Federal Tax Audit: When Negotiation is Not Enough
Federal tax liabilities can come from numerous different sources. The federal tax system depends upon self-assessment and self-reporting of the various taxes that it administers including the income, employment, gift and estates taxes. This system requires accurate calculation, voluntary compliance, and reporting of the tax due by the taxpayer. The Internal Revenue Service (IRS) utilizes its authority to conduct audits to verify that taxpayers have properly reported how much taxes they have due. The system itself is balanced by the rights of the taxpayer to dispute the IRS’ findings both in the administrative system of the IRS and the federal courts. When dealing with federal tax audits, generally the best approach is to negotiate in order to complete all but the most difficult of audits. If the taxpayer disagrees with the proposed audit changes, and an agreement cannot be reached with both parties, there are several options available for protesting the initial outcome.
The taxpayer may file a protest with the IRS Appeals Division following the issuance of the auditor’s Form 950, Examination Report (the “30-Day Letter”) if they disagree with the auditor’s findings. If the proposed additional tax, additions to tax and penalties, proposed overassessment, or claimed refund, credit, or abatement for any tax period, does not exceed $50,000, a request for an appeal can be made using Appeal’s small case procedures. For the taxpayer, this would simply require a written request asking for an Appeals consideration. This states that the taxpayer does not agree with the changes giving their reasons for the disagreement. If, however, a case with a proposed deficiency exceeds $50,000, then it will require a formal written protest to the Appeals Division. Upon receipt of the formal protest, Appeals will review the protest and the case to determine several items including whether the case requires further development by the examiner, whether the examination report should be modified, whether the written protest includes the requested information, and whether the protest is adequate. If the taxpayer and the IRS are able to reach an agreement on the proposed adjustments at the Appeals Division, the case is closed. Otherwise, the taxpayer may decide to litigate the issue in one of the three available forums: U.S. Federal District Court, U.S. Tax Court, or the U.S. Court of Federal Claims.
If, after meeting with IRS Appeals, or the taxpayer does not seek Appeals consideration, the case remains unagreed, the IRS will then issue a statutory Notice of Deficiency or Notice of Determination. This is also known as a 90-day letter. The taxpayer has 90 days after the letter is issued (150 days if the notice is addressed to a person outside the United States) to file a petition with the Tax Court to contest the proposed deficiency. The Notice of Deficiency/Determination is important since it provides the taxpayer with the ability to contest the proposed deficiency in the Tax Court without having to prepay the tax and provides the Tax Court jurisdiction to redetermine the proposed deficiency. However, if prior to filing of their petition with the Tax Court the taxpayer did not pursue an administrative appeal with the IRS Appeals Division, the matter will be sent to the IRS Appeals Division who can consider a settlement of the case prior to the matter being docketed and placed on the Tax Court calendar. IRS Appeals will only review the case if the matter was not previously reviewed by Appeals. Hence, you only get one bite at the apple with IRS Appeals. If a taxpayer reaches an agreement with Appeals, the settlement is made by a stipulation of agreed deficiency or overpayment which is filed with the Tax Court. If the taxpayer is unable to reach a settlement with Appeals during the time allotted, Appeals will no longer make considerations and the Tax Court case will proceed forward.
The taxpayer is not required to pay the proposed deficiency until there is a final determination with regard to the proposed deficiency. However, the proposed deficiency will continue to accrue interest until it is paid. In order to stop the continued accrual of interest during the pendency of the appeal or Tax Court proceeding, the taxpayer can choose to make a deposit, including interest and penalties, of the proposed deficiency. To ensure that the payment is properly designated as a deposit in accordance with IRS procedures care must be taken.
It is strongly recommended that you engage tax counsel that has the necessary education, training and experience with tax litigation matters. The further you go in the tax appeals process, the more difficult it is for someone without legal tax litigation training and experience to properly plead on your behalf. Furthermore, as opportunities to resolve the matter are lost through lack of expertise in the process, the matter becomes more difficult to navigate as negotiation will no longer be enough to settle the dispute leaving your path forward unclear. The conclusion is simple and straight forward. Your best option to handle a federal tax audit is with a highly trained tax professional.