Because the IRS is unable to examine every return, it follows a policy of examining returns that, upon preliminary inspection, indicate the largest possible source of potential tax deficiency.

Returns are rated for audit according to a mathematical formula called the discriminant function system (DIF). In recent years, the IRS has audited fewer returns overall, but has increased audits of high-income taxpayers, Schedule C filers, S corporation and other business owners, and tax-shelter investors.

Taxpayers selected for audit are advised of their right to be represented by a certified public accountant, attorney, or enrolled agent. Once the taxpayer has chosen a representative, the IRS may not interview the taxpayer alone, unless consent is given. Together with the first letter of proposed tax deficiency, the IRS must give the taxpayer a clear and complete explanation of the administrative process from examination and appeals to the collection of taxes.

• How Returns Are Examined
• Audit Rules for Partnerships
• The Time Limits Within Which the IRS Must Act for Additional Taxes
• Filing Refund Claims
• How To Arrange Closing Agreements and Compromises
• How To Get the IRS’ Opinion on a Tax Problem
• Circular 230: Practice Before the IRS
• Tax Return Preparer Penalties

HOW RETURNS ARE EXAMINED

Preliminary Examination

Correspondence notices are used to correct the following types of obvious errors spotted at IRS Service Centers: medical expenses under the applicable adjusted gross income limitation; limits on personal casualty and theft losses; auto mileage rates for business transportation in excess of the IRS mileage allowance; and income on Form W-2 or Form 1099 incorrectly reported on a tax return. Taxpayers are advised by mail of the corrections and of additional tax due. The taxpayer may request an interview or submit additional information if he or she disagrees. Where the correction is made and additional tax is paid before the due date for filing the return, the taxpayer may avoid interest charges.

Where an underpayment of tax results from a mathematical or clerical error, the IRS may use a summary assessment procedure. However, the IRS must give the taxpayer an explanation of the error, and time to file a request for the abatement of the assessment. The IRS must honor that request (IRC §6213(b)(2)). It must then follow the normal deficiency procedures. These procedures are followed for the following types of mathematical and clerical errors: (1) arithmetic errors (addition, subtraction, multiplication, or division); (2) errors in transferring amounts on the tax forms; (3) missing schedules or forms; (4) incorrect use of any Treasury table; and (5) entries that exceed statutory limitations. Summary procedures also apply to the omission of a correct Social Security number by a taxpayer claiming personal exemptions, the dependent care tax credit, child tax credit, higher education credits, or the earned income credit (IRC §6213 (g)(2)).

Where an arithmetic error is made by an IRS representative who is helping a taxpayer prepare a return, the IRS may abate any interest due on the underpayment of tax for any period ending on or before the 30th day following the date of notice and demand for payment of the deficiency (IRC §6404(d)).

Interest Abatement Due to IRS Delay

The IRS may abate interest charges attributable to IRS procedural or mechanical errors that unreasonably delay processing of a deficiency, such as delays resulting from the loss of records, IRS personnel transfers, or extended training, illness, or leave of IRS personnel (IRC §6404(e)(1)(A)). Interest is not eligible for abatement if delay is related to general administrative decisions including IRS work priorities, discretionary judgments, or decisions concerning the application of the tax laws. An abatement request is made on Form 843.

The Tax Court may review whether the IRS has abused its discretion in failing to abate interest if the taxpayer meets the net worth and size requirements for recovering attorneys’ fees (IRC §6404(h)). An eligible taxpayer must file a petition and pay a $60 filing fee (unless hardship is shown); see Tax Court Rule 281 for petition details.

Types of Personal Examinations

A specific examination of a tax return may be by correspondence, at a local IRS office, or at the taxpayer’s place of business, office, or home. An examination at an IRS office or by correspondence is called a desk or office examination; an examination at a place of business or home is called a field examination. The complexity of the transactions reported on a return generally determines whether a return will be subject to an office or field examination.

An office examination is initiated by a letter of notification listing the items to be examined. The agent will ordinarily not go beyond these items. However, the agent may, in his or her discretion, extend an office examination to other items. A field examination may involve a review of the entire return.

A correspondence examination is used to question simple individual returns; it is a type of office examination handled entirely through correspondence. The taxpayer is asked to explain a particular item or to send supporting evidence. A correspondence examination may end up as an interview type of office examination or a field examination. Whether it does or not will depend on how satisfactory the answers to correspondence are and whether or not the answers indicate problems not appearing on the face of the return. If you feel that it is impractical to handle the examination through correspondence or that it places you at a disadvantage, request an office examination conference. Practitioners generally feel that the absence of personal contact and discussion is a disadvantage.

You may request a transfer of a case from an office examination to a field examination. Requests for transfers have been granted in cases of voluminous records or physical incapacity. A request will be denied if it is clear that you have no legitimate reason for the transfer.

A field examination may be shifted to the office of the taxpayer’s representative if he or she has the client’s records and it is more convenient to hold the examination there.

An individual taxpayer may appear at an examination in his or her own behalf, and a corporation may be represented by an officer. The preparer of a tax return may, if authorized, represent the client before an agent in connection with the return although the preparer is not enrolled to practice before the IRS. An attorney, enrolled agent, or CPA may also represent a taxpayer before the IRS.

If you represent a taxpayer, file a power of attorney, IRS Form 2848. Ask the IRS to send you all correspondence involving the examination. In your correspondence with the IRS, always reference the IRS code symbols found on the IRS’ letter to you. Before the examination, review not only the return in question but also the records of prior examinations of the client’s return. The agent has reviewed these records and will use them as a starting point for the present examination.

Restrictions on IRS Examinations of Books

The IRS may not make more than one examination of a taxpayer’s books of accounts for any taxable period unless the taxpayer requests otherwise, or the IRS, after investigation, notifies the taxpayer in writing that an additional inspection is necessary (IRC §7605(b)). However, this restriction does not bar the IRS from examining public records or bank accounts. Nor does it bar examination of the books of a third party, such as the taxpayer’s corporation, unless the identities of the taxpayer and his or her corporation are so inextricable that the examination of the books of one constitutes an examination of the books of the other.

A taxpayer may protest a second examination by refusing to give the agent access to his books. The IRS may then issue a summons. If the taxpayer still refuses access, the IRS may seek enforcement of the summons in district court. The taxpayer then has the opportunity at a hearing in the district court to show that a second examination is unnecessary.

The IRS tries to avoid examining the same items appearing on a taxpayer’s returns for more than one year, such as the treatment of installment sale payments. Thus, where the taxpayer’s return was examined in either of the two years prior to the current examination for the same items, and that examination resulted in no change in tax liability, the IRS will suspend the current examination, upon the taxpayer’s notifying the appointment clerk or the examiner, pending a review of its files to determine whether the examination should proceed. If the IRS decides to proceed with the examination, the taxpayer has no recourse.

The IRS may not conduct audits based on financial status or “economic reality” to determine if income was omitted from a return unless there is a reasonable likelihood that income has not been reported (IRC §7602(e)).

Handwriting samples. The Supreme Court has ruled that the IRS can compel a taxpayer to furnish handwriting samples in the same manner as it can demand other physical evidence (Harvey F. Euge, 444 U.S. 707 (1980)).

Administrative Appeal Procedures Applicable to an Examined Return

It is important to follow IRS administrative appeal procedures to lay a basis for recovering from the IRS litigation costs and for shifting the burden of proof in a later noncriminal court case. If the IRS takes an unreasonable position at an audit and the dispute goes to court, you may not recover an award for litigation costs unless you have exhausted administrative remedies within the IRS (IRC §7430(b)(1)).

Similarly, you may not shift the burden of proof to the IRS if you did not exhaust all administrative appeals. In tax litigation, there is a presumption in favor of the IRS’ determination of tax liability. This requires a taxpayer to come forward with evidence to disprove the IRS’ determinations by a “preponderance of the evidence.” A taxpayer may in a court action shift the burden of proof to the IRS with respect to factual issues relevant in determining tax liability. However, before the burden is shifted, the taxpayer must show: (1) compliance with substantiation and record-keeping requirements imposed by the Code or IRS regulations; and(2) cooperation with reasonable requests by the IRS for meetings, information, and access to witnesses, as well as exhaustion of all IRS administrative appeals (IRC §7491).

How To Handle the Examination

Common sense rules of courtesy should be your guide in your contacts with the agent. Avoid personality clashes; they can only interfere with a speedy and fair resolution of the examination. However, be firm in your approach and, if the agent appears to be unreasonable, make it clear that, if necessary, you will go all the way to court to win your point. A vacillating approach may weaken your position in reaching a settlement.

Where a practitioner is handling the audit, the taxpayer should not be present during discussions with the agent. The taxpayer can add nothing to the discussion that the practitioner does not already know after becoming thoroughly acquainted with the return. The taxpayer may damage the case by volunteering information harmful to his or her position.

In a field audit, the agent will want to review original books and records. If the agent also wants supporting secondary records, ask him or her to give you a list of needs, which you can then present as a unit.

Original records should not be taken out of your client’s office; give copies of relevant records to the agent. Do not volunteer data. The agent will ask for any needed information. Try to provide an adequate area to work in.

After the review and before the report is prepared, the agent will discuss his or her findings and recommendations. At this stage, disputes generally involve questions of fact. The agent will readily use discretion in compromising issues of fact where, for example, there are inadequate primary records but there is other convincing evidence that the taxpayer has made a valid claim. As for conflicting interpretations of law, the agent will abide by well-defined IRS policy. The agent will not lean to an interpretation conflicting with or not covered by IRS policy. Compromises involving open issues or conflicts between IRS and court positions are possible at a higher level conference in the Appeals office. Occasionally, a disputed point in an examination may be resolved by asking the IRS for technical advice.

In some instances, you may be asked by the agent to submit a legal memorandum. This may be a signal that the agent is not sure of the legal issues involved in your case and wants your help. You are not required to do this and may refuse where the memo might reveal more of your case than you would care to divulge. However, where the facts are not in dispute and you feel a clarification of the law might expedite the case, a memo may be advisable. Keep in mind that anything submitted to the agent becomes part of the record that will pass through the levels of IRS review.

Also be alert to the possibility that the agent may be developing a fraud issue, which may be evidenced by the appearance of another agent. If you suspect such a possibility, consider whether you should allow the agent to see further records that may be incriminating. Also consider contacting a practitioner experienced in tax fraud issues.

Your readiness to compromise will depend on the extent of the agent’s examination and the amount of the proposed deficiency or refund. Sometimes an agent will pick up one point but fail to develop another that could lead to a substantial deficiency. Here, it may be tactically advisable to accept the proposal. Carrying the case beyond this point might lead to an opening of other items on the return.

If You Agree With the Examiner

When you agree to the agent’s proposed changes, your client generally will be asked to sign a Form 4549, “Income Tax Examination Changes,” (or Form 4549-A, “Income Tax Examination Changes (Unagreed and Excepted Agreed)” or Form 4549-E, “Income Tax Discrepancy Adjustments”) and a Form 870, “Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment,” or other appropriate agreement form. When signed, the agreement permits an immediate assessment of a deficiency.

The only advantage in signing is to stop the running of interest on the tax deficiency within 30 days after the date the waiver is filed. In an overassessment, that is, where a refund is due, a signed waiver is merely an acknowledgment of the overassessment.

A signed Form 870 does not prevent the IRS from reopening the case to assess an additional deficiency. If on review the deficiency is increased, you will receive a revised Form 870. Your client can refuse to sign the form. The signed first form has the effect of stopping the interest on the original deficiency. As a matter of practice, however, waivers or acceptances ordinarily result in a closing of the case.

If your client signs a Form 870 after a formal deficiency notice (90-day letter) has been mailed, his or her right to appeal to the Tax Court is retained. But if Form 870 is signed before a deficiency notice has been mailed, your client loses the right to appeal to the Tax Court. Although an appeal to the Tax Court may not be made, a suit for a refund may still be filed unless your client agrees on the form not to seek a refund.

The payment of a tax before the deficiency notice is mailed is, in effect, a waiver of the restrictions on assessment and collection. If the payment satisfies your client’s entire tax liability for that year, an appeal cannot be made to the Tax Court. The taxpayer’s only recourse is to sue for a refund in either the district court or U.S. Court of Federal Claims.

If a refund is due and a Form 870 is signed, you may file a protective refund claim. Generally, an agent will process the refund, but if he or she fails to do so or the review staff puts it aside for some reason and the limitation period expires, the refund will be lost. The refund claim will protect your client from such a mishap.

An Agreed Case Is Always Reviewed

Once a Form 4549 and Form 870 are signed, the agent prepares the report, which is reviewed. While the agent’s report is approved in most cases, do not assume that this review is a mere formality. Agreed cases receive closer review than unagreed cases. Once approved, an agreed case has, except for isolated cases, “reached the end of the line.” A reviewer thus realizes that he or she has a greater responsibility in checking the agreed case than in an unagreed case where the facts and law may be reviewed several times as the case proceeds through administrative channels. The reviewer will check the following points:

Facts appearing in the agent’s report and in the return filed by the taxpayer. The reviewer may find facts that the agent overlooked or emphasize facts that did not appear important to the agent.

Agent’s interpretation and application of the Code’s provisions to the facts in the case.

Agent’s judgment. The taxpayer might not have substantiated all of the deductions claimed with primary evidence, but the agent allowed a portion of the deduction based on secondary evidence. The reviewer may question the judgment of the agent or believe that the agent was too lenient. The agent may try to justify his or her position, but if the reviewer and agent cannot agree, the chief reviewer will resolve the problem.

Other tax returns. Where an individual’s return shows income from an estate, trust, or partnership, the reviewer will usually ask the agent to check the estate, trust, or partnership return, or to transfer the case to an agent who may be examining one of these returns.

Tax returns of prior tax years. The agent may be required to examine the facts on the prior returns. The inquiry may result in the development of new facts that may widen the scope of the audit. The number of ways in which a reviewer may develop new facts depends only on his or her ingenuity, experience, and zeal. Therefore, remember that even after an agreement is signed (Form 870), the agent may ask for additional facts, and confront you with new interpretations.

You will not be allowed to argue your case directly with the reviewer. But you may be sure that the agent will present your case in the best light if for no other reason than to justify his or her own judgment.

What To Do If You Disagree With the Agent

If you disagree with the agent at an office examination, the agent is required to explain the adjustments and available appeal rights. If you desire an immediate conference with the agent’s supervisor, it will be granted if practicable. In most cases, mediation may be requested through the IRS’ Fast Track Mediation process to help resolve the dispute. You may withdraw from mediation at any time and either party may reject the mediator’s proposals; see IRS Publication 3605, Fast Track Mediation—A Process for Prompt Resolution of Tax Issues.

If no agreement can be reached, you will receive a copy of the examination report and a 30-day letter providing the following alternatives: (1) You can agree to the proposed adjustments and sign enclosed Forms 4549 and 870; (2) you can request an Appeals office conference by written protest or small case request; or (3) you may ignore the letter, in which case you will eventually receive a statutory notice of deficiency (90-day letter).

If you disagree with the agent at the field examination, he or she will prepare a complete examination report fully explaining the proposed adjustments. The agent will then send it to the review staff for a technical and procedural review. If the review staff agrees with the agent, you will receive a 30-day letter, as in the case of the office examination. The 30-day letter is accompanied by a copy of the examination report and a detailed explanation of the available appeal procedures, with a request that you inform the IRS of your choice of action. You have the following alternatives:

1. Sign a Form 4549 and a Form 870 (which preclude appeal to the Tax Court);
2. Request an Appeals office conference by written protest or small case request;
3. Ignore the 30-day letter and wait for the statutory notice of deficiency (90-day letter); or
4. Pay the tax and file a claim for refund.

A 30-day letter is not required by the Code and, if the IRS wants to, it may dispense with it and send you the 90-day letter. The 30-day letter is merely an additional attempt by the IRS to settle the case without going to trial. If necessary, you may get additional time to file your protest or a small case request. However, if the limitation period for the assessment of tax is running out on the tax year in question, you will get neither a 30-day letter nor an extension unless you sign a waiver extending the limitation period.

Should You Ask for a Conference?

The answer lies in the nature of your disagreement with the auditing agent. You may feel his or her authority to accept proposals for settlement is too limited. You may believe the agent has overemphasized certain facts, or disregarded or failed to give proper weight to other facts. Perhaps he or she has misinterpreted applicable tax law or misapplied it to your case. The agent may even have ignored law that supports your claim.

The very existence of the conference procedure is in itself a recognition that your objection to the agent’s decision may be right. If the IRS were convinced that the auditing agent was always correct, there would be no purpose to the conferences.

It is usually advisable to take your case to the Appeals office. The chances of a settlement are favorable. Most cases are settled in conference. But before going ahead, consider these points:

1. When the IRS has an established policy regarding the disputed issue, taking a case further in the IRS usually gains nothing. All IRS personnel are bound by the same rules.
2. Interest continues to run. It does not stop unless you make a cash deposit.
3. The IRS will find out your position on all issues. If the case comes to trial, there can be no element of surprise.
4. The IRS can always find additional issues.

Appealing Your Case

You start an appeal by filing either a written protest or a small case request.

You can make a small case request if the total amount of the IRS’ proposed change in tax, penalties, and interest for a tax year is $25,000 or less. You can use Form 12203 to make a small case request, or you can simply send in a letter asking for a review of the IRS’ proposed changes, noting the changes to which you object and your reasons. However, no small case requests are allowed for tax disputes of any amount involving partnerships, S corporations, employee plans, and exempt organizations.

When the total in dispute for any tax year (tax, interest, and penalties) exceeds $25,000, you must file a formal written protest. There is no special form for the protest. The important thing is to include information and arguments that will present your case in the best light to the appeals officer.

Seven specific points must be included in the protest:

1. Taxp ayer’s name, address, and daytime telephone number.
2. Date and symbols on the 30-day letter transmitting the proposed adjustments.
3. Years covered and the amounts of tax liability in dispute for each year. List here only the amount of the proposed deficiency with which you disagree. This is often less than the entire proposed deficiency.
4. An itemized schedule of the agent’s findings with which you disagree. Make sure you cover every item contested. Where more than one finding is involved, list each separately and number it.
5. A statements of the facts supporting your position for each of the items named in (4). Use separate numbered paragraphs for each issue; make sure the number of each paragraph corresponds with the number of the item in (4) that it covers.
6. A statement of the law on which you rely for each of the items listed in (4); use separate paragraphs, numbered to correspond with the items in (4).
7. A request for a hearing with the Appeals office. You must make such request in the protest. Otherwise, you will get no hearing and the case will be decided on the basis of what you submit as your protest.

The most important part of the protest is the presentation of your arguments. These you divide into three parts: (1) Give the arguments in summary form, numbered. (2) Provide a statement of facts covering the disputed items. (3) Develop each argument and support it by citations of authority.

Separate protests do not have to be filed if more than one tax year is involved. All the tax years covered in the 30-day letter may be covered in one protest.

An original and a copy of the protest must be filed.

Stress the equities of your case. A case that shows that a decision against you would be unfair may be stronger than one where you have the technicalities on your side.

Write the facts so that they can be understood. They should be clear and accurate. List them in the order in which they happened.

Do not omit the facts that seem to be against you. When explained, they may not be as detrimental to your case as they first appear.

Substantiate the facts with exhibits, affidavits, or any other proof.

Try to avoid unimportant facts that are not relevant to the issue. Make sure you understand the principles of law affecting any fact you state. Otherwise, the argument you will later make may be weak.

Discuss the issues in the order of their importance. Leave the least important for last. Say what and who is involved.

Write short descriptive headings before each issue. Repeat important facts if they help your argument.

Summarize your point and show how it applies to your case.

Sometimes a short quotation from a leading case is effective if you can relate the case to your facts.

Be sure that every case you cite stands for what you say it does.

Try to put yourself in the place of the conferee who is going to read the protest. Ask yourself what you would want to know in order to answer the questions, and then try to supply the information.

Take the time to write a well-organized, succinct, and interesting protest.

Consider the appearance of the letter. Give it eye appeal. Use side heads to break up solid pages of type. Sometimes graphs, photographs, charts, and other illustrations help make your point in an attractive manner.

How the protest is signed. The taxpayer must certify, under penalty of perjury, that the statements of facts in the protest are true. Add the following signed statement to the protest: “Under penalties of perjury, I declare that the facts stated in this protest and in any accompanying documents are true, correct, and complete to the best of my knowledge and belief.”

If you as the taxpayer’s representative submit the protest, a substitute declaration may be used, stating that you prepared the protest and indicating whether you personally know that the statements of facts are true and correct. A power of attorney should be attached to the protest, if not previously filed.

If, after reading a protest, a reviewer believes that there is a basis for settlement, he or she will refer the case back for settlement. For this reason, make sure that your protest presents your case well so that a reviewer can have a basis for such a decision.

How the Appeals Office Operates

In the Appeals office, your case is assigned to an appeals officer. After he or she becomes acquainted with your case, the officer sets the time of the conference. If it is inconvenient, you may ask for another date or time. An immediate hearing may be granted if you have some unusual reason for it. The hearing may be held in a regional appeals office, a local branch of the Service, or “on circuit” (appeals officers sometimes travel to outlying districts to save taxpayers the expense and time involved in a trip to a metropolitan area).

The Appeals office is separated functionally from the Examination Division. The major purpose of the separation is to provide an appellate procedure that, organizationally at least, will tend to produce free and unbiased opinions. An officer in the Appeals office is not responsible to the Revenue Agent and his or her supervisor. Thus, the officer is less likely to be unduly influenced by the conclusions reached in that office and more likely to reach decisions objectively. The officer does not need, and does not seek, the approval of the Revenue Agent or the agent’s supervisor for any decisions made.

To ensure the independence of the Appeals process, the IRS by law must prohibit ex parte communications between Appeals employees and other IRS personnel to the extent that such communications appear to compromise Appeals’ independence (Section 1001(a) of the IRS Restructuring Act of 1998, P.L.105-206).

When you protest the conclusions reached in the Examination Division, the entire case file is sent to the Appeals office, and the Examination Division’s control over the case ceases.

A primary concern of the Appeals office is the status of the statute of limitations. If not much time is available, the case may not be transmitted to an Appeals office unless at least 120 days remain before the limitations period expires. As a condition to appellate review, a taxpayer may be asked to sign either a Form 872, “Consent to Extend the Time to Assess Tax” or a Form 872-A, “Special Consent to Extend the Time to Assess Tax.”

In the majority of cases, neither the agent nor any other representative of the Examination Division will attend your conference with the appeals officer. If, in a few situations, the agent does attend a conference, it will be at the invitation of the Appeals office and only for the purpose of establishing the facts. Since you are appealing from the recommendations of the agent, do not reargue the case with him or her. Your sole problem will be to convince the appeals officer. In all cases, however, you should remember that the officer has a copy of the agent’s recommendations and confidential report, which you never see.

Cases that reach the Appeals office after the 90-day letter has been issued are known as “90-day cases.” Conferences at this stage are not easily granted. You must generally show that you have not had a previous conference for reasons beyond your control, and there is a reasonable expectation that a settlement will be reached.

The settlement authority in the Appeals office is broader than in the Examination Division. The Appeals office may trade or split issues where substantial uncertainties exist either in law or in fact, or in both, as to the correct application of the law. They may also settle issues based on their judgment as to the hazards of litigation. The agents have no authority to consider litigation hazards. One explanation for the reluctance of district office personnel to close a case is that they realize there is another administrative step following theirs. If they have any doubts about the acceptability of a settlement proposal, they can resolve their doubts by recommending that the case be considered by the Appeals office. The appeals officer thinks in terms of the cost and possible result of extended litigation. Cases are generally settled on the “merit approach.” That is, the merits of each issue are considered, regardless of the amount of tax involved. A second, less preferred method of settlement is on the basis of a flat sum or percentage of the dollars involved. This second method is limited in use and may not be used, for example, where an issue will recur in subsequent years or where the issue is present in other similar cases, unless they are all to be disposed of together upon the same basis.

Settlement authority of appeals officers may also depend on whether or not the issue is on an IRS appeals coordinated issue list. If the issue is on the list, the officer does not have independent settlement authority; he or she must submit the proposed settlement to a person within the regional office who is in charge of reviewing issues placed on the coordination list. If this person does not agree to the settlement, the appeals officer may present the dispute to an appeals director in the region for a decision. You will not be given the chance to argue your position at this stage because the appeal coordination list procedure is an internal administration measure through which the IRS attempts to provide a consistent national settlement policy on certain issues that involve large numbers of taxpayers.

How To Handle the Conference

The conference is held in an informal manner. No stenographic record is made. Testimony under oath is not taken. Your approach to the conference will vary, depending on whether your client wishes to settle, whether the issues in dispute are factual or legal, and how strong you feel your case is on a specific issue.

You can assume the conferee:

• Has the agent’s recitation of the facts, opinions, and recommendations—all of which appear in a transmittal memo that you do not receive. He or she also has a record of the informal conference and copies of reports covering examinations of prior years.
• Has read your protest with your version of the facts and your arguments. He or she will read the cases you cite. When you cite a case, make sure that it is on point. If you cite it for the dicta incorporated in the opinion, indicate that fact. There is nothing more discouraging than wading through a case only to find that it is not on point. The appeals officer may well conclude that you do not understand the issue, that you think the conferee does not understand the issue, or that you believe the conferee is careless enough to accept citations without reading the cases. Such conclusions will affect you adversely.
• Knows the strengths and weaknesses of your position and what you would settle for. If your case is the type that should be settled, the appeals officer has thought of possible settlements. As a general proposition, an officer would rather settle cases than send them to the Tax Court. But rarely is he or she more anxious to settle than you are.

You may bring witnesses. However, do not plan on using witnesses unless they are absolutely necessary and you are sure they will not testify beyond your objectives. Instead, you may want to present their statements in affidavit form. Facts brought up for the first time will be referred back to the Examination Division for reconsideration.

Sufficient time is given to present your side of the case. Additional hearings are granted as needed.

An attorney may become aware that his or her client has no hope of winning but is stalling the date of actual payment of the deficiency by going through the various appellate procedures. This tactic violates IRS rules of practice and professional canons of ethics.

Does It Pay To Settle Your Tax Dispute With the IRS?

Here are some approaches followed by practitioners:

If you want rapid settlement of the dispute, consider using the Fast Track Settlement Program if you are a self-employed individual, which can resolve matters within 60 days of acceptance into the program. If you cannot use the program or do not want to and cannot convince the IRS of your position, consider paying the deficiency—then suing for refund in the District Court or Court of Federal Claims. But first check the docket of the District Court where you will sue. Some District Courts are as overloaded as the Tax Court.

In a dispute involving a difference of opinion over the facts, accept a fair offer from the IRS. You may not do any better before the Tax Court. Where the IRS refuses to accept any settlement offer, you may take your case to court. You will have to wait for a hearing, but you stand a good chance of getting a better break.

In a complicated case or one involving a difficult point of law, the Tax Court is favored over the District Court. There is less risk of judicial misinterpretation of the tax law since the Tax Court judges are more familiar with the intricacies of the Code.

Where you have a question of fact and your position is appealing to the average person, pay the deficiency and then sue for a refund in the District Court where a jury will determine the facts. In the Tax Court, the facts are determined by judges who may be less sympathetic. You are not entitled to a jury trial in Tax Court. Your case is also decided by a judge if you pay the deficiency and sue for a refund in the Court of Federal Claims.

What Happens When You Propose a Settlement

Settlement proposals are generally made orally but more complicated proposals may be in writing. If your proposal is accepted, you are asked to sign either a Form 870 or 870-AD. Form 870 is signed for a settlement based on a complete agreement with the changes originally recommended by the agent. Where the IRS makes concessions in reaching a settlement in the Appeals office, a conditional consent, Form 870-AD, is signed. Form 870-AD contains pledges against reopening; the Form 870 does not. This means that once a Form 870-AD is executed, the IRS may not make an additional assessment. If Form 870 is executed, it acts as a waiver of restriction on assessment when received whereas Form 870-AD is not effective until it is signed by the Commissioner of Internal Revenue or his or her delegate.

Form 870-AD has been called an informal closing agreement. It is an agreement not to file a claim for refund, except for overassessments shown on the agreement form and amounts attributed to a net operating loss carryback deduction. Similarly, the IRS agrees not to assert further deficiencies for the year in question, except where there is fraud, malfeasance, concealment, or misrepresentation of a material fact, an important mathematical error, an excessive tentative allowance of a net operating loss carryback or investment credit carryback, or deficiencies determined at a partnership-level audit or S corporation–level audit.

The effect of an 870-AD is one-sided. The taxpayer agrees to an immediate assessment of the deficiency, whereas the IRS does not agree to pay an immediate refund as, for example, where the agreement covers two years, and one year involves an overassessment. It may, therefore, be advisable to file a protective claim for refund at the same time as the Form 870-AD is signed, or at least before the expiration of the refund period for the year in question. The refund claim should be accompanied by a letter explaining that the purpose of the claim is to protect the taxpayer against an unfavorable disposition of the waiver issue, and that the claim will be withdrawn upon the IRS’ favorable action on the waiver.

Whether or not Form 870-AD is binding on the IRS and the taxpayer as a closing agreement has been litigated. The decisions present conflicting opinions on the issue.

Filing a Form 870-AD does not automatically stop the running of interest. Interest stops 30 days after the date the IRS accepts the form. In any event, the accumulation of interest can be avoided by prepaying the deficiency.

After Form 870-AD is signed, the appeals officer presents the report to a reviewing officer, such as an Associate Chief. If the official approves the proposed settlement, he or she will accept the agreement and the case is then ready for closing.

What if the settlement on review is rejected by the Associate Chief or other official? He or she will then discuss the case with the appeals officer. If the case remains unapproved, you may ask for a hearing before the reviewer who turned down the settlement.

What if you do not submit a settlement or the appeals officer rejects your proposal? The officer then prepares the report together with a proposed statutory notice of deficiency. This is sent to an Associate Chief or other official for review. If the official approves the report, the case is then reviewed by the Chief Appeals Officer. The statutory notice of deficiency is checked by the Regional Counsel. After final approval by both offices, a 90-day letter is then mailed to your client.

Cash Deposit Stops Interest Accrual on Potential Deficiency

An individual who faces a potentially large interest charge on a tax deficiency may cut off the accrual of interest by making a cash deposit (not actually in cash despite the name of the deposit) against a potential deficiency. Under Code Section 6603, a taxpayer can make a deposit with the IRS in order to suspend the running of interest on a potential underpayment of income, gift, estate, or generation-skipping transfer tax that has not yet been assessed by the IRS.

Under IRS guidelines provided in Rev. Proc. 2005-18, 2005-13 IRB 798, a deposit is made by submitting a check or money order, accompanied by a written statement that designates the remittance as a Section 6603 deposit, specifies the type of tax (e.g., income tax) and the tax year or years, and describes the amount and nature of the “disputable” tax. Without the required designation and statement, a deposit will be treated as a tax payment and applied toward any outstanding tax liability, starting with the earliest year for which there is a liability.

If the IRS ultimately assesses tax on a proposed deficiency and a Section 6603 deposit is applied against the assessed liability, the suspension of the running of interest is effective as of the date that the IRS received the deposit, not when the liability is later assessed or the deposit is actually applied to the liability.

The taxpayer can request a return of a Section 6603 deposit at any time unless the money has been used to pay a tax or the IRS believes payment is in jeopardy. The request must be made in writing and include the date and amount of the original deposit, the type of tax to which the deposit was intended to apply, and the tax years involved. Interest is payable on a returned deposit to the extent it is attributable to a disputable tax. Interest is figured at the applicable federal short-term rate, compounded daily, from the date of deposit to a date that is no more than 30 days before the date of the check paying the return of the deposit.

What To Do After Receiving a 90-Day Letter

Before the IRS can assess a deficiency, it must send by registered or certified mail a statutory notice of deficiency (IRC §6212(a)). This notice is called a “90-day letter.” It gives your client the chance, within 90 days from the date of its mailing, to file a petition to the Tax Court of the United States. If the notice is mailed to an address outside the United States, you are allowed 150 days. In the event the 90th or 150th day falls on a Saturday or Sunday, or on a legal holiday in the District of Columbia, you have until the next business day to file a petition with the Tax Court (IRC §6213(a)).

The IRS must specifically note on deficiency notices when the 90-day period ends (IRC §6213(a)).

Your client receives a 90-day letter at the end of the period allowed in the 30-day letter if he or she has not signed a Form 870 or filed a formal protest, or after an Appeals office conference. At the end of the 90 (or 150) days, the deficiency is assessed.

On receipt of the 90-day letter, you can do one of the following:

File a petition with the Tax Court. No assessment can be made until its decision (which includes all appeals) becomes final. For a timely Tax Court petition, the Tax Court must receive the petition no later than the 90th day after the IRS’ mailing of the deficiency notice. A petition postmarked by the U.S. Post Office by the 90th day is considered timely even if received by the Tax Court after the 90th day (IRC §7502(a)).

A dated receipt from an IRS-approved private delivery service also qualifies under the “timely-mailing-is-timely-filing” rule (IRC §7502(f)). Specific services from DHL, Federal Express, and United Parcel Service have been approved (Notice 2016-30, 2016-18 IRB 676); the current Form 1040 instructions also has the list.

Do nothing and wait for the assessment of the deficiency. Sign the Form 870. This limits the interest on the deficiency. Your client can still take his or her case to the Tax Court, or pay the disputed deficiency and file a refund claim. When it is rejected, your client can sue for a refund in a Federal District Court or the U.S. Court of Federal Claims.

An assessment may only be made if a notice of deficiency is sent to the taxpayer’s last known address. Generally, a taxpayer’s address is the address shown on his most recently filed return.

For a deficiency involving a joint return, the 90-day letter is mailed as a single joint notice. So, where a husband and wife have separated, notify the IRS of their separate addresses to insure receipt of the notice. The IRS will then send a duplicate original of the joint notice to both the husband and wife.

The IRS may issue more than one 90-day letter for the same year before the earliest of the following events: (1) expiration of the assessment period; (2) execution of a final closing agreement or compromise; or (3) filing of a timely petition to the Tax Court.

When a 90-Day Letter Is Not Necessary

The 90-day letter is the only notice of deficiency that the law requires the IRS to send. Without it, you cannot petition the Tax Court to litigate your matter. However, there are situations in which the 90-day letter is not required and you have no recourse to the Tax Court.

1. A 90-day letter is not sent where a mathematical error has been made in your return. Taking an excessive credit on your tax liability for taxes withheld or for estimated taxes paid is considered a mathematical error.
2. A voluntary payment “paid as a tax or in respect of a tax” eliminates any deficiency, allowing the IRS to assess without the issuance of a 90-day letter.
3. An immediate assessment may be made without issuance of a 90-day letter whenever the IRS believes that assessment or collection will be jeopardized by delay. For example, if the IRS finds out that a taxpayer is leaving the country with all assets before paying his or her tax liability, it is not necessary to send a 90-day letter and then wait 90 days before assessment.
4. In the case of bankruptcy or receivership, an assessment may be made before a 90-day letter is sent.
5. If you sign a Form 870 before a 90-day letter is sent, you are not thereafter entitled to a 90-day letter.

Getting a Settlement After Filing a Petition With the Tax Court

You may still be able to get a settlement even after you have filed a petition in the Tax Court. If you have brought your case to the Tax Court without first appealing to the Appeals office for a conference to settle the dispute, you will be asked to discuss a settlement with the Appeals office.

Even if you have filed a Tax Court petition after an unsuccessful conference in the Appeals office, your case will still be referred back to the Appeals office for settlement unless the Counsel determines that there is little likelihood of a settlement. The Appeals office may enter into a binding settlement. If the case is returned to the Counsel’s office, it determines whether to settle or proceed to trial.

AUDIT RULES FOR PARTNERSHIPS

The IRS determines the tax treatment of partnership items at the partnership level in a unified administrative proceeding rather than in separate proceedings with the individual partners. All partnerships with more than 10 partners are subject to the rules. Partnerships with 10 or fewer partners, all of whom are individuals, C corporations, or estates of deceased partners are exempt, but may elect to have the rules apply (IRC §6231(a)(1)(B)).

Note: The following discussion about partnership audit rules applies to returns filed for partnership tax years beginning before 2018. As provided in the Bipartisan Budget Act of 2015, a new audit regime will begin for partnership returns filed for taxable years beginning after 2017, although partnerships can elect to apply the new rules for taxable years beginning after November 2, 2015 and before January 1, 2018. Detailed proposed regulations on the new audit rules were released in July 2017; see REG-136118-15, 2017-28 IRB 9. See the e-Supplement at jklasser.comfor an update.

S corporations. S corporation shareholders are audited on a shareholder-by-shareholder basis. Shareholders must report S corporation items consistent with the treatment on the corporation’s Form 1120S unless the shareholder identifies the inconsistency in a statement to the IRS (IRC §6037(c)).

Partnership Audit Procedures and Judicial Review (see Note above)

Currently, the IRS generally may not audit individual partners but must bring proceedings at the partnership level. The IRS must conduct an administrative proceeding to challenge the partnership’s treatment of income, deductions, or credit items (IRC §6223). Notice of the proceeding is first given to a so-called “tax matters partner” (TMP). The TMP is a specially designated general partner or, in the absence of a designation, the general partner having the largest interest in partnership profits at the end of the taxable year involved (IRC §6231(a)(7)). Notice of the proceeding is given to the other partners (except for certain indirect partners) by the IRS and the TMP (IRC §6223). In partnerships with more than 100 partners, the IRS does not have to give separate notice to partners with less than a 1% interest, but a group of partners with an aggregate interest of at least 5% may designate one of such partners to receive notice from the IRS (IRC §6223(b)). All partners are entitled to participate in the partnership proceeding.

If the IRS enters into a settlement with some partners, similar settlement terms must be offered to all other partners (IRC §6224).

Within 90 days of the IRS final partnership administrative adjustment (FPAA), the TMP may petition the Tax Court for review. Other notice partners are given an additional 60 days to file a court petition if the TMP does not do so. An appeal from the FPAA may also be filed in a Federal District Court or the U.S. Court of Federal Claims if the petitioning partner first deposits with the IRS an amount equal to the tax that would be owed if the FPAA determination were sustained. A petition filed in the Tax Court takes precedence over petitions filed in other courts. The first Tax Court petition filed is heard; if other partners have also filed petitions, their cases will be dismissed. If no Tax Court petitions are filed, the first petition filed in a Federal District Court or the U.S. Court of Federal Claims takes precedence. Regardless of which petition takes precedence, all partners who hold an interest during the taxable year involved will be bound by the decision unless the statute of limitations with respect to that partner has run (IRC §6226).

Statute of Limitations Against Partners

To assess tax against a partner, the IRS must do so within three years following the later of the actual filing date or the due date for the partnership return (IRC §6229(a)). If the IRS and the TMP so agree, the limitation period may be extended for all partners. Extension agreements may also be made with each partner. If the partnership understates gross income by more than 25%, the limitations period increases to six years. If the partnership return is fraudulent, there is an unlimited limitation period for partners participating in the fraud and a six-year period for other partners. If the IRS mails notice of an FPAA to the TMP, the statute of limitations stops running until one year after a final court decision is made, or, if the FPAA is not appealed, the limitations period is extended until one year after the period for filing a petition for court review expires (IRC §6229(d)).

Refund Requests by Partners

Partners must make refund claims by filing a “request for administrative adjustment,” or RAA (IRC §6227), on Form 8082. The RAA request must be filed within three years of the actual filing date of the partnership return or the due date for the return (without extensions), whichever is later. The IRS may decide to conduct a partnership proceeding in response to the refund request.

If an RAA on behalf of all the partners is filed by the TMP and the IRS has not allowed any part of it within six months of filing, the TMP may petition the Tax Court, a Federal District Court, or the U.S. Court of Federal Claims to uphold the claim. A court petition must be filed between six months and two years after the RAA was filed. It must also be filed before the IRS has notified the partners that it plans to conduct a partnership proceeding. If the IRS conducts a partnership proceeding and notice of an FPAA determination is given to the TMP, a subsequent court petition on the RAA is barred; the TMP must seek review of the FPAA. All partners may participate in a court proceeding related to an RAA (IRC §6228).

If an RAA is filed by a partner other than the TMP and the IRS does not allow any part of the request within six months, that partner may sue for a refund in a Federal District Court or the U.S. Court of Federal Claims; the suit must generally commence within two years of the filing of the RAA. Once a refund action is filed, the partner will not be bound by a subsequent FPAA or judicial review of an FPAA. If the partner is notified that the items in question are to be treated as nonpartnership items, the partner may sue for a refund within two years of the IRS notice (IRC §6228).

THE TIME LIMITS WITHIN WHICH THE IRS MUST ACT FOR ADDITIONAL TAXES

The Three-Year Rule

Generally, the IRS has three years after the date on which your tax return is filed to proceed against you with a tax assessment (IRC §6501(a)). However, when you file a return before the due date, the period does not start from the filing date but from the day after the due date. To illustrate, instead of filing your last quarterly estimated tax payment on January 15, you file a final return on January 31. The limitation period on the final return begins the day after April 15, the date the final return is due, not on January 31, the date the return is filed.

To start the running of the statute of limitations, the IRS must receive your return. In any controversy concerning the statute, you must prove that you filed a return. If you fail to do this, there is no limit on the time during which the government may make an assessment against you. Similarly, filing a return containing insufficient information of your tax liability does not start the running of the statute.

What Is the Starting Date for the Limitation Period?

Amended return. The statute starts running when the original return was filed. If an amended return is filed within the last 60 days of the regular limitations period, the IRS has 60 days from the date the amended return is received to assess additional tax(IRC §6501(c)(7)).

Incorrect return form. The statute starts running when you file (or from the due date if later), if the return has all of the information on which the correct tax liability can be figured.

Tax information on a form other than a return. The statute starts running when you file the information (or from the due date if later), if it contains the information on which your tax liability can be figured. If you claim you do not have to pay a tax, notify the IRS of your claim and the basis for it. A tentative return does not start the period running since it does not specifically state the items of gross income and deductions.

Improperly executed return. The statute starts running when the return is properly executed. Example: A corporate return must be signed by one of the corporation’s officers. Filing a return signed by an unauthorized person does not start the running of the statute.

Sometimes, a taxpayer or a group of taxpayers may operate as a trust or as a partnership without knowing that the organization under the tax law is really a corporation, and so must file a corporate return rather than a trust or partnership return. Even though a partnership or trust return is filed, this filing can be treated as the filing of a corporate return for purposes of starting the statute. To obtain this result, the taxpayer or taxpayers must prove that the determination of the trust or partnership status was made in good faith.

A similar rule covers a situation where a taxpayer, in good faith, determines that it is an exempt organization. In such cases, the filing of a return for an exempt organization starts the statute—even though it is later held to be a taxable corporation for that tax year.

There are several exceptions to the general rule that the filing of a return starts the running of the statutory period:

• Where a false or fraudulent return is filed with intent to evade tax, tax may be assessed at any time (IRC §6501(c)(1)). The Supreme Court has held (Badaracco, 464 U.S. 386 (1984)) that a later filing of an amended nonfraudulent return does not start the running of the three-year period of limitations.
• Where a willful attempt in any manner is made to defeat or evade the tax, tax may be assessed at any time (IRC §6501(c)(2)).
• Where a return is executed by the IRS (IRC §6501(b)(3)), the statute does not run with the making of the return.
• Where no return is filed (IRC §6501(c)(3)), the tax may be assessed at any time, but the subsequent filing of a nonfraudulent return starts the running of the three-year limitation period.

If More Than 25% of Gross Income Is Omitted

If you omit an amount that is more than 25% of the gross income shown on your return, the IRS may make an assessment within six years after the return is filed rather than three years (IRC §6501(e)(1)(A)). For example, on a 2012 return (filed on April 15, 2013), gross income of $50,000 was reported. But a $20,000 gain from the sale of a vacation home was omitted. In this case, the IRS has until April 15, 2019, to assess a deficiency on the 2012 return. The reason: The omitted $20,000 gain is more than 25% of the gross income reported on the return (25% of $50,000, or $12,500). However, if gross income of $100,000 is reported, the three-year statute applies rather than the six-year statute because the omission is not more than 25% of the reported gross income (25% of $100,000, or $25,000).

To apply the six-year statute, the IRS has the burden of proving that there is an omission and that it exceeds 25% of the reported gross income. If it fails to sustain its claim, the three-year statute applies. To be successful against such a claim, you must then show that the items were not omitted, for example, that the item was tax free or not taxable in the particular year, or that the IRS’ valuation is incorrect. You cannot base your defense on a plea of an honest mistake or the use of an incorrect method of accounting, or that the omission was reduced to less than 25% by an amended return. The statute runs from the filing of the original return. It is not affected by the filing of an amended return.

In determining whether capital gains omitted from a return are “gross income” under the 25%-of-gross-income test, treat the gains as gross income, without regard to capital losses that may have been used to figure the net gain or loss shown on the return. Where you are in business, gross income means gross receipts, that is, the total amount received from the sale of goods or services unreduced by the cost of such goods or services. Gross income of a partner’s share of partnership income means the partner’s share of the partnership gross income, not partnership net income.

An overstatement of basis that results in an understatement of income is treated as an omission from gross income for purposes of the 25%-of-gross-income test (IRC §6501(e)(1)(B)(ii), as amended). Congress enacted this law to effectively reverse a prior U.S. Supreme Court decision that reached the opposite (pro-taxpayer) conclusion (Home Concrete & Supply Inc., S.Ct., 2013-1 USTC ¶50,315). The new rule applies to returns filed after July 31, 2015.

The Tax Court has made it clear that when capital gains have been omitted from gross income, it is the amount of the omitted gains and not the entire amounts realized that must be taken into account for purposes of determining whether the six-year statute of limitations applies (G. Douglas Barkett, 143 TC No. 6 (2014)).

Adequate Disclosure. If you omit a questionable item from gross income, you may prevent an extension of the statute by adequately disclosing the facts of the omission. If the disclosure adequately tells the IRS of the nature and amount of the item omitted, that item will not be counted in determining whether there has been an omission of more than 25% of gross income.

The following are examples of adequate disclosure: (1) sales receipts were fully stated, but claimed deductions were excessive; (2) opening inventory was overstated, resulting in understated profits; (3) total income was revealed by a schedule attached to the return; and (4) total income was disclosed on the return, but was erroneously claimed as exempt.

There was not an adequate disclosure where the taxpayer liquidated his real estate corporation, attaching a statement of depreciation on the liquidation property, but failed to report gain realized on the liquidation.

When the Limitation Period May Be Reduced

To expedite the closings of income tax cases of estates and of liquidated corporations, the statutory period may be reduced to 18 months (IRC §6501(d)). After you have filed a return reporting income received by a decedent in his or her lifetime, an estate during administration, or a corporation being liquidated, send the Commissioner a letter specifically asking for a prompt assessment on the return in the following 18 months. Make this request after the return is filed, or it will not be effective. Send your letter in a separate envelope. Do not mail it with the return.

When the request is made for a corporation, you must notify the Commissioner that liquidation is contemplated within 18 months, begin the liquidation in good faith within that time, and complete the liquidation.

When you request a prompt assessment for an estate, also send evidence of your authority to act for the estate.

The receipt of the filing of the request for prompt assessment starts the 18-month period. The shortened limitation period will not apply if more than 25% of gross income is omitted from the return or if there is a fraudulent or willful attempt to evade tax.

Limitation Rules for Carryback

Net operating loss or capital loss carryback. A deficiency resulting from an erroneous carryback may be assessed within the statutory period of the loss year in which the carryback originated (IRC §6501(h)). For example, a net operating loss in 2015 carried back two years (IRC §172(b)(1)) to 2013 results in a refund of $5,000; in an audit of the 2015 return, the carryback is reduced and it is determined that the refund should have been $1,000. The IRS has until April 15, 2019, to recover $4,000 of the refund attributed to the carryback to 2013.

Foreign tax credit carryback. A deficiency resulting from an improper carryback of the foreign tax credit may be assessed within one year after the period for assessment for the year producing the excess foreign tax credit (IRC §6501(i)).

Investment credit or other general business credit carryback. A deficiency resulting from an erroneous carryback may be assessed within the statutory period of the year producing the credit (IRC §6501(j)).

Where a quick refund was elected, the IRS has an extended time to audit the year to which the carryback was made (except in the case of foreign tax credit). The IRS may assess within the statutory period for the year that produced the carryback a tax deficiency not to exceed the amount of the refund or credit arising from the carryback (IRC §6501(k)).

EXAMPLES

1. A calendar year corporation files a quick refund claim for 2015 based on an unused investment credit of $50,000 arising in 2016 and receives a refund of $50,000. In 2017, the IRS reduces the unused investment credit from $50,000 to $30,000. The corporation filed its 2016 return on April 18, 2017, so the period for assessing the excess $20,000 does not expire until April 18, 2020.
2. Same facts as in Example 1, but the IRS also finds that the corporation owes $40,000 of additional tax for 2015 because of its failure to report certain income for that year. On or before April 18, 2020, the IRS may assess a deficiency not in excess of $30,000.

Other Limitation Rules for Married Couples

Where separate returns were originally filed and later a joint return is filed, the period of limitations must extend to at least one year after the time the joint return was actually filed. The regular limitation periods are figured from the following filing dates, but if those periods would expire before one year after the joint return was filed, then the period is extended until the end of that one year (IRC §6013(b)(3) and (b)(4)).

Where both spouses previously filed separate returns, the regular limitation period begins on the last date that either spouse could have filed a separate return.

Where only one spouse filed a return because the other had gross income under the requirement for filing a return, the regular limitation period begins on the last date the spouse who filed could have filed his or her return.

Where only one spouse filed a return, even though the other had gross income requiring the filing of a return, the regular limitation period begins when they file the joint return.

Limitation Periods Where Recognition of Gain Is Deferred

Where an involuntary conversion has occurred, tax on the gain may be deferred by investing the proceeds in similar property. When tax is deferred, the three-year period starts when the IRS is notified that the property has been replaced or that no replacement has been or will be made (IRC §1033(a)(2)(C)).

If a replacement is made before the beginning of the last year in which any part of the gain is received on the conversion, then the limitation period for any year before that year (during which the election to replace was in effect) ends when the limitation period for the last year ends (IRC §1033(a)(2)(D)).

Warning: Failure to notify the IRS prevents the statute of limitation from closing.

Waiving the Limitation Period

If a return is being examined during a time close to the expiration of the statutory period for assessing deficiencies, the IRS may ask for a waiver of the statute of limitations on a Form 872. An IRS request that you agree to an extension of the limitations period for tax assessments must include a notice that you have the right to refuse an extension or limit an extension (IRC §6501(c)(4)(B)).

Should a Waiver Extending the Statute Be Signed?

A return is subject to a possible deficiency assessment for at least three years. An extension of the statute of limitations may be an advantage because the time to file refund claims is extended by the extension period plus six months. However, taxpayers generally regard an extension as a disadvantage. They assume the IRS, in making the request, has become suspicious of the return after a preliminary examination and a more thorough examination is likely to lead to a deficiency assessment.

It is advisable to agree to the consent if it is anticipated that disputed items may be amicably compromised.

If consent is refused, the statute of limitations binds both the taxpayer and the Commissioner. Neither party is obliged to agree to an extension.

What is the practical result of a refusal to consent? If the refusal comes:

• Before the agent has had the opportunity to make an examination, he or she can recommend the disallowance of every claimed deduction. A statutory notice of deficiency (90-day letter) can be sent on that basis. Since the refusal to an extension prevented any reasonable determination, the agent is forced to do this to protect the government’s interest. The agent can, in appropriate cases, also recommend a jeopardy assessment. If a 90-day letter is issued without an audit, the IRS’ action may be attacked as arbitrary.
• Before the agent has completed the examination, or before he or she has time to consider the merits of your position, the agent’s recommendations will be based on the assumption that there is no merit to your position.
• When your case is in the Appeals office and before the appeals officer has an opportunity to consider the merits of your position, the agent’s recommendations might be sustained.

In all of these situations, the case may have to go to court. There will be delay and expense. Give all these facts thought before you object to signing a Form 872.

You may stipulate on the Form 872 how long the statute of limitations is to be extended.

Form 872-A permits flexibility by extending the statute of limitations until 90 days after you are mailed a deficiency notice, or 90 days after you terminate or the IRS terminates the agreement (by filing Form 872-T).

When the Running of the Statute Is Suspended

The limitation period is automatically suspended in the following cases:

When a 90-day letter is sent, the period of limitations is automatically suspended for 150 days. (Technically, this includes the 90-day period during which the IRS cannot assess a deficiency, plus an additional 60 days.) However, if the period would have expired during the suspended period, the IRS cannot assess an additional deficiency after that time, though it can still assess the original deficiency (IRC §6503(a)(1)).

If you file a timely petition in the Tax Court, the limitation period is extended until the Tax Court decision (including all appeals) becomes final and for 60 days afterwards (IRC §6503(a)(1)).

Where a Title 11 bankruptcy case has commenced, a notice of deficiency may be mailed but assessment by the IRS is barred until 60 days after the termination of the case, or, if earlier, 60 days after the stay on assessment is lifted by the bankruptcy court (IRC §6503(h)).

Where assets are in the custody or control of a court, the period of limitation for collection after assessment is suspended for the period in which the assets are in the hands of the court and for six months thereafter (IRC §6503(b)).

When a taxpayer is out of the country for a continuous period of six months or more, the limitation period is suspended during the absence. The period of limitation does not expire until six months after he or she returns to the United States (IRC §6503(c)).

Where property of a third party is wrongfully seized by the government, the limitation period for collection after assessment is suspended. The suspension begins when the property is wrongfully seized or received and ends 30 days after the IRS determines the levy was wrongful and returns the property. If the third party goes to court, the suspension ends 30 days after entry of a final judgment that the levy was wrongful (IRC §6503(f)).

If the IRS is attempting to obtain records from a third party and a dispute over the records is not solved within six months after the IRS issues an administrative summons, the period is suspended until the issue is resolved. Further, if you intervene in a dispute between the IRS and the third-party record keeper, the limitation period is suspended from that date until the entire dispute is resolved (IRC §7609(e)).

Mitigating the Effect of the Limitation Period To Avoid Double Tax

Suppose income that should have been reported on a 2014 return is reported on a 2013 return. In March 2018, after the limitation period for filing a refund claim for 2013 has expired, the IRS asserts a deficiency on this item for 2014. You take the case to the Tax Court, but it upholds the government’s position.

Can you get a refund for the tax paid on this item for 2013 even though the statute has run out on that year?

The answer is yes. In this and in certain other cases, the limitation period is lifted, not only to prevent double taxation of the taxpayer, but also to protect the government in cases where an item of income might otherwise escape taxation (IRC §1311).

EXAMPLES

1. Jones and his son were partners. Each was entitled to one-half of partnership profits. On his 2013 return, Jones Sr. included the entire partnership profits. In early 2017, he filed a timely refund claim for that portion of tax he paid on his son’s share for the year 2013. In 2018, a Federal District Court approves the claim. This allows the IRS to assess a deficiency against the son for that portion of the 2013 profits on which he did not pay tax.
2. Howe assigned his salary in 2012 to his wife. She reported it on her return for 2013. In 2015, the IRS assessed a deficiency against Howe for the omission of the salary in 2012. In 2017, the Tax Court upheld the IRS’ position. Mrs. Howe was then entitled to a refund on the tax she paid on her husband’s salary for 2012, even though the statute had expired for that year.

When a Closed Year May Be Reopened

Before the limitation period can be lifted, the taxpayer or the IRS must show there has been a final determination that requires an adjustment specifically covered by the relief statute. A final determination (IRC §1313(a)) may be a:

Closing agreement. It is considered final when the agreement is approved.

Decision of the Tax Court or other competent court. It is considered final at the end of the time allowed for taking an appeal if no appeal has been taken.

Final disposition of a refund claim. It is considered final as to:

• Allowed items either on the date of the allowance of the refund or the credit or on the date of mailing a notice of disallowance. The last situation arises when the allowed items are offset by other items.
• Disallowed items when time for filing a refund suit expires (unless a suit is started before that time). This rule covers items disallowed in whole or in part, or items that have reduced a refund.
• Informal agreement signed by the taxpayer and the IRS.

As pointed out above, a closed year may be reopened for an adjustment only in limited cases (IRC §1312). The law allows for a reopening in the following seven situations (an eighth situation involving affiliated companies is not discussed here). In the first five situations, there must have been an inconsistent position.

1. The determination includes in gross income an item that was erroneously included in the taxpayer’s gross income or in the gross income of a related taxpayer in a tax year that is now closed (IRC §1312(1)).

Example: Smith, who keeps his books on the cash basis, included in his 2013 return an item of accrued rent. In 2017, after the limitation period for 2013 has expired, the IRS claims that the rent was received in 2015, and asserts a deficiency. It is upheld by the Tax Court. Smith can get a refund for tax paid on the rent on his 2013 return.

2. The determination allows a deduction or a credit that was erroneously allowed to the taxpayer or to a related taxpayer in a tax year now closed (IRC §1312(2)).

Example: Green claimed and was allowed a casualty loss deduction on his 2014 return for the destruction of his house by a fire that occurred in 2015. After the end of the period of limitations for the assessment of a deficiency for 2014, Green files a refund claim for 2015 based upon a deduction for the casualty loss in that year. The refund claim is allowed for 2015, and the IRS may make an assessment for the deduction taken for 2014.

3. The determination excludes from gross income an item on which the taxpayer paid a tax or that was included in a filed return (whether or not he paid a tax on it). However, in a closed year, the item was erroneously excluded or omitted from the taxpayer’s gross income or from the gross income of a related taxpayer (IRC §1312(3)(A)).

Example: Brown, in 2014, received under a contract payments that were included in his 2014 return. In 2017, he filed a refund claim for 2014, asserting he was on the accrual basis, and since the payments had accrued in 2013, they should have been taxed then. The refund claim is allowed in 2018. An assessment may be made for 2013, even though the statute has run out on that year.

4. The determination involves the correction of a deduction or income item of an estate or a trust, or beneficiaries of either. An adjustment to the closed year is allowed where a determination requires the disallowance of an estate or trust deduction of an amount erroneously included in the income of a beneficiary or heir, or where a determination allows an estate or trust deduction for an amount that was erroneously omitted from income of a beneficiary or heir (IRC §1312(5)).

Example: A trustee claimed in a trust’s return for 2013 a deduction for income distributed to the beneficiary. The beneficiary was taxed. In 2017, the IRS asserted a deficiency against the trust for 2013 on the ground that the amount given to the beneficiary was corpus, not income. In 2018, the deficiency is sustained by the Tax Court. Even though the period for filing claims for a refund by the beneficiary for 2013 has expired, the refund may still be allowed.

5. The determination fixes the basis of property for any purpose, and the adjustment affects either an error made in the treatment of a transaction that the basis depends on or an error made in treating the transaction as one involving the basis in the first place (IRC §1312(7)). In applying this rule, the following two tests have to be met:

   1. This error has to be either an erroneous:

      • Inclusion in or omission from gross income;
      • Recognition or nonrecognition of gain or loss;
      • Deduction of an item that should have been charged to a capital account; or
      • Charge to a capital account that should have been deducted from income.

   2. Before any one of the above mistakes may be corrected in a closed year the taxpayer or the IRS must show that a determination was made in:

      • The taxpayer’s case; or

      • A tax case of a party who received title to the property from the taxpayer after it was acquired in a transaction in which he or she treated improperly the basis of the property; or

        A tax case of a party who received title from the taxpayer by gift after erroneously treating a transaction that affected the basis of the donated property. Note that the improperly treated transaction does not have to be the one in which the taxpayer acquired the property. Compare this with the above rule in which the transaction is required to be the one in which the party acquired title.

Example: In 2012, Stone transferred property that had cost him $5,000 to A Co. in exchange for an original issue of stock worth $10,000. On his 2012 return, he treated the exchange as tax free.

In 2017, A Co. claims that gain should have been recognized and so the property should have a $10,000 basis. If its argument is sustained, there can be no adjustment in the 2012 tax of A Co. There was no erroneous inclusion in or omission from its gross income by A Co. or an erroneous recognition or nonrecognition of gain or loss. Nor was there an erroneous deduction of an item that should have been charged to a capital account or a charge to a capital account that should have been deducted from income. As for Stone, the determination on A Co.’s basis did not affect his tax. Nor does the determination relate to a transaction in which he acquired the property. It applies to the property A Co. acquired.

In 2017 Stone sells A Co. stock and claims that since gain should have been recognized on the exchange in 2012, the basis for figuring gain or loss should be $10,000. If his claim is allowed, an adjustment will be made to his 2012 tax. The basis for computing gain on the sale depends on the 2012 transactions. Here there was an erroneous nonrecognition of gain to Stone. He was the taxpayer for whom the determination was made.

Assume Stone does not sell the stock but gives it to his son, who later sells it and claims the $10,000 basis. A closing agreement sustains his claim. Stone’s 2012 tax will be adjusted. The basis for computing gain or loss on the sale by his son depends on the 2012 transaction where there was an erroneous nonrecognition of gain. Stone is deemed the person who acquired title in the transaction and from whom his son derived title subsequent to the transaction.

6. The determination disallows a deduction or a credit that should have been allowed to, but was not allowed to, the taxpayer or to a related taxpayer in a tax year now closed (IRC §1312(4)).

Important: Here, a refund or a credit is allowed only if the deduction was not barred at the time the taxpayer first claimed it in writing, that is, where he or she files a return, a refund claim, or a petition to the Tax Court (IRC §1311(b)(2)(B)).

Example: Burns reports on the accrual basis. For 2013, he deducted an expense item that he paid in that year. (At the time he filed his 2013 return, the statute had not expired for 2012.) Later, the IRS claimed that the item should have been accrued in 2012. In 2017, the Tax Court disallowed the deduction for 2013. But Burns can get an adjustment for 2012 even though it is now a closed year. The reason: When he took the 2013 deduction, 2012 was still an open year. (Note: Suppose the liability should have been accrued in 2009 instead of 2012—Burns could not get an adjustment if a refund or credit for the year 2009 was already barred when he took the deduction by error for 2013.)

7. The determination rejects an IRS deficiency for an item of income that the taxpayer did not report or pay tax for, but holds that the income should have been reported in the taxpayer’s gross income or in the gross income of a related taxpayer in a different tax year now closed (IRC §1312(3)(B)).

Important: Here, an adjustment is allowed only if a deficiency assessment was not barred at the time the IRS first claimed, either in a deficiency notice or before the Tax Court, that the item should be reported for the tax year to which the determination relates (IRC §1311(b)(2)(A)).

Example: Jones reports on the accrual basis. In 2012, he did some work for A Co. He got paid in 2012 and 2013. He did not report the 2013 payment in either year. In 2015, the IRS sent him a deficiency notice for 2012, claiming he should have reported all the payments then. Jones contested the deficiency notice on the basis that in 2012 he had no accruable right to the payments received in 2013. In 2018, the Tax Court agrees with him. But the IRS can assess a deficiency for 2013, even though it is now a closed year. The reason: A deficiency assessment for 2013 was not barred in 2015 when the deficiency notice for 2012 was sent.

Inconsistent Positions Requirement

In the first five situations previously discussed that allow the lifting of the statute of limitations, the taxpayer or the IRS must have maintained an inconsistent position in the determination (IRC §1311(b)(1)). This means that either party would benefit unfairly if the closed year was not reopened for an adjustment (either for a refund or an assessment of a deficiency). Here is how the rule works:

For an additional assessment: The taxpayer—not the IRS—must have maintained an inconsistent position.

Example: Adam, on his 2012 return, claimed and was allowed a deduction for a charitable contribution. In 2017, he filed a refund claim for the year 2013, claiming that the charitable contribution was made in 2013. The claim was later allowed. Adam maintained a position inconsistent with the allowance of the deduction for 2012 by filing a refund claim for 2013 based on the same deduction. So the Commissioner may assert an additional assessment for 2012.

For a refund or credit: The Commissioner—not the taxpayer—must have maintained an inconsistent position.

Example: Evans, in his 2013 return, erroneously included an item of income which should have been reported on his 2014 return. After the limitation period for 2013 has expired, the Commissioner asserts a deficiency for the year 2014 on this item. The Tax Court sustains the deficiency. Here, the Commissioner has maintained an inconsistent position. The Commissioner got Evans’s tax for both 2013 and 2014. Evans may get a refund for the year 2013.

Related taxpayers. Where a taxpayer maintained an inconsistent position, a deficiency adjustment may not affect a related taxpayer unless his or her relationship to the taxpayer was maintained when the inconsistent position was taken in a return, in a refund claim, or in a Tax Court petition (IRC §1311(b)(3)). If a taxpayer does not hold an inconsistent position, then the relationship must be fixed at the time of the final determination. These rules do not apply to situation No. 7 above, which is not subject to the inconsistent position rule.

Only the following are considered “related taxpayers (IRC §1313(c))”:

• Spouses
• Grantor and fiduciary
• Grantor and beneficiary
• Decedent and decedent’s estate
• Partners
• Fiduciary and legatee, heir, or beneficiary
• Members of an affiliated group of corporations

If the Statute Is Lifted

If there is an additional assessment for any of the adjustments described in the preceding pages, you will receive a statutory notice of deficiency (90-day letter). You can pay the deficiency and sue for a refund, or appeal to the Tax Court. The IRS must send a deficiency notice within one year from the date of the determination (IRC §1314(b)).

If entitled to a refund or credit, you must file a refund claim within one year from the date of the determination, unless the IRS makes the refund without a claim (IRC §1314(b)). If the claim is turned down, you can sue for a refund.

An informal agreement involving a closed year can be revoked or altered. When this happens, a later readjustment is treated in the same way as the original adjustment was treated.

Where the adjustment results in an additional assessment by the IRS, you will be charged with interest and penalties. Where the adjustment results in a refund to you, the IRS will pay interest. However, the adjustment that is made by lifting the statute of limitations is not affected by any item other than the one that is the subject of the adjustment.

FILING REFUND CLAIMS

The technical rules outlined in this chapter should be strictly observed. Often, refunds are denied because of a taxpayer’s failure to comply with a technical rule. Moreover, the filing of a refund claim is the first step that must be taken before suing the government. Unless a proper claim has been filed, a suit will be dismissed.

But before you decide to file a refund claim, carefully review the return involved for accuracy. A refund claim opens the return to a thorough investigation in which the IRS may find errors that reduce or completely eliminate the refund claim, and may even lead to the assessment of a deficiency.

Some practitioners wait until the end of the limitation period to file refund claims. If the IRS, after the limitation period, finds a deficiency, it can use the deficiency only to offset the claimed refund.

If, in good faith, you accept an erroneous refund and the IRS later discovers its mistake, repay the refund promptly. Otherwise, you will be liable for interest.

File Timely Refund Claims

A refund claim for income taxes must meet a time limitation and a dollar limitation.

Time limitation for refund. A refund claim for income tax must be filed within three years from the time the return was filed or two years from the time the tax was paid, whichever period ends later (IRC §6511(a)). For purposes of determining the three-year period, a return that is filed before the original due date is deemed to have been filed on the due date. For example, a return due on April 15 but filed April 1 is deemed filed on April 15, the due date. However, where an extension for filing is obtained, a return filed before the extended due date is deemed to have been filed on the actual date of filing and not on the extended due date. For example, if your due date for filing is April 15 but you get an extension to October 15 and actually file the return on October 1, your return is deemed to have been filed on October 1.

Where the last day for filing falls on a Saturday, Sunday, or legal holiday, the return is treated as timely filed if the return is filed or postmarked on the next work day. A legal holiday includes a legal holiday in the District of Columbia, as well as a legal holiday in the state in which you have to file the claim (IRC §7503).

You may file a protective refund claim when a particular issue is being litigated by other taxpayers and you want to await the outcome. This type of claim is generally accompanied by a cover letter to the IRS explaining its nature. Filing the protective refund claim preserves your right to sue for a refund. A suit must be brought before the expiration of two years from the date that the notice of disallowance of your claim was mailed.

With agreement of the IRS, Form 907 may be used to extend the two-year period for filing suit. The two-year period may not be extended once it has run out.

File your refund claim with the IRS Service Center serving the district in which the tax was paid. Where circumstances have forced you to wait until the last minute to file a refund claim, make sure that you meet the filing deadline. If you timely mail the claim or obtain a timely electronic postmark, the claim is deemed to be timely filed even if it is not received by the IRS until after the filing deadline. For an electronically filed claim, an electronic postmark means a record of the date and time (in the taxpayer’s time zone) that an authorized electronic return transmitter receives the claim on its host system (Reg. §301.7502-1(d)).

To be considered timely mailed, a document must be enclosed in an envelope that is properly addressed with postage prepaid and postmarked by the U.S. Postal Service on or before the last day of the statutory period (IRC §7502(a)). A postmark by a private postage meter does not establish the date of mailing (it only indicates the date that the postage was purchased). The IRS may designate certain types of service of a private delivery service (PDS) as being equivalent to the U.S. Postal Service for purposes of the postmark rule (IRC §7502(f); Reg. §301.7502-1(c)(3)).

Proof of registered mail or a certified mail receipt with evidence that the envelope was properly addressed is deemed to be “prima facie evidence” that the document was actually delivered to the IRS (Reg. §301.7502-1(e)(2)(i)). Under final regulations (T.D. 9543, 2013-40 IRB 470), the IRS may extend the “prima facie” delivery rule to a service of a designated private delivery service (PDS) where the IRS determines such service to be substantially equivalent to United States registered or certified mail (Reg. §301.7502-1(e)(2)(ii)). Other than direct proof of physical delivery, the exclusive means of establishing prima facie evidence of delivery of a document to the IRS is proof of proper use of registered or certified mail, or of equivalent PDS services that have been designated by the IRS (designated PDS services are listed in Notice 2016-30, 2016-18 IRB 676). No other evidence of a postmark or of mailing will be prima facie evidence of delivery or raise a presumption that the document was delivered (Reg. §301.7502-1(e)(2)(1)).

Refund claim for bad debt or worthless security. A refund claim to deduct a bad debt or loss from worthlessness of a security may be filed within seven years from the due date (without extensions) of the return for the year of the loss (IRC §6511(d)(1)).

Disability suspends limitations period for refund claims. The statute of limitations is suspended for refund claims made during any period in which a person is unable to manage financial affairs because of a physical or mental impairment that may be expected to result in death or to last for a period of not less than 12 months (IRC §6511(h)). This rule does not apply, however, if a party is authorized to act on the disabled person’s behalf in financial matters.

Dollar limitation for refund. Under a “look-back” rule, the amount of a refund may be limited. If the refund claim is filed within three years from the time the return was filed (thereby meeting the time limitation of Section 6511(a)), a refund is allowed for taxes paid within the three-year period, plus any extension of time for filing, preceding the filing of the refund claim (IRC §6511(b)(2)(A)). If the refund claim is not filed within three years of the filing of the return, a refund may not exceed the amount of tax paid within the two-year period preceding the filing of the claim (IRC §6511(b)(2)(B)). A taxpayer has no absolute right to the refund of an overpayment. The Commissioner may credit the amount of an overpayment against any tax liability of the taxpayer.

Example: Smith’s 2014 return was due on April 15, 2015. He obtained an extension for filing until October 15, 2015. His return was actually filed on October 8, 2015, and he remitted a check with his return for a tax liability of $2,000. On October 3, 2018, Smith files a claim for a refund for $1,000 on his 2014 return. The claim is timely filed since he meets the time limitation (within three years of the actual date of filing, October 8, 2015) and the amount limitation (tax paid within the three years preceding the filing of the refund claim).

If no return was filed, the refund claim must be made within two years from the time the tax was paid, and the amount of the refund cannot be more than the tax paid during the two years immediately preceding the filing of the claim.

Refund of withheld taxes and estimated tax payments. All estimated taxes and taxes withheld by an employer are deemed to have been paid on the original due date of the return (IRC §6513(b); David H. Baral, 120 S. Ct. 1006 (2000)). For example, your 2014 return was due on April 15, 2015, but you received a six-month extension until October 15, 2015. You filed the return on October 8, 2015. Your 2014 withholding taxes and estimated tax payments for 2014 are deemed paid on April 15, 2015, not on the October 8 filing date. Now suppose you file a claim for a refund of a portion of the estimated or withholding tax on July 11, 2018. The claim is timely, even though the estimated or withholding tax is deemed paid on April 15, 2015, or more than three years prior to the claim for refund. You meet the time limitation since the claim is filed within three years of the date the return was filed, October 8, 2015. Also, the refund is allowed under the dollar limitation since the refund claim is filed within three years, plus any extensions of time for filing the return, of the date of payment of estimated or withholding tax, April 15, 2015. The last day for filing a refund claim under the “three years plus extension” look-back period would be October 15, 2018 (three years from the April 15, 2015, payment date plus a six-month extension).

Where a refund is claimed on an original return mailed and postmarked (U.S. Postal Service or private delivery service designated by the IRS) on or slightly before the last day of the “three years plus extension” period, the IRS will allow the refund claim. The Second Circuit held that the refund claim is treated as filed on the date of mailing under the timely mailing/timely filing rule of Code Section 7502 (Weisbart, 222 F.3d 93 (2d Cir. 2000). The IRS acquiesced (Action On Decision 2000-09) to Weisbart and amended the regulations (Reg. §301.7502-1(f)). The IRS treats refund claims included on delinquent original returns as filed on the date of mailing for purposes of applying the “three years plus extension” look-back rule of Section 6511(b)(2)(A). The Ninth Circuit overruled its prior position and now applies the same three-year rule as the IRS (Omohundro, 2002-USTC ¶50,590 (9th Cir. 2002), overturning its prior decision in Miller, 38 F.3d 473 (9th Cir. 1994)).

Extended assessment and refund period. If you fail to claim a bad debt deduction or worthless security deduction on the return for the year in which the debt or security became worthless, you have seven years from the due date of that return to file a refund claim. Here, all you get back is the tax related to the bad debt or worthless security deduction.

When you agree with the IRS to extend the time during which it can assess your tax, you may file a refund claim during this extended period plus an additional six months afterwards (IRC §6511(c)(1)). A refund made during this time includes the refund you would have received if you had filed a claim at the time the extension was signed, plus the tax paid after the agreement was signed but before you filed your claim (IRC §6511(c)(2)). These extension period rules do not apply to refunds of estate taxes. Where your claim is filed more than six months after the end of the extended period, the refunded amount cannot be more than the tax paid during the two years before the filing of the claim (IRC §6511(c)(3)(B)).

Example: A 2014 return, filed on April 15, 2015, is under audit. On January 9, 2018, an agreement is made to extend the statutory period of assessment to July 9, 2018. But for this extension, the deadline for filing a refund claim for 2014 would have been April 17, 2018. With the extension, you now have until January 9, 2019 (six months after July 9, 2018), to file a refund claim on your 2014 return.

Refund lookback period for nonfilers. If no return is filed, a refund claim must be made within two years from when the tax was paid, and the amount of the refund cannot exceed the tax paid during the two years immediately preceding the filing of the claim (Reg. §301.6511(b)-1(b)(1)(iii)).

If the IRS mails the deficiency notice in the third year after the return due date, but before a return has been filed, a refund may be obtained in the Tax Court for taxes paid within the three years preceding the date of the deficiency notice (IRC §6512(b)(3)).

What Refund Form to Use

Refund claims should be filed on Form 1040X (for an individual who originally filed on Form 1040, Form 1040A, or Form 1040EZ) or on Form 1120X (for a corporation that filed Form 1120). Where an income tax form other than Form 1040, Form 1040A, Form 1040EZ, or Form 1120 was filed, a refund claim is generally made on an amended return. However, a partner must use Form 8082 to make a refund claim in the form of a request for administrative adjustment (RAA) of partnership items. Form 843 may be used for claiming refunds for estate, gift, and employment taxes or certain excise taxes.

To correct an error on a return filed before its due date, you can file a corrected return on or before its due date. This return is not considered an amended return. However, a corrected return filed after the due date is an amended return and acts as a refund claim.

Letters to the IRS are usually held by the courts as not satisfying the requirements for an adequate refund claim.

Overwithheld taxes. You need not file a formal claim for overpayment of personal income tax resulting from excessive withholding of taxes on wages or excessive estimated tax payments. In these two cases, a tax return requesting a refund of the overpayment acts as a claim for refund. But there is one exception. On the death of an individual who has overpaid tax, the administrator or executor of the estate files a refund claim on Form 1310.

Generally, refunds for excessive withholding or estimating of tax are made soon after a tax return is filed. However, a return may be subject to a “pre-refund” audit, especially where the income shown on the return is less than $10,000 or there are large deductions or many exemptions that require substantiation.

Preparing Your Refund Claim

The most important part of a refund claim is stating the “reasons” for the refund. A general claim where you just note an overpayment, without supporting facts and grounds, is not sufficient. If a claim is denied by the IRS, it may become the basis of a court suit. If you have not stated all the grounds, you may not be allowed to show them in court. The courts have limited taxpayers to the exact claim shown on the form. Make a full claim and show:

• All the facts that support the claim. You may attach to the form as much evidence as is helpful. Be sure your facts are simply and fully stated.

• All the grounds for the claim. You may hedge if you are uncertain about the exact grounds; alternate and even inconsistent grounds may be given. For example:

  The loss was incurred from an embezzlement; if not, it was incurred from a bad debt.

  The gain from the sale is entitled to capital gain treatment as the property sold was a capital asset; if not, it was depreciable property used in business.

  The loss was due to a loss on the acquisition of real estate and from a partial bad debt (where the claim arose from the extinguishing of a mortgage by a deed in lieu of a foreclosure).

While it is necessary to be complete and precise in specifying the facts and reasons for your claim, you are not required to present your evidence; you must merely inform the IRS of the basis for your claim.

To protect against your understating the amount of your claim, it may be advisable to preface the claim with this phrase: “The following or such greater amounts as may be legally refunded.” However, neither this nor any other “protective clause” will allow you to support your refund claim on grounds other than those mentioned in the original claim or in amendments made before the period of limitations has expired.

A separate claim must be made for each year in which a refund is claimed. It must be made in duplicate and signed under oath by the taxpayer or the duly authorized agent. If an agent signs, he or she must attach to the claim evidence of authority. If the claim is based on a joint return, it must be signed by both spouses.

A refund claim filed before there is an overpayment is invalid, unless the IRS waives the defect.

When you file a petition to the Tax Court, thus giving that court jurisdiction over your case, you may no longer file a refund claim for any part of the tax for the taxable year in question.

Amending the Refund Claim

You may generally amend your refund claim before the occurrence of either of the following events: (1) expiration of the period for filing the original claim (generally two years after paying the tax or three years after filing the return, whichever is later), and (2) final action taken by the IRS on the refund claim. After the expiration of the time limitation, you may not raise new issues or grounds in an amended refund claim, even though the original claim was timely.

Regardless of the time limitations above, file your amended claim immediately upon discovering the need for the amendment. Make certain that your amended claim meets all the technical standards discussed in the previous paragraphs.

Filing an Informal Claim

There is no advantage in filing an informal claim for refund. An informal claim must meet the same requirements as a formal claim made on the official IRS form (Form 1040X, Form 1120X, or Form 843). Although some informal claims have been allowed, many more have been denied and have not been permitted to be the basis of refund suits. For example, you may not base a refund suit on an informal claim that is limited to a:

• Letter suggesting a change in tax computation;
• Request for a ruling stating the facts and grounds for a refund; or
• Sworn statement that states the facts and grounds for a refund but does not include a demand for one.

Refunds based on informal claims have been allowed where an informal claim was accompanied by a brief that gave the basis of the claim or where, as a result of a conference, letters and memoranda stating the taxpayer’s position were filed and a general claim referring to these papers was later filed.

Getting a Partial Refund in a Contested Case

The IRS, in three situations, may allow partial refunds in cases where contested issues still remain to be settled.

1. Two or more refund issues where some issues are settled and others are still contested. Here, a refund may be allowed on the settled issues.

Example: You file a refund claim based on two issues. The first one, which would result in a $1,000 refund, is settled. The second one, which would result in a $500 refund, is contested. The IRS may give you a partial refund of $1,000.

2. Two or more issues where some issues will result in a refund and the others in a deficiency, but the overall netting results in a refund.

Example: A case involves a refund issue that is not contested and a deficiency issue that is contested. The allowance of the refund issue would result in a net overassessment of $5,000 after offsetting the deficiency issue. A $5,000 refund may be allowed, even though the contested issue is still pending.

3. Two or more years are under examination. In one year, there is a contested proposed deficiency. In the other year, there is an agreement on an overassessment that is greater than the proposed deficiency.

Example: For year 2016, the IRS proposes a deficiency of $4,000 that you contest. But for 2017, the IRS agrees that it owes you a refund of $7,000. A partial refund of not more than $3,000 may be made.

Note: The IRS will not give partial refunds in cases where there may be an overall deficiency, even though there is no dispute on the tax refunding issue.

If the refund differs from the amount you sought, you usually get a notice of adjustment explaining the difference before receiving the refund. But sometimes the refund is received without prior explanation. In that case, the IRS recommends this action: If the refund is smaller than you claimed, cash the check and write to your IRS Service Center asking why the refund was less than the amount claimed. If the refund exceeds your claim, return the check to the Service Center with a request for an explanation.

After a Refund Claim Is Filed

No matter how small a refund claim is, it is thoroughly scrutinized by the IRS.

The examination procedure is like the one used in examining your return. It provides for an agent’s examination in a desk examination or in the field, and if the agent disputes your claim you may ask for a conference at a higher level.

If your claim is finally turned down, you are notified by certified or registered mail. A disallowed claim may not be amended. Sometimes the IRS will reconsider a denied claim. But this reopening cannot extend the time in which you can sue for a refund. Of course, you may file a new claim so long as the limitation period within which a claim may be filed has not expired, but it must be on new grounds.

A refund suit may not be filed in a Federal District Court on in the U.S. Court of Federal Claims until six months after the date the refund claim is filed with the IRS, or, if earlier, the date of the IRS’ denial of the claim. The deadline for commencing the court suit is two years from the date the IRS mails the notice of disallowance by certified or registered mail (IRC §6532(a)).

If a claim is allowed, you receive a Certificate of Overassessment. Check it for accuracy. The IRS does not have to pay interest for the period after the filing of the claim if the refund is paid by the 45th day after the claim is filed (IRC §6611(e)(2)). If the refund is not paid within the 45-day period, interest is calculated from the date of overpayment to a date preceding the date of the check by no more than 30 days (IRC §6611(b)(2)).

Before the check is mailed, the IRS investigates to see that no taxes are owed by the taxpayer for other years. If the taxpayer’s record is clear, the check is mailed. If not, the check is held up until payment of the taxes, or it is credited against the outstanding balance.

Refunds in Excess of Two Million Dollars Checked by Congress

A tax refund or credit over $2 million may not be made until 30 days after a report is made ($5 million for C Corporation) to Congress’ Joint Committee on Taxation (IRC §6405). This provision of the law does not apply to refunds or credits resulting from tentative carryback adjustments. Where the refund claim is for the prior taxable year under the special disaster area loss election (IRC §165(i)), the IRS has discretion to allow the refund without regard to the 30-day rule, and to make a later report to the Joint Committee (IRC §6405(c)).

These cases do not require greater documentation and are not subject to closer examination than regular cases. The right to appeal within the IRS is the same as in other cases. If a protest is not made and no Tax Court petition is filed, the report to the Joint Committee will be prepared by regional specialists in the Examination Division, called Joint Committee Coordinators. If a protest is made, the report is prepared either by an appeals officer or counsel attorney. The report contains:

• The name of the person to whom the refund or credit is to be made;
• The amount of the refund or credit;
• A summary of the facts of the case; and
• The decision of the Commissioner.

Quick Refund for Carryback of Loss or Unused Credit

You may file an application for a tentative carryback adjustment of prior years’ taxes due to a carryback of net operating loss, unused general business credit, corporate capital loss, or a previously reported income item under claim of right. If accepted, you may receive a quick refund without extensive audit procedures (IRC §6411).

The application, on Form 1045 (Form 1139 for corporations), must be filed within 12 months from the end of the taxable year in which the loss or unused credit occurs. The IRS must act on your application within 90 days of filing or 90 days from the last day of the month in which your return is due, whichever is later. In the case of a quick refund based on a claim of right under IRC §1341(b)(1), the IRS must act within 90 days from the date on which the application is filed or the date of overpayment (the last day for the payment of tax for the year in which a deduction is allowed for the restoration of income held under a claim of right), whichever is later. (IRC §6411(d)).

The IRS may refuse your application if there are computational errors or material omissions that cannot be corrected within the 90-day period. Further, quick refund claims attributable to questionable tax-shelter losses may be withheld by the IRS. If the IRS determines that a carried back net operating loss is “highly likely” the result of a gross misvaluation or false or fraudulent tax-shelter promotion (under IRC §6700), the IRS may reduce the refund to take into account the improper loss (see Revenue Ruling 84-175, 1984-2 CB 296).

The application does not act as a claim for refund. You may file a separate claim for refund before, at the same time, or after you file your application.

Even though the IRS allows the carryback adjustments according to your application and refunds prior taxes to you, it is not barred from later assessing a deficiency. The purpose of the quick refund procedure is to give you cash immediately when you most likely need it.

HOW TO ARRANGE CLOSING AGREEMENTS AND COMPROMISES

A closing agreement may be used to fix the final tax liability of a taxable period or to determine the tax consequences of specific items without settling the final tax liability of that period (IRC §7121).

A closing agreement is the only statutorily authorized method for entering into an agreement binding on both the service and a taxpayer. Section 7121 permits but does not require the IRS to enter into a closing agreement. As a result, the IRS has the discretion to decide whether and under what conditions a closing agreement is executed.

You may want a closing agreement, even though no tax is due for the period to which the agreement relates. You may enter into a series of agreements relating to the tax liability of a single period. To cover these and other situations, the IRS provides the following closing agreement forms:

• Form 866, which covers liability for any past period.
• Form 906, which closes specific items of tax liability for either past, current, or future periods (Reg §601.202(b)).

Procedures for entering into closing agreements are also detailed in IRS Rev. Proc. 68-16, 1968-1 CB 770, as modified by Rev. Proc. 94-67, 1994-2 CB 800.

Before entering into a closing agreement, make sure that you understand all of its consequences. After both you and the IRS sign, you cannot change your position. A closing agreement is final on the matter expressly stated in the agreement, unless there is a showing of fraud, malfeasance, or misrepresentation of a material fact. It cannot be modified, set aside, or disregarded in a later suit, action, or proceeding.

Why Use a Closing Agreement?

The main object of a closing agreement is to protect the individual against the reopening of an agreed matter at some later date by the IRS. It also stops an individual from suing or filing other claims for refund. A closing agreement also may be used to fix tax liability for a year barred or arguably barred by the statute of limitations.

You may want a closing agreement for recurring transactions. Cost, fair market value, or adjusted basis as of a given date in the past may be established.

Establishing tax liability may facilitate a transaction such as the sale of stock.

A corporation in the process of liquidation or dissolution may want an agreement to wind up its affairs.

In estate tax proceedings, a closing agreement can assure the fiduciary that the estate is closed for federal tax purposes.

When Is Form 866 Used?

Form 866, “Agreement as to Final Determination of Tax Liability,” is used for tax periods ending before the agreement. It closes the total liability of the individual for those periods. It is used where the tax period for which the agreement is asked has ended, and tax liability for the period has been determined.

The total tax liability determined has to be separated into tax periods and types of taxes. Also, the exact section of the law under which each tax covered was imposed must be noted.

Whenever Form 866 is used, the tax liability stated for each period shown in the agreement has to be the total tax liability determined for each period, without any penalty or interest. But the government may want the closing agreement to include ad valorem penalties that have been incurred. Then the tax and penalty are described in the agreement. Three copies of Form 866 must be completed.

When Is Form 906 Used?

Closing agreements on specific items are made on Form 906. This is so whether they are related to past, current, or future periods. A closing agreement of a year ending after the agreement is always made on Form 906. It relates only to a specific item or items affecting tax liability. It cannot attempt to conclude total tax liability for any period. Specific items on past periods that it may cover are items such as:

• Amount of gross income, deductions for losses, depreciation, or depletion;
• Year for which an item of income is to be included in gross income;
• Year for which an item of loss is to be deducted; and
• Value of property on a specified date.

Combined Agreements

Neither Form 866 nor Form 906 is designed to determine both tax liability and tax consequences of specific items. Instead, a combined agreement may be used. The format is shown in Rev. Proc. 68-16, 1968-1 CB 770. The main reason for a combined agreement is that a determination of liability does not fix the amount of income or deductions taken into account in reaching liability. Later, you may be able to prove a net operating loss for the year liability was determined, even though the tax was based on facts showing taxable income. In such a case, while the tax liability has been fixed, the effect of transactions of that year on other years has not. If agreed, the problem may be avoided by a combined agreement determining taxable income for such year and any carryovers from the year.

How To Apply for Closing Agreements

To apply for a closing agreement, send your request to the Director with audit jurisdiction over the returns, or to the Appeals office if your request relates to a case pending before it.

A request is only an offer. It may be withdrawn any time before it is accepted. The closing agreement may be prepared by the taxpayer or the examining agent, but in most cases collaboration is preferable. The taxpayer executes the agreement first, but may withdraw prior to the signing on behalf of the Commissioner.

If it covers a joint return, both spouses have to sign. When an attorney or agent signs, he or she has to include papers proving the authority to sign. Specific instructions for the preparation of closing agreements are contained in Rev. Proc. 68-16, 1968-1 CB 770.

When preparing a closing agreement:

• Fill in the required number of forms. All copies have to be exactly the same. Avoid erasures or corrections; do not switch typewriters.
• Include a statement of how you want the liability fixed and your reasons.
• Use words describing the kind of tax liability involved, such as “Federal income tax.”
• Mention all statutes, regulations, and decisions supporting your case, and show how they apply to your facts.
• Describe the taxes involved.
• Include anything else that will help the IRS decide the case.

When a closing agreement is submitted either on Form 866 or Form 906, the taxpayer is asked to sign a Form 870. This permits the immediate assessment and collection of the agreed deficiency. But it may be conditioned on the approval of the final closing agreement. The IRS will insert a paragraph stating this.

IRS Policy on Closing Agreements

The policy is to enter into a closing agreement in any case in which you can show:

An advantage in having the case permanently closed, as, for example, where, in the settlement of disputed issues, you and the government have made mutual concessions.

• Good and sufficient reasons for desiring a closing agreement, and that the government will suffer no disadvantage if the agreement is entered into.
• The purpose is to mitigate the effect of the statute of limitations or to allow a deficiency dividend.
• Properly executed amended returns have been filed, after the expiration of the period in which assessments might have been made, and no fraud was involved.

A request for a closing agreement is reviewed much more closely than a request for a ruling. The very fact that the IRS is being asked to enter into a binding agreement often makes it suspicious of your motives. Because of the involved nature of the procedure connected with a closing agreement, the IRS is not anxious to use this form. It prefers the much simpler rulings procedure.

There is no assurance in the case of a closing agreement that the Commissioner will agree to it. But no application for a closing agreement can or will be rejected solely because it gives no apparent advantage to the IRS.

Offers in Compromise

The IRS may compromise any civil or criminal case (IRC §7122) unless the case has already been referred to the Department of Justice for prosecution or defense. Once the referral takes place, the Attorney General has the final authority to compromise.

An offer in compromise is a proposal by the taxpayer to pay a sum in full satisfaction of the unpaid tax liability, including interest, penalties, and other additions. When an offer has been accepted and the taxpayer has been notified by letter of the acceptance, the compromise is a legally enforceable contract between the IRS and the taxpayer. All questions of tax liability for the years in question are conclusively and finally settled. Neither the taxpayer nor the IRS may reopen the case except for the showing of falsification, concealment, or mutual mistake of a material fact.

The compromise of a tax liability may rest upon: (1) doubtful liability, (2) doubtful collectibility, or (3) economic hardship or exceptional circumstances. An offer in compromise will be accepted by the IRS if the amount offered reasonably reflects collection potential.

An offer in compromise is filed on Form 656, except for offers based on doubt as to liability, which must be submitted on Form 656-L.

A $186 application fee must accompany Form 656, except for qualifying low-income taxpayers and for taxpayers who have submitted an offer on Form 656-L based on doubt as to liability. Under proposed regulations, this fee would increase to $300 for offers in compromise submitted on or after February 28, 2017, but as of mid-November 2017 the proposed regulation has not been adopted; for an update, see the e-Supplement at jklasser.com.

Low-income status is based on family size and monthly income criteria shown in Section 1 of Form 656 and qualifying taxpayers can certify their eligibility for the fee-payment exception by checking a box in Section 1.

When an offer is based on doubtful collectibility, economic hardship or exceptional circumstances, Form 656 must be accompanied by either Form 433-A (individuals) or Form 433-B (businesses), which are statements of financial condition.

Before rejecting a proposed offer, the IRS must provide for independent administrative review and if an offer is rejected, you must be notified of the right to appeal to the IRS Appeals office.

An offer is deemed to be accepted by the IRS if the IRS does not reject it within 24 months of the submission date, disregarding periods that tax liability is in dispute in a judicial proceeding (IRC §7122(f)).

Economic hardship or exceptional circumstances. Where there is no doubt as to liability or collectibility, the IRS may agree to a compromise to promote effective tax administration on the grounds of economic hardship or exceptional circumstances. The IRS will consider all the facts and circumstances, including the taxpayer’s overall record of tax compliance, in considering the offer. An offer will not be accepted by the IRS if the taxpayer is involved in an open bankruptcy proceeding or if all required federal tax returns have not been filed.

The following are treated as economic hardship situations: (1) long-term illness or disability of the taxpayer or the taxpayer’s dependent makes it likely that the taxpayer’s financial resources will be exhausted, or (2) liquidation of the taxpayer’s assets would prevent the taxpayer from meeting basic living expenses. An example of an exceptional circumstance may be erroneous advice from an IRS employee that results in additional tax liability and penalties (Reg. §301.7122-1(c)(3)(iv)(Example 2)).

Partial payments required. Upfront payments are required (IRC §7122(c)). For a lump-sum offer, which means offers to pay in five or fewer installments, the taxpayer must include with the offer an upfront payment of 20% of the offer amount. For periodic payment offers, the taxpayer must submit the first proposed installment with the application. The upfront payment is in addition to the regular user fee, but the fee will be credited to the outstanding tax liability.

The IRS will waive the partial payment requirement (as well as the application fee) for low-income taxpayers who have certified their status on Form 656, and for taxpayers who have submitted an offer on Form 656-L based on doubt as to liability.

HOW TO GET THE IRS’ OPINION ON A TAX PROBLEM

The IRS provides an invaluable service in giving, through letter rulings and determination letters, opinions on tax questions asked by taxpayers. Any taxpayer may ask for an opinion, and requesting one is often a necessary step in making business decisions. Not every tax problem may be satisfactorily resolved, and where an adverse tax holding might disrupt a planned transaction, requesting an IRS opinion before undertaking the proposed move is advisable. However, a fee must be paid to the IRS with your ruling request and the fee may be substantial.

An IRS opinion may also be requested for a closed transaction to determine how to report it on a tax return.

The IRS’ discretion to rule on taxpayers’ problems is broad. But as a matter of policy, it does not give opinions in certain areas and also distinguishes between the type of opinions that can be given by IRS personnel. A letter ruling is issued by the appropriate Office of Associate Chief Counsel in Washington and is in response to questions involving prospective transactions or completed transactions before a return is filed. A determination letter is issued by a Director in response to questions involving completed transactions. As for prospective transactions, determination letters are issued for determining the qualification of proposed pension or profit-sharing plans, or the exempt status of certain organizations. A determination letter is issued only if the questions presented can be specifically answered by clearly established rules in statutes, regulations, or IRS rulings and court decisions published in the Internal Revenue Bulletin.

Revenue rulings are generally modifications of letter rulings that have been selected because of their importance or interest for publication in the Internal Revenue Bulletin.

Procedures for requesting rulings and determination letters are detailed in Rev. Proc. 2017-1, 2017-1 IRB 1.

Should You Ask for an IRS Ruling?

Before requesting a ruling, it is advisable to carefully research the tax law applying to your problem. If your review shows that IRS policy is against your position, do not ask for a ruling. If you proceed without a ruling, there is always the chance that, if the transaction is examined, a settlement might be reached at that time.

Ask for a ruling if you have a fair chance of receiving a favorable ruling or have an alternative plan if you receive an unfavorable reply. Even if the request is turned down, at least you know that you will encounter possible litigation if you proceed with the transaction. This knowledge may also be important in planning and executing the transaction.

User Fee for Ruling

You must pay the IRS a fee for handling a ruling request. The amount of the fee depends on the specific type of ruling involved.

The user fee schedule can be found in Appendix A of Rev. Proc. 2017-1, 2017-1. After August 15, 2017, taxpayers requesting letter rulings, closing agreements, and rulings using Forms 1128, 2553, 3115 or 8716, must pay the fee electronically at Pay.gov (News Release IR-2017-102).

Getting Advice for Future Transactions

If your question involves a prospective transaction, then only the appropriate Office of Associate Chief Counsel in Washington has the authority to answer in a letter ruling. Unless the law or regulations specifically provide otherwise, the issuance of an answer is a matter that rests within the discretion of Associate Chief Counsel.

If the question is about the qualification of proposed pension, profit-sharing, or stock bonus plans, then a determination letter may be obtained under the rules in Rev. Proc. 2017-4, 2017-1 IRB 146.

Getting Advice on Closed Transactions

A problem concerning a completed transaction may be answered by the appropriate Office of Associate Chief Counsel in a ruling if no return has been filed, and the answer requires the interpretation of the tax laws.

If the answer to the question requires simply the routine application of established principles and policies, the appropriate IRS Director may answer in a determination letter.

In a particular case, it may be difficult to draw the line between a novel or routine problem. If you are not sure of your position, you can send your question to the appropriate Office of Associate Chief Counsel in Washington. The final decision on whether a question is routine or novel, simple or complex, rests with the IRS. If you send a question to an IRS Director on the theory that the matter is routine, he or she may decide that it is novel and refer the question to Associate Chief Counsel. You will be notified of the change.

You Cannot Get a Ruling for . . .

• Hypothetical transactions.
• Questions of fact involving: market value of property; reasonableness of compensation; accumulated earnings penalty.
• Matters involving a court decision adverse to IRS policy and the IRS has not decided whether to follow or litigate the issue.
• An issue that is identical to an issue involved in a return filed by the taxpayer for an earlier year and that issue is under examination or has been examined by an Area Director or has been considered by an Appeals office, and the statute of limitations has not yet expired.
• Questions involved in pending tax cases—if the government’s position would be hurt by giving you a ruling.
• Tax avoidance schemes (you must have a legitimate business purpose in carrying out your transaction).
• Questions that the IRS thinks it cannot properly settle by rulings.
• An issue that is expected to be covered by imminent legislation.
• Questions on replacing involuntarily converted property, even though replacement has not been made, if a return has been filed for the year in which the property was converted. An Area Director can give a determination letter on this issue.

A listing of the areas for which the IRS will not issue rulings or determination letters is published from time to time in the Internal Revenue Bulletin. See Section 6 of Rev. Proc. 2017-1, 2017-1 IRB 1 for a general discussion of no-ruling areas and Section 3 of Rev. Proc. 2017-3, 2017-1 IRB 130 for a list of specific questions and problems for which rulings and determination letters will not be issued. The list is not all-inclusive since the IRS may decline to issue rulings or determination letters on other questions whenever warranted by the facts or circumstances of a particular case. Finally, when there has been new legislation, the IRS hesitates to rule on issues involving Code sections for which regulations have not been made final.

You cannot, by court action, force the IRS to give you a ruling or to apply a ruling in your favor.

Generally, rulings are not issued to business, trade, or industrial associations or to other similar groups relating to the application of the tax laws to members of the groups. However, rulings may be issued to such groups or associations relating to their own tax status or liability.

How To Request a Ruling

Your request must be in writing. The IRS does not issue rulings or determination letters upon oral requests. IRS employees ordinarily will not discuss a substantive tax issue prior to the receipt of a written request for a ruling. If they do, their oral opinions are not binding upon the IRS. This should not discourage an inquiry on whether the IRS will rule on a particular question or a discussion on the procedure for submitting a request for a ruling.

Conference before making a request. Sometimes, it is advisable to ask for a conference before you make your request for a ruling. There are advantages in having a conference before submitting your request. If you are uncertain whether you will get the ruling, the conference allows you to sound out the IRS without exposing the essential facts of the proposed transaction. In making a formal request for a ruling, you are required to supply the National Office with abundant materials and data, such as financial statements, minutes, and balance sheets. These are not returned if the ruling request is denied but are transmitted to the Area Director where they become part of your file.

If a conference is held, understand that what is said during the meeting is merely an aid. It does not bind the IRS. Before going to the conference, prepare your case well. Take with you the draft of your request for a ruling and any proposed contracts or other documents.

Making a ruling request. Appendix B of Rev. Proc. 2017-1 (2017-1 IRB 1) has a sample format for a letter ruling request. To ensure that your request is in order so the IRS can respond quickly, complete the checklist in Appendix C of Rev. Proc. 2017-1, sign and date it, and attach it to the top of your request.

The following rules are highlighted in Appendix B and C:

1. A declaration under penalties of perjury that the facts presented are true, correct, and complete must be signed by the person on whose behalf the request is made; see the required language in Section 7.01(15) of Rev. Proc. 2017-1, 2017-1 IRB 1, and in the sample format shown in Appendix B.

2. Send your letter ruling request to the appropriate Associate Chief Counsel at the following address and mark your package “RULING REQUEST SUBMISSION” (Checklist in Appendix C of Rev. Proc. 2017-1):

   Internal Revenue Service, Attention: CC:PA:LPD:DRU, P.O. Box 7604, Ben Franklin Station, Washington D.C. 20044. If a private delivery service is used, the package should be sent to: Internal Revenue Service, Attention: CC:PA:LPD:DRU, Room 5336, 1111 Constitution Avenue, N.W., Washington, D.C. 20224.

   For determination letters, send the request to the appropriate Small Business/Self-Employed division office, as shown in Appendix F of Rev. Proc. 2017-1.

Submit the original and two copies of the request if more than one issue is presented in the request, or a closing agreement is requested on the issue presented (Section 7.01(16) of Rev. Proc. 2017-1).

3. Do not submit alternative plans in requests for a ruling.

4. Be sure to include:

   • Complete facts.
   • Names, addresses, and taxpayer account numbers of all interested parties.
   • Copies, not originals, of all pertinent documents. The copies should be attested to be the same as the originals. Do not send originals, as they become part of the IRS file and are not returned.

The balance sheet nearest the date of the transaction, if a corporate reorganization, distribution, or similar transaction is involved.

If documents are submitted, they must be accompanied by an analysis of their relevancy to the issue.

5. Give the business reason for the transaction (favorable rulings often depend upon the existence of a bona fide business reason for the transaction).
6. Give the grounds for your stand and your supporting authority and specify what ruling or rulings you want. If you want a particular determination, explain the basis for your contentions, together with a statement of relevant authorities. Even if you do not urge a particular determination, you must give your view of the tax result, supported by a statement of relevant authorities such as statutes and regulations. All requests must include a statement of whether the applicable law is uncertain and whether the issue is adequately addressed by relevant authorities.
7. The IRS encourages the disclosure of any legislation, regulations, revenue rulings, or revenue procedures contrary to the taxpayer’s position. The IRS believes that disclosure will lead to more rapid action. Technically, the IRS encourages but does not require the statement of contrary authorities. However, if contrary authorities are not provided, the IRS wants the ruling request to include a statement that there are no contrary authorities. If the taxpayer does not take either action and refuses a subsequent request of the IRS to do so, the IRS may refuse to issue a ruling (Section 7.01(9) of Rev. Proc. 2017-1). The IRS specifically requires that any relevant pending legislation be identified in the ruling request. The IRS must also be notified if legislation is introduced after the request is filed but before a ruling is issued (Section 7.01(10) of Rev. Proc. 2017-1).
8. If a conference on the issues is desired, ask for one in the ruling request or soon afterwards in writing.
9. Sign the request. If you are representing a taxpayer, include your power of attorney and if you are an enrolled agent, show evidence of enrollment. The ruling request is signed by the taxpayer or by an authorized representative who is (1) an attorney who has filed a written declaration that he or she is currently qualified as an attorney and is authorized to represent the taxpayer; (2) a certified public accountant who files with the IRS written declaration that he or she is currently qualified as a certified public accountant and is authorized to represent the taxpayer; (3) a person, other than an attorney or certified public accountant, enrolled to practice before the Service; or (4) any other person who has received a Letter of Authorization from the IRS Director of the Office of Professional Responsibility to represent the taxpayer in this particular matter.

10. Submit payment of user fee. Each ruling request must be accompanied by the appropriate fee. For specific payment instructions, see Section 15 and Appendix A of Rev. Proc. 2017-1. Note however, that after August 15, 2017, Pay.gov is the only permissible payment method for the following rulings described in Rev. Proc. 2017-1: private letter rulings, closing agreements, and rulings using Forms 1128, 2553, 3115 or 8716; see News Release IR-2017-102 for further details on the new payment procedures.

    User fees for employee plans and exempt organizations are in Section 6.02(15) and Appendix A of Rev. Proc. 2017-4, 2017-1 IRB 146.

Requests that do not comply with the above requirements will be acknowledged, and the requirements that have not been met will be pointed out. If the missing information is not supplied within 21 days, and an extension is not granted, the IRS will notify you in writing that the ruling request has been closed (Section 8.05(1) of Rev. Proc. 2017-1). If you supply the missing information after the closing letter is mailed, your request will be reopened and treated as a new request as of the date of the receipt of the information, but a new user fee must be paid (Section 8.05(3) of Rev. Proc. 2017-1).

The IRS has an alternate two-part procedure to expedite the processing of ruling requests for proposed transactions Section 7.02(3) of Rev. Proc. 2017-1. Under the procedure, you may submit, together with the detailed statement of facts, documents and other required information, a summary statement of the controlling facts that support your request. If the Office of Associate Chief Counsel finds your summary satisfactory, the ruling will be based on these facts. This procedure has the advantage of eliminating many of the facts that the reviewer must assess. In addition, it removes some of the subjectivity exercised by the reviewer in determining whether the transaction was carried out substantially as proposed and whether minor deviations are material. On the other hand, this procedure poses the problem of what is a sufficient statement of the facts.

Withdrawing your request. You may withdraw your request for a ruling or a determination letter at any time prior to the signing of the letter of reply. However, this may prove futile. The Office of Associate Chief Counsel may give its views on your request to the appropriate official with examination jurisdiction of the return. The information you submitted with your request will be considered in a later audit or examination of your return. Even though you withdraw your request, all correspondence and exhibits are retained by the IRS and are not returned to you.

Your Ruling Will Be Open to Public Inspection

Code §6110 requires the IRS to open to public inspection virtually all letter rulings, determination letters, and technical advice memoranda (called “written determinations”) and related background files. Before your ruling is made public, it must be “sanitized” by deleting the following information:

1. Identifying details, such as names, addresses, Social Security numbers, and any other information that would identify any person (other than certain third parties who communicate with the IRS regarding the determination). Identifying details include information that would permit a person in the appropriate community (such as an industry or geographic location) to identify any person.
2. Information specifically authorized to be kept secret in the interest of national defense or foreign policy.
3. Information exempt from disclosure under other laws.
4. Trade secrets and privileged or confidential commercial or financial information.
5. Information the disclosure of which would constitute a clearly unwarranted invasion of personal privacy. This would include, for example, details not yet made public of a pending divorce or of medical treatment.
6. Information concerning the agency regulation of financial institutions.
7. Geological and geophysical information and data, including maps concerning wells.

Requesting deletions from written determination. When you request a determination letter, ruling, or technical advice memorandum, you must also submit a separate statement of proposed deletions (Section 7.01(11) of Rev. Proc. 2017-1). At the same time the letter ruling or determination letter on your case is issued, you will receive a notice that it will be disclosed to the public. You will also receive a copy of the text the IRS proposes to disclose on which is indicated the material the IRS proposes to delete, any substitutions, and any third-party communications. (In the case of a background file or written determination that is disclosed only on written request for disclosure, the disclosure notice will be mailed to you within a reasonable time after the IRS received its first request for disclosure.) You then have 20 days after the notice is mailed to submit a written statement identifying those items that you believe should be deleted but were not. You must also submit a copy of the proposed IRS text and indicate by brackets further deletions that you want the IRS to make. Generally, the IRS will not delete any material that you had not earlier proposed be deleted. The IRS will mail to you its final administrative conclusions regarding deletions within 20 days of receiving your response (Section 7.01(11)(e) of Rev. Proc. 2017-1). The IRS will attempt to resolve the differences, but will not grant a conference specifically for that purpose. However, you may discuss issues involving deletions at any conference that has been otherwise scheduled with respect to the requested ruling or determination letter.

Court remedies when you and the IRS do not agree on deletions. If you are still not satisfied with the deletions proposed by the IRS, you may file a petition in the Tax Court (anonymously, if appropriate) within 60 days after the date on which the IRS mailed the disclosure notice (IRC §6110(f)(3)). You must have exhausted your remedies within the IRS prior to petitioning the Tax Court. If your request for deletions has not been responded to by the IRS within 50 days of the mailing of the disclosure notice, this is considered an exhaustion of administrative remedies allowing a filing of a petition in the Tax Court (Reg. §301.6110-5(b)(3)).

Within 15 days, the IRS will notify by registered or certified mail any other person identified by name and address in the written determination or background file that a petition has been filed in the Tax Court. Such person may intervene in the Tax Court action (anonymously, if appropriate) (IRC §6110(f)(3)(B)).

The Tax Court will make a decision as soon as possible on the extent of deletions and may close its proceedings on the issue to the public (IRC §6110(f)(5) and (6)).

When Written Determinations Are Open to Public Inspection

Generally, written determinations and background files will be open to public inspection no earlier than 75 days and no later than 90 days after the IRS mailed you the disclosure notice. If you sued in the Tax Court regarding deletions, the written determination or background file will be open to the public within 30 days after the court order becomes final, although the court may extend the 30-day period to give the IRS time to comply with its order (IRC §6110(g)).

Request for Delay of Disclosure

Where the transaction that is the subject of the written determination is not complete when the determination is issued, you may request that the IRS postpone disclosure until 15 days after the transaction is completed. However, disclosure generally must occur within 180 days after the IRS mailed you the disclosure notice (IRC §6110 (g)(3)). If the transaction is still not completed within the 180-day period, and disclosure would interfere with the transaction, you may again request a postponement until 15 days after the transaction. Overall, postponement may not exceed 360 days after the IRS mailing of the disclosure notice (IRC §6110 (g)(4); Reg. §301.6110-5(c)(2)(ii)(B)).

Your request for postponement must be in writing and state the date on which you expect to complete the transaction. To get the first postponement, send your request so that the IRS receives it within 60 days after the disclosure notice. To get the second postponement, send your request so that the IRS receives it within 15 days before the date you stated you expected to complete the transaction (Reg. §301.6110-5(c)(2)(ii)(C)).

You must notify the IRS when you complete the transaction if that happens earlier than you expected. The written determination will be open to public inspection 30 days after notice of completion or on the date originally scheduled for disclosure, whichever date is earlier (Reg. §301.6110-5(c)(2)(ii)(D)).

What To Do When the IRS Fails To Meet the Time Limitations or Fails To Make Deletions

Where the IRS fails to meet the time limitations, such as disclosing before 75 days after the disclosure notice was mailed to you or failing to postpone disclosure pursuant to your request, you may sue the government in the U.S. Court of Federal Claims. You or any other person identified in the determination may sue the government in the U.S. Court of Federal Claims if the IRS fails to make deletions as required by its own agreement or by court order. Where the court determines that any employee of the IRS intentionally or willfully failed to make a deletion or failed to act within the time limits, you may recover your actual damages (but not less than $1,000) plus costs and reasonable attorneys’ fees for bringing the action (IRC §6110(j)(2)).

How Soon May You Receive an Answer?

Letter rulings and determination letters are issued on a first-come-first-served basis. You may get a preference by showing a compelling need for a faster consideration but the IRS will grant expedited handling only in rare and unusual cases(for details, see Section 7.02(4) of Rev. Proc. 2017-1). Even if the IRS decides to grant expedited handling, it will not assure you that your request will be processed by the date you request.

You may request that the IRS fax you or your representative a copy of the letter ruling, but the ruling is not considered “issued” until it is mailed (Section 7.02(5) of Rev. Proc. 2017-1).

To learn the status of a tax ruling, contact the representative indicated on the IRS acknowledgment of your request.

You May Get an Information Letter

Even though you request a ruling or a determination letter, you may receive an information letter. This is a statement issued either by the Office of Associate Chief Counsel or by a Director. It does no more than call attention to a well-established interpretation or principle of tax law without applying it to a specific set of facts. You may receive an information letter if your request seeks general information or does not meet all the requirements for a ruling or determination letter (Section 2.04 of Rev. Proc. 2017-1).

Can You Rely on a Letter Ruling?

You can usually rely on a letter ruling sent to you, although the IRS has the power to revoke the ruling retroactively. However, the IRS only under rare circumstances exercises this power. If the ruling is changed or revoked, the effect is almost always prospective. Be sure, in applying a ruling to the actual transaction, that the facts of the transaction are as you had stated them in your request and that the law has not changed in the meantime (Section 11.03 of Rev. Proc. 2017-1).

When preparing the return for the year in which the transaction involved takes place, attach a copy of the ruling or letter to the return. IRS personnel compare the facts reported on the return with the representations upon which the ruling was based. They do this to determine whether there has been a misstatement or omission of a material fact, or if the transaction upon which the ruling was based was actually carried out in a manner materially different from that represented.

When you receive a ruling, the IRS will generally audit the return reporting the transaction that is the subject of the ruling.

You may not rely on a letter ruling issued to another taxpayer, although the ruling may be helpful in discerning the IRS position on a particular issue. The law specifically states that written determinations may not be cited as precedent by either the IRS or taxpayers unless the IRS provides otherwise in regulations (IRC §6110(k)(3)). The Supreme Court has stated that although the law bars the use of private rulings as precedents, they are nonetheless “evidence” of IRS views. The IRS may designate in a widely circulated official government publication (such as the Internal Revenue Bulletin) that a determination will be used as precedent.

You may rely on Revenue Rulings published in the Internal Revenue Bulletin in determining the rule applicable to your own case if the facts and circumstances of your transaction are substantially the same as in the published ruling.

Review and Revocation of Determination Letters

Determination letters involving income taxes are not generally reviewed by the Office of Associate Chief Counsel, as they merely repeat a position previously established in a regulation, ruling, or court decision published in the Internal Revenue Bulletin. If you believe a determination letter to be in error, you may ask the appropriate Director to reconsider the matter. You may also ask the Director to request technical advice from the Associate Office of Chief Counsel (Section 12.06 of Rev. Proc. 2017-1).

A Director may revoke a determination letter on re-examination of the issue or on an audit of the taxpayer’s return. The revocation is generally retroactive because the letter was issued for a completed transaction (so you did not rely upon the letter when entering into the transaction). A Director does not have authority under IRC § 7805(b) to limit the revocation or modification of the determination letter, but if the Field office proposes to revoke or modify the letter, you may ask the Director that issued the determination letter to seek technical advice from the Associate office that would limit the retroactive effect of the revocation or modification (Section 13.02 of Rev. Proc. 2017-1).

The revocation of a determination letter on the status of pension and profit-sharing plans and exempt organizations, however, is generally prospective in effect.

How Letter Rulings Become Revenue Rulings

Revenue Rulings are generally revised letter rulings that the IRS believes have value as precedents or guides for taxpayers and IRS personnel. Although it is on the same subject matter, a Revenue Ruling differs from a letter ruling. When a letter ruling is edited for publication as a Revenue Ruling, the taxpayers’ names and identifying facts are deleted. However, the ruling retains relevant facts with modifications to fit within the IRS’ intention to propound a general rule. Finally, Revenue Rulings are subject to higher review, whereas many letter rulings are issued with no review above the branch level.

Requesting Technical Advice From the National Office

IRS field office personnel determine whether to request a technical advice memorandum (TAM) from the Office of Associate Chief Counsel when an issue is raised during an audit or conference as to the proper application of the Internal Revenue Code or IRS rules to a specific set of facts. A TAM may not be requested for prospective or hypothetical transactions (Section 3.01 of Rev. Proc. 2017-2, 2017-1 IRB 106). Before requesting technical advice, the field office must coordinate with field counsel and all requests for technical advice must be approved in writing by an IRS Director (Section 5.01 of Rev. Proc. 2017-2).

You may request that the IRS Director refer an issue on a closed transaction to the Office of Associate Chief Counsel for a TAM (Section 5.02 of Rev. Proc. 2017-2). You may do this on the grounds that the issue has not been handled by the IRS in a uniform manner, or the issue, because of its complexity or unusualness, warrants consideration by the Associate Chief Counsel. Request for technical advice should be made as early as possible. If you wait until the case is in the Appeals office, the request for technical advice may be made before the Appeals office conference.

Your request for technical advice should be directed to the field office, either orally or in writing (Section 5.02 of Rev. Proc. 2017-2). The field office will notify you if it decides that your request for technical advice is unwarranted, and you may appeal the decision within 30 days of the notification by submitting to the field office a written statement of the reasons why the matter should be referred to the appropriate Office of Associate Chief Counsel (Section 5.03 of Rev. Proc. 2017-2). The statement should describe the pertinent facts and legal authorities and explain your position and the need for technical advice. The statement, along with the field office’s statement of why technical advice is not needed, will be forwarded to the appropriate Compliance Director or territory manager for a decision. No conference will be held with you or your representative. If the Director proposes to deny the request, you will be sent a written explanation. You may not appeal a proposed denial, but at your request the Director will review the file and make a decision solely on the basis of the written record; no conference will be held. The reviewing Director will notify the field office of its decision within 45 days of receiving the information and then the field office will notify you (Section 5.04 of Rev. Proc. 2017-2).

If the field office intends to request technical advice, it will arrange a pre-submission conference to frame the issues and prepare the documents that must be included with the request (Section 6 of Rev. Proc. 2017-2). The pre-submission conference is generally conducted by telephone but may be conducted in person if the parties so choose (Section 6.07 of Rev. Proc. 2017-2).

You will be informed if the Associate Chief Counsel proposes to issue a TAM that is adverse to you, and a conference will be held, generally in person within 10 days unless you waive the right to the conference (Sections 9.01-9.02 of Rev. Proc. 2017-2). Generally, you should attempt to provide all documents and arguments in writing well in advance of the conference, but if at the conference it appears that new information may be helpful, the new information should be provided 10 days after the conference. Extensions of the 10-day period must be requested in writing and are not typically granted by the Associate Chief Counsel (Section 9.03 of Rev. Proc. 2017-2).

A TAM contains: (1) a statement of the issues; (2) a statement of the facts pertinent to the issues; (3) the conclusions of the Associate Chief Counsel; (4) a discussion of the laws, regulations, rulings, and court decisions supporting the conclusions reached by the Associate Chief Counsel. The conclusions give direct answers, whenever possible, to the specific issues raised by the field office (Section 10.1 of Rev. Proc. 2017-2).

Accompanying the TAM is a notice under IRC §6110(f)(1) to disclose a TAM, including a copy of the version proposed to be open to public inspection. Before issuing the TAM, the Associate Chief Counsel will inform you if the IRS has decided to include in the TAM any of the material that you asked to be deleted. In that case, you have 10 days to submit further arguments supporting your proposed deletions (Section 10.09 of Rev. Proc. 2017-2).

After the Associate Chief Counsel provides a copy of the final TAM to the field office, the field office generally gives you a copy of the issued TAM, along with a copy of the version proposed to be open to public inspection (Sections 10.07–10.10 of Rev. Proc. 2017-2). However, a copy of the TAM will not be given to you if your case involved a criminal or civil fraud investigation, or a jeopardy or termination assessment, until all of the proceedings in the investigation or assessment are complete (Section 10.12 of Rev. Proc. 2017-2).

Effect of technical advice. A technical advice memorandum represents the IRS’ views of the law, applied to the facts of your specific case. Generally, a technical advice memorandum has the same effect as a ruling on a closed and completed transaction. It usually disposes of the matter in which it was requested and usually applies retroactively (Section 13 of Rev. Proc. 2017-2). But note: (1) Technical advice is not binding in a subsequent year, even though it is not revoked. (2) The IRS office handling your case may raise an issue in any taxable period, even though it has received technical advice concerning the same issue in another taxable period.

You may not rely on a TAM issued by the IRS for another taxpayer (IRC §6110(k)(3); (Section 13.04 of Rev. Proc. 2017-2).

Technical advice memoranda often form the basis for revenue rulings.

Note: Other details on the furnishing of technical advice are in Rev. Proc. 2017-2, 2017-1 IRB 106.

How To Get Written Determinations Issued to Other Taxpayers

While you may not use letter rulings, determination letters, or technical advice memoranda issued to other taxpayers as precedent, they may be helpful as they reflect IRS policy and interpretation of the law. Written determinations are available from subscription services and in government reading rooms as discussed in the following section; background files are open to inspection only on written request.

Disclosure is not required of any technical advice memorandum (and its related background file) where the case involves civil fraud, criminal investigation, jeopardy, or termination assessment, until any action relating to the investigation or assessment is completed. Furthermore, a determination relating to IRS approval of the adoption or change in accounting method or period, qualified retirement plan funding method or plan year, or taxable year of a partner or partnership need not be open to public inspection, although the IRS must honor a written request for inspection.

Where You May Inspect Written Determinations

Some private publishing firms, such as Tax Analysts, Research Institute of America, and Commerce Clearing House, regularly publish rulings and technical advice memoranda.

The IRS makes letter rulings and technical advice memoranda available in its Electronic Reading Room; go to the section for “Non-precedential Rulings and Advice” at irs.gov/uac/Electronic-Reading-Room#about.

Rulings and technical advice memoranda are also available for inspection and copying in the IRS Freedom of Information Reading Room located at 1111 Constitution Avenue, N.W., Washington D.C. 20224.

Actions To Obtain Additional Disclosure

You may seek disclosure of additional information on any written determination or background file open to public inspection (IRC §6110(f)(4)). You must request the additional disclosure from the Internal Revenue Office that issued the written determination, specifying the deleted information that you believe should be disclosed and why. The IRS says it will not disclose names, addresses, or identifying numbers. The IRS will notify all people identified by name and address in the determination or background file that additional disclosure is sought. If all agree to the additional disclosure within 20 days, the determination or background file will be revised to reflect the additional disclosure. If anyone objects, the IRS will deny your request (Reg. §301.6110-5(d)(1)).

If your request is denied, you may file a petition in Tax Court or the District Court for the District of Columbia for the additional disclosure. The IRS will notify anyone identified by name and address in the determination or background file of the suit within 15 days by registered or certified mail, and such person may intervene in the suit (anonymously, if appropriate) (Reg. §301.6110-5(d)(2)-(5)).

CIRCULAR 230: PRACTICE BEFORE THE IRS

The requirements, privileges, and duties of persons qualified to practice before the IRS are described in Treasury Department Circular No. 230. The IRS Office of Professional Responsibility (OPR) may impose sanctions (discussed below) on practitioners who violate the Circular standards.

There is a link to Circular 230 (with a revision date of June 2014; this is the latest revision) and related tax practice information at the Circular 230 Tax Professionals Home page at www.irs.gov/Tax-Professionals/Circular-230-Tax-Professionals.

Practitioners subject to Circular 230. The provisions of Circular 230 apply to attorneys, certified public accountants, enrolled agents, enrolled retirement plan agents, and enrolled actuaries. Other individuals are subject to Circular 230 to the extent they (1) represent others pursuant to the limited practice regulations (see text below at“Limited Practice in Special Cases”), or (2) they give written advice concerning transactions, arrangements or entities that the IRS determines to have a tax avoidance or evasion purpose.

The attempt by the IRS to subject “unenrolled” tax return preparers (preparers other than attorneys, CPAs, or enrolled agents) to the practice rules of Circular 230 was rejected in 2014 by the Court of Appeals for the District of Columbia Circuit (Loving v. IRS, 742 F.3d 1013 (D.C. Cir. 2014)). The D.C. Circuit held that the IRS lacked the statutory authority to issue the 2011 regulations (T.D. 9527, 2011-27 IRB 1) that treated tax return preparers as engaged in “practice” before the IRS and which required preparers who were not attorneys, CPAs, or enrolled agents to qualify as “registered tax return preparers” (RTRPs) by passing a minimum competency test, undergoing a tax compliance check and background suitability check, and taking continuing education courses. According to the D.C. Circuit, the statute that allows the IRS to regulate individuals who “practice” before it (31 U.S. C. Sec. 330) does not cover those who merely prepare tax returns, as Congress intended “practice” to mean the representation of a taxpayer in a contested proceeding during the examination and appeals stages before the IRS.

Note that the D.C. Circuit decision in Loving has no impact on the statutory requirement that all paid tax return preparers must have a PTIN and enter it on their clients’ tax returns (Code Section 6109(a)(4)). However, the U.S. District Court for the District of Columbia held in June 2017 (Steele v. United States) that the IRS lacks the authority to charge a fee for issuing PTINs; the Steele decision is discussed further below.

Although the regulations on “registered tax return preparers” (RTRPs) were invalidated by the D.C. Circuit’s decision in Loving, those regulations were still in the version of Circular 230 posted on IRS.gov at the time this book was completed (Reg. §§10.3(f), 10.4(c), and 10.5 of the June 2014 revision of Circular 230).

IRS adopts Annual Filing Season Program in response to the Loving decision. In response to the D.C. Circuit decision in Loving, the IRS has implemented a voluntary program of continuing education and testing for unenrolled preparers which it calls the “Annual Filing Season Program”. The requirements for the Annual Filing Season Program and benefits of participation for unenrolled preparers are discussed below.

Preparer representation rights before the IRS. The only tax professionals with unlimited representation rights before the IRS are attorneys, CPAs, and enrolled agents. These credentialed practitioners may represent clients on all matters before the IRS, including audits, payments, collections, and appeals.

Non-credentialed preparers have limited representation rights with respect to returns prepared and signed before 2016. This means they may represent a taxpayer whose tax return they prepared and signed before 2016 during an audit of that return. Representation is allowed only before IRS revenue agents, customer service representatives, and similar IRS employees, including the Taxpayer Advocate Service. Non-credentialed preparers may not represent the taxpayer before appeals or collections officers.

With respect to returns and refund claims prepared and signed after 2015, the only non-credentialed preparers that have limited representation rights are those that have received a Record of Completion under the Annual Filing Season Program (see below) for both the year the return is prepared and the year of representation. Non-credentialed preparers who do not complete the Annual Filing Season Program may not represent taxpayers before the IRS in any way with respect to returns and refund claims prepared and signed after 2015 (News Release IR-2015-123; Rev. Proc. 2014-42, 2014-29 IRB 192).

The IRS Return Preparer Office(RPO). The IRS Return Preparer Office administers the PTIN application system for paid preparers, manages registration applications for enrollment and renewal, including preliminary suitability and tax compliance determinations, and administers the competency testing and continuing education programs. The RPO also receives and processes complaints alleging practitioner misconduct, and initiates preliminary investigations before forwarding the complaints to the Office of Professional Responsibility.

The Office of Professional Responsibility (OPR). The Office of Professional Responsibility (OPR) enforces the Circular 230 standards of practitioner conduct and discipline, including instituting disciplinary proceedings and pursuing sanctions.

PTINs are Mandatory and Must Be Renewed Annually By Paid Tax Return Preparers

Anyone who receives compensation to prepare all or substantially all of a federal tax return or refund claim must obtain a preparer tax identification number (PTIN) from the IRS (Reg. §10.8(a), Circular 230; Reg. §1.6109-2(d)). A paid preparer must include a valid PTIN on federal returns he or she prepares or be subject to penalties (IRC §6695(c); the penalty for 2017 returns is $50 per return, up to a maximum of $25,500).

The PTIN requirement applies to non-credentialed preparers, as well as to attorneys, certified public accountants, enrolled retirement plan agents, and enrolled actuaries if for compensation they prepare or help prepare any tax return or refund claim. All enrolled agents must have a valid PTIN regardless of whether they prepare tax returns.

PTINs are issued for a specific calendar year and must be renewed by the end of a year for the following year. The PTIN “open season” for obtaining or renewing a PTIN for the following year normally begins in mid-October of the prior year. For example, all preparers with 2017 PTINs (over 727,000 preparers) had to renew their PTINs for 2018 by December 31, 2017 (News Release IR-2017-180). There is currently no fee for obtaining or renewing a PTIN, pending the outcome of the U.S. Government’s appeal of the district court decision in Steele; see below.

Preparers are urged to sign up for or renew a PTIN online at http://www.irs.gov/Tax-Professionals/PTIN-Requirements-for-Tax-Return-Preparers. A paper application for obtaining or renewing a PTIN can also be made on Form W-12 (IRS Paid Preparer Tax Identification Number Application), but processing will take 4-6 weeks.

Supervised preparers (non-signing preparers who work under the supervision of an attorney, CPA, or enrolled agent, actuary, or retirement plan agent) and preparers who do not prepare Form 1040 series forms must obtain a PTIN and renew it annually. This is true even though the returns they prepare (or assist in preparing) are reviewed and signed by a supervisor.

The IRS ruled that enrolled retirement plan agents are not required to obtain a PTIN prior to applying for enrollment or renewing enrollment if they prepare only Form 5300 series returns or Form 5500 series returns (Notice 2011-91, 2011-47 IRB 792).

District Court in Steele invalidates fees for PTINs. In Steele v. United States(2017-1 USTC ¶50,238 (D.D.C. 2017)), the District Court for the District of Columbia held (June 1, 2017) that the regulation allowing the IRS to charge user fees for PTINs is invalid ( Reg. §1.6109-2(d)). The IRS has the authority to require the use of a PTIN but lacks the authority to charge PTIN fees. User fees may be charged when certain individuals are bestowed “special benefits” not available to the general public. However, according to the Court, in light of the D.C. Circuit decision in Loving, anyone can obtain a PTIN and prepare tax returns for compensation, and therefore no “special benefit” is being provided by the IRS when it issues PTINs. In a separate order accompanying the opinion, the District Court required the IRS to issue refunds to all preparers who have paid PTIN fees.

At the time this book was completed, the IRS had filed a motion with the District Court to stay enforcement of the Court’s decision enjoining PTIN user fees, pending an appeal to the D.C. Circuit; any developments will be reported in the e-Supplement at jklasser.com.

The IRS’ Annual Filing Season Program Offers Voluntary Continuing Education and Testing for Non-Credentialed Preparers

After the D.C. Circuit decision in Loving struck down mandatory testing and continuing education for non-credentialed tax preparers, the IRS put into place the “Annual Filing Season Program (AFSP)”, starting with the 2015 tax filing season(Rev. Proc. 2014-42, 2014-29 IRB 192). The AFSP is intended to encourage non-credentialed tax preparers (preparers other than attorneys, CPAs, enrolled agents, enrolled actuaries, and enrolled retirement plan agents) to voluntarily undergo annual continuing education and take a tax competency exam (unless exempt) so that they can enhance their credibility with potential clients.

The IRS provides an overview of the AFSP at www.irs.gov/Tax-Professionals/Annual-Filing-Season-Program. There are links to details on the CE courses and test requirements, the test exemptions, frequently asked questions, and other AFSP rules.

Note: The AICPA is challenging the IRS’ authority to establish the Annual Filing Season Program in federal court; see the end of this AFSP section for more on the litigation.

Completing the AFSP allows listing on IRS directory of preparers. Non-credentialed preparers who meet the AFSP continuing education and other requirements (see below) receive a “Record of Completion” from the IRS and are included in a searchable directory of tax preparers that taxpayers can access at irs.treasury.gov/rpo/rpo.jsf. On the directory, which is updated regularly, attorneys, CPAs, enrolled agents, enrolled actuaries, and enrolled retirement plan agents with valid PTINs are recognized as having professional credentials. Preparers that have obtained an AFSP Record of Completion are not called “credentialed” preparers on the directory, but are identified separately as having an “other qualification”. The IRS allows non-credentialed preparers with a an AFSP Record of Completion to state (in advertising and otherwise) only that they have met the IRS requirements for receiving the Record of Completion. They may not state or imply that the IRS has “endorsed”, “certified”, “enrolled”, or “licensed” them.

Continuing education required to obtain AFSP Record of Completion. Generally, 18 hours of continuing education (CE) must be completed by the end of the year to obtain an AFSP Record of Completion for the upcoming tax season. The CE must be from IRS-Approved CE Providers. Unless the preparer has an exemption (see below), the 18 hours must include a six-hour federal tax refresher course followed by a tax comprehension examination. Preparers with an exemption from the refresher course and the test must still complete 15 hours of continuing education. CE providers determine course fees; the IRS does not charge a fee for participating in the AFSP.

For those who are not exempt from the refresher course and testing, the 18 hours of CE must include the following:

1. the six-hour annual tax refresher course (AFTR course) covering filing season and tax law updates, followed by a comprehension examination on the tax topics covered by the AFTR course. The test as well as the AFTR course is designed and administered by the CE provider and not the IRS. The IRS provides a course outline and test parameters that CE providers must follow. For example, the test must have at least 100 multiple choice questions, of which at least 70% must be answered correctly.
2. 10 hours of additional federal tax law topics in addition to the AFTR, and
3. two hours of ethics.

If the preparer is exempt (see next paragraph) from the AFTR course and examination, the preparer must complete 15 hours of CE as follows:

1. 10 hours of federal tax law topics
2. three hours of federal tax law updates, and
3. two hours of ethics.

Exemption from tax refresher course and test. Non-credentialed preparers who have taken other recognized tax competency tests can obtain the AFSP Record of Completion without taking the AFSP refresher course and examination. As shown above, 15 hours of CE must still be taken. Exempted from the refresher course and examination are preparers who passed the IRS’ Registered Tax Return Preparer test between November 2011 and January 2013 (prior to the Loving decision), and preparers in California, Oregon, and Maryland who are currently subject to state-based testing. The full list of exemptions is at irs.gov/Tax-Professionals/Reduced-Requirements-for-Exempt-Individuals-for-the-Annual-Filing-Season-Program-Record-of-Completion.

Preparer must have valid PTIN and consent to certain Circular 230 provisions to obtain AFSP Record of Completion. In addition to completing the required CE, a preparer must consent to be bound by the tax practice obligations in Subpart B of Circular 230 (Reg. Sections 10.20-10.38) and Section 10.51, and must have an active PTIN for the upcoming tax year to receive the Record of Completion. Once preparers have completed their CE requirements and obtained or renewed their PTIN for the upcoming year, they will receive an email from “[email protected]” with instructions on how to consent to the Circular 230 practice requirements, after which they will receive their Record of Completion certificate in their online secure mailbox. Preparers without an online PTIN account will receive a letter with instructions for completing the application process and obtaining their Record of Completion.

Limited representation rights. As noted earlier, for returns prepared and signed before 2016, all non-credentialed preparers with valid PTINs, whether or not they participate in the AFSP, have limited representation rights, meaning that they can represent taxpayers before the IRS during an audit of the return, but only before IRS revenue agents, customer service representatives, and similar IRS employees, including the Taxpayer Advocate Service.

For returns prepared and signed after 2015, a non-credentialed preparer with an AFSP Record of Completion continues to have limited representation rights. Other non-credentialed preparers may not in any way represent a taxpayer before the IRS.

AICPA lawsuit challenging the AFSP. The AICPA has challenged the IRS’ authority to establish the Annual Filing Season Program in federal court. At the time this book was to completed, the case was before the D.C. Circuit. The AICPA is asking the D.C. Circuit to reverse a 2016 decision of the U.S. District Court for the District of Columbia that held that the AICPA lacks standing to bring its lawsuit.

Both courts previously dealt with the standing issue. In 2015, the D.C. Circuit reversed an earlier dismissal of the case by the same District Court on standing grounds.The D.C. Circuit held that the AICPA has standing because its members face competition from AFSP participants that could dilute the AICPA “brand” (American Institute of Certified Public Accountants v. IRS, 804 F.3d 1193 (D.C. Cir. 2015)). However, the case was remanded back to the District Court to address other issues. On remand, the District Court in 2016 again dismissed the AICPA lawsuit, holding that despite its competitive concerns, the AICPA lacks standing because the interest of AICPA members in opposing the AFSP in order to avoid competition is not within the “zone of interests” protected by the statute underlying the AFSP (31 U.S.C. Sec. 330), which is to protect consumers in the tax-services marketplace (American Institute of Certified Public Accountants v. IRS, 199 F.Supp.3d 55 (D.D.C. 2016)).

The AICPA is now appealing this District Court decision to the D.C. Circuit; any developments will be reported in the e-Supplement at jklasser.com.

Attorneys and CPAs, Enrolled Agents, Enrolled Retirement Plan Agents, and Enrolled Actuaries File a Power of Attorney and Declaration

If you are an attorney, a certified public accountant, or enrolled agent in good standing with the IRS (not under suspension or disbarment from practice), you may practice before the IRS by submitting a properly completed Form 2848 signed by you and your client, which serves as a power of attorney and as your declaration that you are currently qualified to practice under Circular 230 and that you are authorized to represent the taxpayer in the tax matters specified on Form 2848 (Reg. §10.3(a),(b), and (c), Circular 230). The IRS may approve a substitute Form 2848; see the Form 2848 instructions.

Enrolled actuary. If you are enrolled as an actuary by the Joint Board for the Enrollment of Actuaries, you may practice before the IRS (assuming you are not under suspension or disbarment by IRS) by representing taxpayers with respect to issues involving specified statutory provisions (such as those related to qualified employee plans). You must have a power of attorney and file a declaration attesting to your enrolled actuary status. Form 2848 can satisfy both requirements (Reg. §10.3(d), Circular 230).

Enrolled retirement plan agent. Individuals who pass a written examination administered by the IRS (or under IRS oversight) and thereby demonstrate special competence in qualified retirement plan matters, may practice before the IRS with respect to such issues as enrolled retirement agents. Enrollment may also be granted on the basis of former employment within the IRS for at least five continuous years in matters relating to qualified retirement plans. An enrolled retirement plan agent must have a power of attorney on Form 2848, and must not have engaged in conduct that would justify suspension or disbarment under the Circular 230 rules (Reg. §§10.3(e), 10.4(b), 10.4(d)(6), Circular 230).

An enrolled retirement plan agent does not need to obtain a PTIN if he or she prepares only Form 5300 or 5500 series returns, or forms that are exempt from the PTIN requirement. See Notice 2011-91 and Notice 2011-6, which has the list of forms for which a PTIN is not required.

Enrolled Agents

To become an enrolled agent, a PTIN must be obtained and a three-part special enrollment examination (SEE; see below) must be passed to demonstrate technical competence in tax matters. Certain former IRS employees may apply for enrollment without examination, as discussed below. In addition to having a PTIN, an applicant for enrollment must not have engaged in conduct that would justify suspension or disbarment under the Circular 230 rules (Reg. §10.4(a), Circular 230).

Enrolled agents, like attorneys and certified public accountants (CPAs), are unrestricted as to which taxpayers they can represent, what types of tax matters they can handle, and which IRS offices they can practice before.

The IRS homepage for the Enrolled Agent Program has links to details on becoming an enrolled agent and maintaining enrolled status, including frequently asked questions, at: irs.gov/Tax-Professionals/Enrolled-Agents.

Special Enrollment Examination (SEE). The test for individuals who want to become Enrolled Agents, the Special Enrollment Examination, is administered by a private company, Prometric. The three parts of the SEE may be taken on the same day or on separate days in any order. There is a non-refundable testing fee for each part of the SEE that is payable when an appointment to take the examination is scheduled. The fee includes an IRS user fee and a fee for Prometric. For the May 2017 to February 2018 testing period, the fee to take each part of the SEE is $111.94, of which $11 is the IRS user fee and $100.94 is Prometric’s fee. Effective March 1, 2018, the IRS user fee is increasing to $81 per part (T.D. 9820, 2017-32 IRB 178). Prometric’s fee will remain $100.94 for the next testing window beginning May 1, 2018 and ending February 28,2019; thus, when the IRS fee increases to $81 per part, the total per part for the SEE will be $181.94 through February 2019. Prometric’s fee increases to $103.97 for the May 2019 to February 2020 testing period.

The IRS has questions and answers on the SEE at: irs.gov/Tax-Professionals/Enrolled-Agents/Enrolled-Agents-Frequently-Asked-Questions. From here, there are links to the Prometric website, including the Candidate Information Bulletin prepared by Prometric on all aspects of the examination.

Former IRS employees. You may be admitted to practice before the IRS without taking the SEE if you apply for enrollment within three years from the date you separated from service with the IRS. You generally must have had at least five years of continuous service with the IRS, and, during those five years, you must have been regularly engaged in applying and interpreting the provisions of the Internal Revenue Code and regulations. The permission to practice may, at the discretion of the IRS, be limited to certain areas (Reg. §10.4(d), Circular 230).

Application for enrollment. After passing all three parts of the SEE or if you are an eligible former IRS employee, you must apply for enrollment on Form 23 (Reg. §10.5(a) of Circular 230). A nonrefundable fee, currently $30, must be paid to the IRS with Form 23. In the process of evaluating your application, the IRS Office of Professional Responsibility (OPR) will conduct a background check that includes your record of tax compliance (Reg. §10.5(d), Circular 230).

Upon receipt of a properly executed application, the IRS may grant you temporary recognition to practice pending a determination as to whether permanent enrollment should be granted, but this is done only in unusual circumstances (Reg. §10.5(e), Circular 230).

If your application is denied, you will be informed of the reasons for the denial in writing and within 30 days after receipt of the notice of denial, you may file a written protest (Reg. §10.5(f), Circular 230).

Continuing education required to renew enrollment. You must renew enrollment status every three years, either online at Pay.gov, or on paper using Form 8554. You must renew your PTIN annually and complete tax-related courses as a requirement for renewal. Renewal periods are staggered, depending on the last digit of the enrolled agent’s Social Security number (Form 8554; Reg. §10.6(d)(2), Circular 230). A renewal fee, currently $30, must be paid with Form 8554.

Generally, you must complete a minimum of 72 hours of continuing education during each three-year cycle, and during each enrollment year, a minimum of 16 hours must be completed, of which two hours is on ethics or professional conduct. However, individuals whose initial enrollment occurs during an enrollment cycle must complete two hours of qualifying CE credit per month and two hours of ethics/professional conduct per year for the rest of that enrollment cycle. When the new enrollment cycle begins,the full 72-hour CE requirement must be satisfied (Reg. §10.6(e)(2), Circular 230). Qualifying courses include federal tax subjects or tax-related matters such as accounting or tax-preparation software. Credit cannot be received for authoring publications (Reg. §10.6(f), Circular 230).

Details on the continuing education requirements are posted on the IRS website at www.irs.gov/Tax-Professionals/FAQs:-Enrolled-Agent-Continuing-Education-Requirements.

Limited Practice in Special Cases

Even if you are not authorized to practice before the IRS, you may represent yourself or members of your immediate family provided you have their authorization. You may also represent a taxpayer in the following cases where you have authorization: (1) You represent your regular full-time employer or a partnership in which you are a partner or full-time employee. (2) You are an officer or regular full-time employee representing a corporation, trust, estate, association, or organized group. (3) You are a fiduciary or full-time employee, representing a trust, receivership, guardianship, or estate. (4) You are an officer or regular employee in the course of your official business, representing a governmental unit, agency, or authority. (5) You are serving as a representative of any individual or entity outside of the United States before personnel of the IRS. The Director of the Office of Professional Responsibility may also authorize any person to represent another without enrollment for the purpose of a particular matter (Reg. §10.7, Circular 230).

Standards for Signing Returns and Advising Clients on Tax Return Positions

The practice standards under Section 10.34 of Circular 230 generally are consistent with the penalty standards for tax return preparers in Code Section 6694 while also providing broader professional ethics standards.

Signing returns. A practitioner may not willfully, recklessly, or through gross incompetence sign a tax return or refund claim that he or she knows or reasonably should know contains a position that either (1) lacks a reasonable basis, (2) is unreasonable under the preparer penalty rules of Code Section 6694(a)(2)(understatement due to unreasonable positions) , or (3) is a willful attempt by the practitioner to understate tax liability or recklessly or intentionally disregard IRS rules (subject to the Code Section 6694(b)(2) penalty) (Regulation §10.34(a)(1)(i)). The IRS will take into account a practitioner’s pattern of conduct in determining whether the practitioner has acted willfully, recklessly, or through gross incompetence (Regulation §10.34(a)(2).

Advice on tax return positions. The standards for client advice mirror the above rules for signing returns. A practitioner may not willfully, recklessly, or through gross incompetence advise a client to take a position on a tax return or refund claim, or prepare a portion of a return containing a position, that either (1) lacks a reasonable basis, (2) is unreasonable under the Code Section 6694(a)(2) penalty rules, or (3) is a willful attempt by the practitioner to understate tax liability or intentionally disregard IRS rules under the Code Section 6694(b)(2) penalty rules (Regulation §10.34(a)(1)(ii)).

Note: Differences with preparer penalties. A practitioner is subject to discipline under Regulation §10.52(see “Sanctions” below) for a violation of Regulation §10.34(a) only after willful, reckless, or grossly incompetent conduct, whereas a preparer penalty under Code Section 6694 may be imposed without such a showing. The fact that a practitioner is assessed a penalty under Code Section 6694 does not automatically mean that the practitioner will be subject to discipline for willful, reckless, or grossly incompetent conduct in violation of Regulation §10.34; an independent determination will be made. Also note that a practitioner may be subject to discipline because a position taken on a return violates Regulation §10.34(a) even if other positions on the return eliminate any tax understatement, whereas a preparer penalty must be abated (Code Section 6694(d)) if there is a final determination that the taxpayer did not understate tax liability.

Standards for Written Tax Advice

In 2014 the IRS eliminated the much criticized “covered” opinion rules (in prior Regulation §10.35, Circular 230) and replaced them with more flexible standards for written tax advice in a revised Regulation §10.37 (T.D. 9668, 2014-27 IRB 1).

Regulation §10.37 requires practitioners to base all written tax advice on reasonable factual and legal assumptions, to exercise reasonable reliance, and consider all relevant facts that the practitioner knows or should know. Reasonable efforts must be made to ascertain the facts relevant to the written advice. Reliance on statements or representations of the taxpayer or any other person, or agreements, findings, appraisals, or financial forecasts of another person, must be reasonable (Regulation §10.37(a)(2)(iv)). Reliance on the advice of another tax practitioner or of any other person (such as an appraiser or other professional) must be reasonable and in good faith; reliance is not reasonable if a practitioner knows or should know that the other practitioner has a conflict of interest, is not competent to give the advice, or otherwise is not giving reliable advice (Regulation §10.37(b)).

In evaluating a federal tax matter, a practitioner must not take into account the possibility that the IRS will not audit the return or raise the issue on audit (Regulation §10.37(a)(2)(vi)). On the other hand, a practitioner providing written advice may take into account the possibility that an issue may be settled, as there may be an obligation to inform the client as to the likelihood of a settlement.

The IRS will apply a “reasonable practitioner” standard, taking into account all facts and circumstances, in evaluating whether written advice meets the standards of Regulation §10.37. In the case of a written opinion that the practitioner knows or has reason to know will be used to market or promote an investment plan that has tax avoidance or evasion as a significant purpose, the IRS will take into account the “additional risk caused by the practitioner’s lack of knowledge of the taxpayer’s particular circumstances,” in applying the reasonable practitioner standard (Regulation §10.37(c)(2)).

Under the revised rules, a practitioner no longer has to provide (as was required by former Regulation §10.35) a detailed account of the relevant facts (including assumptions and representations), or apply the law to those facts along with his or her conclusions. Whether these should be provided in written advice will depend on the type and specificity of advice sought by the client along with other appropriate facts and circumstances.

The IRS intended the elimination of the covered opinion rules and the amendments to Regulation §10.37 to remove the need for disclaimers by practitioners in their written communications to clients. The revised rules do not prohibit the use of disclaimers, but practitioners have been warned against stating that a disclaimer is required by the IRS or by Circular 230.

Firm Managers Must Have Procedures to Ensure Compliance With Circular 230

Managers of a firm who have principal authority and responsibility for overseeing the firm’s tax practice (governed by Subpart B of Circular 230) must take reasonable steps to ensure that the firm has procedures in place for ensuring compliance with Circular 230. The procedures must ensure compliance not only with the provisions of Subpart B of Circular 230 (duties and restrictions relating to practice), but also with Subparts A (authority to practice) and C (sanctions for violations)(Reg. §10.36, Circular 230, as amended by T.D. 9668, 2014-27 IRB 1).

The responsibility for these procedures falls on the principal firm managers who are themselves practitioners subject to Circular 230. In the event that there is no Circular 230 practitioner with principal authority over the firm’s tax practice, the IRS may identify a Circular 230 practitioner who will be held responsible for ensuring that there are compliance procedures (Regulation §10.36(a)).

Sanctions (see below) may be imposed on such a manager if a firm member or employee engages in a pattern or practice of not complying with Subpart B and the manager, through wilfulness, recklessness, or gross incompetence, fails to ensure that compliance procedures are in place or that firm procedures are properly followed. Sanctions may also be imposed on managers who know or should know that members or employees have engaged in noncompliant activities and who, through wilfulness, recklessness, or gross incompetence, fail to promptly take action to correct the noncompliance (Regulation §10.36(b)).

Advertising and Solicitation

A practitioner must avoid misleading or deceptive statements or claims in public communications or private solicitations. Solicitation of employment in matters related to the IRS is prohibited if the solicitation violates a federal or state rule, such as state licensing rules for attorneys. Fee information may be communicated in emails, mailings, professional lists, telephone directories, print media, radio and television. In describing their professional designation, practitioners may not use the term “certified” or imply an employer/employee relationship with the IRS. Details on solicitation and advertising restrictions are in Regulation §10.30 of Circular 230. A solicitation of employment that violates Regulation §10.30 is considered “disreputable” conduct subject to sanctions; see below.

Contingent Fees

Under Reg. §10.27 of Circular 230, a practitioner may charge a contingency fee only in specified circumstances. A contingency fee is allowed for services rendered in connection with an IRS examination of, or challenge to, (1) an original return, or (2) to an amended return or refund claim filed before receiving written notice of the examination or challenge to the original return, or no later than 120 days after receiving such notice ( Notice 2008-43, 2008-15 IRB 748, clarifying Reg. §10.27 (b) (2) (ii), Circular 230).

A contingency fee may also be charged in connection with reviews of interest and penalty assessments, and services connected with tax-related judicial proceedings (Reg. §10.27(b), Circular 230), and in connection with whistleblower claims under Code Section 7623(Notice 2008-43, 2008-15 IRB 748).

However, the U.S. District Court for the District of Columbia, relying on the D.C. Circuit’s decision in Loving v. IRS (discussed earlier), held that the IRS lacks authority to prohibit contingency fees for the preparation and filing of “ordinary refund claims”; that is, refund claims filed by a practitioner after the taxpayer files his or her original return but before the IRS initiates an audit of the return (Gerald Ridgely, Jr., 2014-2 USTC ¶50,359 (D.D.C. 2014)). The District Court agreed with Ridgely, a CPA, that preparing and filing ordinary refund claims does not constitute “practice” before the IRS and thus it is not subject to the Circular 230 prohibition against contingency fees. The IRS did not file an appeal of the Ridgely decision with the D.C. Circuit (which had ruled against the IRS in Loving).

The AICPA has reminded its members that the association’s Code of Professional Conduct contains a prohibition of contingency fees similar to the prohibition in Reg. §10.27 that was successfully challenged in Ridgely, Jr., v. Lew.

Reg. §10.27(a) bars a practitioner from charging an unconscionable fee. Former OPR Director Hawkins stated that the Ridgely decision does not affect this prohibition, and that OPR still has jurisdiction over unconscionable fees whether they are contingency based or hourly based.

Negotiating Client’s Refund Check

Regulation §10.31 prohibits any individual who is subject to the practice rules of Circular 230 (not just tax return preparers) from directing by electronic or any other means a check issued by the IRS to a client into an account owned or controlled by the practitioner or any associate of the practitioner (Reg. §10.31, Circular 230).

To endorse or otherwise negotiate a client’s refund check not only violates Reg. §10.31, but also gives rise to a penalty under Code Section 6695(f) as discussed below (under “Preparer Penalties for Not Meeting Disclosure and Record-Keeping Requirements”).

The Office of Professional Responsibility (OPR) has focused on preparers who take their fee out of part of a client’s refund, such as by using Form 8888 to take part of a refund by setting up a split direct deposit. Splitting the refund is prohibited even if the preparer has the client’s permission.

Sanctions

Any practitioner may be censured (publicly reprimanded), disbarred, or suspended from practice before the IRS for incompetence, willfully violating any of the practice regulations, or engaging in “disreputable” conduct (Reg. §10.50, Circular 230). Examples of disreputable conduct include giving false or misleading information to the IRS, engaging in a prohibited solicitation of employment, willfully assisting or encouraging a client to violate any federal tax law, willfully preparing or signing a return without having a valid PTIN, willfully representing a taxpayer before the IRS without authority under Circular 230, and willfully failing to electronically file income tax returns when required to do so (Reg. §10.51, Circular 230).

A violation of the Section 10.34 rules on tax return positions, the Section 10.36 rules for ensuring a firm’s compliance, and the Section 10.37 rules on giving written advice, are subject to sanction if the violation results from willfulness, recklessness, or gross incompetence (Reg. §10.52(a)(2), Circular 230). Similarly, sanctions may be imposed on a practitioner who through reckless behavior or gross incompetence violates the general standard of competence under Reg. §10.35 (competent practice requires the appropriate level of knowledge, skill, thoroughness, and preparation necessary for the matter for which the practitioner is engaged).

Expedited suspension procedures may be applied by OPR if a practitioner has engaged in serious misconduct as specified in Reg. §10.82. This includes practitioners who have demonstrated willful disreputable conduct by failing to meet their own tax filing obligations. Failure to file income tax returns in four of the five years preceding the initiation of a suspension proceeding can trigger the expedited suspension procedures, as can failure to file returns required more frequently than annually ( employment/excise tax returns) in five of the seven tax years preceding the initiation of a suspension proceeding (Reg. §10.82(b)(5)).

A monetary penalty may be imposed in addition to or in lieu of any suspension, censure, or disbarment. The amount may be up to the gross income derived (or to be derived) from the conduct giving rise to the penalty. A separate monetary penalty may be imposed on the employer of an offending practitioner, or firm on whose behalf the practitioner was acting, if the employer or firm knew or reasonably should have known of the practitioner’s conduct (Reg. §10.50(c), Circular 230).

Further, Code Section 6701 allows a $1,000 penalty ($10,000 with respect to corporate returns) to be imposed on a representative who presents a return or other document (such as an affidavit) at an IRS examination knowing that it understates tax.

Practice by Former Government Employees

If you are a former government employee, you may not represent a client in a matter on which you previously worked as a government employee (Reg. §10.25(b)(2)). The matter may have involved a decision, a finding, a letter ruling, technical advice, or approval or disapproval of a contract. You are considered to have participated in a matter if you were substantially involved in making decisions, or if you prepared or reviewed documents (with or without the right to exercise a judgment of approval or disapproval), participated in conferences or investigations, or gave substantial advice.

Where you had official responsibilities for a particular matter within a period of one year before you left government service, you may not within two years after your government employment ended represent or assist in that matter any person who is or was a specific party to that matter (Reg. §10.25(b)(3)).

Within one year after leaving government service, you may not appear before, or communicate with the intent to influence, the IRS in a matter involving the publication, withdrawal, amendment, modification, or interpretation of a rule if you participated in its development or, within a period of one year prior to the termination of your government employment, you had official responsibility for the rule. However, you may appear on your own behalf or represent a client in a transaction involving the application or interpretation of the rule provided you do not use or disclose any confidential information you acquired in the development of the rule (Reg. §10.25(b)(4), Circular 230). A rule includes Treasury Regulations, whether issued or under preparation for issuance as Notices of Proposed Rule Making or as Treasury Decisions, and revenue rulings and revenue procedures published in the Internal Revenue Bulletin (Reg. §10.25(a)(5), Circular 230).

Firm representation. A firm of which you are a member may not represent or knowingly assist a person who was or is a specific party in any particular matter in which you substantially participated as a government employee, unless the firm isolates you in such a way that you do not assist in the representation. You and another member of your firm acting on behalf of your firm must sign a statement under oath that you will be isolated from participating in the transaction, and the statement must be provided by the firm, upon request, to the IRS Office of Professional Responsibility (OPR) (Reg. §10.25(c), Circular 230).

Tax Information Authorization

If you do not file a power of attorney (Form 2848 or equivalent substitute), you have to file a tax information authorization in order to receive certain confidential tax information of your client, such as his or her tax return, and to receive notices and other written communications from the IRS concerning his or her liability. The tax information authorization is signed by the taxpayer and specifies the particular authorization given. IRS Form 8821 may be used. The authorization only includes the right to receive information and does not allow you to represent the taxpayer before the IRS; representation requires a power of attorney.

No tax information authorization is required where: (1) a power of attorney has already been filed for the same matter, or (2) the taxpayer is present, such as at a conference, when the information is divulged, or (3) the receipt of notices and other matters are not of a confidential nature.

TAX RETURN PREPARER PENALTIES

Preparers are subject to penalties under the Internal Revenue Code for negligent or fraudulent preparation of returns and for violation of specific disclosure and record requirements. Therefore, the rules discussed in this chapter deserve careful consideration by all tax practitioners.

Who Is a Preparer Subject to Penalties?

Anyone who prepares or employs another to prepare all or a substantial part of any income tax return or refund claim for compensation is considered a tax return preparer (IRC §7701(a)(36)(A)).

A person may be considered a preparer regardless of educational qualifications or professional status (Reg. §301.7701-15(d)). But an IRS employee performing his or her official duties is not considered an income tax preparer (Reg. §301.7701-15(f)(1)).

You are not a preparer if you perform only the following services (Reg. §301.7701-15(f)):

• Merely type or reproduce returns; or
• Prepare a return or refund claim for your employer, an officer of your employer, a fellow employee, or a general partner in a partnership in which you are a general partner or an employee. An employee of a subsidiary corporation is also considered an employee of the parent corporation; or
• Prepare a return as fiduciary; or
• Prepare a claim for refund in response to a notice of deficiency issued to the taxpayer or a waiver of restriction after initiation of an audit of the taxpayer or another taxpayer, or a determination whether the audit of that other taxpayer affects the liability of the taxpayer for tax.
• Prepare a return for a friend, a relative, or neighbor with no implicit or explicit agreement for compensation, even though you receive a gift or return service or favor.

Signing and nonsigning preparers. Final regulations provide separate definitions for signing and nonsigning preparers. A signing preparer is the individual preparer with primary responsibility for the overall substantive accuracy of the return or refund claim (Reg. §301.7701-15 (b)(1)). A nonsigning preparer is a preparer other than a signing preparer who prepares all or a substantial portion (discussed below) of a return or refund claim with respect to events that have occurred at the time the advice is given. A preparer who provides written or oral advice to a taxpayer or other preparer is a nonsigning preparer where the advice leads to a position or entry that is a substantial portion of the return (Reg. §301.7701-15 (b)(2)). If you provide advice with respect to a proposed transaction but do not provide advice after it is completed, you are not considered a preparer because the advice was not rendered with respect to events that have occurred. Time spent on advice given after events occur may be ignored in determining whether a person is a nonsigning preparer if such time is less than 5% of the time spent providing advice on a position, but there is an anti-abuse exception to this rule (Reg. §301.7701-15 (b)(2)).

Substantial portion. Only a person who prepares all or a substantial portion of a return or refund claim is considered to be a preparer of the return or claim. You are considered the preparer of an entry on a return or refund claim if you rendered advice that is directly relevant to the determination of the existence, characterization, or amount of that entry (Reg. §301.7701-15 (b)(3)). Whether the entry is a substantial portion of the return or refund claim depends on whether you knew or reasonably should have known that the tax attributable to the schedule, entry or other portion is a substantial portion of the tax required to be shown on the return or refund claim. The IRS will take into account the size and complexity of the item relative to the taxpayer’s gross income and the size of the understatement attributable to the item compared to the tax liability reported by the taxpayer.

A de minimis rule may apply to a person who otherwise would be considered a nonsigning preparer. A schedule, entry or other portion is not considered a substantial portion if it involves gross income, deductions, or amounts on which credits are based that are either (1) less than $10,000, or (2) less than $400,000 and also less than 20% of a taxpayer’s adjusted gross income, or for non-individual taxpayers, 20% of the gross income shown on the return or refund claim. Where more than one schedule or other portion is involved, the amounts are aggregated (Reg. §301.7701-15(b)(3)(ii).

Example:

You prepare for a taxpayer a Schedule B (Form 1040) that reports $4,000 in dividend income and also give advice about Schedule A that results in a claimed medical expense deduction of $5,000. You do not sign the return. You are not considered a nonsigning preparer under the de minimis rule because the total amount of the deductions are less than $10,000.

Even though entries on a return you prepare affect entries on the return of another taxpayer, you are not the preparer of the other return, unless the entries on the return you prepared are directly reflected on that other return and constitute a substantial portion of that return. For example, if you prepare a partnership return, you are not the preparer of a partner’s return, unless the entries on the partnership return reportable on the partner’s return constitute a substantial portion (as discussed above) of the return (Reg. §301.7701-15(b)(3)(iii)).

Preparer Penalties for Understatements of Taxpayer Liability

Section 6694 penalties. There is a “first-tier” penalty under Code Section 6694(a) for understatements due to unreasonable positions and a “second-tier” penalty for willful or reckless conduct under Code Section 6694(b). These penalties apply not only to income tax return preparers, but also to preparers of estate and gift tax, employment tax, and excise tax returns, and returns of exempt organizations.

If there is a signing preparer (discussed above) within a firm, he or she is generally considered the person primarily responsible for all of the positions on the return or refund claim giving rise to an understatement of liability, and thus is subject to a penalty under Section 6694. However, if the IRS concludes based on credible information that a nonsigning preparer (discussed above) within the same firm is primarily responsible for a position giving rise to an understatement, that nonsigning partner is subject to the Section 6694 penalty (Reg. §1.6694-1(b)(2)). If the IRS finds that both a signing and nonsigning preparer within a firm are responsible for a position giving rise to an understatement, the IRS will determine which of them is primarily responsible and the Section 6694 penalty will be assessed only against that primarily responsible preparer (Reg. §1.6694-1(b)(4)).

If preparers from different firms provide advice with respect to a position that gives rise to an understatement, and the IRS determines that both are primarily responsible for the position, both can be penalized (Reg. §1.6694-1(b)(1)). A firm that employs a preparer who is subject to a penalty under Section 6694 may also be subject to a penalty if the management participated in or knew about the conduct giving rise to the penalty or procedures for reviewing return positions were not provided or were willfully or recklessly disregarded (Regs. §1.6694-2(a)(2) and 1.6694-3(a)(2)).

First-tier penalty (Code Section 6694(a)). The first-tier penalty in Code Section 6694(a) applies to a tax return preparer who knew or reasonably should have known of an “unreasonable” position to which an understatement of liability is due. The amount of the first-tier penalty is the greater of $1,000 or 50% of the return preparer’s compensation derived from the return or refund claim. The maximum penalty based on 50% of compensation refers to the compensation that the preparer receives or expects to receive with respect to the position on the return or refund claim that gave rise to the understatement (Reg. §1.6694-1(a)(1)). For purposes of calculating the penalty, only compensation for tax advice that is given with respect to events that have occurred at the time the advice is rendered and that relates to the position giving rise to the understatement is taken into account (Reg. §1.6694-1(f)(2)(ii)).

What is an unreasonable position? An undisclosed position that is not attributable to a tax shelter or reportable transaction is considered unreasonable unless there was substantial authority for the position taken on the return (IRC §6694(a)(2)(A)). A disclosed position that is not attributable to a tax shelter or a reportable transaction is unreasonable unless there was a reasonable basis for it (IRC §6694(a)(2)(B)). However, for positions relating to either tax shelters (under Code Section 6662(d)(2)(C)(ii)) or reportable transactions (under Code Section 6662A)), the penalty applies unless the preparer had a reasonable belief that the position would more likely than not be sustained on its merits, whether or not the position was disclosed (IRC §6694(a)(2)(C)).

There is an exception to the first-tier penalty if the preparer acted in good faith and can show reasonable cause for the understatement (IRC §6694(a)(3)).

The standard for determining whether there is “substantial authority” for a position unrelated to a tax shelter or reportable transaction is not spelled out in Code Section 6694(a) or in Reg. §1.6694-2. However, under Notice 2009-5 (2009-3 IRB 309), which was still in effect at the time this book was completed, the “substantial authority” rules of Section 6662(d) (taxpayer penalty for substantial understatement of tax) apply for purposes of the Section 6694(a) preparer penalty. Specifically, Notice 2009-5 provides that a preparer may consider the authorities listed in Reg. §1.6662-4(d)(3)(iii), and the weight to be accorded those authorities in determining whether there is substantial authority for a position should be based on the analysis required by Reg. §§1.6662-4(d)(3)(i) and (ii).

Similarly, for tax shelter/reportable transaction positions, Reg. §1.6694-2(b) provides that in determining whether it is “reasonable to believe that a position would more likely than not be sustained on its merits,” a preparer should consider the authorities listed in Reg. §1.6662-4(d)(3)(iii) and those authorities should be weighed using the analysis in Reg. §1.6662-4(d)(3)(ii). Notice 2009-5 also provides that a position with respect to a tax shelter will not be deemed unreasonable for purposes of the Section 6694(a) preparer penalty if there was substantial authority for the position and the preparer advises the taxpayer in writing that if the position is deemed to have a significant purpose of tax avoidance or evasion, the taxpayer will be subject to a penalty under Section 6662(d) for a substantial understatement of tax (if otherwise applicable) unless the taxpayer has a reasonable belief that the tax treatment was more likely than not correct.

Second-tier penalty (Code Section 6694(b)). The second-tier penalty in Code Section 6694(b) applies to a tax return if an understatement of liability on the return is due to the preparer’s willful attempt to understate the liability or the preparer’s reckless or intentional disregard of IRS rules. The second-tier penalty is the greater of $5,000 or 75% of the preparer’s compensation. For this purpose, “compensation” is defined as discussed earlier under “First-tier penalty.” The second-tier penalty is reduced by the amount of any first-tier penalty paid with respect to the return (IRC § 6694(b)(3)).

Aiding and abetting understatements. The IRS may impose on a preparer a $1,000 penalty ($10,000 for corporate returns) for aiding and abetting the understatement of tax liability on a tax return or other document (IRC §6701). The Section 6701 penalty is in lieu of a penalty under Section 6694(a) or 6694(b) (IRC §6701(f)(2)).

The $1,000/$10,000 penalty may be imposed on a person who (1) knows or has “reason to believe” that a return or document that he or she has helped prepare will be used in connection with tax matters, and (2) knows that tax liability will be understated on that return or document (IRC §6701(a)). The penalty can apply regardless of whether the taxpayer knows about the understatement (Code Section 6701(d)). A supervisor who does not actually prepare a return or document is subject to the penalty if he or she orders or causes a subordinate to take actions subject to the penalty, or if the supervisor knows of such an act by a subordinate but does not attempt to prevent it (IRC §6701(c)).

Preparer Penalties for Not Meeting Disclosure and Record-Keeping Requirements

Under Code Section 6695, tax return preparers may be penalized for failure to satisfy recordkeeping or disclosure requirements or not providing required information when preparing returns. The Section 6695 penalties apply not only to income tax return preparers, but also to preparers of all other returns (estate and gift, employment and excise tax returns, and returns of exempt organizations).

Each of the Section 6695 penalties has a per return (or refund claim) penalty amount and most have a maximum annual penalty amount. The per return and maximum amounts are subject to annual inflation adjustments (IRC §6695(h)).

Failure to retain records on preparers. A person who employs one or more signing preparers must retain a record of the name, Social Security number, and place of work of each employed preparer (IRC §6060). The records must be retained for a three-year period following the close of the return period (defined as a 12-month period beginning on July 1 of each year), and the records must be made available for inspection upon request by the IRS (Reg. §1.6060-1(a)). For 2017 returns, there is a $50 penalty for each failure to retain and make available a proper record and a $50 penalty for each required item that is missing from the record, unless it is shown that there was reasonable cause for the failure (IRC §6695(e)(2)). The maximum penalty (inflation-adjusted) for 2017 returns is $25,500 (Rev. Proc. 2016-55, 2016-45 IRB 707).

Failure to sign returns. For a return or refund claim that is not electronically signed, a preparer considered to be a signing preparer must sign the return or claim after it is completed and before it is presented to the taxpayer for signature (IRC §6695(b); Reg. §1.6695-1(b)(1)). If more than one person worked on the return, the person primarily responsible for the overall accuracy of the return (Reg. §301.7701-15(b)(1)) must sign the return in order to avoid a penalty under IRC §6695(a). If the preparer required to sign is unavailable to sign the return, another preparer must so advise the client, review the entire preparation of the return or claim, and then sign it (Reg. §1.6695-1(b)(1)).

The information on an electronically signed return must be provided to the taxpayer contemporaneously with furnishing Form 8879, “IRS e-file Signature Authorization” (Reg. §1.6695-1(b)(2)).

For 2017 returns, the penalty for failing to sign is $50 per return unless reasonable cause is shown; the maximum penalty (inflation-adjusted) is $25,500.

Failure to furnish PTIN on return. A preparer considered to be a signing preparer (discussed above) must include his or her PTIN (preparer tax identification number) on each return or refund claim ((IRC §6109(a)(4); PTIN requirement at Reg. §1.6109-2(a)(2)(ii)). Each failure to include the PTIN is subject to a penalty unless it is shown that there was reasonable cause for the failure (IRC §6695(c); Reg. §1.6695-1(c)). For 2017 returns, the per return penalty is $50, subject to a maximum penalty of $25,500.

Failure to furnish client with copy of return or refund claim. A preparer considered to be a signing preparer (discussed above) must furnish a completed copy of the return or refund claim to the taxpayer no later than when it is presented to the taxpayer for signature (IRC §6107(a);Reg. §1.6107-1 (a)(1)). The copy may be provided in any media, including electronic media, that is acceptable to both the taxpayer and the preparer (Reg. §1.6107-1(a)(2)). Where two or more persons are considered preparers with respect to the same return, and there is an employment relationship between them, the employer is responsible for furnishing the copy; where there is a partnership relationship, the partnership must furnish the copy (Reg. §1.6107-1(c)).

A penalty applies to each failure to furnish a copy unless it can be shown that failure was due to reasonable cause and not due to willful neglect (IRC §6695(a); Reg. §1.6695-1(a)(1)). For 2017 returns, the penalty for each failure is $50, subject to a maximum penalty of $25,500.

The preparer may request a receipt as proof of having satisfied this requirement (Reg. §1.6107-1(a)(1)).

Failure to retain copy or list. A signing preparer (see above) must keep for three years and make available for IRS inspection copies of all returns and refund claims he or she prepares or a list of the taxpayers for whom returns were prepared, including each name, taxpayer identification number, taxable year of the taxpayer for whom the return or refund claim was prepared, and the type of return or refund claim prepared (IRC §6107(b); Reg. §1.6107-1(b)).

A penalty may be imposed for each failure unless reasonable cause for the failure is shown (IRC §6695(d);Reg. §1.6695-1(d)). For 2017 returns, the penalty for each failure is $50, subject to a maximum penalty of $25,500.

Where there is an employment relationship or a partnership relationship between two or more preparers, the employer must retain the required records, and in the case of a partnership arrangement, the partnership must keep the records (Reg. §1.6107-1(c)).

If the preparer is a corporation or partnership that goes out of business before the end of the three-year period, the person who is responsible for winding up the affairs of the corporation or partnership under state law must retain the records until the three-year period ends. If state law does not specify who is responsible for winding up, the directors or general partners are subject to the record-retention rules and they will be jointly and severally liable for the Section 6695(d) penalty ($50 per failure and $25,500 maximum penalty for 2017 returns) if the records are not retained(Reg. §1.6107-1(b)(2).

Negotiation of refund checks prohibited. A preparer is subject to a penalty for each endorsement or negotiation of a refund check (including an electronic version of a check) resulting from a return that he or she prepared (IRC §6695(f)). The penalty is $510 for each refund check for 2017. There is no limit on this penalty.

The penalty does not apply to a preparer-bank (a preparer that is also a financial institution) that has not made a refund anticipation loan to the taxpayer if the full amount of the refund check is deposited to the taxpayer’s account or the check is cashed and the cash remitted to the taxpayer (IRC §6695(f); Reg. §1.6695-1(f)(2)).

If the preparer obtains authorization from the taxpayer to affix the taxpayer’s name to a refund check for the purpose of depositing it in the taxpayer’s account, or in an account held jointly with anyone excluding the preparer, the penalty does not apply (Reg. §1.6695-1 (f)(1)).

Failure to be diligent in determining earned income credit, American Opportunity credit, and the child tax credit. A paid tax return preparer is subject to a penalty for failing to meet IRS due diligence requirements in determining a taxpayer’s eligibility for, or the amount of, the earned income credit (EIC), American Opportunity tax credit (AOTC), or the child tax credit and/or additional child tax credit (CTC/ACTC)(IRC §6695(g)).

For each credit for which the due diligence requirements are not met, the penalty with respect to 2017 returns and refund claims for 2017 is $510 per credit per return. There is no limit on this penalty.

Preparers are required to file Form 8867 (Paid Preparer’s Due Diligence Checklist) with the taxpayer’s return (or amended return) claiming the EIC, the AOTC and/or the CTC/ACTC, in order to document that they have met the due diligence requirements for each credit claimed.

If the actions described on the Form 8867 checklist and detailed in the Form 8867 instructions were completed by the preparer for each credit claimed, such as asking the client adequate questions and obtaining sufficient information to determine eligibility for and the amount of the credit, and the Form 8867 is truthfully and accurately completed, the due diligence tests are considered met, provided that specified records are kept for three years. In addition to a copy of Form 8867, the records that must be retained for three years are:

1. The applicable IRS worksheets for the credits claimed or the preparer’s own worksheets that provide equivalent information,
2. Copies of taxpayer documents that were relied upon to determine eligibility for and the amount of the credits,
3. A record detailing how, when, and from whom the information used to prepare the relevant worksheets and Form 8867 was obtained, and
4. A record of any additional questions that were asked of the taxpayer to determine eligibility for and the amount of the credits, and the taxpayer’s answers.

The three-year retention period begins on whichever of these dates is latest: (1) the due date for the return or refund claim, without extensions, (2) the date a signing preparer files it electronically or presents the return to the taxpayer for signature if the taxpayer is filing it, or (3) for a nonsigning preparer, the date that the part of the return for which he or she was responsible is submitted to the signing preparer (Reg. §1.6695-2(b)(4)(ii)).

In certain cases, firms as well as individual paid preparers may be subject to the penalty for failure to exercise due diligence. A firm can be penalized if management participated in the failure or knew prior to the filing of the return that an employed preparer had failed to comply with the rules. If management became aware of the failure after the return was filed, the firm is subject to the penalty if it lacked reasonable procedures to ensure compliance, or it had such procedures but willfully, recklessly or with gross indifference disregarded them when preparing the return or refund claim (Reg. §1.6695-2(c)).

An individual preparer, but not a firm, may be able to avoid a penalty by convincing the IRS that he or she has reasonable office procedures that are routinely followed to ensure compliance with the due diligence requirements, and the failure to meet the rules for a particular tax return or refund claim was isolated and inadvertent(Reg. §1.6695-2(d)).

Preparer Penalty Assessment Procedures

Penalties under IRC §6694(a) for understatements of tax or the penalties under IRC §6695 for failure to meet the disclosure and record-keeping requirements, must be assessed within three years after a return or refund claim is filed; no court proceeding for collection of the penalty without assessment may be begun after the three-year period. Penalties for willful or reckless understatements of tax liability under IRC §6694(b) may be assessed, or court proceedings for collection without assessment may begin, at any time (IRC §6696(d)(1)).

The IRS will issue a preparer a 30-day letter notifying the preparer of a proposed penalty and offering an opportunity to pursue administrative remedies prior to assessment of a penalty under Section 6694(a) or (b). If the preparer appeals an IRS penalty determination, the IRS cannot assess the penalties until after a final determination adverse to the taxpayer is made (Reg. §1.6694-4(a)(2)).

If a penalty for understatement of tax under either Section 6694(a) or (b) is assessed and the preparer does not pursue an administrative remedy or pursues such a remedy but receives an adverse final administrative determination from the IRS, the preparer has two alternatives (Reg. §1.6694-4(a)(4)):

1. Pay the entire amount assessed within 30 days of the IRS’ statement of notice and demand and then file a claim for refund of the amount paid not later than three years from the date the penalty is paid, which if denied may be appealed in court; or
2. Pay 15% or more of the penalty within 30 days of the IRS’ statement of notice and demand for payment and file a claim for refund of the amount paid within the same 30-day period. Form 6118 is used to claim the refund.

If under alternative (2) a preparer timely pays at least 15% of the penalty and files a refund claim, the IRS has six months to act on the claim. During that period, the IRS may not seek collection of the remaining 85% of the penalty (Reg. §1.6694-4(a)(5)). If the IRS denies the refund claim, the preparer may bring an action for refund in a Federal District Court within 30 days of the date of denial. The action must be brought within the 30-day period to postpone or avoid collection measures by the IRS as to the remaining 85% of the penalty under the second alternative above. If the IRS does not deny a claim for refund by the end of six months after the claim is made, the preparer may bring an action in federal district court within 30 days after the expiration of the six-month period to determine liability for the penalty. If such an action is not brought, the IRS may pursue collection of the remaining 85% of the penalty (Reg. §1.6694-4(b)). If such an action is brought, the IRS may counterclaim for the balance of the penalty (Reg. §1.6694-4(a)(6)).

IRS May Seek Injunction Against Preparer

The IRS may seek an injunction in a federal district court to prohibit improper conduct by any tax return preparer (IRC §7407). An injunction may be sought regardless of whether penalties have been or may be assessed against the preparer. An injunction may be issued where the court finds that the preparer has:

• Engaged in conduct subject to the disclosure and record-keeping requirement penalties (IRC §6695) or the understatement of taxpayer liability penalties (IRC §6694);
• Engaged in conduct subject to criminal penalties under the Internal Revenue Code;
• Misrepresented his or her eligibility to practice before the IRS or his or her experience or education as a tax return preparer;
• Guaranteed payment of any tax refund or the allowance of any tax credit; or
• Engaged in other fraudulent or deceptive conduct that interferes with administration of the tax laws.

A court may also enjoin the person from acting as a preparer if it finds that the person has repeatedly engaged in any of the above practices and an injunction prohibiting specified conduct would not be sufficient (IRC §7407(b)).