This is an updated version of a 2007 outline with new materials added and additional chapters added.
Federal Tax Procedure — Fall 2011 [Mazza]
1. Overview of Federal Tax Controversies
a. Introduction — federal tax controversies generally involve disputes between private party taxpayers – either individuals or entities such as corporations, and the Internal Revenue Service (IRS). The IRS is part of the Treasury Department, and is the administrative agency responsible for administering the Internal Revenue Code (IRC) and collecting federal taxes. Other entities involved include (1) Congress, which writes the tax law; (2) the Joint Committee on Taxation, which must approve all refunds exceeding $2M; (3) the Treasury Department, which promulgates regulations to effectuate the laws; and (4) the Department of Justice, which litigates civil tax cases other than those in the Tax Court, and also prosecutes all criminal tax cases.
b. The Self-Assessment System — the federal tax system is founded on the principle of “self-assessment.” The IRS doesn’t compute taxpayers’ liabilities in the first instance; rather, the Code requires taxpayers to determine their own tax liabilities, file returns reflecting those liabilities on proper forms, and pay the resulting liabilities by a certain date.
i. The “Tax Gap” — most taxpayers voluntarily comply with the system; however, the IRS estimates the tax gap, or amount of tax liability owed but not voluntarily and timely paid, at around $345B this year, just for individual taxpayers.
ii. Underreporting is key because if individuals don’t report = hard for IRS to check.
iii. Economic model of non-compliance: Don’t pay taxes if:
Expected cost of non-compliance is less than costs of complaince.
(Perceived risk of detection [audit rate]) (punishment + tax amount)
Audit rate = 1%; punishment = usually 20%.
So if 100K of income and taxed at 35%. Expected cost of non-compliance = (35,000)(.01) + (35,000(.2) = $420. Vs. Compliance: 100K (.35) = $35,000
iv. Techniques to Stimulate Compliant Behavior — the IRS currently relies on:
1. Withholding-at-source — a substantial portion of all collected tax is withheld at the source (e.g., employer) and submitted directly to the government.
2. Information-reporting systems — payors submit information returns (e.g., Form W-2 for wages) to both taxpayers and the IRS; taxpayers’ returns are checked against these documents for accuracy.
4. Civil Tax Penalties.
5. Criminal Prosecution.
c. The Internal Revenue Service — the agency is headed by the Commissioner of Internal Revenue, who is appointed by the President and confirmed by the Senate. IRC § 7802. Until recently, the IRS had a three-tier structure. There were 33 district offices (each headed by a District Director) and ten service centers, organized geographically. Each office was responsible for applying the law to every taxpayer within the office’s geographical boundaries. Four regional offices oversaw the district offices, and a national office in Washington, D.C. oversaw the regions. This structure was largely dismantled by the IRS Reform Act.
i. IRS Restructuring & Reform Act of 1998 — the national office continues to exist in Washington, D.C. but is now called the National Headquarters. The NHQ sets general policy, reviews plans and goals of operating divisions, and develops major improvement initiatives. The Office of Chief Counsel represents the Commissioner in Tax Court cases (see, c.f., DOJ involvement in non-Tax Court cases) and issues case-specific guidance and general legal advice to all components of the IRS. There are now four operating divisions, each responsible for serving specific groups of taxpayers:
1. Wage and Investment Division (W & I) — serves the approximately 85M individual taxpayers who have only wage and investment income, almost all of which is reported to the IRS by third-party payors. Organized into four segments: (1) Communication, Assistance, Research and Education (CARE), which focuses on providing pre-filing assistance, education, and filing support to taxpayers; (2) Customer Account Services (CAS), which is responsible for processing returns and payments; (3) Compliance, which concentrates on commonly encountered issues such as filing status, dependency exemptions, tax credits, and deductions; and (4) a W & I Headquarters, located in Atlanta, Georgia.
2. Small Business and Self-Employed Division (SB/SE) — responsible for the 33M taxpayers who are fully or partially self-employed, and the approximately 7M small businesses (including C corporations, S corporations and partnerships) with assets $10M or less.
3. Large and Mid-Size Business Division (LMSB) — includes 210,000 of the largest filers, each with assets over $10M. Almost 10% of LMSB filers are audited by the IRS each year and the largest of these taxpayers interact with the IRS on a continual basis through the IRS’s Coordinated Examination Program (CEP). Organized into five “industry segments”: (1) Retailers, Food and Pharmaceutical; (2) Natural Resources; (3) Financial Services; (4) Heavy Manufacturing and Transportation; and (5) Communications, Technology and Media.
4. Tax Exempt and Governmental Entities Division (TE/GE) — includes pension plans, exempt organizations, and governmental entities that collectively remit to the government in excess of $198B in employment tax and income tax withholding. Organized into five segments: (1) a headquarters operation, located in Washington, D.C.; (2) Customer Account Services (CAS), which is responsible for service activities such as answering phones and customer relations; (3) Employee Plans, which is responsible for pensions, profit-sharing, and individual retirement plans; (4) Exempt Organizations, which is responsible for public charities, private foundations, and section 527 political organizations; and (5) Governmental Entities, which is responsible for federal, state, and local government agencies, including tax-exempt bond financing, and Indian tribes.
Each division has operations in the field with a geographic structure that meets the specific needs of that division. Each division has at least one “territory” in every state and an operating division’s various multi-state geographic presences are called “areas.” The restructured IRS also has four nationwide units that address specific issues:
5. Appeals — an independent unit for dispute resolution with the authority to settle deficiency, refund, and collection cases.
6. Criminal Investigation — responsible for criminal enforcement of the tax laws.
7. Communications and Liaison — responsible for interacting with Congress and the general public, as well as handling confidentiality and disclosure issues.
8. Taxpayer Advocate Service — ensures that, when the IRS’s standard procedures have broken down, a taxpayer’s problems are resolved quickly and fairly. Taxpayers may request a Taxpayer Assistance Order (TAO) in order to resolve pending issues with the IRS. The division also coordinates with the operating divisions to identify potential administrative problems and help implement solutions.
In addition to the above components, the IRS also has a nine-member Oversight Board, codified at IRC § 7802. The Board is composed of the Treasury Secretary, the Commissioner, a federal employee representative, and six members from the private sector. The Board approves annual and long-range strategic plans for the IRS; (2) reviews the operational functions of the IRS, including training and education, and outsourcing of work; and (3) reviews IRS operations to ensure proper treatment of taxpayers. The Board is prohibited from participating in the development of tax policy, and may not intervene in specific taxpayer cases.
d. Rulemaking Authority of the Treasury Department and the IRS — both the Treasury Department and the IRS have authority to promulgate rules and pronouncements to assist taxpayers in interpreting and applying the Code.
i. Regulations — the Treasury Secretary has the authority to “prescribe all needful rules and regulations” for the enforcement of the Code. IRC § 7805(a). It is the Treasury Department that officially promulgates interpretative and procedural regulations, although the IRS Office of Chief Counsel initially drafts most regulations. Treasury regulations are numbered with a prefix that indicates the regulation’s basic subject matter. Income tax regulations carry the prefix “1”; estate tax regulations carry the prefix “20”; procedural and administrative regulations carry the prefix “301”. The IRS (without Treasury Department involvement) promulgates its own separate set of procedural regulations applicable to its own internal processes. Proc. Reg. § 601.101 et seq.
ii. Revenue Rulings — provide guidance on substantive tax issues applicable to many taxpayers. The IRS uses a standard format: each Revenue Ruling contains a generic set of facts, a statement on the issue, and the IRS’s conclusion about the legal resul
ute is required. Effective until superseded by final regulations, but cannot remain effective for more than three years after enactment. IRC § 7805(e). Need not follow notice and comment procedures. 5 USC § 533(b)(3)(B). IRS says full force. Courts not as clear.
4. Proposed Regulations: When put public on notice of regulations. Gets no more weight than a litigation position. TP cannot rely on theses, unless says TP may rely on them.
5. Final Regulations: When the regulation is finally passed.
iii. Courts’ Deference to Treasury Regulations —
2 Types: (1) General grant of authority and (2) specific grant of authority.
General Grant of Authority: Interpretive Regulations: Don’t have to follow the APA: Don’t have to have notice and comment of these regulations.
Specific grant of authority: Legislative: Have to follow APA and give notice and comment.
Must be issued in proposed form and citizens need to be able to comment on.
How much may a TP rely on regulations: Can rely on as good law.
How much deference are these regulations given by the court: 2 Tests.
Chevron Test: Two parts: Need to have regulation go through notice and comment first.
If notice and comment, doesn’t matter if regulation is leg. or interp.
1. If statute = clear, end of matter. Give effect to congressional intent. Don’t go to step 2.
2. If statute = ambiguous: Uphold regulation’s interpretation if it is based on a permissible construction of the statute. BANKERS LIFE AND CASUALTY.
S.C.: Look at legislative history in step 1. 7th Cir: Look at legislative history in step 2.
· The court need not conclude that the agency construction was the only one it permissibly could have adopted or even that such construction was the same reading the court itself would have reached if the question had initially arisen in a judicial proceeding. In the majority of circuits, a court can look to the legislative history of a statute to determine whether a statute is silent on an issue. In the 7th Circuit, the court withholds that analysis until the second step, wherein the court evaluates the permissibility of a regulation.
1. The IRS’s longstanding interpretation of its own regulation is entitled to “substantial judicial deference” if it is reasonable. U.S. v. Cleveland Indians Baseball Co. (U.S. 2001).
2. If a valid regulation but it is ambigious: interpret in favor of agency. Seminole Rock.
3. What if no regulation; Does IRS interpretation get deference: Maybe: pg 43.
4. An executive agency regulation cannot effectively construe a statute in a manner different from a prior definitive ruling of the court. Bankers Trust N.Y. Corp. v. U.S. (Fed. Cir. 2000).
5. A court’s prior judicial construction of a statute trumps an agency construction otherwise entitled to Chevron deference if the prior court decision holds that its construction follows from the unambiguous terms of the statute and thus leaves no room for agency discretion. Nat’l Cable & Telecom. Assoc. v. Brand X Internet Svcs. (U.S. 2005). Court pretty much say this or the IRS can overrule the court’s interpretation with a new regulation.
When Chevron Applies — the Chevron deference applies “when it appears that Congress delegated authority to the agency generally to make rules carrying the force of law, and that the agency interpretation claiming deference was promulgated in the exercise of that authority. Delegation of such authority may be shown in a variety of ways, including notice-and-comment procedures.” U.S. v. Mead Corp. (U.S. 2001).