Pros and cons of the new IRS mediation program.

An alternative to litigation.

In general, a popular alternative to litigation to resolve disputes has been the use of alternative dispute resolution programs (such as arbitration and mediation); however, until recently, such programs and procedures were not available for disputes between the Internal Revenue Service and taxpayers.

As noted in the January "Tax Briefs" (JofA, page 39), the service has expanded the use of mediation in tax disputes. Under a test program ending in October, taxpayers can elect to resolve certain tax controversies with the IRS rather than risk litigation. While this may be helpful to some taxpayers, there are still several issues that must be considered before mediation may be available or appropriate.

SCOPE OF THE PROGRAM

This test program will apply only when agreement cannot be reached on an issue after good-faith negotiations in the normal IRS Appeals process have been unsuccessful. In addition, it will be available only for certain factual issues, such as valuation, reasonable compensation or transfer pricing.

SELECTION OF MEDIATOR

The most critical issue is selection of the mediator. The person chosen must be mutually acceptable to all the parties. Co-mediators can be used in any case, and may be suitable for complex issues.

The mediator may be an IRS representative (from the Appeals division) or someone from outside the service. If an IRS employee is chosen, the service bears the full cost; if not, the taxpayer and the IRS share the cost.

At a minimum, the mediator must have previous mediation experience or training. Other criteria for selecting a mediator include substantive knowledge of tax law and industry practices as well as each candidates' travel costs, hourly fees and other expenses. If the parties cannot agree on a mediator, the Federal Mediation and Conciliation Service or the Administrative Conference of the United States may assist; in addition, tax accountants and lawyers with mediation training and experience can be found in CPA firms, law firms and universities.

The mediator must not have an undisclosed (personal, official or financial) conflict of interest with the parties. If one exists, the mediator must fully disclose it to the parties in writing, and the parties must decide whether to allow the mediator to serve.

Once chosen, a mediator can't represent the taxpayer or any other party in any pending or future action involving the pertinent transactions or issues. In addition, the mediator's firm is disqualified from representing the taxpayer or any other party involved in the mediation in any actions before the IRS that involve both the same tax year and the transaction or issues that are the particular subject matter of the mediation.

If the action involves a different tax year but the same transaction or issues, the mediator's firm is not disqualified if it uses screening processes that preclude the mediator from any form of participation in the matter (including direct apportionment of the resulting fee).

Confidentiality. As part of the mediation process, any mediator or other person is given access to all of the taxpayer's returns or return information pertaining to the issues being considered, but the process must remain confidential. Thus, the mediator and the participants cannot voluntarily testify in court about the contents of a mediation session or disclose any information regarding the process or any communications made during the process, including the settlement terms.

Use of IRS personnel as mediators. IRS employees are required to report information regarding violations of any revenue laws. Therefore, iran IRS mediator discovers additional tax issues not under investigation during the mediation, he or she must disclose them to the service. In addition, with an IRS mediator, a taxpayer may have serious doubts about the mediator's neutrality.

For a discussion of the pros and cons of using mediation, and the advantages and disadvantages of CPAs serving as mediators, see "Mediating With the IRS," by John Beehler, in the May 1996 issue of The Tax Adviser.

--Nicholas Fiore, editor The Tax Adviser

Clarification: In the February "From The Tax Adviser" (page 34), the first sentence under the heading "WHAT'S INVOLVED" should have read (in part) "...household employers must report and pay Federal Insurance Contributions Act, Medicare and Federal Unemployment Tax Act taxes and income tax withheld on an annual basis when filing their form 1040s."