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).

District Court Enforces Summons to Delaware Dept of Insurance for Micro-Captive Information (10/4/21)

The district court has enforced the IRS summons issued to the Delaware Department of Insurance (“DDOI”) for information and documents on about 200 micro-captive insurance companies that DDOI issued certificates of authority.  United States v. Del. Dep't of Ins., No. 20-829, 2021 U.S. Dist. LEXIS 186623 (D. Del. Sep. 29, 2021), CL here.  I previously wrote on the Magistrate’s Report and Recommendation (“Report”) to enforce the summons.  Magistrate Judge Recommends Enforcement of IRS Summons to Delaware Dept of Insurance for Information Filed by Micro-Captives (Federal Tax Procedure Blog 7/19/21), here.  Substantial portions of the district court’s Background are simply a copy and paste from the Magistrate’s Report.

DDOI raised arguments of error in the Magistrate’s Report related to the interpretation and application of the McCarran-Ferguson Act (“MFA”):

(1) by applying a “threshold test” of whether the conduct at issue constitutes the business of insurance for a non-antitrust case; and (2) by determining that the challenged conduct does not constitute the “business of insurance.” DDOI also argues that the Report erred by failing to recommend dismissal of the Petition on the grounds that the MFA reverse-preempted the Summons.

The resolution of this issue gets into arcana of the MFA, so I won’t delve into it here in detail.  In summary, the district court held that, in non-antitrust cases, there was a threshold requirement for MFA that the activity in question constitute the business of insurance.  In doing so, the district court has an interesting discussion of precedential authority in the Third Circuit regarding whether a subsequent panel opinion that seems inconsistent with an earlier panel precedential decision can reverse the earlier holding without en banc consideration.  The Court finds that, under Third Circuit, authority, the prior precedential opinion controls.  Interesting.

The district court also affirmed the Magistrate’s Report’s finding that the activity in question was record maintenance rather than insurance subject to MFA.

The district court then summarily rejected the DDOI argument for reverse preemption under the MFA.

Magistrate Judge Recommends Enforcement of IRS Summons to Delaware Dept of Insurance for Information Filed by Micro-Captives (7/19/21)

In United States v. Del. Dep't of Ins., Civil Action No. 20-829-MN-CJB, 2021 U.S. Dist. LEXIS 132716 (D. Del. July 16, 2021), here, the magistrate issued a Report and Recommendation that the IRS summons to the Delaware Department of  Insurance (“DDOI”) be enforced to compel production of documents related to “Artex Risk Solutions, Inc. (“Artex”), Tribeca Strategic Advisors, LLC (“Tribeca”) (which is owned by Artex) and others, in transactions involving micro-captive insurance plans.”  The summons “seeks information pertaining to approximately 200 insurance certificates of authority that DDOI issued to micro-captive insurance companies associated with Artex and Tribeca.”

Readers will recall that the routine for such petitions to enforce summons requires a rather minimal showing of need, called the Powell factors (United States v. Powell, 379 U.S. 48, 57-58 (1964)) as stated by the Court:

(1)  “that the investigation will be conducted pursuant to a legitimate purpose”; (2) “that the inquiry may be relevant to the purpose”; (3) “that the information sought is not already within the [IRS’] possession”; and (4) “that the administrative steps required by the Code have been followed.”

The Government handily met that Powell showing and DDOI failed to rebut it (as is usually the case for persons opposing IRS summonses).

The material dispute the Court resolved related to so-called reverse pre-emption.  The State insurance code provided secrecy protections to micro-captive insurance companies submitting documents and information to the DDOI.  Normally, the federal law permitting IRS summonses would pre-empt such a state law.  However, the McCarran-Ferguson Act (“MFA”) permits state statutes to trump federal law in certain circumstances.  The MFA reserves to the states the “regulation and taxation by the several States of the business of insurance.”  The statute, 15 U.S.C. §§ 1012(b), provides that

 (b) Federal regulation
No Act of Congress shall be construed to invalidate, impair, or supersede any law enacted by any State for the purpose of regulating the business of insurance, or which imposes a fee or tax upon such business, unless such Act specifically relates to the business of insurance: Provided, [t]hat . . . the Sherman Act, . . . the Clayton Act[] and . . . the Federal Trade Commission Act . . . shall be applicable to the business of insurance to the extent that such business is not regulated by State law.

The Court says (cleaned up):

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)

Is a Party Entitled to a Hearing in a Summons Enforcement Case Based Solely on Allegations of Improper Purpose? (12/13/13)

The United States has petitioned the Supreme Court in United States v. Clarke, 517 Fed. Appx. 689, 2013 U.S. App. LEXIS 7773 (11th Cir. 2013), here, an unpublished decision.  The Eleventh Circuit's opinion in Clarke is short and pithy, so I quote it all (except I omit the caption and two of the three footnotes):

This case involves the Internal Revenue Service's (IRS) issuance of five administrative summonses, pursuant to 26 U.S.C. § 7602, during an investigation into the tax liabilities of Dynamo Holdings Limited Partnership (Dynamo). Specifically, [List of summonsed parties omitted] appeal the district court's orders granting the IRS's petitions to enforce the summonses. After careful review of the record, and having had the benefit of oral argument, we vacate the district court's order enforcing the summonses and remand for the district court to hold a hearing. 

To obtain enforcement of a summons, the IRS must make a four-part 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 Code have been followed." United States v. Powell, 379 U.S. 48, 57-58, 85 S. Ct. 248, 13 L. Ed. 2d 112 (1964); see also Nero Trading, LLC v. U.S. Dep't of Treasury, IRS, 570 F.3d 1244, 1248 (11th Cir. 2009). Once the IRS makes its prima facie showing, the burden shifts to the party opposing the summons to either (1) disprove one of the four elements of the IRS's prima facie case, or (2) "convince the court that enforcement of the summons would constitute an abuse of the court's process." Nero, 570 F.3d at 1249 (internal quotation omitted). The Supreme Court has stated that because the district court's process is used to enforce a summons, the court should not permit its process to be abused by enforcing a summons that was issued for an improper purpose. See Powell, 379 U.S. at 58. According to the Powell Court, an improper purpose may include any purpose "reflecting on the good faith of the particular investigation." Id. 

In Powell, the Supreme Court also explained that a party opposing a summons is entitled to an adversary hearing before enforcement is ordered, and that, at the hearing, the opponent "may challenge the summons on any appropriate ground." Id. (internal quotation omitted). Subsequently, in United States v. Southeast First National Bank of Miami Springs, we held that "an allegation of improper purpose is sufficient to trigger a limited adversary hearing where the taxpayer may question IRS officials concerning the Service's reasons for issuing the summons." 655 F.2d 661, 667 (5th Cir. 1981) (footnote omitted). More recently, we have reaffirmed Southeast First National Bank, calling it "the legitimate offspring of the Supreme Court's seminal decision in Powell." Nero, 570 F.3d at 1249. 

Appellants contend they were entitled to discovery and an evidentiary hearing before the district court granted the IRS's petitions to enforce the summonses because they alleged the IRS may have issued and sought to enforce the summonses for at least four improper purposes.One of the reasons the IRS may have issued the summonses, according to Appellants, was solely in retribution for Dynamo's refusal to extend a statute of limitations deadline. Although Appellants raised the possibility of numerous improper purposes, federal pleading standards allow claims and defenses to be pled in the alternative, and do not require them to be consistent. See Fed. R. Civ. P. 8(d)(2) & (d)(3). If the IRS issued the summonses only to retaliate against Dynamo, that purpose "reflect[s] on the good faith of the particular investigation," and would be improper. See Powell, 379 U.S. at 58. 

Practitioner Warns of IRS Letters and Notices to Not Ignore (8/17/13)

Edward M. Robbins, Jr., a prominent tax litigator (see bio page here), has posted a good series of articles on six IRS Letters and Notices You Must Not Ignore.  The articles present a good summary of the problems encountered in ignoring these letters and notices; or, to state it differently, the reasons you should pay attention to these letters and notices.  This articles are on a blog sponsored by the law firm of Hochman, Salkin, Rettig, Toscher & Perez, P.C, here, which has a strong team in tax controversy matters. Readers might also want to review that firm's publications web site, here.

Ed's list is:

1. Statutory Notice of Deficiency (Ninety Day Letter).
2. Final Partnership Administrative Adjustment (FPAA) under TEFRA.
3. The IRS Summons (including an IRS caused Grand Jury Subpoena).
4. The Final Notice Before Levy.
5. Statutory Notice of Denial of a Claim for Refund.
6. Notice of Computational Adjustment under TEFRA.

The series of articles is:

1. Six IRS Letters and Notices You Must Not Ignore (Tax Controversy (Civil & Criminal) Report 7/7/13), here, addressing items 1 and 2 on his list.
2. Part II – Six IRS Letters and Notices You Must Not Ignore (Tax Controversy (Civil & Criminal) Report 8/5/13), here, addressing items 3 and 4 on his list.
3. I will post the link to the final article when he posts it.

Deja Vu All Over Again (1/24/13)

The U.K. Supreme Court held that "Advice by accountants cannot be kept secret in the same way that legal counsel is confidential."  See Estelle Shirbon, Tax advice not secret like legal counsel, UK court rules (Reuters 11/23/13), here.

I use the famous Yogi Berra quote (Wikipedia entry here) as the title of this article, but the U.S. has been through this fight before and reached the same result.

I offer the following on the U.S. rule from the most recent draft of my Federal Tax Procedure book (footnotes omitted):

The Courts have resisted expanding the common-law privileges that are available even when strong policy arguments are made that privileges should be available.  Courts thus routinely reject the existence of an accountant/client privilege even though one may exist under state law.  Couch v. United States, 409 U.S. 322 (1973).  In United States v. Arthur Young & Co., 465 U.S. 805 (1984), the IRS issued a summons to the taxpayer's independent certified public accountants to obtain the information and documents behind the tax reserve reported on the taxpayer's certified financial statements.

At this point, I should explain generally the jargon that helps explain the law and IRS policy and practice in this area.  Publicly held companies prepare and file public financial statements that report the financial results of their operations for a period.  The financial statements include a profit and loss statement for a period (a year period for the major filings), as well as an ending balance sheet, and extensive notes to assist in making the statements comprehensible.  In reporting a result for the period, a company must accrue liabilities that arose during the period and, on the ending balance sheet, must show any accrued but unpaid liabilities.  Under financial accounting standards, reserves for federal income tax liabilities must be accrued and reserved in certain cases.  Specifically, with respect to tax planning that might otherwise be reflected as a benefit on the financial statements, reserves must be accrued to reflect the probability that the benefits may not be ultimately sustained.  In making a decision whether and how much to reserve for such unpaid potential liabilities, a company internally will prepare workpapers that back up its decisions.  Similarly, when the independent auditor then attests the financial statements, the auditor prepares audit workpapers that back up the attestation.  The company’s and the auditor’s workpapers underlying that type of liability or reserve are called “tax accrual workpapers” or some variation of that term.  The tax accrual workpapers should be distinguished from the “tax reconciliation workpapers” which reconcile the financial reporting to the tax return.  The tax reconciliation workpapers are not audit workpapers, because they are not prepared by the company in making the financial statements or by the independent accountants in attesting them.

The IRS Administrative Summons as Pretext to Avoid the Need for a John Doe Summons (8/20/12)

I posted earlier today on my Federal Tax Crimes Blog a discussion of the John Doe Summons.  See The IRS Administrative Summons as Pretext to Avoid the Need for a John Doe Summons (8/20/12), here.  The topic of the discussion is a prominent part of the Federal Tax Procedure class.  I accordingly recommend that blog entry to readers of this blog, particularly students in my class.

The principal discussion of the IRS regular administrative summons and the John Doe Summons in the Federal Tax Procedure Book (2012 edition) at pp. 352-362 of the Footnoted version and 256-262 of the NonFootnoted Version.