The IRS has already started implementing a new requirement—weeks before its effective date—to give taxpayers under audit 45 days’ notice before contacting third parties.
The measure, enacted by the Taxpayer First Act (Pub. L. 116-25), means that the agency must notify taxpayers whose returns are under examination at least 45 days before contacting a third party—such as a neighbor, bank, or employer—for information. The law also requires the Internal Revenue Service to reach out to the third party within a year of notifying the taxpayer.
The changes technically go into effect Aug. 16. But “we’ve already started to see the IRS comply with the new provisions,” said Katherine Jordan, director of tax controversy at GBX Group LLC in Cleveland.
The IRS typically reaches out to third parties when it needs information that the taxpayer hasn’t provided or the agency is trying to verify information it has already received. Lawmakers said in a conference report accompanying an earlier version of the tax legislation that contacting third parties can damage a taxpayer’s reputation and business.
The new, more precise, notice requirement is intended to create more transparency and give taxpayers an opportunity to intervene and volunteer the information the IRS is seeking before the agency reaches out to additional people.
The IRS’s implementation efforts began to take shape in July.
The agency informed one individual in a July 19 letter obtained by Bloomberg Tax of its plans to contact a third party, using language taken from the new law. “We are writing to tell you that we intend to contact other persons during the one year period beginning 45 days from the date of this letter and ending one year later,” the IRS said.
In addition, the IRS Small Business/Self-Employed division in a July 26 memo provided employees with interim guidance on contacting third parties. The agency said within a year it will update the Internal Revenue Manual to reflect the new procedures.
Codifying Court’s Opinion
Congress created the new notification requirement by amending tax code Section 7602(c)(1).
The section, prior to the new law, required the IRS to give taxpayers “reasonable notice in advance” before contacting third parties.
But the IRS was taking the position that sending individuals Publication 1, Your Rights as a Taxpayer, at the beginning of an examination was sufficient. The document says generally that the IRS in the course of an audit may need to obtain information from third parties.
The U.S. Court of Appeals for the Ninth Circuit in J.B. v. U.S. rejected the IRS’s stance, ruling that when Congress enacted Section 7602(c)(1) it intended to give taxpayers a “meaningful opportunity” to produce information before contacting third parties. The court found that mailing Publication 1 at the beginning of an audit didn’t provide such opportunity.
Practitioners said in the past, months or even years could pass between the time taxpayers received Publication 1 and the IRS contacted any third parties—so much time that individuals would often forget it was a possibility.
By making it clear that it intends to contact a third party within a 45-day window, the IRS may be able to avoid the future hassle of reaching out to an additional person, Jordan said. “The taxpayer may be inclined to give information that they would not otherwise have given.”
No ‘Fishing Expeditions’
There are several measures curtailing the IRS’s ability to issues summonses that also take effect later this week—though the third-party contact changes may have a broader impact, given they can affect anyone under audit.
One change limits the agency’s ability to issue a “John Doe” summons under Section 7609(f). The tool allows the IRS to go after “a particular person or ascertainable group or class of persons” it suspects of dodging taxes but whose identities are unknown. If the summons is approved by a court, the IRS can obtain names.
The Taxpayer First Act requires the IRS to narrowly tailor these summonses to “guard against fishing expeditions.”
The main driver for the change was the agency’s John Doe summons on Coinbase Inc., one of the largest cryptocurrency exchanges. Many saw the agency’s request as being overly broad. A court in 2017 approved the summons but forced the government to narrow its request.
The new law should be beneficial not just for taxpayers but also for the IRS because the agency is operating with limited resources, said Rosemary Sereti, a managing director with Deloitte Tax LLP’s Washington National Tax and Tax Controversy Services practice groups.
“When you issue a John Doe summons, and you get a lot more than what you need, the Service has to comb through all of that,” said Sereti, who formerly worked as the deputy commissioner for the IRS Large Business and International division.
She said the revised policy may be reflected in later changes to the Internal Revenue Manual but that it’s unlikely practitioners will see any formal guidance on John Doe summonses.
The new law also restricts the IRS’s use of designated summonses under Section 6503(j), which are issued to corporations. The change, like the third-party contact and John Doe summons measures, goes into effect Aug. 16.
While all three measures will help improve some of the IRS’s basic functions, they won’t create a sea change within the agency, said Mike Dolan, national director of IRS policies and dispute resolution in the Washington National Tax practice of KPMG LLP. Dolan is a former IRS deputy commissioner and also served two extended appointments as acting commissioner.
“They represent attempts to put a little more transparency into the process, and that’s never a bad idea,” he said.