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When you have to go toe-to-toe with the IRS, make sure you keep the fight clean. The only way to succeed when arguing your case with an auditor is to follow the IRS’s own procedures. And, the primary way to do that is—you guessed it—keeping proper documentation. With this article, you’ll better understand where tax authority is derived, what rules the IRS must stick to, and what rules the IRS accepts.
Remember Who You’re Dealing With
As you prepare to make your case by checking the appropriate tax rules, remember that the auditor will be your primary audience. You want to build evidence that convinces the IRS. Although it’s possible that your audit could go to court, most do not. It is likely that the auditing process will stay with the IRS, so prepare yourself for that likely scenario.
A good place to start is with the IRS forms themselves, as well as guides, instructions, and other IRS publications. These are not a source of “substantial authority”,[1] but you can begin your research with them in order to get an overview of the particular tax issue you’re looking at. Just be sure you don’t end your research with these documents because they don’t always give the full story. When using these as part of your argument, however, you can be assured knowing that the IRS is unlikely to go against its own advice, even from a non-technical document.
Another type of non-technical documentation is internal IRS guides. These are made for employees, but copies are available to the public. Some examples include the Internal Revenue Manual, chief counsel advice, and audit manuals. They will give you an idea of how the auditor may be evaluating your situation.
Although both public and internal guides are easy to read compared to technical documents, you don’t have much support if you depend solely on them. To support your tax strategy more effectively, you’ll need a document with greater authority.
In order to make your best case, you should remember the following tax-document hierarchy:
- Statues and Regulations. Both the IRS and the courts can be persuaded by appropriate statutes and regulations.
- Case Law. Prior case law is often the next most convincing proof with the court.
- IRS Documents. For the IRS, the next best source is IRS documents, but some are better than others.
It is important to remember that tax laws change all the time. No matter how good you think your authority document is, it does little to help you if a more recent law has been enacted. New statutes even supersede prior Supreme Court rulings. When you need to back up your tax return during an audit, always make sure you check for any updates in the laws.
Here are some specific examples of good authority documents:
- Tax Codes—Statutes in the tax code are always the best authority with the IRS. If possible, find the particular statute (i.e. tax code provision) that specifically addresses your situation. Throughout the process, keeping your argument focused on that provision. As mentioned above, tax statutes are the highest authority in these situations, so if the relevant law does not uphold your case, then don’t try to use a next best authority. Instead, attempt to settle with as little payment due from you as possible. The time that another source of authority comes in handy is when the language in the pertinent tax code is too general (as it often is), and you need additional support for your tax strategy.
- Treasury Regulations—Regulations have almost the same weight as statutes, but the statute takes precedence in the case of any differences between the two.[2] Regulations fall into one of three categories: 1) final, 2) temporary, or 3) proposed. When Congress passes a new statute, the Treasury drafts temporary regulations that are valid for three years. After that, they expire. However, for the period they are valid, temporary regulations are equal in authority to final regulations.[3] In addition, older temporary regulations never expired, and you may find some that are still being used. Proposed regulations carry less weight than the other two types. Their strength is in persuading the IRS because they represent its official position, but they don’t mean as much in court.
A note on out-of-date regulations: Treasury regulations are not updated every time the tax code changes. Because of this, it’s not uncommon to find regulations intended for a law that no longer exists or exists in a newer version. But, that doesn’t necessarily mean the IRS has stopped using the regulation. Even the courts may treat these as relevant law! The only way to know if a regulation is still in use is to research cases, legal treatises, and IRS documents.
Strategy for Talking to the IRS
At the start of your audit, you’re going to be discussing the issues with auditors and agents. These are the typical IRS worker bees. They are knowledgeable about what they do but will be mainly concerned with IRS documents. They probably won’t delve into statutes or court cases. If your case advances, you will then deal with the supervisors and officers, who bring in the tax code and regulations (and possibly court cases). Just remember that at all levels, IRS employees put emphasis on IRS documents.
One of the best sources to build your argument with is an official pronouncement from the IRS. These are sent out in the Internal Revenue Bulletin, which is “the authoritative instrument of the Commissioner of Internal Revenue for announcing official rulings and procedures.”[4] All of these bulletin pronouncements are binding for the IRS, so you have a good case if one of the pronouncements supports your audit strategy. The problem is that they can be confusing to read. You’ll want to make sure you’re clear on what the actual IRS position is.
Here are several types of official pronouncements that provide good backing (the highest on the list are the best sources):
- Revenue Ruling—These are the IRS’s own examples of how they apply their rules to particular sets of facts.
- Revenue Procedure—These are IRS instructions on how to use their documents. Revenue procedures also include updates to monetary amounts to adjust for inflation.
- Acquiescence or Non-Acquiescence—A good item to have if you plan to use a court case as evidence, these are statements of IRS agreement or disagreement with a particular court ruling.
- Notices and Announcements—Providing the least authority (but still useful) are notices and announcements, which indicate the IRS’s official position regarding present issues.
Non-binding documents can also be useful. If you’re uncertain about a tax strategy you plan to use, you can request a private letter ruling (PLR) from the IRS prior to filing your tax return.[5] This allows you to get the okay for your strategy before filing, thus avoiding tax penalties. You will have to pay for the PLR. Technical advice memoranda (TAM)[6], which can be initiated either by the IRS or by you, are also an option and have the same level of authority as a PLR.
If you receive a PLR or TAM, you’ll see a disclaimer at the bottom that states “This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3) provides that it may not be used or cited as precedent.” This is the IRS’s way of telling you that this is only their opinion on the law and that you should not rely on it. Regardless, these rulings (though not binding) are important guidance. Since it comes from the IRS, it is directly useful in dealing with auditors or agents. Furthermore, these documents can be useful in court if no better authority exists for the issue in dispute.
Speaking of court, when do prior court rulings come into play with the IRS? Here are two reasons you’ll want to include them in your research, even if your audit does not go to trial
- Lawyers are well-known for including as many words as possible, and their evidence is thorough. From case law, you can often find all of the regulations, statutes, and forms or other documents needed to support your own argument. Go ahead and pluck those citations right out of the case documents!
- If your audit goes to appeals (the highest level of review at the IRS), appeals officers will consider court cases when making their decision.
What If Your Case Goes to Court?
In the event that your case does go to court, your previous research for the auditing process will help immensely. For the most part, you’ll need all of the same types of documentation. The biggest difference is that prior court cases will now be a higher authority than IRS documents. Statutes and regulations will still be your best sources of documentation.
Be aware that your case will not necessarily go to tax court. Federal tax cases can also be taken to:
- A federal district court,
- A court of appeals,
- The court of federal claims, or
- The Supreme Court (but this is rare).
What is important when choosing the right cases as support for your tax strategy is to choose those that come from the same court your hearing is at, or those from a court of higher authority. Since the tax court specializes in tax law, it is the most cited source. Make sure you know how much authority your particular example case carries. The cases from tax court will be cited as follows:
- T.C. or TC—This is a regular tax court decision, and the only kind that counts as official precedent.
- T.C. Memo, TC Memo, or T.C.M.—The tax court memorandum can help your case, but they carry less authority.
- T.C. Summary Opinion or TC Summary Opinion—Documents labeled summary opinions are not particularly helpful. They carry little authority and do not count as precedent.
It is possible to take your tax dispute to an appeals court after the initial hearing. Keep in mind that different judges make different judgments. That means what a judge in another jurisdiction decides may not be the same as the conclusion the judge in your circuit (i.e. region) comes to. In most circumstances, the tax court will rule in accordance with the circuit where your tax issue originated,[7] but the job of judges is to interpret the laws, and interpretation varies. Tread carefully by being as prepared as possible.
- Reg. Section 1.6662-4(d)(3)(iii). ↑
- Mayo Foundation v U.S., 131 S.Ct. 704. ↑
- IRC Section 7805(e). ↑
- This is in the introduction of all bulletins. See a list at http://apps.irs.gov/app/picklist/list/internalRevenueBulletins.html. ↑
- Rev. Proc. 2013-1. ↑
- Reg. Section 601.105(e)(iii). ↑
- Golsen v Commr., 54 T.C. 742. ↑