Ninth Circuit Rejects IRS’s Approach to Notifying Taxpayers of Third Party Contacts

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Under Section 7602(c)(1), IRS must provide the taxpayer with “reasonable notice in advance” before it summons records from financial institutions, employers or other third parties. The IRS has argued that Publication 1, its Your Rights as a Taxpayer publication, suffices for these purposes. There had not been a published circuit court opinion on the issue until last week’s Ninth Circuit opinion in JB v United States. While the JB opinion is careful to note that its holding is context specific, it holds that Publication 1 did not constitute reasonable advance notice in the case at issue. The opinion also questions whether Publication 1 could constitute reasonable notice in any context.

I will summarize the facts and the court’s approach, and also suggest why this opinion has broad implications.

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The taxpayers JB and PB are an elderly couple; JB is an attorney who as state-appointed counsel represented capital defendants in California. In 2013, they were lucky enough to be selected for a National Research Project (NRP) IRS audit for the 2011 tax year. The NRP audits are extensive line by line reviews of all items on a tax return. The letter that notified the taxpayers that they were selected for audit described the NRP audit process and asked the taxpayers to contact a revenue agent. The packet also included Publication 1.

The taxpayers requested to be excused from the NRP audit due to JB’s age and poor health. In particular they passed on declarations from a doctor that the audit would “worsen his hypertension and contribute to hypertensive retinopathy, a deteriorating eye condition, as well as his serious hearing loss.” (I am no doctor and am not sure how hearing loss connects to the audit but that is not really relevant for this opinion).

IRS refused and the taxpayers filed suit to stop the audit. In the meantime the NRP audit went forward and two years later in 2015 the IRS issued a summons to the California Supreme Court seeking “copies of billing statements, invoices, or other documents . . . that resulted in payment to” J.B. In seeking that information, IRS did not separately notify the taxpayers about its contacting the court.

JB and PB filed a suit in district court to quash the summons arguing that IRS failed to give them reasonable advance notice. The government essentially argued that IRS did comply with its notice requirements, pointing to the Publication 1 that IRS had sent to the taxpayers two years before when it notified them of the NRP audit. That publication included 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. If we do contact other persons, such as a neighbor, bank, employer, or employees, we will generally need to tell them limited information, such as your name. The law prohibits us from disclosing any more information than is necessary to obtain or verify the information we are seeking. Our need to contact other persons may continue as long as there is activity in your case. If we do contact other persons, you have a right to request a list of those contacted. Your request can be made by telephone, in writing, or during a personal interview.

The district court held that the IRS’s sending Publication 1 did not adequately give notice and concluded that “the advance notice procedure cannot be satisfied by the transmission of a publication about the audit process generally.”  As the Ninth Circuit summarized, the district court “instructed that ‘advance notice should be specific to a particular third party,’ reasoning that ‘the implementing regulations contemplate notice for each contact, not a generic publication’s reference that the IRS may talk to third parties throughout the course of an investigation.’”

The Ninth Circuit affirmed the lower court but ostensibly charted a more nuanced course. In so doing, it explored case law rooted in procedural due process jurisprudence that considers what constitutes notice; that law generally requires a context-specific inquiry that is inconsistent with the IRS position in this case:

We reject a categorical approach to this question. We conclude that “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.

The opinion then goes on to explain why in this case Publication 1 was insufficient:

In this case, the sole notice that the government provided J.B. and P.B. that it might contact the California Supreme Court is Publication 1. The IRS sent J.B. and P.B. Publication 1 as part of its initial, introductory letter to the couple explaining that they had been selected for an audit; an audit the couple sought to stop. The Publication did not accompany a specific request for documents, nor is there any evidence that the IRS revisited the notice later in the audit when it knew that J.B. and P.B. had requested an exemption from the research audit and had not provided documents for the audit. More than two years elapsed between when the IRS sent Publication 1 to J.B. and P.B., and when the IRS subpoenaed the billing records and invoices from the California Supreme Court. We do not think that an agency that actually desired to inform a taxpayer of an impending third-party contact would consider Publication 1 adequate notice in these circumstances.

In rejecting the IRS position the court staked out a position that requires the IRS to deliberate and weigh the government’s interest with the individual’s privacy interests, including whether the taxpayer has a reasonable opportunity to give the information the IRS wants so as to avoid the potential embarrassment and loss of privacy that accompanies third-party notifications.

In the context of this case it was easy for the court to conclude that the IRS came up short:

  • This was an NPR audit that is intended to assist the government with its understanding of the tax gap,
  • There was a two-year delay between the audit notice and the summons,
  • The information requested from the court might include privileged information relating to the taxpayer’s legal work representing capital defendants, and
  • The taxpayers and IRS had extensive contact that could have been a vehicle for additional notice by virtue of the lawsuit that the taxpayers brought to stop the audit.

This opinion has implications that go to heart of the IRS’s approach to all third party contacts. Buried in footnote 15 is the following:

Although we limit our holding to the facts of this case, we are doubtful that Publication 1 alone will ever suffice to provide reasonable notice in advance to the taxpayer, as the statute requires. We think it unlikely that the broad and colloquial language in the “Third-Party Contacts” paragraph of Publication 1, which states that the IRS may “sometimes talk with other persons,” gives the taxpayer reasonable advance notice that the IRS intends to subpoena, under threat of penalty, third-party documents.

Thus, the Ninth Circuit strongly suggests that the IRS revisit its approach to third party contacts on a systemic basis. In setting out its views the Ninth Circuit was mindful that this might add significant time and expense, but in its view this is an issue for Congress, not the courts:

We understand that one result of adopting a context- specific rule may be to make it more difficult for IRS officers, and district courts, to determine whether § 7602(c)(1)’s advance notice requirement is satisfied in any given case. But, to the extent such an administrability problem develops, the responsibility lies with Congress, not the courts. We cannot ignore the text of a statute that hinges the adequacy of notice on a determination of reasonableness. Nor can we ignore the congressional mandate to provide taxpayers faced with a potential third-party summons with a meaningful opportunity to respond with the relevant information themselves so as to maintain their privacy and avoid the potential embarrassment of IRS contact with third parties, such as their employers.

The upshot was the Ninth Circuit affirmed the quashing of the summons. The opinion will likely prompt changes to IRS practice, at least in Alaska, California, Hawaii and Arizona, and perhaps an effort to get Congress to revisit the issue.

Leslie Book About Leslie Book

Professor Book is a Professor of Law at the Villanova University Charles Widger School of Law.

Comments

  1. Kenneth H. Ryesky says

    I had an analogous pet peeve in connection with the IRC § 7502 “Postmark Rule, of which I wrote extensively in “Analysis of the Split Authority on Proof of a Postmark under Internal Revenue Code § 7502”, 21 U Dayton L. Rev. 379 (1996).

    It seemed that the IRS insisted that Certified Mail or Registered Mail were the taxpayer’s sole means of proving a timely postmark when the IRS questioned it, whether arising through IRS error or Post Office error, or otherwise. [Never mind that the IRS’s position was contrary to explicitly stated Congressional intent.].

    My pet peeve was that the IRS failed to sufficiently inform the taxpaying public of its position in the Treasury Regulations, the 1040 Instructions, or in Pub. 17. I got in a castigation of the IRS on the point during my oral testimony at the 11 January 2005 rulemaking hearing on Treas. Reg. § 301.7502-1. Section 301.7502-1 was updated on 23 August 2011 to explicitly state the IRS’s position, but even then, it took the IRS a few years to be explicit in its 1040 Instructions and Pub 17.

    Meanwhile, the Postal Service continued to misinform its customers that a Form 3817 Certificate of Mailing was sufficient proof.

    Seems that this and the Third Party Contacts Notice have a common attitudinal thread on the part of the IRS.

  2. Norman Diamond says

    ‘The taxpayers requested to be excused from the NRP audit due to JB’s age and poor health. In particular they passed on declarations from a doctor that the audit would “worsen his hypertension and contribute to hypertensive retinopathy, a deteriorating eye condition, […]”‘

    Hmm, I wonder if this kind of declaration from a doctor could persuade a court to order the IRS to audit me. Some of us do need an way to force the IRS to contact payers.

    ‘Thus, the Ninth Circuit strongly suggests that the IRS revisit its approach to third party contacts on a systemic basis. In setting out its views the Ninth Circuit was mindful that this might add significant time and expense, but in its view this is an issue for Congress, not the courts’

    Surely it would not add significant time or expense. An IRS letter told me, in the letter not in Publication 1, that the IRS might contact payers. My reply letter asked them to do so, long before I was in court, long before my motion to compel the IRS to do so (motion denied). I don’t think the IRS had trouble creating their letter. I bet each time the IRS prepares a summons they could even make a more specific letter a month in advance, copying and pasting the target of the summons into the letter.

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