In a unanimous decision on June 19, the Supreme Court ruled that a taxpayer has a right to conduct an examination of IRS officials regarding their reasons for issuing a summons when the taxpayer points to specific facts or circumstances plausibly raising an inference of bad faith.
The Court's decision in United States v. Clarke, No. 13-301 (2014), expands on its previous decision in United States v. Stuart, 489 U.S. 353, 359 (1989), that the IRS "need only demonstrate good faith in issuing the summons." In an opinion that attempts to balance taxpayers' rights to challenge a summons with the government's responsibility to administer the tax code, the Supreme Court vacated the opinion of the Court of Appeals for the Eleventh Circuit and reiterated the four-factor test of United States v. Powell, 379 U.S. 48 (1964), in holding that "naked allegations of improper purpose are not enough" for a taxpayer to examine an IRS agent to determine bad faith. Rather, "the taxpayer must offer some credible evidence supporting his charge," the Court said.
Under Powell, the IRS need only establish that (1) there is a legitimate purpose to conduct the investigation, (2) the inquiry may be relevant to that purpose, (3) the information sought is not already in the IRS's possession, and (4) administrative steps required by the IRS have been followed. To enforce a summons, the IRS typically submits an affidavit in support of meeting those four factors. At that point, the burden of proof shifts to the summoned party to disprove the satisfaction of at least one of those four factors or to persuade the court that the court's process has been abused.
In Clarke, the IRS examined the information returns of Dynamo Holdings Limited Partnership (DHLP) for the 2005 through 2007 tax years. In connection with the examination, the IRS in October 2010 issued five administrative summonses under Section 7602 to third parties connected with the DHLP, one of whom was the CFO of the partnership, Michael Clarke. Neither Clarke nor the others who were summonsed complied.
A few months later, the IRS issued a final partnership administrative adjustment to the DHLP. The DHLP filed a petition in the Tax Court challenging the adjustments. The IRS also filed five petitions for enforcement of the summonses in federal district court. Clarke and the others responded in court that the purpose of the IRS's investigation was illegitimate and had an "ulterior motive." They argued that the summonses were retribution for the DHLP's refusal to grant an extension of the statute of limitations, among other things.
Clarke and the other respondents argued that they were entitled to explore their allegations through discovery and an evidentiary hearing. The district court ordered the summonses enforced, acknowledging that the respondents were entitled to an adversarial hearing but not an evidentiary hearing or discovery. The Court of Appeals reversed, holding that an allegation of improper purpose — even if lacking in factual support — entitled the taxpayer to contest a summons. The Eleventh Circuit's decision was at odds with every other appeals court before the Supreme Court vacated that opinion.
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