Strategies for Dealing with the IRS: The IRS Examination
This video is the first in a four-part series on Jones Day's approach to dealing with the IRS. In it, partner Chuck Hodges discusses stage one - planning for and handling the IRS examination. He emphasizes the importance of considering how the IRS may challenge the tax implications of transactions before they occur to mitigate potential audit Issues. He also describes Kovel agreements between lawyers and third-party consultants to protect attorney-client privilege and attorney work product immunity.
Watch other videos in our Strategies for Dealing with the IRS series.
Read the full transcript below:
Chuck Hodges:
The Jones Day approach in dealing with the IRS is a four stage process. And I like to refer to it as the four acts of a play. And the first act of the play is examination. And that's what I like to refer to as the fact-finding mission by the IRS. When you're dealing with the IRS from an exam standpoint, what I try to emphasize to people is you don't wait until the IRS is knocking on your door before you actually think about an IRS audit. Instead, while you're going through your planning stages, you've got a transaction going on. You need to be thinking about, "If this gets questioned, if my business purpose gets questioned or the deductibility of an expense I'm taking, what am I doing right now during the transaction to help my case, if and when the IRS ever questions it?"
Chuck Hodges:
Because when you're dealing with the IRS at the examination level, they have to look at things, not at the hazards of litigation of an issue. They have to instead look at it as to whether or not they believe based upon their analysis, is the taxpayer right or is the IRS right? During the exam, I think one of the most important things is who is the face of the taxpayer with the IRS? The Internal Revenue Code allows you to have a representative represent you before the IRS. And so why not have a representative that is trained in dealing with the IRS, that speaks the IRS language, attending the meetings, writing the letters to the IRS, because that way there can be more of a strategy over what the IRS is looking into and the things that you want to prepare for. Because I will tell you, the IRS has a lot of power and their power is in their summons authority, and they are able to analyze any books, papers, records, or other data, which is very broad.
Chuck Hodges:
When you do actually get some form of summons or any type of information request from the IRS, you do not have to create a document to respond to an information and document request. Instead, it can just be the documents that were contemporaneous. Your general ledgers, your trial balances, your records, not anything that you have to create like a spreadsheet for the IRS, where a mistake could be made and when that mistake is made, and then all of a sudden it becomes an admission against you. But then of course at the end of the exam, you may just simply be unagreed. At the end of an unagreed case, the IRS is going to issue what's called a Revenue Agent's Report and that Revenue Agent's Report is going to have a very important caption in there. Taxpayer's position. You want to ask for a draft of the report because you want to see has your position been captured in there. So once you've decided that you're unagreed, still try to make sure that the final work product from IRS exam has your position in it.
Chuck Hodges:
And then I would say for my last tip when it comes to the exam, and this is dealing with the IRS in general. The one thing that we all understand, lawyers know how to read and interpret law. We don't, and we generally shouldn't try to be accountants. We shouldn't try to do anything beyond what we do. But guess what? To do our job, we need other experts. When I'm handling an IRS tax case, I need an accountant to show me the analysis of the tax return and the computations. But a question arises, "Chuck, if you're emailing with that accountant or this economist outside, how is this protected under a privilege?" Because there's only the attorney client privilege. There is a narrow 75/25 privilege for accountants, but that's kind of narrowly construed. So how do I get the accountant as well as the economists and others to fall under my privilege? And there is a great case by the name of US v. Kovel.
Chuck Hodges:
So therefore a lot of times people refer to it as the Kovel Doctrine, and then a Kovel agreement. And what that agreement that we ask people to execute is an agreement between myself, the taxpayer, and then this third party consultant I need, whether it be an economist, whether it be an accounting firm or whatever. I've hired real estate agents, I've hired appraisers and we all signed the agreement that basically says that I'm going to tell the appraiser, the accountant, the real estate agent, I'm going to give them their job responsibilities and they are going to produce a work product from there. But because they're doing it to help me do my job as a lawyer, then that's going to fall under my privilege and it's going to fall under my work product. So then if and when my adversary, there being the IRS, but this is not just about the IRS, but when my adversary says they want to see those records, I can then say there's privilege. That is a very important thing that needs to be considered from the very beginning when more than just an attorney is going to be involved in the exam.
