Remedies for resolving Taxpayer disputes with the Internal Revenue Service
The Internal Revenue Service was created in 1862 as the federal agency responsible for collection of tax and interpretation and enforcement of the Internal Revenue Code. As with any collection of laws and regulations the Internal Revenue Code is open to varying levels of interpretation. Congress and the IRS have developed, over time, an effective set of tools and remedies for taxpayer disputes with the IRS arising out of the varying interpretations of the complex set of laws and regulations that compromise the Internal Revenue Code.
The remedies provided to taxpayers and the IRS in resolving disputes can be divided into four major categories:
- Determination Letters and Rulings – These are letters or rulings with varying degrees of binding effect to transactions. The transactions can be proposed or contemplated transactions, or completed transactions that have not been subject to the examination process
- Examination Process – During the examination process discussions are opened with the IRS and the taxpayer is afforded the opportunity to explain the stance taken under the laws and regulations for specific transactions. The examination process is a period for both finding of fact as well as discussing application of law to specific transactions. Audit determinations, if agreed to, are final and binding.
- Appeals Process and Tax Court – The Appeals Process and the US Tax Court afford the taxpayer an additional avenue for dispute resolution when the taxpayer disagrees with the finding at the examination level. Appeals are an informal process that focuses on determining rule of law to the transactions that were considered in examination. New issues are generally not raised at Appeals. The US Tax Court is the taxpayer’s last step after appeals (before Appellate Courts or the US Supreme Court) to litigate issues under examination.
- Taxpayer Advocate Service – The Taxpayer Advocate Service is available to taxpayers as an independent source within the IRS to help resolve taxpayer disputes. This function is mostly related to resolving issues with communication between the taxpayer and IRS personnel.
Determination Letters and Rulings
Private Letter Rulings
Prior to filing a tax return, taxpayers may request a letter ruling from an Office of Associate Chief Counsel of the IRS to determine the tax status or tax effects of prospective or completed transactions. A letter ruling interprets the tax laws and applies them to the taxpayer’s specific set of facts. Only the requesting taxpayer may rely upon a letter ruling. User fees apply to requests for letter rulings and a letter ruling request will be returned to the taxpayer without payment of the fee. User fees for letter rulings can range from $150 to $50,000 depending on the type of transaction for which the ruling is being requested. Letter rulings may be revoked or modified at any time, however the ruling is binding on the taxpayer when accompanied by a closing agreement. Detailed instructions on the process for applying for letter rulings, under what circumstances the government will issue letter rulings, and a fee schedule for the various technical issues for which letter rulings are being sought are published each year in the 1st revenue procedure of the year.
Determination Letter
A determination letter is issued by a Director that applies the principles and precedents established in a statute, a tax treaty, the regulations, a revenue ruling, or a court decision to a specific set of facts. It is not concluded with a closing agreement, so there is less finality. Only the requesting taxpayer may rely upon a determination letter. A user fee applies to requests for determination letters. Currently, the user fee for determination letter is $275. An example of a determination letter would be an organization’s request for approval of exemption from tax under Code Section 501(c)(3) related to public charity status.
Information Letter
When a taxpayer requests general information or the taxpayer’s request does not meet the requirements for letter ruling or determination letter issuance, an information letter is issued by an Office of Associate Chief Counsel or a Director. An information letter states a well-established interpretation or principle of tax law without applying it to a specific set of facts. It is advisory only and has no binding effect on the IRS. There is no user fee for information letter requests.
Private Letter Rulings and Determination Letters are made available to the public with taxpayer specific information redacted. Other taxpayers may not rely on the specific guidance given to other taxpayers in private letter rulings or determination letters, but these letters can shed light on how the IRS would typically view a situation based on a particular fact pattern.
The Examination Process
The examination process begins when the IRS selects tax returns for examination based upon objective criteria coded into a computer program or manual selection by IRS personnel. If a taxpayer’s account is selected for examination, the taxpayer will be notified what type of examination the IRS intends to perform and which specific transactions or categories of income or expense will be looked at.
Types of Examination
The five major types of examination are:
- Automated under-reporter program: This is the simplest type of examination, in which the IRS computers simply match items reported on tax returns and reported by payers on the forms, and sends a computer-generated notice to the taxpayer proposing a correction to the tax.
- Correspondence examination: This examination is for addressing simple problems that can be resolved by correspondence. The IRS sends a letter to the taxpayer questioning a single tax issue and asking the taxpayer to mail supporting documents to the IRS. Once substantiation has been submitted by the taxpayer, the IRS will propose changes, if any.
- Office examination: In this examination, the taxpayer is asked to visit the IRS office with the requested substantiation that will provide proof for the areas under examination. The office examination is conducted by an interview with an office examiner. During the visit, after all the supporting documents have been presented, the examiner will explain the findings and the amount of additional tax to be proposed, if any.
- Field examination: This examination generally involves more complex issues. It is conducted by a revenue agent at the location where the taxpayer’s books, records, and other relevant documents are maintained and can involve multiple areas of a tax return.
- Research examination: In this examination, returns are chosen at random based on the ending digits of the taxpayer’s tax identification number. Every return is subject to a thorough examination for the IRS research purposes. In a research examination no item declared on the tax return is considered immaterial and all line items are examined.
Audit Determinations
- No Change: An examination in which the taxpayer has substantiated all of the items being reviewed and results in no changes.
- Agreed: An examination where the IRS has proposed changes and the taxpayer understands and agrees with the changes.
- Disagreed: An examination where the IRS has proposed changes and the taxpayer understands, but disagrees with the changes.
When the Taxpayer Disagrees
If the taxpayer disagrees with the examination findings, a supervisory conference with the examiner’s manager may be requested for further review of the issues. The conference with the revenue agent’s manager often gives the taxpayer another avenue to resolve disputes in an informal manner. If the taxpayer and the IRS still cannot agree on the issues under examination, a final audit report is issued and the taxpayer has 30 days to request an appeals conference.
Appeals & Tax Court
Appeals
The IRS has an administrative appeals process to resolve taxpayers’ disagreements with the IRS without resorting to litigation. The Appeals Office of the IRS is an independent, impartial division of the IRS. The Appeals officer is to maintain a standard of impartiality with respect to the taxpayer’s case, however the officer is still required to protect the rights of the IRS.
If an Appeals Office review is desired, a taxpayer may file a formal written protest. Once the Appeals office reviews the taxpayer’s protest and the examiner’s case file, it will arrange a conference with the taxpayer and/or the taxpayer’s authorized representative by telephone, correspondence, or face-to-face to discuss the fact and the law. The conference with the Appeals office is informal, and testimony is not taken under oath. The Appeals office will often request that affidavits be submitted under penalty of perjury in many instances. The Appeals officer has the authority to settle disputes with taxpayers above that afforded to revenue officers in the traditional examination. Additionally, at the Appeals level the Appeals Officer may consider hazards of litigation in considering a settlement. Most disputes are settled at this level.
If the case is settled, the taxpayer can execute a closing agreement with the IRS to bring the case to a final and conclusive resolution. If the case is not settled, the taxpayer has the option of proceeding to court.
Tax Court
If the taxpayer bypasses the IRS Appeals Office or does not agree with the Appeals determination, the taxpayer has the right to take the case to court. Taxpayers have 90 days after a Notice of Deficiency is issued to petition the Tax Court. Cases before the Tax Court, unlike cases taken to the US Court of Federal Claims or US District Court do not require the taxpayer to pay the tax due before filing a petition.
In Tax Court both the taxpayer and the IRS present their case to a judge or panel of judges (en banc review) specializing in tax law. After all evidence has been presented and arguments made, the judge(s) will issue a ruling. If the taxpayer or the IRS further disagree with this finding, they may Appeal to the US Court of Appeals and eventually to the US Supreme Court.
Taxpayer Advocate Service
The Taxpayer Advocate Service (TAS) is an independent division of the IRS for taxpayers that are having problems with a specific case and:
- The problem is causing economic harm or significant cost for the taxpayer;
- The taxpayer is facing an immediate threat of adverse action; or
- The IRS has not responded after repeated attempts to communicate by the taxpayer.
The TAS functions include:
- Interceding more effectively to resolve taxpayers’ problems or disputes with the IRS;
- Identifying areas in which taxpayers have problems in dealing with the IRS;
- Recommending changes in the administrative practices of the IRS to prevent the problems; and
- Identifying potential legislative changes.
A Taxpayer Advocate is authorized to issue a Taxpayer Assistance Order that is intended to provide the taxpayer with an easy way to resolve disputes with the IRS, not to contest the merits of a tax liability.
To request TAS assistance, the taxpayer must file an IRS form with the local Taxpayer Advocate office. There is at least one local Taxpayer Advocate in every state. The service is free.
While by no means perfect, the IRS has a well established process and set of rules and regulations to assist taxpayers in resolving their disputes with the IRS. Taxpayers have remedies both before any prospective action is taken or before filing such as with private letter rulings and determination letters, as well as actions to take when disagreements arise over positions taken under the tax law.
Article by Matthew Wheeler, CPA and Vanessa Mun, CPA