4th Circuit Holds the Tax Partnership Receiving an Administrative Summons is Different Than its Representative for Purposes of § 7602(d) (7/9/22; 7/12/22)

In Equity Inv. Assocs., LLC v. United States, 40 F.4th 156 (4th Cir. July 8, 2022), CA 4 here and GS here, the Court held that, for purposes of the § 7602(d) limitation on IRS administrative summonses after a criminal referral to DOJ, the person investigated for whose records a third party (bank) was summonsed (in this case a syndicated conservation easement tax partnership) is not the same as a related person (the partnership representative under 26 C.F.R. §§ 301.6223-1) who was under criminal referral, at least in part arising from the same set of facts. See the discussion at Slip Op. 8-11 under the heading “A. “Person” in § 7602(d) does not include a legal person's agents.”  The Court rejects the suggestion that anything other than an actual referral of the person to whom the summons is issued will meet the terms of the statutory limitation. See Slip Op. 11-14, saying at Slip Op. 12:.

            Equity [the summonsed tax partnership] must show evidence that a referral existed before the IRS summons, because the IRS can generally use its summons power to further a criminal investigation. § 7602(b). The summons power only ends “at the point where an investigation was referred to the Justice Department for prosecution.” United States v. Morgan, 761 F.2d 1009, 1012 (4th Cir. 1985). And a Justice Department referral is not simply some generalized suspicion of criminal activity, but a specific procedural mechanism used to share information. Id. (describing a Justice Department referral as a “mechanical test”).

These are pretty straightforward holdings that I am surprised were seriously disputed.  Hence, I think they require no further discussion for the prototypical reader of this blog (as I imagine that reader). But I note that the court makes some statements in the opinion that on their face seem noteworthy or curious. I will just list them without further comment:

 1. Slip Op. 2 n1:

   n1 The IRS has broad powers to investigate criminal tax fraud, but it lacks the power to prosecute tax fraud. So if an IRS criminal investigation discovers evidence of criminal activity, the IRS must refer the case to the Justice Department for prosecution. Once referred, the IRS typically plays a continued role in investigating and prosecuting the case.

2. Explaining how the tax partnership inflates the value of the donated easement (Slip Op. 3 n3):

   n3 This inflation is possible because the easement's value is often not calculated based on the land's recent purchase price but based on the value of its highest and best use. See PBBM-Rose Hill, Ltd. v. Comm'r, 900 F.3d 193, 209 (5th Cir. 2018). So the limit on the valuation is little more than the imagination of the appraiser (who may be in on the scheme), tempered only by the fear of an audit. See generally Mary Clark, Greedy Giving, Bad for Business: Examining Problems with Arbitrary Standards in Appraising Conservation Easements, 51 U. Mem. L. Rev. 479 (2021).

3. On the syndication feature of the abusive syndication easement tax partnerships (Slip Op. 3 n4):

   n4 The other aspect of the fraudulent scheme is the “syndication.” The charitable-donation tax deduction is non-transferrable. So, to provide the deductions to wealthy people who can use them, fraudsters sell them shares in a partnership, which makes the easement donation and passes the corresponding deduction through to its members. While a partnership may pass through tax benefits, a partnership with no “economic substance” that serves only to disburse tax benefits is a sham. See Superior Trading, LLC v. C.I.R., 728 F.3d 676, 680 (7th Cir. 2013) (“If the only aim and effect are to beat taxes, the partnership is disregarded for tax purposes.”); see also I.R.C. § 7701(o); Black & Decker Corp. v. United States, 436 F.3d 431, 440–41 (4th Cir. 2006) (describing the economic substance rule). Given the prevalence of sham partnerships and fraudulent appraisals, the IRS demands that many syndicated conservation easements must be reported to the IRS. See IRS Notice 2017-10, 2017-4 I.R.B. 522, 544; I.R.C. §§ 6662A, 6707A.

4. Of particular interest to nitpickers, after reciting the Powell factors, the Court says that the § 7602(d) limitation is an additional constraint beyond the Powell factors (Slip Op. 7 n6):

   n7 The district court analyzed Equity's argument under § 7602(d)(1) as a challenge to the fourth Powell factor that the government did not follow “the administrative steps required by the code.” J.A. 266–67. But the Supreme Court has made clear that § 7602(d) is “an additional constraint on the issuance of summons” beyond the four Powell factors. United States v. Stuart, 489 U.S. 353, 361 (1989) (discussing I.R.C. § 7602(c)(1994), which was redesignated as I.R.C. § 7602(d) by the Internal Revenue Service Restructuring and Reform Act of 1998, Pub. L. No. 105-206, § 3417, 112 Stat. 685, 757); see High Desert Relief, Inc. v. United States, 917 F.3d 1170, 1182 n.5 (10th Cir. 2019) (holding that § 7602(d) is an “analytically distinct issue”). Even so, the evidentiary burdens and framework are the same no matter if the challenge is to the Powell factors or under § 7602(d). See Stuart, 489 U.S. at 360–61 (holding that the government's burden under § 7602(d) was satisfied by an IRS agent's affidavit).

Added 7/12/22 11:00 am: 

5.  Readers interested in this subject should read Leslie Book, Circuit Court Holds That LLC Distinct From Its Agent For Purposes of Criminal Referral Exception To Summons Power (Procedurally Taxing Blog 7/12/22), here.

6.  I revised the opening paragraph to indicate that the administrative summons was to the tax partnership's bank rather than the partnership itself.  That correction makes no difference to the ultimate holding that the taxpayer investigated is not the same as an agent of the taxpayer investigated for purpose of § 7602(d) limitation. 

7. The IRS's and DOJ Tax's public focus has been on syndicated conservation easements.  (See par. 3 above.)  Like many abusive tax shelters, the real abuse (here significant overvaluations) appears in non-syndicated contexts.  And their counterpart in significant undervaluations where undervaluations produce tax benefits appear in nonsyndicated contexts.  Syndicated abusive transactions are widely promoted and thus more likely to catch the attention of the IRS.