A federal tax controversy follows a recognizable path, beginning with the selection of a tax return for examination and potentially ending with judicial review in federal court. Each stage offers opportunities to resolve disputes, but each also carries procedural requirements that affect taxpayer rights and strategy.

Return Selection

The IRS examines only a small percentage of filed returns, but its selection process is increasingly sophisticated. Many returns are chosen through the Discriminant Inventory Function (DIF) system, which assigns scores based on statistical likelihood of error. Others are identified through compliance campaigns, whistleblower tips, or third-party information reporting. Certain transactions, such as those involving large losses, international activity, or complex structures, are more likely to attract IRS attention.

Examination

Once a return is selected, the IRS initiates an examination, commonly referred to as an audit. Examinations may be conducted by correspondence, in an IRS office, or in the field. During this process, the IRS requests documents, interviews taxpayers, and evaluates whether the reported items comply with the law. If the IRS proposes changes, it issues a Revenue Agent’s Report. The taxpayer may agree and resolve the case, or disagree and move forward in the process.

Administrative Appeals

If the taxpayer contests the proposed adjustments, the matter may proceed to the Independent Office of Appeals. Appeals is separate from IRS Examination and is empowered to settle cases based on the “hazards of litigation.” This means Appeals weighs the strengths and weaknesses of each side’s position and may compromise accordingly. For many taxpayers, Appeals represents the best opportunity to resolve a case without the time and expense of litigation.

Judicial Forums

When administrative resolution fails, taxpayers may turn to the courts. Three forums are available, each with distinct advantages:

• U.S. Tax Court. This is the primary pre-payment forum, allowing taxpayers to challenge a deficiency before paying it. Proceedings are specialized, with judges experienced in tax law.
• U.S. District Courts. Taxpayers may pay the disputed tax and sue for a refund in the federal district court for their jurisdiction. District court cases allow for jury trials, which may be strategically important in certain disputes.
• U.S. Court of Federal Claims. Like the district courts, this forum hears refund suits, but it sits in Washington, D.C. and has nationwide jurisdiction.

The choice of forum depends on multiple factors, including the taxpayer’s ability to pay, the type of issue, procedural preferences, and perceived judicial outlook.

Collection Proceedings

Even after liability is determined, disputes may continue at the collection stage. The IRS has broad authority to assess liens, levy assets, and garnish wages. Taxpayers can contest these actions through Collection Due Process hearings or administrative appeals. In some cases, litigation arises over the appropriateness of collection measures or the availability of installment agreements and offers in compromise.

Strategic Considerations

At every stage of the pipeline, taxpayers and their advisors must weigh cost, risk, and procedural posture. Early resolution may be preferable to avoid litigation, but in some cases judicial review is the only way to secure an independent evaluation. Understanding the stages of a tax controversy helps practitioners guide clients effectively through what is often a lengthy and complex process.