The IRS administrative function plays a critical role in our tax administration system. The appeals process settles a majority of all tax disputes. It does so using processes and procedures that have developed over many years.
To the uninitiated who have not experienced the IRS appeals process, the process can be confusing and, unfortunately, the audit and appeals process often does not leave the taxpayer with the sense of fairness and efficiency intended with the IRS appeals process.
Congress and the Treasury have been working on this. Congress passed the Taxpayer First Act and just now, the Treasury has issued additional proposed regulations, to help clarify the role of IRS Appeals and how it is to function.
The Taxpayer First Act
The Taxpayer First Act made certain changes to IRS Appeals. This included some superficial changes, such as changing the name to the IRS Independent Office of Appeals. It also clarified that taxpayers have a right to an IRS appeal (which overturned the Facebook court case) and requires IRS Appeals to offer access to non-privileged documents in the IRS’s administrative file.
The Taxpayer First Act also includes language saying how to protest a denial of the right to an IRS appeal. Specifically, if the taxpayer receives a notice of deficiency and asks that the case be referred to IRS Appeals, if the IRS denies the request, it has to provide a written explanation and explanation as to how to protest the denial.
The Proposed Regulations
The proposed regulations provide an interpretation that expands and limits the Taxpayer First Act.
For example, the proposed regulations clarify that IRS Appeals will continue to consider cases that are not technically “Federal tax controversies.” This includes a myriad of decisions the IRS makes. The proposed regulations cite determinations involving initial or continuing tax exemption or foundation classification of particular organizations and initial or continuing qualification of particular employee plans. These are decisions by IRS Counsel and not the IRS Exam function. Thus, they are not “Federal tax controversies.” The proposed regulation confirms that IRS Appeals will continue to consider these cases.
The proposed regulation even notes that it allows for “the addition of new categories of administrative determinations made by the IRS with respect to a particular person that in the future may become evident as appropriate to fulfill the function of Appeals.” This is helpful given the IRS’s recent penchant for issuing substantive guidance by IRS announcements and IRS notices. These nonbinding announcements and notices do not follow the rulemaking process and are non-binding generally, but the IRS expects taxpayers to comply with them. One only has to look to the IRS’s recent requirements for research tax credit refund claims to see an example. This guidance provides a whole host of items that have to be included with a refund claim that includes a research tax credit and says that the IRS will deny the refund if the information is not provided. The IRS’s position for these refund claims is likely illegal and will not sustain challenge in court, but setting that aside, the proposed regulations suggest that IRS Appeals can consider this type of decision by the IRS.
The regulations go on to list 24 types of cases that IRS Appeals will not consider. This includes everything from the IRS decision to return an offer in compromise to the taxpayer if it is not processable to a decision not to make an award to whistleblowers to file whistleblower claims to report tax cheats.
The New Rules Stop Short
While the Taxpayer First Act and the proposed regulations are helpful in clarifying IRS Appeals and their role, they do not address some of the more problematic aspects of IRS Appeals and the administrative appeals procedure. No doubt the biggest challenge with the administrative appeals process and rules starts with the IRS Exam function.
The IRS Exam function has and continues to take a dim view of IRS Appeals. Given this view, it trains its examiners and its established practice is to deny taxpayers’ positions in full rather than trying to get to the right answer. Its established practice is also to load up every single issue that there could be in a case even though the facts suggest that the additional arguments and positions are borderline frivolous. IRS Exam also has a practice of adding penalties to cases when they are clearly not warranted before the case is sent to IRS Appeals.
The justification for these practices is that IRS Appeals is going to give the case away anyway, so the IRS Exam function has to stack the deck against the taxpayer to prevent IRS Appeals from reaching an effective settlement in the case. This approach is highly effective as the IRS Examiner is the fact finder. They spend more time on the case and they can set the case and files up so that the IRS Appeals Officer cannot easily discern what the real issues are. It’s a slight of hands trick that is intended to deceive the IRS appeals officer. It deprives the IRS appeals officer of an honest assessment of the facts and issues. The result is that the IRS appeals officer is making a decision that is not based on true facts or an assessment of the facts or even a correct statement of the issues in the case.
This practice undermines the IRS appeals function and leaves taxpayers confused by the audit and appeals process. It undermines the integrity of the IRS and the concept of voluntary compliance. This is evident by those who go through audit and appeal who end up taking even more aggressive positions after having this experience, as, like the IRS Exam function, they realize that they need to stack the deck in their favor on their tax return positions if they are to come out of the IRS audit-appeal process with something close to the correct answer. Given this system, the tax return becomes the first offer in the negotiation process rather than an honest report of items of income, expense, and credit. This is clearly not the message our tax system should be sending to taxpayers–but it is. It also multiplies and magnifies the number of tax disputes–thereby increasing the work required by taxpayers and by the IRS.
The Taxpayer First Act and proposed regulations do not address this ever-present issue. And our laws and procedural rules have no curbs or sanctions for IRS exam personnel engaging in these bad acts. There are not even procedural checks by IRS upper management to even identify these practices.
The IRS Appeals Office is a critical part of our tax administration system. It is good to see Congress and the Treasury clarifying the rules and roles for administrative appeals. It is helpful to know that IRS Appeals will continue to hear a variety of cases and that it will welcome cases that are not clearly defined in the current rules.
The clarifying laws and rules do help, but they stop short. The underlying IRS Exam practices negate the very policy reasons and discredit the appeals process even before cases arrive in IRS Appeals. Meaningful changes have to be made to the IRS Exam function first. Anything less is merely a cosmetic fix that fails to address the larger issue that is ever-present with IRS Appeals.