The IRS considers information from third parties during audits and in collecting unpaid taxes. The IRS’s efforts to gather this information can significantly harm the taxpayer, as third parties may not want to do business with the taxpayer given the IRS inquiry.
Recognizing this, Congress has imposed rules that limit the IRS’s ability to make these contacts. These rules generally require advance notice, so that the taxpayer can prepare to explain the contact to the third party or to take steps to mitigate the harm.
But what happens if the taxpayer has a business relationship with a Federal agency other than the IRS? What if the relationship wasn’t a business relationship, but that of a creditor or that the party was sued by the federal agency? Can the IRS contact this other Federal agency? The IRS addresses this in CCM 202013015.
What is a Third Party Contact?
- Initiated by an IRS employee,
- Made to a person other than the taxpayer,
- Made with respect to the determination or collection of the tax liability of such taxpayer,
- That discloses the identity of the taxpayer being investigated, and
- That discloses the association of the IRS employee with the IRS.
The authority for third party contacts is found in Sec. 7602(c).
Advance Notice Required
Section 7602(c) authorizes the IRS to make third party contacts as long as it provides the taxpayer with advance notice of the third party contact.
The rules used to require “reasonable notice;” however, this requirement was changed bu the Taxpayer First Act of 2019.
The rules now require the IRS to notify the taxpayer of the IRS’s actual intent to contact third parties. This differs from the prior less specific “may” contact third parties requirement.
Now, the IRS has to provide taxpayers with notice at least 45 days before the IRS contacts a third party. The IRS also has to tell the taxpayer the time period in which it intends to make the contact. This period may not be more than one year, subject to renewal.
As a practical matter, in the past, the IRS used to satisfy this third party contact notice requirement by including an IRS Publication at to the taxpayer at the start of an IRS audit or collection matter. Congress did not think this generic notice was sufficient to alert taxpayers to third party contacts, given the taint IRS contacts can have on the taxpayer’s business and other relationships. The IRS has since amended many of its letters to specify that it will make third party contacts.
The Government Entity Exception
While the Taxpayer First Act of 2019 changed the third party contact rules, it did not make changes as to who the IRS can contact. The “who” is broad. But, as relevant to this post, there is an exception for contacts with the Federal, state, and local governments.
The IRS frequently contacts other government agencies. For example, as tax attorneys in Houston, we often note that the IRS auditors in Houston typically reach out to the Texas Comptroller to obtain sales tax information. IRS employment tax auditors often reach out to the Texas Workforce Commission to obtain payroll records. Taxpayers are not afforded any advance notice of these contacts.
The IRS does not have to provide notice in these instances, given the government-entities exception in the Reg. § 301.7602-2(f)(5):
Section 7602(c) does not apply to any contact with any office of any local, state, Federal or foreign governmental entity….
The regulation goes on to provide an exception to this exception, which bars IRS contact with the government:
concerning the taxpayer’s business with the government office contacted, such as the taxpayer’s contracts with or employment by the office. The term office includes any agent or contractor of the office acting in such capacity.
This exception to the exception helps to protect government contractors from the possibility of losing business with the government due to an IRS contact.
What does this mean? Basically the IRS can contact government agencies without providing advance notice to the taxpayer, unless the contact could have an impact on the taxpayer’s business relationship with the IRS.
Contacting the U.S. Dept. of Justice Attorney
This brings us back to the question asked in this IRS memorandum. Can the IRS auditor or IRS collection agent contact the U.S. Department of Justice Attorney, without notifying the taxpayer?
In this memorandum, the IRS wanted to contact the U.S. Department of Justice attorney who settled a lawsuit with the taxpayer. The taxpayer had deducted the settlement costs. The IRS wanted to verify that the settlement costs were not payment for a penalty, which is not deductible. The IRS wanted documentary information (such as a Financial Management Information Systems report) and to talk to the attorney.
The answer provided by the IRS in its memorandum is that, yes, the IRS can make the contact without providing notice to the taxpayer. The IRS concluded that this was a permissible contact under the government entity exception.