On April 5, 2017, the Tax Court rendered a fully reviewed T.C. opinion in the case of Mescalero Apache Tribe v. Commissioner, 148 T.C. No. 11. We do not often have two disclosure cases in one week. It doesn’t get much better than this.
After President Nixon tried to run roughshod over the tax information of his enemies and Congress reacted with the new, extremely beefed up section 6103 in 1976, Chief Counsel, IRS soon thereafter created the Disclosure Division. As you might imagine, new attorneys did not flock to that Division as their first (or second or third) choice. So, Chief Counsel’s office created a rule that if you worked in the Disclosure Division for three years, you got first choice on any opening in the country. That rule suggests how sought after a career focused on the disclosure laws was, at least with lawyers in Chief Counsel’s office; however, the disclosure provisions, despite their non-glamorous reputation, contain many important policy issues a number of which have split the circuits. The Mescalero Apache Tribe case demonstrates one of the interesting issues that can lurk in the disclosure provisions.
Before I move on to the disclosure issue, I want to pause and discuss an issue that the Court discusses in a footnote – appellate venue in cases brought by Indian tribes. The issue of appellate venue in Tax Court cases has importance to the outcome of the case at the trial level because of the Golsen rule under which the Tax Court will follow the law of the circuit to which the case will be appealed. The failure to update the appellate venue rules in 1998 when Congress created several new ways to obtain Tax Court jurisdiction led to some interesting issues we have blogged here and here. In this case the Tax Court notes that the rules of appellate venue discuss individuals and corporations but not Indian tribes which have a sovereign nation like status. So, the appellate venue for a Tax Court case involving a tribe put the court in uncharted waters. It defaulted to looking to the law of the 10th Circuit which is the circuit where the tribal lands of the tribe appearing before the court are located. I suspect that most readers will have few cases in which they represent an Indian tribe in Tax Court but the case points out in yet another context a hole that exists in the appellate venue of the Tax Court and how that hole can impact the resolution of the case when a circuit split exists on an issue.
The taxpayer is an Indian tribe that hired workers. At issue in the Tax Court case is the classification of those workers as independent contractors or employees. The tribe classified the works as independent contractors and the IRS seeks in the case to obtain a determination that the workers were employees. If the IRS wins this argument, the tribe would owe the taxes on the workers under the theory that its failure to properly classify the workers and consequent failure to withhold taxes with each payment caused the non-payment of the taxes. Section 3402(d) allows a company deemed to have employees rather than independent contractors to avoid the additional liability to the extent that the company can show that the workers independently paid the taxes to the IRS. This offers a significant way out of what could be a heavy tax liability; however, there is one catch – the payment by the employees of their taxes is return information under IRC 6103 and return information, like tax returns themselves, comes under the broad umbrella of the protection from disclosure.
The structure of 6103 basically sets out the broad general rule at the outset that returns and return information is covered by the disclosure provisions and cannot be disclosed by the IRS. The lengthy code section then has a multitude of exceptions. At issue in this case is the application of one or more of the exceptions. The case is a slightly unusual disclosure case in that both the IRS and the taxpayer before the court know the names of all of the individuals who worked for the tribe. So, the tribe does not want taxpayer identity information but simply whether the identified individuals paid their taxes for the years at issue so that the tribe knows if the defense available in 3402(d) protects it. Before seeking the information in discovery in the Tax Court case, the tribe sought to gather the information from the individuals who previously worked with it. Because of time and mobility of the work force and maybe because some of the former workers did not want to provide the information, the tribe was unable to get information about all of its former workers. So, it sent a discovery request to the IRS seeking to obtain information about a group of identified former workers and whether they paid taxes on the compensation they received. The IRS objected to the request citing the general rule that it may not disclose this return information. The tribe brought an action to enforce discovery citing to an exception in 6103(h) and the Tax Court, in a fully reviewed, unanimous opinion, holds that the tribe is entitled to the information through discovery.
This is a big deal for taxpayers who need information from the IRS in order to defend themselves in a tax matter. The decision here will not open the IRS records in every case but it does provide a model for seeking information in Tax Court cases. Because the Tax Court had not previously addressed this issue, it did so here through court conference.
As the Tax Court examined the issue of whether 6103(h)(4) provides an exception to the general rule of nondisclosure, it found the circuits were split. The 5th Circuit held that this subsection applied to disclosures to certain federal officers because of the title of the section; however, the 10th Circuit held the 6103(h)(4), unlike earlier subparagraphs of the subsection,” speaks specifically of disclosure in a judicial or administrative tax proceeding with no indication that disclosure should be limited to officials.” The Tax Court found that most courts had followed the 10th Circuit; however, the fact that (h)(4) created an opportunity for disclosure in a court proceeding did not mean that its language required or allowed disclosure in this circumstance. So, the Tax Court had to look further at the statute. Subparagraph (h)(4)(B) refers to returns and return information and another part refers only to returns. Without getting into a significant discussion of returns and return information, it is important to understand that these are two different classes of information protected by 6103 and the tribe wants return information. Two circuits found the subsequent reference to returns which omitted the phrase return information to create a limitation on the disclosure of return information. The 10th Circuit had two opinions which, in different contexts, did not impose that limitation.
The Tax Court avoided that issue by looking at 6103(h)(4)(C) which allows for disclosure of both returns and return information; however, it limits disclosure to situations in which “return or return information directly relates to a transactional relationship between a person who is a party to the proceeding and the taxpayer which directly affects the resolution of an issue in the proceeding.” So, the Tax Court needed to decide if the employer/worker relationship is a transactional relationship and whether the return information of the workers directly relates to this relationship and whether “information related to the transactional relationship directly affect(s) the resolution of the issue in this case.”
The court found that the relationship met the necessary test, that the return information directly relates to this relationship and that the return information directly affects the resolution of an issue in the case. So, it found the return information disclosable but that did not end the matter because the IRS objected that even if it is disclosable “it is still not discoverable.” The IRS pointed to the fact that the tribe bore the burden of proof that the workers paid their taxes. This seems like a cruel argument if the IRS has the information that will allow the taxpayer to win their case and does not have to give it to the taxpayer because the taxpayer must prove their case. The Tax Court found that just because the tribe had the burden of proof does not mean that discovery cannot be had of the IRS citing to Tax Court Rule 70(b) which says parties can discover information “regardless of the burden of proof involved.” Keep in mind that sometimes the IRS has the burden of proof and it should be careful of arguments like this that could limit its ability to obtain information from the taxpayer through discovery.
In a case like this the IRS represents the interest of the 70 individuals whose return information will come out even though they have no voice in the matter. The IRS defense of disclosure makes sense but so does the Court’s determination that the information meets the exception in the statute. Failure to allow the information to come out could cause the tribe to pay a tax which its workers already paid. The competing policy interest of the protection of the worker’s return information and the tribe’s interests properly fall on the side of preventing the tribe from having to pay a tax it should not owe. The case does not talk about how the return information of the workers might be protected as the information is disclosed but that issue is present.