Second Circuit Opinion Affirming Denial of Motion to Quash Summons (10/1/15)

We have studied IRS summonses and summons enforcement in the class.  See Student edition pp. 271 - 282.  A recent nonprecedential opinion from the Second Circuit provides a useful review.  Highland Capital Management LP v. United States, 2015 U.S. App. LEXIS _____ (2d. Cir. 2015), here.

The Court provides a helpful introduction (footnote omitted):

Petitioner-Appellant Highland Capital Management, L.P. ("Highland Capital") challenges a decision and order of the District Court denying its motion to quash a third-party summons served by the Internal Revenue Service ("IRS") on Barclays Bank PLC ("Barclays") and granting the IRS's cross-motion for enforcement. The IRS had issued the summons seeking documents related to its audit of Highland Capital (the "2008 audit"), and particularly regarding losses claimed for 2008 related to two transactions with Barclays. On appeal, Highland Capital argues that the District Court erred in refusing to quash the summons because (1) the IRS failed to provide reasonable notice in advance of issuing the summons, as required by 26 U.S.C. § 7602(c)(1);1 (2) the summons seeks privileged and irrelevant documents; and (3) the summons was issued in bad faith or for an improper purpose. Finally, Highland Capital argues that the District Court erred by refusing to grant an evidentiary hearing on the question of the IRS's bad faith. "We review the district court's factual findings for clear error and its interpretation of the Internal Revenue Code de novo." Adamowicz v. United States, 531 F.3d 151, 156 (2d Cir. 2008). We assume the parties' familiarity with the underlying facts and the procedural history of the case.

Summons Relevance

As in some many of the endless stream of summons enforcement and quashing cases, the Court cites the Powell standard:

The standard set forth in United States v. Powell, 379 U.S. 48 (1964), governs motions to quash an IRS summons. Under Powell, "[t]he IRS must make a prima facie showing that: (1) the investigation will be conducted pursuant to a legitimate purpose, (2) 'the inquiry may be relevant to the purpose,' (3) 'the information sought is not already within the Commissioner's possession,' and (4) 'the administrative steps required by the [Internal Revenue] Code have been followed.'"

The Court then moves to the second Powell requirement -- relevance.  The Court reasoned:

Highland Capital contends that the summons seeks irrelevant information insofar as it requests documents related to transactions other than the two being investigated in connection with the 2008 audit. In determining relevancy, "[t]his court has consistently held that the threshold the Commissioner must surmount is very low, namely, 'whether the inspection sought might have thrown light upon' the correctness of the taxpayer's returns." Adamowicz, 531 F.3d at 158 (quoting United States v. Noall, 587 F.2d 123, 125 (2d Cir. 1978)). A court properly "defer[s] to the agency's appraisal of relevancy . . . so long as it is not obviously wrong." Mollison, 481 F.3d at 124 (internal quotation marks omitted). 

Here, the IRS agent conducting the 2008 audit has submitted a declaration explaining that information about the other transactions was necessary to determine how payments made in connection with a settlement agreement relate to the two transactions being investigated in the audit. Highland Capital has provided no reason for us to conclude that the IRS's appraisal of relevancy was "obviously wrong," and we accordingly find that Highland Capital has not satisfied its "heavy" burden to disprove this Powell factor. Mollison, 481 F.3d at 122-23, 124.

JAT Comment:  Basically, the agent said it was relevant to the tax investigation and the taxpayer did not show otherwise.  Obviously in a discovery context where the proponent of the discovery may not know the actual relevance of the documents requested, a broad standard of potential for relevance is required.

Reasonable Notice Pursuant to § 7602(c)(1)
We studied the requirement that, before contacting third persons in an audit, the IRS must give a taxpayer "reasonable notice in advance . . . that contacts with persons other than the taxpayer may be made."  This is often done in the initial correspondence opening the audit and is included the IRS Publication 1, Taxpayer Bill of Rights which contain a boilerplate notice.  Whether those opening salvos are enough is left for another day, because the IRS gave this taxpayer oral notice in a meeting.  Is oral notice the right way.  The Court does answer the question in a general sense, but says it worked here.

Privilege.

The taxpayer asserted that "the documents sought from Barclays may contain material subject to the attorney-client, work-product, or tax-practitioner privileges."  The IRS asserted that privilege was highly unlikely.  I think the IRS asserted that because the documents were transaction and third-party documents and, if legitimately in the possession of a third party, any privilege may have been waived.  Nevertheless, whether there was privileges that could be asserted was never determined by the district court. Hence the district court remanded for the documents to be submitted for in camera inspection with proper identification of the privileges asserted.

IRS Bad Faith

The Power standard requires that the IRS.  The taxpayer asserted bad faith.  The Court rejected the assertion as follows:

Courts will not enforce an IRS summons that is "issued for an improper purpose" or in bad faith. Adamowicz, 531 F.3d at 159-60 (quoting Powell, 379 U.S. at 58). To meet its "heavy" burden of quashing a subpoena for this reason, a taxpayer must allege "specific facts from which a court might infer a possibility of some wrongful conduct by the Government." Id. at 160 (emphasis deleted). 

Here, Highland Capital argues bad faith by reference to three specific allegations: (1) that the IRS contacted Barclays despite knowing of its "acrimonious relationship" with Highland Capital, in order to damage their relationship; (2) that the IRS breached several agreements regarding the scope and timing of its audits; and (3) that the IRS failed to communicate with Highland Capital regarding a Chief Counsel Advice request. The first allegation is unsupported by the record, which suggests only that the IRS preferred to seek documents from a more cooperative source. Highland Capital has "failed to show how" its second and third allegations are "tied to the summons[ ] at issue beyond the fact that they are loosely all part of the same tax investigation." Id.; cf. Appellant Br. 33 (denying the need to show any nexus between the summons and the IRS's improper conduct). The District Court found that Highland Capital failed to meet its burden, and we cannot say that it erred, much less committed clear error, in doing so. See Adamowicz, 531 F.3d at 160.

That's all.