Tax Decision Making under the New Burden of Proof Rules

Abstract

In the late 1990s, controversy over alleged Internal Revenue Service abuses and concern about the extent of the agency's power over taxpayers led to the passage of new rules governing relations between the IRS and taxpayers. An important element of this new set of rules was I.R.C. § 7491, which purported to shift the burden of proof in civil tax cases from the taxpayer to the IRS. Commentators generally agreed that the shift would have little effect on the outcome of cases, but the popular press touted the new provision as an important step to level the playing field between the parties. We conduct an experiment in which we manipulate the applicability of I.R.C. § 7491 and measure role in the tax system (taxpayer versus tax professional). As predicted, we find that taxpayers assess a higher likelihood of success in litigation when the anticipated burden of proof rests with the IRS than when the anticipated burden of proof rests with the taxpayer. Taxpayers who believe that the IRS bears the burden of proof also assess a higher likelihood of success than do tax professionals, regardless of the applicability of I.R.C. § 7491. This increased perceived likelihood of success in litigation translates to an increased willingness on the part of taxpayers to engage in an unsound tax-motivated transaction.