According to the IRS, “[t]he IRS Independent Office of Appeals is here to resolve disputes, without litigation, in a way that is fair and impartial to the government and to you.”¹ It has generally been the case that the Internal Revenue Service’s (IRS) Independent Office of Appeals’ (Appeals) consideration is available to all taxpayers.² While Appeals typically has broad jurisdiction,³ Appeals only obtains jurisdiction when a taxpayer properly requests its consideration.⁴ Taxpayers are not required to seek Appeals’ review; however, its independence from other IRS offices involved in the matter and its mission to review matters impartially, often make it the most attractive route to resolution for taxpayers. And, of course, it’s much less expensive than going to court.
Recently, however, the IRS took measures which could significantly limit a taxpayer’s ability to administratively resolve their case with Appeals. Specifically, on August 24, 2020, the Internal Revenue Service (IRS) issued a memorandum (Memo) providing interim guidance: (1) for the IRS’s compliance staff regarding the criteria they should apply when determining whether requests to designate issues for litigation should be made to the Office of Chief Counsel, and (2) on the Taxpayer First Act (TFA), §1001, requirements regarding “the limitation on designation of cases as not eligible for referral to the IRS Independent Office of Appeals (Appeals).”⁵
In its August 24, 2020, news release, the IRS explained that the Office of Chief Counsel makes the decision as to the designation of issues for litigation. Once designated as such, IRS and taxpayer disputes must resort to litigation for resolution.⁶ According to the IRS:
The IRS took this step to update and clarify its designation procedures as part of its implementation of the Taxpayer First Act (TFA) enacted in July 2019.⁷“
As the Memo noted, as a result of the TFA, if any taxpayer in receipt of a statutory notice of deficiency (SNOD) is denied their request for referral to Appeals, the Commissioner must provide the taxpayer with: (1) a written notice containing a detailed presentation of the facts involved, (2) a detailed explanation regarding how the decision’s basis is applicable to those facts, and (3) the procedures necessary for the taxpayer to protest the denial.⁸
Moreover, according to the Memo, since November 7, 2019, the Deputy Commissioner for Services and Enforcement (DCSE) has the authority to deny a taxpayer’s Appeals referral request after the issuance of a SNOD in a matter designated for litigation and to provide the required written notice to the taxpayer.⁹ The IRS clarified that this same authority may be redelegated to the Business Operating Division (BOD) Commissioners. On the other hand, the DCSE also has the authority to “receive, review and decide a taxpayer’s protest of the decision to deny a request for referral to Appeals after the issuance of a SNOD in a case designated for litigation”¹⁰ – but this specific authority may not be redelegated.
The IRS clarified in the Memo that there are particular legal issues which are “susceptible to recurring compliance challenges that are not effectively addressed administratively or through published guidance.”¹¹ As such, the IRS elaborated that:
Examination personnel should request designation of an issue in a case in the limited circumstances where sound tax administration is best served by establishing a legal precedent on the issue and not merely to prevent Appeals’ review.¹²“
In light of that goal, the IRS outlined three specific examples to illustrate situations where designation for litigation results in sound tax administration benefits most by establishing judicial precedent. These situations exist where designation would:
-stem the proliferation of abusive tax transactions or other significant non-compliance (through early issue resolution); or”
-reduce future compliance and litigation costs of other taxpayers and the government (through early issue resolution, broad-based settlement initiatives, or other means); or”
-resolve issues with respect to which published guidance has not resulted in compliance or where there is a wide divergence between IRS and taxpayer viewpoints on the law.¹³“
Upon designation for litigation, the IRS noted that the parties may secure a partial agreement for the non-designated and agreed issues. The IRS also indicated that instead of a 30-day (or similar) letter regarding any remaining unresolved issues, the taxpayer should expect to receive a SNOD for the unagreed issues. The Memo further clarifies that designation generally will not impede the settlement of remaining issues either before or after a case is docketed.
First, a consultation takes place between the Area Counsel and the BOD examination personnel after an issue is deemed appropriate for designation consideration. Together they will make a “reasonable effort” to identify other cases involving the proposed designated issue for the purpose of allowing “IRS-wide strategic coordination.”14 If the Area Counsel agrees that designation consideration is appropriate, then BOD examination personnel will prepare a written memo presenting the facts, factors, and justifications supporting the consideration for designation of the issue for litigation.
Next, the Exam Director and the Division Counsel will discuss the merits of designating the issue, and the Division Counsel should further consult with the Associate Chief Counsel who has jurisdiction over the issue. Assuming they all concur that designation for litigation is appropriate, the Division Counsel will prepare a Designation Recommendation Memorandum (DRM). The DRM must present the rationale for the decision. The Examination Director must sign the DRM in agreement.
Subsequently, the Exam Director is responsible for notifying the taxpayer. Notification must be given in writing of the proposed designation, the rationale, and notice that the matter will be referred to the BOD Deputy Commissioner. This written notification of the proposed designation will provide the taxpayer an opportunity to either opine in writing and/or request a meeting with both the BOD Deputy Commissioner and the Division Counsel within 60 days of notification of the proposed designation.
After reviewing any additional information from the taxpayer provided within that 60-day timeframe, and after further review of the DRM, if the BOD Deputy Commissioner and the Division Counsel determine that the designation is appropriate, then they will forward the DRM, along with any relevant information, to the Chief Counsel and the Associate Chief Counsel having jurisdiction. Notice must be provided to the taxpayer within 5 days of the date upon which the recommendation was forwarded. This notice will provide the taxpayer with 30 days to opine in writing and/or request a meeting with the Chief Counsel.
Also, within 30 days of receipt of the DRM, the Associate Chief Counsel will present the Chief Counsel with written comments pertaining to the recommendation. And if the Chief Counsel does not approve the designation, then examination continues as usual.
However, if the Chief Counsel approves the designation, then the BOD examination personnel will work on the SNOD’s issuance. Within 5 days, the taxpayer will be notified of the Chief Counsel’s decision to designate. The taxpayer may then request referral to Appeals per TFA procedures described in the next section. Otherwise, the taxpayer may wait for the SNOD and begin the TFA procedures below.
As the IRS reiterates in the Memo, the TFA “prescribes new requirements” which are applicable to: (1) taxpayers who receive a SNOD and make a request for referral to Appeals, and (2) taxpayers with cases designated for litigation.¹⁵
First, once a taxpayer receives a SNOD providing notice that the Chief Counsel decided to designate the matter for litigation, the taxpayer may request referral to Appeals. If the taxpayer makes such request, then the BOD Commissioner must review and approve or deny such request in writing and within 30 days of receipt of such request.
If the BOD Commissioner denies the request for referral to Appeals, then the BOD Commissioner must provide the taxpayer with written notice detailing the facts, the rationale, a detailed explanation of how the rationale applies to the facts, and the necessary protest procedures to use with the DCSE. This notification must be provided to taxpayer within 30 days of receiving the taxpayer’s request.
Finally, the taxpayer has 30 days from receipt of denial notification to protest the denial in writing with the DCSE. Similarly, the DCSE has 30 days to review such protest and provide the taxpayer with a written decision along with the rational for the decision.
The IRS stated that “[t]he designation of issues for litigation has been and remains infrequent,” and notes that there were no designations in all of 2019—as opposed to between 25,000 and 30,000 cases annually litigated in the United States Tax Court.¹⁶ According to the IRS, the Memo outlines a process that “furthers congressional intent by ensuring that designation of cases for litigation will remain infrequent and subject to the highest level of oversight within the IRS and the Office of Chief Counsel.”¹⁷
However, the TFA was intended to make the overall IRS experience more taxpayer-friendly—and the Memo outlines a process that limits the taxpayers’ ability to avail themselves of the independent and more cost-friendly Appeals. Although such designation is only intended to occur upon careful balancing of the need to soundly administer the tax law while still recognizing Appeals’ vital role in resolving tax controversies without litigation—there’s concern that it leaves a door open for potential human error and even abuse in the process. Taxpayers facing a designation for litigation are urged to consult with an experienced tax attorney to make sure their rights are preserved, and they have every opportunity available to resolve the matter.