LLCs Don't Qualify as "Customers" under the Right to Financial Privacy Act

(Parker Tax Publishing July 2018)

In an issue of first impression, the Sixth Circuit affirmed a district court and held that two limited liability companies (LLCs) did not have standing to sue the IRS under the Right to Financial Privacy Act (the Act) after the IRS served John Doe summonses on a bank to obtain the LLCs' financial records. The court concluded that the LLCs were not "customers" under the Act's definition because they did not qualify as either (1) individuals, or (2) a partnership of five or fewer individuals, and the IRS was thus protected by sovereign immunity. Hohman v. Eadie, 2018 PTC 205 (6th Cir. 2018).

Under Code Sec. 7603, the IRS can serve administrative summonses on third parties to produce records related to taxpayers whom the IRS is investigating. Generally, Code Sec. 7609 requires that these summonses identify the person whose records are sought. However, the IRS may also serve a John Doe summons, which does not identify the person whose records are sought. This type of summons may be served only after a federal district court proceeding in which the IRS establishes that (1) the summons relates to the investigation of a particular person or ascertainable group or class of persons; (2) there is a reasonable basis for believing that such person or group or class of persons may fail or may have failed to comply with any provision of any internal revenue law; and (3) the information sought to be obtained is not readily available from other sources.

In 2015, the IRS issued two John Doe summonses on Chase Bank without first obtaining approval in a federal district court. The IRS served the summonses to obtain financial records relating to two limited liability companies (LLCs). The LLCs and subjects of the John Doe summonses alleged that the IRS's use of the John Doe summonses to obtain their financial records violated the Right to Financial Privacy Act (the Act).

The Act waives sovereign immunity for covered claims by a "customer" as defined under the Act. A "customer" is defined under the Act as "any person or authorized representative of that person who utilized or is utilizing any service of a financial institution." A "person" is defined as "an individual or a partnership of five or fewer individuals."

The question before the district court was whether the two LLCs qualified as a "person," and therefore a "customer" with standing under the Act. A district court granted the IRS's motion to dismiss for lack of subject matter jurisdiction after determining that the LLCs did not qualify as "customers" and sovereign immunity thus barred their claims against the IRS. The LLCs appealed, arguing that the district court erred in failing to consider the congressional purpose behind the Act when determining the scope of Congress's waiver of sovereign immunity. They asserted that the district court failed to consider the realities of LLCs, specifically single-member LLCs. The issues before the Sixth Circuit were (1) whether the IRS is subject to the Act when it fails to follow its own procedures under the Tax Code, and (2) whether LLCs fall within the Act's waiver of sovereign immunity.

The Sixth Circuit affirmed the district court's holding on sovereign immunity grounds. The court noted that the question of whether an LLC has standing under the Act was an issue of first impression in the circuit courts, and had only been addressed by two federal district courts and both ruled in favor of the government. The Sixth Circuit noted that, while one of those courts (Exchange Point LLC v. U.S. SEC, 100 F.Supp. 2d 172 (S.D. N.Y. 1999)) found some substance in the argument that a single-member LLC has many of the same attributes and privacy interests as a small partnership or sole proprietorship, the lower court ultimately determined that the plain meaning of the statute simply could not countenance the inclusion of an LLC in the term "individual" or "partnership of five or fewer individuals." The Sixth Circuit agreed. The Sixth Circuit also stated that the lower court was correct in noting that an LLC, unlike other entities that have been held to be persons under the Act, need not have any member that remains liable for the company's debts, even in the case of a single-member LLC. While it is true that single-member LLCs are "disregarded" by the government for federal income tax purposes, the court observed, that fact does not overcome the limited liability aspect and strict textual approach that the Sixth Circuit had to apply when interpreting waivers of sovereign immunity.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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