The federal government took a page from private industry in 1990, when it passed the Administrative Dispute Resolution Act.1The act encouraged federal agencies to use alternative dispute techniques to settle the rising tide of legal claims made against them. Over the past decade, the Internal Revenue Service has initiated several programs to expedite the resolution of examination disputes. These alternative dispute resolution techniques save valuable time and resources for both taxpayers and the government, as well as reduce the uncertainty and delay caused by pending court decisions.
At the forefront of settling tax disputes is the IRS Office of Appeals, an internal office that is independent from other IRS departments, such as the agency's examination function, and now settles more than 100,000 cases annually. Through Appeals, several avenues of dispute resolution are available to taxpayers to help them expeditiously resolve tax disputes. As part of the IRS Industry Issue Focus initiative, questions have been raised concerning Appeals independence and the effectiveness of its dispute resolution tools. In looking at their resolution options, taxpayers should carefully consider various alternatives.
Resolving An IRS Examination
During the course of an IRS examination, parties may disagree on an issue, either around an interpretation of the tax laws, or the facts framing the issue. When an issue arises, the IRS will typically issue a "Notice of Proposed Adjustment" (NOPA), on Form 5701 detailing the agency's understanding of the facts, application of the tax law and conclusion. In response, the taxpayer may agree with the IRS position, present additional facts, or write a formal response citing tax authorities to support their position. If the issue remains unresolved, the IRS will issue a 30-day letter to the taxpayer, proposing a deficiency in tax. In response to the letter, a taxpayer can write a formal protest and request consideration by the IRS Office of Appeals.2
Appeals is charged with settling cases based upon an independent review and, in fashioning a settlement, it can take into consideration the hazards of litigation. Strict ex parte communication rules prevent the examination (audit) team from discussing the case with the Appeals Officer without the taxpayer's consent, thereby preventing the exam team from prejudicing the Appeals Officer's independent judgment.3The success of the Appeals function is evidenced in its ability to settle more than 80 percent of the cases arriving in its office without litigation.4
Formally, moving a case out of examination and into Appeals can be slow and inefficient. The examination team will issue the 30-day letter requiring a written protest in response, and the team may then prepare a written response to the taxpayer's position before administratively sending the case to Appeals. Those steps alone can take months. It is not uncommon for the period between the receipt of a 30-day letter and the first Appeals conference to span more than six months.
Dispute Resolution Through Appeals
In order to expedite the resolution of conflicting issues, the IRS has devised several alternative dispute resolution programs - such as early referral of an issue, or mediation - to allow easier resolution of issues through its Appeals Office. This article will take a close look at four dispute resolution tools: Fast Track Settlement, Early Referral to Appeals, Post-Appeals Mediation and Delegation Orders.
Fast Track to Appeals
The process of moving an examination into Appeals for formal consideration can be time-consuming. Where an examination dispute involves a limited number of issues, requesting a "Fast Track" settlement can resolve the issues within 120 days. (Procedures for Fast Track settlement can be found in Revenue Procedure 2003-40.5 )
Fast Track Settlement is appropriate when at the end of an IRS audit, the taxpayer and examiner cannot reach agreement on just a few issues. Normally, the examiner issues a Notice of Proposed Adjustment on each unagreed issue. With Fast Track, rather than go through the process of receiving a 30-day letter, closing the case in examination and requesting Appeals consideration, a taxpayer can simply ask that an Appeals Officer be assigned to the case while it is still in the audit team's jurisdiction. The case is then on a "Fast Track," where both the taxpayer and the examination team meet with an Appeals Officer to resolve remaining issues. Once accepted, resolution of any remaining issues takes place within 120 days.
During the Fast Track process, the Appeals Officer acts as mediator between the taxpayer and the Examination team to reach a mutually agreeable compromise on the issues. If the two sides are at an impasse, the Appeals Officer can recommend, but not impose, a settlement on the parties. In the event that no agreement can be reached, the taxpayer can still accept a 30-day letter and go to Appeals for consideration of the issue by a different officer.
Advantages to the Fast Track process are the possibility of resolving tax issues at the examination level within 120 days. The disadvantages are that the taxpayer is still sitting across from the examination team throughout the process. Furthermore, examiners frequently bring attorneys from the IRS District Counsel Office to represent the audit team's position, and these attorneys tend to be advocates, rather than facilitators, of a compromise. Still, the ability to settle an issue within 120 days may outweigh any potential disadvantages.
Early Referral to Appeals
Early on in an examination, a taxpayer may determine that a particular issue is incapable of being resolved at the examination level and will have to be elevated to Appeals. Under procedures announced in Revenue Procedure 99-28,6a taxpayer may request that an issue be sent to Appeals on "Early Referral." The Early Referral program allows an unresolved issue to be sent up the chain, while the examination continues on the other issues. Generally, a taxpayer will be issued a Notice of Proposed Adjustment on an unagreed issue during the course of the examination.
Through Early Referral, the contentious issue can be resolved while the rest of the examination winds down to its conclusion. The decision reached in Appeals can then be provided to the examination team, which adds the settlement to any other issues reached by the examination team in filing its final report. Assuming that all issues are settled through the examination itself, or in the Early Referral process, the examiner can then list the issues on Form 4549 and calculate a tax liability.
Unlike at the examination level, Appeals has the authority to settle cases based upon the hazards of litigation. Once the resolution of an issue is reached in Appeals, it is possible to take that settlement and apply it to other tax years still at the examination level. Under Delegation Order 236,7examination team managers are delegated the authority to accept a settlement effected by Appeals with respect to the same issue in a previous or subsequent tax period, even if the settlement is based on hazards of litigation. The conditions allowing for the delegation of such authority are that:
1. The facts of each transaction are substantially the same;
2. The legal authority surrounding the issue is unchanged; and,
3. The issue was settled by Appeals independently of other issues under consideration.
Issues designated by the IRS as "Coordinated Issues" may also be settled at the examination level based on Appeals settlements of the same issue under Delegation Order 4-25.8Delegation Order 4-25 grants examination team managers the authority to settle a coordinated issue along the same lines, for the same taxpayer, for issues that were already determined at Appeals for a different tax period - provided that the issue was settled within the ranges outlined in the Appeals settlement guidelines.
Based on published internal guidelines, certain issues will be treated as coordinated issues within the IRS and require technical coordination by examiners. Similarly, Appeals will often have settlement guidelines on the same issues. The delegation order allows the examination team to roll the Appeals settlement of a coordinated issue into its current examination, saving taxpayers the expense of carrying an identical issue back up to Appeals for resolution.
Appeals Mediation and Arbitration
Although the Office of Appeals settles most cases that come into its jurisdiction, at times the Appeals Officer and the taxpayer are unable to reach an agreement. In those rare instances, Appeals mediation and arbitration are available to try and resolve the impasse.
In post-Appeals mediation procedures, outlined in Revenue Procedure 2002-44,9the taxpayer can select a non-IRS professional to serve as a mediator between the Appeals Officer and the taxpayer, provided the mediator is acceptable to the IRS. The mediator does not have direct settlement authority, but works with the parties to define issues and negotiate a settlement.
In disputes over the facts framing an issue, the IRS recently established an arbitration program in its Revenue Procedure 2006-44.10An arbitrator may be selected from a group of trained Appeals Officers, or an independent non-IRS professional. An arbitration hearing is held with witnesses and exhibits, at which time the arbitrator will make factual determinations. Thirty days after the session, the arbitrator will issue a findings of fact report. The ruling of the arbitrator is final and cannot be appealed through litigation.
Is The Office Of Appeals Independent?
In theory, moving an unagreed case out of examination, and into Appeals, should give the taxpayer a fresh review of the case, with the Office of Appeals exercising its independent judgment. But questions persist over whether the office is truly independent. In recent years, tax practitioners have become increasingly vocal in expressing concerns that the independence of Appeals, in relation to the IRS examination teams, is being undermined. Before seeking an expedited review through Appeals, it is logical that a taxpayer should consider whether Appeals can be truly independent on an issue.
In 2007, the IRS announced a new program at the examination level, the Industry Issue Focus (IIF) initiative. The IIF program is meant to work in tandem with existing IRS procedures, such as Coordinated Issues, to identify and coordinate complex tax issues that the IRS identifies as compliance risks. To coordinate such issues, the IRS puts together Issue Management Teams consisting of personnel from both examination teams and the Office of Appeals. As an issue and its proposed IRS resolution mature, Appeals is brought into the process to work with the examination team. Appeals will develop its own Settlement Guidelines for an issue, but will often use examiner-drafted Coordinated Issue papers as basis for settlement. This raises the logical question of whether Appeals can render an independent judgment on an issue if it participated in developing examination's position on the issue.11
A recent American Bar Association survey indicated that practitioners had concerns about the ability of the Office of Appeals to resolve issues effectively, as well as independently.12Among the concerns raised were that Appeals Officers sometimes seemed unable to reach a decision without first consulting IRS headquarters, and that the influence of IRS industry specialists appeared to undermine the independence of Appeals Officers. In addition, in Fast Track settlement procedures, the examination team participates in the deliberative process and bears some influence on the Appeals Officer. The IRS has insisted that the involvement of Appeals in issue management teams will not compromise its independence.13
Before embarking on resolution of an issue in Appeals using one of the dispute resolution techniques, a taxpayer must do this homework. In Fast Track settlement, is it a help or a hindrance to have the examination team participating in the Appeals conference? Will Appeals independence be compromised by the presence of the examination team? If the issue is subject to a Coordinated Issue paper, has the Office of Appeals participated in developing the coordinated issue? Has Appeals issued its own settlement guidelines on the issue? If the issue is a high-profile issue, such as a Tier I issue in the IIF program, how willing is Appeals to offer a settlement contrary to an examination team's stated position?
Using dispute resolution techniques to obtain an Office of Appeals review of a contested item has the advantage of saving time and expense for the taxpayer. However, taxpayers should be aware that Appeals isn't always independent and may be subject to institutional influence. A review of all procedural routes - Appeals consideration after a 30-day letter, alternative dispute resolution techniques, or by passing Appeals altogether and moving the issue into court - should be weighed and discussed with your tax professional before attempting to resolve a tax dispute with the IRS.