The Lifecycle of a Tax Controversy (Part 1)
By: Michael J. Tedesco, Esq.
We find that accountants and taxpayers are often unfamiliar with certain aspects of the typical tax controversy (i.e. how a tax matter moves through assessment, Tax Court/Appeals and Collections). We have put together a series of articles moving through “The Lifecycle of a Tax Controversy”. What follows is the first part of what will be a four-part series where we will discuss the life of a tax controversy from beginning to end. This article will briefly summarize each of these areas and explain how they fit together, while the next three articles will focus on the three main aspects of a tax controversy: (1) Audit/Assessment; (2) Tax Court and IRS Appeals; and (3) The Collection Process, and will explain each area in greater detail.
The U.S. tax system is based on self-assessments. Whenever a taxpayer completes and files a tax return, they are making a self-assessment (i.e. the taxpayer is determining what tax is owed). For the majority of taxpayers this is the entirety of their assessment process. They will not go through an audit, IRS Appeals or Tax Court. However, if they are unable to pay the amount shown as due on their return, they will take part in the collection process.
For those who are selected for audit, there are three main types of audit conducted by the Internal Revenue Service: Correspondence Audit, Office Audit and Field Audit. The majority of taxpayers selected for audit will be selected for a correspondence audit. A correspondence audit is conducted via letter correspondence from an IRS Service Center. An Office Audit is conducted through the local IRS office and may require a taxpayer to come to the IRS office to meet with the auditor. Finally, a Field audit is typically limited to business taxpayers and more complicated issues. More experienced IRS personnel work the field audit cases.
During the course of the audit numerous unexpected issues may arise, including privilege issues and requests for statute extensions, we will discuss in full some of the more common issues that arise during an audit. Most people are aware of the attorney client privilege but tax professionals other than attorneys also enjoy a practitioner privilege provided by the Internal Revenue Code. It is important to be cautious of what materials may be covered under this privilege and its limitations. Requests for statute extensions are becoming more common during audits as the IRS more often opens years close to expiring under the statute and audits take longer. It is always important for a practitioner to be cognizant of the periods for which an extension is requested and the Service’s need for the requested extension.
Regardless of the type of audit, the examiner will either propose an adjustment (i.e. an additional tax assessment) or issue a no change letter. If the taxpayer disagrees with the proposed assessment, they will have to avail themselves of IRS Appeals or the U.S. Tax Court.
IRS Appeals and the U.S. Tax Court
IRS Appeals is a separate arm of the IRS. Its sole job is to resolve tax controversies between the IRS and taxpayers. IRS Appeals has substantive experts in many of the same areas as the IRS. For example, IRS Appeals has designated Appeals personnel who deal only with collection issues. A number of issues can be protested to IRS Appeals. These include tax deficiencies, assessment of most penalties, including the significant penalties that can be assessed for non-reporting of foreign assets, and a number of different collection matters.
The U.S. Tax Court follows relaxed rules making it friendlier to pro se taxpayers challenging an IRS action. Taxpayers can challenge IRS tax assessments as well as certain collection activities in the Tax Court. If a taxpayer cannot resolve a disagreement regarding an IRS Assessment at audit or IRS Appeals or certain collection actions, they can Petition the Tax Court. The Tax Court is an Article III court – meaning the court is created by statute not by the U.S. Constitution. As such, its jurisdiction is limited. In the case of a tax deficiency, the IRS will issue a Statutory Notice of Deficiency. Once the Notice of Deficiency is issued, the taxpayer has 90 days to Petition the Tax Court. The deadline to file the Petition is jurisdictional. This means that the Petition must be filed timely for the Tax Court to have jurisdiction over the matter Petitioned.
Understanding The Collection Process
Generally, the IRS has 10 years to collect a tax due from the time it is assessed. If the total tax due is based on a self-assessment made on a filed return, the collection statute begins on the later of the return due date or filing date. Certain actions can extend or freeze the collection statute. While the IRS is trying to collect a past due tax debt, the IRS will issue a number of different notices. While most of these notices look quite similar, they can have significantly different meanings. Some of these notices provide the taxpayer with notice of Levy or the filing of Notice of a Federal Tax Lien. These notices, and certain others, have IRS Appeals rights and can have consequences if not responded to within the time provided.
If a taxpayer cannot full pay the tax due, there are a few collections options that allow them to pay an amount less than the full amount due, pay over time or possibly not pay anything at all for a time. All of the collection alternatives offered by the IRS rely, at least in part, on the taxpayer’s financial condition and ability to pay. A taxpayer can enter into an Installment Agreement with the IRS allowing them to pay the balance due over a number of months. They can apply for an Offer In Compromise where the IRS will accept an amount less than the total tax due in satisfaction of the full liability. Finally, a taxpayer may be able to enter Currently Not Collectable status upon a showing that they have no current ability to pay their tax.
Stay tuned for our next entry in the series that will go into detail on the IRS Audit & Assessment process.
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