Confidentiality of tax return information.

June 19, 1999

On June 14, 1999, Tax Executives Institute sent the following letter to Robert Rubin, U.S. Secretary of the Treasury, and Janet Reno, the Attorney General of the United States, in connection with an order of the United States District Court for the District of Puerto Rico concerning the release of tax return information to an unrelated taxpayer (Copies of the letters were provided to the Commissioner of Internal Revenue, the Chief Counsel, and the Solicitor General.) The letter, which was signed by TEI President Lester Ezrati of Hewlett-Packard Company, was prepared under the aegis of the Institute's IRS Administrative Affairs Committee, whose chair is Stephen W. Boocock of Allegheny Teledyne, Inc.

It has come to Tax Executives Institute's attention that the United States District Court for the District of Puerto Rico has ordered the Internal Revenue Service to produce tax return information of unrelated third parties to plaintiffs involved in a tax refund suit. The court's order has arguably placed responsible parties at the IRS on the horns of the dilemma -- they either commit a felony or risk being found in contempt of court.

Equally important, the court's order threatens to undermine the promise of confidentiality that undergirds the tax system. TEI believes that a negotiated settlement of this dispute is both possible and desirable, and we urge the Department of Justice (with the assistance of the Treasury Department and IRS) to take all appropriate actions to modify the court's order and prevent the release of third-party tax return information, while ensuring that the underlying issue involved in the refund litigation can be fairly adjudicated. Unless steps are taken to vindicate the privacy interests of taxpayers, irreparable harm will be done to the self-assessment tax system.

Background

Tax Executives Institute is the preeminent association of business tax executives in North America. The Institute's 5,000 members represent 2,800 of the leading corporations in the United States and Canada. TEI represents a cross-section of the business community, and is dedicated to the development and effective implementation of sound policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and government alike.

For more than 50 years, TEI has worked with representatives of the Internal Revenue Service, Congress, and other interested parties to improve tax law and administration. Although TEI members may find themselves at odds with the IRS in respect of particular matters, as a professional organization the Institute is firmly committed to maintaining a tax system that works -- one that is administrable and with which taxpayers can comply. For example, TEI was pleased to work closely with Congress, the Treasury Department, and the IRS during the development of the IRS Restructuring and Reform Act of 1998, which was intended, among other things, to strengthen taxpayer rights.

The Importance of Taxpayer Confidentiality

For all its flaws, the U.S. tax system works well. Each year, millions of individuals and businesses voluntarily self-assess and pay the billions of dollars necessary to fund the military, the Social Security and Medicare programs, and other government programs. In the tax returns they file annually with the Internal Revenue Service, U.S. taxpayers lay bare not only their souls but also their personal and business lives. The level of detailed information required by the Internal Revenue Code is at once daunting and extraordinarily sensitive, and the willingness of taxpayers to disclose confidential information is largely attributable to assurances that their privacy interests will be safeguarded by the government.

Taxpayers' privacy interests are protected by section 6103(a) of the Internal Revenue Code, which prohibits the disclosure of taxpayer returns and return information (subject to certain limited exceptions). A direct outgrowth of the Watergate scandal and Nixon Administration's attempt to subvert the Internal Revenue Service in the 1970s, section 6103 was motivated by congressional concern that the disclosure of private information by the IRS "would seriously impair the effectiveness of our country's very successful voluntary assessment system, which is a mainstay of the Federal tax system." Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1976, 94th Cong., 2d Sess. 314 (1976). Even before section 6103 was enacted, however, the preservation of taxpayer confidentiality was a core value of the American tax system. Id. at 313 (although tax returns were previously described as "public records," returns were generally open to inspection only under regulations approved by the President or under presidential order).

The promise of confidentiality underlying section 6103 is not hollow. Indeed, the Internal Revenue Code contains a three-tier system of sanctions for those who violate its strictures. First, section 7431(a) accords aggrieved taxpayers a civil cause of action and provides for damages in the case of unauthorized disclosures. Second, section 7213(a)(1) makes the unauthorized disclosure of taxpayer returns and return information a felony. Finally, the law mandates the firing of any federal employee convicted of unauthorized disclosure. I.R.C. [sections] 7213(a)(1).

Section 6103 does contain certain limited exceptions to its bar on the disclosure of confidential information. For example, sections 6103(h)(4)(B) and 6103(h)(4)(C) provide that third-party taxpayer information can be provided in situations where the treatment of an item reflected on the taxpayer's return is directly related to the resolution of an issue in the proceeding in which the information is sought or where there is a direct transactional relationship between the party seeking the information and the taxpayer and that relationship directly affects the resolution of the issue. In light of the important privacy interests underlying section 6103, however, TEI strongly believes that these exceptions should be narrowly construed.

The Current Threat to Taxpayer Privacy

A recent decision by the United States District Court for the District of Puerto Rico threatens to undermine the privacy protections accorded by section 6103 of the Internal Revenue Code, and TEI urges you to take all appropriate actions to staunch the possible damage. In Bristol-Myers Barceloneta, Inc., Bristol Caribbean, Inc., and Bristol Laboratories Corp. v. United States, Civil 97-2567CCC, the court has ordered that the Internal Revenue Service produce tax return information in respect of unrelated parties. The order grew out of the plaintiffs' efforts to secure information relating to their claim that the IRS had improperly denied them the favorable treatment accorded other taxpayers, and it was resisted by the IRS on section 6103 grounds.(1) Although TEI believes it should have been possible to respond to the plaintiffs' request for information without violating section 6103 (for example, by limiting the form and nature of the information disclosed), the issue regrettably escalated to "all or nothing." Hence, the efforts of certain of the affected taxpayers to voice their objections to the disclosure of confidential tax return information -- and to recommend alternative, less-drastic solutions -- proved unsuccessful,(2) and the current status of the matter is unclear.

Let there be no mistake: TEI believes that the plaintiffs' "disparate treatment" claim is worthy of adjudication. Nevertheless, the Institute strongly believes that the claim, even if wholly meritorious, is not sufficient reason to vitiate the protections of the Internal Revenue Code's privacy provisions. Quite simply, tax returns of unrelated parties should not be released. At the same time, the IRS should never invoke section 6103 as a litigating tactic to deny plaintiffs access to the information relevant to their refund claims without proposing meaningful alternatives.

The power of a United States district court is most assuredly not to be trifled with. At the same time, TEI believes that it is imperative that taxpayer confidentiality be safeguarded. Accordingly, we urge both the Treasury Department and the Department of Justice to use all resources at their disposal to prevent the release of tax returns and tax return information in the Bristol-Myers case. The government should work with the plaintiffs and third-party taxpayers to develop one or more alternatives to disclosing the third-party information. These alternatives might include preparation of a statistical summary or the production of the information either in camera or subject to a protective order. We believe such solutions would satisfy the court's need for information necessary to adjudicate the disparate treatment claim without identifying particular taxpayers. Moreover, although we believe section 6103 is manifestly clear, we suggest that the Administration should consider whether any legislative clarification is necessary to prevent situations such as the current one from recurring. TEI would be pleased to assist you in this effort.

Conclusion

Because Tax Executives Institute believes safeguarding taxpayer confidentiality is and must remain a cornerstone of our system of tax administration, we appreciate this opportunity to share our views with you. If you need additional information about this matter, please do not hesitate to contact us.

(1) The plaintiffs had sought to change their taxable year to maximize the tax benefits accorded by section 936 of the Code, following Congress's 1993 amendment of that provision. Plaintiffs argued that several similarly situated corporations were successful in their efforts to change their taxable years, and that the disparate treatment accorded them was improper, citing IBM Corp. v. United States, 343 F.2d 914 (Ct. Cl. 1965). It is the return information of taxpayers filing for a change in taxable year that is the subject of the district court's order.

(2) Following the district court's initial February 5, 1999, order requiring the Internal Revenue Service to produce the confidential third-party information, the IRS's Chief Counsel notified the affected taxpayers. Several of those taxpayers sought to participate in the case as amici curiae, but their motion -- along with the government's motion for reconsideration -- was denied on May 14, 1999.