An IRS audit can be a long, painful, and expensive process. What many taxpayers do not know is that, in some cases, taxpayers can force the IRS to pay the legal and administrative costs of dealing with an audit. Back in 1982, Congress enacted section 7430 pursuant to which the IRS will pay the legal and accounting fees incurred in defending an audit if the taxpayer ultimately prevails on a substantial portion of the amount in controversy or as to the most significant issues. However, the relief in section 7430 is limited in several respects. The taxpayer must not only be the “prevailing party” but he or she must also meet the net worth and size limitations, as well as exhaust all administrative remedies. Also, a taxpayer may recover only if the IRS's position was not “substantially justified.”
Earlier this month, the IRS issued final regulations on awarding administrative and litigation costs under section 7430. In these new regulations, the IRS clarified that though the net worth limit is $2 million for an individual ($7 million for a partnership or corporation), in the case of joint returns, the net worth limitation is combined for the two individuals and therefore increases to $4 million for a married couple, regardless of how their assets are apportioned.
The new regulations also clarify when the IRS takes a “position” that may be unjustified. The regulations clarify that a position is taken by the IRS either at the time it issues a notice of deficiency or a notice of decision from the Office of Appeals. Therefore, the decisions of the initial tax auditor are not a “position” under section 7430. Also, if IRS Appeals concedes the issue, section 7430 relief is not available because technically the IRS had yet to take a “position” that was not substantially justified. However, if the position taken by the IRS at or after Appeals review is not substantially justified, the taxpayer can go back and recover all costs incurred from the date of the 30-day letter (the letter giving the taxpayer the right to contest the determination with IRS Appeals).
Finally, the regulations clarify how and when to seek relief. The taxpayer must file an application for administrative costs within 90 days after the IRS mails the taxpayer a final decision determining tax, interest, or penalty. If the IRS decides not to award administrative costs, the taxpayer has 90 days from the date the IRS mails the adverse decision to petition the Tax Court to review that decision. The new regulations apply to all costs incurred for services performed in cases for which a petition for costs is filed on or after March 1, 2016.