So You Want to Raise an IRC § 7602(e) Issue…

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Previously, I wrote about why it is IRC § 7602(e) wouldn’t keep the IRS from using information returns from banks to audit taxpayers. Let’s now suppose my analysis from the prior post is completely and entirely wrong and the IRS can’t use information returns in the way I suggest. What happens if the IRS still does?

“Well, they’d be violating the law,” you (and my idealistic students) say.

Yes, they would be. But what are the consequences? How would that ever come before a court? And perhaps more importantly, what remedies would individual taxpayers have that are caught up in this process?

Not much, I’d suggest. Let me explain why…

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Apologies for making you click the “read more” button and then abruptly pausing, but I think some important context needs to be laid before going further. To wit, I want to emphasize two important points:

First, I strongly believe that the IRS wouldn’t actually be violating IRC § 7602(e) by using information returns from banks in the ways they are most likely to actually use the data. At the very least, I strongly believe that the IRS would have a strong argument that they were not violating IRC § 7602(e) in most cases.

Second, I do not believe for a moment that the IRS would knowingly violate IRC § 7602(e) as a matter of policy if they believed it did constrain them vis a vis bank information returns. In other words, while individual employees might violate IRC § 7602(e), I fully trust the IRS to set official policies that would abide by the law in determining how to use any bank information returns that come their way.

I don’t make these points just to score some sympathy with the government readers of the blog. I make them because I believe them, and because they are important for understanding the substantive analysis that follows. Even when and if a wayward IRS employee were to violate IRC § 7602(e) the remedies of the taxpayer are extremely limited.

Avenues of Argument: Where to Raise IRC § 7602(e) Concerns

When Prof. Breen wrote his PT post (here) about IRC § 7602(e) he remarked that it did not appear practitioners were raising IRC § 7602(e) issues very often. Prof. Breen found only one Tax Court opinion that cross-referenced IRC § 7602(e), and that particular case found the statute inapplicable. Prof. Breen’s post was published back in October 2016. How much has changed in the past half-decade?

Not much.

There is still only one Tax Court opinion that I found referencing IRC § 7602(e) -the very one Prof. Breen referred to. However, in expanding my search to include opinions in other federal courts the number of opinions referencing IRC § 7602(e) skyrocketed to… nine. Well, eight if you want to look at separate cases. Actually, more like six if you also filter out the absolute nonsense arguments (tax protestors and family law cases).

So in 23 years we’ve had about six cases where IRC § 7602(e) has been raised and a court has given an opinion on its application. And of those six cases the court has found the IRS in violation of IRC § 7602(e)… zero times. In fact, I can’t find a single opinion where IRC § 7602(e) has played a role in yielding an IRS-averse outcome.

It should be noted here, very importantly, that this doesn’t mean that IRC § 7602(e) is meaningless. Indeed, there could be a trove of court orders (rather than opinions) where IRC § 7602(e) comes into play. Similarly, it could be that IRC § 7602(e) comes into play in administrative and behind-the-scenes posturing between the IRS and taxpayers, none of which gets reported on Westlaw. Lastly, and again importantly, IRC § 7602(e) did have a change on IRS policy.

Indeed, an optimist could say “we don’t see IRC § 7602(e) issues in court because the IRS follows it in the first place.” I’ll genuinely reserve judgment on that, since I rarely deal with financial status audits (I can think of once in my career where they’ve come up). But let’s assume we were to see a massive increase in IRC § 7602(e) violations spurred by new bank reporting requirements. How can taxpayers fight against this abuse?

As far as I can tell, there would be three likely ways to get into court and argue that the IRS’s use of bank reporting violated IRC § 7602(e): (1) moving to quash a summons, (2) deficiency proceedings, and (3) collection due process hearings. Let’s take each in turn.

Motion to Quash a Summons

The most straightforward and appropriate way to challenge a perceived IRC § 7602(e) abuse is while the IRS examination is still on-going. Unfortunately, there aren’t a lot of ways to get into a federal court (and virtually no way to get into Tax Court) before the IRS has actually determined a deficiency. However, if you stonewall the IRS requests for information in audit long enough you just might get your wish when the IRS stops playing around and issues a summons.

Indeed, bringing suit against summons appears to be the most natural way to enforce IRC § 7602(e). In the words of one court:

[We] can find no precedent indicating citizens can bring a cause of action against the United States to enforce this section [IRC § 7602(e)], and the statute itself provides no waiver of sovereign immunity. Instead, the context in which this section typically arises is a suit by the IRS to enforce a summons issued under 26 U.S.C. § 7602 or a suit by a taxpayer to quash such a summons.

Mortland v. I.R.S., 2003 WL 21791249, at *3 (W.D. Tex. June 24, 2003)

There is a fairly obvious problem with bringing a suit to quash a summons as it relates to a bank information return. Namely, that the bank information return would not be issued pursuant to a summons. Presumably, the taxpayer argument would be that the (later) summons stems from an inappropriately initiated examination -i.e. one where the IRS is using financial status audit techniques without first having a reasonable indication that you have unreported income. The problem is that the bank information return is prior to the summons and (presumably) would give the IRS exactly the “reasonable indication” it needs. Again, as I raised in my first post, contrary to the Forbes/Brookings article’s contentions, the increased bank reporting would actually reduce the scope of IRC § 7602(e) rather than the other way around.

The horse has left the barn by the time you’re trying to quash a summons based on a bank information return. You’re out of luck in challenging the legality of the information return in this venue, since the only thing at issue is the summons itself. If you want to challenge the information returns prior to the summons you are going to run into the two-headed hydra of sovereign immunity and the Anti-Injunction Act.

Furthermore, the track record of the arguments on quashing summons on IRC § 7602(e) is… not great. At least in the opinions I found. Again, there could be a million court orders out there where the summonses are indeed quashed, and which have flown under the radar of my search (which only covers opinions). But the opinions that can be found on Westlaw don’t paint an optimistic picture for taxpayers. Of the cases I reviewed, literally none of them resulted in a quashed summons and all of them supported my contention that increased bank reporting would actually neuter IRC § 7602(e) arguments.

Many of the cases raising IRC § 7602(e) arguments failed on procedural grounds such that the court didn’t even need to reach the merits. Nonetheless, the courts made a point of saying that “even if they would have” considered the merits, the taxpayers would have lost because the IRS had a reasonable indication of unreported income allowing such financial status exams in the first place. Examples for the requisite reasonable indication of unreported income included:

(1) a tip from someone to the IRS about unreported income (United States v. Abramson-Schmeiler, 2010 WL 11537887 (D. Colo. Oct. 14, 2010));

(2) previous bank records sent by the taxpayer being mysteriously incomplete (Chapin v. IRS); and

(3) tax protestors sending a letter to the IRS declaring they “removing themselves from the income tax system.” (Billheimer v. United States, 2003 WL 22284193 (S.D. Ohio July 31, 2003) It is hard to imagine that the additional information provided to the IRS by bank information reporting would make it harder for them to meet the “reasonable indication” standard.

It is hard to imagine that the additional information provided to the IRS by bank information reporting would make it harder for them to meet the “reasonable indication” standard.

I suppose one could make a long-shot argument that the IRS can’t summons for bank account records under Powell because, if the bank information returns show inflows and outflows, the IRS already has the information requested in the summons. But that argument is pretty much self-defeating. If the banks are really going to be reporting so much information that the actual bank account statements are superfluous I don’t think the IRS is going to waste time issuing summonses for the records. More likely, the information will give a “suggestion” of unreported income (again, ruining IRC § 7602(e) arguments) which could be augmented by a fuller picture of the bank accounts at issue.

The verdict? Challenging a summons isn’t the way to contest the legality of any new bank information reporting requirement. On to the next potential argument…

Raising IRC § 7602(e) Concerns in a Deficiency Proceeding

Generally speaking, if you’re raising concerns about the audit process to the Tax Court you are setting yourself up for failure. The role of the Tax Court is to determine the deficiency, which it does on a de novo review. If you’re arguing about the way you were treated in the steps leading to the notice of deficiency you will get, at absolute best, a “Sorry, but we’re a court of limited jurisdiction” response from the Tax Court. You will also likely get a citation to Greenberg’s Express.

There are, however, some instances where the processes leading to the notice of deficiency matter. And those instances just so happen to be those that involve unreported income and financial status (or “indirect proof”) methods of audit. If you can show that the IRS didn’t really do its homework in determining unreported income, you can remove the “presumption of correctness” that usually attaches to a notice of deficiency determination. Professor Camp has an excellent post on these so-called “naked assessments” which can be found here.

If all the IRS did was look at the information report from the bank and then, without anything more, said “looks like [x] amount of unreported income to me,” there could be an argument that the deficiency determination was a naked assessment unworthy of the cloak of “correctness” that it is usually clothed in. If the IRS didn’t do literally anything other than take the information return at face value, I think that would render it naked. How far of an investigation beyond “nothing at all” that the IRS would need to take, however, is debatable. Note, however, that such a determination would at least appear to violate the IRS’s understanding of IRC § 7602(e) as reflected in the memo I cited to in my previous post.

There also is a twist here, since the information return might (but might not) implicate IRC § 6201(d). There are too many unknowns as to whether the actual information returns from the bank would implicate IRC § 6201(d), both because it might not really be considered an “item of income” and because Congress could put the reporting requirements from banks somewhere other than “under subpart B or C of part III of subchapter A of chapter 61” (i.e. the returns that IRC § 6201(d) covers). However, if the information return does fall under the purview of that section, by putting the information return at issue you could shift the burden of proof to the IRS.

The verdict on arguing against bank information returns in a deficiency proceeding is… maybe. But you may have noticed that I didn’t actually use IRC § 7602(e) in any of my analysis above. That’s because I think it likely would be irrelevant to the Tax Court, even if violated. There are no cases that have found that an IRC § 7602(e) violation would ruin the presumption of correctness, or otherwise have any effect on the deficiency proceeding. I fairly doubt the Tax Court has an appetite for creating any such rule.

IRC § 7602(e) and Collection Due Process

Lastly, we have Collection Due Process jurisdiction. This is the most convoluted route to raising IRC § 7602(e) arguments, but in some ways the best venue for its success. This is because it is the only venue where you have the court empowered to review IRS conduct -something largely absent from deficiency proceedings. The IRS failing to conduct itself in accordance with the law is certainly something the Tax Court would care about in a CDP hearing. The question is how a fundamentally examination issue could ever come up in what is (typically) a collection venue.

I have strained to think of the ways in which you could raise examination issues in a CDP hearing. I have failed. The best argument I can think of is admittedly strained, but I’ll put it out there for those aspiring to make a name for themselves with creative arguments.

As part of a CDP hearing, IRS Appeals is required to verify that “the requirements of any applicable law or administrative procedure have been met.” IRC § 6330(c)(1). Might a taxpayer raise the issue that the audit leading to the deficiency (now in collection) did not meet the applicable law?

Maybe.

But even if they showed such a violation why would it matter and what could the Tax Court do? Again, we run headlong into the issue of remedy, which was the whole impetus for my writing this post. If the relief you’re asking for is the Tax Court to invalidate the assessment… well, I wish you luck. And if you’re not asking the Tax Court to invalidate the assessment, what exactly would you be asking for? A chance to argue the underlying tax anew? Unless you meet one of the Tax Court’s unduly narrow avenues for raising that issue (covered here and here, among others) I doubt they’ll create a new one not directly linked to existing statutory language. Perhaps if you do meet the requirements to raise the underlying liability you could argue for a burden shift in a similar way to the “naked assessments” argument detailed above. However, since I’m doubtful that the IRS will rely solely on bank information returns for omitted income cases, I am doubtful this tactic would get very far.

The verdict on prevailing on IRC § 7602(e) issues in CDP hearings… highly unlikely.

And so the individual taxpayer is largely without recourse when and if that code section was ever violated by the IRS using these new-fangled bank information reports. I didn’t discuss but likewise doubt that any Administrative Procedure Act style argument would prevail, though I am open to being second-guessed on that. To the extent that recent cases have chipped a bit off of the Anti-Injunction Act, I believe more than enough remains to preclude suits based solely on IRS examination tactics.

About Caleb Smith

Caleb Smith is Associate Clinical Professor and the Director of the Ronald M. Mankoff Tax Clinic at the University of Minnesota Law School. Caleb has worked at Low-Income Taxpayer Clinics on both coasts and the Midwest, most recently completing a fellowship at Harvard Law School's Federal Tax Clinic. Prior to law school Caleb was the Tax Program Manager at Minnesota's largest Volunteer Income Tax Assistance organization, where he continues to remain engaged as an instructor and volunteer today.

Comments

  1. Robert Kantowitz says

    A few points.
    1. Was Lois Lerner a “wayward IRS employee”?
    2. All it takes to give IRC § 7602(e) teeth here is to convince one district judge to issue a nationwide injunction (on the basis of a determination that the section was intended to cover this, and the Anti-Injunction Act does not cover this because it is a technique specifically barred by Congress and in any event is not a collection of a tax). Plaintiffs challenging actions of the Trump Administration became very adept at figuring out which district judges might stretch to get to the desired result in Circuits likely to affirm. Questionable or not, unless the Supreme Court eventually decides to take the case and reverse, the program stops in its tracks.
    3. If an injunction were issued, any taxpayer who suspected that it had been violated could ask a judge in his case to demand that the IRS confirm or deny this and if confirmed to dismiss the government’s case with prejudice, to refer any IRS lawyers involved in the violation for disciplinary action and to hold IRS personnel in criminal contempt. Extreme? Sure, but do not put it past an angry federal judge.
    4. The outcry could prompt Congress to strengthen the taxpayer protections. Too many members would not want to face a reelection campaign being charged with harassing taxpayers.

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