Quashing an IRS Summons: Supreme Court Addresses the Notice Requirements

Brian J. McKenna

Brian J. McKenna is an attorney and CPA on the faculty at Governors State University in University Park, Illinois.

In this article, McKenna reviews the arguments in Polselli, the pending Supreme Court case regarding a circuit split on whether the section 7609 exception for notice requirements permits the IRS to execute a no-notice summons.

Introduction

On December 9, 2022, the U.S. Supreme Court granted a writ of certiorari in the case of Polselli¹ agreeing to resolve a split in the circuits on whether the exception in section 7609(c)(2)(D)(i) to the notice requirements for an IRS summons on third-party recordkeepers applies only when the delinquent taxpayer has a legal interest in the summonsed records. In Polselli, the IRS issued a summons for the bank records of a law firm seeking information regarding the source of the funds provided by the delinquent taxpayer. The Sixth Circuit held that the law firm was not entitled to notice and, therefore, had no opportunity to challenge the validity of the summons.² In a prior case, the Ninth Circuit held in Ip³ that a fiancée was entitled to notice when her corporate bank records were summoned by the IRS in an effort to trace the source of funds by the delinquent taxpayer. This article explores the arguments made by the parties and amici in the Polselli case.

The Polselli Summons

The IRS has authority to issue a summons to enforce the provisions of the Internal Revenue Code.⁴ The IRS may summons information from a third-party recordkeeper.⁵ Section 7609(a)(1) establishes special procedures for such summonses. The IRS must give notice of the summons to the person identified in the summons within three days of the service on the third-party recordkeeper and not less than 23 days before the date of record examination. Also, the notice must advise the person identified in the summons of the right to quash the summons.⁶ For example, if the IRS issues a summons directing a bank to produce an account holder’s records, it must notify the account holder, who then has the right to petition a federal district court⁷ within 20 days⁸ to quash the summons. There are several exceptions to the broad notice requirement.⁹

Section 7609(c)(2)(D) establishes one of the exceptions to the notice requirement. The IRS does not need to notify the person identified in a summons when it is 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).

When the exception applies, the person identified in the summons is not given notice and has no right to petition to quash. The rationale for this exception lies in the fact that, at the collection stage,¹⁰ the IRS is concerned that any notice will give the account holder an opportunity to move assets and defeat collection efforts.¹¹ Congress was concerned that notice during the collection phase might allow the delinquent taxpayer to use the litigation delay “to withdraw the money in [their] account, thus frustrating the collection activity of the Service.”¹²

The IRS has been trying to collect unpaid individual income taxes and trust fund recovery penalties of more than $2 million from Remo Polselli for multiple tax years as far back as 2005. To collect this money, the IRS initiated an investigation to locate assets that might be applied against the liability. The IRS learned that Polselli and his wife, Hanna, have had extensive business holdings. The IRS believed that Hanna might have served as a nominee or alter ego for Remo.

Also, the IRS learned that Remo Polselli was a longtime client of petitioner Abraham and Rose PLC, a law firm, and that he had previously used third-party entities to control assets while shielding them from collection. In 2018 Polselli remitted approximately $290,000 toward his tax liabilities using a check drawn on an account of a management company rather than an account in his own name. The IRS determined that it would aid in its tax collection efforts to obtain records disclosing (1) the source of funds that Polselli used to pay Abraham and Rose, (2) the bank accounts used by Polselli, the entities in which Polselli either had an ownership interest in or exerted control over funds, and the bank accounts associated with those entities.

An IRS revenue officer initially issued a summons under section 7602(a) to Abraham and Rose, seeking documents concerning Remo Polselli’s payments to the firm. The firm answered that it did not have any responsive documents that might shed light on how Polselli had paid the firm for its services. Later Abraham and Rose failed to make a representative available to participate in an interview under oath about its efforts to comply with the summons. The revenue officer then issued summonses to three banks — Wells Fargo (Hanna’s accounts), JP Morgan Chase, and Bank of America (law firm accounts) — seeking over two years of bank records on accounts used by Hanna Polselli and the law firm of Abraham and Rose in an effort to trace the source of funds that might be attributable to Remo Polselli.

The three banks notified Abraham and Rose. The IRS offered Abraham and Rose an opportunity to inspect the records before production to ensure that only records relevant to Remo Polselli were produced. Abraham and Rose declined this opportunity to make a preproduction review, instead filing a petition to quash the summonses in the federal district court. The petition was denied.¹³ Abraham and Rose appealed to the Sixth Circuit and the appellate court upheld the district court.¹⁴ Abraham and Rose sought a writ of certiorari from the Supreme Court, which was granted December 9, 2022.¹⁵

Section 7609: Statutory Construction

In 1976, after two Supreme Court decisions left few checks on the IRS’s third-party summons power, Congress enacted section 7609 to protect the public’s privacy interests by granting the right to challenge an IRS summons. This was in response to Donaldson¹⁶ and Bisceglia.¹⁷ In those decisions, the Court held that taxpayers could challenge a third-party IRS summons only in rare circumstances, which did not include a taxpayer’s general interest in privacy.¹⁸

In enacting section 7609, Congress required the IRS to notify any person identified in a third-party summons and gave those identified persons the right to intervene in any proceeding to enforce the summons.¹⁹ In 1982 Congress added another privacy protection by giving identified persons the right to petition to quash the third-party summons.²⁰ These procedural modifications sprang from a conviction that taxpayers deserved greater safeguards against improper disclosure of records held by third parties.²¹

The exception to the general notice requirement of section 7609(a) relevant in this case is section 7609(c)(2)(D)(i), which waives the notice requirement when the summons is “issued in aid of the collection of . . . an assessment made or judgment rendered against the person with respect to whose liability the summons is issued.” The petitioners claim that the exception only applies when the delinquent taxpayer is the account holder; that is, the taxpayer has a legally recognized interest in the accounts subject to the summons.

That position is supported by the Ninth Circuit decision in Ip and the dissent written by Judge Raymond M. Kethledge in Polselli. The IRS position is that it is not required to provide notice to any account holder as long as the summons is issued in aid of the collection of an assessment against any delinquent taxpayer; that is, anyone’s records can be summonsed without notice when the summons is issued in aid of the collection of an assessment. The position is supported by the Sixth Circuit majority in Polselli, the Tenth Circuit in Davidson,²² and the Seventh Circuit in Barmes.²³

The Sixth Circuit in Polselli believed that the IRS was required to demonstrate two elements to satisfy the requirements for a no-notice summons under section 7609(c)(2)(D)(i):

• an assessment was made or a judgment was entered against a delinquent taxpayer; and

• the summons was issued in aid of the collection of that delinquency.²⁴

The court found that the IRS unequivocally met these requirements and upheld the district court’s decision to dismiss the petition to quash on the grounds. The Sixth Circuit held that the district court lacked subject matter jurisdiction because the government had not waived sovereign immunity. Under that interpretation, the identity of the account holder and the relationship to the delinquent taxpayer is irrelevant. The majority reasoned that the plain language of the statute does not require any connection between the account holder and the delinquent taxpayer.

The Sixth Circuit in Polselli noted that its decision aligned with the interpretations of section 7609(c)(2)(D)(i) in the unpublished Tenth Circuit decision in Davidson²⁵ and the per curiam Seventh Circuit decision in Barmes.²⁶ In Davidson, the third-party summons was issued for the records of the delinquent taxpayer’s wife. In Barmes, the third-party summons was issued for the bank records of a trust. The general partners of a delinquent general partnership had signature authority on the trust’s bank accounts.

The Ninth Circuit interpreted the notice exception in section 7609(c)(2)(D)(i) more narrowly in Ip,²⁷ finding that notice was required when the IRS served a third-party summons seeking the bank records of a corporation and the corporate agent was the fiancée of the delinquent taxpayer. The Ninth Circuit created an additional requirement under section 7609(c)(2)(D)(i): “The notice exception applies only where the assessed taxpayer has a recognizable legal interest in the records summoned.”²⁸

Since the delinquent taxpayer had no recognizable interest in the corporate records for which his fiancée served as the corporate agent, the corporation was entitled to notice under section 7609(a).

Kethledge dissented in Polselli, preferring the Ninth Circuit approach in Ip as the “least bad interpretation available.”²⁹ Kethledge believed that there had to be direct connection between the summons and the delinquent taxpayer to justify waiver of the notice requirement — that is, the delinquent taxpayer had to have a legally recognizable interest in the account.

Kethledge, as did the Ninth Circuit in Ip, reasoned that the approach adopted by the majority in Polselli rendered the transferee or fiduciary provision section 7609(c)(2)(D)(ii) as superfluous language.³⁰ Kethledge noted:

Every summons that falls within section 7609(c)(2)(D)(ii) already falls within the government’s (and now the majority’s) interpretation of section 7609(c)(2)(D)(i) — because every such summons is “issued in the aid of the collection of previously assessed tax liabilities.”

* * * * * *

For all its experience administering the tax code, the government offers not a single concrete example of a summons that falls within section 7609(c)(2)(D)(ii) but not (D)(i).³¹

The (D)(ii) language served no independent purpose because every summons issued under (D)(ii) would already be covered by the majority’s expansive interpretation of (D)(i). Kethledge believed that the narrower interpretation of (D)(i) would allow the (D)(ii) transferee or fiduciary provision to continue to serve a purpose.

The IRS contends that the (D)(i) exception waives the notice requirement in the case of an assessed liability against a delinquent taxpayer while (D)(ii) waives the notice requirement in the case of a liability against a transferee or fiduciary of the delinquent taxpayer or a preassessment liability against a transferee or fiduciary.

The IRS argues that (D)(i) covers a direct taxpayer liability³² and (D)(ii) covers a derivative liability.³³ For example, (D)(ii) would allow a summons without notice in trying to collect a derivative liability. A derivative liability might arise against the transferee of a dissolved corporation,³⁴ a taxpayer who has obtained a bankruptcy discharge, a terminated estate, or claim directly against the taxpayer barred by the statute of limitations.³⁵ Thus, under this explanation, (D)(ii) continues to have independent vitality for derivative liabilities.

The IRS further argues that (D)(i) applies to an assessed liability or judgment but that (D)(ii) would include a transferee’s preassessment liability. The government may begin efforts to collect a tax liability before it makes an assessment.³⁶ The IRS does not need to make a formal assessment against the transferee or fiduciary to collect from that transferee or fiduciary.³⁷ Under this explanation, (D)(ii) continues to have an independent function for preassessment liabilities and does at least “modest work”³⁸ under this interpretation.

Finally, the IRS asserted that (D)(ii) should be read under a standard “belts-and-suspenders”³⁹ approach to statutory construction. Congress deliberately built in some possible redundancy to “remove any doubt”⁴⁰ that it intended to grant the IRS authority to issue a no-notice summons to transferees and fiduciaries.

This case involves two competing interpretations of the “in aid of collection” exception. The petitioners assert that the statutory language “in aid of the collection” requires a direct connection between the summons and the collection effort. Under that interpretation, the summonsed account must hold assets that can be seized to pay the delinquent taxes. The government counters that simply gathering useful information about the source of the delinquent taxpayer’s funds serves the purpose of being “in aid of the collection.”

Privacy Concerns

Congress enacted the notice provisions of section 7609 for third-party summonses so that these “should not unreasonably infringe on the civil rights of taxpayers, including the right to privacy.”⁴¹ However, the IRS asserts that Congress tried to balance the protection of taxpayer privacy rights against the need for effective tax collection. Hence, it carved out the section 7609(c)(2)(D) exceptions to the notice requirement when the third-party summons is issued in aid of the collection of a tax. Further, the IRS asserts that there are other provisions in the code to protect taxpayer privacy interests.⁴²

The IRS does not publicly report how often it uses the “in aid of collection” exception. Data collected before the passage of section 7609 suggested that the IRS issued about 45,000 summonses annually to third-party recordkeepers like banks — the vast majority of which were intended to be covered by the procedural requirements of section 7609.⁴³ The Center for Taxpayer Rights reported that summons-related issues have become among the most frequently litigated issues in tax law.⁴⁴ In 2018 alone, the national taxpayer advocate identified 25 instances in which a third party petitioned to quash a summons after incidentally receiving notice.⁴⁵

Anecdotally, the Chamber of Commerce advised the Court that a member bank received about 3,900 summonses from the IRS over the course of a year.⁴⁶ The concern expressed is that “the exception to the notice rule would swallow the rule itself”⁴⁷ and that the IRS would be empowered to summons all kinds of records under the pretext of a collection effort. Once the government obtains the records, there is no limitation on the possible use. In short, early judicial intervention would serve as an effective check against the risk of IRS abusive conduct.

The larger question in balancing interests lies in a citizen’s reasonable expectation of privacy grounded in the Fourth Amendment versus the government’s need to engage in the efficient and effective collection of taxes. The Institute for Justice asserts that the government’s interpretation of section 7609(c)(2)(D)(i) raises serious issues concerning unreasonable searches of the records of innocent individuals.⁴⁸ Under the canon of statutory construction known as constitutional avoidance, the Court should favor the interpretation that avoids raising serious constitutional doubts.⁴⁹

The petitioners and amici argue that the balancing of interests favors a narrow reading of the section 7609(c)(2)(D)(i) exception; that is, notice is not required only when the delinquent taxpayer has a legally recognized interest in the account held by the third-party recordkeeper. They express concerns that the no-notice summons could be subject to abuse. When notice is provided, the account holder has a short window of 20 days to file a petition to quash. This short period stands in contrast to the statute of limitations for the collection of an assessment. The IRS generally has 10 years to collect a tax assessment and even longer to collect a judgment.⁵⁰

Conclusion

Even if the petitioners prevail before the Supreme Court, it is still highly probable that the IRS will be able to secure most of the records that it seeks. If there is a remand, the petitioners would have the burden of challenging the summons on the merits. The IRS believes that it would be entitled to issue a no-notice summons in this case even under the narrower legal interest interpretation. There were significant business dealings between Remo Polselli and Hanna Polselli. Further, the IRS believed that an agency relationship existed between Remo Polselli and Abraham and Rose. While the petitioners could be successful in withholding privileged materials⁵¹ and irrelevant information,⁵² the IRS would be entitled to receive nonprivileged relevant records. A decision is expected by June 30.