Opinion analysis: Court clarifies standard for evidentiary hearing in enforcement of IRS summons
The Supreme Court on June 19 unanimously vacated and remanded an Eleventh Circuit per curiam decision in United States v. Clarke. The Eleventh Circuit had reversed a district court refusal to grant a summons recipient an evidentiary hearing to challenge an IRS summons. The Supreme Court emphasized the abuse of discretion standard applicable to the review of the district court’s decision and clarified the standard that the district court itself should apply. It explained that “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.” The decision leaves open an underlying legal question in the case: whether improper purpose can follow from the issuance of a summons in retaliation for refusal to extend a statute of limitations and/or in anticipation of a not-yet-filed Tax Court suit.
As is typical, the IRS supported its summons request in this case by submitting an affidavit from the investigating agent attesting to the factors described in United States v. Powell. These factors require that a summons is issued for a legitimate purpose, seeks relevant information not yet in the government’s possession, and satisfies required administrative procedures. Federal district courts have authority to enforce a summons, which taxpayers may challenge, including by alleging improper purpose.
In this case, associates of Dynamo Holdings Limited Partnership (“Dynamo”) received summonses in September and October 2010, toward the end of a twice-extended statute of limitations period. In December 2010, the IRS issued a final notice of adjustment. In February 2011, Dynamo challenged the final notice in Tax Court, in a case not yet resolved.
The recipients – the respondents in the Supreme Court – challenged the summonses on grounds of improper purpose. They alleged that improper purpose could be inferred from the rapid issuance of the summonses soon after Dynamo refused to extend the statute of limitations a third time. They also alleged that the summonses were intended to circumvent tighter discovery rules applicable in Tax Court litigation.
The district court concluded that the allegations were not sufficiently persuasive to require an evidentiary hearing. The Eleventh Circuit reversed in a short opinion with virtually no analysis. Although the Eleventh Circuit opinion may have been grounded in the facts of the case, it included language that could be read to mean that the Eleventh Circuit would require an evidentiary hearing when presented with no more than “a bare allegation of improper motive.” The Court recognized that such an approach could eviscerate the summons tool that “is a crucial backstop in a tax system based on self-reporting.”
The Court’s opinion rejects the idea that a “bare allegation” is enough to require an evidentiary hearing. It also reminds appellate courts that an abuse of discretion standard applies for review of a district court decision responding to a challenge to an IRS summons. An appellate court that reverses a district court’s decision on the matter must supply analysis; the Court was not satisfied with the Eleventh Circuit’s apparent application of a “categorical rule” without explanation.
As anticipated at oral argument, the Court’s decision offers guidance on the legal framework to be applied by district courts and reviewed by appellate courts in such cases. It states the rule that “As part of the adversarial 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.” “[C]redible evidence” is required, but it may be “circumstantial.”
Finally, the Court reminds district courts that they may not decide “legal issues about what counts as an illicit motive” in the course of deciding whether to enforce a summons. In particular, the Court explicitly leaves open the underlying legal question of whether improper purpose can derive from the issuance of a summons in retaliation for refusal to extend a statute of limitations and/or in anticipation of a not-yet-filed Tax Court suit. Depending on the fate of this case on remand, the lower courts may have an opportunity to further develop the law on one or both of these issues.