After hearing oral arguments in a case alleging the Internal Revenue Service issued summonses for an improper purpose, the Supreme Court of the United States is set to provide guidance on the type of evidence that a summoned party must show to entitle it to an evidentiary hearing before summons enforcement.
On April 23, 2014, the Supreme Court of the United States heard oral argument in United States v. Clarke (No. 13-1301), a case considering the circumstances under which a party challenging summons enforcement should be entitled to receive an evidentiary hearing before that summons is enforced. The Supreme Court granted the government’s petition for certiorari after the U.S. Court of Appeals for the Eleventh Circuit held that “an allegation of an improper purpose” entitles a party to a “limited adversary hearing” prior to summons enforcement to ascertain whether the Internal Revenue Service (IRS) did issue a summons for such a purpose. At oral argument, the court wrestled with crafting a standard that would provide more helpful guidance to district courts in determining what evidence a summoned party needs to bring forth to entitle it to an evidentiary hearing.
Background: Summons Enforcement
In order to ensure the proper determination of a tax liability, Congress “has endowed the IRS with expansive information-gathering authority.” United States v. Arthur Young & Co., 465 U.S. 805, 816 (1984). Section 7602 of the Internal Revenue Code is the “centerpiece of that congressional design.” Id. at 816. Under section 7602, the IRS is authorized to “examine any books, papers, records, or other data which may be relevant or material to” a tax investigation and to summon any person to produce such documents. Section 7602(a)(1), (2).
That authority, however, is subject to judicial review. When a summoned party refuses to comply, the IRS must petition a federal district court to enforce the summons. Sections 7402(b), 7604(a). Congress intended summons enforcement proceedings to “be summary in nature,” United States v. Stuart, 489 U.S. 353, 369 (1989); it did not “intend the courts to oversee the [IRS’] determinations to investigate,” United States v. Powell, 379 U.S. 48, 56 (1964). Fifty years ago in Powell, the Supreme Court sketched out the analytical framework governing summons enforcement. To establish a prima facie case, the government must demonstrate that:
its investigation is “conducted pursuant to a legitimate purpose;”
the information sought “may be relevant to that purpose;”
the IRS does not already possess the “information sought” to be summoned; and
all statutorily imposed administrative steps have been followed.
Id. at 57-58. Generally, the government can satisfy this initial burden by filing an affidavit executed by the investigating agent simply stating that the four criteria have been met. See, e.g., United States v. Kis, 658 F.2d 526, 536 (7th Cir. 1981); United States v. Davis, 636 F.2d 1028, 1034 (5th Cir. 1981).
Once the government has satisfied that minimal requirement, the burden then shifts to the summoned party to either disprove one of the four elements of the government’s prima facie showing or demonstrate that judicial enforcement of the summons would constitute an abuse of the court’s process. Powell, 379 U.S. at 58. Although there is no all-inclusive list as to what constitutes such an abuse, Powell did provide some guidance. It stated that an “abuse would take place if the summons had been issued for an improper purpose, such as to harass the taxpayer or put pressure on him to settle a collateral dispute, or for any other purpose reflecting on the good faith of the particular investigation.” Id. To help meet its burden of showing such an abuse, Powell stated that a summoned party was “entitled” to a pre-enforcement “adversary hearing” where it could “challenge the summons on any appropriate ground.” Id.
A right to an adversary hearing, however, does not necessarily entitle a summoned party to a pre-enforcement evidentiary hearing. See Tiffany Fine Arts, Inc. v. United States, 469 U.S. 310, 324 n.7 (1985) (finding that a district court “was well within [its] discretion to conclude, after reviewing submissions of the parties and holding oral argument, that an evidentiary hearing on the question of enforcement was unnecessary”). Indeed, most all circuit courts have required more than a bare allegation to trigger such an evidentiary hearing. See, e.g., Sugerloaf Funding, LLC v. U.S. Dep’t of Treasury, 584 F.3d 340, 345 (1st Cir. 2009) (“In order to proceed to an evidentiary hearing, a taxpayer must make a sufficient threshold showing … To make this showing, the taxpayer must do more than allege an improper purpose; he must introduce evidence to support his allegations.”); United States v. Tiffany Fine Arts, Inc., 718 F.2d 7, 14 (2d Cir. 1983) (“Unless a taxpayer opposing enforcement of a summons makes a ‘substantial preliminary showing’ of an alleged abuse, neither an evidentiary hearing nor limited discovery need be ordered by the district court.”); Kis, 658 F.2d at 540 (requiring summoned party to “develop facts from which a court might infer a possibility of some wrongful conduct by the Government” before granting it an evidentiary hearing); United States v. Garden State Nat’l Bank, 607 F.2d 61, 71 (3d Cir. 1979) (entitling taxpayer to evidentiary hearing in situations where it “factually refute[s]” material government allegations or “raises proper affirmative defenses … [that] are factually supported by [its] affidavits”); accord United States v. Judicial Watch, Inc., 371 F.3d 824, 831 (D.C. Cir. 2004); Fortney v. United States, 59 F.3d 117, 121 (9th Cir. 1995); Hintze v. IRS, 879 F.2d 121, 127 (4th Cir. 1989), overruled on other grounds by Church of Scientology v. United States, 506 U.S. 9 (1992); United States v. Balanced Fin. Mgmt., Inc., 769 F.2d 1440, 1444-45 (10th Cir. 1985). The outlier is the Eleventh Circuit. While appearing to equate Powell’s requirement for an adversary hearing with a right to an evidentiary hearing, the Eleventh Circuit has held that “an allegation of improper purpose is sufficient to trigger a limited adversary hearing where the taxpayer may question IRS officials concerning the Service’s reasons for issuing the summons.” Nero Trading, LLC v. U.S. Dep’t of Treasury, 570 F.3d 1244, 1249 (11th Cir. 2009) (quoting United States v. Southeast First Nat’l Bank, 655 F.2d 661, 668 (5th Cir. 1981)); see also id. at 1249 (stating that it viewed “Southeast First National Bank [as] the legitimate offspring of the Supreme Court’s seminal decision in Powell”). The summonses at issue in Clarke involved allegations of improper purposes.
The genesis of the dispute in Clarke arose in 2010 when the IRS wanted to further examine the tax returns of Dynamo Holdings Limited Partnership for tax years 2005-2007. Although the partnership had twice previously agreed to extend the statute of limitations period so that the IRS investigation remained timely, it refused to extend it a third time. Soon after that refusal, in September 2010, the IRS issued summonses to six individuals connected to the partnership, but five of those six individuals (the five are respondents in the Supreme Court case, and in such capacity, the “Respondents”) did not comply. Just before the limitations period closed in December 2010, the IRS issued a Final Partnership Administrative Adjustment (FPAA) to the partnership. The partnership challenged the FPAA in February 2011 by filing a petition in the U.S. Tax Court. In late April 2011—six months after the return date for most of the summonses and almost three months after the partnership filed its petition in Tax Court—the IRS filed summons enforcement actions in the U.S. District Court for the Southern District of Florida.
Before the district court, the Respondents argued that the IRS did not have a legitimate purpose in issuing the summonses because, among other reasons, they were (1) issued in retaliation for the partnership’s refusal to extend the statute of limitations period a third time and (2) designed to circumvent the U.S. Tax Court’s limitations on the scope of discovery. United States v. Clarke, 111 AFTR 2d 2013-1697 (S.D. Fla. Apr. 16, 2012). The Respondents brought forth some evidence supporting the latter contention, including (i) the fact that the IRS sought to continue the Tax Court proceeding on the ground that the summonses were still outstanding and (ii) a declaration from the lawyer of the sixth summoned individual (who ultimately complied with the summons request) that her IRS interview was conducted exclusively by the two lawyers representing the IRS in the Tax Court proceeding and that the examining agent was not even in attendance. To further prove their contentions, the Respondents requested an evidentiary hearing to inquire into the government’s purposes for issuing and enforcing the summonses (and also requested pre-hearing discovery). The district court, however, ordered enforcement of the summonses. It rejected the first argument as a “naked assertion” unsupported by evidence. It then dismissed the second contention because it determined that, even if the IRS had used the summons process to sidestep discovery limitations, such a finding was not a valid reason to quash a summons. Cf. Mary Kay Ash v. Commissioner, 96 T.C. 459, 462, 472-73 (1991) (denying taxpayer’s motion for protective order barring IRS from using evidence obtained through a summons but emphasizing that it was not deciding the enforceability of the summons since that issue was in the district court’s jurisdiction).
While the Eleventh Circuit, in an unpublished opinion, agreed with the district court that the Respondents were not entitled to pre-hearing discovery, it vacated the district court’s order enforcing the summonses and remanded for it “to hold a hearing.” United States v. Clarke, 517 Fed. Appx. 689 (11th Cir. 2013). Without directly addressing the Respondents’ second contention regarding circumvention of discovery limitations, the Eleventh Circuit held that “an allegation of improper purpose,” such as the allegation that the IRS issued the summonses to retaliate against the partnership, “is sufficient to trigger a limited adversary hearing where the taxpayer may question IRS officials concerning the Service’s reasons for issuing the summons.” The Eleventh Circuit reasoned that “requiring the taxpayer to provide factual support for an allegation of improper purpose, without giving the taxpayer a meaningful opportunity to obtain such facts, saddles the taxpayer with an unreasonable circular burden, creating an impermissible ‘Catch 22.’” The government filed a petition for certiorari from that decision, which the Supreme Court granted.
While the question certified by the Supreme Court was whether a summoned party’s “unsupported allegation” that the IRS issued a summons for an improper purpose entitles it to an evidentiary hearing, the parties in their respective merits briefs diverge in characterizing the issue. In line with the certified question, the government views the evidentiary hearing as a significant burden, one that should not be imposed based on “an unsupported obligation.” According to the government, requiring district courts to permit an “examination of IRS officials in response to such bare allegations would have a recurring detrimental effect on the IRS’s efficient enforcement of the federal tax laws.” And such an examination, argues the government, would contravene congressional intent that summons enforcement proceedings should be summary in nature.
In contrast, Respondents, eschewing the notion that their case rested on “unsupported allegations,” argue that a “limited evidentiary hearing” is proper in light of their “substantial allegations.” The government’s position, according to the Respondents, “is not merely that it should receive the benefit of the doubt, but that in practice it should be immune from questioning.” The Respondents argue that their approach “properly balances the taxpayer’s rights against the government’s legitimate interest in expeditious enforcement of its investigative summonses and ensures that summons enforcement proceedings are meaningful, while remaining summary in cases where the taxpayer fails to raise questions as to the IRS’s good faith.” In other words, “[f]or the judiciary to fulfill its function of safeguarding against abusive summonses, it cannot be entirely dependent on one-sided submissions by the government attesting in conclusory fashion that its summons is being pursued for a proper purpose.”
During oral argument at the Supreme Court, the justices’ questions made it objectively clear that most of them viewed the Eleventh Circuit’s negligible threshold to trigger a right to an evidentiary hearing as erroneous. Right from the outset, Justice Scalia stated that “[n]obody defends what the lower court said here,” (and later noted that “we’re way beyond” applying the Eleventh Circuit’s rule); instead, the questioning focused on the differences in the parties’ respective positions. At bottom, the government agreed with Justice Scalia’s characterization of its position “that there is enough evidence here to allow a district court to exercise its discretion [to allow an evidentiary hearing], but not enough to reverse a district court if it did not exercise its discretion in favor of the hearing.” In contrast, the Respondents’ position was that, based “on the facts of this case,” the district court abused its discretion in denying them such a hearing.
The issue then, as Justice Breyer noted, was “how to write the facts into [the decision].” Even though a majority of the justices may not have agreed with the Eleventh Circuit’s reasoning, they did not rule out the possibility that they would affirm on alternative grounds. Indeed, Justice Breyer grilled the government on the IRS’ reasons for seeking the information requested in the summons. While the government’s attorney initially answered that the IRS wanted it to be able to revise the FPAA (which was finalized prior to enforcement of the summonses) if the information obtained necessitated a change in the determination of the partnership’s tax liability, the Respondents’ lawyer noted that section 6223(f) prohibits the IRS from issuing a second FPAA (subject to exceptions not relevant here). On rebuttal, the government clarified that the IRS wanted the information to “amend its final determination of liability for the taxpayer … in the Tax Court.” Justice Breyer then asked whether a district court could properly enforce a summons that was sought “to get information that … has no purpose other than to change, modify, or help [the government’s] case in the Tax Court.” The government’s lawyer diverted answering that question by noting that, while that was the reason for enforcing the summons, it was not the reason for issuing the summons; she then argued that the Tax Court has stated that issuing a summons in such a circumstance “doesn’t offend anything that’s happening in the Tax Court.” She also pointed out that the taxpayer could seek recourse in the Tax Court proceeding by asserting that the Tax Court should exclude any information obtained through the summonses. When Justice Ginsburg raised that point to the Respondents, their attorney stated that, while he could not know for sure whether the Tax Court would exclude it, this “[c]ase isn’t [about] the documents; it’s [about] the examination.”
The justices’ questioning also revealed the parties’ diverging views on the type of “evidence” required to trigger an entitlement to an evidentiary hearing. After the government argued that a summons opponent’s evidence must at least raise an inference of an improper purpose, Justice Alito noted that the question “all depends on what you mean by ‘evidence.’” The government responded that circumstantial evidence would be sufficient. However, Justice Sotomayor later returned to that same question, asking whether the “evidence” required in this setting should be interpreted similarly to the evidence required (1) in “the Iqbal-Twombly world” [referencing the Supreme Court’s decisions in Ashcroft v. Iqbal, 556 U.S. 662 (2009) and Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007), which interpreted the pleading standards in Federal Rule of Civil Procedure (Rule) 8 to require a complainant to describe facts that give rise to a plausible entitlement to relief] or (2) to meet the summary judgment standard, which, under Rule 56, requires a party to proffer certain documents to support its assertion that a fact cannot be or is genuinely disputed.
Unsurprisingly, the government argued that the evidence required to trigger an entitlement to an evidentiary hearing is better analogized to the summary judgment standard. According to the government, the Iqbal-Twombly standard—where a complainant “is entitled to the presumption that what they say is true”—“doesn’t really work here,” since the IRS would have already made a showing of a proper purpose, which raises a presumption that the government is indeed acting in good faith and with a proper purpose. Thus, said the government, it is more appropriate to require the summons opponent to meet the summary judgment standard of evidence to overcome that presumption; that is, the burden to disprove the summons was issued for a proper purpose. In contrast, the Respondents argued that the required evidence need only meet the fact pleading standards under Rule 8. The Respondents’ lawyer reasoned that, if the Respondents did not have “the ability to come forward with allegations that under Iqbal and Twombly would pass muster,” it would lead to “the impermissible Catch-22” discussed by the Eleventh Circuit; there would be “an unreasonable circular burden” to “have evidence to get evidence,” and it could not “get evidence without already having the evidence.”
In sum, it is fairly certain that the Supreme Court’s decision will not rely on the Eleventh Circuit’s reasoning. That said, the oral argument did not clearly indicate whether a majority of the justices were in favor of reversing the Eleventh Circuit and holding the district court properly exercised its discretion, or whether they were more inclined to agree with the Eleventh Circuit’s decision—albeit it on different grounds—to remand to the district court to hold an evidentiary hearing. The court is expected to issue its decision by the end of June.