Earlier this year I wrote about the effort by some Senators to revive the private debt collector provisions that expired several years ago. For the moment the revival of that bad idea seems to have lost steam. A new and creative way to use private parties for what seems like a governmental function – the examination of a tax return – has surfaced and deserves watching.
The IRS has changed the regulation concerning who can participate in an examination to include private contractors. It has hired a private law firm as an expert. Microsoft appears to be the first examination using private contractors to become public. The issue deserves attention in order to determine if this represents a new and better way to examine complex returns or a capitulation of what was previously considered a governmental function.
Today, Microsoft filed a FOIA suit against the IRS seeking to learn more about the terms of the contract between the IRS and Quinn Emanuel, a commercial litigation law firm (the complaint can be found here, along with the required declaration, and Exhibit I.a, Exhibit I.b, Exhibit I.c, Exhibit I.d, Exhibit II, Exhibit III, and Exhibit IV). It appears that the IRS examination team wants to use the law firm to assist it in conducting the examination and has hired the firm as experts. If successful, the FOIA litigation will make clear the precise intentions of the IRS as it moves to a new method of examining tax returns. Those intentions, if they become public, will allow a better understanding of what appears to be a new avenue of removing the wall between government and private contractor in the area of taxation.
Hiring private experts in tax cases does not present new or novel issues. The IRS regularly hires experts to assist it in valuing property or other discreet functions where expert testimony or expertise in a particular subject not within the realm of the IRS is needed. To my knowledge the IRS has not previously hired an expert to participate in the examination of a return but rather has hired experts to assist with discreet issues which turned up during the audit. The hiring of Quinn Emanuel in conjunction with the promulgation of the new temporary regulation allowing private contractors to participate in questioning a taxpayer during the examination process suggests that the IRS seeks to try a new technique in the examination of large corporations presenting sophisticated issues that may test the capabilities of the IRS examiners and the Chief Counsel attorneys who assist them.
Some of the concerns raised about the use of private collectors appear relevant in deciding if this new direction brings a good or bad direction for the IRS. Like collection, the examination of a tax return seems to represent a core government function. If a private contractor can conduct a little bit of the examination of a return, at what point does the use of the contractor stop or could the entire examination process get turned over to third parties? If using a private contractor to assist in the examination of a large and sophisticated corporate tax return becomes accepted, could private contractors also examine the returns of smaller corporations or individuals? Where should the line between core government function and private action exist on the exam side of the equation and does it present different issues about government function than the collection side of this issue? Does this need to stop at the examination level or should the IRS consider hiring private lawyers who might possess greater expertise than Chief Counsel lawyers to provide advice on the case or to try the case?
Bringing greater expertise to the examination of a large corporation makes sense if the IRS lacks the expertise currently but should such expertise come in the form of a private contractor or new government employees. This case appears to start the IRS down a new path which, unlike the decision on the use of private debt collectors has not played out in the public. The temporary regulation is titled “Participation of a Person Described in Section 6103(n) in a Summons Interview Under Section 7602(a)(2) of the Internal Revenue Code.” The description of the change suggests that the change clarifies “that persons with whom the IRS of the Office of Chief Counsel contracts for services described in section 6103(n) and its implementing regulations may be included as person designated to receive summonsed books, papers, records, or other data and to take summoned testimony under oath.” (emphasis added)
Section 7602 is the general summons provision of the Code. The issue of the IRS using summonses in large case examinations has been much debated over the past year as the IRS has initiated a new strategy and received some tongue in cheek commentary from me in a prior blog post. Historically, the IRS has used summonses very sparingly as a part of its examination of large corporations (and of small corporations and of individuals). Summonsing information generally comes as a last resort when a taxpayer refuses to cooperate. The examiners dislike the summons process because it significantly slows down an examination and fosters an adversarial atmosphere. I do not know if summonsing has become routine over the past year following the issuance of the new audit guidelines by the IRS.
The temporary regulation says that the contractor can fully participate in a summons interview and describes full participation to include “receipt, review, and use of summonsed books, papers, records, or other data, being present during summons interviews, questioning the person providing testimony under oath, and asking a summonsed person’s representative to clarify an objection or an assertion of privilege.” The temporary regulation cites to transfer pricing as a circumstance in which outside contractors often assist the IRS by providing specialized knowledge.
The temporary regulation acknowledges the potential concerns of having an outside contractor perform an inherently governmental function and states that the IRS will ensure that the core functions surrounding the summons will remain in the control of the IRS – “deciding whether to issue a summons, deciding whom to summon, what information must be produced or who will be required to testify.” The explanation with the temporary regulation states that the IRS employee will issue the summons and says that it will safe guard the inherent governmental function by making sure that an IRS employee is always present when the private contractor ask questions of a summonsed witness testifying under oath.
The issuance of the temporary regulation giving private contractors the right to examine taxpayers during a summons drew one public comment from the Texas bar. The comment made by the Texas Bar to the temporary regulation acknowledged that giving a private contractor information obtained during a summons enforcement was appropriate and that having an IRS employee consult with an expert during the interview was an appropriate use of the expert but expressed concern with the expert actually questioning the summonsed party. The commenter expressed concern relating to the issue of multiple counsel examining a witness during trial. Courts do not permit more than one counsel to examine a witness and for many of the reasons it is not allowed in court, the Texas Bar commentators felt it would present problems in examining a witness during a summons enforcement proceeding. They also expressed concern about loss of control over the contractor by the government agents and attorneys coupled with the legal uncertainty of the authority of a private contractor to examine a witness. They questioned whether the statute provided authority for the regulation citing the language of the statute which authorizes “only an officer, employee or agency of the Treasury Department to take testimony of witnesses.”
This should be an interesting issue to follow. Whether it will receive attention from Congress or the IRS employee union could add to that interest but it will almost certainly come to the attention of the court system when the IRS seeks the examination under oath by a contractor.