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ODC Tax Audit Defense And Options

You can fight the IRS.©

(This article originally appeared in SCCCA Magazine)

By: Victor J. Yoo, Attorney at Law
Los Angeles Tax Lawyer with Tax Lawyers Group, APC 
Tel: (310) 788-9820

"Nicer and gentler IRS" has been the recent catch phrase being touted by some mainstream media after the IRS suffered serious public image damage stemming from the congressional hearings in 1998. It may seem that the IRS has been somewhat less vigorous with some of its collection methods, but, make no mistake about it, when the IRS comes knocking....they are not coming to give away money.

With all the proposed public programs being promised to the American public and the "environmental" issues leading the forefront of many of the political campaigns by both the Democratic and Republican presidential candidates, it is clear that the IRS will be used to demonstrate to the public that those who are "deemed" unfriendly to the environmental cause will be penalized. In addition, the traditional use of the IRS to generate revenue will need to be pushed into high gear to fund the various public programs being proposed by the candidates.

The additional source of revenues may not come from higher tax rates. Rather, new types of taxes, enforcement of existing tax rules and more efficient tax collection measures will certainly be implemented by the IRS.

As you already know, many of the members of the SCCA have already been targeted and assessed with the tax from the Ozone Depleting Chemical ("ODC") audit. Also, many of you are being audited now, or will be audited in the future. Whatever your situation may be, there are strategies, plans and information that the taxpayer must understand in dealing with the IRS so that your rights are fully protected and your case is reviewed in the most favorable light.

ODC Audit Process with the Internal Revenue Service

For the taxpayer's practical purpose, the IRS consists of three divisions: i) Criminal Investigation Division, ii) Examination Division (fka Audit Division) and iii) Collection Division.

The Criminal Investigation Division pursues suspected criminal tax law violations. For the most part, taxpayers concerned with ODC audits will be dealing with the Examination and Collection Divisions only.

The Examination Division, (fka the Audit Division) audits filed returns to determine whether additional tax, interest, and civil penalties should be assessed. The Examination Division's revenue agents usually begin an audit by sending the taxpayer a letter that (1) advises of the forthcoming audit; (2)identifies which returns are to be examined; and (3) particular items on the returns that require documentation or further explanation. The ODC audits are usually conducted at the taxpayers' place of business or through the local IRS district office.

The IRS itself is uncertain of how to assess the ODC taxes. It can choose several different methods to determine how much ODC tax should be charged to the taxpayer. Each method of calculation can result in a significantly different amount of taxes being owed. Obviously, the taxpayer would be in a great position if he can prove that no ODC was used in the manufacturing of the imported product.

However, in most instances, the content of ODC in the manufacturing process is difficult to ascertain by the American importer. Laboratory tests can help; but, the taxpayer may not have to be concerned about obtaining these results from the outset of the audit case. Further, it is important to keep in mind that the laboratory test results of the ODC content can vary depending on the laboratory procedures.

Regardless, this is not always a fatal situation because the IRS will have very limited, if any, information with respect to the ODC content of the product. In addition, as the audit process graduates to appeals, tax court or other federal courts, including the bankruptcy arena, the leverage the taxpayer has over the IRS will actually increase.

The 1998 IRS Restructuring and Reform Act shifts the burden of proof to the IRS. If the taxpayer is able to provide credible evidence concerning a factual issue with respect to the liability of the taxpayer, the IRS will have to prove that the taxes are owed as opposed to the taxpayer proving that the taxes are not owed. This may appear to be legal jargon, but it may greatly affect the outcome/success of the taxpayer's case.

Note: Keep in mind that even if your company has been selected for an ODC audit, during the course of the audit, the IRS may decide to review other expense or revenue items in the tax return, thus broadening the scope of the audit.

Some factors that IRS considers (non-exhaustive) in audits:

  • All large, unusual, or questionable items will be considered 
  • Inquiries for unreported income 
  • Comparative size of expense item 
  • Absolute size of an expense item 
  • Inherent character of an item

Some factors a taxpayer should consider for ODC and other audits:

  • Do not talk to the IRS agent; talking will not stop an audit 
    • IRS agent is there with an agenda
  • Do not volunteer any information without having tax practitioner review it
  • Use prudence and discretion
  • Conduct professionally with the IRS agents
  • Keep good record/documentation
  • Do not rely on any representation or advice made by the IRS agents...it may not be enforceable
  • Obtain a tax representative for counseling and to buffer sensitive
  • Information provided to the IRS should be presented in manner most favorable to the taxpayer
  • Obtain documentation/information from the foreign supplier concerning ODC content in advance of the audit or have the supplier write to you stating the lack of the ODC content in their products
  • Know your rights in the audit; audit findings is not the end of the world...you have many remaining options
  • Limit scope of the audit so that other tax periods or items on the particular return are not incorporated into the audit
What to do if the IRS Sends You a tax Bill for $1,000,000.00

  Hopefully, you would have resolved your case favorably at the audit, appeal or tax court stage. However, if you have received any deficiency notices or tax assessments notices which have become final, the following choices are available: 1)establish a monthly installment payment arrangement to payoff the tax liability; 2) submit an "Offer in Compromise" to reduce the total taxes being owed. The taxpayer may be able to reduce the tax liabilities by paying few cents on the dollar. To obtain the best result in compromising the taxes owed, proper documentation and planning can make a drastic difference; 3)certain types of taxes which are considered non-priority taxes can be wiped out in full through a bankruptcy procedure. Depending on the type of the entity and the financial structure of the business, bankruptcy may allow a taxpayer saddled with overwhelming taxes and other debts to either wipe out all taxes in full or substantially reduce total taxes owed to the IRS while continuing to operate the business in the ordinary course.

By: Victor J. Yoo, Attorney at Law 
© Copyright 2000

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