THE ROLE OF LITIGATION IN THE FEDERAL TAX SYSTEM
Stuart E. Seigel, Esq.
Internal Revenue Service
April 23, 1979
note: Stuart E. Seigel has been Chief Counsel of the Internal Revenue
Service since 1977. Prior to that he was, for eight years, a partner
in the Washington, D.C., law firm of Cohen and Uretz. He also served
as Tax Legislative Counsel in the Treasury Department.
Mr. Seigel earned his bachelor's and law degrees
from New York University and a Master of Laws in Taxation from Georgetown
He has served on the faculties of Antioch School
of Law and the Law School of George Washington University.
Mr. Seigel is a member of New York and District
of Columbia Bars. He is also a member of numerous other legal associations.]
Litigation of tax cases in the courts plays a central role in the
federal income tax system.
The purpose of the courts in handling tax disputes is, of course,
to resolve controversies over tax liability between the Government
and tax-payers. In this respect, the courts serve the practical and
necessary function of reaching a specific conclusion with regard to
an individual or corporation's tax liability, as well as providing
a forum for the settlement of disputes which remain unresolved through
the administrative process.
A by-product of that function and an important role of the litigation
process is the interpretation of tax issues which have significant
impact. This process helps shape the law and is a touchstone for guidance
in planning transactions and in legislative and regulatory development.
Litigation of income tax cases, as structured today, presents what
is to many a confusing and perplexing array of alternative judicial
procedures and options.
There are three trial forums available to taxpayers -- the United
States Tax Court, the United States District Courts, and the United
States Court of Claims. The District Courts and the Court of Claims
are, as I will elaborate more fully, only available if the taxpayer
has paid the tax in controversy and is seeking a refund. The Tax Court
offers the only trial court available where a dispute can be aired
without prepayment of the tax involved.
Obviously, every tax dispute has its origins in a tax audit or examination
initiated by the Internal Revenue Service. If the taxpayer does not
agree with the agent's determination, and the matter remains unresolved,
in whole or in part after administrative appeals are exhausted, a
formal notice of the deficiency in the tax determined to be due must
be sent to the taxpayer. This notice of deficiency -- or so-called
ninety-day letter -- affords the taxpayer the opportunity to file
a petition within ninety days. If that option is chosen the case,
if not settled before trial, will be heard by a judge of the court
in one of the many cities throughout the country where the Tax Court
holds trial sessions. Although the Tax Court is head-quartered in
Washington, D.C., its judges travel throughout the country to hear
cases. The Government is represented in these proceedings by attorneys
of the Chief Counsel's Office of the IRS. Among the statutory duties
of the Chief Counsel is the responsibility to represent the Commissioner
of Internal Revenue in proceedings before the Tax Court. IRS lawyers
are located in 45 field offices throughout the country, handling,
among other matters, cases pending in the Tax Court. No jury trial
is available in the Tax Court, and the losing party -- the taxpayer
or the Government -- has an automatic right of appeal to one of the
11 United States Courts of Appeals. Further review of the case can
be had in the United States Supreme Court if that Court, in its discretion,
chooses to hear the case upon application by the losing party in the
Court of Appeals. Obviously, only a very limited number of cases originating
in the Tax Court are ultimately presented for decision to the Supreme
If a taxpayer chooses to pay any additional income tax claimed by
Government, whether before or after receipt of a notice of deficiency,
he or she has the right to file a claim for refund of the tax within
a limited period prescribed by statute. If that claim is denied by
the Government, or not acted upon within six months, a suit to recover
the amount may be brought in the United States District Court for
the judicial district within which the taxpayer is located, or in
the United States Court of Claims.
In the District Court, either the taxpayer or the Government can
demand a jury trial and, as in Tax Court proceeding, there is a right
of appeal to the appropriate United States Court of Appeals, with
the further possibility of review by the Supreme Court. The Government
is represented by the Department of Justice, although IRS lawyers
will be involved in recommending the position to be taken in the case
and in determining the acceptability of settlement offers. The lawyer
handling the case for Justice may be one of the attorneys in the Tax
Division in Washington, D.C., who travels to the trial site as necessary,
or, in some larger areas, a local Assistant U.S. Attorney.
The Court of Claims employs a bifurcated procedure. The evidence
is received and the initial decision rendered by a special trial judge,
without a jury. The court is located in Washington, but evidence will
be taken by the trial judge at such place or places as may be most
convenient. The trial judge's decision will be reviewed by judges
of the Court upon application, in an appellate type proceeding. Unlike
the Tax Court or district court, no right of appeal exists from a
final decision of the Court of Claims to the United States Courts
of Appeals. The only appellate review is to the Supreme Court, where
the case will be heard only if the Court, in its discretion, decides
to hear it. Because so few tax cases are heard by the Supreme Court,
the likelihood of any appellate review of a final decision of the
Court of Claims is remote. The Government is represented by a lawyer
from the Tax Division of the Department of Justice in Washington,
with little participation and assistance of IRS lawyers as in district
As you can see from this summary, trial jurisdiction in federal
income tax cases offers a wide range of alternatives. Counsel for
a taxpayer must consider carefully the choices and make appropriate
recommendations to the client on how to proceed. This is a classic
example of forum shopping, where the choice of forum itself may influence
or even control the disposition of the case.
To illustrate -- if the dispute centers about a factual matter which
may be more sympathetically received by a lay jury rather than a trained
jurist, it may be advantageous to pay the disputed sum and seek recovery
in a federal district court -- the only forum available with the right
to a jury trial. Of course, if the taxpayer cannot pay the amount
involved without current adverse financial consequences, the choice
may be limited to the Tax Court, even though a jury trial might be
If the issue is legal, not factual in nature, and the arguments
best comprehended by a judge who specializes in tax matters, going
to the Tax Court may be the best way to proceed.
Another example -- if the Court of Claims has decided the legal
issue in the taxpayer's favor, and the decisions in other courts are
adverse or nonexistent, the Court of Claims becomes the forum to litigate
This complex jurisdictional scheme breeds conflicts among the trial
courts and leads to uncertainty in the predicting of the legal result
in many tax issues, since it is highly unlikely that the government
will be able to effect an appeal seeking to overrule the court's position.
The anomalies of the system are evident. A jury trial can be secured
only by prepaying the tax. Tax Court and district court cases are
subject to review and are bound by decisions of the Court of Appeals.
However, since the Tax Court is a national court, it need not follow
the decision of one court of appeals in deciding a case in which appellate
jurisdiction lies in another court of appeals which has not ruled
on the issue. The Court of Claims, although it may be influenced by
decisions of other courts, is bound only by precedents of the Supreme
If you litigate your case in the Tax Court, an IRS lawyer in or
near the taxpayer's geographical location will handle the case, whereas
if you litigate in the district court or in the Court of Claims, the
case will likely be handled by a Department of Justice lawyer in Washington.
In attempting to treat taxpayers similarly throughout the country,
close coordination is not only required within the technical and litigating
functions of the Service but between the Service and the Justice Department.
If you are in the Tax Court your case will be heard and decided
by a judge whose background and judicial functions are tax-oriented
-- a specialist. In the district court and the Court of Claims, the
judges have wider and more generalized jurisdiction.
Should the system be reformed? Most observers would say we could
probably devise a more rational, plainer, and less confusing system
without much difficulty. Will reform of trial jurisdiction likely
occur in the near future? Probably not. There have been long standing
impediments to dealing forthrightly and in a meaningful way with the
There are institutional barriers. IRS and Treasury officials tend
to believe that trial responsibility can be most effectively discharged
by IRS lawyers. The Service is highly decentralized, so it is argued
that taxpayer convenience and expense can be best served by IRS lawyers
who are on or close to the scene. Also, their day-to-day involvement
and close working association with IRS agents and administrators should
expedite and make more efficient the handling and disposition of the
On the other hand, it is suggested that representation by Department
of Justice lawyers creates more institutional independence and objectivity
than can be expected of agency lawyers. One of the rebuttals to that
notes that the Chief Counsel of the IRS, and the lawyers within the
office, are not organizationally subject to the control of the Commissioner
of Internal Revenue. The Chief Counsel is responsible to the Secretary
of the Treasury through the General Counsel of the Treasury Department,
and is able, therefore, to promote and exercise independent legal
Another issue which must be faced to eliminate the triple forum
trial system is whether it is better to have specialist or generalist
trial judges. Much has been written and voiced on that subject, with
division and sincerity abundant.
There are those who argue that the present system takes account
of the various situations and concerns of taxpayers and is responsive
to their needs -- a primary and overriding factor. Many tax lawyers
also favor the existing structure, since more than a single trial
forum maximizes their opportunity to succeed.
I am hopeful that an objective and searching inquiry into this subject
could produce a consensus either in support of the present system,
or for change. It is a subject worthy of professional concern, since
its impact on taxpayers and tax administration is substantial.
Although the IRS initiates the tax audit and the resulting claim
for additional taxes, the IRS does not make the initial determination
to litigate a tax case. That decision is made by the taxpayer who
decides whether to agree with the Government's assessment, or to litigate
the controversy in the courts, and, if so, in which trial court.
Each year there are thousands upon thousands of tax controversies.
Last year, for example, the IRS examined approximately 2.3 million
returns, resulting in approximately $6.3 billion in recommended additional
tax and penalties. Out of those examinations, about 62,000 proposed
deficiencies were unagreed to by taxpayers, thus setting the stage
for efforts at administrative and judicial resolution of the issues.
Our tax system is designed to dispose of the vast majority of these
cases through administrative appeals within the Service. Over the
last 10 years, we have been able to close about 97 percent of all
disputed tax matters without a trial. Obviously, if most of these
controversies were not handled in that manner, an intolerable burden
would be placed upon the courts.
Most litigated tax cases involve disputes over the facts, rather
than disputes over the law. For example, an agent may have disallowed
deductions claimed as ordinary and necessary business expenses under
section 162 because of a lack of substantiation as to the amount of
the deduction, or the business purpose for the deduction. In such
cases there may be no uncertainty as to the legal standard to be applied
-- only whether the facts can be demonstrated to support the deduction.
In general, cases which present issues of a significant legal nature
should be distinguished from those which are essentially factual in
nature. It is the former category which requires special consideration
and review by the Service in determining our litigation position.
A number of factors are taken into consideration in deciding whether
settlement on a reasonable and equitable basis is possible, or whether
the case will likely have to be tried.
Settlement is based upon a review of the facts and the law taking
into account the hazards of litigation. The exercise is necessarily
judgmental and requires analysis, based upon training and experience,
of the probability of success in the courts.
There are certain issues which are more difficult to compromise
than others. A challenge to the constitutionality of an Internal Revenue
Code provision will likely pose substantial impediments to settlement,
since we will ordinarily presume the constitutionality of congressional
enactments and defend the case. If one is claiming that a regulation
issued by the Treasury is invalid, settlement probably again is not
on the high side -- although the service is not always right, the
validity of regulatory provisions is carefully analyzed during the
promulgation process. Settlement of a case contrary to a published
Revenue Ruling is also generally somewhat more difficult, although
the hazards of litigation will be taken into account.
The decision to litigate a particular issue is therefore often determined
by the existence of a published Service position on that issue. In
establishing litigating positions, our office makes every effort to
insure that the positions taken conform with National Office policy
as expressed in the regulations, published rulings, and positions
taken in decided cases on similar issues. Our field lawyers have procedures
available to make access to technical guidance from the National Office
a reality. Hundreds of requests for such guidance are handled each
If a published legal position of the Service is held invalid by
a trial court, the matter will be carefully reviewed. An appeal will
be taken if we believe that the reasoning of the court is in error.
If the issue is lost on appeal, an evaluation of whether to continue
to litigate the Service's position in other cases must be made. We
may litigate an issue in more than one appellate court where we believe
the issue was wrongly decided although most often two appellate losses
will result in conforming our position to the judicial verdict. Taxpayers
also are free to, and will with more frequency than the Government,
continue to litigate issues lost in one or more appellate courts.
Another type of case where the Service may be more prone to litigate
than settle is a case which would be an important test case on an
issue of significant administrative or legal importance. There are
always many unresolved questions of interpretation of the Internal
Revenue Code. Often a case will arise which we perceive to be an important
"test" case of an issue having significance beyond the tax
liabilities involved in that particular case. For example, the Supreme
Court recently rendered an important decision in the Thor Power
Tool Company case. The main issue involved an accounting practice
whereby the taxpayer, a tool manufacturer, in accordance with generally
accepted accounting principles, "wrote down" its excess
spare parts inventory to their scrap value, but continued to hold
the goods for sale at their original prices. The Service took the
position that the write down did not clearly reflect income, not-withstanding
conformity with good financial accounting, and the Supreme Court upheld
the Service's position.
What is important in a case like Thor is the opportunity
to resolve an issue with important ramifications in the development
of the tax law. Here it was the relationship between financial inventory
and tax inventory -- should GAAP prevail. An important fundamental
issue was addressed in the words of Mr. Justice Blackmun:
... the presumption (taxpayer) postulates is unsupportable
in light of the vastly different objections that financial and tax
accounting have. The primary goal of financial accounting is to provide
useful information to management, shareholders, creditors, and others
properly interested; the major responsibility of the accountant is
to protect these parties from being misled. The primary goal of the
income tax system, in contrast, is the equitable collection of revenue;
the major responsibility of the Internal Revenue Service is to protect
the public fisc. Consistently with its goals and responsibilities,
financial accounting has as its foundation the principle of conservatism,
with its corollary that 'possible errors in measurement [should] be
in the direction of understatement rather than overstatement of net
income and net assets.' In view of the Treasury's markedly different
goals and responsibilities, understatement of income is not destined
to be the guiding light. Given this diversity, even contrariety of
objectives, any presumptive equivalency between tax and financial
accounting would be unacceptable.
This is a landmark case on the issue of tax versus financial accounting,
and one of importance which the Service believed warranted testing.
We are more likely to litigate and less likely to settle an issue
involving significant questions of law on which there is doubt as
to the correct substantive position; cases which would appear to be
of substantial precedential value on issues which would affect a substantial
number of tax-payers; and cases involving important jurisdictional,
procedural, or evidentiary questions.
Along these lines, in the mid 1960's we instituted a litigation
procedure known as the prime issues program. This program established
a list of issues -- "prime issues" -- which the Service
believed needed resolution by the courts and, therefore, would not
generally seek to settle. These were important but unanswered questions
of importance to tax administration. In cases involving these issues,
field offices were instructed to develop the facts fully in preparation
for a trial, and we attempted to make our most complete presentation
of our legal position on brief in the first case to be tried.
The prime issues program was designed to help develop judicial guidance
on important tax questions. From the beginning, however, the program
had difficulties. We found, for example, that the prime issues program
did not significantly contribute to Supreme Court and Courts of Appeals
review of those issues. We also found that issuance of regulations,
or rulings, were often a more effective and speedy means of resolving
problem issues and furnishing guidance to the public. The prime issues
program has essentially been dormant for several years, and we are
now in the process of considering its termination.
The IRS is, as I have mentioned, settlement oriented, and our administrative
and litigation procedures are designed to encourage and facilitate
settlement. In recent years, however, it had been apparent that many
of these procedures were not working as well as they might and we
recently made significant changes in our settlement procedures.
In the past few years, the case load in the Tax Court has increased
dramatically. At the end of fiscal 1973, there were approximately
13,500 cases pending in the Tax Court. At the end of fiscal 1978,
this inventory was over 23,000 cases. In 1973, 9,624 petitions were
filed; in 1978, 13,284. At the same time, there was statistical evidence
indicating that an increasing number of taxpayers were bypassing the
administrative appeals system within the IRS and going directly to
the Tax Court -- needlessly, in many cases, invoking judicial procedures
without adequately testing the possibility for administrative settlement.
Last year we instituted two changes in the handling of disputed
cases. These changes are the movement to a single level of administrative
appeal, and the clarification of settlement authority in cases docketed
in the Tax Court.
The old system of administrative appeal dated back to the early
1950's. Under that system, first, the taxpayer could appeal his case
to District Conference. The District Conferee could resolve factual
disputes, but did not have settlement authority based on hazards of
litigation, except in cases involving $2,500 or less.
Second, the taxpayer could go from District Conference, if the case
was not settled at that level, to the Appellate Division. The Appellate
Conferee had full authority to take hazards of litigation into account
in all cases. A Third available alternative was to take the case directly
to the Appellate Division, without consideration by District Conference.
A fourth possibility was to go to District Conference and, if the
case remained unsettled, file a petition in the Tax Court without
further protesting the case to the Appellate Division.
Yet a fifth alternative existed -- a taxpayer could by-pass both
District and Appellate Conferences and take the case directly to the
Settlement of a case pending in the Tax Court required the approval
of both an Appellate Conferee and the Regional Counsel's Office except
that, after the calendar call in the Tax Court, Regional Counsel had
sole settlement authority. This dual settlement authority applies
to all cases -- those which Appellate had considered in nondocketed
status as well as those which had been brought to the Tax Court without
Whether Appellate would have sole jurisdiction to consider settlement
in a case depended on which option was selected by the taxpayer. If
the taxpayer protested the case to Appellate in nondocketed status,
Appellate had sole settlement authority. If the taxpayer by-passed
Appellate and filed a petition in the Tax Court, settlement of the
case was a dual responsibility of Appellate and Counsel.
There were other anomalies in the system. For cases involving less
than $2,500, the taxpayer could have his case considered at two separate
levels of administrative appeal, each with full settlement authority
taking into account litigating hazards, whereas for larger cases there
was only one forum with full authority to settle -- the Appellate
These procedures were duplicative, time consuming, and expensive.
After careful consideration, we recently took two steps which we
hope will simplify, expedite, and make more rational the system for
disposing of disputes between the IRS and taxpayers.
First, under the new single level of appeal system, which went into
effect last October, a Regional Director of Appeals is in charge of
all appeals within each of the seven IRS regions. This new appeals
organization will have jurisdiction over all appeals, including those
arising from collection matters and those involving employee plans
and exempt organization cases. The District Conference procedure is
Taxpayers will continue to enjoy all rights and opportunities previously
afforded under the two-tiered appeals system, except of course for
the elimination of the District Conference. In any case in which a
taxpayer was previously afforded a District Conference, the taxpayer
may now have a conference with an Appeals Officer who can exercise
full settlement authority. Appeals conferences are offered to taxpayers
at the same locations where District Conferences were previously offered.
One of the advantages we hope to realize through the single level
of appeal is greater uniformity. We believe that having all appeals
under a central managerial system and a uniform reporting system will
promote uniformity in appellate-type decisions. This system will also
emphasize the separateness and independence of the administrative
appeals function of the IRS from its examination and collection functions,
which is an appropriate and necessary aspect of an effective administrative
We believe the single level of appeals system will provide significant
benefits both to taxpayers and to the IRS. For both the IRS and for
tax-payers, the system saves time, effort, and money previously required
to participate in two conferences. The merged system will provide
all tax-payers the opportunity to obtain full settlement of their
disputes at the first conference. For the IRS, the merged system will
eliminate duplicate utilization of limited resources; resources that
can be used more effectively in the administration of the tax laws.
Revenue Procedure 78-9 is the second part of our efforts to improve
the procedures for resolving tax disputes. While the new single level
of appeal is designed to limit taxpayers to a single administrative
appeal, Revenue Procedure 78-9 is designed to help assure that disputes
are considered solely by the Appeals Division at some point. As I
have noted, formerly a taxpayer could preclude Appellate from having
an opportunity to settle a case on its own by docketing the case in
the Tax Court prior to an Appellate hearing.
Revenue Procedure 78-9 is also designed to eliminate duplicative
Appellate consideration of the same case -- once before docketing
and once after docketing with the participation of Regional Counsel.
As I stated, the case load in the Tax Court has increased dramatically
in recent years. This, in part, is attributable to taxpayers increasingly
by-passing the administrative appeals system. Last year over 80 percent
of the cases filed in the Tax Court had not been submitted to the
Appellate Division before bringing the case to court. Forty-four percent
had been neither to District Conference nor to the Appellate Division.
This meant that less than 20 percent of the cases filed in the Tax
Court had been subject to a settlement process where the Government's
representative had authority to settle the case taking into account
litigating hazards. The Tax Court had, to some extent, become a de
facto extention of the administrative appeals process. This result
is contrary to basic concepts or orderly administrative practice --
that judicial proceedings ordinarily should be invoked only after
administrative settlement processes have been exhausted. An effective
and efficient administrative appeals mechanism is central to the orderly
handling of disputed matters.
Appellate has consistently resolved about 75 percent of the cases
it handles in non-docketed status.
It appeared sensible and reasonable to afford the Appellate Division
the sole opportunity to settle every case at some point in the process
under its relatively informal settlement procedures. This step would
put primary settlement authority where it properly belongs and, at
the same time, allow Counsel lawyers more time to devote to cases
that are more likely to be tried.
Furthermore, under the old procedure, if a case had been subject
to Appellate Division consideration before docketing, continuing jurisdiction
of Appellate jointly with Counsel once the case was docketed interfered
with the timely preparation of cases for trial. Taxpayers frequently
operated on the principle that they had little or nothing to lose
by docketing a case. It was likely that the best settlement proposal
worked out in nondocketed status would always be available, since
the same appeals officer would continue to be involved in the settlement
process after the case was filed in court. This meant that some cases
were filed in the Tax Court primarily for the purpose of utilizing
that forum as a mechanism to test the possibility of a better settlement.
Moreover, because of Appellate's continuing role after docketing,
the emphasis continued to be on settlement. Emphasis should be on
further development of the case under the normal judicial procedures
designed to elicit information from both parties to aid in the preparation
Our experience was that in too many cases Counsel got into trial
preparation too late. This encouraged late settlements and hampered
the proper development of the case for trial.
Revenue Procedure 78-9 is designed to deal with these concerns.
Its objectives are to utilize the administrative appellate process
effectively and to provide for earlier and more thorough development
of cases from a litigating standpoint. We hope the result will be
both earlier settlements and better presentation to the court of those
cases that go to trial.
Under Revenue Procedure 78-9, if a case had been to Appeals before
the notice of deficiency was issued, Counsel will have exclusive jurisdiction
of the case from the time it is filed in court. If the case had not
been to Appeals, Counsel will refer the case to Appeals, which will
have sole settlement authority over the case for a stated period,
subject to extensions with Counsel's concurrence.
This means that, unlike the former procedure, Appeals will have
sole settlement authority over every case at some time. Since the
Appeals organization is viewed as the primary settlement mechanism
for all cases, there will be no difference in settlement authority
achieved by docketing a case. Taxpayers and their representatives
are therefore encouraged to bring their case to Appeals first and
not to invoke unnecessarily the processes of the Tax Court. Appeal's
record of settlement is enviable and I think the overwhelming majority
of cases can be disposed of fairly and justly without the necessity
of bringing the case to the Tax Court.
When Counsel acquires sole jurisdiction over the case under Revenue
Procedure 78-9, the initial emphasis will be on trial preparation
-- not settlement. While settlement of the case is always possible,
and is desirable, our lawyers will take a fresh look at the case,
and by utilizing the court's informal discovery process, develop and
exchange relevant facts and evidence. This process will enable Chief
Counsel lawyers to be in a better position to consider independently,
and against a different background, the advisability of settlement.
Only when this process is complete can we then determine whether the
case is susceptible to settlement. We will not be bound by any prior
settlement proposals that Appeals may have considered and will approach
the range of settlement in a given case de novo.
Our procedures provide for Counsel to have available the views of
Appeals prior to concluding any settlement of a case, which we believe
will enhance and strengthen the process.
The new procedures have great potential for stemming the ever increasing
tide of cases being brought to the Tax Court. They also have potential
for the earlier settlement of cases that are filed with the court,
and for the better presentation and development of cases that are
These changes greatly expand the role of the Appeals Division. It
becomes the primary organization to resolve disputed cases by settlement.
It will have sole settlement authority over all disputed cases at
some point. It will handle all disputes -- collection, and Employee
Plans and Exempt Organizations as well as all tax disputes. We hope
the result will be the fair, uniform and expeditious disposition of
most disputes. Generally speaking, Appeals should settle cases --
Counsel should be viewing cases from their litigation posture.
Since the initial portion of my remarks dealt primarily with trial
jurisdiction in tax cases, I would like to close by discussing current
developments affecting appellate jurisdiction. As I have mentioned,
there are 11 Courts of Appeals and the Court of Claims which can render
conflicting decisions resolvable only by the Supreme Court or Congress.
Final resolution of issues affecting taxpayers and the efficacious
planning of business transactions may be delayed for years while courts
struggle with difficult issues. Not infrequently final resolution
can come only if the Supreme Court hears and decides a case involving
an issue which has created a conflict in the decisions of the Courts
of Appeals. A conflict in the circuit courts which have considered
the issue is the most certain basis upon which the Supreme Court will
accept cases for consideration.
Often, legislation in important areas will only be forthcoming when
a final judicial opinion has been established. For example, in the
area of corporate taxation, the Chamberlin case
(1) gave rise to section 306 to prevent preferred
stock bailouts of corporate earnings. The decisions in the Court
Holding (2) and
Cumberland Public Service (3)
cases led to enactment of section 337, to permit tax free sales of
corporate property in liquidation, rather than have the incidence
of taxation depend upon whether the sale was implemented by the corporation
or its shareholders.
Yet, the conflicts in decisions can proceed for years until Congress
or the Supreme Court acts to resolve the matter definitively. This
causes uncertainty for both taxpayers and tax administrators alike.
Over the years there have been a variety of proposals to cure the
problem by restructuring or modifying the present appellate system
for handling tax appeals. The objective has generally been the same
-- to provide for earlier resolution of disputed issues and thereby
enhance uniformity -- although the suggested means to the desired
end have varied.
The subject is again of current vitality. It has been the subject
of recent discussion within the administration, and Senator Kennedy,
Chairman of the Senate Judiciary Committee, has put forward a specific
Senator Kennedy's proposal would provide for a single court of appeals
to hear tax cases brought from the Tax Court or from federal district
courts. Under this bill, the Court of Claims would no longer have
jurisdiction over tax refund suits. The Court would be composed of
judges, selected on a rotating basis for stated periods of service,
from among the judges of various United States Courts of Appeals.
By creating a single court of tax appeals, the uncertainty generated
by litigation ensuing after an initial appellate court has heard and
decided an issue would be ended. The potential for conflicting decisions
among the courts of appeals, with resulting nonuniformity in treatment
among similarly situated taxpayers, would also he terminated.
That uncertainty has had adverse effects for taxpayers and for tax
administration. Conflicting decisions lead to uncertainty in undertaking
business transactions which have significant tax implications. This
can inhibit economic activity and also cause concern over the equity
and efficiency of a tax system whose consequences are not predictable.
On the other hand, lack of finality in appellate decisions encourages
noncompliance and intensifies incentives for arcane tax planning schemes
A concern expressed, however, is that good jurisprudence is an evolutionary
process, where consideration and reconsideration of complex issues
yields, in the end, a more mature and reasoned result. Concern is
also expressed that resort to only one appellate proceeding on an
issue can result in an erroneous decision without prompt, effective
recourse. The sparse opportunities for Supreme Court review leaves
legislative correction by the Congress as the only effective remedy
in most cases -- an uncertain and frequently time consuming alternative.
Single appellate review in tax cases is also said to put a premium
on the quality of the representation in the first proceeding. Perhaps
a case will be lost which might have been decided differently if better
presented and analyzed. Under the existing system the opportunity
for correction exists, since another appellate court may not concur
with the earlier finding, either because it brings new or more sophisticated
analysis to bear, or has the advantage of a better presentation and
discussion of the relevant legal authorities and reasoning.
There is much to appeal to a lawyer's desire for the best legal
result to lead one to favor the reflective qualities of the present
system. Yet, on balance, I believe the practical benefits to tax administration
of a single court of tax appeals outweighs those concerns, assuming
such a court is properly structured.
To merit the confidence of taxpayers, affected Government agencies,
and the bar, the court must be composed of judges of competence and
stature. Moreover, the court must be able, through its procedures
and structure, to build a permanent body of decisional law which will
serve as precedents among the panels of its judges who will hear cases,
and which will guide the lower courts in the discharge of their judicial
This can be accomplished by having the court composed of judges
appointed for life, as is the case in most federal judgeships. The
recent increase in the number of federal judges authorized by Congress,
however, may make any approach which involves the creation of additional
judgeships politically uncertain.
Since the workload of a court of tax appeals will be drawn from
the existing courts of appeals, it can be argued with reason that,
along with the cases, should come a corresponding number of judges.
Since many present appellate judges may not wish to serve permanently
on a court where jurisdiction is limited to tax cases, it may be necessary
to rotate judges for set terms. I think a court composed of a permanent
chief judge, with some permanent and some rotating circuit judges,
sitting for set periods during which they devote their full time to
the work of the court, would be viable and productive. It may present
the mix of generalists and specialists that could assure quality and
confidence in its decisions.
Change is always difficult and there are many who are concerned
with upsetting a traditional system which has functioned for many
years. Where change has the promise of substantial improvement, the
risk is worth taking, and I believe Senator Kennedy's proposal deserves
careful and thoughtful consideration. Clearly the Kennedy proposal
has much to commend it, and we will be following its progress closely
in the next few months. Hearings on this proposal will be held by
the Senate Judiciary Committee in early May.
I believe it is widely recognized by tax practitioners, the Courts,
the Government, and other interested parties that some changes are
needed in the structure of our tax litigation system. The primary
issue to be decided today is what changes would be most appropriate
to correct problems. In the meantime, government, taxpayers, and taxpayers'
representatives must work effectively within the present system. I
believe we all have a responsibility to try to reduce unnecessary
litigation by pursuing settlement negotiations fully and expeditiously.
I am also hopeful that tax practitioners and other interested parties
will support appropriate efforts to eliminate many of the abuses and
problems with the present system.
Tax litigation occupies an important role as the ultimate resolver
of differences of opinion between the Government and individual citizens.
Tax litigation serves, perhaps, an even greater role, however, in
furthering the development of the tax law. We need to be concerned
about the structure of the system and its potential improvement.
v. Commissioner, 207 F.2d 462 (6th Cir. 1953), cert. denied
347 U.S. 918 (1954).
v. Court Holding Co., 324 U.S. 331 (1945).
(3) United States
v. Cumberland Public Service Co., 338 U.S. 451 (1950).
QUESTIONS AND ANSWERS
My question relates to generally accepted accounting principles, and
I was wondering, you mentioned a case, the Thor case, and I believe
you said that it went to the Supreme Court. I was wondering if you
could explain where along the line of these levels, the generally
accepted accounting principles would be reviewed, and why. You said
that that was a landmark case and there were some others coming up.
In the inventory area, there is a rule in the code which, in effect,
defers to the best accounting practice in the industry. However, in
this particular case, the regulations took a position different than
the accepted financial accounting practice in writing down inventory.
There are many other areas where good financial accounting practice
conflicts with tax accounting. For example, there was an issue which
went to the Supreme Court dealing with whether a taxpayer who receives
advance payments of income must include that amount in income for
tax purposes when received, or whether it could be accrued over the
years in which earned. Good accounting practice would match the income
with the period in which it was earned. Under tax accounting principles,
in the other hand, you have economic control over the disposition
of the funds, and are in a position to pay the tax presently. Those
are the kinds of issues which have generated continuing conflict and
discussions between accountants, Government officials, academicians
and others concerned about the inter-relationship between tax accounting
and generally accepted accounting principles. Should generally accepted
accounting principles, take precedence because they do tend to match
income with expenses in a more consistent manner than tax rules would?
The Thor case clearly faced the issue squarely. It was clear that
in the ordinary case, good tax accounting for inventories would follow
the best accepted practice in the industry. And yet, here was a situation
where the Treasury regulations differed from that practice. The Supreme
Court decided the issue in favor of the government in language that
I quoted to you from Mr. Justice Blackmun which, in effect, recognized
very clearly, and I think for the first time, in a succinct and orderly
way, the different purposes of Financial accounting and tax accounting.
Now, that does not mean to say that there are not situations where
the two should be consistent and complement one another. What it does
say is the fact that good accounting practice dictates one result,
does not, in fact, mean that the tax treatment will follow the generally
accepted accounting practice. You must look deeper into the issue.
As the quote explained, financial accounting rules tend to be conservative
because they are designed not to mislead affected parties, whereas
tax rules are looking to economic realities. The importance of the
case no longer is that the write-down of excess spare parts below
original prices may not be done, but rather that there is now precedent
in the Supreme Court, which will be applicable to other disputes in
the future, where generally accepted accounting principles and tax
principles conflict. That's the kind of case where settlement of the
case, itself, is not terribly important. What is useful is getting
an important issue with broad ramifications resolved for the guidance
of the government and taxpayers in the future.
Mr. Seigel, I'm sorry that you determined to reiterate Mr. Justice Blackmun's
observation with respect to financial accounting, where he referred
to the fact that we are committed to, quote "Conservatism,"
close quote. I'm afraid that he just hasn't had any good financial statements
recently. At the outset, I respectfully submit that we, like the tax
collector, are supposed to be committed, at least conceptually, to economic
reality, and that there is this dichotomy, looking to exact whatever
tax is appropriate. It turns out to be somewhat nonsensible if you look
at the United States Steel Corporation report for 1978, for example,
which just comes to mind. If you look at it, the accountants with conservatism,
calculated a pre-tax income, of exactly $250.0 million, with conservatism,
mind you. And then they calculated the amount of tax owing to his tax
collector with liberality, mind you of $8 million. And without a calculator
I can figure that very easily at 3.2%. In short, I recognize the need
for differences, serious differences, between tax accounting and generally
accepted accounting principles. But I believe to label one as conservative
and the other as being somewhat different, I'm afraid it's an over simplification
of the situation and is inclined to be misleading to those who read
Your view of the label which Mr. Justice Blackmun uses may be well
taken. It may be an oversimplification. I think that it's a matter
of personal opinion based upon personal knowledge, and I recognize
that yours is widely respected. On the other hand, I'm not sure that
your example of reporting a large financial income and a small tax
income is attributable necessarily, to differences in tax accounting
and generally accepted accounting principles. More likely than not,
the lower taxable income is attributable to specific provisions of
the Internal Revenue Code which provide incentives for investments
that result in diminishing the incidence of Taxation.
True, right off hand, but I'm merely trying to distinguish conservatism
from liberality. Depreciation is different, straight-line versus accelerated.
The point I'm making is that with conservatism, you say, we straight-line
on the financial statements and then rip-off tax collectors with accelerated
depreciation. Second, you look at the US Steel report and they defer,
for accounting purposes, give it at cost, but write it off for the
tax collector. Again, I understand the Justice's decision in thought,
but somehow or other it creates this kind of a generalization of a
dichotomy that produces misleading results.
Well, the decision is there, and it obviously will have broad impact
in the future. However, as you know, there is an evolutionary process
in court cases. Perhaps, at some future time, that particular issue
may be reconsidered, and perhaps somewhat different results may result.
But I think for the short turn it has made clear, perhaps in an over-simplified
way, perhaps not, that tax accounting need not tract the best financial
Mr. Seigel, this is an historic moment for me because I have never
spoken at one of these lectures. But I think that you can very simply
reconcile the accounting and the tax accounting in the Thor
case. In the Thor case, although they wrote the inventory down,
they kept the selling price. And normally, when you write an inventory
down to scrap value, you write it down and then sell it at that price,
plus a reasonable addition for the normal profit and administrative
expenses. And I doubt that the Treasury or the Government would have
prosecuted that case any further if the Thor Company had adopted that
procedure in respect to the selling price at which these things were
held. So I don't perceive that there is a difference here between
Financial accounting and tax accounting.
I think the issue was presented and, commented upon as a basis for
the decision by the Court. So the language of Mr. Justice Blackmun,
in a unanimous decision of the Supreme Court makes its precedential
value significant. Having framed the issue that way, and having made
the distinction as I have quoted, it will have an effect in the future
in determining, when conflicts arise, as to which set of principles
should take precedence.
President Carter, when he ran for office, described the tax laws as
a national disgrace, and I can't help but feel that part of the litigation
problems that you talked about this evening stem from this, so-called,
national disgrace. What is your view as to the prospect of tax simplification
in the future?
Tax simplification requires some definition. Simplification means
different things to different people. For example, some people talk
about tax simplification in terms of a simple tax form to fill out.
If the form became substantially easier for individuals to cope with,
they would be satisfied that we had made a significant advance in
tax simplification. Others speak with reference to the technical provisions
of the Internal Revenue Code and Regulations. Their view is, can't
we simplify the language somehow, can't we make these complex provisions,
which require intellect and enduring patience to understand, somehow
easier to digest. I think, on the first point, simplification of the
form, there has been improvement in the last couple of years. There
was redesign of the Form 1040-A, and we find that its use has increased
substantially, both last year and during this year's filing season.
With some additional work, it can become even less complex. When you
talk about simplification of the technical provisions of the Code,
however, I think we face a much more difficult problem. The Internal
Revenue Code is complex because society is complex, business is complex.
People want their particular situations reflected when the laws do
not seem to operate fairly. I can give you one illustration from personal
experience. In 1966, I was in the Treasury Department, and I was working
on a proposal that you may remember, to suspend the Investment Tax
Credit. We drafted a proposal that was on four pages, double spaced.
A complete legislative proposal to implement suspension of the Investment
Tax Credit, and it had in it all the essential rules. It had a binding
contract exception, and additional basic rules that could be the basis
for more detailed interpretation by regulation and rulings. As the
bill passed through the legislative process industry after industry,
not necessarily without justification, demanded more specific rules
to be sure that harsh rules would not operate against them. The provisions
dealing with the suspension of the Investment Tax Credit as enacted
covered pages upon pages of fine print. There's a completed contract
rule, there's a building and equipment rule others. They merely reflect
that society and business is sophisticated and tax laws cannot be
simple if they are to operate in a way that will satisfy the concerns
of those affected by the tax system. And everybody is for tax simplification,
and tax reform, unless in the process you take away some tax benefit
they now enjoy. I think there's much that can be done in terms of
trying to weed out of the Code, certain provisions which are no longer
of general use. If time ever permitted, it could probably be rewritten
in some respects in more understandable prose, but I don't have much
hope, myself, for significant advances in simplification in terms
of the need for a layering of complex rules, for the reasons that
Mr. Seigel, you seem to endorse the proposal by Senator Kennedy, to
make one Appellate Court, in lieu of the eleven Circuit Courts which
we now can go to from the Tax Court and District Court. By using one
Appellate Court, would you not eliminate, really, completely from
the picture, the Supreme Court of the United States. And is that a
desirable thing to eliminate them from the tax litigation picture?
The Supreme Court would not in fact, be eliminated from reviewing
decisions of this Appellate Court. What would likely happen is some
reduction in the number of cases in the tax area that the Supreme
Court hears, because there would no longer be conflicts among Circuit
Court decisions for taking cases to the Supreme Court and it would
be limited to issues of administrative importance or impact upon a
broad number of taxpayers. Now you can read that two ways. Sometimes
the conflict cases are really not all that important, and because
the Court tends to favor resolving conflicts, to attain order in the
judicial system, they may bypass more important cases where there
is no conflict. There are many situations where we would like to take
a case to the Supreme Court because it is important, and yet we know
that the probability of the Court taking the case in the absence of
a conflict is so remote that is not really worth the trouble. One
case which is illustrative up to that point was the recent decision
of the Seven Circuit Court of Appeals in the Lester Crown case. That's
a case which involved family loans of $18 million, interest-free.
In other words a father would loan substantial sums of money to his
son, and not charge interest. The Government took the position that
there was a gift, and therefore a gift tax due, on the interest factor
involved in the loan -- the interest that would otherwise have been
paid in an arm's-length transaction. We lost the case in the Seventh
Cir-cuit, 2 to 1. We were able to get a rehearing in the Seventh Circuit
by the entire court, and again we lost by one vote. This is an issue
of tremendous importance to the tax system, much more important, I
would say, than many issues that the Supreme Court has heard in recent
years, because it is a glaring loophole, in my judgement, one that
is now being widely used by tax practitioners. In light of the case,
practitioners should advise their clients of the possibility of using
this device as a form of making tax-free gifts. And yet, because it
is known that there is a great difficulty in getting a case like that
to the Supreme Court in the absence of a conflict, the ulti-mate decision
made by the Solicitor General was not to take the case to the Supreme
Court. So I think, perhaps, this system might well work to our benefit.
By eliminating conflicts, the cases that the Court would take might
tend to be the cases which are of greater importance to taxpayers
and the Government, and are not just heard because of a judicial conflict.
I share your concern because I think it is important that there always
be recourse to the Supreme Court in appropriate tax cases. The question
is, will this system develop a better class of cases than the existing
system? I think the question of a single appellate court is a question
on which rea-sonable people can come out either way. My own judgement
is, on balance, that it would be better to proceed with a proposal
along those lines. It has great potential for doing away with much
of the uncertainty in the tax laws. But I would only be in favor of
it, as I indicated, if it were structured in a manner that I thought
would permit the confidence of the tax bar and taxpayers, and also,
only if there were recourse to the Supreme Court.