While IRS auditors and IRS attorneys typically focus on imposing the most tax possible, the IRS Office of Appeals does not. Appeals is tasked with settling cases. In doing so, Appeals is supposed to be impartial. This allows Appeals to ‘get it right.’ The recent Onyeani v. Commissioner, T.C. Memo. 2020-15 provides an opportunity to consider what impartial means.
Facts & Procedural History
The taxpayer moved to the U.S. from Nigeria. He formed a corporation in the U.S. purportedly to trade Nigerian oil.
He did not follow any of the formalities of a corporation, such as keeping his personal and business expenses separate, maintaining corporate records, etc.
The court opinion suggests that the taxpayer defrauded a U.S. company, but notes that the facts are not clear.
What was clear is that the taxpayer received significant payments into his U.S. bank account in 2015, he spent some of the funds on personal expenses, and then, in the same year, he paid the alleged defrauded party most of the money back pursuant to a settlement agreement.
The IRS’s Quick Assessment
The IRS made a quick assessment for 2015 on the basis that the taxpayer was a flight risk. The taxpayer challenged the assessment in the U.S. District court and lost in 2015. He paid this amount to the IRS in 2015.
In 2016, the taxpayer filed his 2015 tax return. The tax return did not report the income as previously determined by the IRS.
The IRS audited the tax return and concluded that the originally-determined tax was due. The taxpayer filed a protest, asking the IRS Office of Appeals to review the case.
Appeals referred the case to IRS Chief Counsel for review. The IRS Chief Counsel attorney recommended that a civil fraud penalty be imposed (and in the alternative, that accuracy-related penalties be imposed).
The tax and civil fraud penalty were then considered by the U.S. Tax Court.
Independence of the IRS Office of Appeals
The IRS Commissioner delegated his power to settle tax cases to Appeals. This delegation of authority allows Appeals to resolve disputes largely without bias and without input from other IRS functions.
This “independence” of the appeals function is a requirement found in the Revenue Restructuring Act of 1998 (“RRA of 98”).
The RRA of 98 was an act that prohibited the IRS from engaging in taxpayer abuse. It resulted from the questionable tactics the IRS had employed prior to the act. It resulted from widely publicized Congressional hearings that chronicled the IRS’s taxpayer abuses.
Ex Parte Communications
To ensure independence of appeals, the RRA of 98 prohibits ex parte communications by appeals officers.
Ex parte communications are communications with IRS personnel outside of Appeals when the taxpayer is not present or afforded an opportunity to participate.
The IRS has adopted rules that prohibit ex parte communications. The Appeals rules generally prohibit ex parte communications by appeals officers and others within the IRS. But appeals officers do often ask the IRS Chief Counsel for advice on cases.
These communications are an exception to the ex parte communication rules. The exception allows appeals officers to obtain legal advice from its attorneys on legal questions.
These ex parte communication rules and policies have been questioned and clarified over time. This includes the issuance of a revenue procedure and follow up guidance by the IRS.
The IRS’s policy manual summarizes the current rules. It generally explains that appeals officers can ask for legal advice from the IRS Office of Chief Counsel as to how the laws apply, but it is not bound by that advice. They also say that appeals officers are not able to contact the IRS Office of Chief Counsel if they are acting as an advocate for the originating examination function.
Not Raising New Issues
As part of it being independent and impartial, the appeals function is also prohibited from raising new issues.
This is provided in IRS Policy Statement 8-2. It says “Appeals will not raise new issues.” That mandate seems clear. It was followed by Appeals issuing the AJACs rules and the subsequent AJAC rules, which prohibit Appeals from raising new issues.
This rule is intended to encourage those with tax disputes to participate in the administrative appeals process. Absent such a rule, few would be inclined to have Appeals hear their case.
In this case, the IRS examination function made a quick assessment. It did so by only doing a cursory review of the taxpayer’s bank records. The U.S. Tax Court determined that the original assessment was grossly incorrect as it failed to allow amounts that were obviously an offset to the income or deductible by the taxpayer. One would think that a reviewing office would have reached the same conclusion as the court.
But the IRS appeals function sustained the IRS exam function’s error. And worse than that, Appeals imposed a fraud penalty that was not previously assessed (and an accuracy-related penalty as an alternative if the fraud penalty was not upheld).
The Meaning of Impartial
With respect to IRS appeals, the term “impartial” is the sum of these rules. It is an appeals office that is independent, that avoids ex parte communications, and that does not raise new issues. But each of these factors is in question in this case.
The assertion of the penalties apparently resulted from the appeals officer sending the case to the IRS Chief Counsel for review. The IRS attorney then drafted a memo recommending the penalties. The penalties were then approved by the IRS attorneys manager, which is required by law for a penalty to be validly assessed (whether the IRS attorneys manager can fulfill this requirement when the IRS appeals function assessed the penalty is an open question).
The facts set out in the court case seem to suggest that the taxpayer was not able to communicate with the IRS attorney who wrote the memo recommending penalties. This calls into question whether there were prohibited ex parte communications by Appeals.
IRS Counsel advising on a penalty that was not previously imposed seems to go beyond legal advice on an existing issue, to raising a new issue. A penalty that was not assessed seems to be a new issue by any definition.
And that Appeals followed the recommendation to impose penalties calls into question whether Appeals is independent. Reading the court case, it appears that Appeals carried out the aims of the IRS Office of Chief Counsel, which is not consistent with the policies for Appeals. This seems contrary to the express requirements of the RRA of 98 for Appeals to be independent.
Whether Appeals is impartial has been in the tax press lately.
Appeals recent practice of not affording taxpayer’s an in-person appeals conference also raised the issue. This Appeals policy led many to question whether Appeals was just rubber stamping the IRS exam functions determinations without even really considering the taxpayers position.
The court’s determination that taxpayers do not even have a legal right to an IRS appeals review does not help in this regard.
Despite these setbacks, most appeals officers take their mission to be fair and impartial seriously. They defend it vigorously, as we have seen with the IRS appeals officers we work with in Houston. They do so rightly, as they are the front line that helps ensure that the IRS gets it right. Taxpayers deserve no less. This even true for taxpayers who engaged in seemingly questionable financial transactions.