Deficiency litigation is a process under U.S. federal tax law that allows taxpayers to challenge the IRS’s determination that they owe additional tax, known as a “deficiency.” Usually, this involves filing a petition with the U.S. Tax Court seeking judicial review of the tax owed.
Generally, taxpayers file their income tax returns with the IRS, which processes them. But there are occasions where the IRS disagrees with the amount of tax reported on a taxpayer’s return. In these instances, the IRS uses the “deficiency procedures” to inform the taxpayer of its belief that adjustments to the return are necessary. These deficiency procedures provide taxpayers with significant procedural rights to contest the IRS’s determinations.
A defining feature of deficiency litigation is that it is a prepayment forum. This means that the taxpayer does not have to pay the disputed tax, penalties, or interest before going to court. This Prepayment terminology can be misleading, as it implies that prepayment of the tax is required, but in reality, no prepayment is necessary.
IRS collection efforts are automatically paused while the case is ongoing, which helps protect the taxpayer’s cash flow.
Generally, most cases are settled through negotiation with IRS counsel before trial. If unresolved, disputes may go to trial using formal or simplified procedures, depending on the amount involved.
In an international context, this process applies to U.S. citizens or residents abroad and to non-resident aliens with U.S.-source income.
As discussed, the concept of deficiency litigation revolves around challenging the notice of deficiency. However, let’s first consider what the meaning of tax deficiency is.
Next, let’s understand the meaning of tax deficiency.
A Tax Deficiency, as defined under IRC §6211, refers to the amount by which the assessed tax exceeds the following amount:
Deficiencies often arise when the IRS proposes adjustments that the taxpayer may disagree with. The adjustments usually include the following:
From an international perspective, deficiencies can stem from the following:
Now that we have a basic understanding of what a ‘tax deficiency’ means, let’s examine how a taxpayer can effectively challenge a Notice of Deficiency in the United States.
Many taxpayers believe that contesting a Notice of Deficiency requires going through deficiency litigation in the U.S. Tax Court. However, this is not accurate, as notice of deficiency can be challenged in different ways.
It’s important to differentiate between a Notice of Deficiency and deficiency litigation, as the two terms are related but not the same.
Let’s clarify the distinction between a Notice of Deficiency and deficiency litigation.
A Notice of Deficiency is a formal notice issued by the IRS informing a taxpayer that the IRS has determined an additional amount of tax is owed. Receipt of a Notice of Deficiency gives the taxpayer the right to challenge the IRS’s determination before the tax is assessed and collected.
Deficiency litigation generally refers to a case brought in the U.S. Tax Court after the taxpayer files a timely petition in response to a Notice of Deficiency. One significant advantage of the U.S. Tax Court is that the taxpayer need not pay the disputed tax before seeking judicial review.
A Notice of Deficiency is issued when the IRS reviews a taxpayer’s return and determines that the reported tax liability is lower than the amount determined.
When such a notice is issued, Taxpayers generally have two primary options to challenge it. The taxpayer may challenge the deficiency litigation by filing a petition with the U.S. Tax Court, the United States District Court, or the United States Court of Federal Claims.
If a taxpayer litigates in U.S. Tax Court, they do not have to pay the disputed tax amount. In contrast, when filing in the U.S. District Court or the U.S. Court of Federal Claims, taxpayers are generally required to pay the full amount of the disputed tax before filing.
First, let’s understand the deficiency litigation procedure, which occurs before the U.S. Tax Court. In the next section, we will discuss refund litigation.
Understanding this procedure is crucial, as it directly determines the available forums, strict deadlines, and strategic options available to the taxpayer.
Let’s dive into the deficiency litigation procedure.
A Deficiency Litigation Procedure is a formal process through which a taxpayer can challenge a Notice of Deficiency issued by the IRS.
The following is the procedure for deficiency litigation.
The procedure to initiate deficiency litigation begins when the IRS issues a Notice of Deficiency to the taxpayer. The taxpayer may then challenge the IRS’s determination through the deficiency litigation process. This takes place in the U.S. Tax Court before the disputed tax is collected. The process generally follows these steps:
→ Issuance of Notice of Deficiency by the IRS
→ Taxpayer Files Petition with the United States Tax Court (within the prescribed deadline)
→ Procedure for filing a petition against notice of deficiency with the U.S. Tax Court
Understanding each stage of this process can help taxpayers protect their rights and effectively contest a proposed tax deficiency.
The IRS generally sends a statutory notice of deficiency before it can assess and collect the tax, often called the “90-day letter,” under IRC §6212. This notice:
Next, let’s understand the procedure for issuance of a notice of deficiency to someone located outside the United States.
Issuance of Notice of Deficiency Outside the United States
It is common that a notice of deficiency may be issued to a taxpayer residing outside the United States. Let’s understand how such a notice is typically issued.
The notice of deficiency is typically mailed to the taxpayer’s last known address. This is generally the address shown on the most recently filed and processed return, unless the taxpayer has provided clear and concise notification of a change.
However, many taxpayers have their last known address outside the United States. In that case, the original notice of deficiency is sent to the last known address outside the United States by registered mail. This contrasts with sending the notice of deficiency for U.S.-based addresses, which is done by certified mail.
For foreign addresses, the full country name is generally included on the envelope and address. Therefore, abbreviations for country names are not used to ensure proper international delivery.
Generally, Deficiency litigation begins when the taxpayer files a timely petition with the U.S. Tax Court.
Next, let’s understand the timeline for filing a petition for deficiency litigation with the U.S. Tax Court.
Deficiency litigation begins when the taxpayer files a timely petition with the U.S. Tax Court. The petition should be filed within 90 days of the notice being mailed.
Since this discussion focuses on deficiency litigation, we are addressing only proceedings before the U.S. Tax Court. A key advantage of the Tax Court is that taxpayers may challenge the proposed deficiency without first paying the disputed tax. In a later section, we will discuss refund litigation in the U.S. District Courts and the U.S. Court of Federal Claims. Under the refund litigation, payment of the disputed tax is generally required before a lawsuit can be filed.
The 90 days to file the petition before the U.S. Tax Court start from the date the notice is mailed. If the last day or the 90th day falls on a Saturday, Sunday, or legal holiday in the District of Columbia, the deadline is extended to the next business day that is not one of those days.
Next, let’s understand the procedure for filing a petition against a notice of deficiency by persons located outside the United States.
Filing Petition by Persons Situated Outside the United States:
There may be situations in which a notice of deficiency is mailed to persons located outside the United States.
In that case, if a person is outside the U.S., the petition should be filed with the U.S. Tax Court within 150 days under IRC §6213.
The 150 days start from the date the notice is mailed. If the last day or the 150th day falls on a Saturday, Sunday, or legal holiday in the District of Columbia, the deadline is extended to the next business day that is not one of those days.
Now that we have understood the timeline for filing the petition against the notice of deficiency in the U.S. Tax Court. Next, let’s understand how a taxpayer can file a deficiency litigation petition with the U.S. Tax Court.
Next, let’s dive into the procedure for filing a petition against a notice of deficiency with the U.S. Tax Court.
A taxpayer should follow a proper procedure when filing a petition against the notice of deficiency with the U.S. Tax Court. This can be done either electronically or non-electronically. Let’s understand each of these methods in the next section.
Electronically Filing Petition with the U.S. Tax Court
A taxpayer may choose to file a deficiency litigation petition with the U.S. Tax Court through the electronic filing (eFiling) process. This eFiling can be done through the U.S. Tax Court’s secure DAWSON system (Docket Access Within a Secure Online Network). eFiling is particularly convenient for international petitioners, as it avoids international mail delays and is fully accessible worldwide via the internet.
Non – Electronically Filing Petition with the U.S. Tax Court
Alternatively, the taxpayer may prefer not to file electronically. They may download the petition form and related documents, including rules and instructions, from the U.S. Tax Court website. After completing the petition manually, the taxpayer may attach a copy of the Notice of Deficiency and mail it to the following address:
United States Tax Court
400 Second Street, NW
Washington, DC 20217
Taxpayers located outside the United States should be aware that mailing to the address mentioned above may take time. Therefore, electronic filing is often a safer option for international taxpayers to meet strict deadlines.
Now that we have covered the core framework of deficiency litigation, let’s turn our attention to its international tax dimensions.
Next, let’s explore the international tax aspects of deficiency litigation. This area is particularly important because when a taxpayer resides outside the United States, it introduces several unique challenges. This may involve filing a petition, service of documents, and extended response deadlines. Additionally, international tax deficiency cases often involve a broader and more complex range of issues, including foreign income, treaties, cross-border transactions, and multinational tax structures.
Next, let’s understand the international tax aspect of deficiency litigation.
Deficiency litigation may also affect international taxpayers and stem from international tax issues.
Such litigation may affect U.S. citizens/residents abroad, non-resident aliens with U.S.-source income, or entities in cross-border transactions.
Procedurally, the IRS issues a statutory notice of deficiency to the taxpayer’s last known address. If the taxpayer’s location is situated abroad, the IRS sends the notice using registered mail.
Also, international taxpayers outside the U.S. should file a petition with the Tax Court within 150 days of receiving the IRS deficiency notice.
Tax deficiencies in international tax disputes commonly stem from the following matters:
Now that we have understood the first type of litigation, deficiency litigation in U.S Tax Court, which arises without requiring the taxpayer to pay the disputed tax.
However, there is a second type of litigation procedure that requires the taxpayer to first pay the disputed tax in full. This usually happens when the taxpayer pays the tax first and then files a refund claim. Such a refund claim may escalate into a form of refund litigation.
Next, let’s understand the refund litigation.