Supreme Court Resolves Circuit Split on Notice Requirement for Third Party Summonses

(Parker Tax Publishing June 2023)

The Supreme Court unanimously held that the exception in Code Sec. 7609(c)(2)(D)(i) to the general rule in Code Sec. 7609(a)(1) requiring notice of a summons to any person identified in the summons for summonses in aid of the collection of an assessment does not require that the delinquent taxpayer have a legal interest in the accounts or records summoned. The Court found that the legal interest requirement, argued by the taxpayer and previously adopted by the Ninth Circuit in Ip v. U.S., 205 F.3d 1168 (9th Cir. 2000), is contrary to the plain language of Code Sec. 7609(c)(2)(D)(i) and is not required in order to avoid rendering the exception in Code Sec. 7609(c)(2)(D)(ii) to the notice requirement superfluous. Polselli et al. v. IRS, 2023 PTC 132 (S. Ct. 2023).

Background

For multiple years between 2005 and 2017, Remo Polselli underpaid his federal taxes. After investigating, the IRS determined that Polselli was liable for the unpaid amounts and other penalties, and entered official assessments against him totaling more than $2 million. Revenue Officer Michael Bryant then set out to collect the money, and he developed a few leads in his search for assets that Polselli may have been concealing. Bryant focused on bank accounts belonging to Polselli's wife, Hanna Karcho Polselli. Bryant also knew that Polselli had paid nearly $300,000 toward part of his outstanding tax liability from an account owned by Dolce Hotel Management, LLC, and surmised that Polselli might have control over funds belonging to that company. To further his investigation, Bryant issued a summons under Code Sec. 7602 to the law firm Abraham & Rose, PLC, where Polselli had long been a client. But the firm produced no records in response, stating that it did not retain any of the documents requested.

Bryant then issued several additional summonses seeking records concerning Polselli. Bryant issued one summons to Wells Fargo, requesting the financial records of both Mrs. Polselli and Dolce Hotel Management. He also issued summonses to JP Morgan Chase and Bank of America, seeking among other things "copies of all bank statements" relating to Mr. Polselli and petitioners Jerry R. Abraham, P. C., and Abraham & Rose, PLC. Bryant did not provide notice to any of the third parties named in the three summonses. But the banks did, and Mrs. Polselli, Jerry R. Abraham, and Abraham & Rose filed motions to quash the summonses in a district court.

The district court dismissed the case for lack of jurisdiction, reasoning that the IRS did not need to provide notice. Appealing to the Sixth Circuit, Mrs. Polselli and the other appellants argued in favor of a rule - previously adopted by the Ninth Circuit in Ip v. U.S., 205 F.3d 1168 (9th Cir. 2000) - requiring that a taxpayer have "some legal interest or title in the object of the summons" for the notice exception in Code Sec. 7609(c)(2)(D)(i) to apply. Under Ip, to decide whether a taxpayer maintains a sufficient legal interest in the object of the summons, the Ninth Circuit considers whether there was an employment, agency, or ownership relationship between the taxpayer and third party.

In Polselli et al. v. U.S. Dept. of the Treasury - IRS, 2022 PTC 4 (6th Cir. 2022), a divided panel of the Sixth Circuit affirmed, reasoning that no notice was required because the summonses at issue fell "squarely within" the exception provided in Code Sec. 7609(c)(2)(D)(i). The Sixth Circuit panel rejected the Ninth Circuit's legal interest test, concluding that it was contrary to the plain language of Code Sec. 7609(c)(2)(D)(i). The panel instead held that "as long as the third-party summons is issued to aid in the collection of any assessed tax liability the notice exception applies." In so concluding, the Sixth Circuit aligned itself with both the Seventh Circuit (Barnes v. U.S., 199 F.3d 386 (7th Cir. 1999)) and the Tenth Circuit (Davidson v. U.S., 149 F.3d 1190 (10th Cir. 1998)). The Supreme Court granted certiorari in order to resolve the split among the circuit courts.

Under Code Sec. 7602(a), the IRS may issue a summons to determine the liability of a taxpayer or any transferee or fiduciary for unpaid taxes, as well as to collect any such liability. Code Sec. 7602(a)(2) allows the IRS to issue summonses to third parties who possess information concerning a delinquent taxpayer. However, Code Sec. 7609(a)(1) generally requires the IRS to give notice of the summons to any person identified in the summons. There are exceptions to the notice requirement. Under Code Sec. 7609(c)(2)(D), the IRS need not provide notice to a person identified in the summons if the summons is issued "in aid of the collection" of: "(i) an assessment made or judgment rendered against the person with respect to whose liability the summons is issued; or (ii) the liability at law or in equity of any transferee or fiduciary of any person referred to in clause (i)." In other words, the IRS may issue summonses both to determine whether a taxpayer owes money and later to collect any outstanding liability. When the IRS conducts an investigation for the purpose of "determining the liability" of a taxpayer, it must provide notice. But once the IRS has reached the stage of "collecting any such liability," notice may not be required.

Mrs. Polselli and the other petitioners presented two primary arguments for why the "legal interest" test adopted by the Ninth Circuit in Ip should apply. First, they argued for a narrow definition of "in aid of collection." In their view, the phrase refers only to inquiries that "directly advance" the IRS's collection efforts. A summons will not directly advance those efforts, they contended, unless it is targeted at an account containing assets that the IRS can collect to satisfy the taxpayer's liability. And, the petitioners said, the only way that a summons issued to a third party will produce collectible assets is if the delinquent taxpayer has a legal interest in the targeted account. Second, the petitioners argued that the exception provided in Code Sec. 7609(c)(2)(D)(i) must be read narrowly so as to avoid making entirely superfluous the exception found in clause (ii). Clause (ii) exempts from notice any summons "issued in aid of the collection of ... the liability at law or in equity of any transferee or fiduciary of any person referred to in clause (i)." According to the petitioners, if clause (i) already exempts from notice every summons that helps the IRS collect an "assessment" against a delinquent taxpayer, there would be no work left for clause (ii) to do. Adding a "legal interest" requirement, the petitioners contended, would cabin the scope of clause (i), leaving some purpose for clause (ii).

Analysis

The Supreme Court unanimously affirmed the Sixth Circuit's judgment. According to the Court, a straightforward reading of the statutory text leads to the conclusion that the notice exception in Code Sec. 7609(c)(2)(D)(i) does not contain a "legal interest" limitation.

The Court found that Code Sec. 7609 sets forth three conditions to exempt the IRS from providing notice in circumstances like those in this case: (1) the summons must be issued in aid of collection, (2) the summons must aid the collection of an assessment made or judgment entered, and (3) the summons must aid the collection of assessments or judgments "against the person with respect to whose liability" the summons is issued. None of the three components for excusing notice in Code Sec. 7609(c)(2)(D)(i), the Court noted, mentions a taxpayer's legal interest in records sought by the IRS, much less requires that a taxpayer maintain such an interest for the exception to apply. The Court found that if Congress wanted to include a legal interest requirement, it knew how to do so, considering that such a requirement is present in Code Sec. 7610, which requires the IRS to "establish the rates and conditions" for reimbursing costs "incurred in searching for, reproducing, or transporting" information sought by a summons, and provides that the IRS may not provide reimbursement if "the person with respect to whose liability the summons is issued has a proprietary interest in" the records "to be produced."

The Court found that the petitioners' argument for a narrow definition of "in aid of collection" did not give a fair reading to that phrase. The Court reasoned that, even if a summons may not itself reveal taxpayer assets that can be collected, it may nonetheless help the IRS find such assets. In addition, the Court rejected the argument that Code Sec. 7609(c)(2)(D)(ii) would be rendered superfluous without reading a "legal interest" requirement into Code Sec. 7609(c)(2)(D)(i). The Court noted two differences between clauses (i) and (ii). First, clause (i) is applicable upon assessment while (ii) applies upon a finding of liability. Second, clauses (i) and (ii) are addressed to different entities; clause (i) concerns assessments or judgments against a taxpayer, while clause (ii) concerns the liability of a transferee or fiduciary. In the Court's view, these distinctions between liability and assessment or judgment, and between taxpayers and their transferees or fiduciaries, show that the exception in clause (ii) applies in situations where clause (i) may not.

The Court did not dismiss any apprehension about the scope of the IRS's authority to issue summonses. The court noted that tax investigations often involve sensitive records and that in this case the IRS sought information from law firms concerning client accounts. The Court noted that the government proposed a test turning on reasonableness as a limit on the "in aid of collection" requirement. However, the Court said this was not the case to define the precise bounds of "in aid of collection" since the parties did not argue, and the Sixth Circuit panel did not decide, the contours of that phrase.

For a discussion of the notice requirement for a third-party summons, 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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