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By Kay O. Wilburn and Frank M. Messina

And the belief is that the success of the program should help push the tax resolution door wide open in the near future!

Accordingly, tax practitioners, CPAs and CFOs must become familiar with the new option as it represents the way most tax disputes ultimately may be resolved. Beginning on October 30, 1995, the IRS initiated a one-year test of an optional mediation procedure for Coordinated Examination Program (CEP) cases (which generally involve disputed taxes of $10 million or more) assigned to an appeals team chief but not yet docketed in any court. As a result, the test procedure will apply to tax disputes of large corporations regarding, but not limited to, such issues as valuation, transfer pricing, and reorganization. Currently, this program could prove highly significant to corporations in the process of resolving tax disputes. An even greater significance of the program is that it represents the first formal step taken in the tax arena toward utilizing the well-established process of mediation to settle disputes. The ability to use mediation in the Federal tax area is a door of opportunity for both the taxpayer and the IRS. The new test procedure (IRS Announcement 95-86) should clear the way for other future tax resolutions through mediation.

An Overview of Mediation

The stated purpose of the mediation test procedure according to IRS Announcement 95-86 is to "resolve tax controversies, without litigation, on a basis which is fair and impartial to both the government and the taxpayer." Mediation, an alternative dispute resolution process (ADR), has been utilized for many years to resolve all types of legal disputes without the parties having to resort to lengthy litigation and appeals. Advantages of mediation include 1) privacy, 2) reduced legal costs, 3) expediency, and 4) flexibility. Because of its many benefits, mediation in recent years has received heightened support from the courts, legislatures, and administrative agencies.

Mediation is the process through which a neutral third party, the mediator, is directly involved in guiding the disputants in reaching an agreement to resolve the dispute. It is a simple, informal process with a high success rate. The mediator cannot impose a settlement as the process is nonbinding; instead, the mediator assists the parties in exploring various solutions to resolve the conflict. The parties maintain control over the outcome of the dispute as opposed to relinquishing control to a judge or jury. Accordingly, participants commonly celebrate mediation as a more workable and satisfactory method of dispute resolution than the traditional litigation process.

Getting the Process Started

As stated previously, mediation under the IRS procedure is available only for CEP cases assigned to appeals team chiefs and not docketed in any court. Mediation is also unavailable for issues for which the taxpayer has filed a request for competent authority assistance and industry specialization program issues. The purpose of mediation is not to displace the current resolution system in any legal arena and, thus, the process remains optional under IRS Announcement 95-86. The test procedures are effective for mediation requests made during the one-year period beginning on October 30, 1995. Requests for mediation can be made by the taxpayer or the appeals team chief when appeals settlement negotiations fail, but the taxpayer and appeals must consent to the process before it can be used. The requirement of having both parties' consent is not uncommon as the parties are more likely to reach an agreement when they use the process voluntarily.

The taxpayer and appeals team chief must also request, in writing, approval to use mediation from the appropriate Assistant Regional Director of Appeals--Large Case (ARDA-LC). In a typical court proceeding, judges not only permit parties to mediate but also commonly order parties to attempt it. The IRS, however, initially is not expected to approve all requests it anticipates receiving under the test program. The IRS intends to evaluate each case approved for mediation and apparently does not want to be overwhelmed with a voluminous amount of mediations during the test period. However, Thomas Louthan, director of the IRS's Office of International, TEFRA & Dispute Resolution Programs, has been quoted as saying that "[i]f, even as early as six months, the program is deemed a decided success, the IRS might make the decision then to expand it...." The expansion ultimately should open up the process for many other types of tax disputes.

Once the dispute is approved for mediation under the test procedure, the ARDA-LC will schedule a conference, and the taxpayer and appeals will enter into a written agreement for the mediation process. (IRS Announcement 95-86 includes a model agreement the parties may use.) Despite the agreement to mediate, either party may terminate the process at any time before a settlement has been reached. The process is confidential, so the inability to reach settlement through mediation should not prejudice the position of the taxpayer later resorting to a court imposed resolution.

Selection of a Mediator

The taxpayer and appeals are permitted to select the mediator(s). Typically, parties select third party neutrals to serve as mediators to avoid any conflict of interest; however, the IRS procedure intends to include cases using both non-IRS and appeals
personnel as mediators. Accordingly, any appeals' agreement to mediate may depend upon the taxpayer's consent to use an appeals representative as the mediator. This appears to be a major flaw of the test procedure as the effect, as admitted by the IRS, "allows the IRS to select the mediator." Perhaps the IRS will modify this provision as it becomes more confident in the mediation process. In the meantime, the taxpayer's primary safeguard is through its ability to withdraw from the mediation. In any event, to minimize the conflict of interest associated with an appeals mediator, IRS Announcement 95-86 requires that the selected appeals mediator be from another appeals office or region, or from the National Office Appeals. If an appeals mediator is used, appeals must provide a written statement to the taxpayer that a "conflict results from that mediator's continued status as an IRS employee" and the mediation agreement must also contain such a statement.

Participating in the Test
Mediation Process

The taxpayer and appeals must enumerate in the mediation agreement the issues to be mediated and must provide the mediator (and the other party) with a summary of these issues two weeks prior to the mediation session. Also, each party must have representatives with settlement authority attend the mediation session. The taxpayer should also have its attorney and, if appropriate, chief financial officer participate in the mediation. The mediator initiates and conducts the mediation session and typically describes the process and any applicable rules to the participants in the opening meeting where all the participants are present. The primary purpose of the initial joint session is to permit the parties (or their legal representatives) to relate in a narrative fashion a summary of the facts and issues. The joint meeting serves the important function of allowing each party to directly hear the other party's version of the dispute. This "reality-testing" is a significant benefit of the mediation process as each party, perhaps for the first time, sees both the strengths and weaknesses of its position. The mediator then typically meets privately and in confidence with each party, encouraging each to examine ways to resolve the dispute.

For example, suppose that Taxpayer One is the sole shareholder of Corporation A. A plan of reorganization was executed between Corporation A and Corporation B, whereby Taxpayer One received 200,000 shares of Corporation B voting, cumulative preferred stock in exchange for the outstanding stock of Corporation A. Taxpayer One presumes that this transaction will qualify as a tax-free Type B reorganization. An additional agreement was executed whereby the first dividend payable on the stock would be waived by Taxpayer One in exchange for 2,000 additional shares of Corporation B stock. Assume this was done and the sale date was delayed so that the shares and dividend would be paid at the same time to Taxpayer One. The additional 2,000 shares received were treated by Taxpayer One as part of the reorganization proceeds rather than as a separate dividend.

In this example, the IRS might contend that the reorganization was not tax-free and that the dividend was also taxable. Mediation could result in a settlement, such that the reorganization and the agreement to forego the dividend could be considered separate transactions in that the reorganization might be considered tax-free and yet the dividend could be considered taxable. If a dispute goes to court, neither party can be certain of the outcome, and the court resolution could essentially yield a win/lose result. Mediation, on the other hand, can produce a win/win resolution as the parties tailor a settlement arrangement that addresses the major concerns of both sides. The settlement arrangement cannot be used to set precedent, so any concessions made by the taxpayer will not prejudice its position in a later dispute. If particular tax issues are recurring, the taxpayer may determine to pursue a court resolution to establish precedent.

An Historic Event

Usage of the mediation process has enjoyed exponential growth in many fields simply because it works. Based on prior studies, mediation produces settlements in approximately 90% of all cases. Mediation also can be accomplished in much less time than a court proceeding, thereby saving spiraling litigation costs for the taxpayer and the IRS. Statistics clearly reveal that parties are more satisfied with the mediation process than the court process. Tax and financial professionals can better serve their clients in the future by exploring the mediation option now.

The door of availability for mediation may soon be wide open in other areas of the tax arena. Those professionals not familiar with the process need to become familiar with it. IRS Announcement 95-86 marks a historic beginning for using mediation in tax resolution. *

Kay O. Wilburn, JD, is an adjunct professor and Frank M. Messina, DBA, CPA, an assistant professor at the University of Alabama at Birmingham.


Edwin B. Morris, CPA

Rosenberg, Neuwirth & Kuchner

Contributing Editor:

Richard M. Barth, CPA

The CPA Journal is broadly recognized as an outstanding, technical-refereed publication aimed at public practitioners, management, educators, and other accounting professionals. It is edited by CPAs for CPAs. Our goal is to provide CPAs and other accounting professionals with the information and news to enable them to be successful accountants, managers, and executives in today's practice environments.

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