Most of my readers are aware of the “attorney-client privilege”. Generally speaking, the privilege preserves the confidentiality of communications between a lawyer and her clients. When the privilege is in place, attorneys may not divulge their clients’ secrets and cannot be “forced” to divulge them (for example, in a court proceeding or to the Internal Revenue Service (IRS)). The rationale behind the privilege is to encourage clients to openly share information with their attorney. Having faith in the confidential nature of the communications, a client will more easily provide the attorney full and open disclosure of the facts. Only by having had the benefit of such full disclosure, can the attorney provide effective representation.
In mid-May, a federal judge in Texas ruled that the IRS could use a so-called John Doe summons to obtain the identities of a law firm’s clients. (Taylor Lohmeyer Law Firm PLLC v. United States, Western District of Texas, May 17, 2019). The clients whose identities are to be revealed by the law firm were suspected of having used the firm’s services (e.g., creation of foreign trusts or foreign companies) to hide income offshore the United States. By now, my readers know that unreported foreign accounts and assets have been in the IRS’ crosshairs for quite some time.
As a result of an IRS audit of one of the clients of the law firm, the IRS found the firm had created various foreign accounts and entities that helped the client “avoid paying U.S. taxes for which he was liable.” The amount of unreported income was substantial (over USD5 million) and understandably, the IRS wanted to know if other clients of the firm were doing the same thing, but of course the IRS did not know who these other clients might be. Enter, the John Doe summons!
What is a John Doe Summons?
The John Doe Summons has proved to be a very powerful IRS weapon in the battle against tax evaders whose identities are not known at the time. A John Doe summons is unlike the traditional summons used routinely by the IRS in its tax investigations. Since a traditional summons must identify the taxpayer whose conduct is in question, it is of limited value when the taxpayers are not known.
In recent years, the IRS has used the John Doe summons in connection with uncovering those with undisclosed offshore accounts at foreign banks, and domestically, against Coinbase, the largest digital currency exchange firm in the US and the largest exchanger in the United States of bitcoin into US dollars. The John Doe summons in Coinbase mandated the firm to disclose the account records of over 14,000 customers whose Bitcoin transactions exceeded $20,000 per annum so the authorities could identify and obtain evidence on individuals using Bitcoin to either launder money or conceal income.
A federal judge must approve issuance of the summons before it can be enforced. Once the summons is issued, the recipient then has the burden of proving that some reason exists that should bar enforcement of the summons.
The relevant law for issuance of a John Doe summons in a tax matter is contained in the Internal Revenue Code at Section 7609(f). Section 7609(f) sets forth the requirements that the IRS must demonstrate in order for the summons to be served.
Interested readers can also refer to the 1964 United States Supreme Court case of United States v. Powell, 379 US 48 (1964) which established a four-part test for evaluating the legitimacy of an IRS summons. The four factors are that “the investigation[must] be conducted pursuant to a legitimate purpose, [t]he inquiry may be relevant to the purpose, [t]he information sought is not already within the [IRS’] possession, and [t]he administrative steps required by the [Internal Revenue] Code have been followed – in particular, that the ‘Secretary or his delegate,’ after investigation, has determined the further examination to be necessary and has notified the taxpayer in writing to that effect.”
In a nutshell, then, the John Doe summons is used in the offshore context when the IRS does not have the names of particular identifiable US persons, but nonetheless seeks to flush out those persons it believes to be hiding accounts, transactions or other assets. A “John Doe Summons” generally directs the recipient (here, the law firm) to produce records identifying “all US persons” who conducted specified transactions (for example, who used the firm to create foreign entities or foreign accounts).
Hey! What About the Attorney Client Privilege?
The law firm fought the summons, of course, and argued that it should not have to reveal the clients’ names based on the attorney – client privilege. The district court of Texas disagreed and ruled that the law firm must reveal the names of its clients who may have structured offshore entities to avoid US taxes.
The court said, “It is well established that ‘(t)he identity of a client is a matter not normally within the [attorney-client] privilege. Despite the general rule, under a limited and rarely available exception, an attorney must conceal even the identity of a client, not merely his communications. The exception applies when the disclosure of the client’s identity by his attorney would have supplied the last link in an existing chain of incriminating evidence likely to lead to the client’s indictment.” [citations omitted]
In a nutshell, while the law firm doesn’t have to turn over client memos, notes and files, it must still identify the relevant clients, who invariably will be audited by the IRS!
Posted May 30, 2019
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