When the Internal Revenue Service audits a taxpayer, it requests the taxpayer to voluntarily provide documents and information. Where a taxpayer fails or refuses to provide the information, the IRS often issues summonses to the taxpayer or third parties. Failure to comply with a summons can be costly. As two recent appeals court cases make clear, it is very hard for a taxpayer to get an evidentiary hearing to challenge a summons. United States v. Clarke (11th Cir. 3/15/2016), on remand from 573 U.S. ___, 134 S. Ct. 2361 (2014) and Gangi v. United States (1st Circuit, 3/30/2016).
First, some background on the IRS’s summons power. Internal Revenue Code (IRC) §7602(a) authorizes the IRS to issue a summons for the purpose of “ascertaining the correctness of any return, making a return where none has been made, determining the liability of any person for any internal revenue tax . . ., or collecting any such liability.” Unlike an IDR, the IRS can obtain a court order enforcing a summons. A taxpayer can also seek a court order to quash a summons. Where this occurs, the IRS will usually ask the court to enforce the summons.
To obtain a court order enforcing a summons, the IRS must establish that (1) the investigation is being conducted for a legitimate purpose, (2) the information sought may be relevant to the purpose, (3) the information sought is not already in the IRS’s possession, and (4) all administrative steps required by the Code have been followed. United States v. Powell, 379 U.S. 48, 57-58 (1964). The IRS normally makes this showing through a declaration signed by the IRS agent conducting the audit. A person contesting enforcement must then either disprove one of the four elements or establish that enforcement of the summons would constitute an abuse of the court’s process. However, a court reviewing an enforcement petition “may ask only whether the IRS issued a summons in good faith, and must eschew any broader role of ‘oversee[ing] the [IRS’s] determinations to investigate.'” Clarke, 573 U.S. at ___, 134 S. Ct. at 2367 (alterations in original).
The Supreme Court’s decision in Clarke clarified what a taxpayer must show to get an evidentiary hearing in which he can examine IRS agents about their motives for issuing a summons. A “taxpayer is entitled to examine an IRS agent when he can point to specific facts or circumstances plausibly raising an inference of bad faith.” Id. at ___, 134 S. Ct. at 2367. As discussed in a prior blog, in Microsoft v United States, the court granted an evidentiary hearing only to find that the IRS did not abuse its summons power.
In Clarke, the IRS was auditing a partnership, DHLP. During the audit, DHLP twice extended the statute of limitations. After it refused to extend the statute a third time, the IRS issued five summonses to third parties, all of whom failed to comply. Instead of seeking enforcement, the IRS issued a Final Partnership Administrative Adjustment (FPAA). The partnership petitioned the Tax Court to challenge the FPAA.
After the IRS filed its answer in Tax Court, the Government filed petitions in U.S. district court to enforce the summonses, together with a declaration from the IRS agent establishing the four Powell elements. DHLP opposed enforcement on the grounds that the summonses were issued in retaliation for its refusal to extend the statute and to circumvent the Tax Court’s discovery rules. It requested an evidentiary hearing. The district court denied the request for an evidentiary hearing and ordered the summons enforced. On appeal, the Eleventh Circuit reversed, holding that DHLP was entitled to an evidentiary hearing.
The IRS appealed to the Supreme Court, which reversed the Eleventh Circuit and remanded the case for further proceedings to determine whether DHLP was entitled to an evidentiary hearing in light of the standard enunciated by the Court. The Eleventh Circuit sent the case back to the district court to “determine, in light of all of the evidence and the affidavits highlighted by the Supreme Court, whether Appellants pointed to specific facts or circumstances plausibly raising an inference of improper purpose …. [and] whether the improper purposes alleged by Appellants . . . are improper as a matter of law.”
After remand, the district court allowed further briefing but denied DHLP’s request to submit additional evidence. To support their allegations of retaliation, DHLP and the summoned parties stressed the timeline of the IRS’s decision to seek enforcement, which was six months after the summonses were issued, four months after the FPAA was issued, and in the same month that the IRS answered the Tax Court petition. They also pointed out that the FPAA was signed prior to the date the summonses were issued, to support the inference that the summonses were retaliatory.
To support the allegation that the IRS sought enforcement of the summonses to evade more stringent Tax Court discovery rules, DHLP pointed to the fact that a summoned person who complied was examined by the attorney who was representing the IRS in Tax Court and not by the IRS agent.
The district court held that none of the grounds alleged were improper as a matter of the law and that no facts were submitted that gave rise to a plausible inference of improper motive regarding the issuance of the summons. It denied the request for an evidentiary hearing and ordered the summonses enforced. On appeal, the Eleventh Circuit affirmed the district court.
Although it affirmed the district court’s order denying an evidentiary hearing and enforcing the summonses, it rejected two of the district court’s determinations. First, the Eleventh Circuit concluded that issuing a summons for the sole purpose of retaliation against a taxpayer would be improper as a matter of law. Second, the Eleventh Circuit concluded issuing a summons in bad faith for the sole purpose of circumventing Tax Court discovery would be an improper purpose as a matter of law.
Addressing the district court’s denial of the request to submit additional evidence, the Eleventh Circuit held that in light of the summary nature of a summons enforcement proceeding, the district court did not abuse its discretion.
The Eleventh Circuit also found that while DHLP made a number of allegations, the evidence it presented did not give rise to any plausible inference of improper motive. First, the submission that the timeline of the issuance of the summonses supports an inference of retaliation by the IRS requires substantial conjecture that is both implausible and unsupported by the record. Further, none of the’ submissions suggest that the summonses were issued in bad faith anticipation of Tax Court proceedings rather than in furtherance of the audit. Thus, DHLP and the summoned parties were not entitled to an evidentiary hearing.
The Eleventh Circuit also pointed out that the validity of a summons is tested at the date of issuance. Thus, neither the subsequent issuance of an FPAA nor the initiation of Tax Court proceedings affected the IRS’s summons authority or the summoned parties legal obligation to comply.
Prior to the Supreme Court’s decision in Clarke, the Eleventh Circuit was alone in holding that a bare allegation of improper purpose was sufficient to entitle a person challenging a summons to an evidentiary hearing. In Gangi, the taxpayer filed a petition to quash summonses. The district court denied the petition and ordered the summonses enforced. Shortly afterwards, the Supreme Court issued its decision in Clarke. The taxpayer moved to reopen the case and obtain an evidentiary hearing on the ground that Clarke set a new standard for determining when a taxpayer can get an evidentiary hearing. The district court denied the motion. The First Circuit affirmed. In doing so, it held that the Supreme Court’s requirement that a taxpayer must allege “specific facts and circumstances” sufficient to raise a plausible inference of bad faith was virtually identical its standard that a taxpayer needs to allege specific facts and evidence supporting a claim of bad faith in order to obtain an evidentiary hearing.
Based on these two cases and the district court decision in Microsoft, it has become even more difficult after the Supreme Court’s Clarke decision to quash a summons than it was pre-Clarke if the IRS meets the four-part Powell test. And if the taxpayer petitions to quash a third-party record keeper summons, or intervenes in a proceeding to enforce a summons, the statute of limitations on assessment is suspended until the conclusion of the proceeding and any appeals. Thus, a taxpayer’s challenging a summons can result in giving the IRS more time to gather information and examine the return.
ROBERT S. HORWITZ – For more information please contact Robert S. Horwitz – horwitz@taxlitigator.com or 310.281.3200 Mr. Horwitz is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., a former Assistant United States Attorney of the Tax Division of the Office of the U.S. Attorney (C.D. Cal) and represents clients throughout the United States and elsewhere involving federal and state, administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at http://www.taxlitigator.com
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