Civil litigation often follows Internal Revenue Service (“IRS”) assessments of income tax liabilities, interest, and penalties assessments. In these situations, as well as in cases involving criminal indictments, obtaining testimony from IRS employees, such as investigators, managers, or revenue agents, could be highly relevant. The question facing many litigants is how to obtain such testimony. This article will discuss the process and hurdles involved in obtaining testimony from an IRS employee.
Introduction to Touhy Decision
The first step in the process is to understand the Supreme Court case United States ex rel. Touhy v. Ragen, 340 U.S. 462 (1951). Touhy was an inmate in an Illinois State penitentiary who filed a habeas corpus proceeding in federal court alleging a violation of his due process rights by the warden. During the proceeding Touhy served a subpoena upon an FBI agent seeking the production of various documents. The FBI agent refused to turn over any of the records requested based upon administrative regulations promulgated by the Department of Justice. After being called to the witness stand and ordered by the court to comply with the subpoena, the FBI agent refused to produce the records, stating that his refusal was dictated by Department of Justice Order No. 3229. The trial court held the FBI agent in contempt. Upon appeal, the United States Supreme Court reversed the trial court and held that Congress had given administrative agencies, such as the FBI and the IRS, the authority to prescribe regulations relating to the production of documentation and witnesses.
Housekeeping Considerations
Internal agency regulations like DOJ Order No. 3229 are products of the Federal Housekeeping Statute at 5 U.S.C. Section 301. As explained by the 9th Circuit Court of Appeals in Exxon Shipping Co. v. U.S. Department of Interior, 34 F.3d 774, 780 (9th Cir. 1994), the Federal Housekeeping Statute was enacted in 1789 “to help General Washington get his administration underway by spelling out the authority for executive officials to set up offices and file Government documents.” Over the years, federal agencies have used their authority under the Federal Housekeeping Statute as a “convenient blanket to hide anything Congress may have neglected or refused to include under specific secrecy laws.” Id. at 777. Pursuant to the statute, a federal agency, such as the IRS, can issue regulations relating to “the conduct of its employees, the distribution and performance of its business, and the custody, use, and preservation of its records, papers, and property.” .
Pursuant to the Federal Housekeeping Statute, the IRS has promulgated regulations. See 26 CFR 301.9000-1 et seq. Under the IRS regulations, the general rule is that, in response to a request or demand, an IRS agent may not provide testimony or IRS records or information unless the commissioner, or a delegate, gives instructions thereunder. Such an instruction is called a “testimony authorization.” A “testimony authorization” includes an instruction to testify or provide IRS records or information in whole, in part, or not at all. In the interim period between the receipt of a request or demand and the issuance of a testimony authorization, an IRS agent may appear in person to advise that he or she is awaiting instructions (in the form of a testimony authorization). Testimony authorizations are required, for the most part, in situations invoking court testimony.
Procedure in the Event of a Demand for Testimony
After the IRS reaches a decision under its Touhy regulations that an agent will not testify, a motion to compel can be filed with a district court. Agency regulations, such as the ones promulgated by the IRS, do not set forth any procedures for judicial review of their actions in denying a Touhy request. Since different courts have taken varying approaches in analyzing such actions, there is a lack of clarity regarding the precise judicial procedures to be used in challenging an agency’s denial of a Touhy request.
Although there is a lack of clarity regarding the precise judicial procedure to be used to challenge an agency’s denial to comply with a request for testimony, the circuit courts seem to agree that whatever judicial procedure is to be used, the party seeking a review of an agency’s denial must first exhaust its administrative remedies by obtaining a final agency determination on its request. This requirement could be satisfied by having an agency deny the request in a letter.
The question of judicial review becomes one of an entrenched circuit split. The Fourth and Eleventh Circuits currently assess an agency’s decision under its Touhy regulations using the arbitrary and capricious standard set forth of Section 706 of the Administrative Procedure Act (“APA”). The APA makes agency action presumptively subject to judicial review. See 5 U.S.C. Section 702 (“A person…adversely affected or aggrieved by agency action within the meaning of a relevant statute, is entitled to judicial review thereof”). The only exceptions are where a statute precludes judicial review or the “agency action is committed to agency discretion by law.” See 5 U.S.C. Section 701(a).
Although the APA creates more than one standard of review, all agency action is subject to review to determine if it is “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” See 5 U.S.C. Section 706(2)(A). To determine if an agency acted arbitrarily or capriciously, or in abuse of its discretion, a court will conduct a “thorough, probing, in-depth review.” However, a court will presume that the agency acted correctly, and is not permitted to substitute its judgment for the agency’s. Courts adopting the APA standard are more likely to uphold an IRS determination that prevents an IRS agent from testifying in court or in a deposition.
In contrast, the Ninth and D.C. Circuits utilize the “request-friendly” standard found in the Federal Rules of Civil Procedure 45 and 26, also referred to as the “undue burden” standard. The leading case in support of utilizing provisions of the Federal Rules of Civil Procedure to define the scope of review is Exxon Shipping . In reversing the Department of Interior’s application of its Touhy rules, the court rejected the agency’s argument that it was immune from having to comply with discovery requests by virtue of its sovereign immunity since this “argument would also violate the fundamental principle that “the public…has a right to every man’s evidence.” See Exxon Shipping Co, 34 F.3d at 779 (quoting Wigmore, Evidence § 2192 (3d ed.)).
The Ninth Circuit Court of Appeals held that any subpoenas received by the government would be appropriately analyzed under the general rules of discovery in the Federal Rules of Civil Procedure, which “explicitly provide for limitations on discovery in situations such as this.” According to the Ninth Circuit, Rule 26(c) and Rule 45(c)(3) give ample discretion to district courts to quash or modify subpoenas causing “undue burden” on the government. Specifically, the Ninth Circuit cited the protections afforded in the following rules:
- Rule 26(b)(2) instructs district courts to consider a number of factors relevant to the government expressed interests. The Ninth Circuit noted that a court may use Rule 26(b) to limit discovery of agency documents or testimony of agency officials if the desired discovery is relatively unimportant when compared to the government interests in conserving scarce government resources.
- Rule 45(c)(3)(A)(ii) affords nonparties special protection against the time and expense of complying with subpoenas.
- Rule 45(c)(3)(B)(ii), (iii) empowers a court to disallow the taking of a non-retained expert’s testimony unless there is a showing of “substantial need” that “cannot be otherwise met without undue hardship” and payment of reasonable compensation. The Ninth Circuit noted that this provision would prevent litigants from using government employees as tax-funded expert witnesses.
- Rule 45(c)(3)(A)(iii) recognizes and protects privileged information. According to the Ninth Circuit, the government is free to raise any possible claims of privilege from testimonial compulsion that may rightly be available to it. For example, the government may assert its “state secrets privilege” to prevent the disclosure of military secrets. The government also has a qualified executive privilege, in which a litigant’s need for the requested information is balanced against the government’s interest in nondisclosure. In making a determination of executive privilege, the court must weigh “the policy of free and open discovery juxtaposed to the need for secrecy to insure candid expression of opinions by government employees in the formulation of government policy.”
In sum, the Ninth Circuit’s decision in Exxon Shipping establishes a doctrine by which the Federal Housekeeping Statute does not provide federal agencies with broad discretion to withhold information from the public during litigation; rather, any such discretion is circumscribed by the normal application of the Federal Rules of Civil Procedure, which appropriately balance the interests of the government in efficiency or secrecy versus the interests of the parties in acquiring the evidence needed to argue their positions. The Exxon Shipping approach requires the judge hearing the matter to protect the “unique interests” of the government in such situations. This approach is markedly different from the APA analysis discussed above. The D.C. Circuit has largely adopted the Ninth Circuit’s approach. Federal agencies, such as the IRS, often will take the position that they are not subject to subpoenas. Federal agencies have generally taken the position that their own internal administrative regulations shield them from compliance with the Federal Rules of Civil Procedure.
Conclusion
In civil and criminal tax controversies, testimony of an IRS revenue agent could be highly relevant. Rule 26(c) and Rule 45(c)(3) of the Federal Rules of Civil Procedure provide a mechanism to obtain testimony of an IRS employee through the issuance of a subpoena. Despite these rules, the IRS will not likely happily comply with a subpoena served on one of its employees. The circuit courts are largely divided on this issue. The Ninth and D.C. Circuit Courts have held that federal agencies such as the IRS are subject to federal subpoenas. On the other hand, the Fourth and Eleventh Circuit Courts of Appeals have held that the only avenue to seek judicial review of subpoena is through an action under the APA’s highly deferential “arbitrary and capricious” standard. Given the often critical importance of obtaining testimony from an IRS employee, litigants should be prepared to challenge IRS’s arguments that they are immune to federal subpoenas.
Anthony Diosdi is an international tax attorney at Diosdi & Liu, LLP. Anthony focuses his practice on providing tax planning domestic and international tax planning for multinational companies, closely held businesses, and individuals. In addition to providing tax planning advice, Anthony Diosdi frequently represents taxpayers nationally in controversies before the Internal Revenue Service, United States Tax Court, United States Court of Federal Claims, Federal District Courts, and the Circuit Courts of Appeal. In addition, Anthony Diosdi has written numerous articles on international tax planning and frequently provides continuing educational programs to tax professionals. Anthony Diosdi is a member of the California and Florida bars. He can be reached at 415-318-3990 or adiosdi@sftaxcounsel.com.
This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.