How to handle a federal tax dispute. audit, appeal and litigation

How to Handle a Federal Tax Dispute: Audit, Appeal and Litigation

Lauren A. Rinsky

Royse Law Firm, PCDirect Dial: (650) 521‐[email protected]

Overview

Court of Federal Claims

District CourtTax Court

IRS AppealsIRS Audit Notice of Deficiency

Claim for Refund

Federal Circuit

Circuit Court

Supreme Court

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Selection for Audit

• Returns may be selected for a variety of reasons, such as:–Random selection–Computer screening–Document matching program–Related Examinations

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IRS Audit

• IRS process for examining a return to determine its correctness

• Three Types:–Office audit–Correspondence audit–Field audits

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Representation During Audit

• Taxpayer can act on own behalf or• Be represented by a “federally authorized tax practitioner,” such as:– an attorney, CPA, enrolled agent, or enrolled actuary.

• If the taxpayer filed joint return, then one or both spouses can meet with the IRS

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Power of Attorney “POA”

• To act as the taxpayer’s representative, you must have proper written authorization from the taxpayer– IRS Form 2848– For married couples – one form per person

• Existing POAs that the taxpayer does not want to revoke, must be attached to any new POA.

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Attorney‐Client Privilege

• Only an attorney can give the taxpayer the attorney‐client privilege, meaning that the attorney is exempt from testifying against the taxpayer should the case go to trial.

• CPA or tax preparer could be made to testify against the taxpayer.

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Tax Advisor’s Privilege Under IRC § 7525

• Statutory “tax practitioner‐client privilege” provided by IRC §7525(a)(1). Very narrow in scope, and is entirely inapplicable to criminal tax cases. Also:– Applies only to provision of “tax advice”– Does not provide any protection for the tax practitioner’s work product.

– Does not apply to written tax advice to corporate type clients concerning their corporations’ involvement in tax shelters.

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Kovel Engagement

• Originated in United States v. Kovel, 296 F.2d 918 (2d Cir. 1961)

• Attorney retains non‐legal professional, such as a CPA, to assist the attorney in rendering legal advice to the attorney’s client.

• Properly executed, it extends attorney‐client privilege to CPA’s work and communications.

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During IRS Audit

• Keep copies and good records of what you provide

• Ask IRS for an audit plan and timetable

• Ask IRS to send its requests for information in writing

• Be as brief as you can; do not volunteer information

• Do not give original documents to auditor

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To Preserve Privileged or Protected Information and Documents

• Taxpayer can decline to disclose the privileged material, and instead submit a “privilege log”

• The log should state:–Privilege or protection being claimed, and–Describe the material in a manner that, without revealing the information, enables the IRS or court to assess applicability of the claimed privilege or protection

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Results of Audit

• No Change:– IRS accepts return as filed, and taxpayer receives a “no change letter” stating that the examiner proposed no changes! Yay!

• Refund:– Taxpayer is due a refund and gets interest on the refund!! Woo hoo!!

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Results of Audit (continued)

• Agreed:– IRS proposed changes and taxpayer agrees with the changes. • If money is owed, there are several payment options available (i.e., pay in full, installment agreement, offer in compromise)

• Disagreed:– IRS proposed changes and the taxpayer disagrees with those changes...

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Results of Audit (continued)

• Disagreed (continued)– The IRS will issue a notice to the taxpayer called a “30‐day Letter” that states the findings of the examiner and the taxpayer’s appeal rights.

Note: The 30‐day Letter could also be received if taxpayer ignores the IRS audit

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Appeal within the IRS(30‐day Letter)

• To appeal the examiner’s proposed adjustments, the taxpayer has 30 days to file an appeal (i.e., a “Protest”) and request a conference with IRS Appeals Office to discuss the disputed issues

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Appeal within the IRS(30‐day Letter)

• If taxpayer does nothing, then the IRS will issue a 90‐day Letter (Statutory Notice of Deficiency) discussed later.

Note: Since the 30‐day Letter is an administrative letter, and not a statutory notice, the IRS may grant taxpayer’s request for an extension of time to reply to the 30‐day Letter

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Statute of Limitations (“SOL”)for Assessment

• IRS typically gets 3 years from the date the return was filed to make an assessment. See IRC §6501

• 6 years in the case of “substantial omission”– An omission of 25% or more of gross income stated in the return

• Unlimited for unfiled or fraudulent returns!!

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Extending the Statute of Limitations for Assessment

• The assessment period can be extended by agreement. IRC §6501(c)(4) – If only legal issues remain, then it does not make much sense to extend the SOL

– If there are factual issues, then extending SOL might make sense

• For example, substantiation, where taxpayer needs more time to provide documents and information

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Distinguish Between Factual and Legal Issues

• To distinguish between factual and legal issues, ask where you must look to reach a conclusion.– If you consult only the law, then the issue is legal in nature

–Otherwise, it is a factual issue that must be resolved though gathering additional information

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Statutory Notice of Deficiency(90‐day Letter)

• If:– Taxpayer does not respond to 30‐day Letter; or – Is unable to reach an agreement with the Appeals Office following a protest; or

– SOL for assessment is about to expire;

• Then: – IRS will send the taxpayer a Statutory Notice of Deficiency, commonly referred to as a “90‐day Letter.” IRC §6212.

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Statutory Notice of Deficiency(“Ticket to Tax Court”)

• Gives the taxpayer 90 days within which to petition the U.S. Tax Court to redetermine the liability that is proposed by the IRS. – 150 days if the letter is mailed to the taxpayer outside of the U.S.

• Since the 90‐day period is prescribed by statute, it cannot be extended!

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Statutory Notice of Deficiency(90‐day Letter)

• During the 90‐day period, the IRS is barred from making an assessment or collection activity.

• Failure to file a timely petition with the U.S. Tax Court will result in the deficiency being assessed by the IRS!!

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Appeals to the Federal Courts(Judicial Review)

• Taxpayers may request judicial review of IRS determinations by filing a petition with the:–U.S. Tax Court–U.S. District Court–U.S. Court of Federal Claims

• These courts are independent of the IRS

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U.S. Tax Court

• Federal court of limited jurisdiction, established by Congress under Article I of the U.S. Constitution.

• Located in Washington, D.C., and the judges travel around the country to designated cities to hear cases

• Does not require the taxpayer to first pay the amount in dispute. IRC §6213(a)

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U.S. Tax Court (continued)

• No jury trials; case is tried before a judge• Has its own rules and procedures that supplement the Federal Rules of Civil Procedure

• Except for “S cases”, decisions are appealable to the appropriate Circuit Court.

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U.S. Tax Court Judges

– Regular judges• The 19 regular judges appointed by the President, after confirmation by the Senate, for a term of 15 years

– Senior judges• Presidentially appointed judges who have reached mandatory retirement age of 70 and are recalled by the Chief Judge to assist in disposition of cases

– Special trial judges• Equivalent of magistrates in federal district courts, serve at the discretion of the Chief Judge

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Generally, a case petitioned to U.S. Tax Court will be considered for settlement by an IRS Appeals Officer before the U.S. Tax Court hears case.• However, it will be a “docketed appeal,” meaning any settlement will need IRS counsel’s approval

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Golsen Rule

• The U.S. Tax Court is bound by the precedent of the Circuit Court in the geographic jurisdiction in which the taxpayer is located. Golsen v. Comm’r, 54 T.C. 742 (1970)

– Thus, sometimes the U. S. Tax Court will reach different rulings for different taxpayers on same facts

Example: If taxpayer is domiciled in San Francisco, which is in the 9th Circuit, then the U.S. Tax Court would be bound by precedent of the 9th Circuit.

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Federal Courts Circuit Map

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ROYSE LAW

Small Cases (“S cases”)

• For tax disputes involving $50,000 or less for any one year, taxpayers may elect to have case designated as a small tax case (“S case”)

• Heard by a Special Trial Judge.• Less formal procedure than regular cases

Note: Decisions in S cases are final and not appealable!

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• The Statutory Notice of Deficiency has a presumption of correctness.

• Taxpayer generally has burden of proving that the IRS’s determination is improper

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• The case is commenced by the filing of a timely Petition.

• Also,– Filing fee ($60)– Statement of Taxpayer(s) Identification Number(s)

– Request for place of trial– Ownership Disclosure Statement (required for certain taxpayers). See Tax Court Rule 20(c)

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• After the Petition, IRS Answer, and (if required) the Taxpayer’s Reply are filed, – The case is considered “at issue” and pretrial discovery can begin

• This is typically where the IRS administrative file is sent (back) to the Appeals Office to be considered for settlement.

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• Tax Court rules permit the IRS to amend its Answer “when justice so requires”

• Burden of proof on any new matter or increase in deficiency raised in the Amended Answer falls on IRS.

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U.S. Tax Court Pretrial Discovery

• U.S. Tax Court’s rules reflect: – An abbreviated discovery process – A strong preference for stipulation of facts and documents over testimony

– A desire to reduce burdens and expenses associated with litigation in other judicial forums

• Court expects parties to attempt to attain objectives of discovery through informal consultation or communication before utilizing formal discovery procedures

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U.S. District Court

• Taxpayer may challenge IRS’s determination in District Court, but with procedural prerequisite!!– Taxpayer must first pay the disputed tax liability andfile a claim for refund of the tax paid prior to filing the lawsuit

• Option for judge or jury trial• Bound by the legal precedent in the geographic jurisdiction of the taxpayer

• Appeals made to the Circuit Court in the geographic jurisdiction of the taxpayer

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Time for Filing Claim for Refund

• Generally, taxpayer must file claim for a refund within 3 years from the date the original tax return was filed or 2 years from the date the tax was paid, whichever is later.

• Taxpayer generally must file suit for a refund no later than 2 years after the IRS has rejected the claim. – However, taxpayer can file suit if it has been 6 months since the refund claim was filed and the IRS has not yet delivered a decision.

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U.S. Court of Federal Claims

• Court of limited jurisdiction created by Congress under Article I of the U.S. Constitution

• No jury trials• Taxpayer must first pay the disputed tax liability and file a claim for refund of the tax paid prior to filing the lawsuit.

• Bound by precedent of the former Court of Claims, Federal Circuit, and U.S. Supreme Court

• Appeals go to the Federal Circuit

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U.S. Court of Federal Claims

• Taxpayer cannot file suit in the U.S. Court of Federal Claims if Taxpayer’s claim is for credit or refund of a penalty that relates:– To promoting an abusive tax shelter –Or to aiding and abetting the understatement of tax liability on someone else’s return

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