During the height of the most recent tax filing season, the Comptroller of Maryland (“the Comptroller”) announced a major step to try to thwart the filing of allegedly false or fraudulent tax returns.  Significantly, the Comptroller summarily suspended the processing of tax returns filed by those engaging in perceived “questionable” preparation practices, such as Liberty Tax Service and other private preparers.  According to a series of press releases from the Comptroller and other announcements to the public, the action came as a result of a “high volume of questionable returns received” from these preparers.

While tax malfeasance is a growing problem facing both the Internal Revenue Service (“IRS”) and the Comptroller and increased enforcement is justified, the Comptroller cannot run afoul of existing principles of law – such as due process rights of taxpayers and tax preparers.  Moreover, the Comptroller has a mandate to protect taxpayer confidentiality.  Aside from potential due process violations, with his swift statements to the press in these cases, the Comptroller may be side-stepping the confidentiality rights afforded taxpayers and tax preparers.[1]

Press Releases from the Comptroller

In early 2016, the Comptroller began issuing almost weekly press releases about “his ongoing effort to combat tax fraud and identity theft…[and] effective immediately, he has suspended processing electronic and paper tax returns from 22 private tax preparers at 25 locations throughout the region and three out-of-state locations due to a high volume of questionable returns received.”   The press releases named individuals and businesses that were suspended; however, no specific acts triggering these suspensions were alleged or appeared to have yet been investigated by the Comptroller.[2]  Instead, the Comptroller obscurely claimed that the returns prepared by these preparers may contain the following “suspicious characteristics”[3]:

  • Business income reported when taxpayers did not own a business.
    • Refund amounts requested much higher than previous year tax returns.
    • Inflated and/or undocumented business expenses.
    • Dependents claimed when taxpayer did not provide required 50 percent support or care, and/or
    • Inflated wages and withholding information.
    • Inflated itemized deductions.

While these suspensions may have the tangential effects of reducing tax mistakes and/or fraud in Maryland – which are appropriate goals of the Comptroller – the publication of individual’s names raises concerns regarding the potential violation of tax confidentiality laws.

Broad Coverage of Tax Confidentiality Laws

 Both the Internal Revenue Code (“I.R.C.”) and the Tax-General Article of the Annotated Code of Maryland (“TG”) contain provisions that protect taxpayer confidentiality with respect to tax returns and ongoing tax matters.  Pursuant to I.R.C. § 6103(a), “returns and return information shall be confidential, and except as authorized by this title…no officer or employee of the United States…no officer or employee of any State…and…no other person…who has or had access to returns or return information…shall disclose any return or return information obtained by him in any manner in connection with his service as such an officer or an employee or otherwise…”  I.R.C. § 6103(b)(2) specifies that “return information” means “a taxpayer’s identity, the nature, source, or amount of his income, payments, receipts, deductions, exemptions, credits, assets, liabilities, net worth, tax liability, tax withheld, deficiencies, overassessments, or tax payments, whether the taxpayer’s return was, is being, or will be examined or subject to other investigation or processing, or any other data, received by, recorded by, prepared by, furnished to, or collected by the Secretary with respect to a return or with respect to the determination of the existence, or possible existence, of liability (or the amount thereof) of any person under this title for any tax, penalty, interest, fine, forfeiture, or other imposition, or offense…” and certain other items; however, it does not include data “in a form which cannot be associated with, or otherwise identify, directly or indirectly, a particular taxpayer.”  Emphasis supplied.  A number of specified exceptions allow the IRS to disclose this information to third parties for particular uses.

As for Maryland, pursuant to TG § 13-202, “[e]xcept as otherwise provided in this subtitle, an officer, employee, former officer, or former employee of the State or of a political subdivision may not disclose, in any manner, any tax information.”  “Tax information” is defined as “the amount of income or any other particulars disclosed in a tax return required under this article, if the return contains return information, as defined in § 6103 of the Internal Revenue Code” and “any return information, as defined in § 6103 of the Internal Revenue Code, required to be attached to or included in a tax return required under this article.”  TG § 13-201.  The exceptions to this rule, found in TG § 13-203, allow disclosures to other taxing officials under certain conditions, disclosures pursuant to judicial or legislative orders, disclosures to certain officials with a right to review such information for a specific purpose, and disclosures for statistical purposes.  In essence, the Maryland statutes mirror I.R.C. § 6103.

The coverage of these confidentiality laws is extremely broad.  And while there is a lack of precedent in Maryland interpreting these statutes, in reviewing a statute relating to tax disclosures by tax preparers, the Attorney General has stated that these statutes “advance[] the general intent of Maryland’s income tax law to conform to federal law.”  78 Md. Op. Atty. Gen. 3 (1993) (citing to Katzenberg v. Comptroller, 263 Md. 189 (1971) in finding that TG § 13-207 should be interpreted likes its counterpart, I.R.C. § 7216).  Moreover, since I.R.C. § 6103 specifically requires states to adopt confidentiality provisions in order to receive return information from the IRS, the federal and state laws support the same principles of confidentiality.

Ample federal precedent shows that “return information” is not just limited to income, deductions, or the taxes due shown on a return.  Interpretations of I.R.C. § 6103 find that the term “has ‘evolved to include virtually any information collected by the Internal Revenue Service regarding a person’s tax liability”[4] and includes a PTIN (tax preparer identification number) on a return,[5] information about whether a matter is pending before the IRS and the status of any matter pending before the IRS,[6] a report containing information about tax shelter promoters prepared as part of an IRS investigation of tax shelter investors,[7] information relating to alleged fraud of an IRS employee,[8] information about an IRS investigation of  a Ponzi scheme,[9] the existence of a pending tax preparer penalty investigation,[10] or the results of a plea agreement concerning tax evasion.[11]  The identities of the suspended tax preparers released to the press, along with the revelation of their pending investigations by the Comptroller, clearly fits within the definition of “return information” as developed by federal courts.[12]

To avoid impermissible disclosures in federal investigations of tax preparers, the Department of Justice issues press releases only after a complaint is filed or a decision is ordered by the court.  Since information in these press releases would otherwise contain return information, the strict reliance on the contents of the public filings is necessary to avoid violations of I.R.C. § 6103.[13]  However, in the case of tax preparers suspended by the Comptroller, since no court proceeding has been initiated, there appears to be no basis for divulging information related to an ongoing tax investigation.  Moreover, recent press releases highlighting the status of these investigations also raises similar confidentiality and due process concerns.

Why Does It Matter?

Aside from significant due process concerns regarding pre-investigation suspension of tax preparers,[14] the Comptroller’s tactics may infringe on the rights of Marylanders.  For other tax preparers, this could have a chilling impact.  For example, if the Comptroller has any suspicion of wrongdoing, might he publish these allegations too, even if they turn out to be unfounded?  This could expose professionals to complications with other state agencies and could effectively cause financial ruin for businesses.  Moreover, if the Comptroller is not put to task here, might he be emboldened to publish confidential information in other contexts?

Where investigations are fact-driven, the need to rely on publicly available information, such as court filings, helps to prevent a rush to judgment and prevents disclosures made for unjustified reasons, which could otherwise irreparably damage tax professionals and their clientele.  Strict adherence to these rules also prevents would-be fraudsters from intimidating or conning Marylanders into providing confidential information such as Social Security numbers where they can easily identify those currently being scrutinized by the Comptroller.  At least here, it is quite plausible that taxpayers whose returns were prepared by these suspended tax preparers will become a target for phishing or other fraud – as it would not be difficult to use these press releases to frighten unwary taxpayers.

Tax confidentiality is sacrosanct.  Impermissible disclosures, even those seemingly minor and under the auspices of protecting Marylanders, must be dealt with in a serious manner.  The Comptroller, as well as any other parties affected here, should explore available remedies for confidentiality violations – along with breaches of due process – that may have occurred in these cases.[15]  The Comptroller should re-consider policies on press releases in order to preserve taxpayer confidences.  If confidentiality is not deemed necessary by the Comptroller – in light of or in the context of a competing need to address potential fraud – he should push for legislative changes to decouple Maryland law from its federal counterpart.

[1] Separate press releases from March 23, 2016, entitled “Comptroller Franchot Announces Plea Deal in Tax Theft Scheme Case,” and March 18, 2016, entitled “Statement of Comptroller Franchot on Nine in Indictments on Tax Fraud Charges,” similarly raise confidentiality concerns based on their disclosure of tax information.  See infra.  While publication of these cases may be permitted, that information should be independently contained within public record (i.e., court filings, indictments, etc.), in keeping in step with federal interpretations of I.R.C. § 6103.

[2] In a press release from the Comptroller on November 9, 2016 entitled “Comptroller to Convene Taxpayer Security Summit in January at University of Baltimore,” he stated that with respect to 61 companies whose return preparation authority had been suspended, “Not one of those businesses has met with the Comptroller’s office officials to clarify the submitted returns that led to their ban.”  The fact that the Comptroller is disclosing these ongoing matters and that no face-to-face meeting with these preparers has occurred poses grave concerns to confidentiality and may undermine the validity of the Comptroller’s actions.  In order to determine whether the tax returns are fraudulent and that the alleged fraud was of the tax preparer’s doing (and not the taxpayer’s doing), it is highly likely that some investigation would be necessary.  The delay in investigation for over seven months is also troubling in some respects as well.

Further, based on another press release from the Comptroller dated October 3, 2016, entitled “Comptroller’s Office Receives Anti-Fraud Award,” it appears that the suspension of these tax preparers is based solely on a computer algorithm – and not at all on a review of specific tax returns, how they were prepared and upon what information they were based, or any relationship between the tax preparer and taxpayer.  For example, as indicated in that press release: “The state-of the art technology used by my agency, together with the diligent work of my team of investigators, has helped to halt the brazen filing of radioactive state returns…As the perpetrators of this type of fraud have proliferated in recent years and their methods have become highly sophisticated, the Comptroller sought a new strategy with analytic modeling.”  While the initial identification of potential fraud through these methods may be quite useful, a finding more conclusive than is possible from a computer model is necessary, under existing law, to suspend and revoke the ability to prepare tax returns.

[3] Notably, several of these so-called suspicious characteristics are not susceptible to a conclusive determination from the face of a tax return or other information automatically transmitted to the Comptroller.  For example, business expenses can only be deemed “undocumented” if the Comptroller performs an audit of the tax return.  Similarly, the Comptroller cannot determine if a taxpayer did not have a business, did not provide 50 percent support or care for a dependent, or inflated deductions without performing an audit of the taxpayer’s return.  Given the totality of the information received by the Comptroller, returns may be viewed as “suspicious” and should attract further examination; however, this information alone is likely not sufficient to prove mistake, let alone mal-intent or fraud.

[4] Landmark Legal Found. v. IRS, 267 F.3d 1132, 1135 (D.C. Cir. 2001).

[5] IRS PMTA 2015-007.

[6] Internal Revenue Manual (6-5-15); IRS Info Letter 2010-0135 (May 5, 2001).

[7] Mallas v. IRS, 857 F.2d 722, 724 (10th Cir. 1988) (information consisted return information of promoters even though it was gathered in different investigation).

[8] Pritchett v. United States, 2003-1 USTC ¶ 50,351 (E.D. Mich. 2003) (TIGTA investigation file sought by taxpayer in tort suit against government resulting from IRS employee fraudulently changing returns not disclosable because was tax return information of both taxpayer and IRS employee).

[9] Emerging Money Corp. v. United States, 873 F.Supp.2d 451 (2012) (disclosure to victims of Ponzi scheme of nature of Ponzi scheme constituted impermissible disclosure of return information of those under investigation).

[10] See California Franchise Tax Board, TAM 2005-007 (Nov. 8, 2005) (interpreting state law analogously to I.R.C. § 6103).

[11] Johnson v. Sawyer, 640 F.Supp. 1126 (S.D. Tex. 1986) (finding violation of section 6103 even though information was already in the public domain).

[12] TG § 13-203(a)(2) excepts disclosure of “tax information that is contained in a tax report or return, audit of a tax return, or report of a tax investigation and relates to the imposition, assessment, and collection of taxes or to any other matter about taxation generally” under certain circumstances.  This exception demonstrates that “return information” in Maryland includes information outside of the four corners of a return and comports with federal interpretations.

[13] See, e.g., “Justice Department Sues to Stop Florida Tax Return Preparer,” August 18, 2014, available at: https://www.justice.gov/tax/pr/justice-department-sues-stop-florida-tax-return-preparer (specifically referencing complaint for all allegations contained in press release).  I.R.C. § 6103(h)(4) provides an exception for disclosures in judicial proceedings.  Moreover, so long as these press releases contain information of public record (and do not take information directly from information provided to, or gathered by the IRS), no “return information” is being disclosed.

[14] As of the dates of its press releases, it does not appear that any investigation or examination of the tax preparers or underlying tax returns had been performed.  In a press release dated May 24, 2016 entitled “Comptroller Franchot’s IT Shield Against Fraudulent Returns Touted as Superior State Program,” the Comptroller noted that he had used identifying metrics to “red flag” tax returns as fraudulent.  For those tax preparation firms who had prepared a high number of “red flagged returns,” they were “then informed that the agency no longer would process returns from them.”

The Comptroller does not regulate, or have the ability to suspend tax preparers, as they are regulated by the Department of Labor, Licensing and Regulation.  See Md. Ann. Code, Business Occupations and Professions, § 21-101 et seq.  The Comptroller’s ability to regulate tax filing is seemingly limited to its ability to regulate electronic filing.  However, as in other areas of regulation, due process is required to revoke or suspend electronic filing.  In the event of suspension, an administrative review must be allowed.  See 2015 Maryland MeF Handbook for Authorized e-File Providers (October 2015), at p. 41 (regarding administrative review for e-filing).  See also Md. Ann. Code, State Government, § 10-226 (regarding administrative due process generally).  Here, it is not evident that any administrative review was done (or any direct evidence gathered) before indefinitely suspending the capabilities of certain tax preparers.

[15] See, e.g., I.R.C. § 7213(a)(2) (willful, unlawful disclosure is a felony punishable by fine up to $5,000 and 5 years of imprisonment); TG § 13-1018 (unlawful disclosure is a misdemeanor punishable by fine up to $1,000 and 6 months of imprisonment); TG § 13-1026 (misdemeanor for negligent failure to perform a duty).