Looking For A Way To Settle An IRS Dispute? Try A Qualified Offer.

Forbes

a day ago

'I love paying attorneys' fees' said no one, ever. Taxpayers who are embroiled in disputes with the IRS are no different. Fighting the IRS is expensive, so much so that many taxpayers with valid cases often decide to concede issues they could win because of the cost. Tax cases move very slowly, often taking years to resolve. With the recent cuts to IRS staff and attorneys, resolution will likely take even longer in the future. A settlement tool known as a 'qualified offer' is one of my favorite tools to jump-start productive settlement discussions in civil disputes. If a taxpayer makes a valid qualified offer that is not accepted, but later receives a decision that is at least as favorable as the qualified offer, then the taxpayer is eligible to recover attorneys' fees from the date of the qualified offer through the end of the dispute. The prospect of recovering attorneys' fees enables taxpayers who otherwise would be unable to afford to battle the IRS to do so. More importantly, though, making a qualified settlement offer is an incredibly effective way to settle a tax dispute quickly. A well timed and carefully crafted qualified offer will often result in immediate productive settlement discussions that can resolve a tax case in months.
WASHINGTON, DC - SEPTEMBER 15: A sign marks the entrance to the U.S. Internal Revenue Service (IRS) ... More headquarters building on September 15, 2024, in Washington, DC. (Photo by J.)
Before IRC §7430, the law establishing the qualified settlement offer procedure, was enacted, the only way to recover attorneys' fees in tax disputes was through the Equal Access to Justice Act. Litigants seeking fees under that law must establish not only that they were successful on the merits, but also that the government's position was not 'substantially justified.' Proving that another side's position was not 'substantially justified' is an incredibly high bar to meet, and often only results in more time and more money spent with no recovery of fees. The qualified offer procedures offer a simple and straightforward alternative way to recover fees that eliminate the requirement to establish lack of substantial justification. Should the IRS have accepted the offer? If the taxpayer ended up with an outcome that is as good or better than the offer, the answer is yes. So long as the offer was valid, the taxpayer is entitled to recover fees.
Qualified Offer Requirements
A qualified settlement offer will only be deemed valid if it meets the strict requirements set forth in the statute. It must:
Timing is Everything
Attorneys' fees accrue from the date of the settlement offer, so taxpayers should consider making the qualified offer as soon as the qualified offer period opens. But there may be reason to hold off on doing so. Submitting a qualified offer often injects new energy into a case, because the IRS has just 90 days to accept it. Getting the IRS to do anything is 90 days is hard, especially making a decision about a complex issue. In some cases, taxpayers are better off waiting to submit the qualified offer until after there has been at least some minimal exchange of information. The government is more likely to accept the qualified offer if the attorney or appeals officer working the case advocates strongly for acceptance, and that is far more likely to happen after they have had a meaningful opportunity to learn the case.
Qualified Offer Period (Exam)
In most cases, when the taxpayer is under examination and the IRS is considering whether additional tax is due, the IRS may issue a letters that allow taxpayers the opportunity to go to the IRS Independent Office of Appeals, known as a 30 day letter. If no 30 day letter is issued, then the IRS may proceed directly to a notice of deficiency, which allows taxpayers to file a petition in Tax Court within 90 days (or 120 days if the taxpayer is residing outside of the United States) to contest the proposed determination. In deficiency cases, the taxpayer can submit a qualified offer upon issuance of a 30 day letter or filing a petition in Tax Court in response to a statutory notice of deficiency, whichever comes first. Treas. Reg. 301.7430-7(c)(7).
Qualified Offer Period (Refund Cases)
Unlike in Tax Court, there is not always a specific letter, like a Notice of Deficiency, that gives taxpayers the right to litigate refund claims in federal District Court or the Court of Federal Claims. Instead, generally, the entire amount in dispute must be paid in full and an administrative refund claim must be filed with the IRS. If six months pass without a response or the IRS denies the claim (whichever comes first), then the taxpayer may file a lawsuit to enforce the refund claim. Often taxpayers file claims for refund that go unanswered for a long period of time. I have cases that involve refund claims where the IRS hasn't responded for over ten years. Although there is no time period by which the IRS is required to respond to administrative refund claims, there certainly should be. Taxpayers deserve - at a minimum - acknowledgement and either acceptance or denial of a refund claim within two years.*
In refund cases, the qualified offer period begins on the date of the notice of claim disallowance. If there has been no notice of claim disallowance in a refund case, the qualified offer period begins on the date on which the answer or other responsive pleading is filed with the court. In other words, if the IRS never responds to a taxpayer's administrative refund claim with a denial and the basis for jurisdiction is based on waiting six months or more from the date the administrative claim was made, the qualified offer period will not open until the Department of Justice answers the complaint or otherwise pleads.
What about Employee Retention Credit Refund Claims?
Given the significant amount of Employee Retention Credit refund claims pending, the possibility of recovering attorneys' fees from the IRS is top of mind for many employers who have had to spend professional fees defending their claims. The regulations applicable to the qualified offer period do not expressly contemplate the unique procedural landscape applicable to many ERC claims.
If the IRS later disallows an ERC claim that had previously been allowed and paid to an employer, the employer will be assessed the tax and receive a notice and demand for payment. Taxpayers who do not receive an ERC refund will either receive a notice of disallowance or nothing at all. Typically the close of an employment tax audit will result in issuance of IRS Letter 950-D or IRS Letter 5376. Both of these letters are considered 30-day letters. See IRM 4.23.22.6. Either of these letters should start the qualified offer period because they are proposed disallowance that give the taxpayer an opportunity for administrative review in Appeals. It is unclear, however, if the IRS considers employment tax credit cases as refund cases. The regulations and the IRM provide some insight, but not a clear answer.
The good news is that the real point of the qualified offer is to settle the case, and a qualified offer that is outside of the qualified offer period may still accomplish that goal. But taxpayers should be carefully advised about the option of renewing a qualified offer at a later date if the first one was made during a time in which it is unclear whether the qualified offer period was open. Doing so has a downside - it will restart the period during which the taxpayer can recover attorneys' fees. But the upside of ensuring that the offer itself is valid may be well worth the risk of losing some fees.
Qualified Offer Benefits
While the hallmark of a qualified offer is to allow recovery of attorneys' fees, in my opinion, the primary benefit of this procedure is not to actually recover attorneys' fees. Rather, the primary benefit of making a qualified offer is to settle the case quickly. Recovery of attorneys' fees is certainly icing on the cake after winning a battle with the IRS. But the better solution for everyone is to avoid spending the time and expense of the battle to begin with.
A qualified offer starts with the taxpayer making a written offer to the IRS or DOJ, following the rules described above. The government has 90 days to respond. If the offer is accepted, then the parties will work together to formalize the settlement. If the government does not respond at all (and yes, this does happen), or rejects the offer, then the offer is deemed rejected. While it is possible for the government to make a counter-offer, I have never seen this happen formally in practice. In my experience I will receive a phone call discussing informally what the attorneys working on the case thought of the offer and suggesting I make a new offer with a different number.
Generally, if for any reason the IRS determines that the qualified offer is invalid, a response will still be issued stating the reason that the offer isn't valid but the IRS will still consider it. The image below is from a letter I received on behalf of a client who made a qualified offer in a case involving a penalty for failure to file an FBAR, or Report of Foreign Bank Account. The IRS took the position that the qualified offer wasn't valid because the FBAR penalty falls under Title 31 of the United States Code and qualified offers only apply to taxes and penalties under Title 26 of the United States Code. There's no harm in trying to settle a case by making a qualified offer that the IRS may say is not valid. First, the case may settle anyway, like in the case where the IRS issued this letter. The settlement was almost exactly the amount that we offered. But just as importantly, just because the IRS takes the position that a qualified offer isn't valid doesn't make it correct. A court will decide that later if the case doesn't settle and the decision favors the taxpayer.
Portion of a response to a qualified offer
I've made many qualified offers on behalf of taxpayers over the years, and in my experience the first thing the government does when they receive the qualified offer is to look for ways to argue that the qualified settlement offer is invalid. For example, a qualified offer that states 'I propose to agree to an additional amount due of $50,000 and not a penny more' will likely prompt a response from the IRS that the offer is invalid. Why? Because it doesn't state that it is made 'without regard to interest,' and an offer of $50,000 and not a penny more would seem to be the maximum a taxpayer is offering, including tax, interest, and any applicable penalties. It is important to expressly state the amount of tax that a taxpayer is offering to settle for, and separately include any applicable penalties. The qualified settlement offers I make on behalf of my clients all expressly state that the offer is made without regard to interest. (The only exception to this rule is when interest is a key issue in dispute in the case).
Just as attorneys who are zealously advocating for their clients will sometimes draw an objection in court, the notion that the IRS may deem a qualified offer invalid shouldn't deter parties from making them if there is an argument to be made that the offer was valid. Especially when the point is to encourage settlement.
Who Can Make a Qualified Offer?
Aside from the requirements listed in IRC §7430(g), there are three limitations on who can make a qualified offer. First, the party seeking to recover fees must have exhausted administrative remedies. IRC §7430(b)(1). That means that if the taxpayer was given the opportunity to go to IRS Appeals but chose not to go, they cannot later recover attorneys' fees. Second, the party seeking to recover fees must not have unreasonably protracted the litigation. IRC §7430(b)(3). Congress doesn't want to reward bad behavior, so filing a lot of nonsense motions and dragging out litigation will disqualify fee recovery. Finally, the party seeking to recover fees must meet the net worth requirements. Treas. Reg. 301.7430-5(g)(2).
After the case is decided, if the decision is at least as favorable to the taxpayer the amount offered, the taxpayer must formally request fees. Once fees are requested, the taxpayer may be required to establish that the net worth requirements are met, that the fees were reasonable, that administrative remedies were exhausted, and that the taxpayer did not unreasonably protract the litigation.
One final note: taxpayers won't recover the full amount of fees at the hourly rate they are paying. There are limitations on the hourly rate that the government will reimburse taxpayers under this procedure.
Suggestions for Reforming Settlement Considerations
Increasing or eliminating the net worth requirements applicable to qualified offers would open the procedure up to more taxpayers, leading to more quick settlements. This would benefit everyone and help alleviate the significant backlog both at IRS Appeals and in Tax Court. And there is something else Congress can do to help resolve cases - allow the government to consider the cost of litigation when evaluating settlement.
Calculating the cost of and time to resolve a tax dispute is difficult at best. So much depends on what the opponent does. Will the IRS file multiple motions that need to be responded to? Will the DOJ want to depose multiple witnesses? Even at the IRS examination level, there will be a large swing in the cost to respond to one or two Information Document Request as opposed to a case where the IRS issues over twenty. Whenever I speak with a new client, I carefully consider the cost to defend the matter and the amount at stake. Is it worth fighting over? This is something that everyone has to think about. If it will cost $200,000 to defend a $200,000 deduction, most people will walk away and decide to concede the issue.** Not because they are not entitled to the $200,000 deduction, but because the cost doesn't justify the reward, especially when considering the opportunity cost of time spent on dealing with the dispute.
Both the economic cost and opportunity cost of litigation is something that every party takes into account - except the government. The Department of Justice settlement manual expressly states that settlement considerations are limited to the hazards of litigation and concerns about collection, with rare exception. And the IRS settlement procedures prohibit IRS Office of Chief Counsel attorneys from even considering a taxpayer's ability to pay tax except in rare circumstances. Yet the IRS can unilaterally drive up the cost taxpayers incurs to defend their positions. No other litigant would ignore the cost of litigation or an opponents' likely ability to pay after a hard-fought battle.
Increasing or eliminating the net worth requirements applicable to qualified offers and requiring the government attorneys to consider the cost of litigation as part of its settlement considerations would significantly benefit both the taxpayers embroiled in litigation with the IRS and the taxpayers at large - because many more cases would settle quickly.