NorCal Tea Party Patriots v. IRS: Change in the Restrictions on Disclosure of Third Party Information?

Today, we welcome back guest blogger Marilyn Ames writing from the 49th state where she lives following her retirement from the Office of Chief Counsel.  Keith

On April 1, 2015, the court in the NorCal Tea Party Patriots case issued an order requiring the government to turn over information identifying the other organizations allegedly targeted by the Internal Revenue Service for intensive scrutiny when the organizations applied for tax-exempt status.  This order is at odds with a decision by the Court of Appeals for the Federal Circuit, and, if allowed to stand, may signal a sea change in the ability of taxpayers to get information regarding the tax returns and return information of third parties.


For those not familiar with the case, here’s a little background. In May of 2013, ten organizations filed suit against the United States, the Internal Revenue Service and various individual employees of the Internal Revenue Service, alleging that their rights under the Privacy Act, the First and Fifth Amendments and the non-disclosure provisions of IRC § 6103 were violated when they applied for tax exempt status and were then subjected to intensive scrutiny because of their dissent from the policies of the Obama administration.  The plaintiffs also sought to certify a class consisting of all other organizations subjected to the same intensive scrutiny for their “dissenting” beliefs. After some preliminary procedural skirmishing, the Privacy Act count was dismissed, as were the individual IRS employees, leaving the remaining counts to go forward against the United States and the Internal Revenue Service.  The request for class certification also remained to be decided.

In their efforts to certify a class, the plaintiffs served discovery on the government. They requested, among other items, that the government turn over any lists or spreadsheets the IRS used to track groups flagged for heightened review, the list of 298 applicants that the IRS compiled and provided to the Treasury Inspector General for Tax Administration (“TIGTA”) for its use in reviewing the conduct of the IRS, and an additional tracking sheet of applicants also sent to TIGTA.  This information was to form the basis for the plaintiffs’ efforts to certify a class. The government refused, claiming that the disclosure would violate the provisions of the disclosure statute, IRC § 6103.  It is this discovery request that triggered the court’s order of April 1.

Section 6103(a) of the Internal Revenue Code states that “returns and return information” are confidential, and cannot be disclosed except as permitted by the Internal Revenue Code.  Section 6103 then proceeds, in the longest section in the Internal Revenue Code, to detail exactly when a taxpayer’s return or return information can be disclosed.  Fortunately for us, we can skip most of section 6103 and go directly to the subsection at issue – IRC § 6103(h)(4)(B), which deals with when returns or return information can be disclosed in a judicial or tax administration proceeding.  Both parties agreed that the list in question constituted return information as defined in section 6103(b)(2). (Basically, return information is all information regarding a taxpayer’s return received by, recorded by, prepared by, furnished to, or collected by the Internal Revenue Service in its determination of the possible existence or a liability of any person for a tax, penalty, interest, fine, forfeiture or offense.  That covers pretty much everything if taxes are involved.)

The plaintiffs argued that the information they requested meets the exception to disclosure contained in section 6103(h)(4)(B), which provides that disclosure can be made in a judicial proceeding “if the treatment of an item reflected on such return is directly related to the resolution of an issue in the proceeding,” sometimes referred to as the item test. Citing past cases, the court noted that the issue to which the return information relates is not limited to matters concerning the taxpayer’s tax liability.  Quoting Chief Counsel Advisory, IRC CCA 201250020, the court stated: “The item must ‘affect the resolution or be germane to an element of the claim,’ but it need not be dispositive of the issue.” The court concluded that the spreadsheets and lists were directly related to the issue of class certification, denied the government’s motion for a protective order and granted the plaintiffs’ motion to discover the information.

It is in footnote 4 of the court’s order that things get really interesting, because it is here that the court rejects the government’s arguments based on the reasoning of the case of In re United States, 669 F.3d 1333 (Fed. Cir. 2012).  The government relied on the United States case for two propositions.  First, an item reflected on a return can only be information provided by the taxpayer and filed with the IRS. In other words, only returns can be disclosed using the item test, because only returns are filed.  Return information, including return information prepared by the government, cannot be disclosed.  Second, the government argued, the item test did not permit disclosure because the return information in question did not “directly relate” to an issue in the case.  The court in the United States case expressly held an item is never directly related when the only link between the taxpayer and the third party is the same tax treatment.  (It should be noted there is a split in the circuits as to how strictly the “directly related” part of the item test should be applied. The NorCal court mentions several of these cases.) When these two propositions are taken together, a taxpayer seeking information regarding a third party’s tax treatment can almost never get it.

The NorCal court felt that the item test should be more broadly interpreted on both these points, and looked to an unexpected source for support in its decision.  In October of 2012, after the opinion in the United States case was issued, the IRS Chief Counsel issued an advisory opinion that contradicted the United States case on both these points in the results reached.  (While the court recognized the advisory opinion contained in IRS CCA 201250020 is by its own terms not to be used or cited as precedent, the court said it was not citing it as precedent but “for its well-reasoned analysis.”) The issue presented in the advisory opinion was whether third party return information could be used in the cases of other taxpayers involved in similar captive insurance programs all set up by the same individual.  The opinion concluded that third party return information could be disclosed under the item test if it showed a pattern that directly related to the resolution of an issue in the case.  In the situation in the opinion, if return information of a third party showed that the arrangement sold to the taxpayer did not have sufficient individualized risk transfer and distribution to qualify as insurance, the third party information could be disclosed.  It could not be disclosed simply to show that the taxpayer had entered into an invalid transaction similar to that of the third party.

If the government does not seek to block the discovery order, the court in NorCal may have opened a door for a broader reading of section 6103(h)(4)(B).  If so, this would allow taxpayers to obtain information on how the IRS treats those taxpayers who are similarly situated, provided the taxpayer can show a pattern that would bear on the resolution of an issue in the case. It would also allow the IRS to use this information in the same way.  Overall, this can only work towards tax administration that treats similar taxpayers consistently.


“Do Overs” – The Binding Effect of an Offer in Compromise

Today we welcome first time guest blogger Marilyn Ames. Marilyn and I worked together at IRS Chief Counsel’s office for many years separated by about 1,500 miles.  She is retired now and living in Alaska but assisting me in rewriting the Saltzman and Book collection chapters.  We are working on the offer in compromise section of the book and by chance I received a question from another clinic about what to do when the IRS begins auditing your client for a period covered by the offer.  This past summer I had drawn a question from another clinic about what to do when your client discovers they should have received a large refund for a period covered by the offer.  As we looked at those situations, we decided that the effect of the offer was clear under the law but perhaps not clear to those entering into the offer.  That discussion led to this post and I thank Marilyn for her efforts.  Keith  

The IRS has had the authority to compromise with taxpayers since the first income tax code, and taxpayers and the IRS have been litigating over the effect of an accepted compromise almost as long.  Usually it has been the taxpayer who has requested what my children used to call a “do over” when they played games; as in “I don’t like what happened in the move I just completed and now I want to take that move back.”  Recently, however, it appears that the IRS has begun to ask for do overs in the area of offers in compromise.


Section 7122 and its predecessors give the IRS the authority to compromise any civil or criminal case arising under the internal revenue laws. In the first reported do over case involving an accepted offer in compromise, Ely & Walker Dry Goods Co. v. United States, 34 F.2d 429 (8th Cir. 1929), the taxpayer discovered after it entered into a compromise involving its income tax liability and the fraud penalty for its fiscal year ending in 1918, that its inventory was incorrectly computed.  The parties agreed that absent the compromise, the taxpayer would be entitled to a refund.  The taxpayer argued that the compromise was only of the fraud penalty, not the tax, so the compromise was not precluded by the acceptance of the offer in compromise.  The court rejected the taxpayer’s argument, holding that the income tax liability “constituted an entire, single liability, that this single liability, treated as such by the parties, was duly compromised, and that such compromise is a bar to this action.” 34 F.2d at 432. 

Since 1929, taxpayers have unsuccessfully attempted to get a do over by distinguishing the holding in Ely & Walker Dry Goods that a compromise of a tax liability closes that tax year, and the liability cannot be reopened.  The Internal Revenue Service has agreed with that holding, both in its litigation positions and in its publicly stated policy. Treas. Reg. § 301.7122-1(e)(5) expressly states that acceptance of an offer in compromise conclusively settles the liability of the taxpayer specified in the offer, and that neither the taxpayer nor the Government will be permitted to reopen the case after an offer has been accepted unless the taxpayer has committed fraud by supplying false information or documents, or by concealing assets or the ability to pay. The regulations further allow the liability included in an offer in compromise to be reopened in the event of a mutual mistake of material fact.  The court in Rosenberg v. United States, 313 F. Supp. 28 (N.D. 1970)upheld this regulation, stating that it had the force and effect of law as it was not clearly unreasonable.

Absent fraud or mutual mistake of fact, the courts have not allowed taxpayers the requested do over. One of the more recent attempts to avoid the binding effect of an offer in compromise was made by the taxpayer in Dutton v. Commissioner, 122 T.C. 133 (2004), in which the taxpayer tried persuade the Tax Court that his claim for innocent spouse relief should be granted and he should receive a refund. The Tax Court rejected his argument that there was a mutual mistake sufficient to have had a material effect on the agreed exchange of performances.

In Revenue Procedure 2003-71, written for the purpose of describing the process for submitting and resolving an offer in compromise, the IRS emphasizes in section 8.02 that “Acceptance of an offer in compromise will conclusively settle the liability of the taxpayer specified in the offer.”  In PLR 5807022300A, the IRS stated “So long as an offer in compromise is in effect, all rights to further adjustments for the year or periods involved are waived.  For a compromise is a binding contract, conclusive against both the Government and the taxpayer.”

Despite the long-settled legal position that an accepted offer in compromise closes out all tax periods and years included in the offer, the recent case arising in one clinic suggests that the IRS seeks to give itself a de facto do over. It contacted a taxpayer with an accepted offer seeking to audit years included in the compromise.  The contact came in the form of a CP 2000 notice.  These notices are issued by the Automated Under Reporter (AUR) Function when the information returns filed with the Service do not match the information reported on the taxpayer’s return.  Presumably this is not a compromise where the IRS has discovered that there was fraud or a mutual mistake of fact, as the taxpayer has not received the letter required for a rescission IRM, Rescission Procedures (September 23, 2008) of an accepted offer in compromise. Absent fraud, it is doubtful that the existence of this potential additional liability would constitute a mutual mistake of fact that would have kept the IRS from accepting the offer in compromise, and that the compromise could be rescinded.

Apparently this is a case of the right hand and the left hand of the IRS not knowing what the other is doing, although if the IRS computer systems can match income information with returns, it would seem that the system could also be programmed to recognize the existence of an accepted offer in compromise for this tax period. The possibility exists that the AUR Function did not pick up the computer code entered in the offer case or the timing of the underreporter case came just before the offer code appeared on the account.  Since these cases are worked basically by computers rather than individuals, the timing of the offer and the AUR notices may have been ships passing in the night that no one at the IRS observed.

The Internal Revenue Manual IRM, Pending Assessments (May 10, 2013)  contains clear instructions on how to handle audits that are open when an offer in compromise is submitted for the same year, but doesn’t appear to recognize that an audit could be opened after the offer is accepted.  While a taxpayer with an accepted offer who receives a CP 2000 notice may find someone at the IRS who understands the tax year is closed, or may have competent counsel who can make the argument, the possibility exists that many taxpayers in this situation would simply pay the additional liability.  Because this has happened in only one known case, it is unclear if a systemic issue is at play or an anomaly.

One final aspect of later discovered issues in offers bears mentioning.  If the IRS discovers a tax period that should have been included in an offer in compromise but was not, and both parties are in agreement, the procedure is simply to add the additional tax periods to the original offer.  The additional liability must have been assessed before the original offer in compromise was accepted.  IRM, Overlooked Periods (April 15, 2011).  While you want to put every period in which the taxpayer has an assessed liability into an offer and you want to resolve all periods for which the taxpayer is under audit at the time of the offer, sometimes a period gets overlooked.  This procedure can fix the problem if the assessment occurred before the offer acceptance.  This procedure cannot fix the problem if the audit did not result in an assessment.  It also cannot help the taxpayer who later “discovers” they were due a refund for a period covered by the offer.  Because of the binding nature of the offer, a complete review of taxpayer’s circumstances for all open years should take place in conjunction with the submission of the offer to avoid problems of the failure to cover periods or the failure to seek a refund before it’s too late.