Looking for an alternative to court in resolving an IRS dispute? The Service has myriad ways of dealing with taxpayer contests that do not involve litigation. This article details the current IRS alternative dispute resolution programs and expected additional procedures.
* The IRS's stated goal is to resolve taxpayer disputes at the lowest possible level and as early in the process as is practicable.
* The IRS offers pre-filing ADR procedures, audit and Appeals procedures and litigation ADR procedures.
* Controversy over confidentiality erupted when the IRS agreed, after a lawsuit, to begin disclosing redacted APA information.
For years, the IRS has moved toward earlier resolution of taxpayer disputes. Its stated goal is to resolve them at the lowest possible level, as early in the process as practicable.(1) This is expected to lead to reduced taxpayer burden and increased voluntary compliance. New dispute resolution efforts between the IRS and taxpayers have shown much potential and continue to evolve.
The IRS Appeals function (Appeals) can resolve a dispute with taxpayers based on the hazards of litigation and the cost of taking a case to trial. Historically, it has been highly successful in minimizing the number of litigated cases. Appeals contributes greatly to resolving taxpayer disputes before litigation; approximately 85% of its cases are resolved before trial.(2) However, even with this success rate, the courts are still overburdened with tax cases. Thus, the IRS has implemented various alternative dispute resolution (ADR) procedures to improve the Appeals process and resolve disputes before trial. This effort is consistent with the ADR trend in the American legal system today.(3)
This article discusses IRS ADR procedures, categorizes them by when they apply and notes their potential benefits and risks. It also addresses the mandate of the Internal Revenue Service Restructuring and Reform Act of 1998 (IRSRRA '98) to expand ADR procedures to more taxpayers. Knowledge of these ADR techniques allows tax advisers to help clients choose an appropriate procedure.
In this article, IRS ADR procedures are categorized by when they apply. Some apply before a return is filed; these are "pre-filing ADR procedures." Others apply after a return has been filed and is subject to audit and Appeals; these are "audit and Appeals ADR procedures." Finally, some procedures apply during litigation; these are "litigation ADR procedures." See Exhibit 1 on p. 117 for a list of available ADR procedures in these categories.
Exhibit 1: IRS ADR Procedures
Pre-filing ADR APA (Rev. Proc. 96-53; Notice 98-65) Pre-filing Determination (Rev. Proc. 99-1) Advance Valuation of Art (Rev. Proc. 96-15) Audit and Appeals ADR Expanded Settlement Authority (Delegation Orders 236 (Rev. 3) and 247 (Rev. 1)) AIR (Rev. Proc. 94-67) Early Referral Procedures (Rev. Proc. 99-28) CSP (Notice 98-21) Competent Authority (Rev. Proc. 96-13) Mediation (Ann. 98-99) Litigation ADR Mediation (Ann. 98-99) Arbitration (Tax Court Rule 124) Pre-filing ADR Procedures
The advance pricing agreement (APA), program is the highest-profile IRS ADR procedure; it allows a multinational corporation to negotiate an agreement with the IRS on an appropriate transfer pricing methodology (TPM) for international intercompany transactions. An APA assures a taxpayer that a particular TPM is approved by the IRS before a return is filed.
The IRS implemented the APA program in 1991 because of the number and complexity of cases in the Sec. 482 transfer pricing area.(4) The APA program has been extremely successful, as shown by the (1) significant growth in the number of APA cases each year since inception(5) and (2) widespread establishment of similar APA programs by other countries.(6) Some commentators have attributed the proliferation of new IRS ADR procedures to this success.(7)
The APA process is designed to be a flexible problem-solving process, based on cooperative and principled negotiations between a taxpayer and the IRS.(8) A taxpayer proposes a TPM and provides data to show that applying it to international intercompany transactions yields the best method (based on the Sec. 482 regulations) to reflect arm's-length results. The taxpayer must use relevant pricing data from closely comparable uncontrolled transactions. Often, an APA involves agreements with foreign competent authorities under income tax treaties with other countries.
To participate, a taxpayer must file an APA request before the deadline (including extensions) for filing the return for the first tax year to be covered by the APA. For this purpose, payment of the applicable user fee constitutes filing if a substantially complete APA request is filed within 120 days thereafter.(9)
Small business taxpayers may also obtain APAs.(10) The IRS has streamlined the process for routine transactions and reduced the documentation requirements and costs for such taxpayers.
To promote consistency, efficiency and voluntary compliance, the IRS encourages "rollbacks" of a TPM under an APA to open prior tax years. This is feasible whenever records are available and the facts and law are consistent with the years for which the TPM was approved. The taxpayer may request consideration of a rollback; the IRS may determine (whether requested or not) that a TPM be rolled back.(11) This can be both a benefit and a concern; the IRS may try to employ a rollback even if the taxpayer does not request or expect it. Even if consistency of facts or law is not present, a TPM may be rolled back as long as adjustments are made to reflect differences in facts, economic conditions and law from an approved APA.
Confidentiality is another concern. The success of the APA program has been partly attributable to the assurance of confidentiality accompanying the agreement. However, the IRS planned to begin disclosing redacted APAs in October 1999.(12) Much controversy surrounded this decision; many high-profile corporations questioned whether confidentiality could be maintained; some tax executives called for legislation to address this issue.(13) A recently enacted bill provides (1) that APAs are confidential and (2) for an IRS APA annual report with summaries of approved methodologies.(14) When this legislation was pending, the IRS asked a district court to delay by 11 months the Oct. 18, 1999 start date for issuing redacted APAs.(15)
Some taxpayers want to know the tax implications of transactions already completed before filing a return. Pre-filing determinations(16) allow the IRS and a taxpayer to agree on the treatment of such transactions and give the latter assurance that the IRS will accept the agreed-on tax treatment. However, pre-filing determinations are not concluded with a closing agreement. Such determinations are typically requested for noncontroversial issues, such as the qualification of a pension plan or tax-exempt organization status. They are available to all types and sizes of taxpayers, including small businesses.
There are limits on the availability of a pre-filing determination letter.(17) First, issuance is limited to a written request to the District Director on a completed transaction that affects a return over which the district has or will have examination jurisdiction. Second, it will not be issued for a return question if the same question is involved in a return already filed. Third, it cannot be issued if (1) the taxpayer has directed a similar inquiry to the National Office or (2) the same issue, involving the same or a related taxpayer, is pending in litigation, Appeals or an in-process examination. These limits contribute to the small number of pre-filing determinations issued.(18)
The pre-filing determination process is voluntary; either the taxpayer or the district can terminate it at any time. The district has final authority to accept or reject a pre-filing determination request for consideration. A taxpayer receiving a pre-filing determination letter signed by the District Director should attach it to the return when filed.(19) If a taxpayer takes a position contrary to the pre-filing determination, the letter and a statement
to that effect should be attached to the return when filed to satisfy the adequate disclosure requirement. A taxpayer takes a risk when requesting a pre-filing determination letter; if he does not agree with the IRS determination, the IRS is fully aware of the situation and likely to challenge any contrary position the taxpayer takes.
Arguably, letter rulings are pre-filing determinations, because they are obtained prior to filing. The main difference between them and pre-filing determinations is that letter rulings are requested for contemplated (rather than completed) transactions. In addition, letter rulings are issued by the IRS National Office, not a District Director.
Advance Valuation of Art
Another IRS procedure(20) allows taxpayers to obtain a statement of value (SOV) for certain works of art contributed to charity or includible for income, gift or estate tax purposes. This method is available to all taxpayers eligible for a charitable deduction or subject to estate or gift tax (including individuals, corporations, partner' ships, estates and trusts). An SOV may be obtained after the transfer but before the applicable return has been filed, for transfers by contribution, gift or death. The IRS is not authorized to issue an SOV for works of art before their actual transfer. Prior policy forbade IRS approval of any valuation before the actual filing of returns.(21) SOVs assure taxpayers of the value of transferred items before filing returns, giving them peace of mind and reducing the possibility of interest and penalties on future audit.
The works of art covered by the procedure include paintings, sculpture, watercolors, prints, drawings, ceramics, antique furniture, decorative arts, textiles, carpets, silver...