What to Do After Receiving an Adverse Ruling

An adverse ruling from the Internal Revenue Service (IRS) is a formal, negative determination in response to a taxpayer’s request. These requests often come in the form of a private letter ruling or a determination letter, where a taxpayer seeks the IRS’s official position on a specific transaction before it is completed. An adverse ruling signifies that the agency’s stance is contrary to the desired outcome and signals that the IRS is likely to challenge the tax position upon a future examination.

Triggers for an Adverse Ruling

Adverse rulings originate from taxpayer-initiated requests for guidance on complex transactions. For example, a corporation planning a merger might request a private letter ruling to confirm the transaction qualifies as a tax-free reorganization. If the IRS concludes the proposed structure fails to meet statutory requirements, it will issue an adverse ruling stating the transaction is viewed as taxable.

Another common scenario involves worker classification. A business may ask for a determination on whether a worker can be treated as an independent contractor. If the IRS finds the business exercises significant control over the worker, it will issue an adverse determination classifying the individual as an employee, which has significant payroll tax implications. Similarly, an organization seeking to establish a retirement plan may request a determination letter that the plan is “qualified.” An adverse ruling could be triggered if plan provisions are found to be discriminatory, jeopardizing the plan’s tax-deferred status.

Required Information for an Appeal

Before initiating a formal appeal, a taxpayer must compile information into a formal protest letter. This letter must include a copy of the IRS letter showing the disputed findings, often called a “30-day letter.” The protest must also contain:

• The taxpayer’s name, address, and a daytime telephone number.
• A statement indicating the intent to protest the proposed determination.
• A detailed explanation for disagreeing with the IRS’s findings, including a statement of the facts and a summary of the law or other authority the taxpayer is relying on.
• Supporting documents, such as contracts or financial statements, to substantiate the facts.
• A signature with a declaration made under penalties of perjury, affirming that the stated facts are true, correct, and complete.

The Appeals Process

The formal appeals process begins when the taxpayer sends the complete protest package to the IRS address provided in the 30-day letter, within 30 days of the date on that letter. If the total amount of proposed tax and penalties for any period exceeds $25,000, a formal written protest is mandatory. For smaller cases, a less formal “small case request” may be sufficient.

Upon receiving the protest, the case is forwarded to the IRS Independent Office of Appeals, which is designed to resolve tax controversies without litigation. An Appeals Officer is assigned to the case and will review the protest and the initial examiner’s findings. The taxpayer will then be invited to an appeals conference, which is an informal meeting to discuss the disputed issues.

Potential outcomes vary. The Appeals Officer may concede the issue, the taxpayer may concede, or a settlement may be negotiated. A settlement often involves a compromise on the amount of tax or the abatement of penalties. If no agreement can be reached, the IRS will issue a statutory notice of deficiency, which grants the taxpayer 90 days to file a petition with the U.S. Tax Court.