In 2015 IRS began an investigation of Stanley Crow into penalties associated with his promotion of installment sale transactions. The IRS suspected the transactions were tax shelters subject to registration and disclosure requirements. At the start of the examination it sent Crow a Publication 1, Your Rights as a Taxpayer. That publication gives generic information about the audit process, and also informs taxpayers that the IRS may contact third parties during the course of an examination.
Prior to the Taxpayer First Act, under Section 7602(c)(1), enacted as part of the Restructuring and Reform Act of 1998, IRS was required to provide a taxpayer with “reasonable notice in advance” before it contacted financial institutions, employers or other third parties. Pre-TFA there was litigation as to what constituted reasonable advance notice. In many of the cases, the IRS argued that sending Publication 1, at the start of an exam sufficed for these purposes.
In JB v United States, which I discussed in Ninth Circuit Rejects IRS’s Approach to Notifying Taxpayers of Third Party Contacts, the Ninth Circuit held that sending the Publication 1 was insufficient notice, though it did not categorically hold Publication 1 can never constitute “reasonable notice in advance.” The court was skeptical though stating that it was “doubtful that Publication 1 alone will ever suffice to provide reasonable notice in advance to the taxpayer, as the statute requires.”
Shortly after JB v US, TFA did away with the squishy reasonable standard and requires the IRS to provide notice to the taxpayer at least 45 days before the beginning of the period of third-party contact, which may not extend longer than one year. In Keith’s post on the major tax procedural developments of 2019, he discusses the TFA change, and the earlier TAS legislative recommendations that highlighted the problems with the “reasonable advance notice” standard under pre TFA law.
Back to Vaught. The case involves an exam and third-party summonses that were issued in 2018 in connection with the IRS’s examination of Crow and his suspected shelter promotions activities. Two of the summonses were served on Steve Vaught and Alpha Lending, LLC, where Vaught was a key executive. Alpha had a business relationship with Crow, having served as a lender or escrow agent in the installment sales transactions Crow and his company promoted. Vaught/Alpha did not appear or produce the IRS’s requested records. The government filed a petition to enforce the summons, and Crow intervened in the case and filed a motion to quash based on an alleged violation of the advance notice requirements.
As I mention above, the summonses were issued before TFA, so the case involves the old reasonable advance notice standard. As the district court explained, in JB the Ninth Circuit added some meat to the reasonable notice standard:
[T]he Ninth Circuit held the phrase “reasonable notice in advance” means “notice reasonably calculated, under all the relevant circumstances, to apprise interested parties of the possibility that the IRS may contact third parties, and that affords interested parties a meaningful opportunity to resolve issues and volunteer information before third-party contacts are made.” 916 F.3d at 1164 (citing Flowers , 547 U.S. at 226). In so holding, the Ninth Circuit highlighted the purpose of the notice requirement is to protect the taxpayer’s reputational interest by giving the taxpayer an “opportunity to resolve issues and volunteer information before the IRS seeks information from third parties, which would be unnecessary if the relevant information is provided by the taxpayer himself.”
The JB standard requires district courts to examine the totality of the circumstances, “balancing of the interests of the State’ in administering an effective auditing system against the ‘individual interest’ in receiving notice of the potential third-party contact and an opportunity to respond.”
Crow challenged both related aspects of the notice requirement: that the IRS did not provide pre-contact notice and also that the IRS did not provide a reasonable meaningful opportunity to resolve issues and volunteer information before third-party contacts were made.
The government argued it did provide sufficient notice, pointing to the Pub 1 it sent at the start of the exam in November of 2015 as well as supposed oral communications between IRS agents and Crow in December of 2015. At that meeting IRS revenue agents purportedly said that they said that the IRS may contact third parties during the course of the examination of Crow.
The district court found that the IRS failed to satisfy the reasonable advance notice standard, emphasizing the time between the generic notice and the actual contact IRS made with the third party:
Here, the IRS issued the Vaught Summonses in January of 2018, twenty-six months after it sent Crow Publication 1 on November 17, 2015. Similarly, in J.B., two years elapsed between the date the IRS sent Publication 1 to the taxpayers and the date the IRS sought records from a third party. As in J.B , this Court cannot find the IRS satisfied its “administrative duty” of giving Crow a meaningful opportunity to provide relevant documents involving the Alpha Companies by generally informing Crow, over two years before, that it may “talk with other persons” in the course of its investigation
As to the purported oral communication from IRS agents failing to tip the scales toward reasonable notice, the court focused on the absence of specific information concerning the nature of the needed information in the agent’s affidavit:
Neither the Government’s brief, nor Allred’s affidavit, offer any details regarding what London and Allred said about potential third-party contacts on December 16, 2015….[T]he Government does not provide any specific information regarding how the IRS purportedly notified Crow of potential third-party contacts on December 16, 2015. For instance, what did London or Allred say about third-party contacts on this date? Did they reference any specific third parties or types of businesses they may contact if Crow did not provide information himself? Did they give any hint that Crow should produce documents involving the escrow companies or lenders that SCCC used in its installment sales transactions?
Taken together the court concluded that the IRS failed to provide reasonable advance notice. As the opinion notes, IRS could have done more to act consistently with Crow’s legitimate privacy interests. To that end, the opinion discusses (at Crow’s suggestion) steps the IRS could have taken, including renewing its request for information from Crow closer in time to the contact (which was over two years from both the generic notice IRS provided and revenue agent conversation) and specifying that it would contact third parties if Crow did not provide the information it wanted. As a final measure, the court noted that FOIA-obtained IRS case notes erroneously concluded that Alpha and Vaught were not third parties for purposes of the notice requirements. This suggested perhaps that the IRS did not provide additional notice because of the mistaken belief that the contacts did not trigger notice requirements.
The court ultimately concluded that the violation of the advance notice requirement meant that the IRS failed to satisfy the fourth Powell summons requirement, that the IRS follow all administrative requirements in the issuance of the summons. While Vaught involves pre TFA law, it is an important opinion in at least two respects. First, there may be summons enforcement cases still percolating under the pre TFA notice rules. Second, and perhaps more important, the opinion reflects a perspective that emphasizes that taxpayers have legitimate privacy and reputational interests. When there is the scent of shelters or allegedly improper taxpayer conduct at times IRS may fail to adequately weigh or even consider the interests of taxpayers. Vaught should serve as a reminder that privacy and reputational interests are at stake even when there is a taxpayer suspected of engaging or promoting aggressive transactions.
What are the next steps here? I have not dug into the filings but I assume that if the IRS has not received the information it could reissue the summonses, ensuring that it complies with post TFA notice requirements. Challenges to summons enforcement typically toll the SOL on assessment, so perhaps the taxpayer victory is short lived.