Analysis of and reflections on recent cases and rulings.

• Author: Beavers, James A.
• Position: Tax trends

Procedure & Administration

Taxpayers Not Entitled to Question IRS Officials About Summonses

The Supreme Court held that a taxpayer is entitled to question IRS officials about the reasons the IRS issued a summons only if the taxpayer points to specific facts and circumstances that plausibly raise an inference of bad faith on the part of the IRS.

Background

Suspicious about large interest expenses claimed in 2005 through 2007 by Dynamo Holdings Limited Partnership (Dynamo), the IRS initiated an examination of the partnership's returns for those years. As the investigation proceeded, Dynamo agreed to two yearlong extensions of the usual three-year limitation period for assessing tax liability. In 2010, with the second extension period drawing to a close, Dynamo refused to grant the IRS a third extension. Shortly afterward, the IRS issued summonses to four individuals associated with Dynamo (the taxpayers) who the IRS believed had information and records relevant to Dynamo's tax obligations. None of the taxpayers complied with the summonses. In December 2010 (still within the extended limitation period), the IRS issued a final partnership administrative adjustment proposing changes to Dynamo's returns that would result in greater tax liability. Dynamo filed a suit (which is currently pending) in February 2011 in Tax Court to challenge the adjustments. In April 2011, the IRS filed suit in district court to compel the taxpayers to comply with the summonses.

Those enforcement proceedings developed into a dispute about the IRS's reasons for issuing the summonses. The IRS submitted an affidavit from the Service's investigating agent stating that (1) the summonses met the factors from Powell, 379 U.S. 48 (1964), among other things; (2) the testimony and records sought were necessary to properly investigate the correctness of Dynamo's federal tax reporting; and (3) the summonses were not issued to harass or for any other improper purpose.

The taxpayers claimed the IRS had two ulterior motives for issuing the summonses: (1) to punish Dynamo for refusing to agree to a further extension of the applicable statute of limitation and (2) to evade the Tax Court's limitations on discovery and thus gain an unfair advantage in that litigation.

As evidence of the first motive, the taxpayers pointed out that although the IRS had not asked for information in its investigation for some time, it suddenly issued the summonses immediately after Dynamo refused to grant a third extension. As evidence of the second motive, the taxpayers introduced an affidavit of one of their attorneys, who reported that the attorneys handling the Tax Court case, and not the original investigating agents, were present at the interview of his client. In light of this evidence, the taxpayers asked for an opportunity to question the agents about their motives.

The district court denied that request and ordered the taxpayers to comply with the summonses, finding that they "ha[d] made no meaningful allegations of improper purpose" warranting examination of IRS agents and that their statute-of-limitation theory was mere conjecture. The district court further determined that the respondents' evasion-of-discovery-limits claim was incorrect as a matter of law because the validity of a summons is tested as of the date of...