How much can the IRS snoop in your business without you knowing? A lot more now, after a recent Supreme Court decision that is raising privacy concerns among experts.
Last month, the highest court in the nation unanimously sided with the IRS in Polselli v. Internal Revenue Service, solidifying the tax agency's ability to ask for documents or financial records of those associated with a delinquent taxpayer without notifying that third party.
The decision reinforced the tax agency's capacity to get information under wraps, experts say, and gives the IRS too much power and too few limits on how that information can be used.
"I think the concern would be that this allows the IRS to ultimately get access to information that purportedly is in connection with collecting taxes from taxpayer A, but then, inevitably, it is information about taxpayer B that wouldn't have otherwise been available to the IRS," Michael Sardar, tax controversy attorney and partner at Kostelanetz LLP, told Yahoo Finance.
Supreme Court unanimously sided with the IRS in Polselli v. Internal Revenue Service.Dry cleaner theoryJustice Ketanji Brown Jackson used the example of a dry cleaner to illustrate the potential extent of this law in the court brief. In summary, she offered the following.
Think about a delinquent taxpayer who frequents a mom-and-pop dry cleaner. If the IRS believes that financial records from the dry cleaner could help in tax collection, the agency could issue summons to the dry cleaner's bank for years and years of financial statements without even notifying the shop owners.
In this scenario, the shop owners are powerless to object to the collection request.
"It is really important to give a chance for somebody to go to court and say, 'wait, I am that dry cleaner, which is 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 widely the IRS can use information obtained. Although the court's brief said the agency can only use the summons against the taxpayer concerned in the summons, experts worry that the IRS could use the same request as the pretext for another case.
"While the summons is supposed to be about Taxpayer A, if the IRS find something fishy in a third-party's records, then the worry is that the IRS will use that information to launch yet another investigation into another taxpayer," Martinez said.
Although Sardar did note that there are safeguards within the IRS to prevent the crossing over of information from different cases, he acknowledges that typical bank records are not privileged information.
A close up of a file folder stamped "Confidential" rests on top of an IRS Form 1040 document.Another concern is simply the question of privacy.
"I think generally judges are worried about people gaming the system to not pay taxes. I don't think that 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 let people defend their privacy rights in court. Certainly when they're a third party."
"From a privacy concern about what information we want the IRS to have, one would have hoped the court would have been a little bit more attentive to that side of things," Sardar added.
Polselli vs Internal Revenue ServiceThe whole drama began when an IRS agent suspected Remo Polselli, a taxpayer who owed the IRS $2 million in unpaid taxes and penalties, was hiding assets under his business ventures. The officer turned to Polselli's law firm, where he has long been a client, and unsuccessfully requested documentation — including invoices, billing statements, canceled checks, and wire transfers.
The officer then summoned banks for financial records concerning Poselli, Poselli's wife, and his law firm. The law firms filed a federal suit to block the requests after learning about the summons from their banks.
However, the court concluded that because no notice was required, the law firm therefore could not block the request.
"The key is if you don't have notice, you don't have an opportunity to move to quash it," Sardar said. "It's kind of a big deal, the IRS is able to get records about you and you don't even have a notice about it."
When notice is requiredThe exterior of the Internal Revenue Service (IRS) building in Washington, on March 22, 2013. (AP Photo/Susan Walsh, File)An important distinction that the Supreme Court made in this case is that the IRS may issue a summons to help determine taxes due, 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 decision helps the agency in collecting unpaid taxes in two ways. First, taxpayers or their associates can't squash a request because they don’t know it exists, and second, ill-intentioned debtors can't move their assets under someone else's name.
"What sometimes happens in tax collection cases is taxpayers start to do creative things, so that the money is not in their name," Sardar said, "so I'm not shocked or terribly upset that this decision is what it is."
But Sardar still thinks the ruling could have been more precise to address the third-party privacy concerns.
"Personally, I am disappointed," he said. "I would have hoped that there would be more consideration."
Rebecca Chen is a reporter for Yahoo Finance and previously worked as an investment tax certified public accountant (CPA).
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