Following the passage of the Taxpayer First Act, the IRS updated its guidance on how and when an auditor may contact third parties in an audit. Under the new law, the IRS must meet stricter procedural requirements before contacting third parties during an audit. Congress made this change due to concern that contacting third parties may harm a taxpayer’s business or reputation. Taxpayers should be aware of the new procedures to ensure the IRS is following them and to take advantage of the advance notice to voluntarily supply information to the IRS.

Notification Requirement

Historically, the Internal Revenue Code required the IRS to notify the taxpayer under audit when the IRS would contact third parties, such as customers, banks, and former employees. To meet this obligation, the IRS would send taxpayers “Publication 1, Your Rights as a Taxpayer,” which stated that, in the course of an examination, the IRS may need to obtain information from third parties that the taxpayer has not provided or to verify information the IRS has received. The IRS asserted that Publication 1 provided sufficient notice. District courts were split on whether Publication 1 was sufficient or if specific notice was required. In March 2019, the Ninth Circuit held that specific notice was required (see prior client alert). The Taxpayer First Act nullified the issue—specific notice is now required.

Taxpayer First Act

The Taxpayer First Act, signed on July 1, 2019, imposes additional procedure requirements on IRS auditors before they can contact third parties. The Act amended IRC section 7602(c) to provide that:

  • The auditor must notify the taxpayer that he or she intends to contact third parties.
  • When the auditor notifies the taxpayer, he or she must actually intend to contact the third parties.
  • The auditor must notify the taxpayer at least 45 days before he or she contacts the third party.
  • The auditor must tell the taxpayer the time period in which he or she intends to make the contact and the period must not be more than a year.

These requirements make clear that the auditor cannot simply issue a generic notice at the beginning of the audit that he or she may contact third parties at some point during the audit.

IRS Interim Guidance

The IRS recently provided interim guidance to its examining divisions (Large Business & International, Small Business & Self-Employed, Tax-Exempt & Government Entities, and Wage and Investment) on the new advance notice requirements. The memorandum states that Publication 1 no longer satisfies the advance notice requirements. The memorandum specifically states that auditors “may not contact a third party until the 46th day following the date of the notice.” The memorandum states that the advance notice requirements apply to all notices and third party contacts after August 15, 2019.

Record of Contacts

Amended IRC section 7602(c) maintains the requirement that the IRS keep a record of persons contacted. Upon request of the taxpayer, the IRS must provide the taxpayer with a list of those persons contacted.

Bottom Line for Taxpayers

The new rules are good news for taxpayers. Taxpayers will receive advance notice that the IRS is contacting third parties and will be able to obtain a list of who the IRS has contacted. In certain circumstances, taxpayers may be able to reduce the IRS’s contacts with third parties by voluntarily providing the information sought by the IRS.