United States of America v. Artex Risk Solutions, Inc.
Filing
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MEMORANDUM Opinion Signed by the Honorable Samuel Der-Yeghiayan on 9/11/2014: Granting Plaintiff's motion for rule to show cause and Plaintiff's petition to enforce the summonses. This is a final and appealable order. Mailed notice (mw, )
IN THE UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF ILLINOIS
EASTERN DIVISION
UNITED STATES OF AMERICA,
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Petitioner,
v.
ARTEX RISK SOLUTIONS, INC.,
Respondent.
No. 14 C 4081
MEMORANDUM OPINION
SAMUEL DER-YEGHIAYAN, District Judge
This matter is before the court on Petitioner United States of America’s
motion for order to show cause. For the reasons stated below, the motion is granted.
BACKGROUND
Petitioner contends that the Internal Revenue Service (IRS) is conducting an
investigation of Respondent Artex Risk Solutions, Inc. (Artex). The IRS is allegedly
examining Artex’s role in transactions involving captive insurance plans under 26
U.S.C. § 831, and investigating whether such transactions constitute abusive
transactions. On December 19, 2013, the IRS issued two IRS administrative
summonses (Summonses) to Artex. The Summonses directed a representative of
Artex to appear before Revenue Agent Robert W. Meyer (Meyer) on January 9,
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2014, give testimony, and produce for examination records and documents, including
contracts, policies, promotional materials, and claims related to a captive insurance
program or arrangement, as described in the Summonses. On January 9, 2014, an
Artex representative allegedly appeared before Meyer, but failed to provide
testimony or produce any documents. Artex has allegedly subsequently refused to
comply with the Summonses. The IRS contends that the information and records
that are sought in the Summonses may be relevant to the investigation of Artex and
may shed light on whether Artex is subject to liability. Petitioner brought the instant
action seeking to enforce the Summonses, and Petitioner has now filed a motion for
rule to show cause as to why Artex should not have to comply with the Summonses.
DISCUSSION
Congress, has provided the “IRS with extensive authority to conduct effective
tax investigations” and “[a]s a necessary incident to this investigatory power,
Congress gave the [IRS] expansive authority in § 7602(a) to summon any person to
provide information relevant to a particular tax inquiry.” United States v. Crum, 288
F.3d 332, 333 (7th Cir. 2002). The IRS, however, is not empowered with authority
to enforce the summons that it issues. United States v. BDO Seidman, 337 F.3d 802,
809-10 (7th Cir. 2003). The IRS must “apply to the district court to secure an
enforcement order” when “a taxpayer fails to comply with a summons. . . .” Id.
(citing 26 U.S.C. § 7604). In a proceeding in which the IRS is seeking to enforce a
summons, the IRS must first make out a prima facie case. Khan v. United States,
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548 F.3d 549, 554 (7th Cir. 2008); Miller v. United States, 150 F.3d 770, 772 (7th
Cir. 1998)(citing United States v. Powell, 379 U.S. 48, 57-58 (1964)); see also BDO
Seidman, 337 F.3d at 809-10 (stating that in determining whether an IRS
administrative summonses should be enforced, a court “must scrutinize them to
determine whether they are made in good faith and seek information relevant to a
legitimate investigative purpose”); see also United States v. Insurance Consultants of
Knox, Inc., 187 F.3d 755, 759 (7th Cir. 1999)(“[t]he Powell requirements impose
only a ‘minimal burden’ on the agency” and “[t]hey can usually be satisfied by an
affidavit stating that the government has met them”). If the Government is able to
“make[] a prima facie showing of good faith, the burden shifts to the respondent to
show that the enforcement of the summons would constitute an abuse of process.”
BDO Seidman, 337 F.3d at 809-10; see also Miller, 150 F.3d at 772 (stating that
“[t]he Powell requirements impose only a minimal burden on the agency”); Knox,
Inc., 187 F.3d at 759 (stating that “[t]he taxpayer can rebut the government’s prima
facie case only by alleging ‘specific facts’ in rebuttal”).
DISCUSSION
Petitioner argues that it has satisfied all of the necessary steps to present a
prima facie case and warrant enforcement of the Summonses. Artex argues that
Petitioner has not presented a prima facie case. Artex also argues that the
Summonses are an abuse of the IRS’s power.
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I. Evidentiary Hearing and Discovery
Artex argues that “[t]o the extent any of the necessary facts . . . are in dispute,
respondent is entitled to an evidentiary hearing. . . .” (Ans. 7). However, the
Seventh Circuit has made clear that “[s]ummons enforcement proceedings are
intended to be summary in nature, and it is left to the district court’s discretion to
determine whether a hearing is necessary.” BDO Seidman, 337 F.3d at 810 (internal
quotations omitted)(quoting 2121 Arlington Heights Corp. v. IRS, 109 F.3d 1221,
1224 (7th Cir. 1997)); see also United States v. Utecht, 238 F.3d 882, 887 (7th Cir.
2001)(stating that the taxpayer “bears the burden of making a prima facie showing
before the district court must hold a hearing to investigate whether the IRS abused its
civil summons power” and that the taxpayer “must present specific, detailed, and
material facts in order to carry this burden”); United States v. Kis, 658 F.2d 526, 535
(7th Cir. 1981)(stating that “[i]n discussing the relative burdens of the parties in
summons enforcement actions,” the court could not “stress too emphatically that
these proceedings are intended to be summary in nature”); Adams v. I.R.S., 1999 WL
1001584, at *6 (N.D. Ind. 1999)(stating “only if the taxpayer has alleged specific
facts that permit an inference of some improper purpose on the part of the
government is the taxpayer entitled to an evidentiary hearing”). Artex has not
pointed to any material disputed facts or facts indicating bad faith on the part of the
IRS that need to be resolved in an evidentiary hearing prior to a ruling on Petitioner’s
motion. Artex has failed to provide information to the IRS in a timely fashion, and
has further delayed its production while the IRS followed the procedures to enforce
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the Summonses. Artex has not provided sufficient justification to allow a further
delay in its compliance by the scheduling of an evidentiary hearing prior to a ruling
on Petitioner’s motion. Summons enforcement actions are intended to be summary
proceedings and Artex has not pointed to extraordinary circumstances or specific
facts that warrant an evidentiary hearing in this case. Therefore, Artex’s request for
an evidentiary hearing is denied.
Artex also requests leave to conduct discovery in this case before the court
rules on the instant motion. (Ans. Mot. 12). There is ample evidence in the record to
enable the court to rule on the instant motion without discovery. As indicated above,
the summons enforcement process should be summary in nature and Artex has not
pointed to any specific need to conduct discovery in this case. Therefore, Artex’s
request for discovery is denied.
II. Prima Facie Case
Petitioner argues that it can establish a prima facie case. To make a prima
facie case in a summons enforcement action, the IRS must establish: (1) that “the
summons was issued for a legitimate purpose,” (2) that “the summoned data may be
relevant to that purpose,” (3) that “the data is not already in the Government’s
possession,” and (4) that “the administrative steps required by the Internal Revenue
Code for issuance and service have been followed.” Khan, 548 F.3d at 554 (citing
United States v. Powell, 379 U.S. 48, 57-58 (1964))(stating that “the United States
must not violate provisions of § 7602, including § 7602(d)(1), designed to ensure the
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summons is issued in good faith”); see also Miller, 150 F.3d at 772 (stating that the
IRS must make out a prima facie case, by establishing: (1) “that the investigation has
a proper purpose,” (2) that “the information sought may be relevant to that purpose,”
(3) that “the IRS does not already have the information,” and (4) that “the IRS has
followed the statutory requirements for issuing a summons”); Kis, 658 F.2d at 536
(stating that “United States v. Powell . . . established the elements of the prima facie
case that the Government must present” and that “[t]he burden is a slight one, for the
statute must be read broadly in order to ensure that the enforcement powers of the
IRS are not unduly restricted”).
A. Legitimate Purpose and Relevant Information
Petitioner contends that the investigation of Artex is being prosecuted for a
legitimate purpose and that the IRS is seeking relevant information. The IRS is
provided with authority to issue a summons “[f]or the purpose of ascertaining the
correctness of any return, making a return where none has been made, determining
the liability of any person for any internal revenue tax or the liability at law or in
equity of any transferee or fiduciary of any person in respect of any internal revenue
tax, or collecting any such liability. . . .” 26 U.S.C. § 7602(a). In the context of
summons enforcement, “the standard for relevancy . . .is relaxed” and information is
deemed relevant if it has “the potential to shed some light on any aspect of the”
investigation. 2121 Arlington Heights Corp., 109 F.3d at 1224; see also Kis, 658
F.2d at 535 (explaining that “[t]he sole reason for the proceedings and for permitting
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the taxpayer to intervene under section 7609 is to ensure that the IRS has issued the
summons for proper investigatory purposes under section 7602 and not for some
illegitimate purpose (such as, for example, using a civil summons to gather evidence
to be used solely in a criminal prosecution)”); Utecht, 238 F.3d at 887 (indicating
that the IRS cannot “improperly use[] its civil summons power to gather evidence for
a criminal prosecution”).
In the instant action, Petitioner has produced evidence to show that the IRS is
examining Artex’s role in transactions involving captive insurance plans under 26
U.S.C. § 831, and whether such transactions constitute abusive transactions.
Petitioner has also shown that the Summonses might reveal relevant information in
this case. Artex contends that the request for business records for a six-year period is
overly broad. (Ans. Mot. 3). Petitioner has shown that it is not seeking an excessive
amount of documents that would require extensive review for privileged information.
Petitioner has shown that virtually all of the documents sought would include general
business records that would not include privileged material. Petitioner has shown
that its request is narrowly tailored to seek potential relevant information in the
investigation. The Seventh Circuit has made clear that “[t]he information-gathering
authority granted to the IRS under § 7602 is quite broad” and that “the Supreme
Court has described § 7602 as the ‘centerpiece’ of a much larger congressional
design to endow the IRS with expansive authority to conduct effective tax
investigations.” Holifield v. United States, 909 F.2d 201, 205 (7th Cir. 1990)
(quoting in part United States v. Arthur Young & Co., 465 U.S. 805, 815 (1984)).
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The Summonses seek potentially relevant information within the scope of the broad
investigatory authority provided to the IRS. Thus, Petitioner has shown that the
Summonses were initiated for a legitimate purpose in order to seek relevant
information.
B. Information Not in Government’s Possession
Petitioner contends that it is seeking information from Artex in the
Summonses that is not in Petitioner’s possession. Artex has not shown otherwise.
Therefore, Petitioner has met its burden on this element of its prima facie case.
C. Statutory Administrative Requirements
Artex argues that the IRS has not followed its own internal procedures in
initiating the Summonses. Artex contends that the IRS did not follow an IRS Large
Business and International Division directive dated November 4, 2013 (November
2013 Directive). (Ans. Mot. 4). However, the record reflects that the November
2013 Directive addresses information document requests (IDRs) rather than the
enforceability of a summons. (Reply Ex. 2). Thus, the directive is not applicable to
the Summonses that are the basis of this enforcement action. In addition, the court
notes that to the extent that Artex contends that the November 2013 Directive applies
to the IDRs issued to it by the IRS, the directive incorporated a June 18, 2013
directive, which provided that it applies to IDRs issued after June 30, 2013. (Reply
Ex. 1-2). Petitioner asserts, and Artex has not disputed that the IDRs issued to Artex
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were on June 28, 2013, two days before the effective date of the November 2013
Directive. Finally, the directives that Artex points to state the following: “This
Directive is not an official pronouncement of law and cannot be used, cited, or relied
upon as such.” (Reply Ex. 2). Petitioner has thus shown that the IRS followed its
administrative procedures in initiating the Summonses. Petitioner has thus
established a prima facie case.
III. Abusive Practices
Artex argues that the IRS engaged in abusive practices when it issued the
Summonses. Once the IRS has established a prima facie case, the burden shifts to
the taxpayer to show that the enforcement of the summons would be an “abuse of
process” or acted in bad faith. BDO Seidman, 337 F.3d at 809-10; Miller, 150 F.3d
at 772. The taxpayer has a heavy burden to establish that the IRS abused its
authority. See BDO Seidman, 337 F.3d at 809-10 (explaining that “[t]he IRS’ broad
power to investigate possible violations of the tax laws is understood to be vital to
the efficacy of the federal tax system, ‘which seeks to assure that taxpayers pay what
Congress has mandated and to prevent dishonest persons from escaping taxation thus
shifting heavier burdens to honest taxpayers’”)(quoting in part United States v.
Bisceglia, 420 U.S. 141, 146 (1975)); see also Miller, 150 F.3d at 772 (stating
“[o]nce the government meets its prima facie burden, the taxpayer faces a ‘heavy
burden’ to either present facts to disprove one of the Powell factors, or to show that
the IRS issued the summons in bad faith”).
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Artex contends that the IRS engaged in abusive practices because it would not
enter into an agreement pursuant to Federal Rule of Evidence 502 (Rule 502), and
argues that Petitioner has not given Artex reasonable deadlines to produce the
necessary information in a cost-effective fashion.
A. Rule 502 Agreement
Artex contends that the IRS should have agreed to enter into an agreement
governed by Federal Rule of Evidence 502 (Rule 502). Rule 502 provides in part the
following:
(b) Inadvertent Disclosure. When made in a federal proceeding or to a federal
office or agency, the disclosure does not operate as a waiver in a federal or
state proceeding if:(1) the disclosure is inadvertent; (2) the holder of the
privilege or protection took reasonable steps to prevent disclosure; and (3) the
holder promptly took reasonable steps to rectify the error, including (if
applicable) following Federal Rule of Civil Procedure 26(b)(5)(B).
(c) Disclosure Made in a State Proceeding. When the disclosure is made in a
state proceeding and is not the subject of a state-court order concerning
waiver, the disclosure does not operate as a waiver in a federal proceeding if
the disclosure:(1) would not be a waiver under this rule if it had been made in
a federal proceeding; or (2) is not a waiver under the law of the state where the
disclosure occurred.
(d) Controlling Effect of a Court Order. A federal court may order that the
privilege or protection is not waived by disclosure connected with the
litigation pending before the court--in which event the disclosure is also not a
waiver in any other federal or state proceeding.
(e) Controlling Effect of a Party Agreement. An agreement on the effect of
disclosure in a federal proceeding is binding only on the parties to the
agreement, unless it is incorporated into a court order. . . .
Fed. R. Evid. 502. Artex argues that “[t]he IRS knew that any enforcement of the
[S]ummonses would have to be made in the Northern District of Illinois and that the
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policies of that District and of the Seventh Circuit Court of Appeals encourages, if
not mandates, such accommodation.” (Ans. Mot. 8). Artex contends that it needs to
be protected from inadvertent disclosures. However, as Petitioner correctly points
out, there is no requirement that the IRS enter into a Rule 502 Agreement. Nor does
Artex cite any controlling precedent that would require the IRS to enter into such an
agreement with Artex. As Artex acknowledges itself, a Rule 502 agreement is “an
agreement with the other party. . . .” (Ans. Mot. 1). Nothing requires the IRS to
enter into an agreement with Artex. Artex also argues that a Rule 502 agreement
would have been a “reasonable accommodation” by the IRS. (Ans. Mot. 8).
However, the IRS’s obligations are not governed by what Artex believes to be
reasonable and proper. Artex is required by law to provide the necessary information
to the IRS regardless of Artex’s opinion as to what the most reasonable method for
production would be. Artex presents extensive arguments as to why the IRS’s
reasoning for not entering into a Rule 502 agreement is flawed and how the IRS will
not be prejudiced by such an agreement. Artex argues, for example, that the IRS has
“nothing to lose by entering into such an agreement.” (Ans. Mot. 8). However, it is
for the IRS to decide whether it will enter into such an agreement, and the court will
not review the IRS’s reasoning for such a decision. Artex cannot force the IRS to
enter into such an agreement. Nor can Artex use the absence of a Rule 502
agreement as an excuse for refusing to provide the IRS with the requested
information. Artex has not shown that a Rule 502 agreement should be required in
this case and the sought after Rule 502 agreement appears to be nothing more than
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further efforts by Artex to delay its production. The IRS has also shown that the vast
majority of documents that would be produced pursuant to the Summonses would
not be documents likely to contain any privileged materials and Artex has not shown
that any privilege-review process would be nearly as onerous as Artex claims it
would be without a Rule 502 agreement. Petitioner also correctly points out that a
Rule 502 agreement would not relieve Artex from all obligations to avoid the
disclosure of privileged information.
B. Procedures and Deadlines for Production
Artex also argues that the IRS has not provided Artex with reasonable
procedures and deadlines to produce the necessary information at a reasonable cost.
The evidence shows that Artex was served with IDRs in the summer of 2013.
Petitioner has shown that it issued the Summonses only after extensive efforts on the
part of the IRS to obtain all necessary information from Artex. Petitioner has shown
that Artex has had ample time to produce the necessary information and that such
production will not be overly burdensome for Artex. Artex makes vague assertions
that the production for the Summonses would be costly. However, the record shows
that Artex should have been able to compile and produce the necessary information,
by segregating emails and preparing a privilege log without the need to review
“millions” of emails as Artex claims. (Ans. Mot. 4). Artex also argues that the IRS
should make “reasonable accommodations for electronic discovery,” but Artex fails
to specify all of the precise accommodations that it seeks. (Ans. Mot. 1). Artex has
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failed to substantiate its claims as to the burdens it faces in order to comply with the
Summonses. Artex’s objections as to the timing of its production appear to be yet
another attempt by Artex to forestall its production and delay the IRS investigation.
Artex also contends that a return date of January 9, 2014, was not reasonable, given
that there were weekends and holidays within the time-frame. (Ans. Mot. 4). The
IRS has shown that it made efforts well in advance of the issuance of the Summonses
to obtain the necessary information. At this juncture, Artex has had the benefit of an
additional eight months while the IRS proceeded through the necessary steps to
enforce the Summonses. Artex has not shown that any deadlines set by the IRS were
unreasonable. To allow Artex to further delay its production of information that the
IRS has shown to potentially be relevant to the legitimate IRS investigation and to
grant the relief sought by Artex would thwart the statutory investigatory power of the
IRS. Utecht, 238 F.3d at 887 (explaining that the standard for summons enforcement
“prevents defendants from unnecessarily imposing enormous administrative costs
and delays in tax evasion prosecutions by engaging in extended fishing expeditions
to support frivolous challenges”).
Artex also contends that it was not provided with specific facts to justify the
IRS investigation. Petitioner has shown that Artex has been provided with such a
justification. Artex’s demand for further justification from the IRS is yet another
attempt by Artex to place roadblocks in the path of the IRS and further delay the
investigation. Artex also complains that the IRS sent IDRs to Artex’s clients and
insureds, asserting that the IRS attempted “an end-run around the summons
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enforcement process. . . .” (Ans. Mot. 12). However, Artex has not shown that the
IRS acted improperly or violated any law in sending IDRs to other parties. Artex’s
complaint as to such IDRs is one more frivolous reason for refusing to comply with
the Summonses.
Artex also claims that “the purpose of the Summonses could only have been to
harass Artex. . . . .” (Ans. Mot. 10). Artex points to no evidence that the IRS was in
any way attempting to harass Artex. The IRS has shown that the Summonses are
part of a legitimate investigation.
Artex in essence has told the IRS that it will not comply with the Summonses
until the IRS agrees to the conditions set by Artex. Artex, thus, is attempting to
dictate to the IRS the conditions for Artex’s production of information. The law,
however, does not provide the taxpayer with the right to set its own production
requirements. The record shows that the IRS acted appropriately in initiating the
Summonses and that compliance with such Summonses is required under the law.
Petitioner has shown that it has provided Artex with reasonable procedures and
deadlines for the production of the required information. The IRS is granted broad
authority to conduct investigations and the record shows that the IRS remained
within the scope of such authority when issuing the Summonses. Holifield, 909 F.2d
at 205 (stating that “[w]ith this congressional design in mind, the Court stated that,
with the exception of the traditional privileges and limitations, ‘other restrictions
upon the IRS summons power should be avoided ‘absent unambiguous directions
from Congress’”)(quoting in part Arthur Young & Co., 465 U.S. at 816). Artex has
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not shown that the IRS engaged in abusive practices or acted in bad faith. Based on
the above, Petitioner’s motion for rule to show cause is granted.
CONCLUSION
Petitioner’s motion for rule to show cause is granted. The Petition to enforce
the Summonses is granted. This is a final and appealable order.
___________________________________
Samuel Der-Yeghiayan
United States District Court Judge
Dated: September 11, 2014
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