When working with the IRS on an issue that is gray in nature such as valuation, research credit or transfer pricing, there are various shades of gray associated with these types of issues. The easy issues are clearly black and white. It is important to recognize the “easy” issues and to tentatively work these “easy issues” before proceeding to the “harder – grayer issues.” It is suggested that you only finalize and accept all proposed issues when you as the taxpayer fully understand the magnitude of all of the issues near the end of the audit.
Some firms take a very assertive approach and very happy to help their clients have an unagreed case on examination, go to Appeals or even move on to litigation. Several years later and after tremendous cost in terms of time and resources the courts may decide the issue. That is one approach. This approach may significantly impact the tax department in terms of actual costs, opportunity cost lost and negatively impact the tax department staff. The commentary that follows offers an alternative approach to conflict with the IRS focused on building trust, collaboration and creating value going forward.
Exploring estate and gift tax cases the numbers may look something like this:
400,000 estate and gift tax returns filed with the IRS
40,000 with potential issues
360 docketed for court
36 decisions by the courts
Some look at approximate numbers like these and decide to take their chances with the system. That approach assumes an audit roulette. However, most taxpayers attempt to avoid the pain of time, resources and money associated with a conflict with the IRS and comply with the law. When the law is gray and it is open to interpretation this in itself can give rise to conflict.
The decision on how to proceed starts at the top. It is critical to have the buy in of the client as to what approach to take. If the leadership is willing to admit to mistakes or corrections should they be brought to light this says a lot to the IRS about the integrity of the taxpayer. The risks regarding approaches and concepts must be made apparent. The courts today are suggesting a sensitivity analysis related to various inputs to the approach so that the courts can apply resources more proactively to the differences. The same holds true for many IRS examiners.
Being transparent on significant items demonstrates honesty. Not everything needs to be shared, but if there is no reason not to share information, it is a good idea to share the information with the IRS to indicate why decisions were made the way they were.
Often miscommunication takes place because participants failed to adequately discuss what was needed or intended. In the Large Business and International (LB&I) division the IRS has spelled out a process on how to address all requests for information. This process related to discussing requests for information before formally requesting the information generally works well. There is no reason this approach cannot be recommended in any of the other IRS divisions (11 divisions with external clients at the IRS) as a model to ensure clearer communication. My own experience is that no other IRS division has objected to using the approach presented in this directive from LB&I when requested by one of my clients. As such it cannot hurt to ask.
Be fair with the IRS. Treat each other with respect. Be there to develop a good working relationship. Listen to what the IRS wants to do and why. Discuss any concerns that you may have. Work to address these amicably. For example an Information Document Request (IDR) may be broken down into several different IDR’s taking into account where records are located and who may be responsible for obtaining those records.
Encourage working on the tasks in a friendly, consistent manner that encourages a good working relationship. This helps build trust. Be there to help educate the IRS. With IRS training funds having been cut by Congress by more than 90% since 2010 it may be necessary to educate the IRS on elements for which the examiner has not been trained.
When it is time to discuss preliminary proposed adjustments, make them exactly that, preliminary. Ask to have the preliminary proposed adjustments presented as an attachment to an IDR rather than on the form 5701 (the formal proposed adjustment form in LB&I) or on a formal memorandum indicating the proposed adjustment from another division. Once a proposed adjustment has formally been presented to the taxpayer, the clock starts ticking regarding formal procedures and responses. Keeping the preliminary proposed adjustment preliminary in nature helps to clear up any misunderstandings and can catch any errors before the proposed adjustment becomes formal. It helps to have all of the proposed adjustments at one time near the end of the audit to allow both your client and the IRS the ability to understand the implications of any agreements.
When preparing to discuss the preliminary proposed adjustment know what your bottom line is. This is known as your Best Alternative To a Negotiated Agreement or BATNA. Discuss this with your team ahead of time. Since examination resolves cases based on the facts in the case it is important to have completed maybe a half dozen alternatives from a refund computation, to the IRS position, to several alternatives between the IRS position and your BATNA. This allows your side to consider options depending on how the negotiation proceeds. You can always present alternatives to the IRS and see how the IRS responds.
Depending on how the IRS responds you may see a creative way to resolve the issue factually with examination building upon the alternative you prepared going into the negotiation with the IRS. Some alternatives are simply timing adjustments and others may set a precedent for future years. Since the IRS is examining older years, you can explore the implications in your more current years. Remember you can always propose alternatives and the IRS can accept or reject these alternatives on examination, but the IRS has no responsibility to propose creative solutions to the taxpayer. By you presenting a good faith offer this encourages the IRS to reciprocate in kind. If the IRS does not, bring up the reasonableness of your offer and encourage the IRS to reciprocate in a similar manner. This should lead to a good discussion on interests and allow the parties to work towards a negotiated conclusion.
If the case is still unagreed with the IRS audit examiner it may be necessary to elevate the issue to the examiner’s manager and if still not resolved on examination to move the case forward to Appeals. Examination cases are resolved based on the facts and Appeals cases are settled based on the hazards of litigation. Depending on the facts and applicable law applied to your case it may necessary to have Appeals help settle the issue with fast track settlement at the end of the examination, or proceed to Appeals and work with the Appeals Officer to settle the case at Appeals.
By building trust with a good working relationship, it is possible for the parties to listen to each other and through mutual understanding and respect develop an alternative that is considered acceptable to both parties. Understanding how both the taxpayer operates and how the IRS operates with its eleven different divisions, geographically dispersed around the country and operating independently since 2000 can leave the taxpayer in a quandary regarding the culture of the division and geographic approach to issues. Individuals also have their own interests that may also enter into the negotiations. Don’t be afraid to ask the examiner if you can help with the computations. Do not underestimate the benefits of social media sources to gain an additional understanding of the parties you are working with at the IRS. In the end it is all about developing good working relationships, listening to the IRS, educating them on what the taxpayer did and why. All of these actions are very beneficial to prepare the IRS to be receptive to your proposals before entering into the actual negotiations.
I want to share two references with for your further consideration on this issue. These are: Building Trust in the Workplace by Lea Hart from the AICPA and Dealmaking in Negotiation: Six Strategies for Creating Value at the Negotiating Table by the Program on Negotiation Staff at the Harvard Law School Program on Negotiation blog.
Michael Gregory is an expert in conflict resolution dedicated to making thought-leading entrepreneurs and executives more successful. Michael’s books, The Servant Manager: 203 tips from the best places to work in America and Peaceful Resolutions: A 60-step illustrated guide to conflict resolution are available at http://mikegreg.com/books. Free resources are available online at www.mikegreg.com. Check out the blog. Contact Mike directly at firstname.lastname@example.org or call (651) 633-5311.
About the author
Mike Gregory is a professional speaker, an author, and a mediator. You may contact Mike directly at email@example.com and at (651) 633-5311. Mike has written 12 books (and co-authored two others) including his latest book, The Collaboration Effect: Overcoming Your Conflicts, and The Servant Manager, Business Valuations and the IRS, and Peaceful Resolutions that you may find helpful. [Michael Gregory, ASA, CVA, MBA, Qualified Mediator with the Minnesota Supreme Court]