There are a number of forums for litigating tax disputes, such as the U.S. Tax Court. There are pros and cons associated with bringing suit in each forum. Taxpayers often pass on litigating cases in the U.S. Tax Court in cases when they are seeking a refund of an amount in excess of the amount reported on their tax returns. This is often based on a belief that the U.S. Tax Court cannot issue refunds. But is this believe correct?
Federal Tax Litigation
Other than in bankruptcy situations, Federal tax disputes can be litigated in the U.S. Tax Court, U.S. District Courts, or the U.S. Court of Federal Claims.
The U.S. Tax Court is typically the preferred choice of forum as taxpayers are allowed to bring suit without having to first pay the IRS’s proposed increase in tax. With the U.S. District Courts, or the U.S. Court of Federal Claims, taxpayers do have to first pay the tax, file a refund claim, and, once the refund claim is denied or more than six months goes by, the taxpayer can bring suit.
Assume the taxpayer’s tax return shows $100 in tax due. The IRS then conducts an audit and increases the tax by $50 to $150 in total. In many cases the taxpayer may have paid the $100 via withholdings or at the time the tax return was submitted, but it generally has not paid the additional $50 the IRS proposed on audit. The taxpayer can bring suit in the U.S. Tax Court before paying the $50. He cannot bring suit in the U.S. District or Court of Federal Claims before paying the $50 and filing a refund claim for $50.
The taxpayer can also pay the $50, file a refund claim for more than the $50, and bring suit in the U.S. District or Court of Federal Claims. To continue the example, the taxpayer could seek a refund of $75 instead of $50. This is the defining characteristic of litigation in the U.S. District and Court of Federal Claims. The term “refund litigation” is what comes to mind when thinking about bringing suit in these courts. Taxpayers and their advisors often forget that they can also obtain a $75 refund in U.S. Tax Court pursuant to Section 6512 in some cases.
Obtaining Refunds in U.S. Tax Court Cases
Section 6512 authorizes the U.S. Tax Court to determine the amount of an overpayment and entitle the taxpayer to a refund. Continuing the prior example, if the taxpayer’s return reported a $100 tax liability and the IRS determined a $150 tax liability, the U.S. Tax Court could agree with the taxpayer and enter an order granting a $25 refund to the taxpayer.
There are some limits on the U.S. Tax Court’s ability to issue refunds for this type of overpayment. Specifically, the time for filing the refund claim must not have expired at the time the IRS issues the Notice of Deficiency or 90-day letter to the taxpayer. This brings in the refund claim timing rules.
Refund Timing Rules
The refund claim timing rules basically say that a refund claim can be submitted within the later of (1) three years of the tax assessment date or (2) two years from the date of payment. With Section 6512, the law presumes that a tax refund claim was submitted (even though it was not) on the date the Notice of Deficiency or 90 day letter was issued to the taxpayer.
By way of explanation, the Notice of Deficiency or 90-day letter is issued at the end of the IRS audit. It is the legal notice that allows the IRS to assess or record the increased tax liability on its books. So if the IRS issued a Notice of Deficiency in 2015 for the 2012 tax year, the taxpayer could have still filed a refund claim on the date the Notice was issued. As such, the U.S. Tax Court could order the IRS to issue a refund in this scenario.
If the IRS issued the Notice of Deficiency in 2016 for the 2012 tax year, which could come up if the taxpayer did not timely file his 2012 tax return, the taxpayer may be precluded from filing a refund claim for 2012 at the time the Notice of Deficiency was issued. This would preclude the U.S. Tax Court from ordering the IRS to issue a refund. The exception would be if the tax was paid in the two years prior to the Notice of Deficiency. The U.S. Tax Court could order the IRS to issue a refund for the overpayment.
There are several exceptions and nuances to these rules that are beyond the scope of this writing. The takeaway is that the taxpayer may be able to obtain a refund via litigation in the U.S. Tax Court, which is typically true in situations where the taxpayer timely files its tax returns. The U.S. Tax Court will usually not have the authority to do this when the taxpayer files its tax returns late.