Obtaining Tax Return Information: Taxpayer’s Standing, and Timely Requests
July 09, 2018
Tax Returns Are Like Paintings [I]
A not insignificant portion of our tax practice involves disputes among the shareholders and partners of closely held businesses, or among the beneficiaries and fiduciaries of estates or trusts where a significant part of the assets at issue consists of interests in closely held businesses.
In addition to structuring the separation of such parties on a tax efficient basis – including the division of the business where appropriate – we will comb through the tax filings of a business to gather information that may be helpful to our client in negotiating a settlement or, if necessary, in litigating their case. For example, the return will disclose information about distributions, loans by or to owners, compensation paid to owners, rental payments, transactions with affiliated entities, etc. In other words, the return will reveal a number of ways by which value may have been withdrawn from the business.
An earlier post considered how a business owner, to whom information about the business has been denied by their fellow owner(s), may obtain such information, as well as circumstantial evidence about other goings-on in the business, by requesting copies of tax returns from the IRS.
A recent decision[ii] by a Federal District Court described one taxpayer’s efforts to obtain tax return information from the IRS related to his family’s business.
Breach of Fiduciary Duty?
Taxpayer’s grandfather founded a successful business (the “Business”) as a sole proprietorship. Upon his death, the Business passed to Taxpayer’s father, who incorporated the Business (the “Corp”). Taxpayer claimed that he became an “authorized individual” for the business after his father’s death, and he alleged that he was the beneficiary of his father’s estate. Taxpayer’s father and grandfather each created trusts (the “Trusts”) which identified Taxpayer as a beneficiary. It appears that Taxpayer was not a direct owner of the business.
Taxpayer suspected that the trustees of the Trusts had somehow breached their fiduciary duties to the beneficiaries of the Trusts.
In order to confirm his suspicions, Taxpayer submitted forms to the IRS requesting copies of several years of income tax returns for the Business and Corp, most of which the IRS provided, along with a “Business Master File Transcript-Complete,” which listed all tax returns and documents filed on behalf of Corp.[iii]
Taxpayer subsequently submitted more Privacy Act and Freedom of Information Act (“FOIA”) requests for various tax records relating to himself, his father and grandfather, the Business, Corp, his father’s estate, and the Trusts.
Although the IRS contended that it had released all responsive records to which Taxpayer was entitled, he insisted that the IRS was unlawfully withholding documents.
Taxpayer then commenced the suit before the Court, seeking relief under the Code – which mandates disclosure of tax return information to certain persons – FOIA and the Privacy Act.
The IRS moved to dismiss some of these claims, and for summary judgment as to the others.
Laying Down the Rules
The Court reviewed the applicable standards of review, as well as the allocation of the burden of proof.
It noted that, in FOIA cases, the IRS bears the burden of demonstrating the adequacy of its search and that it properly withheld any documents from the requesting party.
The Court stated that it may grant summary judgment based solely on the information provided in the IRS’s affidavits or declarations when they “describe the documents and the justifications for nondisclosure with reasonably specific detail, demonstrate that the information withheld logically falls within the claimed exemption, and are not controverted by either contrary evidence in the record or by evidence of agency bad faith.” Such affidavits or declarations are “accorded a presumption of good faith,” the Court continued, “which cannot be rebutted by ‘purely speculative claims about the existence and discoverability of other documents.’”
The Privacy Act, the Court explained, provides a cause of action against an agency that refuses to comply with an individual’s request for his records. Before bringing such a claim in court, however, a plaintiff must submit a “Privacy Act inquiry [that is] clearly marked ‘request for notification and access’ and ‘contain[s] a statement that it is being made under the provisions of’ [the statute].” Failure to do so is cause for dismissal because exhaustion of administrative remedies under the Privacy Act is a jurisdictional prerequisite for judicial review.
The Court’s Analysis
Even accepting all of Taxpayer’s allegations as true, the Court determined that he did not actually plead that he submitted requests for most of the information sought.
Rather, he cursorily alleged that he “mailed a FOIA and PA Request with supporting documents” and the IRS never responded. Such a conclusory allegation, the Court stated, was not enough to avoid dismissal. The only specific requests Taxpayer mentioned in the complaint were for Corp’s tax returns. He never alleged that he had ever submitted a request for the other documents.
The Court next turned to Taxpayer’s requests for tax information for his grandfather, father, his father’s estate, the Trusts, the Business and Corp.
The IRS contended that it had released all responsive records to which Taxpayer was entitled.
Thus, the Court had to determine whether Taxpayer was authorized to receive the other documents he had requested and, if so, whether the IRS’s search for those records was adequate.
“For good reason,” the Court stated, “not just anyone can obtain the tax information of another person or corporation. Tax returns and accompanying information are ‘confidential’ and can only be disclosed to those authorized by statute and regulation. Before the Service can release an individual’s tax information, the requester must ‘establish [his] identity and right to access such records’ by “provid[ing] adequate proof of the legal relationship under which [he] assert[s] the right to access the requested records.” Until the requester does so, the IRS “is not obligated to process the request,” and if he “nonetheless files suit, [he] is said to have failed to exhaust [his] administrative remedies.” A plaintiff bears the burden of showing entitlement to records.
Taxpayer submitted copies of the death certificates of his father and grandfather, the Trust agreements, and his own social security card. The IRS did not dispute that this information was sufficient for Taxpayer to obtain the records of himself, his father, Corp, the Trusts, and his father’s estate, but it contested that the submitted documents also established that he was authorized to receive records pertaining to his grandfather, the Business, or his grandfather’s estate.
The Court agreed with the IRS.
It explained that, when seeking tax records for a deceased individual or an estate, a requester must show that he is the “administrator, executor, or trustee of [the] estate” or an “heir at law, next of kin, or beneficiary under the will, of such decedent.” None of Taxpayer’s submitted documents established such a relationship. His grandfather’s trust agreement stated that Taxpayer was entitled only to a part of the trust; because trusts and estates are different legal entities, Taxpayer’s rights under the trust did not automatically make him a beneficiary of his grandfather’s estate under his will, as required by statute.
As to the Business, Taxpayer had to show that he was: 1) “designated [for access] by resolution of its board of directors”; 2) “an officer or employee” who has been designated access by a “principal officer and attested to by the secretary or other officer”; 3) a “bona fide shareholder of record owning 1 percent or more of the outstanding stock of such corporation”; 4) for an S corporation, that he was “a shareholder during any part of the period covered by such return during which an election . . . was in effect”; or 5) for dissolved corporations, that he has been “authorized by applicable [s]tate law to act for the corporation” or found by the IRS “to have a material interest which will be affected by” the information.
Taxpayer did not allege that he submitted any of the forms of proof required by the statute. He, instead, stated that “his records” listed him as a “Member/Shareholder of the [Business].” The Court reviewed this document and was unable to locate such an indication. Even if that information did appear on the document, it would still not satisfy the requirements for disclosure because Taxpayer had to show that, as a shareholder, he owned more than 1% of the outstanding stock or that (if an S corporation) he was a shareholder during the relevant period.
Taxpayer also seemed to argue that the IRS would be able to see whether he met the above criteria for disclosure because it could look at the returns filed by the Business and determine how much of a share Taxpayer inherited through his father.
Even if that were true, the Court countered, Taxpayer – not the IRS – bore the burden of establishing access to records. Moreover, to the extent that he attempted to argue that as a shareholder of Corp he was also an owner of the Business, and thus entitled to access, Taxpayer had not established that these two entities were the same, such that being an owner of one would mean he was an owner of the other.
The Court thus agreed with the IRS that Taxpayer had only established authorization to obtain tax information for Corp, his father, his father’s estate, the Trusts, and himself.
The appropriateness of the IRS’s search – and, therefore, of its refusal to disclose records to Taxpayer – would be limited to those entities and individuals.
Adequacy of the Search
Taxpayer challenged the IRS’s search for several categories of his requested records.
The Court explained that “an agency fulfills its obligations under FOIA if it can demonstrate beyond material doubt that its search was ‘reasonably calculated to uncover all relevant documents.’” Stated differently, the issue was not whether there might exist any other documents possibly responsive to the request but, rather, whether the search for those documents was adequate.
The adequacy of an agency’s search for documents requested under FOIA “is judged by a standard of reasonableness and depends . . . upon the facts of each case.” To meet its burden, the agency may submit affidavits or declarations that explain the scope and method of its search “in reasonable detail.” The affidavits or declarations should “set forth the search terms and the type of search performed, and aver that all files likely to contain responsive materials (if such records exist) were searched.” Absent contrary evidence, such affidavits or declarations are sufficient, the Court stated, to show that an agency complied with FOIA. “If, however, the record leaves substantial doubt as to the sufficiency of the search, summary judgment for the agency is not proper.”
The IRS produced the Declaration of a Government Information Specialist in the IRS Office of Privacy, Government Liaison and Disclosure and, based upon this affidavit, contended that it had performed an adequate search and had released all responsive records.
Taxpayer requested K-1 information for himself from several of the entities, stretching back many years. According to the IRS, this information “would show up on Taxpayer’s transcripts” if it existed, but that system only retains information returns for ten years. Unfortunately for Taxpayer, the information for the latest date for which he had requested K-1 information had already been purged.
Next, the IRS manually searched Taxpayer’s transcripts for the requested years “in case he perhaps had attached his Forms K-1 to his own returns.” It then sent a request to its long-term storage facility to locate any responsive files. Personal tax returns however, are destroyed after seven years. Again, the information for the years requested had already been destroyed.
Finally, the IRS “checked to see if the [grandfather’s trust] had filed a Form 1041,” which would have had K-1 information attached – nothing. After realizing it did not search for K-1s from the father’s trust and estate, the IRS conducted a supplemental search using the same method described above and did not locate any responsive records.
Taxpayer next argued that the IRS should have been able to locate the estate tax return filed for his grandfather’s estate because such forms are retained for 75 years. The IRS asserted simply that it had “searched for the Form 706 . . . and [was] unable to locate it.”
Such a cursory explanation, the Court stated, was not a “reasonably detailed” description of the search because it did not “set forth the search terms and the type of search performed.” Although the IRS alleged that it had a copy of the Form 706, Taxpayer sought the original, which he said may have K-1 information attached. Thus, the Court was unable to grant the IRS’s summary judgment motion on this point.
Based upon the foregoing, the Court dismissed most of Taxpayer’s complaints and granted most of the IRS’s motion for summary judgement.
Forewarned is Forearmed
There are a number of ways by which a taxpayer may obtain tax return information relating to themselves or to an entity in which they have a beneficial or other interest. The discussion above identified the most important of these, including Section 6103(e) of the Code, the Freedom of Information Act[iv] (which applies to all Federal agencies, and may provide access to many kinds of IRS records), and the Privacy Act of 1974[v] (which provides access to the taxpayer’s own records).
In every case, the taxpayer has to carefully comply with the requirements of each statutory regime, including the regulations and any other rules promulgated thereunder, if they are to obtain the desired information.
The taxpayer also has to be aware of the fact that the IRS is not required to maintain tax records indefinitely. Thus, it will behoove a taxpayer who reasonably believes that there may be cause for concern over the management of a business or other entity in which they are interested, but over which they have no control and only limited access to information, to request the relevant tax return information sooner rather than later – first, from the entity, then from the IRS – and, thereby, to begin developing a record and supporting their claims.
[i] Ok, a return may not say a thousand words, and the simile may be more akin to saying that ogres are like onions or parfaits. Sorry Shrek.
[ii] U.S. District Court for the District of Columbia, WILLIAM E. POWELL v. INTERNAL REVENUE SERVICE, Civil Action No. 17-278 (JEB).
[iii] Last week’s post described a business-owner who sought copies of the tax returns of another party – a co-owner of the business – through discovery.
[iv] 5 U.S.C. 552.
[v] P.L. 93-579.