Thursday, July 20, 2017

Court Dismisses Claims Where IRS Issued JDS Without Required Court Approval for JDS (7/20/17)

In Hohman v. United States, 2017 U.S. Dist. LEXIS 106439 (ED MI 2017), here, the district court finally dismissed a case where the plaintiffs sued on various claims arising from the IRS's service of John Doe Summonses on a bank.  The thing that caught my attention was that, prior to serving the JDSs on the bank, the IRS did not obtain the predicate court order required by § 7609(f), here.   The summonses are here and here.

My reaction was: "Wow!"

So, I pulled up some of the documents from Pacer, the online system to review and download court documents.  I have limited time that I can devote to these interesting issues, so here is what I picked up in the time allowed.  The documents reviewed are:

1.  The docket entries (as of today), here.
2.  Government Brief on Motion to Dismiss (Dkt. 12), here.
3.  IRS Agent Affidavit (Exhibit to Government Brief (Dkt.12 Exh), here.
4.  Order (Dkt27), here.
5.  Final Order (Dkt45), here.

I could not find quickly an adequate explanation for why the IRS agents involved issued the two JDSs without court approval.  I could only find that they did.   On the face of the summonses, they were issued by a revenue agent and approved by a group manager.  The revenue agent's affidavit did not explain why the summonses were issued without court approval, but did say that the limited production was not reviewed because, by the time of delivery, the IRS was aware of a problem.

The following is what the Government said in an early brief in the case:
The first John Doe summons was issued on September 25, 2015. ¶ 34. The second John Doe summons was issued on September 30, 2015. ¶ 54. Copies of the two summonses are attached hereto as Exhibits 1 and 2.2 
The summonses requested signature cards, monthly checking account statements, and cancelled checks for specified account numbers (which have been redacted). Exs. 1, 2. Both summonses were issued “in the matter of John Doe,” id., and neither identified any “person with respect to whose liability” it was issued, § 7609(f). In keeping with John Doe summons procedures, the IRS did not give notice to the then-unknown account holders, which turned out to be plaintiffs. Nonetheless, Ms. Hohman and Jhoman learned about the summons of September 25, 2015, from the bank (Compl. ¶ 38) and filed a petition to quash the summons in this court on November 25, 2015 (¶ 51), see Case No. 2:15-mc-51669-VAR-APP.  
To address concerns raised in the petition, the IRS agent who had issued both summonses gave a sworn declaration to counsel for Ms. Hohman and Jhohman (Complaint ¶ 52) dated January 4, 2016, a copy of which is attached as Exhibit 3.4 The declaration stated that the agent withdrew both summonses via letters dated December 17, 2015 (Ex. 3 ¶¶ 9, 13), copies of which were attached to the declaration and are also attached hereto as Exhibits 4 and 5. The declaration added that none of the materials received in response to the first summons were reviewed by the IRS (Ex. 3 ¶¶ 5-8). The IRS never received any materials in response to the second summons. Id. ¶ 13. Apparently satisfied, Ms. Hohman and Jhoman voluntarily dismissed their petition the next day on January 5, 2016. 
Nonetheless, three months later plaintiffs filed the instant four-count complaint against the United States5, the IRS agent who issued the summonses (C. Mei Chung), and her manager (Maurice Eadie). Count One seeks damages under the Right to Financial Privacy Act (RFPA), 12 U.S.C. § 3401 et seq. Count Two seeks damages under the Privacy Act, 5 U.S.C. § 552a. Count Three seeks damages, as well as injunctive and declaratory relief, against both the individual IRS employees named as defendants and the United States for alleged constitutional violations. Count Four seeks damages under 26 U.S.C. § 7431.
The Court ultimately dismissed all counts.  The principal issue thrashed around by the court related to Right to Financial Privacy Act (RFPA), 12 U.S.C. § 3401, et seq.  I am not particularly interested in that issue, so I refer readers who are to the court orders for its analysis.  I am interested in the IRS's failure to obtain court orders for the JDSs.  What is the story there?  I am not sure that I have an adequate answer to that broad question.  I do have some more specific questions. I will just list them below and provide some answers if I can give them or reasonably speculate about them.

1.            Was this service of the JDS without a court order an isolated event or has it happened in other cases?

2.            Does the owner of the records obtained under a JDS have any remedy for failure to obtain the court approval.  The requirement of a court order is a statutory protection for the unnamed taxpayers with the court serving as a proxy to assure the integrity of the JDS process.  The Government argued, apparently successfully that there is no statutory remedy and the fall-back Bivens action for constitutional violations does not apply.  The Government argued:
In Count Three, Sixth Circuit precedent holds that a Bivens action is not available against IRS agents for actions arising out of collection of taxes. Sachs v. US ex. rel. IRS, 59 F. App’x 116, 2003 WL 458745 at *3 (6th Cir. 2003). Injunctive and declaratory relief is barred by the AIA, 26 U.S.C. § 7421(a), and tax exception to the DJA, 28 U.S.C. § 2201(a). A summons for bank records does not raise a constitutional question. United States v. Miller, 425 U.S. 435, 442 (1976).
3.            One potential remedy might be exclusion of the information and documents and derivative information and documents in a criminal case.  The affidavit indicates that the the documents were not reviewed, so the documents might  be excluded unless obtained from an untainted source.  The Government would have to get past a Kastigar hearing on that.  And, the issuance by a revenue agent suggests that this is not a criminal investigation anyway.

4.            Is there no requirement that the JDS served on the record-keeper be accompanied by either a copy of the judicial order or at least some affirmative specific representation that such an order has been obtained?  I don't know that answer to this.

5.            Is there no requirement that the recipient of the JDS verify if it has been properly issued?  I don't know the answer to this.

6.            What are the sanctions for the IRS personnel issuing the JDS without the required court order?  I presume that there must be some sanction, but that is only an assumption.

7.            Did the underlying investigation relate to offshore accounts? (E.g., the DOJ or IRS may have gotten information from Swiss banks as to U.S. bank account numbers wiring into the Swiss banks or receiving wires from the Swiss banks and might only have the account numbers; DOJ or IRS could have gotten the information in the required disclosures under the DOJ Swiss bank Program.)  I have no information indicated that foreign bank accounts are involved.

8.            Variation on the same question, if not foreign accounts, how and why did the IRS have the account numbers but not the account holder information?

9.            If the investigation in which the JDS was issued were with respect to another taxpayer (say a vendor from into whose account monies were wired or a customer who wired monies into the account), why didn’t the IRS use the regular summons?  See IRM  (02-01-2011), John Doe Summonses, here (calling the regular summons  in this context a dual purpose summons).

I also provide the following from the working draft of next edition of my Federal Tax Procedure book dealing with the need for the court order for the JDS (note that I omit all footnotes except two:
The “John Doe Summons” (“JDS”) is a summons to a third party who has or may have information related to one or more taxpayers whose identities are unknown to the IRS.  § 7609(f). The quintessential example of a target of a JDS is the promoter of an allegedly abusive tax shelter that has been widely sold where the IRS desires to discover the names of all the investors.  
Since the JDS is issued to determine the identity of one or more unknown taxpayers as well as to obtain other tax relevant information or documents, the IRS cannot give the taxpayer(s) notice otherwise required for third party summonses. n1620 Rather, the IRS must first convince a court that the investigation relates to a particular person or ascertainable group or class of persons, that there is reasonable cause to believe that the person or persons so identified may not have complied with the tax laws, and that the information sought is not readily available from other sources.  The check in the normal third party summons procedures is that the taxpayer, who must be notified (subject to the rules noted above), will have the incentive to contest any overreaching by the IRS.  As to unidentified taxpayers, however, the IRS cannot provide notice because it does not know who they are.  The requirement for advance court approval for such summonses is a surrogate -- a check by an objective third party -- for notice to the taxpayer.
   n1620 § 7609(c)(2)(F) excepts this situation from the general taxpayer notice requirement.  See also Regs. 301.7609-2(f).
   n1621 See United States v. Gertner, 65 F.3d 963, 965 n.1 (1st Cir. 1995) (“[T]he court in effect ‘takes the place of the affected taxpayer’ who, being unnamed, cannot herself be expected to know about—let alone to oppose—the summons even if it is irregular.” (quoting Tiffany Fine Arts, 469 U.S. at 321)).”  Congress could have required – but did not require – that the summoned party, who presumably does know the unnamed targets of the summons, give timely notice to those targets which could give them an opportunity to contest the summons.  Congress did, however, require that the summoned party give notice to those persons when the statute of limitations has been suspended by noncompliance with the JDS.  § 7609(i).  That notice, however, would only be given 6 months after service of the summons.  § 7609(e)(2). 
Like the regular summons, “in  the absence of the resolution of the summoned party’s response to the summons,” the JDS extends the tax statutes of limitation – civil and criminal – for the unidentified persons within the scope of the JDS.  The person receiving the JDS is required to give notice of the statute extension to those unidentified persons. 
The JDS procedures were designed to provide checks and balances.  But, the IRS often finds that the procedures are slower and more cumbersome that the regular summons. For the JDS, the IRS must convince DOJ Tax, whose attorneys are plenty busy with other work, that it is worth going through the procedures to get the summons.  DOJ Tax must gear up and present the matter to a frequently skeptical and almost always overworked District Judge who must play devil's advocate to the Government's ex parte application for the summons.  Obviously, the IRS would much prefer just to use its administrative summons which has no such cumbersome steps.  
In United States v. Tiffany Fine Arts, Inc., 469 U.S. 310 (1985), the Supreme Court blessed the IRS's use of the regular administrative summons rather than the JDS where the target of the summons had transactions relevant to its tax liability which, if discovered, might also identify unknown third parties’ and be relevant to their tax liabilities.  The person summonsed in Tiffany Fine Arts was a tax shelter promoter who sold the allegedly abusive tax shelter product to unknown third parties.  By allegedly investigating the promoter’s tax liability by inquiring into the sources of its income, the IRS could summons the information under the general administrative summons by meeting the minimal requirements of Powell. The Supreme Court blessed that gambit and refused to require the JDS procedure.  After Tiffany Fine Arts, the IRS saw the end-run around the JDS  procedures -- simply find a reason to audit the third party record-keeper such as the tax shelter promoter and find some pretext that obtaining the names of the third parties is relevant under the Powell standards to the audit of the third party record-keeper; indeed, in the IRM, the agents are encouraged to seek such a “dual-purpose” regular summons as in Tiffany-Fine Arts
In United States v. Gertner, 65 F.3d 963 (1st Cir. 1995), which you should now read, a law firm filed a Form 8300 (Report of Cash Payments Over $10,000 Received in a Trade or Business) notifying the IRS that the law firm had received in excess of $10,000 in cash.  The form, however, failed to identify the taxpayer, asserting ethical grounds, the attorney client privilege and constitutional grounds. The IRS then issued a regular IRS summons to the law firm to produce the withheld information.  The IRS used the regular IRS summons as opposed to the JDS on the ground the Supreme Court blessed in Tiffany Fine Arts -- i.e., that the summonsee's – the law firm’s – taxes were being investigated as well as the unknown taxpayer's taxes.  Analyzing the case under the Powell good faith standard, the district court concluded that the IRS's grounds for using the general summons -- i.e., that it was investigating the law firm's tax liability -- was pretextual, mere smoke and mirrors to achieve the real goal of discovering the identify the unknown taxpayer in order to investigate him.  The Court of Appeals affirmed, noting importantly that the JDS procedure required advance court approval, a procedure the Government sought to avoid here on the pretext that it was after something more than the taxpayer's identity.  The Court of Appeals noted that the requirement of advance court approval could not be ignored by the IRS simply by chanting in the affidavit a litany based on Tiffany Fine Arts. 
In the IRS moves against tax shelters, the IRS issued general IRS summonses directly to advisors promoting the products (large accounting and law firms) to obtain the lists of investors that the statute requires them to keep when selling tax shelters.  The general summons was used because the obligation to maintain the lists is on the promoter and thus the IRS was investigating whether the promoters had met that obligation.  Obviously, if the IRS got such a list, the IRS would have the identities of the investors and could proceed against them accordingly.  The accounting and law firms, looking to protect their “clients,” asserted the various privileges (including the attorney-client identity privilege and a variant thereof under the new tax practitioner privilege under § 7525).  After meeting some resistance in the courts, the IRS shifted to using the JDS against the accounting and law firms, and indeed in a recent filing used both the regular summons and JDS.  In the class materials is a copy of the enforcement petition in that recent filing.  It is perhaps not yet foreclosed that the IRS will not ultimately be successful, but the likelihood is that the IRS  will be able to obtain the identities of the investors. 
In two successive initiatives involving foreign bank accounts, the Government has also used JDSs to identify holders of foreign bank accounts and foreign bank credit or debit cards that are the frequent tools of U.S. tax evaders.  The first round in the late 1990s was directed toward the Caribbean banks offering credit cards to the U.S. taxpayers that supposedly left no U.S. paper trail.  The JDS was issued to the U.S. based credit card receipt processors.  The second round, a 2009 initiative, was against UBS, a prominent Swiss bank, that allegedly had up to 52,000 U.S. taxpayer accounts and had extensive U.S. presence so as to be subject to the jurisdiction of U.S. courts.  The IRS’s ability ultimately to force compliance with the summons to UBS, a foreign bank, was ultimately never tested because the Government combined a criminal initiative against UBS (ultimately including a deferred prosecution agreement and a fine of $780 million).  The combination gave UBS and the Swiss Government incentive to reach a deal with the United States.  Compliance ultimately came, at least for 4,500 of the names, from Switzerland’s re-imagination of its obligations under the mutual information exchange provisions of the U.S. / Switzerland’s double tax treaty.  The IRS has used similar JDS’s against other foreign banks with sufficient U.S. presence directly or through subsidiaries to be within the compulsive power of the JDS. 
Both of the initiatives discussed in the last paragraph were coupled with specially targeted voluntary disclosure initiatives to get the U.S. taxpayers to pony up the information and delinquent tax and interest in exchange for reduced penalties.  In the case of the second initiative, the penalty relief included relief from the potentially draconian FBAR penalties discussed beginning on p. 176.  I discuss these voluntary disclosure initiatives beginning on p. 377. 
Since the UBS JDS, the IRS has continued to use the JDS in its broader offshore account initiative when it has been able to obtain a foreign bank affiliate with sufficient U.S. presence to support the issuance of a summons with effective contempt power. 
In 2016, the IRS obtained court permission to serve a JDS on a leading “bitcoin” processor located in the U.S.  Bitcoin is an internet based medium of exchange with features of currency that seemed to offer anonymity to users.  Law enforcement is concerned that bitcoin attracts illegal activity, such as money laundering.  In the tax setting, bitcoin’s perceived anonymity seemed to offer tax evaders the type of risk profile that previously attracted tax risk takers to offshore bank accounts.  The IRS had information that bitcoins had been used to repatriate money from offshore accounts.  The JDS seeks the names of the unknown users of bitcoin accounts, similar to the way the UBS JDS was used for unknown account holders. 
Bitcoin is only one type of “virtual” currency that may lend itself to criminal activity, including tax evasion.  There are reports that the IRS may expand this activity to other virtual currencies.

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