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United States v. Grayson County State Bank and Lloyd Butts, First Pentecostal Church, Etc., Intervenor-Appellee, 656 F.2d 1070, 1st Cir. (1981)

The United States appeals a district court order denying enforcement of an IRS summons seeking bank records related to a church and its minister from 1973-1976. The district court held that enforcing the summons would violate the free exercise of religion clause of the First Amendment and that the summons was not authorized under a code section restricting examination of church records. The appellate court finds that the IRS established a valid purpose for the summons and that enforcing it would not excessively entangle the government with religion or restrict religious activities. The order is reversed.
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59 views10 pages

United States v. Grayson County State Bank and Lloyd Butts, First Pentecostal Church, Etc., Intervenor-Appellee, 656 F.2d 1070, 1st Cir. (1981)

The United States appeals a district court order denying enforcement of an IRS summons seeking bank records related to a church and its minister from 1973-1976. The district court held that enforcing the summons would violate the free exercise of religion clause of the First Amendment and that the summons was not authorized under a code section restricting examination of church records. The appellate court finds that the IRS established a valid purpose for the summons and that enforcing it would not excessively entangle the government with religion or restrict religious activities. The order is reversed.
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656 F.

2d 1070
81-2 USTC P 9680

UNITED STATES of America, Plaintiff-Appellant,


v.
GRAYSON COUNTY STATE BANK and Lloyd Butts,
Defendants-Appellees,
First Pentecostal Church, Etc., Intervenor-Appellee.
No. 80-1892.

United States Court of Appeals,


Fifth Circuit.
Unit A
Sept. 21, 1981.
Janet Hellmich, Asst. U. S. Atty., Tyler, Tex., Joseph W. Clark, M. Carr
Ferguson, Asst. Attys. Gen., Tax Div., Michael L. Paup, Chief, Appellate
Sect., Charles E. Brookhart, R. Russell Mather, John F. Murray, Attys.,
Dept. of Justice, Washington, D. C., for plaintiff-appellant.
Johnson, Bromberg, Leeds & Riggs, Michael P. Carnes, Dallas, Tex., for
intervenor-appellee.
Appeal from the United States District Court for the Eastern District of
Texas.
Before CHARLES CLARK, TATE and SAM D. JOHNSON, Circuit
Judges.
TATE, Circuit Judge:

The United States appeals from an order denying judicial enforcement, see 26
U.S.C. 7604(b), of an Internal Revenue Service (IRS) administrative
summons previously issued, see 26 U.S.C. 7602, to the Grayson County State
Bank, which had failed to respond. By the summons, in connection with the
investigation of the tax liability of an individual taxpayer (the minister of the

church), the IRS sought production of certain bank records pertaining to a


church, as to which the taxpayer (the minister) had signature privileges or
trustee assignment. Having permitted the church to intervene, the district court
granted its motion to quash the summons. In so doing, the district court held:
(1) granting the IRS the discovery of bank records so sought would impair the
free exercise of religion by laying open to governmental examination the
church's financial history; and (2) that 26 U.S.C. 7605(c), which restricts IRS
examination of "the books of account of a church," applied so as to restrict the
IRS examination of the bank records of a church. The government appeals,
contending that the district court erred in both holdings. We agree and,
therefore, reverse.
Factual Context
2

Section 7602 of the Internal Revenue Code of 1954, 26 U.S.C. 7602, grants
the Internal Revenue Service the power to summon books and records, and to
take the testimony of any individual for the purposes, inter alia, of ascertaining
the correctness of a tax return and determining a taxpayer's correct tax liability.
Section 7604 of the Code, 26 U.S.C. 7604 grants authority to the federal
district courts to issue orders compelling, through their powers of contempt,
compliance with the IRS summonses.

Pursuant to Section 7602, the IRS in November 1978 issued a summons to


Grayson County State Bank in connection with an ongoing investigation into
the income tax liability of the minister of the First Pentecostal Church in
Sherman, Texas for the years 1973, 1974, 1975, and 1976. The taxpayer had
produced his personal financial records, but he refused to produce certain
church records requested by the IRS. Officials of the church also refused to
allow revenue agents to inspect any church records. The Grayson County State
Bank through Lloyd Butts was ordered to appear before an IRS special agent to
give testimony and produce certain specified taxpayer-related books and
records "on (or on behalf of) the First Pentecostal Church, 601 N. Harrison,
Sherman, Texas for the years 1973, 1974, 1975, and 1976 on which (the
minister-taxpayer) has signature privileges and/or trustee assignment (See
attachment)."1

On refusal of the bank to provide said records the IRS applied to the federal
district court for enforcement of the administrative summons under Section
7604. A motion to intervene as defendant was granted to the First Pentecostal
Church which filed a motion to quash the summons as constituting excessive
governmental interference or entanglement with church affairs and because its
enforcement would allegedly have a "chilling effect" on the free exercise of

religion by church members.


5

The district court, as earlier noted, denied judicial enforcement of the IRS
summons and quashed the summons on the grounds that (1) it violated the First
Amendment free exercise of religion rights of the intervening church and (2)
that the summons was not an authorized examination of church records because
it was not conducted pursuant to 26 U.S.C. 7605(c),2 a provision restricting
examination of such records.
I. The First Amendment Issue

In denying the IRS's application for enforcement and quashing the summons,
the district court found that the summons in this case sought documents which
would "lay open to government examination the entire financial history
including the manner in which the Church raises, invests, and spends funds
from all accounts that the Church's minister has signature privileges or trustee
assignment" and that such disclosure would be a "burden upon the free exercise
of the religious belief of (the church's) members." The district court found this
clearly raised a substantial question that judicial enforcement of the summons
would be an abusive use of the court's process that thus required the IRS to
show some reason to justify its request. The court further found that, since civil
tax liability for the years had prescribed, the government must come forward
and show some interest by way of tax fraud, which it had not done; in this
respect, the court pointed out that the government had produced no showing of
probable cause to suspect that the minister had committed tax fraud.

The legal principles applicable are not in substantial dispute. In enforcement of


an IRS summons under Section 7602 when the summons authority is necessary
for "the effective performance of congressionally imposed responsibilities to
enforce the tax code, that authority should be upheld absent express statutory
prohibition or substantial countervailing policies." United States v. Euge, 444
U.S. 707, 711, 100 S.Ct. 874, 878, 63 L.Ed.2d 141 (1980). "A defense against
disclosure based upon religious objections can find First Amendment support
only if the disclosure either serves to establish religion or impedes the free
exercise of sectarian conviction. U.S.Const. Amend. 1. Government action can
violate the establishment clause ... if the end result is an excessive
entanglement with religion." United States v. Holmes, 614 F.2d 985, 989 (5th
Cir. 1980).3 Free exercise of religion embraces two concepts: (1) freedom to
believe, which is absolute; and (2) freedom to act, which conduct, however, is
subject to regulation for the protection of society. Cantwell v. Connecticut, 310
U.S. 296, 303, 60 S.Ct. 900, 903, 84 L.Ed. 1213 (1940). (As the district court
recognized, the present issue might arise only under the second concept, as the

church and its members are unimpeded in their beliefs.)


8

Initially, the issuance of an IRS summons must meet a test of good faith as
formulated in United States v. Powell, 379 U.S. 48, 85 S.Ct. 248, 13 L.Ed.2d
112 (1964). The IRS must show that: (1) the investigation will be conducted
pursuant to a legitimate purpose, (2) the inquiry may be relevant to the purpose,
(3) the information sought is not already within the IRS's possession, and (4)
the proper administrative steps have been followed. Powell, supra, 379 U.S. at
57-58, 85 S.Ct. at 255; United States v. Holmes, supra, 614 F.2d at 987-88.

Appellee's argument that the IRS did not meet the Powell test is easily rejected:
A valid purpose was established, namely, to investigate the correct tax liability
of the minister; the records sought were limited only to those "on which (the
taxpayer had) signature privileges and/or trustee assignment" for the applicable
years, indicating relevance of the inquiry; the church has not claimed that the
IRS is in possession of this information; and notice of the summons was
provided to the taxpayer and the church as required by 26 U.S.C. 7609
(1976).4

10

Once a prima facie case for enforcement is shown, the burden shifts to the
taxpayer to show enforcement would be an abuse of the court's process. Powell,
supra, 379 U.S. at 58, 85 S.Ct. at 255; Holmes, supra, 614 F.2d at 988.

11

As the Supreme Court held in Powell,the Government need make no showing


of probable cause to suspect fraud unless the taxpayer raises a substantial
question that judicial enforcement of the administrative summons would be an
abusive use of the court's process, predicated on more than the fact of reexamination and the running of the statute of limitations in ordinary tax
liability.

12

379 U.S. at 51, 85 S.Ct. at 251.

13

The church, citing United States v. Citizens State Bank, 612 F.2d 1091 (8th Cir.
1980), contends that the enforcement of the summons would result in a
"chilling effect" upon the free exercise of the religious beliefs of its members.
In Citizens State Bank the government issued a summons to the bank
requesting all bank records relating to the accounts of the taxpayer in question
and of the organization of which he was president. The Eighth Circuit found
that the appellants met their initial burden by making a prima facie showing of
an arguable First Amendment infringement. Id. at 1094. In the instant case, the
church's reliance on Citizens State Bank is misplaced. The organization there in

question was "a voluntary association of citizens who were opposed to the
current operation of the IRS and who made efforts to bring about changes in
the United States taxation system." Id. at 1093. The conclusion that an IRS
summons of this organization's records would produce a "chilling effect" on
membership is readily apparent.5 However, allowing the IRS access to
information to determine the correct tax liability of the taxpayer, the church's
minister, does not restrict the church's freedom to espouse religious doctrine nor
to solicit members or support. United States v. Holmes, 614 F.2d at 989.
Furthermore, the church has presented no evidence that enforcement of this
summons would restrict the religious activities of its members.6
14

Further, even if the enforcement would place an indirect burden on some First
Amendment rights, we recognized in United States v. Holmes :

15

The Supreme Court has employed a two part balancing test in determining
when such conduct is protected by the free exercise clause. First, plaintiff must
show a burden on the exercise of his religion by the law under review. Second,
the burden will be upheld only if the government interest outweighs the degree
of impairment of free exercise rights. See Wisconsin v. Yoder, 406 U.S. 205,
214, 92 S.Ct. 1526, 1532, 32 L.Ed.2d 15 (1972); Sherbert v. Verner, 374 U.S.
398, 403, 83 S.Ct. 1790, 1793, 10 L.Ed.2d 965 (1963).

16

614 F.2d at 989.

17

We have recognized that compliance with a properly narrowed summons may


result in "only an incidental burden upon (the) free exercise of religion," U. S.
v. Holmes, 614 F.2d at 989; Hearde v. Commissioner, 421 F.2d 846 (9th Cir.
1970), and that "(b)alanced against the incidental burden on church religious
activities is the substantial government interest in maintaining the integrity of
its fiscal policies... This interest is sufficiently compelling to justify any
incidental infringement of plaintiff's First Amendment rights." Holmes, 614
F.2d at 990.

18

We therefore disagree with the district court's conclusion that First Amendment
rights of the church or its members were implicated by the issuance of the
present summons. The summons was issued to secure access to records in the
possession of a bank, in connection with a taxpayer investigation, to examine
those records of the bank pertaining to the church that were relevantly
connected with the taxpayer's financial activity for the tax years of the
investigation. Under the relevant facts, no substantial showing is made of
abusive use of the summons, for its issuance does not constitute any significant

burden upon the free exercise of religious activity by the church or its
members.
19

The appellee church nevertheless contends that the district court's conclusions
to such effect are factual findings and subject to displacement on appellate
review only if clearly erroneous, Fed.R.Civ.P. 52(a). However, it is well settled
that the clearly-erroneous limitation does not apply to the review of a district
court's legal conclusions and inferences drawn from the facts, and that the
appellate court is free to make an independent determination from the same
facts of the determinative legal conclusions and inferences. United States v.
Mississippi Valley Generating Company, 364 U.S. 520, 526, 81 S.Ct. 294, 297,
5 L.Ed.2d 268 (1961); Spray-Bilt, Inc. v. Ingersoll-Rand World Trade, Ltd.,
350 F.2d 99, 103 (5th Cir. 1965); 9 Wright & Miller, Federal Practice and
Procedure, 2588 at 750, 2589 at 753 (1971). (Here, the principal facts
relevant to our determination are undisputed the issuance, scope, and purpose of
the summons.)
II. The Section 7605(c) Issue

20

The second issue presented on appeal is whether the court below erred in
holding that the IRS, in its attempt to obtain and examine bank records
pertaining to the church, is limited to an examination under Section 7605(c) of
the Internal Revenue Code, 26 U.S.C. 7605(c).7 The IRS correctly contends
that 7605(c) is not applicable in the examination of such bank records.

21

Section 7605(c) contains two limitations. The first requires that no examination
of the "books of account of a church " shall be made to determine whether such
organization is engaged in the carrying on of an unrelated trade or business or
may be otherwise engaged in "taxable activities"8 unless the IRS gives the
church written notice of such audit; the second limitation requires that such
examination must be restricted to the extent necessary to determine the amount
of tax imposed upon an unrelated business activity of the church. Paragraph (c)
was added to Section 7605 by the Tax Reform Act of 19699 as an
administrative provision in connection with an amendment to Section 511 of the
Code, which made the unrelated business income tax provisions of the Code
applicable to churches.10 The purpose of Section 7605(c) was to protect
churches from the administrative burden of "unnecessary tax audits" so as not
to interfere with the internal financial matters of the church.11 This section,
therefore, imposes some restriction, but it does not preclude examination of
church records.

22

Here, however, the summons sought to be enforced by the IRS is directed at

22

Here, however, the summons sought to be enforced by the IRS is directed at


records of the Grayson County State Bank, not at books of account of the First
Pentecostal Church.

23

In interpreting paragraph (b) of Section 7605,12 which prohibits a second


inspection of a taxpayer's records absent written notice to the taxpayer, the
courts have narrowly construed the analogous language "taxpayer's books of
account". The courts have consistently found that Section 7605(b) is a
limitation upon the examination of a taxpayer's "books of account " and "does
not apply to an examination of books of account of a third person." Geurkink v.
United States, 354 F.2d 629, 631 (7th Cir. 1965); Hall v. Commissioner of
Internal Revenue, 406 F.2d 706, 710 (5th Cir. 1969). See also: United States v.
Krilich, 470 F.2d 341, 350 (7th Cir. 1972), cert. den. 411 U.S. 938, 93 S.Ct.
1897, 36 L.Ed.2d 399 (1973); Hinchcliff v. Clarke, 371 F.2d 697, 700 (6th
Cir.) cert. den. 387 U.S. 941, 87 S.Ct. 2073, 18 L.Ed.2d 1327 (1967); United
States v. Howard, 360 F.2d 373, 380 (3rd Cir. 1966); Bouschor v. United
States, 316 F.2d 451, 457 (8th Cir. 1963); Application of Magnus, 299 F.2d
335, 336 (2d Cir.), cert. den. 370 U.S. 918, 82 S.Ct. 1556, 8 L.Ed.2d 499
(1962). "This prohibition applies by its express terms only to the taxpayers'
records; it did not prevent the appellants from seeking information from other
sources, such as the bank, regarding the taxpayers' possible liability."
DeMasters v. Arend, 313 F.2d 79, 86 (9th Cir. 1963); "the statutory restriction
against second examinations applies only to the taxpayer's own records, and not
to records of third parties like the Bank." United States v. Chemical Bank, 593
F.2d 451, 458 (2d Cir. 1979).

24

In the instant case the IRS investigation is being conducted in order to


determine the correct tax liability of the taxpayer-minister, not to determine
whether the church is engaged in unrelated, taxable activities. Under consistent
judicial interpretations of comparable provisions, the records sought by the IRS
are not books of account of the church. Therefore, Section 7605(c) is not
applicable and does not preclude enforcement of the summons against the
present bank records pertaining to the church.

Conclusion
25

Accordingly, we find the district court's order denying judicial enforcement of


the administrative summons issued to the Grayson County State Bank must be
VACATED and REMANDED for further proceedings in accordance with this
opinion.

26

VACATED and REMANDED.

The records subject to the taxpayer-minister's signature privilege or trustee


assignment specified by the attachment to the summons were:

Signature cards

Bank Statements for the period beginning January 1, 1973 through January 31,
1977

Cancelled checks, (sic )

Deposit slips

Savings statements for periods beginning January 1, 1973 through January 31,
1977

Savings deposit slips

Savings withdrawal slips

Certificates of Deposit in the name of the First Pentecostal Church, Sherman,


Texas, in effect and/or purchased during 1973, 1974, 1975, and/or 1976

26 U.S.C. 7605 TIME AND PLACE OF EXAMINATION


(c) Restriction on examination of churches. No examination of the books of
account of a church or convention or association of churches shall be made to
determine whether such organization may be engaged in the carrying on of an
unrelated trade or business or may be otherwise engaged in activities which
may be subject to tax under part III of subchapter F of chapter 1 of this title
(sec. 511 and following, relating to taxation of business income of exempt
organizations) unless the Secretary (such officer being no lower than a
principal internal revenue officer for an internal revenue region) believes that
such organization may be so engaged and so notifies the organization in
advance of the examination. No examination of the religious activities of such
an organization shall be made except to the extent necessary to determine
whether such organization is a church or a convention or association of
churches, and no examination of the books of account of such an organization
shall be made other than to the extent necessary to determine the amount of tax
imposed by this title. (as added by 121(f), Tax Reform Act of 1969, Pub.L.
No. 91-172, 83 Stat. 487).

The district court noted that although the church's objection was couched
partially in "establishment clause" language, the claim was in essence grounded

in the free exercise clause and was treated as such


4

The church argues that the notice required by 7605(c) was not given. As we
hold 7605(c) not applicable to this summons, appellee's claim is not pertinent

Here the IRS summons was limited to (1) specified types of documents, (2) on
which the taxpayer-minister had signature privilege, (3) for a restricted time
span. Compare the broad scope of documents requested by the summons
directed to the church itself in Holmes, 614 F.2d at 987 n.3, and by the
summons in Citizens State Bank, 612 F.2d at 1093 n. 3. Furthermore, the court
in Citizens State Bank indicated a more limited summons would be
enforceable, emphasizing that "our decision will only rarely serve to limit the
reach of an IRS summons." Id. at 1094

Additionally the order of the district court recognized in footnote that "(u)nlike
the Church in Holmes, this Church has no option to limit IRS access to church
records by foregoing its tax-exempt status since the records are not requested
under a 7605(c) examination of the Church."

See text of 26 U.S.C. 7605(c) at note 2

Churches are generally exempt from income taxes; however, 26 U.S.C. 511,
512 provide for tax on the unrelated business income of charitable
organizations, including churches

Section 7605(c) was added by Sec. 121(f), Tax Reform Act of 1969, Pub.L.
No. 91-172, 83 Stat. 487 (1969)

10

Section 511 was amended by Sec. 121(a), Pub.L. No. 91-172, 83 Stat. 536
(1969)

11

The Senate Finance Committee, concerning the extension of unrelated business


tax to churches, stated
The bill contains several administrative provisions including one providing that
no audit of a church, its integrated auxiliaries, or a convention or association of
churches is to be made unless the principal internal revenue officer for the
region believes the church may be engaged in a taxable activity and notifies the
church in advance of the examination. This provision is intended to protect
churches from unnecessary tax audits in the interest of not interfering with the
internal financial matters of churches.
S.Rep. No. 91-552, 91st Cong., 1st Sess. reprinted in (1969) U.S.Code Cong. &
Ad.News 2027, 2097.

12 U.S.C. 7605(b)
(b) Restrictions on examination of taxpayer. No taxpayer shall be subjected to
unnecessary examination or investigations, and only one inspection of a
taxpayer's books of account shall be made for each taxable year unless the
taxpayer requests otherwise or unless the Secretary or his delegate, after
investigation, notifies the taxpayer in writing that an additional inspection is
necessary.

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