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IRS alternative dispute resolution initiatives.

Looking for an alternative to court in resolving an IRS dispute? The Service has myriad ways of dealing with taxpayer contests that do not involve litigation. This article details the current IRS alternative dispute resolution programs and expected additional procedures.


* The IRS's stated goal is to resolve taxpayer disputes at the lowest possible level and as early in the process as is practicable.

* The IRS offers pre-filing ADR procedures, audit and Appeals procedures and litigation ADR procedures.

* Controversy over confidentiality erupted when the IRS agreed, after a lawsuit, to begin disclosing redacted APA information.

For years, the IRS has moved toward earlier resolution of taxpayer disputes. Its stated goal is to resolve them at the lowest possible level, as early in the process as practicable.(1) This is expected to lead to reduced taxpayer burden and increased voluntary compliance. New dispute resolution efforts between the IRS and taxpayers have shown much potential and continue to evolve.

The IRS Appeals function (Appeals) can resolve a dispute with taxpayers based on the hazards of litigation and the cost of taking a case to trial. Historically, it has been highly successful in minimizing the number of litigated cases. Appeals contributes greatly to resolving taxpayer disputes before litigation; approximately 85% of its cases are resolved before trial.(2) However, even with this success rate, the courts are still overburdened with tax cases. Thus, the IRS has implemented various alternative dispute resolution (ADR) procedures to improve the Appeals process and resolve disputes before trial. This effort is consistent with the ADR trend in the American legal system today.(3)

This article discusses IRS ADR procedures, categorizes them by when they apply and notes their potential benefits and risks. It also addresses the mandate of the Internal Revenue Service Restructuring and Reform Act of 1998 (IRSRRA '98) to expand ADR procedures to more taxpayers. Knowledge of these ADR techniques allows tax advisers to help clients choose an appropriate procedure.


In this article, IRS ADR procedures are categorized by when they apply. Some apply before a return is filed; these are "pre-filing ADR procedures." Others apply after a return has been filed and is subject to audit and Appeals; these are "audit and Appeals ADR procedures." Finally, some procedures apply during litigation; these are "litigation ADR procedures." See Exhibit 1 on p. 117 for a list of available ADR procedures in these categories.

Exhibit 1: IRS ADR Procedures
Pre-filing ADR

APA (Rev. Proc. 96-53; Notice 98-65)
Pre-filing Determination (Rev. Proc. 99-1)
Advance Valuation of Art (Rev. Proc. 96-15)

Audit and Appeals ADR

Expanded Settlement Authority (Delegation
Orders 236 (Rev. 3) and 247 (Rev. 1))
AIR (Rev. Proc. 94-67)
Early Referral Procedures (Rev. Proc. 99-28)
CSP (Notice 98-21)
Competent Authority (Rev. Proc. 96-13)
Mediation (Ann. 98-99)

Litigation ADR

Mediation (Ann. 98-99)
Arbitration (Tax Court Rule 124)

Pre-filing ADR Procedures


The advance pricing agreement (APA), program is the highest-profile IRS ADR procedure; it allows a multinational corporation to negotiate an agreement with the IRS on an appropriate transfer pricing methodology (TPM) for international intercompany transactions. An APA assures a taxpayer that a particular TPM is approved by the IRS before a return is filed.

The IRS implemented the APA program in 1991 because of the number and complexity of cases in the Sec. 482 transfer pricing area.(4) The APA program has been extremely successful, as shown by the (1) significant growth in the number of APA cases each year since inception(5) and (2) widespread establishment of similar APA programs by other countries.(6) Some commentators have attributed the proliferation of new IRS ADR procedures to this success.(7)

The APA process is designed to be a flexible problem-solving process, based on cooperative and principled negotiations between a taxpayer and the IRS.(8) A taxpayer proposes a TPM and provides data to show that applying it to international intercompany transactions yields the best method (based on the Sec. 482 regulations) to reflect arm's-length results. The taxpayer must use relevant pricing data from closely comparable uncontrolled transactions. Often, an APA involves agreements with foreign competent authorities under income tax treaties with other countries.

To participate, a taxpayer must file an APA request before the deadline (including extensions) for filing the return for the first tax year to be covered by the APA. For this purpose, payment of the applicable user fee constitutes filing if a substantially complete APA request is filed within 120 days thereafter.(9)

Small business taxpayers may also obtain APAs.(10) The IRS has streamlined the process for routine transactions and reduced the documentation requirements and costs for such taxpayers.

To promote consistency, efficiency and voluntary compliance, the IRS encourages "rollbacks" of a TPM under an APA to open prior tax years. This is feasible whenever records are available and the facts and law are consistent with the years for which the TPM was approved. The taxpayer may request consideration of a rollback; the IRS may determine (whether requested or not) that a TPM be rolled back.(11) This can be both a benefit and a concern; the IRS may try to employ a rollback even if the taxpayer does not request or expect it. Even if consistency of facts or law is not present, a TPM may be rolled back as long as adjustments are made to reflect differences in facts, economic conditions and law from an approved APA.

Confidentiality is another concern. The success of the APA program has been partly attributable to the assurance of confidentiality accompanying the agreement. However, the IRS planned to begin disclosing redacted APAs in October 1999.(12) Much controversy surrounded this decision; many high-profile corporations questioned whether confidentiality could be maintained; some tax executives called for legislation to address this issue.(13) A recently enacted bill provides (1) that APAs are confidential and (2) for an IRS APA annual report with summaries of approved methodologies.(14) When this legislation was pending, the IRS asked a district court to delay by 11 months the Oct. 18, 1999 start date for issuing redacted APAs.(15)

Pre-filing Determinations

Some taxpayers want to know the tax implications of transactions already completed before filing a return. Pre-filing determinations(16) allow the IRS and a taxpayer to agree on the treatment of such transactions and give the latter assurance that the IRS will accept the agreed-on tax treatment. However, pre-filing determinations are not concluded with a closing agreement. Such determinations are typically requested for noncontroversial issues, such as the qualification of a pension plan or tax-exempt organization status. They are available to all types and sizes of taxpayers, including small businesses.

There are limits on the availability of a pre-filing determination letter.(17) First, issuance is limited to a written request to the District Director on a completed transaction that affects a return over which the district has or will have examination jurisdiction. Second, it will not be issued for a return question if the same question is involved in a return already filed. Third, it cannot be issued if (1) the taxpayer has directed a similar inquiry to the National Office or (2) the same issue, involving the same or a related taxpayer, is pending in litigation, Appeals or an in-process examination. These limits contribute to the small number of pre-filing determinations issued.(18)

The pre-filing determination process is voluntary; either the taxpayer or the district can terminate it at any time. The district has final authority to accept or reject a pre-filing determination request for consideration. A taxpayer receiving a pre-filing determination letter signed by the District Director should attach it to the return when filed.(19) If a taxpayer takes a position contrary to the pre-filing determination, the letter and a statement

to that effect should be attached to the return when filed to satisfy the adequate disclosure requirement. A taxpayer takes a risk when requesting a pre-filing determination letter; if he does not agree with the IRS determination, the IRS is fully aware of the situation and likely to challenge any contrary position the taxpayer takes.

Arguably, letter rulings are pre-filing determinations, because they are obtained prior to filing. The main difference between them and pre-filing determinations is that letter rulings are requested for contemplated (rather than completed) transactions. In addition, letter rulings are issued by the IRS National Office, not a District Director.

Advance Valuation of Art

Another IRS procedure(20) allows taxpayers to obtain a statement of value (SOV) for certain works of art contributed to charity or includible for income, gift or estate tax purposes. This method is available to all taxpayers eligible for a charitable deduction or subject to estate or gift tax (including individuals, corporations, partner' ships, estates and trusts). An SOV may be obtained after the transfer but before the applicable return has been filed, for transfers by contribution, gift or death. The IRS is not authorized to issue an SOV for works of art before their actual transfer. Prior policy forbade IRS approval of any valuation before the actual filing of returns.(21) SOVs assure taxpayers of the value of transferred items before filing returns, giving them peace of mind and reducing the possibility of interest and penalties on future audit.

The works of art covered by the procedure include paintings, sculpture, watercolors, prints, drawings, ceramics, antique furniture, decorative arts, textiles, carpets, silver, rare manuscripts, historical memorabilia and similar objects. Certain items must accompany an SOV request; these vary slightly depending on whether the request is for income tax charitable deduction purposes or for estate or gift tax purposes. See Exhibit 2 on p. 118 for a summary of items to be included in the request. A taxpayer may withdraw a request at any time before the issuance of an SOV, but the user fee will not be refunded.

Exhibit 2: Items to Accompany an SOV Request
Charitable deduction Estate or gift tax

Copy of appraisal Copy of appraisal
User fee User fee

Form 8283, Noncash Charitable Description of art item
Contributions, Section B,
Appraisal Summary Appraised FMV

District office location Cost of item
that has (or will have)
examination jurisdiction Date and manner acquired
over the return
 Valuation date(*)

 District office location
 that has (or will have)
 examination jurisdiction
 over the return

(*) Date of death (or alternative valuation date) for estate tax purposes; date of gift for gift tax purposes.

The user fee is $2,500 to obtain an SOV for up to three items; additional items in the same request will be appraised for $250 each. To be eligible for advance valuation, an item must generally have a fair market value (FMV) of at least $50,000. However, if an item has a smaller FMV, an SOV can be obtained if at least one item in the request has an FMV of at least $50,000 and the IRS determines that an SOV would be in the best interest of efficient tax administration. The combination of the user fee and the dollar limit reduces the number of SOV requests.

If an SOV request is received after July 15 but before the following January 16, the IRS will issue an SOV by the following June 30. If the request is received after January 15, but before July 16, an SOV will be issued by December 31 of that year.

The SOV must be attached to the return reporting the item of art, whether or not the taxpayer agrees with it. If a taxpayer fries a return containing an item of art before receiving an SOV, a copy of the SOV request must be attached to the return. An amended return, with the SOV attached, must be filed after the SOV is received. If a taxpayer disagrees with an SOV, additional information should be submitted with the return supporting a different value. An SOV has precedential value only to the taxpayer requesting it.

The IRS Art Advisory Panel reviews valuations of artwork for both filed returns under examination or in Appeals and for SOVs. The percentage of SOV valuations is small compared to the number of valuations for examination and Appeals. For example, in 1997, SOVs represented 8% of cases, 14% of items and 21% of the value of all valuations the Panel reviewed.(22) Historically, the valuations for approximately 50% of items submitted are accepted by the Panel.

Audit and Appeals ADR Procedures

Expanded Settlement Authority

Coordinated Examination Program (CEP)(23) case managers have limited settlement authority(24) regarding rollover and recurring issues.(25) This includes the power to execute closing agreements and Forms 870-AD, Offer of Waiver of Restrictions on Assessment and Collection of Deficiency in Tax, to effect final settlement. In 1996, as the result of the IRS Task Force on Examination Settlement Authority, the IRS expanded and clarified the authority of examination case managers in CEP cases. Also, Industry Specialization Program and International Field Assistance Specialization Program cases became eligible for settlement by case managers.(26)

The goal of expanded settlement authority is to ensure that tax disputes are settled at the lowest possible level. Case managers may use a previous Appeals settlement with a taxpayer (or another directly involved taxpayer) in a CEP case to resolve the same issue in a different tax year, if four factors are present:

1. The facts surrounding a transaction or taxable event in the tax period under examination are substantially the same as the facts in the settled tax period.

2. The legal authority relating to the issue in question has remained unchanged.

3. The underlying issue was settled by Appeals independently of other issues.

4. The issue was settled in Appeals for the same taxpayer (including subsidiaries) or another taxpayer who was directly involved in the transaction in the settled tax period.

Expanded settlement authority is useful to CEP taxpayers that had a favorable Appeals settlement in a prior year. By extending it to the present, the taxpayer is assured a continued favorable result. Unfortunately, this procedure is currently not available for non-CEP taxpayers (such as small businesses).

In the past five fiscal years, 150 cases have been resolved under this expanded settlement authority.(27) This has saved taxpayers and the IRS both time and money and has further increased the rate of CEP cases settled at the examination level.(28)


Taxpayers involved in a CEP audit can enter into an Accelerated Issue Resolution (AIR) agreement(29) with the IRS; this is a closing agreement under Sec. 7121 that extends the resolution of issues arising under audit for a particular period to all subsequently, filed returns for tax periods ending before the date of the AIR agreement. This provides a CEP taxpayer with certainty of results for the subsequent tax years as well. To date, the IRS has stated that 118 AIR agreements have been made over the last five years. AIR agreements are not currently available to non-CEP taxpayers (such as small businesses).

A taxpayer begins the AIR process by filing a written request with the CEP case manager; there is no user fee. The process is voluntary; either party can withdraw at any time. Sometimes, the District Director cannot enter an AIR agreement until approval is received from another part of the IRS involved with the issues (e.g., Competent Authority). Further, District Counsel must review an AIR agreement before it is final. The District Director will generally approve the AIR agreement if there appears to be an advantage to permanently and conclusively resolving the issues for the years it covers.

An AIR agreement can only include issues under the jurisdiction of the District Director. Certain issues are excluded, such as those involving APAs, employee plans, exempt organizations, partnership items and issues designated for litigation or resolved contrary to prior rulings and agreements with the taxpayer.

A taxpayer faces a risk if an AIR request is withdrawn before resolution or otherwise does not result in an agreement. The IRS may become privy to information that may be considered in subsequent dealings. If the IRS chooses not to extend settlement to subsequently filed returns, the taxpayer should be suspicious of its motives; the IRS has no obligation to provide an explanation. Conversely, the IRS may become suspicious if a taxpayer withdraws during the AIR process; this may cause subsequently filed returns to be scrutinized.

Early Referral Procedures

Early referral is the process by which taxpayers may request that a contested issue be considered by Appeals, while other issues remain subject to Examination.(30) Early referral is optional and designed to provide for early resolution of an entire case, because both Examination and Appeals work simultaneously on unresolved audit issues. To date, early referral procedures have been used in more than 60 cases, with $8 billion at issue.(31) Early referral benefits taxpayers who know they will take certain items to Appeals in any case, but want to efficiently conclude the rest of an examination.

IRSRRA '98 Section 34650)(1), adding Sec. 7123(a), made all 'taxpayers eligible for early referral, including small businesses. Rev. Proc. 99-28(32) prescribed updated procedures.

A taxpayer requests early referral to Appeals in writing to the case manager; there is no user fee. The early referral is subject to both the District Director's and Appeals' approval. The request must identify issues for which an early referral is sought, the taxpayer(s) involved and the applicable tax period(s) to which those issues relate. Further, the taxpayer's and IRS's positions must be delineated, including a discussion of the material facts and a legal analysis of the issue(s). The request must be signed by the taxpayer and accompanied by a perjury statement.(33)

The case manager must notify the taxpayer within 14 days whether the issues have been approved for early referral to Appeals. If early referral is denied, the taxpayer may obtain an administrative appeal of the issue later. There is no formal appeal if the taxpayer is denied an early referral request; however, the taxpayer can request a conference with the supervisor of the case manager who denied the request.

If early referral is approved, Form 5701, Notice of Proposed Adjustment, will be issued. The taxpayer has 30 days to respond in writing to each issue. A timely response enables the early referral file to be sent to Appeals. Failure to respond within the allotted time is considered a withdrawal of the request.

Once Appeals considers an early referral issue, Form 906, Closing Agreement on Final Determination Covering Specific Matters, is completed if an agreement is reached. A taxpayer may request mediation for an early referral issue for which no agreement is reached. If mediation is not requested or is unsuccessful, the issue is returned to Examination and a deficiency notice issued.(34)

An issue is appropriate for early referral if it is part of a case in which the remaining issues are not expected to be completed before Appeals can resolve the early referral issue. Caution may be warranted if the taxpayer believes that the result for the issue(s) under early referral may affect the resolution of other issues still under examination. Examination may wait for an Appeals resolution before officially settling on related issues. In that case,

a negative Appeals result could have further negative consequences. The best defense may be to carefully choose the issues for which to seek early referral; an early referral of related issues may be the best strategy.


In 1996, the IRS began an optional program to settle worker classification disputes.(35) The classification settlement program (CSP) was originally approved for a two-year test period ending March 5, 1998, but, due to its success, was subsequently extended indefinitely.(36) The CSP procedures allow businesses and IRS examiners to resolve worker classification issues as early in the administrative process as possible. In addition, they should ensure that the RA '78 Section 530 relief provisions are properly applied. The results obtained by the taxpayer under the CSP are supposed to simulate the results under current law if the business had instead exercised its right to administrative and/or judicial appeal. CSP procedures apply to all sizes and types of taxpayers (including small businesses).

Worker classification has historically been a major area of contention between the IRS and taxpayers. A 20-factor test is applied to distinguish between independent contractors and employees(37); it focuses on the extent to which the business has the right to direct and control its workers' performance. Even if a business misclassifies a worker as an independent contractor, RA '78 Section 530 relief is still available, if three requirements are met: (1) reporting consistency, (2) substantive consistency and (3) reasonable basis.(38) RA '78 Section 530 relief allows a business to maintain a worker's classification as an independent contractor without the imposition of taxes or penalties. See Exhibit 3 at left for a description of these requirements.

Exhibit 3: RA '78 Section 530 Requirements

1. Reporting consistency: All Federal tax returns (including information returns) required to be filed by the taxpayer with respect to the individual for the period, must have been filed on a basis consistent with the business's treatment of the individual as not being an employee.

2. Substantive consistency: The business must have consistently treated similarly situated workers as independent contractors. If the business treated a similarly situated worker as an employee, RA '78 Section 530 relief is not available.

3. Reasonable basis: The business must have had a reasonable basis for not treating the worker as an employee. This may consist of reasonable reliance on judicial precedent, a published ruling, a letter ruling or TAM issued to the taxpayer; the results of a past audit of the taxpayer; or a long-standing recognized practice of a significant segment of the industry. Any other reasonable basis will also suffice.

For the CSP to apply, the examiner must first determine whether a business has misclassified a worker as an independent contractor. This occurs only after complete development of the issue, including fact gathering and consideration of eligibility for RA '78 Section 530 relief. The IRS examiner must consult with the Examination group manager to decide if the business is eligible for a CSP settlement offer. If an offer is made, it is accepted when the parties sign a CSP closing agreement from the National Office.

Under the CSP, a series of graduated settlement offers will be available depending on the status of the case and whether various requirements of the RA '78 Section 530 relief provision are met. Exhibit 4 below presents four cases illustrating when various CSP settlement offers apply.

Exhibit 4: CSP Settlement Offers
 Case 1 Case 2 Case 3 Case 4

Reporting consistency? Yes Yes Yes Yes
Substantive consistency? Yes Yes No Arguable
Reasonable basis? Yes No Yes Arguable

CSP settlement offer N/A 100% 100% 25%
(assessment for one year)

Future worker classification IC EE EE EE

EE = employee

IC = independent contractor

N/A = not applicable (RA '78 Section 530 relief is not available)

For each case presented in Exhibit 4, the business has met the reporting consistency requirement; had it not, neither RA '78 Section 530 relief nor a CSP settlement offer would be available. In Case 1, all three requirements for RA '78 Section 530 relief are met. No CSP settlement offer is made here, because RA '78 Section 530 relief applies; the business may continue to classify its workers as independent contractors. The CSP does not apply.

In Case 2, the business meets only the reporting consistency and substantive consistency requirements. The CSP offer is a 100% employment tax assessment(39) for the one tax year under examination. In Case 3, only the reporting consistency and reasonable basis requirements are met; the same CSP offer applies as in Case 2. In each case, the business must agree to prospectively classify its workers as employees.

In Case 4, the business meets only the reporting consistency requirement; however, it has colorable arguments that it meets the substantive consistency and reasonable basis tests. The CSP offer is an assessment of 25% of the employment tax liability for the audit year, plus a prospective classification of workers as employees.

A major benefit of CSP settlement offers is that the assessments do not include open tax years preceding the audit year; they are based only on the employment tax liability for the audit year. CSP offers are designed to consider the hazards of litigation for both parties in an attempt to reach a settlement. In the past, examiners typically have not been allowed to consider the hazards of litigation when proposing adjustments, resulting in many cases in Appeals and in litigation (with significant costs to all parties). Without going to Appeals or to trial, the parties may agree to settle under the CSP as a reasonable compromise.

CSP settlement offers are made based on classes of workers. Some businesses may have multiple classes of workers; one CSP offer may apply to one class (e.g., 100%), while another CSP offer may apply to another (e.g., 25%). For a third class of workers, the business may be eligible for RA '78 Section 530 relief.

A CSP offer may be accepted at any time during the examination, but a taxpayer is under no obligation to accept. Rejection of an offer should not affect the audit's outcome. In any case, the taxpayer retains all rights to take the issue to Appeals and/or court.

Some practitioners believe that the CSP program is being applied unreasonably,(40) citing examples in which IRS agents have threatened to expand an audit to all open tax years if the taxpayer does not agree to pay 100% of one year's tax, when a 25% offer would be more appropriate. They recommend taking these situations to Appeals and/or court. Rev. Proc. 99-28 suggests that a taxpayer who does not agree with a CSP offer's terms or is not eligible for settlement should consider an early referral to Appeals. In any case, a tax practitioner should not recommend that a taxpayer settle if the terms are not appropriate given the other options available.

Competent Authority

Rev. Proc. 96-13(41) provides that taxpayers may request U.S. competent authority assistance (CAA) in matters involving income, estate or gift tax treaties between the U.S. and other countries. CAA may be requested whenever the U.S.'s or a treaty country's actions could result in taxation contrary to treaty provisions. When the tax ramifications of a transaction under a treaty are uncertain, the U.S. competent authority can be requested to intervene and resolve the uncertainties via negotiations with the foreign competent authority. Taxpayers should request CAA both to clarify the tax treatment of an international transaction and to remedy inappropriate international tax results. The Assistant Commissioner (International) is the U.S. competent authority responsible for administering, interpreting and applying tax treaties.

According to the IRS Tax Treaty Division, the IRS received an average of 206 requests for CCA each year for the past four years, but disposed of only 180 cases per year in the same period; this results in an average increase of 26 cases per year. The average processing time for a competent authority case was 761 days for the most recent fiscal year, a 39% increase over the last two years. In over 91% of the cases in the last five years, "full relief" from double taxation was granted; "partial relief" occurred in about 3% of the cases. "No relief" occurred in only about 6% of the cases.

A CAA request must be in writing and provide detailed information about the issues, taxpayers, treaties, transactions, relationships, years involved and relief sought. The taxpayer may request a pre-filing or a post-resolution conference with the U.S. competent authority.

The U.S. competent authority must notify the taxpayer if the request for assistance is approved. A denial is final and not subject to administrative review. If a request is approved, the U.S. competent authority contacts the foreign competent authority and attempts to reach an agreement. The taxpayer must be notified of any agreement reached and can either accept or reject its terms. If accepted, a closing agreement is typically drafted to reflect the terms. If rejected, the taxpayer may withdraw the CAA request and pursue other available options under the laws of the countries involved.

The IRS has implemented three special procedures in this area: (1) a small case procedure; (2) an accelerated procedure; and (3) a simultaneous Appeals-Competent Authority procedure. The CAA small case procedure is simpler and requires that less information initially be submitted. This procedure can be requested only if the proposed adjustment does not exceed $100,000 for individual taxpayers ($200,000 for corporations and other taxpayers). It is useful to small businesses with international transactions.

The accelerated competent authority procedure is similar to the AIR program previously discussed, and enables a taxpayer requesting CAA to resolve an issue for both the period in question and subsequent tax periods ending before the CAA request date. For this procedure to apply, the issues and facts must be substantially identical between years.

The simultaneous Appeals-Competent Authority procedure allows a taxpayer to request that Appeals consider an issue already under review (or to be reviewed) by the U.S. competent authority. This can be done as part of the taxpayer's initial CAA request or via a later statement. Alternatively, this procedure can be requested for a case already in Appeals if the taxpayer later desires CAA. The U.S. competent authority can also request Appeals' involvement when it deems a settlement to be appropriate; in such case, it will notify the taxpayer.

This procedure must coordinate the U.S. competent authority's efforts with the normal Appeals process. Appeals must consult with the taxpayer and the U.S. competent authority before the issue is presented to the foreign competent authority. This enables the tentative agreement to be consistent with the position the U.S. competent authority intends to take with the foreign competent authority. If the competent authorities fail to agree or the taxpayer does not accept the agreement, the taxpayer maintains the right to refer the issue back to Appeals.


In 1995, the IRS initiated a one-year test program for mediation of factual issues in CEP cases already in the Appeals administrative process and not docketed in court.(42) This typically involved taxpayers with more than $10 million in dispute.(43) Initially, the test program was extended for another year, then extended for another two years and expanded to include disputes over factual issues involving non-CEP taxpayers.(44) Cases with at least $1 million in dispute were eligible for mediation.

IRSRRA '98 Section 3465(a)(1), amending Sec. 7123(b)(1), further extended nonbinding mediation to all taxpayers, regardless of the amount in dispute. The success of the mediation program during the test periods and the focus on improved taxpayer service resulted in Congress increasing its scope. This will result in a significant increase in the number of cases subject to mediation, including small business cases, and require further procedural guidance. IRS procedures are expected soon for mediation of cases involving less than $1 million.

A new "fast-track" mediation program has been proposed by the IRS to cover Examination cases before they reach Appeals.(45) Comments have been solicited on this program; various unresolved issues remain.(46) Given the availability of early referral and mediation in Appeals, fast-track mediation might not represent an improvement over a combination of the other alternatives.

To date, mediation has been requested in 29 cases. Nine requests were denied because the criteria for mediation were not met. Of the remaining 20 cases, 10 mediations have been completed; 10 others are still in process. The success rate for the 10 completed mediations is 70% (seven successfully resolved, three not resolved). According to the IRS, the mediation process generally requires 90-120 days; actual mediation sessions are concluded in an average of 3 days.(47)

Mediation is a voluntary, nonbinding process in which a mediator acts as a facilitator (rather than a judge) to guide the parties to a negotiated agreement. The mediator does not render a decision; rather, he meets with the parties, focuses on key issues and the parties' interests, identifies potential options and aids the parties in finding a mutually advantageous solution.

As currently configured, mediation can only be used after Appeals settlement discussions are unsuccessful. Mediation may cover a single issue or multiple issues for which no settlement has been made in Appeals. Taxpayers should use mediation when the benefits of a potential compromise outweigh the net of expected benefits over the costs and hazards of litigation.

A taxpayer must request mediation in writing with Appeals. If the request is approved, the taxpayer and the IRS enter into an agreement to mediate. A model agreement appears in Ann. 98-99.(48)

The taxpayer and Appeals participate in a mediation; however, others with valuable expertise, experience and information useful to the parties and the mediator are encouraged to participate. The participants must include persons with decisionmaking authority. A model participants list is available in Ann. 98-99.

The selection of a mediator is very important; an independent mediator or an Appeals Officer can be selected. The IRS and the taxpayer divide the cost evenly if an independent mediator is chosen. Alternatively, the taxpayer incurs no charge for use of an Appeals Officer as a mediator. The taxpayer must sign a model consent regarding disclosure of returns and return information, acknowledging that all participants to the mediation have access to the taxpayer's return information for all issues to be considered. However, all participants are subject to confidentiality provisions for information disclosed during the mediation process.

A major disadvantage of selecting an Appeals Officer as a mediator is that all IRS employees have a duty under Sec. 7214(a)(8) to report to Treasury violation of any revenue law. This risk may make it cheaper to select an independent mediator.

Either party may withdraw from mediation at any time before reaching a settlement. The party choosing to withdraw must notify the other party and the mediator in writing.

Once the mediation is complete, the parties enter into a mediation agreement if a settlement is reached; the mediator completes a mediation report. A model mediator's report appears in Ann. 98-99. Normal Appeals procedures apply to finalize the agreement.(49) If the parties do not reach an agreement on the mediated issue(s), Appeals will not allow reconsideration and will issue a statutory deficiency notice.

Litigation ADR Procedures


In 1995, the IRS extended the use of mediation to cases docketed in Tax Court.(50) This has continued throughout all the test periods and is expected to continue under the IRSRRA '98 provisions. The same procedures described above for mediation of cases in Appeals apply to docketed Tax Court mediations.


Arbitration is a binding process; the arbitrator acts as a judge, soliciting arguments from both sides and ultimately resolving the case. Arbitration is particularly important when special expertise is needed to resolve a factual issue. A taxpayer should consider arbitration in such situations, especially if the arbitrator's expertise is likely to cast a more favorable light on his position.

The IRS has traditionally not been authorized to use arbitration in tax cases, except for those in the Tax Court.(51) Tax Court Rule 124 provides for voluntary arbitration of any factual issue. Both parties must agree to binding arbitration, by filing a motion with the court before trial. A stipulation must be attached to the motion that includes the issues to be resolved, the parties' agreement to be bound by the decision, the identity of (or the process to select) the arbitrator, the arbitrator's compensation, how it will be borne by the parties and a bar against ex parte communication with the arbitrator.

On receipt of the motion, the Tax Court Chief Judge will assign the case to a judge for supervision of the arbitration. The arbitrator is appointed by order of the court; the order may contain specific instructions to the parties and the arbitrator. The arbitrator's report is presented to the court on completion.

IRSRRA '98 Section 3465(a)(1), amending Sec. 7123 (b) (2), mandates that the IRS create a pilot program for binding arbitration of taxpayer disputes, regardless of the amount at issue.(52) The IRS is expected to issue procedures for binding arbitration for adjustments proposed in excess of $1 million. In time, procedures for smaller amounts should also be issued, making arbitration more readily available to small businesses.

A potential disadvantage of arbitration is that the arbitrator is not bound by precedent. If precedent is strongly in favor of a taxpayer, litigation may be a better choice after weighing the relative costs.

Small Business Eligibility

Many of the IRS ADR procedures were initially designed for large businesses; however, over time, many of them have evolved to include small businesses. Exhibit 5 on p. 126 lists the IRS ADR procedures and their current availability to small businesses.

Exhibit 5: Availability of IRS ADR Procedures to Small Businesses
IRS ADR Procedure Available to small businesses?
APA Yes; special procedures available
Pre-filing Determination Yes
Advance Valuation of Art Yes
Expanded Settlement Authority No; CEP taxpayers only
AIR No; CEP taxpayers only
Early Referral to Appeals Yes
Competent Authority Yes; small case procedure
Mediation Yes; procedures will soon be
 expanded for cases with less
 than $1 million at issue
Arbitration Yes; procedures expected in future


The IRS is expanding its use of ADR techniques in all dealings with taxpayers. The IRSRRA '98 recognized the benefits of IRS ADR procedures, by codifying existing procedures and encouraging more extensive ADR use. Specifically, the new law encouraged more early referrals to Appeals, mediation and other procedures and mandated a pilot program for binding arbitration for disputes of all sizes. This article has examined a wide variety of IRS ADP, procedures, categorized by when they apply. The ADR requirements were outlined and their benefits and risks discussed. Tax practitioners must be aware of all the ADR options when attempting to resolve conflicts between clients and the IRS.

(1) See IRS Policy Statement P-4-40 (3/26/79).

(2) See Louthan and Wrappe, "Building a Better Resolution: Adapting IRS Procedures to Fit the Dispute," 73 Tax Notes 850 (11/18/96).

(3) Judges in nontax cases generally encourage the use of ADR procedures before a case comes to trial; the IRS's ADR efforts follow this positive trend.

(4) See Rev. Proc. 91-22, 1991-1 CB 526, superseded by Rev. Proc. 96-53, 1996-2 CB 375.

(5) To date, more than 198 APAs have been issued; over 196 APAs are pending. Many taxpayers are currently engaged in pre-filing conferences to investigate the suitability of APA use.

(6) See Wrappe and Chung, "Current Status of Global Advance Pricing Agreement Programs," 28 Tax Mngmt. Int'l J. 163 (3/12/99).

(7) See Patton and Wood, "Rev. Proc. 96-53: Continuous Quality Improvement of the APA Process," 26 Tax Mngmt. Int'l J. 80 (2/14/97).

(8) Rev. Proc. 96-53, note 4 supra.

(9) Id., section 5.09(2). Under section 5.14, for 1999, the user fee is generally $25,000, decreasing to $5,000 for taxpayers with gross incomes of less than $100 million; the fee is $15,000 for taxpayers with gross incomes between $100 million and $1 billion.

(10) Notice 98-10, IRB 1998-6, 9. "Small business taxpayers" are defined as those with total gross incomes of less than $200 million; see Notice 98-65, IRB 1998-52, 10. The user fee is $5,000.

(11) Rev. Proc. 96-53, note 4 supra, section 3.06.

(12) See IR-1999-05 (1/11/99); "IRS Asks Court to Delay Deadline in Proposed Schedule for Release of APAs," 18 Tax Mngmt. Weekly Rep't 1508 (9/6/99).

(13) See Hamilton, "Treasury Considers Distinction Between APAs, Background Files," 82 Tax Notes 1911 (3/29/99); see also "Taxpayers Pursue Legislative, Court Options To Shield APA Data; Others Less Concerned," 18 Tax Mngmt. Weekly Rep't 490 (3/22/99).

(14) P.L. 106-170, Ticket to Work and Work Incentives Improvement Act of 1999, 106th Cong., 1st Sess. (12/17/99), Section 521.

(15) See "IRS Asks Court.... "note 12 supra.

(16) See IRM Handbook, No. 42(11)8, Sub-Section (14)51 (2/28/95).

(17) See id., Sub-Section (14)55.

(18) Per the IRS, only seven pre-filing determinations have been made to date (one in fiscal year 1996, four in fiscal year 1997 and two in fiscal year 1998).

(19) See IRM Handbook, note 16 supra, Sub-Section (14)53.

(20) Rev. Proc. 96-15, 1996-1 CB 627.

(21) Rev. Proc. 66-49, 1966-2 CB 1257, modified by Rev. Proc. 96-15, note 20 supra.

(22) The Art Advisory Panel of the Commissioner of the Internal Revenue, Annual Report for 1997.

(23) The CEP program is referred to as the "large case program" and involves a team approach to auditing the 1,500 largest corporations.

(24) See Commissioner's Delegation Order No. 236 (Rev. 3)(8/25/97).

(25) A "rollover" issue involves an adjustment arising from the same legal issue in the same transaction or taxable event affecting more than one tax period. Conversely, a "recurring" issue involves an adjustment arising from the same legal issue in a separate transaction or a repeated taxable event in which the taxpayer advances the same legal position as he advanced in a prior tax period.

(26) See IR-96-13 (3/18/96), Commissioner's Delegation Order No. 247 (Rev. 1)(8/25/97).

(27) According to the IRS, 142 cases have been resolved under Delegation Order No. 236, note 24 supra; eight cases have been resolved under Delegation Order No. 247, note 26 supra.

(28) previous IRS initiatives increased the rate of CEP cases settled at the examination level from 29% in fiscal year 1990 to 88% in fiscal year 1995.

(29) Rev. Proc. 94-67, 1994-2 CB 800.

(30) While Rev. Proc. 96-9, 1996-1 CB 575, superseded by Rev. Proc. 99-28, IRB 1999-29, 109, limited early referral to CEP taxpayers, IR-96-7 (3/5/96) stated that early referral in employment tax cases was not limited to CEP taxpayers. As discussed below, the IRSRRA '98 makes all taxpayers eligible for early referral.

(31) Speech by Thomas Carter Louthan, Director, Office of Alternative Dispute Resolution & Customer Service, National Office Appeals (5/14/99), "Administrative Appeal of Adverse IRS Determination of Tax Exempt Status of Bond Issue," Tax Analysts, Doc. No. 1999-17735.

(32) Rev. Proc. 99-28, note 30 supra, effective for early referral requests filed after July 19, 1999. The procedure also covers early referrals for issues relating to changes in accounting methods, employment taxes, collection, employee plans and exempt organizations.

(33) An early referral request cannot be made for an issue for which the taxpayer has filed (or intends to file) a request for Competent Authority. An issue (1) designated for litigation by the Office of the Chief Counsel or (2) part of a whipsaw transaction is likewise ineligible.

(34) A statutory deficiency notice (90-day letter) is sent if the only unresolved issue is an early referral issue that could not be settled by Appeals. A preliminary deficiency notice (30-day letter) may apply to an early referral issue if the examination is completed for another issue not subject to early referral.

(35) FS-96-5 (3/5/96).

(36) Notice 98-21, IRB 1998-15, 14. According to the IRS, the CSP offer acceptance rate during the test period was 80%; of that, 69% of offers were accepted at 100% of the tax assessment for one year, 30% were accepted at 25% of the tax assessment for one year and 1% of offers were to employers who were protected by Revenue Act of '78 (PA '78) Section 530, but agreed to change classification anyway.

(37) See Rev. Rul. 87-41, 1987-1 CB 296.

(38) See Jackson, Gee, Jr. and Knight, "How to Shift the Burden of Proof to the IRS on Independent Contractor Status," 28 The Tax Adviser 642 (October 1997).

(39) Generally computed under Sec. 3509.

(40) See Frank and Cooper, "Classification Settlement Program Is Being Applied Unreasonably," 59 Tax'n for Accountants 131 (September 1997).

(41) Rev. Proc. 96-13, 1996-1 CB 616.

(42) Ann. 95-86, IRB 1995-44, 27; see Beehler, "Mediating With the IRS," 27 The Tax Adviser 281 (May 1996).

(43) During the one-year test period, four out of nine total requests for mediation were approved.

(44) See Anns. 97-1, IRB 1997-2, 62, and 98-99, IRB 1998-46, 34.

(45) See Dougherty and Hill, Tax Practice & Procedures, "ADR Procedures," 30 The Tax Adviser 734 (October 1999).

(46) See letter from William Stephenson, National Society of Accountants, to Commissioner Charles O. Rossotti (8/3/99), Tax Analysts, Doc. No. 1999-25985.

(47) See note 31, supra.

(48) Ann. 98-99, note 44 supra.

(49) For example, Form 906 will normally be issued.

(50) See IRS Memorandum to Field Administrative Officers from Jennifer S. Turner (10/13/95) and Chief Counsel Directives Manual (CCDM)(35)3(20)0.

(51) See Executive Order 12988 (2/5/96) and Tax Court Rule 124, Voluntary Binding Arbitration.

(52) See Ann. 2000-4 for details of a new two-year test program.

John M. Beehler, Ph.D., CPA Chair, Department of Accounting College of Business Administration The University of Texas at Arlington Arlington, TX
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Author:Beehler, John M.
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Date:Feb 1, 2000
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