The IRS can generally satisfy the requirement of good faith in the issuance of a summons through a simple Powell affidavit completed by the investigating agent. This does not mean, however, that discussion regarding the validity of the summons necessarily ends there.
In 2014, the U.S. Supreme Court held in U.S. v. Clarke, 134 S.Ct. 2361 (2014) that a taxpayer has the right to challenge the motive for a summons and to question the IRS officials who issued it in an adversarial enforcement proceeding. However, the taxpayer must raise a “substantial question” by pointing to specific facts or circumstances that raise an inference of bad faith on the part of the IRS. A mere allegation of improper purpose in issuing the summons is not enough.
The Clarke Case
Suspicious of some large interest expenses reported on the 2005-2007 tax returns of Dynamo Holdings Limited Partnership (Dynamo), the IRS commenced a lengthy investigation. Towards the end of the 3-year statute of limitations period for assessing tax liability, Dynamo agreed to a year-long extension, and agreed to a second extension the following year. The company refused a third request. Shortly thereafter, the IRS issued summonses to four people who were associated with the company (the “respondents”) for the production of Dynamo records relating to the company’s tax obligations that the IRS believed were in their possession. None of the respondents complied with the summonses. In the meantime (and within the limitations period) the IRS issued Dynamo’s Final Partnership Administrative Adjustment. In February of 2011, Dynamo filed suit in the U.S. Tax Court challenging it. Two months later, the IRS brought an enforcement action in district court to compel the respondents to comply with the summonses.
In District Court, the IRS submitted an affidavit attesting to its good faith under the Powell requirements. The respondents, on the other hand, claimed that the IRS issued the summonses in retaliation for Dynamo refusing the IRS’ third request for an extension of the limitations period, and that the IRS was attempting to evade the Tax Court’s time limitations on the discovery process. They claimed that another taxpayer who complied with a summons was interviewed by IRS attorneys handling the Tax Court case and not by the IRS investigating agents, thus indicating a third ulterior motive on the part of the IRS – that of gaining unfair advantage in a subsequent Tax Court proceeding. The district court denied the respondent’s request to question the IRS agents regarding their motives, stating that it was “mere conjecture,” and ordered enforcement of the summonses.
The Court of Appeals for the Eleventh Circuit vacated and remanded the case. It held that even if lacking factual support, an allegation of improper purpose entitles a taxpayer to question IRS officials as to their reasons for issuing the summons. The Supreme Court disagreed, ruling that in order to prevent taxpayers from engaging in a fishing expedition as to the motives of government officials, the court must assess whether the taxpayer has presented facts that support a plausible inference of improper motive. It clarified that although a bare allegation of improper motive is insufficient, a fully “fleshed out case” is not required either, since such direct evidence is generally not available at such an early stage of a case. Circumstantial evidence is enough.
The significance of Clarke
The Supreme Court never discussed whether or not a summons issued for the sole purposes of retaliation against a taxpayer or to circumvent tax court discovery procedures would satisfy its “plausible inference of improper motive” requirement. Although no specific standard was provided, this case is important for clarifying that a taxpayer is entitled to a hearing to examine an IRS investigator’s motive for issuing a summons.
This June 2014 decision was a victory for taxpayers, whose previous requests for evidentiary hearings were rarely granted. The IRS must now make greater efforts to avoid requests for these hearings by ensuring that its summonses do not appear to have been issued for any improper purpose.
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