Settlement Reference Manual For Exhibit Links

I. INTRODUCTION

Civil tax controversies in the courts are either resolved by settlement or by judicial decision. Litigation and settlement are twin aspects of the Tax Division's role in tax policy and tax administration. This reference manual focuses generally on questions concerning resolution by settlement, a term which includes both compromises and outright concessions, as well as alternative dispute resolution.

In settlement, as in every aspect of civil litigation handled by the Tax Division, it is the Trial Attorney who has the laboring oar. The Trial Attorney has the primary responsibility on an ongoing basis of evaluating the litigation potential (and, thus, the settlement potential) of a case. It is the Trial Attorney who negotiates a compromise, prepares the written justification therefor, and, in the subsequent correspondence and implementation of a settlement, assures that the Government gets all that it bargained for and gives away no more.

While there are some cases that should be litigated rather than settled and others that, ideally, should be settled but that, for one reason or another, cannot be, the Division settles many cases in whole or in part. Compromises result when the terms negotiated are both just and in the Government's best interests. And, to the extent that the Government's position is clearly wrong, an issue or a case should be conceded.

Generally, settlement is most readily achieved in refund cases (where the Government already has the money, and the taxpayer wants it back). Refund cases involving counterclaims are the next easiest to settle--typically, the taxpayer is at least represented by counsel, and has taken the initiative to pay for the institution of litigation. On institution of every refund suit, the taxpayer is sent a sheet setting out general information concerning the settlement of such suits.

Clearly, settlement becomes more difficult to the extent that collection is involved, since in many of these cases the Service has tried and failed to collect administratively. Suits to reduce assessments to judgment, fraudulent conveyance actions, etc., are substantially more difficult to settle. Bankruptcy cases are so varied that no general estimate can be made about the degree of difficulty in settlement; specific problems with respect to bankruptcy are discussed subsequently.

This reference manual first addresses the delegation of settlement authority in tax cases (Part II),⁽¹⁾ and goes on to address the settlement process (Part III), peripheral matters in refund cases (offset, double allowances--mitigation of limitations, and equitable recoupment) (Part IV), collectibility settlements (Part V), and alternative dispute resolution (Part VI).

Except to the extent that binding authority is referenced (e.g., in Part II, with respect to settlement authority), the discussion and suggested procedures in this reference manual reflect internal guidelines only and do not bind the Tax Division.

II. SETTLEMENT AUTHORITY

The Attorney General has broad and plenary settlement authority as to any matter referred to the Department of Justice, whether for prosecution or defense. Section 5 of Executive Order 6166, June 10, 1933;⁽²⁾ 38 Op. Att'y Gen. 98 (1934).⁽³⁾

The Attorney General's settlement authority is redelegated on terms set forth in the Code of Federal Regulations. Pursuant to 28 C.F.R. § 0.161, the Deputy Attorney General is authorized to exercise the settlement authority of the Attorney General as to all claims on behalf of, and all claims against, the United States. By order dated October 19, 1992, the Attorney General has directed that the Associate Attorney General, with respect to matters in the Tax Division, should exercise the authority and perform the functions of the Deputy Attorney General under 28 C.F.R. § 0.161. Accordingly, all settlements which do not fall within the authority delegated to the Assistant Attorney General of the Tax Division are referred to the Associate Attorney General.

The Attorney General has delegated the following settlement authority to the Assistant Attorney General (28 C.F.R. §§ 0.160, 0.162, 0.164):

The Assistant Attorney General has redelegated settlement authority in Tax Division Directive No. 105.

Pursuant to § 6405 of the Internal Revenue Code, refunds or credits in excess of $1,000,000 with respect to specified taxes must be reported by the Secretary of the Treasury to the Joint Committee on Taxation. Since the 1930s there has been agreement among the Department of Justice, the Department of the Treasury and the Joint Committee on Taxation that refunds or credits in Justice Department cases, in excess of the amount specified in § 6405, will be reported to the Joint Committee.

The refunds or credits which must be reported to the Joint Committee are those relating to --

Refunds or credits of other excise taxes, employment taxes, and liabilities imposed under § 6672 need not be submitted to the Joint Committee.

Refunds or credits allowed pursuant to § 6411 (tentative allowances) are not referred by the Internal Revenue Service to the Joint Committee at the time of allowance. However, in any such case, to the extent that such an allowance (reduced by deficiencies subsequently determined) exceeds $1,000,000, the refund or credit must be submitted to the Joint Committee. This situation arises, for example, in bankruptcy cases.

For further discussion of settlements requiring reference to the Joint Committee, see Chapter J, infra, re conditions and limitations on redelegations of authority, and Chapter K, infra, concerning determination of the jurisdictional amount.

Although § 6405 provides only that no refund or credit shall be made until after the expiration of 30 days from the date a report is submitted to the Joint Committee, the Department will not authorize an overpayment until the Joint Committee has advised whether it has any adverse criticism to the settlement.

All settlements requiring reference to the Joint Committee on Taxation must be approved by the Assistant Attorney General.

The Assistant Attorney General has redelegated authority to the Chiefs of the Civil Trial Sections and the Court of Federal Claims Section, who are authorized, provided that such action is not opposed by the Internal Revenue Service, to:

The Chiefs of the Civil Trial Sections and the Court of Federal Claims Section are authorized on a case-by-case basis to redelegate in writing to their respective Assistant Section Chiefs or Reviewers the authority delegated to them to reject offers, to accept offers in compromise in which the amount of the Government's concession, exclusive of statutory interest, does not exceed $100,000, and to approve concessions not exceeding $100,000, exclusive of statutory interest, provided that such redelegation is not made to the attorney of record in the case. The redelegations pursuant to this section shall be by memorandum signed by the Section Chief, which shall be placed in the Department of Justice file for the applicable case. A sample form of such a memorandum is set out in the Appendix as Exhibit B.

The Chief of the Appellate Section is authorized, provided that such action is not opposed by the Internal Revenue Service, or by the chief of the section in which the case originated, to:

In any Supreme Court case, the final action on an offer in compromise must have the approval of the Solicitor General. In any case in which the Solicitor General has authorized an appeal to any other court, a compromise offer, or any other action which would terminate the appeal, may be accepted or acted upon only upon advice from the Solicitor General that the principles of law involved do not require appellate review in that case. 28 C.F.R. § 0.163.

The Chief of the Office of Review is authorized, provided that such action is not opposed by the Internal Revenue Service, or the chief of the section to which the case is assigned, to:

The Deputy Assistant Attorneys General are authorized, provided that such action is not opposed by the Internal Revenue Service, to:

With respect to judgments which have been formally referred to the United States Attorney for collection, and provided that such action has the concurrence in writing of the Internal Revenue Service, United States Attorneys are authorized to:

Additionally, United States Attorneys are authorized to release the right of redemption of the United States in respect of tax liens, arising under 28 U.S.C. § 2410(c) or under state law, when the United States has been joined as a party to a suit, provided that:

The settlement authority is subject to these conditions and limitations.

First, when, for any reason, the compromise or concession of a particular claim, as a practical matter, will control or adversely influence the disposition of other claims totaling more than the respective amounts designated, the case shall be forwarded for review at the appropriate level for the cumulative amount of the affected claims.

Second, when, because of the importance of a question of law or policy presented, the position taken by the Internal Revenue Service or by the United States Attorney involved, or any other considerations, the person otherwise authorized to take final action is of the opinion that the proposed disposition should be reviewed at a higher level, the case shall be forwarded for such review.

Third, if the Tax Division has previously submitted a case to the Joint Committee on Taxation leaving one or more issues unresolved, any subsequent compromise or concession in that case must be submitted to the Joint Committee, whether or not the subsequent overpayment exceeds the amount specified in § 6405 of the Internal Revenue Code.

Except for the conditions and limitations on settlement authority just discussed, that authority is entirely dependent on the amount that the Government concedes, whether by compromise or concession. For purposes of determining settlement authority, whether or not the settlement has been achieved as the result of alternative dispute resolution is irrelevant.

Clearly, concession of any part of principal (generally tax and/or penalties) of a claim on behalf of or against the Government is taken into account in determining jurisdictional limits. The only exception to this rule is when the settlement relates only to a specific fund, for example, in an interpleader, and the total amount of the fund is less than the Government's claim.

For purposes of determining who has the authority to act on an offer or proposed concession, unpaid interest on a Government claim, whether or not assessed, is not taken into account.

Generally, in a refund context, interest paid by a taxpayer which will constitute an overpayment under the settlement or concession is taken into account, but statutory interest to be paid on the amount of the overpayment is not taken into account. On the other hand, where a settlement or concession of a claim against the Government relates solely to statutory interest, the amount of statutory interest foregone by the United States is the jurisdictional amount which determines who has authority to act on the claim.

Penalties, whether on a Government claim (whether accrued or assessed) or on a claim against the Government, are always taken into account in determining the jurisdictional amount.

Penalty and interest paid can add up to a very substantial portion of a claim, so that one must really look at the figures when deciding where settlement authority lies. By way of illustration, assume a settlement offer in a valuation case which calls for a refund of tax ($55,000), plus appropriate interest which has been paid ($57,000), plus concession in toto of the § 6659 penalty ($98,000), plus interest paid with respect thereto ($101,000), plus statutory interest. The total refund proposed is thus $311,000, requiring reference to the Office of Review.

Where both refunds and counterclaims (or deficiencies) are involved, add together the amount of the concession as to both claims by and against the Government in order to determine the jurisdictional amount. For example, assume a $500,000 refund claim which is being settled by a refund of $50,000 and concession of a $300,000 counterclaim. The amount of the Government concession is $350,000.

At the commencement of litigation, cases are classified by the Internal Revenue Service as either "standard" or "settlement option" ("SOP"). "Settlement option" cases generally involve factual issues or nonrecurring legal issues.

The classification as "standard" or "SOP" appears either in the defense letter (in defensive litigation) or in the letter from the Internal Revenue Service authorizing institution of the suit. If the letter from District Counsel in general litigation cases involving less than $200,000 fails to classify the case, the Tax Division may assume that the case is classified SOP.⁽⁴⁾ After development of a case, the Trial Attorney may find that the case does not warrant "standard" classification; in that event the Trial Attorney may want to ask the Service whether it would reclassify the case as "SOP".

It is unnecessary to obtain the recommendation of the Service in "settlement option" cases which are compromised. This is so, even though the case requires reference to the Joint Committee on Taxation. However, in cases where full concession of an issue or a case is proposed, the recommendation of the Service must be obtained (except in cases involving liability under § 6672 of the Code).

Pursuant to Section 5 of Executive Order 6166, June 10, 1933, and § 7122 of the Internal Revenue Code, the Department of Justice has exclusive settlement authority as to defense of any tax claim against the Government and prosecution of any tax claim on behalf of the Government. The tax liability for each year or other period constitutes a separate cause of action. Commissioner v. Sunnen, 333 U.S. 591 (1948). Accordingly, the Internal Revenue Service no longer has jurisdiction with respect to a tax liability which is the subject of litigation in a court other than the Tax Court (except to the extent set forth with respect to bankruptcy cases, below).

After a judgment is obtained on a Government claim, e.g., a counterclaim in a refund suit, or a suit to reduce an assessment to judgment, the Department retains all settlement authority. The assistance and efforts of the Internal Revenue Service are, of course, essential in obtaining information re collection potential and collection itself. Nonetheless, without the knowledge and consent of the Trial Attorney the Internal Revenue Service should not, for example, send notices of intent to levy and/or enter into negotiations to settle a judgment until formal reference of the matter back to the Internal Revenue Service for collection. Even after such formal reference a compromise of the judgment must be referred to the Tax Division for approval.

In bankruptcy cases, the Internal Revenue Service has jurisdiction to settle, compromise or reduce the proof of claim under certain limited circumstances. 5 Administration, CCH Internal Revenue Manual, Ex. 8(15)00-1 at 26,260.

Reductions of proofs of claim based on criteria ordinarily used by revenue agents or revenue officers in resolving cases (for example, a concession where there is no doubt that the tax is not due, or one based on acceptance of substantiation) may be agreed to by the Internal Revenue Service whether or not an objection has been filed. After an objection has been filed, however, the Internal Revenue Service may enter into negotiations with respect to a settlement based on criteria ordinarily used by revenue agents or revenue officers in resolving cases only if the debtor or trustee agrees to an extension so that the matter will, in any event, not be brought on for hearing earlier than 30 days after termination of negotiations.

The Internal Revenue Service has exclusive jurisdiction to settle or concede a claim based on litigating hazards after the petition in bankruptcy is filed as long as no objection has been filed and the Service obtains a closing agreement with respect to settlement which binds both the debtor and the trustee. (In a no-asset case, the agreement of the trustee is not necessary.)

The Internal Revenue Service may not enter into compromises or concessions based in any part upon litigating hazards, or considerations such as choosing the proper litigating vehicle, after an objection to a proof of claim is filed.

III. THE SETTLEMENT PROCESS

The most fundamental tenet of Tax Division settlement policy is that we will concede a position that is erroneous, but compromise is justified only by litigation hazards and collectibility concerns.

The courts are the apex of the controversy resolution structure within the Internal Revenue Service, which is very much geared to settlement if at all possible. Thus, settlement is a primary function of the Appeals Offices, and Appeals settles close to 90% of the cases it considers.

The Tax Division does not settle cases based on nuisance value. For it to do so would undercut totally the efficacy of the settlement structure within the Internal Revenue Service. On the other hand, the Division endeavors to litigate when it is appropriate, to concede when it is appropriate, and also to compromise (when it is appropriate) on terms which are just and in the Government's best interests.

From the outset of a case, the question of litigation or settlement should be considered. Bear in mind that the easiest (but not necessarily the most advantageous) course of action is to settle the strongest cases and litigate the weak cases. It is the easiest course of action because taxpayers' counsel will want to settle their weak cases. Unfortunately, settlement of a case where the Government is strong and litigation where it is weak may not contribute to the orderly and rational development of the tax law. Moreover, it is undoubtedly true that hard cases make bad law. Accordingly, both in evaluating the litigation and settlement posture, equities (as well as precedent) must be taken into account, and, if the case is to be litigated, all equities should be developed carefully to show that the Government's position is reasonable.

In weighing litigation versus settlement, it is vital to take into account the case as a whole. Assume, for example, that a case raises a multitude of issues so that, were taxpayer to prevail on all, its tax liability would be reduced by a million dollars, but because of § 6511(b)(2) limitations its ultimate recovery is restricted to $100,000. If the taxpayer agrees that its ultimate recovery is limited to $100,000, settlement may well be appropriate at or approaching that figure. If the taxpayer does not agree that § 6511(b)(2) restricts its recovery, then summary judgment is appropriate to resolve the jurisdictional issue.

The weighing of litigation versus settlement should be a continuing process, as the Trial Attorney's knowledge increases and there are new developments which should be taken into account. In this connection, the Trial Attorney should also consider as the litigation progresses whether the alternative dispute resolution ("ADR") procedures addressed in Part VI are appropriate in a particular case.

The basic principles applicable to litigation are equally applicable to settlement. Good preparation is the key to both. Indeed, the surest way to obtain a good settlement is to do a good job of preparing the case for trial. Considering the work load of the revenue agents, there is virtually no way that an audit could produce all the admissible evidence necessary for a successful trial of a factual issue, such as valuation.

In settlement, as in litigation, it is very important to communicate with the Internal Revenue Service--and this includes not only the attorneys at the Service who prepare defense letters, requests to bring suit, and recommendations re settlement, but also the people who actually worked the cases (or related cases) such as revenue agents, special agents, engineering agents, international examiners, and Special Procedures and Service Center personnel. Often, by talking with these people, the Trial Attorney can obtain information which is not in the files. Moreover, talking with Service personnel is particularly important in cases involving continuing issues--issues which arise not only in the year in suit, but also in subsequent years. Such cases are more difficult (although not impossible) to settle.

Always talk with someone at the Service whose position you disagree with, or do not understand, before launching an offensive in writing. Disagreements re settlements can provoke hard feelings which impede working together harmoniously in the future, and one must negotiate heartfelt cooperation just as one must negotiate a settlement offer.

If it is believed that the Government's case lacks any merit whatsoever, the case should be conceded. Normally, the Service will recommend concession in such a case in its defense letter; however, in cases where it has not done so, the Trial Attorney may subsequently develop facts or law that justify concession. If the Trial Attorney believes that the Government's position is erroneous, the attorney should consult with a supervisor and possibly direct a letter to the Internal Revenue Service requesting it to reconsider the matter. The same procedure should be followed if the Service recommends concession but the Trial Attorney believes that defense is merited. In this connection, bear in mind that it is very dangerous and unproductive to litigate a legal issue contrary to the views of the Internal Revenue Service; the Service can resolve the matter by issuing a revenue ruling which will effectively require concession of the case. If a Trial Attorney litigates and wins an issue over the opposition of the Internal Revenue Service, there is a very great likelihood that the Government will confess error. Accordingly, if the Trial Attorney disagrees with the Service's recommendation for concession, it is necessary to convince the Service that important facts or legal arguments or other considerations were not previously called to their attention, and that defense is appropriate.

In any case involving a counterclaim, just as in any collection matter, collectibility is likely to be a prime consideration. Even though the case may be a strong one for the Government on the merits, one does not want to expend substantial resources to obtain an uncollectible judgment. Accordingly, preliminary steps should always be taken whenever a collection suit or counterclaim is filed. These include:

(a) Contact Special Procedures and actually talk with the people involved to find out what they have done in the past, what they are doing now, and what they believe the collection potential to be. Almost certainly, one will want to be assured that notices of federal tax liens have been filed or refiled in each appropriate location.

(b) As a rough indication of what the taxpayer's financial position may be, ask the Service (or, if necessary, the taxpayer) for copies of income tax returns, beginning with the period in litigation and going up to the present, or some shorter period. If tax returns are not available, ask the Service for transcripts of account for the same period. Matters to consider are not only assets held at the time of litigation, but sources of income which were reflected on earlier returns but disappear on later returns, indicating possible transfers without consideration. And, in this connection, follow up and obtain copies of the income tax returns filed annually, as the suit progresses.

To the extent that it becomes apparent that collectibility will be a major problem, and that the potential for substantial collection is slight, it is more efficient to negotiate a collectibility settlement than to do a lot of work to obtain a judgment which proves uncollectible.

In refund cases, questions which frequently come up in the context of settlement involve offsets, duplicate allowances in other years or with respect to other taxpayers, and equitable recoupment. These are issues which, ideally, should be addressed, and recognized, at the time that the defense letter and administrative files are received.

It may be that the defense letter suggests offsets which should be asserted. One's own analysis of the administrative files may uncover additional offset issues. For example, nonbinding settlements may have been made administratively as to which the taxpayer has now reneged. That is, the revenue agent may have proposed adjustments which were ultimately not made, in a situation where no Form 870-AD (or other Appeals Office agreement) was executed. In this situation, the adjustments previously given up by the Government (if meritorious) should now be asserted.

Additionally, the Trial Attorney should normally talk with the revenue agent about the case; everything that the agent knows may not have been put in writing. For example, there may have been issues raised in subsequent years which (but for limitations) could and would have been raised for the suit years; these, also, could be made the subject of offsets. Bear in mind, however, that it is inappropriate to embark on a general fishing expedition in search of offsets. Most generally, offsets are an adjustment correlative to the taxpayer's prevailing on its claim, or issues ascertained on looking at the return and administrative files, or based on conversations with people at the Service familiar with the case. Offsets are discussed in greater detail in Part IV, Chapter A.

To the extent that a case involves the proper year for allowance of a deduction or inclusion of an amount in income, the Trial Attorney must be aware that resolution of the litigation will likely have consequences in another year. This is relevant in determining how much money is really involved in the litigation, which affects the prospects for settlement.

Similarly, cases may involve questions affecting related taxpayers--for example, whether income is taxable to a trust or its beneficiaries.

In such cases, an important consideration that must be borne in mind in considering settlement is the ambit of the mitigation of limitations provisions, §§ 1311-1314 of the Internal Revenue Code, discussed at Part IV, Chapter B. To fail to do so may result in double allowances in the suit year and the non-suit year, or a double exclusion of the same amounts from income of the trust and its beneficiaries.

In our defensive litigation, equitable recoupment technically involves a situation where the taxpayer is suing for a refund with respect to one kind of tax, and, if the taxpayer were to prevail, there would be an adjustment favorable to the Government with respect to another kind of tax, but the period of limitations has expired with respect to asserting a deficiency. Particularly in the estate tax/income tax area, discussed infra at 50-55, the Trial Attorney should be alert to the possibility of pleading equitable recoupment as an affirmative defense.

Importantly, where an adjustment favorable to the taxpayer in the refund suit should (barring limitations) produce a corresponding adjustment in the Government's favor, the very best defense of all is to ascertain, as early as possible and, ideally, no later than when the answer is filed, whether the period of limitations has expired with respect to the correlative adjustment as to another tax or another taxpayer. The earlier such questions can be resolved, the more likely it is that the period of limitations will still be open (whether for assessment, or because there is another claim for refund pending by the taxpayer which could be offset by a correlative adjustment).

Equitable recoupment is discussed in greater detail in Part IV, Chapter C.

In cases involving the question whether workers are employees or independent contractors, there are several considerations to take into account.

1. The first issue to be considered in all these cases is the applicability of § 530 of the Revenue Act of 1978, Pub. L. No. 95-600, 92 Stat. 2885 (reprinted at 26 U.S.C. § 3401 note). This relief provision was enacted by the 1978 Act as a temporary measure, and subsequently made permanent even though not part of the Internal Revenue Code.

Section 530 was the result of what the industry lobbyists and the Congress viewed as overaggressive audit and assessment activity by the Service. To litigate and lose employment tax cases can only serve to perpetuate the stereotype. Accordingly, these cases are among the most important cases that a Tax Division attorney will be handling, and it is very important to evaluate accurately the litigation hazards, as well as the settlement potential.

If § 530 provides relief (and Congress, in enacting this provision, intended to provide relief where the taxpayer had "any reasonable basis" (liberally construed) to treat workers as nonemployees), one will never get to litigate the employee- independent contractor issue.

2. In determining the amount involved, check to determine whether the Service has correctly applied § 3509. There have been instances where it has failed to do so, resulting in the necessity for partial concession.

3. If employee-independent contractor is a continuing issue, it is difficult to settle without obtaining future compliance. However, such compliance is a very valuable concession which the taxpayer can make without present out-of-pocket cost. In a future compliance settlement, it is important for the owners of the business to agree that, even if the form of business changes, the workers will still be treated as employees in the future.

Effective negotiation is a skill, just like effective cross-examination or any other litigation skill. Effective negotiation also requires preparation--one must think about and prepare for informal settlement discussions or a formal settlement conference just as one prepares for a hearing. Effective negotiation also requires that one must listen to what one's opponent has to say, and imagine oneself in that opponent's place.

Negotiation is not confined to a settlement context. It is involved in negotiating a stipulation of fact, in preparing a joint submission to the court, and in many other aspects of litigation and life.

Accordingly, the possibility of negotiating a settlement, and what the Trial Attorney would want with respect to settlement (or whether any settlement would be desirable or feasible), is something which should be borne in mind from the time the suit authorization letter or the defense letter is received. Of course, as the case is developed factually and legally, perception of the feasibility or appropriate basis for settlement will change, as perception of litigation hazard and the best course of action for prosecuting or defending the case will change. Similarly, the Trial Attorney should consider and revisit the question of the value of using ADR procedures and which ADR procedures may be most appropriate in a particular case throughout the litigation process.

A Trial Attorney does not have settlement authority, and this must be made very clear to opposing counsel during settlement discussions or conferences. Consequently, it is a good idea for a Trial Attorney to discuss settlement potential and problems with the Section Chief before the negotiations are commenced. Bear in mind, however, that these discussions may not cover all aspects of the facts and law, and that a Section Chief may later raise questions or objections which were not perceived until the settlement memorandum was submitted.

It is advisable, particularly in complex cases, to write a memorandum to the file (however brief and informal) concerning settlement negotiations. This will assist in refreshing the Trial Attorney's recollection concerning the course of the negotiations. Moreover, when a case is reassigned (as, for example, on the departure of an attorney), it is exceedingly useful to have a record of what settlement discussions were held, and what they were.

In every refund suit, the taxpayer wants the money as soon as possible, and may request or require a commitment as to the time necessary to process the settlement. Of course, the Trial Attorney should endeavor to write up a negotiated settlement promptly (it takes much less time to write up a settlement if it is done sooner rather than later). However, the Trial Attorney must be careful not to promise more than he or she can do. Moreover, it is essential that the Trial Attorney check with the Service, the Trial Section Chief, and (in a case which requires reference to that Office) the Chief of the Office of Review, before making any commitments as to the time necessary for processing a settlement.

With local rules pushing early settlement conference and the 1993 amendments to the Federal Rules of Civil Procedure (in particular, Rule 16 and Rule 26) requiring the exchange of "core information" and accelerating the time for pretrial conferences, settlement discussions frequently occur early in our cases.

Pursuant to Executive Order 12778 on Civil Justice Reform, and the policy of the Tax Division, as soon as adequate information is available to permit an accurate evaluation of the litigating hazards, the Trial Attorney should offer to discuss settlement with the opposing side. And, in courts where we know settlement conferences occur quickly, the Trial Attorney should make every effort to be ready for meaningful settlement discussions.

There is an obvious tension here. While early settlement discussions are encouraged to avoid unnecessary and costly discovery for both sides, the Trial Attorney can participate meaningfully in settlement discussions only after he or she has undertaken sufficient research and discovery so that the strength of the Government's case can be determined. If trial counsel does not have the necessary information to evaluate the case, settlement discussions will be premature and unproductive.

When settlement discussions get down to concrete figures and other terms, typically opposing counsel suggests a basis for settlement, and the Trial Attorney will respond, advising whether he or she will recommend the settlement proposed, or suggesting some other basis for settlement. The very term "negotiation" suggests some give and take. However, there will be instances where the Trial Attorney (or Assistant Chief or Section Chief) will say that he or she will recommend a settlement of x amount and will not budge one dollar from that figure.

The formulae for possible settlement cover as broad a range as tax matters generally, and the appropriate formula will depend on the case, and the needs of the parties.

Compromise of a § 6672 case based on litigation hazards will obviously depend on the litigation hazards for each quarter. If there is more than one responsible person involved, it is clearly preferable to settle as to all--unfortunately, this is not always possible. As an addendum, in negotiating settlement of these cases, it is always well to bear in mind that substantial interest may have accrued, even though the principal amount of the § 6672 liability remaining is relatively small.

In any multi-issue settlement of tax issues (other than the very small, factual case), it is generally advisable to begin with putting each issue on the table, and knowing how much is involved as to each. A good starting point is the notice of deficiency, or the RAR statement of audit changes. Generally, in an issue settlement, either issues are traded, or one party concedes one or more issues and other issues are settled on a percentage basis. Bear in mind that if there are two issues in a case, and one issue involves $5,000 and the second $100,000, it is not considered as a 50-50 settlement if it is proposed that the taxpayer concede the first issue and the Government the second. Neither is it regarded as a 50-50 settlement where on the first issue (which the taxpayer offers to concede) the Government is supported by the Tax Court and three courts of appeals, while on the second issue which it is proposed the Government concede there is no case directly in point and two conflicting lines of authority.

A settlement may be based on an offer to accept a refund of a flat amount, plus interest. Thus, in a suit for refund involving possibly $5,000, an offer may be submitted to accept a refund of $2,000, plus interest. These settlements are particularly appropriate to the relatively small case involving several issues where the effort and delay in preparing a computation may not be justified. However, this type of settlement is appropriate only if both parties have a pretty good idea of the amount involved, or the amount involved on each issue. Otherwise a recomputation may well be necessary in order to evaluate the concessions being made in a settlement calling for a refund of a flat amount.

In any case where the settlement is based on collectibility, it is imperative to have the necessary financial information before the Trial Attorney can, in any sense, "negotiate." In such cases, the most feasible course of action is to invite the taxpayer to submit the necessary information and to make the best offer possible. The information submitted can then be verified by the Service to the extent appropriate. Typically, such information would consist of (1) a completed Statement of Financial Condition & Other Information (DJ-TD 433 (1996) (Ex. C)⁽⁵⁾ and (2) copies of income tax returns for the prior five years. See Part V, infra, where collectibility settlements are discussed in depth.

The simplest settlement to structure is one where the Service has made a deficiency assessment (based solely on the issue in litigation) and the refund suit only involves this assessment and no other years or parties are involved. Bear in mind, however, that a percentage compromise of a deficiency assessment is to be avoided where the assessment comprehended more than one issue, but only one is being litigated.

Where the disputed liability is substantial or the taxpayer is in a trade or business, a settlement based on income adjustments is the norm. Inter alia, an issue settlement obviates problems which might arise in determining the consequences of loss or credit carrybacks to or through the years in litigation.

An issue settlement is always necessary if the issue(s) in suit have consequences in or occur in subsequent years, or affect other taxes or other taxpayers. For example, if the issue is capital expenditure or ordinary expense, have capital loss carrybacks or carryovers been allowed? Have depreciation deductions been allowed in subsequent years? Are deductions being allowed by settlement which increase alternative minimum tax liability? What are the consequences of allowance of investment tax credits? Are there interrelationships between estate tax and income tax liability? In these situations, the Trial Attorney must be alert to ascertain whether the affected years or liabilities of other taxpayers are open. If it is crystal clear that the affected years or related liabilities are open, make their adjustment part of the settlement. And, if closed, endeavor to make appropriate adjustment part of the settlement, bearing in mind that the affected year can be reopened by mitigation of limitations, if a qualifying "determination" is obtained, or equitable recoupment may be applicable. See Part IV, Chapter B, re Double Allowances--Mitigation of Limitations (§§ 1311-1314), at pp. 47-49, infra, and Part IV, Chapter C, re Equitable Recoupment, at pp. 50-55, infra.

In short, an offer should cover all collateral issues. These include, in addition to those just discussed, the permissibility of crediting any overpayment against any other liability of the taxpayer pursuant to § 6402, waiver of attorney fees, and interest. A carefully crafted settlement can save an attorney a tremendous amount of unnecessary work and the Government a lot of money.

As court dockets become overloaded and courts adopt rules to accelerate settlement conferences, the burden becomes heavier on each party's attorney to be prepared for an early settlement conference. If a court orders a settlement conference before the parties have completed essential discovery, the Trial Attorney should attempt to postpone the conference, preferably with the assistance of opposing counsel. If the parties have utilized the alternative dispute resolution procedures (ADR) described in Part VI, but have been unable to settle the case, it may be appropriate to notify the court of that fact and ask that the parties be excused from participating in a mandatory settlement conference.

Generally, an order requiring a settlement conference will direct the Trial Attorney of record to attend. Before attending the conference, the Trial Attorney should discuss settlement prospects with his or her Section Chief. The Section Chief will normally provide the Trial Attorney with guidelines for an acceptable settlement.

It is essential that Tax Division trial attorneys know who has settlement authority in a particular case and develop skills to participate effectively in court-ordered settlement conferences. By the time of a conference, if not earlier, the Trial Attorney should be able to espouse the strengths of the Government's position and be able to approach settlement discussions with an open and reasonable view. Although settlement conferences may, on occasion, generate considerable pressure on the Trial Attorney to recommend a proposal under discussion, it is shortsighted to agree to recommend unacceptable settlement terms. The ultimate rejection of the Trial Attorney's recommendation and of the offer can cause extreme tension between the Government and both the court and the opposing side; it can create the impression that the Department official having settlement authority rejected the offer without full knowledge of the case.

Court orders (and local rules) vary concerning settlement conferences. When first receiving notice of a conference the Trial Attorney should ascertain who is required to attend since sometimes the orders require that the person with full settlement authority attend. Depending on such factors as the amount in suit and whether the Internal Revenue Service designates the case as "Standard" or "SOP," this type of order often means that the Section Chief or the Assistant Attorney General is ordered to attend and it could possibly require the attendance of the Associate Attorney General. When facing this type of court order, the Trial Attorney should immediately consult with the Section Chief. Normally, the Trial Attorney will be advised to contact the local United States Attorney to determine whether the Department has been excused from similar orders in other cases, and for any advice concerning an appropriate course of action. If it seems appropriate, the Trial Attorney should contact the court's clerk and attempt to find an informal way to be excused from the requirement. In some situations, the Section Chief may believe it will be helpful for the Chief or some other supervisor to be available by phone during the conference and this alternative may be offered to the court as a compromise.

If informal efforts fail, under most circumstances, the Section Chief would authorize the filing of a motion with the trial court, asking to be excused from the local rule or court order and, in the alternative, seeking a stay of the conference pending consideration by the Division and the Solicitor General whether a petition for mandamus will be filed. If this is denied, the Tax Division may seek an emergency stay with a court of appeals and, if granted, file a petition for writ of mandamus on the ground that the Department would be unable to function effectively if key officials could be ordered to appear at court- ordered settlement conferences.

Most courts recognize that the Associate Attorney General should not be required to attend settlement conferences. Because there are usually 22,000 pending cases in the Tax Division, it would also be physically impossible for the Assistant Attorney General to attend settlement conferences on a regular basis, or even to participate by phone. Indeed, if a Section Chief were required to attend all settlement conferences in person, that could consume all or the greater portion of the Chief's time and make it impossible for the Chief to perform the other functions of the position.

The Department has sound legal arguments for contending that a court lacks the inherent power to issue an order requiring the attendance at a settlement conference of the person with full settlement authority. Under the doctrine of separation of powers as expressed in 28 U.S.C. §§ 517 and 519, the Attorney General has the responsibility of representing the United States in judicial proceedings and directing other offices of the Department in conducting litigation. A court lacks the power to tell the Attorney General what settlement authority must be conferred on the Trial Attorney designated to handle a particular case. As stated in the legislative history of the Judicial Improvements Act of 1990, Pub. L. No. 101-650, 104 Stat. 5089 (28 U.S.C. § 473), "the Department cannot realistically send officials with full settlement authority to each settlement conference."⁽⁶⁾

In In re Stone, 986 F.2d 898 (1993), the Fifth Circuit held that the district court has the inherent power to order the Executive Branch to send a high-ranking official to a settlement conference, and it vacated the district court's orders and stated that the district court abused its discretion in routinely ordering the Government to send an official with full settlement authority to a conference. The Circuit went on to state, however, that the court could issue such an order in certain extraordinary circumstances. While the end result in Stone was correct, in the Government's view the Fifth Circuit was incorrect in concluding that the district courts have the inherent power to issue such orders. We expect that this issue will be presented to other courts of appeals and that the Supreme Court may have to resolve it.

To narrow the issues for trial, the parties may wish to enter into a partial settlement. Generally, a Trial Attorney should attempt to negotiate a compromise which disposes of a case completely, where possible, and avoid piecemeal settlements. Relationships between the issues settled and those reserved for litigation may not become apparent until (too late) when the latter are addressed. Moreover, settlement of the case as a whole obviates a need for multiple computations, the preparation of more than one compromise memorandum, and the review of more than one memorandum by the designated official. It also avoids any appearance that partial settlements were negotiated in an effort to keep review of the settlement at the Section Chief level. Bear in mind, moreover, that the total amount conceded in all prior settlements is taken into account in determining jurisdiction to act on any subsequent settlement.

Nonetheless, there are times when partial settlements are either advisable or necessary. If a case presents 20 issues, it is clearly advisable to attempt to settle as many as are feasible. To do so both narrows the issue for trial and permits the Government to present its case most forcibly on appeal, where the page limitations on brief and time limitations on argument are exceedingly stringent.

In a partial settlement, there are pros and cons with respect to when computations should be prepared. Thus, inasmuch as previously unconsidered "issues" (or effects of a computation) may surface when a computation is prepared, it is well to have computations prepared sooner rather than later. Indeed, it is sometimes essential to prepare computations in order to determine who has the authority to approve the settlement. On the other hand, there is merit in having any overpayment computed at the end of the case to avoid the need for multiple computations. Moreover, new offsets may be discovered in the course of litigating a reserved issue. Additionally, whether or not an overpayment is scheduled immediately on conclusion of a partial settlement (in which case computations will probably have been prepared) will depend on a number of factors, including the posture of the case, the complexity of the necessary computations, and any possible interrelationship with issues which remain to be litigated.

Certain cases are more appropriate for settlement than others. However, that there are a number of factors favoring settlement in a particular case does not mean that a case can or should be settled, or that the parties can reach agreement on terms that are fair to both sides. Similarly, that there are factors which weigh against the likelihood of settlement does not mean that a case cannot or should not be settled. Nonetheless, the Trial Attorney may want to consider some of the various factors favoring and disfavoring settlement in weighing the potential for settlement versus litigation.

A term of every settlement should cover the taxpayer's right to claim attorney fees. Unless there are unusual circumstances, we should require that the offer provide that each party is to bear its own costs, including attorney fees. The obvious reason is that little is accomplished in saving litigating costs if we have to litigate taxpayer's right to attorney fees, especially if the principal issue in the fees dispute is whether the Government's position on the settled issue was substantially justified.

Obtaining computations prior to the time a compromise or concession is approved is most desirable. The results of a computation can, on occasion, be surprising--what you may think is a 50% Government concession may turn out to be a 90% Government concession because of the vagaries of the computation, limitations kicking in, etc.

A relatively easy way to approach this, particularly in cases where the taxpayer is a large corporation or a substantial amount is at issue, is to ask taxpayer's counsel to submit a computation together with the offer. Or, if an unsolicited offer is received, and it is worthy of serious consideration, this request can be made at that time. The taxpayer's computation should then be checked either by the Service or by the Tax Division's recomputation specialist.

Please bear in mind that, while the Trial Attorney may not be responsible for the arithmetic involved in a complex computation, the Trial Attorney is responsible for ensuring that the computation is conceptually sound and eyeballing it to ascertain that it is reasonably correct. This is true, also, of computations prepared by Government personnel, which still require review. For example, there have been instances in which an agent, calculating an overpayment in an estate tax case, has picked up, instead of the figure for the gross estate as determined on audit, the figure for the taxable estate, and then proceeded to deduct a second time the amount allowable in going from the gross estate to the taxable estate. Unless attention is paid to the correctness of the computations, settlements which appear greatly to the Government's best interests, when described in terms of litigation hazards, may prove greatly to the Government's detriment when the check is cut.

Be aware that there can be hidden variance problems which can be injected into a case in the course of a computation process. It is possible that a well-informed person preparing a recomputation may perceive issues in making the computation (whether pursuant to settlement or judgment) which had not previously been addressed. If the case were litigated, and the Government won, of course the taxpayer could not recover with respect to an issue not raised in the complaint or claim for refund. Similarly, if we lost, the taxpayer could not prevail on an issue which had not been involved in the litigation. Accordingly, recomputations must be scrutinized to be sure that they do not address issues that the taxpayer has not raised in its refund claim or suit.

In any refund suit, it is not a good idea to accede to a request that all of the overpayment be considered tax, and no part interest. Interest received is taxable, and recoveries of assessed interest or deductible taxes are taxable if previously deducted, but recovery of a nondeductible tax is not includible in income. Moreover, despite a provision in a settlement that assessed or statutory interest is to be waived, or to be calculated in a particular way (e.g., at half the statutory rate), the Service Center may allow assessed interest or calculate statutory interest in the usual way.

In a collectibility settlement, it is usual to require that no part of the payment is deductible for federal income tax purposes.

Pursuant to § 6402 of the Internal Revenue Code, any overpayment due a taxpayer may be credited against any other outstanding tax liability of the taxpayer, and certain other specified liabilities. Every settlement resulting in an overpayment -- whether by compromise or concession -- should provide for the applicability of § 6402.

The Trial Attorney must always be aware that the taxpayer's offer and the Government's acceptance constitute a contract. Failure of the parties to state their intention can lead to the dispute being presented to the court as in any other contract dispute.

All offers must be in writing, i.e., the taxpayer is required to submit a written offer even if the taxpayer makes an oral offer at a pretrial conference with a judge in attendance. The offer should contain all the proposed terms of settlement. This avoids disputes as to what the parties intended and the admission of parol evidence. For example, the offer should address the permissibility of crediting any overpayment pursuant to § 6402, attorney fees, interest on either the refund to or payment by the taxpayer, all problems concerning effect on other years, any issues concerning basis, and so on.

The Trial Attorney should send an acknowledgement letter promptly, generally within three days from the receipt of the offer. This letter should clarify any term of the offer that needs revision. If the terms of the offer do not require clarification, an acknowledgement is still required, but no restatement of the terms of the offer is necessary. If the acknowledgement letter is, in effect, stating new terms (even though they are relatively modest provisions), we should require the taxpayer's representative to agree to the revisions in writing. An effective way of obtaining the agreement is to request the taxpayer or the taxpayer's representative to sign and return a copy of the acknowledgement letter.

Trial Attorneys sometimes spend large amounts of time clarifying (after the fact) what a settlement offer really means. For this reason, it is often a good idea to see a draft offer, approve it or suggest revisions, and then have taxpayer make the actual offer. In the right case, the Trial Attorney may even prefer to propose the terms of the draft offer (being careful, of course, not to seem to be making an offer).

If the offer letter contains some terms which are totally unacceptable but the offer is otherwise worthy of consideration, the Trial Attorney should consider restating the terms that may be acceptable, pointing out the unacceptable terms and asking the taxpayer's representative to confirm in writing if he or she wishes to make an offer on the revised terms.

Inasmuch as the Trial Attorney does not have settlement authority, the Attorney must take care not to seem to be making a settlement offer, rather than stating what the Attorney's recommendation would be. In an unusual case, after a settlement memorandum has been prepared, it may be appropriate for the Trial Attorney, while recommending rejection of a pending offer, to recommend the making of a formal counteroffer (i.e., a statement that, if an offer on these terms is submitted, it will be accepted). Such counteroffers, although not routine, may sometimes be utilized in situations where the Section Chief has settlement authority. They are extremely unusual, but not impossible, when the Office of Review has authority to accept or reject the offer. This discussion assumes, of course, agreement by the Internal Revenue Service to the course proposed (or SOP classification). In all cases the making of formal counteroffers must be approved by the person who would have authority to accept the offer.

As the chief litigator of the United States, one of our important functions is to make sure that the Government has a legitimate litigation position in each case that we handle. We must recognize that requiring a taxpayer to litigate his or her rights in court is expensive and stressful. In addition, we must consider the court's time and our need to retain the court's goodwill. And--quite apart from the costs to others and ourselves--it is our obligation to concede cases in which our position lacks merit.

If the Trial Attorney believes that the Government should concede an issue or the entire case, he or she must obtain the recommendation of the Service, even in cases that have been designated SOP. (There is one exception to this rule, namely, in a responsible person case (§ 6672 of the Internal Revenue Code) we need not request the views of the Service if the case has been classified SOP.)

Generally, it is undesirable to process a proposed concession as to only part of a case if the case can be resolved as a whole by settlement. Accordingly, a proposed partial concession should not be processed until the Trial Attorney has explored the possibility of settlement of the case as a whole, and the Trial Attorney's memorandum should set forth why an overall settlement cannot be achieved.

Whether we should negotiate over attorney fees with taxpayer's representative when concession is being considered, and how we negotiate fees in this context, is a grey area and requires a careful analysis of the situation. The Tax Division's position on this matter is contained in Tax Div. Directive No. 87-62, and it states in pertinent part:

Whenever possible, cases that are conceded by the Government should be terminated by a stipulation for dismissal with prejudice, each party to bear its own fees and expenses including attorney fees. Similarly, whenever possible in partial concessions, each party should bear its own attorney fees and expenses with respect to the issue(s) conceded. Where the person with final authority determines that full concession or partial concession will be conditioned upon settlement of or waiver of costs and attorney fees,⁽⁷⁾ opposing counsel should be informed that any concession is conditioned on disposition of the issue of costs and attorney fees. In cases in which full or partial concession is warranted whether or not the issue of costs and attorney fees is resolved, opposing counsel should be informed of the decision to concede before the issue of costs and attorney fees is broached, and, as a matter of ethics, there should be no suggestion that concession is dependent upon resolution of the issue of costs and attorney fees. Where opposing counsel refuses to waive fees and costs, settlement of the fee and cost issue should be sought. If an offer to settle the fee and cost issue is submitted, the recommendation of District Counsel or Chief Counsel must be requested. Where settlement cannot be reached on the fee and cost issue, a judgment will be entered, leaving the award issue open. But, in such cases, the Trial Attorney should promptly request District Counsel or Chief Counsel to provide the Division with an analysis of the facts and law on the fee and cost issues left open, unless such an analysis has previously been received.

If the Trial Attorney determines that the offer does not merit serious consideration, he or she should promptly prepare a brief memorandum recommending summary rejection of the offer and should not request the recommendation of District Counsel or Chief Counsel. If the offer does merit consideration, however, then the following should be observed.

In cases classified "standard" by District Counsel or Chief Counsel (see Part II, Chapter L), the Trial Attorney shall request promptly (i.e., within 3 days of receipt of the offer) the recommendation of District Counsel or Chief Counsel as to the acceptability of the offer. As soon as possible, the Trial Attorney should forward a copy of a draft compromise memorandum to District Counsel or Chief Counsel to assist in their evaluation of the proposal.

The Trial Attorney should bear in mind that the fact that the parties are participating in ADR does not obviate a need for the Internal Revenue Service recommendation in standard cases.

In cases classified "SOP" (see Part II, Chapter L) by District Counsel or Chief Counsel, the Tax Division may act on an offer to settle the pending case without obtaining the Service's recommendation. A general litigation case may not be classified SOP if the amount in controversy is more than $200,000. If the District Counsel's initial letter to the Tax Division in a general litigation case fails to designate the case as either SOP or standard, the Tax Division will presume that the case is classified SOP if it involves less than $200,000; otherwise, the case must be treated as standard. If the offer covers periods or taxpayers not in suit, the recommendation of the Internal Revenue Service must be obtained.

When a proposed settlement of a standard or SOP case includes a taxpayer or period not in the pending litigation, pursuant to Delegation Order 155 (Rev. 4, Aug. 15, 1996), the Internal Revenue Service recommendation letter must be signed by one of the following officials:

Where a proposed settlement provides for the execution of a closing agreement as part of the settlement, the closing agreement must be reviewed by the appropriate Internal Revenue Service office prior to the Government's acceptance of the offer. Indeed, in almost all cases, as when subsequent years are pending in the Appeals Office of the Service, the Service office involved will prepare the closing agreement. In this situation the Trial Attorney should review the closing agreement, as well.

In cases where the Chief of the Civil Trial Section or the Court of Federal Claims Section determines that the Internal Revenue Service has not timely responded to a request for recommendation on an offer, the Chief may advise the appropriate Internal Revenue Service office by letter that, unless the Tax Division hears from that office within 45 days, the Tax Division will process the case on the assumption that the Internal Revenue Service has no objection to the proposed settlement. A form of letter to District Counsel or Chief Counsel invoking the 45-day rule is in the Appendix as Exhibit D. Before determining that the Internal Revenue Service has failed to respond in a timely manner, the Service must have received (either in advance of or with the 45-day letter) everything needed to review the proposed settlement, including a copy of the compromise memorandum.

The Internal Revenue Service is considered to have responded to the 45-day letter if, within the 45-day period, the Tax Division receives either (1) a recommendation or (2) a request for additional time and an estimate as to when the recommendation will be received. This 45-day procedure is not applicable to settlements that must be approved by the Associate Attorney General or referred to the Joint Committee on Taxation, or that include a taxpayer or period not in suit.

If the Trial Attorney is of the view that a case should be conceded in whole or in part, the Trial Attorney should request the recommendation of District Counsel or Chief Counsel as to the proposed concession, forwarding a copy of his or her concession memorandum. The recommendation of District Counsel or Chief Counsel is required in all cases, except SOP cases involving liability under § 6672 of the Internal Revenue Code. If the Tax Division does not receive a recommendation within 30 days from the date of the letter requesting the recommendation in a refund suit classified SOP, the Tax Division may process the case on the assumption that Chief Counsel or District Counsel has no objection to the proposed concession, except where the proposed concession must be approved by the Associate Attorney General or referred to the Joint Committee on Taxation. Internal Revenue Manual (35)(18)45; Ex. E.

Whenever a settlement offer is received from a taxpayer, it is logged onto the Tax Division's computer. Subsequent action on the offer (e.g, sending it to the Service for its views; receiving the Service's views; action by the Trial Section; action by the Office of Review) is also entered onto the computer. Every two months the Division front office (i.e., the Office of the Assistant Attorney General) calls for a list of all the cases with offers pending, and that list reflects the date the offer was received and what has happened (or not happened) since that time. One column on the list is reserved for remarks, and that space is used to explain why we have not yet acted on an offer.

The Tax Division uses the list to monitor the pace at which we settle cases. "Stale" offers show up, along with our explanations of why we have not yet acted on them. This enables the Division management to ensure that we are processing our offers with reasonable diligence and, if necessary, to prod us when we are not.

The longer it takes the Government to process offers, the less incentive there is to taxpayers to make such offers. Moreover, as a matter of courtesy, offers should be acted on promptly. If an offer is not adequate, it should be rejected promptly. If it is acceptable, it should be accepted promptly--both as a matter of courtesy, and as a reward to the cooperative taxpayer and its counsel. It is poor thanks to a taxpayer who has made a reasonable offer to have that offer languish, while the Trial Attorney attends to what are regarded as more stringent deadlines in cases with less cooperative opponents.

Simultaneously obtaining good settlements and "staying off the offer list" is the attorney's goal. Of course, the obvious way to do this is to immediately write one's compromise memorandum, which is sometimes difficult or impossible. Short of doing that, however, there are useful procedures that can save considerable time:

(a) Discourage unsolicited offers. When settlement first comes up, explain to the opponent that the Trial Attorney's favorable recommendation is almost always necessary for a settlement to occur, and that one would prefer that the taxpayer make no offer until after one has negotiated and agreed to make a favorable recommendation.

(b) Discourage premature offers. Taxpayers sometimes make offers early in the case--aware that we know little or nothing about the case--with the bona fide intention that the settlement offer remain pending while we conduct discovery and learn whether the offer is a good one. Such offers are more harm than help, in that they provoke the Section Chief (and the Front Office) to inquire repeatedly about the pendency of offers which are simply premature.

(c) Keep the Service and supervisory staff familiar with the case informed during settlement negotiations. Particularly in a standard case, check with District Counsel or Chief Counsel to get their informal views on what the offer should look like. It will not only improve the quality of the offer but also cut down (a) the amount of time it takes them to consider the offer and (b) the number of times one has to write supplemental memoranda on additional issues.

(d) Utilize taxpayer's submissions in preparing the compromise memorandum. The compromise memorandum is an evaluation of the case that consists essentially of (1) taxpayer's version of the facts, (2) the Government's version of the facts, (3) taxpayer's legal position, and (4) the Government's legal position. If taxpayer proposes, early in the case, a comprehensive stipulation of facts (with citations to the documents, affidavits, and depositions it relies on), it will probably be very easy to draft a statement of the facts. (Before soliciting such a draft stipulation, consider whether it would be preferable for the Trial Attorney to go first in the stipulation process.) Additionally, the Trial Attorney can ask taxpayer for a statement of taxpayer's position on the specific legal questions to be addressed in the memorandum. (E.g., "Why isn't this a change of accounting method?" "Why isn't this a variance from the refund claim?") If these can be obtained during the negotiation stage, then large chunks of the memorandum will be drafted before the offer is received.

(e) Draft the compromise memorandum during the negotiation process. Most of the material in the memorandum is material that the Trial Attorney will eventually have to write in any event (unless taxpayer gives up)--either as a pretrial brief or as a compromise memorandum. So it is not a question of whether to write it but when to write it. The Trial Attorney might as well do it early: the supervisor who reviews the transmittal letter gets an early look, makes comments, and gets on board; the Service's consideration is assisted and expedited; and the memorandum is ready very shortly after the offer is received.

(f) Send the Service a copy of the draft memorandum. Send it promptly, and give your District Counsel or Chief Counsel counterpart any other information or documents that he or she will need to evaluate the offer. When an offer in a non-SOP case comes in, the Tax Division immediately asks the Service for its views. Thus, remarks on the offer list often state that a stale offer is awaiting the views of the Service. The jaundiced eye, however, may look askance at that explanation. When the Service

gets a settlement offer with no explanation from the Trial Attorney as to why the offer is good (or not good), it often takes the District Counsel or Chief Counsel attorney a long time to evaluate the offer. On the other hand, with a draft of the compromise memorandum, the District Counsel or Chief Counsel attorney is often able to render an opinion quickly.

(g) Reject offers quickly--in the appropriate case. On occasion we receive an offer that the Trial Attorney thinks is not good enough, but the Trial Attorney hopes to be able to negotiate a better offer, and so leaves the offer pending during this post-offer negotiation. Sometimes this is surely the right approach. In other instances, however, leaving the prior offer pending may send the wrong signal to the taxpayer (i.e., that maybe the Government will accept the offer if it can't get a better one) and leaves on the offer list a case that really calls for rejection.

A recommendation for settlement or concession is made in a memorandum prepared by the Trial Attorney. A form of memorandum is contained in the Appendix as Exhibit F. The top page of the memorandum should contain the date, the name of the case, and the nature of the suit, including the years or periods involved in the litigation.⁽⁸⁾ State the amount involved in the litigation, whether it is an amount claimed by the taxpayer or by the Government. Also state the amount to be paid by the Government, and the amount to be paid to the Government (or in a partial concession of a Government claim, the amount of reduction of such claim). In discussing the amounts at issue in the lawsuit and the amounts to be paid by or to the Government, or refunded, the Trial Attorney should always detail the treatment of interest.

The top page of the memorandum should also contain the date of the offer. Normally this date is the date of the offer letter prepared by the taxpayer or other parties seeking to settle. If the offer has been amended, the dates of any amendments should be set out. Next, the memorandum should list the recommendations of the Internal Revenue Service, usually by using one of the following forms:

Remember in preparing this part of the memorandum that the District Counsel, Regional Counsel or Assistant Chief Counsel may not have the authority to sign a recommendation letter on an offer that includes taxpayers or periods not in suit. See discussion at Chapter G of this Part, Section 1.c., pp. 32-33, supra.

Below the Internal Revenue Service recommendation is the Trial Attorney's recommendation. The name, address, and telephone number of the taxpayer's representative also appear in this part of the memorandum. In a refund case which involves the making of a refund, the address stated in the memorandum will be used by the Post Litigation Procedures Unit (PLPU) to ascertain the correct address to which to send the refund check. Therefore, it is important to be sure that this information is correct.

The body of the memorandum consists generally of five to seven parts: (1) questions presented; (2) terms of offer; (3) statutes and regulations involved; (4) a jurisdictional statement, setting out those facts which establish that the refund claim and suit are timely in whole or in part; (5) the statement (which normally sets out the facts); (6) the discussion, which would include any relevant comments by the court; and (7) conclusion. A few points are worth making about the body of the memorandum.

When discussing the questions presented, it is more useful to list the substantive questions rather than to use a more general presentation such as "should the offer be accepted given the litigating hazards?" Since the reader already knows that settlement is being considered either on litigating hazards or a collectibility basis, it is much more useful for the reader to learn something about the case. For example: "Are the hairdressers who work for the taxpayer employees or independent contractors?"

The questions presented and terms of offer may be combined, as, for example: whether the taxpayer has substantiated adequately claimed travel and entertainment expenses for 1989-1990. Under the proposed settlement, the taxpayer concedes 1989 (involving a total of some $100,000 in claimed expenses) and the Government concedes 50% of the $200,000 involved with respect to 1990.

It is extremely helpful if the "statement" section of the memorandum contains the facts needed to verify the presence of jurisdiction for a refund suit, for example, the filing date of the original return, the existence of any extensions of the statute of limitations for assessments and collections with respect to the subject tax period, the filing date of the refund claim, the date of any Service action with respect to the claim, the filing date of the complaint, and the applicability of any Internal Revenue Code § 6511(b) limitations regarding the proposed settlement overpayment. Moreover, at this juncture, it is a good idea to obtain and review a current transcript of account, to make sure that there have been no developments (e.g., a tentative refund) which affect the amount in controversy, or which should be addressed in considering the settlement.⁽⁹⁾

The "discussion" section of the memorandum should, in a litigating hazard settlement, explain the strength and weakness of the Government's position with respect to all issues involved in the case (or all issues covered in a partial settlement). The memorandum should also address any issues identified in the Internal Revenue Service's recommendation. Sometimes the Trial Attorney may believe that the Internal Revenue Service's analysis on a particular issue is wrong or irrelevant. It is very helpful to the person who must act on the offer if the memorandum explains why.

Despite the efforts to make sure that the terms of settlement are clear at the time the offer is made and it is acknowledged by the Government, there will be occasions when an additional matter needs to be addressed in the acceptance letter or by way of counteroffer. These issues should be identified in the memorandum.

When preparing the memorandum, make it as easy as possible for those who must also add their recommendation or act on the offer to check the accuracy of the statements made in the memorandum or to review the relevant documents. If the memorandum refers to documents, please make sure that they are either attached as exhibits to the memorandum or are tabbed in the files which are sent forward with the memorandum.

The materials which should be forwarded with the settlement memorandum and Settlement Checklist are normally the following:

A well-written and thorough settlement memorandum will considerably expedite the settlement process.

Form TAX-108 (Ex. H) is a Settlement Checklist which is to be submitted with the memorandum. Its purpose is two-fold: (1) to set out, on one page, the procedural or generic information (e.g., time limit, date of offer), which makes it easier for the person reviewing the settlement to see at a glance what is involved; and (2) to remind the Trial Attorney of points to consider and/or address in connection with settlement.

With respect to the second point, question V on the Settlement Checklist sheet addresses concerns which are discussed at length in Part V, Collectibility Settlements. Does the offer provide that a lump sum or initial payment be made within a set time? Are fixed deferred payments secured? Do they bear interest? Are there current financial statements on Form DJ-TD 433 (1996)? Has that form been verified by the Internal Revenue Service? Have tax returns for the last five years been analyzed? Is there a collateral agreement? Does taxpayer waive any deductions?

Similarly, question VI of the checklist is intended, inter alia, to remind the Trial Attorney of questions and problems which are addressed in Part IV, Offset, Double Allowances--Mitigation of Limitations, and Equitable Recoupment.

Prior to submitting a non-SOP case to the Office of Review, it is the responsibility of the Civil Trial Section, the Court of Federal Claims Section, or the Appellate Section to obtain the recommendation of the Chief Counsel or District Counsel, except in the situation where the Trial Attorney has discussed the proposed settlement with the Internal Revenue Service attorney assigned the case and has been assured that the Service's favorable recommendation will be forwarded within a few days. In that situation, it remains the Trial Attorney's responsibility to obtain the recommendation of the Service. The Appellate Section also must obtain the recommendation of the Civil Trial Section in which the case originated. Additionally, it is the responsibility of the Civil Trial Section, the Court of Federal Claims Section, or the Appellate Section to obtain and check any computations required under the compromise or concession.

If the Office of Review determines that further factual development of a case is necessary, or additional issues should be addressed, the Civil Trial Section, the Court of Federal Claims Section, or the Appellate Section is responsible for whatever additional work is necessary.

The Office of Review will keep the Trial Attorney advised of any time exigencies which prevent reasonably prompt addressing of the settlement by Review. Conversely, the Trial Attorney should consult with the Office of Review concerning representations made to the court concerning the time necessary to act on the settlement, and furnish the Office of Review with a draft of any such representations before they are submitted to the court.

The Assistant United States Attorney assigned to handle a case on behalf of the Tax Division has the responsibility for preparing a memorandum recommending acceptance or rejection of an offer to compromise such case. If the Assistant United States Attorney determines concession of the case or of an issue is warranted, the Assistant United States Attorney must prepare a memorandum recommending concession. The memorandum should be addressed to the Assistant Attorney General and must contain a statement of the facts, an analysis of the law, a statement of the terms of the proposed settlement, and a discussion of the reasons underlying the recommendation. The memorandum is forwarded to the chief of the section concerned, together with the administrative files and a copy of the offer. If necessary, the Assistant United States Attorney obtains the recommendation of District Counsel or Chief Counsel, a computation, and/or a current transcript of account.

An acceptance letter must be written with the greatest possible care, inasmuch as the offer and acceptance constitute a contract between the parties. Form letters are exactly that

--forms. They frequently must be modified to suit the particular case. A settlement memorandum may describe a settlement greatly in the Government's best interests--but, unless care is taken in the acceptance letter, those benefits may not be achieved.

Forms of letters advising of rejection of an offer or acceptance of an offer are in the Appendix as Exhibit I (Rejection Letters), Exhibit J (Refund Due under the Compromise), and Exhibit K (Payment Due the United States under the Compromise). Forms of Stipulations for Dismissal generally used in compromises (and concessions) are in the Appendix as Exhibit L. Forms of Stipulations for Entry of Judgment where payments are due the Government are in the Appendix as Exhibit M.⁽¹⁰⁾ Forms of concession letters in refund suits are in the Appendix as Exhibit N.

It is the responsibility of the Civil Trial Section, the Court of Federal Claims Section, or the Appellate Section to advise by letter taxpayer's counsel and District Counsel or Chief Counsel of the action taken on the offer or of the approval of a concession in cases where final action is taken by that Section. In all other cases, it is the responsibility of the Office of Review.

In cases that can be acted on within the trial section or the Appellate Section, a Trial Attorney is required to prepare the letters and send them forward at the time the case is submitted to the Section Chief for action. This practice will enable the Section Chief to review the offer efficiently with only one review of the case file and memorandum.

Instructions for completion of the form and sample completed forms are in the Appendix as Exhibit O. Blank forms are available in each section front office. Addresses of Service Centers to be used in memoranda authorizing payment are also included in Exhibit O.

The authorization to issue a refund must be very clear. For example, if you are settling a case involving three years on the basis of overpayments of 50% of the tax and assessed interest paid involved, specify the amounts of the refund of tax and assessed interest paid for each year.

It is the responsibility of the Tax Division to ensure that refund checks issued pursuant to compromises, concessions or judgments are accurate, both as to the principal amount of the refund and as to statutory interest. This review is necessary because, whereas a taxpayer will generally complain if the refund check is inadequate, very few, if any, inquiries are received because a taxpayer believes that the amount allowed is excessive.

Refund checks, together with the notice of adjustment and statutory interest computation, are sent by the Internal Revenue Service to our Post Litigation Support Unit. This Unit will send the Trial Attorney (or Office of Review in cases handled by that Office) a copy of the notice of adjustment and statutory interest computation. Before sending these documents to the Trial Attorney, the Post Litigation Support Unit will ascertain whether the Trial Attorney is scheduled to be in the office within the next week. If the Trial Attorney is not scheduled to be in the office within the next week, the Post Litigation Support Unit will consult with the Section Chief or Assistant Section Chief of the Trial Section.

The Trial Attorney (or Office of Review) should promptly review the notice of adjustment to make sure that it complies with the terms of settlement and the Form M-4457. For example, there may be instances where overpayments for some years trigger deficiencies for other years, for which no deficiencies have been assessed, although, had the case gone to judgment and the same result obtained, the period of limitations would have been reopened by §§ 1311 et seq. of the Code. In such a situation, the Form M-4457 will typically direct that the deficiencies be offset against the overpayments, and only the net amount refunded. Unless great care has been taken, however, there is a good chance that the Service Center will simply allow the overpayment, ignoring the deficiencies because they have not been assessed. Accordingly, if you have this situation, you may want to consult with the Service Center about this at the time the M-4457 is prepared, and be sure to check the notice of adjustment as soon as it is received.

Similarly, the Trial Attorney (or Office of Review) should review the statutory interest computation to make sure that it is correct.⁽¹¹⁾ The Service can make very serious errors in the computation of statutory interest. There have been cases where grossly excessive amounts of interest were allowed, either with respect to settlements or judgments,⁽¹²⁾ but the recovery of the erroneous refund was barred by limitation. Guidelines as to calculation of interest are discussed in "A Bird's Eye View of Some General Principles re Interest," which appears in the Appendix as Exhibit Q.

Preparation of the M-4457 and determination of the amount of judgment require analysis of the transcript of account (which shows the date of all payments of tax). At that time the Trial Attorney (or the Office of Review) will have in mind such questions as whether interest is restricted because of carrybacks. This is the information necessary to verify the calculation of interest, which involves knowing from what date to what date interest is calculated on what amount. Accordingly, to facilitate the verification of the amounts of refund checks, it is suggested that, at the time the Form M-4457 or judgment is prepared, an interim computation also be prepared of the statutory interest payable to date on the amount of the refund.⁽¹³⁾ If an interim computation has been prepared, when the statutory interest computation is received from the Service Center all that needs to be done is to update the interest computation (generally to the date of the refund check), particularly if there has been a significant time lapse or a substantial amount is involved, and to determine whether there is a significant discrepancy.

In all cases, if the Trial Attorney (or a paralegal under the Trial Attorney's direction) is unable to verify the correctness of the refund check, whether as to principal or interest, or to prepare the interim interest computation, or resolve any discrepancies in the computation of the statutory interest, the Trial Attorney should seek the assistance of the Tax Division's recomputation specialist.

The Post Litigation Support Unit will not forward the refund check (and notice of adjustment and statutory interest computation) to taxpayer's counsel until it has been advised by the Trial Attorney or Office of Review that the check is in the correct amount.

IV. OFFSET, DOUBLE ALLOWANCES--MITIGATION OF LIMITATIONS, AND EQUITABLE RECOUPMENT

"Offset" is a word of many meanings. It is oftentimes used colloquially, within the Tax Division, to refer to an adjustment in the Government's favor which reduces the taxpayer's recovery. Such an offset can only be asserted with respect to the same time period and the same kind of tax.

Conceptually, of course, this kind of adjustment is not an offset at all. It simply reflects application of a long-established doctrine--that there can be no overpayment for a year unless, taking into account all adjustments (including those as to which additional deficiencies should have been assessed), there is an overpayment for that period with respect to that tax. Lewis v. Reynolds, 284 U.S. 281 (1932).

Ideally, of course, offsets should be ascertained either by the Service, as it prepares the defense letter, or after the Trial Attorney has received the administrative files and is preparing the answer, and many times offsets are identified and pleaded timely. However, another opportunity to take a look at the case as a whole, and any computational aspect, is also presented when the Trial Attorney prepares a settlement memorandum; accordingly, it is well to keep an eye out for the possibility of offset at this juncture, also. For a refund case holding that the Government had an absolute right to assert an offset for the same taxable year, very late in the settlement review, see Americold Corp. v. United States, 28 Fed. Cl. 747 (1993).

With respect to offsets, there are various points which should be borne in mind--

(a) Never assert an offset in any case where a Form 870-AD (or any equivalent AD agreement) has been executed for the year, reserving to taxpayer the right to litigate the issue in the refund claim and complaint.⁽¹⁴⁾ To do so would be a violation of the Government's agreement in the Form 870-AD, and, however clear the error involved, we never assert offsets where the taxpayer's position is consistent with the Form 870-AD. However, where either Audit or Appeals has conceded all or part of an issue, the concession was erroneous, and no Form 870-AD or closing agreement was executed, an offset would be appropriate.

(b) Offsets should never be asserted when to do so would redound to the Government's disadvantage. For example, any offset involving a change to the taxpayer's method of accounting may trigger adjustments which provide tax benefits to the taxpayer (including possibly reopening years otherwise barred by limitations), which tax benefits may be far greater than the tax detriment which would result from the offset.

(c) Asserting offsets, particularly late in the game, is a rather delicate matter. The later that offsets are asserted, the greater the importance that the offsets are not only defensible, but clearly correct. Good examples are the adjustments correlative to allowance of the taxpayer's claim in whole or in part; it is very hard for the taxpayer to dispute the merits of such an offset. See Americold Corp. v. United States. Indeed, any time the taxpayer is suing on a claim which would have correlative adjustments in the Government's favor for the same year and same type of tax, were the taxpayer to prevail, it is well to plead the offset ab initio. Otherwise, if the case goes to judgment, and the Government loses, the Government may not be able to have the adjustment taken into account as part of the mathematical computation of the overpayment--if, indeed, the adjustment is identified at all at that point.

Section 1311 provides:

The application of these provisions is limited to the seven narrow "circumstances of adjustment" described in § 1312. The first four circumstances involve essentially double allowances or disallowances with respect to the same taxpayer or "related" taxpayers. They are: (1) double inclusion of an item of gross income; (2) double allowance of a deduction or a credit; (3) double exclusion of an item of gross income; and (4) double disallowance of a deduction or a credit. Paragraphs (5) and (6) deal, respectively, with correlative deductions and inclusions for trusts and estates and legatees, beneficiaries, or heirs; or correlative deductions and credits for members of an affiliated group of corporations as defined in § 1504. Section 1312(7), a very complex and opaque provision, concerns basis of property after erroneous treatment of a prior transaction.⁽¹⁶⁾

Bear in mind that mitigation is applicable only if there has been a double allowance, double disallowance, etc., with respect to the same taxpayer or "related" taxpayers. Related taxpayers are defined in § 1313(c) as (1) husband and wife, (2) grantor and fiduciary, (3) grantor and beneficiary, (4) fiduciary and beneficiary, legatee, or heir, (5) decedent and decedent's estate, (6) partners, and (7) members of an affiliated group of corporations (as defined in § 1504). Although related taxpayers generally have a common economic interest, not all taxpayers with identical economic interests qualify as "related" pursuant to § 1313(c). For example, a corporation and the individual who owns 100% of its stock are not "related" under § 1313(c).

There are additional conditions necessary for § 1311 to apply, set out in § 1311(b), concerning maintenance of an inconsistent position, and correction not being barred at the time of the erroneous action.

Lastly, and of great importance in the context of settlements, a "determination" described in § 1313 which will permit relief under these provisions is specifically limited, by § 1313(a), to:

Let us assume that a taxpayer claims a deduction of $100,000 in 1984. On audit, the Service disallows the deduction in 1984, but allows it for 1988. Taxpayer pays the deficiency for 1984, sues for refund, and, in 1994, the taxpayer prevails and the judgment in its favor becomes final. At that time, the three-year period for assessment as to 1988 has run.

Since the taxpayer has obtained a judgment, § 1311 et seq. would reopen for one year the period of assessment for 1988, so that the Government might assess and collect the resulting deficiency. There has been double allowance of a deduction or credit pursuant to § 1312(2). The situation meets the requirement in § 1311(b)(1) that, "in case the amount of the adjustment would be assessed and collected in the same manner as a deficiency under § 1314, there is adopted in the determination the position maintained by the taxpayer * * * and the position maintained * * * by the taxpayer * * * is inconsistent with the erroneous * * * [double] allowance * * *." Further, the decision of the court which has become final qualifies as a "determination" pursuant to § 1313(a)(1).

Let us assume that the same deduction is claimed for 1984 and allowed for 1988, but the case is settled on the basis of allowance of a deduction of 50% of the amount claimed for 1984 -- or, indeed, assume that a full administrative concession is appropriate. Unless special provision is made, the Government will not be able to assess and collect the resulting deficiency for 1988 -- an Attorney General compromise or concession is not a "determination (as defined in section 1313)."

There are several ways around this problem. One is simply to provide that the deficiency for 1988 is offset against the overpayment for 1984, and make sure that the Service Center actually carries out this instruction. See discussion, supra at p. 43. The second is to make it a specific provision of the settlement that there is an agreement between the taxpayer and the Government that the settlement constitutes a determination under § 1313(a) and a correlative deficiency may be asserted for 1988, based on the partial allowance of the claim for 1984. The third is to execute a stipulation for entry of judgment as to whatever the settlement provides.

It is generally preferable to take care of any correlative § 1311 adjustment as part of a settlement rather than leaving the applicability of § 1311 to subsequent litigation.

Section 1312, which sets out the only circumstances of adjustment qualifying for relief, has not been amended to any significant extent since 1954. As stated earlier, it is very narrowly drawn. Moreover, it does not address adjustments correlative to provisions added to the Code since 1954. For example, there are no provisions dealing with the interrelation-ship of qualification for investment tax credit and useful life for depreciation, or the relationship between the income tax and the alternative minimum tax. For such adjustments, the Government is best served by the assertion of offsets for the same taxable year.

Section 1311 has no application with respect to transactions between unrelated taxpayers. A corporation and an individual who owns 100% of the stock of the corporation are not related taxpayers under § 1313. Accordingly, in these situations (as well as potential § 1311 situations), the best protection for the Government is to attempt to ascertain, as soon as suit is filed, whether there are any correlative adjustments which should be made were taxpayer to prevail, to determine whether the affected years for this taxpayer or other taxpayers are still open, and, if so, to endeavor to keep those periods open. While it is certainly true that the Government can lose and has lost in litigation as to both sides of the transaction, keeping the periods open for all taxpayers involved is likely to produce a more equitable result, possibly by settlement.

Equitable recoupment has generally been applied in situations involving offset of one kind of tax against another kind of tax and the same taxpayer (or a related taxpayer). The doctrine has been generally described as follows (Estate of Mueller v. Commissioner, 101 T.C. 551, 551-552 (1993)):

The ancient doctrine of equitable recoupment, which developed concurrently at common law and in equity, was judicially created to preclude unjust enrichment of a party to a lawsuit and to avoid wasteful multiplicity of litigation. See generally McConnell, "The Doctrine of Recoupment in Federal Taxation", 28 Va. L. Rev. 577, 579-581 (1942). The doctrine has been applied in Federal tax matters since the Supreme Court's decision in Bull v. United States, 295 U.S. 247 (1935), to allow the bar of the expired statutory limitation period to be overcome in limited circumstances in order to prevent inequitable windfalls to either taxpayers or the Government that would otherwise result from inconsistent tax treatment of a single transaction, item, or event affecting the same taxpayer or a sufficiently related taxpayer. See also United States v. Dalm, 494 U.S. 596, 605-606 n.5 (1990); Rothensies v. Electric Storage Battery Co., 329 U.S. 296 (1946); Stone v. White, 301 U.S. 532 (1937). The doctrine of equitable recoupment may be applied to relieve inequities caused when a transaction is treated inconsistently under different taxes, such as the income tax and the estate tax. Bull v. United States, supra; Boyle v. United States, 355 F.2d 233 (3d Cir. 1965). However, the party asserting equitable recoupment may not affirmatively collect the time-barred underpayment or overpayment of tax. Equitable recoupment "operates only to reduce a taxpayer's timely claim for a refund or to reduce the government's timely claim of deficiency". O'Brien v. United States, 766 F.2d 1038, 1049 (7th Cir. 1985).

The doctrine of equitable recoupment is most often asserted in situations involving the interrelationship of the estate tax and the income tax. Indeed, the seminal case applying equitable recoupment is Bull v. United States, 295 U.S. 247 (1935). There, income had been included as an asset of the estate for estate tax purposes, and subsequently taxed as income to the estate; in a suit for refund of the income tax which was paid on that income, the estate was allowed recoupment for the estate tax it had previously paid.

There are a great number of possible applications of equitable recoupment to estate tax-income tax situations. A common denominator of the decisions is that they are inconsistent with one another.

Although equitable recoupment is a frequent consideration in settlement, it can be addressed most effectively at the time suit is filed. If resolution of the litigation is likely to have collateral consequences with respect to other taxes, it is well to determine how the transaction was treated with respect to the other tax, and whether the period of limitations is still open, or whether there is a claim pending with respect to the other tax, and a correlative adjustment could be taken into account in resolution of that claim. If the period for making a correlative adjustment is still open, one does not have to rely on equitable recoupment--an appealing, but chancy doctrine. Moreover, to focus on correlative adjustments early (particularly if the period is open) may facilitate settlement. If, hypothetically, the estate tax refund claimed is $1,000, but the correlative income tax adjustment would be an increase in tax liability of $300, the amount at issue in the case can be more accurately measured. And, of course, the same is true if the refund suit is for income tax, but may have estate tax consequences.

One estate-income tax situation which illustrates the inconsistency of the courts in this area is that involving an estate which sues for refund of the decedent's income tax which has been paid by the estate, and deducted as a claim for income tax purposes. Compare Wilmington Trust Co. v. United States, 610 F.2d 703 (Ct. Cl. 1979) (equitable recoupment inapplicable to reduce estate's recovery of income tax deficiency by the estate tax reduction achieved by deduction of that deficiency), with United States v. Herring, 240 F.2d 225 (4th Cir. 1957), United States v. Bowcut, 287 F.2d 654 (9th Cir. 1961), and Rev. Rul. 71-56, 1971-1 C.B. 404 (estate, in unsuccessful suit for refund of income tax deficiency paid, could recover estate tax overpaid by reason of failure to deduct such taxes).

An estate's administrative expenses, as well as losses, can be claimed as deductions either on the estate tax return or on the income tax returns of the estate (or its successor(s)). These include, for example, interest incurred on the federal estate tax, payment of which is deferred under § 6166A of the Code. See Rev. Rul. 81-256, 1981-2 C.B. 183; Rev. Rul. 81-287, 1981-2 C.B. 184. And see Treas. Reg. § 1.163-9T(b)(1)(v). Similarly, attorney fees can be claimed as deductions either on the estate tax return or on the income tax returns.

To preclude the allowance of such deductions a second time (or their offset against the sale price of property in determining gain or loss), § 642(g) of the Code provides that such deductions or offset shall not be allowed for income tax purposes unless a waiver is filed of the right to claim them for estate tax purposes. There are occasions, however, when the deductions have been claimed for income tax purposes, no waiver is filed, and the statute of limitations on income tax assessments has run. In this situation, Rev. Rul. 81-287, supra, holds that equitable recoupment is applicable against a claim for refund of estate tax, where the estate seeks (or has been allowed) a double allowance.

Accordingly, in any suit by an estate seeking a refund of estate taxes and claiming deduction of the attorney fees incurred in such prosecution, ascertain whether such fees have already been deducted for income tax purposes. See Rev. Rul. 81-287, supra. In this situation, before agreeing to a deduction of attorney fees, we generally ask for an affidavit by the administrator of an estate to the effect that attorney fees have been paid and have not been and will not be deducted for income tax purposes.⁽¹⁷⁾

Probably the most typical estate-income tax situation involving equitable recoupment is the situation where the valuation or includibility of an asset in the gross estate determines basis for income tax purposes.

Again, when an estate tax case is filed, it is desirable, at this juncture, to determine if there would be any correlative income tax adjustments if the estate were to prevail. To do so, for example, one must ascertain what happened to the property in question. Is it still held by the estate, or the heirs, beneficiaries, legatees, or recipients of transfers includible in the estate? Was it sold by the estate? Was it sold by the heirs, legatees, or beneficiaries? If so, how was gain or loss reported? Is the period of limitations open or closed? We have found that oral representations that the property has been retained by the estate and/or beneficiaries may turn out to be untrue when confirmation in writing is requested. For that reason, obtain written confirmation.

The Division (and, following our lead, the Service) have endeavored to address this situation by the use of collateral agreements affecting basis, executed by the present holders of the property, whether the executor or administrator, heirs, beneficiaries, distributees, or donees.⁽¹⁸⁾ Such agreements are intended to protect the Government in the situation where the estate and/or beneficiaries have not disposed of the property in a taxable transaction.

If the year in which a taxable disposition occurred is closed and additional income tax is due, the Trial Attorney should attempt to obtain a reduction in the estate tax refund equal to the additional income tax due under the doctrine of recoupment. If the year is open, the offer can provide for the filing of amended returns which are consistent with the settlement.

The income tax consequences of an estate tax determination of includibility or valuation in the estate is a situation which at least one court has addressed (incorrectly, we believe) under § 1311, as a § 1312(7) adjustment.⁽¹⁹⁾ It held that the requirements of § 1312(7) had been met, where the Tax Court had determined higher values than those reported on the estate tax return, and the beneficiaries of the estate had used the returned values for income tax purposes, with resulting barred overpayments. Chertkof v. United States, 676 F.2d 984 (4th Cir. 1982). In so doing, Chertkof invalidated Treas. Reg. § 1.1311(a)-2(b).⁽²⁰⁾ In a similar situation, but without addressing the correctness of Chertkof, the Seventh Circuit held § 1311 inapplicable, on the ground, inter alia, that the error (the use of a lower basis) did not occur "in respect of" the basis-determining transaction, as required by § 1312(7)(A). O'Brien v. United States, 766 F.2d 1038 (7th Cir. 1985). Additionally, O'Brien held the doctrine of equitable recoupment inapplicable, stating (766 F.2d at 1049): "The doctrine * * * operates only to reduce a taxpayer's timely claim for a refund or to reduce the government's timely claim for deficiency."

Equitable recoupment has been asserted (generally without any objection by the taxpayer) where a taxpayer seeks a refund of Railroad Retirement Taxes, and, were the taxpayer to prevail, FICA taxes would be due. Section 6521 specifically provides for mitigation, i.e., offset, in SECA-FICA situations.

V. COLLECTIBILITY SETTLEMENTS

The ability or inability of a taxpayer to pay the United States' claim against the taxpayer is a factor which should be taken into account in considering settlement. When a compromise is reached for the sole reason that it is unlikely that the full amount of a judgment or the Service's claim can be collected, in Division terminology we have entered into a "collectibility settlement." Sometimes a settlement will take into account both doubt as to collectibility and litigating hazards. For example, the Government's chances of winning a $500,000 case may be 60% but the taxpayer is unable to pay fully even a judgment for $300,000, plus interest, so additional negotiation may occur to take into account the taxpayer's inability to pay.

The goal in negotiating a collectibility settlement is first to collect from the taxpayer an amount which closely approximates the value of the taxpayer's net equity in assets that would be legally and practically obtainable through available enforced collection procedures, either administrative or judicial. Second, looking at the taxpayer's likely financial situation in the upcoming five to 10 years (the period depending on such factors as the age of the taxpayer), we attempt to collect additional amounts from taxpayer's annual income over and above that income necessary to pay the taxpayer's reasonable living expenses.

A settlement based on a taxpayer's inability to pay the entire amount of the liability may be entered into either before or after entry of judgment. Of course, if a case can be settled on a collectibility basis after judgment, it is likely that it was amenable to settlement on that basis before judgment was entered. Thus, it makes a great deal of sense to determine whether a collectibility settlement is possible before instituting discovery or doing other work designed to advance the case toward resolution on the merits. For example, frequently in responsible person cases where the liability is large, the assessed parties are unable to pay fully the entire amount, including statutory interest. In these cases and in other cases which seem susceptible to settlement on a collectibility basis, it is helpful early in the proceedings to ask the opposing counsel whether he or she will be considering settlement as the case progresses. The Trial Attorney may use the conversation as an opportunity to explain that the Tax Division settles cases on two bases, litigating hazards and collectibility, or a combination of these factors. Stress from the very beginning that Division policy on collectibility is based on inability to pay, not mere difficulty in paying.

In order to lay the proper foundation for a collectibility settlement that is in the Government's best interests, the Trial Attorney should advise the opposing counsel that, before beginning the negotiation process, the taxpayer should accept the premise that all assets not required to maintain a reasonable standard of living will be disposed of and paid over to the Internal Revenue Service pursuant to the settlement and that a commitment will likely be made to pay additional amounts from future income. Also, the Trial Attorney should explain that an essential part of the process will be identifying and verifying the taxpayer's assets. Before negotiating the terms of a settlement, the Trial Attorney must obtain information as to the taxpayer's financial situation and the taxpayer will be required to cooperate in providing bank records and other information needed to verify the statement.

Before negotiating a settlement based on collectibility, or if the taxpayer makes an unsolicited offer on a collectibility basis, the taxpayer should be asked to submit a Statement of Financial Condition and Other Information (DJ-TD 433 (1996)), set out in the Appendix as Exhibit C. The letter transmitting to the taxpayer a blank Statement of Financial Condition and asking that it be completed and returned must be accompanied by the Privacy Statement which is part of Exhibit C.

The Tax Division uses its own form because Treasury Form 433-A or 433-B is inadequate for our purposes. For example, it does not contain sufficient information about prior transfers--a taxpayer may have no money whatsoever, but the reason may be that everything has been given away to the taxpayer's children. (When considering compromise of a judgment, Rule 69 interrogatory answers containing up-to-date financial information may take the place of a Statement of Financial Condition and Other Information.)

It is not unusual for a taxpayer, inadvertently or by design, to misstate either assets or liabilities. For this reason, you should ask the Internal Revenue Service to verify the financial statement whenever the Government is making a substantial concession based on collectibility. As a rule of thumb, the financial statement should generally be verified where the Government's concession, based on collectibility, is $50,000 or more, including accrued statutory interest, unless the Trial Attorney has determined, as set forth in a memorandum to the file, that the information disclosed by the taxpayer is substantially correct. If the amount of the liability sought to be compromised is less than $50,000, the Service should be requested to verify the financial information only if the information disclosed appears to be inaccurate in light of the other information available to the Trial Attorney, including the taxpayer's income tax returns.

The Trial Attorney should obtain, either from the Service or the taxpayer, copies of the taxpayer's income tax returns for the last five years. In some cases, it may be advisable to obtain copies of the income tax returns for all years beginning with the year to which the liability relates to assist in verifying that fraudulent conveyances have not been made. Fraudulent conveyances are most likely to occur during audit, or shortly before the taxpayer initiates suit drawing attention to taxpayer's situation.

Tax returns can provide very interesting insights into a taxpayer's financial situation, as when the taxpayer reports income from dividends or interest, but no stocks or bank accounts are shown on the financial statement, or where mortgage interest is deducted for real estate not shown on the return. If a taxpayer reports on the tax return a sale of capital assets, ascertain what happened to the proceeds. It is also helpful to see the taxpayer's earnings history. A taxpayer currently without employment may have substantial earnings potential once employment is found, as can be seen from prior years' wage income. Also, a taxpayer may show stock having no or unknown value on the financial statement which turns out to be stock in a closely held business. The tax returns of the closely held corporation may provide information which will assist in evaluating how the income and assets of the business should be taken into account in negotiating the settlement.

If the taxpayer has obtained loans, the Trial Attorney should obtain copies of the loan applications. These applications either will be consistent with the information provided on the financial statement and provide a measure of assurance that the financial statement is correct, or will be inconsistent and helpful for that reason.

If, by virtue of the financial statement or otherwise, the Trial Attorney is aware that the taxpayer owns a controlling interest in a business, the Trial Attorney should immediately request the taxpayer to provide a financial statement for the business so the income and/or the liquidation potential can be taken into account. Asking for this additional financial statement early in the discussions will save considerable time for the Internal Revenue Service and the Division in its consideration of an offer.

In negotiating a settlement, the Trial Attorney should attempt to maximize the amount that the taxpayer will pay shortly after acceptance of the offer and minimize utilization of installment or deferred payment agreements. If the settlement includes an installment or deferred payment agreement, the unpaid amount generally should include statutory interest from the date of acceptance of the offer.

A collateral agreement should be considered in any proposed settlement based upon the taxpayer's inability to pay. There are two types of collateral agreements commonly used by the Division which enable the Government to recover part or all of the difference between the amount of the offer and the liability settled. They are collateral agreements based on future income and those by which a taxpayer gives up present or future tax benefits. The theory underlying a collateral agreement is that, since the balance of the taxpayer's liability will be abated once the taxpayer satisfies the terms of the offer, it is reasonable to expect that the taxpayer will agree to pay additional sums from future income or to give up potential tax benefits as additional consideration for acceptance of the offer.

The total amount which can be recovered under an offer and collateral agreement is the equivalent of the total liability compromised, plus interest and additions to tax that would have accrued in the absence of the settlement.

Future income collateral agreements are used most frequently. Copies of the forms Collateral Agreement--Future Income-Individual and Collateral Agreement--Future Income-Corporation are attached as Exhibit T. Under the terms of a future income collateral agreement, a taxpayer is obligated to pay, for each year the agreement is in force, graduated percentages (generally ranging from 20 to 50%) of "annual income" in excess of a threshold amount or floor.

The threshold or floor at which percentage payments begin to be due must be negotiated with an individual taxpayer in each case. Among the factors to be considered by the Government are the number of dependents, expected changes in the size of the family, number of wage earners in the family, FICA taxes withheld, and unusual expenses, such as alimony, child support, and abnormal medical and dental costs. The completed Form DJ-TD 433 (1996) will contain information concerning living expenses. Note, however, that the purpose of the threshold is not to maintain the taxpayer's present living standard, which may be extravagant, but to allow the taxpayer to retain a reasonable amount of income before payments under the collateral agreement become due. Internal Revenue Service Special Procedures should be contacted as they have knowledge of what terms are accepted in a particular area and the local cost of living. A typical provision for an individual taxpayer might be as follows:

For a corporation, the usual threshold or floor is $10,000, and the agreement usually provides for the payment of 30% of annual income more than $10,000 and less than $15,000, and 50% of annual income exceeding $15,000.

Future income collateral agreements, for both individuals and corporations, usually run for a period of 10 taxable years. A shorter period (no less than five years) can be considered in individual cases where, for example, the taxpayer is elderly and retired or will soon retire.

The term "annual income" is defined in the text of the collateral agreement itself to include, inter alia, all nontaxable income, including the fair market value of gifts, bequests, devises and inheritances. Annual income is reduced by federal, state, and local income taxes reportable for the year for which annual income is being computed, provided that such taxes have been reported and paid. Annual income is further reduced by any regular monthly, annual, or other periodic payment made under the settlement for the year in which such payment is made. It is usually advisable to use the standard definition on the collateral agreement form, but in situations where the taxpayer is self-employed there may be additional complexities to be considered.

A future income collateral agreement is appropriate in those situations where it appears reasonably likely that the taxpayer will have future annual income over and above the taxpayer's necessary living expenses during the period of the agreement. Therefore, if a taxpayer is presently unemployed but is still able to work and has an employment history showing the ability to command annual income greater than the threshold amount, a collateral agreement should be negotiated. On the other hand, if the taxpayer has a lengthy work history and has never earned income greater than the threshold amount, a collateral agreement may not be in the Government's best interests. Generally, where the taxpayer is making a lump-sum payment and has no prospects, collateral agreements will not be required merely because an unlikely event may occur, such as the winning of a lottery or the unexpected inheritance of assets in the future (although it may be appropriate if the inheritance is substantial and appears reasonably likely to occur during the period of the collateral agreement).

Under the terms of the future income collateral agreement, each year the agreement is in force the taxpayer is required to submit to Special Procedures a sworn statement of annual income and copies of the taxpayer's current federal, state, and local income tax returns for the year for which annual income is being computed. Copies of the annual income forms for individuals and corporations are attached as Exhibit U.

After the Trial Attorney has received the executed collateral agreement, he or she should send the original and two copies of the executed collateral agreement to Internal Revenue Service Special Procedures for monitoring of the agreement. A copy of a form letter is attached as Exhibit V. Copies of the agreement should be placed in both the DJ file and the Trial Attorney's personal file.

Where the taxpayer has incurred net operating losses or capital losses for years ending before the date on which the offer will be accepted, and/or the taxpayer has any unused credits from any such prior years, a collateral agreement waiving any carryover of such losses and credits should be considered. This collateral agreement should be used only when the taxpayer is not executing a collateral agreement as to future income as a part of the settlement, since the collateral agreement as to future income contains a waiver of carryover of losses and credits. A copy of the Collateral Agreement--Waiver of Carryovers is attached as Exhibit W.

There are many factors to be considered in deciding how a residence owned or co-owned by the taxpayer should be taken into account in a collectibility settlement. If the taxpayer co-owns the residence with his or her spouse, it is essential to understand any restrictions imposed by state law on the sale of the house by the Government. In many states, the case law is settled that the residence may be sold and each spouse will share equally in the proceeds. In other states, the law is unsettled. While in many situations a collectibility settlement will not involve the sale of the residence, knowing whether it can be sold and the amount that likely can be recovered from it will provide the Trial Attorney with the necessary understanding of the collection potential with respect to this issue.

The Trial Attorney must analyze the taxpayer's equity in the residence. If the residence is a modest one and is mortgaged for 80% of its value, in many situations a collectibility settlement will not require the sale of the residence. For example, a forced sale may not result in any payment to the Government. Moreover, lodging is a necessary living expense and, normally, it will be less expensive, or no more expensive, for the taxpayer to live in the residence, continuing mortgage payments, than to rent an alternative place to live. Even if the residence is mortgaged to the extent of 80% of value, however, the taxpayer's equity may be significant enough to require the sale of the home and payment of that equity to the Government. This most frequently occurs when the house is a lavish one or where there is less expensive alternative lodging clearly available, such as where the taxpayer also owns other, more modest, residential real estate.

In situations where there is equity in the residence which can be withdrawn by borrowing and the income to support increased mortgage payments exists, it is usually in the Government's best interests to make the taxpayer's borrowing a condition of settlement. This borrowing will enable the Government to receive a greater cash payment up front. This lump-sum payment is preferable to receiving payments over time pursuant to a collateral agreement both because it has more real dollar value and because it is surer to occur.

Generally, the Division will not work out a settlement solely on the basis of collectibility in foreclosure actions and fraudulent conveyance actions brought by the Government in order to reach and sell the taxpayer's residence. That is because the Division has determined, prior to bringing the suit, that the sale of the residence is warranted. The most common exception, however, is where the taxpayer seeks alternative ways, usually by borrowing, to pay over the equity in the property to the Government. The Trial Attorney should always question taxpayer's counsel closely about the source of funds to be used to make payments of this type, and seek verification where appropriate, to assure that hidden taxpayer funds are not the source.

The Trial Attorney must know the value of the property as a starting point in determining the value of the taxpayer's equity. The Internal Revenue Service should be requested to determine the range of amounts the Government would likely receive from the sale. Normally, the Service will determine the fair market value and the forced sale value. The Trial Attorney should inquire how those values have been determined and verify that any discount is appropriate. It is important that the fair market value be determined by a revenue officer or real estate broker or agent familiar with comparable sales in the area in which the property is located. No discount should be allowed for lack of marketability of property with a clouded title when the property would be sold after a judicial foreclosure. Moreover, while it is true that property will probably sell for less at forced sale, this is not always the case. The Trial Attorney should inquire about any special circumstances, such as a known, potential purchaser or particularly favorable market, which nullify or mitigate against the property's being affected negatively by the fact of a forced sale.

Once the Trial Attorney has determined the likely result of a forced sale, it is possible to begin negotiating the buy-out figure which should be around the midpoint between fair market value and forced sale value. Both values are estimates and have elements of risk and opportunity to both parties. It is reasonable that neither party bear entirely either the risk or the opportunity of the sale eliminated by the buy-out.

Taxpayers sometimes ask what they can do in order to avoid being subject to the terms of a collateral agreement for a period of years. The alternative is for the taxpayer to increase the up-front cash payment to an amount which will fairly substitute for the potential amount that would be paid pursuant to the collateral agreement, reduced to present value.

Normally, the taxpayer will obtain the additional funds by gift or borrowing. A residence in which the taxpayer and his or her spouse have significant equity is often the collateral for the borrowing. A spouse may be willing to provide the taxpayer access to the spouse's equity in the residence, preferring the known quantity of an increased mortgage payment to the contingent nature and reporting requirements of the collateral agreement.

If a case is being settled on the basis of taxpayer's inability to pay, an asset that the taxpayer can offer in settlement is waiver for federal tax purposes of: (1) any deduction for the payments made pursuant to the settlement; (2) loss carryovers; or (3) credit carryovers. Additionally, in a bankruptcy settlement, an agreement as to reduction of basis of the assets of a reorganized debtor might provide additional consideration for the settlement.

A settlement including deferred or installment payments and/or a collateral agreement should provide for security for the taxpayer's obligations under the settlement. Thus, tax liens should not be released. In negotiating a settlement before judgment has been entered, the Trial Attorney generally should have the taxpayer agree to entry of judgment for the full amount of the Government's claim. If judgment is not to be entered, the taxpayer must waive the benefit of any statute of limitations applicable to the assessment and collection of the liability sought to be compromised and agree to the suspension of the running of the statutory period of limitations on assessment and collection for the period during which the offer in compromise and the settlement are pending, or the period during which any payment due under the settlement remains unpaid, or any provision of the settlement is not carried out in accordance with its terms, and for one year thereafter.

The settlement should provide that the judgment will be marked satisfied after the judgment debtor has completed all obligations under the settlement, including any collateral agreement.

The settlement should cover the Government's options in the event of default by the taxpayer. These options are set forth in the collateral agreement form. If the taxpayer will not be executing a collateral agreement as a part of the settlement, the settlement should set forth the appropriate options.

Abstracts of judgments and other security received for payments, whether received before or after settlement, should be filed and/or recorded in the appropriate districts or other appropriate local offices, except if the settlement provides otherwise. Originals of legal documents, such as mortgages, notes, letters of credit, and insurance policies, should be preserved in a Tax Division safe, and the Trial Attorney should prepare a memorandum to the file setting forth the location of the document.

When the terms of settlement require payments to the Government, the Trial Attorney should give some thought to where the payments should be sent by the taxpayer and who will be responsible for monitoring the receipt.

Taxpayers generally should be directed to send to the Tax Division the following categories of payments:

Taxpayers generally should be directed to send directly to Special Procedures the following categories of payments:

Addresses and telephone numbers of Special Procedures Offices are attached as Exhibit X.

It is the responsibility of the Trial Attorney, with the assistance of a collection paralegal, to monitor the receipt of payments which are directed to the Tax Division and to take appropriate measures on default.

Form acceptance letters in cases where payments are due the Government, under the compromise, and forms of stipulations of dismissal and stipulations for entry of judgment in such cases, are set out in the Appendix as Exhibits K, L, and M. Bear in mind that these forms are simply forms, and must be adapted to the particular case. Thus, they must be crafted bearing in mind all the provisions of the settlement, including those providing for security for the amounts due under the compromise, as well as the directions necessary concerning receipt and monitoring of payments.

Upon receipt of all payments due to be paid directly to the Tax Division (or, if all payments are to be made to the United States Attorney or the Internal Revenue Service, then, upon acceptance of the settlement offer), the case should be closed in the Tax Division. Thus, if all payments are to be made to Special Procedures, the case should be closed and referred to Special Procedures for monitoring of the settlement agreement and receipt of the payments, including payments that may be due under a collateral agreement. Special Procedures should be requested to advise the Tax Division upon any default by the taxpayer, or upon receipt of the final payment due so that any judgment entered may be marked satisfied. If all payments pursuant to a settlement are to be made to the United States Attorney, the Trial Attorney should close the case in the Tax Division and refer it to the United States Attorney.

When the taxpayer has fully complied with the terms of the settlement, the Trial Attorney should:

Normally, the Section Chief has the authority to determine when the taxpayer is in default on a settlement. In the event of a default, the Trial Attorney should proceed as follows:

VI. ALTERNATIVE DISPUTE RESOLUTION

On April 6, 1995, the Attorney General signed an order promoting broader use of Alternative Dispute Resolution in civil cases as a tool for resolving disputes between the Government and its citizens in as prompt, efficient, and inexpensive a manner as possible. As used here, Alternative Dispute Resolution ("ADR") is any nonbinding dispute resolution process facilitated by a third-party neutral. ADR methods include, but are not limited to, arbitration, mediation, early neutral evaluation, and neutral expert evaluation.⁽²³⁾ ADR may be conducted pursuant to the agreement of the litigants, or it may be court-mandated.

The Tax Division always has had, and continues to have, a policy of settling cases, where appropriate, as early in the litigation as reasonably possible. To further this policy, in cases where the attorney assigned to the case, in consultation with his or her reviewer, believes that ADR may be appropriate, he or she should consider using an independent third-party neutral through a court-sponsored program, from another Government agency, or from outside of the Government. Where court-sponsored and/or court-annexed ADR programs are available, Division attorneys are expected to utilize and participate fully in such programs in all appropriate cases.

ADR is not a substitute for traditional negotiation, but rather provides attorneys with additional tools to facilitate settlement of cases on an appropriate basis at the earliest stage at which such a settlement reasonably can be reached.

Attached as Exhibit Y is a statement setting out Tax Division Case Selection Criteria for Alternative Dispute Resolution. Note that many of the factors favoring and disfavoring ADR are the same factors favoring or disfavoring traditional settlement. However, there are additional factors favoring ADR as opposed to traditional settlement, either as a means to reach any settlement or as a means to reach settlement more quickly than is anticipatable using traditional settlement methods.

Bear in mind that a settlement is a settlement, whether or not achieved through ADR. Accordingly, the same jurisdictional lines for approving settlement are applicable, and the IRS recommendation must be obtained in Standard cases, whether the settlement is reached through traditional negotiation or ADR.

Information with respect to engagement of third-party neutrals and their compensation will be supplied in the future.

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Table of Exhibits