Today, the US Supreme Court held that a taxpayer has a right to conduct an examination of Internal Revenue Service (IRS) officials regarding their reasons for issuing a summons when the taxpayer points to specific facts or circumstances plausibly raising an inference of bad faith. United States v. Clarke, Sup. Ct. Slip Op. No. 13-301, rev’g United States v. Clarke, 517 Fed. App’x 689 (11th Cir. 2013).
In Clarke, the IRS had issued summonses to four individuals associated with a limited partnership that the IRS believed had information and records relevant to the tax obligations of the partnership and its partners. None of the individuals complied with those summonses. The IRS instituted proceedings in District Court to compel the individuals to comply with the summonses. The individuals challenged the summonses on the grounds that they were issued to punish the partnership for refusing to agree to additional extensions of the applicable statute of limitations and to evade the Tax Court’s limitations on discovery. They supplied some circumstantial evidence for these accusations. The District Court denied the individuals any opportunity to examine the IRS agents and ordered that the individuals comply with the summonses. The Eleventh Circuit reversed, holding that the individuals were entitled to an adversary hearing upon making allegations of improper purpose.
While the Supreme Court reversed the Eleventh Circuit, it did not give the government the victory for which it had hoped. The Court rejected the proposition that a taxpayer is always entitled to an evidentiary hearing based on a mere allegation of improper purpose. However, the Court emphasized that a taxpayer need only make “a showing of facts that give rise to a plausible inference of improper motive.” The Court specifically stated that “circumstantial evidence can suffice to meet” the taxpayer’s burden, and that direct evidence is not required. All that is required is “some credible evidence.” This is a setback to the government’s attempt to shield IRS agents from being cross-examined about potential IRS abuses. The opinion also undermines the government's position that the IRS can freely issue a summons in retaliation for failure to extend the statute of limitations or in order to circumvent discovery limitations in a Tax Court case. In its opinion, the Court opens the door for the Eleventh Circuit to address the question of what counts as an illicit motive as a legal issue for which the District Court is owed no deference. Under this decision, a summons issued under the Large Business and International (LB&I) information document requests enforcement process is susceptible to challenge. Under the LB&I enforcement process, the IRS recently created rigid deadlines for compliance with a document request issued in connection with a taxpayer audit. Directive LB&I-04-1113-009 (November 4, 2013). If a taxpayer can document that the IRS blindly followed that process without addressing reasonable taxpayer concerns, then this could raise a plausible inference of improper motive triggering an evidentiary hearing under Clarke, even without direct evidence of IRS abuse.