13 minute read
How to navigate a tax controversy
Do’s and don’ts, mistakes to avoid and strategies that work
By Michael G. Goller, JD
After years of handling federal and state audits, appeals and litigation, certain strategies and principles emerge as “best practices” when handling these controversies. This article summarizes some of the strategies that we have observed as being helpful in reaching a positive result and the mistakes that can lead to an unhappy ending.
1. Don't blow critical deadlines.
Both federal and state laws impose strict response deadlines. These deadlines drive how the audit or appeal moves forward. Some jurisdictions move from the tax assessment phase to a collection phase faster than others. As such, it is critical to meet these deadlines. Below are some of the many critical IRS deadlines.
The 30-Day Letter. At the close of an examination, if an agreement cannot be reached, a revenue agent will issue what is referred to as a “30-Day Letter.” The formal title is “Notice of Proposed Assessment.” The document is referred to as a 30-Day Letter because the taxpayer’s representative has 30 days to file a “protest” with the IRS. An audit report will be attached to the 30-Day Letter, showing the agent’s proposed adjustments.
The taxpayer’s protest. A protest is a written document that contains a brief statement of facts supporting the taxpayer’s position and generally outlines the law. If the taxpayer misses the 30-day deadline, the IRS Appeals Office will most likely still grant an appeals conference. However, this is still a deadline that should be met.
The 90-Day Letter. When the statute of limitations on assessment is close to expiring, or if the taxpayer has already gone to the IRS Appeals Office and a resolution cannot be reached, the IRS will issue a Statutory Notice of Deficiency. This notice is normally referred to as a “90-Day Letter” because the taxpayer must file a petition in U.S. Tax Court within 90 days of the date of the Statutory Notice of Deficiency in order for the court to hear the case. Thus, if a petition is not filed within this 90-day period, the tax court lacks jurisdiction. This is a hard deadline.
2. File adequate refund claims on time.
The IRS has prescribed forms for seeking a tax refund. While it is not absolutely necessary to use such forms, some
The IRS has prescribed forms for seeking a tax refund. While it is not absolutely necessary to use such forms, some courts have rejected informal claims that failed to contain the requisite elements.
courts have rejected informal claims that failed to contain the requisite elements. The three principal Claim for Refund forms are as follows: • Form 1040–X is used to claim a refund of individual income taxes. • Form 1120–X is used to claim a refund of an overpayment of corporate income tax. • Form 843 is used to claim a refund of any tax other than income tax as well as penalties and interest. Courts will allow a taxpayer to bring suit on a claim for refund only on the grounds raised in the claim. Thus, care should be taken to ensure that all grounds have been stated in the claim for refund. The tax practitioner should document the date a claim was filed. The burden to show actual filing is on the taxpayer. If
a claim is not delivered to the IRS — for example, if it gets lost in the mail — the taxpayer may not be able to prove filing unless the claim was sent by certified or registered mail or through an approved delivery service (such as FedEx). Under Code Section 7502(c), a claim that does not reach the IRS is treated as filed when mailed only if sent by registered or certified mail. Code Section 6511 provides that a claim for refund must be filed within three years of the date the underlying return was filed or within two years of the date the tax was paid, whichever is later. The amount of the claim is limited by whether the taxpayer has fallen under the three-year statute of limitations or the two-year statute of limitations. The amount that can be recovered through a claim for refund may depend on which statute of limitations the taxpayer is filing under. If the claim is paid within three years from the date the return was filed, the amount refundable cannot exceed the total tax paid within the three-year period (plus any extension period that was granted for filing the return). Conversely, if the claim for refund is filed under the two-year statute of limitations (within two years of payment), then the amount recoverable is limited to the tax paid during the two years immediately preceding the filing of the claim. If a return is filed or the tax is paid prior to the due date, for statute of limitations purposes the return is treated as filed, and the tax is treated as paid on the last possible day the return could have been filed without being delinquent. The “last possible day” does not include any extensions of time to file the return. Thus, for an individual tax return (Form 1040) the “last possible day” is April 15. The early payment of the tax rule occurs when a taxpayer’s wages are subject to withholding or estimated tax payments are made. Returns that are filed early (before the unextended due date) are treated as being filed and the tax being paid on the due date for statute of limitations purposes (§ 6513(a)). However, extended tax returns are treated in a different manner. An extended return is considered to have been filed on the actual date submitted to the IRS and not on the extended due date (§ 6513(a)). Finally, the refund statute of limitations is often extended during a tax audit. If the taxpayer consents to extend the statute of limitations on assessment, the time within which the taxpayer may file a claim for refund is also extended for
an additional six months from the date the extended assessment statute expires.
Importance of the statute of limitations on filing a
complaint in court: The issuance of the certified notice of claim disallowance or the execution of the waiver of statutory notification of claim disallowance begins the running of the two-year statute of limitations under § 6532(a), governing the time in which a suit for refund must be brought in federal court. Unless this period is extended by the taxpayer and IRS, this two-year deadline is mandatory. Failure to file a complaint in court within the two-year period will preclude the IRS from making a refund payment.
Protective refund claims: A protective refund claim should be filed when an audit adjustment of one taxpayer could result in a refund claim of another taxpayer or on another tax form. If a protective claim is not filed, the statute of limitations on the refund claim could run prior to the termination of the audit.
Example: Assume there is an audit of a
C corporation. The IRS is examining payments from the C corporation to the sole shareholder’s children. These payments were treated as deductions on the corporation’s Form 1120 and as wage income on the children’s Forms 1040. If the
IRS disallows the deduction, they will most likely treat the expenses as a constructive dividend to the sole shareholder and a gift to the children. A protective refund claim should be filed with regard to the children’s Forms 1040. If this is not done, they run the risk of not recovering the tax back on the income they reported and the sole shareholder having to pick up the same amount as income.
3. “Scorched earth” and noncooperation rarely work and often lead to a bad result.
Once a notice of audit has been issued, the tax practitioner — after receiving proper authorization — should reach out to the revenue agent to establish communication and inform the agent that the tax practitioner will be representing the taxpayer. Be respectful and cooperative with the agent. An agent is more likely to work with and resolve issues with a cooperative tax practitioner. If you work well with the agent, the audit will progress, and it may be resolved without additional appeals.
4. Control the flow of information.
As part of the exam process, whether a federal or state audit, the taxing authority will ask for documentation. One of the most important things a practitioner can do is control the flow of information. This can happen in a number of ways, such as the following: • Control the timing for giving information, bearing in mind that excessive delays may anger the revenue agent and may constitute an ethical violation under
Circular 230. • Control the format and presentation of information. (Do the agent’s job for him or her.) • Control what access the IRS has to key personnel and records. • Submit written responses to the revenue agent.
Create documents that allow the revenue agent to resolve the case without being second-guessed by his or her manager.
Tax Audit Checklist
4 Do not impede the audit process. 4 Do not allow the agent free access to the business. 4 Do not make promises that cannot be kept. 4 Do not attempt to bully or intimidate the agent. 4 Assign one person to be the primary audit contact. 4 Request that all significant communications be in writing. 4 Keep track of time spent on the audit. 4 Control the records provided to the agent. 4 Cooperate with the agent and promptly respond to all requests. 4 Provide the agent with adequate work accommodations. 4 Meet regularly with the agent to review issues. 4 Attempt to resolve issues before they are written up. 4 Agree to disagree on major irreconcilable issues. 4 Request a concluding conference to discuss the audit conclusions.
5. Take the time and energy to come up with well-thought-out, well-reasoned arguments and convey them in a concise and articulate manner, often in writing.
Responses should be short, sweet, organized and to the point. Putting the time in to come up with thoughtful responses during the examination can often help at later stages because the arguments are well documented. Time and time again we see lengthy responses that don’t address
the agent’s concerns or provide so much information that it detracts from the issue at hand. Arguments are also more persuasive when they are presented in a concise and articulate manner. Further, practitioners need to understand whom they are writing to and for what purpose.
6. Keep your promises.
Audits and tax matters are stressful. Clients and agents alike have certain expectations of tax practitioners. Make sure you are communicating the steps you will being taking, and follow through on those promises. Keeping promises also establishes a level of trust. Failing to keep your promises can frustrate your client and cause agents to distrust you, impacting your ability to resolve the case.
7. Settle when you can; march toward litigation when you have to.
Most cases come down to dollars. Litigation is expensive and time consuming. Before a decision is made to escalate a case to litigation, it is important to ask whether the assessment is large enough to justify the cost of litigation. Sometimes it makes sense to settle a case because the costs of litigation would heavily outweigh the tax benefit.
Michael G. Goller, JD, is a shareholder and chair of the tax practice at Reinhart, Boerner and Van Deuren s.c. in Milwaukee. Contact him at 414-298-8336 or mgoller@reinhartlaw.com.
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