The life cycle of a tax dispute begins with an audit conducted by an Internal Revenue Service (IRS) agent. This is a review or examination of an organization or individual’s accounts and financial information initiated by mail correspondence. Revenue agents are likely accountants, CPAs, or similarly educated individuals who are not typically attorneys. They usually request information or documents by issuing an Information Document Request (IDR) directly to the taxpayer. However, the IRS has broad information-gathering powers and can request information from third parties. For example, the IRS may serve a summons on a taxpayer or other party, but this is generally reserved for situations when a taxpayer or other party will not voluntarily produce the requested information.
Initiating Litigation or Requesting Review
Depending on the issue, a taxpayer that disagrees with the IRS’s decision following an examination generally has two options: seek administrative review by the IRS Independent Office of Appeals (IRS Appeals) or seek judicial review of the IRS decision. IRS Appeals is an office independent from the examination team that made the original decision. It is intended as an efficient route to resolve a tax dispute without litigation. An appeals officer may hold an informal appeals conference, providing a venue for both the taxpayer and the IRS to present arguments. The appeals officer, usually an attorney, acts as a pseudo-judicial party, considering both sides to reach a resolution.
For a formal judicial review of an IRS decision, a taxpayer can choose one of three courts: the US Tax Court, a US federal district court, or the US Court of Federal Claims. Taxpayer claims for overpayment of taxes brought in a federal district court or the Court of Federal Claims are considered tax refund suits. This means that the taxpayer must pay the amount determined by the IRS and then sue for a refund. However, in certain circumstances, a taxpayer may only need to pay a portion of the amount due. By comparison, cases instituted in US Tax Court are considered deficiency cases. This means the taxpayer can file a Petition with the US Tax Court without first submitting payment. For this reason, most deficiency cases are filed with the US Tax Court.
US Tax Court
Petition, Answer, and Reply
To initiate a case in the US Tax Court, a taxpayer (i.e., Petitioner) must file a Petition after the IRS issues a document considered the “ticket” to US Tax Court. The form of the document issued by the IRS varies depending on the taxpayer’s circumstances, but the following are common documents that begin the period to file a Petition with the US Tax Court:
- Notice of Deficiency,
- Notice of Determination,
- Notice of Certification,
- Notice of Final Partnership Adjustment, or
- Notice of Final Partnership Administrative Adjustment.
Depending on the case, the taxpayer must file the Petition within the applicable period.
Small tax cases with deficiencies and penalties of $50,000 or less may be litigated at the US Tax Court with simplified procedures known as “small tax case procedures.” A qualifying Petitioner may include a request in the Petition to apply small tax case procedures in the proceedings. If the Court grants the request, informal and simplified procedures are followed, and Federal Rules of Evidence are “relaxed.” In other words, trials of small tax cases are conducted as informally as possible, and any evidence that the court deems to have probative value is admissible. However, a Petitioner cannot appeal a case litigated under these procedures.
For all US Tax Court cases, the IRS (i.e., Respondent) has 60 days to respond to a Petition by filing an Answer and 45 days to file a motion concerning the Petition (e.g., Motion for More Definite Statement, Motion to Strike, or Motion to Dismiss). If the IRS files an answer, the taxpayer has 45 days to file a reply or 30 days to file a motion with respect to the answer (e.g., Motion for More Definite Statement or Motion to Strike).
Trial Date and Assignment of Judge
The US Tax Court consists of 19 presidentially appointed judges, along with senior judges serving on recall and special trial judges. In the US Tax Court, a judge is not automatically assigned to a case after a Petition is filed. A judge may not be assigned for weeks or months after a Petition is filed. Further, a trial date is not scheduled until after the case becomes at issue. A case is generally at issue after an answer, or any required taxpayer reply is filed.
In the US Tax Court, discovery cannot begin, without leave of the court, until 30 days after the case becomes at issue. Discovery and related motions must generally be completed or filed no later than 45 days before trial.
Unlike many courts, the US Tax Court expects the parties to attempt to complete discovery through informal consultation or communications before resorting to formal discovery rules, including formal interrogatories and requests to produce documents or depositions.
Instead, the parties rely upon “Branerton requests.” Branerton requests (based on a seminal decision in Branerton Corp. v. Commissioner, 61 T.C. 691 (1974)) are informal discovery requests that can include questions and document requests. While the court can limit the frequency or scope of Branerton requests, there is generally no limit on the number of requests that may be issued, and the parties are typically free to negotiate the scope of the requests and deadline(s) to respond. Parties can usually request any matter not subject to privilege relevant to the matter involved in the pending case.
The US Tax Court has referred to the stipulation process as the “bedrock of the US Tax Court practice,” and stipulations are a fundamental part of litigating in the US Tax Court. In effect, the US Tax Court Rules require the parties to stipulate to the fullest extent possible. The stipulation process is meant to help narrow issues before trial and avoid wasting hours of trial time calling witnesses to verify the authenticity of potentially hundreds, thousands, or tens of thousands of otherwise unobjectionable documents. However, the parties can reserve objections within a stipulation of facts. Notably, if a party has refused to execute or confer regarding a stipulation, the opposing party can file a Motion to Compel Stipulation. If granted, the US Tax Court issues an order requiring the delinquent party to explain the basis for not entering into a stipulation of facts.
Events Prior to Trial
Before trial, the US Tax Court may hold pretrial conferences and require the parties to file status reports for the case. The US Tax Court may also request that the parties submit a proposed pretrial schedule setting forth specific deadlines. For example, the proposed pretrial deadlines may address the last day to file or exchange with the other party the following: motions for summary judgment; stipulations of facts; motions to compel discovery; expert witness reports and rebuttal reports; pretrial memoranda; motions in limine; and any documents and materials for use at trial, including demonstratives.
A US Tax Court trial is open to the public and occurs at a federal courthouse in a city generally selected by the taxpayer. Although the US Tax Court is in Washington, DC, the US Tax Court judges will travel to the city selected for the trial’s location. The parties must abide by the Federal Rules of Evidence and the US Tax Court Rules of Practice and Procedure, which are generally mirrored in the Federal Rules of Civil Procedure. Unlike most litigation matters, the taxpayer usually has the burden of proof.
At the end of trial, the judge may decide the case via a bench opinion. In the absence of a bench opinion, the judge may request that the parties file: post-trial briefs, statements of legal authority, or memoranda. Both parties typically prepare findings of fact and post-trial briefs to submit to the court. If a case involves a complex tax matter or an issue of first impression, a US Tax Court judge may not issue an opinion for months or years following trial.
Privilege is an important consideration when defending a tax position. In addition to privileges typically found in other matters, such as attorney-client privilege and work product, there is also the Kovel doctrine (United States v. Kovel, 296 F.2d 918, 919 (2d Cir. 1961)) and the Internal Revenue Code section 7525 privilege. The Kovel doctrine may extend the attorney-client privilege to include non-attorney third parties that assist the attorney (e.g., experts). The Section 7525 privilege, unique to tax cases, may protect communications for obtaining tax advice between taxpayers and federally authorized tax practitioners (e.g., CPAs) in any noncriminal tax matter before the IRS and any noncriminal tax proceeding in federal court.
Each stage of the tax controversy process has distinct considerations. From examination to litigation, a thorough understanding of the process and applicable rules can make all the difference in the outcome of a tax dispute. However, certain missteps can have a significant impact on the outcome. Accordingly, we encourage anyone with a tax dispute to seek assistance and consult with experienced, independent counsel.