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NorCal Tea Party Patriots v. IRS: Change in the Restrictions on Disclosure of Third Party Information?

Posted on Apr. 28, 2015

Today, we welcome back guest blogger Marilyn Ames writing from the 49th state where she lives following her retirement from the Office of Chief Counsel.  Keith

On April 1, 2015, the court in the NorCal Tea Party Patriots case issued an order requiring the government to turn over information identifying the other organizations allegedly targeted by the Internal Revenue Service for intensive scrutiny when the organizations applied for tax-exempt status.  This order is at odds with a decision by the Court of Appeals for the Federal Circuit, and, if allowed to stand, may signal a sea change in the ability of taxpayers to get information regarding the tax returns and return information of third parties.

For those not familiar with the case, here’s a little background. In May of 2013, ten organizations filed suit against the United States, the Internal Revenue Service and various individual employees of the Internal Revenue Service, alleging that their rights under the Privacy Act, the First and Fifth Amendments and the non-disclosure provisions of IRC § 6103 were violated when they applied for tax exempt status and were then subjected to intensive scrutiny because of their dissent from the policies of the Obama administration.  The plaintiffs also sought to certify a class consisting of all other organizations subjected to the same intensive scrutiny for their “dissenting” beliefs. After some preliminary procedural skirmishing, the Privacy Act count was dismissed, as were the individual IRS employees, leaving the remaining counts to go forward against the United States and the Internal Revenue Service.  The request for class certification also remained to be decided.

In their efforts to certify a class, the plaintiffs served discovery on the government. They requested, among other items, that the government turn over any lists or spreadsheets the IRS used to track groups flagged for heightened review, the list of 298 applicants that the IRS compiled and provided to the Treasury Inspector General for Tax Administration (“TIGTA”) for its use in reviewing the conduct of the IRS, and an additional tracking sheet of applicants also sent to TIGTA.  This information was to form the basis for the plaintiffs’ efforts to certify a class. The government refused, claiming that the disclosure would violate the provisions of the disclosure statute, IRC § 6103.  It is this discovery request that triggered the court’s order of April 1.

Section 6103(a) of the Internal Revenue Code states that “returns and return information” are confidential, and cannot be disclosed except as permitted by the Internal Revenue Code.  Section 6103 then proceeds, in the longest section in the Internal Revenue Code, to detail exactly when a taxpayer’s return or return information can be disclosed.  Fortunately for us, we can skip most of section 6103 and go directly to the subsection at issue – IRC § 6103(h)(4)(B), which deals with when returns or return information can be disclosed in a judicial or tax administration proceeding.  Both parties agreed that the list in question constituted return information as defined in section 6103(b)(2). (Basically, return information is all information regarding a taxpayer’s return received by, recorded by, prepared by, furnished to, or collected by the Internal Revenue Service in its determination of the possible existence or a liability of any person for a tax, penalty, interest, fine, forfeiture or offense.  That covers pretty much everything if taxes are involved.)

The plaintiffs argued that the information they requested meets the exception to disclosure contained in section 6103(h)(4)(B), which provides that disclosure can be made in a judicial proceeding “if the treatment of an item reflected on such return is directly related to the resolution of an issue in the proceeding,” sometimes referred to as the item test. Citing past cases, the court noted that the issue to which the return information relates is not limited to matters concerning the taxpayer’s tax liability.  Quoting Chief Counsel Advisory, IRC CCA 201250020, the court stated: “The item must ‘affect the resolution or be germane to an element of the claim,’ but it need not be dispositive of the issue.” The court concluded that the spreadsheets and lists were directly related to the issue of class certification, denied the government’s motion for a protective order and granted the plaintiffs’ motion to discover the information.

It is in footnote 4 of the court’s order that things get really interesting, because it is here that the court rejects the government’s arguments based on the reasoning of the case of In re United States, 669 F.3d 1333 (Fed. Cir. 2012).  The government relied on the United States case for two propositions.  First, an item reflected on a return can only be information provided by the taxpayer and filed with the IRS. In other words, only returns can be disclosed using the item test, because only returns are filed.  Return information, including return information prepared by the government, cannot be disclosed.  Second, the government argued, the item test did not permit disclosure because the return information in question did not “directly relate” to an issue in the case.  The court in the United States case expressly held an item is never directly related when the only link between the taxpayer and the third party is the same tax treatment.  (It should be noted there is a split in the circuits as to how strictly the “directly related” part of the item test should be applied. The NorCal court mentions several of these cases.) When these two propositions are taken together, a taxpayer seeking information regarding a third party’s tax treatment can almost never get it.

The NorCal court felt that the item test should be more broadly interpreted on both these points, and looked to an unexpected source for support in its decision.  In October of 2012, after the opinion in the United States case was issued, the IRS Chief Counsel issued an advisory opinion that contradicted the United States case on both these points in the results reached.  (While the court recognized the advisory opinion contained in IRS CCA 201250020 is by its own terms not to be used or cited as precedent, the court said it was not citing it as precedent but “for its well-reasoned analysis.”) The issue presented in the advisory opinion was whether third party return information could be used in the cases of other taxpayers involved in similar captive insurance programs all set up by the same individual.  The opinion concluded that third party return information could be disclosed under the item test if it showed a pattern that directly related to the resolution of an issue in the case.  In the situation in the opinion, if return information of a third party showed that the arrangement sold to the taxpayer did not have sufficient individualized risk transfer and distribution to qualify as insurance, the third party information could be disclosed.  It could not be disclosed simply to show that the taxpayer had entered into an invalid transaction similar to that of the third party.

If the government does not seek to block the discovery order, the court in NorCal may have opened a door for a broader reading of section 6103(h)(4)(B).  If so, this would allow taxpayers to obtain information on how the IRS treats those taxpayers who are similarly situated, provided the taxpayer can show a pattern that would bear on the resolution of an issue in the case. It would also allow the IRS to use this information in the same way.  Overall, this can only work towards tax administration that treats similar taxpayers consistently.

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