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Senator Hatch questions legality of IRS’s use of third-party contractors in audit

Senate Finance Committee Chairman Orrin Hatch (R-UT) sent a letter on May 13 to IRS Commissioner John Koskinen criticizing the agency’s use of a private law firm to assist in its audit of Microsoft Corp. Senator Hatch said this tactic appeared to violate federal law and the express will of the Congress and removed taxpayer protections by allowing the performance of inherently governmental functions by private contractors. He also questioned whether it was an appropriate use of IRS’s limited resources.

Background. Under Code Sec. 6201, IRS is authorized and required to make inquiries, determinations, and assessments of taxes (including interest, additional amounts, additions to the tax, and assessable penalties) imposed by the Code.

IRS is authorized to examine books and records, and to take testimony under oath, for purposes of ascertaining the correctness of a return, making a return where none has been made, determining the liability of any person for any internal revenue tax, determining the liability at law or in equity of any transferee or fiduciary of any person in respect of any internal revenue tax, collecting any such liability, or inquiring into an offense connected with the tax laws. (Code Sec. 7602(b))

In addition, IRS is authorized to: a) issue summonses to appear before one or more officers or employees of IRS (defined to include officers or employees of the Office of Chief Counsel), at the time and place named in the summons, and to produce those books, records, or other data material; and b) require testimony under oath, as is material to the inquiries listed above. IRS may designate one or more officers or employees of IRS as the individuals before whom a person summoned is to appear, and any so designated officer or employee is authorized to take testimony under oath of the summoned person, and to received the summoned books, etc. in compliance with the summons. (Code Sec. 7602(a); Reg. § 301.7602-1(b)(1))

Persons who may be summoned are the person liable for any internal revenue tax or required to perform the act of collecting such tax liability; any officer or employee of such person; any person having possession, custody, or care of books of account containing entries relating to the business of the person liable for the tax or required to perform the act; and any other person who may be considered proper by the officer issuing the summons. (Code Sec. 7602(a)(2); Reg. § 301.7602-1(b)(1))

Code Sec. 6103(n) and its regs provide a list of “certain other persons” to whom returns and return information can be disclosed as an exception to Code Sec. 6103(a)’s general confidentiality rule. These include “any person…to the extent necessary in connection with the processing, storage, transmission, and reproduction of such returns and return information, the programming, maintenance, repair, testing, and procurement of equipment, and the providing of other services, for purposes of tax administration.” (Code Sec. 6103(n)) The regs further clarify that such persons can include, for example, agents or subcontractors, who, as required, can further disclose returns or return information to another officer or employee of the agent or subcontractor “whose duties or responsibility require the returns or return information” for a permissible purpose. (Reg. § 301.6103(n)-1(a))

In June of 2014, IRS issued a temporary reg, the text of which serves as the text of a contemporaneously issued proposed reg, that modifies the existing Code Sec. 7602(a) regs relating to administrative summonses (see Weekly Alert ¶  1  06/19/2014). The temporary reg clarifies that persons with whom IRS or the Office of Chief Counsel contracts for services described in Code Sec. 6103(n) and Reg. § 301.6103(n)-1(a) may be included as persons designated to receive summoned books, papers, records, or other data and to take summoned testimony under oath. While IRS officers and employees remain responsible for issuing summonses and developing and conducting examinations, the new regs clarify that IRS contractors are permitted to participate fully in a summons interview. Full participation includes, but is not limited to: receipt, review, and use of summoned books, papers, records, or other data; being present during summons interviews; questioning the person providing testimony under oath; and asking a summoned person’s representative to clarify an objection or an assertion of privilege. (Reg. § 301.7602-1T(b)(3))

While the Secretary of the Treasury has broad powers to delegate authorities under the Code, Code Sec. 7701(a)(12)(A) provides that any delegation is limited to an “officer, employee, or agency of the Treasury Department”—unless Congress expressly grants broader authority.

In the past few months, in summon enforcement proceedings in a transfer pricing dispute, Microsoft Corp has opposed the enforcement of IRS summonses claiming that it would be an abuse of process because IRS had improperly attempted to insert a third-party contractor into an inherently governmental function. IRS had retained the private law firm of Quinn Emanuel Urquhart & Sullivan, LLP (Quinn Emanuel) to prepare for litigation. The summonses contemplated that Quinn Emanuel would take sworn testimony in audit interviews. Microsoft claimed that Quinn Emanuel’s participation in the audit violated the Code, relied upon an invalid reg, and was an impermissible delegation of an inherently governmental function.

Senator’s objections. In his letter, Senator Hatch stated that, despite the fact it was issued as a “clarification,” the temporary reg—which allows private contractors to question a witness under oath and ask the witness to clarify objections or assertions of privilege—is an unprecedented expansion of the role of outside contractors in the examination process that violates the Code. The temporary reg, which was issued only weeks after retaining the law firm Quinn Emanuel and without a notice and comment period, runs contrary to Congress’ intent. In the Code, and specifically in Code Sec. 6201, Code Sec. 7602, and Code Sec. 7701, Congress intentionally chose to restrict the performance of certain revenue functions, such as examinations and the taking of sworn testimony, to the Secretary and limited delegates.

Senator Hatch said that turning over inherently government functions, such as the conduct of an examination to private contractors, not only jeopardizes the rights of taxpayers but also confuses the examination process and changes the well-regulated relationship between revenue examiners and private taxpayers. This practice would give private attorneys access to confidential taxpayer information while raising questions over how well that information is then protected from further disclosure. Unlike private contractors, Treasury Department officials are required to swear an oath to the Constitution and are subject to rules of conduct and federal law regulating their interactions with taxpayers

The Senator noted that IRS has over 40,000 employees dedicated to enforcement efforts, including more than 36,000 tasked specifically with exams and collections. Nonetheless, IRS has hired the private contractors under a $2.2 million contract and is paying private attorneys over $1,000 an hour to carry out functions that are more properly carried out by Treasury officials. If none of these IRS employees had sufficient expertise to undertake the examination at hand, the Senator said that there should be a broader conversation about the agency’s hiring practices and recruitment needs.

Immediate action requested. Senator Hatch asked the IRS Commissioner to immediately halt the use of the private contractors for both the examination of records and the taking of sworn testimony. He also asked IRS to brief the Senate Finance Committee staff, without delay, on:

…the reasoning behind and procedure by which IRS issued the temporary reg;
…IRS’s interpretation of the relevant Code provisions;
…the use of private contractors for examination functions generally;
…whether IRS intends to use private contractors to represent IRS in litigation, either under contract and/or as special government employees; and
…whether this practice will be used against other taxpayers.

References: For IRS’s summons authority, see FTC 2d/FIN ¶  T-1201  et seq.; United States Tax Reporter ¶  76,024; TaxDesk ¶  822,001; TG ¶  70004.

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