An inside look at the arbitration and mediation programs.

The mission of IRS Appeals is to resolve tax controversies without litigation, in a manner both fair and impartial to the government and the taxpayer, and in a manner that will enhance voluntary compliance and public confidence in the Service's integrity and efficiency. Appeals has developed two programs to help achieve this mission--nondocketed arbitration and post-appeals mediation. These are alternatives to normal settlement negotiations between Appeals and a taxpayer, when a settlement cannot be reached. Both programs employ a neutral third party to assist the parties in resolving outstanding issues. The main difference between the programs is that the findings in arbitration are binding, while the findings in mediation are not.

Arbitration

Program description. Nondocketed arbitration is an optional process that uses an arbitrator to render a decision binding on both parties. Sec. 7123(b) (2) established the pilot program for arbitration, and Ann. 2000-4 described it. Issues eligible for arbitration are those not resolved under normal Appeals procedures. Arbitration may be used only to resolve factual issues that can be severed from the other issues in a case. A factual issue is one that can be resolved solely on a finding of fact. Any interpretation of law, regulation, ruling or other legal authority must be resolved and agreed on by the parties, for the issue to be eligible for arbitration.

According to Ann. 2000-4, arbitration may not be used for:

* Cases in which arbitration is inappropriate under either 5 USC Section 572, General Authority, or 5 USC Section 575, Authorization of Arbitration;

* Issues involving the substantiation of expenses under Sec. 162 or 274;

* An issue designated for litigation or docketed in any court;

* An Industry Specialization Program (ISP) issue or an Appeals Coordinated Issue (ACI); or

* An issue for which the taxpayer has filed (or intends to file) a request for competent authority assistance.

Appeals' arbitration program is a nondocketed procedure, not meant to become a legal process. If a taxpayer wants a legal process, the courts or docketed arbitration are available, both handled by the IRS Chief Counsel's Office.

Requesting arbitration. Either the taxpayer or Appeals may request arbitration, but both parties must agree to arbitrate for the case to be accepted in the program. Taxpayers should send their request to the Team Case Leader/Appeals Officer responsible for the case. The Team Case Leader/ Appeals Officer will prepare a written recommendation for action on the request and forward the request and recommendation to his immediate supervisor for approval. If the supervisor approves the acceptance of the case for arbitration, he will then forward the documents to the Appeals Area Director for final approval. In addition, the National Chief of Appeals Office will be consulted prior to a final determination of approval. Normally, this final determination is made within 30 days of the Team Case Leader/Appeals Officer receiving the request. If the request is approved, Appeals LMSB Operations will schedule an appointment with the taxpayer to discuss the arbitration process. If the request is denied, the taxpayer could ask for a conference with the Appeals Area Director to discuss the denial.

Arbitration process. Once the arbitration request has been approved, the parties will enter into a written arbitration agreement. The agreement's terms are negotiated at a conference provided by Appeals LMSB Operations. The agreement will provide guidance to the arbitrator, including (but not limited to) the following:

* An outline of the law;

* The authorities to which the arbitrator can refer;

* The parameters to work within; The additional information available; and

* The sources of additional information.

The agreement will contain (among other items) the participants' names, the issues, the site, the date and the agenda for arbitration. Sometimes, the agreement will contain a settlement range within which the arbitrator must work. The Service is also considering the inclusion of a timeframe in the agreement, to ensure no unnecessary delays in the process by either party.

The parties to an arbitration process include the taxpayer, his authorized representative, Appeals, the arbitrator and an administrator. The administrator is from Appeals LMSB Operations or the organization providing the arbitrator. The parties must communicate with the arbitrator through the administrator, unless both are present. The administrator and the arbitrator will explain the arbitration process to the parties and make clear that no ex parte communication may occur between either of the parties and the arbitrator. IRS counsel may also play a role in the arbitration process, by assisting Appeals in drafting the arbitration agreement, developing strategies and presenting the issue at the arbitration hearing. Experts may also be brought into the arbitration process. However, both parties must agree to their admittance.

The taxpayer and Appeals will select an arbitrator with the assistance of the administrator. This arbitrator may be from Appeals or may be non-Service. Usually, the arbitrator is from outside the IRS. The taxpayer and the Service must agree on the arbitrator selection. Appeals arbitrators may not report to the same manager as the Appeals Officer handling the case. If an Appeals arbitrator is used, National Office Appeals will pay the arbitrator's expenses. If a non-IRS arbitrator is employed, the taxpayer and National Office Appeals will share the expenses equally.

One of the main benefits of arbitration is that the process is confidential. All parties will have access to the taxpayer's returns or return information on the issues being considered. However, they may not voluntarily, or through discovery or compulsory process, disclose any information regarding the arbitration process.

Conclusion of process. At the end of the arbitration process, the arbitrator will prepare a written report and submit it to the parties and the administrator. The arbitrator's findings are final; neither party may appeal the findings nor contest them in any judicial proceeding. Appeals will use established procedures to close the case.

Pilot program. The two-year pilot program began on Jan. 18, 2000. Thus far, six taxpayers have requested arbitration. Of these, two were rejected because they did not qualify for the program. Four are in process; two of these are expected to settle prior to arbitration. Currently the Service is accepting requests for this program.

Future of the program. In the future, the IRS is considering the inclusion of ISP issues in the program, when review and concurrence by the Appeals ISP Coordinator is not mandatory. These issues will be considered for arbitration on a case-by-case basis.

Mediation

Description of program. Mediation is an optional nonbinding process that allows the taxpayer and Appeals to continue to negotiate a settlement with the assistance of a neutral third-party mediator. Anns. 95-86 and 97-1 contain the procedures that taxpayers used in the past to request mediation. Prior to Ann. 98-99, mediation was only an option for taxpayers with issues in Coordinated Industry Cases assigned to Appeals Team Case Leaders. Ann. 98-99 expanded the program to include the use of mediation for factual issues, such as valuation, reasonable compensation and transfer pricing, that involve adjustments of at least $1 million. These issues must already be in the Appeals administrative process. Mediation may not be used to resolve:

* An issue designated for litigation or docketed in any court;

* An ISP issue or an ACI; or

* An issue for which the taxpayer has filed (or intends to seek) competent authority assistance.

The two-year test period for the expanded issues began on Nov. 16, 1998. Ann. 2001-9 expanded the test period for mediation for an additional year beginning on Jan. 16, 2001 .While the test program has officially ended, the Service is continuing to accept mediation cases. After the test program, mediation will most likely be extended to additional issues and taxpayers.

Pilot program. The results of the mediation program, from its start in 1995 through March 2002, have been positive. While the program is not designed for everyone, it is definitely all option taxpayers should consider. The number of requests has steadily increased since the program was expanded in 1998 to include a broader range of cases. The following is a summary of the test program's results (as of March 22, 2002):

                  Number
Fiscal year    of requests

1995-1996           6
1997                9
1998                6
1999               12
2000               19
2001               21
2002                8
Total              81

The details of these requests are:

* 13 resolutions;

* 22 resolved prior to mediation;

* 7 not resolved;

* 1 withdrawal;

* 1 returned to Examinations because it was a premature referral;

* 15 in process; and

* 22 nonqualifications, which did not meet the program's eligibility criteria.

The IRS has used 54 mediators, of which 24 were non-Service and 30 were Appeals mediators. The breakout of the number and type of mediators per case is:

* 2 cases with 1 outside mediator per case;

* 3 cases with 1 Appeals mediator;

* 3 cases with 2 Appeals mediators per case; and

* 21 cases with co-mediators (non-IRS and Appeals--one case used 2 outside mediators along with an Appeals mediator).

Appeals currently has 52 mediators trained to participate in this program.

Future of the program. A program is being designed currently that would dramatically expand the number of taxpayers eligible to participate in the mediation program. Proposed changes include:

* Eliminating the $1 million limit to qualify for the mediation program.

* Expanding the program to include ACI and ISP issues.

* Including timeframes when the request is made to ensure that there are no unnecessary delays in the process.

* Assigning an Appeals mediator to all cases. Appeals mediators will be selected within the case's geographic area, unlike the current practice of choosing someone from outside the area. This could result in a taxpayer not having any input in the selection of the Appeals mediator, as a possibility exists that there is only one trained mediator in the geographic area. In this situation, if a taxpayer has serious concerns about the mediator selected, Appeals will take into account these concerns and will consider using an Appeals mediator from another area. Both parties still have to agree to the mediators.

* If the taxpayer elects to use an outside mediator, the taxpayer will pay the full cost, rather than the current practice of sharing the fees with the Service. This should greatly reduce the time between requesting mediation and the actual mediation process, as the onerous government contracting procedures will no longer be necessary; if an outside mediator is selected, he will be a co-mediator with the Appeals mediator. Note: Only two cases have used solely outside mediators, and these occurred early in the program.

Conclusion

In developing these programs, the IRS continues to encourage resolution of disputes without the prospects of prolonged litigation. Arbitration and mediation are unique services offered to taxpayers to assist them in the resolution of their issues and should be considered by taxpayers on a case-by-case basis.

FROM JIM DOUGHERTY, DIRECTOR, AND RONA FAUST, SENIOR MANAGER, TAX CONTROVERSY SERVICES, WASHINGTON NATIONAL TAX, DELOITTE & TOUCHE LLP, WASHINGTON, DC.

Special thanks to Earl Blanche, Jr., Director, Appeals LMSB Operating Unit, and Sandy Cohen, Senior Program Analyst, for their generous time and valuable input in the development of this item.

Editor:
Mark H. Ely, J.D., CPA
Partner
Washington National Tax
KPMG LLP
Washington, DC