Tax litigation in USA

Published by Lexology.

Article by: Steptoe & Johnson LLP – Carina C. Federico, J. Walker Johnson and Robert J. Kovacev

Competent courts

Which courts have jurisdiction to hear tax disputesTax Disputes arise when there is a disagreement between taxpayers and tax authorities regarding the interpretation or application of tax laws. These disputes may concern various issues such as the accuracy of a tax return, the eligibility for tax deductions or credits, the correct amount of tax liability, or transfer pricing adjustments. Tax disputes can lead to lengthy legal proceedings...?

A taxpayer can initiate a tax disputeTax Disputes arise when there is a disagreement between taxpayers and tax authorities regarding the interpretation or application of tax laws. These disputes may concern various issues such as the accuracy of a tax return, the eligibility for tax deductions or credits, the correct amount of tax liability, or transfer pricing adjustments. Tax disputes can lead to lengthy legal proceedings... in the US Tax Court, the Court of Federal Claims or federal district court. In Tax Court, a simplified small tax case procedure is available for certain cases involving US$50,000 or less. Trials in small tax cases are less formal and result in a speedier disposition, but the decisions cannot be appealed.Lodging a claim

How can tax disputesTax Disputes arise when there is a disagreement between taxpayers and tax authorities regarding the interpretation or application of tax laws. These disputes may concern various issues such as the accuracy of a tax return, the eligibility for tax deductions or credits, the correct amount of tax liability, or transfer pricing adjustments. Tax disputes can lead to lengthy legal proceedings... be brought before the courts?

To litigate in the Tax Court, the taxpayer must receive a statutory notice of deficiency (IRC Section 6213). Following an examination or consideration by IRS Appeals, the IRS will inform the taxpayer of any proposed deficiency and request payment. If the taxpayer does not pay the deficiency, the IRS will issue a statutory notice of deficiency. The taxpayer then has 90 days (or 150 days if the notice is addressed to a taxpayer outside the US) to file a petition with the Tax Court. In the Tax Court, the taxpayer seeks a determination that the assessment is incorrect and that no tax is due.

In contrast, to litigate in the Court of Federal Claims or a federal district court the taxpayer must first pay the tax. The tax payment can occur with the tax returnA Tax Return is a formal statement filed by an individual or entity that details income, expenses, and other pertinent tax information to a tax authority. Its primary purpose is to assess tax liability, determine refunds owed, or highlight outstanding taxes due. Tax returns may include information about earnings, capital gains, allowable deductions, and credits, depending on the tax regulations..., following an IRS examination in which a tax deficiency is proposed, or after consideration by IRS Appeals. Within the applicable statute of limitations (Code Section 6511), the taxpayer must then file an administrative refund claim with the IRS (IRC Section 7422). Unless the IRS disallows the claim sooner, the taxpayer must wait six months to file a complaint initiating the suit. If the IRS disallows the claim, the complaint must be filed within two years of the date of the IRS notice of disallowance. In these courts, the taxpayer seeks a determination that the tax is not legally owed and must be refunded.

In most cases, the tax Anti-Injunction Act (IRC Section 7421) prevents a taxpayer from filing suit to restrain the assessment or collection of tax and the Declaratory Judgment Act (28 USC 2201) prevents a taxpayer from filing suit to have a court declare whether the taxpayer is liable for tax.Combination of claims

Can tax claims affecting multiple tax returnsA Tax Return is a formal statement filed by an individual or entity that details income, expenses, and other pertinent tax information to a tax authority. Its primary purpose is to assess tax liability, determine refunds owed, or highlight outstanding taxes due. Tax returns may include information about earnings, capital gains, allowable deductions, and credits, depending on the tax regulations... or taxpayers be brought together?

Each tax year is considered a separate cause of action. Nevertheless, the IRS may examine more than one tax year at a time. If the taxpayer seeks to litigate in the Tax Court, multiple years can be included in the petition. If the taxpayer seeks to litigate in the Court of Federal Claims or a federal district court, the taxpayer must file a separate refund claim for each year, but multiple years can be included in the complaint.

Cases that involve different taxpayers but a common question of law or fact may be consolidated for trial, but separate trials may be ordered to avoid prejudice.Pre-claim payments

Must the taxpayer pay the amounts in dispute into court before bringing a claim?

To litigate in the Tax Court, a taxpayer need not pay the tax assessed, but after the petition is filed, the taxpayer may decide to do so to stop the running of interest. To litigate in the Court of Federal Claims or a federal district court, the taxpayer must first pay the tax.Cost recovery

To what extent can the costs of a dispute be recovered?

A taxpayer may recover litigation costs incurred in connection with a court proceeding brought by or against the US if the taxpayer establishes that it is the prevailing party, that it exhausted the available administrative remedies, that it has not unreasonably protracted the court proceedings and that the claimed litigation costs are reasonable (IRC Section 7430). Recovery will be denied if the taxpayer’s net worth exceeds specified limits. The IRS cannot recover litigation costs from a taxpayer.Third-party funding

Are there any restrictions on or rules relating to third-party funding or insurance for the costs of a tax disputeTax Disputes arise when there is a disagreement between taxpayers and tax authorities regarding the interpretation or application of tax laws. These disputes may concern various issues such as the accuracy of a tax return, the eligibility for tax deductions or credits, the correct amount of tax liability, or transfer pricing adjustments. Tax disputes can lead to lengthy legal proceedings..., including bringing a tax claim to court?

No such restrictions exist.Court decision maker

Who is the decision maker in the court? Is a jury trial available to hear tax disputesTax Disputes arise when there is a disagreement between taxpayers and tax authorities regarding the interpretation or application of tax laws. These disputes may concern various issues such as the accuracy of a tax return, the eligibility for tax deductions or credits, the correct amount of tax liability, or transfer pricing adjustments. Tax disputes can lead to lengthy legal proceedings...?

In the Court of Federal Claims and in the Tax Court, a single judge is the decision-maker and a jury trial is not available. In a district court, a single judge will hear the case, but either party may request a jury trial. The judge decides procedural and legal issues. If no jury is requested, the judge acts as the trier of fact, while in a jury trial, the jury acts as the trier of fact.Time frames

What are the usual time frames for tax trials?

After the taxpayer files its petition or complaint, the government will file an answer, which is due within 60 days, although extensions are typically sought. Thereafter, the judge and the parties usually agree to a scheduling order which sets a time frame for discovery, the exchange of expert reports, pretrial conferences and other matters. Depending on the number of issues and their complexity, this pretrial period may extend for six months or over a year. Trials may take place in a single day or over a month or more, depending on the number of issues, the complexity of the facts and the number of fact and expert witnesses. A case is likely to proceed more quickly in Tax Court than in the Court of Federal Claims or district court because the Tax Court encourages the parties to stipulate to facts, which may shorten the pretrial and trial stages. After the close of trial, the judge likely will not issue a decision for six months or a year or longer.Disclosure requirementsReporting obligations refer to the mandatory requirements imposed by tax authorities on entities or individuals to disclose specific financial and operational information. These obligations are designed to ensure transparency in taxation, help detect and prevent tax evasion, and support compliance with national and international tax standards. Such requirements can vary widely in scope, depending on jurisdiction and the nature of...

What are the requirements concerning disclosure or a duty to present information for trial?

Discovery in the Court of Federal Claims and a district court is often extensive and lengthy. First, the parties are required to make initial disclosures of the potential evidence and witnesses that they may use to support their case. Thereafter, the parties may serve interrogatories (written questions), take depositions (transcribed interviews), seek admissions and move for the production of documents. The judge may limit the number of discovery requests and the period during which discovery can occur. In contrast, the Tax Court requires that the parties are required to seek the objectives of discovery through informal communication before resorting to formal discovery. Moreover, the parties are required to stipulate all relevant facts to the fullest extent possible, which may reduce the need for discovery. As needed, however, the parties can serve interrogatories, take depositions, seek admissions and move for the production of documents.Permitted evidence

What evidence is permitted in a tax trial?

Documentary evidence may be introduced at trial. Fact witnesses can testify at trial regarding facts that are not stipulated. Generally, the taxpayer will present fact witnesses, who may be the taxpayer, employees of the taxpayer, counterparties to a transaction or any other individual with relevant information. The government may present fact witnesses, but often primarily cross-examines the witnesses presented by the taxpayer. If a fact witness was deposed and is unavailable for the trial, his or her deposition testimony may be read into the trial record. Both parties can present expert witnesses, who can be cross-examined by the opposing party. Written expert reports may be introduced into the record.Permitted representation

Who can represent taxpayers in a tax trial? Who represents the tax authorityTax authorities are fundamental institutions within government frameworks, overseeing tax assessment, collection, and administration. Their operations ensure that tax laws are enforced and public funds are collected efficiently. This article delves into tax authorities' purpose, responsibilities, and structure, offering insights into their essential role in supporting government functions and economic stability. What is a Tax Authority? A tax authority is...?

In the Court of Federal Claims and the district courts, taxpayers may represent themselves, but more often are represented by lawyers admitted to practise in those courts. In the Tax Court, taxpayers may also represent themselves, but more often are represented by lawyers or by non-lawyers admitted to practise in the Tax Court.

In the Court of Federal Claims and the district courts, the IRS is represented by trial attorneys in the Tax Division of the US Department of Justice. In the Tax Court, the IRS is represented by IRS attorneys. In major cases in all three courts, the government trial team may have both Tax Division and IRS lawyers.Publicity of proceedings

Are tax trial proceedings public?

In all three courts, trials are held in courtrooms open to the public. Documents introduced into the trial record, testimony given at the trial and briefs prepared by the parties are also open to the public. If evidence sought to be introduced is a trade secret or otherwise confidential, the public can be excluded from the courtroom while that evidence is introduced and that part of the trial record can be sealed to prevent public disclosure.Burden of proofThe burden of proof is a foundational principle in legal proceedings, requiring a party to demonstrate the truth of their assertions to the requisite standard of evidence. In tax law, the burden of proof often determines which party—typically the taxpayer or the revenue authority—must establish that a transaction, deduction, or tax position is justified. This principle ensures fairness and clarity...

Who has the burden of proofThe burden of proof is a foundational principle in legal proceedings, requiring a party to demonstrate the truth of their assertions to the requisite standard of evidence. In tax law, the burden of proof often determines which party—typically the taxpayer or the revenue authority—must establish that a transaction, deduction, or tax position is justified. This principle ensures fairness and clarity... in a tax trial?

The taxpayer has the burden of proofThe burden of proof is a foundational principle in legal proceedings, requiring a party to demonstrate the truth of their assertions to the requisite standard of evidence. In tax law, the burden of proof often determines which party—typically the taxpayer or the revenue authority—must establish that a transaction, deduction, or tax position is justified. This principle ensures fairness and clarity... in tax litigation. In tax refund litigation in the Court of Federal Claims and in district court, the taxpayer bears the burden not only to prove that its position on the issues raised in the complaint is correct, but also that its asserted amount of tax liabilityTax liability represents the total amount of tax owed by an individual or business to a tax authority, whether local, national, or international. This obligation arises through various forms of income, profits, or transactions subject to taxation laws and regulations. Understanding tax liability is essential for compliance and efficient financial management for corporations and individuals. It influences how businesses structure... is correct. Thus, if the IRS raises a new issue to offset the taxpayer’s claimed decrease tax liabilityTax liability represents the total amount of tax owed by an individual or business to a tax authority, whether local, national, or international. This obligation arises through various forms of income, profits, or transactions subject to taxation laws and regulations. Understanding tax liability is essential for compliance and efficient financial management for corporations and individuals. It influences how businesses structure..., the taxpayer bears the burden of proofThe burden of proof is a foundational principle in legal proceedings, requiring a party to demonstrate the truth of their assertions to the requisite standard of evidence. In tax law, the burden of proof often determines which party—typically the taxpayer or the revenue authority—must establish that a transaction, deduction, or tax position is justified. This principle ensures fairness and clarity... on that new issue. In contrast, if the IRS raises a new issue in Tax Court litigation, the IRS bears the burden of proofThe burden of proof is a foundational principle in legal proceedings, requiring a party to demonstrate the truth of their assertions to the requisite standard of evidence. In tax law, the burden of proof often determines which party—typically the taxpayer or the revenue authority—must establish that a transaction, deduction, or tax position is justified. This principle ensures fairness and clarity... on that new issue. By statute (IRC Section 7491), the burden of proofThe burden of proof is a foundational principle in legal proceedings, requiring a party to demonstrate the truth of their assertions to the requisite standard of evidence. In tax law, the burden of proof often determines which party—typically the taxpayer or the revenue authority—must establish that a transaction, deduction, or tax position is justified. This principle ensures fairness and clarity... can shift to the IRS in certain circumstances, but this rule is inapplicable if the taxpayer’s net worth exceeds specified limits.Case management process

Describe the case management process for a tax trial.

Case management begins when the taxpayer engages in a transaction giving rise to a potential tax disputeTax Disputes arise when there is a disagreement between taxpayers and tax authorities regarding the interpretation or application of tax laws. These disputes may concern various issues such as the accuracy of a tax return, the eligibility for tax deductions or credits, the correct amount of tax liability, or transfer pricing adjustments. Tax disputes can lead to lengthy legal proceedings.... Relevant documents and electronic information must be carefully compiled and stored. Before the case is filed, facts must be marshalled, legal research performed, witnesses identified and experts retained. Once the case is filed, discovery will begin in earnest and the value of adequate prior preparation becomes evident.

As trial approaches, the content of the evidence to be introduced and the order of its introduction must be designed. Evidentiary and other motions must be anticipated and responses prepared. In addition, the necessary trial staff must be identified, including the lawyers, staff to organise and manage the documentary evidence, and staff to coordinate the availability of fact and expert witnesses in a timely manner. In the US, the ‘electronic courtroom’ has become standard, with documents stored on computers and displayed on screens throughout the courtroom. Arrangements must be made to prepare and operate this system. In addition, demonstratives (charts, diagrams, summaries) must be prepared in advance. Finally, witness testimony outlines and the opening argument must be finalised.

During the trial, the active trial team will present the evidence and examine and cross-examine witnesses. A team of ‘backroom’ lawyers and staff must be available to locate documents and to research legal issues that become relevant during the trial.Appeal

Can a court decision be appealed? If so, on what basis?

Tax cases can be appealed by either party to one of the 13 US courts of appeals. District courts are located in 94 federal judicial districts, which are organised into 12 regional circuits, each of which is assigned to a court of appeals. Appeals from the Tax Court and a district court are heard by the court of appeals for the judicial district in which the taxpayer is located. Appeals from the Court of Federal Claims are heard by the court of appeals for the Federal Circuit.

The appeal is initiated by timely filing of a notice of appeal. Thereafter, the parties submit briefs pursuant to a scheduling order. After briefing concludes, the parties will orally argue the case before a three-judge panel. After a decision is rendered, which may take up to a year, the unsuccessful party can file a petition seeking US Supreme Court review. Supreme Court review is discretionary, and only a small percentage of petitions are granted, usually in instances in which courts of appeals have reached different conclusions regarding the same issue.