Tax Disputes & Tax Litigation

The IRS, with the assistance of the Department of the Treasury and the Department of Justice, enforces the complex Federal Internal Revenue Code in a myriad of ways that can impact individual taxpayers and business entities. Where international issues are present, these cases can be even more complicated.  At times, the process can bewilder any taxpayer caught up in a tax controversy.  Clients call upon Caplin & Drysdale for our broad and deep knowledge of the tax controversy process and for the credibility we bring in our interactions with the IRS and other domestic and foreign tax authorities.

Although most tax disputes are resolved by agreement or administrative settlement, sometimes the only way a taxpayer can seek to prevail is to go to court, adding another dimension of risks and opportunities.  Caplin & Drysdale’s highly-skilled litigators can translate the firm's substantive knowledge and courtroom experience into a winning litigation strategy in the various forums in which tax cases can be litigated, including the U.S. Tax Court, the U.S. Court of Federal Claims, and Federal District Courts, Bankruptcy Courts, and the various appellate courts around the country.

Caplin & Drysdale attorneys have advised clients in controversies spanning the full range of the Internal Revenue Code, including individual and corporate income taxes, estate and gift taxes, payroll taxes and “backup withholding,” nonresident withholding taxes, and excise taxes; an array of state and local taxes on individuals and businesses; and reporting penalties asserted against taxpayers, information return filers, tax return preparers and “promoters,” and persons required to file reports of foreign accounts (“FBARs”).  

Areas of Focus

THE TAX CONTROVERSY PROCESS

Planning for an IRS Audit

An IRS audit may come as an unwelcome surprise. There are times, however, when it is clear from the outset that an audit of a tax return is likely. The taxpayer may already be under examination, or the return may implicate transactions that are already under scrutiny or include transactions or disclosures that are likely to attract attention. In such cases, prudent steps can be taken either (i) in connection with the initial filing of the return; or (ii) after filing, but before the taxpayer is on notice of an impending audit, that could pay big dividends later. Steps to consider at the pre-filing stage include:

• A well-crafted explanation or disclosure statement on the return may reduce the likelihood of an audit or frame its focus in a more favorable way.
• Surveying the return for potential audit flag issues or exposures.
• A review of past filings for which the statutes of limitation remain open, particularly if the sensitive issue has implications for those years, can guide strategy for a current filing.
• Identifying and gathering supporting documents up front as to any subject that is expected to be the initial focus of the audit can often help focus the IRS’ inquiries and shorten an audit.
• Understanding and developing the facts regarding the taxpayer’s reliance on professional advice, including who provided the advice and in what format, and thinking through potential privilege and waiver concerns.

Even after a tax return has been filed, action before the proverbial knock on the door may preempt an audit and/or mitigate exposures. Steps to consider at this stage include:

• Amending returns before an audit begins may help protect against penalties.
• Requesting deadline relief, i.e., seeking rulings to permit the taxpayer to make an election or take other actions for which the deadline has otherwise already passed.
• Filing protective tax returns or refund claims can start the running of statutes of limitation or protect against possible “whipsaw” situations, where the IRS might contend, for example, that a tax benefit was claimed by the wrong taxpayer and/or in wrong taxable year and the mistake could no longer be corrected.

Rectifying Prior Tax Errors and Tax Non-Compliance

As the complexity of our tax system increases, so too does the opportunity for technical and procedural foot-faults. At times, the flurry of new reporting requirements and the detailed procedures for making elections can confuse even the most seasoned of return preparers. The attorneys at Caplin & Drysdale have decades of experience assisting taxpayers in rectifying prior tax errors across a wide range of issues. In some cases, errors can be corrected with a simple amended filing.  In others, a special request must be submitted to the IRS – either in the form of a “9100 relief” request or through a request for a private letter ruling. More complex matters may require direct discussions with senior personnel at the IRS to determine the best method of remediation. Caplin & Drysdale attorneys leverage their depth of experience from both inside and outside of the government to determine the best methods for our clients.

Caplin & Drysdale has also advised hundreds of clients on various methods for voluntarily disclosing prior non-compliance with reporting requirements, particularly those involving foreign assets, income or transactions. Our attorneys have assisted clients with so-called “quiet disclosures,” with submissions through the IRS’s Delinquent International Information Reporting Submission Procedures (DIIRSP), and with delinquent tax return submissions through the IRS’s Streamlined procedures.  We are well-versed in the pros and cons of each of the IRS’s civil disclosure options, and in helping clients determine whether they might have criminal exposure necessitating consideration of the IRS’s Voluntary Disclosure program. Attorneys from our Criminal Tax Cases practice are available to consult with clients who may have such exposure.

Navigating IRS Audits

Caplin & Drysdale has decades of experience in assisting clients in IRS field audits and related proceedings, as well as audits conducted out of the Service Center and other dealings with the IRS examination function. Our attorneys can play a variety of roles, depending on the client’s preferences, in cooperation with other in-house or outside professionals where appropriate.  In complex cases one or two Caplin & Drysdale attorneys may face the IRS while others remain “on background.”

We are equipped to provide our clients with informed and practical advice on many types of procedural issues, including:

• preserving the taxpayer’s statutory rights and access to court, and rights under potentially applicable tax treaties;
• understanding the IRS’ rights to obtain information from the taxpayer and third parties;
• coordinating dealings with different IRS functions, accessing IRS Appeals, soliciting technical advice from the National Office, and other available internal avenues for dispute resolution; and
• considering state and local amended filings and related procedural issues.

Caplin & Drysdale marries extensive experience with these issues with substantive tax expertise spanning many areas of the Internal Revenue Code. At the audit stage, our attorneys can assist in crafting sophisticated submissions for review up the management chain or to District Counsel, or as a more formal request for technical advice. We can also weigh in on how an audit can be managed with an eye to how the substantive issues are expected to play out before IRS Appeals or in court, and in making the related judgment calls, including:

• Tactical questions: 
• Should the taxpayer try to improve the revenue agents’ report or press for a quick conclusion and rely on IRS Appeals?  
• Should the taxpayer seek or agree to extensions of the statute of limitations?
• Audit management: 
• How best should the taxpayer manage and respond to IRS information requests?
• What will be the most effective way to manage relations with the examiner(s) and other involved IRS personnel?
• Affirmative Issues:  
• How should taxpayers best raise new potentially favorable (“affirmative”) issues on audit for the examiners’ consideration?
• When should formal amended returns or protective refund claims be filed?
• Modeling and cash flows:  
• What assumptions should be made for purposes of reporting financial accounting tax reserves? 
• Should taxpayers make a payment on account or a refundable “deposit”?
• Should taxpayers request “quickie refunds” of carrybacks or excess estimated tax payments?

Handling IRS Administrative Appeals

While our goal always is to achieve success for our clients at the earliest possible stage, it is not always possible to resolve all audit issues at the IRS examination level.  When necessary, we assist clients with preparing written protests to the IRS Office of Appeals and in preparing for conferences with Appeals in an attempt to reach a settlement of any contested issues. Caplin & Drysdale attorneys have experience with both the “traditional” Appeals procedures, as well as the special alternative dispute resolution options available through Appeals, including Fast Track, Early Referral, Rapid Appeals Process, and Post-Appeals Mediation. 

Planning for Appeals is often best accomplished in conjunction with the development of a client’s audit strategy. However, Caplin & Drysdale is also available to consult with taxpayers who are new to the firm. We are both comfortable with and experienced in working with a client’s other tax advisors – whether internal or external – who handled the client’s IRS audit.  We have significant experience in working with accounting firms and return preparers and in using our legal expertise in conjunction with the technical expertise of clients’ accountants.

If a dispute with the IRS implicates collections issues, Caplin & Drysdale can assist with requesting a Collection Due Process (or equivalent) hearing from Appeals. We have successfully represented numerous clients in such hearings, achieving the release of liens and levies and abatement of penalties.

Litigating Tax Cases Though Trial and Appeal

The decision to litigate a tax case can be one of the most important decisions that a client may make. No tax trial is routine. Every case requires a unique strategy and evidentiary game plan. Every tax case requires a deep understanding of the tax law. Caplin & Drysdale’s tax litigation team has decades of experience combining these two legal disciplines – litigation and tax.

Caplin & Drysdale’s litigation team includes former senior leaders at the Tax Division of the U.S. Department of Justice, the Internal Revenue Service Office of Chief Counsel, and the Office of the U.S. Attorney of the Department of Justice. The size of Caplin & Drysdale’s litigation team allows it to handle cases of all sizes and staff projects appropriately. In many cases, Caplin & Drysdale’s litigation group co-counsels with one or more members from the firm's substantive tax practices (e.g., international tax, corporate tax, partnership tax, trust and estate tax, insurance tax) to develop strategy and leverage the firm’s deep understanding of the subject matter.

While the majority of tax litigation occurs in the U.S. Tax Court, many of our clients’ cases are litigated in the U.S. District Courts throughout the country, the U.S. Court of Federal Claims, the U.S. Courts of Appeal, as well U.S. Bankruptcy Courts and state courts. Our attorneys have decades of experience representing clients in each of these forums. We are also frequently called upon to represent third party fact witnesses in trials involving other taxpayers, represent taxpayers in IRS summons enforcement actions, FOIA actions, unlawful disclosure of taxpayer information actions, and IRS collection cases involving Federal tax liens and levies.

Representative engagements include:

• Represented the owners of a large privately held agribusiness and their related captive insurance company in the U.S. Tax Court involving a so-called section 831(b) micro-captive insurance transaction and obtained a full concession of all taxes and penalties.
• Represented an estate before the U.S. Tax Court concerning a spousal exemption involving issues of Israeli law and place of marriage celebration and obtained a favorable ruling after cross-motions for summary judgment.
• Represented a limited liability company facing penalties related to disallowed charitable contribution deduction for conservation easements and obtained a dismissal of the penalties based on the reasonable cause reliance on counsel and substantial authority defenses.
• Currently representing several third-party witnesses, including an economist from a big four accounting advisory firm and former in-house chief of procurement, in all phases of litigation including trial in a $1 billion dollar section 482 transfer pricing case in the U.S. Tax Court.
• Reached global settlement with IRS Office of Chief Counsel in 80 separate Tax Court cases involving common employee benefit plan tax issues.
• Represented a large Wall Street financial services firm in appeal to the U.S. Court of Appeals for the Seventh Circuit involving income tax accounting issues of expenses associated with certain derivative swap transactions.
• Represented a hedge fund and its tax matters partner in a three-way TEFRA partnership litigation with the IRS and an adverse partner in the U.S. Court of Federal Claims concerning the characterization and allocation of income to one of its investors.
• Brought an FOIA action for an environmental activist group that was under examination by the IRS, and after we learned from documents that a foreign country’s government had improperly asked the IRS to revoke the group’s tax exemption, the IRS dropped the examination.  

• Represented a private foundation and defended its tax exemption in a declaratory judgment proceeding brought in the U.S. Tax Court. 
• Represented a global professional services firm in connection with delinquent U.S. filings and obtained a highly favorable pre-litigation settlement with the examination team.

SPECIALIZED EXPERTISE

Sensitive and Potential Fraud Issues on Audit

An IRS examination of a taxpayer that may have potential fraud-related issues can create substantial risks for the taxpayer, as the IRS procedures generally require a civil examiner to refer cases with “badges of fraud” for potential criminal investigation and prosecution. Such audits are typically called “eggshell audits,” since the ultimate objective is to resolve the case civilly without “cracking the eggshell” of a criminal referral.

Caplin & Drysdale has represented taxpayers in eggshell audits since the firm’s inception in 1964. At times our attorneys appear in such examinations, and at times, for tactical reasons, we remain in the background while other professionals interact with the IRS. These types of audits require careful planning and staffing, and an experienced advisor will appreciate the range of tactical and sometimes difficult decisions that need to be made in the course of the examination. Our attorneys have had numerous and confidential successes in our “eggshell audit” representations, where we have managed to resolve as a civil matter circumstances where a criminal referral might have been possible. These types of cases are difficult to navigate, but where such audits are concluded civilly, the taxpayer can generally rest assured that the matter will not proceed to a more serious inquiry.

Defending International and FBAR Reporting and Penalty Cases

Decades before the IRS began focusing on international reporting issues in 2008, Caplin & Drysdale attorneys were representing clients in IRS examinations and in litigation concerning the reporting of foreign bank accounts and other foreign assets. In many of our prior representations our attorneys have been successful in persuading the IRS to reduce or even abate significant penalty adjustments.

These types of cases include:

• The assessment of substantial “willful” or even “non-willful” penalty assessments for the failure to file foreign bank account reports, known as FBARs, and actions by the Department of Justice to collect such penalties (FinCEN Form 114).
• Penalties imposed for a taxpayer’s reporting violations relating to the receipt of distributions from a foreign trust or the taxpayer’s relationship to such a trust (Forms 3520/3520A).
• Penalties arising from the failure to report gifts or inheritance from foreign sources, including non-U.S. family members (Forms 3520).
• Penalties resulting from the failure to report controlled foreign corporations (Form 5471).  

The strategy and tactics in these international penalty cases depend heavily on the facts involved, including the sources of assets held overseas, the taxpayer’s knowledge and understanding of the relevant reporting rules, and advice that may have been given (or not given) by prior professional advisors. Effective representation also hinges on an understanding of the often complex and sometimes frustrating procedures followed by the IRS in such cases, where a misstep can create significant issues for taxpayers as the cases move forward. 

Caplin & Drysdale’s attorneys have served in senior IRS and Department of Justice positions and have years of experience in private practice dealing with these unusual cases, which for now remain a high tax enforcement priority.

Controversies Involving Interest on Federal Taxes

Controversies involving the computation of interest under the Internal Revenue Code frequently arise, particularly in cases involving complex transcripts and multiple tax accounts, and can involve large sums. They can arise at any stage in a tax controversy where tax is assessed or a refund allowed, and present a number of procedural traps for the unwary.   While a taxpayer can demand return of excess underpayment interest previously paid to the IRS in an ordinary refund claim, a taxpayer that accepts a refund of tax with miscomputed interest can lose rights to challenge the interest computation if the statute of limitations has run on filing a fresh refund claim. Different jurisdictional rules (and a different statute of limitations) apply to taxpayers that claim additional refund interest. The law in this area is also complex and, in some respects, unsettled, particularly as regards the so-called “global netting” rules under which corporations may request equalization of the interest rates charged on their tax liabilities and paid on their refunds.  

Caplin & Drysdale has extensive experience working with accountants and other specialists to identify potential claims, and in successfully pursuing corrections through IRS channels (including working with interest computations specialists at Exam, Appeals, and the IRS Ogden campus), and, where necessary, in court. Several of our attorneys are active members of bar of the Court of Federal Claims, where such actions often have to be brought.

Working with the Taxpayer Advocate Service (TAS)

It is no secret that the IRS has had difficulty operating efficiently and effectively in recent years.  When taxpayers have tried to resolve their issues with the IRS through the agency’s normal procedures, but have either received no response or a response that does not comply with the IRS’s own rules, they may be able to seek assistance from the Taxpayer Advocate Service (TAS). Caplin & Drysdale attorneys have represented numerous clients in applications for TAS assistance and in negotiating a reasonable outcome through local Taxpayer Advocates. We are highly experienced in resolving through TAS issues involving, but not limited to, the actual or threatened imposition of liens or levies, erroneous balance due notices, missing refunds, unprocessed tax returns or refund claims, and more.

Defending Against State “False Claims Act” Tax Complaints and State and Local Audits

For years, many states have allowed a private action under traditional qui tam principles, where a private party alleges that another party has profited from false claims against the state government. Recently, many states, including the District of Columbia and New York, have expanded these statutes to allow one private individual to sue another for conduct that constitutes tax evasion. Typically, such cases are filed under seal initially, with state-level officials then deciding whether to join the action, in which case it becomes public. Most typically, these cases entail allegations that an individual should have been filing returns or paying taxes in the relevant jurisdiction as a domiciliary or a statutory resident.

Caplin & Drysdale has defended clients in tax qui tam actions, focusing first and most importantly on attempting to convince the local authorities not to join in the private actions, which, when that decision is made, often leads to a withdrawal of the case or a quick settlement.  If such cases mature into litigation, Caplin & Drysdale's tax litigators will represent the client throughout the proceeding. The firm has many years of experience in the area of state-level domicile and residence issues, and has a body of research and skill into the complex case law that has developed in such matters and that can be drawn upon to allow for an efficient representation.

Our attorneys have also successfully represented taxpayers in audits by state and local taxing authorities, as well as in administrative appeals in those jurisdictions.

 Advising Tax Professionals

Over the years, the IRS and the Department of Justice have targeted tax professionals in various types of cases, including major tax shelters, syndicated conservation easements, tax return preparation, and ethical violations. Tax enforcement officials view misconduct by tax professionals as a high priority, and an area where the government can foster voluntary compliance efficiently by deterring alleged wrongdoers. For decades Caplin & Drysdale has often acted as the “lawyer’s lawyer,” addressing delicate questions arising out of the rendering of complex tax advice, the degree of professional due diligence in a case, the application of tax opinion standards, and the attorney-client work product privileges. Our lawyers have had many successful representations in both the criminal and civil context where the conduct of a professional has been at issue, and we have substantial experience in addressing the unique issues that arise in such cases.

Caplin & Drysdale attorneys also have deep experience in advising return preparers on the procedural and ethical rules that apply to their practice. Drawing on their experience gained in the Department of Treasury and the risk management function of major accounting firms, our attorneys are available to consult on a range of issues facing return preparers, including:

• disclosure rules;
• compliance with Circular 230; and
• the application of AICPA and other professional guidelines.

IRS Office of Professional Responsibility (OPR) Matters

The IRS Office of Professional Responsibility (OPR) enforces a set of ethical rules for tax professionals called Circular 230. Since the early 2000s, when one of Caplin & Drysdale’s attorneys was tapped to head this office, OPR has significantly ramped up its enforcement capabilities and efforts to target tax professionals that OPR believes have engaged in violations of Circular 230. Such cases can result in a private reprimand or a public suspension or disbarment from practice before the IRS.

OPR cases often present complex issues arising from the need to apply and interpret Circular 230 to specific facts, and Caplin & Drysdale’s attorneys have represented dozens of tax professionals targeted by OPR over the years, in many cases with favorable results, including OPR’s termination of the investigation or the issuance of a private letter of reprimand.

Reportable Transaction Compliance and Defense

The IRS has devoted a significant portion of its enforcement resources in recent years to investigating compliance with the detailed rules and regulations regarding reportable transactions. Taxpayers and advisors involved in such transactions – or transactions the IRS deems similar to such transactions – may be required to report their activities on Form 8886 or 8918.  Even minor foot-faults in the reporting of these transactions can result in significant penalties, in some cases up to $200,000 per form per year. Caplin & Drysdale attorneys have experience in advising on whether such reporting is necessary and in defending clients in IRS audits regarding compliance with the IRS’s reportable transaction regime.

The firm’s attorneys have also been at the forefront of analyzing and applying the emerging case law regarding the IRS’s non-compliance with the Administrative Procedure Act (APA), and the effect such non-compliance has on the ability of the IRS to enforce various Notices identifying listed transactions and transactions of interest. In addition to defending against IRS enforcement efforts, the firm’s attorneys can also assist taxpayers who have already paid reportable transaction penalties in seeking refunds at either the administrative level or in federal court.