Obtaining disclosure from the IRS - why it's important and how to do it.

• Author: Galotto, John A.

For most companies, dealing with the Internal Revenue Service during the typical examination keeps members of the tax function busy responding to and managing requests for information from the exam team. There is usually a one-way flow of information, with the exam team on the offensive and the tax department playing defense. There are, however, two well-known but relatively underutilized statutory tools that can help to level the playing field for the taxpayer. The Freedom of Information Act (FOIA) and section 6110 of the Internal Revenue Code can--and should--be used by taxpayers to obtain factual information critical to their case, to uncover the legal theories relied upon by IRS Exam and Appeals, and to understand the secret working law of the IRS that is being applied to them. Congress intended that FOIA and section 6110 be used for precisely these purposes, so taxpayers should not hesitate to use these statutory tools early and often.

This article outlines the policy, black-letter law, and procedural basics of FOIA and section 6110, discusses how taxpayers can benefit from the use of these disclosure devices, and identifies 10 important issues to consider when filing a FOIA or section 6110 request.

Transparency, Secret Law, and the IRS

"Secret law" is a form of information control routinely practiced by totalitarian regimes. (1) Yet even in democratic societies, usually as a result of large and unwieldy bureaucracies, secret law can thrive. This phenomenon is satirically described in Franz Kafka's The Trial, in which the protagonist is charged and tried for a capital offense, but is not told where the trial is occurring and can only get snippets of information regarding his trial from the government and church officials he seeks out. (2) In the United States, the explosion in the size of government in the 20th century resulted in a new "regulatory state" (3) in which secret law flourished; (4) federal agencies such as the Internal Revenue Service developed bodies of working law unknown to the public. (5) This was one of the problems that Congress intended to remedy when it passed the Freedom of Information Act in 1966. (6) In the 40 years since the FOIA was enacted, the IRS has been in continuous litigation seeking to shield its secret working law from disclosure. (7)

Today, the battles over IRS transparency continue. For example, the IRS continues to defend a so-called two-hour rule, which would hold that Chief Counsel legal advice otherwise required to be disclosed under section 6110(i) is exempt from such disclosure if the advice was prepared in less than two hours. This includes large volumes of emails sent from Chief Counsel attorneys in the National Office to the field, containing written legal advice relied upon by the field in determining what course of action to take in the exam. In upholding a challenge to this two-hour rule by Tax Analysts, the federal district court in the District of Columbia found that no "time to prepare" restriction existed in the statute and, moreover, the rule was irrational and arbitrary. (8) Undeterred, the IRS has appealed to the D.C. Circuit, and is attempting to raise a new argument not presented to the court below: Unless advice issued to the field by Chief Counsel attorneys has been reviewed and approved by management personnel, regardless of how long it took to prepare, it is not subject to disclosure under section 6110. If the court of appeals even considers this new argument, (9) it presumably will reject it for the same reason the trial court rejected the two-hour rule argument: There is no language in the statute referring to a management review process.

If the "two-hour rule" case is resolved in Tax Analysts' favor, it will be a great benefit to taxpayers and the system as a whole. What the IRS has characterized as "informal advice" guides exam teams and other IRS field personnel in the positions they take vis-a-vis the taxpayer. If taxpayers were privy to the same guidance, they would better understand the IRS's position and be better equipped to respond to it. Such transparency would increase the efficiency of the process and make it easier to resolve difficult issues during the examination.

Another taxpayer victory in the battle for IRS transparency occurred in the Black & Decker (10) case. In response to a discovery request from Black & Decker, the IRS inadvertently produced an unredacted copy of a field service advice memorandum (FSA) that contained information that had been redacted in the publicly available version of the FSA. What was revealed beneath the redactions was the type of legal advice and analysis required to be disclosed under section 6110(i). The government endeavored to retrieve the unredacted document from the taxpayer, arguing to the federal district court that the previously-redacted portion of the document was exempt from disclosure under the FOIA exemption for law enforcement records whose disclosure would interfere with enforcement proceedings. (11) The court rejected this argument, holding that the redacted information in question was "pure legal analysis ... an evaluation of pertinent statutory and case law;" in other words, it was precisely the type of Chief Counsel legal advice that is required to be disclosed under section 6110(i). The court also noted that the IRS released sections of analysis favorable to its interpretation in the "Law and Analysis" section of the FSA, yet chose to redact the counter-arguments that appeared in the "Case Development, Hazards and Other Considerations" section of the document. (12)

In response to this case, and under pressure from Tax Analysts (which filed a FOIA lawsuit seeking all previously-redacted FSAs), the IRS disclosed hundreds of pages of previously redacted FSA material. (13)

Lack of transparency by the IRS can be extremely prejudicial to tax professionals who are seeking to better manage business transactions and related tax planning efforts while anticipating potential challenges from the IRS. Without an understanding of the substantive law as applied by the agency, it is difficult to understand the rationale behind past IRS decisions or anticipate the reasoning to be applied by the agency in evaluating a particular position taken by a taxpayer. A prime illustration may be found in the IRS's procedures for evaluating a request for an Advance Pricing Agreement (APA). A congressional mandate exists to provide annual reports regarding APAs, so that taxpayers may better understand the criteria applied in accepting APA applications. (14) Despite the intent of Congress that such reports provide substantive guidance to taxpayers, including the transfer pricing methods used and how they were applied in the prior year, the reports contain little more than summary statistical information regarding the APA program.

The foregoing discussion demonstrates that the IRS is predisposed to resist disclosure of its internal documents and working law, and that many times disclosure can only be obtained by utilizing the tools provided in FOIA or section 6110.

The Origins of FOIA and Section 6110

Congress passed the Freedom of Information Act (FOIA) in 1966. (15) Congress enacted this legislation to require government agencies to promptly and efficiently process requests for government records by private parties, consistent with the belief that the American people have the right to know about the activities of their government. The goal of FOIA is to open the "administrative processes to the scrutiny of the press and general public" and prevent the development of a body of secret agency law that is inaccessible and incomprehensible to the public. (16) FOIA therefore requires federal agencies (the act does not apply to Congress or to state government entities) to make certain types of information publicly available for review and to make other records available to the public upon request. Congress has updated FOIA on occasion, most notably in 1996, when it passed several amendments governing how federal agencies handle requests for electronic records. (17)

Following the September 11 terrorist attacks, then-Attorney General John Ashcroft issued a statement that reversed the "presumption of disclosure" policy for responding to FOIA requests that had been instituted in 1993 during the Clinton Administration. (18) The Ashcroft Memorandum instituted a new standard whereby the government would aggressively assert privilege (particularly the deliberative process privilege) if available, and defend agency determinations to withhold documents except in cases where they lacked a "sound legal basis." (19) This new policy effectively lowered the bar for privilege determinations that the Department of Justice would be willing to litigate.

Like many other federal agencies, the IRS responded to the Ashcroft Memorandum by revising its own policy in an April 2004 statement. The revised policy statement provides that even when no prohibition exists for the disclosure of certain information, IRS personnel will utilize administrative discretion to determine if the information can be withheld on other grounds. (20) In April 2005, the IRS Office of the Chief Counsel issued a notice implementing this new policy, asserting that certain categories of documents would be withheld in all cases, barring extraordinary circumstances, under the deliberative process privilege. (21) These categories included documents related to the preparation of published guidance, agency statements of policy or interpretations of law, and documents discussing legal advice in non-docketed cases. Significantly, the Chief Counsel Notice also noted that documents pertaining to litigation that should be withheld included not only documents prepared by the Counsel attorneys, but also any...