So, you and your accountant or tax attorney have met with an IRS examining agent, and you’ve presented solid proof that they’re barking up the wrong tree. But instead of leaving your tree alone, they start barking louder and longer and standing firm in their position. What can you do now? How do you resolve matters?
Keep Your Cool
The first and most important tactic is to keep your cool. Resolving any situation with a government agency like the IRS has a strong mental component to it. As unfair as your situation may be, if you become combative, you will become the bad guy in the agent’s eyes. This makes it difficult to resolve the issues the IRS agent is empowered to resolve, because now it can become a matter of principle to them: “Holding the line against the abusive taxpayer.” Also, the agent can pass this negative impression of you up the chain of command, further tainting the possibility of a peaceful resolution of your case. Keeping your cool means being respectful in both verbal and written discussions. Understanding that you have other avenues of resolution and people you can speak to beyond this one “myopic” agent may help you to stay calm.
Step one in the resolution process is to resolve as much as possible at this lower level. This will save time and money (for both you and the IRS) and emotional stress (for both you and the agent), so everyone is motivated to find solutions. The agent also has an incentive to obtain a quick and peaceful resolution to your case because it makes them look better to their superiors.
It’s important to start by understanding whether the issues involved in your case are factual or legal. For example, if the audit revolves around issues of fact, like the actual amount of sales you had or the reasonableness of the items listed as costs of goods sold, the agent may have substantial authority to resolve the dispute.
Agents have resolution authority, but their settlement authority is much more limited. Since settlement involves settling disputes to avoid “the hazards of litigation,” which are heavily influenced by legal issues and lower-level agents don’t usually have much leeway to resolve legal issues. If a legal matter arises, it often quickly leads to an impasse, and it’s best to respectfully acknowledge this to the agent and move on to the next topic. Generally, legal issues are dealt with during the appeal process, which happens later.
If your case involves both legal and factual issues, the best course is to clarify those factual issues, making sure that the differences between your position and that of the IRS is stated clearly in the examiner’s notes, because their statement of facts and points-of-difference will be relied upon by the IRS in all future settlement discussions.
Does Technical Services Approve?
It’s important to note that any agreement you reach with the IRS is not binding on the IRS until it has been reviewed by its Technical Services department. Technical Services reviews the agent’s paperwork to make sure it covers all the raised issues and conforms with IRS rules. Once Technical Services passes the agreement, the local office will issue a report confirming the agent’s findings. Then, any resolution you’ve reached with the agent becomes final.
If a complete resolution with the examiner cannot be reached, Form 870 is sent with a transmittal letter known as the “30-day letter.” The 30-day letter gives you the following options:
- You can accept the findings of the agent as listed in Form 870;
- You can request a conference with the local IRS appeals office. Your request must, of course, be received within 30 days of the issuance date of the transmittal letter. If your dispute is more than $25,000, your request for a conference must include a formal written protest, prepared by your accountant or lawyer, setting forth your position; or
- You can do nothing, in which case you’ll receive a statutory notice of deficiency.
Statutory Notice of Deficiency
If you receive the notice of deficiency, also known as the “90-day letter,” you have 90 days to file a petition with the U.S. Tax Court or the tax will be assessed. Time is critical. With both the 30-day letter and the 90-day letter, timing is critical. You must respond within these time periods or you’ll lose the ability to appeal.
In the best of all possible worlds, we wouldn’t have to write articles like this, and you could go about your business providing your customers with the finest cannabis possible. But this isn’t that kind of world — we share this planet with the IRS. In some cases, you’ve done your best to avoid an audit, but to no avail. The IRS examining agent has stuck to their guns, and now you’re headed to an appeal.
The appeals phase is like a chess game, with every move carefully planned. So, remember that timing is critical and that the time-constraint on your 30-day letter must be adhered to.
The appeals process is an informal one. Testimony is not taken under oath, although the IRS may require your statements of fact to be presented in the form of affidavits or declarations under penalties of perjury. You or your CPA or attorney meet with an appeals officer and informally discuss the pros and cons of your tax position versus the one taken by the examining officer you met with previously.
Although the appeals office has a veneer of impartiality, the truth is that the appeals officer assigned to your case will be acting to protect the rights of the IRS and will be an advocate on its behalf. You may find the officer raising a new theory in support of the examining agent’s suggested adjustment. However, new issues should not be raised by them. You or your representative may raise new issues, however, if you choose.
One of the rules governing the appeals process is that there are not supposed to be any ex parte communications between your appeals officer and the examining agent. These are any communications taken between the appeals officer and examining agent without the presence of the taxpayer. The intent of this rule is to ensure the independence of the entire appeals organization.
The main mission of the IRS is to avoid litigation “on a basis which is fair and impartial to both the government and the taxpayer and in a manner that will enhance voluntary compliance and public confidence in the integrity and efficiency of the IRS.”
If you and your appeals officer arrive at a “mutual concession,” you’ll be presented with a Form 870-AD which states your mutual understanding. This specialty form contains pledges against reopening the disputed issues that a normal Form 870 does not. The dispute is put behind you and the IRS, unless there is “fraud, malfeasance, concealment, or misrepresentation of material fact,” and no claim for refund or credit may be filed.
The Last BIG Step
Should you and your representative go through the appeals procedure and not reach an agreement, there is one last step: U.S. Tax Court. While U.S. Tax Court is beyond the scope of this article, suffice it to say it is a last resort, but a choice in which justice may be done and tax law interpretations may possibly be changed in favor of cannabis companies.
But remember, if you do choose tax court, respect your deadlines.
Simon Menkes, Rachel Wright and Abraham Finberg are certified public accountants at AB FinWright LLP (www.abfinwright.com) and 420CPA (www.420cpa.com). They serve clients throughout California and in all legalized cannabis states in the U.S. They can be reached at 310-237-3070.
This article is the second of a two-part series on federal tax procedures for businesses in the cannabis industry. Part I was published in the May issue of Marijuana Venture and can be read at www.MarijuanaVenture.com.