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On August 24, 2020, the IRS released a memorandum setting forth an updated process for IRS examination personnel to request that the Office of the Chief Counsel designate an issue for litigation, thereby denying a taxpayer's right to have that issue considered by the IRS Independent Office of Appeals. The guidance is effective immediately and will be incorporated into the appropriate Internal Revenue Manual sections within one year.

Background

All taxpayers generally have the right to have their case heard by the IRS Independent Office of Appeals. IRC Section 7803(e)(4). In certain circumstances, such as the designation of an issue for litigation, the IRS may deny such access, limiting the taxpayer's options to either accepting the IRS's position or litigating the matter in court.

As the August 24 memorandum explains, designation for litigation may be appropriate if it would (1) stem the proliferation of abusive tax transactions, (2) reduce future compliance and litigation costs of other taxpayers and the government, or (3) resolve issues for which IRS and taxpayer viewpoints on the law diverge widely. The IRS cautioned, however, that designation for litigation should be used "infrequently, subject to careful consideration at all levels of the process."

Request for designation

The memorandum details an updated process by which IRS exam personnel may request that the Office of Chief Counsel designate an issue for litigation in a case currently under examination. Specifically, approvals must be sought from at least four levels of IRS management and counsel before it reaches the desk of the Chief Counsel.

At various stages of the process, taxpayers must be provided notice that the issue is being recommended for designation and must be given an opportunity to challenge the recommendation and/or meet with IRS personnel to discuss the matter.

TFA procedures

Once the decision to designate an issue for litigation has been made, taxpayers can also challenge the designation under the procedures established by the Taxpayer First Act of 2019 (TFA). Under the TFA, if a taxpayer requests a referral to Appeals after receiving a statutory notice of deficiency (SNOD), and that request is denied, the appropriate Division Commissioner must provide a written notice to the taxpayer including: (1) a detailed description of the facts, (2) the basis for the decision to deny the request, (3) a detailed explanation of how the decision applies to the facts, and (4) the procedures for protesting the denial to the Deputy Commissioner for Services and Enforcement (DCSE). The taxpayer has 30 days to protest the denial in writing, after which the DCSE has 30 days to provide the taxpayer a written decision sustaining or reversing the denial and the rationale for the decision.

Implications

In recent years, the designation of issues for litigation has been a rare occurrence. Under the TFA, the IRS must submit an annual report to Congress detailing the number of requests for referrals to Appeals that have been denied and the reason for the denial. In its most recent (and first) TFA report, the IRS reported that no issues had been designated for litigation in the prior year. The extensive procedures detailed in the IRS's August 24 memorandum provide some assurance that designation will continue to be relatively rare, and that taxpayers will be provided with opportunities to challenge such decisions throughout the process.

Taxpayers choosing to challenge a designation for litigation using the post-SNOD TFA procedures should pay careful attention to how the timing of the protest process intersects with the requirement to file a petition with the Tax Court within 90 days of SNOD issuance. Taxpayers that wait to utilize the TFA process may find that they need to anticipate litigation (and, therefore, prepare a Tax Court petition) at the same time they protest the designation to avoid missing the 90-day filing deadline.

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