As taxpayers and politicians argue about the impact of additional IRS funding, the Supreme Court is taking a look at the rules for collecting financial and other information without notice to taxpayers.
Who is entitled to notice when the IRS seeks to track down the assets of delinquent taxpayers?
That’s the question that has landed in front of the Supreme Court in Polselli v. Internal Revenue Service.
At a time when some taxpayers and politicians are already concerned about billions in funding for stepped up IRS collection and enforcement activities—and what that might mean for related privacy issues—Polselli is raising questions about the IRS’ right to collect financial and other information without giving taxpayers notice that it’s happening.
Facts
The facts of the Polselli case are not in dispute. Remo Polselli underpaid his federal taxes for many years, resulting in an outstanding balance of more than $2 million. The IRS moved to collect, and eventually sought and was granted an order for Polselli to produce certain financial and business records.
Sometime later, the IRS still hadn’t been paid, so it issued administrative summonses to banks where Polselli’s wife, Hanna Karcho Polselli, and his lawyers had accounts. A summons is typically a demand to hand over specific information–in this case, financial records. The reason for the summonses, according to the IRS, is that the information they were requesting might help them collect what Remo had already been determined to owe.
The IRS did not notify Polselli’s wife or his lawyers about the summonses that were issued to the banks, relying on the exception in section 7609(c)(2)(D)(i) of the Tax Code, which excludes from the notice requirement summonses issued “in aid of the collection” of tax assessments.
IRS Seeks Assets
Here’s why that happened. According to court documents, during his investigation, IRS Revenue Officer Michael Bryant was led to believe that Remo “often uses other entities to shield his assets from the Internal Revenue Service.” Bryant also suspected that Remo might have access to and use bank accounts held in his wife’s name, suggesting that they might be the equivalent of nominee accounts. As a result, summonses were issued to several banks to collect information about accounts in Hanna’s name.
Bryant also learned, as part of his investigation, that Remo was a long-time client of the law firm Abraham & Rose, P.L.C. The IRS wanted to know how Remo had been paying the law firm, so Bryant served them with a summons. The law firm, in turn, claimed attorney-client privilege and also represented that the firm did not retain any of the documents that the IRS requested. To get around those issues, Bryant issued identical summonses against the banks where the law firm and a related law firm, Jerry R. Abraham, P.C., had accounts, seeking any financial records related to the law firms concerning Remo.
The IRS claims that the summonses were intended solely to locate assets to satisfy Remo’s “existing assessed federal tax liability, and not to determine additional federal tax liabilities.” The latter, of course, was a concern since Remo had previously been a target for his unpaid taxes for a period of several years.
The IRS did not tell Hanna Polselli or the law firm about the summonses—but the banks did. Once Hanna and the law firms found out, a flurry of petitions to quash–meaning void–the summonses followed, claiming that the IRS had failed to provide the required notice.
Legal Proceedings
The district court did not quash the summonses. Instead, the court concluded that under the plain language of the statute, Polselli’s wife and lawyers were not entitled to notice. Specifically, the court found “[t]hat section unequivocally provides that the IRS may summon the third-party recordkeeper of any person without notice to that person if (1) an assessment was made or a judgment was entered against a delinquent taxpayer and (2) the summons was issued “in aid of the collection” of that delinquency.”
The matter was appealed to the U.S. Court of Appeals for the Sixth Circuit, where it was affirmed, meaning that the Sixth Circuit agreed with the district court that notice was not required under the statute.
Supreme Court
So how did it end up at the Supreme Court? An earlier Ninth Circuit decision found that “when the IRS issues a summons to a third-party-recordkeeper, it must give notice to the person identified in the summons unless the delinquent taxpayer owns or has a similar legal interest in the summoned records.” In that case, Ip v. United States, the IRS summoned bank account information of a third party without notice to aid in its investigation of another taxpayer. Under the Ip rule, the IRS only need not issue notice when the assessed taxpayer has a recognizable legal interest in the summoned records. The Ninth Circuit rejected the premise that the IRS did not have to issue notice when issuing a summons for the records of a person who has no outstanding tax liability and who has no legal relationship with the assessed taxpayer.
That was a different result from this Sixth Circuit decision and a similar Seventh Circuit decision. The Supreme Court agreed to hear the matter to resolve the split.
Specific Notice
The argument before the court isn’t about whether notice is always required, but rather when an exception might apply. The tax code typically requires the IRS, when it serves a summons for records about a person “identified in the summons” to give that identified person notice. So, for example, if the IRS issues a summons directing a bank to produce an account holder’s records, it must generally notify the account holder. And under section 7609, that person is entitled to ask the court to quash the summons—the IRS may not examine the records before that legal process plays out.
The right of a taxpayer to intervene in IRS requests was codified when section 7609 was signed into law in 1976. It was intended to protect the public’s privacy interests by allowing taxpayers the right to challenge IRS summons. In 1982, the law was amended to allow taxpayers the right to seek to quash the summons.
The IRS doesn’t take issue with the general notice requirements but is, instead, focusing on an exception in the statute. That carve-out, they say, was the result of a concern by Congress that giving notice of a summons in some instances—when the IRS is trying to locate assets, for example—could result in the taxpayer moving those assets before the government could act. The additional language that was written into the statute was intended to prevent that result, the IRS argues, and means that they don’t have to provide notice of “any summons … issued in aid of the collection of (i) an assessment made or judgment rendered against the person with respect to whose liability the summons is issued; or (ii) the liability at law or in equity of any transferee or fiduciary of any person referred to in clause (i).”
The key words the government relies on: in aid of the collection.
The Sixth Circuit acknowledges that a notice requirement applies to many summonses issued in aid of IRS functions outside of collections. But, the Ninth Circuit decision, they reasoned, “overlooked the other functions of the IRS and read too much into Congress’s intent to notify taxpayers of third-party recordkeeper summonses.”
Balance Of Interests
Where is the balance between giving the IRS tools to collect delinquent taxes and protecting the privacy interests of innocent (third) parties? The district court noted that it was “sympathetic to worries that the IRS may be able to access information regarding blameless third parties without notice” but ultimately found that those “conjectural fears” did not defeat Congress’s prerogative to prioritize the IRS’s collection efforts over taxpayer privacy.
Oral Arguments
Oral arguments were heard on March 29, 2023, and lasted about 50 minutes. Shay Dvoretzky of Skadden, Arps, Slate, Meagher & Flom LLP argued for the petitioners. In his opening statement, he claimed that the IRS’ interpretation is inconsistent with the statute’s text, context, and purpose. It would, he said, create the same opportunity for abuse the Congress sought to eradicate. He argued, “The IRS says ‘trust us, we police ourselves’ but Congress repudiated that approach when it enacted Section 7609’s privacy protections for innocent third parties.” Instead, he claims that the interpretation held by the Sixth Circuit and the IRS would nullify most of what Congress intended.
When Dvoretzky mentioned limiting language, Justice Thomas asked him to clarify, eventually saying, “The only problem — the problem is that the limiting language that you’re asking about isn’t there.”
Ephraim McDowell, assistant to the solicitor general in the Department of Justice, argued on behalf of the IRS. He argued that the statute was already a compromise and disputed the petitioners’ claims that limitations are needed to impose a check on the IRS’s summons authority. “[M]ultiple other checks exist,” he said, “including the prospect of a challenge by the recipient of the third-party summonses.”
McDowell took issue with Dvoretzky’s characterization of an assessment as a “bookkeeping notation,” arguing that an assessment only happens “after a very long process” with opportunities to challenge and appeal liabilities. Towards the end of his time, Justice Kagan specifically asked McDowell to walk her through the process before the IRS makes an assessment. After his explanation, she noted, “So, at this point, we can say, if we’re going to be trusting courts at all, he owes money.”
McDowell replied, “Exactly. And I think that’s a critical point because the only time we’re in this situation, when this provision comes into play, is when there is someone who has adjudicated or assessed liability and he’s refusing to pay that liability and likely deliberately evading tax collection.”
Justice Sotomayor noted that “[t]here’s a whole lot about the IRS collection mechanism that has been criticized and continues to be criticized by the world, including me.” She later said that she could understand not giving the taxpayer notice because of concern that they might hide assets. But why, she wondered, would you impose secrecy on an innocent third party?
As part of his closing, McDowell commented that the “IRS has long faced a persistent problem of tax collection evasion.” He cited data from the IRS website about the tax gap, which estimated that between 2014 and 2016, there were $428 billion in uncollected taxes for each of those years.
“So we’re dealing with a very difficult problem,” he said, arguing that “Congress was acting against that backdrop” when it crafted the law. He closed by emphasizing that this law was aimed at those who “are refusing to pay those liabilities and likely deliberately evading the collection process.”
Dvoretzky countered, in his rebuttal, “I think everybody is agreeing here today that “in aid of collection” is not limitless, that it can’t just be a shot in the dark.”
If a limit exists under the statute, and what it might be, remains a question—at least until an opinion is issued.
You can read the transcript of the arguments here.
Looking Ahead
The Supreme Court is not expected to issue an opinion for months, but the arguments come at a crucial time for the IRS. Last year, the Inflation Reduction Act gave the IRS a significant boost—nearly $80 billion in additional funding over the next ten years. That amount has been criticized by those who fear it might increase audits and collections on lower-to-middle-income taxpayers, a move that Danny Werfel, the newly appointed IRS Commissioner, has promised to ensure doesn’t happen.
Still, there are concerns about potential heavy-handedness even from those who generally support additional funding. On March 30, 2023, the American Institute of CPAs, which has publicly advocated for “funding that supports an effective and efficient tax administrative system,” sent a letter to the Department of the Treasury and the IRS, again raising concerns about the allocation of funds between enforcement and service.