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Taxpayer First Act and Third Party Notices – New Rules and New Interpretations to the Notice Requirements By SANDRA R. BROWN and TENZING TUNDEN

The Internal Revenue Service (“IRS”) has several tools to utilize in obtaining information about a taxpayer’s financial records.  One of these tools involves contacting third parties.  Those third parties may be a taxpayer’s business associates or even friends and relatives.  Third parties may, however, also be governmental agencies.  While there are rules in place as to when the IRS must provide a taxpayer with advance notice that the agency intends to contact third parties, there are also exceptions to such rules.  One such example for which the IRS has recently provided notice of such an exception involves contacts with governmental agencies.  As discussed below, pursuant to IRS Office of Chief Counsel Memorandum 202013015, the IRS is now taking the position that contact with government agencies is not considered prohibited third-party contact for which notice, which would otherwise be required by law, must be provided to the taxpayer in advance of such contact.

What are Third-Party Notices

An IRS third-party notice is used to verify or collect information about the taxpayer when the taxpayer is unable or, perhaps, unwilling, to provide the information directly to the IRS. This type of notice is a common tool used by the IRS and is codified in the Internal Revenue Code (“IRC”) in § 7602. There are interpretive regulations published in Treas. Reg. § 301.7602-2 as well.  In 2019, the law surrounding third-party notices was amended to provide taxpayers with additional protections.

Taxpayer First Act, the 9th Circuit, and Third-Party Notices

On July 1, 2019, the Taxpayer First Act (“TFA”) was signed into law.[i]  The TFA, a pro-taxpayer legislation[ii], modified numerous policies at the IRS concerning organizational structure, customer service, enforcement procedures, IRS free file program, and cybersecurity.  It also provided additional procedural protections to taxpayers with regards to the IRS’s issuance of third-party notices.

Provision 1206 of the TFA amended IRC § 7602 and the regulations thereunder with respect to the  requirement for IRS third-party notices.[iii]  Previously, the IRS would issue a relatively generic notice of an intent to contact third parties by simply providing the taxpayer with Publication 1 entitled “Your Rights as a Taxpayer” and sending Letter 3164 to the taxpayer at some point prior to contacting third parties.[iv]  It was this specific practice that in 2018, prior to the enactment of the TFA, was the subject of litigation in the 9th Circuit Court of Appeals.  Ultimately, just months prior to the enactment of the TFA, the 9th Circuit ruled in favor of the taxpayer and held that Publication 1 did not provide taxpayers with reasonable advance notice as was then required under the prior § 7206(c).[v] Recognizing that the third parties whom the IRS may contact could include the taxpayer’s neighbors, employer, employees, or the bank that the taxpayer has accounts with, the court recognized major privacy and reputational concerns for taxpayers came into play when the IRS utilized a third party notice. [vi] As such, the 9th Circuit concluded that a reasonable notice must provide the taxpayer with a meaningful opportunity to volunteer records on his own, so that third-party contacts can be avoided if the taxpayer complies with the IRS’s demand.[vii]

Consistent with the 9th Circuit’s decision, published in February 2019, the TFA amended IRC §7602(c)(1), effective August 15, 2019, providing that:

  • The auditor must notify the taxpayer that he or she intends to contact third parties
  • When the auditor notifies the taxpayer, he or she must actually intend to contact the third parties
  • The auditor must notify the taxpayer at least forty five (45) days before he or she contacts the third party and
  • The auditor must tell the taxpayer the time period in which he or she intends to make the contact and the period must not exceed more than a year.

Taxpayer First Act and Post-Contact Reports of Third-Party Notices

The TFA did not impact IRC § 7602(c)(2) which requires the IRS to provide taxpayers with post-contact reports, both periodically and upon request.[viii] As such, in addition to advance notice requirements under the new law, the taxpayer can  also request post-contact reports from the IRS for information as to who the agency  contacted with third party notices.[ix] The availability of both provisions is important. But it should be noted that there are actually three types of notice that a taxpayer should be aware of: (1) the advance notice provision which only covers every third-party contact that the IRS “may” make; (2) the post-contact notice provision which covers only “persons contacted” while excluding third-party contacts authorized by the taxpayer, where notice would jeopardize collection or could lead to reprisals against the person contacted, and in criminal cases; and (3) a copy of any third-party summons sent by the IRS to the taxpayer.[x] In the 9th Circuit case discussed above, for example, the advance notice provision would have required the IRS to notify the taxpayers before contacting the third-party, which in that case was the California Supreme Court, a governmental agency.  However, because those taxpayers received a copy of the summons which the IRS ultimately sent to the California Supreme Court, under § 7206(c)(2), the IRS would not need to include the California Supreme Court on a list of “persons contacted”.[xi]

IRS Chief Counsel Says Contacts with Other Governmental Agencies Are Not Subject to TFA’s Advance Notice Requirements

Pursuant to a recently published Chief Counsel Memorandum, the IRS has stated that IRS contacts with foreign, federal, state and local government agencies are generally not considered prohibited third-party contacts under Treas. Reg. §301.7602-2(f)(5).[xii] In issuing this memorandum, the IRS is taking this position, not simply in matters where cases are being referred to the Department of Justice for enforcement, but in matters where the IRS is seeking information from a third-party governmental agency involved in a nontax-related settlement with a taxpayer.

The Chief Counsel Memorandum dealt with a taxpayer and the tax treatment of a settlement under IRC §162(f).  In a situation where the underlying settlement was between the taxpayer and the Department of Justice, the IRS sought information from the DOJ attorney with knowledge of the case as well as a request for a DOJ-generated Financial Management Information System (FMIS) audit report and/or other information about the manner in which DOJ handled and/or settled the lawsuit with the taxpayer, similar to information the IRS might seek from a private party who had entered into a monetary settlement with the taxpayer.  The primary issue in the above instance was whether the IRS request for information from the DOJ regarding the government’s settlement with a taxpayer (in a non-tax case) should be considered third-party contacts for which IRC §7602(c) advance notice and post-contact reporting rules apply.

The new amendments to IRC § 7602(c)(1), which generally apply to IRS contacts with any “person other than the taxpayer” contain no explicit exception for contacts with governmental entities.[xiii] Treasury Regulation § 301.7602-2(f)(5), however, specifically excepts governmental entities from the § 7602(c) notice rules[xiv] Citing Congressional concerns about a taxpayer’s reputation, third parties privacy, and the IRS’s enforcement of the law underlying the change in the law governing such notice provisions, Chief Counsel concluded that the exception for governmental entities is consistent with the Congressional intent in amending § 7602(c) of the TFA.  Whether this position will stand is open for debate, particularly in the 9th Circuit, where the Court found the IRS’s use of Publication 1 as insufficient for a contact with a governmental entity, specifically the California Supreme Court, under a less taxpayer-friendly version of § 7206(c).

Sandra R. Brown is a Principal at Hochman Salkin Toscher & Perez P.C.  Prior to joining the firm, Ms. Brown served as the Acting United States Attorney, the First Assistant United States Attorney and the Chief of the Tax Division of the Office of the U.S. Attorney (C.D. Cal)  Ms. Brown  specializes in representing individuals and organizations who are involved in criminal tax investigations, including related grand jury matters, court litigation and appeals, as well as representing and advising taxpayers involved in complex and sophisticated civil tax controversies, including representing and advising taxpayers in sensitive-issue audits and administrative appeals, as well as civil litigation in federal, state and tax court. 

Tenzing Tunden is a Tax Associate at Hochman Salkin Toscher Perez P.C. Mr. Tunden is a 2019 graduated from the Graduate Tax Program at NYU School of Law and the J.D. Program at UC Davis School of Law. During law school, Mr. Tunden served as an intern at the Franchise Tax Board Legal Division and at the Tax Division of the U.S. Attorney’s Office (N.D. Cal).

[i] Taxpayer First Act of 2019, H.R. 3151; Pub.L. 116-25.

[ii] According to the House Ways & Means Committee, the TFA’s passage was the result of the committee’s effort to implement pro-taxpayer reforms at the IRS for the first time in more than 20 years.

[iii] See https://www.congress.gov/bill/116th-congress/house-bill/3151/text. Also see https://www.finance.senate.gov/imo/media/doc/Taxpayer%20First%20Act_Section%20by%20Section-converted.pdf at 3.

[iv] Publication 1 Your Rights as a Taxpayer. Letter 3164 Notification of Third Party Contact.

[v] J.B. v. United States, 916 F.3d 1161, 1173 (9th Cir. 2019); http://cdn.ca9.uscourts.gov/datastore/opinions/2019/02/26/16-15999.pdf.

[vi] Id. at 1165. Also see Publication 1.

[vii] Id.

[viii] IRC § 7602(c)(2). Also See Treas. Reg. § 301.7602-2(e)(1).

[ix] Id.

[x] Cf. I.R.C. § 7602(c)(1) with I.R.C. § 7602(c)(2); see also Treas. Reg. § 301.7602- 2(e)(4), Ex. 4 (“providing a copy of the third party summons to the taxpayer pursuant to section 7609 satisfies the post-contact recording and reporting requirement”).

[xi] Id.

[xii] See IRS Office of Chief Counsel Memorandum 202013015, The Application of I.R.C. §7602(c) to Government Contacts in the Context of DOJ Settlements with a Taxpayer, at 2.

[xiii] IRC §7602(c).

[xiv] See Treas. Reg. §301.7602-2(f)(5) (“Section 7602(c) does not apply to any contact with any office of any local, state, Federal or foreign governmental entities” and that “the term office includes any agent or contractor of the office acting in such capacity.”)

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