that of 102 summons cases in that year, the IRS won 97, the taxpayers won 2 and the remaining 3 cases resulted in decisions upholding the summons in part. It is thus impressive for a taxpayer to prevail in a summons case, especially one involving a universal IRS practice: to provide a taxpayer with Publication 1 and no further explanation of either the taxpayers’ rights or that the IRS may contact third parties as part of its audit or investigation. The decision could lead to the IRS reevaluating how it provides notice to taxpayers of potential third-party contacts.
Contact Robert S. Horwitz at email@example.com or 310.281.3200 Mr. Horwitz is a principal at Hochman Salkin Toscher Perez, P.C., former Chair of the Taxation Section, California Lawyers’ Association, a Fellow of the American College of Tax Counsel, a former Assistant United States Attorney and a former Trial Attorney, United States Department of Justice Tax Division. He represents clients throughout the United States and elsewhere involving federal and state administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at http://www.taxlitigator.com.