Volume 19, Number 6
WHAT TO CONSIDER IN CHOOSING A FORUM TO RESOLVE AN ORDINARY TAX DISPUTE
By Paul E. Treusch
A taxpayer who is unwilling to accept a proposed tax increase and wants to expedite the election of forums for a judicial resolution can request the immediate issuance of a deficiency letter. Once the letter has been issued, the taxpayer's choice of forums is triggered under the statute, which provides two options: The taxpayer may carry the dispute to the tax court, which may entitle the taxpayer to a judicial resolution even before the taxpayer pays the asserted tax deficiency; or the taxpayer may elect to pay the asserted deficiency in full and file a timely refund claim that, if denied, can be filed as a refund suit in district court or the Court of Federal Claims.
Jurisdictional limits. The tax court, district court, and the Court of Federal Claims are courts of limited jurisdiction. Jurisdiction of the tax court has been limited to the authority to redetermine correct tax liability and to certain types of tax, including income, estate and gift, and excess profits taxes. Even where the tax court's jurisdiction is not barred by the type of tax, the taxpayer may not be able to proceed in tax court because of the absence of a deficiency. This occurs if an additional asserted tax is paid in full before a formal deficiency letter has been mailed. Full payment may or may not preserve the ability to bring a post-payment refund suit in the district court or Court of Federal Claims. However, full payment after the mailing of a deficiency in order to stop the running of interest, regardless of when or even whether such mailed deficiency is ever received, will ordinarily not deprive the taxpayer of the tax court option. The tax court is empowered to determine the taxpayer's correct deficiency or overpayment of tax. Although it does not have jurisdiction to entertain a suit for refund directly, it is authorized to find an overpayment of tax and, in the event the refund is not made within the required time, to order the IRS to make the refund.
Deficiency and deficiency notice. The deficiency notice is a notification by the IRS that a deficiency in tax has been finally determined. It must state the basis for and identify the amount of tax due, interest, additional amounts, additions to the tax, and assessable penalties. The tax court requires that the notice, a copy of which is a required attachment to the petition instituting the proceeding, include any stated reasons justifying the claimed deficiency. The notice must be addressed to the taxpayer or the taxpayer's legally appointed representative, successor, or transferee. It must assert a deficiency in tax and/or penalty of the named taxpayer, for an identified tax and a named taxable year or years, and must include notice of the taxpayer's right to file a petiton in tax court within the statutory period. The actual date on which the deficiency letter is sent controls, not the date of notice or of actual receipt. Once the taxpayer has filed a petition in tax court, no additional or corrected deficiency notices can be sent.
A deficiency is the excess of tax liability reported in the taxpayer's return beyond the tax already paid, credited, or abated. Taxes affected are income, estate and gift, excess profit, or those levied with respect to private foundations under sections 4941-4944. It also includes penalties and certain additions. The deficiency must be more than a mere claim for overpayment of tax, rejection of a claimed refund, or rejection of the determination of a mere overpayment of tax.
Refund actions. In making the forum choice, the most critical factor is whether to seek judicial resolution before payment or after payment. Interest on asserted tax liability continues to run until payment, and payment in full before the deficiency letter has been mailed ordinarily bars the tax court option. Payment after the deficiency letter is mailed does not bar that option, although it may stop the running of interest.
The refund route specifically requires payment of the tax in full before either of the refund forums may acquire jurisdiction. Whether or not to make full payment, and when, present difficult choices, including whether or not the taxpayer can or should raise and pay the full tax amount. The time value of money involved in delaying payment as long as possible must also be considered.
The timing of payments also presents problems. Even though early payment may save further interest, it is not necessarily beneficial, especially at the appeals level because this normally presupposes that the taxpayer executed a Form 870AD. The execution of Form 870AD can seriously impact the choice of forum. It not only waives the tax court option but also may impact the taxpayer's ability later to elect the refund option because it includes a representation by the taxpayer that no refund of the agreed deficiency will later be claimed or prosecuted. Whether or not such representation may be expected to bar a later claim and suit for refund depends on which circuit court has jurisdiction over the refund suit. Although all circuits recognize that the closing agreement or compromise procedure is the exclusive means of assuring final settlement, they disagree on the degree of proof sufficient to support the defense of collateral estoppel.
Early payment after issuance of the deficiency letter has advantages in addition to stopping the running of interest. Early payment potentially can limit the reach of IRS efforts to claim in a refund suit a greater deficiency in the year or years covered by the letter. This potential limit on a deficiency claim is not a protection normally available in a refund suit.
The difference in taxpayer burden and government defenses represents a critical difference between tax court and refund claim forums. In tax court the taxpayer has a single burden, and the government's defenses are limited. In the refund forums the taxpayer carries a double burden of proving the correct tax liability and that this liability has been overpaid. The government generally has open-ended rights in defense. The government, of course, bears the burden when seeking a greater deficiency by amended answer in tax court or a reduced refund or deficiency by answer or counter-claim in a refund suit.
Additional factors. Agreeing to settle after, rather than before, suit has been instituted in tax court can make a difference. If settlement is reached after the disputed deficiency is presented to tax court for resolution, the settlement is incorporated into its decision. The court's decision becomes res judicata for the taxable year and a possible collateral estoppel for other taxable years not yet judicially resolved. Furthermore, the tax court has only limited jurisdiction, principally authority to redetermine the deficiency or to find an overpayment. However, tax court generally lacks the broad equity jurisdiction of a district court. Although tax court has the power to render declaratory judgments in statutorily defined situations and has limited power to grant injunctive relief, it is not clear whether it has the power to entertain equitable recoupment.
Other points to consider in deciding choice of forums include:
- Which court has the most favorable precedents;
- Whether the questions at issue would most appropriately be resolved by a jury rather than by a judge (no jury trials in tax court or Court of Federal Claims);
- Impact on settlement procedures;
- Whether a judicial resolution of the disputed issue calls for tax expertise and grassroots understanding of the tax law (tax court is a "court of tax experts");
- Significant procedural differences and the effect of the forums' different venues;
- Manner of trial (tax court offers considerable flexibility, informality, and less costly procedures);
- Availability, scope, and manner of taking pretrial discovery, as well as the availability of a formal pretrial conference with the trial judge; and
- Trial procedures.
Paul E. Treusch is a professor of law at Southwestern University School of Law in Los Angeles, California.
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This article is an abridged and edited version of one that originally appeared on page 83 of The Tax Lawyer, Fall 2001 (55:1).