TAX CONTROVERSY–PART III: TAX COURT
This article is a continuation of our series concerning the key stages and considerations in tax controversy. (For a general overview, click here. For tax audits, click here). When we say «tax controversy,» most people think of audits, which is certainly not wrong. However, the process can go beyond just an examination of your return.
In reality, most disputes with tax authorities are settled. There is not a whole lot to talk about if you reach a settlement. You basically pay and move on with your life. Here, we will discuss what you can do when you are unable to reach an agreement with the examining agent and are considering tax litigation. Let’s look at a typical scenario.
You received a letter from the IRS (or DOR), so you went through a period of providing documents and information to the agent in charge of your review. Maybe you even had an office meeting or two with the agent. Despite your best efforts, the agent rejects the tax treatment in your return and presents you with a large bill, including interest and penalties. So, now what?
Actually, you do have some options:
1) You can utilize one of the special settlement programs or request a conference with an appeals officer;
2) If the agent thinks you should pay more than $25,000, you can file a formal protest;
3) You can pay the amount the agent requires, and then file a claim for refund; or
4) You can file a petition with the court.
Special Settlement Programs & Conference with Appeals Officer
Typically, the agent will prepare a Form 5701 (or similar form) with the proposed changes. Often, the agent will discuss the proposed changes with you prior to filing a formal report. This is an important moment in the process because the agent has greater flexibility prior to filing the formal report. You should make a push to cut a deal at this stage. If that is not happening, however, then consider a low-level dispute resolution technique.
There is something called the Early Referral Program, which allows you to get a specific issue(s) before the Appeals Division for review. This program is designed to encourage quick resolution of key issues, which often facilitates agreement on remaining issues. There is also the Fast-Track Mediation, which allows taxpayers in the Small Business/Self-Employed Operating Division to request the involvement of the Appeals Division to mediate the case while it is still in the examination phase.
If you are still unable to reach an agreement–or you make the strategic decision not to utilize one of the above programs–the agent will likely prepare and deliver to you what is commonly called the 30-Day Letter. Along with the 30-Day Letter you will receive a copy of the revenue agent’s report, called the «RAR,» which explains in detail the agent’s findings and basis for the proposed changes to your return.
At this point, you may request a conference with an appeals officer. You have just 30 days to make the request, so do not delay.
Involving the appeals division can be beneficial in a couple of ways. First, if you or your attorney think the examining agent’s position is unreasonable, or just plain wrong, taking the issue(s) to a more experienced IRS employee can do wonders for pushing through the deadlock. The IRS is not really in a big hurry to spend money on unnecessary litigation so, if you are right, the appeals officer will probably say so. Once you are past the sticky issue(s), you will, hopefully, be able to have more productive dialogue with the agent.
If you choose not to respond to the 30-Day Letter, or you are unable to resolve the key issue(s) through the appeals division, you will receive a Notice of Deficiency (known also as the 90-Day Letter). Now things get a bit more serious.
File a Formal Protest
You are still not at the point where you have to litigate, though you may make the strategic decision to do so. If the amount in controversy is greater than $25,000, you can file a formal protest with the Appeals Division. The step-by-step procedure is available here. The appeals officer will look at your matter with fresh eyes and is required to be fair and impartial to both the government and the taxpayer. For example, the appeals officer is prohibited from conferring with the examining agent outside your presence. (Specifically, no ex parte communications that appear to compromise the independence of the Appeals Division are prohibited).
If you found your relationship with the examining agent deteriorating through the examination process, the ability to deal with a new person alone might bring about the desired result.
You will need to prepare a protest letter, which should contain the following information:
- taxpayer’s (you or your company) name, address, and telephone number;
- statement that you want to appeal the examination findings;
- copy of the 30-Day Letter;
- tax years involved;
- itemized schedule of the adjustments with which you disagree;
- statement of facts supporting your position;
- statement setting forth the law and other authority on which you rely; and
- specific declaration under penalty of perjury that the factual representations are true and correct.
There is no specific form to use and the amount of detail to include is a strategic consideration so, ideally, you would have your accountant or attorney prepare the letter of protest.
The letter can be a «skeletal» protest, an «agent’s report responsive» protest, or a «comprehensive» protest. The best approach for your case will depend upon more factors than can be discussed here.
Pay the Adjustment and File a Claim of Refund
The alternative to filing a petition in Tax Court is to pay the deficiency and sue the government in either federal district court or the Court of Federal Claims. You may be wondering why you would go ahead and pay the assessment if you do not agree with the examiner’s report.
One way to think of this approach is «hedging your bet.»
If you feel like the examiner’s assessment is not the worst case scenario, then you consider taking the route of paying now and filing for refund later. For example, if you make the payment, that will suspend accrual of any interest on underpayment. In fact, if you later prevail on the refund claim, you will likely be entitled to interest on your overpayment.
Also, the risk of the IRS assessing further deficiency is much lower since they have already examined the return. Also, you can reduce the risk even more by filing the claim for refund after the statute of limitations on assessment has run (make sure, of course, the limitations period for refund does not expire).
File a Petition in Tax Court
You may decide to skip the forgoing options and go right to court. This is sometimes called a «Docketed Appeal.» Your case will still go through the Appeals Division, where you will still have an opportunity to settle. However, if your appeal is docketed, the settlement authority will be divided between the appeals officer and the IRS attorney assigned to the case.
There are a number of potential advantages to going the route of the docketed appeal:
- You can selectively brief issuesYou can selectively disclose facts
- The IRS will have to «lock in» its position.
- It is possible for the IRS to raise new issues or allege new facts, but it will bear the burden of proof for those new matters.
- As discussed in earlier parts, limiting the scope of the examination by controlling the flow of information can be a crucial consideration. The last thing you want is to open Pandora’s box through your appeal.
- Docketing the case demonstrates your resolve and willingness to litigate to achieve the appropriate result
- You will receive a trial date, which puts additional pressure on Appeals Officer
- The involvement of the IRS attorney may inject some realism regarding the hazards of litigating the IRS’ position
If you do, in fact, have a good case, then filing your petition quickly may very well be advantageous. You probably would not want to make that decision without legal counsel, of course.
To be fair, there can also be disadvantages to going straight to tax court:
- The petition will «lock in» your legal position. You can amend your petition, just as the IRS can amend its answer, but you risk losing credibility with the court.
- Once you have docketed your case, you are stuck in that court. Otherwise, you would have a choice between Tax Court and Federal District Court.
- You could lose the chance to go through the Appeals Office. Although the IRS’ general practice is to refer a docketed case to Appeals, the decision is, in fact, discretionary and the Chief Counsel may decide not to forward the case. While unlikely, if that happens, you will have no recourse to the Appeals Division.
- You give up privacy. Everything you file in your case is public record.
It is good to have a sense of the lay of the land and to start thinking ahead. As you can see, there are number of key considerations that probably should not be made without professional advice. In earlier sections, we touched on some of the differences (pros and cons) of going through the tax controversy with an accountant versus a tax attorney. Whichever way you go, once you reach this stage of the process, you will almost certainly be better off with an experienced tax professional at your side.
If you are going through an audit, or have already received a notice of deficiency, can contact our office for a free consultation.