Congress has given the IRS broad authority to compel testimony or the production of documents or other information [IRC Sec. 7602(a)]. This authority to issue summonses where necessary has been delegated to Revenue Agents, Revenue Officers, Special Agents from the Criminal Investigation Division, and other IRS personnel. While this authority is subject to various legal and administrative constraints, the bottom line is the IRS has been given a powerful tool for gathering information.

The IRS will issue a "John Doe summons" when the identity of a party is unknown. To issue a John Doe summons, the IRS must establish the following in District Court [IRC Sec. 7609(f)]:

1.the summons relates to the investigation of a particular person or group of persons;
2.there is reasonable basis for believing such person(s) has failed to comply with the tax law; and
3.the identity of the person(s) sought is not readily available from another source.

Within the past few years, the use of John Doe summons procedures has become an issue in the IRS’s efforts to compel attorneys to file complete Forms 8300 (Report of Cash Payments Over $10,000 Received in a Trade or Business) where previous Forms 8300 omitted the client’s name and/or the nature of the services rendered. While the lawyers’ claims that disclosure of the client’s name violates the client’s 4th and 5th Amendment rights and violates the client’s 6th Amendment right to a fair trial have been consistently rejected by the courts [see Goldberger & Dubin v. U.S., 935 F.2d 501 (2nd Cir. 1991); and Ritchie v. U.S., 15 F.3d 592 (6th Cir. 1994)], at least one court has held that since the law firm’s tax liability is not at issue, the John Doe summons procedures must be followed [U.S. v. Gertner, 65 F.3d 963 (1st Cir. 1995)].

More recently, the IRS, through the U.S. Attorney, filed a petition with a Florida District Court requesting permission to serve John Doe summonses on American Express and MasterCard. The purpose is to determine the identities of taxpayers who have credit, charge, or debit cards issued by offshore entities. The petition states that there is a "reasonable basis" for believing that a group of "John Does" have failed to comply with one or more provisions of the Code. To support the request, the declarations of an IRS Revenue Agent and an attorney with experience in mony laundering and offshore banking were attached.

The agent’s declaration states in part that the IRS has been concerned with the growing problem of taxpayers evading the payment of U.S. taxes by concealing unreported taxable income or claiming improper deductions as a result of maintaining diverted funds in accounts in tax haven countries and accessing those funds through the use of credit, charge, or debit cards. The agent states that based on his involvement with an information gathering project on offshore transactions, he found the use of credit, charge, and debit cards to obtain access to offshore funds to be a common practice promoted by offshore professionals and used by persons with offshore accounts.

To engage in an offshore scheme, the "U.S. person" will find an offshore professional to assist in the development of an overall offshore plan. The plan will often include the creation of an entity or entities in a financial secrecy jurisdiction. For example, the offshore professional may help create an International Business Corporation (IBC) in the Bahamas.  The IBC will have nominee owners, usually employees of a Bahamian law firm. The nominee owners will execute some type of agreement or declaration stating that they hold the shares of the IBC for the U.S. person, who then is referred to as the beneficial owner of the IBC. Under Bahamian secrecy laws, there can be no disclosure of the U.S. person's beneficial ownership of the IBC, and there will be no mention of the U.S. person's ownership interest in any of the corporate documents or corporate filings.

Once the offshore structure is created, the next step is to transfer funds or assets to the IBC, which may represent profits the U.S. person is trying to hide from the IRS. The last step is to devise a technique to access the funds when desired, either by repatriation or by use abroad. Credit, charge, and debit cards are a common and purportedly nontraceable method of accessing offshore funds in any location where the card is honored. The card account may be in the name of the U.S. person or of the beneficially owned foreign entity.

Offshore credit cards are typically secured by funds equaling anywhere from 100% to 200% of the credit extended. The funds are locked into an account at the bank offering the credit card. Arrangements can be made for discreet billing and discreet payment of credit payments such that all such transactions occur away from the scrutiny of U.S. investigators.

The Revenue Agent quotes the following from a United Nations Report discussing the use of cards as a repatriation device:

Funds can be repatriated through a debit or credit card issued by an offshore bank.  Withdrawals from ATM machines or expenditures using the card can be settled either by automatic deduction from a foreign bank account or by the cardholder periodically transferring the required funds from one foreign bank account to another. Debit cards are superior from the point of view of automaticity and confidentiality. However, even an ordinary credit card can be turned into a debit card by being secured through the deposit of collateral with the issuing bank. Although secured credit cards were initially intended to give persons who were deemed a bad credit risk the advantages of use of a credit card, something that is increasingly essential for many purposes such as reserving hotel rooms or renting cars, it can be very useful to anyone seeking to lower their financial profile.

The agent concludes that there is a reasonable basis for believing that the documents sought in the John Doe summonses issued to American Express and MasterCard will identify U.S. persons who have diverted income offshore, received unreported income from offshore sources, taken improper deductions or credits, or failed to withhold tax on certain payments made offshore.

The attached declaration of Jack Blum, a partner in the law firm of Lobel, Novins & Lamont and a "recognized... expert on offshore bank secrecy, tax haven and money laundering issues," starts out by stating that "the use of offshore bank accounts and offshore entities to facilitate tax evasion is a massive problem for the [U.S.]. At a minimum, I estimate the annual losses... through offshore evasion by individual taxpayers at $70 billion dollars a year. According to the best available estimates more than five trillion dollars in assets are held offshore. Three trillion dollars is in the form of deposits in tax haven banks."

Mr. Blum noted that "for many years the growth in the use of offshore havens for tax evasion was limited by a single factor - a person with money hidden offshore faced major problems and major expense in getting access to it. Moreover, the access left a paper trail in the form of checks, telephone and telex communications, and other records. Tax evaders were reluctant to pay their bills with checks drawn on foreign banks because of the fees associated with international clearing operations. Many companies refused foreign checks for routine payments because of the fees charged by American banks for processing the checks and the long delays before the depositor had access to the funds."

However, the "widespread use of credit and debit cards has enabled offshore bankers to offer easy and instantaneous access to offshore accounts without an apparent paper trail and without the associated fees. By issuing a bank sponsored credit or debit card and associating it with the offshore account, offshore bankers can and do tell their customers that they can make most purchases, pay for travel, and get cash using the money in the offshore account without arousing suspicion and without leaving a paper trail in the form of communications and correspondence."

In Mr. Blum’s opinion, a John Doe summons is an appropriate way to identify foreign bank account holders because "[o]ffshore banks will not issue bank related credit cards unless the recipient of the card has an associated bank account at the same bank. Thus, the identification of [U.S] persons who are cardholders and who have cards issued by banks in the Bahamas, Cayman Islands, and Antigua will identify a group that has bank accounts at the issuing bank.  The lists provided by the credit card firms will enable the [IRS] to determine whether taxpayers have reported the existence of an offshore bank account they control and whether they have reported the related income."

Sufficiently swayed by this and other information appearing in the government petition, the District Court for the Southern District of Florida granted the IRS’s request on October 30.  In its order, the court noted that the summonses relate to the investigation of an ascertainable group or class or persons - American Express and MasterCard signatories whose charge, debit, or credit cards were issued by or through, or paid for  from funds drawn on, banks in Antigua and Barbuda, the Bahamas, or the Cayman Island during 1998 and 1999.  Furthermore, a reasonable basis exists for believing that such individuals may fail or have failed to comply with provisions of the tax laws [In The Matter of the Tax Liabilities of John Does, 86 AFTR2d 2000-5465 (DC S. Fla. 2000)].

While John Doe summonses are fairly rare, it is not uncommon for practitioners to come across a third-party recordkeeper summons. Special rules apply under IRC Sec. 7609 when the summons is issued to a third-party recordkeeper, which includes an attorney, accountant, enrolled agent, bank, trust company, credit union, savings and loan institution, consumer reporting agency, or broker, as well as the issuer of a credit card. For summonses issued after July 22, 1998, the IRS Restructuring and Reform Act of 1998 expanded the third-party recordkeeper procedures to summonses issued to all persons other than the taxpayer.  Following notification of the issuance of such a summons, the taxpayer has the right to file suit in court (i.e., to intervene) to prevent the third-party recordkeeper or other third party from complying with the summons.

The first rule is that a third-party recordkeeper should never ignore a summons. Failure to respond can waive otherwise valid defenses to the enforcement of the summons. At a minimum, the summoned person should appear on the specified date to challenge the validity of the summons, and should be accompanied by an attorney. If the issue is important enough to merit a summons, too much is at risk to permit the IRS to have unsupervised discussions with the person.

Several grounds are available in court to prevent the enforcement of, or to "quash," a summons. Some of the more common grounds relied on are:

1.The summons was issued for an illegitimate purpose (e.g., for research) or in bad faith (e.g., to pressure the taxpayer into settling some other dispute with the IRS).

2.The IRS has not complied with all administrative requirements for issuing the summons (such as the third-party recordkeeper requirements).

3.The IRS already has the information or the information is not relevant to what the IRS is doing (e.g., the examination of the taxpayer’s return).

4.The information sought is privileged.

5.The information sought is incriminating and so protected from disclosure under the 5th Amendment to the Constitution, or is so broad as to constitute an unreasonable search under the 4th Amendment to the Constitution.

Top Of The News: IRS Targets Offshore Chargers

The IRS has implemented a sweeping probe into thousands of credit-card accounts held by U.S. taxpayers in the offshore banking havens Antigua, Barbuda, the Bahamas and the Cayman Islands. Adalberto Jordan, a U.S. District Judge in Miami, issued an order yesterday that allows the IRS to issue summonses for records of charge, debit and credit cards issued or paid by banks in the Caribbean nations during 1998 and 1999, according to an Associated Press report.

Offshore accounts are legal for U.S. taxpayers. But Americans must file certain IRS forms, and they must pay taxes on income earned in the United States and deposited overseas. The three nations targeted by the IRS have long been known as offshore tax havens and favorite spots for drug-money launderers. Americans might be using credit cards issued by foreign banks to hide purchases, which can be linked to income.

Investigators can use credit-card records to look for the purchase of big-ticket items like cars, boats, airline tickets and hotel rentals. The investigation is one of the largest ever by the IRS targeting offshore accounts.

An affidavit filed with the summons request says the U.S. Treasury loses an estimated $70 billion yearly from individual taxpayers who use offshore accounts to evade taxes. "The records...will reveal transactions by persons who may be liable for United States income taxes and will enable the Internal Revenue Service to investigate whether those persons have complied with internal revenue laws," the petition says.

The countries in question derive revenue from being known as places where bank and credit-card accounts can be opened with few questions asked. "That's their niche," says David Shapiro, a director at Kroll Associates, an investigations firm in New York. "We have our Delaware, which is not as bad. But 'race to the bottom' is a phrase that's often used.

"This is one way to break that shell and get inside that world and explore it," Shapiro says.

MasterCard International and American Express (nyse: AXP) told the AP they are cooperating with U.S. authorities but would not answer questions. MasterCard indicated they keep transaction records only by account number and that the issuing bank stores personal information about the customer.

Offshore banks brag that they can help customers shelter income because the U.S. government cannot penetrate some foreign banking secrecy laws. The IRS may be able to circumvent those laws by obtaining records through the Miami headquarters of the offshore banks.

No one knows how many offshore credit-card accounts are owned by U.S. citizens, but the IRS believes the number is in the thousands.

The island banks require customers to open bank accounts before obtaining credit cards. So by obtaining the names of the cardholders, the IRS may gain insight into bank accounts also.

This week, a group of 11 of the largest international private banks adopted guidelines to combat money laundering, corruption and other related serious crimes. The Bahamas and Cayman Islands are among the reputed scofflaws, but officials in the Cayman Islands promised in June to end tax-haven practices within five years.

That deadline, it seems, is about five years too late for the IRS.