Proposed regulations permitting the IRS to shorten third-party notice requirements in certain circumstances erode important taxpayer protections and could result in a taxpayers bearing the consequences for IRS-caused delays.

Background

The IRS Restructuring and Reform Act of 1998 (RRA 98) instituted major reforms to IRS tax administration. RRA 98 included new provisions providing added taxpayer protections in circumstances where the IRS intends to contact a person other than the taxpayer (a third-party) to obtain information that will assist the IRS in assessing or collecting a tax (IRC § 7602(c)). RRA 98 provided that prior to contacting a third-party, the IRS must provide taxpayers with “reasonable notice” of the contact.

In 2019, the Taxpayer First Act (TFA), another bill instituting tax administration reform, further bolstered RRA 98’s taxpayer third-party contact protections by amending IRC § 7602(c). The TFA substituted the “reasonable notice” requirement for a 45-day notice requirement prior to contacting a third party. There are three statutory exceptions to this 45-day notice requirement:

• When the taxpayer authorizes the contact,
• If the IRS determines for good cause shown that providing the notice would jeopardize tax collection or involve reprisal against any person, or
• With respect to any pending criminal investigation.

This spring, the IRS issued a notice of proposed rulemaking (REG-117542-22) that would implement exceptions to the 45-day notice requirement enacted in the TFA. Proposed Treasury Regulation § 301.7602-2(d)(5)(iii) through (v) would provide that the IRS may shorten the statutory 45-day notification period to 10 days when there is a year or less remaining on the statute of limitations for   or collection and certain other circumstances exist. For example, in the examination context, the IRS could reduce the 45-day notice requirement to 10 days if there is a year or less remaining on the statute of limitations, the case involves an issue with respect to which the IRS would have the burden of proof in a court proceeding, and the IRS has requested but the taxpayer has refused to extend the statute of limitations by agreement. Or, in the collection context, the proposed regulations would reduce the 45-day notice requirement to 10 days if there is a year or less remaining on the statute of limitations and the IRS intends to request the Department of Justice file suit to reduce assessments to judgment or to foreclose a federal tax lien.

Punishing the Taxpayer for IRS Delays

 The IRS’s proposed regulations permitting third-party contact without providing the taxpayer 45-day advance notice in instances when there is one year or less remaining on the statute of limitations would erode an important taxpayer protection and could punish taxpayers for IRS delays.

The IRS typically has three years to assess additional tax and 10 years to collect unpaid tax. The Taxpayer Bill of Rights includes the taxpayer’s right to finality – meaning, the right to know the maximum amount of time the IRS has to audit a particular tax year or to collect a tax debt. The statute of limitations is an important component of the right to finality because it sets forth clear and certain boundaries for the IRS to act to assess or collect taxes.

The IRS may find itself attempting to assess or collect taxes within one year of the statute of limitations for a number of reasons that have nothing to do with actions or events controllable by the taxpayer. For example, the IRS may make conscientious resource allocations or employee oversight may cause the IRS to be up against an expiring statute of limitations. Taxpayers should not lose an important Congressionally enacted taxpayer protection in instances where IRS inaction causes the imminent expiration of the statute of limitations.

Contacting a third-party about a taxpayer’s potential underpayment or nonpayment of tax could cause personal embarrassment or damage to a business’ reputation. Given the extremely short 10-day timeframe the IRS regulations propose, where one year or less remains on the statute of limitations, it is not unreasonable to believe that some taxpayers will feel pressured to agree to extend the statute of limitations or otherwise settle the underlying issue to avoid the potential embarrassment of the IRS contacting a third-party. Furthermore, the 10-day timeframe is so short, that it is possible some taxpayers may not receive the notice with enough time to reply. As a result, those taxpayers may incur the embarrassment and reputational damage caused by having their sensitive tax information shared with a third-party on an expedited basis without adequate time to respond.

 Proposals to Strengthen Third-Party Contact Protections

 In my 2024 Purple Book of Legislative Recommendations, I made several proposals that would strengthen the taxpayer protections surrounding third-party contacts. Specifically, I recommended that Congress amend IRC § 7602(c) to require the IRS to include the specific information it intends to seek when it provides the taxpayer notice of its intent to contact a third-party and provide the taxpayer with a reasonable amount of time to respond and provide the requested information so that the taxpayer has the opportunity to avoid the potentially embarrassing or reputationally damaging third-party contact. The Taxpayer Bill of Rights provides taxpayers the right to be informed and the right to privacy. Providing taxpayers with the specific information the IRS intends to seek via a third-party contact and giving the taxpayer a reasonable amount of time to provide the information to avoid the third-party contact is necessary to protect these important taxpayer rights.

Conclusion

When the IRS contacts a third-party with respect to the determination or collection of a taxpayer’s tax liability, it has serious implications for the taxpayer’s reputation and impacts important taxpayer rights. When Congress enacted RRA 98 and the TFA, it intended to strengthen the taxpayer protections surrounding IRS third-party contacts. The IRS’s proposed regulation shortening the 45-day notice requirement to 10 days in certain circumstances when there is a year or less remaining on the relevant statute of limitations erodes these important taxpayer protections and is a step in the wrong direction.

The IRS should reconsider these proposed regulations and Congress should consider enacting additional taxpayer protections for third-party contacts.

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Source: taxpayeradvocate.irs.gov