Originally published May 1, 2002
Proactive Resolution of Issues Before the Tax Return Is Filed
I. Resolving Issues under the Pre-Filing Program
A. Certain taxpayers can request a pre-filing examination of certain issues in a year for which a tax return is not yet due. Rev. Proc. 2001-22.
B. A Pre-Filing Agreement (PFA) can be used to resolve factual issues and issues involving the application of well-established legal principles to stipulated facts.
C. Note: If the taxpayer wants comfort regarding a legal issue that is not wellsettled, the taxpayer can request a private letter ruling. Rev. Proc. 2002-1.
D. Issues resolved in a PFA are permanently and conclusively resolved for the year covered by the PFA.
Disclosure of Issues to Avoid Penalties
II. Disclosure of Issues on the Tax Return
A. If the taxpayer has a reasonable basis for the tax treatment of an item, and discloses the item on the return, accuracy-related penalties will not be imposed. Code § 6662(d)(2)(B); Treas. Reg. § 1.6662-4(e).
B. If the item is attributable to a tax shelter, disclosure is irrelevant, see ¶ IV, below.
C. Disclosures are made using Form 8275 or Form 8275-R (for positions contrary to Treasury regulations). Treas. Reg. § 1.6662-4(f).
III. Disclosure of Issues on Qualified Amended Returns
A. Disclosures can be made on a qualified amended return. Treas. Reg. § 1.6664- 2(c)(2).
B. The to be "qualified," the amended return must be filed before IRS examination begins.
IV. "Tax Shelter" Disclosures
A. If the item is a "tax shelter," merely disclosing the item will not avoid exposure to penalties. Code § 6662(d)(2)(C); Treas. Reg. § 1.6662-4(e)(2) and (g). "Listed" tax shelters are identified in a list published by the IRS.
1. Penalties can be avoided by filing a timely Qualified Amended Return and paying the tax and interest associated with the item. The payment of tax is treated as tax shown on the original return and eliminates the underpayment on which the penalty is based. Treas. Reg. § 1.6664- 2(c)(2).
B. Instead of being protected by mere disclosure, the taxpayer must be able to justify its position on the merits.
1. Noncorporate taxpayers must have substantial authority and believe that their position is more likely than not correct. Code § 6662(d)(2)(C)(i); Treas. Reg. § 1.6662-4(g)(1).
2. Corporate taxpayers must establish "reasonable cause" (substantial authority) and "good faith" (more likely than not correct) regarding their position. Code § 6664(c); Treas. Reg. § 1.6664-4(e).
C. Previously, the IRS developed a Disclosure Initiative, designed to promote the disclosure of tax shelter and other items, under which penalties could be avoided. IRS Announcement 2002-2.
1. The item had to be disclosed before the earlier of April 23, 2002, and the date on which the issue was raised by the IRS on examination.
2. The taxpayer had to agree to hand over all documents and opinions, including privileged material. Thus, taxpayers who disclosed were at risk of waiving the attorney-client and other privileges.
3. In IRS News Release IR-2002-22 (Feb. 22, 2002), in response to taxpayer concerns, the IRS gave guidance regarding the waiver issue, and provided a model agreement applicable to disclosed documents.
4. LMSB has developed an Abusive Tax Shelters Mandatory Information Document Request (IDR) for examinations started after April 23, 2002, which seeks information regarding listed transactions.
V. IRS Audit/Examination Procedures
A. "Audit File" Disclosures
1. Errors, affirmative issues, and other items can be disclosed by a CIC taxpayer to the IRS at the commencement of the examination. The disclosure statement is treated as a qualified amended return. Treas. Reg. § 1.6664-2(c)(4); Rev. Proc. 94-69.
2. This disclosure procedure will not prevent imposition of penalties if the disclosed item is attributable to a tax shelter.
Examination Mechanics
VI. Commencement of the Audit
1. Coordinated Industry Case (CIC) Program (formerly Coordinated Examination Program (CEP))
a. Large taxpayers are subject to the CIC Program, and are audited for every year.
2. Initial meeting with the CIC examination team
a. IRS Examination Team Members
(i) In large cases, one revenue agent will be the case manager and will lead a team of agents. The case manager develops the audit plan and determines the scope of the audit.
(ii) One agent is the team coordinator. The taxpayer typically has most contact with this member of the audit team.
(iii) International, employee plan, or other special examiners may be brought in for special roles.
(iv) Outside consultants may be brought in.
b. The taxpayer and the agents will discuss the audit plan.
(i) The parties discuss office space and equipment to be provided to the agents, and the exam team’s audit plan.
(ii) Timing and a completion date may be discussed.
3. Time constraints – Limitations on Assessment and Collection
a. Code § 6501 imposes a period of limitations on the IRS’s ability to assess of deficiencies. Tax deficiencies must be assessed within 3 years after the filing of the return. (Under Code § 6501(c) and (e), some special rules may apply, e.g., in the case of fraud, substantial omissions, etc.)
b. Code § 6501(c)(4) provides that the assessment period can be extended by agreement. Extensions of the assessment period are made using Form 872. (Special forms may be used in certain cases, e.g., Form 872-F, 872-P, 872-S, etc.)
c. A taxpayer can refuse to extend the assessment period. However, the IRS can protect itself by issuing a statutory notice of deficiency that asserts a blanket assessment.
d. Taxpayers often extend the assessment period for relatively short time periods, so they can retain some control over timing.
4. Conduct of the audit and special examination procedures
a. Revenue agents are authorized to examine books and records, and to examine persons. Code § 7602(a)(1). Agents ask for information using Form 4564, Information and Document Requests (IDRs).
b. If the taxpayer fails to produce the required information or person, the IRS can issue an administrative Summons. Code § 7602(a)(2).
c. Revenue agents can ask for information from third parties, and can issue a Third-Party Summons. Code § 7602-7604, 7609.
(i) When the agents seek information from third parties, they are required to notify, in advance, the taxpayer being examined. Code § 7602(c). The taxpayer can request to be present during the IRS’s contact with the third party.
(ii) The taxpayer must be given notice of a third party summons. Code § 7609.
d. TEFRA Partnership Provisions – Code § 6221-6234
(i) Partnership items reported on a taxpayer’s return may be separately examined at the partnership level.
(ii) Special rules govern notification to partners, partner participation in the audit, assessments against partners, and judicial review of the proposed adjustments.
(iii) The tax matters partner (TMP) represents the partners as the contact person with the IRS.
e. The Market Segment Specialization Program (MSSP)
(i) Agents with expertise in the segment will develop MSSP audit guides, which describe industry issues and audit techniques. The audit guide is not binding on the agent examining the taxpayer.
(ii) The agents auditing the taxpayer may be specialists in the taxpayer’s segment.
f. Industry Specialist Program (ISP).
(i) The revenue agents will seek guidance regarding legal issues that are "coordinated" under the ISP program. IRM Exhibit 8.7.1-1 lists the ISP issues.
(ii) Certain specialized industries have Industry and Issue Specialists.
(iii) The Industry Specialists write position papers and advise examining agents regarding coordinated issues.
(iv) Examining agents must raise coordinated issues, contact the Industry Specialist, and make adjustments in accordance with the ISP position papers.
g. The Industry Issue Resolution (IIR) program.
(i) This time-limited pilot program is intended to provide guidance to resolve frequently disputed tax issues that are common in various industries. Notice 2000-65.
(ii) The IRS will issue revenue procedures that permit taxpayers to adopt the recommended treatment.
h. Technical Advice Requests
(i) Either the taxpayer or the revenue agent can ask for guidance from the IRS National Office by means of a Request for Technical Advice. In response, the National Office will issue a Technical Advice Memorandum (TAM). Rev. Proc. 2002-2.
(ii) The taxpayer makes a written submission on the facts and applicable law, and will have a conference with the National Office.
(iii) The examining agents will follow the technical advice that they receive.
i. Field Service Advice
(i) Revenue agents can ask for guidance from the IRS National Office by means of a Request for Field Service Advice (FSA).
(ii) Taxpayers may have no notice of the request, cannot review the agent’s request, make no submission of their own, and have no conference.
(iii) FSA’s are not binding on Exam or Appeals.
5. The revenue agents have limited ability to settle issues.
a. Typically, revenue agents do not have authority to settle legal issues based on hazards of litigation assessments.
b. Agents have the ability to raise or not raise issues depending on legal interpretations and factual determinations.
c. If an issue previously was settled by IRS Appeals, revenue agents may settle the issue in the examination on the same basis. Delegation Order 236.
d. If an issue is an ISP Coordinated issue, on which IRS Appeals has established written settlement guidelines, revenue agents may settle the issue in the examination according to the guidelines. Delegation Order 247.
6. The taxpayer and the revenue agents can seek to resolve certain audit issues under a Fast Track Mediation process or a Fast Track Settlement process. Notice 2001-67.
a. Issues must be fully developed, and the taxpayer’s position must be stated in writing.
b. In Fast Track Mediation, an Appeals Officer will act as a mediator to help the parties resolve factual issues.
c. In Fast Track Settlement, the Appeals Officer helps the parties resolve factual or legal issues and exercises Appeals settlement authority to effect the settlement.
d. Agreements are reflected in closing agreements. If no agreement is reached, the issues can be protested to Appeals.
7. In the examination of the tax years under audit, CIC taxpayers may enter into an Accelerated Issue Resolution (AIR) agreement with the IRS to apply the resolution issues in the audit years to other to tax years ending prior to the date of the AIR agreement. Rev. Proc. 94-67.
a. Specified issues cannot be the subject of an AIR agreement.
b. The AIR agreement acts as a closing agreement for the issues addressed.
8. The revenue agents will assert issues by means of a Notice of Proposed Adjustment. (a so-called NOPA, on Form 5701)
9. Early Referral to IRS Appeals
a. CIC taxpayers can ask Exam to refer developed, unagreed issues to Appeals, while the revenue agents continue to audit other issues. Code § 7123(a); Rev. Proc. 99-28.
b. Exam may resist requests for early referral on the ground that the issue is not fully developed, or because the remaining issues will be completed before Appeals could resolve the early referral issue.
c. ISP issues also can be referred to Appeals under the early referral program.
d. Agreements with Appeals are reflected in closing agreements. Unagreed issues are returned to Exam and, if the case is protested, will not be subsequently reconsidered by Appeals.
Bringing the Examination Process to Conclusion
VII. Receipt of the 30-Day Letter and Revenue Agents’ Report (RAR)
A. Normally, the IRS will issue a RAR containing its proposed adjustments.
B. The RAR contains all of the proposed adjustments (usually, copies of the NOPAs), and a recomputation of tax liability showing a proposed deficiency or overassessment.
C. Code § 6212 provides that the IRS is prevented from making an assessment until after it has issued a statutory notice of deficiency (statutory notice, stat notice, or 90-day letter).
D. The issuance of the 30-day letter triggers the running of "hot interest" on large corporate underpayments. Code § 6621(c)(2).
1. The taxpayer can make a payment to stop the running of interest.
2. The taxpayer can make a deposit in the nature of a cash bond.
E. Options available to conclude the examination process.
1. Option #1 – Tentatively agree with the proposed deficiency.
a. The taxpayer can execute a Form 870, which waives the restriction that prevents the IRS from making an immediate assessment.)
b. As a consequence, the taxpayer waives the right to receive a statutory notice of deficiency and thus forfeits the right to go to Tax Court.
c. The taxpayer does not waive the right to file a refund claim and to proceed to refund litigation.
2. Option #2 – Fail to respond to the 30-day letter.
a. The IRS is prohibited from making an assessment, but will issue a statutory notice of deficiency.
b. The taxpayer has the right, within 90 days of the statutory notice, to file a petition in the Tax Court. No assessment will be made and the taxpayer need not pay the proposed deficiency.
c. The taxpayer can pay the asserted deficiency, and can file a refund claim.
3. Option #3 – File a Protest.
a. Within the 30-day period following issuance of the 30-day letter, the taxpayer can file a protest with IRS Appeals.
b. The taxpayer can request an extension of time to file the protest. The outer limit on extensions of time typically is 90 days.
c. Large corporate taxpayers automatically are permitted a 90-day period to file the protest. Treas. Reg. § 601.105(d), 106. IRM, Handbook No. 4.3.11, § 16.4
Protesting Proposed Adjustments to IRS Appeals
VIII. Protest and IRS Appeals
A. To protest or not to protest
1. Yes: opportunity to settle issues; keep forum options open; delay payment of taxes; learn more about IRS’s position
2. No: want to litigate as soon as possible; don’t want to give the IRS more time to develop its position; don’t want the IRS to identify new issues
B. Contents of the Protest
1. The IRS specifies the required form and contents of the protest.
a. Taxpayers can file either a full or a skeletal protest.
b. Taxpayers can raise affirmative issues in the protest.
2. The taxpayer must sign a verification, under penalties of perjury, of the facts set forth in the protest.
3. The taxpayer’s representative should attach a Form 2848, Power of Attorney.
C. The revenue agents’ Rebuttal
1. The revenue agents receive a copy of the protest, and will prepare a written rebuttal supporting their proposed adjustments.
2. The Appeals officers formerly met with the revenue agents prior to the Appeals conference. Now, see "Ex Parte Communications," below.
D. Extensions of the period for assessment
1. Extensions can be effected using Form 872.
2. Extensions also can be made using Form 872-A, which are open ended extensions. Open-ended extensions are terminated using Form 872-T.
Conduct of the Appeals Conference
E. The Appeals Conference
1. Composition of the Appeals team
a. The Appeals team will have a Team Chief, and Appeals Officers
2. Ex Parte Communications
b. Ex parte communications are communications between the Appeals Officer and any other IRS employee, without participation by the taxpayer, in which the merits of issues are discussed.
c. If the Appeals Officer wants to discuss a case with the examining agent, the taxpayer must be offered the opportunity to participate.
3. Attendance at the conference
b. Expert consultants may attend.
4. Appeals’ ability to settle issues
b. Appeals should apply a "hazards of litigation" standard in considering settlement of issues.
5. Appeals’ ability to raise "New issues"
b. Appeals consideration is not a continuation of the examination. New issues should not be raised for bargaining purposes.
6. Mutually Accelerated Appeals Process (MAAP).
a. MAAP is an IRS initiative to reduce the time necessary to resolve cases in Appeals for CIC taxpayers by adding members to Appeals teams and/or creating new teams. Internal Revenue News Release IR-2000-42.
7. Appeals Coordinated Issues (ACI)
a. Certain issues have been designated ACIs, in order to obtain consistency in treatment. Appeals officers have restricted ability to settle ACI issues.
b. IRM § 8.7.1.7. IRM Exhibit 8.7.1-3 lists the ACIs.
8. Technical Advice Requests
a. The taxpayer or the Appeals officer can file a request for technical advice with the IRS National Office. Rev. Proc. 2002-2
b. If the TAM favors the taxpayer, Appeals will follow the TAM.
c. If the TAM favors the IRS, Appeals still is able to concede or settle the issue.
9. Appeals can ask for a legal opinion from district counsel.
10. Appeals Mediation and Appeals Arbitration programs. Code § 7123(b)(1) and (2).
a. Mediation is optional and non-binding. A neutral third party mediator, without authority to impose its decision, assists the parties in settlement negotiations. Not appropriate for ACI and ISP issues. The IRS announced a pilot program for a limited test period. Announcements 2001-9 and 98-99.
b. Arbitration is optional and binding. An arbitrator imposes a binding resolution on the parties. Not appropriate for ACI and ISP issues. The IRS announced a pilot program for a limited test period. Announcement 2000-4.
Options for Closing the Case Out of IRS Appeals
F. Conclusion of the Appeals process.
1. A resolution of issues that affects other years can be effected through a closing agreement. Code § 7121. Form 906.
2. There are three major options for closing a case out of Appeals. The correct option to use depends on what subsequent course of action the taxpayer seeks to take.
3. Option #1 – Totally agreed case
a. Compute the deficiency or overassessment due based on the resolution of the issues, and reflect that amount on Form 870-AD.
b. The Form 870-AD is a waiver of the IRS’s restrictions on assessment. The IRS will assess the tax due and send the taxpayer a notice demanding payment.
c. Under the doctrine of equitable estoppel, the Form 870-AD is intended to have binding effect on both parties.
4. Option #2 – Partially agreed case, with unagreed issues reserved for litigation in district court or the Court of Federal Claims
a. Compute the deficiency or overassessment due based on (i) resolving the settled issues as agreed, and (ii) resolving issues to be reserved for litigation in favor of the IRS.
b. Execute Form 870-AD reflecting the resulting deficiency, reserving the right to file a refund claim with respect to reserved issues, and listing the issues reserved for litigation. IRM § 8.8.1.2.2 ("Settlement with Reservations").
c. The Form 870-AD is a waiver of the IRS’s restrictions on assessment. The IRS will assess the tax due and send the taxpayer a notice demanding payment.
d. The taxpayer must file a timely claim for refund based on the issues reserved for litigation. (see below)
e. If the taxpayer fails to reserve an issue, the issue cannot be raised in the claim for refund.
f. If the government fails to reserve an issue, that issue cannot be raised, except as an offset in refund litigation. (see below)
5. Option #3 – Partially agreed case, with unagreed issues left for litigation in the Tax Court
b. Execute Form 870-AD reflecting the agreed deficiency, listing the issues that have been settled. IRM § 8.8.1.2.1 ("Partial Settlement").
c. The Form 870-AD is a waiver of the IRS’s restrictions on assessment. The IRS will assess the tax due and send the taxpayer a notice demanding payment.
d. The IRS will issue a statutory notice of deficiency seeking the tax due with respect to the unagreed issues.
e. All issues listed as settled in the Form 870-AD are resolved. All other issues (raised or not raised, known or not known) remain fully in dispute. The IRS can raise any unsettled issue in the Tax Court as a "new matter." Tax Court Rule 142.
f. Having received a statutory notice of deficiency, the taxpayer can litigate in the Tax Court. Alternatively, the taxpayer can choose to pay the deficiency asserted in the statutory notice and file a claim for refund.
Proceeding to Refund Litigation
IX. Preparation for Refund Litigation
A. The Tax Refund Route
1. The required first step is to file a Claim for Refund. Code § 7422.
2. The refund claim must be filed within the statutory limitations period. Code § 6511.
a. If no Form 872 agreement extending the period of assessment has been executed, the claim must be filed within three years of the filing of the return (as extended).
b. If a Form 872 agreement extending the period of assessment has been executed, the claim must be filed within 6 months following the expiration of the extended assessment period. See Form 872.
c. Alternatively, a claim for refund can be filed within 2 years of the date a payment is made, but limited to the amount of that payment.
3. Contents of the refund claim
b. Each issue must be adequately described.
c. Under the Variance Doctrine, if an issue is not raised in the refund claim, that issue cannot be raised in subsequent tax litigation (the complaint cannot vary from the claim). Treas. Reg. § 301.6402- 2(b).
4. Taxpayers that have failed to timely file a formal, written refund claim may be able to contend that they have made an Informal Claim for Refund. See, e.g., Arch Eng'g Co., Inc. v. United States, 783 F.2d 190, 192 (Fed. Cir. 1986) (minimum requirements for an "informal" refund claim include written request for sums paid for a particular tax year).
5. IRS action on the claim
a. The taxpayer can ask that the IRS immediately disallow the refund claim. IR New Release IR-1600. The taxpayer can contact its examining agents and ask for immediate disallowance.
b. The IRS will send the taxpayer a notice of proposed disallowance of the refund claim. The taxpayer may protest the proposed disallowance to IRS Appeals.
(i) The IRS will enclose a Form 2297, asking the taxpayer to waive its right to receive a formal notice of disallowance. These forms pose danger, because they start the limitations period for filing suit, usually at an ill-defined date.
c. The IRS will send a formal notice of claim disallowance. The notice must be sent by certified or registered mail.
6. The statute of limitations for filing the refund litigation.
a. The refund suit must be filed within two years of the date of the formal notice of claim disallowance.
b. If the taxpayer executed Form 2297, suit must be filed within two years of the date on which the IRS accepts that form.
c. The statute of limitations for filing suit can be extended using Form 907, if the IRS agrees to execute that form.
7. Ability to commence the refund litigation
a. The taxpayer cannot file suit until after the IRS denies the claim for refund.
b. However, if the IRS has not acted on the claim within 6 months of its filing, the taxpayer is free to file suit.
c. If the taxpayer executed Form 2297, the taxpayer must wait 6 months to file suit.
d. When the claim is filed, the taxpayer can request that the IRS disallow the claim immediately. IRS News Release IR-1600.
Proceeding to Litigation in the Tax Court
X. Preparation for Tax Court Litigation
A. A petition must be filed with the Tax Court.
B. A petition can be filed only if the taxpayer has received a statutory notice of deficiency (the taxpayer’s "ticket to the Tax Court").
C. The petition must be filed within 90 days of the date of the statutory notice. Code § 6213.
Choosing Whether to Litigate in the Tax Court, District Court, or the Court of Federal Claims
XI. Choice of Litigation Forum Issues
A. Tax Court Litigation
1. Applicable precedent.
2. Background/expertise of the judges.
3. Opposing counsel from IRS District Counsel’s office.
4. Tax Court rules of procedure.
5. More limited discovery procedures.
6. The IRS can raise new issues as "new matters." T.C. Rule 142.
7. Appeal will go to the Circuit Court of Appeals in which the taxpayer
resides or has its principal place of business.
B. Refund Litigation
1. District Court
b. Generalist judges.
c. Jury trials are permitted.
d. Opposing counsel from one of the regional sections of the Tax Division of the Justice Department.
e. Federal Rules of Civil Procedure.
f. The government can raise new issues only as offsets.
g. Appeal to the applicable Circuit Court of Appeals.
b. Background/expertise of the judges.
c. No jury trials are permitted.
d. Opposing counsel from the Court of Federal Claims section of the Tax Division of the Justice Department.
e. Court of Federal Claims rules of procedure.
f. The government can raise new issues only as offsets.
g. Appeal to the Federal Circuit Court of Appeals.
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