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Supreme Court helps taxpayers challenge IRS summonses

A recent decision by the U.S. Supreme Court clarifies how taxpayers may challenge an IRS summons where the taxpayer claims the summons was issued for an improper purpose. A taxpayer has a right to conduct an examination of IRS officials regarding their reasons for issuing a summons when the taxpayer points to specific facts or circumstances plausibly raising an inference of bad faith, the Court held. The Court took a different approach than one adopted by the Eighth Circuit Court of Appeals, which had brought the case to the Supreme Court.

IRS summons power

The IRS has many tools in its investigative toolbox. One tool is the power to issue administrative summonses to taxpayers and third parties. The IRS may issue a summons to direct a taxpayer to testify or to produce certain documents. If a taxpayer or third party declines to comply with the summons, the IRS may ask a federal district court to enforce the summons.

The IRS must jump through several hoops to persuade a court to enforce a summons. The IRS must show that the summons was issued for a legitimate purpose, the IRS sought information not already in its possession, and the summons met all the administrative steps required by the Tax Code. Once the IRS makes its prima facie showing to enforce a summons, the burden shifts to the third party opposing the summons.

Like any power, there is the possibility that the summons power cab be abused and the courts have developed some protections for taxpayers. A court will not permit its process to be abused by enforcing a summons that was issued for an improper purpose. An improper purpose may include any purpose reflecting on the good faith of the investigation.

Clarke case

The case before the Supreme Court involved allegations of a summons issued for an improper purpose. The case began when the IRS investigated a partnership. The IRS issued summonses to third parties, seeking certain records related to the partnership and tax deductions it had claimed. One third party declined to give the IRS the records sought by the summons and the IRS asked a federal district court to enforce the summons.

Before the federal district court, the third party argued that the IRS had issued the summons for an improper purpose. One allegation the court noted was that the summons reflected retribution for the partnership’s refusal to extend the statute of limitations. The district court rejected the third party’s argument and he appealed to the Eleventh Circuit. There, he was successful.

The Eleventh Circuit found that the third party was entitled to a hearing to explore the allegation of improper purpose. The decision by the Eleventh Circuit created a split among the courts of appeal. Other circuits had taken a less expansive view of when a taxpayer would be entitled to a hearing when improper purpose is alleged. The IRS appealed to the Supreme Court, which agreed to review the case.

Supreme Court’s decision

The Supreme Court heard arguments on April 23, 2014 and announced its decision on June 19. Justice Kagan delivered the Court’s unanimous opinion. Justice Kagan explained that as part of the process concerning a summons’s validity, the taxpayer is entitled to examine an IRS agent when he can point to specific facts or circumstances plausibly raising an inference of bad faith. “Naked allegations of improper purpose are not enough: The taxpayer must offer some credible evidence supporting his charge,” Justice Kagan wrote.

When the Eleventh Circuit reviewed this case, it did not apply this standard, Justice Kagan wrote. “We have no doubt that the Court of Appeals viewed even bare allegations of improper purpose as entitling a summons objector to question IRS agents. The court applied a categorical rule, demanding the examination of IRS agents even when a taxpayer made only conclusory allegations,” Justice Kagan wrote. The Court vacated and remanded the case to the Eleventh Circuit with instructions to consider the taxpayer’s argument in light of the standard set by the Court.

If you have any questions about the Clarke case or the IRS’s summons power, please contact our office.

Clarke, SCt., June 19, 2014

If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

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