Choice of Forum in Federal Excise Tax Refund Cases

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Taxpayers seeking a refund of the Internal Revenue Service’s administrative decision to impose additional excise tax may petition either the U.S. district courts or the U.S. Court of Federal Claims. Choosing the best refund forum is one of the most significant decisions that must be made when tax litigation is imminent. The authors provide some practice points in deciding in which court to seek redress.

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Introduction

To challenge an administrative determination and assessment of a federal excise tax, a taxpayer has a choice of two different federal courts to bring an action: the U.S. district courts and the U.S. Court of Federal Claims. The choice of a refund forum is one of the most significant decisions that must be made when tax litigation is imminent.

Refund Jurisdiction

The jurisdictional statute for refund suits in the district courts is found in 28 U.S.C. §1346, and provides that the federal district courts have original jurisdiction over suits for the recovery of internal revenue taxes. This would also cover any issues relating to penalties and interest associated with the taxes.

Similarly, the Court of Federal Claims has concurrent jurisdiction with the district courts over suits for the recovery of taxes erroneously and illegally assessed by the United States. See 28 U.S.C. § 1491.

Things to Consider

In deciding whether to seek a refund in the district court or the Court of Federal Claims, a taxpayer should consider several issues in determining the most advantageous forum.

Is There Any Controlling Judicial Precedent?

One of the primary considerations in determining which court to litigate your refund case is the existence of any controlling legal authority. All courts must follow a controlling decision of the Supreme Court of the United States. Similarly, each district court must follow the legal precedent announced by the U.S. Court of Appeals to which an appeal would lie. For example, if the taxpayer’s principal place of business is located in New York City, the taxpayer’s refund action could be brought in the district court for the Southern District of New York, and the appeal from a final decision would lie in the Court of Appeals for the Second Circuit. Alternatively, the taxpayer could bring a refund action in the Court of Federal Claims, and the appeal from a final decision would lie in the Court of Appeals for the Federal Circuit (CAFC).

If, in our example, there is favorable case law in the Second Circuit, then the taxpayer would prefer to bring the action in the district court for the Southern District of New York because the Second Circuit case law would be controlling precedent. Alternatively, if the case law in the Second Circuit is unfavorable but the CAFC has not addressed the issue, the taxpayer would likely prefer to bring the action in the Court of Federal Claims because Second Circuit case law does not bind that court. Before you pick the court in which to litigate your refund case, it is critical to research the state of the law on your issue in each available forum.

Can You Litigate By Paying Only Part of the Tax?

Generally, a district court or the Court of Federal Claims does not have jurisdiction over a tax refund suit unless the taxpayer has fully paid the amount of the tax assessment. In Flora v. United States, 362 U.S. 145 (1960), the Supreme Court resolved the issue of whether 28 U.S.C. § 1346 requires full payment of the tax in issue or only a partial payment. The Supreme Court held that the full payment of the tax was a prerequisite to the court’s jurisdiction The Flora rule is applicable to the Court of Federal Claims as well as to district courts. See DiNatale v. United States, 12 Cl. Ct. 72 (Cl. Ct. 1987).

A different rule applies to a divisible tax. Those taxes are imposed on and may be divided among individual transactions and include alcohol excise taxes. The taxpayer with a divisible tax is considered to make full payment for purposes of the court’s jurisdiction if the taxpayer pays the tax for a single transaction during the applicable period. See Steele v. United States, 280 F.2d 89 (8th Cir. 1960); Spivak v. United States, 370 F.2d 612 (2d Cir. 1967). The district courts and the Court of Federal Claims recognize that full payment of an excise tax is made when the tax on an individual transaction for each period in issue is paid before the suit is filed. If a taxpayer takes this approach and does not pay all of the disputed tax, the taxpayer may be required to post a bond or letter of credit for the balance in order stop the government from using its administrative collection tools to collect the balance. Additionally, the taxpayer should expect that the government will assert a counterclaim during litigation for the unpaid balance in response to taxpayer’s complaint.

The court in Flora also ruled that the full-payment rule did not require the payment of interest, unless the taxpayer challenged the amount of interest: “In some of the cases the only amount remaining unpaid at time of suit was interest. As we have indicated, the statute lends itself to a construction which would permit suit for the tax after full payment thereof without payment of any part of the interest.” Flora v. United States, 362 U.S. 145 (1960) at n.37(d) ; see also Kell-Strom Tool Co. v. United States 205 F. Supp. 190 (D. Conn. 1962); Leeke v. United States, 737 F. Supp. 1013 (S.D. Ohio 1990) (accord). In Shore, for example, the CAFC settled the question by holding that the interest portion of an assessment need not be paid under the full-payment rule. Shore v. United States, 9 F.3d 1524 (Fed. Cir. 1993). The CAFC said, however, that the full-payment rule referred to the tax only, not to interest and penalties.

Where the taxpayer disputes the computation of interest, however, it must pay the full amount of the interest. See Magnone v. United States, 733 F. Supp. 613 (S.D.N.Y. 1989), aff’d, 902 F.2d 192 (2d Cir. 1990). If the taxpayer intends to challenge the assessment of a penalty, it must pay in full the amount of the penalty. See, e.g., Professional Eng’rs, Inc. v. United States, 527 F.2d 597, 599 (4th Cir. 1975) (delinquency penalty); Francis v. United States, 89-1 USTC ¶ 9229 (D. Nev. 1988) (same). Internal Revenue Service (IRS) guidance, however, states that penalties may also be divisible if the penalty is separately imposed on distinct transactions. See IRS Ch. Couns. Adv. Mem. 201315017 (Apr. 12, 2013) [stating that penalties for failure to file information returns under Internal Revenue Code (IRC) section 6721 and failure to furnish payee statements under IRC section 6722 are both divisible penalties because each penalty arises from a separate transaction; the imposition of the penalty, or amount thereof, depends on the circumstances of that single transaction, and the reasonable cause exception must be reviewed per occurrence].

Can the Government Assert Additional Tax Liability?

Once the period for assessment has expired, the government cannot assess additional amounts of tax. But if the taxpayer has filed a refund suit for the same tax period, the government can assert an offset up to the amount of the taxpayer’s refund claim. Although one would expect the government to carry the burden of proof on additional tax that it proposes as an offset, the U.S. Supreme Court has concluded that the taxpayer has the burden of proof on any IRS offset, since the taxpayer must prove that it overpaid its taxes. See Lewis v. Reynolds, 284 U.S. 281, 283 (1932: A).

What Are the Settlement Procedures?

The Tax Division of the U.S. Department of Justice (DOJ) has settlement authority in cases litigated in the Court of Federal Claims and district courts. A prior settlement proposal made by the government agency at the administrative level may or may not be allowed by the Justice Department. The Justice Department generally seeks the views of the government agency with respect to any settlement offer being considered, but the DOJ makes the ultimate settlement decision. There is, however, a required additional level of review by the Joint Committee on Taxation for any settlement providing for a refund in excess of $2 million. See Section 6405.

How Do District Courts and Court of Federal Claims Differ?

In a suit filed in the district court, the taxpayer or the government may ask for a trial by jury. Juries are not available in suits filed in the Court of Federal Claims. The district courts hear few federal tax cases and generally lack tax expertise. The Court of Federal Claims has limited jurisdiction that generally is limited to patent disputes, claims against the government (including federal contract disputes) and tax refund suits.

Place of Trial

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A district court may present a more convenient forum for the taxpayer because the taxpayer’s principal place of business is located in proximity to the court. The Court of Federal Claims is located in Washington, D.C. Thus, it may be more difficult to arrange the schedule of out-of-state witnesses. The difference in locations will not be relevant if the issue is a legal issue that will be decided on motions for summary judgment.

Discovery

The Court of Federal Claims and the district courts permit all typical forms of discovery. For example, both courts permit the taking of depositions, formal requests for information and documents and the issuing of subpoenas to third parties. Notwithstanding the mandatory disclosure obligations imposed by each court’s procedural rules, discovery can and usually is very expensive and intensive in both courts.

Rules of Evidence

Litigants in the Court of Federal Claims are bound by the rules of evidence applicable in the CAFC. Similarly, the district courts follow the Federal Rules of Evidence and the case law stated by the applicable court of appeals with appellate review. Minor differences exist between these discrete sets of evidence rules, but generally those differences would not be sufficient alone to choose to litigate a refund case in one court or the other.

Government Counsel

In cases lying in both the Court of Federal Claims and the district courts, lawyers in the DOJ Tax Division represent the government. Each case is assigned to a trial lawyer in one of the Civil Trial Sections, e.g., Court of Federal Claims Section or Northern Region. Government counsel in the Court of Federal Claims Section is known to independently identify government offsets.

Conclusion

The most important consideration in choosing a refund forum is the controlling case law. When the case presents an issue of first impression, the taxpayer should look more generally to the recent tax decisions in these courts as well as other factors, including the potential for a jury trial, whether the cases will be decided on motions for summary judgment and potential for government offsets.