Quick overview
Litigation and settlement are two paths for resolving disputes with the Internal Revenue Service (IRS). Litigation means filing a petition in the U.S. Tax Court and pursuing a formal judicial decision. Settlement means resolving the dispute outside trial—through negotiation, the IRS Office of Appeals, an Offer in Compromise (OIC), penalty abatement, or other administrative remedies. Each option carries tradeoffs in cost, time, risk, and control.
Authoritative sources: U.S. Tax Court (petition deadlines and procedures) and the IRS Offer in Compromise program are primary resources. See U.S. Tax Court, “Filing a Petition,” and IRS, “Offer in Compromise.” (U.S. Tax Court: https://www.ustaxcourt.gov/; IRS: https://www.irs.gov/individuals/offer-in-compromise). For systemic taxpayer help, refer to the National Taxpayer Advocate at https://taxpayeradvocate.irs.gov/.
How the choice usually begins
Most disputes start with a notice from the IRS (a notice of deficiency or similar notice). You generally have 90 days from the date of a notice of deficiency (150 days if served outside the U.S.) to file a petition in Tax Court instead of paying the tax and suing for a refund in district court or the U.S. Court of Federal Claims (U.S. Tax Court). See U.S. Tax Court guidance for current filing rules (https://www.ustaxcourt.gov/).
Practical point from practice: early triage matters. I routinely ask clients for a quick inventory of documents, the IRS’s legal theory, and estimated costs to litigate before recommending litigation. Many disputes resolve more cheaply in Appeals or by administrative settlement when evidence and documentation can be presented early.
Key factors to weigh when deciding
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Dollar amount at stake vs. litigation cost. If the disputed tax, penalties, and interest are small compared with attorneys’ and expert fees, settlement or administrative remedies typically make more sense.
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Strength of evidence. Clear contemporaneous records (receipts, contracts, bank statements) increase the chances of prevailing at trial and improve leverage in settlement talks.
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Precedent and legal principles. If the case raises an important legal question you want resolved for yourself or others (for example, new or unsettled tax law), litigation may be appropriate even when the immediate monetary benefit is modest.
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Risk tolerance. Litigation carries uncertainty. Consider the probability of an adverse decision and whether you can absorb the potential liability.
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Timing needs. Litigation may take a year or more; settlements or administrative alternatives can be much quicker.
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Collection exposure. If the IRS has already assessed or threatened lien/levy action, an immediate settlement or collection alternative (installment agreement, OIC, lien subordination) may be necessary to stop collection actions.
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Potential collateral consequences. A court loss can affect other tax years, while settlement terms may include nondisclosure or limited precedent effect.
Common settlement options (administrative routes)
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IRS Office of Appeals. An independent appeals officer can often negotiate a compromise without trial. Appeals focuses on hazards-of-litigation analysis (the relative strengths and weaknesses of each party’s position).
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Offer in Compromise (OIC). An OIC allows taxpayers to settle for less than the full amount when paying full tax would cause doubt as to collectibility or would create financial hardship. The IRS’s OIC program has strict documentation rules (https://www.irs.gov/individuals/offer-in-compromise).
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Penalty abatement and compromise. For many taxpayers, negotiated reduction or abatement of penalties is the fastest way to reduce exposure. See internal guidance on penalty negotiation strategies and our glossary entry on Penalty Reduction on Settlement.
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Installment agreements and lien negotiations. Where cash flow is the main issue, a structured payment plan is often preferable to litigation.
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Tax settlement services and professional negotiation. Engaging experienced counsel or firms that specialize in tax settlement can improve outcomes; see our resource page for Tax Settlement Services.
Litigation basics in Tax Court
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Deadline to file: Typically 90 days after the notice of deficiency (150 days if outside the U.S.). Confirm current deadlines on the U.S. Tax Court site (https://www.ustaxcourt.gov/).
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Burden of proof: Generally the taxpayer must prove their position. The burden can shift to the IRS under Internal Revenue Code section 7491 if the taxpayer meets certain substantiation and cooperation requirements, and the IRS has not met its burden. Use a tax professional to evaluate whether 7491 may apply to your facts.
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Pretrial process: Discovery is more limited than in district courts, but parties exchange motions and pretrial memoranda. Many cases settle during pretrial conferences or settlement sessions.
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Trial and decision: Trials are usually bench trials before a Tax Court judge (no jury). Decisions may be published (precedential) or non‑precedential. A published favorable decision can help other taxpayers with similar issues.
When litigation is often the better choice
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Precedent matters. You need a ruling that affects other years or taxpayers.
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Strong documentary evidence plus a favorable legal theory gives a high probability of winning.
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The IRS offers no reasonable settlement and the financial math favors trial even after fees.
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You need a final judicial determination to lift an ongoing enforcement action or to create binding precedent for related transactions.
Example from practice: a client had a novel deduction question that affected later-year tax planning. We chose litigation to clarify the tax law—the case settled in our favor and guided the client’s ongoing compliance strategy.
When settlement is often the better choice
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The cost or delay of litigation would exceed the likely recovery.
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The IRS’s position is supported by reasonable legal interpretations and the risk of loss is material.
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You need a quick resolution to stop enforcement actions (levies, liens) or to free up capital for business operations.
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You prefer a negotiated, confidential resolution that avoids a public court record.
Example from practice: We reduced a small-business owner’s exposure by negotiating penalties down and arranging an installment agreement rather than pursuing an uncertain and costly trial.
Practical negotiation and litigation preparation checklist
- Collect contemporaneous records — receipts, contracts, bank records, and any communications with the IRS.
- Create a litigation budget: attorney fees, expert fees (appraisers/accountants), and estimated time to resolution.
- Get an early legal analysis memo: strengths, weaknesses, and settlement range.
- Open a file for Appeals: many disputes settle before trial if presented to Appeals with a clear hazards‑of‑litigation argument.
- If litigating, preserve evidence and prepare witness statements; if settling, gather supporting documentation for mitigations (financial statements for OIC, proof of reasonable cause for penalty abatement).
- Verify statute-of-limitations and filing deadlines (90/150-day rule for Tax Court petitions).
Common mistakes to avoid
- Waiting to get professional help. Early advice preserves options (including eligibility for certain burden-of-proof shifts).
- Poor recordkeeping—lack of contemporaneous evidence undermines both negotiations and litigation.
- Misjudging the non-monetary costs, such as time and reputational exposure.
- Overlooking administrative routes (Appeals, OIC) before filing a petition.
If an Offer in Compromise was denied or needs reconsideration, consult our guide on How to Reconsider a Denied Offer in Compromise: Next Steps and Documentation.
Decision framework (quick model)
- Estimate expected benefit (probability of success × dollars at issue).
- Subtract expected litigation costs and time value of money.
- Compare with settlement offers and administrative solutions.
- Factor in non-financial objectives (precedent, confidentiality, speed).
- Choose the path that minimizes expected net cost and aligns with your broader financial goals.
Final notes and resources
This guide is educational and does not replace individualized legal advice. For complex disputes, consult a tax attorney or a qualified CPA early in the process. The U.S. Tax Court site provides procedural rules and filing instructions: https://www.ustaxcourt.gov/. For administrative settlement programs and OIC rules, see the IRS Offer in Compromise guidance: https://www.irs.gov/individuals/offer-in-compromise. For additional support and taxpayer protections, the Taxpayer Advocate Service provides independent assistance: https://taxpayeradvocate.irs.gov/.
Internal resources for FinHelp readers: see our glossary entries on Penalty Reduction on Settlement, Tax Settlement Services, and How to Reconsider a Denied Offer in Compromise: Next Steps and Documentation.
Professional disclaimer: This content is informational and educational, not legal advice. Tax outcomes depend on facts and law that change; consult a qualified tax professional for guidance tailored to your situation.
