Exploding Packages and IRS Disclosure of Confidential Tax Return Information

The case brings me back to my first year in law school, over 25 years ago. There is little I remember of my first year of law school classes. There is one exploding exception: Palsgraf v Long Island Railroad. Judge Cardozo’s facts come straight out of an evil law professor’s hypothetical bank:

Plaintiff was standing on a platform of defendant’s railroad after buying a ticket to go to Rockaway Beach. A train stopped at the station, bound for another place. Two men ran forward to catch it. One of the men reached the platform of the car without mishap, though the train was already moving. The other man, carrying a package, jumped aboard the car, but seemed unsteady as if about to fall. A guard on the car, who had held the door open, reached forward to help him in, and another guard on the platform pushed him from behind. In this act, the package was dislodged, and fell upon the rails. It was a package of small size, about fifteen inches long, and was covered by a newspaper. In fact it contained fireworks, but there was nothing in its appearance to give notice of its contents. The fireworks when they fell exploded. The shock of the explosion threw down some scales at the other end of the platform, many feet away. The scales struck the plaintiff, causing injuries for which she sues.

Poor Ms. Palsgraf. She never recovered from the injury. In a late 80’s article discussing the case, the New York Times noted that for the twenty years or so following the accident until her death, “she was plagued by stuttering, dizziness, headaches -and indignation.”

Despite the grievous injuries, as Cardozo explained, sometimes injuries are too remote and unforeseeable to warrant redress: “The judge is not the knight-errant, roaming at will in pursuit of his own ideal of beauty or of goodness.”

What does all this have to do with tax procedure? It provides an excellent opportunity to examine the laws and policies regarding disclosure of tax information as well as the consequences of wrongful disclosure. Under Section 6103, if the IRS discloses confidential tax return information that is not covered by 20 statutory exemptions, a taxpayer may recover damages due the wrongful disclosure. Under Section 6104, certain information, particularly information concerning tax exempt organizations is specifically made public. (For a broader discussion of the policy issues driving certain information into 6103 or 6104 see recent law review articles by Keith on transparency issues in employment taxes and Josh Blank from NYU discussing shaming corporate tax abuse).

As readers know, Section 501(c)(4) has been at the forefront of the recent IRS scandal regarding improper scrutiny of exempt status, as well as an ongoing effort to calibrate how much and the type of political activity those organizations can engage in without blowing their exempt status. A 501(c)(4) organization is permitted to engage in political activities, so long as that is not its primary activity. Social welfare does not include direct or indirect participation or intervention in political campaigns on behalf of or in opposition to any candidate for public office. 501(c)(4) organizations (unlike political organizations exempt under Section 527) do not have to disclose their donors.  This issue is at the heart of the IRS scandal precisely because donors to these organizations do not want their names made public. The IRS action here, though ruled inadvertent, essentially turned the 501(c)(4) organization into one under 527.

So, IRS’s sending of NOM’s donor list was a big deal, especially when one of its donors was linked to a Romney-related organization that donated money to NOM. Amid allegations that the disclosure may have been an intentional IRS/administration effort to out backers of those who opposed state restrictions on same sex marriage, (see for example a Fox news piece IRS Must Be Held Responsible for Leaking National Organization for Marriage Donor List) NOM sued, seeking actual and punitive damages.

The IRS’s disclosure contributed to NOM incurring substantial attorney’s fees to defend against suits that it violated election laws. IRS, borrowing a page from Judge Cardozo, argued in a summary judgment motion that its actions were not the proximate cause of NOM’s actual damages, and that subsequent misuse of NOM’s confidential information was enough to make the harm sufficiently remote and unforeseeable.

To get to foreseeability we need to dig a little deeper into the case. By law under Section 6104(b) IRS must make available certain parts of exempt organization annual returns, but not their donors. In response to an individual’s request for NOM’s publicly available Form 990, IRS sent the NOM return to that individual (who identified himself in the request as a member of the media), but it also included a list of donors who contributed $5,000 or more on Schedule B of the Form 990. IRS should have redacted Schedule B’s donor list. The individual receiving the return (and donor list) gave the donor list on to the HRC. HRC also forwarded NOM’s Schedule B to a journalist at the Huffington Post. Huff Post “published it along with an article focusing on the fact that an Alabama state political action committee associated with Mitt Romney made a $10,000 donation to NOM in 2008.” An opponent of NOM, Fred Karger, used information from the donor list as part of the factual basis for a complaint he filed with the California Fair Political Practices Commission (CFPPC), alleging NOM violated state election laws. CFPPC eventually absolved NOM of wrongdoing, but NOM incurred legal fees to defend the California complaint and to protect the confidentiality of its donors.

Section 7431 provides that taxpayers can recover punitive damages when the IRS disclosure is willful or the result of gross negligence. Absent punitive damages, taxpayers can recover $1,000 for each wrongful disclosure or the actual damages that stem from the disclosure.

Though NOM alleged willful conduct or in the alternative gross negligence, the district court found that the IRS mistakenly disclosed NOM’s donor list on Schedule B of its Form 990. According to the court, its mistake was the result of carelessness, not rising to the level of culpability needed to trigger a finding of gross negligence. The Court also dismissed the claim that the IRS’s systemic process in place was so flawed that as a matter of law its mistake should constitute gross negligence. (It also bounced the claim that there were impermissible IRS employee inspections of NOM’s tax returns, an action that also triggers damages under 7431).

NOM’s complaint alleged actual damages stemming from what it claimed were lost donations and legal fees it incurred as a result of the IRS disclosure. The opinion discusses the standard to establish damages, including a recent Supreme Court case:

The case law is admittedly sparse regarding what is necessary to establish actual damages under § 7431(c). Each court to have addressed this issue, however, has uniformly concluded that that the common law elements of causation — actual and proximate cause — must be proven. See, e.g., Jones v. United States, 9 F. Supp. 2d 1119, 1137 (D. Neb. 1998); see also Paroline v. United States, ___ U.S. ___, 134 S. Ct. 1710, 1720 (2014) (reciting the common maxim that a plaintiff must prove both proximate cause and actual cause to recover damages that are “a result of” a particular defendant’s conduct).

When it came to actual cause, the district court had no trouble finding that the IRS’s disclosure was the actual cause of NOM’s costs:

The Court has little trouble concluding that the unlawful disclosure of NOM’s Schedule B was the actual cause of its claimed damages. Actual cause, or cause in fact, requires “pro[of] that the wrongful act in fact caused the harm; that is, the plaintiff must prove that ‘but for’ the wrongful act, the harm would not have occurred.”. The Government concedes that it unlawfully disclosed NOM’s Schedule B to a third-party. The damages noted above were plainly a direct result of this disclosure. For example, it is clear beyond question that the disclosure gained significant media coverage that resulted in NOM retaining counsel to investigate the leak. In other words, but for the disclosure, NOM would not have incurred the costs it now seeks through this action. (citations omitted).

The government argued that NOM’s choosing to pay counsel fees broke the chain needed for but for or actual causation. The court rightly dismissed that argument:

The Government’s argument that NOM cannot pass the “but for” test because it willingly incurred these expenses is unsuccessful. This argument has no relation to the Court’s inquiry, which simply asks would the injury have occurred without the defendant’s conduct. The answer in this case, without question, is no. (citations omitted).

This brings us back to poor Ms. Palsgraf and proximate cause. To frame the issue, the court looked to a 2014 Supreme Court decision Paroline v. United States which it said was “particularly helpful”:

Every event has many causes, however, and only some of them are proximate, as the law uses that term. So to say that one event was a proximate cause of another means that it was not just any cause, but one with a sufficient connection to the result. The idea of proximate cause, as distinct from actual cause or cause in fact, defies easy summary. It is “a flexible concept” . . . that generally “refers to the basic requirement that . . . there must be ‘some direct relation between the injury asserted and the injurious conduct alleged[.]'” . . . The concept of proximate causation is applicable in both criminal and tort law, and the analysis is parallel in many instances. Proximate cause is often explicated in terms of foreseeability or the scope of the risk created by the predicate conduct. . . . A requirement of proximate cause thus serves, inter alia, to preclude liability in situations where the causal link between conduct and result is so attenuated that the consequence is more aptly described as mere fortuity.

After nicely encapsulating the standard, the court then applied the standard to the facts at hand, finding that “the harms for which NOM seeks damages were both foreseeable and within the scope of risk associated with the IRS’s conduct.”

Congress deliberately exempted from disclosure the names and addresses of an organization’s donors. See 26 U.S.C. § 6104(b). This choice demonstrates its understanding — one that is assumed by the IRS — that such information, if disclosed publicly, could expose an organization and its donors to a multitude of harms…As such, it was certainly foreseeable that releasing NOM’s Schedule B to a member of the media could result in its publication, and that NOM would take legal action to prevent further harm. While the Government may not have predicted the precise conduct at issue here, one cannot reasonably conclude that NOM’s legal expenses were unforeseeable, and that is all the element of proximate cause requires. (citations omitted, emphasis added).

The government argued that there was no proximate cause because the damages arose from “acts by non-IRS personnel, several steps removed from any conduct by the IRS.” The court found the government’s argument weak as it ignored “relevant proximate causation issues, namely, whether the intervening actions were a reasonable and probable consequence of the disclosure.”

The actions of others apart from the IRS after the release were according to the court foreseeable:

The independent actions of Meisel[the journalist who received the Form 990 from the IRS], the HRC, and others cannot immunize the IRS from responsibility in this case given it was clear that publication was likely and the harms claimed (i.e. legal expenses) were certainly a foreseeable consequence of publication. The fact that a third-party was involved in this chain of events does not foreclose finding proximate cause on these facts.

Parting Thoughts

So NOM’s actual damages claim survived the government’s summary judgment motion. The court cited an 8^th Circuit case from the mid 70’s Griggs v. Firestone Tire & Rubber Co. for the point that “the law does not require precision in foreseeing the exact hazard or consequence which in fact transpires; it is sufficient if what occurred was one of the kind of consequences which might reasonably be foreseen.” In today’s increasingly partisan world, 501(c)(4) organizations like NOM are front and center in our country’s most divisive issues. While that may change as a result of future guidance on what those organizations can do in the political arena, IRS should be held to a high duty of care for information relating to those organizations. It is not surprising that confidential information relating to these controversial organizations may be part of litigation, especially when the permissible scope of those organizations’ political activities is far from certain.

The case will move to trial. While it is possible that on trial the government may show that in fact the disclosure resulted in a net inflow of new contributions to NOM—it appears that NOM has used the disclosure and subsequent litigation to generate donations from those who previously did not contribute—the opinion raises the legal issue as to whether collateral sources of support can mitigate damages under Section 7431. In addition to that legal issue (which the court notes the parties not surprisingly disagree) there is a factual question as to whether the new supporters came to the cause as a result of the disclosure (as the government argued) or some other reason. The court declined to conclude as a matter of law that any new donations that came in after the IRS disclosure were solely attributable to NOM’s solicitations referencing the IRS disclosure.