By Jonathan Liss

One of the most interesting aspects of working in state and local tax is the management of audit examinations and appeals. As a rule of thumb, a company should always aim to settle a tax dispute at the lowest level. In some situations, however, an appeal is prudent. This blog addresses the important factors a business must consider when deciding whether or not to challenge a state or local tax audit assessment.

The first questions to ask are what is the dollar exposure to the company, and will the company also have exposure in future years for the same issue(s)? Some companies may have a policy of not appealing an assessment below a certain dollar threshold because it doesn’t make sense for them to challenge an assessment that is not material. Materiality, of course, is in the eye of the beholder.

Once a company has determined that the dollars are large enough to pursue an appeal, it is important to address the scope of the assessment. The decision to appeal is often driven by whether a single issue or multiple issues are in dispute. If multiple issues are on the table, it is more likely that the taxing authority will be amenable to settlement. In most cases, the probability of success will depend on the specific issues in dispute.

Another consideration is the future impact of the disputed issues. In other words, will this be a recurring issue for the company? Would the tax effect of the issue be greater in later years? If the issue is one that will keep coming up year after year, a company may seek a final resolution on appeal (and possibly litigation) rather than continuing to fight it out with the auditors in subsequent audit examinations. However, if the point of disagreement has a 50/50 probability of success, a company could choose to seek a settlement with the taxing authority.

In certain cases, the potential for negative media attention could enter into a company’s decision whether to appeal. Tax litigation may cause the company to be viewed negatively and could impact pending legislation or relationships with state policymakers. It is always wise to have a conversation with the company’s governmental and public relations groups before pursuing an appeal.

It is critical for a company to consider the nature of the issue(s) and the state’s likely position on appeal. Is the disputed adjustment a question of fact, law, or mixed law and fact? A factual issue usually requires the production of more evidence. If the appeal is focused on only one clearly defined issue of law, and both sides have prepared well-reasoned briefs, an appeal may be quicker (and less costly). A company must also evaluate the probability of relief and at what level relief would likely be granted. In this vein, how deferential will an appellate court be to the lower court’s decision? Many states have high standards of review, which makes success on appeal much more difficult. In assessing the probability of relief, it is imperative to research prior state tax department rulings and/or court decisions on the issue(s).

The decision to challenge an assessment will depend in large part on the anticipated internal and external costs to take an appeal. Will the appeal be handed internally, or will the company need to engage outside counsel? The cost of hiring legal counsel can be very expensive, especially if a case proceeds through multiple levels of appeal. Another factor in estimating the costs of an appeal is who has the burden of proof. For example, in states such as Illinois, once a Notice of Assessment has been issued, the notice is considered prima facie correct. The burden then shifts to the taxpayer to prove its case by presenting sufficient evidence in the form of documents and witnesses. This will add to the cost of appealing an assessment.

Another factor to consider is whether you must pay the disputed tax before you appeal. Certain taxing jurisdictions require businesses to pay disputed tax assessments before challenging them in court.

A successful state tax appeal requires a well-thought-out plan and strategy that takes into consideration the hazards of litigation. A company should always be prepared to change its strategy as the appeal proceeds.

Jonathan Liss is senior revenue policy analyst for the Philadelphia Department of Revenue. He is also an adjunct professor at Drexel University and Villanova University School of Law. He can be reached at jonathan.liss@phila.gov.

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