Background
On 14 July 2016, the IRS published final regulations (T.D. 9778) under Code Section 7602 (“2016 Final Regulations“). The 2016 Final Regulations permitted, among others, nongovernmental attorneys who serve as contractors to participate fully in the interview of a person who the IRS has summoned as a witness to provide testimony under oath. The 2016 Final Regulations allowed these nongovernmental persons to ask a summoned witness substantive questions and to ask a summoned person’s representative to clarify an objection or assertion of privilege.
However, T.D. 9778 was one of the “Hateful Eight” regulations targeted by Executive Order 13789 for review by the Secretary of the Treasury for imposing an undue burden on taxpayers, adding complexity to the tax laws or exceeding the IRS’s statutory authority. This review resulted in a report, released in October 2017, that the Department of the Treasury and the IRS were considering proposing an amendment to narrow the scope of T.D. 9778.
Proposed regulations were published on 28 March 2018 (“2018 Proposed Regulations“). These proposed regulations split the 2016 Final Regulations into two subsections. The first, contained in Prop. Reg. § 301.7602-1(b)(3)(i), kept the general rules about contractor participation in summons interviews. Notably, however, the ability of asking a summoned person’s representative to clarify an objection or assertion of privilege was left out.
New Prop. Reg. § 301.7602-1(b)(3)(ii) provided that nongovernmental attorneys were not eligible to be hired by the IRS to participate in an examination unless the nongovernmental attorney fit into one of three exceptions: (1) a specialist in foreign, state or local law, including tax law; (2) a specialist in non-tax substantive law that is relevant to an issue in the examination, such as patent law, property law or environmental law; or (3) a person who happens to be an attorney, but is hired by the IRS for knowledge, skills or abilities other than providing legal services as an attorney. Thus, by the time of the 2018 Proposed Regulations, the IRS had proposed to limit the ability of the IRS to hire nongovernmental attorneys to participate in summons interviews, on a proposed basis.
Before the IRS issued final regulations implementing the 2018 Proposed Regulations, Congress passed the Taxpayer First Act of 2019 (Pub. L. No. 116-25), effective 1 July 2019 (“Taxpayer First Act 2019“). The Taxpayer First Act 2019 added a new subsection (f) to Code Section 7602, which bars nongovernmental persons who are hired by the IRS from questioning a witness under oath whose testimony was obtained pursuant to a summons under Section 7602. The House Ways and Means Committee Report explained that, pursuant to Section 7602(f), the IRS could not, under the authority of Section 6103(n), “provide to a tax administration contractor any books, papers, records or other data obtained by summons, except when such person requires such information for the sole purpose of providing expert evaluation and assistance to the IRS (including, for example, access to such information by translators)” H.R. Rep. No. 116-39, at 50 (2019).
2020 Proposed Regulations
The passage of the Taxpayer First Act 2019 and Section 7602(f) eliminated the need for regulations barring participation by nongovernmental attorneys as contractors in summons interviews under Section 7602. Therefore, the 2018 Proposed Regulations have been withdrawn. However, the IRS took the opportunity to further limit participation by nongovernmental attorneys as contractors.
In Prop. Reg. § 301.7702(b)(3), the IRS may only provide books, papers, records or other data obtained pursuant to Section 7602 to an outside contractor (under Section 6103(n)) for the contractor to provide “expert evaluation and assistance” to the IRS within three limited categories:
- First, expert evaluation and assistance can include persons with specialized knowledge in certain substantive areas. These areas include, but are not limited to, economists, engineers, industry experts or other subject matter area experts. They can also include attorneys, but only those who specialize in an area relevant to an issue in the examination like patent law, property law, environmental law, or foreign, state or local law, including foreign, state or local tax law.
- Second, expert evaluation and assistance can include persons providing ancillary services. This can include court reporters, translators and litigation support services, and similar contractors.
- Third, expert evaluation and assistance can include whistleblower-related contractors described in Treas. Reg. § 301.6103(n)-2.
Prop. Reg. § 301.7602-1(b)(3)(i)(C) expressly forbids the IRS from hiring an attorney as an outside contractor to assist in an examination under Section 7602 unless the attorney is hired by the IRS as a specialist in foreign, state or local law, or in non-tax substantive law relevant to an issue in the summons interview, or unless the attorney is hired for knowledge, skills or abilities other than providing legal services as an attorney. Furthermore, Prop. Reg. § 301.7602-1(b)(3)(ii)(A) provides that no person other than an officer or employee of the IRS or Office of Chief Counsel may question a witness under oath whose testimony was obtained pursuant to Section 7602. Other persons authorized by Section 6103(n), and persons who are covered by Section 7602, may attend summons interviews, but may not question the summoned witness or ask a summoned person’s representative to clarify an objection or assertion of privilege. However, court reporters and translators may ask questions, as appropriate, during an interview.
Implications
If finalized, the 2020 Proposed Regulations will officially put to an end the IRS’s ability to retain outside counsel to conduct and assist in conducting examinations.
Under the express language of Prop. Reg. § 301.7602-1(b)(3)(ii)(A), the IRS will be unable to use outside contractors to ask questions in a summons interview under oath. However, as made clear in the preamble to the proposed regulations, these restrictions only apply to a witness interviewed “under oath,” and “[c]ontractors may continue to ask questions informally (not under oath) of a taxpayer, a taxpayer’s employee, or third parties in appropriate circumstances.” While the IRS can attempt to use so-called “informal” interviews as a workaround to allow its outside contractors to participate, the taxpayer always has the option of insisting that consensual interviews be conducted pursuant to a friendly summons. While summons interviews are typically taken under oath and with a court reporter, the same typically holds true for “informal” interviews, particularly in transfer pricing audits. Moreover, transcribed interviews are often advantageous, as they avoid later disputes about what the witness actually said and provide the opportunity for a well-prepared witness to help make the affirmative factual record necessary for resolution discussions with exam and settlement negotiations with IRS appeals.
