Claim Preclusion and Issue Preclusion

Claim preclusion and issue preclusion promote judicial economy by prohibiting the relitigation of claims and issues. They also protect litigants from the burden of relitigating the same issues of fact or law. Both claim preclusion and issue preclusion may be invoked defensively by a defendant or offensively by a plaintiff.

Res judicata, also known as claim preclusion, prohibits lawsuits involving the same cause of action and the same parties if the court has entered a final judgment on the merits. With respect to federal income taxes, “each year is the origin of a new liability and of a separate cause of action.” Commissioner v. Sunnen, 333 U.S. 591, 598 (1948). Therefore, a final judgment on the merits regarding a liability in one tax year can only prohibit relitigation of a subsequent claim regarding the liability in that same tax year. Its application is much narrower than collateral estoppel.

Collateral estoppel, also known as issue preclusion, prohibits the same issue of fact or law to be litigated again. To be estopped, the issue of fact or law must have been necessary to the decision in the first case. That is, the party against whom it is asserted must have had a full and fair opportunity to litigate the issue in the prior case. The Supreme Court of the U.S. in Montana v. United States, 440 U.S. 147 (1979) defined the following three-prong test for applying collateral estoppel:

1. Whether the issues presented in the subsequent case are substantially the same as those involved in the first case;
2. Whether controlling facts or legal principles have significantly changed since the first case; and
3. Whether other special circumstances warrant an exception to the normal rules of preclusion.

While res judicata precludes the relitigation of claims involving the same parties, collateral estoppel applies to an issue that has been litigated even if the parties in the subsequent suit are completely unrelated to those of the first. Because collateral estoppel does not require the same parties from the prior case to be in the subsequent case, the IRS searches the court dockets for defendants who have been found liable for misappropriation of funds, like the taxpayer in Meier v. Commissioner, 91 T.C. 273 (1988). This U.S. Tax Court case involved a taxpayer who had been sued in Federal District Court by his former employer for diverting company funds for his own benefit. The Federal District Court had held that the taxpayer inappropriately diverted company funds. In the subsequent suit, the IRS sought to offensively use collateral estoppel so that the taxpayer could not deny the diversion of funds, which the IRS argued was unreported income resulting in a deficiency. In order to contest the deficiency, the taxpayer had to show that he did not receive the additional funds. The Tax Court held that the taxpayer was collaterally estopped from denying the diversion of funds because the taxpayer had used all legal and procedural means to defend himself regarding this issue in the prior action.

For taxpayers who have been criminally convicted by the IRS, their convictions do not necessarily collaterally estop them from defending themselves against the assessment of civil tax penalties stemming from the same actions. So long as the elements of the criminal offense and civil offense are not identical, taxpayers may contest the civil tax penalties in a subsequent case. For example, if a taxpayer is convicted of the willful failure to file a return pursuant to 26 U.S.C. Section 7203, the taxpayer may still contest the civil fraud penalty under 26 U.S.C. Section 6663(b), because the elements of each are not identical. If there is an acquittal on the criminal charge, however, it will not exonerate the taxpayer from the civil penalties.

Due to the binding effect a final decision may have, you may want to consider retaining an experienced tax attorney like Pedram Ben-Cohen. Pedram is not only a tax attorney, but also a CPA and a Board Certified Taxation Law Specialist. The tax attorneys at the Ben-Cohen Law Firm are experienced in tax disputes with the IRS, FTB, EDD, and other government tax agencies. Contact us at (310) 272-7600 or complete our online form to set up an appointment.