Judicial Application of Issue Preclusion in Tax Litigation

By Grover Hartt III and Jonathan L. Blacker

This article considers the historical development of collateral estoppel and its unique application to tax cases; the article concludes with several suggestions for the more effective use of collateral estoppel.

Commissioner v. Sunnen. The controversy in Commissioner v. Sunnen, 333 U.S. 591, 604 (1948), related to the assignment of income. The Tax Court gave collateral estoppel effect to a decision by the Board of Tax Appeals for an earlier year, holding that the royalties assigned to the taxpayer’s wife were not his income. The Eighth Circuit affirmed that decision in part but also held in favor of the taxpayer on the merits for other years in dispute.

The Supreme Court held that when different tax years are at issue, a prior judgment only acts as collateral estoppel in the second proceeding on matters actually litigated and determined in the first case. The Court expressed concern about the possibility of abuse of the doctrine by taxpayers when the facts or law upon which the former decision was based changed in the future. This potential abuse was to be prevented by a rigorous insistence that the factual and legal issues in the two cases be identical before collateral estoppel would be applied and by requiring that any intervening “change [in] the legal atmosphere” would preclude its application.

Montana v. United States. The Supreme Court held in Montana v. United States, 450 U.S. 544 (1981), that the federal government could be estopped from relitigating an issue a state court had decided adversely to a private party effectively controlled by the government. The private party, a contractor, hired to build a federal dam, brought suit in Montana’s courts at the behest of the federal government, claiming that a state gross receipts tax unconstitutionally discriminated against the United States and its contractors. The federal government financed and controlled this litigation. Following an adverse decision in the Montana Supreme Court, the solicitor general abandoned the contractor’s request for review by the U.S. Supreme Court. During the litigation in Montana’s courts, a similar challenge brought by the government in a federal district court had been continued. That litigation was resumed after the outcome in state court.

The Supreme Court rejected the attempt to distinguish the state decision on grounds that the contractual provisions in the federal suit were different. It enumerated three questions that were to be answered before collateral estoppel would be invoked: (1) whether the issues in the second case were “in substance” the same as those involved in the first proceeding; (2) whether the controlling facts or legal principles had changed significantly since the first case was decided; and (3) whether any “special circumstances” warranted an exception from the normal rules of collateral estoppel. The Montana Court eliminated Sunnen’s identical facts requirement.

The road from Montana. Other courts have agreed that Montana modified, but did not overrule, Sunnen. Montana has been used to dispose of attempts to escape collateral estoppel by recasting the issue or relying on factual differences that are not material.

Several years after Montana, the Tax Court held in Peck v. Commissioner, 90 T.C. 162, 166-167 (1988), that for collateral estoppel to apply, the following conditions must be met: (1) the issue in the second suit must be identical in all respects with the one decided in the first suit; (2) there must be a final judgment rendered by a court of competent jurisdiction; (3) collateral estoppel may be invoked against parties and their privies to the prior judgment; (4) the parties must actually have litigated the issues, and the resolution of these issues must have been essential to the prior decision; and (5) the controlling facts and applicable legal rules must remain unchanged from those in the prior litigation.

Criminal and civil fraud cases. The most frequent encounter with collateral estoppel in a tax case involves a taxpayer accused of both civil and criminal tax fraud for acts occurring in the same tax year. A conviction for criminal tax fraud will be sufficient to support the invocation of collateral estoppel to prevent the relitigation of the fraud issue in a subsequent civil case. The converse, however, is not true; an acquittal on a charge of criminal tax fraud does not preclude a subsequent assertion by the Service that the same act(s) constitute civil tax fraud. In a civil case that follows a criminal prosecution, the fraud issue has particular significance because it has the ability to keep the statute of limitations open indefinitely. This consideration is important because the Department of Justice’s traditional policy has been to defer pursuit of a related civil case until the criminal case has been concluded.

Bankruptcy cases. Although sometimes overlooked, the bankruptcy courts constitute a fourth forum available for the determination of tax liabilities, the terms for their payment, and the consequences of nonpayment.

One of the most common collateral estoppel issues involves the assertion that a prior ruling by a different court holding a party liable for a debt should prevent that party from contending that the debt is nondischargeable in a subsequent bankruptcy proceeding. Although many debts are discharged in bankruptcy, the Bankruptcy Code provides a number of exceptions. The Supreme Court has expressly held that collateral estoppel principles apply in bankruptcy proceedings and that a ruling by a court prior to the initiation of the bankruptcy proceeding may preclude relitigation of the same issue in the context of an objection to discharge of the debt.

Tax shelter litigation. In 1982 Congress enacted the Tax Equity and Fiscal Responsibility Act (TEFRA), which “allowed the government to challenge efficiently partnership tax shelters in one consolidated partnership-level proceeding rather than multiple partner-level proceedings.”

One important feature of TEFRA is that a dispute regarding the treatment of partnership items or the allocation of these items among partners is resolved at the partnership level in one unified administrative or judicial proceeding rather than numerous separate partner-level proceedings. The goals of TEFRA complement those of collateral estoppel: establishing a single, uniform determination of the tax issues relating to partnership items, avoiding inconsistent results, and conserving resources.

Procedural issues. Many courts have held that the protection offered by the doctrine of collateral estoppel will be waived if it is not asserted in a timely manner. In the Tax Court, collateral estoppel must be pled as an avoidance or affirmative defense.

In a refund suit, a taxpayer must sustain an additional burden in asserting collateral estoppel by including it in the claim for refund or risk being trumped by another affirmative defense: variance. Conversely, the general rule is that the government may assert any defense to a refund suit at least up to the point of trial, conditioned upon the taxpayer’s ability to request a continuance.

A party seeking to rely upon collateral estoppel should assert it at the earliest possible opportunity. One possibility for a party relying on offensive collateral estoppel is to raise its applicability through a motion under Federal Rule of Civil Procedure 16(c), asking the court to prevent the de-fendant from relitigating an issue. Another option is to file a motion for summary judgment based upon collateral estoppel.


This article is an abridged and edited version of one that originally appeared on page 205 of The Tax Lawyer, Fall 2005 (59:1).

For more information or to obtain a copy of the periodical in which the full article appears, please call the ABA Service Center at 800/285-2221.


Periodicals: NewsQuarterly, quarterly newsletter; The Tax Lawyer, quarterly journal; The Practical Tax Lawyer (published by ALI-ABA in cooperation with the Section), subscription available to Section members at a significant discount; The State and Local Tax Lawyer, annual journal.

Books and Other Recent Publications: Effectively Representing Your Client Before the “New” IRS: A Practical Manual for the Tax Practitioner with Sample Correspondence and Forms; Sales and Use Tax Deskbook; The State and Local Tax Lawyer; Property Tax Deskbook; A Comprehensive Analysis of Current Consumption Tax Proposals; State and Local Taxation of Banks and Other Financial Institutions; Value Added Tax: A Model Statute and Commentary.

Grover Hartt III is Assistant Chief, Civil Trial Section, Southwestern Region, Department of Justice, Tax Division; he can be reached at . Jonathan L. Blacker is a trial attorney in the Civil Trial Section, Southwestern Region, Department of Justice; he can be reached at .

Copyright 2007

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