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Mediation under Announcement 95-2: IRS proposes dramatic extension of alternative dispute resolution.

Editor's Note: This article addresses the use of mediation in resolving tax disputes. Tax Executives Institute undertook to educate its members about mediation and other forms of alternative dispute resolution in the fall of 1993, at its 48th Annual Conference. In March 1994, the Institute's IRS Administrative Affairs Committee sponsored a conference session on the use of mediation in the Tax Court and Appeals. (The authors of this article - together with Chief Judge Lapsley Hamblem, then-acting IRS Chief Counsel David Jordan, and IRS National Director of Appeals James Dougherty - participated in the session.) TEI anticipates that it will testify at an upcoming public hearing on Announcement 95-2, and invites TEI members and other readers to submit their comments.

The Internal Revenue Service has recently taken its most dramatic and potentially most useful step toward adoption of traditional alternative dispute resolution techniques for tax matters. In Announcement 95-2, 1995-2 I.R.B. 59, the IRS proposed to test for a one-year period the use of mediation procedures to resolve certain issues under consideration in Appeals. This farsighted decision is a welcome change of position on this matter by the IRS. Outside the tax area there have been numerous studies showing mediation to be the most successful of all forms of alternative dispute resolution (sometimes called ADR).[1]

Although the Appeals' mediation procedures would as proposed apply only in a limited set of circumstances in Appeals, the scope of the procedure may well be expanded in response to taxpayer comments or the results of the one-year test period. The IRS has solicited comments on the proposed mediation procedures and will hold a hearing on February 23, 1995.

This article describes the traditional mediation procedure, explains its benefits and why it is successful, and analyzes the proposed mediation procedures outlined in Announcement 95-2.

Overview of the Traditional Mediation Process

Traditional mediation is a non-binding, voluntary method of ADR that has been used successfully in civil litigation around the country. Its centerpiece is a trained, impartial third-party mediator who helps parties negotiate their own settlement of their dispute. The mediator has no power to impose a settlement on any party; he or she makes no rulings, but simply facilitates settlement discussions. Mediation is based entirely on compromise accomplished with the help of a neutral mediator.

Mediation proceedings are strictly confidential. The public does not know the settlement reached other than what is disclosed in the entry of a court decision. Nothing said or used in the mediation can later be used by any party at trial.[2] There is no fact-finding, decision, or opinion by the mediator-only a settlement developed and agreed to by the parties to the dispute.

Parties can undertake mediation at any point in the dispute process, and it can be done more than once. In a large multi-issue case, mediation can occur at different stages of the case on different issues; or some issues may be the subject of mediation while others would not be. Indeed, mediation sometimes settles some issues in a case and not others. It might even occur before or after another form of ADR is utilized.

The mediation process generally involves six steps. The first step occurs several days prior to the mediation when each side gives the mediator a written submission summarizing the party's position in the case and discussing factors considered germane to the mediation. Often, important pleadings or evidentiary materials are attached. On the day of the mediation, all parties and their lawyers gather in a single room. Each party has present at the mediation someone with authority to agree to a final settlement of the case for that party-a crucial aspect of a successful mediation procedure. The mediator begins the second step with an opening statement describing how the mediation will be conducted and setting forth the ground rules for all the parties.

The third step is for the parties to explain their respective positions in the case to the entire group. This may include giving factual information that is helpful to their side of the case. There is no formal procedure and the normal rules of evidence and discovery do not apply. Everyone in attendance, including the parties, party representatives, or evidentiary witnesses, may participate. At this stage, the mediator's role is to ask questions and enforce reasonable rules of courtesy.

The fourth step involves the mediator's caucusing with the parties. The mediator puts the contesting parties and their representatives in different rooms and then meets with each side privately and confidentially to determine the core issues for each party and the party's candid evaluation of its position. Anything said to the mediator during these meetings is confidential and cannot be repeated to the other party without the express consent of the party making the statement. One of the benefits of this step, and mediation in general, is that it allows the mediator to collect confidential information that can be used to facilitate settlement. The mediator will generally give each side his or her evaluation of the case and the risks each party faces in court.

Following the initial caucuses with each side, the mediator begins the fifth step of shuttling between the parties in their private rooms, carrying information, questions, and settlement offers. The purpose of this step is to encourage settlement and to help the parties create solutions that are in keeping with their objectives. This step is a type of "shuttle diplomacy" and will vary in length from case to case since it is the heart of the process.

The last step is for the parties and their lawyers to document the settlement reached during the mediation. Total time for the mediation process is generally no longer than one day. It is not unusual, however, for mediation sessions to last late into the night on large cases.

Why Mediation is Successful

There are several reasons why mediation is successful. First, mediation involves the parties themselves, and not simply their lawyers or representatives, in the negotiation and settlement process. Unlike arbitration, the people who are 'at risk" are focused on the single objective of settlement during a given intense time period. Once the parties and mediator begin to make progress, the psychology of the process itself encourages a final resolution. Moreover, unlike litigation or arbitration, mediation produces greater satisfaction to the parties because they directly participate in making the decisions that resolve the conflict.

Second, mediation is voluntary and non-binding. Consequently, the process is approached with a more open mind by the parties. They are not threatened with an imposed settlement as they are in arbitration. Parties also consider it even less risky than other forms of ADR. Since no "rulings" are made, the parties are not harmed or threatened by the process if the case does not settle; there is virtually no down-side risk to the process. Indeed, the "threat" of an impending mediation, or the information exchanged in an unsuccessful mediation, frequently leads to a settlement among the parties.

Third, the success of mediation depends in large part on the unique role of the mediator. The mediator has no interest whatsoever in how the substantive issues are resolved - i.e., what the "correct" legal answer is or what the facts show - but only in producing a settlement agreement to which both sides can agree. The mediator works with the parties to help them create their own solution to the problem, rather than having a court or an arbitrator impose a solution upon them. The mediator uses his view of the law and the facts as well as his creativity to reach his only goal - helping the parties produce a settlement that is satisfactory to both sides.

One major reason for the success of mediation is its ability to breakdown the unrealistic expectations of one or all of the parties. It forces them to focus intensely on the difficult issues in the case. Mediators frequently describe themselves as "agents of reality." Sometimes the client is insulated from reality by the unrealistic claims of his or her representative or sometimes by his or her own obduracy. Mediation allows the client to be educated about the risks of the case without the threat of an imposed solution. It can be a sobering experience to see a neutral and objective mediator point out the weaknesses in a case.

To be effective, the mediator must be credible and independent. The importance of this cannot be overemphasized. All parties must view the mediator as fair, impartial and entirely free of any conflict of interest. If the parties do not already have that view of the mediator because of prior experience or reputation, the mediator has only a short time to establish that credibility in the process.

Finally, traditional mediation is the most confidential of all forms of ADR. Nothing revealed to the mediator can be used by either party later in any administrative or court proceeding.

The Benefits of Mediation

In addition to being the most successful method of ADR, mediation is also generally the quickest, least expensive, and most flexible. Mediation requires only a mediator and a short period of time, making it very cost-effective. The selection of the mediator usually is accomplished promptly; there is very little preparation required as compared with other methods of ADR; and the mediation process itself is usually accomplished in no more than one day. Because of its low cost and the swiftness of result, mediation can easily be made available in the widest range of cases, including those where the amounts in issue are small.

Mediation also results in a very high compliance rate on settlements and fewer disputes about implementing settlements. This is a product of the parties themselves negotiating and agreeing to the settlement. Moreover, the voluntary nature of mediation and the resulting settlement minimizes the potential for harm to any existing relationship of the parties to the dispute. This may be of particular importance to large taxpayers who have an on-going relationship with the IRS that both parties may want to maintain on a non-adversarial basis.

Mediation Under Announcement 95-2

Recognizing the benefits of mediation, the IRS has proposed traditional mediation procedures in Appeals for a one-year test period. The mediation procedures proposed in Announcement 95-2 are very similar to the above-described traditional mediation procedures used in civil litigation between private parties. Mediation can accomplish in hardened tax disputes exactly what it has accomplished in other civil litigation between private parties. According to James Dougherty, IRS National Director of Appeals, the IRS expects extensive use of mediation in Appeals.[3]

Scope of the Proposed Mediation Procedures. Mediation is available under Announcement 95-2 only in Coordinated Examination Program (CEP) cases assigned to Appeals Team Chiefs and only after good-faith negotiations between the taxpayer and Appeals are unsuccessful. In fact, mediation is apparently the last step in the Appeals process because Announcement 95-2 provides that Appeals will not reconsider any issue that has been unsuccessfully mediated.

Mediation will not be available for any issue that is designated for litigation, docketed in any court, an Industry Specialization Program Issue, an Industry Coordinated Issue, or a competent authority issue. Announcement 95-2 states that mediation will be appropriate for factual issues, such as valuation, reasonable compensation, and transfer pricing issues, but the delineated issues should be interpreted as merely illustrative of the types of cases that may be resolved through mediation and any factual issue would apparently qualify for mediation. Mr. Dougherty has stated that the IRS expects mediation to be used in a variety of large cases.

Agreement to Mediate. Either the taxpayer or Appeals may request mediation. The other side can then agree or refuse to participate in mediation. If the taxpayer and Appeals agree to mediation, the pertinent Assistant Regional Director of Appeals-Large Case (ARDA-LC) must then approve the request for mediation. The (ARDA-LC) will generally respond within 30 days. If the ARDA-LC denies the mediation request, either party can request a conference to discuss the denial of the mediation request.

After the ARDA-LC approves the mediation request, the taxpayer and Appeals must enter into a written agreement to mediate. This agreement should include the issues to be mediated and the site, date, and agenda for the mediation. Mr. Dougherty says the mediation agreement should be short, between two and four pages, and will be the "roadmap" for the mediation process. A discussion summary of the issues should be prepared and submitted to the mediator two weeks before the mediation; this is analogous to the first step in traditional mediation.

Selection of a Mediator. The taxpayer and Appeals are free to select whomever they want to serve as a mediator. Announcement 95-2 states that if the taxpayer and Appeals cannot agree on a mediator, they can agree on a procedure to select a mediator. Co-mediators can be used in any case and may be helpful in cases requiring specific industry, technological, or other expertise. The parties can also seek the assistance of the Federal Mediation and Conciliation Service or the Administrative Conference of the United States in selecting a mediator.

In traditional mediation, mediators are absolute neutrals. In contrast, pursuant to Announcement 95-2, the mediator could also be a representative from another Appeals office - i.e., an IRS employee. The advantage of agreeing to an Appeals representative to serve as the mediator is that the IRS will then pay all of the expenses of mediation. By contrast, when a non-IRS mediator is selected, both parties share the mediation expenses. Notwithstanding this cost savings, taxpayers should think carefully before agreeing to an Appeals representative's serving as a mediator. Although it may be proper in certain cases, an Appeals Officer is not a neutral party, and ultimately must represent the IRS. Recognizing this inherent conflict of interest, Announcement 95-2 requires that the taxpayer be provided a statement when the Appeals Officer will serve as a mediator confirming that the Appeals Officer is a current IRS employee, and that a conflict results from that mediator's continued status as an IRS employee.

Announcement 95-2 states that the mediator should be an expert in the settlement process and the criteria for selecting a mediator should include previous mediation experience, a substantive knowledge of tax law, knowledge of industry practices, and estimated travel costs, hourly fees, and other expenses. Announcement 95-2 also provides that the mediator shall have no official, financial, or personal conflict of interest with respect to the issue to be mediated, unless such interest is fully disclosed in writing to all parties.

In traditional mediation, the success of the mediation often depends on the credibility and perceived fairness of the mediator. The same is true in the federal tax area. When selecting a mediator, taxpayers must remember that mediation is more successful when both sides view the mediator as fair, impartial, and entirely free of conflicts of interests.

The Mediation Process. The parties to the mediation will be the taxpayer and an Appeals representative assigned to the case. The mediation may also be attended by the parties' representatives (e.g., taxpayer's counsel and the ARDA-LC for the IRS). An absolute requirement is that the participants have decision-making authority. A major reason for the success of traditional mediation is that the parties themselves negotiate and settle the case. Indeed, in some cases the parties should be encouraged to be represented by individuals with decision-making authority who have not been so deeply involved in the case that they may have formed resolute positions, for instance, the taxpayer's chief financial officer.

The mediator will then conduct the mediation. This will usually take no more than one day. In some cases, two days may be required and the mediator may also have to meet in advance with each party's experts. Announcement 95-2 describes the role of the mediator as a facilitator, to assist in defining issues, and to promote settlement negotiations between the parties. Consistent with traditional mediation procedures, Announcement 95-2 gives the mediator no authority to settle the case or render any decisions. Only the parties themselves will have the authority to settle their case.

Announcement 95-2 gives both parties the right to withdraw from the mediation at any time. Any decision reached through the mediation will be non-binding on the parties until final resolution is established through normal Appeals procedures.

Disqualification of Mediator in Subsequent Cases. Announcement 95-2 disqualifies the mediator from representing or otherwise participating in any pending or future action substantially related to the subject matter of the mediation.

Confidentiality. The mediator and any other person participating in the mediation will have access to the taxpayer's return or return information pursuant to section 6103 of the Internal Revenue Code. Announcement 95-2 makes clear, however, that the mediation process will be confidential just as traditional mediation is confidential. Outside mediators, IRS employees involved in the mediation, and persons the IRS invites to participate will be subject to the confidentiality and disclosure provisions of sections 6103, 7213, and 7431. Similarly, the taxpayer and persons that the taxpayer invites to participate shall not disclose any information regarding the mediation process, including the settlement terms.

Precedential Effect of Mediation. Announcement 95-2 states that a decision reached in mediation will not serve as an estoppel in any other proceeding. In addition, a mediation decision will not be considered in any factually unrelated proceeding and will not be used as precedent. Mr. Dougherty has stated, however, that a mediation decision can be used as precedent by the taxpayer and applied retrospectively to an open year. By contrast, an arbitration decision cannot be applied retrospectively.

Conclusion

Mediation can provide most, if not all, of the same benefits in the tax area that it has provided outside the tax area. The IRS has taken a dramatic first step to make traditional alternative dispute resolution techniques available to taxpayers and the IRS. The agency is to be commended for its efforts. Taxpayers can hope that the IRS will extend the proposed mediation procedures to docketed cases and all tax issues. Taxpayers can also anticipate (and press for) adoption of a Tax Court rule specifically authorizing mediation for cases in litigation, as it did in Rule 124 (which permits voluntary binding arbitration).[4] We believe that, after a transitional period, the IRS and the Tax Court will find much greater acceptance of mediation than it has of binding arbitration, particularly in large cases.

In conclusion, the mediation procedures proposed in Announcement 95-2 provide taxpayers and Appeals a useful means of resolving contentious factual disputes. These new procedures are not a threat to the functions traditionally performed by Appeals and, indeed, should enhance Appeals as a forum for the resolution of tax disputes. Taxpayers believing their disputes might be resolved through mediation should not be reluctant to request mediation either from Appeals or from the Tax Court - even if not specifically provided for in Announcement 95-2. It is an idea whose time has come.

DONALD F. WOOD is the Partner in Charge of the Tax Section in the Houston office of Vinson & Elkins L.L.P. and is a member of that firm's Alternative Dispute Resolution Practice Group. He is a member of the ABA Section of Taxation's Court Procedure Committee. He is a frequent speaker at professional meetings, and served as a faculty member for the National Institute for Trial Advocacy. He has spoken on mediation before the United States Tax Court Judicial Conference (in November 1992 and November 1994), and participated in a panel discussion on The Use of Mediation in Tax Court and at Appeals at TEI's 1994 Midyear Conference.

ROBERT D. ADAMS is General Tax Counsel for Halliburton Company. As the chair of TEI's IRS Administrative Affairs Committee, he moderated the panel discussion on The Use of Mediation in Tax Court and at Appeals at TEI's 1994 Midyear Conference. He has also participated in meetings of the IRS's Alternative Dispute Resolution Working Group, has organized several programs on Alternative Dispute Resolution techniques for Tax Executives Institute, and presented testimony on TEI's behalf at the January 1994 hearing on the Early Referral Procedure announced in Announcement 94-41.

[1] See, e.g., Ellen Joan Pollack, Arbitrator Finds Role Dwindling As Rivals Grow, Wall St. J., April 28, 1993, at B1; Gary N. Pridavka, Mediation vs. Litigation, 56 Tex. Bar J. 768 (1991); Administrative Conference of the United States Office of the Chairman, An Introduction to ADR and the Roster of Neutrals 3 (1989). [2] See Fed. R. Evid. 408; T.C. Rule 143(a). [3] See Appeals Director Says IRS Expects Extensive Use of Mediation Procedure, BNA Daily Tax Report, at G-1 (Jan. 5, 1995). Subsequent references to statements by Mr. Dougherty are to his views as reflected in the cited article. [4] In fact, some Tax Court judges have said publicly that Tax Court Rule 124 (adopted in 1990) authorizes mediation even though it is entitled "Voluntary Binding Arbitration" and is phrased entirely in terms of an arbitration proceeding. See Litigation Not Best Method for Settling Transfer Pricing Disputes, Judge Says, BNA Transfer Pricing, at G-5 (Feb. 18, 1994); Tax Court Looking at Expanding Arbitration Rule, Judge Nims Says, BNA Transfer Pricing, at G-9 (Nov. 12, 1992).
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Author:Adams, Robert D.
Publication:Tax Executive
Date:Jan 1, 1995
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