September 30, 2023

IRS gets big power to request private tax information after Supreme Court decision

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

Last month, the nation’s highest court unanimously sided with the IRS Polselli v. Tax and Customs Administrationthereby enhancing the ability of the tax authorities to request documents or financial records from those associated with an arrears taxpayer without notifying that third party.

The decision bolstered the IRS’ ability to keep information secret, experts say, and gives the IRS too much power and too few restrictions on how that information can be used.

“I think the concern would be that this would eventually give the IRS access to information supposedly related to the collection of taxes from Taxpayer A, but then inevitably it would be information about Taxpayer B that would otherwise not have been available to the IRS, Michael Sardar, tax attorney and partner at Kostelanetz LLP, told Yahoo Finance.

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

Dry cleaning theory

Judge Ketanji Brown Jackson used the example of a dry cleaner to illustrate the possible scope of this law in the lawsuit. In summary, she offered the following.

Think of a delinquent taxpayer visiting Mom and Dad’s dry cleaners. If the IRS believes that the dry cleaner’s financial records could help with tax collection, the agency could subpoena the dry cleaner’s bank for years and years of financial statements without even notifying the store owners.

In this scenario, the retailers are powerless to object to the pickup request.

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

The ruling also lacked clarity on how often the IRS can use the information obtained. While the court’s letter stated that the agency can only use the subpoena against the taxpayer involved in the subpoena, experts worry that the IRS could use the same request as a pretext for another case.

“While the subpoena should be against Taxpayer A, the concern is that if the IRS finds something strange in a third party’s records, the IRS will use that information to launch yet another investigation into another taxpayer,” Martinez said.

While Sardar noted that there are safeguards within the IRS to prevent information from being skipped from various cases, he acknowledges that typical bank records are not privileged information.

A close-up of a stamped file folder

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

Another concern is simply the issue of privacy.

“I think judges are generally concerned about people abusing the system to avoid paying taxes. I don’t think that should be the attitude of judges,” Martinez said. to notify people and have their privacy rights defended in court. Especially if it’s a third party.

“Because of privacy concerns about what information we want the IRS to have, one would have hoped the court would have paid a little more attention to that side of the matter,” Sardar added.

Polselli versus the tax authorities

The whole drama started when an IRS agent suspected that Remo Polselli, a taxpayer who owed the IRS $2 million in unpaid taxes and fines, was hiding assets under his business ventures. The officer turned to Polselli’s law firm, where he is a long-time client, and unsuccessfully requested documentation, including invoices, statements of account, canceled checks and wire transfers.

The officer then called banks for financial records on Poselli, Poselli’s wife, and his law firm. The law firms filed a federal lawsuit to block the requests after learning of their banks’ subpoena.

However, the court concluded that the law firm could not block the request because no notice was required.

“The key is if you don’t have notice, you have no chance of destroying it,” Sardar said. “It’s kind of a big deal. The IRS can get data on you and you don’t even have a message about it.”

When notification is required

FILE - The exterior of the Internal Revenue Service (IRS) building in Washington, on March 22, 2013. In an effort to stop personal threats directed at IRS employees, the agency says it will begin restricting employees .  personally identifiable information about communications with taxpayers.  (AP Photo/Susan Walsh, File)

The exterior of the Internal Revenue Service (IRS) building in Washington on 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 assist in determining tax due, but must provide notices to do so, according to IRC 7609(a)(1). But if the subpoena is to collect that balance, no notice is required under IRC 7609(c)(2)(D).

The decision helps the agency collect unpaid taxes in two ways. First, taxpayers or their associates can’t suppress a request because they don’t know it exists, and second, malicious debtors can’t move their assets under someone else’s name.

“Sometimes what happens in tax collection cases is taxpayers start doing creative things so the money doesn’t end up in their name,” Sardar
said, “so I’m not shocked or very upset that this decision is what it is.”

But Sardar still thinks the ruling could have been more precise to address third-party privacy concerns.

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

Rebecca Chen is a reporter for Yahoo Finance and previously worked as a certified public accountant (CPA) for investment taxes.

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