Supreme Court issues decision on IRS summons enforcement

On Thursday, the U.S. Supreme Court vacated and remanded a decision of the Eleventh Circuit, in which the appeals court held “that a bare allegation of improper purpose [in issuing a summons] … entitle[s] a taxpayer to examine IRS officials” (Clarke, No. 13-301 (U.S. 6/19/14),  slip op. at 1). Instead, the Court directed the Eleventh Circuit to consider on remand whether the taxpayer has “pointed to specific facts or circumstances that plausibly raise an inference of improper motive” (id.). The unanimous decision explained that every other court of appeals has rejected the Eleventh Circuit’s view.

The summons dispute arose in connection with an IRS examination of the tax returns of Dynamo Holdings Limited Partnership for 2005 to 2007, during which the IRS was focusing on large interest expenses for those years. Although Dynamo agreed twice to extend the statute of limitation during the exam, it refused the third request. After the refusal, the IRS issued summonses to four individuals who the IRS believed had information about Dynamo, none of whom complied with the summonses. The IRS also issued a final partnership administrative adjustment (FPAA), proposing changes to Dynamo’s tax returns for the years at issue. Dynamo challenged the FPAA in Tax Court, and that proceeding is still pending.

When the IRS issued a summons enforcement action in federal district court, Michael Clarke, who had been Dynamo’s chief financial officer, objected that the summonses were issued for improper purposes. The two improper purposes he alleged were that (1) the summonses were issued in retaliation for Dynamo’s refusal to extend the statute a third time and (2) they were issued, after Dynamo had filed suit in the Tax Court, to evade the Tax Court’s limits on discovery.

The district court rejected Clarke’s allegations, holding that his allegation that the summonses were issued in retaliation for the refusal to extend the statute of limitation was “mere conjecture,” and pointing out that the second theory failed as a matter of law because the validity of a summons must be tested when it is issued and Dynamo had not yet commenced its Tax Court case when the summons was issued. The Eleventh Circuit, however, reversed the district court and held that, under its precedent, “a simple ‘allegation of improper purpose,’ even if lacking any ‘factual support,’ entitles a taxpayer to ‘question IRS officials concerning the Service’s reasons for issuing the summons’” (Clarke, slip op. at 5 (citations omitted)). 

As the Supreme Court explained, the Eleventh Circuit’s holding was overbroad and conflicted with precedent in all the other circuits. The Court held that a taxpayer has a right to conduct an examination of IRS officials regarding their reasons for issuing a summons, but only when the taxpayer points to specific facts or circumstances plausibly raising an inference of bad faith. The Court explained that, “Naked allegations of improper purpose are not enough: The taxpayer must offer some credible evidence supporting his charge.” However, the Court further stated that circumstantial evidence can be used to meet this burden (Clarke, slip op at 6). 

In its remand order, the Supreme Court gave the Eleventh Circuit instructions on the deference it should give to the district court’s opinion in its reconsideration of the case. The Court explained that the district court’s decision was entitled to deference, but only if it is based on the correct legal standard, and that the district court’s latitude did not extend to “legal issues about what counts as an illicit motive” (Clarke, slip op. at 8).           

 —Sally P. Schreiber (sschreiber@aicpa.org) is a JofA senior editor.