Cases in Tax Court can sometimes be settled through a binding arbitration process or other alternative dispute resolution methods rather than tax court litigation. Under Tax Court Rule 124, parties to a Tax Court dispute can jointly agree to submit the matter to binding arbitration, as long as the case has not proceeded to trial yet. Other alternative dispute resolution methods, including mediation, can also be employed in Tax Court.
Arbitration in Tax Court Disputes
The Tax Court adopted Tax Court Rule 124 in 1990 as a means to allow arbitration of factual disputes and standardize the arbitration procedures to be used. In setting those standards, there are several minimal requirements that must be fulfilled before an order allowing arbitration will be granted (1). Arbitration can be extremely beneficial in valuation cases as well as for the resolution of any other factual issues that might arise in a Tax Court case, especially valuation, reasonable compensation, and allocation issues (2). In order to request binding arbitration in the Tax Court, the parties must submit a joint statement and motion containing the following information:
- The issues to be resolved by arbitration;
- A statement that the parties agree to be bound by the decision of the arbitrator;
- A name of a specific arbitrator or a procedure outlining how an arbitrator will be chosen;
- Description of the allocation of the costs and expenses of the arbitrator and a schedule outlining how each party will pay for those costs;
- A provision which prohibits ex parte communications with the arbitrator; and
- Any other provisions that might be appropriate to include.
Once the motion is filed, the Tax Court judge will issue a decision appointing the arbitrator and providing other instructions for the arbitration to take place. Any findings of the arbitrator will be promptly reported to the court, and in the case of a valuation determination or computation, the court will enter a decision or a filing of a Rule 155 computation (3>.
When Should a Taxpayer Use Arbitration Instead of Litigation in Tax Court?
There are many benefits to a taxpayer using arbitration instead of tax litigation in a Tax Court dispute. In general, arbitration affords the possibility of reduced costs and an accelerated timetable for resolving the issues involved in the case. Because arbitration can occur before a full pre-trial workup takes place, the pre-trial discovery and hearing process may be minimized. In addition, the court typically does not require the arbitrator to draft a full written report explaining his or her findings, which can lead to the parties receiving a quick resolution to their dispute. Finally, the arbitration process can simply be more convenient for the parties because it can be scheduled by mutual agreement of the parties. Although the ultimate result of arbitration is not completely confidential, the proceedings themselves can be kept confidential. Thus, the net effect of arbitration can be much less costly than pursuing a full-scale Tax Court trial.
Another interesting option for parties to a Tax Court litigation is to choose an arbitration process that approximates a full-scale trial without the publicity that accompanies a Tax Court trial. An example of this process was seen in Apple Computer v. Commissioner, where the parties filed a stipulation with the Tax Court for a proposed multi-million adjustment in a § 482 dispute. The stipulation filed in that case is instructive for parties considering arbitration because it contained the following checklist of items:
• Three arbitrators were used;
• Each party proposed five potential candidates for the position of arbitrator;
• The issues to be arbitrated were defined with precision in the stipulation;
• The arbitrators were required to select one of the parties’ proposed amounts. The arbitrator did not have the option of splitting the difference;
• The Appeals Division retained settlement authority over the matter despite arbitration being ongoing;
• The panel or arbitrators retained unfettered authority to interview witnesses;
• Normal Tax Court rules pertaining to procedure and evidence were followed;
• The proceeding was kept confidential;
• The arbitrators were required to file their decision three weeks after the conclusion of the hearing; and
• The decision was expressly made non-precedential for other taxable years other than those in issue.
Mediation Instead of Arbitration for Settling Disputes in Tax Court
Tax Court Rule 124 technically refers to “Voluntary Binding Arbitration,” but the Tax Court has made clear that the rule is broad enough to encompass mediation procedures as well. In contrast to arbitration, mediation is nonbinding, and the mediator has no power to impose a settlement on either party. Instead, the mediation process merely facilitates settlement discussions between the parties in an informal setting outside of the court process. As with arbitration, mediation can sometimes be faster, easier, and more cost-efficient than a full trial. The potential downside to mediation is that it is already very similar to the pre-and/or post-docket Appeals Division function, making mediation itself potentially redundant or obsolete. For this reason, arbitration remains the preferred method of alternative dispute resolution in Tax Court cases.
According to the CCDM, mediation should be considered when the following factors are present:
- The issue to be decided is factual in nature;
- Mediator has no existing conflict of interest; and
- The parties must agree to equally share the costs of the mediator.
How a Tax Attorney Can Help with Your Tax Litigation
If you are contemplating a deficiency litigation, then you must consult with an experienced tax attorney. San Diego Tax Attorney William D. Hartsock has been successfully helping clients with tax issues since the early 1980s. Mr. Hartsock offers free consultations with the full benefit and protections of attorney client privilege to help people clearly understand their situation and options based on the circumstances of their case. To schedule your free consultation simply fill out the contact form found on this page, or call (858) 481-4844.
Tax Law Resources:
- Explanatory Note to Tax Ct. R. 124, 93 TC 944 (1990).
- Id. 944–45.
- See Duncan v. Commissioner, 121 TC 293 (2003) (court declined to modify terms of an arbitration agreement to extend deadline for petitioner to submit information).