By John Hyer
It dawned upon me that REI are unfamiliar with the Tax Court, greatly underestimate the benefits of filing a case, and often overestimate the costs of fighting the IRS. We have had some nice successes in Tax Court with REI from all over the country. I thought I'd share how it works:
TIMING: You have ninety days after being assessed by the IRS to file a petition in Tax Court. The IRS sends LOTS of different types of letters looking for money. A lot of those letters are simply “requests” and not formal “assessments”. With a “request”, you do not necessarily owe the money (though people often pay it anyway because they fear the IRS, and the “requests” sure so sound like demands), but the IRS would sure like you to pay it and not fight them. Better than 50% of those “requests” are wrong, so I would not simply jump and pay the IRS because they “asked” you to.
An IRS Notice of Deficiency is quite different. The IRS is no longer asking for money, they are formally saying that you owe it, and that if you disagree, you must speak now or forever hold your peace. A Notice of Deficiency basically says “We the IRS have gone through the legal process to determine how much you owe. We opine that you owe $xx,xxx. If you do not fight us within a certain time frame, then the law says you SHALL owe $xx,xxx”, period, stop, end of sentence. A Notice of Deficiency is easy to recognize. The three things to look for:
- Such a letter is almost always sent via certified mail;
- First page, upper right side of the letter says “Last Day to Petition With the United States Tax Court” followed by a stamped date; and
- First page, about a third of the way down, look for the bolded and capped words “NOTICE OF DEFICIENCY”.
In some cases, you may receive a very similar letter called a “Notice of Determination”. It should be treated as a Notice of Deficiency, and most certainly not ignored.
Such letters are very important and should not be ignored. The date stamped in the letter is set in stone. Miss it by 30 seconds, you can only file in District Court, which is much more expensive than Tax Court, and you must pay all of the taxes that the IRS says you owe first. On the other hand, to go to Tax Court, you do not need to pay the tax demanded in the Notice of Deficiency. Furthermore, litigating in Tax Court is normally much cheaper than doing the same in District Court. In short: Tax Court is normally a much better option than District Court for small REI, and the Letter of Deficiency sets your deadline to file your case.
COST OF FILING, SETTLING AND FIGHTING To sue the IRS in Tax Court, you must file a petition. There are two types of petition:
- Small Tax Case: A small tax case normally involves tax owed of less than $50,000. The procedures in a Small Tax Case are simpler than with a Regular Tax Case, which helps keep the costs low. The major downside when compared to a Regular Tax Case: The case cannot be appealed by the taxpayer or the IRS. The Tax Court's decision is final. For most REI, the cost and low chances of winning mean that an appeal was never a very realistic option. As such, giving up the right to an appeal is a small sacrifice to make in exchange for a simpler & cheaper day in Tax Court. 90% of our clients who litigate in Tax Court choose this option.
- Regular Tax Case: More complex rules apply than in a Small Tax Case. Such rules increase our fees. Such cases can be appealed, but such appeals rarely occur in fact. Very few clients select this option, most of those who do are over the $50,000 threshold.
THE REAL REASON TO FILE: THREE BITES AT THE APPLE Once the case is filed, the IRS Appeals Office will contact you. Often, this is the real reason we file. Here's why:
IRS Appeals Officers are much better trained than regular IRS agents. This higher level of training is especially important when dealing with complex or exotic topics, such as sandwich lease-options or subject-to deals, to name two examples. It is quite common for normal agents to say “that's illegal” or “you cannot do that”. It is also quite common for Appeals Agents to quickly recognize and favorably settle such items. We have often had such settlements result in everything the taxpayer was looking for. In addition to superior knowledge and experience, IRS Appeals Agents are generally looking to avoid litigation if reasonably possible. Lawyers are expensive and the IRS does not have unlimited resources with which to pay them. Sound familiar?
Technically, there are other ways to get to the Appeals Office, but none of those methods tend to get results comparable to filing in Tax Court. For example, our experience has been that when we file a formal petition for Appeals Office review (which is cheaper than filing in Tax Court), there is no pressure on the Appeals Office to act intelligently or promptly. In those cases, the Appeals Office takes its time (often 12 or more months) to act. The bureaucratic shuffle often results in lost paperwork, slow action, transfers from one agent to another, etc. Further, we also find that the lack of a pending court case tends to make for less favorable settlements when they finally do occur. In contrast, when a Tax Court petition is filed,the Appeals Office normally follows up in a comparatively timely manner, and negotiates with a much more open attitude. As a result, most Tax Court cases end up being settled with the Appeals Office on pretty reasonable terms.
The second bite at the apple is with the IRS lawyer assigned to try the case. These lawyers are generally very civilized and reasonable. They are also tough, quite knowledgeable, and tend to drive a much harder bargain than the Appeals Office. Most of the time they will settle, but they will squeeze for everything they can get. Only a minority of cases get this far, because the Appeals Office will normally offer a “good enough” deal to avoid having to talk to the IRS' lawyers. The third bite at the apple occurs in court. Very few cases make it this far, and those that do end with mixed results. It is very hard to predict what will happen in most cases once they are in court. There is usually enough “gray” that the taxpayer and the IRS attorney each think they can win, which is why they are both willing to take a case “all the way” instead of settling. The vast, vast majority of “slam dunk” cases get settled, the ones that have a lot of gray also tend to get settled, and a few of the gray ones end up in front of a judge. In conclusion, filing in Tax Court gets you three things:
- The best chance for a relatively fast and favorable settlement with the Appeals Office;
- A chance at an “OK” settlement with an IRS lawyer; or
- Your day in court.
Depending on the amount of taxes at stake, your lawyer's fees may be a small sum to pay for three bites at the apple.