September 08, 2021

Final Regulations on IRS Contractor Participation in Examinations—Practical Protections for Taxpayers


On September 7, 2021, the US Treasury published final regulations1 that, among other things, prohibit Internal Revenue Service (IRS) contractors from questioning witnesses during summons interviews. The final regulations implement section 1208 of the Taxpayer First Act2 and include prohibitions on (i) IRS use of outside counsel except in limited circumstances and (ii) IRS use of outside counsel or other experts for questioning witnesses in summons interviews.

Regardless of any technical limitations, the regulations provide practical protections for taxpayers under audit. Here, we begin with an overview of the events leading up to section 1208 of the Taxpayer First Act. We then turn to the rules themselves. And, finally, we note some practical considerations for taxpayers.

How We Got Here—the IRS Lawyers Up

The IRS Office of Chief Counsel refers to itself as “the largest tax firm in the country[,] with approximately 1,500 attorneys.” Those attorneys provide legal guidance and interpretive advice to the IRS and Treasury. And they represent the IRS during audit and litigation.

Despite all that, on May 19, 2014, the IRS did something surprising: it engaged an outside law firm, Quinn Emanuel, to provide legal services in connection with a transfer pricing examination of one of the world’s largest companies. A few weeks later, the IRS issued temporary regulations allowing its outside experts to “fully participate” in summons interviews, including questioning witnesses and asking a witness’s counsel to clarify objections or privilege assertions.3 At the same time, it began the process of making those regulations permanent.4

When the taxpayer sued the IRS for information about the Quinn Emanuel contract, it didn’t take long for Congress to take note. Within weeks, the chairman of the Senate Finance Committee objected to the practice as, among other things, (i) violating federal law and the express will of Congress by delegating IRS functions to a third party and (ii) allowing inherently governmental functions to be carried out by private contractors.5 Despite those objections, the following year, the IRS finalized its new rules anyway, asserting authority to continue to use private contractors in those capacities.6

The Taxpayer First Act

In 2018, the new administration proposed regulations that would restrict the IRS’s ability to hire outside counsel and the ability of non-IRS employees to question summoned witnesses.7

But Congress wasn’t satisfied with a regulatory fix. And on July 1, 2019, it enacted the Taxpayer First Act, Pub. L. 116-25.8 The act added section 7602(f) to the code, prohibiting, among other things, a “person other than an officer or employee of the [IRS] or the Office of Chief Counsel” from “question[ing] a witness under oath” in a summons interview.9 The House Report explained that Congress believed that “[s]uch questioning [wa]s a government function that should be performed by government employees” and that “only IRS employees or employees of the Office of Chief Counsel should question summoned witnesses . . . .”10

New Regulations

After the Taxpayer First Act, Treasury withdrew its 2018 proposed regulations and proposed new ones (now finalized). These new rules combined parts of the 2018 proposal with the protections of section 7602(f):

  • Interview Participation. Matching section 7602(f), the regulations prohibit IRS contractors from questioning witnesses in summons interviews. In addition, the regulations go beyond section 7602(f) by prohibiting IRS contractors from asking a witness’s representatives to clarify objections or privilege assertions.
  • Disclosure to IRS Experts. The regulations provide examples of the types of experts to whom the IRS can disclose taxpayer information under section 6103(n) and match section 7602(f) in narrowing the scope of material that can be provided to outside experts to only “when such person requires such information for the sole purpose of providing expert evaluation and assistance to the IRS.“
  • Outside Attorneys. Going beyond section 7602(f), the regulations prohibit the IRS from hiring outside attorneys for either federal tax expertise or general litigation expertise, although the IRS can still hire outside attorneys for other areas (e.g., as an expert on environmental law).

The new regulations are applicable to summonses served on or after the date of the proposed regulations, August 6, 2020.11

Lessons Learned, Best Practices and Open Questions

Many taxpayers routinely agree to allow informal interviews during audit rather than insisting on the formality of the summons process. At first glance, the regulations seem irrelevant to those taxpayers: the preamble to the proposed regulations states that they do not prohibit an IRS expert—for example, a transfer pricing economist—from questioning witnesses in other contexts.12

But taxpayers can negotiate the terms of any informal or “formal” interviews. And taxpayers should consider whether to condition any such interviews on the IRS’s abiding by the same protections that would apply to a summons interview.

Finally, it is unclear whether the new regulations went far enough to protect taxpayers. The answer depends on whether section 7602(f) was intended to address a problem of form (third parties asking the questions) or of substance (third parties directing the questions and developing the IRS’s theory). If the problem was not mere form, it raises a number of questions. For example, should the regulations have required disclosure of any third party’s role in the examination, including what input, if any, the third party had in preparing interview or deposition questions? As audits progress, taxpayers should be observant of the role of IRS experts and should consider options to ensure that the protections of section 7602(f) are not simply form without substance.

1 Final Rule, TD 9952, 86 FR 49923 (Sept. 7, 2021). The pre-publication version was released for public review on September 2, 2021.

2 Taxpayer First Act, Pub. L. 116-25, § 1208(a), 133 Stat. 981, 991 (July 1, 2019).

3 T.D. 9669, 79 F.R. 34625, 34626 (June 18, 2014).

4 Notice of Proposed Rulemaking, REG-121542-14, 79 F.R. 34668 (June 18, 2014).

6 Final rule, T.D. 9778, 81 F.R. 45409 (July 14, 2016).

7 Notice of Proposed Rulemaking, REG-132434-17, 83 F.R. 13206 (Mar. 28, 2018), withdrawn 85 FR 47931 (Aug. 7, 2020).

8 Taxpayer First Act, Pub. L. 116-25, 133 Stat. 981, 991 (July 1, 2019).

9 26 U.S.C. § 7602(f) (2019).

10 Report of the Committee on Ways and Means on H.R. 1957 (Taxpayer First Act of 2019), H. Rept. 116-39, at 48–50 (Apr. 9, 2019).

11 Final Rule, TD 9952, 86 FR 49923 (Sept. 7, 2021).

12 Notice of Proposed Rulemaking, REG-132434-17, 85 FR 47931, 47933 (Aug. 7, 2020) (“Contractors may continue to ask questions informally (not under oath) of a taxpayer, a taxpayer’s employee, or third parties in appropriate circumstances.”).

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