by Roger Russell

In opting to use arbitrators to resolve contingent liability tax shelter disputes, the Internal Revenue Service is, for the first time, going outside its own walls to resolve tax shelter disputes.

The decision is being hailed by the American Arbitration Association, the nonprofit group that the IRS has commissioned to handle the disputes.

"This is an innovative approach to tax shelter disputes," said S. Pierre Paret, the AAA’s vice president for governmental relations in Washington. "Although disputes where a federal agency is a party present unique issues, the speed and cost-efficiency we expect to see in the resolution of these disputes could make this a model for greater use of binding arbitration by the federal government."

The procedure is in line with the new IRS emphasis on speedier and more efficient dispute resolution. Last June, the IRS began offering fast-track mediation of disputed issues related to examinations and collection actions. In those cases, if both parties agreed to mediation, a specially trained IRS mediator from the Appeals Division would help resolve the dispute, which the taxpayer and the IRS could then agree on.

In resolving the contingent liability tax shelter, however, taxpayers who opt for Fast Track Resolution must accept the ultimate outcome of their dispute as it is resolved through binding arbitration.

A contingent liability shelter involves a transfer of a high basis asset -- one with a basis that approaches its fair market value -- to a corporation controlled by the transferor in exchange for stock and the corp-

oration’s assumption of a liability of the transferor. The transferor then sells the stock at a loss equal to the value of the assumed liability, and the transferor claims the tax benefit associated with the liability.

Paret said that this is the first program that exclusively uses "outside neutrals" at the IRS. "Another program used internal IRS employees as 'neutrals,’ but only two cases went to arbitration in two-and-a-half years," he said. "In terms of a true, external independent outside neutral, this is the first."

In order to prepare the list of candidates for contingent liability cases, the AAA identified persons with relevant experience in tax issues from its national roster who match criteria developed in coordination with the IRS. All candidates will have significant federal tax experience and will be screened by the AAA for initial conflicts of interest, with final screening to be carried out by the IRS.

The AAA’s initial list included 50 names, which the IRS narrowed to 20. "The list includes CPAs, academics and attorneys," said Paret. "They all have specific experience in federal tax issues and have been trained as arbitrators."

The quality of the arbitrators is crucial to the success of the program, according to Paret. Taxpayers who participate in the program will select an arbitrator for their case from the list, with fees and expenses to be split between the IRS and the taxpayers.

"Taxpayers can pick and choose from the list. The IRS requires the taxpayer to choose three and rank them. Then, the IRS will go to the first one and, if there’s a conflict, they’ll go on to the next one. That’s why they ask the taxpayer to rank them, so they don’t have to go back and forth. In most cases, the one the taxpayer ranks first will be chosen, then the IRS conducts a secondary conflict check with the neutral," he said.

"To get on the list, they’ve already checked that he hasn’t participated in the formation of shelters and doesn’t have an interest in any shelter. The secondary check comes about when they know who the actual party is that is proceeding to arbitration, so they can ask, for example, if he owns stock in the particular corporation involved."

Taxpayers involved in contingent liability transactions have until March 5, 2003, to file an application to participate in Fast Track Resolution. If the program is successful, said Paret, it will be because it strikes a balance between the government’s interest and the interest of the taxpayer. "Ideally, it will show advantages to both parties in cost and efficiency."

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