Jousting With The Tax Man: ADR At The IRS, Part II.

John Klotsche served as senior adviser to the IRS commissioner from 2003 to 2006 and as senior international adviser from 2007 to 2008. He is currently a partner with Caplin & Drysdale in Washington.

In Part I, I examined the administrative dispute resolution system at the IRS and concluded that it was excessively and unnecessarily protracted and punishing and that major change was necessary. Part I also offered a three-point conceptual framework to analyze that change.

In this second and final part, I will lay out the details for my Extreme Makeover, IRS Edition. A new IRS unit, dubbed the ADR Center, is my recommended approach to accommodate and implement the three changes, and I describe the structural and operational composition of that new center.

My experience is in the large corporate taxpayer segment, and much of the data presented here come from that sector. The ideas and recommendations offered, however, apply broadly to all taxpayer groups, and particularly the three organizational business units at the IRS: the Small-Business/Self- Employed Division, the Tax-Exempt and Government Entities Division, and the Large and Midsize Business Division.

The ideas in parts I and II were the subject of a roundtable conference hosted by Tax Analysts on June 19: ''ADR and the IRS: What Would ADR Mean for the IRS and for Taxpayers?'' Audio and written transcripts of the conference are available at http://www.taxanalysts.com under the ''Mentions and Events'' link.

ADR at the IRS will be the subject of a live webcast hosted by Thomson Reuters at noon Eastern Daylight Time on August 4. Interested Tax Notes readers can sign up at http://westlegaledcenter.com/program_guide/course_detail.jsf?courseId=21165804 .

I. Prologue

This two-part report proposes significant change at the IRS. Like many other federal agencies, the IRS combines an antichange disposition with a risk-averse culture. Both are typically overcome when three things happen: someone puts a good idea on the table; the agency boss decides a good idea is on the table; and the agency boss announces that a good idea is on the table.

Part I1 examined the framework for a good idea: reforming the way the IRS administratively resolves taxpayer disputes. The broad method for that change was to overhaul the system by adopting proven alternative dispute resolution (ADR) principles and practices from the commercial world.

To recap, Part I put three ambitious but concrete ideas on the table:

1. Accelerate the ADR process. The two main ADR programs available to all taxpayers, one for nonbinding mediation and the other for binding arbitration, don't kick in until after the antagonists have jousted with each other, often for years, and then reach an impasse at the end of the appeals process. The next choice is either to try to use one of the ADR programs or go straight to court. Part I recommended the ADR process start much earlier on the resolution timeline before positions become hardened and entrenched.

2. Mandatory mediation. Consistent with the practice in most federal and state civil court systems, the second recommendation would make mediation (but not arbitration) compulsory for all disputes. That mediation is by definition and practice a nonbinding procedure takes the sting out of the mandatory notion; the parties need only use their best efforts to resolve the dispute by mediation.

3. Independent neutrals. The third idea takes the ''independence'' mantra loudly championed by IRS Appeals and applies the principles of plain language to it — independence means a truly neutral third-party mediator or arbitrator with no ties to the antagonists. In the commercial world and at most other federal agencies, ADR is practiced this way. Let's offer taxpayers the real thing and stop playing charades by saying an Appeals employee on the federal government payroll that serves as an arbitrator or mediator is independent.

The denouement in Part I cited the retort lawyers love to use when they don't have an immediate response to a good idea: ''But the devil is in the details.'' I promised to come back to Tax Notes readers and take on the devil and tackle those details, so here we go.

II. Accelerate the ADR Process

ADR and IRS are not simpatico acronyms, and one thing preventing many taxpayers from embracing the ADR programs is the delay in their availability.2 Behavioral scientists warn that the longer the parties argue over a dispute, the more difficult it is to resolve. The IRS's two main ADR programs surely don't heed this unassailable advice.

In a corporate context after lengthy (two- to three year) audits followed by Appeals deliberations that can last three-plus years, taxpayers have little appetite to start a new ADR negotiation process as positions harden and flexibility wanes.3 They are likely to either throw in the towel or put their case in court. Taxpayers would welcome the idea of using mediation or arbitration much earlier in the dispute resolution process — long before Appeals deliberations break down.

A broad-ranging ADR survey in January 2009 of the Manufacturers Alliance for Productivity & Innovation (MAPI) corporate membership posed this question: ''Would you support a change in the Post-Appeals Mediation and Arbitration Programs that accelerated the process so that it took place before rather than after the conventional Appeals process?'' The response was 64 percent yes and 36 percent no.4

The IRS does have four fast-track mediation programs to resolve disputed issues for selected taxpayer groups before the audit concludes.5 The data, however, suggest that none has caught on — over the last four years, of the several hundred thousand disputed IRS cases coming out of audit, only 716 taxpayers successfully used one of these four fast-track programs.

The recent MAPI survey shows a corporate-taxpayer satisfaction rate with the Large and Midsize Business Division (LMSB) fast-track program of only 44 percent — and less than 5 percent of eligible LMSB cases move into the fast-track settlement program.6 I see two ways to accelerate the ADR process. The first is to change the existing post-Appeals mediation and arbitration programs so the ADR process moves to the front end, immediately after the case reaches Appeals. If the early mediation fails, the parties can continue with conventional two-party Appeals negotiations. Of course, an early binding arbitration will end the matter right there, and quickly.

The second way is to set up a new unit within the IRS — we'll call it the ADR Center — separate from Appeals and dedicated to overseeing all the IRS's ADR activities. When the exam ends, taxpayers could choose between using the ADR Center or the conventional appeals process to resolve their dispute, but not both.

I prefer the second approach and will examine it more closely later.

III. Mandatory Mediation7

Requiring parties to mediate a dispute has proven effective in state and federal courts in achieving time and cost savings and favorable case resolution rates, compared with both litigation and conventional two-party negotiations. Seventy-eight percent of the responding corporate tax executives in the MAPI survey said they would like to see mediation become compulsory.8 It is always useful to remember that because mediation is a nonbinding procedure, the parties lose little if they sit down early on with the benefit of a fresh, neutral-party influence. If that's unsuccessful, they can revert to the traditional two-party Appeals negotiations.

Like with process acceleration, the best time to do mandatory mediation would be after the case leaves Exam's jurisdiction and shortly after the taxpayer files it with Appeals. It would be unwise, however, to set up an across-the-board compulsory mediation program for all cases, and the limits on eligible issues that are contained in the existing mediation procedure could serve as a good starting point.

If the ADR Center idea described below were implemented, it would essentially be a taxpayer-selected mandatory ADR program, as it gives the taxpayer the right to have an independent, neutral party hear the case at an early stage.

IV. Independent Neutrals

While many taxpayers and practitioners recognize that Appeals tries hard to deliver on its claim of independence, most believe that truly independent (non-IRS) neutral parties with extensive ADR training and experience would vastly improve the system. A model for this is Judicial Arbitration & Mediation Services (JAMS), an organization of professionals who mediate and arbitrate a broad range of commercial disputes. JAMS is one of the nation's largest providers of private commercial ADR services. It consists of roughly 250 qualified retired judges and attorneys who comprise a panel of full-time neutral resolution experts.

In the commercial world, the hallmark of successful ADR is both the reality and perception of impartiality, and here neutral parties must satisfy the highest standards. Also, many of the ADR programs at other federal agencies provide for independent, third-party mediators and not agency employees. Not surprisingly, the corporate tax executives in the MAPI survey voted 96 percent in favor of that idea.9

Independence can mean many things, but for most tax aficionados it means the tax authority must bring an impartial approach to dispute resolution.10 Each issue should be separately evaluated strictly on a revenueneutral basis, without regard to where the ''tax chips'' may fall. In today's politically charged climate of trilliondollar budget deficits and the annual $300-billion-plus tax gap, a pristine, revenue-neutral resolution process in Appeals seems almost Pollyanna-ish.11

The IRS's ADR programs approach independence haphazardly. The four fast-track programs — those that can be used while the case is still at exam—all require an IRS Appeals officer to don a new uniform and serve as the independent mediator. The main post-Appeals mediation program also requires an IRS Appeals employee to serve as the mediator but allows the taxpayer to bring in at its expense a ''co-mediator'' — provided both the IRS and the taxpayer agree on the other's selection. This approach undermines the neutrality concept, because in a co-mediator environment in which each party has its representative, the neutrals easily slide into the role of advocate, representing the antagonist paying them. Regrettably, this co-mediator idea replaced a truly independent mediator concept under the early mediation pilot program.12

The post-Appeals arbitration program provides for either an Appeals employee as the arbitrator or, if the parties can agree, one from outside the IRS — so it does try to address the lack of independence issue. I noted in my Part I data that the use of arbitration is nonexistent (only five cases in four years), so there are clearly problems other than independence here. The ADR Center idea outlined below addresses them.

The IRS makes a modest effort to train its Appeals officers, but it falls far short of providing them the needed tools to conduct modern negotiation and dispute resolution sessions. And given the scant use of the mediation and arbitration programs as reflected by the data, real-world ADR experience by Appeals officers is de minimis.

Achieving genuine independence with outside neutral parties within the current ADR regime would be difficult for the IRS, given Appeals' structure and culture. A new unit detached from Appeals, like the ADR Center, would seem to provide a fitting vehicle for enhancing the concept of independence while also moving forward with process acceleration, mandatory mediation, and improved ADR training and experience. So let's look critically at the ADR Center idea.

V. The ADR Center

The IRS Alternative Dispute Resolution Center, or ADR Center for short, would be:

staffed by IRS administrative employees who would report to the commissioner;

dedicated to managing the intake, processing, and disposition of unresolved cases taxpayers choose to bring to the center following audit;13

charged with overseeing the parties' selection of the independent, neutral and moving the case through the center to a swift conclusion; and

located in Washington, separate from the IRS headquarters, with dispute resolution conference facilities. ADR hearings would also take place in major U.S. cities at the neutrals' offices.

The graphic at the end of the report displays the proposed ADR Center and here are its main operational features:

1. Today, when an audit concludes and taxpayers receive a 30-day letter and report of proposed tax adjustments from the IRS, they have the choice of taking the case to Appeals or going straight to court. Under a third option, they could take the case to the ADR Center. If it is unresolved there, the courthouse would be the next step (like with an unresolved Appeals case).

2. In the ADR Center, the taxpayer could choose to have the disputed issue (or issues14) go through nonbinding mediation, binding arbitration, or both. Taxpayers can select mediation first, and if that fails, they can go to arbitration or directly to court. If they choose to use both mediation and arbitration, they can use one neutral party for the entire process, or agree on one for the mediation step and another for the arbitration step.

3. If both parties agree, they could link the two ADR processes from the outset so a failed mediation automatically moves the case to binding arbitration. In the commercial ADR world, this is known as Med→Arb, and the parties often agree by contract to link this two-step process. The advantage to this is that knowing an unsuccessful mediation will bring on binding arbitration can be a powerful incentive to resolve the case at the early mediation stage.15

4. The mediator or arbitrator who hears the case would come from a sizable pool of truly independent, neutral parties with significant ADR training and experience. Most would have tax knowledge and expertise, 16 and all would have a solid grounding in ADR principles and practice. The pool would include former judges, active and retired practitioners, and former government employees, all meeting suitable qualification standards.17

5. Selecting the neutral party would be a consensual process for both parties. At the ADR Center, a streamlined selection process would prevent gridlock and rancor. The commercial ADR world provides proven prototypes that can include a single arbitrator or a panel of three.

6. At the ADR Center, the exam team that developed the issue would ''represent'' the IRS with as-needed support from the chief counsel's office. Appeals would not participate and would continue to function as it does now, taking all the cases taxpayers choose not to take to the ADR Center or directly to court. As is the case at Appeals, taxpayers would either represent themselves or present their cases through a professional tax representative at the ADR Center. Tax practitioners would be subject to the IRS Office of Professional Responsibility rules and Circular 230.

7. The ADR Center could be funded in two possible ways. One is through user fees charged to participating taxpayers — similar to the IRS advance pricing agreement and advance rulings programs — set to cover the center's costs plus the neutrals' fees. The second, and more preferable way, would be for the parties to share the out-of-pocket costs of the neutral selected to hear the case, with the IRS absorbing the administrative costs of the ADR Center.

A. Arbitration at the ADR Center

I have noted, based on statistical evidence, that the arbitration program at the IRS is a failure for three reasons:18

1. Delay. When a case concludes unresolved after often prolonged Appeals deliberations, a decision from a judge is almost as close at hand as an arbitrator's binding award, so the normal benefit of ADR speed is lost.

2. 'Trier of Fact.' Disputants are unprepared to sacrifice the integrity of the judicial system, with its trained and experienced judge, for a private judge with shallow adjudicatory qualifications and experience.

3. Panel. The post-Appeals arbitration program requires the arbitrator to be either an IRS Appeals employee or a neutral third party, a procedure that makes both parties uncomfortable with the selection process and the possible result.

The ADR Center addresses each of these shortcomings. The arbitration process would start much earlier without undertaking the prolonged, conventional Appeals process. A pool of highly qualified, independent, neutral parties should alter the antiarbitration bias, particularly as former judges will make up part of that pool. And the neutral selection process could include the commercial convention of appointing three-person panels.19

B. ADR Center: A Critique The seven operational features leave open some important nuts-and-bolts issues. One is which cases would be eligible for the ADR Center. Several categories are not suitable. The current ADR programs exclude them, and the ADR Center should do likewise.20 It will also be appropriate to establish timelines and procedural rules that will govern the ADR proceedings to ensure process efficiency and fairness. Here the recent experience with the introduction of binding arbitration in bilateral tax treaties with Belgium, Canada, France, and Germany could prove useful.

Regarding Appeals coordinated issues (ACI), these would require careful consideration to ensure consistent results among taxpayers that choose different administrative paths to resolve their issues. There are now 43 ACIs, including abusive tax avoidance transactions. As a general proposition, purely factual ACIs would be good candidates for ADR Center resolution, but those that are mixed fact and law should be carefully screened for inclusion. The same analysis should apply to LMSB Tier I issues. Abusive tax shelter and listed transactions should be excluded from the ADR Center.

Finally, the ideas here would need to be calibrated carefully with the IRS's existing administrative ADR pronouncements. One notable example is settlement authority. The ADR Center would require something comparable to Delegation Orders 97 and 4-25 to resolve issues on a litigation-hazards basis.

Some will contend that the ADR Center is nothing more than a new operation set up to compete with Appeals for unresolved cases coming out of audit. While each case that goes to the center would be a loss for Appeals, let's not forget the current backlog of 60,000 cases and the prolonged delays — some lasting for years, with complex and large issues — to get a case through Appeals.21 And surely a little competition for the bureaucracy shouldn't be cause to jettison an otherwise good idea.

Others will argue that the current IRS dispute resolution system, while imperfect, is fundamentally sound and doesn't need a major face-lift. They would likely point to Appeals' roughly 80 percent case resolution success rate. This is not a bad overall rate,22 but there is room for improvement, and tinkering on the margins won't get the job done.

More importantly, that success resolution rate is misleading, because roughly half of Appeals' cases involve individual taxpayer matters for which there is no field audit or no serious factual or legal issue. As a result, Appeals resolves virtually all those cases without litigation. A resolution rate well below 80 percent applies to the remaining 50 percent of Appeals' cases that come out of taxpayer field examinations and are more complex, factually messy, and resource-intensive. Taxpayers with those cases are the ones who should have the choice of using the ADR Center.

But most important is taxpayers' protracted and punishing ordeal in getting to the finish line, and that is why the system needs an extreme makeover, IRS edition. Congress over the years has dealt Appeals an overwhelming caseload that includes everything imaginable — without appropriating the resources to manage it. Appeals is clogged with complex, multi-issue cases of global corporates, charity unrelated business income tax (UBIT) and tax exemption disputes; thousands of penalty feuds; countless small-business tiffs; and, as I just noted, tens of thousands of individual collection due process, offer in compromise, and innocent spouse cases.

More than 100,000 new cases come through Appeals' slowly revolving door each year. The simple cases take months to resolve, and the more complex ones take years — usually preceded by a prolonged and contentious audit. And then at the end of the process the tax man presents his customer with a bill that includes a required gratuity to cover not the services provided but the delay in providing the services — interest on added taxes owed, reaching back to the date of the tax return filing.23 Surely taxpayers deserve an alternative when the existing system treats them so poorly.

And finally, there will be those who staunchly support the current Appeals process because it removes the case from Exam's influence. They say that since the responsibility for a final decision rests with a fresh pair of eyes and Appeals' assessment can consider the hazards of litigation, the process often leads to a reasonable resolution. This is all true and presents a respectable argument; a good number of taxpayers will not view the ADR Center as an attractive alternative but will continue to try to resolve their case under the current system. The ADR Center isn't for everyone — only those who believe the current system doesn't work well and doesn't give them a fair shake.

C. ADR Center — Benchmarking Results The author believes the ideas put forward here should be tested in a pilot program framework. This could be a selected taxpayer group (for example, LMSB) or targeted issues well suited for ADR (for example, asset or business valuation or transfer pricing), or both.24 A pilot is appropriate because these ideas represent significant change for the IRS and incremental implementation is usually less disruptive.

A pilot will also allow for measurement of the success (or failure) of the ideas. There are three possible metrics:

1. Outcomes. Appeals is forever criticized from within by both exam and Chief Counsel for ''giving away the store'' in its issue resolution. While not publicly announced, historically Appeals has had a low ''sustention'' rate of between 25 percent and 50 percent.25 Appeals retort to this claim of softness is that the rate is low because many of the cases it gets should never be there — exam's adjustments are totally meritless. The right answer, of course, is somewhere in the middle. The pilot could compare sustention rates from the ADR Center with those from Appeals in a carefully calibrated selection of similar types of issues. The data would be useful to assess Appeals' against the ADR Center's performance, and whether significantly different outcomes result from the two separate resolution paths.

2. Resolution Rates. In the commercial world, the data shows that mediation results in higher dispute resolution rates than conventional two-party negotiations. The ADR Center would allow for a direct comparison with Appeals' resolution rates.

3. Acceleration of Tax Revenues. Appeals negotiations tend to be undisciplined in their timelines. In contrast, modern-day mediation is a process that is conducted in a disciplined and timely manner; most cases involve only one session even in complex, factually involved cases. The result is that cases at the ADR Center should conclude (successfully or unsuccessfully) in a time period that would be a fraction of that for a similar case at Appeals. The economic benefits of currency can be quantified using a conventional time-value-of-money analysis.

There are other performance metrics that could be developed through customer satisfaction surveys but they tend to be much softer, less reliable, and often political.

That leads to a final point. Appeals functions largely detached from the rest of the IRS and measuring and evaluating its performance is difficult (the sustention rate point is a good example of the varying opinions just within the Service). Few will dispute that Appeals plays an indispensible role in the resolution process and we have noted with some caveats that it has a relatively high overall case resolution rate. Beyond that, however, we have little against which to benchmark Appeals' achievements and performance.

The ADR Center can change that through these performance benchmarks. Appeals could score well on the metrics and the pilot could show the ADR Center adds little benefit. Then again Appeals might not score well and the ADR Center will be seen as providing a good dispute resolution alternative. And in the latter case, appropriate change in Appeals' operations might follow. Under any scenario, the taxpayer wins.

VI. Epilogue

For decades, administrative settlement negotiations between taxpayers and the IRS have taken place in the traditional, timeless, two-party adversarial format. Today, the art and science of modern conflict negotiation and resolution are sorely missing and badly needed. They are powerful reminders of the advisability of early intervention by a trained and experienced neutral party chosen to bring discipline and early closure to the process. Although the IRS notionally commits to using ADR as a part of its dispute resolution tool kit, its programs need a major contemporization.26

The ideas suggested here can help carry out five important goals:

accelerate the collection of badly needed tax revenues in a new era of soaring, trillion-dollar federal deficits;

make ADR a core IRS resolution strategy as Congress envisioned in the 1998 Taxpayer Bill of Rights legislation;27

make ADR more attractive to taxpayers;

help the IRS manage its scarce resources; and

reduce the IRS's cycle time and oversized caseload.

I have one final thought for the IRS commissioner and his senior executives as they continue to promote a balanced offering of taxpayer service and enforcement. In both the commercial world and at federal agencies that are optimizing the use of ADR, favorably resolved mediations have had a measurably positive impact on future relationships by improving the parties' perceptions and reducing conflict. In successful mediations, the neutral party is often able to help the parties not only resolve the dispute, but reach an agreement that better fits with their needs and interests. This all suggests that a proactive system of early intervention and conflict management in the IRS's ADR programs could provide a unique platform for it to balance and advance under one umbrella its twin service and enforcement strategies.

In the long run, improved taxpayer compliance, perhaps more than anything else, could be the compelling legacy of the ADR Center.

Footnotes

1 ''Jousting With the Tax Man: An Extreme Makeover, IRS Edition,'' Tax Notes, Mar. 9, 2009, p. 1241, Doc 2009-2078, or 2009 TNT 44-8.

2 For 2008, of the eligible cases, only one of about every 4,500 cases that closed at Appeals used an ADR program.

3 While some recent improvement is seen, during the last three years the largest corporate cases (coordinated industry cases) took, on average, anywhere from 654 to 813 days to work their way through the appeals process. This is after a lag, on average, of 1,374 days from the tax return filing date to the end of the audit, and it includes 895 days for the audit itself (2008 data). That makes the total ordeal, on average, from 5.5 to 6 years.

4 The MAPI survey is mentioned several times, and readers are cautioned that statisticians would likely view the response rate (that is, the sample size) as insignificant.

5 There is a fast-track settlement program for the Large and Midsize Business Division (LMSB) (Rev. Proc. 2003-41, 2003-25 IRB 1047, Doc 2003-13532, 2003 TNT 107-13); one for Tax Exempt and Government Entities (TE/GE) (Announcement 2008-105, 2008-48 IRB 1219, Doc 2008-25227, 2008 TNT 232-8); and one for Small Business/Self-Employed (SB/SE) (Announcement 2008- 10, 2008-7 IRB 445, Doc 2006-15911, 2006 TNT 163-5). The fourth is a fast-track mediation program for SB/SE taxpayers (Rev. Proc. 2004-44, 2004-31 IRB 134, Doc 2004-13949, 2004 TNT 131-14). Each has limitations on the types of issues that qualify, and the IRS must agree to the taxpayers' fast-track request.

6 The MAPI survey question reads: ''On a scale of 1-10, with 10 being total satisfaction, what level of satisfaction did your company experience with LMSB Fast Track?'' The response: 4.38. There are many reasons cited for the low satisfaction rate: lack of independence of the Appeals mediator; the 120-day resolution window is too short for complex or multiple issue cases; Exam's reluctance to participate because of the IRS ''currency'' initiative; Exam's entrenched issue positions make compromise unlikely; the program rarely works if the taxpayer expects a full concession; any issue that is not eligible will disqualify the entire case; and the involvement of the chief counsel's office impedes the process.

7 The author does not advocate any form of mandatory arbitration given the binding and definitive nature of the process. 8The MAPI survey question reads: ''In most federal district courts, some form of non-binding mediation is mandatory before the case can proceed to discovery or trial. Would you support some form of mandatory non-binding mediation at a pre-docket, administrative stage with the IRS?'' The response was 77.8 percent yes, 22.2 percent no.

9 The MAPI survey question reads: ''Would you support a change in the Fast-Track Settlement and Post-Appeals Mediation Programs that called for the use of truly independent neutrals as mediators rather than Appeals trained mediators?'' The response was 96.3 percent yes, 3.7 percent no.

10 A thoughtful discussion of this topic is in the OECD's 2008 ''Study Into the Role of Tax Intermediaries,'' Annex 7.2, The Impartial Approach (pp. 73-77).

11 The IRS does not institutionally set tax revenue budget targets, and tax collection quotas for IRS employees are prohibited under the 1998 IRS Restructuring and Reform Act.

12 David Parsly, ''The Internal Revenue Service and Alternative Dispute Resolution: Moving From Infancy to Legitimacy,'' 8 Cardozo J. Conflict Resol. 677, 689 (2007).

13 It might make sense to scrap the four pre-Appeals fasttrack mediation programs. They have been little used by taxpayers (see supra notes 5 and 6), and I believe the ADR Center would become the focal point of most ADR activity at the IRS. I would, however, welcome an ''early neutral evaluation'' process for disputed issues before the conclusion of the audit. Here the neutral would intervene not to facilitate negotiations, but strictly to review the parties' factual and legal positions and then provide them with an evaluation of the likely court outcome. The process is meant to give the parties an early reality check on their positions, and the written evaluation often allows for a quick settlement.

14 Multiple issue cases also present opportunities because many cases have a ''keystone'' issue and some ''trailers'' and if the key issue is successfully mediated, then the rest typically fall into place.

15 The existing post-Appeals mediation procedure (Rev. Proc. 2002-44, 2002-2 C.B. 10, section 5.16, Doc 2002-13807, 2002 TNT 111-12) implicitly sanctions a linked process for mediation followed by arbitration.

16 In the commercial ADR world, the mediator's subject matter expertise is often seen as a plus, but some also believe it is nonessential and that the key to success is a deep understanding of the principles and practices of ADR. This latter view rests on the premise that the mediator's role is to influence the result by facilitating discussion so the parties are significantly involved in formulating the resolution. In arbitration, subject matter expertise is more important, because the neutral acts as a private judge and renders a binding decision.

17 Appeals maintains a ''neutral roster'' that currently has 259 names. The roster includes attorneys from diverse private, public, and academic backgrounds — some with ADR experience and almost all with tax backgrounds — and former Tax Court judges. While Appeals accepts all applications and does not screen the roster, it would provide a good starting point for the ADR Center pool.

18 In the commercial world, arbitration often results because the parties contractually agree in advance to the procedure. In the tax world, that agreement can come only after the dispute has arisen. The definitive and binding quality of arbitration is generally thought to make it less popular than its counterpart, nonbinding mediation.

19 Three-person panels normally are formed by each party picking one member, with the two selected choosing the chair from an agreed-on short list provided by the parties. This approach tends to minimize delay and rancor that can sometimes occur if only one arbitrator is to hear the case.

20 An example of nonqualifying cases is collection due process, currently making up about one-third of Appeals' cases. Another is cases or issues designated by chief counsel for litigation.

21 For the fiscal year that ended September 30, 2008, Appeals closed out a whopping 106,000 cases, but its year-end inventory still increased by 16 percent, from 51,502 to 59,899 cases. The Obama administration and Congress were generous to the IRS in its 2009 budget allocations, and Appeals has gone on a hiring spree. But it is starting from a deep hole, and extended economic hard times will only serve to make these numbers worse as taxpayers and their advisers look for ways to put off their day of reckoning with the tax man. Also, the new-found audit enforcement resources aimed at sophisticated individual and corporate taxpayers will aggravate the problem. While eventually producing added tax revenues, they will also create more resource-intensive disputes at exam and Appeals.

22 It is understood that the percentage has slipped over the years from a high of 95 percent a decade ago.

23 Taxpayers, of course, have no discretion over the size of the gratuity to adjust for the quality of service. The interest rate is tied to the federal funds rate, and for the last three years it fluctuated between 5 percent and 8 percent annually. Postaudit, companies pay 2 percentage points more — known as ''hot'' interest. One thing is certain in today's slow-motion process: The gratuity likely will exceed the standard 15 percent to 20 percent we leave at restaurants.

24 Most IRS ADR programs were introduced through a pilot based on a two-year timeline.

25 The sustention rate is the ratio of adjustments proposed by exam to the final adjustment after Appeals concludes the case. A 1995 GAO Report on International Taxation put the number at between 21 percent and 52 percent for an eight-year period involving section 482 issues.

26 The MAPI ADR survey posed this question: ''On a scale of 1-10, with 10 being the most favorable, what is your opinion of the level of IRS commitment to itsADR programs?'' The average response was 5.68.

27 The 1998 IRS Restructuring and Reform Act required the IRS to broaden its ADR programs. See section 7123 of the act.

This article is designed to give general information on the developments covered, not to serve as legal advice related to specific situations or as a legal opinion. Counsel should be consulted for legal advice.

Mr John. Klotsche

Caplin & Drysdale

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Suite 1100

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