In United States v. Titan Int'l, Inc., No. 14-3789 (7th Cir. Feb. 1, 2016), the US Court of Appeals for the Seventh Circuit (the Seventh Circuit) has held that Section 7605(b) does not bar the IRS from issuing a summons for a taxpayer's previously inspected records, even if the IRS has not provided written notice of a re-inspection, if the subsequent inspection relates to the examination of a different tax year.

Background

In 2010, the IRS audited the 2009 tax return of Titan International, Inc. (Titan). In the course of the audit, the IRS summoned Titan's 2009 general ledger and other business documents. Titan complied with the summons and accepted a subsequent adjustment to its 2009 tax liability based upon a reduction of the claimed net operating loss.

In 2014, the IRS began an audit of Titan's 2010 tax return. On its 2010 return, Titan had claimed a net operating-loss carryforward for a loss that occurred in 2009. Accordingly, the IRS again summoned the same 2009 documents it had previously summoned in connection with the 2009 tax return audit. Titan refused to comply with the summons, contending that Section 7605(b) bars the IRS from re-inspecting previously inspected records unless, in accordance with the statute, "the Secretary, after investigation, notifies the taxpayer in writing that an additional inspection is necessary."

The Government sought enforcement of the summons in district court. The District Court rejected Titan's interpretation of Section 7605(b) and ordered Titan to comply with the summons. Titan appealed.

Opinion

Section 7605(b) states that — without notice by the Secretary — "only one inspection of a taxpayer's books of account shall be made for each taxable year." The issue in dispute in Titan's case was whether this statutory language means that the IRS may inspect only once a taxpayer's records created for a particular tax year or that it may inspect only once a taxpayer's records in connection with the auditing of a particular tax year. Titan argued for the former interpretation, and that, accordingly, the IRS could not re-inspect its 2009 records (absent notice from the Secretary).

The Seventh Circuit disagreed and affirmed the district court's decision. The Seventh Circuit called Titan's interpretation of the statute "disjointed" and stated that a "more natural reading" of the language in question limits the IRS to one inspection per audit per tax year (unless the IRS finds a second inspection necessary and issues the requisite notice). In support of its interpretation of the statutory language, the Seventh Circuit cited two cases: Reineman v. United States (Reineman), 301 F.2d 267 (7th Cir. 1962), and Digby v. Commissioner (Digby), 103 T.C. 441 (1994).

In Reineman, with respect to separate audits of two consecutive tax years, the IRS re-inspected records it had already examined for the first year (despite their irrelevancy for the subsequent audit) and then issued a second adjustment for the first year. The Court determined that the second inspection, without investigation and notice by the Secretary, violated Section 7605(b).

Digby also involved back-to-back audits of two consecutive tax years in which the IRS summoned the same documents relating to the earlier year in the subsequent audit. In connection with its second review of those documents, the IRS adjusted both the subsequent year under examination and the earlier year. In Digby, however, the Court determined the re-inspection did not violate Section 7605(b), because the re-inspection of the earlier year's documents was necessary to complete the subsequent year's audit. The Court further held Section 7605(b) does not bar re-adjustment of the earlier year (in addition to the one currently under audit), so long as the earlier documents were relevant to the subsequent year's tax liability and were not pulled for the purpose of adjusting the earlier year's (previously audited) tax liability.

The Seventh Circuit concluded that Titan's case was more like Digby than Reineman, because the inspection of the earlier year's records (that were previously inspected) is necessary for determining the tax liability in the later year currently in audit. Therefore, it held such inspection does not require notice by the Secretary under Section 7605(b).

Implications

This case is a helpful reminder that the IRS will often attempt to review a taxpayer's books and records for a particular tax year for a second time to assist with its examination of a different tax year, and the courts have generally allowed this second review without requiring the issuance of a re-opening notice. Revenue Procedure 2005-32 provides the IRS's view on the types of contacts with taxpayers and other actions by the IRS that are not examinations, inspections or re-openings of closed cases for purposes of Section 7605. This revenue procedure also describes the procedures for re-opening examinations under Section 7605(b), including when a case is deemed closed after examination by the IRS, when a closed case may be re-opened to make an adjustment unfavorable to the taxpayer, and who within the IRS must approve a reopening. While It is unclear here why the IRS needed to seek the documents through a summons when it should already have had the documents through the examination of the prior year, it is important that taxpayers take into consideration these procedures and discuss any unnecessary or duplicative draft information document requests (IDRs) with their IRS examination teams in order to resolve any issues. This is especially true in light of IRS's recent changes to the IDR enforcement process.

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