In the case of the Mescalero Apache Tribe v. Commissioner, 148 TC No. 11 the Tax Court had to consider the taxpayer’s request to obtain information from the IRS regarding other taxpayers, specifically if those taxpayers had reported income received from the Tribe on their income tax returns. Or, as the IRS claimed, did the law (specifically IRC §6103) prevent the agency from disclosing such information about other taxpayers.

The question arose because the IRS had decided in an examination that the Tribe had failed to treat certain individuals as employees that were, in the agency’s view, truly employees. While the Tribe is still contesting that fact, the Tribe sought information from the IRS to reduce the amount due. Specifically, the Tribe wished to know if contractors they had been unable to contact had paid their taxes.

That is important because, while the Tribe is “on the hook” generally for payroll taxes if these individuals are found to truly be employees, IRC §3402 removes the employer’s liability if the employer can show the person had included the amounts on their return for the year in question. [IRC §3402(d)]

The Tribe had used the method outlined in the Internal Revenue Manual (IRM 4.23.8.4) and attempted to contact the individuals in question. While it located many of the individuals, the Tribe was unable to locate 70 of the individuals in question. Some had moved and the Tribe had no current address, while others were in hard to reach areas that lacked utilities or cell phone service.

While the Tribe was unable to obtain the information from the individuals regarding whether they had included the amounts in their income, clearly there was one other source that could answer that question. The IRS clearly had the tax returns for these individuals (or knew they had not filed returns) and thus could provide information that likely would show that some of those 70 that the Tribe could not contact had paid their taxes.

As the Court writes:

The Tribe wants to take advantage of section 3402(d) in this case. But how? It tried to find its old workers and get them to fill out the form the IRS wants employers in this situation to use, but the Tribe argues that the information is just sitting there in the IRS’s records.

Isn’t that what discovery is for?

The IRS objected to providing this information for two reasons. First, as noted above, the IRS claimed that IRC §6103(a) prohibited the IRS from releasing this information to another taxpayer. Second, the agency argued this created an impermissible shift in the burden of proof from the taxpayer to the agency to gain the benefits of IRC §3402(d).

The Court agrees that the information the Tribe seeks is “return information” as defined by IRC §6103 and that the general rule bars such disclosure. But, as the Court notes “general rules usually have exceptions in trail, and section 6103 is no different.”

There is a potential exception found at IRC §6103(h)(4) which provides:

(4) Disclosure in judicial and administrative tax proceedings. — A return or return information may be disclosed in a Federal or State judicial or administrative proceeding pertaining to tax administration, but only —

…

(B) if the treatment of an item reflected on such return is directly related to the resolution of an issue in the proceeding; [or]

(C) if such return or return information directly relates to a transactional relationship between a person who is a party to the proceeding and the taxpayer which directly affects the resolution of an issue in the proceeding;

The opinion first notes that the title of IRC §6103(h) is “Disclosure to Certain Federal Officers and Employees For Purposes of Tax Administration, Etc.” and that the first Circuit Court to look at the issue (the Fifth Circuit Court of Appeals in the case of Chamberlain v. Kurtz, 589 F.2d 827, 837-38 (5th Cir. 1979)) had used that title to limit such disclosure only to Treasury officials. But the Court goes on to note that most other circuits have rejected that view, instead following the Tenth Circuit’s reasoning in the case of First W. Gov’t Sec., Inc. v. United States, 796 F.2d 356, 360 (10th Cir. 1986) that the specific discussion of judicial proceedings broadens the application of the provision.

Since this case would be appealable to the Tenth Circuit, the Tax Court is bound by that Circuit’s view.

The Court concludes that subsection (B) may be a problem because it does not provide for release of “return information” but rather just a return. Whether an item had been included in income would not necessarily be clear from merely looking at the return in question, although the IRS could have other information related to the return (such as all 1099MISC issued to the taxpayer) that would allow for answering the question.

However, the Court notes that subsection (C) does allow for disclosure of return information. But there are a couple of hurdles to be overcome.

As the opinion notes:

First, what is a “transactional relationship” under section 6103, and is the employer/worker relationship included within it? Next, does the return information that the Tribe wants “directly relate” to this relationship? And, finally, does the information related to the transactional relationship directly affect the resolution of the issue in this case?

The opinion notes that historically courts have taken a broad view of what is a transactional relationship:

To “transact” means simply “to carry on business.” Webster’s Third New International Dictionary 2425 (2002). And the wide variety of business relationships that other courts have held are included in the general phrase lead us now to hold that the relationship between an employer and his worker is one that pertains to the carrying on of business.

But is the information sought directly related to the transactional relationship, the next requirement of (C)? Here the Court turns to a Nebraska District Court opinion:

Here we have some help from a district court in Nebraska. In Guarantee Mut. Life, 42 A.F.T.R.2d (RIA) 78-5915, a company sued for a tax refund by establishing that its workers were independent contractors and not employees. The district court there found that the workers’ tax records would contain evidence of how the workers viewed their status — a significant factor in a worker-classification case — and allowed disclosure under section 6103(h)(4)(C). Id. We agree that whether the Tribe’s workers paid their tax liabilities in full tends to show whether they considered themselves independent contractors or employees and thus directly relates to their relationship with the Tribe.

Finally, does that information directly affect the resolution of the issue in this case? The Court finds several cases on this issue and, not surprising, this information is found to directly affect the resolution of the case.

As the opinion notes:

For example, in Texture Source, Inc. v. United States, 851 F. Supp. 2d 1260, 1267 (D. Nev. 2012), the court found that discovery of relevant return information relating to tax treatment of drywall workers was directly related to the tax treatment of those workers as contractors. In Davidson, 559 F. Supp. at 461, the court found that financial statements between a debtor and a creditor directly related to whether the creditor made a material misstatement to a probation officer. This information directly related to the sentencing court’s ability to resolve an issue crucial in arriving at a just sentence for the creditor. Id. at 461-62. And in First Western, 796 F.2d at 359-60, the court found that audit information relating to a transactional relationship between investors and their broker directly affected the investors’ tax liabilities. How the Tribe’s workers viewed themselves — as employees or independent contractors — is a factor in worker-classification cases. See Weber v. Commissioner, 103 T.C. 378, 387 (1994) (whether a worker is a common-law employee or an independent contractor depends in part on the relationship the parties believed they were creating), aff’d, 60 F.3d 1104 (4th Cir. 1995); see also Ewens & Miller, Inc. v. Commissioner, 117 T.C. 263, 270 (2001). And whether the Tribe’s workers paid their income-tax liabilities as independent contractors would tend to prove or disprove the Tribe’s case, which would directly relate to the resolution of one of the issues here. We also shouldn’t overlook the big issue here: If the Tribe’s workers did indeed pay their tax liabilities, then the Tribe’s section 3402(d) defense would be proved and would be entirely resolved.

The Court also does not find this creates an impermissible burden shift for the IRS. The burden remains on the taxpayer, but one way for the taxpayer to obtain information to satisfy that burden is via discovery.

As the opinion states:

The Commissioner still objects that, even if the information is disclosable, it is still not discoverable. It is true that section 3402(d) seems to place the burden on the taxpayer to show that the income tax is paid. And each party in civil litigation must bear “the ordinary burden of financing his own suit.” Eisen v. Carlisle & Jacquelin, 417 U.S. 156, 179 (1974). But that doesn’t mean discovery cannot be had of his opponent. Our Rule 70(b) says that information is discoverable or not “regardless of the burden of proof involved.” We’ve read our Rule to mean what it says. Piscatelli v. Commissioner, 64 T.C. 424, 426 (1975). “Who bears the burden of proof on an issue has no effect on the obligation to comply with appropriate discovery requests.” Guillo v. Commissioner, T.C. Memo. 1998-40, 1998 WL 42189 at *4, aff’d, 165 F.3d 915 (9th Cir. 1998).