On February 26, 2019, in J.B. v. United States, the U.S. Court of Appeals for the Ninth Circuit upheld a taxpayer’s challenge to a third-party summons and held that IRS Publication 1 did not provide the taxpayers with reasonable advance notice to satisfy the requirements of section 7602(c)(1) because “a reasonable notice must provide the taxpayer with a meaningful opportunity to volunteer records on his own, so that third-party contacts may be avoided if the taxpayer complies with the IRS’s demand.” The circuit court affirmed the district court's decision that held that “the advance notice procedure cannot be satisfied by the transmission of a publication about the audit process generally.” J.B. is a significant taxpayer victory and is a notable exception to a line of cases where courts have held that IRS Publication 1 satisfied the pre-contact notice requirement.

Background and Procedural History

On July 25, 2013, the taxpayers received a letter in the mail from the IRS, indicating that they had been selected at random for a compliance research examination. The IRS letter instructed the taxpayers to contact a revenue agent at the IRS to discuss items on their 2011 tax return, as well as the “examination process.” In the same mailing, the IRS enclosed a two-page notice entitled “Your Rights as a Taxpayer.” The IRS refers to this notice as “Publication 1” or “The Taxpayer Bill of Rights.” On the second page of the notice, under a heading entitled “Potential Third Party Contacts,” the notice warns:

Generally, the IRS will deal directly with you or your duly authorized representative. However, we sometimes talk with other persons if we need information that you have been unable to provide, or to verify information we have received. If we do contact other persons, such as a neighbor, bank, employer, or employees, we will generally need to tell them limited information, such as your name. ... Our need to contact other persons may continue as long as there is activity in your case. If we do contact other persons, you have a right to request a list of those contacted.

Two months later, in September 2013, the IRS requested documents. The taxpayers asked the IRS to excuse them from the audit because of poor health and the couple’s advanced age. The IRS refused the couple’s request for an exemption, leading the taxpayers to file a separate suit to stop the audit in the Northern District of California in May 2015.

After filing suit, the IRS continued with its audit. In September 2015, the IRS issued a summons to the California Supreme Court seeking “copies of billing statements, invoices, or other documents ... that resulted in payment to” the taxpayers for the 2011 calendar year. The second page of the four-page summons warned that the IRS had the power to “enforce obedience to the requirements of the summons and to punish such person for his default or disobedience.” The penalties for noncompliance included a fine of “not more than $1,000” or imprisonment “not more than 1 year, or both, together with costs of prosecution.”

The taxpayers did not learn that the IRS had issued the summons until after-the-fact, when the taxpayer’s daughter, whom they had listed as a personal representative, received a notice of service of summons in the mail. In October 2015, the couple filed a petition to quash the summons in the Northern District of California.

The district court evaluated the taxpayers’ petition under United States v. Powell,which sets forth four requirements that the IRS must satisfy to enforce an administrative summons. Under Powell, the IRS must establish a prima facie case of good faith by showing that: (1) the underlying investigation is for a legitimate purpose, (2) the inquiry requested is relevant to that purpose, (3) the information sought is not already in the government’s possession, and (4) the IRS followed the administrative requirements of the Internal Revenue Code.

The district court concluded that the government had not satisfied the last Powell step. The IRS, it concluded, had not provided sufficient notice to the taxpayers that it would contact the California Supreme Court, in violation of section 7602(c)(1)’s requirement that the IRS provide “reasonable notice in advance” to the taxpayer. The district court rejected the IRS’s argument that IRS Publication 1 provided sufficient advance notice, and instead concluded that “the advance notice procedure cannot be satisfied by the transmission of a publication about the audit process generally.” It then instructed that “advance notice should be specific to a particular third party,” reasoning that “the implementing regulations contemplate notice for each contact, not a generic publication’s reference that the IRS may talk to third parties throughout the course of an investigation.” The IRS appealed to the Ninth Circuit Court of Appeals.

Analysis

On review, the Ninth Circuit affirmed. The court acknowledged that section 7602(c) specifically prohibits third-party contacts unless advance reasonable notice is given to the taxpayer. The statute specifically provides:

(c) Notice of contact of third parties.—

(1) General notice.—An officer or employee of the Internal Revenue Service may not contact any person other than the taxpayer with respect to the determination or collection of the tax liability of such taxpayer without providing reasonable notice in advance to the taxpayer that contacts with persons other than the taxpayer may be made.

(2) Notice of specific contacts.—The Secretary shall periodically provide to a taxpayer a record of persons contacted during such period by the Secretary with respect to the determination or collection of the tax liability of such taxpayer. Such record shall also be provided upon request of the taxpayer.

(3) Exceptions.—This subsection shall not apply –

(A) to any contact which the taxpayer has authorized;

(B) if the Secretary determines for good cause shown that such notice would jeopardize collection of any tax or such notice may involve reprisal against any person; or

(C) with respect to any pending criminal investigation.

The Ninth Circuit first looked to the meaning of the phrase “reasonable notice in advance” and concluded that the phrase in section 7602(c)(1) is not ambiguous. The Supreme Court has interpreted “notice” to mean “notice reasonably calculated, under all circumstances, to apprise interested parties” and “afford them an opportunity to present their objections.”

The court found that its interpretation of the phrase “reasonable notice in advance” is supported by the “specific context in which that language is used, and the broader context of the statute as a whole.”“Section 7602(a) allows the IRS to disclose information ‘[f]or the purpose of ascertaining the correctness of any return, making a return where none has been made, determining the liability of any person ... or collecting any such liability,’ I.R.C. § 7602(a), while § 7602(c) protects the taxpayer from unnecessary third-party contacts. As an exception to the general rule that taxpayer records are to be kept confidential, we construe § 7602(a) narrowly in favor of the taxpayer and § 7602(c) broadly as a protective measure.” Moreover, section 7602(c)(1) protects the taxpayer’s reputational interest, because it gives the taxpayer a meaningful opportunity to resolve issues and volunteer information before the IRS seeks information from third parties, which would be unnecessary if the relevant information is provided by the taxpayer himself.

The IRS argued that section 7602(c)(1) cannot require the IRS to provide advance notice “specific to a particular third party,” as the district court held, because that would render superfluous the post-contact notice provision, section 7602(c)(2), which requires the IRS to provide the taxpayer with a “record of persons contacted” after the contact is made. The Ninth Circuit rejected this claim for two reasons. First, the court did not interpret the statute to require the IRS to provide the taxpayer with a list of the people it may contact in advance. Rather, the court held that the statute requires reasonable notice in advance. What is reasonable depends on the facts. Second, the court said that “even if we required the IRS to provide the taxpayer with a list of people it may contact in advance, the IRS’s argument nonetheless fails because the group of people covered by the advance notice provision, I.R.C. § 7602(c)(1), is larger than the group of people covered by the post-contact notice provision, I.R.C. § 7602(c)(2).” The court concluded that “[b]ecause § 7602(c)(2) covers a different group of contacts, serves a different purpose than § 7602(c)(1), and has its own place in a comprehensive statutory scheme, interpreting § 7602(c)(1) as we do here does not render § 7602(c)(2) superfluous.”

In addition, the court concluded that the timeline for the development of Publication 1 and related forms of notice further illustrates the implausibility of the IRS’s insistence that Publication 1 provides “reasonable notice in advance” in all circumstances. Citing to out-of-circuit district court decisions, the IRS argued that the district court’s decision in this case was an outlier because every court to have considered the issue has held that IRS Publication 1 satisfied the pre-contact notice requirement. But the Ninth Circuit stated that “while courts have generally approved of Publication 1, several courts have recognized that § 7602(c)(1) requires a context-dependent inquiry, and have upheld Publication 1 only after evaluating the totality of the circumstances to determine whether the taxpayer received reasonable notice.” However, the court recognized that one result of adopting a context-specific rule may be to make it more difficult for IRS officers, and district courts, to determine whether section 7602(c)(1)’s advance notice requirement is satisfied in any given case. But, the court concluded that to the extent such an administrative problem develops, the responsibility lies with Congress, not the courts. The court could not “ignore the text of a statute that hinges the adequacy of notice on a determination of reasonableness. Nor could the court ignore the congressional mandate to provide taxpayers faced with a potential third-party summons with a meaningful opportunity to respond with the relevant information themselves so as to maintain their privacy and avoid the potential embarrassment of IRS contact with third parties, such as their employers.”

According, the Ninth Circuit held that Publication 1 did not provide the taxpayers with reasonable advance notice because a reasonable notice must provide the taxpayer with a meaningful opportunity to volunteer records on his own, so that third-party contacts may be avoided if the taxpayer complies with the IRS’s demand.