When you are being questioned, audited or in a battle with the IRS, you need to know which documents will help your case.
When you search for tax rules, keep your audience in mind. As you’ll see, the IRS and the courts disagree over the persuasiveness of the different sources of tax law. Unless you are fighting a case in court, focus your research on the documents that convince the IRS. If you are like most business owners, your audit will begin and end with the IRS.
Tax Law Hierarchy
Here are three general rules on the persuasiveness of tax documents:
• Statutes and regulations are highly persuasive with both the courts and the IRS.
• The next-best authority with the courts is prior case law.
• The next-best authorities with the IRS are IRS documents. But as you’ll see, IRS documents range from very strong to very weak.
Tax Code—Always the Best
The tax code is always your best source of authority. If you have a “statute” (a tax code provision) that directly describes your situation, you can pretty much rest easy. Just keep pointing at the statute, and you will win your case.
Likewise, if the tax code is directly against you, don’t waste your money with a prolonged fight. Try to settle and pay as little as possible but know that the law is not on your side.
Unfortunately, the language of the tax code is usually too general to support your tax strategy completely. This means you usually have to add additional forms of authority.
Treasury Regulations—Second Place
Regulations are almost as authoritative as statutes. But if the statute says something different from what’s in the regulation, the statute prevails. You will find more than one type of regulation in your research. In addition to regular, or “final,” regulations, there are also temporary regulations and proposed regulations.
The Treasury writes temporary regulations after Congress passes a new statute. Temporary regulations expire after three years, but while they last, they have the same weight as final regulations. In the old days, temporary regulations did not expire. You find some temporary regulations that are valid today and have been in the books for years and years.
Proposed regulations have less authority than final and temporary regulations. You can rely on proposed regulations as a statement of the IRS’s official position on an issue. These are highly persuasive with the IRS but not so persuasive with the courts.
One big problem with regulations is that the Treasury does not update regulations after every change in the tax code. You will often find a regulation meant for a prior version of a statute or even for a statute that no longer exists. Can you disregard these old regulations? Not always. Sometimes the courts and the IRS treat parts of those regulations as valid law!
How can you know whether an old regulation remains operative law? This is no easy task. You have to read cases, IRS documents, and legal treatises to find out. The regulations themselves give no clue.
Dealing with the IRS
Your tax dispute always begins with the IRS. At the earliest stages of the audit, you work with auditors and agents whose knowledge of the law comes primarily (or solely) from IRS documents, not statutes or court cases. As you advance your case within the IRS, you deal with supervisors and officers who are more knowledgeable and pay more attention to the code, regulations, and court cases.
Throughout the audit, one thing remains constant: IRS documents remain hugely important at all levels within the IRS. The next sections of this article describe the different types of IRS documents, beginning with the strongest authority and moving down to the weakest.
Please note, the courts don’t treat any IRS document as binding authority. But the IRS doesn’t usually argue a position in court that contradicts something it wrote in its published documents (though this does sometimes happen).
Top Authority—Official Pronouncements
You will find official pronunciations from the IRS in the Internal Revenue Bulletin. The Bulletin describes itself as “the authoritative instrument of the Commissioner of Internal Revenue for announcing official rulings and procedures.” All these documents bind the IRS. The problem with official pronouncements is that they are not always easy to read and understand. So, you may have to read through them several times or consult another resource to help make sense of them.
The first type of official publication is a revenue ruling. The revenue ruling reads like a condensed court case and describes how the IRS applies the law to a particular set of facts. The second type of official publication is the revenue procedure. The IRS uses the revenue procedure to administer the law by updating dollar amounts for inflation and by explaining procedures for making elections or filing forms. The third type of official publication is acquiescence or non-acquiescence. At its discretion, the IRS can issue a statement indicating its agreement (acquiescence) or disagreement (non-acquiescence) with a Tax Court ruling. Last, you’ll find notices and announcements that describe the IRS’s official position on recent issues.
Non-Binding Documents Are Important
Usually, the IRS doesn’t pass judgment on your tax strategies until after you file your return. You can pay a fee and obtain an IRS tax ruling in advance. This is called a “private letter ruling” (PLR). If the law is not clear on a tax strategy you want to pursue, it might be worth the cost to receive IRS guidance in advance rather than risk penalties. Technical advice memoranda (TAMs) are like PLRs and carry the same authoritative weight. The taxpayer initiates a PLR, whereas either the taxpayer or the IRS can initiate a TAM.
IRS private letter rulings always end with the same two sentences: “This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3) provides that it may not be used or cited as precedent.” This sounds suspicious as though the IRS is giving you its opinion on an issue of law and telling you not to rely on that opinion. That is exactly what the IRS is doing. You will find similar disclaimers in other documents as well, even in some court cases.
You might ask, is there any reason to read documents with these disclaimers? Absolutely! In practice, the rulings are very important. Tax professionals use them all the time, both in court and when dealing directly with the IRS. PLRs and TAMs are often the only guidance available on an issue in dispute.
Everyday Guidance—Good Place to Start
The IRS publishes IRS forms, instructions, publications, and FAQs (guides). The guides are less technical than official pronouncements, and they don’t include citations. The IRS writes the guides in clear terms so that non-professionals can easily understand them. The guides are a good place to begin your research, because they are easy to read, and they cover the topic in a comprehensive way. But the guides are generally conservative, sometimes misleading, and occasionally mistaken.
In general, you don’t rely on the guides by themselves, even when dealing with the IRS, because the documents are not “substantial authority.” If you find a rule in one of the guides, you can rest assured that the same rule exists in a technical authority as well, such as the code or regulations. It’s just a matter of identifying where that more authoritative document resides. Finally, even though guides are not binding, they help advance your arguments with the IRS. And the IRS is likely to follow its own advice, even from non-technical guidance.
Internal IRS Documents
The IRS also publishes non-technical guidance for the use of IRS employees rather than the general public. These include the Internal Revenue Manual, audit manuals for various industries and professions, and chief counsel advice. Like the other IRS non-technical guides, these documents are not binding and are not substantial authority, but they are certainly helpful when you present them to the IRS in support of your argument, particularly when you deal with lower-level IRS auditors whose knowledge of the law comes primarily from these documents.
Why Court Cases Matter?
Most tax disputes begin and end with the IRS. So where do court cases fit into your legal research?
Court cases matter at the IRS level for two reasons:
1. At the highest level of IRS review (appeals), IRS officers consider court cases.
2. Court cases usually describe all the statutes, regulations, and other important IRS documents you need to support your case. Plagiarizing court cases is not only within the rules for engagement with the IRS, but also a great strategy!
Once your tax dispute leaves the IRS and enters court, your best sources of tax authority are statutes, regulations, and prior court cases.
Which Court Cases Matter?
The Tax Court is not the only court that hears federal tax cases. You could also end up in federal district court, a court of appeals, the court of federal claims, or even the Supreme Court. If you are in court, you want to find prior cases from the court hearing your dispute (or from a court that is higher up in the chain of authority, such as the appeals court or the Supreme Court).
Because the Tax Court is the only court that specializes in tax cases, its rulings usually follow better logic and make more sense than opinions from other courts. That’s why you most often see Tax Court cases cited as authority. Not all Tax Court cases carry the same weight. Only regular decisions count as official precedent. You recognize these by the “T.C.” or “TC” in the citation.
Memorandum opinions are less authoritative than regular decisions, but you can still use them to bolster your position. The citation includes “T.C. Memo,” “TC Memo,” or “T.C.M.” Summary opinions have the least weight. They do not count as precedent, and they are not highly persuasive. The citation shows as “T.C. Summary Opinion” or “TC Summary Opinion.”
Courts of Appeals
If you appeal your case after the Tax Court verdict, it moves to the Court of Appeals in your “circuit,” or region of the country. Sometimes the appeals courts in different circuits decide cases differently. For example, the appeals court for Texas (the Fifth Circuit) might have a different rule for an issue than the appeals court for California (the Ninth Circuit). When this happens, the Tax Court is supposed to rule according to the opinion of the circuit governing the area of the country where you had your tax problem.
Of course, there is always a chance the judges at both the Tax Court and the court of appeals will buck precedent and create their own, new interpretation. You have to love the courts, where the law is the law until the judges change their minds.
What Should I Do If I Am Being Questioned or Audited by IRS?
If you are a Business or Personal CFO client of Neil Jesani Advisors, the in-house team of experienced Tax Attorneys will be assisting and representing you. If you are not yet a CFO client of Neil Jesani Advisors, then please schedule a time to speak with our experienced tax attorney now.