Alternative Dispute Resolution

The Internal Revenue Service Office of Appeals (IRS Appeals) recently announced that it will offer a new virtual “face-to-face” option in the form of web-based communication to taxpayers and representatives to resolve tax disputes. IRS Office of Appeals Pilots Virtual Service, IRS (July 24, 2017. This announcement comes on the heels of other changes at IRS Appeals that curtail the ability of taxpayers to have face-to-face hearings with IRS Appeals. The IRS cites the need for the new service because of IRS Appeals’ large (and growing) case load—more than 100,000 cases each year! For some our prior coverage on recent changes at IRS Appeals, see here, here, here and here.

Practice Point: In the wake of an ever-shrinking budget, resources and staff, the IRS really has no choice but to try new and arguably more efficient methods to move cases along. The backlog of cases at IRS Appeals is staggering, and our clients are experiencing long wait times until a case is even assigned to an IRS Appeals officer. Then when the case is assigned, it typically sits for months until real progress can be made. This is not the fault of the IRS or the individual Appeals’ officers, but really the reality of a resource-starved governmental agency. The virtual appeals conference is seemingly a good method to conduct an Appeals conference for simple cases. If a case is complex, however, a virtual conference may be no different (or no more effective) than a telephonic conference. In cases that require extensive explanation, it is hard to see how the IRS Appeals conference will be effectively conducted virtually. But “hope springs eternal.”

Today, the Internal Revenue Service (IRS) released Revenue Procedure 2017-25 extending the Fast Track Settlement (FTS) program to Small Business / Self Employed (SB/SE) taxpayers.  The IRS’s SB/SE group serves individuals filing Form 1040 (US Individual Income Tax Return), Schedules C, E, F or Form 2106 (Employee Business Expenses), and businesses with assets under $10 million.

FTS offers a customer-driven approach to resolving tax disputes at the earliest possible stage in the examination process. The program provides an independent IRS Appeals review of the dispute.  Under this approach, the IRS Appeals Officer acts as the mediator and has settlement authority.

The purpose of the program is to reduce the time to resolve cases and to provide the IRS Exam Team with the authority to settle cases based on hazards of litigation (which is generally reserved for IRS Appeals Officers).  FTS has been considered a great success by the IRS and many taxpayers.  The expansion of this successful alternative dispute resolution makes sense in light of the ever-shrinking resources of the IRS.

In its annual report to the US Congress, the Taxpayer Advocate Service (TAS) had a lot to say about IRS Appeals and the (lack of) use of other alternative dispute resolution (ADR) techniques. In this post, we will highlight what the TAS had to say in this area.

IRS Appeals

Undoubtedly, one of the Internal Revenue Service’s (IRS) most successful dispute resolution techniques has been IRS Appeals. Briefly, after the IRS’s Examination Division proposes a tax adjustment, taxpayers have the statutory right to seek an “appeal” of the decision. IRS Appeals is a separate and seemingly independent division of the IRS where one or more appeals officers review the redeterminations and adjustments made by the Examination Division, and attempt to settle the dispute directly with the taxpayer based upon a “hazards of litigation” analysis, much in the same manner as a judge would rule. The TAS acknowledged the success and utility of the IRS Appeals program and mission, but requested that Congress expand the program, giving the IRS the resources it needs to manifest the full intent of the program.

The TAS reported that funding for IRS Appeals has diminished sharply—by about 11 percent from 2013 to 2016, with staff reduced during the same period by 24 percent. In response to shrinking resources, but hobbled by the same duties and similar case load, IRS Appeals has been forced to implement procedures and policies that hamper its long-term mission of providing a fair and impartial review of the Examination Division’s adjustments. The TAS pointed out that these policies have resulted in (1) creating an inhospitable Appeals environment; (2) limiting in-person Appeals conferences; (3) reducing the Appeals officer’s ability to perform a quality substantive review; and (4) failing to protect the rights of taxpayers when conducting collection Appeals hearings. The TAS noted that there has been a large increase of cases docketed in the US Tax Court before seeking an IRS appeal. The TAS believes that docketing a case before it goes to Appeals has added inefficiency and unnecessarily increased the case load of the Tax Court.

The TAS suggested the following solutions:

  1. Expand the locations in which Appeals Officers hear matters. Presently, there are numerous states in which there are no IRS appeals officers. As a result, taxpayers who seek an appeal and request an in-person conference are forced to travel to the states in which an IRS appeals officer is located.
  2. Hold more in-person appeals conferences. The TAS report argues that in-person conferences facilitate the efficient and expeditious settlement of matters.
  3. Revise procedures and policies to allow IRS appeals officers additional discretion and time to undertake factual development and provide more substantive review of matters.

Practice point: We have recently reported about many of the issues facing taxpayers seeking review by IRS Appeals. The TAS confirms our critiques of the system. IRS Appeals is a very good and useful technique that has a high probability of settling cases. Generally, appeals officers are thoughtful and engaged; however, the lack of resources has put tremendous pressure on an already overworked and under supported system. It makes little sense that Congress would gut the revenue-collecting arm of the federal government. Practitioners and taxpayers alike would applaud the implementation of the recommendations in the TAS report. Indeed, many of the appeals officers themselves, overworked and stripped of their discretion, would likewise support these considerations.

ADR

There is no question that certain ADR programs produce substantial benefits for governments, and assist in the efficient resolution of controversy matters. The IRS has several ADR methods that it employs, for example fast track settlement and post appeals mediation.The TAS acknowledges the substantial benefits of the IRS’s ADR programs, but suggests that these programs need to be expanded and tweaked to fix real and perceived problems.

The IRS offers four types of ADR techniques: fast track settlement (FTS), fast track mediation for collection matters (FTM), post appeals mediation (PAM), and the rapid appeals process. The TAS reports that these ADR techniques accounted for only 306 cases in fiscal year 2017! Of these 306 cases, 251 were actually resolved through settlement. And the trend over the last three years has been a steady decline in ADR cases. TAS explains that one of the problems with the IRS’s ADR program is that it is only available if the IRS agrees to participate. Another cited problem is the perception among taxpayers that the process is rigged in favor of the IRS, as the presiding officers are IRS employees. When ADR is used in a commercial context, for example in collecting a debt, the facilitators are typically third-party neutral, professionals. In the IRS’s case, the ADR facilitators are IRS appeals officers who are not specifically dedicated to the ADR process, but have normal Appeals cases in addition to ADR cases.

In its report, the TAS makes several good suggestions, including the following points:

  1. Expand ADR. Make it more available, and remove the IRS’s discretion to resolve controversies through ADR. The TAS believes that ADR should be available to all taxpayers. Publicize and encourage taxpayers to engage in ADR with the IRS instead of following the traditional appeals path. In an effort to demonstrate the efficacy of the program, the IRS should maintain and publish statistics on its ADR program.
  2. Independent ADR specialists. The TAS suggests that the IRS have a team of professionals trained and dedicated to ADR. This would increase the public’s trust in the programs.

Practice point: In the last several years, the benefits of seeking resolution under the IRS’s ADR programs have been waning. From experience, the IRS seems to now give only lip service to these programs. The TAS’s suggestions are right on target. A team of dedicated and truly independent ADR professionals could have a profound effect on the system and the number of case both at the IRS and in the courts. The IRS should devote the resources necessary to make this vision a reality and embrace the techniques long used by businesses (think debt collection) and the courts. Indeed, in nearly every court system in the country litigants are required (or at least strongly encouraged) to engage in some sort of ADR prior to seeking redress before the court. If ADR is good enough for the courts, why hasn’t the IRS embraced this tried and tested dispute resolution technique?

On June 9, 2016, the US Tax Court released its opinion in Medtronic, Inc. and Consolidated Subsidiaries v. Commissioner. The Internal Revenue Service had taken issue with the transfer pricing of transactions between Medtronic, Inc. and its Puerto Rican manufacturing arm under §482 of the Internal Revenue Code. Finding the IRS’s application of the comparable profits method (CPM) to the transactions arbitrary and capricious, and taking issue as well with the taxpayer’s comparable uncontrolled transaction (CUT) methodology, the court ultimately made its own decision as to arm’s-length pricing, arriving at new allocations by making adjustments to the taxpayer’s original CUT approach.

Read the full Tax Management International Journal article.

© 2016 Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc.

In a letter dated November 4, 2016, IRS Chief of Appeals Kirsten Wielobob provided some clarification regarding the authority of the Appeals Team Case Leaders (ATCLs) to settle cases, revisions to IRM section 8.6.1.4.4 permitting other IRS employees to attend conferences, clarifications to conference practices, and revisions to how Appeals handles section 9100 relief determinations. After a month of speculation, of interest to most taxpayers and practitioners is the news that, although settlement authority will remain with the ATCLs, Appeals will revise its procedures to make it clear that an Appeals Manager must review a case prior to an ATCL finalizing a settlement. In an apparent attempt to thread the proverbial needle, the letter indicates that the Appeals Manager “will not be accepting or rejecting settlements,” but if the ATCL and Appeals manager “disagree about a settlement,” the next higher level manager supervising ATCL Operations will resolve any disagreement. Although this procedure is contemplated in IRM section 8.7.11.3.1  (03-16-2015), the letter suggests that there will in fact be a procedural shift. It remains to be seen whether, as some have feared, this will lead to increased delays in resolving cases.

Knowing your options for a US Federal tax controversy is helpful in creating a sound and efficient strategy. The attached chart depicts the typical options involved in a US Federal tax controversy, from the IRS’s examination of the return, through administrative appeals, litigation in Tax Court, Circuit Court appeal, and to ultimate assessment of tax.

Due to the enormous amount of electronic data stored by companies in the modern era, discovery requests can involve millions of documents which need to be reviewed prior to being turned over to the opposing party.  In conducting their analysis of this overwhelming quantity of information, litigants must, amongst other things, detect and exclude any privileged material.  Should a party inadvertently fail to do so before such records reach the hands of the opposing counsel, he/she will be deemed to waive privilege in many jurisdictions.  Given the massive quantity of data, however, such mistakes are practically unavoidable.

Federal Rule of Evidence (FRE) 502 was enacted in 2008 in an attempt to combat the issue of inevitable human error and the costs associated with parties’ efforts to avoid it.  FRE 502(d) allows parties to request the court to grant an order stipulating that a disclosure of privileged material does not waive any claims of privilege with respect to those documents.  If the court agrees to enter the order, it is controlling on third parties and in any other federal or state proceeding.

FRE 502(d) has led to the possibility of “quick peek” agreements where the parties give over all or a portion of their documents to opposing counsel without any privilege review whatsoever so that the recipient can identify which material he would like to retain.  The recipient, in turn, agrees not to assert a waiver claim on any document that the producing party intends to withhold from the requested documents as privileged.  These arrangements can dramatically ease the temporal and financial burdens of conducting a privilege review because they allow the producing party to focus only on those documents desired by the recipient while at the same time preserving their right to claim privilege on such documents. Continue Reading Two Current Tax Controversies Utilize ‘Quick Peek’ Agreements to Resolve Privilege Disputes

On March 23, 2016, the Internal Revenue Service (IRS) issued Rev. Proc. 2016-22, 2016-15 IRB 1, which clarifies and describes the practices for the administrative appeals process in cases docketed in the Tax Court.  The stated purpose of the revenue procedure is to facilitate effective utilization of appeals and to achieve earlier development and resolution of Tax Court cases.

Previously, the procedures for the appeals process of Tax Court cases was contained in Rev. Proc. 87-24, 1987-1 C.B. 720.  In October 2015, the IRS released a proposed revenue procedure updating the rules and requesting public comments.  Three substantive comments were received and considered by the IRS, resulting in changes to the proposed revenue procedure.  Rev. Proc. 2016-22 states that some of the suggestions that were not adopted may be addressed in other IRS guidance materials.

The general rule followed by the IRS is that all cases docketed in the Tax Court that have not previously been considered by IRS Appeals will be transferred to Appeals unless the taxpayer notifies IRS counsel that it wants to forego settlement consideration by Appeals.  This rule is subject to certain exceptions, most notably if the case has been designated for litigation by the IRS.  The revenue procedure also provides that “[i]n limited circumstances, a docketed case or issue will not be referred if Division Counsel or a higher level Counsel official determines that referral is not in the interest of sound tax administration.”  Although no definition is provided, examples are provided of: (1) a case involving a significant issue common to other cases in litigation for which the IRS maintains a consistent position; or (2) cases related to a case over which the Department of Justice has jurisdiction.  Referral to IRS Appeals will generally occur within 30 days of the case becoming at issue in the Tax Court, which can be either the date the Answer is filed by the IRS or a Reply (if required) is filed by the taxpayer.

The revenue procedure clarifies, and limits, the role of IRS counsel when a case is referred to Appeals.  Unlike Rev. Proc. 87-24, the new revenue procedure provides that Appeals has sole discretion to determine whether IRS counsel may participate in any settlement conference and will consider input from the taxpayer on this point.  It also clarifies that when a case is forwarded to Appeals for consideration, “Appeals has the sole authority to resolve the case through settlement until the case is returned to Counsel.”  In the past, taxpayers were concerned about the ability of IRS counsel to disrupt a settlement reached with Appeals.  If a settlement is reached with Appeals, IRS counsel’s involvement is ministerial in that counsel should only review any decision document signed by the taxpayer for accuracy and completeness before signing the decision document on behalf of the IRS and filing it with the Tax Court.

The new revenue procedure should also be a welcome development for estate tax cases given that there is no statutory provision to extend the three-year limitations period on assessment.  For this reason, estate tax cases frequently end up in Tax Court without a prior opportunity for the estate/executor to receive consideration by Appeals.  Given that almost all cases are settled at the Appeals level, the new revenue procedure should enhance the ability in estate tax cases to achieve settlement short of litigation with minimal IRS counsel involvement.

Overall, the new revenue procedure provides clarification on certain matters and gives more authority to Appeals when a case is referred to it.  It remains to be seen whether, as indicated in the revenue procedure, the IRS will adopt additional rules and provide further clarification in future IRS guidance materials.  Overall, the new rules should make settling a case that has not previously gone to Appeals more efficient after the case is docketed in Tax Court.

Recently, we published a Special Report in Tax Notes International, “Preparing for a Tsunami of International Tax Disputes.”  The article can be accessed here.  While there is near-universal agreement that the number of tax disputes is going to increase, existing international tax dispute resolution processes remain in serious need of improvement. A global consensus must be reached on a process for resolving worldwide tax disputes that appeals to all stakeholders. This article focuses on recent attempts by the Organisation for Economic Development (OECD), United Nations (UN) and international tax community to achieve such a consensus.

In short, the predictability of tax base results is a serious concern for countries and multi-national enterprises alike.  The only realistic solution is to design a dependable and independent treaty-based dispute resolution process that accommodates the needs of all stakeholders. A foundation for this process has been provided by the inclusion of arbitration in both the OECD and UN model income tax treaties and its successful implementation in a few countries. Arbitration and alternative dispute resolution (ADR) have already evolved successfully in nontax government and commercial contexts. As with any such evolution, there have been both positive and negative experiences for countries and private parties. In the realm of international taxation, the development of these processes is in the early stages. It is important for all stakeholders in the tax arena to explore ways of using experiences from non-tax contexts to develop processes that can relieve emerging pressures relating to international taxation. To distinguish the international tax context from others, the new dispute resolution process could be referred to as the International Taxation Dispute Resolution Process (ITDRP), as suggested in the UN Secretariat Paper on Alternative Dispute Resolution in Taxation released on October 8, 2015.

While the development of a successful ITDRP will inevitably take time and will no doubt be contentious, significant advancements have been made in the past few months that suggest it could soon be on the horizon.  These include the initial Base Erosion and Profit Shifting (BEPS) paper on dispute resolution, the January 2015 Dispute Resolution Conference in Vienna, the OECD Action 14 Final Report (released in October 2015) and the UN Secretariat ADR Paper.

Almost all stakeholders in the international taxation community agree that: (i) the number of disputes will increase; (ii) existing dispute resolution processes are in serious need of improvement; and (iii) a global consensus must be achieved so that global tax disputes can be resolved in a way that serves the interests of all stakeholders. In this regard, it may be fortunate for the tax community that it is arriving late to the ADR processes that have evolved in other areas over the past century. As the OECD and UN processes continue to evolve, it is hoped that lessons from these other areas can be drawn upon to develop an ITDRP that serves the interests of all parties.