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The Internal Revenue Code provides many rights to taxpayers to challenge IRS actions, however as I will point out in this article, the rights given are less than desirable.
Our tax system works against taxpayers in two ways. First, certified public accountants, enrolled agents, or return preparers rather than attorneys usually act as the default practitioners in most legal tax controversies. Second, the “Flora” rule.
The IRS has been given substantial legal administrative authority to assess and collect tax, generally without a judge or jury ever being involved. Most taxpayers go to the person who prepared their tax returns to help them with an audit or tax controversy, and this works fine in the majority of tax controversies.
However, because certified public accountants, enrolled agents or return preparers are not attorneys, they do not know all of the tax controversy procedural rules and often do not fully or correctly advise taxpayers of their limited rights to court hearings. If these rights are not correctly exercised, the IRS is free to assess and collect the tax without a true fight.
After an audit, if the IRS has determined that a taxpayer owes a tax, the IRS will issue a determination known as a Notice of Deficiency, which acts like a proposed judgment against the taxpayer.
I often see clients and accountants who think that if they get a Notice of Deficiency, they can still work with the auditor on the various issues. This is not the case, because the Notice of Deficiency acts as the final IRS decision and they generally will not rescind it. In cases where it is to be rescinded, it needs to be done according to the procedures set forth in Revenue Procedure 98-54.
If the taxpayer does not properly contest the Notice of Deficiency, the proposed assessment contained in the Notice of Deficiency is considered legally assessed after 90 days and the IRS can start collecting on it.
I call this whole process an “administrative lawsuit” because the results are the same as if the IRS had sued a taxpayer and won. If taxpayers wish to contest the proposed tax assessment in the Notice of Deficiency, they can either dispute the matter in Tax Court or pay the tax and file a claim for refund in federal court. Those are generally the only two options.
Generally, Tax Court is the appropriate venue for most taxpayer’s disputes and the taxpayer does not have to pay the tax before the Tax Court hears the case. The Tax Court even offers a simplified procedure for small dollar cases. However, small cases cannot be appealed. Most tax controversies never go to trial at Tax Court and are settled administratively through the Appeals Division.
Tax issues that cannot be heard by the Tax Court must be brought in federal district court or the U.S. Court of Federal Claims. This is generally a bad thing because litigation in federal court is very expensive.
Also, under the “Flora” rule, a taxpayer must full pay the tax owed before a federal court will even entertain a lawsuit. Only a few hundred lawsuits are filed against the IRS in federal court every year. The Tax Court in comparison hears tens of thousands of cases.
This basically means that unless your type of dispute can be heard in Tax Court, you are without a realistic court venue to hear your case. That results in the IRS becoming the de-facto judge and jury in a large number of tax cases. Is that fair? No, but it is the current way the system is set up.
You may ask, what happens if the IRS is flat out wrong about something or made a procedural error. Can’t a taxpayer ask a federal court to help? The answer is unfortunately, no, because of the Anti-Injunction Act. That rule says “no suit for the purpose of restraining the assessment or collection of any tax may be maintained in any court by any person.”
Because there are many barriers that keep taxpayers from getting a fair trial, they must take any IRS notice they get very seriously and address it as soon as possible.
If you receive a notice from the IRS that looks like you are being audited, you should see a tax professional right away who is experienced in tax controversies. Even if contesting in court is not an appropriate option, there are other various administrative remedies that can be sought to correct the wrong.
A tax attorney will be able to correctly advise you on all your options and help you choose the correct procedure to resolve your tax controversy.