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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.

© 2017 McDermott Will & Emery


About this Author


Robin L. Greenhouse is a partner in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Washington, D.C., office.  Robin represents clients in resolving complex federal tax controversies with the IRS at audit or appeals, and in tax litigation in the U.S. Tax Court, the U.S. Court of Federal Claims and the U.S. District Courts.  She has litigated federal tax cases involving numerous issues, including:  foreign tax credits, allocation of expenses between domestic and foreign source income, section 1341 claim of right, calculation...


Ruth Wimer, Esq., CPA, is a partner in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Washington, D.C., office.  She focuses her practice on matters related to executive compensation including international, fringe benefits, personal use of employer aircraft and qualified and non-qualified deferred compensation.

Ruth has extensive experience advising clients on structuring optimum ownership of business aircraft, factoring in deduction and income inclusion for personal use, excise tax, depreciation,  SEC and FAA issues.  She is an industry specialist with respect to incentive compensation and multi-billion dollar fee deferral issues for hedge funds and private equity firms.  She advises on large deduction timing issues with respect to mergers and acquisitions.  Her expertise also covers the gambit of compensation issues including  employment taxes, stock options, section 162(m), section 83, deduction limitations, the entertainment disallowance and a wide variety of fringe benefits including health insurance.

Ruth is a frequent speaker on compensation topics including for the ABA, the AICPA, the NBAA, GWSCPAs, Insight and widely attended client seminars.  In addition, she has authored leading articles on tax topics including “Section 409A and Section 457A International Deferred Compensation Issues,” “Airplanes-Air-pains” and “Deduction Disallowance Under Notice 2005-45.”


Andrew R. Roberson is a partner in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Chicago office.  Andy specializes in tax controversy and litigation matters, and has been involved in over 30 matters at all levels of the Federal court system, including the United States Tax Court, several US Courts of Appeal and the Supreme Court. 

Andy also represents clients, including participants in the CAP program, before the Internal Revenue Service Examination Division and Appeals Office, and has been successful in settling...

K. Christy Vouri, tax, international, world, attorney, McDermott Will, law firm

K. Christy Vouri is an associate in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Washington, D.C., office.  She focuses her practice on U.S. and international taxation. Prior to joining McDermott, Christy served as a law clerk to Judge Robert A. Wherry, Jr. in the United States Tax Court.  She is an adjunct professor of tax practice and procedure litigation at the Georgetown University Law Center.