Representation Before the IRS
Posted on: January 9, 2013 | By: dunn_access | Civil Tax Controversies
By Stephen J. Dunn
In tax controversies, who represents you can be the ballgame. “Tax controversy” is a term or art meaning a contested matter before the IRS, civil or criminal, administrative or judicial.
CPAs are adept at preparing tax returns. They are trained to audit companies’ financial statements for the benefit of their owners. A taxpayer embroiled in a tax controversy, however, needs representation by qualified tax counsel.
In one recent case, a CPA attempted to represent a taxpayer in making an OVDP voluntary disclosure concerning foreign accounts. The purpose of such a voluntary disclosure is to avoid a criminal prosecution of the taxpayer, and to bring the taxpayer into tax compliance with a minimum of monetary penalties. The CPA did not secure assurance from the IRS Criminal Investigation Division that the taxpayer would not be prosecuted. Nor did the CPA succeed in minimizing the taxpayer’s civil penalties, as his submission to the IRS was incomplete. The CPA did, however, allow an IRS agent to interview the taxpayer at length. The interviews may have given the IRS evidence to sustain a willfulness penalty against the taxpayer under 31 USC § 5321. For a successful OVDP applicant, such penalty is 27.5% of the largest balance in the previously undisclosed foreign accounts during the eight-year lookback period. For others the penalty is the greater of 50% of the largest balance in the subject accounts during the lookback period or $100,000. If the IRS cannot prove willfulness, the penalty is $10,000.
The IRS is entitled to examine a taxpayer’s books and records. It is even entitled to tour the taxpayer’s business premises, at a reasonable time. But the IRS is not entitled to interview a taxpayer.
Taxpayers tend to be chatty in talking with Revenue Agents. They try to talk themselves out of problems, real or imagined, invariably with the opposite result. I never allow a Revenue Agent to interview a client, except in conditions controlled by me, when I know it cannot harm the client.
In another case, taxpayers had a limited liability company (“LLC”) and an S corporation. The income from both entities passed through and was reported directly on the owner-taxpayers’ individual income tax returns. The LLC leased software to the S corporation. In an audit of the LLC and the S corporation, an aggressive Revenue Agent disallowed the S corporation’s deduction its lease payments to the LLC, but did not disturb the LLC’s recognition of the lease receipts as taxable income. The CPA who represented the taxpayers in the examination should have filed a protective claim of refund for tax paid on the lease receipts, but by the time I got involved in the matter the statute of limitations on filing such a claim for refund had long since expired. As a result the LLC’s recognition of the lease receipts as taxable income stood, but the S corporation was disallowed a tax deduction for the lease payments.
Just because someone is an attorney does not mean that he or she is qualified to represent a taxpayer before the IRS. A client came to me after an excruciating examination of years’ duration. Representing the taxpayer in the examination were a non-tax lawyer from a large law firm and a CPA from a large local CPA firm, for which representation the client paid $25,000-$30,000 per month. The IRS challenged $3,000,000 in payments which the taxpayer had made to its mortgage broker employees to reimburse them for their travel and office expenses. The IRS asserted that the payments should be reclassified from employee business expenses to compensation. At one point the lawyer recommended to the client resolution of the matter—likely in response to complaints from the client of the onerous cost of the proceeding. The resolution was not for reclassification but disallowance of $300,000 of deductions in controversy. The resolution required the client to pay more than $150,000 in additional tax, penalties and interest. The lawyer had the client believing that the resolution as a good deal—the matter was being resolved for “ten cents on the dollar.”
It was a terrible result. The payments were made, and however characterized—as reimbursement of employee business expenses or compensation—they were allowable business expense deductions. The matter should have been resolved for zero cents on the dollar.
There is a third category of taxpayer representative—Enrolled Agents. EAs must take and pass an examination administered by the IRS. They can handle tax examinations of individuals and small businesses.
Why do representatives take on matters they are not equipped to handle? Certainly present and future fees. And fear of losing the client. But this is very short-sighted, for if a representative attempts to handle a matter beyond his competence, he surely will lose the client. The client’s well being must take precedence over all other interests.
The taxpayer should be represented by qualified tax counsel in any IRS matter other than a routine examination. Matters requiring representation by tax counsel include:
• Complex examination.
• Any matter involving potential for criminal prosecution.
• Appeals Office matter.
• Collection matter, including levy, installment agreement, currently not collectible posting, bankruptcy, and offer in compromise.
• Innocent spouse case.
• Asset forfeiture case.
• Voluntary disclosure case, including OVDP matter.
• Claim for refund.
• Adjustment of assessment.
• Penalty relief.