Criminal Referral of LLC's Agent Didn't Preclude IRS from Issuing Summons to LLC

(Parker Tax Publishing July 2022)

The Fourth Circuit held that, under Code Sec. 7602, a business entity is a distinct person from its agents and, as a result, a district court properly denied an entity's motion to quash an IRS summons on the basis that an existing criminal referral for the entity's lone agent had to be treated as a referral for the business entity itself. According to the court, the IRS can continue to avail itself of the summons power until it crosses the "bright line" of making a Justice Department referral. Equity Investment Associates, LLC v. U.S., 2022 PTC 196 (4th Cir. 2022).

Background

Equity Investment Associates, LLC (Equity) owned 1,920 acres in Brunswick County, North Carolina and donated a conservation easement on 1,297 of those acres to the North American Land Trust. In its 2018 partnership tax return, Equity submitted an appraisal claiming that the full 1,920 acres, if developed as a luxury subdivision, had a value of $270 million, but a value of only $47 million after the conservation easement. Based on the appraisal, Equity claimed a $223 million deduction for the conservation easement. The IRS was suspicious and began investigating.

The sole person with the authority to act on Equity's behalf for federal tax purposes is Jack Fisher. Equity's majority owner is Southeast Property Acquisitions, which owns 80 percent and serves as Equity's manager. In turn, Southeast Property is controlled by its managing member, Inland Capital Management, which Fisher manages. The IRS's investigation into Equity's 2018 conservation easement deduction also embroiled Fisher and the other companies that owned and managed Equity.

In 2019, the IRS executed a search warrant at Inland's offices, which Equity shared with Inland. The warrant alleged various tax fraud violations and authorized seizure of evidence of the alleged fraud, including the documents and information of Equity, Southeast Property, Inland, and other entities created or controlled by Fisher. Around the same time, a grand jury issued a subpoena to Inland seeking records related to transactions with Jack Fisher, Inland, Southeast Property, and Equity. The subpoena specifically requested documents relating to IRS audits and to the preparation and filing of tax returns relating to Fisher, Inland, Southeast Property, and Equity.

The accountants who prepared Equity's tax return, Stein Agee and Corey Agee, pleaded guilty to conspiring to defraud the United States by selling, along with co-conspirators, "investments" in fraudulent syndicated conservation easement tax shelters. The Justice Department labeled the partnerships involved "a sham, lacking economic substance and serving no legitimate business purpose" and noted that the Agees' "convictions signal just the beginning of the department's prosecutive efforts."

While those criminal investigations were ongoing, the IRS continued its civil investigation of Equity. The IRS sent multiple requests for Equity's bank statements and other information. Equity eventually produced its 2018 general ledger and Southeast Property's bank statements. Although the general ledger reflected a bank account in Equity's name at BB&T Bank (now Truist Bank), Equity did not produce those bank statements. The IRS followed up seeking Equity's bank accounts, but Equity again only produced Southeast Property's bank statements.

The IRS then sent a civil administrative summons to Truist for Equity's account information, providing notice of the summons to Equity and its counsel. In response, Equity asked a district court to quash the summons and requested an evidentiary hearing. Under Code Sec. 7602(d)(1), the IRS cannot issue a summons with respect to any "person" if a Justice Department referral is in effect with respect to such person. Equity argued that the summons should be quashed because a Justice Department criminal referral was already in effect for Equity or one of its agents (Fisher). The government responded with a declaration from an IRS agent attesting that a criminal referral was not in effect for Equity. The district court denied Equity's petition to quash the summons and rejected the request for an evidentiary hearing. After the district court ruled, a grand jury indicted Fisher for crimes relating to the fraudulent syndicated conservation easements. The indictment alleged that Fisher was responsible for Equity's fraudulently claimed $223 million deduction.

Equity appealed the district court's decision to deny its petition to quash the IRS summons. Before the Fourth Circuit, Equity argued that it was the subject of a Justice Department criminal referral because Code Sec. 7602(d) applies not only when an entity such as a partnership has been referred, but also when an agent of the partnership has been referred. In support of this view, Equity contended that the court should adopt the definition of "person" in Code Sec. 7343, which defines person to include, in part, a member or employee of a partnership who is under a duty to perform an act in respect of which a violation occurs. Equity also contended that there was evidence in the record of a criminal referral as to Equity itself.

Analysis

The Fourth Circuit affirmed the district court and held that under Code Sec. 7602, a business entity is a distinct person from its agents. Therefore, since Equity itself was not referred to the Justice Department, it could not quash the IRS summons.

The court rejected Equity's argument that the definition of "person" in Code Sec. 7343 should apply to Code Sec. 7602. The court noted that Code Sec. 7343 explicitly applies only for purposes Chapter 75 (i.e., Code Secs. 7201-7345). The definition of person applicable to Code Sec. 7602, the court found, is in Code Sec. 7701(a)(1), which does not consider members, officers, or employees of a business entity to be part of the same "person" as the business entity itself. By omitting officers, members, and employees from the personhood of business entities in Code Sec. 7701(a)(1), but including those same people in the definition adopted for Code Sec. 7343, the court found that Congress made an express decision that "person" for purposes of Code Sec. 7602 only means the business entity itself.

Equity contended that even if the definition of person in Code Sec. 7701(a)(1) applied, it is not exclusive in the list of entities it counts as a person, so it should be read to include business agents as part of the same person. The court rejected that argument, reasoning that an LLC is considered a separate legal person which can exercise rights and powers in its own name. Further, the court noted that the law of North Carolina, where Equity is organized, also provides that LLCs are distinct persons from both their members and managers. The court additionally found that the text of Code Sec. 7602 shows that the statute considers business entities as distinct persons from their agents because Code Sec. 7602(a)(2) authorizes the IRS to summon the person liable for tax or required to perform an act or "any officer or employee of such person." In the court's view, Code Sec. 7602(a)(2) would be superfluous if "person" included the agent of a business entity. Thus, absent statutory direction like that provided in Code Sec. 7343, the court refused to treat a business entity as a part of the same "person" as its members, officers, and employees.

Next, the court found that Equity provided no direct evidence that a Justice Department referral was in effect for Equity and that the circumstantial evidence it offered was largely based on conjecture. For example, Equity noted that the Justice Department possessed Equity's tax records and reasoned that under Code Sec. 7602(d)(2), one way that a criminal referral is in effect is when the Justice Department requests a taxpayer's information from the IRS under Code Sec. 6103(h)(3)(B). But the court rejected this argument, observing that the Justice Department can obtain tax information without obtaining it from the IRS. The court said that in fact, the grand jury investigations and warrants relating to the Agees, Inland, and Fisher provided a likely explanation for how the Justice Department came to possess information about Equity's financial dealings and tax returns without making a request under Code Sec. 6103(h)(3)(B).

For a discussion of the IRS's summons authority, see Parker Tax ¶263,120.

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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