Constitutional, legal, and policy issues regarding the use of tax bounty hunters.

Unbeknownst to many, several taxing jurisdictions have assigned the "discovery" of non-filers, and the valuation, assessment, and collection functions to private third-party contingent fee agents popularly (and derisively) called "ferrets" or "bounty hunters." This is a form of privatization now extant in at least nine states -- Con necticut, Delaware, Georgia, Kansas, Michigan, New Jersey, North Carolina, Pennsylvania and Wyoming.(1)

Tax executives may become involved with contingent fee auditors either directly on behalf of the corporation or perhaps on behalf of a group of employees caught within the bounty hunter's sometimes overreaching net. This article discusses certain constitutional, legal, and policy challenges that the tax executive can assert when confronted with a private contingene fee agent. It, however, is by no means exhaustive. For instance, although the article discusses the Due Process arguments that can generally be lodged against the use of contingent fee (or contract) auditors, it does not address the Equal Protection Clause and tax uniformity arguments that could be asserted under the applicable federal and state constitutions in the right circumstances.(2) Similarly, the article does not delve into how public policy may be violated by the unauthorized disclosure and breach of confidentiality inherent in the use of bounty hunters in some cases.(3) These arguments, however, remain potentially potent ones, and should not be overlooked if appropriate.

Potential Application of Federal Fair Debt Collection Practices Act 

The Federal Fair Debt Collection Practices Act (FDCPA), 15 U.S.C. [sections] 1692, et seq., provides a number of consumer/taxpayer protection measures. Section 1692e of FDCPA proscribes a number of representations as false and misleading. The statute may prove useful in dealing with some contingent fee agents in that it prohibits some of the more offensive tactics of collection agencies. It also provides enforcement powers in the Federal Trade Commission and for attorney's fees and damages for violations.

The definitions contained in FDCPA make it plain that a contingent fee agent would be covered by the Act. Although a 1980 decision by the U.S. Court of Appeals for the Third Circuit holds that capitation taxes are not a "debt"

within the meaning of FDCPA,(4) a taxpayer should be able to argue that transaction taxes and personal income taxes are distinguishable. More fundamentally, to the extent the case requires that the debt come from money owed in return for goods or services for personal purposes instead of "arising out of" a personal transaction, as the statute requires, the Third Circuit decision appears wrongly decided.

In at least one bounty hunter jurisdiction -- New Jersey -- the applicability of FDCPA to tax collection may be a moot issue, because the enabling legislation requires that any collection agent conform to the substance of the Act. 54 N.J.S.A. [sections] 4912.2. Under the Unfair and Deceptive Acts and Practices (UDAP) statutes of many states, any failure to conform to another consumer protection law constitutes a per se violation of the UDAP statute, which in turn may entitle the aggrieved party (here, the taxpayer) to attorney's fees and treble damages. E.g., 940 Mass. Reg. [sections] 3.16C.

To the extent it applies, section 1692e of the federal law prohibits any misleading representation including, but not limited to --

* the false representation or implication that the debt collector is affiliated with any State;

* the use or distribution of any written communication simulating a document authorized, issued, or approved by any agency of any State, or which creates a false impression as to its source, authorization, or approval; and

* the use of any business, company, or organization name other than the true name of the debt collector's business, company, or organization.

Regulations issued under the FDCPA specify that a collection organization's name may not imply that it is connected with or is an agency of government or contain the words "Credit Bureau' or similar terms. 16 C.F.R. [subsections] 237.3, 237.4 (1965). The regulations state that representing that the organization is separated into functional divisions such as credit reporting, collecting, etc., has been specifically prohibited by the Federal Trade Commission. Moreover, the case law indicates that in judging whether statements mislead someone into thinking a governmental body vouches for or is affiliated with a collection service, the court must use the standard of whether 'the least sophisticated consumer" (not necessarily the 'reasonable consumer" `would be misled.'

Taxpayers contacted by contingent fee agents frequently report that they originally thought they were dealing with government employees.(6) This taxpayer perception lends support to the conclusion that some of the auditors' activities may be actionable under the FDCPA.

Does Use of Contingent-Fee Agents Violate Due Process?

Much has been written about the taxpayer's rights to an impartial administrator in the assessment process.(7) At the core of the holdings is the notion that the assessment (as opposed to collection) function is a quasi-judicial one involving discretion about valuation methods, etc. The determinations required for gross income and corporate business taxes with which some bounty hunters are charged, are even more clearly judgmental and discretionary. Determination of nexus alone has occupied the judiciary for decades.(8)

In support of this due process notion also is the Supreme Court's decision in Tumey v. Ohio, 273 U.S. 510 (1927), and a whole line of cases disqualifying judges when they have a pecuniary interest in the outcome.(9) Clearly, it is one thing to allow a contingent fee agent to employ the enforcement powers of the state to collect from a taxpayer where there has already been an adjudication, or the waiver of one. It is quite another to grant the use of this power to third parties at the discovery or assessment stage. This is not an issue of privatization, but the exploitation of a contingent fee.

In defending bounty hunters, governments sometimes draw a parallel to the taxpayer who retains a contingent fees valuation firm, attorney, accountant, or other adviser. The analogy is false. At the federal level, contingent fees are explicitly prohibited in respect of the (self) assessment process for income taxes by Circular 230, which sets forth standards for tax practitioners and advisers. The absence of bias in the assessment process is so fundamental that it is said to be the basis of the presumption in favor of the tax commissioner.(10) It is only after self assessment in the case of income taxes -- and after the government's assessing action in the case of property taxes -- that the taxpayer is free, if not duty-bound, to be an adversary and an advocate. Taxpayers are perfectly within their rights to argue that it is improper and unconstitutional (under the Due Process Clause) for the government to convert what is supposed to be a fair and impartial assessment process into an adversarial proceeding by employing a contingent-fee agent.

Does Use of Contingent Fee Agents Violate Public Policy or Constitute a Nondelegable Responsibility of Government?

Normally, arguing that a procedure or practice of a taxing authority violates "public policy" would not seem a strong basis for upending the procedure or practice. In point of fact, however, public policy was the only ground that the two seminal cases involving contingent fee auditors addressed.(11) In handing Sears a victory in a 1991 case, the Georgia Supreme Court ruled that, since the revenue department was not specifically authorized to engage contingent fee auditors, it was prohibited from doing so by public policy concerns. In language reminiscent of the previously discussed Due Process arguments, the court explained:

The people's entitlement to fair and impartial tax assessments lies at the heart of our system, and, indeed, was a basic principle upon which this country was founded. Fairness and impartiality are threatened where a private organization has a financial stake in the amount of tax collected as a result of the assessment it recommends.(12)

A more recent decision in North Carolina went the other way, with the court noting that there was no specific prohibition on contingency work and explaining that the determination of public policy was for the legislature to decide.(13)

Even assuming a court was disposed to invoking public policy in the absence of a direct prohibition on contingency fee auditors, there is risk in framing the issue in public policy as opposed to Due Process grounds. The risk is that a legislature could always declare a new public policy (sanctioning the use of such auditors) and thereby override the court. Hence, since most of the policy arguments supporting public policy grounds would also support a Due Process attack on contingency fee audits,(14) the constitutional approach seems the superior one.

Recovery of Attorney's Fees under 42 U.S.C. [sections] 1983

Can the taxpayer whose Due Process rights are violated by the state's use of a contingency fee auditor recover attorney's fees under 42 U.S. C. [sections] 1983? The answer may be yes, as long as the action is for damages and not equitable relief. This answer flows from the Supreme Court's recent decision in National Private Truck Council v. Oklahoma Tax Commission, No. 94-688 (June 19, 1995). There, a unanimous court held that neither injunctive, nor declaratory, relief under 42 U.S.C. [sections] 1983 was available against unconstitutional state taxes, primarily because an adequate state remedy against such taxes was found to exist. The existence of such relief triggered the Tax Injunction Act, 42 U.S.C. [sections] 1341. Nor were attorney's fees available under 42 U.S.C. [sections] 1988. Notwithstanding the adverse decision in National Private Truck Council, an action under 42 U.S.C. [sections] 1983 for damages arising from the unconstitutional conduct of a bounty hunter (as opposed to an unconstitutional statute) appears to be a viable alternative.(15) In addition, a meager ray of hope appears in footnote 6 of the Court's decision, which suggests that a state's continued enforcement of a tax held to be unconstitutional might provide a basis for invoking 42 U.S.C. [sections] 1983 because in such a case there would then be no adequate state legal remedy.

Notes

(1) Nackerson-Sheiber, Corporations Challenge Contingency Fee Contracts Between Private Auditors and Taxing Authorities, 10 INTERSTATE TAX REPORT No. 4, 8 (1994). (2) See Carter, Contingent Fee Tax Audit: Void in North Carolina, 3 JOURNAL OF PROPERTY TAX MANAGEMENT 31, 35 (1992). (3) Carter, supra note 2, at 34. (4) Staub u. Harris, 626 F.2d 275 (3d Cir. 1980). (5) E.g., Graziano u. Harrison, 950 F.2d 107 (3d Cir. 1991). (6) E.g., Rendleman & Neely, Can Contingent-Fee Property Tax Audits Be Challenged on Due Process Grounds?, 4 JOURNAL OF MULTISTATE TAXATION 80, 81 (1994). (7) See, e.g., Carter, supra note 2; Rendleman & Neely, supra note 6. (8) E.g., Wisconsin Dept. of Revenue v. William Wrigley, Jr., Co., 505 U.S. 214 (1992). (9) See generally Annotation, Disqualification of Judge, Justice of the Peace, or Similar Judicial Officer for Pecuniary Interest in Fines, Forfeitures, or Fees Payable by Litigants, 72 A.L.R.3D 375 (1976). (10) In re Appeal of AMP, Inc., 287 N.C. 547, 215 S.E.2d 752, 761 (1975). (11) Sears, Roebuck and Co. v. Parsons, 260 Ga. 824, 401 S.E.2d 4 (1991) and Appeal of Philip Morris, U.S.A., 335 N.C. 227, 436 S.E.2d 828 (1993), cert. denied, 114 S. Ct. 2726 (1994). (12) 260 Ga. at 825, 401 S.E.2d at 5. (13) The Sears and Philip Morris cases arose in different procedural contexts, which may have contributed to the different outcomes. Sears was a declaratory judgment before any audit. took place, whereas Philip Morris was fighting an audit assessment with "money on the table." (14) See articles cited in notes 1, 2, and 6, supra; Evatz & Zakrzewski, Keep the Money at Home: The Illusory Promise of Contract Audits, 43 Tax executive 251 (July-August 1991), Comment, State Tax Administratiue Provisions, 45 Tax Executive 84-85 (January-February 1993). (15) Fulton Market Cold Storage Co. v. Cullerton, 582 F.2d 1071 (7th Cir.), cert. denied, 439 U.S. 1121 (1978); see Annotation, Right to Relief under 42 U.S.C.S. [sections] 1983 for Alleged Unlawful Action by State of Local Tax Officials, [sections] 6(b), 50 A.L.R. Fed. 773, 783 (1978); 56 CCH State Tax Rev. No. 32, at 4 (Aug 7, 1995); 59 Tax Administrators News 58 (June 1995).

ROBERT KENNY engages in tax controversy defense work and in business, estate, and tax planning in Lawrenceville, New Jersey. A 1968 graduate of Manhattan College, he received his J.D. from Northeastern University School of Law in 1973. He is a certified public accountant in New York State and a member of several state bars as well as the bar of the U.S. Tax Court. Mr. Kenny is a former member of Tax Executives Institute, and has served as president of the Institute's Western Michigan Chapter. In addition to his experience as a director of large corporate tax departments, Mr. Kenny has had early experience with a Big Six CPA firm, a tax law firm, and IRS Chief Counsel's Office.