PART ONE
PRE-ASSESSMENT

CHAPTER ONE
CREATION OF A FEDERAL TAX LIABILITY

Prerequisites to Making an Assessment

Before the IRS can create a federal tax liability there must be a determination of the tax liability.  A determination of the tax liability must be made before the tax liability can be assessed.  An assessment is the recording of a tax liability on the books and records of the IRS.  The determination of a tax liability can be made by the taxpayer by filing a tax return setting forth the tax liability.  A determination of a federal tax liability based on a filed tax return is often referred to as a "self-assessment" but is more precisely characterized as a "self-determination" because the IRS must still make the assessment.  A "self-determination" occurs when the return is filed.  

For federal income, estate, and gift taxes, the Commissioner of Internal Revenue can also make a determination of additional tax liability by issuance of a notice of deficiency.  For income, estate, and gift taxes, an assessment cannot be made until after the determination of tax liability has reached administrative maturity. A determination of tax due required to be made by the issuance of a notice of deficiency does not mature until after the passage of the applicable time period.
Some taxes, such as employment taxes and the trust fund recovery penalty are not subject to the notice of deficiency procedures.  However, in all situations the federal tax assessment does not occur until after the IRS has followed all appropriate and required procedures for determining and establishing the liability.    
Audit Selection
When a taxpayer files an income tax return, if the IRS agrees with the return, it does not need to provide the taxpayer with a notice of deficiency before assessing the liability.  Instead, the tax return is the taxpayer’s consent to assessment of the amount due.  However, the IRS must still follow the appropriate procedures for assessing the tax due.

However, what happens when the IRS does not agree with the amount of tax shown due on a return?  Or, what happens when a taxpayer fails to file a return?  In either case, before proposing a deficiency, the IRS usually conducts an audit to determine the correct amount of tax due.  
Returns are selected for audit by several methods.  The most common is by use of a computer program called the Discriminate Function System (DIF).  Each return receives a score (DIF score) for potential error.  Returns that receive scores that are higher than normal, based on past IRS audit experience, are flagged for additional review by IRS personnel.  As a result, not all returns that receive a high DIF score are audited.

The DIF system is used for all individual, partnership, and fiduciary income tax returns.  Corporate returns are either DIF scored or manually classified.  This program also identifies returns that have “special” issues or characteristics.  Special items include returns with unallowable items, tax shelters, non-cash charitable contributions, refunds in excess of one million dollars and amended returns or returns that notify the Service of inconsistent treatment of an item.  Returns with “special’ items are also flagged for review by IRS personnel.  Again, not all special returns will actually be audited.
Returns are also selected for audit by the IRS’s use of informants.  Informants may receive awards based on the value of the information received by the IRS and the motivation of the informant as well as whether or not the information was furnished voluntarily.  The informant makes the request for an award on a Form 211 Application for Reward for Original Information.  Whether or not to issue a reward, and the amount of the reward, is in the sole discretion of the IRS.  
Lastly, the IRS also shares information with state and local authorities, and vice versa.  Thus, a client who is audited by the Tax Department, who either concedes to an increase in tax or loses at the Division of Tax Appeals, will most likely be contacted by the IRS for exam, usually within a year or so of the state change.  The taxpayer’s loss of the issue at the state level, however, does not bar the taxpayer from re-litigating the issue at the federal level.  In reverse, the same is true for federal issues that are later addressed by the state.  However, special rules apply regarding the statute of limitations at the state level as they relate to federal changes.
Types of Audits

The IRS conducts three types of audits; correspondence audits, office audits and field audits.  Correspondence audits are often conducted by campuses (or service centers).  Correspondence audits are those that can be handled totally by mail.  These audits include, but are not limited to mathematical errors, mismatched W-2 or 1099 information or problems with social security numbers.  

Office audits occur when the issues are too complex for a correspondence audit, but not complex enough to warrant a field audit.  An office audit is initiated by a letter to the taxpayer informing him or her that a return has been selected for audit.  This letter will also inform the taxpayer of the time and place of the audit, the issues to be addressed, and the documents that should be provided to the IRS by the taxpayer.  Office audits are usually limited to the issues identified in the initial contact letter.  However, if additional issues arise as a result of information obtained at the audit, the auditor may expand the scope of the audit.

Generally, office audits are held in an IRS office of the district in which the taxpayer resides.  In most cases, this is the IRS office closest to the taxpayer’s residence.  The audit will be scheduled during normal workdays and business hours for the IRS.  If a practitioner is unable to attend an audit scheduled for a particular time and place, the practitioner should contact the auditor to reschedule the audit.  Generally, the examiner will work with the practitioner or the taxpayer to arrange a mutually convenient meeting time.

Field audits are conducted for almost all corporate, partnership and fiduciary returns as well as all complicated individual returns and occur at the taxpayer’s home or place of business.  The audit is usually initiated by a letter or telephone call to the taxpayer.  The time and place of the audit are set by the IRS.  However, as with office audits, the examiner will usually work with the practitioner or taxpayer to arrange a mutually satisfactory time and place.  The scope of the field exam is usually set by the revenue agent.  General items will almost always be considered by any revenue agent which include gross receipts, standard of living, and sources of income.




Examiners
Examiners are either auditors or agents.  Auditors are usually used to examine simple returns with simple or routine issues.  Auditors usually have less training and experience than agents.  Agents usually conduct the more complex audits and often have an accounting background or accounting experience.  

All examiners are required to follow certain standards when examining a return.  Practitioners should remember that examiners or agents generally do not have time to audit every item on a return.  Instead, only significant items should be examined and it is the practitioner’s job to narrow the focus of the audit to those items that both the IRS and the taxpayer deem significant. 

Examiners are required to determine the correct amount of tax due pursuant to the Internal Revenue laws as interpreted by the courts or the IRS.  Thus, although examiners cannot settle cases based on the hazard of litigation, they can make determinations about legal and factual issues in conformity with the laws as interpreted by the courts and the IRS.  Therefore, practitioners should present the facts and applicable laws in a manner that allows the examiner to find in favor of the taxpayer.  Arguing that an IRS position is wrong will not result in a matter being resolved at exam.

Initial Client Interview

The following information should be obtained from the client during the first contact:


Full name of taxpayer and spouse, if spouse is involved in the collection action.
Social security numbers and employer identification numbers.
Current address and phone numbers.
Type of tax and relevant tax return forms for the taxes at issue.
Years or periods.

A power of attorney (Form 2848) should be completed and signed by the taxpayer and representative as soon as possible.  
Meeting with Examiners

When a practitioner meets with an examiner for an audit, the practitioner should be polite and courteous.  This does not, however, mean that the practitioner should try to make the examiner his/her friend.  If the practitioner’s personality is friendly and outgoing, the practitioner should be him/herself.  Nevertheless, the practitioner’s job during the audit process is to protect the rights of his/her taxpayer.  This means that the practitioner should not volunteer information that is not requested.  If information is requested but the practitioner believes that the request is inappropriate or unwarranted, the practitioner should object to the request.  

Even though the IRS has broad examination authority, the examiner should only seek information and ask to see books and records that are relevant to the audit.  Sometimes, the examiner will seek information or documents that are outside of the scope of the audit.  For example, it is routine for the examiner to request information about the taxpayer’s bank accounts and other assets.  The purpose of these questions early in the audit is to gather information for collection if a liability is ultimately determined to be due.  However, questions about assets that relate to collection before a liability exists is premature.  It is the practitioner’s job to keep the examiner focused to only those items relevant to the audit of the taxpayer’s return.  Additionally, a taxpayer hires a practitioner to deal with the IRS.  As such, generally, the practitioner, rather than the taxpayer, should attend the audit.  Often taxpayers, in an attempt to make the auditor his/her friend, will offer too much information or documentation.
Finally, during the course of most audits, at one point or another, practitioners and auditors will disagree as to interpretation of facts or legal issues.  Disagreements are part of the normal course of events since the auditor is looking for mistakes made by the taxpayer and the practitioner is defending the actions of the taxpayer.  Nevertheless, the practitioner must always be professional and courteous.  If a matter cannot be resolved with the examiner, the practitioner may ask to speak with the supervisor.  However, this should only be done when the practitioner believes the supervisor will side with the practitioner.  Additionally, the request should be made in a courteous and professional manner.  Keep in mind that the practitioner will often deal with each examiner on many occasions.  It is important to create a reputation of professionalism, even when the parties disagree.  Most examiners know that the issues are not personal and also will remain professional and courteous.  However, even if an examiner becomes argumentative or is rude, the practitioner should remain calm and professional.  This is only the first level of the administrative process.  Again, the practitioner can always seek the intercession of a supervisor if necessary.  
Defenses
During the audit, the examiner will seek information from the taxpayer and propose a particular interpretation of the law as it applies to the facts of the case.  Depending on the case, the practitioner’s defense of the taxpayer may be based on an issue of substantive tax law.  For example, the examiner may propose disallowance of a deduction and the practitioner may argue that the deduction is allowable based on case law.  This would be a defense based on substantive tax law.  However, keep in mind that although the IRS is required to follow the law if it is settled, if a legal issue is unsettled but the IRS has taken a formal position on an issue, the examiner will be bound by the position of the IRS.  In such a case, arguing that the IRS is wrong will not improve the situation.  Rather, the practitioner should try to explain the facts in such a way that he/she presents the case in line with a formal position of the Service.  
Defenses during audit can also be of a factual nature.  Often, the examiner will propose a deficiency based on a reconstruction of the taxpayer’s income based on the spending of the taxpayer.  For example, the examiner may ask to review all bank statements, mortgage statements, credit card statements, etc.  The examiner will add up all of the spending of the taxpayer and if the taxpayer has reported less money than he/she spent, the deficiency is the difference between the amount reported and the amount spent.  However, if the taxpayer had money from a nontaxable source, such as an inheritance, the inheritance is a defense to the proposed deficiency.

The statute of limitations may also be a defense to a proposed deficiency.  Generally, the IRS must assess a tax liability within a certain period of time.  If the auditor is proposing to audit and/or assess a liability for which the statute of limitations has expired, the practitioner should argue against the proposed assessment based on the statute of limitations.

If the examiner proposes an increase of tax liability for a jointly filed return, one of the taxpayers may wish to raise one of the defenses to jointly filed returns.  At the audit level, two of the three defenses to jointly filed returns are applicable.  First, the practitioner may argue that one of the spouses was an “innocent spouse” by establishing that (1) a joint return was filed, (2) the spouse did not know or have reason to know of the understatement, and (3) it would be inequitable to hold the innocent spouse liable under all of the facts and circumstances.  IRC §6015(b).  Second, if the taxpayers are no longer together, IRC §6015(c) provides for an election that enables an individual to limit his/her liability to that portion of a joint deficiency that is attributable to items allocable to that individual.  Items of income are allocated to the respective individuals who earned the income.  For deductions or credits, the amount of the deficiency allocated is limited to the amount of income or tax allocated to such spouse that was offset by the deduction or credit.  A taxpayer is eligible to make an election to allocate liability if (1) the taxpayer is no longer married to the spouse with whom the joint return was filed, (2) the taxpayer is legally separated from the spouse with whom the joint return was filed, or (3) the taxpayer and the spouse with whom the joint return was filed have lived apart for more than 12 months.

Examination Authority Of The IRS

The IRS has very broad examination authority.  Pursuant to IRC §7602, it can do the following:  examination without a summons, examination by use of a summons, and examination under oath.  Generally, during an audit, the Service will first attempt to voluntarily obtain information from the taxpayer.  The service center or tax examiner will usually do so by making an informal request by letter.  The success of an informal investigation is contingent on the taxpayer’s voluntary compliance.  It is the practitioner’s duty to determine when it is in the taxpayer’s best interest to voluntarily comply.


If the taxpayer is unable or unwilling to voluntarily provide the requested documentation or testimony, the IRS can resort to the use of a formal summons procedure to compel production of the requested documents or testimony.  An enforceable summons must contain the following:
The name and address of the person whose records the IRS seeks to obtain.
The periods under investigation.
The identity of the person being summoned.
A description of the documents or information requested.
The date, place and time for return of the summoned documentation or testimony.

The summons must be personally delivered to the person being summoned or left at the person’s last and usual place of abode.  The return date of the summons must be no sooner than 10 days from the date of service of the summons. IRC §7605(a).  

When a summons is issued to a third-party, defined as a person other than the taxpayer, the IRS must follow additional procedures.  Notice of the summons must be given to the taxpayer within three days by certified or registered mail.  The taxpayer is thereafter given up to 23 days to begin a court proceeding to quash the summons.  The IRS is required to serve the summons on the third-party by delivering it to the third-party personally, by leaving it at the usual place of abode, or service by registered or certified mail.



The taxpayer whose liability is being investigated is entitled to bring an action in the appropriate U.S. District Court to quash the summons. The statute of limitations on assessment and collection is stayed during the litigation, and certain kinds of summons specified under present law are not subject to these requirements.

If the taxpayer brings a motion to quash, the third-party is prohibited from complying with the summons until the court rules on the taxpayer's petition or motion to quash, but the statute of limitations for assessment and collection with respect to the taxpayer is stayed during the pendency of such a proceeding.  

The taxpayer voluntarily complies with a summons by appearing at the specified time and place, and by producing the requested documents or testimony.  Even if the person summoned objects to the scope or propriety of the summons, he or she must appear to raise the objections.
If the person summoned appears to raise objections, or fails to appear, the IRS can enforce the summons by commencing a proceeding in federal district court.  The proceeding is commenced by the Service’s filing of a petition in the federal district court where the person summoned resides or is found.

As a practical matter, a practitioner representing a party who intends to comply with the summons but who requires additional time to do so, can contact the revenue agent who issued the summons to request additional time.  Provided that the time requested is reasonable, the revenue agent will usually agree to the extension.  This is because the revenue agent alone cannot determine whether or not to proceed with a summons enforcement proceeding.  If the examiner recommends summons enforcement, it must be reviewed at various levels.  Finally, if the examiner’s determination is sustained, the case is sent to the to the U.S. Attorney’s Office for review.  The U.S. Attorney is usually the office responsible for filing the enforcement petition with the federal district court.  Thus, by the time the administrative review is complete, the person summoned would usually have complied on the extended date and the administrative review is a waste of time.
Essential Elements of Summons Enforcement

If the case proceeds to enforcement, the essential elements for enforcement of a summons were determined by the Supreme Court in United States v. Powell, 379 U.S. 48 (1964).

The summons must be issued for a legitimate purpose.
The records sought must be relevant to the legitimate purpose.
The required administrative procedures must be followed.
The records must not already be in possession of the IRS.
The government's burden on the Powell requirements is usually satisfied by the conclusory allegations in the agent's affidavit.  The summoned person then has the burden of establishing that some defense to the summons exists.

The Attorney Client Privilege

The attorney-client privilege is not as broad as many attorneys think.  Generally, it only applies to confidential communications which have not been otherwise disclosed.  A common law privilege of confidentiality exists for communications between an attorney and client with respect to the legal advice the attorney gives the client. Communications protected by the attorney-client privilege must be based on facts of which the attorney is informed by the taxpayer, for the purpose of securing the professional advice of the attorney. The privilege may not be claimed where the purpose of the communication is the commission of a crime or tort. The taxpayer must either be a client of the attorney or be seeking to become a client of the attorney.

The privilege of confidentiality applies only where the attorney is advising the client on legal matters. It does not apply in situations where the attorney is acting in other capacities. Thus, a taxpayer may not claim the benefits of the attorney-client privilege simply by hiring an attorney to perform some other function. For example, if an attorney is retained to prepare a tax return, the attorney-client privilege will not automatically apply to communications and documents generated in the course of preparing the return.

The privilege of confidentiality also does not apply where the communication is made for further communication to third parties. For example, information that is communicated to an attorney for inclusion in a tax return is not privileged because it is communicated for the purpose of disclosure. The privilege of confidentiality does not apply where an attorney is acting in another capacity, or where an attorney who is licensed to practice another profession is performing such other profession.
The attorney-client privilege is considered waived if the communication is voluntarily disclosed to anyone other than the attorney, the client, or the agents of the client or the attorney.  Additionally, the attorney work product doctrine is applicable to the IRS summons.  Generally, the doctrine protects materials prepared in anticipation of litigation.

The Federal Tax Practitioner Privilege

There is no Accountant-Client privilege under federal law. However, communications and documentation between an accountant and an attorney, who was hired by the attorney for purposes of aiding the attorney in representing a client and rendering legal advice, are protected by the privilege. See U.S. v. Kovel, 296 F.2d 918 (1961).


The IRS Restructuring and Reform Act of 1998 added a provision which provides for the uniform application of confidentiality privilege to taxpayer communications with federally authorized practitioners. 
The Federal Tax Practitioner’s Privilege extends the present law attorney-client privilege of confidentiality to tax advice that is furnished to a client taxpayer (or potential client taxpayer) by any individual who is authorized under Federal law to practice before the IRS if such practice is subject to regulation under §330 of Title 31, United States Code. Individuals subject to regulation under §330 of Title 31, United States Code include attorneys, certified public accountants, enrolled agents and enrolled actuaries.  Tax advice means advice that is within the scope of authority for such individual's practice with respect to matters under Title 26 (the Internal Revenue Code).

The provision allows taxpayers to consult with other qualified tax advisors in the same manner they currently may consult with tax advisors that are licensed to practice law.  The provision does not modify the attorney-client privilege of confidentiality, other than to extend it to other authorized practitioners. The privilege established by the provision applies only to the extent that communications would be privileged if they were between a taxpayer and an attorney. Accordingly, the privilege does not apply to any communication between a certified public accountant, enrolled agent, or enrolled actuary and such individual's client (or prospective client) if the communication would not have been privileged between an attorney and the attorney’s client or prospective client. For example, information disclosed to an attorney for the purpose of preparing a tax return is not privileged under present law. Such information would not be privileged under the provision whether it was disclosed to an attorney, certified public accountant, enrolled agent or enrolled actuary.

The privilege may not be asserted to prevent the disclosure of information to any regulatory body other than the IRS. The ability of any other regulatory body, including the Securities and Exchange Commission (SEC), to gain or compel information is unchanged by the provision. No privilege may be asserted under this provision by a taxpayer in dealings with such other regulatory bodies in an administrative or court proceeding.
The privilege of confidentiality created by this provision will not apply to any written communication between a federally authorized tax practitioner and any director, shareholder, officer, employee, agent, or representative of a corporation in connection with the promotion of the direct or indirect participation of such corporation in any tax shelter.  

The privilege created by this provision may be waived in the same manner as the attorney-client privilege. For example, if a taxpayer or federally authorized tax practitioner discloses to a third party the substance of a communication protected by the privilege, the privilege for that communication and any related communications is considered to be waived to the same extent and in the same manner as the privilege would be waived if the disclosure related to an attorney-client communication.
The privilege of confidentiality may only be asserted in any non-criminal tax proceeding before the IRS, as well as in non-criminal tax proceedings in the Federal Courts where the IRS is a party to the proceeding or in the Federal courts with regard to a non-criminal tax proceeding where the United States is a party.  This provision relates only to matters of privileged communications.

Fifth Amendment Privilege

The privilege against self-incrimination may apply pursuant to the Fifth Amendment to the United States Constitution.  This privilege applies when the individual asserting the privilege can establish (1) compulsion, (2) a testimonial communication, and (3) the incriminating nature of the communication.  An attorney cannot assert a fifth amendment privilege on behalf of a client.  Additionally, in general, this privilege does not apply to corporations.

The taxpayer or any other witness cannot assert a blanket fifth amendment privilege in response to an IRS summons, IRS interrogation or grand jury proceeding.  Instead, the taxpayer or testifying witness must appear and assert the privilege on a question-by-question or document-by-document basis.  The privilege survives the death of the taxpayer.
Negotiating a Resolution

When negotiating with the Auditor or Agent, and also at Appeals, it is important to demonstrate a true understanding of the facts.  Sometimes the Agent and Practitioner will have a different interpretation of the facts.  It is important to discuss the facts and try to reach an agreement as to interpretation of the facts.  This will help facilitate a final settlement of the case.  Often at the beginning of the negotiation process the areas of disagreement are larger than the areas of agreement.  The key to reaching a settlement is to try to expand the areas of agreement and to reduce the areas of disagreement.

Once the factual issues are discussed and there is a reasonable agreement as to interpretation, the parties can discuss and apply the law to the facts at hand.  The practitioner should be well versed in the legal issues of the case and be able to discuss the law as it applies to the facts.  The practitioner should always be well versed in all defenses that apply to the case.  Defenses can be factual, legal and/or procedural.  

If the law is in favor of the taxpayer, the practitioner should present the basis for concession on the part of the IRS.  If the law is against the taxpayer, the practitioner should focus on obtaining some settlement for the taxpayer, often based on the facts rather than the law.  In either case, it is often helpful for the practitioner to propose a resolution to the case.  If the practitioner believes the case is very strong, then he/she can request a no-change.  However, if the IRS has some basis for an adjustment, as is often the case, the practitioner may wish to propose terms along which the taxpayer would be willing to settle.  This sets a starting point for reaching a final settlement of the issues.

Potential Outcome of an IRS Audit

The four potential outcomes for any audit are no-change, agreed, unagreed, or partially agreed.  If the examiner determines that no change is required, a letter is sent to the taxpayer or representative regarding the outcome.  The examiner’s report is usually not provided to the taxpayer unless the audit will result in changes to other returns or years.  However, if the representative is present, and the taxpayer is not, a copy of the exam report is provided to the representative.
If the auditor determines that an additional tax is due, and the taxpayer agrees with the examiner’s report, the taxpayer will be asked to sign a settlement agreement.  The official form to be used depends on the type of tax involved.  A representative may sign an agreement on behalf of the taxpayer if the representative has power of attorney.
If the auditor determines that an additional tax is due, and the taxpayer disagrees with the proposed change(s), the examiner will usually issue a 30-day letter.  The 30-day letter informs the taxpayer of the amount and basis of the proposed deficiency.  The taxpayer has 30 days from the date of the letter to request a conference with an appeals officer of the IRS Appeals Division.  
If the auditor determines that an additional tax is due, and the taxpayer agrees with some issues but disagrees with the examiner on others, the taxpayer will be asked to sign an agreement or waiver as to the agreed issues.  The unagreed issues will be included in the 30-day letter.  
Finally, if the taxpayer fails to request an appeals conference, or if the statute of limitations on assessment does not allow sufficient time for the issuance of a 30-day letter (and if the taxpayer is unwilling to extend the statute) a 90-day letter will be issued.  The 90-day letter is referred to as the Notice of Deficiency or statutory notice.  With only a few exceptions, the IRS cannot assess an income, estate, or gift tax deficiency until after the issuance of the statutory notice of deficiency and the expiration of the applicable period of time. 




Substitute Returns

Under IRC §6020(b), the IRS can file a return for a delinquent taxpayer.  Generally, before this occurs, the Service will attempt to locate the taxpayer and ask the taxpayer to voluntarily prepare and file the return.  If the Service is unable to locate the taxpayer, or the taxpayer refuses to do so, the Service will prepare a substitute return for the taxpayer.  The Service will then ask the taxpayer to sign the return, if the taxpayer is located.  If the taxpayer signs the substitute return, then the return is treated as a return for all purposes, including the statute of limitations.  If the taxpayer fails to sign a substitute return, but agrees to an examination report that incorporates the substitute return, the Form 870 Agreement is treated as if the taxpayer signed the return.  Rev. Rul. 74-203.


If the taxpayer refuses to sign the substitute return, and if the taxpayer refuses to sign a Form 870 Agreement which incorporates the substitute return, the 6020(b) return is treated as prima facie good and sufficient for all legal purposes.  However, prior to assessment of a tax shown on a substitute return, the IRS must issue a notice of deficiency because the taxpayer has not agreed to the tax shown on the return.  The normal procedures for a notice of deficiency must be followed.  

A substitute return, not signed by the taxpayer, does not start the running of the statute of limitations for assessment and collection.  However, once the notice of deficiency is issued, and the assessment is made after the appropriate applicable period of time, collection of said tax is subject to the general ten year rule.  The substitute return does not preclude the taxpayer from electing to file a joint return.  
The Election to File Jointly

Married taxpayers can elect to file a joint return pursuant to IRC §6013.   Under IRC §6013(b), an election to file jointly cannot be made if either spouse has filed a separate return for the taxable year; and one of the following has occurred:

The joint return is more than 3 years late (without regard to any extension of time granted to either spouse); or
Either spouse files a petition in the Tax Court for a statutory notice of deficiency for the year at issue; or
Either spouse has begun a refund action; or
Either spouse has entered into a closing agreement under Section 7121 for the tax year at issue, or any civil or criminal case against either spouse for the tax year at issue has been compromised under section 7122.

The restrictions listed above apply only if one or both of the spouses have previously filed a separate return for the tax year at issue.  Thus, where neither spouse has filed a return for the year at issue, they may file a joint return without regard to the restrictions in §6013(b).



Audit Chapter in Outline Form

The Tax Gap
The tax gap is the difference between what the government collects each year and what it should be collecting.
Stated differently, the IRS definition of the tax gap is true tax liability imposed by law that is not paid voluntarily and timely.
Paid voluntarily means paid without IRS intervention.
Paid timely means paid when legally due.
Reducing the Tax Gap; A Report on Improving Voluntary Compliance.  This report was issued by the IRS on August 2, 2007.
Although federal receipts total $2.4 trillion for 2006, the IRS still estimates the current tax gap to be approximately $290 billion (this figure is down from $345 billion in 2001).
The IRS knows that the reduction from $345 billion to $290 billion occurred in part as a result of its increased enforcement since 2001.  This report details future initiatives to further decrease the tax gap since the Internal Revenue Service collected 95% of the $2.4 trillion needed to run the United States government in 2006.
Noncompliance is only part of the problem creating the tax gap and that an important part of the problem is the growing complexity of the tax laws, which continue to frustrate IRS efforts to improve compliance.
Nevertheless, this report states that the number one strategy for improving compliance is to increase frontline enforcement resources.
Of the $11.1 billion budget request that was submitted to Congress by the IRS for 2008, $410 million is solely designated for new enforcement initiatives.
Compliance and Noncompliance
The IRS Oversight Board has adopted an 86% voluntary compliance standard by 2009.
The current voluntary compliance is estimated to be 85% and has been such for many decades.
The Senate Finance Committee Chairman, Max Baucus, has asked for a 90% compliance goal by 2017.
The IRS recognizes that to make a meaningful improvement in percentage points without a fundamental change in the relationship between taxpayers and the government will require a long term focused effort.
Part of this effort must include an analysis and understanding of the composition of noncompliance.
This report indicates that noncompliance takes three forms.
Non-filing- defined to be failure to timely file, is estimated to be 8% of the tax gap.
Underreporting- defined as underreported gross receipts and/or overstated expenses, estimated to be over 82% of the tax gap.
Underpayment- failure to timely pay in full, estimated to be approximately 10% of the tax gap.
In its report, Reducing the Federal Tax Gap, the Treasury outlines seven strategies, which will form the basis for reform.
Reduce opportunities for evasion.
The IRS submitted 16 legislative proposals in its 2008 budget, which it says will result in an additional $29.5 billion over the next 10 years.
Make multi-year commitment to research.
Updating compliance research more often.
Continue efforts in technology.
Improve compliance with better tools resulting in early detection, better case selection and better case management.
Improve compliance activities.
Audit and collection numbers have improved since 2001.
Further improving exam and collection will also further increase compliance.  Goals include enhanced document matching activity and increased taxpayer contact.
Keeping with the age old IRS concept of deterrence, the IRS proposes increased IRS enforcement presence, which will aid not just as to those contacted, but also deterred from noncompliant behavior.
Enhanced taxpayer services.
The IRS wants to focus on taxpayers who intentionally evade tax obligations.  As a result, this report references the need to help taxpayers avoid unintentional errors.
The Service is working to provide service more efficiently and effectively.  The Taxpayer Assistance Blueprint (TAB) completed in April of 2007 outlines a five year strategic plan for taxpayer service.
Reform and simplify tax laws.
The 2008 IRS budget contains proposals to simplify tax credits and tax treatment and savings.  Continued simplification of the tax laws is urged in this Report.
Coordinate with partners and stakeholders.
This would result in enhanced coordination with states and foreign governments by the IRS to share information and strategies.
The IRS would also expand coordination with professional organizations and professions for a better exchange of information and relationship.
Random tax audits to begin in October of 2007.
The IRS is reviving its once controversial practice of randomly targeting taxpayers for audits even when the agency has no reason to suspect them of wrongdoing.
The first wave of random audits will start in approximately  October of 2007 and will continue throughout 2008.
An estimated 13,000 income tax returns from the 2006 tax year will be selected from various income categories.
The purpose of the random audits is to gather fresh data for the IRS to use in compiling formulas to be used in applying DIF scores to income tax returns.
When a tax return is filed, IRS computers compare it against the National Discriminate Information Function (DIF system, average).  The IRS calculates the DIF score by using closely guarded formulas.  Fresh data is needed to create relevant formulas.
High risk tax audit areas.
Since the IRS does not have sufficient personnel and resources to examine every tax return, it tries to select those tax returns, which upon preliminary inspection, have high audit potential.  In recent years, fewer than 2% of individual income tax returns have been audited.
However, chances of an IRS audit are higher depending on certain types of income, certain amounts of income, profession, types of transactions and types of tax deductions claimed on the return.
High wages- The chance of being audited if you make over $100,000 increases potential audit percentage by ½ of a percent.  Further, if you make over $100,000, that percentage increases further if any of the following circumstances apply:
Large amounts of itemized deductions that exceed IRS targets.
Claimed tax shelter losses.
Complex investment or business expenses on the return.
Own or work in a business which receives cash and/or tips in the ordinary course of business.
Business expenses are large in relation to income.
Rental expenses.
Prior audit that resulted in a tax deficiency.
Complex tax transactions without explanations contained on the return.
Shareholder or a partner in an audited partnership or corporation.
Claimed large cash contributions to charities in relation to income.
Large amounts of itemized tax deductions.
High DIF score
Unreported taxable income
The IRS can discover unreported taxable income in many ways.  It can obtain information from third parties, such as banks or other companies or organizations that file payer information with the IRS.
Self employment
Self employed individuals run a much higher risk of audit since the IRS believes that most underreporting of taxable income and abuse of tax deductions occurs among the self-employed.
Continuing the same idea, the Service is also targeting S corporations.
Home office tax deductions
Unreported alimony
Business expenses contained on an S corporation return or unreimbursed business expenses contained on the Schedule A and Form 2106.
One of the most commonly audited items by the IRS for individuals who own their own businesses and employees of companies who use their car in business, is the tax deduction for business transportation.
It is very important to keep a daily log of business mileage, which should ideally show the date, beginning and ending odometer readings, the location, the business purpose and the client or business associate.
At a minimum, taxpayer should write down the automobile’s odometer reading at the beginning and end of each tax year and have a daily record of appointments that can be used to reconstruct claimed business mileage.
Audit Selection
DIF Score - The most common is by use of a computer program called the Discriminate Function System (DIF).  Each return receives a score (DIF score) for potential error.  Returns that receive scores that are higher than normal, based on past IRS audit experience, are flagged for additional review by IRS personnel.  As a result, not all returns that receive a high DIF score are audited.
Informants - Returns are also selected for audit by the IRS’s use of informants.  
Sharing of Information - The IRS also shares information with state and local authorities, and vice versa.  Thus, a client who is audited by the IRS who either concedes to an increase in tax or loses in Tax Court will likely be contacted by the State Tax Department within a year or so of the federal change.  Special rules apply regarding the statute of limitations at the state level as they relate to federal changes.
Meeting with Examiners
Be Polite an Courteous but Know your Clients Rights
When a practitioner meets with an examiner for an audit, the practitioner should be polite and courteous.  This does not, however, mean that the practitioner should try to make the examiner his/her friend.  If the practitioner’s personality is friendly and outgoing, the practitioner should be him/herself.  Nevertheless, the practitioner’s job during the audit process is to protect the rights of his/her taxpayer.  This means that the practitioner should not volunteer information that is not requested.  If information is requested but the practitioner believes that the request is inappropriate or unwarranted, the practitioner should object to the request.
Even though the IRS has broad examination authority, the examiner should only seek information and ask to see books and records that are relevant to the audit.  Sometimes, the examiner will seek information or documents that are outside of the scope of the audit.  For example, questions about assets that relate to collection before a liability exists is premature.  It is the practitioner’s job to keep the examiner focused to only those items relevant to the audit of the taxpayer’s return
Try to Narrow the Focus of the Audit
All examiners are required to follow certain standards when examining a return.  Practitioners should remember that examiners or agents generally do not have time to audit every item on a return.  Instead, only significant items should be examined and it is the practitioner’s job to narrow the focus of the audit to those items that both the IRS and the taxpayer deem significant.
Arguing that an IRS position is wrong will not result in a matter being resolved at exam
Examiners are required to determine the correct amount of tax due pursuant to the Internal Revenue laws as interpreted by the courts or the IRS.  Thus, although examiners cannot settle cases based on the hazard of litigation, they can make determinations about legal and factual issues in conformity with the laws as interpreted by the courts and the IRS.  Therefore, practitioners should present the facts and applicable laws in a manner that allows the examiner to find in favor of the taxpayer.  Arguing that an IRS position is wrong will not result in a matter being resolved at exam.
How to Disagree with the Examiner
During the course of most audits, at one point or another, practitioners and auditors will disagree as to interpretation of facts or legal issues.  Disagreements are part of the normal course of events since the auditor is looking for mistakes made by the taxpayer and the practitioner is defending the actions of the taxpayer.  Nevertheless, the practitioner must always be professional and courteous.
If a matter cannot be resolved with the examiner, the practitioner may ask to speak with the supervisor.  However, this should only be done when the practitioner believes the supervisor will side with the practitioner.  Additionally, the request should be made in a courteous and professional manner.
Keep in mind that the practitioner will often deal with each examiner on many occasions.  It is important to create a reputation of professionalism, even when the parties disagree.  Most examiners know that the issues are not personal and also will remain professional and courteous.  However, even if an examiner becomes argumentative or is rude, the practitioner should remain calm and professional.  This is only the first level of the administrative process.  Again, the practitioner can always seek the intercession of a supervisor if necessary.
Taxpayer Participation.
A taxpayer hires a practitioner to deal with the IRS.  As such, generally, the practitioner, rather than the taxpayer, should attend the audit.  Often taxpayers offer too much information.
The IRS typically seeks to interview taxpayers near the beginning of an examination.  The Service is becoming much more aggressive about actually interviewing the taxpayer during the audit process.
Previously, although the auditor may have asked to speak with the taxpayer, if the request was denied, the Service would rarely proceed to the issuance of a Summons.
Currently, auditors are encouraged to issue the summons to obtain an interview of the taxpayer.
It is always preferable for a taxpayer to avoid meeting with the Examiner.  However, if this is not possible, it is preferable to postpone the interview until later in the examination process when the representative has had an opportunity to become better versed with the issues.
When an interview is unavoidable, it is important to make sure that the client is well prepared.
Ask probing questions of the client in advance so the client is not taken off guard by questions during the interview.  As stated above, the interview should take place farther into the examination process when the representative is better versed on the issues.  Obviously, the representative should advise the client that the presentation of false and misleading information or documentation is a crime so the client fully understands the magnitude and relevance of his or her actions.  The client should understand that failure to provide accurate and truthful information could result in turning a civil case into a criminal case.
If the representative is aware of or concerned about potential criminal issues, the taxpayer should invoke his or her 5th amendment privileges against self-incrimination.


Defenses
Substantive Defenses.
During the audit, the examiner will seek information from the taxpayer and propose a particular interpretation of the law as it applies to the facts of the case.  Depending on the case, the practitioner’s defense of the taxpayer may be based on an issue of substantive tax law.  For example, the examiner may propose disallowance of a deduction and the practitioner may argue that the deduction is allowable based on case law.  This would be a defense based on substantive tax law.
Keep in mind that although the IRS is required to follow the law if it is settled, if a legal issue is unsettled but the IRS has taken a formal position on an issue, the examiner will be bound by the position of the IRS.  In such a case, arguing that the IRS is wrong will not improve the situation.  Rather, the practitioner should try to explain the facts in such a way that he/she presents the case in line with a formal position of the Service.
Factual Defenses.
Defenses during audit can also be of a factual nature.  Often, the examiner will propose a deficiency based on a reconstruction of the taxpayer’s income based on the spending of the taxpayer.  For example, the examiner may ask to review all bank statements, mortgage statements, credit card statements, etc.  The examiner will add up all of the spending of the taxpayer and if the taxpayer has reported less money than he/she spent, the deficiency is the difference between the amount reported and the amount spent.  However, if the taxpayer had money from a nontaxable source, such as an inheritance, the inheritance is a defense to the proposed deficiency.
The Statute of Limitations
The IRS must assess a tax liability within a certain period of time; generally, three years from the filing date of the return.  If the auditor is proposing to audit and/or assess a liability for which the statute of limitations has expired, the practitioner should argue against the proposed assessment based on the statute of limitations.
Relief from the Joint Liability – IRS Section 6015
If the examiner proposes an increase of tax liability for a jointly filed return, one of the taxpayers may wish to raise one of the defenses to jointly filed returns – Relief from Joint Liability.
Examination Authority of The IRS
The IRS has very broad examination authority.
Pursuant to IRC §7602, it can do the following:
Examination without a summons,
Examination by use of a summons,
Examination under oath.  .
Generally, during an audit, the Service will first attempt to voluntarily obtain information from the taxpayer.  The service center or tax examiner will usually do so by making an informal request by letter.  The success of an informal investigation is contingent on the taxpayer’s voluntary compliance.  It is the practitioner’s duty to determine when it is in the taxpayer’s best interest to voluntarily comply.
If the taxpayer is unable or unwilling to voluntarily provide the requested documentation or testimony, the IRS can resort to the use of a formal summons procedure to compel production of the requested documents or testimony.  An enforceable summons must contain the following:
The name and address of the person whose records the IRS seeks to obtain.
The periods under investigation.
The identity of the person being summoned.
A description of the documents or information requested.
The date, place and time for return of the summoned documentation or testimony.
The summons must be personally delivered to the person being summoned or left at the person’s last and usual place of abode.  The return date of the summons must be no sooner than 10 days from the date of service of the summons. IRC §7605(a).
When a summons is issued to a third-party, defined as a person other than the taxpayer, the IRS must follow additional procedures.  Notice of the summons must be given to the taxpayer within three days by certified or registered mail.  The taxpayer is thereafter given up to 23 days to begin a court proceeding to quash the summons.  The IRS is required to serve the summons on the third-party by delivering it to the third-party personally, by leaving it at the usual place of abode, or service by registered or certified mail.
The taxpayer whose liability is being investigated is entitled to bring an action in the appropriate U.S. District Court to quash the summons.
If the taxpayer brings a motion to quash, the third-party is prohibited from complying with the summons until the court rules on the taxpayer's petition or motion to quash, but the statute of limitations for assessment and collection with respect to the taxpayer is stayed during the pendency of such a proceeding.
The taxpayer voluntarily complies with a summons by appearing at the specified time and place, and by producing the requested documents or testimony.  Even if the person summoned objects to the scope or propriety of the summons, he or she must appear to raise the objections.
If the person summoned appears to raise objections, or fails to appear, the IRS can enforce the summons by commencing a proceeding in federal district court.  The proceeding is commenced by the Service’s filing of a petition in the federal district court where the person summoned resides or is found.
As a practical matter, a practitioner representing a party who intends to comply with the summons but who requires additional time to do so, should contact the revenue agent who issued the summons to request additional time.  Provided that the time requested is reasonable, the revenue agent will usually agree to the extension.
The Attorney Client Privilege
The attorney-client privilege is not as broad as many attorneys think.  Generally, it only applies to confidential communications which have not been otherwise disclosed.  A common law privilege of confidentiality exists for communications between an attorney and client with respect to the legal advice the attorney gives the client.
Communications protected by the attorney-client privilege must be based on facts of which the attorney is informed by the taxpayer, for the purpose of securing the professional advice of the attorney.  The taxpayer must either be a client of the attorney or be seeking to become a client of the attorney.
The privilege may not be claimed where the purpose of the communication is the commission of a crime or tort.
The privilege of confidentiality applies only where the attorney is advising the client on legal matters. It does not apply in situations where the attorney is acting in other capacities.
A taxpayer may not claim the benefits of the attorney-client privilege simply by hiring an attorney to perform some other function. For example, if an attorney is retained to prepare a tax return, the attorney-client privilege will not automatically apply to communications and documents generated in the course of preparing the return.
The privilege of confidentiality also does not apply where the communication is made for further communication to third parties.
For example, information that is communicated to an attorney for inclusion in a tax return is not privileged because it is communicated for the purpose of disclosure.
The privilege of confidentiality does not apply where an attorney is acting in another capacity, or where an attorney who is licensed to practice another profession is performing such other profession.
The attorney-client privilege is considered waived if the communication is voluntarily disclosed to anyone other than the attorney, the client, or the agents of the client or the attorney.
Additionally, the attorney work product doctrine is applicable to the IRS summons.  Generally, the doctrine protects materials prepared in anticipation of litigation.
The Federal Tax Practitioner Privilege
There is no Accountant-Client privilege under federal law. However, communications and documentation between an accountant and an attorney, who was hired by the attorney for purposes of aiding the attorney in representing a client and rendering legal advice, are protected by the privilege. See U.S. v. Kovel, 296 F.2d 918 (1961).
The IRS Restructuring and Reform Act of 1998 added a provision which provides for the uniform application of confidentiality privilege to taxpayer communications with federally authorized practitioners.
The Federal Tax Practitioner’s Privilege extends the present law attorney-client privilege of confidentiality to tax advice that is furnished to a client taxpayer (or potential client taxpayer) by any individual who is authorized under Federal law to practice before the IRS.
The provision allows taxpayers to consult with other qualified tax advisors in the same manner they currently may consult with tax advisors that are licensed to practice law.
The provision does not modify the attorney-client privilege of confidentiality, other than to extend it to other authorized practitioners.
The privilege established by the provision applies only to the extent that communications would be privileged if they were between a taxpayer and an attorney.
The privilege does not apply to any communication between a certified public accountant, enrolled agent, or enrolled actuary and such individual's client (or prospective client) if the communication would not have been privileged between an attorney and the attorney’s client or prospective client.
For example, information disclosed to an attorney for the purpose of preparing a tax return is not privileged under present law. Such information would not be privileged under the provision whether it was disclosed to an attorney, certified public accountant, enrolled agent or enrolled actuary.
The privilege may not be asserted to prevent the disclosure of information to any regulatory body other than the IRS.
The ability of any other regulatory body, including the Securities and Exchange Commission (SEC), to gain or compel information is unchanged by the provision. No privilege may be asserted under this provision by a taxpayer in dealings with such other regulatory bodies in an administrative or court proceeding.
The privilege of confidentiality created by this provision will not apply to any written communication between a federally authorized tax practitioner and any director, shareholder, officer, employee, agent, or representative of a corporation in connection with the promotion of the direct or indirect participation of such corporation in any tax shelter.
The privilege created by this provision may be waived in the same manner as the attorney-client privilege.
For example, if a taxpayer or federally authorized tax practitioner discloses to a third party the substance of a communication protected by the privilege, the privilege for that communication and any related communications is considered to be waived to the same extent and in the same manner as the privilege would be waived if the disclosure related to an attorney-client communication.
The privilege of confidentiality may only be asserted in any non-criminal tax proceeding before the IRS, as well as in non-criminal tax proceedings in the Federal Courts where the IRS is a party to the proceeding or in the Federal courts with regard to a non-criminal tax proceeding where the United States is a party.
Fifth Amendment Privilege
The privilege against self-incrimination may apply pursuant to the Fifth Amendment to the United States Constitution.  This privilege applies when the individual asserting the privilege can establish:
Compulsion,
A testimonial communication, and
The incriminating nature of the communication.
An attorney cannot assert a fifth amendment privilege on behalf of a client.
In general, this privilege does not apply to corporations.
The taxpayer or any other witness cannot assert a blanket fifth amendment privilege in response to an IRS summons, IRS interrogation or grand jury proceeding.  Instead, the taxpayer or testifying witness must appear and assert the privilege on a question-by-question or document-by-document basis.
Negotiating a Resolution
When negotiating with the Auditor or Agent, and also at Appeals, it is important to demonstrate a true understanding of the facts.  Sometimes the Agent and Practitioner will have a different interpretation of the facts.  It is important to discuss the facts and try to reach an agreement as to interpretation of the facts.  This will help facilitate a final settlement of the case.
Often at the beginning of the negotiation process the areas of disagreement are larger than the areas of agreement.  The key to reaching a settlement is to try to expand the areas of agreement and to reduce the areas of disagreement.
Once the factual issues are discussed and there is a reasonable agreement as to interpretation, the parties can discuss and apply the law to the facts at hand.  The practitioner should be well versed in the legal issues of the case and be able to discuss the law as it applies to the facts.  The practitioner should always be well versed in all defenses that apply to the case.  Defenses can be factual, legal and/or procedural.
If the law is in favor of the taxpayer, the practitioner should present the basis for concession on the part of the IRS.  If the law is against the taxpayer, the practitioner should focus on obtaining some settlement for the taxpayer, often based on the facts rather than the law.
It is often helpful for the practitioner to propose a resolution to the case.  If the practitioner believes the case is very strong, then he/she can request a no-change.  However, if the IRS has some basis for an adjustment, as is often the case, the practitioner may wish to propose terms along which the taxpayer would be willing to settle.  This sets a starting point for reaching a final settlement of the issues.
Potential Outcome of an IRS Audit
The four potential outcomes for any audit are:
No-change
Agreed
Unagreed
Partially agreed.
If the auditor determines that an additional tax is due, and the taxpayer agrees with the examiner’s report, the taxpayer will be asked to sign a settlement agreement.  The official form to be used depends on the type of tax involved.  A representative may sign an agreement on behalf of the taxpayer if the representative has power of attorney.
If the auditor determines that an additional tax is due, and the taxpayer disagrees with the proposed change(s), the examiner will usually issue a 30-day letter.  The 30-day letter informs the taxpayer of the amount and basis of the proposed deficiency.  The taxpayer has 30 days from the date of the letter to request a conference with an appeals officer of the IRS Appeals Division.
If the auditor determines that an additional tax is due, and the taxpayer agrees with some issues but disagrees with the examiner on others, the taxpayer will be asked to sign an agreement or waiver as to the agreed issues.  The unagreed issues will be included in the 30-day letter.


CHAPTER TWO
ADMINISTRATIVE APPEALS

How To Appeal
For income, estate or gift taxes, after the IRS issues a 30-day letter, the taxpayer has 30 days to file a protest to contest the examiner’s determination.  If the taxpayer fails to file a protest, Appeals will not obtain jurisdiction of the matter.

The type of protest required depends 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.  The statement should be mailed certified mail return receipt requested.  
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.  A written protest should include the following information:

A statement that the taxpayer wants to appeal the examiner’s determination(s).
The name and address of the taxpayer.
The date and symbols from the letter transmitting the examiner’s proposed adjustments.
The tax periods and years involved.
A statement of facts supporting the taxpayer’s position on factual issues.
A statement of the law on which the taxpayer relies.

Lastly, the taxpayer must affirm under penalty of perjury that the factual information contained in the protest is true.  The statement should read, “Under penalty of perjury, I declare that the facts presented in my written protest, which are set out in the accompanying statement of facts, schedules, and other attached statements, are to the best of my knowledge and belief, true, correct, and complete.”  A practitioner may substitute the above declaration with his or her signature and a statement that he/she prepared the protest and whether or not he/she knows if the facts and accompanying documents are true and correct. See IRS Publication 5, Appeal Rights and Preparation of Protests for Unagreed Cases.
Under reasonable circumstances, the IRS may agree to extend the 30-day period for filing a protest.  Such requests should be in writing and delivered to the Area Director’s office within the 30-day period.  Circumstances where the IRS may grant an extension are as follows: 1) to allow the taxpayer time to obtain a representative; 2) illness of the taxpayer or representative; or 3) the complex factual and legal issues involved. 
It is important to remember that the taxpayer does not have a statutory right to an appeal.  The IRS can simply determine a deficiency and send a 90-day letter without first sending a 30-day letter or offering a conference with appeals.  However, if the taxpayer desires an appeals conference, he or she is rarely denied the opportunity unless the statute of limitations on assessment is close to expiration and the taxpayer is unwilling to sign an extension.




Practical Considerations When Requesting an Appeal

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.

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.   

Two other factors to consider before requesting an appeal is that the issuance of a notice of deficiency and a petition to the Tax Court cut off the use of an administrative summons by the IRS for the tax year or years involved.  This has the practical effect of reducing the information readily available to the IRS, making the use of the government's limited resources and time a factor to be considered in settlement negotiations.  Lastly, statements made to an Appeals Officer during an administrative settlement conference may not be protected from use at trial under Rule 408 of the Federal Rules of Evidence.  Still, these factors should only affect the practitioner’s decision not to proceed to Appeals, if applicable.  In most cases, these factors will not be relevant and Appeals will offer an inexpensive pre-assessment opportunity to resolve the case without litigation.

The Appeals Division of The IRS

The Appeals Division has authority to determine tax liabilities and associated penalties for income, estate, and gift taxes, and several other taxes, penalties and collection activity, including those that are and are not subject to the statutory notice of deficiency procedures.

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").  The jurisdiction of the Appeals Division is set forth in Reg. §601.106(a).

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.

Practice Pointers

Every practitioner contemplating an appearance before the Appeals Division should read the practice rules set forth in Reg. §601.106(f)(1) through (9), some of which are highlighted below.  These rules are in addition to, but not a modification of, the practice rules contained in Circular 230 (31 CFR 10).

The Appeals Officer cannot settle a case based on nuisance value.  The expenses of litigation are generally irrelevant to the IRS.  Potential adverse publicity is also seldom a factor in the Appeals Officer's consideration of a matter.

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.
The applicable procedural rules and the realities of pursuing resolution of issues through litigation.
Legal issues can sometimes be resolved through the use of a request for national office technical advice.  The procedural rules for such requests are set forth in Reg. §601.106(f)(9).

Agreements

If the appeals officer and the representative or taxpayer agree to a settlement, the taxpayer or representative will be asked to sign a settlement agreement or a closing agreement.  The type of agreement to be executed depends on the type of matters involved and the desires of the taxpayer and the IRS.



Settlement Agreements

Settlement agreements exist generally in the form of 870 type agreements or 870-AD type agreements.  Form 870 type agreements do not contain the pledges not to reopen the agreement, which are contained in the 870-AD type agreements.  Additionally, the 870 type agreement is effective when received by the IRS, while the Form 870-AD agreement is not final until accepted and signed by the IRS. See IRM 8.8 1.1.3 (8-22-97).


Generally, a Form 870-AD is used when the settlement involves mutual concessions.  These types of agreements usually include the taxpayer’s waiver not to seek a claim for refund regarding the settled issues or years.  As such, although these agreements do not provide the finality of a formal closing agreement, courts have generally interpreted the Form 870-AD type of agreements as barring a claim for refund based on principles of estoppel.  

Closing Agreements

Closing agreements are provided for in IRC §7121.  This section of the code provides the exclusive procedures for entering into binding closing agreements between the IRS and a taxpayer.  Because these agreements are final, the Service generally discourages the use of them for resolving tax disputes.  As such, in most cases, agreements that are reached at Appeals will generally be contained on a Form 870 type agreement.  However, if either the taxpayer or the Service insists on the use of a closing agreement to finally resolve a liability or issue, both the District and Appeals have authority to enter into closing agreements.

Closing agreements generally exist in two forms.  A Form 866 is used for resolution of a tax liability.  A Form 906 is used for resolution of specific matters.  Both types of agreements can be entered into for periods ending before the agreement.  However, only the Form 906 can be used for matters which relate to periods ending after the date of the closing agreement.  Regs. §301.7121-1(b).


Appeals can enter into a closing agreement with a taxpayer at any time before a case is docketed in the Tax Court.  However, once a case is docketed, Appeals will generally only enter into a Form 906 agreement if the case involves other years.  See Rev. Proc. 68-16.  Additionally, the taxpayer will be required to stipulate to the settled issue(s) in the Tax Court.  If Appeals settles a tax liability for a docketed case, the Form 866 can only be used when authorized by the Tax Court.  IRM 8.13.1 (5-3-01).

Closing agreements are designed to provide finality to tax controversies.  They cannot be reopened unless there is a showing of fraud, malfeasance, or misrepresentation of a material fact.  Closing agreements are interpreted by the courts pursuant to contract principles.  The taxpayer’s signature on a closing agreement is considered an offer by the taxpayer to settle a liability or issue, and is accepted when signed by the authorized official of the IRS.  
Using contract principles, interpretation of the agreement is generally achieved by looking within the four corners of the document.  The agreement binds the parties to only those issues specifically agreed to in the closing agreement.  As such, it is extremely important to be clear and specific when entering into a closing agreement.  Consider and address all issues relevant to, and resolved by, the settlement. 
Closing agreements generally do not address interest, nor do they preclude the IRS from determining additional tax or penalties related to adjustments that result from the agreement. As such, all issues that may be affected by the agreement should be considered and addressed in the agreement.
Lastly, certain Code sections expressly provide that they be given effect notwithstanding any other law or rules of law.  If these code sections apply, the taxpayer can still protect him/herself by expressly providing in the closing agreement the extent to which these provisions will apply.

If the appeals officer and the representative or taxpayer are unable to agree on a settlement, then the Appeals Division will issue the 90-day letter.




Appeals Chapter in Outline Form

How To Appeal
For income, estate or gift taxes, after the IRS issues a 30-day letter, the taxpayer has 30 days to file a protest to contest the examiner’s determination.  If the taxpayer fails to file a protest, Appeals will not obtain jurisdiction of the matter.
The type of protest required depends 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.  The statement should be mailed certified mail return receipt requested.
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.  A written protest should include the following information:
A statement that the taxpayer wants to appeal the examiner’s determination(s).
The name and address of the taxpayer.
The date and symbols from the letter transmitting the examiner’s proposed adjustments.
The tax periods and years involved.
A statement of facts supporting the taxpayer’s position on factual issues.
A statement of the law on which the taxpayer relies.
The taxpayer must affirm under penalty of perjury that the factual information contained in the protest is true.  The statement should read, “Under penalty of perjury, I declare that the facts presented in my written protest, which are set out in the accompanying statement of facts, schedules, and other attached statements, are to the best of my knowledge and belief, true, correct, and complete.”
A practitioner may substitute the above declaration with his or her signature and a statement that he/she prepared the protest and whether or not he/she knows if the facts and accompanying documents are true and correct.
Appeals Division
Appeals settles cases based on the Hazards of 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").
Agreements with Exam and Appeal
Settlement Agreements
Settlement agreements exist generally in the form of 870 type agreements or 870-AD type agreements.
Form 870 type agreements do not contain the pledges not to reopen the agreement (i.e. seek a claim for refund), which are contained in the 870-AD type agreements.
The 870 type agreement is effective when received by the IRS, while the Form 870-AD agreement is not final until accepted and signed by the IRS.
Closing Agreements
Closing agreements are binding between the IRS and a taxpayer.  Because these agreements are final, the Service generally discourages the use of them for resolving tax disputes and in most cases, agreements that are reached at Appeals will generally be contained on a Form 870 type agreement.
Both the District and Appeals have authority to enter into closing agreements.
Closing agreements generally exist in two forms.
A Form 866 is used for resolution of a tax liability.
A Form 906 is used for resolution of specific matters.  Only the Form 906 can be used for matters which relate to periods ending after the date of the closing agreement.
Closing agreements are designed to provide finality to tax controversies.  They cannot be reopened unless there is a showing of fraud, malfeasance, or misrepresentation of a material fact.
Closing agreements are interpreted by the courts pursuant to contract principles.  The taxpayer’s signature on a closing agreement is considered an offer by the taxpayer to settle a liability or issue, and is accepted when signed by the authorized official of the IRS.
Using contract principles, interpretation of the agreement is generally achieved by looking within the four corners of the document.  The agreement binds the parties to only those issues specifically agreed to in the closing agreement.  As such, it is extremely important to be clear and specific when entering into a closing agreement.  Consider and address all issues relevant to, and resolved by, the settlement.


CHAPTER THREE
THE NOTICE OF DEFICIENCY

A deficiency as defined in §6211 of the Internal Revenue is the difference between the correct or actual tax owed by the taxpayer and the amount of tax reported on the taxpayer’s income tax return.  If the taxpayer has failed to file a return, the deficiency is the amount of actual tax owed by the taxpayer.  For purposes of the definition of deficiency in a Notice of Deficiency, the “correct” or “actual” tax is the amount determined to be due by the IRS.  Thus, the deficiency is the Service’s determination or administrative finding of the amount of tax due.  It is the administrative deficiency that is reviewed by the United States Tax Court.  

The IRS cannot issue a notice of deficiency without first making a determination of a taxpayer’s liability.  However, if the notice of deficiency does not reveal that no such determination was made, it is presumed to have occurred.  Clapp v. Commissioner, 875 F.2d 1396 (9th Cir. 1989).  However, if no determination is made, then the notice is invalid.  Scar v. Commissioner, 814 F.2d 1363 (9th Cir. 1987).

With only a few exceptions, the IRS cannot assess an income, estate, or gift tax deficiency until after sending a statutory notice of deficiency.  See IRC §§ 6212 and 6213(a).  The statutory notice of deficiency, the "90-day letter", gives the taxpayer 90 days to file a petition in the United States Tax Court challenging the proposed deficiency, (150 days if the taxpayer’s address is outside of the country on the day the notice of deficiency is mailed, and the taxpayer is actually out of the country on that day).  See IRC §6213(a).  The IRS cannot assess a proposed deficiency until after the 90-day period.  If the taxpayer files a petition with the Tax Court, then the IRS cannot assess the proposed deficiency until after the Tax Court's decision becomes final.  See IRC §6213(a). 

A notice of deficiency must be sent by registered or certified mail to the taxpayer’s last known address.  So long as both requirements are met, the notice is sufficient even if the taxpayer is deceased, or is under a legal disability.  If the proposed deficiency is from a joint return, a single notice is sufficient unless either spouse has notified the Service that separate residences have been established.  Once the Service proves that a notice was mailed by registered or certified mail to the taxpayer’s last known address, it enjoys a strong presumption of delivery, even if it is never received by or signed for by the taxpayer. Hoffenberg v. Commissioner, 905 f2d 665 (2nd Cir 1990).
If the IRS uses an address other than the last known address, the notice is not invalid if the taxpayer receives the notice in time to file a timely petition. Additionally, if the notice is not sent by registered or certified mail, but the taxpayer receives the notice in time to file a timely petition, the notice is still valid.  Balkissoon v. Commissioner, 995 F.2d 525 (4th Cir. 1993).

The last known address is defined as the last known permanent address or legal residence of the taxpayer, or the last known temporary address of a definite duration or period to which all communications during such period should be sent.  Courts differ as to their interpretation of last known address and the Service’s obligation to investigate past the address contained on the last income tax return filed by the taxpayers.  The Tax Court and some Circuit Courts have held that the IRS is entitled to rely on the last address listed on the taxpayer’s most recent tax return, unless there is clear and concise proof of a change of address being made with the IRS.  Pomeroy v. U.S. 864 F.2d 1191 (5th Cir. 1989).  However, some Circuits have held that the address shown on the taxpayers’ most recently filed return was not the taxpayers’ last known address where a more detailed search by the agent issuing the notice of deficiency would have found the taxpayers’ current address that had been entered into the Automated Insolvency System database of the IRS after the taxpayers had recently filed for bankruptcy.  Sicari v. Commissioner, 98-1 USTC ¶50,237 (2nd Cir. 1998).



If the notice of deficiency is not sent to the taxpayer’s last known address, but the taxpayer eventually receives the notice, the taxpayer can either file a petition with the tax court, pay the tax and file a claim for refund, or begin an action in federal district court seeking an injunction.  If a petition with the Tax Court is filed, the Court will dismiss the case.  Prior to doing so, however, the Court will determine one of two things: (1) the notice was valid, thus the petition is late; or (2) the notice was invalid because it was sent to the wrong address.  If the case is dismissed for the latter, the assessment, if made, is also invalid, and the Service must issue another notice of deficiency.  An invalid notice of deficiency does not suspend the running of the statute of limitations on assessment.
Once a notice of deficiency is issued by the IRS, the Tax Court obtains jurisdiction of the matter if a timely petition is filed with the Tax Court.  If a petition is not timely filed, the Tax Court will not have jurisdiction of the matters in issue. See Cerrito Est. v. Commissioner, 73 T.C. 896 (1980).

If the taxpayer pays a tax liability in full, prior to the issuance of a notice of deficiency, then no deficiency exists and the IRS need not issue a notice of deficiency prior to assessment.  However, if the taxpayer pays only part of a liability, or pays the total liability in full after the issuance of a notice of deficiency, then the Tax Court’s jurisdiction is unaffected by the subsequent payment.  Additionally, if the taxpayer makes full payment in the form of a bond rather than directly to the liability, the Tax Court’s jurisdiction is also unaffected.  IRC §6213(b)(4).

Exceptions to the notice of deficiency requirement include:

Tax Shown on Return: The tax shown on a return (and any tax paid) may be assessed by the IRS without prior notice to the taxpayer.  IRC §§ 6201(a) and 6213(b)(4).  Such assessments are known as summary assessments.  They are also referred to by the misnomer of "self-assessment."
Mathematical Errors: Additional income taxes arising from mathematical errors can also be summarily assessed.  Assessments based on mathematical errors, however, cannot be collected until after the IRS has given the taxpayer notice of the assessment.  The taxpayer then has 60 days to request an abatement of the assessment.   The IRS must abate the assessment if a timely request is made by the taxpayer.  After an abatement, the additional taxes attributable to the mathematical error will be subject to the statutory notice of deficiency procedures.  IRC §§ 6213(b)(1) and (2).  Mathematical errors include mistakes in arithmetic, incorrect use of an IRS table, inconsistent entries on a return, omissions of information required to substantiate an item on the return, and a claim that exceeds a limitation imposed by statute or regulation.  IRC 6213(g).

Termination and Jeopardy Assessments: Termination assessments (IRC §6851) and jeopardy assessments (IRC §6861) can be made by the IRS without prior notice to the taxpayer.  They can be made only if the IRS determines that collection of a proposed additional tax will be prejudiced or jeopardized by further delay.  Termination assessments are used to assess proposed tax deficiencies before the close of the taxpayer's current taxable year or before the taxpayer's tax return is due for a preceding taxable year.  Jeopardy assessments can be used for any taxable year but only if the taxable year has ended.  Pursuant to IRC §7429, a taxpayer may seek expedited administrative and judicial review of termination and jeopardy assessments.




Notice of Deficiency Chapter in Outline Form

Notice of Deficiency
Finally, if the taxpayer fails to request an appeals conference, if the statute of limitations on assessment does not allow sufficient time for the issuance of a 30-day letter (and if the taxpayer is unwilling to extend the statute), or if the taxpayer goes to Appeals but is unable to reach an agreement, a 90-day letter will be issued.
The 90-day letter is referred to as the Notice of Deficiency or statutory notice.  With only a few exceptions, the IRS cannot assess an income, estate, or gift tax deficiency until after the issuance of the statutory notice of deficiency and the expiration of the applicable period of time. 
The 90-day letter gives the taxpayer 90 days to file a petition in the United States Tax Court challenging the proposed deficiency, (150 days if the taxpayer’s address is outside of the country on the day the notice of deficiency is mailed, and the taxpayer is actually out of the country on that day).
The IRS cannot assess a proposed deficiency until after the 90-day period.  If the taxpayer files a petition with the Tax Court, then the IRS cannot assess the proposed deficiency until after the Tax Court's decision becomes final.


CHAPTER FOUR
THE UNITED STATES TAX COURT

The Petition


For income, estate and gift taxes, if a taxpayer receives a notice of deficiency and disagrees with the proposed deficiency, the taxpayer has the right to have the case litigated in the United States Tax Court prior to paying the tax.  The United States Tax Court is the taxpayer’s only prepayment litigation opportunity.  To begin an action in Tax Court to contest the existence of, or the amount of, a deficiency, the taxpayer must file a petition.  The form of the petition should be substantially similar to the form contained in Appendix 1 of the Tax Court Rules.  Pursuant to Tax Court Rule 34(b), the petition should contain the following information:

The petitioner’s name and legal residence as of the date of the filing of the petition.
The petitioner’s mailing address, if different from above, the petitioner’s taxpayer identification number (social security number or employer identification number), and the Service Center where the return in issue was filed.
The date of the notice of deficiency in issue and the identity of the IRS office that issued the notice.
The amount of the proposed deficiency, the type of tax, and the years in issue.
A section of separately lettered assignment of errors contained in the notice, including items for which the Service has the burden.
A concise statement of facts on which the petitioner relies, exclusive of issues upon which the IRS has the burden.
A request for relief.
A signature, mailing address, and telephone number of the taxpayer or his or her representative.  The representative should also include the representative’s tax court number.
A copy of the notice of deficiency.
Other exhibits.

Tax Court Rule 39 requires the petitioner to raise any claim of affirmative defense(s).  Failure to raise a defense constitutes waiver.  However, challenge to the Court’s jurisdiction can be raised at any time by motion.  Tax Court Rule 40.  Additionally, any issue not raised in the assignment of errors section is deemed conceded.
The petitioner must file the original petition with two conformed copies.  The petitioner should also file an original and two conformed copies of the taxpayer’s designation of the place of trial.  The form of the designation should be substantially similar to the form contained in Appendix 1 of the Tax Court Rules.  If the petitioner fails to designate the place of trial, the IRS is permitted to do so in its answer.

The petitioner must include a $60.00 filing fee with the petition and the designation of the place of trial.  If the filing fee is not sent with the petition, the taxpayer will be given one opportunity to pay the fee.  If the fee is not paid after demand, the case will be dismissed.

The petition, fee, and designation of place of trial must be either hand delivered or mailed to the United States Tax Court within 90 days of the date contained on the notice of deficiency. If the 90th day is a Saturday, Sunday or other legal holiday in the District of Columbia, then the last day is the next business day. Tax Court Rule 25(a)(2).  
The Tax Court applies the timely mailed, timely filed rule so long as the Tax Court receives the petition within the ordinary delivery time for mail.  Stotter v. Commissioner, 69 T.C. 896 (1978).  The relevant date of mailing is the postmark of the United States Postal Service. Prior to 1997, the timely mailed, timely filed rule did not apply to private delivery services.  However, after 1996, the timely mailed, timely filed rule will apply, but only to those services designated by the Secretary. Taxpayer Bill of Rights 2.

If the taxpayer mails the petition by registered or certified mail, the taxpayer enjoys a presumption of delivery, even if receipt is denied by the Court.  This presumption occurs only when the petition is mailed by registered or certified mail.  Additionally, the timely mailed, timely filed ruled only applies when the envelope is properly addressed to the United States Tax Court.  The address for the Court is United States Tax Court, 400 Second Street, N.W., Washington D.C. 20217. Tax Court Rule 10(e).

Lastly, the taxpayer has a right to amend the petition once prior to the service of the answer from the IRS.  Amendments after the IRS’s service of its answer can only occur by leave of court or by consent of the parties.

Office of Chief Counsel

The Office of Chief Counsel is the local office of the Chief Counsel's Office.  In essence, the Office of Chief Counsel is the in-house counsel to the IRS.  Technically, however, the Office of Chief Counsel attorneys are not employees of the IRS.

The Office of Chief Counsel attorneys are trained as litigators.  They are adept at evaluating the outcome at trial based on the evidence expected to be submitted and the legal arguments to be made.  Cases are settled at the Office of Chief Counsel level for the following reasons:

The parties have fully prepared their case for trial and are well aware of the "hazards of litigation", thereby making rational settlement decisions possible.
One or both parties are not ready for trial and the quickly approaching trial calendar brings about settlement to avoid the hazard of litigating with inadequate preparation.
One of the parties has decided that the time and effort of litigation of the particular case is not worth the expected results, even though the only settlement possibility is something less than the expected results.
As at the Appeals Division, cases are seldom settled on nuisance value, or for raw dollar amounts, or to avoid potential adverse publicity.  Instead, cases are settled on the expected trial outcome of factual issues.  The government's position on legal issues is usually determined by the national office rather than the trial attorney.

Answer


Once the taxpayer files a petition with the United States Tax Court, the Tax Court forwards the petition to the IRS’s National Office.  The National Office then forwards the petition to the Office of Chief Counsel’s office responsible for cases in the city designated as the place of trial.  The IRS has 60 days to file an answer responding to the taxpayer’s allegations contained in the petition.  However, unlike the 90 days provided to the petitioner, the 60 days is not jurisdictional and the Court may permit the IRS to file a late answer if the taxpayer is not prejudiced.  Bolton v. Commissioner, 92 T.C. 656 (1989).  But see Betz v. Commissioner, 90 T.C. 816 (1988), where the IRS was allowed to file a late answer, but was denied a claim for additional interest under IRC §6621(c) as a sanction.
Under the current Tax Court Rules, the answer must advise the petitioner of the nature of the IRS’s defenses to the taxpayer’s allegations contained in the petition.  The responses are in the form of admissions, denials, or unable to admit or deny for lack of sufficient information.  These responses must be designated to correctly respond to the paragraphs of the petition to which they relate.  The answer must also contain factual statements supporting the Service’s allegations for those issues for which the IRS has the burden of proof.  The IRS must also plead any affirmative defenses to the petitioner’s petition in its answer. 

The Service may raise the issue of jurisdiction or the petitioner’s failure to state a claim by motion rather than filing an answer.  If these issues are raised by motion in lieu of the answer, the motion must be filed within 45 days of the date the IRS is served with the petition.  Tax Court Rule 36(a).  If the Court denies the Service’s motion, the IRS is given additional time to file an answer.  Tax Court Rule 25(c).

The IRS has a right to amend its answer once, prior to the service of a reply by the petitioner.  After the petitioner’s service of a reply, the IRS can only amend by leave of court or by consent of the parties. However, the IRS will have the burden of proof for any new matters raised after the filing of a petition in the Tax Court.  Tax Court Rule 142(a).

Reply


The petitioner has 45 days after service of the IRS’s answer to reply to the allegations contained in the answer.  However, a reply is not required and rarely is it advantageous for the petitioner to do so.  If the petitioner fails to file a reply, the petitioner is deemed to deny all of the allegations contained in the IRS’s answer.  Tax Court Rule 37(c).  However, if a reply is filed, and the petitioner fails to deny any or all of the allegations contained in the answer, said allegations are deemed admitted.  Tax Court Rule 37(c).
If the taxpayer fails to file a reply, the IRS can make a motion to compel the reply.  The motion must be filed within 45 days of the expiration of time for filing the reply, and must specify the allegations to which the Service seeks a reply.  When the IRS makes a motion to compel a reply, the Tax Court will designate the time in which the taxpayer has to file a reply.  If the taxpayer fails to file a reply within the time period specified by the Court, the Court can grant the IRS’s motion and order the undenied allegations deemed admitted.

The Tax Court


The Tax Court is governed by the Rules of Practice and Procedure of the United States Tax Court.  Any procedural issue not addressed by the Tax Court Rules can be determined by the Tax Court judge assigned to the case, who will give weight to the Federal Rules of Civil Procedure where suitable.  Tax Court Rule 1.

The Tax Court is a court of limited jurisdiction.  It is an Article I tribunal rather than an Article III judicial court.  This means that it has jurisdiction over cases only to the extent specifically granted by Congress.  The Tax Court has jurisdiction in the following types of cases:

Deficiency cases subject to the notice of deficiency requirements.
Declaratory judgment actions involving the tax exempt status of exempt organizations, employee plans, and tax exempt bonds.
Disclosure cases involving IRC §6103.
TEFRA cases (unified audit procedures).  However, the Tax Court does not have jurisdiction to consider partnership items in a proceeding based on a notice of deficiency involving non-partnership items.
Certain IRS determinations of employment status (pursuant to IRC § 7436, added by the Taxpayer Relief Act of 1997).
Certain collection actions taken by the IRS (pursuant to new code IRC §6330, added by the IRS Restructuring and Reform Act of 1998).
IRS denials of innocent spouse relief and separate liability elections (pursuant to new code IRC §6015(e)(1)(A), added by the IRS Restructuring and Reform Act of 1998).
Refund actions with respect to certain estates that have elected the installment method of payment (pursuant to new code IRC §7422(j)(1), added by the IRS Restructuring and Reform Act of 1998).

The Tax Court also provides for a special litigation process for “small taxpayers”.  The small claims cases are much more informal than regular litigation, the rules of evidence are relaxed, the taxpayers often represent themselves and the decisions are not appealable.  The jurisdictional limitation for small cases is $50,000.

Discovery


Pursuant to the Tax Court Rules, the parties are required to engage in discovery through informal means before resorting to the formal procedures contained in the rules.  The parties are generally not allowed to engage in discovery until 30 days after issue has been joined.  Discovery must be completed no later than 45 days before the case is to be called on the trial calendar.

The petitioner should not expect to settle a case with the Office of Chief Counsel without participating in informal discovery. See Branerton Corp. v. Commissioner, 61 T.C. 691 (1974).  The beginning of the process is attendance at a “Branerton” conference named after a US Tax Court case where the Court required the parties to engage in informal discovery.  It is at the Branerton Conference where the parties have their first opportunity to discuss the merits of the case.  It is at this conference where initial discussion of terms for settlement of the case may be addressed.  However, practitioners should not treat the Branerton conference like a settlement conference.  Its purpose is to assist the parties in preparing for trial by facilitating discovery.  Thus, while potential avenues for ultimate settlement may present themselves at the conference, practitioners must come fully prepared to defend the merits of their case and to begin the discovery and stipulation process.  Failure to do so will disadvantage the client by showing the Office of Chief Counsel attorney a lack of professionalism and understanding of the process as well as possibly missing an opportunity to gather information from the Service’s administrative file that may be helpful to the client at trial.

Generally, once a case is in litigation, the Service can no longer use an administrative summons to obtain information about a taxpayer, and is limited to the informal or formal discovery procedures allowed by the Court.  However, some courts have allowed the use of information obtained pursuant to the administrative summons even though the IRS could have obtained the same information through discovery. National Plate & Window Glass Co. v. United States, 254 F.2d 92, 58-1 USTC ¶ 9421 (2d Cir. 1958), cert. denied, 358 U.S. 822 (1958).

Interestingly, the position of the IRS as to use of information or documentation obtained through a Freedom of Information Act request during a pending Tax Court proceeding is contrary to the position taken by the IRS in National Plate & Window Glass Co., supra.  See Williams v. Internal Revenue Service, 72-1 USTC ¶ 9476 (D.C. Del. 1972), aff'd 479 F.2d 317, 73-1 USTC ¶ 9476 (3d Cir. 1973), cert. denied, 414 U.S. 1024.

Stipulations

The Tax Court does not have a structured settlement procedure, such as mandatory pre-trial settlement conferences with a judge.  The Tax Court, however, could not possibly hold trials for most of the docketed cases.  Thus, the Court relies heavily on the ability of the parties to settle most cases.

The Tax Court Rules contain many procedures that facilitate settlement or help remove barriers to settlement.  These include resolution of legal issues by motions for full or partial summary judgment (Rule 121) and resolution of factual issues by submissions to arbitration (Rule 124).  Most helpful, however, towards settlement of a tax court case is the mandatory process of stipulation pursuant to Tax Court Rule 91.  The petitioner should not expect much aid from the Court if the stipulation process has been ignored.


Tax Court Rule 91 requires the parties to stipulate to all non-privileged matters that are relevant to the case in issue.  A stipulation should include all documents and facts relevant to the case.  Objections to facts or documents should be noted in the stipulation, but said grounds do not provide a sufficient basis for refusing to stipulate.  The proper time to formally object to inclusion of a fact or document is at trial when initially introduced or identified as evidence.  
The Stipulation should be in writing, signed by both parties, and in the format detailed in Tax Court Rule 91(b).  Two copies of the stipulation should be filed with the Court.  However, only one copy of the exhibits need be filed.

Trial


Generally, once a petition is filed, the case is placed on the trial calendar and the parties are given 90 days notice of the date on which the case will be called.  If the petitioner and the IRS are unable to stipulate to all relevant factual issues, or are unable to settle the matter without trial, the case is called at the trial calendar when the Tax Court is in session in the city designated as the place of trial by the petitioner.  
At the calendar call, the Court will call all of the cases in order of the docket numbers.  When the taxpayer’s particular case is called, the parties enter an appearance before the Court and report to the Court on the status of the matter, i.e. settled, ready for trial, etc.  Once all of the cases have been called, the Court will recess to determine the order of the hearings and trials.  When the Court reconvenes, the Court announces the order of the trials and hearings.
There are no jury trials in Tax Court.  Both the legal and factual issues are decided by a Tax Court Judge. The Federal Rules of Evidence are the evidence rules that are controlling in the Tax Court pursuant to Tax Rule 143(a).

The Tax Court follows the “Golsen Rule” when determining issues that were previously decided by the Circuit Court in which the Tax Court sits.  Thus, even if the Tax Court has held differently, if the appeal would be made to a Circuit Court that has previously ruled on the issue, the Tax Court will follow the prior decision of the controlling Circuit.

Burden Of Proof


Generally, the standard of proof in Tax Court is a preponderance of the evidence.  Generally, prior to the IRS Restructuring and Reform Act of 1998, the burden of proof as to factual matters was on the taxpayer.  Following the IRS Restructuring and Reform Act of 1998, the burden of proof is on the Service with respect to factual issues if the taxpayer can introduce credible evidence with respect to a factual issue that is necessary to determine the taxpayer’s liability and demonstrate the following:
That he/she complied with all substantiation and record keeping requirements under the Code and regulations.
That he/she cooperated with all reasonable requests by the Service for witnesses, information, documents, meetings and interviews.  Full cooperation requires the taxpayer to exhaust all administrative remedies, but does not require the taxpayer to extend the statute of limitations.

Examples of the substantiation and record keeping requirements noted by the Senate Finance Committee are §6001 (requiring taxpayer to keep records by the IRS), §§6038 and 6038A (requiring the taxpayer to furnish information with respect to foreign businesses controlled by a U.S. person), §170 (requiring the taxpayer to keep certain records related to charitable contributions), §274(d) (requiring the taxpayer to substantiate claimed deductions related to travel, entertainment, gifts and other expenses) and §905(b) (requiring the taxpayer to provide all information to establish entitlement to the foreign tax credit).

The burden of proof is on the Service if an item of income is asserted solely on statistical information relating to an unrelated taxpayer.  Under these circumstances, there is no requirement that the taxpayer maintain records or cooperate, but rather, the IRS has the burden of proof with respect to that item of income.  This rule only applies to individuals.

Where the IRS asserts any penalty, the Service must initially produce evidence to establish a prima facie entitlement to the penalty.  After the Service has introduced evidence substantiating the appropriateness of the penalty, the general burden of proof rules apply and the taxpayer must then establish credible evidence regarding his/her defense to the penalty.  If established, the burden would then shift back to the IRS under the new law.   This rule only applies to individuals.
Finally, if the IRS asserts fraud either for purposes of the fraud penalty or the statute of limitations, the Service has the burden of proving fraud by clear and convincing evidence pursuant to Tax Court Rule 142.

Briefs


After the trial is completed, the parties are required to file briefs with the Court.  The Judge will direct how and the date by which briefs should be filed.  Most often, the Court will direct the parties to file the briefs simultaneously and no later than 75 days after the completion date of the trial.  Reply briefs should then be filed within 45 days of receipt of the original briefs. 
If briefs are filed seriatim (consecutively), the Court will usually direct one party to file the original brief no later than 75 days after the completion date of the trial.  The answering brief should be filed within 45 days of receipt of the original brief.  The reply brief should then be filed within 30 days after receipt of the answering brief.  The parties are required to file an original and two copies, as well as one copy of each for the other parties.  
The format of the brief is contained in Tax Court Rule 151(e).  The format is as follows:

Table of contents
Statement regarding the nature of the controversy.
Proposed findings of fact.
Statement of points on which the party relies.
Argument regarding law and disputed facts.
Signature of representative or party.
Opinion and Decision Documents


Opinions
After the filing of all briefs, the judge will prepare and issue an opinion.  The opinion will include the judge’s findings of fact and conclusions of law.  The Chief Judge of the Tax Court will review all opinions before they become final.

An opinion can exist in one of three forms.  It can be a regular opinion, a memorandum opinion, or a summary opinion.  A regular opinion is published in the official United States Tax Court Reports and can be used as precedent.  Memorandum opinions are not published by the Tax Court, but are published by some commercial services.  Memorandum opinions, although not precedent, can and should be used and cited for persuasive purposes.  Summary opinions are the opinions of small claims cases and are not precedential and should not be cited.


Decisions
Generally, the decision document is the final paper issued by the Tax Court.  If the case did not settle, the Court will issue the decision document following its opinion.  If the case settled, the parties will usually prepare the decision document and submit it to the Court for approval and signature.  The decision document must state the exact tax liability of the petitioner, if any, for the years in issue.
In unsettled cases, after the Court’s issuance of the opinion, the parties must submit computations regarding the correct tax deficiency, liability and/or overpayments, if any, pursuant to the Court’s opinion.  If the parties are in agreement regarding the tax deficiency and/or overpayments, they may submit an agreed computation with a statement of their agreement.  If the parties are not in agreement regarding the deficiency and/or overpayments, the parties must each submit individual computations.  If overpayments are involved, the exact date and amount of each payment must be specified in the decision document.  The rules governing computations are contained in Tax Court Rule 155.
Neither accrued interest nor payments towards interest will be reflected in the decision document.  However, a representative should request computations regarding interest for the client’s information.  Additionally, if the taxpayer has paid any portion of the interest, the representative should confirm the proper application of said payment by letter.  Lastly, payments are only included in a decision document when an overpayment exists.  Payments applied to years that do not result in overpayments are not included in the decision document.  However, the Court is unconcerned as to what the parties stipulate to “below the signature line.”  Thus, the parties can include the payment amounts and proper applications thereof in the stipulation portion of the decision document which is contained below the judge’s signature.

Post-Trial Motions and Appeals


Post-Trial Motions

If a party is unsatisfied with the findings of the Tax Court, pursuant to Tax Court Rule 161, the party has 30 days from the date the party is served with the Court’s written opinion, to file a motion for reconsideration.  If a party is unsatisfied with the decision of the Tax Court, pursuant to Tax Court Rule 162, the party can make a motion to vacate or revise a decision within 30 days of the Court’s entry of the decision.  The allowance of either type of motion is within the sole discretion of the Tax Court.  Generally, either will only be granted if a party can show substantial error or unusual circumstances. 
Appeals
If a party is unsatisfied with a decision of the Tax Court, said party can appeal the decision to the United States Court of Appeals for the city or town that is the legal residence of the petitioner on the date the original petition was filed.  See Tax Court Rule 190 and IRC 7482(b).  The notice of appeal must be filed with the Tax Court within 90 days from the Court’s entry of the decision.  If an appeal is filed by one party within the 90 days, the remaining parties have 120 days from the Court’s entry of the decision (30 additional days), to file an appeal.  Finally, if a party makes a timely 161 or 162 motion, the motion tolls the 90-day period for perfecting an appeal until after the Tax Court has responded to the post-trial motion. 
A timely notice of appeal does not stay the Service’s ability to assess and collect the liability in issue.  However, the taxpayer can stay the assessment and collection by posting a bond with the Tax Court on or before the filing of the notice of appeal.  The amount of the bond will be determined by the Tax Court, but cannot exceed two times the amount of the deficiency in issue pursuant to IRC §7485(a)(1).  Generally, the Tax Court will set the amount of the bond at the deficiency plus statutory additions and interest to two and a half years from the filing of the notice of appeal.

If no appeal is taken within 90 days after entry of the Tax Court’s decision, the decision of the Tax Court becomes final on the 91st day.  If an appeal is taken from the Tax Court’s decision, the finality of the Tax Court’s decision depends on the action taken by the Court of Appeals.  Either way, once the Tax Court’s decision becomes final, the IRS can assess the deficiency in issue and begin collection.



CHAPTER FIVE

TRUST FUND RECOVERY PENALTY


When an individual is a sole proprietor or a D/B/A., failure to collect and payover trust fund taxes does not present a procedural problem for the IRS because the full amount of the tax, penalties, and interest is assessable against the individual.  However, when the taxpayer responsible for such payments is a corporation, a procedural collection problem arises for the Service when the corporation is unable to pay the trust fund liability.  In those circumstances, pursuant to IRC §6672, the IRS can assess and collect the unpaid tax from any person who meets the following criteria.

The person was responsible for collecting and paying over the tax, and
The person willfully failed to do so.

The amount of the Trust Fund Recovery Penalty (also known as the 100% penalty) is the amount of the unpaid tax assessed against the corporation, exclusive of interest and penalties).  However, once an assessment of the Trust Fund Recovery Penalty is made against an individual, the liability begins to accrue interest from the date of assessment. IRC §6601(e)(2)(A).
The Trust Fund Recovery Penalty is not subject to the notice of deficiency procedures. IRC §6671(a).  However, pursuant to the Taxpayer Bill of Rights 2, the IRS is required to issue a notice to an individual the IRS had determined to be a responsible person with respect to unpaid trust fund taxes at least 60 days prior to issuing a notice and demand for the penalty. The taxpayer has 60 days from the date of the notice to file an administrative appeal.  The statute of limitations shall not expire before 90 days after the date on which the notice was mailed. The provision does not apply if the Secretary of the Treasury finds that the collection of the penalty is in jeopardy.
The Trust Fund Recovery Penalty is not a penalty in the technical sense, but instead is a collection devise for the IRS when a corporation defaults on a trust fund tax liability.  Thus, although the IRS may assess the penalty against many responsible persons, it can only collect the tax once, whether from the business or any responsible person.  This being the case, a corporation who pays part of a liability should designate that the payments be applied to tax, i.e. the trust fund portion. (See discussion below regarding application of payments).  If the total tax is paid, but a corporate liability still exists, the IRS cannot resort to use of the Trust Fund Recovery Penalty to collect the outstanding penalties and interest.

The statute of limitations for assessing the Trust Fund Recovery Penalty is basically the same for the individual as for assessing the tax and penalties against the corporation, except that assessment of all four quarters against an individual runs from April 15th of the year following the quarters in issue.  For example, where a corporation files timely Form 941 quarterly returns for 2004, the statute of limitations begins to run as to any potential responsible officer on April 15th of 2005 and would expire on April 15th of 2008.  Keep in mind that if a corporation fails to file returns or files late, that affects the statute as to potential responsible officers.  Also, the taxpayer and the IRS may agree to extend the statute of limitations.  However, the extension must be obtained from the responsible officer; a corporate extension is not effective against the individual.



Disclosure Of Certain Information Where More Than One Person Liable
Prior to enactment of the Taxpayer Bill of Rights 2, the IRS could not disclose to a responsible person the IRS's efforts to collect unpaid trust fund taxes from other responsible persons who may also be liable for the same tax liability. The new law requires the IRS, if requested in writing by a person considered by the IRS to be a responsible person, to disclose in writing to that person the name of any other person the IRS has determined to be a responsible person with respect to the tax liability. The IRS is required to disclose in writing whether it has attempted to collect this penalty from other responsible persons, the general nature of those collection activities, and the amount (if any) collected. Failure by the IRS to follow this provision does not absolve any individual from any liability for this penalty. (TPBR2 §902. IRC §6103(e)(9)).
Right Of Contribution Where More Than One Person Liable 
A responsible person may seek to recover part of the amount which he has paid to the IRS from other individuals who also may have the obligations of a responsible person, but who have not yet contributed their proportionate share of their liability under §6672.  Prior to enactment of the Taxpayer Bill of Rights 2, taxpayers could only pursue such claims for contribution under state law (to the extent state law permitted such claims). The IRS may collect this penalty from a responsible person from whom it can collect most easily, rather than from the person with the greatest culpability for the failure. If more than one person is liable for this penalty, each person who paid the penalty is entitled to recover from other persons who are liable for the penalty an amount equal to the excess of the amount paid by such person over such person's proportionate share of the penalty. This proceeding is a Federal cause of action and must be entirely separate from any proceeding involving the IRS's collection of the penalty from any responsible party (including a proceeding in which the United States files a counterclaim or third-party complaint for collection of the penalty). The provision applies to penalties assessed after the date of enactment. (TPBR2 §903. IRC §6672(d)).
ADVANCED STRATAGIES

Designate To Trust Fund

A corporation who can pay only part of a liability should designate that its payment(s) be applied to trust fund taxes only for the specific period(s) in issue.  The designation should be made on the front and back of the check as well as the cover letter sent with the check(s).  If the total trust fund tax is paid, but a corporate liability still exists, the IRS cannot resort to the use of the trust fund recovery penalty to collect the outstanding non-trust fund tax, penalties and interest of the corporation. 

Responsibility For One Period Does Not Mean Responsibility For All Periods
If a company is going under and a potentially responsible person is leaving a company, it is important that a resignation notice be given in writing.  It should be mailed by certified mail to prove that the mailing and delivery occurred.  The individual should also take steps to be removed from the corporate signature card.  Proof of the date of removal should be maintained.




Bankruptcy
As evidenced by many recent cases, the Bankruptcy Court is a powerful tool and provides another avenue for litigation of the assertion of the trust fund recovery penalty.  If a taxpayer has missed his or her opportunity to appeal the IRS’s assertion of liability pursuant to IRC §6672, the filing of a bankruptcy provides the taxpayer with a post-assessment litigation opportunity by objecting to the claim filed by the IRS in the taxpayer’s bankruptcy.  Additionally, the Bankruptcy Court is a court of equity.  Many of the standards are applied in a fashion that is more debtor friendly as evidenced by the decisions referenced in Current Developments above.

Offers In Compromise

An offer in compromise based on doubt as to liability also provides a post-assessment opportunity for settlement and resolution based on the facts of a particular case as analyzed pursuant to IRC §6672.  A second option for resolution of a Trust Fund Recovery Penalty is an offer in compromise based on doubt as to collectibility.  An offer based on collectibility has nothing to do with the substantive liability pursuant to IRC §6672, but rather, the Service’s collection potential against the responsible person in issue.

Federal and State Causes Of Action For Contribution

Where a Bankruptcy or Offer in Compromise is not an option due to the assets of the Responsible Officer in issue, a state and/or federal lawsuit against other responsible persons may assist a taxpayer in recouping at least a portion of funds paid to the IRS.  Because this case cannot involve the IRS and may involve substantial litigation costs, it should only be considered where the suit could result in a judgment against an individual who has assets and funds to pay on the judgment.  A judgment against an individual who is judgment proof or who could discharge the judgment in bankruptcy is a waste of time, money and effort.





CHAPTER SIX 
ASSESSMENT
The assessment is the cornerstone of tax procedure.  The concept of assessment includes:

The descriptive definition,
The methods of making an assessment, and
The legal effect of an assessment.

Definition of Assessment

For federal taxes, an assessment is the entry of a determined tax liability on the books of the Internal Revenue Service.  If the entry is not made, then an assessment of federal taxes has not occurred.  IRC §6201(a) authorizes and requires the Secretary of the Treasury to make assessments of all taxes, including interest and penalties.
IRC §6201(a)(1) directs the Secretary of the Treasury to assess all taxes determined by:

The taxpayer on a return or list, or
The Secretary of Treasury on a return or list.

Method of Making an Assessment

IRC §6203 states that the assessment shall be made by recording the liability of the taxpayer in the office of the Secretary in accordance with rules or regulations prescribed by the Secretary.

Reg. §301.6203-1 states:

The Area Director and the director of the regional service center shall appoint one or more assessment officers.
The assessment shall be made by an assessment officer signing the summary record of assessment.
The summary record, through supporting records, shall provide identification of the taxpayer, the character of the liability assessed, the taxable period, if applicable, and the amount of the assessment.
The amount of the assessment shall, in the case of tax shown on a return by the taxpayer, be the amount so shown, and in all other cases the amount of the assessment shall be the amount shown on the supporting list or record.
The date of the assessment is the date the summary record is signed by an assessment officer.
If the taxpayer requests a copy of the record of assessment, he shall be furnished a copy of the pertinent parts of the assessment which set forth the name of the taxpayer, the date of assessment, the character of the liability assessed, the taxable period, if applicable, and the amounts assessed.

The IRS uses a Form 23-C, the "summary record of assessment", to make assessment.  Thus, the assessment date of a federal tax is often referred to as the "23-C date".  The supporting documents normally include the Certificate of Assessments and Payments (Form 4340) and the Form TY 53 (Account Card).  
A signature is required by an authorized individual on a Form 23-C for the assessment to be valid. See Brafman v. United States, 384 F.2d 863(1967).  However, if the validity of the assessment is challenged, the IRS can establish the validity of the assessment at issue by producing the Form 4340 in lieu of the Form 23-C.  If the Form 4340 is produced by the IRS in lieu of the Form 23-C, as usually is the case, the Form 4340 must contain the requisite information and signatures. See Geiselman, et. al. v. U.S., 92-1 USTC ¶50,200.
Prerequisites to Making an Assessment

Before the IRS can make an assessment, there must be a determination of the tax liability.  A determination of the tax liability must be made before the tax liability can be recorded on a Form 23-C.  The determination of a tax liability can be made by the taxpayer by filing a tax return setting forth the tax liability.  A determination of a federal tax liability based on a filed tax return is often referred to as a "self-assessment", but is more precisely characterized as a "self-determination" because the IRS must record the tax liability on a properly executed Form 23-C to make the assessment. A "self-determination" matures when the return is filed.  
For most federal income, estate, and gift taxes, the Commissioner of Internal Revenue can make a determination of additional tax liability by issuance of a notice of deficiency.  For most federal income, estate, and gift taxes, an assessment cannot be made until after the determination of tax liability has reached administrative maturity. A determination of tax due required to be made by the issuance of a notice of deficiency does not mature until after the passage of the applicable time period.
The applicable time period is 90 days if the taxpayer does not file a petition in the United States Tax Court challenging the determination.  If the taxpayer files a timely petition, then the applicable time period is 90 days after the Tax Court decision becomes final.  
Some taxes, such as the Trust Fund Recovery Penalty, are not subject to the notice of deficiency procedures.  However, in all situations the federal tax assessment does not occur until after an appropriate IRS official has signed the Form 23-C setting forth the tax liability.  
Legal Effect of an Assessment

An assessment properly made by the IRS is presumed correct and the taxpayer against whom the assessment occurs has the burden of proving otherwise.  Additionally, for most federal income, estate, and gift taxes, an assessment eliminates the pre-payment remedies for challenging the determination of tax liability.  

As stated above, a tax liability cannot be collected by the IRS until after an assessment has been made.  For federal income, estate, and gift taxes, the no-collection-until-after-assessment rule is consistent with the rule that an assessment cannot be made until after the taxpayer's pre-payment procedural rights have terminated, except in the case of termination and jeopardy assessments or mathematical errors.

The Federal Assessment Lien


For federal tax purposes, a lien arises on all of the taxpayer's real and personal property, and rights to such property, after the assessment has been made and proper notice has been mailed.  The federal tax assessment lien is sometimes referred to as the "secret lien" because only the IRS and the taxpayer are aware of its existence, but the assessment lien is nevertheless effective against all others with the exception of those specifically identified in the Internal Revenue Code.

The assessment lien should not be confused with a filing of a Notice of Federal Tax Lien, which is nothing more than a public proclamation of the existence of the assessment lien.  An understanding of the assessment and collection process is essential to any discussion about administrative or judicial tax proceedings.


The Internal Revenue Service must assess a tax before it can proceed to collect the tax.  The time in which the service can assess a tax is controlled by statute.

STATUTE OF LIMITATIONS ON ASSESSMENT


Generally, pursuant to IRC §6501, the IRS has three years to assess a tax determined to be due.  This rule provides that the three-year period begins to run from the latter of the:

Due date of the return; or
Date return is filed.

A timely mailed return is treated as filed on the due date of the return even if it is received by the IRS after the due date.  IRC §7502.  Amended returns do not extend the original 3-year period.  See Zellerbach Paper Co. v. Helvering, 293 U.S. 172 (1934).
Several occurrences can suspend the three-year statute of limitations.  They are as follows:

Timely issuance of proper and valid notice of deficiency. IRC §6503(a)(1).
Application for Taxpayer Assistance Order.  IRC §7811(d).
Bankruptcy petition. IRC §6503(h).
Receivership.  IRC §6036 and §6872.
Summons issued by IRS to third-party where the taxpayer makes a motion to quash the summons. IRC §7609(a), §7609(e)(1), and §7609(f).
Designated summons issued by IRS to corporate taxpayer. IRC §6501(k).  (Pursuant to the Taxpayer Bill of Rights 2, after 1996, this is limited to corporate taxpayers being examined as part of the Coordinated Examination Program (CEP)).
Exceptions to General Rule


There are several exceptions to the three-year rule.  The first exception to the rule exists if the taxpayer voluntarily agrees to extend the three-year period.  IRC §6501(c)(4).  The consent must be in writing, and must be signed by the taxpayer (or authorized representative) and the IRS before expiration of the original three years, or prior timely consent to extend.  However, the statute of limitations on assessment of estate tax cannot be extended by agreement. IRC §6501(c)(4).
Additionally, following the IRS Restructuring and Reform Act of 1998, the IRS is required to advise taxpayers of their right to refuse to extend the statute of limitations on assessment, or in the alternative, to limit an extension on the assessment statute to particular issues or for specific periods of time each time a request to extend the limitation period is made.
The Taxpayer Bill of Rights 2 makes it clear that failure to voluntarily extend the statute of limitations for assessment cannot be taken into account by a court when awarding attorney’s fees.  Generally, to qualify for an award of attorney's fees, the taxpayer must have exhausted the administrative remedies available within the IRS. In the past, the IRS has taken the position in regulations that attorney's fees cannot be awarded if the taxpayer has not agreed to extend the statute of limitations.  
The second exception to the three-year rule is the six-year rule contained in IRC §6501(e).  A six-year statute of limitations applies if the taxpayer underreports more than 25% of the gross income stated on the original income tax return.  For estate tax, the statute is extended if the estate underreports more than 25% of the gross estate.  For gift tax, the statute is extended if the taxpayer underreports more than 25% of gifts for the taxable period.

Filing of correct amended return does not shorten the six-year rule if it is applied to original return.  See Houston v. Commissioner, 38 T.C. 486 (1962).  Additionally, if the return is a joint return and the omitted gross income is attributable to only one spouse, the statue of limitations is still extended as to both spouses.  See Benjamin v. Commissioner, 66 T.C. 1084 (1976) aff’d, 592 F.2d 1259 (5th Cir. 1979).

The final exception to the three-year rule is the fraud exception.  The three-year rule does not apply to the assessment of taxes (and associated interest and penalties) attributable to a false or fraudulent return filed with the intent to evade the payment of taxes pursuant to IRC §6501(c)(2). The filing of a non-fraudulent amended return does not eliminate the fraud exception to three-year rule. See Badaracco v. Commissioner, 464 U.S. 386 (1984).

The IRS has the burden of proving fraud before the fraud exception to three-year rule can be applied.  Additionally, similar to the law regarding joint liability under the six-year rule, once the IRS proves fraud on the part of one taxpayer spouse, the statute of limitations as to the other spouse is open for purposes of tax, penalties, and interest.  However, if the IRS asserts the fraud penalty as to each spouse, the IRS must prove fraud on the part of each spouse individually.  In either case, the statute of limitations or the fraud penalty, the IRS has the burden of proving fraud by clear and convincing evidence.
Lastly, the IRS cannot assess a tax after the statute of limitations on assessment has expired, even if the taxpayer agrees to the assessment.












PART TWO
POST-ASSESSMENT




CHAPTER SEVEN
CREATION OF A FEDERAL TAX LIEN

Three events give rise to the creation of a federal tax lien.  These events are: 

1.   Assessment of a tax.

2.   Notice and Demand for Payment.

Nonpayment.

Once these events occur, the lien arises and relates back to the date of the assessment.  The date the lien arises is relevant for determining the priority of the lien as it relates to other creditors, and also the property to which the lien attaches.

Assessments are usually made by the service center responsible for the region in which the taxpayer is located.  Once an assessment has occurred, that service center is also usually responsible for the initial collection efforts.  The service center will send a series of notices informing the taxpayer of the liability and requesting payment.  However, it is only the first notice that is the pre-requisite to the creation of the federal tax lien.  This notice is usually a Form 3446, Request for Payment of Balance Due, and must be mailed or hand delivered to the taxpayer within 60 days of the date of assessment. See IRC §6303. The taxpayer has a 21-day grace period before interest begins to accrue.  If the taxpayer fails to make full payment of the liability within the specified period of time, the lien arises and relates back to the date of assessment.

Once a lien arises, it attaches to all real and personal property owned by the taxpayer on the date of the assessment, or acquired after the date of assessment.  This includes all interests in property belonging to the taxpayer, as well as all rights to property that the taxpayer may hold on the date of assessment. IRC §6321.  
Although the reach of the federal tax lien is broad and extensive, the IRS only acquires the rights to the property in issue held by the taxpayer.  This means that the IRS acquires no greater interest than that of the taxpayer.  While IRC §6321 gives the IRS rights to the property held by the taxpayer on the date of assessment, generally it does not give the IRS property interests subject to the taxpayer’s creditors.  Therefore, if property is transferred by the taxpayer prior to the date of assessment, the lien does not attach to the transferee’s interest in the property.  This, of course, assumes that the transfer was not made while the taxpayer was insolvent or to defraud any creditor, including the IRS. See Thomson v. U.S., 66 F.3d 160 (8th Cir. 1995).

The general rule is that state law defines the property to which the federal lien attaches, federal law defines the scope and priority of the lien.  This means that state law determines the nature and extent of a taxpayer’s interest in property.  However, once said determination is complete, federal law determines whether state-created rights are rights to which a federal tax lien can attach.  It is also federal law that determines the priority given to the federal tax lien where other creditors are involved.  See U.S. v. National Bank of Commerce, 472 U.S. 713 (1985).




Statute Of Limitations For Collection From the Taxpayer


Pursuant to IRC §6502(a), the IRS has ten years from the assessment date to either collect the tax by administrative means (seizures, levies, offsets), or begin a suit for collection or a judgment.  If the IRS does not commence a suit for collection or judgment, then the statute of limitations expires 10 years after the date of assessment.  If the IRS commences a timely suit to collect a tax or obtain a judgment, then it may continue its efforts to administratively collect the tax beyond the ten-year period.

The IRS and the taxpayer may agree to extend the statute of limitations for collection if the extension occurs within the ten-year period and it is in conjunction with an installment payment agreement.  The extension must be limited to the period necessary to satisfy the tax liability.  Generally, an extension filed by one spouse is not applicable to the other unless signed by the other, or unless the signing spouse has power of attorney.  See Tallal v. Commissioner, 77 T.C. 1291 (1981).

The ten-year statute of limitations for collection can be tolled under various circumstances.  Said circumstances include, but are not limited to situations where:

The taxpayer’s assets are in the custody or control of a court.
The taxpayer files for bankruptcy.
The taxpayer is continuously abroad for six months or more.
The IRS wrongfully levies on property belonging to a third party.
The taxpayer files an offer in compromise.
The taxpayer files a Collection Due Process Appeal.
The taxpayer files a Request for a Taxpayer Assistance Order.
Perfection of a Federal Tax Lien and Priority Issues


A federal assessment lien is perfected once the following three events have occurred: 1) the physical assessment; 2) demand for payment; and 3) failure to pay.  The IRS need not take any additional steps to perfect its lien, i.e., the IRS does not have to file a Notice of Federal Tax Lien to perfect.  However, there are five types of interests against whom this “secret lien” is not valid.  These five interests are as follows:

Purchasers - Full and adequate consideration.
Holders of security interests - ex. mortgagee.
Mechanic’s lienors - services, labor or materials for improvement of real property.
Judgment Creditors.
Purchase Money Mortgage holder.

For a federal tax lien to have priority over any of the above five creditors, the IRS must file a Notice of Federal Tax Lien pursuant to IRC §6323.  Once the Notice of Federal Tax Lien is filed, priority is determined by time.  This means, generally, the first creditor in time is the first creditor in line.

Super Priorities


Additionally, even if a Notice of Federal Tax Lien is filed, certain interests still enjoy priority over the tax lien.  The protected parties are as follows:

Purchaser or holder of securities (who did not have actual notice).
Purchaser of a motor vehicle (who did not have actual notice).
Retail purchaser.
Personal property purchased at a casual sale (up to $1,000).
Holder of personal property subject to possessory lien under state law (ex. - mechanic’s lien).
Local governments with respect to taxes that attach to real property and have priority under state law.
Holder of mechanic’s lien on residential property for small improvements (up to $5,000).
Attorneys with a lien for work performed if, under local law, that attorney would hold a lien on the amount of the judgment or settlement to the extent of his/her reasonable compensation or settlement.
Insurers of specific contracts under certain circumstances.
A bank or building and loan association possessing a deposit secured loan who has been in continuous possession of the securing documents (who did not have actual knowledge).

IRC §6323(b)(1)-(10).

Where a taxpayer aquires property after a federal tax lien and the previous perfection of a secured interest, an issue arises as to who has priority in the subject property as a result of simultaneous attaching liens.  United States v. McDermott, 507 U.S. 447 (1993) provides that the IRS prevails and has priority where there is a simultaneous attachment of competing liens because of federal supremacy.

The 45-Day Rule


As a result of the Simultaneous Attaching Lien Rule and the definition of security interest under IRC §6323(h)(1), there would be problems for commercial financing when a federal tax lien was involved.  This is due to the fact that commercial financing often will include a security interest that attaches to future property, such as new inventory or accounts receivable.  §6323(h)(1) provides that for a creditor to possess a valid security interest, the following four requirements must be met: 

1.  The interest must be acquired by contract to secure payment, performance of an obligation, or indemnify against loss.

The holder must part with money or money’s worth.
3.    The collateral to which the security interest is to attach must be in existence.

4.   The security interest must be protected under a local law against a subsequent judgment lien arising from the unsecured obligation at the time of the tax filing.  

Since the property must be in existence for the security interest to be perfected, where the property comes into existence after the filing of a Notice of Federal Tax Lien, the security interest is junior to the tax lien.  A strict application of the requirement that the collateral be in existence at the time the tax lien is filed in order for the secured interest to have priority, would seriously impair many commercial financing practices.  Congress was aware of this and therefore provided for limited protection under IRC §6323(c) & (d).  

Although statutory language and definitions are complex, IRC §6323(c) basically provides that even though a Notice of Federal Tax Lien has been filed, it will not have priority over a security interest, even as to property acquired after the tax lien filing, if all of the following are met: 1) The security interest is in “qualified property” – (Qualified property is defined as “commercial financing security” acquired by the taxpayer before the 46th day after the date of the tax lien filing.  “Commercial financing security” includes accounts receivable, real property mortgages, inventory, commercial paper and contract rights); 2) The security interest is covered by a written agreement entered into before the tax lien filing, which constitutes “commercial transaction financing security”, “real property construction or improvement financing agreement”, or an “obligatory disbursement agreement” - Any loan or purchase must be made before the 46th day after the date of the tax lien filing, or before the lender or purchaser had actual notice or knowledge of said filing; 3) The security interest is protected under local law against a judgment lien arising out of an unsecured obligation as of the time of the tax lien filing.  
The effect of §6323(c) is to give a qualifying lender a 45-day grace period to pursue collateral, such as accounts receivable and inventory, after the filing of a tax lien.  IRC §6323(d) provides protection through a grace period for qualifying lenders who advance funds within 45 days after the filing of a tax lien.  These lenders will have priority as to specific property over the previously filed tax lien provided that: 1) the property was in existence at the time a Notice of Lien was filed; 2) the property was covered by a written agreement made before the filing of the tax lien and; 3) the secured interest is protected under local law against a judgment lien arising out of an unsecured obligation.  See Texas Oil & Gas Corp. vs. United States, 466 Fed 2d. 1040 (Fifth Cir. 1972), Cert. Denied, 410 U.S. 929 (1973).  This case provides an excellent historical summary and explanation of the “45-Day Rule”.       
Additionally, certain security interests have priority over filed federal tax liens, even though the federal tax lien is filed first in time.  Although the priority interests for each vary, all require the existence of a written agreement prior to the filing of the federal tax lien which is valid against other judgment lienors under state law.  These security interests are as follows:

Commercial transaction financing agreements (subject to the 45-day rule).
Real property construction or improvement financing agreements.
Obligatory disbursement agreements (third party in ordinary course of business).
Security interests in existing property that are created by reason of disbursements made within 45 days after the tax lien is filed.



CHAPTER EIGHT
RELIEF FROM A FEDERAL TAX LIEN

Relief from a federal tax lien can be achieved in one of five ways.  The taxpayer can receive a release of lien, a withdrawal of lien, a discharge of lien, the lien can be subordinated, or the lien can not attach to certain property.  The relief requested or required depends upon the facts and circumstances of the case and, in some situations, the willingness of the IRS to work with the taxpayer to achieve the desired result.

Release of Lien

The IRS’s ability to release a federal tax lien is strictly governed by IRC §6325(a).  The IRS can only release a lien in three situations.  They are as follows:

The taxpayer fully satisfies the liability (this includes the Service’s acceptance of an offer in compromise).
The liability is unenforceable (passage of time or invalid assessment).
The taxpayer posts a bond which guarantees full payment.

When any of the above events occurs, the IRS has 30 days from the date of the event to issue a Certificate of Release of Federal Tax Lien.  If the IRS fails to timely release the federal tax lien, the taxpayer can make a written Request for Release of Lien to the Chief of Special Procedures.  The request must identify the taxpayer and contain the taxpayer’s current address.  The request must also include a copy of the lien and provide the basis or grounds upon which the taxpayer is seeking the release. Once a proper request is filed, the IRS has 30 days to file the Certificate of Release.  An improperly filed request does not trigger the 30-day period.

Withdraw of Federal Tax Lien

Although the IRS has discretion in filing a notice of federal tax lien, as stated above, it may release a filed notice only if the notice (and the underlying lien) was erroneously filed or if the underlying lien has been paid, bonded, or becomes unenforceable.  The Taxpayer Bill of Rights 2 allows the IRS to withdraw a public notice of tax lien prior to payment in full by the indebted taxpayer without prejudice, if the Secretary determines that one of the following circumstances exists:
The filing of the notice was premature or otherwise not in accordance with the administrative procedures of the IRS.
The taxpayer has entered into an installment agreement to satisfy the tax liability with respect to which the lien was filed.
The withdrawal of the lien will facilitate collection of the tax liability.
The withdrawal of the lien would be in the best interests of the taxpayer (as determined by the Taxpayer Advocate) and of the Government.

The IRS must provide a copy of the notice of withdrawal to the taxpayer. Additionally, at the written request of the taxpayer, the IRS must make reasonable efforts to give notice of the withdrawal of a lien to creditors, credit reporting agencies, and financial institutions specified by the taxpayer.

Discharge of Lien

The difference between a release of lien and a discharge of lien is that the release is appropriate when the lien is no longer valid, while a discharge is not contingent on the validity of the lien.  Instead, a discharge is appropriate where the lien is still valid, but the lien is discharged as to a specific piece of property.  Generally, there are four instances when the IRS will issue a Certificate of Discharge. IRC §6325(b).  They are as follows:

The value of the taxpayer’s other property is at least twice the value of the tax liability.
The taxpayer pays the IRS an amount equal to the value of the tax lien filed against said property.
The IRS’s interest in the property is valueless.
The taxpayer sells the property and the proceeds of the sale are substituted and encumbered.

A taxpayer seeking a Certificate of Discharge must file a written application with the Area Director’s office for the territory in which the property is located.  The request must be in writing, in duplicate, under penalty of perjury, and following the Form contained in Publication 783. 

Subordination of Lien

IRC §6325(d) states that the IRS can issue a Certificate of Subordination if one of the following two circumstances exist.

The taxpayer pays an amount equal to the amount of the lien or interest to which the certificate subordinates the tax lien.
The amount of tax that is ultimately collected from the property will be increased and facilitated by the issuance of the Certificate of Subordination.

To apply for a Certificate of Subordination, the taxpayer must file a written application with the lien advisor of the Special Procedures Division for the District where the lien is filed.  For instructions on the required contents of the request, and how to apply, see Publication 784, How to Prepare Application for Certificate of Subordination.
Certificate of Non-Attachment

If a valid federal tax lien is filed against a debtor taxpayer, but appears to attach to the property or rights to property of an innocent third party, a Certificate of Non-Attachment can be filed to provide the innocent party with evidence that the property is not subject to the lien in issue, i.e. the lien is not attached.  Generally, the Certificate of Non-Attachment is used to correct confusion attributable to a similar name, or some other comparable situation.

To apply for a Certificate of Non-Attachment, the person desiring the certificate must file a written application with the Chief of the Special Procedures Division in the district where the lien is filed.  The application must contain the grounds for the request.  See Publication 1024, How to Prepare Application for Certificate of Non-Attachment.



CHAPTER NINE
LEVIES AND SEIZURES

IRC §6331(b) states that levy includes the power of distraint and seizure by any means.  Generally, the term levy is used to refer to the forcible taking of funds or intangible assets belonging to the taxpayer in the possession of a third party.  Seizure is the forced taking of real property or tangible personal property whether in the possession of the taxpayer or a third party.

The same three events that give rise to the creation of a federal tax lien are the same three events that must occur before the IRS can issue a Notice of Intent to Levy.  Once these three events occur, but prior to the actual levy or seizure, the IRS must issue a Notice of Intent to Levy, which includes information about the relevant statutory provisions and procedures, administrative appeals, alternatives to prevent levy, and procedures regarding redemption. Pursuant to IRC §6331(d)(2), the IRS must serve the Notice of Intent to Levy by one of three ways.
Serve the notice on the taxpayer personally.
Leave the notice at the taxpayer’s residence or usual place of abode.
Mail the notice by registered or certified mail to the taxpayer’s last known address.

Notice of Levy

Prior to actually levying on assets to enforce collection, the Internal Revenue Service must send certain required notification.  The IRS will send what can be called “warning notices” which are entitled Notice of Intent to Levy.  These notices will bear symbols in the upper right hand corner, such as CP 504 or CP 523.  They are, in effect, notices to encourage the taxpayer to pay the liability before enforced collection action is taken.  A Final Notice of Intent to Levy, however, must be sent before an actual levy can be issued.  This notice, which is the one that cannot be ignored, will contain a Form 12153 for a Collection Due Process Appeal.  It will also provide information on the taxpayer’s Collection Due Process Appeal rights.  It allows 30 days to file said Appeal.  Absent the filing of a Collection Due Process Appeal, the Internal Revenue Service can then levy on wages, bank accounts and other property.  (See discussion on CDPs under Collection Defenses, Chapter 11.) 

The IRS effectuates a levy of a taxpayer’s funds or intangible assets in the possession of a third party by serving the third party with a Form 668-C, Notice of Levy, or a Form 668-W, Notice of Levy on Wages, Salary, or Other Income.  There are no specific requirements imposed on the IRS when serving a Notice of Levy on a third party.  The notice can be delivered personally, by ordinary mail, or by facsimile.  
The Service is sensitive to levy and seizure where property is in the hands of a third party.  Revenue Officers are instructed to levy only where there is a reasonable expectation that the third party has property belonging to the taxpayer.  Also, the Internal Revenue Manual instructs Revenue Officers to advise a taxpayer that levy or seizure will be the next action taken and to provide the taxpayer with a reasonable opportunity to pay prior to proceeding with levy action.

It is the IRS’s policy to file the Notice of Federal Tax Lien prior to issuing the Notice of Levy to prevent the taxpayer from transferring property or interests in property prior to the effective date of the levy.  This policy, however, is often not followed and it is very common for levies to be issued without a lien being filed.  Generally, the effective date of the levy is the date the Notice of Levy is received by the third party. 

Unless specifically exempt from levy, all of the taxpayer’s property and rights to property are subject to levy.  The rules governing the determination of “property or rights to property” as they relate to federal tax liens are the same in relation to levies.  Unlike a federal tax lien, however, generally a levy does not reach after acquired property unless it is a levy on wages, salary, or other income.

Property Exempt From Levy

Property exempt from levy includes the following:

Clothing and school books necessary for the taxpayer and family.
Fuel, provisions, furniture and personal effects not exceeding $6,250.00.
Books and tools necessary for taxpayer’s trade not exceeding $3,125.00 in value.
Unemployment Compensation.
Undelivered mail.
Annuity or pension payments under the Railroad Retirement Act, and payments entered on the Army, Navy, Air Force and Cost Guard Medal of Honor Roll.
Worker’s Compensation payment.
A portion of salary or wages subject to judgment of a Court entered prior to levy for child support.
Amounts paid in relation to service connected disability benefit.
Outlook Assistance.
Amounts paid under the Job Training Partnership Act.
The taxpayer’s principal residence (For any liability under $5,000.00.  For all liabilities of $5,000.00 or more, the Service must obtain approval from a US District Court Judge or Magistrate prior to seizing a personal residence).
Certain business assets (unless approved by the Area Director or Assistant Area Director in writing after a determination that the taxpayer has no other assets, or if the Secretary finds that the collection of the tax is in jeopardy).
Wages - any amounts for wages or salary relating to personal services or derived from other sources during any period, to the extent that the total of such amounts payable to or received by the individual during said period does not exceed the applicable “exempt amount”.  The exempt amount, as defined under §6334(d) for an individual paid on a weekly basis is the standard deduction and the aggregate amount of deductions for personal exemptions under §151, divided by 52.  For individuals paid other than weekly, they are entitled to have the equivalent amount exempt from levy.  See Treas. Reg. §301.6334-3.
Certain sources of income.

See IRC §6334(a)(1)-(13).




Personal Liability of Third Parties


A party that is served with a levy by the IRS has only two defenses to not honor the levy:

The party does not have possession of, or is not obligated with respect to, any property or property rights of the taxpayer.
The property is already subject to an attachment or execution under judicial process.

A party in receipt of an IRS levy who does not have one of the above stated defenses can be held personally liable for the value of the property not surrendered, together with costs and interest pursuant to IRC §6332(d)(1).  Moreover, if the failure to surrender the property was without reasonable cause, such person can be liable for a penalty equal to 50% of the aforementioned amount pursuant to IRC §6332(d)(2).

Seizures
Generally, the IRS seizes real property or tangible personal property.  Different from the Notice of Levy procedure discussed previously, to effectuate a seizure the IRS need only take actual possession of the property subject to the lien.  The IRS uses a Form 668-B, Levy, to seize property.  Part 3 of the Form 668-B is given to the taxpayer or left at the taxpayer’s residence or usual place of abode if the taxpayer resides within the district, or if the taxpayer cannot be readily located or resides outside of the district, by certified mail to the taxpayer’s last known address. If the property is seized from a third party, Part 4 of the Form 668-B is left with the third party.

IRC §6335(a) requires the IRS to provide notice of a seizure to the owner of real property or to the possessor of personal property as soon as practicable after the seizure. But see Kaggen v. U.S., 57 F.3d 163 (2d Cir. 1995).  The IRS must serve the notice in person, or leave it at the owner’s or possessor’s residence or usual place of abode if either is located within the district where the property was seized, or mailed to the last known address of the owner or possessor if he/she cannot be located or has no dwelling or place of business within the district. See IRC §301.6335-1(a) and Goodwin v. U.S., 935 F.2d 1061 (9th Cir. 1991).  
Generally, assuming all procedures have been properly followed as set forth above, a Revenue Officer can seize property in a public area without the need of judicial involvement under the provisions of the Internal Revenue Code.  However, when it comes to seizure of property in private areas, there are Fourth Amendment issues and under G.M. Leasing Corp. v. U.S., 429 U.S. 338 (1977), the Service is required to obtain a writ of entry (similar to a search warrant) from a Court of Competent Jurisdiction.  The procedure involves the Revenue Officer requesting, from IRS Counsel, a writ of entry to allow the access to private property to seize assets belonging to the taxpayer and subject to the IRS’s assessment lien.  Counsel will refer the matter to the United States Attorney’s Office, who will thereafter file an Ex Parte Application to the United States Magistrate for a Court Order, which is referred to as a “Writ of Entry”.  Once this is obtained, the Revenue Officer can then enter private property to seize assets subject to the tax lien.



No equity seizures are prohibited.


SALE


Notice of the Sale

Once real or personal property is seized for purposes of satisfying a tax liability, the IRS must sell the property to obtain funds for application towards the liability.  Prior to selling the property at a public sale, the IRS must issue a Notice of Sale to the taxpayer.  The same requirements that apply to the issuance of a notice of seizure apply to the issuance of a notice of sale. IRC §6335(b) also requires the IRS to place a public notice of the pending sale in a local newspaper published in the county where the IRS seized the asset.  If a newspaper with larger circulation in said county is published outside of said county, the IRS may publish in that paper. Regs. §301.6335-1(b)(1).  Additionally, if no newspaper is published in the county, the IRS must alternatively post notices of the pending sale in the post office nearest to the place where the asset was seized, and also post the notice in two other public places. IRC §6335(b).

The notice must specifically describe the property to be sold, as well as the time, place, and conditions of the sale.  The notice must also state that only the taxpayer’s right, title, and interest in the property are to be sold, i.e., the property is sold “as is” subject to other encumbrances if in existence. Regs. §301.6335-1(c)(4)(iii).  A potential buyer who is interested in purchasing property at a public sale can ask the IRS questions regarding encumbrances and may also be allowed to inspect the property.

If the IRS does not provide proper notice of a sale, the owner may invalidate the sale.

The Sale
The IRS must hold the sale on the date, and at the time and place listed in the Notice of Sale.  The guidelines for dates of sale are governed by statute.  The sale must take place no sooner than 10 days following the publishing or posting of public notice of the sale, but no later than 40 days following said date.  The 10-day waiting period is strictly enforced. See Kulawy v. U.S., 917 F.2d 729 (2nd Cir. 1990).  However, the IRS can delay a sale beyond the 40-day period if the Area Director determines that adjournment is in the best interests of either the government or the taxpayer. Regs. §301.6335-1(c).  A delay can only adjourn the sale for a period not to exceed one month.
The IRS can delay a sale, even once the sale has begun, prior to the time the property is declared sold or the bidding reaches the minimum bidding price.  However, the IRS cannot adjourn the sale solely because the bidding has not reached the minimum bidding price.
If the IRS adjourns a sale on the date of the sale, the new date, time, and place of the sale are announced to the bidders present.  The adjourned date must be within one month from the date the original sale was scheduled to take place. Regs. §301.6335-1(c)(2).  Additionally, the IRS is required to provide the owner with notice of the adjournment and of the new date, time, and place for the sale. See U.S. v. Conry, 74-1 USTC ¶9187.

If the sale is not conducted within the time specifications discussed above, the IRS must return the seized property to the taxpayer.  Additionally, if the taxpayer pays the IRS the entire outstanding amount of tax, penalties, and interest, plus the costs incurred by the IRS in seizing the property in issue, the IRS must return the property to the taxpayer.  The full payment must be made before the IRS accepts the highest bid.  The payment must be in cash, a money order, or certified check.
Prior to 1997, the above constituted the sole procedure for obtaining a return of seized property to the taxpayer.  However, following the Taxpayer Bill of Rights 2, the IRS is able to return property (including money deposited in the Treasury) that has been levied upon, if the Secretary determines that one of the following circumstances exists:
The levy was premature or otherwise not in accordance with the administrative procedures of the IRS.
The taxpayer has entered into an installment agreement to satisfy the tax liability.
The return of the property will facilitate collection of the tax liability.
The return of the property would be in the best interests of the taxpayer (as determined by the Taxpayer Advocate) and the Government.

(TPBR2 §501(b). IRC §6323(j) and §6343(d)).

The Service is prohibited from selling property below the minimum bid price. 
The Right of Redemption

A right of redemption exists for certain persons after a sale of seized property.  The persons having a right of redemption are as follows:
The taxpayer/owner or heirs, executors or administrators.
Any person having an interest in the sold property.
Any person holding a lien on the sold property.

The right of redemption must be exercised within 180 days of the sale pursuant to IRC §6337(b)(1).  Additionally, this right exists only as to real property.

To redeem real property, the redeemer pays the purchaser the sum of money paid by the purchaser for the property, plus interest (20% per annum). IRC §6337(b)(2).  This payment is made to the purchaser, unless the purchaser cannot be located in the county in which the property is located.  If the purchaser cannot be located, then the redeemer pays the funds to the IRS who receives said funds on behalf of the purchaser.  In either case, however, the Area Director for the district in which the property is located must be notified that the redeemer is exercising the right of redemption.  See Regs. §301.6337-1(c) for information that must be included in notice to Area Director.
If the IRS bids on the property at the sale as the highest bidder, the redeemer has the normal 180 days to redeem the property from the IRS.  The IRS may not sell the property to another prior to the expiration of 180 days following the sale.



CHAPTER TEN
COLLECTION FROM THIRD PARTIES

IRC §6901 is utilized where the taxpayer has conveyed title to property after the accrual of a tax liability but prior to the creation of an assessment lien, and said transfer is fraudulent under state law.  The procedure involves the issuance of a notice of deficiency to the transferee.  The transferee has the right to challenge the notice of deficiency by filing a petition with the United States Tax Court within 90 days of the issuance of the notice.

Section 6901 can only be utilized as a collection device for income, gift, estate and other taxes related to the reorganization or dissolution of a corporation or partnership and fiduciary liability under 31 USC §192.  Therefore, this procedure cannot be utilized in relation to a trust fund recovery penalty pursuant to IRC §6672.

If the IRS successfully asserts a §6901 liability, said liability is personal and the assessment lien attaches to all real and personal property owned by the transferee, not just the transferred property.  §6901 provides only the procedure for proceeding against an alleged transferee.  State law controls whether or not the transferee is the recipient of a fraudulent transfer.  Commissioner v. Stern, 357 U.S. 39 (1958).

New York Debtor Creditor Law §§272 and 276 address constructive and actual fraud, respectively.  Constructive fraud results when a transferor is insolvent and makes a conveyance for less than fair consideration, or makes a transfer for less than fair consideration that renders him/herself insolvent.  Actual fraud results when a transferor conveys property with the intent to hinder, delay or defraud creditor(s).  Badges of actual fraud include, but are not limited to, lack of consideration, less than arms length transaction and knowledge of liability.
The IRS has one year after the expiration of the applicable statute of limitations against the taxpayer to administratively assess transferee liability.  IRC §6901(c).  

If there are successive transfers, the statute of limitations against a transferee of a transferee is one year after the expiration of the statute against the preceding transferee, to a maximum of three years after the expiration of the assessment period of the initial transferor (the taxpayer).  If the taxpayer’s assessment period is tolled (i.e., failure to file, fraud or voluntary extension), the corresponding period against the transferee is also tolled. 

Administrative Collection Against

Property Titled to Third Parties

Nominee Lien
Where it can be shown that property is nominally held by one other than the taxpayer and that true ownership belongs to the taxpayer, administrative collection action against such property is authorized.  Al-Kim, Inc. vs. U.S., 610 F2d 576 (9th Cir. 1979).



Transferee
As with an assessment pursuant to IRC §6901 where the IRS can show that a transfer was fraudulent under state law, the Service can pursue administrative collection against such property.

Alter Ego
Where an entity holding property is deemed the “alter ego” of the taxpayer, the Service can pursue administrative collection against such property.  G.M. Leasing Corp. vs. U.S., 429 U.S. 338 (1977).  Alter ego usually involves a corporate entity that is disregarded as a sham.

Suit for Fraudulent Conveyance


IRC §7401 grants authority for the United States Department of Justice to commence a court action for the collection of taxes, if authorized by the Secretary.  This would include a suit for fraudulent conveyance, which is often utilized in lieu of administrative collection action against a transferee/nominee/alter ego.  The IRS prefers a judicial remedy because it provides the benefit of clear title, thereby maximizing the return upon sale.

Statute of Limitations


The IRS has one year after the expiration of the applicable statute of limitations for assessment of the taxpayer to administratively assess transferee liability.  IRC §6901( c).  Alternatively, the IRS can commence an action to impose transferee liability under state or federal fraudulent conveyance acts.  The IRS’s position is that statutes of limitations under state law do not apply to the Service with respect to such action.  Thus, the IRS’s position is that the Department of Justice can commence such an action anytime within the 10-year collection period (including any extensions) provided for in §6502.



CHAPTER ELEVEN
DEFENSES TO COLLECTION

Initial Client Interview

The following information should be obtained from the client during the first contact:


Full name of taxpayer and spouse, if spouse is involved in the collection action.
Social security numbers and employer identification numbers.
Current address and phone numbers.
Type of tax and relevant tax return forms for the taxes at issue.
Years or periods.

A power of attorney (Form 2848) should be completed and signed by the taxpayer and representative as soon as possible.  The client should also complete the appropriate financial questionnaires.  If the client is an individual, the client should complete a Form 433-A.  If the client is a business, it should complete a Form 433-B.  A determination of the stage of the collection action must be made immediately to determine the appropriate course of action.

Additionally, at the beginning of every collection case, the practitioner should first consider if the liability can be eliminated because the assessment was defective, untimely, or the period for administrative collection has expired.  To do this, the practitioner should first determine the tax return date, filing date, method of assessment, and assessment date.  The practitioner can request a transcript of account from the Tax Practitioner Priority Hotline or the Service Center.  The transcript will contain the needed information.  If it appears that the assessment was invalid or improperly made, prepare a letter memorandum fully outlining the facts and law to support your conclusion.  If dealing with ACS or the Service Center, submit the memorandum with a Form 911 (Request for Taxpayer Assistance Order) to the Taxpayer Advocate’s Office.  If the collection matter is already in the field and assigned to a revenue officer, send the memorandum to the Revenue Officer or contact person with a request that the assessment be abated immediately.  Your memorandum will be sent to the Special Procedures Branch for evaluation and, if necessary, to the IRS Office of Chief Counsel's Office for a legal opinion or review.  If the Service agrees with your position, the assessment will be abated.  If the Service disagrees with your position, consider a claim for refund or offer in compromise based on doubt as to liability.

ANALYSIS OF TAXPAYER’S FINANCIAL CONDITION

IRM §5323 contains the detailed policy considerations of the IRS when analyzing a taxpayer’s financial condition.  Expenses are divided into two categories: necessary and conditional.  Necessary expenses are defined as those that are necessary to provide for the health and welfare of the taxpayer or family, or necessary for the production of income.  There are three types of necessary expenses: national standards, local standards, and other.




National Standards

National standards are established standards for reasonable amounts of five necessary expenses: food, housekeeping supplies, payroll and services, personal care products and services, and miscellaneous.  They are stratified by income so that as income levels increase, the percentage of income provided for those expenses decreases. 

Local Standards
Two necessary expenses will be determined by local standards.  These two expenses are housing (including utilities) and transportation (including car insurance and public transportation).  Local standards for housing and transportation have been developed with the assistance of the National Office Research and Analysis function and the District Office Research and Analysis sites.  The allowable amount will be the lesser of the local standard or the amount actually paid by the taxpayer.  

Other 
Other necessary expenses are those expenses which are not included in the national and local standards, but are nonetheless usually considered to be necessary.  These other expenses are taxes, health care, court ordered payments, involuntary deductions, accounting and legal fees for representing a taxpayer before the Internal Revenue Service, and secured or legally perfected debts.  (Only minimum payments will be allowable for expenses related to secured or legally perfected debts.)  Accounting and legal fees, other than those for representing a taxpayer before the Service, may be allowable necessary expenses if they meet the necessary expense test of health and welfare and/or production of income.

Depending upon individual circumstances, additional expenses may meet the necessary expense test including, but not limited to, child care, dependent care (elderly, invalid, or disabled), life insurance, charitable deductions, education, disability insurance for a self-employed individual, union dues, professional association dues, and optional telephone services (call waiting, caller identification, etc.) or long distance calls.  Donations to charitable organizations will only be allowed as necessary expenses if they provide for the health and welfare of a taxpayer or family, or are a condition of employment.  For an education expense to be a necessary expense, the taxpayer must be able to demonstrate (1) that the education is for a physically or mentally handicapped dependent and (2) that such education is not otherwise provided by public schools, or that the education is a condition of employment.
Payments on unsecured debts may also be necessary expenses.  If the taxpayer can demonstrate that payments on unsecured debts meet the necessary expense test, minimum payments should be allowed.  However, except for payments required for the production of income, payments on unsecured debts will not be allowed if the tax liability, including projected accruals, can be paid in full within 90 days.




Conditional Expenses

Conditional expenses are those that are not required to provide for the health and welfare of the taxpayer or family, or for the production of income.  Conditional expenses will be allowed if the taxpayer can establish that he/she can remain current in all future tax payments and can pay the outstanding tax liability, including projected accruals, within three years.

Installment Agreements

Installment agreements will be granted if the taxpayer has made a full disclosure of all relevant financial information and has made reasonable efforts to liquidate and pay over non-essential assets, such as bank accounts, stocks, and luxury personal property items. Additionally, the taxpayer must be current for at least one taxable period, or can show that no further tax liabilities will accrue during the current or any future taxable periods.

An installment agreement can be set up to reflect changes in payments during the agreement period based on expected increases or decreases in allowable expenses.  The collection agent should also consider substantiated and justified expenses which will be incurred within the time frame of the installment agreement.  These possible expenses include, but are not limited to, the birth of a child, the necessary replacement of a vehicle or major appliance, or necessary home maintenance such as roof repair.  Lastly, if the taxpayer has previously defaulted on a past installment payment agreement, the collection agent is required to document his or her reasons for approving another installment payment agreement, and obtain group manager approval.  Thus, the taxpayer must be able to demonstrate good cause for his/her past default and the absence of a potential default in the future.
Two special rules apply to the analysis of a taxpayer’s finances when requesting an installment payment agreement.  They are the Three Year Rule and the One Year Rule.

If the taxpayer establishes entitlement to conditional expenses by demonstrating that he/she can remain current and fully pay the outstanding liability within three years, all expenses may be allowed.  This is the three year rule for full payment.  However, although three years are allowed, agreements should always be based on the taxpayer’s maximum ability to pay.  Therefore, the three year rule is a maximum, not automatic, term for an installment payment agreement.  Lastly, if the taxpayer incurred excessive necessary and not allowable conditional expenses after the assessment of the tax liability, these expenses are not covered by the three year rule.  

The one year rule for eliminating excessive necessary and not allowable conditional expenses is contained in IRM §5323.5.  This rule provides that taxpayers who cannot fully pay their accounts within three years may be given up to one year to modify or eliminate excessive necessary and/or not allowed conditional expenses.  With the modification or elimination of some conditional expenses, a taxpayer may be able to fully pay a liability within the three year limit, thus enabling the taxpayer to retain some conditional expenses.  
An installment payment agreement must include a payment increase at the date a taxpayer is expected to have modified or eliminated excessive necessary or not allowable conditional expenses.  The Service has stated that the taxpayer is responsible for determining how best to adjust or eliminate excessive necessary and/or not allowable conditional expenses, but at the expiration of one year, the Service will expect an amount equal to the amount of the excessive or disallowed expenses.  
Default or Termination of an Installment Payment Agreement
The IRS must notify taxpayers 30 days before altering, modifying, or terminating any installment agreement for any reason unless the collection of tax is determined to be in jeopardy. The IRS must include in the notification an explanation of why the IRS intends to take this action. (TPBR2 §201. IRC §6159).  The taxpayer then has the right to file an appeal of the IRS alteration or termination within 30 days of the notice.
The IRS may not levy on property of the taxpayer (1) with a pending installment agreement; (2) during the 30 days following the rejection of the taxpayer’s request for an installment agreement; (3) during any time the rejection of such agreement is being appealed; (4) during any period during which such agreement is in effect; (5) during the 30 days after the termination of the agreement; and (6) while such termination is being appealed.
Additionally, taxpayers with individual income tax liabilities that do not exceed $10,000.00 (exclusive of penalties, interest and additions to tax), who have not failed to file a return, or failed to pay a tax shown on a return, or entered into another installment agreement with the preceding 5 taxable years, are entitled to an installment agreement, if the Service determines that the taxpayer is financially unable to fully pay the tax liability when due, but the tax liability is paid within 3 years (arguably regardless of the other collection options available, although this is not specifically detailed in the statute).
Offer in Compromise

The IRS has the authority to settle a tax debt pursuant to an offer in compromise. IRS regulations provide for three types of offers: 
Doubt as to Collectibility. (The taxpayer is unable to pay the full amount of the tax liability and it is doubtful that the tax, interest, and penalties can be collected).
Doubt as to Liability. (There is doubt as to the validity of the actual tax liability).
Effective Tax Administration. (The Taxpayer has sufficient assets and/or income to pay the outstanding liability, but there are extenuating circumstances as to why he/she should not pay).

If the taxpayer can raise the funds to pay his, her, or its net asset and income value, an offer in compromise is a viable solution.  Thus, when an analysis of a taxpayer’s financial condition shows that the liquidation of all assets and payments under an installment payment agreement will not result in full payment, an offer in compromise should be considered and discussed with the taxpayer. 

The most common offer is based on Doubt as to Collectibility.  This type of offer is comprised of two components: the quick sale value of the taxpayer’s assets, and the present value of a five year payment agreement between the Internal Revenue Service and the taxpayer.  When computing the future income component of an offer, the Service allows only necessary expenses.  

Offers for liabilities exceeding $50,000.00 can only be accepted if the reasons for the acceptance are documented in detail and supported by an opinion of the IRS Chief Counsel.  

The second type of Offer in Compromise is based on Doubt as to Liability.  A doubt as to liability offer does not involve a financial review of the taxpayer’s circumstances.  Rather, it is based on the merits of the tax liability.  A doubt as to liability offer is a good alternative to paying the tax and making a claim for refund where the taxpayer has missed his/her prepayment litigation opportunity to litigate in Tax Court or where no Tax Court jurisdiction exists (for example, the trust fund recovery penalty where the taxpayer failed to exercise appeal rights).  

A taxpayer can submit an offer in compromise based on Effective Tax Administration.  This offer was added by the IRS Restructuring and Reform Act of 1998 and allows the Service to compromise a tax liability where the taxpayer has sufficient assets to full pay the liability but where collection of the liability in full will create an economic hardship or affect voluntary compliance. IRM 5.8.11.2.  Additionally, before an effective tax administration offer can be accepted, the taxpayer must demonstrate that exceptional circumstances exist that warrant acceptance of the offer even though the taxpayer has sufficient assets to full pay. Exception circumstances include, but are not limited to, a long term illness or disability, inability to pay for basic living expenses if assets are liquidated to pay the tax liability, and adverse effects if forced collection of assets occurred.

If the IRS rejects an Offer in Compromise, the taxpayer has 30 days to file an appeal to the Appeals Division.

Finally, on May 17, 2006, President Bush signed into law the Tax Increase Prevention and Reconciliation Act of 2005.  Section 509 of this law created significant changes to the Internal Revenue Service’s Offer in Compromise program by amending IRC §7122. 

The most significant change resulting from this new legislation is the requirement that a taxpayer make a 20% nonrefundable deposit with the submission of any cash Offer in Compromise based on Doubt as to Collectibility.  This 20% nonrefundable deposit is due in addition to the $150 processing fee.  A cash offer will be paid in installments of 5 or less.
If a taxpayer submits an Offer in Compromise which will be paid in periodic installments of six or more, instead of a 20% deposit, the taxpayer must begin making the periodic installment payments with the submission of the offer and continue making the installment payments throughout the processing and evaluation of the Offer in Compromise.  
In addition to Doubt as to Liability offers, low income taxpayers submitting offers based on Doubt as to Collectibility are also exempt from both the deposit requirement and the $150 application fee.  Low income taxpayers are individuals whose income falls at or below poverty levels based on guidelines established by the U.S. Department of Health and Human Services.

This new legislation is expected to have a dramatic impact on the submission of Offers in Compromise.  In particular, Offers in Compromise based on Doubt as to Collectibility are often paid, when accepted, from borrowed funds.  However, the individual or institution loaning the funds feels comfortable in doing so because the funds are paid to the taxpayer only after an Offer in Compromise has been accepted.  In this regard, the individual or institution can feel somewhat comfortable that the Internal Revenue Service is out of the picture.
The one concession allowed by the Internal Revenue Service in this regard is that the payment is considered to be a voluntary payment and as such the taxpayer can designate the application of the 20% lump sum deposit or installment payments, if an Offer in Compromise is ultimately not accepted. 

If an Offer in Compromise is not accepted, the taxpayer should always consider making a designation, as the designation could still be useful to the taxpayer.  For example, if the type of tax in issue is an income tax liability which includes years that could be dischargeable in a bankruptcy and years that could not be dischargeable in a bankruptcy, the taxpayer should consider designating the payment to the priority taxes that would not be discharged.  A second possibility is an employment tax liability, which includes both trust fund tax and non-trust tax penalty and interest.  The designation of a deposit or periodic payments to trust fund tax may be a great benefit to a potentially responsible officer.

Also see Outline for Offers in Compromise below:




Outline for Offers in Compromise

INTRO TO OFFERS IN COMPROMISE

The Government, like other creditors, encounters situations where an account receivable cannot be collected in full or there is a legitimate dispute as to what is owed.  It is an accepted business practice to resolve these issues through negotiation and compromise.  The Internal Revenue Service, with the permission of Congress, has accepted this business practice with the creation and implementation of its Offer in Compromise program.

The Offer in Compromise program includes four types of offers.

Doubt as to Liability.

Effective Tax Administration.

Doubt as to Collectibility.

Doubt as to Collectibility with Special Circumstances

DOUBT AS TO LIABILITY OFFER

In a situation where the taxpayer can establish real doubt as to the assessed tax liability, the taxpayer should consider submitting an Offer in Compromise based on Doubt as to Liability.  Offers submitted based solely on Doubt as to Liability do not involve an evaluation of the taxpayer’s financial circumstances.  Rather, the Doubt as to Liability offer is based on the substantive law that applies to the particular facts.

The Doubt as to Liability offer is most useful in circumstances where the taxpayer has missed his or her opportunity to challenge the assessed tax liability.  For example, if the Internal Revenue Service issued a 60 day letter proposing a trust fund recovery penalty against a potentially responsible officer of a corporation and the potentially responsible officer failed to appeal the trust fund recovery penalty, if the taxpayer can argue that he or she should not be held liable, a Doubt as to Liability offer can be submitted.

An additional circumstance where an Offer in Compromise based on Doubt as to Liability may be useful is where the Internal Revenue Service issued a Notice of Deficiency (90 day letter) and the taxpayer failed to timely petition the Tax Court.  In that circumstance, if the taxpayer can establish that the 6020B return prepared by the Internal Revenue Service is incorrect, a Doubt as to Liability offer may be appropriate.

Doubt as to Liability offers are reviewed by the Exam function of the Internal Revenue Service. 

OFFER IN COMPROMISE BASED ON EFFECTIVE TAX ADMINISTRATION

RRA 98 added §7122(c) of the Internal Revenue Code which provides that the Service shall set forth guidelines for determining when an Offer in Compromise should be accepted.  Items that must be considered by the Internal Revenue Service include:

Hardship

Public policy

Equity


Effective Tax Administration offers are appropriate where the tax is legally owed and the taxpayer has the ability to full pay, however, the taxpayer can establish that, nevertheless, there is a very good reason why the taxpayer should not be forced to full pay.

Effective Tax Administration offers can only be considered where the Service has determined that the taxpayer does not qualify for consideration under Doubt as to Liability or Doubt as to Collectibility.  Unlike Doubt as to Liability offers, any offer submitted based on Effective Tax Administration does involve a review and evaluation of the taxpayer’s financial circumstances.

Factors taken into consideration by the Internal Revenue Service that impact the taxpayer’s financial condition include:

The taxpayer’s ability to provide for basic living expenses;

A taxpayer’s age and employment status;

The number, age and health of the taxpayer’s dependents;

The cost of living in the area in which the taxpayer resides and any extraordinary circumstances such as special education expenses;

Medical catastrophe, natural disaster, etc. that apply to the taxpayer.

Factors that support an economic hardship determination may include:

Taxpayer is not capable of earning a living because of a long term illness, medical condition or disability and it is reasonably forcible that the financial resources will be exhausted providing for care and support during the course of the condition.

Taxpayer may have a set monthly income and no other means of support and the income is exhausted each month in providing for the care of dependents.

Taxpayer has assets, but is unable to borrow against the equity in those assets and liquidation to pay the outstanding tax liabilities would render the taxpayer unable to meet basic living expenses.

The Internal Revenue Manual contains examples of situations that would qualify for an Effective Tax Administration offer.  One such example is as follows:

Taxpayer is retired and the only income is from a pension.  The only asset is a retirement account, but the funds in the account are sufficient to satisfy the tax liability.  However, liquidation of the retirement account will leave the taxpayer without adequate means to provide for basic living expenses.  The taxpayer’s overall compliance history does not weigh against compromise.

DOUBT AS TO COLLECTIBILITY OFFER WITH SPECIAL CIRCUMSTANCES

A little known type of Offer in Compromise that pre-dates RRA 98 is Doubt as to Collectibility with “Special Circumstances”.  This type of offer is appropriate where the taxpayer’s assets are in excess of the amount offered, but less than the outstanding tax liability.  Keep in mind, an Effective Tax Administration offer is an offer where the taxpayer has sufficient assets to full pay, but there is a very good reason why he or she should not.  The Doubt as to Collectibility offer with Special Circumstances is a situation where the taxpayer does not have sufficient assets to full pay, but does have assets in excess of the amount offered.

When evaluating a Doubt as to Collectibility offer with Special Circumstances, the Internal Revenue Service will determine its reasonable collection potential and the taxpayer must then establish the circumstances forming the basis of the “special circumstances”. In essence, the taxpayer must explain why he or she is not offering the full reasonable collection potential.  Factors similar to those listed above under Effective Tax Administration are those that can be used by a taxpayer to establish “special circumstances”.

DOUBT AS TO COLLECTIBILITY

The quick sale value of the taxpayer’s equity in assets plus the present value of a future installment payment agreement between the taxpayer and the Service equals minimum amount needed to Offer.  
Assets


The Service looks at all of the assets belonging to  the taxpayer.


Assets are reported on the Form 433-A Collection  Information Statement for Individuals, and where  applicable, the 433-B Collection Information  Statement for Businesses.  Some assets, such as  cash, bank accounts and IRA’s are valued at 100%.


Retirement accounts such as an IRA or 401(k), are    not exempt from collection by the IRS and as such    must be included in the offer computation.      However, the Service will allow credit for the tax    consequences of the dissipation of pre-taxed funds    including the early withdrawal penalty if the     retirement account is going to be liquidated to fund    the offer if accepted.


Quick Sale Value.  Non-cash items, such as a    house, car, etc., are discounted by 20% since the    IRS realizes that they will not obtain full value if they   force the sale of the asset.  Therefore, 80% of the    fair market value, minus any senior encumbrance is   used to determine the taxpayer’s equity in the asset   for purposes of the offer analysis.

PVFIPA

Information for the income portion of the analysis is taken off of the last page of the Form 433-A.

The left column consists of the client’s gross income.

The right column consists of the allowable expenses under the IRS guidelines.


Expenses

Two categories of expenses; necessary and conditional.  Only necessary expenses are allowed when evaluating an offer in compromise.  No conditional expenses are allowed.

Three types of necessary expenses; national, local and other.

National expenses are food, clothing, personal care products and miscellaneous expenses.  The amount for the national expense is the same across the nation and requires no substantiation to claim it.

Local expenses differ depending on taxpayer’s residence.  Local expenses are for transportation and housing, and although these amounts are also standardized, unlike the National expense, the taxpayer only receives the allowable amount or the actual amount spent on these items, whichever is less.

Other Expenses.  The third type of necessary expense is referred to as “other” because it consists of all of the other expenses that are necessary for the health and welfare of the taxpayer or his or her family or for the generation of income.  Other expenses include medical expenses, taxes, life insurance, child care and court-ordered payments.  The taxpayer must substantiate all “other” expenses, but there are no pre-set caps on the amounts.


Disposable Income.

Allowable expenses subtracted from the taxpayer’s gross income equals “disposable income.” 



Calculation of PVFIPA.

The disposable income is multiplied by a present value factor of 48.  

Calculation of Minimum Offer.

The PVFIPA is then added to the quick sale value of all assets and this is the minimum amount that must be offered to compromise the liability.

Other than the level of review (acceptance of offers for liabilities in excess of $50,000 require approval by the Office of Chief Counsel), the amount of the liability is irrelevant.

Advertisements that make blanket statements that tax liabilities can be settled for “pennies on the dollar,” are therefore often misleading.  Although the calculation may often result in a compromise that is “pennies on the dollar,” as demonstrated above it is more a coincidental evaluation after the fact than a function or part of the process.

PAYMENT OPTIONS

There are three payment options for accepted offers in compromise.  

Cash Offers.


Cash offers must be paid within 90 days from the    date of written acceptance of the offer.

Deferred Cash Offers.


Deferred cash offers must be paid within 24 months   of written acceptance of the offer.


However, if the taxpayer selects the deferred cash    offer, the cost of the offer will increase if the     disposable income.


Disposable income must be multiplied by a factor of   60 instead of 48 for the deferred cash offer.  The    rationale behind this is that use of the factor of 48 is   based on the present value of money.  Where the    Service will not immediately receive all of the     offered amount, the taxpayer should not receive the   benefit arising from the present value  discount.     Still, for taxpayers who cannot come up with a lump   sum and or for taxpayer’s whose offers are     comprised of assets only, the deferred cash offer    may make a great deal of sense, and the payments    divided over 24 months are made to the Service    without the accrual of any interest.

Life of the Statute.


The third payment option is payments over the life    of the remaining collection statute.


Normally, the IRS has ten years to collect a tax    after assessment.


Depending on the amount of time that remains for    collection by the Service, this option could be a    worse or better deal than the cash option.

CHANGES TO THE OFFER IN COMPROMISE PROGRAM IN THE LAST YEAR

Continued Trend of Centralization.

The local Offer Review Unit in Buffalo was one of the last in the country to be disbanded (this occurred last summer).  All Offers in Compromise are now submitted through a Central Processing Unit.  Depending where the taxpayer resides, the Offer is either sent to Brookhaven or Memphis.

If the Offer in Compromise involves an evaluation of collectibility, the offer is worked at the Centralized Offer Unit.  If an Offer in Compromise is submitted based solely on Doubt as to Liability, after processing, the offer is forwarded to the Exam Function.

The vast majority of offers submitted are based on Doubt as to Collectibility.

The more centralized the program has become, the more standardized the rules have become for reviewing the taxpayer’s financial circumstances.  Since no two families or two lives are alike, the rules and standards when applied straight across the board without any discretion sometimes result in a rejection of the offer that in the past the matter would have been settled with a local reviewer.  

Some offers work well for the Centralized Processing sites.  “Cookie cutter offers” with no unique circumstances with process fairly quickly and will most likely accepted.

Another type of offer that occasionally works well at the Central Processing Units is an offer that is extremely complex.  However, the complex offer can go one of two ways. Sometimes a complex offer is accepted because the complexity and nuances of the case are missed by the inexperienced reviewer.  Sometimes, however, the reviewer has just enough knowledge and experience to be dangerous.  In this case the reviewer often spot an issue but does not have discretion to exercise judgment (and/or is too lazy to do so) and simply rejects the offer so he/she doesn’t have to actually make a decision.

An additional drawback to the central processing of offers is that there is no ability to have a face to face conference unless the offer is rejected and the case is forwarded to Appeals.  A taxpayer has 30 days to Appeal a rejected Offer in Compromise.   However, even the appeals of rejected offers are moving more towards centralization.


Retirement of Debt Rule

A recent development in relation to review of Offers in Compromise based on Doubt as to Collectibility involves the retirement of debt rule.  The retirement of debt rule provides that in a circumstance where debt will be retired during the remaining statute of limitations on collection, the reviewer must then re-evaluate the taxpayer’s financial circumstances to determine if the retirement of debt would result in a full pay of the outstanding tax liability over the life of the statute.

If the retirement of debt would result in full pay of the tax liability, the Internal Revenue Service will reject the Offer in Compromise.  However, if a re-evaluation of the taxpayer’s financial circumstances demonstrate that even with the retirement of debt the taxpayer could not full pay the outstanding tax liability over the remaining life of the statute, then the retirement of debt rile does not apply and an Offer in Compromise based on Doubt as to Collectibility can be accepted.

This rule is bizarre in its practical application because it actually favors the more irresponsible taxpayer who has a larger liability.  For example, if a taxpayer owes $50,000 and if under normal Doubt as to Collectibility rules he or she is a candidate for an Offer in Compromise, but applying the retirement of debt rule demonstrates the taxpayer’s ability to full pay $50,000 over the remaining life of the statute, the taxpayer will not be entitled to an Offer in Compromise based on Doubt as to Collectibility.  Compare this to taxpayer #2 who is identical in every respect except that he owes $500,000.  If the retirement of debt analysis would result in the ability to pay more than the amount offered, but not result in a full pay, the fact that the taxpayer could pay more than the amount offered over the life of the statute is irrelevant and the original amount offered will be deemed acceptable.

It is important for practitioners to understand the application of this rule, as even some IRS personnel are not clear on its application.  As stated above, the retirement of debt rule is only relevant where a re-evaluation of the taxpayer’s circumstances would result in a full pay of the tax liability over the life of the statute.  If this re-evaluation would not result in a full pay, the retirement of debt rule is not applicable and the fact that the retirement of debt rule could result in payment of more than the amount offered, but less than the amount due, is irrelevant.  


Changes as a Result of the Tax Increase Prevention and Reconciliation Act of 2005.

On May 17, 2006, President Bush signed into law the Tax Increase Prevention and Reconciliation Act of 2005.  Section 509 of this law created significant changes to the Internal Revenue Service’s Offer in Compromise program by amending IRC §7122.

The most significant change resulting from this legislation is the requirement that a taxpayer make a 20% nonrefundable deposit with the submission of any cash Offer in Compromise based on Doubt as to Collectibility.  This 20% nonrefundable deposit is due in addition to the $150 processing fee.  A cash offer will be paid in installments of 5 or less.

If a taxpayer submits an Offer in Compromise which will be paid in periodic installments of six or more, instead of a 20% deposit, the taxpayer must begin making the periodic installment payments with the submission of the offer and continue making the installment payments throughout the processing and evaluation of the Offer in Compromise.

In addition to Doubt as to Liability offers, low income taxpayers submitting offers based on Doubt as to Collectibility are also exempt from both the deposit requirement and the $150 application fee.  Low income taxpayers are individuals whose income falls at or below poverty levels based on guidelines established by the U.S. Department of Health and Human Services.

This legislation has had an impact on the submission of large (significant) Offers in Compromise.  Since the 20% deposit or periodic installment payments are not refunded even if an offer is ultimately rejected, a large number of lending sources are no longer available to taxpayers.  Individuals or lending institutions that would have previously loaned the funds once an offer was accepted (knowing the IRS will soon be out of the picture) are unwilling to loan the deposit amount since there is no assurance of acceptance at the beginning of the process.

The one concession allowed by the Internal Revenue Service is that the payment is considered to be a voluntary payment and as such the taxpayer can designate the application of the 20% lump sum deposit or installment payments, if an Offer in Compromise is ultimately not accepted.  The designation, however, must be made at the time of the deposit.

If an Offer in Compromise is not accepted, the taxpayer should always consider making a designation, as the designation could still be useful to the taxpayer.  For example, if the type of tax in issue is an income tax liability which includes years that could be dischargeable in a bankruptcy and years that could not be dischargeable in a bankruptcy, the taxpayer should consider designating the payment to the priority taxes that would not be discharged.  A second possibility is an employment tax liability, which includes both trust fund tax and non-trust tax penalty and interest.  The designation of a deposit or periodic payments to trust fund tax may be a great benefit to a potentially responsible officer.

SUMMARY

A.  Strategies.

Legally maximizing the allowable expenses is important.

2. Adequately documenting expenses such as child dependent care and health care is very important since these expenses are not capped.   
3. It is important to know the rules for dischargeability of taxes in bankruptcy since the Internal Revenue Manual allows the IRS to consider whether the taxes could be discharged in a bankruptcy when evaluating the acceptability of an offer  

B. Signed Under Penalty of Perjury.

Concealment of assets or income is a felony.

The 433-A and 656 Offer in Compromise forms are submitted under penalty of perjury and inaccuracies can be extremely problematic for taxpayers as well as practitioners.

The client who is not willing to be totally forthcoming in relation to their assets and income, is not worth having as a client.

The IRS has and will continue to prosecute cases where false statements have been made in relation to an offer in compromise.


EXAMPLE ONE

Client owes $180,000 of federal tax.  The taxpayer’s assets are as follows:

House fair market value – $150,000

Mortgage –   $120,000

IRA  –       $    5,000

Cash –      $    5,000

Old car –    $       500

In addition to the above, the taxpayer’s monthly income and expenses are as follows:

Monthly income –     $3,750

Monthly expenses:

Food, clothing and miscellaneous –  $   621

Housing and utilities –   $1,137

Transportation –     $   393

Health care –    $   300

Taxes –      $   750

Life insurance –    $   100

Total living expenses –    $3,301

The above example with no planning would result in a required minimum offer of $31,952.  This is because the house would be included at:

Quick sale value of $150,000 equals $120,000-$150,000 X 80%
= $120,000 - $120,000 mortgage = 0.

$5,000 IRA

$5,000 cash

$500 car (quick sale value of car = $400) = $10,400.

After evaluating the quick sale value of assets, you must evaluate the present value of a future installment payment agreement.  Subtracting the allowable monthly expenses from the gross monthly income, the disposable income is $449.  If you multiply this figure by a present value factor of 48, the value of the income stream (the present value of a future installment payment agreement) is $21,552.

If you add the equity in assets ($10,400) to the present value of a future installment payment agreement ($21,552), you arrive at the reasonable collection potential of $31,952.  This means that the minimum offer to the Internal Revenue Service must be $31,952 regardless of the amount actually owed by the taxpayer to the Internal Revenue Service.

VII.      EXAMPLE TWO

What are fully appropriate and legal planning strategies that can assist the taxpayer in submitting a lower, but legally acceptable, offer?  First, the taxpayer has to pay attorneys fees for the offer.  $5,000 cash can pay the fees and 20% deposit.

Second, the taxpayer has an old car.  Obviously, to continue to generate income, the taxpayer must have a reliable car.  The taxpayer should consider financing or leasing a new vehicle.  The taxpayer should consider using the funds from the IRA, the trade-in value of the old car, and the cash to make a down payment on the vehicle.  So long as the down payment does not exceed 20% of equity, the use of those funds is protected.

The car payment for a first car can be up to $471 per month.

Re-evaluating the reasonable collection potential of the taxpayer, equity in the house is still zero, but now the taxpayer no longer has the $5,000 IRA, the $5,000 in cash, or the $400 for the old car.  As such, the taxpayer’s equity in assets equals zero.

Looking at the present value of a future installment payment agreement, the taxpayer has added a monthly car payment of $471.  If we add this to the already existing allowable monthly expenses of $3,301, the taxpayer’s allowable monthly living expenses now total $3,772.  Since the taxpayer’s monthly income is only $3,750, the present value of a future installment payment agreement between the taxpayer and the Internal Revenue Service is now also zero.

The taxpayer cannot however submit an Offer in Compromise offering zero dollars.  As such, where the reasonable collection potential is zero, the taxpayer can submit an offer of $500 or $1,000, depending on the circumstances.  Even though the dollar figure is low, a practitioner must keep in mind that when the issue is Doubt as to Collectibility, the amount actually owed is irrelevant.  The issue is substantiation. So long as you can substantiate the reasonable collection potential, the submission of an offer, even for a low dollar amount, is not frivolous and should be processed and accepted.








Currently Non-Collectible Status

If the IRS is convinced that the taxpayer does not currently have the ability to pay the outstanding tax liability, then the account can be placed in a "53" status (taken from the Form 53 used to designate the account as currently uncollectible).  All collection action will be suspended.  However, interest and penalties continue to accrue, and the account will be reviewed periodically.  For liabilities which are close to expiration of the statute of limitations on collection, this may be the best solution.

Conditional expenses will not be allowed if a case is closed as currently not collectible.  However, if a taxpayer is able to modify his/her expenses within one year such that an installment payment agreement can be entered into at the expiration of that year, the case should not be closed as currently not collectible and the taxpayer should be given the appropriate time to make the modifications to his/her expenses. See IRM §5323.63. 
Payment of Tax and Filing of Claim for Refund to Dispute the Liability
If the taxpayer does not timely file a petition in the Tax Court, then the deficiency will be assessed and the IRS will proceed with collection.  See IRC §6213(c).  The taxpayer, however, can still pursue an administrative claim for refund after paying the assessed tax deficiency.  If the refund claim is denied, or if the IRS fails to act on the claim within 6 months, then an action for refund can be commenced in a federal district court or the United States Court of Claims pursuant to IRC §7422.   Pursuant to IRC §6511, a claim for refund must be filed within the later of three years from the date the return was filed or two years from the date the tax was paid.  
If a claim for refund relates to an overpayment of self-employment tax attributable to a Tax Court employment status proceeding under Code § 7436, and the claim would otherwise be prevented by operation of any law, such credit or refund may be allowed or made if a claim is filed on or before the last day of the second year after the calendar year in which the Tax Court decision becomes final.  This exception does not apply where the taxpayer previously compromised his/her tax liability for the same year(s) in issue in the litigation.  Lastly, if the taxpayer was unable to manage his or her financial affairs by reason of a medically determinable physical or mental impairment that can be expected to result in death or that lasts for a continuous period of not less than 12 months, the running of the statute of limitations for claiming refunds is suspended.

For divisible taxes, such as employment taxes or 100% penalty taxes, payment of the smallest allowable portion of the total tax liability, coupled with the filing of a claim for refund, will usually stop collection efforts on the unpaid portion of the tax until after the refund claim has been determined.

Taxpayer Assistance Orders (911)

Relief can be sought by making a request for a Taxpayer Assistance Order through the Taxpayer Advocate’s Office.  To obtain a TAO, the taxpayer has to show that he/she will suffer a significant hardship as a result of the Service’s administration of the tax laws.
The following must be considered by the Taxpayer Advocate in determining if there is a “significant hardship” and if a TAO should be issued:
Is there an immediate threat of adverse action?
Has there been a delay of more than 30 days in resolving the taxpayer’s account problems?
Will the taxpayer have to pay significant costs (including fees for representation) if relief is not granted?
Will the taxpayer suffer irreparable injury, or a long-term adverse impact if relief is not granted?

Additionally, if an IRS employee to whom the TAO would be issued is not following applicable published administrative guidance (including the IRM), the Taxpayer Advocate must construe the factors taken into account in determining whether to issue a TAO in the manner most favorable to the taxpayer, IRC §7811(a)(3).

Collection Due Process Appeal


Relief can also be obtained by filing a Collection Due Process Appeal. 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.  The notice must be personally delivered to the taxpayer, delivered to the taxpayer’s home or place or business, or sent to the taxpayer by registered or certified mail to the person’s last known address.  The notice must inform the taxpayer of the following:
1.  The amount of the unpaid tax.

2.  The person’s right to request a hearing during the 30-day period beginning on the sixth day after the lien is filed.

3.  The available administrative appeals and their procedures.

4.  Procedure for obtaining a release of lien.

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.  The taxpayer may also raise the validity of the underlying liability at the hearing if the taxpayer did not receive a notice of deficiency for the liability in issue or did not otherwise have an opportunity to dispute the liability.  The taxpayer should be prepared to argue any issue regarding the appropriateness of the Service’s actions, propose a less intrusive means of collection or raise any claim or defense to the collection action including a claim for innocent spouse status.  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.  If the taxpayer selects an incorrect forum, he/she has 30 days from notification of selection of an incorrect forum to file the appeal with the correct court.  The statute of limitations under §§§6502 (collection), 6531 (criminal) and 6532 (other suits) is suspended during the period during which the hearing and appeals thereto are pending.




CHAPTER TWELVE
BANKRUPTCY

COURSE HANDOUT
Types of Bankruptcy
Chapter 7, Chapter 11 and Chapter 13


I.  CHAPTER 7 – Requirements
Can be an individual or a corporation
There are no debt limits
Trustee is appointed to liquidate “non-exempt assets”
Goal - Discharge of pre-bankruptcy debt “fresh start” – (Note:  Priority taxes are not dischargeable)

II.  CHAPTER 13
Individuals only
Requires regular income to pay creditors through a plan, up to five years
Unsecured and secured debt limits - $307,675, $922,975 – See Bankruptcy Code §109
Debtor keeps assets
Priority taxes must be paid in full
Treatment of claims
Secured creditors – Must be paid in full with interest, if assets are kept.
Priority taxes and other priority claims paid in full (includes alimony, child support)
Unsecured creditors receive percentage on the dollar depending on Chapter 7 test and disposable income test
Chapter 7 test – Creditors must receive what they would get in the event that a debtor was liquidated
Disposable income test – Creditors must receive payments through the plan equal to excess monthly income.  (Debtor does a budget, much more lenient than IRS guidelines for an offer in compromise)

III. Chapter 11 – Reorganization
Can be a corporation or an individual
No debt limit
Very costly and complex – requires disclosure statement and plan
No trustee – DIP
Pay creditors through plan
Priority taxes must be paid in full

IV.  Creditors Rights 
Automatic stay prevents all collection
Creditor can file proof of claim listing type of claim, either secured, priority or unsecured

V.  Terms Applicable to all Bankruptcies

Exempt assets – §522 of the Bankruptcy Code provides that certain things can be exempt from creditors.  States are allowed to opt out and New York State has.  Under New York Exemption Law - a Homestead exemption of $10,000  -  $20,000 for a married couple.  $2,400 exemption in car.  IRA and ERISA qualified plans are also exempt.  *

*  Exemptions do not apply to IRS outside of bankruptcy.


Automatic stay prevents action by creditors
Estate - Means the assets of the debtor that are controlled by the trustee or the debtor in possession.  See §1398 of the Internal Revenue Code regarding impact on taxes