Federal tax controversies arise when a dispute develops between a taxpayer and the federal government over the proper application or enforcement of the Internal Revenue Code. These disputes may involve individuals, small businesses, large corporations, or tax-exempt organizations. They can be resolved administratively within the Internal Revenue Service (IRS) or judicially in one of several federal courts. Unlike routine tax compliance, which focuses on timely and accurate filing of returns, controversies begin when the IRS challenges a taxpayer’s position or the taxpayer challenges an IRS determination.

Key Government Participants

Although the IRS is the most visible participant, several government entities play important roles in the process. Congress enacts the statutes that govern federal tax obligations. The Treasury Department issues regulations and sub-regulatory guidance interpreting those statutes. The IRS enforces the law by issuing forms, examining returns, assessing liabilities, and collecting taxes. The Department of Justice Tax Division litigates federal civil tax cases in the district courts and the Court of Federal Claims, as well as all federal criminal tax cases. The Joint Committee on Taxation must approve any refund exceeding $2,000,000. Despite this broad institutional framework, the IRS serves as the primary front-line agency in tax controversies, handling the bulk of examinations, administrative appeals, and collections.

The Stages of a Tax Controversy

A tax controversy typically follows a predictable sequence. It begins with return selection, where the IRS identifies a return for review, often through automated scoring systems, referrals, or compliance campaigns. The next stage is examination, where the IRS reviews the return and may propose adjustments. If the taxpayer disagrees, the matter can proceed to the IRS Independent Office of Appeals, which is designed to provide a forum for resolution short of litigation. If no agreement is reached, the taxpayer can seek judicial review. The U.S. Tax Court provides a pre-payment forum, allowing the taxpayer to challenge the deficiency without first paying it. Alternatively, taxpayers may pay the disputed tax and pursue a refund suit in either a U.S. District Court or the U.S. Court of Federal Claims. Even after liability is resolved, disputes may continue over collection actions such as liens, levies, or installment agreements.

Administrative vs. Judicial Resolution

The distinction between administrative and judicial resolution is critical. Administrative proceedings are generally more efficient and less costly, but they take place within the IRS, which acts as both examiner and adjudicator. Judicial proceedings provide independence and formal procedural protections, but often require greater expense and, in refund cases, pre-payment of the tax in dispute. This dual system is designed to balance administrative efficiency with the taxpayer’s right to due process.

Why Tax Controversies Matter

The stakes in tax controversies can be substantial. Financial exposure often includes not only the underlying tax but also penalties and interest. In some cases, precedent set in a single case affects the treatment of many similarly situated taxpayers. Equally important are the rights at issue: the right to be informed, the right to quality service, the right to pay no more than the correct amount of tax, and the right to appeal an IRS determination in an independent forum. Tax controversies also shed light on broader systemic issues, including the “tax gap” — the difference between taxes legally owed and taxes actually collected. By some estimates, this gap reaches hundreds of billions of dollars annually. Effective resolution of controversies therefore serves not only the interests of individual taxpayers but also the integrity of the federal tax system as a whole.