Eleventh Circuit Upholds Enforcement of Summons Relating to Law Firm and Its Clients (And Sweeps in the 1980 Miracle on Ice)

The Eleventh Circuit opinion in Presley v US ostensibly is about how IRS can summons a bank for information relating to deposits from a law firm’s clients. The opinion starts with a recounting of the 1980 Winter Olympics, when the US Olympic hockey team, against heavy odds, beat the Soviets.  Drilling into the details, the opinion includes the average age of the US team (22), links to the E.M. Swift’s Sports Illustrated article on the win, references the 2004 Disney movie Miracle, and how one of the players (Jack O’Callahan), was so moved by Coach Herb Brooks’ pregame speech that he could recount it decades later.

What is the connection between the power of the IRS to gather information from third parties and the Miracle on Ice?

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Writing for a unanimous panel, Judge Rosenbaum contrasts the uphill battle that the US hockey team faced from the battle that the plaintiffs faced:

But forget about tough odds the U.S. hockey team faced, Plaintiffs face-off with something even more formidable…

According to the opinion, more formidable than the Soviet team is the considerable power that the IRS has to get information via its summons powers. The opinion nicely summarizes the statutory framework and Supreme Court guidance that stack the deck heavily in favor of the IRS.

The facts are straightforward. The plaintiffs are a lawyer and his law firm, and they sought court protection to avoid their bank’s compliance with summonses the IRS issued in connection with an exam of Presley’s individual income tax liability.

As the opinion discusses the IRS summonses sought records “pertaining to any and all accounts over which [each Plaintiff] has signature authority,” including bank statements, loan proceeds, deposit slips, records of purchase, sources for all deposited items, and copies of all checks drawn.

Presley objected to the bank’s turning over information related to their clients’ trust and escrow accounts, arguing essentially that his clients’ Fourth Amendment expectation of privacy would be violated if the IRS obtained the information about the clients’ financial transactions with the law firm.

The opinion starts by describing that there is some uncertainty whether the law firm, rather than the clients, can make the Fourth Amendment argument. After all, it is the clients whose privacy interests are at stake. This is akin to a standing dispute; i.e., does the law firm have standing to make the case that its clients’ privacy interests may be violated?

The opinion is able to sidestep that issue, noting that unlike traditional Article III standing disputes, Fourth Amendment standing is not jurisdictional, meaning that the opinion can effectively decide the matter on the merits without weighing in on whether technically Presley can in fact make the argument.

Getting to the merits, Presley argued that in light of the clients’ privacy interests in the financial information the IRS must show probable cause to enforce the summons. The court disagreed, noting that probable cause would only be required if the clients had a reasonable expectation of privacy in the financial records.  The opinion says that there is no such expectation, referring to what is known as the third-party doctrine and citing to the 1976 Supreme Court case US v Miller (also involving an IRS summons and a bank):

[A] party lacks a reasonable expectation of privacy under the Fourth Amendment in information “revealed to a third party and conveyed by [that third party] to Government authorities, even if the information is revealed on the assumption that it will be used only for a limited purpose and the confidence placed in the third party will not be betrayed.”

Presley tried to distinguish Miller, because unlike in that case, there was an intermediary between the clients and the bank, i.e., the clients transferred money to the law firm, which then made deposits on behalf of the clients. The court found that distinction insignificant:

Nor does it matter that Plaintiffs’ clients gave their records to Plaintiffs rather than directly to the bank. Plaintiffs conveyed their records, such as checks for deposit in Presley Law’s escrow or trust accounts, knowing that the firm would, in turn, deposit these items with the Bank. So if Plaintiffs cannot escape Miller directly, Plaintiffs’ clients cannot avoid its application indirectly. In short, Miller precludes us from holding that Plaintiffs’ clients have a reasonable expectation of privacy in the summoned records.

There were two other issues of note in the opinion. Presley also argued that even if there was no Fourth Amendment requirement that the government show probable cause to ensure enforcement, the Florida constitution had a heightened privacy protection for these circumstances. The Eleventh Circuit declined to consider the impact of the Florida constitution on the reach of IRS summons powers, noting that state laws that “conflict with federal laws by impeding the ‘full purposes’ of Congress must give way as preempted,” a doctrine known as the Supremacy Clause. That has come up before in tax cases, as courts have enforced IRS summonses despite, for example, state law doctor-patient privileges.

Once dispelling with the argument that the IRS had to establish heightened probable cause to justify the summonses, the opinion rested on a traditional application of the Powell factors, which in effect is a proxy for the Fourth Amendment protection that an IRS search met the lesser standard that it not be unreasonable. Noting that Presley did not claim a conflict with Powell, and that there was no claim that the IRS was using the summons power as a subterfuge to investigate the clients or violate attorney-client privilege, the opinion found “no reason to discern why the summons should not be enforced.”

As a final argument, Presley argued that the district court failed to comply with the so-called John Doe summons procedures under Section 7609(f). That requires the IRS to go to a district court in an ex parte hearing when it seeks information about unnamed third parties. We have discussed that a few times in PT, and I discuss it heavily in Chapter 13 of Saltzman and Book, including in the context of the IRS investigation of crypto currency users.

Here, while the IRS sought information that included information about unnamed third parties (the clients), the main targets were the law firm and Presley himself, who were named on the summons and who did receive notice of the IRS actions. Moreover, the plaintiffs in Presley conceded that their clients were not the subject of the IRS investigation, unlike in the Bitcoin dispute where IRS has been trying to gather information to allow it to determine whether Bitcoin customers were complying with federal tax laws.

For good measure, additional Supreme Court precedent, Tiffany v US, allows the IRS to effectively issue dual purpose summonses that could also provide information about unnamed third parties, provided that the IRS complies with the notice provisions under Section 7609(a)—which it did here.

Taken together, the defenses that the government mustered were more formidable than Vladislav Tretiak, and the bank will have no choice but to comply with the summons and I doubt there will be a Disney movie about this story.

Summonsing Records for the French Taxing Authority

A couple years ago, I wrote a post about the efforts of the IRS to assist the Danish tax agency to collect from a taxpayer in the United States. That case involved a levy on the taxpayer’s assets. Recently, another one of the five countries that have collection treaties with the IRS had an opinion issued based on the efforts of the IRS to assist it in collecting taxes due to France. In the case of Hanse v. United States, No. 1:17-cv-04573 (N.D. Ill. March 5, 2018), the court analyzes the treaty provisions in the context of a summons enforcement case. The application of the summons laws in this case results in an order that the information sought be provided to the IRS/France.

I wrote a post almost four years ago on the failure of tax administration to negotiate collection provisions into every tax treaty and not just have it in five treaties that happen to have been written at a time when someone thought this was a good idea. In a global economy, it still seems like a good idea. We have passed laws seeking to ensure that we know about the income of U.S. citizens around the world and leaned on other countries to cooperate in helping the IRS know of the income. To complement that effort, the IRS needs to have the treaty tools to collect when assets exist overseas and it cannot obtain personal jurisdiction over the taxpayer. The absence of collection language in our tax treaties makes it difficult, and at times impossible, for the IRS to collect from taxpayers who park their assets in the vast majority of countries since the IRS lacks a mechanism for reaching those assets.

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France is investigating the potential wealth tax and income tax liabilities of Mr. Hanse for the years 2013-15. The French tax authorities sent to the IRS an exchange of information request seeking information in connection with its investigation. France particularly wanted information about two transfers by Mr. Hanse totaling over 500,000 €. The request stated that Mr. Hanse was a French citizen and that the French tax authorities had exhausted the remedies domestically available for gathering the information. The IRS did not have the information requested. The U.S. competent authority determined that the request was proper under the treaty provisions. So, the IRS served a summons on the party to whom the funds were transferred, a third party in the US, and sent notice to the taxpayer at the address provided by the French authorities.

The taxpayer timely filed a petition to quash the summons raising three objections: 1) the IRS failed to comply with the administrative steps necessary for a valid summons under the IRC because it contacted third parties without providing advanced notice under IRC 7602(c)(1); 2) France could not obtain the information through its own laws so it should not use the treaty to accomplish what it could not do if this were an entirely domestic situation; and 3) the summonsed party is a law firm and some of the materials requested by the summons required protection from disclosure by the attorney client privilege.

The IRS moved to dismiss and attached to its motion affidavits from the competent authority and the revenue agent serving the summons. The court decided to treat this as a motion for summary judgment which is normal in most contexts, though not as normal in a summary proceeding such as a summons enforcement.

Before addressing the first argument, the court notes that the IRS must meet the four elements of the Powell test. We have discussed those elements before. A similar notice argument was addressed in a recent post written by Les. The court notes that the burden on the IRS with respect to the summons remains the same whether the summons involves a “normal” U.S. taxpayer or is done at the request of a treaty partner. Here, the court finds that the affidavits allow the IRS to meet its burden under the Powell test, which it acknowledges is not a heavy burden.

Good Faith of French Investigation

The taxpayer argues that French law would not allow the French authorities to obtain the information sought through the summons and, therefore, those authorities should not circumvent French law and obtain the information just because the U.S. laws do permit the gathering of the information. The court takes this as a challenge to the “legitimate purpose” element of the Powell test. This is where a treaty summons gets a little interesting. Looking at prior case law involving other treaty summonses issued on behalf of France, the court finds that to satisfy the Powell test it need not look at the good faith of the treaty partner but only at whether the IRS acted in good faith in issuing the summons. Since the taxpayer did not challenge whether the IRS issued the summons in good faith and the court saw no indication of bad faith, it finds that this challenge fails.

Compliance with IRC

Petitioner challenges the issuance of a summons to a third party where the IRS has not provided the taxpayer with a notice pursuant to IRC 7602(c)(1). We have written very little about IRC 7602(c), which is a provision that came into the code in the 1998 Restructuring and Reform Act. Les addressed it in an earlier post and notes at least one case that has held the taxpayer should receive specific notice of contact of third parties. Most issues involving this code section, which requires the IRS to notify taxpayers before it contacts thirds parties about them looking for information, concern the IRS position that Pub 1 generically informs them of the possibility that the IRS might do this (thus satisfying the statutory requirement) versus the need, in the view of some taxpayers, for the IRS to specifically tell them who it intends to contact.

Here, the IRS neither generically nor specifically informed the taxpayer of its intent to contact a third party by serving the summons. The taxpayer argues that this failure makes the summons unenforceable. The IRS argues that the protection of IRC 7602(c) does not extend to the taxpayer because it “does not include the liability for any tax imposed by any other jurisdiction.” 26 C.F.R. 301.7602-2(c)(3)(C). The court agrees with the IRS. This creates an interesting exception for taxpayers whose summons cases arise under treaty language

Attorney Client Privilege

I recently wrote on another summons case in which the taxpayer sought to keep the IRS from information based on the attorney-client privilege. The court here notes that a blanket assertion of attorney-client privilege does not work and that the taxpayer needs to assert the privilege on a document by document basis. Because the taxpayer did not support the privilege claim with “any facts from which the Court could find a privilege attaches to the documents that are requested in the summons” the court rejects his privilege argument.

Conclusion

Some aspects of the treaty summons differ from a “normal” summons in their application because of the interplay of the code with non-US taxpayers. Here, the summons gets enforced and presumably France gets the information it needs in order to move forward with its tax investigation. Only a handful of these cases have been reported, suggesting either that countries do not need to resort to the treaty very often in order to complete their investigations or that investigators do not use this tool as effectively as they might. As the global economy continues to push through borders, we should expect more of these cases and there could be many more if we negotiated different treaty language regarding collection.

 

 

 

Clash Between Claim of Attorney Client Privilege and Summons Power

In an unpublished opinion in United States v. Servin (No. 2-16-cv-05615), the Third Circuit upheld the enforcement of a summons against a Pennsylvania attorney. This case does not break new ground but serves as a reminder of the power of the IRS summons and the limitations of the attorney-client privilege. Mr. Servin did receive some relief from the summons so his efforts in contesting it were not entirely without success.

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Mr. Servin must owe a decent amount of taxes since his case is in the hands of a revenue officer. Today, taxpayers often must owe in excess of $100,000 to have their case handled by a revenue officer, although that amount can vary based on location and other factors. I have commented before that having a revenue officer assigned to your case is like getting concierge service because you have a knowledgeable individual to work with to resolve the issues rather than having to deal with the Automated Collection Site (ACS); however, my comment was somewhat tongue in cheek because having a revenue officer assigned to your case, particularly if you are not working to resolve the matter, can cause a taxpayer many problems as the knowledgeable revenue officer uses the powerful collection tools at the disposal of the IRS. Here, the taxpayer feels the effect of having his account assigned to a revenue officer rather than to ACS.

This case involves a collection summons which seeks to obtain from him information that would allow the IRS to collect the outstanding liability. Specifically, the revenue officer wants from him information about which clients owe him so that the revenue officer can send a levy to these individuals and businesses in order to collect the outstanding taxes Mr. Servin has not voluntarily paid. The summons requests Mr. Servin’s current client list, including names and addresses of all of the clients and a list of his cases that will be settling or have settled within a specified time period, including names and addresses of the parties to the case (who would also be persons the revenue officer would levy.) Undoubtedly, having levies served on all of your clients and opposing parties would not enhance Mr. Servin’s business. Preventing that from happening would protect his business and professional interest, in addition to client confidentiality which is why we have this summons case on which to report.

Mr. Servin does not contest that the IRS meets the general Powell standards for issuing the summons. The meet the Powell requirements, the government must show that the summons: (1) is issued for a legitimate purpose; (2) seeks information that may be relevant to that purpose; (3) seeks information that is not already within the IRS’s possession; and (4) satisfies all administrative steps required by the Internal Revenue Code. United States v. Powell, 379 U.S. 48, 57-58 (1964). He argues narrowly based upon the defense of attorney-client privilege. Unfortunately for Mr. Servin, the Third Circuit has pre-existing precedent on the issue of using the attorney-client privilege to protect client identities from summons enforcement in the case of United States v. Liebman, 742 F.2d 807 (3d Cir. 1984). The precedent does not favor the outcome he seeks. The Third Circuit precedent is similar to precedent that exists in other circuits.

The general rule does not permit an attorney to protect client names and addresses from summons enforcement based on attorney client privilege. The Third Circuit finds that Mr. Servin fails to identify any circumstances that would cause his case to fall out of the general rule and allow him to shield his client information. The Pennsylvania Rules of Professional Conduct do not prevent this disclosure despite his desire to use those rules and his citation to them.

He does win a partial victory because the court modifies the summons to eliminate the name of individuals that have not yet settled but will settle in the future. This victory reflects the concerns that the IRS limit its intrusion into client information of an attorney. The IRS does not often or lightly summons attorneys for client information. The revenue officer who wants to summons an attorney must persist in order to obtain permission to do so. Summonsing an attorney results in reviews by both Chief Counsel and Tax Division lawyers before the summons is allowed. IRM 5.17.6.14 & 15 discusses some of the special issues related to summonses issued to attorneys. The reason that the IRM requires much higher level of review of summonses issued to attorneys stems from the very matter at issue in this case. The IRS recognizes the sensitivity of client information and does not want to let revenue officers run loose in seeking this information. So, it wants a review before it seeks enforcement. The IRS also does not like to issue summonses that it does not enforce since doing so undermines the authority of its summonses. This causes it to require review of summonses in sensitive areas.

Here, the revenue officer seeks information that the attorney cannot protect. The summons victory may cause Mr. Servin to full pay the liability in order to avoid having levies issued to many of his clients. If so, the summons itself may serve as a very valuable collection tool. If it does not cause Mr. Servin to full pay the liability, his clients and many individuals in his community may be about to learn about their attorney’s tax compliance or tax dispute. It is possible that he could still contest the liability and prove that he does not owe. It’s hard, however, to unring the bell and explain to a host of people that he did not owe when they receive a levy seeking payment of the liability which is why this is a very sensitive matter even if the names are not protected by attorney-client privilege.

The discussion of the relationship between Pennsylvania’s Rules of Professional Conduct serves as an important reminder that those rules too have limits, especially when they run into a valid investigation of an attorney’s conduct. PA Rule of Professional Conduct 1.6 is broader than the attorney client privilege; it provides that “A lawyer shall not reveal information relating to representation of a client unless the client gives informed consent, except for disclosures that are impliedly authorized in order to carry out the representation.”

Servin claimed “in the absence of the client’s informed consent the lawyer must not reveal information relating to the representation – moreover a presumption exists against such disclosure.”

The opinion notes however that the Rules of Professional Conduct are not relevant in the court’s consideration of whether to enforce a summons; rather those rules relate to a state’s possible disciplinary proceedings against a lawyer. Comments to PA Rule 1.6 specifically provide that the scope of the rule is limited by substantive law, and numerous PA cases provide that the Professional Conduct Rules do not govern or affect the application of the attorney-client privilege.

 

 

Treasury Intends to End Allowing Outside Counsel To Participate in Exams

Last month Treasury issued Identifying and Reducing Regulatory Burdens in response to Executive Order 13789. In the report Treasury indicated that it plans to substantially revise regulations under Section 7602 that allowed the participation of private contractors to “participate fully” when the IRS interviewed taxpayers or witnesses who were summoned during an examination. In particular, Treasury has stated its intention to remove the power of private domestic attorneys to participate with IRS employees in interviewing witnesses summoned during an examination.

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The report Treasury issued was in response to an executive order that directed the Secretary of the Treasury to identify significant tax regulations that (i) impose an undue financial burden on U.S. taxpayers, (ii) add undue complexity to the Federal tax laws, or (iii) exceed the statutory authority of the IRS. In June, Treasury identified eight regulations, and the report issued last month discusses the plan to mitigate or eliminate the burdens.

One of the regulations discussed was the regulations under Section 7602 that gave IRS power to use outside contractors to assist in interviewing summoned witnesses in an exam. As Keith previously discussed the regulations have been controversial, and while in US v Microsoft district court in Washington found that Treasury had the authority to issue those regulations, the court was troubled by the outside firm participation in the IRS audit of Microsoft, and suggested that Congress may scale the practice back. There has been proposed legislation to do that, though it has not moved much since its introduction.

The Treasury report states that“[u]nder the amendment currently contemplated by Treasury and the IRS, outside attorneys would not be permitted to question witnesses on behalf of the IRS, nor would they be permitted to play a behind-the-scenes role, such as by reviewing summoned records or consulting on IRS legal strategy.” In explaining why, the report embraces the criticism of the practice:

When the IRS enlists outside attorneys to perform the investigative functions ordinarily performed by IRS employees, the government risks losing control of its own investigation. RS investigators wield significant power to question witnesses under oath, to receive and review books and records, and to make discretionary strategic judgments during an audit— with potentially serious consequences for the taxpayer. The current regulation requires the IRS to retain authority over important decisions, but the risk of a private attorney taking practical control may simply be too great. These powers should be exercised solely by government employees committed to serve the public interest, not by outside attorneys. These concerns outweigh any countervailing need for the IRS to contract with outside attorneys. Treasury remains confident that the core functions of questioning witnesses and conducting investigations are well within the expertise and ability of the IRS’s dedicated attorneys and examination agents.

The Executive Order notes however that Treasury intends to retain the power to allow outside experts who are not US lawyers to help with summons proceedings. The report mentions that subject matter experts, including economists, engineers or non US lawyers, may be necessary in a small subset of cases because of a possible “compelling need” to provide expertise that IRS employees may lack.

Conclusion

Treasury candidly discussed why the practice of bringing in outside counsel in summons proceedings was on balance not consistent with some of the key values that underlie sound tax administration. While IRS resources are spread thin, and at times the complexity of cases challenges even the most seasoned IRS employees, IRS does have at its disposal attorneys from the government, including DOJ attorneys who may be able to provide the perspective and expertise that can help ensure that IRS has what it needs to do its job properly in an exam. In addition, Congress should ensure that IRS has the resources it needs so it does not routinely feel that it is outgunned when examining taxpayers who by the nature of the businesses will present complex returns. Relying on the private sector to help with core tax functions in an exam (or collection for that matter, though that is another story) is not the way to sound tax administration, and this report refreshingly tells us why. It carries additional weight when the government itself acknowledges those costs.

 

A PT Anniversary and Court Finds IRS Summons on Coinbase Suggests an Abuse of Process

Today marks the 4th anniversary of Procedurally Taxing. Our first post, Welcome to Procedurally Taxing, discusses our goals for the blog. As I discussed in that initial post, we hoped to become a source for developments and to act as a filter to allow readers to hone in on some key issues relating to tax administration and tax procedure. When we started we had no idea how much work was involved in writing and editing. We also did not anticipate how much we would benefit from our readers, many of whom contact us, offer comments and become guest posters. So thanks to our readers for inspiring us to remain engaged.

Enough of the mush and on to some tax procedure.

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We have previously discussed the IRS issuance of a John Doe summons on Coinbase. The case has been proceeding and last week an order from a magistrate judge out of the Northern District in California held that an anonymous customer could intervene in the summons enforcement proceedings. This brief posts highlights some of those developments.

Coinbase is an exchange that deals in convertible virtual currency. It operates a bitcoin wallet. It is a big player in the virtual currency market. IRS has been concerned that parties using bitcoin are not complying with their tax obligations. Recall that in 2014 IRS issued Notice 2014-21, where IRS opined that virtual currencies are property for tax purposes, potentially triggering a gain or loss on sale or exchange of a virtual currency.

Flash forward a few years and IRS serves up its John Doe summons on Coinbase. The requested information was voluminous, including:

Account/wallet/vault registration records for each account/wallet/vault owned or controlled by the user during the period stated above including, but not limited to, complete user profile, history of changes to user profile from account inception, complete user preferences, complete user security settings and history (including confirmed devices and account activity), complete user payment methods, and any other information related to the funding sources for the account/wallet/vault, regardless of date.

At the recent ABA Tax Section meeting there was lots of talk about how the IRS summons was overbroad, potentially sweeping up small transactions and people whose information would likely be of no interest to the IRS.

Following service of the summons a number of parties, including Coinbase, sought to intervene to quash the summons. Coinbase also sought to narrow the scope of the summons.

This summer there was oral argument on the motions and IRS informed the court that it has narrowed the scope of the summons. The CA district court order on the motions describes that narrowing:

In particular, [IRS] now seeks information for users with at least the equivalent of $20,000 in any one transaction type (buy, sell, send or receive) in any one year during the 2013-2015 period. Further, the IRS does not seek records for users for which Coinbase filed Forms 1099-K during this period or for users whose identity is known to the IRS.

The order does a nice job laying out the procedures for IRS to get enforcement of a John Doe summons, highlighting that it (as with a generic third party or taxpayer summons) is not self-enforcing and also reviewing the special protections Congress set out in Section 7609(f) before the government can get records when it does not know the identity to whom the records belong.

As with any summons enforcement proceeding, the government has to show that it is issuing its summons in good faith and in pursuit of a Congressionally authorized purpose.

The interesting part of the recent order is the District Court considering whether one of the Coinbase customers has the right to intervene under the Federal Rules of Civil Procedure. There is a bit more to the issue than I describe but whether a party has a right to intervene in the absence of a privilege claim mostly turns on whether the IRS procedures amounted to an abuse of process.

In finding that there was an abuse, the court emphasized that the original summons was far too broad in relation to the government’s legitimate interest in seeking information that may pertain to potential evaders. It is worth honing in on the government’s position and the court’s rebuke:

As of 2014, Coinbase had one million users; thus, the IRS seeks broad data on likely hundreds of thousands of users. These records include complete user profiles including user payment methods, records of Coinbase’s due diligence on their customers, powers of attorney, complete user security settings and history (including confirmed devices and account activity), among other documents. The IRS offers no explanation as to how the IRS can legitimately use most of these millions of records on hundreds of thousands of users; instead, it claims that as long as it has submitted a declaration from an IRS agent that the IRS “is conducting an investigation to determine the identity and correct federal income tax liabilities of United States persons who conducted transactions in a virtual currency during 2013-2015” the Court must find that the Summons does not involve an abuse of process. It contends that “there seems to be a substantial gap between the number of people transacting in virtual currency (for which tax consequences might attach) and those that are reporting such transactions.”

(emphasis added)

The order pushes back on the government’s perspective, claiming that it “proves too much”:

Under that reasoning the IRS could request bank records for every United States customer from every bank branch in the United States because it is well known that tax liabilities in general are under reported and such records might turn up tax liabilities. It is thus no surprise that the IRS cannot cite a single case that supports such broad discretion to obtain the records of every bank-account holding American. While the narrowed Summons may seek many fewer records, the parties agreed to have the Court decide the motion on the original record, and so it has.

The order is also interesting for its rebuke of the government’s position that a customer (unlike Coinbase itself) did not have a protected interest that would allow it to intervene. There is little law in this area, bit the court order distinguishes between enforcement and issuance proceedings. The court holds that a customer who learns of the John Doe summons through some other means can intervene in an enforcement proceeding but not on the issuance of the summons itself:

There is nothing in the John Doe summons procedure adopted by Congress to provide protections to those to whom the IRS could not give notice that suggests that when the John Doe nonetheless learns of a summons from other means the John Doe has no interest in challenging the enforcement of that summons. The government’s assertion that to do so would place an undue burden on the IRS’s legitimate use of John Doe summons makes no sense. All that is being addressed here is the proposed intervenor’s right to intervene in a proceeding that is already taking place. Moreover, as the IRS concedes, if it knew of the applicant’s identity, it would have to give the applicant notice and the applicant would have the opportunity to challenge enforcement. It is thus unsurprising that the one case to have discussed the issue, at least that the parties have cited, assumed that a subject of a John Doe summons could challenge its enforcement.

That the direct interests of the other parties are now involved in this proceeding is as the court implies a good development. Allowing information from customers to be directly introduced provides an opportunity for the court to be better informed. While the government has a clear view as to what it believes Coinbase customers are up to, the strong reaction to the IRS efforts and the IRS’s narrowing of the summons itself suggest that the IRS worldview may be a bit narrow.

Stay tuned, as the court will now likely address the merits of challenges to the summons itself.

Court Allows IRS to Proceed With Summons Issued to Taxpayer in the Medical Marijuana Business

Last week’s article in the New York Times Legal Marijuana Ends at Airport Security, Even if It’s Rarely Stopped discusses the increasingly odd situation of passengers who are legally entitled to possess and use marijuana finding themselves at risk when they transport marijuana across state lines, even if the air travel originates and ends in states where the possession and use is legal. The federal income tax treatment of the marijuana industry likewise reflects an odd reality: those in the business are expected to pay tax on their sizeable profits, yet Section 280E prohibits those in the business from claiming deductions that they would be entitled to if they were trafficking in other products that did not constitute a controlled substance under federal law.

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In the NYT article, a spokesperson for TSA stated that it does not actively look for marijuana when it screens passengers; yet if an agent comes across it in her screening (as an agent did with my banana and apple I forgot about placing in my wife’s carry on bag on our flight last month from Frankfurt), she will alert local law enforcement.

In contrast with TSA, IRS appears to be pretty active in enforcing its mandate under Section 280E.  High Desert Relief v US, out of a district court in New Mexico, highlights a couple of procedural issues, including the IRS’s ability to use its considerable summons powers to gather information about the businesses and their compliance with the federal civil tax laws.

High Desert Relief (HDR) operates a legal medical marijuana business in New Mexico (its motto is “relief through high quality medicine”). IRS began examining its 2014 and 2015 tax years, and as part of the examinations it issued third party summonses to a bank and the New Mexico Department of Health and another state agency.

HDR sought to quash the summonses, essentially on the ground that the IRS could not satisfy the Powell requirements that its actions were conducted pursuant to a legitimate purpose because IRS was using its civil summons powers to conduct a criminal investigation. The government responded and included an affidavit from the Revenue Agent, claiming that she issued the summonses to “assess the correctness of [HDR’s] returns and determine if HDR has unreported taxable income” and to “substantiate the gross receipts reported in HDR’s tax returns.”

As part of its argument, HDR claimed that Section 280E requires a “finding of criminal behavior” that is beyond what was needed in the summary summons process. Unfortunately for HDR, a number of cases have already rejected this and similar arguments. Section 280E, though referencing a criminal statute, does not require any outside determination that a crime has been committed. Quoting from a 2016 federal district court case out of Colorado, Alpenglow Botanicals v US, the opinion explained that

[t]rafficking as used in § 280E means to buy or sell regularly. Californians Helping to Alleviate Med. Problems v. C.I.R., 128 T.C. 173, 182 (T.C. 2007). As such, the real issue here is whether the IRS has authority to determine if, in the course of plaintiffs’ business, they regularly bought or sold marijuana. The Court cannot understand why not. Such a determination does not require any great skill or knowledge, certainly not skill or knowledge of a criminal investigatory bent….

While Section 280E references a criminal statute, as the HDR court explained, IRS civil examinations can investigate “whether a party violates the [Federal Controlled Substances Act] without conducting a criminal investigation.”

There were a couple of other arguments worth highlighting. HDR argued that the information was available for the IRS; under US v Powell, in establishing that the summons was issued in good faith, IRS must show that the information was not already in the Service’s possession. HDR had claimed it made all the requested information available to the IRS. Yet, in making the information available, HDR conditioned its release on it getting “assurance from the IRS, that the IRS will use the information furnished for this civil audit, and not to support the IRS’s determination that the Taxpayer’s business consists of illegal activities.”

The court found that this conditioned availability was not enough. In addition to HDR not showing that there was a complete overlap between the requested documents and what HDR offered to make available, the court pointed to Section 6103(i). That, in certain situations, requires IRS release of tax return information for other federal laws not relating to tax administration. Restricting the IRS’s use of the information was not the same as providing the requested information.

Another issue in the case received relatively little attention and perhaps is the meatiest of the procedural issues. HDR argued that it was not given sufficient notice of the IRS’s use of a third party summons. Section 7602(c) (1) states that during an IRS inquiry and IRS employee may not contact a third party “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.”

The IRS argued that its sending to HDR a Publication 1 was sufficient notice. That publication, which IRS sends to every taxpayer subject to audit, states the following:

            Potential Third Party Contacts

Generally, the IRS will deal directly with you or your duly authorized representative. However, we sometimes talk with other persons if we need information that you have been unable to provide, or to verify information we have received…. Our need to contact other persons may continue as long as there is activity in your case.

Without analysis, the district court in New Mexico found that the generic publication was adequate for purposes of Section 7602(c)(1). As I recently described in the revision to the Saltzman Book IRS Practice and Procedure treatise in the chapter on examinations at 8.7[4] Third Party Contacts and in Chapter 13 addressing the IRS summons power, last year in Baxter v US a federal district court in California concluded that in fact the generic notice is insufficient to meet IRS’s notice requirements for these purposes. The district court held that the government had to tell the taxpayer which third party it was going to contact. This issue deserved a little more attention in the opinion, and as I have noted in the Saltzman write up, the courts are applying Section 7602(c)(1) and reaching differing outcomes. IRS in years past given more specific notice but lately has defaulted to its Pub 1 for these purposes. The current IRS approach seems to be inconsistent with regulations and Congressional purpose in enacting the notice provisions, and I suspect that other courts will give this issue greater attention.

A final issue in HDR is worth mentioning. The taxpayer argued that the “federal criminal drug laws with respect to state-legal marijuana sales [are] dead letter.” As such, it looked to old cases under Section 162 that allowed beer and liquor distributors deductions for activities that technically violated state laws, such as gifting beer or providing rebates to distributors. States turned a blind eye to those practices and did not enforce the laws prohibiting them. The main difference is that while Section 162 disallows deductions for activities in violation of state law, the Code itself provides that the limitation on deduction under Section 162 only applies if the state law is “generally enforced.” No such limitation appears in Section 280E.

The bottom line for HDR is that Section 280E does not in any way limit the government’s broad reach to access documents and information in a civil examination. The tax system thus contributes to the schizophrenic legal approach to the marijuana business. While the federal government is willingly collecting tax revenues and enforcing the internal revenue laws, the marijuana industry operates on a different substantive plane.

Grinches, Liechtenstein Royal Princes, Bankers, Toymakers (and Offshore Evasion): A Holiday Summons Tale

In today’s post returning guest blogger Dave Breen, the acting Director of Villanova’s Low Income Taxpayer Clinic, discusses the case of Greenfield v US. The issue in the case relates to the IRS’s cat and mouse game of finding assets and the unreported income from those assets that citizens have parked in offshore accounts. The issue in these cases does not generally involve much tax law.  The battle is won and lost on the issue of information.  If the IRS gets the information, the taxpayer generally loses.  Summons work is key and the Greenfield case is a major development.  For many years, Dave worked with IRS attorney John McDougal, whose retirement I wrote about last week.  In the spirit of the season, Dave recounts the story of the case and its implications.  Keith

A recent IRS setback in a summons enforcement case out of the Second Circuit piqued my interest, because I spent the final twelve years of my career in IRS Counsel working on IRS’s offshore initiatives addressing tax evasion through the use of offshore accounts in tax secrecy jurisdictions.  My take on this recent case is that taxpayers and some practitioners may believe that the era of IRS investigating offshore tax evasion has run its course.  I think this case does just the opposite.  The Court’s decision demonstrates that much of IRS’s data on offshore tax evasion is dated – possibly even too old to be of any value – but I also suspect that IRS has come to the same conclusion.  Rather than moving on to other areas of non-compliance though, I suspect IRS at this moment is developing more tools to secure the next wave of current information on offshore tax evasion.  This does not bode well for taxpayers who so far have avoided IRS’s inquiry into their offshore holdings.

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A bit of history

In 2000 IRS used permission to use John Doe summonses to secure information on U.S. taxpayers who accessed funds in their secret offshore accounts through American Express and Mastercard credit cards.  IRS’s first major success occurred in 2002 when the U.S. District Court entered an order requiring American Express to comply with IRS’s John Doe summons.  The information IRS received pursuant to this summons provided the data for what became known as the Offshore Credit Card Project.  Rather than go into the specifics, I refer readers to Keith Fogg’s 2012 Villanova Law review article Go West: How the IRS Should Foster Innovation in Its Agents. Subsequent offshore initiatives relied on data secured through John Doe summonses to UBS and other foreign banks, information received from whistleblowers, and information provided by taxpayers applying to one of IRS’s voluntary disclosure programs.

Despite the success in securing records identifying offshore tax evaders, the quality of the information IRS received was sometimes problematic, because it was out of date or incomplete.  For example, when a federal judge in Miami ordered compliance with the aforementioned John Doe summons in 2002, it only covered records for tax years 1998 and 1999 – “old years” in IRS parlance. Further, information received often did not dove-tail with IRS’s information.  IRS is driven by social security number, name, and to a lesser extent, last known address.  Credit card data is driven by credit card number and billing address.  This created a mismatch.  Once IRS received the summoned information it took many months to link a specific taxpayer to a particular offshore account through a credit card, assemble the case, and assign it to an agent specially trained in examining offshore transactions.  The IRM discourages IRS from beginning examinations of “old” tax years – generally those returns beyond the most recent two tax years – unless there are compelling reasons.  IRS prefers to examine more current tax years where plenty of time remains on the 3 year statute of limitations under IRC §  6501(a).   Although the 1998 and 1999 credit card data was sufficient to prove a taxpayer had a foreign bank account in 1998 or 1999, the information was not particularly helpful in proving how much income was unreported in those years or whether there was unreported income in later, more current years.

As a result, examiners assigned to these early cases often had to issue administrative summonses under IRC § 7602 to taxpayers for their most recent foreign bank account records to secure foreign account information for years after 1999.  The Department of Justice, which handles summons enforcement matters before the U.S. District Courts for IRS, has been extremely successful in securing orders enforcing these summonses, but the process takes time.  During this long process the data gets older and has diminishing value to IRS.  Proof that the data has a limited shelf life was recently demonstrated in a summons enforcement case.

Greenfield decision

In August 2016 the Second Circuit placed a speed bump along IRS’s road to identifying offshore tax evasion with dated information.  In United States v Greenfield, 118 AFTR 2d 2016-5275 (2016) the court vacated the District Court’s order enforcing an IRS summons and remanded the case for further proceedings consistent with its opinion.  The case is noteworthy for several reasons, but most importantly I see this as a wake-up call for IRS as well as a reminder to offshore tax evaders that IRS continues to pursue offshore tax evasion rigorously.

In the spirit of the holiday season, I offer the following tale.

Once upon a time there was a toy maker named Harvey Greenfield, his son, Steven, and their toy shop, Commonwealth Toy, Inc.  We also have a Grinch, Heinrich Kieber, whose job was to copy, file, and safeguard records at Liechtenstein Global Trust (LGT) a financial institution owned by the Liechtenstein royal family.  One day, while tending to his copying duties at the bank, Mr. Kieber decided to press “2” instead of “1” and make an extra copy of records that identified individuals who banked (translate: “hid their untaxed income”) at LGT.  Kieber, playing “Secret Santa”, offered the documents to several nations.  Many told him to “go Fish,” while other countries, including the U.S. did not.  The U.S. found the information to be very helpful in finding out who was naughty and who was nice. Needless to say, Mr. Kieber’s decision did not make him any new friends among the 38,000 residents of Liechtenstein.  He was charged with theft of information under Liechtenstein law and promptly went into hiding, leaving a trail of Angry Birds in his wake.  Like the Cabbage Patch doll you stood 3 hours in line to buy for your daughter in 1983, his whereabouts today are unknown.

Back to the Greenfields.  Several of Kieber’s cache of confiscated documents tied Steven and Harvey to certain offshore entities that had been used, or were being used, to evade taxation.  It just so happens that at this time the U.S. Senate’s Permanent Subcommittee on Investigations had begun hearings in response to the LGT disclosure and a similar leak from the Swiss bank, UBS.  Harvey died in 2009, leaving Steven as primary beneficiary of the LGT holdings.  PSI twice invited Steven to come in and talk about LGT, Liechtenstein, and foreign accounts in general.  The first time Steven failed to appear.  PSI was not too pleased with being stood up for its Mystery Date with Steven, so they invited him again.  The second time he appeared but asserted his Fifth Amendment right to remain silent.

Enter the IRS, who decided to audit Steven’s 1040’s for 2005 – 2011.  But there was a snag.  Kieber did not copy everything about the Greenfields – just enough to identify them as beneficial owners controlling the funds in the offshore accounts.  These documents included some memos, a 2001 year-end statement for their Maverick Foundation (a stiftung, under Liechtenstein law), LGT account information forms for Maverick and two entities it owned, and a 2001 LGT profile for Maverick and another company.  Of particular interest to IRS was a March 23, 2001 memorandum prepared by LGT personnel, detailing a meeting in Liechtenstein between the Greenfields, LGT employees, and Prince Philip of Liechtenstein.  The memo stated in part:

“The clients are very careful and eager to dissolve the Trust with the Bank of Bermuda leaving behind as few traces as possible. The clients received indications from other institutions as well that U.S. citizens are not those clients that one wishes for in offshore business.”

Great stuff, but not enough for IRS to determine how much tax was owed.  IRS didn’t have a Clue as to Steven’s gross income.  To fill in the considerable gaps in information, IRS issued an administrative summons to Steven for records and testimony.  After discussions with Steven’s counsel regarding the breadth of the summons, IRS reduced its scope to the production of documents related to foreign entities to the 2001 through 2006 tax years.

Greenfield refused to comply with the “kinder, gentler” version of the IRS summons.  Convinced that this was no Trivial Pursuit, IRS refused to Lego of the issue and brought suit to enforce yet another less expansive version of the original summons in district court.  Steven wasn’t having any of that one either and defended by invoking his Fifth Amendment right to remain silent.

General Summons Law and Greenfield

Generally, a Fifth Amendment right to remain silent is not effective for documents because contents of documents are not testimonial.  Fisher v. United States, 425 U.S. 391 (1976).  However, while Fisher held that documents were not testimony, the Court held that the act of producing the documents could be testimonial, because it may communicate incriminatory statements of fact.  For example, if the only person with access to offshore bank statements is the person who controls the funds in them, the person coming to court with the bank statements is essentially saying (testifying or admitting), “The documents you want exist, I control them, they are authentic, and here they are.”  This is the “act of production” defense Steven raised.  But the Ping-Pong game did not end there.

The government’s comeback to the “act of production” defense is the “foregone conclusion” rule.  If the testimonial aspects of production are a “foregone conclusion”, that is, if the government can establish the “existence, control, and authenticity” of the records independent of the witness’s production of them, the act of producing them loses its testimonial nature.  But the government must be ready to establish independently that the documents exist, the witness controls them, and they are authentic.

Based on the record, the Court found the Government met the first two tests: it accepted the existence of the documents in 2001 and Greenfield’s control of them in 2001.  It was not so willing, however, to accept their authenticity and turned to the Government to establish the third prong of the test.

The Government elves had their work cut out for them.  They went back to their workshop and crafted several arguments with respect to the authenticity of the 2001 records. It put on its Poker face and argued that the 2001 documents could be authenticated in three ways: (1) an LGT employee could come to the United States and authenticate them in court; (2) Kieber himself could come out of hiding and authenticate them; or (3) authentication was possible through Letters of Request issued under the Hague Evidence Convention.

The Second Circuit wasn’t buying any of the Government’s arguments.  First, the Court found it unlikely that LGT would send a witness to the United States to authenticate the records.  Secondly, it was highly unlikely Kieber, who was in hiding, would do it; and (3) the Government could not show a single instance where Letters of Request issued under the Hague Evidence Convention had been used to authenticate documents from LGT or any other Liechtenstein financial institution in the past.  Why would the Government think it would work in this case?

The Court didn’t stop there.  Assuming arguendo that the Government passed the 2001 hurdle, it would still have to show that the documents existed and that Steven controlled them in 2013, twelve years later.  Existence and control in 2001 does not create an inference of existence and control in 2013.  Factors such as the type of records, the likelihood of transfer to another person, and the time interval involved all bear on the matter.  In rejecting the Government’s arguments the Court found any number of reasons why Steven may not have had a Monopoly on control of the records from 2001 to 2013 or that the documents still existed in 2013.  Therefore, the Court did not enforce most of the summons and Steven did not have to produce the records.

Conclusion

But before you settle your brains for a long winter’s nap, think about this.  Even though Steven may have sunk IRS’s Battleship, today IRS is not in any immediate Trouble.  In fact, it is already working on a new Mousetrap.  On November 30, 2016 IRS received permission to issue a John Doe summons to Coinbase, Inc., a virtual currency exchanger headquartered in San Francisco, California, that Les discussed last month in his post IRS Seeks Information via John Doe Summons Request on Bitcoin Users.  

The moral of the story?  Uno’s?  I suspect many clients with assets hidden offshore will still take a big Risk by not coming in under IRS’s voluntary disclosure program, but you don’t have to be a Mastermind to see that many of them will ultimately be Sorry.  But, I guess that’s The Game of Life.  Happy Holidays!

 

 

 

The Practice of Secret Subpoenas in Tax Court: Tax Court Out of Step with Other Courts and IRS Itself

I read with interest blogger Lew Taishoff, whose blog Taishoff Law mainly covers the Tax Court. Last week in The Stealth Subpoena is Alive and Well Lew discussed Tangel v Commissioner. Tangel reveals an odd practice that distinguishes Tax Court litigation apart from other federal courts.  Rule 45(a)(4) of the Federal Rules of Civil Procedure requires parties who issue subpoenas to third parties compelling the production of documents or other evidence to notify the opposing party of the subpoena issuance. Tax Court rules do not explicitly require a party to notify the other side. The absence of an explicit notice requirement with respect to subpoenas creates the possibility of surprise. In addition to being out of step with other federal courts, it is inconsistent with the Tax Court’s general approach of encouraging parties to communicate and cooperate.

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Tangel involves a series of motions that the taxpayers filed relating to IRS counsel having issued subpoenas to third parties under Tax Court Rule 147(a) or 147(b). We have not discussed Rule 147(a) or (b) but the Tax Court rules give the process for which a party may compel attendance of a person or of evidence at a trial or Tax Court proceeding. Essentially 147(a) applies to people required to give testimony; 147(b) extends the reach to commanding a person to bring documents or other evidence, with the Tax Court retaining discretion to quash or modify the latter subpoena if it is “unreasonable or oppressive.”

On their face, Tax Court Rules 147(a) and (b) do not mention of notice, and the subpoena is not filed with the court. It is thus not subject to the general Tax Court rules on notice, found in Rule 21(a). That rule provides that parties serve on other parties or other persons involved in the matter all filed paper including “pleadings, motions, orders, decisions, notices, demands, briefs, appearances, or other similar documents or papers relating to a case….”.

In Tangel, IRS counsel issued subpoenas to third parties and did not notify the Tangels. The order is brief and I have not read (nor can I unless I were to head down to DC) the underlying motions but the Tangels objected to the issuance of the subpoenas in part on the grounds that Counsel failed to notify them of their actions. Judge Chiechi, the judge in Tangel, dismissed that argument, noting that “[a] party that issues a subpoena under Rule 147(a) and/or (b) is not required to give prior notice to the other party.”

Tax Court practice is not always in lock step with federal court practice but not giving notice of a subpoena compelling the production of documents or other evidence seems wrong. Attorney Taishoff has discussed this aspect of Tax Court practice in a prior post called Judge Holmes’ Vendetta, where he discussed an order earlier this year in Ryder v Commissioner, which also involved the issuance of a subpoena under Rule 147(b). Unlike the outcome in Tangel, in Ryder, Judge Holmes explicitly disapproved of the practice of issuing subpoenas without notifying the taxpayer. In so doing, Judge Holmes gave a history lesson on why it is likely that Tax Court rules differ from the federal rules of civil procedure:

We do have to disagree with the Commissioner, however, that this absence of a rule creates an implication that secret subpoenas are favored. We promulgated our Court’s Rule 147, which governs subpoena practice, back in 1973. Tax Court Rules of Practice and Procedure, 60 T.C. 1057, 1137 (1973). At that time, we said that our goal was a rule substantially similar to FRCP 45. Id. Back then, FRCP 45 didn’t require notice for subpoenas. Fed. R. Civ. Proc. 45 (1970). The notice requirement was added in 1991 to give parties the same opportunity to challenge nonparty subpoenas for documents that they had to challenge subpoenas for depositions (since FRCP 30 and 31 already provided notice protection in these circumstances). See Fed. R. Civ. Proc. 45 advisory committee’s note (1991). We have never publicly stated that we intended to deviate from Article III practice — it’s just an example of the two sets of rules drifting apart over time.

We think that the current federal rule is a good one in litigation that is, as in these cases, especially hard-fought. The Court will therefore adopt the notification requirement of Federal Rule 45 as a modification to the pretrial order that governs this case.

Mr. Taishoff suggests perhaps that the judges in Ryder and Tangel get together and “discuss bringing Tax Court into the last decade of the Twentieth Century, if not into the second decade of the Twenty-First.” An earlier post of his suggested the Ryder approach find its way in a published opinion. Another thought is perhaps it is time for the Tax Court to modify its rules and coordinate Tax Court practice with that in other federal courts through a rule change.

It is interesting as well that the Tax Court practice is somewhat inconsistent with the IRS’s administrative practice. Consider the related issue of the notice that is required to be given when the IRS contacts third parties in an examination. As of 1998, Section 7602(c) provides that an employee of the Internal Revenue Service 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.”

This RRA 98 notice of third party contact rule has generated some controversy. The statute fails to define reasonable notice for these purposes, and IRS and taxpayers have fought about whether the IRS’s inclusion of generic notice in its Publication 1 at the start of an exam constitutes “reasonable notice” of a third party contact. For example, earlier this year a district court in California in Baxter v US that found that Publication 1 was insufficient as a matter of law to constitute the advance notice that Section 7602(c) contemplates. That resulted in the district court finding that the IRS did not meet the prima facie good faith requirement under US v Powell and to the court’s quashing of a summons IRS served on a third party.

TAS in its 2015 annual report flagged IRS third party contact procedures as one of its most serious problems, making the sensible point that advance adequate notice allows taxpayers the possibility of themselves providing the IRS what it needs without the possible damage to a taxpayer’s business or reputation that may follow IRS third party contacts. That report criticizes the IRS use of generic notice, finding them “ineffective because they do not identify the information the IRS needs, inform the taxpayer the IRS will make a [third party contact] in the taxpayer’s particular case, or provide the taxpayer with enough advanced notice to deliver the information before the contact.” TAS 2015 Annual Report MSP # 12, at p. 123 (note omitted).

It seems to me that similar taxpayer interests are implicated when considering notice rules for subpoenas at trial, with possibly more at stake in terms of both taxpayer reputation and damage and a heightened need to know what the other side is gathering as a trial looms. It seems prudent for the Tax Court to modify its approach and require both parties to give notice consistent with the Federal Rules of Civil Procedure. This will reduce surprise and provide another chance for the taxpayer himself (if the government is seeking the information) to serve up what is needed, all at rather minimal costs to the government.