Treasury Implements Expanded Interest Abatement Authority
Starting with returns which are filed this year, a new statutory regime applies for compelling the IRS to abate interest on tax deficiencies uncovered in an audit. In January, the Secretary of the Treasury proposed new regulations to flesh out that regime. The new statutory regime and regulations should become a potent tool to bring down excessive IRS interest charges.
Traditionally, the IRS had no power to abate interest on any overdue tax or tax deficiency uncovered in an audit. Audits often drag on for years without resolution, leaving the amount of interest sometimes to exceed by several times the amount of the tax. Recognizing this problem, in 1986, Congress inserted a provision into Internal Revenue Code §6404(e) which allowed the IRS, in its sole discretion, to abate interest for any period in which the IRS delayed in performing a "ministerial act." Interest could not be abated where the taxpayer significantly contributed to the IRS delay.
While heralded as a great victory for taxpayers, the original §6404(e) benefited few people in practice. The main problem was the definition of the term "ministerial act". The IRS took a very narrow reading of that term. A "ministerial act" was defined in regulations as a procedural or mechanical act that did not involve the exercise of judgment or discretion and that occurred during the processing of a taxpayer's case after all prerequisites to the act, such as conferences and reviews by supervisors, had taken place. Ministerial acts did not include delays occasioned by agents being assigned to work for extended periods on audits of other taxpayers or simply taking too much time to decide whether to propose an adjustment. About the only acts that the IRS viewed as ministerial were a failure by an IRS employee to implement instructions from the employee's supervisor, such as a direction to transfer a case to another district for audit or to issue a notice of deficiency.
A second defect with the original §6404(e) was the procedure for getting interest abated. If a taxpayer receives a bill for tax plus interest, usually the taxpayer has to pay the entire tax and interest and file a Form 843 refund claim with respect to the portion of the interest attributable to a delay in performing a ministerial act. The taxpayer might be able to file the Form 843 before paying the disputed interest, but nothing requires the IRS to hold off on using its mandatory collection tools while the IRS is considering the merits of the Form 843 claim.
There is no procedure for the taxpayer to be able to inquire within the IRS as to the cause of any apparent delay. Usually, the taxpayer merely asserts in the Form 843 that there was a ministerial act delay, but is not able to point to any particular act. The IRS typically responds to the Form 843 with a letter saying it finds no ministerial act delay. Such a letter can be protested to the IRS Appeals Office. Typically, the Appeals Officer merely reviews the agent's work log on the case. That log would almost never contain an entry showing the agent's failure to act on instructions from supervisors for extended periods.
Under the former IRS procedure, if the Appeals Officer disagreed with the taxpayer, the taxpayer lost and the matter ended there. There was no recourse to the courts because the statute left it to the sole discretion of the IRS to abate interest.
As part of the Taxpayer Bill of Rights 2 passed in 1996, Congress fixed some of the problems with §6404(e). First, it expanded the situations in which interest should be abated to include IRS delays in performing "managerial acts." Under Proposed Regulation §301.6404-2 issued in January, a "managerial act" is defined as an administrative act that occurs during the processing of a taxpayer's case involving the temporary or permanent loss of records or the exercise of judgment or discretion relating to management of personnel. Thus, for example, a managerial act includes not reassigning the taxpayer's case to another agent while the original agent is sent on an extended IRS training session or is out on extended sick leave.
Second, a new §6404(g) allows certain taxpayers whose net worth is not more than $2 million (if an individual) or $7 million (for all other taxpayers) to petition the United States Tax Court in the event that the IRS rejects an interest abatement request.
The judicial review mechanism applies to all requests for abatement made after July 30, 1996, regardless of the taxable year involved. Thus, the Tax Court has been receiving petitions for interest abatement for over a year. No taxpayer has yet prevailed in those cases, since the taxable years involved in those cases are those in which the taxpayer must show a delay in performing a ministerial act.
The amendment of §6404(e) to allow abatements where there is a delay in performing a managerial act takes effect only for taxable years beginning after July 30, 1996. Returns for those taxable years are only now being filed. It will take several years for those returns to be audited and several more years for sufficient interest on any tax deficiencies on those returns to build up to the point where a taxpayer brings an interest abatement case to the Tax Court. As a result, it may be another four or five years before a body of case law begins to delimit the scope of managerial act abatements.
One shortcoming of the proposed regulations is their failure to deal with the question of how a taxpayer can uncover managerial act delays in the absence of any ability to do discovery of the IRS. Freedom of Information Act requests may help if the goal is to uncover documents, but it is probable that the causes of most delays are not put in writing. Only interviews of agents and supervisors will uncover most delays. It is not clear whether the IRS will be willing to allow taxpayers to speak to agents and supervisors about delays after the audit is concluded.
The Tax Court Rules of Practice and Procedure allow for discovery of parties. It may be that for those taxpayers who can bring an action to Tax Court, the Tax Court rules can be used to depose agents and supervisors.
One partial practical solution to this problem is that when an agent requests an extension of the statute of limitations, the taxpayer condition his signing of the extension on receiving a letter from the agent detailing the reasons why the normal three years allowed for an audit was not enough. Once again, however, it is unclear at this time how the IRS as an institution will respond to such requests.
It is hard to fault the new proposed regulations for their definition of "managerial act". The definition appears consistent with language in the pertinent Congressional Committee Reports. What is really needed, however, is a still broader class of acts which will require interest abatement. There also appears to be no good policy reason for denying access to courts to wealthy taxpayers. The IRS should not be allowed to abuse a taxpayer simply because he or she is wealthy.
For all of the statute's deficiencies, however, practitioners should be aware that there is now at least some practical chance of getting interest abated in future audits. Thus, it will be incumbent on practitioners to track IRS delays during audits in addition to dealing with substantive issues.
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