THE CPA IN MEDIATION AND ARBITRATION

June 2000

NEW OPPORTUNITIES TO REDUCE THE COST OF TAX LITIGATION THROUGH ADR

By Philip Zimmerman

The Association of the Bar of the City of New York, which sponsors many legal education programs that CPAs may attend, recently hosted "Resolving Taxpayer Disputes: Mediating and Arbitrating with the IRS," a major program on alternative dispute resolution (ADR). The use of ADR for taxpayer disputes with the IRS falls under the IRS Appeals Office (Appeals). The ADR program is supervised by Thomas Carter Louthan, director of the office of alternative dispute resolution and customer service programs in the national office of appeals. Louthan, along with Donald L. Black, Jr., national director of appeals, Tax Court judges, members of Appeals, private practice mediators, and tax specialists spoke at the well-attended program.

IRS Mediation

The IRS encourages the use of ADR to create an administrative forum, independent of compliance functions, that can more efficiently prevent or resolve disputes. Since 1995, the IRS has made available a test mediation program for adjustments of $10 million or more. On November 16, 1998, it began a two-year test program for adjustments of $1 million or more. Unfortunately, only 50 mediation requests had been filed by the end of 1999. Of these, 24 mediations have been completed with an 87% success rate, resolving about $3 billion in proposed disallowances. A new policy, which would permit any size disallowance meeting certain requirements to be mediated, is expected to be announced this year. Meanwhile, the IRS is taking certain of these cases into mediation on an ad hoc basis.

How IRS Mediation Works

Mediation is particularly useful and will be considered for cases that are highly factual, involving issues such as valuation, reasonable compensation, transfer pricing, depreciation, computer sales and leasebacks, and debt vs. equity.

If there is no agreement after a good faith effort at negotiation in Appeals, a taxpayer can request mediation before a case is designated for litigation or docketed before the U.S. Tax Court. This gives the taxpayer a second chance to resolve an issue before having to litigate it. Similarly, in certain cases, taxpayers can request early referral of one or more issues from a tax examination to Appeals while allowing other issues to be developed during the continuing examination.

Taxpayers seeking to mediate are required to submit a written request for mediation to the appropriate assistant regional director of appeals (large case) with a copy to the national director of appeals. If the request is granted, the IRS and the taxpayer enter into a mediation agreement that states, among other things,

1) the issues to be mediated,
2) an acknowledgment that the process is voluntary and confidential,
3) an explanation of how the costs are to be paid and the mediator selected, and
4) the procedures for the exchange of participant lists and written summations regarding each issue.

Mediator Selection

There can be one mediator or co-mediators. When a non-IRS mediator or co-mediator is selected, the taxpayer and the national appeals office share the cost equally. If an Appeals mediator or co-mediator is selected, the national appeals office pays the full cost.

Participants in the Bar Association program encouraged the use of an IRS co-mediator, especially one of a higher level than the appeals officer assigned to the case. The IRS co-mediator would generally be more familiar with IRS policy and procedures, which can save time and money for the taxpayer.

Mediators are subject to the approval of both the taxpayer and the IRS. Non-IRS mediators' names can be obtained from a variety of mediation administrative organizations, such as the American Arbitration Association or the national appeals office, which maintains a list of approved mediators by geographic area. It is obviously preferable to select a mediator who has knowledge in both taxation and the taxpayer's industry, as well as experience in mediation. Using such a mediator can save the taxpayer the cost and time involved in educating the mediator.

Participants that had completed IRS mediations stressed that mediation of a case is an "incredible bargain" since the mediator's fee is usually reasonable and the taxpayer only pays half. Litigation costs can amount to tens of thousands of dollars, borne completely by the taxpayer.

IRS Arbitration

Appeals recently expanded the available ADR procedures to include binding arbitration for factual disputes similar to those considered eligible for mediation. These cases can involve disallowances of any amount. The trial program, begun on January 18, will continue for two years. Only cases that could not be successfully resolved in Appeals or by mediation will be considered. Because cases that are mediated cannot go back to Appeals, arbitration is the last option before litigation.

Why Arbitrate?

Arbitration becomes attractive if the taxpayer believes that she will prevail over the IRS in adjudication (called win/lose). On the other hand, in a successful mediation (win/win), the entire disallowance is usually not eliminated. With arbitration, however, as in all adjudications, the outcome is never assured; even with a strong case, there is a chance of losing.

The IRS will not agree to an arbitration if public policy is involved, a precedent is sought, or one of the parties involved in the dispute does not agree to the arbitration.

How IRS Arbitration Works

Assuming both parties agree, the taxpayer should send the written request to the team chief or appeals officer that has responsibility for the case. If approved at that level, the request is forwarded to several other IRS officials for final determination. This can take up to 30 days.

Once the request has final approval, the parties enter into a written arbitration agreement. The agreement is comparable to standard arbitration agreements and contains parts similar to those in an IRS mediation agreement. However, only one neutral (arbitrator) is selected by mutual agreement, and if a non-IRS neutral is selected, the cost will be shared, as in IRS mediation.

Expanded Opportunities

The IRS appears sincere in its efforts to expand the use of ADR in resolving tax disputes. Unfortunately, the bar was originally set at such a high level ($10 million or more in dispute) that only a handful of cases have gone through the process. With the threshold having been lowered to $1 million, and in some cases even lower, it is up to taxpayers and their representatives to request entry into the process. Using ADR can reduce the cost of resolving disputes with the IRS and, more importantly, give taxpayers a second chance to obtain a desirable settlement. *