To commence a lawsuit against the I.R.S. seeking the refund of federal taxes erroneously or illegally assessed or collected, a taxpayer must select a court of proper jurisdiction. Jurisdiction to hear federal tax cases is conferred by federal statute, and different jurisdictional prerequisites exist depending upon in which of the three possible forums the taxpayer chooses to litigate.
The first and most common forum is the Tax Court, whose popularity is attributable to the fact that once filed, a Tax Court petition operates to bar the I.R.S. from assessing disputed taxes until a final Tax Court judgment. In contrast, the District and Claims Courts, other forums, may hear tax disputes only after the taxpayer has paid the entire disputed amount.
To commence suit in Tax Court for a “redetermination” of tax liability, Code Sec. 6213 requires the taxpayer to petition that Court within 90 days of receipt of an I.R.S. “notice of deficiency.” Since Tax Court jurisdiction is predicated upon a deficiency, the taxpayer may not pay the disputed tax before filing a Tax Court petition. On the other hand, once the petition is filed, the taxpayer may elect to pay the disputed tax in order to avoid the running of interest, currently 7% for “underpayments”.
Taxpayers opting to litigate in the District or Claims Court must pay the disputed tax up front and, if they ultimately prevail in court, be awarded a judgment against the I.R.S. for taxes that had been erroneously assessed. Aside from the foregoing “full payment” requirement, two other jurisdictional prerequisites exist for the taxpayer to commence District or Claims Court litigation: First, Code Sec. 7422(a) bars any suit for recovery of federal taxes “until a claim for refund … has been duly filed.” A claim for refund is made directly to the I.R.S., typically on a Form 1040x amended return. Code Sec. 6511 superimposes upon 7422(a) the additional requirement of timeliness in making a refund claim: Refund claims must be made within three years from date the return was filed, or within two years from the date when the tax was paid, whichever is later. The second remaining jurisdictional requirement is found in Code Sec. 6532, which requires the taxpayer to wait at least 6 months from the date of filing a claim for refund, but not more than 24 months from the date of I.R.S. response to that refund claim, before commencing suit.
Naturally, the taxpayer who does not wish to pay the disputed tax liability before a final court adjudication will litigate, if at all, in the Tax Court. A decision to litigate before paying results in economic consequences identical to those that would obtain had the taxpayer borrowed the entire disputed amount from the United States at the beginning of the dispute and agreed to pay (nondeductible) interest at the rate of 7%, (1) until an adverse Tax Court judgment became final, or (2) until a favorable Tax Court judgment became final, but with the government then forgiving the entire amount of principal and interest.
The Tax Court is located in Washington and is staffed by 29 judges, many of whom travel throughout the country and hear cases locally. Therefore, it is not usually necessary for the taxpayer to travel to Washington. Decisions of the Tax Court are appealable to the Court of Appeals for the District in which the taxpayer resides. In rendering its decision, the Tax Court must also apply the law of the Court of Appeals to which an appeal from the Tax Court would lie. Tax Court judges are tax specialists with a reputation for being fair, although not for being pro-taxpayer. Recourse to a jury trial may not be had in the Tax Court; consequently, all cases are decided by the Tax Court judges. The Tax Court also contains a branch that settles small cases, where the amount in controversy is less than $10,000. Decisions from this branch are not appealable.
District Courts, like the Tax Court, are bound in their decisions by the law of the Appeals Court in which the District Court lies, and to which an appeal from the District Court would lie. District Court judges are tax generalists, since in addition to hearing tax cases, they hear all types of civil and criminal cases. Jury trials are available in District Court and are often demanded in cases involving Code Sec. 6672 responsible person penalties, Code Secs. 6694 and 6695 return preparer penalties, Code Sec. 166 bad business debts, and valuation issues.
The Claims Court is perhaps the most sympathetic forum the taxpayer can find to hear a tax claim. Unfortunately, the taxpayer must travel to Washington in order to commence suit in this Court. As in the Tax Court, no recourse to a jury may be had in Claims Court and, as in the District Court, taxpayers wishing to litigate in Claims Court must prepay the entire tax deficiency.
As an illustration, consider a taxpayer who, in 1995, is audited on a 1992 tax return that was filed on April 15, 1993. That return claimed substantial losses relating to the sale of rental unit that recently been converted from a principal residence. Unable to settle the matter informally with the I.R.S. during the audit stage, the taxpayer receives a notice of deficiency in the amount of $25,000 on March 15, 1996. (The I.R.S. has three years from the date the return was filed in which to propose a deficiency.) The taxpayer decides that instead of petitioning the Tax Court for a redetermination of the deficiency (and thereby barring immediate I.R.S. assessment) it would be preferable to make a full payment of the disputed amount, file a claim for refund, and then (assuming the claim for refund is denied), bring suit in District Court, seeking a judgment against the I.R.S. for the disputed amount, plus interest at the rate of “overpayment”, currently 6%, and legal costs.
The taxpayer therefore remits to the I.R.S. $25,000 in full payment of the disputed liability on June 10, 1996 (i.e., within 90 days of receipt of a notice of deficiency) and thereafter files a claim for refund on January 1, 1997 (well within the two year period from which the date the tax was paid). Although the taxpayer may commence a suit for refund as early as June 1, 1997, he delays instituting suit until the I.R.S. notifies him on February 1, 1998 that his claim for refund has been disallowed in full. The taxpayer then has until February 1, 2000 (i.e., two years from the mailing of the notice of disallowance of the refund claim) in which to file a complaint against the I.R.S. in District Court, seeking a judgment for taxes erroneously or illegally collected in 1993.