General Practice, Solo & Small Firm DivisionTechnology & Practice GuideThe Compleat Lawyer, Summer 1996, Vol. 13, No. 3
Your Client Got a Notice from the IRS! Where do you start?BY SUSAN LINDLEY AND RON S. JONG
Susan Lindley and Ron S. Jong are partners at Lindley & Jong in Boulder, Colorado. The firm practices primarily tax law.
One of your clients calls with the news that a notice from the IRS came in the mail today. Chris doesn't want to talk about it over the phone but insists on seeing you first thing tomorrow morning.
You don't want to deal with this case--you took the introductory tax course back in law school, you hated it, and you haven't cracked another tax book since. However, Chris has been a good client. So instead of washing your hands of the matter immediately, you reluctantly set an appointment for the morning. Where do you start?
Chris tells you that there was no attempt to evade taxes, or any other criminal intent, and you believe Chris. After deciding that this is a civil tax matter, you ask to see the notice. The IRS is challenging an item on a return Chris filed a couple of years ago and has sent a tax bill along with a request for information. Chris says this is the first and only notice received. Is it? This is an important question and impacts what response options are open to Chris.
The usual first step taken by the IRS is for a revenue agent to examine a return and determine that not enough tax was paid; in other words, a "deficiency" is alleged. The agent then sends the taxpayer a letter proposing that an adjustment be made. If this is Chris's situation, a meeting with the revenue agent to discuss the items in dispute may resolve the matter.
Before the meeting, you should carefully and thoroughly gather documentary evidence establishing Chris's entitlement to a challenged deduction, or clarifying the source or type of an item of income that is under scrutiny. If you clearly lay out your client's facts and make it easy for the agent to understand and agree with your position, it is a real possibility that the file will be closed early in the process.
However, arriving for the meeting with an adversarial attitude and nothing more is likely to move Chris onto the next phase of the IRS's system. Factual disputes can be settled with the revenue agent at this meeting. Keep in mind, however, that the revenue agent only has the authority to reduce the amount the IRS claims is owed based upon the facts, not upon an interpretation of the law. Arguing about legal issues is not appropriate at this point in the process.
The "30-day" letter. If a resolution cannot be reached with the revenue agent, the case becomes an "unagreed case." The IRS will then issue a "30-day letter," which gives your client 30 days to appeal the agent's finding to the Appeals Office of the IRS. The 30-day letter will set out the reasons for the proposed adjustment in a revenue agent's report. Also included with the 30-day letter: a circular describing Chris's right to appeal, and a form to waive restrictions on immediate assessment, should Chris agree to pay the proposed adjustment.
Assuming the proposed adjustment is for more than $10,000 and Chris wants to administratively appeal the finding of the revenue agent, a "letter of protest" must be submitted within the 30 days unless an extension is granted. This protest letter will set out Chris's version of the facts and your position on the law. Do not underestimate the usefulness of this step in the process. Don't send in a one-liner: "We protest." Instead, take this opportunity to set out the facts and legal arguments in a well-reasoned statement of your position. Let the IRS know that you have a strong position and intend to argue it vigorously.
The Appeals Office will normally set up a conference after reviewing the protest. Again, prepare your facts, but this time be ready to present your legal arguments as well. Unlike the revenue agent you spoke to earlier, Appeals has the authority to settle unagreed cases based on the hazards of litigation; that is, on the legal issues. Note that the appeals officer is likely to be a lawyer.
The "90-day" letter. If Chris does not submit a timely letter of protest and go to Appeals, or if the appeals conference does not resolve the situation, the next step is for the IRS to send a "statutory notice of deficiency." Also called a "90-day letter," this is Chris's ticket to go to Tax Court. Chris has 90 days from the date of the letter to file a petition in Tax Court challenging the alleged tax deficiency (or 150 days if addressed to a person who resides outside the United States). A major advantage of Tax Court is that Chris will not have to pay the tax prior to litigating the case, unlike litigating in refund court.
Once a petition is filed with the Tax Court, Chris may request an opportunity to try to settle the dispute at the administrative level instead of proceeding directly to court. This means going back to the Appeals Office, if that route was chosen earlier by submitting a letter of protest. Or Chris may be going to Appeals for the first time if no protest was previously filed. In other words, it is possible to be in Appeals both before and after the statutory notice of deficiency is issued. If the appeals process still does not resolve the matter, Chris may move on to argue the case in court.
If Chris loses in Tax Court, then the taxes are assessed after the decision of the Tax Court becomes final. An "assessment" is a bookkeeping entry made to record the tax liability and must be done before the tax can be collected. Alternatively, if no Tax Court petition is filed, then assessment occurs after the 90-day period has passed. Assessment is also the demarcation between going through the deficiency procedures and going through refund procedures.
If no Tax Court petition was filed and assessment has already occurred, the tax must first be paid if Chris still wants to argue the matter. After paying the tax, Chris needs to file a claim for a refund with the IRS within the applicable time constraints; i.e., within three years of the date the return was filed or within two years of the date the tax was paid, whichever is later. If the IRS refuses to refund the amount claimed, then Chris can go to "refund court"; that is, either U.S. district court of the U.S. Court of Federal Claims.
Of course, if Chris's notice indicates that it's too late to file in Tax Court, refund procedures are the only option left. If the tax has already been litigated in Tax Court, Chris is barred from later re-litigating the case in refund court. Note that the Tax Court does not have jurisdiction over all tax disputes--for example, employment or excise tax disputes must be litigated in refund court.
Paying or Collecting the Tax
Getting back to the question of whether this is truly Chris's first notice, assume that Chris has ignored notices and the period for filing a tax court petition has passed. Moreover, Chris cannot pay the tax so the refund courts are not an option. If Chris's choices have been narrowed in this manner, or if your research shows that Chris would lose his case anyway--in other words, Chris does owe the tax according to the law--then your range of advice is likewise narrowed. Since the IRS will want payment of the assessed amount immediately, how can you help Chris? Going on the run is not a legal option, no matter how attractive it may appear.
Chris can pay all the taxes, interest, or penalties in a lump sum payable immediately; this is the IRS's preferred choice. Alternatively, the taxes might be paid in installments over a period of time. Guidelines are available from the IRS on what amount a taxpayer can afford to pay each month, given the taxpayer's income and financial commitments. These guidelines are specific to the county in which a taxpayer lives. Ask the collections division of the IRS for this information.
You will not be doing Chris any favors by negotiating an installment plan that will never reduce or pay off the taxes owed, or will create an undue hardship. Make sure Chris knows how long the payments will last, and discuss the consequences of missing an installment. A missed payment can mean the installment plan may be revoked by the IRS, the entire balance may become due immediately, and levies or garnishments may follow. In any case, the IRS may file a lien during the period of the installment payments to protect its interest should payments cease for any reason.
If Chris does not have the money to pay the taxes owed, and the "quick sale" value (normally not less that 70 percent of fair market value) of assets owned is less than the taxes owed, then it may be possible to negotiate an "offer-in-compromise" whereby the IRS will settle for less than the entire amount of taxes owed. The IRS will require Chris to provide a complete financial picture in order to begin the offer-in-compromise process. This includes lists of all assets, with estimates of quick sale values, and all debts. Also required is a full accounting of current income and future income prospects, as well as predictions for future windfalls. A description of any education, health, or age-related issues that will have an effect on future income potential should be included as well. Documents to support the information provided may be requested later by the IRS.
If Chris's assets and income are negligible and future prospects are truly bleak, then an offer will likely not be acceptable. The IRS will instead put Chris on "currently uncollectible" status. This means the IRS will leave Chris alone for a while but the taxes are still owed and interest and penalties continue to accumulate. Federal tax liens, if filed, will continue. Declaring bankruptcy is generally not a viable option for reducing the amount of taxes owed, although it may be feasible in some situations.
If Chris came to you with a "notice of intent to lien and levy" or similar notice, then the assessment has already occurred and the collection process may have gone pretty far. Depending on how many such notices have been received, a lien or levy may be imminent. Before the IRS can levy or garnish, however, certain procedures must be followed. The IRS must have properly assessed the taxes and they must have sent out a series of notices and demands for payment. If payment is not made, then levy or garnishment may follow. Check to see whether the appropriate procedures were followed. For example, was the assessment properly made? Were notices sent to the "last known address"? If not, you may be able to stop the levy or garnishment, at least temporarily. Note that if the statute of limitations for filing a refund has not lapsed, during collection action, Chris can still pay the tax and file for a refund.
Researching the Law
Once you have briefed Chris on the various options, the decision is made to at least begin to research the law. What now? At this point you need to know which authorities can be relied upon, how much weight to give an authority, and what authority is binding and on whom.
Researching the law in tax has its peculiarities. In addition to the usual statutes, regulations, and case law, there are a variety of other authorities. These include revenue rulings, revenue procedures, private letter rulings, technical advice memorandums, general counsel memorandums, and actions on decisions. Some may be binding on the government but not on the court or taxpayers. Taxpayers can rely on and cite some authorities, but not others.
When researching tax case law you will want to look first to your own circuit. But don't forget to check the Court of Federal Claims, since this refund court is available to taxpayers nationwide. When researching Tax Court and district court cases, check for cases that were appealed to your own circuit sincecases appealed to other circuits are not binding. Tax Court memorandum decisions--unpublished decisions of the Tax Court on routine and well settled issues--may not be binding, though they do provide guidance. Finally, the IRS might acquiesce to a Tax Court decision on which they lost. If they do acquiesce, this is a signal that the IRS doesn't intend to continue to fight on the issue decided in that case. However, a taxpayer may not rely on an acquiescence.
Final regulations are binding if they are current. Be warned: many regulations that appear on the books are outdated or superseded by new legislation, so check to make sure the regulation you want to use is current. Note that proposed regulations are merely the Treasury's position, similar to a position espoused in a brief, and do not necessarily have the force of law. Temporary regulations generally go through notice and comment periods and have the same effect as final regulations.
To add to the confusion, regulations are either "legislative," issued under a specific authorization from Congress, or "interpretative," issued under a general grant of congressional authority. Legislative regulations have the force of law and are binding on the IRS and the courts. Interpretative regulations, on the other hand, are binding on the IRS, but not on a court.
Revenue rulings and revenue procedures, which are IRS pronouncements of general applicability on substantive law and procedural law, will likely be binding against the IRS but not binding on the courts or taxpayers. They do not go through notice and comment and are merely statements of the IRS's position. Private letter rulings are rulings issued to a specific taxpayer and describe how the IRS will treat a given fact pattern. Private letter rulings are binding on the IRS only if coupled with a "closing agreement" and only regarding the taxpayer for whom they are issued. They cannot be relied on by any other taxpayer, but other taxpayers often use them for guidance. Nor can the Internal Revenue Manual be relied upon, although, once again, it does provide guidance. Finally, oral communications are the least formal and least reliable statements of IRS positions and the IRS is not bound by its own oral statements.
Sidebar: Beware of the Criminal Tax Matter
When faced with a client who has a tax problem, your first impulse may be to pass the case to the accountant down the hall. However, you should resist this urge until you have met with your client and spoken in depth about the facts of the case. There is no accountant-client privilege for federal tax purposes, so at a minimum you need to check for criminal implications. If your client goes to an accountant first, the accountant can be compelled to divulge incriminating information that might otherwise have been privileged. Not a good move.
If criminal implications potentially exist and the help of an accountant is desired, you may bring in the accountant under the attorney-client privilege by following the proper steps. A "Kovel letter" between the lawyer and the accountant should be drafted to set out the relationship and thus bring the accountant's work under the attorney-client privilege. The accountant works for and is paid by the lawyer, not the client.
Sidebar: Shopping for the Right Court
Tax is one of the few areas of the law where forum shopping is openly and readily available. The choice of court can mean the difference between winning and losing the case. When shopping for your court of choice, it's important to consider that Tax Court and district court decisions are appealed to the circuit court of appeals for the circuit where the taxpayer resides, while Court of Federal Claims opinions are appealed to the Court of Appeals for the Federal Circuit. The precedents for a given court may be favorable or unfavorable to your client--choose your forum carefully.
Besides comparing precedents, there are several other important differences between the courts. For instance, a client can get into Tax Court without first paying the tax claimed to be due by the IRS, not an insignificant factor in many tax disputes. Refund courts (U.S. district court or the U.S. Court of Federal Claims) require that the tax be paid before litigation. If your client has sympathetic facts and wants a jury trial, then the district court where the client resides would be the court of choice. A jury trial is not available in the Court of Federal Claims.
Tax Court judges hear only tax disputes and are generally more aware of the technical arguments. Also consider that in Tax Court litigation, the government can generally add to the deficiency. In refund court, assessment has already occurred and it's usually too late for the IRS to assess more taxes, although a setoff or equitable recoupment may still be possible.