We often get questions as to whether IRS agents can contact various third parties during the course of an IRS audit. The general rule is that IRS agents can in fact contact third parties. And they sometimes do. The ability to do this is limited and it does not exempt IRS agents from the confidentiality rules.
IRS Agents Typically Do Not Contact Third Parties
As a practical matter, the IRS directs its agents to avoid third party contacts where possible. In fact, IRS agents usually do not have an incentive to make inquiries of third parties. Setting aside the nuances, taxpayers generally have the burden to show that their tax tax positions are correct. So the lack of information can and often does help the IRS’s position on audit.
The General Third Party Contact Rule
If you are reading this article, you are probably more interested in the rules that come into play when the third party has harmful information that the IRS agent would like to obtain or it is thought that the third party has this information.
Again, the general rule is that the IRS agent may contact any person other than the taxpayer with respect to the determination or collection of the taxpayer’s tax liability.
IRS agents may not do so unless the agent gives the taxpayer reasonable notice in advance that such contacts may be made. IRS agents usually satisfy this notice requirement by providing the taxpayer with Publication 1, which, among other things, says that third party contacts may be made. The publication is typically provided to taxpayers at the start of the IRS audit and it does not list the individuals who will or who may be contacted. The IRS may also use Letter 3164 or provide the notice verbally.
The rules go on to say that upon request, IRS agents have to provide the taxpayer with a record that identifies the persons who are contacted. IRS agents are supposed to record this information on a form in their case files (on Form 12175), so it can be provided upon request. While required, it is common for IRS agents not to create this record unless it is requested by the taxpayer.
Third Party Contacts
These rules only apply to third party contacts. Not every contact is considered a “third party contact.” There are five elements for determining whether a contract is considered a “third party contact.” These elements say that a third party contact is a communication:
- Initiated by the IRS;
- Made to a person other than the taxpayer, another IRS employee, the taxpayer’s employees/fiduciaries, or any computer database or website;
- Made with respect to the determination or collection of the tax liability of such taxpayer;
- That discloses the identity of the taxpayer being investigated (either directly or by implication); and
- That discloses the association of the IRS employee with the IRS (either directly or by implication).
All of these elements must be met in order for the contact to be a “third party contact.”
When Advance Notice is Not Required
Even if the contact is a third party contact, there are several exceptions to these rules that allow IRS agents to contact third parties without providing the taxpayer with advance notice. These exceptions include communications made:
- To the taxpayer or their representative.
- When there is a good faith belief that providing the taxpayer with either a general pre-contact notice or a record of the specific person contacted may jeopardize the collection of any tax.
- When the IRS agent has good cause to believe that providing the taxpayer with either a general pre-contact notice or a specific record of the person being contacted may cause harm to any person in any way, physically, economically, emotionally or otherwise (a statement by the third party that harm may occur to any person is sufficient to constitute good cause).
- Made during criminal investigations or any inquiry to determine whether to open a criminal investigation.
- Made to governmental entities, including any office of any local, state, Federal or foreign governmental entity, except for contacts concerning the taxpayer’s trade or business with that government office, such as the taxpayer’s contracts with or employment by the office.
- Made to confidential informants if the IRS agent has good cause to believe that providing either the precontact notice or the record of the person contacted would identify a confidential informant whose identity would be protected under Section 6103(h)(4).
- Made in the course of a pending court proceeding.
If any one of these exceptions are met, IRS agents can contact the third party without providing the taxpayer with advance notice.
Confidentiality and Section 6103
The IRS agent will still have to comply with the confidentiality rules in Section 6103. Section 6103(a) provides that returns and return information shall be confidential.
The terms “return” and “return information” are defined broadly. Section 6103(b)(1) defines the term “return” as the actual form filed by the taxpayer, including any supporting schedules, as well as any information return filed by a third party on behalf of or with respect to the taxpayer. Even an item of return information that has its identifier removed is still return information under these rules.
Section 6103(b)(2) defines the term “return information” to include any information gathered by the IRS with regard to a taxpayer’s liability under the Code. It includes, but is not limited to, the taxpayer’s identity, the nature, source, or amount of income, whether the return was, is being, or will be examined or subject to other investigation or processing, and any other data which is received by, recorded by, prepared by, furnished to, or collected by the IRS; with respect to a return or with respect to the determination of the existence or possible existence of liability or the amount of liability under the Code.
There are several exceptions to these rules in Section 6103, which are similar to the exceptions for advance notice of third party contacts described above.
Remedy for the IRS’s Violation of the Confidentiality Rules
Section 7431 provides taxpayers with a civil remedy when their tax return information is disclosed in an unauthorized manner. Specifically, it authorizes a taxpayer to bring a civil cause of action for damages against the U.S. government in district court if a United States officer or employee knowingly or negligently inspects or discloses a taxpayer’s return or return information in violation of Section 6103. Section 7431(c)(3) also allows the taxpayer to recover reasonable attorneys’ fees if he is the prevailing party.