If there is any doubt as to whether a taxpayer is liable for income taxes, there is a good chance that the IRS will agree to settle for less. The IRS Office of Appeals is tasked with doing just that.
IRS appeals settlements are usually all or nothing. If the taxpayer does not accept the settlement, Appeals will usually close the case as unagreed. This presents a dilemma for many taxpayers. Do you take the IRS’s offer or do you press ahead and possibly get a better deal in court?
The situation leaves many wondering if they can accept the IRS’s offer and still preserve the right to dispute the liability in court? Put another way, can one have the assurance that their taxes will be the lower amount in the appeal settlement, but preserve the right to ask the court for a better deal?
This is not something that only taxpayers consider. The IRS considers these issues too. In our prior post, we addressed the IRS taking an inconsistent position from its settlement agreement.
The Du v. United States, Nos. 19-1020T, 19-1021T (Ct. Fed. Cl. 2020) case provides an opportunity to consider this topic from the taxpayer’s perspective.
Facts & Procedural History
This tax dispute involved the 2008 and 2009 tax years. During these years, the taxpayers owned a pharmaceutical consulting company and, separately, owned a bed and breakfast.
The pharmaceutical company was taxed as a S corp. This case involved unfiled tax returns. No S corp. tax returns were filed.
The IRS audited the income tax returns for the taxpayers personally for both years. It adjusted the taxpayer’s income to include the net income from the S corp.
The taxpayers accepted the IRS findings by executing a Form 870, Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment. The taxpayers did not withdraw this waiver, so the IRS issued a 90-day letter.
The taxpayers litigated the issue in the U.S. Tax Court. Before the trial, the taxpayers settled the case with the IRS Office of Appeals. The U.S. Tax Court entered a stipulated order accepting the settlement.
The taxpayers then filed a second petition with the U.S. Tax Court contesting the same issues that they settled with the IRS previously. The U.S. Tax Court dismissed the action.
The taxpayers then filed suit in the Federal Court of Claims to contest the same issues that they settled in the U.S. Tax Court action.
Appealing a U.S. Tax Court Decision
In this case, the taxpayers settled their case with the IRS Office of Appeals. The U.S. Tax Court entered a stipulated (agreed) order accepting the settlement.
If taxpayers want to dispute the settlement that is memorialized in a stipulated tax court order, they have two avenues to do so. They can a motion to vacate or revise the decision under Tax Court Rules 161 or 162. If the dispute involves a disagreement over the calculation of tax, the computational agreement rules in Tax Court Rule 155 may be used.
The second option is to appeal the tax court order. To challenge a tax court decision, one has to file an appeal with the U.S. Court of Appeals for the circuit in which the taxpayer resides. This is set out in Tax Court Rule 190.
It is not clear from the court’s opinion, but it does not appear that the taxpayers pursued these options in the original tax court case. Instead, they commenced a second case in the U.S. Tax Court asking that the first case be vacated. When the request was denied for the second case, the taxpayers appealed the decision not to vacate the decision in the first case. The appeals court declined to do so.
The taxpayers then filed the present case in the Federal Court of Claims. The question was whether the Federal Court of Claims can reverse a decision by the U.S. Tax Court. There are rules for this type of collateral attack.
Collateral Attack on U.S. Tax Court Order
The Court of Federal Claims can hear some types of tax disputes. This includes cases involving refund claims (or amended returns) for taxes that have been paid.
The court noted that the claims at issue here were not paid. Thus, the court did not have jurisdiction on that basis.
The court went on to consider the rule in Sec. 6512 that says no suit can be brought in “any court” to determine tax after the U.S. Tax Court as entered an order:
The present complaints are plainly barred by statute and none of the applicable exceptions apply. Plaintiffs sought relief from the Tax Court for tax years 2008 and 2009. Although a settlement was reached, it was effectuated through a decision by the Tax Court. That being the case, section 6512 bars other courts from hearing a “suit by the taxpayer for the recovery of any part of the tax” previously determined by the Tax Court. I.R.C. § 6512(a).
Thus, the court confirmed that this rule precludes most collateral attacks on orders entered by the U.S. Tax Court.
The decisions of the U.S. Tax Court are final. This includes settlement agreements that are reflected in stipulated orders entered by the U.S. Tax Court.
Keeping the Door Open
It is possible to accept an appeals settlement and preserve the right to litigate the matter. For this to work, taxpayers usually have to plan ahead.
Before the IRS audit closes, the taxpayer would need to ensure that the auditor issues a 30-day letter. This letter allows the taxpayer to go to Appeals before the 90-day letter is issued. In Appeals, the taxpayer would have to agree to the appeals settlement. The taxpayer would not want to enter into a final closing agreement with Appeals. Closing agreements are not all that common, so this is a strong possibility.
With this setup, the taxpayer could pay the lower amount of tax assessed by Appeals and file a refund claim. If the refund claim was denied by the IRS, the taxpayer would have the ability to pursue the dispute in court.
Hindsight is 20/20. It’s hard to know how a case will play out. Those who want the assurance of the lower tax due from an appeal settlement, but who want to preserve the right to litigate the matter need to plan for this strategy. This can help provide some comfort of lower taxes, while keeping the door open to not owing any taxes.