How Taxpayers File a Federal Lawsuit Against IRS

How Taxpayers File a Federal Lawsuit Against IRS

Oftentimes, US Taxpayers can avoid having to go to federal court by instead resolving their IRS tax matter either at the IRS level, IRS Office of Appeals, or Tax Court – none of which require the Taxpayer to pay the alleged tax liability or penalty in dispute first before making a claim. Sometimes, for one reason or another the taxpayer is unable to sufficiently resolve their issue with the Internal Revenue Service or Office of Appeals and after making a claim for refund –– which the IRS denies — the taxpayer decides to move over to Federal Court. Taxpayers have the opportunity to go to either the District Court or the Federal Court of Claims. The process of getting into the Federal Court system is a bit of a winding road through the administrative procedures and requirements at the IRS level. Therefore, we wanted to provide a brief introductory roadmap about how it would work in a situation in which a taxpayer wants to pursue Federal Court litigation in order to get a fair shake:

What is an IRS Deficiency?

The Notice of Deficiency is defined under 26 USC 6211:

26 USC 6211 – Definition of a Deficiency

• • • (a) In general For purposes of this title in the case of income, estate, and gift taxes imposed by subtitles A and B and excise taxes imposed by chapters 41, 42, 43, and 44 the term “deficiency” means the amount by which the tax imposed by subtitle A or B, or chapter 41, 42, 43, or 44 exceeds the excess of—

      • (1) the sum of

        • (A) the amount shown as the tax by the taxpayer upon his return, if a return was made by the taxpayer and an amount was shown as the tax by the taxpayer thereon, plus

        • (B) the amounts previously assessed (or collected without assessment) as a deficiency, over—

        • (2) the amount of rebates, as defined in subsection (b)(2), made.

Before the IRS Federal Lawsuit is Filed

It generally starts out with the Taxpayer and IRS going back and forth on an issue such as a tax or penalty due. The taxpayer and IRS duke it out — and for whatever reason, it does not resolve. The Taxpayer may have received a 30-day letter and went to appeals or not, and the matter does not resolve in Taxpayer’s favor. Subsequently, Taxpayer receives a 90-Day NOD Letter (Notice of Deficiency Letter) and can either file a petition to go to Tax Court or wait for the IRS to assess the tax in which the Taxpayer can pay the tax/penalty and make a claim for refund – and when the refund claim is denied, sue in Federal Court as long as the time to file has not passed.

Notice of Deficiency, What’s Next?

The IRM (Internal Revenue Manual) provides a great summary of how the process works

IRM 34.5.2.2: Pre-Litigation Activity

• • • The Service will assess the deficiency if the taxpayer signs a waiver or fails to file a petition with the Tax Court during the 90-day (or 150-day, if applicable) period. Generally, the taxpayer must pay this assessed deficiency.

    • Pursuant to section 7422(j), however, the federal district courts and the United States Court of Federal Claims have jurisdiction to determine the correct amount of estate tax liability (for estates that have elected the installment method of payment under section 6166), even though the estate has not paid the full amount of the estate tax liability, provided that it has met current paying requirements.

    • After paying the tax, the taxpayer can continue to contest the liability by filing a claim for refund. The taxpayer can also file a refund claim for tax that he paid with the original tax return. Generally, under section 6511, the taxpayer is required to file a claim for refund within three years from the date the original return was filed or two years from the date the tax was paid, whichever is later.

    • A revenue agent or tax auditor will review the claim for refund and inform the taxpayer, by letter, if the Service will accept the claim or disallow the claim in full or in part.

    • A taxpayer can then request a conference with the Appeals Office if the claim is disallowed in whole or in part.

    • If the Appeals Officer agrees with the revenue agent’s determination or if the taxpayer does not request a conference, the Service will generally issue a statutory notice of claim disallowance.

    • Under section 6532, the taxpayer has two years from the date of the notice of claim disallowance in which to bring suit.

    • The statute of limitations does not begin to run until the Service issues a notice of claim disallowance.

    • If the Service does not send the taxpayer a notice of claim disallowance, the taxpayer cannot file a suit less than six months from the date he filed a claim for refund.

    • Under section 6532(a)(3), a taxpayer may waive a notice of disallowance regarding his claim for refund.

    • If this occurs, the two year period for filing a suit begins on the date the taxpayer files such waiver.

    • If the taxpayer does not waive a notice of claim disallowance, and the Service has not issued such notice, then the taxpayer may file a refund suit at any time after six months from the filing of the administrative claim. Rev. Rul. 56-381, 1956-2 C.B. 953, remains valid and in effect and should be followed by Chief Counsel attorneys. The Service and the Department of Justice should be advised that the general six-year period of limitation for bringing claims against the Government in 28 U.S.C. §§ 2401 and 2501 does not apply to tax refund suits.

    • A taxpayer must file a suit for refund of taxes paid in the U.S. district court where the taxpayer resides (or where a corporation has its principal place of business), or in the Court of Federal Claims.

What does this Mean?

It means that once the deficiency has been determined and the Notice of Deficiency Letter has been sent to Taxpayer, they have 90/150 days to Petition the Tax Court before the deficiency is assessed. Once the tax has been assessed and paid to the IRS has been made — the Taxpayer can file a Refund Claim. The time-period for filing the refund is the later filing of the original return filing date (generally presumed based on the timely filing requirements) or two years from the date the tax was paid. The IRS then will issue a notice of disallowance (or either 6-months passes from the filing of the Notice and/or the Taxpayers or signs a waives), which serves as the catalyst for pursuing federal litigation.

IRM 4.5.2.4.2.1: Limitations on Claims for Refund

• • • Generally, the taxpayer must file a claim for refund within three years from the time he files his return or within two years from the time the tax was paid, whichever is later. Section 6511(a). If no tax return was filed, a claim must be filed within two years from the time the tax was paid.

    • If a taxpayer files a claim for refund during the three year period prescribed by section 6511(b)(1), the amount recoverable is limited to the amount paid during the three years immediately preceding the filing of the claim plus the period of any extension of time for filing the return. Section 6511(b)(2)(A). In administrative actions and litigation, the Service can refund a taxpayer’s withholding and estimated taxes if the taxpayer files an original delinquent return/claim for refund more than two but less than three years after the due date of the return. Under section 6513(a), prepaid taxes, such as withholding and estimated taxes, are deemed paid on the last day prescribed for filing the return.

    • When a taxpayer files a claim within the two-year period following payment, but not during the three-year period following the filing of a return, the amount recoverable is limited to the amount of tax paid during the two years immediately preceding the filing of the claim. Section 6511(b)(2)(B).

    • When the taxpayer and the Service execute an agreement to extend the period for assessment (generally by Form 872), the time for filing a claim does not expire until six months after the expiration of the extended assessment period. Section 6511(c)(1). The amount that the taxpayer may claim when the taxpayer and the Service have executed an extension is equal to the tax paid after the execution of the extension, plus any amounts that could have been claimed on the date the Service and the taxpayer executed the extension agreement. Section 6511(c)(2).

Flora Full Payment Rule

The reason why most taxpayers prefer Tax Court – if they believe they can resolve the issue in that forum –– is that in order to sue the IRS in District Court the taxpayer must first make full payment, which is referred to as the flora rule. In other words, unless a Taxpayer pays the IRS the amount of the penalty (which may not be feasible for many Taxpayers) they cannot sue for a refund – – although in the recent case of Mendu, the Court held that this rule should not apply to FBAR, since Taxpayer does not have an opportunity to litigate the FBAR in tax court.

Important IRC Code Sections for Federal Court Lawsuits

Here are three important statutes to be aware of for Federal Court Litigation against the IRS:

Claims for Refund 26 USC 6511

• • • (a) Period of limitation on filing claim

    • Claim for credit or refund of an overpayment of any tax imposed by this title in respect of which tax the taxpayer is required to file a return shall be filed by the taxpayer within 3 years from the time the return was filed or 2 years from the time the tax was paid, whichever of such periods expires the later, or if no return was filed by the taxpayer, within 2 years from the time the tax was paid. Claim for credit or refund of an overpayment of any tax imposed by this title which is required to be paid by means of a stamp shall be filed by the taxpayer within 3 years from the time the tax was paid.

    • (b) Limitation on allowance of credits and refunds

      • (1) Filing of claim within prescribed period No credit or refund shall be allowed or made after the expiration of the period of limitation prescribed in subsection (a) for the filing of a claim for credit or refund, unless a claim for credit or refund is filed by the taxpayer within such period.

      • (2) Limit on amount of credit or refund

        • (A) Limit where claim filed within 3-year period

          • If the claim was filed by the taxpayer during the 3-year period prescribed in subsection (a), the amount of the credit or refund shall not exceed the portion of the tax paid within the period, immediately preceding the filing of the claim, equal to 3 years plus the period of any extension of time for filing the return. If the tax was required to be paid by means of a stamp, the amount of the credit or refund shall not exceed the portion of the tax paid within the 3 years immediately preceding the filing of the claim.

        • (B) Limit where claim not filed within 3-year period

          • If the claim was not filed within such 3-year period, the amount of the credit or refund shall not exceed the portion of the tax paid during the 2 years immediately preceding the filing of the claim.

        • (C) Limit if no claim filed

          • If no claim was filed, the credit or refund shall not exceed the amount which would be allowable under subparagraph (A) or (B), as the case may be, if claim was filed on the date the credit or refund is allowed.

26 U.S. Code § 6532 – Periods of limitation on suits

• • • (a) Suits by taxpayers for refund

      • (1) General rule

        • No suit or proceeding under section 7422(a) for the recovery of any internal revenue tax, penalty, or other sum, shall be begun before the expiration of 6 months from the date of filing the claim required under such section unless the Secretary renders a decision thereon within that time, nor after the expiration of 2 years from the date of mailing by certified mail or registered mail by the Secretary to the taxpayer of a notice of the disallowance of the part of the claim to which the suit or proceeding relates.

      • (2) Extension of time

        • The 2-year period prescribed in paragraph (1) shall be extended for such period as may be agreed upon in writing between the taxpayer and the Secretary.

      • (3) Waiver of notice of disallowance

        • If any person files a written waiver of the requirement that he be mailed a notice of disallowance, the 2-year period prescribed in paragraph (1) shall begin on the date such waiver is filed.

      • (4) Reconsideration after mailing of notice

        • Any consideration, reconsideration, or action by the Secretary with respect to such claim following the mailing of a notice by certified mail or registered mail of disallowance shall not operate to extend the period within which suit may be begun.

      • (5) Cross reference

        • For substitution of 120-day period for the 6-month period contained in paragraph (1) in a title 11 case, see section 505(a)(2) of title 11 of the United States Code.

26 U.S. Code § 7422 – Civil actions for refund

In pertinent part:

• • • (a) No suit prior to filing claim for refund No suit or proceeding shall be maintained in any court for the recovery of any internal revenue tax alleged to have been erroneously or illegally assessed or collected, or of any penalty claimed to have been collected without authority, or of any sum alleged to have been excessive or in any manner wrongfully collected, until a claim for refund or credit has been duly filed with the Secretary, according to the provisions of law in that regard, and the regulations of the Secretary established in pursuance thereof.

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