IRS gets major power to request private tax information after Supreme Court ruling

How much can the IRS snoop around your business without you knowing? Much more now, after a recent Supreme Court ruling that raised privacy concerns among experts.

Last month, the nation’s highest court unanimously sided with the IRS in Polselli v. Internal Revenue Servicestrengthening the ability of the tax administration to request documents or financial records from those associated with a delinquent taxpayer without notifying that third party.

The decision has strengthened the tax authority’s ability to obtain secret information, experts say, and gives the IRS too much power and too few limits on how that information can be used.

“I think the problem would be that it allows the IRS to ultimately have access to information that is supposed to be related to Taxpayer A’s collection of taxes, but then inevitably it’s information about Taxpayer B that would not otherwise have been available to the IRS,” Michael Sardar, tax controversy attorney and partner at Kostelanetz LLP, told Yahoo Finance.

The Supreme Court unanimously sided with the IRS in Polselli v.  Internal Revenue Service.

Dry Cleaner Theory

Judge Ketanji Brown Jackson used the example of a dry cleaner to illustrate the potential scope of this law in the court’s brief. In summary, she proposed the following.

Think of a delinquent taxpayer who frequents a family dry cleaner. If the IRS believes that the dry cleaner’s financial records could help with tax collection, the agency could issue summons to the dry cleaner’s bank for years and years of financial statements without even notifying the store owners.

In this scenario, merchants are powerless to oppose the collection request.

“It’s really important to give someone a chance to go to court and say, ‘Wait, I’m that dry cleaner, who’s just an innocent third party who’s just doing regular business'” , Tyler Martinez, senior attorney at National Taxpayers Union Foundation, told Yahoo Finance.

The ruling also lacked clarity on how often the IRS can use the information obtained. Although the court brief says the agency can only use the summons against the taxpayer to whom the summons relates, experts are concerned that the IRS could use the same request as a pretext for another case.

“While the summons is meant to be for Taxpayer A, if the IRS finds anything suspicious in a third party’s records, the concern is that the IRS will use that information to launch a new investigation of another taxpayer,” Martinez said.

Although Sardar noted that there are safeguards within the IRS to prevent cross-referencing of information from different cases, he acknowledges that typical bank statements are not inside information.

A close up of a stamped folder

A close-up of a folder stamped “Confidential” rests on an IRS Form 1040 document.

Another concern is simply the issue of privacy.

“I think judges are generally worried about people playing the system so they don’t pay taxes. I don’t think that should be the attitude of judges,” Martinez said. “They should treat this like any other law enforcement context where you would need to give notice and allow people to defend their privacy rights in court. Certainly when it comes to a third.”

“From a privacy concern about what information we want the IRS to have, one would hope the court would have been a little more attentive to that aspect of things,” Sardar added.

Polselli against the tax administration

The whole drama started when an IRS agent suspected Remo Polselli, a taxpayer who owed the IRS $2 million in unpaid taxes and penalties, of hiding assets as part of his business ventures. The officer turned to Polselli’s law firm, where he has been a long-time client, and unsuccessfully requested documents including invoices, billing statements, canceled checks and wire transfers.

The officer then summoned banks to obtain financial records relating to Poselli, Poselli’s wife, and his law firm. The law firms filed a federal lawsuit to block the claims after learning of the summons from their banks.

However, the court concluded that since no notice was required, the law firm therefore could not block the application.

“The key is if you don’t have notice, you don’t have the ability to move to cancel it,” Sardar said. “That’s a big deal, the IRS is able to get records on you and you don’t even have an opinion on it.”

When notice is required

FILE - Outside the Internal Revenue Service (IRS) in Washington, March 22, 2013. In an effort to stop personal threats against IRS employees, the agency says it will begin limiting workers& #x002019;  personal identification information on communications with taxpayers.  (AP Photo/Susan Walsh, File)

The exterior of the Internal Revenue Service (IRS) building in Washington, March 22, 2013. (AP Photo/Susan Walsh, File)

An important distinction the Supreme Court made in this case is that the IRS can issue a subpoena to help determine taxes owed, but it must provide notices to do so, according to IRC 7609(a)(1). But if the summons is to help collect that balance, no notice is required, according to IRC 7609(c)(2)(D).

The ruling helps the agency collect unpaid taxes in two ways. First, taxpayers or their associates can’t squash a claim because they don’t know it exists, and second, ill-intentioned debtors can’t move their assets into someone else’s name.

“What happens sometimes in the tax collection business is that taxpayers start doing creative things so that the money isn’t in their name,” Sardar said, “so I’m not not shocked or terribly upset that this decision is what it is.”

But Sardar still thinks the ruling could have been more specific in addressing third-party privacy concerns.

“Personally, I’m disappointed,” he said. “I would have hoped there would be more consideration.”

Rebecca Chen is a reporter for Yahoo Finance and previously worked as a Certified Public Accountant (CPA).

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