There are two opinions in Polselli, a unanimous opinion by Chief Justice Roberts and a concurrence by Justice Jackson that Justice Gorsuch joined. I will briefly summarize them and offer some observations below.

The main opinion mostly walks through the statutory analysis of Section 7609(c)(2)(D). That section provides that the IRS need not provide notice to a person “who is identified in the summons,” …(1), if the summons is: “issued in aid of the collection of— “(i) an assessment made or judgment rendered against the person with respect to whose liability the summons is issued; or “(ii) the liability at law or in equity of any transferee or fiduciary of any person referred to in clause (i).”

As Chief Justice Roberts explains, to fit within the language in (i), a summons must satisfy three conditions:

• First, a summons must be issued in aid of collection;
• Second, it must aid the collection of an assessment made or judgment rendered; and
• Third, a summons must aid the collection of assessments or judgments against the person with respect to whose liability the summons is issued.

What led the Court to accept cert was that the Ninth Circuit in the Ip case added some gloss to the statute, effectively limiting the circumstances when no notice would be required to situations when the taxpayer has a legal interest in accounts or records summoned by the IRS. When the Sixth Circuit declined to follow Ip, there was a clear circuit split.

The Supreme Court did not embrace the Ninth Circuit’s approach:

None of the three components for excusing notice in §7609(c)(2)(D)(i) mentions a taxpayer’s legal interest in records sought by the IRS, much less requires that a taxpayer maintain such an interest for the exception to apply.

The opinion goes deeper into the statutory analysis, but the main takeaway is that the Court declined to read an exception that Congress did not clearly add, emphasizing that the statutory term “in aid of collection” is broad, with “aid” meaning to help or assist.

The opinion applies these broad terms to the case at hand, noting that the IRS had a reasonable belief that Polselli was shielding assets in other entities and perhaps had effective control over bank accounts which he had no legal interest. And for good measure the opinion details how clause (ii) in Section 7609(c)(2)(D), which provides another exception to notice when pursuing a summons to aid in collecting the delinquent taxpayer’s tax debt from transferees or fiduciaries, is not superfluous in light of how clause (ii) may apply when the IRS is attempting to collect taxes from those third parties in the absence of an assessment, a rare but not impossible scenario (see slip opinion, p. 10).

What of the slight window to challenges to collection summonses that I referred to earlier in this post? At oral argument, as the opinion noted, the government conceded that its power to summons is not limitless, and proposed the following test:

So long as a summons is “reasonably calculated to assisting in collection,” it can fairly be characterized as being issued “in aid of ” that collection. Adding some more detail, at oral argument it stated  that the “third party should have some financial ties or ha[ve] engaged in financial transactions with the delinquent taxpayer.”

But the Court declined to adopt this test, as neither party briefed it and it was “not the case to try to define the precise bounds of the phrase ‘in aid of the collection.’”

This is the kind of case that rightfully raises privacy concerns. When, as in Polselli, the government seeks records from the taxpayer’s wife and a law firm and can do so without telling anyone other than the summoned party it disrupts a reasonable expectation in the privacy around one’s sensitive records and information. To be sure, Polselli himself put the third parties in harm’s way by not paying his taxes, and the government is prohibited from disclosing this information to other third parties, but that is unlikely to satisfy someone whose records are released to the IRS without their knowledge.

As the government noted in briefing (see p. 46), some cases such as the Second Circuit’s 2016 Haber v US have entertained limited discovery following a summons issued to aid in collection. Haber involved a summons to a bank purportedly to aid in collection of an assessed liability, and following the taxpayer’s petition to quash, the district court required the government to prove that its summons was in aid of collection.

For litigants interested in the contours of future challenges, Justice Jackson’s concurrence provides a possible roadmap. After recounting how the government’s interest in collection generally trumps the right to notice, the concurrence notes that the government’s right to pursue this information without informing affected parties should yield in certain circumstances:

But, depending on whose information the summons seeks (for example, an innocent third party’s), or the nature of the requested records, it might not be reasonable to conclude that providing notice would frustrate the IRS’s tax-collection goal. And when that is the case, it might unjustifiably tip the scales in the other direction (i.e., entirely in the IRS’s favor) to allow the IRS to proceed without notice just because its delinquency resolution process has entered the collection phase.

Justice Jackson continues, emphasizing that “the statute’s balancing of interests indicates that Congress did not give the IRS a blank check…” Justice Jackson expresses disbelief that the 7609(c)(2)(D)(i) exception could “so dramatically” upset Congress’ objective of allowing courts to check the IRS’s efforts to obtain information “no matter how broad the summons is or how potentially intrusive that records request might be, so long as the agency thinks doing so would provide a clue to the location of a delinquent taxpayer’s assets.”

The concurring opinion expresses reservations about the IRS having a blank check “any time a tax-delinquency matter enters the collection phase.” Noting that this type of inquiry is likely fact specific, she urges courts, and the IRS, to be “ever vigilant” in determining when notice is not required. 

I suspect that the next step will be litigation attempting to cabin precisely when a summons is issued “in aid of collection”, though that litigation is likely dependent on third parties, rather than the IRS, telling interested parties of the summons. Balancing the government’s interest in searching for assets from recalcitrant taxpayers without tipping their hand with the legitimate privacy interest in sensitive information also lends itself to a legislative fix.

Despite a unanimous opinion, this is likely not the last chapter in this story.

After the defeat the taxpayer filed a cert petition; the government opposed the petition. The Center for Taxpayer Right, with counsel Latham & Watkins, filed an amicus brief  in support of the petition (disclosure: I am on the Board of the Center; Keith is President and also on the Board; Nina is the Founder, Executive Director and Treasurer and also a Board Member).

Last month the Supreme Court granted cert over the government’s opposition.

In Polselli, the Sixth Circuit held that Section 7609(c)(2)(D)(i) “unequivocally provides that the IRS may summon the third-party recordkeeper of any person without notice to that person if (1) an assessment was made or a judgment was entered against a delinquent taxpayer and (2) the summons was issued “in aid of the collection” of that delinquency.”

The taxpayer’s cert petition identifies the question presented as “whether the § 7609(c)(2)(D)(i) exception applies only when the delinquent taxpayer owns or has a legal interest in the summonsed records (as the Ninth Circuit holds), or whether the exception applies to a summons for anyone’s records whenever the IRS thinks that person’s records might somehow help it collect a delinquent taxpayer’s liability (as the Sixth Circuit, joining the Seventh Circuit, held below).”

As the petition noted, the government’s summons reached two of the taxpayer’s law firms and his wife, raising privacy interests and possible privilege issues.

Under the government’s and Sixth Circuit’s view, the statute gives the IRS the absolute right to issue a collection summons without notice or right to challenge.

As the Center’s amicus brief highlights, the government and Sixth Circuit’s position effectively provides that the exception to notice in Section 7609 swallows the rule and subverts the balance between privacy and the government’s interest in tax collection:

The Sixth Circuit’s interpretation of one exception leaves a gaping hole in Section 7609’s protections and swallows the general rule of notice. The Sixth Circuit held that the IRS may issue a summons seeking the records of people who do not owe the IRS a penny, without notice, so long as the IRS issued the summons to aid in the collection of someone else’s tax liability. This interpretation places virtually no limits on the IRS’s ability to seek records without notice. And without notice, an innocent person whose records are sought lacks any meaningful opportunity to prevent disclosure of her private information. The Sixth Circuit’s interpretation nullifies the right to protect private information from IRS overreach.

Stay tuned, as this is the latest in a series of important procedural issues reaching the Court.

Under Section 7602(d), the IRS is barred from issuing a summons “with respect to any person if a Justice Department [criminal] referral is in effect with respect to such person.”

Under the BBA partnership audit procedures, Jack Fisher was Equity’s partnership representative. Equity was 80% owned by Southeast Property. In turn, Southeast Property was controlled by its managing member, Inland Capital Management, which Fisher managed.

The IRS issued a summons to Equity’s bank. IRS gave notice of the summons to Equity, which sought to quash that summons, arguing that a Justice Department criminal referral was already in effect for Equity or one of its agents (Fisher). In opposing the motion to quash and requesting that the court order enforcement of the summons, the DOJ submitted a declaration from an IRS Supervisory Special Agent who attested that there was no criminal referral for Equity. 

Equity’s tax return preparers had previously pleaded guilty to conspiring to defraud the United States for selling, along with co-conspirators, “investments” in fraudulent syndicated conservation-easement tax shelters. The government was also conducting a criminal investigation of Fisher, who was subsequently indicted for crimes related to the fraudulent syndicated easement scheme.

Does The Criminal Investigation and Prior Referral of Equity’s Agent Serve to Bar A Summons on Equity?

Equity’s argument was premised on using the definition of person in Section 7343, which states that for purposes of chapter 75 of the IRC, a person “includes an officer or employee of a corporation, or a member or employee of a partnership, who as such officer, employee, or member is under a duty to perform the act in respect of which the violation occurs.” Chapter 75 deals with crimes, offenses and forfeitures (Section 7201 through 7345).

Unfortunately for Equity, the prohibition on IRS summons power when a criminal referral is in place is in Section 7602, and that Code section is within Chapter 78, which deals with civil examinations and encompasses Section 7601 through Section 7655. There is no specific definition of person either in Section 7602 or Chapter 78.

In the absence of a specific definition, the general Code definitional provisions in Section 7701 apply:

Section 7701(a)(1) states that “[w]hen used in [Title 26], where not otherwise distinctly expressed or manifestly incompatible with the intent thereof . . . [t]he term ‘person’ shall be construed to mean and include an individual, a trust, estate, partnership, association, company or corporation.” § 7701(a)(1). That definition does not consider members, officers, or employees of a business entity to be a part of the same “person” as the business entity itself. By omitting officers, members, and employees from the personhood of business entities in § 7701(a)(1) but including those same people in the definition it adopted for § 7343, Congress made an express decision that “person” for purposes of § 7602 only means the business entity itself.

Equity also argued that even if Section 7701 applied, its definition is non-exclusive in the list of entities that count as a person. As such it asked the court to find that the “statute’s specific reference to only the business entities themselves is thus not exclusive because agents of a business entity are “otherwise within the meaning” of the term “person.”

The court disagreed, finding that person is “not naturally read to suggest both a business entity and its officers, members, and employees.”

And for the final nail in the coffin, the opinion considered how the general summons power in Section 7602(a) refers to entities and their agents in a manner reflecting their distinct status:

Indeed, § 7602‘s text shows that the statute considers business entities as distinct persons from their agents. Under § 7602(a)(2) “the Secretary is authorized . . . [t]o summon the person liable for tax or required to perform the act, or any officer or employee of such person.” If “person” already included the officers and employees of a business entity, there would have been no reason for Congress to have provided for “any officer or employee of such person” in § 7602(a)(2), and Equity’s preferred definition as applied to § 7602(a)(2) would create surplusage.

Was There a Referral For Equity?

The opinion also considered the district court’s denial of an evidentiary hearing concerning whether there was a Justice Department referral addressing Equity as an entity. As the opinion notes, a referral is not a generalized suspicion of criminal activity. It occurs only when (1) the IRS recommends a person to the Attorney General for prosecution or (2) the Justice Department requests a taxpayer’s information from the IRS.

Absent Equity introducing evidence that reflected an actual referral to the Justice Department with respect to Equity, the court declined to remand for an evidentiary hearing. The opinion sweeps in the Clarke standard for when in a summons challenge a district court should allow a hearing:

Equity’s other evidence only suggests that the government believed that Equity had committed a crime. However, suspicion and even criminal investigation does not prevent the IRS from issuing a summons. The IRS can continue to avail itself of the summons power until it crosses the “bright line” of making a Justice Department referral. See Morgan, 761 F.2d at 1012. It is evidence of “specific facts or circumstances” suggesting a Justice Department referral, not generalized suspicion, that Equity must rely on to meet its burden. See Clarke, 573 U.S. at 249.

Conclusion

Our blogging colleague Jack Townsend also discusses the opinion here. As Jack notes, this case reflects fairly straightforward holdings. As usual, Jack makes interesting observations, and for readers with a deeper interest I recommend a read.

Equity Investment Associates is generally consistent with other caselaw reflecting that an entity is distinct from the owners for summons purposes, an issue that may arise when an individual may have or wish to assert a privilege even though a summons is directed to a business entity. It is also yet another case reflecting the IRS focus on conservation easement and inflated charitable deductions. The opinion also discusses in a straightforward way how the use of an an entity treated as a partnership for tax purposes makes the easement donation scheme available to others by passing the corresponding deduction through to its members, thus spreading the claimed tax benefit to investors.  

Under a careful but dense statutory scheme, when IRS serves a third party summons, the IRS is supposed to notify the party whose information is being sought. The statutory rules about notice differ depending on the circumstances, including the nature of the underlying matter (e.g., exam versus collection).

In Polselli, the tax delinquency attracted the attention of a revenue officer, who believed that the taxpayer had transferred assets to family members and perhaps related entities to make collection less likely.

The revenue officer issued a summons on a bank. The summons sought bank account and financial records of the wife Hanna and the management company that concerned the taxpayer. The Revenue Officer also served Polselli’s law firm Abraham & Rose with a summons. After the law firm asserted attorney-client privilege, the Revenue Officer issued summonses against two other banks. Those summonses also sought financial records relating to the law firm that related to the taxpayer. The Revenue Officer did not notify the wife or the law firm of these bank summonses.

After the banks (but not the IRS) notified Hanna and Abraham & Rose that the IRS had issued the summonses, Hanna and the firm filed separate petitions to quash the summonses in district court. In their petitions to quash they alleged that the IRS failed to notify them under Section 7609(a).

In general, under Section 7609(a), when the IRS serves a summons on a third-party recordkeeper the IRS must give notice to “any person . . . who is identified” in such a summons within three days of issuing the summons to the third-party recordkeeper. The right to receive notice is the ticket to the government’s waiver of sovereign immunity; absent the right to notice under 7609(a) there is no waiver and thus no way to get into court.

The government argued that Hanna and the law firm were not entitled to notice because the summonses were issued “in aid of the collection” of Polselli’s assessed liability. The government based its argument on the plain language of Section 7609(c)(2)(D)(i), which excludes from the general 7609(a) notice requirements a summons issued “in aid of the collection” of “an assessment . . . against the person with respect to whose liability the summons is issued.”

Under the government’s reading, the absence of Hanna and the law firm’s right to notice from the IRS meant that sovereign immunity barred the suit.

In responding to the government’s motion to dismiss, Hanna and the law firm claimed that the government was taking a “hyperliteral” reading of the statute and asked the court to apply 2000 Ninth Circuit precedent in Ip v. United States.

 Ip  narrowly applied the “in aid of the collection” exception only if (1) “the third party is the assessed taxpayer,” (2) “the third party is a fiduciary or transferee of the taxpayer,” or (3) “the assessed taxpayer has ‘some legal interest or title in the object of the summons.’”

After a government win at the district court, the petitioners appealed, and the Sixth Circuit affirmed:

We agree with the district court that the summonses at issue fall squarely within the exception listed in § 7609(c)(2)(D)(i). That section unequivocally provides that the IRS may summon the third-party recordkeeper of any person without notice to that person if (1) an assessment was made or a judgment was entered against a delinquent taxpayer and (2) the summons was issued “in aid of the collection” of that delinquency. We hold that as long as the IRS demonstrates that these conditions are satisfied, it may issue a summons to a third-party recordkeeper without notice to the person or entity identified in the summons.

In rejecting the Ninth Circuit’s reading of the statute, the Sixth Circuit noted that the Tenth and Seventh circuits had read the in aid of the collection exception without any of limitations. See Davidson v. United States, 149 F.3d 1190 (Table), 1998 WL 339541 (10th Cir. 1998) and Barmes v. United States, 199 F.3d 386 (7th Cir. 1999).

For Those Wanting A Deeper Dive

Why did the Sixth Circuit part ways with the Ip  approach?

The Ninth Circuit approach essentially read additional conditions into the blanket statutory exception to notice when a summons is issued in the collection process.  As Polselli explained,

[in Ip the Ninth Circuit] “examined § 7609’s legislative history and concluded that the statute’s stated purpose was generally to facilitate notice to taxpayers and to enable them to challenge summonses in district court. Because it assumed that Congress would not have allowed the IRS to summon a third-party recordkeeper for the information of any person without notice, the Ninth Circuit held that the notice exception applies “only where the assessed taxpayer ‘has a recognizable [legal] interest in the records summoned.’” Id. at 1176 (quoting Robertson v. United States, 843 F. Supp. 705, 706 (S.D. Fla. 1993)) (alteration in original).

The Ninth Circuit also felt that the literal reading of 7609(c)(2)(D)(i) rendered the notice exception of 7609(c)(2)(D)(ii) as superfluous, which in its view cut against the government’s literal reading of the (i) exception. The exception under (ii) applies to a summons issued in aid of the collection of “the liability at law or in equity of any transferee or fiduciary of a person referred to” in the 7609(c)(2)(D)(i) exception. As the majority opinion in Polselli acknowledged “transferee and fiduciary liability are indeed derivative of the taxpayer’s assessment” so the parties were correct in asserting that there could not be transferee liability without an underlying taxpayer assessment. Yet the Polselli court felt there was space between the two clauses in 7609(c)(2)(D)(i) and (ii) as the efforts to collect against a taxpayer are “legally and procedurally distinct from their collection efforts of the transferee’s or fiduciary’s liability—which liability must be rooted in state law.”

In rejecting Ip, the Sixth Circuit stated that it declined to follow the literal language only when following it would lead to an absurd result or an outcome that is inconsistent with the legislative intent. Given the above and language in the legislative history that suggested that Congress struck the balance between privacy and IRS ability to collect the majority declined to read any extrastatutory condition into when IRS was provided to give notice for a summons issued for collection purposes. While it noted that it “was sympathetic to worries that the IRS may be able to access information regarding blameless third parties without notice” the sympathy was insufficient to overcome the statutory language.

There is brief dissent that would have adopted the Ip approach. The dissent noted that the summonses were “a significant intrusion upon the privacy of those account holders. Cf. U.S. Const. Amend. IV (“The right of the people to be secure in their . . . papers . . . against unreasonable searches and seizures, shall not be violated”).” The dissent poked holes in the majority opinion’s finding space between the 7609(c)(2)(D)(i) and 7609(c)(2)(D)(ii) exceptions:

I think the only way to give concrete meaning to §§ 7609(c)(2)(D)(i) and (D)(ii), and to avoid the “vitiation” of §§ 7609(a) and (b), is to read “in aid of collection of” more narrowly than it would ordinarily be read. In the context of all these provisions, rather, I think we must read that phrase to require a more direct connection between the summons and the “collection” of the liability of the persons described in §§ 7609(c)(2)(D)(i) and (D)(ii). Specifically, I agree with the Ninth Circuit that a summons has this more direct connection with the collection of those persons’ liability “only where the assessed taxpayer[,]” in the case of § 7609(c)(2)(D)(i), or a fiduciary or transferee, in the case of § 7609(c)(2)(D)(ii), “has a recognizable legal interest in the records summoned.” 205 F.3d at 1176 (cleaned up). In this case we must either maul the bulk of § 7609 or read narrowly one phrase within it.

To be sure, the dissent acknowledges that the majority view has merit, stating the “the Ninth Circuit’s interpretation, in my view, is the least bad interpretation available to us here.” For now, there is a clean split in the circuits on this issue, and Polselli is likely not the last word.

IRS had previously investigated Artex Risk Solutions, Inc. (“Artex”) and Tribeca Strategic Advisors, LLC (“Tribeca”) (which is owned by Artex) in transactions involving micro-captive insurance plans. As part of its investigation into possibly abusive micro-captive insurance transactions, IRS served an administrative summons on DDOI asking for a wide range of information relating to Artex and Tribeca. DDOI turned over thousands of pages of documents but refused to turn over client specific information.

As justification for its refusal, DDOI relied on Section 6920 of the Delaware Insurance Code, which provides for confidential treatment of materials and information that captive insurers submit to the state tax commissioner, either directly or through DDOI, as part of the application and licensing process.

In response to the IRS’s seeking client specific information, DDOI contacted the parties and asked for consent to comply with the IRS summons. A handful agreed but most did not. DDOI then sought to enforce the summons and DDOI filed a petition to quash, relying on Section 6920 of the Delaware Insurance Code.

As a general matter, when there is a conflict between a federal statute and a state statute, the state statute yields under the doctrine of preemption. The McCarran-Ferguson Act (“MFA”) creates an exception to this general rule.  The MFA generally provides that states are entitled to regulate the business of insurance and that “no Act of Congress shall be construed to invalidate, impair, or supersede any law enacted by any State for the purpose of regulating the business of insurance, or which imposes a fee or tax upon such business, unless such Act specifically relates to the business of insurance.”

MFA thus sets out a reverse preemption principle. State law cedes to federal law but not when the state law pertains to the state’s role in regulating the business of insurance. The opinion discusses the policy underlying the MFA:

“Congress was mainly concerned with the relationship between insurance ratemaking and the antitrust laws, and with the power of the States to tax insurance companies.” S.E.C. v. Nat’l Sec., Inc. , 393 U.S. 453, 458-59 (1969) (citing 91 Cong. Rec. 1087-1088). The MFA attempted “to assure that the activities of insurance companies in dealing with their policyholders would remain subject to state regulation.” Nat’l Sec., 393 U.S. at 459.

While the language in the MFA is broad, the opinion notes that It did not “purport to make the States supreme in regulating all the activities of insurance companies; its language refers not to the persons or companies who are subject to state regulation, but to laws ‘regulating the business of insurance.’ Insurance companies may do many things which are subject to paramount federal regulation; only when they are engaged in the ‘business of insurance’ does the [MFA] apply.” 

The opinion gets into some detailed discussion about how cases have applied the MFA and its reach but essentially the magistrate and ultimately the district court held that the MFA “simply does not apply – i.e., the MFA only allows for reverse preemption when the conduct at issue is the “business of insurance,” which was found missing here. “

DDOI asserted that the conduct “is more properly characterized as “receiving, maintaining and restricting dissemination of application and licensing information of captive insurers,” which it argues is fundamental to insurance regulation.”

The magistrate and district court judge disagreed, framing the state’s conduct as akin to maintaining records rather than actual regulation:

Here, the Court finds no error in the Report’s conclusion that the challenged conduct itself is fairly characterized as “record maintenance” and, more specifically, the dissemination and maintenance of information, documents, and communications maintained by the state. In the Court’s view, this is a fair characterization because it flows directly from the language of Section 6920, which is what DDOI argues protects it from complying with the Summons. Section 6920 protects from disclosure broad swathes of information, not merely application and licensing information of captive insurers (as DDOI suggests). See, e.g. , 18 Del. C. § 6920 (“ … all examination reports, preliminary examination reports, working papers, recorded information, other documents, and any copies of any of the foregoing, produced or obtained by or submitted or disclosed to the Commissioner that are related to an examination pursuant to this chapter … ”). Given the broad scope of documents and information covered by Section 6920, the Report committed no error in characterizing the conduct at issue.

I am giving somewhat short shrift to the MFA arguments that DDOI made, including a disagreement on the standard relating to how to define the business of insurance, but they will be of interest more to a small group of practitioners. Not only does the case highlight the IRS appetite to challenge captive insurance arrangements, but it also resonates n light of the recent Pandora Papers scandal. The Pandora Papers release reveals how at times states’ trust laws are designed to shield information from taxing authorities and other creditors. Many state laws, such as in the DDOI case, present formidable but not insurmountable barriers to engaged and inquisitive IRS employees. Tax havens are not only located outside the US. We will likely see government efforts to obtain information that is potentially subject to state laws that are meant to make it difficult, though not impossible, to attract the eyes of the federal government.

In 2015 IRS began an investigation of Stanley Crow into penalties associated with his promotion of installment sale transactions. The IRS suspected the transactions were tax shelters subject to registration and disclosure requirements.  At the start of the examination it sent Crow a Publication 1, Your Rights as a Taxpayer. That publication gives generic information about the audit process, and also informs taxpayers that the IRS may contact third parties during the course of an examination.

Prior to the Taxpayer First Act, under Section 7602(c)(1), enacted as part of the Restructuring and Reform Act of 1998, IRS was required to provide a taxpayer with “reasonable notice in advance” before it contacted financial institutions, employers or other third parties.  Pre-TFA there was litigation as to what constituted reasonable advance notice. In many of the cases, the IRS argued that sending Publication 1, at the start of an exam sufficed for these purposes. 

In JB v United States, which I discussed in Ninth Circuit Rejects IRS’s Approach to Notifying Taxpayers of Third Party Contacts, the Ninth Circuit held that sending the Publication 1 was insufficient notice, though it did not categorically hold Publication 1 can never constitute “reasonable notice in advance.” The court was skeptical though stating that it was “doubtful that Publication 1 alone will ever suffice to provide reasonable notice in advance to the taxpayer, as the statute requires.”

Shortly after JB v US, TFA did away with the squishy reasonable standard and requires the IRS to provide notice to the taxpayer at least 45 days before the beginning of the period of third-party contact, which may not extend longer than one year.  In Keith’s post on the major tax procedural developments of 2019, he discusses the TFA change, and the earlier TAS legislative recommendations that highlighted the problems with the “reasonable advance notice” standard under pre TFA law.

Back to Vaught. The case involves an exam and third-party summonses that were issued in 2018 in connection with the IRS’s examination of Crow and his suspected shelter promotions activities. Two of the summonses were served on Steve Vaught and Alpha Lending, LLC, where Vaught was a key executive. Alpha had a business relationship with Crow, having served as a lender or escrow agent in the installment sales transactions Crow and his company promoted. Vaught/Alpha did not appear or produce the IRS’s requested records. The government filed a petition to enforce the summons, and Crow intervened in the case and filed a motion to quash based on an alleged violation of the advance notice requirements.

As I mention above, the summonses were issued before TFA, so the case involves the old reasonable advance notice standard. As the district court explained, in JB the Ninth Circuit added some meat to the reasonable notice standard:

[T]he Ninth Circuit held the phrase “reasonable notice in advance” means “notice reasonably calculated, under all the relevant circumstances, to apprise interested parties of the possibility that the IRS may contact third parties, and that affords interested parties a meaningful opportunity to resolve issues and volunteer information before third-party contacts are made.” 916 F.3d at 1164 (citing Flowers , 547 U.S. at 226). In so holding, the Ninth Circuit highlighted the purpose of the notice requirement is to protect the taxpayer’s reputational interest by giving the taxpayer an “opportunity to resolve issues and volunteer information before the IRS seeks information from third parties, which would be unnecessary if the relevant information is provided by the taxpayer himself.”

The JB standard requires district courts to examine the totality of the circumstances, “balancing of the interests of the State’ in administering an effective auditing system against the ‘individual interest’ in receiving notice of the potential third-party contact and an opportunity to respond.”

Crow challenged both related aspects of the notice requirement:  that the IRS did not provide pre-contact notice and also that the IRS did not provide a reasonable meaningful opportunity to resolve issues and volunteer information before third-party contacts were made.

The government argued it did provide sufficient notice, pointing to the Pub 1 it sent at the start of the exam in November of 2015 as well as supposed oral communications between IRS agents and Crow in December of 2015. At that meeting IRS revenue agents purportedly said that they said that the IRS may contact third parties during the course of the examination of Crow.

The district court found that the IRS failed to satisfy the reasonable advance notice standard, emphasizing the time between the generic notice and the actual contact IRS made with the third party:

Here, the IRS issued the Vaught Summonses in January of 2018, twenty-six months after it sent Crow Publication 1 on November 17, 2015. Similarly, in J.B., two years elapsed between the date the IRS sent Publication 1 to the taxpayers and the date the IRS sought records from a third party. As in J.B , this Court cannot find the IRS satisfied its “administrative duty” of giving Crow a meaningful opportunity to provide relevant documents involving the Alpha Companies by generally informing Crow, over two years before, that it may “talk with other persons” in the course of its investigation

As to the purported oral communication from IRS agents failing to tip the scales toward reasonable notice, the court focused on the absence of specific information concerning the nature of the needed information in the agent’s affidavit:

Neither the Government’s brief, nor Allred’s affidavit, offer any details regarding what London and Allred said about potential third-party contacts on December 16, 2015….[T]he Government does not provide any specific information regarding how the IRS purportedly notified Crow of potential third-party contacts on December 16, 2015. For instance, what did London or Allred say about third-party contacts on this date? Did they reference any specific third parties or types of businesses they may contact if Crow did not provide information himself? Did they give any hint that Crow should produce documents involving the escrow companies or lenders that SCCC used in its installment sales transactions?

Taken together the court concluded that the IRS failed to provide reasonable advance notice. As the opinion notes, IRS could have done more to act consistently with Crow’s legitimate privacy interests. To that end, the opinion discusses (at Crow’s suggestion) steps the IRS could have taken, including renewing its request for information from Crow closer in time to the contact (which was over two years from both the generic notice IRS provided and revenue agent conversation) and specifying that it would contact third parties if Crow did not provide the information it wanted. As a final measure, the court noted that FOIA-obtained IRS case notes erroneously concluded that Alpha and Vaught were not third parties for purposes of the notice requirements. This suggested perhaps that the IRS did not provide additional notice because of the mistaken belief that the contacts did not trigger notice requirements.

Conclusion

The court ultimately concluded that the violation of the advance notice requirement meant that the IRS failed to satisfy the fourth Powell summons requirement, that the IRS follow all administrative requirements in the issuance of the summons.  While Vaught involves pre TFA law, it is an important opinion in at least two respects. First, there may be summons enforcement cases still percolating under the pre TFA notice rules. Second, and perhaps more important, the opinion reflects a perspective that emphasizes that taxpayers have legitimate privacy and reputational interests. When there is the scent of shelters or allegedly improper taxpayer conduct at times IRS may fail to adequately weigh or even consider the interests of taxpayers. Vaught should serve as a reminder that privacy and reputational interests are at stake even when there is a taxpayer suspected of engaging or promoting aggressive transactions.

What are the next steps here? I have not dug into the filings but I assume that if the IRS has not received the information it could reissue the summonses, ensuring that it complies with post TFA notice requirements. Challenges to summons enforcement typically toll the SOL on assessment, so perhaps the taxpayer victory is short lived.