Should a taxpayer take on the U.S. Government in court on a tax matter or try to settle through negotiation? For some taxpayers this is a crucial question. While a court case is handled by a lawyer, the CPA can greatly help in dealing with this important question. If the litigation route is chosen, there are many alternatives to consider.

When taxpayers are notified of additional assessments resulting from IRS audits, they usually first contact their tax advisor about the alternatives available to dispute the assessment. It is particularly important that the tax advisor be well-informed, since the advisor's recommendations are often the major factor in the client's decision concerning which alternative to pursue.

In evaluating the alternatives, two key questions must be addressed:

1. Should settlement of the dispute be pursued at the administrative level or through litigation?

2. If litigation is pursued, which court (forum) would be the most conducive to a successful outcome?

The decision to pursue administrative proceedings or to litigate requires an assessment of the probability of a successful outcome for each alternative. To assess the litigation alternative, the tax advisor must evaluate the extent to which the attributes of each forum will contribute to a successful outcome.

Negotiating a Settlement Through the Appeals Office

There are advantages and disadvantages of negotiating a settlement through the appeals office. The IRS has recently attempted to make the offer and compromise procedures more viable as a real alternative (See The CPA Journal, August 1992).

Advantages. There are a number of attractive advantages to pursuing a settlement through administrative appeals rather than litigation. Since administrative appeals usually require significantly less preparation than litigation, the costs may be significantly lower. Also, the administrative process is usually conducted in a "give and take" atmosphere which results in at least some concessions from the IRS. This give and take atmosphere is generally absent in court proceedings. In addition, the time required to settle a dispute is usually much shorter than for litigation. Together these factors reduce the level of stress experienced by the taxpayer. Negotiated settlements are particularly appropriate for disputes of relatively small dollar amounts and/or where there are a number of disputed items which facilitate a give and take process.

The Hurdle. An important advantage of a negotiated settlement is that the taxpayer has a much broader choice of representation. Many tax advisors are CPAs. In an administrative proceeding, the taxpayer can be represented by the original preparer. If the taxpayer is considering litigation and the original preparer is not an attorney, an additional issue arises since persons other than attorneys are rarely permitted to represent taxpayers in court. Therefore, to pursue litigation when the original tax advisor/preparer is a non-attorney, the taxpayer is required to seek and engage an attorney unfamiliar with the case. The additional time and expense required often constitutes a significant hurdle to litigation.

Attorneys may represent taxpayers in any of the courts. Non-attorneys are unequivocally excluded from practicing in the claims and district courts. In the Tax Court, non-attorneys may represent taxpayers if they are licensed to do so. Licensure requires the successful completion of a long and difficult exam.

Prior to 1942, there were no qualifications to practice before the court. In 1942, when licensure became required for non-attorneys, 7,099 non-attorneys benefitted from a "grandfathered clause" and were recognized as qualified individuals. However, since 1942 only 166 persons have been so licensed, an average of about three per year. Thus, the current system effectively excludes advisors and preparers other than attorneys. This evidence contradicts the promotional assertions of the Tax Court, which characterizes itself as readily accessible to the average taxpayer.

Disadvantages. The major disadvantage to a negotiated administrative settlement is that IRS appeals officer is likely to be less impartial and objective than a court judge. Also, in an administrative proceeding, the give and take atmosphere may result in the taxpayer's having to make concessions which he/she believes are unjustified. Finally, the potential benefits of a jury trial--a sympathetic jury--are unavailable.

Choice of Battle Terrain: Choice of Forum

In the United States, civil tax cases may be heard in either the U.S. Tax Court, a U.S. District Court, or the U.S. Claims Court. The taxpayer has the right to choose the forum. The three courts have different jurisdictions and procedural guidelines, and to some extent are governed by different precedents. In addition, each court differs regarding the training, experience and expertise it requires of its judges. Given these important differences, it is not surprising that these courts have on occasion reached opposite conclusions when faced with identical cases.(1) Consequently, the choice of tax forum is likely to be the single most important decision in planning for litigation. A summary of the numerous characteristics, advantages and disadvantages is presented later.

Jurisdiction. The process of selecting a forum begins with identifying the courts within whose jurisdiction the dispute may be adjudicated. The District Courts and the Claims Court have the broadest jurisdiction while the Tax Court is the most limited. The jurisdiction of the Tax Court is presented in Exhibit 2; the jurisdictions of the Claims and Districts Courts are presented in Exhibit 3.

The U.S. Tax Court

The majority of tax litigation is tried in the Tax Court. Created under Article I of the U.S. Constitution, this Court is exclusively a tax tribunal with limited jurisdiction as described in IRC Sec 7442. Its jurisdiction includes income, estate, gift, and certain excise taxes under Chapters 41-45 of the Code.(2)

The Tax Court was created to provide a forum in which a taxpayer could litigate a contested tax liability prior to payment of the liability. This is a major advantage of the Tax Court since it is the only forum which does not make payment of the taxes in question a prerequisite to filing suit.

The Tax Court consists of nineteen judges each appointed to fifteen-year term. Judges may be reappointed for a second term upon expiration of the first term. Due to the limited jurisdiction of the Tax Court (only tax cases), Tax Court judges are considered experts in tax matters.

Based in Washington, D.C., the Tax Court is a nationwide tribunal which hears cases and motions in most major cities of the United States. A trial by jury is not available. The Tax Court procedure is similar to a non-jury trial conducted in a District Court. However, the Court is more lenient than the District Court or Claims Court in enforcing the rules of evidence. This leniency may permit marginally questionable material to be entered as evidence by the taxpayer. However, if the taxpayer's case rests on barring certain IRS evidence, the Tax Court may not be the best choice.

The defendant ("respondent") in a Tax Court case is always the Commissioner of the IRS. The Commissioner is represented by an attorney from one of the offices of the IRS's District Counsel. Although the District Counsel is under the general jurisdiction of the Chief Counsel in Washington, D.C., to a significant extent District Counsel attorneys function autonomously. The IRS's attorneys are usually accessible for compromise negotiations, informal conferences, stipulations, and other matters attendant to a lawsuit.

Unlike the District Court and Claims Court, the Tax Court permits the representation of taxpayers by specifically licensed individuals who are not attorneys. However, as previously discussed, since only 166 persons in the past 50 years have obtained such licensure, this is not a significant advantage.

Another important characteristic of the Tax Court is the unique decision making process. After hearing a case and considering all the evidence, the Tax Court judge will write an opinion. This opinion is then submitted to the Chief for consideration. The Chief Judge will either allow the trial judge's opinion to constitute the decision of the Court or will refer the case to its "Full Court" which is composed of all nineteen Tax Court judges. The Full Court then decides the case en banc, resulting in a decision "reviewed by the court." Either party in a Tax Court case has the right to appeal the decision to a U.S. Court of Appeals.

Small Tax Case Procedure. If the amount of the deficiency is $10,000 or less, the Tax Court offers a "small tax case procedure" in which the taxpayer may request a trial before a Special Trial Judge.(3) Here the proceedings are less formal, the rules of evidence are not strictly enforced, and taxpayers are allowed to represent themselves. Although the losing party in a standard Tax Court case has the right to appeal, a losing party in a "small tax case" has no appeal.(4)

U.S. District Court

The U.S. District Courts are the only courts in which a taxpayer may obtain a jury trial as well as a non-jury trial. Created under Article III of the Constitution, they are trial courts of general jurisdiction in the Federal judicial system. Since these Courts are general trial courts, their jurisdiction is not limited to tax cases. In contrast to the Tax Court and Claims Court which are nationwide tribunals, the District Court is a local tribunal with a geographic scope limited to a single Federal district. As a result, District Court Judges have a greater proximity to the local business community and are likely to possess a greater understanding of the local economy and local business customs and the related transactions than would an "outside" national tribunal judge from Washington, D.C.

The District Court is strictly a tax refund tribunal. Failure to pay the assessed deficiency precludes litigation in a District Court. The United States is the defendant in a District Court tax refund case and is represented by attorneys from the Justice Department's Tax Division, except in the Southern District of New York and in two California districts, where the court is represented by assistant U.S. attorneys.

Since District Courts are general trial courts with broad jurisdiction, district judges tend to be well-rounded lawyers rather than tax specialists. Consequently, it is reasonable to expect a broader approach to a tax case heard in a District Court as compared to the Tax Court or the Claims Court. However, the rules of evidence are strictly construed in these courts, especially in jury trials.

U.S. Claims Court

The U.S. Claims Court is a Washington, D.C., based tribunal that specializes in hearing cases involving claims against the U.S. Government. The Claims Court is an Article I "legislative" court. Appeals from the Claims Court are heard in the Court of Appeals for the Federal Circuit. Since the Claims Court is a tax refund tribunal, taxpayers who are unable to pay the assessed tax are precluded from litigating in this court.

The Claims Court hears cases and motions in most major cities. The court consists of sixteen judges who are appointed for a fifteen-year term. Judges may be reappointed for a second term upon expiration of their first term. Although the Claims court has jurisdiction in areas other than taxation, tax refund suits account for approximately one-third of all cases heard. Claims Court judges have less tax expertise than Tax Court judges, but are viewed generally as having more tax expertise than District Court Judges.

Due to the Claims Court's nationwide jurisdiction, its judges travel regularly to major cities to hear cases. Although the Claims Court does not provide a local forum for the taxpayer, it does offer unique trial procedures. Judges will hear evidence at one or more locations for the convenience of the parties and witnesses. Also, Claims Court Judges will schedule several trial sessions in the same case, which provides significant intervals of time between witnesses. Such spacing of witnesses may provide time to make strategic adjustments and preparations. This opportunity usually is not available in the Tax or District Courts, where cases usually are heard on a continuous basis.

Some practitioners believe that the Claims Court tends to be relatively liberal in admitting evidence and is more likely to take a broad approach to technical restrictive rules in its effort to reach an equitable result. Additional characteristics, advantages and disadvantages of the Claims Court are noted in Exhibit 4.

Precedents

A major factor influencing choice of forum are the binding precedents developed by each court on the issues involved in the taxpayer's case. Only after conducting research of relevant cases decided in the three trial forums, the appellate courts, and the Supreme Court, can the most favorable tribunal be identified.

U.S. Claims Court. The U.S. Claims Court adopted all published decisions of the U.S. Court of Claims, which was abolished October 1, 1982. The Claims Court also follows decisions of the U.S. Court of Appeals for the Federal Circuit and the U.S. Supreme Court.

U.S. District Courts. The U.S. District Courts are bound by precedents in their respective U.S. Court of Appeals based on location of a district court, as well as by decisions of the U.S. Supreme Court. The decisions of other circuits, including the U.S. Court of Appeals for the Federal Circuit, will be considered but not necessarily followed.

U.S. Tax Court. The U.S. Tax Court's system of precedent is more complicated than the other courts. Although the Tax Court is viewed as a national tribunal--similar to the Claims Court--its decisions are subject to review by the appellate courts in the various circuits. Prior to 1970, the Tax Court would not consider itself bound by decisions of the Court of Appeals. Due to jurisdictional problems, the Tax Court agreed in 1970 in Golsen v. Commissioner to follow decisions of the Court of Appeals in the circuit in which the appeal can be filed. This is referred to as the "Golsen rule."(5)

The Golsen rule forces the Tax Court to follow a decision from the Court of Appeals which is squarely on point where the only appeal from the Tax Court decision is to that Court of Appeals. However, the Tax Court's "forced precedent" makes it possible for two taxpayers with identical cases to receive inconsistent results from the same tribunal by virtue of appellate review. For example, assume the First Circuit has reversed the Tax Court on a specific point of law. A new case is then brought to the Tax Court which addresses the same point of law and the related appeal route would be the First Circuit. Here, the Tax Court will follow the precedent set previously by the First Circuit. However, if the appeal were to a Circuit which had not ruled on the specific point, the Tax Court can follow its own precedents. The Tax Court, like claims and district courts, is bound by all U.S. Supreme Court decisions.

Choose Wisely

Although numerous factors must be considered in choosing a forum, the existence of certain constraints often narrows the alternatives to one court. The most basic constraint is jurisdiction. The second most limiting factor is the ability of the taxpayer to pay the tax and then file a refund suit. If the taxpayer is unable to do so, the only alternative is the Tax Court. A final major factor which narrows and simplifies the choice of forum is the body of precedents which affect the decision-making process of each court. The tax advisor's research often will identify court-specific precedents which clearly will be favorable or unfavorable to the case in dispute. Nevertheless, regardless of the complexity of an individual case, a comprehensive understanding of the advantages and disadvantages of litigation as well as the attributes and characteristics of each forum is essential for the formulation of effective tax strategies.

1 For example, see Freeland v. Commissioner, TC Memo. Par. 66, 283 (1966) aff'd, 393 F. 2d 573 (9th Cir. 1968), and Morse v. United States, 371, F.2d 474, 482 (ct.cl. 1967).

2 Tax Court Rule 13.

3 IRC Sec. 7463.

4 IRC Sec. 7481 (b).

5 Golsen v. Commissioner, 54 TC 742 (1970).

Note: Portions of Exhibit 4 were adopted from Prentice Hall Federal Tax Guide (1991) and Marvel, op. cit., (1982)

Thomas M. Brinker, Jr., JD, CPA, is a partner in the firm of Brinker, Simpson & Nicastro and adjunct professor of accounting and taxation, Widener University and St. Joseph's University.

James J. Tucker, III, PhD, CPA, is associate professor in the Department of Accounting and Taxation, School of Management, Widener University.