In a recent ground-breaking ruling, the Fifth Circuit made it more difficult for taxpayers to challenge certain IRS penalties before paying them first. In Norcave Properties, L.L.C. v. Internal Revenue Service, the court held that accuracy-related penalties are subject to the Anti-Injunction Act (AIA), a federal law that generally prevents taxpayers from using the courts to stop the IRS from assessing or collecting taxes before payment.

As a result, taxpayers who want to contest IRS accuracy-related penalties generally must follow the traditional tax dispute process rather than filing a separate lawsuit in federal district court.

Why the Norcave Decision Matters

Norcave reinforces that taxpayers generally cannot circumvent the normal tax-litigation rules by characterizing an accuracy-related penalty as a separate penalty or constitutional claim. For taxpayers and businesses facing accuracy-related penalties, the ruling makes clear that the path for disputing those penalties is narrower than some had argued in recent years. The ruling is particularly relevant to penalties arising from negligence, substantial understatements, and valuation-related issues.

What Taxpayers Facing an IRS Penalty Should Do

Norcave provides important guidance for taxpayers facing accuracy-related penalties, but does not necessarily resolve how the AIA applies to every type of penalty or IRS requirement. The Fifth Circuit also did not decide whether taxpayers may ultimately have a right to a jury trial concerning these penalties.

Therefore, taxpayers facing an accuracy-related penalty should evaluate the appropriate procedural path before filing a claim or commencing litigation. Tax court, federal district court, and the Court of Federal Claims have different procedural and payment requirements.

Accordingly, taxpayers should promptly:

  • Review IRS notices and applicable filing deadlines.
  • Engage tax counsel early.
  • Evaluate judicial forum and payment/deposit requirements.
  • Preserve contemporaneous documentation supporting position and the process used to reach it.
  • Determine available defenses to the accuracy-related penalty.
  • Conduct a prospective compliance review to identify why the issue arose.
  • Work proactively with their tax advisers and legal counsel to identify and address positions that could give rise to accuracy-related penalties in the first place.
  • Strengthen tax return review and documentation procedures to reduce the risk of similar penalties in future years.

Key Takeaways for Taxpayers

Norcave highlights the importance of both proper procedural planning and proactive tax compliance. For a deeper discussion of the decision, its potential application to your circumstances, or strategies for reducing the risk of accuracy-related penalties, please reach out to your tax adviser or legal counsel.

Early consultation can help taxpayers and businesses evaluate reporting positions, documentation, reasonable-cause considerations, and other compliance matters before they develop into a penalty dispute.