The prospect of forcing the IRS to pay legal fees can be an enticing one. And the qualified offer provides a strategic weapon to do just that. A taxpayer who makes a qualified offer to the IRS and later prevails in court can recover legal fees and other costs from the IRS. How’s that for turning the tables on the IRS?
Under the qualified offer provisions, a taxpayer can recover attorney’s fees, along with administrative and litigation costs, from the IRS if a court determines that the taxpayer’s liability is equal to or less than the liability that the taxpayer would have incurred if the IRS had accepted the taxpayer’s qualified offer. In addition, to recover under the rule, the taxpayer must satisfy the net worth requirement and have properly exhausted their administrative remedies—requirements that are discussed below.
What is a Qualified Offer?
To be classified as a “qualified offer,” the taxpayer’s offer must be written and must: (1) be made during the qualified offer period; (2) specify the amount of the offer; (3) be designated as a qualified offer; and (4) remain open during the required period.
An offer is not a qualified offer unless it is designated, in writing, at the time it is made that it is a qualified offer for purposes of section 7430(g). Moreover, under Treasury Regulations, the offer is not considered to be a qualified offer unless at the time of the offer (or prior to making the offer), the taxpayer has provided the government with the substantiation and legal and factual arguments necessary to allow it to make an informed consideration of the merits of the adjustments at issue. The offer must be made to the proper party required under the regulations. The proper address or office may depend upon the procedural status of the taxpayer’s case. Lack of compliance with these provisions is a common foot-fault that can doom a qualified offer.
To satisfy the requirement that a taxpayer specify the amount, the taxpayer may provide a specific dollar amount or a percentage of the adjustments at issue. The offer should specify the offered amount of the taxpayer’s liability without regard to interest—that is, the offer should be made without regard to interest. Under the rules, interest can only be included in the offer if interest “is a contested issue in the proceeding.”
In cases involving multiple tax years, if adjustments in different tax years arise from separate and distinct issues—such that the resolution of issues in one or more tax years will not affect the taxpayer’s liability in one or more of the other tax years in the proceeding—then a qualified offer can be made for less than all of the tax years involved. A qualified offer, however, must resolve all of the issues for the tax years covered by the offer and also must cover all tax years in the proceeding affected by those issues. A tax year (affected year) is affected by an issue if the treatment of the issue in another tax year involved in the proceeding necessarily affects the treatment of the issue in the affected year.
What is the Qualified Offer Period?
The qualified offer period begins on the date that the IRS informs the taxpayer of a proposed deficiency. This date is generally the date of the first letter of proposed deficiency that allows the taxpayer an opportunity for review in Appeals. The period ends 30 days before the first trial date. The qualified offer period is extended, however, if the taxpayer’s case is removed from the Tax Court’s trial calendar more than thirty days before the court’s calendar call.
The offer, by its written terms, can remain open longer and can also be extended by the taxpayer prior to its expiration. But an extension can’t be used to satisfy the minimum period that an offer must remain open.
How Long must the Qualified Offer Stay Open?
By its terms, a qualified offer must remain open during the period beginning on the date that it is made and ending on the earliest of (i) the date the offer is rejected, (ii) the date the trial begins, or (iii) the 90th day after the date the offer is made. Again, the offer can remain open longer and can also be extended by the taxpayer prior to its expiration.
Who is a “Prevailing Party?”
Generally section 7430 requires that a taxpayer be the “prevailing party” in a proceeding before the taxpayer qualifies for an award of fees and costs against the IRS. And normally, a taxpayer cannot qualify for an award of litigation costs or attorney’s fees if the government establishes that its position in the proceeding was substantially justified.
Under the qualifying offer rules, however, a party is treated as the prevailing party if the court finds that the taxpayer’s liability is equal to or less than what the taxpayer’s liability would have been if the United States had accepted the qualified offer. This rule applies whether or not the IRS’s position is substantially justified.
In addition, a taxpayer must first exhaust administrative remedies and satisfy a net worth and size limitation.
The Tax Code imposes several additional requirements on a taxpayer. Namely, the taxpayer must satisfy a net worth test and size limitation in order to recover costs.
Net Worth Requirement
To qualify for an award of litigation costs and attorney’s fees, an individual taxpayer’s net worth cannot exceed $2 million at the time that the petition at issue was filed. Taxpayers who filed joint returns, however, are subject to a separate $2 million net-worth limitation, although it is evaluated jointly. Thus, if their combined assets are equal to or less than $4 million, they will qualify. For these purposes, net worth is determined using the cost-of-acquisition standard employed under generally accepted accounting principles (GAAP) rather than the fair market value of assets.
An estate or a trust meets the net worth and size limitations if the estate or trust’s net worth does not exceed two million dollars. The net worth of an estate is determined as of the date of the decedent’s death provided the date of death is prior to the date the court proceeding is commenced. The net worth of a trust is determined as of the last day of the last taxable year involved in the proceeding.
A taxpayer that is a partnership, corporation, association, unit of local government, or organization meets the net worth and size limitations if the taxpayer’s net worth does not exceed seven million dollars, and the taxpayer does not have more than 500 employees.
An owner of an unincorporated business is subject to the test applicable to a corporation if the tax at issue relates directly to the business activities of the unincorporated business.
Taxpayers should remain aware that the Tax Court has refused to award costs when the taxpayers failed to provide proof of their net worth.
Exhaustion of Administrative Remedies
The specific steps necessary to exhaust administrative remedies will vary depending on the taxpayer’s specific situation. A taxpayer should consult a qualified tax attorney in order to determine whether administrative remedies have been exhausted or whether the taxpayer may qualify for an exception.
Administrative and Litigation Costs
An award of reasonable administrative and litigation costs under the qualified offer rule includes those costs incurred on or after the date of the last qualified offer and is limited to those costs attributable to the adjustments at issue at the time that the last qualified offer was made that were included in the court’s judgment other than by reason of settlement.
 Under the regulations, all relevant information includes, but is not limited to, the legal and factual arguments supporting the taxpayer’s position on any adjustments raised by the taxpayer after the issuance of the first letter of proposed deficiency which allows the taxpayer an opportunity for administrative review in the Internal Revenue Service Office of Appeals. A taxpayer has disclosed all relevant information if the taxpayer has supplied sufficient information to allow informed consideration of the taxpayer’s tax matter to the extent the information and its relevance were known or should have been known to the taxpayer at the time of the conference.
 The offer should be addressed the United States. Under the regulations, a qualified offer is made to the United States when it is delivered to the office or personnel within the Internal Revenue Service, Office of Appeals, Office of Chief Counsel (including field personnel) or Department of Justice that has jurisdiction over the tax matter at issue in the administrative or court proceeding. If those offices or persons are unknown to the taxpayer making the qualified offer, the taxpayer may deliver the offer to the appropriate office, as follows:
(A) If the taxpayer’s initial pleading in a court proceeding has been answered, the taxpayer may deliver the offer to the office that filed the answer.
(B) If the taxpayer’s petition in the Tax Court has not yet been answered, the taxpayer may deliver the offer to the Office of Chief Counsel, 1111 Constitution Avenue, NW., Washington, DC 20224.
(C) If the taxpayer’s initial pleading in any Federal court, other than the Tax Court, has not yet been answered, the taxpayer may deliver the offer to the Attorney General of the United States, 950 Pennsylvania Ave., NW., Washington, DC 20530-0001. For a suit brought in a United States district court, a copy of the offer should also be delivered to the United States Attorney for the district in which the suit was brought.
(D) In any other situation, the taxpayer may deliver the offer to the office that sent the taxpayer the first letter of proposed deficiency which allows the taxpayer an opportunity for administrative review in the Internal Revenue Service Office of Appeals.
 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. The qualified offer period ends on the date that is thirty days before the date the case is first set for trial.
 Furthermore, to qualify for an award, taxpayers must meet the remaining requirements of section 7430, such as not unreasonably protracting the proceedings.