Monday, July 11, 2011

The Long Shot in IRS Summons Avoidance -- the Bad Faith Claim (7/11/11)

The IRM requires that IRS revenue agents discontinue or suspend their audit after receiving firm indications of fraud. Proceeding beyond that point create the risk that the taxpayer will be mislead as to the nature of the investigation (civil or criminal) and result in the taxpayer not being aware that he or she should consider asserting his or her constitutional rights. See generally IRM 25.1.2.  Thus, where the continued audit by the agent results in obtaining incriminating statements from the taxpayer, the taxpayer will cry foul in any resulting criminal prosecution in which the Government attempts to use those confessions. Those taxpayer claims are usually, but not always, unsuccessful unless the taxpayer can show that the agent's continued efforts were based upon some bad faith by affirmative misrepresentation as to the nature of the continued investigation.

The high water mark in terms of sanctions for such affirmative misrepresentations was United States v. Tweel, 550 F.2d 297 (5th Cir. 1977) where a tax indictment was dismissed because the civil agent’s actions misled the taxpayer as to the criminal nature of the investigation.  Since Tweel, the courts have applied the dismissal remedy -- more usually a suppression remedy which might result in dismissal -- sparingly (really almost never), requiring some express misrepresentation (rarely found) rather than just a joint civil and criminal use of the fruits of the audit.  See e.g., United States v. Rutherford, 555 F.3d 190 (6th Cir. 2009). 

This type of bad faith can also be asserted as a basis for denying the IRS ability to judicially enforce a summons. United States v. Powell, 379 U.S. 48, 57-58 (1964) sets minimal standards for judicial enforcement of summonses. One of those minimal standards is that the IRS issue the summons in good faith (or, stated in reverse, that it not be issued in bad faith). See also United States v. LaSalle Nat'l Bank, 437 U.S. 298, 316 (1978).

In United States v. Sakai, 2011 U.S. Dist. LEXIS 69249 (D HI 2011) (Magistrate Judge Findings and Recommendations), adopted as opinion of the Court without objection, 2011 U.S. Dist. LEXIS 70252 (D. HI 2011), the taxpayer was subject to audit. The critical time line is:

On January 29, 2009, IRS Revenue Agent Stephen Nomura began an audit of the Sakais' 2005 federal income tax return. On February 17, 2009, Agent Nomura sent the Sakais an Information Document Request, which requested information concerning the Sakais' Schedule C claims. Subsequently, communications regarding this issue occurred between Agent Nomura and Lai as well as the Sakais' legal counsel, Charles P. Rettig. On April 15, 2009, Agent Nomura advised Mr. Rettig that he needed to interview the Sakais to "verify whether Forms 1099 should have been issued." See Declaration of Charles P. Rettig ("Rettig Decl.") ¶ 9; Reply at 4.

On July 9, 2009, Agent Nomura determined that the Sakais' 2005 federal income tax return "warrants possible assertion of civil fraud penalty." See Exh. 6 to Opposition. On September 3, 2009, in response to an inquiry Mr. Rettig, Agent Nomura disclosed the IRS' consideration of a civil fraud penalty for the Sakais. On that same day, prior to receiving Mr. Rettig's inquiry, Agent Nomura's supervisor suggested that the Sakais' audit be expanded to include the 2003 and 2004 taxable years. On September 4, 2009, counsel for the Sakais submitted a Freedom of Information Act (FOIA) request to the IRS Disclosure Office, seeking all documents relating to their investigation of the Sakais. The IRS responded to the FOIA request on September 30, 2009, but the 475 pages of documents did not reference Forms 1099. See Rettig Decl. ¶ 12.
The IRS thereafter issued a summons to the taxpayer and certain related parties (his corporation and his spouse). The parties refused to produce documents and answer questions, asserting their Fifth Amendment privileges. There is no indication that the matter was ever referred to CI for criminal investigation. Thus, although fraud was considered, it was civil fraud rather than criminal fraud. Presumably, however, the taxpayer and his attorneys were concerned that, with the documents and information that might be disclosed, a criminal investigation and prosecution might still be possible.

Among other defenses (all rejected by the Magistrate Judge), the taxpayers asserted that the IRS revenue agent had acted in bad faith in representing to the taxpayer that he wished to interview the individuals (taxpayer and his spouse) to verify whether Forms 1099 should have been issued. The Magistrate Judge and District Court rejected the claim as follows:

In this case, Respondents claim that the IRS engaged in bad faith when Agent Nomura advised Mr. Rettig that he needed to interview the Sakais to "verify whether Forms 1099 should have been issued" in an April 9, 2009 voicemail message. Respondents argue that Agent Nomura's statement constitutes an "affirmative misrepresentation" made for the purpose of inducing the Sakais to agree to be interviewed. See Opposition at 14. Respondents contend that Agent Nomura should have remained silent, changed the topic, or told the truth, i.e., that the IRS was considering pursuing a civil fraud penalty against the Sakais, because his statement amounts to "fraud and deceit on the part of the government." See id. (citing Groder v. United States, 816 F.2d 139, 144 (4th Cir. 1987)).

However, the Ninth Circuit, in interpreting Groder, emphasized that bad faith is "not simply an agent acting unreasonably or unsatisfactorily." Crystal v. United States, 172 F.3d 1141, 1149 (9th Cir. 1999); see also Groder, 816 F.2d at 145 (rejecting taxpayer's attempt to introduce a "reasonable agent" standard into the bad faith inquiry). Indeed, even if the motivation of an individual IRS agent is suspect, the summons may nevertheless be enforced absent a showing that the improper motivation somehow "infected the institutional posture of the IRS." Crystal, 172 F.3d at 1150 (quoting 2121 Arlington Heights Corp. v IRS, 109 F.3d 1221, 1226 (7th Cir. 1997)).

Here, there is no evidence that Agent Nomura's statement was motivated by an illegitimate purpose or was affirmatively misleading as to the potential consequences of the IRS' audit. In the first place, as soon as the Sakais received the IDR from Agent Nomura on February 17, 2009, the Sakais and their legal counsel were on notice that a civil fraud penalty could be imposed if improprieties were found in their 2005 federal income tax return. Further, the record clearly shows that Agent Nomura did not make the determination that the Sakais should be examined for potential fraud until July 9, 2009, three months after the voicemail message was left. See Exh. 6 to Opposition at 2. Moreover, when Agent Nomura was asked directly by the Sakais' counsel about the possible penalties the IRS was considering, Agent Nomura immediately responded that the IRS was considering a civil fraud penalty. See Exh. 3 to Opposition at 1-2.

In addition, even if Agent Nomura's conduct was suspect, there is no evidence in the record that it somehow infected the institutional posture of the IRS. In fact, once the neutrality of Agent Nomura was called into question by the Sakais' counsel, the IRS promptly reassigned the case to Agent Tsuha. See Rettig Decl. ¶ 16.

Finally, even if it was assumed that Agent Nomura's statement was false and misleading, Respondents did not suffer any harm as a result. Unlike the taxpayers in Crystal, Respondents did not voluntarily disclose any information in detrimental reliance upon an agent's statement. Rather, in the present case, Respondents flatly refused to turn over any documents or answer any questions other than their name, current address, and cell phone number in response to the instant summonses. For these reasons, the Court finds that Respondents have failed to allege specific facts of bad faith to invalidate the summonses.
In short, as in the suppression context despite the Tweel precedent, it will be the rare case indeed that a court will be inclined to find the type of bad faith that will result in any action favorable to the taxpayer.


  1. Another great post, especially since I was just clipping this case for a later book supplement. I co-authored the seminal article on Tweel as a law student many years ago. I do not think that there will be an actionable affirmative misrepresentation determined like that ever again. Later cases all water it down.

    As a side note, contesting a summons and losing carries some negatives. One is the courts costs. Another is that contesting a summons can be viewed as an indicium of fraud. And of course, some summons compliance contests toll the SOL.

  2. I agree with Mr. Harris's points that Tweel has been watered down and that most IRS agents are not so unwise as to affirmatively deceive or mislead anyone. Nevertheless, I respectfully disagree with his view that contesting a summons is pervaded with negatives. On the contrary, challenging a summons based on Fifth Amendment grounds often brings positive results.

    The important thing is finding an energetic attorney who is well versed in the wide-ranging Fifth Amendment jurisprudence including such vital areas as the "Hoffman doctrine" (341 US 479, 486-87 (1951)), the act-of-production doctrine first enunciated in Doe (1984), the collective entity doctrine enunciated in Braswell (1988), the "Shapiro doctrine" (1948), the waiver doctrine enunciated in Rodgers (1951)/Klein v. Harris (2nd. Cir. 1981), and the reach of use/derivative use immunity enunciated in such cases as Murphy (1964), Kastigar (1972), McDaniel (8th. Cir. 1973(, Portash (1979), Apfelbaum (1980), North (D.C. Cir. 1990), Hubbell (2000) and Ponds (D.C. Cir. 2006).

    One more thing: I have found the US DOJ Tax Division's Summons Enforcement Manual very helpful. Ideally, it should be read together with such fine resources as Jack's materials, IRS Practice and Procedure by Michael Saltzman, the IRM, the USAM and the US DOJ Tax Division's Criminal Tax Manual.


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