IRS TAKES TAXPAYER CONFIDENTIALITY SERIOUSLY

DATELINE: December 9, 2009, Chicago

Several weeks ago, we stumbled across an IRS legal memorandum that indicates just how seriously the IRS takes taxpayer confidentiality in the exempt organization area. ILM 200942039 (released October 16, 2009)  The IRS had conducted an examination of an exempt organization that touched on the intermediate sanctions and excess benefits.  It decided to issue a “no-change” letter.  In that letter, the IRS planned to include advisory concerns that transactions between the organization and a disqualified person could potentially result in excess benefits and private inurement.   The organization’s representative wrote to the IRS, informing them that the organization was considering releasing the advisory, which would...

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disclose the name of the disqualified person.  Clearly the organization can release any communication it receives from the IRS involving itself.  The question was whether the IRS was violating Section 6103 by releasing information pertaining to the disqualified person to the exempt organization or whether the subsequent release of the information by the exempt organization would place the IRS in violation of Section 6103.  After all, the disqualified person and the tax-exempt organization are separate taxpayers, each having rights under Section 6103.   In examining the issue, the IRS pointed out that Section 6103 defines return information in the “broadest way.”  It then pointed out that the same information could be relevant and constitute part of an examination for more than one taxpayer.  The IRS noted that:  

Everything in the "no change" letter consists of "data . . . generated by . . . the Secretary . . . with respect to the determination of the existence, or possible existence, of liability . . . under [Title 26] for any tax . . ." of the Exempt Organization. This includes any language in the advisory regarding the potential tax liability of, and tax consequences to, Exempt Organization resulting from its transactions with Disqualified Person.  

From that, the IRS concluded that it could release the information to the exempt organization despite the fact that the advisory included information about another taxpayer.  The courts have supported this conclusion.  The IRS cited Solargistic Corp. v. United States, 921 F.2d 729 (7^th Cir. 1991).  In that case, the IRS sent letters to investors of plaintiff's company, telling them that because plaintiff was under audit, adjustments made to plaintiff's return would necessarily affect the investors' tax liability. Plaintiff sued, claiming that its return information was wrongfully disclosed to the recipients of the letters.  The court, in rejecting that view, held that the fact of the Solargistic audit, in addition to being the return information of Solargistic, was also the return information of the investors since it constituted " 'data . . . prepared by . . . the Secretary . . . with respect to the determination of the . . . possible existence' of any tax liability of the investors." 921 F.2d at 731. Accordingly, the court found the disclosure to the investors was authorized under IRC § 6103(e)(1)(A). The fact that certain of a taxpayer's return information may also constitute the return information of another taxpayer does not mean that the IRS is prohibited from disclosing to the first taxpayer its own return information.  

The IRS also pointed to Section 6103(h)(4). It authorizes the tax administration proceeding disclosures of a third party's return information, i.e. information developed in the third party's investigation, if the return information directly relates to a transactional relationship between the taxpayer and third party and directly affects the resolution of an issue in the taxpayer's proceeding.  Section 6103(h)(4) would appear to cover the relationship between an exempt organization and disqualified persons.

There are two lessons to be taken from ILM 200942039.  First, as noted at the outset, the fact that the IRS would go to such lengths to analyze whether it could release information under these circumstances demonstrates just how seriously the IRS takes disclosure of taxpayer information.    Second, the fact that the law permits the disclosure under these circumstances demonstrates the close linkage between tax-exempt organizations and disqualified persons. 

Some organizations are reluctant to answer the question on the Form 990 asking whether the organization engaged in an excess benefit transaction or became aware that it had engaged in an excess benefit transaction with a disqualified person.  Core Form 990, Part IV, Questions 25a and b.  These organizations apparently believe that they need not do the IRS’s work in identifying disqualified persons who may have received excess benefits.  Given the position taken by the IRS in ILM 200942039, the IRS is unlikely to be receptive to such arguments.

Internal Revenue Service - Circular 230 Disclosure: As provided for in Treasury regulations, any advice (but none is intended) relating to federal taxes that is contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.

THE FOREGOING IS NOT AND SHOULD NOT BE TAKEN AS LEGAL ADVICE. IF LEGAL ADVICE IS REQUIRED, THE NONPROFIT OR OTHER PARTY IN QUESTION SHOULD SEEK THE ADVICE OF QUALIFIED LEGAL COUNSEL. If you liked this post, please visit http://www.charitygovernance.com for a description of our training and consulting services. You will also want to acquire a copy of Jack Siegel's book, A Desktop Guide for Nonprofit Directors, Officers, and Advisors: Avoiding Trouble While Doing Good." Copyright 2009, Charity Governance Consulting LLC. All Rights Reserved. You may not copy any portion of this post to a computer "clipboard" for re-posting anywhere or e-mailing, or otherwise reproduce this post. If you want others to review this post, you may provide them with a link to this web blog. Any use of the material or ideas in this post by reporters or other publishers shall make reference to Jack Siegel, author of "A Guide for Non-Profit Directors, Officers and Advisors: Avoiding Trouble While Doing Good" and this web blog. For additional information call 773-325-2124