THE MODEL STATE ADMINISTRATIVE TAX TRIBUNAL ACT: FAIRNESS FOR ALL TAXPAYERS I. INTRODUCTION

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1 The State and Local Tax Lawyer, Vol. 10, 2005, p. 83 THE MODEL STATE ADMINISTRATIVE TAX TRIBUNAL ACT: FAIRNESS FOR ALL TAXPAYERS by Garland Allen* and Craig B. Fields** I. INTRODUCTION Over the last 40 years, one state after another has established an independent tribunal or court to adjudicate state tax disputes. Still, almost half the states have not institutionally separated the function of collecting state taxes from that of resolving taxpayer challenges to state tax determinations. To encourage states to take this important step toward tax fairness, the State and Local Tax Committee of the American Bar Association s Section of Taxation has developed a Model State Administrative Tax Tribunal Act (the Model Act or the Act ). The Model Act would not only provide a legislative template and rationale for an independent tax tribunal, but would also implement a number of state tax court or tribunal best practices and require the state revenue department to maintain a program for settling disputed tax liabilities after audit but before the commencement of any proceeding in the new tax tribunal. The State and Local Tax Committee s membership overwhelmingly approved the draft Model Act in January, The Model Act now advances to the next step in the American Bar Association s process for becoming an officially endorsed legislative recommendation. Until that process is complete which may take another year or more the Model Act is not an official or sanctioned product of the ABA and cannot be advertised as such. *Mr. Allen conducts a state tax consulting practice based in Santa Monica, California, and Naperville, Illinois. Formerly a Chicago partner of the law firm of Hopkins & Sutter and of PricewaterhouseCoopers LLP, Mr. Allen is vice-chair of the ABA Section of Taxation State and Local Tax Committee task force that drafted the Model Act and can be reached at or at farrokhjune@hotmail.com. **Mr. Fields is a partner in the law firm of Morrison & Foerster, LLP, and is based in New York City. Partner, Morrison & Foerster LLP. Mr. Fields is chair of the ABA task force that drafted the Model Act and can be reached at or at cfields@mofo.com. 1

2 Because the Model Act has not been finalized, the ABA welcomes suggestions for improvement consistent with the Act s core objectives. Meanwhile, the authors would be more than happy to provide advice and support to state efforts to create an independent state tax tribunal or court. To make comments or request help, please contact one of the authors of this article. II. THE MODEL ACT S OBJECTIVES There are still more than 20 states including California, Illinois, Texas, Florida, Georgia, North Carolina, Oklahoma and Missouri in which the taxpayer s first and last hearing before a person who is required to be knowledgeable about state taxes is in front of an employee of the state revenue department that made the determination being challenged. Another 15 states or The State and Local Tax Lawyer, Vol. 10, 2005, p. 84 so including Pennsylvania, Michigan, North Carolina, California, and Colorado make the taxpayer pay or provide a bond for the tax in issue before letting the taxpayer have a hearing before a forum, usually a court, that is independent of the state revenue department. The Model Act would guarantee that every taxpayer who receives a state tax assessment gets a de novo hearing of record, before paying the tax, from a tax expert that is completely independent from the tax collector. An admittedly cheesy acronym BRIE may help you remember the Act s four main goals, i.e., B(efore payment), a taxpayer who receive a tax assessment must be able to make his R(ecord) before an I(ndependent body) that has E(xpertise in tax matters). How does the Act achieve these goals? 1. (B)efore payment. Per section 7(c), every taxpayer shall have the right to have his case heard by the Tax Tribunal prior to the payment of any of the amounts asserted as due... and prior to the posting of any bond. An exception is provided for denials of refund claims and jeopardy assessments. Thus, a taxpayer need not pay or post a bond for an asserted tax liability in order to obtain a hearing and decision from the new tribunal. Note that the Model Act insures a pre-payment forum for tax assessment challenges without doing away with other pre-payment remedies. The Act would not automatically repeal existing state laws 2

3 that allow either a suit on a refund claim, or a suit to recover a tax paid under protest, to be brought in the regular courts. A state that desires to eliminate these alternatives to the Tax Tribunal s jurisdiction would have to take separate legislative action. Nor would the Model Act preclude an enacting state from conditioning appeal of a Tax Tribunal decision upon prepayment or bonding of the tax. Except in the case of real estate property taxes, however, most states currently allow a taxpayer to litigate a tax assessment challenge all the way to the U.S. Supreme Court, if necessary, without pre-payment or bonding, and the Committee recommends that this practice be adopted by all states. 2. (R)ecord. Model Act section 15(a) provides that the taxpayer or department shall be entitled to judicial review as to a final decision of the Tax Tribunal... in accordance with the procedure for appeal from a decision of the [general trial] court...., except for a decision of the Tribunal s small claims division, and as to an interlocutory decision under the same conditions and in the same manner as an interlocutory decision of the [general trial] court. By providing for direct appeal of the Tribunal s decisions in the same manner as those of the state s regular trial courts, the Model Act makes clear that the Tribunal proceeding is the hearing of record for further court review. 3. (I)ndependent body. Section 2(b) of the Model Act provides that the new Tax Tribunal shall be separate from and independent of the authority of the The State and Local Tax Lawyer, Vol. 10, 2005, p. 85 [commissioner of revenue] and the [department of revenue], thus providing the legal separation that is the key to fairness in this area. Other provisions insure that a Tribunal judge will not be subject to the influence of the state s tax collection agency, even though, like the head of the revenue department in most states, each judge is appointed by the state s chief executive and can be removed for neglect of duty, inability to perform duties, malfeasance in office, or other good cause (section 3(g)). The governor s appointment and any attempted removal are themselves subject to the advice and consent of the Senate (sections 3(b) and (g)), guaranteeing input by a separate branch of government. Furthermore, each judge is appointed for a 3

4 period of ten years (section 3(b)), a term exceeding that of most governors, thereby making it less likely that a Tax Tribunal judge will be viewed as just another political appointee, and giving the judge some protection against the enmity, or sense of accountability, of a single governor. The requirement that the judge s salary be no less than that of a regular state trial court judge (section 3(c)), combined with the tenyear term, should attract quality candidates and encourage judges to remain in the position, thereby developing the additional independence that comes from experience. The Model Act further insures the perception of independence from the state s tax collection agencies. The Act requires that the Tribunal s principal office be in a building separate from that of the revenue department and that hearings around the state be held in facilities physically separated from those occupied by the department (section 5(c)); requires that a judge not engage in any other gainful employment or business, nor hold another office or position of profit... (section 4(c)); makes the Tribunal responsible for the hiring and firing of its own staff (section 6(d)); and authorizes the Tribunal to promulgate and adopt all reasonable rules and forms as may be necessary or appropriate to carry out the intent and purposes of the Act (section 19). 4. (E)xpertise in tax matters. The Model Act requires that every judge, at the time of his or her appointment, have substantial knowledge of the tax law and substantial experience making the record in a tax case suitable for court review (section 4(a)). As a result, a newly appointed judge should have the subject matter expertise, training, and intellectual confidence necessary to reach decisions that are firmly based in the tax law and that take into account the practicalities of tax administration and tax compliance. The knowledge and experience requirements should also increase the likelihood that the Tax Tribunal s decisions will be well reasoned and over time will provide a rational body of precedent. The requirements should also make it more likely that the Tax Tribunal will achieve the institutional reputation for fairness and excellence that is crucial to the public s perception of fairness. 4

5 The State and Local Tax Lawyer, Vol. 10, 2005, p. 86 III. THE MODEL ACT S OTHER FAIRNESS GUARANTEES As already explained, the Model Act creates a state tax dispute resolution system that assures the taxpayer a just decision on the merits, as well as a fair opportunity to make the fact and legal record that will be reviewed by the courts in the event of an appeal. In addition to provisions that directly implement its goals, described above, the Model Act mandates a number of resolution procedures best practices of existing independent tax tribunals and courts that further insure the fairness of the dispute resolution process: 1. Department of Revenue must offer an independent, informal review and opportunity to settle. Section 8 requires the department to maintain a robust system for the informal review of tax determinations, including the opportunity for the taxpayer and the department to settle cases based on the hazards of litigation as well as the facts of the case. This provision is modeled on the Internal Revenue Service s Appeals function, and also incorporates the best features of the most effective informal review/settlement programs that presently exist or are being developed in several states. The overwhelming majority perhaps more than 90% of state tax determinations that generate a reasonable dispute about the governing law or the application of the law to the facts are currently resolved informally, by concession made by one of the parties or by settlement. A state enacting the Model Act can be expected to do away with its formal, internal administrative hearing procedure. There is concern that, once it divests itself of the responsibility for conducting hearings on disputed issues, the department of revenue may no longer devote personnel and resources to the effort to resolve legitimate tax disputes by informal means prior to litigation. The consequences of eliminating the internal hearing function could be that taxpayers would be forced to concede tax issues that they could and should win but cannot afford to litigate, or that responsibility for settlement negotiations would be thrust upon and threaten to overwhelm the lawyers who represent the department in contested proceedings, or both. Such a result would represent a net loss of fairness to the state s taxpayers, even with the new Tax Tribunal. 5

6 To address this concern, the Model Act mandates that the state maintain a system of internal review and settlement. Section 8 of the Act sets forth standards for the conduct of the informal review, which represent the practice of the Service and the best practices of statelevel informal review and settlement functions. To make the system work, the informal review must be done by experienced department personnel who were not themselves involved in the tax determination under review. Under the Act, informal review must be offered to the taxpayer [b]efore the [department of revenue] finalizes a determination that triggers a taxpayer s right to commence a proceeding in the Tax Tribunal... (section 8(a)). Seeking informal review is the taxpayer s option, and the taxpayer s decision to forego review would not constitute a failure to exhaust an adminis- The State and Local Tax Lawyer, Vol. 10, 2005, p. 87 trative remedy. 2. Broad discovery and mandatory stipulation. In many states, state revenue departments defeat meritorious taxpayer challenges simply by not cooperating with the taxpayer to stipulate the relevant facts, by not divulging its audit methods or findings, or by not disclosing its prior enforcement pattern with respect to the determination in dispute. Such practices increase the burden on the taxpayer by expanding what the taxpayer must prove to win his case, thereby making the dispute resolution process more expensive and time-consuming and less fair. The Model Act evens the playing field by mandating the parties to accomplish discovery by informal means before using more formal and expensive discovery methods (section 11(a)); requiring the parties to stipulate the relevant facts to the fullest possible extent (section 11(b)); and specifically authorizing the use of written interrogatories and requests for admission (section 11(c)). The Act gives the Tax Tribunal the authority to enforce these important protections by order in particular cases (section 11(g)) or by regulation (section 19). 3. Taxpayer s burden of proof is preponderance of the evidence. The Model Act specifically provides that, in a Tax Tribunal proceeding, the taxpayer shall have the burden of persuasion by a preponderance of the evidence in the record, except that the [department of revenue] shall have the burden of persuasion in the 6

7 case of an assertion of fraud and in other cases provided by law (section 12(g)). By adopting the standard common to civil litigation, the Model Act not only clarifies the hurdle the taxpayer must clear in litigation with the department, but makes clear that this standard of proof applies before the Tax Tribunal notwithstanding the existence of common statutory provisions that give the revenue department s determination a presumption of correctness or other special evidentiary status. 4. Payment of the tax in dispute does not moot the proceeding. If, after commencing a Tax Tribunal proceeding, the taxpayer decides to pay the tax in issue, e.g., to avoid interest or penalties, but wishes to continue his challenge, section 7(d) states that the Tribunal shall treat the taxpayer s petition as a protest of a denial of a claim for refund of the amount so paid. The effect is that the taxpayer will be able to proceed with the hearing without further delay. This contrasts to the situation in many state hearing and court systems, in which payment of the disputed tax automatically moots the dispute and requires the taxpayer to start over by filing a refund claim, waiting for audit and denial of the claim, and then initiating a new proceeding in the Tax Tribunal to contest the department s determination. 5. Written decisions. Section 13 requires the Tax Tribunal to issue a written decision, containing at least a concise statement of the facts found and the conclusions of law reached, within six months after conclusion of the hearing or any related briefing. In this way, the Model Act enhances the The State and Local Tax Lawyer, Vol. 10, 2005, p. 88 perception of fairness by making sure that an aggrieved taxpayer not only gets a fair hearing, but also receives a decision that sets forth its rationale and gives the parties a logical basis for determining whether an appeal should be taken. 6. Publication of decisions. By mandating publication of Tax Tribunal decisions, at least in electronic form, the Model Act (section 17) not only guarantees that Tribunal decisions will be reviewed and criticized by other tax experts, but also makes available potentially useful precedent to every future taxpayer considering a challenge to a department determination. 7

8 7. Small Claims Division. The Model Act (section 14) gives a taxpayer with a net amount of $25,000 or less in controversy the option to proceed in the Tax Tribunal s Small Claims Division, in which the taxpayer may challenge an assessment or other determination in an informal setting. Since a Small Claims Division decision may not be appealed by either the taxpayer or the department (section 14(h)), may not be considered as precedent in any other proceeding (section 14(h)), and is not required to be published (section 17), the Model Act allows a taxpayer with a small amount at issue, limited resources or unusual circumstances to obtain a fair hearing before an independent forum, without concern that the department will press a legal technicality simply because not doing so might create precedent for other taxpayers. IV. MODEL ACT PROVISIONS THAT HAVE GENERATED DISCUSSION A few provisions of the Model Act have generated concern among tax lawyers and accountants who regularly represent taxpayers in state tax disputes, even though most would agree that each likewise furthers the objective of achieving real and perceived fairness for state taxpayers. The following paragraphs explain why the policy choice was made and why the concern is not well-founded or why the obvious alternative is not recommended. 1. Locating the Tax Tribunal in the executive branch, rather than in the judicial branch. The Model Act establishes the Tax Tribunal in the executive branch, rather than in the judicial branch of state government. This choice is more likely to improve the state tax dispute resolution process in the states most in need of reform, even though it also means that the Tribunal will be unable to overturn a tax statute or provision on the ground that it is unconstitutional on its face. Two practical reasons recommend location of the Tax Tribunal in the executive branch. First is the fact that the 30-year old effort by the ABA to encourage states to establish judicial tax courts has been amazingly unsuccessful. By contrast, executive branch tax tribunals have been much easier to establish. According to the Explanation accompanying the American Bar Association s Revised Model State Tax Court Act , when the National Conference of Commissioners on Uniform State Laws 8

9 (NCCUSL) promulgated its Model State Tax Court Act in 1957, only 11 states had The State and Local Tax Lawyer, Vol. 10, 2005, p. 89 independent tax tribunals and all were located in the executive branch. Between 1957 and 1971, additional states created independent tribunals of some kind, but, with two exceptions Oregon and Hawaii all were located in the executive branch. Inspired by Oregon, which established a tax court in the state s judicial branch in 1961, and Hawaii, which converted its administrative tax tribunal to a judicial court in 1967, the ABA embarked on a project to revise the 1957 Model Act to promote the creation of independent tax courts located in the state judiciary. This effort culminated in the ABA s Revised Model State Tax Court Act , which recommended the creation of a state tax court modeled on the Oregon Tax Court. Since the 1971 Model Act was promulgated, the number of states adopting independent executive branch tax tribunals has jumped from 11 in 1957 to approximately 24 today. By contrast, only four additional states have created a judicial branch tax court or have established a tax division within the regular judicial court New Jersey (1979), Indiana (1986), Arizona (1988) and Connecticut (1993) bringing the total to 6 states. Why have states overwhelmingly chosen executive branch tax tribunals over judicial tax courts? A major reason may be constitutional. Many state constitutions do not permit the legislature to establish a specialized court within the judicial branch. And a number of state constitutions require judicial branch judges to be elected in a manner that makes it difficult or impossible to insure that the court will have tax expertise. In Oregon, where a tax court judge is elected, for example, the sole expertise-related requirement is that the judge must have practiced law any kind of law for at least three years. The second major reason for the Model Act s approach is that executive branch tribunals work. The track record of executive branch tax tribunals over the last 35 years is impressive, demonstrating that such forums can efficiently achieve the Model Act s principal goals. Tribunals in states such as Maryland, Massachusetts, Michigan and New York have operated successfully for many years and have earned a reputation for fairness and for tax 9

10 expertise. That being said, the Committee recognizes that a judicial branch tax court, unlike the Tax Tribunal, could strike down a state tax statute or regulation on the ground that it is unconstitutional on its face. This is a significant advantage, given that constitutional challenges occur in the state tax field with some frequency. Such power would also obviate the need for the Model Act s somewhat awkward provisions contained in section 7(e), which require a taxpayer with a constitutional challenge to determine whether the challenge is facial and, if so, which procedure he wishes to follow to segregate the facial challenge from the rest of the case, so that it can be decided by a regular, judicial branch court. Accordingly, the judicial branch alternative should be pursued in any state in which it is legally and politically possible to create a new judicial The State and Local Tax Lawyer, Vol. 10, 2005, p. 90 branch court that is staffed by real tax experts and that can decide cases on a pre-payment basis. In such a case, the Model Act s many beneficial procedural provisions could be adopted either by statute or as tax court rules. 2. Judge not required to be a licensed attorney. Rather than requiring that a candidate for a Tax Tribunal judgeship be a licensed attorney in practice for a certain number of years, the Model Act instead requires that any person appointed as a judge must have substantial knowledge of the tax law and substantial experience making the record in a tax case suitable for judicial review (section 4(a)). In the view of the task force, this requirement not only satisfies the reason normally given for requiring that persons performing judicial or quasijudicial functions be practicing attorneys, but sets a higher standard of expertise that will insure better decisions on the merits and better records for review. 3. Taxpayers may choose to be represented before the Tax Tribunal by persons other than practicing attorneys. Following the practice of the U. S. Tax Court and a number of independent state tax courts and tribunals, the Model Act (section 16) allows a taxpayer to be represented before the Tax Tribunal by the taxpayer, by an attorney admitted to practice in this State (including an attorney who is a member of or is employed by an accounting or other professional 10

11 services firm), by an accountant licensed in this State, or by an enrolled agent authorized to practice before the Internal Revenue Service. The section also allows the Tribunal to permit attorneys and accountants licensed by other states to appear pro hac vice. The Model Act rule is based on several realities. In many cases, a non-attorney tax professional, such as an accountant with years of experience in tax dispute resolution, is competent to present a tax case effectively. Moreover, experienced tax attorneys and litigators are today commonly employed as members or employees of accounting or other professional services firms. Finally, many taxpayers prefer to have their regular tax professionals represent them in the first hearing before an independent forum, rather than absorb the time and expense of hiring and educating legal counsel. Representation before the Tax Tribunal may constitute the unauthorized practice of law in some jurisdictions, e.g., Missouri and Illinois currently do not permit persons other than practicing attorneys to represent taxpayers at internal administrative hearings. At the same time, most states either permit non-attorneys to represent taxpayers in administrative hearings, independent tax courts, and tribunals, or have not taken a position on the question. Under such circumstances, it seemed prudent to allow any unauthorized practice of law issue that may arise to be resolved on a state-by-state basis. 4. Department allowed discovery. Section 11 of the Model Act allows the department, as well as the taxpayer, to engage in discovery in advance of a The State and Local Tax Lawyer, Vol. 10, 2005, p. 91 hearing in the Tax Tribunal. Some have argued that the department should not be allowed discovery, since the department has already conducted an audit. In other words, the department should not be able to force the taxpayer to undergo a second "audit" as the price of contesting the resulting assessment. Although this argument was considered, it was ultimately decided that discovery by the department should be permitted. Allowing discovery by the department is justified by fairness, by current practice in many states, and by practical considerations. First, discovery by the department is appropriate in cases in which facts with key legal importance to the determination of the taxpayer's liability have not been developed by the audit staff. While auditors can interview employees and officers or the individual taxpayer, such 11

12 interviews are quite different from trial depositions. Moreover, when expert witnesses are used by a party, the other party (be it the department or the taxpayer) should be able to discover information concerning such testimony and to receive a copy of any report prior to the time the individual is called as a witness. Second, many states administrative hearing regimes already permit discovery by the department, so that allowing it does not expand the department s powers in those states. Finally, the practical effect of not allowing state discovery would likely be to intensify the scrutiny given by the audit staff to all taxpayers, since the audit staff and the department's representatives could not be sure which matters would eventually go to trial. By contrast, experience demonstrates that departments that are permitted to conduct discovery at trial rarely abuse the discovery process. Moreover, if abuse were to occur, the Tax Tribunal can and should step in to prevent it. 5. Hearing open to the public. Under the Model Act (section 12(c)), hearings before the Tax Tribunal are open to the public, although the Tax Tribunal may close part or all of a hearing based on a showing of good cause. This provision makes the hearing process more transparent and accountable and therefore contributes directly to the fairness of the system. This is the practice followed by virtually all state trial courts of general jurisdiction and by independent tribunals in a number of states, e.g., Maryland and Massachusetts. The fact that departmental hearings are often closed to the public and that some taxpayers appreciate the opportunity to make their case in a forum that is not open to the public, e.g., in Illinois, was not thought to be a sufficient reason to preclude public access to a hearing before an independent tribunal more akin to a state trial court. 6. The State, as well as the Taxpayer, is allowed to appeal. It has been asserted that, since department internal hearing decisions are usually not subject to appeal by the department, Model Act section 15 which permits the department as well as the taxpayer to appeal an adverse Tribunal decision should be eliminated. This concern, however, is based on a false analogy. The State and Local Tax Lawyer, Vol. 10, 2005, p. 92 In most states, the decision of an internal hearing officer is legally, 12

13 as well as practically, the decision of the director, commissioner or department of revenue. Thus, the hearing officer s decision is usually a mere recommendation to the head of the revenue department, who may either countersign the decision or rewrite the decision to suit himself. For this reason, state law does not typically allow the department to seek court review of an internal administrative hearing decision. The Tax Tribunal, in contrast, is a state agency of tax experts that is completely independent of the department of revenue, more similar to a trial court of general jurisdiction than to an internal hearing system. General trial court decisions in tax matters are always subject to appeal by the department, and so should the decisions of the Tax Tribunal. V. CONCLUSION No matter how hard department hearing officers and administrative law judges try, most taxpayers believe that internal hearing regimes are not fair. And their belief is not illogical. Why should a taxpayer trust the objectivity of a state employee who is paid, provided office space and support, supervised, and evaluated by revenue department officials whose main job is to collect taxes? The Model Act provides a template for a pre-payment, state tax dispute resolution forum that is truly independent of the revenue department. Since the tax tribunal judge will be an experienced tax expert, the tribunal s decisions are likely to be legally correct and far more likely to be perceived as just by taxpayers. Like other good government reforms, the Model Act has no natural political constituency, primarily because no interest group can quantify the benefit of BRIE. But the benefit is real and substantial. Since each state tax system depends on voluntary compliance, the state s taxpayers must trust the system to be aggressive, smart and fair. If they do not, only very honest or very gullible taxpayers will end up paying the costs of government and each will pay way more than his share. All taxpayers, including business taxpayers of great sophistication and size, have a stake in this proposal. Understandably, but ironically, the tax lawyers, tax accountants, and revenue officials most familiar with a state s internal hearing system are often reluctant to admit that the state needs an independent tax tribunal or court. Like most people, we love what we know and we hate to see it change. In this instance, however, all of us need to focus on the reality that 13

14 public confidence in the fairness of our tax collection system cannot be achieved without an independent tax tribunal or tax court. In states where independent, pre-payment tribunals do not yet exist, or do not work properly, individuals and local organizations are working to establish such a forum. We applaud these efforts. With persistence and luck, state tax dispute resolution systems throughout the country will soon be covered with the Model Act s special brand of cheese. 14