Appealing an IRS Audit Report
By Gary Bluestein
Sometimes, for a variety of reasons, it is just not possible to settle a case at the examination level. For income, estate or gift tax cases that do not settle at exam, time permitting, the IRS will issue a 30-day letter advising the taxpayer of the changes the Service proposes to a return. In response, the taxpayer has 30 days to file a protest to contest the examiner’s determination.
Employment taxes and the Trust Fund Recovery Penalty are not subject to the notice of deficiency procedures. However, prior to assessment and collection the IRS is required to issue a 60 day notice advising of the proposed assessment for additional employment taxes or of the trust fund assessment. In response the taxpayer has 60 days from the date of the notice to file an administrative appeal.
After the Service’s issuance of either a 30 day or 60 day letter, the type of protest required depends not on the type of tax but rather on the amount of money involved. For cases involving less than $25,000, a brief written statement regarding disputed issues, rather than a full protest is sufficient. For cases involving $25,000.00 or more (including penalties), and for employee plan, exempt organizations, partnerships, and S-Corporation cases, a full written Protest is required. (See IRS Publication 5, Appeal Rights and Preparation of Protests for Unagreed Cases for more details). Since either action is time sensitive, either the Statement or Protest should always be mailed certified mail return receipt requested.
The mission of the Appeals Division is to “resolve tax controversies, without litigation, on a basis which is fair and impartial to both the Government and the taxpayer and in a manner that will enhance voluntary compliance and public confidence in the integrity and efficiency of the Service. The Appeals Division is highly successful at resolving tax disputes and has a settlement rate of between 85%-90% of its cases. Nevertheless, in a pre-assessment case, the practitioner should always consider whether or not a Protest should be filed, or if the taxpayer might be better served waiting for a Notice of Deficiency and requesting consideration by the US Tax Court.
The Appeals Division settles cases on an issue by issue basis rather than by compromising the total dollar figure. The general standard used by Appeals Officers is an analysis of the hazards of litigation. This means that the Appeals Officer can settle a tax controversy on a basis which fairly reflects the hazards which would exist if the case were litigated. Note the references to litigation. The practitioner must convince the Appeals Officer that there are significant “hazards of litigation”. Thus, effective representation of a client before the Appeals Division, in both docketed and non-docketed cases, requires a mastery of the facts of the matter at issue, the likelihood of proving those facts at trial, including an understanding of the evidentiary problems for both the taxpayer and the IRS, the relative strengths and weaknesses of the legal arguments for both sides and the applicable procedural rules and the realities of pursuing resolution of issues through litigation.
So what factors should be considering when requesting an Appeal? First, litigation is often expensive. If a case can be settled at Appeals, it may be less expensive for the taxpayer to resolve the case without the expense and hassle of litigation. Second, the authority of the auditor or agent is much more restricted than that of the Appeals Officer. Novel or complex issues may not receive adequate consideration at the examination level. Appeals officers, however, are willing to give consideration to such matters. Third, requesting an appeal allows the taxpayer to keep his/her options open as to the forum for litigation. For example, if it is unclear if the taxpayer would rather litigate in the US Tax Court or the Federal District Court, Appeals consideration of the case allows the taxpayer time to consider the ultimate forum for litigation. Fourth, if the taxpayer is not in a hurry to resolve a case, requesting an Appeal may allow negotiations to occur over a longer period of time because there is no pressure from a Court to resolve the case (assuming the statute of limitations is not in issue).
Last but not least, an Appeals conference may be the only method of settling some cases. This may be true for many different reasons. If the taxpayer has an argument to a proposed adjustment from exam but it is unclear whether he/she would win if the issue were litigated, requesting an Appeal and settling the issue is probably the best way to resolve the case. Additionally, some cases, like employment taxes or the trust fund recovery penalty, cannot be litigated until after the tax is paid. Thus, Appeals offers the only prepayment opportunity for resolution. Finally, for post-assessment cases, Appeals is a necessary step for obtaining review of penalty assessments, rejections of offers in compromise and appeals of certain collection activities of the IRS against a taxpayer.
Even though there are many good reasons why a practitioner should request an Appeal on behalf of a client, the practitioner should remember that the Appeals Division may add to, as well as subtract from, the proposed deficiency. Generally, Appeals Officers are more highly trained and have much more experience than the IRS auditors. They may spot and raise issues that the auditor missed, resulting in a statutory notice of deficiency well in excess of that proposed in the 30-day letter. Thus, requesting an Appeals conference exposes the taxpayer to possible additions to the deficiency proposed at the examination level. In reality, this does not happen often and the Appeals Officer will try to limit inquiry only to those issues raised by exam. Nevertheless, if the practitioner is aware of a large issue that was missed by exam that exposes a client to substantial liability, consideration of an increased deficiency should be discussed with the client.
Prior to the IRS Restructuring and Reform Act of 1998, Tax Court Rule 142 provided that the taxpayer had the burden of proof on any items set forth in the statutory notice of deficiency. This included any additions added to the deficiency proposed by the Appeals Division. The IRS, however, would have the burden of proof for any new matters raised after the filing of a petition in the Tax Court. The burden of proof is very difficult for the IRS to carry because the taxpayer is in control of the evidence. Thus, refusing a conference with Appeals could serve as a practical barrier to the addition of items to those in the 30-day letter.
Following the Restructuring and Reform Act, this strategy is less appealing because to obtain the shift of the burden of proof from the taxpayer to the IRS, the taxpayer must exhaust all administrative remedies for resolution, which includes timely responding to a 30-day letter. However, there may still be times when a taxpayer should skip Appeals prior to the issuance of a notice of deficiency. If a taxpayer will be unable to shift the burden because he/she will be unable to meet the criteria for doing so, and if Exam would issue a “bad” notice of deficiency, it may still be appropriate to accept the notice of deficiency and petition the Tax Court. Usually, the taxpayer will have another opportunity to settle with Appeals prior to trial because often the Office of Chief Counsel attorney will send the case to Appeals prior to trial in an attempt to settle the case without litigation.
The major function of the Appeals Division is to determine whether there is a basis for settlement of a tax dispute. A tax dispute can reach the Appeals Division as either an administrative appeal (a “non-docketed case”) or for settlement of a petition in the Tax Court (a “docketed case”). As detailed above, the taxpayer must initiate the request for an appeals conference in a non-docketed case. However, the taxpayer need not file a written request or protest in a docketed case. Generally, the case will be transferred by Office of Chief Counsel to the Appeals Division for settlement consideration after the initial pleadings are completed provided the taxpayer did not previously have a conference with Appeals.
Finally, after RRA 98, another important function of Appeals is to hold Collection Due Process Hearings in response to Collection Due Process Appeals filed in response to Filing of Federal Tax Liens and Final Notices of Intent to Levy. The IRS must notify any person subject to a lien within five days of the filing date of the lien. The IRS must also give any person subject to levy, notice of the levy at least 30 days prior to the levy.
If the taxpayer timely exercises his/her right to appeal a notice of lien or notice of intent to levy, a hearing will be held before an Appeals Officer of the IRS. The taxpayer is entitled to one hearing per tax period covered by the lien. The Appeals Officer must consider whether the actions of the IRS are in compliance with all applicable laws and administrative procedures. It is the Appeals Officer’s responsibility to determine if the Service’s proposed collection action properly balances the taxpayer’s legitimate concerns regarding the IRS action.
If the taxpayer is dissatisfied with the determination of the Appeals Officer, the taxpayer may file a request for judicial review of the Appeals Officer’s determination within 30 days of the determination. The Appeal should be made to the Tax Court if the Court would have jurisdiction of the underlying liability. If the Tax Court would not have jurisdiction of the underlying liability, the request for review should be made to the Federal District Court.