IRS is Required to Search Tax Return Information Records to Help Determine Worker Classification

On April 5, 2017, in an unanimous court reviewed opinion, the United States Tax Court determined that disclosure of a worker’s tax return information to absolve the employer from liabilities arising out of the employer’s withholding requirement is not subject to the general prohibition against disclosing taxpayer return information pursuant to Internal Revenue Code (IRC) Section 6103, and does not shift the burden of proof to the Internal Revenue Service (IRS).

In Mescalero Apache Tribe v. Commissioner, 148 T.C. 11 (2017), the IRS determined that a number of the Mescalero Apache Tribe’s workers were not independent contractors, but employees. If the IRS prevailed in its worker reclassification determination then, as the employer, the Mescalero Apache Tribe would be jointly and severally liable for Federal income tax that should have been withheld on the workers’ earnings. To prevent double taxation, IRC Section 3402(d) provides that the IRS cannot collect from the employer the withholding tax liability if the employees have already paid income tax on their earnings. To prove its position that the workers were independent contractors and alternatively to reduce any potential withholding tax liability if the workers were classified as employees, the Mescalero Apache Tribe asked each worker to complete Form 4669, Statement of Payments Received. However, the Mescalero Apache Tribe had trouble locating each of its workers because many had moved or lived in hard-to-reach areas without phone service or basic utilities.

The Mescalero Apache Tribe was unable to find 70 of these workers, and during litigation sought the information from the IRS. The IRS argued that IRC Section 6103(a) required the IRS to keep taxpayer return information confidential, and that the exception in IRC Section 6103(h) only indicates that information is disclosable, but not discoverable, because it would improperly shift the burden of proof to the IRS.

The Tax Court disagreed with the IRS’s arguments, finding that the exception allowing disclosure for return information that “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” under IRC Section 6103(h)(4)(C) squarely applied to the workers’ return information. The court explained that “how the workers viewed themselves—as employees or independent contractors—is a factor in worker-classification cases.” Accordingly, whether the workers paid their income tax liabilities as independent contractors could tend to prove or disprove the worker classification determination. Additionally, the court noted that even if a party bears the burden of proof, it “doesn’t mean discovery cannot be had of his opponent.” Tax Court Rule 70(b) provides that information is discoverable or not “regardless of the burden of proof involved.” Further, in a footnote, the court stated that IRC Section 3402(d) “implies that the Commissioner should have some responsibility for reviewing his own records for the proof that the Tribe may not be liable for withholding taxes.”

Practice Point: The protection of taxpayer information is of paramount important to taxpayers and the IRS. However, there are limits to this protection and the disclosure rules must be interpreted in a practical manner that balances the protection against the purpose of the disclosure exceptions in IRC Section 6103. The unanimous opinion by the Tax Court sends a message to the IRS that it may not engage in blanket reliance on the disclosure rules when third-party tax information may be necessary for a taxpayer to prove its case. In other words, the IRS should review each request for third-party information in light of the purpose of IRC Section 6103 and the purpose of the statute. For taxpayers that may want to avoid a similar fight with the IRS, a first step to obtain the type of information at issue in the Mescalero Apache Tribe case might be to seek the last known address of each of the putative independent contractors.

Robin L. GreenhouseRobin L. Greenhouse
Robin L. Greenhouse represents businesses and individuals in resolving complex, large-dollar federal tax controversies. Robin is adept at using dispute resolution techniques, including fast track mediation, pre-filing agreements, Internal Revenue Service (IRS) appeals and post-appeals mediation, and has been the lead lawyer in significant litigation. Over her 30-year career as a government and private practice tax litigator, she has argued more than 100 cases in federal courts at every level. Read Robin Greenhouse's full bio.


K. Christy Vouri-MissoK. Christy Vouri-Misso
  K. Christy Vouri-Misso focuses her practice on all stages of complex federal tax controversies including Internal Revenue Service (IRS) examinations, administrative appeals, voluntary disclosures, and litigation. She has settled multiple tax disputes with IRS legal counsel avoiding costly litigation in court. Read K. Christy Vouri-Misso's full bio.


Andrew R. RobersonAndrew R. Roberson
Andrew (Andy) R. Roberson focuses his practice on tax controversy and litigation matters. He represents clients before the Internal Revenue Service (IRS) Examination Division and Appeals Office and has been involved in more than 50 matters at all levels of the federal court system, including the US Tax Court, several US courts of appeal and the Supreme Court. Andy has experience settling tax disputes through alternative dispute resolution procedures, including Fast Track Settlement and Post-Appeals Mediation, and in representing clients in Compliance Assurance Process (CAP) audits. He also represents individuals in Global High Wealth Industry Group audits and in connection with offshore disclosure programs. Read Andy Roberson's full bio.


Ruth WimerRuth Wimer
Ruth Wimer, Esq., certified public accountant (CPA), focuses her practice on matters related to executive compensation, including international, fringe benefits, personal use of employer aircraft, and qualified and nonqualified deferred compensation. Read Ruth Wimer's full bio.

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