Tax Strategy Problem – Home Products Universal
Your client, Home Products Universal (HPU), distributes home improvement products to independent retailers throughout the country. Its management wants to explore the possibility of opening its own home improvement centers. Accordingly, it commissions a consulting firm to conduct a feasibility study, which ultimately persuades HPU to expand into retail sales. The consulting firm bills HPU $150,000, which HPU deducts on its current year tax return. The IRS disputes the deduction, contending that, because the cost relates to entering a new business, it should be capitalized. HPU’s management, on the other hand, firmly believes that, because the cost relates to expanding HPU’s existing business, it should be deducted. In contemplating legal action against the IRS, HPU’s management considers the state of judicial precedent: The federal court for HPU’s district has ruled that the cost of expanding from distribution into retail sales should be capitalized. The appellate court for HPU’s circuit has stated in dictum that, although in some circumstances switching from product distribution to product sales entails entering a new trade or business, improving customer access to one’s existing products generally does not. The Federal Circuit Court has ruled that wholesale distribution and retail sales, even of the same product, constitute distinct businesses. In a case involving a taxpayer from another circuit, the Tax Court has ruled that such costs invariably should be capitalized. HPU’s Chief Financial Officer approaches you with the question, “In which judicial forum should HPU file a lawsuit against the IRS: (1) U.S. district court, (2) the Tax Court, or (3) the U.S. Court of Federal Claims?” What do you tell her?
Home Products Universal (HPU) is a distributor of home improvement products to retailers nationwide. The management of HPU wants to explore the possibility of opening its own retail centers. HPU hired a consulting firm to study the feasibility of expanding into retail sales. The consulting firm billed HPU $150,000 for services rendered. HPU deducted the charge on its current year tax return. The IRS disputed the deduction saying that since the cost is related to entering into a new business, the cost should be capitalized. HPU’s management contends that since the cost is related to HPU expanding its existing business, the cost should be deducted. The management HPU has considered legal action against the IRS. The Federal Court in HPU’s district has ruled that if a company expands from distribution into retail sales that the cost of the expansion should be capitalized. The Appellate Court ruled that in certain circumstances switching from product distribution to product sales is considered entering into a new trade. In a separate case involving a taxpayer from another circuit, the Tax Court ruled that the cost of expansion should be capitalized. In considering legal action against the IRS, HPU’s Chief Financial Officer has raised the question of which judicial forum the lawsuit should be filed: the U.S. District Court, the Tax Court, or the U.S. Court of Federal Claims.
The appropriate forum for filing the lawsuit against the IRS would be the U.S. Tax Court. The U.S. Tax Court, established in 1942, has national jurisdiction and hears only tax-related cases. In considering its lawsuit against the IRS, HPU would not want to file its lawsuit in U.S. District Court due to that fact that the company distributes products to companies nationwide. Each state has at least one U.S. District Court and the courts are independent of one another. Due to this fact, the decision made by the U.S. District Court in one state may not apply in another state. Since HPU distributes products nationwide and wants to expand nationwide, the company would want the case to be heard in a court that has national jurisdiction.
The U.S. Tax Court specializes in handling tax disputes that occur before the Internal Revenue Service has made an assessment of a formal tax. HPU can decide to file their lawsuit in another court forum. However, the U.S. Tax Court is the only forum where HPU can have its case heard without having to pay the amount in dispute. If the case was tried in the United States Court of Federal Claims or a U.S. District court, the tax would have to be paid before the lawsuit could be filed. The Legislative Branch of the United States government makes the U.S. Tax Court unique and singular. By having the case tried in the U.S. Tax Court, the management of Home Products Universal can have the company’s CPA’s represent them in court even though the CPA’s have no legal training.
U.S. Tax Court is a court of national jurisdiction and its rulings are uniform for everyone regardless of their place of business or residence. The Tax Court is not bound by the decisions of the U.S. District Court or the U.S. Court of Federal Claims even if the U.S. District Court has jurisdiction over the taxpayer. Cases in the U.S. Tax Court are decided by judges, who are experts in the field of tax law, without jury trials. Judges in the Tax Court are appointed by the President and serve terms of 15 years. The U.S. Tax Court is more relaxed in comparison to other formal courts which helps facilitate dispute settlement more cooperatively.